Davis + Henderson Income Fund Reports Revenue and Cash Flow Growth in 2007′s First Quarter

TORONTO, May 1, 2007 (Canada NewsWire via COMTEX News Network) — Website: www.dhltd.com

TSX Stock Symbol: “DHF.UN”

Davis + Henderson achieved year-over-year growth in revenue and cash flow for the three months ended March 31, 2007.

Highlights

<<
- Revenue increased by $19.2 million, or 26.7%, compared to the same
quarter in 2006. Of this increase, $12.7 million, or 17.6%, related
to the inclusion of Filogix and 9.1% was due to organic growth.

- Net income increased by $1.7 million, or 10.0%, compared to the first
quarter of 2006. This increase reflected the benefit of higher sales,
partially offset by increases in interest and amortization expense
related to the Filogix acquisition. Net income per unit decreased
5.1%, or $0.022 per unit, to $0.415 per unit. Net income per unit
included an expense for amortization of intangible assets related to
the Filogix acquisition of $0.057 per unit.

- Declared distributions in the first quarter of 2007 of $0.388 per
unit were 5.1% higher than in the first quarter of 2006.
>>

Management Commentary

We are pleased with the results of the first quarter of 2007. From a performance perspective, we benefited from the inclusion of the Filogix results and from several important organic initiatives. Organic growth in sales and cash flow in the first quarter was driven by positive results from successful program initiatives, including our iDefence(R) and BizAssist(TM) programs and stronger than expected cheque order volumes.

Looking forward, Davis + Henderson remains committed to its financial objective of delivering stable and modestly growing distributions. With the addition of Filogix, we have significantly strengthened our capabilities and the breadth of services we offer to the Canadian financial services marketplace. From our established platforms, we look to increase value for our customers and owners as we seek to build on our programs and achieve our vision.

For a more detailed discussion of first quarter results and management’s outlook, please see the Management’s Discussion and Analysis section of this report.

Caution Concerning Forward-Looking Statements

Forward-looking statements may also include, without limitation, any statement relating to future events, conditions or circumstances. Davis + Henderson cautions you not to place undue reliance upon any such forward-looking statements, which speak only as of the date they are made. Risks related to forward-looking statements include, among other things, challenges presented by declines in the use of cheques by consumers; the Fund’s dependence on a limited number of large financial institutions and dependence on their acceptance of new programs; exposure to fluctuations in residential real estate and mortgage activity; strategic initiatives being undertaken to meet the Fund’s financial objective as well as general market conditions, including economic and interest rate dynamics and investor interest in, and government regulations relating to income trusts.

Forward-looking statements are based on management’s current plans, estimates, projections, beliefs and opinions, and Davis + Henderson does not undertake any obligation to update forward-looking statements should assumptions related to these plans, estimates, projections, beliefs and opinions change.

Conference Call

Davis + Henderson will discuss its financial results for the first quarter ended March 31, 2007 via conference call at 10:00 a.m. EST (Toronto time) on Wednesday May 2, 2007. The number to use for this call is 416-644-3421 for Toronto area callers or 1-800-732-0232 for all other callers. The conference call will be hosted by Bob Cronin, Chief Executive Officer and by Catherine Martin, Chief Financial Officer. The conference call will also be available on the web by accessing CNW Group’s website www.newswire.ca/webcast/. For anyone unable to listen to the scheduled call, the rebroadcast number is: 416-640-1917 for Toronto area callers, or 1-877-289-8525 for all other callers, with reservation number 21226302 followed by the number sign. The rebroadcast will be available until Wednesday May 16, 2007. An archive recording of the conference call will also be available at the above noted web address for one month following the call and a text version of the call will be available at www.dhltd.com

ADDITIONAL INFORMATION

Additional information relating to the Fund, including the Fund’s most recently filed Annual Information Form, is available on SEDAR at www.sedar.com.

MANAGEMENT’S DISCUSSION AND ANALYSIS

Management’s Discussion and Analysis (“MD&A”) for the first quarter of 2007 should be read in conjunction with MD&A in the Davis + Henderson Income Fund’s (the “Fund” or the “Business” or “Davis + Henderson”) Annual Report for the year ended December 31, 2006, dated February 27, 2007 and the attached interim unaudited consolidated financial statements. External economic and industry factors remain substantially unchanged from the annual MD&A and the Fund’s most recently filed Annual Information Form, unless otherwise stated.

STRATEGY

The Fund’s financial goal is to deliver stable and modestly growing cash distributions to unitholders by targeting annual revenue growth in the range of 3% to 5% and maintaining margins. The Fund has three primary strategies to meet this financial goal. These are to: enhance the value of the Business’ cheque supply program; offer additional programs to serve the chequing account; and deliver programs within the lending services market. The Fund advances its strategies through internal (or organic) initiatives, as well as by partnering with third parties and by way of selective acquisitions.

In growing its cheque supply program, Davis + Henderson is focused on increasing value by continuously introducing product design alternatives, enhancing security components and combining other logical products and services into convenient and valuable packages for chequing account holders.

Other Davis + Henderson programs that serve the chequing account include a deposit program, which is directed towards small business account holders, and eSwitch(R), a service that allows financial institutions to more easily move electronic pre-authorized payments and direct deposit authorizations between chequing accounts on behalf of account holders at the time of new account openings.

To advance its third key strategy, the Business acquired Filogix and Advanced Validation Systems Limited Partnership (“AVS” or “AVS L.P.”). Among other services, Filogix provides processing services related to the origination and underwriting of mortgages in Canada. AVS, under Davis + Henderson’s brand Collateral Guard(TM), provides lenders with, among other offerings, personal property search and registration programs across Canada. The addition of these business interests has created another business platform for Davis + Henderson.

Late in 2006, the Minister of Finance (Canada) released draft legislation which, if enacted, would result in certain income trusts, including the Fund, paying taxes after fiscal 2010, similar to those paid by taxable Canadian corporations. The payment of such taxes would reduce the cash flow of the Fund, thereby reducing the amount available for distributions to unitholders. The proposed changes have caused uncertainty in the capital markets and variability in the unit prices of many income trusts, including the Fund. This uncertainty and the related impacts may affect the Fund’s ability to make future acquisitions. Since the announcement of the proposed changes, management and the Trustees have been monitoring the changes in the income trust environment and are continuing to review potential impacts on the Fund’s current strategy and the alternatives available to the Fund, consistent with protecting and enhancing unitholder value. The tax proposals are not law, but may become law at any time.

FINANCIAL INFORMATION PRESENTATION

The Fund’s results for the quarter ended March 31, 2007 include the results of the Filogix business acquired on June 15, 2006. The inclusion of Filogix had a significant impact on the financial results and has also resulted in changes to the form of Davis + Henderson’s disclosures.

With the acquisition of Filogix, the Fund now operates in two business segments, the “Davis + Henderson Segment” and the “Filogix Segment”. The Davis + Henderson Segment includes the cheque supply program, deposit program, eSwitch and the personal property search and registration programs, among other offerings. The Filogix Segment includes services related to the origination and underwriting of mortgages in Canada, among other offerings. Corporate expenses have also been segmented and include expenditures related to public company activities, a share of executive corporate management costs and certain other corporation-wide costs.

 

    <<
    OPERATING RESULTS FOR THE FIRST QUARTER

    Consolidated Statement of Income

    (in thousands of Canadian dollars, except per unit amounts, unaudited)

                                                          Three months ended
                                              March 31, 2007  March 31, 2006
    -------------------------------------------------------------------------
    Revenue                                         $ 91,149        $ 71,918
    Cost of sales and operating expenses              63,913          51,016
    Amortization of capital and other assets           3,706           3,000
    -------------------------------------------------------------------------
                                                      23,530          17,902

    Interest expense                                   2,230             695
    Net unrealized gain on interest rate swaps          (324)              -
    Amortization of intangible assets                  3,294             647
    Minority interest                                    109               -
    -------------------------------------------------------------------------
    Net income                                      $ 18,221        $ 16,560
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------
    Net income per unit, basic and diluted          $ 0.4146        $ 0.4367
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------

    Operating Results by Business Segment
    (in thousands of Canadian dollars, unaudited)

                                           Three months ended March 31, 2007
    -------------------------------------------------------------------------
                     Davis +
                   Henderson         Filogix
                     Segment         Segment       Corporate    Consolidated
    -------------------------------------------------------------------------
    Revenue         $ 78,497        $ 12,652        $      -        $ 91,149
    Cost of sales
     and operating
     expenses         54,486           8,748             679          63,913
    Amortization of
     capital and
     other assets      2,377           1,329               -           3,706
    -------------------------------------------------------------------------
                      21,634           2,575            (679)         23,530

    Interest expense       -               -           2,230           2,230
    Net unrealized
     gain on interest
     rate swaps            -               -            (324)           (324)
    Amortization of
     intangible
     assets              811           2,483               -           3,294
    Minority interest    109               -               -             109
    -------------------------------------------------------------------------
    Net income      $ 20,714        $     92        $ (2,585)       $ 18,221
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------
    >>

 

Revenue

Total revenue for the first quarter of 2007 was $91.1 million, an increase of $19.2 million, or 26.7%, compared to the first quarter of 2006. The inclusion of the Filogix Segment accounted for $12.7 million of the increase, with the balance of the increase, $6.5 million, attributable to the Davis + Henderson Segment.

Revenue for the Davis + Henderson Segment increased by 9.1% year-over-year. This is higher than the Business’ overall long-term objective of growing revenue in the 3% to 5% range and is primarily related to successful program initiatives introduced in 2006, including product and service enhancements such as iDefence(R) and BizAssist(TM) and stronger than expected order volume including the benefit of accelerated reorders related to changes in the imaging standard on cheques as further discussed below.

Historically, cheque order volumes have, on average, been declining by low single digit percentages annually as a result of declining cheque usage. In 2006 and in the first quarter of 2007, the Davis + Henderson Segment did not experience this decline and overall cheque order volume was generally comparable to prior year levels. These stronger than anticipated order volumes are believed to be the result of increased customer promotional activities and programs, the continuing movement of consumers to orders with fewer cheques and increased orders related to branch mergers or system conversion activities. In addition, during the first quarter of 2007, management estimates that the Business received incremental orders contributing approximately $2.0 million of revenue related to one particular financial institution that advised its customers of the July 1, 2007 date for converting cheques to the new imaging formats. Management believes this customer communication accelerated reorders that would otherwise have been received in future periods pursuant to normal reorder cycles. Management continues to believe that declining cheque usage will continue to contribute to declining cheque orders as it has in the past.

As well, during the first quarter of 2007, the Business also benefited from its increased ownership of the AVS business, the expansion of the personal property search and registration programs to two additional financial institutions and continued growth in eSwitch volume related to customer promotional programs. These initiatives, while still small relative to the cheque program and Filogix revenue, continue to grow and enhance the value of the Business’ service offerings.

Revenue for the Filogix Segment in the first quarter of 2007 was stronger than expected with continued year-over-year growth in fees related to mortgage origination and underwriting services. Management believes that these higher than anticipated revenues are the result of the continuing high level of sales activity in the real estate market. Market forecasters have generally expected a gradual market slowdown in 2007 and as such, this growth in the Filogix Segment may not continue in future quarters.

Cost of Sales and Operating Expenses

On a consolidated basis, cost of sales and operating expenses for the first quarter of 2007 increased by $12.9 million, or 25.3%, when compared to the first quarter of 2006. The addition of the Filogix Segment accounted for $8.7 million of the increase. The remaining $4.2 million is related to the Davis + Henderson Segment and to corporate expenses.

Of the 8.1% year-over-year increase for the Davis + Henderson Segment and corporate expenses, more than one half was related to increased revenues as described above and to revenue generating initiatives being implemented. The balance of the increase was primarily a result of increased spending on information technology costs related to infrastructure upgrade initiatives and increased support costs related to enhancing the Business’ overall computing environment.

Cost of sales and operating expenses of the Filogix Segment during the period since acquisition were consistent with expectations and reflected continued spending on product enhancements.

While Davis + Henderson operates primarily in Canada, the Business also services a U.S. subsidiary of one of our Canadian customers. All revenue and substantially all expenses relating to our U.S. cheque supply program are contracted for in U.S. dollars. As the net U.S. dollar contribution from this activity is relatively modest, the change in relative dollar valuations has not had a meaningful impact on the results of the Business.

Other Expenses and Net Income

Amortization of capital and other assets on a consolidated level increased by $0.7 million, or 23.5%, to $3.7 million when comparing the first quarter of 2007 to the same quarter in 2006. The inclusion of the Filogix Segment, which contributed $1.3 million to the increase, was partially offset by a decline in expense in the Davis + Henderson Segment of $0.6 million, relating to certain capital and other assets having become fully amortized.

Net interest expense of $2.2 million incurred in the first quarter of 2007 increased by $1.5 million compared to the comparable 2006 period. This increase reflected the drawdown of additional debt for the acquisition of the Filogix business late in the second quarter of 2006. Included in this balance is $0.2 million of amortization of net losses in fair market value of interest-rate swaps that were deferred prior to January 1, 2007. Commencing January 1, 2007, the Business no longer designates its interest-rate swaps as hedges for accounting purposes.

An unrealized gain in interest rate swaps of $0.3 million reflects the recognition of the change in fair market value of the interest-rates swaps during the first quarter of 2007. This unrealized gain is recognized in income as these swaps are no longer designated as hedges for accounting purposes. For further discussion on the amortization of net losses in fair market value and the net gain or loss from change in fair value of interest-rate swaps, see the Comprehensive Income section below.

Amortization of intangibles increased by $2.6 million to $3.3 million when comparing the first quarter of 2007 to the first quarter of 2006. This increase was primarily related to incremental intangible assets arising on the purchase of the Filogix business. These intangible assets consist of rights related to customer relationships, brand names and proprietary software and are amortized on a straight-line basis over periods ranging between 10 and 15 years.

Income earned by the Business and distributed annually to unitholders is not subject to taxation in the Business, but is taxed at the individual unitholder level. The Fund and its subsidiaries are not anticipated to be subject to taxes as long as all taxable income generated by the Fund is paid to unitholders in the form of distributions. Accordingly, there are no provisions for income taxes recorded. In 2006, the Minister of Finance (Canada) released draft legislation that could result in the Fund paying taxes on distributions made, starting in 2011. For additional information see Income Tax Matters under the Business Risk section of the Company’s 2006 Annual Report dated February 27, 2007.

With respect to delivery of products and services under its U.S. cheque supply contract, the Business does not have a permanent establishment in the U.S. for the purposes of determining tax liability and therefore does not have U.S. income tax liability.

During the second quarter of 2006, the Fund increased its ownership in AVS to 75%. The acceleration of the ownership interest in AVS was initiated by the Business so as to better serve customers on an integrated basis. With the increased ownership, the Business now fully consolidates the results of AVS. The minority interest recorded in the consolidated statement of income represents the 25% interest in the earnings of AVS that do not accrue to the Business.

Net income of $18.2 million for the first quarter of 2007 represents an increase of $1.7 million, or 10.0%, when compared to the first quarter of 2006. On a per unit basis, net income decreased by $0.0221 per unit to $0.4146 per unit. The per unit decrease reflects the negative impact of an increase in amortization of intangible assets of $0.0565 per unit related to intangible assets recorded on the acquisition of Filogix.

Comprehensive Income

On January 1, 2007, the Business adopted the Canadian Institute of Chartered Accountants (CICA) handbook sections 3855 “Financial Instruments – Recognition and Measurement”, 1530 “Comprehensive Income ” and 3251 “Equity”.

The standards require that all financial assets be classified as trading, designated at fair value, available for sale, held to maturity, or loans and receivables. In addition, the standards require that all financial assets, including all derivatives, be measured at fair value with the exception of loans and receivables, debt securities classified as held-to-maturity, and available-for-sale equities that do not have quoted market values in an active market. As required, these standards have been applied on a prospective basis and accordingly, the recording of an adjustment to opening Deficit and the recognition of Accumulated Other Comprehensive Income (Loss) (“AOCI”) have been made. As a result, the Deficit balance decreased by $0.1 million and AOCI increased by $2.2 million. Prior period balances have not been restated.

The Business expects to continue to enter into interest-rate swaps for the purpose of hedging interest rates.

During the quarter ended March 31, 2007, the Business recognized $0.2 million of comprehensive income reflecting the amortization of previously deferred net losses charged to net income as discussed above.

 

    <<
    EIGHT QUARTER CONSOLIDATED STATEMENT OF INCOME - SUMMARY
    (in thousands, except per unit amounts, unaudited)

                                2007                                    2006
                                  Q1        Q4        Q3        Q2        Q1
    -------------------------------------------------------------------------
    Revenue                 $ 91,149  $ 87,932  $ 87,966  $ 75,900  $ 71,918
    Net income              $ 18,221  $ 16,467  $ 15,785  $ 17,717  $ 16,560
    -------------------------------------------------------------------------
    Net income per unit     $ 0.4146  $ 0.3747  $ 0.3592  $ 0.4477  $ 0.4367
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------
    Weighted average
     units outstanding        43,947    43,947    43,947    39,576    37,921
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------

                                                    2005
                                  Q4        Q3        Q2
    -----------------------------------------------------
    Revenue                 $ 69,232  $ 69,845  $ 71,226
    Net income              $ 14,982  $ 15,292  $ 15,922
    -----------------------------------------------------
    Net income per unit     $ 0.3951  $ 0.4033  $ 0.4199
    -----------------------------------------------------
    -----------------------------------------------------
    Weighted average
     units outstanding        37,921    37,921    37,921
    -----------------------------------------------------
    -----------------------------------------------------
    >>

 

The Fund has generally reported quarterly revenues that are stable and growing on a year-over-year basis. The significant increases in revenue from the second to the third quarter of 2006 are primarily a result of the inclusion of the Filogix Segment revenue beginning in mid-June 2006.

Net income has been trending consistently with changing revenue. Net income per unit has generally increased consistent with increases in revenue, except, commencing in the third quarter of 2006 and continuing thereafter, when as a result of the acquisition of Filogix, as previously described, the Business incurred increased amortization of intangible assets expense.

Going forward, management believes that the combined Davis + Henderson results will be subject to seasonality with the inclusion of revenue from the Filogix Segment. Historically, Filogix has recorded stronger results in the second and third quarters, with lower results in the first quarter of each year. In the first quarter of 2007, Filogix revenue was stronger than expected.

CASH FLOW AND LIQUIDITY

Non- GAAP Measures

The following table is derived from, and should be read in conjunction with, the consolidated statement of cash flows. Management believes this supplementary disclosure provides useful additional information related to the cash flows of the Fund including the amount of cash available for distribution to unitholders, repayment of debt and other investing activities. Certain subtotals presented within the cash flows table below, such as “Adjusted cash flows from operating activities”, “Distributable cash after maintenance capital and contract payments”, “Distributable cash after all capital and contract payments” and “Distributable cash after all capital, contract payments and distributions paid”, are not defined terms under Canadian generally accepted accounting principles (“GAAP”). These subtotals are used by management as measures of internal performance and as a supplement to the statement of cash flows. Investors are cautioned that these measures should not be construed as an alternative to using net income as a measure of profitability or as an alternative to the GAAP statement of cash flows. Further, the Fund’s method of calculating each measure may not be comparable to calculations used by other income trusts bearing the same description.

 

    <<
    Summary of Cash Flows
    (in thousands of Canadian dollars, unaudited)

                                                          Three months ended
                                              March 31, 2007  March 31, 2006
    -------------------------------------------------------------------------
    Cash flows from operating activities            $ 21,674        $ 18,358

    Add:
      Changes in non-cash working capital and
       other items                                     3,399           1,849
    -------------------------------------------------------------------------
    Adjusted cash flows from operating
     activities (Note 2)                              25,073          20,207

    Less:
      Expenditures on maintenance capital              1,889           1,545
      Contract payments, maintenance                   1,517           1,250
    -------------------------------------------------------------------------
    Distributable cash after maintenance capital
     and contract payments (Note 1)                   21,667          17,412

    Less:
      Expenditures on growth capital                     183               -
      Contract payments, non-maintenance                   -               -
    -------------------------------------------------------------------------
    Distributable cash after all capital and
     contract payments (Note 1)                       21,484          17,412

    Less:
      Distributions paid during period                16,875          13,879
    -------------------------------------------------------------------------
    Distributable cash after all capital, contract
     payments and distributions paid                   4,609           3,533

    Changes in non-cash working capital and other
     items (Note 2)                                   (3,399)         (1,849)
    Cash flows used in acquisition of businesses          91            (547)
    -------------------------------------------------------------------------
    Increase in cash and cash equivalents for the
     period                                         $  1,301        $  1,137
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------
    >>

 

Note 1 Maintenance capital expenditures are defined by the Fund as

capital expenditures necessary to maintain and sustain the current

productive capacity of the Business or generally improve the efficiency

of the Business. Maintenance expenditures also include recurring fixed

customer contract payments that are made annually over the life of the

contract. Growth capital expenditures are defined by the Fund as capital

expenditures that increase the productive capacity of the Business with a

reasonable expectation of an increase in cash flow. Non-maintenance

capital expenditures are defined as expenditures, which are expected to

increase future operating cash flows of the Business, that are infrequent

and include non-maintenance contract payments, which are payment

obligations under certain long-term customer contracts.

Note 2 Changes in non-cash working capital and certain other balance

sheet items have been excluded from cash flows from operating activities

so as to remove the effects of timing differences in cash receipts and

cash disbursements, which generally reverse themselves but can vary

significantly across quarters. Minority interest and changes to other

long-term liabilities are deducted from adjusted cash flow from

operations. For details, see the Changes in Non-Cash Working Capital and

Other Items section.

 

    <<
    Summary of Cash Flows per Unit
    (in Canadian dollars, unaudited)

                                          Three months ended
                              March 31, 2007  March 31, 2006        % Change
    -------------------------------------------------------------------------
    Adjusted cash flows from
     operating activities           $ 0.5705        $ 0.5329            7.1%
    Distributable cash after
     maintenance capital and
     contract payments              $ 0.4930        $ 0.4592            7.4%
    Distributable cash after
     all capital and contract
     payments                       $ 0.4889        $ 0.4592            6.5%
    Distributions paid during
     period                         $ 0.3840        $ 0.3660            4.9%
    Distributions declared
     during period                  $ 0.3880        $ 0.3690            5.1%
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------
    >>

 

During the first quarter of 2007, the Business generated $25.1 million in adjusted cash flow from operating activities, an increase of $4.9 million compared to the first quarter of 2006. This increase is primarily due to the inclusion of the Filogix business, net of increased interest expense, and, in general, increases in cash flow from the organic growth initiatives and higher than expected order volume within the Davis + Henderson Segment, as previously described.

 

    <<
    Summary of Capital Expenditures by Segment
    (in thousands of Canadian dollars, unaudited)

                                                          Three months ended
                                              March 31, 2007  March 31, 2006
    -------------------------------------------------------------------------

    DAVIS + HENDERSON SEGMENT
      Maintenance capital expenditures              $    578        $  1,545
      Maintenance contract payments                    1,517           1,250
      Growth capital expenditures                          -               -
      Non-maintenance capital expenditures                 -               -
      Non-maintenance contract payments                    -               -
    -------------------------------------------------------------------------
                                                    $  2,095        $  2,795
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------

    FILOGIX SEGMENT
      Maintenance capital expenditures              $  1,311             n/a
      Maintenance contract payments                        -             n/a
      Growth capital expenditures                        183             n/a
      Non-maintenance capital expenditures                 -             n/a
      Non-maintenance contract payments                    -             n/a
    -------------------------------------------------------------------------
                                                    $  1,494             n/a
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------

    CONSOLIDATED
      Maintenance capital expenditures              $  1,889        $  1,545
      Maintenance contract payments                    1,517           1,250
      Growth capital expenditures                        183               -
      Non-maintenance capital expenditures                 -               -
      Non-maintenance contract payments                    -               -
    -------------------------------------------------------------------------
                                                    $  3,589        $  2,795
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------
    >>

 

The table above sets out capital expenditures and payments under customer contracts. The Business has various payment obligations under customer contracts. Certain long-term customer contracts provide for fixed contract or program initiation payments to be made, and these are treated as non-maintenance capital because they are not regularly recurring disbursements. Other fixed customer contract payments are made annually over the life of the contract and therefore are treated as recurring maintenance capital. The aggregate of all contract payments, both fixed and variable, reflects, among other things, the high degree of integration and sharing between Davis + Henderson and the financial institutions of the many activities related to ordering, data handling, customer service and other activities undertaken by financial institutions related to the operation of the cheque supply and other programs.

The level of capital expenditures in the Davis + Henderson Segment in 2007 is expected to be similar to the expenditure levels in 2006. Maintenance capital expenditures in the Davis + Henderson Segment for the quarter ended March 31, 2007 have decreased year-over-year by $1.0 million as a result of timing of expenditures. This reduction is not indicative of the full-year expenditure program. Maintenance capital expenditures in the Filogix Segment of $1.3 million were disproportionately large relative to the annual plan due to timing between quarters.

Growth expenditures of $0.2 million made in the Filogix Segment in the first quarter of 2007 relate to hardware and software acquired to support the implementation of new underwriting service customers.

The Business’ capital program provides for continued expenditures to be funded by cash flows from operations. The Business’ 2007 capital program is expected to be approximately $12 million to $13 million of which $2 million to $3 million is expected to be growth capital. Most of the increase arises as a result of including a full-year capital program for the Filogix business. The level of investment in 2007 required to maintain and sustain the productive capacity of the Business is expected to be comparable to the annualized expenditures in 2006.

Distributions

The Fund paid distributions of $16.9 million ($0.3840 per unit) during the first quarter of 2007 compared to $13.9 million ($0.3660 per unit) in the first quarter of 2006. In June 2006, the Fund issued 6,026,000 additional units to finance the Filogix acquisition. On a per unit basis, distributions paid increased by 4.9% when comparing the first quarters of 2007 and 2006.

Distributions paid can be different than distributions declared during a period. Monthly distributions are declared by the Fund for unitholders of record on the last business day of each month and are paid within 31 days following each month end. On a declared basis, the year-over-year increase in distributions per unit was 5.1% for the quarter ended March 31, 2007.

On an annualized basis, the monthly distribution rate for March 2007 was $1.58 per unit as compared to $1.50 per unit annualized in March 2006, representing an increase of 5.6%.

The estimated tax allocation of distributions declared for 2007 is 100% “other income”, as was the case for all of 2006.

The Fund may issue an unlimited number of trust units. Each trust unit is transferable and represents an equal, undivided beneficial interest in any distribution from the Fund and the net assets of the Fund. All units are of the same class with equal rights and privileges and are not subject to future calls or assessments. Each unit entitles the holder to one vote at all meetings of unitholders.

As at March 31, 2007 and May 1, 2007, 43,946,792 trust units were outstanding. This reflects the issuance of an additional 6,026,000 trust units on June 15, 2006 in exchange for subscription receipts issued on June 6, 2006, which was the first new issuance of units by the Fund since April 2, 2002.

 

    <<
    Changes in Non-Cash Working Capital and Other Items
    (in thousands of Canadian dollars, unaudited)

                                                          Three months ended
                                              March 31, 2007  March 31, 2006
    -------------------------------------------------------------------------
    Minority interest                               $    109        $      -
    Decrease in non-cash working capital items        (3,526)         (1,875)
    Changes in other operating assets and
     liabilities                                          18              26
    -------------------------------------------------------------------------
    Changes in non-cash working capital and other
     items                                          $ (3,399)       $ (1,849)
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------
    >>

 

The decrease in non-cash working capital items for the three months ended March 31, 2007 was primarily related to the payment of certain accruals, including performance based compensation which is paid annually in the first quarter of every year.

Cash Flows Used in Acquisition of Business

Cash flows relating to the acquisition of the AVS business and customer service contracts reflect minor purchase price adjustments for interests previously acquired by the Business.

Cash Balances and Long-term Indebtedness

The Business has continued to generate operating cash flow in excess of distributions, capital expenditures and contractual obligations. Management expects to use a portion of any future excess flow to pay down debt during 2007 and, in April 2007, the Fund made a voluntary debt payment of $2 million.

At March 31, 2007, cash and cash equivalents totalled $7.1 million, compared to $5.8 million at December 31, 2006.

Total debt facilities available at March 31, 2007 and December 31, 2006 were $170.0 million and include a $120.0 million non-revolving term loan and a $50.0 million revolving term credit facility. As of March 31, 2007 and December 31, 2006, the Business had drawn $120.0 million under the non-revolving term loan and $25.0 million under the revolving term credit facility. The Business is permitted to draw on the revolving facility’s available balance of $25.0 million to fund capital expenditures or for other general corporate purposes.

The Credit Agreement for the Business contains a number of covenants and restrictions including the requirement to meet certain financial ratios and financial condition tests. The financial covenants include a leverage test, a fixed charge coverage ratio test, a minimum net worth test and a limit on the maximum amount of distributions that may be made by Davis + Henderson, Limited Partnership to the Fund during each rolling, four-quarter period. Davis + Henderson was in compliance with all of its financial covenants and financial condition tests as of the end of its latest quarterly period. A copy of the Credit Agreement is available on SEDAR at www.sedar.com.

As of March 31, 2007, the Fund had interest-rate swap hedge contracts in place with certain of its lenders, such that the borrowing rates on 91% of outstanding indebtedness are effectively fixed at the interest rates and for the time periods ending as follows:

 

    <<
    (in thousands of Canadian dollars,
     unaudited)                             Fair value - Interest rate swaps
    -------------------------------------------------------------------------
    Maturity Date    Notional Amount    Asset    Liability   Interest Rate(1)
    -------------------------------------------------------------------------

    June 30, 2007    $        12,000    $  14    $       -            5.140%
    June 30, 2008             12,000       16            -            5.410%
    January 4, 2009           10,000      121            -            4.880%
    July 15, 2009             20,000        -          269            6.063%
    July 15, 2010             33,000        -          609            6.065%
    June 15, 2011             20,000        -          421            5.935%
    June 15, 2011             25,000        -          336            5.935%
    -------------------------------------------------------------------------
                     $       132,000    $ 151    $   1,635
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------
    (1) The listed interest rates are inclusive of banker's acceptance
        fees currently in effect. Such fees could increase or
        decrease depending on the Fund's financial leverage as compared
        to certain levels specified in the Credit Agreement.
    >>

 

The Fund would have to pay the fair value of $1.6 million ($2.0 million at December 31, 2006) if it were to close out four of the contracts and would receive $0.2 million ($0.2 million at December 31, 2006) on the closing of the other three contracts, as set out on the balance sheet. It is not the present intention of the Fund to close out these contracts. As at March 31, 2007, consistent with the new accounting pronouncements implemented with effect from January 1, 2007, the fair value of the interest-rate swaps is now recorded on the balance sheet. For a further description of this accounting treatment, see the Comprehensive Income section.

The Fund’s remaining indebtedness is subject to floating interest rates that may be funded either by way of prime-rate loans or through the issuance of banker’s acceptance with maturities, and thus interest rates, resetting typically in the one-month to three-month range.

The average effective interest rate applicable to the Fund’s total indebtedness was 5.77% as at March 31, 2007.

Cash flows from operations together with cash balances on hand and unutilized term credit facilities are expected to be sufficient to fund the Business’ operating requirements, capital expenditures, contractual obligations and anticipated distributions.

The Fund intends to make monthly cash distributions of its distributable cash, as defined in the Fund’s Declaration of Trust, subject to working capital requirements, debt repayments and other reserves.

In general, mutual fund trusts, like the Fund, must distribute all their taxable income to their unitholders in order not to pay income taxes in the trust. Taxable income may be less than distributable cash if the Business has excess tax deductions it can utilize to reduce taxable income.

Historically, Davis + Henderson has paid distributions below the level of distributable cash generated, using the excess to pay down debt and to fund acquisitions. It has been possible to pay less than 100% of its distributable cash generated to unitholders and not pay taxes within the trust as the Business had excess tax deductions available to reduce taxable income. These excess tax deductions diminish each year and, if the Business continues to generate growing cash flow, the Fund will need to pay out a higher proportion of the distributable cash it generates to unitholders in order not to pay taxes in the trust.

BUSINESS RISKS

For a comprehensive discussion of risks, please refer to the Fund’s most recently filed Annual Information Form and Annual Report available on SEDAR at www.sedar.com.

On October 31, 2006, the Minister of Finance (Canada) announced the “Tax Fairness Plan” and tabled a Notice of Ways and Means Motion that proposes to significantly change the income tax treatment of most publicly traded trusts and partnerships (other than certain real estate investment trusts) and the distributions and allocations, as the case may be, from these entities to their investors. On March 29, 2007, the Minister of Finance (Canada) introduced Bill C-52 in the House of Commons to implement these proposals. Under the proposals, certain income earned by these entities will be taxed in a manner similar to income earned by a corporation and distributions or allocations of such income made by these entities to investors will be taxed in a manner similar to dividends from taxable Canadian corporations. The deemed dividend will be eligible for the enhanced dividend tax credit if paid or allocated to a resident of Canada. These proposals will generally be effective beginning in the 2011 taxation year for trusts and partnerships that were publicly traded prior to November 1, 2006, such as the Fund. However, the proposals will apply immediately in any taxation year ending after 2006 if the income trust does not comply with the guidelines concerning “normal growth” released by the Department of Finance on December 15, 2006 as may be amended from time to time, unless the excess growth arose as a result of a prescribed transaction. Under these guidelines, an income trust such as the Fund will be limited as to the amount of new units it can issue after October 31, 2006 in order to avoid becoming subject to these proposals prior to the 2011 taxation year. The payment of such taxes would reduce the cash flow of the Fund thereby reducing the amount available for distributions to the Fund’s unitholders. Additionally, in spite of recent recovery in value, uncertainty in the capital markets reflected in price variability in income trust units, including the Funds, may impact the Fund’s ability to make future acquisitions.

Since the announcement of the proposed changes, management of Davis + Henderson and the Trustees have been monitoring the changes in the income trust environment and are continuing to review potential impacts on the Fund’s current strategy and the alternatives available to the Fund, consistent with protecting and enhancing unitholder value. The tax proposals may become law during 2007. Until the final legislation implementing the proposed changes becomes law, the exact impact of the changes to the Fund is unknown.

CHANGES IN ACCOUNTING POLICY

The Fund reviews all revisions to the Canadian Institute of Chartered Accountants (“CICA”) Handbook when issued. All revisions are considered and applied by the effective date or earlier if practical.

If the draft legislation to tax distributions of certain mutual fund trusts, as previously described,is enacted in 2007, the Fund will be subject to taxation in future periods and as such will commence to account for future income taxes through the recognition of future tax balances. On-going changes to future tax balances will be recognized in the Consolidated Statement of Income. Additionally, if enacted, this change may affect the carrying value of certain of the Fund’s assets including goodwill. GAAP requires accounting for changes in tax legislation only upon substantial enactment.

DISCLOSURE CONTROLS AND INTERNAL CONTROLS

The Fund and its subsidiaries have designed and maintain a set of disclosure controls and procedures designed to ensure that information required to be disclosed in filings made pursuant to Multilateral Instrument 52-109 is recorded, processed, summarized and reported within the time periods specified in the Canadian Securities Administrators’ rules and forms.

The Fund and its subsidiaries have also designed and maintain a set of internal controls over financial reporting to provide reasonable assurance regarding the reliability of financial reporting and preparation of financial statements for external purposes in accordance with Canadian GAAP.

There have been no changes in the Fund’s internal controls over financial reporting during the quarter ended March 31, 2007, that have materially affected, or are reasonably likely to materially affect its internal control over financial reporting.

OUTLOOK

Davis + Henderson’s overall long-term objective is to deliver stable and modestly growing distributions through growing revenue in the 3% to 5% range and maintaining margins. In 2007, revenues are expected to grow in excess of the targeted range as a result of the consolidation of the Filogix business acquired on June 15, 2006.

As set out in the Fund’s statement of strategy, the objective is to grow profits and cash flow by enhancing the value of our cheque supply program, offering additional programs to serve the chequing account and delivering programs within the lending services market.

In 2006, Davis + Henderson made a significant investment with the acquisition of the Filogix business. This strategically aligned acquisition added another significant platform for the Business and in 2007 is contributing to growth in the overall business of the Fund.

The Business’ operational plans include many initiatives which, when combined, are intended to allow us to meet our objectives. Examples include further implementations and enhancements of our iDefence, BizAssist and eSwitch programs relating to the chequing account. Relating to lending markets, the Business looks to gain market share from its personal property search and registration programs and by increasing volumes related to mortgage origination and underwriting services.

The Business’ capital program provides for continued expenditures to be funded by cash flows from operations. The Business’ 2007 capital program is expected to be approximately $12 million to $13 million, of which $2 million to $3 million is expected to be growth capital. Most of the increase over the 2006 expenditures of $9.9 million arises as a result of including a full year capital program for the Filogix business.

Late in 2006, the Minister of Finance (Canada) released draft legislation which, if enacted, would result in certain income trusts, including the Fund, paying taxes after fiscal 2010, similar to those paid by taxable Canadian corporations. The payment of such taxes would reduce the cash flow of the Fund, thereby reducing the amount available for distributions to unitholders. The proposed changes have caused uncertainty in the capital markets and variability in the unit prices of many income trusts, including the Fund. This uncertainty and the related impacts may affect the Fund’s ability to make future acquisitions. Since the announcement of the proposed changes, management and the Trustees have been monitoring the changes in the income trust environment and are continuing to review potential impacts on the Fund’s current strategy and the alternatives available to the Fund, consistent with protecting and enhancing unitholder value. The tax proposals are not law, but may become law at any time.

Caution Concerning Forward-looking Statements

This MD&A contains certain statements that constitute forward-looking information within the meaning of applicable securities laws (“forward-looking statements”) including those set out in the Outlook above. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements of the Business, or developments in Davis + Henderson’s industry, to differ materially from the anticipated results, performance, achievements or developments expressed or implied by such forward-looking statements. Forward-looking statements include all disclosure regarding possible events, conditions or results of operations that are based on assumptions about future economic conditions and courses of action. Forward-looking statements may also include, without limitation, any statement relating to future events, conditions or circumstances. Davis + Henderson cautions you not to place undue reliance upon any such forward-looking statements, which speak only as of the date they are made.

Risks related to forward-looking statements include, among other things, challenges presented by declines in the use of cheques by consumers; the Fund’s dependence on a limited number of large financial institutions and dependence on their acceptance of new programs; strategic initiatives being undertaken to meet the Fund’s financial objective, as well as general market conditions, including economic and interest rate dynamics and investor interest in, and government regulations relating to income trusts. Forward-looking statements are based on management’s current plans, estimates, projections, beliefs and opinions, and Davis + Henderson does not undertake any obligation to update forward-looking statements should assumptions related to these plans, estimates, projections, beliefs and opinions change.

 

    <<
    CONSOLIDATED BALANCE SHEETS
    (in thousands of Canadian dollars, unaudited)

    -------------------------------------------------------------------------
                                                    March 31,    December 31,
                                                        2007            2006
    -------------------------------------------------------------------------

    ASSETS
    Current Assets:
      Cash and cash equivalents                     $  7,089        $  5,788
      Accounts receivable                             18,386          18,299
      Inventory                                        4,767           5,238
      Prepaid expenses                                 3,179           3,920
    -------------------------------------------------------------------------
                                                      33,421          33,245
    Capital assets (note 3)                           31,601          32,567
    Other assets (note 4)                              8,933           7,369
    Interest rate swaps (note 8 )                        151               -
    Intangible assets (note 5)                       127,252         130,546
    Goodwill (note 6)                                438,502         438,546
    -------------------------------------------------------------------------
                                                    $639,860        $642,273
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------

    LIABILITIES AND UNITHOLDERS' EQUITY
    Current Liabilities:
      Accounts payable and accrued liabilities      $ 32,271        $ 36,600
      Distributions payable to unitholders             5,801           5,625
      Current portion of disbursement obligations
       on customer contracts (note 7)                  2,962           2,195
      -----------------------------------------------------------------------
                                                      41,034          44,420

    Disbursement obligations on customer
     contracts (note 7)                                2,212           2,195
    Long-term indebtedness (note 8 )                 145,000         145,000
    Other long-term liabilities (note 9)               2,469           2,520
    Interest rate swaps (note 8 )                      1,635               -
    Minority interest                                    372             263
    -------------------------------------------------------------------------
                                                     192,722         194,398
    Unitholders' Equity:
      Trust units (note 10)                          474,585         474,585
      Deficit                                        (25,424)        (26,710)
      Accumulated other comprehensive income (loss)   (2,023)              -
    -------------------------------------------------------------------------
                                                     447,138         447,875

    Commitments (note 11)
    -------------------------------------------------------------------------
                                                    $639,860        $642,273
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------

    The accompanying notes are an integral part of these consolidated
    financial statements.

    CONSOLIDATED STATEMENTS OF INCOME
    (in thousands of Canadian dollars, except per unit amounts, unaudited)

    -------------------------------------------------------------------------
                                                          Three months ended
                                              March 31, 2007  March 31, 2006
    -------------------------------------------------------------------------

    Revenue                                         $ 91,149        $ 71,918
    Cost of sales and operating expenses              63,913          51,016
    Amortization of capital and other assets           3,706           3,000
    -------------------------------------------------------------------------
                                                      23,530          17,902

    Interest expense                                   2,230             695
    Net unrealized gain on interest rate swaps          (324)              -
    Amortization of intangible assets                  3,294             647
    Minority interest                                    109               -
    -------------------------------------------------------------------------
    Net income                                      $ 18,221        $ 16,560
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------
    Net income per unit, basic and diluted          $ 0.4146        $ 0.4367
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------
    The accompanying notes are an integral part of these consolidated
    financial statements.

    CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
    (in thousands of Canadian dollars, unaudited)

    -------------------------------------------------------------------------
                                                          Three months ended
                                              March 31, 2007  March 31, 2006
    -------------------------------------------------------------------------

    Net income                                      $ 18,221        $ 16,560

    Other comprehensive income:

      Amortization of transitional adjustment
       to net income                                     176               -
    -------------------------------------------------------------------------

    Other comprehensive income                      $    176        $      -
    -------------------------------------------------------------------------

    Total comprehensive income                      $ 18,397        $ 16,560
    -------------------------------------------------------------------------
    The accompanying notes are an integral part of these consolidated
    financial statements.

    CONSOLIDATED STATEMENTS OF DEFICIT AND ACCUMULATED OTHER
    COMPREHENSIVE INCOME (LOSS)
    (in thousands of Canadian dollars, unaudited)

    -------------------------------------------------------------------------
                                                          Three months ended
                                              March 31, 2007  March 31, 2006
    -------------------------------------------------------------------------

    Deficit:
    Deficit, beginning of period                    $(26,710)       $(31,049)
    Transitional adjustment on adoption of
     financial instruments standards                     116               -
    Net income                                        18,221          16,560
    Distributions                                    (17,051)        (13,993)
    -------------------------------------------------------------------------
    Deficit, end of period                           (25,424)        (28,482)

    Accumulated Other Comprehensive Income (Loss):
    Accumulated other comprehensive income (loss),
     beginning of period                                   -               -
    Transitional adjustment on adoption of
     financial instruments standards                  (2,199)              -
    Other comprehensive income :
      Amortization of transitional adjustment
       to net income                                     176               -
    -------------------------------------------------------------------------
    Accumulated other comprehensive income (loss),
     end of period                                    (2,023)              -
    -------------------------------------------------------------------------
    Deficit and accumulated other comprehensive
     income (loss), end of period                   $(27,447)       $(28,482)
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------
    The accompanying notes are an integral part of these consolidated
    financial statements.

    CONSOLIDATED STATEMENTS OF CASH FLOWS
    (in thousands of Canadian dollars, unaudited)

    -------------------------------------------------------------------------
                                                          Three months ended
                                              March 31, 2007  March 31, 2006
    -------------------------------------------------------------------------

    Cash and cash equivalents provided by
     (used in):

    OPERATING ACTIVITIES
    Net income                                      $ 18,221        $ 16,560
    Add:
      Amortization of capital assets                   3,038           1,914
      Amortization of other assets                       668           1,086
      Amortization of intangible assets                3,294             647
      Amortization of transitional adjustment
       in interest expense                               176               -
      Net unrealized gain on interest rate swaps        (324)              -
      Minority interest                                  109               -
    -------------------------------------------------------------------------
                                                      25,182          20,207

    Decrease in non-cash working capital items        (3,526)         (1,875)
    Changes in other operating assets and
     liabilities                                          18              26
    -------------------------------------------------------------------------
                                                      21,674          18,358
    -------------------------------------------------------------------------
    FINANCING ACTIVITIES
    Distributions paid to unitholders                (16,875)        (13,879)
    -------------------------------------------------------------------------
                                                     (16,875)        (13,879)
    -------------------------------------------------------------------------
    INVESTING ACTIVITIES
    Expenditures on capital assets                    (2,072)         (1,545)
    Payments pursuant to long-term supply contracts   (1,517)         (1,250)
    Acquisitions and acquisition adjustments              91            (547)
    -------------------------------------------------------------------------
                                                      (3,498)         (3,342)
    -------------------------------------------------------------------------
    Increase in cash and cash equivalents
     for the period                                    1,301           1,137
    Cash and cash equivalents, beginning of
     period                                            5,788           8,304
    -------------------------------------------------------------------------
    Cash and cash equivalents, end of period        $  7,089        $  9,441
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------

    Supplementary information:
      Cash interest paid                            $  2,072        $    845
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------
    The accompanying notes are an integral part of these consolidated
    financial statements.

    Notes to Consolidated Financial Statements
    Three months ended March 31, 2007 and 2006
    (in thousands of Canadian dollars, except unit and per unit amounts,
    unaudited)

    1.  SIGNIFICANT ACCOUNTING POLICIES

    The consolidated financial statements have been prepared using the
    following accounting policies generally accepted in Canada and follow the
    same accounting policies and their method of application as the Fund's
    consolidated financial statements for the year ended December 31, 2006,
    which are included in the 2006 Annual Report along with changes in
    accounting policies that became effective January 1, 2007. They do not
    conform in all respects with disclosures required for annual financial
    statements and should be read in conjunction with the audited
    consolidated financial statements of the Fund for the year ended
    December 31, 2006.

    2.  INCOME TAXES

    Income earned by the Fund that is distributed annually to unitholders is
    not subject to taxation in the Fund, but is taxed at the individual
    unitholder level.

    The Fund does not recognize any future tax assets or liabilities on
    temporary differences between the carrying amount of the balance sheet
    items and their corresponding tax basis because the Fund is committed to
    distribute to its unitholders, all or virtually all of its taxable income
    and taxable gains. The Fund intends to continue to meet the "mutual fund
    trust" requirements under the Income Tax Act (Canada) and there is no
    indication that the Fund will fail to meet those requirements. As at
    December 31, 2006, the excess of the carrying value of the Fund's assets
    and liabilities, excluding goodwill, over their tax basis is
    approximately $112.0 million (2005 - $(6.3) million) of which
    $130.5 million (2005 - $6.9 million) is related to the carrying value of
    intangible assets over their tax basis. The tax basis of goodwill as at
    December 31, 2006 was $157.8 million (2005 - $169.7 million).

    On December 21, 2006 the Minister of Finance (Canada) released draft
    legislation (the "Proposals") relating to the federal income taxation of
    publicly-traded trusts and partnerships. On March 29, 2007, the Minister
    of Finance (Canada) introduced Bill C-52 in the House of Commons to
    implement these Proposals. The Proposals are contemplated to apply to a
    publicly-traded trust that is a specified investment flow-through entity
    (a "SIFT") which existed before November 1, 2006 ("Existing Trust")
    commencing with taxation years ending in or after 2011.

    Certain distributions attributable to a SIFT will not be deductible in
    computing the SIFT's taxable income, and the SIFT will be subject to tax
    on such distributions at a rate that is substantially equivalent to the
    general tax rate applicable to Canadian corporations. Distributions paid
    by a SIFT as returns of capital will not be subject to this tax. There
    will be circumstances where an Existing Trust may lose its transitional
    relief where its equity capital grows beyond certain dollar limits
    measured by reference to the Existing Trust's market capitalization at
    the close of trading on October 31, 2006.

    The Fund is a SIFT as defined in the Proposals. If enacted, the Fund
    would be subject to taxes on certain income earned from investments in
    its subsidiaries. The Fund would also be required to recognize future
    income tax assets and liabilities with respect to the temporary
    differences of its assets and liabilities and those of its subsidiaries
    that are expected to reverse in or after 2011.

    3.  CAPITAL ASSETS

                                                              March 31, 2007
    -------------------------------------------------------------------------
                                                  Accumulated
                                          Cost   amortization            Net
    -------------------------------------------------------------------------
    Machinery and equipment       $     15,127   $      6,970   $      8,157
    Computer equipment and
     software                           38,046         17,373         20,673
    Furniture, fixtures and
     leasehold improvements              7,898          5,127          2,771
    -------------------------------------------------------------------------
                                  $     61,071   $     29,470   $     31,601
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------

                                                           December 31, 2006
    -------------------------------------------------------------------------
                                                  Accumulated
                                          Cost   amortization            Net
    -------------------------------------------------------------------------
    Machinery and equipment       $     15,014   $      6,689   $      8,325
    Computer equipment and
     software                           36,211         14,827         21,384
    Furniture, fixtures and
     leasehold improvements              7,774          4,916          2,858
    -------------------------------------------------------------------------
                                  $     58,999   $     26,432   $     32,567
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------

    Amortization during the three months ended March 31, 2007 was $3,038 (Q1
    2006 - $1,914).

    4.  OTHER ASSETS

                                                    March 31,    December 31,
                                                        2007            2006
    -------------------------------------------------------------------------
    Cost:
      Long-term supply contracts                $     12,051    $      9,750
      Deferred finance costs                           1,451           1,451
      Other                                              370             370
    -------------------------------------------------------------------------
                                                      13,872          11,571

    Accumulated amortization                          (4,939)         (4,202)
    -------------------------------------------------------------------------
                                                $      8,933    $      7,369
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------

    Amortization during the three months ended March 31, 2007 on long-term
    supply contracts and deferred finance fees was $668 (Q1 2006 - $1,086)
    and $69 (Q1 2006 - nil), respectively. Amortization of deferred finance
    fees is recognized as interest expense.

    5.  INTANGIBLE ASSETS

                                                    March 31,    December 31,
                                                        2007            2006
    -------------------------------------------------------------------------
    Cost:
      Cheque supply outsourcing contracts       $     16,329    $     16,329
      Customer service contracts                       3,669           3,669
      Proprietary software                            41,993          41,993
      Brand names                                      8,400           8,400
      Customer relationships                          77,887          77,887
    -------------------------------------------------------------------------
                                                     148,278         148,278
    Accumulated amortization                         (21,026)        (17,732)
    -------------------------------------------------------------------------
                                                $    127,252    $    130,546
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------

    Amortization during the three months ended March 31, 2007 was $ 3,294 (Q1
    2006 - $647).

    6.  GOODWILL

                                                    March 31,    December 31,
                                                        2007            2006
    -------------------------------------------------------------------------
    Balance, beginning of period                $    438,546    $    361,288
    Goodwill acquired during the period:
      AVS acquisition                                    (44)          5,318
      Filogix acquisition                                  -          71,940
    -------------------------------------------------------------------------
    Balance, end of period                      $    438,502    $    438,546
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------

    7.  DISBURSEMENT OBLIGATIONS ON CUSTOMER CONTRACTS

                                                    March 31,    December 31,
                                                        2007            2006
    -------------------------------------------------------------------------
    Current portion                             $      2,962    $      2,195
    Long-term portion                                  2,212           2,195
    -------------------------------------------------------------------------
    Total disbursement obligations on customer
     contracts                                  $      5,174    $      4,390
    -------------------------------------------------------------------------

    The Fund has fixed customer contract disbursement obligations payable
    as of March 31, 2007 as follows:

    2007                                                        $      1,445
    2008                                                               2,962
    2009                                                                 767
    -------------------------------------------------------------------------
                                                                $      5,174
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------

    8.  LONG-TERM INDEBTEDNESS

                                                    March 31,    December 31,
                                                        2007            2006
    -------------------------------------------------------------------------

    Non-revolving term loan                     $    120,000    $    120,000
    Revolving credit facility                         25,000          25,000
    -------------------------------------------------------------------------
                                                $    145,000    $    145,000
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------

    The Fund has $170.0 million of available term credit facilities due
    June 15, 2011 (December 31, 2006 - $170.0 million), consisting of a
    $120.0 million non-revolving term loan and a $50.0 million revolving
    credit facility. The facilities bear interest at rates that depend on
    certain financial ratios of the Fund and vary in accordance with
    borrowing rates in Canada and the United States. The credit facilities,
    including any hedge contracts with the lenders, are secured in first
    priority by a pledge of substantially all of the Fund's assets and by a
    pledge of the Fund's indirect ownership interests in Davis + Henderson
    L.P. The carrying value of long-term indebtedness approximates its fair
    value as it bears interest at floating rates that reset in most cases
    within three months and in all cases within one year.

    The Credit Agreement for the Fund contains a number of covenants and
    restrictions including the requirement to meet certain financial ratios
    and financial condition tests. As at March 31, 2007, the Fund was in
    compliance with all of its financial covenants and financial condition
    tests.

    As of March 31, 2007, the Fund has entered into interest-rate swap hedge
    contracts with its lenders, such that the borrowing rates on
    $132.0 million, or 91.0%, of its outstanding term indebtedness are
    effectively fixed at interest rates and for periods shown in the
    following table:

                                       Fair value - Interest rate swaps
    -------------------------------------------------------------------------
    Maturity Date    Notional Amount    Asset    Liability   Interest Rate(1)
    -------------------------------------------------------------------------
    June 30, 2007    $        12,000    $  14    $       -            5.140%
    June 30, 2008             12,000       16            -            5.410%
    January 4, 2009           10,000      121            -            4.880%
    July 15, 2009             20,000        -          269            6.063%
    July 15, 2010             33,000        -          609            6.065%
    June 15, 2011             20,000        -          421            5.935%
    June 15, 2011             25,000        -          336            5.935%
    -------------------------------------------------------------------------
                     $       132,000    $  151   $   1,635
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------
    (1) The listed interest rates are inclusive of banker's acceptance
        fees currently in effect. Such fees could increase or
        decrease depending on the Fund's financial leverage as compared
        to certain levels specified in the Credit Agreement.

    At March 31, 2007, the Fund would have to pay the fair value of
    $1.6 million ($2.0 million at December 31, 2006) if it were to close out
    four of the contracts and would receive $0.2 million ($0.2 million at
    December 31, 2006) on the closing of the balance of the contracts as set
    out on the balance sheet.

    9.  OTHER LONG-TERM LIABILITIES

                                                    March 31,    December 31,
                                                        2007            2006
    -------------------------------------------------------------------------

    Deferred compensation program               $      1,682    $      1,659
    Employee future benefits                             787             861
    -------------------------------------------------------------------------
                                                $      2,469    $      2,520
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------

    The deferred compensation program is a five-year long-term incentive plan
    for management, subject to certain performance criteria and vesting
    terms, payable after December 31, 2008.

    Employee future benefits consist of defined contribution pension plans
    and a non-pension post-retirement benefit plan. Obligations relating to
    employee future benefits relate to the non-pension post-retirement
    benefit plan.

    The Fund's principal pension plans are defined contribution pension plans
    that provide pensions to substantially all eligible employees. Total
    expense for the Fund's defined contribution pension plan for the three
    months ended March 31, 2007 was $0.5 million (Q1 2006 - $0.4 million).

    The Fund's non-pension post-retirement benefit plan provides certain
    health care, life insurance and dental benefits to eligible employees.
    Terms of the plan were amended effective January 1, 2005, resulting in a
    reduction in obligations of $1.8 million and actuarial losses of
    $1.6 million. Reductions in obligations from the plan amendment are being
    amortized over three-and-one-half years and the actuarial losses are
    being amortized over six years.

    10. TRUST UNITS

    An unlimited number of trust units may be issued by the Fund pursuant to
    the Fund's Declaration of Trust. Each unit is transferable and represents
    an equal, undivided beneficial interest in any distributions from the
    Fund and in the net assets of the Fund. All units are of the same class
    with equal rights and privileges and are not subject to future calls or
    assessments. Each unit entitles the holder to one vote at all meetings of
    unitholders and a pro rata share of distributions declared by the Fund.
    The Fund intends to make monthly cash distributions of its distributable
    cash, as defined in the Fund's Declaration of Trust, subject to working
    capital requirements and other reserves. The net proceeds from the
    issuance of trust units and the number of units outstanding are as
    follows:

                                                    March 31,    December 31,
                                                        2007            2006
    -------------------------------------------------------------------------

    Balance, beginning of period                $    474,585    $    365,385
    Units issued                                           -         109,200
    -------------------------------------------------------------------------
    Balance, end of period                      $    474,585    $    474,585
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------
    Units outstanding, end of period              43,946,792      43,946,792
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------

    The weighted average number of units outstanding during the three months
    ended March 31, 2007 was 43,946,792 (Q1 2006 - 37,920,792).

    11. COMMITMENTS

    As of March 31, 2007, the Fund has annual lease obligations with respect
    to real estate, vehicles and equipment as follows for the years ending:

    2007                                                        $      3,201
    2008                                                               3,405
    2009                                                               2,589
    2010                                                               2,577
    2011                                                               1,072
    Thereafter                                                           583
    -------------------------------------------------------------------------
                                                                $     13,427
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------

    12. RELATED PARTY TRANSACTIONS

    A Trustee of the Fund serves as Chairman of the Board of Canada Post
    Corporation, one of the Company's major suppliers. Total purchases from
    this supplier during the three months ended March 31, 2007 were $6,044
    (Q1 2006 - $5,922). As at March 31, 2007, $1,405 (December 31, 2006 -
    $1,285) was owing to Canada Post Corporation. This amount has been
    included in accounts payable and accrued liabilities.

    13. SIGNIFICANT CUSTOMERS

    For the three months ended March 31, 2007, the Fund earned 78% (Q1 2006 -
    83%) of its revenue from its seven largest customers. Five of these
    customers individually accounted for greater than 10% but not more than
    17% of the Fund's total revenue.

    14. SEGMENTED INFORMATION

    The Fund operates its business in two segments, organized on the basis of
    products, services and markets served. The Davis + Henderson Segment
    includes the cheque supply program, deposit bags program, eSwitch(R) and
    the personal property search and registration programs, among other
    offerings. The Filogix Segment includes services related to the
    origination and underwriting of mortgages in Canada, among other
    offerings.

    Segment assets include goodwill and intangible assets recognized with the
    acquisition of businesses included with each respective Segment.

    Corporate costs include costs incurred by the Fund for the operation of a
    public entity. Corporate assets consist primarily of cash and cash
    equivalents.

    Prior to June 15, 2006, the Fund operated in one segment, the Davis +
    Henderson Segment.

    Summarized financial information for the three months ended March 31,
    2007 are as follows:

                                                          Three months ended
                                                              March 31, 2007
    -------------------------------------------------------------------------
                           Davis +
                         Henderson       Filogix
                           Segment       Segment     Corporate   Consolidated
    -------------------------------------------------------------------------
    Revenue             $   78,497    $   12,652    $        -    $   91,149
    Cost of sales and
     operating expenses     54,486         8,748           679        63,913
    Amortization of
     capital and other
     assets                  2,377         1,329             -         3,706
    -------------------------------------------------------------------------
                            21,634         2,575          (679)       23,530

    Interest expense             -             -         2,230         2,230
    Net unrealized gain
     on interest rate
     swaps                       -             -          (324)         (324)
    Amortization of
     intangible assets         811         2,483             -         3,294
    Minority interest          109             -             -           109
    -------------------------------------------------------------------------
    Net income          $   20,714    $       92    $   (2,585)   $   18,221
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------
    Capital and
     other assets
     expenditures       $    2,095    $    1,494    $        -    $    3,589
    Intangible assets   $    7,000    $  120,252    $        -    $  127,252
    Goodwill            $  366,562    $   71,940    $        -    $  438,502
    Total assets        $  445,686    $  187,085    $    7,089    $  639,860
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------

    For the Davis + Henderson Segment, five customers individually accounted
    for greater than 10% but not more than 19% of the Davis + Henderson
    Segment revenue. For the Filogix Segment, three customers individually
    accounted for greater than 10% but not more than 16% of the Filogix
    Segment revenue.

    Supplementary Information

    -------------------------------------------------------------------------
    (in thousands of       Three      Three      Three      Three      Three
     Canadian dollars,    months     months     months     months     months
     except per unit       ended      ended      ended      ended      ended
     amounts,              March   December  September       June      March
     unaudited)         31, 2007   31, 2006   30, 2006   30, 2006   31, 2006
    -------------------------------------------------------------------------
    Revenue            $  91,149  $  87,932  $  87,966  $  75,900  $  71,918
    Cost of sales and
     operating expenses   63,913     62,034     62,754     52,989     51,016
    Amortization of
     capital and
     other assets          3,706      3,902      3,752      3,286      3,000
    -------------------------------------------------------------------------
                          23,530     21,996     21,460     19,625     17,902
    Interest expense       2,230      2,186      2,248        887        695
    Net unrealized
     gain on interest
     rate swaps             (324)         -          -          -          -
    Amortization of
     intangible assets     3,294      3,254      3,339        996        647
    Minority interest        109         89         88         25          -
    -------------------------------------------------------------------------
    Net income         $  18,221  $  16,467  $  15,785  $  17,717  $  16,560
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------

    Cash flows from
     operating
     activities        $  21,674  $  22,111  $  22,786  $  26,498  $  18,358
    Change in non-cash
     working capital
     items                 3,526      1,671        268     (4,424)     1,875
    Minority interest       (109)       (89)       (88)       (25)         -
    Changes in other
     operating assets
     and liabilities         (18)       (70)       (90)       (50)       (26)
    -------------------------------------------------------------------------
    Adjusted cash flows
     from operations(2)   25,073     23,623     22,876     21,999     20,207

    Less:
      Expenditures on
       maintenance
       capital             1,889      1,912        997      1,377      1,545
      Contract payments,
       maintenance         1,517         20        800        625      1,250
    -------------------------------------------------------------------------
    Distributable cash
     after maintenance
     capital and
     contract
     payments(1)          21,667     21,691     21,079     19,997     17,412

    Less:
      Expenditures on
       growth capital(3)     183         34        884        411          -
      Expenditures on
       non-maintenace
       capital                 -          -          -          -          -
      Contract payments,
       non-maintenance         -          -          -          -          -
    -------------------------------------------------------------------------
    Distributable cash
     after all capital
     and contract
     payments          $  21,484  $  21,657  $  20,195  $  19,586  $  17,412
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------

    Summary of Cash Flows Per Unit

    -------------------------------------------------------------------------
    Adjusted cash flows from
     operating activities   $ 0.5705  $ 0.5375  $ 0.5205  $ 0.5559  $ 0.5329
    Distributable cash after
     maintenance capital
     and contract payments  $ 0.4930  $ 0.4936  $ 0.4796  $ 0.5053  $ 0.4592
    Distributable cash
     after all capital and
     contract payments      $ 0.4889  $ 0.4928  $ 0.4595  $ 0.4949  $ 0.4592
    Distributions paid
     during period          $ 0.3840  $ 0.3780  $ 0.3750  $ 0.3750  $ 0.3660
    Distributions declared
     during period          $ 0.3880  $ 0.3810  $ 0.3750  $ 0.3750  $ 0.3690
    -------------------------------------------------------------------------

    (1) Maintenance capital expenditures are defined by the Fund as
        capital expenditures necessary to maintain and sustain the current
        productive capacity of the Business or generally improve the
        efficiency of the Business. Maintenance expenditures also include
        recurring fixed customer contract payments that are made annually
        over the life of the contract. Growth capital expenditures are
        defined by the Fund as capital expenditures that increase the
        productive capacity of the Business with a reasonable expectation of
        an increase in cash flow. Non-maintenance capital expenditures are
        defined as expenditures, which are expected to increase future
        operating cash flows of the Business, that are infrequent and include
        non-maintenance contract payments which are payment obligations under
        certain long-term customer contracts.

    (2) Changes in non-cash working capital and certain other balance sheet
        items have been excluded from cash flows from operating activities so
        as to remove the effects of timing differences in cash receipts and
        cash disbursements, which generally reverse themselves but can vary
        significantly across quarters. Minority interest and changes to other
        long-term liabilities are deducted from adjusted cash flow from
        operations.

    (3) For the quarter ending June 30, 2006, approximately $0.4 million
        pertaining to Filogix capital expenditures has been classified as
        growth capital rather than maintenance capital.

    Condensed Consolidated Balance Sheet
    -------------------------------------------------------------------------
    (in thousands of
     Canadian dollars,     March   December  September       June      March
     unaudited)         31, 2007   31, 2006   30, 2006   30, 2006   31, 2006
    -------------------------------------------------------------------------
    Cash and cash
     equivalents       $   7,089  $   5,788  $   8,893  $   4,607  $   9,441
    Other current
     assets               26,332     27,457     27,384     28,834     17,136
    Capital and other
     assets               40,685     39,936     41,908     42,701     29,220
    Goodwill and other
     intangible assets   565,754    569,092    572,215    575,635    369,131

    -------------------------------------------------------------------------
                       $ 639,860  $ 642,273  $ 650,400  $ 651,777  $ 424,928
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------

    Payables and other
     current
     liabilities       $  41,034  $  44,420  $  47,100  $  48,064  $  32,697
    Other long-term
     liabilities           6,316      4,715      4,797      4,604      5,328
    Long-term
     indebtedness        145,000    145,000    150,000    150,000     50,000
    Minority interest        372        263        351        263          -
    Unitholders' equity  447,138    447,875    448,152    448,846    336,903

    -------------------------------------------------------------------------
                       $ 639,860  $ 642,273  $ 650,400  $ 651,777  $ 424,928
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------

    Distribution History
    -------------------------------------------------------------------------
                                                               Distributions
                                                                 per unit(1)
    Month          2007     2006     2005     2004     2003     2002     2001
    -------------------------------------------------------------------------
    January     $0.1280  $0.1220  $0.1200  $0.1150  $0.1117  $0.1083  $     -
    February     0.1280   0.1220   0.1200   0.1150   0.1117   0.1083        -
    March        0.1320   0.1250   0.1200   0.1168   0.1117   0.1083        -
    April             -   0.1250   0.1200   0.1168   0.1133   0.1083        -
    May               -   0.1250   0.1200   0.1168   0.1133   0.1083        -
    June              -   0.1250   0.1200   0.1168   0.1133   0.1083        -
    July              -   0.1250   0.1200   0.1168   0.1133   0.1117        -
    August            -   0.1250   0.1220   0.1168   0.1133   0.1117        -
    September         -   0.1250   0.1220   0.1168   0.1133   0.1117        -
    October           -   0.1250   0.1220   0.1168   0.1150   0.1117        -
    November          -   0.1280   0.1220   0.1200   0.1150   0.1117        -
    December(2)       -   0.1280   0.1220   0.1200   0.1150   0.1117   0.0427
    -------------------------------------------------------- ----------------
                $0.3880  $1.5000  $1.4500  $1.4044  $1.3599  $1.3200  $0.0427
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------
    (1) Monthly distributions are made to unitholders of record on the last
        business day of each month and are paid within 31 days following each
        month end.
    (2) Distributions paid in 2001 are in respect of the 12 calendar days
        from December 20, 2001 to December 31, 2001.

    Tax Allocation of Distributions

    -------------------------------------------------------------------------
                       2007     2006      2005      2004      2003      2002

    -------------------------------------------------------------------------
    Dividend income    0.0%     0.0%      0.0%     15.0%     19.5%     16.9%
    Other income     100.0%   100.0%     91.6%     75.2%     69.5%     71.5%
    Return of
     capital           0.0%     0.0%      8.4%      9.8%     11.0%     11.6%
    -------------------------------------------------------------------------
    Total
     distributions
     for the period  100.0%   100.0%    100.0%    100.0%    100.0%    100.0%
    -------------------------------------------------------------------------

    The above tax allocation of distributions for 2007 represents an estimate
    based on the total expected distributions for the year ended December 31,
    2007.

    Other Statistics
    (in thousands, except per unit amounts)

                                                         Number
                 Trading price range of                of units       Market
                  units (TSX: "DHF.UN")    Average  outstanding   capitaliz-
      Quarter   -------------------------    daily   at quarter     ation at
        ended     High     Low     Close    volume          end  quarter end
    -------------------------------------------------------------------------
    2007 - Q1   $ 17.19  $ 15.00  $ 16.60       87       43,947      729,517
    2006 - Q4     19.80    13.80    15.46      143       43,947      679,417
         - Q3     19.49    17.21    19.19       96       43,947      843,339
         - Q2     21.99    16.99    17.70      100       43,947      777,858
         - Q1     23.18    19.50    21.50       61       37,921      815,297
    2005 - Q4     24.00    16.32    23.19       92       37,921      879,383
         - Q3     24.07    19.50    21.19       88       37,921      803,542
         - Q2     22.85    19.58    20.92       61       37,921      793,303
         - Q1     23.25    19.65    22.00       67       37,921      834,257
    2004 - Q4     23.25    18.80    22.70       81       37,921      860,802
         - Q3     19.62    16.75    19.45       58       37,921      737,559
         - Q2     19.34    15.05    18.00       93       37,921      682,574
         - Q1     19.40    16.71    19.40       92       37,921      735,663
    2003 - Q4     17.50    15.10    17.45       67       37,921      661,718
         - Q3     15.65    14.52    15.30       99       37,921      580,188
         - Q2     15.20    12.91    15.00       82       37,921      568,812
         - Q1     13.69    12.48    12.94       92       37,921      490,695
    2002 - Q4     13.25    11.22    12.86      139       37,921      487,661
         - Q3     12.13    10.45    12.10      165       37,921      458,842
         - Q2     11.25    10.00    10.95      176       37,921      415,233
         - Q1     11.20    10.11    10.51      149       18,955      199,217
    >>

 

ABOUT DAVIS + HENDERSON

Davis + Henderson and its predecessors have been serving the Canadian financial services industry since 1875. Through integrated service offerings, Davis + Henderson is a market leader in providing programs to customers who offer chequing account and lending services within Canada. Davis + Henderson Income Fund is listed on the Toronto Stock Exchange, symbol DHF.UN.

Further information can be found in the disclosure documents filed by Davis + Henderson Income Fund with the securities regulatory authorities, available at www.sedar.com.

%SEDAR: 00017092EF

SOURCE: Davis + Henderson Income Fund

Bob Cronin, Chief Executive Officer, Davis + Henderson, Limited Partnership, (416) 696-7700, extension 5301, bob.cronin@dhltd.com; Catherine Martin, Chief Financial Officer, Davis + Henderson, Limited Partnership, (416) 696-7700, extension 5265, catherine.martin@dhltd.com