This MD&A should be read in conjunction with the audited annual consolidated financial statements of A&W Revenue Royalties Income Fund (the Fund) for the.
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ChairmanÕs Report to Unitholders On behalf of the Trustees of the A&W Revenue Royalties Income Fund (the Fund), I am pleased to report the results of the year ended December 31 ,2016.The Fund enjoyed solid growth in 201 6, with s ame store sales growth of+3.4 .This same store sales growth isparticularly notable when added to last yearÕs + 7.6% same store sales growth, bringing the two year stacked same store sales growth to + 11.0%.Annual royalty income for 201 6was $34,135,000based on sales of $1,137,8 30,000,an increase of7.3% from royalty income of $31,826,000and sales of $1,060,851,000in 201 5.The increase in sales and royalty income was due to the 3.4%same store sales growth and the increase in the number of restaurant s in the Royalty Pool on January 5, 201 6from 814to838.The Fund, through its investment in A&W Trade Marks Inc. and A&W Trade Marks Limited Partnership , owns the A&W trade -marks and licenses them to A&W Food Services of Canada Inc. (A&W Food Services ), in exchange for a royalty of 3% of sales reported by the restaurants in the Royalty Pool. The Royalty Pool is adjusted annually to include sales from net new A&W restaurants opened by A&W Food Services over the previous year. As noted above, t he Royal tyPool was increased from 814to838A&W restaurants onJanuary 5,2016.OnJanuary 5,2017,the Royalty Pool was increased again to861A&W restaurants. Distributable cash per equivalent unit increased to $1. 577per unit in 201 6from $1. 559per unit for 201 5.Two increases in the monthly distribution rate were announced in 201 6: from 12.5¢per unit to 13.0¢per unit starting with the May 2016 distribution, and then from 13.0¢per unit to 13.3¢per unit starting with the July 2016 distribut ion. The current monthly distribution rate of 13.3¢per unit translates into an annualized distribution of $1. 596per unit, an increase of 6. 4%from the 201 5 annualized rate of $1. 500per unit. The annual payout ratio was 98.8% compared to92.4% for 201 5.Looking forward, the Trustees are confident that A&W Food Service sÕstrategic initiatives will continue to attract new guest visits, grow same store sales and consequently grow royalty income in the Fund. The most significant of these initiatives isthe differentiati on ofA&W with Òbetter ingredientsÓ, which include beef raised without the use of hormones or steroids, eggs from hens fed a diet without animal by -products ,chicken raised without the use of antibiotics ,organic and Fair Trade coffee , and bacon from pork raised without antibiotics .A second strategic initiative is A&W Food ServicesÕ reimage program to modernize itsrestaurants . This initiative also yielded strong results with 90restaurants reimaged in 201 6and strong sales increase s in these restaurants. There is no cost to the Fund for these modernizations. Insummary, on behalf of the Trustees, I am pleased to be able to report these continued strong results to our unitholders. I would like to express my sincere appreciation to unitholders who have placed their trust in the Fund. (signed) John R. McLernon Chairman A&W Revenue Royalties Income Fund 1
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Report to Fund Unitholders The A&W restaurant business enjoyed another excellent year in 2016, building on the outstanding performance in 20 15.Same store sales grew by 3.4%, on top of an increase of 7.6%for the prior year. Same store sales are one of the most important performance measures for a restaurant business, because they gauge the ability of the brand to connect with its guests on an ongoing basis. Fifteen straight quarters of same store sales increases proves the strength ofA&WÕs strategy and in particular the key strategic initiatives which have been implemented over the past several years .A&WÕs Mission is Òto delight time -crunched Canadian burger lovers with the joy of great tasting natur alfood, made by people they trust Ó.One of the key differentiators of the A&W brand is ourcommitment to Òbetter ingredientsÓ. A&WÕs better ingredients include beef raised without the use of hormones or steroids, eggs from hens fed adiet without animal by-products ,chicken raised without the use of antibiotics, organic and Fair Trade coffee and bacon from pork raised without the use of antibiotics. Ourguests feel good about their choice when they visit one of our restaurants. Another important strategic initiative for A&W is the expansion of new restaurants. Making A&W easily accessible to ourguests across the country is critical to achieving our strategic objectives. In2016,31new restaurants opened across Canada, bringing the to tal number of restaurants in the chain to 879. Of particular note is the progress that we made in the Ontario and Quebec market s, where 21new restaurant sopened in 2016 . The growth of restaurants in these provinces is a key objective and there are now o ver 360 restaurants in these two provinces versus just over 200 in 2006. Overall system sales once again grew at industry leading rates, increasing by 6.3%, and bringing our total system sales to $ 1.162billion. I am delighted to report that this marks the 25thstraight year of system sales growth for A&W. A&W continued its support of the Multiple Sclerosis Society of Canada in 2016. Our eighth annual ÒBurgers to Beat MS DayÓ (previously ÒCruisin to End MS DayÓ) raised $1.75 million to fund res earch and to improve the lives of MS patients and their families. Overall 2016was a nother successful year for A&W. The business enjoyed good growth and solid results. More importantly ,momentum continued on the key strategic initiatives which wil lensure A&WÕs long term growth and success in the future. In particular ,our strategic commitment to using natural ingredients is fundamental to our long term success and I a mproud of the outstanding work of our management team and franchisees in bringing this innovation to the market. A&W was CanadaÕs first burger chain when it was launched back in 1956 and we are committed to extending our reputation for being the best. (signed) Paul F. B. Hollands Chairman and Chief Executive Officer A&W Food Services of Canada Inc. 2
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A&W Revenue Royalties Income Fund Management Discussion and Analysis This Management Discussion and Analysis (MD&A )covers the fourth quarter period from September 1 2, 2016 to December 31, 2016 and the year ended December 31, 2016, and is dated February 14, 2017 . This MD&A should be read in conjunction with the audited annual consolidated financial statements of A&W Revenue Royalties Income Fund (the Fund) for the year ended December 31, 2016 . Readers are also referred to the audited annual consolidated financial statements of A&W Food Services of Canada Inc. (Food Services) for the 52 week year ended January 1, 2017. Such financial statements and additional infor mation about the Fund and Food Services are available at www.sedar.com or www.awincomefund.ca .The financial results reported in this MD&A are derived from the audited annual consolidated financial statements of the Fund,which are prepared in accordance with International Financial Reporting Standards (IFRS) asissued by the International Accounting Standards Board (IAS B)and IFRS Interpretations Committee (IFRIC). Theaccounting policies applied in the audited annual consolidated financial statements an d this report have been consistently applied to all years presented unless otherwise stated. Readers should be aware that 2016 quarterly results are not directly comparable to 2015 quarterly results , as there were 8 7days of sales in Q1, 201 6compared to 8 1days in Q1, 201 5,and 111 days of sales in Q4, 2016 compared to 116 days in Q4, 2015 . The second and third quarter sof both years each had 84 days. Same store sales growth is based on an equal number of days in each quarter. HIGHLIGHTS ¥Same store sales (1)for the fourth quarter of 2016 grew by 1.7% as compared to the same quarter of 2015. Annual same store sales growth (1)for 2016 was +3. 4%.¥Total sales in the Royalty Pool (as hereinafter defined) and royalty income increased by 1.0%for the fourth quarter compared to the same quarter of 2015, and by 7.3 %for 2016 as compared to 2015 .¥Annual net income increased in 2016 by 12.2%. ¥Annual payout ratio (2)in 2016 was 98.8% compared to 92.4% for 2015. ¥Monthly distribution rate was in creased twice in 2016, from 12.5 ¢per unit to 13.3 ¢per unit. The current annual distribution rate is $1.5 96per unit, a 6.4% increase over 2015Õs annual distribution rate. (1) Same store sales and same store sales growth do not have a standardized m eaning prescribed by IFRS and therefore may not be comparable to similar measures presented by other issuers. This information is provided as it is a key driver of growth in the Fund. Same store sales growth is based on an equal number of days in each quarter and year. See ÒSales PerformanceÓ. (2) The p ayout ratio does not have a standard ized meaning pr escribed by IFRS and therefore may not be comparable to similar measures presented by o ther issuers. This information is provided as it identifies the extent to which distributable cash is distributed to unitholders and F oodServi ces. See ÒDistributa ble C ashÓ. 3
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The following selected information , other than Ò Same store sales growthÓ, Ò Total distribut able cash generated for distributions an d dividendsÓ, ÒDistribut able cash per equivalent unitÓ and ÒNet income, excluding non -cash itemsÓ have been prepared in accordance with IFRS and all dollar amounts are reported in Canadian currency .(dollars in thousands except per unit amounts) Period from Sep 12 , 2016 to Dec 31 , 2016 Period from Sep 7 , 2015 to Dec 31 , 2015 Year ended Dec 31 , 2016 Year ended Dec 31 , 2015 Same store sales growth (1)+1.7 %+5.3% +3. 4%+7.6% Number of restaurants in the Royalty Pool 838814838814Sales reported by the restaurants in the Royalty Pool $351,494 $348,116 $1,137,8 30$1,060,851 Royalty income $10,545 $10,444 $34,135 $31,826 General and administrative expenses 214117586558Net third party interest expense 7817732,574 2,419 Current income tax provision 1,982 1,792 6,500 5,660 Total distributable cash generated for distributions and dividends (2)$7,568 $7,762 $24,475 $23,189 Distributable cash per equivalent unit (201 6Ð15,517,9 88units; 201 5Ð14, 870,367 units )(2)(3)$0.488 $0.522 $1.577 $1.559 Distributions and dividends declared per equivalent unit $0.532 $0.496 $1.558 $1.440 Net income (4)$8,973 $7,706 $23,916 $21,319 Net income, excluding non -cash items (4)$7,205 $7,762 $22,446 $23,189 (1) Same store sales growth doesnot have a standardized meaning prescribed by IFRS and therefore may not be comparable to similar measures presented by other issuers. This information is provided as it is a key driver of growth in the Fund. Same store sales growth is based on an equal number of days in each quarter and year .See ÒSales PerformanceÓ. (2) Distributable cash and distributable cash per equivalent unit do not have a standardized meaning prescribed by IFRS and therefore may not be comparable to similar measures presented by other issuers. This information is provi ded as it identifies the amount of actual cash generated to pay distributions to unitholders and dividends to Food Services. See ÒDistributable CashÓ. (3) The number of equivalent units and distributa ble cash per equivalent unit in 2016includes the 157,774 LP units (as hereinafter defined) exchange dfor 315,548 common shares of Trade Marks (as hereinafter defined) representing the final consideration paid in December 2016 for the January 5, 201 6adjustment to the Royalty Pool .The number of equivalent units and distributa ble cash per equivalent unit in 2015includes the 181,101 LP units exchange dfor 362,202 common shares of Trade Marks representing the final consideration paid in December 2015 for the January 5, 201 5adjustment to the Royalty Pool .(4)Net income in 201 6and 201 5includes non -cash gains and losses on interest rate swaps , amortization of deferred financing fees and deferred income taxes . These non -cash items have no impact on the FundÕs ability to pay distributions to unitholders. The FundÕs net income excluding these non -cash items is presented for information purposes only. Net income excluding non -cash items does not have a standardized meaning prescribed by IFRS and therefore may not be comparable to similar measures presented by other issuers. SALES PERFORMANCE Same store sales growth by A&W restaurants for which the royalty is payable (the Royalty Pool) by Food Services to A&W Trade Marks Limited Partnership (the Partnership) is a key performance indicator for the Fund. Same store sales growth is the change in sales of A&W restaurants in the Royalty Pool that operated during the entire 26 4 -week periods ending December 31 , 2016.Same store sales for the fourth quarter of 2016 grew by 1.7% as compared to the same quart er of 4
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capital reserves, by way of dividends on its common shares held by the Fu nd and Food Services. The Fund in turn makes distribut ions tounitholders. Trade MarksÕ general and administrative expenses include the expenses of the Fund as the Fund has entered into an administration agreement with Trade Marks whereby Trade Marks, at its expense, provides or arranges for the provision of services required in the administration of the Fund. A key attribute of the Fund is that the distributable cash available to make distributions to unitholders is based on the sales of the A&W res taurants in the Royalty Pool, less operating expenses associated with operating the Fund , interest and taxes . The Fund is a top -line fund, meaning it is not subject to variability of earnings or expenses associated with an operating business. Another imp ortant aspect of the Fund is that Food Services owns the equivalent of 21.8% (2015 Ð18.4%) of the units of the Fund through its ownership of common shares of Trade Marks. As a result, interests of Food Services are closely aligned with the interests of u nitholders. Growth in the Fund is achieved in two ways: first, and most importantly, by increasing the same store sales of the A&W restaurants in the Royalty Pool, and second by adding new A&W restaurants to the Royalty Pool each year. The Royalty Pool is adjusted annually to reflect sales from new A&W restaurants added to the Royalty Pool, net of the sales of any A&W restaurants that have permanently closed. Food Services is paid for the additional royalty stream related to the sales o f the net new restaurants, based on a formula set out in the Amended and Restated Licence and Royalty Agreement. The formula provides for a payment to Food Services based on 92.5% of the amount of estimated sales from the net new A&W restaurants and the c urrent yield on the units of the Fund, adjusted for income tax espayable by Trade Marks. The consideration is paid to Food Services in the form of additional LP units . The additional LP units are, at the option of Food Services, exchangeable for addition alcommon shares of Trade Marks ,which are in turn exchangeable for units of the Fund on the basis of two common shares for one unit of the Fund. ADJUSTMENT TO THE ROYALTY POOL The 201 6adjustment to the Royalty Pool took place on January 5, 201 6. The n umber of A&W restaurants in the Royalty Pool was increased by 32 new restaurants less eight restaurants that permanently closed during 201 5.The addition of these 24 net new restaurants br ought the total number of A&W restaurants in the Royalty Pool to 8 38. The estimated annual sales of the 3 2new A&W restaurants were $41,502,000 and annual sales for the eight permanently closed restaurants were $ 3,905,000. The initial consideration for the estimated additional royalty stream was $16,079,000, calculated b y discounting the estimated additional royalties by 7.5% and dividing the result by the yield on units of the Fund for the 20 trading days ending October 26, 2015. The yield was adjusted to reflect income tax payable by Trade Marks. The Partnership paid Food Services 80% of the initial consideration or $12,863,000 by issuance of 489,847LP units which were subsequently exchanged for 979,694non-voting common shares of Trade Marks. The final adjustment to the number of LP units issued was made on December 19, 2016 based on the actual annual sales reported by the new A&W restaurants of $43,599,000 6
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compared to the original estimate of $41,502,000. As a result, $3,216,000 representing the remaining 20% of the initial consideration ,and additional consideration of $927,000 ,were paid to Food Services by issuance of 157,774 additional LP units, which were subsequently exchanged for 315,548 non -voting common shares of Trade Marks. Subsequen t to December 31, 201 6, the 201 7adjustment to the Royalty Pool took place on January 5, 201 7. The number of A&W restaurants in the Royalty Pool was increased by 3 0new restaurants less seven restaurants that permanently closed during 201 6.The addition of these 2 3net new restaurants brings the total number of A&W restaurants in the Royalty Pool to 8 61. Theestimated annual sales of the 3 0new A&W restaurants are $ 33,355 ,000 and annual sales for the seven permanently closed restaurants were $ 4,251 ,000.The initial consideration for the estimated additional royalty stream was $15,046,000, calculated by discounting the estimated additional royalties by 7.5% and dividing the result by the yield on units of the Fund for the 20 trading days ending October 31, 2016. The yield was adjusted to reflect income tax payable by Trade Marks. The Partnership paid Food Services 80% of the initial consideration or$12,037,000by issuance of 346,386LP units which were subsequently exchanged for 692,772non-voting commo n shares of Trade Marks. The remaining 20% of the consideration or $3,009,000will be paid in Decembe r 201 7by issuance of additional LP units, which may be exchanged for non-voting common shares of Trade Marks. The actual amount of the consideration paid in December 201 7may differ from this amount depending on the actual annual sales reported by the new A&W restaurants. After the initial consideration was paid for the January 5, 201 7adjustment to the Royalty Pool, Food ServicesÕ indirect interest in the Fund increased to 23.5%.COMMON SHARES OF TRADE MARKS The common shares of Trade Marks are owned by the Fund and Food Services as follows: (dollars in thousands) Fund Food Services Total Number of shares Trade MarksÕ book value $%Number of shares Trade MarksÕ book value $%Number of shares Trade MarksÕ book value $Balance as at December 31, 2014 24,262,671 114,680 84.7 4,376,669 35,498 15.3 28,639,340 150,178 January 5, 2015 adjustment to the Royalty Pool –(3.1) 1,101,318 13,595 3.1 1,101,318 13,595 Balance as atDecember 31, 2015 24,262,671 114,680 81.6 5,477,987 49,093 18.4 29,740,658 163,773 January 5, 201 6adjustment to the Royalty Pool (1) –(3.4 )1,295,242 17,006 3.4 1,295,242 17,006 Balance as atDecember 31 , 2016 24,262,671 114,680 78.2 6,773,229 66,0 9921.831,035,900 180,779 (1) The number of common shares includes the 157,774 LP units exchange dfor 315,548 common shares of Trade Marks representing the final consideration paid in December 2016 for the January 5, 201 6adjustment to the Royalty Pool .7
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OWNERSHIP OF THE FUND The ownership of the Fund, on a fully -diluted basis, is as follows: December 31 , 2016 December 31, 201 5Number of units %Number of units %Fund units held by public unitholders 12,131,373 78.2 12,131,373 81.6 Number of Fund units issuable upon exchange of securities of Trade Marks held by Food Services (1) (2) 3,386,615 21.82,738,994 18.4 Total equivalent units 15,517,9 88100.0 14,870,367 100.0 (1) The number of Fund units issuable includes the 157,774 LP units exchange dfor 315,548 common shares of Trade Marks representing the final consideration paid in December 2016 for the January 5, 201 6adjustment to the Royalty Pool .(2) Common shares of Trade Marks held by Food Services may be exchanged for units of the Fund on the basis of two co mmon shares for a unit of the Fund. The chart below shows the ownership of the Fund, on a fully -diluted basis, after the initial consideration was paid for the January 5, 2017 adjustment to the Royalty Pool. Number of units %Fund units held by public unitholders 12,131,373 76.5 Number of Fund units issuable upon exchange of securities of Trade Marks held by Food Services 3,733,001 23.5 Total equivalent units 15,864,374 100.0 The chart below shows the ownership of the Fund, on a fully -diluted basis, when the remaining 20% of the consideration for the January 5, 2017 adjustment to the Royalty Pool is expected to be paid in December 2017, by issuance of 86,596 LP units exchangeable for 173,192 common shares of Trade Marks. The actu al amount of the consideration paid in December 2017 may differ from this amount depending on the actual annual sales reported by the new A&W restaurants. Number of units %Fund units held by public unitholders 12,131,373 76.1 Number of Fund units issuable upon exchange of securities of Trade Marks held by Food Services 3,819,597 23.9 Total equivalent units 15,950,970 100.0 FINANCIAL RESULTS INCOME Royalty income for the fourth quarter of 201 6was $ 10,545,000 based on sales of $ 351,494,000.This was an increase of 1.0 % from royalty income of $ 10,444,000 and sales of $ 348,116,000 for the fourth quarter of 201 5.There were 111 days of sales in the fourth quarter of 2016 as compared to 11 6days in the same quarter of 2015. Annual royalty income for 2016 was $34,135,000 based on sales of $1,137,830,000, an increase of 7.3% from royalty income of 8
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$31,826,000 and sales of $ 1,060,851,000 for 2015. The increase in sales and royalty income was due to the combined impact of the additional net 24 new A&W restaurants in the Royalty Pool and the same store sales growth of 1.7%for the fourth quarter of 2016 as compared to the same quarter of 2015 and 3.4%for the full year 2016 as compared to 2015. EXPENSES The FundÕs cash expenses excluding income taxes were as follows: (dollars in thousands) Period from Sep 12, 2016 to Dec 31, 2016 Period from Sep 7, 2015 to Dec 31, 2015 Year ended Dec 31, 2016 Year ended Dec 31, 2015 General and administrative $214$117$586$558Net interest on term loan and other $781$773$2,574 $2,419 General and administrative expenses for the fourth quarter of 2016 increased by $97,000 to $214,000 compared to $117,000 for the fourth quarter of 2015. The increase for the quarter was due to timing of expenses. General and administrative expenses for the full year 2016 increased by$28,000to $586,000 compared to $558 ,000 in 2015. The annual increase was primarily due to higher TSX filing fees and professional fees. Interest on the term loan increased by $ 8,000 to $ 781,000 for the fourth quarter of 2016 compared to $ 773,000 for the fourth quarter of 2015, and by $155,000 to $ 2,574,000 for the full year 2016 compared to $ 2,419,000 for 2015. Interest expense increased due to the new interest rate swap agreement which became effective on December 22, 2015 .See ÒLiquidity and Capital ResourcesÓ. GAIN/LOSS ON INTERES T RATE SWAP The FundÕs net income included non -cash gains and losses on the interest rate swap equal to the change in the fair value of the interest rate swap. These non -cash items had no impact on the FundÕs cash available to pay distributions. (dollars in thousands) Period from Sep 12, 2016 to Dec 31, 2016 Period from Sep 7, 2015 to Dec 31, 2015 Year ended Dec 31, 2016 Year ended Dec 31, 2015 (Gain) loss on interest rate swap ($1,98 6)$30($1,089) $2,4 96See ÒLiquidity and Capital ResourcesÓ. 9
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