Second Cup Announces Third Quarter Results

MISSISSAUGA, ON, Nov. 3, 2014 /CNW/ - The Second Cup Ltd. (TSX: SCU) ("Second Cup" or the "company") reported financial results today for the 13 weeks ended (the "quarter") and 39 weeks (the "year to date") ended September 27, 2014.

Highlights

• Same store sales trend improved in Q3 to -2.9% compared with -5% in Q2 and -6.9% in Q1.
• Adjusted earnings per share of $0.04 compared to $0.11 a year ago.
• Basic loss per share of $2.65, including a non-cash impairment charge of $25.7 million or $2.60 per share after-tax, compared with earnings per share of $0.09 a year ago.
• Introduced Flat White, the best new product launch in years.   
• Added Vanda Provato to the Leadership Team as Vice President, Marketing.
• Following quarter end, announced intention to acquire 17 cafés in the Toronto area.

Alix Box, President & CEO commented, "Fiscal 2014 has been a year of transition. We have made some difficult decisions in rebuilding our foundation so that we can move forward to create long-term growth. The launch of Flat White this quarter is a great example of the innovation to come from Second Cup.  Since I joined in February, we have completed the restructuring of Coffee Central, improved franchisee profitability, built a new management team, and developed plans for the café of the future. While much remains to be done, we are now fully engaged in the process of transformation to restore Second Cup to a place of leadership and greater profitability."

In the third quarter, Second Cup introduced Flat White via an innovative marketing campaign centered on "Piaggio" sampling vehicles.  The Piaggio cross-country tour introduced this authentic espresso-based beverage to Canadians in key markets, and they have embraced this exciting new product.  Flat White sales contributed to the trend improvement in same store sales this quarter.  Innovation and coffee excellence will be key drivers of the brand's reinvention and sales growth.

Following quarter end, Second Cup announced its intention to acquire 17 cafés in prime Toronto locations from long-standing franchisees, Debbie and Bob Riche, who will join the Coffee Central team. The combination of financial resources from Second Cup and management talent from the Riches provides a value creation opportunity for the company. 

In the coming weeks, key openings include the new café of the future in downtown Toronto and a flagship café in the heart of Montreal.

Impairment of Trademarks
As a result of impairment indicators, mainly the decline in the stock price, the company recorded a non-cash, after-tax trademark impairment charge of $25.7 million, which reduced earnings per share by $2.60.

Second Cup has announced a new three-year strategic plan, with highlights disclosed in a separate press release issued today. "This is a year of change for Second Cup.  I am confident that we are taking the necessary steps to rebuild the company.  I am optimistic that we will see significant performance improvements beginning next year," says Ms. Box. 

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 Unaudited Condensed Interim Financial Statements of the company for the 13 and 39 weeks ended September 27, 2014.

		13 weeks ended				39 weeks ended
(in thousands of Canadian dollars,  except same store sales, number of  cafés, per share amounts, and number  of common shares.)		September 27, 2014		September 28, 2013		September 27, 2014		September 28, 2013
System sales of cafés^1		$43,596		$44,894		$133,355		$139,536
Same store sales^1		(2.9%)		(3.7%)		(5.1%)		(3.1%)
Number of cafés - end of period		349		351		349		351
Total revenue		$6,695		$6,268		$20,805		$19,150
Gross profit		$4,846		$5,226		$15,906		$16,185
Operating expenses		$4,113		$3,634		$13,169		$11,571
Restructuring charges		-		-		$2,166		-
Provision for café closures		1,239		231		1,239		374
Impairment charges		29,708		-		29,708		$13,253
Operating income (loss) ^1		($30,124)		$1,361		($30,376)		($9,013)
Adjusted EBITDA^1		$1,079		$1,902		$3,536		$5,501
Net (loss) income and comprehensive  (loss) income		($26,230)		$918		($26,564)		($8,546)
Basic and diluted earnings (loss) per share as reported		($2.65)		$0.09		($2.68)		($0.86)
Adjusted basic and diluted earnings per share^1		$0.04		$0.11		$0.17		$0.33
Total assets - end of period		$44,578		$74,262		$44,578		$74,262
Number of common shares issued and outstanding - end of period		9,903,045		9,903,045		9,903,045		9,903,045

¹See the section "Definitions and discussion on certain non-GAAP financial measures" for further analysis.

OPERATIONAL REVIEW

Café network

		13 weeks ended				39 weeks ended
		September 27, 2014		September 28, 2013		September 27, 2014		September 28, 2013
Number of cafés - beginning of period		357		362		356		360
Cafés opened		1		1		8		9
Cafés closed		(9)		(12)		(15)		(18)
Number of cafés - end of period		349		351		349		351

The company ended the quarter with 17 (2013 - eleven) company-operated cafés.

Third quarter

System sales of cafés
System sales of cafés for the 13 weeks ended September 27, 2014 were $43,596 compared to $44,894 for the 13 weeks ended September 28, 2013, representing a decrease of $1,298 or 2.9%.  The decrease is attributable to decreased same store sales and to the marginally reduced store count. 

Same store sales
During the quarter, Second Cup same store sales declined by 2.9%, compared to a decline of 3.7% in the comparable quarter of 2013. The decrease in sales is predominantly due to lower customer counts.

Analysis of revenue
Total revenue for the quarter was $6,695 (2013 - $6,268) and consisted of royalty revenue, revenue from the sale of goods, and services and other revenue.

Royalty revenue for the quarter was $2,805 (2013 - $3,285).  The reduction in royalty revenue of $480 is primarily a result of reduced royalty rates introduced in August, as well as lower café sales, and to a lesser extent, the mix of cafés. 

Quarterly revenue from the sale of goods, which consists of revenue from company-operated cafés and wholesale revenue was $2,406 (2013 - $1,363). The increase of $1,043 was due to the increased number of company-operated cafés and due to sales of Second Cup coffee in grocery channels. The latter revenue stream commenced in January 2014 and was added to with the launch of two new K-Cup compatible skus late in the quarter.

Services and other revenue for the quarter was $1,484 (2013 - $1,620).  The decrease of $136 in services and other revenue was primarily due to reduced levels of new store openings and store ownership changes. The decrease was partially offset with increased licensing revenue from the sale of 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 wholesale channels, plus the cost of direct labour in the company-operated cafés.  Cost of goods sold was $1,849 (2013 - $1,042).  This increase of $807 is due to the higher number of company-operated cafés and the costs associated with wholesale coffee that did not exist in the prior year.

Operating expenses
Operating expenses include Coffee Central expenses and the overhead expenses of company-operated cafés. Total operating expenses for the quarter were $4,113 (2013 - $3,634).

Coffee Central
Coffee Central expenses for the quarter were $3,415 (2013 - $3,130). The $285 increase was due to more overhead expenses, mainly as a result of one-time transformation projects, and depreciation. Salaries, wages, benefits, and incentives costs were flat with prior year due to an increase in incentive expenses in 2014 and due to stock option expenses (there was no plan in 2013) offset by savings from the restructuring program announced in June 2014.

Company-operated cafés
Company-operated café expenses for the quarter were $698 (2013 - $504).  The $194 increase is due to the larger number of company-operated cafés in comparison to the prior period.

Provision for café closures
Provision for café closures were $1,239 (2013 - $231). The company recorded provisions for eight underperforming cafés for estimated lease exit costs and severances.  Two of the eight cafés were closed during the third quarter and the remainder are expected to close in the fourth quarter.   

Impairment charges
Impairment charges were $29,708 (2013 - $nil). During the quarter ended September 27, 2014, the company recognized an impairment charge of $29,658 to its trademark assets and $50 related to its property and equipment. The impairment charge had no impact on the company's liquidity, cash flow, borrowing capability or operations.

Interest and financing
The company incurred interest and financing expenses of $116 (2013 - $90).

Income tax recovery
Current income tax recovery of $249 (2013 - expense $439) and deferred income tax recovery of $3,851 (2013 - $86) were recorded in the quarter. Current income taxes decreased as a result of nil taxable income primarily driven by restructuring charges. The change in deferred income taxes was driven by the impairment charges in the quarter.

Adjusted EBITDA
Adjusted EBITDA for the quarter was $1,079 (2013 - $1,902).

Net income (loss)
The company's net loss for the quarter was $26,230 or $2.65 loss per share, compared to net income of $918 or $0.09 earnings per share in 2013.  The reduced income of $27,148 or $2.74 per share was mainly due to the impairment charges discussed above.

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

Year to date

System sales of cafés
System sales of cafés for the 39 weeks ended September 27, 2014 were $133,355 compared to $139,536 for the 39 weeks ended September 28, 2013, representing a decrease of $6,181 or 4.4%.  The decrease is attributable to decreased same store sales and to the marginally smaller store network. 

Same store sales
For the year to date, there was a decline of 5.1% compared to a decline of 3.1% in the comparable period ended September 28, 2013. The nature of the decrease is consistent to what was discussed above in the quarter.

Analysis of revenue
Total revenue for the year to date was $20,805 (2013 - $19,150).

Royalty revenue for the year to date was $9,283 (2013 - $10,301). The reduction in royalty revenue of $1,018 is primarily a result of reduced royalty rates introduced in August, as well as lower café sales, and to a lesser extent, the mix of cafés. 

Revenue from the sale of goods was $6,728 (2013 - $3,980). The increase of $2,748 in revenue from the sale of goods was mainly due to sales of Second Cup coffee in grocery channels. The increase was also due to having an increased number of company-operated cafés.

Services and other revenue for the year to date was $4,794 (2013 - $4,869).  The decrease of $75 or 1.5% in services and other revenue was primarily due to lower revenues from store network activity as discussed above in the quarter. 

Cost of goods sold
Cost of goods sold for year to date was $4,899 (2013 - $2,965).  The $1,934 increase is due to the product costs pertaining to wholesale coffee sold in the grocery channel and the larger number of company-operated cafés active during the period.

Operating expenses
Total operating expenses for the year to date were $13,169 (2013 - $11,571).

Coffee Central
Coffee Central expenses for the year to date were $11,505 (2013 - $10,163).  The company incurred retail listing fees of $1,060 in the period related as discussed above.  There were no listing fees incurred in the prior year to date period.  Depreciation expense of $539 (2013 - $411) was also higher this year due to additional IT hardware.

Company-operated cafés  
Company-operated café expenses for the year to date were $1,664 (2013 - $1,408).  The increase is due to the larger number of company-operated cafés active during the period as discussed above

Restructuring charges
Restructuring charges of $2,166 (2013 - $nil) were primarily related to severance costs during the front half of the fiscal year.

Provision for café closures
Provisions for café closures were discussed above in the quarter.

Impairment charges
Impairment charges were discussed above in the quarter.

Interest and financing
The company incurred interest and financing expenses of $372 (2013 - $262).  The increase in interest and financing expenses is due to the fair value adjustments of the interest rate swap which captures an interest rate premium to fix the effective interest rate on the long-term debt.

Income tax recovery
Current income tax recovery of $387 (2013 - expense $1,076) and deferred income tax recovery of $3,797 (2013 - $1,805) were recorded in the year to date period. Current income taxes decreased as a result of nil taxable income primarily driven by restructuring charges and retail listing fees. The change in deferred income taxes was driven by the impairment charges incurred in the quarter and prior year to date period as discussed above.

Adjusted EBITDA
Adjusted EBITDA for the year to date was $3,536 (2013 - $5,501).

Net income (loss)
The company's net loss for the year to date was $26,564 or $2.68 loss per share, compared to a loss of $8,546 or $0.86 loss per share in 2013. An increase in net loss of $18,018 or $1.82 per share was mainly due to the impairment charges incurred and by reduced royalty revenue, restructuring charges, and retail listing fees incurred in the current year to date period as discussed above.  This was offset partially by the margin realized in the current year to date period pertaining to the wholesaling of coffee in the grocery channel.

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

Dividend
As Second Cup transforms towards a new era of growth in sales and profitability, the company sees emerging attractive opportunities to invest capital. Accordingly the company believes it is prudent to retain available cash resources for redeployment into investments that will maximize long-term growth in share value. Given this renewed focus on growth, the Board of Directors decided to continue the dividend suspension announced with the release of the second quarter 2014 results.

SELECTED QUARTERLY INFORMATION

(in thousands of Canadian dollars, except number of cafés, same store sales, and per share amounts)		Q3 2014		Q2 2014		Q1 2014		Q4 2013^2
System sales of cafés^1		$43,596		$45,829		$43,930		$51,898
Same store sales^1		(2.9%)		(5.0%)		(6.9%)		(4.3%)
Number of cafés - end of period		349		357		357		356
Total revenue		$6,695		$6,498		$7,612		$8,038
Operating (loss) income^1		($30,214)		($388)		$226		$1,891
Adjusted EBITDA^1		$1,079		$1,516		$941		$2,868
Net (loss) income for the period		($26,230)		($390)		$56		$1,177
Basic/diluted earnings (loss) per share		($2.65)		($0.04)		$0.01		$0.12
Dividends declared per share		-		-		$0.085		$0.085
		Q3 2013		Q2 2013		Q1 2013		Q4 2012^2
System sales of cafés^1		$44,894		$47,688		$46,954		$53,515
Same store sales^1		(3.7%)		(2.2%)		(3.3%)		(4.2%)
Number of cafés - end of period		351		362		361		360
Total revenue		$6,268		$6,636		$6,246		$7,785
Operating (loss) income^1		$1,361		($11,401)		$1,027		($12,988)
Adjusted EBITDA^1		$1,246		$2,122		$1,334		$3,027
Net (loss) income for the period		$918		($10,152)		$688		($12,024)
Basic/diluted (loss) earnings per share		$0.09		($1.03)		$0.07		($1.21)
Dividends declared per share		$0.085		$0.085		$0.085		$0.085
^1See the section "Definitions and discussion on certain non-GAAP financial measures" for further analysis.
^2The company's fourth quarter system sales of cafés have historically been higher than other quarters due to the seasonality of the business (see "Seasonality of system sales of cafés" above).

OUTLOOK

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

While the company continues to operate in a competitive industry with national, regional and local competitors, it believes that there is opportunity for growth. The Canadian economy is still challenged but there are economic indicators signaling better times ahead as well as stronger consumer confidence which management believes would be beneficial for our café sales.

A strategic plan has been developed with the objective of growing both same store sales and the expansion of the café of the future concept once validated.  The café of the future format will be rolled out over the next few years to new café locations and renovated cafés including many of the corporately operated cafés in prime locations. 

2014 has been and continues to be a year of major transformation for the company.  The company continues to execute on the initiatives set our earlier this year with the intent of cleaning up past issues that inhibited growth, allowing it to enter 2015 in a more favourable position to successfully execute its new plans.     

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 MD&A, the company reports certain non-IFRS measures such as system sales of cafés, same store sales, operating income (loss), 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 change of the overall café network.

Changes in system sales of cafés result from the number of cafés and same store sales (as described below).  The primary factors influencing the number of cafés within the Second Cup café network include the availability of quality locations and the availability of qualified franchisees.

Same store sales
Same store sales represents the percentage change, on average, in sales at cafés operating system-wide that have been open for more than 12 months, including cafés closed temporarily for renovations / remodelling.  The inclusion of cafés temporarily closed is a change in methodology. Since the impact of this revision is inconsequential, the company will not restate same store sales results for previously reported years.  It is one of the key metrics the company uses to assess its performance as an indicator of appeal to customers. Same store sales provides a useful comparison between periods while also encompassing other matters such as seasonality. The two principal factors that affect same store sales are changes in customer traffic and changes in average transaction size.

Operating income (loss)
Operating income (loss) represents revenue, less cost of goods sold, less operating expenses, less restructuring charges, less provision for café closures, 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 or recoveries.

EBITDA and Adjusted EBITDA
EBITDA represents earnings before interest, taxes, depreciation, and amortization.  As there is no generally accepted method of calculating EBITDA, this measure is not necessarily 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 and 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, if incurred, 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, if incurred, are a reconciling item in the calculation of adjusted EBITDA as management believes such costs are non-recurring and not an indicative performance measure directly linked to the company's business operations. 

Provision for café closures, if incurred, are a reconciling item in the calculation of adjusted EBITDA as management believes that while such costs may be recurring, they could be larger than normal during this period of transformation of the business and are not an indicative performance measure directly linked to the company's business operations from ongoing cafés. 

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

			13 weeks ended						39 weeks ended
			September 27, 2014			September 28, 2013			September 27, 2014			September 28, 2013
Net income (loss)		$	(26,230)		$	918		$	(26,564)		$	(8,546)
Interest and financing			116			90			372			262
Income taxes (recovery)			(4,100)			353			(4,184)			(729)
Depreciation of property and equipment			254			187			645			543
Amortization of intangible assets			94			123			244			360
Loss (gain) on disposal of property and equipment			(2)			-			(90)			(16)
EBITDA			(29,868)			1,671			(29,577)			(8,126)
Impairment charges			29,708			-			29,708			13,253
Provision for café closures			1,239			231			1,239			374
Restructuring charges			-			-			2,166			-
Adjusted EBITDA		$	1,079		$	1,902		$	3,536		$	5,501

Adjusted basic and diluted earnings per share

Adjusted earnings per share represents earnings per share excluding any impairment charges, provision for café closures, and restructuring charges.  Impairment charges are non-cash, but material items that are adjusted as management concluded that this is 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.  Provision for café closures are a reconciling item as management believes that while such costs may be recurring, they could be larger than normal during this period of transformation of the business and are not an indicative performance measure directly linked to the company's business operations from ongoing 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.

A reconciliation of net income (loss) to adjusted basic and diluted earnings per share is provided below:

			13 weeks ended						39 weeks ended
			September 27, 2014			September 28, 2013			September 27, 2014			September 28, 2013
Net income (loss)		$	(26,230)		$	918		$	(26,564)		$	(8,546)
Restructuring charges			-			-			2,166			-
Provision for café closures			1,239			231			1,239			374
Impairment charges			29,708			-			29,708			13,253
Tax effect of restructuring and impairment charges			(4,270)			(61)			(4,845)			(1,855)
Adjusted earnings			447			1,088			1,704			3,226
Weighted average number of shares issued and outstanding (unrounded)			9,903,045			9,903,045			9,903,045			9,903,045
Adjusted basic and diluted earnings per share		$	0.04		$	0.11		$	0.17		$	0.33

For the 13 and 39 weeks ended September 27, 2014, there were 500,000 outstanding share option awards (13 and 39 weeks ended September 28, 2013 - nil) that were not included in the determination of adjusted diluted earnings per share because they are non-dilutive for the periods presented.

About Second Cup
Founded in 1975, The Second Cup Ltd. is a Canadian specialty coffee retailer operating over 345 cafés across the country.  All of the approximately 4,000 Second Cup baristas are trained coffee experts who handcraft over 1 million coffee and tea beverages every week, and are committed to ensuring excellence in every cup and the very best customer experience possible.  For more information, please visit www.secondcup.com or find us on Facebook and Twitter.

SOURCE: The Second Cup Ltd.

Steve Boyack, Chief Financial Officer, [phone] or [email protected].

Related Links

www.secondcup.com