UE Waterheater Income Fund
TSX : UWH.UN

UE Waterheater Income Fund

February 28, 2007 16:05 ET

UE Waterheater Income Fund Announces Financial Results for the Fourth Quarter and Year Ended December 31, 2006

TORONTO, ONTARIO--(CCNMatthews - Feb. 28, 2007) -

NOT FOR DISTRIBUTION IN THE UNITED STATES OR OVER UNITED STATES WIRE SERVICES.

UE Waterheater Income Fund (TSX:UWH.UN), today released financial results for the fourth quarter and year ended December 31, 2006. Highlights for the year are as follows:

http://www.ccnmatthews.com/docs/uwhun228.pdf

"Management is very pleased with the Fund's overall performance in 2006. The Fund continues to deliver on its strategic plan, growing revenues from new product lines including Comfort Protection Plans, rental HVAC and security, improving both the efficiency and effectiveness of our service infrastructure, and constantly strengthening the capabilities of our entire employee team," says Chief Executive Officer Roger Rossi, adding: "In 2006, distributable cash per unit increased over 26% and the Fund increased distributions to unitholders 10% per unit effective November 2006 reflecting strong operating performance and our confidence in the ongoing stability of the Fund's cash flows."



Financial Highlights
(In thousands of dollars, except for unit information) (Unaudited)

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Three months ended December 31, Year ended December 31,
2006 2005 2006 2005
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Revenue $ 82,314 $ 75,177 $ 321,522 $ 260,618
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Cost of sales,
general and
administration 43,994 40,460 170,914 130,222
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Depreciation and
amortization 19,903 18,968 77,749 66,465
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Operating income 18,417 15,749 72,859 63,931
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Change in fair
value of
interest rate
contracts 93 (9) 436 357
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Finance and
interest charges 4,776 4,706 19,146 18,063
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Income before
income taxes 13,548 11,052 53,277 45,511
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Income and large
corporations taxes - 252 - 943
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Net income $ 13,548 $ 10,800 $ 53,277 $ 44,568
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Cash from
operating activities $ 41,172 $ 38,005 $128,101 $108,232
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Cash from (used in)
financing activities (12,320) (11,027) (51,090) 96,330
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Cash used in
investing activities (24,281) (21,886) (88,159) (210,569)
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Unitholder cash
distributions
declared 12,644 11,078 48,210 40,836
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Unitholder cash
distributions paid 12,250 11,076 47,556 40,082
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Earnings before
finance and interest
charges, taxes,
depreciation and
amortization
(EBITDA)(1) 38,320 34,717 150,608 130,396
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Total assets 1,019,019 1,007,919 1,019,019 1,007,919
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Total long-term
liabilities $ 458,479 $ 419,931 $ 458,479 $ 419,931
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Unit Analysis
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Total outstanding
units at December 31 49,260,679 49,233,000 49,260,679 49,233,000
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Weighted average
units outstanding
for the period 49,246,365 49,233,000 49,243,070 45,108,616
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Earnings per unit
- basic and diluted $0.27 $0.22 $1.08 $0.99
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EBITDA(1) per unit
- basic and diluted $0.78 $0.70 $3.06 $2.89
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Distribution declared
per unit - basic and
diluted $0.26 $0.22 $0.98 $0.90
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Distributable cash(1)
generated per unit
- basic and diluted $0.44 $0.36 $1.62 $1.29
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(1) See "Non-GAAP Measures" section.
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February 28, 2007

This document is intended to assist in the understanding and assessment of the trends and significant changes in the results of operations and financial condition of UE Waterheater Income Fund (the "Fund") and its subsidiaries for the fourth quarter of 2006. It should be read in conjunction with the Fund's audited consolidated financial statements and accompanying notes for the year ended December 31, 2006, as well as the Fund's unaudited interim consolidated financial statements and accompanying notes for the period ended December 31, 2006. In this document, "we", "us", "our" and "the Fund" refer to UE Waterheater Income Fund and its subsidiaries. The annual information form, annual report, other quarterly reports of, and other information relating to UE Waterheater Income Fund are available on SEDAR at www.sedar.com. Certain terms and measures used in this document are defined and described in the section, "Non-GAAP Measures".

This document contains forward-looking statements about the objectives, financial condition, results of operations and business of the Fund. These statements are "forward-looking," as they are based on current expectations about the Fund's business and the markets the Fund operates in and on various estimates and assumptions.

- Forward-looking statements in this document describe the Fund's expectations on February 28, 2007.

- Actual results could be materially different from the Fund's expectations if known and unknown risks affect the Fund's business or if the Fund's estimates or assumptions turn out to be inaccurate. As a result, the Fund cannot guarantee that any forward-looking statement will materialize.

- Forward-looking statements do not take into account the effect that transactions or non-recurring items announced or occurring after the statements are made have on the Fund's business.

- The Fund disclaims any intention or obligation to update any forward-looking statement even if new information becomes available, as a result of future events or for any other reason.

- Risks that could cause actual results to differ from the Fund's current expectations include the risks discussed under the heading "Risks and Uncertainties".

The following should be read in conjunction with the Fund's audited consolidated financial statements for the year ended December 31, 2006. These consolidated financial statements, presented in Canadian dollars, have been prepared in accordance with Canadian generally accepted accounting principles ("GAAP").

About the UE Waterheater Income Fund

UE Waterheater Income Fund is an unincorporated, open-ended, limited purpose trust established under the laws of Ontario that indirectly holds, through the UE Waterheater Operating Trust, the water heater rental business of Union Energy Limited Partnership ("Union Energy LP") and its related commercial activities as well as the security monitoring business of Protectron Limited Partnership ("Protectron LP"). Each unit of the Fund represents an indirect ownership interest in Union Energy LP and Protectron LP, which own and operate the businesses.

The Fund reports its operations in two segments: the "Water Heater and HVAC" segment, and the "Security" segment.

The Water Heater and HVAC segment rents and services a portfolio of more than one million residential water heaters in Ontario. The residential water heater portfolio is Canada's second largest and was initiated in the 1960s. In addition, this segment has related commercial activities that complement the water heater rental business, being the retail sale, rental, service and maintenance, and financing of heating, ventilation and air-conditioning ("HVAC") equipment. The segment operates under the Union Energy, UEI Financial, Reliance Home Comfort, and Reliance Commercial Solutions brand names.

The Security segment operations began July 15, 2005 with the acquisition of Protectron Holdings Inc. ("Protectron"). This segment provides electronic security system sales, installation, rental, service, monitoring, and related commercial activities, serving more than 194,000 customers across Canada under the "Reliance Protectron Security Systems" brand name. The Security segment has its head office, a call centre and monitoring station in Montreal, a call centre and monitoring station in Ottawa, monitoring stations in Quebec City and Vancouver, and has branch offices across Canada. The segment also maintains a network of authorized dealers throughout Canada.

Products of both segments are also marketed under the Reliance brand, providing consumers integrated home comfort and security solutions.

RESULTS OF OPERATIONS - CONSOLIDATED FINANCIAL RESULTS

Income

For the quarter ended December 31, 2006, the Fund reported net income of $13.5 million on revenues of $82.3 million, compared to net income of $10.8 million on revenues of $75.2 million for the quarter ended December 31, 2005. Operating income (see "Non-GAAP Measures" section) for the quarter ended December 31, 2006 was $18.4 million, an increase of $2.7 million, or 17%, from the same period last year.

For the year ended December 31, 2006, the Fund reported net income of $53.3 million on revenues of $321.5 million, compared to net income of $44.6 million on revenues of $260.6 million for the year ended December 31, 2005. Operating income for 2006 was $72.9 million, an increase of $9.0 million, or 14%, over 2005. The results are consistent with management's expectations and demonstrate the result of the Fund's growing portfolio of rental water heaters and HVAC equipment and revenue growth of its related HVAC and other commercial activities, as well as reflecting a full year of sales and income of the Security segment.

Rental and security monitoring revenues increased by $6.8 million, or 12%, for the three months ended December 31, 2006, compared with the same period in 2005. Rental revenue increased 10% in the quarter, as compared to 2005, reflecting rental price increases, the net increase in the number of installed units, and changes in product mix of the Water Heater and HVAC segment. Security monitoring revenues increased $2.1 million, or 19%, reflecting growth in recurring monthly revenue (see "Non-GAAP Measures" section) due to customer base growth.

Rental and security monitoring revenues increased by $47.7 million, or 23%, to $252.2 million for the year ended December 31, 2006, compared to $204.5 million for 2005. Water Heater and HVAC segment rental revenue increased $17.9 million, or 10% in 2006, as compared to 2005, reflecting rental price increases, the net increase in the number of installed units, and changes in product mix. Security monitoring revenues increased $29.8 million, or 140%, primarily as a result of reflecting a full year of revenue as compared to the five-and-a-half months of operation following the acquisition in the third quarter of 2005, as well as growth in recurring monthly revenue of 12% as measured at the end of the year.

Sales, service and other revenue was $0.2 million higher in the fourth quarter when compared to the corresponding period a year prior, reflecting an increase of Water Heater and HVAC segment revenues of $0.3 million comprised of higher Comfort Protection Plan sales, net of lower HVAC sales and service revenue, and lower Security sales and service of $0.1 million as more focus is placed on recurring monthly revenues rather than one-time billings.

Sales, service and other revenue increased by $12.6 million, or 28%, to $57.9 million for the year ended December 31, 2006 compared to $45.3 million for 2005, primarily as a result of Security segment sales and service revenues increasing $8.3 million, reflecting a full year of operations. In addition, Water Heater and HVAC revenue was 11% higher than 2005, contributing $4.4 million of the revenue increase. The increase in the Water Heater and HVAC segment was primarily a result of continuing to leverage cross-selling opportunities to the Fund's base of approximately 1.1 million rental customers, with increased revenues from Comfort Protection Plans offsetting a decline in other HVAC product line sales.

Finance revenue was $2.9 million for the quarter ended December 31, 2006, compared to $2.8 million for the comparable period in 2005. Finance revenue was $11.4 million for the year ended December 31, 2006, compared to $10.8 million for the year ended December 31, 2005. The increases primarily reflect a higher average finance contract portfolio balance during the periods, offset by a slightly lower weighted average effective interest rate caused by issuing new contracts at lower stated interest rates in 2006 than the weighted average interest rate of the portfolio. The Fund sets its rates according to various factors, including market competition.

Cost of sales and general and administrative expenses for the three months ended December 31, 2006 increased by $3.5 million, or 9%, to $44.0 million from $40.5 million for the quarter ended December 31, 2005, but decreased as a percentage of revenue to 53% in 2006 compared to 54% for the same quarter in 2005.

Cost of sales and general and administrative expenses for the year ended December 31, 2006, increased by $40.7 million, or 31%, to $170.9 million, from $130.2 million for the year ended December 31, 2005. The increase reflects a full year of operations in the Security segment, compared to five-and-a-half months in 2005. Higher costs in the Water Heater and HVAC segment contributed 11% of the consolidated increase, or $14.0 million. The increase included costs related to marketing and customer acquisition as well as costs related to servicing additional Comfort Protection Plan and rental customers. Cost of sales and general and administrative expenses for the year were 53% of total revenues, compared to 50% in 2005, reflecting the costs of servicing a higher percentage of revenue generated from sources other than rental water heaters due to growth in other business lines that have lower capital requirements and thus lower margins.

Depreciation and amortization was $19.9 million for the quarter, compared to $19.0 million in the same period in 2005, consistent with asset growth.

Depreciation and amortization was $77.7 million for the year ended December 31, 2006, an increase of $11.2 million, or 17%, compared to 2005. The increase primarily reflects $16.7 million amortization of the intangible assets and depreciation related to fixed assets of the Security segment in 2006, compared to $6.5 million for the five-and-a-half months of operations in 2005. In addition, depreciation of assets in the Water Heater and HVAC segment increased $1.1 million in 2006, compared to 2005. The increase reflects higher depreciation of $2.6 million in 2006 as a result of revised depreciation rates, offset by the effect of certain other assets being fully amortized in 2005.

In November 2003, the Fund entered into interest rate contracts to substantially fix the average effective interest rate on the offering of senior secured notes that were issued on February 10, 2004. Upon issuance of the senior secured fixed interest rate notes, the Fund entered into offsetting interest rate contracts resulting in a total effective fixed cash interest rate of 5.23% per annum for the Fund.

The interest rate contracts are accounted for using fair value accounting. The current fair values of these contracts are reflected on the Fund's balance sheet. Changes in the fair values are recorded in income as they arise, resulting in a charge to income of $0.4 million for each of the years ended December 31, 2006, and 2005. There was a $0.1 million charge to income for the three months ended December 31, 2006, and a small credit to income in the fourth quarter of 2005.

The fair value liability accrued at December 31, 2006 of $10.0 million will reverse over the terms of the senior secured notes as payments are made under the terms of the interest rate contracts. Payments made under the terms of the interest rate contracts were $3.2 million for each of the years ended December 31, 2006, and 2005. No payments were made in the three months ended December 31, 2006 or 2005. The fair value liability at December 31, 2005 was $12.8 million.

Finance and interest charges represent interest on senior secured notes and interest on the short-term debt associated with the acquisition of the Security segment on July 15, 2005 (which was converted to long-term debt in July, 2006), net of other interest income and expense.

Finance and interest charges were $4.8 million for the quarter ended December 31, 2006, compared to $4.7 million for the quarter ended December 31, 2005. The increase reflects lower net interest income, offset by lower interest due to the reduction of revolving term credit facilities in the third quarter of 2006.

Finance and interest charges were $19.1 million for the year ended December 31, 2006, compared to $18.1 million for 2005. The net increase results primarily from interest paid on debt related to the acquisition of the Security segment for a full year in 2006, compared to five-and-a-half months in 2005.

The Fund recorded no income tax expense for 2006, reflecting the repeal of the Federal Large Corporations Tax. During the year, the receipt of notices of assessment for prior years for certain subsidiaries, resulted in the recognition of a tax expense recovery of $0.3 million, which was completely offset by one-time income taxes in connection with finalizing the corporate reorganization to integrate the Protectron business into the income fund structure.

The Federal government has recently announced its intention to amend tax legislation to make mutual fund trusts subject to federal income taxes. The proposed legislation and the Fund's analysis are discussed in the section "Income Taxes".

EBITDA (See "Non-GAAP Measures")

Earnings before interest and financing charges, depreciation, amortization and taxes ("EBITDA") was $38.3 million for the quarter ended December 31, 2006, an increase of $3.6 million, or 10%, when compared to EBITDA of $34.7 million for the comparable period in 2005.

For the year ended December 31, 2006, EBITDA was $150.6 million, an increase of $20.2 million, or 16%, compared to EBITDA of $130.4 million for 2005.

The following table reconciles net income of the Fund determined under GAAP with EBITDA, as calculated consistently for each period:



(in thousands of dollars)
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Three months ended Year ended
December 31 December 31
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2006 2005 2006 2005
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Net income $ 13,548 $ 10,800 $ 53,277 $ 44,568
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Adjustments
Depreciation and amortization 19,903 18,968 77,749 66,465
Finance and interest charges (1) 4,869 4,697 19,582 18,420
Income and large corporations
taxes - 252 - 943
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Earnings before interest, taxes,
depreciation and amortization
(EBITDA) $ 38,320 $ 34,717 $ 150,608 $ 130,396
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(1) Includes finance and interest charges and mark-to-market valuation of
interest rate contracts.
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The EBITDA increase in the current quarter, as compared to the fourth quarter of 2005, reflects higher revenue net of higher costs in the Water Heater and HVAC segment and revenue and income increases in the Security segment resulting from customer-base growth.

The EBITDA increase for the year ended December 31, 2006 as compared to 2005, reflects the $9.8 million accretive impact of the Security segment in which is included in operations for a full year in 2006, but only five-and-a-half months in 2005, and the revenue growth of the Water Heater and HVAC segment, net of higher costs in that segment. In addition, revenue and income increases in the Security segment reflect customer-base growth in 2006.

Adjusted EBITDA (as defined in the Supplemental Trust Indentures) was 7.9 times Net Interest Expense for the year ended December 31, 2006, significantly in excess of the requirement of 3.0 times Net Interest Expense under the Supplemental Trust Indenture pursuant to which the Series 1 and Series 2 Senior Secured Notes were issued.

Distributable cash (See "Non-GAAP Measures" section)

The Fund distributes cash to its unitholders on a monthly basis. Although the Fund has made a distribution for each month of its operation, the amount and timing of distributions cannot be assured and are dependent on operating performance, as cash available for distributions is derived solely from operating cash flows of the Fund's subsidiaries.

The breakdown between taxable income and return of capital for 2006 cash distributions to its unitholders subject to Canadian income taxes was 100% income. Cash distributions to unitholders by the Fund for the year ended December 31, 2005 was 92% income and 8% return of capital.

Distributable cash for the quarters and years ended December 31, 2006 and 2005 has been calculated and reconciled to cash from operating activities of the Fund as determined under GAAP as follows:



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Three months ended Year ended
December 31 December 31
(In thousands of dollars,
except per unit data) 2006 2005 2006 2005
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Cash from operating activities $ 41,172 $ 38,005 $ 128,101 $ 108,232

Adjustments:
Operating cash flow from
finance contracts related
to Fund sales 279 811 2,080 2,979
Change in non-cash
operating working capital (5,321) (7,134) 2,252 (842)
Change in warranty liability (137) 105 (630) 160
Maintenance capital
expenditures (1) (2) (14,185) (14,052) (51,849) (52,293)
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Distributable cash (2) $ 21,808 $ 17,735 $ 79,954 $ 58,236
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Total distributions declared $ 12,644 $ 11,078 $ 48,210 $ 40,836
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Distributable cash (2) per
unit - basic and diluted $ 0.44 $ 0.36 $ 1.62 $ 1.29
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Distributions declared per
unit - basic and diluted $ 0.26 $ 0.22 $ 0.98 $ 0.90
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(1) Total net capital expenditures for the three and twelve months ended
December 31, 2006 were $22.6 million and $81.1 million, respectively.
The corresponding amounts for the three and twelve months ended
December 31, 2005 were $20.9 million and $70.1 million, respectively.
Total net capital expenditures include purchases of fixed assets and
expenditures related to deferred customer accounts, net of proceeds
from the sale of fixed assets and deferred customer acquisition
revenue.
(2) See "Non-GAAP Measures".
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Distributable cash of the Fund is equal to cash flow from operating activities before changes in non-cash operating working capital and after maintenance capital expenditures and adjustments for warranty liabilities and finance contracts related to Fund sales.

Changes in non-cash working capital and warranty liabilities are considered by management to be primarily temporary fluctuations, and are not expected to impact cash distributions. Growth in non-cash working capital that cannot be funded through cash on hand will be financed by the $30.0 million in working capital financing facilities the Fund has available.

The Fund defines its productive capacity as the investments required to maintain current levels of recurring revenue from the Water Heater and HVAC rental portfolio and the security monitoring contracts. Productive capacity is not a recognized measure under GAAP, and therefore has no standardized meaning prescribed by GAAP and may not be comparable to similar terms and measures presented by similar issuers.

Total net capital expenditures of the Fund and the amounts of maintenance and growth capital for the quarters and years ended December 31, 2006 and 2005 are as follows:



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Three months ended Year ended
December 31 December 31
(In thousands of dollars) 2006 2005 2006 2005
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Purchase of fixed assets $ (18,787) $ (18,394) $ (71,997) $ (68,156)

Deferred customer acquisition
revenue 1,871 1,329 6,217 2,647
Deferred customer accounts
- Internally generated (3,268) (3,141) (12,316) (6,408)
Deferred customer accounts
- acquired (3,751) (1,377) (7,279) (1,377)
Proceeds from sale of fixed
assets 1,362 642 4,313 2,614
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Total net capital expenditures $ (22,573) $ (20,941) $ (81,062) $ (70,680)
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Maintenance capital expenditures
- Water Heater and HVAC segment (12,335) (12,121) (45,046) (48,936)
Maintenance capital expenditures
- Security segment (1,850) (1,931) (6,803) (3,357)
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Total maintenance capital
expenditures (14,185) (14,052) (51,849) (52,293)
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Growth capital expenditures $ (8,388) $ (6,889) $ (29,213) $ (18,387)
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Maintenance capital represents management's calculation of the estimated amount the Fund is required to spend in a period on fixed and intangible assets to maintain the productive capacity as at the beginning of that period, including the fixed and intangible assets associated with the acquiring, administering and servicing those revenues. Maintenance capital expenditures of the Water Heater and HVAC segment include expenditures during the period for rental equipment installed to replace rental equipment removed from service at the end of its useful life, additional rental units purchased to offset the impact on rental portfolio revenues of buyouts and terminations, and ongoing expenditures related to information technology and other capital investments required to maintain operating and administrative capacity. Maintenance capital expenditures of the Security segment include security customer acquisition costs incurred to replace recurring monthly revenue attrition related to security monitoring customers existing at the end of the prior period, and ongoing expenditures related to information technology and other capital investments required to maintain operating and administrative capacity. Non-maintenance capital expenditures of both segments represent expenditures related to investments in future revenue growth and are not recorded as a reduction from distributable cash as these expenditures are intended to be funded from either cash on hand or through the Fund's committed $88.0 million growth credit facility that is available for expansion, investments and acquisitions, of which $35.0 million is drawn.

Distributable cash is also adjusted for the operating cash flow effect of changes in finance contracts related to Fund sales. This flow of funds is considered to be a net investment in the capital value of the overall finance contract portfolio notwithstanding that these changes are reported in operating cash flows.

Distributable cash for the quarter ended December 31, 2006 was $21.8 million, as compared to $17.7 million for 2005. The increase is primarily due to higher cash flows from operating activities as adjusted. Maintenance capital expenditures increased slightly during the quarter as compared to 2005, primarily due to expenditures related to the purchase and installation of software designed to enhance operational efficiency in the areas of workforce management, customer information, billing, and asset management, net of fewer units of rental equipment being replaced in the Water Heater and HVAC segment.

Distributable cash for the year ended December 31, 2006 was $80.0 million, as compared to $58.2 million for 2005. The increase is primarily due to higher cash flows from operating activities as adjusted, and $0.4 million lower maintenance capital expenditures. Despite unit costs increasing, maintenance capital expenditures decreased due to approximately 9,000 fewer units of rental equipment being replaced in the Water Heater and HVAC segment. Management believes the lower number of units replaced in the Water Heater and HVAC segment reflect operational improvements implemented over the past year, with an increased focus on repairing water heaters rather than replacement, contributing to an overall $3.9 million decrease in maintenance capital expenditures in the segment. In addition, maintenance capital expenditures of $6.8 million of the Security segment reflected a full year of operations, increasing $3.4 million from 2005. Security segment maintenance capital expenditures fluctuate primarily with customer attrition which historically has been lower in the first and fourth quarters due to fewer customers moving during the winter months.

The Fund increased cash distributions to a monthly amount of $0.08025 per unit (equivalent to $0.963 per unit on an annualized basis) as of January 2006, a 7% increase over the 2005 distribution rate. In October, 2006, the Fund announced an increase in cash distributions to a monthly amount of $0.08825 per unit (equivalent to $1.059 per unit on an annualized basis) effective November 2006. During 2005, the Fund paid cash distributions of 0.075 per unit (equivalent to $0.90 on an annualized basis).

The Fund has generated significantly more cash than it has paid out in distributions in 2006. Management of the Fund believes that distributable cash not distributed to unitholders should be applied to revenue generating asset growth. During the year, the Fund began a three-year program to purchase and install software designed to enhance operational efficiency in the areas of workforce management, customer information, billing, and asset management. In 2006, the Fund spent approximately $2.8 million, approximately $2.7 million of which was maintenance capital, and $0.1 million was operating expense. The Fund expects ongoing infrastructure investments to reduce distributable cash by approximately $1.6 million in 2007, approximately $5.9 million in 2008, and approximately $2.5 million in 2009, without regard to the impact of any operational efficiencies.

RESULTS OF OPERATIONS - WATER HEATER AND HVAC SEGMENT

The following table presents selected unaudited financial information of the Water Heater and HVAC segment for the quarters and years ended December 31, 2006 and 2005:



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Three months ended Year ended
(in thousands of dollars) December 31, December 31,
2006 2005 2006 2005
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Revenues:
Rental $ 51,581 $ 46,916 $ 201,124 $ 183,210
Sales, services and other 10,314 10,043 42,575 38,216
Finance 2,943 2,810 11,373 10,844
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Total revenues 64,838 59,769 255,072 232,270
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Cost of sales, general and
administration expenses 31,690 29,242 124,246 110,240
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Depreciation and amortization 15,427 15,181 61,005 59,926
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Operating income $ 17,721 $ 15,346 $ 69,821 $ 62,104
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Results for the quarter and year are in line with management's expectations and reflect investments in brand marketing and customer-base growth as the Water Heater and HVAC segment grows its Comfort Protection Plan business, the benefits of which will be realized in future periods. Customer-base growth costs primarily reflect telemarketing expenditures incurred by the segment as it continues to drive strong growth in its Comfort Protection Plan business. Increased marketing costs reflect expenditures related to researching, developing, and implementing a new brand, as the rights to use the Union Energy and the Ontario Hydro Energy brands expire in 2008 and 2007, respectively. The Fund has been introducing the brand name "Reliance Home Comfort" market by market, as previously announced. A staggered implementation approach allows the Fund to better understand the impact of the move to a new name and also has allowed the Fund to effectively manage the transition, which is expected to be complete by mid-2007.

Revenues

Water Heater and HVAC segment rental revenues increased by 10% for each of the quarter and year ended December 31, 2006 when compared to the corresponding periods in 2005, reflecting rental price increases, rental portfolio growth, and changes in product mix.

Sales, service and other revenue was $10.3 million and $42.6 million, respectively, for the three and twelve months ended December 31, 2006. Sales, service and other revenue was $10.0 million and $38.2 million for the comparable periods in 2005. The Fund continues to leverage cross-selling opportunities to its base of approximately 1.1 million rental customers. The 2006 quarter and annual increases in sales, service and other revenues reflects growth in the Fund's Comfort Protection Plan business, offset by lower revenues in other product lines. The decrease in other product lines may reflect an increased number of customers joining the rental HVAC program, rather than purchasing HVAC equipment, which reduces sales, service and other revenue but increases the Fund's rental revenue. The generally moderate weather in the third and fourth quarters of 2006 appears to have postponed consumer HVAC purchases.

Finance revenue was $2.9 million and $11.4 million, respectively, for the quarter and year ended December 31, 2006, compared to $2.8 million and $10.8 million for the comparable periods in 2005. Revenues fluctuate primarily with the balance of finance contracts outstanding, offset by a slightly lower weighted average effective interest rate caused by issuing new contracts at lower stated interest rates in 2006 than the weighted average interest rate of the portfolio. The Fund sets its rates according to various factors, including market competition.

Cost of Sales, General and Administration Expenses

Cost of sales, general and administration expenses in the Water Heater and HVAC segment for the quarter ended December 31, 2006 increased by $2.4 million, or 8%, from $29.2 million for the same period in 2005. Cost of sales, general and administration expenses in the Water Heater and HVAC segment for the year ended December 31, 2006 increased by $14.0 million, or 13% from $110.2 million for the same period in 2005. The increases in 2006 over 2005 primarily reflect higher marketing costs relating to branding initiatives and customer acquisition costs pertaining to growing the Fund's Comfort Protection Plan and rental HVAC businesses, and the costs of servicing additional Comfort Protection Plan and rental customers.

Depreciation and Amortization

Depreciation and amortization expense in the Water Heater and HVAC segment was $15.4 million in the quarter, an increase of $0.2 million from the fourth quarter of 2006, and $61.0 million for the year ended December 31, 2006, an increase of $1.1 million from 2005. The changes from period to period reflect increases due to revised rental depreciation, and a growing rental portfolio, offset by reductions primarily due to certain non-rental assets being fully depreciated in 2005.

Portfolio of Rental Assets

A breakdown of the changes in the installed units for the fourth quarter and year ending December 31, 2006 compared to the corresponding periods in 2005 is as follows:



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(in thousands of units) Three months ended Year ended
December 31, December 31,
2006 2005 2006 2005
---------------------------------------------------------------------------
Beginning units 1,101 1,075 1,078 1,059
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Retirements (12) (15) (53) (63)
Replacements 12 15 53 63
Buyouts and terminations (8) (7) (26) (23)
Additions 11 10 52 42
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Net change 3 3 26 19
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Ending units 1,104 1,078 1,104 1,078
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For the quarter and year ended December 31, 2006, the portfolio of Water Heater and HVAC rental assets grew by 3,587 and 26,367 net units, respectively, bringing the number of installed units to 1,104,352. During the quarter and year ended December 31, 2005, the portfolio grew by 3,125 and 18,662 net units respectively, totaling 1,077,985 units at December 31, 2005.

In the fourth quarter of 2006, a total of $9.5 million was spent to replace 12,698 rental units that had reached the end of their useful life and $8.2 million was spent on 10,920 additional rental units. During the fourth quarter of 2005, the Fund spent $9.4 million to replace 14,755 units and $6.8 million on 9,684 additional units.

During the year ended December 31, 2006, a total of $32.9 million was spent to replace 53,384 rental units that had reached the end of their useful life and $31.3 million was spent on 52,518 additional rental units, including the acquisition of a portfolio of approximately 12,500 installed water heaters for $4.4 million. In 2005, the Fund spent $37.0 million to replace 62,957 units, and $28.6 million on 41,966 additional units, including the acquisition of a portfolio of approximately 5,500 installed water heaters for $1.5 million.

Buyouts and terminations totaled 7,333 in the fourth quarter of 2006, compared to 6,559 in the fourth quarter of 2005. Buyouts and terminations totaled 26,151 in 2006, compared to 23,334 in 2005. The increases over the 2005 periods reflect portfolio growth and other modest portfolio adjustments.

RESULTS OF OPERATIONS - SECURITY SEGMENT

The following table presents selected financial information of the Security segment for the quarters and years ended December 31, 2006 and 2005:



---------------------------------------------------------------------------
Three months ended Year ended
(in thousands of dollars) December 31, December 31,
2006 2005 2006 2005 (3)
---------------------------------------------------------------------------
Revenues:
Monitoring $ 13,470 $ 11,319 $ 51,087 $ 21,255
Sales, service and other 4,006 4,089 15,363 7,093
---------------------------------------------------------------------------
Total revenues 17,476 15,408 66,450 28,348
---------------------------------------------------------------------------
---------------------------------------------------------------------------
Cost of sales, general and
administration 12,304 11,218 46,668 19,982
---------------------------------------------------------------------------
Depreciation and amortization 4,476 3,786 16,744 6,539
---------------------------------------------------------------------------
---------------------------------------------------------------------------
Operating income $ 696 $ 404 $ 3,038 $ 1,827
---------------------------------------------------------------------------
---------------------------------------------------------------------------
Total number of customers (1) 194,000 180,000 194,000 180,000
---------------------------------------------------------------------------
---------------------------------------------------------------------------
Recurring monthly revenue (2)
("RMR") - end of period $ 4,476 $ 3,998 $ 4,476 $ 3,998
---------------------------------------------------------------------------
---------------------------------------------------------------------------
Annualized net RMR attrition
rate (2) - monitoring accounts 7.2% 7.2% 7.7% 8.0%
---------------------------------------------------------------------------
---------------------------------------------------------------------------
(1) Includes wholesale customers of approximately 28,000 at December 31,
2006 (December 31, 2005 - 28,000).
(2) See "Non-GAAP Measures".
(3) The 2005 comparative figures reflect results for the Security segment
from July 15, 2005, the date it was acquired by the Fund.
---------------------------------------------------------------------------
---------------------------------------------------------------------------


Revenues

Total revenues of $17.5 million and $66.5 million, respectively, for the quarter and year ended December 31, 2006 are consistent with management's expectations. Security monitoring revenues are growing at a faster rate than sales, service and other revenues as more focus is placed on recurring monthly revenues rather than one-time billings.

During the quarter ended December 31, 2006, the Security segment increased its total number of customers by approximately 6,000. RMR increased by 4% to $4.5 million at the end of the quarter, up from $4.3 million at the beginning of the quarter. In the fourth quarter of 2005, the number of customers increased by approximately 1,000, and RMR increased 2% to $4.0 million at December 31, 2005.

During the year ended December 31, 2006, the Security segment increased its total number of customers by approximately 14,000, compared to an increase of approximately 3,000 in the five-and-a-half month period ended December 31, 2005. RMR increased by 12% to $4.5 million at the end of the year, up from $4.0 million at the beginning of the year.

Monitoring revenue for the quarter was $13.5 million, compared to $11.3 million for the fourth quarter of 2005, reflecting the increased number of customers.

Monitoring revenue for the year ended December 31, 2006 was $51.1 million, compared to $21.3 million for the five-and-a-half months of operations in the 2005 period. The increase reflects a full year of operations and customer-base growth.

Included in security monitoring revenue is the amortization of deferred installation revenue of $0.2 million for the quarter and $0.6 million for the year ended December 31, 2006.

Sales, service and other revenue was $4.0 million in the current quarter, compared to $4.1 million in the fourth quarter of 2005. Sales, service and other revenue was $15.4 million in the year ended December 31, 2006, compared to $7.1 million in the five-and-a-half months of operations in the 2005 period. Sales, service, and other revenue is primarily dependent on successful bidding and negotiation of commercial installation contracts, and may fluctuate from quarter to quarter. The Security segment is focusing on recurring monthly revenue rather than one-time billings that have lower margins.

Cost of Sales, General and Administration Expenses

Cost of sales, general and administration expenses reflect costs associated with marketing, monitoring and installing of commercial and residential electronic security systems, and other administration expenses. Cost of sales, general and administration expenses for the quarter were $12.3 million compared to $11.2 million for the fourth quarter of 2005, reflecting marketing, customer acquisition and administration costs of growing the RMR in the period, and the costs of servicing the increased number of customers, including costs associated with replacing customers due to the RMR attrition in the period. Cost of sales, general and administration expenses were $46.7 million for the year ended December 31, 2006, compared to $20.0 million for the five-and-a-half months of operations in the 2005 period. In addition to the full period of operations in the current year, as compared to 2005, the increase reflects marketing, customer acquisition and administration costs of growing the RMR in 2006, and the costs of servicing the increased number of customers, including costs associated with replacing customers due to the RMR attrition in the year. Cost of sales, general and administration expenses are consistent with expectations at 70% of revenues for both the 2006 and 2005 periods.

Depreciation and Amortization

Depreciation and amortization of $4.5 million and $16.7 million for the quarter and year ended December 31, 2006 reflects depreciation of security systems installed in customers' homes, corporate assets and amortization of intangible assets, including customer relationships. Depreciation and amortization for the quarter and five-and-a-half months ended December 31, 2005 was $3.8 million and $6.5 million, respectively. The increases primarily reflect a full year of operations and the increase in monitoring equipment and subscriber accounts associated with the growing customer-base.

UNIT COMPENSATION

The Fund has a deferred unit compensation plan (the "Deferred Unit Plan"). The Deferred Unit Plan provides for the grant of deferred Fund units ("Deferred Units") to non-management trustees and directors.

The Deferred Unit Plan provides that once a Deferred Unitholder ceases to be a trustee or a director, he or she will be entitled to receive a number of units equal to the number of Deferred Units held at the time of retirement.

Additional Deferred Units are granted to holders of Deferred Units based on distributions paid by the Fund on units. The number of Deferred Units granted is calculated by multiplying the aggregate number of Deferred Units held on the record date for a distribution by the amount of such distribution paid by the Fund on one unit and dividing the result by the market price of a unit on the date the distribution is paid.

For the year ended December 31, 2006, the Fund granted 6,585 Deferred Units and recorded approximately $95 thousand of compensation expense. For the year ended December 31, 2005, the Fund granted 5,390 Deferred Units and recorded approximately $70 thousand of compensation expense. The Fund records unit-related compensation expense in the consolidated statement of income using the fair value method.

The Fund also has a long-term incentive plan ("LTIP") for certain senior executives. Payments under this incentive plan may be made in cash, units, or a combination of cash and units, at the option of the board of trustees of the Fund. The award under the 2004 LTIP vested and was paid December 31, 2006. Awards under the current LTIP vest and are paid one-third immediately and one-third on each successive anniversary. The number of unvested unit awards is increased in future years to the extent of equivalent notional amounts of distributions paid on Fund units during the vesting period. This increase is recorded as compensation expense and additional contributed surplus.

For the year ended 2006, the Fund granted 104,824 vested and unvested units, including 38,441 units for the 2004 LTIP. The fair value of $1.5 million was recorded as compensation expense and contributed surplus. Additional compensation expense of $28 thousand was recorded as compensation expense and contributed surplus for notional distributions on unvested unit awards.

In 2005, the Fund recorded $617 thousand compensation expense and contributed surplus, the fair value of 44,822 vested and unvested units awarded at the end of the year.

Income Taxes

The Fund is a mutual fund trust for income tax purposes and its principal operating subsidiaries are arranged as limited partnerships and trusts. As such, the Fund and its principal operating subsidiaries are only taxable on any amount of taxable income not allocated to unitholders through distributions. As it is the Fund's policy to distribute all taxable income to unitholders on an annual basis, no provision for income taxes on earnings has been made in the Fund's consolidated financial statements. Income tax liabilities relating to distributions of the Fund are taxed in the hands of the unitholders.

On October 31, 2006, the Minister of Finance (Canada) announced new tax proposals concerning the taxation of publicly-traded income trusts and other flow-through entities. The proposal was followed by the release of draft legislation by the Department of Finance on December 21, 2006. The proposed amendments, if enacted as currently drafted, will subject the Fund to trust-level taxation as of January 1, 2011. In addition, the taxable distributions received by investors from the Fund, would be treated as taxable dividends.

If and when the Fund becomes subject to the proposed amendments, retained earnings of the Fund may be adversely affected to the extent future income tax liabilities are recorded. The amount of future tax liabilities recorded would depend on the amount of temporary differences between the carrying values and tax values of assets and liabilities, and the expected timing of reversals of those temporary differences. To the extent any differences reverse prior to the Fund's earnings being taxable under the proposed amendments, no future tax asset or liability would be recorded. Temporary differences reversing in periods after the Fund becomes taxable would result in future tax assets or liabilities being recorded at the effective tax rates substantially enacted at that time. The estimation of the timing of reversals is subject to many factors, including expected future taxable income, amounts of discretionary deductions for tax, and other considerations, including potential changes in the structure of the operations. These factors are subject to uncertainty at this time, and consequently cannot be reasonably estimated.

There can be no assurance that the Fund will be able to retain the benefit of the deferred application of the new tax regime until 2011. If the Fund is deemed to have undergone "undue expansion" during the period from November 1, 2006 to December 31, 2010, as described in the "Normal Growth Guidelines" issued by the Department of Finance on December 15, 2006, the proposed amendments would become effective on a date earlier than January 1, 2011.

The Normal Growth Guidelines indicate that the Fund will not lose the benefit of the deferred application of the new tax regime to 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) before 2011 by an amount that exceeds the greater of $50 million 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 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 $748.5 million. It is therefore assumed, for the purposes of this summary that the Fund will not be subject to the proposed amendments until January 1, 2011.

However, in the event that the Fund issues additional Units or convertible debentures (or other equity substitutes) on or before 2011, the Fund may become subject to the proposed amendments prior to 2011. No assurance can be given that the proposed amendments will not apply to the Fund prior to 2011. Loss of the benefit of the deferred application of the new tax regime until 2011 could have a material and adverse effect on the value of units of the Fund.

NON-GAAP MEASURES

The following financial measures included in this MD&A do not have a standardized meaning under Canadian generally accepted accounting principles ("GAAP"):

Earnings before finance and interest charges, taxes, depreciation and amortization (EBITDA)

In addition to net income or loss, EBITDA is a useful supplemental measure of cash available for distribution prior to debt service, changes in working capital, capital expenditures and income taxes. EBITDA is not a recognized measure under GAAP, and therefore has no standardized meaning prescribed by GAAP and may not be comparable to similar terms and measures presented by other similar issuers. EBITDA is intended to provide additional information on the Fund's performance and should not be considered in isolation or as a substitute for measures of performance prepared in accordance with GAAP. In particular, investors should also consider the impact of interest expense on the Fund's long-term debt and its capital expenditure requirements to fully assess the cash flow available to finance cash distributions.

Distributable cash

Distributable cash of the Fund is equal to the consolidated cash flow from operations of the Fund, adjusted for changes in non-cash working capital and related items, and reduced by maintenance capital expenditures. This measure reflects cash generated from operations available to fund growth or distribute to unitholders.

The Fund reports on cash distributions per unit because it is a key measure used by investors to value and assess the Fund. Cash distributions per unit depend on cash available for distributions and the Fund's distribution policy. Distributable cash is a non-GAAP measure generally used by Canadian open-ended trusts as an indicator of financial performance, and it should not be seen as a measurement of liquidity or a substitute for comparable metrics prepared in accordance with GAAP. Distributable cash may differ from similar calculations as reported by other entities and, accordingly, may not be comparable to distributable cash as reported by such entities.

Maintenance capital expenditures

Maintenance capital expenditures include expenditures during the period for rental equipment installed to replace rental equipment removed from service at the end of its useful life, additional rental units purchased to offset the impact on rental portfolio revenues of buyouts and terminations, and customer acquisition costs incurred to replace recurring monthly revenue attrition to the opening pool of customers. Non-maintenance capital expenditures are not recorded as a reduction from distributable cash as these expenditures are intended to be funded either from cash on hand or through the Fund's committed growth credit facility that is available for expansion, investments and acquisitions.

Maintenance capital is not a recognized measure under GAAP, and therefore has no standardized meaning prescribed by GAAP and may not be comparable to similar terms and measures presented by other similar issuers. Maintenance capital is intended to provide additional information on the Fund's performance in minimizing the number and cost of replacements and should not be considered in isolation or as a substitute for measures of performance prepared in accordance with GAAP.

Operating Income

Operating income measures income independent of the Fund's capital and tax structure. Operating income is computed in the financial statements of the Fund as revenues less cost of sales, general and administration expenses, and depreciation and amortization. Operating income is not a recognized measure under GAAP, and therefore has no standardized meaning prescribed by GAAP and may not be comparable to similar terms and measures presented by other similar issuers. Operating income is intended to provide additional information on the Fund's performance and should not be considered in isolation or as a substitute for measures of performance prepared in accordance with GAAP. In particular, investors should also consider the impact of interest expense on the Fund's long-term debt and its capital expenditure requirements to fully assess the cash flow available to finance cash distributions.

Recurring monthly revenue

Recurring monthly revenue ("RMR") is revenue in the Security segment that includes monitoring, leasing, service, supervised lines and patrol contracts in effect during that period. RMR provides a measure that can be used to estimate annualized revenue at current levels of activity and is a key measure that can be used to evaluate performance, results of operations, and cash flows. The Fund's calculation of RMR may differ from similar calculations as reported by other entities and, accordingly, may not be comparable to RMR as reported by such entities. RMR should not be viewed or used by investors as an alternative to cash flow from operations or actual monthly revenues as determined under GAAP.

Net RMR attrition rate

RMR attrition is calculated based on the RMR lost due to security customer cancellations net of reconnections of existing systems, existing customers moving to new homes and recoveries through cancellation guarantees provided by dealers and acquisition account vendors. This measure is useful when expressed as an annualized percentage of total RMR at the beginning of a specified period. RMR attrition may differ from similar calculations as reported by other entities and, accordingly, may not be comparable to RMR attrition as reported by such entities.



Attachments:
Consolidated Balance Sheets
Consolidated Statements of Income
Consolidated Statements of Changes in Unitholders' Equity
Consolidated Statements of Cash Flows



UE WATERHEATER INCOME FUND
Consolidated Balance Sheets
(In thousands of dollars) (Unaudited)
---------------------------------------------------------------------------
---------------------------------------------------------------------------
December 31, 2006 December 31, 2005
---------------------------------------------------------------------------

Assets
Current assets:

Cash and cash equivalents $ 5,538 $ 16,686
Accounts receivable 23,670 23,160
Inventories 7,463 6,612
Prepaid expenses 3,037 2,047
Current portion of finance
contracts (Note 4) 16,765 14,465
--------------------------------------------------------------------------
56,473 62,970

Finance contracts (Note 4) 67,628 60,751
Fixed assets 447,175 433,584
Intangible assets and deferred charges 299,776 302,647
Goodwill 147,967 147,967
---------------------------------------------------------------------------
$ 1,019,019 $ 1,007,919
---------------------------------------------------------------------------
---------------------------------------------------------------------------

Liabilities and Equity
Current liabilities:

Accounts payable and accrued liabilities $ 39,913 $ 39,814
Distributions payable to unitholders 4,346 3,692
Unearned revenue 22,925 19,573
Short-term debt - 38,223
--------------------------------------------------------------------------
67,184 101,302

Long-term liabilities:

Deferred customer acquisition revenue 8,290 2,647
Revolving term credit facilities 34,875 -
Interest rate contracts 9,987 12,760
Warranty liabilities 1,441 811
Senior notes payable 400,000 400,000
Other long-term debt 618 526
Accrued pension liability 1,440 1,367
Employee future benefit liability 1,828 1,820
--------------------------------------------------------------------------
458,479 419,931

Unitholders' equity:
Unit capital 495,204 494,823
Contributed surplus 1,909 687
Retained earnings (deficit) (3,757) (8,824)
--------------------------------------------------------------------------
493,356 486,686
--------------------------------------------------------------------------
$ 1,019,019 $ 1,007,919
---------------------------------------------------------------------------
---------------------------------------------------------------------------

See accompanying notes to interim consolidated financial statements.



UE WATERHEATER INCOME FUND
Consolidated Statements of Income
(In thousands of dollars, except per unit data) (Unaudited)
---------------------------------------------------------------------------
---------------------------------------------------------------------------
Three months ended December 31, Year ended December 31,
2006 2005 2006 2005
---------------------------------------------------------------------------
Revenue:
Rental and security
monitoring $ 65,051 $ 58,235 $ 252,211 $ 204,465
Sales, service and other 14,320 14,132 57,938 45,309
Finance 2,943 2,810 11,373 10,844
--------------------------------------------------------------------------
82,314 75,177 321,522 260,618
---------------------------------------------------------------------------
Expenses:
Cost of sales,
general and
administration 43,994 40,460 170,914 130,222
Depreciation of
fixed assets 14,089 13,647 55,344 52,083
Amortization of
intangible assets 5,814 5,321 22,405 14,382
--------------------------------------------------------------------------
63,897 59,428 248,663 196,687
---------------------------------------------------------------------------

Operating income 18,417 15,749 72,859 63,931

Mark-to-market (gain)
loss on valuation
of interest rate
contracts 93 (9) 436 357
Interest:
Long-term debt 4,859 4,499 18,451 17,791
Other (83) 207 695 272
---------------------------------------------------------------------------

Income before income
taxes 13,548 11,052 53,277 45,511

Income taxes:
Income and large
corporations taxes - 252 - 943
---------------------------------------------------------------------------
Net income $ 13,548 $ 10,800 $ 53,277 $ 44,568
---------------------------------------------------------------------------
---------------------------------------------------------------------------

Net income per Fund
unit (Note 5)

Basic $ 0.27 $ 0.22 $ 1.08 $ 0.99
Diluted $ 0.27 $ 0.22 $ 1.08 $ 0.99

See accompanying notes to interim consolidated financial statements.



UE WATERHEATER INCOME FUND
Consolidated Statements of Changes in Unitholders' Equity
(In thousands of dollars) (Unaudited)
---------------------------------------------------------------------------
---------------------------------------------------------------------------
Three months ended December 31, Year ended December 31,
2006 2005 2006 2005
---------------------------------------------------------------------------

Unit Capital:
Balance at beginning
of period $ 495,007 $ 494,823 $ 494,823 $ 396,178
Units issued under
the long-term
incentive plan 197 - 381 -
Units issued under
subscription
receipt offering - - - 98,645
--------------------------------------------------------------------------
Balance at end
of period $ 495,204 $ 494,823 $ 495,204 $ 494,823
---------------------------------------------------------------------------

Contributed Surplus:
Balance at
beginning of period $ 600 $ 48 $ 687 $ -
Deferred units
granted as trustee
compensation 22 21 87 69
Deferred units
granted under
the long-term
incentive plan 1,480 617 1,480 617
Deferred units
granted in lieu
of distributions 4 1 36 1
Units issued under
the long-term
incentive plan (197) - (381) -
--------------------------------------------------------------------------
Balance at end of
period $ 1,909 $ 687 $ 1,909 $ 687
---------------------------------------------------------------------------

Retained Earnings
(Deficit):
Balance at beginning
of period $ (4,661) $ (8,546) $ (8,824) $ (12,556)
Net income 13,548 10,800 53,277 44,568
Distributions to
unitholders (12,644) (11,078) (48,210) (40,836)
--------------------------------------------------------------------------
Balance at end of
period $ (3,757) $ (8,824) $ (3,757) $ (8,834)
---------------------------------------------------------------------------
Equity $ 493,356 $ 486,686 $ 493,356 $ 486,686
---------------------------------------------------------------------------
---------------------------------------------------------------------------
See accompanying notes to interim consolidated financial statements.



UE WATERHEATER INCOME FUND
Consolidated Statements of Cash Flows
(In thousands of dollars) (Unaudited)
---------------------------------------------------------------------------
---------------------------------------------------------------------------
Three months ended Year ended
December 31, December 31,
2006 2005 2006 2005
---------------------------------------------------------------------------
Cash provided by (used in):
Operating activities:
Net income $ 13,548 $ 10,800 $ 53,277 $ 44,568
Adjustments and other items
not involving cash:
Depreciation and amortization 19,473 18,846 76,454 66,323
Amortization of deferred
customer accounts in excess
of deferred customer
acquisition revenue 230 122 721 142
Amortization of deferred
financing costs 17 142 339 260
Gain on disposal of fixed
assets (287) (178) (1,251) (910)
Unit-based compensation 1,506 639 1,603 687
Difference between pension
and other employee
benefits expense and
funding 17 (84) 81 (210)
Mark-to-market valuation
of interest rate
contracts 93 (9) 436 357
Payments on interest rate
contracts, net - - (3,209) (3,182)
Change in unearned revenue 1,396 1,509 3,352 2,494
Warranty liability 137 (105) 630 (160)
Finance contracts related
to Fund sales (279) (811) (2,080) (2,979)
Change in non-cash operating
working capital (Note 6 (a)) 5,321 7,134 (2,252) 842
--------------------------------------------------------------------------
41,172 38,005 128,101 108,232
---------------------------------------------------------------------------

Financing activities:
Distributions to unitholders (12,250) (11,076) (47,556) (40,082)
Net change in revolving term
credit facilities (54) - (3,355) -
Proceeds from short-term debt,
net of repayments - (18) 7 38,223
Other long term debt, net (10) 67 92 112
Deferred financing charges (6) - (278) (568)
Proceeds from issuance of
subscription receipts - - - 98,645
--------------------------------------------------------------------------
(12,320) (11,027) (51,090) 96,330
---------------------------------------------------------------------------
Investing activities:
Purchase of fixed assets (18,787) (18,394) (71,997) (68,156)
Deferred customer acquisition
revenue 1,871 1,329 6,217 2,647
Deferred customer accounts
- internally generated (3,268) (3,141) (12,316) (6,408)
Deferred customer accounts
- acquired (3,751) (1,377) (7,279) (1,377)
Proceeds from sale of fixed
assets 1,362 642 4,313 2,614
Finance contracts related
to independent dealers (1,708) (945) (7,097) (2,025)
Purchase of business,
net of cash acquired - - - (137,864)
---------------------------------------------------------------------------
(24,281) (21,886) (88,159) (210,569)

Increase (decrease) in cash
and cash equivalents 4,571 5,092 (11,148) (6,007)
Cash and cash equivalents,
beginning of period 967 11,594 16,686 22,693
---------------------------------------------------------------------------
Cash and cash equivalents,
end of period $ 5,538 $ 16,686 $ 5,538 $ 16,686
---------------------------------------------------------------------------

---------------------------------------------------------------------------
Supplemental cash flow information (Note 6(b))
See accompanying notes to interim consolidated financial statements.



UE WATERHEATER INCOME FUND
Notes to Interim Consolidated Financial Statements
(Unaudited)
December 31, 2006
(In thousands of dollars)
---------------------------------------------------------------------------
---------------------------------------------------------------------------


1. Nature of operations:

The UE Waterheater Income Fund (the "Fund") is an unincorporated, open-ended, limited purposes trust established pursuant to the Fund declaration of Trust on November 7, 2003, as amended and restated on December 19, 2003 and governed by the laws of the Province of Ontario.

The Fund reports its operations in two segments, the "Water Heater and HVAC" segment and the "Security" segment.

The Water Heater and HVAC segment rents and services a portfolio of more than one million residential water heaters in Ontario, under the Union Energy, and Reliance Home Comfort brand names. The residential water heater portfolio is Canada's second largest and was initiated in the 1960s. In addition, this segment has related commercial activities that complement the water heater rental business, being the retail sale, rental, servicing and financing of HVAC equipment through eight branch locations in Ontario.

The Security segment operations began July 15, 2005 with the acquisition of Protectron Holdings Inc. This segment provides electronic security system sales, installation, service, monitoring, and related commercial activities across Canada, under the "Protectron Security Systems" brand name.

The Fund does not own assets directly. Each unit of the Fund represents an indirect ownership interest in the businesses. Substantially all of the assets of the Fund have been pledged as security for the senior secured notes and other debt of subsidiaries of the Fund. Unitholders do not have a residual interest in the assets owned by the Fund's subsidiaries, but receive distributions from the cash generated by the operation of the businesses. Certain events, including debt covenant violations or failure to refinance any series of the senior secured notes would preclude the Fund from making distributions. The Fund and UE Waterheater Operating Trust (the "Trust") declarations of trust provide that all of the taxable income the Trust and the Fund be distributed to unitholders such that the Trust and the Fund will not be liable for income tax in any year. If the Fund were precluded from making distributions to unitholders, the Fund would be liable for income taxes on its undistributed income.

2. Basis of presentation and accounting policies:

Except as described in Note 3, the interim consolidated financial statements have been prepared following the same accounting policies and methods of computation as the consolidated financial statements for the year ended December 31, 2006, but do not contain all disclosures required for annual financial statements prepared in accordance with generally accepted accounting principles.

Accordingly, the interim consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes thereto for the year ended December 31, 2006.

The consolidated financial statements of the Fund include the accounts of the Fund and its wholly owned subsidiaries, including Union Energy Limited Partnership and Protectron Limited Partnership ("Protectron"). In addition, Westcap Trust is consolidated with the Fund's financial statements, as a variable interest entity of which Union Energy Limited Partnership is the primary beneficiary. All of the assets of Westcap Trust have been pledged as collateral without limit for the debt it owes to Union Energy Limited Partnership.

Certain comparative figures have been reclassified to conform to the financial presentation adopted in the current period.

3. Changes in significant accounting policies and estimates:

Depreciation rates

In the first quarter of 2006, the Fund revised depreciation rates of Water Heater and HVAC segment rental assets to reflect the results of a depreciation study. The revised depreciation rates are based on the estimated useful lives of the assets as indicated in the study. The changes in estimates have been accounted for prospectively.



The following table sets out expected useful lives compared to the
previous estimate:
---------------------------------------------------------------------------
---------------------------------------------------------------------------
Revised expected Previous expected
Assets included in study useful life in years useful life in years
---------------------------------------------------------------------------
Residential water heaters:
Gas 10-14 14
Electric 15 6-15
Commercial equipment 13 8
Rental heating, ventilation
and air-conditioning equipment 15-19 13
---------------------------------------------------------------------------


Depreciation expense increased approximately $2.6 million in 2006 as a result of the revised depreciation rates.

4. Finance contracts:

The Fund offers financing on HVAC equipment sold and installed by the Fund and also for HVAC equipment sold and installed by independent dealers.



---------------------------------------------------------------------------
---------------------------------------------------------------------------
December 31, 2006 December 31, 2005
---------------------------------------------------------------------------
Finance contracts related to Fund
sales $ 31,278 $ 29,198
Finance contracts related to
independent dealers 53,115 46,018
---------------------------------------------------------------------------
84,393 75,216
Less: current portion 16,765 14,465
---------------------------------------------------------------------------
$ 67,628 $ 60,751
---------------------------------------------------------------------------
---------------------------------------------------------------------------



5. Net income per Fund unit:

The reconciliation of the number of units used in the basic and diluted
net income per unit calculation is as follows:

---------------------------------------------------------------------------
---------------------------------------------------------------------------
Three months ended December 31 Year ended December 31
2006 2005 2006 2005
---------------------------------------------------------------------------

Units outstanding
for the entire period 49,246,365 41,513,000 49,233,000 41,513,000
13,365 units issued
March 31, 2006 - - 10,070 -
14,314 units issued
December 31, 2006 - - - -
7,720,000 units
issued July 15, 2005 - 7,720,000 - 3,595,616
---------------------------------------------------------------------------
Weighted average
number of units for
basic income per
unit calculations 49,246,365 49,233,000 49,243,070 41,108,616
Dilutive effect of
deferred units 45,088 5,119 45,173 2,095
---------------------------------------------------------------------------

Weighted average
number of units for
dilutive income per
unit calculations 49,291,453 49,238,119 49,288,243 45,110,711
---------------------------------------------------------------------------
---------------------------------------------------------------------------



6. Supplemental cash flow information:

a) The change in non-cash operating working capital consists of the
following:

---------------------------------------------------------------------------
---------------------------------------------------------------------------
Three months ended December 31 Year ended December 31
2006 2005 2006 2005
---------------------------------------------------------------------------
Accounts receivable $ (685) $ 1,578 $ (510) $ 1,664
Inventories (683) (941) (851) (1,070)
Prepaid expenses (551) (371) (990) 660
Accounts payable and
accrued liabilities 7,240 6,868 99 (412)
---------------------------------------------------------------------------

$ 5,321 $ 7,134 $ (2,252) $ 842
---------------------------------------------------------------------------
---------------------------------------------------------------------------

b) Cash payments made related to interest and income and capital taxes
during the periods were as follows:

---------------------------------------------------------------------------
---------------------------------------------------------------------------
Three months ended Year ended
December 31 December 31
2006 2005 2006 2005
---------------------------------------------------------------------------

Interest paid $ 307 $ 320 $ 22,400 $ 21,486
Income and capital taxes paid 330 670 1,653 2,705
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7. Defined benefit pension expense:

The total expense related to the defined benefit pension plan and post-retirement benefit program recognized in operating income was $188 and $715 (2005 - $134 and $589) for the fourth quarter and year-to-date, respectively.

8. Purchases of fixed assets and subscriber accounts:

During the first quarter of 2006, the Fund acquired a portfolio of approximately 12,500 installed electric water heaters for $4,405. The amount is included in purchases of fixed assets in the statement of cash flows. During the third quarter of 2005, the Fund acquired a portfolio of approximately 5,500 installed electric water heaters for $1,500, included in purchases of fixed assets in the statement of cash flows.

9. Segmented information:

Effective July 15, 2005, with the acquisition of Protectron, the Fund has two reportable segments. The segments, based on differences in products and services are "Water Heater and HVAC", and "Security". The Water Heater and HVAC segment rents and services a portfolio of more than one million residential water heaters in Ontario and has related commercial activities that complement the water heater business, being the sale, rental, servicing and financing of HVAC equipment. The Security segment comprises security installation, monitoring and related activities.

Management measures and evaluates segment performance based on a number of measures including earnings before income taxes, depreciation and amortization ("EBITDA"), attrition rate, capital maintenance, number of services and other items. Operating revenues and expenses directly associated with each segment are included in the operating segment results.

Inter-segment transactions are reflected at fair value. There were no significant inter-segment transactions during the period.

The accounting policies followed by the segments are the same as those of the Fund.

Neither segment relies on major customers, nor do transactions with any one customer exceed 10% of the Fund's revenues.



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Three months ended December 31, Year ended December 31,
2006 2005 2006 2005
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Revenue:
Water Heater and HVAC $ 64,838 $ 59,769 $ 255,072 $ 232,270
Security 17,476 15,408 66,450 28,348
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Net sales 82,314 75,177 321,522 260,618
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Operating income:
Water Heater and HVAC 17,721 15,345 69,821 62,104
Security 696 404 3,038 1,827
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Operating income $ 18,417 $ 15,749 $ 72,859 $ 63,931

Interest 4,776 4,706 19,146 18,063
Mark-to-market (gain)
loss on valuation
of interest rate of
contracts 93 (9) 436 357
Large corporations tax - 252 - 943
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Net income $ 13,548 $ 10,800 $ 53,277 $ 44,568
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December 31,
2006 2005
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Identifiable assets:
Water Heater and HVAC $ 871,886 $ 850,945
Security 169,014 161,100
Elimination of
inter-segment balances (21,881) (4,126)
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$ 1,019,019 $ 1,007,919
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