Second Cup announces fourth quarter results and quarterly dividend

MISSISSAUGA, ON, March 10, 2014 /CNW/ - The Second Cup Ltd. (TSX:SCU) reported financial results today for the 13 weeks (the "Quarter") and 52 weeks (the "Year") ended December 28, 2013. All amounts in this news release are presented in thousands of Canadian dollars, unless otherwise indicated.

Highlights

• Alix Box was appointed as the new Chief Executive Officer effective February 24, 2014.
• Reconstituted the Board of Directors. The new Board is led by Chairman Michael Bregman, along with Stephen Kelley, Alton McEwen, Rael Merson, Alan Simpson, and Alix Box.
• Declared a quarterly dividend of $0.085 per share.
• System sales of cafés decreased by 3.0% to $51,898 for the Quarter and 1.5% to $191,434 for the Year compared to a year ago. Same café sales decreased 4.3% in the Quarter and decreased 3.6% for the Year.
• Adjusted basic and diluted earnings per share of $0.17 for the Quarter compared to $0.18 in the comparable Quarter a year ago and $0.45 for the Year, stable versus a year ago.

Alix Box, President & CEO of Second Cup commented, "I am excited for the opportunity to lead Second Cup.  Our objectives are ambitious.  Working with the Board of Directors, we intend to reinvigorate this iconic Canadian brand to become a best in class specialty coffee retailer.  This mission is clear and I will be working closely with our franchise partners to establish the highest levels of excellence and innovation throughout the organization.  Notwithstanding the near-term impact on profitability, I am committed to make the best decisions to maximize long-term shareholder value."

FINANCIAL HIGHLIGHTS

The following table sets out selected IFRS and certain non-GAAP financial measures of the Company and should be read in conjunction with the MD&A and Audited Financial Statements of the Company for the 52 weeks ended December 28, 2013.

OPERATIONAL REVIEW

Fourth Quarter

System sales of cafés
System sales of cafés for the 13 weeks ended December 28, 2013 were $51,898 compared to $53,515 for the 13 weeks ended December 29, 2012, representing a decrease of $1,617 or 3.0%.  The decrease is attributable to decreased Same café sales and to the marginally smaller store network.

Same café sales
During the Quarter, Second Cup continued to be impacted by competitive activity resulting in a same café sales decline of 4.3%, compared to a decline of 4.2% in the comparable Quarter of 2012.

Analysis of revenue
Total revenue for the Quarter was $8,038 (2012 - $7,785) and consisted of royalty revenue, revenue from sale of goods, and services revenue.

Royalty revenue for the Quarter was $3,816 (2012 - $4,017).  The reduction in royalty revenue of $201 is primarily a result of overall lower System sales of cafés, and to a lesser extent, the mix of cafés with varying royalty rates.

Revenue from the sale of goods, which consists of revenue from Company-operated cafés and from the e-commerce channel was $1,526 (2012 - $1,597) for the Quarter. The decrease of $71 in revenue from the sale of goods was mainly due lower customer traffic across the Company-operated café portfolio and changes within the portfolio of cafés. There were ten Company-operated cafés at the end of both Years.

Services revenue for the Quarter was $2,696 (2012 - $2,171).  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, wholesale revenue, purchasing coordination fees, and other ancillary fees (such as IT support and training fees).  The $525 increase in services revenue was primarily due to sales pertaining to the partnership with Kraft Canada Inc. to produce, market, and sell Second Cup branded TASSIMO T-Discs.

Cost of goods sold
Cost of goods sold represents the product cost of goods sold in Company-operated cafés and through the e-commerce channel, plus the cost of direct labour to prepare and deliver the goods to the customers in the Company-operated cafés. Cost of goods sold was $1,089 (2012 - $1,147) or alternatively as a percentage of revenue from the sale of goods was 71% (2012 - 72%).  The improvement 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 $4,759 (2012 - $3,970), an increase of $782.

Head office
Head office expenses for the Quarter were $4,406 (2012 - $3,424), an increase of $982 or 29%.  During the Quarter, the Company recorded $883 of restructuring charges pertaining to the reconstitution of the Board of Directors and change in Chief Executive Officer.  The Company also recorded bad debt expense of $265 in the Quarter. Offsetting impacts included lower salaries, wages, benefits, and incentives coupled with a gain of $372 relating to breakage income on gift cards.

Company-operated cafés
Company-operated café expenses for the Quarter were $353 (2012 - $546), a decrease of $193 or 35%.  The decrease is due to gains on disposal of capital related items as a result of required software upgrades in advance of the anticipated launch of the loyalty program.

Impairment charges
The Company recognized impairment charges of $299 (2012 - $15,649).  The 2013 charge pertained to leasehold improvement assets carried at a value in excess of its recoverable amount that cannot be redeployed to another Company-operated café.

The 2012 charges of $15,649 were a result of the Company's annual impairment analysis, which consisted of $12,850 to trademarks, $2,444 to goodwill, and $355 to other assets.

Interest and financing
The Company incurred interest and financing expenses of $254 (2012 - $128).  The swap agreement expired on April 1, 2013 and was subsequently renewed during the Quarter on September 30, 2013. The increase in interest and financing expenses is due to the fair value adjustment primarily realized at inception of the renewed swap which captures an interest rate premium to fix the effective interest rate on the Long-term debt.  Details are discussed in the "Liquidity and capital resources" section onward in this news release.

Income taxes (recovery)
Current income taxes of $427 (2012 - $596) and deferred income tax expense of $33 (2012 - tax recovery of $1,688) were recorded in the Quarter. Current income taxes decreased as a result of decreased royalties. The change in deferred income taxes was driven by the impairment charges recorded in 2012.

Adjusted EBITDA
Adjusted EBITDA for the Quarter was $2,868 (2012 - $3,027). The decrease of $159 in Adjusted EBITDA was primarily due to decreased royalty revenue.

Net income (loss)
The Company's net income for the Quarter was $1,177 or $0.12 per share, compared to a loss of $12,024 or $1.21 per share in 2012. The increase in net income of $13,201 or $1.33 per share was mainly due to the non-cash impairment charge that was recorded in the prior Year.

A reconciliation of net income (loss) to Adjusted EBITDA is provided in the section "Definitions and discussion of certain non-GAAP financial measures".

Year

System sales of cafés
System sales of cafés for the Year were $191,434 compared to $194,387 for 2012, representing a decrease of $2,953 or 1.5%.  The decrease is attributable to lower same café sales and to the marginally smaller store network.

Same café sales
For the Year, there was a decline of 3.6% compared to a decline of 1.9% in the comparable Year of 2012.  The nature of the decrease is consistent to what was discussed above in the Quarter.

Analysis of revenue
Total revenues for the Year were $27,188 (2012 - $26,346).

Royalty revenue for the Year was $14,117 (2012 - $14,927).  The reduction in royalty revenue of $810 was mainly a result of overall lower system sales of cafés and the reduction in the effective royalty rate from 7.9% in 2012 to 7.6% in the Year. 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 and the e-commerce channel was $5,506 (2012 - $4,698) for the Year. The increase in revenue from the sale of goods was mainly due to a range of ten to eleven Company-operated cafés compared to a 2012 range of seven to ten Company-operated cafés.

Services revenue for the Year was $7,565 (2012 - $6,721).  The $844 increase in services revenue was primarily due to the full year 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, hence the 2013 Year benefitted from having a full period of sales.

Cost of goods sold
Cost of goods sold was $4,054 (2012 - $3,523) or alternatively as a percentage of revenue from the sale of goods was 74% (2012 - 75%).  The improvement was discussed above in the Quarter.

Operating expenses
Total operating expenses for the Year were $16,704 (2012 - $15,417), an increase of $1,287.

Head office
Head office expenses increased by $1,191 (9%) in the Year to $14,943 from $13,752 in 2012.  The Company incurred $883 in restructuring charges as discussed above in the Quarter.  The increase was also driven by adjustments to closed café lease provisions and increases in other onerous lease related provisions where the Company is on the headlease.  The increase also pertains to expenditures on innovation, test concepts, and initiatives mostly due to costs towards the loyalty program and new café branding and design costs.  Offsetting some of the increase was a gain of $797 relating to breakage income on gift cards recorded in the Year.

Company-operated cafés
The overhead expenses in Company-operated cafés for the Year increased by $96 to $1,761 from $1,665 in 2012.  The increase is due to a larger number of Company-operated cafés offset partially by a gain on disposal of capital related items, both of which were discussed above in the Quarter.

Impairment charges
The Company incurred impairment charges of $13,552 (2012 - $15,656).  During the second Quarter of 2013, the Company identified impairment indicators on its trademark assets, 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 the expected recoverable amount of the cash generating unit which has been determined using fair value less costs to sell. The determination of the recoverable amount 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 pertaining to trademarks.  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.

Further impairment charges are discussed above in the Quarter.

Interest and financing
The Company incurred interest and financing expenses of $516 (2012 - $503).  The increase in interest and financing expenses was discussed above in the Quarter.  Offsetting the increases were recoveries pertaining to higher interest income as a result of higher cash balances.  Further recoveries were a result of a lower fixed effective interest rate of 4.82% vs. 5.79% under the previous interest rate swap that ended on April 30, 2013.  Details are discussed in the "Liquidity and capital resources" section onward in this news release.

Income taxes (recovery)
Current income taxes of $1,503 (2012 - $1,644) and deferred income tax recoveries of $1,772 (2012 - $993) were recorded in the Year.  The decline in current taxes is consistent with the discussion above in the Quarter.  The income tax recoveries pertaining to deferred income taxes were driven by the impairment charges discussed above.

Adjusted EBITDA
Adjusted EBITDA for the Year was $7,570 (2012 - $8,643). The Adjusted EBITDA decrease of $1,073 was primarily due to an increase in operating expenses before restructuring charges, the change in estimate pertaining to the gift card breakage rate, and a decrease in royalty revenue as discussed above.

Net loss
The Company's net loss for the Year was $7,369 or $0.74 loss per share, compared to net loss of $9,404 or $0.95 loss per share in 2012. The improvement of net loss of $2,035 or $0.20 per share was mainly due to lower non-cash impairment charges in the current Year.

Dividend
On March 7, 2014 the Board of Directors of Second Cup approved a quarterly dividend of $0.085 per common share, payable on March 28, 2014 to shareholders of record at the close of business on March 21, 2014.

The Company's dividend policy is to continue to pay a portion of earnings while retaining funds for organic growth initiatives. The determination to declare and make payable dividends from Second Cup is at the discretion of the Board of Directors of Second Cup and until declared payable, Second Cup has no requirement to pay cash dividends to shareholders. Taking into account current economic conditions and their impact on the profitability of Second Cup, the Board of Directors will continually review the level of dividends paid by the Company and there can be no assurance the dividends will remain at the current level.

Café network

Closure activity in 2013 was predominantly driven by the planned closures of eight low volume cafés located inside home improvement retail centres.  The Company ended the Year with ten (2012 - ten) Company-operated cafés.

SELECTED QUARTERLY INFORMATION

OUTLOOK

This section is qualified by the section "Caution Regarding Forward-Looking Statements" onward in this news release.

The Second Cup business continues to operate in a competitive marketplace and a challenging consumer environment. In 2013, management continued to invest in the business, including investing in the development of 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.

As well, the Company introduced and will further expand a coffee revitalization program. Promotions will be geared to put coffee at the forefront as one of the Company's key success factors.  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 roast & ground coffee to grocery stores across Canada commencing in February 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 potential advertising support in 2014.

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

As a result of the reconstitution of the Board of Directors, a change in the Chief Executive Officer, and an ongoing review of the Second Cup's operational direction, the Company may incur certain transitional and restructuring related charges onward in 2014. The Company will focus on embracing change and implementing improvements to better the economic health of the franchise network, which is intended to ultimately benefit the Company and its shareholders.

CAUTION REGARDING FORWARD-LOOKING STATEMENTS

Certain statements in this news release may constitute forward-looking statements within the meaning of applicable securities legislation. The terms the "Company", "Second Cup", "we", "us", or "our" refer to The Second Cup Ltd. 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 financial performance and speak only as of the date of this news release. It should not be read as a guarantee of future performance or results and will not necessarily be an accurate indication of whether or not those results will be achieved. Forward-looking statements are based on a number of assumptions and are subject to known and unknown risks, uncertainties and other factors, many of which are beyond Second Cup's control 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 such forward-looking statements. The foregoing list of factors is not exhaustive, and investors should refer to the risks described under "Risks and Uncertainties" in Second Cup's Management's Discussion and Analysis ("MD&A") and Annual Information Form, which is available at www.sedar.com.

Although the forward-looking statements contained in this news release are based on what management believes are reasonable assumptions, there can be no assurance that actual results will be consistent with these forward-looking statements and, as a result, the forward-looking statements may prove to be incorrect.

As these forward-looking statements are made as of the date of this news release, Second Cup does not undertake to update any such forward-looking statements whether as a result of new information, future events or otherwise. Additional information about these assumptions and risks and uncertainties is contained in the Company's filings with securities regulators. These filings are also available on the Company's website at www.secondcup.com.

DEFINITIONS AND DISCUSSION ON CERTAIN NON-GAAP FINANCIAL MEASURES

In this news release, the Company reports certain non-IFRS measures such as System sales of cafés, Same café sales, EBITDA, Adjusted EBITDA, and Adjusted earnings per share.

System sales of cafés
System sales of cafés comprise the net revenue reported to Second Cup by franchisees of Second Cup cafés and by Company-operated cafés. This measure is useful in assessing the operating performance of the entire Company network, such as capturing the net growth of the overall café network.  Sales are reported by franchisees to Second Cup on a weekly basis without audit or other form of independent assurance. Second Cup's substantiation of sales reported by its franchisees is through analytical and financial reviews performed by management, comparison to sales data on the POS, on-site visits, and analyses of raw materials purchased by the cafés as reported by authorized vendors.

Increases in System sales of cafés result from the addition of new cafés and Same café sales (as described below).  The primary factors influencing the number of cafés added to the Second Cup café network include the availability and cost of high quality locations, competition from other specialty coffee retailers and other businesses for prime locations, and the availability of qualified franchisees.

System sales of cafés are also affected by the permanent closure of Second Cup cafés. Cafés are closed when they cease to be viable or, occasionally, when a renewal of a lease for a particular location is not available or when an alternative, preferable location is available.

Same café sales
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 with specific focus on organic growth. Organic growth is an indicator on how the Company is impacted by operational effectiveness, the results of marketing efforts, pricing, and responsiveness to competition. Same café sales provides a useful comparison between periods while also encompassing other matters such as seasonality. The two principal factors that affect same café sales are changes in customer traffic and changes in average sale.

Operating income (loss)
Operating income (loss) represents Revenue, less Cost of goods sold, less Operating expenses, and less Impairment charges. This measure is not defined under IFRS, although the measure is derived from input figures in accordance with IFRS.  Management views this as an indicator of financial performance that excludes costs pertaining to Interest and financing, and Income taxes.

EBITDA and Adjusted EBITDA
EBITDA represents earnings before interest, taxes, depreciation, and amortization.  As there is no generally accepted method of calculating EBITDA, the measure as calculated by the Company is likely not comparable to similarly titled measures reported by other issuers. EBITDA is presented as management believes it is a useful indicator of the Company's ability to meet debt service, capital expenditure requirements, and evaluate liquidity.  Management interprets trends in EBITDA as an indicator of relative financial performance.  EBITDA should not be considered by an investor as an alternative to net income or cash flows as determined in accordance with IFRS.

Impairment charges are a reconciling item in the calculation of Adjusted EBITDA as its nature is non-cash and management interprets this measure to be similar in substance to depreciation and amortization.  This interpretation by management is consistently applied regardless of whether impairment charges are or are expected to be recurring.

Restructuring charges are a reconciling item in the definition of Adjusted EBITDA as management believes such costs are non-recurring and not an indicative performance measure directly linked to the focus of the Company's business operations and strategic imperatives.  As there is no generally accepted method of calculating Adjusted EBITDA, the measure as calculated by the Company is likely not comparable to similarly titled measures reported by other issuers.  Adjusted EBITDA should not be considered by an investor as an alternative to net income or cash flows as determined in accordance with IFRS.

The change in estimate pertaining to the gift card breakage rate was captured as a reconciling item to Adjusted EBITDA as management believes this change in estimate was material and not an indicative performance measure used to evaluate the sustainable current and ongoing financial performance.

A reconciliation of net income (loss) to EBITDA and Adjusted EBITDA is provided below:

Adjusted basic and diluted earnings per share
Adjusted earnings per share represents earnings per share excluding impairment and restructuring charges, and the change in estimate pertaining to the gift card breakage rate.  Impairment charges of trademarks and goodwill are non-cash, but material items that were adjusted as management concluded that this was not a direct measure of the company's focus on day to day operations, is not indicative of future operating results, and thus better evaluates the underlying business of the Company.  Impairment charges of tangible assets are primarily related to leasehold improvements at Company-operated cafés. The Company typically operates such cafés for exploratory purposes or with the intention to improve underperformers and to subsequently refranchise the cafés.  Restructuring charges are a reconciling item as management believes these costs are non-recurring and not an indicative performance measure directly linked to the focus of the Company's business operations on a per share basis.  The change in estimate pertaining to the gift card breakage rate was captured as a reconciling item to Adjusted earnings per share as management believed this change in estimate was material and not an indicative performance measure used to evaluate the sustainable current and ongoing financial performance.

A reconciliation of Adjusted based and diluted earnings per share is provided below:

About Second Cup®

Founded in 1975, Second Cup® is Canada's largest specialty coffee franchisor operating more than 350 cafés across the country.  All of approximately 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.