Sun Gro Horticulture Income Fund Releases 2006 Year-End Results - Fund Generates Record Distributable Cash and Operating Income



    TRADING SYMBOL: Toronto Stock Exchange - GRO.UN

    Sun Gro Horticulture Income Fund will hold a conference call and webcast
to discuss 2006 fourth quarter and year-end results on March 9, 2007 at
7:30 am Pacific Time (10:30 am Eastern). The call can be accessed by dialing:
1-800- 814-4860 or 416-644-3417. A replay will be available through March 23,
2007 at: 1-877-289-8525 or 416-640-1917. (Passcode: 21218117 followed by the
number sign)

    To access the live and archived webcast, please go to:
http://www.vcall.com/IC/CEPage.asp?ID=113422 or to the fund's website at:
www.sungro.com.

    VANCOUVER, March 8 /CNW/ - Sun Gro Horticulture Income Fund (the Fund)
today reported financial results for the three and twelve-month periods ended
December 31, 2006. The three-month period represents the final quarter of the
Fund's 2006 fiscal year.

    Distributable Cash

    For the fourth consecutive quarter, the Fund generated record year-over-
year distributable cash. In the three months ended December 31, 2006, it
earned $4.5 million, or $0.21 per unit, of distributable cash, up from
$3.8 million, or $0.17 per unit, in the final quarter of 2005. Distributable
cash for the twelve-month period totalled $24.3 million, or $1.10 per unit, up
from $20.1 million, or $0.91 per unit, in 2005. Distributable cash paid to
unitholders was unchanged at $5.0 million, or $0.225 per unit, for the quarter
and $19.8 million, or $0.90 per unit, for the twelve months in both years.
This represents a payout ratio of 82% for 2006 compared to 99% in fiscal 2005.
    "Thanks to the sustained improvement in our distributable cash generation
in 2006, we made significant progress in reducing the Fund's payout ratio, one
of our primary goals for the year," said Mitch Weaver, president and CEO of
the Fund's wholly owned subsidiary, Sun Gro Horticulture Canada (Sun Gro, or
the company) and a Trustee of the Fund. "We are pleased with Sun Gro's
performance and remain dedicated to building value for our unitholders over
the long term."

    
     (in thousands of dollars except per unit amounts)

                                    For the    For the
                                      three      three    For the   For the
                                     months     months       year      year
    Statement of distributable        ended      ended      ended     ended
     cash                          December   December   December   December
                                   31, 2006   31, 2005   31, 2006   31, 2005
                                   ------------------------------------------
    Cash flows from operating
     activities before change
     in non-cash operating
     working capital               $  4,629   $  3,335   $ 22,409   $ 16,675
    Adjustments:
      Realized gain on
       foreign currency
       contracts                        617      1,538      4,691      5,702
      Sustaining capital
       expenditures                    (664)      (614)    (2,650)    (2,821)
      Proceeds from government
       grants and loans                   -          -         60        688
      Repayment of government
       loans                            (50)       (25)      (200)      (100)
      Current income taxes
       expected to seasonally
       reverse in the current
       fiscal year                                (416)
                                   ------------------------------------------
    Distributable cash             $  4,532   $  3,818   $ 24,310   $ 20,144
                                   ------------------------------------------
                                   ------------------------------------------
    Distributable cash per unit    $   0.21   $   0.17   $   1.10   $   0.91
                                   ------------------------------------------
                                   ------------------------------------------

    Distributions declared
     per unit                      $  0.225   $  0.225   $   0.90   $   0.90
                                   ------------------------------------------
                                   ------------------------------------------
    

    Fourth Quarter Operating Results

    In the final three months of 2006, Sun Gro sustained the trend of gross
margin improvement it began early in the year. Gross margin for the quarter
increased to 46% from 45% in 2005. The gain was mainly due to the positive
impact of Sun Gro's pricing strategy and a return to more normal peat harvest
volumes in 2006 after an unprecedented two consecutive years of harvest
shortfalls.
    The company's fourth quarter revenues of $46.5 million were up by
$3.8 million, or 9%, from $42.7 million in 2005. The revenue gain was driven
by a 4% year-over-year increase in overall sales volumes, including a nearly
13% increase in growing mix volumes, and improved pricing performance. The
company's average fourth quarter US dollar prices for growing mixes were up by
4% and Canadian dollar revenue per equivalent bale, or EB (10 cubic feet of
peat), of growing mixes was flat from the same period in 2005. In the fourth
quarter, peat moss prices were up by 21% year-over-year in US dollars and by
17% in Canadian dollars.
    During the fourth quarter of 2006, the value of the Canadian dollar
averaged US$0.88, compared to US$0.86 in the same period of 2005. The negative
impact of the year-over-year difference in exchange rates was effectively
offset by the company's pricing strategy.
    Fourth quarter operating income of $2.5 million increased by $0.9 million
from $1.6 million in 2005. The gain was primarily due to improved product
prices and the production efficiencies that resulted from this year's larger
peat harvest. Sun Gro also realized truck loading efficiencies in its West and
Central regions as dryer harvest conditions enabled a greater number of
pallets to be shipped per truck. Per-EB distribution costs during the quarter
were down by 2% year-over-year. General and administrative expenses were up by
20% during the period, due in part to higher professional fees. These were
associated with tax matters and the establishment of necessary procedures to
satisfy regulatory requirements relating to internal controls and
certification of internal controls over financial reporting. In addition, the
company incurred interest expense of $0.3 million related to the repayment of
an income tax refund received in 2003.
    Fourth quarter net earnings were $67,000 in 2006, generating basic and
diluted earnings of $0.003 per unit. In the corresponding period of 2005, Sun
Gro generated basic and diluted earnings of ($0.54) per unit on a fourth
quarter net loss of $11.8 million. The variance between quarters was primarily
due to differences in unrealized gains on forward currency contracts and the
2005 impairment of goodwill.

    Full-Year Operating Results

    For the twelve months ended December 31, 2006, revenue of $197.3 million
was down by $1.5 million, or 0.75%, from the $198.8 million reported in fiscal
2005. The slight decrease was primarily due to a 6% decline in annual sales of
Sun Gro's higher priced mixes, partially offset by increased sales of peat
moss. In 2006, the average US dollar exchange rate was $0.88, compared to
$0.83 in 2005. As in the fourth quarter, the negative impact of foreign
exchange was effectively offset by Sun Gro's pricing strategy.
    Gross profit margin for the twelve months increased to 48% from 46% in
2005. As with the quarterly result, the improvement was primarily due to
improved pricing performance and the year's larger peat harvest. Total harvest
volumes were up by 9% over 2005.
    Annual operating income rose to a record $16.5 million from $9.6 million
in 2005, reflecting the year's improved gross margin and a 6% decrease in
distribution expenses. The distribution cost decrease was due to the year's
lower sales volumes, reduced cross-regional shipments and weather-related
truck loading efficiencies. In 2005, a peat harvest shortfall necessitated
significant shipments to customers in the central US from other regions,
pushing up distribution expenses.
    Net earnings increased to $15.9 million, or $0.72 per unit, from a loss
of $3.5 million, or ($0.16) per unit, in 2005. The net earnings difference is
mainly attributable to the $13.6 million impairment of goodwill that was
recorded in 2005 and improved overall performance.

    Operational Highlights

    Of Sun Gro's total sales in 2006, professional and retail growing mixes
accounted for 64% of revenues, peat moss contributed 30%, and fertilizers and
minerals made up the remaining 6%. In keeping with its strategic focus on the
higher margin professional growing mix market, Sun Gro launched a number of
initiatives designed to increase sales of its value-added peat and bark-based
growing mix products to professional growers. One initiative was the
development of new products, such as the lighter-weight line of Metro-Mix(R)
bark-based growing mixes that are more cost-effective to deliver to customers.
The company also continued to build sales momentum for the Multicote(R)
controlled release fertilizers that Sun Gro added to its professional product
offerings in 2005. Revenues for the Multicote(R) line in 2006 were
$1.9 million, up from $0.3 million in 2005.
    In August 2006, Sun Gro enhanced its long-term peat supply by acquiring
substantially all of the operating assets of Fort Frances, Ontario peat moss
producer Normiska Peat Inc. Funded through the company's existing acquisition
line of credit, the $3.4 million transaction gives Sun Gro an expanded
presence in Central Canada. The acquired assets included a peat processing
plant and related harvesting equipment, inventory on hand, and 1,440 acres of
largely undeveloped professional grade peat bogs.
    In September, Sun Gro strengthened its financial position by negotiating
an amendment to its credit facilities with its lenders. The amendment extended
the maturity of the company's term loans to November 1, 2009 and its revolving
operating facility to November 1, 2008. Maturity of both the term loans and
operating facility may be further extended by one year annually, subject to
the approval of the lender.
    In the final months of the year, Sun Gro entered into agreements for two
acquisitions in California, North America's largest horticultural market. Both
transactions were successfully completed early in 2007. On January 16, Sun Gro
acquired all of the outstanding shares of Sun-Up Horticulture in Sacramento,
adding two peat-mixing plants and a bark-processing plant to its North
America- wide production network. On January 24, Sun Gro purchased the
operating assets of Kellogg-Rich Grow, LLC. in Santa Maria, including an
additional peat-mixing plant. The four newly acquired plants have
significantly enhanced the company's ability to increase its share of both the
professional and retail growing mix markets in California.

    Income Tax Settlements

    In March 2007, Sun Gro reached the basis of a settlement with the United
    States Internal Revenue Service (IRS) regarding the proposed adjustment
of the interest rate charged between the Fund's Canadian and US subsidiaries
on $18.2 million of inter-company notes established at the Fund's inception.
The IRS proposed to reduce the deductible portion of the interest rate on the
notes from 13% to approximately 7%. Sun Gro has agreed with the IRS to settle
the matter at an interest rate of 10.5% and has recorded an accrual of
$0.7 million in its financial statements based on the settlement.
    As previously announced, through an internal review of tax matters Sun
Gro determined that it had filed an income tax return for 2002 that
incorrectly carried back operating losses in that year to a prior period. This
resulted in an income tax refund of $1.1 million that was received in 2003.
The operating losses should have been carried forward to offset taxable income
in subsequent years. The company has reached an agreement with the Canada
Revenue Agency and to repay the $1.1 million tax refund plus $0.3 million of
accrued interest. Payment will be made in March 2007 with funds drawn on Sun
Gro's revolving operating facility. The company has restated its 2005 balance
sheet to reflect a reclassification of this income tax asset. The benefit of
these operating losses will be available to offset taxes payable in future
years. The reclassification did not affect earnings or distributable cash in
2005 and 2006.

    Proposed Changes to Tax Legislation Affecting Income Trusts

    On October 31, 2006, the Canadian federal government announced proposed
changes to the way in which income trusts are taxed. Under the proposed
changes, a portion of the distributions that are currently paid out and taxed
in the hands of unitholders would first be subject to tax at the trust level.
If passed into legislation, the proposed changes to the existing tax treatment
of trust income and distributions will take effect in 2011 for existing income
trusts like the Fund.

    Current Tax Position

    Sun Gro is subject to income tax in both Canada and the Unites States.
The total income tax recovery of $3.4 million for 2006 consists of a recovery
of $3.9 million in Canada and an expense of $0.6 million in the United States.
In 2006, Sun Gro utilized $0.9 million of non-capital loss carryforwards to
offset taxable income in Canada. This leaves Sun Gro with $9.9 million of loss
carryforwards as at December 31, 2006 to offset future taxable income in
Canada. Of this total, $5.4 million expire in 2010 and $4.5 million expire in
2015. By utilizing these loss carryforwards, the company has not yet needed to
take any tax deduction for depreciation. These deductions will still be
available to offset future taxable income in Canada after the loss
carryforwards are utilized.
    In 2006, Sun Gro paid income taxes of $0.8 million, most of which was for
income taxes in the United States. Management anticipates that U.S. income
taxes will continue to comprise the majority of Sun Gro's income tax payments
for the next several years and that Sun Gro's Canadian current income tax
exposure will not be significant for the near future.

    
    Financial Highlights

    Comparative Statements
     of Earnings
    (In thousands of
     dollars except per      For the three                For the three
     unit amounts and        months ended                 months ended
     number of units       December 31, 2006            December 31, 2005
     outstanding and EBs)     (unaudited)                  (unaudited)
                        -------------------------   -------------------------
    Revenue             $   46,459          100%    $   42,730          100%
    Cost of goods sold      25,029           54%        23,448           55%
                        -----------                 -----------
    Gross profit            21,430           46%        19,282           45%

    Distribution expenses   10,176           22%        10,001           23%
    Selling expenses         3,680            8%         3,496            8%
    General and
     administrative
     expenses                5,066           11%         4,210           10%
                        -----------                 -----------
    Total operating
     expenses               18,922           41%        17,707           41%
                        -----------                 -----------
    Operating income         2,508            5%         1,575            4%

    Other income
     (expense), net         (2,860)          -6%          (497)          -1%
    Goodwill impairment          -            0%       (13,572)         -32%
    Interest expense        (1,066)          -2%          (812)          -2%
                        -----------                 -----------
    Earnings (loss)
     before income taxes    (1,418)          -3%       (13,306)         -31%
    Income tax
     (provision) recovery
      Current                  356            1%           565            1%
      Future                 1,129            2%           964            2%
                        -----------                 -----------
    Income tax (provision)
     recovery, net           1,485            3%         1,529            3%
                        -----------                 -----------
    Net earnings (loss)
     for the period     $       67            0%    $  (11,777)         -28%
                        -----------                 -----------
                        -----------                 -----------
    Basic and diluted
     earnings (loss) per
     unit               $     0.00                  $    (0.54)
                        -----------                 -----------
                        -----------                 -----------
    Weighted average
     number of units
     outstanding        22,023,000                  22,023,000
                        -----------                 -----------
                        -----------                 -----------

    Selected supplemental
     revenue information

      Volume in thousands
       of EBs (1)
      Growing Mixes          1,578                       1,401
      Peat Moss              1,152                       1,215
      Fertilizer and
       Minerals                 60                          66
                        -----------                 -----------
      Total company sales    2,790                       2,682
                        -----------                 -----------
                        -----------                 -----------
      Average revenue per
       EB(1) (US $)
      Growing Mixes     $    18.31                  $    17.67
      Peat Moss               9.22                        7.61
      Fertilizer and
       Minerals              36.30                       25.62
                        -----------                 -----------
      Total company
       sales            $    14.94                  $    13.31
                        -----------                 -----------
                        -----------                 -----------
      Average revenue per
       EB(1)
       (Canadian $)
      Growing Mixes     $    20.67                  $    20.59
      Peat Moss              10.41                        8.87
      Fertilizer and
       Minerals              41.00                       29.87
                        -----------                 -----------
      Total company
       sales            $    16.86                  $    15.52
                        -----------                 -----------
                        -----------                 -----------

    (1) An EB, or equivalent bale, is Sun Gro's standard unit of measure
    referring to 10 cubic feet of peat. Average revenue per EB calculation
    does not include transportation-related surcharges.

        Comparative Statements
     of Earnings
    (In thousands of
     dollars except per         For the                      For the
     unit amounts and          year ended                   year ended
     number of units       December 31, 2006            December 31, 2005
     outstanding and EBs)       (audited)                    (audited)
                        -------------------------   -------------------------
    Revenue             $  197,307          100%    $  198,761          100%
    Cost of goods sold     102,161           52%       107,317           54%
                        -----------                 -----------
    Gross profit            95,146           48%        91,444           46%

    Distribution expenses   44,410           22%        47,441           24%
    Selling expenses        15,331            8%        15,954            8%
    General and
     administrative
     expenses               18,942           10%        18,425            9%
                        -----------                 -----------
    Total operating
     expenses               78,683           40%        81,820           41%
                        -----------                 -----------
    Operating income        16,463            8%         9,624            5%

    Other income, net          449            0%           602            0%
    Goodwill impairment          -            0%       (13,572)          -7%
    Interest expense        (4,316)          -2%        (2,896)          -2%
                        -----------                 -----------
    Earnings (loss)
     before income taxes    12,596            6%        (6,242)          -4%
    Income tax
     (provision)
     recovery
      Current                 (956)           0%          (553)           0%
      Future                 4,307            2%         3,335            2%
                        -----------                 -----------
    Income tax
     (provision)
     recovery, net           3,351            2%         2,782            2%
                        -----------                 -----------
    Net earnings (loss)
     for the year       $   15,947            8%    $   (3,460)          -2%
                        -----------                 -----------
                        -----------                 -----------
    Basic and diluted
     earnings (loss)
     per unit           $     0.72                  $    (0.16)
                        -----------                 -----------
                        -----------                 -----------
    Weighted average
     number of units
     outstanding        22,023,000                  22,023,000
                        -----------                 -----------
                        -----------                 -----------

    Selected supplemental
     revenue information

      Volume in thousands
       of EBs(1)
      Growing Mixes          6,143                       6,509
      Peat Moss              6,076                       6,044
      Fertilizer and
       Minerals                324                         345
                        -----------                 -----------
      Total company sales   12,543                      12,898
                        -----------                 -----------
                        -----------                 -----------
      Average revenue per
       EB(1) (US $)
      Growing Mixes     $    18.05                  $    16.70
      Peat Moss               8.49                        7.38
      Fertilizer and
       Minerals              30.17                       23.07
                        -----------                 -----------
      Total company
       sales            $    13.73                  $    12.50
                        -----------                 -----------
                        -----------                 -----------

      Average revenue
       per EB(1)
       (Canadian $)
      Growing Mixes     $    20.46                  $    20.25
      Peat Moss               9.61                        8.94
      Fertilizer and
       Minerals              34.22                       27.98
                        -----------                 -----------
      Total company
       sales            $    15.56                  $    15.16
                        -----------                 -----------
                        -----------                 -----------

    1) An EB, or equivalent bale, is Sun Gro's standard unit of measure
    referring to 10 cubic feet of peat. Average revenue per EB calculation
    does not include transportation-related surcharges.

    

    Outlook

    The information contained in "Outlook" is forward-looking information.
Please see "Forward-Looking Statements" below for a discussion of the risks
and uncertainties in connection with forward-looking information.
    Industry-wide, supply is expected to remain tight until the 2007 harvest
begins. Assuming that the new harvest commences in line with last year's and
normal harvest levels are achieved, Sun Gro expects that overall sales volumes
will be slightly higher than in 2006, largely due to the bog resources added
by the Normiska peat acquisition and the company's recent expansion in
California.
    "Through our strategic acquisitions of the past several years, we have
enhanced and strengthened the geographic diversity of our peat resources,
while expanding our product offerings," said Weaver. "We are moving forward on
a very solid footing, and remain confident in our ability to generate
sufficient distributable cash to continue to meet the current rate of
distributions, as well as provide for other corporate purposes."
    Sun Gro holds foreign currency contracts to manage the near-term impact
of a strengthening of the Canadian dollar. For 2007, the company has entered
into foreign currency contracts with a blended rate of $1.14 (US$0.88) that
will offset approximately 70% of its expected net US dollar cash flows.

    Forward-Looking Statements

    This news release contains forward-looking statements. These statements
relate to future events or future performance and reflect Sun Gro's
expectations regarding its growth, results of operations, performance,
business prospects, opportunities or industry performance or trends. These
forward-looking statements reflect management's current internal projections,
expectations or beliefs and are based on information currently available. In
some cases, forward-looking statements can be identified by terminology such
as "may", "will", "should", "expect", "intend", "plan", "anticipate",
"believe", "predict", "potential", "continue" or the negative of these terms
or other comparable terminology. A number of factors could cause actual events
or results to differ materially from those discussed in the forward-looking
statements. Important factors that could cause actual results to differ
materially from Sun Gro's expectations include, among other things,
fluctuations in currency exchange rates, changes in tax laws, the impact of
adverse weather conditions on harvesting operations, an increase in freight
rates, and the impact of an increase in fuel costs. You should specifically
consider these factors, including the risks and uncertainties described in the
Fund's most recent annual information form. In addition, the Fund's ability to
make distributions to unitholders is entirely dependent on Sun Gro's
performance. Although management believes that the forward-looking statements
contained in this news release are based on reasonable assumptions, readers
cannot be assured that actual results will be consistent with such statements.
Forward-looking statements are made as of the date of this news release and
Sun Gro assumes no obligation to update or revise them to reflect new events
or circumstances.

    Non-GAAP Measures

    Distributable cash is not an earnings measure recognized by GAAP and does
not have a standardized meaning prescribed by GAAP. Therefore, the
distributable cash of the Fund may not be comparable to the distributable cash
measures presented by other issuers. However, distributable cash is commonly
used by Canadian open-ended trusts as an indicator of financial performance
and the Fund believes that distributable cash is a useful supplemental measure
that may assist in assessing the potential return on an investment in the
Fund.
    The calculation of distributable cash is based on cash flows from
operating activities before changes in non-cash operating working capital,
adjusted for sustaining capital expenditures, realized gains from forward
currency contracts, government grants and government loans. Certain
expenditures that are incurred as part of earnings-enhancing capital projects
and acquisitions are excluded from the determination of distributable cash
flow if the project or acquisition is funded by term debt or equity financing.

    Income Fund Profile

    Sun Gro Horticulture Income Fund was launched with the completion of an
Initial Public Offering of 22,023,000 trust units on March 27, 2002. The Fund
is dependent on Sun Gro's operations, with monthly distributions to its
unitholders based entirely on Sun Gro's performance.

    Company Profile

    Sun Gro was founded in 1929 in Vancouver, BC and has grown to become
North America's largest producer of sphagnum peat, and the largest distributor
of peat moss, and peat and bark-based growing media to professional plant
growers in the US and Canada. Sun Gro sells its professional products
primarily to greenhouse, nursery and specialty crop growers, as well as to
golf course developers and landscapers. Sun Gro also sells peat moss and peat-
based growing mixes to retail customers, either by way of private label
partnerships or under its own brand names. Approximately 80% of the company's
sales volume goes to the US.

    


    Sun Gro Horticulture Income Fund
    Consolidated Balance Sheet
    (in thousands of dollars)
    (audited)
                                                       As at         As at
                                                   December 31,  December 31,
    Assets                                             2006          2005
                                                  ---------------------------
                                                                 (Restated -
                                                                  note 2)
    Current assets
      Accounts receivable                           $   38,338    $   46,310
      Inventories (note 5)                              33,874        29,856
      Unrealized gain on foreign currency
       contracts (note 19)                                   -         3,041
      Prepaid expenses and other assets                  3,522         3,844
                                                        75,734        83,051
                                                  ---------------------------

    Property, plant and equipment (note 6)             122,459       126,608
    Intangible assets (note 6)                          33,653        35,616
    Goodwill (note 8)                                   11,202        11,202
    Other assets                                           442           119
                                                  ---------------------------
                                                    $  243,490    $  256,596
                                                  ---------------------------
                                                  ---------------------------
    Liabilities and Unitholders' Equity

    Current liabilities
      Bank indebtedness                             $      649    $    1,053
      Operating line (note 9)                           31,146        38,329
      Accounts payable and accrued
       liabilities (note 10)                            15,781        17,170
      Unrealized loss on foreign currency
       contracts (note 19)                                 824             -
      Current portion of long-term debt (note 9)           221           200
      Distribution payable to unitholders (note 11)      1,652         1,652
                                                  ---------------------------
                                                        50,273        58,404

    Other liabilities (note 12)                          4,561         4,175
    Long-term debt (note 9)                             27,511        24,261
    Future income taxes (note 14)                       13,678        17,940
                                                  ---------------------------
                                                        96,023       104,780
    Unitholders' equity
      Capital contributions (note 13)                  209,733       209,733
      Cumulative translation account                   (15,717)      (15,245)
      Cumulative earnings                               57,395        41,448
      Cumulative distributions declared (note 11)     (103,944)      (84,120)
                                                  ---------------------------
                                                       147,467       151,816
                                                  ---------------------------
                                                    $  243,490    $  256,596
                                                  ---------------------------
                                                  ---------------------------

    Commitment and contingencies (note 15)
    Subsequent events (note 20)


    Approved by the Trustees

    (Signed)                           (Signed)
    W. John Dawson, FCA                Mitchell J. Weaver
    Chairman of the                    Trustee; President and CEO
    Board of Trustees


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


    Sun Gro Horticulture Income Fund
    Consolidated Statements of Earnings and Cumulative Earnings
    (in thousands of dollars except per unit amounts and number of units
    outstanding)
    (audited)

                                                    Year ended    Year ended
                                                   December 31,  December 31,
                                                       2006          2005
                                                  ---------------------------

    Revenue                                         $  197,307    $  198,761
    Cost of goods sold                                 102,161       107,317
                                                  ---------------------------
    Gross profit                                        95,146        91,444

    Distribution expenses                               44,410        47,441
    Selling expenses                                    15,331        15,954
    General and administrative expenses                 18,942        18,425
                                                  ---------------------------
    Total operating expenses                            78,683        81,820
                                                  ---------------------------
    Operating income                                    16,463         9,624

    Other income, net (note 16)                            449           602
    Goodwill impairment (note 8)                             -       (13,572)
    Interest expense                                    (4,316)       (2,896)
                                                  ---------------------------
    Earnings (loss) before income taxes                 12,596        (6,242)
    Income tax (provision) recovery (note 14)
      Current                                             (956)         (553)
      Future                                             4,307         3,335
                                                  ---------------------------
    Income tax (provision) recovery, net                 3,351         2,782
                                                  ---------------------------
    Net earnings (loss) for the year                    15,947        (3,460)
    Cumulative earnings - beginning of year             41,448        44,908
                                                  ---------------------------
    Cumulative earnings - end of year               $   57,395    $   41,448
                                                  ---------------------------
                                                  ---------------------------

    Basic and diluted earnings per unit             $     0.72    $    (0.16)
                                                  ---------------------------
                                                  ---------------------------
    Weighted average number of units
     outstanding                                    22,023,000    22,023,000
                                                  ---------------------------
                                                  ---------------------------

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


    Sun Gro Horticulture Income Fund
    Consolidated Statements of Cash Flows
    (in thousands of dollars)
    (audited)

                                                    Year ended    Year ended
                                                   December 31,  December 31,
                                                       2006          2005
                                                  ---------------------------
    Cash flows from operating activities
    Net earnings (loss) for the year                $   15,947    $   (3,460)
      Items not affecting cash
        Depreciation, depletion and accretion            9,655         8,919
        Amortization of intangible assets                1,963         2,077
        Gain on foreign currency contracts                (826)       (1,068)
        Gain on disposal of property, plant
         and equipment                                     (23)          (30)
        Goodwill impairment                                  -        13,572
        Future income tax recovery                      (4,307)       (3,335)
                                                  ---------------------------
                                                        22,409        16,675

      Change in non-cash operating working capital       3,306        (8,583)
                                                  ---------------------------
                                                        25,715         8,092
    Cash flows from investing activities
      Acquisitions (note 4)                             (3,366)       (3,250)
      Realized gain on foreign currency contracts        4,691         5,702
      Additions to property, plant and equipment        (2,650)       (2,821)
      Proceeds from disposal of property, plant
       and equipment                                        43           498
                                                  ---------------------------
                                                        (1,282)          129

    Cash flows from financing activities
      Distributions paid to unitholders (note 11)      (19,824)      (19,824)
      Proceeds from term loans                           3,350         3,250
      Increase (decrease) in operating line             (7,183)        6,540
      Proceeds from government grants and loans            165           688
      Repayment of government loan                        (200)         (100)
                                                  ---------------------------
                                                       (23,692)       (9,446)

    Effect of exchange rate changes on cash               (337)          334
                                                  ---------------------------

    (Increase) decrease in bank indebtedness               404          (891)
    Bank indebtedness - beginning of year               (1,053)         (162)
                                                  ---------------------------
    Bank indebtedness - end of year                 $     (649)   $   (1,053)
                                                  ---------------------------
                                                  ---------------------------

    Supplemental cash flow information
      Interest paid                                 $    4,652    $    2,801
      Income taxes paid                             $      767    $      416

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



    Notes to the Consolidated Financial Statements
    (tabular amounts in thousands of dollars, except per unit amounts)

    1.  Nature of operations and basis of presentation

    Nature of operations

    Sun Gro Horticulture Income Fund (the "Fund") is a limited purpose,
    open-ended trust established under the laws of the Province of British
    Columbia on February 12, 2002. The Fund was created to acquire and hold,
    directly and indirectly, 100% of the outstanding securities of Sun Gro
    Horticulture Canada Ltd. and its wholly owned subsidiaries (collectively
    "Sun Gro" or the "Company"). These subsidiaries are: Sun Gro Horticulture
    CM Ltd., Horticulture Brands Limited Partnership, Sun Gro Holdings Inc.,
    and its wholly owned subsidiaries, Sun Gro Horticulture Processing Inc.
    and Sun Gro Horticulture Distribution Inc. Sun Gro, founded in 1929 in
    Vancouver, British Columbia, is a producer and distributor of
    horticultural-grade peat moss and peat and bark-based growing media with
    customers throughout North America.

    Basis of presentation

    The consolidated financial statements of the Fund have been prepared in
    accordance with accounting principles generally accepted in Canada.

    Fiscal year end

    The fiscal year end of the Fund is December 31. The fiscal year of the
    Fund's subsidiaries is a 52-week or 53-week period ending on the Sunday
    nearest to December 31. Fiscal years 2006 and 2005 ended on December 31,
    2006 and January 1, 2006, respectively. The financial statements of the
    Fund for the year ended December 31, 2006 include Sun Gro for the period
    from January 2, 2006 to December 31, 2006. The financial statements of
    the Fund for the year ended December 31, 2005 include Sun Gro for the
    period from January 3, 2005 to January 1, 2006.

    Principles of consolidation

    The consolidated financial statements include the accounts of the Fund
    and its wholly owned subsidiaries. All significant intercompany
    transactions and balances have been eliminated.

    Cash and cash equivalents

    Cash and cash equivalents consist of cash and highly liquid investments
    having original terms to maturity of 90 days or less when acquired.

    Inventories

    Inventories are stated at the lower of average cost or net realizable
    value. Cost of finished goods includes materials, labour and an
    allocation of manufacturing overhead.

    Property, plant and equipment

    Property, plant and equipment are stated at cost, less accumulated
    depreciation and proceeds from government grants, and are depreciated on
    a straight-line basis using the following estimated useful lives:

        Buildings                                                   20 years
        Machinery and equipment                                 3 to 8 years

    Peat bogs consist of peat bog acquisition costs and bog development costs
    to prepare bog areas for harvesting operations, such as building access
    roads, clearing surface vegetation and creating drainage ditches. Peat
    bogs are depleted based on the volume of peat produced during the period
    over the total expected volume of the peat bog.

    Depreciation of property, plant and equipment, including peat bog
    depletion, is included in cost of goods sold, except for depreciation not
    directly related to production, which is included in general and
    administrative expenses.

    Intangible assets

    Intangible assets include brand names, customer relationships and
    internally developed software and databases. The Sunshine brand name has
    been determined to have an indefinite useful life and is not amortized.
    The remaining intangible assets are amortized on a straight-line basis
    using the following estimated useful lives:

        Brand names (other than Sunshine)                           10 years
        Customer relationships                                 3 to 20 years
        Internally developed software and databases            5 to 10 years

    Amortization of brand names and customer relationships are included in
    selling expenses and amortization of internally developed software and
    databases is included in general and administrative expenses.

    Impairment of long-lived assets

    Property, plant and equipment and intangible assets with a finite life
    are reviewed for impairment whenever events or changes in circumstances
    suggest that the carrying amount of an asset may not be recoverable and
    may be in excess of its fair value.

    Impairment is assessed using a two step approach. Under the first step,
    long-lived assets are tested for recoverability by comparing the carrying
    amount of an asset to the undiscounted estimated future net cash flows
    expected from its use and disposal.

    If the carrying amount of the asset exceeds the undiscounted cash flows,
    it is considered to be impaired. The impairment loss is then measured and
    recorded as the amount by which the carrying amount of the asset exceeds
    its fair value, which is estimated based on the discounted future
    expected cash flows of the asset.

    Intangible assets with an indefinite life are reviewed for impairment
    annually or more frequently if events or changes in circumstances
    indicate that the asset might be impaired. The asset is written down when
    the carrying value exceeds its fair value.

    Goodwill

    Goodwill comprises the excess of cost over fair values of the acquired
    underlying net assets arising from business combinations accounted for
    using the purchase method and is not amortized. Management tests goodwill
    for impairment annually, or more frequently if events or changes in
    circumstances indicate that it might be impaired. Goodwill impairment is
    assessed based upon the comparison of the fair value of the Fund to the
    underlying carrying values of the Fund's net assets, including goodwill.
    If the carrying amount of the Fund exceeds its fair value, an impairment
    charge is recorded to the extent that the carrying amount of the goodwill
    exceeds its fair value (see note 8).

    Asset retirement obligations

    The Fund records the estimated fair value of a liability for asset
    retirement obligations in the period a reasonable estimate of fair value
    can be made. The Fund's asset retirement obligations relate primarily to
    the Company's peat bogs, which are located on land leased from Canadian
    provincial governments. These leases generally contain provisions that
    require the Company to rehabilitate the bogs once they become fully
    depleted. The nature of the rehabilitation varies among the leases, may
    not be specified in the leases, or may be specified at a later date. The
    obligation to rehabilitate is incurred when an area of a bog is cleared
    for harvesting operations and the liability is settled in the period in
    which the rehabilitation work is completed. In the period a reasonable
    estimate can be made, the fair value of the liability is added to the
    carrying amount of the peat bog and is depleted over its useful life. The
    liability is accreted over time through periodic charges to earnings, and
    is reduced by actual costs of rehabilitation.

    Revenue recognition

    The Fund's revenues are earned from the sale of various grades of peat
    moss, horticultural growing media (including both peat-based and bark-
    based growing mixes), and water-soluble and controlled release
    fertilizers and minerals. Revenues are recognized, net of customer
    rebates and discount programs, when the significant risks and rewards of
    ownership are transferred, which is generally at the time of shipment to
    the customer. The Fund classifies amounts charged to its customers for
    shipping and handling as part of its revenues and recognizes costs
    incurred for shipping and handling of products to customers as part of
    distribution expenses.

    Reporting currency and foreign currency translations

    The accounts of the Fund's United States operations are considered to be
    self-sustaining and are translated into Canadian dollars using the
    current rate method. Assets and liabilities are translated at the rates
    in effect at the balance sheet date and revenue and expenses are
    translated at average exchange rates for the period. Gains or losses
    arising from the translation of the financial statements of self-
    sustaining United States operations are recorded in a cumulative
    translation account in unitholders' equity.

    Hedging relationships

    The Fund generates a significant portion of its operating cash flows in
    US dollars and makes distributions to unitholders in Canadian dollars.
    The Fund utilizes foreign currency contracts to manage a portion of its
    foreign currency risk. The Fund's policy is not to utilize foreign
    currency contracts for trading or speculative purposes. All contracts
    have been marked to market value and recorded in other income.

    Income taxes

    Income taxes are accounted for using the asset and liability method.
    Under this method, future tax assets and liabilities are recognized for
    temporary differences between the financial statement carrying amounts of
    assets and liabilities and their respective tax bases. Future tax assets
    and liabilities are measured using enacted or substantively enacted tax
    rates expected to apply when the asset is realized or the liability
    settled. The effect on future tax assets and liabilities of a change in
    tax rates is recognized in income in the period that enactment or
    substantive enactment occurs.

    Use of estimates

    The preparation of financial statements in conformity with Canadian
    generally accepted accounting principles requires management to make
    certain estimates and assumptions that affect the reported amounts of
    assets and liabilities at the date of the financial statements and the
    reported amounts of revenues and expenses during the reporting period.
    Actual results could differ from those estimates. The most significant
    estimates are related to economic lives of depreciable long-lived assets,
    asset impairment, asset retirement obligations, accounts receivable
    valuation, inventory valuation, and income taxes.

    2.  Reclassification of 2005 income tax balances

    During 2006, the Company determined that it incorrectly recorded its
    income tax liabilities as a result of filing an income tax return for
    2002 that incorrectly carried back operating losses in that year to a
    prior period; rather, the operating losses should have been carried
    forward to offset taxable income in subsequent years. A refund of
    $1.1 million was received in 2003 in respect of those losses.
    Accordingly, the 2005 balances of accounts payable and accrued
    liabilities and future income taxes have been revised as follows:

                                                      Accounts
                                                   payable and        Future
                                                       accrued        income
                                                   liabilities         taxes
                                                  ------------    -----------
    December 31, 2005 balance as reported
     previously                                       $ 16,059      $ 19,051
    Reclassification of 2002 operating losses
     to future income taxes                              1,111        (1,111)
                                                  ------------    -----------
    December 31, 2005 balance as revised              $ 17,170      $ 17,940
                                                  ------------    -----------
                                                  ------------    -----------

    This correction did not affect earnings of prior periods. Accrued
    interest of $0.3 million is reflected in the 2006 consolidated statement
    of earnings. As at December 31, 2006, the total liability of $1.4 million
    is included in accounts payable and accrued liabilities on the
    consolidated balance sheet. The Company will pay the amount owing to the
    Canada Revenue Agency in March 2007.

    3.  Changes in accounting policy

    Accounting for consideration given a customer

    Effective January 1, 2006 the Fund adopted EIC-156 "Accounting by a
    Vendor for Consideration Given to a Customer", providing guidance as to
    the circumstances under which a consideration is an adjustment of the
    selling price of the vendor's products or services and under which it is
    a cost incurred by the vendor to sell its products. Early payment
    discounts to customers previously included in general and administrative
    expenses are now reported as a reduction of revenue. The EIC was applied
    retroactively and did not affect retained earnings. The adoption of the
    statement resulted in the reduction of revenue and the reduction of
    general and administrative expenses. Following the application of
    EIC-156, revenue for the years ended December 31, 2006 and 2005, was
    reduced by $1.6 million and $1.2 million respectively.

    4.  Acquisitions

    Normiska Peat Inc.

    On August 15, 2006, Sun Gro acquired substantially all of the assets of
    Normiska Peat Inc., a peat moss and bark producer in Fort Frances,
    Ontario for cash consideration of $3.4 million. The acquired assets
    include leased peat bogs, inventories and related assets at a production
    facility. The acquisition was funded through additional borrowings under
    Sun Gro's credit facility.

    The acquisition has been accounted for by the purchase method and the
    results of the acquired business have been included in the Fund's
    consolidated financial statements from the date of acquisition. These
    consolidated financial statements reflect the assets and liabilities
    acquired from Normiska Peat Inc. at assigned fair values as follows:

    Inventories                                                         $553
    Property, plant and equipment                                      2,869
    Other liabilities                                                    (56)
                                                                    ---------
    Total acquistion cost                                             $3,366
                                                                    ---------
                                                                    ---------

    Pigeon Hill Peat Ltd.

    On January 27, 2005, Sun Gro acquired substantially all of the assets of
    Pigeon Hill Peat Ltd., a peat producer in New Brunswick, for cash
    consideration of $3.25 million. The acquired assets include leased peat
    bogs, inventories and related assets at a production facility. The
    acquisition was funded through additional borrowings under Sun Gro's
    credit facility.

    The acquisition has been accounted for by the purchase method and the
    results of the acquired business have been included in the Fund's
    consolidated financial statements from the date of acquisition. These
    consolidated financial statements reflect the assets and liabilities
    acquired from Pigeon Hill Peat Ltd. at assigned fair values as follows:



    Inventories            $    90
    Property, plant
     and equipment           3,287
    Other liabilities         (127)
    -------------------------------

    Total acquisition cost $ 3,250
    -------------------------------
    -------------------------------


    5.  Inventories


                                                   December 31,  December 31,
                                                          2006          2005
                                                   ------------  ------------
    Raw materials                                    $   7,264     $   6,913
    Scratch peat                                         4,691         2,870
    Packaging                                            5,586         5,923
    Finished goods                                      16,333        14,150
                                                   ------------  ------------
                                                     $  33,874     $  29,856
                                                   ------------  ------------
                                                   ------------  ------------

    6.  Property, plant and equipment

                                                December 31, 2006
                                     ----------------------------------------
                                                   Accumulated
                                                  Depletion and
                                          Cost     Depreciation       Net
                                     ------------  ------------  ------------
    Peat bog acquisition and
     development costs                 $ 100,068     $ (16,573)    $  83,495
    Land                                   3,380             -         3,380
    Buildings                             21,499        (4,470)       17,029
    Machinery and equipment               34,153       (15,598)       18,555
                                     ------------  ------------  ------------
                                       $ 159,100     $ (36,641)    $ 122,459
                                     ------------  ------------  ------------
                                     ------------  ------------  ------------

                                                December 31, 2005
                                     ----------------------------------------
                                                   Accumulated
                                                  Depletion and
                                          Cost     Depreciation       Net
                                     ------------  ------------  ------------
    Peat bog acquisition and
     development costs                 $  96,888     $  12,557)    $  84,331
    Land                                   3,317             -         3,317
    Buildings                             21,430        (3,396)       18,034
    Machinery and equipment               32,212       (11,286)       20,926
                                     ------------  ------------  ------------
                                       $ 153,847     $ (27,239)    $ 126,608
                                     ------------  ------------  ------------
                                     ------------  ------------  ------------

    7.  Intangible assets

                                                December 31, 2006
                                     ----------------------------------------
                                                   Accumulated
                                          Cost     Amortization       Net
                                     ------------  ------------  ------------
    Brand names
      Sunshine                         $  13,753     $       -     $  13,753
      Other                                1,903          (679)        1,224
    Customer relationships                24,796        (6,422)       18,374
    Internally developed software
     and databases                         2,210        (1,908)          302
                                     ------------  ------------  ------------
                                       $  42,662     $  (9,009)    $  33,653
                                     ------------  ------------  ------------
                                     ------------  ------------  ------------

                                                December 31, 2005
                                     ----------------------------------------
                                                   Accumulated
                                          Cost     Amortization       Net
                                     ------------  ------------  ------------
    Brand names
      Sunshine                         $  13,753     $       -     $  13,753
      Other                                1,903          (488)        1,415
    Customer relationships                24,796        (5,051)       19,745
    Internally developed software
     and databases                         2,210        (1,507)          703
                                     ------------  ------------  ------------
                                       $  42,662     $  (7,046)    $  35,616
                                     ------------  ------------  ------------
                                     ------------  ------------  ------------

    8.  Goodwill

    During the 2006 annual impairment testing, Sun Gro identified no
    impairment to the value of goodwill. In 2005, Sun Gro recorded a goodwill
    impairment charge of $13.6 million. This impairment charge was due to the
    carrying amount of the recorded value of goodwill exceeding the implied
    fair value of the goodwill, as measured by the market value of the Fund's
    units. The impairment was a non-cash charge.

    9.  Credit Facilities

    Sun Gro's credit facilities include a revolving operating facility, term
    loans and an acquisition line. In September 2006, Sun Gro amended its
    credit facilities to extend the maturity date of the term loans to
    November 1, 2009 and the revolving operating facility to November 1,
    2008. In future years, subject to the approval of the lender and the
    payment of certain fees, Sun Gro may extend the maturity of the term
    loans and revolving operating facility by one year between March 1 and
    May 31 of each year. Historically, Sun Gro has been able to renew its
    credit facilities under terms acceptable to the Company. The credit
    facilities consist of the following:

      a) Revolving operating facility

    In February 2006, Sun Gro amended its revolving operating facility to
    increase the amount available at all times to $50.0 million except for
    the period from March 1 to May 31 of each year, during which the total
    amount available is $55.0 million. In addition, the amendment increased
    the senior leverage ratio permitted under the credit facility for Sun
    Gro's first quarter of each year.

    The amount of revolving operating facility available is dependent upon
    meeting certain covenant requirements. As at December 31, 2006, Sun Gro
    had drawn $31.1 million (2005 - $38.3 million) of the fully available
    $50.0 million revolving operating facility at a weighted average interest
    rate of 6.4%. In addition the revolving operating facility includes
    US$15.0 million which can be drawn on by Sun Gro's US subsidiaries to
    finance working capital and general corporate requirements. Interest on
    the revolving operating facility is due monthly at the Canadian prime
    rate, LIBOR, Banker Acceptance rate, or US base rate, plus a margin based
    on Sun Gro's senior debt ratio. Inventories, trade accounts receivable,
    certain peat bog lease assignments and owned real property are provided
    as security.

      b) Long-term debt

                                                   December 31,  December 31,
                                                          2006          2005
                                                   ------------  ------------
    Term loan due November 2009 (2005 - due
     September 2008)                                 $  17,100     $  13,750
    Term loan (US$8.5 million), due November 2009
     (2005 - due September 2008)                         9,902         9,886
    Government loans due monthly through 2011
     (2005 - due monthly through 2010)                     730           825
                                                   ------------  ------------
                                                        27,732        24,461
    Less: Current portion                                 (221)         (200)
                                                   ------------  ------------
                                                     $  27,511     $  24,261
                                                   ------------  ------------
                                                   ------------  ------------

      Term loans

    The term loans are collateralized by certain property, plant and
    equipment along with the leasing rights to certain peat bogs. Interest on
    the term loans is due monthly at the Canadian prime rate, LIBOR, Banker
    Acceptance rate, or US base rate, plus a margin based on Sun Gro's senior
    leverage ratio. At December 31, 2006, the weighted average interest rate
    on the term loans was 7.0%.

      Government grant and loans

    During September 2006, Sun Gro received a provincial government grant of
    $60,000 and related interest free loan of $105,000. The loan proceeds
    have been allocated to offset some of the expenses associated with the
    repairs and upgrades in one of our New Brunswick plants that was damaged
    by a fire in June of 2005. The grant was recorded as a reduction of the
    cost of the equipment. Principal payments on the loan are due monthly
    beginning in 2007 through 2011.

    During 2005, Sun Gro received a provincial government grant of $188,000
    and related loan of $500,000 to finance equipment purchases. The grant
    was recorded as a reduction of the cost of the equipment. The loan
    principal and interest are due monthly through 2010. Interest is
    calculated by the bank's floating base rate, currently 8.0%.

    Amounts due under the term and government loans are as follows:

      2007               $     221
      2008                     221
      2009                  27,148
      2010                     121
      2011                      21
                         ----------
                         $  27,732
                         ----------
                         ----------

      c) Acquisition line

    In August 2006, $3.4 million was drawn under the acquisition line to fund
    the acquisition of substantially all of the assets of Normiska Peat Inc.
    This amount is now included in the term loan due November 1, 2009. Of the
    total $10.0 million acquisition line $6.6 million is available to fund
    future acquisitions. (see note 20)

    10. Accounts payable and accrued liabilities

                                                   December 31,  December 31,
                                                          2006          2005
                                                   ------------  ------------
                                                                 (Restated -
                                                                  note 2)

    Trade accounts payable                           $   9,177     $   9,584
    Employee compensation payable                        3,656         3,058
    Other accrued liabilities                            2,948         4,528
                                                   ------------  ------------
                                                     $  15,781     $  17,170
                                                   ------------  ------------
                                                   ------------  ------------

    11. Distributions to unitholders

    The Fund's distribution policy is to make level distributions to
    unitholders of its available cash. The Fund makes monthly cash
    distributions of its net monthly cash receipts, less estimated amounts
    required for the payment of expenses.

    Cash distributions are payable monthly to the unitholders of record on
    the last business day of each month and are paid no later than the 15th
    day of the following month or, if such day is not a business day, no
    later than the next business day. The cash receipts of the Fund depend on
    the performance of Sun Gro and its payment of dividends and interest on
    the securities of Sun Gro held by the Fund. Due to the seasonality of Sun
    Gro's operations and cash flows during certain months, the revolving
    operating facility is used to supplement Sun Gro's available cash.

    During each of the years ended December 31, 2006 and December 31, 2005,
    the Fund declared distributions to the unitholders of $19.8 million or
    $0.90 per unit. The amounts and record dates of these distributions were
    as follows:

    Year ended December 31, 2006

        2006 Record Date                              Amount       Per Unit
                                                    -------------------------
        January 31                                  $    1,652    $   0.0750
        February 28                                      1,652        0.0750
        March 31                                         1,652        0.0750
        April 28                                         1,652        0.0750
        May 31                                           1,652        0.0750
        June 30                                          1,652        0.0750
        July 31                                          1,652        0.0750
        August 31                                        1,652        0.0750
        September 29                                     1,652        0.0750
        October 31                                       1,652        0.0750
        November 30                                      1,652        0.0750
        December 29                                      1,652        0.0750
                                                    -------------------------
                                                    $   19,824    $   0.9000
                                                    -------------------------
                                                    -------------------------

    Year ended December 31, 2005

        2005 Record Date                              Amount       Per Unit
                                                    -------------------------
        January 31                                  $    1,652    $   0.0750
        February 28                                      1,652        0.0750
        March 31                                         1,652        0.0750
        April 29                                         1,652        0.0750
        May 31                                           1,652        0.0750
        June 30                                          1,652        0.0750
        July 29                                          1,652        0.0750
        August 31                                        1,652        0.0750
        September 30                                     1,652        0.0750
        October 31                                       1,652        0.0750
        November 30                                      1,652        0.0750
        December 30                                      1,652        0.0750
                                                    -------------------------
                                                    $   19,824    $   0.9000
                                                    -------------------------
                                                    -------------------------

    The distribution of $1,652,000 with a record date of December 29, 2006
    was accrued at December 31, 2006 and paid in January 2007.

    The distributions declared have been allocated as follows for income tax
    purposes:

                                                    Year ended    Year ended
                                                   December 31,  December 31,
                                                       2006          2005
                                                   ------------  ------------
    Taxable - interest                              $   18,235    $   17,851
    Taxable - dividends                                  1,589         1,973
                                                   ------------  ------------
    Total distribution                              $   19,824    $   19,824
                                                   ------------  ------------
                                                   ------------  ------------
    Per unit                                        $   0.9000    $   0.9000
                                                   ------------  ------------
                                                   ------------  ------------

    12. Other liabilities

                                                   December 31,  December 31,
                                                       2006          2005
                                                   ------------  ------------
    Pension plan (note 17)                          $      298    $      358
    Asset retirement obligations                         4,263         3,817
                                                   ------------  ------------
                                                    $    4,561    $    4,175
                                                   ------------  ------------
                                                   ------------  ------------

    Sun Gro's asset retirement obligations relate primarily to its obligation
    to rehabilitate its leased peat bogs. Asset retirement obligations
    activity for the years ended December 31, 2006 and December 31, 2005 is
    as follows:

                                                    Year ended    Year ended
                                                   December 31,  December 31,
                                                       2006          2005
                                                   ------------  ------------
    Obligations at the beginning of the year        $    3,817    $    3,265
    Liabilities incurred                                   109           200
    Liabilities acquired from acquisitions                  56           127
    Accretion expense                                      281           225
    Rehabilitation work completed                            -             -
                                                   ------------  ------------
    Obligations at the end of the year              $    4,263    $    3,817
                                                   ------------  ------------
                                                   ------------  ------------

    The estimated undiscounted future cash flows required to settle the
    obligations are approximately $21.5 million and are discounted at credit
    adjusted risk free rates ranging from 7.2% to 7.6% over periods ranging
    from 8 to 72 years based on the estimated remaining life of the related
    bogs.

    13. Capital contributions

    The Fund's Declaration of Trust provides that an unlimited number of
    units may be issued. Each unit is transferable and represents an equal
    undivided beneficial interest in any distributions of the Fund and in the
    net assets of the Fund. All units have equal rights and privileges. Each
    unit entitles the holder thereof to participate equally in allocations
    and distributions and to one vote at all meetings of unitholders for each
    whole unit held. The units issued are not subject to future calls or
    assessments. Units are redeemable at any time at the option of the holder
    at amounts related to market prices at the time, subject to a maximum of
    $50,000 in cash redemption by the Fund in any particular month. This
    limitation may be waived at the discretion of the Trustees of the Fund.
    Redemption in excess of this amount, assuming no waiving of the
    limitation, shall be paid by way of a distribution in specie of a pro
    rata number of Sun Gro securities held by the Fund.

    As at December 31, 2006 and 2005, capital contributions consisted of
    22,023,000 units issued at $10.00 per unit, less net expenses pursuant to
    the initial public offering of $10.5 million.

    14. Income taxes

    The Fund is a unit trust for income tax purposes and, accordingly, the
    Fund is taxable only on any taxable income not allocated to the
    unitholders. Subsidiaries of the Fund are subject to tax at statutory
    rates. During the years ended December 31, 2006 and December 31, 2005,
    all taxable income of the Fund has been distributed to unitholders. Any
    income tax obligations relating to the distributions are the obligations
    of the unitholders.

    The income tax provision (recovery) varies from the amount computed by
    applying combined Canadian federal and provincial tax rates to earnings
    before income taxes as follows:

                                                    Year ended    Year ended
                                                   December 31,  December 31,
                                                       2006          2005
                                                   ------------  ------------
    Earnings (loss) before income taxes             $   12,596    $   (6,242)
                                                   ------------  ------------
                                                   ------------  ------------

    Income taxes at statutory rates                 $    4,447    $   (2,247)
    Income tax benefit of Fund distributions            (6,385)       (6,429)
    Impairment of goodwill                                   -         4,886
    Changes in statutory income tax rates               (2,516)            -
    Large corporations tax                                   -           173
    Non deductible expenses                                296           315
    Other                                                  807           520
                                                   ------------  ------------
                                                    $   (3,351)   $   (2,782)
                                                   ------------  ------------
                                                   ------------  ------------

    Temporary differences that gave rise to future income tax assets and
    liabilities are as follows:

                                                   December 31,  December 31,
                                                       2006          2005
                                                   ------------  ------------
                                                                 (Restated -
                                                                    note 2)
    Future income tax assets (liabilities)
      Property, plant and equipment                 $  (22,562)   $  (29,826)
      Intangible assets                                  2,678         3,255
      Unit issue costs                                   1,798         3,254
      Non-capital loss carryforwards                     3,168         4,020
      Asset retirement obligations                       1,322         1,466
      Other                                                (82)         (109)
                                                   ------------  ------------
                                                    $  (13,678)   $  (17,940)
                                                   ------------  ------------
                                                   ------------  ------------

    The Fund's Canadian subsidiaries have non-capital loss carryforwards of
    $5.4 million which expire in 2010, and $4.5 million which expire in 2015.
    The benefit of these non-capital loss carry forwards have been recognized
    as a future income tax asset. The subsidiaries also have capital loss
    carryforwards of $776,000 which may be used to reduce future taxable
    capital gains. Due to the uncertainty of these carryforwards being
    utilized, the capital loss carryforwards have not been recorded as an
    asset.

    Income tax matter

    Settlement of IRS Audit for years 2002-2004: In July 2005, one of Sun
    Gro's US subsidiaries received a Notice of Proposed Adjustment from the
    United States Internal Revenue Service (IRS) regarding the interest rate
    charged between the Fund's Canadian and US subsidiaries on US$18.2
    million of inter-company notes established at the Fund's inception. The
    IRS notice proposed to reduce the interest rate on the notes that would
    be deductible from 13% to approximately 7%. Sun Gro appealed the proposed
    adjustment and in February 2007 agreed with the IRS to settle the matter
    based on an interest rate of 10.5%. An accrual for the estimated
    liability of $0.8 million for the difference between the 13% rate and the
    agreed upon rate of 10.5% for all financial periods through December 31,
    2006 has been recorded in Sun Gro's 2006 financial statements.

    15. Commitments and contingencies

    Lease commitments

    The Company has various operating lease commitments relating to bog
    sites, offices and warehouse facilities requiring the following future
    minimum annual lease payments:

        2007            $   4,267
        2008                2,925
        2009                1,666
        2010                  778
        2011                  430
        Thereafter            358
                        ----------
                        $  10,424
                        ----------
                        ----------

    Total rent expense under these operating lease agreements for the years
    ended December 31, 2006 and 2005 was $4.0 million and $3.3 million,
    respectively. Certain of the facility lease agreements give the Company
    the option to renew the agreements beyond their original terms.

    Claims

    During the ordinary course of business, certain product liability claims
    may be brought against the Company and its suppliers. Management contests
    these claims and believes that they are without merit and that any
    possible settlement will have no material impact on the financial
    position or results of operations of the Company.

    16. Other income

    Other income consists of the following:

                                                     Year Ended December 31,
                                                    -------------------------
                                                       2006         2005
                                                   ------------  ------------

    Realized gain on foreign currency contracts     $    4,691    $    5,702
    Unrealized (loss) on foreign currency contracts     (3,865)       (4,634)
    Gain on disposal of property, plant and
     equipment                                              23            30
    Other                                                 (400)         (496)
                                                   ------------  ------------
    Total other income                              $      449    $      602
                                                   ------------  ------------
                                                   ------------  ------------

    17. Employee benefit plans

    Defined Contribution Plans

    Sun Gro sponsors a Registered Pension Plan (a defined contribution plan)
    for Canadian salaried and certain hourly employees (the "Canadian Plan")
    and a 401(k) Retirement Savings Plan for salaried and hourly United
    States employees (the "US Plan"). The total pension expense related to
    the US Plan and the Canadian Plan was $768,000 and $730,000 for the years
    ended December 31, 2006 and 2005, respectively.

    Pension Plan

    Sun Gro sponsors an unfunded Salaried Employee Retirement Pension (SERP)
    plan for a small number of former management employees. In 1997, Sun Gro
    altered its SERP arrangement, froze membership and benefits payable in
    this plan as of that date and accrued the full actuarially determined
    liability in the financial statements at that time. As at December 31,
    2006 and 2005, the liability for the SERP amounted to $298,000 and
    $358,000, respectively. The remaining plan participants are no longer
    active employees (see note 12).

    Long-Term Incentive Plan

    In December 2006, Sun Gro canceled the Long-Term Incentive Plan (the
    "LTIP") that was implemented in January 2005. The LTIP provided eligible
    employees the opportunity to receive units of the Fund based on the
    achievement of certain distributed cash targets, as defined in the LTIP.
    For 2006 and 2005, the threshold amount of $1.00 per unit of distributed
    cash was not met; accordingly, no contributions were made to the LTIP for
    2006 or 2005.

    Restricted Unit Plan

    In December 2006, Sun Gro's Human Resources and Compensation Committee
    (the "Committee") canceled the LTIP and authorized a restricted unit
    grant (the "2006 Grant") to certain management employees and directors,
    subject to the subsequent adoption of a restricted unit plan to be
    effective December 31, 2006 (the "Restricted Unit Plan"). Under the
    Restricted Unit Plan, the Committee shall have the authority to grant
    restricted units at any time as a bonus for services rendered by the
    participants in the fiscal year of the grant. The units will be purchased
    on the open market from funds contributed to the Restricted Unit Plan by
    Sun Gro. Units shall vest based on the passage of time on the date or
    dates determined by the Committee on the grant date, the achievement of
    certain performance criteria, or both. Additional restricted units will
    be granted automatically to participants for distributions on previously
    granted restricted units. The number of additional restricted units
    granted will be determined by the distribution paid less any applicable
    withholding taxes divided by the fair market value of the Fund's units on
    the date the distributions are paid.

    As at December 31, 2006, Sun Gro has recorded a liability in the
    consolidated financial statements of approximately $489,000 for the 2006
    Grant. The accrual represents the fair value as at December 31, 2006 of
    the units to be purchased under the 2006 Grant. The majority of the units
    will vest over a predetermined period to a maximum of three years. The
    liability will be amortized over the vesting period.

    18. Segment information

    The Fund has one reportable business segment, related to the
    manufacturing and sale of horticultural growing media. Substantially all
    assets of the business support these operations. Geographic segment
    information is presented as follows:

                                                    Year ended    Year ended
                                                   December 31,  December 31,
                                                       2006          2005
                                                   ------------  ------------
    Revenue
    United States                                   $  152,644    $  154,312
    Canada                                              28,268        26,603
    Mexico and other                                    16,395        17,846
                                                   ------------  ------------
                                                    $  197,307    $  198,761
                                                   ------------  ------------
                                                   ------------  ------------

                                                   December 31,  December 31,
    Property, plant and equipment                      2006          2005
                                                   ------------  ------------
    United States                                   $    9,805    $   11,324
    Canada                                             112,654       115,284
                                                   ------------  ------------
                                                    $  122,459    $  126,608
                                                   ------------  ------------
                                                   ------------  ------------
    Goodwill
    Canada                                          $   11,202    $   11,202
                                                   ------------  ------------
                                                    $   11,202    $   11,202
                                                   ------------  ------------
                                                   ------------  ------------
    Intangible assets
    United States                                   $   28,823    $   30,866
    Canada                                               4,830         4,750
                                                   ------------  ------------
                                                    $   33,653    $   35,616
                                                   ------------  ------------
                                                   ------------  ------------

    19. Financial instruments

    Foreign currency contracts

    During the year ended December 31, 2006, the Company realized gains on
    maturing foreign currency contracts of $4.7 million (2005 - $5.7 million)
    and recorded unrealized losses of $3.9 million (2005 - unrealized gains
    of $4.6 million) on outstanding contracts, which are included in other
    income (note 16). As at December 31, 2006, the Company held foreign
    currency contracts to purchase $56.0 million at a weighted average
    exchange rate of $1.14 (US$ 0.88). Unrealized losses on these contracts
    were $0.8 million at December 31, 2006 (2005 - unrealized gains of
    $3.0 million). These contracts mature during the period January 2007
    through December 2007.

    Fair value of financial instruments

    As at December 31, 2006, the carrying amounts of accounts receivable,
    bank indebtedness, operating line, accounts payable and accrued
    liabilities, distribution payable to unitholders, other liabilities and
    long-term debt approximate their fair values.

    Interest rate risk

    Sun Gro maintains a revolving operating facility and term debt with
    interest due monthly based on the current market interest rates. Interest
    rate fluctuations could have a material affect on interest expense.

    Concentration of credit risk

    The Company is subject to credit risk primarily through its accounts
    receivable. Credit risk on accounts receivable is minimized as a result
    of the large customer base. The Company does not require collateral for
    its accounts receivable. Certain professional product customers are
    granted deferred payment terms due to the seasonality of their
    businesses.

    20. Subsequent Events

    On January 16, 2007, Sun Gro acquired all of the outstanding shares of
    Sacramento, California horticultural growing mix and bark producer,
    Sun-Up Horticulture for US $4.3 million plus a cash payment of US $0.4
    million each year for three years, including six percent (6%) simple
    interest calculated on the balance then due.

    On January 23, 2007, Sun Gro acquired substantially all of the operating
    assets of Santa Maria, California horticultural growing mix producer,
    Kellogg-Rich Grow, LLC. for US $0.9 million and purchased the product
    inventory on hand for US $0.2 million.

    These acquisitions were funded by the existing term debt facility and
    will be accounted for by the purchase method. The financial results of
    the acquired companies will be included in the Fund's consolidated
    financial statements from the date of acquisition. Sun Gro has not yet
    finalized the allocation of the purchase price for each company.

    
    %SEDAR: 00017490E




For further information:

For further information: Bradley A. Wiens, Vice-President, Finance and
CFO, Sun Gro Horticulture Income Fund, Tel: (425) 373-3603, Email:
bradw@sungro.com, Website: www.sungro.com

Organization Profile

SUN GRO HORTICULTURE INCOME FUND

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