AnnuAl
report
2012
The Second Cup Ltd. There’s a little love in every cup.™
Our baristas continue to delight
our guests with latte art on all
of our European beverages.
Letter from the Chairman
and President & Ceo
finanCiaL highLights
management’s disCussion
and anaLysis
Overview and Business of Second Cup
Basis of Presentation
Financial Highlights
System Sales
Café Network
Income, Operating Expenses
and Net Income
Selected Quarterly Information
Liquidity and Capital Resources
Off-Balance Sheet Arrangements
audited finanCiaL statements
Auditors’ Report
Statements of Financial Position
Statements of Operations and
Comprehensive Income (Loss)
Statements of Changes in
Shareholders’ Equity
Statements of Cash Flows
Notes to the Financial Statements
Shareholder Information
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70
Future Accounting Standards
Management of Capital
Outstanding Share and Unit Data
Evaluation of Disclosure Controls
and Procedures
Critical Accounting Estimates
Risks and Uncertainties
Outlook
Forward-Looking Information
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37
contents Letter from the Chairman
and President & Ceo
of The Second Cup Ltd.
With our investment in a new point of sale system in
2011, we are able to better assess our business and
are now using the system as a platform for building
café business plans, national plans and for supporting
our test initiatives.
2012 HigHligHtS
Michael Rosicki,
Chairman
Stacey Mowbray,
President & CEO
At Second Cup, our care and commitment to quality
We are pleased to present our Annual Report for
set us apart from our competitors. In 2012, we
the fiscal year ended December 29, 2012, on behalf
reinforced this point of difference with the launch
of the Board of Directors for the Second Cup Ltd.
of latte art on all of our hero latte beverages. Our
(“Second Cup”). All amounts stated are expressed
baristas delight our guests with their craftsmanship
in thousands of Canadian dollars, except shares,
and consistently deliver on our brand promise, “There’s
unless otherwise indicated.
a little love in every cup.” We also surprised and
Summary
delighted our guests with new products, such as our
S’mores Hot Chocolate, new Maple Flavoured Coffee,
Honey Vanilla Tea Latte and customizable Iced Coffee.
We experienced a marginal growth of 0.4% in system
sales to $194,387. Corporate revenue increased
In 2012, we entered into a partnership with Kraft
from $25,001 in 2011 to $26,346 in 2012, however,
Canada Inc. to produce, market and sell Second Cup
adjusted earnings per share declined from $0.64 in
signature coffees across Canada using the Tassimo
2011 to $0.42 in 2012. The financial results reflect the
T-Disc on-demand beverage system. The results so far
continuing intense competitive activity in the coffee
category, as well as our continued investments
in new initiatives, including a loyalty program,
coffee revitalization and a new café design.
These initiatives will be tested in 2013 and
will roll out in the latter part of the year.
New in 2012:
Second Cup formed a
partnership with Tassimo,
Canada’s leading on-demand
coffee brand, to produce,
market and sell Second Cup
signature blend coffees and
lattes across Canada.
®/MD
When it comes to serving our
guests, our goal is to make sure
“There’s a little love in every cup” to
deliver on our brand promise.
7
We strive to surprise and delight
our guests with tempting new
product offerings and limited-
time seasonal favourites.
have been encouraging and we are looking to
expand the offerings in 2013. The partnership offers
our cafés a new category of business for sales and
traffic in the rapidly growing single-serve segment of
the coffee business. It also provides a new income
stream for Second Cup through the licencing
agreement with Kraft and the sales of Second Cup
branded Tassimo T-Discs into grocery and other
channels outside of the café business.
We continued to improve our café network with
the opening of 18 cafés and closure of 17 to
complete the year at 360 cafés. Many of the new
cafés have drive thru and several of them are located
outside urban areas to grow our presence beyond
our core markets. We also fully implemented the
new point of sales system throughout the majority of
our cafés. We are now tracking comparable data for
business analytics both nationally and at the
café level to drive sales.
In 2012, we also announced a long-term partnership
with Free the Children, a Canadian charity founded
by Craig and Marc Kielburger aimed at empowering
and enabling young people to be agents of change.
Second Cup cafés have become the Social Change
Headquarters for youth to meet and plan activities in
support of Free the Children initiatives. Additionally,
Second Cup cafés provide bricks and mortar
locations to support the retail of select Me To We
products in an effort to raise funds and awareness
for Free the Children, as well as being a part of a
movement for social good. This partnership is just
another way to celebrate our Care and Quality point
of difference and our Canadian roots.
New in 2012:
Long-term partnership
with Canadian charity,
Free the Children
9
Board of directorS
The Board welcomed two new members:
Bryan Held, as independent Director and a member
of the Audit Committee, and Stephen Kelley, also as
an independent Director. James Anas became the
Chair of the Audit Committee.
dividendS
The quarterly dividend has been reduced to $0.085
per share to allow for investments into the business,
while still offering a good return for shareholders at
6.6% (based on the year-end price of $5.13).
2013 outlook
In 2013, we will continue to focus on our Care and
Quality point of difference in the premium coffee
segment. We will be testing and launching a loyalty
program and customer relationship system. We
believe this program will grow our transactions
efficiently and create further loyalty in this very
competitive environment.
We will continue to improve our café network by
adding more drive-thru locations, closing
underperforming cafés and penetrating into small
centres outside of our core marketing areas. The
launch of our new look café will be showcased
in downtown Toronto. The design reflects
care and quality with a real focus on
our coffee roots and our community
involvement. Portions of this
design will be adaptable to our
existing cafés.
Our Frrrozen Hot Chocolate®
drinks are made with an
exclusive blend of rich, imported
cocoas and Madagascar vanilla,
blended with milk and ice.
11
Whether it’s a fresh cranberry
muffin or a raspberry Danish,
our café treats match the gourmet
quality of our signature coffees.
Throughout the year we will work towards
limited-time product offerings and a “Custom Cup”
regaining our leadership within brewed coffee and
one cup offer for guests wanting a special cup of
bean sales. We believe we have the highest quality
coffee that is worth the wait.
coffee of any national chain, as well as the broadest
selection of brewed beverages, the strongest
As the second largest speciality coffee retailer in
flavour portfolio and the leading café brand when it
Canada and largest franchisor, we are confident
comes to offering beans with Rain Forest Alliance
in the strength of the Second Cup brand. Our
and Fair Trade Organic certification. We also have
commitment to caring, emphasis on quality
the systems to support the delivery of a quality cup.
and franchise partners differentiate us from the
These systems include:
competition, and our initiatives allow us to further
build our brand and leverage our core equities.
• Freshly grinding the beans
in our cafés prior to brewing
• Testing the beans 112 times before they
are served to a guest
• Swiss water decaffeinating, which is a
100% non-chemical process
• Adding flavours at the roasting stage to
infuse them into our coffees
Sincerely,
Michael Rosicki
Chairman, The Second Cup Ltd.
All these systems ensure the highest quality for our
President & CEO, The Second Cup Ltd.
Stacey Mowbray
guests. In 2013, we will celebrate our leadership in
quality through new in-store merchandising, new
13
We offer a wide variety of
cold beverages, from Icepresso®
to Italian Sodas, which are
always a popular choice in the
hot summer months.
The Second Cup Ltd.
FInAncIAl hIGhlIGhts
(in thousands of Canadian dollars, except number of cafés and per share amounts)
System sales of cafés1
Number of cafés – end of period
Same café sales growth1
Total revenue
Gross profit
Operating expenses
Impairment of goodwill and trademarks
Operating (loss) income
Income before interest, tax, depreciation,
amortization and impairment (“EBITDA”)1
(Loss) income before income taxes
Net (loss) income for the period
Adjusted net income1
Basic and diluted (loss) earnings per share as reported
Adjusted basic and diluted earnings per share1
Total assets
13 weeks
ended
December
29, 2012
$53,515
360
(4.2%)
$7,785
$6,638
4,332
15,294
($12,988)
$3,027
($13,116)
($12,024)
$1,567
($1.21)
$0.16
$88,680
13 weeks
ended
December
31, 2011
$54,404
359
1.2%
$7,363
$6,603
3,393
-
$3,210
$3,647
$3,116
$2,352
$2,116
$0.23
$0.21
$105,554
52 weeks
ended
December
29, 2012
$194,387
360
(1.9%)
$26,346
$22,823
15,779
15,294
($8,250)
52 weeks
ended
December
31, 2011
$193,660
359
(0.1%)
$25,001
$22,778
13,176
-
$9,602
$8,643
($8,753)
($9,404)
$4,187
($0.95)
$0.42
$88,680
$10,600
$8,887
$13,301
$6,358
$1.34
$0.64
$105,554
1 “System sales of cafés”, “Same café sales growth”, “EBITDA”, “Adjusted net income” and “Adjusted basic and diluted earnings per share”
are not recognized performance measures under IFRS and, accordingly, may not be comparable to similar computations as reported
by other issuers.
15
We love nothing more than creating the
perfect coffee experience. That’s why we
hand select our beans, so all we are left with
is fairly traded, sustainable coffee from
across the world.
The Second Cup Ltd. Annual Report 2012
The Second Cup Ltd.
MAnAGeMent’s dIscussIon
And AnAlYsIs
The following Management’s Discussion and Analysis (“MD&A”) has been prepared as of March 5, 2013 and is intended
to assist in understanding the results of operations and financial condition of The Second Cup Ltd. (“Second Cup”
or the “Company”) for the 13 weeks (the “Quarter”) and the year ended December 29, 2012, and should be read in
conjunction with the audited financial statements of the Company and accompanying notes, which are available at
www.sedar.com. Past performance may not be indicative of future performance. All amounts are presented in thousands
of Canadian dollars, unless otherwise indicated and have been prepared in accordance with International Financial
Reporting Standards (“IFRS”).
In this MD&A, the Company also reports certain non-IFRS measures such as system sales of cafés, same café sales
growth, EBITDA and adjusted net income. System sales of cafés and same café sales are discussed below under
“System Sales”. EBITDA represents earnings before interest, taxes, depreciation, amortization and impairment charges.
As there is no generally accepted method of calculating EBITDA, the measure as calculated by the Company might not
be 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 because
management interprets trends in EBITDA as an indicator of relative operating performance. EBITDA should not be
considered by an investor as an alternative to net income or cash flows as determined in accordance with IFRS.
As previously discussed, the Company (formerly Second Cup Income Fund) (the “Fund”) converted from an income trust
structure to a public corporation (“Conversion”) on January 1, 2011. The Fund was not subject to income taxes to the
extent that its taxable income was distributed to unitholders. On the IFRS transition date of January 1, 2010 an increase
in the deferred tax liability was recorded by the Fund reflecting the highest marginal tax rate. After Conversion, the lower
corporate tax rate resulted in a reduction in the deferred tax liability in 2011. The Company performed an impairment
test on its franchise business cash generating unit (discussed below under “Operating Expenses”) and recorded an
impairment charge of $15,294 related to goodwill and trademarks for 2012. Management has separated the 2011
deferred income tax recovery due to Conversion and the 2012 impairment of goodwill and trademarks resulting in the
non-IFRS measures of adjusted net income and adjusted basic and diluted earnings per share.
OVERVIEW AND BUSINESS OF SECOND CUP
Second Cup is Canada’s largest specialty coffee café franchisor and retailer (as measured by the number of cafés) with
360 cafés operating under the trade name Second Cup™ in Canada, of which ten are Company-operated and the
balance are operated by franchise partners who are selected and trained to retail Second Cup’s product offering.
Second Cup owns the trademarks, trade names, operating procedures and systems and other intellectual property used
in connection with the operation of Second Cup cafés only in Canada, excluding the Territory of Nunavut.
Second Cup is incorporated and domiciled in Canada. The address of its registered office is 6303 Airport Road, 2nd
Floor, Mississauga, Ontario L4V 1R8. The Company’s website is www.secondcup.com.
Second Cup’s fiscal year follows the method implemented 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 fiscal year is made up of 52 or 53 week
periods ending on the last Saturday of December.
The common shares of the Company are listed on the Toronto Stock Exchange under the symbol “SCU.”
17
MANAGEMENT’S DISCUSSION & ANALYSIS
As at March 5, 2013, the Company’s issued share capital consisted of 9,903,045 common shares, unchanged from year end.
Additional information relating to the Company, including the Company’s Annual Information Form, is on SEDAR
at www.sedar.com.
BASIS OF PRESENTATION
The financial statements of Second Cup have been prepared in accordance with IFRS and International Financial
Reporting Interpretation Committee (“IFRIC”) interpretations.
The preparation of financial statements in accordance with IFRS requires the use of certain critical accounting estimates.
It also requires management to exercise its judgement in the process of applying the Company’s accounting policies. The
areas involving a higher degree of judgement or complexity, or areas where assumptions and estimates are significant to
the financial statements are disclosed in Note 4 of the financial statements.
The accounting policies applied in the financial statements are based on IFRS effective for the fiscal year ended
December 29, 2012, as issued and outstanding as of February 28, 2013, the date the Board of Directors approved the
financial statements.
The company’s business is classified as one operating segment that is reported in a manner consistent with the internal
reporting provided to the chief operating decision maker. The Company is structured as a franchisor with all of its
operating revenues derived in Canada. Operating revenues comprise the sale of goods from Company-operated cafés
and the sale of goods through ancillary channels, royalties and other service fees. Management is organized based on
the Company’s operations as a whole rather than the specific revenue streams.
As a franchisor, Second Cup opens, acquires, closes and refranchises individual café locations in the normal
course of business.
The Second Cup Ltd. Annual Report 2012
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 audited financial statements of the Company.
(in thousands of Canadian dollars,
except number of cafés and per share amounts)
System sales of cafés1
Number of cafés – end of period
Same café sales growth1
Total revenue
Gross profit
Operating expenses
Impairment of goodwill and trademarks
Operating (loss) income
Amortization of property and equipment
and intangible assets
Loss on disposal of property and equipment
Impairment of property and equipment
Impairment of goodwill and trademarks
Income before interest, tax, depreciation,
amortization and impairment (“EBITDA”)1
(Loss) income before income taxes
Current income tax (charge)
Deferred income tax recovery (charge)
excluding Conversion
Deferred income tax recovery due to Conversion 2
Net (loss) income for the period
Deferred income tax recovery due to Conversion 2
Impairment of goodwill and trademarks
Tax effect
Adjusted net income1
Basic and diluted (loss) earnings per share as reported
Adjusted basic and diluted earnings per share1
Total assets
13 weeks
ended
December
29, 2012
$53,515
360
(4.2%)
$7,785
$6,638
4,332
15,294
13 weeks
ended
December
31, 2011
$54,404
359
1.2%
$7,363
$6,603
3,393
-
52 weeks
ended
December
29, 2012
$194,387
360
(1.9%)
$26,346
$22,823
15,779
15,294
52 weeks
ended
December
31, 2011
$193,660
359
(0.1%)
$25,001
$22,778
13,176
-
($12,988)
$3,210
($8,250)
$9,602
324
42
355
15,294
287
20
130
-
1,167
70
362
15,294
832
36
130
-
$3,027
$3,647
$8,643
$10,600
($13,116)
(596)
1,688
-
($12,024)
-
15,294
(1,703)
$1,567
($1.21)
$0.16
$88,680
$3,116
(894)
(106)
236
$2,352
(236)
-
-
$2,116
($8,753)
(1,644)
993
-
($9,404)
-
15,294
(1,703)
$4,187
$8,887
(1,527)
(1,002)
6,943
$13,301
(6,943)
-
-
$6,358
$0.23
$0.21
$105,554
($0.95)
$0.42
$88,680
$1.34
$0.64
$105,554
1 “System sales of cafés”, “Same café sales growth”, “EBITDA”, “Adjusted net income” and “Adjusted basic and diluted earnings per
share” are not recognized performance measures under IFRS and, accordingly, may not be comparable to similar computations as
reported by other issuers.
2 At the annual and special meeting of unitholders held on June 10, 2010, the unitholders approved the proposed conversion from an
income trust structure to a public corporation (“Conversion”). The Conversion was completed on January 1, 2011.
19
MANAGEMENT’S DISCUSSION & ANALYSIS
SYSTEM SAlES
Overview of System Sales
System sales comprise the gross revenue reported to Second Cup by franchisees of Second Cup cafés and by cafés
owned by Second Cup. 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 Point of Sales System (“POS”), on-site visits
and analyses of raw materials purchased by the cafés as reported by authorized vendors.
Increases in system sales result from the addition of new cafés and same café sales growth. System sales from existing
cafés are primarily dependent on pricing, product and marketing initiatives undertaken by Second Cup, maintaining
operational excellence within the café network and general market conditions, including weather, disposable consumer
income, consumer confidence, recessionary and inflationary trends, job security and unemployment, equity market levels,
consumer credit availability and competitive activities. 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 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, more
preferable location is available.
Analysis of System Sales and Same Café Sales Growth
System sales for the 13 weeks ended December 29, 2012 were $53,515 compared to $54,404 for the 13 weeks ended
December 31, 2011, representing a decrease of $889 or 1.6%. The total number of cafés at the end of the Quarter was
360 compared to 359 cafés at the end of the fourth quarter of 2011.
System sales for the 52 weeks ended December 29, 2012 were $194,387, compared to $193,660 for the 52 weeks
ended December 31, 2011, representing an increase of $727 or 0.4%.
Same café sales represents percentage change, on average, in retail sales at cafés (franchised and Company-operated)
operating system wide that have been open for 15 or more 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 growth are changes in customer traffic and changes in average check. These factors are dependent upon
existing cafés maintaining operational excellence within each Second Cup café, general market conditions, pricing and
marketing programs undertaken by Second Cup.
During the Quarter Second Cup continued to be impacted by increased competitive activity resulting in a same café sales
decline of 4.2%, compared to an increase of 1.2% in the comparable quarter of 2011. For 2012, same café sales decline
was 1.9% (2011 – 0.1% decline).
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.
Seasonality of System Sales
The following table shows the percentage of annual system sales achieved, on average, in each fiscal reporting quarter
over the last three fiscal years:
% of Annual System Sales
First quarter
Second quarter
Third quarter
Fourth quarter
2010
23.8
24.4
24.0
27.8
100.0
2011
23.5
24.4
24.0
28.1
100.0
2012
24.2
24.4
23.9
27.5
100.0
Average
23.9
24.4
23.9
27.8
100.0
The Second Cup Ltd. Annual Report 2012
Historically, revenue has been higher in the fourth quarter, which includes the holiday sales periods of November and
December. Because of this seasonality, the results for any quarter are not necessarily indicative of what may be achieved
for any other quarter or for the full fiscal year.
CAFÉ NETWORK
Number of cafés - beginning of period
Cafés opened
Cafés closed
Number of cafés - end of period
Number of cafés renovated
13 weeks
ended
December
29, 2012
358
4
(2)
360
4
13 weeks
ended
December
31, 2011
359
7
(7)
359
6
52 weeks
ended
December
29, 2012
359
18
(17)
360
19
52 weeks
ended
December
31, 2011
349
22
(12)
359
25
During the Quarter, four cafés were renovated (2011 - six), there were four café openings (2011 - seven) and two café
closures (2011 - seven) with 360 cafés open at December 29, 2012. For the year, 19 cafés (2011 - 25) were renovated;
there were 18 café openings (2011 - 22) and 17 café closures (2011 - 12).
INCOME, OPERATINg EXPENSES AND NET INCOME
Fourth Quarter
Analysis of Revenues
Total revenues for the Quarter were $7,785 (2011 - $7,363) and consisted of royalty revenue, revenue from sale of goods
and services revenue.
Royalty revenue for the Quarter was $4,017 (2011 - $4,346). The reduction in royalty revenue of $329 was mainly due to
a decrease in system sales and a reduction in the effective royalty rate (excluding sales from Company-operated cafés)
from 8.1% in 2011 to 7.7% in the Quarter as a result of the revised royalty structure for new cafés. New cafés that opened
in 2011 and 2012 pay a royalty rate of 3% in the first year, a rate of 6% in the second year and, thereafter, a rate of 9%. In
addition the effective royalty rate was impacted by 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 $1,597, compared to $1,042 for the 13 weeks ended December 31, 2011. The
increase in revenue from the sale of goods was mainly due to operating twelve Company-operated cafés for most of the
fourth quarter in 2012 compared to nine for most of the fourth quarter in 2011. The Company franchised two cafés late
in the Quarter, ending the Quarter with ten Company-operated cafés.
Services revenue for the Quarter was $2,171 (2011 - $1,975). 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, purchasing coordination fees and other ancillary fees (IT support, tuition and construction black
line drawings). The $196 increase in services revenue is mainly due to an increase in product licencing revenue, transfer
fees and other ancillary fees offset by decreases in initial franchise fees and purchasing coordination fees. The increase in
product licence revenue was as a result of the new partnership with Kraft Canada Inc. to produce, market and sell Second
Cup signature blend coffees and lattes across Canada using the TASSIMO T-Disc on-demand beverage system.
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 72% in the Quarter (2011 - 73%).
21
MANAGEMENT’S DISCUSSION & ANALYSIS
Operating Expenses
Operating expenses include the head office expenses of Second Cup and the overhead expenses of Company-operated
cafés. Total operating expenses were $4,332 (2011 - $3,393), an increase of $939.
Head Office Operating Expenses
Head office expenses of Second Cup increased by $567 (19.8%) from $2,857 in 2011 to $3,424. Comparatively, the
major expenses for the Quarter were salaries, wages and benefits $1,484 (2011 - $1,611), occupancy and lease costs
$589 (2011 - $329), head office overheads $282 (2011 - $215), travel and franchise partner meetings $202 (2011 - $193),
professional fees $164 (2011 - $84), legal costs $160 (2011 - $120), amortization of property and equipment $137 (2011
- $110), amortization of intangible assets $116 (2011 - $105), research and innovation $115 (2011 - $nil), advertising and
franchise development $93 (2011 - $76), inventory markdowns $46 (2011 - $7), and bad debt expense $36 (2011 - $7).
All material changes in operating expenses are explained in the table below.
Expenses
Increase / Decrease
in Expenses
Explanation for Change
Salaries, wages
and benefits
Decrease of $127
Reduction in incentives, severance costs, Directors’ deferred
share unit plan (“DSUP”) and long-term incentive plan (“LTIP”)
offset by increases in Directors’ fees and inflationary increases
in salaries, wages and benefits. Directors’ fees increased as a
result of an additional Director in 2012.
Occupancy and
lease costs
Increase of $260
Increase in provision for vacant properties which had not been sublet
offset by recoveries for rent arrears from franchise partners.
Research and
innovation
Increase of $115
New expenditure on test concepts and initiatives to build the
brand and drive growth.
Professional
fees
Head office
overheads
Increase of $80
Primarily due to the partial outsourcing of the cafés IT network
support and upgrading head office accounting software and
help desk software.
Increase of $67
Increase in POS support costs as a result of an increase in
the install base.
Legal costs
Increase of $40
Increased litigation costs in preparation for a trial from an outstanding
2009 landlord claim and due to increased leasing activity.
Impairment of Goodwill and Trademarks
The Company considers the franchise business as a separate cash generating unit (“CGU”). The Company performed
its annual impairment test on the franchise business CGU and the valuation based on the forecasted cash flows and
using an 11.5% discount rate indicated impairment. As a result, the Company recognized a total impairment charge of
$15,294 which consisted of $2,444 to goodwill and $12,850 to trademarks in the Quarter. The after tax impact of these
impairment charges were $13,591 and reduced earnings per share by $1.37. The impairment charges have no impact on
the Company’s liquidity, cash flow, borrowing capability or operations.
The Second Cup Ltd. Annual Report 2012
Corporate Café Operating Expenses
The overhead expenses in Company-operated cafés increased by $372 from $536 in 2011 to $908. Comparatively, the
expenses for the Quarter were impairment of property and equipment $355 (2011 - $130), lease costs $282 (2011 - $178),
other operating expenses $107 (2011 - $102), amortization of property and equipment $71 (2011 - $72), advertising and
local marketing $51 (2011 - $34) and a loss on disposal of property and equipment $42 (2011 - $20).
The valuation of corporate cafés CGU based on revenue growth and future cash flows indicated an impairment. As a result,
the Company recorded a loss of $355 (2011 - $130) on the impairment of two (2011 – one) Company-operated cafés.
Expenses
Increase / Decrease
in Expenses
Explanation for Change
Impairment of
property and
equipment
Increase of $225
Leaseholds of two corporate cafés written off and property and
equipment written down to their recoverable amount versus one
corporate café (kiosk in mall) written down in 2011.
Lease costs
Increase of $104
The Company had ten (2011 - seven) Company-operated cafés
at the end of the Quarter. The reduction in the amortization of
liabilities arising from the 2009 acquisition of the Company by
the Fund was $11.
Other Income and Expenses
The Company incurred interest expense of $159 (2011 - $177), and $22 (2011 - $18) in amortization of financing charges
relating to the term loan. The Company also recorded a non-cash credit of $47 (2011 - $86) 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 $10 (2011 - $20) primarily due to interest earned from short-term highly liquid bank investments
with original maturities of three months or less and from notes receivable.
Income Taxes
Current income taxes of $596 (2011 - $894) were recorded in the Quarter. A deferred tax recovery of $1,688 (2011 -
recovery of $130) was recorded in the Quarter. The deferred tax recovery was mainly due to the impairment charge of
$15,294 to goodwill and trademarks in the Quarter.
EBITDA
EBITDA for the Quarter was $3,027 (2011 - $3,647). The decrease in EBITDA was due to an increase in gross profit of $35
offset by an increase in operating expenses of $655 (excluding amortization, loss on disposal of property and equipment
and impairment charges) as discussed above.
Net Income
The Company’s net loss for the Quarter was $12,024 or ($1.21) per share, compared to net income of $2,352 or $0.23
per share in 2011. Excluding the after tax impact of the goodwill and trademark impairment charge of $13,591 in 2012
and the Conversion deferred tax recovery of $236 in 2011, adjusted net income for the Quarter was $1,567 or $0.16 per
share, compared to $2,116 or $0.21 per share in 2011. The decline in adjusted net income of $549 or $0.05 was mainly
due to the $225 increase in impairment of property and equipment, the $714 increase in operating expenses (excluding
the $225 impairment above), the $34 increase in net interest expense, offset by a $35 increase in gross profit and a $389
decrease in income taxes (excluding the income tax impact of Conversion and goodwill and trademarks impairment).
23
MANAGEMENT’S DISCUSSION & ANALYSIS
Reconciliation of Net (Loss) Income to EBITDA for the 13 Weeks Ended
Net (loss) income
Net interest expense
Income taxes (recovery)
Amortization of property and equipment
Amortization of intangible assets
Loss on disposal of property and equipment
Impairment of property and equipment
Impairment of goodwill and trademarks
EBITDA
Dec. 29, 2012
($12,024)
128
(1,092)
208
116
42
355
15,294
$3,027
Dec. 31, 2011
$2,352
94
764
182
105
20
130
-
$3,647
Full Year
Analysis of Revenues
Revenues were $26,346 compared to $25,001 in 2011 and consisted of royalty revenue, revenue from the sale of goods
and services revenue.
Royalty revenue was $14,927 (2011 - $15,631). The reduction in royalty revenue of $704 was mainly due to a reduction
in the effective royalty rate (excluding sales from Company-operated cafés) from 8.2% in 2011 to 7.9% as a result of the
revised 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 $4,698 compared to $3,006 for the 52 weeks ended December 31, 2011. The increase
in revenue from the sale of goods was mainly due to an increase in the weighted average number of Company-operated
cafés from six in 2011 to eight in 2012. The Company ended the year with ten (2011 - seven) Company-operated cafés.
Services revenue was $6,721 (2011 - $6,364). The $357 increase in services revenue is mainly due to an increase in
product licencing revenue, IT support fees, purchasing coordination fees and café resale fees offset by decreases in initial
franchise fees, construction administration fees and renewal fees. Product licencing fees increased $443 largely due to the
new partnership agreement with Kraft Canada Inc. to produce, market and sell Second Cup signature blend coffees and
lattes across Canada using the TASSIMO T-Disc on-demand beverage system. IT support fees increased $172 and relate
to POS implemented in the second half of 2011. Café resale fees increased $37 and are recognized when title transfers
on the sale of a café between franchise partners. There were 28 cafés sold (2011 - 33) during the year reflecting a higher
average price per transaction. Excluding new corporate cafés, the Company opened 17 new franchised cafés compared
to 21 in 2011 and as a result initial franchise fees decreased by $178. Construction administration fees decreased by $138
as a result of lower franchise renovation projects which decreased from 25 in 2011 to 17 in 2012. The decrease in renewal
fees is due to timing as renewal fees are recognized at the commencement of a new franchise term.
Cost of Goods Sold
Cost of goods sold as a percentage of revenue from the sale of goods was 75% compared to 74% for the 52 weeks
ended December 31, 2011.
Operating Expenses
Operating expenses include the head office expenses of Second Cup and the overhead expenses of Company-operated
cafés. Operating expenses were $15,779 (2011 - $13,176), an increase of $2,603.
Head Office Operating Expenses
Head office expenses of Second Cup increased by $1,744 from $12,008 in 2011 to $13,752 or 14.5%. Comparatively,
the major expenses for the year ended December 29, 2012 were salaries, wages and benefits $6,540 (2011 - $7,311),
occupancy and lease costs $1,614 (2011 - $882), travel and franchise partner meetings $1,010 (2011 - $888), head office
overheads $992 (2001 - $833), professional fees $632 (2011 - $476), legal costs $518 (2011 - $394), amortization of
property and equipment $506 (2011 - $289), research and innovation $476 (2011 - $nil), amortization of intangible assets
$451 (2011 - $392), bad debt expense $422 (2011 - $257), advertising and franchise development $304 (2011 - $263) and
inventory markdowns $287 (2011 - $23).
The Second Cup Ltd. Annual Report 2012
Impairment of Goodwill and Trademarks
As discussed above, the Company recognized an impairment charge of $2,444 to goodwill and $12,850 to trademarks.
Expenses
Increase / Decrease
in Expenses
Explanation for Change
Salaries, wages
and benefits
Decrease of $771
Reduction in incentives, severance costs, and DSUP
offset by increases in Directors’ fees, LTIP and inflationary
increases in salaries, wages and benefits. LTIP increased
due to the number of shares granted in December 2011
offset by a decrease in the share price.
Occupancy and
lease costs
Increase of $732
The increase is mostly due to two vacant sites which have been
vacant since 2009 and have not been successfully sublet.
Research and
innovation
Inventory
markdowns
Amortization of
property and
equipment
Increase of $476
New expenditure on test concepts and initiatives to build the
brand and drive growth.
Increase of $264
Inventory mark-downs increased as a result of 3 products
which had sales below expectations.
Increase of $217
Increase due to an increase in amortization on POS
hardware and head office leasehold amortization. The
Second Cup head office was renovated in the fourth quarter
of 2011.
Bad debt expense
Increase of $165
Increase in the allowance for doubtful accounts and a discount
factor for a promissory note.
Head office
overheads
Increase of $159
Increase in IT support costs related to a larger install base
of new POS.
Professional fees
Increase of $156
Legal costs
Increase of $124
Primarily due to the partial outsourcing of the IT network support
for cafés and upgrading head office accounting software and
help desk software.
Increased use of external legal professionals as a result of staff
vacancies in the legal department as well as increased real
estate activity and litigation costs.
Travel and franchise
partner meetings
Increase of $122
Increase in the cost of the annual franchise partner convention
and the induction program for new franchise partners.
Amortization of
intangible assets
Advertising
and franchise
development
Increase of $59
Increase due to a greater number of POS installed in cafés.
Increase of $41
Increased new business development and advertising to attract
new franchise partners.
25
MANAGEMENT’S DISCUSSION & ANALYSIS
Corporate Café Operating Expenses
The overhead expenses in Company-operated cafés increased by $859 to $2,027 from $1,168 in 2011. Comparatively,
the major expenses for the 52 weeks ended December 29, 2012 were lease costs $885 (2011 - $504), impairment of
property and equipment $362 (2011 - $130), other operating expenses $350 (2011 - $253), amortization of property and
equipment $210 (2011 - $151), advertising and local marketing $150 (2011 - $94) and a loss on disposal of property and
equipment $70 (2011 - $36).
As discussed above, the Company recorded a loss of $362 (2011 - $130) on the impairment of two Company-operated cafés.
Expenses
Increase / Decrease
in Expenses
Explanation for Change
Lease costs
Increase of $381
Impairment of property
and equipment
Increase of $232
The Company had ten (2011 - seven) Company-operat-
ed cafés at the end of year. The reduction in the amor-
tization of liabilities arising from the 2009 acquisition of
the Company by the Fund was $43.
Leaseholds of two corporate cafés written off and
property and equipment written down to their
recoverable amount versus one corporate café (kiosk in
a mall) written down in 2011.
Other operating
expenses
Increase of $97
Increased number of Company-operated cafés.
Advertising and local
marketing
Increase of $56
Increased number of Company-operated cafés
resulted in increased revenue subject to a 3%
Co-op Fund contribution.
Amortization of property
and equipment
Increase of $59
Increased number of Company-operated cafés.
Other Income and Expenses
The Company incurred interest expense of $672 (2011 - $717), and $82 (2011 - $72) in amortization of financing charges
relating to the term loan. The reduction in interest expense is a result of renegotiating the term loan and operating credit
facilities discussed below under “Term Loan, Operating Credit Facility and Interest Rate Swap”. The Company also
recorded a non-cash credit of $206 (2011 - $29) 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 $61 (2011 - $67)
primarily due to interest earned from short-term, highly liquid bank investments with original maturities of three months
or less and from notes receivable.
Income Taxes
The income tax expense of $651 (2011 - recovery of $4,414) consists of:
• current income tax expense of $1,644 (2011 - $1,527);
• deferred income tax expense of $480 (2011 - $nil) due to the income tax rate change discussed below;
• deferred income tax recovery of $nil (2011 - $6,943), due to the Conversion; and
• deferred income tax (recovery) expense of ($1,473) (2011 - expense of $1,002), excluding the impact of the Conversion.
The Second Cup Ltd. Annual Report 2012
The increase in current income tax expense is a result of the Company reducing its 2011 current income taxes by utilizing
tax losses carried forward from prior years. The Ontario 2012 budget was substantively enacted on June 20, 2012,
freezing corporate tax cuts with the effect that the income tax rate would remain at 11.5% until the province can achieve
a balanced budget. Previously, the corporate income tax rate was slated to decrease to 10.0% by 2014. The impact of
the income tax rate change is estimated to be a future income tax increase of $480. The $1,473 deferred tax recovery in
2012 was mainly due to the impairment charge of $15,294 to goodwill and trademarks in the Quarter.
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 marginal 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 28.16% and resulted in a reduction in the deferred tax liability of
$6,943 and a corresponding non-cash credit to income in the first quarter of 2011.
EBITDA
EBITDA was $8,643 (2011 - $10,600). The decline in EBITDA was due to an increase in gross profit of $45 offset by
an increase in operating expenses of $2,002 (excluding amortization, loss on disposal of property and equipment and
impairment charges) as discussed above.
Net Income
The Company’s net loss was $9,404 or $0.95 per share, compared to net income of $13,301 or $1.34 per share in
2011. Excluding the 2011 deferred income tax recovery of $6,943 due to Conversion and the 2012 after tax impairment
of goodwill and trademarks of $13,591, adjusted net income was $4,187 (2011 - $6,358). The reduction in adjusted net
income of $2,171 was mainly due to the non-cash $232 increase in the impairment of property and equipment charge, the
$2,371 increase in operating expenses (excluding the $232 impairment above) offset by the $212 decrease in net interest
expense (including a non-cash $177 increase in the movement of the derivative interest rate swap), a $45 increase in
gross profit and a $175 decrease in income taxes (excluding the recovery due to Conversion and the income tax impact
of goodwill and trademarks impairment).
Reconciliation of Net (Loss) Income to EBITDA for the 52 Weeks Ended
Net (loss) income
Net interest expense
Income taxes (recovery)
Amortization of property and equipment
Amortization of intangible assets
Loss on disposal of property and equipment
Impairment of property and equipment
Impairment of goodwill and trademarks
EBITDA
Dec. 29, 2012
($9,404)
503
651
716
451
70
362
15,294
$8,643
Dec. 31, 2011
$13,301
715
(4,414)
440
392
36
130
-
$10,600
27
MANAGEMENT’S DISCUSSION & ANALYSIS
Dividend
On February 28, 2013, the Board of Directors of Second Cup approved a dividend of $0.085 per common share, payable on
March 28, 2013 to shareholders of record at the close of business on March 15, 2013. The dividend will be considered an
eligible dividend for income tax purposes.
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 that the amount of the dividend
will remain at the current level.
Annual General Meeting of Shareholders
The Board of Directors has set a record date of March 24, 2013 for the Annual General Meeting of shareholders. The
Annual General Meeting will be held at 10:00 a.m. on Friday, May 3, 2013 at the offices of Stikeman Elliott LLP, 53rd Floor,
5300 Commerce Court West, 199 Bay Street, Toronto, Ontario.
SElECTED QUARTERlY INFORMATION
A discussion of the Company’s previous interim results can be found in the Company’s quarterly MD&A reports available
at www.sedar.com.
(in thousands of Canadian dollars,
except number of cafés and per share amounts)
System sales of cafés2
Same café sales growth2
Number of cafés at end of period
Total revenue
Operating (loss) income for the period
Amortization of property and equipment
and intangible assets
Loss (gain) on disposal of property and equipment
Impairment of property and equipment
Impairment of goodwill and trademarks
EBITDA2
Net (loss) income before income taxes
Current income tax charge
Deferred income tax (recovery) charge
Net (loss) income for the period
Basic/diluted (loss) earnings per share
Dividends declared per share
Q4 20121
$53,515
(4.2%)
360
$7,785
($12,988)
324
42
355
15,294
$3,027
($13,116)
596
(1,688)
($12,024)
($1.21)
$0.085
Q3 2012
$46,389
(2.8%)
358
$6,378
$1,133
306
29
-
-
$1,468
$1,017
275
(4)
$746
$0.08
$0.15
Q2 2012
$47,382
(1.5%)
356
$6,175
$2,063
Q1 2012
$47,101
0.4%
355
$6,008
$1,542
271
-
-
-
$2,334
$1,920
422
656
$842
$0.09
$0.15
266
(1)
7
-
$1,814
$1,426
351
43
$1,032
$0.10
$0.15
The Second Cup Ltd. Annual Report 2012
System sales of cafés2
Same café sales growth2
Number of cafés at end of period
Total revenue
Operating income for the period
Amortization of property and equipment
and intangible assets
Loss on disposal of property and equipment
Impairment of property and equipment
EBITDA2
Net income before income taxes
Current income tax charge
Deferred income tax (recovery) charge
Net income for the period
Basic/diluted earnings per share
Dividends declared per share
Q4 2011 1,3
$54,404
1.2%
359
$7,363
$3,210
287
20
130
$3,647
$3,116
894
(130)
$2,352
$0.23
$0.15
Q3 20113
$46,369
(0.1%)
359
$6,138
$2,362
219
9
-
$2,590
$2,095
511
(68)
$1,652
$0.17
$0.15
Q2 20113
$47,294
0.3%
350
$6,072
$2,506
Q1 20113
$45,593
(2.3%)
352
$5,428
$1,524
185
-
-
$2,691
$2,283
122
616
$1,545
$0.16
$0.15
141
7
-
$1,672
$1,393
-
(6,359)
$7,752
$0.78
$0.00
1 The Company’s fourth quarter system sales are higher than other quarters due to the seasonality of the business (see “Seasonality
of System Sales” above).
2 System sales of cafés”, “Same café sales growth” and “EBITDA” are not recognized performance measures under IFRS and,
accordingly may not be comparable to similar computations as reported by other issuers.
3 Results for 2011 include deferred income tax (recovery) charge of ($6,756), $85, ($36) and ($236) in the first, second, third and fourth
quarters respectively, as a result of the Conversion to a public corporation from an income trust structure.
lIQUIDITY AND CAPITAl RESOURCES
Second Cup collects royalties based on franchise partner system sales, franchise fees and other amounts from its
franchise partners and also generates revenues from its Company-operated cafés. The performance of Second Cup
franchise partners and Company-operated cafés could impact the ability of the Company to declare and pay dividends to
its shareholders. For a more detailed discussion of the risks and uncertainties affecting the Company’s liquidity, see “Risks
and Uncertainties” below.
fourth quarter
Cash Flows for the 13 Weeks Ended
Cash flows from operating activities
Cash flows (used in) investing activities
Cash flows (used in) financing activities
Increase (decrease) in cash during the period
Dec. 29, 2012
$1,765
(221)
(844)
$700
Dec. 31, 2011
$3,574
(976)
(1,513)
$1,085
Cash generated by operating activities was $1,765 for the Quarter compared to $3,574 for the same quarter last year.
The decrease is the result of increases in non-cash working capital including income taxes and a decrease in net income.
During the Quarter, cash used in investing activities was $221 (2011 - $976). The Company purchased $387 (2011 -
$966) of property and equipment and $24 (2011 - $63) of software primarily for POS. The Company received proceeds of
$159 (2011 - $35) on the disposal of property and equipment. The Company received proceeds of $31 (2011 - $26) on
the repayment of leases receivable and promissory notes.
29
MANAGEMENT’S DISCUSSION & ANALYSIS
Financing activities resulted in cash usage of $844 (2011 - $1,513). During the Quarter, Second Cup paid a dividend
totalling $842 (2011 - $1,485). The Company also paid $2 in financing charges related to the term loan. During 2011, the
Company repaid $25 on a note payable to a previous landlord and made payments of $3.
full year
Working Capital as at
Current assets
Current liabilities
Working capital (deficiency)
Dec. 29, 2012
$9,593
10,649
($1,056)
Dec. 31, 2011
$11,225
12,025
($800)
The Company has a working capital deficiency of $1,056 as of December 29, 2012. Second Cup has a gift card program
that allows customers to prepay for future purchases by reloading a dollar value onto their gift cards. Current liabilities
includes $4,560 (2011 - $4,353) gift card liability. The gift cards do not have an expiration date. The Company will honour
all Second Cup gift cards presented for payment but may recognize breakage based on historical redemption patterns.
Gift card holders are not entitled to any interest, dividends or returns on prepaid amounts and the Company does not
charge a service fee. The gift card program continues to provide a source of working capital.
Cash Flows for the 52 Weeks Ended
Cash flows from operating activities
Cash flows (used in) investing activities
Cash flows (used in) financing activities
(Decrease) increase in cash during the year
Dec. 29, 2012
$5,150
(1,367)
(5,368)
($1,585)
Dec. 31, 2011
$8,305
(2,925)
(5,328)
$52
Year to date, the Company generated cash from operations of $5,150 compared to $8,305 in 2011. The decrease is
primarily the result of paying the 2011 income taxes of $1,548 and the 2012 income tax installments of $1,287.
Year to date, cash used by investing activities was $1,367 (2011 - $2,925). Second Cup purchased $1,758 (2011
- $2,731) of property and equipment primarily to renovate two corporate cafés, construct a new corporate café,
purchase three cafés from franchise partners, POS and head office computer upgrades. In addition, $180 (2011 - $312)
of software was purchased primarily for POS. Second Cup received proceeds of $350 (2011 - $49) on the disposal of
property and equipment primarily from the sale of three cafés. The Company received proceeds of $221 (2011 - $97)
on the repayment of leases receivable and promissory notes. During 2011, the Company agreed to finance certain
franchisees $50 to enable them to purchase certain equipment, furniture and fixtures, all of which are owned by the
Company as the underlying security. During 2011, the Company invested $291 in assets held for sale, which were sold
for proceeds of $313.
Financing activities resulted in cash usage of $5,368 in 2012, compared to $5,328 in 2011. Second Cup paid dividends
totalling $5,298 (2011 - $4,456) and the December 2010 distribution to unitholders of $759 in 2011. The Company
repaid $18 (2011 - $101) on a note payable to a previous landlord and made payments of $2 (2011 - $12) on a
long-term lease. Both the note payable and long-term lease have been fully repaid. The Company renegotiated its term
loan and operating credit facilities and incurred $50 in financing charges related to the extension of the term loan to May
31, 2015 (see “Term Loan, Operating Credit Facility and Interest Rate Swap” below).
The Company had cash and cash equivalents of $3,880 at December 29, 2012 (December 31, 2011 - $5,465).
The Company continues to believe it has sufficient financial resources to pay future dividends and operating expenses
when declared and due.
The Second Cup Ltd. Annual Report 2012
Term Loan, Operating Credit Facility and Interest Rate Swap
On June 12, 2012, the Company renegotiated its term loan and operating credit facilities including an extension of the
maturity of the credit facilities, to May 31, 2015 and a decrease in interest rates. The revised credit facilities comprise an
$11,000 non-revolving term credit facility, fully drawn, and an undrawn $2,000 revolving credit facility. As a result of the
refinancing, the Company capitalized loan extension fees of $50. The term credit facilities are collateralized by substantially
all the assets of the Company.
The $11,000 non-revolving term credit facility bears interest at the bankers’ acceptance rate plus 2.75% (December 31,
2011 - 3.50%). As at December 29, 2012, the full amount of the $11,000 non-revolving term credit facility was drawn.
The $2,000 operating credit facility bears interest at the bankers’ acceptance rate plus 2.75% (December 31, 2011 - 3.50%).
As at December 29, 2012, no advances had been drawn on this facility.
The Company has an interest rate swap agreement with a notional value of $11,000 maturing on April 1, 2013, which fixes
the interest rate on the Company’s non-revolving credit facility at 3.04% per annum plus the margin noted above, which
results in a fixed effective interest rate of 5.79% (December 31, 2011 - 6.54%). As at December 29, 2012, the estimated
fair value of this contract is a $96 liability to the Company (December 31, 2011 - $302) which is recorded as a liability on the
Company’s Statements of Financial Position, and the fair value movement of the interest rate swap has been recorded as a
non-cash credit to income on the Company’s Statements of Operations and Comprehensive Income (Loss).
Pursuant to the terms of the Company’s operating loan and term loan, the Company is subject to certain financial and other
customary covenants, including requirements to maintain a ratio of senior debt to EBITDA and to maintain a trailing four-
quarter fixed charge coverage ratio. During the year ended December 29, 2012, the Company was in compliance with all
financial and other covenants of the Company’s operating loan and term loan.
In accordance with IFRS 7, Financial Instruments: Disclosures, the term loan is presented net of transaction costs. Transaction
costs are amortized to the Statements of Operations and Comprehensive Income (Loss) using the effective interest method.
OFF-BAlANCE SHEET ARRANgEMENTS
Second Cup has lease commitments for Company-operated cafés and also acts as the head tenant on leases, which it,
in turn, subleases to franchise partners. The Company’s lease commitments at December 29, 2012 are as follows:
December 31, 2013
December 31, 2014
December 31, 2015
December 31, 2016
December 31, 2017
Thereafter
$
Headlease commitments
19,246
18,346
16,710
14,676
12,667
35,706
$ 117,351
Sublease to franchisees
$ 17,867
17,121
15,474
13,430
11,501
31,647
$ 107,040
Net
$ 1,379
1,225
1,236
1,246
1,166
4,059
$ 10,311
The Company believes it has sufficient resources to meet the net commitment of $10,311.
Total occupancy and lease costs expensed in the quarter are as follows:
Company head office and franchise café locations
Company-operated cafés
52 weeks ended
December 29, 2012
1,614
$
885
2,499
$
52 weeks ended
December 31, 2011
882
504
$ 1,386
$
31
MANAGEMENT’S DISCUSSION & ANALYSIS
Second Cup is involved in litigation and other claims arising in the normal course of business. Management must use its
judgement to determine whether or not a claim has any merit, the amount of the claim and whether to record a provision,
which is dependent on the potential success of the claim. Second Cup believes that it will not incur any significant loss or
expense with such claims. However, there can be no assurance that unforeseen circumstances will not result in significant
costs. The outcome of these actions is not determinable at this time and adjustments, if any, will be recorded in the period
of settlement.
The Coffee “C” contract is the world benchmark for Arabica coffee. The contract prices physical delivery of exchange grade
green beans from one of 19 countries of origin in a licensed warehouse to one of several ports in the U.S. and Europe, with
stated premiums / discounts for ports and growth. Second Cup sources high altitude Arabica coffee which tends to trade
at a premium above the “C” coffee commodity price. Second Cup has a contract with a third party company to purchase
and roast the coffee that is sold in all Second Cup cafés by franchise partners. In terms of this supply agreement,
Second Cup has guaranteed a minimum volume of coffee purchases amounting to $4,421 (2011 - $9,462). The coffee
purchase commitment represents purchase commitments made up to the end of December 2013. The coffee purchase
commitment is comprised of three components: unapplied futures commitment contracts, fixed price physical contracts
and flat price physical contracts. As at December 29, 2012 most of the unapplied futures commitments for 2013 had
been contracted, however, only a portion of the physical contracts had been negotiated. As a result, the majority of the
decrease in the total commitments was due to a planned delay in committing to certain fixed price physical contracts.
Second Cup has entered into a marketing agreement with a third party through 2014 and has committed to spend $200
per year on advertising placed in various media offered by the third party over the term of the agreement.
FUTURE ACCOUNTINg STANDARDS
Financial Instruments – Recognition and Measurement
IFRS 9, Financial Instruments (“IFRS 9”), was issued in November 2009 and addresses classification and measurement
of financial assets. It replaces the multiple category and measurement models in International Accounting Standard 39,
Financial Instruments: Recognition and Measurement (“IAS 39”) for debt instruments with a new mixed measurement
model having only two categories: amortized cost and fair value through profit and loss. IFRS 9 also replaces the models
for measuring equity instruments. Such instruments are either recognized at fair value through profit or loss or at fair value
through other comprehensive income. Where equity instruments are measured at fair value through other comprehensive
income, dividends are recognized in profit or loss to the extent that they do not clearly represent a return of investment;
however, other gains and losses (including impairments) associated with such instruments remain in accumulated compre-
hensive income indefinitely.
Requirements for financial liabilities were added to IFRS 9 in October 2010 and they largely carried forward existing require-
ments in IAS 39, except that fair value changes due to credit risk for liabilities designated at fair value through profit and loss
are generally recorded in other comprehensive income.
IFRS 13, Fair Value Measurement (“IFRS 13”), is a comprehensive standard for fair value measurement and disclosure for
use across all IFRS. The new standard clarifies that fair value is the price that would be received to sell an asset, or paid
to transfer a liability in an orderly transaction between market participants, at the measurement date. Under existing IFRS,
guidance on measuring and disclosing fair value is dispersed among the specific standards requiring fair value measure-
ments and does not always reflect a clear measurement basis or consistent disclosures.
IFRS 9 and IFRS 13 are effective for annual periods beginning on or after January 1, 2015 and January 1, 2013, re-
spectively, with earlier adoption permitted. The Company will adopt IFRS 13, effective January 1, 2013, but does not
expect it to have a significant impact. The Company has not yet assessed the impact of IFRS 9 or determined whether
it will early adopt the standard.
The Second Cup Ltd. Annual Report 2012
MANAgEMENT OF CAPITAl
The capital structure of the Company consists of $10,941 (2011 - $10,909) in long-term debt and $56,700 (2011 - $71,402)
in shareholders’ equity, which comprises issued shares and accumulated earnings, less accumulated cash distributions.
The Company’s objectives relating to the management of its capital structure are to:
a) safeguard its ability to continue as a going concern;
b) maintain financial flexibility in order to preserve its ability to meet financial obligations;
c) maintain a capital structure that provides financing options to the Company when the need arises to access capital;
d) ensure it has sufficient cash and cash equivalents to pay declared dividends to its shareholders; and
e) deploy capital to provide an adequate return to its shareholders.
The Company’s primary uses of capital are to finance increases in non-cash working capital and capital expenditures.
The Company determines the appropriate level of long-term debt in the context of its cash flow and overall business risks.
The Company has historically generated sufficient cash flows to pay quarterly dividends to its shareholders. In order to
maintain or modify the capital structure, Second Cup may adjust the amount of dividends paid to its shareholders. The
current level of capital is considered adequate in the context of current operations.
Under the term loan and operating facility, the Company is required to comply with a number of covenants and restrictions,
including the requirements to meet certain financial ratios. These financial ratios include a senior leverage ratio and a fixed
charge coverage ratio. To date, the Company has complied with these ratios.
There were no changes in the Company’s approach to capital management during the Quarter.
OUTSTANDINg UNIT AND SHARE DATA
Balance December 31, 2010
Conversion January 1, 2011
Reduction in stated capital January 1, 2011
Balance December 31, 2011
Income Fund Units
$
89,972
(89,972)
-
-
#
9,903,045
(9,903,045)
-
-
Share Capital
$
-
89,972
(88,972)
1,000
#
-
9,903,045
-
9,903,045
At the annual and special meeting of unitholders held on June 2, 2010, the unitholders approved the Conversion to be
undertaken on January 1, 2011. Included as part of the Conversion was a reduction in the stated capital from $89,972
to $1,000, resulting in a reduction of the deficit by $27,575 and an increase in contributed surplus of $61,397. The
Conversion and the associated reduction in share capital were approved by court orders dated June 11, 2010 and
December 17, 2010.
EVAlUATION OF DISClOSURE CONTROlS AND PROCEDURES
Multilateral Instrument 52-109 (“MI 52-109”) requires the Company’s Chief Executive Officer (“CEO”) and Chief Financial
Officer (“CFO”) to make certain certifications related to the information contained in the Company’s annual filings.
Specifically, the CEO and CFO must acknowledge that they are responsible for establishing and maintaining disclosure
controls and procedures and internal control over financial reporting (“ICFR”) for the Company. The control framework
used by the CEO and CFO to design the Company’s ICFR is Internal Control Over Financial Reporting – Guidance for
Smaller Public Companies issued by COSO. In addition, in respect of:
(a) Disclosure Controls and Procedures
The CEO and CFO must certify that they have designed the disclosure controls and procedures, or caused them to be
designed under their supervision, to provide reasonable assurance that material information relating to the Company is
made known to them in a timely manner and that information required under securities legislation is recorded, processed,
summarized and reported in a timely manner.
33
MANAGEMENT’S DISCUSSION & ANALYSIS
As at December 29, 2012, the Company’s management, under the supervision of, and with the participation of, the CEO
and CFO, evaluated the design of the disclosure controls and procedures. Based on this evaluation, the CEO and CFO have
concluded that, as at December 29, 2012, the Company’s disclosure controls and procedures were appropriately designed.
Consistent with the concept of reasonable assurance, the Company recognizes that the relative cost of maintaining
these controls and procedures should not exceed their expected benefits. As such, the Company’s disclosure controls
and procedures can only provide reasonable, and not absolute, assurance that the objectives of such controls and
procedures are met.
(b) Internal Controls Over Financial Reporting
The CEO and CFO must certify that they have designed such internal controls over financial reporting, or caused them
to be designed under their supervision, to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance with IFRS.
As at December 29, 2012, the Company’s management, under the supervision of, and with the participation of, the
CEO and CFO, evaluated the design of the controls over financial reporting. No material weaknesses in the design of
these controls over financial reporting were identified. Based on this evaluation, the CEO and CFO have concluded
that, as at December 29, 2012, the Company’s controls over financial reporting were appropriately designed and are
operating effectively.
Consistent with the concept of reasonable assurance, the Company recognizes that the relative cost of maintaining
these controls should not exceed their expected benefits. As such, the Company’s internal controls over financial
reporting can only provide reasonable, and not absolute, assurance that the objectives of such controls are met.
During the 52 weeks ended December 29, 2012, there has been no change in the Company’s internal control over
financial reporting that has materially affected, or is reasonably likely to materially affect, the Company’s internal control
over financial reporting.
CRITICAl ACCOUNTINg ESTIMATES
The preparation of financial statements requires management to use judgement in applying its accounting policies and
estimates and assumptions about the future. Estimates and other judgements are continuously evaluated and are based
on management’s experience and other factors, including expectations about future events that are believed to be
reasonable under the circumstances. Estimates and underlying assumptions are reviewed on an ongoing basis. Revisions
to accounting estimates are recognized in the period in which the estimates are revised and in any future periods affected.
The following discusses the most significant accounting judgements and estimates that the Company has made in the
preparation of the financial statements:
Impairment analysis
Impairment analysis is an area involving management judgement requiring assessment as to whether the carrying value
of assets is recoverable. Fair value less cost to sell is determined by estimating the net present value of future cash
flows derived from such assets using cash flow projections, which have been discounted at an appropriate rate. In
calculating the net present value of the future cash flows, certain assumptions are required to be made in respect of
highly uncertain matters including:
a) Growth in total revenue
b) Growth in cash flows, calculated as adjusted operating profit before depreciation and amortization,
c) Long term growth rates
d) Selection of discount rates to reflect the risks involved.
Management has estimated cash flows based on market participant assumptions and expected future operations.
The discount rate is based upon a weighted average cost of capital derived from the benchmark analysis from similar
retail or franchise businesses in Canada and the United States.
The Second Cup Ltd. Annual Report 2012
Changing the assumptions selected by management, in particular the discount rate and the growth rate assumptions
used in the cash flow projections, could significantly affect the impairment evaluations and, hence, the results.
The Company’s review includes the key assumptions related to sensitivity in the cash flow projections. Further details
are provided in Note 13 to the financial statements.
Recoverable amount and Cash Generating Units (CGUs)
A CGU is defined as the smallest identifiable group of assets that generates cash inflows that are largely independent
of the cash inflows from other assets or group of assets.
Goodwill is not amortized but tested for impairment at least once a year or more frequently when there is an indication
that it may be impaired.
An impairment test is performed at the level of each CGU within each operating segment. This allocation is reviewed if
the Company changes the level at which it monitors goodwill or changes in operating segments.
An impairment charge is recognized when the carrying value of the assets and liabilities of the franchise business
CGU is higher than its recoverable amount. The recoverable amount of the franchise business CGU was estimated
based on fair value less costs to sell. Fair value less costs to sell is the best estimate of the amount obtainable from
the sale of a CGU in an arm’s length transaction between knowledgeable, willing parties, less costs to sell. This
estimate is determined on December 29, 2012. The Company determined goodwill and trademarks were impaired and
recognized an impairment charge of $2,444 and $12,850 respectively. The Company also determined the valuation of
two corporate cafés indicated impairment and recognized an impairment charge of $362 mainly related to leaseholds.
Deferred income taxes
The timing of reversal of timing differences and the expected income allocation to various tax jurisdictions within
Canada affect the effective income tax rate used to compute the deferred income tax asset. Management estimates
the reversals and income allocation based on historical and budgeted operating results and income tax laws existing at
the Statements of Financial Position date. In addition, management occasionally estimates the current or future deduct-
ibility of certain expenditures, affecting current or deferred income tax balances and expenses.
Fair value of derivative
Second Cup’s over-the-counter derivative consists of an interest rate swap used to economically hedge exposure to
variable cash flows associated with interest payments on the Company’s borrowings. Management estimates the fair
value of this derivative as the present value of expected future cash flows to be received or paid, based on available
market data, which includes market yields and counterparty credit spreads.
Estimated useful lives
Management estimates the useful lives of property and equipment based on the period during which the assets are
expected to be available-for-use. The amounts and timing of recorded expenses for amortization of property and
equipment for any period are affected by these estimated useful lives. The estimates are reviewed at least annually and
are updated if expectations change as a result of physical wear and tear, technical or commercial obsolescence and
legal or other limits to use. It is possible that changes in these factors may cause significant changes in the estimated
useful lives of the Company’s property and equipment in the future.
Provisions
Second Cup has lease commitments since it acts as the head tenant on café leases. In cases where the lease contract
specifies a termination fee due to the landlord or a fee is negotiated with the landlord upon termination, the Company
records the expense at the time written notice is given or agreed to by the landlord. When ceasing operations under
operating leases where the landlord does not allow the Company to prematurely exit the lease, but allows for subleasing,
the Company estimates the fair value of sublease income in calculating the provision to the end of the lease term.
35
MANAGEMENT’S DISCUSSION & ANALYSIS
RISKS AND UNCERTAINTIES
The performance of Second Cup is primarily dependent on its ability to maintain and increase the sales of existing cafés,
add new profitable cafés to the network and redevelop and modernize cafés as their leases come due. System sales of the
Second Cup café network are affected by various external factors that can affect the specialty coffee industry as a whole.
Potential risks include the following:
The specialty coffee industry is characterized by intense competition with respect to price, location, coffee and food quality
and numerous factors affecting discretionary consumer spending. Competitors include national and regional chains, all
restaurants and food service outlets that serve coffee and supermarkets that compete in the whole bean segment. If
Second Cup cafés are unable to successfully compete in the Canadian specialty coffee industry, system sales may be
adversely affected, which, in turn, may adversely affect the ability of Second Cup to pay dividends.
Growth of the café network depends on Second Cup’s ability to secure and build desirable locations and find high calibre
qualified franchise partners to operate them. Adverse credit markets, such as those currently being experienced, may affect
the ability of franchise partners to obtain new credit or refinance existing credit on economically reasonable terms.
Second Cup faces competition for café locations and franchise partners from its competitors and from franchisors and
operators of other businesses. The success of Second Cup franchise partners is significantly influenced by the location
of their cafés. There can be no assurance that current Second Cup café locations will continue to be attractive, or that
additional café sites can be located and secured as demographic patterns change. Also, there is no guarantee that the
property leases in respect of the Second Cup cafés will be renewed or suitable alternative locations will be obtained and,
in such event, one or several cafés could be closed. It is possible that the current locations or economic conditions where
Second Cup cafés are located could decline in the future, resulting in potentially reduced sales in those locations, which will
have an adverse effect on System Sales. There is no assurance that future sites will produce the same results as past sites.
There is also no assurance that a franchise partner will continue to pay its rental obligations in a timely manner, which could
result in Second Cup being obligated to pay the rental obligations pursuant to its head lease commitment, which would
adversely affect the profitability of Second Cup’s business.
A shortage in supply or an increase in the price of premium quality coffee beans could adversely affect Second Cup.
Second Cup has no material long-term contracts with coffee bean suppliers and relies on historical relationships to ensure
availability. While there are a number of coffee bean suppliers, there can be no assurance that coffee bean suppliers that
have relationships with Second Cup will continue to supply coffee beans at competitive prices.
The Canadian specialty coffee industry is also affected by changes in discretionary spending patterns, which are in turn
dependent on consumer confidence, disposable consumer income and general economic conditions. Factors such as a
change in general economic conditions, recessionary or inflationary trends, job security and unemployment, equity market
levels, consumer credit availability and overall consumer confidence levels may affect their business. The specialty coffee
industry is also affected by demographic trends and traffic and weather patterns as well as the type, number and location
of competing cafés.
Second Cup relies heavily on information technology network infrastructure. The Company’s ability to manage operations
effectively and efficiently depends on the reliability and capacity of these technology systems, most of which are administered
by third party suppliers. The Company relies on POS for system sales for both marketing trends and royalty calculations
through the IT network infrastructure. Cafés rely on IT network infrastructure to order goods and process credit, debit and
café card transactions. Head Office financial and administrative functions rely on IT infrastructure for accurate and reliable
information. The failure of these systems to operate effectively, problems with upgrading or replacing systems could cause
a material negative financial result. The Company is continually reviewing its systems and procedures to minimize risk.
Second Cup’s business could be adversely affected by increased concerns about food safety in general or other
unusual events.
As a Franchisor, Second Cup guarantees the lease of its franchise partners for most of its franchised cafés.
The Second Cup Ltd. Annual Report 2012
Changes in government regulations and other regulatory developments (such as smoking by-laws) could have an adverse
impact on system sales and royalties.
The loss of key personnel and/or a shortage of experienced management and hourly employees could have an adverse
impact on Second Cup’s operations and cafés.
A more detailed discussion of the risks and uncertainties affecting Second Cup is set out in the Second Cup’s Annual
Information Form, which is available at www.sedar.com.
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 an increasingly competitive marketplace and a challenging consumer
environment. For 2013, management will continue to re-invest in the business, specifically a loyalty and communications
capability, a coffee revitalization plan, and a newly designed café. These initiatives will be in test in 2013 with expected
roll-outs towards the end of the year. In addition, Second Cup will leverage new and growing commercial opportunities,
including the expansion and support of the newly introduced Second Cup signature coffees and lattes using the TASSIMO
T-Disc on demand beverage system and expects to increase its product licencing revenue as a result.
Second Cup will continue to improve the café network with the opening of cafés while closing below average
performing cafés.
FORWARD-lOOKINg INFORMATION
Certain statements in this MD&A may constitute forward looking information within the meaning of applicable securities
legislation. Forward looking information can be identified by words such as “may”, “will”, “should”, “expect”, “anticipate”,
“believe”, “plan”, “intend” and other similar words. Forward-looking information reflects current expectations regarding
future events and operating performance and speaks only as of the date of this MD&A. 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 information is based on a number of assumptions and is 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 information. The following are
some of the factors that could cause actual results to differ materially from those expressed in the underlying forward looking
information: competition; availability of premium quality coffee beans; the ability to attract qualified franchise partners; the
location of Second Cup cafés; the closure of Second Cup cafés; loss of key personnel; compliance with government
regulations; potential litigation; the ability to exploit and protect the Second Cup Marks; changing consumer preferences
and discretionary spending patterns including, but not restricted to, the impact of weather and economic conditions on
such patterns; reporting of system sales by franchise partners; and the results of operations and financial condition of
Second Cup. The foregoing list of factors is not exhaustive, and investors should refer to the risks described under “Risks
and Uncertainties” above and in Second Cup’s Annual Information Form, which is available at www.sedar.com.
Although the forward looking information contained in this MD&A is based on what management believes are reasonable
assumptions, there can be no assurance that actual results will be consistent with this forward looking information and, as
a result, the forward-looking information may prove to be incorrect.
As these forward looking statements are made as of the date of this MD&A, Second Cup does not undertake to update any
such forward-looking information, 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.
37
The Second Cup Ltd.
AudIted FInAncIAl
stAteMents
For the 52 week periods ended
December 29, 2012 and December 31, 2011
39
PricewaterhouseCoopersLLPPwCTower,18YorkStreet,Suite2600,Toronto,Ontario,CanadaM5J0B2T:+14168631133,F:+14163658215,www.pwc.com/ca“PwC”referstoPricewaterhouseCoopersLLP,anOntariolimitedliabilitypartnership.TotheShareholdersofMarch5,2013IndependentAuditor’sReportTheSecondCupLtd.WehaveauditedtheaccompanyingfinancialstatementsofTheSecondCupLtd.,whichcomprisethestatementsoffinancialpositionasatDecember29,2012andDecember31,2011andthestatementsofoperationsandcomprehensiveincome(loss),statementsofchangesinequityandstatementsofcashflowsforthetwofifty-twoweekperiodsthenended,andtherelatednotes,whichcompriseasummaryofsignificantaccountingpoliciesandotherexplanatoryinformation.Management’sresponsibilityforthefinancialstatementsManagementisresponsibleforthepreparationandfairpresentationofthesefinancialstatementsinaccordancewithInternationalFinancialReportingStandards,andforsuchinternalcontrolasmanagementdeterminesisnecessarytoenablethepreparationoffinancialstatementsthatarefreefrommaterialmisstatement,whetherduetofraudorerror.Auditor’sresponsibilityOurresponsibilityistoexpressanopiniononthesefinancialstatementsbasedonouraudits.WeconductedourauditsinaccordancewithCanadiangenerallyacceptedauditingstandards.Thosestandardsrequirethatwecomplywithethicalrequirementsandplanandperformtheaudittoobtainreasonableassuranceaboutwhetherthefinancialstatementsarefreefrommaterialmisstatement.Anauditinvolvesperformingprocedurestoobtainauditevidenceabouttheamountsanddisclosuresinthefinancialstatements.Theproceduresselecteddependontheauditor’sjudgment,includingtheassessmentoftherisksofmaterialmisstatementofthefinancialstatements,whetherduetofraudorerror.Inmakingthoseriskassessments,theauditorconsidersinternalcontrolrelevanttotheentity’spreparationandfairpresentationofthefinancialstatementsinordertodesignauditproceduresthatareappropriateinthecircumstances,butnotforthepurposeofexpressinganopinionontheeffectivenessoftheentity’sinternalcontrol.Anauditalsoincludesevaluatingtheappropriatenessofaccountingpoliciesusedandthereasonablenessofaccountingestimatesmadebymanagement,aswellasevaluatingtheoverallpresentationofthefinancialstatements.Webelievethattheauditevidencewehaveobtainedinourauditsissufficientandappropriatetoprovideabasisforourauditopinion.OpinionInouropinion,thefinancialstatementspresentfairly,inallmaterialrespects,thefinancialpositionofTheSecondCupLtd.asatDecember29,2012andDecember31,2011anditsfinancialperformanceanditscashflowsforthefifty-twoweekperiodsthenendedinaccordancewithInternationalFinancialReportingStandards.CharteredAccountants,LicensedPublicAccountants The Second Cup Ltd. Annual Report 2012
The Second Cup Ltd.
stAteMents oF FInAncIAl posItIon
As at December 29, 2012 and December 31, 2011
(Expressed in thousands of Canadian dollars)
ASSETS
Current assets
Cash and cash equivalents (note 6)
Trade and other receivables (note 7)
Current portion of notes and leases receivable (note 9)
Inventories (note 8)
Prepaid expenses and other assets
Non-current assets
Notes and leases receivable (note 9)
Property and equipment (note 10)
Goodwill (note 11)
Intangible assets (note 12)
Total assets
lIABIlITIES
Current liabilities
Accounts payable and accrued liabilities (notes 14 and 27)
Current portion of other long-term liabilities (note 19)
Provisions (note 15)
Income tax payable
Gift card liability
Deposits from franchise partners
Non-current liabilities
Deferred income taxes (note 17)
Other long-term liabilities (note 19)
Provisions (note 15)
Fair value of derivative interest rate swap (note 18)
Term loan (note 18)
Total liabilities
Shareholders’ equity (note 1)
Total liabilities and shareholders’ equity
Contingencies, commitments and guarantees (note 20) and subsequent event (note 29)
See accompanying notes to financial statements.
Approved by the Directors February 28, 2013
Michael Rosicki, Director James Anas, Director
december 29,
2012
december 31,
2011
$ 3,880
4,616
265
137
695
9,593
741
3,544
-
74,802
$ 5,465
5,338
149
79
194
11, 225
469
3,478
2,444
87,938
$ 88,680
$ 105,554
$ 3,313
189
365
318
4,560
1,904
10,649
9,190
421
683
96
10,941
$ 4,093
166
447
1,509
4,353
1,457
12,025
10,183
392
341
302
10,909
31,980
34,152
56,700
71,402
$ 88,680
$ 105,554
41
The Second Cup Ltd.
stAteMents oF operAtIons And
coMprehensIVe IncoMe (loss)
For the years ended December 29, 2012 and December 31, 2011
(Expressed in thousands of Canadian dollars, except per share amounts)
Revenue
Royalty
Sale of goods
Services
Cost of goods sold
Gross profit
Operating expenses (note 22)
Impairment of goodwill and trademarks (note 13)
Operating (loss) income
Interest income
Interest expense (note 18)
Net interest expense
(Loss) income before income taxes
Income taxes (recovery) (note 16)
Current
Deferred
Net (loss) income for the year
Other comprehensive income
Comprehensive (loss) income
2012
2011
$ 14,927
4,698
6,721
26,346
$ 15,631
3,006
6,364
25,001
3,523
2,223
22,823
22,778
15,779
15,294
31,073
13,176
-
13,176
(8,250)
9,602
(61)
564
503
(67)
782
715
(8,753)
8,887
1,644
(993)
651
1,527
(5,941)
(4,414)
(9,404)
13,301
-
-
$
(9,404)
$ 13,301
Basic and diluted (loss) earnings per share (note 21)
$
(0.95)
$
1.34
See accompanying notes to financial statements.
The Second Cup Ltd. Annual Report 2012
The Second Cup Ltd.
stAteMents oF chAnGes In
shAreholders’ eQuItY
(Expressed in thousands of Canadian dollars)
Share
capital
(*see below)
contributed
Surplus
(deficit)
retained
earnings
total
Balance - December 31, 2010
$ 89,972
$
160
$
(27,575)
$ 62,557
Reduction in share capital
(88,972)
61,397
27,575
-
Net income for the year
Dividends to shareholders
-
-
-
-
13,301
13,301
(4,456)
(4,456)
Balance - December 31, 2011
$
1,000
$ 61,557
$
8,845
$ 71,402
Net loss for the year
Dividends to shareholders
-
-
-
-
(9,404)
(5,298)
(9,404)
(5,298)
Balance - December 29, 2012
$
1,000
$ 61,557
$
(5,857)
$ 56,700
* Prior to the conversion from an income trust structure to a public corporation (“Conversion”) Share Capital was referred to as Income
Fund Units (notes 1 and 5)
See accompanying notes to financial statements.
43
The Second Cup Ltd.
stAteMents oF cAsh FloWs
For the years ended December 29, 2012 and December 31, 2011
(Expressed in thousands of Canadian dollars)
CASH PROVIDED BY (USED IN)
Operating Activities
Net (loss) income for the year
Items not involving cash
Amortization of deferred financing charges (note 3(m))
Amortization of intangible assets (note 3(i))
Amortization of leasehold inducements (note 3(l))
Amortization of property and equipment (note 3(g))
Amortization of provisions (note 3(k))
Deferred income taxes
Impairment of property and equipment
Impairment of goodwill
Impairment of trademarks
Loss on disposal of property and equipment
Movement in fair value of derivative interest rate swap
Income taxes
Leasehold inducement
Changes in non-cash working capital (note 24)
Investing activities
Investment in notes and leases receivable
Proceeds from disposal of assets held for sale
Proceeds from disposal of property and equipment
Proceeds from repayment of leases receivable
Proceeds from repayment of notes receivable
Purchase of assets held for sale
Purchase of property and equipment
Purchase of software
Financing activities
Deferred financing charges
Distributions paid to unitholders
Dividends paid to shareholders
Payments on long-term lease
Repayment of note payable
(Decrease) increase in cash and cash equivalents during the year
2012
2011
$
(9,404)
$ 13,301
82
451
(35)
716
(89)
(993)
362
2,444
12,850
70
(206)
(1,191)
61
32
5,150
-
-
350
36
185
-
(1,758)
(180)
(1,367)
(50)
-
(5,298)
(2)
(18)
(5,368)
(1,585)
72
392
(3)
440
(112)
(5,941)
130
-
-
36
(29)
1,584
406
(1,971)
8,305
(50)
313
49
6
91
(291)
(2,731)
(312)
(2,925)
-
(759)
(4,456)
(12)
(101)
(5,328)
52
Cash and cash equivalents - Beginning of year
5,465
5,413
Cash and cash equivalents - End of year
$ 3,880
$ 5,465
See accompanying notes to financial statements.
The Second Cup Ltd. Annual Report 2012
The Second Cup Ltd.
notes to the FInAncIAl stAteMents
For the years ended December 29, 2012 and December 31, 2011
(Expressed in thousands of Canadian dollars, except per share amounts)
1. ORgANIzATION AND NATURE OF BUSINESS
The Second Cup Ltd. (“Second Cup” or “the Company”) is Canada’s largest specialty coffee café franchisor (as measured by the
number of cafés) with 360 cafés operating under the trade name Second Cup™ in Canada, of which ten are Company operated
and the balance are operated by franchise partners who are selected and trained to retail Second Cup’s product offering.
Second Cup owns the trademarks, trade names, operating procedures and systems and other intellectual property used in
connection with the operation of Second Cup cafés only in Canada, excluding the Territory of Nunavut.
Second Cup is incorporated and domiciled in Canada. The address of its registered office is 6303 Airport Road, 2nd Floor,
Mississauga, Ontario, L4V 1R8. The Company’s website is www.secondcup.com.
Second Cup’s fiscal year follows the method implemented 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 fiscal year is made up of 52 or 53 week periods ending on
the last Saturday of December.
Prior to January 1, 2011, Second Cup Income Fund (the “Fund”) was an unincorporated open-ended trust established under the
laws of the Province of Ontario. An unlimited number of units could have been issued pursuant to the Fund’s declaration of trust.
Units were redeemable by the holder at any time, subject to certain limitations.
The common shares of the Company are listed on the Toronto Stock Exchange under the symbol “SCU”.
Conversion of the Fund
At the annual and special meeting of unitholders held on June 2, 2010, unitholders of the Fund approved the conversion from an
income trust structure to a public corporation (“Conversion”). The Conversion was completed on January 1, 2011. Under the plan
of arrangement, unitholders of the Fund received, for each unit of the Fund held, one common share of Second Cup. As a result
of this Conversion, the Fund was dissolved with its assets and liabilities assumed by Second Cup. The common shares of Second
Cup commenced trading on the Toronto Stock Exchange on January 4, 2011 under the symbol “SCU.”
The exchange of the units of the Fund into shares of the Company was recorded at the carrying values of the Fund’s assets and
liabilities on January 1, 2011 in accordance with the continuity of interest method of accounting, as the Company is considered to
be a continuation of the Fund.
As a result of the Conversion, unitholders’ capital of $89,972 was reclassified to share capital. Included as part of the Conversion
was a reduction in the stated capital from $89,972 to $1,000, resulting in a reduction of the deficit by $25,575 and an increase
in contributed surplus of $61,397. The Conversion and the associated reduction in share capital were approved by court orders
dated June 11, 2010 and December 17, 2010.
2. BASIS OF PREPARATION
The financial statements of Second Cup have been prepared in accordance with International Financial Reporting Standards
(“IFRS”) and International Financial Reporting Interpretation Committee (“IFRIC”) interpretations.
The preparation of financial statements in accordance with IFRS requires the use of certain critical accounting estimates.
It also requires management to exercise its judgement in the process of applying the Company’s accounting policies.
45
NOTES TO ThE fINANCIAL STATEMENTS
The areas involving a higher degree of judgement or complexity, or areas where assumptions and estimates are significant
to the financial statements are disclosed in note 4.
The accounting policies applied in the financial statements are based on IFRS effective for the fiscal year ended December 29,
2012, as issued and outstanding as of February 28, 2013, the date the Board of Directors approved the financial statements.
3. SUMMARY OF SIgNIFICANT ACCOUNTINg POlICIES
(a) Basis of measurement
The financial statements have been prepared under the historical cost convention, except for certain financial instruments
that are measured at fair values, as explained in the accounting policies below. Historical cost is generally based on the fair
value of the consideration given in exchange for assets.
(b) Segmented information
Second Cup operates within Canada, which is considered to be its sole operating segment. As a franchisor, Second Cup
opens, acquires, closes and refranchises individual café locations in the normal course of business.
(c) Cash and cash equivalents
Cash and cash equivalents include cash on hand, deposits held with banks and other short-term highly liquid investments
with original maturities of three months or less.
(d) Financial instruments
Financial assets and liabilities are recognized when the Company becomes a party to the contractual provisions of the
instrument. Financial assets are derecognized when the rights to receive cash flows from the assets have expired or have
been transferred and the Company has transferred substantially all risks and rewards of ownership.
Financial assets and liabilities are offset and the net amount reported in the Statements of Financial Position when there is
a legally enforceable right to offset the recognized amounts and there is an intention to settle on a net basis, or realize the
asset and settle the liability simultaneously.
At initial recognition, the Company classifies its financial instruments in the following categories depending on the purpose
for which the instruments were acquired:
(i) Financial assets and liabilities at fair value through profit or loss (“FVTPL”): A financial asset or liability is classified
in this category if acquired principally for the purpose of selling or repurchasing in the short-term. Derivatives are also
included in this category unless they are designated as hedges. The only instruments held by the Company classified in
this category are interest rate swaps (see (v) below). The Company fair values the swap at the end of each quarter with
the change in fair value accounted through profit or loss.
Financial instruments in this category are recognized initially and subsequently at fair value. Transaction costs are expensed
in the Statements of Operations and Comprehensive Income (Loss). Gains and losses arising from changes in fair value
are presented in the Statements of Operations and Comprehensive Income (Loss) within other gains and losses in the year
in which they arise. Financial assets and liabilities at FVTPL are classified as current, except for the portion expected to be
realized or paid beyond 12 months of the Statements of Financial Position dates, which is classified as non-current.
(ii) Loans and receivables: Loans and receivables are non-derivative financial assets with fixed or determinable payments
that are not quoted in an active market. The Company’s loans and receivables comprise trade receivables, notes
receivable and cash and cash equivalents, and are included in current assets due to their short-term nature, except
for the portion expected to be realized beyond 12 months of the Statements of Financial Position dates. Loans and
receivables are initially recognized at the amount expected to be received, less, when material, a discount to reduce
the loans and receivables to fair value. Subsequently, loans and receivables are measured at amortized cost using the
effective interest method less a provision for impairment, if necessary.
(iii) Leases: The Company has entered into lease agreements with some franchise partners relating to point of sale
systems (“POS”). The lease term is for the major part of the economic life of the POS although the Company does not
transfer title. The Company recognizes leases as finance type leases and records a lease receivable at an amount equal
to the net investment in the lease. The Company’s leases receivable are included in current assets due to their short-term
nature, except for the portion expected to be realized beyond 12 months of the Statements of Financial Position dates.
The Second Cup Ltd. Annual Report 2012
Leases receivable are initially recognized at the amount expected to be received, less, when material, a discount to
reduce the leases receivable to fair value. Subsequently, leases receivable are measured at amortized cost using the
effective interest method less a provision for impairment.
(iv) Financial liabilities at amortized cost: Financial liabilities at amortized cost include trade payables, deposits from
franchise partners, gift card liability, bank debt and long-term debt. Trade payables are initially recognized at the amount
required to be paid less, when material, a discount to reduce the payables to fair value. Subsequently, trade payables
are measured at amortized cost using the effective interest method.
The sale process of a new café requires a deposit from a franchise partner at the outset, including an amount for
franchise fees, which is recognized as revenue when the café opens. Deposits from franchise partners are applied
against the cost of constructing a new café or the renovation of an existing café. Gift card liability represents liabilities
related to unused balances on Second Cup’s reloadable payment card (“Second Cup Café Card”) net of estimated
breakage. These balances are included as sales from franchised cafés, or as revenue of Company operated cafés at
the time the customer redeems the amount in a café for products or services. Breakage represents management’s
estimate of balances outstanding relating to gift cards that may never be redeemed. Bank debt and long-term debt
are recognized initially at fair value, net of any transaction costs incurred and, subsequently, at amortized cost using the
effective interest method.
Financial liabilities are classified as current liabilities if payment is due within 12 months. Otherwise, they are presented
as non-current liabilities.
(v) Derivative financial instruments: The Company uses derivatives in the form of interest rate swaps to manage risks
related to its variable rate debt. All derivatives have been classified as FVTPL, are included on the Statements of Financial
Position within other liabilities and are classified as current or non-current based on the contractual terms specific to the
instrument.
Gains and losses on remeasurement are included in interest income (expense).
(vi) Classification as debt or equity: Debt and equity instruments issued by the Company are classified as either financial
liabilities or as equity in accordance with the substance of the contractual arrangements and the definitions of a financial
liability and an equity instrument.
(e) Impairment of financial assets
At each reporting date, the Company assesses whether there is objective evidence that a financial asset is impaired.
The criteria used to determine if objective evidence of an impairment loss include:
a) significant financial difficulty of the borrower/lessee;
b) delinquencies in interest or principal payments; and
c) it becomes probable that the borrower/lessee will enter bankruptcy or other financial reorganization.
If such evidence exists, the Company recognizes an impairment loss, as follows:
(i) Financial assets carried at amortized cost: The loss is the difference between the amortized cost of the loan or receivable
and the present value of the estimated future cash flows, discounted using the instrument’s effective interest rate. The
carrying value of the asset is reduced by this amount either directly or indirectly through the use of an allowance account.
Notes receivable and leases receivable are assessed for impairment quarterly on an individual basis based on the ability
of the debtor/lessee to make the required payments and the value of the security. When there is no longer reasonable
assurance that a note receivable or lease receivable will be collected, its carrying value is reduced and an impairment
charge is recorded in the year.
Impairment losses on financial assets carried at amortized cost are reversed in subsequent years if the amount of the
loss decreases and the decrease can be related objectively to an event’s occurring after the impairment was recognized.
Impairment losses on available-for-sale equity instruments are not reversed.
47
NOTES TO ThE fINANCIAL STATEMENTS
(f) Inventories
Inventories are stated at the lower of cost and net realizable value, with cost being determined on a first-in, first-out (“FIFO”)
method. Net realizable value is the estimated selling price less applicable selling expenses. If carrying value exceeds net
realizable amount, a writedown is recognized. The writedown may be reversed in a subsequent year if the circumstances
that caused it no longer exist.
(g) Property and equipment
Property and equipment are stated at cost less accumulated amortization net of any impairment losses. Cost includes ex-
penditures that are directly attributable to the acquisition of the asset. Subsequent costs are included in the asset’s carrying
value or recognized as a separate asset, as appropriate, only when it is probable that future economic benefits associated
with the item will flow to the Company and the cost can be measured reliably. The carrying value of a replaced asset is derec-
ognized when replaced. Repairs and maintenance costs are charged to the Statements of Operations and Comprehensive
Income (Loss) during the year in which they are incurred.
Amortization is calculated using the straight-line basis at the following rates, which are based on the expected useful lives
of the asset:
Leasehold improvements
Equipment, furniture, fixtures and other
Computer hardware
lesser of 10 years and the remaining term of the lease
3 to 7 years
3 years
Property and equipment are reviewed for impairment annually or at any time if an indicator of impairment exists (refer to note 3(j)).
(h) Goodwill
Goodwill represents the excess of the cost of acquisition over the fair values of assets, liabilities and contingent liabilities
acquired. Goodwill is carried at cost less accumulated impairment losses.
Goodwill is reviewed for impairment annually or at any time if an indicator of impairment exists (refer to note 3(j)).
(i) Intangible assets
Intangible assets consist of trademarks, franchise rights and software, which are amortized or assessed for impairment
(refer to note 3(j)) as follows:
(i) Trademarks
Trademarks consist of trade names, operating procedures and systems and other intellectual property used in connection
with the operation of the Second Cup cafés in Canada and are recorded at the historical cost less impairment writedowns.
The trademark is an indefinite life intangible asset that is tested annually for impairment.
Management believes the trademarks related to Second Cup are very well established in the marketplace and will
continue to provide benefits indefinitely into the future.
(ii) Franchise rights
As a result of the acquisition of Second Cup in 2009, franchise rights were recognized as an intangible asset. The
franchise rights intangible asset is based on the net present value of the discounted future net cash flows expected from
the existing franchise partners of Second Cup as at the date of acquisition, including royalties and franchise fees.
(iii) Software
Purchased software costs are recorded at cost and are amortized commencing when the asset is available for use.
Amortization is calculated using the straight-line basis at the following rates, which are based on the expected useful
lives of the assets:
Franchise rights
Software
average remaining term of the existing franchise agreement
3 to 7 years
The Second Cup Ltd. Annual Report 2012
(j) Impairment of non-financial assets
Property and equipment and intangible assets are tested for impairment when events or changes in circumstances indicate the
carrying value may not be recoverable. Long-lived assets that are not amortized are subject to an annual impairment test or any
time an impairment indicator exists.
For the purpose of measuring recoverable amounts, assets are grouped at the lowest levels for which there are separately identi-
fiable cash inflows (cash generating units or “CGUs”). The recoverable amount of each particular CGU is the higher of an asset’s
fair value less costs to sell and value in use. For the purposes of the impairment test, the Company estimates the fair value less
costs to sell of the individual cash generating units.
The impairment analysis involves comparing the carrying value of the CGUs with their estimated recoverable amounts based
on fair value less costs to sell values. Management considers a number of factors in estimating the recoverable value of each
CGU. These factors are included in the discounted cash flow estimates. Each of these valuation methods use estimates and
assumptions that are sensitive to change and require judgement. These key judgements include estimates of discount rates,
forecast growth in system sales and other estimates impacting future cash flows. Changes in these estimates and assumptions
may have a significant impact on recoverable amounts. Costs to sell are estimated based on the most recent transactions in the
retail and franchise business.
An impairment loss is recognized for the amount by which the asset’s carrying value exceeds its recoverable amount. Impairment
losses for CGUs reduce first the carrying value of any goodwill allocated to that CGU. Any remaining impairment loss is charged
pro rata to the other intangible assets in the CGU.
The Company evaluates impairment losses, other than goodwill impairment, for potential reversals when events or circum-
stances warrant such consideration.
(k) Provisions
Provisions are recognized when the Company has a present legal or constructive obligation as a result of past events; it
is more likely than not that an outflow of resources will be required to settle the obligation; and the amount can be reliably
estimated. Provisions are measured at management’s best estimate of the expenditure required to settle the obligation at
the end of the reporting period and are discounted to present value where the effect is material. The Company performs
evaluations to identify onerous contracts and, where applicable, records provisions for such contracts.
(i) Headlease liabilities
On June 27, 2009, Second Cup Trade-Marks Limited Partnership, on behalf of the Fund, completed the acquisition of all
of the outstanding shares of Second Cup. Headlease liabilities represent the provision for lease guarantees provided by
Second Cup for franchised operations at the date of acquisition, June 27, 2009. The liability was recorded at estimated
fair value based on the net present value of the future estimated negative cash flows when Second Cup is required to
cover rental arrears of its franchise partners, to terminate unfavourable leases or to cover shortfalls if a location is sublet
to a third party. This liability is amortized over the average remaining length of these existing lease agreements.
(ii) Café lease agreements
The Company café lease liability is based on the net present value of the difference between the market related rental rates
and the contract lease rates paid by Second Cup from the date of the acquisition until the end of each respective lease
agreement. The café lease agreement liability is amortized over the average remaining length of these Company café leases.
(l) Other long-term liabilities
(i) Deferred revenue
The Company has entered into several supply agreement contracts and receives an allowance from the supplier in consid-
eration for achieving certain volume commitments over the term of the supply agreement. Deferred revenue is amortized
over the term of the supply agreement based on the proportion of volume commitments met during the fiscal year. In
addition, the Company defers construction administration fees received at the commencement of a new franchise term
until the café renovation is completed.
49
NOTES TO ThE fINANCIAL STATEMENTS
(ii) Leasehold inducement
Leasehold inducements are amortized to rent expense on a straight-line basis over the term of the lease.
(m) Deferred financing charges
Deferred financing charges represent costs associated with the Company’s term loan, and are offset against the term loan
and expensed to the Statements of Operations and Comprehensive Income (Loss) using the effective interest rate method.
(n) Income taxes
Income tax comprises current and deferred income taxes. Income taxes are recognized in the Statements of Operations
and Comprehensive Income (Loss) except to the extent that it relates to items recognized directly in equity, in which case
the income tax is also recognized directly in equity.
Current income taxes are the expected taxes payable on the taxable income for the year, using tax rates enacted, or sub-
stantively enacted, at the end of the reporting period, and any adjustment to tax payable in respect of previous years.
Deferred income taxes are recognized in respect of temporary differences arising between the tax bases of assets and
liabilities and their carrying values in the financial statements. Deferred income taxes are determined on a non-discounted
basis using tax rates and laws that have been enacted or substantively enacted at the Statements of Financial Position
dates and are expected to apply when the deferred income tax asset or liability is settled. Deferred income tax assets are
recognized to the extent that it is probable that future taxable profit will be available against which the deductible temporary
differences can be utilized.
Deferred income tax assets and liabilities are presented as non-current.
Prior to its 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 a tax on distributions declared subsequent to January 1, 2011. As a result of this
legislation, the Fund had provided for the future income 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. On January 1, 2011,
the Fund completed its conversion to a corporation. Second Cup is now subject to corporate income tax.
(o) Advertising and co-operative fund assets and liabilities
Second Cup manages an advertising and co-operative fund (the “Co-op Fund”) established to collect and administer
funds contributed for use in advertising and promotional programs, national training programs and, among other things,
initiatives designed to increase sales and enhance the reputation of the Second Cup brand. Contributions to the Co-op
Fund are required to be made from both franchised and Company-owned and operated cafés and are based on a
percentage of café sales. The revenue, expenses and cash flows of the Co-op Fund are not included in the Company’s
Statements of Operations and Comprehensive Income (Loss) and Cash Flows because the contributions to this fund are
segregated and designated for a specific purpose. The assets and liabilities of the Co-op Fund are included in the assets
and liabilities of the Company.
(p) Gift card liability
Second Cup has a gift card program that allows customers to prepay for future purchases by reloading a dollar value
onto their gift cards through cash or credit/debit card in the cafés or online through credit cards, when and as needed.
The purpose of the gift card program is to expand the Second Cup brand through increased exposure as well as to
increase sales. Gift card liability represents liabilities related to unused balances on the Second Cup Café Card net of
estimated breakage. These balances are included as sales from franchised cafés, or as revenue of Company operated
cafés, at the time the customer redeems the amount in a café for products or services. Breakage represents manage-
ment’s estimates of balances outstanding relating to gift cards that may never be redeemed. This breakage factor is
estimated based on historical redemption patterns and is reviewed quarterly by management. Breakage income is
recognized by the Co-op Fund.
The Second Cup Ltd. Annual Report 2012
(q) Revenue recognition
Revenue is recognized when it is probable the economic benefits will flow to the Company and delivery has occurred, the
sales price is fixed or determinable, and collectability is reasonably assured. Revenue is measured at the fair value of the con-
sideration received or receivable. Revenue is reduced for estimated customer returns, rebates and other similar allowances.
Royalty revenue from franchised cafés is recognized as the products are sold as reported by the franchise partner.
Revenue from the sale of goods from Company operated cafés, from the sale of products through wholesale and
e-commerce channels are recognized as the products are sold to customers.
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, purchasing coordination fees and other
ancillary fees (IT support and training fees).
Initial franchise fees are recognized as income when the café commences operations, renewal fees are recognized at
the commencement of a new franchise term, café resale fees are recognized when title transfers on the sale of a café
between franchise partners and construction administration fees are recognized on the completion of a café renovation
and re-opening. All fees are recognized as revenue after the franchise agreement has been signed and the Company has
performed substantially all services and met all material conditions required by the franchise agreement.
For Second Cup branded products sold by third parties, product licencing revenue is recognized when goods are shipped
from the distributor.
Purchasing coordination fees are derived from purchases made by franchise partners from approved suppliers and are
recognized as the services are rendered or goods delivered and all significant conditions have been met.
(r) 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.
(s) Operating leases
Operating lease payments are recognized as rent expense on a straight-line basis over the lease term. Leasehold
inducements are amortized to rent expense on a straight-line basis over the lease term. For the purposes of determining
the lease term, the Company considers option periods for which failure to renew the lease impose an economic penalty on
the Company of such an amount that the renewal appears to be reasonably assured at the inception of the lease.
(t) Long-term incentive plan and Directors deferred share unit plan
In December 2009, Second Cup implemented a long-term incentive plan (“LTIP”), as described in note 27. Under IFRS 2,
Share-based Payment, the fair value of each tranche of the grants is amortized over their respective vesting period using the
graded amortization method. Compensation expense is measured at the grant date at fair value and recognized over the service
period based on the vesting period and is adjusted for any changes in fair value of the Company’s share price. Shares granted
under the LTIP vest over a three-year period and are paid out in cash on December 15 of each year. In terms of the LTIP, any
dividends paid by the Company during the vesting period will be accrued based on the total number of shares granted.
In January 2011, the Company implemented a Directors deferred share unit plan (“DSUP”), as described in note 27. Com-
pensation expense is measured at the grant date (beginning of year) at fair value vesting on the last day of the year in
which the shares are granted and is adjusted for any changes in fair value of the Company’s share price. Shares granted
under the DSUP vest on the last day of the year in which they are granted and are paid out in cash on the termination of
the director. In terms of the DSUP, any dividends paid by the Company during the vesting period will be accrued based on
the total number of shares granted.
51
NOTES TO ThE fINANCIAL STATEMENTS
(u) Earnings per share
Basic earnings per share (“EPS”) is calculated by dividing the net income (loss) for the year attributable to equity owners of
the Company by the weighted average number of common shares outstanding during the year.
Diluted EPS is calculated by adjusting the weighted average number of common shares outstanding for dilutive
instruments. The number of shares included with respect to options, warrants and similar instruments is computed using
the treasury stock method.
(v) Related parties
For the purposes of these financial statements, a party is considered related to the Company if such party or the Company
has the ability to, directly or indirectly, control or exercise significant influence over the other entity’s financial and operating
decisions, or if the Company and such party are subject to common influence. Related parties may be individuals or other
entities. All transactions with related parties are recorded at fair value.
(w) Dividends
Dividends on common shares are recognized in the Company’s financial statements in the period in which the dividends
are approved by the Board of Directors.
(x) Future changes in accounting policies
IFRS 9, Financial Instruments (“IFRS 9”), was issued in November 2009 and addresses classification and measurement
of financial assets. It replaces the multiple category and measurement models in International Accounting Standard 39,
Financial Instruments: Recognition and Measurement (“IAS 39”), for debt instruments with a new mixed measurement
model having only two categories: amortized cost and FVTPL. IFRS 9 also replaces the models for measuring equity
instruments. Such instruments are either recognized at FVTPL or at fair value through other comprehensive income. Where
equity instruments are measured at fair value through other comprehensive income, dividends are recognized in profit
or loss to the extent that they do not clearly represent a return of investment; however, other gains and losses (including
impairments) associated with such instruments remain in accumulated comprehensive income indefinitely.
Requirements for financial liabilities were added to IFRS 9 in October 2010 and they largely carried forward existing require-
ments in IAS 39, except that fair value changes due to credit risk for liabilities designated at FVTPL are generally recorded
in other comprehensive income.
IFRS 13, Fair Value Measurement (“IFRS 13”), is a comprehensive standard for fair value measurement and disclosure for
use across all IFRS. The new standard clarifies that fair value is the price that would be received to sell an asset, or paid
to transfer a liability in an orderly transaction between market participants, at the measurement date. Under existing IFRS,
guidance on measuring and disclosing fair value is dispersed among the specific standards requiring fair value measure-
ments and does not always reflect a clear measurement basis or consistent disclosures.
IFRS 9 and IFRS 13 are effective for annual periods beginning on or after January 1, 2015 and January 1, 2013, respec-
tively, with earlier adoption permitted. The Company will adopt IFRS 13, effective January 1, 2013, but does not expect it
to have a significant impact. The Company has not yet assessed the impact of IFRS 9 or determined whether it will early
adopt the standard.
4. CRITICAl ACCOUNTINg ESTIMATES
The preparation of financial statements requires management to use judgement in applying its accounting policies and
estimates and assumptions about the future. Estimates and other judgements are continuously evaluated and are based on
management’s experience and other factors, including expectations about future events that are believed to be reasonable
under the circumstances. Estimates and underlying assumptions are reviewed on an ongoing basis. Revisions to accounting
estimates are recognized in the year in which the estimates are revised and in any future years affected.
The Second Cup Ltd. Annual Report 2012
The following discusses the most significant accounting judgements and estimates that the Company has made in the
preparation of the financial statements:
Impairment analysis
Impairment analysis is an area involving management judgement requiring assessment as to whether the carrying value of assets
is recoverable. Fair value less cost to sell is determined by estimating the net present value of future cash flows derived from such
assets using cash flow projections that have been discounted at an appropriate rate. In calculating the net present value of the
future cash flows, certain assumptions are required to be made in respect of highly uncertain matters including:
a) Growth in total revenue
b) Growth in cash flows, calculated as adjusted operating profit before depreciation and amortization,
c) Long term growth rates
d) Selection of discount rates to reflect the risks involved
Management has estimated cash flows based on market participant assumptions and expected future operations.
The discount rate is based upon a weighted average cost of capital derived from the benchmark analysis from similar retail
or franchise businesses in Canada and the United States.
Changing the assumptions selected by management, in particular, the discount rate and the growth rate assumptions used
in the cash flow projections, could significantly affect the impairment evaluations and, hence, results.
The Company’s impairment test includes the key assumptions related to sensitivity in the cash flow projections. Further
details are provided in note 13 to the financial statements.
Recoverable amount and CGUs
A CGU is defined as the smallest identifiable group of assets that generates cash inflows that are largely independent of the
cash inflows from other assets or group of assets.
Goodwill is not amortized but tested for impairment at least once a year or more frequently when there is an indication that
it may be impaired.
An impairment test is performed at the level of each CGU within each operating segment. This allocation is reviewed if the
Company changes the level at which it monitors goodwill or changes in operating segments.
An impairment loss is recognized when the carrying value of the assets and liabilities of the franchise business CGU is higher
than its recoverable amount. The recoverable amount of the franchise business CGU was estimated based on fair value less
costs to sell. Fair value less costs to sell is the best estimate of the amount obtainable from the sale of a CGU in an arm’s length
transaction between knowledgeable, willing parties, less costs to sell. This estimate is determined on December 29, 2012.
Deferred income taxes
The timing of reversal of timing differences and the expected income allocation to various tax jurisdictions within Canada
affect the effective income tax rate used to compute the deferred income tax asset. Management estimates the reversals
and income allocation based on historical and budgeted operating results and income tax laws existing at the Statements of
Financial Position dates. In addition, management occasionally estimates the current or future deductibility of certain expen-
ditures, affecting current or deferred income tax balances and expenses.
Fair value of derivative
Second Cup’s derivative consists of an interest rate swap used to economically hedge exposure to variable cash flows
associated with interest payments on the Company’s borrowings. Management estimates the fair value of this derivative
as the present value of expected future cash flows to be received or paid, based on available market data, which includes
market yields and counterparty credit spreads.
53
NOTES TO ThE fINANCIAL STATEMENTS
Estimated useful lives
Management estimates the useful lives of property and equipment based on the period during which the assets are expected
to be available-for-use. The amounts and timing of recorded expenses for amortization of property and equipment for any
year are affected by these estimated useful lives. The estimates are reviewed at least annually and are updated if expecta-
tions change as a result of physical wear and tear, technical or commercial obsolescence and legal or other limits to use.
It is possible that changes in these factors may cause significant changes in the estimated useful lives of the Company’s
property and equipment in the future.
Provisions
Second Cup has lease commitments since it acts as the head tenant on café leases. In cases where the lease contract
specifies a termination fee due to the landlord or a fee is negotiated with the landlord upon termination, the Company records
the expense at the time written notice is given or agreed to by the landlord. When ceasing operations under operating leases
where the landlord does not allow the Company to prematurely exit the lease, but allows for subleasing, the Company
estimates the fair value of sublease income in calculating the provision to the end of the lease term.
5. SHARE CAPITAl
Second Cup is authorized to issue an unlimited number of common shares.
Balance January 1, 2010
income fund units
$
89,972
#
9,903,045
Share capital
$
#
-
-
Balance December 31, 2010
9,903,045
89,972
-
-
Conversion January 1, 2011
(9,903,045)
(89,972)
9,903,045
89,972
Reduction in stated capital January 1, 2011
Balance December 31, 2011
-
-
-
-
-
(88,972)
9,903,045
1,000
At the annual and special meeting of unitholders held June 2, 2010, the unitholders approved the Conversion to be
undertaken on January 1, 2011. Included as part of the Conversion was a reduction in the stated capital from $89,972 to
$1,000, resulting in a reduction of the deficit by $27,575 and an increase in contributed surplus of $61,397. The Conversion
and the associated reduction in share capital were approved by court orders dated June 11, 2010 and December 17, 2010.
6. CASH AND CASH EQUIVAlENTS
Cash
Cash equivalents
Cash and cash equivalents
Interest rate per annum
$
2012
2,836
1,044
$
2011
3,040
2,425
$
3,880
$
5,465
1.10%
1.10%
The cash equivalent represents short-term savings with maturity of less than three months since December 29.
7. TRADE AND OTHER RECEIVABlES
Trade and other receivables
Less: Allowance for doubtful accounts
Trade and other receivables - net
The Second Cup Ltd. Annual Report 2012
$
2012
4,839
(223)
2011
$ 5,449
(111)
$
4,616
$ 5,338
The Company wrote-off $78 (2011 - $5), recovered $91 (2011 - $192) and increased the allowance for doubtful accounts
$281 (2011 - $234) on trade and other receivables.
8. INVENTORIES
Merchandise held for resale
Supplies
Less: Provision for obsolete inventory
9. NOTES AND lEASES RECEIVABlE
Notes and leases receivable due in 1 year
Notes and leases receivable due after 1 year, but before 5 years
Notes and leases receivable due after 5 years
Less: Allowance for doubtful accounts due in 1 year
Less: Allowance for doubtful accounts due after 1 year
Less: Current portion
$
$
$
2012
131
24
155
(18)
137
2012
341
797
57
1,195
(76)
(113)
1,006
265
$
$
$
2011
67
12
79
-
79
2011
162
543
50
755
(13)
(124)
618
149
Notes and leases receivable - net
$
741
$
469
The Company entered into lease agreements with some franchise partners relating to POS. These leases bear interest at 8%.
These were accounted for as finance leases totalling $209 (2011 - $74). The Company owns title to all POS. During 2012,
the Company received proceeds from the repayment of leases receivable of $36 (2011 - $6).
In 2012 the Company did not provide financing to any franchise partners to assist them to purchase certain equipment,
furniture and fixtures (2011 - $50). The Company received proceeds from the repayment of notes receivable of $185
(2011 - $91) related to previous agreements. The Company settled $741 (2011 - $437) of trade receivables in return for notes
receivable during the year. The Company received repayments totalling $225 (2011 - $22) from capitalized trade receivables.
In addition, the Company wrote-off $114 (2011 - $nil), recovered $24 (2011 - $nil) and increased the allowance for doubtful
accounts $190 (2011 - $137) on notes and leases receivable.
55
NOTES TO ThE fINANCIAL STATEMENTS
10. PROPERTY AND EQUIPMENT
Net carrying value
As at December 31, 2010
Cost
Accumulated amortization
As at December 31, 2010
Additions
Disposals - original cost
Disposals - accumulated amortization
Capitalized to lease
Impairment charge
Amortization
leasehold
improvements
equipment,
furniture,
fixtures and
other
computer
hardware
total
$
589
(247)
342
664
(25)
1
-
(81)
(104)
$ 1,257
(171)
$
168
(105)
$ 2,014
(523)
1,086
1,959
(107)
24
(67)
(49)
(282)
63
1,491
108
-
-
-
-
(54)
2,731
(132)
25
(67)
(130)
(440)
$
$
117
$ 3,478
276
(159)
$ 4,546
(1,068)
As at December 31, 2011
$
797
$ 2,564
Cost
Accumulated amortization
$ 1,228
(431)
$ 3,042
(478)
As at December 31, 2011
$
797
$ 2,564
$
117
$ 3,478
Net carrying value
As at December 31, 2011
Cost
Accumulated amortization
As at December 31, 2011
Additions
Disposals - original cost
Disposals - accumulated amortization
Capitalized to lease
Impairment charge
Amortization
$ 1,228
(431)
$ 3,042
(478)
$
276
(159)
$ 4,546
(1,068)
797
851
(177)
20
-
(345)
(200)
2,564
117
3,478
857
(297)
34
(194)
(17)
(446)
50
-
-
-
-
(70)
1,758
(474)
54
(194)
(362)
(716)
As at December 29, 2012
$
946
$ 2,501
Cost
Accumulated amortization
$ 1,902
(956)
$ 3,408
(907)
As at December 29, 2012
$
946
$ 2,501
$
$
$
97
$ 3,544
326
(229)
$ 5,636
(2,092)
97
$ 3,544
11. gOODWIll
Opening balance
Impairment charge
Closing balance
The Second Cup Ltd. Annual Report 2012
2012
2,444
(2,444)
2011
$ 2,444
-
-
$ 2,444
$
$
The Company determined goodwill was impaired and recognized an impairment charge of $2,444. There were no additions
or disposals during the reporting periods (note 13).
12. INTANgIBlE ASSETS
Net carrying value
As at December 31, 2010
Cost
Accumulated amortization
As at December 31, 2010
Additions (acquired)
Disposals - original cost
Disposals - accumulated amortization
Capitalized to lease
Amortization
trademarks
franchise
rights
Software
total
$ 86,905
-
86,905
-
-
-
-
-
$ 1,331
(424)
$
312
(99)
$ 88,548
(523)
907
-
-
-
-
(283)
213
88,025
312
(43)
43
(7)
(109)
312
(43)
43
(7)
(392)
As at December 31, 2011
$ 86,905
$
624
Cost
Accumulated amortization
$ 86,905
-
$ 1,331
(707)
$
$
409
$ 87,938
574
(165)
$ 88,810
(872)
As at December 31, 2011
$ 86,905
$
624
$
409
$ 87,938
Net carrying value
As at December 31, 2011
Cost
Accumulated amortization
As at December 31, 2011
Additions (acquired)
Capitalized to lease
Impairment charge
Amortization
$ 86,905
-
$ 1,331
(707)
$
574
(165)
$ 88,810
(872)
86,905
-
-
(12,850)
-
624
-
-
-
(283)
409
87,938
180
(15)
-
(168)
180
(15)
(12,850)
(451)
As at December 29, 2012
$ 74,055
$
341
Cost
Accumulated amortization
$ 74,055
-
$ 1,331
(990)
$
$
406
$ 74,802
739
(333)
$ 76,125
(1,323)
As at December 29, 2012
$ 74,055
$
341
$
406
$ 74,802
Management concluded trademarks were impaired and recognized an impairment charge of $12,850 (note 13).
57
NOTES TO ThE fINANCIAL STATEMENTS
13. IMPAIRMENT OF ASSETS
During the accounting periods presented, the Company had two CGUs - corporate cafés and franchise business.
Goodwill of $2,444 as well as the Trademark of $86,905 were allocated fully to the franchise business CGU. The CGUs
recoverable amount has been determined using fair value less costs to sell.
Key assumptions
The discounted cash flow uses estimates and assumptions that are sensitive to change and require judgement. These key
judgements include estimates of discount rates, forecast growth in system sales and other estimates impacting future cash
flows. Changes in these estimates and assumptions may have a significant impact on recoverable amounts. General market
uncertainty and the recessionary operating environment for the Company and other similar retail entities were also factors
taken into account in the analysis. The changes in the market growth rates reflect the current general economic pressures
now impacting the national economy.
These calculations use cash flow projections based on financial forecasts covering a five-year period. Cash flows beyond the
five-year period are extrapolated using the estimated growth rates stated below. The following are key assumptions used in
the fair value less costs to sell calculation:
Forecast same café sales growth
Forecast revenue growth
Average growth rate used to extrapolate cash flows beyond the budget period 2%
Discount rate
11.5%
-2% to 4%
-2% to 8%
The valuation of two corporate cafés based on revenue growth and future cash flows indicated an impairment of $362. The
Company wrote down leasehold improvements and property and equipment to their estimated recoverable amounts for
both cafés.
The valuation of the franchise business CGU based on the forecasted cash flows and using an 11.5% discount rate indicates
impairment. The Company recognized an impairment charge of $2,444 to goodwill and $12,850 to trademarks.
The effect of a change in management’s key assumptions is reflected below:
Sensitivity
Key assumption
Revenue growth
Discount rate
Effect on fair value less cost to sell of CGU
Impact on impairment loss
Low growth
High growth
-2% to 2%
1% to 8%
11.0%
($1,796)
13.0%
$5,749
Additional impairment loss
of $1,796
No impairment
The Second Cup Ltd. Annual Report 2012
$
2012
1,280
577
235
1,221
2011
$ 1,157
1,126
134
1,676
$
3,313
$ 4,093
legal
50
$
total
$ 1,005
$
$
9
(59)
-
-
-
-
-
-
-
-
-
$
$
141
(358)
788
447
341
788
689
(429)
1,048
365
$
683
Headlease
liabilities
955
$
$
$
132
(299)
788
447
341
788
689
(429)
1,048
365
$
683
$
14. ACCOUNTS PAYABlE AND ACCRUED lIABIlITIES
Accounts payable and accrued liabilities consist of:
Accounts payable - trade
Accrued salaries, wages and benefits
Sales tax payable
Accrued liabilities
15. PROVISIONS
As at December 31, 2010
Provisions charged during the year
Provisions utilized during the year
As at December 31, 2011
Less: Current portion
Provisions
As at December 31, 2011
Provisions charged during the year
Provisions utilized during the year
As at December 29, 2012
Less: Current portion
Provisions
16. INCOME TAXES
Income tax expense is recognized based on management’s best estimate of the weighted average annual income tax rate
expected for the full financial year. The Ontario 2012 budget was substantively enacted on June 20, 2012, freezing corporate
tax cuts with the effect that the income tax rate would remain at 11.5% until the province can achieve a balanced budget.
Previously, the corporate income tax rate was slated to decrease to 10.0% by 2014. The impact of the income tax rate
change is estimated to result in an increase in income tax of $480 and has been recognized in the Statements of Operations
and Comprehensive Income (Loss).
Under Canadian generally accepted accounting principles, income trusts were not subject to income taxes to the extent
that their taxable income was distributed to unitholders. Under IAS 12 the rate to apply in 2010 was the highest marginal tax
rate, which was estimated to be 46.41%. After the Conversion the tax rate is estimated to be 28.16%. The benefit of the rate
reduction in 2011 due to the Conversion was $7,462. As a result of the Conversion, Second Cup recognized certain deferred
income tax assets and liabilities that were not previously recognized, resulting in a net charge of $519 in 2011.
59
NOTES TO ThE fINANCIAL STATEMENTS
Income tax expense (recovery), as reported differs from the amount that would be computed by applying the combined
Canadian federal and provincial statutory income tax rates to income before income taxes. The reasons for the differences
are as follows:
(Loss) income before income taxes
Combined Canadian federal and provincial tax rates
2012
$
(8,753)
26.50%
2011
$ 8,887
28.16%
Tax (recovery) provision at statutory rate
Increased (reduced) by following differences
Change in income tax rates
Deferred income tax assets and liabilities not previously recognized
Non-deductible permanent differences - impairment of goodwill and trademarks
Non-deductible permanent differences - other
Other
(2,320)
480
-
2,350
13
128
2,503
(7,462)
519
-
9
17
Income tax expense (recovery)
$
651
$ (4,414)
17. DEFERRED INCOME TAX
The analysis of deferred income tax assets and liabilities is as follows:
Deferred income tax assets
Deferred tax asset to be recovered after more than 12 months
Deferred income tax asset to be recovered within 12 months
Deferred income tax liabilities
Deferred income tax liability to be recovered after more than 12 months
Deferred income tax liabilities - net
Beginning of year
Income tax expense due to change in Ontario tax rates
Income tax (recovery)
End of year
The movement in deferred income tax assets and liabilities during the year is as follows:
$
2012
(133)
(361)
(494)
$
2011
(234)
(237)
(471)
9,684
10,654
$
9,190
$ 10,183
$ 10,183
480
(1,473)
$ 16,124
-
(5,941)
$
9,190
$ 10,183
As at December 31, 2010
Charged (credited) to the income statement
Property and
equipment
(3,165)
4,312
$
trademarks
$ 19,419
(10,070)
intangible
assets
-
158
$
$
other
(130)
(341)
total
$ 16,124
(5,941)
As at December 31, 2011
Charged (credited) to the income statement
1,147
391
9,349
(1,294)
158
(68)
(471)
(22)
10,183
(993)
As at December 29, 2012
$
1,538
$
8,055
$
90
$
(493)
$ 9,190
The Second Cup Ltd. Annual Report 2012
18. TERM lOAN AND OPERATINg FACIlITY
On June 12, 2012, the Company renegotiated its term loan and operating credit facilities, including an extension of the
maturity of the credit facilities, to May 31, 2015 and a decrease in interest rates. The revised credit facilities comprise an
$11,000 non-revolving term credit facility, fully drawn, and an undrawn $2,000 revolving credit facility. As a result of the
refinancing, the Company capitalized loan extension fees of $50. The term credit facilities are collateralized by substantially
all the assets of the Company.
The $11,000 non-revolving term credit facility bears interest at the bankers’ acceptance rate plus 2.75% (December 31,
2011 - 3.50%). As at December 29, 2012, the full amount of the $11,000 non-revolving term credit facility was drawn.
The $2,000 operating credit facility bears interest at the bankers’ acceptance rate plus 2.75% (December 31, 2011 - 3.50%).
As at December 29, 2012, no advances had been drawn on this facility.
The Company has an interest rate swap agreement with a notional value of $11,000 maturing on April 1, 2013, which fixes
the interest rate on the Company’s non-revolving credit facility at 3.04% per annum plus the margin noted above, which
results in a fixed effective interest rate of 5.79% (December 31, 2011 - 6.54%). As at December 29, 2012, the estimated fair
value of this contract is a $96 liability to the Company (December 31, 2011 - $302) which is recorded as a liability on the
Company’s Statements of Financial Position and the fair value movement of the interest rate swap has been recorded as a
non-cash credit to income on the Company’s Statements of Operations and Comprehensive Income (Loss).
Pursuant to the terms of the Company’s operating loan and term loan, the Company is subject to certain financial and other
customary covenants, including requirements to maintain a ratio of senior debt to EBITDA and to maintain a trailing four-
quarter fixed charge coverage ratio. During the years ended December 29, 2012 and December 31, 2011, the Company
was in compliance with all financial and other covenants of the Company’s operating loan and term loan.
In accordance with IFRS 7, Financial Instruments: Disclosures (“IFRS 7”), the term loan is presented net of transaction costs.
Transaction costs are amortized to the Statements of Operations and Comprehensive Income (Loss) using the effective
interest method.
Face value of long-term debt
Unamortized transaction costs
2012
$ 11,000
(59)
$ 10,941
2011
$ 11,000
(91)
$ 10,909
At maturity on May 31, 2015, the Statements of Financial Position value of the term loan will be equal to the face value.
Interest expense consists of the following:
Interest on term loan
Interest on derivative interest rate swap
Movement in fair value of derivative interest rate swap
Amortization of deferred financing charges
Other interest expense
2012
480
192
(206)
82
16
564
$
$
2011
525
192
(29)
72
22
782
$
$
61
NOTES TO ThE fINANCIAL STATEMENTS
19. OTHER lONg-TERM lIABIlITIES
Deferred revenue (i)
Promissory note payable
Leasehold inducement (note 3(l))
Other
Less: Current portion
2012
181
-
429
-
610
189
421
$
$
$
2011
135
18
403
2
558
166
392
$
$
$
(i) Deferred revenue on purchasing co-ordination fees and new term fees will be earned as follows: 2013 - $150, 2014 - $11, 2016 - $20.
20. CONTINgENCIES, COMMITMENTS AND gUARANTEES
Second Cup has lease commitments for Company-operated cafés and also acts as the head tenant on leases, which it
in turn subleases to franchise partners. To the extent that the Company may be required to make rent payments due to
headlease commitments, a provision has been recognized (note 15). The Company’s lease commitments at December 29,
2012 are as follows:
December 31, 2013
December 31, 2014
December 31, 2015
December 31, 2016
December 31, 2017
Thereafter
Headlease
commitments
$ 19,246
18,346
16,710
14,676
12,667
35,706
$ 117,351
$
Sublease to
franchisees
17,867
17,121
15,474
13,430
11,501
31,647
$ 107,040
net
$ 1,379
1,225
1,236
1, 246
1,166
4,059
$ 10,311
Total occupancy and lease costs expensed in the year are as follows:
Company head office and franchise café locations
Company operated cafés
2012
1,614
885
2,499
$
$
$
2011
882
504
$ 1,386
Second Cup is involved in litigation and other claims arising in the normal course of business. Management must use its
judgement to determine whether or not a claim has any merit, the amount of the claims and whether to record a provision,
which is dependent on the potential success of the claim. Second Cup believes it will not incur any significant loss or expense
with such claims. However, there can be no assurance that unforeseen circumstances will not result in significant costs. The
outcome of these actions is not determinable at this time, and adjustments, if any, will be recorded in the period of settlement.
Second Cup has a contract with a third party company to purchase and roast the coffee that is sold in all Second Cup
cafés by franchise partners. In terms of this supply agreement, Second Cup has guaranteed a minimum volume of coffee
purchases of $4,421 (2011 - $9,462). The coffee purchase commitment represents purchase commitments made up to the
end of December 2013.
Second Cup has entered into a marketing agreement with a third party through 2014 and has committed to spend $200 per
year on advertising placed in various media offered by the third party over the term of the agreement.
The Second Cup Ltd. Annual Report 2012
21. BASIC AND DIlUTED EARNINgS (lOSS) PER SHARE
Earnings (loss) per share are based on the weighted average number of shares outstanding during the year. Basic and diluted
earnings (loss) per share are determined as follows:
Net (loss) income
Weighted average number of shares issued and outstanding
Basic and diluted (loss) earnings per share
2012
$
(9,404)
9,903,045
(0.95)
$
2011
$ 13,301
9,903,045
1.34
$
22. OPERATINg EXPENSES
Expenses by nature
Head office
Salaries, wages and benefits
Occupancy and lease costs
Travel and franchise partner meetings
Head office overheads
Professional fees
Legal costs
Amortization of property and equipment
Research and innovation
Amortization of intangible assets
Bad debt expense
Advertising and franchise development
Inventory markdowns
Company cafés
Lease costs
Impairment of property and equipment
Other operating expenses
Amortization of property and equipment
Advertising and local marketing
Loss on disposal of property and equipment
Operating expenses
Salaries, wages and employee benefits
Salaries and wages
Employee benefits
Directors’ compensation
Severance costs
LTIP
Recovery from Co-op Fund
Total head office
$
2012
6,540
1,614
1,010
992
632
518
506
476
451
422
304
287
13,752
885
362
350
210
150
70
2,027
$ 15,779
2012
5,868
705
373
139
130
(675)
6,540
$
$
$
2011
7,311
882
888
833
476
394
289
-
392
257
263
23
12,008
504
130
253
151
94
36
1,168
$ 13,176
2011
6,245
651
291
687
93
(656)
7,311
$
$
63
NOTES TO ThE fINANCIAL STATEMENTS
23. COMPENSATION OF KEY MANAgEMENT
Key management is defined as the senior management team and the Board of Directors.
Salaries and short-term employee benefits
Severance costs
Stock-based compensation - LTIP (note 27)
Stock-based compensation - DSUP (note 27)
Pension costs - defined contribution plans
Total compensation
24. SUPPlEMENTARY CASH FlOW INFORMATION
Changes in non-cash working capital are as follows:
Trade and other receivables
Notes and leases receivable
Inventories
Prepaid expenses and other assets
Accounts payable and accrued liabilities
Provisions
Other long-term liabilities
Gift card liability
Deposits from franchise partners
Supplementary information
Interest paid
Income taxes paid (recovered)
25. MANAgEMENT OF CAPITAl
2012
2,106
-
130
40
33
2,309
2012
722
(400)
(58)
(501)
(780)
349
46
207
447
32
689
2,835
$
$
$
$
$
$
2011
2,083
687
93
89
29
2,981
2011
505
(278)
(30)
167
(2,350)
(105)
(75)
186
9
(1,971)
739
(57)
$
$
$
$
$
$
The capital structure of the Company consists of $10,941 (2011 - $10,909) in long-term debt and $56,700 (2011 - $71,402)
in shareholders’ equity, which comprises issued shares and accumulated earnings, less accumulated cash dividends.
The Company’s objectives relating to the management of its capital structure are to:
a) safeguard its ability to continue as a going concern;
b) maintain financial flexibility in order to preserve its ability to meet financial obligations;
c) maintain a capital structure that provides financing options to the Company when the need arises to access capital;
d) ensure it has sufficient cash and cash equivalents to pay declared dividends to its shareholders; and
e) deploy capital to provide an adequate return to its shareholders.
The Company’s primary uses of capital are to finance increases in non-cash working capital and capital expenditures.
The Company determines the appropriate level of long-term debt in the context of its cash flows and overall business
risks. The Company has historically generated sufficient cash flows to pay quarterly dividends to its shareholders. In order
to maintain or modify the capital structure, Second Cup may adjust the amount of dividends paid to its shareholders. The
current level of capital is considered adequate in the context of current operations.
The Second Cup Ltd. Annual Report 2012
Under the term loan and operating facility, the Company is required to comply with a number of covenants and restrictions,
including the requirements to meet certain financial ratios. These financial ratios include a senior leverage ratio and a fixed
charge coverage ratio. To date, the Company has complied with these ratios.
There were no changes in the Company’s approach to capital management during the year.
26. FINANCIAl INSTRUMENTS AND FINANCIAl RISK MANAgEMENT
Financial Instruments
The Company’s financial instruments consist of cash and cash equivalents, trade and other receivables, notes receivable,
accounts payable and accrued liabilities, gift card liability, other long-term liabilities, dividends payable to shareholders, term
loan, the derivative interest rate swap and deposits from franchise partners.
Categories of financial instruments
The Company has designated each of its significant categories of financial instruments outstanding as follows:
Financial assets
Cash and cash equivalents
Loans and receivables
Trade and other receivables
Leases receivable
Notes receivable
Financial liabilities
FVTPL
Derivative interest rate swap
Other financial liabilities
Accounts payable and accrued liabilities
Gift card liability
Promissory note payable and other long-term liabilities
Term loan
Financial liabilities designated as at FVTPL
Opening fair value
Additions during the year
Realized during the year
Change in value
Closing fair value
2012
2011
$
3,880
$
5,465
4,616
245
761
96
3,313
4,560
-
10,941
5,338
71
547
302
4,093
4,353
20
10,909
2012
302
-
-
(206)
96
$
$
2011
331
-
-
(29)
302
$
$
Fair value of financial instruments
The fair values of cash and cash equivalents, trade and other receivables, accounts payable and accrued liabilities and gift
card liability approximate their carrying values due to their short-term maturity. The fair value of notes receivable approxi-
mates their carrying value as the interest charged is considered to be based on market rates.
65
NOTES TO ThE fINANCIAL STATEMENTS
The fair value of the Company’s term loan approximates its carrying value less transaction costs due to the floating interest
rate of the term loan.
IFRS 7 requires financial instruments that are measured subsequent to initial recognition at fair value to be grouped in
Levels 1 to 3 in the fair value hierarchy, based on the degree to which the fair value is observable. The three levels of the
fair value hierarchy are:
• Level 1 - inputs derived from quoted prices (unadjusted) in active markets for identical assets or liabilities;
• Level 2 - inputs other than quoted prices included within Level 1 that are observable for the asset or liability,
either directly (i.e., as prices) or indirectly (i.e., derived from prices); and
• Level 3 - fair value derived from valuation techniques that include inputs for the asset or liability that are not based
on observable market data (unobservable inputs).
The fair value for the derivative interest rate swap, classified as a Level 2, was derived using a discounted cash flow model
that considers various observable inputs including time to maturity, forward interest rates and credit spreads.
as at december 31, 2011
Derivative interest rate swap
as at december 29, 2012
Derivative interest rate swap
level 1
-
-
level 1
-
-
$
$
level 2
(302)
(302)
level 2
(96)
(96)
$
$
level 3
-
-
level 3
-
-
$
$
There were no transfers between Level 1 and Level 2 in the year.
The Company’s financial instruments are exposed to credit risk, liquidity risk and interest rate risk.
Credit Risk
The Company’s financial instruments exposed to credit risk include cash and cash equivalents, trade and other receivables,
leases receivable and notes receivable. The Company places its cash with institutions of high creditworthiness. The
Company’s trade and other receivables, leases receivable and notes receivable primarily comprise amounts due from
franchise partners. Based on experience, management believes its trade and other receivables, leases receivable and
notes receivable credit risk exposure is limited. Credit risk from trade and other receivables, leases receivable and notes
receivable is minimized as a result of the review and evaluation of franchise partner account balances beyond a particular
age, and management accounts for a specific bad debt provision when the expected recovery is less than the actual
accounts receivable. The provision relating to past due trade and other receivables as at December 29, 2012 was $223
(December 31, 2011 - $111). The provision relating to past due leases receivable and notes receivable as at December 29,
2012 was $189 (December 31, 2011 - $137).
The maturities of the Company’s trade and other receivables as at December 29, 2012 are as follows:
Total
maturing maturing between maturing between
1 year and less
than 2 years
$-
90 days and less
than a year
$3
in the next
90 days
$4,613
maturing
after 2 years
$-
total
$4,616
The creditworthiness of new franchise partners is reviewed during the application process. A new franchise partner requires
a minimum 30% of their investment in unencumbered cash, written confirmation of financing for the remaining 70% from
their bank and a deposit of $100 to accompany the signed franchise agreement.
The Second Cup Ltd. Annual Report 2012
The maturities of the Company’s notes and leases receivable as at December 29, 2012 are as follows:
Total
maturing maturing between maturing between
1 year and less
than 2 years
$229
90 days and less
than a year
$195
in the next
90 days
$70
maturing
after 2 years
$512
total
$1,006
Liquidity Risk
Liquidity risk is the risk the Company will encounter difficulty in meeting obligations as they come due associated with its
financial liabilities. The Company manages liquidity risk through regular monitoring of dividends, forecast and actual cash
flows, and also the management of its capital structure and senior leverage ratios as outlined in note 18. The Company’s main
source of income is royalty receipts from its franchise partners.
The contractual maturities of the Company’s financial liabilities as at December 29, 2012 are as follows:
maturing maturing between maturing between
1 year and less
than 2 years
90 days and less
than a year
in the next
90 days
maturing
after 2 years
total
Accounts payable and
accrued liabilities
Gift card liability
Derivative interest rate swap
Term loan
Total
$ 2,873
4,560
84
76
$ 7,593
$
$
367
-
-
334
701
$ 73
-
-
445
$ 518
$
-
-
-
11,188
$ 11,188
$ 3,313
4,560
84
12,043
$ 20,000
Interest Rate Risk
Interest rate risk is the risk the fair value of future cash flows of a financial instrument will fluctuate because of changes in
market interest rates.
The Company is exposed to interest rate risk on its cash and cash equivalents and term loan, which earn and bear interest
at floating rates. The Company entered into an interest rate swap agreement to minimize risk.
Interest expense on the long-term debt is adjusted to include the payments made or received under the interest rate swap
agreement. The interest rate swap agreement is recognized in the Statements of Financial Position at its estimated fair value.
During the year ended December 29, 2012, the Company recorded a net interest recovery of $206 on the Statements of
Operations and Comprehensive Income (Loss) relating to the interest rate swap (2011 - recovery of $29).
Sensitivity Analysis
IFRS 7 requires disclosure of a sensitivity analysis to illustrate the sensitivity of the Company’s financial position and performance
to changes in market variables such as interest rates as a result of changes in the fair value of cash flows associated with the
Company’s financial instruments. The sensitivity analysis provided discloses the effect on net loss as at December 29, 2012,
assuming that a reasonably possible change in the relevant risk variable has occurred as at December 29, 2012.
The following table shows the Company’s exposure to interest rate risk and the pre-tax effects on net loss for the year ended
December 29, 2012 of a 1% change in interest rates management believes is reasonably possible:
Term loan
Interest rate swap agreement
Pre-tax effects on net income – increase (decrease)
carrying amount
1% increase
in interest rates
of liability
$ 11,000
$
96
1% decrease
in interest rates
(110)
$
110
-
110
(110)
-
$
$
67
NOTES TO ThE fINANCIAL STATEMENTS
27. lONg-TERM INCENTIVE PlAN AND DIRECTORS DEFERRED SHARE UNIT PlAN
Shares granted under the LTIP vest over a three-year period and are paid out in cash on December 15 of each year. Shares
are granted based on the weighted average price of the Company’s shares for the 20 trading days prior to the grant date.
The fair value of the shares outstanding is determined based on the market value of the underlying shares of the Company.
A summary of the status of the Company’s LTIP is presented below:
Notional shares outstanding as at December 31, 2010
Shares forfeited
Shares paid out
Shares granted in lieu of dividends
Shares granted on December 23, 2011
Change in fair value
Notional shares outstanding as at December 31, 2011
Expensed in current year
Notional shares outstanding as at December 31, 2011
Shares forfeited
Shares paid out
Shares granted in lieu of dividends
Change in fair value
Notional shares outstanding as at December 29, 2012
Expensed in current year
notional Shares
77,083
(14,680)
(6,263)
3,872
28,751
88,763
notional Shares
88,763
(3,723)
(32,682)
6,205
58,563
fair value
$ 445
(90)
(50)
25
180
(92)
$ 418
93
$
fair value
$ 418
(19)
(175)
41
(9)
$ 256
$ 130
Shares granted under the DSUP vest on the last day of the year in which they are granted and are paid out in cash on the
termination of the director. Shares are granted based on the weighted average price of the Company’s shares for the five
trading days prior to the grant date. The fair value of the shares outstanding is determined based on the market value of the
underlying shares of the Company.
A summary of the status of the Company’s DSUP is presented below:
Notional shares outstanding as at December 31, 2010
Deferred share units granted
Shares granted in lieu of dividends
Shares forfeited
Shares paid out
Change in fair value
Notional shares outstanding as at December 31, 2011
Expensed in current year
Notional shares outstanding as at December 31, 2011
Deferred share units granted
Shares granted in lieu of dividends
Change in fair value
Notional shares outstanding as at December 29, 2012
Expensed in current year
notional Shares
-
19,727
1,221
(4,367)
(2,183)
14,398
notional Shares
14,398
9,018
1,760
25,176
$
fair value
-
155
8
(34)
(17)
(23)
89
89
$
$
$
fair value
89
55
12
(27)
$ 129
40
$
The Second Cup Ltd. Annual Report 2012
28. SEgMENTED REPORTINg
The Company’s business is classified as one operating segment that is reported in a manner consistent with the internal
reporting provided to the chief operating decision maker. The Company is structured as a franchisor with all of its operating
revenues derived in Canada. Operating revenues comprise the sale of goods from Company-operated cafés and the sale
of goods through ancillary channels, royalties and other service fees. Management is organized based on the Company’s
operations as a whole rather than the specific revenue streams.
29. SUBSEQUENT EVENT
On February 28, 2013, the Board of Directors of Second Cup approved a quarterly dividend of $0.085 per common share,
payable on March 28, 2013 to shareholders of record at the close of business on March 15, 2013.
69
The Second Cup Ltd.
shAreholder InForMAtIon
CORPORATE HEAD OFFICE
THE SECOND CUP lTD.
Board of Directors
THE SECOND CUP lTD.
Senior Management Team
The Second Cup Ltd.
6303 Airport Road
2nd Floor
Mississauga, Ontario
Canada L4V 1R8
Registrar and Transfer Agent
Computershare Trust Company
of Canada
Auditors
PricewaterhouseCoopers LLP
Market Information
Shares Listed:
Toronto Stock Exchange
Symbol: Scu
Investor Enquiries
Robert Masson
Chief Financial Officer
Tel: (905) 362-1824
Fax: (905) 362-1121
E-mail: investor@secondcup.com
Website:
www.secondcup.com
Michael Rosicki (1) (2)
Chairman
James Anas (1)
Bryna Goldberg (2)
Bryan Held (1)
Stephen Kelley
Peter Saunders (1) (2)
Committees of the Board
(1) Audit Committee
(2) Governance/Human
Resources/Compensation
Committee
Stacey Mowbray
President and
Chief Executive Officer
Robert Masson
Chief Financial Officer
Wayne Vanderhorst
Vice President,
Franchise Development
Cathy Whelan Molloy
Chief Marketing Officer
Dan Caldarone
General Counsel,
VP Human Resources
and Corporate Secretary
Rita Toporowski
Vice President,
Corporate Planning and Development
Tom Zacharias
Vice President, Operations
Rainforest
Alliance
Certified
Fair Trade
Certified
OCIA
Certified
Organic
Printed on environmentally-
responsible paper that contains
FSC certified 50% post-
consumer and 50% virgin fiber.
There’s a little love
in every cup.TM
The Second Cup Ltd.
Annual Report 2012
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