Record Label Pro Forma Financial Statements - PDF

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					                                 Madacy Entertainment Income Fund

Management’s Discussion and Analysis
May 10, 2006

This management’s discussion and analysis (“MD&A”) of Madacy Entertainment Income Fund (the “Fund” or
“Madacy”) for our 91-day fiscal first quarter ended April 1, 2006, should be read in conjunction with the attached
unaudited interim consolidated financial statements for such period and with the audited consolidated financial
statements and related notes and MD&A for the 256-day fiscal period from April 20 to December 31, 2005. Additional
information relating to the Fund is available on the System for Electronic Document Analysis and Retrieval (SEDAR) at
www.sedar.com. Results are reported in United States dollars unless otherwise stated and have been prepared in
conformity with Canadian generally accepted accounting principles (“GAAP”).


The Fund completed its initial public offering (“IPO”) and commenced operations on April 20, 2005. As a result, there
are no comparative financial results of the Fund available. The attached unaudited interim consolidated financial
statements contain financial results for the period from January 1 to April 1, 2006 (the “First Quarter”). However, in
order to enhance the usefulness of this MD&A, certain financial and operating results are compared to the unaudited
consolidated results of the predecessor privately owned company adjusted on a pro forma basis to reflect the financial
structure of the Fund (see Note 1 to “Selected Consolidated Financial Information” below). This information is for
reference purposes only and is not intended to represent a comprehensive comparison of the consolidated financial
results or what the results would have been if the Fund had been created and operational in the first quarter of 2005.

This discussion contains forward looking statements. Please see “Forward-Looking Statements” for a discussion of the
risks, uncertainties and assumptions relating to these statements. This discussion also refers to certain non-GAAP
measures, such as EBITDA and distributable cash, to assist in assessing Madacy's financial performance. Non-GAAP
measures do not have any standard meaning prescribed by GAAP and therefore may not be comparable to similar
measures presented by other issuers. See “Non-GAAP Measures – EBITDA and Distributable Cash”.


Overview

The Fund is an unincorporated open-ended limited purpose trust formed under the laws of the Province of Quebec
pursuant to a Trust Agreement dated March 1, 2005, and an Amended and Restated Trust Agreement dated April 12,
2005. The Fund completed an IPO of 7,540,000 units (“Fund Units”) on April 20, 2005, at a price of C$10 per unit.
The Fund used the gross proceeds of the IPO, together with drawings on credit facilities totaling $15.2 million to
indirectly acquire its 65% interest in the assets and liabilities of Madacy Entertainment Group, Limited (the “Business”)
through Madacy Entertainment LP (“Madacy LP”), a limited partnership established under the laws of the Province of
Quebec and to pay expenses of issuing the units. The Fund holds, indirectly, 65% of the limited partnership units of
Madacy LP.

The owners of Madacy Entertainment Group, Limited (“Previous Securityholders”) have retained a 35% interest in the
Business in the form of Class B exchangeable units of Madacy LP (“Exchangeable Units”), which are exchangeable
into Fund Units provided that the Fund achieves certain objectives for a minimum of two years. Distributions to the
Previous Securityholders are subject to subordination arrangements until at least the second anniversary of the IPO.

Madacy operates in the business of recorded music and home video products with a primary focus on the development
and marketing of budget and mid-priced recorded music products. Madacy is also involved in the distribution of mid-
priced and full price products of other music labels and the licensing of its proprietary recordings. According to industry
data, Madacy is the largest independent budget and mid-priced music label in North America by number of units sold; a
                                                                                                                           2

distinction held for the past ten years. Through its predecessor businesses, Madacy has been a leader in the budget
music business for virtually all of its 25-year history. Madacy also develops and markets budget and mid-priced home
video products.

Madacy Entertainment Income Fund units are listed on the Toronto Stock Exchange under the symbol MEG.UN.


Business Strategy

As mentioned, we are North America’s largest independent budget and mid-priced record label. Our business strategy
is to continually enhance our position as leading supplier of budget recorded music product to virtually all of North
America’s leading retailers of recorded music through the continued execution of organic growth strategies. At the
same time, we are continually executing our growth strategy of establishing and expanding relationships with non-
traditional retailers to create new distribution channels. Moreover, as part of our strategy to increase our overall market
share, we are expanding our relationships with the major record labels (the “Major Labels”) and various other record
labels to obtain increased access to their music content.

We have identified the following strategic imperatives as critical to maximizing the long-term sustainability and growth
of our business:

• Increase our leading market share of the budget and mid-priced music business of the mass merchant and specialty
  retailers that dominate the marketplace.
• Continue to be an innovator in packaging and design of new product lines.
• Expand our reach outside of the traditional music marketplace with new initiatives targeted to non-traditional
  retailers.
• Increase our music licensing business by focusing on numerous telephony opportunities and by licensing our
  extensive library of master recordings to online music retailers as a new and growing source of licensing revenue.
• Increase the efficiency of our entire cost structure including increasing the effectiveness of our key suppliers.

We believe that the successful execution of our business strategy combined with these initiatives should result in the
sustaining of our distributable cash and contribute to future growth.


Highlights

Highlights of the overall performance of the Fund for the fiscal quarter ended April 1, 2006, include:

• Reported net sales of $16.208 million for the quarter, a 12% increase compared to the same period in the prior year.
• Announced increase in revolving credit loan facility from US$12.0 million to US$17.0 million.
• Declared steady monthly distributions at rate of C$0.09375 per Fund Unit.


Fiscal Period and Seasonality

As a result of a significantly higher level of net sales, the third and fourth quarters of each year are typically seasonally
stronger than the first half of the year. Normally, the fourth quarter (October to December) is the strongest quarter of
the year with the highest level of net sales, EBITDA and distributable cash generated. The impact of seasonality in
Madacy’s business is discussed further in “Distributable Cash and Distributions” and “Outlook” below.

The Fund’s first three quarterly periods end on the closest Saturday to the calendar quarter end. The Fund’s year end is
December 31.
                                                                                                                          3


Non-GAAP Measures – EBITDA and Distributable Cash

References to “EBITDA” are to earnings (loss) before interest, income taxes, amortization, mark-to-market (unrealized)
gains or losses on foreign exchange and interest rate swap contracts, realized foreign exchange gains or losses on
foreign exchange contracts entered into to eliminate foreign exchange exposure on distributions to unitholders and the
share of net earnings (net loss) of the Exchangeable Units interest. Management believes that, in addition to net
earnings or loss, EBITDA is a useful supplemental measure of performance and cash available for distribution prior to
debt service, changes in working capital, capital expenditures and income taxes and provides a meaningful reflection of
the underlying trends of our business. Specifically, Management believes that EBITDA is an appropriate measure from
which to make adjustments to determine the distributable cash available to unitholders of the Fund (“Unitholders”).

EBITDA of the predecessor company presented for comparative purposes has been adjusted (“Adjusted EBITDA”) on
a pro forma basis to reflect the Fund’s capital structure and the acquisition of the Business by the Fund. Pro forma
adjustments relate to changes in capital tax expense, public company expenses, certain pension plan expenses incurred
by the predecessor company, foreign exchange and Exchangeable Units interest.

EBITDA is not an earnings measure recognized by GAAP and does not have a standardized meaning prescribed by
GAAP. Investors are cautioned that EBITDA should not replace net earnings or net loss (as determined in accordance
with GAAP) as an indicator of the Fund’s performance, or cash flows from operating, investing and financing activities
as a measure of the Fund’s liquidity and cash flows. Our method of calculating EBITDA may differ from the methods
used by other issuers. Therefore, our EBITDA may not be comparable to similar measures presented by other issuers.

Distributable cash available to Unitholders is a non-GAAP measure generally used by Canadian open-ended income
funds as an indicator of financial performance. We define distributable cash (“Distributable Cash”) as EBITDA less
interest, income taxes and capital expenditures. Our method of calculating Distributable Cash available to Unitholders
may differ from similar computations as reported by other similar entities and, accordingly, may not be comparable to
Distributable Cash as reported by such entities. Management believes that Distributable Cash is a useful supplemental
measure that may assist investors in assessing the ability of the Fund to earn and distribute cash returns to Unitholders.


Selected Consolidated Financial Information

(Unaudited)
(in thousands of U.S. dollars except where indicated)                                  For the three       For the three
                                                                                       months ended       months ended
                                                                                        April 1, 2006     April 2, 2005
                                                                                                           (predecessor
                                                                                                             company –
                                                                                                            pro forma 1)

Statement of Earnings Data:
  Net Sales                                                                                $ 16,208           $ 14,498
  Cost of Sales                                                                              10,559              9,167
  Gross Margin                                                                                5,649              5,331
    Gross Margin %                                                                           34.9%              36.8%
  Selling, General and Administrative Expenses                                                4,738              4,345
  Net Loss                                                                                     (519)               (61)
  EBITDA                                                                                   $    996           $    986


Distributable Cash and Distributions:
 Distributable Cash 2                                                                      $     (34)         $     (54)
 Cash Distributions on Fund Units 3                                                        $   1,842
                                              3
 Cash Distributions on Exchangeable Units                                                  $     212
                                                                                                                       4


Balance Sheet Data:
 Total Assets                                                                             $ 113,847
    Long-term Debt Outstanding                                                            $ 10,000

Per Unit information:
Fund Units
Basic Net Loss                                                                            $   (0.069)
Diluted Net Loss                                                                          $   (0.069)
Distributable Cash per Fund Unit 4                                                        $   (0.003)
Cash Distributions on Fund Units                                                          $   0.244
Distributable Cash per Fund Unit 5                                                       C$ (0.004)
Cash Distributions on Fund Units 6                                                       C$ 0.281


Exchangeable Units
                                              4,5
Distributable Cash per Exchangeable Unit                                                  C$ (0.004)
Cash Distributions on Exchangeable Units 7                                                          -


1
  The results of operations of the predecessor company have been adjusted on a pro forma basis to reflect the Fund’s
capital structure and the acquisition of the Business by the Fund. Pro forma adjustments relate to changes in interest,
income taxes, Exchangeable Units interest, capital tax expense, public company expenses, foreign exchange, and
certain pension plan expenses incurred by the predecessor company.
2
 Distributable Cash represents cash available for distribution to holders of Fund Units (“Fund Unitholders”) and to the
Previous Securityholders on their Exchangeable Units interest in Madacy LP. Distributions on the Exchangeable Units
will only be made to the extent the terms of the subordination agreement between the Fund and the Previous
Securityholders are satisfied.
3
  Canadian dollar cash distributions are converted into United States dollars for reporting purposes at the foreign
exchange rate in effect at the end of the month to which the distribution relates. The Fund manages its exposure to
fluctuations in exchange rates between the Canadian dollar and the United States dollar using currency derivatives (see
“Financial Instruments” below). Cash distributions on the Exchangeable Units are declared and paid following the end
of each fiscal quarter subject to the availability of sufficient Distributable Cash to fund such distributions (see
“Distribution Cash and Distributions” below).
4
 Distributable Cash per Fund Unit and per Exchangeable Unit is derived by dividing the portion of Distributable Cash
allocable to the Fund Units and to the Exchangeable Units by the aggregate number of issued Fund Units and
Exchangeable Units, respectively. On an annual basis, Distributable Cash is allocated between the Fund Units and the
Exchangeable Units based on distributions effected with respect to the year in accordance with the terms of the
subordination agreement. For the current fiscal quarter, Distributable Cash has been allocated on a pro rata basis to the
Fund Units and the Exchangeable Units. See “Distributable Cash and Distributions” below for discussion of the Fund’s
policy regarding distributions to holders of Fund Units and Exchangeable Units.
5
  Distributable Cash per Fund Unit and per Exchangeable Unit is presented in Canadian dollars for purposes of
comparison to the Canadian dollar denominated cash distributions. For this purpose, United States dollar denominated
Distributable Cash is converted into Canadian dollars applying the exchange rate of the Fund’s foreign exchange
contracts relating to the period, which is C$1.2122/US$1.00 (see “Financial Instruments” below).
6
    Actual Canadian dollar cash distributions declared in the period.
7
  Actual Canadian dollar cash distributions declared immediately following the fiscal quarter with respect to the period
(see “Distribution Cash and Distributions” below).
                                                                                                                             5


Operating Results for the First Quarter Ended April 1, 2006
Net Sales
Net sales for the First Quarter increased by $1.710 million, or 11.8%, to $16.208 million from the comparative period in
the prior year. Substantially all of this increase was attributable to an organic increase in business with the mass
merchant and specialty retailer accounts. As a result of a general inventory rationalization at a number of the Fund’s
customers, Management has taken a higher reserve in the First Quarter for anticipated future returns. Such increased
reserve negatively impacted net sales in the First Quarter by an amount of approximately $1.2 million.

Cost of Sales
Cost of sales, as a percentage of net sales in the First Quarter, increased to 65.1% from 63.2% for the comparative
period in the prior year. The increase in cost of sales relates, primarily, to the cost of providing the in-store service
program to Best Buy as part of the strategic relationship program with them. As this service cost is based on an hourly
service rate, it will represent a higher percentage of net sales in seasonally slower fiscal quarters. In addition, as a result
of the general inventory rationalization discussed above, cost of sales in the First Quarter was negatively impacted by
an amount of approximately $0.7 million.

Gross Margin
Gross margin for the First Quarter increased by $0.318 million, or 6.0%, to $5.649 million from the comparative period
in the prior year. Gross margin as a percentage of net sales for the First Quarter was 34.9% compared to 36.8% for the
comparative period in the prior year. As discussed above, the lower gross margin percentage is primarily a result of
service costs relating to the in-store service provided under the strategic relationship program with Best Buy. In
addition, as a result of the general inventory rationalization discussed above, gross margin in the First Quarter was
negatively impacted by an amount of approximately $0.5 million.

Selling, General and Administrative Expenses
SG&A increased by $0.393 million, or 9.0%, to $4.738 million for the First Quarter, from $4.345 million for the
comparative period in the prior year. This increase is primarily due to a higher level of variable expenses, such as
freight, resulting from the higher level of net sales. SG&A represented 29.2% of net sales in the First Quarter compared
to 30.0% of net sales in comparative period in the prior year. This overall improvement resulted mainly from increased
efficiencies and the scalability of fixed expenses realized as a result of the greater volume of business which was offset,
in part, by an increase in variable costs.

Loss on derivative financial instruments and foreign currency translation
Net loss for the First Quarter includes a loss (realized and unrealized) on derivative financial instruments and foreign
currency translation of $0.053 million. Included in such amount is an unrealized mark-to-market loss of $0.254 million
resulting from a modest depreciation in the Canadian dollar relative to the US dollar on the Fund’s outstanding foreign
exchange contracts. Concurrently with the completion of the IPO, the Fund entered into foreign exchange contracts to
reduce its exposure to foreign exchange fluctuations with respect to its anticipated cash distributions to unitholders and
its net exposure to Canadian dollar denominated outlays for an initial three year period. Management continues to
monitor the Fund’s foreign exchange contract policy to mitigate the impact of foreign exchange fluctuations on the
conversion of United States dollars into Canadian dollars required to effect cash distributions to unitholders. Further
discussion of the Fund’s foreign exchange contracts can be found under “Financial Instruments” below.

Amortization Expenses
Amortization expenses increased by $0.638 million, or 107.2%, to $1.233 million for the First Quarter, from the
comparative period in the prior year. This increase is primarily due to the impact of the amortization of intangible
assets recognized on the purchase of the Business following the IPO.

Exchangeable Units Interest
As part of the formation of the Fund and the acquisition of the Business, Madacy LP issued 4,059,111 Exchangeable
Units to the Previous Securityholders. The Exchangeable Units, which represent the remaining 35% interest in Madacy
LP, are accounted for as an Exchangeable Units interest due to their subordinated status regarding cash distributions.
                                                                                                                         6

The annual allocation of the earnings (loss) to the Exchangeable Units interest is determined based on their share of
Canadian dollar Distributable Cash for the year in accordance with the terms of the subordination agreement.

Net Loss
Net loss for the First Quarter was $0.519 million, compared to net loss of $0.061 million in the comparative period of
2005. The increase in net loss primarily reflects the amortization of intangible assets created on the acquisition of the
Business and the mark-to-market loss in valuation of outstanding foreign exchange contracts.

EBITDA
EBITDA increased by $0.010 million, or 1.0%, for the First Quarter to $0.996 million from the comparative period in
the prior year.

The following sets out a reconciliation of Net Loss to EBITDA:


(Unaudited)
(in thousands of U.S. dollars)                                                     For the three          For the three
                                                                                   months ended          months ended
                                                                                    April 1, 2006        April 2, 2005
                                                                                                          (predecessor
                                                                                                            company –
                                                                                                            pro forma)


Net Loss                                                                                 $ (519)               $   (61)
Add:

Amortization of tangible and intangible assets                                             1,233                   595
Income taxes                                                                                  92                   178
Interest expense                                                                             331                   307
Realized gain on derivative financial instruments 1                                         (108)
Unrealized loss on derivative financial instruments                                          246
Exchangeable Units interest                                                                 (279)                  (33)
EBITDA                                                                                     $ 996                $ 986

1
  Realized gain on derivative financial instruments entered into to manage the Fund’s exposure to fluctuations in
exchange rates between the Canadian dollar and the United States dollar on its cash distributions.


Distributable Cash and Distributions
The Fund has established a policy of making stable monthly distributions to Fund Unitholders based on Management’s
estimate of Distributable Cash for the year. Distributions on Fund Units with respect to each month are declared during
the month and paid on or before the 15th day of the following month. Madacy LP also makes distributions on the
Exchangeable Units. Such distribution entitlement of the Exchangeable Units is, on a per unit basis, equivalent to the
respective distributions to Fund Unitholders. Distributions on the Exchangeable Units are made pursuant to the terms
of a subordination agreement.

The Fund’s distribution policy recognizes that there is a significant degree of seasonality with respect to the Business.
Management reviews and considers their estimate of EBITDA and Distributable Cash for the entire year and compares
such estimate to the prior year’s results when making distributions on Fund Units and on the Exchangeable Units. As
set out in the subordination agreement, during the subordination period, any shortfalls in Distributable Cash are first
applied to reduce quarterly distributions on the Exchangeable Units and then, if necessary, applied to the Fund Units.
Due to the seasonally low amount of Distributable Cash generated in the first and second fiscal quarters, the board of
directors has decided to defer, with the concurrence of the holders of the Exchangeable Units, the declaration and
                                                                                                                         7

payment of distributions on the Exchangeable Units with respect to such quarters until the second half of the year when
such Distributable Cash has been generated. Management currently believes that the Fund will generate sufficient
Distributable Cash in 2006 to enable it to make full distributions to both the Fund Unitholders and to holders of the
Exchangeable Units.

A comparison of the percentage of net sales and Adjusted EBITDA generated in each half of 2005 is as follows:

                    Semi-annual 2005 Net Sales and Adjusted EBITDA
                    as a percentage of Annual 2005 Net Sales and Adjusted EBITDA

                                          Jan – June        July - Dec                  TOTAL

                       Net Sales            36.2%             63.8%                     100.0%
                       Adjusted
                                            19.4%             80.6%                     100.0%
                       EBITDA

Note: EBITDA for the pre-IPO period, from January 1, 2005, to April 19, 2005, has been adjusted on a pro forma basis
to reflect the Fund’s capital structure and the acquisition of the Business by the Fund. In addition, the foregoing
analysis reflects the impact of the commencement of the strategic relationship program with Best Buy in the second half
of 2005. The benefits to the Fund of this relationship will be reflected in both halves of 2006.

Distributable Cash increased by $0.020 million, for the First Quarter to ($0.034) million from ($0.054) million for the
comparative period in the prior year. Madacy’s quarterly and year-to-date levels of capital expenditures are in line with
our annual anticipated requirements.

During the First Quarter, the Fund declared aggregate distributions of C$0.28125 per unit to the Fund Unitholders.

The following sets out a reconciliation of EBITDA to Distributable Cash:

(Unaudited)
(in thousands of U.S. dollars)                                                         For the three        For the three
                                                                                       months ended        months ended
                                                                                        April 1, 2006      April 2, 2005
                                                                                                            (predecessor
                                                                                                              company –
                                                                                                              pro forma)
EBITDA                                                                                        $ 996              $ 986
Less:
Income taxes                                                                                      (92)             (178)
Interest expense                                                                                 (331)             (307)
Capital expenditures                                                                             (607)             (555)
Distributable Cash                                                                           $    (34)            $ (54)



Payout Rate
The Fund’s payout rate is a function of the Distributable Cash generated in the period and the aggregate distributions to
unitholders during the period. For this purpose, it is appropriate to consider all distributions declared on both the Fund
Units and the Exchangeable Units. In addition, as distributions are only declared on the Exchangeable Units following
the end of each fiscal quarter, the distribution declared on the Exchangeable Units after the end of a fiscal quarter which
relates to such fiscal quarter (the “B Lag Distribution”) is also included in the computation.
                                                                                                                      8

For the 256-day fiscal period ended December 31, 2005, (the “2005 Period”), the Fund generated Distributable Cash of
US$6.810 million (C$8.255 million applying the exchange rate of the Fund’s foreign exchange contracts). The 256-day
fiscal period ended December 31, 2005, was affected by one-time charges (the “2005 Charges”) relating to the return of
product by Best Buy as part of the commencement of the strategic relationship program with them and the write-off of a
receivable balance relating to the bankruptcy of one of the Fund’s customers. Ignoring the impact of these one-time
charges results in a normalized Distributable Cash of C$10.506 million with respect to the 2005 Period. During the
2005 Period, the Fund declared aggregate distributions of C$5.914 million to Fund Unitholders and C$2.042 million on
the Exchangeable Units. In addition, the Fund declared a distribution of C$0.244 million during the First Quarter on
the Exchangeable Units with respect to the 2005 Period resulting in aggregate distributions with respect to the 2005
Period of C$8.200 million (99.33% of Distributable Cash generated in the 2005 Period).

In the First Quarter, the Fund generated Distributable Cash of $(0.034) million, or C$(0.041) million, and declared
distributions of C$2.121 to Fund Unitholders. Since its IPO (being the 2005 Period and the First Quarter, resulting in a
347-day period (the “347-Day Period Since IPO”), the Fund has generated Distributable Cash of C$8.214 million.
Ignoring the 2005 Charges, the Fund has generated normalized Distributable Cash of C$10.465 million. During the
347-Day Period Since IPO, the Fund has declared distributions on the Fund Units and the Exchangeable Units of
C$8.035 million and C$2.286 million, respectively, for a total of C$10.321 million. As discussed above, the
distribution on the Exchangeable Units with respect to the First Quarter has been deferred to the second half of the
fiscal year.

Management expects the Fund’s performance to continue to be positive and the Fund to generate sufficient
Distributable Cash to allow it to meet the current annual rate of cash distributions of C$1.125 per unit.


Liquidity and Capital Resources
Cash Flows from Operating Activities
Cash flow from operating activities for First Quarter was a net outflow of $0.658 million. This outflow is the result of
an increase in the Fund’s non-cash operating elements of working capital as set out below.

Working capital includes cash, accounts receivable, inventories, prepaid expenses, accounts payable and accrued
liabilities, distribution payable on Fund Units, income taxes payable, the short-term portion of any unrealized gain or
loss on foreign exchange contracts and amounts owing on the Fund’s revolving line of credit. As at April 1, 2006,
working capital was $16.427 million compared to $18.478 million at December 31, 2005, representing a decrease of
$2.051 million in the quarter. Non-cash operating elements of working capital increased by $1.492 million in the First
Quarter. This increase is mainly explained by significantly lower account receivable and account payable balances
generating a net inflow of $2.114 million, offset by an increase in inventory of $3.532 million resulting from an
increase in major label products required to support upcoming releases and from a seasonally high level of product
returns.

Cash Flows from Investing Activities
During the First Quarter, the Fund used $0.607 million in funds for capital expenditures compared to $0.555 million
during the comparative period in the prior year. See discussion entitled “Capital Expenditures” below.

Cash Flows from Financing Activities
During the First Quarter, the Fund paid distributions of $2.056 million (C$2.364 million) on Fund Units and
Exchangeable Units (respectively $1.844 million and $0.212 million). The Fund declared distributions to Fund
Unitholders in the amount of $1.842 million (C$2.121 million) and declared and paid a distribution in the amount of
$0.212 million (C$0.244 million) on the Exchangeable Units with respect to the fourth quarter of 2005. Subsequent to
April 1, 2006, a distribution of $0.605 million (C$0.707 million), which had been declared in the First Quarter, was
paid to Fund Unitholders.
                                                                                                                        9

Capital Expenditures
Capital expenditures consist primarily of the purchase and production of master recordings, the disbursing of funds for
royalty advances (net of recovery of prior advances) and property and equipment purchases (primarily computers and
software). Management defines “sustaining” capital expenditures to be capital expenditures necessary to sustain the
earnings capacity of the Business and “growth” capital expenditures to be capital expenditures of a more material nature
which are considered to be accretive, in the short-term, to operations. In the First Quarter, the Fund made
approximately $0.607 million of capital expenditures, of which $0.348 million relates to “sustaining” capital
expenditures and $0.259 million to “growth” capital expenditures. Management expects, notwithstanding the “growth”
capital expenditures in the First Quarter, to incur total capital expenditures with respect to the fiscal year of
approximately $1.0 million.

The following sets out a reconciliation of the capital expenditures:

(Unaudited)
                                                                                      For the three        For the three
(in thousands of U.S. dollars)
                                                                                      months ended        months ended
                                                                                       April 1, 2006      April 2, 2005
                                                                                                           (predecessor
                                                                                                             company –
                                                                                                             pro forma)
Additions to property and equipment                                                               34                  42
Additions to master recordings                                                                   445                 150
Royalty advances                                                                                 261                 475
Less: Recovery of royalty advances                                                              (133)               (112)
Capital Expenditures                                                                          $ 607               $ 555


Credit Facilities
Bank Indebtedness
The Fund has, following the end of the First Quarter, increased the borrowing limit on its revolving credit loan facility
to $17.0 million from $12.0 million (see “Subsequent Events” below). The credit facility is intended to provide for the
ongoing working capital requirements of the Fund and to provide seasonal liquidity for distributions. The increase in
the borrowing limit was entered into to support the growth and seasonality of the business. The balance outstanding on
the revolving credit facility as at April 1, 2006, was $9.5 million. Management believes that the credit facility is
sufficient to meet the Fund’s current requirements.

As security, the Fund has pledged all of its assets.

Long-Term Debt
Long-term debt at April 1, 2006, was $10.0 million. The long-term debt is a term loan repayable in full on April 20,
2007 with no scheduled repayments of principal required prior to maturity. Interest on the long-term debt is payable
monthly with respect to U.S. base rate based borrowings and on maturity with respect to LIBOR based borrowings.


Interest Rate Swap Contracts
The Fund has entered into an interest rate swap contract with respect to its variable interest obligations under the term
loan for the duration of its term. Under this swap contract, variable interest has been swapped for a fixed rate of 5.85%.
                                                                                                                       10


Contractual Obligations
The table below sets forth other remaining contractual obligations of the Fund as at April 1, 2006, due in the years
indicated:

(in thousands of U.S. dollars)                                         Payments Due by Period
                                                          Total               2006    2007-2008         2009-2010
Operating Leases                                        $ 1,127               $208      $ 475                $444
Royalty Payments                                          1,534                342        1,067               125
Long-term Debt                                           10,000                          10,000
Total                                                   $12,661               $550      $11,542               $569

Operating leases are entered into for premises. In the First Quarter, total occupancy costs (including rent) totaled $0.142
million.

In the ordinary course of its business, the Fund continually enters into agreements with owners of audio and video
content which require minimum royalty payments or minimum purchase obligations over their term, which usually
ranges from two to five years. Each of these agreements is typically for one product or package and, as such, is not
material in nature. The Fund does have two material agreements requiring the payment of royalties as disclosed above.


Off-Balance Sheet Arrangements
The Fund has no off balance sheet arrangements other than derivative financial instruments which are discussed below.


Related Party Transactions
The Fund has entered into transactions with parties to which it is related.

For the First Quarter, distributions of $0.212 million were paid on the Exchangeable Units held by the Previous
Securityholders.

The Fund receives managerial services from a corporation controlled by one of its officers in consideration for a
monthly management fee of $12,500.


Financial Instruments
The Fund uses currency derivatives to manage its exposure to fluctuations in exchange rates between the Canadian
dollar and the United States dollar and interest rate risk on certain of the Fund’s debt. The Fund has not elected to
designate any of its foreign exchange contracts or its interest rate swap as hedges for accounting purposes.
Accordingly, the fair value of these derivatives is recognized in the balance sheet using a mark-to-market valuation
basis with changes in fair value recognized currently in the statement of earnings. The Fund does not enter into
derivative financial instruments for trading or speculative purposes.

In the First Quarter, the Fund entered into foreign exchange contracts to convert an additional $2.00 million into
Canadian dollars, the whole in accordance with the Fund’s foreign exchange policy. As a result, at April 1, 2006, the
Fund had 30 monthly foreign exchange contracts to convert, each month until September 2008, on average, U.S.$1.26
million into C$1.52 million, reflecting an average exchange rate of C$1.2066/US$1.00. In addition, the fair value of all
outstanding foreign exchange contracts has been reflected in the financial statements. Based on the Fund’s current
monthly distribution of C$0.09375 per unit, the principal value of the monthly foreign exchange contracts is sufficient
to cover the amount of US dollars necessary to be converted to Canadian dollars in order to pay distributions to Fund
                                                                                                                    11

Unitholders and to holders of Exchangeable Units until September 2008. The Fund has swapped its variable interest
rate on its $10.0 million term loan into a fixed rate of 5.85% for its entire two-year term.


Subsequent Event

On May 9, 2006, the Fund concluded an amendment to its bank financing increasing the borrowing limit on its
revolving credit loan facility from $12.0 million to $17.0 million. The term loan remains unchanged at $10.0 million.
A third Canadian chartered bank joined the Fund’s banking syndicate as part of the amendment. The amendment did
not result in any increase in the Fund’s borrowing rate and only resulted in banking covenant amendments necessary to
permit the Fund to utilize the higher borrowing limit.

Due to the seasonally low amount of Distributable Cash generated in the first and second fiscal quarters, the board of
directors has elected to defer the declaration and payment of distributions on the Exchangeable Units with respect to
such quarters until the second half of the year when such Distributable Cash has been generated.



Critical Accounting Estimates
Madacy prepares its financial statements in conformity with GAAP, which requires Management to make estimates,
judgments and assumptions that Management believes are reasonable based upon the information available. These
estimates, judgments and assumptions influence the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Management bases its estimates on historical experience and other assumptions,
which it believes to be reasonable under the circumstances. Management also evaluates its estimates on an ongoing
basis.

The significant accounting policies of Madacy are described in the December 31, 2005, annual audited consolidated
financial statements of the Fund. The estimates which Management believes are the most critical to aid in fully
understanding and evaluating the reported financial results of the Fund include the following:

Provision for Future Returns
Madacy accounts for a provision for future product returns based on a percentage of its gross sales. Based on the
seasonal sales patterns of Madacy’s business, the reserve balance is built up during the September to December period,
when sales are typically highest with more modest returns, and drawn down during the January to August period when
higher product returns are experienced. The provision is included in the computation of Madacy's net sales and is
established by Management based on recent historical return experience. Management believes that the current reserve
is adequate.

Provision for Inventory Impairment
Madacy maintains a provision for inventory impairment and discounts given on liquidation of discontinued and
overstocked product lines based on a continuing review and analysis of its various inventory categories and its ongoing
sales of each inventory item. This provision is included in the computation of Madacy's cost of sales and is established
by Management based on recent historical experience regarding inventory impairment and the liquidation of inventory.
Management believes that the current reserve is adequate.

Provision for Receivables
Madacy maintains a provision for potential credit losses and potential settlements on reconciliation of discrepancies of
its customers' accounts based on a continuing review and analysis of its customers’ balances. This provision is included
in the computation of Madacy's SG&A and is established by Management based on factors, such as recent historical
experience regarding its customers’ credit history, economic conditions, and the write-downs required for settlements
on reconciliation of discrepancies of its customers’ accounts.

Management reviews the level of all of these provisions periodically to ensure their continued appropriateness.
                                                                                                                       12

Allocation of Purchase Price
The allocation of the purchase price for the business acquired at the time of our IPO required judgment, specifically the
allocation between goodwill and other intangible assets, and the amortization period of the intangible assets, which we
have determined to be 5 to 10 years using the straight-line basis.

Long-Lived Assets
Long-lived assets comprise property and equipment, master recordings and intangible assets other than goodwill.
Long-lived assets held for use are reviewed for impairment, when certain events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable. Impairment is assessed by comparing the carrying amount
of an asset with the expected future net undiscounted cash flows from its use together with its residual value. If such
assets are considered to be impaired, the impairment to be recognized is measured at the amount by which the carrying
amount of the assets exceeds their fair value and is presented as an impairment adjustment in the consolidated statement
of earnings.

Long-lived assets with limited useful life are recorded at cost. They are amortized using the straight-line method over
their useful lives for the Fund, represented by the period during which Management estimates that an asset will
contribute to future cash flows. The use of different assumptions with regard to useful life could result in different book
values for these assets as well as for the amortization expenses.

Goodwill
Goodwill represents the excess of the purchase price over the fair value of net assets acquired. Goodwill is not
amortized and is subject to an annual impairment test. Goodwill impairment is evaluated between annual tests upon the
occurrence of certain events or circumstances. Goodwill impairment is assessed based on a comparison to the fair value
of a reporting unit's net assets including goodwill. When the carrying amount of the reporting unit exceeds its fair
value, the fair value of the reporting unit's goodwill is compared with its carrying amount to measure the amount of
impairment loss, if any. The use of different assumptions when applying the annual tests could result in different fair
values and, consequently, different book values for goodwill and operating results.

Employees Future Benefits
The Fund accounts for its obligations under the employee benefits plan and the related costs, net of the plan assets. The
cost of pension benefits earned by employees is actuarially determined using the projected benefit method prorated on
services, and Management's best estimate of expected plan investment performance, salary escalation and retirement
ages of employees. The use of different assumptions could result in different book values for accrued benefit assets and
expenses for defined benefit plans.


Change in Accounting Policy

In December 2005, the Emerging Issues Committee amended EIC 151, “Exchangeable Securities Issued by
Subsidiaries of Income Trusts” to provide detailed guidance on the measurement of exchangeable securities
representing the retained interest in a subsidiary of an income trust. EIC 151 requires that the measurement of
exchangeable securities which are not economically equivalent to the income trust units reflects that difference. This
amendment has taken effect on January 1, 2006, and is to be applied retroactively to the date of issuance of the
exchangeable securities.

Therefore, in accordance with this amendment, during the First Quarter, the Fund has retroactively restated its
consolidated balance sheet to adjust the carrying value of the Exchangeable Units to reflect the impact of the
subordination features. The effect of this change in accounting policy on the consolidated balance sheet as at April 1,
2006, and December 31, 2005, was to reduce the carrying value of both the Exchangeable Units and goodwill by $5.0
million.
                                                                                                                       13


Outlook
Results for the First Quarter were slightly below Management’s expectations due to a higher than normal provision for
future returns taken by Management in response to a general inventory rationalization at a number of the Fund’s
customers. The business continued to expand in the period, typically a low sales and low EBITDA quarter. Business
with mass merchant and specialty retailer accounts continued to grow. Retail sales of Madacy’s products remained
strong. According to industry statistics, music industry retail unit sales were up 3.98% in the First Quarter compared to
the same period in the prior year. Madacy has been successful, over the same period, in increasing the retail unit sales of
its product resulting in Madacy having a market share to the end of March 2006 of 1.82% of the entire recorded music
market.

Madacy continues to execute on its strategic imperatives, as discussed above. In particular, Madacy has increased its
focus on the licensing of its master library, a fast growing high margin area of business.

As our business moves into the second quarter, another seasonally slow quarter, we are focused on executing on the
many programs and product lines that we have generated during the past year. In addition, Management is firmly
focused on achieving its goals for 2006 and to building on the strong demand for Madacy’s products and executing on
the many opportunities available to it both within its core customer base and with non-traditional music retailers.
Management expects the Fund’s performance to continue to be positive and to generate sufficient Distributable Cash to
allow it to meet the current annual rate of cash distributions of C$1.125 per unit.


Disclosure Controls and Procedures

An evaluation of the effectiveness of the design of our disclosure controls and procedures was conducted as of April 1,
2006, by and under the supervision of the Fund’s management, including the CEO and CFO. Based on this evaluation,
the CEO and CFO have concluded that our disclosure controls and procedures, as defined in Multilateral Instrument
52-109, Certification of Disclosure in Issuers’ Annual and Interim Filings are designed effectively to ensure that
information required to be disclosed in reports that we file or submit under Canadian securities legislation is recorded,
processed, summarized and reported within the time periods specified in those rules and forms.


Risks and Uncertainties
An investment in Fund Units involves risks inherent in the ordinary course of business of the Fund including: the
sustainability of customer and supplier relationships, the financial stability of customers, competition, price volatility
and exchange rate and interest rate fluctuations. These risks should be carefully considered in addition to the other
information contained in this MD&A. For a more detailed description of these and other risks and uncertainties facing
investors in the Fund, please refer to the December 31, 2005, annual MD&A.


Forward-Looking Statements
This MD&A may contain forward-looking statements, which reflect Management’s expectations regarding the future
growth, results of operations, performance and business prospects, and opportunities of the Fund. Forward-looking
statements contain such words as “anticipate”, “believe”, “continue”, “could”, “expects”, “intend”, “may”, “plans” or
similar expressions suggesting future conditions or events. Such forward-looking statements reflect Management’s
current beliefs and are based on information currently available to us. Forward-looking statements involve significant
risks and uncertainties. A number of factors could cause actual results to differ materially from results discussed in the
forward-looking statements, including the effects of, as well as changes in: national and local business conditions;
political or economic instability in local markets; competition; consumer preferences, spending patterns and
demographic trends; legislation and governmental regulation. Although the forward-looking statements contained in
this MD&A are based on what we believe to be reasonable assumptions, we cannot assure readers that actual results
will be consistent with these forward-looking statements. There should not be an expectation that such information will
                                                                                                                    14

in all circumstances be updated, supplemented or revised whether as a result of new information, changing
circumstances, future events or otherwise.



Additional Information
Additional information relating to the Fund, including all public filings, is available on SEDAR (www.sedar.com).

				
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