Sun Gro Annual Report 2008 - Sun Gro Horticulture

Sun Gro Horticulture Income FundAnnual Report to Unitholders2008

Sun Gro Horticulture Income FundSun Gro Horticulture Income Fund is a limited purpose, open-ended trust created to acquire and holdthe securities of Sun Gro Horticulture Canada Ltd. and our wholly owned subsidiaries (collectively,“Sun Gro”). Distributions to the Fund’s unit holders, are dependent on the financial performance ofSun Gro.Sun Gro Horticulture Canada Ltd.Founded in 1929 in Vancouver, British Columbia, Sun Gro Horticulture Canada Ltd. is North America’slargest producer of horticultural-grade peat and the largest distributor of peat moss, and peat and barkbasedgrowing mixes to professional plant growers in the United States and Canada.Sun Gro sells professional products, primarily to greenhouse, nursery and specialty crop growers, as wellas to golf course developers and landscapers. In addition, Sun Gro sells peat moss and peat and bark-basedgrowing mixes to retail customers, either by way of private label partnerships or under our own brandnames. The United States is Sun Gro’s largest market, accounting for approximately 80% of all sales.Business strategyOur business strategy is five-fold.We are working to grow our business by:1. Building on our position as the leading supplierof growing mixes to professional growers;2 Increasing our participation in the privatelabel retail sector;3. Expanding our presence in new markets,such as golf course construction andcontrolled release fertilizers;4. Improving our long-term supply of highqualitypeat moss; and5. Broadening the range and value of theproducts we offer to both greenhouse andnursery growers.With a long-term supply of high-quality peat,strong customer loyalty, established brand namesand leading market share, Sun Gro is wellpositioned to achieve future growth.FacilitiesSun Gro operates a network of 25 productionfacilities, comprising 12 Canadian peat and peatmixingplants, and 13 US peat and bark-mixingplants. These plants support an extensive Canadianpeat harvesting operation, as well as barkcomposting operations in the United States. Theyalso act as an efficient product distributionnetwork.Table of Contents01 Report to Unitholders04 Management’s Discussion andAnalysis of Operating Results30 Management’s Reportto Unitholders30 Audiotrs’ Report31 Consolidated FinancialStatements35 Notes to the ConsolidatedFinancial Statements48 Unitholder Information

Sun Gro Horticulture Income FundTo our UnitholdersThe year 2008 was one of unprecedented global economic uncertainty,and one of the toughest yet for Sun Gro. While it is clear that many of thechallenges we faced during the year will continue to affect ourperformance in 2009, we remain optimistic about the long-term outlookfor our business. We are confident that we have the right business andfinancial strategies in place to profitably build on our long-establishedindustry leadership when market conditions improve.Maintaining revenues and volumesdespite reduced demandSun Gro’s performance in 2008 was significantlyimpacted by a considerable reduction in demandfor peat moss, and peat and bark-based growingmixes from our nursery customers in several keymarkets. During the key spring selling season, bothour nursery and greenhouse customers across theUS were affected by generally weak sales of greengoods. At the same time, the addition of sand-basedgrowing mixes for golf courses and sports fieldsto our product offerings was not as fruitful asexpected due to a sharp decline in new golf courseopenings. Looking ahead, most professionalgrowers continue to be cautious in their cropplantings.Despite the significant decrease in demand weexperienced in 2008, we maintained our overallsales volumes and revenues at close to our 2007levels. This was thanks mainly to the success ofour strategy to increase our bulk bark business,which we accomplished with our October 2007acquisition of Florida Potting Soils, Inc, as wellas subsequent enhancements to our bulk barkproduction capabilities. Under the first full year ofownership, the Florida business added US $26.5million of revenue from bulk bark and sand-basedmix sales, beating earlier estimates of US $23.0 -$25.0 million. Capital upgrades completed during2008 at our Valdosta, Georgia plant enabled us tofurther increase our sales of bulk bark mixes.During 2008, we also leveraged our NorthAmerica-wide sales and distribution network toexpand our presence in the fertilizer market. Ourcontinuing success with this strategy is reflected inan 84% year-over-year increase in sales volumes ofwater soluble fertilizers, building on our earliersuccess with controlled release fertilizers.Challenged by wildly fluctuatingexchange rates, energy prices, andpoor harvest conditionsWith the vast majority of our sales denominatedin US dollars, the strengthening of the Canadiandollar during the first nine months of 2008 had asignificant negative impact on our sales revenues.The average value of the Canadian dollar was upby 9% over the level of the first three quarters of2007, effectively reducing our nine-month revenueby $16.2 million. This reduction was partiallyoffset by the rebound of the US dollar in the fourthquarter, which effectively increased our revenue forthe final three months of the year by $6.5 million,when compared to the same period of 2007.Sun Gro’s financial performance was alsonegatively affected by poor peat harvest conditionsand volatile energy prices. Wet weather acrossCanada reduced our annual harvest volumes by18% year-over-year. In addition to restrictingavailable supply, the poor harvest createdproduction inefficiencies at certain plants. At thesame time, higher energy prices through the secondquarter and early part of the third quarter drove upour trucking and harvest costs.2008 Annual Report to Unitholders 01

Sun Gro Horticulture Income FundManagement’s Discussion and Analysis ofOperating Results and Financial PositionAs at March 30, 2009This Management’s Discussion & Analysis (“MD&A”) was prepared as of March 30, 2009 to assist readers in understandingthe consolidated financial performance of Sun Gro Horticulture Income Fund (“Sun Gro” or the “Fund”) for the year endedDecember 31, 2008, and the significant trends that may affect Sun Gro’s future performance. This MD&A should be readtogether with the accompanying consolidated financial statements for the year ended December 31, 2008 and the notes to thesestatements. Sun Gro’s consolidated financial statements have been prepared in accordance with Canadian generally acceptedaccounting principles (“GAAP”) using our reporting currency, the Canadian dollar. Sun Gro’s units trade on the Toronto StockExchange under the symbol “GRO.UN.” Additional information relating to Sun Gro, including our Annual Information Form,is available on the System for Electronic Document Analysis and Retrieval (SEDAR) website at www.sedar.com.2008 OverviewOperating Environment• US housing starts declined by 33% over 2007,impacting Sun Gro’s nursery customers inseveral key markets.• Both our nursery and greenhouse customersreduced crop plantings as a precaution inresponse to an expected decrease in consumerspending in 2009.• Golf course developers posted the lowestnumber of openings in two decades, with a36% decline over 2007, negatively impactingour sand-based mix business.• Peat harvest volumes were down by 18% from2007 due to wet weather conditions acrossCanada. This resulted in restricted peat supplyand higher cost of goods sold.• The sustained strength of the Canadian dollarin the first nine months of the year effectivelyreduced Sun Gro’s revenue by $16.2 millionover the same period of 2007. In the fourthquarter, the trend reversed, effectively increasingSun Gro’s Q4 revenue by $6.5 million.• Our senior leverage ratio increased through thefirst three quarters of the year as performancedeclined. In the fourth quarter, currencyexchange rates increased the amount of ourUS$ debt when reflected in Canadian dollars.• Costs for raw materials, including energy andfertilizer, were volatile throughout the year.Managing Our Operating Cost Structure• Paid reduced level of compensation tosenior management, trustees and directors,and maintained freeze on staff salaries andnew hiring. These measures, which wereimplemented in the first quarter of 2008,yielded savings of approximately $0.7 millionin 2008.• Outsourced baling operations at our Rivière duLoup and Port-Cartier peat plants in Quebec,avoiding $110,000 in capital spending toinstall and upgrade baling equipment.• Completed $2.9 million in sustaining capitalprojects, including peat bog development workinitiated in 2007 and plant improvements toincrease efficiency and upgrade productioncapacity.• Decreased annual plastic consumption by100,000 kg (220,000 lbs) through increaseduse of Sun Tower balers as part of our wastereduction program.• Improved upon an already exemplary safetyrecord, reducing the number of lost-timeaccidents from five in 2007 to two in 2008.• Sub-leased our Abbotsford, BC depot andoutsourced distribution operations to the newleaseholder, generating $120,000 in annualsavings.• Completed planned rationalization of operationsat our Terrell, Texas production facility,restricting production to bulk products. Thisenabled staff reductions at the Terrell facilityand improved efficiency at other regionalfacilities.• Installed new baling equipment to increaseefficiency and upgrade the production capacityof our Elma, Manitoba peat processing anddistribution facility. The conversion shouldsave approximately $95,000 in the first year.• Completed capital upgrades to increase barkproduction at our Valdosta, Georgia plant,driving an 11% increase in sales volumes ofbulk bark mixes in the fourth quarter.• Increased sales volumes of water solublefertilizers by 84% over 2007.04 2008 Annual Report to Unitholders

Sun Gro Horticulture Income FundMANAGEMENT’S DISCUSSION AND ANALYSISRationalizing Our ProductionNetwork and Infrastructure• Completed the planned closure of ourKennetcook, Nova Scotia peat productionfacility and redeployed equipment from theplant to peat harvest operations in Quebec.In a normal harvest season, these measures,together with a sharpened focus on harvestingat locations with more predictable weatherconditions, should add approximately$1.3 million per year in operating income.• Closed our Niagara, Ontario depot and, duringthe first quarter of 2009, sold the property fornet proceeds of $1.3 million.• Transitioned our St. Raphael, New Brunswickfacility to a harvest-only operation andtransferred the baling equipment to our FortFrances, Ontario peat plant, reducing fixedcosts by approximately $200,000 per year.• Replaced the baling line at the Fort Francesplant, increasing production per shift andallowing us to utilize labour more efficiently.Financial Cost and Balance SheetImprovements• Completed a US$50.0 million refinancingof our long-term debt, improving Sun Gro’scapital structure by matching our debt servicecosts to our predominant cash flows andreducing exposure to exchange ratefluctuations.• Benefited from the rapid appreciation of theUS dollar in the final quarter of the year, whichhelped to drive gross margin for the threemonths up to 46% from 39% in 2007.• Reduced monthly distributions to unitholdersby 50%, effective with the April 2008distribution payment, and subsequentlysuspended distributions, effective with theSeptember 2008 payment, in order to redirectavailable funds to debt reduction, thusstrengthening our balance sheet.Exchange Rate TrendC$1 = US$$1.20$1.10$1.00$0.90$0.80$0.70$0.60Selected ConsolidatedFinancial Information(in thousands of dollarsexcept units outanding,per-unit amounts andequivalent bales sold) Year ended Year endedDecember 31 December 312008 2007Revenue $ 221,935 $ 224,994Gross profit 92,851 98,811Operating income 5,991 11,798Unrealized gains(losses) on foreigncurrency contracts (13,999) 4,938Realized gains on foreigncurrency contracts 1,108 3,939Goodwill andasset impairment (24,945) –Net earnings (loss)for the year (42,061) 15,891Basic and diluted earnings(loss) per unit $ (1.89) $ 0.72Weighted average of numberof units outstanding 22,284,681 22,088,420Distributable cash (1) 8,379 18,070Distributions declared 9,193 19,881Number of unitsoutstanding 22,284,681 22,284,681Distributable cashper unit (1) based onnumber of units outstanding $ 0.38 $ 0.82Distributions declaredper unit $ 0.4125 $ 0.90Payout ratio 110% 110%Average US dollarexchange rate (2) $ 0.94 $ 0.93Volume in thousands ofequivalent bales sold (3) 14,323 14,475(1) Distributable cash is not an earnings measure recognizedby Canadian generally accepted accounting principles(GAAP) and does not have a standardized meaningprescribed by GAAP. Therefore, distributable cash of theFund is unlikely to be comparable to similar measurespresented by other issuers. Refer to Management’sDiscussion and Analysis of distributable cash for adescription of the calculation method used by the Fund.(2) The average US dollar exchange rates were suppliedby the Bank of Canada.(3) An EB, or equivalent bale, is Sun Gro’s standard unit ofmeasure, referring to 10 cubic feet of product.Jan 07Feb 07Mar 07Apr 07May 07Jun 07Jul 07Aug 07Sep 07Oct 07Nov 07Dec 07Jan 08Feb 08Mar 08Apr 08May 08Jun 08Jul 08Aug 08Sep 08Oct 08Nov 08Dec 08Jan 09Feb 092008 Annual Report to Unitholders 05

Sun Gro Horticulture Income FundGeneral Sun Gro Horticulture Income Fund (the“Fund”) is a limited purpose, open-ended trustestablished under the laws of the Province ofBritish Columbia. Launched with an initial publicoffering in March 2002, the Fund was created toacquire and hold, directly and indirectly, thesecurities of Sun Gro Horticulture Canada Ltd. andseveral wholly owned subsidiaries (collectively“Sun Gro”). The Fund’s current subsidiaries are:Sun Gro Horticulture CM Ltd., HorticultureBrands Limited Partnership and Sun Gro HoldingsInc., which in turn has three subsidiaries: Sun GroHorticulture Processing Inc., Sun Gro HorticultureDistribution Inc. and Florida Potting Soils Inc.References to “we” or “our” in this report refer,collectively, to the Fund and Sun Gro. The Fund’sactivities are primarily restricted to holding thesecurities of Sun Gro, receiving interest anddividend income, and distributing such income tounitholders. The Fund’s financial condition andresults are entirely dependent on the operations ofSun Gro. Distributions to unitholders, are likewiseentirely dependent on Sun Gro’s financialperformance.Business Strategy Sun Gro’s primary focus is thehigher-margin professional grower market – anestablished and loyal customer base that tends tostick with a proven supplier who can help themachieve consistent results. The private label retailmarket is an important secondary focus. Ourgrowth strategy is five-fold. We are working togrow our business by:• building on our position as the leading supplierof growing mixes to professional growers;• increasing our participation in the private labelretail sector;• expanding our presence in new markets, suchas golf course construction and controlledrelease fertilizers;• improving our long-term supply of high-qualitypeat moss; and• broadening the range and value of products weoffer to both greenhouse and nursery growers.The successful implementation of our strategyhas been supported by a series of seven acquisitionscompleted over the past six years. Today, inaddition to being the continent’s largest producerof peat moss, we are the largest distributor of peatmoss, and peat-based and bark-based growingmedia products to the North Americanprofessional plant growers market. We have thelargest network of production plants and thebiggest customer support organization in ourindustry. We sell our products primarily toprofessional greenhouse, nursery and specialtycrop growers, as well as to golf course developersand landscapers. The underlying driver of SunGro’s business is gardening among consumers,particularly baby boomers. This can be attributedto a combination of social and demographictrends, including an aging population base, homeownership and “big box” retailers. The greenhousesegment, which typically produces annual crops, isgenerally associated with existing levels of homeownership and is relatively resilient. In recentmonths, nursery growers, which are the producersof foundation and ornamental plants, have seenmarked sales declines due to reduced new homeconstruction activity across North America. Thesetwo segments of the professional grower marketaffect the demand for high-quality growing medialike Sun Gro’s. The diversity of our peat resourcesremains a critical competitive advantage for SunGro. The climatic conditions of Canada’s northernpeat bog regions limit the peat harvest season toApril through October. Typically, there are about50 suitable harvest days during this period. Tominimize the effects of weather, Sun Gro hassecured rights to peat bogs strategically located inwestern, central and eastern Canada. Thisgeographic diversity of supply reduces the impactof wet weather during harvesting at any particularharvest location.Industry The growing media industry provides abroad range of peat, peat-based and bark-basedgrowing mixes, soil amendments, and othergrowing media products to professional plantgrowers, and directly to retail consumers throughmass merchandisers, “big box” home improvementcentres, independent garden centres, food anddrug chains, and other retail outlets. Demand forquality growing media arises from consumer lawnand garden activity throughout North America,which drives demand for all types of green goods(primarily annuals, bedding plants, evergreens,shrubs and indoor/outdoor plants). Professionalgrowers, the principal suppliers of green goods tothe retail market, have focused on respondingeffectively to this demand. These growers use highqualitygrowing media in order to maximize costefficiencies and product quality, and to meetdelivery schedules on a timely basis. The NorthAmerican peat industry has historically beencharacterized by a small number of long-termparticipants, a diversified customer base andincreasing demand for its products. The NorthAmerican industry benefits from barriers to entry,including the superiority of peat moss compared toother growing media, the capital required todevelop new peat bogs, and establish processingfacilities and transportation networks, and the06 2008 Annual Report to Unitholders

Sun Gro Horticulture Income Fundcustomer loyalty exhibited by professionalcustomers. Demand for sphagnum peat in theUnited States far exceeds domestic supply. Canadaconsistently exports 80% of the sphagnum peatit produces to the United States, accounting forvirtually all United States sphagnum peatconsumption. Canadian peat producers play adominant role in the peat-based growing mediamarket in North America. In addition toparticipating in the growing media industry, SunGro also produces sand-based mixes that are usedin the construction and maintenance of golf coursesand sports fields.Seasonality Sun Gro’s sales are subject toseasonal variances due to the seasonality of ourcustomers’ growing and selling cycles. Ourbusiness is also impacted by the seasonal natureof the peat harvest. The first two quarters of theyear have historically been our most profitable,offsetting lower earnings during the second half.Typically, approximately 55% to 60% of SunGro’s annual sales are generated in the first half ofthe year. Revenues generated in the first six monthsof 2008 and 2007 respectively accounted for55.2% and 57.7% of total revenue.On an historical basis, the seasonality of SunGro’s business has created a discrepancy in certainmonths between distributable cash generated anddistributions declared. Distributable cash per unithas been higher in the first half of the yearcompared to the second half. In the past, to providea regular income stream to unitholders throughoutthe year, the Fund had levelled distributions. Asdiscussed below under Distributable Cash,monthly distributions to unitholders weresuspended after the August 2008 distributionpayment. Since that time, distributable cashgenerated has been redirected to debt reduction,thus strengthening our balance sheet.Products Sun Gro’s product range is extensive,encompassing five broad categories: professionaland retail peat and bark-based growing mixes;bulk bark mixes; sand-based mixes; peat moss; andwater soluble and controlled release fertilizers andminerals.Sand-based mixes represent a new productcategory for Sun Gro, added with the 2007acquisition of GrowBest Holdings, LLC. Thesemixes are used in the construction andmaintenance of golf courses and sports fields.Previously, Sun Gro supplied peat moss to otherproducers for use in sand-based mixes but did notdirectly participate in this market segment.Sales by Product Category(in millions of dollars) 2008Peat and bark-based growing mixes $126.0 57%Peat moss 50.4 23%Bulk bark mixes 24.0 11%Sand-based mixes 7.2 3%Fertilizers and minerals 14.3 6%2007Peat and bark-based growing mixes $139.1 62%Peat moss 60.6 27%Bulk bark mixes 10.8 5%Sand-based mixes 2.6 1%Fertilizers and minerals 11.9 5%Fiscal Calendar The fiscal year-end of the Fundis December 31. The fiscal year of Sun Gro is a52-week or 53-week period ending on the Sundaynearest to December 31. The financial statementsof the Fund for the year ended December 31, 2008and December 31, 2007 include the results of SunGro for the periods from December 31, 2007 toDecember 28, 2008 and January 1, 2007 toDecember 30, 2007, respectively.Acquisitions To position Sun Gro for futuregrowth, the Fund has completed a total of sevenacquisitions since 2002, including four transactionsin 2007. Our acquisition strategy is focused onachieving four goals: building Sun Gro’s position asthe leading supplier of growing mixes toprofessional growers; improving our long-termsupply of high-quality peat moss; broadening therange and value of products we offer to bothgreenhouse and nursery growers; and expandingSun Gro’s presence in new markets, such as golfcourse construction and maintenance, andcontrolled release fertilizers. Through our 2007acquisitions in California and Florida, we have alsostrengthened our US market coverage, whileproviding Sun Gro with options to furtherrationalize North American production and tosource local materials in the US.The 2007 transactions were funded throughadditional borrowings under Sun Gro’s acquisitionfacility and the issuance of 261,861 units. Theseacquisitions have been accounted for by thepurchase method and the results of the acquiredbusinesses have been included in the Fund’sconsolidated financial statements from the date ofacquisition.2008 Annual Report to Unitholders 07

Sun Gro Horticulture Income FundMANAGEMENT’S DISCUSSION AND ANALYSISSun-Up Horticulture On January 16, 2007, SunGro acquired all of the outstanding shares ofSacramento, California horticultural growing mixand bark producer, Sun-Up Horticulture. Thepurchase price comprised cash consideration ofUS$4.3 million and future cash payments ofUS$0.4 million each year for three years, plus 6%simple interest calculated on the balance then due.Kellogg-Rich Grow, LLC On January 23, 2007, SunGro acquired substantially all of the operatingassets and inventory of Santa Maria, Californiahorticultural growing mix producer, Kellogg-RichGrow, LLC, for cash consideration of US$1.2million.Tourbière Omer Bélanger Inc. On August 6, 2007,Sun Gro acquired Quebec-based peat mossproducer Tourbière Omer Bélanger Inc. Thepurchase price was comprised of a payment of $2.4million for all outstanding shares, plus $0.5 millioncash consideration for other assets associated withthe operations of Tourbière Omer Bélanger. Inaddition, Sun Gro extinguished $1.0 million ofcertain Tourbière Omer Bélanger liabilities.GrowBest Holdings, LLC On October 1, 2007, SunGro acquired all of the outstanding shares ofGrowBest Holdings, LLC for US$20.6 million.GrowBest Holdings owns Florida Potting Soils,Inc. and Sunshine Peat, Inc., both based inOrlando, Florida. The purchase was fundedthrough the issuance of US$2.0 million of trustunits of the Fund and borrowings under a newacquisition line of credit established for thetransaction. The outstanding shares of GrowBestHoldings were acquired for US$18.6 million incash and 261,861 trust units. Additional relatedreal estate assets were purchased for US$1.2million.Distributable Cash Distributable cash is not anearnings measure recognized by GAAP and doesnot have a standardized meaning prescribed byGAAP. Therefore, the distributable cash of theFund may not be comparable to the distributablecash measures presented by other issuers. However,distributable cash is commonly used by Canadianopen-ended trusts as an indicator of financialperformance and Sun Gro believes thatdistributable cash is a useful supplemental measurethat may assist in assessing the potential return onan investment in the Fund.The Fund’s calculation of distributable cash isbased on cash flows from operating activities,adjusted for changes in non-cash operatingworking capital, sustaining capital expenditures,government grants and government loans,repayment of term loans for certain productionequipment and capital lease obligations. Certainexpenditures that are incurred as part of earningsenhancingcapital projects and acquisitions may beexcluded from the determination of distributablecash flow if the project or acquisition is funded bydebt or equity financing. The Fund’s calculation ofdistributable cash is prepared using reasonable andsupportable assumptions, all of which reflect theFund’s planned courses of action given ourjudgment about the most probable set of economicconditions. Actual results may vary, perhapsmaterially, from any forward-looking projections.Please see “Forward-Looking Information” onpage 29.The Fund’s monthly distributable cash variesthroughout the year according to the seasonalityof Sun Gro’s business and other factors, such asharvest volumes, capital spending patterns andfluctuations in currency exchange rates. As a result,distributions in certain months have been fundedfrom temporary borrowings under the Fund’scredit facility. Historically, distributions have beenfunded with such borrowings wheneverdistributable cash has been insufficient to fully fundestablished rates of distribution.In response to the adverse effects of currencyexchange and deteriorating US economicconditions on Sun Gro’s distributable cash flow, theFund announced a 50% reduction in cashdistributions to unitholders on March 26, 2008.Effective with the April 2008 distribution paid inmid-May 2008, the monthly distribution amountwas reduced to $0.0375 per unit.On August 13, 2008, we announced that theFund intended to indefinitely suspend distributionsto unitholders following the October 2008distribution to be paid in mid-November 2008. Inlight of Sun Gro’s significantly reduced financialperformance, the Trustees subsequently determinedthat it would be prudent to discontinuedistributions two months earlier than previouslyplanned and apply available funds for internalpurposes, primarily debt reduction. Accordingly,monthly distributions to unitholders weresuspended effective after the August 2008distribution paid in mid-September 2008, asannounced September 15, 2008.08 2008 Annual Report to Unitholders

Sun Gro Horticulture Income FundMANAGEMENT’S DISCUSSION AND ANALYSISFor the year ended December 31, 2008, the Fundgenerated distributable cash of $8.4 million,or $0.38 per unit, and distributed $9.2 million,or $0.41 per unit. In the same period of 2007, theFund generated distributable cash of $18.1 millionor $0.82 per unit, and distributed $19.9 million,or $0.90 per unit.For the three months ended December 31, 2008,the Fund generated distributable cash of $2.6million, or $0.12 per unit, and did not make anydistributions. In the same period of 2007, the Fundgenerated distributable cash of $1.0 millionor $0.04 per unit, and distributed $5.0 million,or $0.225 per unit. Distributable cash in the fourthquarter of 2008 was favourably impacted by therapid weakening of the Canadian dollar comparedto the previous 12 months, including the fourthquarter of 2007. The average value of theCanadian dollar in the fourth quarter of 2008 was20% lower than in the fourth quarter of 2007.Statement of Distributable Cash(in thousands of dollars except per-unit amounts)For the three For the three For the For themonths ended months ended year ended year endedDec. 31 2008 Dec. 31 2007 Dec. 31 2008 Dec. 31 2007Cash flows from operating activities $ 1,427 $ (2,995) $ 10,717 $ 16,273Adjustments:Change in non-cash operating working capital (1) 1,773 5,097 1,056 5,688Sustaining capital expenditures (2) (491) (800) (2,901) (3,560)Repayments on government loans (3) (55) (55) (221) (221)Repayments on equipment loans (4) (13) (45) (138) (45)Repayments on capital lease obligations (5) (33) (65) (134) (65)Current income taxes expected to seasonallyreverse in the current fiscal year (6) – (144) – –Distributable cash $ 2,608 $ 993 $ 8,379 $ 18,070Distributable cash per unit $ 0.12 $ 0.04 $ 0.38 $ 0.82Distributions declared per unit (7) $ – $ 0.225 $ 0.4125 $ 0.90Payout Ratio 110% 110%(1) Non-cash working capital fluctuates significantly on a quarterly basis as a result of the seasonality of Sun Gro’s business.(2) Sustaining capital expenditures are defined as cash outlays, capital in nature, required to maintain the business at its currentoperating capacity and efficiency level. Investment capital expenditures are those that are for the purpose of business expansionand are not recorded as a reduction from distributable cash.(3) Government grants and loans were received to directly support certain capital projects. Proceeds and repayments are includedin the calculation of distributable cash, as the related capital spending is presented on a gross basis.(4) As part of the acquisition of GrowBest Holdings, LLC, Sun Gro assumed loans related to equipment that is required to maintainthe current operating capacity. Repayment of these equipment loans is included in the calculation of distributable cash.(5) Capital leases are used to finance certain harvesting and transportation equipment. Repayment of the capital leases is includedin the calculation of distributable cash.(6) Each quarter, Sun Gro records the amount of current income tax expense or recovery based on the quarter’s taxable income orloss. Due to the seasonal nature of Sun Gro’s operations, the company typically records current income tax expense in the firsthalf of the year and current tax recoveries in the second half of the year. Accordingly, distributable cash is adjusted on a quarterlybasis to eliminate this seasonality and recognize only the current income tax expense Sun Gro expects to incur for the full year.(7) For 2009, the Fund is prohibited from making distributions under our credit agreement.2008 Annual Report to Unitholders 09

Sun Gro Horticulture Income FundMANAGEMENT’S DISCUSSION AND ANALYSISOverview of Selected Annual Information (1)(In thousands of dollars except per-unit amounts, number of units outstanding and EBs (2) )2008 2007 2006Revenue $ 221,935 $ 224,994 $ 197,307Gross profit 92,851 98,811 95,146Operating income 5,991 11,798 16,463Goodwill and asset impairment 24,945 – –Net earnings (loss) for the year (42,061) 15,891 15,947Basic and diluted earnings (loss) per unit $ (1.89) $ 0.72 $ 0.72Weighted average number of units outstanding 22,284,681 22,088,420 22,023,000Distributions declared per unit $ 0.4125 $ 0.90 $ 0.90Number of units outstanding 22,284,681 22,284,681 22,023,000Total assets $ 263,042 $ 281,829 $ 243,490Total current liabilities 70,754 82,072 50,273Total long-term liabilities (3) 94,555 61,238 45,750Exchange rates (CDN $1 = US$)Closing exchange rate at year-end $ 0.82 $ 1.01 $ 0.86Average rate for the year $ 0.94 $ 0.93 $ 0.88Volume in thousands of EBs (2) 14,323 14,475 12,543(1) As part of the strategic expansion into key US horticultural markets, Sun Gro made two acquisitions in California in January 2007and one acquisition in Florida in October 2007. These acquisitions affect the comparability of 2007 results with the prior year,particularly for sales, cost of sales and gross margin. The table above should be read with consideration given to thoseacquisitions.(2) An EB, or equivalent bale, is Sun Gro’s standard unit of measure, referring to 10 cubic feet of product.(3) See page 16 for a discussion of Sun Gro’s credit facilities and the impact of exchange rate fluctuations.Sun Gro’s 2008 revenue of $221.9 million wasdown by $3.1 million from the $225.0 million wereported in 2007. The 1% decrease was caused bythe appreciation of the Canadian dollar in the firstnine months of the year, as well as by lower annualsales volumes. In 2007, Sun Gro’s revenueincreased by $27.7 million from the $197.3 millionwe reported in 2006, due primarily to the salesadded by the businesses we acquired in Californiaand Florida in 2007, partially offset by thestrengthened Canadian dollar.Sun Gro’s gross margin for 2008 was 42%,down from the 44% we recorded in 2007. Thegross margin reduction was primarily due tostrengthening of the Canadian dollar during thefirst nine months of 2008, inefficiencies associatedwith the poor peat harvest conditions and, asexpected, the significant volumes of lower-marginproducts added with Sun Gro’s strategic expansionin Florida. The 44% gross margin recorded in 2007was down by 4% from the 48% Sun Gro achievedin 2006. This year-over-year reduction was dueprimarily to the lower-margin products addedby Sun Gro’s strategic expansion in California and,in the final quarter of 2007, by the lower-marginvolumes added in Florida.Sun Gro’s 2008 operating income of $6.0 millionwas down by $5.8 million from the $11.8 millionwe recorded in 2007, due mainly to lower harvestvolumes and the high value of the Canadian dollarrelative to the US dollar in the first nine months ofthe year. Our operating income for the first threequarters was down by $10.2 million, compared to2007. In the fourth quarter, we saw a $4.4 millionimprovement in operating income, due to the rapidweakening of the Canadian dollar. In 2007, SunGro’s operating income was down by $4.7 millionfrom the 2006 level, due mainly to the impact ofthe weaker US dollar and, to a lesser extent, lowerthan anticipated harvest volumes in Manitoba.Other expense for 2008 totalled $24.9 million.This consisted primarily of a $12.9 million net losson foreign currency contracts, a $10.4 million loss10 2008 Annual Report to Unitholders

Sun Gro Horticulture Income FundMANAGEMENT’S DISCUSSION AND ANALYSISfrom Sun Gro’s exposure to US dollar denominatedliabilities, particularly its US dollar debt, net ofunrealized gains on US dollar assets, and expensesincurred for the amortization of debt issuance costsand fees on Sun Gro’s credit facility.Sun Gro recorded a net loss of $42.1 millionin 2008, compared to net income of $15.9 millionin 2007. The net loss for 2008 was affected bya $24.9 million decrease in goodwill and assetimpairments, as well as by unrealized losses inother income. These consisted of a $14.0 millionunrealized loss on forward foreign currencycontracts and a $10.4 million unrealized foreignexchange loss on US dollar assets. Sun Gro’s totalassets in 2008 decreased by $18.8 million, or 7%,from 2007, due to the impairment of goodwill. Ourliabilities increased by $22.0 million, or 15%, from2007, due mainly to the revaluation of US$50.0million of long-term debt, with the difference inunitholders’ equity.Results of Operations The financial informationcontained in this Management’s Discussion andAnalysis of Operating Results and FinancialPosition has been prepared by management inaccordance with GAAP. Certain lines of thecomparative financial statements have beenadjusted to conform with current presentation.Operating Results for the years ended December 31, 2008 and 2007Comparative Statements of Earnings (Loss) and Comprehensive Income (Loss)(In thousands of dollars except per-unit amounts, number of units outstanding and EBs (1) )Year endedYear endedDec. 31 2008 Dec. 31 2007Revenue $ 221,935 100% $ 224,994 100%Cost of goods sold 129,084 58% 126,183 56%Gross profit 92,851 42% 98,811 44%Distribution expenses 49,064 22% 49,937 22%Selling expenses 16,353 8% 16,445 8%General and administrative expenses 21,443 9% 20,631 9%Total operating expenses 86,860 39% 87,013 39%Operating income 5,991 3% 11,798 5%Other income (expense), net (24,883) -11% 8,052 4%Goodwill and asset impairments (24,945) -11% – 0%Interest expense (7,440) -4% (5,143) -2%Earnings (loss) before income taxes (51,277) -23% 14,707 7%Income tax (provision) recoveryCurrent 111 0% (828) 0%Future 9,105 4% 2,012 0%Income tax (provision) recovery, net 9,216 4% 1,184 0%Net earnings (loss) for the year $ (42,061) -19% $ 15,891 7%Other comprehensive income (loss):Unrealized gain (loss) on translating financial statementsof self-sustaining foreign operations 10,468 5% (6,951) -3%Comprehensive income (loss) for the period $ (31,593) -14% $ 8,940 4%Basic and diluted earnings (loss) per unit $ (1.89) $ 0.72Weighted average number of units outstanding 22,284,681 22,088,4202008 Annual Report to Unitholders 11

Sun Gro Horticulture Income FundMANAGEMENT’S DISCUSSION AND ANALYSISSelected supplemental revenue informationYear endedYear endedDec. 31 2008 Dec. 31 2007Volume in thousands of EBs (1)Peat and Bark-based Growing Mixes 6,114 6,808Peat Moss 4,581 5,901Bulk Bark Mixes 2,680 1,220Sand-based Mixes 628 256Fertilizer and Minerals 320 290Total 14,323 14,475Average revenue per EB (1) (US $)Peat and Bark-based Growing Mixes $ 20.09 $ 18.81Peat Moss 10.73 9.50Bulk Bark Mixes 8.66 8.61Sand-based Mixes 11.08 10.63Fertilizer and Minerals 43.86 37.84Total $ 15.09 $ 14.38Average revenue per EB (1) (Canadian $)Peat and Bark-based Growing Mixes $ 20.74 $ 20.52Peat Moss 11.06 10.30Bulk Bark Mixes 8.96 8.90Sand-based Mixes 11.47 10.35Fertilizer and Minerals 45.17 41.22Total $ 15.58 $ 15.60(1) An EB, or equivalent bale, is Sun Gro’s standard unit of measure, referring to 10 cubic feet of product. Average revenue per EBcalculation does not include transportation-related surcharges or the cost of early payment discounts.RevenueRevenue for the year ended December 31, 2008was $221.9 million, a decrease of $3.1 million, or1%, from the $225.0 million we reported in fiscal2007. Overall sales volumes decreased by 152,000equivalent bales (EBs), also 1%. An EB is Sun Gro’sstandard unit of measure, referring to 10 cubic feetof peat. The Florida operations acquired in October2007 added 1,977,000 EBs of volume in the bulkbark and sand-based mix categories, while samestorevolumes (excluding the Florida volumes)declined by 2,129,000 EBs, or 16%.Sales Revenue (in thousands) Sales Volume (thousands of EBs)2008 2007 2008 2007Sun Gro, excluding Florida operations $ 195,846 $ 217,819 11,604 13,733Florida operations (acquired October 1, 2007) 26,089 7,175 2,719 742$ 221,935 $ 224,994 14,323 14,47512 2008 Annual Report to Unitholders

Sun Gro Horticulture Income FundMANAGEMENT’S DISCUSSION AND ANALYSISVolumes of professional and retail peat andbark-based growing mixes in 2008 were down by10% from 2007 levels. The higher volumes in 2007were due in part to a single-season contract inCalifornia that added 60,000 EBs of retail mixvolumes. Professional mix volumes were down dueto generally lower demand from growers. Peatmoss volumes decreased by 22% from 2007 levels.The lower peat volumes were due to the combinedimpact of the expiration of a peat moss supplyagreement in effect in 2007, restricted supply as aresult of an 18% year-over-year harvest reductionand decreased demand from our professionalgrower customers.The effect of exchange rate fluctuations on SunGro was significant in 2008. The average US dollarexchange rate for the first nine months of the yearwas $0.98, compared to $0.90 in 2007, effectivelyreducing Sun Gro’s revenue by $16.2 million. Withthe rapid appreciation of the US dollar in the fourthquarter, the US dollar exchange rate for the threemonths averaged $0.82, compared to $1.03 in2007, effectively increasing our revenue by $6.5million. On a full-year basis, the average US dollarexchange rate was $0.94, compared to $0.93 in2007.Cost of goods soldCost of goods sold for 2008 was $129.1 million,an increase of $2.9 million, or 2%, from $126.2million in 2007. Cost of goods sold was higher in2008 despite the small decrease in volumes solddue to the impact of the poor harvest results and,to a lesser degree, input price increases in the firstnine months of the year. Volumes harvested duringthe year decreased by 18% from 2007. For the lastthree months of the year, cost of goods sold wasconsistent with the lower sales volumes.Gross marginSun Gro’s 2008 gross margin of 42% was downby 2% from the 44% recorded in 2007. The grossmargin reduction was primarily due to reducedsales volumes, poor harvest conditions, and thestrength of the Canadian dollar in the first ninemonths of the year, as discussed above. In thefourth quarter of 2008, our gross margin improvedsignificantly to 46%, due to the weakening of theCanadian dollar during the period.Distribution expensesDistribution expenses for 2008 were $49.1million, a decrease of $0.8 million, or 2%, from the$49.9 million Sun Gro incurred during 2007. Thedecrease was partially due to the lower salesvolumes. A full year of production at Sun Gro’sacquired Florida operations helped to reduce ouroverall distribution expense. In addition,approximately 4% of sales volumes in 2007 wererelated to a peat supply agreement that did notinclude distribution expense. This agreementexpired in the second quarter of 2008 and only100,000 EBs were sold under the agreement duringthe year. Per-EB distribution expenses on samestorevolumes were up by 3% over 2007. Theincrease was due to the effect of exchange rates onour US dollar freight costs in the fourth quarter of2008.Selling expensesSelling expenses for both 2008 and 2007equalled $16.4 million, or 8% of revenue. Sun Groincurred increased expenses with our 2007acquisitions, driven primarily by amortization ofnew intangible assets and the growth of Sun Gro’ssales force. These were offset by the favourableeffect of the stronger Canadian dollar on ourprimarily US dollar selling cost during the first ninemonths of 2008.General and administrative expensesGeneral and administrative expenses for 2008were $21.4 million, or 9% of revenue, comparedto $20.6 million, or 9% of revenue, in 2007.The increased expenses from the acquired Floridaoperations and higher professional fees recorded asa result of expenses associated with financingactivities were offset by a substantial decreasein variable compensation expense and thefavourable effect of the stronger Canadian dollaron our US dollar costs during the first nine monthsof 2008. The decrease in variable compensationexpense was due to lower profitability.Operating incomeFor the year ended December 31, 2008, SunGro’s operating income was $6.0 million,a decrease of $5.8 million from the $11.8 millionwe recorded in 2007. This decline occurred for thereasons noted above.Other income (expense), netOther expense for 2008 totalled $24.9 million.We incurred a $12.9 million net loss on foreigncurrency contracts, and a $10.4 million unrealizedforeign exchange loss on Sun Gro’s US dollar assetsand liabilities. The latter was primarily related toour US$62.4 million of term debt. Other expensesof $1.3 million were incurred for the amortizationof debt issuance costs and fees on Sun Gro’s creditfacility.For 2007, other income totalled $8.1 million andconsisted primarily of a net gain of $8.8 millionon foreign currency contracts, a $0.6 millionunrealized foreign exchange loss on Sun Gro’s US2008 Annual Report to Unitholders 13

Sun Gro Horticulture Income FundMANAGEMENT’S DISCUSSION AND ANALYSISdollar assets and liabilities, and expenses incurredfor the amortization of debt issuance costs and feeson Sun Gro’s revolving operating facility.Non-cash unrealized gains and losses are createdby changes in the exchange rates used to value SunGro’s outstanding foreign currency contracts at theend of each quarter.Interest expenseInterest expense for 2008 was $7.4 million. Thisrelates to interest on Sun Gro’s revolving operatingfacility, as well as interest on term debt. Therevolving operating facility has historically beenused to support seasonal working capital needs andto level cash distributions to unitholders in certainmonths of the year. The term debt is associatedwith Sun Gro’s acquisitions and our May 2008refinancing. At that time, we refinanced a portionof our term debt with US$50.0 million of fixed-rateterm debt. Proceeds, after financing fees, were usedto repay $37.8 million of variable-rate term debtand US$2.0 million of variable-rate term debt, andto reduce the revolving operating facility byapproximately $9.2 million. The average rateon the fixed-rate term debt in 2008 was 8.0%. Theaverage rate on variable-rate term debt duringthe year was 6.3%. After refinancing, the variablerateterm debt now consists of two elements,a US$12.4 million (C$15.1 million) obligation anda $5.9 million obligation.For the same period in 2007, interest expense of$5.1 million related to interest on Sun Gro’srevolving operating facility and $59.0 million ofterm debt. The average interest rate on the termdebt was 7.1%.Average borrowings on Sun Gro’s revolvingoperating facility during the year were $39.1million at an average interest rate of 6.4%. Thiscompares to average borrowings of $35.3 millionat an average interest rate of 6.5% in 2007.Income tax (provision) recoverySun Gro recorded a net income tax recovery of$9.2 million in 2008, compared to a net income taxrecovery of $1.2 million in 2007. The 2008 incometax recovery consisted of a future tax recoveryof $9.1 million and a current tax recovery of$0.1 million. The recovery resulted primarily fromthe net loss incurred during the year, offset by nodeductable expenses and impairments.For 2007, the net income tax recovery consistedof a future tax recovery of $2.0 million and acurrent tax provision of $0.8 million. The futureincome tax recovery resulted primarily fromdifferences between tax depreciation andaccounting depreciation for facilities in bothCanada and the US and the utilization of operatingloss carryforwards in Canada. The current incometax provision resulted primarily from taxableincome from Sun Gro’s US operations.Net earnings (loss)In 2008, the Fund recorded a net loss of $42.1million, or $(1.89) per unit (22,284,681 weightedaverage units outstanding). The net loss was largelydriven by the goodwill impairment, unrealizedlosses on foreign currency contracts and unrealizedforeign exchange losses on Sun Gro’s US dollarassets and liabilities, as described above. Thiscompares to net earnings of $15.9 million, or $0.72per unit (22,088,420 weighted average unitsoutstanding) in 2007.Liquidity and Capital ResourcesCash flowsCash flow generated by Sun Gro’s operations isrequired to pay interest and taxes, repay therevolving operating facility and term loans, andmake sustaining capital expenditures. Previously,operating cash flow was also used to funddistributions to unitholders. As discussed earlier,distributions are currently suspended indefinitely.In 2008, Sun Gro had operating cash flows of$10.7 million. This included a $1.1 million growthin non-cash working capital. Due to the seasonalcyclicality of our business, working capital of$12.6 million was used during the first quarter of2008. In the same period we drew $15.5 million onour operating line to fund working capital, as wellas capital spending and distributions tounitholders. Looking forward through 2009, weanticipate an adequate annual level of operatingcash flows to fund working capital and sustainingcapital expenditures, as well as interest and debt repayments.However, during the first few months ofthe year, we will be dependent upon access to ouroperating line to meet our cash needs. We areconfident that amounts available under the newmargined operating facility will be adequate.In 2009, operating cash flow will be used fordebt reduction. Under the terms of the amendeddebt agreements, a minimum principal reduction of$5.6 million will be required by the lenders and ourgoal is to reduce term debt in excess of obligatoryamounts. Payments on the fixed rate term debt willbe held as restricted cash. We anticipate that capitalspending will be similar to the $2.9 million spent in2008.In 2008, cash flows used for investing activitiesconsisted of $2.9 million for sustaining capitalexpenditures and a $0.4 million repayment on avendor note from a business acquisition. In 2007,cash flows used for investing activities consisted of$28.9 million to acquire the outstanding shares and14 2008 Annual Report to Unitholders

Sun Gro Horticulture Income FundMANAGEMENT’S DISCUSSION AND ANALYSISrelated real estate of GrowBest Holdings, LLC, theoutstanding shares of Tourbière Omer BélangerInc., the outstanding shares of Sun-Up Horticultureand the operating assets of Kellogg-Rich Grow.Capital expenditures in 2007 were $5.0 million,which included $1.4 million of expansion capitalspent at our California sites and $3.6 million insustaining capital expenditures for peat bogdevelopment and plant upgrades.Cash flows used for financing activities in 2008related primarily to the refinancing of our debt.Proceeds from the new term loans, net of fees,totalled $50.4 million. The proceeds were used torepay $39.8 million of variable-rate term loans andto reduce the operating line by $9.2 million. Duringthe year, Sun Gro paid $10.9 million in cashdistributions to unitholders and used an additional$0.5 million to pay various loans and capital leaseobligations. In the same period of 2007, Sun Groborrowed $33.0 million to fund the acquisitionslisted above and paid $19.9 million in cashdistributions to unitholders.Cash flows from debt refinancing werematerially used as planned and previously disclosedas follows:(in thousands of dollars)Use of proceedsActual PlannedVariable rate term loans $ 39,790 $ 39,800Operating line 9,198 9,000Vendor note on acquistion 392 400Capitalized fees 1,045 1,000$ 50,425 $ 50,200Cash DistributionsIn 2008, the Fund generated distributable cashof $8.4 million, or $0.38 per unit, and declareddistributions through August of $9.2 million, or$0.4125 per unit, to unitholders. The $0.8 milliondifference between distributable cash generatedand distributions declared was funded fromborrowings under Sun Gro’s credit facility.By comparison, in 2007, the Fund generateddistributable cash of $18.1 million, or $0.82 perunit, and declared distributions of $19.9 million, or$0.90 per unit to unitholders. Again, the differencebetween distributable cash generated anddistributions declared was funded from temporaryborrowings under Sun Gro’s credit facility. Thelower level of distributable cash generated in 2008was primarily due to reduced profitability.As noted earlier, the Fund has historically reliedon cash generated from Sun Gro’s operations tosupport distributions to unitholders. The Fund’smonthly distributable cash varies throughout theyear according to the seasonality of Sun Gro’sbusiness and other factors, such as harvestvolumes, capital spending patterns and fluctuationsin currency exchange rates. As a result,distributions in certain months during the yearhave typically been funded from temporaryborrowings under the credit facility.Previous distributions were payable on thefifteenth day (or the closest business day following)of the month following the declaration. All of theFund’s distributions in 2008 and 2007 weretaxable as interest and dividends to the Fund’sunitholders.As discussed earlier, and announced onSeptember 15, 2008, in light of Sun Gro’ssignificantly reduced financial performance, theFund suspended monthly distributions tounitholders indefinitely, effective after the August2008 distribution paid in mid-September 2008.Financial position and working capitalThe seasonality of Sun Gro’s business has asignificant impact on working capital throughoutthe year due to our customers’ growing and sellingcycles. In the fourth quarter, Sun Gro’s inventoriesincrease as we prepare for our customers’ plantingneeds. In the first quarter, accounts receivableincrease as we enter our peak selling season. At theconclusion of the spring season, in the second andthird quarters, Sun Gro has substantial cashcollections. These seasonal factors require us tomaintain a significant balance on our revolvingoperating facility.Working capital was $22.6 million at December31, 2008, compared to working capital of $2.6million at December 31, 2007. The increase inworking capital was primarily due to theclassification of term debt for the GrowBestHoldings acquisition as current in 2007, and areclassification of this debt to non-current with theMay 2008 refinancing. Also, a $13.0 millionreduction in the unrealized value of foreigncurrency contracts in 2008 had an impact. Otherfactors included a $6.2 million increase ininventories and a $4.2 million increase in accountsreceivable, offset by a $1.8 million increase inaccounts payable and accrued liabilities, overthe levels at December 31, 2007. Overall in 2008,we used $1.1 million of working capital. This wasthe net effect of several factors, as described above.For 2009, assuming a stable exchange rateenvironment, we would expect only a modestchange in working capital based on our currentplan and forecast.2008 Annual Report to Unitholders 15

Sun Gro Horticulture Income FundMANAGEMENT’S DISCUSSION AND ANALYSISCredit facilitiesSummary of credit facilitiesSun Gro’s credit facilities include a variable-raterevolving operating facility and variable and fixedrateterm loans. The fixed-rate term loans relate tothe completion, in May 2008, of the US$50.0million private placement of long-term debt witha major life insurance company. The proceeds, netof $1.0 million in financing fees, were used torepay various variable-rate term loans and reducethe revolving operating facility. This resulted ina greater amount of Sun Gro’s debt beingdenominated in US dollars, providing an additionalprotection against unfavourable exchange ratefluctuations. At the same time, we amended ourexisting variable-rate credit facilities to extend thematurity date of the remaining variable-rate termloans to November 1, 2011 and the revolvingoperating facility to November 1, 2010.Sun Gro’s revolving operating facility and termdebt are secured by substantially all of the assets ofSun Gro and our subsidiaries.At December 31, 2008, Sun Gro’s debt consistedof the following components:Revolving operating facilityUnder the revolving operating facility, Sun Gromay borrow up to $50.0 million at all times and upto $55.0 million during the period from March 1to May 31. The revolving operating facilityincludes US$15.0 million that can be drawn onby Sun Gro’s US subsidiaries to finance workingcapital and general operating requirements. Theavailability under the revolving operating facility isdependent upon Sun Gro meeting certain financialcovenant requirements.Interest on Sun Gro’s revolving operating facilityis paid monthly, based on the Canadian primerate, LIBOR, Banker Acceptance rate, or US baserate, plus a margin determined by Sun Gro’s seniorleverage ratio. At December 31, 2008, Sun Gro haddrawn $34.1 million at a weighted average interestrate of 5.8% on the revolving operating facility.The facility matures on November 1, 2010.In January 2009, the operating facility wasamended to increase the margin interest rate by1.5%. The margin rate will decrease by 1.0% whenthe senior leverage ratio (as defined by terms of thecredit facility) is reduced below 3.0.Term loansAt December 31, 2008, Sun Gro had a total of$81.1 million in term loans outstanding, relatingprimarily to the US$50.0 million (CDN$60.1million) in fixed-rate debt payable to a largeinsurance company. The balance consists ofvariable-rate loans with a major Canadian bank, asdescribed below. The original terms of the fixedratedebt were for principal of US$25.0 million duein May 2013, with interest of 7.31% paidquarterly and principal of US$25.0 million due inMay 2015, with interest of 8.08% paid quarterly.In August 2008, the interest rate on Sun Gro’sfixed-rate term loans was increased by 0.50%.Since issuance, the average interest rate on thefixed-rate term debt has been 8.0%. In January2009, these loans were amended, increasing theinterest rate to 9.31% on the May 2013 trancheand 10.08% on the May 2015 tranche. Theinterest rate will be reduced to 8.31% and 9.08%,respectively, when the senior leverage ratio (asdefined by terms of the credit facility) is reducedbelow 3.0.Proceeds from the May 2008 private placementwere used to repay the $21.5 million term loanborrowed for the purchase of GrowBest Holdingsand to repay $16.3 million and US$2.0 millionof variable-rate term loans borrowed for earlieracquisitions. The remaining funds, net of$1.0 million of financing fees, were used to reducethe revolving operating facility by approximately$9.2 million.As noted earlier, the remaining variable-rate termloans were amended and the maturity extended toNovember 1, 2011. The variable-rate term loansconsist of a US$12.4 million and a $5.9 millionloan. Interest on the term loans is due monthlyat the Canadian prime rate, LIBOR, BankerAcceptance rate, or US base rate, plus a marginbased on Sun Gro’s senior leverage ratio. Duringthe year the average interest rate on the variablerateterm loans was 6.3%.At December 31, 2008, the weighted averageinterest rate on the variable-rate term loans was5.2%. Subsequent to year-end, this rate wasadjusted to comply with the terms of the fourthamendment to the credit agreement describedbelow. These funds were borrowed between June2004 and October 2007 for acquisitions andcapital expenditures associated with thoseacquisitions. In January 2009, the agreement onthe variable-rate term loans was amended,increasing the margin rate by 1.5%, based on SunGro’s senior leverage ratio. The margin rate willdecrease 1.0% when the senior leverage ratio (asdefined by terms of the credit facility) is reducedbelow 3.0.At December 31, 2008, US dollar denominatedterm debt totalled $62.4 million (CDN$75.2million). The Fund intends to repay these debtswith US dollar cash flows.16 2008 Annual Report to Unitholders

Sun Gro Horticulture Income FundMANAGEMENT’S DISCUSSION AND ANALYSISOther loansIn January 2007, as part of the acquisitionagreement with Sun-Up Horticulture, Sun Groagreed to pay a cash payment of US$0.4 millioneach year, for three years on the anniversary date ofclosing, plus 6% simple interest calculated on thebalance then due. A cash payment of $0.4 millionplus interest was made in January 2008.In October 2007, as part of the acquisition ofGrowBest Holdings, Sun Gro assumed loansrelated to certain property, plant and equipmenttotalling $0.4 million. Payments are due monthlythrough September 2010. Interest ranges from 0%to 8% and is calculated on the monthly balancethen due.In September 2006, Sun Gro received an interestfreeloan of $105,000 from the province of NewBrunswick. The loan proceeds have been allocatedto offset some of the expenses associated withrepairing and upgrading one of Sun Gro’s NewBrunswick plants, which was damaged by a fire inJune of 2005. The principal repayments on theloan began in January 2007 and will continuethrough December 2011.In December 2005, Sun Gro borrowed $500,000under a Canadian federal government-backed loanprogram to finance plant equipment that waspurchased and installed earlier that year. The loanis collateralized by a general security agreement oncertain equipment. The monthly payments ofprincipal and interest commenced in January 2006and are payable through December 2010. Interestis calculated at the bank’s floating base rate, whichis currently 5.25%.Capital lease obligationsIn August 2008, Sun Gro entered into anadditional capital lease totalling $161,000 withinterest at 2% and payments due monthly throughJuly 2012. In December 2007, Sun Gro enteredinto several capital leases with lease obligationstotalling $395,000. The leases are being repaidover a five-year term to December 2012. Thecapital leases interest rates range from 1% to 7%.The lease obligation as at December 31, 2008 was$433,000.Fourth Amendment to Credit FacilitiesAt September 30, 2008, Sun Gro was inviolation of the senior leverage ratio covenant ofour credit facilities. We sought and received fromour lenders a waiver of compliance with thiscovenant. Subsequent to year-end, we negotiated afourth amendment to the credit agreements withour lenders, which amended the senior leverageratio effective December 31, 2008, and we are incompliance with the covenant as of that date. Weanticipate that funds available from Sun Gro’soperating activities in 2009 will enable us tostrengthen our balance sheet and maintaincompliance with financial covenants.The recent amendment will impose a highermargin on Sun Gro’s borrowings. In addition, thereare limitations on distributions to unitholders,a new measure of revolving operating facilityavailability based on eligible accounts receivableand inventory and required principal repayments in2009.We have taken and are considering a number ofmeasures to reduce the company’s leverage. Theseinclude working capital management measures,such as a tightening of credit terms to customersin order to accelerate cash collections, and newinitiatives designed to reduce our purchases ofraw materials. As described earlier, we have alsomade a number of changes to improve ourmanufacturing cost structure.Summary of Contractual ObligationsSun Gro has entered into operating leases inthe normal course of business and term loanswith future annual payment commitments atDecember 31, 2008, as follows:Summary of Contractual ObligationsOperating Term Capital Other(in thousands of dollars) Leases Loans Leases Loans2009 $ 5,432 $ 5,612 $ 153 $ 8332010 4,056 7,482 130 6772011 3,101 18,208 88 212012 2,399 3,736 62 –2013 252 16,113 – –Thereafter 205 29,948 – –$ 15,445 $ 81,099 $ 433 $ 1,5212008 Annual Report to Unitholders 17

Sun Gro Horticulture Income FundMANAGEMENT’S DISCUSSION AND ANALYSISQuarterly Operating ResultsOperating results for the last nine quarters of operations of the Fund are presented below. Each ofSun Gro’s quarters represent financial results for a 13-week period.(In thousands of dollars except per-unit amounts, number of units outstanding and EBs (1) )2008 2007 2006Q4 Q3 Q2 Q1 Q4 Q3 Q2 Q1 Q4Revenue $53,654 $45,871 $62,053 $60,357 $52,464 $42,683 $63,181 $66,666 $46,459Cost of goods sold 28,764 25,783 37,609 36,928 31,909 22,415 35,712 36,147 25,029Gross profit 24,890 20,088 24,444 23,429 20,555 20,268 27,469 30,519 21,430Gross profit percentage 46% 44% 39% 39% 39% 47% 43% 46% 46%Distribution expenses 10,744 10,272 14,984 13,064 11,949 9,596 14,436 13,956 10,176Selling expenses 3,977 4,077 4,129 4,170 4,021 3,988 4,225 4,211 3,680General andadministrative expenses 6,599 4,927 4,906 5,011 5,439 4,844 4,677 5,671 5,066Total operating expenses 21,320 19,276 24,019 22,245 21,409 18,428 23,338 23,838 18,922Operating income (loss) 3,570 812 425 1,184 (854) 1,840 4,131 6,681 2,508Other income (expense), net (21,407) (2,135) 209 (1,550) 294 4,166 3,320 272 (2,860)Asset and goodwillimpairments – – (23,373) (1,572) – – – – –Interest expense (2,178) (1,853) (1,776) (1,633) (1,627) (1,103) (1,238) (1,175) (1,066)Earnings (loss) beforeincome taxes (20,015) (3,176) (24,515) (3,571) (2,187) 4,903 6,213 5,778 (1,418)Income tax (provision) recoveryCurrent 874 269 (673) (359) (107) 1,172 (436) (1,457) 356Future 2,094 446 3,996 2,569 2,936 (490) (882) 448 1,129Income tax (provision)recovery, net 2,968 715 3,323 2,210 2,829 682 (1,318) (1,009) 1,485Net earnings (loss)for the period $(17,047) $(2,461) $(21,192) $(1,361) $642 $5,585 $4,895 $4,769 $67Other comprehensivegain (loss):Unrealized gain (loss) ontranslating financialstatements ofself-sustainingforeign operations 8,190 916 (866) 2,228 (223) (1,807) (4,362) (559) 1,623Comprehensive incomefor the period $(8,857) $(1,545) $(22,058) $867 $419 $3,778 $533 $4,210 $1,690Basic and diluted earnings(loss) per unit (3) (based onnumber of units outstanding) $(0.76) $(0.11) $(0.95) $(0.06) $0.03 $0.25 $0.22 $0.22 $0.00Additional Quarterly InformationNumber of unitsoutstanding 22,284,681 22,284,681 22,284,681 22,284,681 22,284,681 22,023,000 22,023,000 22,023,000 22,023,000Average Exchange Rate (4) $0.82 $0.96 $0.99 $1.00 $1.03 $0.96 $0.90 $0.85 $0.88EBs Sold (1) 3,103 3,149 4,213 3,858 3,693 3,008 4,183 3,591 2,790Distributable cash $2,608 $1,340 $2,171 $2,260 $993 $4,201 $6,251 $6,625 $4,532Distributable cash perunit (2) (5) (based on numberof units outstanding) $0.12 $0.06 $0.10 $0.10 $0.04 $0.19 $0.28 $0.30 $0.21(1) An EB, or equivalent bale, is Sun Gro’s standard unit of measure, referring to 10 cubic feet of product.(2) Distributable cash is not an earnings measure recognized by GAAP and does not have a standardized meaning prescribed by GAAP.Therefore, distributable cash of the Fund is unlikely to be comparable to similar measures presented by other issuers. Refer topage 8 of Management’s Discussion and Analysis for a description of the calculation method used by the Fund.(3) Excluding asset impairments, the second and first quarter 2008 basic and diluted earnings per unit were $0.10 and $0.01,respectively.(4) The average US dollar exchange rates were supplied by the Bank of Canada.(5) Annual amounts may differ from reported quarterly amounts due to rounding.18 2008 Annual Report to Unitholders

Sun Gro Horticulture Income FundMANAGEMENT’S DISCUSSION AND ANALYSISThe variation of the Fund’s results betweenquarters is primarily due to the seasonality of SunGro’s business. Other influences on quarterlyresults include the impact of exchange rates onrevenue and expenses, the impact of wet weatheron our harvest and general economic conditions.Approximately 55% to 60% of our annual salesare recorded during the first half of the year. Thepeat harvest occurs in the second and thirdquarters.In the third and fourth quarters of 2008, ourgross margin improved from the level recorded ineach of the three immediately preceding quarters.The fourth quarter also marked the first time since2006 that our gross margin was better than in thesame quarter of the previous year. The decrease ingross margin during the prior periods was dueprimarily to the affects of foreign currencyfluctuations, changes in Sun Gro’s sales mix, andproduction inefficiencies at our Canadian plants asa result of lower peat harvest volumes. In 2007,each of the quarterly gross profit percentages werelower than in the comparable 2006 period, due tothe significant volumes of lower-margin productsadded by our strategic acquisitions in the US.Distribution expenses correspond to salesvolumes, but have also been impacted bysignificant fluctuations in energy costs and generaleconomic activity. Due to the shorter shippingdistances, transportation costs in California andFlorida have had a positive impact on our averagecost.In the first nine months of 2008, Sun Groexperienced a favourable impact of exchange rateson our primarily US dollar-denominated sellingexpenses. This helped to offset the increase inexpenses that we experienced with theamortization of new intangible assets and thegrowth of Sun Gro’s sales force that resulted fromour 2007 acquisitions.General and administrative (G&A) expenseshave increased over the last two years inconjunction with the overall growth of Sun Gro’sbusiness. Included in the fourth quarter 2007 and2008 G&A expense are additional accruals in theallowance for doubtful accounts.Other income (expense) variances correlateprimarily to gains and losses on foreign currencycontracts, revaluation of debt held in foreigncurrency, and gains or losses recorded on the sale ofproperty, plant and equipment. Foreign currencycontracts are marked to market each quarter,causing volatility in other income and expense.Interest expense relates to the revolvingoperating facility balance held during the year andinterest on Sun Gro’s term loans. Borrowings onthe revolving operating facility have generallyincreased since the inception of the Fund, peakingin the second quarter of each year. Higher interestrates also contributed to increased interest expenseover the last two years. In 2008, the US$50.0million refinancing included fixed interest ratesthat were higher than rates paid in 2007.Fourth Quarter 2008 ResultsSun Gro’s revenue for the fourth quarter of 2008was $53.7 million, an increase of $1.2 million, or2%, from the $52.5 million we reported in the finalquarter of 2007. The revenue increase wasprimarily driven by exchange rates, as the averageCanadian dollar exchange rate for the fourthquarter weakened from $1.03 in 2007 to $0.82 in2008. The positive effect of exchange rates wasoffset by a 16% decrease in overall sales volumes.Sales volumes of growing mixes decreased by9% during the quarter as our customers plantedfewer crops than in the fourth quarter of 2007.Straight peat moss volumes decreased by 32%from the same period in 2007, due to our lowerharvest and decreased customer demand. Salesvolumes of bulk bark mixes increased by 11% inthe fourth quarter, primarily due to the capitalupgrades we completed during 2008 at ourValdosta, Georgia plant. Fourth quarter resultswere influenced by the decline in housing starts insome key US markets and the decline in the USeconomy in general.The rapid weakening of the Canadian dollarduring the fourth quarter had a significant positiveimpact on Sun Gro’s revenue. The average value ofthe Canadian dollar was 20% lower than in thefourth quarter of 2007. This effectively increasedSun Gro’s 2008 fourth quarter revenue by $6.5million. Gross margin for the final three months of2008 increased to 46% from 39% in 2007.Sun Gro’s fourth quarter distribution expensesdecreased by $1.2 million, or 10%, over 2007,due to our lower sales volumes. However, dueto the effect of exchange rates on our US dollardenominated freight, per-EB distribution costincreased by approximately 3%.Sun Gro’s fourth quarter general andadministration expenses increased by 21% over2007, due to the effect of exchange rates on ourprimarily US dollar denominated general andadministrative expenses and the increasedallowance for doubtful accounts.Interest expense of $2.2 million for the fourthquarter of 2008 was up by $0.6 million from the$1.6 million we reported in the same period of2007. The increase relates to higher interest rateson our outstanding debt.2008 Annual Report to Unitholders 19

Sun Gro Horticulture Income FundMANAGEMENT’S DISCUSSION AND ANALYSISIncome taxes for the fourth quarter of 2008 werea recovery of $3.0 million, compared to a recoveryof $2.8 million in 2007. The increased recovery in2008 was due primarily to a reduction in tax ratesin Canada.OutlookThe information contained in “Outlook”contains forward-looking information. Please see“Forward-Looking Information” below for adiscussion of the risks and uncertainties inconnection with forward-looking information.IndustryThe lawn and garden industry is somewhat morerecession resistant than many other sectors, due toa relatively low cost of participation andfavourable age and home owning demographics. Intimes of economic stress, larger discretionarypurchases can be deferred, and increased time athome may translate into more lawn and gardenspending.Sales volumeDespite decreased demand, overall sales volumesfor 2008 were nearly flat compared to the sameperiod in 2007. This was entirely due to thevolumes added by the business we acquired inFlorida in October 2007. As the current economicweakness in the US is causing our growercustomers to be conservative in their crop plans, weexpect that our volumes in 2009 will not exceedthe 2008 levels. The greenhouse segment, whichtypically produces annual crops, is generallyassociated with existing levels of home ownershipand is therefore relatively resilient to economicdownturns. However, nursery growers, whoproduce foundation and ornamental plants, haveseen marked sales declines due to the rapid drop innew home construction activity. Until there is asubstantial improvement in general economicconditions, we expect to see limited opportunitiesfor significant volume improvements.Sales pricingWhile the overall strengthening of the Canadiandollar in recent years has driven several priceincreases, current exchange rates and the poor stateof the economy would suggest that we will not beable to increase prices further in 2009.Gross marginWe anticipate that our gross margin percentagewill continue to improve year-over-year, due to amore favourable exchange rate environment andthe positive impact of the productivity initiativeswe launched in 2008. These have included majorplant initiatives at our facilities in Terrell, Texas;Valdosta, Georgia; St. Raphael, New Brunswick;Kennetcook, Nova Scotia; Port-Cartier and Rivièredu Loup, Quebec; and Elma, Manitoba.Raw material costs are decreasing, particularlyfor energy and fertilizers. The lower energy pricesare positively impacting packaging costs. Currentenergy prices would also reduce harvest costs, ascompared to last year.TransportationOur transportation costs have been decliningdue to lower freight rates. This has been caused byweakened overall demand and lower energy prices.We have also improved the efficiency of truckloading and routing. In addition, we do not expectto ship any peat moss cross-regionally this spring.Operating incomeOperating income in the first quarter of 2009will improve substantially compared to the firstthree months of 2008 because of the expandedgross margin and lower transportation costs, asdiscussed above. Other overhead costs shouldremain relatively level in their local currency.We have no plans to add significant selling oradministrative costs.Foreign exchangeA weaker Canadian dollar will positively impactour sales and gross margin percentages goingforward. The Fund’s average rate of US dollarexchange in 2008 was $1.06. To date in 2009,the US dollar has traded well above thisamount. Accordingly, unless the Canadian dollarstrengthens considerably, the Fund expects thatforeign exchange rates will support higher salesand gross margins in 2009, as compared to the2008 levels. However, the benefit of a weakerCanadian dollar will be tempered in 2009 as theFund’s 2009 US dollar exposure has been largelyhedged with forward foreign exchange contacts atan average rate of $1.03. A decrease in theCanadian dollar will also result in an unrealizedloss on the Fund’s US dollar denominated debt.These factors will mitigate part of the gain notedabove. The 2009 foreign exchange contracts totalUS$46.0 million. For 2010, we have foreignexchange contracts of US$15.0 million at anaverage rate of US$1.14.20 2008 Annual Report to Unitholders

Sun Gro Horticulture Income FundMANAGEMENT’S DISCUSSION AND ANALYSISDistributable cashIn September 2008, as described earlier, the Fundsuspended monthly distributions to unitholders,effective after the August 2008 distributionpayment. The suspension was due to Sun Gro’ssignificantly reduced financial performance. We arecurrently using all available funds for internalpurposes, primarily debt reduction. As required byour credit facilities, the Fund does not expect toresume distributions in 2009.In the first quarter of 2008, the Fund earneddistributable cash of $2.3 million, or $0.10 perunit. Current performance trends suggest thatdistributable cash in the first quarter of 2009 willlikely double the 2008 results.Income Tax MattersIn 2007, the Income Tax Act (Canada) (the “TaxAct”) was amended to change the manner in whichspecified investment flow-through trusts (“SIFTTrusts”) such as the Fund and distributions fromthem are taxed (the “SIFT Rules”). In generalterms, the SIFT Rules will tax a SIFT Trust on itsincome at a rate approximately equal to the taxrate applicable to a Canadian public corporation,and will tax distributions of such income tounitholders as taxable dividends received from ataxable Canadian corporation. Subject to certainconditions, the SIFT Rules will apply to the Fundand any distributions to the Fund’s unitholdersafter 2010.Once in effect, the SIFT Rules will reduce theamount of the Fund’s income available fordistribution to unitholders. An individualunitholder who is resident in Canada and receivessuch a distribution from the Fund will generally besubject to tax based on the enhanced gross-up anddividend tax credit applicable to eligible dividends.As a result, the combined tax payable by the Fundon our income and by the unitholder on his or herdistributions from the Fund will approximatelyequal the tax that the unitholder would have paidhad he or she earned the income directly ratherthan through the Fund. However, reduceddistributions will be an absolute cost to other typesof unitholders including pension funds, registeredretirement savings plans and non-residents whowould not benefit from the characterization ofthe distributions as dividends.The Fund will not be subject to this new taxtreatment until 2011, provided that we do not,during the period from November 1, 2006 toDecember 31, 2010, exceed the “Normal GrowthGuidelines” released by the Department ofFinance. We do not expect that the Fund willexceed the normal growth guidelines before 2011.On February 6, 2009, the Minister of Financetabled Bill C-10 in the House of Commons. BillC-10 contains provisions that, in general, areintended to facilitate the conversion of SIFT Trustssuch as the Fund from trust to corporate formwithout giving rise to any liability for tax forinvestors.Conversion to CorporationSince the original announcement of the SIFTRules in October 2006, the Trustees have regularlyreviewed the merits of continuing to operate SunGro as an income trust structure. The tabling of BillC-10 (originally issued in draft form on July 14,2008) prompted the Trustees to considerconverting the Fund to a corporation and to initiatea review of the process and implications of doingso. As detailed in the Fund’s second quarter 2008Report to Unitholders, the Trustees believed thatcertain opportunities for future growth andacquisitions could potentially be best achievedunder a corporate structure. These acquisitionopportunities are not likely to develop in thecurrent economic climate, and thus the Trusteesdetermined that it would be prudent to deferfurther discussion of the conversion process.Financial InstrumentsOur financial instruments consist of cash,accounts receivable, bank indebtedness, accountspayable and accrued liabilities, debt, distributionspayable and forward foreign exchange contracts.The carrying value for current financial assets andliabilities is estimated to reasonably approximatetheir fair value. The carrying value for non-currentfinancial liabilities is accounted for at amortizedcost using the effective interest rate method andis estimated to approximate fair value. Thesefinancial instruments expose us to a variety offinancial risks, including foreign currency risk,interest rate risk, credit risk and liquidity risk.Foreign currency riskOur foreign currency risk relates to our UnitedStates operations and our US dollar denominateddebt. Most of the production from our Canadianplants, and virtually all of the US production is soldin the United States. Sales to customers in theUnited States are generally denominated inUS dollars, as are expenses incurred by our2008 Annual Report to Unitholders 21

Sun Gro Horticulture Income FundMANAGEMENT’S DISCUSSION AND ANALYSISUS operations. The related accounts receivable andaccounts payable are subject to foreign currencyrisk. Our US dollar denominated debt is alsosubject to foreign currency risk.Sales revenue, which is mostly in US dollars, isused to pay Canadian production and distributioncosts, Canadian dollar interest expense and, untilsuspended in August 2008, distributions tounitholders. We utilize foreign currency contractsto manage a portion of our foreign currency risk.Our policy is not to utilize foreign currencycontracts for trading or speculative purposes.These contracts do not eliminate the exposureto fluctuations in exchange rates. The contractsare used to fix the future date and exchange rateat which Canadian dollars will be purchased. Theyare settled at maturity with cash flows fromoperating activities. Future cash flows areestimated based on sales forecasts and expectedworking capital availability. All of our contractshave been marked to market value based on pricesquoted by financial institutions.Our credit risk on foreign currency contractsarises from potential non-performance bycounterparties to these contracts. We manage thisrisk by only entering into foreign currencycontracts with a limited number of large financialinstitutions and by limiting the duration of thecontracts. Our exposure to credit risk at thereporting date is estimated to be nil as the carryingvalue of our foreign currency contracts is anunrealized loss of $9.9 million at December 31,2008.During 2008, we realized gains on maturingforeign currency contracts of $1.1 million andrecorded unrealized losses of $14.0 million onoutstanding contracts, both of which are includedin other income. As at December 31, 2008, we heldforeign currency contracts and options to purchase$64.4 million at a weighted average exchangerate of $0.95 (US$1.06). Unrealized losses on allcontracts were $9.9 million at December 31, 2008.Maturity of the contracts ranges throughJune 2010.Interest rate riskInterest rate risk relates to our operating line anddebt. In May 2008, we converted US$50.0 millionin term loans to fixed interest rate debt. On ourremaining term loans, the interest rate managementpolicy has been to generally borrow on theoperating line and variable-rate term debt at shorttermfixed rates utilizing bankers’ acceptance ratesor LIBOR, plus a margin. Other loans and debtobligations are at fixed interest rates or have nointerest. The annual impact on interest expense ofa change in interest rates of 1% of our variable-rateterm loans and revolving operating facility,assuming all other variables remain constant,would be approximately $0.6 million, based on thedebt amounts outstanding at December 31, 2008.Liquidity riskLiquidity risk relates to our ability to meet ourfinancial obligations on the revolving operatingfacility, term debt, foreign currency contracts,accounts payable and accrued liabilities as theybecome due. To manage liquidity risk, wecontinuously forecast cash flows and utilize arevolving operating facility for working capitalneeds. To manage liquidity on the revolvingoperating facility and term debt, we have been ableto extend the maturity of these facilities toNovember 1, 2010 and 2011, respectively. We havealso financed US$50.0 million of debt at fixedinterest rates with terms of five and seven yearswith a major life insurance company and have usedthe proceeds to reduce existing term debt withearlier maturities. Our financial obligations aresummarized below:Liquidity RiskAccountsOperatingPayable and Foreign Line andAccrued Currency Term Capital Other(in thousands of dollars) Liabilites Contracts Loans Leases Loans2009 $ 21,204 $ 47,224 $ 5,612 $ 168 $ 9172010 17,172 41,591 144 6972011 – 18,258 97 212012 – 3,736 68 –2013 – 16,490 – –Thereafter – 30,500 – –$ 21,204 $ 64,396 $116,187 $ 477 $ 1,63522 2008 Annual Report to Unitholders

Sun Gro Horticulture Income FundMANAGEMENT’S DISCUSSION AND ANALYSISWe are subject to financial covenants related tothe revolving operating facility and the term debt.As at December 31, 2008, we were in compliancewith the terms of our credit facilities.Credit riskOur credit risk relates primarily to our accountsreceivable and the ability of our customers to meettheir obligations. We manage credit risk foraccounts receivable through an established creditmonitoring process that considers customer creditratings, the current financial status of customers,length of time receivables are past due and pastcustomer history. As is customary in thehorticultural industry, our grower customers oftenhave terms in excess of the typical commercial tradeterms of 30 days. Such terms do not usually exceeda customer’s crop growing cycle. Terms can varyfrom 30 to 210 days with approximately 60% ofsales occurring with terms of 90 days or less.Amounts owing under these extended terms(Future) are not considered due until payment isowed under the terms of the sale. The majority ofcustomer accounts are evaluated on an individualbasis and, when it is determined that a customer isunable to meet its financial obligations, a specificallowance is established. Additional reserves arebased on our estimates and take into considerationhistorical trends, market conditions and customerbase. The largest individual customer balance was4% of accounts receivable at December 31, 2008.Our maximum exposure to credit risk at thereporting date is equal to the carrying value of ouraccounts receivable. The following table providesinformation regarding the aging and collectabilityof our accounts receivable balance:December 31 December 31(in thousands of dollars) 2008 2007Future $ 26,859 $ 22,971Current 6,993 7,428Past due 1-60 days 5,773 5,592Past due 61+ days 5,997 5,168Less allowance fordoubtful accounts (1,784) (1,560)$ 43,838 $ 39,599A reconciliation of changes in the allowance fordoubtful accounts is as follows:(in thousands of dollars)Balance, December 31, 2007 $ 1,560Additional allowance 1,781Write off of accounts receivable (2,004)Recoveries of previous write-offs 96Other comprehensive income 351Balance, December 31, 2008 $ 1,784International FinancialReporting Standards (IFRS)In January 2006, the Accounting StandardsBoard announced its decision to require all PubliclyAccountable Enterprises to report underInternational Financial Reporting Standards foryears beginning on or after January 1, 2011 withappropriate comparative financial data for 2010.We are currently evaluating the impact on the Fundof the conversion to IFRS. The full impact ofadopting IFRS on the Fund’s consolidated financialstatements has not yet been determined. Ourpreliminary view is that there are many similaritiesbetween Canadian GAAP and IFRS for ourbusiness.We believe that the conversion to IFRS will notrequire material changes to our IT systems. Ingeneral, IFRS requires more expansive footnotedisclosures than Canadian GAAP, particularly forinterim reporting. Accordingly, there will likely beinstances where the accounting for certain itemsmay not change significantly, however disclosuresmay.Over the course of 2009, we intend to furtheranalyze the impact of converting to IFRS in orderto be in a position to quantify the impact on theFund’s consolidated financial statements. Inaddition, training needs will be identified and thetransitional options available under IFRS at theadoption date will be evaluated, along with themost appropriate accounting policies. Once thisassessment is completed, we will proceed withidentifying any necessary changes to our businessprocesses in order to comply with the requirementsof IFRS.2008 Annual Report to Unitholders 23

Sun Gro Horticulture Income FundMANAGEMENT’S DISCUSSION AND ANALYSISChanges in Accounting Principlesincluding Initial AdoptionDisclosure and presentationfor financial instrumentsEffective January 1, 2008, the Fund adopted therecommendations of CICA Handbook Sections3862, “Financial Instruments – Disclosures”, and3863, “Financial Instruments – Presentation”.Section 3862 replaces the disclosure requirementsof Sections 3861, “Financial Instruments –Disclosure and Presentation”, including requireddisclosure of the assessment of the significance offinancial instruments for an entity’s financialposition and performance and of the extent of risksarising from financial instruments to which theFund is exposed and how the Fund manages thoserisks, whereas Section 3863 carries forward thepresentation related requirements of Section 3861.These new sections relate to disclosure andpresentation only and did not have an impact onthe Fund’s financial results. These disclosures arecontained in note 18 of the audited consolidatedfinancial statements.Measurement and disclosure of inventoriesEffective January 1, 2008, the Fund adoptedCICA Section 3031, “Inventories”, whichintroduces changes to measurement and disclosureof inventories. The new standard provides guidanceon the types of costs that can be capitalizedand requires the reversal of previous inventorywrite-downs if economic circumstances change.There has been no material impact on the adoptionof the standard on the Fund’s audited consolidatedfinancial statements.Capital risk managementEffective January 1, 2008, the Fund adoptedCICA Handbook Section 1535, which establishesstandards for disclosing information about anentity’s capital and how it is managed. The newstandard requires the Fund to disclose informationabout our objectives, policies and processes formanaging capital, and to disclose whether or notwe have complied with any capital requirements towhich we are subject and the consequences of noncompliance.Disclosure requirements pertainingto Section 1535 are addressed in note 12 of theaudited consolidated financial statements.General standards of financialstatement presentationEffective January 1, 2008, the Fund adoptedCICA Handbook Section 1400, “GeneralStandards of Financial Statement Presentation”,which establishes guidance related to management’sresponsibility to assess the ability of theFund to continue as a going concern. The newstandard requires us to take into account allavailable information about the future, lookingforward at least 12 months from the balance sheetdate. Disclosure is required of materialuncertainties related to events or conditions thatmay cast significant doubt upon the Fund’s abilityto continue as a going concern. We have reviewedthe guidance in Section 1400 and determined thatno material uncertainties exist with respect to theFund’s ability to continue as a going concern.Critical Accounting EstimatesThe preparation of financial statements requiresthe Fund to make certain estimates andassumptions that affect the reported amounts ofassets and liabilities at the dates of the financialstatements and the reported amounts of revenuesand expenses during the reporting period. Actualresults could differ from those estimates. The mostsignificant estimates are related to fair value offinancial instruments, economic lives of depreciablelong-lived assets, asset impairment, asset retirementobligations, accounts receivable valuation,inventory valuation and income taxes, each ofwhich are summarized below:Fair Value of Financial InstrumentsWe generate a significant portion of ouroperating cash flows in US dollars and make themajority of our disbursements in Canadian dollars.The Fund utilizes foreign currency contracts tomanage a portion of our foreign currency risk. Ourpolicy is not to utilize foreign currency contracts fortrading or speculative purposes. All contracts havebeen marked to market value, and gains and lossesare recorded in other income. Inherent in forwardcurrency contracts is the related balance sheet riskas their value depends upon prevailing exchangerates. At year-end, Sun Gro had a liability of $9.9million to settle these contracts. See the discussionof financial instruments above for furtherinformation.Long-lived AssetsSun Gro records property, plant and equipmentat cost, less any government grants received relatedto the assets. We depreciate property, plant andequipment over its productive life using the24 2008 Annual Report to Unitholders

Sun Gro Horticulture Income FundMANAGEMENT’S DISCUSSION AND ANALYSISstraight-line method. The productive life forproperty, plant and equipment is determined bymanagement. Other long-lived assets consist ofgoodwill and other intangible assets, includingbrand names, customer relationships, andinternally developed software and databases.Goodwill is not amortized to earnings, but is testedannually for impairment. The Sunshine ® brandname has been determined to have an indefiniteuseful life and is not amortized. The remainingintangible assets are amortized on a straight-linebasis. The estimated lives of our property, plant andequipment, and definite lived intangible assets areset out in note 1 to the Fund’s audited consolidatedfinancial statements.Asset ImpairmentThe application of CICA Handbook Section3062, “Goodwill and Other Intangible Assets”,requires that the excess of the purchase amount ofacquisitions over the value of the identifiable netassets should not be amortized to earnings, butperiodically tested for impairment. Sun Gro reviewsnon-amortized intangible assets and goodwill forimpairment annually and whenever events orchanges in circumstances indicate that the carryingamount may not be recoverable. We use certainoperating and financial assumptions to conduct ourimpairment test, including current marketinformation, when available, or other generallyaccepted valuation methods, such as discountedcash flows.Differences in assumptions regarding discountrates and projection of future operating cash flowscould have a significant impact on thedetermination of asset impairment reported in thestatement of earnings. These assumptions are testedagainst relevant independent information forconsistency and reliability. Where the carryingvalue exceeds estimated fair value, the assets arewritten down to fair value.Changes in estimates or assumptions could affectgoodwill impairment in the statement of earningsand goodwill in the balance sheet of the Fund’sconsolidated financial statements.In March, 2008, we announced a reductionin the distributions to unitholders for 2008. Asexpected, the announcement resulted in asignificant decline in the Fund’s unit trading price.We concluded that this decline was a circumstancewhich required us to test our goodwill forimpairment.We determined that the Fund is a single reportingunit and therefore used the Fund’s marketcapitalization as an indicator of fair value. Thecarrying value of the Fund’s net assets exceeded theFund’s market capitalization during the secondquarter of 2008. Therefore, we carried out thesecond step of the goodwill impairment test, whichcompares the implied fair value of the Fund’sgoodwill, determined as the excess of the marketcapitalization over the fair value assigned by us tothe Fund’s other assets and liabilities. From thistest, we determined that the fair value of the Fund’snet assets and liabilities, excluding goodwill,exceeded the Fund’s market capitalization andtherefore recorded a goodwill impairment charge of$23.3 million in the second quarter. This amountcomprised the entire balance of goodwill.In March, 2008, we closed our productionfacility in Kennetcook, Nova Scotia. We relocatedthe Kennetcook equipment for use at otherproduction facilities. In order to retain rights to thebog for possible future operations, we continue tomake rental payments under the bog lease. In lightof the facility closure, we concluded that thecarrying value of the bog was no longerrecoverable. Accordingly, we determined that thecarrying value of the bog exceeded its estimated fairvalue and recorded an impairment charge of $1.6million in the first quarter of fiscal 2008 to adjustthe value of the bog.At December 31, 2008, given the currentdisruption and uncertainty in the global economy,and the significant decrease in the Fund’s unit priceover the previous nine months, we concluded thatthe appropriate triggers had been reached for animpairment test of all long-lived assets. The Fundperformed asset recoverability tests on all longlivedassets using undiscounted cash flows. Thesetests were based on internal projections forrevenues and expenses covering the estimatedremaining life of such assets. We concluded that theundiscounted cash flows exceeded the carryingvalue of all intangible assets tested, and therefore,no impairment was recorded.We estimated the fair value for our indefinitelived Sunshine ® brand name using a ‘relief fromroyalty’ method. This method calculates the valueby determining the savings enjoyed by Sun Gro bynot having to pay an external third party for the useof this brand name. These savings were determinedas a percentage of gross sales, adjusted for incometax at a weighted average corporate tax rate of36%, and then calculated as a present value usinga discount rate of 15%. We concluded that thediscounted cash flows exceeded the carrying valueof the Sunshine ® brand name, and therefore, noimpairment was recorded.2008 Annual Report to Unitholders 25

Sun Gro Horticulture Income FundMANAGEMENT’S DISCUSSION AND ANALYSISAsset Retirement ObligationsCICA Handbook Section 3110, “Asset RetirementObligations”, focuses on the recognition,measurement and disclosure of liabilities related tolegal obligations associated with the retirement oftangible long-lived assets. These obligations areinitially measured at the fair value of the estimatedfuture cash flows required to settle the obligations,and are subsequently adjusted for the passage oftime and any changes in estimates to the underlyingcash flows. The asset retirement cost is capitalizedto the related asset and amortized into earningsover time. For Sun Gro, asset retirement obligationsrelate primarily to the need to rehabilitate our peatbogs. Determining the fair value of the future cashflows required to settle the obligations requirescertain estimates to be made regarding the nature ofthe rehabilitation work to be performed, the costthat would be charged by a third party to performsuch work, and the useful lives of the bogs.Changes to these estimates may result in changesto the liabilities for asset retirement obligations.Accounts Receivable ValuationSun Gro regularly reviews the age of the accountsreceivable in detail by customer and follows upwith delinquent accounts directly with thecustomer. We manage accounts receivable throughan established credit monitoring process thatconsiders customer credit ratings, the currentfinancial status of customers, length of timereceivables are past due and past customer history.The majority of customer accounts are evaluatedon an individual basis and, when we determine thata customer is unable to meet its financialobligations, a specific allowance is established.Additional reserves are based on our estimates andtake into consideration historical trends, marketconditions and customer base. See the discussionof financial instruments and credit risk above forfurther information on accounts receivable. Thefollowing table provides a year-over-yearcomparison of the aging and collectability of thecompany’s account receivable balances:December 31 December 31(in thousands of dollars) 2008 2007Future $ 26,859 $ 22,971Current 6,993 $7,428Past due 1-60 days 5,773 5,592Past due 61+ days 5,997 5,168Less allowance fordoubtful accounts (1,784) (1,560)$ 43,838 $ 39,599Inventory ValuationFinished goods inventories include material,labour and manufacturing overhead stated at thelower of average cost or net realizable value. Rawmaterials inventory is stated at the lower of averagecost or net realizable value. Inventory valuationreserves are maintained for the estimatedimpairment of the inventory. Impairment may be aresult of slow moving or excess inventory, productobsolescence, or changes in the valuation of theinventory.Effective January 1, 2008, the Fund adoptedCICA Section 3031, “Inventories”, whichintroduces changes to measurement and disclosureof inventories. The new standard provides guidanceon the types of costs that can be capitalized andrequires the reversal of previous inventory writedownsif economic circumstances change. Theadoption of this standard has had no materialimpact on the Fund’s audited consolidated financialstatements.Income TaxesThe application of CICA Handbook Section3465, “Income Taxes”, requires that future incometax assets and liabilities be recognized for the futureincome tax consequences of events that have beenincluded in the consolidated statement of earningsor income tax returns. Provision for future incometax is made using the liability method andrecognizes all significant temporary differencesbetween the tax and consolidated financialstatements bases of assets, liabilities and certaincarry forward items.Future income tax assets are recognized only tothe extent that, in our opinion, it is more likely thannot that the future income tax assets will berealized. This opinion is based on certain estimatesand assumptions. If these estimates or assumptions26 2008 Annual Report to Unitholders

Sun Gro Horticulture Income FundMANAGEMENT’S DISCUSSION AND ANALYSISchange in the future, the Fund could be required toreduce the value of the future income tax assets,resulting in an income tax provision or recovery.We evaluate our future income tax assetsperiodically. Future tax assets and liabilities aremeasured using enacted or substantively enactedtax rates expected to apply when the asset isrealized or the liability settled. At year-end, SunGro’s future income tax assets are $9.8 million andliabilities total $21.3 million, for a net tax liabilityof $11.5 million. The effect of a change in tax rateson future tax assets and liabilities is recognized inincome in the period that enactment or substantiveenactment occurs.Changes in estimates or assumptions could affectthe income tax in the statement of earnings and thefuture income taxes in the balance sheet of theFund’s consolidated financial statements.Controls and ProceduresDisclosure controls and procedures are designedto provide reasonable, but not absolute, assurancethat all relevant information is gathered andreported to senior management, including the ChiefExecutive Officer (CEO) and the Chief FinancialOfficer (CFO), on a timely basis so that theappropriate decisions can be made regarding publicdisclosure.As of December 31, 2008, an evaluation of theeffectiveness of the Fund’s disclosure controls andprocedures, and internal control over financialreporting, as defined under Multilateral Instrument52-109 issued by the Canadian SecuritiesAdministrators, was carried out under thesupervision of our management team with theparticipation of the CEO and CFO. Based on thatevaluation, the CEO and CFO concluded that thedesign and operation of these disclosure controlsand procedures were effective.Risks and Uncertainties:Resource Supply. Sun Gro leases approximately65,000 acres of land in Canada from provincialgovernments, from which we harvest our peat.Although we have historically been able to renewour leases upon expiration on terms not materiallydifferent from those of the existing leases, there canbe no assurance that Sun Gro will be able to do soin the future. The inability to renew these leases, orto renew them on substantially the same terms,could have a material adverse effect on Sun Gro.Sun Gro successfully renewed leases for over 4,000acres during 2008.Since 2004, we have added approximately13,000 acres to Sun Gro’s peat resources throughstrategic acquisitions and new lease agreements.During 2004, we acquired over 2,000 acres of bogsas part of our Lameque Group acquisition. In2005, we acquired approximately 300 acres ofbogs as part of our Pigeon Hill Peat Ltd.acquisition. With the acquisition of Normiska PeatInc. in 2006, we added approximately 1,440 acresof leased bogs to our peat resources. In 2007,we added another 3,000 acres with our acquisitionof Tourbière Omer Bélanger Inc.Competition. Sun Gro competes with several largeCanadian peat producers and local and nationalbark mix competitors near our US plants. The priceand profitability of peat depends to a large extenton supply and demand, which in turn can beaffected by harvest conditions and bogdevelopment activity. Bark pricing and profitabilityare influenced by demand for energy applications,which in turn is affected by relative pricing of otherfuels, as well as by mill output levels. We believethat Sun Gro can compete effectively, due to ourability to provide consistent, high-quality productsin large volumes, our well-established distributionnetwork and our value-added services.Effect of Seasonality, Weather and OtherRelated Factors. Sun Gro’s production of peatmoss and peat-based growing mixes may benegatively affected by unusual weather conditions.For example, the harvest of peat requires dryweather and may be hampered by unseasonablerain. Weather can affect harvest levels for the entireindustry, causing fluctuations in the market sellingprice of peat products from year to year or withincertain regions. In addition, Sun Gro stores peatoutdoors in large piles. The volume of these pilescan be reduced by severe weather conditions.To mitigate extreme weather risk, Sun Gro’s harvestoperations are geographically diversified, located infive provinces across Canada.Adverse weekend weather during the springselling season can also materially affect the demandfor green goods, or garden plants, andconsequently, the financial performance of SunGro’s professional grower customers. It can alsoaffect the sales of Sun Gro’s retail products,including company brands and private labelproducts. This risk is mitigated to a certain degree2008 Annual Report to Unitholders 27

Sun Gro Horticulture Income FundMANAGEMENT’S DISCUSSION AND ANALYSISby the sales of products to customers locatedthroughout North America. However, there is noassurance that such measures will adequatelyaddress this risk.Environmental Risks. Sun Gro is subject tovarious federal, provincial and municipal laws,including statutes, regulations, policies and otherrequirements overseeing or relating to dischargesinto water; the prevention, presence andremediation of hazardous materials in soil andgroundwater, both on and off site; land use andzoning matters; and the restoration or reclamationof operating sites. Accordingly, Sun Gro operationsand ownership carry an inherent risk ofenvironmental liabilities (including potential civilactions, compliance or remediation orders, finesand other penalties). This could result in Sun Grobeing involved in administrative and judicialproceedings relating to such matters, which couldhave an adverse effect on Sun Gro’s business,financial condition and results of operation.We recognize our environmental stewardshipresponsibilities and have acquired for ouroperations the required permits and otherapprovals relating to the protection of theenvironment. Additionally, through our membershipin the Peatland Ecology Research Group andthe Canadian Sphagnum Peat Moss Association,Sun Gro works with Canadian governments andthe peat moss industry in looking for ways topromote an integrated sustainable management ofthe Canadian peatlands, accelerate bogregeneration, and provide accurate information tothe public on harvesting and environmental issues.Operational Risk. Sun Gro is subject to potentialproduct liabilities connected with our operations,including liabilities and expenses associated withproduct defects. We have in place product liabilityand other insurance coverage that we believe tobe generally in accordance with the diversity of ourcustomers and their crops. Despite this, there canbe no assurance that Sun Gro will always beadequately insured against all such potentialliabilities.Sun Gro’s peat harvesting and other operationsare subject to federal and provincial regulation, andpeat harvesting in general has received attentionfrom various environmental groups. The regulatoryagencies may affect Sun Gro by regulating orprohibiting the use of such projects, procedures oroperations. We do not anticipate that futureexpenditures for compliance with suchenvironmental laws and regulation will have amaterial adverse effect on Sun Gro. No assurancecan be given, however, that such compliance withother laws and regulation that may be enacted inthe future will not have a material adverse effect.Sun Gro has unionized operations at a number ofour harvest and production locations. No labourstoppages have occurred since the inception of theFund. However, future strikes, lockouts or workstoppages could restrict Sun Gro’s ability to serviceour customers and consequently adversely affectrevenue. Sun Gro has collective bargainingagreements with all of our unionized facilities withcontract expiry dates ranging from April 30, 2009to May 26, 2010. Historically, labour relationswith Sun Gro’s unionized employees have beengood. We believe they will remain positive into thefuture; however, there can be no assurance that thiswill be the case.Reliance on Key Personnel. Sun Gro’s success islargely dependent on the skills, experience andefforts of our senior management. Loss of theservices of one or more members of seniormanagement could have a material adverse effecton Sun Gro.Sun Gro does not maintain key-man lifeinsurance policies on any members of management.Only two members of senior management arebound by non-competition agreements. If anymembers were to depart and subsequently competewith Sun Gro, such competition could have amaterial adverse effect on Sun Gro.Interest Rate Risk. Sun Gro maintains anoperating line and term debt with interest duemonthly, based on the current market interest rates.Interest rate fluctuations could have a materialeffect on interest expense for Sun Gro’s operatingline and variable-rate term debt. In May 2008, SunGro converted US$50.0 million in term loans tofixed interest rate debt. On Sun Gro’s remainingterm loans, the interest rate management policy hasbeen to generally borrow on the operating line andterm debt at short-term fixed rates utilizingbankers’ acceptance rates or LIBOR plus a margin.Other loans and debt obligations are at fixedinterest rates or have no interest. The annualimpact on interest expense of a change in interestrates of 1% would be approximately $0.6 million,based on amounts outstanding at December 31,2008.28 2008 Annual Report to Unitholders

Sun Gro Horticulture Income FundMANAGEMENT’S DISCUSSION AND ANALYSISForeign Exchange Risk. Approximately 60% ofSun Gro’s consolidated costs are incurredin Canadian dollars, while approximately 85%of Sun Gro’s consolidated revenues are earned inUS dollars. As a result, Sun Gro’s operations aresubject to the risks normally attributable tofluctuations in foreign currency values. There canbe no assurance that currency fluctuations will nothave a material adverse affect on Sun Gro.To reduce the risks of exchange rate fluctuations,Sun Gro has entered into foreign currency contractsfor the purchase of Canadian dollars. As of March30, 2009, Sun Gro held foreign currency contractsto purchase $64.4 million Canadian dollars,maturing through June 2010. Additional contractsmay be acquired, subject to review of marketconditions. There is no guarantee that thesecontracts will be sufficient to offset the risksassociated with foreign exchange rate fluctuations.Tax Matters. The Fund is of the view that allexpenses to be claimed by the Fund, Sun Gro andany of our direct and indirect subsidiaries will bereasonable and deductible, and all transactionsbetween Sun Gro’s Canadian and US subsidiarieswill comply with all requirements of applicable taxlaw and its administrative interpretation. However,the Canada Revenue Agency and/or US InternalRevenue Service may take the view that certainincome of Sun Gro’s direct or indirect subsidiariesshould be imputed to Sun Gro or that certainincome of Sun Gro should be imputed to oursubsidiaries, or that transactions between Sun Groand our subsidiaries should be treated differentlyfor tax purposes, any of which could have amaterial adverse affect on the Fund.Forward-Looking InformationThis MD&A contains “forward-lookinginformation”. Forward-looking information relatesto future events or future performance and reflectsthe Fund’s expectations regarding Sun Gro’sgrowth, results of operations, performance,business prospects, opportunities or industryperformance, or trends. Any forward-lookinginformation included in this MD&A reflects ourcurrent internal projections, expectations or beliefsand is based on information currently available.In some cases, forward-looking information canbe identified by terminology such as “may”, “will”,“should”, “expect”, “intend”, “plan”,“anticipate”, “believe”, “predict”, “potential”,“continue” or the negative of these terms or othercomparable terminology. A number of factorscould cause actual events or results to differmaterially from those discussed in any forwardlookinginformation. Important factors that couldcause actual results to differ materially from SunGro’s expectations include, among other things,fluctuations in currency exchange rates and interestrates, changes in tax laws, the impact of adverseweather conditions on harvesting operations, anincrease in freight rates, failure to successfullyimplement Sun Gro’s strategies of adding mixproducts and targeting the professional growermarket, failure of acquisitions to be accretive tounitholders or to be accretive within Sun Gro’santicipated timeframes, inability to refinanceacquisition debt, failure to meet certain financialcovenant requirements, the impact of an increase infuel costs, reduced consumer demand from naturaldisasters and economic factors, and competitiveactivity. Readers should specifically consider thesefactors, including the risks and uncertaintiesdescribed in this MD&A. Although Sun Grobelieves that any forward-looking informationcontained in this MD&A is based on reasonableassumptions, readers cannot be assured that actualresults will be consistent with such statements.Accordingly, readers are cautioned against placingundue reliance on forward-looking information.Any forward-looking information provided in thisMD&A is provided as of the date of the MD&Aand Sun Gro assumes no obligation to update orrevise them to reflect new events or circumstances,except as required by law.Additional InformationAdditional information relating to the Fund,including the Fund’s annual information form, isavailable on SEDAR at www.sedar.com.As of March 30, 2009 there were 22,284,681units of the Fund issued and outstanding.2008 Annual Report to Unitholders 29

Sun Gro Horticulture Income FundManagement’s Report to UnitholdersAuditors’ ReportManagement’sResponsibilityThe management of Sun Gro is responsible forthe preparation, integrity and fair presentation ofthe accompanying consolidated financialstatements and other information contained in thisAnnual Report.The audited consolidated financial statementsand related notes have been prepared in accordancewith accounting principles generally accepted inCanada and reflect where necessary management’sbest estimates and judgments. Financialinformation provided elsewhere in this AnnualReport is consistent with that in the consolidatedfinancial statements. Management is alsoresponsible for maintaining systems of internal andadministrative controls to provide reasonableassurance that the Fund’s assets are safeguarded,that transactions are properly executed inaccordance with appropriate authorization andthat the accounting systems provide timely,accurate and reliable financial information.The Board of Directors of Sun Gro is responsiblefor assuring that management fulfills itsresponsibility for financial reporting and internalcontrols. The Audit Committee of the Boardperforms this responsibility at its meetings wheresignificant accounting, reporting and internalcontrol matters are discussed. The AuditCommittee is entirely comprised of independentdirectors who meet periodically during the yearwith the external auditors and management toreview the consolidated financial statements, theadequacy of financial reporting, accountingsystems, and controls and external auditingfunctions. The auditors have full access to the AuditCommittee and meet with the committee both withand without the presence of management.The consolidated financial statements of the Fundhave been audited by PricewaterhouseCoopers LLP,the external auditors of the Fund whose reportfollows. The Auditors’ Report outlines the scopeof their examination and their independentprofessional opinion on the fairness of thesefinancial statements.To the Unitholders ofSun Gro Horticulture Income FundWe have audited the consolidated balance sheetsof Sun Gro Horticulture Income Fund as atDecember 31, 2008 and 2007 and the consolidatedstatements of earnings (loss) and comprehensiveincome (loss), changes in unitholders’ equityand cash flows for each of the years then endedDecember 31, 2008. These consolidated financialstatements are the responsibility of the Fund’smanagement. Our responsibility is to express anopinion on these financial statements based on ouraudits.We conducted our audits in accordance withCanadian generally accepted auditing standards.Those standards require that we plan and performan audit to obtain reasonable assurance whetherthe financial statements are free of materialmisstatement. An audit includes examining, on atest basis, evidence supporting the amounts anddisclosures in the financial statements. An auditalso includes assessing the accounting principlesused and significant estimates made bymanagement, as well as evaluating the overallfinancial statement presentation.In our opinion, these consolidated financialstatements present fairly, in all material respects,the financial position of the Fund as at December31, 2008 and 2007 and the results of its operationsand its cash flows for each of the years then endedin accordance with Canadian generally acceptedaccounting principles.Chartered AccountantsVancouverMarch 30, 2009Mitchell J. WeaverPresident & CEOSun Gro HorticultureCanada Ltd.Bradley A. WiensVice-President, Finance & CFOSun Gro HorticultureCanada Ltd.30 2008 Annual Report to Unitholders

Sun Gro Horticulture Income FundCONSOLIDATED FINANCIAL STATEMENTSConsolidated Balance Sheet(in thousands of dollars)As at December 31 As at December 312008 2007AssetsCash $ 2,277 $ –Accounts receivable 43,838 39,599Inventories (note 4) 43,003 36,803Unrealized gain on foreign currency contracts (note 18) – 4,114Prepaid expenses and other assets 4,200 4,15993,318 84,675Property, plant and equipment (note 5) 123,492 129,077Intangible assets (note 6) 44,853 44,428Goodwill (note 7) – 23,263Other assets 1,379 386$ 263,042 $ 281,829Liabilities and Unitholders' EquityCurrent liabilitiesBank indebtedness $ – $ 1,966Operating line (note 8) 34,109 36,614Accounts payable and accrued liabilities (note 9) 21,204 19,394Unrealized loss on foreign currency contracts (note 18) 8,843 –Current portion of long-term debt (note 8) 6,598 22,427Distribution payable to unitholders (note 10) – 1,67170,754 82,072Other liabilities (note 11) 5,518 5,038Unrealized loss on foreign currency contracts (note 18) 1,042 –Long-term debt (note 8) 76,455 37,189Future income taxes (note 13) 11,540 19,011165,309 143,310Unitholders' equityCapital contributions (note 12) 211,726 211,726Accumulated other comprehensive loss (12,200) (22,668)Cumulative earnings 31,225 73,286Cumulative distributions declared (note 10) (133,018) (123,825)97,733 138,519$ 263,042 $ 281,829Commitments and contingencies (note 14)Subsequent event (note 19)Approved by the TrusteesW. John Dawson, FCA Mitchell J. WeaverChairman of the Board of TrusteesTrustee; President and CEOThe accompanying notes are an integral part of these consolidated financial statements.2008 Annual Report to Unitholders 31

Sun Gro Horticulture Income FundCONSOLIDATED FINANCIAL STATEMENTSConsolidated Statements of Earnings (Loss)and Comprehensive Income (Loss)(in thousands of dollars except per-unit amounts and number of units outstanding)Year endedYear endedDecemer 31 2008 December 31 2007Revenue $ 221,935 $ 224,994Cost of goods sold 129,084 126,183Gross profit 92,851 98,811Distribution expenses 49,064 49,937Selling expenses 16,353 16,445General and administrative expenses 21,443 20,631Total operating expenses 86,860 87,013Operating income 5,991 11,798Other income (expense), net (note 15) (24,883) 8,052Goodwill and asset impairments (note 7) (24,945) –Interest expense (7,440) (5,143)Earnings (loss) before income taxes (51,277) 14,707Income tax (provision) recovery (note 13)Current 111 (828)Future 9,105 2,012Income tax (provision) recovery, net 9,216 1,184Net earnings (loss) for the year (42,061) 15,891Other comprehensive income (loss):Unrealized gain (loss) on translating financial statementsof self-sustaining foreign operations 10,468 (6,951)Comprehensive income (loss) for the year $ (31,593) $ 8,940Basic and diluted earnings (loss) per unit $ (1.89) $ 0.72Weighted average number of units outstanding 22,284,681 22,088,420The accompanying notes are an integral part of these consolidated financial statements.32 2008 Annual Report to Unitholders

Sun Gro Horticulture Income FundCONSOLIDATED FINANCIAL STATEMENTSConsolidated Statements of Changes in Unitholders’ Equity(in thousands of dollars)AccumulatedOtherUnitholders’ Comprehensive Cumulative CumulativeCapital Loss Earnings Distributions TotalBalance - December 31, 2006 $ 209,733 $ (15,717) $ 57,395 $(103,944) $ 147,467Units issued as part of acquisition 1,993 – – – 1,993Earnings for the year – – 15,891 – 15,891Other comprehensive lossfor the year – (6,951) – – (6,951)Distributions for the year – – – (19,881) (19,881)Balance - December 31, 2007 $ 211,726 $ (22,668) $ 73,286 $(123,825) $ 138,519Loss for the year – – (42,061) – (42,061)Other comprehensive incomefor the year – 10,468 – – 10,468Distributions for the year (note 10) – – – (9,193) (9,193)Balance - December 31, 2008 $ 211,726 $ (12,220) $ 31,225 $(133,018) $ 97,733The accompanying notes are an integral part of these consolidated financial statements.2008 Annual Report to Unitholders 33

Sun Gro Horticulture Income FundMANAGEMENT’S DISCUSSION AND ANALYSISConsolidated Statements of Cash Flows(in thousands of dollars)Year endedYear endedDecember 31 2008 December 31 2007Cash flows from operating activitiesNet earnings (loss) for the year $ (42,061) $ 15,891Items not affecting cashDepreciation, depletion and accretion 10,904 10,321Amortization of intangible assets 2,450 2,139Asset impairment (note 7) 1,572 –Goodwill impairment (note 7) 23,373 –Unrealized loss (gain) on foreign currency contracts 13,999 (4,938)Unrealized foreign exchange loss on US dollar assets and liabilities 10,429 635Loss (gain) on disposal of property, plant and equipment 212 (75)Future income tax recovery (9,105) (2,012)11,773 21,961Change in non-cash operating working capital (1,056) (5,688)10,717 16,273Cash flows from investing activitiesAcquisitions (note 3) – (28,900)Repayment of vendor note for business acquisition (392) –Additions to property, plant and equipment (2,901) (4,991)Proceeds from disposal of property, plant and equipment 75 190(3,218) (33,701)Cash flows from financing activitiesDistributions paid to unitholders (note 10) (10,864) (19,862)Proceeds from term loans 50,425 33,035Repayment of term loans (39,790) –Increase (decrease) in operating line (2,505) 5,556Payments on capital leases and other term loans (493) (331)(3,227) 18,398Effect of exchange rate changes on cash (29) (2,287)Decrease (increase) in bank indebtedness 4,243 (1,317)Bank indebtedness - beginning of the year (1,966) (649)Cash (bank indebtedness) - end of the year $ 2,277 $ (1,966)Supplemental cash flow informationInterest paid $ 7,194 $ 4,542Income taxes paid $ 445 $ 532Equipment acquired under capital lease obligations $ 161 $ 486The accompanying notes are an integral part of these consolidated financial statements.34 2008 Annual Report to Unitholders

Sun Gro Horticulture Income FundNotes to theConsolidated Financial Statements(tabular amounts in thousands of dollars, except per-unit amounts)1. Nature of operationsand basis of presentationNature of operationsSun Gro Horticulture Income Fund (the “Fund”) is a limitedpurpose, open-ended trust established under the laws of theProvince of British Columbia on February 12, 2002. The Fundwas created to acquire and hold, directly and indirectly,100% of the outstanding securities of Sun Gro HorticultureCanada Ltd. and its wholly owned subsidiaries (collectively“Sun Gro” or the “Company”). These subsidiaries are: Sun GroHorticulture CM Ltd., Horticulture Brands Limited Partnership,Sun Gro Holdings Inc., and its wholly owned subsidiaries, SunGro Horticulture Processing Inc. and Sun Gro HorticultureDistribution Inc. Sun Gro, founded in 1929 in Vancouver,British Columbia, is a producer and distributor ofhorticultural-grade peat moss and peat and bark-basedgrowing media with customers throughout North America.Basis of presentationThese audited consolidated financial statements have beenprepared by management in accordance with accountingprinciples generally accepted in Canada.Fiscal year-endThe fiscal year end of the Fund is December 31. The fiscalyear of the Fund’s subsidiaries is a 52 week or 53 weekperiod ending on the Sunday nearest to December 31. Thefinancial statements of the Fund for the year endedDecember 31, 2008 include the results of Sun Gro for theperiod from December 31, 2007 to December 28, 2008. Thefinancial statements of the Fund for the year endedDecember 31, 2007 include the results of Sun Gro for theperiod from January 1, 2007 to December 30, 2007.Principles of consolidationThe consolidated financial statements include the accountsof the Fund and its wholly owned subsidiaries. All significantintercompany transactions and balances have beeneliminated.Cash and cash equivalentsCash and cash equivalents consist of cash and highly liquidinvestments having original terms to maturity of 90 days orless when acquired.Accounts receivableAccounts receivable are recorded when the significant risksand rewards of ownership are transferred, which is generallyat the time of shipment to the customer. Accounts receivableare reduced by an allowance for doubtful accounts managedthrough an established credit monitoring process. Themajority of customer accounts receivable are evaluated on anindividual basis and when the Company determines that acustomer is unable to meet its financial obligations a specificallowance is established. Additional reserves are based onmanagement’s estimates and take into considerationhistorical trends, market conditions and customer base. Thecarrying value of accounts receivable is net of the allowancefor doubtful accounts.InventoriesInventories are stated at the lower of average cost and netrealizable value. Cost of finished goods includes materials,labour and an allocation of manufacturing overhead.Property, plant and equipmentProperty, plant and equipment are stated at cost, lessaccumulated depreciation and proceeds from governmentgrants, and are depreciated on a straight-line basis using thefollowing estimated useful lives:Buildings20 yearsMachinery and equipment 3 to 8 yearsPeat bogs consist of peat bog acquisition costs anddevelopment costs to prepare bog areas for harvestingoperations, such as building access roads, clearing surfacevegetation and creating drainage ditches. Peat bogs aredepleted based on the volume of peat produced during theperiod over the total expected volume of the peat bog.Depreciation of property, plant and equipment, including peatbog depletion, is included in cost of goods sold, except fordepreciation not directly related to production, which isincluded in general and administrative expenses.Intangible assetsIntangible assets include brand names, customerrelationships and internally developed software anddatabases. The Sunshine brand name has been determinedto have an indefinite useful life and is not amortized. Theremaining intangible assets are amortized on a straight-linebasis using the following estimated useful lives:2008 Annual Report to Unitholders 35

Sun Gro Horticulture Income FundNOTES TO THE CONSOLIDATED STATEMENTSBrand names (other than Sunshine) 10 yearsCustomer relationships10 to 20 yearsInternally developed softwareand databases10 yearsAmortization of brand names and customer relationships areincluded in selling expenses and amortization of internallydeveloped software and databases is included in general andadministrative expenses.Impairment of long-lived assetsProperty, plant and equipment and intangible assets with afinite life are reviewed for impairment whenever events orchanges in circumstances suggest that the carrying amountof an asset may not be recoverable and may be in excess ofits fair value.Impairment is assessed using a two step approach. Underthe first step, long-lived assets are tested for recoverability bycomparing the carrying amount of an asset to theundiscounted estimated future net cash flows expected fromits use and disposal.If the carrying amount of the asset exceeds the undiscountedcash flows, it is considered to be impaired. The second stepis then carried out whereby an impairment loss is thenmeasured and recorded as the amount by which the carryingamount of the asset exceeds its fair value, which is estimatedbased on the discounted future expected cash flows from theasset.Intangible assets with an indefinite life are reviewed forimpairment annually or more frequently if events or changesin circumstances indicate that the asset might be impaired.The asset is written down when the carrying value exceeds itsfair value.GoodwillGoodwill comprises the excess of cost over fair values of theacquired underlying net assets arising from businesscombinations accounted for using the purchase method andis not amortized. Management tests goodwill for impairmentannually, or more frequently if events or changes incircumstances indicate that it might be impaired. Goodwillimpairment is assessed based upon the comparison of thefair value of the Fund to the underlying carrying values of theFund’s net assets, including goodwill. If the carrying amountof the Fund exceeds its fair value, an impairment charge isrecorded to the extent that the carrying amount of thegoodwill exceeds its fair value (note 7).Asset retirement obligationsThe Fund records the estimated fair value of a liability forasset retirement obligations in the period a reasonableestimate of fair value can be made. The Fund’s assetretirement obligations relate primarily to Sun Gro’s peat bogs,which are located on land leased from Canadian provincialgovernments. These leases generally contain provisions thatrequire Sun Gro to rehabilitate the bogs once they becomefully depleted. The nature of the rehabilitation varies amongthe leases, may not be specified in the leases, or may bespecified at a later date. The obligation to rehabilitate isincurred when an area of a bog is cleared for harvestingoperations and the liability is settled in the period in whichthe rehabilitation work is completed. In the period areasonable estimate can be made, the fair value of theliability is added to the carrying amount of the peat bog andis depleted over its useful life. The liability is accreted overtime through periodic charges to earnings, and is reduced byactual costs of rehabilitation.Revenue recognitionThe Fund’s revenues are earned from the sale of variousgrades of peat moss, horticultural growing media (includingpeat-based, bark-based and sand-based growing mixes),and water-soluble and controlled release fertilizers andminerals. Revenues are recognized, net of customer rebatesand discount programs, when the significant risks andrewards of ownership are transferred, which is generally at thetime of shipment to the customer. The Fund classifiesamounts charged to its customers for shipping and handlingas part of its revenues and recognizes costs incurred forshipping and handling of products to customers as part ofdistribution expenses.Reporting currency and foreign currency translationsThe accounts of the Fund’s United States operations areconsidered to be self-sustaining and are translated intoCanadian dollars using the current rate method. Assets andliabilities are translated at the rates in effect at the balancesheet date and revenue and expenses are translated ataverage exchange rates for the period. Gains or losses arisingfrom the translation of the financial statements of selfsustainingUnited States operations are recorded in othercomprehensive income.Hedging relationshipsThe Fund generates a significant portion of its operating cashflows in US dollars and makes distributions to unitholders inCanadian dollars. The Fund utilizes foreign currency contractsto manage a portion of its foreign currency risk. The Fund’spolicy is not to utilize foreign currency contracts for trading orspeculative purposes. All contracts have been marked tomarket value and gains and losses are recorded in otherincome (expense).36 2008 Annual Report to Unitholders

Sun Gro Horticulture Income FundNOTES TO THE CONSOLIDATED STATEMENTSIncome taxesIncome taxes are accounted for using the asset and liabilitymethod. Under this method, future tax assets and liabilitiesare recognized for temporary differences between thefinancial statement carrying amounts of assets and liabilitiesand their respective tax bases. Future tax assets andliabilities are measured using enacted or substantivelyenacted tax rates expected to apply when the asset isrealized or the liability settled. The effect on future tax assetsand liabilities of a change in tax rates is recognized in incomein the period that enactment or substantive enactmentoccurs.Use of estimatesThe preparation of financial statements in conformity withCanadian generally accepted accounting principles requiresmanagement to make certain estimates and assumptionsthat affect the reported amounts of assets and liabilities atthe date of the financial statements and the reportedamounts of revenues and expenses during the reportingperiod. Actual results could differ from those estimates. Themost significant estimates are related to economic lives ofdepreciable long-lived assets, asset impairment, assetretirement obligations, accounts receivable valuation,inventory valuation, income taxes and fair value of financialinstruments.Recently issued accounting pronouncementsGoodwill and intangible assetsThe CICA issued Section 3064, “Goodwill and IntangibleAssets”, which establishes standards for the recognition,measurement and disclosure of goodwill and intangibleassets. The standard is effective for the Fund’s 2009 fiscalyear. The Fund’s adoption of this standard will have no impacton its consolidated financial statements.International financial reporting standardsIn January 2006, the CICA ratified a strategic plan calling forthe evolution and convergence of Canadian GAAP with IFRS,after a specified transition period, by publicly accountableenterprises in Canada. The CICA has more recently confirmedJanuary 1, 2011 as the date IFRS will replace currentCanadian standards and interpretations as GAAP for thiscategory of reporting entity. As a result, the Fund will berequired to prepare its consolidated financial statements inaccordance with IFRS for interim and annual financialstatements relating to fiscal years beginning on or afterJanuary 1, 2011, at the latest. On February 13, 2008, theCanadian Securities Administrators issued, for publiccomment, a Concept Paper proposing that listed companiesbe permitted to adopt IFRS earlier, for financial yearsbeginning on or after January 1, 2009. The Fund is currentlydeveloping an implementation plan and assessing theimpacts of the conversion on the consolidated financialstatements and disclosures of the Fund.2. Changes in accounting policiesDisclosure and presentation of financial instrumentsEffective January 1, 2008, the Fund adopted therecommendations of CICA Handbook Sections 3862,“Financial Instruments – Disclosures”, and 3863, “FinancialInstruments – Presentation”. Section 3862 replaces thedisclosure requirements of Sections 3861, “FinancialInstruments – Disclosure and Presentation”, includingrequired disclosure of the assessment of the significance offinancial instruments for an entity’s financial position andperformance and of the extent of risks arising from financialinstruments to which the Fund is exposed and how the Fundmanages those rises, whereas Section 3863 carries forwardthe presentation related requirements of Section 3861.These new sections relate to disclosure and presentation onlyand did not have an impact on the Fund’s financial results.These disclosures are contained in note 18.The Fund’s financial instruments consist of cash, accountsreceivable, bank indebtedness, accounts payable andaccrued liabilities, debt, distributions payable and, at times,forward foreign exchange contracts. The Fund’s financialinstruments expose the Company to a variety of financialrisks, including foreign currency risk, interest rate risk, creditrisk and liquidity risk. Financial instruments are initiallyrecognized at fair value with subsequent measurementdepending on classification as described below.The Fund has made the following classifications of itsfinancial instruments:CashHeld for tradingAccounts receivable Loans and receivablesAccounts payable andaccrued liabilitiesOther financial liabilitiesDebtOther financial liabilitiesForward foreignexchange contractsHeld for tradingHeld for TradingCash is measured at fair value at the end of the period beingreported on. Changes to fair value including interest earned,interest accrued, gains and losses on disposal, andunrealized gains and losses are included in net earnings(loss).The Fund enters into forward foreign exchange contracts, fromtime to time, to manage its exposure to currency ratefluctuations related primarily to future cash inflows andoutflows of US dollars. The Fund does not hold or issuederivative financial instruments for trading or speculativepurposes. The Fund has chosen not to designate its forward2008 Annual Report to Unitholders 37

Sun Gro Horticulture Income FundNOTES TO THE CONSOLIDATED STATEMENTSforeign exchange contracts as hedges. These contracts aredesignated as “held for trading” on the balance sheet and fairvalued each quarter. The resulting gain or loss on thevaluation of these financial instruments is included in netearnings (loss).Loans and ReceivablesAccounts receivable are designated as “loans andreceivables” and are accounted for at amortized cost usingthe effective interest rate method. Subsequent measurementof accounts receivable is at amortized cost less an allowancefor doubtful accounts.Other Financial LiabilitiesAccounts payable and accrued liabilities and debt aredesignated as “other financial liabilities” and are accountedfor at amortized cost using the effective interest rate method.Transaction costs associated with debt financing arecapitalized and amortized over the term of the debt.Measurement of inventoriesEffective January 1, 2008, the Fund adopted CICA Section3031, “Inventories” which introduces changes to themeasurement and disclosure of inventories. The newstandard provides guidance on the types of costs that can becapitalized and requires the reversal of previous inventorywrite-downs if economic circumstances change. There hasbeen no material impact from the adoption of the standardon the consolidated financial statements.Capital disclosuresEffective January 1, 2008, the Fund adopted CICA HandbookSection 1535, which establishes standards for disclosinginformation about an entity’s capital and how it is managed.The new standard requires the Fund to disclose informationabout its objectives, policies and processes for managingcapital and disclose whether or not it has complied with anycapital requirements to which it is subject and theconsequences of non-compliance. Disclosure requirementspertaining to Section 1535 are contained in note 12 of theseconsolidated financial statements.General standards offinancial statement presentationEffective January 1, 2008, the Fund adopted CICA HandbookSection 1400 “General Standards of Financial StatementPresentation” which establishes standards for management’sresponsibility to assess the ability of the Fund to continue asa going concern. The new standard requires management toassess the Fund’s ability to continue as a going concern andtake into account all available information about the futureincluding at least the next 12 months from the balance sheetdate. Disclosure is required of material uncertainties relatedto events or conditions that may cast significant doubt uponthe Fund’s ability to continue as a going concern. The Fund’sadoption of the standard did not have a material effect on itsconsolidated financial statements.3. AcquisitionsAll acquisitions have been accounted for by the purchasemethod and the results of the acquired business have beenincluded in the Fund’s consolidated financial statementsfrom date of acquisition.GrowBest Holdings, LLCOn October 1, 2007, Sun Gro acquired all of the outstandingshares of GrowBest Holdings, LLC for US$20.6 million(CDN$20.4 million). GrowBest Holdings owns Florida PottingSoils, Inc. and Sunshine Peat, Inc., both based in Orlando,Florida. The purchase was funded through the issuance of261,681 trust units of the fund valued at US$2.0 million(CDN$2.0 million) and US$18.6 million (CDN$18.4 million)cash obtained from borrowings under a new acquisition lineof credit, which was limited to this acquisition. Furtherborrowings on the acquisition line of US$1.2 million(CDN$1.2 million) were used to acquire related real estateon which the operations are situated.These consolidated financial statements reflect the assetsacquired from GrowBest Holdings, LLC at assigned fair valuesas follows:Accounts receivable $ 3,313Prepaid expenses and other assets 99Inventories 1,804Property, plant and equipment 6,064Intangibles 10,550Goodwill 9,481Accounts payable and accrued liabilities (4,156)Current portion of long-term debt (180)Long-term debt (246)Future income taxes (5,145)Total acquistion cost $ 21,584Tourbière Omer Bélanger Inc.On August 6, 2007, Sun Gro acquired Quebec-based peatmoss producer Tourbière Omer Bélanger Inc. The purchaseprice was comprised of a payment of $2.4 million for alloutstanding shares plus $0.5 million in cash considerationfor other assets associated with the operations of TourbièreOmer Bélanger Inc. The purchase was funded throughadditional borrowings of $2.9 million under Sun Gro’s creditfacility.38 2008 Annual Report to Unitholders

Sun Gro Horticulture Income FundNOTES TO THE CONSOLIDATED STATEMENTSThese fair values assigned to the assets and liabilitiesacquired from Tourbière Omer Bélanger Inc. at the date ofacquisition are as follows:Accounts receivable $ 469Prepaid expenses and other assets 94Inventories 575Property, plant and equipment 4,907Accounts payable and accrued liabilities (1,814)Other liabilities (169)Future income taxes (1,093)Total acquistion cost $ 2,969Kellogg-Rich Grow, LLCOn January 23, 2007, Sun Gro acquired substantially all ofthe operating assets and inventory of Santa Maria, Californiahorticultural growing mix producer, Kellogg-Rich Grow, LLC,for cash consideration of US$1.2 million (CDN$1.3 million).The acquisition was funded through additional borrowingsunder Sun Gro’s credit facility.The fair values assigned to the assets acquired from Kellogg-Rich Grow, LLC on the date of acquisition are as follows:Inventories $ 163Property, plant and equipment 608Intangible assets 383Goodwill 156Total acquistion cost $ 1,310Sun-Up HorticultureOn January 16, 2007, Sun Gro acquired all of theoutstanding shares of Sacramento, California horticulturalgrowing mix and bark producer, Sun-Up Horticulture, for cashconsideration of US$4.3 million (CDN$5.0 million) andfuture cash payments under a vendor note of US$0.4 millioneach year for three years, plus six percent (6%) simpleinterest calculated on the balance then due. The acquisitionwas funded through additional borrowings under Sun Gro’scredit facility.The fair values assigned to the assets and liabilities acquiredfrom Sun-Up Horticulture at the date of acquisition are asfollows:Accounts receivable $ 1,169Other assets 184Inventories 628Property, plant and equipment 1,609Intangible assets 2,437Goodwill 3,090Accounts payable and accrued liabilities (1,271)Future income taxes (1,412)Total acquisition cost $ 6,434Cash consideration paid $ 5,030Note payable to seller 1,404Total acquisition cost $ 6,4344. InventoriesDecember 31 December 312008 2007Raw materials $ 13,694 $ 10,143Scratch peat 5,364 4,981Packaging 6,188 5,009Finished goods 17,757 16,670$ 43,003 $ 36,8035. Property, plant and equipmentDecember 31 2008AccumulatedDepletion andCost Depreciation NetPeat bog acquisitionand developmentcosts $ 103,952 $ (24,133) $ 79,819Land 3,798 – 3,798Buildings 24,458 (6,891) 17,567Equipment undercapital leases 647 (266) 381Machineryand equipment 47,895 (25,968) 21,927$ 180,750 $ (57,258) $123,492December 31 2007AccumulatedDepletion andCost Depreciation NetPeat bog acquisitionand developmentcosts $104,482 $ (20,450) $ 84,032Land 3,387 – 3,387Buildings 22,958 (5,398) 17,560Equipment undercapital leases 486 (91) 395Machineryand equipment 43,070 (19,367) 23,703$ 174,383 $ (45,306) $129,0772008 Annual Report to Unitholders 39

Sun Gro Horticulture Income FundNOTES TO THE CONSOLIDATED STATEMENTS6. Intangible assetsDecember 31 2008AccumulatedCost Amortization NetBrand namesSunshine $ 13,753 $ – $ 13,753Other 6,093 (1,617) 4,476Customer relationships 36,615 (10,123) 26,492Internally developedsoftware anddatabases 2,210 (2,078) 132$ 58,671 $ (13,818) $ 44,853December 31, 2007AccumulatedCost Amortization NetBrand namesSunshine $ 13,753 $ – $ 13,753Other 5,272 (980) 4,292Customer relationships 34,300 (8,088) 26,212Internally developedsoftware anddatabases 2,210 (2,039) 171$ 55,535 $ (11,107) $ 44,4287. Goodwill and asset impairmentsUnder Canadian GAAP, goodwill is not amortized but issubject to an impairment test annually or more frequently ifevents or changes in circumstances indicate the Fund’sgoodwill might be impaired. In March, 2008, managementannounced reduced distributions to unitholders for 2008.As expected, the announcement resulted in a significantdecline in the Fund’s unit trading price. Managementconcluded that this decline was a circumstance whichrequired it to test its goodwill for impairment.Management determined that the Fund is a single reportingunit and therefore used the Fund’s market capitalization asan indicator of fair value. The carrying value of the Fund’s netassets exceeded the Fund’s market capitalization during thesecond quarter. Management therefore carried out thesecond step of the goodwill impairment test, which comparesthe implied fair value of the Fund’s goodwill, determined asthe excess of the market capitalization over the fair valueassigned by management to the Fund’s other assets andliabilities. From this test, management determined that thefair value of the Fund’s net assets and liabilities, excludinggoodwill, exceeded the Fund’s market capitalization andtherefore recorded a goodwill impairment charge of $23.4million in the second quarter, comprising the entire balanceof goodwill.Year ended Year endedDecember 31 December 312008 2007Goodwill at the beginningof the year $ 23,263 $ 11,202Goodwill acquiredduring the year 12,727Goodwill impairment recordedduring the year (23,373)Unrealized foreign currency gain(loss) on US dollar assetsand liabilities 110 (666)Goodwill at the end of the year $ – $ 23,263In March, 2008, Sun Gro closed its production facility inKennetcook, Nova Scotia. Sun Gro relocated the Kennetcookequipment for use at other production facilities andcontinues to make rental payments under the bog lease inorder to retain rights to the bog for possible future operations.In light of the facility closure, management concluded thatthe carrying value of the bog was no longer recoverable.Management determined that the carrying value of the bogexceeded its estimated fair value and recorded animpairment charge of $1.6 million in the first quarter of fiscal2008 to adjust the value of the bog.At December 31, 2008, given the current disruption anduncertainty in the global economy, and the significantdecrease in the Fund’s unit price over the last nine months,management concluded that the appropriate triggers hadbeen reached for an impairment test of all long-lived assets.The Fund performed asset recoverability tests on all longlivedassets using undiscounted cash flows based on internalprojections for revenues and expenses covering theestimated remaining life of such assets. The Companyconcluded that the undiscounted cash flows exceeded thecarrying value of all intangible assets tested, and therefore,no impairment was recorded.40 2008 Annual Report to Unitholders

Sun Gro Horticulture Income FundNOTES TO THE CONSOLIDATED STATEMENTSThe Fund estimated the fair value for its indefinite livedSunshine brand name using a ‘relief from royalty’ method.This method calculates the value by determining the savingsenjoyed by Sun Gro by not having to pay an external thirdparty for the use of this brand name. These savings weredetermined as a percentage of gross sales adjusted forincome tax at a weighted average corporate tax rate of 36%and then calculated annually as a present value usinga discount rate of 15%. The Company concluded that thediscounted cash flows exceeded the carrying value of theSunshine brand name, and therefore, no impairment wasrecorded.8. Credit facilitiesSummary of credit facilitiesSun Gro’s credit facilities include a variable rate revolvingoperating facility and variable and fixed rate term loans. Thefixed rate term loans relate to the completion, in May 2008,of US$50.0 million fixed rate private placement of long-termdebt with a major life insurance company. At the same time,Sun Gro amended its existing variable rate credit facilities toextend the maturity date of the remaining variable rate termloans to November 1, 2011 and the revolving operatingfacility to November 1, 2010. The revolving operating facilityand term debt are collateralized by substantially all of theassets of Sun Gro and its subsidiaries. The credit facilitiesconsist of the following:a) Revolving operating facilityAs at December 31, 2008, Sun Gro had drawn $34.1 million,net of $0.1 million of deferred financing fees, at a weightedaverage interest rate of 5.8% At the end of the year $50.0million of the revolving operating facility was fully availableincluding US$15.0 million which can be drawn on by SunGro’s US subsidiaries to finance working capital and generalcorporate requirements. Interest on the revolving operatingfacility is due monthly at the Canadian prime rate, LIBOR,Banker Acceptance rate, or US base rate, plus a marginbased on Sun Gro’s senior leverage ratio.b) Long-term debtDecember 31 December 312008 2007Term Loans:Fixed rate term loan -(US$25.0 million)due May 2015 * $ 29,948 $ –Fixed rate term loan -(US$25.0 million)due May 2013 * 30,123 –Variable rate term loan -due November 2011; 2007 -due November 2010 * 5,934 22,093Variable rate term loan -due June 2008(GrowBest Holdings, LLC) * – 21,396Variable rate term loan -(US$12.4 million),due November 2011; 2007 -(US$14.0 million)due November 2010 * 15,094 13,668Other Loans:Equipment loans -due monthly through 2012 257 378Note payable to vendor(US$0.8 million; 2007 -US$1.2 million), due annuallythrough January 2010 (note 3) 976 1,177Government loans -due monthly through 2011 288 509Capital leases -due monthly through 2012 433 39583,053 59,616Less: Current portion (6,598) (22,427)$ 76,455 $ 37,189* Stated amount is net of deferred financing feesTerm loansIn May 2008, Sun Gro borrowed US$50.0 million of fixed rateprivate placement long-term debt with a major life insurancecompany. Terms of the debt were for principal of US$25.0million due in May 2013 with interest of 7.31% paidquarterly and US$25.0 million of principal due in May 2015with interest of 8.08% paid quarterly. In August, the debtagreement was amended increasing the interest rate by0.50%. In January 2009, the debt agreement was amendedto further increase the interest rate an additional 1.5%, untilsuch time as the senior leverage ratio (as defined) is reducedbelow 3.0 to 1. Proceeds were used to repay the $21.5million variable rate term loan borrowed for the purchase ofGrowBest Holdings and partially repay $16.25 million andUS$2.0 million of variable rate term loans borrowedpreviously for various acquisitions. The remaining funds of$9.2 million, after $1.0 million of financing fees, were usedto reduce the revolving operating facility.2008 Annual Report to Unitholders 41

Sun Gro Horticulture Income FundNOTES TO THE CONSOLIDATED STATEMENTSThe remaining variable rate term loans are due in November2011. Interest on the variable rate term loans is due monthlyat the Canadian prime rate, LIBOR, Banker Acceptance rate,or US base rate, plus a margin based on Sun Gro’s seniorleverage ratio. At December 31, 2008, the weighted averageinterest rate on the variable rate term loans was 5.2%.Subsequent to year-end, this rate was adjusted to complywith the terms of the fourth amendment to the creditagreement (see below).c) Acquisition facilityIn May 2008, Sun Gro refinanced its term debt and amendedits credit facility retaining the $6.0 million unused capacityon the acquisition facility. In June 2008, Sun Gro borrowedUS$0.4 million under the acquisition facility to fund theprevious payment made on the note payable to seller underthe acquisition agreement with Sun-Up Horticulture. Theamount is now included in the US$12.4 million term loandue November 1, 2011. The unused capacity of theacquisition facility was cancelled in November 2008.Fourth Amendment to Credit AgreementsAt September 30, 2008, Sun Gro was in violation of thesenior leverage ratio covenant of its credit facilities andobtained a waiver. Subsequent to year end, Sun Gro and itslenders negotiated a Fourth Amendment to the creditagreements which amended the senior leverage ratioeffective December 31, 2008 and we are in compliance withthe covenant as of that date. The Fourth Amendment imposesa higher margin on Sun Gro’s borrowings. In addition, thereare limitations on distributions, a new measure of therevolving operating facility availability based on eligibleaccounts receivable and inventory, and required principalrepayments.Effective January 1, 2009, as part of the amended debtagreements the interest rates on the floating rate debt andfixed rate term debt were increased 1.5%, until such timeas the senior leverage ratio (as defined by terms of the creditfacility) is reduced below 3.0.Other loansIn October 2007, as part of the acquisition of GrowBestHoldings, Sun Gro assumed loans related to certain property,plant and equipment totaling $0.4 million. Payments are duemonthly through September 2010. Interest ranges from0% to 8% calculated on the monthly balance then due.In January 2007, as part of the acquisition agreement withSun-Up Horticulture, Sun Gro agreed to pay a cash paymentof US$0.4 million each year, for three years, on theanniversary date of closing, plus 6% simple interestcalculated on the balance then due. The first payment wasmade in January 2008.In September 2006, Sun Gro received a provincialgovernment grant of $60,000 and related interest free loanof $105,000. The loan proceeds have been utilized to offsetsome of the expenses associated with the repairs andupgrades at a New Brunswick plant that was damaged by afire in June of 2005. The grant was recorded as a reductionof the cost of the equipment. Principal payments on the loanare due monthly through 2011.During 2005, Sun Gro received a provincial government grantof $188,000 and a related loan of $500,000 to financeequipment purchases. The grant was recorded as a reductionof the cost of the equipment. The loan principal and interestare due monthly through 2010. Interest is payable monthly atthe bank’s floating base rate, currently 5.25%.Capital lease obligationThe capital lease obligation of $433,000 represents severalcapital leases. The leases are being repaid over a five-yearterm to December 2012. The capital leases’ interest ratesrange from 1% to 7%. Interest due over the term of the leasestotals $49,000. An amount of $146,000 has been includedin the current portion of long-term debt for these leases.9. Accounts payable and accrued liabilitiesDecember 31 December 312008 2007Trade accounts payable $ 14,615 $ 13,120Employee compensation payable 3,420 3,647Other accrued liabilities 3,169 2,627$ 21,204 $ 19,39410. Distributions to UnitholdersMonthly distributions to Unitholders were suspendedeffective after the August 2008 distribution paid in mid-September 2008. Prior to the suspension of distributions, theFund’s distribution policy was to make monthly distributionsto unitholders. Distributions were made monthly tounitholders of record on the last business day of each monthand were paid no later than the 15th day of the followingmonth or, if such day was not a business day, no later thanthe next business day.The cash receipts of the Fund depend on the performance ofSun Gro and its payment of dividends and interest on thesecurities of Sun Gro held by the Fund. Due to the seasonalityof Sun Gro’s operations and cash flows during certainmonths, the revolving operating facility has been used tosupplement Sun Gro’s available cash.During the year ended December 31, 2008, the Funddeclared distributions to the Unitholders of $9,193,000 or42 2008 Annual Report to Unitholders

Sun Gro Horticulture Income FundNOTES TO THE CONSOLIDATED STATEMENTS$0.4125 per unit. The amounts and record dates of thesedistributions were as follows:Year ended December 31, 20082008 Record Date Amount Per UnitJanuary 31 $ 1,671 $ 0.0750February 29 1,671 0.0750March 31 1,671 0.0750April 30 836 0.0375May 30 836 0.0375June 30 836 0.0375July 31 836 0.0375August 29 836 0.0375$ 9,193 $ 0.4125During the year ended December 31, 2007, the Funddeclared distributions to the unitholders of $19.9 million or$0.90 per unit. On October 1, 2007, the Fund issued261,681 units for the purchase of GrowBest Holdings, LLC.The amounts and record dates of these distributions were asfollows:Year ended December 31, 20072007 Record Date Amount Per UnitJanuary 31 $ 1,652 $ 0.0750February 28 1,652 0.0750March 30 1,652 0.0750April 30 1,652 0.0750May 31 1,652 0.0750June 29 1,652 0.0750July 31 1,652 0.0750August 31 1,652 0.0750September 28 1,652 0.0750October 31 1,671 0.0750November 30 1,671 0.0750December 31 1,671 0.0750$ 19,881 $ 0.9000The distributions declared have been allocated as follows forincome tax purposes:Year ended Year endedDecember 31 December 312008 2007Taxable - interest $ 8,760 $ 18,298Taxable - dividends 433 1,583Total distribution $ 9,193 $ 19,881Per unit $ 0.4125 $ 0.900011. Other liabilitiesDecember 31 December 312008 2007Pension plan (note 16) $ 300 $ 199Asset retirement obligations 5,218 4,839$ 5,518 $ 5,038Sun Gro’s asset retirement obligations relate primarily to itsobligation to rehabilitate its leased peat bogs. Assetretirement obligations activity for the years ended December31, 2008 and December 31, 2007 is as follows:Year ended Year endedDecember 31 December 312008 2007Obligations at the beginningof the year $ 4,839 $ 4,263Liabilities incurred 55 121Liabilities acquiredfrom acquisitions – 169Accretion expense 324 286Rehabilitation work completed – –Obligations at the endof the year $ 5,218 $ 4,839The estimated undiscounted future cash flows required tosettle the obligations are approximately $22.6 million andare discounted at credit adjusted risk free rates ranging from7.2% to 8.4% over periods ranging from 3 to 67 years basedon the estimated remaining life of the related bogs.12. Capital disclosuresThe Fund’s Declaration of Trust provides that an unlimitednumber of units may be issued. Each unit is transferable andrepresents an equal undivided beneficial interest in anydistributions of the Fund and in the net assets of the Fund.All units have equal rights and privileges. Each unit entitlesthe holder thereof to participate equally in allocations anddistributions and to one vote at all meetings of unitholders foreach whole unit held. The units issued are not subject tofuture calls or assessments. Units are redeemable at any timeat the option of the holder at amounts related to marketprices at the time, subject to a maximum of $50,000 in cashredemption by the Fund in any particular month. Thislimitation may be waived at the discretion of the Trustees ofthe Fund. Redemption in excess of this amount, assuming nowaiving of the limitation, shall be paid by way of a distributionin specie of a pro rata number of Sun Gro securities held bythe Fund.As at December 31, 2008, capital contributions consisted of261,681 units issued at $7.62 per unit, related to theacquisition of GrowBest Holdings, LLC and 22,023,000 unitsissued at $10.00 per unit, less offering expenses.2008 Annual Report to Unitholders 43

Sun Gro Horticulture Income FundNOTES TO THE CONSOLIDATED STATEMENTSThe Fund’s definition of capital includes equity, which iscomprised of issued units, cumulative earnings (loss) anddistributions to unitholders.The Fund’s primary objectives with respect to capitalmanagement are to ensure that it has resources to maintainthe productive capacity of the Company, meet debtobligations and fund possible future acquisitions and growthinitiatives. To secure the additional capital necessary topursue these objectives, the Fund may raise additional fundsfrom time to time through the issuance of units andamending distributions paid to unitholders.The Fund is not subject to external regulatory capitalrequirements. The Fund’s credit facilities (as described innote 8) contain various covenants, including limitations ontotal indebtedness, capital spending, lease expense,distributions and required principal repayments.13. Income taxesThe Fund is a unit trust for income tax purposes and,accordingly, the Fund is taxable only on any taxable incomenot allocated to the unitholders. Subsidiaries of the Fund aresubject to tax at statutory rates. During the years endedDecember 31, 2008 and December 31, 2007, all taxableincome of the Fund has been distributed to unitholders. Anyincome tax obligations relating to the distributions are theobligations of the unitholders.The income tax provision (recovery) varies from the amountcomputed by applying combined Canadian federal andprovincial tax rates to earnings before income taxes asfollows:Year ended Year endedDecember 31 December 312008 2007Earnings (loss) beforeincome taxes $ (51,277) $ 14,707Income taxes atstatutory rates $ (16,648) $ 5,000Income tax benefit ofFund distributions (2,803) (6,221)Goodwill impairment(non-deductible) 7,909 –Changes in statutoryincome tax rates 820 (147)Non deductible expenses 2,286 465Other (780) (281)Net recovery $ (9,216) $ (1,184)Temporary differences that gave rise to future income taxassets and liabilities are as follows:December 31 December 312008 2007Future income tax assets (liabilities)Property, plantand equipment $ (18,426) $ (21,868)Intangible assets (2,857) (1,999)Unit issue costs 866 1,035Non-capital loss carryforwards 5,899 2,537Asset retirement obligations 1,409 1,452Other 1,569 (168)Net liability $ (11,540) $ (19,011)The Fund’s Canadian subsidiaries have non-capital losscarryforwards of $3.6 million that expire in 2010, $4.5million that expire in 2015 and $14.2 million that expire in2018. The benefit of these non-capital loss carry forwardshave been recognized as a reduction of future income taxliability.14. Commitments and contingenciesLease commitmentsSun Gro has various operating and capital leasecommitments relating to machinery, equipment, bog sites,offices and warehouse facilities requiring the following futureminimum annual lease payments:Operating leases Capital leases2009 $ 5,432 $ 1532010 4,056 1302011 3,101 882012 2,399 622013 252 –Thereafter 205 –$ 15,445 $ 433Total rent expense under these operating lease agreementsfor the years ended December 31, 2008 and 2007 was $5.6million and $4.3 million, respectively. Certain of the facilitylease agreements give Sun Gro the option to renew theagreements beyond their original terms.ClaimsDuring the ordinary course of business, certain productliability claims may be brought against Sun Gro and itssuppliers. Management investigations of these claimstypically indicate that they are without substantial merit andthat any possible settlement would not have a materialimpact on the financial position or results of Sun Gro’soperations.44 2008 Annual Report to Unitholders

Sun Gro Horticulture Income FundNOTES TO THE CONSOLIDATED STATEMENTS15. Other income (expense), netOther income consists of the following:Year ended December 312008 2007Realized gain on foreigncurrency contracts $ 1,108 $ 3,939Unrealized gain (loss) onforeign currency contracts (13,999) 4,938Unrealized foreign currencyloss on US dollar assetsand liabilities (10,429) (635)Gain (loss) on disposal ofproperty, plant and equipment (212) 75Other (1,351) (265)Total other income (expense) $ (24,883) $ 8,05216. Employee benefit plansDefined contribution plansSun Gro sponsors a Registered Pension Plan (a definedcontribution plan) for Canadian salaried and certain hourlyemployees (the “Canadian Plan”) and a 401(k) RetirementSavings Plan for salaried and hourly United States employees(the “US Plan”). The total pension expense related to the USPlan and the Canadian Plan was $1.1 milliion and$907,000 for the years ended December 31, 2008 and2007, respectively.Pension planSun Gro sponsors an unfunded Salaried EmployeeRetirement Pension (SERP) plan for a small number of formermanagement employees. In 1997, Sun Gro altered its SERParrangement, froze membership and benefits payable in thisplan as of that date and accrued the full actuariallydetermined liability in the financial statements at that time.As at December 31, 2008 and 2007, the liability for theSERP amounted to $300,000 and $199,000, respectively.The remaining plan participants are no longer activeemployees (see note 11).Restricted unit planEffective December 31, 2006, the Fund established aRestricted Unit Plan for certain management employees anddirectors that allowed for the grant of restricted units at anytime as a bonus for services rendered by eligible participants.The units were purchased on the open market from fundscontributed to the Restricted Unit Plan by Sun Gro. Unitswould vest based on the passage of time on the date ordates established on the grant date, the achievement ofcertain performance criteria, or both. Additional restrictedunits were granted automatically to participants fordistributions on previously granted restricted units.The number of additional restricted units granted was to bedetermined by the distribution paid less any applicablewithholding taxes divided by the fair market value of theFund’s units on the date the distributions are paid.In November of 2008 the Restricted Unit Plan wasdiscontinued. No additional restricted units have beengranted since the initial and only grants on December 31,2006. All restricted units have been settled during the yearand there is no further liability at December 31, 2008. Thetotal expense related to the plan for the year endedDecember 31, 2008 and December 31, 2007 were$167,000 and $330,000 respectively. All units for the planwere purchased in the open market.17. Segment informationThe Fund has one reportable business segment, related tothe manufacturing and sale of horticultural growing media.Substantially all assets of the business support theseoperations. Geographic segment information is presented asfollows:Year ended Year endedDecember 31 December 312008 2007RevenueUnited States $ 182,929 $ 181,683Canada 22,122 26,732Mexico and other 16,884 16,579$ 221,935 $ 224,994Property, plant and equipmentUnited States $ 18,531 $ 16,414Canada 104,961 112,663$ 123,492 $ 129,077GoodwillUnited States $ – $ 12,061Canada – 11,202$ – $ 23,263Intangible assetsUnited States $ 40,368 $ 39,954Canada 4,485 4,474$ 44,853 $ 44,4282008 Annual Report to Unitholders 45

Sun Gro Horticulture Income FundNOTES TO THE CONSOLIDATED STATEMENTS18. Financial instrumentsand risk managementThe Fund’s financial instruments consist of cash, accountsreceivable, bank indebtedness, accounts payable andaccrued liabilities, debt, distributions payable and forwardforeign exchange contracts. For the Fund’s current financialassets and liabilities the carrying value is estimated toreasonably approximate the fair value. The carrying value forNon-current financial liabilities is accounted for at amortizedcost using the effective interest rate method and is estimatedto approximate fair value. The Fund’s financial instrumentsexpose the Company to a variety of financial risks, includingforeign currency risk, interest rate risk, credit risk and liquidityrisk.Foreign currency riskThe Fund’s foreign currency risk relates to Sun Gro’s UnitedStates operations and its US dollar denominated debt. Mostof the production from Sun Gro’s Canadian plants, andvirtually all of the US production is sold in the United States.Sales to customers in the United States are generallydenominated in US dollars, as are expenses incurred by SunGro’s US operations. The related accounts receivable andaccounts payable are subject to foreign currency risk. SunGro’s US dollar denominated debt is also subject to foreigncurrency risk.Sales revenue, which is mostly in US dollars, is used to payCanadian production and distribution costs, Canadian dollarinterest expense and, until suspended in August 2008,distributions to unitholders. The Fund utilizes foreign currencycontracts to manage a portion of Sun Gro’s foreign currencyrisk. Sun Gro’s policy is not to utilize foreign currencycontracts for trading or speculative purposes. These contractsdo not eliminate the Fund’s exposure to fluctuations inexchange rates. The contracts are used to fix the future dateand exchange rate at which Canadian dollars will bepurchased.At December 31, 2008, the Fund’s financial assets andliabilities included US dollar denominated accountsreceivable, term debt, accounts payable and accruedliabilities and unrealized losses on foreign currency contracts.Management estimates that by itself, the impact of a $0.10change in the exchange rate on its year-end financial assetsand liabilities would be approximately an $11.4 millionincrease or decrease to net earnings and othercomprehensive income.Interest rate riskThe Fund’s interest rate risk relates to Sun Gro’s operating lineand debt. In May 2008, Sun Gro converted US$50.0 millionin term loans to fixed interest rate debt. On Sun Gro’sremaining term loans the interest rate management policyhas been to generally borrow on the operating line and termdebt at short-term fixed rates utilizing bankers’ acceptancerates or LIBOR plus a margin. Other loans and debtobligations are at fixed interest rates or have no interest. Theannual impact on interest expense of a change in interestrates of 1% of our variable rate term loans and revolvingoperating facility, assuming all other variables remainconstant, would be approximately $0.6 million based ondebt amounts outstanding at December 31, 2008.Liquidity riskThe Fund’s liquidity risk relates to the ability to meet SunGro’s financial obligations on the revolving operating facility,term debt, foreign currency contracts, accounts payable andaccrued liabilities as they become due. To manage liquidityrisk Sun Gro continuously forecasts cash flows and utilizesa revolving operating facility for working capital needs.To manage liquidity on the revolving operating facility andterm debt, Sun Gro has been able to extend the maturity ofthese facilities to November 1, 2010 and 2011, respectively.Sun Gro has also financed US$50.0 million of debt at fixedinterest rates with terms of five and seven years with a majorlife insurance company and used the proceeds to reduceterm debt. The Fund’s financial obligations are summarizedbelow:Liquidity RiskAccountsOperatingPayable and Foreign Line andAccrued Currency Term Capital Other(in thousands of dollars) Liabilites Contracts Loans Leases Loans2009 $ 21,204 $ 47,224 $ 5,612 $ 168 $ 9172010 17,172 41,591 144 6972011 – 18,258 97 212012 – 3,736 68 –2013 – 16,490 – –Thereafter – 30,500 – –$ 21,204 $ 64,396 $116,187 $ 477 $ 1,63546 2008 Annual Report to Unitholders

Sun Gro Horticulture Income FundMANAGEMENT’S DISCUSSION AND ANALYSISSun Gro is subject to financial covenants related to therevolving operating facility and the term debt. Subsequent toyear end the credit facilities were amended as of December31, 2008 and the Company is in compliance with theamended facilities.Credit riskAccounts receivableThe Fund’s credit risk primarily relates to Sun Gro’s accountsreceivable and the ability of the Company’s customers tomeet their obligations. Sun Gro manages credit risk foraccounts receivable through an established credit monitoringprocess that considers customer credit ratings, the currentfinancial status of customers, length of time receivables arepast due and past customer history. As is customary in thehorticultural industry, our grower customers often have termsin excess of typical commercial trade terms of 30 days. Suchterms do not usually exceed a customer’s crop growing cycle.Terms can vary from 30 to 210 days with approximately 60%of sales occurring with terms of 90 days or less. Amountsowing under these extended terms (Future) are notconsidered due until payment is owed under the terms of thesales. The majority of customer accounts are evaluated on anindividual basis and when the Company determines that acustomer is unable to meet its financial obligations a specificallowance is established. Additional reserves are based onmanagement’s estimates and take into considerationhistorical trends, market conditions and customer base. Thelargest individual customer balance was 4% of accountsreceivable at December 31, 2008. Sun Gro’s maximumexposure to credit risk at the reporting date is equal to thecarrying value of accounts receivable. The following tableprovides information regarding the aging and collectability ofthe Company’s account receivable balances as follows:A reconciliation of changes in the allowance for doubtfulaccounts is as follows:Allowance for doubtful accountsBalance, December 31, 2007 $ 1,560Additional allowance 1,781Write off of accounts receivable (2,004)Recoveries of previous write offs 96Other comprehensive income 351Balance, December 31, 2008 $ 1,784Foreign currency contractsThe Fund’s credit risk on foreign currency contracts arisesfrom potential non-performance by counterparties to thesecontracts. Sun Gro manages this risk by only entering intoforeign currency contracts with a limited number of largefinancial institutions and by limiting the duration ofthe contracts. At December 31, 2008, Sun Gro has enteredinto forward foreign currency contracts to purchase$64.4 million Canadian dollars maturing through June 2010.Sun Gro’s exposure to credit risk at the reporting date isestimated to be nil as the carrying value of the Company’sforeign currency contracts is an unrealized loss of$9.9 million at December 31, 2008.19. Subsequent eventIn February 2009, Sun Gro completed the sale of itspreviously closed Niagara depot for net proceeds of$1.3 million and a realized gain on disposal of propertyplant and equipment of $1.1 million.December 31 December 312008 2007Future $ 26,859 $ 22,971Current 6,993 $ 7,428Past due 1-60 days 5,773 5,592Past due 61+ days 5,997 5,168Less allowance fordoubtful accounts (1,784) (1,560)$ 43,838 $ 39,5992008 Annual Report to Unitholders 47

Sun Gro Horticulture Income FundUnitholder InformationSun Gro HorticultureCanada Ltd. and SubsidiariesSun Gro HorticultureIncome FundOfficersClarence BreauVice President, Eastern RegionKirk JohansonVice President, Central RegionMark SpongVice President, Western RegionRobert SytsmaVice President, Southeast RegionMitchell J. WeaverPresident andChief Executive OfficerBradley A. WiensVice President, Finance andChief Financial OfficerTrustees and DirectorsW. John DawsonTrustee, Director, andChairman of the Boardof TrusteesIndependent Business AdvisorJack EdwardsDirectorBusiness ExecutiveJohn T. GoldsmithTrustee and DirectorBusiness ExecutiveT. Richard TurnerTrustee, Director andChairman of the Boardof DirectorsPresident andChief Executive Officer,TitanStar Capital Corp.Mitchell J. WeaverTrustee and DirectorPresident andChief Executive Officer,Sun Gro HorticultureCanada Ltd.John ZaplatynskyDirectorPresident andChief Executive Officer,Canada GardenWorks Ltd.Head OfficeSuite 1200 - 200 Burrard St.Vancouver, British ColumbiaCanada V7X 1T2www.sungro.comcontactus@sungro.comInvestor RelationsBradley A. Wiens425-373-3603bradw@sungro.comAuditorsPricewaterhouseCoopers LLPVancouver, British ColumbiaTrust Units ListedToronto Stock ExchangeTrading Symbol: GRO.UNTransfer AgentComputershareInvestor Services Inc.48 2008 Annual Report to Unitholders