Sculptor Capital Management Annual Report 2017

FY2017 Annual Report · Sculptor Capital Management

Loading PDF…

THE SECOND CUP LTD.
Annual Report 2017

Vision
—
To be the Canadian specialty coffee brand of choice
across Canada, committed to superior quality, innovation
and profitable growth.

2 THE SECOND CUP LTD.

Table of Contents

Letter from the Chairman

Letter from the President & CEO

Pinkberry

Café Revitalization Continues

Driving Innovation

A Look at 2018

Financial Highlights

Management's Discussion & Analysis

Audited Financial Statements

Shareholder Information

ANNUAL REPORT 2017 1

Letter from
the Chairman

Second Cup strengthened significantly
during 2017. Garry Macdonald became
CEO mid-year and has brought stability
to the organization. The company’s
capital structure improved materially
and at year end was debt free with $4.5
million of cash.

The year saw a successful return to
Second Cup‘s asset light business model.
The year ended with 12 corporate
stores compared with a peak of 47
in 2015. Product innovation stepped
up, highlighted by the successful
introduction of Pinkberry frozen
yogurt in a number of test stores.
Pinkberry has proven to be a highly
complementary addition to Second
Cup’s core offering, resulting in growth
in store sales and profitability. The
Pinkberry program is now being rolled
out across the country.

As a result of the debt exchange

last August, the shareholders of Serruya
Private Equity became Second Cup’s
largest shareholders. Michael and Aaron

Serruya joined the Second Cup Board
of Directors. The Serruya family has
a long track record of value creation
in businesses similar to Second Cup.
We expect the company to generate
positive cash flow in the future. With
a solid financial foundation, Second
Cup may now actively consider new
opportunities to create value for
shareholders.

There is much additional opportunity

for improvement at Second Cup, but
today the company is stronger than it
has been in many years. For this I thank
our management team, franchisees,
directors and shareholders.

Michael Bregman
Chairman

2 THE SECOND CUP LTD.

Letter from the
President & CEO

Last May when I assumed the leadership
role at Second Cup, I was thrilled to join
the iconic Canadian brand and excited by
the growth potential. As I reflect on the
past twelve months, I am pleased with the
significant improvement in profitability and
the innovation that will further enhance our
brand presence, and create added value
and returns for our franchisee partners and
shareholders.

We ended 2017 with an incredible 383%
growth in EBITDA (adjusted) and in Q4 it
was more than double compared to the
same quarter in the prior year. Growing
same store sales remains a priority. We
ended the year at -0.2%, an improvement
from -1.1% in 2016.

There were numerous product innovations

in 2017 with a focus on differentiated,
premium offerings that have mass appeal.
These included a new Better For You menu,
our unparalleled Flash Cold Brew and new
fresh food offerings including Bagels and
Cheese Melts. We will continue to drive sales
and profit improvement through innovation
and differentiation in our new product
development including enhancements to
breakfast, lunch and snack programs.
Our Rewards program membership
grew by 30% and continues to be valued

by customers and franchisee partners. We
know from our research that it is the number
one driver of brand choice among coffee
drinkers and Rewards members spend more
per transaction. We have plans to further
enhance the Rewards member experience
this year.

The most promising new product
introduction is Pinkberry frozen yogurt -
recognized as the premium brand leader
in the frozen yogurt category. The roll out
began late last year and response to this
complimentary, premium offering has been
very favourable, attracting new customers to
our cafés and driving incremental sales. We
are aggressively working to launch Pinkberry
in more cafés across the network in time for
the peak frozen yogurt season.

Second Cup has great real estate

locations. In 2017 many more of our cafés
were renovated to reflect the modernized
brand with improvements in costs. We
will continue to focus on expanding our
traditional café model in carefully selected,
high profile locations, as well as our concept
upgrades and renovations while restoring our
asset light business model. We ended the
year with 12 corporately-owned cafés, which
is down from a peak of 47 stores in 2015.
One of our priorities in 2018 will be to

expand the Second Cup footprint nanionally
to add brand value and access. In support
of this initiative, we have developed a new
non-traditional format program and a
new co-brand licensing format, offering
our premium quality Second Cup branded/
signature products in smaller footprint
venues with a lower capital cost profile.
Partnering examples in the non-traditional
sector may include compatible QSR chains,
entertainment venues, institutional,
petroleum, convenience, etc.

Second Cup is an incredible brand. The

company is in a much stronger position
today and I wish to thank the dedicated
management team, staff at Coffee Central
and our committed franchisee partners. I
am very appreciative of the support of our
Board of Directors.

I look forward to a year of accelerated
growth to help Second Cup realize its full
potential.

Garry Macdonald
President & CEO

ANNUAL REPORT 2017 3

Pinkberry

Second Cup entered into a category
exclusive licensing agreement with
Pinkberry Canada Inc., and in Q4 2017 we
began rolling out the Pinkberry Frozen
Yogurt program in Second Cup cafés
across the country. Early results have been
very positive with Pinkberry contributing
significantly to sales and profitability as
well as attracting new customers.

The Pinkberry brand is the leading
premium brand in the frozen yogurt
category. Launched in California in
2005, Pinkberry has developed a cult-like
following and is made with high-quality
fresh ingredients, fresh hand-cut fruit
and premium toppings.

This licensing agreement brings

together two great brands and provides

Canadians with an opportunity to
experience the best in frozen yogurt and
the best specialty coffee.

“Pinkberry is a delicious product that has
been well-received by my customers. It
has brought in new customers that I have
never seen in the nearly five years we’ve
been open. Customers are coming in
exclusively for Pinkberry. Canadians like
frozen yogurt at any time of the year. I
can’t wait for the summer and expect to
see my patio filled with Pinkberry fans!”

—
Tamara Belamy
Second Cup Franchisee Partner and
Advisory Council Member

4 THE SECOND CUP LTD.

ANNUAL REPORT 2017 5

Café Revitalization
Continues

In 2017 we continued to modernize
our Second Cup cafés to reflect
the updated brand design in
new and existing locations. We
continue to work on enhancing
the experience while delivering
cost efficiency. The Pinkberry
frozen yogurt concept has now

been integrated into the café
design and is a standard offering.
We have designated one of
our downtown Toronto cafés as
an innovation centre for testing
new ideas to drive sales and
profitability that we then rapidly
roll-out across the system.

“I have a very loyal customer base and they
love the new design of the café. It’s bright
and airy and has reenergized my staff. The
new merchandising displays really show off
our premium food and beverage products.
With Pinkberry, we now have another
reason for customers to visit more often
and to bring in new customers.”

—
Jeetesh Jogie
Second Cup Franchisee Partner
Toronto, ON

6 THE SECOND CUP LTD.

ANNUAL REPORT 2017 7

Full fl avour, extra smooth.

Mocca

Classic Black

8 THE SECOND CUP LTD.

Rethink the cold.

Vanilla Bean

CHEESE MELTS

BAGEL BAR

Comfort classics
made better.

Fresh, toasted bagels
& spreads.

Full fl avour, extra smooth.

Mocca

Classic Black

Vanilla Bean

Rethink the cold.

Driving Innovation

Second Cup significantly advanced
its food and beverage offerings last
year with numerous introductions
and a focus on products that are
differentiated and have mass appeal to
drive incremental sales.

FLASH COLD BREW
Second Cup has made uncompromising
improvements to every aspect of our
coffee process, from farm to cup, to
ensure we're delivering the best tasting
coffee. Flash Cold Brew was introduced
last spring and has resulted in significant
growth in our cold coffee category, the

fastest growing segment in the coffee
market. The result of this specialized,
Flash Brew method is a superior coffee
taste profile that's full flavour and extra
smooth.

FRESH FOOD
Expanding Second Cup’s premium, fresh,
local food offering in the breakfast
and lunch dayparts is a key strategy
for café sales growth. In 2017 major
advancements were made with the
launch of a fresh Bagel and Spreads
program and a line of premium Cheese
Melt sandwiches – a classic, remastered.

ANNUAL REPORT 2017 9

BETTER FOR YOU MENU
In the first quarter of last year we
launched a Better For You menu
to meet the growing customer
demand for healthier options. A line
of smoothies is at the core of the
program and opened the door to a

whole new group of customers for
our cafés. Additional low calorie and
high-protein bakery and sandwich
menu items compliment the offer.
This program will be expanded with
new menu innovation underway.

10 THE SECOND CUP LTD.

Simply Rewarding
Members earn FREE coffee!

SECOND CUP COFFEE CO. REWARDS
A free Rewards program remains a top driver of brand
choice for coffee consumers and continues to be a customer
favourite. In 2017 our loyalty member base grew by 30%
and members’ average transaction is significantly higher
than the average. With Second Cup Coffee Co. Rewards,
members earn points for every dollar they spend and
through personalized bonus point offers sent by email and
on the mobile app.

DOWNLOAD THE APP

Second Cup Coffee Co.TM Rewards Program available at participating Second Cup Coffee Co.TM Cafés in Canada. TMTrademark of The Second Cup Ltd. See secondcup.com/rewards for full program details, terms and conditions.

ANNUAL REPORT 2017 11

Always Delicious
NOW CLEAN
LABEL!

Going Clean...
Always Delicious

NO
Preservatives

NO
Artifi cial
Colours

NO
Artifi cial
Flavours

NO
High-Fructose
Corn Syrup

Committed to
Clean Label beverages.

fresh is our
secret ingredient

Made with non-fat milk
and hand-cut fresh fruit.

12 THE SECOND CUP LTD.

Going Clean...

Always Delicious

Preservatives

Artifi cial

Colours

Artifi cial

Flavours

High-Fructose

Corn Syrup

Committed to

Clean Label beverages.

A look at 2018

Second Cup’s dramatic improvement in
our profitability last year sets the stage
for an accelerated growth plan in 2018.
The focus is on driving same store sales
with innovation led by the expansion
of Pinkberry, as well as upgrading and
expanding Second Cup in traditional and
non-traditional formats. You can expect
more exciting fresh food, beverage and
Rewards innovation this year.

Leading the Canadian coffee market
with Clean Label beverages

In January, Second Cup led the Canadian
coffee market with a move to Clean
Label beverages which now represent
over 70% of the beverage menu.

Clean Label products contain no
artificial colours, flavours, preservatives
or high fructose corn syrup. Canadian
consumers are making more informed
food choices. They care about what's in
their food and drinks, and they're looking
for options they can feel good about.

“At Second Cup, we're on a continual
mission to provide the most innovative
premium coffee experience in the country
- and we believe that our Clean Label
commitment is another important step
in that journey."

—
Garry Macdonald
President & CEO

ANNUAL REPORT 2017 13

14 THE SECOND CUP LTD.

Financial Highlights

The following table sets out selected IFRS and certain non-GAAP financial measures of the Company and should be read
in conjunction with the Audited Financial Statements of the Company for the 52 weeks ended December 30, 2017.

( In thousands of Canadian dollars, except same café sales, number
of cafés, per share amounts, and number of common shares.)

December 30,
2017

December 31,
2016

December 30,
2017

December 31,
2016

13 weeks ended 14 weeks ended

52 weeks ended 53 weeks ended

$41,326

$46,743

$154,153

$163,738

System sales of cafés1

Same café sales1

Number of cafés – end of period

Total revenue

Operating costs and expenses

Operating income (loss)1

EBITDA1

Adjusted EBITDA1

Net income (loss) and comprehensive income (loss)

Adjusted net income (loss) and comprehensive income (loss)1

Basic and diluted earnings (loss) per share as reported

Adjusted basic and diluted earnings (loss) per share1

(1.1%)

286

$6,085

$5,092

$993

$1,339

$655

$0.04

(1.0%)

294

$7,500

$7,199

$302

$667

$147

$0.01

(0.2%)

286

$23,636

$22,660

$976

$2,434

$2,721

($3,097)

$110

($0.21)

$0.01

(1.1%)

294

$30,351

$31,336

($985)

$563

($975)

($0.08)

$45,314

Total assets – end of period

$44,700

$45,314

$44,700

Number of weighted average common shares issued

and outstanding

17,041,473

12,830,945

14,485,081

12,830,945

1 See the section “Definitions and Discussion on Certain non-GAAP Financial Measures” for further analysis.

System wide sales
(in millions of Canadian dollars)

Number of Second Cup cafés
(in Canada)

200

150

100

191.4

182.8

174.9

163.7

154.2

2013

2014

2015

2016

2017

400

350

300

250

200

150

100

356

347

310

294

286

2013

2014

2015

2016

2017

ANNUAL REPORT 2017 15

Management’s Discussion and Analysis

CAUTION REGARDING FORWARD-LOOKING STATEMENTS

Certain statements in this Management’s Discussion and Analysis (“MD&A”) may constitute forward-looking
statements within the meaning of applicable securities legislation. The terms the “Company”, “Second Cup”,
“we”, “us”, or “our” refer to The Second Cup Ltd. Forward-looking statements include words such as “may”,
“will”, “should”, “expect”, “anticipate”, “believe”, “plan”, “intend” and other similar words. These statements
reflect current expectations regarding future events and financial performance and speak only as of the date of this
MD&A. The MD&A should not be read as a guarantee of future performance or results and will not necessarily be
an accurate indication of whether or not those results will be achieved. Forward-looking statements are based on
a number of assumptions and are subject to known and unknown risks, uncertainties and other factors, many of
which are beyond Second Cup’s control that may cause Second Cup’s actual results, performance or achievements,
or those of Second Cup cafés, or industry results to be materially different from any future results, performance or
achievements expressed or implied by such forward-looking statements. The following are some of the factors that
could cause actual results to differ materially from those expressed in the underlying forward-looking statements:
competition; availability of premium quality coffee beans; the ability to attract qualified franchisees; 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 trademarks; 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 franchisees; and the financial performance 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” below and in Second Cup’s Annual Information Form, which is available at www.sedar.com.

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

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

INTRODUCTION

The following MD&A has been prepared as of February 23, 2018 and is intended to assist in understanding the
financial performance and financial condition of The Second Cup Ltd. (“Second Cup” or the “Company”) for the 13
weeks (the “Quarter”) and 52 weeks (the “Year”) ended December 30, 2017, and should be read in conjunction with
the Audited Financial Statements of the Company for the 52 weeks ended December 30, 2017, accompanying notes
and the Annual Information Form, 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, except number of cafés, per share
amounts or unless otherwise indicated and have been prepared in accordance with International Financial Reporting
Standards (“IFRS”). The Company also reports certain non-IFRS measures such as system sales of cafés, same café
sales, operating income (loss), EBITDA, adjusted EBITDA, adjusted net income (loss) and adjusted net income (loss) per
share that are discussed in the “Definitions and Discussion of Certain non-GAAP Financial Measures” in this MD&A.

16 THE SECOND CUP LTD.

TABLE OF CONTENTS

Core Business, Strategic Imperatives, and Key Performance Drivers

Capabilities

Financial Highlights

Operational Review

Selected Quarterly Information

Liquidity and Capital Resources

Evaluation of Disclosure Controls and Procedures

Critical Accounting Estimates

Changes in Accounting Policies

Risks and Uncertainties

Outlook

Definitions and Discussion on Certain Non-GAAP Financial Measures

ANNUAL REPORT 2017 17

CORE BUSINESS, STRATEGIC IMPERATIVES, AND KEY PERFORMANCE DRIVERS

Core business
Second Cup is a Canadian specialty coffee retailer with 286 cafés operating under the trade name Second Cup™ in
Canada, of which 12 are Company-owned and the balance is operated by franchisees.

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 in Canada, excluding the Territory of Nunavut.

The Company was incorporated under the Business Corporations Act (Ontario) in 2011. The address of its registered
office is 6303 Airport Road, 2nd Floor, Mississauga, Ontario, L4V 1R8. The website is www.secondcup.com. The
common shares are listed on the Toronto Stock Exchange under the symbol “SCU”.

The fiscal year follows the method, 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. Fiscal year 2017 consists of 52 weeks.

As at December 30, 2017, the issued share capital consisted of 17,041,473 common shares.

Additional information including the Annual Information Form is on SEDAR at www.sedar.com.

As a franchisor, Second Cup opens, acquires, closes and refranchises individual café locations in the normal
course of business.

Strategic imperatives and key performance drivers

Second Cup’s vision of being the coffee brand most passionately committed to quality and innovation will drive
management’s strategies and actions going forward. Coffee will be at the core of the offering supported by ongoing
food and beverage innovation.

As the Canadian specialty coffee company, bringing the best coffees in the world to customers is at the core of
the brand and fundamental to redefining Second Cup as the coffee brand most passionately committed to quality
and innovation. In January 2018, Second Cup announced a move to Clean Label beverages, with a commitment to
eliminate artificial colours and flavours, preservatives and high fructose corn syrup from all beverages on the menu.

In September 2017, Second Cup obtained category exclusive license right from Pinkberry Canada Inc. and began
rolling out the Pinkberry Frozen Yogurt program in Second Cup cafés. As at December 30, 2017, Pinkberry was being
served at 24 cafés across Canada.

The Company is encouraged by its progress in franchising corporate stores to strong operators, returning to an asset
light business model, and expects to make further reductions in the number of Company-owned cafés in 2018.

CAPABILITIES

This section documents factors that affect the Company’s ability to execute strategies, manage key performance
drivers and deliver results. This section is qualified by the section “Caution Regarding Forward-Looking Statements”
at the beginning of this MD&A.

The Second Cup brand
The brand – Second Cup Coffee Co.TM – reflects an independent spirit, a commitment to deliver the world’s finest
coffee, and the Company’s vision to be the coffee brand most passionately committed to quality and innovation. A
proud Canadian company since 1975 with 286 cafés across Canada, Second Cup Coffee Co.™ is a specialty coffee
retailer. The Company maintains its commitment to the communities it operates in, celebrating the franchisees’ local
ownership and their focus on providing quality and friendly service to each customer in every café.

18 THE SECOND CUP LTD.

MANAGEMENT’S DISCUSSION AND ANALYSIS

The people
The franchise network consists of approximately 3,500 team members. Team members range from baristas,
managers and franchisees at the cafés to support personnel employed at Coffee Central (head office). Baristas and
franchisees complete extensive training and certification to deliver a quality product to our customers. Franchisees
and baristas are subject to operational quality checks to monitor performance.

Product
As of today, 27 beverages achieve the Clean Label standard, representing 70% of Second Cup’s beverage menu.
Clean Label beverages contain no artificial colours or flavours, no preservatives and no high fructose corn syrup.
Second Cup will continue to reformulate other menu items to meet the Clean Label standard.

The Company has a strategic partnership with an independent roaster of coffees. The Company has also partnered
with Swiss Water Decaffeinated Coffee Company Inc. to decaffeinate its coffee. This process is 100% chemical-
free, unlike other decaffeination methods that use methylene chloride or ethyl acetate to remove the caffeine. This
decaffeination process gently removes 99.9% of the caffeine while maintaining the unique taste characteristics of the
coffee. The process reflects Second Cup’s commitment to natural and healthy products.

Second Cup prides itself that all of its coffee and espresso beverages are certified by third parties such as Rainforest
Alliance™ - certification that the coffee is grown and processed in a socially and environmentally responsible manner.
The Company offers a fair-trade and organic certified blend of coffee called Cuzco®.

In addition to coffee-based products and other beverages, cafés carry a variety of complementary products, including
Pinkberry, pastries, sandwiches, muffins, cookies, coffee accessories and coffee-related gift items.

The Pinkberry brand is the leading premium brand in the frozen yogurt category. Launched in California in 2005,
Pinkberry has developed a cult-like following and is made with high-quality fresh ingredients, fresh hand-cut fruit and
premium toppings.

Liquidity, capital resources and management of capital
The Company’s objectives relating to the management of its capital structure are to:
• safeguard its ability to continue as a going concern;
• maintain financial flexibility in order to preserve its ability to meet financial obligations; and
• 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.

On August 10, 2017 (“Issuance Date”), the Company issued 4,210,528 common shares and 300,000 warrants of
Second Cup to the four shareholders of SPE Finance LLC (SPE), an affiliate of Serruya Private Equity. The Company
also extinguished its $8,000 debt to SPE, cancelled 600,000 of old warrants and became debt-free. These
transactions resulted in one-time, non-cash financing charges of $3,290. These charges consist of the difference
between the share price of $2.60 on the Issuance Date and the agreed-to share price of $1.90, and the write-off of the
unamortized portion of deferred transaction costs related to the debt.

Competition
The Canadian specialty coffee market is highly competitive and highly fragmented, with few barriers to entry. There
are national, regional and local coffee retailers who are specialty coffee providers or quick serve restaurants with
broad menus.

ANNUAL REPORT 2017 19

Technology
Second Cup relies heavily on information technology network infrastructure including point of sale system (“POS”)
hardware and software in cafés, gift and loyalty card transactions, and head office financial and administrative
functions. The 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 has made significant
investments in POS systems across its store network as it relies on the POS system to help analysis for both marketing
initiatives and royalty calculations.

FINANCIAL HIGHLIGHTS

The following table sets out selected IFRS and certain non-GAAP financial measures of the Company and should be
read in conjunction with the Audited Financial Statements of the Company for the 52 weeks ended December 30, 2017.

( In thousands of Canadian dollars, except same café sales, number
of cafés, per share amounts, and number of common shares.)

December 30,
2017

December 31,
2016

December 30,
2017

December 31,
2016

13 weeks ended 14 weeks ended

52 weeks ended 53 weeks ended

$41,326

$46,743

$154,153

$163,738

System sales of cafés1

Same café sales1

Number of cafés – end of period

Total revenue

Operating costs and expenses

Operating income (loss)1

EBITDA1

Adjusted EBITDA1

Net income (loss) and comprehensive income (loss)

Adjusted net income (loss) and comprehensive income (loss)1

Basic and diluted earnings (loss) per share as reported

Adjusted basic and diluted earnings (loss) per share1

(1.1%)

286

$6,085

$5,092

$993

$1,339

$655

$0.04

(1.0%)

294

$7,500

$7,199

$302

$667

$147

$0.01

(0.2%)

286

$23,636

$22,660

$976

$2,434

$2,721

($3,097)

$110

($0.21)

$0.01

(1.1%)

294

$30,351

$31,336

($985)

$563

($975)

($0.08)

$45,314

Total assets – end of period

$44,700

$45,314

$44,700

Number of weighted average common shares issued

and outstanding

17,041,473

12,830,945

14,485,081

12,830,945

1 See the section “Definitions and Discussion on Certain non-GAAP Financial Measures” for further analysis.

20 THE SECOND CUP LTD.

MANAGEMENT’S DISCUSSION AND ANALYSIS

OPERATIONAL REVIEW

Seasonality of System sales of cafés
The following table shows the percentage of annual system sales of cafés achieved, on average, in each fiscal
reporting quarter over the last three years:

% of annual System sales of cafés

First Quarter

Second Quarter

Third Quarter

Fourth Quarter

2015

24.7

25.0

23.5

26.8

100.0

2016

23.9

24.6

23.0

28.5

100.0

2017

24.6

24.0

26.8

100.0

Average

24.4

24.7

23.5

27.4

100.0

Historically, system sales of cafés have been higher in the fourth quarter, which includes the holiday sales periods of
November and December. In 2016, Fourth Quarter contains one extra week, for a total of 14 weeks. The Company’s
comparative results take into account the inclusion of the additional selling week in 2016.

Café network

Number of cafés – beginning of period

Cafés opened

Cafés closed

Number of cafés – end of period

13 weeks ended

14 weeks ended

52 weeks ended

53 weeks ended

December 30,
2017

December 31,
2016

December 30,
2017

December 31,
2016

289

(5)

286

298

(6)

294

(12)

286

310

(20)

294

The Company ended the Year with 12 (2016 - 22) Company-owned cafés. Café closures are mainly attributable to
leases that are not renewed on expiration, under-performing locations and landlord re-development of specific sites.

Fourth Quarter

Inclusion of an additional week in 2016 has a direct impact on the following analysis of the Fourth Quarter results.

System sales of cafés
System sales of cafés for the 13 weeks ended December 30, 2017 were $41,326 compared to $46,743 for the 14 weeks
ended December 31, 2016 representing a decrease of $5,417 or 11.6%. The decrease in system sales of cafés is
primarily due to the reduction in café count.

Same café sales
During the Quarter, same café sales declined 1.1%, compared to a decline of 1.0% in the comparable Quarter of
2016. The decline is primarily due to reduced transactions.

Analysis of revenue
Total revenue for the Quarter was $6,085 (2016 - $7,500), a decrease of $1,415, consisting of Company-owned café
and product sales, royalty revenue, fees and other revenue.

Company-owned cafés and product sales were $1,713 (2016 - $3,210), a decrease of $1,497. The decrease in revenue
is primarily due to the reduced Company-owned café count from 22 last year to 12 this Quarter. Reducing Company-
owned cafés is consistent with the Company’s strategy of returning to an asset light business model.

ANNUAL REPORT 2017 21

Franchise revenue was $4,372 for the Quarter (2016 - $4,290), an increase of $82. The increase in franchise revenue
in the Quarter is primarily driven by an increase in franchising fees, partially offset by a decrease in royalties and
coordination fees.

Operating costs and expenses
Operating costs and expenses include the costs of Company-owned cafés and product sales, franchise-related
expenses, general and administrative expenses, loss/gain on disposal of assets, and depreciation and amortization.
Total operating costs and expenses for the Quarter were $5,092 (2016 - $7,199), a decrease of $2,107.

Company-owned cafés and product sales related expenses for the Quarter were $1,772 (2016 - $3,410), a decrease of
$1,638. The decrease in costs is due to the reduction in store count of Company-owned cafés and lower product sales
as compared to the Quarter in 2016.

Franchise related expenses for the Quarter were $1,670 (2016 - $2,006), a decrease of $336. The decrease in franchise
related expenses is primarily due to a lower provision for café leases and enhanced operating efficiencies.

General and administrative expenses were $1,206 for the Quarter (2016 - $1,502), a decrease of $296. This decrease
in expenses is primarily due to a reduction in remunerations and directors’ fees.

A loss on disposal of $98 was recognized in the Quarter (2016 - gain of $84). Gain and loss on disposal of assets are
related to the franchising of Company-owned cafés to franchise partners.

Depreciation and amortization expense was $346 (2016 - $365), a decrease of $19.

EBITDA
EBITDA for the Quarter was $1,339 (2016 - $667), an increase of $672. The increase is primarily driven by the
reduction in franchise related expenses and the increase in franchise revenue, as described.

Interest and financing costs
Interest and financing income for the Quarter was $5 compared to interest and financing costs of $96 in the same
Quarter of 2016. The Company became debt-free in the third quarter this year.

Net income (loss)
The Company’s net income for the Quarter was $655 or $0.04 per share, compared to a net income of $147 or $0.01
per share in 2016.

Reconciliations of net income (loss) to EBITDA, adjusted EBITDA, adjusted net income (loss) and adjusted net income
(loss) per share are provided in the section “Definitions and Discussion of Certain non-GAAP Financial Measures”.

Year
Inclusion of an additional week in 2016 has a direct impact on the following analysis of the Year.

System sales of cafés
System sales of cafés for the Year were $154,153 (2016 - $163,738), a decrease of $9,585 or 5.9%. The decrease is
primarily due to the reduction in café count.

Same café sales
For the Year, same café sales declined by 0.2% compared to a decline of 1.1% in 2016. The decline in the Year was
primarily due to the decline in the fourth quarter same café sales as described above.

22 THE SECOND CUP LTD.

MANAGEMENT’S DISCUSSION AND ANALYSIS

Analysis of revenue
Total revenue for the Year was $23,636 (2016 - $30,351), a decrease of $6,715, consisting of Company-owned café and
product sales, royalty revenue, fees and other revenue.

Company-owned cafés and product sales were $8,562 (2016 - $14,663), a decrease of $6,101. The decrease is due
to the reduction of Company-owned café count from 22 to 12 this Year. Reducing Company-owned cafés count is
consistent with the Company’s strategy of returning to an asset light business model.

Franchise revenue was $15,074 for the Year (2016 - $15,688), a decrease of $614. The decrease in franchise revenue is
primarily due to lower royalties and coordination fees as a result of lower café count.

Operating costs and expenses
Operating costs and expenses include the costs of Company-owned cafés and product sales, franchise-related
expenses, general and administrative expenses, loss/gain on disposal of assets, and depreciation and amortization.
Total operating costs and expenses for the Year were $22,660 (2016 - $31,336), a decrease of $8,676.

Company-owned cafés and product related expenses were $9,303 for the Year (2016 - $15,681), a decrease of $6,378.
The decrease in costs is attributable to the reduction of Company-owned café count and lower product sales as
compared to 2016.

Franchise related expenses were $5,693 for the Year (2016 - $8,103), a decrease of $2,410. This decrease in expenses
is primarily due to a reduction in remuneration, an improvement in operational effectiveness and moving from a
national franchisee convention format to regional meetings with franchisees this year.

General and administrative expenses were $6,009 for the Year (2016 - $5,779), an increase of $230. This increase
is driven by higher professional fees related to legal matters and one-time transition costs, partially offset by a
reduction in general and administrative remuneration.

A loss on disposal of assets of $197 was recognized for the Year (2016 - $225 loss). Gain and loss on disposal of assets
are primarily related to the franchising of Company-owned cafés to franchise partners.

Depreciation and amortization expense was $1,458 (2016 - $1,548), a decrease of $90.

EBITDA
EBITDA was $2,434 for the Year (2016 - $563), an increase of $1,871. Adjusted for one-time transition costs of $287
incurred in the second quarter of 2017, adjusted EBITDA was $2,721 compared to an adjusted EBITDA of $563 in
2016. The increase of $2,158 is primarily driven by the reduction in franchise related expenses, lower corporate café
operating loss, and lower provision for café leases, partially offset by the decrease in franchise revenue.

Interest and financing costs
Interest and financing costs was $3,897 for the Year (2016 - $255), an increase of $3,642. The increase is primarily
driven by one-time, non-cash financing charges of $3,290. These charges consist of the difference between the share
price of $2.60 on the Issuance Date and the agreed-to share price of $1.90, and the write-off of the unamortized
portion of deferred transaction costs related to the debt.

Net loss
The Company’s net loss for the Year was $3,097 or $0.21 loss per share, compared to a net loss of $975 or $0.08 loss
per share in 2016. Adjusted for the after-tax expense on fair market value difference on issuance of shares of $3,207
($0.22 per share), adjusted net income was $110 or $0.01 per share compared to an adjusted net loss of $975 or $0.08
loss per share in 2016.

ANNUAL REPORT 2017 23

Reconciliations of net income (loss) to EBITDA, adjusted EBITDA, adjusted net income (loss) and adjusted net income
(loss) per share are provide in the section “Definitions and Discussion of Certain non-GAAP Financial Measures”.

SELECTED QUARTERLY INFORMATION

( in thousands of Canadian dollars, except Number of cafés,
Same café sales, and per share amounts.)

System sales of cafés1

Same café sales1

Number of cafés – end of period

Total revenue

Operating income (loss)1

EBITDA1

Adjusted EBITDA1

Net income (loss) for the period

Adjusted net income (loss) for the period1

Basic and diluted earnings (loss) per share

Adjusted basic diluted earnings (loss) per share1

System sales of cafés1

Same café sales1

Number of cafés – end of period

Total revenue

Operating (loss) income1

EBITDA1

Adjusted EBITDA1

Net (loss) income for the period

Adjusted net income (loss) for the period1

Basic and diluted (loss) earnings per share

Adjusted basic diluted earnings (loss) per share1

Q4 20172

$41,326

(1.1%)

286

$6,085

$993

$1,339

$655

$0.04

Q4 20162

$46,743

(1.0%)

294

$7,500

$302

$667

$147

$0.01

Q3 2017

$37,014

0.0%

289

$5,339

$436

$805

($2,962)

$245

($0.19)

$0.02

Q3 2016

$37,717

(1.2%)

298

$7,656

($25)

$357

($75)

($0.01)

Q2 2017

$37,898

Q1 2017

$ 37,915

0.7%

291

$6,237

($138)

$230

$517

($315)

($0.02)

(0.2%)

293

$5,975

($315)

$60

($475)

($0.04)

Q2 2016

$40,207

Q1 2016

$39,071

(1.3%)

304

$7,761

($528)

($128)

($441)

($0.03)

(1.1%)

307

$7,434

($733)

($332)

($606)

($0.05)

1 See the section “Definitions and Discussion on Certain non-GAAP Financial Measures” for further analysis.
2 The Company’s fourth quarter System sales of cafés are higher than other quarters due to the seasonality of the business (see “Seasonality of system sales

of cafés” above).

24 THE SECOND CUP LTD.

MANAGEMENT’S DISCUSSION AND ANALYSIS

The system sales decreases quarter over quarter are primarily related to the reduction in total network café count and
to a lesser extent to the changes in the same café sales.

Seasonal factors and the timing of holidays cause the Company’s revenue to fluctuate from quarter to quarter.
Revenue decreases quarter over quarter are primarily related to the reduction of Company-owned cafés count and
reduction in café count.

LIQUIDITY AND CAPITAL RESOURCES

Second Cup collects royalties based on the franchisees’ portion of System sales of cafés, fees, and other amounts
from its franchisees and also generates revenues from its Company-owned cafés and product sales. The performance
of Second Cup franchisees and Company-owned 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 the “Risks and uncertainties” section below.

Summary of cash flows

Cash flows provided by (used in)

operating activities

Cash flows provided by (used in)

investing activities

Cash flows provided by (used in)

financing activities

Increase (decrease) in cash and cash

equivalents during the period

Fourth Quarter

13 weeks ended

14 weeks ended

52 weeks ended

53 weeks ended

December 30
2017

December 31,
2016

December 30,
2017

December 31,
2016

$1,583

($498)

$1,862

($1,253)

(150)

(124)

$1,309

1,542

$1,044

(297)

$1,569

(365)

1,542

($76)

Cash provided by operating activities was $1,583 for the Quarter compared to cash used of $498 for the same
Quarter in 2016. The increase in cash of $2,081 is primarily due to changes in non-cash working capital and higher
profit.

During the Quarter, cash used in investing activities was $150 compared to cash used of nil for the same Quarter in
2016 due to purchases of capital expenditures and intangible assets in 2017.

Cash used in financing activities was $124 for the Quarter compared to cash provided by financing activities of $1,542
for the same Quarter in 2016. In 2016, the Company received net cash of $2,000 due to the new term loan. In 2017,
the Company paid financing charges related to the issuance of shares.

Year

Cash provided by operating activities was $1,862 for the Year compared to cash used in operating activities of $1,253
for 2016. The increase in cash of $3,115 was primarily due to changes in non-cash working capital and higher profit.

ANNUAL REPORT 2017 25

During the Year, cash provided by investing activities was $4 compared to cash used of $365 for 2016. The change of
$369 in cash was primarily due to lower payments for intangible assets and higher proceeds from disposal of capital
items.

Cash used in financing activities was $297 for the Year compared to cash provided by financing activities of $1,542
in 2016. In 2016, the Company received net cash of $2,000 due to the new term loan. In 2017, the Company paid
financing charges related to the issuance of shares.

Working capital as at

Current assets

Current liabilities

Working capital (deficiency)

December 30,
2017

December 31,
2016

$10,122

9,869

$253

$9,096

10,242

($1,146)

The Company’s working capital was $253 as at December 30, 2017 improved by $1,399 from December 31, 2016,
primarily as a result of an increase in cash and cash equivalents and a reduction in accounts payable and accrued
liabilities at the end of the Year. Gift card liability ended the Year at $3,432, a decrease of $52 compared to the end
of 2016. Based on the historical redemption patterns, the Company believes that it has sufficient financial resources
to cover the gift card liability. The Company operates in the franchise industry, in which a working capital deficit is
considered normal.

Financial instruments
The following summarizes the nature of certain risks applicable to the Company’s financial instruments:

Financial instrument

Financial assets

Cash and cash equivalents

Restricted cash

Trade and other receivables

Notes and leases receivable

Financial liabilities

Risks

Credit and interest rate

Credit

Accounts payable and accrued liabilities

Liquidity, currency and commodity

Gift card liability

Deposits from franchisees

Term credit facility

Liquidity

Liquidity and interest rate

(i) Credit risk
Cash and cash equivalents, restricted cash and interest rate swap
Credit risk associated with cash and cash equivalents, restricted cash and the interest rate swap is managed by
ensuring these assets are placed with institutions of high creditworthiness.

Trade and other receivables, and notes and leases receivable
Trade and other receivables and notes and leases receivable primarily comprise amounts due from franchisees.
Credit risk associated with these receivables is mitigated as a result of the review and evaluation of franchisee account
balances beyond a particular age. Prior to accepting a franchisee, the Company undertakes a detailed screening

26 THE SECOND CUP LTD.

MANAGEMENT’S DISCUSSION AND ANALYSIS

process which includes the requirement that a franchisee has sufficient financing. The risk is further mitigated due to
a broad franchisee base that is spread across the country, which limits the concentration of credit risk.

Other receivables may include amounts owing from large organizations where often those organizations have a
simultaneous vendor relationship with the Company’s franchisees. Credit risk is mitigated as a result of the Company
directing and maintaining certain controls over the vendor relationship with the franchisees.

Specific bad debt provisions are accounted for when the expected recovery is less than the actual receivable.

(ii) Liquidity risk
Liquidity risk is managed through regular monitoring of forecast and actual cash flows, monitoring maturity dates of
financial assets and liabilities, and also the management of the Company’s capital structure. The Company’s main
source of income is royalty receipts from its franchisees, corporate café sales, and sales from goods and services.

(iii) Currency and commodity risk
The Company purchases certain products, such as coffee, in U.S. dollars, thereby exposing the company to risks
associated with fluctuations in currency exchange rates. The Company is also directly and indirectly exposed to
commodity market risk. The exposure relates to the changes in coffee commodity prices given it is a material input
for product offerings. The direct exposure pertaining to the wholesale business is mitigated given that the Company
has the ability to adjust its sales price if commodity prices rise over a threshold level. The indirect risk exists
where franchisee profitability may be impacted, thus potentially resulting in an impeded ability to collect accounts
receivable or the need for other concessions to be made to the franchisee. This risk is mitigated by entering fixed
price purchase commitments through coffee commodity brokers and by having the ability to adjust retail selling
prices.

Contingencies, commitments and guarantees

Contractual Obligations

Obligations from Operating Leases

Purchase Obligations

Total Contractual Obligations

Total

$8,878

2,286

$11,164

1 year

$1,488

2,286

$3,774

2 – 3 years

4 – 5 years

After 5 years

$2,637

Nil

$2,637

$2,128

Nil

$2,128

$2,625

Nil

$2,625

Payments Due by Period

Obligations from operating leases
Second Cup has lease commitments for Company-owned cafés and also acts as the head tenant on most leases,
which in turn it subleases to franchisees. To the extent the Company may be required to make rent payments due to
head lease commitments, a provision has been recognized.

Head lease commitments

Sublease to franchisees

December 29, 2018

December 28, 2019

December 26, 2020

December 25, 2021

December 31, 2023

Thereafter

$17,954

16,158

13,907

12,034

10,835

27,637

$98,525

$16,466

14,736

12,692

10,938

9,803

25,012

Net

$1,488

1,422

1,215

1,096

1,032

2,625

$89,647

$8,878

The Company believes it has sufficient resources to meet the net commitment of $8,878 over the term of the leases.

ANNUAL REPORT 2017 27

Purchase obligations
Contracts are in place with third party companies to purchase the coffee that is sold in all cafés. In terms of these
supply agreements, there is a guaranteed minimum value of coffee purchases of $1,392 (2016 - $1,140) for the
subsequent 12 months. The coffee purchase commitment is comprised of two components: unapplied futures
commitment contracts and fixed price physical contracts.

Due to the Company acting as the primary coordinator of café construction costs on behalf of its franchisees and for
Company-operated cafés, there is $894 (2016 - $241) of contractual commitments pertaining to construction costs
for new locations and renovations as at the end the Year. Construction costs financed for franchise projects are from
deposits received from franchisees and for corporate projects from the Company’s cash flows.

Other obligations
The Company is involved in litigation and other claims arising in the normal course of business. Judgment must be
used 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. It is believed that no significant losses or expenses will
be incurred 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.

Related parties
Related parties are identified as key management, members of the Board of Directors, and shareholders that
effectively exercise significant influence on the Company. Such related parties include any entities acting with or on
behalf of the aforementioned parties.

EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES

The Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”) must acknowledge 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 as issued by COSO. In addition, in respect of:

Disclosure controls and procedures
The CEO and CFO must certify 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.

As at February 23, 2018, 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 30, 2017, 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.

During the 13 weeks ended December 30, 2017 and up to the date of the approval of the Audited Financial
Statements and MD&A, there has been no change that has materially affected, or is reasonably likely to materially
affect the Company’s disclosure controls and procedures.

28 THE SECOND CUP LTD.

MANAGEMENT’S DISCUSSION AND ANALYSIS

Internal controls over financial reporting
The CEO and CFO must certify 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 the Unaudited Condensed Interim Financial Statements for external purposes in
accordance with IFRS.

As at February 23, 2018, 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 30, 2017, the Company’s controls over financial reporting were appropriately
designed and were 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 13 weeks ended December 30, 2017 and up to the date of the approval of the Audited Financial
Statements and MD&A, 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 the Audited Financial Statements requires management to make estimates, assumptions, and
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. Revisions
to accounting estimates are recognized in the period in which the estimates are revised and in any future periods
affected. The accounting estimates will, by definition, seldom equal the related actual results.

Estimates
The following are examples of estimates and assumptions the Company makes:
• the recoverability of tangible and intangible assets subject to depreciation, amortization, or with indefinite lives;
• the derivation of income tax assets and liabilities;
• the estimated useful lives of assets;
• café lease provisions and restructuring charges; and
• the allowance for doubtful accounts.

Use of judgement
The following discusses the most significant accounting judgements and estimates that the Company has made in
the preparation of the Audited Financial Statements:

(i) Impairment charges
Impairment analysis is an area involving management judgement in determining the recoverable amount of an asset.
The recoverable amount of a cash generating unit (“CGU”) is calculated as the higher of the fair value less costs
of disposal, and its value in use. Fair value 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 and based
on a market participant’s view. 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:
• growth in total revenue;
• change and timing of cash flows such as the increase or decrease of expenditures;
• selection of discount rates to reflect the risks involved; and
• applying judgement in cash flows specific to CGUs.

ANNUAL REPORT 2017 29

Changing the assumptions selected by management, in particular the discount rate and the growth rate used in the
cash flow projections, could significantly affect the impairment evaluations and recoverable amounts.

The Company’s impairment tests include key assumptions related to the scenarios discussed above.

(ii) Deferred income taxes
The timing of reversal of temporary differences and the expected income allocation to various tax jurisdictions within
Canada affect the effective income tax rate used to compute the deferred income taxes. 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 expenditures, affecting current or deferred income tax balances and expenses.

(iii) Estimated useful lives
Estimates for the useful lives of property and equipment are based on the period during which the assets are
expected to be available-for-use. The amounts and timing of recorded expenses for depreciation of property and
equipment for any period are affected by these estimated useful lives. It is possible that changes in these factors may
cause significant changes in the estimated useful lives of property and equipment in the future.

(iv) Café lease provisions
Café lease provisions require judgement to evaluate the likelihood and measurement of settlements, temporary
payouts or subleasing. Management works with landlords and franchises and uses previous experience to obtain
adequate information needed to make applicable judgements.

(v) Allowance for doubtful accounts
The allowance for impairment of trade and other receivables is established when there is objective evidence that the
Company will not be able to collect all amount due according to the original terms of the receivable. The carrying
amount of the asset is reduced through the use of an allowance account, and the amount of the loss is recognized
in expenses in the statement of income. When an account is deemed uncollectible, it is written off against the
allowance account. Subsequent recoveries of amounts previously written off are recognized as a recovery in
expenses in the statement of income.

CHANGES IN ACCOUNTING POLICIES

In accordance with the IFRS Interpretations Committee (“IFRIC”) agenda decision addressing the expected
manner of recovery of an intangible asset with an indefinite useful life for the purposes of measuring deferred tax in
accordance with IAS 12, Income Taxes (“IAS 12”), the IFRIC noted that an intangible asset with an indefinite useful
life does not mean infinite life, nor does it mean the expected manner of recovery of the carrying amount would
result solely through sale. Therefore, in applying IAS 12, an entity must determine its expected manner of recovery
of the carrying value of the intangible asset with an indefinite life and should reflect the tax consequences that follow
from that expected manner of recovery. Previously, the Company measured deferred taxes on temporary differences
arising from certain indefinite life intangible assets using capital gains rates on the basis that the assets will be
recovered through its disposition. As a result of the IFRIC agenda decision, the Company has changed its accounting
policy to measure deferred taxes at the income tax rate applicable to ordinary taxable income expected to apply in
the years in which the temporary differences are expected to be recovered or settled. The Company adopted this
change on a retrospective basis as an accounting policy change in accordance with IAS 8, “Accounting Policies,
Changes to Accounting Estimates and Errors” and the impact on the financial statements was an increase to deferred
tax liabilities at December 27, 2015 of $2,388, a corresponding adjustment to retained earnings (deficit) of $2,388.

30 THE SECOND CUP LTD.

MANAGEMENT’S DISCUSSION AND ANALYSIS

Recent accounting pronouncements not yet effective
In May 2014, the IASB issued IFRS 15, a new comprehensive model for entities to use accounting for revenue arising
from contracts with customers. In September 2015, the IASB deferred adoption of the new standard by one year.
Several updates have been issued since then to clarify the implementation guidance. The new guidance supersedes
the most current revenue recognition guidance, including industry-specific guidance, enhances revenue recognition
disclosures, and is now effective commencing in 2018. The guidance allows for either a full retrospective or modified
retrospective transition method. We currently expect to apply the modified retrospective transition method.

Under current accounting guidance, we recognize initial franchise fees when we have performed all material
obligations and services, which generally occurs when the franchised café opens. As required under the new
guidance, we anticipate deferring the initial franchise fees and recognizing revenue over the term of the related
franchise agreement (generally ten years).

We anticipate an increase in deficit as at December 31, 2017, the date of initial adoption and a corresponding
increase in deferred revenue reflecting initial franchise fees previously recognized that are now recorded over the
term.

We anticipate that the new guidance will also change our reporting of the Co-op Fund contributions from
franchisees and the related advertising and promotional expenditures, which are currently reported on a net basis
in our Statements of Financial Position. Under the new guidance, Co-op Fund contributions from franchisees and
advertising and promotional expenditures will be reported on a gross basis.

In addition, we anticipate that the estimated breakage income on gift cards will be recognized as gift cards are
utilized instead of our current policy of recognizing on a pro rata basis based on historical gift card redemption
patterns.

We do not believe this guidance will materially impact our recognition of revenue from Company-owned cafes and
product sales or our recognition of franchise royalties revenue.

IFRS 9 replaces the incurred loss model under IAS 39 with a model on expected credit losses. Under the new
standard, expected credit losses will need to be recorded. Under our current accounting, losses are recognized when
probable. We are currently assessing the impact of the new standard, however, the new standard will likely increase
our allowance for doubtful account provision.

IFRS 16, Leases, sets out the principles for the recognition, measurement, presentation and disclosure of leases for
both parties to a contract, the customer (‘lessee’) and the supplier (‘lessor’). This will replace IAS 17, Leases, and
related Interpretations. IFRS 16 provides revised guidance on identifying a lease and for separating lease and non-
lease components of a contract. IFRS 16 introduces a single accounting model for all leases and requires a lessee to
recognize right-of-use assets and lease liabilities for leases with terms of more than 12 months, unless the underlying
asset is of low value, and depreciation of lease assets separately from interest on lease liabilities on the Statements of
Operations and Comprehensive Loss.

Under IFRS 16, lessor accounting for operating and finance leases will remain substantially unchanged. IFRS 16 is
effective for annual periods beginning on or after January 1, 2019, with earlier application permitted for entities
that apply IFRS 15, Revenue from Contracts with Customers. The guidance allows for either a full retrospective
or modified retrospective transition method. The Company currently expects to apply the modified retrospective
transition method. Further, the Company currently expects to apply the practical expedients to i) grandfather the
assessment of which transactions are leases; ii) recognition exemption of short-term leases; and iii) recognition
exemption leases of low-value items.

ANNUAL REPORT 2017 31

The Company has completed a preliminary assessment of the potential impact on its financial statements, but has
not yet completed its detailed assessment. So far, the most significant impact identified is that the Company will
recognize new assets and liabilities for its subleases, operating leases of its head office and corporate cafés.

RISKS AND UNCERTAINTIES

This section is qualified by the section “Caution Regarding Forward-Looking Statements” at the beginning of this
MD&A.

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 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, independent cafés, all restaurants and food service outlets that serve coffee, and supermarkets that compete
in the whole bean and roast and ground segments.

Growth of the café network depends on Second Cup’s ability to secure and build desirable locations and find high
calibre, qualified franchisees to operate them. Credit markets may affect the ability of franchisees to obtain new
credit or refinance existing credit on economically reasonable terms.

Second Cup faces competition for café locations and franchisees from its competitors and from franchisors and
operators of other businesses. The success of franchisees is significantly influenced by the location of their cafés.
There can be no assurance that current café locations will continue to be attractive, or that additional café sites can
be located and secured as demographic and traffic patterns change. Also, there is no guarantee that the property
leases in respect of the cafés will be renewed or suitable alternative locations will be obtained and, in such event,
cafés could be closed. It is possible that the current locations or economic conditions where cafés are located could
decline in the future, resulting in reduced sales in those locations. There is no assurance that future sites will produce
the same results as past sites. There is also no assurance that a franchisee will continue to pay 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 the business.

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 changes 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, traffic and weather patterns, as well competing
cafés.

Business could be adversely affected by increased concerns about food safety in general or other unusual events.
On May 28, 2015, the government of Ontario enacted the Making Healthy Choices Act, 2015. The Act came into force
on January 1, 2017. Restaurant chains and other food service providers with 20 or more locations operating under
the same (or substantially the same) name in Ontario have made changes to the information they display on menus,
menu boards and displays.

Second Cup relies heavily on information technology (IT) network infrastructure. The ability to manage operations
effectively and efficiently depends on the reliability and capacity of these IT 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. Cafés rely on IT network infrastructure to order goods and process credit, debit and café card

32 THE SECOND CUP LTD.

MANAGEMENT’S DISCUSSION AND ANALYSIS

transactions. Coffee Central financial and administrative functions rely on IT infrastructure for accurate and reliable
information. The failure of these systems to operate effectively, or 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.

The company’s cash flow can also be impacted by underperformance of its franchise network through reduced
royalties, higher lease exit provisions or the increase in the number of corporate stores. Reduced earnings could
impact the company’s ability to comply with its credit facility covenants.

The loss of key personnel and/or a shortage of experienced management and hourly employees could have an
adverse impact on 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

This section is qualified by the section “Caution Regarding Forward-Looking Statements” at the beginning of
this MD&A.

Second Cup continues to rollout Pinkberry premium frozen yogurt which is now in 30 cafés across the country.
Response to this complimentary, premium offering has been very favourable with new customers attracted to the
cafés, driving incremental sales. Pinkberry will be introduced to more cafés across the network in time for the peak
frozen yogurt season.

In January, Second Cup led the Canadian coffee market with a move to Clean Label beverages which now represent
over 70% of the beverage menu. Clean Label products contain no artificial colours, flavours, preservatives or high
fructose corn syrup.

DEFINITIONS AND DISCUSSION ON CERTAIN NON-GAAP FINANCIAL MEASURES

In this MD&A, the Company reports certain non-GAAP financial measures such as system sales of cafés, same café
sales, operating income (loss), EBITDA, adjusted EBITDA, adjusted net income (loss) and adjusted net income (loss)
per share. Non-GAAP measures are not defined under IFRS and are not necessarily comparable to similarly titled
measures reported by other issuers.

System sales of cafés
System sales of cafés comprise the net revenue reported to Second Cup by franchisees of Second Cup cafés and
by Company-owned cafés. This measure is useful in assessing the operating performance of the entire Company
network, such as capturing the net change of the overall café network.

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

Same café sales
Same café sales represent the percentage change, on average, in sales at cafés operating system-wide that have
been open for more than 12 months. It is one of the key metrics the Company uses to assess its performance as an
indicator of appeal to customers. Two principal factors that affect same café sales are changes in customer count and
changes in average transaction size.

ANNUAL REPORT 2017 33

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

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

Adjusted net income (loss) and adjusted net income (loss) per share
Adjustments to net earnings (loss) and net earnings (loss) per share are for items that are not necessarily reflective
of the Company’s underlying operating performance. These measures are not defined under IFRS, although the
measures are derived from input figures in accordance with IFRS. Management views these as indicators of financial
performance.

34 THE SECOND CUP LTD.

MANAGEMENT’S DISCUSSION AND ANALYSIS

Reconciliations of net income (loss) to operating income (loss), EBITDA, adjusted EBITDA, adjusted net income (loss)
and adjusted net income (loss) per share are provided below:

Net income (loss)

Income taxes (recovery)

Interest and financing costs

Operating income (loss)

Net income (loss)

Income taxes (recovery)

Interest and financing costs

Depreciation of property and equipment

Amortization of intangible assets

EBITDA

Add (deduct) impact of the following:
One-time transition costs

Adjusted EBITDA

13 weeks ended

14 weeks ended

52 weeks ended

53 weeks ended

December 30,
2017

December 31,
2016

December 30,
2017

December 31,
2016

$655

343

(5)

$993

$147

$302

($3,097)

176

3,897

$976

($975)

(265)

255

($985)

13 weeks ended

14 weeks ended

52 weeks ended

53 weeks ended

December 30,
2017

December 31,
2016

December 30,
2017

December 31,
2016

$655

343

(5)

228

118

1,339

$1,339

$147

291

$667

($3,097)

176

3,897

1,002

456

2,434

287

$2,721

($975)

(265)

255

1,168

380

563

$563

13 weeks ended

14 weeks ended

52 weeks ended

53 weeks ended

December 30,
2017

December 31,
2016

December 30,
2017

December 31,
2016

Net income (loss)

$655

$147

($3,097)

($975)

Add impact of the following:
After-tax fair value difference on shares

issued and other costs

Adjusted net income (loss)

$655

$147

3,207

$110

($975)

13 weeks ended

14 weeks ended

52 weeks ended

53 weeks ended

December 30,
2017

December 31,
2016

December 30,
2017

December 31,
2016

Net income (loss) per share

$0.04

$0.01

($0.21)

($0.08)

Add impact of the following:
After-tax fair value difference on shares

issued and other costs

Adjusted net income (loss) per share

$0.04

$0.01

0.22

$0.01

($0.08)

ANNUAL REPORT 2017 35

Audited Financial Statements

For the 52 weeks ended December 30, 2017 and 53 weeks ended December 31, 2016

INDEPENDENT AUDITOR’S REPORT

February 23, 2018

To the Shareholders of
The Second Cup Ltd.

We have audited the accompanying financial statements of The Second Cup Ltd., which comprise the statements
of financial position as at December 30, 2017 and December 31, 2016 and the statements of operations and
comprehensive loss, statements of changes in shareholders’ equity and statements of cash flows for the fifty-two
and fifty-three week periods then ended, and the related notes, which comprise a summary of significant accounting
policies and other explanatory information.

Management’s responsibility for the financial statements
Management is responsible for the preparation and fair presentation of these financial statements in accordance with
International Financial Reporting Standards, and for such internal control as management determines is necessary to
enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error.

Auditor’s responsibility
Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our
audits in accordance with Canadian generally accepted auditing standards. Those standards require that we comply
with ethical requirements and plan and perform the audit to obtain reasonable assurance about whether the financial
statements are free from material misstatement.

An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial
statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of
material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments,
the auditor considers internal control relevant to the entity’s preparation and fair presentation of the financial
statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose
of expressing an opinion on the effectiveness of the entity’s internal control. An audit also includes evaluating the
appropriateness of accounting policies used and the reasonableness of accounting estimates made by management,
as well as evaluating the overall presentation of the financial statements.

We believe that the audit evidence we have obtained in our audits is sufficient and appropriate to provide a basis for
our audit opinion.

Opinion
In our opinion, the financial statements present fairly, in all material respects, the financial position of The Second Cup
Ltd. as at December 30, 2017 and December 31, 2016 and its financial performance and its cash flows for the fifty-two
and fifty-three week periods then ended, respectively, in accordance with International Financial Reporting Standards.

Chartered Professional Accountants, Licensed Public Accountants

36 THE SECOND CUP LTD.

Statements of Financial Position

As at December 30, 2017 and December 31, 2016
(Expressed in thousands of Canadian dollars)

2017

2016

ASSETS

Current assets
Cash and cash equivalents

Restricted cash (note 23)

Trade and other receivables (note 6)

Notes and leases receivable (note 7)

Inventories (note 8)

Prepaid expenses and other assets

Income tax receivable

Non-current assets
Notes and leases receivable (note 7)

Property and equipment (note 9)

Intangible assets (note 10)

Total assets

LIABILITIES

Current liabilities
Accounts payable and accrued liabilities (note 11)

Provisions (note 12)

Other liabilities (note 13)

Gift card liability

Deposits from franchisees

Income tax payable

Non-current liabilities
Provisions (note 12)

Other liabilities (note 13)

Long-term debt (note 14)

Deferred income taxes (note 19)

Total liabilities

SHAREHOLDERS’ EQUITY

Total liabilities and shareholders’ equity

Contingencies, commitments and guarantees (note 24)
See accompanying notes to financial statements.

Approved by the Directors February 23, 2018

Michael Bregman, Director

Rael Merson, Director

$4,573

1,359

3,716

205

10,122

2,132

32,372

$44,700

$3,974

934

459

3,432

979

9,869

230

179

6,160

16,438

28,262

$44,700

$3,004

1,947

3,023

139

200

251

532

9,096

173

3,434

32,611

$45,314

$3,700

1,598

217

3,484

1,243

10,242

530

267

7,181

6,206

24,426

20,888

$45,314

ANNUAL REPORT 2017 37

Statements of Operations
and Comprehensive Loss

For the periods ended December 30, 2017 and December 31, 2016
(Expressed in thousands of Canadian dollars, except per share amounts)

Revenue (note 15)

Company-owned cafés and product sales

Franchise revenue

Operating costs and expenses (note 16)

Company-owned cafés and cost of product sales

Franchise

General and administrative

Loss on disposal of assets

Depreciation and amortization

Income (loss) from operations

Interest and financing costs (notes 14 and 18)

Loss before income taxes

Income taxes (note 19)

Net loss and comprehensive loss for the period

Basic and diluted loss per share (note 20)

See accompanying notes to financial statements.

2017

$8,562

15,074

22,636

9,303

5,693

6,009

197

1,458

22,660

976

3,897

(2,921)

176

($3,097)

($0.21)

2016

$14,663

15,688

30,351

15,681

8,103

5,779

225

1,548

31,336

(985)

255

(1,240)

(265)

($975)

($0.08)

38 THE SECOND CUP LTD.

Statements of Changes in
Shareholders’ Equity

For the periods ended December 30, 2017 and December 31, 2016
(Expressed in thousands of Canadian dollars)

Share Capital

Warrants

Contributed
Surplus

Retained
Earnings
(Deficit)

Total

Balance – December 26, 2015
(note 2.x)

Net loss for the period

Stock option plan expense (note 26)

Issuance of warrants (note 14)

$8,652

–

Balance – December 31, 2016

$8,652

Net loss for the period

Stock option plan recovery (note 26)

Warrants extinguished (note 14)

Warrants issued (note 14)

Shares issued (note 3)

Balance – December 30, 2017

See accompanying notes to financial statements.

$–

–

10,619

$19,271

$–

–

271

$271

$–

–

(271)

165

–

$165

$61,736

($48,849)

$21,539

–

$61,789

$–

(42)

–

(975)

–

($49,824)

($3,097)

–

(975)

271

$20,888

($3,097)

(42)

(271)

165

10,619

$61,747

($52,921)

$28,262

ANNUAL REPORT 2017 39

Statements of Cash Flows

For the periods ended December 30, 2017 and December 31, 2016
(Expressed in thousands of Canadian dollars)

2017

2016

CASH PROVIDED BY (USED IN)

Operating activities

Net loss for the period

Items not involving cash

Depreciation of property and equipment

Amortization of intangible assets

Amortization of deferred financing costs

Share-based compensation expense

Deferred income taxes (note 19)

Loss on disposal of capital related items

Fair value difference on shares issued and other costs (note 4)

Bad debt expense for notes and leases receivable

Change in fair value of interest rate swap (note 5)

Changes in non-cash working capital & other (note 21)

Cash provided by (used in) operating activities

Investing activities

Proceeds from disposal of capital related items

Cash payments for capital expenditures (note 21)

Cash payments for intangible assets (note 21)

Notes receivable repayment

Cash provided by (used in) investing activities

Financing activities

Repayment of term loan (note 14)

Proceeds from new term loan

Transaction costs

Cash (used in) provided by financing activities

Increase (decrease) in cash and cash equivalents during the period

Cash and cash equivalents – Beginning of the period

Cash and cash equivalents – End of the period

See accompanying notes to financial statements. Supplemental cash flow information is provided in note 21.
Information on non-cash transactions and supplemental cash flow information are described further in

notes 5, 14, 21, and 22.

($3,097)

1,018

456

139

197

3,290

—

(274)

1,862

473

(383)

(217)

131

—

(297)

1,569

3,004

$4,573

($975)

1,168

403

—

238

225

—

(77)

(2,288)

(1,253)

334

(382)

(393)

(365)

(6,000)

8,000

(458)

1,542

(76)

3,080

$3,004

40 THE SECOND CUP LTD.

Notes to the Financial Statements

For the periods ended December 30, 2017 and December 31, 2016
(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 a Canadian specialty coffee retailer with 286 (2016 - 294)
cafés operating under the trade name Second Cup™ in Canada, of which 12 (2016 - 22) are Company-operated and
the balance operated by franchisees.

The Company owns the trademarks, trade names, operating procedures, systems and other intellectual property
used in connection with the operation of Second Cup cafés in Canada.

The Company was incorporated under the Business Corporations Act (Ontario) in 2011 and is domiciled in Canada.
The address of its registered office and principal place of business is 6303 Airport Road, 2nd Floor, Mississauga,
Ontario, L4V 1R8. The Company hereafter refers to its head office activities as “Coffee Central”. The Company’s
website is www.secondcup.com. The common shares of the Company are listed on the Toronto Stock Exchange
under the symbol “SCU”.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

a. Basis of preparation
The financial statements (the “financial statements”) have been prepared in accordance with International Financial
Reporting Standards (“IFRS”) as issued by the International Accounting Standards Board (“IASB”). The financial
statements have been prepared on the historical cost basis except for certain financial instruments that are measured
at fair values at the end of each reporting period. The Company’s functional currency is the Canadian dollar.

The Company’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. Fiscal 2017 is a 52-week period (2016 - 53 weeks).

The Company 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, and 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-operated cafés and are based on a percentage of café sales. The revenue,
expenses and cash flows of the Co-op Fund are not consolidated, but are netted on the Statement of Financial
Position in accounts payable if there is a surplus, or in accounts receivable if there is a deficit to the extent that the
Company will recover the deficit from franchisees. The assets and liabilities of the Co-op Fund are included in the
assets and liabilities of the Company on the Statements of Financial Position. The policy is established because the
contributions to the Co-op Fund are segregated, designated for a specific purpose and the Company is acting as
an agent. Since the decisions as to the content and nature of the marketing campaigns are made solely by a body
made up of six franchisees elected by their peers and includes representation from each region of our network
(the “Advisory Council”) and fulfilled by third parties, the Company does not have the primary responsibility for
completing marketing campaigns using the Co-op Fund contributions provided by each franchisee.

b. Segmented information and reporting
Operating segments are reported in a manner consistent with the internal reporting provided to the Chief Executive
Officer. The Company substantially operates and is managed as one reportable segment. Operating revenues are
comprised of royalties, the sale of goods from Company-operated cafes, the sale of goods through retail and other
ancillary channels, and other service fees.

Management is organized based on the Company’s operations as a whole rather than the specific revenue streams.

ANNUAL REPORT 2017 41

c. Critical accounting estimates, assumptions and the use of judgement
The preparation of financial statements requires management to make estimates, assumptions, and use judgement
in applying its accounting policies and in determining 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. Revisions
to accounting estimates are recognized in the period in which the estimates are revised and in any future periods
affected. The accounting estimates will, by definition, seldom equal the related actual results.

Estimates

The following are examples of critical estimates, assumptions and judgements the Company makes in determining
the amounts reported in the financial statements:
• the determination of the recoverable amounts of tangible and intangible assets subject to depreciation,

amortization, or with indefinite lives;

• the derivation of income tax assets and liabilities;
• the estimated useful lives of assets;
• café lease provisions and restructuring charges; and
• the allowance for doubtful accounts.

Use of judgement

The following discusses the critical judgements and accounting estimates that the Company has made in the
preparation of the financial statements:

The Company’s impairment tests include key assumptions related to the scenarios discussed above. Further details
are provided in note 17 to the financial statements.

(ii) Deferred income taxes
The timing of reversal of temporary differences and the expected income allocation to various tax jurisdictions within
Canada affect the effective income tax rate used to compute the deferred income taxes. Management estimates the
reversals based on historical and budgeted operating results and income tax laws existing at the reporting dates. In
addition, management occasionally estimates the current or future deductibility of certain expenditures, affecting
current or deferred income tax balances and expenses.

42 THE SECOND CUP LTD.

NOTES TO THE FINANCIAL STATEMENTS

(iii) Estimated useful lives
The useful lives of property and equipment are based on the period during which the assets are expected to be
available-for-use. The amounts and timing of recorded expenses for depreciation of property and equipment for any
period are affected by these estimated useful lives. It is possible that changes in these factors may cause significant
changes in the amount of depreciation recorded in respect of the Company’s property and equipment in the future.

(iv) Café lease provisions
Café lease provisions are based on the evaluation of the likelihood and measurement of settlements, temporary
payouts, or sub-leasing. Management works with landlords, franchisees and uses previous experience to obtain
adequate information needed to make these assessments.

(v) Allowance for doubtful accounts
The allowance for impairment of trade and other receivables is established when there is objective evidence that the
Company will not be able to collect all amounts due according to the original terms of the receivable. The carrying
amount of the asset is reduced through the use of an allowance account, and the amount of the loss is recognized
in expenses in the statement of operations and comprehensive loss. When an account is deemed uncollectible, it is
written off against the allowance account. Subsequent recoveries of amounts previously written off are recognized as
a recovery in expenses in the statement of operations and comprehensive loss.

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
liabilities are derecognized when obligations are discharged, cancelled or they expire.

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. Hedge accounting is not used.

On recognition, the Company classifies its financial instruments in the following categories depending on the
purpose for which the instruments were acquired:

Categorization

Recognition method

Financial instrument

Financial assets

Cash and cash equivalents

Restricted cash

Loans and receivables

Trade and other receivables

Loans and receivables

Notes and leases receivable

Loans and receivables

Financial liabilities

Accounts payable and accrued liabilities

Other financial liabilities

Gift card liability

Deposits from franchisees

Term credit facility

Other financial liabilities

Amortized cost

ANNUAL REPORT 2017 43

(i) Cash and cash equivalents, restricted cash, trade and other receivables, and notes and leases receivable: Loans
and receivables are non-derivative financial assets with fixed or determinable payments that are not quoted in an
active market. Loans and receivables are initially recognized at the amount expected to be received, and if necessary,
less a present value discount if collection is to be expected beyond one year. Subsequently, loans and receivables
are measured at amortized cost using the effective interest method less a provision for impairment, if necessary.

(ii) Transaction costs: Long-term debt and share capital are accounted for at fair value, net of any transaction costs
incurred. Long-term debt, subsequently, is accounted for at amortized cost using the effective interest method.
Transaction costs associated with instruments recognized at amortized cost are amortized over the expected life of
the instrument. This classification has been selected as it results in better matching of the transaction costs with the
periods benefiting from the transaction costs.

e. Cash and cash equivalents and restricted cash
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. Restricted cash represents cash on deposit with banks
that are held in trust of the Co-op Fund and Development Fund as well as $240 held as security for cash management
services.

f. Leases receivable
The Company has entered into lease agreements acting as the lessor with certain franchisees relating to point of
sale systems (“POS”). The lease term is for the major part of the economic life of the POS although the title is not
transferred. Leases are recognized as finance type leases and recorded as leases receivable at an amount equal to
the net investment in the lease. Leases receivable are initially recognized at the amount expected to be received,
less a present value discount if collection is to be expected beyond one year. Subsequently, leases receivable are
measured at amortized cost using the effective interest method less a provision for impairment.

g. Inventories
Inventories are stated at the lower of cost and net realizable value, with cost being determined on an average
cost basis for items that are interchangeable. For inventory items that are not interchangeable, specific costs are
attributed to the specific individual items. Net realizable value is the estimated recoverable amount less applicable
selling expenses. If carrying value exceeds net realizable amount, a write-down is recognized. The write-downs are
reversed if the circumstances that caused the initial write-down no longer exist.

h. Property and equipment
Property and equipment are stated at cost less accumulated depreciation net of any impairment losses. Cost includes
expenditures 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 removed when replaced. Repairs and maintenance costs are charged to the Statements of
Operations and Comprehensive Loss during the period in which they are incurred. Where property and equipment
construction projects are of a sufficient size and duration, an amount is capitalized for the costs used to finance
construction.

Depreciation is calculated using the straight-line basis as this approach best reflects consumption and benefit
patterns pertaining to the asset’s use. Depreciation is charged commencing when the asset is available for use. The
following rates are based on the expected useful lives of the assets:

Leasehold improvements

lesser of 10 years and the remaining term of the lease

Equipment, furniture, fixtures and other

Computer hardware

3 to 7 years

3 years

4 4 THE SECOND CUP LTD.

NOTES TO THE FINANCIAL STATEMENTS

Intangible assets

i.
Intangible assets consist of trademarks and software, which are amortized or assessed for impairment 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 write-downs. The trademark is an indefinite life intangible asset that is tested annually for impairment
or at any time an indicator for impairment exists. The trademark assets do not have continual renewal requirements
nor is there any deterioration incurred due to usage. As a result of the combination of the aforementioned, the
trademark assets are considered to have indefinite lives.

(ii) 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 as management believes this approach best reflects
consumption and benefit patterns pertaining to the asset’s use. The following rate is based on the expected useful
life of the asset:

Software

3 to 7 years

Where software implementation projects are of a sufficient size and duration, an amount is capitalized for the costs
used to finance development.

j. Provisions
Provisions are recognized when there is 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 the 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. Evaluations are
performed to identify onerous contracts and, where applicable, provisions are recorded for such contracts.

Provisions for café closures are estimates for costs expected to be incurred by the Company for operational franchise-
owned cafés. Lease and other occupancy costs not expected to be fully paid by the franchisee are recorded as the
Company has liability on the café head lease.

k. Other liabilities
(i) Deferred revenue
The Company has entered into several supply agreement contracts and receives allowances from certain suppliers
in consideration for the café network achieving certain volume thresholds over the term of the supply agreement.
Deferred revenue is amortized over the term of the supply agreements based on the proportion of volume thresholds
met during the fiscal year or other rational basis.

Cash received from franchisees for the commencement of a new franchise term, licensing fees, construction
management, or a pending transfer arrangement are deferred as deposits from franchisees until the revenue
recognition criteria are met.

(ii) Leasehold inducements
Leasehold inducements are amortized to rent expense on a straight-line basis over the term of the lease.

ANNUAL REPORT 2017 45

Income taxes

l.
Income taxes comprise of current and deferred income taxes. Income taxes are recognized in the Statements of
Operations and Comprehensive Loss except to the extent that they relate 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 period, using tax rates enacted, or substantively enacted, at the end of the reporting
period, and any adjustment to tax payable in respect of previous periods.

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 recovered or
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.

m. Gift card liability
The gift card program allows customers to prepay for future purchases by loading a dollar value onto their gift cards
through cash or credit/debit cards in the cafés or online through credit cards, when and as needed. The gift card
liability represents liabilities related to unused balances on the 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. Gift cards do not have an expiration date and outstanding unused balances are
not depleted.

When it is determined the likelihood of the remaining balance of a gift card being redeemed by the customer
is remote, the amount is recorded as breakage. The determination of the gift card breakage rate is based upon
Company-specific historical load and redemption patterns. The 2017 analysis determined that a breakage rate of 3%
was applicable to gift card sales, which is consistent with 2016 experience. Gift card breakage is recognized on a pro
rata basis based on historical gift card redemption patterns. Breakage income is fully allocated to the Co-op Fund
and not recorded in earnings.

n. Deposits from franchisees
The development process of a new or to be renovated café requires a deposit from a franchisee at the outset.
Deposits from franchisees are applied against the cost of constructing a new café or the renovation of an existing
café.

o. Revenue recognition
Revenue is recognized when it is probable that 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 consideration received or receivable. Revenue is reduced for estimated customer returns,
rebates and other revenue related concessions.

(i) Royalties
Royalty revenue from franchised cafés is based on agreed percentage royalty rates of the franchise location sales.
Revenue is recognized on an accrual basis in accordance with the substance of the relevant agreement, provided
that it is probable that the economic benefits will flow to the Company and the amount of revenue can be measured
reliably.

46 THE SECOND CUP LTD.

NOTES TO THE FINANCIAL STATEMENTS

(ii) Services and other
Services and other consists of initial franchise fees, renewal fees, transfer fees earned on the sale of cafes from one
franchisee to another, construction administration fees, purchasing coordination fees, and other ancillary fees (such as
IT support and training fees).

(iii) Company-owned cafés and product sales
Company-owned cafés and product sales revenue includes the sale of goods from Company owned cafés, as well as
products sold in grocery stores through wholesale distribution channels and third party licensing agreements.

p. Operating costs and expenses
(i) Company-owned cafés and cost of product sales
Company-owned cafés and cost of product sales represents the product cost of goods sold in Company-operated
cafés and through the wholesale grocery channel, plus the cost of direct labour to prepare and deliver the goods to
the customers in the Company-operated cafés and any occupancy related costs.

(ii) Franchise
Franchise costs represent the cost of direct labour to support the network, travel and franchisee meetings, business
development initiatives as well as professional fees directly related to franchise operations.

(iii) General and administrative
General and administrative costs include labour and related expenses for head office, professional fees not directly
attributable to franchise operations and occupancy costs.

q. Operating leases
Operating lease payments are recognized as an 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, option periods are considered for which failure to renew the lease imposes an economic
penalty on the Company of such an amount that the renewal appears to be reasonably assured at the inception of
the lease.

r. Directors’ deferred share unit plan
Units granted under the Directors’ deferred share unit plan have graded vesting for each month of service completed
over the course of one year. Units are paid out in cash upon the termination of the director. Units are granted based
on a weighted average price of the Company’s shares on the five most recent days preceding the grant date. The
fair value of the grants is amortized over the respective vesting period using the graded amortization method.
Compensation expense is adjusted for changes in fair value of the Company’s share price thereafter. Any dividends
paid during the vesting period will be accrued based on the total number of units granted. Amounts recognized are
recorded in general and administrative expenses.

Recorded values of the plan are presented as accounts payable and accrued liabilities in the Statements of Financial
Position.

s. 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 there is objective evidence of an impairment loss include:
• significant financial difficulty of the borrower/lessee;
• delinquencies in interest or principal payments; and
• it becomes probable that the borrower/lessee will enter bankruptcy or other financial reorganization.

ANNUAL REPORT 2017 47

If such evidence exists, an impairment loss is recognized for assets carried at amortized cost as follows:

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 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 a charge is
recorded in operating expenses.

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 of non-financial assets

t.
Property and equipment and intangible assets without indefinite lives are tested for impairment when events or
changes in circumstances indicate the carrying value may not be recoverable. Assets with indefinite lives are subject
to an annual impairment test or any time an impairment indicator exists. The yearend date has been selected as the
mandatory annual test date.

For the purpose of measuring recoverable amounts, assets are grouped at the lowest levels for which there are
separately identifiable cash inflows that are largely independent of the cash inflows from their assets or group of
assets, which represent a cash generating unit (CGU). The recoverable amount of each particular CGU is the higher of
an asset’s fair value less costs of disposal and value in use. CGUs have been determined to be as follows:
• franchising, distribution, and wholesale; and
• Company-operated cafés; each Company-operated café is considered a separate CGU.

The impairment analysis involves comparing the carrying value of the CGUs with their estimated recoverable
amounts. An impairment loss is recognized for the amount by which the CGU’s carrying value exceeds its recoverable
amount. Impairment losses for a CGU reduce first the carrying value of any goodwill allocated to that CGU. Any
remaining impairment loss is charged pro rata to the other assets in the CGU.

Impairment losses, other than goodwill impairment, are evaluated for potential reversals when events or
circumstances warrant such consideration.

u. 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 and include members of key management of the Company. All transactions with
related parties are recorded at fair value.

v. Share-based compensation
For share option awards granted as part of the stock option plan, a fair value is determined at the date of grant and that
fair value is recognized in the financial statements over the vesting period. Proceeds arising from the exercise of share
option awards are credited to share capital, as are the recognized grant-date fair values of the exercised share option
awards. Share option awards which are determined to be settled on a net-equity basis are accounted for as equity
instruments. Share option awards which are determined to be settled on a net-cash settlement basis are accounted as
liability instruments. The stock option plan was introduced in May 2014 and is further discussed in note 26.

48 THE SECOND CUP LTD.

NOTES TO THE FINANCIAL STATEMENTS

w. Reclassification
Certain comparable figures have been reclassified to conform to the current period’s financial statement
presentation. The reclassification has been made to enhance the presentation of the company’s activities and the
financial statements. This reclassification has been made to enhance the presentation of the Company’s activities and
the financial statements.

x. Changes in accounting policies
In accordance with the IFRS Interpretations Committee (“IFRIC”) agenda decision addressing the expected
manner of recovery of an intangible asset with an indefinite useful life for the purposes of measuring deferred tax in
accordance with IAS 12, Income Taxes (“IAS 12”), the IFRIC noted that an intangible asset with an indefinite useful
life does not mean infinite life, nor does it mean the expected manner of recovery of the carrying amount would
result solely through sale. Previously, the Company measured deferred taxes on temporary differences arising
from certain indefinite life intangible assets using capital gains rates on the basis that the assets will be recovered
through its disposition. As a result of the IFRIC agenda decision, the Company has changed its accounting policy to
measure deferred taxes at the income tax rate applicable to ordinary taxable income expected to apply in the years
in which the temporary differences are expected to be recovered or settled. The Company adopted this change
on a retrospective basis as an accounting policy change in accordance with IAS 8, “Accounting Policies, Changes
to Accounting Estimates and Errors” and the impact on the financial statements was an increase to deferred tax
liabilities at December 27, 2015 of $2,388 and a corresponding adjustment to retained earnings (deficit) of $2,388.

Recent accounting pronouncements not yet effective
In May 2014, the IASB issued IFRS 15, a new comprehensive model for entities to use accounting for revenue arising
from contracts with customers. In September 2015, the IASB deferred adoption of the new standard by one year.
Several updates have been issued since to clarify the implementation guidance. The new guidance supersedes the
most current revenue recognition guidance, including industry-specific guidance, enhances revenue recognition
disclosures, and is now effective commencing in 2018. The guidance allows for either a full retrospective or modified
retrospective transition method. We currently expect to apply the modified retrospective transition method.

We do not believe this guidance will materially impact our recognition of revenue from Company-owned cafes and
product sales or our recognition of franchise royalties revenue.

ANNUAL REPORT 2017 49

IFRS 9 replaces the incurred loss model under IAS 39 with a model on expected credit losses. Under the new
standard, expected credit losses will need to be recorded. Under our current accounting, losses are recognized when
probable. We are currently assessing the impact of the new standard and expect the new standard will likely increase
our allowance for doubtful account provision.

3. SHARE CAPITAL

The Company is authorized to issue an unlimited number of common shares. Common shares are classified as equity
and have no par value. Incremental costs directly attributable to the issue of new common shares are shown in equity
as a deduction, net of tax, from the proceeds. On August 10, 2017, the Company issued 4,210,528 common shares
and 300,000 warrants of Second Cup to the four shareholders of SPE Finance LLC (SPE), an affiliate of Serruya Private
Equity. See note 4 Management of Capital for further details.

Shares outstanding at the fiscal year ended December 30, 2017 are 17,041,473 (2016 - 12,830,945).

4. MANAGEMENT OF CAPITAL

On August 10, 2017, the Company issued 4,210,528 common shares and 300,000 warrants of Second Cup to the
four shareholders of SPE Finance LLC (SPE), an affiliate of Serruya Private Equity. The Company also extinguished
its $8,000 debt to SPE and cancelled 600,000 of old warrants. These transactions resulted in one-time, non-cash
financing charges of $3,290. These charges consist of the difference between the share price of $2.60 on the issuance
date and the agreed-to share price of $1.90, and the write-off of the unamortized portion of deferred transaction
costs related to the debt.

The Company’s objectives relating to the management of its capital structure are to:
• safeguard its ability to continue as a going concern;
• maintain financial flexibility in order to preserve its ability to meet financial obligations; and
• 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.

50 THE SECOND CUP LTD.

NOTES TO THE FINANCIAL STATEMENTS

5. FINANCIAL INSTRUMENTS AND FINANCIAL RISK MANAGEMENT

Financial instruments
The following summarizes the nature of certain risks applicable to the Company’s financial instruments:

Financial instrument

Financial assets

Cash and cash equivalents

Restricted cash

Trade and other receivables

Notes and leases receivable

Financial liabilities

Interest rate swap

Risks

Credit and interest rate

Credit

Credit, liquidity, and interest rate

Accounts payable and accrued liabilities

Liquidity, currency, and commodity

Gift card liability

Deposits from franchisees

Term credit facility

Liquidity

Liquidity and interest rate

Fair value of financial instruments
The fair values of cash and cash equivalents, restricted cash, trade and other receivables, accounts payable and
accrued liabilities, provisions, other liabilities and gift card liability approximate their carrying values due to their
short-term maturity. The fair value of notes and leases receivable approximates their carrying value as the implicit
interest used to discount the base value is considered to be based on an appropriate credit and risk rate pertaining
to the debtor. The following table summarizes the financial instruments measured at fair value:

Interest rate swap

Opening fair value

Repaid during the year

Change in fair value

Closing fair value

2017

$–

–

$–

2016

($77)

–

$–

The interest rate swap expired in the third quarter of 2016.

Financial instruments that are measured subsequent to initial recognition at fair value are to be categorized in Levels
1 to 3 of 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).

At December 30, 2017, there were no financial instruments classified as Level 2.

ANNUAL REPORT 2017 51

There were no changes between levels in the period ended December 30, 2017 versus the period ended December
31, 2016.

Credit risk
a. Cash and cash equivalents, restricted cash and interest rate swap
Credit risk associated with cash and cash equivalents, restricted cash and the interest rate swap is managed by
ensuring these assets are placed with institutions of high creditworthiness.

b. Trade and other receivables, notes and leases receivable
Trade and other receivables and notes and lease receivable primarily comprise amounts due from franchisees. Credit
risk associated with these receivables is mitigated as a result of the review and evaluation of franchisee account
balances beyond a particular age. Prior to accepting a franchisee, the Company undertakes a detailed screening
process which includes the requirement that a franchisee has sufficient financing. The risk is further mitigated due to
a broad franchisee base that is spread across the country, which limits the concentration of credit risk.

Specific bad debt provisions are accounted for when the expected recovery is less than the actual receivable.

An analysis of aging of trade and other receivables from the billing date net of an allowance for doubtful accounts is
as follows:

0-30 Days

31-60 Days

61-90 Days

> 90 Days

Gross amount as at December 30, 2017

Allowance for doubtful accounts

Net amount 2017

Gross amount as at December 31, 2016

Allowance for doubtful accounts

Net amount 2016

$3,452

(18)

$3,434

$2,630

(38)

$2,592

$158

(60)

$98

$173

(67)

$106

$109

(40)

$69

$247

(112)

$135

$2,322

(2,207)

$115

$2,163

(1,973)

$190

Total

$6,041

(2,325)

$3,716

$5,213

(2,190)

$3,023

Trade and other receivables include a combined allowance for doubtful accounts of $2,325 (December 31, 2016 -
$2,190). Credit terms vary by customer in the range of 30 to 90 days. The net amount due of $115 aged over 90 days
has no specific terms of repayment. Trade and other receivables are further discussed in note 6.

The payment maturity dates of the notes and leases receivable as at December 30, 2017, net of an allowance for
doubtful accounts, are as follows:

2017

2016

< 90 Days

$22

$32

90 Days
to < 1 year

1 year
to < 2 years

2 years
and after

$42

$107

$42

$105

$32

$68

Total

$138

$312

Notes and leases receivable included a combined allowance for doubtful accounts of $55 (December 31, 2016 - $12).
Notes and leases receivable are further discussed in note 7.

52 THE SECOND CUP LTD.

NOTES TO THE FINANCIAL STATEMENTS

Liquidity risk
Liquidity risk is managed through regular monitoring of forecast and actual cash flows, monitoring maturity dates of
financial assets and liabilities, and also the management of the Company’s capital structure and debt leverage as
outlined in note 14. The Company’s main source of income is royalty receipts from its franchisees, corporate café
sales, and sales from goods and services.

Commodity and currency risk
The Company purchases certain products, such as coffee, in U.S. dollars, thereby exposing the company to risks
associated with fluctuations in currency exchange rates. The Company is also directly and indirectly exposed to
commodity market risk. The exposure relates to the changes in coffee commodity prices given it is a material input
for product offerings. The direct exposure pertaining to the wholesale business is mitigated given that the Company
has the ability to adjust its sales price if commodity prices rise over a threshold level. The indirect risk exists
where franchisee profitability may be impacted, thus potentially resulting in an impeded ability to collect accounts
receivable or the need for other concessions to be made to the franchisee. This risk is mitigated by entering fixed
price purchase commitments through coffee commodity brokers and by having the ability to adjust retail selling
prices.

6. TRADE AND OTHER RECEIVABLES

Trade and other receivables

Less: Allowance for doubtful accounts

Net trade and other receivables

2017

$6,041

(2,325)

$3,716

2016

$5,213

(2,190)

$3,023

During the period, $464 (2016 - $576 expense) was recorded as a charge pertaining to trade and other receivables.

7. NOTES AND LEASES RECEIVABLE

Notes receivable – current

Lease receivable – current

Less: Allowance for doubtful accounts – current

Notes and leases receivable – current

Notes receivable – long-term

Lease receivable – long-term

Less: Allowance for doubtful accounts – long-term

Notes and leases receivable – long-term

Notes and leases receivable

2017

$26

(37)

(18)

$138

2016

$71

(2)

139

151

(10)

173

$312

Notes and leases receivable are discounted using an effective discount rate ranging between eight and nine percent.

ANNUAL REPORT 2017 53

8. INVENTORIES

Inventories relate to goods held for resale, at the corporate cafés, and equipment for construction, and are
comprised of the following:

2017

$180

$205

Equipment,
furniture,
fixtures and
construction
in process

Computer
hardware

Leasehold
improvements

$2,396

(1,297)

1,099

–

635

(585)

469

(336)

$5,826

(2,467)

3,359

236

(635)

(769)

344

(689)

$1,358

$1,866

$2,522

(1,164)

1,358

–

(403)

(296)

759

2,462

(1,703)

$759

$4,677

(2,811)

1,866

324

(2)

(389)

(608)

1,275

4,613

(3,338)

$1,275

$835

(532)

303

–

(4)

(142)

$210

$881

(671)

210

–

(1)

(114)

881

(783)

$98

2016

$161

$200

Total

$9,057

(4,296)

4,761

362

–

(1,358)

816

(1,167)

$3,434

$8,080

(4,646)

3,434

369

–

(793)

126

(1,018)

2,132

7,956

(5,824)

$2,132

Merchandise held for resale

Supplies

9. PROPERTY AND EQUIPMENT

Net carrying value
As at December 26, 2015

Cost

Accumulated depreciation

As at December 26, 2015

Additions from operations

Additions from franchise stores reacquired

Reclass of transfers from construction in process

Disposals – original cost

Disposals – accumulated depreciation

Depreciation

As at December 31, 2016

Net carrying value
As at December 31, 2016

Cost

Accumulated depreciation

As at December 31, 2016

Additions from operations

Additions from franchise stores reacquired

Reclass of transfers from construction in process

Disposals – original cost

Disposals – accumulated depreciation

Depreciation

As at December 30, 2017

Cost

Accumulated depreciation

As at December 30, 2017

54 THE SECOND CUP LTD.

10. INTANGIBLE ASSETS

Net carrying value

As at December 26, 2015

Cost

Accumulated amortization

As at December 26, 2015

Additions

Disposals – original cost

Disposals – accumulated amortization

Amortization

As at December 31, 2016

Cost

Accumulated amortization

As at December 31, 2016

Additions

Amortization

As at December 30, 2017

Cost

Accumulated amortization

As at December 30, 2017

11. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES

Accounts payable and accrued liabilities consist of:

Accounts payable – trade

Accrued liabilities

Accrued salaries, wages, benefits, and incentives

Sales tax payable – government remittances payable

NOTES TO THE FINANCIAL STATEMENTS

Trademarks

Software

Total

$31,144

–

31,144

–

$31,144

–

31,144

–

31,144

–

$31,144

$2,615

(1,120)

1,495

393

(29)

(403)

$1,467

$2,979

(1,512)

1,467

217

(456)

1,228

3,194

(1,966)

$1,228

2017

$2,247

848

574

305

$3,974

$33,759

(1,120)

32,639

393

(29)

(403)

$32,611

$34,123

(1,512)

32,611

217

(456)

32,372

34,338

(1,966)

$32,372

2016

$1,825

1,492

127

256

$3,700

ANNUAL REPORT 2017 55

12. PROVISIONS

As at December 26, 2015

Provisions charged during the period

Provisions utilized during the period

As at December 31, 2016

Current portion

Long-term portion

As at December 31, 2016

Provisions charged during the period

Provisions utilized during the period

As at December 30, 2017

Current portion

Long-term portion

As at December 30, 2017

Head lease
liabilities

Café leases (a)

Other (b)

$26

–

(26)

$–

–

$–

–

$–

–

$–

$2,421

794

(1,113)

$2,102

$1,572

530

$2,102

239

(1,274)

$1,067

$837

230

$1,067

$190

186

(350)

$26

–

$26

480

(409)

$97

–

$97

Total

$2,637

980

(1,489)

$2,128

$1,598

530

$2,128

719

(1,683)

$1,164

$934

230

$1,164

a. Café leases
Provisions for café leases are estimates for costs to be incurred by the Company as a result of the following
circumstances: a) closure of cafés, and b) franchisee failure to make payment of occupancy costs at an operational
café.

Provisions for café closures of $239 (2016 - $794) were charged in the year and are reflected in the franchise line on
the Statements of Operations and Comprehensive Loss.

b. Other
Provisions for other items of $480 (2016 - $186) were charged in the year. The remaining provision will be settled
throughout the course of 2018.

13. OTHER LIABILITIES

Deferred revenue – current

Leasehold inducements – current

Other liabilities – current

Deferred revenue – long-term

Leasehold inducements – long-term

Other liabilities – long-term

Deferred revenue

Leasehold inducements

Other liabilities

56 THE SECOND CUP LTD.

2017

$423

459

–

179

$179

$423

215

$638

2016

$181

217

215

$267

$233

251

$484

14. LONG-TERM DEBT

Face value of long-term debt

Unamortized transaction costs

NOTES TO THE FINANCIAL STATEMENTS

2017

$–

–

$–

2016

$8,000

(819)

$7,181

On August 10, 2017, the Company issued 4,210,528 common shares and 300,000 warrants of Second Cup to the four
shareholders of SPE Finance LLC (SPE), an affiliate of Serruya Private Equity. The Company also extinguished its $8,000
debt to SPE and cancelled 600,000 of old warrants. These transactions resulted in one-time, non-cash financing charges
of $3,290. These charges consist of the difference between the share price of $2.60 on the issuance date and the agreed-
to share price of $1.90, and the write-off of the unamortized portion of deferred transaction costs related to the debt.

15. REVENUE

Franchise revenue

Royalties

Services and other

Company-owned cafés and product sales

2017

2016

$10,299

4,775

15,074

8,562

$23,636

$10,509

5,179

15,688

14,663

$30,351

ANNUAL REPORT 2017 57

16. OPERATING COSTS AND EXPENSES

Company-owned cafés and cost of product sales

Cost of product sales

Labour and related expenses

Occupancy and other

Depreciation of property and equipment

Loss on disposal of assets

Franchise

Labour and related expenses

Travel and franchisee meetings

Professional fees and other

General and administrative

Labour and related expenses

Professional fees and other

Occupancy

Other

Depreciation and amortization

17. IMPAIRMENT OF ASSETS

2017

$3,270

2,966

3,067

308

197

9,808

3,939

345

1,409

5,693

2,045

3,503

461

6,009

1,150

2016

$5,795

4,873

5,013

394

225

16,300

4,330

670

3,103

8,103

2,003

3,322

454

5,779

1,154

$22,660

$31,336

Impairment of trademarks

a.
The Company’s trademarks are allocated fully to the franchising, distribution, and wholesale CGU. The CGU’s
recoverable amount has been determined using fair value less costs of disposal.

Key assumptions
The Company uses a discounted cash flow methodology, which includes the use of estimates and assumptions that
are sensitive to change and require judgement. This methodology used to test impairment is classified as Level 3
per the hierarchy described in note 5. 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 competitive 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.

58 THE SECOND CUP LTD.

NOTES TO THE FINANCIAL STATEMENTS

Probability weighted cash flow projections are used based on financial forecasts covering a three-year period. These
projections are approved by the Board of Directors based on management’s expectations of potential outcomes.
Cash flows beyond the three-year period are extrapolated using the estimated growth rates as stated in the table
below. The valuation of the franchising, distribution, and wholesale business CGU is based on various probabilities
assigned to each forecasted cash flows. The analysis performed as at December 30, 2017 does not indicate any
impairment (2016 - $nil). The following are key assumptions used in the fair value less costs of disposal calculation as
well as a sensitivity analysis for the various range of assumptions used and the related impact.

Discount rate

Forecast same café sales avg. growth rate

Avg. growth rate used to extrapolate cash flows

beyond the forecast period

Amount by which recoverable amount exceeds

Low growth

High growth

Low growth

High growth

2017

2016

12.0%

16.0%

0.0%

4.5% – 5.5%

0.0%

12.0%

(1.0%)

0.0%

16.0%

2.5% – 4.0%

0.0%

carrying amount

$6,500

$5,300

$4,500

$28,400

b. Corporate cafes – Impairment of leasehold improvements, equipment, furniture, fixtures, and other
Impairment indicators include when an individual Company-operated café experiences poor performance directly
impacting cash flows. The impairment analysis is based on historical and forecasted performance measures for
each café with impairment indicators. The asset’s recoverable amount has been determined using value in use. The
recoverable amount was compared to the net book value of the assets. This methodology used to test impairment is
classified as Level 3 per the hierarchy described in note 5. As a result of the impairment test, impairment charges of
$nil for the year ended December 30, 2017 (2016 - $nil) were recorded to assets that were not able to be redeployed
to a different CGU as the carrying amount exceeded the recoverable amount. A sensitivity of 2% increase or
decrease in sales for each CGU pertaining to the impacted assets would not have had an impact on the impairment
recorded.

18. INTEREST AND FINANCING COSTS

Fair value difference on shares issued and other costs

Interest expense

Amortization of deferred financing costs

Interest income

2017

$3,290

505

139

(37)

$3,897

2016

$–

259

(35)

$255

ANNUAL REPORT 2017 59

19. INCOME TAXES

Income taxes, as reported, differ from the amount that would be computed by applying the combined Canadian
federal and provincial statutory income tax rate to income before income taxes. The reasons for the differences are as
follows:

2016

($1,240)

26.68%

(331)

($265)

($503)

238

($265)

2016

15.00%

11.68%

26.68%

Total

$5,869

238

6,206

(76)

Other

($827)

150

–

(677)

(37)

($663)

$6,160

Loss before income taxes

Combined Canadian federal and provincial tax rate

Tax recovery at statutory rate

Increased (reduced) by following differences

Change in tax rates

Non-deductible permanent differences

Other

Income tax expense (recovery)

Current income tax expense (recovery)

Deferred income tax expense (recovery)

Income tax expense (recovery)

2017

($2,922)

26.70%

(780)

786

151

$176

$146

$176

The blended weighted average statutory income tax rate is an aggregate of the following:

Basic federal rate

Weighted average provincial rate

Combined Canadian federal and provincial tax rates

2017

15.00%

11.70%

26.70%

The movement in deferred income tax (assets) and liabilities during the year is as follows:

Property and
equipment

Trademarks

Warrants

As at December 26, 2015 (Note 2.x)

$1,944

$4,752

Charged (credited) to the income statement

Charged to equity

As at December 31, 2016

Charged (credited) to the income statement

Charged to equity

As at December 30, 2017

–

2,011

(21)

–

4,773

–

$1,990

$4,773

$–

–

(39)

$60

60 THE SECOND CUP LTD.

NOTES TO THE FINANCIAL STATEMENTS

20. BASIC AND DILUTED LOSS PER SHARE

Loss per share is based on the weighted average number of shares outstanding during the period. Share option
awards and warrants to purchase shares are excluded due to anti-dilutive impact. Basic and diluted loss per share is
determined as follows:

Net loss

Weighted average number of shares issued and outstanding

Basic and diluted loss per share

21. SUPPLEMENTAL CASH FLOW INFORMATION

Changes in non-cash working capital & other (inflow (outflow)):

Trade and other receivables

Inventories

Prepaid expenses and other assets

Accounts payable and accrued liabilities

Provisions

Other liabilities

Gift card liability

Deposits from franchisees & change in restricted cash

Income taxes

Cash payments for capital expenditures

Cash payments for intangible assets

Supplementary information

Interest paid

Income taxes paid

2017

($3,097)

14,485,081

($0.21)

2016

($975)

12,830,945

($0.08)

2017

($693)

(5)

293

(964)

154

(52)

324

623

($274)

($383)

(217)

($600)

$505

$–

2016

$411

176

(1,658)

(483)

(282)

(70)

(566)

155

($2,288)

($382)

(393)

($775)

$318

$–

22. MOVEMENT OF NON-CASH FINANCING ACTIVITIES

The Company recognized the following non-cash financing activities as a result of the changes as described in Note 4
Management of Capital: i) a decrease of $7,146 in long-term debt; ii) an increase of $10,760 in share capital; and iii) a
net decrease of $106 in warrants.

ANNUAL REPORT 2017 61

23. RESTRICTED CASH

The Company has established certain accounts that have been classified as restricted cash primarily representing:
a) deposits from franchisees for the cost of constructing a new café or the renovation of an existing café, b) funds
contributed for use in advertising and promotional programs where the Company is acting as an agent on behalf of
the Co-op Fund, and c) a deposit held by the Company’s bank as security for cash management services.

Development Fund

Co-op Fund

Security Deposit held by bank

Total Restricted Cash

A summary of activities in 2017 and 2016 in the Co-op Fund is provided as follows:

Co-op Fund – opening balance

Contributions by franchisees

Contributions by Company for Company-owned cafés

Other contributions by Company

Payments to third party suppliers for goods and services

Repayments to Company in respect of promissory notes

Co-op Fund – closing balance

2017

$408

711

240

$1,359

2017

$487

2,586

290

–

(2,652)

–

$711

2016

$1,220

487

240

$1,947

2016

$319

2,728

238

150

(2,594)

(354)

$487

24. CONTINGENCIES, COMMITMENTS AND GUARANTEES

The Company has lease commitments for Company-operated cafés and acts as the head tenant on most leases,
which it in turn subleases to franchisees. To the extent the Company may be required to make rent payments due
to head lease commitments, a provision has been recognized (note 12). The Company’s lease commitments as at
December 30, 2017 are as follows:

December 29, 2018

December 28, 2019

December 26, 2020

December 25, 2021

December 31, 2022

Thereafter

Head lease
commitments

$17,954

16,158

13,907

12,034

10,835

27,637

$98,525

Sublease to
franchisees

$16,466

14,736

12,692

10,938

9,803

25,012

$89,647

Net

$1,488

1,422

1,215

1,096

1,032

2,625

$8,878

The Company believes it has sufficient resources to meet the net commitment of $8,878 over the term of the leases.

62 THE SECOND CUP LTD.

NOTES TO THE FINANCIAL STATEMENTS

The Company is involved in litigation and other claims arising in the normal course of business. Judgement must be
used 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. It is believed that no significant losses or expenses will
be incurred 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.

Contracts are in place with third party companies to purchase the coffee that is sold in all cafés. In terms of these
supply agreements, there is a guaranteed minimum value of coffee purchases of $1,392 (2016 - $1,140) for the
subsequent 12 months. The coffee purchase commitment is comprised of two components: unapplied futures
commitment contracts and fixed price physical contracts.

Due to the Company acting as the primary coordinator of café construction costs on behalf of its franchisees and for
Company-operated cafés, there is $894 (2016 - $241) of contractual commitments pertaining to construction costs for
new locations and renovations as at the end of the fiscal year. Construction costs are financed for franchise projects
from deposits received from franchisees and for corporate projects from the Company’s cash flows.

25. RELATED PARTIES

Related parties are identified as key management, members of the Board of Directors and shareholders that
effectively exercise significant influence on the Company. Such related parties include any entities acting with or on
behalf of the aforementioned parties.

Compensation of key management

Key management is defined as the senior management team and the Board of Directors. The following summarizes
the compensation expense of key management personnel and the composition thereof:

Salaries and short-term employee benefits

Termination costs

Share-based compensation

Total compensation

26. SHARE-BASED COMPENSATION

2017

$2,236

247

$2,543

2016

$2,455

–

$2,528

Stock option plan
The stock option plan was introduced in May 2014 to advance the interests of the Company by:
• providing eligible persons with incentives;
• encouraging share ownership by participants;
• increasing the proprietary interest of participants in the success of the Company;
• encouraging participants to remain with the Company or its affiliates; and
• attracting new directors and employees.

Stock options are to be settled on a net-equity basis. Compensation expense/gain for stock awards is recognized
using the fair value when the stock awards are granted using the Black-Scholes option pricing model. All options vest
in tranches and are amortized over the awards’ vesting period using the accelerated expense attribution method.

ANNUAL REPORT 2017 63

Recognition of the expense/gain is recorded as a charge to operating expenses with a corresponding increase/
decrease to contributed surplus.

The following weighted average assumptions have been used to estimate the weighted average fair value per award
of $0.39 granted as of December 30, 2017:

Risk-free interest rate (%)

Volatility (%)

Expected term (years)

The table below summarizes all activity for the year ended December 30, 2017:

Assumption

1.63

32.63

7.8

As at December 31, 2016

Granted

Forfeited

As at December 30, 2017

Stock option plan recovery during the period

Number of share
options outstanding

Weighted average
share option price

670,000

50,000

(460,000)

260,000

$4.08

1.60

4.25

$3.30

$42

The range of exercise prices for share options outstanding at December 30, 2017 is $1.60 to $4.54. Of the
share options outstanding, 76,000 share options are exercisable. The weighted average years to expiration are
approximately eight years. Share award options are able to be exercised upon vesting.

27. DIRECTORS’ DEFERRED SHARE UNIT PLAN

A summary of the status of the Company’s directors’ deferred share unit plan is presented below:

Notional units outstanding as at December 26, 2015

Deferred units granted

Change in fair value

Notional units outstanding as at December 31, 2016

Expensed in the period

Notional units outstanding as at December 31, 2016

Deferred units granted

Change in fair value

Notional units outstanding as at December 30, 2017

Expensed in the period

Notional units

Recorded value

75,403

36,878

–

112,281

$219

110

(90)

$239

$20

Notional units

Recorded value

112,281

45,047

–

157,328

$239

$341

$102

The average fair value price of deferred units granted was $2.18 (2016 - $2.98).

64 THE SECOND CUP LTD.

Shareholder Information

CORPORATE HEAD OFFICE

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 Inquiries
Ba Linh Le
Vice President, Finance
and Chief Financial Officer
Tel: (905) 362-1827
Fax: (905) 362-1121
E-mail:
investor@secondcup.com

Website
www.secondcup.com

THE SECOND CUP LTD.
Board of Directors

THE SECOND CUP LTD.
Senior Management Team

Michael Bregman (1),(2)
Chairman

Melinda Lee (1)
Garry Macdonald
Alton McEwen (2)
Paul W. Phelan
Michael Serruya (1)
Aaron Serruya
Alan Simpson (2)

Committees of the Board
(1) Audit Committee
(2) Governance, Human
Resources and
Compensation Committee

Garry Macdonald
President and
Chief Executive Officer

Ba Linh Le
Vice President, Finance
and Chief Financial Officer

Vanda Provato
Vice President,
Marketing and Category

Chris Sonnen
Vice President,
Coffee Experience

Audra Wosik
Vice President, Franchising

Ted Tai
Vice President, Operations

John Kazmierowski
Vice President,
Development-Leasing
& Construction

ANNUAL REPORT 2017 65