priszm brandz

Priszm Priszm Canadian Income Fund Annual Report 2003 Our secret recipe for success Table of Contents 1 2 3 4 Highlights Letter from the Chairman and CEO Trustees’ Letter to Unitholders Priszm’s Secret Recipe – 11 Ingredients for an Outstanding Investment Opportunity 12 14 17 17 Fund Governance Management’s Discussion and Analysis Management’s Statement of Responsibility Auditors’ Report 18 19 20 21 Consolidated Balance Sheet Consolidated Statement of Income Consolidated Statement of Cash Flows Notes to the Consolidated Financial Statements ibc Corporate Information Table of Contents PRISZM CANADIAN INCOME FUND HIGHLIGHTS November 10 to December 31, 2003 Priszm > Priszm Canadian Income Fund’s IPO was completed on November 10, 2003 at $10 per unit. > Priszm operates 466 quick-service restaurants across Canada through its controlling interest in KIT Limited Partnership. > Priszm’s restaurant portfolio includes 414 KFC restaurants and 52 multi-branded locations combining the KFC, Pizza Hut, and Taco Bell concepts, making its operating entity one of the largest KFC franchisees in the world, accounting for approximately 70% of all KFC sales in Canada. > Priszm is different from a royalty trust in that it owns and operates the restaurant business. This allows unitholders to benefit from cost efficiencies, economies of scale, and potential earnings growth, as well as revenue growth. > Initial distribution was $0.17 for the period from November 10, 2003 to December 31, 2003. Cash distributions to unitholders are expected to be at least $1.20 per unit on an annualized basis. > Priszm’s units are listed on the Toronto Stock Exchange under the symbol QSR.UN. Note: This report covers the period from the beginning of the Fund’s operations on November 10, 2003 until December 31, 2003. 2003 FINANCIAL SUMMARY November 10 to December 31, 2003 (in thousands of dollars) Revenues EBITDA Net income Distributable cash Distributions per unit $ $ $ $ $ 62,871 6,370 3,935 5,777 0.17 Priszm Canadian Income Fund 2003 1 LETTER FROM THE CHAIRMAN AND CEO John I. Bitove Chairman and Chief Executive Officer Priszm has all the ingredients it needs to achieve long-term success. We intend to grow sales and distributions through focused advertising, new product introductions, multi-branding, building new restaurants, and acquiring other KFC franchisees. Dear fellow unitholders: On behalf of the more than 8,000 employees who work in our restaurants, our talented executive team, and the nearly 1.5 million customers we serve every week, we are pleased to announce that our financial results exceeded our expectations in the brief period covered by this Annual Report, and the outlook remains positive. We are confident that our geographically diverse network of KFC and multi-branded restaurants across Canada will continue to provide a predictable cash flow for the benefit of unitholders in 2004 and beyond. Growth is very much part of our plans for the future. We believe we will be able to achieve a steady increase in sales and distributable cash through a multi-pronged approach to growth. First, we intend to boost same-restaurant sales via focused advertising and new product introductions, such as our wildly popular Boneless Wings promotion. Second, we are planning to expand the number of multi-branded restaurants in select, high-growth Canadian markets to bring increased choice and convenience to our customers. To that end, we opened a new multi-branded KFC/Taco Bell restaurant in Brampton, Ontario, in early 2004. During the next 12 months, we intend to build another two multi-branded locations and add a Taco Bell, Pizza Hut or Long John Silver’s to at least 10 existing KFC restaurants. We’ve identified at least 100 additional good multi-branding opportunities. Third, we will pursue opportunities to acquire restaurants from other franchisees of the KFC brand in Canada or abroad if they can be expected to be immediately accretive to the Fund. As we pursue our growth strategy, we will also sharpen our focus on productivity and cost efficiencies throughout our operations, recognizing that all the headway we can make in this regard will provide additional cash for distribution. While competition in the quick-service sector is intense, we have all the ingredients we need for successful performance, including popular brands, a strong global franchisor in Yum! Brands, great locations, a dominant market share, a proven marketing strategy, and positive industry fundamentals. As important, we have a highly experienced management team with a proven track record. Senior managers each have 10 years or more of experience in the quick-service food industry, and at the restaurant level, the average tenure of restaurant general managers is more than 14 years. Above all, we have a strong tradition of outstanding customer service, which is a highly important factor in competing effectively in the quick-service restaurant marketplace. I wish to take this opportunity to thank all of our employees for their hard work and superior efforts to make our business a success. Sincerely, John I. Bitove (SIGNED) Chairman and Chief Executive Officer Priszm Canadian Income Fund 2003 2 TRUSTEES’ LETTER Borden Rosiak, Glen Swire, Stanley Thomas Priszm’s operations are on track to produce a steady, predictable stream of cash distributions into the future. To ensure the best interests of unitholders, Trustees have adopted the highest standards of ethics and corporate governance. Dear fellow unitholders: We are pleased to present the first Annual Report for Priszm Canadian Income Fund. This report covers the period from the beginning of the Fund’s operations on November 10, 2003 until December 31, 2003. Priszm’s distributable cash during this period fully met and exceeded the expectation indicated in the prospectus for the initial public offering (the “IPO”). As a result, we declared a cash distribution of $0.17 per unit for the period, which is consistent with the projection of at least $1.20 per unit in the Fund’s first full year of operation. As Priszm Trustees, we have the responsibility to ensure that Priszm operates in the best interests of unitholders. In addition to serving as Trustees, we are also Directors of KIT Inc., the general partner of KIT LP, and responsible for overseeing the restaurant operations of KIT LP. Priszm owns 60.2% of both KIT Inc. and KIT LP. We are pleased to report that we have implemented stringent guidelines in order to ensure that corporate governance of both the Board of Trustees of Priszm and the Board of Directors of KIT Inc. is conducted in accordance with the highest of ethical standards that meet and exceed the requirements of the relevant authorities. All three Trustees of Priszm are independent of management. Each is an “unrelated” director within the meaning of the corporate governance policy of the Toronto Stock Exchange. KIT Inc.’s policy is that a majority of its six-member Board of Directors must be unrelated directors, and only unrelated directors are permitted to be members of the Audit, Compensation, and Governance committees of the Board. Our focus on corporate governance includes ensuring that the Trustees of Priszm are able to, and in fact do, function independently of management, that management’s performance is reviewed on a regular basis, that the boards of both Priszm and KIT Inc. function at all times in the best interests of Priszm unitholders, and that Priszm management continues to leverage its many strengths. Finally, we note that KIT LP’s sales in the first part of 2004 were above year-earlier levels, and this bodes well for the continuation of a steady, predictable stream of cash distributions to Priszm unitholders. Sincerely, Borden Rosiak (SIGNED) Glen Swire (SIGNED) Stanley Thomas (SIGNED) Albert Gnat, who served as a member of the Priszm Boards of Directors and Trustees since Priszm’s first day of operations in November 2003, passed away prior to the printing of this report. Mr. Gnat helped lay the foundation for Priszm’s corporate governance structure and was instrumental in the successful completion of Priszm’s initial public offering. He will be sorely missed. Priszm Canadian Income Fund 2003 3 11 Ingredients for an Outstanding Investment Opportunity – PRISZM’S SECRET RECIPE PRISZM’S SECRET RECIPE 11 Ingredients for an Outstanding Investment Opportunity Ingredient 1. Four Strong, Differentiated Brands KFC is one of the most popular and recognized restaurant brands in the world. A key competitive advantage is the Colonel, one of the best known commercial icons of all time, and his secret blend of 11 herbs and spices that makes Kentucky Fried Chicken so delicious and appealing to consumers. Pizza Hut is the world’s largest pizza restaurant company and the largest national pizza chain in Canada. Taco Bell is the world’s largest Mexican-style, quick-service restaurant company. Although Priszm’s restaurant portfolio does not currently include the Long John Silver’s concept, there may be an opportunity for Priszm to multi-brand its KFC restaurants with the Long John Silver’s concept in the future. Long John Silver’s is the largest quick-service seafood chain in the United States. Priszm benefits through the exchange of ideas, best practices, and menu innovations from a worldwide franchise network of nearly 33,000 restaurants in more than 100 countries and territories. Priszm Canadian Income Fund 2003 5 PRISZM’S SECRET RECIPE 11 Ingredients for an Outstanding Investment Opportunity Ingredient 2. Great Locations Priszm’s 466 KFC restaurants are located in choice, high-traffic locations and attract approximately 1.5 million customers a week, generating approximately $460 million in sales annually. Priszm has a diverse asset base consisting of: 337 Free Standing restaurants, 84 In-Line and Storefront sites, and 45 Foodcourt locations. Priszm also operates 52 Pizza Hut and Taco Bell restaurants that have been multi-branded into existing KFC restaurants. Channels to market: In each concept, consumers can either dine in or carry out food. In addition, Taco Bell and KFC offer a drive-through option in many stores. Pizza Hut and KFC offer extensive delivery services. Ingredient 3. Large-scale, National Operations Priszm’s large-scale operations across Canada give it a significant advantage over smaller franchisees in the areas of access to capital, protection against regional economic downturns, and the ability to spread costs over a larger system. Geographic diversification 42% 20% 4% 6% 9% 12% 7% Ontario Quebec New Brunswick Nova Scotia British Columbia Alberta Manitoba 466 restaurants across Canada Priszm Canadian Income Fund 2003 6 PRISZM’S SECRET RECIPE 11 Ingredients for an Outstanding Investment Opportunity Ingredient 4. Driving Results of Individual Restaurants We at Priszm understand that happy customers equate to great results. We have the key processes in place to ensure customer satisfaction. Restaurant management receives bonuses based on a combination of measures including customer satisfaction, speed of service, product quality, cleanliness, maintenance, hospitality and progress achieved in meeting aggressive profitability targets. Our 2004 goal is to increase same-store sales and improve bottom-line profitability for each and every restaurant in our portfolio. “I have the tools to effectively manage my restaurant bottom line. My team understands our customers and we work hard to make every customer a repeat customer.” Ingredient 5. Priszm’s favourable operating efficiencies compared with other quick-service restaurant chains include: KFC Operating Efficiencies Average transaction revenue $15 lower labour costs due to a shorter work day concentrated around prime customer demand between 2 p.m. and 8 p.m.; one of the highest transaction revenue averages in the industry; and diverse menu offerings for snacks, quick meals or family feasts. In addition, Priszm produces its own coleslaw, potato salad and macaroni salad at a wholly-owned, 41,000-square-foot commissary located in Toronto, Ontario. $12 $9 Average QSR $6 $3 $0 2003 2003 Source: Crest/MPNPD Food Services Information Group Priszm Canadian Income Fund 2003 7 PRISZM’S SECRET RECIPE 11 Ingredients for an Outstanding Investment Opportunity Ingredient 6. Average weekly sales per restaurant (in thousands) 20 Strong, Predictable Cash Flow The KFC brand has generated stable, predictable cash flow since its introduction in Canada in the 1950s. Priszm’s distributable cash is expected to be at least $30.9 million or $1.20 per unit in the first year following the IPO. 15 10 5 0 1997 1998 1999 2000 2001 2002 2003 Unaudited pre mid-2000 Restaurant sales (in millions) $500 $400 $300 $200 $100 $0 Number of restaurants: 1997 443 1998 443 1999 443 2000 443 2001 452 2002 463 2003 466 Unaudited pre mid-2000 Ingredient 7. Experienced Management Team with a Proven Track Record Priszm has a strong, experienced group of officers and directors who are complemented by an outstanding team of senior and operational managers with extensive experience in the quick-service food industry. Priszm’s 8,000 hard working employees are focused on driving sales and reducing costs. from left: Glen Swire, Lilly Di Massimo, John I. Bitove, Rupert Altschuler, Stanley A. Thomas, Peter Walkey Absent: Borden Rosiak Priszm Canadian Income Fund 2003 8 PRISZM’S SECRET RECIPE 11 Ingredients for an Outstanding Investment Opportunity Ingredient 8. Percentage share of total of 2003 chicken occasions in quick-service restaurants Percentage share of total of 2003 chicken-on-the-bone occasions in quickservice restaurants Dominant Market Share KFC sells approximately 73% of the “chicken-on-the-bone” in the Canadian QSR industry. In 2003, KFC passed all of its competitors in total chicken occasions with a 23.6% market share. KFC 23.6% Competitors 27% Nearest competitor 21.5% KFC 73% Total independents 13.4% Source: Crest/MPNPD Food Services Information Group Ingredient 9. Canadian quick-service restaurant industry sales 1997–2002 (in billions) $12 $10 $8 $6 $4 $2 $0 1997 1998 1999 2000 2001 2002 Positive Industry Fundamentals Quick-service restaurants are experiencing stronger growth than the overall restaurant industry. The gain in market share is at the expense of casual, family mid-scale restaurants and fine-dining establishments. 10.1 9.2 10.6 11.1 11.6 11.8 Source: Statistics Canada Priszm Canadian Income Fund 2003 9 PRISZM’S SECRET RECIPE 11 Ingredients for an Outstanding Investment Opportunity Ingredient 10 . Sales Growth – Industry-leading Marketing and Product Innovation Priszm expects to grow sales and distributable cash through a focus on consumer-driven strategic initiatives. Home Meal Replacement is a large and growing segment within the food service industry. We anticipate further strengthening our share of this business in 2004 through the addition of new product offerings as well as packaging and bundling innovations. While we are a leader in dinner occasions, there are significant opportunities for growth during the lunchtime hours by focusing on small-pack meals and sandwiches. KFC will participate in this highly competitive segment with craveable products that are unique to KFC. KFC has enjoyed great success in recent years with continuous testing, new product launches and value-added promotions. From the launch of fresh green salads, Boneless Wings, and the Variety Bucket to our association with Lord of the Rings and Canada’s leading chocolate bar, KFC remains as relevant a choice today as it was 30 years ago. Listening and responding to the consumer is the cornerstone of KFC’s marketing into 2004 and beyond. Because of its position as dominant franchisee, Priszm manages marketing, advertising, and product innovation for the entire KFC network in Canada. Priszm Canadian Income Fund 2003 10 PRISZM’S SECRET RECIPE 11 Ingredients for an Outstanding Investment Opportunity Ingredient 11 . Development Growth Multi-branding existing restaurants, whereby Pizza Hut, Taco Bell, or Long John Silver’s are combined with KFC in a single restaurant, adds significant incremental average sales per unit with a small capital investment and leverages long-term lease, building, equipment, and labour costs. “Multi-branding is our growth engine,” says John Bitove, Chairman and Chief Executive Officer. “Priszm is uniquely positioned to take advantage of this opportunity since we can choose from four strong brands.” Multi-branding is the single biggest sales and profit innovation in our industry since the drive-through window. Priszm will also pursue profitable opportunities to expand by establishing new restaurants and making acquisitions of independent KFC franchisees on the basis that would be accretive to the Fund’s unitholders. PEDESTRIAN SI EXISTING SITE ACCESS TO REMAIN KFC DRIVE THRU EXIT BARRIER FREE ACCESS RAMP PAINTED LINES NEW WOOD FENCE RECYCLING ENCLOSURE RE-FACED DIRECTIONAL SIGN PEDESTRIAN CROSSWALK EXISTING KFC RESTAURANT NEW GARBAGE ENCLOSURE MENUBOARD AND SPEAKER NEW CUPOLA & TOWER EXISTING PARKING - 4 CARS EXISTING LANDSCAPING 2 WAY FUTUREACCESS NEW DIRECTIONAL KFC DRIVE SIGN THRU ENTRANCE NEW CLEARANCE SIGN PRE-MENUBOARD NEW WOOD FENCE GREASE ENCLOSURE EXISTING FRAME SHED NEW CEDAR ACOUSTIC FENCE Multi-branding, putting two or three restaurant concepts under one roof, gives Priszm a distinct advantage over its competitors. Priszm Canadian Income Fund 2003 11 11 Ingredients Together = an Outstanding Investment Opportunity Priszm Canadian Income Fund 2003 12 FUND GOVERNANCE The Priszm Canadian Income Fund’s Board of Trustees consists of three independent senior business executives. All three are members of the Board of Directors of the general partner, KIT Inc., responsible for overseeing the management of KIT LP, the restaurant operator. Borden D. Rosiak, Trustee and Director 2, 3, 4, 5, 6 A Chartered Accountant with extensive experience as a senior financial executive, Mr. Rosiak has served as Chief Financial Officer for Crystallex International Corporation, Newcourt Credit Group, and Confederation Life Insurance, among other companies, and was Chief Executive Officer of Cameron Capital Corporation. Glen M. Swire, Trustee and Director 2, 3, 4, 5, 6 Mr. Swire was President of Swire Restaurants Ltd., a family-owned firm that operated 17 KFC restaurants in Ontario for 33 years. He served as President of the Canadian KFC Franchisee Association and was a recipient of the KFC Franchisee of the Year honour. Stanley A. Thomas, Trustee and Director 2, 3, 4, 5, 6 Mr. Thomas was President and Chief Operating Officer of Shoppers Drug Mart Inc. until he retired in 2001. Mr. Thomas is now an investor, shareholder, and director of several private companies and continues to serve the community on volunteer boards. John I. Bitove, Director, Chairman, and Chief Executive Officer 1, 2 Mr. Bitove is one of Canada’s leading businessmen with a distinguished record of accomplishments in business and community service. He is the majority owner and Chairman of Scott’s Restaurants Inc., and PBI LP, which has a 39.8% interest in KIT Limited Partnership. Lilly Di Massimo, Director 2 Ms. Di Massimo has 16 years of experience in the financial accounting and analysis of KFC restaurants with Scott’s Restaurants Inc., where she is Chief Financial Officer. She is a Certified General Accountant and worked in public accounting at Clarkson Gordon for five years prior to joining Scott’s Restaurants Inc. Rupert Altschuler, President and Chief Operating Officer 1 Mr. Altschuler has more than 10 years of experience with the KFC concept. He became an Area Manager in 1995, KFC Regional Director of Operations for British Columbia in 1997, and assumed the role of Senior Regional Director responsible for KFC, Pizza Hut, and Taco Bell in British Columbia in 2002. Peter Walkey, Chief Financial Officer and Corporate Secretary 1 Mr. Walkey, a Certified General Accountant, has 15 years of experience in the hospitality industry, 10 of those associated with the KFC brand. He most recently held the position of Chief Financial Officer for Yum! Restaurants International (Canada). 1 Management, 2 Director, 3 Trustee, 4 Audit Committee, 5 Compensation Committee, 6 Governance Committee Priszm Canadian Income Fund 2003 13 MANAGEMENT’S DISCUSSION AND A N A LY S I S For the period from November 10, 2003 (commencement of operations) to December 31, 2003 Overview Priszm Canadian Income Fund (“Priszm”) commenced operations on November 10, 2003, when it completed its initial public offering (the “IPO”) for 15,000,000 units for aggregate proceeds of $150,000,000. Units of Priszm trade on the Toronto Stock Exchange (TSX) under the symbol QSR.UN. Priszm is an unincorporated open-ended limited purpose trust established under the laws of the Province of Ontario created to acquire the KFC restaurant business of priszm brandz LP. The $273.4 million acquisition was done concurrent with the IPO and completed through Priszm Canadian Operating Trust (the “Trust”), operating entity KIT Limited Partnership (“KIT LP”) and its general partner, KIT Inc., collectively the “Company.” The Company acquired the business for cash of $170.4 million and the issuance of KIT LP Exchangeable and Subordinated Units. Following completion of the transaction and the subsequent sale of additional units through the IPO over-allotment option, Priszm has a 60.2% interest in KIT LP through the ownership of regular units. The remaining interest is held by PBI LP (formerly priszm brandz LP) through its ownership of Exchangeable and Subordinated Units. Priszm is entirely dependent upon the operations and assets of the Company. The Company operates 466 KFC restaurants in Canada. KFC is one of the most recognized brands in the world with over 33,000 locations worldwide. The Company has the right to use the KFC, Pizza Hut, and Taco Bell names, logos and products pursuant to the terms of its franchise agreement. This discussion summarizes the significant factors affecting the operations and financial position of Priszm from commencement of operations to December 31, 2003. This discussion should be read in conjunction with the audited consolidated financial statements and accompanying notes of Priszm. Restaurant Operations The following table presents summary information covering the restaurant operations for the period from November 10, 2003 to December 31, 2003. Although Priszm was not in existence in the prior year, results for these restaurants are used in the following discussion and analysis for the comparable period of time corresponding to the prior year. Period from November 10, 2003 to December 31, 2003 Period from November 11, 2002 % of sales to December 31, 2002 (In thousands of dollars) % of sales Sales Cost of restaurant sales Restaurant operating expenses Franchise royalty expense Depreciation and amortization expense $ 62,871 37,961 12,622 3,775 1,466 55,824 — 60.4% 20.1% 6.0% 2.3% 88.8% 11.2% $ 60,679 35,925 12,770 3,641 1,410 53,746 — 59.2% 21.0% 6.0% 2.3% 88.5% 11.4% Income from restaurant operations $ 7,047 $ 6,933 Restaurant sales increased by $2.2 million or 3.6% for the seven-week period ending December 31, 2003. In addition to the improved economic environment in the latter half of 2003, sales also increased due to the launch of “Boneless Wings” in Canada and greater Christmas promotion activity. Cost of restaurant sales as a percentage of sales increased by 1.2%. The benefits of improved labour cost efficiency in 2003 were more than offset by higher food and supplies costs due to higher promotional activity involving product giveaway. Overall restaurant operating expenses were comparable at $12.6 million during the 2003 period and $12.7 million for 2002. Land and buildings owned by priszm brandz LP which were not acquired by Priszm, resulted in higher rent expense of approximately $1.1 million. This amount was offset in part by lower advertising expense of $0.8 million due to the timing of spending. Priszm Canadian Income Fund 2003 14 MANAGEMENT’S DISCUSSION AND A N A LY S I S For the period from November 10, 2003 (commencement of operations) to December 31, 2003 General and Administrative Expenses General and administrative expenses for the period at 4.3% of sales were in line with management’s expectations and include amortization of the acquired Franchise Rights and the cost of operating Priszm. Liquidity and Capital Resources On November 10, 2003 Priszm completed an IPO, issuing 15,000,000 units to the public for net proceeds of $136.8 million. The net proceeds from the IPO and the issuance of $60 million of long-term debt were sufficient to provide the funding for the $170.4 million cash component of the purchase of the KFC restaurant business by KIT LP. The remaining net proceeds were sufficient to establish a capital pool in excess of $25 million to be used for upgrading existing restaurants and replacing restaurant equipment. Cash provided by operations will be a secondary source of capital funding. Management estimates that the cost of multi-branding and the cost of fully upgrading the Company restaurants will, on average, be approximately $50,000 to $250,000 per restaurant depending on the type and size of restaurant facility. During the seven-week period ended December 31, 2003, the Company generated $6 million of cash flow from operations prior to the utilization of $2.5 million from additional working capital investment. The Company normally operates with negative working capital as cash sales precede the payment of restaurant food, supplies and labour. Spending on capital expenditures during the seven-week period ended December 31, 2003 amounted to $0.6 million. Maintenance capital items accounted for half of this expenditure; the remaining amount was spent towards a new store that will be opened in the first quarter of 2004. The Company has a term debt facility of $60 million with a syndicate of banks that matures on November 10, 2006. All the assets of the business have been pledged as collateral for this debt. The debt carries a floating rate based on Canadian prime rate plus approximately 0.25%. The Company believes that it will be able to generate sufficient cash resources to fund the interest on this debt through to maturity and still maintain unitholder distributions at a level of $1.20 per year. Consideration is being given to fixing the interest rate on all or a portion of this facility through to maturity through the use of interest rate swaps. The Company is not required to and does not plan to make any principal payments on the facility prior to maturity. The facility will be repaid on maturity with accumulated cash from operations and a new long-term debt facility on or prior to its maturity. Distributable Cash Period from November 10, 2003 to December 31, 2003 Net earnings for the period Additions: Amortization Deductions: Maintenance capital expenditures(1) Period from November 10, 2003 to December 31, 2003 $ 3,935 2,112 270 Distributable cash Distributions declared and payable Distributions declared and payable per unit $ $ $ 5,777 4,389 0.17 Note: Distributable cash and maintenance are not measures recognized by generally accepted accounting principles (“GAAP”), do not have standardized meanings prescribed by GAAP and therefore may not be comparable to similar measures presented by other issuers. However, management believes that they are important and useful measures for readers to evaluate the performance of Priszm. (1) Maintenance capital expenditures refers to capital expenditures that are necessary to sustain current revenue levels. Management believes that funding for maintenance capital expenditures must come out of operating cash flow. Priszm Canadian Income Fund 2003 15 MANAGEMENT’S DISCUSSION AND A N A LY S I S For the period from November 10, 2003 (commencement of operations) to December 31, 2003 Risks and Uncertainties The performance of Priszm is directly dependent upon the cash distributions Priszm receives from the Company. The amount of the cash distributions will be dependent upon cash flow from operations of the 466 restaurants operated by the Company, which is subject to a number of factors that affect the restaurant industry generally and the quickservice segment of this industry in particular, including intense competition with respect to price, service, location and food quality. For a more detailed list of risks and uncertainties please refer to “Risk Factors” detailed in the prospectus dated October 31, 2003. Outlook Management was very satisfied with the results for the seven-week period. Sales and profits exceeded our internal targets, which allowed Priszm to make distributions in line with representations made during its IPO. Management believes that it will be able to grow restaurant sales throughout 2004 and continue to improve operating efficiencies which should enable Priszm to complete its planned distributions of $1.20 per unit. Additional Information Additional information, including Priszm’s Annual Information Form, is available at www.sedar.com. Forward-Looking Statements Management’s discussion and analysis contains certain forward-looking statements. These statements relate to future events or future performance. In some cases, forward-looking statements can be identified by terminology such as “may,” “will,” “should,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” “continue” or the negative of these terms or other comparable terminology. Such statements reflect the views of management of Priszm with respect to future events. Actual events or results may differ materially. In evaluating these statements readers should specifically consider various factors, including the risks outlined under “Risk Factors” in Priszm’s Annual Information Form which is available at www.sedar.com. These factors may cause actual results to differ materially from any forward-looking statement. Priszm Canadian Income Fund 2003 16 M ANAGEMENT ’ S S TATEMENT OF R ESPONSIBILITY The accompanying consolidated financial statements are the responsibility of management and have been reviewed and approved by the Board of Directors and the Trustees. The consolidated financial statements have been prepared by management in accordance with Canadian generally accepted accounting principles and, where appropriate, reflect management’s best estimates and judgements. Management has also prepared financial and all other information in the Annual Report and has ensured that this information is consistent with the consolidated financial statements. The Fund maintains appropriate systems of internal control, policies and procedures, which provide management with reasonable assurance that assets are safeguarded and the financial records are reliable and form a proper basis for preparation of financial statements. The Board of Directors and the Trustees ensure that management fulfills its responsibilities for financial reporting and internal control through an Audit Committee. This committee reviews the consolidated financial statements and reports to the Trustee. The auditors have full and direct access to the Audit Committee. The consolidated financial statements have been independently audited by PricewaterhouseCoopers LLP in accordance with Canadian generally accepted auditing standards. Their report below expresses their opinion on the consolidated financial statements of the Fund. John I. Bitove (SIGNED) Chairman and Chief Executive Officer Peter Walkey (SIGNED) Chief financial Officer AUDITORS’ REPORT To the Unitholders of Priszm Canadian Income Fund We have audited the consolidated balance sheet of Priszm Canadian Income Fund as at December 31, 2003 and the consolidated statements of income and cash flows for the period from November 10, 2003 to December 31, 2003. These financial statements are the responsibility of the Fund’s management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with Canadian generally accepted auditing standards. Those standards require that we plan and perform an audit to obtain reasonable assurance whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. In our opinion, these consolidated financial statements present fairly, in all material respects, the financial position of the Fund as at December 31, 2003 and the results of its operations and its cash flows for the period from November 10, 2003 to December 31, 2003 in accordance with Canadian generally accepted accounting principles. PriceWaterhouseCoopers LLP (SIGNED) Chartered Accountants Toronto, Ontario April 2, 2004 Priszm Canadian Income Fund 2003 17 C O N S O L I D AT E D B A L A N C E S H E E T As at December 31, 2003 (in thousands of dollars) $ ASSETS Current assets Cash and cash equivalents Trade and other accounts receivable Inventories Prepaid expenses Other assets Property and equipment Franchise rights Goodwill (note 7) (note 5) (note 6) 28,432 2,072 4,703 819 233 36,259 77,339 1,304 64,514 156,617 336,033 Deferred financing charge (note 3) LIABILITIES Current liabilities Accounts payable and accrued liabilities Distributions payable to unitholders Long-term debt (note 9) (note 8) 32,272 4,389 36,661 60,000 96,661 (note 4) UNITHOLDERS’ EQUITY Capital contributions (note 4) 239,826 3,935 (4,389) 239,372 336,033 Net income for the period Distributions declared Borden Rosiak (SIGNED) Trustee Stanley Thomas (SIGNED) Trustee The accompanying notes are part of these financial statements Priszm Canadian Income Fund 2003 18 C O N S O L I D AT E D S TAT E M E N T OF INCOME For the period from November 10, 2003 to December 31, 2003 (in thousands of dollars except per unit amount) $ Restaurant sales Restaurant cost and expenses Cost of restaurant sales (note 11) (note 11) 62,871 37,961 12,622 3,775 (note 11) Restaurant operating expenses Franchise royalty expense Depreciation and amortization 1,466 55,824 Income from restaurant operations General and administrative expenses (including amortization of $585) Income before the undernoted Interest income Interest expense (note 9) 7,047 2,728 4,319 85 (469) 3,935 (note 4) Net income for the period Basic and diluted earnings per unit 0.1524 The accompanying notes are part of these financial statements Priszm Canadian Income Fund 2003 19 C O N S O L I D AT E D S TAT E M E N T OF CASH FLOWS For the period from November 10, 2003 to December 31, 2003 (in thousands of dollars) $ CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES Net income for the period Add non-cash items: Amortization of property and equipment Amortization of franchise rights Amortization of financing fees Cash provided by operations Net change in non-cash working capital Cash provided by operating activities INVESTING ACTIVITIES (note 16) 3,935 1,565 486 61 6,047 (2,508) 3,539 Acquisition of business, net of acquired restaurant cash Purchase of property and equipment Cash used in investing activities FINANCING ACTIVITIES (note 3) (169,911) (621) (170,532) Initial public offering of Fund Units, net of expenses Proceeds from long-term debt, net of financing fees Cash provided by financing activities Change in cash and cash equivalents – During the period Cash and cash equivalents – Beginning of period Cash and cash equivalents – End of period Represented by Cash Term deposit 136,790 58,635 195,425 28,432 — 28,432 3,832 24,600 28,432 Supplementary disclosure of cash flow information (note 16) The accompanying notes are part of these financial statements Priszm Canadian Income Fund 2003 20 NOTES TO THE C O N S O L I D AT E D F I N A N C I A L S TAT E M E N T S December 31, 2003 (in thousands of dollars) 1. Organization Priszm Canadian Income Fund (“Priszm”) is an unincorporated open-ended limited purpose trust with an unlimited number of Trust Units established under the laws of the Province of Ontario pursuant to a Declaration of Trust dated September 24, 2003. Priszm was established to acquire, through wholly owned KIT LP, the KFC restaurant business of PBI LP (formerly priszm brandz LP) comprising 466 KFC restaurants (52 of which are multi-brand restaurants that include a KFC outlet) and a salad production facility. Priszm commenced operations on November 10, 2003, with an initial public offering (the “IPO”) of 15,000,000 Fund Units, at a price of $10 per Fund Unit, for aggregate proceeds of $150,000. Concurrent with the closing of the IPO, the Company acquired the KFC restaurant business of PBI LP. 2. Summary of significant accounting policies The consolidated financial statements of the Fund have been prepared in accordance with Canadian generally accepted accounting principles, and include the following significant accounting policies: Principles of consolidation The consolidated financial statements include the accounts of the Fund and all of its subsidiary companies. All material intercompany transactions and balances have been eliminated. Cash and cash equivalents Cash and cash equivalents consist of cash on hand and cash balances with major financial institutions and highly liquid short-term investments with an original maturity of three months or less. Inventories Inventories are valued at the lower of cost and net realizable value. Cost is determined on a first-in, first-out basis. Property and equipment Property and equipment are recorded at cost, and adjusted to fair market value when cost is below the net recoverable amount. Repairs and maintenance that do not enhance the service potential of the related assets are charged to expenses as incurred. Renewals and betterments which materially prolong the useful lives of the assets are capitalized. The cost and related accumulated amortization of property acquired or sold are removed from the accounts, and gains or losses are recognized in the consolidated statement of income. Impairment of long-lived assets The Fund reviews long-lived assets for impairment whenever events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. If the sum of the expected future undiscounted cash flows is less than the carrying amount of the asset, an impairment loss is recognized. Measurement of the impairment loss for long-lived assets is based on the fair value of the asset. Restaurants under development Restaurants under development consist of restaurants under construction. The cost of restaurants under development includes direct costs associated with the site acquisition and restaurant construction, including direct internal payroll and payroll-related costs. Only those site-specific costs incurred subsequent to the time that the site acquisition is considered probable are capitalized. Acquisitions are considered probable upon final site approval. If a subsequent determination is made that a site for which internal development costs have been capitalized will not be acquired or developed, any previously capitalized internal development costs are expensed and included in general and administrative expenses. Restaurants under development are recorded at the lower of cost and net realizable value, reduced for impairment losses where appropriate. Priszm Canadian Income Fund 2003 21 NOTES TO THE C O N S O L I D AT E D F I N A N C I A L S TAT E M E N T S December 31, 2003 (in thousands of dollars) Amortization Amortization is computed primarily on a straight-line basis, at rates sufficient to amortize the cost of the assets over their estimated useful lives: Building Leasehold improvements Furnishings and equipment 20 years initial lease term plus the first renewal period, if applicable 3 to 10 years Deferred financing charge Costs associated with the arrangement of long-term financing are deferred and amortized on a straight-line basis over the term of the related financing. Franchise rights The cost of franchise and development rights are amortized on a straight-line basis over the term of the related agreements, typically 20 years. Goodwill Goodwill represents the excess of the cost of business acquired over the fair value of identifiable assets acquired and liabilities assumed. In accordance with the recommendations of the CICA’s handbook Section 3062, goodwill is not amortized but will be tested for impairment annually, or when an event or circumstance occurs that could indicate that the fair value is less than the carrying value. Any impairment in the value of goodwill is written off against income. Income taxes Income tax obligations relating to distributions from Priszm are obligations of the Unitholders and, accordingly, no provision for income taxes has been made in respect of the income of Priszm. Foreign currency translation Monetary assets and liabilities denominated in foreign currencies are translated at the exchange rate in effect at the consolidated balance sheet date and non-monetary items are translated at historical exchange rates. Operating revenue and expenses are translated at average exchange rates prevailing during the year. Gains or losses arising from these transactions are included in income. Revenue recognition The Fund earns revenues from the sale of food and beverages at its operating restaurants. Revenues are recognized as the goods and services are delivered. Financial instruments Financial instruments that potentially subject Priszm to concentrations of credit risk consist primarily of trade and other accounts receivable. Priszm performs periodic credit evaluations of the financial condition of its customers. Allowances are maintained for potential credit losses consistent with the credit risk of specific customers, historical trends and other information. The carrying amounts of cash and cash equivalents, trade and other accounts receivable and accounts payable and accrued liabilities approximate their fair values because of the near-term maturity of these instruments. The fair value of the long-term debt approximates its carrying amount, given that interest is charged at floating rates and the debt can be repaid in whole or in part at any time prior to maturity. Priszm Canadian Income Fund 2003 22 NOTES TO THE C O N S O L I D AT E D F I N A N C I A L S TAT E M E N T S December 31, 2003 (in thousands of dollars) Use of estimates The preparation of consolidated financial statements in conformity with Canadian generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and sales and expenses for the period reported. Actual results may differ from those estimates. 3. Business acquisition On November 10, 2003, the Fund acquired, through KIT LP, the KFC businesses of PBI LP. The acquisitions were accounted for by the purchase method with the results of operations included in income from the date of acquisition on November 10, 2003. Priszm is currently in the process of finalizing its estimate of the fair value of the assets acquired and the liabilities assumed and expects to complete this process by December 2004. The purchase price allocated to the assets acquired and the liabilities assumed, based on their estimated fair values on the date of acquisition, was as follows: $ Current assets Restaurant cash Accounts receivable Inventories Prepaid expenses and other assets 489 1,195 4,243 2,052 7,979 Property and equipment Franchise rights (i) Goodwill Current liabilities Accounts payable and accrued liabilities Net assets acquired Consideration Cash (including settlement of $1,100 of assumed liabilities) 5,656,000 Exchangeable Units 5,164,000 Subordinated Units 78,285 65,000 156,617 307,881 34,445 273,436 170,400 56,560 46,476 273,436 (i) With an average remaining term of 18 years, including the 10-year renewal option. Priszm Canadian Income Fund 2003 23 NOTES TO THE C O N S O L I D AT E D F I N A N C I A L S TAT E M E N T S December 31, 2003 (in thousands of dollars) 4. Fund Units As at December 31, 2003, Units outstanding and capital contributions are as follows: Number of Units Amount $ Fund Units Issuance under IPO Issuance upon the exercise of the over-allotment option Issuance costs Exchangeable Units Issuance under IPO – net of redemption Subordinated Units Issuance under IPO Total Fund, Exchangeable and Subordinated Units 15,000,000 550,000 — 15,550,000 5,106,000 150,000 5,500 (13,210) 142,290 51,060 5,164,000 25,820,000 46,476 239,826 Fund Units The Fund Trust Indenture provides that an unlimited number of Fund Units may be issued. Each Fund Unit represents an undivided beneficial interest in the distributions from the Fund and the net assets remaining after satisfaction of all liabilities in the event of termination of the Fund. All Fund Units have equal voting rights and privileges. Fund Units are redeemable at any time on demand at the option of the holders at a price per Fund Unit (the “Redemption Price”) equal to the lesser of: (i) 90% of the weighted average price per Fund Unit during the period of the last ten days during which the Fund Units traded; and (ii) an amount equal to the price of the Fund Units on the date of redemption, as defined in the Fund Trust Indenture. The aggregate Redemption Price payable by Priszm in respect of any Fund Units surrendered for redemption during any calendar month will be satisfied by way of a cash payment by the Fund no later than the last day of the calendar month following the calendar month in which the Units were tendered for redemption, provided that the entitlement of the Unitholders to receive cash upon the redemption of their Units is subject to the limitations that: i) the total amount payable in cash by Priszm in respect of such Units and all other Units tendered for redemption in the same calendar month may not exceed $50,000 (the “Monthly Limit”), provided that the Trustees may, at their sole discretion, waive such limitation in respect of all Units rendered for redemption in any calendar month; ii) at the time such Units are tendered for redemption, the outstanding Units must be listed for trading on a stock exchange or traded or quoted on another market that, at the sole discretion of the Trustees, provides a representative fair market value price for the Units; and iii) the normal trading of Units must not be suspended or halted on any stock exchange on which Units are listed on the date that the Units are tendered for redemption or for more than five trading days during the ten trading day period prior to the date on which the Units are tendered for redemption. Special Fund Units The Declaration of Trust and the Exchange Agreement provide for the issuance of voting non-participating units (the “Special Fund Units”) to the holders of Exchangeable Units and Subordinated Units of KIT LP used solely for providing voting rights proportionate to the votes of Fund Units issuable on exchange of the Exchangeable Units and Subordinated Units on a one-for-one basis. The Special Fund Units are non-transferable other than to the Fund or to affiliates or associates of the original investors. If the Exchangeable Units and Subordinated Units are purchased in accordance with the Exchange Agreement, a like number of Special Fund Units will be redeemed by Priszm for a nominal price. The Fund issued 10,820,000 Special Fund Units relating to the 5,656,000 Exchangeable Units and 5,164,000 Subordinated Units at the time of the IPO, of which 550,000 Exchangeable Units were subsequently redeemed upon the exercise of the underwriters’ over-allotment option. Priszm Canadian Income Fund 2003 24 NOTES TO THE C O N S O L I D AT E D F I N A N C I A L S TAT E M E N T S December 31, 2003 (in thousands of dollars) Exchangeable Units The Exchangeable Units issued by KIT LP to PBI LP have economic and voting rights equivalent, in all material respects, to the Fund Units. As a result, they have been treated for accounting purposes as Fund Unit equivalents. They are exchangeable, directly or indirectly, on a one-for-one basis for Fund Units at the option of the holder, under the terms of an Exchange Agreement. Each Exchangeable Unit entitles the holder to receive distributions from KIT LP, pro rata with distributions made by the Fund on a Fund Unit. Subordinated Units The Subordinated Units have economic and voting rights equivalent to, in all material respects, to the Fund Units, except in connection with the subordination terms as described below. As a result they have been treated for accounting purposes as Fund Unit equivalents. Distributions of up to an equivalent amount of distributions made monthly to the Fund Units and Exchangeable Units will be made quarterly to the Subordinated Units subject to available cash. However, until the release from subordination, Subordinated Unit distributions will be subordinated to those of the Fund Units and Exchangeable Units and only made if the monthly distributions of $0.10 per unit have been made to the Fund and Exchangeable Unitholders. To the extent that the Subordinated Unitholders have not received their quarterly distributions for the preceding four fiscal quarters, any excess at the end of any given quarter will be paid to the Subordinated Unitholders, up to $0.30 per quarter. Any excess distributable cash, determined quarterly, after payment of the monthly $0.10 distribution to the Fund and Exchangeable Unitholders and the $0.30 quarterly distribution to the Subordinated Unitholders, will be shared pro rata between the Fund Units, Exchangeable Units and Subordinated Units. The Subordinated Unit distributions are subordinated until December 31, 2008 provided that the earnings before income taxes, depreciation and amortization (“EBITDA”) of the Company are equal to or greater than $39,191, and the average monthly cash distributions per Fund Unit have been equal to or greater than $0.10 per Fund Unit throughout the period from formation of the Fund to December 31, 2008. However, 50% of the Subordinated Units will automatically convert into Exchangeable Units if for the fiscal year ended December 31, 2006, the Fund has earned EBITDA equal to or greater than $43,110 and has paid out average monthly cash distributions equal to or greater than $0.11 per Fund Unit. Distributions to Unitholders Distributions to Unitholders are determined based on income before amortization of intangible assets and property and equipment, reduced by capital maintenance expenditures. Distributions totalling $0.17 per Fund, Exchangeable and Subordinated Units, (aggregate distributions of $4,389), were declared and accrued by the Fund’s management for the period ended December 31, 2003. 5. Property and equipment Cost $ Accumulated amortization $ Net $ Building Leasehold improvements Furnishings and equipment Restaurants under development 613 35,632 42,239 420 78,904 6 380 1,179 — 1,565 607 35,252 41,060 420 77,339 Priszm Canadian Income Fund 2003 25 NOTES TO THE C O N S O L I D AT E D F I N A N C I A L S TAT E M E N T S December 31, 2003 (in thousands of dollars) 6. Deferred financing charge Deferred financing charge is net of accumulated amortization of $61. 7. Franchise rights Franchise rights are net of accumulated amortization of $486. 8. Accounts payable and accrued liabilities Accounts payable and accrued liabilities are comprised of the following: $ Trade accounts payable Royalties payable Advertising payable Payroll payable Sales taxes payable Other accrued liabilities 15,418 2,127 1,044 6,165 5,483 2,035 32,272 9. Long-term debt Priszm has a $60,000 credit facility with a security pledge on substantially all of the assets of Priszm. Interest on the facility is calculated daily and paid monthly at the Canadian prime interest rate plus approximately 25 basis points. The facility can be repaid in whole or in part prior to the November 10, 2006 maturity. Interest expense comprises the following: $ Interest expense on long-term debt Amortization of deferred financing charges 408 61 469 10. Related party accounts and transactions Priszm entered into the following transactions during the period, which were in the normal course of operations and were measured at the exchange amount, which is the amount of consideration established and agreed to by the related parties. The terms of trade with related parties are similar to those with other third parties. a) Priszm paid rents for certain leased properties amounting to $766 to the partner who controls PBI LP and this expense is included in restaurant operating expenses. The Chief Executive Officer of Priszm is also the indirect controlling shareholder of PBI LP. b) As at December 31, 2003, $17 was due from PBI LP related to the reimbursement of costs incurred by Priszm on behalf of PBI LP. Priszm Canadian Income Fund 2003 26 NOTES TO THE C O N S O L I D AT E D F I N A N C I A L S TAT E M E N T S December 31, 2003 (in thousands of dollars) 11. Costs and expenses Costs of restaurant sales, restaurant operating expenses and depreciation and amortization consisted of the following: Period from November 10, 2003 to December 31, 2003 $ Cost of restaurant sales Food and supplies Labour 23,853 14,108 37,961 Restaurant operating expenses Occupancy, utilities and maintenance Advertising Other 7,217 2,385 3,020 12,622 Depreciation and amortization Depreciation and amortization of restaurant assets 1,466 12. Contingent liabilities Priszm is subject to various claims and disputes from time to time. Priszm does not expect to incur any material losses with respect to such matters. 13. Commitments The Fund is committed to the following amounts under non-cancellable operating leases for its own operated restaurants and corporate facilities. Total annual minimum lease payments in the table below exclude the Fund’s share of common costs, such as real estate taxes and utilities, which cannot be determined in advance. $ 2004 2005 2006 2007 2008 Thereafter 24,845 23,520 21,953 20,792 19,688 144,323 255,121 Included in the amounts above are the following commitments to the partner who controls PBI LP: $ 2004 2005 2006 2007 2008 Thereafter 5,416 5,373 5,361 5,408 5,510 49,307 76,375 Priszm Canadian Income Fund 2003 27 NOTES TO THE C O N S O L I D AT E D F I N A N C I A L S TAT E M E N T S December 31, 2003 (in thousands of dollars) 14. Income taxes Since the Fund is not a taxable entity, these consolidated financial statements do not include a provision for Canadian income taxes related to the Fund’s income. 15. Benefit plans Priszm sponsors a group registered retirement savings plan and a registered pension plan, which is a defined contribution plan for selected members. Under these plans, contributions are made by plan members with varying matching contributions by Priszm. The total expense related to these plans was $40. 16. Supplemental disclosures of cash flow information Net change in non-cash working capital is comprised of the following: $ Trade accounts receivable Inventories Prepaid expenses Accounts payable and accrued liabilities (877) (460) 1,000 (2,171) (2,508) Supplemental disclosures of cash flow information: $ Interest paid Interest received 164 85 17. Segmented information For financial reporting purposes, the Fund considers itself to be in one business segment as its various restaurant operations have similar economic and business characteristics. All restaurant operations are located in Canada. Priszm Canadian Income Fund 2003 28 C O R P O R AT E I N F O R M AT I O N The Priszm Canadian Income Fund is traded on the Toronto Stock Exchange (TSX) under the trading symbol QSR.UN. Auditors: PricewaterhouseCoopers LLP Outside Counsel: Stikeman Elliott Transfer Agent: CIBC Mellon Corporate & Unitholder Information: Peter Walkey, CFO and Corey Evan Goodman, Director, Corporate and Legal Affairs 101 Exchange Avenue, Vaughan, Ontario, L4K 5R6, toll-free 1-866-774-7961 Annual Meeting: June 7, 2004, 11:00 a.m. EST, Priszm Canadian Restaurant Support Centre, 101 Exchange Avenue, Vaughan, Ontario Trademarks: KFC, Pizza Hut, Taco Bell and Long John Silver’s are trademarks of Yum! Restaurants International (Canada) LP. Web site: www.priszm.com Priszm w w w. p r i s z m . c o m