Sculptor Capital Management Annual Report 2018

FY2018 Annual Report · Sculptor Capital Management

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THE SECOND CUP LTD.
ANNUAL REPORT 2018
THE NATIONAL CANADIAN SPECIALTY COFFEE COMPANY

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

BRAND PURPOSE
—
Second Cup Coffee Co.TM ignites customers' passion
for the ultimate coffee experience.

VALUES
—

Authentic
Superior Quality
Competitive Spirit

Coffee Passion
Innovative
Community Minded

2 THE SECOND CUP LTD.

Table of Contents

Letter from the Chairman

Letter from the President & CEO

This is Handcrafted: Coffee Innovation

Pinkberry

This is Handcrafted: Better For You

This is Handcrafted: Food Innovation Driving Growth

Now Delivered with Uber Eats & Skip The Dishes

Café Upgrades & New Locations

A Look at 2019

Financial Highlights

Management's Discussion & Analysis

Audited Financial Statements

Shareholder Information

ANNUAL REPORT 2018 1

Letter from
the Chairman

From its one time pinnacle as Canada’s
leading and largest specialty coffee
retailer, Second Cup lost its way and its
market position eroded over many years.
Recent improvements have restored
stability and now we need to accelerate
the rate of progress. For Second Cup to
flourish as a company, we must attract
more customers to our stores and we
need to improve store economics for our
franchisees.

There is a unified sense of urgency for
the need to improve. A comprehensive
project is underway to reshape the
future of Second Cup. Management,
franchisees, directors and customers
are being drawn upon. Our collective
aim is to restore Second Cup to operate
best in class coffee stores. While this is
a long-term project, we expect to see
clear positive signs of improvement in
the coming months.

Our aim is to create material value
for shareholders. While working to build
the core business, we need to pursue
additional value creation opportunities.
Accordingly, we have embarked on
a strategic process whereby we are
examining a range of options to create

shareholder value. While there is no
assurance of a particular outcome, this
strategic process is a priority.

Second Cup’s financial foundation
has been materially strengthened. The
company generated positive cash flow
and issued new equity in 2018. At year
end, Second Cup was debt free with
close to $15 million cash. There are
ample financial resources to support
future plans.

We recognize that we have not

created value in recent years and this is
not acceptable. As a public company
we must prioritize value creation for
our stakeholders including shareholders,
franchisees and employees. We remain
optimistic about Second Cup’s future
and now is the time to pursue the most
attractive strategic options available.

Sincerely,

Michael Bregman
Chairman of the Board

2 THE SECOND CUP LTD.

Letter from the
President & CEO

of café sales at year end. Further program
enhancements are planned for 2019
including Mobile Order & Pay Ahead.

Upgrading and expanding the Second
Cup network is a key part of our strategy.
Forty percent of our cafés have been
upgraded and new cafés continue to open in
traditional and non-traditional formats.
While progress has been made in

elevating the brand, we are actively engaged
in a brand strategy review to identify and
test new innovations to aggressively grow
café sales and improve the café economic
model which remain top priorities.

My sincere thanks goes to the committed

and passionate members of our franchise
community, my management team
and Coffee Central staff. I also greatly
appreciate the support of our dedicated
Board of Directors.

In 2018, Second Cup achieved its highest
profit in four years. We continue to deliver
improvement in profitability and our focus
remains on growing café sales as well as
enhancing our customer experience.

We introduced a number of initiatives

throughout the year that have demonstrated
strong potential to build sales for 2019 in
particular, Pinkberry frozen yogurt, now in
over 35% of our cafés, and delivery services
like UberEats and Skip The Dishes. We
led the Canadian coffee market with the
introduction of Clean Label beverages and
the “Better For You” category introduced in
2017 continues to gain momentum.

In addition to product innovation, we
continued our focus on delivering a truly
“handcrafted” coffee experience to our
customers with expanded training programs
and tools for all cafés and baristas. Our
national Latte Art Championship in the fall
created excitement among our baristas.
Our barista Champion, from Edmonton
joined us on our annual coffee expedition
to one of our coffee farms in Costa Rica
alongside many Second Cup franchisees
and Coffee Central staff.

The Second Cup Rewards program

continues to grow, representing one quarter

Garry Macdonald
President & CEO

ANNUAL REPORT 2018 3

2018

Championnat
L AT TE ART
Championship

4 THE SECOND CUP LTD.

This is Handcrafted

COFFEE INNOVATION

In January 2018, Second Cup led the
Canadian coffee market with a move
to Clean Label beverages – which now
represent over 85% of the beverage menu.
Clean Label products contain no artificial
colours or flavours, no preservatives and no
high-fructose corn syrup.

Canadian consumers are making
more informed choices. They care about
what is in their food and drinks, and
they are looking for options they can
feel good about. We are on a continual
mission at Second Cup to provide the
most premium and innovative coffee
experience in the country - and we
believe that this is an important step in
that journey. Marketing supported this
initiative throughout the year, with each
new campaign highlighting the Clean
Label commitment and benefit for all
new beverages and customer faves in
our beverage categories including Flash
Cold Brew, FroChos, Frappes, Smoothies,
brewed coffees and lattes – even our

Pumpkin Spice! The campaign kicked off
with a significant investment in outdoor
billboards across the country, followed by
a cross-Canada sampling tour with the
Flash Cold Brew coffee bikes.

In 2018, while we continued to enhance
our coffee offering, we also continued our
focus on delivering a truly “handcrafted”
coffee experience to our customers. We
expanded our training programs and tools
for all cafés and Baristas, and created
excitement among our Baristas with a
national Latte Art Championship. Our
very best Baristas were flown into Toronto
from across the country to compete in
a final showdown in Yorkdale Shopping
Centre’s Centre Court. Customers
across the country have been treated to
wonderfully handcrafted coffee beverages
topped off with latte art, while our Barista
Champion, So-Young Lee from Edmonton
enjoyed an all-expenses paid trip for two
to one of our coffee farms in Costa Rica
alongside many Second Cup franchisees.

ANNUAL REPORT 2018 5

Pinkberry

Second Cup entered into a category
exclusive licensing agreement with
Pinkberry Canada Inc. in 2017, and
since then have rolled out the Pinkberry
Frozen Yogurt Brand and program in
over one third of Second Cup Coffee
Co. cafés across the country. Results

in this first full year have been positive,
peaking during the summer months
and making Pinkberry our fastest
growing new category. Additionally,
Pinkberry is driving incremental
transactions and positively impacting
same store sales.

6 THE SECOND CUP LTD.

ANNUAL REPORT 2018 7

This is Handcrafted

BETTER FOR YOU

The “Better For You” category was introduced in 2017 and
continued to gain momentum in 2018. This program offers our
customers healthier options and is anchored by the Smoothie
category – a line of delicious clean label smoothies made with a
whole banana and protein boosts like whey. The breakfast cookie
made with 10 grams of protein is the top selling bakery item.

Working with best in class bakeries and food partners across
the country continues to provide a competitive advantage. We
work collaboratively with our partners to develop delicious,
regionally relevant items that are made locally and delivered
fresh to our cafés.

8 THE SECOND CUP LTD.

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.

Handmade locally.
Baked with fresh ingredients.
Delivered fresh to our cafés.

ANNUAL REPORT 2018 9

This is Handcrafted

FOOD INNOVATION DRIVING GROWTH

Expanding Second Cup’s premium, fresh,
local food offering in the lunch day part
drove growth in food category sales
in 2018. Cheese Melts and the Bagel

program launched in 2017 continue to
be customer favourites along with new
introductions like savoury chicken and
meat pies and premium quality soups.

10 THE SECOND CUP LTD.

ANNUAL REPORT 2018 11

12 THE SECOND CUP LTD.

Now Delivered With

Second Cup has partnered with Uber Eats
and Skip the Dishes, giving Canadians the
flexibility to have their favourite Second
Cup menu items delivered to them
wherever they are.

“The feedback I hear most often from
Canadians is that they love Second Cup
- but that they wish there was a café
closer to their home or work,” says Garry
Macdonald, President and CEO of Second

Cup. “Our new partnership with Uber Eats
and Skip the Dishes gives Canadians the
flexibility to enjoy our premium coffee and
food offerings anywhere that is convenient
to them - not just anywhere we have a
café.”

The program continues to roll out

across the country in all delivery accessible
locations, and has proven to drive
incremental sales for cafés.

ANNUAL REPORT 2018 13

Café Upgrades
& New Locations

Over 40% of our Second Cup cafés
have been modernized to reflect
the new design. We continue to
work on enhancing the experience
while delivering cost efficiency. The
Pinkberry Frozen Yogurt concept
has been integrated into the café
design and is a standard offering.
Growing points of access for

customers continues to be a focus
including non-traditional channels.
New cafés opened in 2018
including University of Toronto,
University of Guelph, Ottawa
National Art Gallery, Canadian
Museum of History & Indigo (New
Brunswick). Tests in new channels
are underway.

“Second Cup has been on campus for over
20 years serving our students, faculty, staff
and visitors, as well as being a responsible
and collaborative tenant in our buildings.
One of the goals of our Food Service
operation is to support the work of local
suppliers, so working with a Canadian
coffee brand like Second Cup feels great.”

—
Anne Macdonald
Assistant Vice-President Ancillary Services
University of Toronto St. George Campus

14 THE SECOND CUP LTD.

ANNUAL REPORT 2018 15

Order & Pay
Ahead!
COMING SOON

16 THE SECOND CUP LTD.

A Look at 2019

Reinventing the Second Cup brand to
offer the most premium and innovative
coffee experience in Canada is an
on-going effort. In the coming year, we
will continue to enhance the experience
at every touch point – including an
updated café design. At the same
time, expanding Second Cup points of
distribution with new cafés and more
non-traditional locations continues to be
a focus.

Delivering a best-in-class experience

and product innovation to drive same
store sales growth remains our priority.
Mobile Order and Pay Ahead will be
introduced this year bringing the in-café
experience into a new digital dimension -
providing the customer with added

convenience by allowing them to skip the
line and avoid wait times.

The Rewards program grew by 68,000

in 2018, ending the year with a total
of 438,000 members. The Rewards
members are our best customers and
the loyalty program is key to our growth
– our members come more often and
spend more than non-members. The
integration of Mobile Order & Pay Ahead
into the Rewards Program will aid in the
acceleration of member growth and
enhance member loyalty.

Growing Pinkberry awareness and trial
will be a key marketing priority – we know
that once a customer tastes Pinkberry,
they love it! Expect to see new items added
to the “Better For You” menu as well.

ANNUAL REPORT 2018 17

Financial Highlights

18 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 Consolidated Financial Statements of the Company for the 52 weeks ended
December 29, 2018.

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

December 29,
20182

December 30,
2017

December 29,
20182

December 30,
2017

13 weeks ended

52 weeks ended

System sales of cafés1

Same café sales1

Number of cafés – end of period

Total revenue

Operating costs and expenses

Operating income1

EBITDA1

Adjusted EBITDA1

Net income (loss) and comprehensive income (loss)

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

Basic and diluted earnings (loss) per share as reported

Adjusted basic and diluted earnings (loss) per share1

$38,860

$41,326

$146,697

$154,153

(2.0%)

262

$7,176

$6,362

$814

$1,138

$1,297

($55)

$594

$0.00

$0.03

(1.1%)

286

$6,085

$5,092

$993

$1,339

$655

$0.04

(1.2%)

262

$25,714

$24,342

$1,372

$2,707

$2,930

$1,151

$1,074

$0.06

(0.2%)

286

$23,636

$22,660

$976

$2,434

$2,721

($3,097)

$110

($0.21)

$0.01

Total assets – end of period

$56,001

$44,700

$56,001

$44,700

Number of weighted average common shares issued

and outstanding

19,940,073

17,041,473

18,920,785

14,485,081

1 See the section “Definitions and Discussion on Certain non-GAAP Financial Measures” for further analysis.
2 Adoption of new standard on a modified retrospective basis – Consolidated financial statements for 2018 are prepared under the new standard whereas the

previous periods are on the old standard. See the section “Changes in Accounting Policies” for further analysis.

System wide sales
(in millions of Canadian dollars)

Number of Second Cup cafés
(in Canada)

200

150

100

182.8

174.9

163.7

154.2

146.7

2014

2015

2016

2017

2018

400

350

300

250

200

150

100

347

310

294

286

262

2014

2015

2016

2017

2018

ANNUAL REPORT 2018 19

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 March 1, 2019 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 29, 2018, and should be read in conjunction with the
Audited Financial Statements of the Company for the 52 weeks ended December 29, 2018, 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.

20 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 2018 21

CORE BUSINESS, STRATEGIC IMPERATIVES, AND KEY PERFORMANCE DRIVERS

Core business
Second Cup is a Canadian specialty coffee retailer with 262 cafés operating under the trade name Second Cup™ in
Canada, of which 25 are Company-owned and the balance are 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 2018 consists of 52 weeks.

As at December 29, 2018, the issued share capital consisted of 19,940,073 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.

On April 12, 2018, the Company and National Access Cannabis Corp. (“NAC”) established a strategic alliance to
develop and operate a network of NAC-branded recreational cannabis dispensaries initially across Western Canada,
expanding to include additional provinces where legally permissible. NAC will apply for licences to dispense
cannabis products and upon receipt, work with Second Cup and applicable franchisees to leverage Second Cup’s
extensive Canadian retail footprint to construct retail stores carrying leading cannabis products.

The Company has been assisting NAC in its applications for recreational cannabis dispensary licenses in Alberta
in respect of select locations that are currently occupied by Second Cup cafés. Of the five applications submitted
for the City of Calgary, there are two locations – where a development permit by the City has been granted – that
the joint venture are in the various stages of negotiations with the respective landlords and franchisees to convert
to a cannabis dispensary. In November 2018, the Alberta Gaming, Liquor and Cannabis (the “AGLC”) announced
a moratorium on new dispensary licences due to logistics issues, cannabis shortages and high demand. The
Company will continue to work with NAC and other parties towards conversion of these two cafés when the
moratorium is lifted by the AGLC.

22 THE SECOND CUP LTD.

MANAGEMENT’S DISCUSSION AND ANALYSIS

The Company continues to focus on strengthening its franchise network, franchising corporate stores to strong
operators to follow an asset light business model, and expects to make further reductions in the number of
Company-owned cafés in 2019.

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 262 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.

The people
The franchise network consists of approximately 3,000 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, 85% of Second Cup’s beverage menu is Clean Label. 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®.

Second Cup has introduced a line of Better For You products that continues to grow. This includes smoothies made
with a whole banana and added protein boosts and its best-selling breakfast cookie with 10 grams of protein.

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.

ANNUAL REPORT 2018 23

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, capital expenditures,
and other corporate purposes.

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.

On April 17, 2018, the Company entered into an agreement with Clarus Securities Inc. (the “Underwriter”), pursuant
to which the Underwriter agreed to purchase, on a “bought deal” basis, 2,898,600 common shares of the Company
at a price of $3.45 per share for aggregate gross proceeds to the Company of $10,000 (the “Offering”). The
Offering closed on May 8, 2018, with the Company receiving aggregate gross proceeds of $10,000 and net proceeds
of $9,190.

On December 18, 2018, the Company announced that the Toronto Stock Exchange (the “TSX”) had approved its
notice of intention to make a normal course issuer bid for a portion of its common shares. Pursuant to the normal
course issuer bid, the Company intends to acquire up to 1,000,000 Common Shares, representing approximately
7.4% of its public float of 13,463,184 common Shares, in the 12-month period commencing December 20, 2018
and ending on December 19, 2019 or such earlier time that the Company completes its purchases pursuant to the
normal course issuer bid or provides notice of termination. Under the normal course issuer bid, the Company may
purchase up to 12,071 common shares on the TSX during any trading day. As of December 29, 2018, the Company
had repurchased 60,335 common shares for an aggregate total value of $115.

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.

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.

24 THE SECOND CUP LTD.

MANAGEMENT’S DISCUSSION AND ANALYSIS

FINANCIAL HIGHLIGHTS

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

December 29,
20182

December 30,
2017

December 29,
20182

December 30,
2017

13 weeks ended

52 weeks ended

System sales of cafés1

Same café sales1

Number of cafés – end of period

Total revenue

Operating costs and expenses

Operating income1

EBITDA1

Adjusted EBITDA1

Net income (loss) and comprehensive income (loss)

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

Basic and diluted earnings (loss) per share as reported

Adjusted basic and diluted earnings (loss) per share1

$38,860

$41,326

$146,697

$154,153

(2.0%)

262

$7,176

$6,362

$814

$1,138

$1,297

($55)

$594

$0.00

$0.03

(1.1%)

286

$6,085

$5,092

$993

$1,339

$655

$0.04

(1.2%)

262

$25,714

$24,342

$1,372

$2,707

$2,930

$1,151

$1,074

$0.06

(0.2%)

286

$23,636

$22,660

$976

$2,434

$2,721

($3,097)

$110

($0.21)

$0.01

Total assets – end of period

$56,001

$44,700

$56,001

$44,700

Number of weighted average common shares issued

and outstanding

19,940,073

17,041,473

18,920,785

14,485,081

previous periods are on the old standard. See the section “Changes in Accounting Policies” for further analysis.

ANNUAL REPORT 2018 25

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

2016

23.9

24.6

23.0

28.5

100.0

2017

24.6

24.0

26.8

100.0

2018

24.5

24.7

24.3

26.5

100.0

Average

24.3

24.6

23.8

27.3

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.

Café network

Number of cafés – beginning of period

Cafés opened

Cafés closed

Number of cafés – end of period

13 weeks ended

52 weeks ended

December 29,
2018

December 30,
2017

December 29,
2018

December 30,
2017

270

(11)

262

289

(5)

286

(31)

262

294

(12)

286

The Company ended the Year with 25 (2017 - 12) 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

System sales of cafés
System sales of cafés for the 13 weeks ended December 29, 2018 were $38,860 compared to $41,326 for the 13
weeks ended December 30, 2017 representing a decrease of $2,466 or 6.0%. The decrease in system sales of cafés is
primarily due to the reduction in café count and lower transactions.

Same café sales
During the Quarter, same café sales declined 2.0%, compared to a decline of 1.1% in the comparable Quarter of
2017. The decline is primarily due to a reduction in transactions.

Analysis of revenue
Total revenue for the Quarter was $7,176 (2017 - $6,085), an increase of $1,091, consisting of Company-owned café
and product sales, royalty revenue, Co-op Fund contributions, fees and other revenue. The transition to IFRS 15 on a
modified retrospective basis in 2018 requires the presentation of the Co-op Fund contributions and related expenses
on a gross basis. As a result, revenue for the Quarter includes Co-op Fund contributions of $855.

26 THE SECOND CUP LTD.

MANAGEMENT’S DISCUSSION AND ANALYSIS

Company-owned cafés and product sales for the Quarter were $2,441 (2017 - $1,713), an increase of $728. The
number of Company-owned cafés increased in the Quarter to 25 (2017 – 12), part of the Company’s short-term
effort to improve the operation and customer experience by taking back certain underperforming cafés. The
Company maintains its on-going objective of reducing the number of Company-owned cafés, consistent with the
Company’s strategy of returning to an asset light business model.

Franchise revenue was $4,735 for the Quarter (2017 - $4,372), an increase of $363. The increase is due to the
consolidation of Co-op Fund contributions of $855, offset by lower royalties and coordination fees as a result of a
lower number of franchise cafés.

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 $6,362 (2017 - $5,092), an increase of $1,269, including
Co-op Fund expenses of $849.

Company-owned cafés and product sales related expenses for the Quarter were $2,852 (2017 - $1,772), an increase
of $1,080. The increase in costs is due to the increase in Company-owned cafés compared to prior year.

Franchise related expenses for the Quarter were $2,021 (2017 - $1,670), an increase of $351. The increase in
franchise related expenses is primarily due to the consolidation of Co-op Fund expenses of $849, offset by lower
remuneration.

General and administrative expenses were $1,140 for the Quarter (2017 - $1,206), a decrease of $66. This decrease
in expenses is primarily due to a reduction in remunerations and directors’ fees expenses.

A loss on disposal of $25 was recognized in the Quarter (2017 - loss of $98). Gain and loss on disposal of assets are
related to the franchising of Company-owned cafés to franchise partners.

Depreciation and amortization expense was $324 (2017 - $346), a decrease of $22.

EBITDA
EBITDA for the Quarter was $1,138 (2017 - $1,339), a decrease of $201. The savings in franchise and corporate
expenses offset the lower franchise revenue and higher operating losses attributed to Company-owned cafés.
Adjusted for non-recurring transaction costs, EBITDA for the Quarter was $1,297.

Other expenses
Other expenses for the Quarter were $885, comprised of a change in fair value of NAC warrants of $1,105 and asset
impairment charges of $216, offsetting recognized income from the NAC strategic alliance of $436.

In entering into the strategic alliance with NAC, the Company received five million warrants that will expire after
five years from the date of issuance. The Black-Scholes fair value of the warrants received ($2,655) was recorded in
deferred income and is being recognized as other income over the life of the agreement which is 18 months.

As of December 29, 2018, the fair value of the warrants was $0.344 versus $0.565 at the end of the third quarter,
resulting in a decrease to the fair value of the NAC warrants of $1,105. The change in fair value of the NAC
warrants will fluctuate in accordance with the trading price of the NAC common shares.

The Company incurred impairment charges of $216 (2017 - $nil) related to an impairment of property and
equipment of some Company-owned cafés.

ANNUAL REPORT 2018 27

Interest and financing income
Interest income for the Quarter was $63 compared to interest income of $5 in the same Quarter of 2017.

Net income (loss)
The Company’s net loss for the Quarter was $55 or $nil per share, compared to a net income of $655 or $0.04 per
share in 2017. Adjusted for extraordinary items, net income for the Quarter was $594 or $0.03 per share.

The consolidated financial statements for 2018 reflect the consolidation of the Co-op Fund under IFRS 15 whereas
the condensed interim financial statements for the previous three quarters were prepared under the guidance of
the previous standard. See the section “Changes in Accounting Policies” for further analysis.

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”.

YEAR

System sales of cafés
System sales of cafés for the Year were $146,697 (2017 - $154,153), a decrease of $7,456 or 4.8%. The decrease is
primarily due to the reduction in café count.

Same café sales
For the Year, same café sales declined by 1.2% compared to a decline of 0.2% in 2017. The decline is primarily due to
reduced transactions.

Analysis of revenue
Total revenue for the Year was $25,714 (2017 - $23,636), an increase of $2,078, consisting of Company-owned café
and product sales, royalty revenue, Co-op Fund contributions, franchise fees and other revenue. The transition to
IFRS 15 on a modified retrospective basis in 2018 requires the presentation of the Co-op Fund contributions and
related expenses on a gross basis. As a result, revenue for the Year includes Co-op Fund contributions of $3,031.

Company-owned cafés and product sales were $7,885 (2017 - $8,562), a decrease of $677. While the Company
maintains its on-going objective of reducing the number of Company-owned cafés, consistent with the Company’s
strategy of returning to an asset light business model, the Company took back a number of low-performing
franchise cafés during the year as part of its effort to improve café operation and customer experience.

Franchise revenue was $17,829 for the Year (2017 - $15,074), an increase of $2,755. The increase is primarily due to
the consolidation of Co-op Fund contributions of $3,031, offset by lower royalties and coordination fees as a result
of a lower number of franchise cafés. There was also a net positive impact of $118 due to the application of the
new revenue recognition standard IFRS 15.

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 on disposal of assets, and depreciation and amortization. Total
operating costs and expenses for the Year were $24,342 (2017 - $22,660), an increase of $1,682.

Company-owned cafés and product related expenses were $8,954 for the Year (2017 - $9,303), a decrease of $349.
The decrease in costs is attributable to lower sales as compared to 2017.

28 THE SECOND CUP LTD.

MANAGEMENT’S DISCUSSION AND ANALYSIS

Franchise related expenses were $8,961 for the Year (2017 - $5,693), an increase of $3,268. This increase in expenses
is primarily driven by the inclusion of Co-op Fund expenses of $3,022, an increase in provisions for bad debts of $653
offset by savings in remuneration and other operating expenses.

General and administrative expenses were $5,064 for the Year (2017 - $6,009), a decrease of $945. This decrease
in expenses is primarily due to the one-time transition costs in 2017 and reductions in remuneration, directors’ fees,
and IT related expenses.

A loss on disposal of assets of $28 was recognized for the Year (2017 - $197 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 $1,335 (2016 - $1,458), a decrease of $123.

EBITDA
EBITDA was $2,707 for the Year (2017 - $2,434), an increase of $273. The increase is primarily driven by corporate
expense savings offset by higher Company-owned café operating loss and bad debts. Adjusted for non-recurring
transaction costs, EBITDA for the Year was $2,950 compared with $2,721 last year.

Other income and expenses
Other income for the Year was $105 (2017 - $nil), comprised of recognized income from the NAC strategic alliance
of $1,256 offset by a change in fair value of NAC warrants of $935 and asset impairment charges of $216.

As of December 29, 2018, the fair value of the warrants was $0.344 each versus $0.531 each at issuance on April 12,
2018, resulting in a decrease to the fair value of the NAC warrants of $935 for the Year. The change in fair value of
the NAC warrants will fluctuate in accordance with the trading price of the NAC common shares.

The Company incurred impairment charges of $216 (2017 - $nil) related to an impairment of property and
equipment of some Company-owned cafés.

Interest and financing costs
Interest income was $165 for the Year compared to interest and financing costs of $3,897 in 2017. In the third
quarter of 2017, one-time, non-cash financing charges of $3,290 was recognized. 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 income (loss)
The Company’s net income for the Year was $1,151 or $0.06 per share, compared to a net loss of $3,097 or $0.21 per
share in 2017. Adjusted for extraordinary items, net income for the Year was $1,074 or $0.06 per share compared to
a net income of $110 or $0.01 per share in 2017.

ANNUAL REPORT 2018 29

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 20182,3

$38,860

Q3 20183

$35,704

Q2 20183

$36,213

Q1 20183

$35,920

(2.0%)

262

$7,176

$814

$1,138

$1,297

($55)

$594

$0.00

$0.03

0.3%

270

$5,937

$520

$858

$880

$766

$432

$0.04

$0.03

(1.0%)

275

$5,627

$212

$537

$559

$577

$186

$0.03

$0.01

(2.2%)

279

$4,897

($175)

$174

$194

($138)

($0.01)

Q4 20172

$41,326

Q3 2017

$37,014

Q2 2017

$37,898

Q1 2017

$37,915

(1.1%)

286

$6,085

$993

$1,339

$655

$0.04

0.0%

289

$5,339

$436

$805

($2,962)

$245

($0.19)

$0.02

0.7%

291

$6,237

($138)

$230

$517

($315)

($0.02)

(0.2%)

293

$5,975

($315)

$60

($475)

($0.04)

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).

3 Adoption of new standard on a modified retrospective basis – Financial statements for 2018 are prepared under the new standard whereas the previous periods

are on the old standard. See the section “Changes in Accounting Policies” for further 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 same café sales.

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

LIQUIDITY AND CAPITAL RESOURCES

Second Cup collects royalties based on the franchisees’ portion of System sales of cafés, franchise fees, and other
amounts from its franchisees and also generates revenues from its Company-owned cafés and product sales. For
a more detailed discussion of the risks and uncertainties affecting the Company’s liquidity, see the general risks
outlined below and the “Capabilities” section above.

30 THE SECOND CUP LTD.

MANAGEMENT’S DISCUSSION AND ANALYSIS

Summary of cash flows

13 weeks ended

52 weeks ended

December 29,
2018

December 30
2017

December 29,
2018

December 30,
2017

Cash flows provided by operating activities

$1,050

$1,583

Cash flows provided by (used in)

investing activities

Cash flows provided by (used in)

financing activities

Increase in cash and cash equivalents during

the period

(248)

(3)

$799

$2,209

(1,084)

9,190

$1,862

(297)

(150)

(124)

$1,309

$10,315

$1,569

FOURTH QUARTER

Cash provided by operating activities was $1,050 for the Quarter compared to $1,583 for the same period last year.
The decrease in operating cash of $533 is mainly due to changes in share-based compensation and other non-cash
working capital items.

During the Quarter, cash used in investing activities was $248 compared to cash used of $150 for the same Quarter
in 2017. The increase is mainly due to higher capital expenditures.

Cash used in financing activities was ($3) for the Quarter compared to $124 last year. In the Quarter, the Company
repurchased 60,335 common shares under a normal course issuer bid for an aggregate total value of $115 with
settlement in 2019.

YEAR

Cash provided by operating activities was $2,209 for the Year compared to $1,862 for 2017. The increase in
operating cash of $347 is primarily due to a reduction in interest and financing costs and an increase in interest
income offset by changes in non-cash working capital.

During the Year, cash used by investing activities was $1,084 compared to cash provided of $4 for 2017. The
increase in 2017 is primarily driven by higher payments for capital expenditures in Company-owned cafés to be
refranchised.

Cash provided by financing activities was $9,190 for the Year compared to cash used of $297 in 2017. The Company
closed the Offering on May 8, 2018, net of transaction costs. As of December 29, 2018, the Company had
repurchased 60,335 common shares under a normal course issuer bid for an aggregate total value of $115 with
settlement in 2019.

Working capital as at

Current assets

Current liabilities

Working capital (deficiency)

December 29,
2018

December 30,
2017

$20,199

11,153

$9,046

$10,122

9,869

$253

ANNUAL REPORT 2018 31

The Company’s working capital was $9,128 as at December 29, 2018 compared to a working capital balance of
$253 at December 30, 2017. The Offering closed on May 8, 2018 with the Company receiving net proceeds of
$9,190, leading to an increase in cash balance. The increase in current liabilities in 2018 is primarily due to the
unamortized income related to the NAC strategic alliance. Gift card liability ended the Year at $2,327, a decrease
of $1,107 compared to the end of 2017. The application of IFRS 15 accounting on gift card balances outstanding
at December 31, 2017 is reflected as a $927 decrease in gift card liability and a $927 increase in accrued liabilities.
Based on the historical redemption patterns, the Company believes that it has sufficient financial resources to
cover the gift card liability.

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

Warrants

Financial liabilities

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

Liquidity

(i) Credit risk
Cash and cash equivalents and restricted cash
Credit risk associated with cash and cash equivalents and restricted cash 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 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 capital and 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.

(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 and debt leverage.
The Company’s main source of income is royalty receipts from its franchisees, corporate café sales, and sales from
goods and services.

32 THE SECOND CUP LTD.

MANAGEMENT’S DISCUSSION AND ANALYSIS

(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 the Company’s product offerings. The direct exposure is mitigated given that the Company has the
ability to adjust its sales price as commodity prices change. 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 forward 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

$16,681

1,812

$18,493

1 year

$2,451

1,812

$4,263

2 – 3 years

4 – 5 years

After 5 years

$4,409

Nil

$4,409

$3,934

Nil

$3,934

$5,887

Nil

$5,887

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 28, 2019

December 26, 2020

December 25, 2021

December 31, 2022

December 30, 2023

Thereafter

$16,929

15,286

13,679

12,519

10,750

27,712

$96,875

$14,478

12,978

11,578

10,492

8,843

21,825

Net

$2,451

2,308

2,101

2,027

1,907

5,887

$80,194

$16,681

The Company believes it has sufficient resources to meet the net commitment of $16,681 over the term of the
leases.

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 $1,601 (2017 - $1,392) 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 $211 (2017 - $894) of contractual commitments pertaining to construction
costs for new locations and renovations as at the end the Year. Construction costs are financed from deposits
received from franchisees for franchise projects and from the Company’s cash flows for corporate projects.

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

ANNUAL REPORT 2018 33

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 March 1, 2019, the Company’s management, under the supervision of, and with the participation of, the
CEO and CFO, evaluated the design of the disclosure controls and procedures. Based on this evaluation, the CEO
and CFO have concluded that, as at December 29, 2018, 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 29, 2018 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.

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 March 1, 2019, the Company’s management, under the supervision of, and with the participation of, the CEO
and CFO, evaluated the design of the controls over financial reporting. No material weaknesses in the design of
these controls over financial reporting were identified. Based on this evaluation, the CEO and CFO have concluded
that, as at December 29, 2018, the Company’s controls over financial reporting were appropriately designed and
were operating effectively.

34 THE SECOND CUP LTD.

MANAGEMENT’S DISCUSSION AND ANALYSIS

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 29, 2018 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 Consolidated Financial Statements requires management to make estimates,
assumptions, and use judgement in applying its accounting policies 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 in determining the amounts
reported in the consolidated 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 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.

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.

ANNUAL REPORT 2018 35

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 allocations 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.

(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 adoption of IFRS 9 has changed the accounting for impairment losses, with respect to financial assets, by
replacing IAS 39’s incurred loss approach with a forward-looking expected credit loss (“ECL”) approach. For the
Company, it is not expected that impairment losses will be materially different under IFRS 9, as compared to the
incurred loss approach. IFRS 9 requires the Company to record an allowance for expected credit losses (“ECLs”)
for all loans and other debt financial assets that are not held at fair value through profit and loss. ECLs are based
on the difference between the contractual cash flows due in accordance with the contract and all the cash flows
that the Company expects to receive. The shortfall is then discounted at an approximation to the asset’s original
effective interest rate.

The Company notes that its cash equivalents and short-term investments are high-grade investments that are
held with reputable financial institutions. As such, these assets are considered to be low credit risk investments.

For trade and other receivables, the Company has applied the standard’s simplified approach and has calculated
ECLs based on lifetime expected credit losses. The Company has established a provision matrix that is based on
the Company’s historical credit loss experience, adjusted for forward-looking factors specific to the debtors and
the economic environment. The adoption of the ECL requirements of IFRS 9 resulted in no changes to impairment
allowances of the Company’s financial assets. As such, there were no retrospective adjustments made upon
transition.

CHANGES IN ACCOUNTING POLICIES

In May, 2014, the IASB issued IFRS 15, Revenue from Contracts with Customers (“IFRS 15”) a new comprehensive
model for entities to use accounting for revenue arising from contracts with customers. On December 31,
2017, (“Transition Date”) the Company applied IFRS 15 using the modified retrospective transition method.
The consolidated financial statements reflect the application of IFRS 15 beginning in 2018, while the financial
statements for previous periods were prepared under the guidance of the previous standard. The details and
quantitative impact of the changes are disclosed below.

36 THE SECOND CUP LTD.

MANAGEMENT’S DISCUSSION AND ANALYSIS

Franchise revenue consists of royalties, as well as initial and renewal of franchise fees, and other fees. Our
performance obligations under franchise agreements include a franchise licence as well as pre-opening services
including training. These obligations are highly interrelated and, as required under the new guidance, the Company
defers the initial franchise and licensing fees and recognizes revenue over the term of the related agreement.
Previously, the Company recognized initial franchise fees when all material obligations and services had been
performed, which generally occurred when the franchised café opened. On the Transition Date, the Company
recognized an increase of $3,118 to deferred income, a decrease to deferred income taxes of $832 and a decrease to
the retained earnings (deficit) of $2,286.

The transition to IFRS 15 requires the consolidation of the Co-op Fund contributions and related expenses on a gross
basis. The adoption of IFRS 15 had no net impact on the Company’s cash provided by operating activities, cash
used in investing activities or cash provided by financing activities during the year.

Under IFRS 15, the Company recognizes gift card breakage income proportionately as gift cards are redeemed
using an estimated breakage rate based on our historical experience. Previously, the Company recognized the
estimated breakage income on gift card sales on a pro rata basis based on an estimate breakage rate. The
application of IFRS 15 accounting on gift card balances outstanding at December 31, 2017 is reflected as a $927
decrease in gift card liability and a $927 increase in other accrued liabilities.

IFRS 9, Financial Instruments (“IFRS 9”) replaced the incurred loss model under IAS 39 with a model on expected
credit losses. Under the new standard, expected credit losses are recorded. The application of IFRS 9 had no
material impact to the opening retained earnings (deficit) and to the fiscal year ended December 29, 2018.

Recent accounting pronouncements not yet effective
IFRS 16, Leases (“IFRS 16”) 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 (i) 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 (ii) depreciation of lease assets separately from interest on lease liabilities
on the unaudited condensed interim statements of income and comprehensive income.

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. 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.

The Company is in the process of completing its analysis but the most significant impact will be in the area of
accounting for its franchisee subleases and the 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.

ANNUAL REPORT 2018 37

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
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.

38 THE SECOND CUP LTD.

MANAGEMENT’S DISCUSSION AND ANALYSIS

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.

Earlier in the year, following the strengthening of the balance sheet, Second Cup initiated a strategic review to
examine alternatives to create shareholder value. This review is ongoing.

Reinventing the Second Cup brand is an on-going initiative. While progress has been made in elevating the brand,
the company is actively engaged in a brand strategy review to identify and test new innovations to aggressively
grow cafe sales and improve the café economic model which remain top priorities.

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.

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

ANNUAL REPORT 2018 39

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 – fair value gain/loss on NAC warrants, impact of
amortization of deferred income, and asset impairments in 2018 and fair value difference on debt exchange in 2017.
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.

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

Other loss (income)

Operating income (loss)

Net income (loss)

Income taxes

Interest and financing (income) costs

Other loss (income)

Depreciation of property and equipment

Amortization of intangible assets

EBITDA

Add impact of the following:
Transition costs

Transaction costs and other

Adjusted EBITDA

13 weeks ended

52 weeks ended

December 29,
20181

December 30,
2017

December 29,
20181

December 30,
2017

$(55)

(63)

885

$814

$655

343

(5)

$993

$1,151

($3,097)

491

(165)

(105)

$1,372

176

3,897

$976

13 weeks ended

52 weeks ended

December 29,
20181

December 30,
2017

December 29,
20181

December 30,
2017

$(55)

(63)

885

190

134

1,138

159

$1,297

$655

343

(5)

228

118

1,339

$1,339

$1,151

491

(165)

(105)

825

510

2,707

223

$2,930

($3,097)

176

3,897

1,002

456

2,434

287

$2,721

40 THE SECOND CUP LTD.

Net income (loss)

$(55)

$655

$1,151

($3,097)

13 weeks ended

52 weeks ended

December 29,
20181

December 30,
2017

December 29,
20181

December 30,
2017

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

issued and other costs

After-tax other loss (income)

Adjusted net income (loss)

649

$594

$655

(77)

$1,074

3,207

$110

Net income (loss) per share

$0.00

$0.04

$0.06

($0.21)

13 weeks ended

52 weeks ended

December 29,
20181

December 30,
2017

December 29,
20181

December 30,
2017

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

issued and other costs

After-tax other loss (income)

Adjusted net income (loss) per share

0.03

$0.03

$0.04

0.00

$0.06

0.22

$0.01

1 Adoption of new standard on a modified retrospective basis – Financial statements for 2018 are prepared under the new standard whereas the previous periods

are on the old standard. See the section “Changes in Accounting Policies” for further analysis.

ANNUAL REPORT 2018 41

Audited Consolidated Financial Statements

For the 52 weeks ended December 29, 2018 and December 30, 2017

INDEPENDENT AUDITOR’S REPORT

To the Shareholders of The Second Cup Ltd.

Our opinion
In our opinion, the accompanying consolidated financial statements present fairly, in all material respects, the
financial position of The Second Cup Ltd. and its subsidiaries (together, the Company) as at December 29, 2018
and December 30, 2017, and its financial performance and its cash flows for the 52-week periods then ended in
accordance with International Financial Reporting Standards (IFRS).

What we have audited
The Company’s consolidated financial statements comprise:
• the consolidated statements of financial position as at December 29, 2018 and December 30, 2017;
• the consolidated statements of operations and comprehensive income (loss) for the 52-week periods then ended;
• the consolidated statements of changes in shareholders’ equity for the 52-week periods then ended;
• the consolidated statements of cash flows for the 52-week periods then ended; and
• the notes to the consolidated financial statements, which include a summary of significant accounting policies.

Basis for opinion
We conducted our audit in accordance with Canadian generally accepted auditing standards. Our responsibilities
under those standards are further described in the Auditor’s responsibilities for the audit of the consolidated
financial statements section of our report.

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

Independence
We are independent of the Company in accordance with the ethical requirements that are relevant to our audit of
the consolidated financial statements in Canada. We have fulfilled our other ethical responsibilities in accordance
with these requirements.

Other information
Management is responsible for the other information. The other information comprises the Management’s
Discussion and Analysis, which we obtained prior to the date of this auditor’s report and the information, other
than the consolidated financial statements and our auditor’s report thereon, included in the annual report, which is
expected to be made available to us after that date.

Our opinion on the consolidated financial statements does not cover the other information and we do not and will
not express an opinion or any form of assurance conclusion thereon.

In connection with our audit of the consolidated financial statements, our responsibility is to read the other
information identified above and, in doing so, consider whether the other information is materially inconsistent
with the consolidated financial statements or our knowledge obtained in the audit, or otherwise appears to be
materially misstated.

If, based on the work we have performed on the other information that we obtained prior to the date of this
auditor’s report, we conclude that there is a material misstatement of this other information, we are required
to report that fact. We have nothing to report in this regard. When we read the information, other than the
consolidated financial statements and our auditor’s report thereon, included in the annual report, if we conclude

42 THE SECOND CUP LTD.

that there is a material misstatement therein, we are required to communicate the matter to those charged with
governance.

Responsibilities of management and those charged with governance for the consolidated financial statements
Management is responsible for the preparation and fair presentation of the consolidated financial statements
in accordance with IFRS, and for such internal control as management determines is necessary to enable the
preparation of consolidated financial statements that are free from material misstatement, whether due to fraud
or error.

In preparing the consolidated financial statements, management is responsible for assessing the Company’s ability
to continue as a going concern, disclosing, as applicable, matters related to going concern and using the going
concern basis of accounting unless management either intends to liquidate the Company or to cease operations, or
has no realistic alternative but to do so.

Those charged with governance are responsible for overseeing the Company’s financial reporting process.

Auditor’s responsibilities for the audit of the consolidated financial statements
Our objectives are to obtain reasonable assurance about whether the consolidated financial statements as a whole
are free from material misstatement, whether due to fraud or error, and to issue an auditor’s report that includes
our opinion. Reasonable assurance is a high level of assurance, but is not a guarantee that an audit conducted
in accordance with Canadian generally accepted auditing standards will always detect a material misstatement
when it exists. Misstatements can arise from fraud or error and are considered material if, individually or in the
aggregate, they could reasonably be expected to influence the economic decisions of users taken on the basis of
these consolidated financial statements.

As part of an audit in accordance with Canadian generally accepted auditing standards, we exercise professional
judgment and maintain professional skepticism throughout the audit. We also:
• Identify and assess the risks of material misstatement of the consolidated financial statements, whether due to
fraud or error, design and perform audit procedures responsive to those risks, and obtain audit evidence that is
sufficient and appropriate to provide a basis for our opinion. The risk of not detecting a material misstatement
resulting from fraud is higher than for one resulting from error, as fraud may involve collusion, forgery, intentional
omissions, misrepresentations, or the override of internal control.

• Obtain an understanding of internal control relevant to the audit 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
Company’s internal control.

• Evaluate the appropriateness of accounting policies used and the reasonableness of accounting estimates and

related disclosures made by management.

• Conclude on the appropriateness of management’s use of the going concern basis of accounting and, based

on the audit evidence obtained, whether a material uncertainty exists related to events or conditions that may
cast significant doubt on the Company’s ability to continue as a going concern. If we conclude that a material
uncertainty exists, we are required to draw attention in our auditor’s report to the related disclosures in the
consolidated financial statements or, if such disclosures are inadequate, to modify our opinion. Our conclusions
are based on the audit evidence obtained up to the date of our auditor’s report. However, future events or
conditions may cause the Company to cease to continue as a going concern.

• Evaluate the overall presentation, structure and content of the consolidated financial statements, including the

disclosures, and whether the consolidated financial statements represent the underlying transactions and events
in a manner that achieves fair presentation.

• Obtain sufficient appropriate audit evidence regarding the financial information of the entities or business

activities within the Company to express an opinion on the consolidated financial statements. We are responsible
for the direction, supervision and performance of the group audit. We remain solely responsible for our audit
opinion.

ANNUAL REPORT 2018 43

We communicate with those charged with governance regarding, among other matters, the planned scope and
timing of the audit and significant audit findings, including any significant deficiencies in internal control that we
identify during our audit.

We also provide those charged with governance with a statement that we have complied with relevant ethical
requirements regarding independence, and to communicate with them all relationships and other matters that
may reasonably be thought to bear on our independence, and where applicable, related safeguards.

The engagement partner on the audit resulting in this independent auditor’s report is Aneil Manji.

Chartered Professional Accountants, Licensed Public Accountants

Toronto, Ontario

March 1, 2019

4 4 THE SECOND CUP LTD.

Consolidated Statements of Financial Position

As at December 29, 2018 and December 30, 2017
(Expressed in thousands of Canadian dollars)

2018

2017

ASSETS

Current assets
Cash and cash equivalents

Restricted cash (note 24)

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)

Investments in equity securities (note 16)

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

Deferred income (note 27)

Income tax payable

Non-current liabilities
Provisions (note 12)

Other liabilities (note 13)

Deferred income (note 27)

Deferred income taxes (note 20)

Total liabilities

SHAREHOLDERS’ EQUITY

Total liabilities and shareholders’ equity

Contingencies, commitments and guarantees (note 25)
See accompanying notes to consolidated financial statements.
Approved by the Directors March 1, 2019

$14,888

1,750

2,561

525

259

186

20,199

1,720

2,044

32,015

$56,001

$5,251

634

130

2,327

769

2,042

11,153

297

157

2,357

5,591

19,555

36,446

$56,001

$4,573

1,359

3,716

205

206

10,123

2,132

32,372

$44,701

$3,974

934

208

3,433

1,230

–

9,870

230

179

6,160

16,439

28,262

$44,701

Michael Bregman, Director

Melinda Lee, Director

ANNUAL REPORT 2018 45

Consolidated Statements of Operations
and Comprehensive Income (Loss)

For the periods ended December 29, 2018 and December 30, 2017
(Expressed in thousands of Canadian dollars, except per share amounts)

Revenue (note 14)

Company-owned cafés and product sales

Franchise revenue

Operating costs and expenses (note 15)

Company-owned cafés and cost of product sales

Franchise expenses

General and administrative expenses

Loss on disposal of assets

Depreciation and amortization

Income from operations

Other income (notes 5, 16, 17 and 19)

Interest and financing costs (income)(note 18)

Income (loss) before income taxes

Income taxes (note 20)

Net income (loss) and comprehensive income (loss) for the
period

Basic and diluted income (loss) per share (note 21)

See accompanying notes to consolidated financial statements.

2018

7,885

17,829

25,714

8,954

8,961

5,064

1,335

24,342

1,372

(105)

(165)

1,642

491

$1,151

$0.06

2017

$8,562

15,074

23,636

9,303

5,693

6,009

197

1,458

22,660

976

3,897

(2,921)

176

($3,097)

($0.21)

46 THE SECOND CUP LTD.

Consolidated Statements of Changes
in Shareholders’ Equity

For the periods ended December 29, 2018 and December 30, 2017
(Expressed in thousands of Canadian dollars)

Share Capital

Warrants

Balance – December 31, 2016

$8,652

Net loss for the period

Stock option plan recovery

Warrants extinguished (note 3)

Warrants issued (note 3)

Shared issued (note 3)

Balance – December 30, 2017

Adoption of new accounting policy - net

of tax (note 2(x))

Net income for the period

Stock option plan expense (note 28)

Shares repurchased (note 4)

Shares issued net of tax (note 4)

$–

–

10,619

$19,271

$–

–

(87)

9,406

$271

$–

–

(271)

165

–

$165

$–

–

Contributed
Surplus

$61,789

$–

(42)

–

Retained
Earnings
(Deficit)

($49,824)

$(3,097)

–

$61,747

($52,921)

$–

–

($2,286)

1,151

–

(28)

–

Total

$20,888

$(3,097)

(42)

(271)

165

10,619

$28,262

($2,286)

1,151

(115)

9,406

Balance – December 29, 2018

$28,590

$165

$61,775

($54,084)

$36,446

See accompanying notes to consolidated financial statements.

ANNUAL REPORT 2018 47

Consolidated Statements of Cash Flows

For the periods ended December 29, 2018 and December 30, 2017
(Expressed in thousands of Canadian dollars)

CASH PROVIDED BY (USED IN)

Operating activities

Net income (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 20)

Loss on disposal of property related items

Other income

Change in fair value of investments in securities

Asset impairment charges

Fair value of difference on shares issued and other cost

Bad debt expense for notes and leases receivable

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

Cash provided by (used in) operating activities

Investing activities

Proceeds from disposal of assets

Cash payments for capital expenditures (note 22)

Cash payments for intangible assets (note 22)

Notes receivable repayment

Cash (used in) provided by investing activities

Financing activities

Proceeds from issuance of shares

Transaction costs

Cash (used in) provided by financing activities

Increase 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 consolidated financial statements. Supplemental cash flow information is provided in note 22.
Information on non-cash transactions and supplemental cash flow information are described further in notes 5, 23, and 24.

48 THE SECOND CUP LTD.

2018

2017

$1,151

($3,097)

825

510

–

480

(1,256)

935

216

–

(733)

2,209

304

(1,281)

(157)

(1,084)

10,000

(810)

9,190

10,315

4,573

$14,888

1,018

456

139

197

–

3,290

(274)

1,862

473

(383)

(217)

131

–

(297)

1,569

3,004

$4,573

Notes to the Consolidated Financial Statements

For the periods ended December 29, 2018 and December 30, 2017
(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 262 (2017
- 286) cafés operating under the trade name Second Cup™ in Canada, of which 25 (2017 - 12) 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 consolidated 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 consolidated financial statements have been prepared on the historical cost basis except for
certain financial instruments that are measured at fair value 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 consists
of 13 weeks and ends 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 2018 is a 52-week period (2017 – 52-week period).

These consolidated financial statements include the advertising and co-operative fund (the “Co-op Fund”). The
Company manages 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. In accordance with the guidance of IFRS 15, Revenue from
Contracts with Customers (“IFRS 15”), the revenue, expenses and cash flows of the Co-op Fund are consolidated in
the Consolidated Statements of Financial Position. The assets and liabilities of the Co-op Fund are included in the
assets and liabilities of the Company on the Consolidated Statements of Financial Position.

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 2018 49

c. Critical accounting estimates, assumptions and the use of judgement
The preparation of consolidated financial statements requires management to make estimates and 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 consolidated 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 consolidated financial statements:

The Company’s impairment tests include key assumptions related to the scenarios discussed above. Further details
are provided in note 19 to the consolidated 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

50 THE SECOND CUP LTD.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

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 adoption of IFRS 9, Financial Instruments (“IFRS 9”) has changed the accounting for impairment losses, with
respect to financial assets, by replacing International Accounting Standard 39, Financial Instruments: Recognition
and Measurement (“IAS 39”)’s incurred loss approach with a forward-looking expected credit loss (“ECL”)
approach. For the Company, it is not expected that impairment losses will be materially different under IFRS 9,
as compared to the incurred loss approach. IFRS 9 requires the Company to record an allowance for ECLs for all
loans and other debt financial assets that are not held at fair value through profit and loss. ECLs are based on the
difference between the contractual cash flows due in accordance with the contract and all the cash flows that the
Company expects to receive. The shortfall is then discounted at an approximation to the asset’s original effective
interest rate.

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 Consolidated 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.

Financial assets classified as fair value through profit and loss (“FVPL”) are measured at fair value with
any resultant gain or loss recognized in profit or loss. Financial assets classified as fair value through other
comprehensive income (“FVOCI”) are measured at fair value with any subsequent remeasurement recognized in
other comprehensive income. When FVOCI financial assets are derecognized, the cumulative gain or loss previously
recognized directly in equity is recognized in profit or loss. Financial assets classified as loans and receivables
and held to maturity are measured at amortized cost using the effective interest rate method. Transaction costs
associated with FVPL financial assets are expensed as incurred, while transaction costs associated with all other
financial assets are included in the initial carrying amount of the asset. All financial liabilities are recognized initially
at fair value plus, in the case of loans and borrowings, directly attributable transaction costs. Financial liabilities are
classified as other financial liabilities, and are subsequently measured at amortized cost using the effective interest
rate method. The Company has classified its financial instruments as follows:

ANNUAL REPORT 2018 51

Financial instrument

Financial assets

Cash and cash equivalents

Restricted cash

Trade and other receivables

Notes and leases receivable

Warrants

Financial liabilities

Recognition method

Amortized cost

Fair value through profit and loss

Accounts payable and accrued liabilities

Amortized cost using the effective interest rate method

Deposits from franchisees

Term credit facility

Amortized cost using the effective interest rate method

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 $241 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
Consolidated 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:

52 THE SECOND CUP LTD.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

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

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 income
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 income is amortized over the term of the supply agreements based on the proportion of volume
thresholds met during the fiscal year or on 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 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 2018 53

Income taxes

l.
Income taxes comprise current and deferred income taxes. Income taxes are recognized in the Consolidated
Statements of Operations and Comprehensive Income (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 consolidated 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 Consolidated 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.

The determination of the gift card breakage rate is based upon Company-specific historical load and redemption
patterns. As part of the process of adopting IFRS 15, the 2018 redemption analysis determined that a breakage
rate of 3.59% was applicable to gift card sales. Gift card breakage is recognized on a pro rata basis based on
historical gift card redemption patterns. Breakage income is allocated to the Co-op Fund. See note 2(x) for more
information.

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 determined that performance obligation has been fulfilled and the associated
economic benefits will flow to the Company, the sales price is fixed or determinable, and collectibility 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
For 2017 and 2018, royalty revenue from franchised cafés is based on agreed percentage royalty rates of the
franchise location sales as they happen. 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.

(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, Co-op Fund contributions, construction administration fees, purchasing coordination fees,
and other ancillary fees (such as IT support and training fees).

54 THE SECOND CUP LTD.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

Under a franchise agreement, the Company provides the franchisee with (i) a franchise license to use the
Company’s intellectual property and advertising and promotion management, (ii) pre-opening services, such
as training and inspections, and (iii) ongoing services, such as development of training materials, menu items
and café monitoring and inspections. The services provided are highly interrelated and constitute the Company’s
performance obligations under the term of franchise agreement. For fiscal 2018, franchise fees and renewal fees
are recognized over the term of franchise agreements (note 2(x)). For fiscal 2017, under the previous accounting
standard, franchise fees were recorded in revenue when performance obligations were satisfied, usually when the
café opened.

The Company receives food and beverage, and product and service coordination fees relating to agreements with
vendors. Fees are generally earned based on the value of purchases during the period. Agreements that contain
an initial upfront fee, in addition to ongoing fees are generally recorded to income over the term of the respective
agreement.

(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.
Revenue is recognized at a point in time when the services are rendered and the product is sold to the end
consumer. Payment is collected at the time of sale and the consideration received is unconditional.

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 expenses
Franchise costs represent the cost of direct labour to support the network, Co-op Fund expenses, travel and
franchisee meetings, business development initiatives as well as professional fees directly related to franchise
operations.

(iii) General and administrative expenses
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.

ANNUAL REPORT 2018 55

Recorded values of the plan are presented as accounts payable and accrued liabilities in the Consolidated
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.

IFRS 9 replaces the provisions of IAS 39 that relate to the recognition, classification and measurement of financial
assets and financial liabilities, derecognition of financial instruments, impairment of financial assets and hedge
accounting.

The adoption of IFRS 9 Financial Instruments from January 1, 2018 resulted in changes in accounting policies and
adjustments to the amounts recognized in the consolidated financial statements. The new accounting policies are
set out below. In accordance with the transitional provisions in IFRS 9, comparative figures have not been restated.

The adoption of IFRS 9 had no impact on the Company’s classification of financial assets and financial liabilities
that continue to be measured on the same basis as was previously applied under IAS 39. IFRS 9 replaces the
incurred loss model of IAS 39 with a model based on expected credit losses. Under the new standard, the loss
allowance for a financial instrument will be calculated at an amount equal to 12-month expected credit losses, or
lifetime expected credit losses if there has been a significant increase in the credit risk on the instrument.

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 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 consolidated 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.

56 THE SECOND CUP LTD.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

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 consolidated 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 that are determined to be settled on a net-equity basis
are accounted for as equity instruments. Share option awards that 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 28.

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

x. Changes in accounting policies
In May, 2014, the IASB issued IFRS 15, a new comprehensive model for entities to use accounting for revenue arising
from contracts with customers. On December 31, 2017, (“Transition Date”) the Company applied IFRS 15 using the
modified retrospective transition method. The consolidated financial statements reflect the application of IFRS
15 beginning in 2018, while the financial statements for previous periods were prepared under the guidance of the
previous standard. The details and quantitative impact of the changes are disclosed below.

The transition to IFRS 15 requires the consolidation of the Co-op Fund contributions and related expenses on a gross
basis. See note 14 for more details. The adoption of IFRS 15 had no net impact on the Company’s cash provided by
operating activities, cash used in investing activities or cash provided by financing activities during the year.

IFRS 9 replaced the incurred loss model under IAS 39 with a model based on expected credit losses. Under the new
standard, expected credit losses are recorded. The application of IFRS 9 had no material impact to the opening
retained earnings (deficit) and to the fiscal year ended December 29, 2018.

Recent accounting pronouncements not yet effective
IFRS 16, Leases (“IFRS 16”) 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 (i) right-of-use assets and lease liabilities for leases with terms of more than 12

ANNUAL REPORT 2018 57

months, unless the underlying asset is of low value; and (ii) depreciation of lease assets separately from interest on
lease liabilities on the consolidated statements of operations and comprehensive income (loss).

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.

On May 8, 2018, the Company issued 2,898,600 common shares of Second Cup as a result of an agreement with
Clarus Securities Inc. (the “Underwriter”) on a “bought deal” basis.

See note 4 for more details.

Shares outstanding at the fiscal year ended December 29, 2018 are 19,940,073 (2017 – 17,041,473).

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, an affiliate of Serruya Private Equity. The Company also extinguished its $8,000 debt to SPE and
cancelled 600,000 old warrants.

On April 17, 2018, the Company entered into an agreement with the Underwriter, pursuant to which the Underwriter
agreed to purchase, on a “bought deal” basis, 2,898,600 common shares of the Company at a price of $3.45 per
share for aggregate gross proceeds to the Company of $10,000 (the “Offering”). The Offering closed on May 8, 2018,
with the Company receiving aggregate gross proceeds of $10,000 and net proceeds of $9,190.

On December 18, 2018, the Company announced that the Toronto Stock Exchange (the “TSX”) had approved its
notice of intention to make a normal course issuer bid for a portion of its common shares. Pursuant to the normal
course issuer bid, the Company intends to acquire up to 1,000,000 common shares, representing approximately 7.4%
of its public float of 13,463,184 common Shares, in the 12-month period commencing December 20, 2018 and ending
on December 19, 2019 or such earlier time that the Company completes its purchases pursuant to the normal course
issuer bid or provides notice of termination. Under the normal course issuer bid, the Company may purchase up to
12,071 common shares on the TSX during any trading day. As of December 29, 2018, the Company had repurchased
60,335 common shares for an aggregate total value of $115.

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.

58 THE SECOND CUP LTD.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

The Company’s primary uses of capital are to finance increases in non-cash working capital, capital expenditures,
and other corporate purposes.

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

Warrants

Financial liabilities

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

Liquidity

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 fair value of warrants received in 2018 (see note 17) is determined using the Black-Scholes pricing
model. This valuation model requires five input variables: the exercise price of the warrants, the current price of
the underlying stock, the time to expiration, the risk-free interest rate, and the stock’s volatility. The following table
summarizes the financial instruments measured at fair value:

Warrants

Opening fair value

Fair value of warrants received

Change in fair value

Closing fair value

2018

2017

$–

2,655

(935)

$1,720

$–

–

$–

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).

ANNUAL REPORT 2018 59

Credit risk
a. Cash and cash equivalents and restricted cash
Credit risk associated with cash and cash equivalents and restricted cash 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 that 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.

The Company has applied IFRS 9’s simplified approach and has calculated ECLs based on lifetime expected credit
losses. The Company has established a provision matrix that is based on the Company’s historical credit loss
experience, adjusted for forward-looking factors specific to the debtors and the economic environment.

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 29, 2018

Allowance for doubtful accounts

Net amount 2018

Gross amount as at December 30, 2017

Allowance for doubtful accounts

Net amount 2017

$2,252

(69)

$2,183

$3,452

(18)

$3,434

$285

(121)

$164

$158

(60)

$98

$238

(137)

$101

$109

(40)

$69

$3,351

(3,238)

$113

$2,322

(2,207)

$115

Total

$6,126

(3,565)

$2,561

$6,041

(2,325)

$3,716

Trade and other receivables include a combined allowance for doubtful accounts of $3,565 (December 30, 2017 -
$2,325). Credit terms vary by customer in the range of 30 to 90 days. The net amount due of $113 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 29, 2018, net of an allowance for
doubtful accounts, are as follows:

2018

2017

< 90 Days

$22

90 Days
to < 1 year

1 year
to < 2 years

2 years
and after

$22

$42

$19

$42

$32

Total

$53

$138

Notes and leases receivable included a combined allowance for doubtful accounts of $90 (December 30, 2017 -
$55). Notes and leases receivable are further discussed in note 7.

60 THE SECOND CUP LTD.

NOTES TO THE CONSOLIDATED 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.
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

2018

$6,126

(3,565)

$2,561

2017

$6,041

(2,325)

$3,716

During the period, $1,240 (2017 - $464 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

2018

2017

$41

(77)

(13)

$26

(37)

(18)

$138

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

ANNUAL REPORT 2018 61

8. INVENTORIES

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

Merchandise held for resale

Supplies

9. PROPERTY AND EQUIPMENT

Net carrying value
As at December 31, 2016

Cost

Accumulated depreciation

As at December 31, 2016

Additions

Reclass of transfers from construction in process

Disposals – original cost

Disposals – accumulated depreciation

Depreciation

As at December 30, 2017

Net carrying value
As at December 30, 2017

Cost

Accumulated depreciation

As at December 30, 2017

Additions

Disposals – original cost

Disposals – accumulated depreciation

Impairment charge (note 19)

Depreciation

As at December 29, 2018

Cost

Accumulated depreciation

As at December 29, 2018

2018

$474

$525

Equipment,
furniture,
fixtures and
construction
in process

Computer
hardware

Leasehold
improvements

$2,522

(1,164)

1,358

(403)

(296)

759

$2,462

(1,703)

759

281

(107)

–

(14)

(282)

637

2,619

(1,982)

$637

$4,677

(2,811)

1,866

338

(2)

(389)

(608)

1,275

$4,613

(3,338)

1,275

999

(227)

(197)

(463)

1,393

5,010

(3,617)

$1,393

$881

(671)

210

–

(1)

(114)

$881

(783)

–

(5)

(80)

853

(839)

$14

2017

$180

$205

Total

$8,080

(4,646)

3,433

383

–

(793)

126

(1,018)

2,132

$7,956

(5,824)

2,132

1,281

(334)

(216)

(825)

2,044

8,482

(6,438)

$2,044

62 THE SECOND CUP LTD.

10. INTANGIBLE ASSETS

Net carrying value

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

Additions

Disposals – original cost

Disposals – accumulated amortization

Amortization

As at December 29, 2018

Cost

Accumulated amortization

As at December 29, 2018

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 CONSOLIDATED FINANCIAL STATEMENTS

Trademarks

Software

Total

$31,144

–

31,144

–

$31,144

–

$31,144

–

$31,144

31,144

–

$31,144

$2,979

(1,512)

1,467

217

(456)

$1,228

$3,194

(1,966)

$1,228

157

(298)

294

(510)

$871

3,053

(2,182)

$871

2018

$1,689

2,855

532

175

$5,251

$34,123

(1,512)

$32,611

217

(456)

$32,372

34,338

(1,966)

$32,372

157

(298)

294

(510)

$32,015

34,197

(2,182)

$32,015

2017

$959

1,834

916

265

$3,974

ANNUAL REPORT 2018 63

12. PROVISIONS

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

Provisions charged during the period

Provisions utilized during the period

As at December 29, 2018

Current portion

Long-term portion

As at December 29, 2018

Café leases (a)

Other (b)

$2,102

239

(1,274)

$1,067

$837

230

$1,067

(176)

$931

$634

297

$931

$26

480

(409)

$97

–

$97

(111)

$–

–

$–

Total

$2,128

719

(1,683)

$1,164

$934

230

$1,164

(287)

$931

$634

297

$931

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

Provisions for café leases of $40 (2017 - $239) were charged in the year and are reflected in the franchise expenses
line on the Consolidated Statements of Operations and Comprehensive Income (Loss).

b. Other
Provisions for other items of $14 (2017 - $480) were charged in the year.

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

64 THE SECOND CUP LTD.

2018

$94

$130

$14

143

$157

$108

179

$287

2017

$172

$208

$–

179

$179

$172

215

$387

14. REVENUE

Franchise revenue

Royalties

Advertising fund contributions

Services and other

Company-owned cafés and product sales

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

2018

2017

$9,930

3,031

4,868

17,829

7,885

$25,714

$10,299

–

4,775

15,074

8,562

$23,636

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.

Advertising fund contributions
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 Company has adopted IFRS 15 accounting as it relates to the
Co-op Fund using the modified retrospective transition method. The consolidated financial statements reflect
the application of IFRS 15 beginning in 2018, while the financial statements for previous periods were prepared
under the guidance of the previous standard. The transition to IFRS 15 requires the presentation of the Co-op
Fund contributions and related expenses on a gross basis. As a result, franchise revenue includes Co-op Fund
contributions of $3,031 in 2018. For 2017, applying the new standard would result in an increase of $3,033 in
franchise revenue due to the consolidation of the Co-op Fund.

Franchise fees, services and other
Franchise fees, services and other consist of initial franchise fees, renewal fees, transfer fees earned on the sale of
cafés from one franchisee to another, construction administration fees, purchasing coordination fees, licensing fees
and other ancillary fees (such as IT support and training fees).

Balance at December 31, 2017

Franchise fees additions to deferred income

Franchise fees recognized as income in the year

Balance at December 29, 2018

Deferred income

$3,118

875

(993)

$3,000

For 2017, applying IFRS 15 would result in a decrease of $454 to the franchise fees previously reported.

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.
Revenue is recognized at a point in time when the services are rendered and the product is sold to the end
consumer. Payment is collected at the time of sale and the consideration received is unconditional.

ANNUAL REPORT 2018 65

15. 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 expenses

Labour and related expenses

Advertising fund expenses

Travel and franchisee meetings

Professional fees and other

General and administrative expenses

Labour and related expenses

Professional fees and other

Occupancy

Other

Depreciation and amortization

2018

$3,101

2,941

2,912

361

9,343

3,768

3,022

285

1,886

8,961

1,707

2,879

478

5,064

974

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

$24,342

$22,660

The Company has adopted IFRS 15 accounting as it relates to the Co-op Fund using the modified retrospective
transition method. The consolidated financial statements reflect the application of IFRS 15 beginning in 2018, while
the financial statements for previous periods were prepared under the guidance of the previous standard. The
transition to IFRS 15 requires the presentation of the Co-op Fund contributions and related expenses on a gross
basis. As a result, franchise expenses includes Co-op Fund expenses of $3,022 in 2018. For 2017, applying the new
standard would result in an increase of $2,737 in franchise expenses and a decrease of $151 in Company-owned
café expenses.

16. OTHER EXPENSE (INCOME)

Recognition of NAC deferred income

Change in fair value of NAC warrants as at end of year

Asset impairment charges

2018

$(1,256)

935

216

$(105)

2017

$–

–

$–

66 THE SECOND CUP LTD.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

17. WARRANTS

On April 12, 2018, the Company established a strategic alliance with National Access Cannabis Corp. (“NAC”)
to develop and operate a network of NAC-branded recreational cannabis dispensaries initially across Western
Canada, expanding to include additional provinces where legally permissible. NAC will apply for licences to dispense
cannabis products and upon receipt, work with Second Cup and applicable franchisees to leverage Second Cup’s
extensive Canadian retail footprint to construct retail stores carrying leading cannabis products. As consideration,
the Company received 5,000,000 warrants to purchase common shares of NAC at a strike price of $0.91 at any
time during the period of five years following the issuance date. As at the date of issuance, the fair value of $2,655,
($0.531 each) of warrants was recorded as an asset with a corresponding entry to deferred income. As of December
29, 2018, the fair value was $0.344 each, resulting in a decrease to the fair value of the warrants of $935.

The deferred income is recognized over the term of the agreement with NAC, which commenced on the date
of agreement, April 12, 2018, and terminates on the twelve-month anniversary of the coming into force of the
Cannabis Act, which is October 17, 2019. Included in other income for 2018 is $1,256 for the amortization of the
deferred income.

18. INTEREST AND FINANCING COSTS (INCOME)

Fair value difference on shares issued and other costs

Interest expense

Amortization of deferred financing costs

Interest income

2018

$–

–

(165)

$(165)

2017

$3,290

505

139

(37)

$3,897

19. IMPAIRMENT OF ASSETS

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.

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 29, 2018 does not indicate any

ANNUAL REPORT 2018 67

impairment (2017 - $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 carrying amount

2018

12.0%

-1.0%

0.0%

$9,000

2017

12.0%

0.0%

$6,500

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 $216 for the year ended December 29, 2018 (2017 - $nil) were recorded to assets that were
not able to be redeployed to a different CGU as the carrying amount exceeded the recoverable amount. The
impacted assets were adjusted to a carrying value of $nil.

20. 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:

Income (loss) before income taxes

Combined Canadian federal and provincial tax rate

Tax expense (recovery) at statutory rate

Increased (reduced) by following differences

Change in tax rates

Non-deductible permanent differences

Other

Income tax expense

Current income tax expense

Deferred income tax expense

Income tax expense

2018

$1,642

26.67%

437

$491

$11

480

$491

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

2018

15.00%

11.67%

26.67%

68 THE SECOND CUP LTD.

2017

($2,922)

26.70%

(780)

786

151

$176

$146

$176

2017

15.00%

11.70%

26.70%

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

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

As at December 31, 2016

Charged (credited) to the income statement

Credited to equity

As at December 30, 2017

Charged to the income statement

Credited to equity

As at December 29, 2018

Property and
equipment

Trademarks

Warrants

2,011

(21)

–

1,990

–

4,773

–

4,773

–

(39)

134

–

Other

(677)

(37)

(663)

318

(1,049)

$2,018

$4,773

$194

$(1,394)

Total

6,206

(76)

6,160

480

(1,049)

$5,591

21. BASIC AND DILUTED INCOME (LOSS) PER SHARE

Income (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 income
(loss) per share is determined as follows:

Net income (loss)

Weighted average number of shares issued and outstanding

Basic and diluted income (loss) per share

22. SUPPLEMENTAL CASH FLOW INFORMATION

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

Trade and other receivables

Inventories

Prepaid expenses and other assets

Accounts payable and accrued liabilities

Provisions

Other liabilities

Deferred income

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

2018

$1,151

18,920,785

$0.06

2018

$1,155

(320)

(53)

1,171

(233)

(100)

(118)

(1,106)

(852)

(277)

$(733)

$(1,281)

(157)

$(1,438)

$–

$11

2017

($3,097)

14,485,081

($0.21)

2017

($693)

(5)

293

(964)

154

(52)

324

623

($274)

($383)

(217)

($600)

$505

$–

ANNUAL REPORT 2018 69

23. MOVEMENT OF NON-CASH FINANCING ACTIVITIES

In 2017, 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.

24. RESTRICTED CASH

The Company has established certain accounts that have been classified as restricted cash primarily representing:
i) deposits from franchisees for the cost of constructing a new café or the renovation of an existing café, ii) 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 iii) 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

2018

$746

763

241

$1,750

2017

$408

711

240

$1,359

25. 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 29, 2018 are as follows::

December 28, 2019

December 26, 2020

December 25, 2021

December 31, 2022

December 30, 2023

Thereafter

Head lease
commitments

$16,929

15,286

13,679

12,519

10,750

27,712

$96,875

Sublease to
franchisees

$14,478

12,978

11,578

10,492

8,843

21,825

$80,194

Net

$2,451

2,308

2,101

2,027

1,907

5,887

$16,681

The Company believes it has sufficient resources to meet the net commitment of $16,681 over the term of the
leases.

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 $1,601 (2017 - $1,392) for

70 THE SECOND CUP LTD.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

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 $211 (2017 - $894) of contractual commitments pertaining to construction
costs for new locations and renovations as at the end of the fiscal year. Construction costs are financed from
deposits received from franchisees for franchise projects and from the Company’s cash flows for corporate
projects.

26. 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

27. DEFERRED INCOME

Deferred income – miscellaneous income

Deferred income – contract liability

Current deferred income

Deferred income – miscellaneous income

Deferred income – contract liability

Long term deferred income

Total deferred income

28. SHARE-BASED COMPENSATION

2018

$2,344

–

$2,362

2018

$1,399

643

$2,042

–

2,357

$2,357

$4,399

2017

$2,236

247

$2,543

2017

$ –

–

$ –

–

$ –

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.

ANNUAL REPORT 2018 71

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. 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 $0.23 granted as of December 29, 2018:

Risk-free interest rate (%)

Volatility (%)

Expected term (years)

The table below summarizes all activities for the year ended December 29, 2018:

Assumption

1.66

40.67

8.1

As at December 30, 2017

Granted

Forfeited

As at December 29, 2018

Stock option plan recovery during the period

Number of share
options outstanding

Weighted average
share option price

260,000

300,000

(50,000)

510,000

$3.30

2.23

3.13

$2.69

$28

The range of exercise prices for share options outstanding at December 29, 2018 is $1.60 to $4.54. Of the share
options outstanding, 108,000 share options are exercisable. The weighted average years to expiration are
approximately eight years. Share award options are able to be exercised upon vesting.

29. 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 31, 2016

Deferred units granted

Change in fair value

Notional units outstanding as at December 30, 2017

Expensed in the period

Notional units outstanding as at December 30, 2017

Deferred units granted

Deferred units paid out

Change in fair value

Notional units outstanding as at December 29, 2018

Recovery in the period

Notional units

Recorded value

112,281

45,047

–

157,328

$239

$341

$102

Notional units

Recorded value

157,328

37,504

(13,889)

–

180,943

$341

(42)

(48)

$331

$(10)

The average fair value price of deferred units granted was $2.13 (2017 - $2.18).

72 THE SECOND CUP LTD.

Shareholder Information

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 &
Construction

Ted Tai
Vice President, Operations

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

ANNUAL REPORT 2018 73

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