The Consumers' Waterheater Income Fund
TSX : CWI.UN

The Consumers' Waterheater Income Fund

July 28, 2005 20:55 ET

The Consumers' Waterheater Income Fund Announces Strong Financial Results for the Second Quarter of 2005 and a 3.6% Increase in Monthly Distributions

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

Highlights:

- Announced increase in monthly unitholder distributions of 3.6% to $0.0958 per unit effective September 1, 2005, this follows a 3.7% increase effective January 1, 2005.

- Net income of $5.5 million, up 47% compared to last year.

- Revenues increased by 5% to $37.3 million.

- Portfolio of installed assets continues to increase, but at a lower rate due to lower new home construction completions reflecting a slowing of the market and increased competition.

- Entry into commercial sector provides diversification and growth area outside of residential market.

- Customer attrition stable at about 1.2% of portfolio

The Fund announced today an increase in monthly cash distributions to $0.0958 per unit effective for the month of September 2005. The new distribution rate represents a 3.6 % increase over the Fund's distribution rate since January 2005 of $0.0925 per unit. The increased distribution is equivalent to $1.15 per unit on an annualized basis, compared to annualized rate of $1.11 per unit since January, 2005.

The decision to increase the distribution rate reflects the strong financial performance realized by the Fund and the stability associated with the rental water heater business. The increase is consistent with the Fund's financial objective of providing growth in the distributions to unitholders, supported by growth in the size of the installed asset base.

"The Fund's results for the second quarter reflect the strength and stability of our underlying business," said Robert Huggard, CEO of the Fund's administrative agent. "The increase in the monthly distribution to unitholders we announced today demonstrates that we have the ability to simultaneously grow our business and the installed asset base, while increasing our distribution rate."

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) Three months ended Six months ended
June 30 June 30
(in thousands of dollars, except
unit and per unit amounts) 2005 2004 2005 2004
$ $ $ $
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Total revenue 37,296 35,570 74,528 71,324
Net earnings 5,485 3,732 10,259 9,292
EBITDA 33,028 31,381 65,107 62,652
Cash flow from operating
activities 35,321 33,613 55,102 54,540
Capital expenditures (Net)(2) 12,058 11,082 24,558 23,094
Unitholder distributions
declared 13,743 13,253 27,486 26,337
Total assets 1,110,072 1,165,081 1,110,072 1,165,081
Average Fund units
outstanding 49,524,092 49,524,092 49,524,092 49,524,092

Per Unit Analysis
Net earnings $ 0.111 $ 0.075 $ 0.207 $ 0.188
Operating cash flow $ 0.713 $ 0.679 $ 1.113 $ 1.101
Capital expenditures $ 0.243 $ 0.224 $ 0.496 $ 0.466
Unitholder distributions $ 0.278 $ 0.268 $ 0.555 $ 0.532

Operating Highlights
Asset replacements 13,494 12,887 29,925 29,571
Additions 6,225 7,869 11,769 14,576
Removals 3,894 3,514 8,544 7,350
Assets in service 1,322,040 1,311,422 1,322,040 1,311,422
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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 June 30, 2005 and 2004 and the 2004 audited consolidated financial statements. All amounts are in Canadian dollars.

Results of Operations

During the second quarter of 2005, the Fund reported earnings of $5.5 million on total revenues of $37.3 million. Comparable amounts for the second quarter of 2004 were $3.7 million and $35.6 million, respectively. The year over year improvement in the current period quarterly earnings is largely attributable to an increase in the rental revenue. Operating costs, interest expense and income tax benefits were substantially at last year's levels.

In the six months ended June 30, 2005 the Fund reported earnings of $10.3 million on total revenues of $74.5 million compared with $9.3 million and $71.3 million in the same period last year, respectively. An increase in rental revenue during the first six months of 2005 compared with last year was partially offset by lower future income tax benefits, higher general and administrative costs, and higher losses on disposal of property and equipment. The timing of recognizing future income taxes of a subsidiary company, which is subject to income taxes, resulted in recording lower future tax benefits during the first quarter of 2005. It is important to note that the future tax balances recorded in the earnings statement do not entail the use of cash, and consequently management is of the opinion that pre-tax earnings are a better proxy for operational performance. During the first six months of 2005, the Fund reported pre-tax earnings of $3.7 million, compared to $1.4 million that was reported in the same period of 2004.

Operating results as measured by earnings before interest, taxes, depreciation and amortization ("EBITDA") were $33.0 million for the second quarter of 2005 compared to $31.4 million in the same period last year. The $1.6 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.

The EBITDA for the first six months of 2005 was $65.1 million compared to $62.7 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, offset to some degree by higher general and administrative expenses and losses incurred from the 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 second quarter of 2005, and 88% of operating revenue in the same period last year. The relative comparability of the 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 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 Six First
Quarter Quarter Months Quarter
Unaudited 2005 2005 2005 2004
(in thousands of dollars) $ $ $ $
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Total revenue 37,232 37,296 74,528 35,753
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Net earnings 4,774 5,485 10,259 5,560
Adjustments:
Amortization 24,520 24,596 49,116 24,423
Interest expense 6,097 6,164 12,261 6,151
Income taxes (3,312) (3,217) (6,529) (4,863)
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Earnings before interest, taxes
and amortization (EBITDA) 32,079 33,028 65,107 31,271
Unitholder distributions declared 13,743 13,743 27,486 13,084
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Unitholder payout ratio
Before expansionary capital
expenditures 84% 74% 79% 76%

After expansionary capital
expenditures 88% 83% 85% 86%

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Quarterly Results
Second Six Third Fourth Total
Quarter Months Quarter Quarter Fiscal
Unaudited 2004 2004 2004 2004 2004
(in thousands of dollars) $ $ $ $ $
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Total revenue 35,570 71,324 35,596 35,967 142,886
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Net earnings 3,732 9,292 2,644 3,720 15,656
Adjustments:
Amortization 24,541 48,964 24,585 24,828 98,377
Interest expense 6,154 12,305 6,220 6,217 24,742
Income taxes (3,046) (7,910) (2,855) (3,811) (14,575)
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Earnings before interest,
Taxes and amortization
(EBITDA) 31,381 62,652 30,594 30,954 124,200
Unitholder distributions
declared 13,253 26,337 13,253 13,252 52,842
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Unitholder payout ratio
Before expansionary capital
expenditures 71% 73% 74% 76% 74%

After expansionary capital
expenditures 85% 86% 93% 83% 87%

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As outlined in the above table, total revenue and EBITDA are relatively evenly dispersed throughout each quarter. The increased EBITDA for the second quarter of 2005 is attributable to a large extent to a reduction in the losses incurred on disposal of water heaters and to lower general and administrative expenses.

Rental Revenue:

Second quarter 2005 rental revenue of $37.1 million exceeded the same period last year by $1.7 million or approximately 5%. 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 10,618 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.

Similarly, during the first six months of 2005, rental revenues of $74.2 million were realized, representing a $3.1 million improvement over the same period last year. This favourable variance is also mostly attributable to the rental rate increase and a higher installed asset base.

Rental revenues are derived from the Fund's 65% interest in rental revenues charged to customers 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 second quarter and first six months of 2005, the Fund generated investment income of approximately $0.2 million and $0.3 million respectively, both $0.1 million higher than the same periods last year. 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 $24.6 million incurred during the second quarter of 2005 compares with $24.5 million recorded in the same period last year. The six-month amounts were $49.1 million and $49.0 million, respectively. The small increases of $0.1 million realized in both periods 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 second quarter general and administrative expenses of approximately $2.3 million were $0.3 million lower than the $2.6 million booked during the second quarter of 2004. The decrease was largely driven by a reduction in the accrued Incentive Fees due Direct Energy and to a lesser degree by the absence of an unusual adjustment to bad debt expense reported in 2004 results.

2005 year-to-date general and administrative costs of $5.1 million were $0.4 million higher than the same period in 2004. Approximately one half of the increase is as a result of an accrual of the incentive fee payable to Direct Energy and increased public company costs. The incentive fee payable to Direct Energy was accrued in anticipation of the Fund generating cash flow available for distribution in excess of last year's levels, while no incentive fee accrual was made during the first half of 2004.

Also included in general expenses are fees payable to Direct Energy under the Administration and Origination Agreements. In both 2004 and 2005, in the second quarter and during the first six months pursuant to the Administration Agreement, the Fund paid Direct Energy $0.26 million and $0.5 million, respectively. Under the Origination Agreement, Direct Energy receives a fee in respect of each water heater supplied and installed for inventory management and logistics services. The fees paid were approximately $0.8 million in the second quarter of both 2005 and 2004. While these Inventory Servicing fees were $1.7 million in the first half of 2005, in the same period last year they were $1.6 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 second quarter of 2005, on $500.0 million long-term debt, in line with the $6.2 million booked in the same quarter last year. For the first half of 2005 and 2004, the respective amounts were $12.3 million.

Loss on Disposal of Property and Equipment:

During the second quarter of 2005, the Fund reported a loss of $1.9 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, while the losses recorded for the same period in 2004 were at $1.6 million. In the second quarter of 2005, asset exchanges and customer-initiated removals totaled 17,388 water heaters, while a year earlier the number was 16,401.

In the first half of 2005 the Fund experienced a loss on disposal of property and equipment of $4.3 million while the amount incurred during the same period last year was $3.9 million. The year over year increase of $0.4 million is mainly as a result of higher number of asset retirements.

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

Future Income Taxes:

2005 second quarter future tax benefit of $3.3 million was comparable to the $3.2 million that was booked the same period in 2004, while the Fund booked $1.5 million lower future tax benefits during the first six months of 2005 compared to the same period last year. This was mainly due to the timing of accounting for future income tax liabilities of a subsidiary company, which is subject to income taxes.

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 5.8 times Net Interest Expense for the twelve-month period ended June 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 second quarter of 2005 was $28.7 million, an increase of $2.1 million from the same period last year. Contributing factors include: the impact of the January 1, 2005 rental rate increase; the higher installed asset base; lower general and administrative costs and the lower large corporations tax. The respective amounts for the six-month periods were $56.8 million and $53.9 million. The increase was mainly as a result of the January 1, 2005 rental rate increase and the higher installed asset base; the impact of which were to some extent offset by higher general and administrative expenses.

In the second quarter of 2005, the Fund's non-cash working capital of $(7.5) million represents a reduction in the negative non-cash working capital from last year-end of $1.6 million. As depicted in the table below, the change is for the most part attributable to a reduction in amounts due to Direct Energy. This variance is largely a result of an anticipated reduction in the incentive fee accruals due to Direct Energy.



Non-cash Working Capital
Unaudited June 30 June 30 December 31,
(in thousands of dollars) 2005 2004 2004
$ $ $
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Accounts and other receivables 14,446 13,673 13,999
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Less:
Accounts payable and accrued
liabilities 1,310 1,534 1,003
Interest payable 10,432 10,467 10,534
Income and other taxes payable 615 546 558
Distribution payable to
unitholders 4,581 4,418 4,418
Amounts due to related parties 4,973 9,812 6,535
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21,911 26,777 23,048
Non-cash working capital (7,465) (13,104) (9,049)
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Capital Expenditures:

Capital expenditures of $12.8 million in the second quarter of 2005 were approximately $0.8 million higher than those incurred the same period in 2004. Approximately $0.4 million of the variance reflects the impact of origination of commercial rental water heaters from Direct Energy after the decision to re-enter the commercial building market sector. The balance of the variance primarily reflects increase in water heater unit prices with the introduction of FVIR technology1, which was partially offset by the impact of a lower number of units purchased than the same period last year. Aggregate water heater purchases were 19,719 units in 2005 compared to 20,756 in 2004, reflecting a lower level of activity in the residential new home construction market.

During the second quarter the asset portfolio grew by net 2,331units bringing the installed asset base to 1,322,040 units. Capital expenditures were comprised of the addition of 13,494 water heaters to replace tanks that had reached the end of their useful lives, at a capital cost of $7.8 million and 6,099 additional units in the "new construction" segment of residential market, at a capital cost of $4.6 million. Water heater installations in the commercial segment were 126 units at a cost of $0.4 million. Comparable figures for the second quarter of last year were 4,355 net additions, 12,887 replacement units at a capital cost of $6.5 million and 7,869 new construction units at a cost of $5.5 million. The slower growth in the asset portfolio during the second quarter of 2005 versus last year is to a large extent as a result of slower new home construction activity.

During the 2005 fiscal year-to-date, the asset portfolio grew by 3,225 units. During the first half of the fiscal year total capital expenditures of $26.1 million were comprised of the addition of 29,925 water heaters to replace tanks that had reached the end of their useful lives, at a capital cost of $16.9 million, 11,585 additional units in the "new construction" segment of the residential market at a capital cost of $8.6 million and installation of 184 commercial water heaters at a cost of $0.6 million. Comparable figures for the same period of last year were 7,226 net additions, $24.9 million total capital expenditures represented by 29,571 replacement units at a capital cost of $14.7 million and 14,576 new construction units at a cost of $10.2 million.

Consistent with prior history during the past five years, the overall 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, second quarter and year-to-date asset continuity:



Unit Continuity

Second Second Six months
(Unaudited) Quarter Quarter ended June 30
(in units of asset portfolio) 2005 2004 2005 2004
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Beginning units 1,319,709 1,307,067 1,318,815 1,304,196
Retirements (13,494) (12,887) (29,925) (29,571)
Replacements 13,494 12,887 29,925 29,571
Buyouts and terminations (3,894) (3,514) (8,544) (7,350)
Additions 6,225 7,869 11,769 14,576
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Ending units 1,322,040 1,311,422 1,322,040 1,311,422

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As at June 30, 2005 the net indebtedness of the Fund represented 51.8% of the net present value of total projected cash flow. This ratio is in compliance with the 70% limit set out in the Supplemental Trust Indenture pursuant to which the Series 2003 Secured Notes were issued.

The Fund had total assets of $1.110 billion as at June 30, 2005 of which 96% was invested in the portfolio of primarily residential water heaters. Current assets of $40.8 million were comprised of $26.4 million in cash and $14.4 million in trade accounts receivable, all of which were collectible and liquid.



Capitalization
Second Second
Quarter Quarter Fiscal
(Unaudited) 2005 2004 2004
(in thousands of dollars, except
ratios and percentages) $ $ $
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Cash and cash equivalents 26,401 22,658 23,180
Net investment in non-cash
working capital (7,465) (13,104) (9,049)
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Net working capital 18,936 9,554 14,131
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Total debt 500,000 500,000 500,000
Unitholders' equity 331,471 368,839 348,698
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Total capitalization 831,471 868,839 848,698
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Debt to total capitalization
ratio 60.1% 57.5% 58.9%
Debt to total asset ratio 45.0% 42.9% 44.0%
Interest coverage 5.8 X 5.7 X 5.7 X
Debt to net present value of
cash flow ratio 51.8% 50.4% 48.4%
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Current assets of $40.8 million are sufficient to fully retire all current liabilities, which totaled $21.9 million at June 30, 2005. The most significant current liability is the $10.4 million accrued interest payable on the Series 2003 Secured Notes, followed by $5.0 million due to Direct Energy. The amounts owed to Direct Energy primarily relate to ongoing operating activity including amounts payable for the month of June 2005 capital expenditure program and administration fees. The net investment in working capital at June 30, 2005 of $18.9 million is comprised of net cash reserves (defined as cash less accrued interest) of $16.0 million and $2.9 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 June 30 Six months ended June 30
(Unaudited) 2005 2004 2005 2004
(in thousands
of dollars) $ $ $ $
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Cash flow from operating
activities 35,321 33,613 55,102 54,540
Adjustments
Net changes in non-cash working
capital (6,658) (7,008) 1,747 (649)
Interest expense 6,164 6,154 12,261 12,305
Proceeds on disposal
of property and equipment 769 911 1,571 1,832
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Cash flow from operations before
interest expense 35,596 33,670 70,681 68,028
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Capital expenditures
Maintenance 10,948 8,931 23,576 19,858
Expansionary 1,879 3,062 2,553 5,068
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12,827 11,993 26,129 24,926
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Net cash available to service
capital 22,769 21,677 44,552 43,102
Interest costs on debt 6,164 6,154 12,261 12,305
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Net cash available to
unitholders 16,605 15,523 32,291 30,797
Unitholder distributions
declared 13,743 13,253 27,486 26,337
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Increase in distributable
cash 2,862 2,270 4,805 4,460
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Unitholder payout ratio

Before expansionary capital
expenditures 74% 71% 79% 73%
After expansionary capital
expenditures 83% 85% 85% 86%

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Certain last quarter results have been restated to conform to
new method of presentation for Commercial asset additions.


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
Total 1 Year 2 Years 3 Years 4 Years 5 Years
$ $ $ $ $ $
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Long-term
debt
Interest 97,814 24,725 24,725 24,725 11,835 11,804
Principal 500,000 275,000 225,000
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Total 597,814 24,725 24,725 24,725 286,835 236,804
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There has been no change in the contractual obligations of the Fund during the second quarter of 2005.

See also related party transactions below.

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 June 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 agreed 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:

Second Second Six months Six months
Quarter Quarter ended June 30 ended June 30
(Unaudited) 2005 2004 2005 2004
(in thousands of dollars) $ $ $ $
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Origination agreement
Capital expenditures 12,827 11,993 26,129 24,926
Inventory service fee 850 791 1,733 1,768
Incentive fee (190) - 110 268
Administration agreement 260 256 519 510
Unitholder Distributions
Declared to Direct Energy 2,735 2,637 5,470 5,241
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Co-Ownership Agreement: Revenues are distributed out of the
Custodial Trust Account on a 35% / 65% basis so 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 second 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 current 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, management is not currently aware of any product defect issues that are likely to be material to the Fund.

Update to Risk Factors

Direct Energy has 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, originally scheduled to expire December 31, 2005, 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. 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.

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.

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 1.3% of the size of the portfolio and management expects a continuation of this trend for the remainder of 2005.

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




The Consumers' Waterheater Income Fund
Interim Consolidated Balance Sheets
(Unaudited)
As at June 30, 2005, and December 31, 2004

(in thousands of dollars)

June 30, December 31,
2005 2004
---------------------------------------------------------------------

Assets

Current assets
Cash and cash equivalents $ 26,401 $ 23,180
Accounts and other receivables 14,446 13,999
---------------------------------------------------------------------

40,847 37,179

Deferred financing charges 2,626 3,151

Property and equipment 459,971 465,771

Intangible assets 606,628 629,164
---------------------------------------------------------------------

$ 1,110,072 $ 1,135,265
---------------------------------------------------------------------
---------------------------------------------------------------------

Liabilities

Current liabilities
Accounts payable and accrued liabilities $ 1,310 $ 1,003
Interest payable 10,432 10,534
Income and other taxes payable 615 558
Distribution payable to unitholders 4,581 4,418
Amounts due to related parties 4,973 6,535
---------------------------------------------------------------------

21,911 23,048

Long-term debt 500,000 500,000

Future income taxes 256,690 263,519
---------------------------------------------------------------------
778,601 786,567


Unitholders' Equity 331,471 348,698
---------------------------------------------------------------------

$ 1,110,072 $ 1,135,265
---------------------------------------------------------------------
---------------------------------------------------------------------

See accompanying notes to interim consolidated financial statements.



The Consumers' Waterheater Income Fund
Interim Consolidated Statements of Earnings
(Unaudited)
(in thousands of dollars, except unit and per unit amounts)

Three months ended Six months ended
June 30 June 30
2005 2004 2005 2004
---------------------------------------------------------------------

Revenue
Rental revenue 37,136 35,462 74,240 71,118
Investment income 160 108 288 206
---------------------------------------------------------------------

37,296 35,570 74,528 71,324
---------------------------------------------------------------------


Expenses
Amortization 24,596 24,541 49,116 48,964
General and administrative 2,349 2,616 5,118 4,738
Interest 6,164 6,154 12,261 12,305
Loss on disposal of property
and equipment 1,919 1,573 4,303 3,935
---------------------------------------------------------------------

35,028 34,884 70,798 69,942
---------------------------------------------------------------------

Earnings before income taxes 2,268 686 3,730 1,382
---------------------------------------------------------------------

Income taxes
Future (3,337) (3,241) (6,829) (8,300)
Large corporations tax 120 195 300 390
---------------------------------------------------------------------

(3,217) (3,046) (6,529) (7,910)
---------------------------------------------------------------------

Net earnings for the period 5,485 3,732 10,259 9,292
---------------------------------------------------------------------

Weighted average number
of units 49,524,092 49,524,092 49,524,092 49,524,092
---------------------------------------------------------------------
---------------------------------------------------------------------
Basic and diluted earnings
per Unit and Class B
exchangeable unit $ 0.111 $ 0.075 $ 0.207 $ 0.188
---------------------------------------------------------------------
---------------------------------------------------------------------
See accompanying notes to interim consolidated financial statements.



The Consumers' Waterheater Income Fund
Interim Consolidated Statements of Unitholders' Equity
(Unaudited)
(in thousands of dollars)



Three months ended Six months ended
June 30 June 30
2005 2004 2005 2004
---------------------------------------------------------------------

Capital - Fund and Class B
exchangeable units

Balance- beginning and end
of period 476,868 476,868 476,868 476,868
---------------------------------------------------------------------
Deficit:

Balance - beginning of
period (137,139) (98,508) (128,170) (90,984)

Net earnings for the period 5,485 3,732 10,259 9,292

Distributions declared (13,743) (13,253) (27,486) (26,337)
---------------------------------------------------------------------

Balance - end of period (145,397) (108,029) (145,397) (108,029)
---------------------------------------------------------------------

Total Unitholders' Equity 331,471 368,839 331,471 368,839
---------------------------------------------------------------------
---------------------------------------------------------------------

See accompanying notes to interim consolidated financial statements.



The Consumers' Waterheater Income Fund
Interim Consolidated Statements of Cash Flows
(Unaudited)
(in thousands of dollars)



Three months ended Six months ended
June 30 June 30
2005 2004 2005 2004
---------------------------------------------------------------------

Cash provided by (used in)

Operating activities
Net earnings for the period $ 5,485 $ 3,732 $ 10,259 $ 9,292
Items not affecting cash
Amortization 24,596 24,541 49,116 48,964
Future income taxes (3,337) (3,241) (6,829) (8,300)
Loss on disposal of property
and equipment 1,919 1,573 4,303 3,935
---------------------------------------------------------------------
28,663 26,605 56,849 53,891

Net changes in non-cash
working capital 6,658 7,008 (1,747) 649
---------------------------------------------------------------------

35,321 33,613 55,102 54,540
---------------------------------------------------------------------

Investing activities
Purchase of property and
equipment (12,827) (11,993) (26,129) (24,926)
Proceeds from disposal of
property and equipment 769 911 1,571 1,832
---------------------------------------------------------------------

(12,058) (11,082) (24,558) (23,094)
---------------------------------------------------------------------

Financing activities
Distribution to
unitholders (13,743) (13,253) (27,323) (26,252)
---------------------------------------------------------------------
(13,743) (13,253) (27,323) (26,252)
---------------------------------------------------------------------
Increase in cash and cash
equivalents during the
period 9,520 9,278 3,221 5,194
Cash and cash equivalents -
beginning of period 16,881 13,380 23,180 17,464
---------------------------------------------------------------------
Cash and cash equivalents -
end of period $ 26,401 $ 22,658 $ 26,401 $ 22,658
---------------------------------------------------------------------
---------------------------------------------------------------------

Supplementary information
Interest paid $ - $ 6 $ 12,363 $ 12,372
Income taxes paid $ 120 $ 195 $ 300 $ 390

See accompanying notes to interim consolidated financial statements.


The Consumers' Waterheater Income Fund
Note to Interim Consolidated Financial Statements
(Unaudited)
June 30, 2005 and 2004
(in thousands of dollars)



Basis of presentation

The accompanying unaudited interim consolidated financial statements do not include all information and footnote disclosures required under Canadian generally accepted accounting principles for annual financial statements.

In the opinion of management, all adjustments (consisting primarily of normal recurring adjustments) considered necessary for a fair presentation of the financial position, results of operations and cash flows at June 30, 2005 and for all periods presented, have been included.

The unaudited interim consolidated financial statements have been prepared in accordance with Canadian generally accepted accounting principles for interim financial statements. These interim consolidated financial statements should be read in conjunction with annual consolidated financial statements and notes thereto included in the Fund's financial statements for the year ended December 31, 2004.

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