Menu Foods Income Fund
TSX : MEW.UN

Menu Foods Income Fund

August 13, 2008 14:00 ET

Menu Foods Income Fund Announces 2008 Second Quarter Results

TORONTO, ONTARIO--(Marketwire - Aug. 13, 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 second quarter ended June 30, 2008.

A conference call to review these results will take place tomorrow Thursday, August 14, 2008 at 8:30 a.m. EST (Toronto time). The conference call will be chaired by Paul Henderson, Menu's President and Chief Executive Officer. Paul will be joined on the call by Mark Wiens, Menu's Executive Vice-President and Chief Financial Officer.

To access the conference call in real time, please call 416-850-9150 or 1-866-809-4939. A replay will be available from approximately one hour after the end of the conference call until August 28, 2008 by dialing 416-915-1035 or 1-866-245-6755, using passcode 395906 followed by the number sign. A live audio webcast of the conference call is also available, it can be accessed by entering http://events.onlinebroadcasting.com/menufoods/081408/index.php on an Internet browser. A replay of the webcast will be available for one year, it can be accessed by entering http://events.onlinebroadcasting.com/menufoods/081408/index.php on an Internet browser.

Message to Unitholders

As we began 2008, we recognized that this would be a year of rebuilding for Menu. I am pleased to report that the good progress made against this objective in the first quarter of 2008 continued in the quarter ended June 30, 2008. It is particularly satisfying to note that volume within our continuing business is growing and that Menu earned a profit in this quarter.

While the 2007 recall is now largely behind us, its impact on our profitability and on our leverage ratios will be felt for some time to come. Given the covenants contained in our credit facilities and our goal of rebuilding the business, the Fund's management and employees' near-term focus will continue to be on cash flow generation and the day-to-day effective operation of the business. In the second quarter, we realized benefits of this approach, although to a reduced extent due to the influence of market-wide material cost increases.

Menu's performance during the quarter ended June 30, 2008 was noteworthy for a number of reasons:

- The Fund earned a profit for the first time since the fourth quarter of 2006, generating net income of $0.7 million compared to a loss of $3.6 million for the same period in the prior year.

- Despite the significant increases in the costs of raw and packaging materials, delivery and operational expenses of the Fund's production facilities, in general, the Fund achieved adjusted EBITDA of $5.0 million. This is in line with the $5.1 million earned in the first quarter of 2008 and up significantly from $2.0 million in the fourth quarter of 2007.

- The Fund followed the leading national brands; successfully implementing a price increase to private-label customers which had the effect of increasing sales by more than 2.5% during the quarter. While cost increases eroded all of the benefit of this price increase, its timely implementation allowed the Fund to earn adjusted EBITDA consistent with the prior quarter and more than sufficient to meet the covenants as set out by its Lenders.

- Volume from the Fund's continuing business increased by 6.3% as compared to the first quarter of 2008. This increase followed an increase of 12.6% realized in the first quarter of 2008, as compared to the fourth quarter of 2007.

- Selling, general and administrative expenses continued to decrease; largely reflecting the expected benefits from the prior year's restructuring efforts.

- Inventory levels were managed downward from levels at the end of the first quarter and are now more in line with the levels needed to support the Fund's ongoing business.

Significant progress continues to be made in respect of the industry-wide Pet Food Multi-District litigation. On May 30, 2008, the United States District Court for the District of New Jersey and, on July 9, 2008, the Canadian courts provided preliminary approvals for the comprehensive cross border settlement agreement reached in respect of this litigation. Motions for final approval have been scheduled for October 14, 2008 in the United States and November 3, 2008 in Canada. The Fund is pleased with this negotiated settlement, which, if finally approved will provide restitution to the pet owners affected by the 2007 pet food recalls.

As we look ahead to the final half of 2008, we foresee continued cost escalation within cost of sales, which will more than offset the benefit of our second quarter price increase. The branded manufacturers of wet pet food have many of the same input costs as the Fund and we believe that they are experiencing cost escalations similar to our own. Early in the third quarter we confirmed that the national branded manufacturers have increased prices in Canada. Shortly thereafter, the Fund initiated a price increase to its Canadian private-label customers. Given this movement in Canada, we expect leading national branded manufacturers to initiate price increases in the United States in order for them to recover the cost increases experienced in that marketplace. When this happens the Fund expects to follow with a price increase of its own. However, until such time as we are able to pass those cost increases along to customers, the Fund expects that its gross margin and EBITDA will continue to be adversely impacted.

Once again, I want to thank our lenders, suppliers, customers, and our employees who are seeing us through these challenging times and have already helped Menu to strengthen its business foundation. 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 June 30, 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 August 13, 2008 and is supplementary to and should be read in conjunction with the unaudited consolidated financial statements for the quarters ended June 30, 2008 and 2007.

The Fund is the indirect owner of Menu Foods Limited ("Menu"), the leading North American private label/contract manufacturer of wet pet food products. The Fund's results include those of Menu, its subsidiaries, affiliates and the partnerships that 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, cost increases and the pricing environment, 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 For the six months
ended June 30, ended June 30,
2008 2007 2008 2007
$ $ $ $
Sales 60,330 47,244 115,911 111,750
Cost of sales 53,591 43,461 101,693 100,208
-----------------------------------------
Gross profit 6,739 3,783 14,218 11,542
Selling, general and administrative
expenses 4,582 5,561 9,440 11,927
-----------------------------------------
Income (loss) before the
undernoted 2,157 (1,778) 4,778 (385)
Product recall expenses - 1,914 - 41,029
Restructuring and related expenses 70 - 172 -
Financial expenses 1,347 1,853 6,046 5,135
-----------------------------------------
Income (loss) before income taxes
and non-controlling interest 740 (5,545) (1,440) (46,549)
-----------------------------------------
Current income taxes 5 20 29 (194)
Future income taxes - (94) - (14,295)
-----------------------------------------
Total income taxes 5 (74) 29 (14,489)
-----------------------------------------
Income (loss) before
non-controlling interest 735 (5,471) (1,469) (32,060)
Non-controlling interest of Class
B Exchangeable Units - (1,869) - (10,949)
-----------------------------------------
Net income (loss) for the period 735 (3,602) (1,469) (21,111)
-----------------------------------------
-----------------------------------------

Basic net income (loss) per Trust
Unit 0.036 (0.189) (0.072) (1.106)
Diluted net income (loss) per Unit 0.025 (0.189) (0.072) (1.106)

Diluted distributable cash per
Trust Unit and Class B Unit 0.110 (1.0567) 0.094 (1.0281)

Basic weighted average number of
Trust Units outstanding (000s) 20,362 19,087 20,362 19,084
Diluted weighted average number
of Units outstanding (000s) 28,989 28,984 28,985 29,091

Average US/Cdn exchange rate
per Bank of Canada 0.9901 0.9104 0.9928 0.8810


Operating Results for the Quarter Ended June 30, 2008

Beginning on March 16, 2007, the Fund announced a series of recalls of a portion of the dog and cat food it manufactured between November 8, 2006 and March 7, 2007 (the "recall"). The recall primarily related to "cuts and gravy" style pet food in cans and pouches manufactured and sold under private-label and 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 the 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.

While a substantial portion of the expected costs of the recall were expensed by the Fund during the first quarter of 2007, since the recall happened so close to quarter-end, its impact on Menu's sales and operations to March 31, 2007 was minimized. By contrast, while fewer recall-related expenses arose in the second quarter of 2007, significant impacts in terms of lost sales and higher operating costs were experienced as the Fund suspended shipments of most "cuts and gravy" products while the recall was in effect. Any comparative analysis between the second quarter of 2008 and the second quarter of 2007 needs to consider this and much of the explanation for variances between the quarters will be attributed to the recall.

As reported during 2007, the impact of the recall on sales and operating costs was greatest during the second quarter of the year. Many customers significantly reduced or suspended purchases from Menu during that time. By the third quarter of 2007 the Fund had resumed shipping to most of its private-label customers and, in fact, benefited from an increase in demand as customers who had been without product for several months refilled their 'pipelines'. Sales in the fourth quarter of 2007 were considered to be more indicative of recurring volumes. Taking these factors into consideration, it is more meaningful to measure the change in sales and operating performance during 2008 against the fourth quarter of 2007.

Given the comments above, we will evaluate the results for the quarter ended June 30, 2008 in two ways:

1. relative to the trend in performance since the fourth quarter of 2007. It is this trend that is more relevant in evaluating how Menu has recovered from the impacts of the recall of 2007; and

2. relative to the quarter ended June 30, 2007. Since the recall accounts for much of the change in performance compared to 2007, and since this is an underlying explanation it is not repeated in the commentary.

Relative to the trend since the fourth quarter of 2007



For the quarter ended
June 30, 2008 March 31, 2008 December 31, 2007
$ $ $

Sales 60,330 55,581 55,001
Cost of sales 53,591 48,102 49,743
-----------------------------------------------------
Gross profit 6,739 7,479 5,258
Selling, general and
administrative
expenses 4,582 4,858 6,029
Financial expenses 1,347 4,699 3,887
-----------------------------------------------------
Income (loss)(1) 810 (2,078) (4,658)
-----------------------------------------------------
-----------------------------------------------------
Average US/Cdn
exchange rate 0.9901 0.9955 1.0184
-----------------------------------------------------
-----------------------------------------------------

(1) Income (loss) is before product recall expenses, restructuring and
related expenses, goodwill impairment, income taxes and non-controlling
interests and is not a recognized measure under GAAP


Quarter ended March 31, 2008 compared to the quarter ended December 31, 2007

Sales for the quarter ended March 31, 2008 were $55.6 million, up $0.6 million or 1.0% compared to the fourth quarter in 2007. This increase is attributable to:

1. Effect of Change in Sales Volume. A 3.4% decrease in volume resulting in a sales decrease of $1.7 million. Most of this decrease results from a 59.2% decline in volume sold to customers who had advised the Fund during 2007 that they would no longer be purchasing from Menu. The remaining volume to these customers will be lost throughout 2008 and into 2009. Volume to continuing customers increased by 12.6%.

2. Price and Cost Increases/Adjustments. 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.

3. Foreign Exchange Effect on Sales. The strengthening of the United States dollar relative to the Canadian dollar had the effect of increasing sales by $1.0 million relative to the fourth quarter in 2007.

Gross profit increased by $2.2 million or 42.2% during the quarter ended March 31, 2008 compared to the fourth quarter of 2007. This increase is attributable to:

1. Effect of Change in Sales Volume. As previously noted, total volume during the first quarter of 2008 decreased by 3.4%. This change in sales volume decreased gross profit by $0.3 million.

2. Price and Cost Increases/Adjustments. On a comparative basis to the fourth quarter in 2007, the increase in costs of certain inputs to production, including raw and packaging materials and labour and benefits, lead to higher cost of sales. However, as the Fund has returned to more normal levels of production during the quarter ended March 31, 2008 it began to realize more typical operating efficiencies and, accordingly, reduced factory overhead. The increased costs and other variables were more than offset by the selling price increases to contract-manufacturing customers and the improved operating efficiencies, increasing gross profit by $2.1 million.

3. Foreign Exchange Effect on Sales. The strengthening of the United States dollar relative to the Canadian dollar during the quarter had the effect of increasing sales by approximately $1.0 million and that translated into an increase in gross profit of $0.2 million for the quarter ended March 31, 2008.

4. Decrease in Amortization. The amortization of capital projects completed in the past year was more than offset by the effect of fully amortized assets, resulting in a decrease in total amortization. Furthermore, higher finished goods inventory levels resulted in more amortization being included in inventory as part of factory overhead costs rather than expensed as part of cost of sales. Taken together, this resulted in a decrease in amortization included in the cost of sales of $0.2 million versus the fourth quarter in 2007.

Selling, general and administrative expenses for the quarter ended March 31, 2008 decreased by $1.2 million compared to the fourth quarter in 2007. This improvement was largely attributed to 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), which became fully effective during the first quarter of 2008.

Financial expenses were $0.8 million higher during the quarter ended March 31, 2008 than in the fourth 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 $1.0 million in the fourth quarter last year. Excluding the effect of the accounting for the interest rate swaps, on a comparative basis, interest expense increased by $0.1 million during the quarter.

Quarter ended June 30, 2008 compared to the quarter ended March 31, 2008

Sales for the quarter ended June 30, 2008 were $60.3 million, up $4.7 million or 8.5% compared to the first quarter in 2008. This increase is attributable to:

1. Effect of Change in Sales Volume. A 4.2% increase in volume resulting in a sales increase of $2.7 million. Volume to continuing customers increased by 6.3% while volume sold to customers who had advised the Fund during 2007 that they would no longer be purchasing from Menu declined by 15.7%, continuing the trend noted in the first quarter of 2008.

2. Price and Cost Increases/Adjustments. The impact of the price increase to private-label customers that was implemented during the second quarter of 2008 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 $1.7 million.

3. Foreign Exchange Effect on Sales. The strengthening of the United States dollar relative to the Canadian dollar during the quarter had the effect of increasing sales by $0.3 million relative to the first quarter in 2008.

Gross profit decreased by $0.7 million or 9.9% during the quarter ended June 30, 2008 compared to the first quarter of 2008. This decrease is attributable to:

1. Effect of Change in Sales Volume. As previously noted, total volume during the second quarter of 2008 increased by 4.2%. This change in sales volume increased gross profit by $0.4 million.

2. Price and Cost Increases/Adjustments. On a comparative basis to the first quarter in 2008, the increase in costs of certain inputs to production, particularly raw and packaging materials, have led to higher cost of sales. Furthermore, in order to reduce inventories and bank indebtedness the Fund reduced production with a resultant impact on operating efficiencies and an increase in factory overhead per case. These increased costs and other variables were only partially offset by the price increase to private-label customers and the selling price increases to contract-manufacturing customers, decreasing gross profit by $0.7 million.

3. Foreign Exchange Effect on Sales. The strengthening of the United States dollar relative to the Canadian dollar during the quarter had the effect of increasing sales by approximately $0.3 million and that translated into a nominal increase in gross profit for the quarter ended June 30, 2008.

4. Increase in Amortization. The reduction in finished goods inventory levels during the quarter resulted in less amortization of capital assets being included in inventory as part of factory overhead costs, and more being expensed as part of cost of sales. This contrasts with the first quarter, during which finished goods inventory levels increased resulting in less amortization of capital assets being expensed to cost of sales and more being included in the cost of inventory. The net effect was an increase in the amortization associated with the cost of sales of $0.4 million versus the first quarter in 2008.

Selling, general and administrative expenses for the quarter ended June 30, 2008 decreased by $0.3 million compared to the first quarter in 2008. This decrease can be attributed to a number of small decreases across a variety of expense categories.

Financial expenses were $3.4 million lower during the quarter ended June 30, 2008 than in the first quarter of 2008. The Fund recorded a gain of $1.5 million on interest rate swaps during the second quarter of 2008 compared to a loss of $1.7 million in the first quarter this year. Excluding the effect of the accounting for the interest rate swaps, on a comparative basis, interest expense decreased by $0.2 million during the quarter.

Relative to the quarter ended June 30, 2007

Sales for the quarter ended June 30, 2008, were $60.3 million, up 27.7% or $13.1 million compared to the same quarter last year. This increase is attributable to:

1. Effect of Change in Sales Volume. A 34.9% increase in volume resulting in a sales increase of $16.2 million.

2. Price and Cost Increases/Adjustments. The impact of the price increase to private-label customers that was implemented during the second quarter of 2008 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 $3.1 million.

3. Foreign Exchange Effect on Sales. The strengthening of the Canadian dollar relative to the United States dollar had the effect of decreasing sales by $6.2 million relative to the second quarter of 2007.

Overall, volume (expressed in cases of 24 cans or pouches) was up 34.9% compared to the quarter ended June 30, 2007. Can volume, which represented 88.5% of Menu's volume in the second quarter of 2008 (98.9% in 2007), grew by 20.8% (equating to an increase in total volume of 20.6%) while pouch volume, which represented 11.5% of total volume (1.1% in 2007), increased dramatically (equating to an increase in total volume of 14.3%) compared to the second quarter of 2007. Virtually all customers had suspended the purchase of the pouch format, which is exclusively in the "cuts and gravy" style of product, during the second quarter of 2007.

During 2007, the Fund was advised that customers whose volume represented approximately 37% of sales in 2006 and 33% of sales during the first quarter of 2007 would no longer be purchasing these products from Menu. This lost business primarily impacted 2007, but will affect 2008 and 2009 as well. For the quarters ended June 30, 2007 and 2008, respectively, volume to these customers declined to 33.4% and 18.4% of the levels achieved during the first quarter of 2007. Overall, for the quarters ended June 30, 2007 and 2008, respectively, these customers accounted for 18.6% and 7.6% of total volume for the quarter. Compared to the second quarter of 2007, during the quarter ended June 30, 2008, volume to these customers decreased 44.9% (equating to 8.2% of total volume). This decrease was more than offset by the 53.1% increase (equating to 43.3% of total volume) in volume to the Fund's continuing customers.

Gross profit increased by $3.0 million (or 78.1%) for the quarter ended June 30, 2008, compared to the prior year. This increase is attributable to:

1. Effect of Change in Sales Volume. As previously noted, total volume for the second quarter increased by 34.9%. This change in sales volume increased gross profit by $1.8 million.

2. Price and Cost Increases/Adjustments. In February 2007, Menu followed a leading national brand manufacturer and announced a price increase on canned products sold to its United States private-label customers. This price increase was effective in the second quarter of 2007. During the first quarter of 2008, Menu again followed the leading national brands and announced a price increase to private-label customers that was implemented during the second quarter of 2008. While costs continue to rise, this price increase should enable Menu to recover some of the cost increases experienced since the last price increase to its private-label customers.

On a comparative basis to the same quarter in 2007, the increase in costs of certain inputs to production, including raw and packaging materials and labour and benefits, have led to higher cost of sales. During 2007 the dramatic decline in sales due to the recall translated to a significant reduction in production, which resulted in factory overhead associated with the Fund's production facilities being allocated over a reduced number of cases, thereby increasing the cost of the Fund's inventory, and in turn, its cost of sales as that inventory was sold. During the fourth quarter of 2007, the Fund restructured its operations in order to better align its costs to its ongoing business. This restructuring had the effect of reducing production costs during the second quarter of 2008 as compared to the same quarter of 2007. These reduced costs of manufacturing, together with the selling price increases referred to above, as well as selling price increases to contract-manufacturing customers, more than offset the increases in input and other costs thereby increasing gross profit by $2.3 million.

3. 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 $6.2 million and that translated into a reduction in gross profit of $0.9 million for the quarter ended June 30, 2008.

4. Increase in Amortization. The amortization associated with the South Dakota facility, which was sold during the third quarter of 2007, together with the effect of fully amortized assets, the write down of capital assets and the customer relationship as part of last year's restructuring by the Fund and the stronger Canadian dollar more than offset the additional amortization of capital projects completed in the past year, resulting in lower total amortization when compared to the second quarter of 2007. However, the reduction in finished goods inventory levels during the second quarter of 2008 has resulted in less amortization of capital assets being included in inventory as part of factory overhead costs, and more being expensed as part of cost of sales. This contrasts with the second quarter of 2007 during which finished goods inventory levels increased resulting in less amortization of capital assets being expensed as part of cost of sales. On a comparative basis the foregoing netted to an increase in the amortization associated with the cost of sales of $0.2 million versus the second quarter of 2007.

Selling, general and administrative expenses for the quarter ended June 30, 2008 decreased by $1.0 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 $1.0 million compared to 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 GAAP, depending upon their nature, were to be both accrued and expensed in 2007 or are to be expensed as incurred in future periods. A further $0.1 million in restructuring costs was expensed during the second 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, lost margin on returned product of $2.9 million, $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 during 2007, were accrued in the first quarter of 2007. An additional $1.9 million (of the $3.0 million) in recall-related costs was expensed during the second quarter of 2007. The estimate for product recall costs was revised in the fourth quarter of 2007 and adjusted to $55 million.

Adjusted EBITDA for the quarter ended June 30, 2008 amounted to $5.0 million. In order to have any meaningful comparison to EBITDA in the second quarter of 2007 it is necessary to remove the impacts of the recall as described above. Adjusting for the $1.9 million in recall related costs in the second quarter of 2007 the foregoing resulted in an adjusted EBITDA (see Note A) of $1.4 million. On this basis, adjusted EBITDA during the second quarter of 2008 increased by $3.6 million (or 259.9%) 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 second quarter of 2008 versus the same period in 2007 reduced EBITDA by approximately $0.8 million and Distributable Cash by approximately $0.6 million.

Amortization (which is included in cost of sales and selling, general and administrative expenses) in the second quarter of 2008 was $0.3 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 customer relationship 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 $3.8 million of capital expenditures made during the twelve-month period ended June 30, 2008 together with the full quarter amortization of the $0.8 million of capital expenditures made during the quarter ended June 30, 2007.

Financial expenses were $0.5 million lower during the quarter ended June 30, 2008 than in the second quarter of 2007. The Fund recorded a gain of $1.5 million on interest rate swaps during the second quarter of 2008 compared to a gain of $0.8 million in the same quarter last year. Excluding the effect of the accounting for interest rate swaps, interest expense increased by $0.2 million, reflecting both the higher interest rates and the higher amounts borrowed this year.

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.

Income before non-controlling interest of Class B Exchangeable Units ("Class B Units") for the quarter ended June 30, 2008, was $0.7 million, compared to a loss of $5.5 million for the quarter ended June 30, 2007.

Operating Results for the Six Months Ended June 30, 2008

The various recalls initiated by the Fund during the first half of 2007 have had a significant impact on the Fund's results for the six months ended June 30, 2007. In order to draw meaningful conclusions with respect to the Fund's performance in the first half of 2007 and thereby permit a meaningful comparison to the first half of 2008, it is important to isolate the effects of the recalls from the ongoing business.

The following table further evaluates the results noted above:



For the six months ended June 30, 2007
2008 Total Recall Costs Excluding
Recall
$ $ $ $

Sales 115,911 111,750 (14,320) 126,070
Cost of sales 101,693 100,208 (11,435) 111,643
--------------------------------------------------
Gross profit 14,218 11,542 (2,885) 14,427
Selling, general and
administrative expenses 9,440 11,927 - 11,927
--------------------------------------------------
Income before the
undernoted 4,778 (385) (2,885) 2,500
Product recall expenses - 41,029 41,029 -
Restructuring and related
expenses 172 - - -
Financial expenses 6,046 5,135 - 5,135
--------------------------------------------------
Loss before income taxes
and non-controlling
interest (1,440) (46,549) (43,914) (2,635)
--------------------------------------------------
--------------------------------------------------


Sales for the six months ended June 30, 2008, were $115.9 million, up 3.7% or $4.2 million compared to the same period last year. This increase is attributable to:

1. Effect of Change in Sales Volume. A 1.1% decrease in volume resulting in a nominal change in sales primarily due to the impact of the recall, particularly during the second quarter in the comparative period. Upon announcing the recall in 2007, Menu and its customers suspended the sale and purchase, respectively, of the recalled products (primarily cuts and gravy style). Pouch sales were particularly affected with only minimal sales during the quarter ended June 30, 2007.

2. Foreign Exchange Effect on Sales. The strengthening of the Canadian dollar relative to the United States dollar during the six-month period had the effect of reducing sales by approximately $14.0 million. These decreased sales were partially offset by:

3. Effect of Product Recall. As a further consequence of the product recall, sales returns were received or accrued during the quarter ended March 31, 2007. There were no such returns during the six months ended June 30, 2008, resulting in increased sales on a comparative basis of $14.3 million.

4. Price and Cost Increases/Adjustments. 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 $3.9 million.

Overall, excluding actual returns arising from the product recall, volume (expressed in cases of 24 cans or pouches) was down 1.1% compared to the six months ended June 30, 2007. Can volume, which represented 87.5% of Menu's volume in the first half of 2008 (85.8% in 2007), increased by 1.0% (equating to an increase in total volume of 0.9%). Conversely, pouch volume decreased over the same period in the prior year, since while all customers stopped purchasing this product during the second quarter of 2007, sales had been stronger during the first quarter of 2007. During the first six months of 2008, case sales of the pouch product, which represented 12.5% of total volume (14.2% in 2007), decreased by 13.4% (equating to a decrease in total volume of 1.9%) compared to the first six months 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. This lost business primarily impacted 2007, but will affect 2008 and 2009 as well. During the six months ended June 30, 2008, volume to these customers decreased 69.8% as compared to the six months ended June 30, 2007, which more than offset the 25.5% increase in volume to the Fund's continuing customers. Over this same period the significance of these lost customers has decreased as well, with their volumes accounting for only 8.5% of total volume compared to 27.8% in 2007.

Gross profit increased by $2.7 million (or 23.2%) for the six months ended June 30, 2008, compared to the prior year. This increase is attributable to:

1. Effect of Change in Sales Volume. As previously noted, excluding actual returns arising from the product recall, total volume for the first half of the year decreased by 1.1%. This change in sales volume decreased gross profit by $0.2 million.

2. Product Recall Impacts. As noted above, due to the product recall, $14.3 million in sales returns were received or accrued during the quarter ended March 31, 2007. The gross profit associated with these returns amounted to $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 canned products sold to its United States private-label customers. This price increase was effective in the second quarter of 2007. During the first quarter of 2008, Menu again followed the leading national brands and announced a price increase to private-label customers that was implemented during the second quarter of 2008. While costs continue to rise, this price increase should enable Menu to recover some of the cost increases experienced since the last price increase to its private-label customers.

On a comparative basis to the same period in 2007, the increase in costs of certain inputs to production, including raw and packaging materials and labour and benefits, have led to higher cost of sales. However, during 2007 and particularly during the second quarter of 2007, lower sales translated to lower levels of production, which necessitated that the factory overhead associated with the Fund's production facilities had to be allocated over fewer cases, thereby increasing the cost of the Fund's inventory, and in turn, its cost of sales as that inventory was sold. During the fourth quarter of 2007, the Fund restructured its operations in order to better align its costs to its ongoing business. This restructuring had the effect of reducing production costs during the first six months of 2008 as compared to the same period of 2007. These reduced costs of manufacturing, together with the selling price increases referred to above, as well as selling price increases to contract-manufacturing customers, more than offset the increases in input and other costs thereby increasing gross profit by $1.1 million.

4. Foreign Exchange Effect on Sales. The strengthening of the Canadian dollar relative to the United States dollar during the period had the effect of reducing sales by approximately $14.0 million and that translated into a reduction in gross profit of $2.2 million for the six months ended June 30, 2008.

5. Decrease in Amortization. The amortization associated with the South Dakota facility, which was sold during the third quarter of 2007, together with the effect of fully amortized assets, the write down of capital assets and the customer relationship as part of last year's restructuring by the Fund, and the stronger Canadian dollar more than offset the additional amortization of capital projects completed in the past year, resulting in lower total amortization when compared to the first six months of 2007. Furthermore, the reduction in finished goods inventory levels during the first half of 2008 has resulted in less amortization of capital assets being included in inventory as part of factory overhead costs, and more being expensed as part of cost of sales This contrasts with the first half of 2007 during which finished goods inventory levels increased resulting in less amortization of capital assets being expensed to cost of sales. On a comparative basis the foregoing netted to a decrease in the amortization associated with the cost of sales of $1.1 million versus the first half of 2007.

Selling, general and administrative expenses for the six months ended June 30, 2008 decreased by $2.5 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 $1.0 million less than in 2007, largely as a result of the reduction in amortization associated with fully-amortized assets during the period and resulting from the sale of the South Dakota facility 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 $1.4 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 half of last year.

During the first quarter of 2007, management estimated that the total costs associated with the 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 consumer concerns and $3.2 million in professional and associated fees necessary to manage this difficult process. All but $1.1 million of these costs, had to be expensed as incurred under Canadian generally accepted accounting policies, were reflected in the results for the six months ended June 30, 2007. The estimate for product recall costs was revised in the fourth quarter of 2007 and adjusted to $55 million.

In order to have any meaningful discussion of EBITDA it is necessary to remove the impacts of the recall as described above. Adjusting for the $43.9 million in recall related costs, the foregoing resulted in an adjusted EBITDA (see Note A) of $9.8 million for the six months ended June 30, 2007. This compares to adjusted EBITDA of $10.1 million (adjusted for restructuring and related expenses) for the six months ended June 30, 2008, an increase of $0.3 million (or 3.1%) over the same period in 2007.

The strengthening of the Canadian dollar, relative to the United States dollar, has decreased 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 $0.38 million and Distributable Cash (see Note A) by approximately $0.28 million, on an annual basis. Menu estimates that the strengthening of the Canadian dollar during the first half of 2008 versus the same period in 2007 reduced EBITDA by approximately $2.0 million and Distributable Cash by approximately $1.5 million. Subsequent to June 30, 2008 the United States dollar has strengthened relative to the Canadian dollar. Should this be sustained throughout the balance of the year there will be a reversal of the trends noted during the first half of 2008.

Amortization (which is included in cost of sales and SG&A expense) in the first six months of 2008 was $2.1 million less 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, the write down of the customer relationship, 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 $3.8 million of capital expenditures made during the twelve-month period ended June 30, 2008 together with the full period amortization of the $2.6 million of capital expenditures made during the six months ended June 30, 2007.

Financial expenses were $0.9 million higher during the six months ended June 30, 2008 than in the first half of 2007. The Fund recorded a loss of $0.2 million on interest rate swaps during the first half of 2008 compared to a gain of $0.6 million in the same period last year. Excluding the effect of accounting for the interest rate swaps, interest expense increased by $0.9 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 GAAP, for accounting purposes, they resulted in a settlement of the original senior secured notes facility. As a consequence, during the first half 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 $0.3 million in amortization of deferred commitment fees reflected in the six months ended June 30, 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 on the taxing jurisdiction and the legal structure in which the income is earned. Since the Fund has approximately $69.5 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 six months ended June 30, 2008, was $1.5 million, compared to a loss of $32.1 million for the six months ended June 30, 2007.

Liquidity

During the six months ended June 30, 2008, the Fund generated cash flow from operations of $2.9 million. This amount was increased by $1.2 million as a result of changes in non-cash working capital items. The most significant of these changes related to accounts payable and prepaid expenses. Accounts payable were reduced by $0.6 million, primarily reflecting the payment timing of inventory and other purchases during the period. Inventory, which had grown by approximately $3.0 million during the first quarter of 2008, was reduced by $3.3 million during the second quarter as the Fund brought inventory levels into line with ongoing sales for a net decline of $0.3 million. Prepaid expenses were reduced by $0.9 million due primarily to the timing of prepaid items being incurred and amortized. The $0.2 million decrease in accounts receivable reflects the timing of sales during the second quarter of 2008.

No distributions were declared during the first half of 2008.

On May 14, 2007, the Fund reached an 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 was reduced by US$2.5 million on each of September 30, 2007, October 19, 2007 and March 31, 2008 and was to 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. During June 2008 the Fund agreed with its Lenders to defer the reductions due on June 30, 2008 and September 30, 2008 until December 31, 2008, at which time the reductions in respect of the last three quarters of 2008 will still aggregate to US$7.5 million. The Fund had drawn or committed US$32,196 ($32,830) of the US$42.5 million bank facility on June 30, 2008. Cash flow from operations, together with the remaining unutilized bank facilities, the expected proceeds from the sale of assets 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.

Initiatives have been ongoing to reach a mediated settlement in respect of the purported class actions referenced above. On May 30, 2008, the United States District Court for the District of New Jersey preliminarily approved the comprehensive settlement agreement in the pet food multi-district litigation. The settlement agreement would resolve more than 100 class action lawsuits filed in the U.S. and Canadian courts. Similar motions for approval were subsequently granted by the Canadian courts. Motions for final approval of the settlement agreement have been scheduled in the U.S. District Court for October 14, 2008 and in various Canadian courts for November 3, 2008.

Capital Resources

During the six months ended June 30, 2008, Menu spent $2.0 million, net of the proceeds of sale, on capital assets. Capital expenditures, which the Fund defines as being of a maintenance nature for purposes of determining Distributable Cash, which totalled $1.3 million for the six months ended June 30, 2008, were financed from the cash flow of the business. These maintenance capital expenditures were over and above the $4.5 million (2007 - $6.4 million) for labour and parts expended by Menu for the ongoing repairs and maintenance of its plants that have been expensed as part of cost of sales. Capital expenditures of a growth nature totalled $1.0 million for the six months ended June 30, 2008.

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 and June 30, 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.

On June 30, 2008, the Fund agreed to issue 1 million five-year Trust Unit warrants in the Fund as part of the settlement of certain claims against the Fund relating to the recall. The Trust Unit warrants will be issued on August 22, 2008 at fair market value.

Controls and Procedures

Multilateral Instrument No. 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 controls 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 June 30, 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 June 30, 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 GAAP.

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 June 30, 2008.

Recent Canadian accounting pronouncements issued and not yet adopted

The Accounting Standards Board has adopted a strategic plan that will have GAAP converge with International Financial Reporting Standards ("IFRS") effective January 2011. The Fund will commence its planning and transition from GAAP to IFRS during 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, proceeds from asset sales 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 an 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 May 30, 2008, the United States District Court for the District of New Jersey preliminarily approved the comprehensive settlement agreement in the pet food multi-district litigation. The settlement agreement would resolve more than 100 class action lawsuits filed in the U.S. and Canadian courts. Similar motions for approval were subsequently granted by the Canadian courts. Motions for final approval of the settlement agreement have been scheduled in the U.S. District Court for October 14, 2008 and in various Canadian courts for November 3, 2008.

The settlement agreement creates a settlement fund of US$24 million that will allow a potential recovery of up to 100% of all economic damages incurred by pet owners, subject to certain limitations. The settlement fund, administered by a neutral claims administrator, will be available to persons in the United States and Canada who purchased or obtained, or whose pets used or consumed, recalled pet food. Pursuant to the settlement agreement, the settlement fund will be funded by the defendants, including Menu Foods Income Fund and its product liability insurer. The Fund's corporate contribution to the settlement is within its previously recorded recall provision of $55 million

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. Much of this business was lost during 2007 and by the second quarter of 2008 these customers were only accounting for about 7.6% of the Fund's total volume. This remaining business will be lost over the remainder of 2008 and into 2009. Business with our remaining customers continues to re-establish itself. 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 has been the case in the past, 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 and continue to occur in 2008. 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, meat and grain products, 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")

The US and Canada have been categorized by OIE, the World Organization for Animal Health, as having minimal risk for BSE. Both countries, however, continue to enhance their feed safety systems to further reduce this risk. Effective July 12, 2007, Canada announced an enhanced feed rule whereby specified risk materials (i.e. those components of the animal thought to have the highest level of infectivity when consumed) are banned in all animal feed, including pet food. This rule includes the elimination of tissues from animals that did not pass both pre- and post-mortem inspection. While having immediate impact on some pet food raw materials, the impact on finished pet food will not be felt until Part IV of CFIA's Health of Animals Regulations is revised. This implementation date for these changes could be as early as October 2008, with publication in the Canada Gazette is a pre-requisite. On April 27, 2008, the US announced a revised BSE Feed Rule, which becomes effective in 2009, that has the same objective but allows for some tissues to be recovered from animals which did not pass the inspections noted above.

Since 2003, import permits have been required to allow the transport of some raw materials and all finished pet foods from Canada to the United States. These permits preclude the use of Canadian beef in Menu's Streetsville facility. As a consequence, it is expected that import permits will soon be required in order to ship product from the US to Canada. The regulations appear to preclude the presence of any specified risk materials in the facility (using the CFIA definition of such materials, which is more restrictive than the US definition). This does not present an issue to Menu and our US facilities have already been inspected in anticipation of these regulation changes.

The equivalence regarding BSE status may ultimately allow some relaxation of existing requirements. Until that time Menu Foods is well placed, having facilities on both sides of the border and having a long-standing policy of specifying absence of specified risk materials in their plants.

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 that 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 June 30, 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 June 30, 2008, the Fund had $32.1 million drawn on its bank facility and $76.2 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 risk factors include adequacy of credit facilities, the ability to obtain price increases in the face of rising costs, 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.

Many of the 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 that may be assessed, the cost of any resulting litigation or investigations, including the extent to which these costs 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 substantively enacted under GAAP. 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.

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 May 30, 2008, the United States District Court for the District of New Jersey preliminarily approved the comprehensive settlement agreement in the pet food multi-district litigation. The settlement agreement would resolve more than 100 class action lawsuits filed in the U.S. and Canadian courts. Similar motions for approval were subsequently granted by the Canadian courts. Motions for final approval of the settlement agreement have been scheduled in the U.S. District Court for October 14, 2008 and in the various Canadian courts for November 3, 2008.

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 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. Adjusted EBITDA restates EBITDA by removing the effects of non-recurring items.

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 and disclosure 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 "Distributable Cash in Income Trusts and Other Flow-Through Entities - Guidance on Preparation and Disclosure in Management's Discussion and Analysis - Draft Interpretive Release."

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 second quarter:



For the Quarter ended
June 30,
2008 2007
$'000's $'000's
Net income (loss) 735 (3,602)
Adjust for:
Non-controlling interest of Class B Exchangeable
Units - (1,869)
Amortization of property, plant and equipment 2,696 2,880
Amortization of customer relationship - 127
Unit based compensation 155 144
Future income taxes - (94)
Current income taxes 5 20
Financial expenses 1,347 1,853
----------------------
EBITDA 4,938 (541)
Product recall - 1,914
Restructuring and related expenses 70 -
----------------------
Adjusted EBITDA 5,008 1,373
----------------------
----------------------



For the Quarter ended
June 30,
2008 2007
$'000's $'000's
Cash flow from operating activities 3,906 (30,251)
Adjust for:

Maintenance capital expenditures (713) (369)
Principal repayments (7) (7)
----------------------
Distributable Cash from Operations 3,186 (30,627)
----------------------
----------------------


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



Since Inception
For the Six Months (May 22, 2002)
ended June 30, to June 30, 2008
2008 2007
$'000's $'000's $'000's
Net loss (1,469) (21,111) (85,809)
Adjust for:
Goodwill impairment loss - - 124,030
Non-controlling interest of
Class B Exchangeable Units - (10,949) (30,210)
Amortization of property, plant
and equipment 5,036 6,837 84,149
Amortization of customer
relationship - 260 2,789
Unit based compensation 311 225 954
Future income taxes - (14,295) (7,370)
Current income taxes 29 (194) 3,031
Financial expenses 6,046 5,135 47,357
----------------------------------------
EBITDA 9,953 (34,092) 138,921
Product recall - 43,914 55,000
Restructuring and related expenses 172 - 4,608
----------------------------------------
Adjusted EBITDA 10,125 9,822 198,528
----------------------------------------
----------------------------------------



Since Inception
For the Six Months (May 22, 2002)
ended June 30, to June 30, 2008
2008 2007
$'000's $'000's $'000's
Cash flow from operating activities 4,060 (29,063) 80,392
Adjust for:

Maintenance capital expenditures (1,332) (832) (15,079)
Principal repayments (14) (13) (608)
----------------------------------------
Distributable Cash from Operations 2,714 (29,908) 64,705
----------------------------------------
----------------------------------------



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

As at
June 30, December 31,
2008 2007
$ $

Assets

Current assets
Cash 251 25
Accounts receivable
Trade 13,269 13,458
Other 907 772
Inventories (note 6) 32,263 31,161
Prepaid expenses and sundry assets 1,234 2,194
---------------------------------------------------------------------------
Total Current Assets 47,924 47,610
Property, plant and equipment (note 7) 57,215 65,915
Assets held for sale (note 7) 10,842 3,339
Goodwill (note 8) 41,357 41,357
Other assets (note 9) 557 840
---------------------------------------------------------------------------
Total Assets 157,895 159,061
---------------------------------------------------------------------------
---------------------------------------------------------------------------

Liabilities

Current liabilities
Bank indebtedness (note 10) 32,081 33,770
Accounts payable and accrued liabilities
(notes 2 and 3) 29,465 31,339
Income taxes payable 1,018 776
Current portion of long-term debt (note 11) 15 30
---------------------------------------------------------------------------
Total Current Liabilities 62,579 65,915
Long-term debt (note 11) 76,238 74,017
---------------------------------------------------------------------------
Total Liabilities 138,817 139,932
---------------------------------------------------------------------------

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

Unitholders' Equity

Trust Units (note 13) 176,004 176,004
Contributed surplus (note 15) 969 658
Deficit (145,292) (144,529)
Accumulated other comprehensive loss (note 17) (12,603) (13,004)
---------------------------------------------------------------------------
Total Unitholders' Equity 19,078 19,129
---------------------------------------------------------------------------
Total Liabilities, Class B Exchangeable Units
and Unitholders' Equity 157,895 159,061
---------------------------------------------------------------------------
---------------------------------------------------------------------------

(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 June 30,
2008 2007
$ $

Sales 60,330 47,244
Cost of sales (note 20) 53,591 43,461
----------------------------------------------------------------------------
Gross profit 6,739 3,783
Selling, general and administrative expenses 4,582 5,561
----------------------------------------------------------------------------
Income (loss) before the undernoted 2,157 (1,778)
Product recall (note 2) - 1,914
Restructuring and related expenses (note 3) 70 --
Financial expenses (note 18) 1,347 1,853
----------------------------------------------------------------------------
Income (loss) before income taxes and
non-controlling interest 740 (5,545)
----------------------------------------------------------------------------
Current income taxes 5 20
Future income taxes - (94)
----------------------------------------------------------------------------
Total income taxes 5 (74)
----------------------------------------------------------------------------
Income (loss) before non-controlling interest 735 (5,471)
Non-controlling interest of Class B Exchangeable
Units (note 12) - (1,869)
----------------------------------------------------------------------------
Net income (loss) for the period 735 (3,602)
Deficit - beginning of period (146,027) (99,909)
----------------------------------------------------------------------------
Deficit - end of period (145,292) (103,511)
----------------------------------------------------------------------------
----------------------------------------------------------------------------

Basic net income (loss) per Trust Unit $ 0.036 $ (0.189)
Diluted net income (loss) per Trust Unit $ 0.025 $ (0.189)

Basic weighted average number of Trust Units
outstanding (note 13) 20,361,654 19,087,019
Diluted weighted average number of Trust Units
outstanding (note 13) 28,989,389 28,984,243



Consolidated Statements of Comprehensive Income (Loss)
(All figures expressed in thousands of Canadian dollars, unaudited)

Quarter ended June 30,
2008 2007
$ $

Net income (loss) for the period 735 (3,602)
Other comprehensive income (loss), net of tax of
$nil (2007 - $nil):
Unrealized gains (losses) on translating financial
statements of self-sustaining foreign operations 73 (15,300)
Gains on hedges of unrealized foreign currency
translation 28 11,895
----------------------------------------------------------------------------
Comprehensive income (loss) for the period 836 (7,007)
----------------------------------------------------------------------------
----------------------------------------------------------------------------

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)

Six months ended June 30,
2008 2007
$ $

Sales 115,911 111,750
Cost of sales (note 20) 101,693 100,208
----------------------------------------------------------------------------
Gross profit 14,218 11,542
Selling, general and administrative expenses 9,440 11,927
----------------------------------------------------------------------------
Income (loss) before the undernoted 4,778 (385)
Product recall (note 2) - 41,029
Restructuring and related expenses (note 3) 172 -
Financial expenses (note 18) 6,046 5,135
----------------------------------------------------------------------------
Loss before income taxes and non-controlling
interest (1,440) (46,549)
----------------------------------------------------------------------------
Current income taxes 29 (194)
Future income taxes - (14,295)
----------------------------------------------------------------------------
Total income taxes 29 (14,489)
----------------------------------------------------------------------------
Loss before non-controlling interest (1,469) (32,060)
Non-controlling interest of Class B
Exchangeable Units (note 12) - (10,949)
----------------------------------------------------------------------------
Net loss for the period (1,469) (21,111)
Deficit - beginning of period, as previously
reported (144,529) (82,400)
Impact of change in accounting policies (note 4) 706 -
----------------------------------------------------------------------------
Deficit - end of period (145,292) (103,511)
----------------------------------------------------------------------------
----------------------------------------------------------------------------

Deficit comprises:
Accumulated net loss (85,103) (43,322)
Accumulated distributions (60,189) (60,189)
----------------------------------------------------------------------------
(145,292) (103,511)
----------------------------------------------------------------------------
----------------------------------------------------------------------------

Basic net loss per Trust Unit $ (0.072) $ (1.106)
Diluted net loss per Trust Unit $ (0.072) $ (1.106)

Basic weighted average number of Trust Units
outstanding (note 13) 20,361,654 19,084,165
Diluted weighted average number of Trust Units
outstanding (note 13) 28,985,058 29,090,942



Consolidated Statements of Comprehensive Loss
(All figures expressed in thousands of Canadian dollars, unaudited)

Six months ended June 30,
2008 2007
$ $

Net loss for the period (1,469) (21,111)
Other comprehensive (loss) income, net of tax
of $nil (2007 - $nil)
Unrealized gains (losses) on translating
financial statements of self-sustaining
foreign operations 4,241 (16,258)
Gains (losses) on hedges of unrealized foreign
currency translation (3,840) 12,502
----------------------------------------------------------------------------
Comprehensive loss for the period (1,068) (24,867)
----------------------------------------------------------------------------
----------------------------------------------------------------------------

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 June 30,
2008 2007
$ $

Cash provided by (used in)
Operating activities
Net income (loss) for the period 735 (3,602)
Adjustments for non-cash items
Non-controlling interest of Class B Exchangeable
Units - (1,869)
Amortization of property, plant and equipment 2,696 2,880
Amortization of customer relationship - 127
Interest accretion and amortization of deferred
commitment fees 182 -
Unit-based compensation 155 144
Gain on sale of property, plant and equipment (116) -
Inventory write-off (notes 2 and 3) - 4,918
Recall and restructuring costs not yet paid
(notes 2 and 3) (276) (3,962)
Marked-to-market adjustment (note 24) (1,505) (805)
Future income taxes - (94)
----------------------------------------------------------------------------
1,871 (2,263)

Change in non-cash working capital items
Accounts receivable (1,327) (8,921)
Inventories 3,222 (12,462)
Accounts payable and accrued liabilities (698) (6,684)
Prepaid expenses and sundry assets 576 (680)
Income taxes 262 759
----------------------------------------------------------------------------
3,906 (30,251)
----------------------------------------------------------------------------
Financing activities
Change in bank indebtedness (2,641) 30,991
Long-term debt repayments (7) (7)
----------------------------------------------------------------------------
(2,648) 30,984
----------------------------------------------------------------------------
Investing activities
Purchase of property, plant and equipment (1,544) (752)
Proceeds from sale of property, plant and equipment 270 -
----------------------------------------------------------------------------
(1,274) (752)
----------------------------------------------------------------------------
Decrease in cash (16) (19)
Cash - beginning of period 267 487
----------------------------------------------------------------------------
Cash - end of period 251 468
----------------------------------------------------------------------------
----------------------------------------------------------------------------

Supplementary information

Income taxes (refunded) paid (243) 105
Interest paid 2,702 2,080

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)

Six months ended June 30,
2008 2007
$ $

Cash provided by (used in)
Operating activities
Net loss for the period (1,469) (21,111)
Adjustments for non-cash items
Non-controlling interest of Class B
Exchangeable Units - (10,949)
Amortization of property, plant and equipment 5,036 6,837
Amortization of customer relationship - 260
Interest accretion and amortization of deferred
commitment fees 364 1,176
Unit-based compensation 311 225
Gain on sale of property, plant and equipment (116) (6)
Inventory write off (notes 2 and 3) - 19,238
Recall and restructuring costs not yet paid
(notes 2 and 3) (1,350) 14,668
Marked-to-market adjustment (note 24) 165 (589)
Future income taxes - (14,295)
----------------------------------------------------------------------------
2,941 (4,546)

Change in non-cash working capital items
Accounts receivable 219 11,052
Inventories 259 (27,565)
Accounts payable and accrued liabilities (568) (7,951)
Prepaid expenses and sundry assets 965 (494)
Income taxes 244 441
----------------------------------------------------------------------------
4,060 (29,063)
----------------------------------------------------------------------------
Financing activities
Change in bank indebtedness (1,799) 29,210
Issuance of Trust Units, net - 44
Long-term debt repayments (14) (13)
----------------------------------------------------------------------------
(1,813) 29,241
----------------------------------------------------------------------------
Investing activities
Purchase of property, plant and equipment (2,295) (2,553)
Proceeds from sale of property, plant and equipment 274 30
----------------------------------------------------------------------------
(2,021) (2,523)
----------------------------------------------------------------------------
Increase (decrease) in cash 226 (2,345)
Cash - beginning of period 25 2,813
----------------------------------------------------------------------------
Cash - end of period 251 468
----------------------------------------------------------------------------
----------------------------------------------------------------------------

Supplementary information

Income taxes (refunded) paid (181) 181
Interest paid 5,583 3,945

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



Menu Foods Income Fund
Notes to Consolidated Financial Statements
June 30, 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 revolving 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 ("GAAP") 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 June 30, 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 material. 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 material effect on the liquidity of the Fund.

The recall costs noted above include product collection, customer fines and penalties, write off and disposal costs of $46,455, lost margin on returned product of $2,885, $2,400 to establish and operate a call centre to respond to consumer concerns and $3,260 in professional and associated fees necessary to manage through this difficult process. As at June 30, 2008, the Fund has incurred $44,168 of actual recall costs, including inventory write offs, and has accrued a further $10,832 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.

On May 30, 2008, the United States District Court for the District of New Jersey and, by July 9, 2008, the Canadian courts preliminarily approved the comprehensive Settlement Agreement in the Pet Food Multi-District Litigation. The Settlement Agreement would resolve more than 100 class action lawsuits filed in United States and Canadian courts. The Settlement Agreement creates a Settlement Fund of US$24,000 that will allow a potential recovery of up to 100% of all economic damages incurred by pet owners, subject to certain limitations. The Settlement Fund, administered by a neutral claims administrator, will be available to persons in the United States and Canada who purchased or obtained, or whose pets used or consumed, recalled pet food. Pursuant to the Settlement Agreement, the Settlement Fund will be funded by the defendants, including Menu Foods Income Fund and its product liability insurer. The Fund's corporate contribution to the settlement is within its previously recorded recall provision of $55,000. Motions for final approval of the Settlement Agreement have been scheduled in the United States District Court for October 14, 2008 and in the various Canadian courts for November 3, 2008.

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, or that it will be available to the Fund, if needed.

These consolidated financial statements have been prepared in accordance with GAAP on a going concern basis. The Fund's ability to continue as a going concern is dependent on the success of future operations, being able to timely dispose of assets held for sale, 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 GAAP, depending upon their nature, were recognized in 2007, the first and second quarters of 2008 or will be recognized in future periods. While most of these initiatives have already been accounted for, some will not be completed until later in 2008 or thereafter. To date, in aggregate these activities resulted in a net restructuring expense of $4,609, of which $70 and $172 were expensed during the quarter and six months ended June 30, 2008, respectively, and, principally as a result of sales of assets, have generated approximately $22,020 in cash (net of $1,142 in lenders' fees). As at June 30, 2008, the accrual for restructuring, which primarily comprises costs associated with inventory disposal together with severance costs, amounted to $1,144 (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 would no longer be purchasing those products from Menu. This caused the Fund to write down certain assets associated with these customers and to write down or undertake to 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 The 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.

5. Summary of significant accounting policies

a) Basis of presentation

The Fund prepares its consolidated financial statements in accordance with GAAP.

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 GAAP 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 June 30, 2008.

b) Use of estimates

The preparation of consolidated financial statements in conformity with GAAP 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 tested by comparing the Fund's carrying value of goodwill to its fair value. If the carrying value exceeds the fair value, then there is a potential impairment of goodwill. Any impairment in goodwill is measured by allocating the fair value of the Fund in a manner similar to a purchase price allocation and comparing the notional goodwill from the fair value allocation to the carrying value of the goodwill.

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 comprehensive income (loss).

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 June 30, 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 June 30, As at December 31,
2008 2007
$ $

Raw materials and packaging 9,252 8,488
Finished goods 23,011 22,673
----------------------------------------------------------------------------
32,263 31,161
----------------------------------------------------------------------------
----------------------------------------------------------------------------



7. Property, plant and equipment

As at June 30, 2008

Accumulated
Cost amortization Net
$ $ $

Land 4,093 - 4,093
Buildings 37,709 7,746 29,963
Machinery and equipment 82,246 52,985 29,261
Other property and equipment 16,358 14,107 2,251
Construction-in-progress 2,489 - 2,489
----------------------------------------------------------------------------
142,895 74,838 68,057

Less:
Assets held for sale 12,526 1,684 10,842
----------------------------------------------------------------------------
130,369 73,154 57,215
----------------------------------------------------------------------------
----------------------------------------------------------------------------


As at December 31, 2007

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:
Assets 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 ("MFLP"), $165,387 of the purchase price was assigned as goodwill in the consolidated financial statements. Under GAAP, 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 June 30, 2008 and December 31, 2007.



9. Other assets

As at June 30, As at December 31,
2008 2007
$ $

Deferred commitment fees (note 10)
Cost 1,003 1,037
Accumulated amortization (446) (197)
----------------------------------------------------------------------------
557 840
----------------------------------------------------------------------------
----------------------------------------------------------------------------


10. Bank indebtedness

The banking agreement provides the Fund with a US$42,500 (December 31, 2007 - US$45,000) operating facility of which $32,081 (US$31,461) was drawn upon as at June 30, 2008 (December 31, 2007 - $33,770 (US$34,066)). At June 30, 2008, the Fund had an outstanding irrevocable letter of credit in the amount of $749 (US$735) (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. In June 2008 the bank agreed to defer the US$2,500 reductions in the facility due to occur in each of June and September of 2008 until the earlier of December 31, 2008 or until the sale of certain assets is completed.

Pursuant to its amended banking agreement, this operating facility bears interest at Canadian prime rate (4.75% as at June 30, 2008) plus 3.5%, US base rate (5.00% as at June 30, 2008) plus 3.5% or Euro rate (2.78% as at June 30, 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-month 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-month 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 ended June 30, 2008; $15,000 for the nine months ending September 30, 2008; and $20,000 on a trailing twelve-month 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 $378 (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 June 30, As at December 31,
2008 2007
$ $

Senior secured notes (a) 76,238 74,017
Obligation under capital lease (b) 15 30
----------------------------------------------------------------------------
76,253 74,047

Less: Current portion 15 30
----------------------------------------------------------------------------
76,238 74,017
----------------------------------------------------------------------------
----------------------------------------------------------------------------



a) Senior secured notes
As at June 30, As at December 31,
2008 2007
$ $

Senior secured notes 76,638 74,504
Transaction costs (400) (487)
----------------------------------------------------------------------------
76,238 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 June 30, 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-month 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 3 to 1.

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 GAAP, 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 June 30, As at December 31,
2008 2007
$ $

2008 15 31
----------------------------------------------------------------------------
Total minimum lease payments 15 31
Less: Amounts representing interest
at 10.40% - 1
----------------------------------------------------------------------------
Balance of obligation 15 30
Less: Current portion 15 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 -
----------------------------------------------------------------------------
June 30, 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 GAAP, 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 June 30, 2008 these unabsorbed losses amount to $4,402 (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 June 30, 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

Number of units Gross proceeds Issuance costs Net proceeds
$ $ $

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 June 30, 2008 20,361,654 187,304 11,300 176,004
----------------------------------------------------------------------------
----------------------------------------------------------------------------


On June 30, 2008, the Fund agreed to issue 1 million five-year Trust Unit warrants in the Fund as part of the settlement of certain claims against the Fund relating to the recall. The Trust Unit warrants will be issued on August 22, 2008 at fair market value. The fair value of the Trust Unit warrants to be issued, which amounted to $524, has been determined using the Black-Scholes model, and the cost is included in the Fund's $55,000 estimate for the
overall recall costs.

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 June 30, 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 June 30,
2008 2007

Weighted average number of Trust Units
outstanding - basic 20,361,654 19,087,019
Weighted average number of Class B Units
outstanding - basic (note 12) 8,622,589 9,897,224
Dilutive effect of options (note 15) 5,146 -
----------------------------------------------------------------------------
Weighted average number of units outstanding
- diluted 28,989,389 28,984,243
----------------------------------------------------------------------------
----------------------------------------------------------------------------



Six months ended June 30,
2008 2007

Weighted average number of Trust Units
outstanding - basic 20,361,654 19,084,165
Weighted average number of Class B Units
outstanding - basic (note 12) 8,622,589 9,897,224
Dilutive effect of options (note 15) 815 109,553
----------------------------------------------------------------------------
Weighted average number of units outstanding
- diluted 28,985,058 29,090,942
----------------------------------------------------------------------------
----------------------------------------------------------------------------


14. Distributions

No distributions were declared on either the Trust Units or the Class B Units during the quarters and six-month periods ended June 30, 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 $155 and $311 was recognized for the quarter and six months ended June 30, 2008 (2007 - $144 and $225), respectively, 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 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.

The fair value of the Trust Unit options issued in the quarter ended June 30, 2008 was determined using the Black-Scholes model, incorporating a 2.97% risk free interest rate, a 60% volatility factor, 0.0% expected distributions and expected life of 39 months. On this basis, each Trust Unit option was valued at $0.54.



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

Number Range of Weighted average
of options exercise prices exercise 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
June 30, 2008 (21,000) 4.56 4.56
(8,400) 7.34 7.34
(31,200) 1.82 1.82

Options issued during the
quarter ended
June 30, 2008 27,900 1.35 1.35
21,000 1.10 1.10
----------------------------------------------------------------------------
June 30, 2008 2,111,092 0.92-7.34 3.32
----------------------------------------------------------------------------
----------------------------------------------------------------------------



The outstanding options are summarized as follows:

Options outstanding Vested options outstanding

Number Weighted average Number Weighted average
remaining life remaining life

Exercise price
4.56 610,134 11 months 305,881 11 months
5.25 6,000 11 months 4,000 11 months
7.34 271,368 23 months 90,456 23 months
3.00 18,390 28 months - -
1.82 1,135,300 32 months - -
0.92 21,000 33 months - -
1.35 27,900 38 months - -
1.10 21,000 38 months - -
----------------------------------------------------------------------------
2,111,092 25 months 400,337 14 months
----------------------------------------------------------------------------
----------------------------------------------------------------------------



Contributed surplus attributed to Trust Unit options

As at June 30, As at December 31,
2008 2007
$ $

Opening balance 658 272
Compensation expense recognized for
unit options during the period 311 396
Options exercised - (10)
----------------------------------------------------------------------------
Ending balance 969 658
----------------------------------------------------------------------------
----------------------------------------------------------------------------


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 $55,000 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 June 30, 2008 was 3.52 (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 ended 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 thereafter.

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 June 30, As at December 31,
2008 2007
$ $
Unrealized losses on translating
financial statements of
self-sustaining foreign operations (35,162) (39,403)
Gains on hedges of unrealized foreign
currency translation, net of tax 22,559 26,399
---------------------------------------------------------------------------
(12,603) (13,004)
---------------------------------------------------------------------------
---------------------------------------------------------------------------



18. Financial expenses

Quarter ended June 30,
2008 2007
$ $

Interest and accretion on senior secured notes 2,014 2,022
Interest on bank indebtedness 838 636
Gain on interest rate swap (1,505) (805)
---------------------------------------------------------------------------
1,347 1,853
----------------------------------------------------------------------------
----------------------------------------------------------------------------



Six months ended June 30,
2008 2007
$ $

Interest and accretion on senior secured notes 4,118 4,757
Interest on bank indebtedness 1,763 967
Loss (gain) on interest rate swap 165 (589)
----------------------------------------------------------------------------
6,046 5,135
----------------------------------------------------------------------------
----------------------------------------------------------------------------


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 GAAP. 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 June 30, As at December 31,
2008 2007
$ $

Current future income tax assets:
Accounts receivable, accounts payable
and accrued liabilities 289 348
Inventory provisions 367 414
Valuation allowance (656) (762)
----------------------------------------------------------------------------
- -
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Long-term future income tax (assets)
and liabilities:
Property, plant and equipment 8,684 12,394
Tax benefits of loss carry-forwards (24,901) (27,765)
Valuation allowance 17,196 17,524
Other (979) (2,153)
----------------------------------------------------------------------------
- -
----------------------------------------------------------------------------
----------------------------------------------------------------------------


The benefits of these future tax loss carry-forwards, which aggregate to approximately $69,500, expire between 2008 and 2028.

20. Other expenses and income

Research and development expenses amounted to $57 and $118 for the quarter and six months ended June 30, 2008 (2007 - $58 and $122), respectively. These expenses are included in cost of sales.

21. Obligations under operating leases

Future minimum payments under operating leases at June 30, 2008 are as follows:



$

2008 489
2009 667
2010 365
2011 123
2012 50
Thereafter -
----------------------------------------------------------------------------
1,694
----------------------------------------------------------------------------
----------------------------------------------------------------------------


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 $70 and $180 for the quarter and six months ended June 30, 2008 (2007 - $388 and $804), respectively .

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 June 30,
2008 2007
$ $

Sales
Canada
Domestic 10,755 7,817
Foreign 8,718 10,551
Intersegment transfers 3,404 2,078
----------------------------------------------------------------------------
22,877 20,446
----------------------------------------------------------------------------
United States
Domestic 42,682 29,740
Foreign 308 343
Intersegment transfers 8,256 12,742
----------------------------------------------------------------------------
51,246 42,825
----------------------------------------------------------------------------
74,123 63,271
Elimination of intersegment transfers (11,660) (14,820)
Discounts (2,133) (1,207)
----------------------------------------------------------------------------
60,330 47,244
----------------------------------------------------------------------------
----------------------------------------------------------------------------



Six months ended June 30,
2008 2007
$ $

Sales
Canada
Domestic 20,840 18,420
Foreign 14,729 29,097
Intersegment transfers 6,255 5,619
----------------------------------------------------------------------------
41,824 53,136
----------------------------------------------------------------------------
United States
Domestic 83,873 67,305
Foreign 776 684
Intersegment transfers 16,715 35,978
----------------------------------------------------------------------------
101,364 103,967
----------------------------------------------------------------------------
143,188 157,103
Elimination of intersegment transfers (22,970) (41,597)
Discounts (4,307) (3,756)
----------------------------------------------------------------------------
115,911 111,750
----------------------------------------------------------------------------
----------------------------------------------------------------------------



As at June 30, As at December 31,
2008 2007
$ $

Property, plant and equipment
Canada 38,489 37,027
United States 91,880 97,142
----------------------------------------------------------------------------
130,369 134,169
Less: Accumulated amortization 73,154 68,254
----------------------------------------------------------------------------
57,215 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 June 30, As at December 31,
2008 2007
$ $

Measured at fair value:
Cash 251 25
Interest rate swap (1,713) (1,548)
Measured at amortized cost:
Accounts receivable 14,176 14,230
Bank indebtedness (32,081) (33,770)
Accounts payable and accrued liabilities (27,752) (29,791)
Long-term debt (76,253) (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 $260 at June 30, 2008 ($591 - December 31, 2007). The net change during the quarter and six months ended June 30, 2008 of $129 and $331, respectively, has been credited to selling, general and administrative expenses. The remaining balance of trade accounts receivable includes $1,213 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 June 30, 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 June 30, 2008 resulted in an unrealized loss of $165 (2007 - gain $589), which is included in financial expense during the six-month period. The cumulative unrealized loss on the interest rate swap is $1,713 (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 year.

Market risk

The principal 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 $800, while having only a nominal impact on earnings, and a fifty basis point change in interest rates will impact earnings by approximately $200, 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 and accounts payable and accrued liabilities 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 six months ended June 30, 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 GenPar Limited
    Mark Wiens
    Chief Financial Officer
    (905) 826-3870