Empire Company Annual Report 2005

Plain-text annual report

E M P I R E enduring value: consistent, steady long-term performance, businesses we know and understand, strong management and dedicated people, disciplined financial management, prospects for future growth Empire Company Limited 2005 Annual Report IFC Contents 2 Letter to Shareholders 6 Message from Operating Management 10 Long-term Progress 12 Message from the Chairman 12 15 16 18 19 Management’s Discussion and Analysis 58 Management’s Statement of Responsibility Board of Directors Corporate Governance Community Involvement Corporate Officers for Financial Reporting Financial Highlights ($ in millions, except per share amounts) Operations Revenue Operating income Operating earnings Capital gain (loss), net of tax Net earnings Financial Condition Total assets Long-term debt Shareholders’ equity Per Share Information, basic and diluted Operating earnings Capital gain (loss), net of tax Net earnings Book value Dividends Share Price High Low Close *Restated 59 60 61 62 63 64 Auditors’ Reports Consolidated Balance Sheets Consolidated Statements of Retained Earnings Consolidated Statements of Earnings Consolidated Statements of Cash Flows Notes to the Consolidated Financial Statements Eleven-year Financial Review Investor Information 84 86 IBC Mission Statement 53 Weeks Ended May 7th 2005 52 Weeks Ended April 30th 2004* 52 Weeks Ended April 30th 2003* $ 12,435.2 463.7 182.9 3.7 186.6 4,929.2 974.4 1,709.0 2.78 0.05 2.83 25.87 0.48 38.00 24.25 36.66 $ 11,284.0 422.8 163.3 9.2 172.5 4,679.7 995.7 1,567.6 2.48 0.14 2.62 23.67 0.40 29.50 23.10 26.65 $ 10,624.2 444.4 159.3 (6.0) 153.3 4,519.3 1,122.4 1,418.5 2.42 (0.09) 2.33 21.41 0.33 33.25 23.70 23.85 Empire Company Limited is a diversified Canadian company whose key businesses include food retailing, real estate and corporate investment activities. Guided by conservative business principles, our primary goal is to grow long-term shareholder value through income and cash flow growth and equity participation in businesses that have the potential for long-term growth and profitability. This is Empire Food Sobeys Inc. (“Sobeys”), a 68.4%-owned subsidiary of Empire, is a leading national grocery retailer and food distributor with annual revenue of $12 billion. Headquartered in Stellarton, Nova Scotia, Sobeys owns or franchises more than 1,300 stores in all 10 Canadian provinces under retail banners that include Sobeys, IGA extra, IGA and Price Chopper. During fiscal 2005, Empire increased its ownership in Sobeys to 68.4% from 65.0% a year earlier. Real Estate Empire owns one of the largest portfolio’s of prime retail properties in Eastern Canada through wholly-owned Crombie Properties Limited (“Crombie”) and Sobey Leased Properties Limited (“SLP”). Crombie owns and operates a diversified portfolio which includes shopping centres and office properties. The real estate division, through Crombie, also owns 35.7% of Genstar Development Partnership (“Genstar”), a residential land development business with operations primarily in Western Canada. Food Revenue(1) ($ in millions) Food Operating Income ($ in millions) Real Estate Revenue(1) ($ in millions) Real Estate Operating Income ($ in millions) 4 . 9 8 1 , 2 1 4 . 1 6 0 , 1 1 5 . 4 1 4 , 0 1 5 . 2 3 7 , 9 0 . 3 6 1 , 9 4 . 1 3 2 6 . 5 2 6 3 . 6 9 2 6 . 2 2 3 3 . 4 9 2 2 . 9 2 5 2 . 0 1 2 6 . 8 9 1 1 . 5 8 8 1 . 5 6 1 2 . 2 2 1 0 . 1 1 1 8 . 3 0 1 6 . 0 0 1 3 . 2 8 01 02 03 04 05 01 02 03 04 05 01 02 03 04 05 01 02 03 04 05 Fiscal Year (1) Includes gain of $14.6 million on sale of redundant real estate in ﬁscal 2004. Fiscal Year Fiscal Year (1) Revenue is before inter-segment elimination. Fiscal Year Other Operations Empire’s other operations consist primarily of wholly-owned Empire Theatres Limited (“Empire Theatres”), the leading movie exhibitor in Atlantic Canada with 176 screens in 27 locations at fiscal year-end. Empire Theatres is committed to providing its customers with an enjoyable movie-going experience by offering modern stadium-style seating, curved screens, digital sound, a broad concession variety, and exceptional customer service. Investments Empire manages an investment portfolio that carried a market value of $465.5 million as at fiscal 2005 year-end. Empire is committed to maintaining a high quality, liquid investment portfolio that offers a combination of yield and attractive growth characteristics, providing Empire with a pool of capital to support the growth and development of the operating businesses and to enhance shareholder net asset value. Other Operations Revenue ($ in millions) Other Operations Operating Income ($ in millions) Investment Income(1) ($ in millions) Investment Portfolio Total Return* vs. Benchmarks 4 . 4 7 4 . 4 5 6 . 0 6 2 . 6 5 1 . 9 4 5 . 6 8 . 9 5 . 9 0 . 9 0 . 9 01 02 03 04 05 01 02 03 04 05 Fiscal Year Fiscal Year 8 . 9 2 7 . 5 1 Total Investment Income Equity Earnings 0 . 8 1 8 . 5 1 9 . 4 1 0 . 1 2 0 . 2 1 1 . 6 5 . 0 0 . 3 02 01 Empire Company Investment Portfolio S&P/TSX Index $185.77 S&P 500 Index (in Canadian $) $110.36 $72.88 250 200 150 100 50 0 03 04 05 01 02 03 04 05 Fiscal Year (1) The decline in equity earnings in ﬁscal 2002 is related to the sale of Empire’s investment in Hannaford Bros. Co. on July 28, 2000. Fiscal Year *$100 invested on 04/30/2000 in Empire Company investment portfolio or the index, including reinvestment of dividends. Paul Sobey, President and Chief Executive Officer, with Rob Dexter – a Director of Empire since 1987, who succeeded Donald Sobey as Chairman in September, 2004, becoming the first Chair from outside the Sobey family. Enduring value At Empire, we are very proud of our legacy of value creation and we remain fully focused on the long-term. Our approach is clear and unwavering: we commit our capital to businesses operating in sectors we know and understand.We ensure that these operations have outstanding management and are provided with the capital they need to fund economically attractive growth and development. Paul D. Sobey President and C.E.O. Robert P. Dexter Chairman Empire Company Limited || 1 Letter to Shareholders ‘‘With higher operating company earnings and a very strong investment performance, Empire once again built on our long-term legacy of value creation.’’ Building value in 2005 Empire Company achieved strong, balanced performance in 2005, posting record results in revenues, operating earnings and cash flows. Our revenues grew by 10.2% to reach $12.4 billion, operating earnings grew by 12.0% to reach $182.9 million or $2.78 per share. Dividends paid to common shareholders increased by 20% and we are pleased to note that the Board approved a further 16.7% increase in the common share dividend rate per share effective July, 2005.This represents the tenth straight year of growth in the dividend and is a reflection of the Board’s confidence in the fundamentals of our business. We are pleased to see that the returns enjoyed by our shareholders once again reflect the strong underlying performance of our Company. Empire provided a 39.8% total return to share- holders in fiscal 2005, more than double that recorded by the S&P/TSX Index over the same time period.We believe that such returns reflect, at least in part, a growing understanding of the value of each of our operating businesses as well as our long-term track record of building value. That track record, in turn, reflects our ongoing commitment to initiatives which enhance the long-term value of Empire and our operating businesses.We have not and will not be persuaded to pursue short-term goals at the expense of long-term value creation. Investments to enhance Sobeys’ operational efficiency made this year and planned for the future are an example of the longer term focus of this organization.We are pleased that throughout Empire, tough decisions are made easier through the clarity of this core principle: our shareholders deserve nothing less. Empire’s steady and consistent performance and legacy of value creation has largely been the result of paying close attention to the needs of our customers – consumers shopping for groceries, movie-goers enjoying our theatres, and tenants of our commercial real estate properties. Along with the leadership, good planning and disciplined execution demonstrated by the management of our operations, we have clearly benefited from the collective efforts of thousands of hard working employees who have the passion and desire to succeed and do better for their respective customers. Managing Growth in 2005 Sobeys has effectively pursued its food focused strategy, and through significant investments in merchandising, store network development, 2 || 2005 Annual Report Paul D. Sobey President and C.E.O., Empire Company Limited margin and selling initiatives, has successfully delivered sales growth well above the industry average, with same store sales growth of 3.7%, resulting in market share gains in its four major markets. Bottom line performance improved in 2005 and during the year, Sobeys has, with renewed vigour, focused on productivity initiatives to reduce costs and increase efficiencies.These initiatives carry a price tag in the short-term: we are confident they will lead to enhanced and sustainable profitability over the longer term. Empire’s confidence in Sobeys’ strategy and execution was tangibly demonstrated through our acquisition of 1.86 million Sobeys common shares in fiscal 2005, increasing our ownership interest in Sobeys to 68.4% from 65.0% at the start of the fiscal year. Our real estate division continues to deliver strong financial results, with our residential real estate operations once again exceeding our performance metrics and expectations. For several years we have cautioned that residential development follows its own market cycle and that a slowdown would begin catching up with Genstar.We have been delighted to have been proven wrong. Genstar is a very well managed business which has been focused on markets in Western Canada where demand has remained quite strong. Although a slowdown must surely eventually occur, we are confident that Genstar will continue to outperform its market sector through all stages of the economic cycle. The real estate division’s commercial real estate business has also remained strong. Management has been successful in achieving growth in this business, consistent with their strategic plan. Our occupancy level has remained healthy at 93.5%. In addition, we are pleased that Empire’s real estate management have achieved geographic diversification, another strategic goal: Genstar is focused in the West, largely in Calgary, Edmonton, and Vancouver, while the commercial portfolio is focused in Atlantic Canada and Ontario. Our theatre operation had a good year, posting top line growth of 13.7% and a continued strong return on equity despite the fact that the movie theatre industry was in the doldrums for much of the fiscal year due to a lack of blockbuster movies. Empire Theatres’ performance was largely driven by the acquisition and development of six theatres and 34 movie-screens during the year. Empire Company Limited || 3 “What is key with our operating businesses is to give top quality management the authority, responsibility and accountability to perform.” This performance reflects on the quality of its management, its attention to cost controls and the pursuit of its strategy of focusing on markets where Empire Theatres can be the entertainment destination of choice. While turning in a solid financial performance, Empire Theatres continues to build value for the future with the addition of new screens, the ongoing modernization of its existing circuit and a passion for operational effectiveness and efficiency. During fiscal 2005 our investment portfolio generated investment income of $21.0 million, realized investment capital gains of $4.4 million and increased our unrealized capital gain position by $73.4 million. Empire’s investment returns continued to outpace industry benchmarks for the year and also over the longer term. Our first quartile return performance was centered around the solid performance by our equity accounted investment in Wajax Limited. Wajax earnings performance was the best in seven years, reflecting their continued adherence to the disciplines initiated in 2002 in order to return Wajax’s profitability to an acceptable level. Their focus on business fundamentals as well as the implementation of growth and profit improvement strategies in each of Wajax’s core 4 || 2005 Annual Report businesses contributed to these solid results.We acknowledge the hard work of the management and employees of Wajax for delivering solid financial results, a strong capital position, and a renewed commitment to growing revenues and delivering sustainable earnings. Subsequent to fiscal year end, on June 15, 2005 Wajax completed its conversion to an income fund. Empire subsequently via a “secondary” offering reduced its holding from 45.0% on a fully diluted basis, to 27.6%. We believe that this conversion has not only enhanced shareholder value and liquidity but has also provided a new platform for the growth and development of Wajax. Ongoing Progress Looking ahead through fiscal 2006, we will continue to focus on our core operating companies and expect further progress towards the execution of their respective business plans. We will also support and encourage continued progress towards making each of our businesses more efficient. Each of our operating businesses will continue to work towards enhancing value for the long-term and all are prepared for challenges in their markets.While fluctuations through a From Left to Right: Carol A. Campbell, Vice President, Risk Management John G. Morrow, Vice President and Comptroller, Paul V. Beesley, Senior Vice President and Chief Financial Ofﬁcer, Stewart H. Mahoney, Vice President Treasury and Investor Relations cycle are to be expected; our focus will remain on the long-term trends – and over the long- term, Empire has done well for all stakeholders. Empire’s management team has a significant portion of personal net worth linked to the Company’s fortunes; our interests are well aligned with all shareholders of the Company and we prefer nothing less. To further enhance the long-term value in Empire we are committed to the constant review of our operating businesses and of our investments. We will continue to monitor our progress closely and analyze all tangible options for improving long-term shareholder value. We are very fortunate in having the support, counsel and direction of a very strong Board of Directors – including our new Chairman, Rob Dexter, and our Chairman Emeritus, Donald Sobey.The Company owes much to Donald Sobey, Chairman of the Company for 20 years. His experience and sound judgment have provided wise counsel to the Empire Board and to our management team, and we look forward for his continued contributions as a Director of the Company. We are also very fortunate in the quality and dedication of the management and employees of Empire and our operating businesses.Their enthusiasm, hard work, passion and desire to succeed and do better for their customers has resulted in another successful year.With their support we look forward to continuing to build value together. Paul D. Sobey President and C.E.O. July 15, 2005 Empire Company Limited || 5 Message from Operating Management Bill McEwan President and C.E.O., Sobeys Inc. Food Retailing Strategic Focus At Sobeys, our focus is clear and steadfast – we are focused on food, driven by our fresh expertise, supported by superior customer service – in the right-sized, right format stores for each individual market we serve. Our passion for food sets us apart in a highly competitive marketplace. Our customers see and feel the difference, and their growing patronage is driving our sales and earnings growth. Progress in 2005 In fiscal 2005 we continued to invest in our food-focused strategy and we delivered encouraging growth in revenues, same-store- sales and market share. We enhanced our store network further as we opened, replaced, expanded, acquired or converted close to 100 stores across the country. As well, we continued to develop unique formats for different markets. We also introduced our new private label brand – Compliments – in every banner across the country.This product line is unique in Canadian retailing, with three tiers of products under the one brand.We will have launched approximately 3,000 products by October, 2005. On the productivity side, we invested in our SMART Retailing initiative – a store based 6 || 2005 Annual Report continuous improvement program designed to reduce shrink and waste, effect savings and engage employees to operate our stores more efficiently.We continued the roll-out of our common point of sale system, which is providing us with better customer information while enabling improved service at the check-out, with increased efficiency. Our bottom line progress reflects the net impact of improved merchandising, pricing and productivity improvements throughout the year – achieved while we continue to make significant investments in our retail network and infrastructure for the long term. Bill McEwan President and C.E.O., Sobeys Inc. Peter C. Godsoe Chairman, Sobeys Inc. J. Stuart Blair President and C.E.O., Crombie Properties Limited Real Estate Strategic Focus The foundation of our real estate business is our commercial property portfolio in Atlantic Canada, where Crombie and its affiliates are the clear market leaders, with 77 properties, and 12.9 million square feet of gross leaseable area. In recent years, while continuing our leadership in this core market, we have also been pursuing a diversification strategy: we have targeted geographic expansion of our commercial real estate in central Canada, often in conjunction with Sobeys.To date, we have 12 properties and 1.1 million square feet of leasable space in Central Canada. Meanwhile, we have complemented our commercial holdings with a stake in residential development, through our investment in Genstar. Progress in 2005 Genstar exceeded expectations once again in 2005, with an outstanding sales and earnings performance. Our commercial retail business also continued to deliver steady results, posting record levels for rental income and earnings. Occupancy rate remained healthy at 93.5%. While we remain committed to geographic expansion, we made no major acquisitions in Central Canada during the year, although we did launch a major new retail development on a significant property we own in Montreal, Quebec. As noted last year, our targeted markets in Ontario seem fully valued at present – and we have no intention of overspending.We are constantly reviewing and monitoring opportunities and have been developing a joint capability with Sobeys in Ontario as we continue to see long term opportunities in Canada’s largest markets. While expansion in other markets has slowed for the short term, we continued to strengthen our leadership in core Atlantic markets. For example, we replaced Wal-Mart with Sears, added Winners and redeveloped the food court and exterior at Avalon Mall – the largest mall in Newfoundland.We still have plenty of scope for further development in Atlantic Canada, and look forward to further growth in Central Canada in 2006. J. Stuart Blair President and C.E.O., Crombie Properties Limited Frank C. Sobey Chairman, Crombie Properties Limited Empire Company Limited || 7 Stuart G. Fraser President and C.E.O., Empire Theatres Limited Other Operations Strategic Focus Empire Theatres has performed well over the years by focusing on being the entertainment focal point in the markets it serves.This strategy has proven effective and has resulted in steady growth in an industry which faces increasing competition from home entertainment.We are committed to providing a terrific cinema experience to our customers, with modern complexes featuring stadium seating, self-serve electronic ticketing, large curved screens and digital sound, modern arcade amenities, and branded food choices. Progress in 2005 A relative lack of blockbuster movies led to a flat year for the cinema industry – particularly in the second half of our fiscal year.We are pleased that Empire Theatres outpaced the industry, posting revenue growth of 13.6% over the prior year. While the industry box office was somewhat lackluster, we made great progress with our program of controlled theatre expansion, as we moved on attractive opportunities that arose in markets we know and like. During the year, we grew from 22 locations with 149 screens to 27 locations with 176 screens.We acquired four locations with 23 screens from Viacom Canada in Nova Scotia and New Brunswick, purchased 8 || 2005 Annual Report an independent theatre in Rothesay, New Brunswick and constructed a new theatre centre in Bridgewater, Nova Scotia.We also completed major renovations of venues in Halifax and Moncton.With our joint venture in Western Canada, we added one location and grew by nine screens, for a total of four locations and 24 screens. Looking forward, we expect a better year in 2006. Major new movies such as the new installments of “Star Wars” and “Harry Potter”, along with “Madagascar” and “War of the Worlds” are expected to generate excitement – and box office improvement.We will remain focused on improving operational efficiency and maximizing same theatre revenue while pursuing controlled theatre expansion in markets which make economic sense. Stuart G. Fraser President and C.E.O., Empire Theatres Limited Stuart G. Fraser President and Chief Executive Ofﬁcer, Empire Theatres Limited Paul V. Beesley Senior Vice-President, Chief Financial Ofﬁcer and Secretary Empire Company Limited Frank C. Sobey Chairman, Crombie Properties Limited Stewart H. Mahoney Vice-President, Treasury and Investor Relations Empire Company Limited Investments Strategic Focus Our long term perspective and focus on good management and strong fundamental analysis shapes our approach to investing.We invest in a relatively small number of high quality, large cap stocks – just 12 stocks on average over the past four years – and we tend to hold them for the long term. In fact, some of them have never left the portfolio. We avoid “hot stocks” and focus on under- valued businesses that have outstanding fundamentals and growth prospects.We maintain a highly disciplined stock-picking approach and actively monitor our holdings to advance returns.This approach has resulted in superior performance over time, greatly exceeding that which could be expected from a more passive index-based strategy or from a money- market strategy. Progress in 2005 In fiscal 2005, investment income equalled $21.0 million, realized capital gains amounted to $4.4 million and the unrealized capital gain position grew by $73.4 million.Total portfolio market value climbed from $391 million at the start of the fiscal year to $465 million at fiscal year end – largely as a result of share price appreciation from Wajax as well as from financial services and energy related stocks. Empire’s investments continued to generate returns well in excess of market benchmarks. Total investment return for the twelve months ended March 31, 2005 equalled 26.9%, compared to 13.9% for the S&P/TSX Index and a negative 1.5% for the S&P 500 Index in Canadian dollars. This contributes to a continuum of good performance and long term value creation. Over the past four years – a period of more difficult equity markets – we have done quite well, with an annual compound rate of return exceeding 16%.That is more than double the S&P/TSX Index for the same period and more than triple the S&P 500 Index in Canadian dollars. A strong investment performance provides Empire with considerable flexibility and financial resources to support and build our core businesses to create further value. During fiscal 2005, we allocated $70 million in investment capital to purchase 1.86 million additional common shares of Sobeys – increasing our ownership interest from 65.0% to 68.4%. Stewart H. Mahoney Vice-President, Treasury and Investor Relations Properties Empire Company Limited || 9 Long-term progress Empire’s focus on enduring value is reflected in it’s long-term performance and progress through different business cycles since the Company went public 23 years ago. It all adds up to a legacy of value creation. Assets $4.9 Billion Operating Cash Flow $486.6 Million 8% 21% $4.9 Billion 71% 3% 15% $502.3 Million 82% 2005 Year Ended May 7 2005 Year Ended May 7 4 9 Billion 4 9 Billion Food Distribution Real Estate Investments and Other Operations February, 1983 Empire increases its ownership in Hannaford Bros. Co. (a U.S. food retailer) to 25% resulting in a cost base of $20 million. July, 1982 On July 9, 1982 Empire goes public at $8/share, $0.67 split adjusted. Annual revenue $300 million; total assets $260 million; net earnings $7 million. December, 1993 The real estate division increases its ownership of Halifax Developments Limited (HDL) to 100% from 36% at a cost of $12.7 million. $625 $625 $625 $625 $4.6$4.6$4.6$4.6 $0.51 $0.51 $0.51 $0.51 1983 82 83 84 10 || 2005 Annual Report 90 91 92 93 88 89 87 85 86 June, 1987 Empire purchases common shares of Sobeys to increase its ownership to 100%. March, 2002 Sobeys sells its SERCA Foodservice operation to SYSCO for $411 million. January, 2001 The real estate division purchases a 35.8% interest in Genstar Development Partnership. December, 1998 Sobeys went public on the TSE and acquired the assets of the Oshawa Group for $1.5 billion, tripling the size of its food operations. 2005 $12,435 $182.9 $36.66 05 03 04 02 June, 2005 Wajax converts to an income trust. Empire 01 sells 2.875 million units. 00 99 98 94 95 96 Sobeys and 6 Commisso’s properties by Crombie. 97 February, 2004 Acquisition of Commisso’s Food Markets by July, 2000 Empire sells its 25% investment in Hannaford Bros. Co. for a $1.2 billion Canadian consideration. REVENUE ($ in millions) OPERATING EARNINGS ($ in millions) SHARE PRICE ($ per share) Empire Company Limited || 11 Message from the Chairman ‘‘One of the strengths of Empire is that the major shareholding family not only demands long-term growth in profitability but enables it.” A legacy of enduring value It is a great honour to succeed Donald Sobey as Chair of this great enterprise. Now Chairman Emeritus, Donald served as Chairman of Empire for two decades – two extraordinary decades of value creation. This legacy of value creation is no accident. It is the result of strong governance, carefully developed and implemented business plans and strategies, and outstanding efforts by management and thousands of employees of Empire and its operating companies. As well, it is a testament to the stewardship, vision and values of Empire’s major shareholders, the Sobey family, as exemplified by the leadership of Donald and his brother David. All shareholders have benefited from the family ownership model of Empire. As someone who has been associated with the company since before it went public in 1982 and who has been a director since 1987, I have observed this model first hand. I can attest that one of the strengths of Empire is that the major shareholding family not only demands long term profitability, but enables it.That is because the vision and focus is always on the longer term – and the family has always been prepared to accept short term sacrifices to achieve the vision. In creating a legacy, this family constantly looks beyond the next quarter and the next business cycle to future generations.The results speak for themselves. While maintaining family control, the Sobey family has always been assiduous about good governance and has long since broadened and Board of Directors John L. Bragg 3, 6 Collingwood, Nova Scotia Director since 1999. Chairman, President and Co-Chief Executive Ofﬁcer of Oxford Frozen Foods Ltd. Sir Graham Day 3, 5 Hantsport, Nova Scotia Director since 1991. Counsel to Stewart McKelvey Stirling Scales. Robert P. Dexter Halifax, Nova Scotia Director since 1987. Chairman and Chief Executive Ofﬁcer of Maritime Travel Inc. Jim Gogan 2 New Glasgow, Nova Scotia Director since 1972. Corporate Director Ed Harsant 1 Woodbridge, Ontario Director since 2003. Corporate Director 12 || 2005 Annual Report Donald R. Sobey Director and Chairman Emeritus, Empire Company Limited Robert P. Dexter Chairman, Empire Company Limited strengthened the Board with strong, independent directors.The Company and all shareholders have benefited from the counsel and advice of independent directors, who bring diverse business experience to the Empire board and those of its subsidiaries.The value has become particularly apparent as Empire – while remaining firmly rooted in Atlantic Canada – has expanded to a national platform.We were pleased at our last Annual General Meeting to welcome two new independent directors: Anna Porter, Publisher of Key Porter Books of Toronto, and Stephen Savidant, CEO of Esprit Exploration of Calgary. They succeeded Mary Mogford of Toronto, who retired from the Board, and Peter Godsoe – former Chair and CEO of the Bank of Nova Scotia – who left to assume his role as Chair of Sobeys Inc. This focus on outside directors began long before the recent concerns about governance models and the resulting regulatory pressures. A clear indication of this can be seen from the fact that Empire established a board for Crombie Properties and its predecessors more than thirty years ago. Crombie was then – and remains today – a wholly-owned subsidiary of Empire; it is not a public company and there is no requirement for it to have a board. But both the family and outside directors of Empire appreciated and have long understood the value of Board stewardship and governance. Again, the results speak for themselves. Anna Porter 1 Toronto, Ontario Director since 2004. Corporate Director E. Courtney Pratt 4, 5 Toronto, Ontario Director since 1995. President and Chief Executive Ofﬁcer of Stelco Inc. Stephen J. Savidant 1 Calgary, Alberta Director since 2004. President and Chief Executive Ofﬁcer of Esprit Exploration Ltd. J. William Sinclair 5 Pictou, Nova Scotia Director since 1980. Corporate Director David F. Sobey 3 New Glasgow, Nova Scotia Director since 1963. Chairman Emeritus of Sobeys Inc. Empire Company Limited || 13 Robert P. Dexter Chairman, Empire Company Limited In addition to strong governance on behalf of all shareholders, Empire has also been dedicated to the values of good citizenship and corporate responsibility – in the interest of all stakeholders. At Empire, we are very cognizant of the leadership role we play in the communities where our businesses operate and we seek to be an employer of choice with progressive employment policies and a model citizen, with far reaching corporate philanthropy and community support programs. The ongoing success of Empire is a source of pride to me as a Nova Scotian and as a business person. I am very pleased that all stakeholders contributed to another strong year for the Company in fiscal 2005, with stellar results and Board of Directors further gains in the legacy of shareholder value. I am proud to have been part of this legacy and I look forward to helping build upon it. I am committed to ensuring that as Empire goes through transitions in the Board and in its businesses, the core values that are fundamental to our success will endure. Robert P. Dexter Chairman July 19, 2005 Donald R. Sobey 3 Pictou County, Nova Scotia Director since 1963. Chairman Emeritus of Empire Company Limited John R. Sobey 1 Pictou County, Nova Scotia Director since 1979. Corporate Director Karl R. Sobey 3 Halifax, Nova Scotia Director since 2001. Corporate Director Paul D. Sobey Pictou County, Nova Scotia Director since 1993. President and Chief Executive Ofﬁcer of Empire Company Limited Rob G. C. Sobey Stellarton, Nova Scotia Director since 1998. Senior Vice-President, Merchandising and Marketing of Sobeys Atlantic 14 || 2005 Annual Report Corporate Governance Corporate Governance Practices At Empire, we are committed to the highest level of corporate governance.We believe that a strict code of business conduct - emphasizing accountability - and a comprehensive disclosure policy - ensuring transparency - are the pillars of a successful firm. Empire’s Board is committed to delivering value to its stakeholders while assuming the explicit responsibility of the stewardship of the company. At Empire, we constantly review and monitor our own governance policies and practices. We consistently examine our policies with a strict eye to ensure that Empire is a leader in governance practices. A comprehensive review of our corporate governance policies and practices can be found in our Proxy Circular and on our website at www.empireco.ca. Further, a detailed explanation of our Corporate Disclosure Policy, approved by our Corporate Governance and Nominating Committee of our Board of Directors, as well as our Code of Business Conduct is available on our website. Board Committees At Empire, the governance of the corporation is the responsibility of the Board of Directors which is supported by three key committees: the Corporate Governance and Nominating 1 Audit Committee Member 2 Audit Committee Chairman 3 Human Resources Committee Member 4 Human Resources Committee Chairman 5 Corporate Governance and Nominating Committee Member 6 Corporate Governance and Nominating Committee Chairman Committee, the Human Resources Committee, and the Audit Committee. All members of the Audit Committee and the Corporate Governance and Nominating Committee are independent directors and all are unrelated as recommended by TSX Guidelines.The Human Resource Committee is entirely composed of outside directors, of which all but three are unrelated. In addition, the Audit Committee meets the independence and financial literacy tests set out in Multilateral Instrument 52-110 adopted by most of the Canadian securities regulators.The responsibilities of each committee of the Board are as follows: Corporate Governance and Nominating Committee – develops the Company’s corporate governance policies, including responsibility for disclosure; reviews and assesses the effectiveness of the Board as a whole, the committees of the Board and the contribution of individual directors; recommends suitable compensation of directors; and is responsible for recommending nominees for election or appointment as Directors. Human Resource Committee – monitors man- agement compensation and succession planning; reviews the Company’s management training and development programs; conducts the annual performance review for the CEO and establishes annual and longer term objectives for the CEO; oversees the Company’s pension plan. Audit Committee – reviews and assesses the Company’s financial reporting practices and procedures; reviews the adequacy and reporting of its internal accounting controls and the independence of external auditors from man- agement; assesses risk management and reviews consolidated quarterly and annual financial statements and related communications; communicates directly with internal and external auditors; and directly oversees the work of the external auditor.The external auditor communicates directly to the Audit Committee. Empire Company Limited || 15 Community Involvement ‘‘Empire’s operating companies are active members of the communities in which they operate through the volunteer efforts of thousands of employees.’’ Valuing our Community Community Value The enduring value of Empire and our community based operating businesses – grocery retailing, real estate and theatres – is absolutely dependent on the economic vitality of the markets where we operate and on the support of the people who live in the communities we serve.We have always understood the importance of giving something back, and we believe we have a particular responsibility to provide leadership where our roots are – in Atlantic Canada – as one of the few major corporations based in the region. Empire is proud to be a member of the Imagine corporate giving program and we sponsor numerous charitable initiatives through our operating companies and franchisees as well as through the Sobey Foundation.The Sobey Foundation is a private Foundation, which uses endowed funds to support charitable organizations whose focus and activities directly relate to education, culture, and health, with emphasis on infrastructure and equipment.This support is strengthened and enhanced by the volunteer efforts of thousands of employees in communities across Canada. Community Support Grassroots efforts by our community based operations have contributed in a significant way to the well being of communities across Canada. As a prime example, Sobeys food stores under all our banners and in all regions have been major supporters of local food banks, and have launched creative campaigns ranging from Fill’er Up in Moncton to Hampers of Hope, Pot of Soup, Campers for Hampers and Fame for Food in Western Canada. As well, in 2005, with support from franchisees, employees and customers across Canada, Sobeys raised over $300,000 for Tsunami relief efforts in Asia and was the driving force behind an award winning concert in Halifax for Oxfam’s relief efforts. Management and employees of Crombie Properties have focused primarily on communi- ties in Atlantic Canada where we are leaders in the commercial property market – supporting business development organizations as well as family and health oriented charities such as the Special Olympics, the Children’s Aid Society’s Families for Christmas program, and the Dragon Boat Race on the River for Breast Cancer research. 16 || 2005 Annual Report From Left to Right: Jean-Pierre Gauthier, Artist, 2004 Winner, Donald R. Sobey, Director and Chairman Emeritus, Empire Company Limited, Brian Jungen, Artist, 2002 Winner Educational Support We believe quality education is the most important contributor to the future growth of our communities and to employment opportunities for young people. As a result, Sobeys Inc. and the Sobey family has had a special focus on education and scholarship: Sobeys Inc. Scholarship Program – which assists employees and their families pursuing university education. Frank H. Sobey Fund for Excellence in Business Studies – assisting business students at universities in Atlantic Canada. Donald R. Sobey Atlantic Leadership Scholarship – scholarships for students from Atlantic Canada to attend Queen’s School of Business in Ontario. As well, of particular note in fiscal 2005, Sobeys Inc. combined its focus on food with our emphasis on education and community support and funded Sobeys Culinary Centres – two major teaching kitchens at community colleges in Halifax and Toronto.These will also serve as test kitchens for Compliments food innovations. Cultural Support Since 1981, the Sobeys Art Foundation has built on the vision of the late Frank H. Sobey, a dedicated collector and supporter of Canadian art, having assembled one of the finest collections of 19th and 20th century Canadian art at Crombie House in Nova Scotia. In 2001, we extended the vision to the future, extending support to contemporary art, with the creation of the bi-annual Sobeys Art Award.This award – which at $50,000 is the richest of its kind in Canada – is designed to provide assistance for young artists (under the age of 40) while increasing public awareness of their work. In fiscal 2005, our Chairman Emeritus Donald Sobey was proud to present the second Sobeys Art Award to Montreal-based artist Jean-Pierre Gauthier, who creates kinetic installations. For information about this dynamic award, please visit the website at www.sobeyartaward.ca. Empire Company Limited || 17 Crombie Properties Limited Frank C. Sobey Chairman J. Stuart Blair President and Chief Executive Officer William T. Brock Corporate Director David G. Graham President, Atlantic Developments Inc. David J. Hennigar Chairman, Acadian Securities Inc. Kenneth C. Rowe Chairman, President and Chief Executive Officer of IMP Group Ltd. John B. Roy Corporate Director David F. Sobey Chairman Emeritus, Sobeys Inc. Donald R. Sobey Chairman Emeritus, Empire Company Limited John R. Sobey Corporate Director Paul D. Sobey President and Chief Executive Officer, Empire Company Limited Corporate Officers Officers of Empire Company Limited Marc Poulin President Operations, Sobeys Quebec Directors of Operating Companies Duncan F. Reith Chief Merchandising Officer Michael G. Scott President Operations, Sobeys Atlantic J. Bruce Terry Executive Vice-President and Chief Financial Officer François Vimard Executive Vice-President Crombie Properties Limited Frank C. Sobey Chairman J. Stuart Blair President and Chief Executive Officer Allan K. MacDonald Vice-President, Leasing Scott R. MacLean Vice-President, Operations Pat G. Martin Vice-President, Development of Ontario and Quebec Region John G. Morrow Vice-President, Finance and Secretary Paul W. Wigginton Comptroller Empire Theatres Limited Stuart G. Fraser President and Chief Executive Officer Kevin J. MacLeod Vice-President, Operations Sobeys Inc. Peter C. Godsoe Chairman Bill McEwan President and Chief Executive Officer John L. Bragg Chairman, President and Chief Executive Officer of Oxford Frozen Foods Ltd. Marcel Côté Senior Partner of Secor Inc. Christine Cross President of Christine Cross Ltd. Sir Graham Day Counsel to Stewart McKelvey Stirling Scales. Former Chairman, Sobeys Inc. Robert P. Dexter Chairman and Chief Executive Officer, Maritime Travel Inc., and Chairman, Empire Company Limited Malen Ng Chief Financial Officer, Workplace Safety and Insurance Board of Ontario Mel A. Rhinelander President and Chief Executive Officer, Extendicare Inc. David F. Sobey Chairman Emeritus Donald R. Sobey Chairman Emeritus, Empire Company Limited Frank C. Sobey Chairman, Crombie Properties Limited John R. Sobey Corporate Director Paul D. Sobey President and Chief Executive Officer, Empire Company Limited Robert P. Dexter Chairman Paul D. Sobey President and Chief Executive Officer Paul V. Beesley Senior Vice-President, Chief Financial Officer and Secretary Stewart H. Mahoney Vice-President, Treasury and Investor Relations John G. Morrow Vice-President and Comptroller Carol A. Campbell Vice-President, Risk Management Officers of Operating Companies Sobeys Inc. Peter C. Godsoe Chairman Bill McEwan President and Chief Executive Officer Craig T. Gilpin President Operations, Sobeys Ontario R. Glenn Hynes Executive Vice-President and Chief Development Officer Paul A. Jewer Vice-President, Finance and Treasurer J. Gary Kerr President Operations, Sobeys West Karin McCaskill Senior Vice-President, General Counsel and Secretary L. Jane McDow Assistant Secretary 18 || 2005 Annual Report 9667_Empire AR 05 B. F. MIL 7/25/05 11:26 AM Page 19 Management’s Discussion and Analysis Revenue(1) ($ in millions) Operating Earnings(1) ($ in millions) Shareholders’ Equity ($ in millions) 5 3 4 , 2 1 4 8 2 , 1 1 4 2 6 , 0 1 6 2 9 , 9 1 3 3 , 9 12434.998024 10362.498353 8289.998682 6217.499012 4144.999341 2072.499671 0.000000 0 . 9 0 7 , 1 6 . 7 6 5 , 1 5 . 8 1 4 , 1 6 . 0 9 2 , 1 0 . 5 1 1 , 1 9 . 2 8 1 3 . 3 6 1 3 . 9 5 1 2 . 2 3 1 5 . 8 8 182.8866 152.4055 121.9244 91.4433 60.9622 30.4811 0.0000 1708.999695 1424.166412 1139.333130 854.499847 569.666565 284.833282 0.000000 01 02 03 04 05 01 02 03 04 05 01 02 03 04 05 Fiscal Year (1) Includes gain of $14.6 million on sale of redundant real estate in ﬁscal 2004. Fiscal Year (1) Earnings before net capital gain (loss) and other items. Fiscal Year 20 Introduction 21 Company Overview Food Real Estate Investments and Other Operations 23 Strategic Direction 24 Consolidated Operating Results 41 25 Explanation of 2005 Annual Results Revenue Operating Income Interest Expense Income Taxes Minority Interest Operating Earnings Capital Gain Net Earnings 27 Operating Performance by Division Food Real Estate Investments and Other Operations 35 Quarterly Results of Operations Results by Quarter Fourth Quarter Results 38 Financial Condition Assets and Net Asset Value Capital Structure and Key Financial Condition Measures Shareholders Equity Liabilities Financial Instruments Liquidity and Capital Resources Sources of Liquidity Major Cash Flow Components Operating Activities Investing Activities Financing Activities 45 Accounting Standards CICA Section 1100, Generally Accepted Accounting Principles EIC-144, Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor CICA Section 3870, Stock-Based Compensation and Other Stock Based Payments AcG-13, Hedging Relationships CICA Section 3110, Asset Retirement Obligations Lease Accounting AcG-15, Consolidation of Variable Interest Entities 50 Critical Accounting Estimates Pension, Post-Retirement and Post- Employment Benefits Goodwill and Long-lived Assets Income Taxes 51 Disclosure Controls 51 Related Party Transactions 52 Contingencies 53 Risk Management Competition Financial Insurance Human Resources Environmental, Health and Safety Food Safety Technology Real Estate Legal, Taxation and Accounting Franchise Operations Foreign Operations Foreign Currency Equity Price 56 Outlook 57 Non-GAAP Financial Measures Empire Company Limited || 19 9667_Empire AR 05 B. F. MIL 7/25/05 11:26 AM Page 20 Management’s Discussion & Analysis Exchange Commission. Adjustments were required to restate certain prior period information and further information can be found in the section entitled “Lease Accounting” included in this MD&A. Also, effective for the fourth quarter of ﬁscal 2005, the Company implemented Accounting Guideline 15 “Consolidation of Variable Interest Entities” (“AcG-15”). AcG-15 required the Company to consolidate certain entities that are deemed to be subject to control of the Company on a basis other than through ownership of a voting interest in the entity.The guideline was adopted retroactively without restatement of prior periods. See Note 22 to the audited annual consolidated ﬁnancial statements. Please review the section titled “AcG-15, Consolidation of Variable Interest Entities” included in this MD&A for more information. This discussion contains forward-looking information about the future performance of the Company and its divisions.These statements are based on management’s assumptions and beliefs in light of the information currently available to them.These forward- looking statements are subject to inherent uncertainties, risks and other factors that could cause actual results to differ materially from such statements, including but not limited to: general industry and economic conditions, pricing pressures and competitive factors, rates of return on capital spending, the results of business improvement and development initiatives and the availability and terms of ﬁnancing, amongst other factors.When relying on forward-looking statements to make decisions, the Company cautions readers not to place undue reliance on these statements, as a number of important factors could cause actual results to differ materially from any estimates or intentions expressed in such forward- looking statements.The Company does not undertake to update any forward-looking statements that may be made from time to time by or on behalf of the Company. There are measures included in this MD&A that do not have a standardized meaning under Canadian generally accepted accounting principles (“GAAP”). Management includes these measures because it believes certain investors use these measures as a means of assessing relative ﬁnancial performance. Additional information relating to non-GAAP ﬁnancial measures is provided at the end of this document. Introduction This Management’s Discussion and Analysis (“MD&A”) contains commentary from management on the consolidated ﬁnancial condition and results of operations of Empire Company Limited (“Empire” or the “Company”) for the 53 weeks ended May 7, 2005, as compared to the 52 weeks ended April 30, 2004. Management also provides an explanation of the Company’s fourth quarter results, changes in accounting policies, critical accounting estimates and factors that the Company believes may affect its prospective ﬁnancial condition, cash ﬂows and results of operations. This MD&A also provides analysis of operating performance of the Company’s divisions as well as a discussion of cash ﬂows, the impact of risks and the outlook for the business. Additional information about the Company, including the Company’s Annual Information Form, can be found on SEDAR at www.sedar.com. The discussion and analysis is the responsibility of management.The Board of Directors carries out its responsibility for review of this disclosure principally through its audit committee, comprised exclusively of independent directors.The audit committee has reviewed and approved this disclosure and it has also been approved by the Board of Directors. This discussion and analysis should be read in conjunction with the audited annual consolidated ﬁnancial statements of the Company and the accompanying notes for the 53 weeks ended May 7, 2005. In ﬁscal 2005, the ﬁscal year-end of the Company changed to the ﬁrst Saturday in May to be consistent with its major subsidiary, Sobeys Inc. The reader should note that the implementation of Emerging Issues Committee Abstract 144, “Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor” (“EIC-144”) resulted in a restatement of certain prior periods’ information, as outlined in the section entitled “EIC-144, Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor” included in this MD&A. Also, in the fourth quarter of ﬁscal 2005, the Company reviewed its accounting practices in relation to leases as a result of recent clariﬁcation by the Ofﬁce of the Chief Accountant of the U.S. Securities and 20 || 2005 Annual Report 9667_Empire AR 05 B. F. MIL 7/25/05 11:26 AM Page 21 Company Overview Empire is a diversified Canadian company headquartered in Stellarton, Nova Scotia. Empire’s key businesses are food retailing – through a 68.4% ownership of Sobeys Inc. (“Sobeys”), real estate through two wholly-owned operating subsidiaries: Sobey Leased Properties Limited (“SLP”), and Crombie Properties Limited (“Crombie”), including 35.7% ownership of Genstar Development Partnership (“Genstar”); and corporate investment activities and other operations which includes wholly-owned Empire Theatres Limited (“Empire Theatres”). With $4.9 billion in assets, Empire employs approximately 37,000 people directly and through its subsidiaries. Guided by conservative business principles, Empire’s continuing to build new stores.The Company’s four major banners – Sobeys, IGA extra, IGA and Price Chopper – constitute our primary formats. primary goal is to grow long-term shareholder value through income and cash ﬂow growth and equity appreciation.This is accomplished through direct ownership and equity participation in businesses that management believes have the potential for long-term growth and proﬁtability. Food Division Sobeys is a leading national retail grocery and food distributor headquartered in Stellarton, Nova Scotia. Founded in 1907, Sobeys owns or franchises more than 1,300 corporate and franchised food stores located in all 10 provinces under various retail banners: including Sobeys, IGA extra, IGA, and Price Chopper. Sobeys and its subsidiaries conduct business in four operating regions: Sobeys West, Sobeys Ontario, Sobeys Quebec, and Sobeys Atlantic. Sobeys’ strategy is focused on delivering the best food shopping experience to its customers in the right-sized, right format, stores, supported by superior customer service.The ﬁve speciﬁc store formats deployed by the Company to satisfy its customers’ principal shopping requirements are the full service, fresh service, convenience service, community service and price service formats.The Company remains focused on improving the product, service and merchandising offerings within each format by realigning and renovating its current store base, while During the year, Sobeys opened, replaced, expanded, renovated, acquired and/or converted the banners in 98 stores (2004 – 200 stores). Sobeys continued to execute a number of initiatives in support of its food-focused strategy including productivity initiatives and business process and system upgrades. In ﬁscal 2005, Sobeys continued the roll-out of the Sobeys banner in Western Canada with the introduction of 11 Sobeys stores in Saskatchewan.The Saskatchewan store program combines a traditional full service Sobeys offering with a discount format grocery pricing position. The conversion of the Saskatchewan stores brings the total Sobeys banner stores in Western Canada to 72. Sobeys opened Ontario’s ﬁrst two Sobeys express stores in conjunction with the new Canadian Tire gasoline retail concept called “Q”.These Sobeys express stores combine convenience products and service with additional fresh food and “on-the-go” programs. Sobeys is committed to remaining competitive in increasingly competitive markets as demonstrated by its continued implementation of the “We Serve.You Save.” pricing program across the country. Sobeys sales growth in ﬁscal 2005 was partially fuelled by this aggressive pricing posture in addition to continued implementation of sales, merchandising and capital spending initiatives. Compliments, Sobeys new private label brand, was launched during the year to contribute to growth of company-wide proﬁtability by earning a greater share Empire Company Limited || 21 9667_Empire AR 05 B. F. MIL 7/25/05 11:26 AM Page 22 Management’s Discussion and Analysis of customers’ food and grocery shopping requirements. The Compliments brand consists of three tiers: Value, Selection and Sensations.The Company plans to have launched approximately 3,000 Compliments products by October 2005. At the end of ﬁscal 2005, 1,049 selection tier and 625 value tier items were launched representing 56 percent of the planned total. In addition to the above noted sales and merchandising initiatives which have driven sales growth, Sobeys remains focused on short, medium and long-term productivity and business process optimization initiatives designed to improve its processes and cost structure for the long-term. A key productivity focus in ﬁscal 2005 was the roll-out of the ﬁrst phase of Sobeys SMART Retailing initiative. SMART Retailing focuses on continuous improvement processes that have resulted in improved labour productivity in the handling of back-shop inventories, reduction in back room inventories and shrink (product waste) reduction in produce, bakery, and meat departments. SMART Retailing has been implemented in 397 stores to date with planned completion of the remaining 315 targeted stores in ﬁscal 2006.The next phase of SMART Retailing will be focused on the implementation of a comprehensive store performance management process supported by a balanced scorecard.This will support the ongoing implementation of SMART Retailing and focus on customer satisfaction, sales growth and margin improvements. During ﬁscal 2005 Sobeys also made signiﬁcant progress in the implementation of system-wide business process optimization initiatives that are designed to reduce complexity and improve processes throughout the Company.To this end, Sobeys continued the roll- out of a common point-of-sale (POS) system.This common POS system provides improved customer information and enhanced customer service at store check-outs, and is a key enabler of other business process optimization initiatives currently underway. Sobeys is also engaged in the roll-out of a new scale networking solution, which will enable full compliance with the new nutritional labeling requirements that come into effect on December 12, 2005. 22 || 2005 Annual Report System and process complexities in the Ontario business, as discussed in the ﬁscal 2004 MD&A, negatively impacted earnings in that region. In ﬁscal 2006 Sobeys intends to advance its business process and information systems transformation plan for the Company by focusing on the signiﬁcant opportunity to upgrade capabilities and improve efﬁciencies in the Ontario region.The system and processes that are being implemented have been developed over several years and are currently employed in Sobeys Atlantic Region. The Ontario roll-out will simplify, standardize and streamline the “back shop”, in support of Sobeys food focused strategy.This move will leverage technology investments, improve efﬁciencies and lower costs over the long term.The anticipated cost of this roll-out is expected to approximate $0.20 to $0.25 per Sobeys share in ﬁscal 2006. Real Estate Empire’s real estate operations are focused on the development and management of a commercial property portfolio and through a 35.7 percent interest in Genstar, the sale of residential housing lots. Management is committed to strengthening its existing real estate operations while also pursuing accretive acquisitions and developments, primarily in the Ontario market. At the end of ﬁscal 2005, real estate operations had 12.9 million square feet under ownership, unchanged from last year. Commercial real estate operations are conducted through Crombie and SLP, while residential land development is primarily conducted through Genstar, which operates principally in high growth communities in Ontario and Western Canada. Empire’s real estate property portfolio is diversiﬁed geographically with the commercial property portfolio operating in Atlantic Canada and, to a growing extent, Central Canada, and the residential portfolio operating mainly in Western Canada. The real estate division now manages 1.1 million square feet of property in Ontario and Quebec.The trend towards increasing the percentage of total property square footage in Ontario relative to the total portfolio is expected to continue. 9667_Empire AR 05 B. F. MIL 7/25/05 11:26 AM Page 23 The commercial property portfolio is also diversiﬁed between retail and ofﬁce use.Today, 87 percent of the gross leasable area in Empire’s real estate portfolio is retail space, of which 41 percent is leased to Empire- afﬁliated companies.The retail segment of the real estate portfolio includes 74 properties.The real estate portfolio also includes nine ofﬁce properties, representing 13 percent of total gross leasable area. Investments & Other Operations The third component of Empire’s business is its investments and other operations. Empire’s investment portfolio consists of Canadian and U.S. common equity investments. At ﬁscal year-end, Empire’s investments, excluding its investment in Genstar, carried a market value of $465.5 million consisting of Canadian common equity investments valued at $331.0 million, foreign common equities valued at $133.0 million in Canadian dollars, and preferred equities and other investments valued at $1.5 million.The Canadian common equity investment market value includes the market value of Empire’s equity accounted investment in Wajax Limited (approximately a 45% ownership position on a fully diluted basis) of $144.6 million at ﬁscal year-end. All of Empire’s investments are listed on a recognized public stock exchange. Other operations primarily consist of wholly- owned Empire Theatres, a movie exhibitor with 176 screens in 27 locations in Atlantic Canada and, through a joint venture, 24 screens in four locations in Western Canada. On June 15, 2004, Empire Theatres acquired from Viacom Canada Inc. four cinemas operating 23 screens in Nova Scotia and New Brunswick. Empire’s Strategic Direction Management’s primary objective is to maximize the long-term sustainable value of Empire through enhancing the worth of the Company’s net assets and in turn, having that value reﬂected in Empire’s share price. The strategic direction of the Company is to stay the course by continuing to direct its energy and capital towards growing the long-term sustainable value of each its core operating businesses – food distribution, real estate and theatres.While these respective core businesses are well established and proﬁtable in their own right, the diversiﬁcation they offer Empire by both business line and by market area served is considered by management to be an additional source of strength. Together, these core businesses reduce risk and volatility, thereby contributing to greater consistency in consolidated earnings growth over the long-term. Going forward, the Company intends to continue to direct its resources towards the most promising opportunities within these core businesses in order to maximize long-term shareholder value. In carrying out the Company’s strategic direction, Empire management deﬁnes its role as having four fundamental responsibilities: ﬁrst, to support the development and execution of sound strategic plans for each of its operating companies; second, to regularly monitor the development and the execution of business plans within each operating company; third, to ensure that Empire is well governed as a public company; and fourth, to prudently manage a pool of investment capital in order to augment the growth in our core operating businesses. The Company also remains committed to holding an investment portfolio consisting largely of high quality common equities. A liquid investment portfolio provides Empire with the opportunity to augment earnings while waiting to make further investment in its core operations as attractive opportunities unfold. Historically the Company has been successful in generating investment returns well in excess of the Company’s cost of capital and well in excess of returns that would otherwise have been generated by either passively investing, using index-based investments, or from investing in money market investments. Empire Company Limited || 23 9667_Empire AR 05 B. F. MIL 7/25/05 11:26 AM Page 24 Management’s Discussion and Analysis Consolidated Operating Results The consolidated ﬁnancial overview presented below reports on the ﬁnancial performance for ﬁscal 2005 relative to the last two ﬁscal years. Summary Table of Consolidated Financial Results ($ in millions, except per share information) 2005 % of Revenue Revenue 53 Weeks Ended May 7 52 Weeks Ended April 30 2004(2) % of Revenue 52 Weeks Ended April 30 2003 % of Revenue Food (1) Real estate, net of inter-segment Other operations $ 12,189.4 98.02 % $ 11,061.4 1.38 % 158.2 0.60 % 64.4 171.4 74.4 98.03 % 1.40 % 0.57 % $ 10,414.5 149.2 60.5 98.03 % 1.40 % 0.57 % $ 12,435.2 100.00 % $ 11,284.0 100.00 % $ 10,624.2 100.00 % Consolidated revenue Operating income Food Real estate Investments and other Consolidated operating income Interest expense Income taxes (from operating activities) Minority interest Operating earnings Capital gain (loss) and other items, $ $ 322.6 122.2 18.9 463.7 86.7 130.5 63.6 182.9 3.73 % 0.70 % 1.05 % 0.51 % 1.47 % net of tax Net earnings Cash ﬂows from operating activities 3.7 0.03 % $ $ 186.6 486.6 1.50 % $ 3.91 % $ Total assets Total long-term liabilities $ 4,929.2 $ 1,552.3 Per share, basic and fully diluted Operating earnings Capital gain (loss) and other items, net of tax Net earnings $ $ Basic and fully diluted weighted average number of shares outstanding Dividends $ 2.78 0.05 2.83 65.7 0.48 $ $ $ $ $ 293.7 111.0 18.1 422.8 92.4 108.6 58.5 163.3 9.2 172.5 467.2 4,679.7 1,696.7 2.48 0.14 2.62 65.8 0.40 3.75 % 0.82 % 0.96 % 0.52 % 1.45 % 0.08 % 1.53 % 4.14 % $ $ $ $ $ $ $ $ 324.2 103.8 16.4 444.4 93.7 123.9 67.5 159.3 4.18 % 0.88 % 1.17 % 0.64 % 1.50 % (6.0) (0.06)% 1.44 % 3.34 % 153.3 356.1 4,519.3 1,711.9 2.42 (0.09) 2.33 65.8 0.33 (1) Fiscal 2004 revenue includes a $14.6 million gain on the sale of several real estate assets. (2) Fiscal 2004 and fiscal 2003 have been restated to reflect retroactive adjustments related to lease accounting and vendor allowances respectively. Please see the section entitled “Lease Accounting” and “EIC-144, Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor” in this MD&A. 24 || 2005 Annual Report 9667_Empire AR 05 B. F. MIL 7/25/05 11:26 AM Page 25 Explanation of Fiscal 2005 Annual Results The financial performance for each of the Company’s businesses (food, real estate, investments and other operations) are discussed in detail in further sections of this MD&A. The following is a review of Empire’s consolidated performance for the 53 weeks ended May 7, 2005 compared to the 52 weeks ended April 30, 2004. Revenue The effect on ﬁscal 2005 revenue of eliminating the impact of VIE consolidation and the 53rd week of revenue: Reported Revenue Fiscal 2005 12,435 Growth over Fiscal 2004 10.2 % ($ in millions) Fiscal 2005 VIE Impact (137) 53rd Week Impact (241) Adjusted 12,057 Growth over Fiscal 2004 6.9 % Reported Revenue Fiscal 2004 11,284 Each of Empire’s operating businesses contributed to growth in the Company’s consolidated revenue in ﬁscal 2005 over the prior ﬁscal year; an increase of $1,151.2 million or 10.2 percent.The revenue increase is largely attributed to an increase in food division revenues of $1,128.0 million or 10.2 percent over the prior year. Growth in real estate revenues (net of inter-segment) totalled $13.2 million or 8.3 percent, while other operations recorded revenue growth of $10.0 million or 15.5 percent, primarily as a result of strong revenue growth at Empire Theatres. Fiscal 2005 contained 53 weeks of operations compared to 52 weeks in ﬁscal 2004.The additional week accounted for $241 million or 2.1 percentage points of the 10.2 percent ﬁscal 2005 revenue increase. Also impacting revenue growth in ﬁscal 2005 was the consolidation of VIEs in the fourth quarter, which accounted for approximately $137 million or 1.2 percentage points of the increase over ﬁscal 2004. Excluding the additional selling week and the VIE consolidation, revenue growth in ﬁscal 2005 equalled 6.9 percent. Fiscal 2005 revenue growth was also positively impacted by the acquisition of Commisso’s Food Markets Limited and Commisso’s Grocery Distributors Limited (“Commisso’s”) by Sobeys and the acquisition by Crombie of certain real estate properties previously owned by Commisso’s at the beginning of the fourth quarter of ﬁscal 2004. Fiscal 2005 revenue contains a full year of Commisso’s sales versus only the fourth quarter sales in ﬁscal 2004. Operating Income The year-over-year increase in operating income or earnings before interest and taxes (“EBIT”) of $40.9 million or 9.7 percent is the result of a $28.9 million or 9.8 percent increase in operating income contribution from the food distribution division, an $11.2 million or 10.1 percent increase in operating income from the real estate division and an $0.8 million or 4.4 percent increase in operating income from investments and other operations.The year-over-year change in operating income for each division is explained in the section which follows, “Operating Performance by Division”. Interest Expense The $5.7 million decline in interest expense is largely attributed to reduced interest expense on long-term debt. Interest on long-term debt declined $5.4 million, or 6.2 percent largely as a result of $79.8 million of long-term debt repayments made during the year compared to $39.9 million of new long-term debt issued during the ﬁscal year. The majority of the Company’s debt carries ﬁxed interest rates and therefore there is minimal exposure to interest rate risk from ﬂuctuating short-term interest rates. Income Taxes The ﬁscal 2005 effective tax rate was 34.6 percent compared to 32.9 percent in ﬁscal 2004.The ﬁscal 2004 tax rate was favourably impacted by a lower effective Empire Company Limited || 25 9667_Empire AR 05 B. F. MIL 7/25/05 11:26 AM Page 26 Management’s Discussion and Analysis tax rate on a pre-tax capital gain of $14.6 million from real estate divestments recorded by Sobeys in the fourth quarter of the year. As well, there was a slight shift in the current year to a greater portion of taxable earnings in jurisdictions with higher statutory tax rates. Minority Interest The Company incurs minority interest expense as a consequence of not owning 100 percent of Sobeys. Fiscal 2005 minority interest equalled $63.6 million, an increase of $5.1 million or 8.7 percent from the $58.5 million recorded in ﬁscal 2004.The increase in minority interest is attributed to increased Sobeys net earnings offset by an increase in Empire’s ownership interest in Sobeys, from 65.0 percent last ﬁscal year to 68.4 percent at the end of ﬁscal 2005. Empire purchased a total of 1,864,600 common shares of Sobeys in ﬁscal 2005 resulting in the increase in ownership.These share purchases totalled $70.0 million and were funded largely through bank indebtedness. Over the last two years Empire has purchased 3,833,400 common shares of Sobeys for a total cost of $137.8 million. Operating Earnings The $19.6 million or 12.0 percent improvement in operating earnings (earnings before net capital gain (loss) and other items) over the prior year was the result of the $40.9 million increase in operating income, the $5.7 million reduction in interest expense, the $21.9 million increase in income tax expense and the $5.1 million increase in minority interest as previously discussed. Capital Gain The capital gain (net of tax) of $3.7 million resulted from the sale of portfolio equity investments during the year (2004 – $9.2 million). Net Earnings The increase in net earnings of $14.1 million or 8.2 percent from last year is the result of the $19.6 million increase in operating earnings as discussed and the decrease in net capital gain (loss) over the prior year of $5.5 million. Operating Earnings ($ in millions) Operating Earnings per Share ($ per share) 9 . 2 8 1 3 . 3 6 1 3 . 9 5 1 8 7 . 2 2 4 . 2 8 4 . 2 2 . 2 3 1 5 . 8 8 0 0 . 2 3 3 . 1 01 02 03 04 05 01 02 03 04 05 Fiscal Year Fiscal Year Sobeys Queensway Store Toronto, Ontario Avalon Mall St. John’s, Newfoundland 26 || 2005 Annual Report 9667_Empire AR 05 B. F. MIL 7/25/05 11:26 AM Page 27 Operating Performance by Division Food Division Highlights • Sobeys achieved sales growth of 10.3 percent and same-store sales growth of 3.7 percent. Excluding the additional selling week in ﬁscal 2005 and the consolidation of variable interest entities, Sobeys sales growth equalled 6.9 percent. • EBITDA as a percentage of sales increased to 4.09 percent compared to 4.05 percent last year. EBITDA increased 11.6 percent. • Sobeys contributed $123.1 million in net earnings to Empire (66% of total Empire net earnings); a 14.5 percent increase over last year. • Total property and equipment purchases equalled $268.5 million (total company-wide capital expenditures, which includes franchisee and third party spending, equalled $436.0 million). • Opened 41 corporate and franchised stores, expanded 19 stores and rebannered 36 stores. • Launched Compliments, Sobeys new private label brand. • Rolled-out the ﬁrst phase of the SMART Retailing initiative and continued implementation of a common point- of-sale system. Sales Fiscal 2005 sales illustrated to reﬂect the elimination of VIE consolidation and the 53rd week of sales: Reported Sales Fiscal 2005 12,189 Growth over Fiscal 2004 10.3% ($ in millions) Fiscal 2005 VIE Impact (137) 53rd Week Impact (241) Adjusted 11,811 Growth over Fiscal 2004 6.9% Reported Sales Fiscal 2004 11,047 In ﬁscal 2005, Sobeys achieved sales of $12.2 billion, an increase of $1.1 billion or 10.3 percent over ﬁscal 2004. Fiscal 2005 contained 53 weeks of operations compared to 52 weeks in ﬁscal 2004.This additional week accounted for $241 million or 2.2 percentage points of the 10.3 percent ﬁscal 2005 sales increase. Also impacting sales growth in Sobeys Toronto, Ontario IGA Longlier, Quebec Empire Company Limited || 27 9667_Empire AR 05 B. F. MIL 7/25/05 11:26 AM Page 28 Management’s Discussion and Analysis ﬁscal 2005 was the consolidation of VIEs in the fourth quarter, which accounted for approximately $137 million or 1.2 percentage points of the increase over ﬁscal 2004. Finally, the acquisition of Commisso’s occurred at the beginning of the fourth quarter of ﬁscal 2004, therefore ﬁscal 2005 sales growth was positively impacted by a full year of Commisso’s sales versus only the fourth quarter sales in ﬁscal 2004. Excluding the additional selling week and VIE consolidation, sales growth in ﬁscal 2005 equalled 6.9 percent. Sales growth was also driven by Sobeys continued implementation of sales and merchandising initiatives across the country, coupled with the increased retail selling square footage resulting from the opening of new stores and an ongoing program to enlarge and renovate existing store assets. Store square footage increased by 2.5 percent in ﬁscal 2005 as a result of the opening of 41 new stores and the expansion of 19 stores. Sobeys same-store sales, (sales from stores in the same locations in both reporting periods) increased by 3.7 percent. Sobeys expects continued sales growth in ﬁscal 2006 as a result of ongoing capital investment in its retail store network, and continued offering, merchandising and marketing improvements across the country. Earnings before Interest, Income Taxes, Depreciation and Amortization Sobeys ﬁscal 2005 EBITDA (“earnings before interest, income taxes, depreciation and amortization”) increased $52.0 million or 11.6 percent to $499.0 million from $447.0 million reported in ﬁscal 2004. EBITDA as a percentage of sales increased to 4.09 percent from 4.05 percent last year. Included in the previous year EBITDA were one- time pre-tax costs of $20.2 million related to the uninsured cost of the power failure in Ontario ($4.9 million), the adverse outcome in a long-standing real estate lawsuit ($4.0 million), closure costs related to the Grande Prairie and Peace River, Alberta distribution centres ($1.2 million), increase in estimate of store closing costs ($5.3 million), and pension and beneﬁt costs for employees on long-term disability ($4.8 million). Also included in the previous year EBITDA, was a $14.6 million pre-tax gain on the sale of several redundant real estate assets. Earnings before Interest, Income Taxes, Depreciation, Amortization and Rent Fiscal 2005 earnings before interest, income taxes, depreciation and amortization and rent (EBITDAR) was $774.9 million compared to $698.1 million in ﬁscal 2004. Sobeys leases a substantial portion of its store Compliments Selections Brand Compliments Sensations Brand 28 || 2005 Annual Report 9667_Empire AR 05 B. F. MIL 7/25/05 11:26 AM Page 29 network.Therefore, to arrive at a measure of operating performance excluding the impact of capital, gross rent expense of $275.9 million in ﬁscal 2005 and $251.1 million in ﬁscal 2004 is added to EBITDA to arrive at EBITDAR. EBITDAR as a percent of sales in ﬁscal 2005 was 6.36 percent compared to 6.32 percent in ﬁscal 2004. Earnings before Interest and Income Taxes Sobeys EBIT increased to $322.6 million in ﬁscal 2005, a 9.6 percent increase from the prior year, with an EBIT margin of 2.65 percent compared to 2.66 percent in ﬁscal 2004. Included in ﬁscal 2005 EBIT was a $23.7 million increase in depreciation and amortization expense ($176.4 million current year compared to $152.7 million last year), reﬂecting Sobeys continued capital investments.The 53rd week of operations in ﬁscal 2005 favourably impacted EBIT by approximately $6.1 million or 2.1 percentage points. Sobeys will continue to focus on disciplined cost management initiatives, supply chain and retail productivity improvements and migration of best practices across its four regions to continue to fuel and fund investments to drive sales and improve margins over time. Net Earnings Sobeys’ ﬁscal year 2005 net earnings were $186.7 million compared with $166.5 million last year, a $20.2 million or 12.1 percent increase. Sobeys net earnings in ﬁscal 2005 were favourably impacted by approximately $3.5 million as a result of the 53rd week of operations. Fiscal 2005 net earnings reﬂect increased depreciation and amortization expense, while ﬁscal 2004 earnings were impacted by the net effect of the one-time items and gain on sale of redundant real estate, both referred to above.The consolidation of VIEs resulted in a $0.6 million reduction in net earnings in ﬁscal 2005. Sobeys’ contribution to Empire’s net earnings equalled $123.1 million (66.0 percent of Empire consolidated net earnings) compared to $107.5 million (62.3 percent of consolidated earnings) the previous ﬁscal year, a 14.5 percent increase. Food Division Revenue ($ in millions) Food Division Operating Income ($ in millions) 4 . 9 8 1 , 2 1 4 . 1 6 0 , 1 1 5 . 4 1 4 , 0 1 5 . 2 3 7 , 9 0 . 3 6 1 , 9 6 . 5 2 6 3 . 6 9 2 6 . 2 2 3 3 . 4 9 2 4 . 1 3 2 01 02 03 04 05 01 02 03 04 05 Fiscal Year Fiscal Year Empire Company Limited || 29 9667_Empire AR 05 B. F. MIL 7/25/05 11:26 AM Page 30 Management’s Discussion and Analysis Real Estate Division Highlights • Occupancy rate remained strong at 93.5 percent (93.6 percent last year). • Exceptional year for residential operations with growth in net earnings of 25.3 percent. • Funds from operations increased 10.3 percent to $64.4 million from $58.4 million last year. • The real estate portfolio was strengthened and diversiﬁed through the development of existing properties and continued residential development activity through Genstar. The table below segments real estate division revenue, funds from operations and net earnings for commercial and residential operations. ($ in millions) Revenue Commercial Residential Inter-segment Funds from operations Commercial Residential Net earnings Commercial Residential 53 weeks ended May 7, 2005 % Change over 2004 52 weeks ended April 30, 2004 % Change over 2003 $ 194.2 35.0 229.2 (57.8) $ 171.4 $ $ $ $ 42.7 21.7 64.4 24.4 21.3 45.7 7.7 % 15.9 % 8.9 % 10.5 % 8.3 % 4.7 % 23.3 % 10.3 % (2.0)% 25.3 % 9.1 % $ 180.3 30.2 210.5 (52.3) $ 158.2 $ $ $ $ 40.8 17.6 58.4 24.9 17.0 41.9 4.0 % 19.4 % 6.0 % 5.9 % 6.0 % 9.4 % 7.3 % 8.8 % 18.0 % (4.5)% 7.7 % Genstar Calgary, Alberta Barhaven Ottawa, Ontario 30 || 2005 Annual Report 9667_Empire AR 05 B. F. MIL 7/25/05 11:26 AM Page 31 Revenue Commercial property related revenue increased $13.9 million or 7.7 percent as a result of continued strong occupancy rates, generally higher rental renewal rates, ongoing property development, and acquisition activity that occurred in the fourth quarter last year. At the start of the fourth quarter last ﬁscal year, Crombie acquired six properties from Commisso’s Properties Ltd. in Southwestern Ontario which added gross leasable area of 0.5 million square feet. Leasing activity has remained strong with an overall (retail plus ofﬁce) occupancy rate of 93.5 percent, relatively unchanged from 93.6 percent a year ago. The retail occupancy rate was 94.2 percent compared to 94.4 percent a year earlier. Ofﬁce vacancy at 9.5 percent compared to 9.8 percent a year earlier remained below the average ofﬁce vacancy rate in the Halifax and Moncton markets, respectively.The majority of the Company’s ofﬁce space is located in the Halifax and Moncton markets. Revenue from residential activities increased $4.8 million or 15.9 percent largely as a result of stronger than expected lot sales in Genstar’s Western Canadian operation, particularly in Calgary and Edmonton markets. Genstar continues to beneﬁt from continued strong housing markets in Western Canada. At this time, it is expected that this trend will continue for the remainder of the calendar year. Operating Income The $11.2 million or 10.1 percent increase in real estate division operating income in ﬁscal 2005 was largely the result of a strong contribution from Genstar, the beneﬁt of having the six Ontario properties acquired in the fourth quarter last year for a full operating year, successful re-development activities and generally higher net effective rental rates. Costs and operating costs as a percentage of revenues were unchanged at 39.5 percent.The real estate operation contributed 26.4 percent of Empire’s total operating income in ﬁscal 2005 (2004 – 26.3 percent). Net Earnings Real estate division contribution to Empire’s ﬁscal 2005 net earnings was $45.7 million (24.5 percent of Empire consolidated net earnings), an increase of $3.8 million or 9.1 percent from the $41.9 million recorded in ﬁscal 2004.The increase is principally the result of the higher operating income generated in ﬁscal 2005 net of additional income tax expense paid. Interest expense was relatively unchanged from the prior year. Funds from operations (net income plus depreciation) increased 10.3 percent to $64.4 million from $58.4 million last year as a result of improved operating earnings performance. Real Estate Revenue ($ in millions) 2 . 9 2 5 2 . 0 1 2 6 . 8 9 1 1 . 5 8 8 1 . 5 6 1 Real Estate Operating Income ($ in millions) 2 . 2 2 0 1 . 1 1 1 8 . 3 0 1 6 . 0 0 1 3 . 2 8 01 02 03 04 05 01 02 03 04 05 Fiscal Year Fiscal Year Empire Company Limited || 31 9667_Empire AR 05 B. F. MIL 7/25/05 11:26 AM Page 32 Management’s Discussion and Analysis Investments and Other Operations Highlights • Empire’s liquid portfolio investments generated a 26.9 percent return in ﬁscal 2005, resulting in ﬁrst quartile return performance. • Four-year annualized return performance for Empire’s portfolio investments was 16.2 percent compared to a 7.9 percent total return for the S&P/TSX Composite Index and a negative 4.5 percent total return for the S&P 500 Index, in Canadian dollars. • Net investment capital gains of $3.7 million were realized in ﬁscal 2005 largely as a result of the sale of common equity investments. • Empire Theatres acquired four locations with 23 screens from Viacom Canada Inc. in Nova Scotia and New Brunswick, purchased one independent theatre and constructed one new theatre. Investment Value At ﬁscal year-end, May 7, 2005, Empire’s total investments (excluding cash) carried a market value of $465.5 million on a cost base of $325.9 million, resulting in an unrealized gain of $139.6 million.This compares to an unrealized gain of $66.2 million at the end of ﬁscal 2004. Portfolio Composition At ﬁscal year end, May 7, 2005, Empire’s investment portfolio consisted of: $ in millions (Canadian) Canadian equities U.S. equities Wajax Preferred and other Market Value $ 186.4 133.0 144.6 1.5 $ 465.5 % of Portfolio 40.0% 28.6 31.1 0.3 100.0% Cost 135.0 134.3 55.1 1.5 325.9 $ $ Unrealized Gain (Loss) $ 51.4 (1.3) 89.5 – $ 139.6 Empire’s direct debt matched to these investments was $137.7 million Canadian at year-end, equivalent to 29.6 percent of total investment market value. Management considers a ratio of debt to investment value of no greater than 35 percent as prudent. Revenue Investments and other operations’ revenue, primarily generated by Empire Theatres, reached $74.4 million versus $64.4 million last year. Revenue growth at Empire Theatres was primarily the result of the acquisition of the Park Lane Theatre Halifax, Nova Scotia Bayers Lake Theatre Halifax, Nova Scotia 32 || 2005 Annual Report 9667_Empire AR 05 B. F. MIL 7/25/05 11:26 AM Page 33 23 screens from Viacom Canada Inc. along with continued modernization of existing locations. Empire Theatres had 176 screens in operation at the end of ﬁscal 2005 compared to 149 at the end of the prior ﬁscal year. Investment Return The total return on the Empire investment portfolio, as independently benchmarked against over 100 North American equity fund managers, has provided ﬁrst quartile return performance (i.e. in the top 25 percent of surveyed equity fund managers) over one, two, three, four and ﬁve year trailing periods ended March 31, 2005, respectively. Total portfolio return for the twelve month period ended March 31, 2005 was 26.9 percent.This compares to a 13.9 percent total return for the S&P/TSX Composite Index and a negative 1.5 percent total return for the S&P 500 Index in Canadian dollars over the same twelve month period. Empire’s investment return performance was ranked as being in the top quartile for the twelve month period ended March 31, 2005. The tables below present the return performance for Empire's investments, relative to Canadian and U.S. equity benchmarks over each of the last ﬁve years ended March 31st, as well as on a two, three, four and ﬁve-year annualized compounded basis. Investment returns are measured using a calendar quarter-end cycle, consistent with industry practice. Total Investment Return (Annual Returns for Periods Ended March 31) Empire Investment Portfolio S&P/TSX Composite Index S&P 500 Index (in Cdn.$) 2001 19.8% –18.6% –14.8% Total Investment Return (Annualized Compound Returns for Periods Ended March 31, 2005) Empire Investment Portfolio 1st Quartile Manager Return Median Manager Return S&P/TSX Composite Index S&P 500 Index (in Cdn.$) Other Operations Revenue ($ in millions) Other Operations Operating Income ($ in millions) 4 . 4 5 6 . 0 2 6 . 6 5 1 . 9 4 4 . 4 7 8 . 9 5 . 9 0 . 9 0 . 9 5 . 6 01 02 03 04 05 01 02 03 04 05 Fiscal Year Fiscal Year 2002 18.2% 4.9% 1.4% 2-year 44.0% 23.8% 20.6% 25.3% 8.9% 2003 –25.6% –17.6% –30.7% 3-year 15.5% 5.8% 4.2% 8.9% –6.3% 2004 63.4% 37.7% 20.5% 4-year 16.2% 5.8% 4.0% 7.9% –4.5% 2005 26.9% 13.9% –1.5% 5-year 16.9% 4.7% 1.8% 2.0% –6.6% The median manager and ﬁrst quartile manager returns as presented in the table above were calculated using Canadian and U.S. equity manager return data, as supplied by an independent analytical ﬁrm, multiplied by the respective Canadian and U.S. equity weights for the Empire investment portfolio. Despite the volatility in equity markets, management continues to believe that equity market returns will be superior to either ﬁxed income or money market investment returns over the long term. Management remains committed to prudently managing a high quality, liquid portfolio of common equities to augment the growth in the Company’s core operating businesses. Empire Company Limited || 33 9667_Empire AR 05 B. F. MIL 7/25/05 11:26 AM Page 34 Management’s Discussion and Analysis Performance Attribution The increase of $73.4 million in investment market value over book cost over the last twelve months ending March 31, 2005 was largely attributed to a $57.9 million increase in the unrealized gain position in the Wajax investment combined with an increase in value of the majority of liquid common equities in the portfolio. Investments in Wajax, ﬁnancial-related equities and energy-related equities performed particularly well relative to overall benchmark index returns. Hedging Investment Currency Risk At May 7, 2005, Empire had hedged approximately 75 percent of the market value of its U.S. based common equity investments by way of $61.0 million in U.S. dollar short-term borrowings.The average foreign exchange rate associated with these U.S. dollar bank loans is $1.3538 (73.86 cents).The fair value of the hedge was $5.2 million at the end of the ﬁscal year (close to zero dollars at the end of ﬁscal 2004) as a result of the foreign exchange rate equalling $1.2432 (80.44 cents) at the end of the ﬁscal year. Management has documented and accounted for the U.S. bank loans as a fair value hedge.This hedge value is not included in the $139.6 million unrealized investment gain discussed above. Capital Allocation from Investments During ﬁscal 2005 Empire purchased 1,864,600 common shares of Sobeys for a total cost of $70.0 million. This outlay was funded through capital reallocation from the investment division and bank indebtedness.This resulted in an increase in Empire’s ownership of Sobeys of 3.4 percentage points, with total interest of 68.4 percent at the end of ﬁscal 2005 versus 65.0 percent a year earlier. Over the last two years Empire has purchased 3,833,400 common shares of Sobeys for a total cost of $137.8 million, serving to increase its ownership from 62.0 to 68.4 percent over this time period. Investment Income Investment income generated by the investment portfolio equalled $18.8 million in ﬁscal 2005, an increase of $2.9 million or 18.2 percent over the prior year.The increase is the result of equity accounted earnings from Wajax being higher than last year by $4.6 million combined with a decrease in dividend income of $1.7 million.The decline in dividend income was expected as a result of changes in the investment portfolio mix.The growth in Wajax equity earnings was higher than expected and is largely the result of management’s attention to cost controls and a strong resource sector which beneﬁts Wajax products and services. Operating Earnings Fiscal 2005 operating earnings from investments (net of corporate expenses) and other operations equalled $14.1 million, an increase of $0.4 million or 2.9 percent over the prior year.The increase is attributed to the $2.9 million increase in investment income offset by a $0.6 million reduction in theatre operating earnings and a $1.9 million increase in corporate expenses. Capital Gain The capital gain (net of tax) realized on the sale of investments in ﬁscal 2005 of $3.7 million (2004 – $9.4 million) was largely the result of the sale of common equity investments. Net Earnings Investments (net of corporate expenses) and other operations contributed $17.8 million to Empire’s consolidated net earnings (9.5 percent of Empire consolidated net earnings).This compares to a $23.1 million net earnings contribution last year (13.4 percent of Empire consolidated net earnings). The decline is due to the reduction in realized capital gains as discussed offset by the increase in operating earnings. 34 || 2005 Annual Report 9667_Empire AR 05 B. F. MIL 7/25/05 11:26 AM Page 35 Quarterly Results of Operations The following table is a summary of selected consolidated ﬁnancial information from the Company’s unaudited interim consolidated ﬁnancial statements for each of the eight most recently completed quarters. ($ in millions, except per share information) Revenue Operating income Operating earnings Net capital gain (loss) and other items Q4 (14 weeks) May 7, 2005 $3,360.2 124.0 49.3 Q3 (13 weeks) Jan. 29, 2005 $2,978.5 113.3 46.2 Q2 (13 weeks) Oct. 30, 2004 $3,022.8 111.6 42.9 Q1 (13 weeks) July 31, 2004 $3,073.7 114.8 44.5 Q4 (13 weeks) Apr. 30, 2004 $ 2,876.4 100.9 41.0 Q3 (13 weeks) Jan. 31, 2004 $ 2,798.5 109.9 44.0 Q2 (13 weeks) Oct. 31, 2003 $ 2,794.4 104.4 38.9 Q1 (13 weeks) July 31, 2003 $ 2,814.7 107.6 39.4 5.5 1.4 (3.0) (0.2) (0.1) 8.8 (2.2) 2.7 Net earnings $ 54.8 $ 47.6 $ 39.9 $ 44.3 $ 40.9 $ 52.8 $ 36.7 $ 42.1 Per Share Information, basic and fully diluted Operating earnings (1) $ Net capital gain (loss) and other items Net earnings $ Weighted average number of shares outstanding (in millions) 0.75 $ 0.70 $ 0.66 $ 0.67 $ 0.62 $ 0.67 $ 0.59 $ 0.60 0.08 0.83 $ 0.02 0.72 (0.05) – – $ 0.61 $ 0.67 $ 0.62 $ 0.13 0.80 (0.03) $ 0.56 $ 0.04 0.64 65.7 65.8 65.8 65.8 65.8 65.8 65.8 65.8 All quarters previous to the fourth quarter of fiscal 2005 have been restated to reflect the retroactive adjustment related to lease accounting and EIG-144. Please see the sections entitled “Lease Accounting” and “EIC-144” in this fiscal 2005 annual MD&A. (1) Operating earnings is net earnings before net capital gain (loss) and other items. The Company’s operations are impacted to some degree by certain holiday periods in the year; however business is not materially cyclical or seasonal. Fourth Quarter Results Summary Table of Consolidated Financial Results for the Fourth Quarter 14 Weeks Ended May 7, 2005 $ % of Revenue 13 Weeks Ended April 30, 2004 $ % of Revenue 100.00% 3.69% 0.69% 1.09% 16.3% $ 2,876.4 100.9 22.7 24.1 40.9 100.00% 3.51% 0.79% 0.84% 1.42% ($ in millions, except per share data) Revenue Operating income Interest expense Income taxes Net earnings Per Share, basic and diluted Operating earnings Weighted average number of shares outstanding, basic and diluted (in millions) Dividends $ 3,360.2 124.0 23.3 36.6 54.8 $ $ 0.75 65.7 0.120 Fourth quarter fiscal 2004 has been restated to reflect retroactive adjustments related to lease accounting and EIC-144. $ $ 0.62 65.8 0.100 Empire Company Limited || 35 9667_Empire AR 05 B. F. MIL 7/25/05 11:26 AM Page 36 Management’s Discussion and Analysis Impact of VIEs on Revenue, EBIT and EBITDA ($ in millions) Revenue Operating income Earnings, before interest, taxes, depreciation and amortization Excluding VIEs 14 Weeks Ended May 7, 2005 $ % of Revenue Including VIEs 14 Weeks Ended May 7, 2005 $ % of Revenue $ 3,222.8 124.2 100.00% 3.85% $ 3,360.2 124.0 100.00% 3.69% 172.2 5.34% 173.8 5.17% The following is a review of ﬁnancial performance for the 14-week period ended May 7, 2005 compared to the 13-week period ended April 30, 2004. Revenue Revenue for the fourth quarter was $3.36 billion compared to $2.87 billion last year, a 16.8 percent increase.The food division reported revenue of $3.29 billion, an increase of $477.0 million or 16.9 percent (Sobeys’ revenue in the fourth quarter last year includes a capital gain of $14.6 million). For the food division, the fourth quarter of ﬁscal 2005 contained 14 weeks of operations compared to 13 weeks in ﬁscal 2004.The additional week accounted for approximately $241 million of the revenue increase. Also impacting revenue growth was the consolidation of variable interest entities in the fourth quarter, this accounted for approximately $137 million of the revenue increase over ﬁscal 2004. The table below presents the impact of the additional selling week and the consolidation of variable interest entities in the fourth quarter on Empire’s consolidated revenue. ($ in millions) Reported Revenue Q4 2005 Fourth Quarter 3,360 Growth over Q4 2004 16.8% VIE Impact (137) 53rd Week Impact (241) Adjusted 2,982 Growth over 2004 3.7% Reported Revenue Q4 2004 2,876 Revenue increased $483.8 million or 16.8 percent compared to the fourth quarter of ﬁscal 2004.The fourth quarter of ﬁscal 2005 contained 14 weeks of operations compared to 13 weeks in ﬁscal 2004 and this additional week accounted for approximately $241 million or 8.4 percentage points of the fourth quarter sales increase. Another signiﬁcant impact on quarter four revenue growth in ﬁscal 2005 was the consolidation of VIEs in the fourth quarter, which accounted for approximately $137 million or 4.7 percentage points of the increase over ﬁscal 2004.The acquisition of Commisso’s occurred at the beginning of the fourth quarter of ﬁscal 2004 and as a result it did not impact the quarter-over-quarter growth. Excluding the additional selling week and the VIE consolidation, fourth quarter revenue growth in ﬁscal 2005 equalled 3.7 percent. Food division same-store sales grew 4.5 percent during the fourth quarter of ﬁscal 2005.The growth in retail sales was a direct result of Sobeys’ aggressive pricing posture, the continued implementation of sales and merchandising initiatives across Sobeys, increased retail selling square footage of 0.6 million additional square feet and Sobeys’ ongoing ﬁnancial commitment to upgrade and renovate existing store assets. Same-store sales growth outpaced overall Company sales growth as there was no growth in Sobeys’ wholesale sales to independent customers in the fourth quarter this year compared to the fourth quarter last year. In particular, Sobeys experienced a decline in the sale of tobacco products to its independent wholesale customers. Wholesale sales to independent customers are not included in same-store sales growth. 36 || 2005 Annual Report 9667_Empire AR 05 B. F. MIL 7/25/05 11:26 AM Page 37 Real estate operations reported fourth quarter revenues (net of inter-company eliminations) of $47.4 million, an increase of $4.0 million or 9.2 percent over the fourth quarter last year. Commercial property revenue grew by $1.6 million or 4.8 percent while revenue from residential operations increased $2.4 million or 24.2 percent.The growth in commercial property revenues was the result of continued strong occupancy levels and generally higher rental renewal rates.The increase in residential revenue from Genstar was the result of exceptionally strong lot sales, particularly in Calgary and Edmonton markets. Operating Income The $23.1 million or 22.9 percent increase in consolidated operating income in the fourth quarter was largely the result of an $18.9 million or 28.8 percent increase in food division operating income contribution to Empire compared to the fourth quarter last year. Sobeys’ EBITDA for the quarter ended May 7, 2005 was $133.1 million; an increase of 20.0 percent or $22.2 million versus the $110.9 million recorded in the same quarter last year. EBITDA as a percentage of sales increased to 4.04 percent from 3.96 percent when compared to fourth quarter ﬁscal 2004 results. Sobeys experienced a modest increase in gross margin percentage, excluding the impact of consolidating VIEs, compared to the same quarter last year as a result of the continued implementation of enhanced merchandising programs and store productivity initiatives. Sobeys’ EBITDA for the fourth quarter of ﬁscal 2005 was also positively impacted by approximately $6.1 million due to the extra week of operations in the fourth quarter. EBITDA for the fourth quarter of ﬁscal 2004 was positively impacted by the sale of redundant real estate for a pre-tax gain of $14.6 million and negatively impacted by expenses related to an increase in an estimate of store closing costs of $5.3 million and pension and beneﬁt costs for employees on long- term disability of $4.8 million, both before tax.The net impact from the gain, store closure costs and pension and beneﬁt amounts was $0.06 per Sobeys share, after tax. Sobeys’ EBIT for the fourth quarter increased $18.3 million or 27.6 percent to $84.6 million. EBIT margin, which is EBIT divided by sales, for the fourth quarter increased to 2.57 percent from 2.37 percent in the same quarter last year. Real Estate division operating income grew by $3.7 million or 11.7 percent over the fourth quarter last year. Commercial operations operating income was unchanged at $23.0 million while residential operations operating income increased 43.5 percent to reach $12.2 million.This scale of growth in residential operations operating income is not expected to be sustainable. Management recognizes that selling residential lots is a cyclical industry and that growth will likely soften when interest rates rise and/or other macroeconomic events dampen residential real estate activity. Investments and other operations’ fourth quarter operating income increased by $0.5 million, as a result of a $1.8 million increase in investment income, offset by increased corporate expenses of $0.7 million and a reduction in operating income from other operations of $0.6 million. Interest Expense The $0.6 million increase in fourth quarter interest expense is due to an increase in interest expense connected to short-term debt.The Company’s bank loans increased in the fourth quarter as a result of funding the purchase of 1.5 million common shares of Sobeys in early April, 2005. Sobeys’ consolidation of VIEs also served to increase interest expense. Income Taxes The effective income tax rate for the fourth quarter was 35.2 percent compared to 30.7 percent in the fourth quarter last year.The ﬁscal 2004 quarterly tax rate was favourably impacted by the lower effective rate on a capital gain recorded by Sobeys of $14.6 million in the fourth quarter. In ﬁscal 2005 there was a shift to a greater portion of taxable earnings in jurisdictions with higher statutory rates. Empire Company Limited || 37 9667_Empire AR 05 B. F. MIL 7/25/05 11:26 AM Page 38 Management’s Discussion and Analysis Minority Interest The $2.8 million increase in minority interest relative to the fourth quarter last year was the result of higher earnings from Sobeys offset by an increase in Empire’s ownership interest.The purchase of 1.5 million Sobeys shares in early April 2005 served to increase Empire’s interest in Sobeys from 66.1 percent to 68.4 percent. Operating Earnings The $8.3 million or 20.2 percent increase in operating earnings over the fourth quarter last year is the result of a $7.5 million increase in food distribution division earnings contribution; a $1.5 million increase in real estate division earnings contribution and a $0.7 million decrease in earnings contribution from investments and other operations. Capital Gain (Loss) The capital gain (net of tax) of $5.5 million and the net capital loss of $0.1 million recorded in the fourth quarter of ﬁscal 2005 and ﬁscal 2004, respectively, were the result of the sale of investments. Net Earnings Net earnings in the fourth quarter, including net capital gains and other items, totalled $54.8 million or $0.83 per share versus $40.9 million or $0.62 per share in the fourth quarter last year. Sobeys accounted for $7.5 million of the increase in consolidated earnings. Sobeys earnings were favourably impacted by approximately $3.5 million as a result of the additional week of operations in the fourth quarter ﬁscal 2005.The additional week positively impacted Empire’s net earnings by $2.4 million. Financial Condition Assets and Net Asset Value At ﬁscal year end May 7, 2005, management calculates Empire’s consolidated net asset value (management’s estimate of the market value of the Company’s assets less indebtedness) at $2,536 million ($38.59 per Empire common share), an increase of $491 million or 24.0 percent from the calculated net asset value at April 30, 2004 of $2,045 million ($31.08 per Empire common share). The table below presents the composition of net asset value by business segment: ($ in millions) Food (1) Real Estate (2) Investments and Other (3) Less: corporate debt and preferred shares Net asset value Per share May 7, 2005 April 30, 2004 Net Asset Value 1,662 493 527 2,682 146 2,536 38.59 $ $ $ $ Percent of Total 62% 18% 20% 100% Net Asset Value 1,226 452 453 2,131 86 2,045 31.08 $ $ $ $ Percent of Total 58% 21% 21% 100% (1) Food division net asset value at May 7, 2005 equals the 44.67 million common shares of Sobeys owned at fiscal year-end multiplied by the market price of a Sobeys common share at fiscal year-end. Food distribution net asset value at April 30, 2004 equalled the 42.81 million common shares of Sobeys owned at fiscal year-end multiplied by the market price of a Sobeys common share at fiscal year-end. (2) Real estate net asset value for May 7, 2005 and for April 30, 2004 respectively have been calculated at nine times trailing funds from commercial operations plus five times trailing funds from residential operations. (3) Investment net asset value is derived from stated public market values of securities held in the portfolio. 38 || 2005 Annual Report 9667_Empire AR 05 B. F. MIL 7/25/05 11:26 AM Page 39 At May 7, 2005, approximately 80 percent of Empire’s net asset value was derived from assets that are valued by publicly available market prices from recognized public stock exchanges.This includes Sobeys common shares and securities held in Empire’s investment portfolio. For each dollar increase in Sobeys’ share price, Empire’s net asset value increases by approximately $0.68 per share. Book value per common share was $25.87 at May 7, 2005, compared to $23.67 at April 30, 2004. The Company’s ﬁnancial condition at May 7, 2005 continued to strengthen as indicated in the table below. Capital Structure and Key Financial Condition Measures ($ in millions, except ratio calculations) May 7, 2005 April 30, 2004 Shareholders’ equity Short-term debt Long-term debt, including current portion Funded debt to total capital Adjusted debt to total capital(1) Debt to EBITDA Interest coverage Total assets $ 1,709.0 219.4 $ $ 1,567.6 140.8 $ $ 974.4 $ 995.7 41.4% 42.2% 57.4% 1.87x 5.35x $ 4,929.2 55.3% 1.98x 4.58x $ 4,679.7 (1) Adjusted debt includes capitalization of lease obligations based on six times net annual lease payments (gross lease payments net of expected sub-lease income). Shareholders’ Equity Total common shares outstanding at May 7, 2005 equalled 65,735,810, relatively unchanged from a year ago.There were 31,150,585 Non-Voting Class A shares outstanding and 34,585,225 Class B common shares outstanding at May 7, 2005. During ﬁscal 2005, 9,400 options were exercised compared to 30,000 in ﬁscal 2004. At May 7, 2005, Empire had 27,674 options outstanding expiring in October, 2006. During ﬁscal 2005 Empire purchased for cancellation 100,000 series 2 preferred shares for $2.5 million. Empire has a policy of repurchasing enough Class A Non-Voting shares to offset the dilutive effect of shares issued to fulﬁll the Company’s obligation under its stock option and share purchase plans. During ﬁscal 2005 Empire purchased 61,129 Non-Voting Class A shares for cancellation versus 68,477 shares purchased for cancellation in ﬁscal 2004. At July 15, 2005, Empire had 65,756,064 common shares outstanding, consisting of 31,170,839 Non-Voting Class A shares and 34,585,225 Class B common shares outstanding, along with 27,674 options outstanding expiring in October, 2006. Options allow the holder to purchase Non-Voting Class A shares at $6.555 per share. Dividends paid to common shareholders amounted to $31.6 million ($0.48 per share) versus $26.3 million ($0.40 per share) for the same period last year. Net Asset Value per Share ($ per share) 7 5 . 9 3 9 5 . 8 3 1 9 . 3 3 8 0 . 1 3 8 8 . 4 2 Closing Share Price ($ per share) Book Value per Share ($ per share) Common Dividends per Share ($ per share) 6 6 . 6 3 8 8 . 8 2 5 6 . 6 2 5 8 . 3 2 0 0 . 7 1 7 8 . 5 7 2 6 . 3 1 2 4 . 1 2 7 4 . 9 2 1 8 . 6 1 8 4 . 0 0 4 . 0 3 3 . 0 1 2 . 0 7 1 . 0 01 02 03 04 05 01 02 03 04 05 01 02 03 04 05 01 02 03 04 05 Fiscal Year Fiscal Year Fiscal Year Fiscal Year Empire Company Limited || 39 9667_Empire AR 05 B. F. MIL 7/25/05 11:26 AM Page 40 Management’s Discussion and Analysis Liabilities Empire ﬁnances a signiﬁcant portion of its assets through the use of debt (consisting of bank indebtedness, long- term debt and long-term debt due within one year), the majority of which is ﬁxed-rate and long-term in nature.Total ﬁxed-rate, long-term debt (including the current portion of long-term debt) at ﬁscal year-end of $861.3 million represents 71.4 percent of Empire’s total funded debt. Long-term debt (including current portion) by operating company is detailed in the table below. ($ in millions) May 7, 2005 April 30, 2004 Food Real Estate Other Operations Total $ $ 457.8 512.2 4.4 974.4 $ $ 453.1 538.2 4.4 995.7 Of the total long-term debt outstanding at ﬁscal year end, 47.0 percent was directly related to the food distribution segment, 52.6 percent was directly related to the real estate segment, and 0.4 percent was related to other operations.There is no long-term debt carried by the investment segment.The investment segment’s assets are short-term and liquid in nature, therefore associated ﬁnancing is also short-term. Empire ﬁnances its long-term assets predominately with ﬁxed-rate long- term debt, thereby reducing both interest rate and reﬁnancing risk. A total of $488.1 million in long-term debt is due within the next ﬁve years, and a further $486.3 million with longer maturities.The fair value of the Company’s long-term debt is estimated to be $1,126.0 million. Long-term debt maturities, including capital leases, in ﬁscal 2006 and 2007 amount to $247.0 million and $42.6 million, respectively.The Company anticipates being able to fund these maturities through the following sources of cash: cash generated from operations, use of short-term credit facilities and the issuance of additional long-term debt. Management monitors capital markets with a view to replacing maturing debt with new debt having longer-term maturities. 40 || 2005 Annual Report At May 7, 2005, interest coverage (operating income divided by interest expense) improved to 5.35 times from the 4.58 times coverage reported as of April 30, 2004.The improvement in coverage is the result of a 9.7 percent increase in year-over-year operating income coupled with a 6.2 percent decrease in interest expense over the same period.The ratio of debt to EBITDA also improved from last ﬁscal year end, reﬂecting the growth in EBITDA. The debt to total capital ratio declined 0.8 percentage points to 41.4 percent as a result of equity growing at a faster rate than funded debt. Excluding the impact of the VIEs (variable interest entities), the ratio of debt to total capital would be 40.8 percent.The net debt (debt less cash and cash equivalents) to total capital ratio declined 1.1 percentage points to 36.6 percent. The Company also monitors adjusted debt to total capital, where net annual lease payments are capitalized at six times annual lease payments, and this capitalized lease obligation is then added to funded debt. Adjusted debt to capital at ﬁscal year end was 57.4 percent versus 55.3 percent the prior year. Empire’s investment portfolio consisting of liquid publicly traded securities also strengthens the Company’s ﬁnancial position. At ﬁscal year end May 7, 2005 the portfolio carried a market value of $465.5 million (2004 – $390.9 million). Funded Debt to Total Capital (percentage) 6 . 9 4 4 . 6 4 9 . 5 4 2 . 2 4 4 . 1 4 Interest Coverage (times) 4 . 5 8 . 4 6 . 4 7 . 3 3 . 2 01 02 03 04 05 01 02 03 04 05 Fiscal Year Fiscal Year 9667_Empire AR 05 B. F. MIL 7/25/05 11:26 AM Page 41 Through established credit ratings, Empire and Sobeys maintain access to the capital markets. Empire has a corporate unsecured debt rating of BBB- (stable trend) from Standard & Poor’s and a debt rating of BBB (negative trend) from Dominion Bond Rating Service. Sobeys has a corporate unsecured debt rating of BBB- (stable trend) from Standard and Poor’s and a debt rating of BBB high (negative trend) from Dominion Bond Rating Service. Empire and its subsidiaries have provided covenants to its lenders in support of various ﬁnancing facilities. All covenants were complied with in ﬁscal 2005 and ﬁscal 2004. Empire anticipates ready availability of any required longer-term ﬁnancing due to its investment grade credit rating and previous experience in the capital markets. Financial Instruments Empire utilizes interest rate instruments from time to time to prudently manage exposure to interest rate volatility and also to ﬁx future long-term debt maturities which are expected to be reﬁnanced. At May 7, 2005, the gross notional amount of all interest exchange agreements totalled $43.8 million at rates ranging from 4.22 percent to 6.18 percent. To mitigate the currency risk associated with the Company’s U.S. dollar investments, Empire has designated U.S. bank loans as hedges.This debt is short- term in nature and provides ﬂexibility to hedge the U.S. dollar exposure. Empire and its subsidiaries use hedging instruments to mitigate risk exposure, not for speculative purposes. Sobeys has locked in the interest rate on the underlying government of Canada 15 year yield, for reﬁnancing $100 million of a November 2005 Series A Medium Term Note (MTN) maturity, using a bond forward. Liquidity and Capital Resources Sources of Liquidity Empire’s liquidity remains strong as a result of the following sources of liquidity: • Cash and cash equivalents on hand; • Unutilized bank credit facilities; • Availability of long-term debt ﬁnancing; • Empire’s portfolio of liquid investments; and • Cash generated from operating activities The Company anticipates that these sources of liquidity will be sufﬁcient to meet expected cash outﬂows over the next year. At May 7, 2005 cash and cash equivalents were $281.7 million versus $202.2 million at April 30, 2004. On a non-consolidated basis, Empire maintains authorized bank lines for operating, general and corporate purposes of $325.0 million, of which 41 percent was utilized at year-end. Financial instruments are used from time to time to manage the risk of short-term interest rate ﬂuctuations on underlying short-term bank indebtedness. On a consolidated basis, Empire’s authorized bank credit facilities exceeded borrowings by $548.2 million at May 7, 2005. The Company normally reﬁnances existing long- term debt as it matures, and maintains ﬁnancial ﬂexibility through its investment portfolio and access to the capital markets for additional long-term debt or equity ﬁnancing. Longer-term ﬁnancing is obtained by Sobeys’ through Canadian public debt markets via Sobeys’ established medium term note (MTN) program. Sobeys’ Short Form Base Shelf Prospectus, which enables the issuance of MTNs, expired on January 20, 2005. In view of the high levels of liquidity and access to committed credit facilities, Sobeys is determining when it will renew its MTN program. Sobeys also utilizes capital leases for the ﬁnancing of selected properties and assets.The Company, along with Sobeys, anticipates continued ready access to ﬁnancing sources as a result of in-place investment grade credit ratings as mentioned and previous capital markets experience. Empire Company Limited || 41 9667_Empire AR 05 B. F. MIL 7/25/05 11:26 AM Page 42 Management’s Discussion and Analysis Major Cash Flow Components ($ in millions) Earnings for Common Shareholders Items not affecting cash Net change in non-cash working capital Cash ﬂows from operating activities Cash ﬂows used in investing activities Cash ﬂows (used in) from ﬁnancing activities Discontinued operations Initial impact of variable interest entities $ 14 Weeks May 7, 2005 54.8 95.0 149.8 111.8 261.6 (205.8) 34.9 – 32.9 $ 13 Weeks April 30, 2004 40.8 80.2 121.0 147.7 268.7 (169.1) (26.9) – – $ 53 Weeks May 7, 2005 186.3 316.0 502.3 (15.7) 486.6 (447.0) 7.0 – 32.9 $ 52 Weeks April 30, 2004 172.1 272.3 444.4 22.8 467.2 (435.6) (147.5) 1.3 – Increase (decrease) in cash and cash equivalents $ 123.6 $ 72.7 $ 79.5 $ (114.6) Fiscal 2004 has been restated to reflect retroactive adjustments related to release accounting and EIC-144. See sections entitled “Lease Accounting” and “EIC-144” in this MD&A. Operating Activities Cash ﬂows from operating activities amounted to $261.6 million in the fourth quarter compared to $268.7 million in the fourth quarter last ﬁscal year.The decrease of $7.1 million was attributed to a decline in non-cash working capital of $35.9 million, offset by increased earnings for common shareholders of $14.0 million, and an increase in items not affecting cash of $14.8 million. Cash ﬂows from operating activities on an annual basis amounted to $486.6 million compared to $467.2 million last ﬁscal year.The increase of $19.4 million was the result of a $14.2 million improvement in earnings for common shareholders, a $43.7 million increase in items not affecting cash (primarily as a result of a $27.8 million increase in depreciation and amortization expense) offset by a $38.5 million decline in non-cash working capital. Major Components of Non-Cash Working Capital (Including VIEs) ($ in millions) Including VIEs as of May 7, 2005 $ Receivables Inventories Prepaid expenses Accounts payable and accrued liabilities Income taxes receivable (payable) Variable interest entities Business acquisitions and reclassiﬁcations 257.8 639.6 52.3 (1,149.1) 15.0 (74.2) (8.9) $ Jan. 29, 2005 298.9 543.5 40.8 (1,042.9) 12.5 – (8.5) Quarter Increase (Decrease) in Cash Flows $ 41.1 (96.1) (11.5) 106.2 (2.5) 74.2 0.4 $ April 30, 2004 329.5 483.6 49.3 (1,138.4) (7.2) – – Year-to-Date Increase (Decrease) in Cash Flows $ 71.7 (156.0) (3.0) 10.7 (22.2) 74.2 8.9 Total $ (267.5) $ (155.7) $ 111.8 $ (283.2) $ (15.7) Fiscal 2004 has been restated to reflect retroactive adjustments related to release accounting and EIC-144. See sections entitled “Lease Accounting” and “EIC-144” in this MD&A. 42 || 2005 Annual Report 9667_Empire AR 05 B. F. MIL 7/25/05 11:26 AM Page 43 Major Components of Non-Cash Working Capital (Excluding VIEs) ($ in millions) Excluding VIEs as of May 7, 2005 $ Receivables Inventories Prepaid expenses Accounts payable and accrued liabilities Income taxes receivable (payable) Business acquisitions and reclassiﬁcations 279.7 518.3 48.1 (1,119.5) 14.8 (8.9) $ Jan. 29, 2005 298.9 543.5 40.8 (1,045.7) 12.5 (8.5) Quarter Increase (Decrease) in Cash Flows $ 19.2 25.2 (7.3) 73.8 (2.3) 0.4 $ April 30, 2004 329.5 483.6 49.3 (1,138.4) (7.2) – Year-to-Date Increase (Decrease) in Cash Flows $ 49.8 (34.7) 1.2 (18.9) (22.0) 8.9 (15.7) Total $ (267.5) $ (158.5) $ 109.0 $ (283.2) $ Fiscal 2004 has been restated to reflect retroactive adjustments related to release accounting and EIC-144. See sections entitled “Lease Accounting” and “EIC-144” in this MD&A. Excluding the impact of VIEs, receivables decreased $19.2 million, inventory levels decreased $25.2 million and accounts payable and accrued liabilities increased $73.8 million compared to the third quarter of ﬁscal 2005. Contributing to the decrease in accounts receivable during the fourth quarter is the collection of supplier revenue that was outstanding at the end of the third quarter.The increase in accounts payable and accrued liabilities was consistent with the prior year and can be attributed to a combination of higher trade payables and higher accrued liabilities such as construction costs and employee incentives. Compared to April 30, 2004 ﬁscal year-end levels and excluding the impact of the VIEs, accounts receivable decreased $49.8 million, inventory increased $34.7 million and income taxes payable decreased $22.0 million.The decrease in receivables is primarily attributable to the reclassiﬁcation of $31.0 million of customer-related payables in the second quarter of ﬁscal 2005. Historically, some customer receivables were reported at a gross value and the customer payables were reported in accounts payable. During the second quarter of ﬁscal 2005, the food division began netting the receivables and related payables for these customers. The increase in inventory is required to support Sobeys’ expanded store network and growing sales. Investing Activities Cash ﬂows used in investing activities of $205.8 million in the fourth quarter was $36.7 million higher than in the fourth quarter of last ﬁscal year.The increase is largely the result of $58.6 million of cash used to purchase common shares of Sobeys in the quarter compared to $1.0 million used to purchase Sobeys’ shares in the fourth quarter last year. In ﬁscal 2004, proceeds from the sale of redundant real estate assets were partially offset by the cost of the Commisso’s acquisition. Fiscal year cash used in investing activities increased $11.4 million to total $447.0 million. Purchases of shares in Sobeys totalled $93.5 million in ﬁscal 2005 compared to $74.2 million last ﬁscal year. Other factors contributing to the increase included proceeds from the sale of property being $46.3 million lower than the prior year and purchases of property, equipment and other assets being down $59.0 million from the prior year. Consolidated on balance sheet purchases of property equipment and other assets totalled $372.0 million compared to $431.0 million last ﬁscal year.The table below presents balance sheet capital expenditures over the last two years by business segment. ($ in millions) Food Real estate Investments and other $ Total capital expenditures $ 2005 321.1 33.2 17.7 372.0 2004 384.9 34.2 11.9 431.0 $ $ Food division company-wide capital investment includes on-balance sheet capital expenditures, all known capital investments by franchise afﬁliates and capital investments by third-party landlords. Company- wide capital investment totalled $436 million in ﬁscal 2005, down from $553 million in the previous year. Sobeys remains committed to growing and improving its store network. During the fourth quarter, Empire Company Limited || 43 9667_Empire AR 05 B. F. MIL 7/25/05 11:26 AM Page 44 Management’s Discussion and Analysis 13 corporate and franchised stores were opened compared to 36 corporate and franchised stores opened, replaced or acquired during the fourth quarter of last year. During the fourth quarter of ﬁscal 2004, Sobeys completed the acquisition of 15 stores, six cash and carry outlets and the wholesale business of Commisso’s. An additional seven stores were expanded during the quarter.There were 16 stores rebannered in the current quarter compared to 20 for the same quarter last year. On an annual basis, the food division opened 41 corporate and franchised stores this ﬁscal year compared to 76 corporate and franchise stores opened or replaced last year. An additional 19 stores were expanded in the year compared to 18 stores last year and 36 stores were rebannered this year compared to 90 last year. Net retail store square footage increased during the fourth quarter by 189,516 square feet (327,902 square feet opened, less 138,386 square feet closed). Net retail store additions for the year totalled 578,517 square feet (1,042,599 square feet opened less 464,082 square feet closed). At May 7, 2005, Sobeys’ square footage totalled 25.0 million square feet, a 2.5 percent increase over the beginning of the ﬁscal year. Sobeys continues to focus on growth through a combination of new store openings, renovations, replacements and enlargements and, where appropriate, through strategic acquisitions.The majority of total Food Capital Expenditures ($ in millions) Real Estate Capital Expenditures ($ in millions) 9 . 8 5 4 2 . 1 1 4 9 . 4 8 3 1 . 1 2 3 7 . 6 5 2 1 . 8 4 2 . 4 3 2 . 3 3 1 . 5 2 6 . 0 2 01 02 03 04 05 01 02 03 04 05 Fiscal Year Fiscal Year 44 || 2005 Annual Report company-wide capital spending in ﬁscal 2006, which will approximate the average spending of the past number of years, will be allocated to the retail store network. During ﬁscal 2006, the Company plans to open, expand, or renovate approximately 70 corporate and franchised stores across Canada, increasing square footage by approximately four percent. During ﬁscal 2005 the Real estate division capital spending was primarily focused around the modernization and development of existing commercial properties such as conversion of the Downsview Mall in Lower Sackville, Nova Scotia from an enclosed shopping centre to a strip centre and the renovation of the Avalon Mall Food Court in St. John’s, Newfoundland. New developments in Central Canada consisted of the Greenﬁeld Park commercial development in Montreal, Quebec and the purchase of land for development in Oshawa, Ontario. Capital spending by investments and other operations equalled $17.7 million in ﬁscal 2005 ($11.9 million in 2004) largely as a result of expenditures to acquire and modernize the four theatre locations (23 screens) purchased by Empire Theatres from Viacom Canada Inc. during the year. Financing Activities Financing activities during the fourth quarter generated $34.9 million in cash compared to $26.9 million of cash used in the comparable period of ﬁscal 2004. The Company incurred increased bank loans of $43.3 million in the fourth quarter primarily in connection with the purchase of common shares in Sobeys. In the fourth quarter of ﬁscal 2004, bank loans of $4.4 million were repaid. For the ﬁscal year, ﬁnancing activities increased cash by $7.0 million compared to $147.5 million of cash used in ﬁnancing activities the prior year. Repayments of long-term debt were signiﬁcantly higher last ﬁscal year, largely reﬂecting the repayment of a $100 million Series B MTN in the second quarter ﬁscal 2004. Also in ﬁscal 2005, the issuance of long- term debt totaling $39.9 million was $25.0 million higher than the long-term debt issued the prior year. Further, the Company increased its bank indebtedness by $78.6 million in ﬁscal 2005 compared to a $41.5 million increase in bank indebtedness last year. 9667_Empire AR 05 B. F. MIL 7/25/05 11:26 AM Page 45 The Company’s share capital was comprised of the following at its ﬁscal year end, May 7, 2005: Accounting Standards Authorized Number of Shares Preferred shares, par value of $25 each, issuable in series as a class 2002 Preferred Shares, par value 2,846,000 $25 each, issuable in series as a class 992,000,000 Non-Voting Class A shares, without par value Class B common shares, without par value, voting 259,174,746 40,800,000 Issued Preferred shares, Series 2 cumulative, redeemable, rate of 75% of prime Non-Voting Class A Class B common 331,900 31,150,585 34,585,225 CICA Section 1100, Generally Accepted Accounting Principles During ﬁscal 2004, the Canadian Institute of Chartered Accountants (“CICA”) introduced Handbook Section 1100 which discusses primary sources of GAAP, what to do when a matter is not dealt with explicitly in the sources of GAAP and identiﬁes other sources to be consulted when a matter is not addressed within the sources of GAAP. Effective May 1, 2004, the Company adopted this handbook section prospectively without restatement. As a result the Company now recognizes depreciation of real estate buildings, rental expense and income from tenant leases on a straight-line basis. Adoption of the straight-line method of depreciation resulted in additional depreciation of $1.2 million during ﬁscal 2005. As of July 15, 2005 the Company had common Effective May 1, 2004, the Company also changed shares outstanding of 65,756,064. Dividend Payments Dividends of $31.6 million ($0.48 per share) were paid in ﬁscal 2005 on Empire’s common shares, up from the $26.3 million ($0.40 per share) paid in ﬁscal 2004.The dividend rate increased from $0.40 to $0.48 per share. There was no material change in the number of common shares outstanding year-over-year. Debt Repayments Empire’s repaid long-term debt of $79.8 million during ﬁscal 2005 compared to $188.9 million in long-term debt repayments made in ﬁscal 2004. In ﬁscal 2004 Sobeys repaid a $100 million Series B MTN; reﬁnancing with proceeds of a new MTN issued in February 2003. Share Repurchases During ﬁscal 2005, Empire repurchased 61,129 Non- Voting Class A shares ($1.6 million) under a Normal Course Issuer Bid announced on July 8, 2004.The Company issued 42,129 Non-Voting Class A shares ($0.9 million) to fulﬁll its obligations under its stock option and share purchase plans. The Company anticipates that its capital resources and liquidity position will meet its capital and liquidity requirements over the next year, which is expected to include capital expenditures, dividends and planned debt reduction. its policy to record real estate lease expense on a straight-line basis. Additional real estate lease expense of $2.7 million was recorded in ﬁscal 2005 as a result of this policy change.The Company also changed its policy to record income of a straight-line basis, resulting in additional straight-line real estate revenue of $2.2 million during ﬁscal 2005. EIC-144, Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor In January 2004, the CICA issued a new accounting standard, EIC-144 titled “Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor”. EIC-144 provides that cash consideration received from a vendor is presumed to be a reduction in the prices of the vendor’s products or services and should, therefore, be characterized as a reduction in cost of sales and related inventory when recognized in the customer’s income statement and balance sheet. If the consideration is a payment for assets or services delivered to the vendor, the cash consideration should be characterized as revenue or other income. If it is a reimbursement of costs incurred to sell the vendor’s products, the cash consideration should be characterized as a reduction of that cost, provided certain conditions are met. EIC-144 requires retroactive application to all ﬁnancial statements for annual and interim periods ending after August 15, Empire Company Limited || 45 9667_Empire AR 05 B. F. MIL 7/25/05 11:26 AM Page 46 Management’s Discussion and Analysis 2004.The Company adopted EIC-144 in the current ﬁscal year, adjusting for it retroactively, with restatement of the comparative periods for the current and prior ﬁscal year. The Company receives allowances from certain vendors, whose products are purchased for resale. Included in these vendor programs are allowances for volume purchases, exclusivity allowances, listing fees, and other allowances. Due to the retroactive implementation of EIC-144, the timing of recognition of certain vendor allowances has changed, resulting in the Company recording a decrease in opening retained earnings for ﬁscal 2004 of $3.8 million (net of income taxes receivable of $3.4 million and minority interest of $2.1 million), and a decrease in inventory of $9.3 million.The implementation of EIC-144 did not result in a material change in the annual net earnings for ﬁscal 2005 or ﬁscal 2004 or in ﬁscal 2005 or ﬁscal 2004 quarterly net earnings. CICA Section 3870, Stock-Based Compensation and Other Stock-Based Payments At the beginning of ﬁscal 2003, the Company adopted, on a prospective basis, the CICA Handbook 3870 “Stock-Based Compensation and Other Stock-Based Payments”.There was no effect on the Company upon implementation of this standard. In ﬁscal 2004, the Company adopted the Emerging Issues Committee Abstract 132 “Share Purchase Financing”.This abstract requires share purchase loans that are not treated as assets on the balance sheet to be accounted for as stock-based compensation.There was no effect on the Company upon implementation of this abstract. AcG-13, Hedging Relationships Accounting guideline (“AcG”) 13, “Hedging Relationships”, came into effect during the current ﬁscal year.This guideline addresses the identiﬁcation, designation, documentation and effectiveness of hedging relationships for the purpose of applying hedge accounting and provides guidance with respect to the discontinuance of hedge accounting.There was no effect on the Company of prospectively adopting this guideline. 46 || 2005 Annual Report CICA Section 3110, Asset Retirement Obligations During the current ﬁscal year, CICA Handbook Section 3110, “Asset Retirement Obligations,” was adopted.This section establishes standards for the recognition, measurement, and disclosure of legal obligations associated with the costs to retire long-lived assets. A liability associated with the retirement of long- lived assets is recorded in the period in which the legal asset is capitalized as part of the related asset and depreciated over its useful life. Subsequent to the initial measurement of the asset retirement obligation, the obligation is adjusted to reﬂect the passage of time and changes in the estimated future costs underlying the obligation.There has been no impact on the Company from the retroactive adoption of this section. Lease Accounting On February 7, 2005, the Ofﬁce of the Chief Accountant of the U.S. Securities and Exchange Commission (“SEC”) issued a clariﬁcation in respect of accounting for various components of property leases and leasehold improvements on which U.S. and Canadian accounting governing bodies had been largely silent. As a result of the SEC clariﬁcation the Company has adopted the following two accounting policies: lease inducements received as a reimbursement for leasehold improvement (costs are amortized over the term of the lease) and lease expense related to a store fixturing period (is expensed during the fixturing period). A store ﬁxturing period varies by store but is generally considered to be one month prior to the store opening. The Company has adopted this guideline retroactively with restatement. The Company has reviewed its practices related to lease accounting and has determined that adjustments were required to align to the recent clariﬁcation of lease accounting guidelines.The ﬁrst adjustment relates to lease allowances and incentives. Historically the Company classiﬁed lease allowances as a reduction of the related capital assets, which effectively reduced the depreciation expense over the expected life of the asset. The guideline clariﬁcation suggests these lease allowances should be recorded as a deferred credit and amortized as a reduction of lease expense over the term of the lease.The second adjustment relates to rent expense to be recorded during a store’s ﬁxturing period.The Company is often granted a ﬁxturing period during 9667_Empire AR 05 B. F. MIL 7/25/05 11:26 AM Page 47 Variable interest entities are deﬁned under AcG-15 as entities that do not have sufﬁcient equity at risk to ﬁnance their activities without additional subordinated ﬁnancial support, or where the equity holders lack the overall characteristics of a controlling ﬁnancial interest. The guideline requires that the VIE be consolidated with the ﬁnancial results of the entity deemed to be the primary beneﬁciary of the VIEs’ expected losses and its expected residual returns. The Company has implemented AcG-15 on May 7, 2005 retroactively without restatement of prior periods. Entities that have been identiﬁed as meeting the characteristics of a VIE have been consolidated in the Company’s results for the fourth quarter of ﬁscal 2005. The Company has identiﬁed the following entities as VIEs: Franchisees The Company has identiﬁed 287 franchisees whose franchise agreements result in the Company being deemed the primary beneﬁciary of the entity according to AcG-15.The results for these entities were consolidated with the results of the Company. Warehouse and Distribution Agreement The Company has an agreement with an independent entity to provide warehouse and distribution services. The terms of the agreement with this entity require the Company to consolidate its results with those of the Company pursuant to AcG-15. The Company has consolidated the results of these independent franchisees and the entity providing warehouse and distribution services for the fourth quarter of ﬁscal 2005. which rent is not charged.The ﬁxturing is generally considered to be one month prior to the store opening. Historically, when the Company was granted a ﬁxturing period rent expense was not recorded as none was being charged and the store was not yet open.The clariﬁcation of the accounting guidance however requires that the ﬁxturing period be considered a free-rent period that should be included in the term of the lease. Since lease expense must be recognized on a straight-line basis over the lease term an appropriate portion of the straight- line expense must be recorded for the ﬁxturing period. The third adjustment relates to the capitalization of long term leases. An evaluation was completed in the fourth quarter of the current year and certain long term leases have been identiﬁed as capital leases.These changes have been accounted for on a retroactive basis with restatement resulting in the following net impact on the comparative statements for the period ended May 7, 2005: • As at April 30, 2004 a reduction to retained earnings of $5.4 million. • A reduction in net income for the 52 week period ended April 30, 2004 of $0.6 million from $173.1 million to $172.5 million, and a reduction in earnings per share from $2.63 to $2.62. • As at April 30, 2004 an increase to property and equipment, future income taxes, long-term debt and long-term lease obligation of $10.1 million, $4.4 million, $10.3 million and $12.5 million respectively, and a decrease in minority interest of $2.9 million. These lease accounting adjustments did not have any material impact on the Company’s ﬁscal 2005 net earnings, historical or future revenues, cash ﬂows or lease payments. AcG-15, Consolidation of Variable Interest Entities Effective for the fourth quarter ended May 7, 2005, the Company was required to implement Accounting Guideline 15 “Consolidation of Variable Interest Entities” (“AcG-15”) issued by the CICA. AcG-15 requires the Company to consolidate certain entities that are deemed to be subject to control of the Company on a basis other than through ownership of a voting interest in the entity. Empire Company Limited || 47 9667_Empire AR 05 B. F. MIL 7/25/05 11:26 AM Page 48 Management’s Discussion and Analysis Impact of the Consolidation of VIEs Balance Sheet as at May 7, 2005 ($ in millions) Assets Current Cash and cash equivalents Receivables Income taxes receivable Inventories Prepaid expenses Investments, at cost (quoted market value $320.9) Investments, at equity (realizable value $162.4) Current assets and marketable investments Property and equipment Assets for realization Other assets Goodwill Liabilities Current Bank indebtedness Accounts payable and accrued liabilities Future income taxes Long-term debt due within one year Long-term debt Long-term lease obligations Deferred revenue Employee future beneﬁt obligations Future income taxes Minority interest Shareholders’ Equity Capital stock Retained earnings Cumulative translation adjustment 48 || 2005 Annual Report Consolidated Balance Sheet as at May 7, 2005 before AcG-15 Impact Impact of the Implementation of AcG-15 Consolidated Balance Sheet as at May 7, 2005 after AcG-15 Impact $ $ $ $ 247.6 279.7 14.8 518.3 48.1 1,108.5 270.8 72.9 1,452.2 2,395.3 11.5 321.7 684.9 $ 4,865.6 $ 219.4 1,119.5 52.4 245.1 1,636.4 709.6 12.3 3.0 94.5 158.8 531.9 3,146.5 194.6 1,525.6 (1.1) 1,719.1 $ 4,865.6 $ 34.1 (21.9) 0.2 121.3 4.2 137.9 – – 137.9 34.5 – (108.8) – 63.6 – 29.6 – 1.9 31.5 17.8 – – – – 24.4 73.7 – (10.1) – (10.1) 63.6 $ 281.7 257.8 15.0 639.6 52.3 1,246.4 270.8 72.9 1,590.1 2,429.8 11.5 212.9 684.9 $ 4,929.2 $ 219.4 1,149.1 52.4 247.0 1,667.9 727.4 12.3 3.0 94.5 158.8 556.3 3,220.2 194.6 1,515.5 (1.1) 1,709.0 $ 4,929.2 9667_Empire AR 05 B. F. MIL 7/25/05 11:26 AM Page 49 The impact of implementation of AcG-15 on the consolidated balance sheet of the Company can be explained as follows: • Accounts receivable and long-term notes receivable due from the franchisees were eliminated upon consolidation. Cash, inventories, ﬁxed assets, accounts payable and debt ﬁnancing of the ﬁxed assets have been consolidated. • A charge of $9.5 million has been recorded to opening retained earnings (net of minority interest of $5.0 million) to reﬂect: a) the reduction of inventory values of the franchisees that include charges from the Company for distribution costs and vendor allowances that are not recognized by the Company until ﬁnal sale to customers, and b) goodwill that is carried on the accounts of stores determined to be VIEs has been assessed as being impaired with no fair market value, and, as such, has been eliminated. • Minority interest represents the equity in the VIEs held by the common shareholders. Income Statement impact for 53 weeks ended, May 7, 2005. ($ in millions) Revenue Operating expenses Consolidated Income Statement before AcG-15 Impact Consolidated Impact of the Income Statement after AcG-15 Impact Implementation of AcG-15 $ 12,297.8 $ 137.4 $ 12,435.2 Cost of sales, selling and administrative expenses Depreciation and amortization 11,655.2 199.7 135.8 1.8 11,791.0 201.5 Investment income Operating income Interest expense Long-term debt Short-term debt Capital gain and other items Earnings before income taxes and minority interest Income taxes Earnings before minority interest Minority interest Net earnings Earnings per share basic and diluted Basic and diluted weighted average number of common shares outstanding, in millions 442.9 21.0 463.9 81.1 5.1 86.2 377.7 4.4 382.1 131.3 250.8 63.8 187.0 2.84 65.7 $ $ (0.2) – (0.2) 0.4 0.1 0.5 (0.7) – (0.7) (0.1) (0.6) (0.2) (0.4) (0.01) $ $ 442.7 21.0 463.7 81.5 5.2 86.7 377.0 4.4 381.4 131.2 250.2 63.6 186.6 2.83 65.7 $ $ The impact of implementation of AcG-15 on the consolidated income statement of the Company can be explained as follows: Franchise retail sales are recorded and sales from the Company’s distribution centres and cost of goods sold to the franchisee have been eliminated.The impact on all other ﬁnancial statement line items including net earnings is immaterial. Empire Company Limited || 49 9667_Empire AR 05 B. F. MIL 7/25/05 11:26 AM Page 50 Management’s Discussion and Analysis Critical Accounting Estimates Pension, Post-Retirement and Post-Employment Beneﬁts Certain estimates and assumptions are used in actuarially determining the Company’s deﬁned pension and employee future beneﬁt obligations. Signiﬁcant assumptions used to calculate the pension and employee future beneﬁt obligations are the discount rate, the expected long-term rate of return on plan assets and expected growth rate of health care costs.These assumptions depend on various underlying factors such as economic conditions, investment performance, employee demographics and mortality rates.These assumptions may change in the future and may result in material changes in the pension and employee beneﬁt plans expense.The magnitude of any immediate impact, however, is mitigated by the fact that net actuarial gains and losses in excess of 10 percent of the greater of the accrued beneﬁt plan obligation and the market value of the beneﬁt plan assets are amortized on a straight-line basis over the average remaining service period of the active employees. Changes in ﬁnancial market returns and interest rates could also result in changes in funding requirements for the Company’s deﬁned beneﬁt pension plans. The discount rate is based on current market interest rates, assuming a portfolio of Corporate AA bonds with terms to maturity that, on average, match the terms of the obligation.The appropriate discount rate is determined on April 30th every year. For ﬁscal 2005, the discount rate used for calculation of pension and other beneﬁt plan expense was 5.5 percent compared to 6.0 percent for ﬁscal 2004.The expected long-term rate of return on plan assets for pension beneﬁt plans for each of ﬁscal 2005 and 2004 was 7.0 percent.The expected growth rate in health care costs is 10 percent for ﬁscal 2005.The cumulative growth rate to 2012 is expected to be 6.0 percent.The expected future growth rate is evaluated on an annual basis.The table below outlines the sensitivity of the 2005 key economic assumptions used in measuring the accrued beneﬁt plan obligations and related expenses of the Company’s pension and other beneﬁt plans.The sensitivity of each key assumption has been calculated independently. Changes to more than one assumption simultaneously may amplify or reduce the impact on the accrued beneﬁt obligations or beneﬁt plan expenses. Pension Plans Other Benefit Plans ($ in millions) Expected long term rate of return on plan assets Impact of: 1% increase Impact of: 1% decrease Discount rate Impact of: 1% increase Impact of: 1% decrease Growth rate of health care costs(1) Impact of: 1% increase Impact of: 1% decrease Benefit Obligations 5.50% (29.3) 32.9 $ $ Benefit Cost(1) 7.00% (2.4) 2.4 5.50% 0.3 (0.6) $ $ $ $ Benefit Obligations Benefit Cost(1) 5.75% (15.7) 18.9 10.00% 15.9 (13.0) $ $ $ $ 5.75% (0.8) 0.9 10.00% 1.9 (1.5) $ $ $ $ (1) Reflects the impact on the current service cost, the interest cost and the expected return on assets. 50 || 2005 Annual Report 9667_Empire AR 05 B. F. MIL 7/25/05 11:26 AM Page 51 Goodwill and Long Lived Assets Goodwill is not amortized and is assessed for impairment at the reporting unit level at least annually. Any potential goodwill impairment is identiﬁed by comparing the fair value of a reporting unit to its carrying value. If the fair value of the reporting unit exceeds its carrying value, goodwill is considered not to be impaired. If the carrying value of the reporting unit exceeds its fair value, potential goodwill impairment has been identiﬁed and must be quantiﬁed by comparing the estimated fair value of the reporting unit’s goodwill to its carrying value. Any goodwill impairment will result in a reduction in the carrying value of goodwill on the consolidated balance sheet and in the recognition of a non-cash impairment charge in operating income. The Company periodically assesses the recoverability of long-lived assets when there are indications of potential impairment. In performing these analyses, the Company considers such factors as current results, trends and future prospects, current market value and other economic factors. A substantial change in estimated undiscounted future cash ﬂows for these assets could materially change their estimated fair values, possibly resulting in additional impairment. Changes which may impact future cash ﬂows include, but are not limited to, competition and general economic conditions and unrecoverable increases in operating costs. Income Taxes Future income tax assets and liabilities are recognized for the future income tax consequences attributable to temporary differences between the ﬁnancial statement carrying values of assets and liabilities and their respective income tax bases. Future income tax assets or liabilities are measured using enacted or substantively enacted income tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.The calculation of current and future income taxes requires management to make estimates and assumptions and to exercise a certain amount of judgement.The ﬁnancial statement carrying values of assets and liabilities are subject to accounting estimates inherent in those balances.The income tax bases of assets and liabilities are based upon the interpretation of income tax legislation across various jurisdictions.The current and future income tax assets and liabilities are also impacted by expectations about future operating results and the timing of reversal of temporary differences as well as possible audits of tax ﬁlings by the regulatory authorities. Management believes it has adequately provided for income taxes based on current available information. Changes or differences in these estimates or assumptions may result in changes to the current or future income tax balances on the consolidated balance sheet. A charge or credit to income tax expense may result in cash payments or receipts. Disclosure Controls Based on an evaluation of the Company’s disclosure controls and procedures, the Company’s Chief Executive Ofﬁcer and Chief Financial Ofﬁcer have concluded as of May 7, 2005 that these controls and procedures operated effectively. Related Party Transactions Sobeys continues to lease certain real property from Crombie and its afﬁliates at fair market values.The rates are determined based primarily on the ﬁnancing of the actual costs incurred at the time of construction of the leased properties.The aggregate net payments under these leases amounted to approximately $56.8 million (2004 – $52.2 million). Sobeys was charged administrative expenses of $0.3 million (2004 – $0.4 million). Empire Theatres leased certain real property from Crombie and its afﬁliates, at fair market value, during the year.The aggregate payments under the leases amounted to approximately $4.4 million (2004 – $3.2 million). Empire Company Limited || 51 9667_Empire AR 05 B. F. MIL 7/25/05 11:26 AM Page 52 Management’s Discussion and Analysis Contingencies During the fourth quarter, Lumsden Brothers Limited (“Lumsden”), a wholesaling subsidiary of Sobeys, received notice from Canada Revenue Agency (CRA) that it is proposing a reassessment related to Goods and Services Tax (GST) for ﬁscal years 1999 and 2000.The proposed reassessment relates to GST on sales of tobacco products to status Indians. CRA asserts that Lumsden was obliged to collect GST on the sales of these tobacco products to status Indians.The total tax, interest and penalties in the proposed reassessment are approximately $13 million. On June 17, 2005, Lumsden received a notice of reassessment from Canada Revenue Agency (CRA) related to the Goods and Services Tax (GST) matter outlined above. Lumsden has reviewed this matter, has received legal advice, and believes it was not required to collect GST. Lumsden is challenging this reassessment. Accordingly, Sobeys has not recorded in its ﬁnancial statements any of the tax, interest or penalties set-out in the notice of reassessment. The table below illustrates the Company’s signiﬁcant contractual obligations. ($ in millions) Long-term debt Capital leases Operating leases Total contractual obligations $ 2006 242.0 5.0 205.3 $ 2007 38.9 3.7 186.7 $ 2008 73.8 3.3 163.3 $ 2009 75.4 2.9 146.5 $ 2010 Onwards 41.0 2.1 132.6 $ 480.1 6.2 1,091.9 $ Total 951.2 23.2 1,926.3 $ 452.3 $ 229.3 $ 240.4 $ 224.8 $ 175.7 $ 1,578.2 $ 2,900.7 Operating leases, net of lease income received by the Company, are as follows: ($ in millions) 2006 2007 2008 2009 2010 Onwards Total $ 129.3 $ 115.1 $ 99.1 $ 88.0 $ 80.6 $ 708.2 $ 1,220.3 Other contractual obligations not reﬂected in the table above are discussed below. At May 7, 2005, Sobeys was contingently liable for letters of credit issued in the aggregate amount of $26.2 million (2004 – $22.0 million). Sobeys has also guaranteed certain bank loans contracted by franchisees. As at May 7, 2005, these loans amounted to approximately $2.4 million (2004 – $5.0 million). Upon entering into the lease of its new Mississauga distribution centre in March 2000, Sobeys Capital Incorporated guaranteed to the landlord the performance by SERCA Foodservice Inc. of all of its obligations under the lease.The remaining term of the lease is 15 years with an aggregate obligation of $46.2 million. At the time of the sale of assets of SERCA Foodservice Inc. to Sysco Corporation, the lease of the Mississauga distribution centre was assigned to and assumed by a subsidiary of the purchaser and Sysco Corporation agreed to indemnify and hold Sobeys Capital Incorporated harmless from any liability it may incur pursuant to its guarantee. Sobeys leases space for certain company-owned and franchised stores.The terms of these leases vary by location with typical renewal options. At May 7, 2005 Crombie was contingently liable for letter of credit issued in the aggregate amount of $17.7 million (2004 – $20.0 million). 52 || 2005 Annual Report 9667_Empire AR 05 B. F. MIL 7/25/05 11:26 AM Page 53 Risk Management Through its operating companies and investment portfolio, Empire is exposed to a number of risks in the normal course of business that have the potential to affect its operating performance.The Company has operating and risk management strategies and insurance programs to help minimize these operating risks. Competition Empire’s food retail business, through Sobeys, operates in a dynamic and competitive market. Other national and regional food distribution companies along with non-traditional competitors, such as mass merchandisers and warehouse clubs, represent a competitive risk to Sobeys’ ability to attract customers and operate proﬁtably in its markets. Sobeys maintains a strong national presence in the Canadian retail food and food distribution industry. The most signiﬁcant risk to Sobeys is the potential for reduced revenues and proﬁt margins as a result of increased competition.To mitigate this risk, Sobeys’ strategy is to be geographically diversiﬁed with the beneﬁts of national scale, to be customer and market- driven, to be focused on superior execution, and to have efﬁcient, cost effective operations. Sobeys reduces its exposure to competitive or economic pressures in any one region of the country by operating in each region of Canada through a network of corporate, franchised, and afﬁliated stores, and through servicing the needs of thousands of independent, wholesale accounts. Sobeys approaches the market with a variety of store formats, sizes, and banners, in order to enhance proﬁtability by region and by target market. Empire’s real estate operations compete with numerous other developers, managers, and owners of real estate properties in seeking tenants and new properties for future development.The existence of competing developers, managers, and owners could affect our real estate group’s ability to lease space in its properties and on rents charged or concessions granted. Commercial property revenue is also dependent on the renewal of lease arrangements by key tenants.These factors could adversely affect revenues and cash ﬂows. Other than space leased to afﬁliated companies, no one tenant accounts for more than 5.0 percent of real estate division total base rental income. Continued growth of rental income is dependant on renewing expiring leases and ﬁnding new tenants to ﬁll vacancies at market rental rates, hereby ensuring an attractive return on our investment.The success of the real estate portfolio is also subject to general economic conditions, the supply and demand for rental property in key markets served, and the availability of attractive ﬁnancing to expand the real estate portfolio where deemed prudent. During ﬁscal 2005, our real estate operations encountered generally positive economic conditions in our key markets and a relative lack of new rental space resulted in relatively stable rental rates. Financial Empire and its operating companies have adopted a number of ﬁnancial policies to manage interest rate risk and foreign exchange risk. The majority of Empire’s consolidated debt is at ﬁxed rates and accordingly there is limited exposure to interest rate ﬂuctuations. Fixed rate debt issues have staggered maturity dates which minimize the Company’s exposure to reﬁnancing risk. In the ordinary course of managing ﬂoating rate debt, the Company utilizes ﬁnancial instruments from time to time to manage the volatility of borrowing costs. Financial instruments are not used for speculative purposes. Insurance Empire and its subsidiaries are self-insured on a limited basis with respect to certain operational risks. In addition to maintaining comprehensive loss prevention programs and management programs to mitigate the ﬁnancial impact of operational risks, the Company and its afﬁliates also purchase excess insurance coverage from ﬁnancially stable third-party insurance companies. Human Resources Empire is exposed to the risk of labour disruption in its operating companies. Subsequent to year-end, Sobeys successfully ratiﬁed a four-year collective agreement with employees located at its Edmonton, Alberta distribution centre. Labour disruptions pose a moderate operational risk, as Sobeys operates an integrated network of more than 20 distribution centres across the country. Sobeys have good relations with its employees and unions and does not anticipate any material labour disruptions in ﬁscal 2006. However, Sobeys has stated Empire Company Limited || 53 9667_Empire AR 05 B. F. MIL 7/25/05 11:26 AM Page 54 Management’s Discussion and Analysis that it will accept the short-term costs of a labour disruption to support a steadfast commitment to maintaining fair and equitable work environments while building and sustaining a competitive cost structure for the long term. Effective leadership is very important to the growth and continued success of the Company.The Company develops and delivers training programs at all levels across its various operating regions in order to improve employee knowledge and better serve its customers.The ability of Sobeys to properly develop and retain its employees could affect the Company’s future performance. Environmental, Health and Safety Empire has an effective environmental, health and safety program in place including policies targeted at ensuring compliance with relevant legislation. Employee awareness and training programs are conducted and environmental, health and safety risks are reviewed on a regular basis. Any environmental site remediation is completed using appropriate, qualiﬁed internal and external resources and health and safety issues are proactively dealt with.The Board of Directors receives regular reports which review outstanding matters, identify new legislation and outline new programs being implemented across the Company to positively impact the environment and employee health and safety. Existing environmental protection regulatory requirements are not expected to have a material ﬁnancial or operational effect on the capital expenditures, earnings or competitive position of the Company during the current ﬁscal year or in future years. Sobeys has developed programs to promote a healthy and safe workplace, as well as progressive employment policies focused on the well being of the thousands of employees who work in its stores, distribution centres and ofﬁces.These policies and programs are reviewed regularly by the Human Resources Committee of the Board. Each operating business conducts an ongoing, comprehensive environmental monitoring process and the Company is unaware of any material environmental liabilities in any of its operating companies. Empire’s Board of Directors receives quarterly reports that review any outstanding issues including plans to resolve them. 54 || 2005 Annual Report Food Safety Sobeys is subject to potential liabilities connected with its business operations, including potential liabilities and expenses associated with product defects, food safety and product handling. Such liabilities may arise in relation to the storage, distribution and display of products and, with respect to private label products, in relation to the production, packaging and design of products. A large majority of Sobeys’ sales are generated from food products and Sobeys could be vulnerable in the event of a signiﬁcant outbreak of food-borne illness or increased public health concerns in connection with certain food products. Such an event could materially affect ﬁnancial performance. Procedures are in place to manage food crises, should they occur.These procedures identify risks, provide clear communication to employees and consumers and ensure that potentially harmful products are removed from inventory immediately. Food safety related liability exposures are insured by the Company’s insurance program. In addition, Sobeys has food safety procedures and programs, which address safe food handling and preparation standards. Sobeys employs best practices for storage and distribution of food products. Technology The Company and each of its operating companies are committed to improving their respective operating systems, tools and procedures in order to become more efﬁcient and effective.The implementation of major information technology projects carries with it various risks that must be mitigated by disciplined change management and governance processes. Sobeys has a business process optimization team staffed with knowledgeable internal and external resources that is responsible for implementing the various initiatives. Sobeys’ Board of Directors also created an Oversight Committee to ensure appropriate governance of these change initiatives is in place and this committee receives regular reports from the Company’s management. 9667_Empire AR 05 B. F. MIL 7/25/05 11:26 AM Page 55 small produce brokerage business based in the State of Florida. Crombie, through its interest in Genstar, has certain residential land development in the California market but on a limited scale.These foreign operations are relatively small and are not considered material to Empire on a consolidated basis, as such, the Company does not have any material risks associated with foreign operations. Foreign Currency The Company conducts the majority of its operating business in Canadian dollars and its foreign exchange risk is limited to currency ﬂuctuations between the Canadian and U.S. dollar. U.S. dollar purchases of product by the food division represent approximately two percent of the Company’s total annual purchases. Sobeys uses forward contracts to ﬁx the exchange rate on some of its expected requirements for U.S. dollars for periods of not more than 30 days. At May 7, 2005, Empire had common equity investments totalling $106.9 million denominated in U.S. dollar currency.To mitigate exposure to currency ﬂuctuation, the Company has hedged a portion of its foreign currency exposure through the use of U.S. dollar denominated debt against the assets. At May 7, 2005 the ratio of U.S. dollar debt to the market value of U.S. equities was 57.1 percent. Equity Price Risk The carrying values of the investments in Empire’s investment portfolio are based on cost; however the realizable value of each investment and therefore the portfolio is based on market prices and is subject to market price ﬂuctuations. Empire has a disciplined, long-term approach to select quality investments and has been successful in generating above market portfolio returns.While portfolio returns may not match those of the prior year, or exceed median manager returns, management will continue to manage the portfolio prudently to ensure appropriate diversiﬁcation and liquidity. Real Estate The Company is focused on obtaining the most attractive real estate locations for its retail grocery stores as well as for its commercial property operations and residential development operations, with direct Company ownership being an important, but not overriding, consideration. Sobeys develops certain retail store locations on owned sites, however, the majority of its store development is done in conjunction with external developers.The availability of high potential new store sites and/or the ability to expand existing stores is therefore in large part contingent upon successful negotiation of operating leases with these developers and Sobeys ability to purchase high potential sites. Legal, Taxation and Accounting Changes to any of the various federal and provincial laws, rules and regulations related to the Company’s business could have a material impact on its ﬁnancial results. Compliance with any proposed changes could also result in signiﬁcant cost to the Company. Failure to fully comply with various laws, rules and regulations may expose the Company to proceedings which may materially affect its performance. Similarly, income tax regulations and/or accounting pronouncements may be changed in ways which could negatively affect the Company. Franchise Operations The success of Sobeys is closely tied to the performance of its retail stores. Franchisees operate approximately 61 percent of these retail stores. Sobeys relies on the franchisees to successfully execute retail programs and strategies. To maintain controls over Sobeys’ brands and the quality and range of products and services offered at its stores, each franchisee agrees to purchase merchandise from Sobeys. In addition, each franchisee agrees to comply with the policies, marketing plans and operating standards prescribed by Sobeys.These obligations are speciﬁed under franchise agreements which expire at various times for individual franchisees. As well, Sobeys maintains head lease control, or has long-term buying agreements, to control the vast majority of its retail locations. Foreign Operations Empire does not directly carry out foreign operations, however, Sobeys and Crombie do have certain foreign operations. Sobeys’ foreign operations are limited to a Empire Company Limited || 55 9667_Empire AR 05 B. F. MIL 7/25/05 11:26 AM Page 56 Management’s Discussion and Analysis Outlook Management’s primary objective will continue to be to maximize the long-term sustainable value of Empire through enhancing the worth of the Company’s net assets and in turn, having that value reﬂected in Empire’s share price. The Company will continue to direct its energy and capital towards growing the long-term sustainable value of each its core operating businesses – food distribution, real estate and theatres.While these respective core businesses are well established and proﬁtable in their own right, the diversiﬁcation they offer Empire by both business line and by market area served is considered by management to be an additional source of strength. Going forward, the Company intends to continue to direct its resources towards the most promising opportunities within these core businesses in order to maximize long-term shareholder value. Comments with respect to the outlook for each of the Company’s divisions are noted below. Food Division Sobeys will continue to invest in infrastructure and productivity improvements in a manner consistent with its expressed intention to build a healthy and sustainable retail business and infrastructure for the long term. In ﬁscal 2006 Sobeys will advance its business process and information systems transformation plan for the Company by focusing on the signiﬁcant opportunity to upgrade capabilities and improve efﬁciencies in Ontario.The system and processes that are being implemented have been developed over several years and are currently employed in the Food division’s Atlantic Region.The Ontario initiative will simplify, standardize and streamline the “back shop”, in support of the Company’s food focused strategy.These efforts will leverage technology investments, improve efﬁciency and lower costs over the long term.The anticipated cost of the Ontario initiative is expected to approximate $0.20 to $0.25 per Sobeys share in ﬁscal 2006. Real Estate Division Over the next year, Empire’s real estate management group will continue its policy of maximizing and prudently reinvesting its cash ﬂow to further strengthen and diversify its portfolio of residential and commercial properties. Empire’s real estate management group expects overall retail occupancy levels to remain strong during ﬁscal 2006 as a result of the diligence of our leasing team and general economic conditions. Management looks forward to continuing its strong relationship with Sobeys and to pursuing attractive opportunities to jointly develop locations with Sobeys. Investments and Other Operations Growth in the Company’s investment portfolio will be dependent on a number of factors including investor sentiment in the U.S. and Canada. Equity markets may continue to remain volatile. Management remains committed to maintaining a portfolio of high quality, liquid common equity investments as a pool of capital to augment the growth in its core operating companies as attractive opportunities arise. With respect to Empire Theatres’ outlook, management recognizes that future growth will remain highly dependent on a steady supply of quality product. Based on the quality of ﬁlm releases expected in ﬁscal 2006, an experienced operations team, and planned screen development, management looks forward to continued revenue growth in this business. 56 || 2005 Annual Report 9667_Empire AR 05 B. F. MIL 7/25/05 11:26 AM Page 57 Non-GAAP Financial Measures There are measures included in this MD&A that do not have a standardized meaning under GAAP and therefore may not be comparable to similarly titled measures presented by publicly traded companies.The Company includes these measures because it believes certain investors use these measures as a means of assessing ﬁnancial performance. Empire’s deﬁnition of the non-GAAP terms are as follows: • Operating Income or EBIT is calculated as operating earnings plus interest expense, income taxes and minority interest. • EBITDA is calculated as operating income plus depreciation and intangible amortization. • EBITDAR is calculated as EBITDA plus gross rent expense. • Operating earnings is calculated as net earnings before capital gains (losses) and other items. • Funds from operations is calculated as operating earnings plus depreciation expense. • Interest coverage is calculated as operating income divided by interest expense. • Net asset value is management’s estimate of the market value of the Company’s assets less liabilities. • Funded debt is all interest bearing debt, which includes bank loans, bankers’ acceptances, long-term debt and capital lease obligations. • Net debt is calculated as funded debt less cash and cash equivalents. • Adjusted debt is funded debt plus the capitalized value of operating lease payments, which is calculated as six times net annual operating lease payments. • Total capital is calculated as funded debt plus shareholders’ equity. • Company-wide capital investment includes on- balance sheet capital expenditures, all known capital investments by franchise afﬁliates and capital investments by third-party landlords. Additional Information Additional ﬁnancial information relating to Empire, including the Company’s Annual Information Form, can be found on the Company’s web site or on the SEDAR web site for Canadian regulatory ﬁlings at www.sedar.com. June 23, 2005 Stellarton, Nova Scotia Empire Company Limited || 57 9667_Empire AR 05 B. F. MIL 7/25/05 11:26 AM Page 58 Management’s Statement of Responsibility for Financial Reporting Preparation of the consolidated ﬁnancial statements accompanying this annual report and the presentation of all other information in the report is the responsibility of management.The consolidated ﬁnancial statements have been pre- pared in accordance with Canadian generally accepted accounting principles and reﬂect management’s best estimates and judgements. All other ﬁnancial information in the report is consistent with that contained in the consolidated ﬁnancial statements. The Board of Directors, through its Audit Committee, oversees management in carrying out its responsibilities for ﬁnancial reporting and systems of internal control.The Audit Committee, which is chaired by and composed solely of directors who are unrelated to, and independent of, the Company, meet regularly with ﬁnancial management and external auditors to satisfy itself as to reliability and integrity of ﬁnancial information and the safeguarding of assets.The Audit Committee reports its ﬁndings to the Board of Directors for consideration in approving the annual consolidated ﬁnancial statements to be issued to shareholders.The external auditors have full and free access to the Audit Committee. Paul D. Sobey President and Chief Executive Ofﬁcer June 23, 2005 Paul V. Beesley Senior Vice President, Chief Financial Ofﬁcer and Secretary June 23, 2005 58 || 2005 Annual Report 9667_Empire AR 05 B. F. MIL 7/25/05 11:26 AM Page 59 Auditors’ Report To the Shareholders of Empire Company Limited We have audited the consolidated balance sheets of Empire Company Limited as at May 7, 2005 and April 30, 2004, and the consolidated statements of earnings, retained earnings, and cash ﬂows for the 53 week and 52 week ﬁscal years then ended, respectively.These consolidated ﬁnancial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated ﬁnancial statements based on our audits. We conducted our audits in accordance with Canadian generally accepted auditing standards.Those standards require that we plan and perform an audit to obtain reasonable assurance whether the consolidated ﬁnancial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated ﬁnancial statements. An audit also includes assessing the accounting principles used and signiﬁcant estimates made by management, as well as evaluating the overall consolidated ﬁnancial statement presentation. In our opinion, these consolidated ﬁnancial statements present fairly, in all material respects, the ﬁnancial position of the Company as at May 7, 2005 and April 30, 2004, and the results of its operations and its cash ﬂows for the ﬁscal years then ended in accordance with Canadian generally accepted accounting principles. Grant Thornton LLP Chartered Accountants New Glasgow, Canada June 14, 2005, except for Note 24(a) which is as of June 17, 2005 and Note 24(b) which is as of June 21, 2005 Empire Company Limited || 59 9667_Empire AR 05 B. F. MIL 7/25/05 11:26 AM Page 60 Consolidated Balance Sheets (in millions) Assets Current Cash and cash equivalents (Note 2) Receivables Income taxes receivable Inventories Prepaid expenses Investments, at cost (quoted market value $320.9; 2004 – $312.6) Investments, at equity (realizable value $162.4; 2004 – $92.4) Current assets and marketable investments Property and equipment (Note 4) Assets for realization Other assets (Note 5) Goodwill Liabilities Current Bank indebtedness (Note 6) Accounts payable and accrued liabilities Income taxes payable Future income taxes (Note 11) Long-term debt due within one year Long-term debt (Note 7) Long-term lease obligation (Note 21) Deferred revenue Employee future beneﬁt obligation (Note 17) Future income taxes (Note 11) Minority interest Shareholders’ Equity Capital stock (Note 8) Retained earnings Cumulative translation adjustment See accompanying notes to the consolidated financial statements. Contingent liabilities (Note 16) Approved on behalf of the Board, Director Paul D. Sobey 60 || 2005 Annual Report Director Robert P. Dexter May 7, 2005 (See Note 23) April 30, 2004 Restated (Note 1) $ 281.7 257.8 15.0 639.6 52.3 1,246.4 270.8 72.9 1,590.1 2,429.8 11.5 212.9 684.9 $ 202.2 329.5 – 483.6 49.3 1,064.6 278.0 60.8 1,403.4 2,298.2 16.3 304.9 656.9 $ 4,929.2 $ 4,679.7 $ 219.4 1,149.1 – 52.4 247.0 1,667.9 727.4 12.3 3.0 94.5 158.8 556.3 3,220.2 194.6 1,515.5 (1.1) 1,709.0 $ 140.8 1,138.4 7.2 46.3 82.7 1,415.4 913.0 12.5 6.6 90.4 133.2 541.0 3,112.1 196.7 1,371.5 (0.6) 1,567.6 $ 4,929.2 $ 4,679.7 9667_Empire AR 05 B. F. MIL 7/25/05 11:26 AM Page 61 Consolidated Statements of Retained Earnings Years Ended (See Note 23) (in millions) Balance, beginning of year as previously reported Adjustment due to adoption of accounting standards prior year (Note 1) Balance, beginning of year as restated Adjustment due to adoption of accounting standards current year (Note 1) Net earnings Refundable taxes recovered Dividends declared Preferred shares Common shares Premium on common shares purchased for cancellation (Note 8) Balance, end of year See accompanying notes to the consolidated financial statements. May 7, 2005 (53 Weeks) April 30, 2004 (52 Weeks) $ 1,380.7 (9.2) $ 1,230.6 (8.6) 1,371.5 (9.5) 186.6 1,548.6 – (0.3) (31.6) (31.9) (1.2) 1,222.0 – 172.5 1,394.5 5.1 (0.4) (26.3) (26.7) (1.4) $ 1,515.5 $ 1,371.5 Empire Company Limited || 61 May 7, 2005 (53 Weeks) April 30, 2004 (52 Weeks) Restated (Note 1) $12,435.2 11,791.0 $ 11,284.0 10,703.3 644.2 201.5 442.7 21.0 463.7 81.5 5.2 86.7 377.0 4.4 381.4 99.5 31.7 131.2 250.2 63.6 186.6 2.83 $ $ 580.7 173.7 407.0 15.8 422.8 86.9 5.5 92.4 330.4 11.6 342.0 93.4 17.6 111.0 231.0 58.5 172.5 2.62 $ $ 9667_Empire AR 05 B. F. MIL 7/25/05 11:26 AM Page 62 Consolidated Statements of Earnings Years Ended (See Note 23) (in millions except per share amounts) Revenue Cost of sales, selling and administrative expenses Depreciation and amortization Investment income (Note 9) Operating income Interest expense Long-term debt Short-term debt Capital gain and other items (Note 10) Earnings before income taxes and minority interest Income taxes (Note 11) Current Future Earnings before minority interest Minority interest Net earnings Earnings per share, basic and diluted (Note 3) See accompanying notes to the consolidated financial statements. 62 || 2005 Annual Report 9667_Empire AR 05 B. F. MIL 7/25/05 11:26 AM Page 63 Consolidated Statements of Cash Flows Years Ended (See Note 23) (in millions) Operating Activities Net earnings Items not affecting cash (Note 12) Preferred dividends Net change in non-cash working capital Cash ﬂows from operating activities Investing Activities Net decrease in investments Purchase of shares in subsidiary, Sobeys Inc. Purchase of property, equipment and other assets Proceeds from sale of property Business acquisitions, net of cash acquired Cash ﬂows used in investing activities Financing Activities Increase in bank indebtedness Decrease in construction loans Issue of long-term debt Repayment of long-term debt Increase (decrease) in long-term lease obligation Minority interest Repurchase of preferred shares Issue of Non-Voting Class A shares Repurchase of Non-Voting Class A shares for cancellation Common dividends Refundable taxes Cash ﬂows from (used in) ﬁnancing activities Increase (decrease) in cash from continuing operations Initial impact of variable interest entities Discontinued operations Increase (decrease) in cash and cash equivalents Cash and cash equivalents, beginning of year Cash and cash equivalents, end of year See accompanying notes to the consolidated financial statements. May 7, 2005 (53 Weeks) April 30, 2004 (52 Weeks) Restated (Note 1) $ $ 186.6 316.0 (0.3) 502.3 (15.7) 486.6 3.0 (93.5) (372.0) 35.1 (19.6) (447.0) 78.6 (1.1) 39.9 (79.8) (0.2) 4.4 (2.5) 0.9 (1.6) (31.6) – 7.0 46.6 32.9 – 79.5 202.2 281.7 $ 172.5 272.3 (0.4) 444.4 22.8 467.2 52.3 (74.2) (431.0) 81.4 (64.1) (435.6) 41.5 (0.9) 14.9 (188.9) 0.9 6.9 – 1.1 (1.8) (26.3) 5.1 (147.5) (115.9) – 1.3 (114.6) 316.8 $ 202.2 Empire Company Limited || 63 9667_Empire AR 05 B. F. MIL 7/25/05 11:26 AM Page 64 Notes to the Consolidated Financial Statements May 7, 2005 (in millions except share capital and per share data) 1. Summary of Signiﬁcant Accounting Policies The consolidated ﬁnancial statements have been prepared in accordance with Canadian generally accepted accounting principles (GAAP). Principles of Consolidation These consolidated ﬁnancial statements include the accounts of the Company and all subsidiary companies and entities considered variable interest entities. Investments in which the Company has signiﬁcant inﬂuence are accounted for by the equity method. Investments in signiﬁcant joint ventures are consolidated on a proportionate basis. Changes in Accounting Policies (a) Generally accepted accounting principles During ﬁscal 2004, the Canadian Institute of Chartered Accountants (CICA) introduced Handbook Section 1100,“Generally accepted accounting principles”, which deleted the reference to industry practice that had previously constituted a source for Canadian GAAP. The Company had been following industry practice with respect to depreciation and lease accounting. Section 1100 now requires the Company to recognize depreciation of real estate buildings, rental expense and income from tenant leases on a straight-line basis. Effective May 1, 2004, the Company adopted this handbook section prospectively without restatement. Depreciation The sinking fund method was used to record depreciation of the real estate buildings, calculated as an amount which, compounded annually at the rate of 5%, would have fully amortized the cost of the buildings over their estimated useful lives ranging from 20 to 40 years. Effective May 1, 2004 the straight-line method is now used to record depreciation of the real estate buildings. Depreciation is determined with reference to each rental property’s book value, its estimated useful life (not greater than 40 years) and its residual value. Adoption of the straight-line method has resulted in additional depreciation of $1.2 during the current ﬁscal year. Real Estate Leases Rental expense was recognized in accordance with the lease agreements with landlords. Effective May 1, 2004 the Company has changed its policy to record real 64 || 2005 Annual Report estate lease expense on a straight-line basis. Additional real estate lease expense of $2.7 was recorded in the current ﬁscal year as a result of this policy change in the food distribution reporting segment. Real estate revenue was recognized in accordance with the lease agreements with tenants.The Company has changed its policy to record income on a straight-line basis. Adoption of this policy resulted in recognition of additional straight-line real estate revenue of $2.2 during the current ﬁscal year. On February 7, 2005, the Ofﬁce of the Chief Accountant of the U.S. Securities and Exchange Commission (SEC) issued a clariﬁcation in respect of accounting for various components of property leases and leasehold improvements on which U.S. and Canadian accounting governing bodies had been largely silent. As a result of the SEC clariﬁcation the Company has adopted the following two accounting policies. Lease inducements received as a reimbursement for leasehold improvement costs are amortized over the term of the lease.The total lease expense is amortized straight-line over the entire term of the lease including rent free periods related to store ﬁxturing. A store ﬁxturing period varies by store but is generally considered to be one month prior to the store opening. The Company has adopted this guideline retroactively with restatement (see Note 20). (b) Asset Retirement Obligations Beginning in ﬁscal 2005, the CICA Handbook Section 3110,“Asset retirement obligations”, was adopted retroactively.This section establishes standards for the recognition, measurement and disclosure of legal obligations associated with the costs to retire long-lived assets. A liability associated with the retirement of long- lived assets is recorded in the period in which the legal asset is capitalized as part of the related asset and depreciated over its useful life. Subsequent to the initial measurement of the asset retirement obligation, the obligation is adjusted to reﬂect the passage of time and changes in the estimated future costs underlying the obligation.There has been no impact on the Company from the adoption of this section. (c) Hedging Accounting Guideline (AcG) 13,“Hedging relationships”, came into effect during the current ﬁscal year.This guideline addresses the identiﬁcation, designation, documentation and effectiveness of hedging relationships for the purpose of applying hedge 9667_Empire AR 05 B. F. MIL 7/25/05 11:26 AM Page 65 accounting and provides guidance with respect to the discontinuance of hedge accounting.There was no effect on the Company of adopting this guideline. Pursuant to the requirements of AcG-13, the Company has formally identiﬁed and documented loans denominated in U.S. dollars as hedges for a portion of its U.S. investments. (d) Vendor Allowances In January 2004, the CICA’s Emerging Issues Committee (EIC) issued a new accounting standard, EIC-144,“Accounting by a customer (including a reseller) for certain consideration received from a vendor”. EIC-144 outlines that cash consideration received from a vendor is presumed to be a reduction in the prices of the vendor’s products or services and should be accounted for as a reduction in cost of sales and related inventory, when recognized in the customer’s income statement and balance sheet. Certain exceptions apply if the consideration is a payment for assets or services delivered to the vendor or for reimbursement of costs incurred to sell the vendor’s products, provided certain conditions are met.The Company adopted EIC-144 in the second quarter, adjusting for it retroactively, with restatement of the comparative periods for the current and prior ﬁscal year (see Note 21). (e) Variable Interest Entities (VIEÕs) Effective for the fourth quarter ended May 7, 2005, the Company was required to implement AcG-15 “Consolidation of variable interest entities” issued by the CICA. AcG-15 requires the Company to consolidate certain entities that are deemed to be subject to control of the Company on a basis other than through ownership of a voting interest in the entity (see Note 22). Cash and Cash Equivalents Cash and cash equivalents are deﬁned as cash, treasury bills and guaranteed investments with a maturity less than 90 days. Inventories Warehouse inventories are valued at the lower cost and net realizable value with cost being determined substantially on a ﬁrst-in, ﬁrst-out (FIFO) basis. Retail inventories are valued at the lower of cost and net realizable value. Cost is determined by using FIFO or the retail method.The retail method uses the anticipated selling price less normal proﬁt margins, substantially on an average cost basis. Real Estate inventory of residential properties is carried at the lower of cost and net realizable value. Portfolio Investments Portfolio investments are accounted for under the cost method. Investment income is recognized on an accrual basis. Portfolio investments are written down when the inherent loss is determined to be other than temporary. Gains and losses on sale of investments are recorded in earnings as realized. Depreciation and Amortization Depreciation on real estate buildings is calculated using the straight-line method with reference to each property’s book value, its estimated useful life (not exceeding 40 years) and its residual value. Deferred leasing costs are amortized over the terms of the related leases. Depreciation of other property and equipment is recorded on a straight-line basis over the estimated useful lives of the assets as follows: Equipment Buildings Leasehold improvements 3 – 20 years 10 – 40 years 7 – 10 years Capitalization of Costs (a) Construction Projects Certain subsidiary companies and joint ventures capitalize interest during the construction period until the project opening date.The amount of interest capitalized to construction in progress in the current year was $0.1 (2004 – $0.6). (b) Commercial Properties Certain subsidiaries and joint ventures capitalize the direct carrying and operating costs applicable to the unleased areas of each new project for a reasonable period from the project opening date until a certain level of occupancy is reached. No amounts were capitalized in ﬁscal 2004 or 2005. (c) Development Properties and Land Held for Future Development A subsidiary company capitalizes interest and real estate taxes to the extent that they relate to properties for immediate development.The carrying costs on the balance of development properties are expensed as incurred.The amount of real estate taxes capitalized in the current year was $0.1 (2004 – $0.1). Empire Company Limited || 65 9667_Empire AR 05 B. F. MIL 7/25/05 11:26 AM Page 66 Notes to the Consolidated Financial Statements Long-lived Assets Effective May 1, 2003, the Company adopted two new CICA Handbook sections prospectively. Section 3063, “Impairment of long-lived assets”, provides guidance with regard to the measurement, recognition and disclosure of the impairment of long-lived assets.There was no impact of the application of Section 3063 on the ﬁnancial statements. Section 3475, “Disposal of long-lived assets and discontinued operations”, provides guidance with regard to the identiﬁcation, measurement and disclosure of any long-lived assets not held for use and discontinued operations. Leases Leases meeting certain criteria are accounted for as capital leases.The imputed interest is charged against income and the capitalized value is depreciated on a straight-line basis over the lesser of the lease term and its estimated useful life. Obligations under capital leases are reduced by rental payments net of imputed interest. All other leases are accounted for as operating leases. Goodwill Goodwill represents the excess of the purchase price of the business acquired over the fair value of the underlying net tangible and intangible assets acquired at the date of acquisition. Goodwill and intangible assets with indeﬁnite useful lives are subject to an annual impairment review. Any permanent impairment in the book value of goodwill or intangible assets (i.e. trademarks) will be written off against earnings.The Company has completed its review and has determined the book value of existing goodwill is not impaired. Intangibles Intangibles arise on the purchase of new businesses, existing franchises and the acquisition of pharmacy prescription ﬁles. Amortization is on a straight-line basis over 10-15 years. Deferred Costs Deferred costs consist of deferred store marketing, deferred ﬁnancing, transitional pension assets and deferred purchase agreements. Deferred costs are amortized as follows: Deferred store marketing – 7 years Deferred ﬁnancing – over the term of the debt Deferred purchase agreements – over the term of the franchise agreement 66 || 2005 Annual Report Assets for Realization Certain land and buildings have been listed for sale and reclassiﬁed as “Assets for realization” in accordance with CICA Handbook Section 3475.These assets are expected to be sold within a twelve month period, are no longer productive assets and there is no longer an intent to develop for future use. Assets for realization are valued at the lower of cost and fair value less cost of disposal. Store Opening Expenses Opening expenses of new stores and store conversions are written off during the ﬁrst year of operation. Stock-based Compensation Plans At the beginning of ﬁscal 2003, the Company adopted, on a prospective basis, the CICA Handbook Section 3870, “Stock-based compensation and other stock- based payments”. In ﬁscal 2004, the Company adopted EIC Abstract 132, “Share purchase ﬁnancing”.This abstract requires share purchase loans that are not treated as assets on the balance sheet to be accounted for as stock-based compensation.There was no effect on the Company upon implementation of this section and abstract. The Company’s stock option plan and share purchase plan are described in Note 8. Future Income Taxes The Company accounts for income taxes under the liability method.The difference between the tax basis of assets and liabilities and their carrying value on the balance sheet is used to calculate future tax assets and liabilities.The future tax assets and liabilities have been measured using the substantively enacted tax rates that will be in effect when the differences are expected to reverse. Deferred Revenue Deferred revenue consists of long-term supplier purchase agreements and rental revenue arising from the sale of subsidiaries. Deferred revenue is being taken into income over the term of the related agreements. Foreign Currency Translation Assets and liabilities of self-sustaining foreign investments are translated at exchange rates in effect at the balance sheet date.The revenues and expenses are translated at average exchange rates for the year. Cumulative gains and losses on translation are shown as a separate component of shareholders’ equity. 9667_Empire AR 05 B. F. MIL 7/25/05 11:26 AM Page 67 Other assets and liabilities are translated at the currency exchange rate in effect at the balance sheet date.These exchange gains or losses are recognized in operating income. Revenues and expenses denominated in foreign currencies are translated into Canadian dollars at the average currency exchange rate for the period. Revenue Recognition Food distribution sales are recognized at the point-of- sale. Sales include revenue from customers through corporate stores operated by the Company, consolidated VIE’s and revenue from sales to franchised stores, afﬁliated stores and independent accounts. Revenue received from franchise stores, associated stores and independent accounts is mainly derived from the sale of product.The Company also collects franchise fees under two types of arrangements. Franchise fees contractually due based on the dollar value of product shipped are recorded as revenue when the product is shipped. Franchise fees contractually due based on the franchisee’s retail sales are recorded as revenue weekly upon invoicing based on the franchisee’s retails sales. Real Estate revenue is recognized in accordance with the lease agreements with tenants on a straight-line basis as described above. Financial Instruments The Company uses interest rate instruments to manage exposure to ﬂuctuations in interest rates.The realized gain or loss arising from these instruments is included in interest expense. The Company also uses derivative ﬁnancial instruments to partially hedge its exposure to foreign exchange in its U.S. dollar denominated investment portfolio.These instruments are accounted for as hedges of anticipated transactions and accordingly, gains and losses on these instruments are included in measurement of the related hedged risk when realized. Pension Beneﬁt Plans and Other Beneﬁt Plans The cost of the Company’s pension beneﬁts for deﬁned contribution plans are expensed as contributions are paid.The cost of deﬁned beneﬁt pension plans and other beneﬁt plans is accrued based on actuarial valuations, which are determined using the projected beneﬁt method pro-rated on service and management’s best estimate of the expected long-term rate of return on plan assets, salary escalation, retirement ages and expected growth rate of health care costs. Current market values are used to value beneﬁt plan assets.The obligation related to employee future beneﬁts is measured using current market interest rates, assuming a portfolio of Corporate AA bonds with terms to maturity that, on average, match the terms of the obligation. The impact of changes in plan amendments is amortized on a straight-line basis over the expected average remaining service life (EARSL) of active members. For pension beneﬁt plans, the actuarial gains and losses and the impact of changes in the actuarial basis in excess of 10% of the greater of the projected beneﬁt obligation and the market value of assets are amortized on a straight-line basis over the EARSL of the active members. For other beneﬁt plans, actuarial gains and losses are recognized immediately. For the supplementary executive retirement plan, the impact of changes in the plan provisions are amortized over 5 years. Use of Estimates The preparation of consolidated ﬁnancial statements in conformity with Canadian GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated ﬁnancial statements and accompanying notes.These estimates are based on management’s best knowledge of current events and actions that the Company may undertake in the future. Earnings Per Share Earnings per share is calculated by dividing the earnings available to common shareholders by the weighted average number of common shares outstanding during the year. Diluted earnings per share is calculated using the treasury stock method. 2. Cash and Cash Equivalents Included in cash and cash equivalents is restricted cash of $7.5 (2004 – $30.4) relating to the sale of assets. Empire Company Limited || 67 9667_Empire AR 05 B. F. MIL 7/25/05 11:26 AM Page 68 Notes to the Consolidated Financial Statements 3. Earnings Per Share Earnings per share amounts are calculated on the weighted average number of shares outstanding (2005 – 65,750,928 shares; 2004 – 65,772,518 shares) after providing for preferred share dividends accrued to the balance sheet date. Diluted earnings per share have been calculated on the assumption that all the outstanding stock options were exercised and share purchase loans were repaid at the beginning of the year.There is no effect as a result of this calculation. Earnings applicable to common shares is comprised of the following: Operating earnings Capital gain and other items, net of tax of $0.7 (2004 – $2.4) Net earnings Preferred share dividends Earnings applicable to common shares Earnings per share is comprised of the following: Operating earnings Capital gain and other items Basic earnings per share Diluted earnings per share 4. Property and Equipment Real estate segment Land Land held for future development Buildings Food division and other segments Land Land held for future development Buildings Equipment Leasehold improvements Oil and gas exploration costs Assets under capital leases 2005 (53 Weeks) 2004 (52 Weeks) Restated (Note 1) $ $ $ $ $ 182.9 3.7 186.6 (0.3) 186.3 2.78 0.05 2.83 2.83 $ $ $ $ $ 163.3 9.2 172.5 (0.4) 172.1 2.48 0.14 2.62 2.62 Cost Accumulated Depreciation May 7, 2005 Net Book Value $ 147.1 9.1 915.0 1,071.2 $ – – 174.3 174.3 $ 95.2 85.4 615.7 1,714.2 328.3 10.7 35.8 2,885.3 – – 125.5 1,016.2 198.2 0.8 11.7 1,352.4 147.1 9.1 740.7 896.9 95.2 85.4 490.2 698.0 130.1 9.9 24.1 1,532.9 Total $ 3,956.5 $ 1,526.7 $ 2,429.8 68 || 2005 Annual Report 9667_Empire AR 05 B. F. MIL 7/25/05 11:26 AM Page 69 Real estate segment Land Land held for future development Buildings Food division and other segments Land Land held for future development Buildings Equipment Leasehold improvements Oil and gas exploration costs Assets under capital leases April 30, 2004 Restated (Note 1) Cost Accumulated Depreciation Net Book Value $ 144.4 11.7 887.7 1,043.8 72.8 81.4 573.0 1,619.4 293.4 0.6 23.9 2,664.5 $ – – 161.7 161.7 – – 107.4 960.4 174.0 – 6.6 $ 144.4 11.7 726.0 882.1 72.8 81.4 465.6 659.0 119.4 0.6 17.3 1,248.4 1,416.1 Total 5. Other Assets Loans and mortgages receivable Deferred costs Intangibles (less accumulated amortization of $2.4 2004 – $0.5) May 7, 2005 April 30, 2004 Restated (Note 1) $ $ 41.7 149.6 21.6 212.9 $ $ 147.8 144.0 13.1 304.9 Loans Receivable Loans receivable represent long-term ﬁnancing to certain retail associates.These loans are primarily secured by inventory, ﬁxtures and equipment, bear various interest rates and have repayment terms up to ten years.The carrying amount of the loans receivable approximates fair value based on the variable interest rates charged on the loans and the operating relationship of the associates with the Company. Loans receivable decreased by $108.8 as a result of the consolidation of VIE’s (see Note 22). The loans and mortgages receivable are net of current portions of $15.5 (2004 – $15.4). $ 3,708.3 $ 1,410.1 $ 2,298.2 6. Bank Indebtedness As security for certain bank loans the Company has provided an assignment of certain marketable securities and, in certain divisions and subsidiaries, general assignments of receivables and leases, ﬁrst ﬂoating charge debentures on assets and the assignment of proceeds of ﬁre insurance policies. Under the terms of a credit agreement entered into between the Company and a banking syndicate, a revolving term credit facility of $300.0 was established. This 364-day revolving unsecured facility will expire on June 22, 2006.Various provisions of the agreement provide the Company with the ability to extend the facility for a minimum period of two years. Interest is payable on this facility at rates which ﬂuctuate with changes in the prime rate. In the ordinary course of managing its debt the Company uses various ﬁnancial instruments, which are not reﬂected on the balance sheet, to reduce or eliminate exposure to interest rate and foreign currency risks. Interest rate swaps, caps, collars and forward contracts are used to hedge or reduce the exposure to ﬂoating interest rates and foreign currency ﬂuctuations associated with short-term obligations. At May 7, 2005 the Company had no such instruments in place for short-term obligations. Empire Company Limited || 69 9667_Empire AR 05 B. F. MIL 7/25/05 11:26 AM Page 70 Notes to the Consolidated Financial Statements 7. Long-term Debt First mortgage loans, average interest rate 9.1%, due 2005 – 2026 Bank loans, average interest rate 6.4%, due September 30, 2004 Medium term note, interest rate 7.6%, due November 1, 2005 Medium term note, interest rate 7.2%, due February 26, 2018 Debentures, average interest rate 10.6%, due 2005 – 2016 Notes payable and other debt at interest rates ﬂuctuating with the prime rate Construction loans at interest rates ﬂuctuating with the prime rate Capital lease obligations, due 2005 – 2011, net of imputed interest Less amount due within one year The Company has ﬁxed the interest rate on $16.0 of its long-term debt at 4.2 percent by utilizing an interest exchange agreement.Through a bond forward the Company has locked in the rate on the underlying Government of Canada 15 year yield for refinancing $100.0 of the Medium term note due November 1, 2005. Long-term debt is secured by land and buildings, speciﬁc charges on certain assets and additional security as described in Note 6. During ﬁscal 2001 the Company negotiated a new unsecured $550.0 credit facility consisting of $250.0 of non-revolving debt to be repaid over ﬁve years, plus a $300.0 revolving line of credit.The balance of $250.0 of the non-revolving debt was retired on September 30, 2004. Debt retirement payments and capital lease obligations in each of the next ﬁve ﬁscal years are: 70 || 2005 Annual Report Real Estate Segment Food Distribution Segment May 7, 2005 April 30, 2004 Restated (Note 1) Total Total $ 401.1 $ 23.9 $ 425.0 $ 443.6 – – – 69.9 45.2 516.2 0.4 – 516.6 52.1 464.5 2006 2007 2008 2009 2010 $ – 175.0 100.0 68.2 67.5 434.6 – 23.2 457.8 194.9 262.9 $ – 175.0 100.0 138.1 112.7 950.8 0.4 23.2 974.4 247.0 727.4 $ 20.0 175.0 100.0 147.6 85.1 971.3 1.5 22.9 995.7 82.7 913.0 $ Long-term Debt Capital Leases $ $ $ $ $ 242.0 38.9 73.8 75.4 41.0 $ $ $ $ $ 5.0 3.7 3.3 2.9 2.1 Operating Leases The net aggregate, annual, minimum rent payable under operating leases for ﬁscal 2006 is approximately $129.3 ($205.3 gross less expected sub-lease income of $76.0). The commitments over the next ﬁve ﬁscal years are: 2006 2007 2008 2009 2010 Net Lease Obligation Gross Lease Obligation $ $ $ $ $ 129.3 115.1 99.1 88.0 80.6 $ $ $ $ $ 205.3 186.7 163.3 146.5 132.6 9667_Empire AR 05 B. F. MIL 7/25/05 11:26 AM Page 71 8. Capital Stock Authorized: Preferred shares, par value of $25 each, issuable in series as a class. Series 2 cumulative, redeemable, rate of 75% of prime Non-Voting Class A shares, without par value Class B common shares, without par value, voting Issued and outstanding: Preferred shares, Series 2 cumulative, redeemable, rate of 75% of prime Non-Voting Class A Class B common Loans receivable from ofﬁcers and employees under share purchase plan Number of Shares Number of Shares May 7, 2005 431,900 30,869,585 34,885,225 331,900 31,150,585 34,585,225 $ 8.3 183.0 7.7 199.0 (4.4) $ 194.6 Number of Shares 994,846,000 259,174,746 40,800,000 April 30, 2004 $ 10.8 182.5 7.7 201.0 (4.3) $ 196.7 During the year the Company purchased for cancellation 100,000 Series 2 preferred shares for $2.5. During the year, under a normal course issuer bid which expires on July 11, 2005, the Company purchased for cancellation 61,129 (2004 – 68,477) Non-Voting Class A shares.The purchase price was $1.6 of which $1.2 of the purchase price (representing the premium on common shares purchased for cancellation) was charged to retained earnings. During the year 9,400 (2004 – 30,000) options were exercised resulting in 9,400 (2004 – 30,000) Non- Voting Class A shares being issued for $0.1 (2004 – $0.2). Options allow holders to purchase Non-Voting Class A shares at $6.555 per share. Options expire in October 2006.There were 27,674 options outstanding at May 7, 2005. During the year 32,729 (2004 – 34,429) Non- Voting Class A shares were issued under the Company’s share purchase plan to certain ofﬁcers and employees for $0.8 (2004 – $0.9), which was based on the average trading price of the Non-Voting Class A shares on the Toronto Stock Exchange for the ﬁve previous trading days. Loans receivable from ofﬁcers and employees of $4.4 (2004 – $4.3) under the Company’s share purchase plan are classiﬁed as a reduction of Shareholders’ Equity. Loan repayments will result in a corresponding increase in Share Capital.The loans are non-interest bearing and non-recourse, secured by 245,030 (2004 – 255,597) Non-Voting Class A shares. Market value of the shares at May 7, 2005 was $9.0 (2004 – $6.8). Under certain circumstances, where an offer (as deﬁned in the share conditions) is made to purchase Class B common shares, the holders of the Non-Voting Class A shares shall be entitled to receive a follow-up offer at the highest price per share paid, pursuant to such offer to purchase Class B common shares. During the year 300,000 Class B common shares were exchanged for 300,000 Non-Voting Class A shares. Empire Company Limited || 71 9667_Empire AR 05 B. F. MIL 7/25/05 11:26 AM Page 72 Notes to the Consolidated Financial Statements 9. Investment Income 10. Capital Gain and Other Items 2005 (53 Weeks) 2004 (52 Weeks) Dividend and interest income $ 9.0 $ 10.7 Share of income of companies accounted for by the equity method $ 11. Income Taxes 12.0 21.0 $ 5.1 15.8 Gain on sale of investments Other items 2005 (53 Weeks) 2004 (52 Weeks) $ $ 2.9 1.5 4.4 $ $ 11.7 (0.1) 11.6 Income tax expense varies from the amount that would be computed by applying the combined federal and provincial statutory tax rate as a result of the following: 2005 (53 Weeks) 2004 (52 Weeks) Restated (Note 1) $ 133.1 $ 114.6 – – (5.5) 2.9 130.5 0.7 131.2 Future 32.7 (1.0) 31.7 $ $ $ (3.8) (1.4) (4.1) 3.3 108.6 2.4 111.0 Total 130.5 0.7 131.2 $ $ $ Current Future Restated (Note 1) Total Restated (Note 1) 85.0 8.4 93.4 $ $ 23.6 (6.0) 17.6 $ $ 108.6 2.4 111.0 Income tax expense according to combined statutory rate of 35.3% (2004 – 34.7%) Increase (decrease) in income taxes resulting from Adjustment to future tax assets and liabilities for substantially enacted changes in tax laws Non-taxable gains Non-taxable dividends and equity earnings Large corporation tax Capital gain and other items Current 97.8 1.7 99.5 May 7, 2005 income tax expense attributable to net income consists of: Operations Capital gain and other items April 30, 2004 income tax expense attributable to net income consists of: Operations Capital gain and other items $ $ $ $ 72 || 2005 Annual Report 9667_Empire AR 05 B. F. MIL 7/25/05 11:26 AM Page 73 The tax effect of temporary differences that give rise to signiﬁcant portions of future income taxes are presented below: May 7, 2005 April 30, 2004 Restated (Note 1) Property and equipment Investments Future employee beneﬁt $ 112.7 36.0 $ obligation Restructuring provisions Pension contributions Deferred cost Deferred credits Goodwill Other Future income taxes – current Future income taxes – non-current (32.2) (5.3) 16.0 23.7 57.7 6.0 (3.4) 211.2 52.4 158.8 211.2 $ $ $ $ $ $ 12. Supplementary Cash Flow Information 90.5 35.4 (31.0) (1.5) 16.2 18.8 47.8 6.3 (3.0) 179.5 46.3 133.2 179.5 a) Items not affecting cash Depreciation and amortization Future income taxes Amortization of deferred $ costs Equity in earnings of other companies, net of dividends received Minority interest Employee future beneﬁt obligation b) Other information Net interest paid Net income taxes paid $ $ $ 2005 (53 Weeks) 2004 (52 Weeks) Restated (Note 1) 201.5 31.7 34.0 (8.4) 53.1 4.1 316.0 85.1 124.7 $ $ $ $ 173.7 17.6 25.5 (4.8) 48.3 12.0 272.3 93.2 145.6 13. Joint Ventures The ﬁnancial statements include the Company’s proportionate share of the accounts of incorporated and unincorporated joint ventures. A summary of these amounts is as follows: May 7, 2005 April 30, 2004 Assets Liabilities Equity and advances Revenues Expenses Income before income taxes Cash provided (used) Operating activities Investing activities Financing activities $ $ $ $ $ $ $ 101.6 41.9 59.7 101.6 2005 (53 Weeks) 43.2 7.9 35.3 36.8 (8.4) (0.1) 28.3 $ $ $ $ $ $ $ 81.4 55.1 26.3 81.4 2004 (52 Weeks) 34.4 7.0 27.4 23.6 (18.0) (3.6) 2.0 14. Segmented Information 2005 (53 Weeks) 2004 (52 Weeks) Revenue Food division Sales Gain on sale of assets $ 12,189.4 – $ 11,046.8 14.6 12,189.4 11,061.4 Real estate Commercial Inter-segment Residential Other operations Elimination 136.4 57.8 35.0 229.2 74.4 128.0 52.3 30.2 210.5 64.4 12,493.0 (57.8) 11,336.3 (52.3) $ 12,435.2 $ 11,284.0 In ﬁscal 2004, Sobeys Inc. sold several redundant real estate assets.These assets were not considered strategic for the long-term plans of the Company.The gain realized on the sale of these assets was $14.6. Empire Company Limited || 73 9667_Empire AR 05 B. F. MIL 7/25/05 11:26 AM Page 74 Notes to the Consolidated Financial Statements Operating income Food Real estate Commercial Residential Other operations Investment income Corporate expenses 2005 (53 Weeks) 2004 (52 Weeks) Restated (Note 1) $ 322.6 $ 293.7 89.1 33.1 9.5 18.8 (9.4) 85.8 25.2 9.8 15.9 (7.6) $ 463.7 $ 422.8 May 7, 2005 April 30, 2004 Restated (Note 1) Identiﬁable assets Food Food distribution Goodwill $ Real estate Investments Other (including goodwill of $3.8; 2004 - $Nil) 2,829.0 681.1 3,510.1 1,017.9 325.9 $ 2,620.2 656.9 3,277.1 990.8 324.7 75.3 87.1 $ 4,929.2 $ 4,679.7 2005 (53 Weeks) 2004 (52 Weeks) Restated (Note 1) Depreciation and amortization Food Real estate Corporate and other Capital expenditure Food Real estate Corporate and other $ $ $ $ 176.4 18.7 6.4 201.5 2005 (53 Weeks) 321.1 33.2 17.7 372.0 $ $ $ $ 152.7 16.3 4.7 173.7 2004 (52 Weeks) 384.9 34.2 11.9 431.0 The Company operates principally in two business segments: food distribution and real estate.The food distribution segment consists of distribution of food products in Canada. The real estate segment 74 || 2005 Annual Report consists of development and ownership of both commercial and residential properties. Commercial real estate is mainly shopping centres and ofﬁce buildings in Central and Eastern Canada. Residential real estate is the development of housing lots for resale. Inter-segment transactions are at market values. 15. Financial Instruments Credit Risk There is no significant concentration of credit risk. The credit risk exposure is considered normal for the business. Other Financial Instruments The book value of cash and cash equivalents, receivables, loans and mortgages, bank indebtedness, accounts payables and accrued liabilities and income taxes payable approximate fair values at May 7, 2005. The fair value of investments is $483.3. The total fair value of long-term debt is estimated to be $1,126.0.The fair value of variable rate debt is assumed to approximate its carrying amount.The fair value of other long-term debt has been estimated by discounting future cash ﬂows at a rate offered for debt of similar maturities and credit quality.The fair value of the bond forward and of the delayed start interest rate swaps is $(3.6). Interest Rate Risk The majority of the Company debt is at ﬁxed rates. Accordingly, there is limited exposure for interest rate risk. Foreign Currency Risk Investments include $152.1 Canadian that is denominated in U.S. funds. Bank indebtedness includes $87.9 Canadian that is denominated in U.S. funds and it acts as a partial hedge to the foreign exchange ﬂuctuations inherent in the market value of the U.S. investments. 16. Contingent Liabilities At May 7, 2005 the Company was contingently liable for letters of credit issued in the aggregate amount of $44.0 (2004 – $42.0). The Company has guaranteed certain bank loans contracted by franchisees. As at May 7, 2005 these loans amounted to approximately $2.4 (2004 – $5.0). 9667_Empire AR 05 B. F. MIL 7/25/05 11:26 AM Page 75 Upon entering into the lease of its Mississauga distribution centre in March 2000 Sobeys Inc., a subsidiary of the Company, guaranteed to the landlord a performance, by SERCA Foodservice, of all its obliga- tion under the lease.The remaining term of the lease is 15 years with an aggregate obligation of $46.2. At the time of the sale of assets of SERCA Foodservice to Sysco Corp., the lease of the Mississauga distribution centre was assigned to and assumed by the purchaser, and Sysco Corp. agreed to indemnify and hold Sobeys Inc. harmless from any liability it may incur pursuant to its guarantee. Sobeys Inc. has received notice from Canada Revenue Agency (CRA) that it is proposing a reassessment related to Goods and Services Tax (GST) for ﬁscal years 1999 and 2000.The proposed reassessment relates to GST on sales of tobacco products to status Indians. CRA asserts that Sobeys Inc. was obliged to collect GST on the sales of these tobacco products to status Indians.The total tax, interest and penalties in the proposed reassessment are approximately $13.0. Sobeys Inc. has reviewed this matter, has received legal advice and believes it was not required to collect GST. Sobeys Inc. is challenging this proposed reassessment and if necessary will defend against any reassessments to the appropriate judicial bodies. Accordingly, the Company has not recorded any of the proposed tax, interest or penalties in its ﬁnancial statements. The Company has agreed to indemnify its directors and ofﬁcers and particular employees in accordance with the Company’s policies.The Company maintains insurance policies that may provide coverage against certain claims. The Company has entered into the following delayed start interest rate swaps: – Notional amount of $5.5, commencing on September 7, 2007 and terminating September 7, 2017.The Company pays interest at a ﬁxed rate of 6.16% and receives interest based on the 90-day bankers’ acceptance rate. – Notional amount of $22.3, commencing on November 30, 2007 and terminating November 30, 2017.The Company pays interest at a ﬁxed rate of 6.18% and receives interest based on the 90-day bankers’ acceptance rate. There are various claims and litigation, which the Company is involved with, arising out of the ordinary course of business operations.The Company’s management does not consider the exposure to such litigation to be material, although this cannot be predicted with certainty. 17. Employee Future Beneﬁts The Company has a number of deﬁned beneﬁt and deﬁned contribution plans providing pension and other retirement beneﬁts to most of its food distribution and real estate employees. Deﬁned Contribution Pension Plans The contributions required by the employee and the employer are speciﬁed.The employee’s pension depends on what level of retirement income (for example, annuity purchase) that can be achieved with the combined total of employee and employer contributions and investment income over the period of plan membership, and the annuity purchase rates at the time of the employee’s retirement. Deﬁned Beneﬁt Pension Plans The ultimate retirement beneﬁt is deﬁned by a formula that provides a unit of beneﬁt for each year of service. Employee contributions, if required, pay for part of the cost of the beneﬁt, but the employer contributions fund the balance.The employer contributions are not speciﬁed or deﬁned within the plan text, they are based on the result of actuarial valuations which determine the level of funding required to meet the total obligation as estimated at the time of the valuation. Most recent valuation date Next required valuation date Retirement Pension Plan December 31, December 31, 2006 2003 Senior Management Pension Plan December 31, December 31, 2007 2004 Deﬁned Contribution Plans The total expense and cash contributions for the Company’s deﬁned contribution plans are as follows: 2005 2004 $ $ 12.1 11.5 Empire Company Limited || 75 9667_Empire AR 05 B. F. MIL 7/25/05 11:26 AM Page 76 Notes to the Consolidated Financial Statements Deﬁned Beneﬁt Plans Information about the Company’s deﬁned beneﬁts plans, in aggregate, is as follows: Pension Benefit Plans Pension Benefit Plans Other Benefit Plans Other Benefit Plans 2005 2004 2005 2004 Accrued beneﬁt obligation Balance, beginning of year New incidence (post-employment beneﬁts) Current service cost Interest cost Employee contributions Past service costs Special termination beneﬁts Beneﬁts paid Actuarial losses (gains) Balance, end of year Plan assets Market value, beginning of year Actual return on plan assets Employer contributions Employee contributions Beneﬁts paid Market value, end of year Funded status Deﬁcit Unamortized past service cost Unamortized actuarial losses Accrued beneﬁt asset (liability) Expense Current service cost Interest cost Special termination beneﬁts Actual return on plan assets Actuarial losses (gains) Past service costs New incidence (post-employment beneﬁts) Expense before adjustments Expected vs actual return on plan assets Recognized vs actual past service costs Recognized vs actual actuarial losses (gains) $ $ $ $ $ $ $ $ $ $ $ $ $ $ 252.0 – 2.2 14.8 0.4 0.7 – (18.4) 15.3 267.0 223.5 31.3 7.6 0.4 (18.4) 244.4 (22.6) 1.0 49.9 28.3 2.2 14.8 – (31.3) 15.3 0.7 – 1.7 16.0 (0.5) (12.9) Net expenses $ 4.3 $ 235.0 – 2.5 14.9 0.5 – 1.3 (16.6) 14.4 252.0 199.8 36.8 3.0 0.5 (16.6) 223.5 (28.5) 0.4 53.1 25.0 2.5 14.9 1.3 (36.8) 14.4 – – (3.7) 23.3 – (10.9) 8.7 $ $ $ $ $ $ $ $ 112.0 0.4 2.4 5.9 – – – (4.4) (7.6) 108.7 – – 4.4 – (4.4) – (108.7) 1.2 13.0 (94.5) 2.4 5.9 – – (7.6) – 0.4 1.1 – 0.1 7.2 8.4 $ $ $ $ $ $ $ $ 90.4 7.7 2.4 6.2 – 1.3 – (4.4) 8.4 112.0 – – 4.5 – (4.5) – (112.0) 1.3 20.3 (90.4) 2.3 6.2 – – 8.4 1.3 7.7 25.9 – (1.3) (6.9) 17.7 76 || 2005 Annual Report 9667_Empire AR 05 B. F. MIL 7/25/05 11:27 AM Page 77 Classiﬁcation of accrued beneﬁt asset (liability) Other assets Accrued liabilities/expected ﬁscal 2006 contributions Other long-term liabilities Accrued beneﬁt asset (liability) Pension Benefit Plans Pension Benefit Plans Other Benefit Plans Other Benefit Plans 2005 $ 55.2 (9.2) (17.7) $ 28.3 2004 49.2 (7.3) (16.9) 25.0 $ $ 2005 2004 $ $ – (4.9) (89.6) (94.5) $ $ – (4.4) (86.0) (90.4) Included in the above accrued beneﬁt obligation at year-end are the following amounts in respect of plans that are not funded: Accrued beneﬁt obligation Pension Benefit Plans Pension Benefit Plans Other Benefit Plans Other Benefit Plans 2005 19.5 $ 2004 18.5 $ 2005 94.5 $ 2004 90.4 $ The signiﬁcant actuarial assumptions adopted in measuring the Company’s accrued beneﬁt obligations are as follows (weighted-average assumptions as of May 7, 2005): Discount rate Expected long-term rate of return on plan assets Rate of compensation increase Pension Benefit Plans Pension Benefit Plans Other Benefit Plans Other Benefit Plans 2005 5.50% 7.00% 4.00% 2004 6.00% 7.00% 4.00% 2005 5.75% 2004 6.00% For measurement purposes, a 10% ﬁscal 2005 annual rate of increase in the per capita cost of covered health care beneﬁts was assumed.The cumulative rate expectation to 2012 is 6%.The expected average remaining service period of the active employees covered by the pension beneﬁt plans ranges from 11 to 19 years with a weighted average of 11 years at year end.The expected average remaining service period of the active employees covered by the other beneﬁt plans range from 13 to 17 years with a weighted average of 16 years at year end. Pension Plans Other Benefit Plans Expected long-term rate of return on plan assets Impact of: 1% increase 1% decrease Discount rate Impact of: 1% increase 1% decrease Growth rate of health costs(1) Impact of: 1% increase 1% decrease Benefit Obligations 5.5% (29.3) 32.9 $ $ Benefit Cost(1) 7.0% (2.4) 2.4 5.5% 0.3 (0.6) $ $ $ $ Benefit Obligations Benefit Cost(1) 5.75% (15.7) 18.9 10.0% 15.9 (13.0) $ $ $ $ 5.75% (0.8) 0.9 10.0% 1.9 (1.5) $ $ $ (1) Reﬂects the impact on the current service cost, the interest cost and the expected return on assets. Empire Company Limited || 77 9667_Empire AR 05 B. F. MIL 7/25/05 11:27 AM Page 78 Notes to the Consolidated Financial Statements The asset mix of the deﬁned beneﬁt pension plans as at year end is as follows: Cash and short-term investments Bonds, debenture, ﬁxed income pooled funds and real estate funds Equities and pooled equities fund Accrued interest and dividends Total investments 2005 7.06% 17.71% 74.96% 0.27% 2004 3.21% 21.27% 75.24% 0.28% 100.00% 100.00% Within these securities are investments in Empire Company Limited.The market value of these shares at year end are as follows: 2005 80.2 $ % of plan assets 10.0% $ 2004 57.7 % of plan assets 8.1% Commisso’s Acquisitions During the 2004 ﬁscal year the Company acquired substantially all of the assets and trade liabilities of Commisso’s Food Markets Limited, Commisso’s Grocery Distributors Limited and Commisso’s Properties Inc. which are located in Southern Ontario. Acquired were six grocery stores (and the shopping centres where they are located), nine additional grocery stores, six cash-and-carry outlets and a wholesale business and distribution centre.The acquisition was completed February 1, 2004 and was accounted for using the purchase method, with operating results being included in the consolidated ﬁnancial statements at this date. Inventories Property and equipment Goodwill Intangibles Other assets Accounts payable Long-term liabilities Other liabilities Expenses Cash consideration $ $ 16.2 56.1 62.5 5.4 3.1 (32.1) (38.5) (21.2) 51.5 (0.8) 50.7 18. Business Acquisitions Sobeys Inc. During ﬁscal 2005 the Company increased its ownership interest in Sobeys Inc. from 65.0% to 68.4% by way of purchase of shares on the open market. The acquisition was accounted for using the purchase method with operating results being included in the consolidated ﬁnancial statements from the date of each share acquisition.The cash consideration paid was $93.5, goodwill increased by $27.1 and minority interest decreased by $66.4. During ﬁscal 2004 the Company increased its ownership interest in Sobeys Inc. from 62% to 65% by way of purchase of shares on the open market. The acquisition was accounted for using the purchase method with operating results being included in the consolidated ﬁnancial statements from the date of each share acquisition.The cash consideration paid was $74.2, goodwill increased by $26.2 and minority interest decreased by $48.0. Other Acquisitions During the year the Company acquired franchisee stores and prescription ﬁles in its food distribution segment as part of its normal course of operations and acquired four cinemas in Nova Scotia and New Brunswick in its other operations segment for total cash consideration of $19.1.The acquisitions were accounted using the purchase method with net identiﬁable assets recorded at $15.3 (including intangible assets of $7.2) and goodwill recorded at $3.8. 78 || 2005 Annual Report 9667_Empire AR 05 B. F. MIL 7/25/05 11:27 AM Page 79 19. Stock-based Compensation Members of the Board of Directors may elect to receive all or any portion of their fees in Deferred Share Units (DSU’s) in lieu of cash.The number of DSU’s received is determined by the market value of the Company’s common shares on each directors’ fee payment date. Additional DSU’s are received as dividend equivalents. DSU’s cannot be redeemed for cash until the holder is no longer a director of the Company.The redemption value of a DSU equals the market value of a Empire Company Limited common share at the time of the redemption. On an ongoing basis, the Company values the DSU obligation at the current market value of a common share and records any increase in the DSU obligation as an operating expense. At May 7, 2005 there were 50,420 (April 30, 2004 – 36,643) DSU’s outstanding. During the year, the stock-based compensation expense was $0.9 (2004 – $0.2). 20. Real Estate Leases The Company has reviewed its practices related to lease accounting and has determined that adjustments were required to align to the recent clariﬁcation of lease accounting guidelines.The ﬁrst adjustment relates to lease allowances and incentives. Historically the Company classiﬁed lease allowances as a reduction of the related capital assets, which effectively reduced the depreciation expense over the expected life of the asset. The guideline clariﬁcation suggests these lease allowances should be recorded as a deferred credit and amortized as a reduction of lease expense over the term of the lease.The second adjustment relates to rent expense to be recorded during a store’s ﬁxturing period.The Company is often granted a ﬁxturing period during which rent is not charged.The ﬁxturing period is generally considered to be one month prior to the store opening. Historically, when the Company was granted a ﬁxturing period, rent expense was not recorded as none was being charged and the store was not yet open.The clariﬁcation of the accounting guidance however requires that the ﬁxturing period be considered a rent free period that should be included in the term of the lease. Since lease expense must be recognized on a straight-line basis over the lease term an appropriate portion of the straight-line expense must be recorded for the ﬁxturing period.The third adjustment relates to the capitalization of long-term leases. An evaluation was completed in the fourth quarter of the current year and certain long-term leases have been identiﬁed as capital leases.These changes have been accounted for on a retroactive basis with restatement resulting with the following net impact on the comparative statements: As at April 30, 2004 a reduction to retained earnings of $5.4. A reduction in net income for the 52 week period ended April 30, 2004 of $0.6 from $173.1 to $172.5, and a reduction in earnings per share from $2.63 to $2.62. As at April 30, 2004 an increase to Property and equipment, Future income taxes, Long-term debt and Long-term liabilities of $10.1, $4.4, $10.3 and $12.5, respectively and a decrease in Minority interest of $2.9. These lease accounting adjustments did not have any material impact on the Company’s ﬁscal 2005 net earnings, historical or future revenues, cash ﬂows or lease payments. 21. Vendor Allowances The Company receives allowances from certain vendors, whose products are purchased for resale. Included in these vendor programs are allowances for volume purchases, exclusivity allowances, listing fees and other allowances. Due to the retroactive implementation of EIC-144, the timing of recognition of certain vendor allowances has changed, resulting in the Company recording a decrease in opening retained earnings for ﬁscal 2004 of $3.8 (net of income tax effect of $3.4 and minority interest of $2.1) and a decrease to inventory of $9.3.The implementation of EIC-144 did not result in a material change in the annual net earnings for ﬁscal 2004 or in the current year. 22. Variable Interest Entities Variable interest entities are deﬁned under AcG-15 as entities that do not have sufﬁcient equity at risk to ﬁnance their activities without additional subordinated ﬁnancial support, or where the equity holders lack the overall characteristics of a controlling ﬁnancial interest. The guideline requires that the VIE be consolidated with the ﬁnancial results of the entity deemed to be the primary beneﬁciary of the VIE’s expected losses and its expected residual returns. Empire Company Limited || 79 9667_Empire AR 05 B. F. MIL 7/25/05 11:27 AM Page 80 Notes to the Consolidated Financial Statements The Company has implemented AcG-15 on May 7, 2005 retroactively without restatement of prior periods. Entities that have been identiﬁed as meeting the characteristics of VIE have been consolidated in the Company’s results for the fourth quarter. The Company has identiﬁed the following entities as VIE’s: Franchisees The Company has identiﬁed 287 franchisees whose franchise agreements result in the Company being deemed the primary beneﬁciary of the entity according to AcG-15.The results of these entities require consolidation with the results of the Company. Warehouse and Distribution Agreement The Company has an agreement with an independent entity to provide warehousing and distribution services. The terms of the agreement with this entity require the Company to consolidate its results with those of the Company pursuant to AcG-15. The Company has consolidated the results of these independent franchisees and the entity providing warehouse and distribution services effective at the fourth quarter of ﬁscal 2005. Balance Sheet as at May 7, 2005 Consolidated Balance Sheet as at May 7, 2005 before AcG-15 Impact Impact of the Implementation of AcG-15 Consolidated Balance Sheet as at May 7, 2005 after AcG-15 Impact $ 247.6 279.7 14.8 518.3 48.1 1,108.5 270.8 72.9 1,452.2 2,395.3 11.5 321.7 684.9 $ 34.1 (21.9) 0.2 121.3 4.2 137.9 – – 137.9 34.5 – (108.8) – $ 281.7 257.8 15.0 639.6 52.3 1,246.4 270.8 72.9 1,590.1 2,429.8 11.5 212.9 684.9 $ 4,865.6 $ 63.6 $ 4,929.2 Assets Current Cash and cash equivalents Receivables Income taxes receivable Inventories Prepaid expenses Investments, at cost (quoted market value $320.9) Investments, at equity (realizable value $162.4) Current assets and marketable investments Property and equipment Assets for realization Other assets Goodwill 80 || 2005 Annual Report 9667_Empire AR 05 B. F. MIL 7/25/05 11:27 AM Page 81 Balance Sheet as at May 7, 2005 Liabilities Current Bank indebtedness Accounts payable and accrued liabilities Future income taxes Long-term debt due within one year Long-term debt Long-term lease obligation Deferred revenue Employee future beneﬁt obligation Future income taxes Minority interest Shareholders’ Equity Capital stock Retained earnings Cumulative translation adjustment Consolidated Balance Sheet as at May 7, 2005 before AcG-15 Impact Impact of the Implementation of AcG-15 Consolidated Balance Sheet as at May 7, 2005 after AcG-15 Impact $ $ 219.4 1,119.5 52.4 245.1 1,636.4 709.6 12.3 3.0 94.5 158.8 531.9 3,146.5 194.6 1,525.6 (1.1) 1,719.1 $ 4,865.6 $ – 29.6 – 1.9 31.5 17.8 – – – – 24.4 73.7 – (10.1) – (10.1) 63.6 $ 219.4 1,149.1 52.4 247.0 1,667.9 727.4 12.3 3.0 94.5 158.8 556.3 3,220.2 194.6 1,515.5 (1.1) 1,709.0 $ 4,929.2 Accounts receivable and long-term notes receivable due from the franchisees were eliminated upon consolidation. Cash, inventories, ﬁxed assets, accounts payable and debt ﬁnancing the ﬁxed assets has been consolidated. A charge of $9.5 has been recorded to opening retained earnings (net of minority interest of $5.0) to reﬂect: 1) The reduction of inventory values of the franchisees that include charges from the Company for distribution costs and vendor allowances that are not recognized by the Company until ﬁnal sale to customers, 2) Goodwill that is carried on the accounts of stores determined to be VIE’s has been assessed as being impaired with no fair market value and, as such, has been eliminated. Minority interest represents the equity in the VIE’s held by the common shareholder. Empire Company Limited || 81 9667_Empire AR 05 B. F. MIL 7/25/05 11:27 AM Page 82 Notes to the Consolidated Financial Statements Income Statement for the 53 weeks ended May 7, 2005 Sales Operating expenses Consolidated Income Statement as at May 7, 2005 before AcG-15 Impact Consolidated Income Statement as at May 7, 2005 after AcG-15 Impact Impact of the Implementation of AcG-15 $ 12,297.8 $ 137.4 $ 12,435.2 Cost of sales, selling and administrative expenses Depreciation and amortization 11,655.2 199.7 135.8 1.8 11,791.0 201.5 Investment income Operating income Interest expense Long-term debt Short-term debt Capital gain and other items Earnings before income taxes and minority interest Income taxes Earnings before minority interest Minority interest Net earnings Earnings per share basic and diluted Basic and diluted weighted average number of common shares outstanding, in millions 442.9 21.0 463.9 81.1 5.1 86.2 377.7 4.4 382.1 131.3 250.8 63.8 187.0 2.84 65.7 $ $ (0.2) – (0.2) 0.4 0.1 0.5 (0.7) – (0.7) (0.1) (0.6) (0.2) (0.4) (0.01) $ $ 442.7 21.0 463.7 81.5 5.2 86.7 377.0 4.4 381.4 131.2 250.2 63.6 186.6 2.83 65.7 $ $ The impact of implementation of AcG-15 on the consolidated income statement of the Company can be explained as follows: Franchise retail sales are recorded and sales from the Company’s warehouse and cost of goods sold to the franchisees have been eliminated.The impact on all other ﬁnancial statement line items including net earnings is immaterial. 82 || 2005 Annual Report 9667_Empire AR 05 B. F. MIL 7/25/05 11:27 AM Page 83 23. Change in Fiscal Year-end Effective for ﬁscal 2005, Empire’s year-end changed from April 30th to the ﬁrst Saturday in May. As such, the quarter-end dates and ﬁscal year-end will be consistent with Sobeys Inc. 24. Subsequent Events (a) On June 17, 2005, Sobeys Inc. received notice from Canada Revenue Agency (CRA) that a notice of reassessment was forthcoming related to the Goods and Services Tax (GST) matter outlined in Note 16. Sobeys Inc. has reviewed this matter, has received legal advice and believes it was not required to collect GST. Sobeys Inc. is challenging this proposed reassessment and if necessary will defend against any reassessments to the appropriate judicial bodies. Accordingly, the Company has not recorded any of the proposed tax, interest or penalties in its ﬁnancial statements. (b) On June 6, 2005, the shareholders of Wajax Limited (Wajax), an equity accounted investment, approved a Plan of Arrangement to convert Wajax into an income fund.The Company owned approximately 45% of the outstanding shares of Wajax (on a fully diluted basis).The Plan of Arrangement was completed on June 15, 2005 with the Company receiving one unit of Wajax Income Fund (Fund) for each Wajax share held.Through a secondary offering, on June 21, 2005, the Company sold a total of 2.5 million Fund units for net proceeds of approximately $44.This reduced the Company’s ownership percentage to approximately 29.9%.The net proceeds from this sale are expected to be used to repay bank indebtedness.The Company has granted an over-allotment option to the underwriters exercisable to July 21, 2005, whereby the underwriters can purchase from the Company up to 375,000 units at $19.25 per unit. 25. Comparative Figures Comparative ﬁgures have been reclassiﬁed, where necessary, to reﬂect the current year’s presentation and to record the effects of retroactive application of certain new accounting standards. Empire Company Limited || 83 9667_Empire AR 05 B. F. MIL 7/25/05 2:11 PM Page 84 Eleven-Year Financial Review Years Ended(1) Financial Results ($ in millions; except ROE) Revenue Operating income Interest expense Income taxes Minority interest Earnings from continuing operations before net capital gains and other items Earnings from discontinued operations (2) Operating earnings (3) Capital gain (loss) and other items, net of tax Net earnings Return on equity Financial Position ($ in millions) Total assets Long-term debt (excluding current portion) Shareholders’ equity Per Share Data ($ per share) Operating earnings Capital gain (loss) and other items, net of tax Net earnings Dividends Non-Voting Class A common shares Class B common shares Book value Share Price, Non-Voting Class A Shares ($ per share) High Low Close Weighted Average Number of Common Shares Outstanding (in millions) 2005 2004 Restated 2003 Restated 2002 2001 $ 12,435.2 $ 11,284.0 $ 10,624.2 $ 9,926.5 $ 9,331.1 463.7 86.7 131.2 63.6 182.9 – 182.9 3.7 186.6 11.4% 4,929.2 727.4 1,709.0 2.78 0.05 2.83 0.4800 0.4800 25.87 38.00 24.25 36.66 65.7 422.8 92.4 111.0 58.5 163.3 – 163.3 9.2 172.5 11.6% 4,679.7 913.0 1,567.6 2.48 0.14 2.62 0.4000 0.4000 23.67 29.50 23.10 26.65 65.8 444.4 93.7 120.0 67.5 159.3 – 159.3 (6.0) 153.3 11.4% 4,519.3 923.1 1,418.5 2.42 (0.09) 2.33 0.3300 0.3300 21.41 33.25 23.70 23.85 65.8 416.2 111.6 104.8 50.0 123.5 8.7 132.2 63.7 195.9 16.4% 4,318.0 975.0 1,290.6 2.00 0.97 2.97 0.2138 0.2138 19.47 33.30 15.75 28.88 65.7 341.1 145.8 131.9 34.3 78.5 10.0 88.5 491.5 580.0 69.1% 4,254.3 1,107.2 1,115.0 1.33 7.49 8.82 0.1700 0.1700 16.82 18.25 13.88 17.00 65.6 (1) Fiscal years are ended April 30th except ﬁscal 2005 which ended May 7, 2005 (a 53 week year), reﬂecting a change in ﬁscal year end to the ﬁrst Saturday in May, consistent with the ﬁscal year end of Sobeys Inc. (2) Discontinued operations reﬂect the ﬁnancial contribution of SERCA Foodservice operations, which was sold at the end of 2002. (3) Operating earnings equals net earnings before capital gain (loss) and other items. 84 || 2005 Annual Report 2002 926.5 416.2 111.6 104.8 50.0 123.5 8.7 132.2 63.7 195.9 16.4% 318.0 975.0 290.6 2.00 0.97 2.97 .2138 .2138 19.47 33.30 15.75 28.88 65.7 9667_Empire AR 05 B. F. MIL 7/25/05 11:27 AM Page 85 2001 2000 1999 1998 1997 1996 1995 $ 9,331.1 $ 9,100.1 $ 5,362.7 $ 2,912.2 $ 3,149.7 $ 2,915.2 $ 2,699.5 341.1 145.8 131.9 34.3 78.5 10.0 88.5 491.5 580.0 69.1% 4,254.3 1,107.2 1,115.0 1.33 7.49 8.82 0.1700 0.1700 16.82 18.25 13.88 17.00 65.6 309.7 159.6 68.1 32.9 78.8 5.9 84.7 2.1 86.8 13.3% 184.4 112.6 49.1 9.2 59.0 1.1 60.1 74.9 135.0 21.7% 108.6 76.8 17.9 – 56.1 8.1 64.2 23.6 87.8 114.2 79.2 16.9 0.4 51.5 – 51.5 1.4 52.9 17.9% 11.9% 4,171.0 1,332.0 602.8 4,023.5 1,391.8 737.5 1.10 0.03 1.13 0.1400 0.1400 8.73 16.98 12.33 16.05 75.6 0.78 1.00 1.78 0.1363 0.1363 9.03 16.275 12.50 13.00 75.0 1,907.2 616.5 558.3 0.85 0.32 1.17 0.1213 0.1163 7.06 14.25 7.80 13.63 73.9 1,797.4 606.8 479.6 0.65 0.02 0.67 0.1100 0.0900 5.93 7.85 6.13 7.85 74.0 110.1 87.7 13.7 0.5 41.1 – 41.1 (19.4) 21.7 3.9% 1,731.4 656.1 474.9 0.47 (0.26) 0.21 0.1075 0.0825 5.24 7.88 5.75 6.15 74.6 122.5 89.3 16.8 0.5 42.7 – 42.7 (1.5) 41.2 9.4% 1,761.1 648.0 469.5 0.49 (0.02) 0.47 0.1000 0.0600 5.12 8.25 6.50 6.69 74.5 Empire Company Limited || 85 9667_Empire AR 05 B. F. MIL 7/25/05 11:27 AM Page 86 Investor Information Empire Company Limited Head Office: 115 King Street Stellarton, Nova Scotia B0K 1S0 Telephone: (902) 755-4440 Fax: (902) 755-6477 Email: www.empireco.ca Investor Relations and Inquiries Shareholders, analysts, and investors should direct their financial inquiries or requests to: Stewart H. Mahoney, CFA, Vice President, Treasury and Investor Relations E-mail: investor.relations@empireco.ca Communications regarding investor records including changes of address or ownership, lost certificates, or tax forms, should be directed to the Company’s transfer agent and registrar, CIBC Mellon Trust Company. Affiliated Company Web Addresses www.sobeys.com www.empiretheatres.com www.crombieproperties.com Shareholders’ Annual General Meeting September 8, 2005 at 11:00 a.m. (ADT) Aberdeen Cinemas 610 East River Road New Glasgow, Nova Scotia Stock Exchange Listing The Toronto Stock Exchange Stock Symbols Non-Voting Class A shares – EMP.NV.A Preferred shares: Series 2 – EMP.PR.B Average Daily Trading Volume (TSX) 27,500 Common Dividend Record and Payment Dates for Fiscal 2006* Record Date Payment Date July 15, 2005 October 14, 2005 January 16, 2006 April 14, 2006 * subject to approval by Board of Directors July 29, 2005 October 28, 2005 January 31, 2006 April 28, 2006 31,170,839 27,674 34,585,225 Outstanding Shares As of July 15, 2005 Non-Voting Class A Options exercisable with Non-Voting Class A shares Class B common, voting Transfer Agent and Registrar CIBC Mellon Trust Company Investor Correspondence P.O. Box 7010 Adelaide Street Postal Station Toronto, Ontario M5C 2W9 Telephone: (800) 387-0825 Email: enquiries@cibcmellon.com Bankers Bank of Montreal Bank of Nova Scotia Canadian Imperial Bank of Commerce National Bank of Canada Royal Bank of Canada TD Canada Trust Solicitors Stewart McKelvey Stirling Scales Halifax, Nova Scotia Auditors Grant Thornton, LLP New Glasgow, Canada Multiple Mailings If you have more than one account, you may receive a separate annual report for each. If this occurs, please contact CIBC Mellon Trust Company at (800) 387-0825 to eliminate the multiple mailings. Exemplaire Français Vous pouvez obtenir un exemplaire français de ce rapport annuel en écrivant à : Empire Company Limited Investor Relations 115 King Street Stellarton, Nova Scotia B0K 1S0 86 || 2005 Annual Report s r e t e i P n a i r B : y h p a r g o t o h P s n o i t a c i n u m m o C e t a r o p r o C e g a S : s e c i v r e S l a i r o t i d E m o c . b i a r c . w w w s n o i t a c i n u m m o C & n g i s e D b i a r C : n g i s e D 9667_Empire AR 05 B. F. MIL 7/25/05 11:27 AM Page 87 Mission Statement Goal Empire is committed to building shareholder value through long-term proﬁtability and growth by becoming a market leader in its core operating businesses and by investing in other opportunities to augment this growth in value. How We believe that the three key factors in the creation of value are ﬁrst, strong management, second, ﬁnancial structures which facilitate growth and third, emphasis on long-term growth in cash ﬂow that exceeds the after-tax dollar cost of capital. Values Empire will be a good corporate citizen, upholding the highest standards of integrity and ethical conduct. www.empireco.ca E M P I R E C O M P A N Y L I M I T E D Empire Company Limited || 87 E M P I R E C O M P A N Y L I M I T E D www.empireco.ca

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