Second Cup Announces Third Quarter Results and Quarterly Dividend

TRADING SYMBOL:  The Toronto Stock Exchange - SCU

MISSISSAUGA, ON, Oct. 31, 2013 /CNW/ - The Second Cup Ltd. ("Second Cup" or the "Company") reported financial results today for the 13 weeks ended September 28, 2013 (the "Quarter") and 39 weeks ended September 28, 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.
• Adjusted basic and diluted earnings per share of $0.09 for the Quarter compared to $0.08 in the comparable quarter a year ago and $0.30 for the Year to Date period compared to $0.26 in the comparable period a year ago.
• System sales decreased by 3.2% to $44,894 for the Quarter and 0.9% to $139,536 for the Year to Date period compared to a year ago.
• Same café sales decreased 3.7% in the Quarter and 3.1% in the Year to Date period.
• Launched a new look café design, elements of which are being incorporated throughout the café network as cafés are opened or renovated.
• Announced an expanded partnership with Kraft Canada with the intention to launch Second Cup branded whole bean and ground coffee in grocery stores across Canada commencing in February 2014.
• Launched two new single-serve product offerings on the TASSIMO system late in the Quarter.
• Extended the terms of the Company's long-term debt to September 30, 2016.

Stacey Mowbray, President & CEO of Second Cup commented, "We continue to be encouraged by the progress of the three long-term strategic initiatives first communicated in 2012, and the successful introduction of a new point-of-sale system in 2012.

Initial results of the loyalty program pilot, launched in 31 cafés in June, are promising and a rollout is planned for 2014.  The response to the opening of our new café design prototype has been positive and elements of the design will be incorporated into new cafés and existing cafés when renovated. The third strategic initiative, the revitalization of our gold standard coffee credentials, involves the recent launch of external coffee credential communications with new, in café coffee category merchandising, the expansion of the TASSIMO T-disc line up with the addition of two new offerings, and the intended launch of Second Cup branded whole bean and roast and ground coffee into grocery in early 2014 through a partnership with Kraft Canada. There will also be new look coffee packaging and a new limited time offer Kenyan reserve coffee available for the holiday season. 

One of the company's stated goals is to improve the overall café network.  As a result, in the Quarter we closed 12 cafés, of which eight were small kiosks located inside a home improvement banner, with low volumes, and a poor representation of the brand. We opened one new café in the Quarter.

Despite ongoing competitive pressure (which has impacted same café sales and revenues) and our disappointment with sales, we are confident in the strategic direction of the brand and the positive impact of the investments we are making to improve performance. Second Cup has a sound cash position of $5.3 million at the end of the Quarter, up from $3.2 million a year ago.

As Second Cup rebuilds the brand, I want to thank the franchise partners who are passionate about delivering the highest quality to our guests, in a caring and warm environment, every day."

FINANCIAL HIGHLIGHTS

The following table sets out selected 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 39 weeks ended September 28, 2013 which are expected to be released on or before November 4, 2013.

Third Quarter Analysis

Analysis of System Sales and Same Café Sales
System sales for the 13 weeks ended September 28, 2013 were $44,894 compared to $46,389 for the 13 weeks ended September 29, 2012, representing a decrease of $1,495 or 3.2%. System sales for the 39 weeks ended September 28, 2013 were $139,536 compared to $140,872 for the 39 weeks ended September 29, 2012, representing a decrease of $1,336 or 0.9%.  The total number of cafés at the end of the Quarter was 351 compared to 358 cafés at the end of the third quarter of 2012, a decrease of seven cafés, and 362 cafés at the end of the second Quarter 2013, a decrease of 11 cafés.  The activity during the Quarter was predominantly due to the planned closure of eight low volume cafés located inside home improvement retail centres.

Same café sales represents the percentage change, on average, in sales at cafés (franchised and Company-operated) operating system-wide that have been open for more than 12 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 on existing cafés maintaining operational excellence within each Second Cup café, general market conditions, pricing, marketing programs undertaken by Second Cup, and the level of competitive activity.

During the Quarter, Second Cup continued to be impacted by competitive activity resulting in a same café sales decline of 3.7%, compared to a decline of 2.8% in the comparable quarter of 2012. On a Year to Date basis there was a decline of 3.1% compared to a decline of 1.2% in the comparable Year to Date period of 2012.

Management is not aware of any reliable third party comparable data on the trends affecting the Canadian specialty coffee market or the performance of Second Cup's competitors in the Canadian specialty coffee market during the year.

Analysis of Revenue
Total revenues for the Quarter were $6,268 (2012 - $6,378) and consisted of royalty revenue, revenue from sale of goods, and services revenue.

Royalty revenue for the Quarter was $3,285 (2012 - $3,532). The reduction in royalty revenue of $247 was partially due to the reduction in the effective royalty rate (excluding sales from Company-operated cafés) from 7.8% 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%.  The remaining reduction of royalty revenue is as a result of overall lower system sales.

Revenue from the sale of goods, which consists of revenue from Company-operated cafés was $1,363 (2012 - $1,235) for the Quarter. The increase of $128 in revenue from the sale of goods was mainly due to 11 Company-operated cafés in the Quarter compared to ten in 2012.

Services revenue for the Quarter was $1,620 (2012 - $1,611), a $9 increase which was relatively stable compared to 2012.  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).

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 76% (2012 - 79%).  The difference is due to menu price increases at cafés and decreases pertaining to product purchase costs as a result of improved vendor pricing.

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 $3,865 (2012 - $4,274), a decrease of $409.

Head Office Operating Expenses
Head office expenses decreased by $429 (11.3%) in the Quarter to $3,361 from $3,790 in 2012.  Lower salaries, wages, benefits, and incentives coupled with a gain of $425 relating to breakage income on gift cards as a result of revised estimates were partially offset by additional provisions for closed cafés and increases in other lease related provisions where the Company is on the headlease.

Corporate Café Operating Expenses
The overhead expenses in Company-operated cafés for the Quarter stayed relatively flat increasing by $20 to $504 from $484 in 2012.  The small increase was mainly due to 11 Company-operated cafés in the Quarter compared to ten in 2012.

Other Income and Expenses
The Company incurred interest expense of $113 (2012 - $159) on the term loan and interest rate swap, and $3 (2012 - $22) in amortization of deferred financing charges relating to the term loan.  The swap agreement expired on April 1, 2013, whereas in 2012, there was a $53 gain pertaining to the movement in the fair value of the interest rate swap.  The Company earned other interest income of $26 (2012 - $12) 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 $439 (2012 - $275) and deferred income tax recovery of $86 (2012 - $4) were recorded in the Quarter.

EBITDA
EBITDA for the Quarter was $1,671 (2012 - $1,468). The increase of $203 in EBITDA was primarily due to a decrease in operating expenses offset by a decrease in royalty revenue as discussed above.

Net Income
The Company's net income for the Quarter was $918 or $0.09 per share, compared to $746 or $0.08 per share in 2012.  The increase in net income of $172 or $0.01 per share was mainly due to decreased operating expenses as discussed above.

Year to Date Analysis

Analysis of System Sales and Same Café Sales
System sales for the 39 weeks ended September 28, 2013 were $139,536 compared to $140,872 for the 39 weeks ended September 29, 2012, representing a decrease of $1,336 or 0.9%.

Same café sales on a Year to Date basis had a decline of 3.1% compared to a decline of 1.2% in the comparable Year to Date period of 2012.

Please see the discussion above in the Quarter that discusses factors that impact system sales and same café sales.

Analysis of Revenue
Total revenues for the Year to Date period were $19,150 (2012 - $18,561) and consisted of royalty revenue, revenue from sale of goods and services revenue.

Royalty revenue for the Year to Date period was $10,301 (2012 - $10,910). The reduction in royalty revenue of $609 was mainly due to the reduction in the effective royalty rate (excluding sales from Company-operated cafés) from 7.9% 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 $3,980, (2012 - $3,101) for the Year to Date period. The increase in revenue from the sale of goods was mainly due to a range of ten to eleven Company-operated cafés in the current period compared to a 2012 range of seven to ten Company-operated cafés.

Services revenue for the Year to Date period was $4,869 (2012 - $4,550).  The $319 increase in services revenue was primarily due to the Year to Date impact of the partnership with Kraft Canada Inc. to produce, market and sell Second Cup TASSIMO T-Discs.  Sales of TASSIMO T-Discs commenced in the third quarter of 2012.

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 74% (2012 - 77%). The difference is due to menu price increases at cafés and decreases pertaining to product purchase costs as a result of improved vendor pricing.

Operating Expenses
Total operating expenses for the Year to Date period were $11,945 (2012 - $11,447), an increase of $498.

Head Office Operating Expenses
Head office expenses increased by $209 (2.0%) in the Year to Date period to $10,537 from $10,328 in 2012.  The increase was driven by adjustments to closed café lease provisions and increases in other lease related provisions where the Company is on the headlease.  In addition, the Company incurred expenditures on innovation, test concepts, and initiatives mostly due to costs towards the loyalty program and new café branding and design costs.  The Year to Date period change pertaining to innovation and related costs was largely driven by first quarter spending.  Offsetting the increase was a gain relating to breakage income on gift cards recorded in the Quarter as discussed above.

Corporate Café Operating Expenses
The overhead expenses in Company-operated cafés for the Year to Date period increased by $289 to $1,408 from $1,119 in 2012.  The increase is due to a larger number of Company-operated cafés as was discussed above.

Impairment of Trademarks
During the second quarter of the current fiscal year, the Company identified impairment indicators, which were primarily a result of the decline in its stock price and a 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 Year to Date period.  The after-tax impact of this impairment charge was $11,497 and reduced earnings per share by $1.16. The impairment charge had no impact on the Company's liquidity, cash flow, borrowing capability or operations.

Other Income and Expenses
The Company incurred interest expense of $389 (2012 - $525) on the term loan and derivative interest rate swap, and $30 (2012 - $60) in amortization of deferred financing charges relating to the term loan. The Company also recorded a non-cash gain of $96 (2012 - $159) 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 $61 (2012 - $51) 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 $1,076 (2012 - $1,048) and deferred income taxes of $1,805 - recovery (2012 - $695 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 $5,127 (2012 - $5,616). The decrease in EBITDA of $489 was primarily due to an increase in operating expenses (excluding depreciation, amortization, loss on disposal of property and equipment and impairment) and lower royalty revenues as discussed above.

Net (Loss) Income
The Company's net loss for the Year to Date period was $8,546 or $0.86 loss per share, compared to net income of $2,620 or $0.26 earnings per share in 2012. The decline in net income of $11,166 or $1.13 per share was mainly due to the non-cash impairment charge.

CAFÉ NETWORK

DIVIDEND

On October 30, 2013, the Board of Directors of Second Cup approved a quarterly dividend of $0.085 per common share, payable on November 29, 2013 to shareholders of record at the close of business on November 15, 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 is being tested in 31 cafés, with positive initial results.  In 2014, Second Cup plans to roll out the loyalty program nationally.

The prototype of the new look café opened in July.  Elements of the prototype are expected to be rolled out immediately to new cafés and existing cafés when renovated.  As well, the Company introduced and will further expand a coffee revitalization program. Included in the revitalization program was the expansion of the TASSIMO T-Disc line, which was launched in market late in the Quarter.

Second Cup has announced that it will leverage its success with its partner, Kraft Canada Inc., to distribute its Second Cup branded whole bean and ground coffee to grocery stores across Canada in early 2014.  The new revenue stream is intended to increase corporate sales, while increasing brand presence in the marketplace to attract customers into cafés in addition to their homes.  This new venture will require an initial investment in listing fees and advertising support in 2014.

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.