Second Cup Announces Second Quarter Results and Quarterly Dividend

TRADING SYMBOL:  The Toronto Stock Exchange - SCU

MISSISSAUGA, ON, July 31, 2013 /CNW/ - The Second Cup Ltd. ("Second Cup" or the "Company") reported financial results today for the 13 weeks ended June 29, 2013 (the "Quarter") and 26 weeks ended June 29, 2013 ("Year to Date"). 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.

Highlights

• Declared a quarterly dividend of $0.085 per share.
• Working capital improvement of $707 since December 29, 2012 driven by a higher cash balance.
• System sales increased by 0.6% to $47,688 in the Quarter and an increase of 0.2% to $94,642 for the Year to Date period compared to a year ago.
• Same café sales declined 2.2% in the Quarter.
• Recorded a non-cash after-tax impairment charge of $11,497 to intangible assets.
• Adjusted basic and diluted earnings per share of $0.13 for the Quarter compared to $0.09 in the comparable Quarter a year ago ($0.20 for the Year to Date period compared to $0.19 in the comparable period a year ago).

Stacey Mowbray, President & CEO of Second Cup commented, "We are encouraged at the progress being made on the three long-term strategic initiatives we first communicated during the release of the third quarter results in 2012, following the successful investment and roll-out of a new point-of-sale system ending in 2012.  We are pleased with the early results of both the loyalty program pilot which launched in 31 cafés in the Quarter and with the initial response to the opening of our new café design prototype, elements of which are expected to be incorporated immediately into new cafés and existing cafés when renovated.  This fall will see the continued expansion of the Tassimo T-disc business and a reinforcement of our gold standard coffee credentials with new in store merchandising, new packaging, and new coffees to add to our already impressive line-up.

In the second Quarter, we opened four new cafés and closed three cafés, as we continue to grow and improve the café network.

We are continuing to work on these long-term initiatives to strengthen the Second Cup business.  We have been able to maintain a strong dividend return to shareholders while investing in each of these initiatives during a difficult economic environment."

As a result of impairment indicators, including the decline in the stock price and sales performance, management performed an impairment test and it resulted in the recording of a non-cash, trademark impairment charge. The after-tax impact of this impairment charge was $11,497 and reduced earnings per share by $1.16. The impairment charge has no impact on the Company's liquidity, cash flow, borrowing capability or operations and will not detract from the above mentioned strategic initiatives to improve performance.

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 unaudited condensed interim financial statements of the Company for the 13 and 26 weeks ended June 29, 2013, which are expected to be released on or before August 2, 2013.

Second Quarter Analysis

Analysis of System Sales and Same Café Sales
System sales for the 13 weeks ended June 29, 2013 were $47,688 compared to $47,382 for the 13 weeks ended June 30, 2012, representing an increase of $306 or 0.6%. The total number of cafés at the end of the Quarter was 362 compared to 356 cafés at the end of the second Quarter of 2012, an increase of six cafés.

Same café sales represents the percentage change, on average, in retail sales at cafés (franchised and Company-operated) operating system wide that have been open for 12 or more months. It is one of the key metrics the Company uses to assess its performance and provides a useful comparison between quarters. The two principal factors that affect same café sales are changes in customer traffic and changes in average sale. These factors are dependent upon existing cafés maintaining operational excellence within each Second Cup café, general market conditions, pricing, and marketing programs undertaken by Second Cup.

During the Quarter, Second Cup continued to be impacted by competitive activity resulting in a same café sales decline of 2.2%, compared to a decline of 1.5% in the comparable quarter of 2012.

Analysis of Revenues
Total revenues for the Quarter were $6,636 (2012 - $6,175) and consisted of royalty revenue, revenue from sale of goods, and services revenue.

Royalty revenue for the Quarter was $3,519 (2012 - $3,700). The reduction in royalty revenue of $181 was mainly due to the reduction in the effective royalty rate (excluding sales from Company-operated cafés) from 8.0% in 2012 to 7.6% in the Quarter. This was partially a result of café specific arrangements in place during the period that lowered the effective royalty rate. In addition, new cafés that opened in 2011 through 2013 to date pay a royalty rate of 3% in the first year, a rate of 6% in the second year and, thereafter, a rate of 9%.

Revenue from the sale of goods, which consists of revenue from Company-operated cafés was $1,328, (2012 - $966) for the Quarter. The increase in revenue from the sale of goods was mainly due to ten Company-operated cafés in the Quarter compared to seven in 2012.

Services revenue for the Quarter was $1,789 (2012 - $1,509). 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 licensing revenue, purchasing coordination fees, and other ancillary fees (IT support, tuition, and construction black line drawings). The $280 increase in services revenue was partially 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. The remainder of the increase is mainly due to an increase of purchasing coordination fees and transfer fees charged.

Cost of Goods Sold
Cost of goods sold represents the product cost of goods sold in corporate cafés 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 in the Quarter was 72% (2012 - 75%).  The difference is due to menu price increases at cafés and decreases pertaining to product purchase costs.

Operating Expenses
Operating expenses include the head office expenses of Second Cup and the overhead expenses of Company-operated cafés. Total operating expenses for the Quarter were $3,828 (2012 - $3,383), an increase of $445.

Head office expenses of Second Cup increased by $329 (10.7%) in the Quarter to $3,394 from $3,065 in 2012. This increase was mainly due to increases in salaries, wages, benefits and incentives of $417 (due to increased severance costs and a reduction of 2012 incentive plan costs), increases in occupancy and lease costs of $136 (due to an increase in vacant properties), and obsolete inventory of $135. Offsetting some of the increases, were decreases in travel and franchise partner meetings of $250, decreases in research and innovation of $93, decreases in bad debt expense of $62 and a decrease in legal costs of $47.

The overhead expenses in Company-operated cafés for the Quarter increased by $116 to $434 from $318 in 2012, due to ten Company-operated cafés during the Quarter compared to seven in 2012.

Impairment of Trademarks
The Company identified impairment indicators which were primarily a result of the decline in its stock price and decline in sales in comparison to internal projections.  The impairment test is based on management's expectations of future cash flows and incorporates an element of risk in meeting those expectations. As a result of the impairment test, the Company recognized an impairment charge of $13,253 in the Quarter. The after-tax impact of these impairment charges was $11,497 and reduced earnings per share by $1.16 for the Quarter. 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 $113 (2012 - $181) on the term loan and derivative interest rate swap, and $5 (2012 - $20) in amortization of deferred financing charges relating to the term loan. The Company also recorded non-cash gain of $1 (2012 - $41) for the movement in the fair value of the derivative interest rate swap that fixed the interest rate on the Company's term loan. The Company earned other interest income of $22 (2012 - $17) primarily due to interest earned from short-term, highly liquid bank investments with original maturities of three months or less.

Income Taxes
Current income taxes of $415 (2012 - $422) and deferred income taxes of $1,759 recovery (2012 - $656 expense) were recorded in the Quarter.  The income tax recovery pertaining to deferred income taxes was driven by the impairment charge recorded in the Quarter.

EBITDA
EBITDA for the Quarter was $2,122 (2012 - $2,334). The decrease of $212 in EBITDA was primarily due to an increase in operating expenses (excluding amortization, loss on disposal of property and equipment, and impairment charges) as discussed above.

Net (Loss) Income
The Company's net loss for the Quarter was $10,152 or $1.03 loss per share, compared to net income of $842 or $0.09 earnings per share in 2012. The decline in net income of $10,994 or $1.12 per share was mainly due to the non-cash impairment charge.

Year to Date Analysis

Analysis of System Sales and Same Café Sales
System sales for the 26 weeks ended June 29, 2013 were $94,642 compared to $94,483 for the 26 weeks ended June 30, 2012, representing an increase of $159 or 0.2%. The total number of cafés at the end of the Quarter was 362 compared to 356 cafés at the end of the second Quarter of 2012.

The same café sales metric was discussed above.  During the Year to Date period, Second Cup continued to be impacted by competitive activity, resulting in a same café sales decline of 2.8%, compared to a decline of 0.5% in the comparable Year to Date period of 2012.

Analysis of Revenues
Total revenues for the Year to Date period were $12,882 (2012 - $12,183) and consisted of royalty revenue, revenue from sale of goods and services revenue.

Royalty revenue for the Year to Date period was $7,016 (2012 - $7,378). The reduction in royalty revenue of $362 was mainly due to the reduction in the effective royalty rate (excluding sales from Company-operated cafés) from 8.0% in 2012 to 7.6% in the Year to Date period. This change was consistent with what was discussed above pertaining to the Quarter.

Revenue from the sale of goods, which consists of revenue from Company-operated cafés was $2,617, (2012 - $1,866) for the Year to Date period. The increase in revenue from the sale of goods was mainly due to ten Company-operated cafés compared to seven in 2012.

Services revenue for the Year to Date period was $3,249 (2012 - $2,939). The $310 increase in services revenue was consistent with what was discussed above pertaining to the Quarter.

Cost of Goods Sold
Cost of goods sold represents the product cost of goods sold in corporate cafés 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 in the Year to Date period was 73% (2012 - 75%).  The difference is due to menu price increases at cafés and decreases pertaining to product purchase costs.

Operating Expenses
Operating expenses include the head office expenses of Second Cup and the overhead expenses of Company-operated cafés. Total operating expenses for the Year to Date period were $8,080 (2012 - $7,173), an increase of $907.

Head office expenses of Second Cup increased by $638 (9.8%) in the Year to Date period to $7,176 from $6,538 in 2012. This increase was mainly due to increases in salaries, wages, benefits and incentives of $215 (due to increased severance costs and a reduction of the 2012 incentive plan costs), increases in occupancy and lease costs of $259 (due to an increase in vacant properties), increases in research and innovation of $228 (due to Quarter 1 spend on initiatives such as the loyalty program and café design), and obsolete inventory of $148. Offsetting some of the increases, were decreases in travel and franchise partner meetings of $95, decreases in bad debt expense of $131 and a decrease in legal costs of $96.

The overhead expenses in Company-operated cafés for the Year to Date period increased by $269 to $904 from $635 in 2012 due to ten Company-operated cafés during the Year to Date period compared to seven in 2012.

Impairment of Trademarks
As discussed above, the Company recognized an impairment charge of $13,523 to trademarks.

Other Income and Expenses
The Company incurred interest expense of $276 (2012 - $366) on the term loan and interest rate swap, and $27 (2012 - $38) in amortization of deferred financing charges relating to the term loan. The Company also recorded non-cash gain of $96 (2012 - $106) for the movement in the fair value of the interest rate swap that expired on April 1, 2013, that fixed the interest rate on the Company's term loan. The Company earned other interest income of $35 (2012 - $39) primarily due to interest earned from short-term highly liquid bank investments with original maturities of three months or less.

Income Taxes
Current income taxes of $637 (2012 - $773) and deferred income taxes of $1,719 - recovery (2012 - $699 expense) were recorded in the Year to Date period. The income tax recovery pertaining to deferred income taxes was driven by the impairment charge recorded in the Year to Date period.

EBITDA
EBITDA for the Year to Date period was $3,456 (2012 - $4,148). The decrease in EBITDA of $692 was primarily due to an increase in operating expenses (excluding amortization, loss on disposal of property and equipment and impairment charges) as discussed above.

Net (Loss) Income
The Company's net loss for the Year to Date period ended was $9,464 or $0.96 loss per share, compared to net income of $1,874 or $0.19 earnings per share in 2012. The decline in net income of $11,338 or $1.15 per share was mainly due to the non-cash impairment charge.

Café Network

Dividend
On July 31, 2013, the Board of Directors of Second Cup approved a quarterly dividend of $0.085 per common share, payable on August 30, 2013 to shareholders of record at the close of business on August 16, 2013. The dividend will be considered an eligible dividend for income tax purposes.

OUTLOOK

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

The Second Cup business continues to operate in a competitive marketplace and a challenging consumer environment. In 2013, management continues to invest in the business, including a loyalty program which went into test in 31 cafés, with positive initial results. In addition, the prototype of the new look café opened in July, elements of which are expected to be rolled out immediately to new cafés and existing cafés when renovated.  As well, a coffee revitalization program, including the expansion of the TASSIMO T-Disc line, will be in market this fall.

Commencing in July 2013, the Company began a phased transition to a new distributor to supply products to cafés.  The change to a new distributor was driven due to favourable operational capabilities.  The Company does not believe the changeover will have a material impact on operations nor financial results during the transition period.

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

FORWARD-LOOKING STATEMENTS

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", "EBITDA", and "adjusted 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 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.