Table of Contents Chairman s Letter to Unitholders 2005 President and Chief Executive Officer s Letter to Unitholders

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1 2005 Annual Report

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3 Table of Contents Chairman s Letter to Unitholders President and Chief Executive Officer s Letter to Unitholders 3 Management Discussion and Analysis 4 Consolidated Financial Statements 21 Notes to Consolidated Financial Statements 27 Corporate Information 53

4 CanWel Building Materials Income Fund 2005 Annual Report Chairman s Letter to Unitholders was a very exciting year for your fund, a year in which we have seen significant change occur. The year began with the closing of the acquisition of the Sodisco- Howden Group, an event that essentially doubled the size of the fund. In May, we paid a special dividend to our common shareholders, converted from a public corporation into an income trust structure and completed an issue of trust units. This allowed us to pay down debt and provide our unit holders with a monthly distribution stream. The changes manifested by the acquisition and our capital markets activity have been felt throughout our organization. I would like to personally thank the employees from across all of our business units for their contributions in CanWel Building Materials Income Fund s growth into a leader in building materials and hardware distribution in Canada is a direct result of our employees dedication and commitment to providing our customers and vendors with value in everything we do also proved to be a very busy and challenging year from an operations perspective. While the market for new home, construction and renovation activity remained firm in Canada, your fund experienced challenges in wood-based commodity product markets. In addition, we faced software implementation issues at CanWel Hardware Division. We redoubled our efforts during these events and our persistence resulted in record revenues for your fund. We will continue to diligently work towards the very high expectations and goals that we have set for our business. In August of 2005 I was pleased to announce the addition of two independent members to CanWel s board, both of whom are strong voices and bring complementary skills to the Board. The Board of your fund now consists of eight members, five of whom are independent trustees. The Board of Trustees of CanWel is committed to excellence in governance, integrity, accountability and value maximization. On behalf of the entire Board of Trustees, I want to thank our unit holders for their confidence and support in As we move through 2006, we remain confident in the outlook for our business and for building increased value for unit holders in both the short and long run. Amar S. Doman Chairman of the Board

5 2005 Annual Report CanWel Building Materials Income Fund President and Chief Executive Officer s Letter to Unitholders CanWel is focused on being the leading distributor of hardware, building materials and home improvement products in Canada. Our customers in the retail and industrial markets are our prime focus each and every day as we build CanWel into the leading distributor within our industry. Results for 2005 once again produced record sales numbers. For the year ended December 31, 2005 sales increased to $1 billion, an increase of 67% over the $598 million for Income before tax was $13.1 million compared to $16.4 million for the previous year. However, EBITDA increased to $26.5 million in 2005 from $22.3 million in These results however, were not in alignment with management s expectations for growth in Over the course of 2005, CanWel was not without its challenges. In particular, a notable decrease in the average price of wood-based commodity products along with computer system problems placed considerable pressure on our businesses as well as our employees. Our people responded to the challenges with diligence and solid performance, and we have emerged from the events of 2005 as a stronger company. As a distribution company, CanWel s value-added proposition for our customers and vendors is always built around our people. I feel confident and proud of our CanWel team from coast to coast. The new home and renovation market continued to be strong throughout CMHC reported that Canadian housing starts in 2005 were 223,900 compared to 233,431 in Employment and interest rate environments continued to positively impact consumer confidence for the year, thus producing a vibrant market for the products we distribute. CanWel also welcomed a new Chief Financial Officer, Martin Hope, to our team in Mr. Hope and his knowledge and passion for excellence have strengthened our ability to expand and grow our business over the long run. Additional highlights of this dynamic year include the announcement of our strategic alliance with TruServ Canada to build the Pro and Ace banners and the subsequent rebranding of Sodisco-Howden s hardware operations to CanWel Hardware. Our primary focus continues to be on distribution and recent agreements with EMCO Building Products and Unilin Flooring demonstrate our commitment to ensure the CanWel brand is synonymous with excellence in distribution of hardware and building materials within Canada. CanWel continues to emphasize its commitment to be a value-based organization. Our commitment to being customer-based and supplier centric is consistently driven throughout our organization. Our values of teamwork, accountability and responsibility continue to be ingrained within our organization. Tom Donaldson President and Chief Executive Officer 5

6 CanWel Building Materials Income Fund Management Discussion and Analysis Management Discussion and Analysis March 22, 2006 This Management Discussion and Analysis provides a review of the significant developments that have impacted the Fund in the quarter and year ended December 31, 2005 relative to This discussion of the financial condition and results of operations of the Fund should be read in conjunction with the audited consolidated financial statements and notes thereto for the years ended December 31, 2005 and December 31, Certain statements made in the Management Discussion and Analysis which are not historical facts are forwardlooking statements or assumed future results of the operations of the Fund. These statements are subject to risks which were described in our Prospectus dated May 9, 2005 and our public filings on and would include, but are not limited to, dependence on market economic conditions, sales and margin risk, competition, information system risks, availability of supply of products, volatility of commodity prices, inventory risks, customer and vendor risks, acquisition integration risks, credit and interest rate risks. In addition, there are numerous risks associated with an investment in units, which are also further described in our Prospectus dated May 9, 2005 and our public filings on These risks and uncertainties may cause actual results to differ materially from those contained in the statements. Such statements reflect management s current views and are based on certain assumptions. They are, by necessity, only estimates of future developments and actual developments may differ materially from these statements due to a number of factors. Investors are cautioned not to place undue reliance on these forward-looking statements. No forward-looking statement is a guarantee of future results. 1. In the discussion, reference is made to EBITDA, which represents earnings before interest, provision for income taxes, gain or loss on sale of fixed assets, depreciation and amortization and stock based compensation. This is a non-gaap measure and, as there is no generally accepted method of calculating EBITDA, the measure as calculated by the Fund might not be comparable to similarly titled measures reported by other companies. EBITDA is presented as we believe it is a useful indicator of a company s ability to meet debt service and capital expenditure requirements and because we interpret trends in EBITDA as an indicator of relative operating performance. Reference is also made to EBT, which represents Earnings before tax which management uses for reasons similar to EBITDA. Neither EBITDA nor EBT should be considered by an investor as an alternative to net income or cash flows as determined in accordance with Canadian GAAP. 2. Reference is also made to Distributable Cash of the Fund. This is a non-gaap measure generally used by Canadian open ended income funds as an indicator of financial performance. Management believes that this measure provides investors with an indication of the cash available for distribution to unitholders. We define distributable cash as net earnings before depreciation, amortization, gain or loss on sale of fixed assets, provision for future income taxes, stock-based compensation and after maintenance of business capital expenditure and contributions to any reserves the Board of Trustees deem to be reasonable and necessary for the operations of the Fund. Business Overview CanWel Building Materials Ltd. ( CanWel ) is a Canadian national wholesale distributor of hardware, building materials and home renovation products. Operating from 17 distribution centers strategically located across Canada, CanWel services the new home construction, home renovation and industrial markets by supplying the retail lumber and building materials industry, hardware stores, industrial and furniture manufacturers and similar concerns across Canada. Pursuant to a plan of arrangement (the Arrangement ), which became effective May 18, 2005, CanWel Building Materials Income Fund (the Fund ) acquired 100% of the shares of CanWel in exchange for units of the Fund and exchangeable partnership units in a majority owned partnership of the Fund (the Conversion ). The common shares of CanWel had previously traded on the Toronto Stock Exchange ( TSX ). On May 18, 2005, units of the Fund commenced trading on the TSX in place of common shares of CanWel. Additionally, pursuant to the Arrangement, the Fund issued 8,620,873 Fund units in an initial public offering at a price of $8.70 per unit for gross proceeds of $75,002,000. Concurrent with the initial public offering, a significant holder of Fund units undertook a secondary offering of 5,747,127 Fund units.

7 Management Discussion and Analysis CanWel Building Materials Income Fund The Board of Directors of CanWel announced aggregate dividends of $1.25 per share to shareholders of record on May 17, 2005, which dividends were paid on May 20, In connection with the offering, CanWel agreed to appoint an additional independent trustee to its Board. On August 31, 2005 the Fund appointed two additional independent trustees, Peter Dhillon and Todd Grenich. In the period from the date of Conversion to December 31, 2005 the Fund declared distributions to unitholders totalling of $ per unit. The exchange of the common shares of CanWel to the Fund was recorded at the carrying values of CanWel s assets and liabilities on May 18, 2005 in accordance with the continuity of interest method of accounting as the Fund is considered to be a continuation of CanWel. Further detailed information regarding the Arrangement and the Fund is contained in CanWel s management information circular dated April 8, 2005 for the annual and special meeting of shareholders of CanWel held on May 9, Based on the requirements of Multilateral Instrument , Certification of Disclosure in Issuers Annual Financial and Interim Filings, management of CanWel, under the supervision of the Chief Executive Officer and Chief Financial Officer of CanWel, evaluated the effectiveness of the Fund s disclosure controls and procedures (as defined in Multilateral Instrument ). Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that the Fund s disclosure controls and procedures were effective as of December 31, 2005 to provide reasonable assurance that material information relating to CanWel would be made known to them by others within CanWel. Restated Balance Sheet at December 31, 2004 The acquisition of 85.2 % of the outstanding common shares of Sodisco-Howden Group Inc. ( Sodisco- Howden ) as at December 31, 2004 was recorded using the purchase method of accounting whereby the purchase price paid was allocated to the estimated fair value of the assets acquired and liabilities assumed. The preliminary allocation was determined by the Fund s management based on information furnished by the management of Sodisco-Howden and independent valuations of intangible assets and property, plant and equipment conducted at the time of the acquisition. In reviewing the values assigned to assets and liabilities, management determined that certain adjustments are required to the preliminary purchase equation with respect to future income taxes and to the accounting for cash discounts from suppliers and to customers, and the determination of inventories to align the accounting policies of Sodisco-Howden with those of the Fund. The Consolidated Balance Sheet of the Fund as at December 31, 2004 has been restated, on a retroactive basis, to reflect the above described adjustments to the allocation of the purchase price of the Sodisco-Howden acquisition in December A summary of the restatement is as follows: As originally As restated reported $ $ Consolidated balance sheet Accounts receivable trade 85,949 86,148 Inventories 113, ,919 Future income taxes (current) 2,099 1,336 Future income taxes (long-term) 3,530 1,454 Goodwill 597 1,103 Accounts payable and accrued liabilities 78,747 79,173

8 CanWel Building Materials Income Fund Management Discussion and Analysis Distributions to Unitholders The distribution policy of the Fund is to make distributions of its available cash to the maximum extent possible to unitholders. Distributable cash is defined as the Fund s net earnings before depreciation, amortization, gain or loss on sale of fixed assets, provision for future income taxes and after maintenance of business capital expenditure and contributions to any reserves the Board of Trustees deem to be reasonable and necessary for the operations of the Fund. In addition, in making decisions relating to distributions, the Fund believes that the underlying trends in revenues and earnings before interest, taxes, depreciation, amortization and other expenses ( EBITDA ) should be considered sustainable before distribution levels are either increased or decreased. Results of Operations Selected Annual Information Fiscal Year Ended December 31, Sales ($ millions) $1,000 $598 (1) $531 (1) Net Earnings ($ millions) $9.4 $10.5 $7.4 Net Earnings per Unit/Share (Basic and Fully Diluted) (dollars) $0.31 $0.52 $0.58 Total Assets ($ millions) $283.7 $267.8 $114.0 Long Term Debt ($ millions) $87.9 $89.7 $15.8 Cash Dividends declared ($ millions) $15.3 $17.3 Distribution declared to unitholders ($ millions) $20.3 Number of units/shares outstanding (2) 30,091,824 20,198,392 12,832, Impact of Accounting Policy Changes on Sales. The Company contemplated revised Section 1100, General Accepted Accounting Principles together with Section 3400, Revenue, of the CICA Handbook and determined it was necessary to revise the presentation of incentives provided to customers. The incentives are now recorded as a deduction from revenue rather than an element of cost of sales. The accounting change was applied retroactively. This change reduced sales by $10.9 million in 2004 and $11.0 million in There was no effect on gross margin. 2. The number of units outstanding at December 31, 2005 and 2004 is the weighted average number of units (or adjusted common shares) outstanding for the period and includes securities exchangeable into units for no further consideration. The number of shares outstanding at December 31, 2003 reflects the consolidation of the Company s shares on May 3, The per unit/share and number of units/shares have been retroactively restated to reflect the 1:2 conversion of shares into units effective May 18, Comparison of the Year Ended December 31, 2005 and December 31, 2004 Sales and Gross Margin Sales in 2005 increased to $1 billion versus $598 million in 2004, an increase of $402 million or 67%. The inclusion of the revenues generated by Sodisco- Howden contributed a very large part of this increase (Sodisco-Howden was acquired on December 31, 2004 and accordingly, its sales were not included in those of CanWel in 2004). CanWel continued to show strength in the lumber and panel products market while reducing our overall exposure to this market to 41% of total

9 Management Discussion and Analysis CanWel Building Materials Income Fund revenues, down from 63% in Total sales of lumber and panel products increased for the year to $408 million versus $376 million in Reasonable market conditions coupled with an increased share of certain target accounts provided the foundation for this increase. This increase was also accomplished despite the average price for lumber decreasing approximately 13% and the average price of panel products decreasing approximately 25%, for 2005 versus Notwithstanding the volume increases, the reduced contribution margin per transaction provided a decrease in gross margin per transaction in 2005, as the average price of lumber and panel products, as noted above, were down substantially versus Specialty and hardware product sales increased to $592 million versus $222 million on 2004, an increase of $370 million, or 167%. Specialty and hardware products now represent 59% of the Fund s revenue, up dramatically from 37% in Sales of siding, paint and hardware products were particularly strong and these sales more than offset lower insulation revenue due to a continuing supply shortage in that product line. Flooring sales continued to grow in the current fiscal period. Additionally, early in 2006, CanWel announced a new distribution deal with Unilin to distribute the Hercules Laminate Flooring line in Canada with a view to further increase sales in this area in Gross margin dollars increased by 71% to $102.1 million in 2005, or 10.2% of sales, compared to $59.6 million, or 10% of sales, in Lumber and panel product margins were challenged during the year due to the erosion in market prices as previously noted, however the increased sales of specialty and hardware products more than offset this. Integration Update The integration of Sodisco-Howden was completed during 2005 despite some enterprise resource planning ( ERP ) software implementation issues encountered in the third quarter. The structure of Sodisco-Howden has been changed so that leadership and accountabilities are clearly defined within the operations. Execution of the restructuring plan has created a platform for significant productivity growth as in excess of $5 million in annual costs have now been eliminated. In early November we also announced two other components of the restructuring plan. We announced a strategic alliance with Tru Serv Canada Cooperative Inc. ( Tru Serv ) in regard to the Pro and Ace retail brands in Canada. Under the terms of this strategic alliance, the Pro and Ace brands are now part of a national network of independent building supply and hardware retailers that are 1,400 plus locations strong. Tru Serv will provide the Pro and Ace banners with a significant value added package that includes strong branding, marketing and category management services. Also in November, we announced that Sodisco-Howden s hardware operations were rebranded as CanWel Hardware. Under the CanWel Hardware brand, we have clearly stated that CanWel Hardware will focus on distribution competencies and that the name CanWel will stand for excellence in distribution in both hardware and lumber and building materials. Expenses and Operating Earnings Expenses for the year ended December 31, 2005 were $84.0 million, an increase of $43.9 million or 109% over the expenses for the same period last year. Distribution, selling and administrative expense increased from $37.2 million in 2004 to $73.6 million in 2005, an increase of $36.4 million due to the inclusion of the Sodisco-Howden expenses this year. Stock-based compensation cost increased to $1.4 million from $0.9 million in 2004 as a full year s expense was incurred as compared to last year s expense which only commenced

10 CanWel Building Materials Income Fund Management Discussion and Analysis May 13, The acquisition of the assets of Sodisco-Howden caused total depreciation and amortization expense, (being depreciation related to the Sodisco-Howden acquisition and amortization of the value placed on the Sodisco-Howden customer relationships) to total $7.0 million versus $2.0 million recorded for One time costs related to the income trust reorganization ($1,412,000) and Sodisco-Howden integration costs ($584,000) were expensed this year and there were no similar costs last year. The lower than expected gross margins on lumber and panel products and increased one time expenses combined to reduce operating earnings to $18.1 million from $19.5 million in 2004, a decrease of $1.4 million or 7.2%. Interest Expense Interest expense increased in 2005 to $5.0 million from $3.1 million in 2004, an increase of $1.9 million. This year, borrowing increased as a result of the Sodisco-Howden acquisition and to finance higher levels of inventory and accounts receivable. Interest rates in 2005 also increased compared to those in 2004 impacting interest expense. The increased borrowing was reduced in 2005 by net cash proceeds from the initial public offering of Fund units, and from the proceeds of the issuance of Fund units through the exercise of Fund options by such holders. Income Taxes The Fund s corporate organization structure changed on May 18, 2005 to a trust over a corporation structure, whereby most entities below the trust are taxable. Taxable income earned below the trust is offset with loss carry forwards and tax depreciation. Interest and dividend income earned by the trusts is flowed to and taxable to the Fund unitholders. Net Earnings For the year ended December 31, 2005, the provision for income taxes was $3.7 million compared to $5.9 million in The main component of the tax charge in 2005 is a valuation allowance for non capital losses of $4.4 million. The combined statutory tax rate for 2005 and 2004 was 35.9% and 34.8% respectively. However, the Fund s effective combined tax rates differ from this rate due to lower taxable income for the Fund s wholly owned subsidiary CanWel due to interest expense on subordinated debt created as part of the Arrangement. Interest revenue received by the Fund from the subsidiary is not tax affected, as the Fund is only taxable on taxable income not allocated to unitholders. As all taxable income is allocated to unitholders, no provision for income taxes has been recorded for the Fund. As a result of the foregoing, including the valuation allowance for non capital losses of $4.4 million and the expensing of non-recurring costs of $2.0 million for Sodisco-Howden integration and trust conversion costs, net earnings for 2005 decreased to $9.4 million from $10.5 million in EBITDA for the year ended December 31, 2005 increased from that for The non-recurring costs also impacted this financial measure. EBITDA increased to $26.5 million compared to $22.3 million in Without one time costs, normalized EBITDA would have been $28.5 million for the year. 10

11 Management Discussion and Analysis CanWel Building Materials Income Fund Reconciliation of Net Income to Earnings before Interest, Tax, Depreciation and Amortization (EBITDA): Year ended December 31 ($ thousands) Net earnings $9,359 $10,491 Provision for income taxes 3,748 5,910 Interest expense 4,994 3,076 Amortization of intangible and other assets 1, Depreciation 5,060 1,965 Amortization of deferred gain (73) (65) (Gain)/loss on disposal of fixed assets 143 (3) Stock-based compensation 1, EBITDA $26,543 $22,290 Fourth Quarter Results Sales in the fourth quarter increased to $206 million from $128 million in the same period last year, an increase of 61%. The inclusion of the Sodisco- Howden sales contributed a substantial part of this increase. Gross margin dollars increased by 120% to $25.3 million in the quarter, 12.3% of sales, compared to $11.5 million, or 9% of sales in the same period last year. Margins improved across all of our product categories. EBITDA for the quarter was $5.8 million compared to $3.2 million last year, an increase of 81%. However, earnings before tax in the quarter only increased by 21% to $2.3 million compared to $1.9 million last year, due to an increase of $1.6 million over last year in depreciation and amortization costs. The increase is due to the increase in the depreciable assets acquired on the acquisition of Sodisco-Howden. Net earnings in the fourth quarter of 2005 totalled to $1.7 million compared to $1.5 million in the same period last year. Summary of Quarterly Results For the Quarters ended ($ millions, per Unit/Share in Dollars) Dec 31 Sept 30 June 30 Mar 31 Dec 31 Sept 30 June 30 Mar 31 Sales EBITDA Earnings before tax Net earnings (loss) (0.2) Net earnings (loss) per unit/share (1) (0.02) Basic and fully-diluted. Changes in Q1, 2004 now reflect consolidation of share capital in Q2, 2004 and May The Fund operates in a seasonal industry that generally experiences higher sales in the second and third quarters and reduced sales in the first and fourth quarters. 11

12 CanWel Building Materials Income Fund Management Discussion and Analysis Financial Condition Liquidity and Capital Resources During the year ended December 31, 2005, the Fund generated $6.6 million in cash versus using $9.1 million in The following activities in the respective years were responsible for the change in cash. Operating activities used $2.9 million in cash for 2005, versus $2.4 million in Net earnings decreased by $1.1 million in 2005 compared to 2004, however cash generated by operating activities, before working capital changes, increased to $18.8 million in the year versus $12.6 in This was due to higher deferred taxes caused by the non-cash valuation allowance, higher unit based non-cash compensation expenses and depreciation and amortization charges, partially offset by a higher reduction in pension benefit obligation, in Working capital changes consumed $20.4 million during 2005 compared to $15.0 million in The increase in 2005 was substantially caused by an increase during the year in trade accounts receivable of $11.8 million and a decrease of $7.8 million in accounts payable due to the settlement of some one time payables outstanding at December 31, In addition, during 2005, $1.3 million of cash was applied to restructuring costs associated with the Sodisco-Howden acquisition that had not been accrued at December 31, Concurrent with the conversion to an income trust on May 18, 2005, an initial public offering of 8,620,873 trust units at a price of $8.70 per unit was completed. The gross proceeds of this offering amounted to $75 million. Costs of the issue amounted to $6.4 million ($4.2 million after adjusting for future income taxes). Subsequent to this 535,579 units were issued pursuant to exercise of options and the employee unit ownership plan, for proceeds of $2.3 million. In 2004 $39.8 million of cash was generated by the net proceeds of an initial public offering of common shares of CanWel. Partial proceeds of the 2004 offering were used to repay shareholder loans of $10 million. In December 2004, CanWel borrowed $7.6 million from its principal shareholder on a short term basis to bridge its cash needs to acquire Sodisco-Howden and this was repaid as agreed within seven days in January 2005, free of interest charges. Long term debt and capital lease obligations were reduced by $4.4 million in 2005, whilst in 2004 long term debt increased by $33.5 million due to the Sodisco-Howden acquisition. During 2005, a special dividend of $15.3 million was paid to shareholders, and monthly cash distributions to unitholders and exchangeable partnership unitholders totaling $17.5 million were paid. In 2004 a dividend of $17.3 million was paid. In 2004 CanWel acquired 85.2% of the common shares of Sodisco-Howden for total consideration of $64.0 million, including acquisition costs and bank indebtedness assumed. In 2005 CanWel acquired the remaining portion of these shares, for a net cash consideration of $10.6 million. In 2005 $5.7 million of cash was invested in new capital assets, of which $4.3 million was for the ERP installation project at Sodisco-Howden, as previously planned and disclosed. In 2004 $0.6 million was invested in capital assets and there was cash generated by the sale of land and buildings of $4.9 million. The Fund is well prepared to finance its cash needs as it has arranged committed revolving credit facilities with limits totaling $225 million. These facilities mature in 2007 and are in the nature of a revolving loan and will be sufficient to accommodate the daily operating needs of the Fund. In addition to these loans, the Fund has also arranged a committed credit facility with a limit of $50 million to be used for acquisition purposes. Both these facilities are limited to a defined percentage of the accounts receivable and inventory of the Fund. At December 31, 2005, borrowing against the revolving facility was $83.8 million and the Fund is comfortably operating within the credit limits and security requirements. 12

13 Management Discussion and Analysis CanWel Building Materials Income Fund The Fund s cash flow from operations and credit facilities are expected to be sufficient to meet operating requirements, capital expenditures and anticipated distributions. Certain long-term debt requires monthly installments and these payments are all current. Total Assets Total assets of the Fund were $284 million at December 31, 2005 versus $268 million at December 31, 2004, an increase of $16 million. This increase is substantially due to the increase of $11.8 million in trade accounts receivable and additions to property, plant and equipment of $5.7 million. Total Liabilities Total liabilities were $174 million at December 31, 2005 versus $206 million at December 31, 2004 a decrease of $32 million. This decrease was due to a reduction in accounts payable and bank indebtedness of $14.4 million, the repayment of the shareholder bridge loan of $7.6 million and the removal of the minority interest of $9 million as CanWel acquired the remaining Sodisco-Howden shares. Outstanding Unit/Share Data CanWel has only one class of authorized shares, being its common shares. On December 31, 2004, and May 17, 2005 there were 12,201,350 common shares of CanWel issued and outstanding. Additionally, CanWel had issued 1,050,000 stock options to purchase common shares.the Fund is an unincorporated, open-ended, limited purpose trust, with an authorized capital of an unlimited number of units and special voting units. Pursuant to the Arrangement, on May 18, 2005, 8,184,766 of the issued and outstanding common shares were exchanged for 16,369,532 Fund units. The balance of the 4,016,584 outstanding CanWel common shares, were exchanged for 8,033,168 exchangeable partnership units in a majority owned limited partnership, which units entitle the holder to convert to an equal amount of Fund units for no additional consideration. Also in connection with the Arrangement, the outstanding issued stock options were exchanged for 1,050,000 Fund options which on exercise convert into 2,100,000 units of the Fund. On May 18, 2005 the Fund completed an initial public offering of 8,620,873 units at $8.70 per unit. As at December 31, 2005, there were 25,525,984 units and 8,033,168 special voting units of the Fund issued and outstanding. Related to and in connection with the special voting units, there are 8,033,168 exchangeable partnership units outstanding which are exchangeable into Fund units on a one for one basis, in accordance with their terms, with no additional consideration to the Fund. During the year, 532,252 Fund units were issued pursuant to the exercise of options at $4.195 each. The exercise price and vesting period of the options is discussed in greater detail at note 11 of the December 31, 2005 audited consolidated financial statements. In addition 3,327 Fund Units were issued at $8.27 each, pursuant to the Employee Unit Ownership Plan. Distributable Cash Distributable cash of the Fund is a non-gaap measure generally used by Canadian open-ended income funds as an indicator of financial performance and should not be seen as a measure of liquidity or a substitute for comparable metrics prepared in accordance with GAAP. The Fund s distributable cash may differ from similar calculations as reported by other similar entities and accordingly may not be comparable with distributable cash as reported by such entities. 13

14 CanWel Building Materials Income Fund Management Discussion and Analysis The Fund defines distributable cash as net earnings before depreciation, amortization, stock based compensation, gain or loss on the sale of fixed assets, provision for future income taxes and after maintenance of business capital expenditure and contributions to any reserves the Board of Trustees deem to be reasonable and necessary for the operations of the Fund. The Fund believes distributable cash calculated from cash available for distribution is the most appropriate measure to help readers evaluate the performance of the Fund. CanWel converted to an income trust on May 18, 2005, and an initial public offering of Fund units was undertaken at that time which raised net cash proceeds of $68.6 million. These proceeds were used to repay current and long term debt. In view of the material change in debt structure at the time of conversion and the inherent difficulties associated with measuring financial results at a mid point in a quarter, management did not prepare a calculation of distributable cash for the period May 18, 2005 to June 30, 2005 as, in management s opinion, it would not provide accurate or useful information for such a period. The following is the Fund s calculation of distributable cash for the six months ended December 31, 2005: Distributable cash July 1, 2005 to (in thousands of dollars) December 31, 2005 Net earnings per financial statements $6,957 Income tax expense 477 Interest expense 1,952 Amortization of intangible and other assets 1,177 Amortization of deferred gains (37) Loss on sale of property, plant and equipment 168 Depreciation 2,984 Stock-based compensation 576 EBITDA $14,254 Interest expense (1,952) Maintenance capital expenditure (577) Provision for current taxes payable (530) Distributable cash 11,195 Weighted average of units and special voting units outstanding in the period 33,553,618 Distributable cash per unit cents Distributions declared per unit for the six months cents Payout ratio 147% The total capital expenditures of the Fund in the six month to December 31, 2005 was $2,204,000, included in this amount is $1,627,000 for the continuing implementation of the ERP project that Sodisco-Howden commenced in This project has been excluded from the calculation of maintenance capital expenditure as it is for the completion of a project that had been substantially complete at time of the conversion to a trust. The decrease in pension and other post retirement benefits, shown in cash flow from operations in the Consolidated Statements of Cash Flow, has been excluded from the calculation of distributable cash as this relates to the settlement of a long term obligation of CanWel that was outstanding prior to the conversion to a trust. This obligation will be settled by an increase in the long term borrowings of the Fund. 14

15 Management Discussion and Analysis CanWel Building Materials Income Fund The Fund and its majority owned partnership, CanWel Holding Partnership, make monthly distributions of available cash to unitholders and exchangeable partnership unitholders of record on the last business day of each month payable on or about the 20th day of the month following. The amount of cash distributed per unit is equal to a pro rata share of interest received on the notes and distributions received from CanWel common shares after deducting expenses of the Fund during the month for which the distribution is calculated. During the period from May 18, 2005 to December 31, 2005 the Fund declared total distributions to unitholders of $15,402,000 and its majority owned partnership, CanWel Holding Partnership, declared total distributions to Exchangeable Partnership unitholders of $4,848,000. The December 2005 distribution was accrued and paid to unitholders on January 20, The amounts and record dates of distributions declared were as follows (in thousand of dollars, except per unit amounts): Trust Units Exchangeable Partnership Units Record date Amounts Amounts $ per unit $ per unit June 30, ,890 $ $ July 31, ,085 $ $ August 31, ,085 $ $ September 30, ,086 $ $ October 31, ,085 $ $ November 30, ,086 $ $ December 30, ,085 $ $ ,402 $ ,848 $ The Trustees of the Fund have equalized monthly distributions notwithstanding the impact of seasonal fluctuations in distributable cash. The Trustees consider this seasonality in assessing the levels of available cash at the end of each reporting period. The distributions to unitholders was in excess of distributable cash in the six month period ended December 31, However, the Fund s liquidity and financial resources are sufficient to absorb this shortfall in cash distributed over distributable cash generated. The shortfall was financed by the Fund s revolving credit facility. Future Payments and Contractual Obligations The following table shows, at December 31, 2005, the Fund s contractual obligations within the periods indicated. Payment Made by Year Contractual Obligations Total Thereafter Long Term Debt $88,337 $930 $87,407 $ $ Capital Lease Obligations 1, Operating Leases 29,544 4,683 10,340 5,446 9,075 Total Contractual Obligations $119,163 $6,419 $98,219 $5,450 $9,075 15

16 CanWel Building Materials Income Fund Management Discussion and Analysis Hedging The Fund enters into foreign exchange contracts with financial institutions to hedge the value of foreign currency denominated sales and purchases. These foreign exchange contracts are not designated as hedging instruments. At December 31, 2005, foreign exchange contracts were outstanding to purchase US$1,000,000 ( US$650,000) against future liabilities at an average exchange rate of $1.163, all with maturities of less than one year. The fair value of these foreign exchange contracts as at December 31, 2005 was $(150) ( $11,785). Related Party Transactions The Fund deals on an arms-length basis with parties that are related through common control. Wood pressure treatment services, warehousing and handling costs are purchased from treatment plants owned by a related party. Prices paid are market competitive. In the twelve months ended December 31, 2005, pressure treating services purchased from the related party were $19.8 million, compared to $17.4 million in the same period in 2004, reflecting greater sales activity. Land and buildings are leased from related companies who own distribution facilities used by the Fund to store and process inventory. All lease rates were market tested in advance of the signing of the lease agreements. Leases payments to such related parties were $1.6 million in the year ended December 31, 2005, compared to $1.2 million in the same period in As aforementioned, the sale and leaseback of buildings to a related party resulted in a gain of $881,000 in The net gain has been deferred and is being amortized over the life of the related leases (12 years). During the year ended December 31, 2005, the Fund was charged professional fees of $572,000 ( $175,000) by a company owned by an officer of the Fund. Additionally, fees of $615,787 ( $303,500) were paid for management fees and other services to a related company. Certain employees of the Fund provide accounting and managerial services to the related companies at no charge and certain employees of the related companies provide service to the Fund and no charge is made for these services. During the year ended December 31, 2005, the Fund paid $nil ( $116,000) of operating cost related to a property used by management for offsite business meetings and owned by a trustee of the Fund. As at December 31, 2005, accounts receivable owed by a trustee was $30,000 (December 31, $79,382). As at December 31, 2005, accounts payable and accrued liabilities include amounts due to related companies in relation to the foregoing transactions totaling $3.7 million (December 31, $12.5 million). As at December 31, 2005, inventories included $3.5 million (December 31, $4.4 million) of treatment costs purchased from related companies. The Fund has real estate operating lease commitments with related parties. The minimum payments under the terms of these leases are as follows: $1,830,755 in each of 2006 to 2009, $1,885,000 in 2010 and $9,080,000 thereafter. Additional information is contained in note 14 of the December 31, 2005 audited consolidated financial statements. 16

17 Management Discussion and Analysis CanWel Building Materials Income Fund Contingencies and Commitments Countervailing and Anti-Dumping Duties The U.S. Department of Commerce ( USDOC ) has conducted softwood lumber countervailing and anti dumping investigations against Canadian interests. The USDOC s investigations have resulted in a countervailing duty ( CVD ) and an anti dumping duty ( ADD ) on U.S. imports of Canadian lumber, both to be posted by cash deposits. The Fund incurred CVD and ADD expenses of $566,000 in the year ended December 31, 2005 (2004- $720,000). For the period from May 22, 2002 to December 31, 2005 the total expense incurred amounts to $1,956,000. The Fund and other Canadian forest product companies, the Federal Government and Canadian provincial governments continue to deny the U.S. allegations that sales of Canadian softwood lumber into the U.S. threaten material injury to the U.S. industry. Canadian interests continue to pursue appeals of the final countervailing and anti-dumping determinations with the appropriate courts, NAFTA panels and the WTO and numerous rulings have been made by these bodies. Management believe these rulings should have resulted in the U.S. withdrawal of the CVD and ADD cases and the refund of the cash deposits, with interest. To date, the U.S. has refused to comply with the rulings. Lease Commitments The Fund has operating lease commitments for the rental of most of its distribution centre properties in Canada and for vehicles, warehouse equipment, a computer hosting contract and the leasing of computer network communication lines. Future minimum payments due under the terms of these leases are as follows: Year ending December 31 (in thousands of dollars) $ , , , , ,894 Thereafter 11,627 29,544 Buyback Arrangements Under buyback arrangements, the Fund is committed to financial institutions to purchase the inventories of some of its customers, limited to the lesser of the amount of the advance or the value of these inventories. In the case that the Fund is called upon for these commitments, the inventory would normally be sold in the normal course of operations. At December 31, 2005, amounts for which the Fund could be called upon totaled $5.3 million (December 31, $6.3 million). The agreements expire at various dates in Claims During the normal course of business, certain product liability claims have been brought against the Fund and its suppliers. Management has contested the validity of these claims and believes that they are without merit and that any possible settlement will have no material effect on the financial position or future earnings of the Fund. 17

18 CanWel Building Materials Income Fund Management Discussion and Analysis A former officer of Sodisco-Howden has initiated an action under the Quebec Human Rights Commission in connection with his departure from Sodisco-Howden in 2003, claiming $600,000 in damages. The Fund believes there is no merit to this claim and is vigorously defending the matter, however, it is unable to estimate the outcome of the proceedings. A supplier of freight services to the Fund has made a claim alleging a breach of contract in the amount of $269,000. The Fund believes there is no merit to this claim and is vigourously defending the matter; however, it is unable to estimate the outcome of the proceedings. Guarantees At December 31, 2005, letters of guarantee amounting to $1.2 million (December 31, $1.3 million) were issued in favour of third parties with whom the Fund has business relationships. The letters of guarantee expire at various dates in Pensions In 2004, as a result of a Supreme Court of Canada decision in respect of partially terminated pension plans, additional benefits may be payable from the registered pension plan. The regulator has not yet completed its review of the pension plan; however, management anticipates that the financial impact of the application of the Supreme Court decision will not be material. Letters of Credit The Fund has issued letters of credit amounting to $1.8 million (December 31, $1.7 million) in respect of historical obligations for an unfunded closed pension fund for former executives. The Fund has issued a letter of credit of $1 million as security for an operating line of credit with a financial institution. Additional information is contained in notes 7 and 10 of the December 31, 2005 audited consolidated financial statements. Critical Accounting Estimates The preparation of financial statements in conformity with Canadian generally accepted accounting principles ( GAAP ) requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Financial results as determined by actual events could differ from those estimates. Significant areas requiring estimates are asset valuations, intangible assets, inventory, and the composition of future income taxes, volume rebates and certain actuarial and economic assumptions used in the determination of the cost and accrued benefit obligations of employee future benefits. Management believes the estimates utilized in preparing its financial statements are reasonable and prudent. Actual results may differ from these estimates. 18

19 Management Discussion and Analysis CanWel Building Materials Income Fund Changes in Accounting Policies New accounting policies Exchangeable Securities Issued by Subsidiaries of Income Trusts Effective May 18, 2005, the Fund adopted CICA EIC 151, Exchangeable Securities Issues by Subsidiaries of Income Trusts. As certain exchangeable securities issued by a subsidiary of the Fund have substantially the same rights as Fund units, they have been accounted for in unitholders equity. Risks and Uncertainties The Fund is subject to normal business risks associated with distribution firms operating within the building materials segment in Canada, which are described in greater detail in our Prospectus dated May 9, 2005 and our public filings on which the reader is encouraged to review. Demand for the Fund s products is significantly dependant upon the home renovation and new home construction markets that are cyclical in nature. The renovation and new home construction markets have sensitivity to many market factors including interest rates, employment and income levels. A significant change in any or all of these factors could have a material effect on the firms financial performance. In addition, there are numerous risks associated with an investment in units, which are also further described in our Prospectus dated May 9, 2005 and our public filings on Approximately forty percent of the Fund s revenue comes from commodity type products. The risk associated with commodity type products is two fold: 1) the movement up or down of the average price has a direct impact on the Fund s revenues and margins; and 2) the impact of price volatility on the down side could have a negative impact on inventory valuations, revenues and margins. A material change in the financial health of the Fund s customers or suppliers within the value chain would have a negative impact on the firm s performance. The Fund s ability to effectively manage growth of sales and margins with the firm s customers, source products from the firm s supply base, manage and control internal expenses, and manage credit facilities with its customer base could also negatively impact the firm s performance. Information Systems Risk CanWel is implementing its ERP information management system at Sodisco-Howden. Implementation is ongoing and is expected to be completed in The ERP system will provide information to CanWel management which is expected to be used to improve financial controls, reporting and sales analysis and strategies. There can be no assurance that the ERP or other systems will be implemented on schedule or on budget or that once implemented, it will provide the information and benefits expected by management. CanWel may also experience disruptions in its business and a diversion of management s attention to CanWel s business relating to the implementation of the ERP system. Any of these factors could have a material adverse impact on CanWel s business and results of operations, and accordingly the Fund. 19

20 CanWel Building Materials Income Fund Management Discussion and Analysis Dependence on Market Economic Conditions Demand for the Fund s products depends significantly upon the home improvement, new residential and commercial construction markets. The level of activity in the home improvement and new residential construction markets depends on many factors, including the general demand for housing, interest rates, availability of financing, housing affordability, levels of unemployment, shifting demographic trends, gross domestic product growth, consumer confidence and other general economic conditions. Since such markets are sensitive to cyclical changes in the economy, future downturns in the economy or lack of further improvement in the economy would have a material adverse effect on the Fund. Sales and Margin Risk As a distributor, the Fund s profitability depends on its ability to maintain and grow sales to its customers and to sustain its profit margins. If the Fund s cost of goods increases, for example through increased prices from suppliers for products or increases in commodity prices for products the Fund has already agreed to sell, operating costs increase or if competitors compete more aggressively with the Fund, its sales or margins, or both, would be adversely affected. Some of the Fund s competitors may bundle products that compete with those of the Fund s for promotional purposes or as a long-term pricing strategy or provide guarantees of prices and product implementations. These practices could, over time, limit the prices that the Fund can charge for its products. If the Fund cannot offset price reductions with a corresponding increase in sales or with reduced expenses, then the Fund s margins and operating results would be adversely affected. Competition The Fund faces competition from one or more competitors in all geographic areas where its Distribution Centres are located. The Fund competes with distributors, product manufacturers that engage in direct sales and mass merchandisers. There can be no assurance that the Fund s principal competitors will not be successful in capturing, or that new competitors will not emerge and capture, a share of the Fund s present or potential customer base. In addition, it is possible that some of the Fund s suppliers or customers could become competitors of the Fund if they decide to distribute their own building materials products. Furthermore, if one or more of the Fund s competitors were to merge or partner with another of its competitors, the change in the competitive landscape could adversely affect the Fund s ability to compete effectively. Disruptions in the Fund s business caused by these events could reduce its revenues. Supply of Commodities and Volatility of Commodity Prices The financial performance of the Fund is directly influenced by the cost of certain commodity products, such as plywood, OSB, panel boards and lumber. The prices of such commodity products are subject to significant volatility. There can be no assurance that the Fund s manufacturers or suppliers will continue to have these commodity products available to them at reasonable prices or that significant increases in the costs of such commodities will not materially adversely affect the operations of the company as a consequence of the increased burden on the Fund s suppliers. Inventory Risk Large sales volumes and low gross margins characterize the wholesale forest products and building materials distribution industry. It is highly sensitive to price, quality, timeliness of delivery and continuity of supply. In addition, demand for some of the Fund s products is cyclical and prices can change rapidly. The Fund s buying practices are designed to minimize the risk of rapidly changing prices, although there can be no assurance that such practices will reduce risk. Substantially all purchases are made based on current orders and anticipated sales, and substantially all sales are made against inventory or product on order. Inventory 20

21 Management Discussion and Analysis CanWel Building Materials Income Fund levels are monitored in an attempt to achieve balance between maximum inventory turnover and optimal customer service. However, as a wholesale building products distributor, the Fund maintains significant quantities of inventory, the value of which is subject to the risk of changing prices. Renewals of Supply and Customer Arrangements Are Not Guaranteed The majority of the Fund s supply and customer arrangements vary significantly in length. Most arrangements are for individual purchase orders and are satisfied upon delivery of the goods to the customer. Some arrangements involve customers purchasing goods several months in advance of delivery. These arrangements, known as bookings, vary in length but are generally less than nine months long. There can be no assurance that these customers will renew their bookings or continue to place purchase orders with the Fund Supply-Side Risks As is customary in the building materials/distribution industry, the Fund does not have long- term contracts with any of its major suppliers. Although the Fund believes that it has access to similar products from competing suppliers, any disruption in the Fund s sources of supply, particularly of the most commonly sold items or any material fluctuation in the quality, quantity or cost of such supply, could have a material adverse effect upon the Fund s results of operations and financial condition. Supply shortages occur at times as a result of unanticipated demand, production difficulties or delivery delays. In such cases, building material and commodity suppliers often allocate products among distributors. Future supply shortages may occur from time to time and may have a short-term material adverse effect on the Fund s results of operations and financial conditions. Risks of Acquisitions A key component in the Fund s growth strategy is to complete acquisitions or other business combinations. Acquisitions and business combinations involve inherent risks, including assumption of transaction costs, risk of non-completion, undisclosed liabilities, assimilation and successfully managing growth. There can also be no assurance that competition for acquisition candidates will not escalate, thereby increasing the costs of making acquisitions. In addition, the process of integrating an acquired company s business into the Fund s operations may result in operating difficulties and expenditures, may absorb significant management attention that would otherwise be available for the ongoing development of the Fund s business, may cause disruptions to the ongoing business, may involve the assumption of significant disclosed and undisclosed liabilities and may result in unanticipated expenses, events or circumstances and possibly charges to operating results. Importation of Foreign Products Similar products to those distributed by the Fund may be imported into North America from countries with low labour costs. Any increase in the importation of products similar to those distributed by the Fund by other parties could increase competition for distributors in North America. An increase in imports in North America could reduce the Fund s sales and opportunities for growth and adversely affect the Fund s business, financial condition and results of operations. 21