Morneau Sobeco Income Fund
TSX : MSI.UN

Morneau Sobeco Income Fund

March 06, 2008 12:49 ET

Morneau Sobeco Releases 2007 Fourth Quarter and Year-End Results

Highlights: - 11.4% annual revenue growth - Net income of $12.1 million - EBITDA of $30.8 million

TORONTO, ONTARIO--(Marketwire - March 6, 2008) - 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 2007 and for the one-year period ending December 31, 2007. Annual revenue was $147.1 million which represents revenue growth of 11.4% for the year 2007.

"In 2007, Morneau Sobeco has consistently capitalized on its three proven growth strategies," said Bill Morneau, Chairman & CEO. "We have expanded mandates from our existing clients, we have gained new clients, and we completed one more acquisition."

Clients representing 98.8% of 2006 revenues remained with Morneau Sobeco in 2007. Those recurring clients alone generated 100.7% of total 2006 revenue in 2007, reflecting the strength of the Fund's recurring revenue model. Morneau Sobeco also increased the number of large client relationships in 2007, with 240 clients generating over $100,000 in revenue, versus 223 in 2006. "Our very strong recurring revenue model enables our continuing focus on growth strategies," commented Bill Morneau.

2007 Year-end Results

The Fund's financial results for 2007 showed that revenue increased by $15.0 million to $147.1 million compared to $132.1 million in 2006. The increase in revenue was a result of additional consulting and outsourcing business from a variety of new and existing clients, and from recent acquisitions. Specifically, $3.8 million of the revenue increase was due to the Fund's acquisition of Heath Benefits Consulting Inc. in June 2006, and $2.6 million was due to the June 2007 acquisition of the defined benefit pension administration and actuarial consulting practices of Cowan Benefits Consulting Limited.

Net income for the year ended December 31, 2007 was $12.1 million compared to net income of $14.0 million for the same period in 2006.

In 2007, Morneau Sobeco increased its investment in its outsourcing business by approximately $1.4 million in operating costs as the firm worked to integrate a number of new mandates. Morneau Sobeco won a number of new outsourcing mandates in 2007, and is working to put these clients onto its Ariel® systems' platform, in order to provide service in 2008 and beyond. The firm's revenue and expense recognition for its outsourcing contracts is conservative, since all costs incurred to integrate new businesses are expensed as incurred, and only relatively modest integration revenue is recognized over this period.

EBITDA at the end of the 2007 year was $30.8 million. This represents an increase of $1.0 million when compared to an EBITDA of $29.8 million for the same period in 2006.

EBITDA margin for the year ended December 31, 2007 was 21.0% compared to 22.6% for 2006. Adjusting for two tax credits and salary accounting related to a prior acquisition, the EBITDA margin was 21.5% for the 2007 year compared to 22.4% for 2006. The lower margin reflects the firm's additional $1.4 million investment in outsourcing.

Standardized Distributable Cash (defined as Cash from operating activities, including the effects of changes in non-cash operating working capital, less maintenance capital expenditures and Consolidated Distributable Cash available to non-controlling interest) was $20.8 million resulting in a payout ratio (defined as declared distributions divided by Standardized Distributable Cash) of 92.7%.

Adjusted Consolidated Distributable Cash (defined as Consolidated Distributable Cash, excluding changes in non-cash operating working capital) for the year ended December 31, 2007 was $28.2 million resulting in a payout ratio (defined as declared distributions divided by Adjusted Consolidated Distributable Cash) of 86.0%, which is the measure on which management focuses. This reflects the 7% increase to the Fund's monthly distributions in March 2007.

2007 Fourth Quarter Results

Revenue in the 2007 fourth quarter increased by 7.7% to $36.7 million compared to $34.1 million for the same period in 2006, reflecting the trends evident in Morneau Sobeco's 2007 year-end results, and an increase in revenue of $1.1 million due to the Cowan DB business acquisition.

Net income for the three months ended December 31, 2007 increased by $1.5 million to $4.5 million compared to $3.0 million for the same period in 2006.

In the fourth quarter of 2007, EBITDA was $7.4 million compared to $7.9 million for the fourth quarter of 2006. This $500,000 (or 6.3%) decrease was partially due to increased salaries and benefits expense, of which $0.4 million related to the firm's investment in its outsourcing practice and $0.7 million related to an e-commerce tax credit in 2006. The 2007 fourth quarter EBITDA margin remained strong at 20.1%, reflecting the strong final quarter for the year, a seasonal occurrence which was anticipated by management.

The Standardized Distributable Cash Payout Ratio for the fourth quarter was 62.6% compared to 66.6% for the same period in 2006. This reflects a $600,000 decrease in capital expenditures (since 2006 included additional real estate integration costs for the Health acquisition), and it was partially offset by the 7% increase to the target monthly distribution commencing March 2007. The Adjusted Consolidated Distributable Cash Payout Ratio for the quarter was 87.3% compared to 86.7% for the same period in 2006.

2008 Outlook

In 2007, Morneau Sobeco initiated a fourth growth strategy: strategic alliances with providers of complementary expertise and services in other geographies or in other fields. Through alliances, the firm is expecting to offer more comprehensive solutions to its clients, including the targeting of mid-size clients in the United States. The Fund is currently making significant progress in its efforts to find alliance partners in the U.S.

"As part of our growth strategy, we continue to look for new acquisitions and alliances to expand our business and our service offerings. Our acquisition and alliance efforts will continue to focus on the Canadian and American markets," Mr. Morneau concluded.

Morneau Sobeco Income Fund's 2007 fourth quarter and year-end results will be discussed during a conference call with Bill Morneau, Chairman & CEO, and Nancy Lala, CFO, this afternoon, Thursday, March 6, 2007 at 4:00 p.m. EST. 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 1,100 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 45 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

To assist investors in assessing the Fund's financial performance, this news release also makes reference to certain non-GAAP measures such as EBITDA, Standardized Distributable Cash, Adjusted Consolidated Distributable Cash, Standardized Distributable Cash Payout Ratio and Adjusted Consolidated Distributable Cash Payout Ratio. Morneau Sobeco believes 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 rather than net income due to the significant amount of amortization expense related to the firm's intangible assets. Morneau Sobeco also believes that Standardized Distributable Cash, Adjusted Consolidated Distributable Cash, Standardized Distributable Cash Payout Ratio and Adjusted Consolidated 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. See the footnotes to the "Results of Operations" chart in the firm's MD&A 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.

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 Morneau Sobeco's publicly filed documents (available on SEDAR at www.sedar.com) and in the firm's 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 the firm's actual results and could cause Morneau Sobeco's actual results to differ materially from those expressed or implied in any forward-looking statement made by Morneau Sobeco or on the firm's 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, Morneau Sobeco undertakes no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise. Additionally, Morneau Sobeco undertakes 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.

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Consolidated Financial Statements of
MORNEAU SOBECO INCOME FUND
For the Years Ended December 31, 2007 and 2006


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 (currently, there is a vacancy as a result of the resignation of one of the Trustees upon his appointment as President of the Fund). 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 Lala
Chairman and CEO Chief Financial Officer


MORNEAU SOBECO INCOME FUND
CONSOLIDATED BALANCE SHEETS
As at December 31
(In thousands of dollars)
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2007 2006
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Assets

Current assets:
Cash $2,898 $5,257
Accounts receivable 27,855 23,315
Unbilled fees 2,067 4,117
Income taxes recoverable 388 774
Prepaid expenses and other 2,016 1,875
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35,224 35,338

Future income taxes (note 12) 3,258 4,383
Interest-rate swap (note 7) 785 840
Capital assets (note 4) 10,186 10,833
Intangible assets (note 5) 115,524 125,027
Goodwill (note 6) 169,451 169,451
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$334,428 $345,872
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Liabilities and Unitholders' Equity
Current liabilities:
Accounts payable and accrued liabilities $6,553 $5,868
Accrued compensation and related benefits 6,943 7,025
Unitholder distributions payable (including
non-controlling) 2,045 2,793
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15,541 15,686
Insurance premium liabilities:
Payable to insurance companies 9,946 9,108
Less related cash and investments held (9,946) (9,108)
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- -

Long-term debt (note 7) 34,913 35,000
Future considerations related to acquisition
(note 3) 2,044 -
Future income taxes (note 12) 29,810 35,047
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82,308 85,733
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Non-controlling interest (note 9) 54,452 56,520
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Unitholders' equity:
Fund units (note 8) 211,833 210,607
Deficit (14,165) (6,988)
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197,668 203,619
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$334,428 $345,872
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Commitments and Contingencies (notes 3,7,15 and16)

See accompanying notes to consolidated financial statements

Robert Chisholm William Morneau
Trustee, Audit Committee Chair Trustee, Chairman and CEO



MORNEAU SOBECO INCOME FUND
CONSOLIDATED STATEMENTS OF INCOME,
OTHER COMPREHENSIVE INCOME AND DEFICIT
(In thousands of dollars except unit and per unit amounts)
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Year Ended Year Ended
December 31, December 31,
2007 2006
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Revenue
Fees $124,313 $113,942
Commissions 22,201 17,669
Other 572 476
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147,086 132,087

Expenses
Salaries and benefits 87,987 76,240
Other operating 28,256 26,004
Amortization of capital assets (note 4) 2,350 2,131
Amortization of intangible assets (note 5) 15,324 14,521
Interest (note 7) 1,718 883
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135,635 119,779

Income before income taxes and non-controlling
interest 11,451 12,308

Income taxes (recovery) (note 12)
Current 322 199
Future (4,110) (5,426)
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(3,788) (5,227)
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Income before non-controlling interest 15,239 17,535

Non-controlling interest (note 9) (3,119) (3,562)
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Net income 12,120 13,973
Other comprehensive income (note 2(l)) - -
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Comprehensive income 12,120 13,973

Deficit, beginning of year (6,988) (2,535)
Distributions declared (note 10) (19,297) (18,426)
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Deficit, end of year $(14,165) $(6,988)
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Net income per Unit (basic and diluted) (note 14) $0.549 $0.634
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See accompanying notes to consolidated financial statements



MORNEAU SOBECO INCOME FUND
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands of dollars)
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Year Ended Year Ended
December 31, December 31,
2007 2006
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Cash provided by (used in):
Operating activities
Net income $12,120 $13,973
Items not involving cash:
Amortization of capital assets (note 4) 2,350 2,131
Amortization of intangible assets (note 5) 15,324 14,521
Amortization of debt issue costs (note 7) 50 -
Non-controlling interest of Class B LP Units 3,119 3,562
Future income taxes (recovery) (4,110) (5,426)
Salary component of Heath acquisition (note 3) 999 513
Fair value of interest-rate swap agreements
(note 7) 55 (840)
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29,907 28,434

Change in non-cash operating working capital:
Accounts receivable (4,540) 777
Income taxes recoverable 386 (9)
Unbilled fees 2,050 365
Prepaid expenses and other (272) 33
Accrued compensation and related benefits (217) 1,261
Accounts payable and accrued liabilities 564 162
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27,878 31,023

Financing activities
Distributions paid (25,007) (22,802)
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(25,007) (22,802)
Investing activities
Business acquisition (note 3) (3,783) (5,097)
Cash and bank indebtedness assumed (note 3) 256 (907)
Purchase of capital assets (1,703) (1,308)
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(5,230) (7,312)

Net increase (decrease) in cash for the year (2,359) 909
Cash, beginning of year 5,257 4,348
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Cash, end of year $2,898 $5,257
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Supplemental disclosures:
Interest paid $1,707 $1,723
Income taxes (refunded) (40) (100)


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See accompanying notes to consolidated financial statements.



MORNEAU SOBECO INCOME FUND
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the years ended December 31, 2007 and 2006
(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 on August 22, 2005.

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, employee compensation and benefit programs.

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
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Morneau Sobeco Limited Partnership ("MSLP") 79.9
Morneau Sobeco Group Limited Partnership ("MS Group LP") 79.9
Morneau Sobeco, Ltd. ("MSUS") 79.9
Morneau Sobeco Corporation ("MS Corp") 79.9
Morneau Sobeco Trust ("Trust") 100.0
Morneau Sobeco GP Inc. ("MS GP") 100.0


All material intercompany transactions and balances have been eliminated upon consolidation.

(b) 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.

(C) 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 the effective date of the policy, net of a provision for return commissions due to policy cancellation.

Investment income is recorded on the accrual basis.

(d) 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. The exchange loss (gain) for the year ended December 31, 2007 was $426 and for the year ended December 31, 2006 was ($69).

(e) 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


(f) 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.

(g) 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.

(h) 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 sheets.

(i) 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 over the three-year vesting period.

(j) Employee future benefits

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

The defined benefit option was closed effective January 1, 1998 and included 8 employees, 5 retirees and 54 deferred vested members as at December 31, 2007. 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.

(k) Income taxes

The Fund uses the asset and liability method of accounting for income taxes. Future income taxes are recognized for the temporary differences between the financial statement carrying amounts of assets and liabilities and their respective tax bases. Future income tax assets and liabilities are measured using enacted or substantively enacted tax rates and laws that are expected to apply to taxable income in the years in which those temporary differences are expected to be reversed or settled. The effect on future income tax assets and liabilities of a change in tax rate is recognized in income in the period that includes the date of enactment or substantive enactment.

(l) Financial instruments

Effective January 1, 2007, the Fund adopted the new recommendations of the Canadian Institute of Chartered Accountants ("CICA") Handbook Section 1530, Comprehensive Income; Section 3855, Financial Instruments - Recognition and Measurement; and section 3865, Hedges, retroactively without restatement. These new Handbook sections provide requirements for the recognition and measurement of financial instruments and the use of hedge accounting. Section 1530 establishes standards for reporting and presenting comprehensive income, which is defined as the change in equity from transactions and other events from non-owner sources. Other comprehensive income refers to items recognized in comprehensive income that are excluded from net income calculated in accordance with generally accepted accounting principles.

Under Section 3855, financial instruments must be classified into one of these five categories: held-for-trading, held-to-maturity, loans and receivables, available-for-sale financial assets or other financial liabilities. All financial instruments, including derivatives, are measured in the balance sheet at fair value except for loans and receivables, held-to-maturity investments and other financial liabilities which are measured at amortized cost. Subsequent measurement and changes in fair value will depend on their initial classification, as follows: held-for-trading financial assets are measured at fair value and changes in fair value are recognized in net income; available-for-sale financial instruments are measured at fair value, with changes in fair value recorded in other comprehensive income until the investment is derecognized or impaired, at which time the amounts would be recorded in net income; and financial assets held-to-maturity, loans and receivables and other financial liabilities are measured at amortized cost using the effective interest method of amortization. Transaction costs are expensed as incurred for financial instruments classified or designated as held-for-trading. For other financial instruments, transaction costs are capitalized on initial recognition.

Upon adoption of these new standards, the Fund designated its cash and short-term investments as held-for-trading, which are measured at fair value. Accounts receivable is classified as loans and receivables, which are measured at amortized cost. Bank indebtedness, accounts payable and accrued liabilities, accrued compensation and related benefits, Unitholder distributions payable and long-term debt, are classified as other financial liabilities. The Fund had neither available-for-sale nor held-to-maturity instruments as at December 31, 2007.

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. The interest-rate swap agreements are classified as held-for-trading and are recorded at their fair value with a corresponding adjustment to interest expense.

The adoption of these Handbook sections had no impact on opening deficit. The Fund had no "other comprehensive income or loss" transactions during the year ended December 31, 2007, and no opening or closing balances for accumulated other comprehensive income or loss.

(j) Future accounting changes

(i) Section 3862, Financial Instruments - Disclosures and Section 3863, Financial Instruments - Presentation, which replace the existing Section 3861, Financial Instruments - Disclosure and Presentation. These new sections revise and enhance disclosure requirements and carry forward unchanged existing presentation requirements. These new sections place an increased emphasis on disclosures and presentation regarding the risks associated with both recognized and unrecognized financial instruments and how the Fund manages those risks.

(ii) Section 1535, Capital Disclosure. This section requires disclosure of the Fund's objectives, policies and processes for managing capital, quantitative data about what the Fund regards as capital and whether the Fund has complied with any capital requirements.

(iii) Section 1400, General Standards of Financial Statement Presentation. This section was amended to include guidance on an entity's ability to continue as a going concern. The revised standard explicitly requires management to assess the Fund's ability to continue as a going concern.

These standards will be effective for the Fund as of January 1, 2008. The Fund does not expect the adoption of these standards will have an impact on the consolidated financial statements as these standards relate to note disclosures or the Fund's ability to continue as a going concern.

3. BUSINESS ACQUISITION

(a) Heath Benefits Consulting Inc. ("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 million, 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 million. These instalments will be primarily settled by issuing a number of Class B LP Units of MS Group LP based on a predetermined value of $12.52 per unit. In addition to the estimate of $15 million, contingent consideration will include amounts to compensate for forgone distributions payable on its second and third instalments during the period from June 1, 2006 to December 1, 2008, which amounted to approximately $645 to the end of December 31, 2007.

These contingent consideration elements will be recorded when the final purchase price has been established 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 estimated payable amount as at December 31, 2007 is $1,512 and the expense for the year ended December 31, 2007 was $ 999 and for the year ended December 31, 2006 was $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 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 3,179
Bank indebtedness (1,734)
Accounts payable and accrued liabilities (1,527)
Future income tax liability (1,923)
Payable to insurance companies (3,156)
Related cash and investments held 3,156
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$9,014
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Consideration:
Cash $449
Debt assumed and repaid 4,648
Exchangeable Units (first instalment paid
on June 20, 2006) 3,917
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$9,014
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These consolidated financial statements include the results of Heath from the date of acquisition.

(b) Cowan Benefits Consulting Limited ("Cowan")

On June 1, 2007, a subsidiary of the Fund directly acquired certain assets, liabilities and contracts of the defined benefit pension administration and actuarial consulting practices ("Cowan DB business") of Cowan, a benefits consulting firm based in the Waterloo region, in Ontario. The purchase price is based on the final pension administration and actuarial consulting services revenue and certain other integration conditions and is expected to be approximately $6 million. The acquisition will be paid in three instalments.

The first instalment was made on the closing date of June 1, 2007 and was funded by $3,800 of the operating line of credit. In addition, the Fund issued a standby letter of credit in the amount of $400, which will be paid on or before December 31, 2008 to the extent the vendor has performed all of its transition services obligations. The second and third instalments are subject to the purchase price adjustment and will be payable on August 1, 2008 and August 1, 2009, respectively.

The contingent consideration has been recognized to the extent the acquired assets net of liabilities assumed exceed the first instalment of the purchase price. 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 acquired.



Assets and liabilities acquired:
Cash $256
Prepaid expenses and other 6
Intangible assets 5,821
Accrued compensation and related benefits (135)
Accounts payable and accrued liabilities (121)
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$5,827
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Consideration:
Cash (financed via operating line of credit) $3,783
Future considerations 2,044
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$5,827
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These consolidated financial statements include the results of the Cowan DB business from the date of acquisition.

4. CAPITAL ASSETS

The Fund's capital assets are comprised of:



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Accumulated Net Book Net Book
Cost Amortization Value Value
2007 2007 2006
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Computer equipment $2,472 ($1,041) $1,431 $1,401
Furniture and equipment 3,628 (1,247) 2,381 2,675
Leasehold improvements 9,032 (2,658) 6,374 6,757
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$15,132 ($4,946) $10,186 $10,833
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Amortization for the years ended December 31, 2007 and 2006 was $2,350 and
$2,131, respectively.

5. INTANGIBLE ASSETS

The Fund's intangible assets are comprised of:

---------------------------------------------------------------------
Accumulated Net Book Net Book
Cost Amortization Value Value
2007 2007 2006
---------------------------------------------------------------------
Customer relationships $103,911 ($11,245) $92,666 $92,110
Customer contracts 5,000 (4,142) 858 2,917
Proprietary software 40,000 (18,000) 22,000 30,000
---------------------------------------------------------------------
$148,911 ($33,387) $115,524 $125,027
---------------------------------------------------------------------
---------------------------------------------------------------------


Amortization for the years ended December 31, 2007 and 2006 was $15,324 and $14,521, respectively.

6. GOODWILL



2007 2006
------------------------------------------------------------------
Balance at beginning of year $169,451 $166,272
Acquisitions (note 3) - 3,179
------------------------------------------------------------------
$169,451 $169,451
------------------------------------------------------------------
------------------------------------------------------------------

7. BANK INDEBTEDNESS AND LONG-TERM DEBT

2007 2006
------------------------------------------------------------------
Secured term loan $35,000 $35,000
Debt issue costs, net of accumulated
amortization (87) -
------------------------------------------------------------------
$34,913 $35,000
------------------------------------------------------------------
------------------------------------------------------------------


The secured term loan of $35,000 is with two Canadian chartered banks and is 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, 2007, the fair value of the swap was $785 (December 31, 2006 - $840). The adjustment to interest expense for the years ended December 31, 2007 and 2006 was $55 and ($840), respectively.

As a result of adopting the new financial instruments standard in 2007, debt issue costs incurred on the secured term loan have been reclassified from prepaid expenses and other to long-term debt. The corresponding amortization of $50 for the year ended December 31, 2007 has been removed from other operating expenses and is now reflected as interest expense. The debt issue costs, net of accumulated amortization, as at December 31, 2006 were $137 and have not been restated.

The Fund also has available a secured operating line of credit for $15,000 with no amount drawn at December 31, 2007 and 2006. The line of credit bears interest at the bankers' acceptance rate plus 1% and the undrawn portion incurs a standby fee of 0.2%. The bank indebtedness and term loan are secured by a general assignment of the assets of the Fund.

The Fund as part of the Cowan DB business acquisition issued a standby letter of credit of $400 to the vendor.

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 up to an aggregate maximum monthly amount of $50. Trustees may, in their sole discretion, waive this limitation. 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:



---------------------------------------------------------------------------
Units Issued Special Voting Total Units Amount
Units
---------------------------------------------------------------------------
Balance,
December 31, 2005 21,977,212 5,494,303 27,471,515 $209,534
Units issued related to
the Heath acquisition 85,704 227,141 312,845 1,073
---------------------------------------------------------------------------
Balance,
December 31, 2006 22,062,916 5,721,444 27,784,360 $210,607
Exchange of
non-subordinated
Class B LP Units 130,003 (130,003) - 1,226
---------------------------------------------------------------------------
Balance,
December 31, 2007 22,192,919 5,591,441 27,784,360 $211,833
---------------------------------------------------------------------------


9. NON-CONTROLLING INTEREST

The former shareholders of Morneau Sobeco and Heath own 5,591,441 Class B LP Units of MS Group LP. 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 20.1% (December 31, 2006 - 20.6%) in the Fund. Some of the Class B LP Units were subordinated in their rights to receive distributions.

Distributions on the Subordinated Class B LP Units were subordinated in favour of the Fund Units and the Non-subordinated Class B LP Units. The distributions on the Subordinated Class B LP Units were 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 had been paid.

The subordination provisions of the Subordinated Class B LP Units applied until the date on which both of the following conditions were satisfied: (i) for four consecutive fiscal quarters of the Fund beginning on December 31, 2006, the Fund 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 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.



--------------------------------------------------------------------------
Class B LP Units Issued
Subordinated Non-subordinated Total Amount
--------------------------------------------------------------------------
Balance,
December 31, 2005 4,095,060 1,399,243 5,494,303 $54,309
Non-subordinated
units issued - 312,845 312,845 3,917
Exchange Units - (85,704) (85,704) (1,073)
Salary component of
Heath acquisition 513
Share of income for
the year 3,562
Distribution for the
year (4,708)
--------------------------------------------------------------------------
Balance,
December 31, 2006 4,095,060 1,626,384 5,721,444 $56,520
Exchange Units - (130,003) (130,003) (1,226)
Subordination
conditions met (4,095,060) 4,095,060 - -
Salary component of
Heath acquisition 999
Share of income for
the year 3,119
Distribution for the
year (4,960)
--------------------------------------------------------------------------
Balance,
December 31, 2007 - 5,591,441 5,591,441 $54,452
--------------------------------------------------------------------------


On October 16, 2007, the Audit Committee of the Fund declared that the conditions of the subordination provisions which applied to approximately 72% of the Class B LP Units had been satisfied and the subordination end date was determined to be September 30, 2007.

10. DISTRIBUTIONS TO UNITHOLDERS

The Board of Trustees determines the amount of distributions. The Fund's Declaration of Trust provides that distributions must be made to ensure that the Fund will not be liable for ordinary income taxes under the Income Tax Act (Canada). Any taxable income of the Fund that is unavailable for cash distribution will be distributed to Unitholders in the form of additional Units, which Units will be immediately consolidated such that each Unitholder will hold after consolidation the same number of Units as the Unitholder held prior to the distribution, subject to certain exceptions.

Commencing on March 2007, the monthly distribution has increased from $0.06875 per Unit to $0.07356 per Unit. Distributions announced during the years ended December 31, 2007 and 2006 were as follows:



-----------------------------------------------------------------------
Paid or payable for the year
Unitholder record date Total Per Unit ended December 31, 2007
Trust Units
-----------------------------------------------------------------------
January 31, 2007 $1,517 $0.06875 February 15, 2007
February 28, 2007 1,517 0.06875 March 15, 2007
March 30, 2007 1,623 0.07356 April 16, 2007
April 30, 2007 1,623 0.07356 May 15, 2007
May 31, 2007 1,623 0.07356 June 15, 2007
June 29, 2007 1,623 0.07356 July 16, 2007
July 31, 2007 1,623 0.07356 August 15, 2007
August 31, 2007 1,627 0.07356 September 17, 2007
September 28, 2007 1,627 0.07356 October 15, 2007
October 31, 2007 1,631 0.07356 November 15, 2007
November 30, 2007 1,631 0.07356 December 17, 2007
December 31, 2007 1,632 0.07356 January 15, 2008
-----------------------------------------------------------------------
$19,297 $0.87310
-----------------------------------------------------------------------
-----------------------------------------------------------------------



Class B LP Units
Non-subordinated
January 31, 2007 $ 112 $ 0.06875 February 15, 2007
February 28, 2007 112 0.06875 March 15, 2007
March 30, 2007 120 0.07356 April 16, 2007
April 30, 2007 120 0.07356 May 15, 2007
May 31, 2007 120 0.07356 June 15, 2007
June 29, 2007 120 0.07356 July 16, 2007
July 31, 2007 120 0.07356 August 15, 2007
August 31, 2007 116 0.07356 September 17, 2007
September 28, 2007 116 0.07356 October 15, 2007
October 31, 2007 412 0.07356 November 15, 2007
November 30, 2007 411 0.07356 December 17, 2007
December 31, 2007 411 0.07356 January 15, 2008
-------------------------------------------------------------------------
$ 2,290 $0.87310
-------------------------------------------------------------------------
Subordinated
March 30, 2007 $ 864 $ 0.21106 April 16, 2007
June 29, 2007 903 0.22068 July 16, 2007
September 28, 2007 903 0.22068 October 15, 2007
-------------------------------------------------------------------------
$ 2,670 $0.65242
-------------------------------------------------------------------------



Unitholder record date Total Per Unit Paid or payable for the year
ended December 31, 2006
Trust Units
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
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
-------------------------------------------------------------------------


11. LONG-TERM INCENTIVE PLAN

Senior management is eligible to participate in Morneau Sobeco's Long-Term Incentive Plan ("LTIP"), which is designed to align compensation with the performance of the Fund's subsidiaries, to aid in the retention of a select group of senior professionals. The Fund's Compensation, Nominating and Corporate Governance Committee of the Board of Trustees (the "Committee") determines (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 sets aside a pool of funds in an amount determined by the Board. Morneau Sobeco or a trustee purchases Units in the market with this pool of funds and holds the Units until such time as ownership vests to each participant. Generally, Units will either vest upon departure from the firm after a period of at least three years, or in equal amounts over a period of three years following the grant of the awards. LTIP participants are 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, or as otherwise directed.

The Committee awarded a payment under the terms of the LTIP of $1,340 for the year ended December 31, 2007 (December 31, 2006 - $386). This amount is recorded as salary expense over a three-year vesting period subsequent to the year of the grant. The expense recognized for the year ended December 31, 2007 was $129 (for the year ended December 31, 2006 - $nil).

12. INCOME TAXES

The Fund currently qualifies as a Mutual Fund Trust for Canadian income tax purposes. Prior to new legislation relating to the federal income taxation of publicly-listed or traded trusts, as discussed below, income earned by the Fund and distributed annually to Unitholders was not, and would not be, subject to taxation in the Fund. For financial statement reporting purposes, the tax deductibility of the Fund's distributions was treated as an exemption from taxation as the Fund distributed and was committed to continue distributing all of its income to its Unitholders. Accordingly, the Fund did not previously record a provision for income taxes, or future income tax assets or liabilities, in respect of the Fund and its flow-through entities. The Fund, however, recorded current and future income tax liability relating to the corporate subsidiaries.

On June 22, 2007, legislation relating to the federal income taxation of a "specified investment flow-through" trust or partnership (a "SIFT"), received Royal Assent (the "SIFT Rules"). A SIFT includes a publicly-listed or traded partnership and trust, such as an income trust and a real estate investment trust. The Fund is a SIFT, as discussed below.

Under the SIFT Rules, following a transition period for qualifying SIFTs, certain distributions from a SIFT will no longer be deductible in computing a SIFT's taxable income, and a SIFT will be subject to tax on such distributions at a rate that is substantially equivalent to the general tax rate applicable to a Canadian corporation. Distributions paid by a SIFT as returns of capital will not be subject to the tax.

A SIFT which was publicly listed on or before October 31, 2006 (an "Existing Trust") will become subject to the tax on distributions commencing with the 2011 taxation year end. However, an Existing Trust may become subject to this tax prior to the 2011 taxation year if its equity capital increases beyond certain limits measured against the market capitalization of the Existing Trust at the close of trading on October 31, 2006.

As a result of the SIFT Rules, the Fund commenced recognizing future income tax assets and liabilities with respect to the temporary differences between the carrying amounts and tax bases of its assets and liabilities, and those of its flow-through entities that are expected to reverse in or after 2011. Future income tax assets or liabilities are recorded using tax rates and laws expected to apply when the temporary differences are expected to reverse. The SIFT Rules resulted in the Fund recording a future income tax expense of $2,670 at the initial application in June 2007.

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 Year Ended
December 31, December 31,
2007 2006
Federal 22.12% 22.12%
Provincial 12.06% 12.17%
--------------------------------------------------------------------------
34.18% 34.29%
--------------------------------------------------------------------------
--------------------------------------------------------------------------
Income tax provision applied to income before
income taxes:
Combined basic federal and provincial income
taxes at statutory rates applied to income
from operations $3,914 $4,220
Earnings taxed in the hands of the Unitholders (7,486) (7,588)
Non-deductible expenses 474 297
Impact of new SIFT rules 2,670 -
Adjustment to future income tax assets and liabilities
for change in income tax rate (2,938) (2,543)
Other (422) 387
--------------------------------------------------------------------------
--------------------------------------------------------------------------
$(3,788) $(5,227)
--------------------------------------------------------------------------
--------------------------------------------------------------------------

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

2007 2006
Future income tax assets:
Initial Fund Unit issuance costs $2,581 $3,691
Capital assets 652 638
Others 25 54
--------------------------------------------------------------------------
$3,258 $4,383
--------------------------------------------------------------------------
--------------------------------------------------------------------------
Future income tax liability:
Intangible assets $29,810 $35,047
--------------------------------------------------------------------------
--------------------------------------------------------------------------


13. EMPLOYEE FUTURE BENEFITS

The Fund offers a pension benefit plan for 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. Information about the pension plan's defined benefit option is as follows:



Year Ended Year Ended
December 31, December 31,
2007 2006
--------------------------------------------------------------------------
Fair value of plan assets $2,897 $2,562
Accrued benefit obligation 3,218 3,164
--------------------------------------------------------------------------
Funded status -- deficit $(321) $(602)
--------------------------------------------------------------------------
--------------------------------------------------------------------------

Plan assets:
Fair value, beginning of year $2,562 $2,954
Actual return on plan assets 108 217
Employer contributions 285 260
Benefits paid (58) (869)
--------------------------------------------------------------------------
Fair value, end of year $2,897 $2,562
--------------------------------------------------------------------------
--------------------------------------------------------------------------

Accrued benefit obligation:
Balance, beginning of year $3,164 $3,896
Current service cost 91 90
Interest cost 161 169
Benefits paid (58) (869)
Actuarial gains (140) (122)
--------------------------------------------------------------------------
Balance, end of year $3,218 $3,164
--------------------------------------------------------------------------
--------------------------------------------------------------------------

Reconciliation of plan assets to accrued benefit
obligation, end of year:
Fair value of plan assets $2,897 $2,562
Accrued benefit obligation 3,218 3,164
--------------------------------------------------------------------------
Funded status -- deficit (321) (602)
Unamortized net actuarial loss (gain) (36) 155
Unamortized transitional obligation 359 449
--------------------------------------------------------------------------
Accrued benefit asset: $2 $2
--------------------------------------------------------------------------
--------------------------------------------------------------------------
End of year allocation of fair value of plan assets (%):
Pooled Equities Fund 45% 45%
Pooled Bond Fund 55% 55%
--------------------------------------------------------------------------
100% 100%
--------------------------------------------------------------------------
--------------------------------------------------------------------------
Pension plan cost:
Current service cost $91 $90
Interest cost on accrued benefit obligation 161 169
Return on plan assets (108) (217)
Actuarial gains during the year on accrued benefit
obligation (140) (122)
--------------------------------------------------------------------------
$4 $(80)
Other adjustments:
Difference between actual and expected return
on plan assets (79) 32
Amortization of actuarial losses 270 223
Transitional amounts 90 90
--------------------------------------------------------------------------
Net pension plan expense $285 $265
--------------------------------------------------------------------------
--------------------------------------------------------------------------


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

Year Ended Year Ended
December 31, December 31,
2007 2006
--------------------------------------------------------------------------
Employer contributions $285 $260
Benefits paid 58 869


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, 2006.



Weighted average assumptions:

Weighted average of the amounts assumed Year Ended Year Ended
in accounting for the plan: December 31, December 31,
2007 2006
--------------------------------------------------------------------------
Discount rate at the end of the current fiscal
period used to determine the accrued benefit
obligation 5.50% 5.00%
Discount rate at the end of preceding period used
to determine the benefit cost 5.00% 4.75%
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%


The net expense for the Fund's defined contribution option for the year ended December 31, 2007 was $1,848 and for the year ended December 2006 was $1,623.

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 following table reconciles the weighted average number of Units outstanding used in computing basic Net income per Unit to weighted average number of Units in computing diluted Net income per Unit:



Year Ended Year Ended
December 31, December 31,
2007 2006
--------------------------------------------------------------------------
Basic:
Net income $12,120 $13,973
--------------------------------------------------------------------------

Weighted average number of Units outstanding 22,098,207 22,022,529
--------------------------------------------------------------------------
Diluted:
Net income $12,120 $13,973
Non-controlling interest 3,119 3,562
--------------------------------------------------------------------------
Net income available to Unitholders and
Class B LP Unitholders $15,239 $17,535
--------------------------------------------------------------------------

Weighted average number of Units outstanding
- basic 22,098,207 22,022,529
Weighted average exchangeable Class B LP
Units outstanding 5,686,153 5,632,407
--------------------------------------------------------------------------
Total weighted average number of diluted Units 27,784,360 27,654,936
--------------------------------------------------------------------------
Net income per Unit - basic and diluted $0.549 $0.634
--------------------------------------------------------------------------
--------------------------------------------------------------------------


15. COMMITMENTS

The Fund has lease commitments for office premises and equipment with options for renewal. As at December 31, 2007 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:



2008 $6,021
2009 5,454
2010 4,398
2011 3,704
2012 2,769
Thereafter 4,347
--------------------------------------
Total $26,693
--------------------------------------
--------------------------------------


In addition, the Fund entered into a sublease agreement in 2006 to sublet one of the former Heath 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 on October 30, 2011. The fair value of the total future lease payments as at December 31, 2007 was $667. The Fund considers the risk of default by the subtenant to be low therefore no accrual has been set up for the guarantee.

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

Revenue from the Fund's largest client was approximately 11% of the total revenue for the year ended December 31, 2007 (for the year ended December 31, 2006 - 12%). The Fund's top 10 clients accounted for approximately 31% of the total revenue for the year ended December 31, 2007 (for the year ended December 31, 2006 - 34%).

Accounts receivable from the Fund's largest client was approximately 2% of the total accounts receivable as at December 31, 2007 (December 31, 2006 - 4%). The Fund's top 10 clients accounted for approximately 24% of the total accounts receivable as at December 31, 2007(December 31, 2006 - 27%).

The Fund, in its normal course of business, is exposed to credit risk from its clients. Risk associated with concentration of credit risk with respect to accounts receivable is limited due to the credit rating of the Funds top 10 clients. The Fund has over 1,000 clients, with no client consisting of greater than 1% of total revenue with the exception of the top 10 clients.

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 Year Ended
Revenue: December 31, December 31,
2007 2006
-------------------------------------------------------------------
Canada $138,745 $125,156
United States 8,341 6,931

2007 2006
-------------------------------------------------------------------
Assets:
Canada $332,397 $343,823
United States 2,031 2,049
Liabilities:
Canada $136,367 $141,967
United States 393 286


The Fund is not engaged in currency hedging activities and does not own other instruments that may be settled by the delivery of non-financial assets. The Fund realizes a portion of sales in U.S. dollars and is 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$4,126 for the year ended December 31, 2007 (for the year ended December 31, 2006 - US$3,026).

19. 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.

-------------------------------------------------------------------------

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").

This Management's Discussion and Analysis ("MD&A") covers the year ended December 31, 2007 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, 2007 as well as the MD&A, Supplemental MD&A and Restated Audited Consolidated Financial Statements and notes thereto contained for the year ended December 31, 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, Standardized Distributable Cash, Adjusted Consolidated Distributable Cash, Standardized Distributable Cash Payout Ratio and Adjusted Consolidated 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 rather than net income due to the significant amount of amortization expense related to our intangible assets. We also believe that Standardized Distributable Cash, Adjusted Consolidated Distributable Cash, Standardized Distributable Cash Payout Ratio and Adjusted Consolidated 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. 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.

This MD&A is in all material respects in accordance with the recommendations provided in CICA's publication Standardized Distributable Cash in Income Trusts and Other Flow-Through Entities: Guidance on Preparation and Disclosure.

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 22,192,919 Class A Limited Partnership units of Morneau Sobeco Group Limited Partnership ("MS Group LP"), which represents a 79.9% 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 20.1% 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. 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, 2007, 22,192,919 Units and 5,591,441 Special Voting Units of the Fund were issued and outstanding, and 5,591,441 MS Group LP Class B 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 1,100 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. 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.

SUMMARY AND OUTLOOK

The results for 2007 met our expectations, from both a revenue and profitability standpoint. Revenue growth was 11.4% compared to 9.8% for 2006, and EBITDA margin was 21.0% compared to 22.6% for 2006. Adjusting for the one-time tax credit in June 2007 of $0.2 million and in December 2006 of $0.7 million and the salary component of the Heath acquisition(1) for the years ending 2007 and 2006 in the amount of $1.0 million and $0.5 million respectively, the EBITDA margin was 21.5% for the year ended December 31, 2007 compared to 22.4% for 2006.

During the year, we increased our investment in our outsourcing business by approximately $1.4 million in operating costs as we worked to integrate a number of new mandates. Our revenue and expense recognition for our outsourcing contracts is conservative, as all costs incurred to integrate new businesses are expensed as incurred, and only relatively modest integration revenue is recognized over this period.

On June 1, 2007, a subsidiary of the Fund directly acquired certain assets, liabilities and contracts of the defined benefit pension administration and actuarial consulting practices ("Cowan DB business") of Cowan Benefits Consulting Limited, a benefits consulting firm based in the Waterloo region, in Ontario. The purchase price is based on the final pension administration and actuarial consulting services revenue and certain other integration conditions and is expected to be approximately $6.0 million. The first instalment of the purchase price was made on the closing date of June 1, 2007 and was funded by an operating line of credit of $3.8 million. The operating line of credit was repaid in the third quarter with excess funds from operations. The balance of the purchase price will be paid in two instalments on August 1, 2008 and August 1, 2009. The Cowan DB business has been fully integrated and was immediately accretive to the Fund.

Our business remains solid. We continue to achieve organic growth. In addition, the market for our services continues to be positive as we have successfully obtained a number of new clients which we are investing in today and they will contribute positively to our 2008 and 2009 organic growth. As part of our growth strategy, we continue to look for new acquisitions and alliances to expand our business and our service offerings. Our acquisition and alliance efforts are focused on the Canadian and American markets.

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.

As a result of our consistent growth, the Board of Trustees 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 paid on April 16, 2007.

On October 16, 2007, the Audit Committee of the Fund declared that the conditions of the subordination provisions which applied to approximately 72% of the Class B LP Units had been satisfied and the subordination end date was determined to be September 30, 2007.

The following table presents excess / (shortfall) cash flow from operating activities and net income over distributions to Unitholders for the years ended December 31, 2007 and 2006 and the period from August 22, 2005 to December 31, 2005.

(1) On June 1, 2006, the Fund indirectly acquired all of the issued and outstanding shares of Heath Benefits Consulting Inc. ("Heath"). A portion of the purchase price, which is conditional on the continuing employment of certain selling shareholders, is being recorded as salary expense over the required employment period to December 2008.




Period from
August 22,
Year ended Year ended 2005 to
December December December
(In thousands of dollars) 31, 2007 31, 2006 31, 2005
---------------------------------------------------------------------------
Cash flows from operating activities $27,878 $31,023 $6,329
Net income 12,120 13,973 2,048
Distributions to Unitholders,
including Class B LP Units 24,257 23,134 5,729
Excess of cash flow from operating
activities over distributions 3,621 7,889 600
(Shortfall) of net income from operating
activities over distributions (12,137) (9,161) (3,681)


We consider the amount of cash generated by the business in determining the amount of distributions payable to Unitholders. In general, we do not take into account quarterly working capital fluctuations as these tend to be temporary in nature. We do not generally consider net income in setting the level of distributions as this is a non-cash metric and is not reflective of the level of cash flow that we generate. The divergence is particularly relevant for us since we have a relatively high level of amortization expense as well as non-controlling interest related to the Class B LP Units. Excess cash from operating activities over distributions has been used to finance growth in accounts receivable, capital expenditures and acquisitions.

The Standardized Distributable Cash Payout Ratio for the year ended December 31, 2007 was 92.7% compared to 77.9% for the same period in 2006. This reflects the 7% increase to the target monthly distribution commencing March 2007, increased accounts receivable in line with our revenue growth, and additional capital expenditures related to our business expansion and recent acquisition of the Cowan DB business. The Adjusted Consolidated Distributable Cash Payout Ratio for the year ended December 31, 2007 was 86.0% compared to 85.3% for the same period in 2006.



ANALYSIS OF 2007 OPERATING RESULTS
Results of Operations

Selected Unaudited Consolidated
Financial Information Three months ended Year ended
(In thousands of dollars December 31 December 31
except per unit amounts) 2007 2006 2007 2006
--------------------------------------------------------------------------
Revenue $36,707 $34,079 $147,086 $132,087
Deduct:
Salaries and benefits expense 22,027 18,741 87,987 76,240
Other operating expense 7,289 7,448 28,256 26,004
Interest 613 471 1,718 883
Amortization of capital and
intangible assets 4,587 4,251 17,674 16,652
Income taxes (recovery) (3,444) (623) (3,788) (5,227)
Non-controlling interest 1,146 781 3,119 3,562
--------------------------------------------------------------------------
Net income for the period 4,489 3,010 12,120 13,973
Add (deduct):
Amortization of capital and
intangible assets 4,587 4,251 17,674 16,652
Income taxes (recovery) (3,444) (623) (3,788) (5,227)
Interest 613 471 1,718 883
Non-controlling interest 1,146 781 3,119 3,562
--------------------------------------------------------------------------
EBITDA(1) $7,391 $7,890 $30,843 $29,843
--------------------------------------------------------------------------
EBITDA margin 20.1% 23.2% 21.0% 22.6%
--------------------------------------------------------------------------

Cash from operating activities $10,012 $9,861 $27,878 $31,023
Deduct: Capital expenditures 197 781 1,703 1,308
--------------------------------------------------------------------------
Consolidated Distributable
Cash(2) 9,815 9,080 26,175 29,715
Deduct: Consolidated
Distributable Cash available to
non-controlling interest 2,003 1,870 5,358 6,076
--------------------------------------------------------------------------
Standardized Distributable
Cash (available for
Unitholders)(3) $7,812 $7,210 $20,817 $23,639
--------------------------------------------------------------------------

Consolidated Distributable
Cash(2) $9,815 $9,080 $26,175 $29,715
Add (deduct): Non-cash
operating working capital (2,790) (2,103) 2,028 (2,589)
--------------------------------------------------------------------------
Adjusted Consolidated
Distributable Cash(4) $7,025 $6,977 $28,203 $27,126
--------------------------------------------------------------------------

Net income per Unit
(basic and diluted) $0.203 $0.136 $0.549 $0.634
Standardized Distributable
Cash per Unit
(basic and diluted) $0.352 $0.327 $0.942 $1.073
Adjusted Consolidated

Distributable Cash per Unit
(basic and diluted) $0.253 $0.251 $1.015 $0.981
Standardized Distributions
declared per Unit
(basic and diluted) $0.221 $0.218 $0.873 $0.837
Standardized Distributable
Cash Payout Ratio(5) 62.6% 66.6% 92.7% 77.9%
Adjusted Consolidated
Distributable Cash Payout
Ratio(6) 87.3% 86.7% 86.0% 85.3%


Footnotes:

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

(2) "Consolidated Distributable Cash" is defined as cash from operating activities adjusted for maintenance capital expenditures.

(3) "Standardized Distributable Cash" is defined as cash from operating activities, including the effects of changes in non-cash operating working capital, less maintenance capital expenditures and Consolidated Distributable Cash available to non-controlling interest.

(4) "Adjusted Consolidated Distributable Cash" is defined as Consolidated Distributable Cash excluding changes in non-cash operating working capital.

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

(6) "Adjusted Consolidated Distributable Cash Payout Ratio" is defined as declared distributions divided by Adjusted Consolidated Distributable Cash.

ANALYSIS OF 2007 ANNUAL RESULTS

Revenue

Revenue for the year ended December 31, 2007 increased by $15.0 million, or 11.4%, to $147.1 million compared to $132.1 million for the same period in 2006. The increase in revenue was a result of additional consulting and outsourcing business from a variety of clients. Revenue also increased by $3.8 million due to the Heath acquisition and by $2.6 million due to the Cowan DB business acquisition.

Salaries and Benefits

Salaries and benefits for the year ended December 31, 2007 increased by $11.8 million, or 15.4%, to $88.0 million compared to $76.2 million for the same period in 2006. The increase was mainly attributable to increased salaries and benefits of $2.2 million for Heath, increased salary component of Heath accounting of $0.5 million, increased salaries and benefits of $1.2 million for the Cowan DB business, additional staffing related to the outsourcing business of $1.4 million and general increases of $6.0 million. The increase was also attributable to a non-recurring tax credit of $0.7 million in 2006 related to e-commerce in Quebec compared to a $0.2 million research and development tax credit in 2007.

Other Operating Expenses

Other operating expenses for the year ended December 31, 2007 increased by $2.3 million, or 8.7%, to $28.3 million compared to $26.0 million for the same period in 2006. The increase was primarily attributable to Heath operating expenses of $0.8 million, Cowan DB business operating expenses of $0.3 million, an increase in recruitment costs of $0.5 million and a general increase of $0.7 million.

Interest Expense

Interest expense for the year ended December 31, 2007 increased by $0.8 million to $1.7 million compared to $0.9 million for the same period in 2006. The change was primarily related to the reduction in interest expense of $0.8 million as a result of the recognition of the fair value of the interest-rate swap in 2006 compared to $0.1 million interest expense as a result of change in the fair value of the interest-rate swap in 2007.

Amortization of Capital and Intangible Assets

Amortization for the year ended December 31, 2007 increased by $1.0 million, or 6.1%, to $17.7 million compared to $16.7 million for the same period in 2006. The increase was primarily attributable to the increase in the amortization of intangible assets as a result of the acquisitions of Heath and the Cowan DB business.

Income Tax Recovery

Income tax recovery for the year ended December 31, 2007 decreased by $1.4 million, or 27.5%, to $3.8 million compared to $5.2 million for the same period in 2006. The change was primarily attributable to the initial application of the income taxation of specified investment flow-through entities ("SIFT") rules which resulted in a future income tax expense of $2.7 million. This was offset by a higher future income tax recovery of $0.9 million in 2007 compared to 2006 as a result of the changes in future tax rates and taxable subsidiary share of temporary differences between the carrying amounts and tax bases of its assets and liabilities.

Net Income

As a result of the changes noted above, the net income for the year ended December 31, 2007 was $12.1 million compared to the net income of $14.0 million for the same period in 2006.

Cash from Operating Activities

Cash from operating activities for the year ended December 31, 2007 decreased by $3.1 million to $27.9 million compared to $31.0 million for the same period in 2006. This decrease was primarily due to decreased changes in non-cash operating working capital of $4.6 million (see below) offset by improved EBITDA of $1.5 million after adjusting for the changes in the salary component of the Heath acquisition of $0.5 million.

Changes in Non-Cash Operating Working Capital

Changes in non-cash operating working capital for the year ended December 31, 2007 decreased by $4.6 million to a use of $2.0 million compared to a source of $2.6 million for the same period in 2006. The decrease was primarily attributable to increased changes in accounts receivable net of unbilled fees of $3.6 million due to growth in revenue, and decreased changes in accrued compensation and related benefits of $1.5 million, as a portion of the 2005 bonuses were paid prior to the IPO. These were partially offset by a decrease of $0.4 million in income tax recoverable and $0.1 million changes in payables and prepaid expenses.

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

EBITDA

EBITDA for the year ended December 31, 2007 increased by $1.0 million, or 3.4%, to $30.8 million compared to $29.8 million for the same period in 2006. The increase was due to increased revenue of $15.0 million, partially offset by increased salaries and benefits expense and operating costs of $14.0 million.

Standardized Distributable Cash

Standardized Distributable Cash for the year ended December 31, 2007 decreased by $2.8 million, or 11.9%, to $20.8 million compared to $23.6 million for the same period in 2006. This decrease was primarily due to decreased cash from operating activities of $3.1 million and increased capital expenditures of $0.4 million as a result of additional leasehold improvements due to the expansion of our Montreal and Toronto locations and the opening of our new office in Kitchener-Waterloo as part of the Cowan DB business acquisition. This was partially offset by a decrease of $0.7 million in Consolidated Distributable Cash available to non-controlling interest.

Adjusted Consolidated Distributable Cash

Adjusted Consolidated Distributable Cash for the year ended December 31, 2007 increased by $1.1 million, or 4.0%, to $28.2 million compared to $27.1 million for the same period in 2006. The increase was primarily due to an increase in EBITDA of $1.5 million after adjusting for the salary component of the Heath acquisition of $0.5 million. This was partially offset by increased capital expenditures of $0.4 million as a result of additional leasehold improvements due to the expansion of our Montreal and Toronto locations and the opening of our new office in Kitchener-Waterloo as part of the Cowan DB business acquisition.

ANALYSIS OF 2007 FOURTH QUARTER RESULTS

Revenue

Revenue for the three months ended December 31, 2007 increased by $2.6 million, or 7.7%, to $36.7 million compared to $34.1 million for the same period in 2006. The increase in revenue was a result of additional consulting and outsourcing business from a variety of clients, with $1.2 million from two new outsourcing clients. Revenue also increased by $1.1 million due to the Cowan DB business acquisition.

Salaries and Benefits

Salaries and benefits for the three months ended December 31, 2007 increased by $3.3 million, or 17.5%, to $22.0 million compared to $18.7 million for the same period in 2006. The increase was attributable to increased salaries and benefits of $0.5 million for the Cowan DB business, the additional staffing costs related to the outsourcing business of $0.4 million and general increases of $1.7 million. The increase was also attributable to a non-recurring tax credit of $0.7 million in 2006, related to e-commerce activities in the province of Quebec.

Other Operating Expenses

Other operating expenses for the three months ended December 31, 2007 decreased by $0.2 million, or 2.1%, to $7.3 million compared to $7.5 million for the same period in 2006. The decrease was primarily attributable to streamlined communication expenses of $0.2 million and general cost containment of $0.2 million. It was partially offset by $0.2 million due to the Cowan DB business acquisition.

Interest Expense

Interest expense for the three months ended December 31, 2007 increased by $0.1 million to $0.6 million compared to $0.5 million for the same period in 2006. The change was primarily related to the recognition of the fair value of the interest-rate swap of $0.2 million in 2007 compared to $0.1 million for the same period in 2006.

Amortization of Capital and Intangible Assets

Amortization for the three months ended December 31, 2007 increased by $0.3 million, or 7.9%, to $4.6 million compared to $4.3 million for the same period in 2006. The increase was primarily attributable to the increase in the amortization of intangible assets as a result of the acquisition of the Cowan DB business.

Income Tax Recovery

Income tax recovery for the three months ended December 31, 2007 increased by $2.8 million to $3.4 million compared to $0.6 million for the same period in 2006. The increase was primarily attributable to a decline in net future income tax liability of $2.9 million as a result of the change in future tax rates.

Net Income

As a result of the changes noted above, the net income for the three months ended December 31, 2007 was $4.5 million compared to the net income of $3.0 million for the same period in 2006.

Cash from Operating Activities

Cash from operating activities for the three months ended December 31, 2007 increased by $0.2 million to $10.0 million compared to $9.8 million for the same period in 2006. This increase was primarily due to increased changes in non-cash operating working capital of $0.7 million (see below) offset by lower EBITDA of $0.5 million.

Changes in Non-Cash Operating Working Capital

Changes in non-cash operating working capital for the three months ended December 31, 2007 increased by $0.7 million to $2.8 million compared to $2.1 million for the same period in 2006. The increase was

primarily attributable to the decrease in accounts receivable net of unbilled fees of $0.8 million due to timing of collections and the decrease in income tax recoverable of $0.9 million primarily due to the receipt of the 2006 e-commerce tax credit in 2007. This was partially offset by increased payables and accrued compensation of $1.1 million.

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

EBITDA

EBITDA for the three months ended December 31, 2007 decreased by $0.5 million, or 6.3%, to $7.4 million compared to $7.9 million for the same period in 2006. The decrease was due to increased salaries and benefits expense of $3.3 million, of which $0.4 million related to our investment in the outsourcing practice and $0.7 million related to our e-commerce tax credit in 2006. This was partially offset by decreased operating costs of $0.2 million and increased revenue of $2.6 million.

Standardized Distributable Cash

Standardized Distributable Cash for the three months ended December 31, 2007 increased by $0.6 million, or 8.4%, to $7.8 million compared to $7.2 million for the same period in 2006. This increase was primarily due to increased cash from operating activities of $0.2 million and decreased capital expenditures of $0.6 million, of which $0.4 million related to the integration of the Heath locations in 2006. This was partially offset by an increase of $0.2 million in Consolidated Distributable Cash available to non-controlling interest.

Adjusted Consolidated Distributable Cash

Adjusted Consolidated Distributable Cash for the three months ended December 31, 2007 was $7.0 million, comparable to the Adjusted Consolidated Distributable Cash of $7.0 million for the same period in 2006.

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 Three months ended Year ended
Financial Information December 31 December 31
(In thousands of dollars) 2007 2006 2007 2006
--------------------------------------------------------------------------
Cash provided by (used in):
Operating activities $10,012 $9,861 $27,878 $31,023
Investing activities (197) (781) (5,230) (7,312)
Financing activities (6,732) (5,731) (25,007) (22,802)
--------------------------------------------------------------------------
Increase (decrease) in cash $3,083 $3,349 $(2,359) $909
--------------------------------------------------------------------------


2007 Annual Results

Cash from operating activities for the year ended December 31, 2007 decreased by $3.1 million to $27.9 million compared to $31.0 million for the same period in 2006. This decrease was primarily due to decreased changes in non-cash operating working capital of $4.6 million partially offset by improved EBITDA of $1.5 million after adjusting for the salary component of the Heath acquisition of $0.5 million.

Cash outflows from investing activities for the year ended December 31, 2007 decreased by $2.1 million to $5.2 million compared to cash outflows of $7.3 million for the same period in 2006. This decrease was primarily attributable to lower business acquisition spending net of cash assumed of $2.5 million for the acquisition of the Cowan DB business compared to the acquisition of Heath during the same period in 2006. This was partially offset by increased capital expenditures of $0.4 million compared to the same period in 2006 as a result of additional leasehold improvements due to expansion of our Montreal and Toronto locations and the opening of our new office in Kitchener-Waterloo as part of the Cowan DB business acquisition.

Cash outflows from financing activities for the year ended December 31, 2007 increased by $2.2 million to $25.0 million compared to cash outflows of $22.8 million for the same period in 2006. This increase was primarily attributable to the 7% increase to our target monthly distribution from $0.06875 per Unit to $0.07356 per Unit, commencing with the March 2007 distribution.

2007 Fourth Quarter Results

Cash from operating activities for the three months ended December 31, 2007 increased by $0.2 million to $10.0 million compared to $9.8 million for the same period in 2006. This increase was primarily due to increased changes in non-cash operating working capital of $0.7 million offset by lower EBITDA of $0.5 million.

Cash outflows from investing activities for the three months ended December 31, 2007 decreased by $0.6 million to $0.2 million compared to cash outflows of $0.8 million for the same period in 2006. This decrease was primarily attributable to decreased capital expenditures of $0.6 million compared to the same period in 2006, as 2006 expenditures included $0.4 million in leasehold improvements related to the integration of the Heath locations.

Cash outflows from financing activities for the three months ended December 31, 2007 increased by $1.0 million to $6.7 million compared to cash outflows of $5.7 million for the same period in 2006. This increase was primarily attributable to the 7% increase to our target monthly distribution from $0.06875 per Unit to $0.07356 per Unit, commencing with the March 2007 distribution.

Capital Expenditures

Pension and benefits consulting and outsourcing is not a capital intensive business. Our capital expenditures typically include office furniture, facility improvements, and information technology hardware. Additional capital expenditure requirements may result from significant business expansion. Such amounts are expected to be funded from our operating cash flow.

Contractual Obligations

Commitments

We lease office space and selected equipment under operating lease agreements with terms ranging from one to twelve 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 2008 to 2009 2010 to 2011 Beyond 2011
---------------------------------------------------------------------------
Term loan $35,000 $35,000 $- $-
Operating leases 26,693 11,475 8,102 7,116
---------------------------------------------------------------------------
Total $61,693 $46,475 $8,102 $7,116
---------------------------------------------------------------------------


In addition, the Fund has entered into a sublease agreement to sublet one of Heath's office premises. According to the agreement, we are liable for the rent in case of a default by the subtenant. The average annual rent for the lease is $190,000 and the lease expires on October 30, 2011.

Contingent Considerations



The purchase price for the Cowan DB business is expected to be approximately $6 million and the amount will be paid in three instalments. The first instalment of $3.8 million was made on the closing date of June 1, 2007. The second and third instalments are subject to adjustment based on final pension administration and actuarial consulting services revenue and will be payable on August 1, 2008 and August 1, 2009 respectively. In addition, we have issued a standby letter of credit in the amount of $0.4 million which will be paid before December 31, 2008 to the extent the vendor has performed all of its transition services obligations.

The purchase price for Heath is estimated to be approximately $15 million and is being paid in three instalments. The first instalment of $9.0 million was made on closing in 2006. The second and third instalments are conditional upon the success in retaining and growing revenue from specified Heath clients and will be settled on June 30 and December 1 of 2008. These instalments will be settled primarily by issuing a number of Class B LP Units of MS Group LP based on a predetermined value of $12.52 per Unit. In addition to the estimate of $15 million, contingent consideration will include amounts to compensate for forgone distributions payable on its second and third instalments during the period June 1, 2006 to December 31, 2008, which amounted to approximately $0.6 million to the end of December 31, 2007.

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 As at
(In thousands of dollars) December 31, December 31,
2007 2006
--------------------------------------------------------------------------
Cash $2,898 $5,257

Working capital (including cash) $19,683 $19,652

Long-term debt, net of unamortized debt issue cost $34,913 $35,000

Unitholders' equity $197,668 $203,619


We have historically utilized cash from operations to finance working capital requirements and fund growth. As at December 31, 2007, the Fund's working capital (current assets minus current liabilities) was approximately $19.7 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 $35.0 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 December 31, 2007 were 1.1 and 27.8 respectively.

The credit facilities also include a secured operating line of credit of up to $15.0 million bearing interest at bankers' acceptance rates plus 1% and a standby fee of 0.2% on the undrawn portion. As at December 31, 2007, the Fund had no amount drawn from the secured operating line of credit.

It is our current intention to renew the long-term debt on maturity.

SELECTED BALANCE SHEET DATA

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




Selected Balance Sheet Data As at As at
(in thousands of dollars) December 31, December 31,
2007 2006
--------------------------------------------------------------------------
Current assets $35,224 $ 5,338

Other long-term assets $299,204 $310,534

Current liabilities $15,541 $15,686


Current Assets

Current assets as at December 31, 2007 decreased by $0.1 million to $35.2 million from $35.3 million as at December 31, 2006. The decrease was primarily due to decreased cash of $2.4 million as a result of the decreased cash for operating activities of $3.1 million, increased distributions of $2.2 million and increased capital expenditures of $0.4 million, partially offset by a smaller cash investment of $3.5 million in our Cowan acquisition compared to our Heath acquisition of $6.0 million in 2006. This was partially offset by increased accounts receivable net of unbilled fees of $2.5 million.

Other Long-Term Assets

Other long-term assets as at December 31, 2007 decreased by $11.3 million to $299.2 million from $310.5 million as at December 31, 2006. The decrease was a result of the amortization expense of $17.7 million and the change in the future income tax asset of $1.1 million. This was partially offset by increased intangibles of $5.8 million related to the Cowan DB business acquisition and capital expenditures of $1.7 million.

Current Liabilities

Current liabilities as at December 31, 2007 decreased by $0.2 million to $15.5 million from $15.7 million as at December 31, 2006. The decrease was primarily due to lower Unitholder distributions payable of $0.8 million as a result of the end of the subordination provision respecting the Class B LP Units on September 30, 2007. This was partially offset by a net increase of $0.6 million related to accounts payable and accrued liabilities due to the growth in the business.

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

Intangible assets consist of customer relationships, proprietary software and customer contracts. 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 accounts 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 Taxes

The Fund uses the asset and liability method of accounting for income taxes. Future income taxes are recognized for the temporary differences between the financial statement carrying amounts of assets and liabilities and their respective tax bases. Future income tax assets and liabilities are measured using enacted or substantively enacted tax rates and laws that are expected to apply to taxable income in the years in which those temporary differences are expected to be reversed or settled. The effect on future income tax assets and liabilities of a change in tax rate is recognized in income in the period that includes the date of enactment or substantive enactment.

Future Accounting Changes

1. Section 3862, Financial Instruments - Disclosures and Section 3863, Financial Instruments - Presentation, which replace the existing Section 3861, Financial Instruments - Disclosure and Presentation. These new sections revise and enhance disclosure requirements and carry forward unchanged existing presentation requirements. These new sections place an increased emphasis on disclosures and presentation regarding the risks associated with both recognized and unrecognized financial instruments and how the Fund manages those risks.

2. Section 1535, Capital Disclosure. This section requires disclosure of the Fund's objectives, policies and processes for managing capital, quantitative data about what the Fund regards as capital and whether the Fund has complied with any capital requirements.

3. Section 1400, General Standards of Financial Statement Presentation. This section was amended to include guidance on an entity's ability to continue as a going concern. The revised standard explicitly requires management to assess the Fund's ability to continue as a going concern.

These standards will be effective for the Fund as of January 1, 2008. The Fund does not expect the adoption of these standards will have an impact on the consolidated financial statements as these standards relate to note disclosures or the Fund's ability to continue as a going concern.

Financial Instruments

Effective January 1, 2007, the Fund adopted the new recommendations of the Canadian Institute of Chartered Accountants ("CICA") Handbook Section 1530, Comprehensive Income; Section 3855, Financial Instruments -- Recognition and Measurement; and Section 3865, Hedges, retroactively without restatement. These new Handbook sections provide requirements for the recognition and measurement of financial instruments and the use of hedge accounting. Section 1530 establishes standards for reporting and presenting comprehensive income, which is defined as the change in equity from transactions and other events from non-owner sources. Other comprehensive income refers to items recognized in comprehensive income that are excluded from net income calculated in accordance with generally accepted accounting principles.

Under Section 3855, financial instruments must be classified into one of these five categories: held-for-trading, held-to-maturity, loans and accounts receivable, available-for-sale financial assets or other financial liabilities. All financial instruments, including derivatives, are measured in the balance sheet at fair value except for loans and accounts receivable, held-to-maturity investments and other financial liabilities which are measured at amortized cost. Subsequent measurement and changes in fair value will depend on their initial classification, as follows: held-for-trading financial assets are measured at fair value and changes in fair value are recognized in net income; available-for-sale financial instruments are measured at fair value with changes in fair value recorded in other comprehensive income until the investment is derecognized or impaired, at which time the amounts would be recorded in net income; and financial assets held-to-maturity, loan and accounts receivable and other financial liabilities are measured at amortized cost using the effective interest method of amortization. Transaction costs are expensed as incurred for financial instruments classified or designated as held--for-trading. For other financial instruments, transaction costs are capitalized on initial recognition.

Upon adoption of these new standards, the Fund designated its cash and short-term investments as held-for-trading, which are measured at fair value. Accounts receivable is classified as loans and accounts receivable, which are measured at amortized cost. Bank indebtedness, Accounts payable and accrued liabilities, Accrued compensation and related benefits, Unitholder distributions payable and Long-term debt are classified as other financial liabilities. The Fund had neither available-for-sale nor held-to-maturity instruments during the three months ended December 31, 2007 and for the year ended December 31, 2007.

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. The interest-rate swap agreements are classified as held-for-trading and are recorded at their fair value with a corresponding adjustment to interest expense.

The adoption of these Handbook sections had no impact on opening deficit. The Fund had no "other comprehensive income or loss" transactions during the three months ended December 31, 2007 and for the year ended December 31, 2007 and no opening or closing balances for accumulated other comprehensive income or loss.

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 estimated current market value.

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$1.4 million for the three months ended December 31, 2007 and US$4.1 million for the year ended December 31, 2007. In our normal course of business, we are exposed to credit risk from our clients. Risk associated with concentration of credit risk with respect to accounts receivable are limited due to the credit rating of our top 10 clients. Our top 10 clients accounted for approximately 24% of the total accounts receivable as at December 31, 2007 (December 31, 2006 -- 27%). We have over 1,000 clients, with no client consisting of greater than 1% of total revenue with the exception of our top ten clients.

In our view, we are 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 its strategic initiatives.

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 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 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, 2007, Morneau Sobeco's largest client accounted for approximately 11% of revenue (for the year ended December 31, 2006 - 12%) and the top 10 clients accounted for approximately 31% of the total revenue for the year ended December 31, 2007 (for the year ended December 31, 2006 - 34%). 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 in 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.

Foreign Exchange Risk

A portion of Morneau Sobeco's sales are in U.S. dollars and thus Morneau Sobeco is exposed to fluctuations in the value of the U.S. dollar relative to the Canadian dollar. The firm is not currently engaged in currency hedging activities. The net revenue exposure after accounting for related expenses denominated in U.S. dollars was approximately US$4.1 million for the year ended December 31, 2007. An increase in foreign revenues would expose the Fund to fluctuations in exchange rates which 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.

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 intellectual property 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.

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 may adversely affect the Unitholders.

The Fund's 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.

On June 22, 2007, legislation that proposed changes to the taxation of publicly traded income trusts received Royal Assent. Certain income of (and distributions made by) the Fund will be taxed in a manner similar to income earned by (and distributions made by) a corporation in the 2011 taxation year.

As a result, the Fund has recognized a $2.7 million future income tax liability as at June 30, 2007 on temporary differences in the reported amounts for financial statement and tax purposes in the intangible and capital assets. The Fund will be liable for income tax at a rate of 29.5% on its taxable income earned in 2011 and 28.0% thereafter.

This legislation is effective for the 2007 taxation year with respect to trusts which commenced 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.

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.

On December 20, 2007, the Department of Finance (Canada) announced proposed technical amendments to clarify certain aspects of the new rules (which, as discussed above, will be effective on January 1, 2011, subject to compliance with the normal growth guidelines). One of the proposed amendments is intended to exempt from the new rules a subsidiary partnership that (i) is not publicly traded, and (ii) is wholly-owned by a publicly traded trust or partnership, a taxable Canadian corporation or a combination of these entities. Although the MS Group LP is not publicly traded, the proposed amendments do not appear to exempt a partnership with individual partners. Draft legislation implementing these amendments has not yet been released. However, the Fund believes that the MS Group LP will not be subject to tax under the new rules prior to January 2011, assuming that the Fund complies with the normal growth guidelines.

This legislation 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, are 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 Morneau Sobeco Corporation or its subsidiaries. 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 interest, 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 Standardized 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 (i.e., 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), 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's 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 20.1% 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's 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 non-diluted and fully diluted bases). 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 that a restructuring of the Fund is 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 Sheets
Selected Unaudited Consolidated Financial
Information (In thousands of dollars except per unit amounts)

Quarter ended December 31 September 30 June 30 March 31
2007 2007 2007 2007
-------------------------------------------------------------------------
Revenue $36,707 $37,231 $37,057 $36,091
Net income 4,489 2,907 1,680 3,045
EBITDA(1) 7,391 7,481 8,106 7,865
EBITDA margin 20.1% 20.1% 21.9% 21.8%
Standardized Distributable
Cash(2) 7,812 8,097 5,835 (927)
Adjusted Consolidated
Distributable Cash 7,025 6,515 7,223 7,439
Distributions declared 6,131 6,131 6,131 5,865
Net income per Unit
(basic and diluted)(1) $0.203 $0.132 $0.076 $0.138
Standardized Distributable
Cash per Unit
(basic and diluted) $0.352 $0.366 $0.264 $(0.042)
Adjusted Consolidated
Distributable Cash per Unit
(basic and diluted) $0.253 $0.234 $0.260 $0.268
Distributions declared
per Unit (basic and diluted) $0.221 $0.221 $0.221 $0.211
Standardized Distributable
Cash Payout Ratio 62.6% 60.2% 83.4% (502.1)%
Adjusted Consolidated
Distributable Cash Payout Ratio 87.3% 94.1% 84.9% 78.8%
Twelve-month rolling
Standardized Distributable
Cash Payout Ratio 92.7% 95.0% 90.6% 83.5%
Twelve-month rolling Adjusted
Consolidated Distributable
Cash Payout Ratio 86.0% 85.9% 84.3% 83.3%
Total assets $334,428 $337,391 $342,569 $338,530
Total long-term debt $34,913 $34,901 $34,888 $34,876
-------------------------------------------------------------------------

Selected Unaudited Consolidated Financial
Information (in thousands of dollars except per unit amounts)

--------------------------------------------------------------------------
Quarter ended December 31 September 30 June 30 March 31
2006 2006 2006 2006
--------------------------------------------------------------------------
Revenue $34,079 $33,037 $32,793 $32,178
Net income 3,010 2,482 5,646 2,835
EBITDA(1) 7,890 7,053 7,672 7,228
EBITDA margin 23.2% 21.3% 23.4% 22.5%
Standardized Distributable
Cash (2) 7,210 8,725 7,213 486
Adjusted Consolidated
Distributable Cash 6,977 6,736 6,868 6,566
Distributions declared 6,050 5,731 5,688 5,666
Net income per Unit (basic
and diluted)(1) $0.136 $0.112 $0.257 $0.129
Standardized Distributable
Cash per Unit
(basic and diluted) $0.327 $0.396 $0.328 $0.022
Adjusted Consolidated
Distributable Cash per Unit
(basic and diluted) $0.251 $0.243 $0.248 $0.239
Distributions declared per
Unit (basic and diluted) $0.218 $0.206 $0.206 $0.206
Standardized Distributable
Cash Payout Ratio 66.6% 52.1% 63.0% 932.0%
Adjusted Consolidated
Distributable
Cash Payout Ratio 86.7% 84.9% 83.3% 86.3%
Twelve-month rolling
Standardized Distributable
Cash Payout Ratio 77.9% 85.2% n/a n/a
Twelve-month rolling
Adjusted Consolidated
Distributable Cash
Payout Ratio 85.3% 85.3% n/a n/a
Total assets $345,872 $345,398 $353,149 $342,322
Total long-term debt $35,000 $35,000 $35,000 $35,000
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(1) In the second quarter of 2007 we recorded a non-cash charge to
earnings of $2.7 million. The charge relates to our future tax
liabilities recorded as a result of Bill C-52 which received Royal
Assent on June 22, 2007. This non-cash charge relates to temporary
differences between the accounting and tax bases of our assets and
liabilities primarily related to intangible assets. The charge has no
current impact on our cash flow, EBITDA, Standardized Distributable
Cash and Adjusted Consolidated Distributable Cash.

(2) The Standardized Distributable Cash for the three months ended
March 31, 2007 and 2006 are significantly lower than the distributions
declared, as the Fund pays its employees their annual bonuses in the
first quarter of each year.


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, 2007.

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 6, 2008.

Contact Information

  • Morneau Sobeco Income Fund
    William Morneau
    Chairman & CEO
    416-445-2700
    or
    Morneau Sobeco
    Andre Pinsonneault
    Director, Corporate Communications
    416-383-6499