MISSISSAUGA, ON, March 9 /CNW/ - Second Cup Royalty Income Fund (the "Fund") reported today financial results for the fourth quarter and year ended December 31, 2008, and other matters as discussed below. The Fund's units are traded on the Toronto Stock Exchange under the symbol "SCU.UN". All amounts in this news release are presented in thousands of Canadian dollars, unless otherwise indicated.
Performance Highlights
- System sales for 2008 increased by 0.8% to $197,340
- Same store sales for 2008 grew 0.2% for the year
- Distributable cash per unit increased to $1.1510 per unit from
$1.1356
- After-tax non-cash impairment charge of $20,956 or $2.12 per unit
- Bank term loan extended to January 2011 at lower effective interest
rate
"Like most of the retail sector, Second Cup experienced a softening of same cafe sales throughout 2008 with the fourth quarter reflective of the sharp downturn in the Canadian economy," commented Stacey Mowbray, President of The Second Cup Ltd. ("Second Cup"). "That said, we are confident in the strength of the Second Cup brand and are undertaking several initiatives around product innovation, value promotions and cafe experience excellence with a view to driving average cheque and consumer traffic. I would like to thank our franchise partners and colleagues for their passion, teamwork and commitment to Second Cup. We view our independently owned network as a great asset in these more challenging economic times," added Ms. Mowbray.
Distribution Announcement
The Fund announced that its Board of Trustees has approved a cash distribution of $0.0940 per unit for the month of February 2009 to be paid on March 31, 2009 to Unitholders of record at the close of business on March 27, 2009.
2008 Year Analysis
System sales increased 0.8% to $197,340 from $195,750 in 2007. Same cafe sales growth was 0.2% for the year. Same cafe sales for the year were positively impacted by the extra leap year day; by Second Cup's promotional programs and food innovation, which continued to shift its sales mix to food, resulting in higher year over year average cheque amounts; and by a modest price increase. On the other hand, the sharp downturn in the Canadian economy had a negative impact on same cafe sales in the fourth quarter.
The source of revenue for the Fund is through its 100% ownership in Second Cup Trade-Marks Limited Partnership ("MarksLP") and, prior to the 2007 reorganization, Second Cup Trade-Marks Inc. ("MarksCo"), which, in turn, receives royalty income from Second Cup under a Royalty and Licence Agreement (the "Agreement"). The earnings of MarksLP and MarksCo are recorded on an equity-accounted basis in the Fund's financial statements.
The Fund is required, at least on an annual basis, to assess potential impairment by evaluating whether the carrying value of its assets exceed their fair values. Driven primarily by a change in market conditions, the Fund concluded the carrying value of its investment in MarksLP exceeded its fair value as of December 31, 2008. As a result, the Fund recorded a pre-tax non-cash charge in the fourth quarter and for the year ended December 31, 2008 reducing the carrying value of the non amortizable investment in MarksLP by $24,349 to $88,500. After taking into account the related recovery of future income taxes, the after-tax non-cash charge to income is $20,956 or $2.12 per unit.
For the year, MarksLP earned royalty revenue of $12,991 (2007 - $12,829), an increase of 1.3%. Aggregate general and administrative expenses incurred by the Fund and MarksLP were $840 (2007 - $965 including MarksCo). The decrease is primarily due to lower costs incurred for professional services. Net interest expense for the Fund and MarksLP amounted to $683 in 2008 compared to $569 in 2007 including MarksCo. The Fund also incurred a non-cash charge of $269 relating to the movement in the fair value of its derivative interest rate swap (2007 - $143) which fixes the interest rate on the term loan at 6.62%. Also, as noted above, the Fund recorded a non-cash impairment charge of $24,349 in 2008. Non-cash amortization of deferred financing charges amounted to $50 (2007 - $173 including MarkCo). In 2007 the Fund incurred expenses of $312 related to the reorganization of its structure. The Fund has no current income tax expense and recognized a non-cash future income tax recovery of $3,664 in 2008 primarily related to the non-cash impairment charge. In the fourth quarter of 2007, as a result of reassessments obtained subsequent to a federal income tax audit relating to its predecessor corporation, MarksLP recorded a recovery of $450 in current income tax. Excluding this one-time recovery of $450, the balance of current income tax expense in 2007 was $56 and related to income tax expense incurred by MarksCo up to the reorganization of the Fund's structure in April 2007. Primarily as a result of the reorganization and new legislation impacting income tax rates in 2011 and onwards, the combined entities recognized a non-cash future income tax charge of $2,865 in 2007.
The Fund recorded a net loss of $9,531 or $0.9642 per unit for 2008, compared to net income of $8,196 or $0.8442 per unit in 2007. In 2008, excluding the impact of the non-cash impairment charge of $24,349, non-cash movements in the fair value of the interest rate swap of $269 and amortization of deferred financing charges of $50, and the non-cash future income tax recovery of $3,664, net earnings for the year were $11,473 or $1.1607 per unit. In 2007, excluding the impact of the $2,865 non-cash future income tax charge, reorganization costs of $312, the current income tax recovery of $450 relating to prior years as described above, and the non-cash movements in the fair value of the interest rate swap of $143 and amortization of deferred financing charges of $173, net earnings for the year were $11,239 or $1.1576 per unit. Using this measure, the Fund's improvement over 2007 was 0.3%.
During the final quarter of 2008 an agreement was reached between MarksLP and Second Cup whereby the payment of certain royalties for 2008 was deferred. This deferral (which is not included in distributable cash) which amounted to $573 ($0.058 per unit) was requested by Second Cup to deal with a cash shortfall it experienced resulting from Second Cup's commitment to open new cafe locations made prior to the slowdown of the economy; the requirement for Second Cup to take back cafe locations from franchisees that were underperforming; and operational difficulties including restructuring costs encountered as a result of the deterioration of economic conditions and the reduction in consumer spending.
Distributable cash is not an earnings measure recognized by generally accepted accounting principles ("GAAP") and therefore may not be comparable to similar measures presented by other issuers. Distributable cash is based on cash flows from the combined operating activities of the Fund, MarksLP and, in 2007, MarksCo. Distributable cash was $11,377, or $1.1510 per unit compared to $11,025, or $1.1356 per unit, for the prior year. Excluding the impact of changes in non-cash working capital of the Fund, MarksLP and MarksCo, the reorganization costs and the one-time recovery of income taxes relating to prior years, distributable cash would have been $11,473, or $1.1607 per unit, compared to $11,239, or $1.1576 per unit in 2007, which represents a 0.3% increase in distributable cash per unit.
Fourth Quarter Analysis
System sales for the fourth quarter of 2008 were $53,562 (2007 - $54,402) and same cafe sales growth was -1.4% (2007: 0.7%) for the same period. This quarter was affected by the sharp downturn in the Canadian economy that impacted key seasonal sales drivers such as merchandise.
For the quarter, MarksLP earned royalty revenue of $3,574 (2007 - $3,593), a decrease of 0.5% compared to 2007. Aggregate general and administrative expenses incurred by the Fund and MarksLP were $275 (2007 - $229). Net interest expense for the Fund and MarksLP amounted to $173 in the quarter compared to $148 in 2007. The Fund also recorded a non-cash charge of $176 relating to the movement in the fair value of its interest rate swap (2007 - $179) which fixes the interest rate on the term loan at 6.62%. Also, as noted above, the Fund recorded a pre-tax non-cash impairment charge of $24,349 in the quarter. Non-cash amortization of deferred financing charges amounted to $12 (2007 - $12). The Fund has no current income tax and, in the fourth quarter of 2008, recognized a non-cash future income tax recovery of $3,735. In the fourth quarter of 2007, as discussed above, MarksLP recorded a recovery of $450 in current income tax. Also in 2007, primarily as a result of new legislation reducing future income tax rates commencing in 2011 and onwards, the combined entities recorded a non-cash future income tax recovery of $2,041 in the quarter.
Therefore the Fund's net loss for the quarter was $17,675 or $1.7881 per unit, compared to net income of $5,525, or $0.5691 per unit in 2007. Excluding the non-cash impairment charge of $24,349; future income tax recovery of $3,735 (2007 - non-cash future income tax recovery of $2,041 as described above); current income tax recovery of $450 in 2007 relating to prior years as described above; the non-cash movements in the fair value of the derivative interest rate swap; and amortization of deferred financing charges of $188 (2007 - $191), net earnings for the quarter were $3,127 or $0.3163 per unit compared to $3,225 or $0.3322 per unit in 2007, a decrease of 4.8% on a per unit basis.
As noted above in the fourth quarter, an agreement was reached between MarksLP and Second Cup to defer the payment of $573 ($0.058 per unit) of 2008 royalties. This amount is not included in the calculation of distributable cash.
Distributable cash is not an earnings measure recognized by generally accepted accounting principles ("GAAP") and therefore may not be comparable to similar measures presented by other issuers. Distributable cash is based on cash flows from the combined operating activities of the Fund, MarksLP and, in 2007, MarksCo. Distributable cash was $2,551, or $0.2581 per unit compared to $3,040, or $0.3131 per unit for the comparable period. Excluding the impact of changes in non-cash working capital of the Fund and MarksLP in 2007, and the recovery of income taxes relating to prior years, distributable cash would have been $3,127, or $0.3163 per unit, compared to $3,225, or $0.3322 per unit for the fourth quarter of 2007, representing a 4.8% decrease in distributable cash per unit.
Tax Treatment of Distributions
The tax treatment of the 2009 distributions is approximately 18.1% return of capital and 81.9% other taxable income.
Term Loan Extension
The Fund also announced that, on March 4, 2009, its term loan and operating credit facilities including an extension of the maturity of the credit facilities to January 2, 2011 were renegotiated. The revised $12,000 credit facilities are comprised of an $11,000 non-revolving term credit facility, fully drawn, and an undrawn $1,000 revolving credit facility, bearing interest at prime or base rate plus 2.5% or LIBOR advances or bankers' acceptances plus 3.5%. The derivative interest rate swap was also extended to January 2, 2011. As a result, the effective interest rate as of March 2, 2009 has been reduced from 6.62% to 6.41%.
Outlook
The information contained in this "Outlook" is forward-looking information. Please see "Forward-Looking Information" below for a discussion of the risks and uncertainties in connection with forward-looking information.
The Fund's "top line" structure means that its success and growth depend primarily on Second Cup's ability to maintain and increase the overall system sales of cafes in the Royalty Pool. Growth in system sales is dependent on same cafe sales growth and adding new cafes to the cafe network.
Given the uncertainty in the retail and economic environment across Canada and Second Cup's dependence upon consumer discretionary spending, management is not providing specific guidance on same cafe sales for 2009. Management believes fiscal 2009 will be challenging and therefore, a number of initiatives are planned to strengthen the long term success of the Second Cup brand and its franchisees.
- Second Cup will continue its focus on operational excellence at the
cafe level, which it believes will yield increasing consistency
across the chain and improve the overall guest experience.
- In an effort to drive loyalty among specialty coffee customers,
Second Cup's promotional strategies will focus on targeted branding
initiatives promoting and innovating around its premium priced
specialty beverages, brewed coffees, tea, food and merchandise. Value
added offers will also be a core part of the promotional calendar.
- Second Cup will also be taking selective price increases on several
of its products during the year.
- Second Cup will continue to develop and build neighbourhood cafes
with a focus on expansion in key urban markets utilizing a
disciplined cafe development process, and continuing its
concentration on the delivery of cost savings to franchisees.
In terms of 2009 network expansion, Second Cup expects: (1) to open 10 to 15 new cafes in Canada; (2) to close 15 to 20 cafes during 2009, the majority of which have sales below the average performance of cafes in the Royalty Pool; and (3) approximately 24 of its cafes will be renovated.
FINANCIAL HIGHLIGHTS
The following table sets out selected proforma and non-GAAP financial information and other data of the Fund and its wholly owned subsidiaries and should be read in conjunction with the audited consolidated financial statements of the Fund.
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(in thousands of dollars, Three months ended Year ended
except number of cafes and Dec. 31, Dec. 31, Dec. 31, Dec. 31,
per unit amounts) 2008 2007 2008 2007
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System sales of cafes in
the Royalty Pool(3) $53,562 $54,402 $197,340 $195,750
Number of cafes in Royalty Pool 357 351 357 351
(359 cafes post January, 2009
adjustment)
Number of active cafes -
end of period 341 342 341 342
Same cafe sales growth(3) -1.4% 0.7% 0.2% 3.0%
Royalty revenues earned by
MarksLP and MarksCo(1) $3,574 $3,593 $12,991 $12,829
Earnings before items
noted below(2) $3,127 $3,225 $11,473 $11,239
Reorganization expense - - - $312
Non-cash impairment charge(1) $24,349 - $24,349 -
Non-cash movement in fair
value of the derivative
interest rate swap and
non-cash amortization of
deferred financing fees(1) $188 $191 $319 $316
Recovery of income taxes
relating to prior years(1) - ($450) - ($450)
Non-cash future income tax
expense (recovery)(1) ($3,735) ($2,041) ($3,664) $2,865
Net earnings (loss) for
the period ($17,675) $5,525 ($9,531) $8,196
Earnings per unit before
Reorganization expense,
non-cash impairment charge,
non-cash movement in fair value
of the derivative interest rate
swap, non-cash amortization,
recovery of income taxes
relating to prior years, and
non-cash future income taxes(3) $0.3163 $0.3322 $1.1608 $1.1576
Basic earnings (loss) per unit ($1.7881) $0.5691 ($0.9642) $0.8442
Diluted earnings (loss) per unit ($1.7881) $0.5672 ($0.9642) $0.8414
Distributable cash per unit
excluding Reorganization costs,
changes in non-cash working
capital, and recovery of income
taxes relating to prior years(3) $0.3163 $0.3322 $1.1607 $1.1576
Distributable cash per unit(3) $0.2581 $0.3131 $1.1510 $1.1356
Distributions declared per unit $0.2820 $0.2730 $1.1250 $1.0877
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(1) "Royalty revenues earned by MarksLP and MarksCo", "Non-cash
impairment charge", "Non-cash movement in fair value of the
derivative interest rate swap and amortization of deferred financing
fees", "Recovery of income taxes relating to prior years" and "Non-
cash future income tax expense (recovery)" represent the combined
amounts of the consolidated Fund and its wholly owned subsidiaries,
MarksLP and MarksCo, which are consolidated with the statements of
Second Cup for reporting purposes in accordance with GAAP. The Fund
accounts for the earnings of MarksLP and MarksCo on an equity-
accounted basis in its consolidated financial statements, in
accordance with GAAP.
(2) "Earnings before items noted below" is a non-GAAP measure and
represents the earnings, before Reorganization expense, non-cash
impairment charge, non-cash movements in fair value of the derivative
interest rate swap, non-cash amortization of deferred financing fees
and non-cash future income taxes and recovery of income taxes
relating to prior years, of the consolidated Fund and its wholly
owned subsidiaries, MarksLP and MarksCo, which are consolidated with
the statements of Second Cup for reporting purposes in accordance
with GAAP.
(3) "System sales of cafes in the Royalty Pool", "Same cafe sales
growth", "Earnings per unit before Reorganization expense, non-cash
impairment charge, non-cash movement in fair value of the derivative
interest rate swap, non-cash amortization, recovery of income taxes
relating to prior years, and non-cash future income taxes",
"Distributable cash per unit excluding Reorganization costs, changes
in non-cash working capital, and recovery of income taxes relating to
prior years" and "Distributable cash" are non-GAAP measures.
The audited consolidated financial statements of the Fund, together with its Managements Discussion and Analysis, are expected to be available at www.sedar.com and on the Fund's website at www.secondcupincomefund.com on or before March 13, 2009.
Income Tax effective in 2011
On June 12, 2007, new income tax legislation regarding the taxation of income trusts that were publicly traded prior to November 1, 2006 was enacted by the federal government. As a result of the legislation, the Fund will be taxed on earnings before distributions to Unitholders commencing January 1, 2011. On December 14, 2007, new legislation was substantively enacted reducing the income tax rate from 31.5% to 29.5% in 2011 and 28% for 2012 onwards. Under the legislation, certain income earned by these entities will be taxed in a manner similar to income earned by a corporation and distributions or allocations made by these entities to Unitholders will be taxed similar to dividends from taxable Canadian corporations. The deemed dividends will be eligible for the proposed new enhanced dividend tax credit if paid or allocated to a resident of Canada. These new tax laws are not expected to have an immediate impact on the Fund's tax treatment, or distribution policy or the tax treatment of distributions to Unitholders. There can be no assurances that the Fund will be able to undertake any measures to minimize such impact.
Forward Looking Information
Certain statements in this report may constitute forward-looking information within the meaning of applicable securities legislation. Forward-looking information can be identified by words such as "may", "will", "should", "expect", "anticipate", "believe", "plan", "intend" and other similar words. Forward-looking information reflects current expectations regarding future events and operating performance and speaks only as of the date of this report. It should not be read as a guarantee of future performance or results and will not necessarily be an accurate indication of whether or not those results will be achieved. Forward-looking information is based on a number of assumptions and is subject to known and unknown risks, uncertainties and other factors, many of which are beyond the Fund's control, that may cause the Fund's actual results, performance or achievements, or those of the Fund, MarksLP, Second Cup cafes, or industry results to be materially different from any future results, performance or achievements expressed or implied by such forward-looking information. The following are some of the factors that could cause actual results to differ materially from those expressed in or underlying forward-looking information: competition; availability of premium quality coffee beans; the ability to attract qualified franchisees; the location of Second Cup cafes; the closure of Second Cup cafes; loss of key personnel; compliance with government regulation; potential litigation; the ability to exploit and protect the Second Cup Marks; changing consumer preferences and discretionary spending patterns including, but not restricted to, the impact of weather and economic conditions on such patterns; reporting of system sales by franchisees; and the results of operations and financial condition of Second Cup. The foregoing list of factors is not exhaustive, and investors should refer to the risks described under "Risks and Uncertainties" above and in the Fund's Annual Information Form, which is available at www.sedar.com.
Although the forward-looking information contained in this report is based on what management believes are reasonable assumptions, there can be no assurance that actual results will be consistent with this forward-looking information and, as a result, the forward-looking information may prove to be incorrect.
As these forward-looking statements are made as of the date of this report, the Fund does not undertake to update any such forward-looking information whether as a result of new information, future events or otherwise. Additional information about these assumptions and risks and uncertainties is contained in the Fund's filings with securities regulators. These filings are also available on the Fund's website at www.secondcupincomefund.com.
About the Fund
The Fund is an open-ended trust established under the laws of the Province of Ontario. It holds, through an indirect wholly-owned limited partnership, the Canadian trade-marks and other intellectual property and associated rights used by Second Cup in connection with the operation of Second Cup cafes in Canada. For more information on the Second Cup Royalty Income Fund please visit www.secondcupincomefund.com.
About Second Cup
Second Cup is Canada's largest specialty coffee cafe franchisor and second largest retailer of specialty coffee, as measured by number of cafes. For the ultimate on-line coffee experience, visit www.secondcup.com.
%SEDAR: 00021352E