Menu Foods Income Fund
TSX : MEW.UN

Menu Foods Income Fund

May 15, 2008 12:25 ET

Menu Foods Income Fund Announces 2008 First Quarter Results

TORONTO, ONTARIO--(Marketwire - May 15, 2008) -

NOT FOR RELEASE OVER US NEWSWIRE SERVICES

Attention Business/Financial Editors:

Menu Foods Income Fund (TSX:MEW.UN) announces its financial results for the first quarter ended March 31, 2008.

The financial results for the quarter ended March 31, 2008 will be discussed at Menu Foods Income Fund's annual meeting. The annual meeting is to be held today, May 15, 2008 at 2:00pm in Salon F of the Mississauga Convention Centre, located at 75 Derry Road, Mississauga, Ontario. The meeting will be chaired by Ian Ross, Chairman and Trustee of Menu Foods Income Fund. Ian will be joined by Paul Henderson, Menu's President and Chief Executive Officer and Mark Wiens, Menu's Executive Vice President and Chief Financial Officer.

Message to Unitholders

The quarter ended March 31, 2008 was a period of significant turn-around for Menu. To put things in context, the recalls that began in the first quarter of 2007 seriously affected the Fund's business and financial position in each of the past four quarters. Over this same timeframe, Menu confronted its new reality and began the process of rebuilding its business. Last year, we successfully negotiated amendments to our credit agreements with our Lenders and this gave us the funds we needed to finance the recall and our ongoing operations. Having lost customers representing approximately 37% of our volume in 2006, we restructured our business during the final quarter of 2007 to more effectively match our capacity with the ongoing demand of our continuing customers. The initial positive effects of this restructuring are reflected during the first quarter of 2008. While there is still considerable work to be done, it is a very good start to the rebuilding that the Fund is undertaking.

Specifically, the results for the first quarter include some strong indications that the corner has been turned:

- Adjusted EBITDA of $5.1 million (9.2% of sales) improved significantly compared to the adjusted EBITDA of $2.0 million (3.5% of sales) generated in the fourth quarter of 2007.

- Volume for Menu's continuing business rose by 5.3% in 2008 as compared to the first quarter of 2007. This occurred despite the fact that Menu's second and third largest U.S. private-label customers, during 2006, did not resume the shipment of cuts and gravy products until part way through the first quarter.

- Selling, general and administrative costs were down by 23.7% as compared to the 22.6% decline in volume. This decrease is a direct result of the restructuring undertaken by Menu during the fourth quarter of 2007.

- All of the above was achieved in an environment of significant appreciation of the Canadian dollar as compared to the United States dollar, which averaged $0.9955 for the first quarter of 2008 as compared to $0.8535 in the first quarter of the prior year.

Also, during the first quarter of 2008 Menu followed the leading national brands and implemented a price increase to our private-label customers that will be implemented during the second quarter of 2008. This increase in price is expected to increase sales by more than 3%. The costs of certain raw materials have risen considerably since the increase was announced and are expected to continue to increase throughout the remainder of 2008. Further price increases may be required, however, there can be no assurance that they can be attained, or that margins will not be compressed as a result of these developments.

On April 1, 2008, the parties to the Pet Food Multi-District Litigation advised the United States District Court for the District of New Jersey that they had reached a comprehensive, cross border agreement, in principle, addressing all major terms of settlement. The definitive terms of settlement, together with a motion for preliminary approval thereof are scheduled to be filed with the United States District Court on May 20, 2008, with a hearing scheduled on May 30, 2008. The scheduling for Canadian Court approval has not yet been determined, but is expected to occur in a similar timeframe.

The settlement amount will be funded by the defendants, including the Fund and its product liability insurer. Menu's estimate for recall-related costs remains unchanged at $55 million.

We have made considerable progress and our prospects look better today than at any other time during this past year. As we move the business forward, we do so focusing on our core competency - the manufacture of high quality wet pet food. We will continue to work to solidify our customer base and further adjust our cost structure in line with our ongoing business. Despite the difficult issues still facing the Fund, including restrictive credit facilities, rising costs and an increasingly competitive environment, we remain optimistic in Menu's ability to address these challenges and emerge a leaner, more competitive organization.

Once again, I want to thank all of those who stood by us during this difficult period. I look forward to reporting to you again next quarter.



Paul Henderson

President & Chief Executive Officer
Menu Foods GenPar Limited
Administrator of Menu Foods Income Fund


Management's Discussion and Analysis of Financial Results

(For the quarter ended March 31, 2008)

Presentation of Financial Information

The following discussion and analysis of the financial results of Menu Foods Income Fund (the "Fund") is dated as of May 15, 2008 and is supplementary to and should be read in conjunction with the unaudited consolidated financial statements for the quarters ended March 31, 2008 and 2007.

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

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

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

Overall Performance and Results of Operations

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



For the quarter
ended March 31,
2008 2007
$ $
Sales 55,581 64,506
Cost of sales 48,102 56,747
-----------------
Gross profit 7,479 7,759
Selling, general and administrative expenses 4,858 6,366
-----------------
Income before the under noted 2,621 1,393
Product recall expenses - 39,115
Restructuring and related expenses 102 -
Financial expenses 4,699 3,282
-----------------
Loss before income taxes and non-controlling interest (2,180) (41,004)
-----------------
Current income taxes 24 (214)
Future income taxes - (14,201)
-----------------
Total income taxes 24 (14,415)
-----------------
Loss before non-controlling interest (2,204) (26,589)
Non-controlling interest of Class B Exchangeable Units - (9,080)
-----------------
Net loss for the period (2,204) (17,509)
-----------------
-----------------

Basic net loss per Trust Unit (0.108) (0.918)
Diluted net loss per Unit (0.108) (0.918)

Distributions per Trust Unit - -
Distributions per Class B Exchangeable Unit - -

Basic weighted average number of Trust Units outstanding
(000's) 20,362 19,081
Diluted weighted average number of Units outstanding
(000's) 29,984 29,245

Average US/Cdn exchange rate per Bank of Canada 0.9955 0.8535


Operating Results for the Quarter Ended March 31, 2008

On March 16, 2007 the Fund announced the recall of a portion of the dog and cat food it manufactured between December 3, 2006 and March 6, 2007. This recall primarily related to "cuts and gravy" style pet food in cans and pouches manufactured at two of the Fund's United States facilities. These products were both manufactured and sold under private-label and were contract-manufactured for some national brands.

The Fund's investigation discovered that the timing of production associated with reported concerns and certain other events, coincided with the introduction of wheat gluten from a new supplier. Subsequent investigation has proven that that supplier's wheat gluten had in fact been adulterated with melamine and related compounds. Menu was the first of a number of companies within the pet food industry to recall product adulterated with melamine and related compounds in connection with one of the largest recalls in the industry's history. Menu, its competitors, its customers and consumers were all victims of a terrible fraud perpetuated on the pet food industry as a whole.

The recall had a significant impact on the Fund's results for the quarter ended March 31, 2007 and on each subsequent quarter during 2007. In order to draw meaningful conclusions with respect to the Fund's performance in the first quarter of 2007, it is important to isolate the effects of the recall from the ongoing business. The following table further evaluates the results noted above:



For the quarter 2007
ended March 31 Recall Excluding
2008 2007 Costs Recall
$ $ $ $
Sales 55,581 64,506 (14,320) 78,826
Cost of sales 48,102 56,747 (11,435) 68,182
-----------------------------------
Gross profit 7,479 7,759 (2,885) 10,644
Selling, general and administrative
expenses 4,858 6,366 - 6,366
-----------------------------------
Income before the under noted 2,621 1,393 (2,885) 4,278
Product recall expenses - 39,115 39,115 -
Restructuring and related expenses 102 - - -
Financial expenses 4,699 3,282 - 3,282
-----------------------------------
(Loss) income before income taxes and
non-controlling interest (2,180) (41,004) (42,000) 996
-----------------------------------
-----------------------------------


Sales for the quarter ended March 31, 2008, were $55.6 million, down 13.8% or $8.9 million compared to the same quarter last year. This decrease is attributable to:

1. a 22.6% decrease in volume resulting in a sales decrease of $16.2 million;

2. the strengthening of the Canadian dollar relative to the United States dollar had the effect of decreasing sales by $7.8 million relative to the first quarter of 2007;

3. take-or-pay agreements in the first quarter of 2007, which did not recur in 2008, had the effect of decreasing sales by $0.5 million relative to the first quarter of 2007. These decreases in sales were partially offset by:

4. as a consequence of the product recall, last year, $14.3 million in sales returns were received or accrued during the quarter ended March 31, 2007, which had the effect of increasing sales on a comparative basis; and

5. the impact of the price increases since the end of the first quarter of 2007 and the effect of pricing adjustments to pass through cost increases to Menu's contract manufacturing customers, together with changes to sales mix and other variables, had the effect of increasing sales by $1.3 million.

Overall, excluding actual returns arising from the product recall during 2007, volume (expressed in cases of 24 cans or pouches) was down 22.6% compared to the quarter ended March 31, 2007. Can volume, which represented 86.5% of Menu's volume in the first quarter of 2008 (77.9% in 2007), contracted by 14.1% (equating to a decrease in total volume of 11.0%) while pouch volume, which represented 13.5% of total volume (22.1% in 2007), decreased by 52.6% (equating to a decrease in total volume of 11.6%) compared to the first quarter of 2007.

During 2007, the Fund was advised that customers whose volume represented approximately 37% of sales in 2006 would no longer be purchasing these products from Menu. The effects of this lost business will be felt over time, with almost 14% being lost during the second and third quarters of 2007, approximately 11% during the fourth quarter of 2007 and the remainder being lost during 2008 and into 2009. During the quarter ended March 31, 2008, volume to these customers decreased 78.2%, which more than offset the 5.3% increase in volume to the Fund's continuing customers.

Gross profit decreased by $0.3 million (or 3.6%) for the quarter ended March 31, 2008, compared to the prior year. This decrease is attributable to:

1. Effect of Change in Sales Volume. As previously noted, excluding actual returns arising from the product recall during the first quarter of 2007, total volume for the first quarter of 2008 decreased by 22.6%. This change in sales volume decreased gross profit by $5.0 million.

2. Product Recall Impacts. As noted above, due to the product recall last year, $14.3 million in sales returns were received or accrued during the quarter ended March 31, 2007. The gross profit associated with these returns caused an increase in comparative gross profit of $2.9 million.

3. Price and Cost Increases/Adjustments. In February 2007 Menu followed a leading national brand manufacturer and announced a price increase on aluminum canned cat food sold to its United States private-label customers. This increase was effective in the second quarter of 2007. On a comparative basis to the same quarter in 2007, the costs of certain inputs to production, including raw and packaging materials and labour and benefits, have continued to rise and have increased cost of sales as a result. The price increases referred to above, together with selling price increases to contract manufacturing customers, improved operating efficiencies and other variables, combined to more than offset these cost increases, and increased gross profit by $2.3 million.

In January 2008, Menu followed the leading national brand manufacturers and increased prices to its private-label customers. These price increases, which will be fully implemented during the second quarter, are expected to increase Menu's annualized sales by more than 3% and should enable it to recover some of the cost increases absorbed during the time since the last price increases;

4. Take-or-Pay Agreement. In 2007, the quarter's sales included an accrual under a take-or-pay agreement that did not recur in 2008 and had the effect of decreasing comparative gross profit by $0.5 million;

5. Decrease in Amortization. The incremental amortization arising from capital projects completed in the past year was more than offset by the effect of fully-amortized assets, the sale of the South Dakota facility, the write-down of idle assets and the stronger Canadian dollar, resulting in a decrease in the amortization associated with the cost of goods sold of $1.3 million versus the first quarter of 2007; and

5. Foreign Exchange Effect on Sales. The strengthening of the Canadian dollar relative to the United States dollar during the quarter had the effect of reducing sales by approximately $7.8 million and that translated into a reduction in gross profit of $1.3 million for the quarter ended March 31, 2008.

Selling, general and administrative expenses for the quarter ended March 31, 2008 decreased by $1.5 million compared to the prior year. Savings resulting from the Fund's restructuring initiatives announced on October 10, 2007 (including the sale of its production facility in North Sioux City, South Dakota) accounted for the majority of the decrease. Amortization was $0.5 million less than in 2007, largely as a result of the reduction in amortization associated with fully-amortized assets during the period exceeding amortization associated with newly acquired assets being put into service and as a result of the stronger Canadian dollar. Foreign exchange losses on the United States dollar exposure in working capital in Menu's Canadian operations increased by about $0.4 million compared to last year. Bonus expense, which was negligible in 2007 due to the recall' increased by $0.2 million, compared to the first quarter last year.

As reported last year, as a consequence of the recall, the Fund had to restructure to better align costs with its ongoing business operations. The restructuring initiatives took several forms and under Canadian generally accepted accounting principles, depending upon their nature, were to be both accrued and expensed in 2007 or expensed as incurred in future periods. A further $0.1 million in restructuring costs were expensed during the first quarter of 2008.

During the first quarter of 2007, management estimated that the total costs associated with the product recall would approximate $45 million. This estimate principally comprised product collection, write-off and disposal costs of $36.5 million, the lost margin on returned product of $2.9 million discussed above, $2.4 million to establish and operate a call centre to respond to customer concerns and $3.2 million in professional and associated fees necessary to manage through this difficult process. All but $3.0 million of these costs, which were expensed as incurred later in 2007, were accrued in the first quarter of 2007. The estimate for product recall costs was revised in the fourth quarter of 2007 and adjusted to $55 million.

EBITDA for the quarter ended March 31, 2008 amounted to $5.1 million. In order to have any meaningful comparison to EBITDA in the first quarter of 2007 it is necessary to remove the impacts of the recall as described above. Adjusting for the $42 million in recall related costs in the first quarter of 2007 the foregoing resulted in an adjusted EBITDA (See Note A) of $8.4 million. On this basis, EBITDA during the first quarter of 2008 decreased by $3.3 million (or 39.4%) compared to the same period in 2007.

The strengthening of the Canadian dollar, relative to the United States dollar, has reduced sales, gross margin, selling, general and administrative expenses, amortization, interest and EBITDA. Menu estimates that each change of $0.01 in the cost of the Canadian dollar changes EBITDA by approximately $0.095 million and Distributable Cash (see Note A) by approximately $0.070 million, on a quarterly basis. Menu estimates that the strengthening of the Canadian dollar during the first quarter of 2008 versus the same period in 2007 reduced EBITDA by approximately $1.3 million and Distributable Cash by approximately $1.0 million.

Amortization (which is included in cost of sales and SG&A expense) in the first quarter of 2008 was $1.7 million lower than in 2007. This decrease is directly attributable to fully amortized assets, the sale of the South Dakota facility, the write-down of idle assets and the effects of the strengthening of the Canadian dollar relative to the United States dollar, offset by the additional amortization in 2008 on the $3.0 million of capital expenditures made during the twelve-month period ended March 31, 2008 together with the full-quarter amortization on the $1.8 million of capital expenditures made during the quarter ended March 31, 2007.

Financial expenses were $1.4 million higher during the quarter ended March 31, 2008 than in the first quarter of 2007. The Fund recorded a loss of $1.7 million on interest rate swaps during the first quarter of 2008 compared to a loss of $0.2 million in the same quarter last year. Interest expense increased by $1.0 million, reflecting both the higher interest rates and the higher amounts borrowed this year. Offsetting this comparative increase, the amendments to the Agreements with the Fund's Lenders were such that under Canadian generally accepted accounting principles, for accounting purposes, they resulted in a settlement of the original senior secured notes facility. As a consequence, during the first quarter of 2007 it was necessary to write-off $1.1 million in costs associated with the establishment of the original facility. This compares to the almost $0.2 million in amortization of deferred commitment fees reflected in the quarter ended March 31, 2008 and this accounts for virtually all of the remaining comparative difference.

The Fund operates using a number of different legal structures (e.g. partnerships, trusts, corporations etc.) in a number of jurisdictions. Each of these structures and jurisdictions is subject to income tax at different rates. The effective tax rate can vary from quarter-to-quarter, depending upon the taxing jurisdiction and the legal structure in which the income is earned. Since the Fund has approximately $78.5 million in available tax losses it is not expecting to pay any current income taxes for the foreseeable future.

Loss before non-controlling interest of Class B Exchangeable Units ("Class B Units") for the quarter ended March 31, 2008, was $2.2 million, compared to a loss of $26.6 million for the quarter ended March 31, 2007.

Liquidity

During the quarter ended March 31, 2008, the Fund generated cash flow from operations of $2.1 million that was reduced by a further $1.9 million as a result of changes in non-cash working capital items. The increase in non-cash working capital items related primarily to accounts receivable and inventories. The $1.5 million decrease in accounts receivable reflects the timing of sales during the first quarter of 2008. The Fund invested a further $3.0 million in inventory to service ongoing business. Accounts payable were reduced by $0.9 million, reflecting the payments of certain recall and/or restructuring accruals as well as the timing of inventory and other purchases during the quarter.

No distributions were declared during the first quarter of 2008.

On May 14, 2007 the Fund reached agreement with its Lenders to modify the terms of its existing credit facilities. This arrangement modified the terms governing the US$30 million bank and the non-revolving US$85 million senior secured notes facilities and increased the bank facility by US$20 million. On October 19, 2007 the Fund reached agreement with its Lenders to further modify the terms of its credit facilities given changes in estimated recall costs and the restructuring of the Fund's operations. The available bank facility reduced by US$2.5 million on each of September 30, 2007, October 19, 2007 and March 31, 2008 and will be further reduced by US$2.5 million on June 30, 2008, September 30, 2008, December 31, 2008, March 31, 2009 and June 30, 2009 at which time the additional US$20 million facility will have been extinguished. The Fund had drawn or committed US$34,961 ($35,713) of the US$42.5 million bank facility on March 31, 2008. Cash flow from operations, together with the remaining unutilized bank facilities and working capital management, is expected to be sufficient to fund Menu's normal, ongoing operating requirements and maintenance capital expenditures.

Various legal actions and investigations have been commenced against the Fund as a consequence of the product recall. It is possible that additional actions or investigations may arise in the future. The Fund expects to expend significant amounts and to devote considerable management time to these matters. It is not possible to predict the amount of such expenses, the resolution of any claims or investigations, or the extent to which these items will be paid by insurance. Furthermore, if the actual cost of the recall and restructuring exceed management's estimates of $55 million and $5.4 million respectively or if the degree to which business is re-established is unexpectedly low, the Fund may need to obtain additional credit facilities, although there can be no assurances that such facilities would be available.

Capital Resources

During the quarter ended March 31, 2008, Menu spent $0.8 million on property, plant and equipment. Capital expenditures, which the Fund defines as being of a maintenance nature for purposes of determining Distributable Cash, which totalled $0.6 million for the quarter ended March 31, 2008, were financed from the cash flow of the business. These maintenance capital expenditures were over and above the $2.3 million (2007 - $3.5 million) for labour and parts expended by Menu for the ongoing repairs and maintenance of its plants that have been expensed as part of cost of sales. Capital expenditures of a growth nature totalled $0.2 million for the quarter.


Outstanding Units

The following table highlights the number of units outstanding:



Class B
Trust Units Exchangeable
Units

December 31, 2005 17,766,159 11,133,655
Conversion of Class B Units during the year 1,236,431 (1,236,431)
Options exercised during the year 74,683 -
-------------------------
December 31, 2006 19,077,273 9,897,224
Conversion of Class B Units during the year 1,274,635 (1,274,635)
Options exercised during the year 9,746 -
-------------------------
December 31, 2007 20,361,654 8,622,589
Options exercised during the quarter - -
-------------------------
March 31, 2008 20,361,654 8,622,589
-------------------------
-------------------------


During the year ended December 31, 2007, 390,156 unit options with an exercise price of $7.34 were granted to 47 employees; 18,390 unit options with an exercise price of $3.00 were granted to one employee;. 1,189,300 unit options with an exercise price of $1.82 were granted to 70 employees; and 21,000 unit options with an exercise price of $0.92 were granted to one employee. These options vest in equal annual amounts over three years and will expire 39 months after the day they were granted. During the year ended December 31, 2007; 219,416 unit options with an exercise price of $4.56, 21,000 unit options with an exercise price of $5.00; 21,000 unit options with an exercise price of $6.20; 6,000 unit options with an exercise price of $6.55, and 87,588 unit options with an exercise price of $7.34 were forfeited. During the year ended December 31, 2007, 9,746 options with an exercise price of $4.56 were exercised by one employee.

Controls and Procedures

Multilateral Instrument 52-109 ("MI 52-109") requires the Fund's Chief Executive Officer ("CEO") and Chief Financial Officer ("CFO") to make certain certifications related to the information contained in the Fund's annual filings. Specifically, the CEO and CFO must acknowledge that they are responsible for establishing and maintaining disclosure controls and procedures and internal control over financial reporting for the Fund. In addition, in respect of:

(a) Disclosure Controls and Procedures

The CEO and CFO must certify that they have designed the disclosure controls and procedures, or caused them to be designed under their supervision, to provide reasonable assurance that material information relating to the Fund, including its consolidated subsidiaries, is made known to them in a timely manner.

As at March 31, 2008, the Fund's management, under the supervision of, and with the participation of the CEO and CFO evaluated the design of the disclosure controls and procedures. Based on this evaluation, the CEO and CFO have concluded that as at March 31, 2008, the Fund's disclosure controls and procedures were appropriately designed.

Consistent with the concept of reasonable assurance, the Fund recognizes that the relative cost of maintaining these controls and procedures should not exceed their expected benefits. As such, the Fund's disclosure controls and procedures can only provide reasonable, and not absolute, assurance that the objectives of such controls and procedures are met.

(b) Internal Controls over Financial Reporting

The CEO and CFO must certify that they have designed such internal controls over financial reporting, or caused them to be designed under their supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with Canadian generally accepted accounting principles.

Consistent with the concept of reasonable assurance, the Fund recognizes that the relative cost of maintaining these controls should not exceed their expected benefits. As such, the Fund's internal controls over financial reporting can only provide reasonable, and not absolute, assurance that the objectives of such controls are met.

No material changes were made to the design of the internal controls over financial reporting during the three month period ended March 31, 2008.

Outlook

Product Recall and Litigation

On March 16, 2007 the Fund announced the recall of a portion of the dog and cat food it manufactured between December 3, 2006 and March 6, 2007. This recall was primarily related to "cuts and gravy" style pet food in cans and pouches manufactured at two of the Fund's United States facilities. These products were both manufactured and sold under private-label and were contract-manufactured for some national brands.

On March 24, 2007 the Fund instituted a withdrawal of all varieties of recalled pet food, regardless of the dates, to reduce the risk that any recalled product might remain on the retailer's shelves. On April 5, 2007 Menu expanded the recall to include certain products manufactured by its Emporia, Kansas plant between November 8, 2006 and December 2, 2006. This was necessary to align the Fund's recall with that of the supplier of the adulterated ingredient. On April 10, 2007 Menu expanded the recall to include some limited production from its Streetsville, Ontario facility. Finally, on April 17, 2007, May 2, 2007 and May 22, 2007 the Fund made some further refinements to the list of recalled products.

Throughout this period of time, the Fund worked closely with regulatory authorities and its customers to learn as much as it could about the cause for the recall. It was ultimately determined that the contaminated ingredient was wheat gluten adulterated with melamine and related compounds. This ingredient was imported from China by a broker in the United States. Subsequent to Menu's recall a number of other significant companies in the pet food industry, who had also purchased wheat gluten from this same broker, followed suit and instituted recalls of their own. As it transpired, the Fund, the pet food industry, our customers and consumers were all victims of a fraud of monumental proportions.

The Fund estimates that, based on currently available information, the direct costs associated with this recall, which will be financed from a combination of internally generated cash flow and bank credit facilities, will approximate $55 million, which had a significant impact on the results for the year ended December 31, 2007.

On May 14, 2007 the Fund reached agreement with its Lenders to increase the amount available under the bank facility and on May 14, 2007 and again on October 19, 2007 to modify the terms of its existing facility. Management expects that the direct and indirect costs of the recall will lead to a further utilization of available credit facilities by the Fund. The amended agreements increase the rates of interest paid by the Fund. Both of these changes are expected to increase the Fund's financial expenses going forward.

Lawsuits have been initiated against the Fund and certain of its subsidiaries in the United States and in Canada, which seek to recover damages on behalf of the named plaintiffs and a purported class of pet owners. Furthermore, the U.S. Food and Drug Administration is conducting an investigation into the situation. The United States Attorney for the Western District of Missouri, based in Kansas City has informed Menu that it is the target of a criminal investigation for possible violations of the U.S. federal Food, Drug and Cosmetic Act. It is possible that additional actions or investigations may arise in the future. The Fund expects to expend significant amounts and devote considerable management time to these matters. The Fund cannot predict the amount of such expenses, the resolution of any claims or investigations, the extent to which these items will be paid by the Fund's insurers, or whether the Fund will have sufficient resources to pay any or all of these items.

Initiatives have been ongoing to reach a mediated settlement in respect of the purported class actions referenced above. On April 1, 2008, the parties to the Multi-District Litigation advised the U.S. District Court that their mediation had produced a comprehensive, cross-border agreement in principle between the parties, addressing all major terms of settlement. The settlement in principle is subject to several conditions, including the approval of certain other parties, the execution of a definitive settlement agreement and review and approval of the U.S. District Court and the Canadian courts. The parties advised the court that they were confident that a definitive settlement agreement can be reached. The definitive terms of settlement, together with a motion for preliminary approval thereof will be filed with the U.S. District Court on May 20, 2008, with the hearing to be held on May 30, 2008. The scheduling for Canadian court approval has not yet been determined, but is expected to occur in a similar timeframe.

Customers

During 2007 the Fund was advised that customers whose volume represented approximately 37% of sales in 2006 would no longer be purchasing these products from Menu. The effects of this lost business will be felt over time, with customers who accounted for just over 25% of 2006 volume impacting 2007 and the remainder being lost during 2008 and into 2009. Upon announcing the recall, Menu's customers suspended the purchase of most cuts and gravy products. Management expected that this business would be slowly re-established, with this process having started late in the second quarter of 2007, and that sales for the remainder of the year would be at less than historical levels, as the effects of the recall continued to be felt. The Fund believes that the recall did not cause it to violate any of its contracts with its customers because, among other things, the recall was caused by unforeseen circumstances beyond the Fund's control. However, it is possible that in the future Menu may be found to have breached contracts with one or more of its customers as a result of the recall.

Cost and Price Increases

In respect of its private-label business, in both the United States and Canada, Menu's practice, in order to help ensure that the Fund's products are competitively priced at retail, has been to initiate price increases once leading national brand manufacturers have announced price increases on their products. Typically these increases follow a period of rising costs and consequently are preceded by a time of compressed margins. In some instances, as was the case in 2005, outside factors can allow the period of compression to continue for much longer than would otherwise be the case. Absent regular price increases in the future, Menu expects that the margins on its private-label business will continue to be compressed from time-to-time.

Increasing input costs are a regular part of Menu's business. Rising costs of steel and aluminum mean higher can costs. Higher utility costs, together with increases in medical benefits (escalating at rates well above inflation) and labour, push the cost of operating higher. Higher fuel costs, together with legislation in the United States on work hours for truck drivers and trucking delays crossing the Canadian/United States border similarly increases the cost of delivery. Such cost increases have occurred routinely over the past number of years. Regular price increases are essential to mitigate the effect rising costs have on margins.

For the contract-manufacturing portion of Menu's business, most of these cost increases are automatically passed on to customers (albeit with some timing delays). Consequently, the degree of margin compression is not as severe as it can be in the case of the private-label business.

In January 2008, Menu again followed the leading national brand manufacturers and increased prices to its private-label customers. These price increases are expected to increase Menu's sales by more than 3% and should enable Menu to recover some of the cost increases absorbed during the time since the last price increase. Subsequent to this increase, Menu noted the continued escalation of costs in such inputs as aluminum and steel, diesel fuel and medical benefits. As in the past, these increases are expected to adversely impact the Fund's margin until such time as national brand price increases permit the Fund to once again increase prices.

Bovine Spongiform Encephalopathy ("BSE")

BSE surveillance continues to confirm an extremely low incidence of BSE in North America, with cases in both the U.S. and Canada. Both countries instituted a ruminant feed rule in 1997 as part of their prevention programs. Cases have been identified in Canada in cattle born after the feed ban. In response to this, Canada has announced a strengthening of the feed ban to prevent the addition of specified risk materials (those components of the animal thought to have the highest level of infectivity when consumed) in all animal feed, including pet food. The effective date of implementation was July 12, 2007. This change does not impact the Fund's formulations, as these risk materials are not currently used.

Additionally, the U.S. has published information stating that the BSE agents found in its cases come from a rare strain also seen in France, Sweden and Poland, which is harder to detect and mainly found in older cattle. It is possible that these cases form spontaneously in older cattle without consumption of ruminant material.

The U.S. currently requires companies to obtain import permits for Canadian pet food imported into the country and Canada will shortly impose similar requirements for products manufactured in the U.S. An announcement to be published in the Canada Gazette, outlining the specifics of the program, is expected shortly, after which there will be a grace period, with implementation expected by the summer of 2008.

Subordination and Distributions

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

On May 11, 2005 certain holders of Class B Units (including senior management), representing more than 11 million units, agreed to forego a portion of their distributions until February 2006. Specifically, holders of approximately 3.4 million units agreed to forego all distributions, while holders of approximately 7.7 million units agreed to forego receipt of distributions in excess of $0.02 per unit. Such unitholders are entitled to a reimbursement of such foregone distributions, which at March 31, 2008 amounted to $4.2 million, only to the extent that the Fund generates sufficient Distributable Cash in the future and declares distributions in excess of 9 cents per unit, per month.

Financial Covenants

Most of the Fund's outstanding debt is represented by its bank facility and senior secured notes. As at March 31, 2008, the Fund had $34.9 million drawn on its bank facility and $76.3 million of senior secured notes outstanding. Each of these facilities has financial covenants and cross default provisions that must be met.

The costs associated with the recall announced on March 16, 2007 have been significant and resulted in the Fund not being in compliance with certain financial covenants with its Lenders as at March 31, 2007. Accordingly, on May 14, 2007, the Fund entered into amended Agreements with its Lenders, which among other things; define the terms and conditions governing the Fund's US$30 million bank and non-revolving US$85 million senior secured notes facilities, going forward. In addition, the agreement with the bank was expanded to include a new US$20 million credit facility (subsequently reduced to US$15 million on October 19, 2007 and to US$12.5 million on March 31, 2008). Events after May 14, 2007 resulted in the Fund not being in compliance with these amended terms and on October 19, 2007 the Fund entered into amended Agreements with its Lenders, which among other things, define the terms and conditions governing the Fund's bank and senior secured notes facilities, going forward.

Legislative Changes

Like others in the trust sector, the Fund was impacted by the Canadian Government's decision on October 31, 2006 to introduce a tax on distributions made by publicly traded income trusts. Bill C-52, which, in part, imposes this new tax on income funds and other similar flow through entities, passed fourth reading in the House of Commons on June 12, 2007. To put things in context, it is important to note that the majority of the Fund's business is conducted outside of Canada and that the Fund is taxable in each of the foreign jurisdictions in which it operates. Since the Fund's IPO, for the periods ended December 31, 2002, 2003, 2004 and 2005, the percentage of distributions that were considered "other taxable income" amounted to 22.79%, 22.38%, 21.05% and 34.98%, respectively. Given the difficult conditions experienced in 2005, management does not consider the composition of distributions in that year to be representative of future expectations. Distributions have been suspended since 2005, and the Fund's distribution strategy will not be revisited until such time as distributions are permitted under the covenants with its Lenders. Management's interpretation of the announcements made by the Department of Finance is that it is only this "other taxable income" that will be subject to the proposed tax of 31.5% starting in 2011.

Risks and Uncertainties

Menu and the Fund are subject to numerous risk factors in its ongoing business. These include reliance on key customers, absence of long-term sales contracts, customer performance and relationships, foreign exchange fluctuations, governmental regulations and restrictions, legislative changes, reliance on key suppliers, reliance on key personnel, among others. For a review of some of the risks affecting the business, please refer to notes 24 and 25 to the accompanying consolidated financial statements. Additional information about the Fund is available at www.sedar.com.

In the present economic climate, the most significant risks and uncertainties facing the Fund result from the product recall, including its ultimate final cost, the timing and extent of the resumption of normal business, the extent of any fines or penalties which may be assessed, the cost of any resulting litigation or investigations, including the extent to which these will be covered by insurance, and the impacts of the foregoing on liquidity.

The continued strength of the Canadian dollar relative to the United States dollar and the ongoing inability to pass input cost increases on to private-label customers in a timely manner are more traditional risks facing the Fund. Since a majority of the Fund's operations and assets are in the United States, a "natural" business hedge exists. However, while it is possible, for specified periods, to hedge distributable cash flow against future fluctuations in the currency (as has been done in the past during periods when distributions were being paid), it is not possible to hedge business operations, so a continuation of a strong Canadian dollar will have a negative impact on the relative contribution of the Fund's United States dollar denominated business. Similarly, if the Fund must continue to absorb increased raw material and other costs without the benefit of a timely price increase to its private-label customers, gross margin will be depressed and profitability and the Fund's ability to pay distributions will be curtailed. Given the nature of the industry, price increases are largely beyond Menu's control.

The Fund's Lenders do not permit the Fund to make any monthly distributions unless it is in compliance with the covenants contained in the original Agreements with the Lenders, including a total debt to EBITDA ratio of 3 to 1 or less. There can be no assurance as to either when the Fund will resume monthly distributions, or the amount of the monthly distributions that will be paid at that time.

On October 31, 2006 the Department of Finance (Canada) announced the "Tax Fairness Plan" whereby the income tax rules applicable to publicly traded trusts and partnerships were significantly modified. Bill C-52, which imposes a new tax on distributions of income funds and other similar public flow through entities, passed fourth reading in the House of Commons on June 12, 2007 and is therefore considered substantially enacted under Canadian generally accepted accounting principles. The Fund is considering the possible impact of the new rules. The new rules may adversely affect the marketability of the Fund's units and the ability of the Fund to undertake financings and acquisitions, and, at such time as the new rules apply to the Fund, the distributable cash of the Fund may be reduced.

On March 16, 2007 the Fund announced the recall of a portion of the pet food it manufactured between December 3, 2006 and March 6, 2007. Since March 16, 2007 the recall has been expanded on a number of occasions. The Fund estimates the cost of the recall will be significant. There can be no assurance that these costs will not exceed available resources or that customers affected by the recall will continue to purchase the Fund's products. In addition, there can be no assurance that the customers supplied by the Fund prior to the recall will continue to purchase from the Fund or purchase from the Fund at historical levels. As discussed above, several significant customers have discontinued, or stated their intent to discontinue, all or a portion of their business with Menu.

Lawsuits have been initiated against the Fund and certain of its subsidiaries in the United States and Canada, which seek to recover damages on behalf of the named plaintiffs and a purported class of affected pet owners. Furthermore, the U.S. Food and Drug Administration is conducting an investigation of the situation. The United States Attorney for the Western District of Missouri, based in Kansas City, has informed Menu that it is the target of a criminal investigation for possible violations of the U.S. federal Food, Drug and Cosmetic Act. It is possible that additional actions or investigations may arise in the future. The Fund expects to expend significant amounts and to devote considerable management time to these matters. We cannot predict the amount of such expenses, the resolution of any claims or investigations, the extent of any fines or penalties, or the extent to which these items will be paid by the Fund's insurers.

Initiatives have been ongoing to reach a mediated settlement in respect of the purported class actions referenced above. On April 1, 2008, the parties to the Multi-District Litigation advised the U.S. District Court that their mediation had produced a comprehensive, cross-border agreement in principle between the parties, addressing all major terms of settlement. The settlement in principle is subject to several conditions, including the approval of certain other parties, the execution of a definitive settlement agreement and review and approval of the U.S. District Court and the Canadian courts. The parties advised the court that they were confident that a definitive settlement agreement can be reached. The definitive terms of settlement, together with a motion for preliminary approval thereof, will be filed with the U.S. District Court on May 20, 2008, with the hearing to be held on May 30, 2008. The scheduling for Canadian court approval has not yet been determined, but is expected to occur in a similar timeframe.

In addition to the matters noted above, the Fund is involved in various claims and litigation both as plaintiff and defendant. In the opinion of management, the resolution of claims against the Fund will not result in a material effect on the consolidated financial position of the Fund. Any settlements or awards will be reflected in the consolidated statement of operations as the matters are resolved.

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

Distributable Cash is not a recognized measure under Canadian GAAP. Management believes that together with net income and EBITDA, Distributable Cash is a useful supplemental measure of operating performance, which provides investors with an indication of cash available for distribution after adjusting for maintenance capital expenditures and certain principal repayments. The computation of Distributable Cash in this Management's Discussion and Analysis is in all material respects in accordance with the guidance provided in the CICA's publication "Standardized Distributable Cash in Income Trusts and Other Flow-Through Entities - Management's Discussion and Analysis Guidance on Preparation and Disclosure." and with Canadian Securities Administrator's National Policy 41-201 ("NP 41-201"). The disclosures of Distributable Cash are in all material respects in accordance with NP 41-201.

Distributable Cash per Trust Unit is not a recognized measure under Canadian GAAP. Management believes that together with net income, EBITDA and Distributable Cash, Distributable Cash per Trust Unit is a useful supplemental measure of operating performance. Distributable Cash per Trust Unit, is defined as Distributable Cash divided by the diluted weighted average number of Trust Units outstanding during the period.

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

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



Since
Inception
For the Quarter (May 22,
ended 2002) to
March 31 March 31
2008 2007 2008
$'000's $'000's $'000's
Net loss (2,204) (17,509) (86,544)
Adjust for:
Goodwill impairment loss - - 124,030
Non-controlling interest of Class B
Exchangeable Units - (9,080) (30,210)
Amortization of property, plant and equipment 2,340 3,957 81,453
Amortization of customer relationship - 133 2,789
Unit based compensation 156 81 799
Future income taxes - (14,201) (7,370)
Current income taxes 24 (214) 3,026
Financial expenses 4,699 3,282 46,010
------------------------------
EBITDA 5,015 (33,551) 133,983
Product recall - 42,000 55,000
Restructuring and related expenses 102 - 4,538
------------------------------
Adjusted EBITDA 5,117 8,449 193,521
------------------------------
------------------------------




Since
Inception
For the Quarter (May 22,
ended 2002) to
March 31 March 31
2008 2007 2008
$'000's $'000's $'000's
Cash flow from operating activities 154 1,188 76,486
Adjust for:
Maintenance capital expenditures (619) (463) (14,366)
Principal repayments (7) (6) (601)
------------------------------
Distributable Cash (472) 719 61,519
------------------------------
------------------------------




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

As at
March 31, December 31,
2008 2007
$ $
Assets

Current assets
Cash 267 25
Accounts receivable
Trade 12,486 13,458
Other 469 772
Inventories (note 6) 35,985 31,161
Prepaid expenses and sundry assets 1,813 2,194
--------------------------------------------------------------------------
Total Current Assets 51,020 47,610
Property, plant and equipment (note 7) 65,670 65,915
Assets held for sale (note 7) 3,595 3,339
Goodwill (note 8) 41,357 41,357
Other assets (note 9) 701 840
--------------------------------------------------------------------------
Total Assets 162,343 159,061
--------------------------------------------------------------------------
--------------------------------------------------------------------------

Liabilities

Current liabilities
Bank indebtedness (note 10) 34,870 33,770
Accounts payable and accrued liabilities (note 2) 32,278 31,339
Income taxes payable 755 776
Current portion of long-term debt (note 11) 23 30
--------------------------------------------------------------------------
Total Current Liabilities 67,926 65,915
Long-term debt (note 11) 76,330 74,017
--------------------------------------------------------------------------
Total Liabilities 144,256 139,932
--------------------------------------------------------------------------

Class B Exchangeable Units (note 12) - -
--------------------------------------------------------------------------

Unitholders' Equity

Trust Units (note 13) 176,004 176,004
Contributed surplus (note 15) 814 658
Deficit (146,027) (144,529)
Accumulated other comprehensive loss (note 17) (12,704) (13,004)
--------------------------------------------------------------------------
Total Unitholders' Equity 18,087 19,129
--------------------------------------------------------------------------
Total Liabilities, Class B Exchangeable Units and
Unitholders' Equity 162,343 159,061
--------------------------------------------------------------------------
--------------------------------------------------------------------------

(Contingencies and Commitments - notes 2, 3 and 21)

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




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


Quarter ended March 31,
2008 2007
$ $
Sales 55,581 64,506
Cost of sales (note 20) 48,102 56,747
---------------------------------------------------------------------------
Gross profit 7,479 7,759
Selling, general and administrative expenses 4,858 6,366
---------------------------------------------------------------------------
Income before the undernoted 2,621 1,393
Product recall (note 2) - 39,115
Restructuring and related expenses (note 3) 102 -
Financial expenses (note 18) 4,699 3,282
---------------------------------------------------------------------------
Loss before income taxes and non-controlling
interest (2,180) (41,004)
---------------------------------------------------------------------------
Current income taxes 24 (214)
Future income taxes - (14,201)
---------------------------------------------------------------------------
Total income taxes 24 (14,415)
---------------------------------------------------------------------------
Loss before non-controlling interest (2,204) (26,589)
Non-controlling interest of Class B Exchangeable
Units (note 12) - (9,080)
---------------------------------------------------------------------------
Net loss for the period (2,204) (17,509)
Deficit - beginning of period, as previously
reported (144,529) (82,400)
Impact of change in accounting policies (note 4) 706 -
---------------------------------------------------------------------------
Deficit - end of period (146,027) (99,909)
---------------------------------------------------------------------------
---------------------------------------------------------------------------

Deficit comprises:
Accumulated net loss (85,838) (39,720)
Accumulated distributions (60,189) (60,189)
---------------------------------------------------------------------------
(146,027) (99,909)
---------------------------------------------------------------------------
---------------------------------------------------------------------------

Basic net loss per Trust Unit $ (0.108) $ (0.918)
Diluted net loss per Trust Unit $ (0.108) $ (0.918)

Basic weighted average number of Trust Units
outstanding (note 13) 20,361,654 19,081,280
Diluted weighted average number of Trust Units
outstanding (note 13) 28,984,243 29,244,963




Consolidated Statements of Comprehensive Loss
(All figures expressed in thousands of Canadian
dollars, unaudited)
Quarter ended March 31,
2008 2007
$ $
Net loss for the period (2,204) (17,509)
Other comprehensive (loss) income, net of tax of
$nil (2007 - $nil):
Unrealized gains (losses) on translating financial
statements of self
sustaining foreign operations 4,168 (958)
Gains (losses) on hedges of unrealized foreign
currency translation (3,868) 607
---------------------------------------------------------------------------
Comprehensive loss for the period (1,904) (17,860)
---------------------------------------------------------------------------
---------------------------------------------------------------------------

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




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

Quarter ended March 31,
2008 2007
$ $
Cash provided by (used in)
Operating activities
Net loss for the period (2,204) (17,509)
Adjustments for non-cash items
Non-controlling interest of Class B Exchangeable Units - (9,080)
Amortization of property, plant and equipment 2,340 3,957
Amortization of customer relationship - 133
Interest accretion and amortization of deferred
commitment fees 182 1,176
Unit-based compensation 156 81
Gain on sale of property, plant and equipment - (6)
Mark-to- market adjustment (note 24) 1,670 216
Future income taxes - (14,201)
---------------------------------------------------------------------------
2,144 (35,233)

Change in non-cash working capital items
Accounts receivable 1,546 20,973
Inventories (2,963) (783)
Accounts payable and accrued liabilities (944) 16,363
Prepaid expenses and sundry assets 389 186
Income taxes (18) (318)
---------------------------------------------------------------------------
154 1,188
---------------------------------------------------------------------------
Financing activities
Change in bank indebtedness 842 (1,781)
Issuance of Trust Units, net - 44
Long-term debt repayments (7) (6)
---------------------------------------------------------------------------
835 (1,743)
---------------------------------------------------------------------------
Investing activities
Purchase of property, plant and equipment (751) (1,801)
Proceeds from sale of property, plant and equipment 4 30
---------------------------------------------------------------------------
(747) (1,771)
---------------------------------------------------------------------------
Increase (decrease) in cash 242 (2,326)
Cash - beginning of period 25 2,813
---------------------------------------------------------------------------
Cash - end of period 267 487
---------------------------------------------------------------------------
---------------------------------------------------------------------------

Supplementary information

Income taxes paid 62 76
Interest paid 2,881 1,865

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


Menu Foods Income Fund

Notes to Consolidated Financial Statements March 31, 2008

(All figures, except Unit and per Unit amounts, expressed in thousands of Canadian dollars, unaudited)

1. Description of the business

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

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

2. Product recall, litigation and going concern

On March 16, 2007, the Fund announced the recall of a portion of the dog and cat food it manufactured between December 3, 2006 and March 6, 2007. Other products and dates of manufacture were added to the recall on April 5, April 10, April 17, May 2 and May 22, 2007 and the Fund announced a voluntary withdrawal of certain products on March 24, 2007. The recalls and withdrawal related primarily to "cuts and gravy" style products manufactured by Menu, but included certain other products as well. These products were manufactured and sold under private-label and contract manufactured for some national brands.

Management originally estimated that the costs associated with the recalls and withdrawal noted above would amount to approximately $45,000. On October 10, 2007 this estimate was increased to $55,000. The costs associated with the recall, including the increase in the estimated cost, resulted in the Fund not being in compliance with certain financial covenants included in the loan agreements with its lenders.

Accordingly, on May 14, 2007 and again on October 19, 2007, the Fund entered into amended agreements with its lenders, which among other things, defined the terms and conditions governing the Fund's US$30,000 bank facility (expanded to US$50,000 with a new US$20,000 credit facility on May 14, 2007 and subsequently reduced to US$45,000 on October 19, 2007 and further reduced to US$42,500 on March 31, 2008) and non-revolving US$85,000 senior secured notes facility. The amendments to the senior secured notes facility on May 14, 2007 were such that under Canadian generally accepted accounting principles they resulted in a deemed settlement of the original facility, necessitating a write-off of $1,101 in previously capitalized costs (note 11).

The estimated product recall costs are based on the best information currently available to the management of the Fund. The above-noted estimate of $55,000 remains unchanged as at March 31, 2008. The ultimate determination of these costs is dependent on the amount of product actually returned, the actual extent of customer fines and penalties and certain other factors. Accordingly, actual amounts could differ from these estimates and the differences could be significant. Furthermore, even with the new credit facility the ongoing impact of the product recall, especially as it relates to returning to normalized business, could have a significant effect on the liquidity of

The recall costs noted above include product collection, customer fines and penalties, write-off and disposal costs of $46,455, period costs associated with the recall of $3,000, lost margin on returned product of $2,885, $2,400 to establish and operate a call centre to respond to consumer concerns and $260 in professional and associated fees necessary to manage through this difficult process. As at March 31, 2008, the Fund has incurred $44,004 of actual recall costs, including inventory write-offs, and has accrued a further $10,996 in accrued liabilities for costs not yet incurred in connection with the recall.

Lawsuits have been initiated against the Fund and certain of its subsidiaries in the United States and Canada, which seek to recover damages on behalf of the named plaintiffs and a purported class of affected pet owners. Furthermore, the U.S. Food and Drug Administration is conducting an investigation of the situation. In addition, the United States Attorney for the Western District of Missouri based in Kansas City has informed Menu that it is the target of a criminal investigation for possible violations of the U.S. Federal Food, Drug and Cosmetic Act. It is possible that additional actions or investigations may arise in the future. The Fund expects to expend significant amounts and to devote considerable management time to these matters. The Fund cannot predict the amount of such expenses, the resolution of any claims or investigations, possible fines or penalties that might result, or the extent to which these items will be paid by the Fund's insurers or whether the Fund will have sufficient resources to pay any of these claims. Costs to the Fund are being expensed as incurred or committed.

Initiatives have been ongoing to reach a mediated settlement in respect of the purported class actions referenced above. On April 1, 2008, the parties to the Multi-District Litigation advised the U.S. District Court that their mediation had produced a comprehensive, cross-border agreement in principle between the parties, addressing all major terms of settlement. The settlement in principle is subject to several conditions, including the approval of certain other parties, the execution of a definitive settlement agreement and review and approval of the U.S. District Court and the Canadian courts. The parties advised the court that they are confident that a definitive settlement agreement can be reached. The definitive terms of settlement, together with a motion for preliminary approval thereof, are scheduled to be filed with the U.S. District Court on May 20, 2008, with the hearing scheduled to occur on May 30, 2008. The scheduling for Canadian court approval has not yet been determined, but is expected to occur

In addition to the matters noted above, the Fund is involved in various claims and litigation, both as plaintiff and defendant. In the opinion of management, the resolution of claims against the Fund will not result in a material effect on the consolidated financial position of the Fund. Any settlements or awards will be reflected in the consolidated statement of operations as the matters are resolved.

Given the restructuring activities (note 3) and based on current forecasts, management believes that the Fund will generate sufficient income and cash flows to discharge its obligations as they become due in the normal course of operations and that the Fund will not require any significant additional credit facilities. However, given the significant uncertainty of this situation and the legal and regulatory matters referred to above, there is no assurance that additional financing will not be required, nor that it will be available to the Fund, if needed.

These consolidated financial statements have been prepared in accordance with Canadian generally accepted accounting principles on a going concern basis. The Fund's ability to continue as a going concern is dependent on the success of future operations, the continued support of the Fund's lenders and the outcome of litigation and investigations. If the going concern assumption was not appropriate for these consolidated financial statements, then adjustments, which could be material, would be necessary to the carrying values of assets, liabilities, the reported net loss and the balance sheet classifications used.

3. Restructuring and related expenses

As a consequence of the product recalls, the Fund had to restructure its operations to better align costs with its ongoing business. The restructuring initiatives took several forms and under Canadian generally accepted accounting principles, depending upon their nature, were recognized in 2007, the first quarter of 2008 or in future periods. While most of these initiatives were accounted for and completed in 2007, some will not be completed until later in 2008 or thereafter. To date, in aggregate these activities resulted in a net restructuring expense of $4,539, of which $102 was expensed during the first quarter of 2008, and, principally as a result of sales of assets, have generated approximately $22,090 in cash (net of $1,142 in lenders' fees). As at March 31, 2008 the accrual for restructuring amounted to $1,227 (December 31, 2007 - $1,666).

Specifically:

(a) Since March 16, 2007, the Fund has been advised that customers who represented approximately 37% of sales volume in 2006 will no longer be purchasing those products from Menu. This has caused the Fund to write-down certain assets associated with these customers and to write-down or sell other assets that are no longer required given the down-sizing of the business;

(b) On August 9, 2007, Menu entered into agreements to release a customer from certain contractual obligations and to sell it a production facility and certain other assets for aggregate cash proceeds of US$26,300; and

(c) On October 10, 2007, the Fund announced a formal plan to restructure operations.

4. Changes in accounting policies and new accounting pronouncements

On January 1, 2008, the Fund adopted Canadian Institute of Chartered Accountants ("CICA") Handbook Section 1400, General Standards of Financial Statement Presentation; Section 1535, Capital Disclosures; Section 3031, Inventories; Section 3064, Goodwill and Intangible Assets; Section 3862, Financial Instruments -- Disclosures; and Section 3863, Financial Instruments -- Presentation.

Section 1400 provides revised guidance related to management's responsibility to assess and disclose the ability of an entity to continue as a going concern.

Section 1535 establishes disclosure requirements about an entity's capital and how it is managed. The purpose of this section is to enable users of the financial statements to evaluate objectives, policies and processes for managing capital.

Section 3031 replaces Section 3030 - Inventories, revising and enhancing guidance on the disclosure and determination of inventory costing.

Section 3064 replaces Section 3062 -- Goodwill and Other Intangible Assets and Section 3450 -- Research and Development Costs. This new section establishes standards for the recognition, measurement and disclosure of goodwill and other intangible assets.

Sections 3862 and 3863 replace Section 3861- Financial Instruments - Disclosure and Presentation, revising and enhancing its disclosure requirements while carrying forward its presentation requirements. These new sections place increased emphasis on disclosure about the nature and extent of risks arising from financial instruments and how the entity manages those risks.

These new standards have generally enhanced the disclosures in these financial statements when compared to the disclosures in the financial statements for the year ended December 31, 2007. Comparative figures have not been restated and have not affected the Fund's results or cash flows from operations. The opening deficit was decreased by $706 upon adoption of Section 3031.

Recent Canadian accounting pronouncements issued and not yet adopted

The Accounting Standards Board (the "AcSB") has adopted a strategic plan that will have Canadian GAAP converge with International Financial Reporting Standards ("IFRS") effective January 2011. The Fund will commence its planning and transition from Canadian GAAP to IFRS during 2008.

5. Summary of significant accounting policies a) Basis of presentation

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

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

These consolidated financial statements are based on accounting principles consistent with those used and described in the annual consolidated financial statements as at December 31, 2007 except as discussed in note 4, and should be read in conjunction with those consolidated financial statements. The disclosures contained in these unaudited interim consolidated financial statements may not include all requirements of Canadian generally accepted accounting principles for annual statements.

Accounting measurements at interim dates involve greater reliance on estimates than at year-end. In the opinion of management, the accompanying unaudited interim consolidated financial statements include all adjustments of a normal recurring nature to present fairly the financial position of the Fund as at March 31, 2008.

b) Use of estimates

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

c) Cash and cash equivalents

Deposits in banks and short-term investments with original maturities of three months or less are considered cash and cash equivalents. Cash equivalents are carried at fair value.

d) Inventories

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

e) Property, plant and equipment

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



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


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

f) Income taxes

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

g) Research and development

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

h) Other financial liabilities and transaction costs

The Fund classified long-term debt as other financial liabilities, which are measured at amortized cost. Transaction costs, which are netted against the carrying value of the long-term debt are amortized using the effective interest rate method, and are included in financial expenses.

i) Goodwill

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

j) Foreign currency translation

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

The assets and liabilities of all foreign subsidiaries, which are considered to be self-sustaining operations, are translated at the exchange rate in effect at the consolidated balance sheet date. Revenues and expenses are translated at average exchange rates prevailing during the period. The Fund has designated its United States dollar indebtedness, to a maximum of US$85 million, as a hedge of its net investment in the United States. The indebtedness is translated at the exchange rate in effect at the consolidated balance sheet date. The resulting gains or losses, together with the related income taxes, are included in the foreign currency translation adjustment in the consolidated statement of other comprehensive income.

k) Revenue recognition

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

l) Supplier rebates

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

m) Unit-based compensation

The Fund expenses awards made under its unit-based compensation plans in accordance with the fair value based method.

n) Asset retirement obligations

The fair value of any liability for an asset retirement obligation is recognized in the period in which it is incurred, if a reasonable estimate of fair value can be made. The associated retirement costs are capitalized as part of the carrying amount of the long-lived assets and amortized over the life of the asset. As at March 31, 2008, the Fund has concluded that there were no asset retirement obligations associated with its assets.

o) Financial Instruments

The Fund designates its cash as held-for-trading, which is measured at fair value. Accounts receivable are classified as loans and receivables, which are measured at amortized cost. Bank indebtedness, accounts payable and accrued liabilities and long-term debt are classified as other financial liabilities, which are recorded at amortized cost. Derivative instruments are recorded in the statement of operations at fair value except for contracts entered into for the purposes of the Fund's own usage requirements. The Fund uses interest rate swaps to fix interest rates on a portion of its indebtedness.

6. Inventories



As at March 31, As at December 31,
2008 2007
$ $
Raw materials and packaging 11,987 8,488
Finished goods 23,998 22,673
----------------------------------------------------------------------
35,985 31,161
----------------------------------------------------------------------
----------------------------------------------------------------------


7. Property, plant and equipment



As at March 31, 2008

Accumulated
Cost amortization Net
$ $ $
Land 4,100 - 4,100
Buildings 37,949 7,459 30,490
Machinery and equipment 81,869 50,998 30,871
Other property and equipment 16,189 13,831 2,358
Construction-in-progress 1,446 - 1,446
--------------------------------------------------------------
141,553 72,288 69,265
Less:
Buildings held for sale 3,911 316 3,595
--------------------------------------------------------------
137,642 71,972 65,670
--------------------------------------------------------------
--------------------------------------------------------------


As at December 31, 2008

Accumulated
Cost amortization Net
$ $ $
Land 4,044 - 4,044
Buildings 37,045 6,970 30,075
Machinery and equipment 79,429 48,079 31,350
Other property and equipment 16,201 13,475 2,726
Construction-in-progress 1,059 - 1,059
---------------------------------------------------------------
137,778 68,524 69,254
Less:
Building held for sale 3,609 270 3,339
---------------------------------------------------------------
134,169 68,254 65,915
---------------------------------------------------------------
---------------------------------------------------------------


8. Goodwill

When the Fund purchased its interest in Menu Foods Limited Partnership, $165,387 of the purchase price was assigned as goodwill in the consolidated financial statements. Under Canadian generally accepted accounting principles, goodwill is subject to an annual impairment test, which, for the Fund, takes place as at September 30th of each year, unless events indicate that an impairment has arisen at some other time. An assessment of the carrying value of goodwill was carried out in 2005, resulting in a writedown of $93,415. The annual impairment test as at September 30, 2007 did not identify any further impairment. Since the Fund's units were trading at lower than their book value at December 31, 2007, another assessment of goodwill was carried out at that time. Following a fair value assessment of the Fund's assets and liabilities, goodwill was written down, for the year ended December 31, 2007 by $30,615. This charge was a non-cash item and did not impact the Fund's credit facilities. The carrying value of goodwill is $41,357 as at March 31, 2008 and December 31, 2007.

9. Other assets




As at March 31, As at December 31,
2008 2007
$ $
Deferred commitment fees (note 10)
Cost 1,009 1,037
Accumulated amortization (308) (197)
-----------------------------------------------------------------------
701 840
-----------------------------------------------------------------------
-----------------------------------------------------------------------


10. Bank indebtedness

The banking agreement provides the Fund with a US$42,500 (December 31, 2007 - US$45,000) operating facility of which $34,870 (US$34,136) was drawn upon as at March 31, 2008 (December 31, 2007 - $33,770 (US$34,066)). At March 31, 2008, the Fund had an outstanding irrevocable letter of credit in the amount of $843 (US$825) (December 31, 2007 - $818 (US$825)) which further reduces the amount available under the facility.

The costs associated with the product recalls first announced on March 16, 2007 (note 2) were significant and resulted in the Fund not being in compliance with certain financial covenants with its bank and senior secured noteholders (note 11) (the "Lenders") as at March 31, 2007. Accordingly, on May 14, 2007, the Fund entered into amended agreements (the "Agreements") with its Lenders that, among other things, defined the terms and conditions governing the Fund's US$30,000 bank and US$85,000 senior secured notes facilities (note 11) going forward. In addition, the agreement with the bank was extended to June 30, 2009 and expanded to include a new US$20,000 credit facility.

Increases in the estimated costs associated with the product recall (note 2), together with the restructuring (note 3) necessary as a consequence of the product recall, once again resulted in the Fund not being in compliance with certain financial covenants with its Lenders during the quarter ended September 30, 2007. On October 19, 2007 the Fund entered into amended agreements with its Lenders that, among other things, define the terms and conditions governing the Fund's bank operating and senior secured notes facilities going forward. Furthermore, on October 19, 2007 the new US$20,000 credit facility was reduced to US$15,000 and on March 31, 2008 the credit facility was reduced by another US$2,500 and will be reduced by US$2,500 on each calendar quarter end until this portion of the facility is extinguished.

Pursuant to its amended banking agreement, this operating facility bears interest at Canadian prime rate (5.25% as at March 31, 2008) plus 3.5%, U.S. base rate (5.25% as at March 31, 2008) plus 3.5% or Euro rate (2.69% as at March 31, 2008) plus 4.75% (the "Base Rates") depending on the currency advanced. These interest rates will continue to apply until the additional US$20,000 facility is extinguished and the balance owing under the US$30,000 facility is less than US$15,000 for five consecutive business days and the Fund achieves a total debt to EBITDA (a non-GAAP measure that is defined in the amended banking agreement) ratio (the "Leverage Ratio"), on a trailing twelve months basis, of 3 to 1 or less, at which time the interest rates will revert to those set out in the Fund's credit facilities prior to amendment, provided that there are no other defaults. The Fund is precluded from paying distributions to its Unitholders at any time the Leverage Ratio exceeds 3 to 1.

Certain of the pre-existing covenants have been suspended until such time as the recall costs no longer impact the Fund's Leverage Ratio and until the additional US$20,000 facility is extinguished and the balance owing under the US$30,000 facility is less than US$15,000 for five consecutive business days and the Fund achieves a Leverage Ratio, on a trailing twelve months basis, of 3 to 1 or less. In addition, EBITDA before recall and restructuring costs and operating leases must be at least $5,000 for the quarter ended March 31, 2008; $10,000 for the six months ending June 30, 2008; $15,000 for the nine months ending September 30, 2008; and $20,000 on a trailing twelvemonths basis each quarter thereafter. Under the terms of the amended agreements, not more than $55,000 may be utilized by the Fund for recall-related costs and restructuring costs should approximate $4,000, upon completion of the restructuring. These changes are consistent with the terms and conditions governing the senior secured notes (note 11).

The amended agreement of May 14, 2007 required the Fund to pay commitment fees to the bank of $412 (US$380), plus all associated professional costs. The amended agreement of October 19, 2007 required the Fund to pay commitment fees to the bank of $625, plus all associated professional costs. These fees are recorded in Other assets and are amortized on a straight-line basis over the life of the credit facility (note 9).

Certain bank indebtedness has been identified as priority indebtedness under an agreement between the bank and senior secured noteholders. Otherwise, the Fund has pledged, on a pari passu basis with its senior secured noteholders, as security for bank indebtedness, all moveable property and book debts and, in addition, has signed a general security agreement.

11. Long-term debt


As at March 31, As at December 31,
2008 2007
$ $
Senior secured notes (a) 76,330 74,017
Obligation under capital lease (b) 23 30
----------------------------------------------------------------------
76,353 74,047
Less: Current portion 23 30
----------------------------------------------------------------------
76,330 74,017
----------------------------------------------------------------------
----------------------------------------------------------------------

a) Senior secured notes
As at March 31, As at December 31,
2008 2007
$ $
Senior secured notes 76,773 74,504
Transaction costs (443) (487)
----------------------------------------------------------------------
76,330 74,017
----------------------------------------------------------------------
----------------------------------------------------------------------


On October 31, 2003, the Fund closed a private placement offering for US$85,000 in non-revolving floating rate senior secured notes (the "Notes Facility"). The notes, of which US$75,157 was outstanding at March 31, 2008 and December 31, 2007, are repayable on October 31, 2010, with interest payable quarterly. Certain bank indebtedness has been identified as priority indebtedness under an agreement between the bank and senior secured noteholders. Otherwise, the Fund has pledged, on a pari passu basis with its bank, as security for its senior secured notes, all moveable property and book debts and, in addition, has signed a general security agreement.

The Fund was not in compliance with certain financial covenants with its Lenders as at March 31, 2007 and during the quarter ended September 30, 2007. Accordingly, on May 14, 2007 and again on October 19, 2007, the Fund entered into amended agreements with its Lenders that, among other things, define the terms and conditions governing the Fund's bank operating and senior notes facilities going forward. The amendments are more fully described in note 10.

Pursuant to the terms of the Agreements, the Notes Facility now bears interest at floating rate, three-month LIBOR plus 580 basis points. This rate will continue to apply until the additional US$20,000 bank facility is extinguished and the balance owing under the US$30,000 bank facility is less than US$15,000 for five consecutive business days and the Fund achieves a Leverage Ratio, on a trailing twelve months basis, of 3 to 1 or less, at which time the interest rates will revert to those set out in the Fund's existing Notes Facility, provided that there are no other defaults. The Fund is precluded from paying distributions to its Unitholders at any time the Leverage Ratio exceeds

Certain of the pre-existing covenants have been suspended on an identical basis with those of the bank, as described in note 10. Furthermore, under the terms of the amended agreements, not more than $55,000 may be utilized by the Fund for recall-related costs and restructuring costs should approximate $4,000 upon completion of the restructuring. The amended agreement of October 19, 2007 required the Fund to pay fees and expenses to the senior secured noteholders of $515 (US$517). These transaction costs are netted against the senior secured notes and are being amortized until October 31, 2010 using the effective interest method.

The amendments to the Agreements with the Fund's Lenders completed on May 14, 2007 were such that under Canadian generally accepted accounting principles, they resulted in a deemed settlement of the original senior secured notes facility. As a consequence, it was necessary to write-off the remaining $1,101 in costs associated with the establishment of the original facility (note 2).

During the quarter ended March 31, 2006, the Fund fixed interest rates at 5.35% plus the applicable spread on US$50,000 through to October 2010 (note 24).

b) Obligation under capital lease

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



Minimum lease payments:

As at As at
March 31, 2008 December 31, 2007

$ $

2008 24 31
--------------------------------------------------------------------------
Total minimum lease payments 24 31
Less: Amounts representing interest
at 10.40% 1 1
--------------------------------------------------------------------------
Balance of obligation 23 30
Less: Current portion 23 30
--------------------------------------------------------------------------
- -
--------------------------------------------------------------------------
--------------------------------------------------------------------------




12. Class B Exchangeable Units

Number Carrying
of units value
$
Class B Exchangeable Units of MFLP
January 1, 2007 9,897,224 27,823
Conversion of Class B Exchangeable Units to Trust
Units (note 13) (1,274,635) (1,302)
Share of net loss for the year (23,138)
Share of net foreign currency translation
adjustment for the year (3,383)
--------------------------------------------------------------------------
December 31, 2007 8,622,589 -
Share of net loss for the period -
Share of net foreign currency translation
adjustment for the period -
--------------------------------------------------------------------------
March 31, 2008 8,622,589 -
--------------------------------------------------------------------------
--------------------------------------------------------------------------


The Class B Exchangeable Units together with their related Special Trust Units (note 13) can be exchanged on a one-for-one basis with the Fund for Trust Units at the option of the holder.

A portion of the gains or losses arising from the translation of foreign subsidiaries is included in accumulated other comprehensive loss in unitholders' equity. The foreign currency translation adjustment is allocated between the Class B Exchangeable units and unitholders' equity on a pro-rata basis.

Under Canadian generally accepted accounting principles, when the losses applicable to the non-controlling interest exceed their investment in the Fund's units, the excess and any further losses applicable to the non-controlling interest are allocated to the Trust Unitholders. This process continues until such time as all previously absorbed losses are recovered by the Trust Unitholders. As at March 31, 2008 these unabsorbed losses amount to $4,687 (December 31, 2007 - $4,084).

During the second quarter of 2005, certain holders of Class B Exchangeable Units agreed to subordinate their entitlement to distributions for a ten-month period beginning with the distributions in respect of the month of May 2005 and ending with the distributions in respect of the month of February 2006. Distributions subordinated amounted to $4,151. Such Unitholders are entitled to a reimbursement of such subordinated distributions before distributions can be increased above 9 cents per unit, per month. No obligation arises to the Fund in respect of these subordinated amounts until it has generated sufficient distributable cash and declares distributions in excess of 9 cents per unit, per month. Accordingly, no amount has been accrued in distributions payable at March 31, 2008 and December 31, 2007.

The Class B Units have economic and voting rights equivalent, in all material respects, to the Trust Units.

13. Trust Units



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

Issued

Gross Issuance Net
Number of proceeds costs proceeds
units $ $ $
Trust Units
January 1, 2007 19,077,273 185,948 11,300 174,648
Conversion of Class B
Exchangeable Units during the
quarter ended (note 12)
December 31, 2007 1,274,635 1,302 - 1,302
Exercise of options during the
quarter ended (note 15)
March 31, 2007 9,746 54 - 54
------------------------------------------------------------------------
December 31, 2007 and March 31,
2008 20,361,654 187,304 11,300 176,004
------------------------------------------------------------------------
------------------------------------------------------------------------


Special Trust Units

Special Trust Units are used solely for providing voting rights to the holders of Class B Exchangeable Units ("Class B Units") (note 12) and by their terms have voting rights of the Fund. Special Trust Units are not transferable separately from the Class B Units to which they relate. Conversely, the Special Trust Units will automatically be transferred upon a transfer of the associated Class B Units. Each Special Trust Unit entitles the holder thereof to a number of votes at any meeting of Unitholders and holders of Special Trust Units equal to the number of Units that may be obtained upon the exchange of the Class B Units to which the Special Trust Unit relates, but do not otherwise entitle the holder to any rights with respect to the Fund's property or income. The Fund issued 12,631,915 Special Trust Units relating to the Class B Units at the date of acquisition of Menu. There were 8,622,589 Special Trust Units outstanding as at December 31, 2007 and March 31, 2008 (note 12).

Weighted average number of Units outstanding

Basic net income (loss) per Trust Unit is computed by dividing net income (loss) for the period by the weighted average number of Trust Units outstanding during the period. Diluted net income (loss) per Trust Unit includes the effect of exercising unit options (note 15), only if dilutive, and includes the Class B Exchangeable Units using the "if converted" method.

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



Quarter ended March 31,
2008 2007
Weighted average number of Trust Units
outstanding - basic 20,361,654 19,081,280
Weighted average number of Class B Units
outstanding - basic (note 12) 8,622,589 9,897,224
Dilutive effect of options (note 15) - 266,459
--------------------------------------------------------------------------
Weighted average number of units outstanding -
diluted 28,984,243 29,244,963
--------------------------------------------------------------------------
--------------------------------------------------------------------------


14. Distributions

No distributions were declared on either the Trust Units or the Class B Units during the quarters ended March 31, 2008 and 2007.

15. Unit-based compensation

Unit option plan

The option plan under which these options were granted, which authorizes 2,815,000 units, was approved by the Unitholders at the Annual and Special Meeting of the Fund held on May 11, 2006. Compensation expense of $156 was recognized for the quarter ended March 31, 2008 (2007 - $81) which was added to contributed surplus. Total compensation expense to be recognized under these awards is estimated to be $2,236. All options expire 39 months after the date of grant, if not exercised.

The fair value of the Trust Unit options issued in 2006 was determined using the Black-Scholes model, incorporating a 3.90% risk free interest rate, a 34% volatility factor, 3.33% expected distributions and expected life of 39 months. On this basis, each Trust Unit option was valued at $1.02.

The fair value of the Trust Unit options issued in the quarter ended March 31, 2007 was determined using the Black-Scholes model, incorporating a 4.05% risk free interest rate, a 31% volatility factor, 4.2% expected distributions and expected life of 39 months. On this basis, each Trust Unit option was valued at $1.40.

The fair value of the Trust Unit options issued in the quarter ended December 31, 2007 was determined using the Black-Scholes model, incorporating a 3.92% risk free interest rate, a 43% volatility factor, 0.0% expected distributions and expected life of 39 months. On this basis, each Trust Unit option was valued at $0.63.

A summary of option activities since January 1, 2007 is as follows:



Weighted
Range of average
Number exercise exercise
of options prices prices
$ $
January 1, 2007 956,296 4.56-6.55 4.62
Options granted during the quarter
ended
March 31, 2007 390,156 7.34 7.34
September 30, 2007 18,390 3.00 3.00
December 31, 2007 1,189,300 1.82 1.82
21,000 0.92 0.92
Options forfeited during the
quarter ended
December 31, 2007 (219,416) 4.56 4.56
(21,000) 5.00 5.00
(6,000) 6.55 6.55
(21,000) 6.20 6.20
(87,588) 7.34 7.34
Options exercised during the
quarter ended
March 31, 2007 (9,746) 4.56 4.56
--------------------------------------------------------------------
December 31, 2007 2,210,392 0.92-7.34 3.42
Options forfeited during the
quarter ended
March 31, 2008 (42,000) 4.56 4.56
(22,800) 7.34 7.34
(22,800) 1.82 1.82
--------------------------------------------------------------------
March 31, 2008 2,122,792 0.92-7.34 3.37
--------------------------------------------------------------------
--------------------------------------------------------------------




The outstanding options are summarized as follows:



Options outstanding Vested options outstanding

Number Weighted average Number Weighted average
remaining life remaining life
Exercise
price
4.56 631,134 14 months 305,881 14 months
5.25 6,000 14 months 4,000 14 months
7.34 279,768 26 months 93,256 26 months
3.00 18,390 31 months - -
1.82 1,166,500 35 months - -
0.92 21,000 36 months - -
---------------------------------------------------------------------------
2,122,792 27 months 309,881 18 months
---------------------------------------------------------------------------
---------------------------------------------------------------------------

Contributed surplus attributed to Trust Unit options

As at March 31, As at December 31,
2008 2007
$ $
Opening balance 658 272
Compensation expense recognized for unit
options during the period 156 396
Options exercised - (10)
----------------------------------------------------------------------------
Ending balance 814 658
----------------------------------------------------------------------------
----------------------------------------------------------------------------


As the Trust Unit options are exercised, the associated contributed surplus is reclassified to Trust Units (note 13).

16. Capital Management

The Fund views its capital as the combination of its bank indebtedness and senior secured notes ("Indebtedness"), Class B Exchangeable Units and equity balances. In general, the overall capital of the Fund is determined and evaluated in the context of its financial objectives and its strategic plan.

The appropriate level of Indebtedness is assessed with reference to expected cash flows and the Fund's overall business needs and risks. In addition, the Fund's Indebtedness is subject to a number of covenants and restrictions including the requirement to meet certain financial ratios. One such ratio is the Leverage Ratio as defined in the Agreements with the Fund's lenders. The Fund is precluded from paying distributions to its Unitholders at any time the Leverage Ratio, on a trailing twelve-month basis, exceeds 3 to 1. The $55 million in recall related costs expensed in 2007, together with the impact of the recalls on the operations for the year, significantly increased the Fund's Indebtedness.

The Leverage Ratio for the twelve months ended March 31, 2008 was 4.11 (December 31, 2007 -- 3.50) . Furthermore, as described more fully in note 10, the Fund is required to have EBITDA before recall and restructuring costs and operating leases of: $5 million for the quarter ended March 31, 2008; $10 million for the six months ending June 30, 2008; $15 million for the nine months ending September 30, 2008; $20 million for the twelve months ending December 31, 2008; and $20 million on a trailing twelve-months basis each quarter.

In common with other income trusts, the Fund uses its cash flow from operations to invest in capital projects, repay Indebtedness and pay distributions to its Unitholders. For the foreseeable future cash flow will primarily be used to reduce Indebtedness and finance maintenance capital expenditures until such time as the Leverage Ratio, on a trailing twelve-month basis, is less than 3 to 1.

For the time being, the equity component of capital, which was seriously depleted as a consequence of the events in 2007, will only increase by the amount of income earned and retained by the business. Since cash flow from operations generated by the Fund will be used to reduce the Indebtedness component of capital, the Fund's overall capital will decrease, but the Leverage Ratio will improve. The Fund will review its level of equity in light of its ongoing performance and future needs and opportunities and additional equity may be issued if deemed appropriate or necessary.

17. Accumulated other comprehensive loss



As at As at
March 31, December 31,
2008 2007
$ $
Unrealized losses on translating financial
statements of self-sustaining foreign operations (35,235) (39,403)
Gains on hedges of unrealized foreign currency
translation, net of tax 22,531 26,399
---------------------------------------------------------------------------
(12,704) (13,004)
---------------------------------------------------------------------------
---------------------------------------------------------------------------




18. Financial expenses


Quarter ended March 31,
2008 2007
$ $
Interest and accretion on senior secured notes 2,054 2,735
Interest on bank indebtedness 971 328
Net loss on interest rate swap 1,670 216
Other, net 4 3
---------------------------------------------------------------------
4,699 3,282
---------------------------------------------------------------------
---------------------------------------------------------------------


19. Income taxes

On October 31, 2006, the Department of Finance (Canada) announced tax proposals pertaining to the taxation of income distributed by publicly listed trusts and the tax treatment of trust distributions to their unitholders. On June 12, 2007 the draft legislation, which had been issued on December 31, 2006 passed fourth reading in the House of Commons, and is therefore considered substantively enacted under Canadian generally accepted accounting principles. The new legislation will apply to the Fund effective January 1, 2011 and will result in a portion of the Fund's income being subject to tax at the trust level.

Until 2011, income tax obligations relating to distributions from the Fund are obligations of the Unitholders and, accordingly, no provision for income taxes is made in respect of distributed income of the Fund. A provision for income taxes is recognized for the Fund's subsidiaries that are subject to tax.

The provision for income taxes in the consolidated statements of operations and deficit reflects an effective rate that differs from the combined Canadian federal and provincial rates primarily as a result of lower taxes in foreign jurisdictions and valuation allowances taken against available tax losses.

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



As at As at
March 31, December 31,
2008 2007
$ $
Current future income tax assets:
Accounts receivable, accounts payable and accrued
liabilities 314 348
Inventory provisions 389 414
Valuation allowance (703) (762)
---------------------------------------------------------------------------
- -
---------------------------------------------------------------------------
---------------------------------------------------------------------------
Long-term future income tax liabilities:
Property, plant and equipment 10,415 12,394
Tax benefits of loss carry-forwards (28,391) (27,765)
Valuation allowance 19,346 17,524
Other (1,370) (2,153)
---------------------------------------------------------------------------
- -
---------------------------------------------------------------------------
---------------------------------------------------------------------------


The benefits of these future tax loss carry-forwards, which aggregate to approximately $78,500, expire between 2008 and 2028.

20. Other expenses and income

Research and development expenses amounted to $61 for the quarter ended March 31, 2008 (2007 - $64). These expenses are included in cost of sales.

21. Obligations under operating leases

Future minimum payments under operating leases at March 31, 2008 are as
follows:



$
2008 769
2009 871
2010 365
2011 123
2012 50
Thereafter -
----------------------------------------------------------
2,178
----------------------------------------------------------
----------------------------------------------------------


22. Employee benefit plans

The Fund sponsors a 401(K) retirement savings plan in the United States for all eligible employees and a registered defined contribution pension plan for all eligible Canadian employees. The Fund has no past service pension liabilities. Under these plans, contributions are made by plan members, with varying matching contributions from the Fund.

The total expense related to these plans was $110 for the quarter ended March 31, 2008 (2007 - $416).

23. Segmented information

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

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



Quarter ended March 31,
2008 2007
$ $
Sales
Canada
Domestic 10,085 10,603
Foreign 6,011 18,546
Intersegment transfers 2,851 3,541
-----------------------------------------------------------------------
18,947 32,690
-----------------------------------------------------------------------
United States
Domestic 41,191 37,565
Foreign 468 341
Intersegment transfers 8,459 23,236
-----------------------------------------------------------------------
50,118 61,142
-----------------------------------------------------------------------
69,065 93,832
Elimination of intersegment
transfers (11,310) (26,777)
Discounts (2,174) (2,549)
-----------------------------------------------------------------------
55,581 64,506
-----------------------------------------------------------------------
-----------------------------------------------------------------------

As at March 31, As at December 31,
2008 2007
$ $
Property, plant and equipment
Canada 37,196 37,027
United States 100,446 97,142
-----------------------------------------------------------------------
137,642 134,169
Less: Accumulated amortization 71,972 68,254
-----------------------------------------------------------------------
65,670 65,915
-----------------------------------------------------------------------
-----------------------------------------------------------------------


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

24. Financial instruments

The Fund has the following categories of financial instruments:



As at March 31, As at December 31,
2008 2007
$ $
Measured at fair value
Cash 267 25
Interest rate swap (3,218) (1,548)
Measured at amortized cost
Accounts receivable 12,955 14,230
Bank indebtedness (34,870) (33,770)
Accounts payable and accrued
liabilities (29,060) (29,791)
Long term debt (76,353) (74,047)


The fair value of the interest rate swap, which is included in accounts payable and accrued liabilities, is calculated by discounting the anticipated cash flows at the period end forward rates at the time the fair value is calculated.

Credit risk

The Fund, in the normal course of business, reviews significant new customers' credit history and financial statements before extending credit and performs regular reviews of its existing credit performance. Since the Fund's market is primarily in North America, credit risk is considered similar over all of the customer base.

On an ongoing basis the credit worthiness of customers is reassessed and provisions are made for amounts that are more than 30 days past due. This allowance for doubtful accounts amounted to $389 at March 31, 2008 ($591 -- December 31, 2007). The net change during the quarter ended March 31, 2008 of $202 has been credited to selling, general and administrative expenses. The remaining balance of trade accounts receivable includes $1,358 that is 1 to 30 days past due.

Foreign exchange and interest rate risks

The Fund generates significant cash flows in foreign currency and is therefore exposed to risks relating to foreign exchange fluctuations. The Fund's United States dollar denominated long-term senior secured notes have been designated as a hedge of the United States operations and act to reduce exposure to foreign exchange fluctuations. It is also subject to risks relating to interest rate fluctuations. In order to reduce these risks, the Fund may use derivative financial instruments, which are not held or issued for speculative purposes.

As at March 31, 2008 and December 31, 2007 the Fund did not have any outstanding foreign currency forward contracts.

The Fund has fixed interest rates on a portion of its indebtedness (note 11). The mark-to-market value of the contract at March 31, 2008 resulted in an unrealized loss of $1,670 (2007 - loss $216), which is included in financial expense during the period. The cumulative unrealized loss on the interest rate swap is $3,218 (December 31, 2007 - $1,548) and is included in accounts payable and accrued liabilities.

Liquidity risk

The Fund's banking agreement expires on June 30, 2009 (note 10) and its Notes Facility expires on October 31, 2010 (note 11). The Fund expects to be in a position at that time to renew or replace these arrangements on their maturity at the prevailing market conditions then in place, which management expects to be similar to those contained in the existing Agreements. Furthermore, the Fund expects to liquidate its accounts payable within one

Market risk

The principle market risks of the Fund's financial instruments relate to fluctuations in: exchange rates between Canada and the United States and interest rates on floating rate debt. Market risks are best assessed in relation to the budgeted or expected performance of the Fund. On an annualized basis, for the current year, a one cent change in the exchange rate between Canada and the United States dollars will impact other comprehensive income by approximately $900, while having only a nominal impact on earnings, and a fifty basis point change in interest rates will impact earnings by approximately $100, net of fair value adjustments to the interest rate swap.

Fair value of financial instruments

The carrying values of cash, trade and other receivables, bank indebtedness, accounts payable and accrued liabilities and income taxes payable approximate their fair values because of the short-term nature of these instruments. The carrying value of long-term debt bearing interest at variable rates (note 11) approximates its fair value because effective rates represent the rates that would be used to calculate fair value.

25. Economic dependence

For the quarter ended March 31, 2008, no single customer accounted for more than 10% of sales. The Fund relies on single suppliers for the majority of its can and pouch requirements. Should these suppliers fail to deliver in a timely manner, delays and/or shutdowns of the Fund's operations could result.

Contact Information

  • Menu Foods Income Fund
    Mark Wiens
    Executive Vice-President & CFO
    (905) 826-3870 Ext 420