Second Cup Announces Third Quarter Results

MISSISSAUGA, ON, Nov. 4, 2011 /CNW/ - The Second Cup Ltd. ("Second Cup" or the "Company") reported today financial results for the third quarter ended October 1, 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

• System sales increased $786 or 1.7% in the quarter.
• EBITDA of $2,590 for the quarter, down from $3,063 in the comparable quarter a year ago.
• Same café sales decline of 0.1% in the quarter.
• Declared third quarter dividend of $0.15 per share.
• 10 new cafés opened in the quarter.

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 have remained relatively flat given the continued intense competition in the category and the recent effects of the economy. In terms of our café development we are pleased that we have opened 15 new cafés up to the end of the third quarter. We are also proud of our continued leadership and commitment to sustainability through third party certification. Earlier this year we announced that 80% of our coffees and 100% of our espresso beverages are now Rainforest Alliance certified. In October, we launched a new line of high quality, full leaf teas in silken pyramid bags and are proud to say that all of our teas and tisanes are also Rain Forest Alliance certified. This commitment to quality and certification supports Second Cup's unique position in the market as The Coffee Company that Cares."

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 39 weeks ended October 1, 2011, which are expected to be released on or before November 4, 2011.

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. The effect of this change in the current quarter is that the third quarter of 2011 consisted of 91 days compared to 92 days in the comparable quarter in 2010. Year to date, 2011 and 2010 are comparable.

Analysis of System Sales and Same Café Sales Growth

System sales for the 13 weeks ended October 1, 2011 were $46,369 compared to $45,583 for the three months ended September 30, 2010, representing an increase of $786 or 1.7%. The total number of cafés at the end of the quarter was 359 compared to 345 cafés at the end of the third quarter of 2010. During the quarter the Company opened 10 new cafés and closed one underperforming café. Same café sales declined by 0.1% in the quarter.

Year to date system sales for the 39 weeks ended October 1, 2011 were $139,256, compared to $137,276 for the nine months ended September 30, 2010, representing an increase of $1,980 or 1.4%. The year to date same café sales decline was 0.6%. The Company closed five underperforming cafés and opened 15 new cafés to date.

Third Quarter Analysis

Analysis of Revenues

Total revenues for the quarter were $6,138 (2010 - $6,687) and consisted of royalty revenue, revenue from sale of goods and services revenue.

Royalty revenue for the quarter was $3,741 (2010 - $3,828). The reduction in royalty revenue of $87 was mainly due to a reduction in the effective royalty rate (excluding sales from Company-operated cafés) from 8.6% in 2010 to 8.2% in the current quarter as a result of the 3,6,9 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 $750, compared to $963 for the three months ended September 30, 2010. The reduction in revenue from the sale of goods was mainly due to operating eight Company-operated cafés in 2010 compared to six for most of the third quarter in 2011 with two additional cafés becoming corporate at the end of the quarter. The Company opened a new café at the end of the quarter which is located in Metro Toronto Convention Centre.This café will be used as a training site.

Services revenue for the quarter was $1,647 (2010 - $1,896). 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 $249 decrease in services revenue is mainly due to a decrease in purchasing coordination fees and renewal fees offset by increases in initial franchise fees, project management fees, transfer fees and other ancillary 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 77% in the current quarter, unchanged from the three months ended September 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 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 $3,193 (2010 - $3,000), an increase of $193. Salaries, wages and benefits increased $135 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. Amortization increased by $98 compared to 2010 due to the purchase of POS hardware and software.

Other Income and Expenses

The Company incurred interest expense of $179 (2010 - $184), and $18 (2010 - $49) in amortization of financing charges relating to the term loan. The Company also recorded a non-cash charge of $82 (2010 - $36) 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 $17 (2010 - $6) 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 $9 (2010 - $29) on the disposal of property and equipment. In the third quarter of 2010, the Fund expensed $3 in conversion costs relating to the Conversion discussed above.

Income Taxes

Current income taxes of $511 (2010 - $nil) were recorded in the quarter. A deferred tax recovery of $68 (2010 - expense of $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 $2,590 (2010 - $3,063). The decline in EBITDA was due to a decrease in gross profit of $378 and an increase in operating expenses of $95 (excluding amortization) as discussed above.

Net Income

The Company's net income for the quarter was $1,652 or $0.17 per share, compared to $2,605 or $0.26 per unit in 2010. The reduction in net income of $953 was mainly due to income taxes of $443 in 2011 and a decrease of $378 in gross profit.

Year to Date

Analysis of Revenues

Revenues were $17,638 compared to $18,681 in 2010 and consisted of royalty revenue, revenue from sale of goods and services revenue.

Royalties were $11,285 (2010 - $11,477). The reduction in royalty revenue of $192 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% as a result of the 3,6,9 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 $1,964 compared to $2,707 for the nine months ended September 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 for most of 2011 until two cafés were added at the end of the third quarter as discussed above.

Services revenue was $4,389 (2010 - $4,497). 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 $108 decrease in services revenue is due to a decrease in purchasing coordination fees of $489 primarily as a result of a coffee pricing adjustment in 2010, a decrease in renewal fees of $385 which corresponds to the timing of the actual renewal date of the lease offset by increases in initial franchise fees of $178, increases in project management fees of $176, increases in transfer fees of $123 and increases in other ancillary fees of $319.

Cost of Goods Sold

Cost of goods sold as a percentage of revenue from the sale of goods was 74% compared to 76% for the nine months ended September 30, 2010.

Operating Expenses

Operating expenses amounted to $9,767 (2010 - $8,875), an increase of $892. Salaries, wages and benefits increased $558 primarily due to an increase in severance costs of $511, an increase of $113 in salaries and benefits due to an inflationary increase in salaries and additional headcount offset by a reduction in long term incentive plan. Head office overheads increased $168 due to increases in IT costs related to POS and increases in recruitment fees. Occupancy and lease costs decreased by $164 from 2010 due to a reduction in lease costs associated with cafés previously closed but not yet sublet. Bad debt expense increased by $123 compared to 2010.  Amortization increased by $184 compared to 2010 due to POS hardware and software as discussed above.

Other Income and Expenses

The Company incurred interest expense of $540 (2010 - $538), and $54 (2010 - $137) in amortization of financing charges relating to the term loan. The Company also recorded a non-cash charge of $57 (2010 - $151) 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 $47 (2010 - $16) 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 $16 (2010 - $28) on the disposal of equipment. In 2010, the Fund expensed $315 in Conversion costs during the quarter relating to the Conversion discussed above.

Income Taxes

The income tax recovery of $5,178 (2010 - $122) consists of:

• recovery of $6,707 due to the Conversion;
• current tax expense of $633 (2010 - $83 recovery); and
• deferred tax expense of $896 (2010 - $39 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 $6,707 and a corresponding non-cash credit to income in the first quarter.

EBITDA

EBITDA was $6,953 (2010 - $8,115). The decline in EBITDA was due to a decrease in gross profit of $454, as well as, an increase in operating expenses of $708 (excluding amortization) as discussed above.

Net Income

The Company's net income was $10,949 or $1.11 per share, compared to $6,699 or $0.68 per unit in 2010. Excluding the deferred income tax recovery of $6,707 referred to above and Conversion costs of $315 in 2010, net income was $4,242 (2010 - $7,014). The reduction in adjusted net income of $2,772 was mainly due to a decline in gross profit of $454, an increase in operating expenses of $892 (including an increase in severance costs of $511) as well as the fact that Second Cup is now subject to corporate income tax, which resulted in a deferred tax expense of $896 excluding the impact of the Conversion (2010 - $39 recovery) and a current tax expense of $633 (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, six cafés were renovated (2010 - 13), there were 10 café openings (2010 - three) and one café closure (2010 - nil) with 359 cafés open at October 1, 2011. Year to date, 19 cafés (2010 - 27) were renovated; there were 15 café openings (2010 - eight) and five café closures (2010 - seven).

Third Quarter Dividend

On November 3, 2011 the Board of Directors of Second Cup approved a dividend of $0.15 per common share for the quarter ended October 1, 2011, payable on November 30, 2011 to shareholders of record at the close of business on November 16, 2011. The dividend will be considered an eligible dividend for income tax purposes.

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 approximately 25 new cafés; (2) to close 10 to 15 cafés, the majority of which have sales below the average performance of its cafés; and (3) approximately 25 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.