Morneau Sobeco Income Fund
TSX : MSI.UN

Morneau Sobeco Income Fund

March 15, 2007 15:15 ET

Morneau Sobeco Releases 2006 Fourth Quarter and Year-End Results

Highlights: ·9.8% annual revenue growth ·Net income of $9.8 million ·EBITDA margin of 22.6% ·Distributable Income of $27.1 million ·Distributable Cash of $29.7 million ·2006 special one-time cash distribution ·Distributions to increase by 7%

TORONTO, ONTARIO--(CCNMatthews - March 15, 2007) - - NOT FOR DISTRIBUTION TO U.S. NEWS WIRE SERVICES OR FOR DISSEMINATION IN THE U.S.

Morneau Sobeco Income Fund (TSX:MSI.UN) (the "Fund") today announced positive results for its operating business in the fourth quarter of 2006 and for the one-year period ending December 31, 2006.

"In 2006, Morneau Sobeco completed its first full year of public ownership and rewarded Unitholders by generating increased revenue and showing evidence of strong financial performance to support consistent cash distributions," said Bill Morneau, President & CEO. Revenue growth was 9.8% for the year 2006 and EBITDA margin was 22.6% compared to 21.5% for 2005.

In order to provide investors with a more meaningful assessment of the Fund's performance, and for comparison purposes, the 2005 figures mentioned in this release include the financial data of the Fund's predecessor company, W.F. Morneau Services Inc. which carried on the Morneau Sobeco business prior to September 30, 2005, when the firm completed its initial public offering ("IPO").

2006 Year-end Results

The Fund's financial results for 2006 showed revenue growth of 9.8% to $132.1 million compared to $120.3 million in 2005. The increase in revenue was a result of additional consulting and outsourcing business from a variety of new and existing clients. Revenue also increased by $5.4 million due to the Fund's acquisition of Heath Benefits Consulting Inc. on June 1, 2006.

Net income for the year ended December 31, 2006 increased by $8.2 million to $9.8 million compared to net income of $1.6 million for the same period in 2005. Cash from operating activities for 2006 increased by $10.8 million to $31.0 million compared to cash from adjusted operating activities of $20.2 million for the same one-year period in 2005.

Because of changes in the financial structure as a result of the IPO, management believes that earnings before interest, taxes, depreciation, amortization and adjusted for compensation changes ("Adjusted EBITDA") provides investors with a better understanding of 2005 results. EBITDA for the year ended December 31, 2006 increased $3.9 million, or 15.1%, to $29.8 million compared to Adjusted EBITDA of $25.9 million for the same period in 2005.

Distributable Income (defined as net income for the period adjusted for specific non-cash items, including amortization, future income taxes and maintenance capital expenditures) for the year ended December 31, 2006 increased by $2.9 million, or 12.0%, to $27.1 million compared to $24.2 million for the same period in 2005. This resulted in a Distributable Income Payout Ratio (defined as declared distributions divided by Distributable Income) of 85.3%.

Distributable Cash (defined as cash from operating activities adjusted for maintenance capital expenditures) for the year ended December 31, 2006 increased by $10.0 million, or 51.0%, to $29.7 million compared to $19.7 million for the same period in 2005. This resulted in a Distributable Cash Payout Ratio (defined as declared distributions divided by Distributable Cash) of 77.9%.

Clients representing 96.8% of 2005 revenues remained with Morneau Sobeco in 2006, generating increased year-over-year revenue of 3.3%, reflecting the strength of the Fund's recurring revenue model. Morneau Sobeco also increased the number of large client relationships in 2006, with 223 clients generating over $100,000 in revenue, versus 199 in 2005.

2006 Fourth Quarter Results

Revenue in the 2006 fourth quarter increased by 13.3% to $34.1 million compared to $30.1 million for the same period in 2005, reflecting the trends evident in Morneau Sobeco's 2006 year-end results, and an increase in revenue of $2.0 million due to the Heath acquisition.

Net income for the three months ended December 31, 2006 increased by $0.3 million to $2.4 million compared to $2.1 million for the same period in 2005. Cash from operating activities for the three months ended December 31, 2006 increased by $3.5 million to $9.9 million compared to $6.4 million for the same period in 2005.

The 2006 fourth quarter EBITDA increased by 10.4% to $7.9 million compared to $7.1 million for the fourth quarter of 2005. The 2006 fourth quarter EBITDA margin came in at 23.2%, reflecting the strong final quarter for the year, a seasonal occurrence which was anticipated by management.

Distributable Income for the three months ended December 31, 2006 increased by $0.4 million, or 6.6%, to $6.9 million compared to $6.5 million for the same period in 2005.

The 2006 fourth quarter Distributable Cash increased by $2.8 million, or 44.4%, to $9.1 million compared to $6.3 million for the same quarter in 2005.

"Morneau Sobeco's performance in 2006 was ahead of the objectives we set for ourselves for the year," stated Mr. Morneau. "This performance enabled our Board of Trustees to declare an additional, one-time distribution which brought total distributions to $0.8365 per unit for the year," he added. The Fund declared a special one-time cash distribution of $0.0115 per unit in December 2006 which represented the incremental taxable income arising from the Fund's strong financial performance in 2006.

2007 Outlook

Going forward, management believes that 2007 will be a solid year for Morneau Sobeco. The firm's strategy for future growth continues to focus on expanding relationships with current clients, attracting new clients (especially in the growing outsourcing market), targeting underserved markets, and pursuing selected acquisitions.

"As a result of our consistent growth, the Board of Trustees of Morneau Sobeco Income Fund has authorized a 7% increase to our target monthly distribution from $0.06875 per Unit to $0.07356 per Unit," announced Mr. Morneau. This increase will start with the March 2007 distribution which will be paid April 16, 2007 to Unitholders of record on March 30, 2007.

"Based on our recurring revenue business model and our analysis of clients, assignments and opportunities in the market, we expect that revenues and Distributable Cash will continue to grow in 2007 and beyond," Mr. Morneau concluded.

Morneau Sobeco Income Fund's 2006 fourth quarter and year-end results will be discussed during a conference call with Bill Morneau, President & CEO, and Nancy Reid, CFO, this afternoon, Thursday, March 15, 2007 at 4:00 p.m. EDT. The conference call is open to all those wishing to attend, with a Question & Answer period to follow the presentation. In order to participate in the live conference call, please call (416) 641-6110 if in the Toronto area, or 1-866-542-4237 throughout the rest of Canada. A replay of the call will be available via the Morneau Sobeco Web site at www.morneausobeco.com.

About Morneau Sobeco

Morneau Sobeco is the largest Canadian owned pension and benefits consulting and outsourcing firm, providing services to organizations across Canada and in the United States. With over 1,000 employees in offices in 12 cities across North America, Morneau Sobeco has focused on the integrated design and delivery of pension and benefit plans for over 40 years. Units of Morneau Sobeco Income Fund trade on the Toronto Stock Exchange under the symbol MSI.UN. Further information about Morneau Sobeco can be obtained on the firm's Web site at www.morneausobeco.com.

Non GAAP Financial Measures

Adjusted EBITDA, Distributable Income, Distributable Cash, Distributable Income Payout Ratio, and Distributable Cash Payout Ratio are not earnings measures recognized under GAAP and do not have standardized meanings prescribed by GAAP. Therefore, they may not be comparable to similar measures presented by other entities. Investors are cautioned that these non-GAAP financial measures should not be construed as an alternative to net income or loss determined in accordance with GAAP as indicators of the Fund's performance or to cash flows from operating, investing and financing activities as measures of liquidity and cash flows.

Forward-Looking Statements

This news release contains "forward-looking statements" within the meaning of applicable securities laws, such as statements concerning anticipated future events, results, circumstances, performance or expectations that are not historical facts. Use of words such as "may", "will", "expect", "believe", or other words of similar effect may indicate a "forward-looking" statement. These statements are not guarantees of future performance and are subject to numerous risks and uncertainties, including those described in our publicly filed documents (which are available on SEDAR at www.sedar.com). Those risks and uncertainties include income tax matters, ability to maintain profitability and manage growth, reliance on information systems and technology, reputational risk, dependence on key clients, reliance on key professionals and general economic conditions. Many of these risks and uncertainties can affect our actual results and could cause our actual results to differ materially from those expressed or implied in any forward-looking statement made by us or on our behalf. Given these risks and uncertainties, investors should not place undue reliance on forward-looking statements as a prediction of actual results. All forward-looking statements in this news release are qualified by these cautionary statements. These statements are made as of the date of this news release and, except as required by applicable law, we undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise. Additionally, we undertake no obligation to comment on analyses, expectations or statements made by third parties in respect of the Fund, its financial or operating results or its securities.

Consolidated Financial Statements of

MORNEAU SOBECO INCOME FUND

Years Ended December 31, 2006 and 2005

MANAGEMENT STATEMENT OF RESPONSIBILITY FOR FINANCIAL REPORTING

The accompanying consolidated financial statements for Morneau Sobeco Income Fund (the "Fund") have been prepared by management and approved by the Board of Trustees of the Fund. Management is responsible for the preparation and presentation of these financial statements and all the financial information contained in the Annual Report within reasonable limits of materiality. The Fund's consolidated financial statements have been prepared in accordance with Canadian generally accepted accounting principles. In the preparation of these financial statements, estimates are necessary because a precise determination of certain assets and liabilities is dependent on future events. Management believes such estimates have been based on careful judgments and have been properly reflected in the accompanying consolidated financial statements.

To assist management in discharging these responsibilities, the Fund maintains a system of internal controls, which is designed to provide reasonable assurance that the Fund's assets are safeguarded, that transactions are executed in accordance with management's authorization and that the financial records form a reliable base for the preparation of accurate and timely financial information.

Management recognizes its responsibilities for conducting the Fund's affairs in compliance with established financial reporting standards and applicable laws, and for the maintenance of proper standards of conduct in its activities.

KPMG LLP, Chartered Accountants, were appointed as external auditors by the Trustees of the Fund and have audited the consolidated financial statements of the Fund in accordance with Canadian generally accepted auditing standards. Their report outlines the nature of their audit and expresses their opinion on the consolidated financial statements of the Fund.

The Board of Trustees of the Fund has appointed an Audit Committee composed of three Trustees who are not members of management. The Audit Committee meets periodically with management and the external auditors to discuss internal controls over the financial reporting process, auditing matters and financial reporting issues. The Audit Committee is responsible for reviewing the Fund's annual and interim consolidated financial statements and the report of the external auditors. The Audit Committee reports the results of such reviews to the Board of Trustees of the Fund and makes recommendations with respect to the appointment of the Fund's external auditors. In addition, the Board of Trustees may refer to the Audit Committee on other matters and questions relating to the financial position of the Fund and its subsidiaries.

The Board of Trustees of the Fund is responsible for ensuring that management fulfills its responsibilities for financial reporting and is responsible for approving the consolidated financial statements of the Fund.



"William Morneau" "Nancy Reid"
William Morneau Nancy Reid
President and CEO Chief Financial Officer


MORNEAU SOBECO INCOME FUND
CONSOLIDATED BALANCE SHEET
As at December 31
(In thousands of dollars)
---------------------------------------------------------------------

2006 2005
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Assets
Current assets:
Cash $5,257 $4,348
Accounts receivable 23,315 22,562
Unbilled fees 4,117 4,482
Income taxes recoverable 774 659
Prepaid expenses and other 1,875 1,807
---------------------------------------------------------------------
35,338 33,858

Future income taxes (note 12) 741 600
Interest-rate swap (note 7) 840 -
Capital assets (note 4) 10,833 11,291
Intangible assets (note 5) 125,027 131,458
Goodwill (note 6) 127,767 126,511
---------------------------------------------------------------------
$300,546 $303,718
---------------------------------------------------------------------
---------------------------------------------------------------------

Liabilities and Unitholders' Equity
Current liabilities:
Accounts payable and accrued liabilities $5,868 $4,179
Accrued compensation and related benefits 7,025 5,764
Unitholder distributions payable (including
non-controlling) 2,793 2,461
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15,686 12,404

Insurance premium liabilities:
Payable to insurance companies 9,108 5,413
Less related cash and investments held (9,108) (5,413)
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- -

Long-term debt (note 7) 35,000 35,000
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50,686 47,404
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Non-controlling interest (note 9) 55,461 54,322
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Unitholders' equity:
Fund units (note 8) 205,549 204,476
Deficit (11,150) (2,484)
---------------------------------------------------------------------
194,399 201,992
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$300,546 $303,718
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Commitments and Contingencies (notes 15 and 16)

See accompanying notes to consolidated financial statements


"Robert Chisholm" "William Morneau"
Robert Chisholm William Morneau
Trustee, Audit Committee Chair Trustee, President and CEO


MORNEAU SOBECO INCOME FUND
CONSOLIDATED STATEMENT OF INCOME AND DEFICIT

(In thousands of dollars except unit and per unit amounts)
----------------------------------------------------------------------

Year Ended Period Ended
December 31, December 31,
2006 2005
(Note 2 (a))

Revenue
Fees $113,942 $26,658
Commissions 17,669 3,337
Other 476 76
----------------------------------------------------------------------
132,087 30,071

Expenses
Salaries and benefits (note 12) 76,240 17,024
Other operating 26,004 5,866
Loss on disposal of capital assets - 35
Amortization of capital assets (note 4) 2,131 483
Amortization of intangible assets (note 5) 14,521 3,542
Interest (note 7) 883 478
----------------------------------------------------------------------
119,779 27,428

Income before income taxes and
non-controlling interest 12,308 2,643

Income taxes (recovery) (note 12)
Current 199 83
Future (141) (64)
----------------------------------------------------------------------
58 19
----------------------------------------------------------------------

Income before non-controlling interest 12,250 2,624

Non-controlling interest (note 9) (2,490) (525)
----------------------------------------------------------------------
Net income 9,760 2,099

Deficit, beginning of year/period (2,484) -
Distributions declared (note 10) (18,426) (4,583)
----------------------------------------------------------------------
Deficit, end of year/period $(11,150) $(2,484)
----------------------------------------------------------------------
----------------------------------------------------------------------

Net income per Unit (basic and
diluted) (note 14) $0.44318 $0.09553
----------------------------------------------------------------------
----------------------------------------------------------------------

See accompanying notes to consolidated financial statements


MORNEAU SOBECO INCOME FUND
CONSOLIDATED STATEMENT OF CASH FLOWS

(In thousands of dollars)
----------------------------------------------------------------------

Year Ended Period Ended
December 31, December 31,
2006 2005
(Note 2 (a))

Cash provided by (used in):
Operating activities
Net income $9,760 $2,099
Items not involving cash:
Amortization 16,652 4,025
Loss on disposal of capital assets - 35
Non-controlling interest of Class B LP Units 2,490 525
Future income taxes (141) -
Salary component of Heath
acquisition (note 3) 513 -
Fair value of interest-rate swap
agreements (note 7) (840) -
----------------------------------------------------------------------
28,434 6,684

Change in non-cash operating working capital:
Accounts receivable 777 2,790
Income taxes recoverable (9) 1,601
Unbilled fees 365 (394)
Prepaid expenses and other 33 (464)
Accrued compensation and related benefits 1,261 (2,411)
Accounts payable and accrued liabilities 162 (1,477)
----------------------------------------------------------------------
31,023 6,329

Financing activities
Issuance of Units (note 1) - 199,793
Expenses related to issuance of Units (note 1) - (15,296)
Proceeds from long-term debt (note 7) - 35,000
Issuance of over-allotment Units (note 1) - 19,979
Repayment of term loan - (10,000)
Distributions paid (22,802) (3,268)
----------------------------------------------------------------------
(22,802) 226,208

Investing activities
Business acquisition (note 3) (5,097) (208,104)
Additional acquisition through
over-allotment (note 1) - (19,979)
Cash and bank indebtedness assumed (note 3) (907) -
Purchase of capital assets (1,308) (106)
----------------------------------------------------------------------
(7,312) (228,189)

Net increase in cash for the year/period 909 4,348
Cash, beginning of year/period 4,348 -
----------------------------------------------------------------------
Cash, end of year/period $5,257 $4,348
----------------------------------------------------------------------
----------------------------------------------------------------------

Supplemental disclosures:
Interest paid $1,723 $314
Income taxes refunded $(100) $(1,461)

See accompanying notes to consolidated financial statements.


MORNEAU SOBECO INCOME FUND
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

For the year ended December 31, 2006 and 2005
(In thousands of dollars except unit and per unit amounts)


1. ORGANIZATION AND NATURE OF THE BUSINESS

Morneau Sobeco Income Fund (the "Fund") is an unincorporated, open-ended, limited purpose trust established under the laws of the Province of Ontario by a Declaration of Trust made as of August 22, 2005. The Fund was established through the issuance of one unit for $10.00.

The Fund is the largest Canadian-owned pension and benefits consulting and outsourcing firm, providing services to organizations across Canada and in the United States. The Fund focuses on the integrated design and delivery of retirement and employee compensation and benefit programs.

On September 30, 2005, the Fund completed an initial public offering ("IPO") and the sale of 19,979,284 trust units ("Units") for $10.00 per Unit, for total gross proceeds of $199,793 before issuance costs of $15,296. On October 18, 2005 the over-allotment option of the Fund's IPO was exercised resulting in the issuance of an additional 1,997,928 Units, for gross proceeds of $19,979.

On June 1, 2006, the Fund indirectly acquired all of the issued and outstanding shares of Heath Benefits Consulting Inc. ("Heath") through Morneau Sobeco Group Limited Partnership ("MS Group LP") in exchange for 312,845 Class B LP Units, $449 in cash, the assumption of debt of $4,648 and two additional instalments that will be made in 2008 subject to certain conditions (see note 3).

On June 22, 2006 the Fund issued 85,704 Units in exchange for Class B LP Units of MS Group LP and Special Voting Units.

2. SIGNIFICANT ACCOUNTING POLICIES

The consolidated financial statements of the Fund have been prepared by management in accordance with Canadian generally accepted accounting principles and the significant accounting policies are summarized below:

(a) Basis of presentation

These consolidated financial statements include the assets, liabilities, revenue and expenses of the following entities:



% Ownership
-----------
Morneau Sobeco Limited Partnership ("MSLP") 79.4
Morneau Sobeco Group Limited Partnership ("MS Group LP") 79.4
Morneau Sobeco, Ltd. ("MSUS") 79.4
Morneau Sobeco Corporation ("MS Corp") 79.4
Morneau Sobeco Trust ("Trust") 100
Morneau Sobeco GP Inc. ("MS GP") 100


The Fund was established on August 22, 2005 and had no revenue or expenses until September 30, 2005 when the Fund acquired W.F. Morneau Services Inc.. The comparative amounts reflect results for the period from August 22, 2005 to December 31, 2005.

On July 1, 2006 Heath Benefits Consulting Inc. ("Heath"), Heath Benefits Consulting AB Inc., Norfolk Living Benefits Inc., Morneau Heath Acquisition Inc. and Morneau Sobeco Corporation were amalgamated and continue to operate as MS Corp.

(b) Financial instruments

The fair value of the Fund's financial assets and liabilities approximate carrying values due to their short-term nature or with respect to the long-term debt instruments, because they bear interest at market rates. The Fund does not enter into financial instruments for trading or speculative purposes.

Interest-rate swap agreements are used as part of the Fund's program to manage the fixed and floating interest rate mix of the Fund's total debt outstanding and related overall cost of borrowing. The interest-rate swap agreements involve the periodic exchange of payments without the exchange of the notional principal amount upon which the payments are based and are recorded at their fair value with a corresponding adjustment to interest expense.

(c) Measurement uncertainties

The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

(d) Revenue recognition and unbilled fees

Fees for administrative, actuarial and consulting services are recognized when the services are rendered.

Unbilled fees are recorded at the lower of unbilled hours worked at normal billing rates and the amount which is estimated to be recoverable upon invoicing.

Commissions are recognized when earned which is at the later of the billing or effective date of the policy, net of a provision for return commissions due to policy cancellation.

Investment income is recorded on the accrual basis.

(e) Foreign currency translation

Monetary assets and liabilities denominated in foreign currencies have been translated into Canadian dollars at the exchange rate prevailing at the consolidated balance sheet dates. Non-monetary items have been translated into Canadian dollars at the exchange rate prevailing when the assets were acquired or obligations incurred. Revenue and expenses have been translated at rates in effect on the transaction dates. Exchange gains or losses are reflected in income for the period.

(f) Capital assets

Capital assets are stated at their initial capital cost less accumulated amortization. Amortization is recognized over the assets' estimated useful lives as follows:



Asset Basis Rate
----- ----- ----
Computer equipment Declining balance 30%
Furniture and equipment Declining balance 20%
Leasehold improvements Straight-line Over term of the lease


(g) Intangible assets and goodwill

Intangible assets consist principally of customer relationships, proprietary software and customer contracts, based on management's best estimate of the relative fair values. These intangible assets are being amortized on a straight-line basis over their estimated useful lives of 15 to 20, 5 and 3 years respectively.

Goodwill is not amortized and is subject to an annual impairment test. Goodwill impairment is assessed based on a comparison of the estimated fair value of the Fund and the carrying value of its net assets including goodwill. An impairment loss will be recognized if the carrying amount of the Fund's net assets exceeds its estimated fair value.

(h) Impairment of long-lived assets

The Fund periodically reviews the useful lives and the carrying values of its long-lived assets for continued appropriateness. The Fund reviews long-lived assets for impairment annually or whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. An impairment loss is measured at the amount by which the carrying amount of the long-lived asset exceeds its fair value.

(i) Insurance premium liabilities and related cash and investments

In its capacity as consultants, the Fund collects premiums from insureds and remits premiums, net of agreed deductions, such as taxes, administrative fees and commissions, to insurance underwriters. These are considered flow-through items for the Fund and, as such, the cash and investment balances relating to these liabilities are deducted from the related liability in the consolidated balance sheet.

(j) Long-term incentive plan

The Fund has a long-term incentive plan under which participants are eligible to receive Units. The amount awarded under this plan is recorded as salaries and benefits expense on a straight-line basis over the three year vesting period.

(k) Employee future benefits

The Fund has a pension benefit plan covering its employees, which includes a defined benefit option and a defined contribution option.

The defined benefit option was closed effective January 1, 1998 and includes 8 employees, 5 retirees and 54 deferred vested members as at December 31, 2006. All other employees are covered by the defined contribution option of the plan.

The Fund accrues its obligations under the defined benefit option of the plan as the employees render the services necessary to earn the pension. For the defined contribution option, the Fund matches member contributions and may be required to make additional contributions at the option of the member, up to the limits defined in the plan text.

(l) Income taxes

The Fund is a mutual fund trust for income tax purposes. As such, the Fund is only taxable on any amount not distributed to Unitholders. As substantially all taxable income will be distributed to the Unitholders, no provision for income taxes on earnings has been made in these consolidated financial statements. Income tax liabilities relating to the Fund are taxed in the hands of the unitholders.

The Fund uses the asset and liability method of accounting for income taxes of its subsidiaries. Under this method of tax allocation, future tax assets and liabilities are recognized on the basis of future tax consequences attributable to differences between the carrying amounts of assets and liabilities as recorded in the consolidated financial statements and their respective tax bases. Future tax assets and liabilities are measured using enacted or substantively enacted tax rates expected to apply to taxable income in the years in which temporary differences are expected to be recovered or settled. The effect on future tax assets and liabilities of a change in tax rates is recognized in income in the period in which the date of enactment or substantive enactment occurs.

(m) Proposed Canadian income tax rule changes

On October 31, 2006, the Department of Finance (Canada) announced the "Tax Fairness Plan" whereby the income tax rules applicable to publicly traded trusts and partnerships will be significantly modified. In particular, certain income of (and distributions made by) these entities will be taxed in a manner similar to income earned by (and distributions made by) a corporation. These proposals will be effective for the 2007 taxation year with respect to trusts which commence public trading after October 31, 2006, but the application of the rules will be delayed to the 2011 taxation year with respect to trusts which were publicly traded prior to November 1, 2006 (although the announcement suggested that this transitional relief could be lost under certain circumstances, including the "undue expansion" of an income trust). On December 21, 2006, the Department of Finance (Canada) issued for public comment the draft legislation to implement these proposals. There is no assurance that the draft legislation will be enacted in the manner proposed or at all.

On December 15, 2006, the Department of Finance (Canada) released guidance for income trusts and other flow-through entities that qualify for the four-year transitional relief. The guidance establishes objective tests with respect to how much an income trust is permitted to grow without jeopardizing its transitional relief. In general, the Fund will be permitted to issue new equity over the next four years equal to its market capitalization as of the end of trading on October 31, 2006 (subject to certain annual limits). Market capitalization, for these purposes, is to be measured in terms of the value of the Fund's issued and outstanding publicly traded units. If these limits are exceeded, the Fund may lose its transitional relief and thereby become immediately subject to the proposed rules.

Currently the Fund is only taxable on amounts that are not distributed to Unitholders. If enacted in its current form, the proposed legislation will result in a change in which the earnings of the Fund will be subject to income tax regardless of whether amounts are distributed to the Unitholders or not.

The Fund is considering these announcements and the possible impact of the proposed rules to the Fund. The impact of the proposed rules (including the guidance released on December 15, 2006) may adversely affect the marketability of the Fund's Units and the ability of the Fund to undertake financings and acquisitions, and, at such time as the proposed rules apply to the Fund, the Distributable Cash of the Fund may be materially reduced.

(n) Future accounting changes

The CICA has issued three new accounting standards:

(i) Section, 3855, Financial Instruments -- Recognition and Measurement, effective for fiscal years beginning on or after October 1, 2006. This section describes the standards for recognizing and measuring financial instruments in the balance sheet and the standards for reporting gains and losses in the financial instrument. Financial assets available for sale, assets and liabilities held for trading and derivative financial instruments, part of a hedging relationship or not, have to be measured at fair value. The impact of remeasuring our financial assets and liabilities at fair value will be recognized in opening deficit and opening accumulated other comprehensive income as appropriate.

(ii) Section 1530, Comprehensive Income, effective for fiscal years beginning on or after October 1, 2006. It describe reporting and disclosure recommendations with respect to comprehensive income and it components. Comprehensive income is the change in Unitholders' equity, which results from transactions other than those resulting from investments by Unitholders and distributions to Unitholders. These transactions and events include unrealized gains and losses resulting from changes in fair value of certain financial instruments.

(iii) Section 3865, Hedges, effective for fiscal years beginning on or after October 1, 2006. The recommendations expand the guidelines outlined in Accounting Guideline 13 ("AcG-13"), Hedging Relationships. This Section describes when and how hedge accounting can be applied as well as the disclosure requirements. Hedge accounting enables the recording of gains and losses, revenues and expenses from the derivative financial instruments in the same period as for those related to the hedged item.

These standards will be effective for the Fund as of January 1, 2007. Any adjustment of the previous carrying amounts will be recognized as an adjustment to either accumulated other comprehensive income or retained earnings at January 1, 2007 and prior period consolidated statements will not be restated. The impact of the adoption of these new standards on the Fund financial statements is not expected to be material.

3. BUSINESS ACQUISITION

(a) W.F. Morneau Services Inc.

On September 30, 2005, through a series of transactions subsequent to the IPO, the Fund indirectly acquired common shares of W.F. Morneau Services Inc. ("Morneau Sobeco") with the former shareholders of Morneau Sobeco (comprised of the senior management of Morneau Sobeco and Morneau family members) retaining an approximate 27.3% interest in Morneau Sobeco. This interest was reduced to 20% when the over-allotment option of the IPO was exercised.

The acquisition has been accounted for by the purchase method. The allocation of the purchase price is summarized as follows:



Assets and liabilities acquired:
Cash $1,689
Accounts receivable 25,352
Income taxes recoverable 2,325
Unbilled fees 4,087
Prepaid expenses and other 1,343
Future income taxes 536
Capital assets 11,703
Intangible assets 135,000
Goodwill 126,511
Accrued compensation and related benefits (8,175)
Accounts payable and accrued liabilities (5,656)
Payable to insurance companies (5,964)
Related cash balances held 5,964
Term loan (10,000)
--------
$284,715

Consideration:
Cash $209,793
--------
Class B LP Units 74,922
--------
$284,715
--------


(b) Heath

On June 1, 2006, the Fund indirectly acquired all of the issued and outstanding shares of Heath, a Vancouver-based benefits consulting firm with over 90 employees across Canada.

The consideration is based on future revenue from the Heath business with a minimum purchase price of $9,014. The consideration, which is currently estimated to be approximately $15,400, is being paid in three instalments and is satisfied primarily through the assumption and repayment of the Heath debt of $4,648 on closing and the issuance of Class B LP Units of MS Group LP.

The first instalment of the purchase price was made on closing. The purchase price is conditional upon the success in retaining and growing revenue from specified Heath clients, as well as achieving targeted cost efficiencies. The second and third instalments, which represent contingent consideration, will be settled on June 30 and December 1 of 2008 and are currently estimated to be approximately $6,400. These instalments will be settled by issuing a number of Class B LP Units of MS Group LP based on a pre-determined value of $12.52 per unit. In addition to the estimate of $15,400, contingent consideration will include amounts to compensate for foregone distributions payable on instalments 2 and 3 during the period June 1, 2006 to December 1, 2008, which amounted to approximately $250 to the end of December 31, 2006.

These contingent consideration elements will be recorded when the final purchase price has been established except for a portion of instalment 3 which is conditional on the continuing employment of certain selling shareholders and is being recorded as salary expense over the required employment period to December, 2008. The estimated payable amount as at December 31, 2006 is $513.

The acquisition has been accounted for by the purchase method based on management's best estimate of the relative fair value of the identifiable assets and liabilities assumed. The actual calculation and allocation of the purchase price will be based on the assets purchased and liabilities assumed at the effective date of the acquisition transaction and other information available. The first instalment of the purchase price has been accounted for as follows:



Assets and liabilities acquired:
Cash $ 827
Accounts receivable 1,530
Income taxes recoverable 106
Prepaid expenses and other 101
Capital assets 365
Intangible assets 8,090
Goodwill 1,256
Bank indebtedness (1,734)
Accounts payable and accrued liabilities (1,527)
Payable to insurance companies (3,156)
Related cash balances held 3,156
------
$9,014

Consideration:
Cash $ 449
Debt assumed and repaid 4,648
Exchangeable Units (first instalment paid
in June 20, 2006) 3,917
------
$9,014
------


These consolidated financial statements include the results of Heath from the date of acquisition. On July 1, 2006 Heath and its subsidiary were amalgamated with MS Corp.

As part of the exit activities, two office premises were closed which resulted in exit costs related to occupancy lease terminations and severance of $429.



4. CAPITAL ASSETS

The Fund's capital assets are comprised of:

-------------------------------------------
Accumulated Net Book Net Book
Cost Amortization Value Value
2006 2006 2005
-------------------------------------------
Computer equipment $1,982 (581) 1,401 $1,385
Furniture and equipment 3,368 (693) 2,675 2,573
Leasehold improvements 8,097 (1,340) 6,757 7,333
-------------------------------------------
$13,447 (2,614) 10,833 $11,291
-------------------------------------------
-------------------------------------------

Amortization for the year ended December 31, 2006 and period ended
December 31, 2005 were $2,131 and $483 respectively.

5. INTANGIBLE ASSETS

The Fund's intangible assets are comprised of:

-------------------------------------------
Accumulated Net Book Net Book
Cost Amortization Value Value
2006 2006 2005
-------------------------------------------
Customer relationships $98,090 $(5,980) $92,110 $88,875
Customer contracts 5,000 (2,083) 2,917 4,583
Proprietary software 40,000 (10,000) 30,000 38,000
-------------------------------------------
$143,090 $(18,063) $125,027 $131,458
-------------------------------------------
-------------------------------------------

Amortization for the year ended December 31, 2006 and period ended
December 31, 2005 were $14,521 and $3,542 respectively.

6. GOODWILL

----------------------
2006 2005
----------------------
Balance at beginning of year $126,511 $-
Acquisitions (note 3) 1,256 126,511
----------------------
$127,767 $126,511
----------------------
----------------------


7. BANK INDEBTEDNESS AND LONG-TERM DEBT

At December 31, 2006 and 2005, the Fund had a secured term loan of $35,000 with two Canadian chartered banks repayable in full on September 30, 2009. The term loan bears interest at the bankers' acceptance rate plus 1%. The Fund entered into interest-rate swap agreements on September 30, 2005 in order to fix the interest rate at 4.4% for the duration of the loan. These interest-rate swap agreements have been recorded at their fair value with the corresponding adjustment to interest expense. As at December 31, 2006 the fair value of the swap was $840 and the adjustment to interest expense for the year was $840.

The Fund also has available a secured operating line of credit for $15,000 with no amount drawn at December 31, 2006 and 2005. The line of credit bears interest at the bankers' acceptance rate plus 1% and the undrawn portion incurs a standby fee of 0.20% . The bank indebtedness and term loan are secured by a general assignment of the assets of the Fund.

8. FUND UNITS

The Fund is authorized to issue an unlimited number of Units and an unlimited number of special voting units ("Special Voting Units"). Special Voting Units are not entitled to any beneficial interest in any distribution from the Fund.

Units are redeemable at any time on demand by the unitholders. The redemption price is calculated based on the lesser of:

(i) 90% of the "market price", as defined in the prospectus, as of the date on which the Units were surrendered for redemption; and

(ii) 100% of the "closing market price", as defined in the prospectus, on the redemption date.

The following details the issued and outstanding Units and Special Voting Units:



-----------------------------------------------
December 31, 2006 December 31, 2005
Units Issued Amount Units Issued Amount
-----------------------------------------------
Units 22,062,916 $205,549 21,977,212 $204,476
Special Voting Units 5,721,444 - 5,494,303 -
-----------------------------------------------
27,784,360 $205,549 27,471,515 $204,476
-----------------------------------------------
-----------------------------------------------


As part of the Heath acquisition, on June 1, 2006 the Fund issued 312,845 Special Voting Units.

On June 22, 2006 the Fund issued 85,704 Units in exchange for Class B LP Units of MS Group LP and Special Voting Units.

9. NON-CONTROLLING INTEREST

The former shareholders of Morneau Sobeco retained 5,494,303 Class B LP Units of MS Group LP after over-allotment and former shareholders of Heath retained 227,141 Class B LP Units of MS Group LP, as part of the Heath acquisition. The Class B LP Units are fully exchangeable for equal Units in the Fund, subject to certain restrictions, and provide the former shareholders of Morneau Sobeco and Heath with a non-controlling interest of 20.59% in the Fund. Some of the Class B LP Units are subordinated in their rights to receive distributions.



2006 2005
Units Issued Amount Units Issued Amount
-------------------------------------------
Subordinated Class B LP
Units 4,095,060 $40,951 4,095,060 $40,951
Non-subordinated Class
B LP Units 1,626,384 16,836 1,399,243 13,992
----------------------------------------
5,721,444 57,787 5,494,303 54,943
----------------------------------------
Balance, beginning
of year/period 5,494,303 54,322 5,494,303 54,943
Non-subordinated units
issued (note 3) 312,845 3,917 - -
Exchanged units (note 8) (85,704) (1,073) - -
Salary component of Heath
acquisition (note 3) - 513 - -
Share of net income for the
year/period - 2,490 - 525
Distributions for the
year/period - (4,708) - (1,146)
----------------------------------------
Balance, end of year/period 5,721,444 $55,461 5,494,303 $54,322
----------------------------------------


Distributions on the Subordinated Class B LP Units will be subordinated in favour of the Fund Units and the Non-subordinated Class B LP Units. These distributions will be paid at the end of a fiscal quarter to the extent that an average monthly distribution of at least $0.06875 per Unit and Non-subordinated Class B LP Unit in respect of that quarter has been paid, and any deficiency in such distributions to holders of Units and Non-subordinated Class B LP Units during the subordination period, has been satisfied.

The subordination provisions of the Subordinated Class B LP Units apply until the date on which both of the following conditions have been satisfied: (i) for four consecutive fiscal quarters of the Fund beginning on December 31, 2006, the Fund has earned EBITDA of at least $25,169 during such period; and (ii) commencing with the 12 month period ending September 30, 2007, the Fund and MS Group LP have respectively paid an average distribution of at least $0.06875 per Unit and per Class B LP Unit per month for the preceding 12 month period. "EBITDA" is defined as earnings before interest, income taxes, depreciation and amortization.

10. DISTRIBUTIONS TO UNITHOLDERS

The Board of Trustees determines the amount of distributions. Distributions announced during the year ended December 31, 2006 and period ended December 31, 2005 were as follows:



Trust Units
Unitholder record date Total Per Unit Paid or payable for the year
ended December 31, 2006
January 31, 2006 $1,511 $0.06875 February 15, 2006
February 28, 2006 1,511 0.06875 March 15, 2006
March 31, 2006 1,511 0.06875 April 17, 2006
April 28, 2006 1,511 0.06875 May 15,2006
May 31, 2006 1,511 0.06875 June 15, 2006
June 30, 2006 1,517 0.06875 July 17, 2006
July 31, 2006 1,517 0.06875 August 15, 2006
August 31, 2006 1,517 0.06875 September 15, 2006
September 29, 2006 1,516 0.06875 October 16, 2006
October 31, 2006 1,516 0.06875 November 15, 2006
November 30, 2006 1,517 0.06875 December 15, 2006
December 29, 2006 1,517 0.06875 January 15, 2007
December 29, 2006 254 0.01150 January 15, 2007
----- --------
$18,426 $0.83650
----- --------

Class B LP Units
Unitholder record date Total Per Unit Paid or payable for the year
ended December 31, 2006
Non-subordinated
January 31, 2006 $96 $0.06875 February 15, 2006
February 28, 2006 96 0.06875 March 15, 2006
March 31, 2006 96 0.06875 April 17, 2006
April 28, 2006 96 0.06875 May 15, 2006
May 31, 2006 96 0.06875 June 15, 2006
June 30, 2006 112 0.06875 July 17, 2006
July 31, 2006 112 0.06875 August 15, 2006
August 31, 2006 112 0.06875 September 15, 2006
September 29, 2006 112 0.06875 October 16, 2006
October 31, 2006 112 0.06875 November 15, 2006
November 30, 2006 112 0.06875 December 15, 2006
December 29, 2006 112 0.06875 January 15, 2007
December 29, 2006 19 0.01150 January 15, 2007
----- --------
$1,283 $0.83650
----- --------

Subordinated
March 31, 2006 $845 $0.20625 April 17, 2006
June 30, 2006 845 0.20625 July 17, 2006
September 29, 2006 844 0.20625 October 16, 2006
December 29, 2006 844 0.20625 January 15, 2007
December 29, 2006 47 0.01150 January 15, 2007
----- --------
$3,425 $0.83650
----- --------

Trust Units
Unitholder record date Total Per Unit Paid or payable for the
period ended December
31, 2005
October 31, 2005 $1,561 $0.07104 November 15, 2005
November 30, 2005 1,511 0.06875 December 15, 2005
December 31, 2005 1,511 0.06875 January 16, 2006
----- --------
$4,583 $0.20854
----- --------

Class B LP Units
Unitholder record date Total Per Unit Paid or payable for the
period ended December
31, 2005
Non-subordinated
October 31, 2005 $100 $0.07104 November 15, 2005
November 30, 2005 96 0.06875 December 15, 2005
December 31, 2005 96 0.06875 January 16, 2006
----- --------
$292 $0.20854
----- --------
Subordinated
December 31, 2005 $854 $0.20854 January 31, 2006
----- --------
$854 $0.20854
----- --------


11. LONG-TERM INCENTIVE PLAN

Executives are eligible to participate in Morneau Sobeco's Long-Term Incentive Plan (LTIP), which is designed to align compensation with distributable cash earned by the Fund's subsidiaries. The LTIP provides compensation opportunities for performance resulting in the Fund exceeding its distributable cash targets. The Fund's Compensation, Nominating and Corporate Governance Committee of the Board of Trustees (the "Committee") will determine (i) who will participate in the LTIP; (ii) the level of participation; and (iii) the time or times when LTIP awards will vest or be paid to each participant.

Pursuant to the LTIP, Morneau Sobeco will set aside a pool of funds based upon the amount, if any, by which the distributable cash per Unit (fully diluted) exceeds certain defined threshold amounts. Morneau Sobeco or a Trustee will purchase Units in the market with this pool of funds and will hold the Units until such time as ownership vests to each participant. Generally, one-third of these Units will vest equally over the three years following the grant of the awards. LTIP participants will be entitled to receive distributions on all Units held for their account prior to the applicable vesting date. Unvested Units held by the Trustee for an LTIP participant will be forfeited if the participant resigns or is terminated prior to the applicable vesting date and those Units will be sold and the proceeds returned to Morneau Sobeco.

Initially, the LTIP provides for awards that may be earned based on the amount by which distributable cash per Unit exceeds a base distribution threshold of $0.825 per Unit per annum. The percentage amount of that excess, which forms the LTIP incentive pool, will be determined in accordance with the table below:



Percentage by which Maximum Proportion of Excess
Distributable Cash Distributable
per Unit Exceeds Base Threshold(1) Cash Available for LTIP Payments
5% or less 10%
Over 5% to 10% 15% of any excess over 5% to 10%
Greater than 10% 20% of any excess over 10%

(1) Annualized for fiscal periods of less than 12 months.


The base distribution threshold is subject to review by the Committee at least annually. The Committee awarded a payment under the terms of the LTIP of $386 for the year ended December 31, 2006 (period ended December 2005 -- $nil). This amount will be recorded as salary expense over the three year vesting period 2007 to 2009.

12. INCOME TAXES

Income tax obligations relating to distributions from the Fund are obligations of the unitholders and, accordingly, no provision for income taxes has been made in respect of income of the Fund. A provision for income taxes is recognized for the Fund's subsidiaries that are subject to tax, including Large Corporations Tax.

The difference between income taxes calculated using the Fund's effective income tax rates and the amounts that would result from the application of the statutory income tax rates arises from the following:



Income taxes at statutory rates: Year Ended Period Ended
December 31, December 31,
2006 2005
(Note 2 (a))
--------------------------
Federal 22.12% 22.12%
Provincial 12.18% 11.98%
--------------------------
34.30% 34.10%
--------------------------
--------------------------

Income tax provision applied to income
before income taxes:
Combined basic federal and provincial
income taxes at statutory rates applied
to income from continuing operations $3,952 $955

Income taxed in the hands of the unitholders (7,399) (1,774)
Non-deductible expenses 141 38
Non-deductible intangible asset amortization 4,233 1,045
Financing cost deductible for tax purposes (974) (252)
Effect of higher tax rates in non-Canadian
jurisdictions 12 26
Non-capital loss carried forward (51) (79)
Non-deductible salary expense 154 -
Other (10) 60
--------------------------
$58 $19
--------------------------
--------------------------


Future income tax assets and liabilities are provided for temporary
differences between the financial statement carrying values of existing
assets and liabilities and their respective tax bases.

The significant components of future income tax assets and liabilities
related to continuing operations are as follows:

Future income tax assets comprised of : 2006 2005
Excess of tax bases of capital assets and
intangibles over their carrying values $741 $589
Non-capital losses - 11
------------
$741 $600
------------
------------


The Fund received an income tax credit related to salary costs regarding employees carrying out e-business activities in the province of Quebec of $743. This credit has been recorded as a reduction in salaries and benefits expense for the year ended December 31, 2006.

13. EMPLOYEE FUTURE BENEFITS

The Fund has a pension benefit plan covering its employees, which includes a defined benefit option and a defined contribution option. The defined benefit option was closed to new members effective January 1, 1998.

As of January 1, 1998, all new members participate in a defined contribution option, whereby the Fund matches member contributions and may be required to make additional contributions at the option of the members up to a limit prescribed under the Income Tax Act (Canada). Under the defined contribution option, each member is required to contribute a specific dollar amount based on the member's job level classification. Each member may elect to make an optional contribution of between 50% and 300% of the member's required contribution. The Fund matches required contributions. For employees with less than 10 years of service, the Fund contributes 50% of optional contributions and for members with 10 or more years, 75% of optional contributions.

The pension fund assets and obligations are measured as at December 31, 2006. Information about the pension plan's defined benefit option is as follows:



Year Ended Period Ended
December 31, December 31,
2006 2005
(Note 2 (a))
--------------------------
Fair value of plan assets $2,562 $2,954
Accrued benefit obligation 3,164 3,896
--------------------------
Funded status -- deficit $(602) $(942)
--------------------------
--------------------------
Plan assets:
Fair value, beginning of year/period $2,954 $2,854
Actual return on plan assets 217 65
Employer contributions 260 42
Benefits paid (869) (7)
--------------------------
Fair value, end of period $2,562 $2,954
--------------------------
--------------------------


Year Ended Period Ended
December 31, December 31,
2006 2005
(Note 2 (a))
--------------------------

Accrued benefit obligation:
Balance, beginning of year/period $3,896 $3,687
Current service cost 90 18
Interest cost 169 47
Benefits paid (869) (7)
Actuarial losses (gains) (122) 151
--------------------------
Balance, end of period $3,164 $3,896
--------------------------
--------------------------

Reconciliation of plan assets to accrued
benefit obligation, end of period:
Fair value of plan assets $2,562 $2,954
Accrued benefit obligation 3,164 3,896
--------------------------
Funded status -- deficit (602) (942)
Unamortized net actuarial loss 155 410
Unamortized transitional obligation 449 539
--------------------------
Accrued benefit asset: $2 $7
--------------------------
--------------------------

End of period allocation of fair value
of plan assets (%)
Pooled Equities Fund 45% 0%
Pooled Balanced Fund (60% equities, 40% bonds) 0% 90%
Pooled Bond Fund 55% 10%
--------------------------
100% 100%
--------------------------
--------------------------

Pension plan cost
Current service cost $90 $18
Interest cost on accrued benefit obligation 169 47
Return on plan assets (217) (65)
Actuarial losses (gains) during the
year/period on accrued benefit obligation (122) 151

--------------------------
$(80) $151

Other adjustments:
Difference between actual and expected
return on plan assets 32 19
Amortization of actuarial losses (gains) 223 (151)
Transitional amounts 90 22
--------------------------
Net pension plan expense $265 $41
--------------------------
--------------------------

Other information about the Fund's defined
benefit option is as follows:

Employer contributions $260 $42
Benefits paid 869 7


The net expense for the year ended December 31, 2006 for the Fund's defined benefit option is $265 (period ended December 2005 -$41) and for defined contribution option is $1,623 (period ended December 2005 - $368).

Actuarial valuations:

Actuarial valuation for the Fund's pension plan is generally required every three years. The most recent actuarial valuation of the Fund's pension plan was conducted as of December 31, 2003 and the next valuation is scheduled for January 01, 2007.



Weighted average assumptions:
Weighted average of the amounts assumed in
accounting for the plan:
Year Ended Period Ended
December 31, December 31,
2006 2005
(Note 2 (a))
Discount rate at the end of the current
fiscal period used to determine
the accrued benefit obligation 5.00% 4.75%
Discount rate at the end of preceding
period used to determine the benefit cost 4.75% 5.75%
Rate of compensation increase used to
determine the accrued benefit obligation 2.50% 2.50%
Rate of compensation increase used to
determine the benefit cost 2.50% 2.50%
Expected long-term rate of return on plan
assets 7.00% 7.00%


14. NET INCOME PER UNIT

Net income per unit is calculated by dividing net income by the weighted average number of units outstanding during the year. The weighted average number of units outstanding used in computing basic and diluted earnings per units is 22,022,529 (period ended December 31, 2005 -- 21,977,212).

15. COMMITMENTS

The Fund has lease commitments for office premises and equipment with options for renewal. As at December 31, 2006 the minimum payments not including operating expenses, due in each of the next five years and thereafter, are expected to be as follows for each year ending December 31:



2007 4,745
2008 4,255
2009 3,649
2010 2,993
2011 2,626
Thereafter 3,005
-------
Total $21,273
-------
-------


In addition, the Fund has entered into a sublease agreement to sublet one of the former Heath's office premises. According to the agreement, the Fund is liable for the rent in case of a default by the subtenant. The average annual rent for the lease is $190 and the lease expires in October 30, 2011.

16. CONTINGENCIES

From time to time, the Fund is involved in routine litigation incidental to the Fund's business. Management believes that adequate provisions have been made where required and the ultimate resolution with respect to any claim will not have a material adverse effect on the financial position or results of operations of the Fund.

17. ECONOMIC DEPENDENCE

The Fund's largest client for the year ended December 31, 2006, accounted for approximately 12% (period ended December 2005 -14%) of revenue and its top 10 clients, in the aggregate, accounted for approximately 34% of revenue for the year ended December 31, 2006 (period ended December 2005 - 37%). As clients may terminate engagements on minimal notice, there can be no assurance that the Fund will be able to retain its relationships with its largest clients. Moreover, there can be no assurance that such clients will continue to use the services of the Fund in the future. Any negative change involving any of the Fund's largest clients, including but not limited to a client's financial condition or desire to continue using the Fund's services, could result in a significant reduction in business, which could have a material adverse effect on the Fund's business, results of operations and financial condition and the ability of the Fund to make distributions on the Units.

18. SEGMENTED INFORMATION

The Fund's operations consist of one reporting segment, which provides employee pension and benefits consulting and outsourcing services. Geographic data are as follows:



-------------------------
Year Ended Period Ended
Revenue December 31, December 31,
2006 2005
-------------------------
(Note 2 (a))
-------------------------
Canada $125,156 $27,959
United States 6,931 2,112


Assets held in Canada and the United States mainly consist of cash, accounts receivable, prepaid expenses, income tax recoverable, capital assets, intangibles and goodwill, and liabilities include accounts payable, accrued compensation, income tax payable, unitholder distributions, long-term debt and non-controlling interest. The book values are as follows:



-------------------------
2006 2005
-------------------------
Assets
Canada $298,497 $301,756
United States 2,049 1,962
Liabilities
Canada $105,861 $101,401
United States 286 325


MANAGEMENT'S DISCUSSION AND ANALYSIS

Morneau Sobeco Income Fund (the "Fund") was formed on August 22, 2005 and commenced operations on September 30, 2005 when it completed an initial public offering ("IPO"). Using the proceeds from the IPO, the Fund indirectly acquired a controlling interest in Morneau Sobeco Group Limited Partnership ("MS Group LP"), which in turn acquired Morneau Sobeco Corporation ("Morneau Sobeco"), the successor to W.F. Morneau Services, Inc. ("WFMS").

This Management's Discussion and Analysis ("MD&A") covers the year ended December 31, 2006 and should be read in conjunction with the accompanying Audited Consolidated Financial Statements of the Fund and notes thereto for the year ended December 31, 2006 as well as the MD&A and Audited Consolidated Financial Statements and notes thereto contained in the Fund's Annual Report for the year ended December 31, 2005. Since the Fund formed on August 22, 2005, comparative information for the period from August 22, 2005 to December 31, 2005 is provided in the Fund's Audited Consolidated Statement of Income and Deficit and the Audited Consolidated Statement of Cash Flows. In order to provide meaningful information to the user, this MD&A includes financial data of WFMS, which carried on the Morneau Sobeco business prior to September 30, 2005. WFMS data is used to provide full year operating data for 2005 for comparison to full year operating data of the Fund for 2006.

All financial information is presented in Canadian dollars and in accordance with Canadian generally accepted accounting principles ("GAAP") unless otherwise noted. Certain totals, subtotals and percentages may not reconcile due to rounding.

This MD&A contains "forward-looking statements" within the meaning of applicable securities laws, such as statements concerning anticipated future events, results, circumstances, performance or expectations that are not historical facts. Use of words such as "may", "will", "expect", "believe", or other words of similar effect may indicate a "forward-looking" statement. These statements are not guarantees of future performance and are subject to numerous risks and uncertainties, including those described in our publicly filed documents (available on SEDAR at www.sedar.com) and in this MD&A under the heading "Risks and Uncertainties". Those risks and uncertainties include income tax matters, ability to maintain profitability and manage growth, reliance on information systems and technology, reputational risk, dependence on key clients, reliance on key professionals and general economic conditions. Many of these risks and uncertainties can affect our actual results and could cause our actual results to differ materially from those expressed or implied in any forward-looking statement made by us or on our behalf. Given these risks and uncertainties, investors should not place undue reliance on forward-looking statements as a prediction of actual results. All forward-looking statements in this MD&A are qualified by these cautionary statements. These statements are made as of the date of this MD&A and, except as required by applicable law, we undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise. Additionally, we undertake no obligation to comment on analyses, expectations or statements made by third parties in respect of the Fund, its financial or operating results or its securities.

To assist investors in assessing the Fund's financial performance, this discussion also makes reference to certain non-GAAP measures such as EBITDA and Adjusted EBITDA. As a result of adopting the CSA Staff Notice 52-306 (Revised) in the third quarter of 2006 we modified our method of calculating Distributable Cash. Further, as a result of incorporating draft recommendations expected to be implemented in 2007, we have introduced a new non-GAAP performance metric: Distributable Income. Distributable Income is defined as net income for the period adjusted for specific non-cash items, including amortization and future income taxes and adjusted for maintenance capital expenditures. See the footnotes to the "Results of Operations" chart for more details. Non-GAAP measures do not have any standard meaning prescribed by GAAP and therefore may not be comparable to similar measures presented by other issuers.

FORMATION AND OWNERSHIP STRUCTURE OF THE FUND

The Fund is an unincorporated, open-ended, limited purpose trust established under the laws of Ontario. It indirectly owns 22,062,916 Class A Limited Partnership units of MS Group LP, which represents a 79.4% ownership interest. MS Group LP owns directly and indirectly 100% of Morneau Sobeco Limited Partnership and Morneau Sobeco, Ltd. (the "Morneau Sobeco Operating Entities"). The 20.6% non-controlling interest in MS Group LP is held through Class B LP units of the limited partnership (the "Class B LP Units") and an equal number of Special Voting Units of the Fund, which together are exchangeable into Units provided that the Fund achieves certain objectives. Management employees and former owners of the predecessors of the Morneau Sobeco Operating Entities ("Management Securityholders") hold this non-controlling interest.

As at December 31, 2006, 22,062,916 Units and 5,721,444 Special Voting Units of the Fund were issued and outstanding, and 5,721,444 MS Group LP Units were issued and outstanding.

BUSINESS OVERVIEW

Morneau Sobeco is the largest Canadian-owned pension and benefits consulting and outsourcing firm, providing services to organizations across Canada and in the United States. We focus on the integrated design and delivery of retirement, employee compensation and benefits programs. We have over 1,000 professionals and support staff with offices in 12 cities across North America. Our clients are primarily large and medium-sized organizations in Canada and the United States, which typically utilize our services on a recurring or contracted basis over a long term.

We derive our revenue primarily from fees charged to clients for pension and benefits consulting and outsourcing engagements. Fees from consulting engagements are charged based on billable hours or a fee-for-service basis. In some cases, consulting engagements may be billed on a fixed-fee basis, although these engagements are typically much smaller and the services are delivered over a shorter period of time. For some benefits consulting assignments which involve the purchase of an insurance policy underwritten by an insurance company, we may be paid commissions (in lieu of fees) by the client's insurance company, which is a common practice in the industry. These commissions are based on a percentage of the premiums paid by the client to the insurance company and our policy is to disclose them to our client. We assume no underwriting risk as the insurance policy is underwritten by the insurance company. In addition, we earn interest income from our cash balances which is included in other revenue. Fees from outsourcing engagements are generally based on negotiated fees or a formula tied to the nature of the service being provided. Our outsourcing business is characterized by fixed contracts, which typically have three-year to five-year terms. Most outsourcing contracts contain an upfront implementation fee and an ongoing monthly service fee. Implementations usually take three to twelve months and involve transferring the administration of a client's pension and/or benefits plans onto our systems, tailoring our systems and training our employees. Additional services provided that are outside the scope of the outsourcing contract are usually paid on a fee-for-service basis.

Our largest operating expense is compensation and related costs. This includes salaries, annual performance-based bonuses, benefits (e.g., pension, health, dental), payroll taxes and temporary staffing services. For the comparable operating results of WFMS contained in this MD&A, compensation expense also includes distributions paid as bonuses to employee-shareholders. Other operating expenses include occupancy costs, technology costs (equipment leases, telecommunications and software), non-recoverable client service costs (such as printing, travel and third-party professional services), training, marketing, office costs, professional services (legal and audit) and insurance.

OVERVIEW AND OUTLOOK

The results for 2006 met our expectations, from both a revenue and profitability standpoint. Revenue growth was 9.8% for the year and EBITDA margin was 22.6% compared to 21.5% for 2005.

On June 1, 2006, the Fund indirectly acquired all of the issued and outstanding shares of Heath Benefits Consulting Inc. ("Heath") through its subsidiary MS Group LP. Heath was a Vancouver-based benefits consulting firm with over 90 employees across Canada. The integration of Heath is proceeding according to plan. The consideration is based on future revenue from the Heath business going forward as well as achieving targeted cost efficiencies. The consideration, which is currently estimated to be approximately $15.4 million, is being paid in three instalments and is satisfied primarily through the assumption and repayment of the Heath debt of $4.6 million and the issuance of Class B LP Units. The first instalment of the purchase price was made on closing. The second and third instalments plus an amount to compensate for foregone distributions payable will be settled in June and December of 2008. These amounts will be recorded at that time except for a portion of the third instalment which is conditional on the continuing employment of certain selling shareholders and is being recorded as salary expense over the required employment period to December, 2008.

The salary component of the Heath acquisition recorded for the fourth quarter and for the year were $0.2 million and $0.5 million respectively. Eliminating the effects of this resulted in an EBITDA margin of 23.8% and 23.0% respectively for the quarter and the year.

Distributable Income Payout Ratio and Distributable Cash Payout Ratio for the year were 85.3% and 77.9% respectively (see "Results of Operations" for details). These figures take into account a special one-time cash distribution of $0.0115 per Unit in December 2006, representing the incremental taxable income arising from the Fund's strong financial performance in 2006.

We believe 2007 will be a solid year for Morneau Sobeco. We continue to execute our business strategy which includes focusing on our core services and striving to deliver high-quality services in the most efficient and cost-effective manner. Our strategy for future growth encompasses expanding relationships with current clients, continuing to attract new clients especially in the growing outsourcing market, targeting underserved markets and pursuing selected acquisitions.

As a result of our consistent growth, the Board of Trustees has authorized a 7% increase to our target monthly distribution from $0.06875 per Unit to $0.07356 per Unit, commencing with the March, 2007 distribution to be paid April 16, 2007.




ANALYSIS OF 2006 OPERATING RESULTS

Results of Operations
Selected Unaudited Consolidated Financial Information

Quarter Ended Year Ended
(In thousands of dollars December 31 December 31
except per unit amounts) 2006 2005 2006 2005

Revenue $34,079 $30,071 $132,087 $120,323
Deduct :
Salaries and benefits
expense 18,741 17,024 76,240 81,117
Other operating expense 7,448 5,901 26,004 23,160
Interest 471 478 883 663
Amortization 4,251 4,025 16,652 5,920
Partnership distributions - - - 6,825
Income taxes 84 19 58 477
Non-controlling interest 635 525 2,490 525
------------------------------------------------------------------------
Net income for the period 2,449 2,099 9,760 1,636
Add :
Amortization 4,251 4,025 16,652 5,920
Income taxes 84 19 58 477
Interest 471 478 883 663
Non-controlling interest 635 525 2,490 525
------------------------------------------------------------------------
EBITDA(1) 7,890 7,146 29,843 9,221
Adjustment:
Executive compensation and
employee-shareholder and
partner distributions - - - 16,703
adjustments(2)
------------------------------------------------------------------------
Adjusted EBITDA(3) 7,890 7,146 29,843 25,924
Adjusted EBITDA Margin 23.2% 23.8% 22.6% 21.5%
Add (deduct):
Current taxes 49 (19) (199) (477)
Salary component of Heath
acquisition 220 - 513 -
Interest paid (401) (478) (1,723) (663)
Capital expenditures (4) (781) (106) (1,308) (556)
------------------------------------------------------------------------
Distributable Income (5) 6,977 6,543 27,126 24,228
EBITDA(1) 7,890 7,146 29,843 9,221
Add (deduct) :
Change in non-cash
operating working capital 2,103 (291) 2,589 (5,548)
Current taxes 49 (19) (199) (477)
Loss on sale of property - 35 - 35
Salary component of Heath
acquisition 220 - 513 -
Interest paid (401) (478) (1,723) (663)
------------------------------------------------------------------------
Cash from operating
activities 9,861 6,393 31,023 2,568
Adjustment:
Change in
employee-shareholder
distributions and one-time
bonuses paid (2) - - - 17,664
------------------------------------------------------------------------
Cash from adjusted
operating activities 9,861 6,393 31,023 20,232
(Deduct):
Capital expenditures (4) (781) (106) (1,308) (556)
------------------------------------------------------------------------
Distributable Cash (6) $9,080 $6,287 $29,715 $19,676
------------------------------------------------------------------------
Distributable Cash
available to
non-controlling interest 1,870 1,257 6,076 n/a
------------------------------------------------------------------------
Distributable Cash
available for Unitholders 7,210 5,030 23,639 n/a
------------------------------------------------------------------------
Net income per Unit (basic
and diluted) 0.11100 0.09553 0.44318 n/a
------------------------------------------------------------------------
Distributable Income per
Unit (basic and diluted) 0.25111 0.23817 0.98087 n/a
------------------------------------------------------------------------
Distributable Cash per Unit
(basic and diluted) 0.32680 0.22886 1.07341 n/a
------------------------------------------------------------------------
Distributions declared per
Unit (basic and diluted) 0.21775 0.20854 0.83650 n/a
------------------------------------------------------------------------
Distributable Income Payout
Ratio (7) 86.7% 87.6% 85.3% n/a

------------------------------------------------------------------------
Distributable Cash Payout
Ratio (8) 66.6% 91.1% 77.9% n/a
------------------------------------------------------------------------

Footnotes:

(1) "EBITDA" is defined as earnings (loss) before interest expense,
income taxes, depreciation, amortization and non-controlling
interest.

(2) Represents the difference between historical executive compensation
(including employee-shareholder and partner distributions) and
compensation arrangements in place since the acquisition of Morneau
Sobeco by the Fund.

(3) "Adjusted EBITDA" is EBITDA adjusted for items that were applicable
prior to the acquisition of Morneau Sobeco by the Fund in order to
make historical comparisons more meaningful.

(4) Non-maintenance capital expenditures are not shown as a reduction
from Distributable Income or Distributable Cash for the periods prior
to September 30, 2005 since these expenditures are considered non-
recurring.

(5) "Distributable Income" is defined as net income for the period
adjusted for specific non-cash items, including amortization, future
income taxes and maintenance capital expenditures. In the comparable
data for the periods prior to September 30, 2005, Distributable
Income has also been adjusted for items that were applicable prior to
the acquisition of Morneau Sobeco by the Fund in order to make
historical comparisons more meaningful.

(6) "Distributable Cash" is defined as Cash from operating activities
adjusted for maintenance capital expenditures. In the comparable data
for the periods prior to September 30, 2005, Distributable Cash has
also been adjusted for items that were applicable prior to the
acquisition of Morneau Sobeco by the Fund in order to make historical
comparisons more meaningful.

(7) "Distributable Income Payout Ratio" is defined as declared
distributions divided by Distributable Income.

(8) "Distributable Cash Payout Ratio" is defined as declared
distributions divided by Distributable Cash.


Non-GAAP Financial Measures: EBITDA, Adjusted EBITDA, Distributable Income, Distributable Cash, Distributable Income Payout Ratio and Distributable Cash Payout Ratio

We believe that EBITDA is a useful measure in evaluating performance of the Fund. It is used to monitor compliance with debt covenants and to make decisions related to distributions to Unitholders. Adjusted EBITDA is a useful measure in evaluating the performance for comparison purposes with prior periods as certain previous arrangements are non-recurring and will differ materially from ongoing arrangements as a public entity. We also believe that Distributable Income, Distributable Cash, Distributable Income Payout Ratio and Distributable Cash Payout Ratio are useful supplemental measures of performance as they are generally used by Canadian open-ended business income funds as indicators of financial performance.

In order to make historical data of WFMS more comparable to the ongoing performance data of the Fund, we have made the following two adjustments to EBITDA and to Distributable Cash:

(i) As a private company, WFMS historically paid out substantial amounts of pre-tax income as distributions to its shareholders and partners each year. Distributions to employee-shareholders were reflected as salary expenses. Distributions to partners were reflected as partnership earnings. Since the practice of paying such distributions has been discontinued effective September 30, 2005, we believe that an adjustment to historical EBITDA to account for such distributions should be made to arrive at an adjusted amount of EBITDA.

(ii) As the new executive compensation arrangements effective October 1, 2005 differ materially from the previous arrangements, we believe that adjustments relating to the new executive compensation arrangements are a more useful reflection of the results of operations for WFMS. To provide consistency, adjustments have been made to executive compensation arrangements as if the new compensation arrangements had been in place for all of 2005.

As a result of adopting the CSA Staff Notice 52-306 (Revised), the Distributable Cash calculation in this MD&A has been revised from previous MD&As to incorporate the changes in non-cash operating working capital. This change enables the Distributable Cash to reconcile back to the Cash from operating activities which is a GAAP measure.

Distributions to Unitholders

Monthly distributions are declared by the Fund for Unitholders of record on the last business day of each month and are paid on about the 15th day of the following month.

To reduce Unitholder risk, approximately 72% of the Class B LP Units are subordinated in their rights to distributions until Unitholders of the Fund receive their target distributions. This subordination is in place until September 30, 2007, or later if the Fund has not made its target distributions or met specified EBITDA targets.

ANALYSIS OF 2006 ANNUAL RESULTS

Revenue

Revenue for the year ended December 31, 2006 increased by $11.8 million, or 9.8%, to $132.1 million compared to $120.3 million for the same period in 2005. The increase in revenue was a result of additional consulting and outsourcing business from a variety of new and existing clients, with one existing client increasing our revenue by $3.1 million and a new client contributing $1.1 million. Revenue also increased by $5.4 million due to the Heath acquisition. The increase in revenue was partially offset by reduced volumes and special projects of $1.1 million for a large outsourcing client, and a $2.5 million reduction in outsourcing fees related to two contracts in the U.S. which ended in 2005.

Salaries and Benefits

Salaries and benefits for the year ended December 31, 2006 decreased by $4.9 million, or 6.0%, to $76.2 million compared to $81.1 million for the same period in 2005. The decrease was attributable to the elimination of employee-shareholder distributions and reduced executive compensation of $11.2 million and a non-recurring tax credit of $0.7 million related to employees carrying out e-commerce activities in the province of Quebec. This was partially offset by salary increases of $3.7 million, or 5.3%, salary and benefits of $2.8 million for Heath and the salary component of the Heath acquisition of $0.5 million.

Other Operating Expenses

Other operating expenses for the year ended December 31, 2006 increased by $2.8 million, or 12.3%, to $26.0 million compared to $23.2 million for the same period in 2005. The increase was primarily attributable to Heath operating expenses of $1.0 million, increased technology spending of $0.5 million, increased professional fees including legal, audit and public company costs of $0.6 million, and increased general expenses of $0.7 million.

Interest Expense

Interest expense for the year ended December 31, 2006 increased by $0.2 million to $0.9 million compared to $0.7 million for the same period in 2005. Interest expense for 2006 consists of $1.7 million in interest charges as a result of the $35 million of debt restructuring in connection with the change in ownership of the business on September 30, 2005 and the formation of the Fund, $0.05 million of interest on the $5.1 million incremental debt for 90 days related to the acquisition of Heath on June 1, 2006 offset by the recognition of the fair value of our swap agreements of $0.8 million. This compares to interest charges of $0.7 million on an average debt of $13.3 million for the year ended December 31, 2005.

Amortization

Amortization for the year ended December 31, 2006 increased by $10.7 million, or 181.3%, to $16.7 million compared to $5.9 million for the same period in 2005. The increase was attributable to the increase in intangible assets as a result of the purchase of WFMS by the Fund and acquisition of Heath on June 1, 2006.

Partnership Distributions

Distributions from WFMS's limited partnership subsidiary for the year ended December 31, 2006 was $nil compared to $6.8 million for the same period in 2005.

Income Tax Expense

Income tax expense for the year ended December 31, 2006 decreased by $0.4 million to $0.1 million compared to $0.5 million income tax expense for the same period in 2005. The changes in income tax expense are primarily attributable to changes in the corporate structure.

Net Income

As a result of the changes in revenue and expenses described above, net income for the year ended December 31, 2006 increased by $8.2 million to $9.8 million compared to net income of $1.6 million for the same period in 2005.

Changes in Non-Cash Operating Working Capital

Changes in non-cash operating working capital for the year ended December 31, 2006 increased by $8.1 million to $2.6 million compared to a use of $5.5 million for the same period in 2005. The increase was attributable to the change in accrued compensation and related benefits due to the elimination of the employee-shareholder distribution of $9.8 million in 2005, partially offset by a decrease in income tax recoverable of $1.7 million.

Cash from Operating Activities

Cash from operating activities for the year ended December 31, 2006 increased by $10.8 million to $31.0 million compared to cash from adjusted operating activities of $20.2 million for the same period in 2005. This increase was primarily due to improved Adjusted EBITDA of $4.4 million after taking into account the salary component of the Heath acquisition of $0.5 million, a decrease in current taxes of $0.3 million and an increase in non-cash operating working capital of $7.1 million after adjusting for executive compensation as well as employee-shareholders and partner distributions. This was partially offset by an increase in interest paid of $1.0 million.

Non-GAAP Financial Measures: Adjusted EBITDA, Distributable Income and Distributable Cash

Adjusted EBITDA

EBITDA for the year ended December 31, 2006 increased $3.9 million, or 15.1%, to $29.8 million compared to Adjusted EBITDA of $25.9 million for the same period in 2005. The increase was due to increased revenue of $11.8 million, partially offset by increased salaries and benefits of $5.1 million and increased operating costs of $2.8 million.

Distributable Income

Distributable Income for the year ended December 31, 2006 increased by $2.9 million, or 12.0%, to $27.1 million relative to $24.2 million for the same period in 2005. The increase was due to increased Adjusted EBITDA of $4.4 million after taking into account the salary component of the Heath acquisition of $0.5 million and a decrease in current taxes of $0.3 million. This was partially offset by higher interest payments of $1.0 million as a result of the new financing structure on September 30, 2005 and increased capital expenditures of $0.8 million which included leasehold improvements of $0.4 million related to the integration of the Heath locations.

Distributable Cash

Distributable Cash for the year ended December 31, 2006 increased by $10.0 million, or 51.0%, to $29.7 million relative to $19.7 million for the same period in 2005. This increase was primarily due to increased cash from adjusted operating activities of $10.8 million, partially offset by higher capital expenditures of $0.8 million.

ANALYSIS OF 2006 FOURTH QUARTER RESULTS

Revenue

Revenue for the three months ended December 31, 2006 increased by $4.0 million, or 13.3%, to $34.1 million compared to $30.1 million for the same period in 2005. The increase in revenue was a result of additional consulting and outsourcing business from a variety of clients, with one existing client increasing our revenue by $0.6 million. Revenue also increased by $2.0 million due to the Heath acquisition. The increase in revenue was partially offset by a $0.3 million reduction in outsourcing fees related to one contract in the U.S. which ended in late 2005.

Salaries and Benefits

Salaries and benefits for the three months ended December 31, 2006 increased by $1.7 million, or 10.1%, to $18.7 million compared to $17.0 million for the same period in 2005. The increase was attributable to salary and benefits of $1.0 million for Heath, the salary component of the Heath acquisition of $0.2 million and increases in salaries and bonuses of $1.2 million. This was partially offset by a non-recurring tax credit of $0.7 million related to employees carrying out e-commerce activities in the province of Quebec.

Other Operating Expenses

Other operating expenses for the three months ended December 31, 2006 increased by $1.6 million, or 26.2%, to $7.4 million compared to $5.9 million for the same period in 2005. The increase was primarily attributable to Heath operating expenses of $0.4 million, increased technology spending of $0.4 million and increased general expenses of $0.8 million.

Interest Expense

Interest expense for the three months ended December 31, 2006 remains unchanged at $0.5 million compared to the same period in 2005. The 2006 interest expense consisted of $0.4 million in interest charges on $35 million of debt and $0.1 million due to the recognition of the fair value of our swap agreements. This compares to interest charges of $0.5 million on an average debt of $36.1 million for the three months ended December 31, 2005.

Amortization

Amortization for the three months ended December 31, 2006 increased by $0.2 million, or 5.7%, to $4.2 million compared to $4.0 million for the same period in 2005. The increase was mainly attributable to the increase in intangible assets as a result of the acquisition of Heath on June 1, 2006.

Income Tax Expense

Income tax expense for the three months ended December 31, 2006 was $0.1 million compared to $19 thousand tax expense for the same period in 2005. The changes in tax expense are primarily attributable to minor changes in taxable income.

Net Income

As a result of the changes in revenue and expenses described above, net income for the three months ended December 31, 2006 increased by $0.3 million to $2.4 million compared to $2.1 million for the same period in 2005.

Changes in Non-Cash Operating Working Capital

Changes in non-cash operating working capital for the three months ended December 31, 2006 increased by $2.4 million to $2.1 million compared to a use of $0.3 million for the same period in 2005. The increase was primarily attributable to increased accrued compensation and related benefits and payable and accrued liabilities of $6.9 million as one-time IPO related expenses were paid in the fourth quarter of 2005. This was partially offset by the change in receivables, net of unbilled fees of $1.9 million and the change in income tax recoverable of $2.6 million relating to the acquisition of W.F. Morneau Service Inc. during the fourth quarter of 2005.

Cash from Operating Activities

Cash from operating activities for the three months ended December 31, 2006 increased by $3.5 million to $9.9 million compared to $6.4 million for the same period in 2005. This increase was primarily due to improved EBITDA of $1.0 million after taking into account the salary component of the Heath acquisition of $0.2 million, an increase in changes in non-cash operating working capital of $2.4 million and lower current taxes of $0.1 million.

Non-GAAP Financial Measures: EBITDA, Distributable Income and Distributable Cash

EBITDA

EBITDA for the three months ended December 31, 2006 increased $0.8 million, or 10.4%, to $7.9 million compared to $7.1 million for the same period in 2005. The increase was due to increased revenue of $4.0 million partially offset by increased salaries and benefits expense and operating costs of $3.2 million.

Distributable Income

Distributable Income for the three months ended December 31, 2006 increased by $0.4 million to $6.9 million compared to $6.5 million for the same period in 2005. The increase was due to increased EBITDA of $1.0 million after taking into account the salary component of the Heath acquisition in the amount of $0.2 million and lower current taxes of $0.1 million. This was partially offset by increased capital expenditures of $0.7 million which included leasehold improvements of $0.4 million related to the integration of the Heath locations.

Distributable Cash

Distributable Cash for the three months ended December 31, 2006 increased by $2.8 million, or 44.4%, to $9.1 million compared to $6.3 million for the same period in 2005. This increase was primarily due to improved cash from adjusted operating activities of $3.5 million partially offset by higher capital expenditures of $0.7 million.



LIQUIDITY AND CAPITAL RESOURCES

Cash Flows

The following table provides an overview of the Fund's cash flows for the
periods indicated.

Cash Flow Information
Selected Unaudited Consolidated Financial Information
(In thousands of dollars)
Quarter Ended Year Ended
December 31 December 31
2006 2005 2006 2005

Operating Activities $9,861 $6,393 $31,023 $2,568
Less employee-shareholder
distributions and one-time
bonuses (1) - - - (17,664)
--------------------------------------------------------------------------
Adjusted Operating Activities 9,861 6,393 31,023 20,232

Investing Activities (781) (106) (7,312) (212,421)

Financing Activities (5,731) (8,628) (22,802) 209,729
Less partner distributions - - - (2,500)
--------------------------------------------------------------------------
Adjusted Financing Activities (5,731) (8,628) (22,802) 212,229
--------------------------------------------------------------------------
Increase (decrease) in cash
before employee-shareholder
and partner distributions
and one-time bonuses(1) 3,349 (2,341) 909 20,040
--------------------------------------------------------------------------
Employee-shareholder and
partner distributions and one
time bonuses(1) - - - (20,164)
--------------------------------------------------------------------------
Increase (decrease) in cash
after employee-shareholder and
partner distributions and
one-time bonuses $3,349 $(2,341) $909 $(124)
--------------------------------------------------------------------------
--------------------------------------------------------------------------

(1) Represents the sum of the aggregate employee-shareholder and partner
distributions and one-time bonuses deducted from Operating Activities
and Financing Activities.



2006 Annual Results

Cash inflows from operating activities for the year ended December 31, 2006 increased by $10.8 million to $31.0 million compared to cash from adjusted operating activities of $20.2 million for the same period in 2005. This increase was primarily due to improved Adjusted EBITDA of $4.4 million after taking into account the salary component of the Heath acquisition in the amount of $0.5 million, a decrease in current taxes of $0.3 million and an increase in non-cash operating working capital after adjustments related to executive compensation as well as employee-shareholders and partner distributions of $7.1 million. This was partially offset by an increase in interest paid of $1.0 million.

Cash outflows from investing activities for the year ended December 31, 2006 decreased by $205.1 million to $7.3 million for the year ended December 31, 2006 from $212.4 million for the same period in 2005. Cash outflows for 2005 consisted of the purchase of WFMS for $209.8 million on September 30, 2005 and the payment of $1.2 million of dividends compared to cash outflows of $6.0 million related to the purchase of Heath on June 1, 2006.

Cash outflows from adjusted financing activities for the year ended December 31, 2006 were $22.8 million for the year ended December 31, 2006 compared to net cash inflows of $212.2 million for the same period in 2005. The cash outflows in 2006 consisted of Unitholder distribution payments of $22.8 million. The net cash inflows in 2005 consisted of net proceeds of the IPO in the amount of $184.6 million plus $31.0 million in additional term loans partially offset by distribution payments of $3.3 million.

2006 Fourth Quarter Results

Cash inflows from operating activities for the three months ended December 31, 2006 increased by $3.5 million to $9.9 million compared to cash from operating activities of $6.4 million for the same period in 2005. This increase was primarily due to improved EBITDA of $1.0 million after taking into account the salary component of the Heath acquisition in the amount of $0.2 million plus an increase in changes in non-cash operating working capital of $2.4 million.

Cash outflow from investing activities for the three months ended December 31, 2006 increased by $0.7 million to $0.8 million for the three months ended December 31, 2006 from $0.1 million for the same period in 2005. This increase was primarily due to higher capital expenditures as a result of additional leasehold improvements of $0.4 million related to the integration of the Heath locations and the timing of technology spending.

Cash outflows from financing activities for the three months ended December 31, 2006 decreased by $2.9 million to $5.7 million compared to cash outflows of $8.6 million for the same period in 2005. The decrease was attributed to the one-time repayment of $5.0 million from the Fund's line of credit which was initially drawn down in order to facilitate cash transfers at the IPO closing as well as additional IPO related cost of $0.3 million in the fourth quarter of 2005. This is partially offset by higher Unitholder distribution payments of $2.4 million in the quarter.

Capital Expenditures

Pension and benefits consulting and outsourcing is not a capital intensive business. Historically, capital expenditures have included office furniture, facility improvements, and information technology software and hardware. In 2005 our capital expenditures relating to buildings, office furniture, facility improvements and information technology software and hardware were $0.6 million. In 2006, our capital expenditures were $1.3 million, of which $0.4 million related to leasehold improvements for the integration of the Heath locations. Going forward, we expect that the capital expenditures required to maintain our current platform will be principally related to information technology hardware and telecommunications equipment. Additional capital expenditure requirements may result from significant business expansion. Such amounts are expected to be funded from our operating cash flow.

Contractual Obligations

We lease office space and selected equipment under operating lease agreements with terms ranging from one to seven years. We also have a term loan described under "Capital Resources". Future expected payments are as follows:



Summary of Contractual Obligations
(In thousands of dollars)

Total 2007 to 2009 2010 to 2011 Beyond 2011

Term loan $35,000 $35,000 - -
Operating leases $21,273 $12,649 $5,619 $3,005
----------------------------------------------------------------------
Total $56,273 $47,649 $5,619 $3,005
----------------------------------------------------------------------


In addition, the Fund has entered into a sublease agreement to sublet one of Heath's office premises. According to the agreement, the Fund is liable for the rent in case of a default by the subtenant. The average annual rent for the lease is $190 and the lease expires in October 30, 2011.

The Fund has no material contractual obligations other than those described in this MD&A and has no off-balance sheet financing arrangements.

Capital Resources



The following table provides an overview of the Fund's capital resources:

Capital Resources As at December As at December
(In thousands of dollars) 31, 2006 31, 2005

Cash $5,257 $4,348
Long-term debt $35,000 $35,000
Working capital $19,652 $21,454
Unitholders' equity $194,399 $201,992


We have historically utilized cash from operations to finance working capital requirements and fund growth. As at December 31, 2006, the Fund's working capital (current assets minus current liabilities) was approximately $19.7 million. Liabilities consist mainly of accounts payable and accrued liabilities of $5.9 million, accrued compensation and related benefits of $7.0 million and Unitholder distributions payable of $2.8 million.

We have also maintained credit facilities to manage working capital requirements throughout the year. The Fund's credit facilities include a secured term loan of $35 million repayable in full on September 30, 2009. The term loan bears interest at bankers' acceptance rates plus 1%, which have been fixed at 4.4% using an interest-rate swap. This secured term loan requires the Fund to maintain certain financial covenants on a consolidated basis as follows:

(i) Ratio of Debt to EBITDA not to exceed 2.5 to 1.0

(ii) Ratio of EBITDA to interest expense of not less than 3.0 to 1.0

The Fund complied with all the required financial covenants and the ratios at year end were 1.2 and 17.3 respectively.

The credit facilities also include a secured operating line of credit of up to $15 million bearing interest at bankers' acceptance rates plus 1% and a standby fee of 0.2% on the undrawn portion. As at December 31, 2006, the operating line was undrawn and the Fund had excess cash of $5.3 million.

SELECTED BALANCE SHEET DATA

The following table provides an overview of the Fund's selected balance sheet data:



Selected Balance Sheet Data As at December As at December
(in thousands of dollars) 31, 2006 31, 2005

Current assets $35,338 $33,858
Other long-term assets $265,208 $269,860
Current liabilities $15,686 $12,404


Current Assets

Current assets for the year ended December 31, 2006 increased by $1.5 million to $35.3 million from $33.8 million in 2005. The increase was primarily due to increased cash of $0.9 million, increased accounts receivables net of unbilled fees of $0.4 million and increased income tax recoverable and prepaid of $0.2 million.

Other Long-Term Assets

Other long-term assets for the year ended December 31, 2006 decreased by $4.6 million to $265.2 million from $269.8 million in 2005. The decrease was as a result of amortization expense of $16.7 million partially offset by intangible assets and goodwill acquired through the Heath acquisition of $9.3 million, capital asset additions of $1.3 million and the interest-rate swap fair value of $0.8 million.

Current Liabilities

Current liabilities for the year ended December 31, 2006 increased by $3.3 million to $15.7 million from $12.4 million in 2005. The increase was primarily due to increased accounts payable and accrued liabilities of $1.7 million due to the timing of suppliers' payments, an increase in accrued compensation and related benefits of $1.2 million due to changes in the timing of payment of certain bonuses and increased Unitholder distributions of $0.3 million due to a special one-time cash distribution which represented the incremental taxable income arising from the Fund's strong financial performance in 2006.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The preparation of financial statements, in accordance with GAAP, requires us to make estimates and assumptions that affect the reported values of assets and liabilities as well as disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. These estimates are reviewed periodically and, as adjustments become necessary, they are reported in earnings in the periods in which they become known. Accordingly, actual results could differ from these estimates. The accounting policies and estimates that are critical to the Fund's business relate to the following items:

Revenue Recognition

We earn fee-for-service revenue based on hourly rates and the time spent delivering those services. We also earn contracted revenue based on negotiated fixed amounts or on a formula tied to the nature of the service, rather than the time spent. Revenue is recognized in the period that the service is rendered, irrespective of when it is invoiced. Unbilled fees are recorded at the lower of unbilled hours worked at standard billing rates and the amount which we estimate can be recovered upon invoicing. Expenses are recognized as incurred. Losses on fixed-fee contracts are recognized during the period in which the loss becomes probable. Billings in excess of revenue are recorded as a deferred revenue liability, included with accounts payable and accrued liabilities, until services are rendered. Revenue does not include reimbursements for recoverable expenses, such as employee travel expenses, outside printing and third-party professional services. Reimbursements are accounted for as a reduction to expenses.

We also earn commission revenue as payment for the provision of benefits consulting services to clients, as a percentage of insurance premiums paid by our clients. Commission revenue is received annually, semi-annually, quarterly or monthly. Annual fees are typically paid at the beginning of the insurance policy period and are recognized as income at the later of the billing or effective date of the policy, net of a provision for return commissions due to policy cancellations or change of broker.

Amortization of Finite-Life Intangible Assets

We have accounted for our acquisition of WFMS and Heath using the purchase method of accounting. Intangible assets consisting principally of customer relationships, proprietary software and customer contracts have been recognized on acquisition based on our best estimate of the relative fair values. These finite-life intangible assets are being amortized over their estimated useful lives of 15 to 20, 5 and 3 years respectively. Impairment is assessed annually, or when events or changes in circumstances indicate the carrying amount of assets may not be recoverable.

Goodwill is not amortized and is subject to an impairment test at least annually or when it is more likely than not that the carrying amount of the Fund's net assets exceeds its fair value. Goodwill impairment is assessed based on a comparison of the fair value of the Fund and its net assets including goodwill.

Allowance for Doubtful Accounts

A provision for accounts receivable resulting from the potential risk that the receivable will not be collected has been recorded. We continually monitor past due accounts to assess the likelihood of collection to estimate the required provision.

Litigation and Claims

We are involved in litigation and other claims arising in the normal course of business. We must use judgment to determine whether or not a claim has any merit, the amount of the claim and whether to record a provision, which is dependent upon the potential success of the claim. We believe that none of the current claims will have a material adverse impact on the financial position of the Fund.

Future Income Tax

We use the asset and liability method of accounting for income taxes. Future income tax assets are recognized only to the extent that we determine it is more likely than not that the future income tax assets will be realized. In 2006, Morneau Sobeco was approved for a tax credit for e-commerce activities performed prior to the IPO. These credits are no longer available.

Future Accounting Changes

The CICA has issued three new accounting standards:

1. Section, 3855, Financial Instruments -- Recognition and Measurement, effective for fiscal years beginning on or after October 1, 2006. This section describes the standards for recognizing and measuring financial instruments in the balance sheet and the standards for reporting gains and losses in the financial instrument. Financial assets available for sale, assets and liabilities held for trading and derivative financial instruments, part of a hedging relationship or not, have to be measured at fair value. The impact of remeasuring our financial assets and liabilities at fair value will be recognized in opening deficit and opening accumulated other comprehensive income as appropriate.

2. Section 1530, Comprehensive Income, effective for fiscal years beginning on or after October 1, 2006. It describes reporting and disclosure recommendations with respect to comprehensive income and its components. Comprehensive income is the change in Unitholders' equity, which results from transactions other than those resulting from investments by Unitholders and distributions to Unitholders. These transactions and events include unrealized gains and losses resulting from changes in the fair value of certain financial instruments.

3. Section 3865, Hedges, effective for fiscal years beginning on or after October 1, 2006. The recommendations expand the guidelines outlined in Accounting Guideline 13 ("AcG-13"), Hedging Relationships. This section describes when and how hedge accounting can be applied as well as the disclosure requirements. Hedge accounting enables the recording of gains and losses, revenues and expenses from the derivative financial instruments in the same period as for those related to the hedged item.

These standards will be effective for the Fund as of January 1, 2007. Any adjustment of the previous carrying amounts will be recognized as an adjustment to either accumulated other comprehensive income or retained earnings at January 1, 2007 and prior period consolidated statements will not be restated. The impact of the adoption of these new standards on the Fund's financial statements is not expected to be material.

FINANCIAL INSTRUMENTS AND OTHER INSTRUMENTS

The Fund's financial instruments consist of cash, accounts receivable, accounts payable and accrued liabilities, Unitholder distributions payable, interest-rate swaps and a term loan.

We have a secured term loan of $35 million with two Canadian chartered banks repayable on September 30, 2009. We have entered into interest-rate swap agreements to fix the interest rate at 4.4% for the four year term. We also have available a secured operating line of credit for $15 million. The line of credit bears interest at the bankers' acceptance rate plus 1% and the undrawn portion incurs a standby fee of 0.20% .

The carrying value of the financial instruments approximates their fair values due to their short-term nature with the exception of the interest-rate swap agreements in place on the term loan, which have been recorded at the current market rate.

We are not engaged in currency hedging activities and do not own other instruments that may be settled by the delivery of non-financial assets. We realize a portion of our sales in U.S. dollars and are thus exposed to fluctuations in the value of the U.S. dollar relative to the Canadian dollar. The net revenue exposure after accounting for related expenses denominated in U.S. dollars was approximately US$1.0 million for the three months ended December 31, 2006 and US$3.0 million for the year ended December 31, 2006.

In our view, the Fund is not exposed to significant interest, currency or credit risks arising from financial instruments.

RISKS AND UNCERTAINTIES

The results of operations, business prospects and financial condition of the Fund are subject to a number of risks and uncertainties and are affected by a number of factors outside our control.

Risk Related to the Business of Morneau Sobeco

Ability to Maintain Profitability and Manage Growth

There can be no assurance that Morneau Sobeco will be able to sustain profitability in future periods. Morneau Sobeco's future operating results will depend on a number of factors, including its ability to continue to successfully execute the strategic initiatives outlined under "Description of the Business --Business and Growth Strategy".

There can be no assurance that Morneau Sobeco will be successful in achieving its strategic plan or that its strategic plan will enable the firm to maintain its historical revenue growth rates or to sustain profitability. Failure to successfully execute any material part of Morneau Sobeco's strategic plan could have a material adverse effect on its business, financial condition and operating results, and the ability of the Fund to make distributions on the Units.

There can be no assurance that Morneau Sobeco will be able to effectively manage its growth, and any failure to do so could have a material adverse effect on the firm's and the Fund's business, financial condition and operating results, and on the ability of the Fund to make distributions on the Units.

Reliance on Information Systems and Technology

Information systems are an integral part of Morneau Sobeco's business and the products and services offered to its clients. Morneau Sobeco relies on systems to maintain accurate records and to carry out required administrative functions in accordance with the terms of its contractual obligations to its clients. Morneau Sobeco relies on the Internet as a key mechanism for delivering services to clients and achieving efficiencies in its service model. The Internet has experienced, and is expected to continue to experience, significant growth in the number of users and volume of traffic. As a result, its performance 16 and reliability may decline. In order to maintain the level of security, service and reliability that clients require, Morneau Sobeco may be required to make significant investments in the online means of delivering consulting and outsourcing services. In addition, Web sites and proprietary online services have experienced service interruptions and other delays. If these outages or delays occur frequently in the future, Internet usage as a medium of exchange of information could decline and the Internet might not adequately support the firm's Web-based tools. The adoption of additional laws or regulations with respect to the Internet may impede the efficiency of the Internet as a medium of exchange of information and decrease the demand for Morneau Sobeco's services.

Any disruptions in Morneau Sobeco's systems, the failure of the systems to operate as expected or the firm's ability to use the Internet effectively to deliver services could, depending on the magnitude of the problem, result in a loss of current or future business and/or potential claims against Morneau Sobeco, all of which could have a material adverse effect on Morneau Sobeco's business, financial condition and operating results, and on the ability of the Fund to make distributions on the Units.

Reputational Risk

Morneau Sobeco depends, to a large extent, on its relationships with its clients and its reputation for high-quality outsourcing and consulting services. As a result, the impact of a client not being satisfied with Morneau Sobeco's services or products may be more damaging in Morneau Sobeco's business than in other businesses. Moreover, if the firm fails to meet its contractual obligations, Morneau Sobeco could be subject to legal liability and a loss of client relationships.

Dependence on Key Clients

For the year ended December 31, 2006, Morneau Sobeco's largest client accounted for approximately 12% of revenue and its top 10 clients, in the aggregate, accounted for approximately 35% of revenue. As clients may terminate engagements with minimal notice, there can be no assurance that Morneau Sobeco will be able to retain relationships with its largest clients. Moreover, there can be no assurance that such clients will continue to use Morneau Sobeco's services in the future. Any negative change involving any of Morneau Sobeco's largest clients, including but not limited to a client's financial condition or desire to continue using the firm's services, could result in a significant reduction in revenue which could have a material adverse effect on Morneau Sobeco's business, financial condition and operating results, and on the ability of the Fund to make distributions on the Units.

Risk of Future Legal Proceedings

Morneau Sobeco may be threatened with, or may be named as a defendant in, or may become subject to, various legal proceedings in the ordinary course of conducting its business, including lawsuits based upon professional errors and omissions. Morneau Sobeco's business involves assumptions and estimates concerning future events, the actual outcome of which cannot be known with certainty in advance. In addition, computational, software programming or data management errors could occur. For example, possible legal proceedings could result from:

(i) a client's assertion that actuarial assumptions used in a pension plan were unreasonable, leading to plan underfunding;

(ii) a claim that inaccurate data was used, which could lead to an underestimation of plan liabilities; or

(iii) a claim that employee benefits plan documents were misinterpreted or plan amendments were misstated in plan documents, which could lead to overpayments to beneficiaries.

Defending lawsuits of this nature could require much management attention, which could divert its focus from operations. Such claims could produce negative publicity that could hurt Morneau Sobeco's reputation and business. A significant judgment against Morneau Sobeco, or the imposition of a significant fine or penalty as a result of a finding that Morneau Sobeco failed to comply with laws or regulations, could have a material adverse effect on Morneau Sobeco's business, financial condition and operating results, and on the ability of the Fund to make distributions on the Units.

Reliance on Key Professionals

Morneau Sobeco's operations are dependent on the abilities, experiences and efforts of its professionals, many of whom have excellent reputations and a significant number of contacts in the industry in which Morneau Sobeco operates. Morneau Sobeco's business depends, in part, on its professionals' ability to develop and maintain alliances with businesses such as brokerage firms, financial services companies, healthcare organizations, insurance companies, business process outsourcing organizations and other companies, in order to develop, market and deliver its services. If Morneau Sobeco's strategic alliances are discontinued due to the loss of professional staff or if the firm has difficulty developing new alliances, profitability could be negatively impacted. Should any member of its professional staff be unable or unwilling to continue his or her relationship with Morneau Sobeco, this change could have a material adverse effect on Morneau Sobeco's business, financial condition and operating results, and on the ability of the Fund to make distributions on the Units.

Competition

Morneau Sobeco operates in a highly competitive North American market. As a result, Morneau Sobeco competes with many domestic and international firms. Some of its competitors have achieved substantially more market penetration in certain of the areas in which Morneau Sobeco competes. In addition, some of Morneau Sobeco's competitors have substantially more financial resources and/or financial flexibility than Morneau Sobeco. Competitive forces could result in reduced market share and thus have a material adverse effect on Morneau Sobeco's business, financial condition and operating results, and on the ability of the Fund to make distributions on the Units.

Legislative and Regulatory Changes

The business of pension and benefits consulting and outsourcing is highly regulated and laws are constantly evolving. Any changes to laws, rules, regulations or policies could have a material adverse effect on Morneau Sobeco's business, financial condition and operating results, and on the ability of the Fund to make distributions on the Units.

Changes in Business Conditions

Morneau Sobeco's future success depends, in part, on its ability to develop and implement technology solutions that anticipate and keep pace with rapid and continuing changes in technology, industry standards and client preferences. The firm may not be successful in anticipating or responding to these developments on a timely basis and its ideas may not be accepted in the marketplace. The effort to gain technological expertise and develop new technologies in its business requires Morneau Sobeco to incur significant expenses. If Morneau Sobeco cannot offer new technologies as quickly as its competitors, or if the competition develops more cost-effective technologies, Morneau Sobeco could lose market share. Also, products and technologies developed by Morneau Sobeco's competitors may make the firm's service or product offerings non-competitive or obsolete. Any one of these circumstances could have a material adverse effect on Morneau Sobeco's ability to obtain and fulfill important client engagements, and thus could have a material adverse effect on Morneau Sobeco's business, financial condition and operating results, and on the ability of the Fund to make distributions on the Units.

Timely Completion of Projects and Performance of Obligations

In its contracts with clients, Morneau Sobeco is sometimes committed to complete a project by a scheduled date. If the project is not completed by the scheduled date, Morneau Sobeco may either incur significant additional costs or be held responsible for the costs incurred by the client to rectify damages due to the late completion. Morneau Sobeco's success depends in large part on whether it fulfills these and other contractual obligations with clients and maintains client satisfaction. If Morneau Sobeco fails to satisfactorily perform its contractual obligations, its clients could terminate contracts and/ or take legal action against Morneau Sobeco. Such occurrences could result in a loss of its professional reputation and extra costs needed to defend or rectify the situation and thus have a material adverse effect on Morneau Sobeco's business, financial condition and operating results, and on the ability of the Fund to make distributions on the Units.

Implications of Fixed-Price Contracts

A portion of Morneau Sobeco's revenue comes from fixed-price contracts. A fixed-price contract requires Morneau Sobeco to perform either all or a specified portion of work under the contract for a fixed price. Fixed-price contracts expose Morneau Sobeco to a number of risks, including underestimation of costs, ambiguities in specifications, unforeseen costs or difficulties, problems with new technologies, delays beyond the control of Morneau Sobeco, failures of subcontractors to perform, and economic or other changes that may occur during the contract period. Increasing use of fixed-price contracts and/or increasing the size of such contracts would increase Morneau Sobeco's exposure to these risks. Losses under fixed-price contracts could have a material adverse effect on Morneau Sobeco's business, financial condition and operating results, and on the ability of the Fund to make distributions on the Units.

Interest Rate Fluctuations

Morneau Sobeco may be exposed to fluctuations in interest rates under its borrowings. Increases in interest rates may have a material adverse effect on Morneau Sobeco's business, financial condition and operating results, and on the ability of the Fund to make distributions on the Units.

Protection of Intellectual Property

Morneau Sobeco continually develops and improves its proprietary technology solutions for clients. No assurance can be given that Morneau Sobeco's competitors will not develop substantially similar technology. Morneau Sobeco relies on one or more of the following to protect its proprietary rights: trademarks, copyrights, trade secrets, confidentiality procedures and contractual provisions. Despite Morneau Sobeco's efforts to protect its proprietary rights, unauthorized parties may attempt to obtain and use information that Morneau Sobeco regards as proprietary. Stopping unauthorized use of Morneau Sobeco's proprietary rights may be difficult, time-consuming and costly. There can be no assurance that Morneau Sobeco will be successful in protecting its proprietary rights and, if it is not, this could have a material adverse effect on Morneau Sobeco's business, financial condition and operating results, and on the ability of the Fund to make distributions on the Units.

Rising Insurance Costs

The cost of maintaining professional errors and omissions insurance as well as director and officer liability insurance is significant. Morneau Sobeco could experience higher insurance premiums as a result of adverse claims experience or because of general increases in premiums by insurance carriers for reasons unrelated to its own claims experience. Generally, Morneau Sobeco's insurance policies must be renewed annually. Its ability to continue to obtain insurance at affordable premiums depends upon its ability to continue to operate with an acceptable claims record. A significant increase in the number of claims, the existence of one or more claims in excess of its policy limits or the inability to obtain adequate insurance coverage at acceptable rates, or at all, could have a material adverse effect on Morneau Sobeco's business, financial condition and operating results, and on the ability of the Fund to make distributions on the Units.

Absence of Operating History as a Public Entity

Although management has significant experience in the pension and benefits consulting and outsourcing industry, it does not have experience operating Morneau Sobeco as a public company. To operate effectively as a public company, it will be required to continue to implement changes in certain aspects of its business, and its management and other employees will need to learn how to comply with ongoing public company requirements. Failure to take such actions, or delay in the implementation thereof, could have a material adverse effect on Morneau Sobeco's business, financial condition and operating results, and on the ability of the Fund to make distributions on the Units.

Risk Related to the Structure of the Fund

Income Tax Matters

There can be no assurance that Canadian federal income tax laws and administrative policies respecting the treatment of mutual fund trusts will not be changed in a manner which adversely affects the holders of Units.

The Fund Declaration of Trust provides that a sufficient amount of the Fund's net income and net realized capital gains shall be distributed each year to Unitholders in order to eliminate the Fund's liability for tax under Part 1 of the Income Tax Act (Canada). Where such amount of net income and net realized capital gains of the Fund in a taxation year exceeds the cash available for distribution in the year, such excess net income and net realized capital gains will be distributed to Unitholders in the form of additional Units. Unitholders are generally required to include an amount equal to the fair market value of those Units in their taxable income, in circumstances when they do not directly receive a cash distribution.



(1) Trusts governed by registered retirement savings plans, registered
retirement income funds, deferred profit sharing plans and registered
education savings plans, each as defined in the Income Tax Act
(Canada).


On October 31, 2006, the Department of Finance (Canada) announced the "Tax Fairness Plan" whereby the income tax rules applicable to publicly traded trusts and partnerships will be significantly modified. In particular, certain income of (and distributions made by) these entities will be taxed in a manner similar to income earned by (and distributions made by) a corporation. These proposals will be effective for the 2007 taxation year with respect to trusts which commence public trading after October 31, 2006, but the application of the rules will be delayed to the 2011 taxation year with respect to trusts which were publicly traded prior to November 1, 2006 (although the announcement suggested that this transitional relief could be lost under certain circumstances, including the "undue expansion" of an income trust). On December 21, 2006, the Department of Finance (Canada) issued for public comment the draft legislation to implement these proposals. There is no assurance that the draft legislation will be enacted in the manner proposed or at all.

On December 15, 2006, the Department of Finance (Canada) released guidance for income trusts and other flow-through entities that qualify for the four-year transitional relief. The guidance establishes objective tests with respect to how much an income trust is permitted to grow without jeopardizing its transitional relief. In general, the Fund will be permitted to issue new equity over the next four years equal to its market capitalization as of the end of trading on October 31, 2006 (subject to certain annual limits). Market capitalization, for these purposes, is to be measured in terms of the value of the Fund's issued and outstanding publicly traded units. If these limits are exceeded, the Fund may lose its transitional relief and thereby become immediately subject to the proposed rules.

The Fund is considering these announcements and the possible impact of the proposed rules to the Fund. The impact of the proposed rules (including the guidance released on December 15, 2006) may adversely affect the marketability of the Fund's Units and the ability of the Fund to undertake financings and acquisitions, and, at such time as the proposed rules apply to the Fund, the distributable cash of the Fund may be materially reduced.

Dependence on Morneau Sobeco Group LP and Its Subsidiaries

The Fund is an unincorporated open-ended, limited purpose trust that is entirely dependent on the operations and assets of the Trust. Cash distributions to Unitholders will be dependent on, among other things, the ability of the Trust to pay interest on the Trust Notes and to make cash distributions in respect of the Trust Units, which, in turn, is dependent on MS Group LP making cash distributions. MS Group LP's ability to make cash distributions is dependent on the ability of its subsidiaries to make cash distributions or other payments or advances. This will be subject to applicable laws and regulations and contractual restrictions contained in the instruments governing any indebtedness of those entities, including restrictive covenants in the credit facilities.

Cash Distributions Are Not Guaranteed and Will Fluctuate with the Business Performance

Although the Fund intends to distribute the interest received in respect of the Trust Notes and the cash distributions received in respect of the Trust Units, less expenses and amounts, if any, paid by the Fund in connection with the redemption of Units, there can be no assurance regarding the amounts of income to be generated by MS Group LP's businesses or ultimately distributed to the Fund. The ability of the Fund to make cash distributions, and the actual amount distributed, will be entirely dependent on the operations and assets of MS Group LP (and its subsidiaries), and will be subject to various factors including each of its financial performance, its obligations under applicable credit facilities, fluctuations in its working capital, the sustainability of its margins and its capital expenditure requirements. The market value of the Units may deteriorate if the Fund is unable to meet its distribution targets in the future, and that deterioration may be significant. In addition, the composition of cash distributions for tax purposes may change over time and may affect the after-tax return for investors.

Restrictions on Potential Growth

The payout by Morneau Sobeco of substantially all of its operating cash flow will make additional capital and operating expenditures dependent on increased cash flow or additional financing in the future. Lack of those funds could limit the future growth of Morneau Sobeco and its cash flow.

Nature of Units

The Units share certain attributes common to both equity securities and debt instruments. The Units do not represent a direct investment in the businesses of Morneau Sobeco and should not be viewed by investors as direct securities of MS Corp or its subsidiaries. As holders of Units, Unitholders will not have the statutory rights normally associated with ownership of shares of a corporation including, for example, the right to bring "oppression" or "derivative" actions or rights of dissent. The Units represent a fractional interest in the Fund. The Fund's primary assets are Trust Units and Trust Notes.

The Units are not "deposits" within the meaning of the Canada Deposit Insurance Corporations Act (Canada) and are not insured under the provisions of that Act or any other legislation. Furthermore, the Fund is not a trust company and, accordingly, is not registered under any trust and loan company legislation as it does not carry on or intend to carry on the business of a trust company.

Market Price of Units

Publicly traded investment trusts such as the Fund do not necessarily trade at prices determined solely by reference to the underlying value of their investments. Increases in market rates of interest may lead purchasers to demand a higher yield on the Units, which may adversely affect their price. In addition, the market price for the Units may be affected by changes in general market conditions, fluctuations in the markets for equity securities and other factors beyond the Fund's control.

The market value of the Units may deteriorate if the Fund is unable to meet its distribution targets in the future, and that deterioration may be material. In addition, the composition of cash distributions for tax purposes may change over time and may affect the after-tax return for investors.

Leverage and Restrictive Covenants in Agreements Relating to Indebtedness of Morneau Sobeco

The ability of the Trust and its subsidiaries to make distributions or make other payments or advances will be subject to applicable laws and contractual restrictions contained in the instruments governing any indebtedness of those entities. The degree to which MS Group LP or Morneau Sobeco is leveraged could have important consequences to the Unitholders including: Morneau Sobeco's ability to obtain additional financing for working capital, capital expenditures or acquisitions in the future may be limited; a significant portion of Morneau Sobeco's cash flow from operations may be dedicated to the payment of the principal of and interest on its indebtedness, thereby reducing funds available for future operations; certain borrowings will be at variable rates of interests, which exposes Morneau Sobeco to the risk of increased interest rates; and, Morneau Sobeco may be more vulnerable to economic downturns and be limited in its ability to withstand competitive pressures. These factors may increase the sensitivity of distributable cash to interest rate variations.

Distribution of Securities on Redemption or Termination of the Fund

It is anticipated that the redemption right will not be the primary mechanism for Unitholders to liquidate their investments. Upon redemption of Units or termination of the Fund, the Trustees may distribute the Trust Notes and Trust Units directly to the Unitholders, subject to obtaining all required regulatory approvals. Trust Units and Trust Notes so distributed may not be qualified investments for registered plans(1) depending upon the circumstances at the time. There is currently no market for the Trust Notes and the Trust Units.

Dilution of Existing Unitholders and MS Group LP Unitholders

The Fund Declaration of Trust authorizes the Fund to issue an unlimited number of Units for that consideration and on those terms and conditions as shall be established by the Trustees without the approval of any Unitholders. The Unitholders will have no pre-emptive rights in connection with such further issues. Additional Units will be issued by the Fund in connection with the indirect exchange of the Class B MS Group LP Units. In addition, MS Group LP is permitted to issue additional MS Group LP Units for any consideration and on any terms and conditions.

Future Sales of Units by the Management Securityholders

The Management Securityholders hold all of the Class B LP Units, representing in aggregate 20.6% of the outstanding MS Group LP Units, which, pursuant to the Exchange Agreement, can be exchanged for Units at any time, subject to certain conditions. Certain of the Management Securityholders have also been granted certain registration rights by the Fund. If the Management Securityholders sell a substantial number of Units in the public market, the market price of the Units could fall. The perception among the public that these sales will occur could also contribute to a decline in the market price of the Units.

Restrictions on Certain Unitholders and Liquidity of Units

The Fund Declaration of Trust imposes various restrictions on Unitholders. Non-resident Unitholders are prohibited from beneficially owning either more than 40% of Units and/or the Special Voting Units (on a non-diluted and a fully diluted basis). These restrictions may limit (or inhibit the exercise of) the rights of certain persons, including non-residents of Canada and U.S. persons, to acquire Units, to exercise their rights as Unitholders and to initiate and complete takeover bids in respect of the Units. As a result, these restrictions may limit the demand for Units from certain Unitholders and thereby adversely affect the liquidity and market value of the Units held by the public.

Statutory Remedies

The Fund is not a legally recognized entity within the relevant definitions of the Bankruptcy and Insolvency Act, the Companies' Creditors Arrangement Act and in some cases, the Winding- up and Restructuring Act. As a result, in the event a restructuring of the Fund were necessary, the Fund and its stakeholders may not be able to access the remedies and procedures available thereunder.



SUPPLEMENTARY SUMMARY OF QUARTERLY RESULTS

Operating results, distribution summary and condensed balance sheet history
are as follows:

Operating Results, Distribution and Condensed Balance Sheet
Selected Unaudited Consolidated Financial Information
(in thousands of dollars except per unit amounts)

Three Three Three Three Three
Months Months Months Months Months
Ended Ended Ended Ended Ended
December September June March December
31 30 30 31 31
2006 2006 2006 2006 2005

Revenue $34,079 $33,037 $32,793 $32,178 $30,071
Net Income 2,449 1,798 3,355 2,158 2,099
EBITDA 7,890 7,053 7,672 7,228 7,146
EBITDA Margin 23.2% 21.3% 23.4% 22.5% 23.8%
Distributable
Income 6,977 6,753 6,830 6,566 6,543
Distributable Cash(1) 9,080 10,988 9,039 608 6,287
Distributions
declared 6,050 5,731 5,688 5,666 5,729
Net income per
Unit (basic and
diluted) $0.11100 $0.08148 $ 0.15245 $ 0.09821 $0.09553
Distributable
Income per Unit
(basic and
diluted) $0.25111 $0.24305 $ 0.24769 $ 0.23902 $0.23817
Distributable
Cash per Unit
(basic and
diluted) $0.32680 $0.39559 $ 0.32777 $ 0.02212 $0.22886
Distributions
declared per Unit
(basic and
diluted) $0.21775 $0.20625 $ 0.20625 $ 0.20625 $0.20854
Distributable
Income Payout
Ratio 86.7% 84.9% 83.3% 86.3% 87.6%
Distributable
Cash Payout Ratio(1) 66.6% 52.1% 63.0% 932.0% 91.1%
Twelve-month
rolling
Distributable
Income Payout Ratio 85.3% 85.5% n/a n/a n/a
Twelve-month

rolling
Distributable
Cash Payout Ratio 77.9% 85.2% n/a n/a n/a

Total Assets $300,546 $299,723 $307,188 $297,753 $303,718
Total Long-term
debt $35,000 $35,000 $35,000 $35,000 $35,000

(1) Distributable Cash has been restated for the quarters ended December
31, 2005, March 31, 2006 and June 30, 2006 to include changes in non-
cash operating working capital. The Distributable Cash for the three
months ended March 31, 2006 is significantly lower than the
Distributions declared as the company pays its employees their annual
bonuses in that quarter.


Disclosure Controls and Procedures

The Fund's disclosure controls and procedures have been designed to provide reasonable assurance that all relevant information is identified to its Disclosure Committee to ensure appropriate and timely decisions are made regarding public disclosure.

The Chief Executive Officer and the Chief Financial Officer have concluded that the disclosure controls and procedures are operating effectively based on the evaluation of these controls and procedures conducted at December 31, 2006.

Additional Information

The Fund's Units trade on the Toronto Stock Exchange under the symbol MSI.UN. Additional information relating to the Fund, including all public filings, is available on the SEDAR Web site (www.sedar.com) and on our own Web site at www.morneausobeco.com.

The content of this MD&A reflects information known as of March 15, 2007.

Contact Information

  • Morneau Sobeco Income Fund
    William Morneau
    President & CEO
    (416) 445-2700
    or
    Morneau Sobeco
    Andre Pinsonneault
    Manager, Corporate Communications
    (416) 383-6499