UE Waterheater Operating Trust

UE Waterheater Operating Trust

November 01, 2005 17:57 ET

UE Waterheater Operating Trust Announces Financial Results for third quarter ended September 30, 2005

TORONTO, ONTARIO--(CCNMatthews - Nov. 1, 2005) -

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

UE Waterheater Operating Trust today released financial results for the third quarter ended September 30, 2005. Highlights for the quarter are as follows:

- Strong revenues for the third quarter of 2005, increasing by 28% in total over the same period last year

- Acquired Protectron, increasing revenues by $12.9 million or 23%, and operating income by $1.4 million over the third quarter of 2004

- Operating income increased by 10% to $18.2 million from $16.6 million in 2004

Please click on the following link to view a chart of Gross Revenue ($ millions);

http://www.ccnmatthews.com/docs/uegr1.pdf

"Management is pleased with the Trust's performance during the third quarter of 2005. We continued to invest successfully in the rapid growth of our Comfort Protection Plan business," says Roger Rossi, President and CEO, adding: "The phased introduction of our new name, Reliance Home Comfort, is going well, with the remainder of our electric customers served under the Ontario Hydro Energy brand expected to be converted early in 2006. The performance of our recent security business acquisition, Protectron, is in line with management's expectations. We are focused on identifying and realizing opportunities for revenue growth and cost savings, while constantly improving customer service. The latter should continue to provide growth in cash flow and a solid base for unitholder distributions."



Consolidated Financial Highlights
For the quarter ended September 30, 2005
(Unaudited)
(in thousands of dollars, except for unit data)
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Three months ended Nine months ended
September 30, September 30,
-------------------------------------------
2005 2004 2005 2004
---------------------------------------------------------------------
Revenue $ 71,981 $ 56,124 $ 185,441 $ 164,767
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Cost of sales, general
and administration 35,807 24,055 89,287 73,695
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Depreciation and
amortization 17,850 15,214 47,497 45,415
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Operating income 18,324 16,855 48,657 45,657

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Mark-to-market (gain)
loss on valuation of
interest rate
contracts (15) 263 366 5,538
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Finance and interest
charges 5,487 4,817 14,983 14,799
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Income before income
taxes 12,852 11,775 333,308 25,320
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Taxes 247 303 691 911
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Net income $ 12,605 $ 11,472 $ 32,617 $ 24,409
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Cash from operating
activities $ 24,595 $ 19,370 $ 68,193 $ 67,433
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Cash from (used in)
financing activities 126,886 (8,344) 109,336 (23,441)
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Cash used in investing
activities (158,335) (15,025) (188,638) (41,664)
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Unitholder
distributions
declared 10,407 8,344 28,132 26,219
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Unitholder cash
distributions paid 9,905 8,344 27,455 23,441
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Earnings before finance
and interest charges,
taxes, depreciation
and amortization
(EBITDA)(1) $ 36,174 $ 32,069 $ 96,154 $ 91,072
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Total assets $ 999,373 $ 837,361 $ 999,373 $ 837,361
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(1) See "EBITDA" on page 5.
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November 1, 2005

This Management's Discussion and Analysis ("MD&A") 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 Operating Trust (the "Trust") and its subsidiaries for the third quarter of 2005. It should be read in conjunction with the Trust's audited consolidated financial statements and accompanying notes for the year ended December 31, 2004, as well as the Trust's unaudited interim consolidated financial statements and accompanying notes for the period ended September 30, 2005. In this MD&A, "we", "us", "our" and "the Trust" refer to UE Waterheater Operating Trust and its subsidiaries. The annual information form, annual report, other quarterly reports of, and other information relating to UE Waterheater Operating Trust are available on SEDAR at www.sedar.com.

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

- Forward-looking statements in this MD&A describe the Trust's expectations on November 1, 2005.

- Actual results could be materially different from the Trust's expectations if known and unknown risks affect the Trust's business or if the Trust's estimates or assumptions turn out to be inaccurate. As a result, the Trust 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 Trust's business.

- The Trust 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 Trust's current expectations include the risks discussed under the heading "Risks and Uncertainties".

About the UE Waterheater Operating Trust

UE Waterheater Operating Trust is an unincorporated, open-ended, limited purpose trust established under the laws of Ontario, created to indirectly acquire and hold, through the water heater rental business of Union Energy Limited Partnership ("Union Energy LP") and its related commercial activities. The Trust is a wholly-owned entity of the UE Waterheater Income Fund (the "Fund"), an unincorporated, opened-ended, limited purpose trust established under the laws of the Province of Ontario which holds all the Trust units and Subordinated Trust Notes of the Trust.

The Trust 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, Ontario Hydro 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, the segment has related commercial activities that complement the water heater rental business, being 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. The segment provides electronic security system sales, installation, service, monitoring, and related commercial activities across Canada, under the "Protectron" brand name.

RESULTS OF OPERATIONS - CONSOLIDATED FINANCIAL RESULTS

For the quarter ended September 30, 2005, the Trust's consolidated net income was $12.6 million on revenues of $72.0 million compared to net income of $11.5 million on revenues of $56.1 million for the three months ended September 30, 2004. Operating income for the quarter ended September 30, 2005 was $18.3 million, an increase of $1.4 million or 8% over the same period last year.

Revenues increased by $15.9 million, or 28%, during the three months ended September 30, 2005 with the acquisition of the security business contributing $12.9 million of the increase. Rental and security monitoring revenues increased by $11.3 million, or 25% in the current quarter; sales, service and other revenue increased $4.2 million, or 47%; and finance revenues increased $0.3 million, or 13% over the same quarter last year.

The $1.1 million increase in net income over the third quarter of 2004 is primarily due to the net effect of higher revenue, offset by increased investment in marketing on brand and customer growth in the Comfort Protection Plan business in the Water Heater and HVAC segment, plus the net income of the newly acquired Security business. In addition, the Trust incurred $0.5 million additional interest expense during the quarter ended September 30, 2005 from new debt related to the acquisition.

For the nine months ended September 30, 2005, the Trust's net income was $32.6 million on revenues of $185.4 million compared to net income of $24.4 million on revenues of $164.8 million for the nine months ended September 30, 2004. Operating income for the nine months ended September 30, 2005 was $48.7 million, an increase of $3.0 million or 7% over the same period last year.

Revenues increased by $20.6 million, or 13%, during the nine months ended September 30, 2005 with the acquisition of the security business contributing $12.9 million of the increase. Rental and security monitoring revenues increased by $15.5 million, or 12% during the nine-month period, sales, service and other revenue increased $4.4 million, or 16%, and finance revenues increased $0.8 million, or 11% over the same period last year.

The increase in net income for the nine-month period is primarily due to the net effect of higher revenue, offset by increased investment in marketing on brand and customer growth in the Comfort Protection Plan business in the Water Heater and HVAC segment, plus the income of the newly acquired Security business.
EBITDA

Earnings before finance and interest charges, taxes and depreciation and amortization ("EBITDA") was $36.2 million for the quarter and $96.2 million for the nine months ended September 30, 2005. EBITDA increased $4.1 million, or 13%, and $5.1 million, or 6%, respectively, when compared to EBITDA of $32.1 million and $91.1 million for the comparable periods in 2004.

The Trust believes that 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. The Trust reports on EBITDA because it is a key measure used by management to evaluate performance, and is utilized in measuring compliance with debt covenants and in making decisions relating to distributions to unitholders. The Trust believes EBITDA assists investors in comparing its performance on a consistent basis from period to period without regard to depreciation and amortization, which are non-cash in nature, and interest and taxes.

EBITDA is not a recognized measure under generally accepted accounting principles ("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 Trust'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 Trust's long-term debt and its capital expenditure requirements to fully assess the cash flow available to finance cash distributions.

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



(in thousands of dollars)
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Three months ended Nine months ended
September 30, September 30,
---------------------------------------
2005 2004 2005 2004

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Net income $ 12,605 $ 11,472 $ 32,617 $ 24,409
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Adjustments:
Depreciation and
amortization 17,850 15,214 47,497 45,415
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Finance and interest
charges (1) 5,472 5,080 15,349 20,337
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Income taxes 247 303 691 911
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Earnings before finance
and interest charges, taxes,
depreciation and amortization
(EBITDA) $ 36,174 $ 32,069 $ 96,154 $ 91,072
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(1) Includes finance and interest charges and mark-to-market
valuation of interest rate contracts.
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Depreciation and amortization were $17.9 million for the quarter and $47.5 million for the nine months ended September 30, 2005, an increase of $2.6 million or 17% for the quarter and $2.1 million or 5% for the nine months when compared to the same periods in 2004. This increase reflects primarily depreciation and amortization of Security segment assets, as well as the leasing of rather than purchasing of non-rental assets, including vehicles and computer hardware.

Finance and interest charges were $5.5 million and $15.3 million, respectively, for the quarter and nine months ended September 30, 2005 compared to $5.1 million for the quarter and $20.3 million for the nine months ended September 30, 2004. Finance and interest charges for 2005 represent interest on the senior secured notes and demand Trust notes, net interest payments and mark-to-market valuation of the related interest rate contracts, interest on short term debt beginning July 15, 2005 and other interest expenses, net of interest income. Finance and interest charges for 2004 represent interest on the senior secured notes that were issued on February 10, 2004 and on the bank credit facility prior to issuance of the notes, interest on the demand Trust notes, and the net interest payments and mark-to-market valuation of the related interest rate contracts.

In November 2003, the Trust 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 Trust entered into offsetting interest rate contracts resulting in a total effective fixed cash interest rate of 5.23% per annum for the Trust.

The interest rate contracts are marked-to-market at each balance sheet date. Changes in the market values are recorded in income as they arise, resulting in an insignificant income effect in the current quarter and an expense of $0.4 million for the nine months ended September 30, 2005. For comparable periods, a charge to income of $0.3 million and $5.5 million for the three and nine months ended September 30, 2004 resulted.

The market value liability accrued at September 30, 2005 of $12.8 million will reduce as payments are made under the terms of the interest rate contracts. Payments of $1.6 million were made in each of the current quarter and the first quarter of 2005, for $3.2 million year-to-date. Payments totaling $1.6 million were made in the quarter ended September 30, 2004.

The amount of earnings realized in the quarter is well in excess of those determined by management to be adequate to service interest on the outstanding long-term debt of the Trust. Adjusted EBITDA (as defined in the Supplemental Trust Indentures) was 6.6 times Net Interest Expense for the quarter ended September 30, 2005, 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.

Summary of quarterly results

The following is a summary of selected financial information derived from the Trust's unaudited interim consolidated financial statements for each of the eight most recently completed quarters:



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(In thousands of dollars, Third Second First Fourth
except per unit data) Quarter Quarter Quarter Quarter
---------------------------------------------------------------------
2005 2005 2005 2004
---------------------------------------------------------------------
Total revenue $ 71,981 $ 57,210 $ 56,250 $ 55,742
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Net income $ 12,605 $ 10,358 $ 9,654 $ 7,332
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(In thousands of dollars, Third Second First Fourth
except per unit data) Quarter Quarter Quarter Quarter
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2004 2004 2004 2003
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Total revenue $ 56,124 $ 54,381 $ 54,262 $ 51,793
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Net income $ 11,472 $ 9,903 $ 3,034 $(27,265)
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The third quarter of 2005 reflects increasing Waterheater and HVAC segment revenue and the acquired Security segment revenues. Total revenue changes for successive quarters are primarily a result of rental portfolio growth, rental price increases, and changes in the HVAC business. HVAC revenue changes are primarily the result of continuing to leverage cross-selling opportunities to the Trust's rental customers, as well as the seasonal fluctuations inherent in the HVAC business. The increase in the third quarter of 2005 reflects the inclusion of the Security business segment since acquisition on July 15, 2005.

Successive increases in net income for the 2005 quarters and as compared to the same quarters in 2004 reflect higher operating income. Changes in net income from quarter to quarter in 2004 were primarily due to increases in operating income for the first three periods and reduced operating income in the fourth quarter resulting from increased one-year deferred consumer financing contracts related to HVAC sales and increased expenses related to marketing and customer growth in the Comfort Protection Plan business. Changes in net income as compared to the fourth quarter of 2003 resulted primarily from improved operating performance and changes in income taxes, interest, and mark-to-market valuation of interest rate contracts resulting from the Trust's restructuring in 2003.

RESULTS OF OPERATIONS - WATER HEATER AND HVAC SEGMENT

The following table presents selected unaudited financial information for the three and nine months ended September 30, 2005 and 2004:



Three months ended Nine months ended
(in thousands of dollars) September 30, September 30,
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2005 2004 2005 2004
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Revenues:
Rental $ 45,949 $ 44,594 $ 136,294 $ 130,713
Sales, services and other 10,313 9,068 28,173 26,881
Finance 2,779 2,462 8,034 7,421
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Total revenues 59,041 56,124 172,501 164,767
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Cost of sales, general
and administration
expenses 27,043 24,055 80,523 73,695
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Depreciation and
amortization 15,098 15,214 44,745 45,415
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Operating income $ 16,900 $ 16,855 $ 47,233 $ 45,657
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Results for the quarter are in line with management's expectations and reflect the current period investments in marketing on brand 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 reflect primarily 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 Trust has begun the process of introducing the brand name "Reliance Home Comfort" market by market, as announced at the Trust's recent annual general and special meetings held in June 2005. A staggered implementation approach allows the Trust to better understand the impact of the move to a new name and also allows the Trust to effectively manage the transition.

Revenues

Water Heater and HVAC segment rental revenues increased by 3% and 4%, respectively, for the three and nine months ended September 30, 2005 when compared to the corresponding periods a year prior, reflecting rental price increases, rental pool growth, and changes in product mix.

Sales, service and other revenue was $10.3 million and $28.2 million for the three and nine months ended September 30, 2005, respectively. Sales, service and other revenue was $9.1 million and $26.8 million, respectively, for the comparable periods in 2004. The Trust continues to leverage cross-selling opportunities to its base of approximately one million customers. Higher revenues from Comfort Protection Plans accounted for most of the revenue growth in the third quarter as compared to the third quarter of 2004. The increase in year-to-date sales, service and other revenues reflects growth in the Trust's Comfort Protection Plan business, offset by lower revenues in other product lines as compared to the particularly strong sales in 2004, especially in the first quarter.

Finance revenue was $2.8 million and $8.0 million for the three and nine months ended September 30, 2005, respectively, compared to $2.5 million and $7.2 million, respectively, for the comparable periods in 2004. 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, 2005 increased by $3.0 million or 12%, from $24.1 million for the same period in 2004. For the nine months ended September 30, 2005, cost of sales, general and administrative expenses of $80.5 million was $6.8 million higher than the nine-month period a year prior. The increases in 2005 over 2004 reflect primarily higher marketing costs relating to branding initiatives and customer acquisition costs pertaining to growing the Trust's Comfort Protection Plan business.

Depreciation and Amortization

Depreciation and amortization in the Water Heater and HVAC segment were $15.1 million for the quarter and $44.7 million for the nine months ended September 30, 2005, a decrease of $0.1 million for the quarter and $0.7 million for the nine months when compared to the same periods in 2004. The changes from period to period reflect a growing rental portfolio, as well as leasing, rather than owning non-rental assets, including vehicles and computer hardware.

Portfolio of Rental Assets

For the three and nine months ended September 30, 2005, the portfolio of rental assets grew by 9,637 and 15,537 net units, respectively, bringing the number of installed units to 1,074,860. In the third quarter of 2005, $8.4 million was spent to replace 14,246 rental units that had reached the end of their useful life and $8.9 million was spent on 15,085 additional rental units. Comparable figures for the third quarter in 2004 were 3,547 net additions, with the addition of 9,349 units at a cost of $7.9 million and 13,247 replacement units at a capital cost of $7.1 million. In the nine months ended September 30, 2005, $27.5 million was spent to replace 48,202 water heaters that had reached the end of their useful life and $21.8 million was spent on 32,312 additional units. For the nine months ended September 30, 2004, 6,065 net units had been added, with 24,863 new units at a cost of $19.9 million and 45,011 replacement units at a capital cost of $23.6 million. Included in the current quarter numbers was the acquisition of a portfolio of 5,500 installed water heaters for $1.5 million.

The following table breaks out the changes in the installed units for the three and nine months ended September 30, 2005 compared to the corresponding periods in 2004:



Installed units - Water Heater and HVAC Rental

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Three months ended Nine months ended
(in thousands) September 30, September 30,
2005 2004 2005 2004
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Beginning units 1,065 1,052 1,059 1,049
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Retirements (14) (13) (48) (45)
Replacements 14 13 48 45
Buyouts and terminations (5) (6) (16) (19)
Additions 15 9 32 25
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Net change 10 3 16 6
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Ending units 1,075 1,055 1,075 1,055
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Outlook

The outlook for the Water Heater and HVAC segment remains strong. Management expects rental revenues to continue to increase due to rental pool growth, and that investments in customer acquisition will lead to higher sales, service and other revenues.

RESULTS OF OPERATIONS - SECURITY SEGMENT

The following table presents selected unaudited financial information for the three months ended September 30, 2005 (operating results from July 15, 2005, the date the segment was acquired):



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Three months ended
(in thousands of dollars) September 30, 2005 (1)
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Revenues:
Monitoring $ 9,936
Sales, service and other 3,004
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Total revenues 12,940
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Cost of sales, general and administration 8,764
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Depreciation and amortization 2,753
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Operating income $ 1,423
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Total Number of Customers 178,800
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Recurring Monthly Revenue ("RMR") -
end of period $ 3,920
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Annualized Net RMR Attrition Rate -
Monitoring Accounts 8.84%
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(1) Operating results from July 15, 2005, the date the segment was
acquired.
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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 management believes it 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 the result of customer cancellations reduced by reconnections of existing systems, existing customers moving to new homes and recoveries through cancellation guarantees provided by dealers and acquisition account vendors. Management believes 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.

Revenues

Monitoring and service revenue of $12.9 million for the three months ended September 30, 2005 is consistent with expectations. During the period July 15, 2005 to September 30, 2005, the Trust increased its total number of customers by approximately 2,400 and its RMR by 1% from $3,873 to $3,920.

Cost of Sales, General and Administration Expenses

Cost of sales, general and administration expenses are consistent with expectations and reflect costs associated with monitoring and the installation of commercial customer installations.

Depreciation and Amortization

Depreciation and amortization of $2.8 million for the three months ended September 30, 2005 (results from July 15, 2005, the date the segment was acquired) reflects depreciation of security systems installed in customers' homes and corporate assets, and amortization of intangibles assets, including customer relationships.

On July 15, 2005, the Trust purchased 100% of Protectron Holdings Inc. for approximately $137.9 million including acquisition costs. These results for the current quarter reflect the initial allocation of the purchase price to the fair values of the assets and liabilities acquired by the Trust.

The purchase price allocation has not yet been completed pending finalization of the valuation of the net identifiable assets required, including intangible assets, property, plant and equipment, certain accrued liabilities relating to employee costs and customer service costs, and unearned revenue.

Any adjustments resulting from the purchase price allocation finalization will be accounted for retroactively to July 15, 2005.

Outlook

Prior to the Trust's acquisition of the business, this segment was increasing both revenues and income through acquisitions and new sales. Management expects this to continue, and in addition, intends to leverage its relationship with existing Water Heater and HVAC customers over time in Ontario to increase Security sales.

LIQUIDITY AND CAPITAL RESOURCES

For the quarter ended September 30, 2005, cash generated from operating activities was $24.6 million compared to $19.4 million for the same period in 2004. The operating cash flow for the current quarter reflects the Trust's strong operating results and changes in non-cash operating working capital. Semi-annual interest payments on the senior secured notes and net payments on the related interest rate contracts totaled $10.4 million during the current quarter, compared to $10.5 million paid in the same quarter in 2004.

For the nine months ended September 30, 2005, cash generated from operating activities was $68.2 million compared to $67.4 million a year prior. The 2005 period reflects the payment of $17.7 million of interest on the senior secured notes and $3.2 million for the related interest rate contracts, net of the interest and other accruals since the period of last payment. The 2004 period reflects collection of receivables and payment of significant accounts payable and accrued liabilities. For the nine months ended September 30, 2004, $8.4 million interest was paid on the senior secured notes, and $1.6 million was paid on the related interest rate contracts.

Cash provided in financing activities for the quarter and nine months ended September 30, 2005 was $126.9 million and $109.3 million, respectively, compared to cash used of $8.3 million and $23.4 million for the corresponding periods in 2004. On July 15, 2005, the Trust raised $99.1 million through the issuance of Trust units and demand notes. In addition, the Trust obtained $38.2 million short-term debt to fund the Security segment acquisition. For the quarter ended September 30, 2005, the Trust declared distributions of $10.4 million and paid $9.9 million. During the three and nine months ended September 30, 2004, the Trust declared distributions of $8.3 million and $26.2 million and paid $8.3 million and $23.4 million to unitholders, respectively.

On February 10, 2004, UE Waterheater Operating Trust (the "Trust"), a wholly owned subsidiary of the Trust, issued $400 million of Series 1 and Series 2 Senior Secured Notes which were both given a rating of A from Standard & Poor's and AA (low) from Dominion Bond Rating Service. The proceeds of this issue were used to retire the bank credit facility that was drawn upon when the business was acquired from EPCOR Utilities Inc. ("EPCOR") on December 19, 2003.

The following table summarizes expected and actual proceeds from the issuance of Trust units and debt financing during the quarter ended September 30, 2005, and the expected and actual application of those proceeds:


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Nature of offering: Expected and actual Expected and actual
proceeds: application of
proceeds:
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July 15, Issuance of 991,180 $9.9 million Acquisition of
2005 Trust units for cash Protectron
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July 15, Short-term revolving $38.3 million Acquisition of
2005 credit facility Protectron
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July 15, Issuance of demand $89.2 million Acquisition of
2005 Trust notes Protectron
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In the Trust unit issuance and debt financing, the Trust achieved the expected proceeds and applied them as expected, purchasing 100% of the common shares of Protectron Holdings Inc. for approximately $137.9 million.

As at September 30, 2005, the Trust had the following credit facilities: a fully utilized $38.3 million secured revolving loan facility maturing on July 14, 2006; an unused $30.0 million secured revolving demand loan facility maturing on July 14, 2006; and a $10.0 million secured revolving demand loan facility, of which $0.75 million was utilized by way of an irrevocable standby letter of credit to guarantee the contract performance of a subsidiary. The letter of credit matures September 27, 2006, and is extendable automatically for one year. The facilities are with Canadian chartered banks.

Cash used in investing activities for the three and nine months ended September 30, 2005 was $158.3 million and $188.6 million, respectively, compared to $15.0 million and $41.7 million for the three and nine months ended September 30, 2004, respectively. Included in the 2005 three- and nine- month periods is $137.9 million used to acquire 100% of the outstanding equity of Protectron Holdings Inc. For the three- and nine- months ended September 30, 2005, $18.1 million and $49.8 million were used for the purchase of property, plant and equipment compared to $15.0 million and $43.5 million for the corresponding periods in 2004. Included in capital expenditures during the current quarter and year-to-date total are $0.4 million and $1.3 million related to compliance with new flammable-vapour regulations that became effective in late 2004 and are being phased in over the next two years. Finance contracts with customers of independent dealers used $1.1 million for both the three and nine months ending September 30, 2005. Finance contracts with customers of independent dealers used $0.6 million in the third quarter of 2004, and provided cash of $0.2 million for the nine months ended September 30, 2004. Proceeds from the sale of property, plant and equipment were $0.6 million and $2.0 million for the three and nine months ended September 30, 2005, and $0.6 million and $1.6 million for the corresponding periods in 2004.

Summary of contractual obligations

Contractual obligations are substantially the same as those reported in management's discussion and analysis for the year ended December 31, 2004, except that the Trust has extended the lease for its head office premises beyond its December 31, 2006 term to 2016.

Refinancing of Senior Secured Notes

The Trust expects to refinance the outstanding Series 1 and Series 2 Senior Secured Notes on the expected final payment date for each series (being January 30, 2009 and January 31, 2011). A failure to refinance any series of senior secured notes on its Expected Final Payment Date would give rise to a Cash Sweep Remedy. A Cash Sweep Remedy essentially would preclude the Trust from making distributions and other expenditures (including capital expenditures other than for the replacement of existing water heaters) until the secured notes are paid in full. The maturity dates of the Series 1 and series 2 Senior Secured Notes are January 30, 2016 and January 31, 2018, respectively. Based on current market conditions, the Trust believes that it will be able to arrange such refinancing. However, no assurances can be given with respect to future market conditions.

INTERCOMPANY AND RELATED PARTY TRANSACTIONS

For the quarter ended September 30, 2005, the Trust paid the Fund $0.7 million and $1.6 million, respectively, in relation to the demand Trust notes. For the corresponding period in 2004, the Trust paid $0.5 million and $1.4 million, respectively.

DEFERRED UNIT PLAN

Effective June 14, 2005, the Fund unitholders approved a deferred unit compensation plan (the ''Deferred Unit Plan''). The Deferred Unit Plan provides for the grant to non-management trustees and directors of deferred Fund units (''Deferred Units'').

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 nine months ended September 30, 2005, the Fund granted 3,535 Deferred Units and recorded approximately $48 thousand of compensation expense. No compensation expense relating to Deferred Units was recorded in 2004. The Fund records unit-related compensation expense in the consolidated statement of income using the fair value method.

ACCOUNTING POLICIES

INITIAL ADOPTION OF ACCOUNTING POLICIES

Unit-Based Compensation

On June 14, 2005, the Fund unitholders approved and implemented a deferred unit compensation plan (the "Deferred Unit Plan") providing for the grant to non-management trustees and directors of deferred Fund units ("Deferred Units") as described in the prior section "Deferred Unit Plan".

The Fund also has established a long-term incentive plan for certain senior executives. Payments under the incentive plan may be made in cash, units, or a combination of cash and units, at the option of the Fund. For the three and nine months ended September 30, 2005, no units were issued pursuant to the long-term incentive plan.

Under CICA Handbook Section 3870, Stock-based Compensation and Other Stock-Based Payments, Deferred Units and units granted under these plans are accounted for using the fair value-based method. The fair value of Deferred Units granted for annual director fees is recorded as compensation expense in the period granted. The fair value of Deferred Units granted in lieu of cash distributions is recorded as compensation expense in the period the distribution is declared. The fair value of units granted under the long-term incentive plan is recorded as compensation expense over the vesting period.

Vendor Rebates

EIC 144 Abstract, Accounting by a Purchaser for a Vendor Rebate, was amended to address when a customer should recognize and how a customer should measure a rebate. The abstract is effective for annual and interim periods commencing on or after February 15, 2005 and states that discretionary rebates should be recognized by a customer when paid by the vendor or when the vendor becomes obligated to pay. Where there is a binding agreement that requires the vendor to pay a rebate provided the customer completes a specified cumulative level of purchases or remains a customer for a specified period of time, the rebate should be recognized as a reduction of the cost of purchases for the period, provided the rebate is probable and reasonably estimable. The customer should measure the rebate based on the estimated amount of the rebate that is expected to be received for the underlying transactions that have occurred and that result in progress by the customer toward achieving the specified requirement to receive the rebate. There was an insignificant effect on net income from the date of adoption, April 1, 2005.

Revenue Recognition on Sale and Installation of Monitoring Products and Services

Revenues from installation of monitoring products and the related monitoring services provided to residential customers are accounted for as one unit of accounting. Installation revenues are deferred and amortized into rental and security monitoring revenue on a straight-line basis at 10% per annum, the estimated life of the residential customer relationship. Monitoring revenues are reflected in income as services are provided.

Revenues generated from commercial installations and monitoring services are recognized in the period in which the sale is completed or the service is provided and collectability is reasonably assured.

Customers are billed for monitoring and maintenance services primarily on a monthly, quarterly or annual basis in advance of the period in which such services are provided. Contracts for monitoring services are generally for an initial non-cancelable term of three to five years with automatic renewal on an annual basis thereafter, unless terminated by either party. When customers are invoiced, the portion of unearned revenue is recorded as unearned revenue.

Deferred Costs Related to Customer Accounts

Internally generated customer accounts

Residential customer accounts are recorded at cost and include the direct and incremental costs incurred in originating contracts, installing equipment and activating monitoring services. All direct installation costs that result in deferred revenue, including materials and labour are capitalized to the extent such costs do not exceed the total of the deferred installation revenue and expected margin from monitoring services during the initial monitoring contract term. Capitalized residential customer costs, to the extent of deferred revenues, are amortized on a straight-line basis at a rate of 10% per annum, the estimated life of the customer relationship.

At the outset of the contract, to the extent that deferred customer costs exceed the total of deferred installation revenue and the expected margin from monitoring services during the initial monitoring contract term; the excess is expensed in the period in which the installation is completed.

When capitalized residential customer costs are in excess of deferred installation revenues, but less than the expected margin from monitoring services during the initial monitoring contract term, then the excess is amortized on a straight-line basis over the initial term of the monitoring contract, generally three to five years.

At each reporting period, the recoverability of the net deferred residential customer costs is compared to the total remaining deferred installation revenue and the expected margin from monitoring services during the remaining monitoring contract term. If the evaluation indicates that the carrying value is not recoverable from future estimated net undiscounted cash flows, then an impairment loss is recognized as a period cost.

Acquired customer accounts

Customer accounts acquired from dealers are recorded at cost. The costs of acquiring these accounts are capitalized and amortized on a straight-line basis at the rate of 10% per annum.

At each reporting period, the recoverability of the capitalized costs, net of accumulated amortization, is compared to the expected margin from monitoring services during the remaining monitoring contract term. If the evaluation indicates that the carrying value is not recoverable from future estimated net undiscounted cash flows, then an impairment loss is recognized as a period cost.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the periods. These estimates are based on our historical experience and various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the reported amounts of revenues, expenses, assets and liabilities that are not readily apparent from other sources. The critical accounting estimates for the Fund are the estimated useful lives of rental assets and the allowance for doubtful accounts.

Estimated useful lives of rental assets

The estimated useful lives of the assets have a direct impact on the amount of the amortization expense. There is measurement uncertainty with respect to the remaining useful life of the installed rental assets; however, the method is supported by amortization studies. Management conducts comprehensive amortization studies on a periodic basis to ensure that the amortization expense is an accurate measurement of the cost of amortization for each asset category and to update the service lives and the resulting amortization rates.

A study completed in September 2003 reported on the leased water heaters and rental appliances acquired prior to November 2001. As a result of the September 2003 report, the effective amortization rates were revised and the change has been accounted for prospectively. No study has been completed on electric water heaters and, accordingly, new electric water heaters are being amortized based on estimates of useful life provided by manufacturers. With respect to the electric water heaters acquired from Hydro One Inc., the Trust is amortizing the cost attributed to these water heaters over the remaining useful lives based on data provided by Hydro One Inc. on the age of the water heaters acquired.

Allowance for doubtful accounts

The allowance for doubtful accounts is evaluated and established based on historical patterns of collections and economic conditions. Adequacy of the provision is assessed on a periodic basis.

Estimated attrition rate of security customers

The estimated attrition rate of the security customers has a direct impact on the amortization of deferred revenue into income as well as the amortization of deferred customer accounts into amortization expense.

The historical average annual customer attrition rate experienced prior to the acquisition of the security segment by the Fund was 8.5%. Customer attrition varies over time and results from relocation of customers, customers' inability or unwillingness to pay, competition and adverse financial or economic conditions among other factors.

FUTURE CHANGES IN ACCOUNTING STANDARDS

The Trust reviews all revisions to the Canadian Institute of Chartered Accountants ("CICA") Handbook when issued.

The following is a discussion of relevant Handbook revisions that were released, revised or became effective since the Trust's financial statements for the year ended December 31, 2004 were issued.

Handbook Section 3840, Related Party Transactions, replaces references to "culmination of the earnings process" with "commercial substance" as a result of issuing new Section 3831, Non-monetary Transactions. A non-monetary transaction has commercial substance when the entity's future cash flows are expected to change significantly as a result of the transaction. Based on our review, we do not expect a material effect on the Trust's financial statements when we adopt the new standard no later than January 1, 2006.

Handbook Section 1530, Comprehensive Income, requires presenting comprehensive income and its components (defined as the change in equity during a period from transactions and other events and circumstances from non-owner sources) in financial statements as well as net income. Based on our review, we do not expect a material effect on the Trust's financial statements when we adopt the new standard no later than January 1, 2007.

Handbook Section 3855, Financial Instruments - Recognition and Measurement, establishes standards for recognizing and measuring financial assets, financial liabilities and non-financial derivatives. It provides standards for the classification of financial instruments, related interest, dividends, losses and gains, the circumstances in which financial assets and financial liabilities are offset, and disclosures about financial instruments and non-financial derivatives. Based on our review, we do not expect a material effect on the Trust's financial statements when we adopt the new standard no later than January 1, 2007.

Handbook Section 3865, Hedges, establishes standards for when and how hedge accounting may be applied, ensuring that counterbalancing gains, losses, revenues and expenses are recognized in net income in the same period or periods. Based on our review, we do not expect a material effect on the Trust's financial statements when we adopt the new standard no later than January 1, 2007.

Handbook Section 3051, Investments, establishes standards for accounting for investments subject to significant influence and for measuring and disclosing certain other non-financial instrument investments. Based on our review, we do not expect a material effect on the Trust's financial statements when we adopt the new standard no later than January 1, 2007.

Handbook Section 3251, Equity, replaces Handbook Section 3250, Surplus, and establishes standards for the presentation of equity and changes in equity during the reporting period. Based on our review, we do not expect a material effect on the Trust's financial statements when we adopt the new standard no later than January 1, 2007.

Handbook Section 3861, Financial Instruments - Disclosure and Presentation, replaces Handbook Section 3860, Financial Instruments - Disclosure and Presentation, and establishes standards for presentation of financial instruments and non-financial derivatives, and identifies information that should be disclosed. Based on our review, we do not expect a material effect on the Trust's financial statements when we adopt the new standard no later than January 1, 2007.

RISKS AND UNCERTAINTIES

Risks and uncertainties related to economic and industry factors and the structure of the Trust are discussed in detail in the 2004 annual MD&A, as well as the 2005 second quarter MD&A.

2005 OUTLOOK

The outlook for the Trust and its underlying businesses is positive and stable for 2005. The Trust has seen strong revenues during the third quarter and should continue to deliver strong performance through 2005, providing a reliable stream of stable cash flow to support cash distributions to unitholders.

Management believes that the ongoing cash flow from operations and credit facilities will be sufficient to allow it to meet ongoing requirements for capital expenditures, investments in working capital, interest expense and cash distributions. The Trust's actual cash flow will be dependent upon its future financial performance, which in turn will be subject to financial, tax, business and other factors, including elements beyond the Trust's control.



Attachments:
Consolidated Balance Sheets
Consolidated Statements of Income
Consolidated Statement of Cash Flows



UE WATERHEATER OPERATING TRUST
Consolidated Balance Sheets
(In thousands of dollars)
(Unaudited)
---------------------------------------------------------------------
---------------------------------------------------------------------
September 30, 2005 December 31, 2004
---------------------------------------------------------------------
Assets

Current assets:

Cash and cash equivalents $ 11,584 $ 22,693
Accounts receivable 25,738 19,359
Inventories 5,671 4,053
Prepaid expenses 1,657 1,867
Current portion of finance
contracts (Note 4) 15,591 14,840
--------------------------------------------------------------------
60,241 62,812

Property, plant and equipment 429,304 405,354
Finance contracts (Note 4) 57,869 55,372
Intangible assets and deferred
charges (Note 5) 303,591 203,296
Goodwill 148,368 119,640
---------------------------------------------------------------------

$ 999,373 $ 846,474
---------------------------------------------------------------------
---------------------------------------------------------------------

Liabilities and Equity

Current liabilities:

Accounts payable and accrued
liabilities $ 32,524 $ 31,222
Distribution payable to unitholder 3,458 2,781
Unearned revenue 18,649 8,352
Short-term debt (Note 6) 38,241 -
Demand Trust notes 406,148 316,942
--------------------------------------------------------------------
499,020 359,297

Long-term liabilities:

Senior notes payable (Note 7) 400,000 400,000
Interest rate contracts (Note 8) 12,769 15,586
Deferred revenue 1,318 -
Warranty liability 916 971
Other long-term debt 459 -
Accrued pension liability 1,412 1,524
Employee future benefit liability 1,859 1,873
--------------------------------------------------------------------
418,733 419,954

Equity (Note 9) 81,620 67,223
---------------------------------------------------------------------
$ 999,373 $ 846,474
---------------------------------------------------------------------
---------------------------------------------------------------------
See accompanying notes to interim consolidated financial statements.



UE WATERHEATER OPERATING TRUST
Consolidated Statements of Income
(In thousands of dollars)
(Unaudited)
---------------------------------------------------------------------
---------------------------------------------------------------------
Three months ended Nine months ended
September 30, September 30,
2005 2004 2005 2004
---------------------------------------------------------------------
Revenue:
Rental and security
monitoring $ 55,885 $ 44,594 $ 146,230 $ 130,713
Sales, service and other 13,317 9,068 31,177 26,811
Finance 2,779 2,462 8,034 7,243
--------------------------------------------------------------------
71,981 56,124 185,441 164,767
Expenses:
Cost of sales, general
and administration 35,806 24,055 89,287 73,695
Depreciation of property,
plant and equipment 13,428 12,894 38,436 38,456
Amortization of intangible
assets 4,423 2,320 9,061 6,959
--------------------------------------------------------------------
53,657 39,269 136,784 119,110
---------------------------------------------------------------------

Operating income 18,324 16,855 48,657 45,657

Mark-to-market (gain) loss
on valuation of interest
rate contracts (15) 263 366 5,538

Interest:
Long-term debt 4,498 4,439 13,292 11,338
Other 989 378 1,691 3,461
---------------------------------------------------------------------

Income before income taxes 12,852 11,775 33,308 25,320

Income taxes:
Current 247 303 691 911
---------------------------------------------------------------------
Net income $ 12,605 $ 11,472 $ 32,617 $ 24,409
---------------------------------------------------------------------
---------------------------------------------------------------------

See accompanying notes to interim consolidated financial statements.



UE WATERHEATER OPERATING TRUST
Consolidated Statements of Cash Flows
(In thousands of dollars)
(Unaudited)
---------------------------------------------------------------------
---------------------------------------------------------------------
Three months ended Nine months ended
September 30, September 30,
2005 2004 2005 2004
---------------------------------------------------------------------

Cash provided by (used in):
Operating activities:
Net income $ 12,605 $ 11,472 $ 32,617 $ 24,409
Adjustments and other items
not involving cash:
Depreciation and
amortization 17,850 15,214 47,497 45,415
Amortization of deferred
financing costs 118 - 118 -
Gain on disposal of
property, plant and
equipment (164) (130) (731) (391)
Difference between pension
and other employee
benefits expense and
funding (72) (6) (126) (51)
Mark-to-market valuation
of interest rate contracts (15) 263 366 5,538
Payments on interest rate
contracts, net (1,566) (1,592) (3,182) (1,592)
Warranty liability 430 (54) (57) (1,093)
Finance contracts related
to Trust sales (Note 4) (1,397) (1,810) (2,168) (2,610)
Change in non-cash operating
working capital (Note 12(a)) (3,194) (3,987) (6,141) (2,192)
---------------------------------------------------------------------
24,595 19,370 68,193 67,433
---------------------------------------------------------------------

Financing activities:
Distributions to unitholders (9,905) (8,344) (27,455) (23,441)
Proceeds from short-term
debt, net of repayments 38,241 - 38,241 -
Deferred financing costs (568) - (568) -
Proceeds from issuance of
units 9,912 - 9,912 -
Proceeds from issuance of
Demand Trust notes 89,206 - 89,206 -
Repayment of bank loan - - - (400,000)
Proceeds from senior
secured notes - - - 400,000
---------------------------------------------------------------------
126,886 (8,344) 109,336 (23,441)
---------------------------------------------------------------------

Investing activities:
Purchase of property, plant
and equipment (18,066) (15,047) (49,762) (43,541)
Deferred revenue 1,318 - 1,318 -
Customer accounts (3,267) - (3,267) -
Proceeds from sale of
property, plant and
equipment 586 593 1,972 1,633
Purchase of business, net
of cash acquired (Note 10) (137,864) - (137,864) -
Other long-term liabilities,
net 45 - 45 -
Finance contracts related to
independent dealers (Note 4) (1,087) (571) (1,080) 241
Other - - - 3
---------------------------------------------------------------------
(158,335) (15,025) (188,638) (41,664)
---------------------------------------------------------------------

Increase (decrease) in
cash and cash equivalents (6,854) (3,999) (11,109) 2,328
Cash and cash equivalents,
beginning of period 18,438 26,748 22,693 20,421
---------------------------------------------------------------------
Cash and cash equivalents,
end of period $ 11,584 $ 22,749 $ 11,584 $ 22,749
---------------------------------------------------------------------
---------------------------------------------------------------------

Supplemental cash flow information (Note 12(b))
See accompanying notes to interim consolidated financial statements.


UE WATERHEATER OPERATING TRUST
Notes to Interim Consolidated Financial Statements
(Unaudited)
September 30, 2005
(In thousands of dollars)
---------------------------------------------------------------------
---------------------------------------------------------------------


1. Nature of operations:

The UE Waterheater Operating Trust (the "Trust") is an unincorporated, open-ended trust governed by the laws of the Province of Ontario. It is wholly owned by the UE Waterheater Income Fund (the "Fund").

The principal business of the Trust is integrated and consists of water heater rentals, sales, rental and service of heating, ventilation and air-conditioning ("HVAC") equipment and its related financing to customers within, but not limited to, Ontario.

2. Basis of presentation and accounting policies:

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, 2004, with the exception of policies adopted with respect to the acquisition of Protectron Holdings Inc. and those relevant to unit-based compensation as disclosed in Note 3(b), 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 in the Fund's annual report for the year ended December 31, 2004.

The consolidated financial statements of the Trust include the accounts of the Trust and its wholly owned subsidiaries: Union Energy Limited Partnership, 4211782 Canada Inc. (formerly Union Energy Inc.), WestCap Trust, 4202201 Canada Inc., GP Waterheater Trust, Protectron Inc., 6411398 Canada Inc., 6415741 Canada Inc., Protectron Limited Partnership ("Protectron LP") and GP Protectron Trust.

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

3. Significant accounting policies:

The following accounting policies and changes in policies have been adopted in the current year:

a) Unit-based compensation

On June 14, 2005, the Trust and the Fund approved and implemented a deferred unit compensation plan (the "Deferred Unit Plan") providing for the grant to non-management trustees and directors of deferred Fund units ("Deferred Units").

The Trust and the Fund also have established a long-term incentive plan for certain senior executives. Payments under the incentive plan may be made in cash, Fund units, or a combination of cash and Fund units, at the option of the Trust. For the three and nine months ended September 30, 2005, no Fund units were issued pursuant to the long-term incentive plan.

Under CICA Handbook Section 3870, Stock-based Compensation and Other Stock-Based Payments, Deferred Units and units granted under these plans are accounted for using the fair value-based method. The fair value of Deferred Units granted for annual director fees is recorded as compensation expense in the period granted. The fair value of Deferred Units granted in lieu of cash distributions is recorded as compensation expense in the period the distribution is declared. The fair value of Fund units granted under the long-term incentive plan is recorded as compensation expense over the vesting period.

b) Accounting policies in connection with Protectron

Intangible assets

Intangible assets represent the fair value of customer relationships, deferred customer accounts, trademarks, wholesaler and dealer relationships and other miscellaneous agreement and will be amortized using the following annual rates and methods:



---------------------------------------------------------------------
---------------------------------------------------------------------
Customer relationships 10% straight-line
Trademarks 10% straight-line
Wholesaler and dealer relationships 20% declining balance
Other 50% straight-line
---------------------------------------------------------------------
---------------------------------------------------------------------


Accounting for deferred customer accounts is described below.

Revenue recognition

Revenues from installation of monitoring products and the related monitoring services provided to residential customers are accounted for as one unit of accounting. Installation revenues are deferred and amortized into rental and security monitoring revenue on a straight-line basis at a rate of 10% per annum, the estimated life of the residential customer relationship. Monitoring revenues are reflected in income as services are provided.

Revenues generated from commercial installations and monitoring services are recognized in the period in which the sale is completed or the service is provided and collectability is reasonably assured.

Customers are billed for monitoring and maintenance services primarily on a monthly, quarterly or annual basis in advance of the period in which such services are provided. Contracts for monitoring services are generally for an initial non-cancelable term of three to five years with automatic renewal on an annual basis thereafter, unless terminated by either party. When customers are invoiced, the portion of unearned revenue is recorded as unearned revenue.

Deferred costs relating to customer accounts

Internally generated customer accounts

Residential customer accounts are recorded at cost and include the direct and incremental costs incurred in originating contracts, installing equipment and activating monitoring services. All direct installation costs that result in deferred revenue, including materials and labour are capitalized to the extent such costs do not exceed the total of the deferred installation revenue and expected margin from monitoring services during the initial monitoring contract term. Capitalized residential customer costs, to the extent of deferred revenues, are amortized on a straight-line basis at a rate of 10% per annum, the estimated life of the customer relationship.

At the outset of the contract, to the extent that deferred customer costs exceed the total of deferred installation revenue and the expected margin from monitoring services during the initial monitoring contract term; the excess is expensed in the period in which the installation is completed.

When capitalized residential customer costs are in excess of deferred installation revenues, but less than the expected margin from monitoring services during the initial monitoring contract term, then the excess is amortized on a straight-line basis over the initial term of the monitoring contract, generally three to five years.

At each reporting period, the recoverability of the net deferred residential customer costs is compared to the total remaining deferred installation revenue and the expected margin from monitoring services during the remaining monitoring contract term. If the evaluation indicates that the carrying value is not recoverable from future estimated net undiscounted cash flows, then an impairment loss is recognized as a period cost.

Acquired customer accounts

Customer accounts acquired from dealers are recorded at cost. The costs of acquiring these accounts are capitalized and amortized on a straight-line basis at the rate of 10% per annum.

At each reporting period, the recoverability of the capitalized costs, net of accumulated amortization, is compared to the expected margin from monitoring services during the remaining monitoring contract term. If the evaluation indicates that the carrying value is not recoverable from future estimated net undiscounted cash flows, then an impairment loss is recognized as a period cost.

4. Finance contracts:



---------------------------------------------------------------------
---------------------------------------------------------------------
September December
30, 2005 31, 2004
---------------------------------------------------------------------
Finance contracts related to Trust sales $ 28,387 $ 26,219
Finance contracts related to independent dealers 45,073 43,993
---------------------------------------------------------------------
73,460 70,212
Less: current portion 15,591 14,840
---------------------------------------------------------------------
$ 57,869 $ 55,372
---------------------------------------------------------------------
---------------------------------------------------------------------


The Trust offers financing on HVAC equipment sold and installed by the Trust and on HVAC equipment sold and installed by independent dealers.

Beginning January 1, 2005, net cash flows from finance contracts related to Trust sales are reflected as operating activities. Net cash flows from finance contracts related to independent dealers are reflected as investing activities. The 2004 comparative figures have been reclassified to conform with the new presentation.

5. Intangible assets and deferred charges:



-----------------------------------------------------------------------
-----------------------------------------------------------------------
Accumulated Net book
September 30, 2005 Cost amortization value
-----------------------------------------------------------------------
Customer relationships -
waterheater rentals $ 210,300 $ 15,036 $ 195,264
Customer relationships - security 93,090 1,669 91,421
Trademarks - waterheater rentals 2,600 1,527 1,073
Trademarks - security 7,100 150 6,950
Wholesaler and dealer relationships 4,600 194 4,406
Deferred customer accounts 3,267 20 3,247
Deferred finance charges 568 118 450
Other 850 70 780
-----------------------------------------------------------------------
$ 322,375 $ 18,784 $ 303,591
-----------------------------------------------------------------------
-----------------------------------------------------------------------

-----------------------------------------------------------------------
-----------------------------------------------------------------------
Accumulated Net book
December 31, 2004 Cost amortization value
-----------------------------------------------------------------------
Customer relationships -
waterheater rentals $ 210,300 $ 8,727 $ 201,573
Trademarks 2,600 877 1,723
-----------------------------------------------------------------------
$ 212,900 $ 9,604 $ 203,296
-----------------------------------------------------------------------
-----------------------------------------------------------------------

For a summary of additions to intangibles during the quarter, see
Business Acquisitions Note 10.


6. Short-term debt:

On June 15, 2005, the Trust amended its credit agreement with a Canadian chartered bank. The amended and restated agreement consists of the following facilities:

(a) $38.3 million revolving term facility maturing July 14, 2006;

(b) $30.0 million demand revolving facility maturing July 14, 2006, extendable annually at the option of the lender.

(c) $10.0 million revolving demand facility, of which $0.75 million has been drawn through an irrevocable standby letter of credit to guarantee the contract performance of a subsidiary. The letter of credit matures September 27, 2006, and is extendable automatically for one year.

The credit facilities are funded through demand loans or revolving bankers' acceptances issued by the chartered bank, at the option of the Trust. Interest on demand loans is payable monthly at the greater of the bank's Canadian commercial loan reference rate and the Canadian Dollar Offered Rate plus 0.625%. Interest on bankers' acceptances is payable at maturity of each bankers' acceptance at the lesser of the bank's offered rate and the Canadian Dollar Offered Rate. The agreement contains certain financial maintenance covenants, and the debt is secured by a general security agreement against substantially all assets of the Fund, subject to the priority of senior secured noteholders.

7. Senior notes payable:



---------------------------------------------------------------------
---------------------------------------------------------------------
Senior Annual
Secured Interest Expected Final
Notes Rate Principal Payment Date Maturity Date
---------------------------------------------------------------------
Series 1 4.145% $ 200,000 January 30, 2009 January 30, 2016
Series 2 4.722% 200,000 January 31, 2011 January 31, 2018
---------------------------------------------------------------------
$ 400,000
---------------------------------------------------------------------
---------------------------------------------------------------------


The notes contain certain financial maintenance covenants and interest is paid semi-annually.

The Expected Final Payment Date for each series of notes is the date it is expected that the principal on the notes will be repaid. The Maturity Date is the maturity date for the series but the repayment date is expected to be the earlier date.

8. Interest rate contracts:

The Trust entered into interest rate contracts in November 2003 in order to fix, to the extent possible, the effective borrowing cost of long-term notes issued in February 2004.

The Trust does not enter into interest rate contracts or swap agreements for trading or speculative purposes. However, the interest rate contracts entered into by the Trust do not qualify for hedge accounting and, as such, are recorded at their fair value as either an asset or liability, with changes in fair value recognized in income in the period they occur.

The following is a summary of interest rate contracts outstanding at September 30, 2005 and December 31, 2004:



-----------------------------------------------------------------------
-----------------------------------------------------------------------
Net Net
Fair Value Fair Value
Asset Asset
Fixed Total (Liability) (Liability)
Settlement Rate of Notional September December Termination
Based On Interest Value 30, 2005 31, 2004 Date
-----------------------------------------------------------------------

Payment of
fixed rates, 4.74% $ 200,000 $ (7,605) $ (9,892) January 2009
receipt of
floating rates 5.13% 200,000 (13,343) (13,237) January 2011

Receipt of
fixed rates, 3.82% 200,000 1,535 2,138 January 2009
payment of
floating rates 4.46% 200,000 6,644 5,405 January 2011
-----------------------------------------------------------------------
$ (12,769) $ (15,586)
-----------------------------------------------------------------------
-----------------------------------------------------------------------


9. Equity:

Equity as at September 30, 2005 and December 31, 2004 is comprised of:

---------------------------------------
---------------------------------------
Number
of Units Retained
Outstanding Amount Earnings Equity
---------------------------------------
---------------------------------------

Equity at the date of formation
of the Trust $ - $ - $ -

Units issued for cash 2,510,500 25,105 - -
Units issued for business
assets 5,413,000 54,130 - -
Net loss for the 13 days ended
December 31, 2003 - - (9,190) -
---------------------------------------
Equity as at December 31, 2003 7,923,500 $ 79,235 $ (9,190) $ 70,045

Net income for the year ended
December 31, 2004 - - 31,741 -
Distributions to unitholder
for the year ended
December 31, 2004 - - (34,563) -
---------------------------------------
---------------------------------------
Equity as at December 31, 2004 7,923,500 $ 79,235 $(12,012) $ 67,223

Units issued for acquisition 991,180 9,912 - -
Net income for the period ended
September 30, 2005 - - 32,617 -
Distributions to unitholder
for the period ended
September 30, 2005 - - (28,132) -
---------------------------------------
Equity as at September 30, 2005 8,914,680 $ 89,147 $ (7,527) $ 81,620
---------------------------------------
---------------------------------------


On December 11, 2003, the Fund subscribed for 2,510,500 units of the Trust for cash consideration of $25,105.

On December 18, 2003, the Trust issued 5,413,000 units as partial consideration for the acquisition of the business.

On July 15, 2005, the Trust issued 991,180 units for cash.

10. Business acquisition:

On July 15, 2005, the Trust purchased 100% of issued and outstanding equity in Protectron Holdings Inc., a privately held security monitoring company, for approximately $137.9 million including acquisition costs. The consideration was paid in cash raised through a subscription receipts offering and a bank credit facility.

The acquisition has been accounted for using the purchase method, with the results of Protectron operations included in these financial statements from July 15, 2005.

The following table summarizes the initial allocation of the purchase price to the fair values of the assets and liabilities acquired by the Trust:



---------------------------------------------------------------------
Net assets acquired:

Net working capital deficiency $ (9,954)
Property, plant and equipment 13,864

Intangible assets:
Customer relationships $ 93,090
Trademarks 7,100
Wholesaler and dealer relationships 4,600
Other 850 105,640
--------
Goodwill 28,728

Less liabilities assumed:

Other long-term liabilities (414)
---------------------------------------------------------------------
Total purchase price, including costs of
acquisition $ 137,864
---------------------------------------------------------------------
---------------------------------------------------------------------


The purchase price allocation has not yet been completed, pending finalization of the valuation of the net identifiable assets acquired, including intangible assets, property, plant and equipment, and certain accrued liabilities relating to employee costs, customer servicing costs, and unearned revenue.

11. Unit-based compensation:

(a) Deferred unit plan:

Pursuant to the Deferred Unit Plan, each eligible participant is entitled to elect in advance to have all or a portion of his or her annual retainer for the ensuing period allocated to the Deferred Unit Plan. Directors and trustees who have not achieved the requisite level of Fund unit ownership as provided in the Fund's Unit Ownership Guidelines are required to elect to have at least one-third of their annual retainer allocated to the Deferred Unit Plan. Upon such election, a number of Deferred Units are allocated to the eligible participant in lieu of cash payment of remuneration based on the market value of the Fund units at the time of the allocation.

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.

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 Fund units equal to the number of Deferred Units held at the time of retirement. The Fund will fulfill any obligation to deliver Fund units under the Deferred Unit Plan by issuing the requisite number of Fund units from treasury.

For the three and nine months ended September 30, 2005, the Fund granted 3,535 Deferred Units and the Trust recorded $48 as compensation expense. No compensation expense relating to Deferred Units was recorded in 2004.

The following table summarizes the information about Deferred Units at September 30, 2005



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Deferred Units
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Outstanding, beginning of period -
Granted as compensation expense 3,476
Granted in lieu of distributions 59
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Outstanding, end of period 3,535
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(b) Long-term incentive plan ("LTIP"):

Effective January 1, 2005, executives and senior management employees of Union Energy are eligible to participate in the LTIP. In order to be eligible for an incentive award, two performance gates must be satisfied for the relevant Performance Cycle (being a period of one calendar year commencing on January 1st of each year). In the case of 2005 grants, annual distributed cash for 2005 must be equal or exceed an established benchmark and the Trust must have adhered to the defined preventative maintenance program and equipment specification standards as approved by the Board of Trustees.

If both performance gates are satisfied the participant will be eligible to receive an incentive award the amount of which will be determined based on the Trust's financial performance during the Performance Cycle in relation to a target performance measure for the relevant Performance Cycle. For 2005 the performance measure will be based on distributable cash per Fund unit.

One-third of an incentive award will vest and be paid shortly after the end of the relevant Performance Cycle while the balance will vest and be paid in equal amounts on each of the first two anniversaries. Amounts paid on such later dates will be increased by any cash distributions made by the Fund on the units after the end of the Performance Cycle.

12. Supplemental cash flow information:

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



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Three months ended Nine months ended
September 30, September 30,
2005 2004 2005 2004
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Accounts receivable $ (906) $ (2,086) $ (704) $ 7,709
Inventories (33) 395 (129) 1,944
Prepaid expenses 448 (49) 989 (912)
Accounts payable and
accrued liabilities (3,217) (2,722) (7,283) (11,579)
Unearned revenue 514 475 986 646
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$ (3,194) $ (3,987) $ (6,141) $ (2,192)
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b) Cash payments made related to interest and income and capital
taxes during the periods were as follows:

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Three months ended Nine months ended
September 30, September 30,
2005 2004 2005 2004
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Interest paid $ 11,103 $ 10,452 $ 22,543 $ 13,763
Income and capital taxes paid 560 485 1,854 2,021
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Included in interest are $671 and $1,625 (2004 - $478 and $1,433) paid to the Fund for the third quarter and year-to-date respectively.

13. Defined benefit pension expense:

The total expense related to the defined benefit pension plan and post-retirement benefit program recognized in operating income was $131 and $385 (2004 - $102 and $295) for the third quarter and year-to-date respectively.

14. Segmented information:

Effective July 15, 2005, the Trust has two reportable segments after the acquisition of Protectron. 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 inter-segment transactions during the period.

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

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



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Three months ended Nine months ended
September 30, September 30,
2005 2004 2005 2004
---------------------------------------------------------------------
Revenue:
Water Heater and HVAC $ 59,041 $ 56,124 $ 172,501 $ 164,767
Security 12,940 - 12,940 -
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Net sales 71,981 56,124 185,441 164,767
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Operating income:
Water Heater and HVAC 16,900 16,855 47,233 45,657
Security 1,424 - 1,424 -
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Operating income $ 18,324 $ 16,855 $ 48,657 $ 45,657
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Mark-to-mark (gain) loss
on valuation of interest
rate of contracts (15) 263 366 5,538
Interest 5,487 4,817 14,983 14,799
Income taxes 247 303 691 911
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Net income - Consolidated $ 12,605 $ 11,472 $ 32,617 $ 24,409
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September 30,
2005 2004
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Identifiable assets:
Water Heater and HVAC $ 841,714 $ 837,276
Security 158,677 -
Eliminations (1,018) -
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$ 999,373 $ 837,276
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