Second Cup Announces 2012 Results and Quarterly Dividend

MISSISSAUGA, ON, March 1, 2013 /CNW/ - The Second Cup Ltd. ("Second Cup" or the "Company") reported financial results today for the thirteen weeks ended December 29, 2012 (the "Quarter" or "Q4") and year ended December 29, 2012 (the "Full Year"). The Company's shares are traded on the Toronto Stock Exchange under the symbol "SCU".  All amounts in this news release are presented in thousands of Canadian dollars, unless otherwise indicated.

Summary

• System sales decline of 1.6% in the Quarter and an increase of 0.4% to $194,387 for the Full Year.
• Non cash after tax impairment charge of $13,591 to goodwill and trademarks.
• Adjusted basic and diluted earnings per share of $0.16 for the Quarter compared to $0.21 in the comparable quarter a year ago.
• Adjusted basic and diluted earnings per share of $0.42 for the Full Year vs. $0.64 last year.
• Declared a quarterly dividend of $0.085 per share.

Stacey Mowbray, President & CEO of Second Cup commented, "The Quarterly results reflect the continuing intense competitive activity in the coffee category, as well as, the continued investment in new initiatives, which include a loyalty program, coffee revitalization and a new café design. These initiatives will go into test in 2013 and will roll out in the latter part of the year. With the investment in a point of sale system in 2011, we are able to better assess our business and are using the system as a platform for building café business plans, national plans, as well as, supporting our test initiatives.

This Quarter, the Company earned revenue from a Kraft Tassimo partnership, based on a licencing agreement. We are encouraged with the results so far, and are looking to expand the offerings in 2013.

In 2012 we continued to improve the café network, with the opening of 18 new cafés and the closure of 17, most of which were underperforming locations.

As the second largest specialty coffee retailer in Canada and largest franchisor, we are confident in the strength of the Second Cup brand. Care, quality and our Franchise Partners are what set us apart from the competition. Our new initiatives will enable us to further build the brand and leverage these core equities."

Non-cash impairment charges recorded in the fourth quarter of 2012 totaled $15,294 and consisted of goodwill impairment charges of $2,444 and trademark impairment charges of $12,850. The after tax impact of these impairment charges were $13,591 and reduced earnings per share by $1.37. The impairment charges have no impact on the Company's liquidity, cash flow, borrowing capability or operations.

FINANCIAL HIGHLIGHTS

The following table sets out selected International Financial Reporting Standards ("IFRS") financial information and other data of the Company and should be read in conjunction with the audited financial statements of the Company for the 13 and 52 weeks ended December 29, 2012, which are expected to be released on or before March 5, 2013.

Analysis of System Sales and Same Café Sales Growth
System sales for the 13 weeks ended December 29, 2012 were $53,515 compared to $54,404 for the 13 weeks ended December 31, 2011, representing a decrease of $889 or 1.6%. The total number of cafés at the end of the Quarter was 360 compared to 359 cafés at the end of the fourth quarter of 2011.

System sales for the 52 weeks ended December 29, 2012 were $194,387, compared to $193,660 for the 52 weeks ended December 31, 2011, representing an increase of $727 or 0.4%.

During the Quarter Second Cup continued to be impacted by increased competitive activity resulting in a same café sales decline of 4.2%, compared to an increase of 1.2% in the comparable quarter of 2011. For 2012, same café sales decline was 1.9% (2011 - 0.1% decline).

Fourth Quarter

Analysis of Revenues
Total revenues for the Quarter were $7,785 (2011 - $7,363) and consisted of royalty revenue, revenue from sale of goods and services revenue.

Royalty revenue for the Quarter was $4,017 (2011 - $4,346). The reduction in royalty revenue of $329 was mainly due to a decrease in system sales and a reduction in the effective royalty rate (excluding sales from Company-operated cafés) from 8.1% in 2011 to 7.7% in the Quarter as a result of the revised royalty structure for new cafés. New cafés that opened in 2011 and 2012 were permitted to pay a royalty rate of 3% in the first year, a rate of 6% in the second year and, thereafter, a rate of 9%. In addition the effective royalty rate was impacted by café specific arrangements in place during the period.

Revenue from the sale of goods, which includes revenue from Company-operated cafés and the sale of coffee through wholesale and retail channels, was $1,597, compared to $1,042 for the 13 weeks ended December 31, 2011. The increase in revenue from the sale of goods was mainly due to operating twelve Company-operated cafés for most of the fourth quarter in 2012 compared to nine for most of the fourth quarter in 2011. The Company franchised two cafés late in the Quarter, ending the Quarter with ten Company-operated cafés.

Services revenue for the Quarter was $2,171 (2011 - $1,975). Services revenue includes initial franchise fees, renewal fees, transfer fees earned on the sale of cafés from one franchise partner to another, construction administration fees, product licencing revenue, purchasing coordination fees and other ancillary fees (IT support, tuition and construction black line drawings). The $196 increase in services revenue is mainly due to an increase in product licencing revenue, transfer fees and other ancillary fees offset by decreases in initial franchise fees and purchasing coordination fees. The increase in product licence revenue was as a result of the new partnership with Kraft Canada Inc. to produce, market and sell Second Cup signature blend coffees and lattes across Canada using the TASSIMO T-Disc on-demand beverage system.

Cost of Goods Sold
Cost of goods sold represents the product cost of goods sold in corporate cafés and through retail and wholesale channels plus the cost of direct labour to prepare and deliver the goods to the customers in the cafés. Cost of goods sold as a percentage of revenue from the sale of goods was 72% in the Quarter (2011 - 73%).

Operating Expenses
Operating expenses include the head office expenses of Second Cup and the overhead expenses of Company-operated cafés. Total operating expenses were $4,332 (2011 - $3,393), an increase of $939. This increase was mainly due to increases in occupancy lease costs of $260 (due to an increase in the provision for vacant properties), café impairment of $225, research and innovation costs of $115 and increases in corporate café lease costs, advertising and local marketing and other expenses of $126 due to ten (2011 - seven) Company-operated cafés at the end of the Quarter.

Impairment of Goodwill and Trademarks
The Company considers the franchise business as a separate cash generating unit ("CGU"). The Company performed its annual impairment test on the franchise business CGU and the valuation based on the forecasted cash flows and using an 11.5% discount rate indicated impairment. As a result, the Company recognized a total impairment charge of $15,294 which consisted of $2,444 to goodwill and $12,850 to trademarks in the Quarter. The after tax impact of these impairment charges were $13,591 and reduced earnings per share by $1.37. The impairment charges have no impact on the Company's liquidity, cash flow, borrowing capability or operations.

Other Income and Expenses

The Company incurred interest expense of $159 (2011 - $177), and $22 (2011 - $18) in amortization of financing charges relating to the term loan. The Company also recorded a non-cash credit of $47 (2011 - $86) for the movement in the fair value of the derivative interest rate swap that fixes the interest rate on the Company's term loan. The Company earned other interest income of $10 (2011 - $20) primarily due to interest earned from short-term highly liquid bank investments with original maturities of three months or less and from notes receivable.

Income Taxes
Current income taxes of $596 (2011 - $894) were recorded in the Quarter. A deferred tax recovery of $1,688 (2011 - recovery of $130) was recorded in the Quarter. The deferred tax recovery was mainly due to the impairment charge of $15,294 to goodwill and trademarks in the Quarter.

EBITDA
EBITDA for the Quarter was $3,027 (2011 - $3,647). The decrease in EBITDA was due to an increase in gross profit of $35 offset by an increase in operating expenses of $655 (excluding amortization, loss on disposal of property and equipment and impairment charges) as discussed above.

Net Income
The Company's net loss for the Quarter was $12,024 or ($1.21) per share, compared to net income of $2,352 or $0.23 per share in 2011. Excluding the after tax impact of the goodwill and trademark impairment charge of $13,591 in 2012 and the Conversion deferred tax recovery of $236 in 2011, adjusted net income for the Quarter was $1,567 or $0.16 per share, compared to $2,116 or $0.21 per share in 2011. The decline in adjusted net income of $549 or $0.05 was mainly due to the $225 increase in impairment of property and equipment, the $714 increase in operating expenses (excluding the $225 impairment above), the $34 increase in net interest expense, offset by a $35 increase in gross profit and a $389 decrease in income taxes (excluding the income tax impact of the Conversion and goodwill and trademarks impairment).

Full Year

Analysis of Revenues
Revenues were $26,346 compared to $25,001 in 2011 and consisted of royalty revenue, revenue from the sale of goods and services revenue.

Royalty revenue was $14,927 (2011 - $15,631). The reduction in royalty revenue of $704 was mainly due to a reduction in the effective royalty rate (excluding sales from Company-operated cafés) from 8.2% in 2011 to 7.9% as a result of the revised royalty structure for new cafés as well as café specific arrangements in place during the period.

Revenue from the sale of goods, which includes revenue from Company-operated cafés and the sale of coffee through wholesale and retail channels, was $4,698 compared to $3,006 for the 52 weeks ended December 31, 2011. The increase in revenue from the sale of goods was mainly due to an increase in the weighted average number of Company-operated cafés from six in 2011 to eight in 2012. The Company ended the year with ten (2011 - seven) Company-operated cafés.

Services revenue was $6,721 (2011 - $6,364). The $357 increase in services revenue is mainly due to an increase in product licencing revenue, IT support fees, purchasing coordination fees and café resale fees offset by decreases in initial franchise fees, construction administration fees and renewal fees. Product licencing fees increased $443 largely due to a new partnership agreement with Kraft Canada Inc. to produce, market and sell Second Cup signature blend coffees and lattes across Canada using the TASSIMO T-Disc on-demand beverage system. IT support fees increased $172 and relate to POS implemented in the second half of 2011. Café resale fees increased $37 and are recognized when title transfers on the sale of a café between franchise partners. There were 28 cafés sold (2011 - 33) during the year reflecting a higher average price per transaction. Excluding new corporate cafés, the Company opened 17 new franchised cafés compared to 21 in 2011 and as a result initial franchise fees decreased by $178. Construction administration fees decreased by $138 as a result of lower franchise renovation projects which decreased from 25 in 2011 to 17 in 2012. Black line drawing fees were also impacted by the decrease in the number of new site and renovation projects. The decrease in renewal fees is due to timing as renewal fees are recognized at the commencement of a new franchise term.

Cost of Goods Sold
Cost of goods sold as a percentage of revenue from the sale of goods was 75% compared to 74% for the 52 weeks ended December 31, 2011.

Operating Expenses
Operating expenses include the head office expenses of Second Cup and the overhead expenses of Company-operated cafés. Operating expenses were $15,779 (2011 - $13,176), an increase of $2,603. This was mainly due to increases in head office occupancy and lease costs of $732, research and innovation costs of $476, corporate café lease costs of $381, inventory markdowns of $264 and head office and corporate café amortization of $335 and a charge of $362 (2011 - $130) on the impairment of two Company-operated cafés.

Impairment of Goodwill and Trademarks
As discussed above, the Company recognized an impairment charge of $2,444 to goodwill and $12,850 to trademarks.

Other Income and Expenses

The Company incurred interest expense of $672 (2011 - $717), and $82 (2011 - $72) in amortization of financing charges relating to the term loan. The reduction in interest expense is a result of renegotiating the term loan and operating credit facilities discussed below under "Term Loan, Operating Credit Facility and Interest Rate Swap". The Company also recorded a non-cash credit of $206 (2011 - $29) for the movement in the fair value of the derivative interest rate swap that fixes the interest rate on the Company's term loan. The Company earned other interest income of $61 (2011 - $67) primarily due to interest earned from short-term, highly liquid bank investments with original maturities of three months or less and from notes receivable.

Income Taxes

The income tax expense of $651 (2011 - recovery of $4,414) consists of:

• current income tax expense of $1,644 (2011 - $1,527);
• deferred income tax expense of $480 (2011 - $nil) due to the income tax rate change discussed below;
• deferred income tax recovery of $nil (2011 - $6,943), due to the Conversion; and
• deferred income tax (recovery) expense of ($1,473) (2011 - expense of $1,002), excluding the impact of the Conversion.

The increase in current income tax expense is a result of the Company reducing its 2011 current income taxes by utilizing tax losses carried forward from prior years. The Ontario 2012 budget was substantively enacted on June 20, 2012, freezing corporate tax cuts with the effect that the income tax rate would remain at 11.5% until the province can achieve a balanced budget. Previously, the corporate income tax rate was slated to decrease to 10.0% by 2014. The impact of the income tax rate change is estimated to be a future income tax increase of $480. The $1,473 deferred tax recovery in 2012 was mainly due to the impairment charge of $15,294 to goodwill and trademarks in the Quarter.

EBITDA
EBITDA was $8,643 (2011 - $10,600). The decline in EBITDA was due to an increase in gross profit of $45 offset by an increase in operating expenses of $2,002 (excluding amortization, loss on disposal of property and equipment and impairment charges) as discussed above.

Net Income
The Company's net loss was $9,404 or ($0.95) per share, compared to net income of $13,301 or $1.34 per share in 2011. Excluding the deferred income tax recovery of $6,943 due to Conversion in 2011 and the after tax impairment charge to goodwill and trademarks of $13,591 in 2012, adjusted net income was $4,187 (2011 - $6,358). The reduction in adjusted net income of $2,171 was mainly due to a non-cash $232 increase in impairment of property and equipment charge, a $2,371 increase in operating expenses (excluding the $232 impairment above) as previously discussed above, offset by a $212 decrease in net interest expense, a $45 increase in gross profit and a $175 decrease in income taxes (excluding the recovery due to Conversion and income tax impact of the goodwill and trademarks impairment).

Café Network
To accelerate the growth of new cafés, Second Cup introduced a revised royalty structure for new cafés.

During the Quarter, four cafés were renovated (2011 - six), there were four café openings (2011 - seven) and two café closures (2011 - seven) with 360 cafés open at December 29, 2012. For the year, 19 cafés (2011 - 25) were renovated; there were 18 café openings (2011 - 22) and 17 café closures (2011 - 12).

Term Loan, Operating Credit Facility and Interest Rate Swap
On June 12, 2012, the Company renegotiated its term loan and operating credit facilities, including an extension of the maturity of the credit facilities to May 31, 2015 and a decrease in interest rates. The credit facilities bear interest at the bankers' acceptance rate plus 2.75% (December 31, 2011 - 3.50%). The Company has an interest rate swap agreement with a notional value of $11,000 maturing on April 1, 2013, which fixes the interest rate on the Company's non-revolving term credit facility at 3.04% per annum plus the margin noted above, which results in a fixed effective interest rate of 5.79% (December 31, 2011 - 6.54%).

Dividend
On February 28, 2013 the Board of Directors of Second Cup approved a quarterly dividend of $0.085 per common share, payable on March 28, 2013 to shareholders of record at the close of business on March 15, 2013. The dividend will be considered an eligible dividend for income tax purposes.

Annual General Meeting of Shareholders
The Board of Directors has set a record date of March 24, 2013 for the Annual General Meeting of shareholders. The Annual General Meeting will be held at 10:00 a.m. on Friday, May 3, 2013 at the offices of Stikeman Elliott LLP, 53rd Floor, 5300 Commerce Court West, 199 Bay Street, Toronto, Ontario.

OUTLOOK

The information contained in this "Outlook" is forward-looking information. Please see "Forward-looking Information" below for a discussion of the risks and uncertainties in connection with forward-looking information.

The Second Cup business continues to operate in an increasingly competitive marketplace and a challenging consumer environment. For 2013, management will continue to re-invest in the business, specifically a loyalty and communications capability, a coffee revitalization plan, and a newly designed café. These initiatives will be in test in 2013 with expected roll-outs towards the end of the year. In addition, Second Cup will leverage new and growing commercial opportunities, including the expansion and support of the newly introduced Second Cup signature coffees and lattes using the TASSIMO T-Disc on demand beverage system and expects to increase its product licencing revenue as a result.

Second Cup will continue to improve the café network with the opening of cafés while closing below average performing cafés.

FORWARD LOOKING INFORMATION

Certain statements in this news release may constitute forward-looking statements. Forward-looking statements include words such as "may", "will", "should", "expect", "anticipate", "believe", "plan", "intend" and other similar words. These statements reflect current expectations regarding future events and operating performance and speak only as of the date of this release. These forward-looking statements should not be read as guarantees of future performance or results and will not necessarily be accurate indications of whether or not those results will be achieved. Forward-looking statements are subject to known and unknown risks, uncertainties and other factors that may cause Second Cup's actual results, performance or achievements, or those of Second Cup cafés, or industry results to be materially different from any future results, performance or achievements expressed or implied by those forward-looking statements.

NON-IFRS TERMS

In addition to using financial measures prescribed by IFRS, non-IFRS financial measures and other terms are used in this press release. These terms include "system sales of cafés", "same café sales growth", "EBITDA", "adjusted net income" and "adjusted basic and diluted earnings per share". These terms are not financial measures recognized by IFRS and do not have any standardized meaning prescribed by IFRS and, therefore, may not be comparable to similar terms and measures presented by other similar issuers. These non-IFRS measures and terms are intended to provide additional information on the Company's performance and should not be considered in isolation or as a substitute for measures of performance prepared in accordance with IFRS.

System sales of cafés and same café sales growth are presented in reference to the sales performance of all cafés in Canada. The Company believes they are useful measures as they provide an indication of the top-line sales on which the royalty that is Second Cup's direct source of income is based.

Additional information relating to the Company, including the Company's Annual Information Form, is on SEDAR at www.secondcup.com.

About Second Cup®

Founded in 1975, Second Cup® is Canada's largest specialty coffee franchisor operating more than 350 cafés across the country.  All 4,000 Second Cup® associates are trained coffee experts who handcraft over 1,000,000 coffee and tea beverages every week, and are committed to ensuring "there's a little love in every cup.™"  For more information, please visit www.secondcup.com or find us on Facebook and Twitter.

SOURCE: The Second Cup Ltd.