Somerset Entertainment Income Fund
TSX : SOM.UN

Somerset Entertainment Income Fund

November 08, 2006 06:00 ET

Somerset Entertainment Income Fund Announces Financial Results for the Third Quarter of 2006

TORONTO, ONTARIO--(CCNMatthews - Nov. 8, 2006) - Somerset Entertainment Income Fund ("The Fund") (TSX:SOM.UN)



Third Quarter Financial Highlights

- Sales increased 15.3% to $22.9 million
- EBITDA decreased to $4.4 million
- $3.9 million in distributable cash
- Payout ratio of 84.6%

Nine months ended September 30, 2006 Highlights

- Sales increased 26.8% to $66.8 million
- EBITDA declined 8.4% to $10.9 million
- $9.5 million in distributable cash
- Payout ratio of 128.6%


Somerset Entertainment Income Fund ("The Fund") (TSX:SOM.UN) announced today the financial results for the three and nine month period ended September 30, 2006.

"Unfortunately, due to challenges facing the Compass division, Somerset delivered lower than expected results during the quarter," said Andy Burgess, CEO, Somerset Entertainment, "Although Somerset will post record sales this year, we are disappointed in the results and are focused on improving future performance," he said.

Three months ended September 30, 2006

Sales for the three months ended September 30, 2006 were $22.9 million, a 15.3% increase from $19.9 million in the previous year. Sales in Canada and Internationally decreased compared to the previous quarter. Canadian sales were affected by lower rollout sales and reduced sales over the prior year and declined 7.2% to $2.4 million. International sales declined 20.7% to $2.1 million as a result of reduced sales to retailers in Germany and the UK, where the prior period included rollout sales to new customers obtained in 2005.

US sales increased to $18.4 million during the quarter, a 25.9% increase over the same period in the prior year. Excluding the Compass division, sales decreased by 8.9% or $1.3 million. Although the prior year results exclude Compass sales, Compass sales decreased to US$4.6 million from US$9.7 million in the prior year. Lower retail sales, markdowns associated with the relaunch of the product line and the strategic decision by a mass merchant retailer to suspend orders for a period of time all contributed to Compass's reduced sales.

Gross profit for the quarter was $8.3 million, a 7.8% decrease from the same period in the previous year. Gross profit as a percentage of sales was 36.4% compared with 45.1% for the three month period ended September 30, 2005.

EBITDA decreased to $4.4 million during the third quarter, a decrease of $1.6 million or 26.7% compared with $6.0 million for the three months ended September 30, 2005. Compass generated a loss of $0.2 million compared to estimated EBITDA of $3.5 million in the previous year.

Beginning in the month of August, distributions were reduced 40% to $0.05 per unit ($0.60 on an annualized basis). The fund generated $3.9 million in cash (including the non-controlling interest share) and made three distributions totalling $3.3 million. Payout ratio for the period was 84.6%.

Nine months ended September 30, 2006

Consolidated sales for the nine months ended September 30, 2006 were $66.8 million compared with $52.7 million in the nine months ended September 30, 2005. The 26.8% increase was positively affected by increased sales in the U.S. The slight decrease in Canadian sales of 1.3% to $7.3 million and 17.5% decline in International sales to $6.0 million partially offset the increased sales for the period. In the U.S. sales increased 40.6% to $53.6 million. $19.9 million in sales is attributed to the Compass acquisition.

Gross profit increased $1.0 million during the period to $22.7 million, a 4.6% increase over the nine months ended September 30, 2005. As a percentage of sales, gross profit represented 34.0% compared with 41.1% previously.

EBITDA decreased $1.0 million to $10.9 million for the nine months ended September 30, 2006. The decline of 8.4% was influenced by lower sales, $0.9 million write-down of Richard Simmons production costs and royalty advances and increased selling, general and administrative expenses associated with an increased headcount and professional fees. Although the prior year results exclude Compass earnings, Compass generated $2.3 million EBITDA compared to an estimated EBITDA of $7.8 million in the same nine month period of the previous year.

The Fund generated $9.5 million in distributable cash (including the non-controlling interest share) during the nine months ended September 30, 2006. Nine distributions were made totalling $12.2 million and resulting in a payout ratio of 128.6%.

Operational Review

At Compass, lower retail sales on all major product lines compared to the previous year generated reduced replenishment orders and lower sales for Compass during the quarter. However, Compass is in the process of upgrading these offerings through a combination of new packaging design and enhanced value propositions over the next six months.

A compilation line at a major customer was re-launched during the quarter and Compass supported markdowns of the previous line for a total cost of $700,000. Because the retailer had restrictions on its purchase of the new inventory, wholesale shipments were lower than expected and the associated gross margin was not sufficient to offset these costs. Preliminary results of the new product line have been below expectations and lower than previous year's sales.

In addition, a major mass merchant customer reviewed the strategy for Compass's 5 Star Collection music line during the quarter. All orders for this product line were suspended for several weeks while the customer tested an enhanced version. This resulted in reduced sales for Compass during the quarter. Recently, the customer decided to list the updated product but will move it from an endcap to an in-line location in order to merchandise new release product there. Further sales of the 5 Star Collection are expected to be reduced as sales from in-line locations are typically lower than from endcaps.

Elsewhere in the Somerset business, the company increased penetration with current customers by receiving a commitment to expand the Reflections line to an additional 500 stores at a major mass merchant. The product is expected to ship in January 2007 and will be merchandised on the smaller sidewing display. Internationally, Somerset rolled out the Reflections program to 250 stores of a UK mass merchant. In France, Somerset completed a successful test of Fisher-Price® and secured an order to expand the program to 75 hypermarkets. Somerset has contracted a new distributor in Spain and has shipped its first order to that territory following the bankruptcy of the previous distributor last year.

Foreign Exchange Hedging Policy

Previously the Fund hedged its entire net U.S. dollar exposure for a full two years. Because of the significant changes in the exchange rate over the past two years, the cost of purchasing forwards and the lack of flexibility in the existing policy, Somerset will now adopt a policy which requires significantly lower amounts of forward exchange contracts. In the future, the Fund will hedge 50-100% of the estimated U.S. dollar exposure for the next twelve months; 25-50% for the next 13-24 months; and 0-25% for the next 25-36 months.

Conference Call

Andy Burgess, Chief Executive Officer, and Rob Meier, Chief Financial Officer, will hold a conference call to discuss results for the Fund on Wednesday, November 8, 2006, at 11:00 a.m. (EST). To access the call, please dial 416-644-3427 or 1-866-249-2165. A replay of the conference call will be available as of 1:00 p.m. the same day, until 11:59 Wednesday, November 15, 2006. To access the replay dial, 416-640-1917 or toll free at 1-877-289-8525 followed by the passcode 21207725#.

Nine months ended September 30, 2006 compared with nine months ended September 30, 2005

The Fund completed its initial public offering on March 18, 2005. As a result, the attached unaudited consolidated statement of income and deficit provides comparative information only for the period from March 18, 2005 to September 30, 2005 (see Exhibit 1). To provide meaningful disclosure to the reader, this release covers the nine months ended September 30, 2006, compared with the nine months ended September 30, 2005 (see Exhibit 2). As the comparative nine month period is, except with respect to the period from March 18, 2005 to September 30, 2005, prior to the Fund's acquisition of Holdings, this information is not based on the Fund's results and is provided for reference purposes only. All financial information included for the period from January 1, 2005 to March 17, 2005, is derived from the unaudited consolidated results of Holdings.

Non-GAAP Measures

References to "EBITDA" are to earnings before interest, income taxes, amortization and non-controlling interest. References to "Adjusted EBITDA" are to EBITDA adjusted for the effects of non-recurring items. Non-recurring items are transactions or events that management believes are unusual in the context of a publicly traded issuer in the business of producing and distributing specialty music primarily through interactive displays, and are not expected to reoccur within the foreseeable future. These include non-recurring stock compensation costs associated with the purchase for cancellation of employee stock options outstanding under the former corporate structure and the issuance of preferred shares and cash to employees prior to the Fund's acquisition of Somerset Entertainment Holdings Inc.

Management views distributable cash as an operating performance measure, as it is a measure generally used by Canadian income funds as an indicator of financial performance. Distributable cash is defined as EBITDA, less interest, capital expenditures and current tax expense. The long-term incentive plan ("LTIP") non-cash compensation expense has been added back and the full amount of the LTIP funding requirements relating to the current fiscal year have been deducted in determining distributable cash. Distributable cash is significant, as it summarizes the funds available for distribution to Unitholders. As the Fund will distribute a significant portion of its cash on an ongoing basis, and since EBITDA and Adjusted EBITDA are metrics used by many investors to compare issuers on the basis of the ability to generate cash from operations, management believes that, in addition to net income or loss, EBITDA and Adjusted EBITDA are useful supplementary measures from which to make adjustments to determine distributable cash.

EBITDA, Adjusted EBITDA and distributable cash are not earnings measures recognized under generally accepted accounting principles ("GAAP") and do not have standardized meanings prescribed by GAAP. Therefore, EBITDA, Adjusted EBITDA and distributable cash may not be comparable with similar measures presented by other entities. Investors are cautioned that EBITDA and Adjusted EBITDA should not be construed as alternatives to net income or loss determined in accordance with GAAP as indicators of the Fund's performance, or to cash flows from operating, investing and financing activities as measures of liquidity and cash flow.

Forward-Looking Statements

Certain statements in this news release contain "forward-looking" statements that involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements of the Fund or Somerset to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. When appearing in this news release, these statements use such words as "may," "will," "intend," "should," "expect," "believe," "plan," "anticipate," "estimate," "predict," "potential," "continue," the negative of these terms or other similar terminology. These statements reflect current expectations regarding future events and operating performance and speak only as of the date of this news release. Forward-looking statements involve significant risks and uncertainties, should not be read as guarantees of future performance or results, and will not necessarily be accurate indications of whether or not such results will be achieved. A number of factors could cause actual results to differ materially from the results discussed in the forward-looking statements, including, but not limited to, customer concentration, integration of the Compass business, lack of written customer contracts, reliance on suppliers and other risks described in the Fund's Annual Information Form dated March 18, 2006 (which can be found at www.sedar.com). The forward-looking statements contained in this news release are made as of the release date of this document, and the Fund does not assume any obligation to update or revise such statements to reflect new events or circumstances.

About Somerset Entertainment

Somerset Entertainment Ltd. is the leading North American producer and distributor of specialty music sold through non-traditional retailers using proprietary interactive displays. The Company has 19 diverse product lines targeted at consumers over the age of 30, which represents a variety of music genres, including world, relaxation, jazz, classical, children's and hit compilations. The extensive network includes over 28,000 interactive displays in 18,500 locations in more than 20 countries. Based in Toronto, Canada, the Company employs over 150 people at offices in Toronto, Ontario (Canada); Buffalo Grove, Illinois, and Minneapolis, Minnesota, (U.S.A.); and Essex, England (U.K.).

Units of the Somerset Entertainment Income Fund are traded on the Toronto Stock Exchange under the symbol SOM.UN. Additional information relating to the Somerset Entertainment Income Fund, including unaudited financial information as of September 30, 2006, is available at www.somersetent.com and www. sedar.com.




EXHIBIT 1

Somerset Entertainment Income Fund

CONSOLIDATED STATEMENTS OF
INCOME AND DEFICIT
Unaudited

(in thousands of Canadian dollars, except for units and per-unit amounts)

Period from
Nine months March 18, 2005
Three months ended ended to
September 30, September 30, September 30,
2006 2005 2006 2005
($) ($) ($) ($)
--------------------------------------------------------------------------
Sales $ 22,903 $ 19,871 $ 66,802 $ 39,985
Cost of goods sold 14,573 10,902 44,111 23,702
--------------------------------------------------------------------------
Gross profit 8,330 8,969 22,691 16,283
--------------------------------------------------------------------------

Expenses
Selling, general and
administrative 4,488 3,443 14,087 7,413
Provincial sound tax
credits (123) (389) (705) (753)
Foreign exchange
loss (gain) (403) (62) (1,583) 263
--------------------------------------------------------------------------
Income before
amortization,
interest,
taxes and
non-controlling
interest 4,368 5,977 10,892 9,360
--------------------------------------------------------------------------

Amortization of
property, plant and
equipment 111 127 327 227
Amortization of
deferred financing
costs 56 23 168 48
Amortization of
intangible assets 2,422 1,393 7,303 3,001
Interest 313 112 725 233
--------------------------------------------------------------------------
Income before income
Taxes and
non-controlling
interest 1,466 4,322 2,369 5,851
--------------------------------------------------------------------------
Provision for
(recovery of) income
taxes (note 7)
Current 168 226 558 149
Future (1,534) 526 (5,022) (475)
--------------------------------------------------------------------------
(1,366) 752 (4,464) (326)
--------------------------------------------------------------------------
Income before
non-controlling
interest 2,832 3,570 6,833 6,177
Non-controlling
interest (528) (885) (1,273) (1,531)
--------------------------------------------------------------------------
Net income for the
period 2,304 2,685 5,560 4,646

Deficit, beginning
of period (4,780) (792) (792) -
Distributions
declared (2,656) (2,394) (9,900) (5,147)
--------------------------------------------------------------------------
Deficit, end of
period $ (5,132) $ (501) $ (5,132) $ (501)
--------------------------------------------------------------------------
--------------------------------------------------------------------------

Basic and diluted
net income per unit $ 0.159 $ 0.266 $ 0.384 $ 0.461
--------------------------------------------------------------------------
--------------------------------------------------------------------------

Weighted average
number of units
outstanding,
Basic (note 8) 14,493,300 10,074,400 14,493,300 10,074,400
--------------------------------------------------------------------------
--------------------------------------------------------------------------



EXHIBIT 2

Somerset Entertainment Income Fund

Selected Financial Information for the
three and nine months ended September 30, 2006


Three months Nine months
July 1 to September 30 January 1 to September 30
--------------------------------------------------------------------------
--------------------------------------------------------------------------
2006 2005 2006 2005 (1)
--------------------------------------------------------------------------
Sales $ 22,903 $ 19,871 $ 66,802 $ 52,671
Cost of goods sold 14,573 10,902 44,111 31,019
--------------------------------------------------------------------------
Gross profit 8,330 8,969 22,691 21,652
36.4% 45.1% 34.0% 41.1%
Selling, general and
administrative
expenses 4,488 3,443 14,087 10,299
Provincial sound tax
credit (123) (389) (705) (815)
Foreign exchange loss
(gain) (403) (62) (1,583) 263
--------------------------------------------------------------------------
Adjusted EBITDA (2) $ 4,368 $ 5,977 $ 10,892 $ 11,905
--------------------------------------------------------------------------
19.1% 30.1% 16.3% 22.6%
--------------------------------------------------------------------------
Non-recurring items:
Employee compensation
(3) - - - 6,281
--------------------------------------------------------------------------
EBITDA (2) 4,368 5,977 10,892 5,624
--------------------------------------------------------------------------
Amortization 2,589 1,543 7,798 3,367
Interest 313 112 725 290
--------------------------------------------------------------------------
Income before income
taxes and
non-controlling
interest $ 1,466 $ 4,322 $ 2,369 $ 1,967
--------------------------------------------------------------------------


(1) Derived from the unaudited consolidated results of Holdings for the period from January 1, 2005 to March 17, 2005, and from the unaudited consolidated results of the Fund for the period from March 18, 2005 to September 30, 2005.

(2) See "Definition of EBITDA, Adjusted EBITDA, Distributable Cash and Non-GAAP Measures".

(3) Employee compensation costs are non-recurring costs associated with the purchase for cancellation of employee stock options outstanding under the former corporate structure and the issuance of preferred shares and cash to employees prior to the Fund's acquisition of Holdings.

Income taxes and net income have not been presented as they are not comparable, due to the changes to the capital structure of Holdings and the Fund in connection with the IPO completed on March 18, 2005.

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