we love what we do and it shows!

Transcription

1 we love what we do and it shows! SIR Royalty Income Fund 2006 Strategy and Progress Report 1

2 Inspiration SIR stands for Service Inspired Restaurants and to us it means bringing people together, building lasting relationships and setting a standard for best-in-class. Our employees share in our vision to be the best and it shows. Our average weekly restaurant sales are among the highest in the industry. Agility Our corporate ownership model provides us with the agility to rapidly implement enhancements to our restaurants to drive same store sales growth ( SSSG ). In 2006, we essentially finished the system-wide evolution of Jack Astor s and completed the evolution of all five Alice Fazooli s! restaurants. We also completed major renovations at reds. SIR s Royalty Pooled Restaurants generated 5.9% SSSG in Stability SIR Royalty Income Fund unitholder distributions are derived from top line pooled restaurant revenue. In 2006, the Fund increased its annualized cash distributions by 5% to 1.26 per trust unit from 1.20 per trust unit, reflecting the strong performance of restaurants in the Royalty pool. The Fund has paid monthly cash distributions since its inception in October 2004.

3 81,200 Average weekly sales per restaurant 5.9% Same Store Sales Growth 1.26 Annualized Cash Distribution per Fund Unit 1

4 Building our brands At SIR Corp. ( SIR ) we are passionate about what we do and it shows. We thrive on creating, developing, and operating best-in-class restaurants. This means we focus on hiring the best people, serving the best food, and creating the best atmosphere at every one of our restaurants. Everyone associated with our company lives and breathes these values, and this commitment is reflected in the high standards and attention to detail evident at all of our restaurants. Building our brands is an ongoing process that is dependent on our ability to continuously adapt and evolve, while maintaining our core focus on being the best at what we do. Our corporate restaurant ownership model gives us the agility to continually build and strengthen our brands, while making sure our restaurants keep pace with our guests preferences. We adapt more quickly because we don t have to convince restaurant franchisees of the merits of restaurant enhancement initiatives, we just act when the time is right. Some of our recent initiatives include the successful system-wide evolutions of our Jack Astor s and Alice Fazooli s! Concept Restaurants, and renovations at our Far Niente and reds Signature Restaurants in downtown Toronto. Over the past two years, the renovations of Far Niente and reds have resulted in solid same store sales growth, as well as earning positive reviews. Toronto.com, Canada s most popular local search site, recently listed Far Niente as one of Toronto s Top 10 Restaurants. We are very happy with the results of our Jack Astor s evolutions, which has reinforced its irreverent and fun image, and its rare ability to draw crowds for lunch and dinner, as well as after work drinks. As our flagship concept brand, we are confident that Jack Astor s is now well positioned to outperform in its market segment for years to come. We are also very pleased with our refined Alice Fazooli s! concept. We believe Alice Fazooli s! now represents the best, multi-unit, Italianinspired restaurant concept in Canada, in terms of quality, value, and atmosphere. Our Canyon Creek TM restaurants continue their strong performance as we work to enhance their position as casual and elegant destinations that offer guests the many benefits of fine dining, without the formality. Great food is an essential part of building great restaurant brands. We always go the extra mile to ensure our menus offer innovative and pleasing selections that appeal to the varied tastes of our guests. Some of our efforts in this area include consulting with leading chefs from 2

5 across North America and Europe to gather their insights on our menu selections, and carrying out guest chef programs, where renowned international chefs visit our restaurants and work with our people to explore new ideas in food preparation and presentation. Our multiple restaurant brand diversity offers our customers a variety of options, ranging from casual to refined, but always inspired. Whether our guests are looking for the casual, relaxed atmosphere of a Jack Astor s or the fine dining experience of one of our Signature Restaurants, they can be confident that they will be greeted with exceptional service and great food, served in a warm, welcoming environment. As we work to strengthen our brands, we are also elevating our market exposure. With the growth of Jack Astor s, we now have the scale to increase the scope of our promotional efforts. With this in mind, we retained TAXI, an internationally recognized advertising firm, as our agency of record for the past two years. TAXI developed our Jack Astor s branding and launched a promotional radio advertising campaign for the Greater Toronto Area, which won industry recognition at the prestigious Canadian Marketing Awards. We are committed to building lasting relationships with our existing customers, while continuing to introduce new guests to our multiple restaurant brands. With the ongoing expansion of our restaurant network, we look forward to broadening our relationships with discerning Canadian diners. We opened three new Canyon Creek TM restaurants in Ontario in 2006, and a new Jack Astor s in Hamilton, Ontario in March, We will be developing at least two more Jack Astor s in 2007, one in Dartmouth, Nova Scotia and the other at a prime downtown Toronto location, overlooking Dundas Square, at the intersection of Yonge and Dundas streets. Our passion for what we do is reflected in our restaurant brands and our name, which stands for Service Inspired Restaurants. It s about bringing people together, building lasting relationships and setting the standard for best-in-class. Whatever your tastes, casual or refined, if you enjoy exceptional service and great food, served in a warm, welcoming environment, we have something for you. 3

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7 Gordon Mackie Executive Chef, Far Niente Chef Gordon Mackie s lifelong love affair with food began at an early age. Growing up in Grimsby, Ontario, he studied the careers of the world s star chefs the way most Canadian kids follow their favourite hockey players. The son of a caterer, his future was clear by the time he was nine years old, when he started cooking dinner for his entire family. Classically trained at George Brown College, Gordon honed his craft at leading restaurants in Toronto and London, England. It was while studying under legendary chefs such as Jean-Georges Vongerichten and Gordon Ramsay, that Chef Mackie developed his personal culinary philosophy focusing on freshness, creativity and the reinterpretation of classic ideas. I love fish 5

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9 Far Niente gives Gordon the opportunity to indulge his culinary dreams, creating a menu full of what he likes to call, luxurious comfort food. In contrast to many restaurants in Toronto s business district, Far Niente offers an array of unique seafood dishes, ranging from fresh New Zealand sea bass to decadent lobster pot pie. Gordon believes a menu peppered with fish and seafood allows him the fullest expression of his culinary ideals. I love the lightness and freshness of fish, he says. It gives me great flexibility to create a wide variety of exciting dishes, full of colour and energetic flavours. Cioppino, the dish shown here, is a perfect example of Gordon s philosophy. With roots that can be traced to Italy, Cioppino came to prominence in San Francisco more than a century ago. Originally a seafood soup made by local fishermen, Cioppino s name is derived from the Genoese word ciuppin, meaning little soup. Gordon s version of Cioppino maintains its traditional ingredients and flavours but gives the dish a Far Niente twist, turning it into a main course with a filet of New Zealand sea bass as the star of the show. There is no love sincerer than the love of food. George Bernard Shaw 7

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11 Steve Fletcher Vice President of Development, SIR Corp. When it comes to designing and building restaurants, Steve Fletcher is of two minds. Trained as both an engineer and an architect, he struggles to reconcile the often competing demands of form and function. It is this dichotomy that makes him the perfect man to lead the ongoing expansion of SIR s restaurants. After starting his career as a mechanical engineer, Steve discovered his love of architecture while traveling the globe. It was while visiting the cathedrals and mosques of Europe and Asia that he was first struck by the powerful impact that could be wrought by an architect s creative use of light and space. I love space 9

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13 As SIR s Vice President of Development, Steve oversaw the successful renovations at reds (photo at left) and is currently developing the rollout plan for SIR s ongoing restaurant expansion. In this role, Steve draws on his unique background to act as a mediator between designers and engineers, decorators and contractors, to ensure each restaurant incorporates engineering solutions that don t compromise design. For new Concept Restaurants, Steve is focused on developing repeatable prototypes, in order to maintain predictable costs. This is a complicated task that involves considering every aspect of a restaurant s design from how to maximize its sales per square foot, to the ergonomic correctness of the kitchen. But his job doesn t stop there. Some of SIR s restaurants are located in architecturally unique or historical buildings and Steve s task is to preserve the unique character of these spaces, while allowing the restaurant s brand character to shine through. Steve s position at SIR carries a great deal of responsibility but he wouldn t have it any other way. He believes in sweating the details and staying focused on precision and process. Steve s uncompromising approach is perfectly suited to SIR s restaurant expansion program. His mantra is, Do it right the first time and everyone wins. We couldn t agree more. The space within becomes the reality of the building. Frank Lloyd Wright 11

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15 Ann John General Manager, Jack Astor s, Richmond Hill Ask Ann John the secret to her success and she will answer proudly, It s the people, always the people. Ann should know. She has been General Manager of Jack Astor s Richmond Hill restaurant since Over that time, Ann has developed a remarkable bond with both her staff and regular guests, all of whom she regards as members of her own family, I do everything I can to make sure each guest feels relaxed and welcome here, she says. It s a relationship that begins on a new hire s first day, and carries on as long as they work at Jack Astor s. Ann readily admits to acting as a mother figure to her employees, a sentiment echoed by her staff. It s a unique arrangement that clearly works; more than 10 percent of Ann s 76 staff members have been with her for at least 10 years. I love people 13

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17 Being part of Ann s Jack Astor s family means working hard, having fun, and taking pride in what you do. She places great importance on the quality of the people who work for her, actively involving herself in the interview process and ensuring that she personally conducts each employee s initial orientation. Ann believes in empowering her staff, by making sure they are exceptionally well trained and prepared to excel at their jobs. Having faith in her employees gives her the freedom she needs to focus on making sure guests walk away feeling good about their Jack Astor s experience. I work hard to make my job easier, Ann says. To Ann, working at Jack Astor s is the same as being in show business, The curtain goes up when the first guest arrives, everything before that is rehearsal, she says. To pull it all together, Ann s team uses an approach that is equal parts pride, teamwork, and attention to detail. The end result is a restaurant where guests know what to expect: friendly staff, exceptional service, and first rate food in a fun, relaxing environment. Don t open a shop unless you like to smile. Chinese proverb 15

18 In 2006, we opened three new Canyon Creek TM restaurants in prime Ontario locations including, Vaughan, Scarborough, and at the Fallsview Casino Resort in Niagara Falls. With our new restaurants in Vaughan and Scarborough, we continued our successful cluster development strategy, locating multiple SIR Concept brands in the best GTA locations. Toronto / Southern Ontario Jack Astor s Alice Fazooli s! Canyon Creek reds Loose Moose Tap & Grill Armadillo Texas Grill Newmarket Far Niente Soul of the Vine Brasserie Frisco Vaughan Richmond Hill 16

19 For 2007, we opened a new Jack Astor s in Hamilton, Ontario in March, and have secured two new development sites for Jack Astor s ; one in Dartmouth, Nova Scotia and another in downtown Toronto at the intersection of Yonge and Dundas streets, overlooking Dundas Square. Outside of the GTA, we are now looking at prime markets across Canada where we can build our presence and gradually infill these strategic markets with our Concept brands. Halifax/ Dartmouth Montreal Ottawa Calgary 17

20 Concept Restaurants SIR s Concept Restaurants have multiple locations, reflecting their broad demographic appeal. SIR concept brands include: Jack Astor s Bar and Grill, with 23 locations in Canada; Alice Fazooli s! and Canyon Creek Chop House, with five and seven locations, respectively, throughout southern Ontario. On a segmented basis, Jack Astor s, Alice Fazooli s! and Canyon Creek TM contributed 64.3%, 12.5% and 10.9%, respectively, to Royalty Pooled Revenue in % SIR s Concept Restaurants cumulatively generated 87.7% of Royalty Pooled Revenue in % 10.9% 18

21 Signature Restaurants SIR s Signature Restaurants are one-of-a-kind brands located in prime downtown Toronto locations and offer a range of consumer choices from fine dining with award-winning menus, to a very active sports bar. Our Signature Restaurants comprise the upscale reds, Far Niente & Soul of the Vine, Brasserie Frisco TM, the casual Armadillo Texas Grill and the Loose Moose Tap & Grill. SIR s Signature Restaurants cumulatively generated 12.3% of Royalty Pooled Revenue in

22 President s Letter Since completing our Initial Public Offering ( IPO ) in October 2004, we have been investing in our Royalty Pooled Restaurants to strengthen our brands and drive same store sales growth ( SSSG ). We have also been expanding our network of Concept Restaurants to increase the number of restaurants that contribute to the Royalty pool. These initiatives are aimed at generating stable and growing distribution income for our unitholders. We essentially completed the multi-year evolution of Jack Astor s, finished our Alice Fazooli s! renovation program and a makeover of reds. The average sales performance of the two Jack Astor s added to the Royalty pool, effective January 1, 2006, was significantly higher than the Jack Astor s system average for the prior year. We also added three new Canyon Creek TM restaurants to the Royalty pool, effective January 1, System-wide SSSG was 5.9% in 2006 and unitholder distributions were increased 5.0% during the year. Our Jack Astor s evolution program is a prime example of investing in our existing Royalty Pooled Restaurants to drive SSSG. With three additional Jack Astor s evolutions completed in 2006, we have now evolved 19 of the 20 Jack Astor s that were part of the Royalty pool at the time of our IPO. Jack Astor s generated 5.5% SSSG in We also completed renovations and menu enhancements at two Alice Fazooli s! in 2006 and have now completed the system-wide evolution of this concept brand. Alice Fazooli s! generated SSSG of 8.3% in Our renovation at reds during the third quarter, contributed to the Signature Restaurants 8.1% SSSG in the fourth quarter of 2006 and SSSG of 4.2% for the year. Our multiple brand diversity provides us a distinct competitive advantage in executing our expansion strategy, as it allows us to successfully operate multiple SIR brands in close proximity to one another in the best markets, without cannibalizing sales. Single concept restaurant operators typically can only have one restaurant in any given location. This ability to cluster develop our Concept Restaurants has been a key to our successful expansion throughout the Greater Toronto Area ( GTA ). Outside of the GTA, we are now looking at prime markets across Canada where we can build our presence and gradually infill these strategic markets with our Concept brands. 20

23 Canyon Creek TM was the focus of our expansion efforts in 2006, as we opened three new Canyon Creek TM restaurants in prime locations including Vaughan, Scarborough, and the Fallsview Casino Resort in Niagara Falls, Ontario. With our new Canyon Creek TM restaurants in Vaughan and Scarborough, we continued our successful cluster development strategy, locating multiple SIR Concept brands in the best GTA locations. In Vaughan, our new Canyon Creek TM is in close proximity to our existing Jack Astor s and Alice Fazooli s!, while in Scarborough, our new Canyon Creek TM is near our existing Jack Astor s at the Scarborough Town Centre. For 2007, we opened a new Jack Astor s in Hamilton, Ontario in March, and have secured two new development sites for Jack Astor s ; one in Dartmouth, Nova Scotia and another in downtown Toronto at the intersection of Yonge and Dundas streets, overlooking Dundas Square. We expect to add the Hamilton and Dartmouth locations to the Royalty pool in January, 2008, provided the Dartmouth location is in operation 60 days prior to calendar year end. We continue to look for additional strategic locations for our restaurant expansion program. Our longterm goal is to have 68 Royalty Pooled Restaurants by the end of With our unique corporate ownership model and multiple brand diversity, and through extensive investments in our existing Royalty Pooled Restaurants, we believe we have created a strong foundation from which to continue building our market presence. In carrying out our future expansion plans, we will maintain our disciplined approach in terms of site selection and ensuring we have the strongest possible platform to build upon. We believe this consistent approach will result in stable and sustainable growth, which in turn will drive long-term value creation for Fund unitholders. Our vision is to be the best, and this guides our operating philosophy and strategy every day. We believe we are creating a unique Canadian restaurant company with distinct competitive strengths including a solid corporate ownership structure, multiple industry-leading brands, and a committed management team with dedicated employees who are inspired by quality, creativity and exceptional service. Looking ahead, we are confident that our operating strategy is closely aligned with market opportunities and the best interests of our unitholders. Thank you for your interest in the SIR Royalty Income Fund and the dynamic and distinct brands that comprise Service Inspired Restaurants. Sincerely, Peter Fowler President & Chief Executive Officer, SIR Corp. 21

24 Chairman s Letter On behalf of the Trustees of the SIR Royalty Income Fund (the Fund ), I am pleased to present our 2006 annual report. The two key factors that contribute to increasing the Fund s distributable cash are same store sales growth ( SSSG ) of Royalty Pooled Restaurants and expanding the number of restaurants in the Royalty pool. In 2006, SIR delivered on both fronts, adding two new Jack Astor s to the Royalty pool effective January 1, 2006, and delivering SSSG of 5.9% compared to With SIR s success in investing in its existing Royalty Pooled Restaurants to drive SSSG and adding new high-performing restaurants to the Royalty pool, the Trustees of the Fund authorized a 5.0% increase to unitholder distributions beginning with the distribution paid in June 2006, raising annualized distributions to 1.26 per unit. Distributable cash (2) for the year ended December 31, 2006 was 6.89 million, or 1.29 per unit, and distributions paid were 6.62 million or 1.24 per unit, representing a payout ratio (2) of 96.1% for the year. As a royalty trust, the Fund s payout ratio (2) is intended to average 100% per annum over time. The successful Jack Astor s evolution, renovations and menu enhancements to Alice Fazooli s! and the renovation of reds during 2006, all demonstrate SIR s ongoing commitment to strengthening the SIR brands, driving SSSG and increasing Royalty Pooled Revenue. SIR also opened three new Canyon Creek TM restaurants in prime locations in 2006, including Vaughan, Scarborough and Niagara Falls. These new restaurants were added to the Royalty pool, effective January 1, In addition to these initiatives to enhance the stability and growth of distributable cash, the Fund also has a number of structural features that are designed to support the stability of distributions. I would like to briefly review these features with you: Unitholder distributions paid out by the Fund are derived from a percentage of Royalty Pooled Revenue. SIR, the operating company, is responsible for maintenance and growth capital expenditures. (2) See footnote (2) on page

25 SIR owns the restaurants that contribute to the Royalty pool. As a result, cash remaining in the operating company after royalties are paid out, is available for SIR to reinvest in its restaurants to drive SSSG. In the event of a permanent closure of a Royalty Pooled Restaurant, SIR is obligated to indirectly pay the Fund a Make Whole Payment. This is intended to compensate for the loss in value of the decreased future Royalty stream, as was the case with the Jack Astor s restaurant in Don Mills, Ontario. We expect the Don Mills location to reopen at a later date, following the completion of site redevelopment by the landlord at this location. When the Fund acquires a royalty stream based on sales of a new SIR restaurant, the purchase price is discounted to ensure the royalty stream is accretive to the Fund. On October 31, 2006, Canada s Minister of Finance announced a tax fairness plan for Canadians that will affect the tax treatment of trusts, such as the Fund that were publicly traded prior to November 1, The Trustees of the Fund and SIR s senior management team have considered these changes and continue to evaluate the possible impact of the new rules to the Fund. We would like to emphasize that this development does not impact SIR s current operations or Pooled revenue. However, the new rules may adversely affect the marketability of the Fund s units and the use of these units to finance future growth. The Trustees and management of SIR will continue to monitor this development while carefully considering the best interests of Fund unitholders. The Trustees of the Fund remain committed to governing the Fund in the best interests of unitholders. We will continue to oversee discipline in managing Fund operating costs, strict compliance with regulatory policies, and best practices in disclosure. We look forward to reporting to you on SIR s continued progress in building value for Fund unitholders. On behalf of the Trustees of the Fund, thank you for your support. Sincerely, John McLaughlin Chairman, SIR Royalty Income Fund 23

26 SIR Royalty Income Fund Overview SIR Corp. 6% Royalty on Pooled Revenue Interest Income from SIR Loan SIR Royalty Limited Partnership Distribution Income SIR Royalty Income Fund Monthly Distributions Unitholders All trademarks related to the Concept and Signature brands are used by SIR Corp. ( SIR ) under a license agreement with SIR Royalty Limited Partnership (the Partnership ) in consideration for a Royalty equal to 6% of the revenue of the 38 restaurants included in the Royalty pool as of January 1, SIR Royalty Income Fund (the Fund ) receives distribution income from its investment in the Partnership and interest income from the SIR Loan. The Fund pays distributions to unitholders on a monthly basis. Note: the above illustration is for descriptive purposes only and is qualified in its entirety by the description in the actual agreements and by the Fund s prospectus on SEDAR. 24

27 SIR Royalty Income Fund Management s Discussion and Analysis Year Ended December 31, 2006 (For the 12-month periods ended December 31, 2006) Executive Summary Highlights for the 3-month periods ended December 31, 2006 ( Q4 ) and the 12-month periods ended December 31, 2006 ( YTD ), include: Annual net earnings increased to 6.9 million in 2006, from 6.5 million in 2005 and in Q4 of 2006 decreased to 1.6 million, from 1.8 million in Q4 of Annual net earnings per Fund Unit increased to 1.29 in 2006, from 1.21 in 2005 while net earnings per Fund Unit decreased to 0.31 in Q4 of 2006, from 0.33 in Q4 of The annual payout ratio was 96.1% in 2006, compared to 99.4% in 2005 while the payout ratio for Q4 of 2006 was 102.8%, compared to 91.0% in Q4 of Please refer to footnotes 2 on page 30 and 12 on page 39 for the definition and calculation of payout ratio. The net earnings, distributable cash, and payout ratios for the fourth quarter were affected by the 0.23 million Priority Special Conversion Distribution ( Conversion Distribution ) paid by the SIR Royalty Limited Partnership (the Partnership ). This distribution was paid on the Class B GP Units that were converted to Class A GP Units, effective January 1, 2007 related to the Second Incremental Adjustment for the restaurants added to the Royalty pool effective January 1, As no new restaurants were added to the Royalty pool effective January 1, 2005, there was no similar adjustment in the fourth quarter of Pooled Revenue increased by 9.9% in Q4 of 2006 to 38.7 million, from 35.2 million in Q4 of 2005 and annual Pooled Revenue increased by 14.8% to million in 2006, from million in Same store sales growth (1) ( SSSG (1) ) for restaurants in the Royalty pool for Q4 of 2006 was 2.5% compared to Q4 of 2005 and annual SSSG (1) was 5.9% for 2006 compared to (1) Same store sales ( SSS ) and same store sales growth ( SSSG ) are non-gaap financial measures that do not have standardized meanings prescribed by GAAP. However, the Fund believes that SSS and SSSG are useful measures and provide investors with an indication of the change in year-over-year sales. The Fund s method of calculating SSS and SSSG may differ from those of other issuers and, accordingly, SSS and SSSG may not be comparable to measures used by other issuers. SSS includes revenue from all SIR Restaurants except for the Jack Astor s locations in Whitby, on Front Street in Toronto and in Don Mills, Ontario because they were not open for the entire year of both 2005 and SSSG is the percentage increase in SSS over the prior comparable period. 25

28 SSSG (1) was positive in Q4 and the YTD of 2006 for all of SIR Corp. s ( SIR ) Concept Restaurants (Jack Astor s,canyon Creek TM, and Alice Fazooli s! ) as well as for the downtown Toronto Signature Restaurants compared to prior year: Jack Astor s SSSG (1) was 0.3% for Q4 and 5.5% YTD; Canyon Creek SSSG (1) was 5.0% for Q4 and 7.4% YTD, Alice Fazooli s! SSSG (1) was 3.7% for Q4 and 8.3% YTD, and the Signature Restaurants SSSG (1) was 8.1% for Q4 and 4.2% YTD. Three Jack Astor s evolutions were completed in 2006 (none in Q4). All but one of the Jack Astor s currently operating has now been evolved. reds was closed for 11 days in Q3 for renovations. Management is pleased with the results of these renovations. During 2006, two Alice Fazooli s! restaurants were renovated (one completed in the first quarter and the second completed in Q4). Now, all five Alice Fazooli s! restaurants have been renovated since the Initial Public Offering ( IPO ). The renovated Alice Fazooli s! restaurants are averaging revenue increases in the first full year after the renovation in excess of 10%. The two Jack Astor s restaurants that opened in 2005 became part of the Royalty pool effective January 1, Subsequent to year-end, SIR opened a Jack Astor s in Hamilton, Ontario on March 26, SIR has also secured two additional sites for Jack Astor s restaurants, one of which is planned to open in 2007 and the other is planned to open in Three new Canyon Creek restaurants were opened in Each of these three restaurants was added to the Royalty pool effective January 1, On May 24, 2006 the Trustees authorized a 5.0% distribution increase to Unitholders. The monthly distributions increased from per Unit to per Unit beginning with the distribution paid in June This will increase the estimated annualized distribution from 1.20 to During Q2 of 2006, the Jack Astor s in Don Mills, Ontario was closed. This location has been demolished by the landlord and is to be redeveloped into a major lifestyle mall. It is expected that this project will be completed in the second half of 2008 and a new Jack Astor s would open in this location at that time. SIR was required to pay a Make-Whole Payment for this location from the date of the closure until December 31, On January 1, 2007, the revenue of the closed restaurant was netted against the revenue of the new SIR Restaurants opened from November 2, 2005 to November 1, 2006, to determine the number of Class B GP Units of the Partnership, held by SIR, which were converted into Class A GP Units of the Partnership. (1) See footnote (1) on page

29 On October 31, 2006, the Federal Department of Finance announced a plan that proposes changes to the manner in which distributions from certain publicly listed flow-through entities ( FTEs ) including income funds are taxed. However, existing Income Trusts would not be subject to this proposed taxation of distributions until the 2011 taxation year so long as the Fund meets the requirements for normal growth. On December 21, 2006, the Federal Department of Finance issued draft legislation on the proposed taxation legislation for public comment. On March 27, 2007, the Minister of Finance issued a Notice of Ways and Means Motion to implement the draft legislation. The Trustees of the Fund and senior management of SIR will continue to monitor this development. While SIR is not owned by the Fund, the Fund is economically dependent upon SIR. SIR files its interim and annual consolidated financial statements and MD&A which, can be found on SEDAR under the Fund s listing named Other. SIR s Q2 consolidated financial statements and MD&A are listed having a filing date of March 28, Same Store Sales Growth (1) (unaudited) Same Store Sales Growth for the 3-month period ended December 31, 2006 vs same period in prior year 12% 8% 8.1% 4% 5.0% 3.7% 2.5% 0.3% 0 Jack Astor s Canyon Creek Alice Fazooli s! Signature Total SIR Restaurants Same Store Sales Growth for the 12-month period ended December 31, 2006 vs same period in prior year 15% 10% 5% 5.5% 7.4% 8.3% 4.2% 5.9% 0 Jack Astor s Canyon Creek Alice Fazooli s! Signature Total SIR Restaurants (1) See footnote (1) on page

30 SIR reported to the Fund that SSSG (1) was 2.5% and 5.9%, respectively, for Q4 of 2006 and for the year versus the comparable periods in the prior year. SIR s Management attributes the strong annual performance of Jack Astor s in large part due to evolutions of existing restaurants. The evolution program started in 2004 and now only one of the Jack Astor s currently operating remains to be evolved. The evolved Jack Astor s restaurants experienced strong average SSSG (1), averaging over 10% in the first year following the year of evolution. Now that the program is near completion and most of the evolved restaurants have been evolved for more than one year, the velocity of Jack Astor s SSSG (1) driven by evolutions is reduced. SIR s management believes that changes in smoking legislation in Ontario and Quebec are negatively affecting bar sales, particularly in those restaurants that previously benefited from Designated Smoking Rooms in their bars. SIR s management believes that the effect of the Smoke-Free Ontario Act will be mitigated over time and anticipates that the effect will be lessened during the summer months when patios are open. Canyon Creek continues to perform well, with SSSG (1) of 5.0% during Q compared to the prior year. Annual SSSG (1) was 7.4% for 2006 compared to The performance of Alice Fazooli s! continues to improve. SSSG (1) in Q4 of 2006 was 3.7%. Annual SSSG (1) was 8.3% compared to the prior year. This annual growth was achieved even though the dining room of the Alice Fazooli s! in downtown Toronto was closed for nine days during the first quarter for renovations and during Q4, the Alice Fazooli s! in Mississauga was closed also for nine days for renovations and an expansion of the bar. All five of the Alice Fazooli s! locations have now been renovated since the IPO. During Q4, the Signature Restaurants, which are located in downtown Toronto, had SSSG (1) of 8.1%. Brasserie Frisco and Armadillo Texas Grill /the Loose Moose Tap & Grill revenues were below the prior year during Q4. These declines in Q4 were offset by positive SSSG (1) at Far Niente /Soul of the Vine and reds. Annual SSSG (1) for the Signature Restaurants remains positive at 4.2%. During Q3 of 2006, reds was closed 11 days for renovations. During Q4 of 2005, Far Niente was closed for approximately three weeks for renovations. During Q1 and part of Q2 of 2005, the NHL lockout had a significant negative effect on the revenue of the Signature Restaurants. The same group of restaurants benefited from the end of the lockout over the same period in In addition, Signature Restaurants sales benefited from increased sales at Far Niente after the major renovations in the fall of (1) See footnote (1) on page

31 Restaurant Renovations and Advertising SIR used a significant portion of the proceeds of the Fund s IPO to invest in its existing restaurants to drive SSSG (1). As at December 31, 2006, 19 Jack Astor s restaurant evolutions had been completed (four of these had been completed prior to the IPO). These evolutions continue to drive sales in Jack Astor s. The renovations at the five Alice Fazooli s! restaurants which were completed during 2005 and 2006 have also delivered strong SSSG (1) on average, in excess of 10% in the first full year after the renovation. A renovation was completed at reds during Q3 of 2006 (from August 28 to September 7, 2006). During mid-october 2005 through November 7, 2005, extensive renovations were completed at Far Niente in downtown Toronto. These renovations are driving increased guest counts and SSSG (1) going forward. Since the IPO, SIR has increased its investment in marketing initiatives. In particular, Jack Astor s with 22 restaurants (which in Q4 of 2006 represents approximately 61.5% of Pooled Revenue) has benefited from radio-based campaigns created by a leading North American advertising agency. New and Closed Restaurants SIR opened two new restaurants during the Fund s fiscal 2005 year: Jack Astor s at Front Street and University Avenue in downtown Toronto in February 2005, and Jack Astor s in Whitby, Ontario, at the end of August These restaurants became part of the Royalty Pooled Restaurants on January 1, 2006, at which time the Partnership paid SIR, in Partnership securities exchangeable for Units of the Fund, an amount intended to reflect the value to the Partnership of the increased future Royalty stream related to these restaurants, in accordance with the formula described in the License and Royalty Agreement. This adjustment for new revenues that will be part of the Royalty pool is designed to be accretive for Fund Unitholders. During 2006, SIR opened three Canyon Creek restaurants (Scarborough, Ontario in Q1, Vaughan, Ontario in Q2, and at the Fallsview Casino Resort in Niagara Falls, Ontario in Q3). Each of these three restaurants was added to the Royalty Pooled Restaurants subsequent to year-end on January 1, One Royalty Pooled Restaurant has been closed since the IPO was completed. On May 27, 2006, the Jack Astor s in Don Mills, Ontario was closed. This location has been demolished by the landlord and is to be redeveloped into a major lifestyle mall. It is expected that this project will be completed in the second half of 2008 and that a new Jack Astor s would open in this location at that time. Under the terms of the License and Royalty Agreement, SIR paid a Make-Whole Payment for this location from the date of the closure until December 31, In accordance with the License and Royalty Agreement, the revenue of the closed restaurant was netted against the revenue of the new SIR Restaurants opened from November 2, 2005 to November 1, 2006, to reduce the number of Class B GP Units of the Partnership, held by SIR, which were converted into Class A GP Units of the Partnership on January 1, Subsequent to year-end, SIR opened a Jack Astor s in Hamilton, Ontario on March 26, SIR has also secured two additional sites for Jack Astor s restaurants, one of which is planned to open in Dartmouth, Nova Scotia during 2007 and the other at the corner of Dundas and Yonge streets in Toronto, Ontario during (1) See footnote (1) on page

32 Distributions Distributions to Unitholders are intended to be made monthly in arrears based on distributable cash and cash redemptions of Fund Units and subject to the Fund retaining such reasonable working capital and other reserves as may be considered appropriate by the Trustees of the Fund. The Fund s intention, with the assistance of SIR, is to pay even distributions, and if possible, allow the Fund to maintain consistent monthly distributions to Unitholders. The Fund intends to make monthly distributions of its available distributable cash to the extent possible and has paid its expected monthly cash distribution of 0.10 per Unit per month since inception. On May 24, 2006 the Trustees authorized a 5.0% distribution increase to Unitholders. The monthly distributions increased from 0.10 per Unit to per Unit beginning with the distribution paid in June This will increase the estimated annualized distribution from 1.20 to The payout ratio (2) of cash distributed to distributable cash (2) is intended to average 100% per annum over the longer term. Since the Fund pays even monthly distributions when its underlying cash flow from the Partnership is subject to seasonal fluctuations (as experienced by SIR), there are times during the year when the payout ratio (2) may exceed 100%. The payout ratio (2) for the fourth quarter of 2006 was affected by the 0.23 million Conversion Distribution paid by the Partnership. YTD, the payout ratio (2) in 2006 was 96.1% compared to 99.4% for the same period in Overview and Business of the Fund On October 1, 2004, SIR Royalty Income Fund (the Fund ) filed a final prospectus for a public offering of Units of the Fund. The net proceeds of the Offering of 51,166,670 were used by the Fund to acquire, directly, certain bank debt of SIR and indirectly, through SIR Holdings Trust (the Trust ), all of the Ordinary LP Units of the Partnership. The Partnership owns the Canadian trademarks (the SIR Rights ) formerly owned or licensed by SIR or its subsidiaries and used in connection with the operation of the majority of SIR s restaurants in Canada. The Partnership has granted SIR a 99-year license to use the SIR Rights in most of Canada in consideration for a Royalty, payable by SIR to the Partnership, equal to 6% of the revenue of the restaurants included in the Royalty pool (the License and Royalty Agreement ). The Partnership also issued its own securities to SIR in return for the SIR Rights acquired. The Fund indirectly participates in the revenue generated under the License and Royalty Agreement through its investment in the Partnership. The Partnership s financial statements are provided separately at under the SIR Royalty Income Fund profile and on SIR s website at (2) Distributable cash and payout ratio are non-gaap financial measures and do not have a standardized meaning prescribed by GAAP. However, the Fund believes that distributable cash and the payout ratio are useful measures as they provide investors with an indication of cash available for distribution. The Fund s method of calculating distributable cash and the payout ratio may differ from that of other issuers and, accordingly, distributable cash and the payout ratio may not be comparable to measures used by other issuers. Investors are cautioned that distributable cash and the payout ratio should not be construed as an alternative to the statement of cash flows as a measure of liquidity and cash flows of the Fund. The payout ratio is calculated as cash distributed for the period as a percentage of the distributable cash for the period. Distributable cash represents the amount of money which the Fund expects to have available for distribution to Unitholders of the Fund, and is calculated as cash provided by operating activities of the Fund, adjusted for the net change in non-cash working capital items. 30

33 The Fund intends to make monthly distributions of its available cash to the maximum extent possible. During the year, monthly distributions of 535,667 or 0.10 per Unit were declared and paid for each of the months of December 2005 through April Monthly distributions of 562,450 or per Unit were declared and paid for each of the months of May 2006 through November Subsequent to December 31, 2006, distributions of per Unit were declared and paid for the months of December 2006 and January 2007 and a distribution of per Unit was declared for the month of February The Units of the Fund are publicly traded on the Toronto Stock Exchange under the symbol SRV.UN. Overview and Business of SIR and the Partnership SIR is a private company amalgamated under the Business Corporations Act of Ontario. As at December 31, 2006, SIR operated 38 Concept Restaurants and Signature Restaurants in Canada (in Ontario, Quebec, Alberta and Nova Scotia). The Concept Restaurants are Jack Astor s Bar and Grill, Canyon Creek Chop House and Alice Fazooli s!. The Signature Restaurants are reds, Far Niente/Soul of the Vine, Brasserie Frisco, and the Armadillo Steak House/Loose Moose Tap & Grill. As at December 31, 2006, 36 SIR Restaurants were included in the SIR Royalty Pooled Restaurants. New Canyon Creek restaurants were opened in Scarborough, Ontario in March 2006, in Vaughan, Ontario in May 2006, and at the Fallsview Casino Resort, in Niagara Falls, Ontario in August Subsequent to year end, on January 1, 2007, these three new restaurants were added to the Royalty Pooled Restaurants. The two new Jack Astor s that were opened in 2005 (downtown Toronto, Ontario in February and Whitby, Ontario in August) were added to the Royalty Pooled Restaurants effective January 1, In May 2006, the Jack Astor s in Don Mills, Ontario was closed. Based on the terms of the License and Royalty Agreement, SIR was required to pay a Make-Whole Payment in respect of the lost Royalty resulting from the reduction in revenue of this closed restaurant. As a result, the Jack Astor s in Don Mills, Ontario effectively remained part of the Royalty Pooled Restaurants until December 31, SIR owns 100% of all its Canadian restaurants, except for Jack Astor s Don Mills Limited (50%). SIR also has an investment in one (2005 two) Jack Astor s restaurant in the U.S., which is not included in the SIR Royalty Pooled Restaurants. During the year, the Jack Astor s restaurant located in Irving, Texas was sold to a local independent restaurant operator and it will no longer operate as a Jack Astor s restaurant. SIR owned the land and building for this location that was financed by U.S. debt. The proceeds from the sale were used to repay the associated U.S. debt. The Partnership has granted SIR a 99-year license to use the SIR Rights in most of Canada in consideration for a Royalty, payable by SIR to the Partnership, equal to 6.0% of the revenue of the restaurants included in the Royalty pool. The Partnership also issued its own securities to SIR in return for the SIR Rights acquired. On January 1 of each year (the Adjustment Date ) following December 31, 2005, the restaurants subject to the License and Royalty Agreement are adjusted for new restaurants that have been open for at least 60 days prior to the Adjustment Date and which were not previously included in the Royalty Pooled Restaurants. Under the formula as defined in the Partnership Agreement, the number of Class A GP Units issued to SIR on the Initial Adjustment date is equal to only 80% of the estimated value 31

34 of the additional Royalty revenue. Additional Class B GP Units may be converted to Class A GP Units in respect of these new SIR Restaurants if the actual revenues of the new SIR Restaurants exceed 80% of the January 1 Initial Adjustment s estimated revenue applied to the formula defined in the License and Royalty Agreement and the Partnership Agreement. Conversely, Class A GP Units would be converted to Class B GP Units by SIR if the actual revenues of the new SIR Restaurants are less than 80% of the January 1 Initial Adjustment s estimated revenue. In December of each year, a Conversion Distribution will be payable to the Class B GP Unitholders based on actual revenues of the new SIR Restaurants exceeding 80% of the Initial Adjustment s estimated revenue or there will be a reduction in the cash distributions to the Class A GP Unitholders if revenues are less than 80% of the Initial Adjustment s estimated revenue. The Conversion Distribution results in an adjustment to SIR s share of the Partnership income to reflect the actual contribution of the revenues of the new SIR Restaurants for the fiscal year. As this amount is not declared until December 31st, when the actual revenues for the New Additional Restaurants are known, the effect of this adjustment is not included in the results of quarters one through three. On January 1, 2006, two new SIR Restaurants were added to the Royalty pool in accordance with the License and Royalty Agreement. As consideration for the additional Royalty associated with the addition of two new restaurants, SIR converted 438,820 Class B GP Units to 438,820 Class A GP Units based on the formula defined in the Partnership Agreement. The 438,820 Class A GP Units have been recorded at their estimated fair value of 4.1 million. As a result of this exchange, SIR s interest in the Partnership increased to 16.2% effective January 1, The revenues of the new SIR Restaurants exceeded 80% of the Initial Adjustment s estimated revenue and, as a result, an Additional Distribution of 0.23 million was declared in December 2006 and paid in cash to SIR in January On January 1, 2007, three new SIR Restaurants were added to the Royalty pool in accordance with the License and Royalty Agreement. As consideration for the additional Royalty associated with the addition of three new restaurants on January 1, 2007, as well as the Second Incremental Adjustment for the two new SIR Restaurants added to the Royalty Pooled Restaurants on January 1, 2006, SIR is able to convert its Class B GP Units into Class A GP Units based on the formula defined in the Partnership Agreement. The number of Class B GP Units that SIR is able to convert to Class A GP Units was reduced by an adjustment for the closure of one SIR Restaurant during the year. The net effect of these adjustments to the Royalty Pooled Restaurants was that SIR converted 421,004 Class B GP Units of the Partnership into 421,004 Class A GP Units of the Partnership on January 1, 2007 at an estimated fair value of 3.5 million. As a result of this exchange, SIR s interest in the Partnership increased to 21.4% effective January 1, As at December 31, 2006, SIR retained a 16.2% ( %) interest in the Partnership as the holder of the 1,034,005 ( ,185) Class A GP Units of the Partnership, representing SIR s initial retained interest as at the closing date of the Offering plus the Class A GP Units that were received as part of the conversion that took place on January 1, 2006 when the two new Jack Astor s were vended in to the Royalty Pooled Restaurants. The Class A GP Units are entitled to receive a pro rata share of all residual distributions of the Partnership and are exchangeable into Units of the Fund on a one-for-one basis. SIR agreed to subordinate the initial 10% share (595,185 Units retained at the time of the Offering) of the distributions for a minimum of two years, subject to certain terms. Subordination is expected 32

35 to continue until at least August 26, In addition, SIR is obligated to pay the Partnership a Make-Whole Payment, subject to certain terms, initially equal to the amount of the Royalty that otherwise would have been paid to the Partnership in the event of a permanent closure of a restaurant in the Royalty pool. SIR is not required to pay any Make-Whole Payment in respect of a closed restaurant in the Royalty pool following the date on which the number of restaurants in the Royalty pool is equal to or greater than 68, or following October 12, 2019, whichever occurs first. However, other adjustments or payments may still be required in respect of closed restaurants after such date by SIR, depending upon the circumstances. SIR s fiscal year is comprised of 13 periods of four weeks each, ending on the last Sunday in August. To preserve this year-end, an additional week must be added approximately every five years. Fiscal quarters of SIR consist of accounting periods of 12, 12, 12 and 16 (or 17) weeks. Consolidated financial statements of SIR can be found at under the SIR Royalty Income Fund profile, other category and on SIR s website at Seasonality The full service restaurant sector of the Canadian foodservice industry, in which SIR operates, experiences seasonal fluctuations in revenues. Favourable summer weather generally results in increased revenues during SIR s fourth quarter (ending the last Sunday in August) when patios have been open for an extended period. Additionally, certain holidays and observances also affect guest dining patterns both favourably and unfavourably. Accordingly, distribution income recognized by the Fund will vary in conjunction with the seasonality in revenue experienced by SIR. The Fund s intention, with the assistance of SIR, is to pay even distributions in order to reduce the effect of seasonality, and if possible, allow the Fund to maintain consistent monthly distributions to Unitholders. Selected Consolidated Financial Information The consolidated financial statements of the Fund are presented in Canadian dollars, are prepared in accordance with Canadian generally accepted accounting principles ( GAAP ) and include the accounts of the Fund and its subsidiaries, namely the Trust and SIR GP Inc. The information in this Management s Discussion and Analysis should be read in conjunction with the annual audited consolidated financial statements of the Fund, including the notes thereto. The Fund has been in existence since August 23, 2004, and began operating on October 12, 2004 upon closing of the Offering. 33