Rockwater Capital Corporation
TSX : RCC

Rockwater Capital Corporation

August 03, 2005 07:30 ET

Rockwater Reports Second Quarter 2005 Results

TORONTO, ONTARIO--(CCNMatthews - Aug. 3, 2005) -

NOT FOR DISTRIBUTION TO U.S. NEWS WIRE SERVICES OR FOR DISSEMINATION IN THE U.S.

Rockwater Capital Corporation ("Rockwater") (TSX:RCC) today released its unaudited consolidated results for the three-month and six-month periods ending June 30, 2005. Rockwater recorded second quarter earnings of $1.6 million on revenues of $46.8 million compared with earnings of $114 thousand on revenues of $32 million in the second quarter of 2004. Earnings before taxes, interest, and amortization(1) were $6.8 million for the quarter compared with $3.5 million for the second quarter of last year.

For the six months ended June 30, 2005, Rockwater recorded earnings of $2.7 million, after a tax provision of $1.5 million, on revenues of $96.5 million. For the same six-month period in 2004, Rockwater recorded earnings of $2.6 million on revenues of $74.6 million. No tax provision was charged against the 2004 earnings since Rockwater was able to eliminate its tax provision by recording the benefit of previously unrecognized income tax loss carryforwards. On a before tax basis, Rockwater earned $4.2 million for the current six-month period and $2.6 million for the same period in the prior year. Earnings before taxes, interest, and amortization were $14.3 million for the first six months of 2005. The comparable figure for 2004 was $9.4 million.

"We are pleased with our continued track record of reporting positive quarterly earnings as we continue to build the businesses," said Robert Schultz, Chairman of Rockwater. "Our revenue for the quarter is up $14.8 million, an increase of 46%, compared to the second quarter of 2004. This growth is supported by strong year over year revenue growth in each of our three business areas. Of particular note is the record success of our capital markets business this quarter, with its $6.2 million increase in revenues."

"Rockwater has spent time strengthening our platforms in asset management, wealth management and capital markets," said William Packham, President and Chief Executive Officer of Rockwater. "We are pleased with the growth in each of these businesses and look forward to maintaining a profitable momentum going forward. We remain committed to achieving Rockwater's goal of becoming Canada's leading independent diversified financial services company."

Highlights of results for the three months ended June 30, 2005 compared to results for the three months ended June 30, 2004:

- Capital markets revenues are up $6.2 million, an increase of 123%

- Participated in 72 financing transactions, up from 32

- Wealth management revenues up $3.5 million, an increase of 14.8%

- Assets under administration are up $1.2 billion to a total of $6.2 billion

- Asset management revenues up $5.1 million, an increase of 150%, primarily due to KBSH acquisition

- Disciplined Leadership mutual funds reach one year anniversary with strong performance and total assets of approximately $290 million

(1) See "Non-GAAP Measures" in the accompanying MD&A.

About Rockwater

Rockwater Capital Corporation (TSX:RCC) is an independent diversified financial services company that offers a broad range of products and services to individuals, corporations and institutions. Rockwater conducts its operations through its three subsidiaries: First Associates Investments Inc., Rockwater Asset Management Inc., and KBSH Capital Management Inc. Rockwater operates its wealth management and capital markets businesses through its full service broker dealer, First Associates. Rockwater's asset management business operates through Rockwater Asset Management and KBSH, both investment counseling and portfolio management firms.

Report to Shareholders

Rockwater's momentum continued through the second quarter of 2005. Each of our businesses continued to experience profitable growth, enabling Rockwater to once again report positive earnings for the period while building these businesses.

Compared to the second quarter of 2004, Rockwater's revenue for the quarter is up $14.8 million-an increase of 46%. Please note that our six-month earnings of $2.7 million are not directly comparable to last year's six-month earnings, as our continued profitability has now placed us in a taxable position. Last year we were able to make use of tax loss carryforwards and did not have to record a tax provision. Further details on the effect of taxes on Rockwater's earnings can be found in the accompanying MD&A.

Revenues increased in each business compared to last year: wealth management increased $3.5 million, asset management increased $5.1 million, and capital markets increased $6.2 million. With an improvement of 123% in revenue and 125% in deal participation (72 financing deals up from 32), our capital markets business experienced a record quarter. We are pleased with the growth of our capital markets platform and attribute it to successful recruiting and growing industry recognition of our strengths.

As we move into the second half of 2005, we look forward to maintaining our profitable momentum. Thank you for your continued support of Rockwater and our vision of becoming an independent leader in Canada's financial services industry.



Sincerely,

(signed) (signed)

Robert Schultz William Packham
Chairman President & CEO


ROCKWATER CAPITAL CORPORATON
Management Discussion and Analysis
For the three-month and six-month period ended June 30, 2005


This management discussion and analysis ("MD&A") is dated as of August 2, 2005 and is supplemental to the unaudited interim consolidated financial statements and the notes thereto of Rockwater Capital Corporation (the "Corporation") for the three-month and six-month period ended June 30, 2005. This MD&A is intended to provide shareholders with additional information on the Corporation's recent performance, its current financial situation and its prospects. It should be read in conjunction with the unaudited interim consolidated financial statements and the audited consolidated financial statements and MD&A for the year ended December 31, 2004. There has been no material change to the information contained in the annual MD&A for 2004 except as disclosed below. The financial information presented below is unaudited, expressed in Canadian dollars and is prepared in accordance with Canadian generally accepted accounting principles ("GAAP"). This MD&A has been prepared by, and is the responsibility of, the management of the Corporation. The Corporation's board of directors reviewed this MD&A prior to it being released.

Caution Regarding Forward-looking Statements

This MD&A includes forward-looking statements concerning the future performance of the business of the Corporation and its financial performance and condition. Forward-looking statements may include, but are not limited to, comments with respect to the Corporation's objectives for 2005 and beyond, its strategies or future actions, expectations for its financial condition, and the results of and/or outlook for its operations. These forward-looking statements are based on current expectations.

Forward-looking statements require the Corporation to make assumptions that are subject to inherent risks and uncertainties. There is significant risk that estimates, projections, and other forward-looking statements will not prove to be accurate. The Corporation cautions readers of this document not to place undue reliance on forward-looking statements as a number of factors could cause actual future results, conditions, actions or events to differ materially from the targets, expectations, estimates or intentions expressed in the forward-looking statements. Some of the factors that could affect future performance include, but are not limited to, economic conditions, regulatory change, competitive environment and technological change. Therefore, future events and results may vary significantly from what the Corporation currently foresees. The Corporation is under no obligation, and expressly disclaims any such obligation, to update or alter the forward-looking statements whether as a result of new information, future events or otherwise.

Corporate Overview

The Corporation is an independent diversified financial services company that offers a broad range of financial products and services to individuals, institutions and corporations in the areas of wealth management ("Wealth Management"), asset management ("Asset Management") and capital markets ("Capital Markets"). The Corporation's business is conducted primarily through three operating subsidiaries: First Associates Investments Inc. ("FAI"), a full service investment dealer registered in all of the provinces and territories of Canada, Rockwater Asset Management Inc. ("RAM"), an investment counsel and portfolio manager registered in the provinces of British Columbia, Alberta, Saskatchewan, Manitoba, Ontario, Nova Scotia, New Brunswick, Newfoundland and Labrador and Prince Edward Island, and KBSH Capital Management Inc. ("KBSH"), an investment counsel and portfolio manager registered in all of the provinces of Canada.

The Corporation's shares are traded on the Toronto Stock Exchange ("TSX") under the stock symbol "RCC".

Non-GAAP Measures

The Corporation's consolidated financial statements are prepared in accordance with GAAP. For internal purposes, the Corporation utilizes certain measures that are not defined under GAAP in order to evaluate and assess the financial performance of its business segments. The Corporation believes these non-GAAP measures are important indicators of operating performance. There are no prescribed standards or definitions applicable to non-GAAP measures, and, as such, the non-GAAP measures employed by the Corporation are specific to the Corporation. Therefore, these non-GAAP measures are unlikely to be comparable to similar measures presented by other companies.

"Earnings before interest, taxes, depreciation and amortization" or "EBITDA" is calculated as earnings before income taxes, amortization of capital and intangible assets, amortization of deferred employment arrangements and interest expense. Book value per share is calculated by dividing total shareholders' equity by the number of common shares outstanding at the end of the reporting period. Management believes EBITDA and book value per share are important metrics in assessing the financial performance and valuation of its businesses. The following table reconciles EBITDA to consolidated net earnings for the periods indicated.




($000's Cdn, For the Three-Months Ended For the Six-Months Ended
except % June 30, June 30, June 30, June 30,
amounts) 2005 2004 Change 2005 2004 Change
---------------------------------------------------------------------

Net Earnings 1,641 114 1,339.5% 2,683 2,636 1.8%

Add:

Interest expense 1,303 387 236.7% 2,706 1,105 144.9%

Amortization of
capital and
intangible assets 1,176 513 129.2% 2,308 1,007 129.2%
Amortization of
deferred
employment
arrangements 2,493 2,458 1.4% 5,091 4,676 8.9%

Tax provision 193 - n/m 1,489 - n/m
----------------- -------------------

EBITDA 6,806 3,472 96.0% 14,277 9,424 51.5%
----------------- -------------------
----------------- -------------------


The Corporation also utilizes cash operating earnings to assess each of its businesses and to measure the overall performance of the Corporation. In particular, cash operating earnings is used to assess the ability of the Corporation to generate internal capital to finance its strategic business plan.

"Assets under administration" or "AUA" represents the market value of client assets administered by the Corporation in respect of which the Corporation earns commissions and administrative and other fees. "Assets under management" or "AUM" represents the market value of client assets managed by the Corporation on a discretionary basis and in respect of which the Corporation earns an investment management fee. Management uses AUA and AUM to assess the operational performance of its Wealth Management and Asset Management businesses respectively. AUA and AUM are not reflected on the Corporation's balance sheet.



Summary of Key Financial Data
------------------------------

($000's except
where noted For the Three-Months For the Six-Months
and per share, Ended Ended
employee, June 30, June 30, % June 30, June 30, %
% amounts) 2005 2004 Change 2005 2004 Change
---------------------------------------------------------------------

Revenue 46,810 32,043 46.1% 96,505 74,585 29.4%

Operating
expenses 40,004 28,571 40.0% 82,228 65,161 26.2%
------------------ -----------------

EBITDA (1)(2) 6,806 3,472 96.0% 14,277 9,424 51.5%

Interest expense 1,303 387 236.7% 2,706 1,105 144.9%

Amortization of
capital and
intangible
assets 1,176 513 129.2% 2,308 1,007 129.2%
Amortization of
deferred
employment
arrangements 2,493 2,458 1.4% 5,091 4,676 8.9%
------------------ -----------------

Earnings before
taxes 1,834 114 1,508.8% 4,172 2,636 58.3%

Tax provision 193 - n/m 1,489 - n/m
------ -------

Net earnings 1,641 114 1,339.5% 2,683 2,636 1.8%
------------------ -----------------
------------------ -----------------

Earnings per share
(EPS) - Basic $0.07 $0.01 600.0% $0.13 $0.16 (18.8%)

Earnings per share
(EPS) - Diluted $0.07 $0.01 600.0% $0.13 $0.16 (18.8%)

Book value per
share $5.57 $4.72 18.0% $5.57 $4.72 18.0%

Total assets
- $Million Cdn 641 465 37.8% 641 465 37.8%

Total long-term
liabilities
- $Million Cdn 66 3 n/m 66 3 n/m

Number of employees 655 591 10.8% 655 591 10.8%

AUA(2)
- $Billion Cdn 6.2 5.1 21.6% 6.2 5.1 21.6%

AUM(2)
- $Billion Cdn 6.2 0.5 1,140.0% 6.2 0.5 1,140.0%

(1) See reconciliation of net earnings to EBITDA in non-GAAP measures
section of the MD&A.
(2) EBITDA, book value per share, AUA, and AUM are non-GAAP measures.


Industry Outlook

The operating results and financial condition of the Corporation are closely related to the performance of the Canadian equity markets, which are cyclical by nature. In the second quarter of 2005, activity in the Canadian equity markets remained strong, and the Corporation expects this positive environment to continue for the remainder of the year. The Corporation's objective is to continue to build each of its business segments while maintaining control over fixed expenses in order to remain profitable in all market cycles.

In addition to being cyclical, Canadian equity markets experience significant seasonal variations in activity resulting in considerable fluctuations in revenue and income from quarter to quarter. Historically, revenue for capital markets participants is higher in the first and last quarters of the calendar year and the Corporation's experience generally follows that of the industry.



Results of Operations
---------------------

Revenue

Revenue by Type For the Three-Months For the Six-Months
($000's Cdn, Ended Ended
except % June 30, June 30, June 30, June 30,
amounts) 2005 2004 Change 2005 2004 Change
---------------------------------------------------------------------

Commissions 21,591 20,498 5.3% 47,869 48,612 (1.5%)

Investment
banking 8,592 3,616 137.6% 15,718 7,017 124.0%

Asset management
and account fees 9,186 2,334 293.6% 18,851 6,065 210.8%

Interest income 3,226 2,586 24.7% 6,134 5,424 13.1%

Principal
transactions 3,132 1,228 155.0% 5,764 4,492 28.3%

Other income(1) 1,083 1,781 (39.2%) 2,169 2,975 (27.1%)
------------------ -----------------

Total Revenue 46,810 32,043 46.1% 96,505 74,585 29.4%
------------------ -----------------
------------------ -----------------

(1) Includes revenue generated from stock borrowing and lending
agreements, repurchase and resale agreements and foreign currency
transactions.


In the second quarter of 2005, total revenue increased by $14.8 million to a total of $46.8 million. Each of the Corporation's business segments contributed to the increase in revenue. By segment, Wealth Management revenue was up $3.5 million, Asset Management revenue was up $5.1 million and Capital Markets revenue was up $6.2 million from the second quarter of 2004.

Commission revenue increased by $1.1 million or 5.3% from the prior year, primarily due to an increase in institutional commissions earned by the sales and trading division of Capital Markets. Investment banking revenue totalled a record $8.6 million, up $5.0 million from the same period in the prior year. This reflects the positive momentum achieved by the Corporation's equity underwriting business. In the second quarter of 2005, the Corporation participated in 72 underwriting transactions compared to 32 in the second quarter of 2004. Asset management and account fees increased by $6.9 million from the second quarter of 2004 to a total of $9.2 million, primarily due to the KBSH acquisition completed in the fourth quarter of 2004. Principal transactions revenue was $3.1 million, up $1.9 million from the same quarter year in the prior year. Interest income totalled $3.2 million and other income was $1.1 million. The comparable figures for the prior year were $2.6 million and $1.8 million respectively.

For the six month period ended June 30, 2005, total revenue increased by $21.9 million to a total of $96.5 million, with each of the Corporation's business segments contributing positive revenue growth. Wealth Management revenue was up $2.4 million, Asset Management revenue was up $9.7 million and Capital Markets revenue was up $9.8 million from the six-month period ended June 30, 2004.



Operating Expenses

For the Three-Months For the Six-Months
($000's Cdn, Ended Ended
except % June 30, June 30, June 30, June 30,
amounts) 2005 2004 Change 2005 2004 Change
---------------------------------------------------------------------

Incentive
compensation 20,031 13,164 52.2% 42,162 32,880 28.2%

Fixed salaries
and benefits 7,632 5,959 28.1% 15,812 12,456 26.9%

Stock-based
compensation 1,372 375 265.9% 2,836 516 449.6%
------------------ -----------------

Total compensation
and benefits 29,035 19,498 48.9% 60,810 45,852 32.6%

Other operating
expenses(1) 10,969 9,073 20.9% 21,418 19,309 10.9%
------------------ -----------------

Total Operating
Expenses 40,004 28,571 40.0% 82,228 65,161 26.2%
------------------ -----------------
------------------ -----------------

(1) Other operating expenses are comprised of trading costs
(brokerage, clearing and exchange fees), as well as occupancy,
communications and technology, and general and administrative
costs.


Total operating expenses were $40.0 million in the second quarter of 2005, up $11.4 million from the second quarter of 2004, primarily due to increased compensation. As a percentage of revenue, total compensation expense increased to 62.0% from 60.8% in the prior year. Incentive compensation increased by $6.9 million from the second quarter of 2004, primarily due to the increase in revenue. Fixed salaries and benefits were up $1.7 million from the comparable quarter in the prior year. The acquisition of KBSH accounts for $0.8 million of this increase. The remaining increase primarily reflects increased staffing levels relative to the second quarter of 2004. The year-over-year increase in the number of employees is principally due to the KBSH acquisition and an increase in business support staffing levels for the planned growth of the Corporation's businesses. Stock-based compensation related to stock option, deferred share unit ("DSU") and performance share unit ("PSU") awards granted to senior management and other employees of the Corporation increased by $1.0 million from the second quarter of 2004. The DSU awards granted to Investment Advisor ("IAs"), Capital Markets professionals and other employees represent the stock-based component of various compensation programs. The PSU plan was approved by the Board of Directors on February 21, 2005 and is available to executives and key senior employees of the Corporation. Under the terms of the plan, the Corporation must achieve certain key financial targets over the 2005 to 2007 time period in order for the PSUs to be awarded. A total of 711,578 DSUs and 500,000 PSUs have been awarded as at June 30, 2005. The expense associated with the DSU and PSU awards is new in 2005, and is recognized over their three-year vesting periods.

For the three months ended June 30, 2005, other operating expenses increased by $1.9 million to a total of $11.0 million from the three-month period ended June 30, 2004. As a percentage of revenue, other operating expenses declined to 23.4% in the second quarter of 2005 from 28.3% in the comparable quarter in 2004, which reflects the Corporation's strategy of controlling these expenses relative to revenue. Occupancy costs were up $0.5 million due to new Wealth Management branch offices and the addition of the KBSH office space. Trading costs were up $0.3 million due to increased trading activity. Communications and technology costs were up $0.4 million, primarily due to the increase in the number of employees, and general and administrative costs were up $0.7 million as result of higher business development and professional services costs.

For the six-month period ended June 30, 2005, operating expenses were up by $17.1 million from the same six-month period in the prior year. The increase was driven by higher compensation expense, occupancy, general and administrative and communications and technology expenses. These increases generally reflect the increase in revenue and the build-out of the Corporation's business unit infrastructure to support the increased operating activity in each business segment.



Other Expenses

For the Three-Months For the Six-Months
($000's Cdn, Ended Ended
except % June 30, June 30, June 30, June 30,
amounts) 2005 2004 Change 2005 2004 Change
---------------------------------------------------------------------

Interest expense 1,303 387 236.7% 2,706 1,105 144.9%

Amortization,
capital and
intangible assets 1,176 513 129.2% 2,308 1,007 129.2%
Amort'n deferred
employment
arrangements 2,493 2,458 1.4% 5,091 4,676 8.9%
------------------ -----------------

Total Other
Expenses 4,972 3,358 48.1% 10,105 6,788 48.9%
------------------ -----------------
------------------ -----------------


Interest expense was $1.3 million for the three months ending June 30, 2005, up $0.9 million from the same period in the prior year. The increase reflects interest paid on the subordinated loans from the former shareholders of KBSH in the amount of $0.2 million and on the convertible debentures in the amount of $0.6 million. The subordinated loans from the former shareholders of KBSH, including accumulated interest thereon, were repaid in full on April 28, 2005 with the proceeds received from a public offering of common shares as described below. See "Convertible Debentures" and "Outstanding Share Data" below.

Amortization of deferred employment arrangements for the three-month period ended June 30, 2005, was $2.5 million, unchanged from the three-month period in the prior year. Amortization of deferred employment arrangements includes amortization related to both employee acquisition and recruitment.

Interest expense increased $1.6 million to $2.7 million for the six month period ending June 30, 2005 when compared to the same period in 2004. The increase reflects interest paid on the subordinated loans from the former shareholders of KBSH in the amount of $0.5 million and on the convertible debentures in the amount of $1.2 million.

For the six month period ended June 30, 2005, amortization of deferred employment arrangements was $5.1, an increase of $0.4 million over the comparable period last year. The table below outlines the amortization expense related to deferred employment contracts entered into as at June 30, 2005.



($000's Cdn) 2005 2006 2007 2008

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

Acquisition Related 2,152 1,705 932 655
Recruitment Related(a) 2,781 4,450 3,008 2,282
----------------------------------------

Total Amortization 4,933 6,155 3,940 2,937
----------------------------------------
----------------------------------------

(a) Only includes current employee arrangements and does not include
any amortization related to planned or forecasted deferred
employment contracts. This expense is expected to increase as a
function of recruitment. The total for 2005 represents the
expected amortization expense for the remaining six months of
the fiscal year.


Income Taxes

In the second quarter of 2005, the Corporation recorded a tax provision of $0.2 million, which represents an effective tax rate of 10.5%. For the six months ending June 30, 2005, the tax provision and effective tax rate are $1.5 million and 35.7%, respectively. The low effective tax rate in the second quarter reflects the recognition of the benefit of tax losses that were not previously recognized. As at June 30, 2005 there are no significant remaining unrecognized tax losses. Therefore, the Corporation's effective tax rate will be significantly higher in the third and fourth quarters of the year, principally due to non-deductible expenses relating to business acquisitions made in 2002. These non-deductible expenses are expected to decline by approximately 50% in 2006, which will reduce the Corporation's effective tax rate to a more normal level.

Net Income

The Corporation recorded EBITDA of $6.8 million for the three-month period ended June 30, 2005, an increase of $3.3 million from the second quarter of 2004. Net earnings were $1.6 million and diluted earnings per share of $0.07. This compares to the net earnings of $0.1 million and diluted earnings per share of $0.01 recorded in the three-month period ended June 30, 2004.

For the six-month period ended June 30, 2005, EBITDA was $14.3 million, net earnings were $2.7 million and diluted earnings per share were $0.13. This compares to EBITDA of $9.4 million, net earnings of $2.6 million and diluted earnings per share of $0.16 for the six-month period ended June 30, 2004. The decline in diluted earnings per share reflects the increase in common shares outstanding associated with the acquisition of KBSH.



Business Segment Analysis
-------------------------

Wealth Management

($000's Cdn, For the Three-Months For the Six-Months
except employee, Ended Ended
% amounts and June 30, June 30, June 30, June 30,
asset totals) 2005 2004 Change 2005 2004 Change
---------------------------------------------------------------------

Revenue 27,261 23,743 14.8% 58,362 55,954 4.3%

Expenses 25,085 20,282 23.7% 51,776 47,311 9.4%
------------------ -----------------

EBITDA(1) 2,176 3,461 (37.1%) 6,586 8,643 (23.8%)

Amortization of
capital assets 339 264 28.4% 663 511 29.7%

Amortization of
deferred employment
arrangements 1,318 1,122 17.5% 2,657 2,145 23.9%

Interest expense 495 380 30.3% 899 1,098 (18.1%)
------------------ -----------------

Net earnings 24 1,695 (98.6%) 2,367 4,889 (51.6%)
------------------ -----------------
------------------ -----------------

AUA(1)
- $Billion Cdn 6.2 5.1 21.6% 6.2 5.1 21.6%

Number of Investment
Advisors 180 203 (11.3%) 180 203 (11.3%)

Number of employees 355 358 (0.8%) 355 358 (0.8%)

(1) See "Non-GAAP Measures".


Wealth Management Business

The Corporation conducts its Wealth Management business through the private client group (the "Private Client Group") of its subsidiary, FAI. The goal of the Private Client Group is to become Canada's leading source of independent investment advice for individual investors. The Private Client Group currently serves investors across the country through its twelve branches in major centres across Canada.

In the second quarter of 2005, Private Client Group revenue increased by $3.5 million to a total of $27.3 million from the comparable quarter in 2004. The increase reflects higher managed account fees of $1.1 million compared to the same period last year. The increase in managed account fees is consistent with the Corporation's strategy to increase client assets on its managed account platform. Commission revenue increased by $0.6 million from the second quarter of 2004, primarily due to the growth in the new equity issue business in the natural resources sector. Principal transaction revenue was up $1.9 million from the comparable quarter in the prior year. The increase in principal transactions revenue reflects the growth in client facilitation trading activity, which is recorded as principal, and an increase in realized and unrealized gains on share purchase warrants that have been received as payment in various underwriting assignments.

As at June 30, 2005, the Corporation had AUA of $6.2 billion and 180 IAs, compared to $5.1 billion in AUA and 203 IAs as at June 30, 2004. AUA per advisor increased from $24.9 million at June 30, 2004 to $34.6 million at June 30, 2005. Although the number of IAs has declined year-over-year, total AUA and AUA per IA has steadily increased. This is a result of both the recruitment of IAs with larger asset books and organic growth from asset appreciation and new client assets.

The Corporation continues to focus on achieving its stated objective of 300 IAs with $20 billion of AUA by 2008. A number of initiatives have been undertaken to enable the Corporation to attract and retain qualified IAs in a competitive recruiting and retention environment. These initiatives include changes to the management structure, implementation of a DSU program that offers equity ownership to IAs, the opening of new branch offices in Edmonton and Guelph and the launch of an Integrated Managed Account ("IMA") platform to support asset gathering and wealth management activities. Through these initiatives the Corporation believes that its recruiting momentum will continue to grow in terms of both the number of IAs and average AUA per IA.

The Private Client Group generated net earnings of $24 thousand and EBITDA of $2.2 million in the second quarter of 2005, compared to net earnings and EBITDA of $1.7 million and $3.5 million respectively in the second quarter of 2004. The decrease in net earnings of 1.7 million and EBITDA $1.3 million reflects higher incentive compensation costs of $2.8 million, trading costs of $0.4 million, fixed salaries and benefits of $0.6 million and operating costs of $0.9 million.



Asset Management

($000's Cdn, For the Three-Months For the Six-Months
except employee, Ended Ended
% amounts and June 30, June 30, June 30, June 30,
asset totals) 2005 2004 Change 2005 2004 Change
---------------------------------------------------------------------

Revenue 8,383 3,300 154.0% 17,585 7,897 122.7%

Expenses 5,339 3,098 72.3% 11,557 7,339 57.5%
------------------ -----------------

EBITDA(1) 3,044 202 1,406.9% 6,028 558 980.3%

Amortization of
capital assets 48 38 26.3% 126 58 117.2%

Interest expense 54 2 n/m 88 2 n/m
------------------ -----------------

Net earnings 2,942 162 1,716.0% 5,814 498 1,067.5%
------------------ -----------------
------------------ -----------------

AUM(1)
- $Billion Cdn(1) 6.2 0.5 1,140.0% 6.2 0.5 1,140.0%

Number of
Investment
Professionals 27 8 237.5% 27 8 237.5%

Number of employees 68 20 240.0% 68 20 240.0%

(1) See "Non-GAAP Measures".


Asset Management Business

The Corporation's Asset Management business provides discretionary investment management services to institutional, corporate and high net worth clients. The acquisition of KBSH has enabled the Corporation to significantly expand the scope and scale of its asset management business. KBSH's global growth management expertise complements the Corporation's existing capabilities in momentum style management. The Corporation intends to further diversify its breadth and depth of investment style offerings. KBSH provides a scalable platform to make further acquisitions in the asset management industry and positions the Corporation as a consolidator in an industry that the Corporation believes is ripe for consolidation.

The Corporation's AUM as at June 30, 2005 was $6.2 billion. This represents a substantial increase of $5.7 billion from the second quarter of 2004, principally due to the acquisition of KBSH. The total AUM attributable to KBSH as at June 30, 2005 is $5.4 billion, a decline of approximately $800 million since December 31, 2004, the closing date of the KBSH acquisition. Notwithstanding this net decline in AUM, with improved recent performance, consistent application of its investment style and focused marketing efforts, KBSH has been winning new investment mandates that are expected to partially offset these declines.

Total AUM attributable to RAM is $695 million and $122 million of AUM is attributable to the Corporation's IMA platform. The AUM attributable to RAM as at June 30, 2004 was $547 million. There were no IMA assets at the end of the second quarter last year as the platform was launched in the fourth quarter of 2004. The increase in AUM attributable to RAM of $148 million or 27.1% primarily reflects the growth in the Disciplined Leadership mutual funds.

In the three-month period ended June 30, 2005, the Asset Management business generated net earnings and EBITDA of $2.9 and $3.0 million respectively on revenue of $8.4 million. This compares to net earnings and EBITDA of $0.2 million on revenue of $3.3 million for the comparable period in 2004. The growth in net earnings, EBITDA and revenue is primarily attributable to the acquisition of KBSH. The KBSH acquisition closed on December 31, 2004, and therefore the operating results of KBSH were included in the operating results of the Corporation for the full quarter.



Capital Markets

($000's Cdn, For the Three-Months For the Six-Months
except Ended Ended
employee June 30, June 30, June 30, June 30,
and % amounts) 2005 2004 Change 2005 2004 Change
---------------------------------------------------------------------

Revenue 11,166 5,000 123.3% 20,558 10,734 91.5%

Expenses 8,216 4,085 101.1% 15,595 8,340 87.0%
------------------ ----------------

EBITDA(1) 2,950 915 222.4% 4,963 2,394 107.3%

Amortization of
capital assets 86 67 28.4% 164 131 25.2%

Amortization of
deferred
employment
arrangements 400 259 54.4% 792 406 95.1%

Interest expense 16 - n/m 23 - n/m
------------------ ----------------

Net earnings 2,448 589 315.6% 3,984 1,857 114.5%
------------------ ----------------
------------------ ----------------

Number of
Professionals 61 51 19.6% 61 51 19.6%

Number of Employees 75 66 13.6% 75 66 13.6%

(1) See "Non-GAAP Measures".


Capital Markets Business

The Corporation's Capital Markets business, operating under FAI, focuses on providing investment banking services, independent research and specialized trade execution to institutional clients in Canada and the United States.

Net earnings and EBITDA contributed by the Capital Markets group was $2.4 million and $3.0 million respectively in the second quarter of 2005. These totals represent quarterly records for our Capital Markets group. The comparable totals for the second quarter of 2004 were $0.6 million and $0.9 million respectively. Revenue for the three-month period ended June 30, 2005 increased by $6.2 million to $11.2 million, also a record total, compared to the three-month period in the prior year. This was primarily due to an increase in institutional commission revenue of $1.1 million and an increase in investment banking revenue of $5.0 million. These increases reflect the growing momentum and recognition achieved by the Corporation's Capital Markets group and the successful recruiting efforts in 2004. The Corporation's recruiting efforts will continue in the second half 2005 with the goal of adding additional traders and investment bankers to the Capital Markets group. Expenses for the three-month period ended June 30, 2005 were up $4.1 million or from the comparable period in the prior quarter, primarily due to higher compensation expense. The increase in compensation expense is generally a function of the increase in revenue and a strategic decision to ensure that the compensation model for Capital Markets professional staff is competitive with the market.

Financial Condition

The following is a discussion of the major components of the Corporation's capital structure.

Securities and Client Related Balances

Client account balances at any given period end are presented on a trade-date basis and therefore include balances related to unsettled trades. These balances may vary significantly on a day-to-day basis, reflecting changes in the volume of trading activity, although such variance does not necessarily represent any change to the Corporation's financial position. As at June 30, 2005, receivables from customers, receivables from brokers, dealers and clearing organizations, receivables under securities borrowed transactions and receivables under repurchase agreements totalled $413 million. The comparable balances at the end of December 31, 2004, totalled $365 million. Due to customers, due to brokers, dealers and clearing organizations and due to brokers under securities loaned transactions totalled $377 million at June 30, 2005, compared to $332 million as at December 31, 2004.

Short-term Borrowings

The Corporation used the proceeds received from the issuance of senior unsecured convertible debentures to repay in full the $35 million short-term bridge loan received from a major Canadian financial institution to fund the cash component of the purchase consideration for the KBSH acquisition. In addition, the $25 million in subordinate secured notes issued in conjunction with the KBSH acquisition were repaid in full on April 28, 2005 with the proceeds received from a public offering of common shares. See "Convertible Debentures" and "Capital Stock" below.

Future Tax Liability

The net future tax liability of $10.9 million principally reflects the future tax liability associated with the intangible assets subject to amortization that were acquired as a result of the KBSH acquisition. This is a non-cash liability and it is reduced as the intangible assets are amortized. The future tax liability associated with the intangible assets is partially offset by the benefit of tax loss carryforwards and other temporary differences between the tax and book values of certain assets and liabilities.

Convertible Debentures

On January 4, 2005, the Corporation entered into agreements to complete a private placement of $35 million principal amount of senior unsecured convertible debentures due December 31, 2010. Caisse de depot et placement du Quebec (the "Caisse") subscribed for $30 million of the debentures and members of senior management of the Corporation subscribed for $5 million of the debentures. The terms of the debentures initially bore interest at 6.75% per annum, which was reduced to 6.5% per annum as at April 28, 2005. Effective June 30, 2005, the debentures became convertible at the holders' option into common shares of the Corporation at a price of $7.19 per common share. After December 31, 2008, the Corporation may, at its option, redeem the debentures, in whole or in part, subject to specified conditions. The Corporation will have the right to repay the outstanding principal amount of the debentures, on maturity or redemption, through the issuance of its common shares.

Capital Stock

On April 28, 2005, the Corporation completed a public offering with a syndicate of underwriters of 5,686,275 common shares from treasury at a price of $5.10 per common share for gross proceeds of approximately $29.0 million. In addition, on May 11, 2005 the underwriters exercised an over-allotment option to acquire 852,941 additional common shares at a price of $5.10 per common share for gross proceeds of $4.35 million. The number of common shares and the issue price gives effect to the consolidation of the outstanding common shares of the Corporation on a one-for-ten basis which took place immediately prior to the closing of the offering. Please see the "Outstanding Share Data" section of this MD&A for further discussion on the share consolidation and its impact on the number of outstanding shares of the Corporation. As a result of the offering the capital stock of the Corporation has increased to approximately $166 million as at June 30, 2005 from $136.0 million at December 31, 2004.

Liquidity and Capital Resources

The Corporation's business requires capital for operating and regulatory requirements. The Corporation's policy is to maintain sufficient capital for the variety of risks that the Corporation is exposed to in its businesses and operations. The principal sources of capital for the Corporation's businesses are shareholders' equity, preferred shares issued by subsidiaries, convertible debentures, subordinated debt in the form of bank loans, customer credit balances and other payables and cash flow from operations. As described above, in the second quarter the Corporation completed an offering for 6,539,216 common shares for net proceeds of approximately $30.7 million. The Corporation used a portion of the net proceeds to repay in full the subordinated secured notes from the former shareholders of KBSH. The balance of the proceeds was used to pay the professional fees associated with the offering, the acquisition of KBSH and to provide capital to the Corporation's operating subsidiaries. The Corporation does not expect to require any additional capital from the public equity markets for the foreseeable future, other than in conjunction with a major acquisition.

It is expected that the Corporation will continue to generate sufficient amounts of cash and cash equivalents in the short term and long term to maintain current operating capacity, achieve its growth objectives and to meet any unexpected fluctuations in liquidity. The expense structure of the Corporation is geared towards maintaining the current level of activity and providing capacity to support planned growth initiatives. If the general capital markets environment were to deteriorate significantly resulting in a decline in revenue-generating activity and the ability of the Corporation to realize its growth objectives, the Corporation would need to readjust its growth initiatives and expense structure accordingly with a view to avoiding ongoing operating losses. The table below illustrates the Corporation's cash operating earnings for the three and six-month period ended June 30, 2005.



For the Three-Months For the Six-Months
($000's Cdn, Ended Ended
except % June 30, June 30, June 30, June 30,
amounts) 2005 2004 Change 2005 2004 Change
---------------------------------------------------------------------

Net Earnings 1,641 114 1,339.5% 2,683 2,636 1.8%

Add:

Amortization of
capital assets 719 513 40.2% 1,394 1,007 38.4%

Amortization of
intangible assets 457 - n/m 914 - n/m

Amortization of
deferred
employment
arrangements 2,493 2,458 1.4% 5,091 4,676 8.9%

Stock-based
compensation 1,372 375 265.9% 2,836 516 449.6%

Deferred financing
charges 38 - n/m 113 - n/m

Future tax
provision (79) - n/m 862 - n/m
---------------- ----------------

Cash Operating
Earnings 6,641 3,460 91.9% 13,893 8,835 57.2%
---------------- ----------------
---------------- ----------------


In the second quarter of 2005, cash flow from operations, before changes in non-cash working capital balances, was $6.6 million. This represents an increase of $3.2 million from the same period in the prior year.

Investing activities consumed $4.4 million of cash in the three-month period ended June 30, 2005 ($4.0 million in Q2 2004). This includes $0.7 million ($0.2 million in Q2 2004) for the purchase of capital assets and $3.7 million for deferred employment arrangements ($3.8 million in Q2 2004).

Financing activities provided $1.0 million ($1.8 million in Q2 2004), including a net outflow from the repayment of short-term borrowings of $25 million ($nil in Q2 2004), $28.3 million from the issuance of common shares ($1.8 million in Q2 2004), partially offset by a decrease in preferred shares issued by subsidiaries of $2.4 million related to the repurchase of Class T preferred shares issued to the former shareholders of FAI ($nil million in Q2 2004).

Outstanding Share Data

The Corporation's authorized capital stock consists of an unlimited number of common shares.

On April 28, 2005, the Corporation completed a public offering and issued 5,686,275 common shares for gross proceeds of $29.0 million. In addition, the over-allotment option granted to the underwriters under the offering to acquire up to 852,941 additional common shares for additional gross proceeds of $4.35 million was exercised on May 11, 2005. Immediately prior to the completion of the offering, the Corporation executed the previously announced consolidation of the outstanding common shares on a one-for-ten basis. After giving effect to the issuance of these common shares and the one-for-ten consolidation, the common shares issued and outstanding are as follows:



Outstanding as of
-------------------
June 30, March 31, December 31,
2005 2005 2004
---------------------------------------------------------------------
Common shares outstanding
- basic 25,057,089 18,915,786 18,768,632
Common shares outstanding
- diluted 25,174,698 19,363,119 19,215,965
Weighted average shares
outstanding - basic 23,446,530 18,914,515 16,131,735
Weighted average shares
outstanding - diluted 23,536,703 19,134,290 16,782,877


In addition, there are also options outstanding to purchase 2,167,766 common shares, warrants outstanding to purchase 1,000,000 common shares, 198,509 common shares reserved and allocated for issuance pursuant to the Company's Key Employee Retention Plan and 315,789 common shares reserved and allocated for issuance pursuant to the terms of the acquisition of Brawley Cathers Limited. In addition, the debentures are convertible at the holder's option into common shares of the Corporation at a conversion price of $7.19 per share. The debentures will also be convertible, at the option of the holder, into common shares at the lower of (i) $7.19; and (ii) 135% of the reference price in the event of a take-over, merger or amalgamation with a party dealing at arm's length with the Corporation.

Critical Accounting Estimates

The Corporation's financial statements are prepared in accordance with Canadian GAAP requirements. The Corporation's significant accounting policies are described in Note 2 of the interim unaudited consolidated financial statements for the fiscal quarter ended June 30, 2005. Certain of these policies require the Corporation to make estimates or assumptions that in some cases may relate to matters that are inherently uncertain. Due to the inherent uncertainty involved in making estimates, actual amounts or results could differ from estimates and the difference could have a material impact on the financial statements. In order to ensure that the estimates and assumptions made by the Corporation are well controlled, the Audit Committee reviews the Corporation's accounting policies and the application of these policies with respect to the unaudited interim consolidated financial statements. The Audit Committee also reviews all quarterly filings and recommends adoption of the Corporation's interim consolidated financial statements to the Corporation's Board of Directors. The accounting policies that require management's judgment include the fair value of certain financial instruments, valuation of goodwill and intangible assets, the valuation of stock-based compensation and income taxes. The application of these policies is consistent with the Corporation's 2004 Annual Report.

New Accounting Policies

Convertible debentures

The liability and equity components of debentures that grant an option to the holder to convert the instrument into common shares of the Corporation are classified and presented on the balance sheet separately as a liability or as equity in accordance with CICA Handbook Section 3860, Financial Instruments - Disclosure and Presentation. The Corporation determines the initial carrying amount of the liability component of such financial instruments by discounting the stream of future payments of interest and principal at the prevailing market rate for a similar liability that does not have an associated equity component. After initial recognition, the financial liability component is measured on the balance sheet at amortized cost using the effective interest method. The carrying amount of the equity component is determined by deducting the carrying amount of the financial liability from the amount of the instrument as a whole.

Future accounting changes

In early 2005, the CICA issued three new accounting standards: Section 1530, Comprehensive Income; Section 3855, Financial Instruments - Recognition and Measurement; and Section 3865, Hedges. In addition, extensive revisions were made to Section 3050, Long-term Investments, which has been reissued as Section 3051, Investments; Section 3250, Surplus, which has been reissued as Section 3251; and Section 3860, Financial Instruments - Disclosure and Presentation, which has been reissued as Section 3861. The new standards will be effective for the Corporation's fiscal year commencing January 1, 2007. The Corporation will assess the impact of adopting the new standards on its financial position, statement of operations and cash flows and determine whether early adoption is appropriate.

Related Party Transactions

The Corporation executes securities transactions on behalf of employees, officers, directors and shareholders and their related corporations. These transactions are conducted in accordance with terms and conditions applicable to all clients of the Corporation. Commission income earned from these transactions in the aggregate is not material in relation to the overall operations of the Corporation.

The Corporation completed a private placement for $35 million of senior unsecured convertible debentures. The Caisse subscribed for $30 million and senior management subscribed for $5 million of these debentures. The debentures issued to senior management contain the identical terms and conditions as the debentures issued to the Caisse. See the sub-heading "Convertible Debentures" in the "Financial Condition" section of this MD&A for a detailed description of the terms and conditions of the debentures.

Risk Factors

For a description of the identifiable risks that could affect the Corporation's business, please see the Corporation's Annual Information Form dated March 23, 2005, which is available on SEDAR at www.sedar.com.

Additional Information

Additional information relating to the Corporation, including the Corporation's most recently filed annual information form and information circular, is available on SEDAR at www.sedar.com.



Selected Quarterly Data(1) (Unaudited)
($000's Cdn except per share and asset totals)

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

2005 2004

Jun Mar Dec Sep Jun Mar
30 31 31 30 30 31
---------------------------------------------------------------------

Revenue $46,810 $49,683 $43,956 $34,301 $32,043 $42,456

Expenses 40,004 42,224 39,056 30,564 28,578 36,582
---------------------------------------------------------------------
EBITDA 6,806 7,459 4,900 3,737 3,465 5,874

Amortization of
capital and
intangible assets
and deferred
employment
arrangements 3,669 3,730 2,614 2,801 2,964 2,720

Interest 1,303 1,403 407 422 387 718

Recovery on prior
Business
Activities - 12 12 - - 86

Tax provision
(recovery) 193 1,296 (3,479) - - -
---------------------------------------------------------------------
Net earnings $1,641 $1,042 $5,370 $514 $114 $2,522
---------------------------------------------------------------------
---------------------------------------------------------------------
Earnings per share
- basic $0.07 $0.06 $0.33 $0.03 $0.01 $0.16
---------------------------------------------------------------------
---------------------------------------------------------------------
Earnings per share
- diluted $0.07 $0.05 $0.32 $0.03 $0.01 $0.15
---------------------------------------------------------------------
---------------------------------------------------------------------

AUA(2)-$Billion Cdn $6.2 $6.2 $5.7 $5.3 $5.1 $5.4

AUM(2)-$Billion Cdn $6.2 $6.6 $6.8 $0.5 $0.5 $0.5


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

2003

Dec 31 Sep 30
---------------------------------------------------------------------
Revenue $40,756 $29,995

Expenses 36,342 27,917
---------------------------------------------------------------------
EBITDA 4,414 2,078
Amortization of capital and
intangible assets and deferred
employment arrangements 2,650 2, 320

Interest 603 728

Recovery on prior business
activities 93 1,074

Tax provision (recovery) (508) -
---------------------------------------------------------------------
Net earnings $1,762 $104
---------------------------------------------------------------------
---------------------------------------------------------------------
Earnings per share - basic $0.12 $0.01
---------------------------------------------------------------------
---------------------------------------------------------------------
Earnings per share - diluted $0.12 $0.01
---------------------------------------------------------------------
---------------------------------------------------------------------

AUA(2) - $Billion Cdn $5.0 $3.9
AUM(2) - $Billion Cdn $0.5 $0.4

(1) Certain comparative figures have been reclassified to conform to
the current period presentation.
(2) See "Non-GAAP Measures".


The table disclosed above provides unaudited, selected quarterly financial information from the eight most recently completed financial quarters ended June 30, 2005. The Corporation's business is generally seasonal over the fiscal year and may experience considerable variations in revenue and income from quarter to quarter. Historically, revenue for capital markets participants is higher in the first and last quarters of the fiscal year and the Corporation's experience follows that of the industry. In 2004, 57% of the Corporation's revenue was recorded in the first and last quarters. Therefore, quarter-to-quarter comparisons of financial results are not necessarily meaningful and should not be relied upon as an indication of future performance.



Interim Consolidated Financial Statements (Unaudited)

Rockwater Capital Corporation
June 30, 2005



Rockwater Capital Corporation
Interim Consolidated Balance Sheets (Unaudited)
(in thousands of Canadian dollars)

As at June 30, As at December 31,
2005 2004
$ $
---------------------------------------------------------------------

ASSETS
Current
Cash and cash equivalents 18,679 13,274
Securities owned, at market
(note 4) 26,835 19,332
Receivables from customers
(note 14) 317,760 245,668
Receivables from brokers,
dealers and clearing
organizations 26,388 45,018
Receivables under securities
borrowed transactions
(note 3) 49,615 25,267
Receivables under repurchase
agreements (note 3) 19,356 49,199
Accounts receivable and
prepaid expenses 14,363 16,460
Cash deposited with clearing
organizations 1,421 1,304
---------------------------------------------------------------------
Total current assets 474,417 415,522
---------------------------------------------------------------------

Corporate investments,
net of reserves 1,890 1,460
Capital assets, net 12,397 12,615
Goodwill 92,239 93,264
Intangible assets 40,681 41,610
Deferred employment arrangements,
net (note 6) 18,288 16,423
Other assets 641 1,950
---------------------------------------------------------------------
Total assets 640,553 582,844
---------------------------------------------------------------------
---------------------------------------------------------------------

LIABILITIES AND SHAREHOLDERS'
EQUITY
Current
Short-term borrowing (note 7) - 60,000
Securities sold short, at market
(note 4) 14,365 10,367
Due to customers (note 14) 330,982 299,757
Due to brokers, dealers and
clearing organizations 45,683 20,833
Due to brokers under securities
loaned transactions (note 3) 392 11,556
Accounts payable and accrued
liabilities 41,979 39,199
Subordinated loan 2,000 2,000
---------------------------------------------------------------------
Total current liabilities 435,401 443,712
---------------------------------------------------------------------

Convertible debentures
(note 8) 34,003 -
Future tax liability 10,942 10,194
Preferred shares issued by
subsidiaries (note 9) 20,663 24,116
---------------------------------------------------------------------
Total liabilities 501,009 478,022
---------------------------------------------------------------------

Shareholders' equity
Capital stock (note 10) 165,760 136,039
Contributed surplus 6,227 3,574
Deficit (32,443) (34,791)
---------------------------------------------------------------------
Total shareholders' equity 139,544 104,822
---------------------------------------------------------------------
640,553 582,844
---------------------------------------------------------------------
---------------------------------------------------------------------

See accompanying notes



Rockwater Capital Corporation
Interim Consolidated Statements of Operations and Deficit (Unaudited)
(in thousands of Canadian dollars, except per share amounts)

For the three For the six
months ended: months ended:
---------------------------------------------------------------------
June 30, June 30, June 30, June 30,
2005 2004 2005 2004
$ $ $ $
---------------------------------------------------------------------

REVENUES
Commissions 21,591 20,498 47,869 48,612

Asset management and
account fees 9,186 2,334 18,851 6,065

Investment banking 8,592 3,616 15,718 7,017

Interest income 3,226 2,586 6,134 5,424

Principal transactions 3,132 1,228 5,764 4,492

Other income 1,083 1,781 2,169 2,975
---------------------------------------------------------------------
46,810 32,043 96,505 74,585
EXPENSES
Compensation and benefits 29,035 19,498 60,810 45,852

Brokerage, clearing and
exchange fees 3,033 2,715 5,973 6,003

General and administrative 2,996 2,299 5,749 5,000

Occupancy 2,768 2,246 5,469 4,510

Communications and
technology 2,172 1,813 4,227 3,796

Amortization 1,176 513 2,308 1,007

Interest expense 1,303 387 2,706 1,105
---------------------------------------------------------------------
42,483 29,471 87,242 67,273
---------------------------------------------------------------------

Earnings before amortization
of deferred employment
arrangements 4,327 2,572 9,263 7,312

Amortization of deferred
employment arrangements
(note 6) 2,493 2,458 5,091 4,676
---------------------------------------------------------------------
---------------------------------------------------------------------

Earnings before income tax 1,834 114 4,172 2,636
---------------------------------------------------------------------
---------------------------------------------------------------------

Income taxes
Current 272 - 627 -

Future (79) - 862 -
---------------------------------------------------------------------
193 - 1,489 -
---------------------------------------------------------------------

Net earnings for the period 1,641 114 2,683 2,636
---------------------------------------------------------------------
---------------------------------------------------------------------

Excess on acquisition of
preferred shares (note 9) (335) - (335) -

Deficit, beginning of the
period (33,749) (40,487) (34,791) (43,009)
---------------------------------------------------------------------
---------------------------------------------------------------------

Deficit, end of the period (32,443) (40,373) (32,443) (40,373)
---------------------------------------------------------------------
---------------------------------------------------------------------

Basic and diluted earnings
per common share (note 12) 0.07 0.01 0.13 0.16
---------------------------------------------------------------------
---------------------------------------------------------------------

See accompanying notes



Rockwater Capital Corporation
Interim Consolidated Statements of Cash Flows (Unaudited)
(in thousands of Canadian dollars)

For the three For the six
months ended: months ended:
---------------------------------------------------------------------
June 30, June 30, June 30, June 30,
2005 2004 2005 2004
$ $ $ $
---------------------------------------------------------------------
OPERATING ACTIVITIES

Net earnings for the period 1,641 114 2,683 2,636

Add (deduct) items not
affecting cash

Amortization 1,176 513 2,308 1,007

Amortization of deferred
employment arrangements 2,493 2,458 5,091 4,676

Future income taxes (79) - 862 -

Deferred financing charges 38 - 113 -

Stock-based employee
compensation 1,372 375 2,836 516
---------------------------------------------------------------------
6,641 3,460 13,893 8,835

Net change in non-cash
working capital
balances related
to operations 11,049 (22,747) (1,222) (41,002)
---------------------------------------------------------------------
Cash generated (used) in
operating activities 17,690 (19,287) 12,671 (32,167)
---------------------------------------------------------------------
---------------------------------------------------------------------

INVESTING ACTIVITIES

Purchase of capital assets (692) (236) (1,078) (961)

Deferred employment
arrangements (3,690) (3,790) (6,956) (7,091)

Investments from prior
business activities - - - 643

Corporate investments - - (501) -
---------------------------------------------------------------------
Cash used in investing
activities (4,382) (4,026) (8,535) (7,409)
---------------------------------------------------------------------
---------------------------------------------------------------------

FINANCING ACTIVITIES

Repayment of short-term
borrowing (25,000) - (60,000) -

Issuance of convertible
Debentures - - 35,000 -

Issuance of common shares
(note 10) 28,319 1,843 29,721 4,203

Decrease in preferred
shares issued by
subsidiaries (2,366) - (3,452) (924)
---------------------------------------------------------------------
Cash provided by financing
activities 953 1,843 1,269 3,279
---------------------------------------------------------------------
---------------------------------------------------------------------

Net increase (decrease)
in cash and cash
equivalents for the
period 14,261 (21,470) 5,405 (36,297)

Cash and cash equivalents,
beginning of period 4,418 31,176 13,274 46,003
---------------------------------------------------------------------
Cash and cash equivalents,
end of period 18,679 9,706 18,679 9,706
---------------------------------------------------------------------
---------------------------------------------------------------------


Supplemental cash flow
information

Interest paid 2,184 386 2,629 1,063

Income taxes paid 249 71 249 98
---------------------------------------------------------------------
---------------------------------------------------------------------

See accompanying notes



Notes to Interim Consolidated Financial Statements (Unaudited)
(in thousands of Canadian dollars, except where noted and per
share amounts)


1. DESCRIPTION OF THE BUSINESS

Rockwater Capital Corporation (the "Corporation") is a financial services holding corporation, which through its principal operating subsidiaries offers a broad range of financial products and services to individuals, institutions and corporations in the areas of wealth management, asset management and capital markets. The Corporation's operating subsidiaries include: First Associates Investments Inc. ("FAI"), a full service investment dealer registered in all the provinces and territories of Canada; Rockwater Asset Management Inc. ("RAM"), an investment counsel and portfolio manager registered in the provinces of British Columbia, Alberta, Saskatchewan, Manitoba, Ontario, Nova Scotia, New Brunswick, Newfoundland and Labrador and Prince Edward Island; and KBSH Capital Management Inc. ("KBSH"), an investment counsel and portfolio manager registered in all the provinces of Canada.

The Corporation's common shares are traded on The Toronto Stock Exchange ("TSX") under the stock symbol "RCC".

2. SIGNIFICANT ACCOUNTING POLICIES

The unaudited interim consolidated financial statements include the accounts of all subsidiaries on a consolidated basis and are presented in accordance with Canadian generally accepted accounting principles ("GAAP"). These unaudited interim consolidated financial statements follow the same accounting policies and methods of application as those disclosed in Note 2 to the Corporation's audited consolidated financial statements as at and for the year ended December 31, 2004 ("Audited Consolidated Financial Statements"), except as noted below. However, they do not include all disclosures required by Canadian GAAP for annual financial statements, and accordingly, these unaudited interim consolidated financial statements should be read in conjunction with the Audited Consolidated Financial Statements.

The preparation of these unaudited interim consolidated financial statements and the accompanying notes, in accordance with GAAP, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities as at the date of the consolidated balance sheet and the revenue and expenses recorded in the reporting period. Actual results could differ from those estimates.

Certain reclassifications and format changes have been made to the prior year's amounts to conform to the current year's presentation.

Convertible debentures

The liability and equity components of debentures that grant an option to the holder to convert the instrument into common shares of the Corporation are classified and presented on the balance sheet separately as a liability or as equity in accordance with CICA Handbook Section 3860, Financial Instruments - Disclosure and Presentation. The Corporation determines the initial carrying amount of the liability component of such financial instruments by discounting the stream of future payments of interest and principal at the prevailing market rate for a similar liability that does not have an associated equity component. After initial recognition, the financial liability component is measured on the balance sheet at amortized cost using the effective interest method. The carrying amount of the equity component is determined by deducting the carrying amount of the financial liability from the amount of the instrument as a whole.

Future accounting changes

In early 2005, the CICA issued three new accounting standards: Section 1530, Comprehensive Income; Section 3855, Financial Instruments - Recognition and Measurement; and Section 3865, Hedges. In addition, extensive revisions were made to Section 3050, Long-term Investments, which was been reissued as 3051, Investments; Section 3250, Surplus, which has been reissued as Section 3251; and Section 3860, Financial Instruments - Disclosure and Presentation, which has been reissued as Section 3861. The new standards will be effective for the Corporation's fiscal year commencing January 1, 2007. The Corporation will assess the impact of adopting the new standards on its financial position, statement of operations and cash flows and determine whether early adoption is appropriate.

3. SECURITIES LENDING AND BORROWING AND REPURCHASE AGREEMENTS

The Corporation employs securities lending and borrowing primarily to facilitate the securities settlement process. These arrangements are typically short-term in nature, with interest being received on the cash delivered. These transactions are collateralized by securities owned and unpaid client securities and are subject to margin calls for any deficiency between the market value of the security given and the amount of collateral received. The Corporation manages its credit exposure by establishing and monitoring aggregate limits by counterparty for these transactions. Securities lending and borrowing and repurchase agreements consist of the following:



Cash Securities
-----------------------------------------------------
Loaned or Borrowed or Borrowed or Loaned or
delivered as received as received as delivered as
collateral collateral collateral collateral
$ $ $ $
---------------------------------------------------------------------

Securities lending and borrowing

June 30, 2005 49,615 392 47,998 660
December 31, 2004 25,267 11,556 27,995 15,015
---------------------------------------------------------------------
---------------------------------------------------------------------
Repurchase agreements

June 30, 2005 19,356 - 19,361 -
December 31, 2004 49,199 - 47,882 -
---------------------------------------------------------------------
---------------------------------------------------------------------


4. SECURITIES OWNED AND SOLD SHORT

Securities owned and sold short consist of the following:

June 30, 2005 December 31, 2004
-----------------------------------------------------
Securities Securities Securities Securities
owned sold short owned sold short
$ $ $ $
---------------------------------------------------------------------

Corporate and
government debt 18,812 11,266 16,302 9,788
Equities 8,023 3,099 3,030 579
---------------------------------------------------------------------
26,835 14,365 19,332 10,367
---------------------------------------------------------------------
---------------------------------------------------------------------


As at June 30, 2005, corporate and government debt maturities range from 2005 to 2033 (December 31, 2004-2005 to 2032) and bear interest ranging from 2.25 to 10.5% (December 31, 2004 - 2.75% to 10.75%).

5. FINANCIAL INSTRUMENTS

Foreign exchange

The Corporation uses financial instruments to manage and hedge foreign exchange risk on pending settlements in foreign currencies. Realized and unrealized gains and losses related to these contracts are recognized in income in the period in which they occur. Forward contracts outstanding consists of the following:



Forward contracts outstanding as June 30, 2005:

Notional Amounts Average Price Maturity
---------------------------------------------------------------------

To sell US dollars $ 861 $1.2265 July 6, 2005
To buy US dollars $8,239 $1.2279 July 7, 2005

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

Forward contracts outstanding as December 31, 2004:

Notional Amounts Average Price Maturity
---------------------------------------------------------------------

To sell US dollars $2,084 $1.2151 January 4, 2005
To buy US dollars $19,091 $1.2060 January 6, 2005

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


6. DEFERRED EMPLOYMENT ARRANGEMENTS

The Corporation's net carrying value of deferred employment
arrangements consists of the following:

June 30, 2005 December 31 2004
------------------------------------------------
Net Net
Carrying carrying
Cost Amortization value value
$ $ $ $
---------------------------------------------------------------------

Acquisition
Related 17,925 15,138 2,787 4,796
Recruitment
related 23,385 7,884 15,501 11,627
---------------------------------------------------------------------
41,310 23,022 18,288 16,423
---------------------------------------------------------------------
---------------------------------------------------------------------


7. SHORT-TERM BORROWING

Short-term borrowing consists of the following:

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

Bridge loan - 35,000
Subordinated loans from former KBSH
Shareholders - 25,000
---------------------------------------------------------------------
- 60,000
---------------------------------------------------------------------
---------------------------------------------------------------------


The Corporation obtained a bridge loan of $35,000 from a major Canadian financial institution on December 31, 2004. The loan proceeds were used to fund the cash component of the purchase consideration for the KBSH acquisition. The loan was repaid on January 11, 2005 with the proceeds received from a private placement of convertible debentures.

Subordinated loans of $25,000 were issued to the former KBSH shareholders on December 31, 2004 as part of the purchase consideration provided by the Corporation to acquire KBSH. The loans bear interest at a rate of 6% per annum for the first three months, and 8% per annum thereafter. On April 28, 2005, the Corporation used the net proceeds from an offering of common shares to repay the subordinated loans in full, including accumulated interest.

From time to time, the Corporation borrows money to facilitate the securities settlement process for both client and principal securities transactions. The use of call loans is customary in the brokerage industry to satisfy daily cash requirements, and these loans are collateralized by either unpaid client securities or securities owned by the Corporation. The call loans bear interest at the prevailing interest rate set by the Corporation's primary lenders as a function of the prime rate.

8. CONVERTIBLE DEBENTURES

On January 11, 2005, the Corporation completed a private placement of $35 million of senior unsecured convertible debentures (the "Debentures") due December 31, 2010. Caisse de depot et placement du Quebec has purchased $30 million of the Debentures and members of senior management of the Corporation have purchased $5 million of the Debentures. The Debentures initially bore interest at 6.75% per annum, which was reduced to 6.50% per annum as at April 28, 2005. Interest is payable on June 30 and December 31 in each year starting on June 30, 2005. Commencing June 30, 2005, the Debentures are convertible at the holder's option into common shares of the Corporation at a conversion price of $7.19 per share. The Debentures will also be convertible, at the option of the holder, into common shares at the lower of (i) $7.19; and (ii) 135% of the reference price in the event of a take-over, merger or amalgamation with a party dealing at arm's length with the Corporation, all subject to standard adjustments. After December 31, 2008, the Corporation may, at its option, redeem the Debentures, in whole or in part, subject to specified conditions. The Corporation will have the right to repay the outstanding principal amount of the Debentures, on maturity or redemption, through the issuance of its common shares.



The amortized cost of the Debentures is as follows:

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

Principal amount 35,000 -
Discount (997) -
---------------------------------------------------------------------
Net carrying value 34,003 -
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9. PREFERRED SHARES ISSUED BY SUBSIDIARIES

Preferred shares issued by subsidiaries consist of the following:

2005 2004
$ $
---------------------------------------------------------------------

Class T preferred shares issued
by First Associates Investments Inc. - 2,366
Preferred shares issued by Rockwater Asset
Management Ltd. 20,663 21,750
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20,663 24,116
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---------------------------------------------------------------------


In the second quarter of 2005, the Corporation repurchased the Class T preferred shares issued by FAI. The excess of the purchase price over the carrying value of the shares was charged directly to retained earnings.

10. CAPITAL STOCK AND CONTRIBUTED SURPLUS

Authorized

The Corporation's authorized capital stock consists of an unlimited number of common shares.

On April 28, 2005, the Corporation executed the previously announced consolidation of the outstanding common shares on a one-for-ten basis. The number of common shares issued and outstanding in the table presented below have been restated to give effect to this consolidation.



Issued

---------------------------------------------------------------------
Common Capital Contributed
shares Warrants stock surplus
# # $ $
---------------------------------------------------------------------

Balance at
December 31, 2004 18,768,606 1,000,000 136,039 3,574

Issuance of common
shares pursuant to
secondary
offering of common
shares 6,539,216 - 30,702 -

Issuance for deferred
employment
arrangements 303,985 - 2,351 (2,169)

Issuance on exercise
of options 50,000 - 250 -

Acquisition of common
shares for deferred
share unit plans (466,089) - (2,965) 163

Cancellation of common
shares pursuant to
acquisitions (138,629) - (617) -

Stock-based compensation - - - 2,836

Equity component of
convertible debentures
issued - - - 1,066

Amortization of deferred
employment arrangements - - - 757
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Balance at June 30,
2005 25,057,089 1,000,000 165,760 6,227
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On January 2, 2005, 138,629 shares relating to the acquisitions of KBSH and Platinum Wealth Management Inc. were cancelled due to forfeiture.

A total of 303,985 common shares were issued pursuant to deferred employment arrangements and 50,000 common shares were issued for options exercised.

On January 11, 2005, the Corporation issued $35 million in convertible debentures as described in Note 8. The equity component associated with these debentures is $1,066.

On April 28, 2005, the Corporation issued 6,539,216 common shares for net proceeds of approximately $30.7 million pursuant to a public offering.

In May and June 2005, 466,089 common shares were acquired pursuant to the Corporation's deferred share unit ("DSU") plans. The excess of the acquisition amount over the book value of the common shares acquired was charged directly to contributed surplus.

11. STOCK-BASED COMPENSATION PLANS

The Corporation adopted the fair value method of accounting recommended by the CICA in Handbook Section 3870, Stock-based Compensation and Other Stock-based Payments, prospectively for new awards granted after January 1, 2003. Total stock-based compensation expense for stock option, DSU awards and performance share unit ("PSU") awards for the three-month period and six-month period ended June 30, 2005 was $1,372 and $2,836 respectively ($375 and $516 for the three-month period and six-month period ending June 30, 2004). The unamortized expense for stock-based compensation plans as at June 30, 2005, is $8,520 ($10,078 as at June 30, 2004).

The Corporation has provided pro forma disclosures below, which demonstrate the effects if the recommended recognition provisions of CICA Section 3870 had been adopted for awards granted before 2003:



For the three months For the six months
ended: ended:
---------------------------------------------------------------------
June 30, June 30, June 30, June 30,
2005 2004 2005 2004
$ $ $ $
---------------------------------------------------------------------

Earnings attributable to
common shareholders
- as reported 1,641 114 2,683 2,636

Stock-based compensation
expense 184 202 368 404

Earnings (Loss) attributable
to common shareholders
- pro forma 1,457 (88) 2,315 2,232
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Earnings per share
- as reported 0.07 0.01 0.13 0.16

Earnings (Loss) per share
- pro forma 0.06 (0.01) 0.11 0.13
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12. EARNINGS PER SHARE

The following table sets forth the computation of basic and diluted
earnings per common share.

For the three months For the six months
ended: ended:
---------------------------------------------------------------------
June 30, June 30, June 30, June 30,
2005 2004 2005 2004
$ $ $ $
---------------------------------------------------------------------

Basic earnings per
common share
Net earnings for the
period 1,641 114 2,683 2,636
Weighted average number
of common shares 23,446,530 16,117,581 21,089,795 16,103,404
Basic earnings per
common share 0.07 0.01 0.13 0.16
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Diluted earnings per
common share
Net earnings for the
period 1,641 114 2,683 2,636
Weighted average number
of common shares 23,446,530 16,117,581 21,089,795 16,103,404
Dilutive effect of
unvested shares 90,173 529,373 152,395 529,290
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Adjusted weighted
average number of
common shares 23,536,703 16,646,954 21,242,190 16,632,694
Diluted earnings
per common share 0.07 0.01 0.13 0.16
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13. SEGMENTED INFORMATION

For management reporting, the Corporation's results are categorized into three business segments: Wealth Management, Asset Management and Capital Markets. Wealth Management revenues are comprised of commission and fee income earned on private client transactions and interest income on private client portfolio management services. Asset Management revenues are comprised primarily of fees charged to clients for the provision of discretionary investment management services and supervision of assets. Revenues from Capital Markets are earned from underwriting and investment banking fees, as well as institutional commissions derived from equity trading and other principal trading. Amortization of deferred employment arrangements related to acquisitions and certain corporate expenses are not attributed to segments because management excludes these items from operating results when evaluating segment performance. These expenses are included and reported as corporate items. Amortization of deferred employment arrangements related to recruitment is attributed to the proper business segment. The Corporation evaluates the performance of its segments and allocates resources to them based on profitability. Therefore, asset information by segment is not reported since the Corporation does not produce such information for internal use.

The tables below present information about the reported revenues, operating expenses, consisting of direct and allocated corporate expenses, amortization of deferred employment arrangements and net earnings (loss) of the Corporation's segments for the three-month periods and six-month periods ended June 30, 2005 and 2004:



For the three months ended June 30, 2005
--------------------------------------------------
Wealth Asset Capital
Management Management Markets Corporate Total
$ $ $ $ $
---------------------------------------------------------------------

Revenues 27,261 8,383 11,166 - 46,810
Operating expenses 25,085 5,339 8,216 1,364 40,004
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Earnings (loss)
before the
undernoted 2,176 3,044 2,950 (1,364) 6,806
Amortization 339 48 86 703 1,176
Amortization of
deferred employment
arrangements 1,318 - 400 775 2,493
Interest expense 495 54 16 738 1,303
Income tax - - - 193 193
---------------------------------------------------------------------
Net earnings (loss)
for the period 24 2,942 2,448 (3,773) 1,641
---------------------------------------------------------------------
---------------------------------------------------------------------


For the six months ended June 30, 2005
--------------------------------------------------
Wealth Asset Capital
Management Management Markets Corporate Total
$ $ $ $ $
---------------------------------------------------------------------

Revenues 58,362 17,585 20,558 - 96,505
Operating expenses 51,776 11,557 15,595 3,300 82,228
---------------------------------------------------------------------
Earnings (loss)
before the
undernoted 6,586 6,028 4,963 (3,300) 14,277
Amortization 663 126 164 1,355 2,308
Amortization of
deferred employment
arrangements 2,657 - 792 1,642 5,091
Interest expense 899 88 23 1,696 2,706
Income tax - - - 1,489 1,489
---------------------------------------------------------------------
Net earnings (loss)
for the period 2,367 5,814 3,984 (9,482) 2,683
---------------------------------------------------------------------
---------------------------------------------------------------------


For the three months ended June 30, 2004
--------------------------------------------------
Wealth Asset Capital
Management Management Markets Corporate Total
$ $ $ $ $
---------------------------------------------------------------------

Revenues 23,743 3,300 5,000 - 32,043
Operating expenses 20,282 3,098 4,085 1,106 28,571
---------------------------------------------------------------------
Earnings (loss)
before the
undernoted 3,461 202 915 (1,106) 3,472
Amortization 264 38 67 144 513
Amortization of
deferred employment
arrangements 1,122 - 259 1,077 2,458
Interest expense 380 2 - 5 387
Income tax - - - - -
---------------------------------------------------------------------
Net earnings (loss)
for the period 1,695 162 589 (2,332) 114
---------------------------------------------------------------------
---------------------------------------------------------------------


For the six months ended June 30, 2004
--------------------------------------------------
Wealth Asset Capital
Management Management Markets Corporate Total
$ $ $ $ $
---------------------------------------------------------------------

Revenues 55,954 7,897 10,734 - 74,585
Operating expenses 47,311 7,339 8,340 2,171 65,161
---------------------------------------------------------------------
Earnings (loss)
before the
undernoted 8,643 558 2,394 (2,171) 9,424
Amortization 511 58 131 307 1,007
Amortization of
deferred employment
arrangements 2,145 - 406 2,125 4,676
Interest expense 1,098 2 - 5 1,105
Income tax - - - - -
---------------------------------------------------------------------
Net earnings (loss)
for the period 4,889 498 1,857 (4,608) 2,636
---------------------------------------------------------------------
---------------------------------------------------------------------


14. RELATED PARTY TRANSACTIONS AND FUNDS HELD IN TRUST

Transactions with employees, officers and directors

During the period, the Corporation entered into certain transactions in the normal course of business with employees, officers and directors and their related corporations. Included in receivables from and due to customers are $26,024 and $13,808 (December 31, 2004 - $54,174 and $20,369), respectively relating to these transactions. Commission income earned on these transactions is not material to the overall operations of the Corporation.

Funds held in Trust

The Corporation holds RRSP cash funds in trust on behalf of certain clients. These funds are included in the consolidated financial statements. At June 30, 2005, RRSP cash funds held in trust amount to $96,044 (December 31, 2004 - $92,264).

Contact Information

  • Rockwater Capital Corporation
    William D. Packham
    President and CEO
    (416) 864-2100
    or
    Rockwater Capital Corporation
    Gordon H. Weir
    Chief Financial Officer
    (416) 874-8037