UE Waterheater Income Fund
TSX : UWH.UN

UE Waterheater Income Fund

October 30, 2006 16:45 ET

UE Waterheater Income Fund announces financial results for the third quarter ended September 30, 2006 and a 10% increase in distributions effective November 2006

TORONTO, ONTARIO--(CCNMatthews - Oct. 30, 2006) -

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 third quarter ended September 30, 2006. Highlights for the quarter are as follows:

http://www.ccnmatthews.com/docs/uew1030.pdf

The Fund today announced an increase in cash distributions to $0.08825 per unit (equivalent to $1.059 per unit on an annualized basis) commencing the month of November 2006 to be paid on January 2, 2007 to unitholders of record at November 30, 2006. This represents a 10% increase over the current distribution rate of $0.08025 per unit (equivalent to $0.963 on an annualized basis).

Commenting on the Fund's performance for the quarter, Chief Executive Officer Roger Rossi said, "I am very pleased with the Fund's third quarter performance. The substantial increase in distributable cash per unit reflects the Fund's success in profitably growing revenue and market share while driving operating costs down."



SELECTED FINANCIAL INFORMATION
(in thousands of dollars, except for unit information)
---------------------------------------------------------------------------
Three months ended Nine months ended
September 30, September 30,
---------------------------------------------------------------------------
2006 2005 2006 2005
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Revenue $ 81,152 $ 71,981 $ 239,208 $ 185,441
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Cost of sales, general and
administration 42,370 35,976 126,920 89,762
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Depreciation and amortization 19,596 17,850 57,846 47,497
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Operating income 19,186 18,155 54,442 48,182
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Mark-to-market valuation of
interest rate contracts 229 (15) 343 366
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Finance and interest charges 4,785 4,817 14,370 13,357
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Income before income taxes 14,172 13,353 39,729 34,459
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Income and large corporations
taxes (300) 247 - 691
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Net income $ 14,472 $ 13,106 $ 39,729 $ 33,768
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Cash provided by operating
activities $ 25,285 $ 25,662 $ 86,929 $ 70,227
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Cash provided by (used in)
financing activities (15,358) 125,865 (38,770) 107,357
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Cash used in investing
activities (22,297) (158,380) (63,878) (188,683)
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Unitholder cash distributions
declared 11,857 11,077 35,566 29,758
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Unitholder cash distributions
paid 11,856 10,498 35,306 29,006
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Earnings before finance and
interest charges, taxes,
depreciation and
amortization (EBITDA) (1) $ 38,782 $ 36,005 $ 112,288 $ 95,679
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Total assets $1,005,725 $ 998,404 $1,005,725 $ 998,404
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Unit Analysis
---------------------------------------------------------------------------
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Total outstanding units at
September 30 49,246,365 49,233,000 49,246,365 49,233,000
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Weighted average units
outstanding for the period 49,246,365 48,130,143 49,241,959 43,718,714
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Earnings per unit - basic
and diluted $ 0.29 $ 0.27 $ 0.81 $ 0.77
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EBITDA(1) per unit - basic
and diluted $ 0.79 $ 0.75 $ 2.28 $ 2.19
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Distributions declared per
unit - basic and diluted $ 0.24 $ 0.23 $ 0.72 $ 0.68
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(1) See "Non-GAAP Measures" section.


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 October 30, 2006.

- 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 the situation described in 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 may 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 consolidated financial statements for the year ended December 31, 2005. These consolidated financial statements, presented in Canadian dollars, have been prepared in accordance with Canadian generally accepted accounting principles ("GAAP").

ABOUT 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 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. Each unit of the Fund represents an indirect ownership interest in Union Energy LP and Protectron Limited Partnership, 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, 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 1960's. In addition, this segment has related commercial activities that complement the water heater rental business: the retail sale, rental, servicing and financing of heating, ventilation and air-conditioning ("HVAC") equipment.

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 188,000 customers across Canada, under the 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, and 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 Home Comfort brand, providing consumers integrated home comfort and security solutions.

RESULTS OF OPERATIONS - CONSOLIDATED FINANCIAL RESULTS

Income

For the quarter ended September 30, 2006, the Fund reported net income of $14.5 million on revenues of $81.2 million, compared to net income of $13.1 million on revenues of $72.0 million for the quarter ended September 30, 2005. Operating income (see "Non-GAAP Measures" section) for the third quarter of 2006 was $19.2 million, an increase of $1.0 million, or 6%, over the third quarter of 2005.

For the nine months ended September 30, 2006, the Fund reported net income of $39.7 million on revenues of $239.2 million, compared to net income of $33.8 million on revenues of $185.4 million for the nine months ended September 30, 2005. Operating income for the first nine months of 2006 was $54.4 million, an increase of $6.2 million, or 13%, over the same period in 2005.

Rental and security monitoring revenues increased by $7.9 million, or 14%, to $63.8 million for the quarter ended September 30, 2006, compared to $55.9 million for the same period in 2005. Rental revenue increased 10% in the quarter, as compared to 2005, reflecting the net increase in the number of installed units, rental price increases and changes in product mix of the Water Heater and HVAC segment. Security monitoring revenues increased $3.2 million, or 32%, primarily as a result of reflecting a full quarter of revenue as compared to the two-and-a-half months of operation following the acquisition in the third quarter of 2005, as well as growth in recurring monthly revenue of 10% as measured at the end of the quarter.

For the nine months ended September 30, 2006, rental and security monitoring revenues increased by $40.9 million, or 28%, to $187.2 million, compared to $146.2 million for the same period in 2005. The increase primarily reflects the new security monitoring revenues of $24.5 million for the first six months of 2006, representing 17% of the consolidated increase. In addition, the three months ended September 30, 2006 reflects a full quarter compared to the two-and-a-half months of 2005, as well as growth in recurring monthly revenue of 10% at the end of the period. Rental revenue increased 10% in the nine month period, as compared to 2005, reflecting the net increase in the number of installed units, rental price increases and changes in product mix of the Water Heater and HVAC segment.

Sales, service and other revenue increased by $1.2 million, or 9%, to $14.5 million for the quarter ended September 30, 2006 compared to $13.3 million for 2005, primarily as a result of Security segment sales and service revenues increasing $0.7 million, or 5% of the increase, reflecting a full quarter of operations. Water Heater and HVAC segment sales, service and other revenue was 5% higher than the third quarter of 2005, contributing $0.5 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 1.3 million rental and security monitoring customers, with increased revenues from Comfort Protection Plans offsetting a decline in other HVAC product line sales.

For the nine months ended September 30, 2006, sales, service and other revenue increased by $12.4 million, or 40%, to $43.6 million, compared to $31.2 million for the same period in 2005, primarily as a result of the additional Security segment sales and service revenues of $7.7 million in the first six months of 2006, and a full period of operations in the third quarter. Water Heater and HVAC segment sales, service and other revenue for the nine month period was 15% higher than the same period in 2005, contributing $4.1 million of the revenue increase. The Water Heater and HVAC segment increase was primarily a result of the Fund continuing to leverage cross-selling opportunities, 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 September 30, 2006, compared to $2.8 million for the quarter ended September 30, 2005. For the nine months ended September 30, 2006, finance revenue was $8.4 million, compared to $8.0 million for the nine months ended September 30, 2005. The increases reflect higher average finance contract portfolio balances in the 2006 quarter and nine month periods.

Cost of sales and general and administrative expenses for the quarter ended September 30, 2006, increased by $6.4 million, or 18%, to $42.4 million, from $36.0 million for the quarter ended September 30, 2005. The increase reflects a full quarter of operations in the Security segment, compared to two-and-a-half months in the third quarter of 2005. In addition, of the 18% consolidated increase, higher costs in the Water Heater and HVAC segment contributed 9%, or $3.2 million, including 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 quarter were 52% of total revenues, compared to 50% in the third quarter of 2005, also reflecting changes in product mix, as a higher percentage of revenue is being generated from sources other than rental water heaters.

For the nine months ended September 30, 2006, cost of sales and general and administrative expenses increased by $37.1 million, or 41%, to $126.9 million, from $89.8 million for the nine months ended September 30, 2005. Of the 41% consolidated increase, costs related to the operation of the Security segment of $22.4 million for the first six months of 2006 represent 25%. Of the 41% consolidated increase for the nine month period ended September 30, 2006 as compared to 2005, higher costs in the Water Heater and HVAC segment contributed 13%, or $11.6 million, including costs related to marketing and customer acquisition as well as costs related to servicing additional Comfort Protection Plan and rental customers. The full quarter of operations of the Security segment in 2006, as compared to two-and-a-half months in the third quarter of 2005, account for the balance of the consolidated increase. Costs of sales and general and administrative expenses for the nine month period in 2006 were 53% of total revenues, compared to 48% in the same period in 2005, also reflecting changes in product mix, as a higher percentage of revenue is being generated from sources other than rental water heaters.

Depreciation and amortization was $19.6 million for the quarter ended September 30, 2006, an increase of $1.8 million, or 10%, for the quarter when compared to the same period in 2005. The increase primarily reflects amortization of the intangible assets and depreciation related to fixed assets of the Security segment for the full quarter, as compared to two-and-a-half months in the third quarter of 2005. In addition, depreciation of assets in the Water Heater and HVAC segment increased $0.2 million in the three months ended September 30, 2006, compared to the same period in 2005. The increase reflects the net effect of higher depreciation of $0.6 million in the 2006 quarter as a result of revised depreciation rates, offset by the effect of certain other assets being fully amortized in 2005.

For the nine months ended September 30, 2006, depreciation and amortization was $57.8 million, an increase of $10.3 million, or 22%, compared to the same period in 2005. The increase primarily reflects $8.0 million amortization of the intangible assets and depreciation related to fixed assets of the Security segment for the first six months of 2006, and a full quarter of operations, compared to two-and-a-half months in the third quarter of 2005. In addition, depreciation of assets in the Water Heater and HVAC segment increased $0.8 million in the nine months ended September 30, 2006, compared to the same period in 2005. The increase reflects higher depreciation of $1.8 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 net effective fixed cash interest rate of 5.23% per annum for the Fund.

The interest rate contracts are accounted for using mark-to-market accounting. The current market values of these contracts are reflected on the Fund's balance sheet. Changes in the market values are recorded in income as they arise, resulting in a charge to income of $0.2 million in the current quarter and an insignificant gain for the quarter ended September 30, 2005. The expense was $0.3 million and $0.4 million for the nine month periods ended September 30, 2006 and September 30, 2005, respectively.

The mark-to-market liability accrued at September 30, 2006 of $9.9 million will reverse over the remaining 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 $1.6 million during each of the quarters ended September 30, 2006 and September 30, 2005, and $3.2 million in each of the nine month periods. The mark-to-market liability at September 30, 2005 was $12.8 million.

Finance and interest charges were $4.8 million for the quarter ended September 30, 2006, compared to $4.8 million for the same period in 2005. Finance and interest charges were $14.4 million for the nine months ended September 30, 2006, compared to $13.4 million for the same period in 2005. The net increases are primarily $0.8 million interest paid on short-term debt related to the acquisition of the Security segment during the first six months of 2006. 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.

During the quarter, the Fund revised its estimates of taxes payable at certain subsidiaries as a result of the repeal of the Federal Large Corporation Tax and the receipt of notices of assessment for the prior years, resulting in the recognition of a tax expense recovery of $0.3 million. The tax expense recorded prior to this quarter relates to one-time income taxes in connection with finalizing the corporate reorganization to integrate the Protectron business into the income fund structure.

EBITDA (See "Non-GAAP Measures" section)

Earnings before interest and financing charges, taxes and depreciation and amortization ("EBITDA") was $38.8 million for the quarter ended September 30, 2006, an increase of $2.8 million, or 8%, when compared to EBITDA of $36.0 million for the quarter ended September 30, 2005.

For the nine months ended September 30, 2006, EBITDA was $112.3 million, an increase of $16.6 million, or 17%, compared to EBITDA of $95.7 million for the nine months ended September 30, 2005.

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



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Three months ended Nine months ended
September 30, September 30,
-------------------------------------------
-------------------------------------------
2006 2005 2006 2005
(in thousands of dollars)
---------------------------------------------------------------------------

Net income $ 14,472 $ 13,106 $ 39,729 $ 33,768
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Adjustments
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Depreciation and amortization 19,596 17,850 57,846 47,497
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Finance and interest charges (1) 5,014 4,802 14,713 13,723
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Income and large corporations
taxes (300) 247 - 691
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EBITDA $ 38,782 $ 36,005 $ 112,288 $ 95,679
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(1) Includes finance, 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 third 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 and a full quarter of operations, as compared to the third quarter of 2005.

The EBITDA increase in the nine months ended September 30, 2005 as compared to the same period in 2006, reflects the $9.8 million accretive impact of the Security segment in the first six months of the year, 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 and a full quarter of operations in the third quarter of 2006, as compared to the third quarter of 2005.

Adjusted EBITDA (as defined in the Supplemental Trust Indentures) was 7.8 times Net Interest Expense for the quarter ended September 30, 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 2005 cash distributions to its unitholders, subject to Canadian income taxes, was 92% income and 8% return of capital. The breakdown for 2006 distributions is not yet known.

Distributable cash for the quarters ended September 30, 2006 and 2005 has been calculated and reconciled to cash provided by operating activities of the Fund, as determined under GAAP, as follows:



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Three months ended Nine months ended
(In thousands of dollars, September 30, September 30,
except per unit data) 2006 2005 2006 2005
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Cash from operating activities $ 25,285 $ 25,662 $ 86,929 $ 70,227

Adjustments:
Operating cash flow from
finance contracts related to
Fund sales 690 1,397 1,801 2,168
Change in non-cash operating
working capital 7,236 3,190 7,573 6,292
Change in warranty liability (167) (430) (493) 56
Maintenance capital
expenditures (1) (2) (11,171) (13,948) (37,664) (38,242)
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Distributable cash (2) $ 21,873 $ 15,871 $ 58,146 $ 40,501
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Total distributions declared $ 11,857 $ 11,077 $ 35,566 $ 29,758
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Distributable cash (2) per
unit - basic and diluted $ 0.44 $ 0.33 $ 1.18 $ 0.93
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Distributions declared per
unit - basic and diluted $ 0.24 $ 0.23 $ 0.72 $ 0.68
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(1) Total capital expenditures for the three and nine months ended
September 30, 2006 were $16.4 million and $53.2 million, respectively.
The corresponding amounts for the three and nine months ended
September 30, 2005 were $18.1 million and $49.8 million, respectively.
(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 timing differences, 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 calculation of distributable cash in 2005 has been restated to include the cash flows related to unearned revenue, rather than excluding the change in unearned revenue as part of non-cash working capital.

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 security business equipment and customer acquisition costs incurred to replace recurring monthly revenue attrition related to customers existing at the end of the prior period. Non-maintenance capital expenditures represent expenditures related to 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.

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 finance contract portfolio.

Distributable cash for the quarter ended September 30, 2006 was $21.9 million, as compared to $15.9 million for 2005. The increase is primarily due to higher cash flows from operating activities as adjusted, and lower maintenance capital expenditures. Despite unit costs increasing, maintenance capital expenditures decreased due to fewer units of rental equipment being replaced in the Water Heater and HVAC segment. In addition, maintenance capital expenditures of $1.2 million of the Security segment decreased $0.2 million from the third quarter of 2005. 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 a $1.7 million decrease in maintenance capital expenditures in the segment. The $0.2 million decrease in maintenance capital in the Security segment from the third quarter of 2005 reflects the lower attrition associated with customer relocations than experienced in the third quarter of 2005. Security segment maintenance capital expenditures fluctuate primarily with customer attrition which tends to be lower in the first and fourth quarters due to fewer customers moving during the winter months.

Distributable cash for the nine months ended September 30, 2006 was $58.1 million, as compared to $40.5 million for 2005. The increase is primarily due to higher cash flows from operating activities, and lower maintenance capital expenditures. Maintenance capital expenditures decreased due to $4.1 million lower maintenance capital expenditures in the Water Heater and HVAC segment resulting from fewer units of rental equipment being replaced, offset by higher unit costs, net of $3.8 million in maintenance capital expenditures in the Security segment in the first six months of the year, plus the effect of a full third quarter of operations, as compared to two-and-a-half months in 2005.

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. This represents a 7% increase over the 2005 distribution rate 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 the first nine months of 2006. Management of the Fund believes that distributable cash not distributed to unitholders should be applied to revenue generating asset growth and investments in future operational efficiencies and business infrastructure. In the third quarter of 2006, the Fund spent $1.0 million to purchase and install software designed to enhance operational efficiency over the next three years in the areas of workforce management, customer information, and billing, approximately $0.9 million of which was maintenance capital, and $0.1 million was operating expense. The Fund expects the infrastructure investments to reduce distributable cash by approximately $0.6 million in the fourth quarter of 2006, approximately $1.6 million in 2007, approximately $5.0 million in 2008, and approximately $2.5 million in 2009, without regard to any impact of any operational efficiencies.

RESULTS OF OPERATIONS - WATER HEATER AND HVAC SEGMENT

The following table presents selected financial information for the Water Heater and HVAC segment for the quarters ended September 30, 2006 and 2005:



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Three months ended Nine months ended
(in thousands of dollars) September 30, September 30,
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2006 2005 2006 2005
---------------------------------------------
Revenues:
Rental $ 50,657 $ 45,949 $ 149,543 $ 136,294
Sales, service and other 10,835 10,313 32,261 28,173
Finance 2,906 2,779 8,430 8,034
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Total revenues 64,398 59,041 190,234 172,501
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Cost of sales, general and
administration 30,439 27,212 92,556 80,998
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Depreciation and amortization 15,295 15,098 45,578 44,745
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Operating income $ 18,664 $ 16,731 $ 52,100 $ 46,758
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Results for the quarter are in line with management's expectations and continue to reflect investments in brand marketing and customer-base growth. Customer-base growth costs primarily reflect telemarketing expenditures incurred by the segment as it continues to drive strong growth in its Comfort Protection Plan and rental HVAC businesses. 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 is continuing the process of introducing the new 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 allows the Fund to effectively manage the transition.

Revenues

Water Heater and HVAC segment rental revenues increased by 10%, to $50.7 million, for the quarter ended September 30, 2006, compared to $45.9 million in 2005, reflecting rental price increases, rental portfolio growth, and changes in product mix.

Sales, service and other revenue was $10.8 million for the quarter ended September 30, 2006, an increase of 5%, compared to $10.3 million in 2005. The Fund continues to leverage cross-selling opportunities to its base of approximately 1.3 million customers. The increase in sales, service and other revenue reflects strong growth in the Fund's Comfort Protection Plan business, offset by lower revenues in other product lines. The decrease in revenues of other product lines reflects lower HVAC sales, primarily due to lower demand associated with moderate weather. The decrease also reflects 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.

Finance revenue was $2.9 million for the quarter ended September 30, 2006, compared to $2.8 million for the same quarter in 2005. Revenues fluctuate primarily with the balance of finance contracts outstanding.

Water Heater and HVAC segment rental revenues increased by 10%, to $149.5 million, for the nine months ended September 30, 2006, compared to $136.3 million in the same period in 2005, reflecting rental price increases, rental portfolio growth, and changes in product mix.

Sales, service and other revenue was $32.3 million for the nine months ended September 30, 2006, an increase of 15%, compared to $28.2 million for the same period in 2005, reflecting the same factors as for the quarter.

Finance revenue was $8.4 million for the nine months ended September 30, 2006, compared to $8.0 million for the same period in 2005. Revenues fluctuate primarily with the balance of finance contracts outstanding.

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 September 30, 2006 increased by $3.2 million, or 12%, from $27.2 million for the same period in 2005. The increases in 2006 over 2005 primarily reflect higher marketing costs relating to branding initiatives and customer growth costs pertaining to growing the Fund's Comfort Protection Plan business, and the costs of servicing additional Comfort Protection Plan and rental customers. Cost of sales, general and administration expenses were 47% of segment revenues in 2006, compared to 46% in 2005.

Cost of sales, general and administration expenses in the Water Heater and HVAC segment for the nine months ended September 30, 2006 increased by $11.6 million, or 14%, from $81.0 million for the same period in 2005. The increases in 2006 over 2005 primarily reflect higher marketing costs relating to branding initiatives and customer growth costs pertaining to growing the Fund's Comfort Protection Plan business, and the costs of servicing additional Comfort Protection Plan and rental customers. Cost of sales, general and administration expenses were 49% of segment revenues in 2006, compared to 47% in 2005.

Depreciation and Amortization

Depreciation and amortization expense in the Water Heater and HVAC segment was $15.3 million for the quarter ended September 30, 2006, an increase of $0.2 million, or 1%, when compared to the same period in 2005. Depreciation and amortization expense in the Water Heater and HVAC segment was $45.6 million for the nine months ended September 30, 2006, an increase of $0.8 million, or 2%, compared to the same period in 2005. The increases are primarily due to revised rental depreciation, net of depreciation reductions primarily due to certain other assets being fully depreciated.

Portfolio of Rental Assets

For the quarter ended September 30, 2006, the portfolio of Water Heater and HVAC rental assets grew by 4,990 net units, bringing the number of installed units to 1,100,765. During the quarter ended September 30, 2005, the portfolio grew by 9,637 net units, totaling 1,074,860 units at September 30, 2005.

During the quarter ended September 30, 2006, a total of $6.6 million was spent to replace 11,818 rental units that had reached the end of their useful life and $6.9 million was spent on 12,276 additional rental units. In the third quarter of 2005, the Fund spent $8.4 million to replace 14,246 units, and $8.9 million on 15,085 additional units, including the acquisition of a portfolio of approximately 5,500 installed water heaters for $1.5 million. Buyouts and terminations totaled 7,286 in the third quarter of 2006, compared to 5,448 in 2005.

For the nine months ended September 30, 2006, the portfolio of Water Heater and HVAC rental assets grew by 22,780 net units. During the nine months ended September 30, 2005, the portfolio grew by 15,537 net units.

During the nine months ended September 30, 2006, a total of $23.4 million was spent to replace 40,686 rental units that had reached the end of their useful life and $23.1 million was spent on 41,598 additional rental units, including the acquisition of a portfolio of approximately 12,500 installed water heaters for $4.4 million. In the nine months ended September 30, 2005, the Fund spent $27.5 million to replace 48,202 units, and $21.8 million on 32,312 additional units, including the acquisition of a portfolio of approximately 5,500 installed water heaters for $1.5 million. Buyouts and terminations totaled 18,718 in 2006, up from 16,675 in 2005, growing at a rate consistent with overall portfolio growth.

A breakdown of the changes in the installed units for the periods ended September 30, 2006 and 2005 is as follows:



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Three months ended Nine months ended
September 30, September 30,
(in thousands of units) 2006 2005 2006 2005
---------------------------------------------------------------------------
Beginning units 1,096 1,065 1,078 1,059
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Retirements (12) (14) (41) (48)
Replacements 12 14 41 48
Buyouts and terminations (7) (5) (18) (16)
Additions 12 15 41 32
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Net change 5 10 23 16
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Ending units 1,101 1,075 1,101 1,075
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RESULTS OF OPERATIONS - SECURITY SEGMENT

The following table presents selected financial information for the Security segment for the quarter ended September 30, 2006:



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Three months ended Nine months ended
(in thousands of dollars) September 30, September 30,
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2006 2005 (3) 2006 2005 (3)
--------------------------------------------
Revenues:
Monitoring $ 13,100 $ 9,936 $ 37,617 $ 9,936
Sales, service and other 3,654 3,004 11,357 3,004
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Total revenues 16,754 12,940 48,974 12,940
---------------------------------------------------------------------------
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Cost of sales, general and
administration 11,931 8,764 34,364 8,764
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Depreciation and amortization 4,301 2,753 12,268 2,753
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Operating income $ 522 $ 1,423 $ 2,342 $ 1,423
---------------------------------------------------------------------------
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Total number of customers -
end of period (1) 188,000 179,000 188,000 179,000
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Recurring monthly revenue (2)
("RMR") - end of period $4,298 $ 3,920 $4,298 $ 3,920
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Annualized net RMR attrition
rate (2) - monitoring accounts 6.8% 8.9% 7.7% 8.9%
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(1) Includes wholesale customers of approximately 27,000 at
September 30, 2006 (September 30, 2005 - 29,000).
(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.
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Revenues

Total revenues of $16.8 million for the quarter ended September 30, 2006 are consistent with management's expectations. During the quarter, the Security segment increased its total number of customers by approximately 3,000. Recurring monthly revenue ("RMR") increased 3% to $4.3 million at the end of the quarter, up from $4.2 million at the beginning of the quarter. RMR at the end of the quarter increased $0.4 million, or 10%, compared to the end of the third quarter of 2005.

Monitoring revenue for the quarter was $13.1 million, compared to $9.9 million for the third quarter of 2005, reflecting the increased number of customers, and the impact of a full quarter of operations in the current quarter, as compared to two-and-a-half months in the third quarter of 2005.

Sales, service and other revenue was $3.7 million in the current quarter, compared to $3.0 million in the third quarter of 2005, reflecting the increased number of customers and the impact of a full quarter of operations in the current quarter, as compared to two-and-a-half months in the third quarter of 2005.

Total revenues of $49.0 million for the nine months ended September 30, 2006 are consistent with management's expectations. During the period, the Security segment increased its total number of customers by approximately 9,000. RMR increased by $0.3 million, or 8%, to $4.3 million at the end of the nine months, up from $4.0 million at the beginning of the period.

Monitoring revenue for the nine months ended September 30, 2006 was $37.6 million, compared to $9.9 million for the two-and-a-half months of operations in the 2005 period. Monitoring revenue has increased each successive quarter since the acquisition July 15, 2005, reflecting customer-base growth.

Sales, service and other revenue was $11.4 million in the nine months ended September 30, 2006, compared to $3.0 million in the two-and-a-half months of operations in the 2005 period. Sales, service, and other revenue is primarily dependent on successful bidding and negotiation of residential and 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 customer electronic security systems, and other administration expenses. Cost of sales, general and administration expenses in the Security segment were $11.9 million for the current quarter, compared to $8.8 million for the two-and-a-half months of operations in the 2005 period. In addition to the full period of operations in the current quarter, as compared to the 2005 period, the increase reflects marketing, customer acquisition and administration costs of growing the RMR during the periods, and the costs of servicing the increased number of customers, including costs associated with replacing customers due to the RMR attrition in the quarter. Cost of sales, general and administration expenses are consistent with expectations at 71% of revenues for the 2006 quarter and 68% for the 2005 quarter.

Cost of sales, general and administration expenses in the Security segment were $34.4 million for the nine months ended September 30, 2006, compared to $8.8 million for the two-and-a-half months of operations in the 2005 period. In addition to the full period of operations in the current quarter, as compared to the 2005 period, and the $22.4 million expenses incurred in the first six months of 2006, the increase reflects marketing, customer acquisition and administration costs of growing the RMR during the periods, and the costs of servicing the increased number of customers, including costs associated with replacing customers due to RMR attrition in the period.

Depreciation and Amortization

Depreciation and amortization of $4.3 million and $12.3 million, respectively, for the quarter and nine months ended September 30, 2006 reflects depreciation of security systems installed in customers' homes and corporate assets, and amortization of intangible assets, including customer relationships. Depreciation and amortization for the two-and-a-half month period ended September 30, 2005 was $2.8 million. The increase in the current quarter reflects a full quarter of operations and the increase in monitoring equipment and subscriber accounts associated with the growing customer-base.

Annualized Net RMR Attrition Rate

The annualized net RMR attrition rate of 6.8% for the quarter has not been seasonally adjusted for the higher rate resulting from more customers moving to new homes in the quarter. Historically, RMR attrition rates have been lower in the first and fourth quarters, when fewer customers move. The attrition rate for the quarter is consistent with management's expectations and is comparable to prior periods of the segment before its acquisition by the Fund.

NON-GAAP MEASURES

The following financial measures included in this document 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 calculation of distributable cash was changed in 2005 to include the cash flows related to unearned revenue, rather than excluding the change in unearned revenue as part of non-cash working capital. The inclusion of these cash flows better reflects distributable cash, as unearned revenue has not yet been reflected in income, whereas other non-cash working capital components have been reflected in income.

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

September 30, 2006 December 31, 2005
---------------------------------------------------------------------------

Assets
Current assets:
Cash and cash equivalents $ 967 $ 16,686
Accounts receivable 22,985 23,160
Inventories 6,780 6,612
Prepaid expenses 2,486 2,047
Current portion of finance contracts 16,993 14,465
--------------------------------------------------------------------------
50,211 62,970

Finance contracts 65,413 60,751
Fixed assets 443,552 433,584
Intangible assets and deferred charges 298,582 302,647
Goodwill 147,967 147,967
---------------------------------------------------------------------------
$ 1,005,725 $ 1,007,919
---------------------------------------------------------------------------
---------------------------------------------------------------------------

Liabilities and Equity
Current liabilities:
Accounts payable and accrued liabilities $ 32,673 $ 39,814
Distribution payable to unitholders 3,952 3,692
Unearned revenue 21,529 19,573
Short-term debt - 38,223
--------------------------------------------------------------------------
58,154 101,302

Long-term liabilities:
Deferred customer acquisition revenue 6,619 2,647
Revolving term credit facilities 34,929 -
Interest rate contracts 9,894 12,760
Warranty liabilities 1,304 811
Senior notes payable 400,000 400,000
Other long-term debt 628 526
Accrued pension liabilities 1,443 1,367
Employee future benefit liability 1,808 1,820
--------------------------------------------------------------------------
456,625 419,931

Unitholders' equity:
Unit capital 495,007 494,823
Contributed surplus 600 687
Retained earnings (deficit) (4,661) (8,824)
--------------------------------------------------------------------------
490,946 486,686
---------------------------------------------------------------------------
$ 1,005,725 $ 1,007,919
---------------------------------------------------------------------------
---------------------------------------------------------------------------



UE WATERHEATER INCOME FUND
Consolidated Statements of Income
(Unaudited)
(In thousands of dollars, except per unit data)
---------------------------------------------------------------------------
---------------------------------------------------------------------------

Three months ended Nine months ended
September 30, September 30,
2006 2005 2006 2005
---------------------------------------------------------------------------

Revenue:
Rental and security monitoring $ 63,757 $ 55,885 $ 187,160 $ 146,230
Sales, service and other 14,489 13,317 43,618 31,177
Finance 2,906 2,779 8,430 8,034
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81,152 71,981 239,208 185,441
Expenses:
Cost of sales, general and
administration 42,370 35,976 126,920 89,762
Depreciation of property, plant
and equipment 13,900 13,428 41,255 38,436
Amortization of intangible assets 5,696 4,422 16,591 9,061
--------------------------------------------------------------------------
61,966 53,826 184,766 137,259
---------------------------------------------------------------------------

Operating income 19,186 18,155 54,442 48,182

Mark-to-market (gain) loss on
valuation of interest rate
contracts 229 (15) 343 366

Interest:
Long-term debt 4,746 4,498 13,592 13,292
Other 39 319 778 65
---------------------------------------------------------------------------

Income before income taxes 14,172 13,353 39,729 34,459

Income and large corporations
taxes (300) 247 - 691
---------------------------------------------------------------------------
Net income $ 14,472 $ 13,106 $ 39,729 $ 33,768
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---------------------------------------------------------------------------


Net income per Fund unit

Basic and diluted $ 0.29 $ 0.27 $ 0.81 $ 0.77



UE WATERHEATER INCOME FUND
Consolidated Statements of Changes in Unitholders' Equity
(Unaudited)
(In thousands of dollars)
---------------------------------------------------------------------------
---------------------------------------------------------------------------

Three months ended Nine months ended
September 30, September 30,
2006 2005 2006 2005
---------------------------------------------------------------------------

Unit Capital:

Balance at beginning of period $ 495,007 $ 396,178 $ 494,823 $ 396,178
Units issued under subscription
receipts offering - 98,645 - 98,645
Units issued under the
long-term incentive plan - - 184 -
--------------------------------------------------------------------------
Balance at end of period 495,007 494,823 495,007 494,823
---------------------------------------------------------------------------

Contributed Surplus:

Balance at beginning of period 568 - 687 -
Deferred units granted as
compensation 22 48 65 48
Deferred units granted in
lieu of distributions 10 - 32 -
Units issued under the
long-term incentive plan - - (184) -
--------------------------------------------------------------------------
Balance at end of period 600 48 600 48
---------------------------------------------------------------------------

Retained Earnings (Deficit):

Balance at beginning of period (7,276) (10,575) (8,824) (12,556)
Net income 14,472 13,106 39,729 33,768
Distributions to unitholders (11,857) (11,077) (35,566) (29,758)
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Balance at end of period (4,661) (8,546) (4,661) (8,546)
---------------------------------------------------------------------------
Equity $ 490,946 $ 486,325 $ 490,946 $ 486,325
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UE WATERHEATER INCOME FUND
Consolidated Statements of Cash Flows
(Unaudited)
(In thousands of dollars)
---------------------------------------------------------------------------
---------------------------------------------------------------------------

Three months ended Nine months ended
September 30, September 30,
2006 2005 2006 2005
---------------------------------------------------------------------------

Cash provided by (used in):

Operating activities:
Net income $ 14,472 $ 13,106 $ 39,729 $ 33,768
Adjustments and other items not
involving cash:
Depreciation and amortization 19,226 17,850 56,981 47,497
Amortization of deferred
customer accounts in excess
of deferred customer
acquisition revenue 206 - 491 -
Amortization of deferred
financing costs 42 118 322 118
Gain on disposal of property,
plant and equipment (300) (164) (964) (731)
Unit-based compensation 32 48 97 48
Difference between pension and
other employee benefits expense
and funding 11 (72) 64 (126)
Mark-to-market valuation of
interest rate contracts 229 (15) 343 366
Payments on interest rate
contracts, net (1,583) (1,565) (3,209) (3,182)
Change in unearned revenue 709 513 1,956 985
Warranty liability 167 430 493 (56)
Finance contracts related to
Fund sales (690) (1,397) (1,801) (2,168)
Change in non-cash operating
working capital (7,236) (3,190) (7,573) (6,292)
--------------------------------------------------------------------------
25,285 25,662 86,929 70,227
--------------------------------------------------------------------------
Financing activities:
Distributions to unitholders (11,856) (10,498) (35,306) (29,006)
Net change in revolving term
credit facilities (3,301) - (3,301) -
Proceeds from short-term debt,
net of repayments - 38,241 7 38,241
Deferred financing costs (272) (568) (272) (568)
Other long-term debt, net 71 45 102 45
Proceeds from issuance of
subscription receipts - 98,645 - 98,645
--------------------------------------------------------------------------
(15,358) 125,865 (38,770) 107,357
--------------------------------------------------------------------------
Investing activities:
Purchase of fixed assets (16,351) (18,066) (53,210) (49,762)
Deferred customer acquisition
revenue 1,675 1,318 4,346 1,318
Deferred customer accounts (3,848) (3,267) (9,048) (3,267)
Purchase of subscriber accounts (1,605) - (3,528) -
Proceeds from sale of property,
plant and equipment 972 586 2,951 1,972
Finance contracts related to
independent dealers (3,140) (1,087) (5,389) (1,080)
Purchase of business, net of
cash acquired - (137,864) - (137,864)
--------------------------------------------------------------------------
(22,297) (158,380) (63,878) (188,683)
---------------------------------------------------------------------------
Decrease in cash and cash
equivalents (12,370) (6,853) (15,719) (11,099)
Cash and cash equivalents,
beginning of period 13,337 18,447 16,686 22,693
Cash and cash equivalents,
end of period $ 967 $ 11,594 $ 967 $ 11,594
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