Second Cup Announces Second Quarter Results

MISSISSAUGA, ON, Aug. 11, 2011 /CNW/ - (TSX:SCU) - The Second Cup Ltd. ("Second Cup" or the "Company") reported today financial results for second quarter ended July 2, 2011 (the "quarter"). 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

• Basic and diluted net earnings per share of $0.16 for the quarter compared to $0.21 in the comparable quarter a year ago.
• Gross profit of $5,607 for the quarter, up from $5,450 in the comparable quarter a year ago.
• EBITDA of $2,691 for the quarter, down from $2,825 in the comparable quarter a year ago.
• Same café sales growth of 0.3% in the quarter.
• Declared second quarter dividend of $0.15 per share.

On January 1, 2011 the Second Cup Income Fund (the "Fund") converted from an income trust structure to a public corporation (the "Conversion"). As a result of the Conversion, Second Cup is now subject to corporate income tax and therefore, the results of 2011 will not be directly comparable to 2010.

Stacey Mowbray, President & CEO of Second Cup commented, "Same café sales improved in Q2 versus Q1, largely a result of a price increase of approximately 2.0% in April and some improvement in traffic trends. The focus for the balance of the year is to continue to drive same café sales through product news, media support, offers and in café execution, in addition to expanding the number of cafés in the system.

The implementation of the new café technology platform, previously announced, is on track with completion in all cafés by the end of 2011. The new platform will provide improved management information and customer service, as well as, simplifying administration.

In the second quarter, we announced that 80% of our coffees and 100% of our espresso beverages are now Rainforest Alliance certified. We are committed to certification of coffees, both in terms of a point of difference in the market and as our responsibility to farmers who grow our premium beans. This commitment is part of Second Cup's unique position in the market as The Coffee Company that Cares.

We are proud of Second Cup's leadership role in certification of coffees and in our position as Canada's largest specialty coffee franchisor."

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 interim financial statements of the Company for the 13 and 26 weeks ended July 2, 2011, which are expected to be released on or before August 11, 2011.

¹ "System sales of cafés", "Same café sales growth", "EBITDA", "Adjusted net income" and "Adjusted basic and diluted earnings per share/unit" are not recognized performance measures under IFRS and, accordingly, may not be comparable to similar computations as reported by other issuers.

Change of accounting quarter end
In 2010, the Fund's quarter and year end followed the calendar method. In 2011 Second Cup implemented the method followed by many retail entities, such that each quarter will consist of 13 weeks and will end on the Saturday closest to the calendar quarter-end. This change had no impact in the current quarter as the second quarter of both 2011 and 2010 consisted of 91 days. Year to date, 2011 has two additional days compared to 2010.

Analysis of System Sales and Same Café Sales Growth
System sales for the 13 weeks ended July 2, 2011 were $47,294, compared to $46,353 for the three months ended June 30, 2010, representing an increase of $941 or 2.0%. The total number of cafés at the end of the quarter was 350 compared to 342 cafés at the end of the second quarter of 2010. During the quarter the Company closed two under performing cafés. Same café sales growth was 0.3% in the quarter. The core GTA market continues to show strong sales growth while other markets are improving.

Year to date system sales for the 26 weeks ended July 2, 2011 were $92,887, compared to $91,693 for the six months ended June 30, 2010, representing an increase of $1,194 or 1.3%. There were two additional days in 2011 compared to 2010. The year to date same café sales decline was 0.9%. The Company closed four under performing cafés and opened five new cafés to date.

Second Quarter Analysis

Analysis of Revenues
Total revenues for the quarter were $6,072 (2010 - $6,065) and consisted of royalty revenue, revenue from sale of goods and services revenue.

Royalty revenue for the quarter was $3,824 (2010 - $3,870). The reduction in royalty revenue of $46 was mainly due to a reduction in the effective royalty rate (excluding sales from Company operated cafés) from 8.5% in 2010 to 8.2% in the current quarter.

Revenue from the sale of goods, which includes revenue from Company operated cafés and the sale of coffee through wholesale and retail channels, was $628 compared to $830 for the three months ended June 30, 2010. The reduction in revenue from the sale of goods was mainly due to a reduction in the number of Company operated cafés from eight in 2010 to six at the end of the current quarter.

Services revenue for the quarter was $1,620 (2010 - $1,365). Services revenue includes initial franchise fees, renewal fees, transfer fees earned on the sale of cafés from one franchise partner to another, construction project management fees, purchasing coordination fees and other ancillary fees (IT support, tuition and construction black line drawings). The $255 increase in services revenue is mainly due to an increase in purchasing coordination fees, resale fees and other ancillary fees offset by decreases in initial franchise fees and renewal fees.

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 74% in the current quarter compared to 74% for the three months ended June 30, 2010.

Operating Expenses
In January 2011, the Board of Directors approved capital expenditure of $2,100 for the implementation of a new café technology platform, which includes new point of sale systems (``POS"`) to be distributed to the majority of cafés. The implementation is expected to be completed in all cafés by the end of 2011 and will provide improved management information, improved customer service and will simplify administration. The franchise partners will pay a monthly fee to cover the support and maintenance of the system.

Operating expenses include the general overhead expenses of Second Cup, overhead expenses of corporate cafés and amortization. Operating expenses amounted to $3,101 (2010 - $2,744), an increase of $357. Salaries, wages and benefits increased $110 due to an inflationary increase in salaries and additional headcount.  Head office overheads increased due to an increase in operating costs relating to POS discussed above. Bad debt expense increased by $115 compared to 2010, which included a recovery of $31 from a balance previously written off. Amortization increased by $66 compared to 2010 due to the purchase of POS hardware and software.

Other Income and Expenses
The Company incurred interest expense of $180 (2010 - $177), and $18 (2010 - $49) in amortization of financing charges relating to the term loan. The Company also recorded a non-cash charge of $33 (2010 - $134) 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 $14 (2010 - $5) primarily due to interest earned from short-term highly liquid bank investments with original maturities of three months or less and from notes receivable. The Company recorded a loss of $12 in 2010 on the disposal of property and equipment. In the second quarter of 2010, the Fund expensed $312 in conversion costs relating to the Conversion discussed above.

Income Taxes
Current income taxes of $122 (2010 - recovery $83) were recorded in the quarter. A deferred tax expense of $616 (2010 - $37) was recorded in the quarter. As previously stated, Second Cup is now subject to corporate income tax as of January 1, 2011.

EBITDA
EBITDA for the quarter was $2,691 (2010 - $2,825). The decline in EBITDA was due to an increase in gross profit of $157 offset by an increase in operating expenses of $291 (excluding amortization) as discussed above.

Net Income
The Company's net income for the quarter was $1,545 or $0.16 per share, compared to $2,066 or $0.21 per unit in 2010. The reduction in net income of $521 was mainly due to income taxes of $738 in 2011 as Second Cup is now subject to corporate income tax, offset by Conversion costs of $312 and an income tax recovery of $46 in 2010.

Year to Date

Analysis of Revenues
Revenues were $11,500 compared to $11,994 in 2010.

Royalties were $7,544 (2010 - $7,649). The reduction in royalty revenue of $105 was mainly due to a reduction in the effective royalty rate (excluding sales from Company-operated cafés) from 8.5% in 2010 to 8.2%.

Revenue from the sale of goods, which includes revenue from Company-operated cafés and the sale of coffee through wholesale and retail channels, was $1,214 compared to $1,744 for the six months ended June 30, 2010. The reduction in revenue from the sale of goods was mainly due to a reduction in the number of Company-operated cafés from eight in 2010 to six at the end of the current quarter.

Services revenue was $2,742 (2010 - $2,601). Services revenue includes initial franchise fees, renewal fees, transfer fees earned on the sale of cafés from one franchise partner to another, construction project management fees, purchasing coordination fees and other ancillary fees (IT support, tuition and construction black line drawings). The $141 increase in services revenue is mainly due to an increase in resale fees of $125 and an increase in ancillary fees of $192 offset by a decrease in renewal fees of $118. The decrease in renewal fees corresponds to the timing of the actual renewal date of the lease.

Cost of Goods Sold
Cost of goods sold as a percentage of revenue from the sale of goods was 73% compared to 75% for the six months ended June 30, 2010.

Operating Expenses
Operating expenses amounted to $6,574 (2010 - $5,875), an increase of $699. Salaries, wages and benefits increased $423 primarily due to an increase in severance costs of $511, offset by a reduction in other salaries and wages of $88. Bad debt expense increased by $155 compared to 2010. Amortization increased by $86 compared to 2010 due to POS hardware and software as discussed above.

Other Income and Expenses
The Company incurred interest expense of $361 (2010 - $354), and $36 (2010 - $88) in amortization of financing charges relating to the term loan. The Company also recorded a non-cash credit of $25 (2010 - charge of $115) 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 $30 (2010 - $10) primarily due to interest earned from short-term, highly liquid bank investments with original maturities of three months or less and from notes receivable. The Company recorded a loss of $7 (2010 - gain of $1) on the disposal of equipment. In 2010, the Fund expensed $312 in Conversion costs during the quarter relating to the Conversion discussed above.

Income Taxes
The income tax recovery of $5,621 (2010 - $159) consists of:

• recovery of $6,756 due to the Conversion;
• current tax expense of $122 (2010 - $83 recovery); and
• deferred tax expense of $1,013 (2010 - $76 recovery), excluding the impact of the Conversion.

Prior to the Conversion in 2011, the Fund was an unincorporated open-ended trust and was not subject to income taxes to the extent that its taxable income was distributed to unitholders. As a result of new tax legislation substantively enacted on June 12, 2007, the Fund would have paid tax on distributions declared subsequent to January 1, 2011. As a result of this legislation, the Fund had provided for the future tax effect of existing temporary differences between the accounting and tax bases of assets and liabilities that were expected to reverse subsequent to January 1, 2011 at the specified investment flow through ("SIFT") entity tax rates under Canadian GAAP. Under IFRS, the taxation rate to apply to temporary differences of the Fund that were expected to reverse after 2010 was the highest personal tax rate of 46.41% rather than the lower SIFT tax rate used previously of 28.25%. On the IFRS Transition Date, this IFRS adjustment resulted in an increase of $7,495 to the deferred tax liability and a corresponding decrease to equity. As a corporation, the deferred tax liability is measured using the corporate tax rate of 28.25% and resulted in a reduction in the deferred tax liability of $6,756 and a corresponding non-cash credit to income in the first quarter.

EBITDA
EBITDA was $4,363 (2010 - $5,052). The decline in EBITDA was due to a decrease in gross profit of $76, as well as, an increase in operating expenses of $613 (excluding amortization) as discussed above.

Net Income
The Company's net income was $9,297 or $0.94 per share, compared to $4,094 or $0.42 per unit in 2010. Excluding the deferred income tax recovery of $6,756 referred to above and Conversion costs of $312 in 2010, net income was $2,541 (2010 - $4,406). The reduction in adjusted net income of $1,865 was mainly due to a decline in gross profit of $76, an increase in operating expenses of $699 as well as the fact that Second Cup is now subject to corporate income tax, which resulted in a deferred tax expense of $1,013 excluding the impact of the Conversion (2010 - $76 recovery) and a current tax expense of $122 (2010 - $83 recovery).

Café Network
In order to promote the opening of new cafés, Second Cup introduced a revised royalty structure for new cafés that will open in 2011. In terms of the revised royalty structure, cafés that open in 2011 are 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% ongoing.

During the quarter, nine cafés were renovated (2010 - nine), there were no café openings (2010 - three) and two café closures (2010 - three) with 350 cafés open at July 2, 2011. Year to date, 13 cafés (2010 - 14) were renovated; there were five café openings (2010 - five) and four café closures (2010 - seven).

Second Quarter Dividend

On August 3, 2011 the Board of Directors of Second Cup approved a dividend of $0.15 per common share for the quarter ended July 2, 2011, payable on August 31, 2011 to shareholders of record at the close of business on August 17, 2011.

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 a highly competitive market place and a challenging consumer environment. For 2011, management is targeting to regain growth with positive same café sales, and the addition of net new cafés.  The focus will be on driving traffic into cafés through external messaging, sampling and product news. In café, the focus will be on operational excellence, training and promotion of the brand's quality credentials as the Trusted Coffee Experts™.

In terms of 2011 network expansion, Second Cup expects: (1) to open 25 to 30 new cafés; (2) to close five to 10 cafés, the majority of which have sales below the average performance of its cafés; and (3) approximately 30 cafés will be renovated.

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.

About Second Cup®

Founded in 1975, Second Cup® is Canada's largest specialty coffee franchisor, operating more than 350 cafés across the country.  As a proudly Canadian company, Second Cup celebrates its franchisees' local ownership, and prioritizes the support of local businesses through daily deliveries from neighbourhood partners.  Committed to caring for every guest, all 5,000 associates of Second Cup are Trusted Coffee Experts™ who sell 1,000,000 coffee and tea beverages every week.  For more information, please visit www.secondcup.com.