The Consumers' Waterheater Income Fund
TSX : CWI.UN

The Consumers' Waterheater Income Fund

October 28, 2005 07:00 ET

The Consumers' Waterheater Income Fund Announces Continued Strong Financial Results for the Third Quarter of 2005

TORONTO, ONTARIO--(CCNMatthews - Oct. 28, 2005) - The Consumers' Waterheater Income Fund (TSX:CWI.UN) (the "Fund") today released financial results for the third quarter ended September 30, 2005.

HIGHLIGHTS:

- Revenues increased by 4.8% to $37.3 million

- Net earnings of $5.6 million more than double last years result as increased revenues and reduced operating costs flow to improve earnings

- September's unit holder distributions increased by 3.6% to $0.0958 per unit, while maintaining a pay-out ratio of 85% after internally funding all capital expenditures

- Customer attrition stable at about 1.2% of the portfolio.

- Portfolio of installed water heater continues to grow

- Outlook for the remainder of 2005 is positive

"The Funds results for the third quarter of 2005 are in line with our expectations, indicative of the strength and stability of underlying business," said Robert Huggard, CEO of the Fund's administrative agent. "We are further encouraged by an upturn in the number of builder permits issued in our operating area, which should support further growth in the installed asset base of the Fund."

About The Consumers' Waterheater Income Fund

The Consumers' Waterheater Income Fund indirectly owns a portfolio of approximately 1.3 million installed water heaters and other assets, rented primarily to residential customers in Ontario.

The Fund is an unincorporated open-ended trust established with an unlimited number of trust units under the laws of the Province of Ontario pursuant to a Declaration of Trust dated October 28, 2002.

The Fund commenced operations on December 17, 2002, when it completed its initial public offering ("IPO") of Fund units, the proceeds of which were used to fund the purchase of the rental portfolio from Direct Energy Marketing Limited ("Direct Energy").

Direct Energy continues to provide service support to the rental portfolio and receives 35% of aggregate rental revenues for its co-ownership interest in certain water heater related assets (with the Fund owning and receiving the remaining 65%). As a result, the Fund's exposure to operating risk is significantly reduced. The Fund has no investment interest in Direct Energy's services business or operations. Through its ownership of Class B exchangeable units, Direct Energy currently holds a 19.9% effective residual interest in the Fund.

Additional information regarding the Fund, including its current Annual Information Form ("AIF") is available on SEDAR at www.sedar.com.



Financial and Operating Highlights(1)
(Unaudited)
(in thousands, except per unit amounts)

Three months ended Nine months ended
September 30 September 30
2005 2004 2005 2004
$ $ $ $
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Total revenue 37,296 35,596 111,824 106,920
Net earnings 5,569 2,644 15,828 11,936
EBITDA 33,187 30,594 98,294 93,246
Cash flow from
operating activities 23,245 19,418 78,347 73,958
Capital expenditures
(Net)(2) 11,912 11,694 36,470 34,788
Unitholder distributions
declared 13,906 13,253 41,392 39,590
Total assets 1,093,284 1,145,286 1,093,284 1,145,286
Average Fund units
outstanding 49,524,092 49,524,092 49,524,092 49,524,092

Per Unit Analysis
Net earnings $ 0.112 $ 0.053 $ 0.320 $ 0.241
Operating cash flow $ 0.469 $ 0.392 $ 1.582 $ 1.493
Capital expenditures $ 0.241 $ 0.236 $ 0.736 $ 0.702
Unitholder distributions $ 0.281 $ 0.268 $ 0.836 $ 0.799

Operating Highlights
Asset replacements 12,679 12,541 42,604 42,112
Additions 7,321 9,060 19,090 23,636
Removals 3,833 3,841 12,377 11,191
Assets in service 1,325,528 1,316,641 1,325,528 1,316,641
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(1) Financial results have been prepared in accordance with Canadian
generally accepted accounting principles ("GAAP").
Specific accounting policies are disclosed in the Fund's Audited
Annual Financial Statements, which are available on
www.sedar.com.
(2) Net of proceeds realized from the disposition of assets.


Certain statements in this News Release are forward-looking statements, which reflect management's expectation regarding the Fund's growth, results of operations and business prospects. Such forward-looking statements reflect management's current beliefs and are based on information available to them. Many factors could cause results to differ materially from the results discussed in the forward-looking statements. Although the forward-looking statements are based on what management believes to be reasonable assumptions, the Fund cannot assure investors that actual results will be consistent with these forward-looking statements. Management is under no obligation (and expressly disclaims any such obligation) to update or revise the forward-looking information, whether as a result of new information, future events or otherwise.

Management's Discussion and Analysis

The Management's Discussion and Analysis ("MD&A") should be read in conjunction with the unaudited interim consolidated financial statements of The Consumers' Waterheater Income Fund (the "Fund") for the 3 month period ending September 30, 2005 and 2004 and the 2004 audited consolidated financial statements. All amounts are in Canadian dollars.

Results of Operations

During the third quarter of 2005, the Fund reported earnings of $5.6 million on total revenues of $37.3 million. Comparable amounts for the third quarter of 2004 were $2.6 million and $35.6 million, respectively. Total revenues increased by 4.8 percent from last year, primarily due to a 3.5% increase in rental rates commencing at the beginning of the fiscal year. Net additions to the residential asset portfolio and entry into the commercial water heater business segment further supported growth in revenue. The impact of increased revenues combined with the favourable affect of reducing operating costs in the current quarter by approximately 3 percent resulted in earnings more than doubling last years results.

For the nine months ended September 30, 2005 the Fund reported earnings of $15.8 million on total revenues of $111.8 million compared with $11.9 million and $106.9 million in the same period last year. As was the case in the third quarter, increases in total revenues of approximately 4.6 percent combined with relative comparability in operating costs contributed to a 33 percent increase in net earnings.

Operating results as measured by earnings before interest, taxes, depreciation and amortization ("EBITDA") were $33.2 million for the third quarter of 2005 compared to $30.6 million in the same period last year. The $2.6 million improvement largely reflects the impact of a 3.5% increase in rental rates implemented on January 1, 2005 and a higher rental asset base supported by lower general and administrative costs and losses resulting from the disposal of equipment.

The EBITDA for the first nine months of 2005 was $98.3 million compared to $93.3 million in 2004. The increase in operating results is for the most part attributable to the rental rate increase, combined with the positive impact of a higher installed asset base and lower general and administrative costs, offset to some degree by marginally higher losses incurred from retirement of assets.

EBITDA is presented as a measure of operating cash flow as management believes that it is relevant to an understanding of the business of the Fund because it is a measure of the amount of cash available to service debt, satisfy capital expenditures and fund unitholder distributions. EBITDA is a non-GAAP financial measure, and therefore has no standardized meaning prescribed by GAAP and may not be comparable to similar terms and measures presented by other similar issuers. EBITDA is intended to provide additional information on the Fund's performance and should not be considered in isolation or as a substitute for measures of performance prepared in accordance with GAAP. In particular, investors should also consider the impact of interest expense on the Fund's long-term debt and its capital expenditure requirements to fully assess the cash flow available to finance cash distributions.

EBITDA represented 89% of operating revenue for the third quarter of 2005, and 86% of operating revenue in the same period last year. The relatively high relationship between EBITDA and revenue in both quarters emphasizes the inherent stability of the operating income associated with the rental business. These results are consistent with the relatively small amount of general and administrative costs the Fund incurs and the prevailing level of losses resulting from the retirement of assets from service. The improvement in current quarter earnings results from reductions in the amount of general and administrative cost and losses on retirement of assets, combined with increased revenue which effectively flows directly to earnings. The Fund mitigates its exposure to operating risk through the Co-Ownership Agreement with Direct Energy, pursuant to which Direct Energy manages the day-to-day rental business operation and provides life-cycle service support for the portfolio and receives 35% of rental revenues charged to customers.

The following table demonstrates comparative quarterly results for 2005 and 2004, and reconciles net earnings to EBITDA:



Quarterly Results

First Second Third Nine
Quarter Quarter Quarter Months
Unaudited 2005 2005 2005 2005
(in thousands of dollars) $ $ $ $
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Total revenue 37,232 37,296 37,296 111,824
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Net earnings 4,774 5,485 5,569 15,828
Adjustments:
Amortization 24,520 24,596 24,653 73,769
Interest expense 6,097 6,164 6,232 18,493
Income taxes (3,312) (3,217) (3,267) (9,796)
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Earnings before interest,
taxes and amortization
(EBITDA) 32,079 33,028 33,187 98,294
Unitholder distributions
declared 13,743 13,743 13,906 41,392
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Unitholder payout ratio

Before expansionary
capital expenditures 84% 74% 73% 77%

After expansionary capital
expenditures 88% 83% 85% 85%
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Quarterly Results

First Second Third Nine Fourth Total
Quarter Quarter Quarter Months Quarter Fiscal
Unaudited 2004 2004 2004 2004 2004 2004
(in thousands
of dollars) $ $ $ $ $ $
---------------------------------------------------------------------

Total revenue 35,754 35,570 35,596 106,920 35,966 142,886
---------------------------------------------------------------------
Net earnings 5,560 3,732 2,644 11,936 3,720 15,656
Adjustments:
Amortization 24,423 24,541 24,585 73,549 24,828 98,377
Interest
expense 6,151 6,154 6,220 18,525 6,217 24,742
Income taxes (4,864) (3,046) (2,855)(10,765) (3,810) (14,575)
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Earnings before
interest, taxes
and amortization
(EBITDA) 31,270 31,381 30,594 93,245 30,955 124,200
Unitholder
distributions
declared 13,084 13,253 13,253 39,590 13,252 52,842
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Unitholder
payout ratio
Before
expansionary
capital
expenditures 76% 71% 74% 74% 76% 74%

After
expansionary
capital
expenditures 86% 85% 93% 88% 83% 87%
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As outlined in the above table, total revenue and EBITDA are relatively evenly dispersed throughout each quarter. The slight increase in reported quarterly EBITDA in 2005 is attributable to a large extent on increased operating revenue, principally due to increases in the size of the asset portfolio. The small decline in the amount of EBITDA reported in the third quarter of 2004 for the most part is a function of the timing of the recognition of the incentive fee earned by Direct Energy.

Rental Revenue:

Third quarter 2005 rental revenue of $37.1 million exceeded the same period last year by $1.6 million or 4.6%. This increase is largely the result of the rental rate increase of 3.5% implemented on January 1, 2005. The impact of a higher installed asset base of 8,887 units combined with a slightly higher composition of the asset portfolio invested in higher priced power vented tanks, further contributed to the impact of the rental rate adjustment. Revenues derived from the installation of commercial water heaters also contributed to the increase; however the amount is relatively insignificant in light of the fact that the Fund launched the initiative in the first quarter of 2005.

For the nine months of fiscal 2005, rental revenues of $111.4 million exceeded last year's comparable amount by $4.8 million or 4.5 percent. The third quarter results further contributed the higher amount of operating revenues realized in the first half of the fiscal year.

Rental revenues are derived from the Fund's 65% interest in rental revenues under the Co-Ownership Agreement with Direct Energy.

Investment Income:

Investment income is earned from the short-term investment of cash generated by the Fund pending utilization in operations or distributions to unitholders. During the third quarter and first nine months of 2005, the Fund generated investment income of approximately $0.2 million and $0.5 million respectively, $0.1 million and $0.2 million higher than the same periods last year, respectively. The increase in the amount of investment income is mainly a result of higher cash balances available for investment compared to the same periods of 2004.

Amortization:

The amortization expense of approximately $24.7 million incurred during the third quarter of 2005 compares with $24.6 million recorded in the same period last year. The nine-month amounts were $73.8 million and $73.6 million, respectively. The small increases of $0.1 million in the third quarter and $0.2 million in the nine-month period are consistent with growth in the capitalized cost of the water heater portfolio. The investment in property and equipment, and intangible assets is amortized using the straight-line method over 16 years. Amortization expense also includes the write-off of debt financing expenditures over five years.

General and Administrative Expenses:

2005 third quarter general and administrative expenses of approximately $2.5 million were $0.8 million lower than the $3.3 million booked during the third quarter of 2004. The decline in the amount of expenses was primarily driven by a reduction in the accrued Incentive Fees due to Direct Energy; however reductions in the amount of customer claims, insurance costs, public company costs and capital taxes further contributed to the total cost reduction.

2005 year-to-date general and administrative costs of $7.7 million were $0.3 million lower than the same period in 2004. The decrease is largely attributable to lower insurance premiums and capital taxes. Other operational costs were mostly in line with last year's amounts.

Also included in general expenses are fees payable to Direct Energy under the Administration and Origination Agreements. In both 2004 and 2005, in the third quarter and during the first nine months pursuant to the Administration Agreement, the Fund paid Direct Energy $0.26 million and $0.8 million, respectively. Under the Origination Agreement, Direct Energy is paid a fee in respect of each water heater supplied and installed for inventory management and logistics services. The fees paid were approximately $0.9 million in the third quarter of both 2005 and 2004. While these Inventory Servicing fees were $2.6 million in the first nine months of 2005, in the same period last year they were $2.5 million, both consistent with the level of capital expenditures incurred in the respective periods.

Interest Expense:

The Fund incurred interest expense of $6.2 million during the third quarter of 2005, on $500 million long-term debt, in line with the $6.2 million booked in the same quarter last year. For the first nine months of 2005 and 2004, the respective amounts were $18.5 million.

Loss on Disposal of Property and Equipment:

During the third quarter of 2005, the Fund reported a loss of $1.6 million resulting from the retirement of water heaters whose book value had not been fully depreciated or recovered through proceeds realized on disposition of the asset, comparable to the loss recorded in the same period in 2004 of $1.7 million. In the third quarter of 2005, asset exchanges and customer-initiated removals totaled 16,512 water heaters, while a year earlier the number was 16,382 water heaters.

During the nine months of 2005 the Fund reported a loss on disposal of property and equipment of $5.9 million while the amount incurred during the same period last year was $5.6 million. The year over year increase of $0.3 million is mainly as a result of a slightly higher number of asset retirements. In the current fiscal year a total of 54,981 water heater were removed from service, while a year ago the number reached 53,303 assets.

Customer initiated removals in both fiscal periods remain comparable at approximately 1.2% of the total portfolio of installed assets.

Future Income Taxes:

2005 third quarter future tax benefit of $3.4 million was $0.4 million higher than that was booked the same period in 2004. This was mainly due to the timing of accounting for future income tax liabilities of a subsidiary company, which is subject to income taxes. The Fund booked $1.1 million lower future tax benefits during the first nine months of 2005 compared to the same period last year. The variance is a result of a combination of higher revenues earned by a subsidiary company, which is subject to income taxes and lower net book value of assets due to lower capital expenditures.

All revenues, expenses and resulting earnings are in line with management's expectations for the year.

The amount of earnings realized on a rolling twelve-month basis is well in excess of that determined by management to be adequate to service interest on the outstanding long-term debt of the Fund. Adjusted EBITDA (as defined in the Supplemental Trust Indenture) was 5.9 times Net Interest Expense for the twelve-month period ended September 30, 2005 and significantly in excess of the requirement of 3.6 times Net Interest Expense required under the Supplemental Trust Indenture pursuant to which the Series 2003 Secured Notes were issued.

Liquidity and Capital Resources

Cash generated from operating activities prior to changes in non-cash working capital during the third quarter of 2005 was $28.4 million, an increase of $2.5 million from the same period last year. The increase is a result of higher operating revenues of approximately $1.7 million and lower general and administrative costs of $0.8 million.

Cash generated from operating activities prior to changes in non-cash working capital for the nine-months of 2005 was $85.2 million, representing an increase of $5.4 million from the $79.8 million reported in the comparable period of 2004. As was the case in the quarter, higher operating revenues and lower general and administrative costs contributed to the higher level of operating cash flow.

In the third quarter of 2005, the Fund's non-cash working capital of $(2.5) million represents a reduction in the negative non-cash working capital from the same period last year of $4.1 million. As depicted in the table below, the change is for the most part attributable to a reduction in amounts due to Direct Energy. The reduction in the amount owing DE is largely due to the inclusion in 2004 amounts of a $3.7 million payable that related to "Transaction Costs" associated with the establishment of the income fund in 2002. The obligation was settled by the Fund in the last quarter of 2004.



Non-cash Working Capital
Unaudited September 30 September 30 December 31,
(in thousands of dollars) 2005 2004 2004
$ $ $
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Accounts and other receivables 14,371 14,006 13,999
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Less:
Accounts payable and accrued
liabilities 1,315 1,262 1,003
Interest payable 4,301 4,319 10,534
Income and other taxes payable 526 524 558
Distribution payable to
unitholders 4,745 4,418 4,418
Amounts due to related parties 5,990 10,117 6,535
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16,877 20,640 23,048
Non-cash working capital (2,506) (6,634) (9,049)
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Capital Expenditures:

Capital expenditures were approximately $12.8 million in the third quarter of both 2005 and 2004. Total water heater purchases of 20,000 units in the third quarter of 2005 compares to 21,601 units in 2004. The reduction of the number of purchases is primarily due to a lower level of activity in the residential new home construction market. The impact of the volume decline was offset by higher costs incurred to install a water heater in 2005, which substantially reflects the introduction of higher priced FVIR technology(1), applicable to conventional tanks installed in 2005.

During the third quarter the asset portfolio grew by net 3,488 units bringing the installed asset base to 1,325,528 units. Capital expenditures were comprised of the addition of 12,679 water heaters to replace tanks that had reached the end of their useful lives, at a capital cost of $7.2 million and 7,230 additional units in the "new construction" segment of residential market, at a capital cost of $5.4 million. Water heater installations in the commercial segment were 91 units at a cost of $0.2 million. Comparable figures for the third quarter of last year were 5,219 net additions, 12,541 replacement units at a capital cost of $6.3 million and 9,060 new construction units at a cost of $6.5 million. The slower growth in the asset portfolio during the third quarter of 2005 versus last year is to a large extent as a result of slower new construction activity and an increased level of competition.

During the 2005 fiscal year-to-date, the asset portfolio grew by 6,713 units. During the first nine months of the fiscal year total capital expenditures of $38.9 million were comprised of the addition of 42,604 water heaters to replace tanks that had reached the end of their useful lives, at a capital cost of $24.1 million, 18,815 additional units in the "new construction" segment of residential market at a capital cost of $14.0 million and installation of 275 commercial water heaters at a cost of $0.8 million. Comparable figures for the same period of last year were 12,445 net additions, $37.7 million total capital expenditures represented by 42,112 replacement units at a capital cost of $21.0 million and 23,636 new construction units at a cost of $16.7 million. Consistent with prior history during the past five years the overall annualized level of customer attrition continues to be low, at approximately 1.2% of the asset portfolio.

The following table summarizes a comparison of 2005 and 2004, third quarter and year-to-date asset continuity:

(1) As noted in the AIF, FVIR (Flammable Vapour Ignition Resistant) technology is required on conventional water heaters manufactured after July 1, 2004. This is further explained in the Update to Risk Factors section.



Unit Continuity

Third Third Nine Months
(Unaudited) Quarter Quarter ended September 30
(in units of asset portfolio) 2005 2004 2005 2004
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Beginning units 1,322,040 1,311,422 1,318,815 1,304,196
Retirements (12,679) (12,541) (42,604) (42,112)
Replacements 12,679 12,541 42,604 42,112
Buyouts and terminations (3,833) (3,841) (12,377) (11,191)
Additions 7,321 9,060 19,090 23,636
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Ending units 1,325,528 1,316,641 1,325,528 1,316,641
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As at September 30, 2005 the net indebtedness of the Fund represented 49.4% of the net present value of total projected cash flow. This ratio is in compliance with the 70% limit set forth in the Supplemental Trust Indenture pursuant to which the Series 2003 Secured Notes were issued.

The Fund had total assets of $1.093 billion as at September 30, 2005 of which 96% was invested in the portfolio of primarily residential water heaters and customers. Current assets of $38.4 million were comprised of $24.0 million in cash and $14.4 million in trade accounts receivable, all of which were collectible and liquid.



Capitalization

Third Third
Quarter Quarter Fiscal
(Unaudited) 2005 2004 2004
(in thousands of dollars,
except ratios and percentages) $ $ $
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Cash and cash equivalents 23,992 17,129 23,180
Non-cash working capital (2,506) (6,634) (9,049)
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Net working capital 21,486 10,495 14,131
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Total debt 500,000 500,000 500,000
Unitholders' equity 323,134 358,230 348,698
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Total capitalization 823,134 858,230 848,698
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Debt to total capitalization ratio 60.7% 58.3% 58.9%
Debt to total asset ratio 45.7% 43.7% 44.0%
Interest coverage 5.9 X 5.7 X 5.7 X
Debt to net present value of
cash flow ratio 49.4% 52.1% 48.4%

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Current assets of $38.4 million are sufficient to fully retire all current liabilities, which totaled $16.9 million at September 30, 2005. The most significant current liability is $6.0 million due to Direct Energy followed by the $4.7 million distribution payable to unit holders and $4.3 million accrued interest payable on the Series 2003 Secured Notes.

The amounts owed to Direct Energy primarily relate to ongoing operating activity including amounts payable for the month of September 2005 capital expenditure program and administration fees. The net investment in working capital at September 30, 2005 of $21.5 million is comprised of net cash reserves (defined as cash less accrued interest) of $19.7 million and $1.8 million of non-cash working capital which is realizable and liquid. The amount of cash reserves retained by the Fund is subject to Trustee approval, but is generally regarded as a means of assisting the Fund to sustain the level of unitholder distributions through periods where there may be fluctuations in the Fund's cash requirements from month to month, particularly with respect to fluctuations in the amount of capital expenditures.

In September 2004, the Fund secured a $15.0 million revolving operating line of credit with a Canadian chartered bank. The facility may be used to finance ordinary course working capital requirements, including funding the purchase of additional water heaters. Outstanding draws on the facility are secured by the assets of the Fund, pari passu with the $500 million of Secured Notes. The facility matures on January 28, 2008. There exists no immediate need to draw on this facility.

Management believes that a combination of cash on hand, available credit facilities and expected cash flow from operations to be adequate to allow the Fund to finance all normal operating requirements and fund its growth objectives in 2005.

Summary of Distributable Cash

Distributable cash is presented as a measure of the extent to which the level of cash flow from operations is sufficient to service interest costs on outstanding debt, finance capital expenditures and fund unitholder distributions. Management believes that disclosure of distributable cash information is relevant to an understanding of the financial results of the Fund. Distributable cash is a non-GAAP financial measure, and therefore has no standardized meaning prescribed by GAAP and may not be comparable to similar terms and measures presented by other similar issuers. Distributable cash is intended to provide additional information on the Fund's performance and should not be considered in isolation or as a substitute for measures of performance prepared in accordance with GAAP.

The following table outlines the amount of Distributable Cash for the Fund in the reporting periods:



Summary of Distributable Cash

Three months ended Nine months ended
September 30 September 30
(Unaudited) 2005 2004 2005 2004
(in thousands of dollars) $ $ $ $
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Cash flow from operating
activities 23,245 19,418 78,347 73,958

Adjustments
Net changes in non-cash
working capital 5,123 6,470 6,870 5,821
Interest expense 6,232 6,220 18,493 18,525
Proceeds on disposal of
property and equipment 883 1,078 2,454 2,910
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Cash flow from operations
before interest expense 35,483 33,186 106,164 101,214
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Capital expenditures
Maintenance 10,126 9,053 33,702 28,911
Expansionary 2,669 3,719 5,222 8,787
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12,795 12,772 38,924 37,698
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Net cash available to service
capital 22,688 20,414 67,240 63,516
Interest costs on debt 6,232 6,220 18,493 18,525
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Net cash available to
unitholders 16,456 14,194 48,747 44,991
Unitholder distributions
declared 13,906 13,253 41,392 39,590
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Increase (decrease) in cash 2,550 941 7,355 5,401
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Unitholder payout ratio

Before expansionary capital
expenditures 73% 74% 77% 74%
After maintenance & expansionary
capital expenditures 85% 93% 85% 88%
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The financial results support the ability of the Fund to internally finance all capital expenditures, both maintenance and expansionary expenditures, cover interest costs on debt and add to the amount of cash reserves accumulated in the Fund. The level of cash reserves supports the ability to sustain unitholder distributions at current levels.

Summary of Contractual Obligations

Long-term contractual obligations of the Fund include debt service on the $500,000,000 of Secured Notes issued on January 22, 2003. The terms of the Secured Notes are as follows:



1. $ 275,000,000 4.70% Secured Notes maturing on January 28, 2008
2. $ 225,000,000 5.245% Secured Notes maturing on January 28, 2010


The following schedule outlines the implications of the Secured
Notes:

Schedule

Less
than
(Unaudited) Total 1 Year 2 Years 3 Years 4 Years 5 Years
(in thousands
of dollars) $ $ $ $ $ $
---------------------------------------------------------------------
Long-term debt
Interest 85,552 24,725 24,725 18,350 11,801 5,951
Principal 500,000 - - - 275,000 225,000
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Total 585,552 24,725 24,725 18,350 286,801 230,951
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There has been no change in the contractual obligations of the Fund during the third quarter of 2005.

See also related party transactions.

Refinancing of the Notes

The Fund expects to refinance the outstanding Notes of each Series on the Expected Final Payment Date for that Series (being January 28, 2008 and January 28, 2010). A failure to refinance any Series of Secured Notes on its Expected Final Payment Date would give rise to a Cash Sweep Remedy. A Cash Sweep Remedy essentially would preclude the Fund from making distributions and other expenditures (including capital expenditures) until the Secured Notes are paid in full. The maturity dates of the Secured Notes are January 28, 2014 and January 28, 2016. Based on current market conditions, the Fund believes it would be able to arrange such refinancing; however, no assurances can be given with respect to future market conditions.

Related Party Transactions

As at September 30, 2005, Direct Energy continues to retain a 19.9% residual equity interest in the Fund. Under the terms of the Co-Ownership Agreement, the Origination Agreement and the Administration Agreement (the principal agreements between the Fund and Direct Energy), Direct Energy provides certain prescribed services to the Fund. These agreements set out the rights and obligations of the respective parties and the fees payable by the Fund to Direct Energy for the respective services. Copies of these agreements are available on www.sedar.com.
In summary the respective agreements are as follows:

Co-Ownership Agreement: Direct Energy receives 35% of the gross revenue generated by the portfolio of assets, and is obligated to service the asset portfolio, effectively operating the day-to-day activities of the rental business.

Origination Agreement: Direct Energy must offer to sell all rental water heaters to the Fund at prescribed prices, essentially at Direct Energy's cost plus inventory service fee and set installation fee. The Fund has no obligation to purchase any water heaters. The agreement also established an Incentive Fee payable to Direct Energy should profitable portfolio growth targets be achieved.

Administration Agreement: A subsidiary of Direct Energy administers the day-to-day administrative operations of the Fund, including its responsibilities as a reporting issuer under applicable securities laws. The fee payable for these services is set at $1.0 million per year subject to an annual inflation adjustment.

The amounts paid or payable by the Fund to Direct Energy in the periods indicated are as follows:



Amounts paid or payable to Direct Energy:

Third Third Nine Months Nine Months
Quarter Quarter ended ended
September 30 September 30
(Unaudited) 2005 2004 2005 2004
(in thousands of dollars) $ $ $ $
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Origination agreement
Capital expenditures 12,795 12,772 38,924 37,698
Inventory service fee 859 847 2,592 2,475
Incentive fee 470 800 580 700
Administration agreement 259 256 778 766
Unitholder Distributions
Declared to Direct Energy 2,767 2,637 8,237 7,878
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Co-Ownership Agreement: Revenues are distributed out of the Custodial Trust Account on a 35% / 65% basis and as a result, no funds are actually paid by the Fund to Direct Energy.

Summary of Outstanding Units

The Fund's Declaration of Trust provides that an unlimited number of units of the Fund may be issued. Each unit is transferable and represents an equal and undivided beneficial interest in any distribution of the Fund and in the net assets of the Fund. There exist two classes of units, Fund units and Special Trust Units. The Special Trust Units are issued in tandem with Class B exchangeable units, all of which are held by Direct Energy. The Class B exchangeable units have economic and voting rights equivalent in all material respects to the Fund units and are exchangeable on a one-for-one basis for Fund units (subject to typical anti-dilution protection).



As at the date hereof, the following are issued and outstanding:

Fund Units 39,668,798
Class B Exchangeable Units(1) 9,855,294
-------------------------------------------

Total Issued 49,524,092
-------------------------------------------
-------------------------------------------

(1) Assuming the deemed exchange of Class B exchangeable units for
Fund units on a one-for-one basis.


There has been no change to Fund units during the third quarter of 2005.

Summary of Risks and Uncertainties

There are a number of risks and uncertainties that could affect the operations of the Fund and the distributable cash generated by the Fund.

A thorough discussion of the material risks relating to the business and structure of the Fund can be found in the Fund's Annual Information Form ("AIF"), which is available on www.sedar.com. Except as described below under "Update to Risk Factors," the risk factors remain unchanged from the date of the AIF.

Of the risk factors described in the Fund's AIF, the following summarizes those risk factors management believes are the most relevant to the operations of the Fund.

The Ontario marketplace is unique in that the vast majority of homeowners rent their water heaters. There can be no assurance that homeowners will continue to rent their water heaters, or, if they do, that they will rent them for an indefinite period. Management of the Fund believes that so long as the rental rates charged for the rental product are competitive and that servicing standards are maintained in accordance with the customers' expectations, customers will continue to choose to rent rather than to purchase their water heaters. To ensure that both variables are appropriately managed, Direct Energy, as servicer of the water heaters, analyzes a number of performance metrics to determine if timely and appropriate service standards are adhered to and makes necessary adjustments to its servicing activities if they are not. In addition, Direct Energy, in accordance with the Origination Agreement, undertakes a supplier tendering process so that water heaters can be acquired from competing suppliers on a cost effective and competitive basis.

The attractiveness of renting a natural gas fired water heater is also dependent on the price of gas compared to other alternative energy sources. Currently, natural gas enjoys, and is forecast by management to continue to enjoy, a competitive advantage over electricity (the most common alternative way to heat water).

As owner of the rental portfolio assets, the Fund is exposed to potential product liability and product defect risks, as described in the AIF. Not all of these risks are, or can be, covered by insurance. The Fund mitigates its operating risk exposure through the Co-Ownership Agreement with Direct Energy. Direct Energy assumes responsibility for all ordinary-course servicing expenses and indemnifies the Fund in respect of any costs resulting from any service or installation deficiencies. However, Direct Energy does not take financial responsibility for manufacturing or product design defects and any related product losses or liabilities, including recalls or related "extraordinary" servicing expense.

Historically, these product defects have been relatively uncommon and Direct Energy (and its predecessors) has generally been successful, either through warranty coverage or the strength of its supplier relationships, in negotiating recoveries from the manufacturers involved. Except as described in the AIF and below, management is not currently aware of any product defect issues that are likely to be material to the Fund.

In July 2005 Direct Energy entered into a two year extension of the Customer Services Agreement with CustomerWorks Limited Partnership (and by way of subcontract, Accenture Business Services for Utilities Inc., a subsidiary of Accenture Ltd). Direct Energy's billing arrangements with Enbridge Inc. have been extended so that they are co-terminus with the extended Customer Services Agreement or for four years, whichever is shorter. The Customer Services Agreement is now scheduled to expire December 31, 2007, subject to a one year renewal right to December 31, 2008 and subject to early termination upon the occurrence of certain stated events. Pursuant to the terms of the extension agreement, the Fund will continue to have the benefit of the collection guarantee pursuant to which, subject to certain limitations, CustomerWorks and Accenture have guaranteed that at least 99.5% of the stated amount of all invoices delivered to customers on the Enbridge Inc. bill for rental payments for installed water heaters owned by the Fund during the initial two year extension of the Customer Services Agreement will be collected. The collection guarantee is subject to renegotiation for the additional one year renewal term. There can be no assurance that comparable alternative arrangements will be established on any termination of billing arrangements with Enbridge Inc. and/or any termination of the guarantee. It may be materially adverse to the Fund's financial performance if comparable alternative arrangements are not established in these circumstances. For more information on the customer Services Agreement and billing arrangements, please see the section titled "Customer Services Agreement; Joint Billing" at page 10 of the Fund's annual information form dated March 24, 2005 which is available on SEDAR at www.sedar.com.

Update to Risk Factors

In January 2005 the Canadian Standards Association ("CSA") announced that effective January 1, 2006 power vented water heaters must be FVIR compliant.

The introduction of FVIR technology applicable to power vented water heaters has been anticipated for some time, and management does not expect the capital cost implications to have an adverse effect on the Fund or its ability to maintain distributions.

It has been recently reported by Direct Energy, as Servicer, that there may be a potential issue with approximately 8,000 Bradford White power vented water heaters in the portfolio. Certain of these water heaters have produced excessive flue gas temperatures that are causing deterioration of the plastic pipe venting system. Direct Energy is continuing to have discussions with the Technical Standards and Safety Authority and Bradford White to determine the extent and cause of the high flue gas temperatures and potential remedial actions and has commenced its own investigation into the matter. While it is too early to assess definitively, some or all of these water heaters may need to be replaced. If Bradford White or another party is not determined to be wholly or partly liable for these issues, the Fund may bear all or some of the cost of the replacements. Management does not consider the potential cost to be material to the Fund's financial position.

On September 8, 2005, the Department of Finance released a paper initiating a consultation process with regard to business income trusts and other flow through entities and requesting submissions by December 31, 2005. Any further initiatives in this area, if any, will be taken following the completion of such consultations. On September 19, 2005, the Minister of Finance announced that he had requested that CRA postpone providing advance income tax rulings respecting flow through entity structures effective immediately, that the Department of Finance is closely monitoring developments in the flow through entity market with a view to proposing measures in response to the consultations and that consideration would be given to what, if any, transitional measures are appropriate. Given that the consultation process is ongoing, it is not possible for the Fund to assess what impact, if any, this process will have on the Fund.

Outlook

The Fund continues to show strong financial performance having foundations built on stable operations and customer base. The outlook for 2005 remains positive with an expectation for modest growth. Rental rates remain competitive in the market, while water heater purchase prices remain comparable with those experienced in 2004. Customer initiated contract terminations are expected to continue at levels of around 1.2% of the size of the portfolio and management expects a continuation of this trend for the remainder of 2005.
Certain statements in this News Release are forward-looking statements, which reflect management's expectation regarding the Fund's growth, results of operations and business prospects. Such forward-looking statements reflect management's current beliefs and are based on information available to them. Many factors could cause results to differ materially from the results discussed in the forward-looking statements. Although the forward-looking statements are based on what management believes to be reasonable assumptions, the Fund cannot assure investors that actual results will be consistent with these forward-looking statements. Management is under no obligation (and expressly disclaims any such obligation) to update or revise the forward-looking information, whether as a result of new information, future events or otherwise.

Further information concerning the Fund is available on www.sedar.com.

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