Supremex Inc.
TSX : SXP

Supremex Inc.

November 08, 2006 20:22 ET

Supremex Income Fund: 2006 Third-Quarter Results

MONTREAL, QUEBEC--(CCNMatthews - Nov. 8, 2006) - Not for distribution in the United States or over U.S. newswires - Supremex Income Fund (TSX:SXP.UN)

- Revenue of $48.6 M vs $48.2 M in Q3 2005

- EBITDA of $12.1 M

- Payout ratio of 86.7% for the quarter and 84.8% since the inception of the Fund

Supremex Income Fund ("the Fund"), Canada's largest provider of stock and custom-manufactured envelopes (TSX:SXP.UN), today announced steady revenue for the third quarter ended September 30, 2006.

The following financial information includes the results of the Fund for the 184-day period ended September 30, 2006 along with the results of the acquired businesses for the nine-month period ended September 30, 2005 and for the period from January 1, 2006 to March 30, 2006.

For the third quarter of fiscal 2006, the Fund posted revenue of $48.6 million compared with $48.2 million for the corresponding period last year. Revenue grew by 5.1% to $8.2 million in the U.S. and remained steady at $40.4 million in Canada during the quarter.

EBITDA of $12.1 million remained stable with Adjusted EBITDA of the third quarter of last year,.

Distributable cash was $10.4 million for the third quarter and $21.2 million since the inception of the Fund on March 31st, 2006. The Fund payout ratio, or distribution declared as a percentage of distributable cash earned, was 86.7% for the third quarter of 2006 and 84.8% since the inception of the Fund. The excess distributable cash generated is explained by the timing in maintenance capital expenditures and the lower net financing charges resulting from the cash generated during the period.

"Within a few quarters, Supremex has already proven it can keep its promises, namely of being a stable income fund that generates highly predictable revenues, profits and above all, distributable cash, " said Gilles Cyr, President and Chief Executive Officer of the Fund.

"On October 31, without any consultation, the federal government changed the rules related to income trusts. Like other Canadian income trusts, Supremex saw a significant drop in its unit value. This was a very sad week for all investors in trusts. I just want to mention that these changes have no impact on the actual business of Supremex. We have in place sufficient financing to execute our growth strategy. The tax changes will take effect for Supremex only in 2011, which gives us time to reassess our overall strategy to maximize the value of our unitholders' equity in the long term," says Cyr.

For the first nine months of fiscal 2006, the Fund generated revenue of $145.8 million, compared to $145.9 million for the same period in 2005 and an Adjusted EBITDA of $35.8 million, compared to $35.7 million last year.

On March 31, 2006 the Fund closed its first initial public offering by way of the issue of 17,500,000 trust units at a price of $10 per unit for net proceeds of $165.1 million. On April 28, 2006 an additional 2,500,000 trust units were issued subsequent to the exercise of the over-allotment option, bringing the net proceeds to $189.2 million.

Organizational Change

At the end of last October, Jean Moreau, Vice-President and General Manager - Eastern Region departed from Supremex to take up new challenges. Mr. Moreau had held this position since early 2006. Following Jean Moreau's departure, Gilles Cyr, President and Chief Executive Officer of the Fund, will also assume the role of Vice-President and General Manager - Eastern Region, a role he previously assumed from 1995 to early 2006.

Conference Call

A conference call covering the results of the third quarter of fiscal 2006 will be webcasted on http://supremex.com and http://events.onlinebroadcasting.com/supremex/110906/index.php at 10:30 am. ET on November 9, 2006 and will be available thereafter on these websites.

Forward-Looking Statements

This press release contains forward-looking statements relating to the future performance of the Fund. These statements relate to future events or future performance and reflect current assumptions, expectations and estimates of Management regarding growth, results of operations, performance and business prospects and opportunities. Such forward-looking statements reflect current assumptions, expectations and estimates of Management and are based on information currently available to the Fund as at the date of this document. Forward-looking statements are subject to certain risks and uncertainties, and actual results may differ materially from the conclusion, forecast or projection stated in such forward-looking statements. Such risks and uncertainties are discussed throughout our MD&A for the third quarter of 2006 and, in particular, in Risk Factors. Consequently, readers should not place any undue reliance on such forward-looking statements. The Fund disclaims any intention or obligation to update or revise any forward-looking statement, whether as a result of new information, future events or otherwise unless being held there according to the laws on the applicable transferable securities.

For further details, please see the Financial Statements below. The Financial Statements and Management's Discussion and Analysis can also be found on http://www.sedar.com and on the Fund website http://supremex.com.

Non-GAAP Measures

References to EBITDA are to earnings from continuing operations before net financing charges, income taxes amortization of property, plant and equipment, intangible assets, deferred compensation and gain on disposal of machinery and equipment.

Adjusted EBITDA is EBITDA adjusted to take into consideration the conversion at Closing of a portion of Supremex' management profit sharing plan into Units and the non-cash inventory step-up charge resulting from the adjustment to fair value of inventory at the date of acquisition of Supremex by the Fund.

Management views distributable cash as an operating performance measure. It is also generally used by Canadian income funds as an indicator of financial performance. Distributable Cash is defined as cash flow related to operating activities adjusted for the net change in non-cash working capital balances, change in post-retirement benefits obligation, change in accrued pension benefits assets, non-cash inventory step-up charges and maintenance capital expenditures. Distributable cash is important as it summarizes the funds available for distribution to unitholders.

EBITDA, Adjusted EBITDA and Distributable Cash are not earnings measures recognized under GAAP and do not have standardized meanings prescribed by GAAP. Therefore, EBITDA, Adjusted EBITDA and Distributable cash may not be comparable to similar measures presented by other entities. Investors are cautioned that EBITDA, Adjusted EBITDA and Distributable cash should not be construed as an alternative to net earnings 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 flows.

About the Fund

Supremex Income Fund is Canada's largest manufacturer and marketer of a broad range of stock and custom envelopes and related products. Supremex is the only national envelope manufacturer in Canada, with 13 facilities in nine cities across seven provinces and employs approximately 750 people. This nationwide presence enables it to manufacture products tailored to the specifications of major national customers such as leading Canadian corporations, national resellers and governmental entities, as well as paper merchants and process and solutions providers.



Consolidated Financial Statements

Supremex Income Fund
Unaudited
For the three months and 184-day periods ended September 30, 2006

All amount expressed in Canadian dollars



Supremex Income Fund

CONSOLIDATED BALANCE SHEET

As at September 30, 2006 Unaudited

$
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ASSETS (note 11)
Current
Cash 8,054,677
Accounts receivable (note 4) 26,906,706
Income taxes receivable 2,978,466
Inventories (note 5) 15,754,580
Prepaid expenses 2,056,773
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Total current assets 55,751,202
---------------------------------------------------------------------

Property, plant and equipment, net (note 6) 42,036,766
Accrued pension benefit asset (note 7) 5,649,430
Future income tax assets (note 12) 6,132,449
Deferred financing costs, net (note 8) 452,458
Intangible assets, net (note 9) 53,393,532
Goodwill (note 2) 245,171,998
---------------------------------------------------------------------
408,587,835
---------------------------------------------------------------------
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LIABILITIES AND UNITHOLDERS' EQUITY
Current
Accounts payable and accrued liabilities (note 10) 23,052,273
Distribution payable 2,999,658
Payable to Cenveo (note 2) 5,617,322
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Total current liabilities 31,669,253
---------------------------------------------------------------------

Term credit facility (note 11) 75,000,000
Future income tax liabilities (note 12) 23,990,018
Other post-retirement benefits obligation (note 7) 755,600
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Unitholders' equity
Funds units (note 13) 302,300,852
Deferred compensation (note 13) (20,650,130)
Deficit (4,477,758)
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277,172,964
---------------------------------------------------------------------
408,587,835
---------------------------------------------------------------------
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Commitments, contingencies and guarantees (note 15)
Subsequent events (note 19)

See accompanying notes

On behalf of the Trustees:

By: (Signed) L.G. Serge Gadbois By: (Signed) Gilles Cyr
Trustee Trustee



Supremex Income Fund

CONSOLIDATED STATEMENT OF EARNINGS
AND DEFICIT

Unaudited

Three months 184-day period
ended ended
September 30, September 30,
2006 2006
$ $
---------------------------------------------------------------------

Revenue 48,635,679 96,804,834
Cost of good sold, selling, general and
administrative expenses 36,489,171 77,038,721
---------------------------------------------------------------------
Earnings before the following 12,146,508 19,766,113
---------------------------------------------------------------------

Amortization of property, plant and
equipment 894,648 1,754,434
Amortization of intangible assets 1,405,500 2,826,468
Amortization of deferred compensation 1,476,165 2,968,508
Gain on disposal of property, plant and
equipment (145,958) (227,409)
Net financing charges (note 11) 970,023 2,052,608
---------------------------------------------------------------------
4,600,378 9,374,609
---------------------------------------------------------------------
Earnings before income taxes 7,546,130 10,391,504
Provision for income taxes (recovery)
(note 12) (410,802) (3,128,686)
---------------------------------------------------------------------
Net earnings for the period 7,956,932 13,520,190
Deficit, beginning of period (3,435,715) -
Distribution declared (note 14) (8,998,975) (17,997,948)
---------------------------------------------------------------------
Deficit, end of period (4,477,758) (4,477,758)
---------------------------------------------------------------------
---------------------------------------------------------------------

Basic and diluted net earnings per unit 0.2541 0.4318
---------------------------------------------------------------------
---------------------------------------------------------------------

Weighted average number of units
outstanding (note 13) 31,311,667 31,311,667
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---------------------------------------------------------------------

See accompanying notes



Supremex Income Fund

CONSOLIDATED STATEMENT OF CASH FLOWS

Unaudited

Three months 184-day period
ended ended
September 30, September 30,
2006 2006
$ $
---------------------------------------------------------------------

OPERATING ACTIVITIES
Net earnings for the period 7,956,932 13,520,190
Items not affecting cash and cash
equivalents
Amortization of property, plant and
equipment 894,648 1,754,434
Amortization of intangible assets 1,405,500 2,826,468
Amortization of deferred compensation 1,476,165 2,968,508
Amortization of deferred financing
costs 32,344 65,042
Gain on disposal of property, plant
and equipment (145,958) (227,409)
Future income tax recovery (633,025) (3,350,909)
Change in other post-retirement
benefits obligation (4,000) (8,000)
Change in accrued pension benefit
assets (251,467) (494,930)
Net change in non-cash working capital
balances 5,601,397 8,917,689
---------------------------------------------------------------------
Cash flows related to operating
activities 16,332,536 25,971,083
---------------------------------------------------------------------

INVESTING ACTIVITIES
Business acquisitions, net of cash
acquired (note 2) - (207,752,714)
Additions to property, plant and
equipment (1,194,609) (3,509,967)
Proceeds from disposal of property,
plant and equipment 151,064 373,473
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Cash flows related to investing
activities (1,043,545) (210,889,208)
---------------------------------------------------------------------

FINANCING ACTIVITIES
Issuance of trust units on initial
public offering (note 2) - 175,000,000
Issuance of trust units at the exercise
of the over-allotment option (note 2) - 25,000,000
Issuance of trust units to management
(note 2) - 23,642
Expenses related to initial issuance of
trust units (note 2) - (16,217,723)
Financing costs incurred - (517,500)
Term credit facility proceed - 75,000,000
Repayment of the due to an entity under
common control - (26,692,327)
Repayment of the note payable to Cenveo
(note 2) - (23,625,000)
Distribution paid on Fund units (8,998,975) (14,998,290)
---------------------------------------------------------------------
Cash flows related to financing
activities (8,998,975) 192,972,802
---------------------------------------------------------------------

Net increase in cash and cash
equivalents 6,290,016 8,054,677
Cash and cash equivalents, beginning
of period 1,764,661 -
---------------------------------------------------------------------
Cash and cash equivalents, end of
period 8,054,677 8,054,677
---------------------------------------------------------------------
---------------------------------------------------------------------

Supplemental information
Interest paid 1,044,443 3,126,340
Income taxes paid 39 12,039
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---------------------------------------------------------------------

See accompanying notes


Supremex Income Fund

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2006 Unaudited


1. NATURE OF BUSINESS AND BASIS OF PRESENTATION

Supremex Income Fund (the "Fund") is an unincorporated open-ended trust established under the laws of the Province of Quebec pursuant to a declaration of Trust dated February 10, 2006, as may be amended, supplemented or restated from time to time. The Fund was created to indirectly acquire and hold all the shares of Supremex Inc. and the net assets of Cenveo Depew Division ("Supremex"). The Fund remained inactive until it indirectly acquired Supremex on March 31, 2006 (note 2). The statements of earnings and cash flows consist of the operations of the Fund for the three-month and 184-day periods ended September 30, 2006.

Supremex is a manufacturer and marketer of a broad range of stock and custom envelopes and related products.

The business of Supremex follows seasonal patterns with the highest revenue occurring from August to February due to the seasonal advertising and mailing patterns of its customers whereby higher number of mailings related to events including the return to school, fund raisers and the holiday and tax seasons occurs during that period. As a result, revenue and financial performance for the three-month and 184-day periods ended September 30, 2006 are not necessarily indicative of the revenue and financial performance that may be expected for a full year.

2. INITIAL PUBLIC OFFERING AND BUSINESS ACQUISITIONS

On March 31, 2006, the Fund completed its initial public offering ("IPO") with the sale of 17,500,000 trust units (the "units") for $10.00 per unit, for total net proceeds of $165,093,194 after deducting $9,906,806 which represents the underwriters' total fees of $9,625,000 and other issuance expenses of $5,217,723 less related future income taxes of $4,935,917.

On March 31, 2006, in conjunction with the IPO, the Fund indirectly acquired Supremex from Cenveo Corporation and/or its related companies ("Cenveo") for $331,641,239. Consideration paid to Cenveo for the acquisition was comprised of cash of $212,924,527, units of the Fund with a value of $89,474,390, a payable for acquired businesses of $5,617,322 for a working capital adjustment and a note payable of $23,625,000.

The acquisition was accounted for by the purchase method with the results of Supremex' operations included in the Fund's earnings from the date of acquisition. These consolidated financial statements reflect the allocation of the consideration to the assets acquired and liabilities assumed based on their fair values as follows:



Cenveo
Supremex Depew Total
division $
---------------------------------------------------------------------
Cash and cash equivalents 5,171,813 5,171,813
Accounts receivable 27,077,695 378,589 27,456,284
Inventories 20,539,428 467,509 21,006,937
Income taxes receivable 5,503,249 5,503,249
Prepaid expenses 1,138,130 28,925 1,167,055
Property, plant and equipment 40,253,650 173,647 40,427,297
Accrued pension benefit asset 5,154,500 5,154,500
Future income tax assets 1,338,811 1,338,811
Intangible assets 56,220,000 56,220,000
Goodwill 245,171,998 245,171,998
Accounts payable and accrued
liabilities (21,371,322) (200,262)(21,571,584)
Due to an entity under common
control (26,692,327) (26,692,327)
Future income tax liabilities (27,949,194) (27,949,194)
Post-retirement benefits
obligation (763,600) (763,600)
---------------------------------------------------------------------
Net assets acquired 330,792,831 848,408 331,641,239
---------------------------------------------------------------------
---------------------------------------------------------------------
Consideration
Cash 212,924,527
Units 89,474,390
Payable to Cenveo 5,617,322
Note payable to Cenveo 23,625,000
---------------------------------------------------------------------


As part of the acquisition 2,364,228 units valued at $23,642,280 were issued to management employees of Supremex for a cash consideration of $23,642 to amend the then existing management profit sharing plan. These units are held in escrow and 50% will be released on March 31, 2008, 25% on March 31, 2009 and 25% on March 31, 2010, subject to earlier release under certain circumstances or sold to Supremex for a nominal consideration of $0.01 per unit in the event of the voluntary departure of the employee or termination by Supremex for cause prior the expiry of the four year escrow period. The initial value of such units, net of the cash consideration received, is recorded as deferred compensation and is recorded as compensation expense over the vesting period.

The payable to Cenveo relates to an adjustment based on the working capital of the acquired businesses which adjustment should be finalized during the last quarter of 2006. This is the only item that could require an adjustment to the purchase price allocation which will be made when known.

On April 28, 2006 the underwriters exercised in full their over-allotment option, resulting in the issuance by the Fund of 2,500,000 additional units at a price of $10 per unit for gross proceeds of $25,000,000 and net proceeds of $24,090,988 after deducting $909,012 which represents the underwriters' fees of $1,375,000 less related future income taxes of $465,988. The net cash proceeds were used by the Fund to repay the note payable to Cenveo.

3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The consolidated financial statements have been prepared by management in accordance with Canadian generally accepted accounting principles which require management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. By their nature, these estimates are subject to measurement uncertainty. The effect on the financial statements of changes in such estimates in future periods could be material and would be accounted for in the period the change occurs.

The financial statements have, in management's opinion, been properly prepared within reasonable limits of materiality and within the framework of the accounting policies summarized below:

Principles of consolidation

The consolidation financial statements include the accounts of the Fund and its subsidiaries. All significant intercompany accounts and transactions are eliminated upon consolidation. The consolidated financial statements are for the three-month period ended September 30, 2006 and 184-day period from March 31, 2006, the date of commencement of operations, to September 30, 2006 inclusive and accordingly no comparative information is provided.

Net earnings per unit

Net earnings per unit are calculated by dividing net earnings by the weighted average number of units outstanding during the period. For the purpose of the weighted average number of units outstanding, units are determined to be outstanding from the date they are issued. The units issued relating to the over-allotment option on April 28, 2006 have been considered issued since March 31, 2006 since there was no contingencies that would result in these units not being issued.

Cash and cash equivalents

Cash and cash equivalents include cash less amounts drawn under the operating revolving credit facility.

Inventories

Raw materials are carried at the lower of cost, determined on a first-in, first-out basis, and replacement cost. Work in process and finished goods are carried at the lower of cost, including labour and overhead, determined on a first-in, first-out basis, and net realizable value.

Property, plant and equipment

Property, plant and equipment are recorded at cost. Amortization is computed under the straight-line method over the following estimated useful lives:



Buildings and building improvements 10 to 40 years
Leasehold improvements Over the terms of the leases
Machinery and equipment 7 to 15 years
Office equipment 3 to 5 years
Computer equipment 3 years


Long-lived assets

Long-lived assets, including property plant and equipment, are tested for impairment whenever events or changes in circumstances indicate that the carrying value of the assets may not be fully recoverable. Impairment is assessed when the undiscounted expected future cash flows derived from an asset are less than its carrying amount. Impairment losses are recognized for the amount by which the carrying value of an asset exceeds its fair value. The estimated useful lives of all long-lived assets are periodically reviewed and revised if necessary.

Deferred financing costs

Financing costs related to credit facilities are capitalized and amortized on a straight line basis over the four-year term of the credit facilities.

Intangible assets

Intangible assets are assets acquired that lack physical substance and that meet the specified criteria for recognition apart from goodwill. Intangible assets acquired are comprised mainly of customer relationships and non-compete agreements which are amortized on a straight-line basis over ten years.

The customer relationships are tested for recoverability whenever events or changes in circumstances indicate that its carrying amount may not be recoverable. When the carrying value of customer relationships and the non-compete agreements is less than its net recoverable value as determined on an undiscounted basis, an impairment loss is recognized to the extent that fair values, measured as the discounted cash flows over the life of the assets when quoted market prices are not readily available, are below the asset carrying value.

Goodwill

Goodwill represents the excess of the acquisition cost over the fair value of net assets of business acquired. Goodwill is tested for impairment annually or more often if events or changes in circumstances indicate that it might be impaired. The impairment test consists of a comparison of the fair value of the reporting unit to which goodwill is assigned with its carrying amount. Any impairment loss in the carrying amount compared with the fair value is charged to earnings in the year in which the impairment occurs. The Fund uses the discounted cash flows method to determine the fair value of its reporting unit.

Revenue recognition

The Fund recognizes revenue when persuasive evidence of an arrangement exists, product delivery has occurred, pricing is fixed or determinable, and collection is reasonably assured. In addition, when the customer requests a bill and hold, revenue is recognized when the customer is invoiced for goods that have been produced, packaged and made ready for shipment. These goods are segregated from inventory which is available for sale, the risk of ownership of the goods is assumed by the customer, and the terms and collection experience on the related billings are consistent with all other sales.

The Fund has rebate agreements with certain customers. These rebates are recorded as reductions of revenue and are accrued using revenue data and rebate percentages specific to each customer agreement.

Employee future benefits

The Fund maintains defined benefit pension plans, two of these plans are hybrid by also having a defined contribution component, covering substantially all of its employees. The acquired businesses have also provided in the past post retirement and post employment benefits plans to a limited number of employees covering health care, dental care and life insurance coverage.

The Fund accrues its obligations for the defined benefits component of its pension plans and other post retirements and employment benefits and related costs, net of plan assets. The cost of pensions and other retirement benefits earned by employees is actuarially determined, at least every three years, using the projected benefit method prorated on service and management's best estimate of plan's investment performance, salary escalating, retirement age of employees and estimated health care costs. For the purpose of calculating the expected return on plan assets, those assets are valued at fair market value. The most recent actuarial valuations were performed on December 31, 2005.

Past service costs are amortized on a straight-line basis over the remaining service period of active employees ("EARSL"), which is 15 years. The excess of net actuarial gain or loss over 10% of the greater of the benefit obligation and the fair value of plan assets is amortized over the EARSL.

For the defined contribution component of a pension plan, the pension expense is equal to the contributions paid by the Fund.

Income taxes

The Fund's corporate subsidiaries are subject to corporate income taxes and use the liability method of accounting for income taxes. Under the liability method, future income tax assets and liabilities are determined based on temporary differences between the financial reporting and tax bases of assets and liabilities and are measured using tax rates substantially enacted at the balance sheet date. The effect of changes in income tax rates on future income tax assets and liabilities is recognized in earnings in the period that the change becomes substantially enacted.

Under the current terms of the Income Tax Act (Canada), the Fund is not subject to income taxes to the extent that its taxable income in a year is paid or payable to a unitholder. Accordingly, no provision for current income taxes for the Fund is made. In addition, the Fund is not subject to the recommendations of CICA Section 3465, as the Fund is contractually committed to distribute to its unitholders all or virtually all of its taxable income and taxable capital gains that would otherwise be taxable in the Fund. The Fund intends to continue to meet the requirements under the Income Tax Act (Canada) applicable to such trusts, and there is no indication that the Fund will fail to meet those requirements.

On October 31, 2006, the Minister of Finance (Canada) announced proposed changes to the taxation of publicly traded income trusts. The proposed changes, if enacted, will result in the taxation, at the rate of 31.5%, of distributions made by the Fund beginning in the year 2011.

Foreign currency

The Fund follows the temporal method to translate its foreign currency balances and transactions including its integrated foreign subsidiary. Under this method, monetary assets and liabilities are translated at the rates of exchange in effect at balance sheet date and the other items in the balance sheet and statement of earnings are translated at the exchange rates in effect at the date of transaction. Exchange gains and losses are included in net earnings for the year.

Financial instruments

The Fund uses interest rate swap to hedge the interest rate exposure. The Funds objective is to offset gains and losses resulting from interest rate exposure with losses and gains on the derivative contract used to hedge it. The Fund does not use derivative contracts for speculative purposes. To qualify as a hedge, the hedge relationship is designated and formally documented at inception detailing the particular risk management objective and strategy for the hedge, which includes the item and risk that is being hedged, as well as how effectives is being hedge. The derivative used must be highly effective in accomplishing the objective of offsetting changes in cash flows for the risk being hedged. If a hedge relationship is found to be ineffective, it not longer qualifies as a hedge and any excess gain or losses attributable to such ineffectiveness, as well as subsequent changes in fair value, are recognized in earnings.

The Fund has designated its interest rate swap on its variable interest term credit facility as hedge against the fluctuation in interest expense due to change in the interest rate. Accordingly, the fair value of this financial instrument and any changes thereto has not been recorded in the consolidated financial statements. Gains and losses on financial instruments that qualify as hedge are recognized at the time the hedged expenses are incurred.

The fair value of this financial instrument is disclosed in note 17. Such fair value estimates is not necessarily indicative of the amounts, the Fund might pay or receive in actual market transactions. Potential transaction costs have also not been considered in estimating fair value.



4. ACCOUNTS RECEIVABLE

September 30,
2006
$
---------------------------------------------------------------------
Trade receivables 21,893,171
Receivable from Cenveo 4,000,000
Others 1,013,535
---------------------------------------------------------------------
26,906,706
---------------------------------------------------------------------
---------------------------------------------------------------------


5. INVENTORIES

September 30,
2006
$
---------------------------------------------------------------------
Raw materials 3,696,771
Work in process 298,708
Finished goods 11,759,101
---------------------------------------------------------------------
15,754,580
---------------------------------------------------------------------
---------------------------------------------------------------------


6. PROPERTY, PLANT AND EQUIPMENT

September 30, 2006
---------------------------------------------------------------------
Accumulated Net book
Cost Amortization value
$ $ $
---------------------------------------------------------------------

Land 7,517,895 - 7,517,895
Buildings and building
improvements 10,968,419 175,410 10,793,009
Leasehold improvements 552,212 43,538 508,674
Machinery and equipment 24,230,040 1,467,808 22,762,232
Office equipment 215,177 27,824 187,353
Computer equipment 308,393 40,790 267,603
---------------------------------------------------------------------
43,792,136 1,755,370 42,036,766
---------------------------------------------------------------------
---------------------------------------------------------------------


7. POST-RETIREMENT BENEFITS

(a) Pension Plans

The Fund maintains three defined benefit pension plans covering certain salaried and hourly employees who have bargained for such benefits. Two of these pension plans are hybrid because they also have a defined contribution component.

As at September 30, 2006, the surplus of the fair value of plans assets over the benefit obligation is $5,649,430 and is recognized as accrued pension benefit asset. The total benefit cost in the pension plan for the three-month and 184-day periods ended September 30, 2006 is approximately $425,000 and $865,000 respectively.

The assumptions used in computing the benefit obligation were as follow:



September 30
2006
%
---------------------------------------------------------------------
Discount rate of projected benefit obligation 5.50
Discount rate for net pension cost 5.75
Expected return on plan assets 7.00
Rate of compensation increase 3.50
---------------------------------------------------------------------
---------------------------------------------------------------------

(b) Post-retirement benefits other than pension

Post-retirement benefits other than pension relates to post-
retirement and post-employment benefits plans provided to a limited
number of employees covering health care, dental care and life
insurance coverage which are not funded and for which the benefit
obligation is $755,600 as at September 30, 2006. The expense is
approximately $28,000 and $56,000 for the three-month and 184-day
periods ended September 30, 2006


8. DEFERRED FINANCING COSTS

September 30, 2006
---------------------------------------------------------------------
Accumulated Net book
Cost Amortization value
$ $ $
---------------------------------------------------------------------
Deferred financing costs 517,500 65,042 452,458
---------------------------------------------------------------------
---------------------------------------------------------------------


9. INTANGIBLE ASSETS

September 30, 2006
---------------------------------------------------------------------
Accumulated Net book
Cost Amortization value
$ $ $
---------------------------------------------------------------------
Customer relationships 55,465,000 2,788,511 52,676,489
Non-compete agreements 755,000 37,957 717,043
---------------------------------------------------------------------
56,220,000 2,826,468 53,393,532
---------------------------------------------------------------------
---------------------------------------------------------------------


10. ACCOUNTS PAYABLE AND ACCRUED LIABILITES

September 30,
2006
$
---------------------------------------------------------------------
Trade payables 7,403,521
Trade payables to Cenveo 172,958
Accrued liabilities 15,475,794
---------------------------------------------------------------------
23,052,273
---------------------------------------------------------------------
---------------------------------------------------------------------

The Fund has $4 million of third party accrued liability relating to
transactions with Cenveo which is included in accrued liabilities as
at September 30, 2006 and which will be reimbursed by Cenveo if and
when it is required to be paid. Accordingly, a receivable of $4
million from Cenveo has been recorded in the Fund's financial
statements and is included in accounts receivable.


11. SECURED CREDIT FACILITIES

The Fund has senior secured credit facilities consisting of a
revolving operating credit facility of up to $40 million and a term
credit facility of $75 million. Both facilities bear interest at a
floating rate based on the Canadian prime rate, U.S. base rate, LIBOR
or bankers' acceptance rates plus an applicable margin to those
rates.

The revolving operating credit facility may be used for general
corporate purposes, working capital requirements and permitted
acquisitions. Both facilities mature on March 31, 2010 and there are
no scheduled repayments of principal required prior to maturity.

Amounts drawn under revolving and term credit facilities are as
follows:

September 30,
2006
$
---------------------------------------------------------------------
Revolving credit facility -
Term credit facility 75,000,000
---------------------------------------------------------------------
75,000,000
---------------------------------------------------------------------
---------------------------------------------------------------------

As at September 30, 2006, the interest rates on the revolving and
term credit facilities were 6.0% and 5.62% respectively. The Fund
entered into an interest swap agreement for its term credit facility
to pay a fixed rate of 5.426% until March 31, 2007, 5.663% form April
1, 2007 to March 31, 2008, 5.866% from April 1, 2008 to March 31,
2009 and 6.067% from April 1, 2009 to March 31, 2010 (see note 17).

Under the terms of the credit facility, the Fund is required, amongst
other conditions, to meet certain covenants. The Fund was in
compliance of these covenants as at September 30, 2006.

The credit facilities are collateralized by hypothec and security
interest covering all present and future assets of the Fund and its
subsidiaries.

Net financing charges

Three months 184-day period
ended ended
September 30, September 30,
2006 2006
$ $
---------------------------------------------------------------------
Interest on secured credit facilities 1,040,055 2,105,737
Other interest (102,376) (118,171)
Amortization of deferred financing costs 32,344 65,042
---------------------------------------------------------------------
970,023 2,052,608
---------------------------------------------------------------------
---------------------------------------------------------------------

12. INCOME TAXES

(a) Future income taxes reflect the net effects of temporary
differences between the carrying amounts of assets and liabilities
for financial reporting purposes and the amounts used for income tax
purposes.

The tax effects of temporary differences that give rise to
significant portions of future tax assets and liabilities are as
follows:

September 30,
2006
$
---------------------------------------------------------------------
Future income tax assets
Initial public offering expenses 4,486,376
Post-retirement benefits obligation 235,708
Non-capital losses 1,410,365
---------------------------------------------------------------------
6,132,449
---------------------------------------------------------------------

Future income tax liabilities
Property, plant and equipment 5,030,150
Accrued pension benefit asset 1,762,331
Intangible assets 16,656,033
Other 541,504
---------------------------------------------------------------------
23,990,018
---------------------------------------------------------------------
---------------------------------------------------------------------

The goodwill related to Supremex acquisition is not deductible for
tax purposes.

(b) The income taxes expense differs from the expenses that would be
obtained by applying the combined Canadian income tax (federal and
provincial) as a results of the following:

Three months 184-day period
ended ended
September 30, September 30,
2006 2006
$ $
---------------------------------------------------------------------
Earnings before income taxes 7,546,130 10,391,504
---------------------------------------------------------------------

Income taxes at combined federal and
provincial statuary rate of 33.43% 2,514,420 3,473,880

Impact of interest expense of Supremex
paid to the Fund, eliminated on
consolidation (3,092,165) (6,198,591)
Effect of change in enacted tax rates (57,820) (1,430,210)
Impact of amortization of deferred
compensation not deductible for tax
purposes 489,154 992,372
Non deductible expenses and other (264,391) 33,863
---------------------------------------------------------------------
Provision of income taxes (recovery) (410,802) (3,128,686)
---------------------------------------------------------------------
---------------------------------------------------------------------

Provision for income taxes (recovery)
is as follow:
---------------------------------------------------------------------
Current 222,223 222,223
Future (633,025) (3,350,909)
---------------------------------------------------------------------
Provision for income taxes (recovery) (410,802) (3,128,686)
---------------------------------------------------------------------
---------------------------------------------------------------------


On May 2, 2006, Canadian Federal budget announced several general
corporate income tax rate reductions, which will gradually be reduced
from 22.12% to 19% in 2010 which was enacted on June 22, 2006. In
addition, during the second quarter of 2006 other provincial tax rate
reductions became enacted. As a result, at the end of the second
quarter, the Fund has reassessed its future income tax assets and
liabilities in light of the new enacted tax rates.

13. UNITHOLDERS' EQUITY

Fund units

The Fund 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 from the
Fund and in the net assets of the Fund. All units are of the same
class with equal rights and privileges, except that Cenveo, pursuant
to the Fund Declaration of Trust, may designate one trustee as long
as they own not less than 10% of the total units issued. Each unit
entitles the holder to participate equally in all allocations and
distributions and to one vote at all meetings of unitholders for each
whole unit held.

The Fund units are redeemable at any time at the option of the holder
at the lesser of 90% of the weighted average price of the Fund unit
during the last ten trading days of the units on an open market and
the closing market price on the redemption date. All redemptions are
subject to a maximum of $50,000 in cash redemptions by the Fund at
any particular month. Redemptions in excess of this amount will be
paid by way of a distribution in specie of the assets of the Fund.

Number Amount
$
---------------------------------------------------------------------
Fund units
Issued on IPO 17,500,000 175,000,000
Issued at the exercise of the over-allotment
option 2,500,000 25,000,000
Issued to employees 2,364,228 23,642,280
Issued to Cenveo in consideration of
businesses acquired 8,947,439 89,474,390
---------------------------------------------------------------------
31,311,667 313,116,670
Issuance costs, net of future income taxes
of $5,401,905 - (10,815,818)
---------------------------------------------------------------------
Balance as at September 30, 2006 31,311,667 302,300,852
---------------------------------------------------------------------
---------------------------------------------------------------------

Employees units

As part of the acquisition 2,364,228 units valued at $23,642,280 were
issued to management employees of Supremex for a cash consideration
of $23,642 to amend the then existing management profit sharing plan.
These units are held in escrow and 50% will be released on March 31,
2008, 25% on March 31, 2009 and 25% on March 31, 2010, subject to
earlier release under certain circumstances or sold to Supremex for a
nominal consideration of $0.01 per unit in the event of the voluntary
departure of the employee or termination by Supremex for cause prior
the expiry of the four year escrow period. Employees are allowed to
distribution declared on these units. The initial value of such
units, net of the cash consideration received, is recorded as
deferred compensation and is recorded as compensation expense over
the vesting period.

Over-Allotment option

On April 28, 2006, the underwriters exercised in full their over-
allotment option, resulting in the issuance by the Fund of 2,500,000
additional units on the same terms as the initial public offering.

In addition, as consideration for the business acquisitions, the Fund
issued a note payable which was repaid with the net proceeds of the
over-allotment option.

Basic and diluted net earnings

The number of units used in the determination of the basic weighted
average number of units outstanding includes the 2,500,000 units
relating to the over-allotment option as if they would have been
issued since March 31, 2006 since there were no contingencies that
would result in these units not being issued.

14. DISTRIBUTION

The Fund makes monthly distributions of its available cash to
unitholders of record on the last business day of each month, payable
on or about the 15th day of the following month. Distributions to
unitholders are recorded on an accrual basis. The September
distribution in the amount of $2,999,658 was declared and accrued in
September 2006 and paid to unitholders on October 16, 2006 (see note
19). Distributions for the period from April 1, 2006 to September 30,
2006 are as follows:

Distri-
Per unit bution
Period Record date Payment date $ $
---------------------------------------------------------------------
April
2006 April 28, 2006 May 15, 2006 0.0958 2,999,658
May 2006 May 31, 2006 June 15, 2006 0.0958 2,999,658
June 2006 June 30, 2006 July 17, 2006 0.0958 2,999,658
July 2006 July 31, 2006 August 15, 2006 0.0958 2,999,658
August
2006 August 31, 2006 September 15, 2006 0.0958 2,999,658
September
2006 September 30, 2006 October 16, 2006 0.0958 2,999,658
---------------------------------------------------------------------
0.5748 17,997,948
---------------------------------------------------------------------

15. COMMITMENTS, CONTINGENCIES AND GUARANTEES

(a) Operating lease and other commitments

The Fund has entered into operating leases mainly for buildings. The
minimum lease payments required under such leases by fiscal years and
thereafter are as follows:

$
-------------------------------------------------------
2006 532,432
2007 2,027,573
2008 1,582,587
2009 1,241,338
2010 974,361
Thereafter 486,056
-------------------------------------------------------


As at September 30, 2006, the Fund also had a firm commitment to purchase machinery and equipment amounting to approximately $336,000 which will be paid in 2006.

(b) Contingencies

In the normal course of its operations, the Fund is exposed to various claims, disputes and legal proceedings. These disputes often involve numerous uncertainties and the outcome of the individual cases is unpredictable. According to management, their resolution should not have a significant negative impact on the Fund's financial position.

One of the Fund's subsidiaries is being investigated by the Canadian Competition Bureau for alleged price maintenance by certain of its customers. Management believes that it is unlikely that this investigation would result in any material liability to the Fund.

In addition to the price maintenance investigation, the Competition Bureau has also indicated its interest in broadening the inquiry, or starting a new inquiry, to investigate whether price fixing or market sharing took place in the 1980's and 1990's in respect of the supply of envelopes market in Canada. While Competition Bureau activity is continuing, management is presently not able to assess or predict the scope or outcome of the current inquiry or any new inquiry that may be commenced and the impact, if any, of such proceedings on the Fund's financial position.

The Fund exposure toward the above matters is mitigated by the fact that the acquisition agreement of the Fund businesses contains representations and warranties and related indemnities for any liabilities arising before September 30, 2008 from Cenveo in favour of the Fund.

(c) Guarantees

In the normal course of business, the Fund has entered into agreements that contain features which meet the definition of a guarantee. These agreements may require the Fund to compensate the counterparties for costs and losses incurred as a result of various events including breaches of representations and warranties, loss of or damages to property, claims that may arise while providing services and environmental liabilities. These agreements provide for indemnification and guarantees to counterparties as follows:

Operating leases

The Fund has general indemnity clauses in many of its real estate leases whereby it, as lessee, indemnifies the lessor against liabilities related to the use of the leased property. These leases mature at various dates through October 2011. The nature of the agreements varies based on the contracts and therefore prevents the Fund from estimating the total potential amount it would have to pay to lessors. Historically, Supremex has not made any significant payments under such agreements, has insurance coverage for certain of the obligations undertaken, and, as at September 30, 2006, the Fund has not recorded any liability associated with these indemnifications.

Business disposals

As a result of the sale of business operations, shares or net assets, Supremex may occasionally agree to provide indemnity against claims from previous business activities. The nature of these indemnifications prevents the Fund from estimating the maximum potential liability that it could be required to pay to guarantee parties. Historically, Supremex has not made any significant indemnification payments, and, as at September 30, 2006 the Fund has not recorded any liability associated with these indemnifications.

16. SEGMENTED INFORMATION

The Fund currently operates in one business segment being the manufacturing and sale of envelopes. The Fund's net assets amounted to $275,330,814 in Canada and $1,842,150 in United States as at September 30, 2006. The Fund's revenue amounted to $40,413,417 and $81,246,592 in Canada and $8,222,262, $15,558,242 in the United States for the three-month and 184-day periods ended September 30, 2006 respectively.

17. FINANCIAL INSTRUMENTS

Interest rate and foreign exchange risk

The Fund is exposed to interest rate risk on its secured credit facilities. The Fund has entered into an interest swap agreement for the full amount of its term credit facility to pay a fixed rate of 5.426% until March 31, 2007, 5.663% from April 1, 2007 to March 31, 2008, 5.866% from April 1, 2008 to March 31, 2009, and 6.067% from April 1, 2009 to March 31, 2010. As described in note 3, the Fund accounts for this financial instrument as a hedge. As of September 30, 2006, the mark-to-market on the Fund's interest rate swap is a loss of $1,029,785.

The Fund operates in Canada and in the United States which give rise to a risk that its earnings and cash flows may be adversely impacted by fluctuations in the exchange rate between the US and Canadian dollar. In the recent past, purchases and capital expenditures in US dollars were similar to the revenue earned in US dollars which have limited the Fund's foreign exchange exposure. Cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities include balances denominated in US dollars at the end of the period.

Fair value

The carrying value of the accounts receivable, accounts payable and accrued liabilities and payable to Cenveo are a reasonable estimate of their fair value because of their short maturity.

The fair value of the secured credit facilities approximates their carrying value based on market rates available to the Fund for financial instruments with similar risks, term and maturity.

Credit risk and customer concentration

The Fund performs ongoing credit evaluation of customer and provisions have been set-up for potential credit losses. As at September 30, 2006, no customer accounted for over 10% of total accounts receivable or revenues.

18. RELATED PARTY TRANSACTIONS

The Fund had the following transactions with Cenveo which were conducted in the normal course of business and recorded at the exchange value:



Three months 184-day period
ended ended
September 30, September 30,
2006 2006
$ $
---------------------------------------------------------------------
Revenue 2,017,948 3,602,110
Purchases of raw materials 447,104 964,082
---------------------------------------------------------------------


19. SUBSEQUENT EVENTS

On October 16, 2006, the Fund declared the distribution for the period from October 1, 2006 to October 31, 2006 on the amount of $2,999,658 or $0.0958 per unit, for registered unitholders on October 31, 2006. This distribution will be paid on November 15, 2006.

On October 31, 2006, the Minister of Finance (Canada) announced proposed changes to the taxation of publicly traded income trusts. The proposed changes, if enacted, will result in the taxation, at the rate of 31.5%, of distributions made by the Fund beginning in the year 2011. Management is reviewing the proposed changes.

Contact Information

  • Supremex Income Fund
    Stephane Lavigne, CA
    Vice-President and Chief Financial Officer
    514-595-0555