TERRAVEST INCOME FUND
TSX : TI.UN

TERRAVEST INCOME FUND

March 16, 2007 07:00 ET

TerraVest Income Fund Releases 2006 Q4 and Year End Financial Results

VEGREVILLE, ALBERTA--(CCNMatthews - March 16, 2007) - TerraVest Income Fund (TSX:TI.UN) today released its financial results for the 2006 fourth quarter and for the 12-month period to December 31, 2006.

The Fund's highlights for the 12 months ended December 31, 2006 were:

- Sales of $271.3 million, up 37% from 2005;

- Distributable cash of $23.5 million, up 18% from 2005;

- Payout ratio of 92% on a cash basis, and 108% on a fully diluted basis; and

- Net earnings of $17.5 million (before non-cash goodwill write-down), up 74% from 2005.

At the end of the fourth quarter of 2006, the Fund recorded a non-cash goodwill write-down of $24.6 million, attributable to some of the portfolio businesses, namely, Beco, Don Park, and Stylus. The goodwill write-down was partially offset by a recovery from retractable, non-controlling interest. The goodwill write-down is a non-cash charge that is primarily due to a reduction in recent financial performance of those businesses, and the government's decision to tax income trusts starting in 2011. The reduction in the carrying value of goodwill on the Fund's businesses does not impact the calculation of distributable cash for the Fund's investors.

The Fund's long-term financial liabilities decreased $6.1 million in 2006 compared to 2005, due primarily to the goodwill write-down and its impact on the carrying value of the retractable non-controlling interest.

For the three months ended December 31, 2006, the Fund reported sales of $67.3 million and a net loss of $12.9 million ($0.84 per Unit). For the year ended December 31, 2006, the Fund reported a net loss of $0.2 million ($0.01 per Unit).

For the 2006 period, the Fund reported Distributable Cash of $23.5 million ($1.52 per Unit), up from $19.9 million ($1.73 per Unit) in 2005. Distributable Cash for the 2006 fourth quarter totaled $4.8 million ($0.27 per Unit), which compares with $5.6 million ($0.44 per Unit) during the 2005 fourth quarter.

The 2006 fourth quarter reduction in Distributable Cash reflects a shift in order patterns from customers at RJV, the Fund's largest business, which resulted in increased orders in the third quarter of 2006 and a corresponding reduction in the fourth quarter of 2006. Additionally, Distributable Cash during both the fourth quarter and full year periods of 2006 was reduced by a tax provision of $1.1 million made by the Fund as a result of a reassessment by the Canada Revenue Agency against Diamond for expenses prior to its acquisition in 2005. Management is appealing this reassessment. Per Unit amounts for Distributable Cash reflect a 35% increase in the weighted average number of Units outstanding in 2006.



Highlights from the Fund's fourth quarter and its 2006 reporting period are
as follows:

thousands of dollars

Three
Months ended Year ended
December 31 December 31
2006 2005 Change 2006 2005 Change
----------------- -----------------
Sales
RJV 16,681 17,814 74,136 64,302
Ezee-On 1,021 1,972 9,244 15,272
Stylus 8,439 11,535 33,493 40,016
Don Park 22,089 24,005 85,338 70,135
Diamond 6,891 6,638 27,296 6,638
Beco 12,220 1,779 41,840 1,779
----------------- -----------------
Total revenues 67,341 63,743 6% 271,347 198,142 37%
----------------- -----------------

Net (loss) earnings (12,874) 3,210 (205) 10,091
----------------- -----------------
----------------- -----------------
Per Unit (basic) (0.84) 0.25 (0.01) 0.88
----------------- -----------------
----------------- -----------------
Per Unit (diluted) (0.84) 0.25 (0.01) 0.88
----------------- -----------------
----------------- -----------------

Net earnings before
goodwill write-down(1) 4,849 3,210 51% 17,518 10,091 74%
----------------- -----------------
----------------- -----------------
Per Unit (basic) 0.30 0.25 20% 1.13 0.88 29%
----------------- -----------------
----------------- -----------------
Per Unit (diluted) 0.28 0.25 12% 1.11 0.88 26%
----------------- -----------------
----------------- -----------------

Cash flow from
operations before
working capital
changes 5,244 6,135 (15%) 27,430 22,047 24%
Less: Maintenance
capital (439) (530) (3,113) (1,936)
expenditures
Less: Retractable
non- controlling
interest 5 27 (804) (224)
----------------- -----------------

Distributable cash 4,810 5,632 (15%) 23,513 19,887 18%
----------------- -----------------
----------------- -----------------
Per Unit 0.27 0.44 1.52 1.73

Distributions declared
Per Unit 0.35 0.34 1.38 1.27
Payout ratio 126% 77% 92% 73%
Proforma payout
ratio(2) 140% 96% 108% 93%

(1) Adjustments to net earnings for 2006 include: goodwill write-down of
$24.6 million, goodwill recovery from retractable non-controlling
interest amounting to ($4.9) million, and non-controlling interest
impact of ($1.9) million.
(2) Assumes exchange of all Exchangeable Shares for Units at the beginning
of 2006 and 2005, respectively


"Both RJV and Diamond benefited from a year of robust business conditions in the energy sector," said Dale Laniuk, President and Chief Executive Officer. "During 2007, Management intends to concentrate on improving the overall operating and financial performance of its existing portfolio businesses while it assesses the impact of the federal government's plan to impose new taxation on the income trust sector in 2011."

The Fund disclosed the breakdown of cash distributions to Canadian Unitholders for income tax purposes. Total distributions during 2006 of $1.38 per Unit are classified as taxable other income.

As of December 31, 2006, there were 17,625,845 Units issued and outstanding and 1,411,112 Exchangeable Shares issued and outstanding. The Exchangeable Shares are held primarily by Fund Management and are not listed or traded on an exchange.

The Fund's audited financial statements, MD&A and Annual Information Form are available on SEDAR at www.sedar.com and on the Fund's website at www.terravestindustries.com.

The Fund will hold a conference call today with management to review the 2006 results. The details are as follows:



Time: 3:30 pm E.S.T.
Participants: Dale Laniuk, President and CEO
Tom Kileen, Chief Financial Officer
Tim Zosel, Senior Vice President

Access Number: Toronto: 416-695-9712
Toll-Free Access: 1-800-769-8320


A replay of the conference call will be available at (416-695-5275) (Toll-Free Access: 1-888-509-0081) for seven days after the conference call (Pass code: 640111). A transcript can be viewed (usually within 48 hours) by visiting the Fund's website and clicking to "Corporate Presentations."

About TerraVest Income Fund

TerraVest Income Fund is an income trust whose Units trade on the Toronto Stock Exchange. Its mandate is to invest in a diversified group of income producing businesses to provide its Unitholders with stable and increasing cash returns. TerraVest has made six investments:

- RJV is one of the largest providers of wellhead processing equipment for the Canadian natural gas industry.

- Stylus is one of Canada's leading made-to-order upholstered furniture manufacturers.

- Don Park is the largest fabricator and wholesaler of HVAC ducts and related equipment in Ontario.

- Diamond Energy Services is an oil and natural gas well servicing company operating in Saskatchewan and Alberta.

- Beco Industries is the largest Canadian designer, manufacturer and importer of home textile products.

- Ezee-On manufactures heavy duty equipment for large acreage grain farms and livestock operations.

MANAGEMENT'S DISCUSSION AND ANALYSIS

For the period ended December 31, 2006

Dated: March 15, 2007

Caution Regarding Forward-Looking Statements

The public communications of TerraVest Income Fund (the "Fund") often include written or oral forward-looking statements. Statements of this type are included in this Management's Discussion and Analysis ("MD&A"), and may be included in filings with Canadian securities regulators, or in other communications. Forward-looking statements may involve, but are not limited to, comments with respect to our objectives for 2007 and beyond, our strategies or future actions, and our targets or expectations for our financial performance and condition. All statements other than statements of historical fact contained in this MD&A are forward-looking statements, including, without limitation, statements regarding the future financial position and operations, business strategy, proposed acquisitions, budgets, distributions, projected costs and plans and objectives of or involving the Fund. Readers can identify many of these statements by looking for words such as "believe", "expects", "will", "intends", "projects", "anticipates", "estimates", "continues", and similar words or the negative thereof. Although Management believes that the expectations represented in such forward looking statements are reasonable, there can be no assurance that such expectations will prove to be correct.

By their nature, forward-looking statements require us to make assumptions and are subject to inherent risks and uncertainties including those discussed in this MD&A. There is significant risk that predictions and other forward-looking statements will not prove to be accurate. We caution readers of this MD&A not to place undue reliance on our forward-looking statements because 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.

Assumptions and analysis about the performance of the Fund, as a whole, and the Fund's portfolio businesses and the markets in which they compete are considered in setting the business plan for the Fund, in forecasting the Fund's expected financial results and the Fund's ability to pay distributions, in setting financial targets for the Fund and in making related forward-looking statements. The key assumption in respect of the Fund's level of distributions is that the cumulative distributable cash will be able to support the Fund's current level of distributions. The Fund receives distributable cash from its portfolio businesses. In respect of the portfolio businesses, key assumptions include those relating to the demand for products and services of the portfolio businesses and in respect of the Canadian and other markets in which the Fund's businesses are active (and in particular, the Canadian oil and natural gas industry in western Canada and the markets for household materials and household goods). Should any of these factors or assumptions vary, actual results may differ materially from the forward-looking statements.

The information set forth under "Risk Factors" herein and the annual information form of the Fund dated March 15, 2007, identifies additional factors that could affect the operating results and performance of the Fund and its portfolio businesses. In making forward-looking statements, the Fund makes assumptions about those of these risk factors which are relevant. We caution that the list of factors discussed under "Risk Factors" herein and the annual information form of the Fund dated March 15, 2007 is not exhaustive and that, when relying on forward-looking statements to make decisions with respect to the Fund, investors and others should carefully consider the factors discussed, as well as other uncertainties and potential events, and the inherent risks and uncertainties of forward-looking statements.

The forward-looking statements contained herein are expressly qualified in their entirety by this cautionary statement. The forward-looking statements included in this MD&A are made as of the date of this MD&A. Except as required by applicable securities laws, the Fund does not undertake to update any forward-looking statement, whether written or oral, that it may make or that may be made, from time to time, on its behalf.

(NOTE: numbers in thousands except Unit and per Unit amounts, share and per share amounts)

ABOUT TERRAVEST

TerraVest Income Fund (the "Fund") is an unincorporated, open-ended, limited purpose trust established to invest in a diversified group of income producing businesses.

The Fund was created in June 2004 to provide a means whereby investors could acquire an interest in Canadian businesses that are capable of producing attractive investment returns to the owners of the Fund ("Unitholders").

The Fund's initial investment was the acquisition of 100% of the issued and outstanding securities of Laniuk Industries Inc. ("Laniuk") and it's wholly owned subsidiary corporations, RJV Gas Field Services ("RJV") and Ezee-On Manufacturing ("Ezee-On"). Subsequently, the Fund acquired four other operating divisions: Stylus Made to Order Sofas ("Stylus"); Don Park and Don Park (USA) (collectively, "Don Park"); Diamond Energy Services ("Diamond"); and Beco Industries ("Beco"). RJV, Ezee-on, Stylus, Don Park, Diamond and Beco are collectively referred to as the portfolio businesses.

RJV is one of Canada's largest providers of wellhead processing equipment for natural gas industry in western Canada. Ezee-on manufactures heavy-duty equipment for large acreage grain farms and livestock operations. Stylus is one of Canada's leading made-to-order upholstered furniture manufacturers. Don Park is one of Canada's leading manufacturers and suppliers of heating, ventilation and air conditioning products. Diamond is a market leader in providing well servicing to the oil and natural gas sector in south-western Saskatchewan, with a growing presence in Alberta. Beco is one of Canada's largest designers, manufacturers and importers of home textile products.

Overall Strategies of the Fund

Investments

The Fund is focused on investing in diverse businesses which operate independently without reliance on synergistic acquisition assumptions. Growth in the Fund's cash flow is intended to take place both through long-term organic growth of the portfolio businesses and through investments in other businesses which fit the investment criteria of the Fund.

Part of the Fund's investment strategy is to ensure that the senior management of each acquired business retains an interest in the operating business after the investment in order to create an incentive to increase the overall value of that operating business.

Management believes that the diversity of the various portfolio businesses enhances the stability of the Fund's overall distributable cash generation capabilities. Diversification minimizes the overall effect on the Fund of changes in market circumstances in any one of the Fund's businesses, thus facilitating stable monthly distributions to Unitholders.

Cash Distributions

In negotiating its investments, Management endeavours to ensure that Unitholders receive priority returns from the distributable cash of the portfolio businesses. In four of the investments, Stylus, Don Park, Diamond and Beco, the Fund is entitled to preferred returns of annual distributable cash from the limited partnerships (the "Limited Partnerships") under which these businesses are operated. Each year, this preference entitles the Fund to receive all distributions of cash by these Limited Partnerships up to pre-established thresholds, before any distributions of cash are available to the retractable non-controlling interests. After the first pre-established threshold is met by one of these Limited Partnerships, the retractable non-controlling interest holders receive all distributions of cash from that Limited Partnership to a second higher pre-determined threshold. Once both of the thresholds are achieved by one of these Limited Partnerships, the distributions of cash are allocated on a pre-determined basis in relation to the respective ownership interests.

Investment Criteria

Generally, the Fund intends to invest in manufacturing or service oriented businesses that meet its investment criteria. Businesses that meet the Fund's investment criteria will have:

- annual revenues exceeding $20,000,

- demonstrated track record of generating stable cash flow,

- durable competitive advantage in an attractive industry,

- ongoing participation of key senior personnel post-investment,

- opportunities for organic growth under existing business practices, and

- immediate and longer term accretion to the Fund's distributable cash per Unit.

Management believes that, to the vendor of a private middle market business, the Fund is an attractive alternative over other potential buyers due to its: (i) tax efficient structure, which may result in a cost of capital advantage; (ii) ability to utilize publicly-traded Units as an acquisition currency; and (iii) ability to provide operating management teams of acquired businesses with a less complex and more conservatively leveraged capital structure than traditional acquirers of private businesses.

Recent Developments Affecting the Implementation of Investment Strategy

Since its inception in 2004, the Fund's businesses have operated autonomously and maintained their individual business identities. The Fund relies on the high quality management teams of its businesses and does not rely on operating synergies to justify acquisitions. TerraVest Industries Inc., the Fund's Administrator, does provide additional managerial support through its experience in strategy development, assistance with planning and analysis, industry contacts, and focus on operational and financial disciplines.

To further diversify its sources of distributable cash flow, the Fund has invested in businesses that operate in many different industries. The Fund's strategy has been to seek further investments that complement its present businesses in the energy, home design and improvement, construction and agriculture sectors, as well as looking at other unrelated market segments to further enhance its diversity. Management selects businesses for long term investment, with a belief that products or services sold will continue to meet customer demands, despite short term economic swings in particular business sectors. In the natural gas market, RJV has developed a stable customer base that is committed to continued development of new and existing sources of natural gas. Diamond provides service rigs at existing and new oil wells and, to a lesser extent, provides service rigs and coiled tubing units to natural gas extractors. The geographic location of Diamond's marketplace and the large number of producing wells has enabled the business to maintain attractive utilization rates. Don Park provides heating and air conditioning components to the residential new construction and the residential renovation markets, as well as wholesale distribution and commercial construction segments. Stylus and Beco provide reasonably priced household furnishings that appeal to consumers despite fluctuations in other closely-related segments of the economy. Ezee-On continues to supply equipment to the agricultural industry in western Canada and the United States, Australia and Asia.

On October 31, 2006, the Minister of Finance (Canada) released proposals to change the taxation regime applicable to certain income trusts and limited partnerships, to be known as specified investment flow-throughs ("SIFTs"), as well as the taxation regime applicable to investors of SIFTs. Specifically, certain distributions made by a SIFT that are attributable to the SIFT's "non-portfolio earnings", other than certain dividends, will not be deductible in computing the SIFT's income and will be subject to tax, at a rate that is equivalent to the federal general corporate tax rate plus 13% (a proxy for provincial tax). Amounts that become payable to a SIFT investor, which the SIFT cannot deduct will, as a result of these proposals, be taxed in the hands of the SIFT investor on the same basis as eligible taxable dividends received from a taxable Canadian corporation. These proposals will not apply to SIFTs that were publicly traded before November 1, 2006, or to investors in such SIFTs, until January 1, 2011. The Normal Growth Guidelines for existing SIFTs as proposed by the Minister of Finance (Canada) indicate that the Fund will continue to benefit from the deferred application of the new tax regime until 2011 if the equity capital of the Fund does not grow as a result of issuances of new equity (which includes trust units, debt that is convertible into trust units, and potentially other substitutes for such equity) in any year before 2011 by an amount that exceeds the greater of $50,000 and an objective "safe harbour" amount based on a percentage of the Fund's October 31, 2006 market capitalization. The Normal Growth Guidelines provide for a "safe harbour" amount equal to 40% of the Fund's October 31, 2006 market capitalization for the period from November 1, 2006 to the end of 2007, and 20% for each of the 2008 to 2010 calendar years. These amounts of "safe harbour" are cumulative during the transition period. The Fund's October 31, 2006 market capitalization was approximately $138,010. It is therefore assumed, for the purposes of this summary that the Fund will not be subject to the 2006 Proposed Amendments until January 1, 2011.



Normal Growth Summary:

Permitted
Safe Growth
Market Harbour Safe (maximum Cumulative
Capitalization Percentage Harbour $50,000) Growth
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Outstanding Debt
October 31, 2006 $ 56,395 $ 56,395
November 1, 2006-
December 31, 2007 $ 138,010 40% $ 55,204 $ 55,204 $ 111,599
Calendar Year 2008 $ 138,010 20% $ 27,602 $ 50,000 $ 161,599
Calendar Year 2009 $ 138,010 20% $ 27,602 $ 50,000 $ 211,599
Calendar Year 2010 $ 138,010 20% $ 27,602 $ 50,000 $ 261,599
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The proposed changes to the taxation regime impact the Fund in two ways: first, the carrying value of its portfolio businesses has been reduced, and are reflected as part of the write-down in the goodwill carrying value of certain of the portfolio businesses in the fourth quarter of 2006; and second, the Fund's ability to implement its stated investment strategy was interrupted due to the higher cost of equity financing resulting from a lower Unit value. The goodwill write-downs are driven by the anticipated tax obligation based on net earnings starting in 2011 which impact the discounted cash flows expected in future periods. The write-downs also reflect reduced financial performance in the most recent fiscal periods of certain of the portfolio businesses. Management continues to work with each of the portfolio businesses to improve financial performance in future periods.

The proposed tax provisions may impact on the Fund's future ability to implement its stated investment strategy. The extent of this impact on the Fund is uncertain at this time. Management intends to concentrate during 2007 on improving the overall operating and financial performance of its portfolio businesses. Management intends to monitor future developments to determine whether its investment and operating strategies will require change in order to maximize overall Unitholder values. The Fund's current investments are well positioned to be effective competitors in their industries and through growth strategies provide stable and growing returns. Management will continue to creatively seek ways to partner with successful Canadian businesses and grow the Fund. Management believes the market uncertainty will also bring opportunity, and is committed to capitalizing on opportunities as they arise.

INVESTMENTS AND CAPITALIZATION OF THE FUND

2004

- In July 2004, the Fund issued 2,830,000 Units at a price of $8.15 per Unit. The aggregate proceeds from the offering were $23,065. On July 9, 2004, the Fund acquired the business operations of Laniuk, which comprised the operating divisions of RJV and Ezee-On. Consideration for the acquisition consisted of a note payable to the former shareholders of Laniuk in the amount of $33,743 and the issuance of exchangeable shares for $17,946. The Fund then issued Units to the former shareholders of Laniuk to satisfy the note payable of $33,743. Costs related to the acquisition of Laniuk totaled $1,658. Additional costs of $2,632 were incurred by the Fund for the issuance of the Units. The total cost of the transaction and the issuance of the Units was $4,290.

- In late 2004, the Fund issued 3,277,500 Units at a price of $10.60 per Unit for aggregate proceeds of $34,741. On December 17, 2004, the Fund acquired an 80% interest in the assets and shares of Stylus Furniture Ltd. for $21,816 plus costs of $586 for a total acquisition price of $22,402. Additional costs of $2,520 were incurred by the Fund for the issuance of the Units. The total cost of the transaction and the issuance of the Units was $3,106.

2005

- On April 1, 2005, the Fund acquired an 80% interest in the assets of Don Park, Inc. and Don Park (USA), Inc. for $30,157 plus transaction costs of $1,000 for a total acquisition price of $31,157. The acquisition was funded by existing credit facilities.

- In July 2005, the Fund issued 2,550,000 Units at $13.65 per Unit for gross proceeds of $35,063. Costs related to this offering were $2,046. The Fund used the net proceeds to reduce the debt incurred on the acquisition of Don Park.

- On October 3, 2005, the Fund acquired an 87.1% interest in the assets of Diamond Energy Services, Inc. for $33,735 plus acquisition costs of $1,230. The acquisition was funded by existing credit facilities.

- On December 5, 2005, the Fund acquired an 80% interest in the assets of Beco Industries Inc. for $33,600 plus acquisition costs of $1,373. The acquisition was funded by existing credit facilities.

2006

- In April 2006, the Fund issued 2,950,000 Units, at a price of $11.60 per Unit. The total proceeds from the offering were $34,220. Costs related to this offering were $2,004. The net proceeds of $32,216 were used to reduce the debt incurred to acquire Diamond and Beco.

DISTRIBUTABLE CASH

The Fund has a policy of paying stable monthly distributions to Unitholders from its distributable cash. The Fund targets to distribute less than 90% of the distributable cash forecasted by its income producing businesses in its monthly distributions. In accordance with the Declaration of Trust, the independent Trustees determine the amount of distributable cash to be distributed to Unitholders.

Distributable cash is not a defined term under Canadian generally accepted accounting principles and does not have a standard meaning, but is determined by the Fund to be cash flow from operating activities, adjusting for changes in non-cash working capital items, less capital expenditures related to maintenance of the portfolio businesses' property, plant and equipment, and retractable non-controlling interest charges.

In the view of Management, the Fund has taken a conservative approach to differentiating maintenance capital expenditures (which are treated as a deduction in determining distributable cash) from capital expenditures for growth or expansion of the portfolio businesses (which are not treated as a deduction in determining distributable cash). In order to be classified as a capital expenditure for growth or expansion, the capital expenditure must be for a new product line, a new division or a facet of the business that will create a new stream of revenue that did not previously exist in the organization. All other investments in capital assets are considered to be for the maintenance of existing lines of business, whether or not they yield significant cost or production efficiencies. Management believes that maintenance capital expenditures should be funded by cash flow from existing operating activities. Capital expenditures related to future growth or expansions are expected to provide additional future cash flows and as such are not deducted in arriving at distributable cash.

Management believes that distributable cash as a liquidity measure is a useful supplemental measure as it provides the independent Trustees with an indication of the amount of cash available for distribution to the Unitholders. Investors are cautioned, however, that distributable cash should not be construed as an alternative to using net earnings as a measure of profitability or to using information contained in the audited consolidated statements of cash flows as a measure of liquidity. Further, the Fund's method of calculating distributable cash may not be comparable to measures used by other entities.

The Fund receives indirect payments of cash from the portfolio businesses and from this cash pays distributions to the Unitholders, costs and expenses of the Fund, and any amounts payable by the Fund in connection with any redemption or purchase of Units. Certain of the portfolio businesses experience seasonality and, as a result, there are timing differences in the generation of cash flow from operations and hence distributable cash in individual months. It has been the Fund's experience that distributable cash generated by the portfolio businesses will exceed cash distributed to the Fund in some months and that the Fund will also have months in which cash distributed will exceed distributable cash generated.



The following summary table shows the calculation of distributable cash
generated during the periods shown:

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Three months ended Year ended
December 31 December 31
----------------------------------------------------------------------------
2006 2005 2006 2005
----------------------------------------------------------------------------
Cash provided by operating
activities $ 13,910 $ 4,240 $ 24,640 $ 14,454
Change in non-cash working capital (8,666) 1,895 2,790 7,593
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5,244 6,135 27,430 22,047
Maintenance capital expenditures (439) (530) (3,113) (1,936)
Retractable non-controlling interest 5 27 (804) (224)
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Distributable cash generated $ 4,810 $ 5,632 $ 23,513 $ 19,887
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Distributions (excluding Exchangeable
Shares)
Distributions declared $ 6,079 $ 4,311 $ 21,584 $ 14,663
Distributable cash per Unit $ 0.27 $ 0.44 $ 1.52 $ 1.73
Distributions declared per Unit $ 0.35 $ 0.34 $ 1.38 $ 1.27
Payout ratio 126% 77% 92% 73%
Proforma distributions (including
Exchangeable Shares)
Proforma distributions declared $ 6,710 $ 5,423 $ 25,385 $ 18,534
Proforma distributable cash per Unit $ 0.25 $ 0.35 $ 1.29 $ 1.34
Distributions declared per Unit $ 0.35 $ 0.34 $ 1.38 $ 1.25
Proforma payout ratio 140% 96% 108% 93%
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Distributable cash per Unit is not defined under Canadian generally accepted accounting principles and does not have a standard meaning, but it is determined by the Fund to be distributable cash divided by the weighted average number of Units outstanding.

The above calculations under "Proforma distributions (including Exchangeable Shares)" are calculated as though, before commencement of the relevant period, the Exchangeable Shares had been exchanged for Units and where the distributions paid by the Fund in the relevant year had also been paid in respect of such Units. Accordingly, distributions declared, distributable cash per Unit, distributions declared per Unit and payout ratio under "Proforma distributions (including Exchangeable Shares)" do not reflect distributions actually paid by the Fund, but, rather, reflect a hypothetical scenario. The Fund believes that presenting these amounts in this fashion provides useful supplemental information which reflects on the performance of the Fund and provides information that would be relevant should all of the Exchangeable Shares be exchanged for Units.

Holders of Exchangeable Shares do not receive cash distributions from the Fund. Rather, the exchange ratio is adjusted to account for distributions paid to Unitholders as described herein and as more particularly described in the Annual Information Form of the Fund dated March 15, 2007.

Distributable cash generated for the year ended December 31, 2006 was $23,513 as compared to $19,887 for the year ended December 31, 2005. Distributable cash generated for the three month period ended December 31, 2006 was $4,810 compared to $5,632 for the three month period ended December 31, 2005. The Fund declared distributions to its Unit holders of $21,584 for the year ended December 31, 2006 as compared to $14,663 for the year ended December 31, 2005. Cash distributions declared to Unitholders in the fourth quarter of 2006 were $6,079 compared to $4,311 for the same period of 2005.

Cash provided by operating activities in 2006 was $24,640 compared to $14,454 in 2005. Change in non-cash working capital increased $4,803, from ($7,593) in 2005 to ($2,790) in 2006. The net result was cash provided by operating activities before change in non-cash working capital increased to $27,430 in 2006 from $22,047 in 2005. The increase of $5,383 is attributable primarily to an increase of $10,193 in earnings from operations, offset by a $1,065 tax provision in Diamond, increased interest costs of $2,680, increased management incentive expense of $617 and additional taxes of $405.

Maintenance capital expenditures for 2006 were $3,113 as compared to $1,936 in 2005. The increase in maintenance capital expenditures was primarily attributable to the inclusion of a full year of operations for each of Don Park, Diamond and Beco. Maintenance capital expenditures in 2006 for RJV were $838, Don Park $980, Diamond $675, Beco $300, Stylus $132, and Ezee-On $188. Maintenance capital expenditures in 2005 for RJV were $630, Don Park $766, Diamond $226, Beco $6, Stylus $178, Ezee-On $82 and at the Fund level $48.

Retractable non-controlling interest, as discussed under "Cash Distributions", for the year ended December 31, 2006, was $804 compared to $224 for the year ended December 31, 2005. For the year ended December 31, 2006, retractable non-controlling interest recovery recorded on the consolidated statement of operations of $5,880 includes $4,917 for the goodwill write-down and $963 for allocations of proportionate losses to retractable non-controlling interest. The retractable non-controlling interest $804 represents the third parties' portion of the actual cash distributions to be paid based on the distributable cash of the portfolio businesses in 2006.

For the year ended December 31, 2006, the payout ratio increased to 92% (before the proforma allocation of distributions to Exchangeable Shares) as compared to 73% in the prior year. The increase for the year is the result of several factors including the issuance of additional Units by the Fund and an increase in distributions per Unit declared is the effect of which was not fully offset by an increase in the Fund's distributable cash generated. In April, 2006, the Fund issued 2,950,000 new Units. On September 1, 2006, at the request of the Fund, the Chief Executive Officer of the Fund exchanged 1,486,465 Exchangeable Shares for 1,871,355 Units of the Fund.

The weighted average Units outstanding during the year ended December 31, 2006 was 15,482,816 as compared to 11,489,589 for the year ended December 31, 2005.



Details of the cash distributions declared by the Fund for the year ended
December 31, 2006 are as follows:

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Period Record Date Payment Date Per Unit Total
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January January 31 February 15 $ 0.115 $ 1,472
February February 28 March 15 0.115 1,473
March March 31 April 15 0.115 1,473
April April 30 May 15 0.115 1,812
May May 31 June 15 0.115 1,812
June June 30 July 17 0.115 1,812
July July 31 August 15 0.115 1,812
August August 31 September 15 0.115 1,812
September September 30 October 16 0.115 2,027
October October 31 November 15 0.115 2,027
November November 30 December 15 0.115 2,026
December December 29 January 15, 2007 0.115 2,026
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Total $ 1.380 $ 21,584
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On January 22, 2007, the Fund announced a reduction in the annual cash distribution to $1.00 per Unit from $1.38 per Unit, a reduction of 28%. The change in monthly distributions to Unitholders is consistent with the Fund's stated policy of establishing equal monthly payments for a 12-month period that will, in the aggregate, amount to less than 90% of the distributable cash forecasted by its income producing businesses. The Fund's new level for its monthly distributions to Unit holders was established by its independent Trustees after reviewing Management's 2007 forecast for distributable cash. Management expects that cash available from its energy related businesses will be lower in 2007 than 2006 as a result of the expected reduction in exploration and development drilling. This reduction for the energy businesses is expected to be partially offset by improved performance during 2007 by the other portfolio businesses.



SELECTED FINANCIAL INFORMATION

Annual Information

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TerraVest TerraVest TerraVest Laniuk
Year ended Year ended July 9, 2004 to Year ended
December December December 31, August 31,
31, 2006 31, 2005 2004 2003
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Sales $ 271,347 $ 198,142 $ 25,793 $ 42,992
Net (loss) earnings $ (205) $ 10,091 $ 1,237 $ 2,761
Earnings per
Unit/Share-basic $ (0.01) $ 0.88 $ 0.17 $ 0.07
Earnings per
Unit/Share-diluted $ (0.01) $ 0.88 $ 0.17 $ 0.07
Net earnings before
goodwill write-
down(1) $ 17,518 $ 10,091 $ 1,237 $ 2,761
Earnings before
goodwill write-
down per Unit/
Share - basic $ 1.13 $ 0.88 $ 0.17 $ 0.07
Earnings before
goodwill write-
down per Unit/
Share - diluted $ 1.11 $ 0.88 $ 0.17 $ 0.07
Total assets $ 255,966 $ 286,853 $ 136,852 $ 35,457
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Long-term financial
liabilities
Long-term debt $ - $ - $ - $ 21
Redeemable
Preferred Shares - - - 9,000
Accrued interest on
preferred shares - - - 3,150
Capital lease
obligations 115 124 7 -
Accrued long-term
compensation 101 49 - -
Retractable
non-controlling
interest 20,949 27,110 5,537 -
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Total long-term
financial
liabilities $ 21,165 $ 27,283 $ 5,544 $ 12,171
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(1) Adjustments to net earnings for 2006 include: goodwill write-down of
$24,586, goodwill recovery from retractable non-controlling interest
amounting to ($4,917), and non-controlling interest impact of ($1,946).


The Fund has grown significantly since its inception in July 2004, when the transaction with Laniuk occurred. Laniuk's largest business, RJV, is today TerraVest's largest portfolio business in terms of distributable cash generated. 2006 marked the third straight year of strengthening results for this business, fueled by high levels of drilling activity in western Canada and strong natural gas pricing. The business experienced record sales in 2006, with $74,136 in annual sales and record net earnings. Diamond also benefited from a robust energy sector by posting revenues of $27,296 in 2006. A weak agriculture industry, coupled with the 2005 bulk sale of the entire inventory of Ezee-On's Australia subsidiary resulted in a reduction of Ezee-On's 2006 sales to $9,244, from $15,272 in 2005.

The Fund has experienced significant additional growth through the execution of its investment strategy. In December 2004, the Fund added Stylus; Don Park was added in April 2005; Diamond was added in October 2005; and Beco followed in December 2005. Don Park, Diamond and Beco increased the Fund's 2006 sales by $75,922 in aggregate, over the amounts contributed for each of these businesses during their partial years with the Fund in 2005.

During fiscal 2006, the Fund recorded a goodwill write-down of $24,586, attributable to Beco, Don Park and Stylus in the amounts of $12,000, $6,586 and $6,000, respectively. The goodwill write-down is a non-cash charge and is primarily due to a reduction in expected future cash flows given the current financial performance of those businesses, particularly at Beco and Don Park, and the government's decision to tax income trusts starting in 2011. Management is working diligently to improve performance at each of these businesses. The reduction in the carrying value of goodwill on the Fund's businesses does not impact the calculation or distribution of distributable cash for the Fund's investors. Management continuously monitors the performance of each of the Fund's businesses and incorporates all available information in its projections which are used to determine the Fund's distribution policy.

Long-term financial liabilities decreased $6,118 in 2006 compared to 2005, due primarily to the goodwill write-down and its impact on the carrying value of the retractable non-controlling interest. Debt requirements continue to be primarily funded by a 364-day operating loan and a 364 day fixed term-loan. Long-term financial liabilities consist of capital lease obligations, retractable non-controlling interests in each of Stylus, Don Park, Diamond and Beco, and accrued long-term compensation.



Quarterly Information

The quarterly financial information presented below represents eight
quarters of TerraVest's operating results:

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2006 2006 2006 2006
Fourth Third Second First
Quarter Quarter Quarter Quarter
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Sales $ 67,341 $ 72,915 $ 63,757 $ 67,334
Net (loss) earnings $ (12,874) $ 6,608 $ 3,319 $ 2,742
Earnings per Unit/Share
- Basic $ (0.84) $ 0.40 $ 0.22 $ 0.21
- Diluted $ (0.84) $ 0.40 $ 0.22 $ 0.21
Net earnings before goodwill
write-down (1) $ 4,849 $ 6,608 $ 3,319 $ 2,742
Earnings before goodwill write-
down per Unit/Share
- Basic $ 0.30 $ 0.40 $ 0.22 $ 0.21
- Diluted $ 0.28 $ 0.40 $ 0.22 $ 0.21
Distributable cash $ 4,810 $ 7,936 $ 5,327 $ 5,440
Distributable cash per Unit $ 0.27 $ 0.48 $ 0.35 $ 0.42
Distributions declared per Unit $ 0.35 $ 0.35 $ 0.35 $ 0.35
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2005 2005 2005 2005
Fourth Third Second First
Quarter Quarter Quarter Quarter
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Sales $ 63,743 $53,462 $ 48,961 $ 31,976
Net (loss) earnings $ 3,210 $ 2,357 $ 1,646 $ 2,878
Earnings per Unit/Share
- Basic $ 0.25 $ 0.19 $ 0.16 $ 0.28
- Diluted $ 0.25 $ 0.19 $ 0.16 $ 0.28
Net earnings before goodwill
write-down (1) $ 3,210 $ 2,357 $ 1,646 $ 2,878
Earnings before goodwill write-
down per Unit/Share
- Basic $ 0.25 $ 0.19 $ 0.16 $ 0.28
- Diluted $ 0.25 $ 0.19 $ 0.16 $ 0.28
Distributable cash $ 5,632 $ 4,087 $ 3,899 $ 6,269
Distributable cash per Unit $ 0.42 $ 0.32 $ 0.38 $ 0.61
Distributions declared per Unit $ 0.34 $ 0.32 $ 0.32 $ 0.29
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(1) Adjustments to net earnings for 2006 include: goodwill write-down of
$24,586, goodwill recovery from retractable non-controlling interest
amounting to ($4,917), and non-controlling interest impact of ($1,946).


Significant changes during each quarter were as follows:

- The decrease in sales from the third quarter to the fourth quarter of 2006 can be attributed primarily to reduced sales at RJV (a decrease of $5,716), resulting primarily from a shift in order patterns from customers in the second half of 2006. Year-over-year, second half orders for RJV grew by $7,800, an increase of 25%. Additionally, Ezee-On (a decrease of $1,366), Diamond (a decrease of $253), Beco (an increase of $547), Stylus (an increase of $1,203) and Don Park (an increase of $11) contributed to the variance on an aggregate basis.

- The increase in sales from the second quarter to the third quarter can be attributed primarily to the increased performances of RJV (an increase of $6,568), Diamond (an increase of $1,988), and Beco (an increase of $2,608), offset by decreases of Ezee-On (a decrease of $470), Stylus (a decrease of $1,362), and Don Park (a decrease of $174).

- Seasonality resulted in higher sales in the first quarter for RJV and Diamond. Beco's and Don Park's sales for the second quarter were lower than Management's expectations, and this further contributed to the net decrease in total sales from the first quarter to the second quarter.

- Sales increased in the first quarter of 2006 over the fourth quarter of 2005 primarily due to the inclusion of Beco for the full three months, as compared to including Beco only from the date of acquisition on December 5, 2005 in the previous quarter.

- Sales increased in the fourth quarter of 2005 from the third quarter primarily due to the addition of Diamond and Beco, adding $8,417 in the period. The remaining increase was the result of continued strong performance by RJV, and Stylus, particularly in sales of its leather furniture. Net earnings for the fourth quarter of 2005 increased over the previous quarter for similar reasons.

- The increase in sales in the third quarter of 2005 relative to the second quarter of 2005 resulted from increased Stylus sales, an increase in sales at Don Park, reflecting seasonal strength in heating and ventilation products, and the bulk sale of Ezee-On (Australia) Pty Ltd's inventory. Net earnings increases generally followed the sales increases for the quarter.

- The increase in sales in the second quarter over the first quarter of 2005 resulted primarily from the addition of Don Park on April 1, 2005. Net earnings in the quarter were lower than in the first quarter of 2005, reflecting a seasonally slower period for RJV, profit pressure at Don Park, as well as acquisition related amortization charges related to intangible assets in the second quarter.

- Increased sales in 2005's first quarter over 2004's fourth quarter resulted from the addition of Stylus and record sales for RJV. Net earnings in the first quarter of 2005 reflected the additional sales, and improved profits which reflected pricing taken in response to the rapidly increasing steel costs for RJV and Ezee-On.

OVERALL FUND RESULTS

The consolidated financial statements of the Fund for the year ended December 31, 2006 include the operations of the six portfolio businesses. Don Park, Diamond and Beco were acquired on April 1, 2005, October 3, 2005 and December 5, 2005, respectively. For the purposes of this Management's Discussion and Analysis, comparative figures include operations of the portfolio businesses owned by the Fund during 2005. Portfolio businesses acquired by the Fund during 2005 are included only for the portions of the relevant periods in which they were owned by the Fund.




Summary Financial Table
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Three months ended Year ended
December 31 December 31
Acquired 2006 2005 2006 2005
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Sales
RJV July 2004 $ 16,681 $ 17,814 $ 74,136 $ 64,302
Ezee-On July 2004 1,021 1,972 9,244 15,272
Stylus December 2004 8,439 11,535 33,493 40,016
Don Park March 2005 22,089 24,005 85,338 70,135
Diamond October 2005 6,891 6,638 27,296 6,638
Beco December 2005 12,220 1,779 41,840 1,779
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$ 67,341 $ 63,743 $271,347 $198,142

Cost of sales $ 48,923 $ 47,000 $195,610 $147,836
Gross profit $ 18,418 $ 16,743 $ 75,737 $ 50,306
Net (loss)
earnings $(12,874) $ 3,210 $ (205) $ 10,091
Net earnings
before goodwill
write-down (1) $ 4,849 $ 3,210 $ 17,518 $ 10,091
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(1) Adjustments to net earnings for 2006 include: goodwill write-down of
$24,586, goodwill recovery from retractable non-controlling interest
amounting to ($4,917), and non-controlling interest impact of ($1,946).


Summary

Consolidated sales of the Fund in 2006 were $271,347 compared to $198,142 in 2005. The increase reflects the full year of operations in 2006 for Don Park, Diamond and Beco and the continued strong performance of RJV. Sales for the 2006 fourth quarter were $67,341 compared to $63,743 for the same period in 2005. This increase was due to the inclusion of Beco's operations for three months in 2006, in contrast to its inclusion for part of December 2005, which was offset in reduced sales in Stylus ($3,096), Don Park ($1,916), RJV ($1,133) and Ezee-On ($951). Cost of sales for 2006 was $195,610 compared to $147,836 in 2005. The increase is the result of the inclusion of Don Park, Diamond and Beco for a full fiscal year. Cost of sales represented 72% of consolidated sales in 2006 as compared to 75% in 2005. Gross profit for 2006 was $75,737 as compared to $50,306 in 2005. Gross profit, as a percentage of sales, was 28% in 2006 as compared to 25% in 2005. The change in consolidated gross profit, as a percentage of sales, is the result of changes in the product mix due to the acquisitions in 2005, as well as increased profits due to improved product mix and pricing initiatives at the Fund's energy businesses. Gross profit, as a percentage of sales, in the 2006 fourth quarter was 27% compared to 26% for the same period in 2005 and in line with 2006 annual gross profit.

Fourth quarter 2006 reported a loss of $12,874 compared to net earnings of $3,210 in 2005. Fiscal 2006 resulted in a net loss of $205 compared to net earnings for 2005 of $10,091. A goodwill write-down of $24,586 was recorded in the fourth quarter, reducing the carrying value for three of the Fund's investments. This was partially offset by allocations to retractable non-controlling interest. In order to show a fair comparison to the prior period, net earnings before the goodwill write-down is also presented.

Operating Activities

RJV

RJV continued to benefit from the robust energy sector throughout 2006. Sales reached a record $74,136 for the year ended December 31, 2006, which represents a 15% increase over sales of $64,302 for 2005. Revenues in the year increased as a result of more product volume shipped and price and product mix changes. Given the strength of demand for RJV's products, the business experienced stronger pricing resulting in strengthened gross profit. A shift in order patterns from customers in the second half of 2006 resulted in increased orders during the third quarter, with reduced volume during the fourth quarter. Year-over-year, second half orders for RJV grew by $7,800, an increase of 25%. Gross profit continued to improve in the fourth quarter of 2006 over the fourth quarter of 2005. RJV's financial performance for the year ended December 31, 2006 exceeded Management's expectations.

Ezee-On

Ezee-On continued to face challenges in the agricultural industry sector. Total sales for the year ended December 31, 2006 were $9,244 compared to $15,272 for the year ended December 31, 2005. The sales for the fourth quarter in 2006 were $1,021 compared to $1,972 in the fourth quarter of 2005. Reduced export sales were a major contributor to the decline in the fourth quarter and full year financial performance. Part of the annual reduction in sales is attributable to the one-time bulk sale of inventory in 2005 for $2,579 to an independent distributor in Australia which resulted in negligible sales to Australia in 2006. Adjusting for the bulk sale of inventory in Australia, sales were approximately 73% of prior year sales. Sales in Canada were below prior year, but above Management's expectations. The reduction was attributed to soft commodity prices which generally impacts equipment purchases by farmers. Additionally, dealers reduced inventory levels. Sales in the U.S. were less than expected in 2006 due to commodity pricing and to the strengthening of the Canadian dollar. The product sales mix for the period and the strength of the Canadian dollar in buying components priced in U.S. funds enabled Ezee-On to increase its gross profits over the comparative period. Despite challenges in generating sales, product mix and diligent efforts to control costs resulted in Ezee-On's delivery of distributable cash during the year in line with Management's expectations.

Stylus

Stylus' 2006 fourth quarter sales of $8,439 were up from $7,236 of the previous quarter, but down from $11,535 during 2005's fourth quarter. In addition, there were $1,750 of inventory close-outs recorded in the fourth quarter of 2005. Consumer confidence continued to be sluggish in 2006 and did not significantly improve during the traditionally busy fall season leading up to Christmas. Total annual sales decreased $6,523 from $40,016 in 2005 to $33,493 in 2006. 2006 was a challenging year for the furniture industry in North America. The shake-out of manufacturers with large investments in North American manufacturing plants continued. Stylus expanded its hybrid - manufacture/import model which allows for short order, customized products at competitive prices. In 2006, industry wide demand for home furnishings was lower than in previous years. Additionally, the business incurred a number of costs during the year in dealing with the organization of its labour force in April 2006. Employees subsequently voted to decertify the union at the end of 2006. Gross profit at Stylus were negatively impacted by increased labour cost and lower sales volumes. The business made several operating changes during the year to position it for growth in the coming years. In November, the company opened up a larger finished goods warehouse to allow for expansion of its imported products. The business continued its marketing initiatives through its showroom in Las Vegas and focused on efforts to expand its geographic reach within the United States. Stylus has a growing network of boutique retailers and is actively increasing its imported product offering. The business improved the productivity of its manufacturing facility and broadened its sources of off-shore suppliers. Overall, Stylus' annual financial performance was below Management's expectations, but its numerous operational improvements position it for future growth.

Don Park

Don Park's fourth quarter sales in 2006 were $22,089, a decrease of $1,916 for the comparable period in 2005. Total sales of $85,338 in 2006 reflect a full year's sales compared to nine months sales as a part of TerraVest in 2005 of $70,135. Don Park has three lines of business: Residential Branch Stores, Residential Wholesale, and Commercial. Despite having two-thirds of the stores ending the year with sales increases over 2005, the overall sales in the Residential Branch Stores division did not meet Management's expectations for the year. Sales in the Residential Wholesale division were lower than sales for 2005 in both the U.S. and Canadian distribution units, in part due to management efforts to reduce low margin business. The Commercial division met expectations, with sales 3% ahead of prior year levels on a full year basis. Overall, the business was impacted by approximately $500 of expenses related to the Canadian restructuring of the business. The Ontario market continues to be impacted by reduced levels of new construction, resulting in distributors purchasing less in 2006 than 2005. The market remains weaker than in prior years, with mixed results for Don Park accounts. Management's continued focus on cost reductions was clearly evident in the profits in the fourth quarter. Distributable cash generated for the year ended December 31, 2006 was below Management's expectations. A management restructuring was completed in November with the appointment of a new Chief Executive Officer, Peter Olierook, a 20 year industry veteran.

Diamond

Overall, results at Diamond were strong. Diamond's fourth quarter sales in 2006 were in line with 2005 fourth quarter sales. Diamond's total sales for 2006 of $27,296 exceeded Management's expectations. Diamond added two new service rigs to its fleet at the end of 2006. Performance at the core Swift Current operation finished the year ahead of Management's expectations, driven by stronger rates and higher utilization rates. The coiled tubing division experienced utilization rates below expectations due to reduced activity levels in shallow gas fields. By concentrating in select geographical areas, the business has been able to establish itself as an important supplier to the oil and gas companies producing and exploring in those areas. The largest portion of Diamond's business is derived from servicing producing operating wells. On a comparative basis, the business operated with more rigs in 2006, given new equipment which entered the field during 2005. Gross profit at Diamond increased as a result of the continued strong demand for service equipment in the oil and gas well servicing sector. Diamond's overall financial performance for the year ended December 31, 2006 exceeded Management's expectations.

Beco

Beco generated fourth quarter and annual sales of $12,220 and $41,840, respectively. Beco was purchased on December 5, 2005, and thus the comparable 2005 figures for the quarter and full year represent financial results for the period since acquisition. Beco's gross profit was lower than expected due to reduced sales volumes relative to fixed costs of production. The business faced several challenges with key customers including significant changes to product specifications and organizational changes affecting key relationships. Beco management responded to these challenges with several initiatives. The business' sales efforts were re-organized to achieve a more efficient and effective sales approach. This change has been well received by customers and Beco employees. The management team was expanded during the year to increase capability and address operational weaknesses. With the management changes and commensurate new processes, Beco dramatically improved its relationship with its key customers and has been successful in expanding its relationship with its largest customers. The realignment of the sales efforts and expansion of Beco's management capabilities drove stronger performance during the fourth quarter, indicating improved financial performance is underway. In addition, the actions taken in the second and third quarters to reduce costs contributed to the improving financial performance as the year progressed. Beco has revised many of its internal processes to improve its selling efforts, strengthen its supply chain management capabilities, enhance its management reporting and reinforce its control systems. Beco's financial performance for the year ended December 31, 2006 was below Management's expectations.

Administration expenses

Administration expenses for 2006 were $24,308 compared to $12,356 in 2005. The increase is primarily due to the inclusion of Don Park, Diamond and Beco for a full year. In 2006 and 2005, the Fund's administration expenses were $6,451 and $4,131, respectively. The increased costs at the Fund level can be attributed to increases in external manager contract costs (see "Related Party Transactions"), increased audit and legal fees, increased payroll costs as the Fund expanded its infrastructure to meet the demands of the portfolio businesses, and increased costs related to public company compliance issues specifically related to internal controls, governance and Chief Executive Officer and Chief Financial Officer certifications.

Selling expenses

Selling expenses for 2006 were $17,874 as compared to $14,534 in 2005. The increase is the result of the inclusion of the Fund's three 2005 acquisitions of Don Park, Diamond and Beco, for the full fiscal year. Selling expenses represented approximately 7% of consolidated sales in 2006 and 2005.

Amortization expense

In 2005, the Fund acquired $34,942 in capital assets through the acquisitions of Don Park, Diamond and Beco. During 2006, the Fund's portfolio companies acquired $7,139 in new capital assets. This is comprised of $4,026 in growth capital expenditures and $3,113 in maintenance capital expenditures. Amortization expense of $4,853 reflects utilization of existing assets during the year.

Retractable non-controlling interest

The retractable non-controlling interest represents a specified percentage interest in each of Stylus Limited Partnership, Don Park Limited Partnership, Don Park (USA) Limited Partnership, Diamond Energy Limited Partnership and Beco Limited Partnership (collectively the "Limited Partnerships") held by third parties. In each case, the Fund is entitled to preferred returns of annual distributable cash from the Limited Partnerships. This preference entitles the Fund to receive its proportionate share of all cash available for distribution by the Limited Partnerships up to pre-established thresholds, before any distributions of cash are available to the retractable non-controlling interests. After the pre-established threshold is met by a Limited Partnership, the retractable non-controlling interest holders receive their proportionate share of distributable cash from that Limited Partnership to a second higher pre-determined threshold. Once both the thresholds are achieved by a Limited Partnership, the distributions are allocated on a pre-determined basis in relation to the respective ownership interests. The amount recorded on the consolidated statement of operations of $5,880 represents the total allocation of loss from the respective partnerships to their non-controlling interest holders during the year. It includes their proportionate share of the goodwill writedown ($4,917).

The retractable non-controlling interest holders have the right to cause the Fund to acquire their interest at the end of the terms of their employment agreements, at a value based upon an agreed multiple of the previous year's financial performance of the respective Limited Partnership. The retractable non-controlling interest is recorded on the consolidated balance sheets at the greater of the carrying value of the retractable non-controlling interest and the formula based value of the put liability at the balance sheet date, and will be revalued on the same basis at each balance sheet date thereafter.

Non-controlling interest

The non-controlling interest on the consolidated balance sheets consists of the fair value of the Exchangeable Shares upon issuance plus the accumulated earnings attributable to the non-controlling interest. The net earnings attributable to the non-controlling interest on the consolidated statement of operations of $1,295 represents the cumulative share of net earnings attributable to the non-controlling interest based on the Units issuable for Exchangeable Shares in proportion to total Units issued and issuable at each month end during the period.

Interest expense

The Fund's affiliates, TerraVest Industries Limited Partnership, Stylus, Don Park, Diamond and Beco as guarantors, and the Fund as covenantor, are parties to a credit agreement with a maximum available operating loan of $75,000 and a 364 day term loan totaling $35,000 for total debt capacity of $110,000. At December 31, 2006, the Fund had drawn $21,436 on its operating loan and $30,000 on its term loan. Interest was charged at prime plus 0.25% on the operating loan and prime plus 0.50% on the term loan. Total interest charged for the current three-month period was $1,019. In the three months ended December 31, 2005, total interest charged was $770. Interest charged for the year ended December 31, 2006 was $4,247 as compared to $1,567 in 2005. The overall increase in interest cost is the result of additional debt being carried as compared to the same periods in 2005, and increases to the prime lending rate during the period ended December 31, 2006.

Income taxes and future income taxes

The net provision for taxes and future income taxes in the year was $618, compared to $1,269 in 2005. The provision is primarily due to the provision of $1,065 for Diamond described below and the result of changes in substantively enacted tax rates.

A wholly-owned subsidiary of Diamond Energy Services Limited Partnership, Diamond Energy Services Inc. ("DESI"), has received a notice of reassessment from Canada Revenue Agency with respect to certain deductions claimed on the filing of its income tax return for the year end August 31, 2005 and the period September 1, 2005 to October 2, 2005. The reassessment totaled $953 including Federal and Saskatchewan taxes plus interest and penalties. No reassessment has yet been received from the Alberta tax authorities. These consolidated financial statements reflect an accrual made by DESI in the aggregate amount of $1,065 related to this matter. It is Management's intent to appeal this notice of reassessment.

TOTAL ASSETS

Total assets at December 31, 2006 were $255,966 compared to $286,853 at December 31, 2005. The decrease is primarily the result of a write-down in goodwill of $24,586 made up of $6,586 for Don Park, $12,000 for Beco and $6,000 for Stylus. The goodwill write-down is a non-cash expense. It reflects lower than expected future cash flows based on weaker financial performance of these businesses relative to expectations, particularly in the cases of Beco and Don Park, as well as the effect of the proposed taxation of tax income trusts starting in 2011. The reduction in the carrying value of goodwill on the Fund's businesses does not impact the calculation or distribution of distributable cash for the Fund's investors. Management continuously monitors the performance of each of the Fund's businesses and incorporates all available information in its projections which are used to determine the Fund's distribution policy.

Goodwill and intangible assets with indefinite lives are recorded at cost and are not amortized. Management tests these assets for impairment annually, in the 4th quarter, or more frequently if events or changes in circumstances indicate that the asset might be impaired. Goodwill and intangible assets with indefinite lives are written down when the carrying value exceeds the fair value.

The Fund uses the discounted cash flow method as well as a capitalized cash flow approach for determining the fair value of its goodwill and intangible assets with indefinite lives. In the fourth quarter of fiscal 2006, Management tested the carrying value of goodwill in accordance with Canadian Institute of Chartered Accountants ("CICA") Handbook Section 3062 and determined that impairment existed in three of its portfolio businesses. The proposed changes to the taxation of trusts and operating results that were significantly lower than Management's expectations were the primary causes of impairment. As a result, goodwill was written down by $24,586 and charged to earnings, partially offset by the retractable non-controlling interest recovery.

LIQUIDITY AND CAPITAL RESOURCES

Consolidated working capital at December 31, 2006 was $39,738 compared to $9,030 as at December 31, 2005. The working capital position has increased since December 31, 2005, primarily due to the issuance of 2,950,000 Units in April 2006, for net proceeds of $32,216, which were used to pay down indebtedness incurred by the Fund to invest in Beco and Diamond.

Short-term borrowings under the operating loan provide flexibility for managing seasonal fluctuations in working capital. The credit facility has financial covenants related to: minimum interest coverage; funded debt to earnings before interest, taxes, depreciation and amortization; funded debt to capitalization; net worth; and working capital. As at December 31, 2006, the Fund met all of its financial covenants.

In Management's view, the Fund has sufficient resources available to meet its liquidity needs for the next twelve months. The credit facility has been extended to May 31, 2007 in order to align with the Fund's reporting and budgeting processes. Fund Management has been working with the debt providers to renew the credit facility.

If cash distributed to Unitholders exceeds distributable cash generated in a particular month, the shortfall will be funded through the Fund's credit facilities, as long as the Fund meets all of its debt covenants, and through reductions in working capital. Conversely, if the distributable cash generated exceeds cash distributed to Unitholders, the excess will be used to reduce the outstanding amount on the credit facilities.

The Fund's off balance sheet financing arrangements as at December 31, 2006 consist of documentary letters of credit totaling $2,453 for the purchase of raw materials and standby letters of credit totaling $422.

Certain risks related to the Fund and its portfolio companies could impact the liquidity of the Fund. Please see the discussion of Risk Factors later in this MD&A.



COMMITMENTS

Contractual obligations consist of the following amounts:
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Total 1 year 2-3 years 4-5 years
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Operating leases $ 20,831 $ 5,989 $ 9,585 $ 5,257
Capital leases 155 40 80 35
Documentary letters of credit 2,453 2,453 - -
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Total $ 23,439 $ 8,482 $ 9,665 $ 5,292
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The Fund is liable for payment of an incentive fee, originally in the form of Units, to its external manager if certain targets related to distributions per Unit are met. Pursuant to the Management Services Agreement between the Fund and the external manager, the incentive fee is payable when monthly distributions per Unit exceed $0.08829 per Unit by 10%. An incentive fee of $931 was earned in the year ended December 31, 2006 and has been recorded as an expense of the Fund. On August 11, 2006, the incentive plan was amended to provide a quarterly cash payment in arrears to the external manager rather than a Unit payment. On September 6, 2006, the external manager was paid $725, being the accrued but unpaid incentive as at June 30, 2006, of which $314 was recorded as contributed surplus at December 31, 2005.

The Fund had foreign exchange contracts to purchase U.S. $1,000 currency for CDN$1,147 at an average rate of 1.1473 maturing up to January 31, 2007. These contracts have a fair market value of $18 (2005 - liability of $68).

CONTINGENCIES

During the ordinary course of business activities, the Fund and its subsidiaries may be made a party to certain claims and become contingently liable for various matters. Management believes that adequate provisions have been recorded in the accounts as required.

Although it is not possible to estimate the extent of potential costs and losses, if any, Management believes that the ultimate resolution of such contingencies will not have a material adverse effect on the financial position, results of operations or cash flows of the Fund and its subsidiaries.

The Fund is contingently liable for a payment of a maximum of $3,200, as additional consideration, to the vendors of Beco Industries Ltd. if certain targets related to Beco's earnings before interest, taxes, depreciation and amortization are met during the period January 1, 2006 through December 31, 2007. Additional consideration, if any, will be recorded once the contingency is resolved. Based on results to date and forecasted earnings in 2007, Management does not expect to make any payment under this contingency.

Entities within the Fund, and their predecessor entities, may be subject to audits from federal and provincial tax authorities. These audits may give rise to assessments related to tax filing positions the Fund or its predecessors have taken. While Management of the Fund believes that the filing positions are appropriate and supportable, the possibility exists that certain matters may be reviewed and challenged by the tax authorities. Management of the Fund regularly reviews the potential for adverse outcomes and the adequacy of provisions relating to these matters, and believes it has adequately provided for such matters.

UNITS AND EXCHANGEABLE SHARES OUTSTANDING

The Fund's Units are listed on the Toronto Stock Exchange under the symbol TI.UN.

The Declaration of Trust provides that an unlimited number of Units of the Fund may be issued. Each Unit is transferable and represents an equal undivided interest in any distributions of the Fund and in the net assets of the Fund. All Units have equal rights and privileges. Each Unit entitles the holder thereof to participate equally in allocations and distributions and to one vote at all meetings of Unitholders for each whole Unit held. The Units issued are not subject to future calls or assessments. Units are redeemable at any time at the option of the holder at amounts related to market prices at the time, subject to a maximum of $50 in cash redemptions by the Fund in any particular month. This limitation may be waived at the discretion of the Trustees of the Fund. Redemptions in excess of this amount, assuming no waiving of the limitation, shall be paid by way of a distribution in specie of a pro rata number of notes or securities held by the Fund.

As at March 15, 2007, there were 17,625,845 Units issued and outstanding.

The Exchangeable Shares referred to below are not listed or traded on any stock exchange.

Exchangeable Shares

The Exchangeable Shares - Series 1 ("Exchangeable Shares") are convertible at the option of the holder into Units at any time. In addition, the Fund may cause the holders of the Exchangeable Shares to convert their shares to Units upon 90 days written notice.

The Exchangeable Shares - Series 2 were subordinated to both the Units and the Exchangeable Shares and were not exchangeable for Units until the subordination period ended. The subordination period expired on July 9, 2006 after certain conditions related to distribution levels and financial results of the Fund were met. As a result, the remaining Exchangeable Shares - Series 2 were automatically converted to Exchangeable Shares.

On September 1, 2006, at the request of the Fund, the Chief Executive Officer of the Fund exchanged 1,486,465 Exchangeable Shares for 1,871,355 Units in accordance with the terms thereof. As at March 15, 2007, there were 1,411,112 Exchangeable Shares issued and outstanding.

The number of Units issuable upon conversion of the Exchangeable Shares is based on the exchange ratio in effect at the conversion date. The exchange ratio, which was originally one-to-one at the time the Fund acquired Laniuk, is cumulatively adjusted each time a distribution is made to Unitholders. The adjustment to the exchange ratio is based on the cash distributions paid to Unitholders divided by a weighted average Unit price. The exchange ratio giving effect to the December 2006 distribution declared was 1.35444 which is effective December 31, 2006. The Exchangeable Shares can only be exchanged for Units of the Fund.

The terms of the Exchangeable Shares are summarized in the Annual Information Form of the Fund dated March 15, 2007.

Unitholder Rights Plan

TerraVest implemented a Unitholder rights plan (the "Plan") effective January 22, 2007. The Plan is designed to ensure that all Unitholders are treated fairly in the event that a take-over bid is made for the Units and that sufficient time and rights are available for the Trustees and all Unitholders to fully evaluate any offer and pursue options to maximize Unitholder value. The rights issued to Unitholders under the Plan will entitle the holders thereof to acquire Units at a 50% discount to market upon a person or group acquiring 20% or more of the outstanding Units. However, the rights are not exercisable in the event of a "Permitted Bid". A Permitted Bid is a take-over bid made by way of a circular to all Unitholders, which remains open for at least 60 days and otherwise complies with customary Permitted Bid requirements. These requirements are designed to ensure that TerraVest is in a position to effectively pursue options to any take-over bid. The rights will not be exercisable and will not trade separate and apart from the Units at any time prior to a person or group acquiring, or announcing an intention to acquire (in a manner that does not constitute a Permitted Bid) 20% or more of the outstanding Units.

The Plan has been conditionally approved by the Toronto Stock Exchange, but is subject to approval by Unitholders at their next meeting, and in any event within six months following the initial adoption of the Plan.

The Plan is filed on SEDAR and may be accessed at www.sedar.com. This description of the Plan is qualified by reference to the Plan.

RISK FACTORS

A detailed description of the risks relating to the structure of the Fund is included in the Annual Information Form of the Fund dated March 15, 2007.

Risks Relating to the Businesses

The Fund's economic condition depends on the economic condition of its portfolio businesses. While stronger performance by one of the portfolio businesses may compensate for weaker performance by another of the portfolio businesses, any negative effects on the financial condition or results of operations of a portfolio business has a negative effect on the financial condition or results of operations of the Fund.

Demand for Products and Services

All of the portfolio businesses operate in industries in which the demand for their products or services is sensitive to many factors.

The oil and natural gas industry, in which RJV, through its manufacture and sale of natural gas well-head processing equipment, and Diamond, through its oil and gas well servicing business, participate, is dependent on the perception of future oil and natural gas prices. Oil and natural gas pricing had historically been cyclical and there is no assurance that prices will remain at current levels. In the fourth quarter of 2006, certain of RJV's major clients have announced reductions in their capital expenditure budgets. The effect that this will have on RJV is yet to be determined.

More recently, natural gas prices have lagged behind oil prices relative to the price correlation between these commodities which has occurred historically. The price of oil is determined by a global market that is affected, on the demand side, by economic conditions generally and economic growth rates in emerging economies and, on the supply side, by geopolitical conditions in the regions where there is significant oil production such as parts of the Middle East and Africa. By comparison, the price of gas is determined primarily by a North American market (with some imports of liquid natural gas) where the demand side is significantly affected by the rate of consumption of natural gas for heating in winter and cooling in the summer, with consumption being greater during periods of extreme temperatures in heavily populated areas of North America. The supply of natural gas is generally more stable, subject to disruptions (particularly in the Gulf of Mexico caused by tropical storms). The price of natural gas can fall significantly when the capacity available for storage is full.

The market for RJV's products and Diamond's services is geographically concentrated in the Western Canadian Sedimentary Basin and demand for such products and services may be affected by changes in the levels of exploitation of the basin depending on pricing of natural gas in the case of RJV and oil and natural gas in the case of Diamond. This is particularly so for RJV because most of the well-head processing equipment that RJV manufactures is installed on new natural gas wells and is left in place through the life of the well and, accordingly, demand for RJV's equipment depends more directly on the number of gas wells drilled, whereas a greater share of Diamond's business relates to the maintenance of existing wells for which services are required even when drilling activity subsides - so long as current production is not being shut-in.

The demand for the products manufactured or imported by Stylus and Beco is sensitive to consumer confidence. The home furnishings manufactured or imported by Stylus and the home textile products manufactured or imported by Beco are sold to retailers whose customers are individuals purchasing for their homes. Accordingly, these portfolio businesses are dependent on the general economic cycles in Canada and the United States which are affected by interest rates, employment levels and levels of new home ownership. Reduced consumer confidence may result in lower demand for home furnishing and home textile products.

The demand for heating, ventilation and air conditioning equipment manufactured by Don Park is dependent on the rates of construction of new homes and businesses, replacement of old equipment in existing homes, and renovation of existing homes and businesses in Ontario and the other markets that it serves. The replacement market, which makes up the largest portion of Don Park's sales, is impacted by weather. The demand for new homes and the levels of renovation activity generally depend on the strength of the economy, interest rates and consumer confidence. As the demand for new homes falls there is lower demand for some of the products of Don Park.

The demand for short-line agricultural equipment manufactured by Ezee-On relates generally to agricultural commodity prices for the crops to which Ezee-On's equipment is applicable in Canada, the United States, Australia and other markets in which Ezee-On sells its equipment. Ezee-On's agricultural equipment is primarily suited to farming of large scale grain farms. An exception is the demand for Ezee-On's front-end loaders which is more generally sensitive to the agricultural industry as a whole because front-end loaders are more widely used in both farming and the raising of livestock. Demand for Ezee-On's agricultural equipment is also affected by weather conditions in the major agricultural producing regions and government agricultural policies in its markets. Reduced cash flow of farms in these regions will result in lower demand for Ezee-On's equipment.

Lower demand for any of the portfolio businesses' products or services may result in lower sales which will have an adverse effect on the results of operations and financial condition of the affected business and the Fund.

Competition

All the markets in which the portfolio businesses operate are highly competitive and competition in the respective markets involves a broad range of competitors, some of whom have better product or service offerings than the portfolio businesses. Some of the competitors are divisions of large corporations that have greater financial and other resources. There can be no assurances that such competitors will not substantially increase the resources devoted to the development and marketing of products or services that compete with those of the portfolio businesses or that new competitors will not enter into the markets served by the portfolio businesses. The portfolio businesses also compete with smaller manufacturers or service providers in the markets which the portfolio businesses serve, some of which have competitive advantages such as lower overhead costs, stronger customer relationships or specialized regional strength.

The oil and gas sector in the Western Canadian Sedimentary Basin is generally a regional market and, accordingly, RJV and Diamond primarily compete with other companies located in the region, whereas the market for products manufactured or imported by Stylus, Beco and Don Park is generally Canada and the United States but with competition from manufacturers around the world. The majority of the value of the products sold by Beco is now imported from countries such as China, Bangladesh, India, Pakistan, Korea and Thailand. In 2005, Stylus commenced importing leather furniture from China. Ezee-On's agricultural equipment is sold primarily in Canada and the United States, but is also sold in Australia and other parts of the world in competition with agricultural equipment manufactured in North America and other parts of the world.

Limited Customer Bases

Each of the portfolio businesses drives a significant portion of its revenues from a limited customer base, particularly in the case of RJV, Diamond and Beco. If one or more of the significant customers of such portfolio businesses were to cease doing business with them, or significantly reduced or delayed its purchase of equipment or services, the financial condition and results of operations of such portfolio business could be materially adversely affected.

Input Costs

The manufacturing portfolio businesses of RJV, Ezee-On, Stylus, Don Park and Beco all rely heavily on the cost of materials used to manufacture product. While not dependent on a single supplier of materials, these portfolio businesses purchase materials that are priced on world markets which may be subject to economic and seasonal fluctuations and for which prices may raise at rapid rates over short periods of time. In some, but not all, cases, the sale price of a product can be raised in order to recover the higher costs of materials used to manufacture the product, but such a response often lags by some time the increase in the price of materials and is very difficult in periods when the prices of materials are more volatile.

Steel is a major component of the products manufactured by Don Park and Ezee-On and, to a lesser extent, RJV and, accordingly, an increase in the price of steel may have a material adverse effect on the financial condition and results of operations of these portfolio businesses and the Fund.

Environmental Legislation

Environmental matters are subject to regulation under a variety of federal, provincial, territorial, state and municipal laws relating to health and safety and the environment.

Management believes that the portfolio businesses are in compliance with applicable environmental legislation; however regulation is subject to change and, accordingly, it is impossible to predict the costs of compliance with new laws or the effects that changes would have on the portfolio businesses or their future operations.

Among the portfolio businesses, Management believes that the risk of non-compliance with environmental regulation is greatest for Diamond, due to the nature of its oil and gas well servicing business.

The trend in environmental regulation has been to impose increasingly stringent restrictions and limitations on activities that may affect the environment. In 1994, the United Nations' Framework Convention on Climate Change came into force and three years later led to the Kyoto Protocol which required nations to reduce their emissions of carbon dioxide and other greenhouse gases. Canada ratified the Kyoto Protocol in December 2002. The implementation of new laws and regulations, such as the Kyoto Protocol, could result in materially greater costs, stricter standards and enforcement, larger fines and liability and increased capital expenditures and operating costs, particularly for RJV's or Diamond's customers, which may have a material adverse effect on RJV's or Diamond's business, financial condition, results of operations and cash flows.

Liability and Insurance

Due to the nature of the products and services provided by RJV, Ezee-On, Stylus, Don Park, Diamond and Beco, general liability, product liability and product defect claims may be asserted against these portfolio businesses. Although insurance coverage is carried at levels which Management believes to be standard in Canada for businesses operating in the sectors in which the portfolio businesses operate, there can be no assurance that the coverage will be sufficient to satisfy any liability claim. There can be no assurance that adequate insurance coverage will be available in the future or available on commercially acceptable terms or rates. Any such claims that exceed the scope of coverage or an inability to obtain coverage or adequate coverage could result in material liabilities to one or more of the portfolio businesses.

Foreign Exchange

A number of the portfolio businesses conduct business transactions in US dollars and are therefore subject to foreign exchange risk that may occur between the Canadian and US currencies. These portfolio businesses sell products to customers in the US and other markets and also purchase raw materials and other products for resale from jurisdictions outside of Canada, which transactions are denominated in US dollars.

The Administrator manages exposure to exchange rate risk by monitoring purchases and sales in US dollars, recognizing natural hedging inherent in the portfolio businesses. Imbalances between foreign currency purchases and sales, if deemed material, are managed through future purchase or sale commitments of US funds.

Fluctuations in exchange rates between the Canadian dollar and US dollar could have a material adverse effect on the financial condition or results of operations of one or more of the portfolio businesses, if the Administrator does not, or can not, adequately and effectively manage the net foreign exchange exposure.

Foreign Operations

Beco sources raw material and products from factories in China, Bangladesh, India, Pakistan, Korea and Thailand. Importing product over great distances involves logistical challenges for Beco. This coupled with stringent delivery schedules and product specifications set by its customers means that, should Beco fail to deliver products which meet its customers' delivery schedules and product specifications, the customer may refuse to take delivery of the product or cancel orders. As many of Beco's products are seasonal, if a customer does take late delivery of a product, sales may not be strong and Beco will lose the benefit of replenishment orders during the season. Failures in meeting logistical and product specification requirements of its customers will adversely affect Beco's sales and will have an adverse affect on its results of operations and financial condition.

Obsolescence

The technology used by the portfolio businesses is constantly undergoing development and change. New technologies may be developed, or existing technologies refined, which could render existing equipment or processes technologically or economically obsolete. The development of new technologies or new applications for existing technologies may require existing systems to be adapted or new systems to be acquired in order to successfully compete. Due to cost factors, competitive considerations or other constraints, there can be no assurance that a given portfolio business will be able to acquire or have access to any new or improved equipment that they may need in order to serve their clients and customers. Any inability of a portfolio business to provide state-of-the-art products and technologies may adversely affect its business and financial condition and results of operations.

There is no proprietary protection for the primary product lines or processes of RJV, Ezee-On, Stylus, Diamond and Beco. There is only limited proprietary protection for the primary product lines and processes of Don Park.

Customers of Stylus and Beco count on these portfolio businesses to provide fashionable home furnishing and textile products that appeal to current consumer tastes. Should Stylus or Beco fail to deliver suitable product they may lose business which may have an adverse effect on the financial condition and results of operations of their businesses.

Labour

The success of the Fund depends on the ability of the portfolio businesses to maintain their respective productivity and profitability. The productivity and profitability of the portfolio businesses may be limited by their ability to employ, train and retain the skilled personnel necessary to meet their respective requirements. None of portfolio businesses can be certain that they will be able to maintain the adequate skilled labour force necessary to operate efficiently and to support their growth strategies. As well, none of the portfolio businesses can be certain that their labour expenses will not increase as a result of a shortage in the supply of these skilled personnel. Labour shortages or increased labour costs could impair the ability of a portfolio business to maintain or grow its respective portfolio business.

In addition, a collective bargaining unit was established at Stylus, in 2005. The initial Collective Bargaining Agreement was ratified on April 16, 2006. However, on December 4, 2006, employees in the bargaining unit voted to decertify the union.

Key Personnel

The success of the Fund depends on the skills, experience and effort of its Management and the senior management of each of its portfolio businesses. The loss of one or more members of Management or senior management of a portfolio business could significantly weaken the performance of the Fund and the affected operating portfolio business.

Leverage and Restrictive Covenants

The Fund and its portfolio businesses have third party debt service obligations under the Credit Facility, which obligations will rank in priority to obligations under debt securities of the Fund's portfolio businesses. In addition, these portfolio businesses may borrow additional funds from other third parties, with the approval of the Administrator of the Fund. The degree to which the Fund's portfolio businesses are leveraged could significantly affect the amount of income to be generated and, therefore, the funds available to the Fund. The consequences to the Fund and to the holders of the Units arising from borrowing activities of the Fund's portfolio businesses include: (a) reduced ability to obtain additional financing for working capital; (b) dedication of cash flow from operations to the payment of the interest on such indebtedness thereby reducing funds available for payment to the Fund; and (c) exposure to the risk of increased interest rates. The ability of the Fund's portfolio businesses to make scheduled payments of interest on, or to refinance, its indebtedness will depend on future cash flow, which is subject to the operations of their businesses, prevailing economic conditions, prevailing interest rate levels, and financial, competitive, business and other factors, many of which are beyond their control. These factors might inhibit refinancing of indebtedness on favourable terms, or at all.

The Credit Facility contains restrictive covenants that limit the discretion with respect to certain business matters and may, in certain circumstances, restrict the portfolio businesses' ability to pay interest or make distributions on equity securities which could adversely impact cash distributions on the Units. These covenants will place restrictions on, among other things, the ability of the borrower to incur additional indebtedness, to create other security interests, to complete mergers, amalgamations and acquisitions, to undertake an unsolicited take-over bid utilizing the Credit Facility, to make capital expenditures, to pay dividends or make certain other payments, investments, loans and guarantees, and to sell or otherwise dispose of assets. In addition, the Credit Facility includes covenants restricting a change of control of the borrower (excluding the effect of any sales of securities by Dale H. Laniuk or Lee-Lan Holdings Ltd.). The Credit Facility also contains financial covenants requiring the borrower to satisfy financial ratios and tests. A failure of the borrower to comply with its obligations under the Credit Facility could result in an event of default which, if not cured or waived, could permit the acceleration of the relevant indebtedness. The Credit Facility is secured by customary security for entities of this type, including first ranking security over all present and future personal property of the borrower and a first ranking pledge of all present and future material portfolio businesses of the borrower and an assignment of insurance. In addition, the Fund has provided a limited recourse guarantee secured by a first ranking pledge of all securities of the borrower held by the Fund. If the borrower is not able to meet its debt service obligations, it risks the loss of some or all of its assets to foreclosure or sale. There can be no assurance that, if the payment of the indebtedness under the Credit Facility were to be accelerated, the borrower's assets would be sufficient to repay in full that indebtedness.

The Credit Facility has been extended to May 31, 2007, with full repayment due at maturity. If the Credit Facility is replaced by new debt that has less favourable terms, funds available for distribution to the Fund and cash distributions to Unitholders may be adversely impacted.

Tax Related Risks

The income of the Fund and its portfolio businesses must be computed and will be taxed in accordance with Canadian and U.S. tax laws, all of which may be changed in a manner that could adversely affect the amount of distributable cash. There can be no assurance that Canadian federal income tax laws respecting the treatment of mutual fund trusts will not be changed in a manner which adversely affects the holders of Units. If the Fund ceases to qualify as a "mutual fund trust" under the Income Tax Act (Canada), as amended, including the regulations promulgated thereunder (the "Tax Act"), the income tax considerations integral to the proper valuation of the Units would be materially and adversely different in certain respects. Further, interest on the debt securities of the Fund's portfolio businesses accrues at the Fund level for income tax purposes whether or not actually paid. The declaration of trust by which the Fund is constituted provides that an amount equal to the taxable income of the Fund will be distributed each year to Unitholders in order to eliminate the Fund's taxable income and provides that additional Units may be distributed to Unitholders in lieu of cash distributions. In such event, Unitholders will generally be 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.

If the Fund ceases to qualify as a "mutual fund trust" under the Tax Act, the Units will cease to be qualified investments for trusts governed by registered retirement savings plans, registered retirement income funds and deferred profit sharing plans and registered education savings plans, as defined in the Tax Act ("Exempt Plans"). The Fund will endeavour to ensure that the Units continue to be qualified investments for Exempt Plans. The Tax Act imposes penalties for the acquisition or holding of nonqualified investments in such plans and there is no assurance that the conditions prescribed for such qualified investments will be adhered to at any particular time. Finally, if the Fund ceases to qualify as mutual fund trust for purposes of the Tax Act, the Fund may be required to pay tax under Part XII.2 of the Tax Act. The payment of Part XII.2 tax by the Fund will affect the amount of cash available for distribution by the Fund and may have adverse consequences for Unitholders. One of the ways in which the Fund could cease to qualify as a "mutual fund trust" would be if non-residents of Canada (within the meaning of the Tax Act) were to become the beneficial owners of a majority of the Trust Units. There can be no assurance that income tax laws and the treatment of mutual fund trusts will not be changed in a manner which may adversely affect Unitholders. Management believes that non-residents of Canada own fewer than ten percent of the Units and fewer than ten percent of the Units and Exchangeable Shares (assuming exchange for Units of all Exchangeable Shares). The Fund confirms the level of non-resident ownership of its Units with its transfer agent from time to time. The Fund does not actively monitor the level of non-resident ownership of its Units, but will implement an active process to monitor non-residents' ownership of its Units should it become aware that non-residents of Canada own greater than 30% of the Units or greater than 30% of the Units and Exchangeable Shares (assuming exchange for Units of all Exchangeable Shares).

RELATED PARTY TRANSACTIONS

During the year, pursuant to a Management Services Agreement between the Fund and its external manager, TerraVest Management Partnership ("TMP"), which is controlled by significant Unitholders of the Fund, three of whom are also Trustees of the Fund, the Fund incurred the following expenses related to management of the Fund:



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2006 2005
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Management fees $ 852 $ 749

Incentive fees 931 314

Reimbursement of expenses 734 276

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$ 2,517 $ 1,339

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The amounts paid or payable to TMP are recorded at the exchange amount under normal business conditions. As at December 31, 2006, accounts payable included $212 for management fees and $239 for incentive fees payable to the external manager.

During the year the Fund, through its subsidiary Limited Partnerships, paid rent for manufacturing and operating facilities to various parties controlled by the non-controlling interest holders of the respective Limited Partnership as follows:



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Expense Incurred by 2006 2005
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Stylus Limited Partnership $ 569 $ 460

Don Park (USA) Limited Partnership 349 278

Don Park Limited Partnership 1,465 1,384

Beco Industries Limited Partnership 500 -

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$ 2,883 $ 2,122

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The amounts paid or payable by the respective Limited Partnership are pursuant to lease agreements with expiry dates ranging from November 30, 2008 through November 30, 2014, and are based upon fair market values for similar facilities.

OUTLOOK

A brief outlook for the Fund is as follows:

Natural gas prices softened late in 2006 and as a result many exploration and production businesses indicated reduced activity levels in 2007. Natural gas prices strengthened in early 2007, but it remains unclear as to whether activity levels of RJV's key customers will increase in the second through fourth quarters of 2007. Some of RJV's major clients have announced reductions in their capital expenditure budgets. RJV management is carefully monitoring market conditions and will respond to available levels of activity. Fund management is projecting a reduction in RJV's activity levels for 2007 and, therefore, a reduction in sales and distributable cash have been budgeted. RJV management will continue to work closely with its customers to maintain market share.

Diamond expects the reduced activity levels in the natural gas sector to drive its mix of business more in favor of oil well servicing. Management is delaying new equipment additions until visibility in the energy sector improves. Diamond will pursue opportunistic investment opportunities. Diamond added two new service rigs to its fleet at the end of 2006, which are servicing both existing and new customers. Diamond management is intensely focused on cost control and is pursuing new customers to maintain its market position.

Ezee-On's performance is expected to remain flat year over year. In addition to its efforts in the domestic markets in Canada, management of Ezee-On will continue its sales initiatives in the United States and internationally.

Stylus has made significant progress in increasing its targeted boutique retail customer base. The business' continuing participation at the Las Vegas Market allowed Stylus to increase its dealer base in the United States. With the completion of the move to the new warehouse facilities the business is in a better position to grow its import program. Stylus's import efforts have expanded sourcing to four factories in China. Stylus is currently pursuing efforts to increase it sales in the U.S. Stylus management anticipates improved year on year performance for its business.

Don Park is striving to improve its performance as Management has made several key strategic decisions in order to improve operational efficiencies. While the market is expected to remain competitive, Don Park is focusing its efforts on increasing efficiencies in its Branch Store, Wholesale and Commercial divisions. In 2006, the business implemented a significant cost reduction program. Management anticipates improved Stores performance, continuing competitive pressure in Wholesale and continued solid performance in its Commercial division. As a result of improved operating efficiencies and cost reductions implemented in 2006, and the recent hiring of a new Chief Executive Officer, Management is expecting improved financial performance in 2007.

Beco has addressed its fulfillment, quality and customer issues experienced in 2006, as demonstrated by improved sales performance in the fourth quarter of 2006. Sales prospects for early 2007 are positive as the business has renewed its reputation as a quality and service leader in the key segments in which it operates. The business continues to add value to its customer base by designing innovative products and sourcing across an international network. Management of Beco continues to focus on ways to grow the business, including adding additional product lines to existing accounts and expanding its base of customers. Management of Beco is also focused on a number of initiatives to continue its improvement in its supply chain management and its continued focus on reducing operating expenses. The business significantly reduced its operating costs in 2006 and Management expects improved financial performance in 2007.

Fund Management continues to work with portfolio businesses to improve financial performance and provide strategic oversight. The future change in the taxability of income trusts impacts TerraVest's cost of equity and the capital market's willingness to invest further in income trusts. Management believes that the financing market is likely to remain uncertain until the legislation proposed is finalized. Management continues to evaluate acquisition opportunities which may be of interest to the Fund. Additionally, Management is working hard to assure prudent financial management during this period of uncertainty. The reduction in distributions initiated in January 2007, cost reductions at the Fund level in the first quarter of 2007, and continuing efforts to increase the Fund's effectiveness and efficiency are all parts of this initiative.

ACCOUNTING POLICIES

The Fund prepares its financial statements in accordance with Canadian GAAP. The Fund's accounting policies are disclosed in the notes of the audited consolidated financial statements for the period ended December 31, 2006.

The comparative consolidated financial statements of the Fund for the year ended December 31, 2006 include operations of RJV, Ezee-On and Stylus for the year ended December 31, 2005, Don Park for the fiscal period April 1, 2005 to December 31, 2005, Diamond for the fiscal period October 3, 2005 to December 31, 2005, and Beco for the period December 5, 2005 to December 31, 2005.

IMPACT OF NEW ACCOUNTING STANDARDS

The CICA has issued three new accounting standards:

(a) Section 3855 Financial Instruments - Recognition and Measurement

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

(b) Section 1530 Comprehensive Income

Section 1530 is effective for fiscal years beginning on or after October 1, 2006. It describes reporting and disclosure recommendations with respect to comprehensive income and its components. Comprehensive income is the change in Unitholders' equity, which results from transactions other than those resulting from investments by Unitholders and distributions to Unitholders. These transactions and events include unrealized gains and losses resulting from changes in the fair value of certain financial instruments. The impact of the adoption of this new section on the consolidated financial statements is not expected to be material.

(c) Section 3865 Hedges

Section 3865 is effective for fiscal years beginning on or after October 1, 2006. The recommendations expand the guidelines outlined in Accounting Guideline 13, Hedging Relationships. This Section describes when and how hedge accounting can be applied as well as the disclosure requirements. Hedge accounting enables the recording of gains, losses, revenues and expenses from the derivative financial instruments in the same period as for those related to the hedged item. The impact of the adoption of this new section on the consolidated financial statements is not expected to be material.

These standards will be effective for the Fund as of January 1, 2007 and will be adopted on a retroactive basis without restatement basis

CRITICAL ACCOUNTING ESTIMATES

The Fund's consolidated financial statements include estimates and assumptions made by Management relating to the results of operations, financial condition, contingencies, commitments and related disclosures. Actual results may vary from these estimates. The following are, in the opinion of Management, the Fund's most critical accounting estimates.

Inventory valuation requires the use of estimates to determine obsolescence and to ensure that the cost of inventory is not in excess of net realizable value.

Capital assets amortization requires estimates by Management as to the estimated useful life of the assets, the residual value at the end of the useful life, and the appropriate amortization rates.

Goodwill impairment incorporates, at a minimum, an annual assessment of the value of the Fund's goodwill by applying a fair value based test to each segment of goodwill. Each fair value test may incorporate estimates such as normalized earnings, future earnings, price earnings multiples, future cash flows, discount rates, and terminal values. Goodwill arose on the Fund's acquisition of Laniuk, Stylus, Don Park, Diamond and Beco. Any impairment of goodwill would reduce net earnings. Management conducts an annual assessment of goodwill in the fourth quarter of each fiscal year.

Intangible asset impairment incorporates, at a minimum, an annual assessment of the value of the Fund's intangible assets by applying a fair value based test to each segment of intangible asset. Each fair value test may incorporate estimates such as normalized earnings, future earnings, price earnings multiples, future cash flows, discount rates and terminal values. The intangible assets arose on the Fund's acquisition of Laniuk, Stylus, Don Park, Diamond and Beco. Any impairment of intangible assets would reduce net earnings. Management conducts an annual assessment of intangible assets in the fourth quarter of each fiscal year.

Warranty costs require estimates by Management as to the warranty expense expected to be incurred. An estimate of future warranty costs is made annually based on historical results and any change is charged to income in the period.

Income tax provisions, including current and future income tax assets and liabilities, and potential tax reassessments, may require estimates and interpretations of federal and provincial income tax rules and regulations, and judgments as to their interpretation and application to the Fund's specific situation. Current income taxes are not provided by the Fund, as the Fund's intention is to minimize its tax liabilities through distributions to its Unitholders. However, income taxes may be incurred and payable at the entity level, and in such cases are reflected in the operations of the particular entity. Any changes in future income tax assets and liabilities are charged to income in the period.

Accounts receivable collectibility may require an assessment and estimation of the creditworthiness of customers, the timing of collection, and the amounts that will be received. An allowance is provided against any amount estimated to be uncollectible, and reflected as a bad debt expense.

Valuation of acquired assets and liabilities on the acquisition date requires the use of estimates to determine the purchase price allocation. Estimates are made as to the valuations of capital assets, intangible assets and goodwill as well as to the fair value of assets acquired. In certain circumstances such as the valuation of intangible assets and property, plant and equipment, Management also relies on independent third party estimates.

FINANCIAL INSTRUMENTS

The Fund's financial instruments consist primarily of cash, accounts receivable, amounts payable under the operating loan, accounts payable and accrued liabilities, derivative instruments, distributions payable, term debt and capital lease obligations.

The carrying values of cash, accounts receivable, amounts payable under the operating loan, accounts payable and accrued liabilities, derivative instruments, distributions payable, term debt and capital lease obligations approximate fair values due to immediate or short-term maturity of these financial instruments.

The Fund is exposed to interest rate risk arising from fluctuations in interest rates on its term debt and amounts payable under the operating loan.

The Fund is exposed to credit risk. Credit risk arises from the potential that a counterparty will fail to perform its obligations. The Fund's credit risk is minimized by a large number of diverse customers in different industries. The Fund maintains allowances for potential bad debts on its accounts receivable and any such losses to date have been provided for.

The Fund is subject to foreign exchange risk for sales and purchases denominated in foreign currencies. Foreign currency risk arises from the fluctuation of foreign exchange rates and the degree of volatility of these rates relative to the Canadian dollar.

2006 INCOME TAX INFORMATION

The following table outlines the breakdown of cash distributions per Unit declared by TerraVest Income Fund for the year ended December 31, 2006 for Canadian Income Tax purposes.



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Total Distribution Taxable other
Record Date Payment Date paid Per Unit income/Unit
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January 31 February 15 $ 0.115 $ 0.115
February 28 March 15 0.115 0.115
March 31 April 17 0.115 0.115
April 30 May 15 0.115 0.115
May 31 June 15 0.115 0.115
June 30 July 17 0.115 0.115
July 31 August 15 0.115 0.115
August 31 September 15 0.115 0.115
September 30 October 16 0.115 0.115
October 31 November 15 0.115 0.115
November 30 December 15 0.115 0.115
December 29 January 15, 2007 0.115 0.115
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Total per Unit $ 1.380 $ 1.380
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CONTROLS AND PROCEDURES

Disclosure controls and procedures

Disclosure controls and procedures are designed to provide reasonable assurance that all relevant information is gathered and reported to senior management, including the Fund's Chief Executive Officer and Chief Financial Officer, on a timely basis so that appropriate decisions can be made regarding public disclosure. As at December 31, 2006, the Management of the Fund, with the participation of the Chief Executive Officer and the Chief Financial Officer, evaluated the effectiveness of the Fund's disclosure controls and procedures as required by the Canadian securities laws. Canadian Securities Administrators' Multilateral Instrument 52-109 ("MI 52-109") requires that the Fund's internal disclosure controls and procedures must be sufficiently effective to provide reasonable assurance that material information relating to the Fund is made known to Management and disclosed in accordance with applicable securities regulations. There are two main components to the definition of "disclosure controls and procedures" contained within MI 52-109. These are:

1. Disclosure controls and procedure include controls over the external communication of information contained in all reports filed or submitted under provincial and territorial securities legislation within the specific time periods; and

2. Disclosure controls and procedures also cover the internal communications to the CEO and CFO of information that may need to be disclosed by the filings within the appropriate time periods. In addition, MI 52-109 requires CEOs and CFOs to certify they have designed internal control over financial reporting, or caused it to be designed under their supervision.

The Chief Executive Officer and Chief Financial Officer have concluded that, as at December 31, 2006, the disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed in the Fund's annual filings and interim filings (as such terms are defined under MI 52-109 Certification of Disclosure in Issuer's Annual and Interim Filings) and other reports filed or submitted under Canadian securities laws are recorded, processed, summarized and reported within the time periods specified by those laws and that material information is accumulated and communicated to Management of the Fund, including the Chief Executive Officer and the Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

Internal control over financial reporting

Management is responsible for establishing and maintaining adequate internal controls over financial reporting to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAP. Management has concluded that, in one of the portfolio businesses, there was a short-term weakness in internal controls due to a change in business processes. Corrective action was immediately taken and effective controls and procedures have now been designed and implemented. Based on that corrective action, Management has attested that internal controls over financial reporting have been designed to provide reasonable assurance that the Fund's financial reporting is reliable and that the Fund's financial statements are prepared in accordance with GAAP.

Additional information concerning the Fund can be found at www.sedar.com.

Contact Information