Empire Company Annual Report 2008

Plain-text annual report

clearly focused on our strengths EMPIRE COMPANY LIMITED 2008 ANNUAL REPORT Financial Highlights ($ in millions, except per share amounts) 52 Weeks Ended May 3, 2008 52 Weeks Ended May 5, 2007* 52 Weeks Ended May 6, 2006* Operations Revenue Operating income Operating earnings Capital gains and other items, net of tax Net earnings Financial Condition Total assets Long-term debt Shareholders’ equity Per Share Information Operating earnings (fully diluted) Capital gains and other items, net of tax Net earnings (fully diluted) Book value Dividends Share Price High Low Close *Restated. $ 14,065.0 $ 13,366.7 $ 13,063.6 472.6 242.8 73.0 315.8 431.1 200.1 5.7 205.8 491.4 202.0 94.8 296.8 $ 5,706.9 $ 5,241.5 $ 5,051.5 1,475.0 2,382.3 875.1 2,131.1 809.8 1,965.2 $ $ 3.69 1.11 4.80 36.14 0.66 55.19 35.40 39.25 $ $ 3.04 0.09 3.13 32.31 0.60 45.25 39.49 42.33 $ $ 3.07 1.44 4.51 29.77 0.56 44.35 33.37 43.29 Consolidated Revenue $ IN MILLIONS Consolidated Operating Earnings $ IN MILLIONS 14,065.0 242.8 12,000 9,000 6,000 3,000 200 150 100 50 FISCAL YEAR 04 05 06 07 08 FISCAL YEAR 04 05 06 07 08 Empire Company Limited (TSX: EMP.A) is a Canadian company whose core businesses are food retailing and related real estate. Guided by conservative business principles, our primary goal is to build 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. knowledge & experience in food retailing & real estate It’s a powerful combination of strengths built upon 100+ years in food retailing and 40+ years in real estate. Our focus on these core businesses will continue to guide Empire as we further enhance our capabilities and competitive advantages to sustain growth in our businesses. 2 EMPIRE’S CORE BUSINESSES Our strengths, performanc Our strengths, performanc 4 LETTER TO SHAREHOLDERS Fiscal 2008 was a transfo Fiscal 2008 was a transfo enhanced our corporate st enhanced our corporate st a solid platform for growth a solid platform for growth 8 FOOD RETAILING In an environment of intens In an environment of intens our focus on food has not a our focus on food has not a 14 REAL ESTATE During 2008 we expanded o During 2008 we expanded o team with experienced individ team with experienced individ dedicated to expanding our p dedicated to expanding our p 16 OUR LONG-TERM PROGRESS Empire continues to deliver s Empire continues to deliver s 18 LETTER FROM THE CHAIR Empire’s long-term perspecti Empire’s long-term perspecti distinguishing advantage. distinguishing advantage. 22 COMMUNITY INVOLVEMENT Our goal is to “proudly serve o Our goal is to “proudly serve o 27 MANAGEMENT’S DISCUSSION & ANALYSIS 70 CONSOLIDATED FINANCIAL STATEMENTS AND NOTES Danielle McNelly, Assistant Meat Ma Danielle McNelly, Assistant Meat Ma EMPIRE’S CORE BUSINESSES PROFILE COMPETITIVE STRENGTHS Sobeys Inc. owns and operates more than 1,300 corporate and franchise afﬁliate stores in every province across Canada under retail banners that include Sobeys, IGA, IGA extra, Foodland, Price Chopper and Thrifty Foods, as well as Lawtons Drug Stores. Our ﬁve core retail formats are designed to ensure that we have the right offering in the right-sized stores for each individual market we serve – from our full service format to the convenience format, each designed to satisfy the occasion-based food shopping needs of our customers. Empire’s real estate business includes commercial and residential property operations. Our commercial real estate operations are focused on the development of food-anchored shopping plazas and ownership of retail and ofﬁce properties through a 47.8 percent ownership interest in Crombie REIT. The focus of our residential operations is on land development, predominantly through a 35.7 percent ownership interest in Genstar Development Partnership. Our customer focus and superior service delivery. Our passionate “best in food” focus supported by our fresh food expertise and our exceptional (cid:36)(cid:80)(cid:78)(cid:81)(cid:77)(cid:74)(cid:78)(cid:70)(cid:79)(cid:85)(cid:84) private label products. Our committed and knowledgeable franchise affiliates and store operators. Our enhanced supply chain, back shop processes, systems and tools that support our employees in serving the needs of our customers. Our knowledge, strength of management and experience in real estate. The close working relationship with Sobeys and Crombie REIT that enables Empire to accelerate the development of food-anchored shopping plazas across Canada. The preferential development agreement between our commercial division and Crombie REIT. This agreement reduces risk and enhances opportunities for both businesses. Our residential property operation, through Genstar, has attractive land holdings primarily in Western Canada and a proven, experienced management team. food retailing The right-sized, right format offering for each market that we serve (cid:115) FOOD RETAIL LOCATION real estate An expanding capability to develop food-anchored shopping plazas (cid:115) REAL ESTATE PROPERTY 2 E M PI R E COM PANY LI M ITE D KEY PERFORMANCE INDICATORS VISION AND STRATEGIC PRIORITIES Food Retailing Revenue $ IN MILLIONS Food Retailing Operating Income $ IN MILLIONS 13,768.1 359.0 12 ,000 9,000 6,000 3,000 320 240 16 0 80 FISCAL YEAR 04 05 06 07 08 FISCAL YEAR 04 05 06 07 08 Real Estate Revenue $ IN MILLIONS Real Estate Funds from Operations $ IN MILLIONS 240 18 0 120 60 160.6 60 45 30 15 64.4 29.1 35.3 FISCAL YEAR 04 05 06 07 08 FISCAL YEAR 04 05 06 07 08 COMMERCIAL RESIDENTIAL We are determined to be widely recognized as the best food retailer in Canada. Our focus in fiscal 2008 remained on three key imperatives: continued improvement in operational execution through the engagement and development of our employees; reducing our cost base and improving productivity throughout our organization; and innovation in the product and services offered to our customers. Sustaining a competitive retail price position in each format and every market is a corner- stone commitment from which we will not waver. Creating an environment in which our people are empowered with the skills, tools and processes to do their jobs well is fundamental to our superior execution and sustained growth. The goal of our commercial real estate division is to create both certainty and pace of growth for Crombie REIT and Sobeys by continuing to accelerate growth in our development pipeline across Canada. Our strategy rests firmly on the combination of strengths brought to the business by Sobeys with its substantial in-house expertise in selecting commercial locations, Crombie REIT with its decades of management expertise, and the development expertise that we have within our commercial operations. Guiding our decisions at all times is a set of criteria that exemplifies our investment discipline. 2008 AN N UAL R E PORT 3 LETTER TO SHAREHOLDERS focused on our strengths Our solid operating achievements and financial performance in fiscal 2008 demonstrate the value of Empire’s privatization of Sobeys. We have created a solid platform for growth in food retailing and food-anchored shopping plaza development across Canada. With a strong, dedicated team, we see significant opportunity to leverage this model beyond our established presence in Eastern Canada, expanding more aggressively into Central Canada and British Columbia. Fiscal 2008 was a transformative year. The successful privatization of Sobeys simpliﬁed and enhanced our structure and corporate governance and intensiﬁed our focus on the return on capital employed. But it represented just one step in the implementation of a strategy designed to realign our activities and renew our focus on our strengths. In 2008, solid strategic progress, including expanded market presence, was made in each of our core businesses. Upon the close of the Sobeys privatization transaction in June 2007, we began negotiations to sell a portfolio of 61 commercial properties representing approximately Paul D. Sobey (left), President and CEO, Empire Company Limited; Stewart H. Mahoney, Vice President, Treasury and Investor Relations; and Paul V. Beesley, Executive Vice President and CFO. interest in the Trust and we look forward to proﬁting from strong performance going forward. The sale of these properties was not only a sound ﬁnancial transaction. Just as important, it aligned well with Empire’s real estate strategy by supporting signiﬁcant growth for Crombie REIT and strength- ening the solid relationship between our core businesses of food retailing and related real estate. The transaction also conﬁrms our conﬁdence in the Crombie management team and their strategies to sustain the solid operating and ﬁnancial performance that they have achieved since the REIT’s launch in March 2006. We look forward to the 3.3 million square feet of gross leaseable area to generation of further transaction opportunities as Empire’s Crombie REIT. property development program evolves. The transaction closed in April 2008 for $428.5 million, While our real estate division successfully negotiated effectively monetizing the value of our assets and providing the sale of properties to Crombie REIT, Sobeys acquired Empire with funds to repay bank indebtedness and reduce our British Columbia-based grocery retailer Thrifty Foods. consolidated debt to capital ratio to 39.8 percent at the end Thrifty’s business includes 21 full-service supermarkets, of ﬁscal 2008. With an additional equity investment in a main distribution centre and a wholesale division on Crombie REIT, Empire now holds a 47.8 percent ownership Vancouver Island and the lower mainland of British Columbia. 4 E M PI R E COM PANY LI M ITE D Daniel Giroux, Meat Counter Manager, IGA extra, Mascouche, Québec The similarities between Sobeys and Thrifty Foods were While the turmoil in the capital markets has had an clear to us: an unwavering focus on food, dedicated impact on our share price over the last year, we have still employees, a great service culture and strong values, delivered an average annual total return to shareholders including a strong commitment to their communities. Thrifty of 12.0 percent over the last 10 years. Foods was not only a great strategic ﬁt for our Company, it also expanded our footprint in British Columbia creating Food retailing opportunities for future growth within food retailing and Sobeys achieved a 5.6 percent increase in sales to reach real estate development. Financial highlights $13.77 billion and a 17.3 percent increase in net earnings in ﬁscal 2008. Once again, Sobeys’ solid performance was the result of an unwavering commitment to its food-focused We were pleased with Empire’s ﬁnancial results in ﬁscal strategy. Our strategy is executed through the collective 2008. Revenues grew by 5.2 percent to $14.06 billion passion of our employees, franchisees and afﬁliates and while operating earnings increased to another record high, their knowledge of the food business in the distinct $242.8 million or $3.69 per share. Dividends paid to common markets that we serve and our commitment to operational shareholders increased by 10.0 percent to $0.66 per excellence and innovation. annum while book value per share grew by 11.9 percent. Subsequent to ﬁscal year-end, coinciding with the release of our fourth qua June 26, 2008, to announce a fu in the Empire div to $0.70 on an annualized basis Rennie Bugeja, Real Estate Consultant, Sobeys Ontario; Derick Hendricks, Manager Construction Ontario/Québec, Crombie REIT; and Mark Stone, Manager of Real Estate Planning, ECL Developments Ltd., work together in a real estate business model uniquely capable of prospering throughout the traditional real estate cycles. 2008 AN N UAL R E PORT 5 Every initiative that was implemented in ﬁscal 2008 – Crombie REIT’s real estate management skills and Sobeys’ from the launch of (cid:36)(cid:80)(cid:78)(cid:81)(cid:77)(cid:74)(cid:78)(cid:70)(cid:79)(cid:85)(cid:84)(cid:1)(cid:43)(cid:86)(cid:79)(cid:74)(cid:80)(cid:83)(cid:1)(cid:37)(cid:74)(cid:84)(cid:79)(cid:70)(cid:90)(cid:1)and the regional expertise in identifying superior locations, we have introduction of almost 100 new products for kids to Fresh created a strong set of capabilities, assets and access to Item Management, a new SMART retailing program – markets. We’re simply stronger together than apart. was aimed at achieving our goal to “out-food”, “out-fresh”, With respect to our residential operations, Genstar “out-service” and “out-market” those who choose to continues to be an excellent investment, contributing compete with us. This focus is not only protecting Sobeys’ $34.7 million in earnings to Empire in ﬁscal 2008. Genstar’s position in the industry – it’s allowing the Company to grow earnings contribution is expected to decline moderately in an intensely competitive market place. in ﬁscal 2009 as a result of an anticipated slowdown in Real estate residential lot selling activity. Genstar has a very strong management team and holds an attractive mix of undeveloped In ﬁscal 2008, we made substantial progress in the land and serviced lots. These properties were acquired at transformation of our real estate division, which works favourable prices and continue to represent very good closely with Sobeys on the development of food-anchored value, even in a stable or declining market environment. shopping plazas. We now have 1.9 million square feet of property either under development or offered for sale. Empire Theatres and other investments We also have established new teams in Québec and British As the second largest movie exhibitor in Canada, Columbia to work with our existing teams in Ontario and wholly-owned Empire Theatres owns or has an interest in Atlantic Canada to expand our development pipeline. 53 locations representing 387 screens, operating in eight These teams will work closely with Crombie REIT, provinces from coast-to-coast. During ﬁscal 2008, it opened which has provided an average annual investment return new theatres in Dartmouth, Nova Scotia and Bolton, Ontario of 12.0 percent since going public in March 2006 and and adopted new technologies such as digital cinema and has provided Empire shareholders with a second year Real D 3D. Attendance at existing theatres was driven by of exemplary operating and ﬁnancial performance. programming from The Metropolitan Opera, The Royal Opera By combining the development talents that we’re House, The Royal Ballet and World Wrestling Entertainment building within our commercial real estate division with in addition to the traditional major studio releases. 6 E M PI R E COM PANY LI M ITE D Both Empire Theatres and Wajax beneﬁt Empire by providing a steady cash ﬂow, while enhancing our ﬁnancial ﬂexibility. Empire Theatres executives (left to right): Kevin J. MacLeod, Executive Vice President; Stuart G. Fraser, President and CEO; and Paul W. Wigginton, Vice President, Finance and CFO. Our investment in Wajax Income Fund generated solid expenditures. By reducing our debt and managing our performance in ﬁscal 2008, contributing equity earnings capital prudently, we hope to return the rating assigned to of $20.4 million and unit price appreciation of 14.0 percent our Company to investment grade by both rating agencies. over ﬁscal 2007. Wajax Income Fund is a leading Canadian distributor and service support provider of mobile equipment, Heartfelt appreciation industrial components and power systems. This is a very We have the ﬁnancial strength to execute our operating solid business with a superb management team. Wajax is strategies, and we expect our ﬁnancial capacity to improve well positioned in the market with substantial ties throughout ﬁscal 2009. We have a Board of Directors, to Alberta’s oil sands. corporate management team and leadership in our core Both Empire Theatres and Wajax beneﬁt Empire businesses that have the experience and expertise to by providing a steady cash ﬂow, while enhancing our ensure we remain focused on our strengths and that ﬁnancial ﬂexibility. Strategic priorities our strategies are executed efﬁciently and capital is allocated prudently. It is our people across the Company, however, who As we move into ﬁscal 2009, we will continue to focus build this Company with consistent focus on superior on our core strategic priorities. First, we remain committed execution as they work together day-to-day with enthusi- to supporting Sobeys in its goal to be widely recognized asm and commitment. With the continued support of our as the best food retailer in Canada in what continues to employees, franchisees and afﬁliates we are conﬁdent in be an intensely competitive environment. Second, we are our ability to grow our proﬁtability in the years ahead. committed to the ongoing evolution of our real estate business into a developer of new properties to be vended, preferably, to Crombie REIT. Finally, we are determined to reduce our leverage over the coming year through prudent working capital management and a renewed focus and scrutiny on capital y President and CEO Empire Company Limited June 26, 2008 2008 AN N UAL R E PORT 7 FOOD RETAILING focused on food In an environment of intense competition our focus has not wavered and will not waver. Sobeys is focused on food. As a result we have continued to make solid progress along a continuum in our determination to be widely recognized as the best food retailer in the country. We strive to (cid:178)(cid:80)(cid:86)(cid:85)(cid:14)(cid:71)(cid:80)(cid:80)(cid:69)(cid:179), (cid:178)(cid:80)(cid:86)(cid:85)(cid:14)(cid:71)(cid:83)(cid:70)(cid:84)(cid:73)(cid:179), (cid:178)(cid:80)(cid:86)(cid:85)(cid:14)(cid:84)(cid:70)(cid:83)(cid:87)(cid:74)(cid:68)(cid:70)(cid:179) and (cid:178)(cid:80)(cid:86)(cid:85)(cid:14)(cid:78)(cid:66)(cid:83)(cid:76)(cid:70)(cid:85)(cid:179) all those who choose to compete with us in the Canadian food retail marketplace. At the core of our food-focused strategy are our regional and local market management structures and teams of store operators who, by virtue of their “in the market” presence and knowledge, deploy market-tailored offerings to satisfy the unique occasion based needs of our customers. We capitalize on the diversity across the Canadian retail landscape by deploying our ﬁve distinct store formats based on individual market requirements and opportunities: full service, fresh ﬁll-in, community service, convenience and price discount food stores. Our ability to compete for customer patronage and loyalty – and grow sales per square foot – depends on being relevant in each Bill McEwan (right), President and CEO, Sobeys Inc., with Joan Muise, Administration Clerk and Donald MacLean, Owner/Operator of Foodland Westville, Nova Scotia. reducing our cost base and improving productivity throughout our organization; and innovation in the products and services offered to our customers. Sustaining a competitive retail price position in each format and every market is a cornerstone commitment that we will not waver from and creating an environment in which our people are empowered with the tools, skills and processes to do their jobs well is fundamental to superior execution and sustained growth. Continued solid performance With our focus clear and intact, Sobeys continued to achieve solid location with the right-sized store, the right format store, the operating and ﬁnancial performance in what remains an right price and promotion position, the right range of products intensely competitive food retail environment. Total revenue and the right balance of services and self serve offerings. for the year reached $13.77 billion compared to $13.03 billion During ﬁscal 2008, Empire’s privatization of Sobeys in ﬁscal 2007 as we sustained full year same-store sales served to support the three imperatives that are the tactical growth driven by continued increases in sales per square foundation of our strategy: operational execution through foot – key indicators of our strategic progress and evidence the engagement and development of our employees; of improved productivity. 8 E M PI R E COM PANY LI M ITE D strength in freshness Sobeys can “out-food”, “out-fresh” and “out-service” our competitors with innovative initiatives such as SMART retailing. SMART helps store managers like Joe Glover at Sobeys Store 925 in Oshawa achieve operational excellence by providing the tools and processes that allow them to use their local market knowledge to satisfy the unique needs of their customers more effectively. 2008 AN N UAL R E PORT 9 Growing our store network In ﬁscal 2008 we continued to expand and improve the quality of Sobeys’ retail square footage, opening or relocating 44 new stores, acquiring 22 stores and expanding 31 stores, while closing 67 stores; a net increase of 127,000 new square feet across the country. We announced the acquisition of British Columbia-based Thrifty Foods in ly 2007. Thrifty Foods is a very well respected food- cused retailer with great management, a strategy entirely nsistent with ours, and a reputation for exceptional stomer service, innovative product development and mmunity service. Building on the great foundation and putation of Thrifty Foods, we are committed to expanding r business on Vancouver Island and beyond. strength in communication Our focus on fresh is just as vibrant on Sobeys.com as it is in our stores. Consumers can create shopping lists as they read our weekly ﬂyer, explore fresh tastes and meal ideas or visit our Countertop Buzz, our chefs’ blogs about great food, good fun, and inspirational meal ideas. 10 E M PI R E COM PANY LI M ITE D Sobeys launched the third wave of SMART retailing in 2008. Fresh Item Management provides store managers with the capability to analyze shopping patterns and determine the quantity of freshly produced items required throughout the day. Sobeys’ pharmacy customers know they can depend on knowledgeable customer service from employees like Rosa Milano. Monica Juliao, Baker, Oshawa Sobeys Sustaining our retail price position implementation of two new SMART programs in 2008. The intimate knowledge of each of our regional These initiatives were also made possible by the powerful management teams has been key to sustaining our information platform that we have implemented in Atlantic competitive retail price position in the face of new Canada, Ontario and the West. The ﬁrst of our new competition and, at times, unusual competitive pricing initiatives in 2008 was Workforce Management. This and promotional tactics. It is a position that has been initiative provides information to support the right levels of hard earned and one that we will not relinquish. service at all times to service the needs of our customers Sustaining our price position relies signiﬁcantly in each store. Simply through more effective scheduling we on our ability to control and cut our costs and increase can improve service at a lower cost and higher productivity productivity in distribution centres, administrative ofﬁces to achieve increased customer satisfaction. and our stores. Initiatives such as SMART retailing, our The second initiative in 2008 was Fresh Item store-based operational excellence and productivity Management. By analyzing shopping patterns we can program, have been critical enablers. This program is determine the quantity of freshly produced items required all about the details of retail: continuous, incremental throughout the day. This ensures freshness while eliminating improvements that enhance our competitive position, the waste that inevitably results from over production. increase productivity and contribute to better top and In turn, this reduces shrink – a major drain on proﬁtability bottom-line performance. in food retailing. SMART retailing – the third wave We’re now in the third wave of SMART retailing with the launch of Peer-to-Peer management in 2007, which allows stores across our network to share information and best practices. Furthermore, it was a key enabler for the 2008 AN N UAL R E PORT 11 Sobeys Québec’s new distribution centre is the ﬁrst in Canada to be built according to the LEED® (Leadership in Energy and Environmental Design) standard, the North American benchmark for green construction. To ensure our products are meeting the needs of our customers, we’ve established a number of independent, consumer product appraisal panels that benchmark the quality of every one of our private label products. John Hale (second from right), Director of Product Appraisal, works with one of the panels. Upstream in the supply chain we are building new The introduction of (cid:36)(cid:80)(cid:78)(cid:81)(cid:77)(cid:74)(cid:78)(cid:70)(cid:79)(cid:85)(cid:84)(cid:1)(cid:43)(cid:86)(cid:79)(cid:74)(cid:80)(cid:83)(cid:1)(cid:37)(cid:74)(cid:84)(cid:79)(cid:70)(cid:90) builds distribution facilities and expanding others to ensure on our successful launch in 2007 of (cid:36)(cid:80)(cid:78)(cid:81)(cid:77)(cid:74)(cid:78)(cid:70)(cid:79)(cid:85)(cid:84)(cid:1)(cid:48)(cid:83)(cid:72)(cid:66)(cid:79)(cid:74)(cid:68)(cid:84)(cid:1) optimal service levels to our stores and to reduce errors and (cid:36)(cid:80)(cid:78)(cid:81)(cid:77)(cid:74)(cid:78)(cid:70)(cid:79)(cid:85)(cid:84)(cid:1)(cid:67)(cid:66)(cid:77)(cid:66)(cid:79)(cid:68)(cid:70)(cid:14)(cid:110)(cid:82)(cid:86)(cid:74)(cid:77)(cid:74)(cid:67)(cid:83)(cid:70). To sustain our track and out-of-stocks. Our automated distribution centre under record of successful product innovation we have established construction in Vaughan, Ontario – just north of Toronto – professional in-house talent and independent consumer- is proceeding on time and on budget. We anticipate based product appraisal panels that benchmark the quality opening the facility in early ﬁscal 2010. of every one of our products. Delicious, nutritious and fun Embracing the challenges During 2008 we continued to expand our private label The challenge as we move into ﬁscal 2009 will be to (cid:36)(cid:80)(cid:78)(cid:81)(cid:77)(cid:74)(cid:78)(cid:70)(cid:79)(cid:85)(cid:84) line with the co-branded launch of our new respond effectively to an emerging cost of goods inﬂationary kids’ line – (cid:36)(cid:80)(cid:78)(cid:81)(cid:77)(cid:74)(cid:78)(cid:70)(cid:79)(cid:85)(cid:84)(cid:1)(cid:43)(cid:86)(cid:79)(cid:74)(cid:80)(cid:83)(cid:1)(cid:37)(cid:74)(cid:84)(cid:79)(cid:70)(cid:90). To date we have environment. We must manage the potential increased cost introduced nearly 100 new products including (cid:36)(cid:80)(cid:78)(cid:81)(cid:77)(cid:74)(cid:78)(cid:70)(cid:79)(cid:85)(cid:84)(cid:1) inputs in a way that will continue to provide fair value to the (cid:43)(cid:86)(cid:79)(cid:74)(cid:80)(cid:83)(cid:1)(cid:37)(cid:74)(cid:84)(cid:79)(cid:70)(cid:90)(cid:1)(cid:46)(cid:74)(cid:68)(cid:76)(cid:70)(cid:90)(cid:1)(cid:35)(cid:86)(cid:83)(cid:72)(cid:70)(cid:83)(cid:84)(cid:13)(cid:1)(cid:36)(cid:80)(cid:78)(cid:81)(cid:77)(cid:74)(cid:78)(cid:70)(cid:79)(cid:85)(cid:84)(cid:1)(cid:43)(cid:86)(cid:79)(cid:74)(cid:80)(cid:83)(cid:1)(cid:37)(cid:74)(cid:84)(cid:79)(cid:70)(cid:90)(cid:1) consumer while at the same time not disrupting our (cid:34)(cid:77)(cid:81)(cid:73)(cid:66)(cid:14)(cid:53)(cid:66)(cid:85)(cid:70)(cid:83)(cid:84) and (cid:36)(cid:80)(cid:78)(cid:81)(cid:77)(cid:74)(cid:78)(cid:70)(cid:79)(cid:85)(cid:84)(cid:1)(cid:43)(cid:86)(cid:79)(cid:74)(cid:80)(cid:83)(cid:1)(cid:37)(cid:74)(cid:84)(cid:79)(cid:70)(cid:90)(cid:1)(cid:39)(cid:83)(cid:86)(cid:74)(cid:85)(cid:1)(cid:49)(cid:74)(cid:68)(cid:14)(cid:46)(cid:74)(cid:89) earnings position or interrupting our growth potential. Our dried fruit snack mix. More than 75 percent of the (cid:43)(cid:86)(cid:79)(cid:74)(cid:80)(cid:83)(cid:1) keen focus on costs and productivity affords us a competitive (cid:37)(cid:74)(cid:84)(cid:79)(cid:70)(cid:90) products meet the Heart and Stroke Foundation’s advantage in this environment and, while we have made nutrient criteria for healthy choices and bear the Health progress in line with our expectations, further sales per Check™ symbol. In addition, (cid:36)(cid:80)(cid:78)(cid:81)(cid:77)(cid:74)(cid:78)(cid:70)(cid:79)(cid:85)(cid:84)(cid:1)(cid:43)(cid:86)(cid:79)(cid:74)(cid:80)(cid:83)(cid:1)(cid:37)(cid:74)(cid:84)(cid:79)(cid:70)(cid:90) square foot across our system is achievable and we look products do not contain any artiﬁcial ﬂavours, artiﬁcial forward to continued improvement in ﬁscal 2009. colours or added hydrogenated oils. But it is our (cid:81)(cid:70)(cid:80)(cid:81)(cid:77)(cid:70) who will execute and sell our way to growth – one customer at a time, one transaction at a time, one store at a time – that makes the greatest difference. In fact, our success resides not in the quality 12 E M PI R E COM PANY LI M ITE D Josée Rompré, Warehouse Clerk, Sobeys Québec Trois-Rivières Distribution Centre of our strategy, but in our ability to provide a workplace where our people can engage to win with tools, training, encouragement, processes and rewards that help them to get the job done well. We are exceptionally fortunate that our franchise afﬁliates and employees across the Company share our commitment to superior customer service and being the very best food retailer in the country. The retail food industry has always been challenging and dynamic, but Sobeys has the strategic focus and ﬁnancial capacity to embrace both the opportunities and challenges that will inspire and confront us in the years ahead. Our performance over the years has proven that we are a company capable of building a healthy and sustainable retail food business and supporting infrastructure for the long term. We will stay the course to earn broader acknowledgement as the very best food fun & retail business in Canada. innovative Bill McEwan President and CEO Sobeys Inc. June 26, 2008 During 2008, Sobeys introduced nearly 100 new products under the co-branded Compliments Junior Disney line of products for kids. More than 75 percent meet the Heart and Stroke Foundation’s nutrient criteria for healthy choices and bear the Health Check™ symbol. Compliments Junior Disney products do not contain any artiﬁcial ﬂavours, artiﬁcial colours or added hydrogenated oils. 2008 AN N UAL R E PORT 13 REAL ESTATE focused on development During 2008, we expanded our team with experienced, talented individuals capable of executing effectively and dedicated to expanding our presence across the country. Our expertise in real estate, as well as our commitment to our disciplined investment criteria, will help to ensure that Empire prospers within the traditional economic cycles of the real estate industry. Critical to our successful transition from an owner and manager of properties to a developer was the expansion of our team to include real estate development vice presidents in Atlantic Canada, Québec and British Columbia. These individuals bring integrity consistent with the Empire reputation and a commitment to excellence over the long term. Their innovative and contrarian thinking is imbedded in a wealth of property development talent and experience in regions that we believe are particularly attractive at this time. These teams, in addition to our existing real estate teams in Atlantic Canada and Ontario, will work closely with Sobeys, including Frank C. Sobey (centre), President, ECL Properties Limited with Donald E. Clow, President, ECL Developments Limited, and Aaron Bryant, Director of Engineering, Crombie REIT. grocery stores. The sale closed in April 2008, representing the second wave of real estate transactions between Empire and Crombie REIT. The ﬁrst created Crombie REIT in March 2006 with the sale of 44 commercial properties owned by Empire. A unique business model As Empire’s real estate development capacity matures, we will establish an expanding pipeline of projects that creates both certainty and pace of growth for Crombie REIT, which holds the right of ﬁrst refusal on the sale of any Empire properties. In fact, the newly-acquired Thrifty Foods, to develop properties that sustainable competitive advantage inherent in Empire’s expand the growth potential for the food retailing division real estate business today is the combination of strengths and Crombie REIT. brought to the business by Sobeys with its substantial A second step in our transition was the sale of 61 retail in-house expertise in selecting commercial locations, properties to Crombie REIT – 40 freestanding grocery Crombie REIT with its decades of management expertise, stores carrying various Sobeys banners and 21 strip and the robust development expertise that we’re gathering plazas, 20 of which are also anchored by Sobeys bannered within our real estate division. 14 E M PI R E COM PANY LI M ITE D Working together are Pat Martin, Vice President Leasing, Crombie REIT; Steve Cleroux, Director Development, ECL Developments; Michael April, Vice President Real Estate Services, ECL Developments; and Joe Fiander, Vice President Real Estate and Engineering, Sobeys Atlantic. Pipeline development strategy performance remained robust in ﬁscal 2008 as it continued Today our development pipeline comprises 14 properties to beneﬁt from the relative strength of the residential real – 1.9 million square feet in projects in Nova Scotia, New estate market in Canada. The market has softened from the Brunswick, Québec and Ontario. Several are targeted for peak experienced in 2007 and we expect a continued completion this year, others are multi-year projects. Our goal slowdown of residential selling activity in 2009, but we is to accelerate the growth of square feet available in our remain conﬁdent that Genstar will continue to yield a solid pipeline for sale each year to Crombie REIT. We intend to return on our investment. focus our investment on the locations with the greatest opportunity for proﬁt. Guiding our investments is a set of Outlook in challenging times criteria that will entrench discipline. Those criteria include: Volatile capital markets and a real estate slowdown in the A satisfactory return on investment from every project; United States are likely to affect the Canadian economy. A beneﬁcial competitive effect on Sobeys and Not only is credit tight, which has a signiﬁcant impact on a Crombie REIT; capital intensive business like real estate, consumers and Credit-worthy tenants with long-term leases that include real estate buyers have become hesitant. We are convinced, contractual increases; however, that the strength of our relationships with Sobeys Enhanced geographic diversiﬁcation; and and Crombie REIT, combined with our strict discipline, will Competitive positioning in the local market through prove to be a sustainable competitive advantage as we location or quality. continue to build shareholder value through the real estate Our real estate division continues to hold an investment in commercial real estate through Crombie REIT in which Empire owns a 47.8 percent interest. Crombie REIT’s operating and ﬁnancial performance continued to be exemplary in ﬁscal 2008. We also hold an investment in residential real estate through Genstar in which Empire maintains a 35.7 percent ownership interest. Genstar’s and economic cycles. Frank C. Sobey President ECL Properties Limited June 26, 2008 2008 AN N UAL R E PORT 15 OUR LONG-TERM PROGRESS focused on growth Empire’s ability to build shareholder value has been based on continually investing in businesses we know and understand. This is reflected in our long-term performance and progress through different business cycles and will continue to ensure solid performance despite competition in food retailing and aggressive growth in real estate. REVENUE ($ IN MILLIONS) OPER ATING EARNINGS ($ IN MILLIONS) BOOK VALUE ($ PER SHARE) March 2002 December 1998 Sobe the TS asset Group triplin food March 2000 Empire repurchases 5.5 million Non-Voting Class A shares for $187 million. July 2000 Empire sells its 25% investment in Hannaford naford Bros. Co. for a $1.2 billion consideration.n. $1.2 b 1999 $9.03 $5,362.7 $60.1 January 2001 The real estate division purchases a 35.8% interest in G Development Partne for $29 million. FISCAL YE AR 99 00 01 02 16 E M PI R E COM PANY LI M ITE D March 2006 Crombie REIT completes ties million August 2006 Sobeys acquires Québec’s Achille de la Chevrotièreière ch includes 25 Ltée, which includes 25 stores in northern Québec tores in northe and Ontario as well as and O a distribution centre in Rouyn-Noranda for $79.2 million. 2008 $14,065.0 $242.8 $36.14 res the common beys that it or $1.06 billion, 0% ownership. 2007 ires Thrifty 261.8 million. Thrifty’s assets full-service s, a distribution wholesale ancouver Island er mainland olumbia. April 2008 Empire sells 61 retail properties for $428.5 million to Crombie REIT. June 2005 nverts to a come trust. Wajax converts to an income trust. Empire sells 2.875 million units, sells 2 f for a $25.6 million gain. September 2005 E ac th $ February 2004 Acquisition of Commisso’s Food Markets by Sobeys and six Commisso’s properties by the real estate division for $61 million. Madeleine Blouin, Pricing Clerk, IGA (cid:70)(cid:89)(cid:85)(cid:83)(cid:66), Mascouche, Québec 04 05 06 07 08 2008 AN N UAL R E PORT 17 LETTER FROM THE CHAIR focused on governance As we look ahead, the Board remains confident that Empire’s continued focus on its core strengths in food retailing and related real estate has positioned the Company for enduring success. Thanks to the hard work of management and employees at Empire and in our operating companies, Empire posted record operating earnings in fiscal 2008. Although food and related real estate have been the foundation of Empire’s ability to create long-term wealth for many decades, the decision to privatize Sobeys and increase our focus on food and related real estate was taken only after very careful study of our options and the possible ramiﬁcations. A year after the fact, Sobeys has achieved solid results despite the most competitive environment that we’ve seen in many years. We believe that a signiﬁcant portion of Empire’s ﬁscal 2008 results were driven by management’s commitment to achieving a single Board mandate: Make Robert P. Dexter, Chair, Empire Company Limited Halifax, Nova Scotia – Director since 1987, Chair and CEO of Maritime Travel Inc. distinguishing competitive advantage that we believe will ensure Sobeys’ ability to sustain its performance for another 100+ years. A second major accomplishment of the year was the completion of the transformation of our commercial real estate division, from an owner and manager of commercial real estate into a business focused on food-anchored shopping plaza development. During the year Empire sold 61 properties to Crombie REIT – a sale that was made easier with the privatization of Sobeys. All remaining property owned and managed by Sobey Leased Properties Sobeys the best food retailer in the Canadian market. has been folded into Sobeys. At the same time, our real estate With the support of Empire’s Board of Directors, Sobeys’ development division completed its ﬁrst full year of operations management team is able to take a long-term perspective, by establishing teams of experienced real estate developers achieving progress along a continuum with a strategy that in British Columbia and Québec. The Board is watching the has proven effective historically and we feel will sustain development of this business with keen interest. our growth in the future. This long-term perspective is a E M PI R E COM PANY LI M ITE D Foreground, from left to right Background, from left to right Robert P. Dexter Halifax, Nova Scotia Director since 1987. Chair and Chief Executive Ofﬁcer, Maritime Travel Inc., Chair, Empire Company Limited David Leslie(1) (9) Toronto, Ontario Director since 2007. Former Chairman and Chief Executive Ofﬁcer, Ernst & Young LLP Mel Rhinelander(4) (5) (7) Toronto, Ontario Director since 2007. Vice Chairman, Extendicare REIT Marcel Côté(3) (5) (7) Montreal, Québec Director since 2007. Senior Partner, Secor Inc. Christine Cross(3) (9) Thundridge, Hertfordshire, United Kingdom Director since 2007. President, Christine Cross Ltd. Paul D. Sobey Pictou County, Nova Scotia Director since 1993. President and Chief Executive Ofﬁcer, Empire Company Limited Edward C. Harsant(1) (5) (7) Woodbridge, Ontario Director since 2003. Corporate Director John L. Bragg(3) (6) (8) Collingwood, Nova Scotia Director since 1999. Chairman, President and Co-Chief Executive Ofﬁcer, Oxford Frozen Foods Ltd. Bill McEwan New Glasgow, Nova Scotia Director since 2007. President and Chief Executive Ofﬁcer, Sobeys Inc. Malen Ng(2) (9) Toronto, Ontario Director since 2007. Chief Financial Ofﬁcer, Workplace Safety and Insurance Board of Ontario Stephen J. Savidant(1) (5) (7) Calgary, Alberta Director since 2004. Corporate Director Chairman, ProspEx Resources Inc. Frank C. Sobey(10) Stellarton, Nova Scotia Director since 2007. Chairman, Crombie REIT David F. Sobey New Glasgow, Nova Scotia Director since 1963. Chair Emeritus, Sobeys Inc. Donald R. Sobey Pictou County, Nova Scotia Director since 1963. Chair Emeritus, Empire Company Limited John R. Sobey(1) Pictou County, Nova Scotia Director since 1979. Corporate Director Karl R. Sobey(5) Halifax, Nova Scotia Director since 2001. Corporate Director David S. Ferguson(3) (9) Atlanta, Georgia Director since 2007. Principal, D.S. Ferguson Enterprises, LLC. Robert G. C. Sobey(9) Stellarton, Nova Scotia Director since 1998. President and Chief Executive Ofﬁcer, Lawtons Drug Stores Limited 1 Audit Committee Member 2 Audit Committee Chair 3 Human Resources Committee Member 4 Human Resources Committee Chair 5 Corporate Governance Committee Member 6 Corporate Governance Committee Chair 7 Nominating Committee Member 8 Nominating Committee Chair 9 Oversight Committee Member 10 Oversight Committee Chair 2008 AN N UAL R E PORT 19 Focused on experience John L. Bragg, Chair of Empire’s Corporate Governance Committee, was recognized by the Institute of Corporate Directors with the ICD Fellowship Award for his efforts to foster excellence in governance in Canada. Mr. Bragg is Chairman, President and co-Chief Executive Ofﬁcer of Oxford Frozen Foods Limited, a food manufacturer, and an ofﬁcer of several associated and afﬁliated companies. In addition to his role at Empire, he serves as director for many leading Canadian companies including TD Bank Financial Group and Canada Bread Limited. In recognition of his leadership and innovative thinking, Mr. Bragg was appointed an Ofﬁcer of the Order of Canada in 1996. Effective stewardship Acknowledgements Intense scrutiny of Empire’s corporate strategies and their As Chair, I would like to thank the management and execution is key to effective governance and Empire has a employees of Empire and its operating companies for their Board comprised of individuals particularly capable of commitment and for their hard work. I would also like to providing this oversight. Although several members of the thank my fellow directors for their consistent dedication Empire Board retired at the end of ﬁscal 2007, with the to their role as stewards of shareholder interests. We ﬁrmly privatization of Sobeys, the Empire Board expanded to believe good corporate governance is critical to our welcome eight new directors: Marcel Côté, Christine Cross, David Ferguson, David Leslie, Bill McEwan, Malen Ng, Mel Rhinelander and Frank Sobey. Our Board truly reﬂects a diversity of experience among its directors. Some have had many years of experi- ence serving Empire, and the new additions bring new insights to the Board. Together they represent a mix of talents and experiences in diverse companies and countries. This Board became very cohesive very quickly, a testament to their individual capabilities and resolve. We have also continued to ensure the Board’s ability to act independently through measures that recognize the size of the Board, the structure of the Company and our shareholder structure. long-term success in the marketplace, and that this Company can sustain the performance it has so adeptly achieved for more than 100 years. Robert P. Dexter Chair Empire Company Limited June 26, 2008 20 E M PI R E COM PANY LI M ITE D CORPORATE GOVERNANCE On behalf of Empire’s shareholders, the Board of Directors Recommends the appointment of the external auditors; is responsible for the stewardship of the Company. To fulﬁll Communicates directly with external auditors; this responsibility it establishes policies aimed at ensuring Directly oversees the work of the external auditors; the Company’s corporate governance practices are Reviews and assesses risk management; and among the best in Canada. Supporting those policies is a Reviews consolidated quarterly and annual ﬁnancial Code of Business Conduct and Ethics that emphasizes statements and related communications prior to accountability and a Corporate Disclosure Policy that public disclosure. ensures transparency. While written policies and standards provide the Corporate Governance Committee foundation for governance, thorough oversight demands a Develops, monitors and ensures compliance with Empire’s Board that is fully engaged in ensuring the Company can corporate governance policies, including responsibility continue to grow shareholder value. At Empire, every director for disclosure; is involved in establishing Empire’s strategies, assessing Annually assesses the effectiveness of the Board as a performance and progress in meeting established long and whole, the committees of the Board and the contributions short-term goals, and understanding the major risks to the of individual directors; Company’s ability to deliver results. Because the Board is Recommends suitable compensation of directors; and composed of a diversity of individuals with a combination of Recommends the composition of the Board committees. skills and experience, it is particularly capable of guiding and challenging the senior management team. Nominating Committee A comprehensive discussion of Empire’s corporate Monitors the composition of the Board for skill and governance policies and practices can be found in our expertise; and Management Information Circular and also on our website Identiﬁes, evaluates and recommends suitable candidates at www.empireco.ca along with our Corporate Disclosure for election or appointment as directors of the Company. Policy and Code of Business Conduct and Ethics. Human Resources Committee Board Committees Reviews all Company policies related to compensation; The Board of Directors fulﬁlls many of its responsibilities Recommends compensation for executive management; with the support of ﬁve committees: Audit Committee, Reviews the Company’s management training and Corporate Governance Committee, Nominating Committee, development programs; Human Resources Committee, and Oversight Committee. Ensures Empire’s compliance with occupational health Every member of the Audit Committee, the Human Resources and safety standards; Committee and the Nominating Committee is independent Undertakes CEO and executive succession planning and according to the standards of corporate and securities laws monitors management succession planning; as well as Empire’s own governance policies. All members Conducts the annual performance review for the CEO; of the Audit Committee meet the independence and ﬁnancial Establishes annual and longer-term objectives for the literacy tests set out in Multilateral Instrument 52-110 CEO; and adopted by most of the Canadian securities regulators. Oversees the Company’s pension plan. The responsibilities of each committee of the Board include the following: Oversight Committee Audit Committee Reviews all matters related to business process optimization and information technology, including Reviews and assesses the Company’s ﬁnancial reporting guiding principles, governance models, strategies, practices and procedures; planning and risk management processes; and Reviews the adequacy and reporting of internal Monitors all related projects. accounting controls and the independence of external auditors from management; 2008 AN N UAL R E PORT 21 COMMUNITY INVOLVEMENT focused on giving Our goal to “proudly serve our communities” extends beyond the workplace to the hundreds of charities across Canada supported by the management, franchisees and employees of Empire, Sobeys, ECL Properties and Empire Theatres at both a corporate and personal level, collectively contributing over $13 million to our communities. In fact, we believe that this commitment to community is fundamental to sustaining our success and we encourage our employees to participate in enhancing the well being of the communities in which they live and work. Here are just a few examples of how we made a difference in 2008. Helping the hungry Most closely related to our core business are the hundreds of thousands of dollars raised every year to help feed those in need: Sobeys’ stores in Atlantic Canada raised close to $150,000 in food products for local food banks through Sobeys’ 100th anniversary celebrity shopping sprees and holiday food drive. Sobeys, Foodland, IGA and Price Chopper stores in Ontario raised $387,000 to feed hungry children through the Breakfast for Learning program. Sobeys employees and customers across Canada support dozens of causes and raise hundreds of thousands of dollars every year to help eliminate hunger among children. Foundation’s Centre of Care Fund in its ﬁght against breast cancer. Thrifty Foods’ stores sold Jeans Day buttons to raise funds for the B.C. Children’s Hospital, the only pediatric acute care hospital in B.C. By matching every dollar raised, the stores raised over $32,000. Supporting those who help others Our charity extends to those organizations and events that raise funds for a multitude of charities and causes: Sobeys and Empire Theatres are national sponsors of Kids Help Finding a cure Phone. Sobeys stores across the Atlantic region raised Our employees and stores support dozens of organizations $34,000 in support of Kids Help Phone through a bonus seeking cures for diseases that plague our communities AIR MILES® promotion. Empire Theatres launched its ﬁrst as well as the hospitals that care for the sick and injured: annual National Movie Day in 42 locations across Canada Sobeys’ stores in Saskatchewan sold pink ribbons to raising over $20,000 for Kids Help Phone. raise $63,000 to support the Saskatoon City Hospital 22 E M PI R E COM PANY LI M ITE D Employees at the Caledon East Foodland in Ontario have reduced the use of plastic bags at their store by 65 percent in one year. The dramatic reduction in waste was achieved in part by the determination of employees as demonstrated by cashier Jessica Preston (pictured) and co-workers who were shocked at the number of plastic bags used on a typical Saturday. They created a sign that asked customers to think twice about using plastic bags and encouraged them to use Sobeys’ re-useable Green Bags for Life. 2008 AN N UAL R E PORT The 2007 Sobey Art Award recognized Michel de Broin for his passion for creating works that provoke debate and excite our senses – such as the piece shown at right. Sobey Art Foundation Chair Donald Sobey and Jeffrey Spalding, former Director of the Art Gallery of Nova Scotia, present the $50,000 2007 Sobey Art Award to Montreal artist Michel de Broin. (cid:35)(cid:77)(cid:66)(cid:68)(cid:76)(cid:1)(cid:56)(cid:73)(cid:80)(cid:77)(cid:70)(cid:1)(cid:36)(cid:80)(cid:79)(cid:71)(cid:70)(cid:83)(cid:70)(cid:79)(cid:68)(cid:70) 72 Chairs, 400 cm in diameter Creating a greener community Arts and culture On Earth Day, Sobeys Québec collected funds by The Sobey Art Award, created in 2002 by the Sobey Art donating 10 cents for each transaction for which shoppers Foundation, is designed to recognize and support contem- used their reusable grocery bags and asking these porary Canadian artists under the age of 40. Michel de customers to donate another 10 cents “for the Earth”. Broin of Québec was the 2007 winner of the $50,000 In an effort to reduce waste, over 100 Sobeys store Sobey Art Award presented in partnership with Scotiabank and ofﬁce employees in Pictou County, Nova Scotia and the Art Gallery of Nova Scotia. The 25 artists selected participated in the 2008 (cid:40)(cid:80)(cid:1)(cid:40)(cid:83)(cid:70)(cid:70)(cid:79)(cid:13)(cid:1)(cid:40)(cid:70)(cid:85)(cid:1)(cid:36)(cid:77)(cid:70)(cid:66)(cid:79) campaign to participate in the competition represented the remarkable by collecting 2,000 kg of litter around their workplaces. breadth of talent in Canada. Each of these artists is a The Sobey Foundation leader in their region and an ambassador for Canadian art on the international stage. For more information about the The generosity of the employees of Empire and its Sobey Art Award visit (cid:88)(cid:88)(cid:88)(cid:15)(cid:84)(cid:80)(cid:67)(cid:70)(cid:90)(cid:66)(cid:83)(cid:85)(cid:66)(cid:88)(cid:66)(cid:83)(cid:69)(cid:15)(cid:68)(cid:66). subsidiaries is amply supported by the Sobey Foundation, contributions from our operating companies, as well as the Healthcare investments by individual members of the Sobey family. In ﬁscal 2008, Empire, Sobeys and the Sobey Foundation We are proud of our decades of commitment to enhancing supported the David Foster Gala, an event that supports the lives of Canadians. Education families and children with lifesaving organ transplants. Members of management at Empire and Sobeys volunteer their time to community-based groups such as the Aberdeen Education is a key focus of the Sobey family efforts. Several Hospital Foundation, the Dalhousie Medical Research scholarships are dedicated to providing a brighter future Foundation and the Summer Street Industries Foundation. for young people and their communities. Over the past two years the Sobey Foundation has also contributed to the capital campaigns at several Atlantic Canadian universities. 24 E M PI R E COM PANY LI M ITE D Paul A. Jewer, Senior Vice President, Finance and Treasurer, Sobeys Inc., with Melanie Thomas, CA Program Analyst, Sobeys Inc. focused on leadership Top 40 under 40™ Paul A. Jewer, Senior Vice President, Finance and Treasurer at Sobeys, was recognized as one of Canada’s Top 40 Under 40™ in May 2008. Founded in 1995 to celebrate Canada’s leaders of today and tomorrow, this is a national program managed by The Caldwell Partners. Winners of the award must be under the age of 40 and have already achieved signiﬁcant success – demonstrating vision, leadership and innovation – while making a meaningful contribution to their communities. A native of Grand Falls-Windsor, NL, Paul is a Chartered Accountant who graduated from Acadia University in 1994. He joined Sobeys in 2003 with a diverse background in accountancy and the software industry. Sobeys to train CAs The Institute of Chartered Accountants of Nova Scotia (ICANS) and Sobeys Inc. have established Nova Scotia’s first Chartered Accountant Training Office in industry. Historically, CA students have been required to train in a public practice chartered accountancy firm or the Office of the Auditor General. Sobeys Inc. is the first industry organization in Nova Scotia – and one of a select group of leading corporations across Canada – to meet the strict criteria required to provide CA designation training. Melanie Thomas was one of the first students enrolled in this program. The establishment of this innovative professional program at Sobeys is evidence of the Company’s commitment to establishing the career paths of tomorrow’s finance leaders while providing Sobeys with the opportunity to attract the best finance talent to the Company. ™ The Caldwell Partners 2008 AN N UAL R E PORT 25 CORPORATE OFFICERS Ofﬁcers of Empire Company Limited Robert P. Dexter Chair Paul D. Sobey President and Chief Executive Ofﬁcer Paul V. Beesley Executive Vice President and Chief Financial Ofﬁcer Frank C. Sobey Vice President, Real Estate Stewart H. Mahoney Vice President, Treasury and Investor Relations Carol A. Campbell Vice President, Risk Management John G. Morrow Vice President and Comptroller Karin McCaskill Secretary Ofﬁcers of Operating Companies Sobeys Inc. Robert P. Dexter Chair Bill McEwan President and Chief Executive Ofﬁcer Craig T. Gilpin President Operations, Sobeys Ontario J. Gary Kerr President Operations, Sobeys West Jason Potter President Operations, Sobeys Atlantic Marc Poulin President Operations, Sobeys Québec Dennis Folz Chief Human Resources Ofﬁcer François Vimard Chief Financial Ofﬁcer Belinda Youngs Chief Marketing Ofﬁcer Karin McCaskill Senior Vice President, General Counsel and Secretary Paul A. Jewer Senior Vice President, Finance and Treasurer L. Jane McDow Assistant Secretary ECL Properties Limited Empire Theatres Limited Frank C. Sobey President Donald E. Clow Vice President Paul V. Beesley Chief Financial Ofﬁcer Stuart G. Fraser President and Chief Executive Ofﬁcer Kevin J. MacLeod Executive Vice President Paul W. Wigginton Vice President, Finance and Chief Financial Ofﬁcer 26 E M PI R E COM PANY LI M ITE D MANAGEMENT’S DISCUSSION AND ANALYSIS TABLE OF CONTENTS 28 INTRODUCTION 46 QUARTERLY RESULTS OF OPERATIONS 28 FORWARD-LOOKING INFORMATION 49 FINANCIAL CONDITION 29 NON-GAAP FINANCIAL MEASURES 29 EMPIRE’S STRATEGIC DIRECTION 29 OVERVIEW OF THE BUSINESS Food Retailing Real Estate Investments and Other Operations 32 SOBEYS PRIVATIZATION 33 ACQUISITION OF THRIFTY FOODS 34 SALE OF 61 PROPERTIES TO CROMBIE REIT 35 OPERATIONAL CHANGES 36 CONSOLIDATED OPERATING RESULTS 37 MANAGEMENT’S EXPLANATION OF FISCAL 2008 ANNUAL CONSOLIDATED RESULTS Revenue Operating Income Interest Expense Income Taxes Minority Interest Earnings before Capital Gains and Other Items Capital Gains and Other Items Net Earnings 39 FISCAL 2008 OPERATING PERFORMANCE BY DIVISION Food Retailing Real Estate Investments and Other Operations Capital Structure and Key Financial Condition Measures Shareholders’ Equity Liabilities Financial Instruments 52 LIQUIDITY AND CAPITAL RESOURCES Operating Activities Investing Activities Financing Activities 55 ACCOUNTING POLICY CHANGES 58 CRITICAL ACCOUNTING ESTIMATES 60 CONTROLS AND PROCEDURES 60 INTERNAL CONTROLS OVER FINANCIAL REPORTING 60 RELATED PARTY TRANSACTIONS 60 OTHER MATTERS 62 GUARANTEES AND COMMITMENTS 63 DESIGNATION FOR ELIGIBLE DIVIDENDS 63 CONTINGENCIES 63 RISK MANAGEMENT 67 OUTLOOK 68 NON-GAAP FINANCIAL MEASURES Consolidated Revenue $ IN MILLIONS Consolidated Operating Earnings Consolidated Shareholders’ Equity $ IN MILLIONS $ IN MILLIONS 14,065.0 242.8 2,382.3 12,000 9,000 6,000 3,000 200 150 100 50 2,000 1,500 1,000 500 FISCAL YEAR 04 05 06 07 08 FISCAL YEAR 04 05 06 07 08 FISCAL YEAR 04 05 06 07 08 2008 AN N UAL R E PORT 27 MANAGEMENT’S DISCUSSION AND ANALYSIS The following 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 52 weeks ended May 3, 2008, as compared to the 52 weeks ended May 5, 2007. 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 the 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. This 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 52 weeks ended May 3, 2008 as compared to the 52 weeks ended May 5, 2007. The consolidated ﬁnancial statements and accompanying notes have been prepared in accordance with Canadian Generally Accepted Accounting Principles (“GAAP”) and are reported in Canadian dollars. These consolidated ﬁnancial statements include the accounts of Empire and its subsidiaries and variable interest entities (“VIEs”) which the Company is required to consolidate. Included in the Company’s 2008 Annual Report, on page 106, is a glossary of terms used throughout this MD&A. The information contained in this MD&A is current to June 26, 2008, unless otherwise noted. Forward-Looking Information This discussion contains forward-looking statements which reﬂect management’s expectations regarding the Company’s objectives, plans, goals, strategies, future growth, results of operations, performance and business prospects and opportunities. These forward-looking statements include the following items: Sobeys’ expectation that there will not be a material adverse impact on its business as a result of global disruption in the market for third-party Asset-Backed Commercial Paper (“ABCP”) liquidity, and its belief that it has sufﬁcient credit facilities to satisfy its ﬁnancial obligations; Sobeys’ expectations that administrative and business rationalization activities as well as system process initiatives in the current year and upcoming quarters will have a cost impact as expected and will provide thereafter annualized cost reductions, both of which could be impacted by the ﬁnal scope and scale of these activities; Sobeys’ expectations that the new distribution centre announced in Ontario and the closures of distribution centres in Québec will reduce overall distribution costs, which could be impacted by the number of positions eliminated at these distribution centres; Sobeys’ expectation that sales growth will continue through 2009 could be impacted by market conditions and therefore may not be realized; Management’s belief that the growth rate in residential lot sales will continue to be impacted by general economic conditions, particularly in the Western Canada housing market, with lot sales likely to slow moderately from the level experienced in ﬁscal 2008; The Company’s expectations on future capital spending for its Real Estate and Food Retailing Divisions, which could be impacted by the availability of labour, capital resource allocation decisions, as well as general economic and market conditions; The Company’s expectation that certain real estate property held by ECL Properties can be successfully redeveloped or leased up to the point where such property can be offered for sale to Crombie REIT and if refused by Crombie REIT, then offered to a third party; The Company’s expectations regarding the purchase of 158,200 Series 2 Preferred Shares for cancellation by the end of calendar 2008 could be impacted by market conditions and availability of sellers; Management’s expectations that funded debt to capital ratio will decline in ﬁscal 2009 as a result of equity growth and plans to generate free cash ﬂow which will be used to reduce bank debt; The Company’s expectations that its capital resources and liquidity position will meet its capital and liquidity requirements over the next year; The Company’s expectations relating to pending tax matters with Canada Revenue Agency (“CRA”) and provincial tax authorities, which could be determined differently by CRA. This could cause the Company’s effective tax rate and its earnings to be affected positively or negatively in the period the matter is resolved; and The Company’s expectations that the adoption of accounting standards relating to increased disclosure in ﬁnancial statements will not have a signiﬁcant impact on the Company’s ﬁnancial statements disclosure. 28 E M PI R E COM PANY LI M ITE D MANAG E M E NT’S DISCUSSION AN D ANALYSIS Forward-looking statements are typically identiﬁed by words or phrases such as “anticipates”, “expects”, “believes”, “estimates”, “intends” and other similar expressions. 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. These uncertainties and risks are discussed in the Company’s materials ﬁled with the Canadian securities regulatory authorities from time to time, including those discussed in the Risk Management section of this MD&A. Non-GAAP Financial Measures 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, other than as required by Canadian security regulations. There are measures included in this MD&A that do not have a standardized meaning under Canadian 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. 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. This is accomplished through direct ownership and equity participation in businesses that management believes have the potential for long-term growth and proﬁtability. As an outcome of its strategic review session, the Company is resolved to clearly focus on its core strengths in food retailing and related real estate while continuing to direct its energy and capital towards growing the long-term sustainable value of each of its core operating businesses. 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 its capital in order to augment the growth in its core operating businesses. Overview of the Business Empire’s key businesses include food retailing, real estate, and investments and other operations. Food retailing is carried out through wholly-owned Sobeys Inc. (“Sobeys”). The real estate business is carried out through a wholly-owned operating subsidiary ECL Properties Limited (“ECL”), which includes a 100 percent ownership interest in ECL Developments Limited (“ECL Developments”), as well as a 35.7 percent ownership interest in Genstar Development Partnership and a 43.3 percent interest in Genstar Development Partnership II (collectively referred to as “Genstar”) and a 47.8 percent ownership interest in Crombie REIT. The results of Sobey Leased Properties Limited (“SLP”) until April 22, 2008 were consolidated under real estate business; results after April 22, 2008 were reported under Sobeys. Corporate investment activities and other operations includes wholly-owned ETL Canada Holdings Limited (“Empire Theatres”); Kepec Resources Limited (“Kepec”), a joint venture with APL Oil and Gas Limited, which has ownership interests in various oil and gas properties in Alberta; and a 27.6 percent ownership position in Wajax Income Fund (“Wajax”). With over $14 billion in annual revenue and approximately $5.7 billion in assets, Empire employs approximately 42,000 people directly and through its subsidiaries. 2008 AN N UAL R E PORT 29 Food Retailing Sobeys conducts business through approximately 1,300 retail grocery stores (corporately owned and franchised). Empire owned 100.0 percent of Sobeys at the end of ﬁscal 2008 compared to a 72.1 percent ownership interest at the end of ﬁscal 2007. On June 15, 2007, Empire acquired the outstanding common shares of Sobeys that it did not already own, achieving 100 percent ownership. See the section entitled “Sobeys Privatization” on page 32. Sobeys’ strategy is focused on delivering the best food shopping experience to its customers in the right format, right-sized stores, supported by superior customer service. The ﬁve distinct store formats deployed by Sobeys to satisfy its customers’ principal shopping requirements are: full service, fresh service, convenience service, community service and price service. Sobeys remains focused on improving the product, service and merchandising offerings within each format by realigning and renovating its current store base, while continuing to build new stores. Sobeys’ six major banners are the primary focus of these format development efforts: Sobeys, IGA, IGA (cid:70)(cid:89)(cid:85)(cid:83)(cid:66), Foodland, Price Chopper and Thrifty Foods. During the ﬁscal year, Sobeys opened, replaced, expanded, renovated, acquired and/or converted the banners in 157 stores (2007 – 150 stores). In ﬁscal 2008, Sobeys continued to execute a number of initiatives in support of its food-focused strategy, including productivity initiatives and business process, supply chain and system upgrades. (cid:36)(cid:80)(cid:78)(cid:81)(cid:77)(cid:74)(cid:78)(cid:70)(cid:79)(cid:85)(cid:84), Sobeys private label brand, was launched in ﬁscal 2005 to contribute to growth of company-wide sales and proﬁtability and earn a greater share of customers’ food and grocery shopping requirements. The (cid:36)(cid:80)(cid:78)(cid:81)(cid:77)(cid:74)(cid:78)(cid:70)(cid:79)(cid:85)(cid:84) brand consists of three quality tiers: Value, Selection and Sensations. In addition, Sobeys introduced two sub-brands during ﬁscal 2006, (cid:36)(cid:80)(cid:78)(cid:81)(cid:77)(cid:74)(cid:78)(cid:70)(cid:79)(cid:85)(cid:84)(cid:1)(cid:48)(cid:83)(cid:72)(cid:66)(cid:79)(cid:74)(cid:68)(cid:84) and (cid:36)(cid:80)(cid:78)(cid:81)(cid:77)(cid:74)(cid:78)(cid:70)(cid:79)(cid:85)(cid:84)(cid:1)(cid:67)(cid:66)(cid:77)(cid:66)(cid:79)(cid:68)(cid:70)(cid:14)(cid:110)(cid:82)(cid:86)(cid:74)(cid:77)(cid:74)(cid:67)(cid:83)(cid:70), an organic and healthy line of products respectively. During ﬁscal 2008, Sobeys partnered with The Walt Disney Company and launched (cid:36)(cid:80)(cid:78)(cid:81)(cid:77)(cid:74)(cid:78)(cid:70)(cid:79)(cid:85)(cid:84)(cid:1)(cid:43)(cid:86)(cid:79)(cid:74)(cid:80)(cid:83)(cid:1)(cid:37)(cid:74)(cid:84)(cid:79)(cid:70)(cid:90), a line of nutritious alternatives for snacks, lunch box ideas and easy-to-prepare meals for children. At the end of ﬁscal 2008, Sobeys had launched approximately 4,800 (cid:36)(cid:80)(cid:78)(cid:81)(cid:77)(cid:74)(cid:78)(cid:70)(cid:79)(cid:85)(cid:84) products. Business Process and Information Systems Transformation and Rationalization Costs Sobeys continues to make signiﬁcant progress in the implementation of system-wide business process optimization and rationalization initiatives that are designed to reduce complexity and improve processes and efﬁciency throughout Sobeys. In ﬁscal 2006, Sobeys began its business process and information systems transformation plan for the Company by focusing on the signiﬁcant opportunity to upgrade information processing and decision support capabilities and improve efﬁciencies in Ontario. The system and processes that were implemented were developed over several years and were focused on standardizing and streamlining the “back shop” in support of the Sobeys’ food-focused strategy. This move allows Sobeys to leverage technology investments, improve efﬁciencies and expects to lower costs over the long-term. During the third quarter of ﬁscal 2007, Sobeys completed the implementation of the system in Ontario. This implementation supports all aspects of that business including operations, merchandising, distribution and ﬁnance and is an important enabler of further initiatives in Ontario including a new distribution facility that was announced on November 21, 2006. When opened in the ﬁrst quarter of ﬁscal 2010, the new distribution centre, located in Vaughan, Ontario, will utilize automation technology and is expected to signiﬁcantly increase Sobeys’ warehouse and distribution capacity while reducing overall distribution costs and improving service to its store network and customers. During the third quarter of ﬁscal 2007, Sobeys recognized $5.3 million of severance costs related to the development of this automated facility. Subsequent to year end, additional severance costs of approximately $4.6 million have been incurred related to this automated facility and will be recognized in the ﬁrst quarter of ﬁscal 2009. The new distribution centre, when opened in ﬁscal 2010, is expected to provide annual distribution savings in excess of the costs incurred in the third quarter and any additional business rationalization or restructuring costs incurred leading up to its opening. A business process and information system transformation plan, similar to that deployed in the Ontario region, began in Western Canada during ﬁscal 2007 and was completed during the second quarter of ﬁscal 2008. In the fourth quarter of ﬁscal 2007, Sobeys completed the closure of two small distribution facilities, one in Anjou and one in the Abitibi region of Québec. Rationalization costs related to these facilities of $5.6 million were incurred in the fourth quarter of ﬁscal 2007. During ﬁscal 2008, $3.5 million of these costs were reversed as a result of changes in management’s estimate of the expected costs. It is expected that the annualized savings associated with this closure will be approximately $5.0 million. During the third quarter of ﬁscal 2007, Sobeys completed a rationalization of administrative functions in Atlantic Canada. In addition to asset write-offs, in excess of 100 people were impacted by this rationalization; however, a number of these people were redeployed into Sobeys’ retail store network. Pre-tax costs of $7.9 million were incurred during the third quarter of ﬁscal 2007 as a result of this rationalization. During the ﬁrst quarter of ﬁscal 2008, Sobeys also completed a rationalization of administrative functions in its National departments. An additional $1.0 million of rationalization costs is anticipated in the ﬁrst quarter of ﬁscal 2009. 30 E M PI R E COM PANY LI M ITE D MANAG E M E NT’S DISCUSSION AN D ANALYSIS The total pre-tax costs of the above Sobeys initiatives can be summarized as follows: ($ in millions) 13 Weeks Ended May 3, 2008 13 Weeks Ended May 5, 2007 52 Weeks Ended May 3, 2008 52 Weeks Ended May 5, 2007 Business process and system initiative costs Rationalization costs Total costs $ $ – (0.5) (0.5) $ $ 4.9 5.6 10.5 $ $ 8.6 (1.8) 6.8 $ $ 30.3 18.8 49.1 The business process and system initiative costs primarily include labour, implementation and training costs associated with the business process and system implementations. Costs in the second half of ﬁscal 2008 were insigniﬁcant as Sobeys has substantially completed its upgrade of information processing and decision support capabilities. Real Estate Empire’s real estate division includes commercial and residential property operations. Our commercial operations are focused on the development of food-anchored shopping plazas through wholly-owned ECL, which includes wholly-owned ECL Developments, a self-storage operation and a 47.8 percent ownership interest in Crombie REIT. ECL also owns various commercial properties held for sale or redevelopment. Our residential operations are conducted through our 35.7 percent ownership interest in Genstar. Genstar’s business is the development of raw land for residential use primarily carried out in Ontario and Western Canada. Genstar is accounted for on a proportionate consolidation basis. Empire summarizes its real estate’s ﬁnancial results between commercial property operations consisting of ECL, and residential propery operations which consist primarily of Genstar. At the end of ﬁscal 2008, commercial real estate operations had approximately 0.8 million square feet of gross leaseable area (“GLA”) as compared to approximately 5.7 million square feet at the end of last ﬁscal year. The decrease is largely the result of the sale of 61 properties totalling 3.3 million square feet of GLA to Crombie REIT in the fourth quarter and the concurrent transfer of the remaining assets of SLP totalling approximately 1.1 million square feet of GLA to Sobeys. In addition, commercial real estate operations had planned developments equalling 1.1 million square feet of GLA in various stages of development. The wholly-owned real estate operations are focused on commercial property development. For new commercial property development, management is committed to adhering to a disciplined growth strategy. Speciﬁcally, investment decisions are expected to meet certain criteria, including: A satisfactory return on investment; A beneﬁcial competitive effect on Sobeys and Crombie REIT; Credit-worthy tenants with long-term leases that include contractual increases; Enhanced geographic diversiﬁcation; and Competitive positioning in the local market through location or quality. Pursuant to a Development Agreement with Crombie REIT, ECL provides Crombie REIT with a preferential right to acquire all property developments proposed to be undertaken by ECL. ECL also has a Non-Competition Agreement with Crombie REIT whereby it will not compete with Crombie REIT in the acquisition, ownership, investment in or development of any grocery-anchored shopping plazas in Canada. These agreements are for an initial 10-year term, subject to an extension reached by mutual agreement. Empire subsidiaries will continue to work closely with Crombie REIT to identify development opportunities that further Crombie REIT’s external growth strategy. Investments and Other Operations The third component of Empire’s business is its investments and other operations, consisting primarily of a 27.6 percent ownership interest in Wajax, wholly-owned Empire Theatres and Kepec. During the ﬁrst quarter of ﬁscal 2008, the Company sold its portfolio marketable securities, with the exception of its investment in Wajax, to assist in ﬁnancing the privatization of Sobeys as detailed below. The market value of Empire’s equity accounted investment in Wajax at the end of ﬁscal 2008 was $153.4 million (2007 – $154.6 million), representing an unrealized gain of $121.8 million (2007 – $122.4 million). Other operations include wholly-owned Empire Theatres, the second largest movie exhibitor in Canada which, as of May 3, 2008, owned or had an interest in 53 locations representing 387 screens, and Kepec. 2008 AN N UAL R E PORT 31 Sobeys Privatization On April 26, 2007, Empire and Sobeys jointly announced that they had entered into an arrangement agreement (the “Arrangement”) pursuant to which Empire would acquire all of the outstanding common shares of Sobeys that it did not then own at a price of $58.00 per share. The transaction valued the Sobeys shares not then owned by Empire at approximately $1.06 billion. The Arrangement required various approvals to comply with applicable corporate and securities laws. Sobeys’ shareholders approved the Arrangement at a Special Shareholders’ Meeting held on June 9, 2007 by the requisite majority; the Supreme Court of Nova Scotia gave its sanction to the Arrangement on June 13, 2007; the Arrangement became effective upon registration of the ﬁnal Court order with the Nova Scotia Registry of Joint Stock Companies at the close of business on June 15, 2007, at which time Empire acquired all of the outstanding shares of Sobeys that it did not previously own. Subsequently, the Sobeys common shares ceased trading on the Toronto Stock Exchange, and were de-listed at the close of business on June 18, 2007. The acquisition was accounted for using the purchase method with operating results being included in the consolidated ﬁnancial statements since the acquisition date. The ﬁnal purchase price allocation, which has incorporated management’s assessment of fair value, is as follows: ($ in millions) Consideration Cash Acquisition costs Total consideration paid Less: Carrying amount of net assets acquired Excess consideration paid over net assets acquired Allocation of excess consideration paid over net assets acquired Property and equipment Accrued beneﬁt liability Employee future beneﬁts obligation Amortizable intangible assets Indeﬁnite-life intangible assets Goodwill Future income taxes Accumulated other comprehensive loss $ 1,061.7 4.0 1,065.7 576.5 $ 489.2 $ 81.7 (13.1) (3.8) 49.9 243.7 165.2 (35.0) 0.6 $ 489.2 The acquisition was ﬁnanced by funds of $278.0 million generated primarily from the sale of certain portfolio investments and by advances of $787.7 million under new credit facilities (the “Credit Facilities”). At the time of ﬁnancing, the Credit Facilities consisted of a $950.0 million unsecured revolving credit facility maturing on June 8, 2010 (subject to annual one-year extensions at the request of the Company) and a $50.0 million unsecured non-revolving credit facility that matured on June 30, 2007. The unsecured non-revolving credit facility was repaid on June 30, 2007 with funds drawn from the unsecured revolving credit facility. The Credit Facilities are subject to certain ﬁnancial covenants. Interest on the debt varies based on the designation of the loan (bankers’ acceptances (“BA”) rate loans, Canadian prime rate loans, U.S. base rate loans or London InterBank Offered Rate (“LIBOR”) loans), ﬂuctuations in the underlying rates, and in the case of BA rate loans or LIBOR loans, the margin applicable to the ﬁnancial covenants. On June 18, 2007, Empire entered into two delayed ﬁxed rate interest swaps. The ﬁrst swap in an amount of $200.0 million is three years in duration and carries a ﬁxed interest rate of 4.998 percent. The second swap in an amount of $200.0 million is for a period of ﬁve years at a ﬁxed interest rate of 5.051 percent. Both swaps became effective on July 23, 2007. 32 E M PI R E COM PANY LI M ITE D MANAG E M E NT’S DISCUSSION AN D ANALYSIS On June 27, 2007, pursuant to the terms of the Credit Facilities, Empire and Sobeys ﬁled notice with the lenders requesting the establishment of a new $300.0 million ﬁve-year credit facility in favour of Sobeys at the same interest rate and substantially on the same terms and conditions as the Credit Facilities. At July 23, 2007, Sobeys drew down $300.0 million from its new credit facility, the proceeds of which were used to pay a dividend to the Company. The Company used the proceeds from the dividend to reduce its indebtedness under the Credit Facilities and the Credit Facilities were reduced to $650.0 million accordingly. On that date, the Company transferred the second swap to Sobeys. On July 30, 2007, Sobeys exercised an option under its new Credit Facility to increase the size of the credit from $300.0 million to $600.0 million. At the same time, Sobeys terminated its previously existing $300.0 million operating Credit Facility which would have expired on December 20, 2010. At May 3, 2008, $275.0 million of this new Credit Facility was drawn down; $250.0 million has been classiﬁed as long-term debt and $25.0 million has been classiﬁed as bank indebtedness. Sobeys had also issued $41.7 million in letters of credit against the facility at May 3, 2008. As mentioned, the closing date of the Sobeys privatization was on June 15, 2007, which was approximately mid-way through the ﬁrst quarter of ﬁscal 2008. Empire’s weighted average ownership of Sobeys during ﬁscal 2008 amounted to 97.0 percent as compared to a weighted average ownership interest of 71.8 percent in ﬁscal 2007. This resulted in signiﬁcantly lower minority interest expense during ﬁscal 2008 relative to the prior year. Acquisition of Thrifty Foods On September 12, 2007, Sobeys acquired all the assets of Thrifty Foods for $253.6 million. The assets acquired consisted of 20 full-service supermarkets, a main distribution centre and a wholesale division on Vancouver Island and the lower mainland of British Columbia. The acquisition was accounted for using the purchase method with the results of Thrifty Foods being consolidated as of the acquisition date. Management carried out a detailed analysis and changes were made to the preliminary allocation of the excess consideration paid over net assets acquired as disclosed in the previous quarters of ﬁscal 2008. The measurement and allocation of ﬁnite and inﬁnite intangible assets, and goodwill (approximately $174.0 million of which is deductible for tax) was completed during the fourth quarter of ﬁscal 2008. The ﬁnal purchase price allocation, incorporating management’s assessment of fair value, is as follows: ($ in millions) Consideration Cash Acquisition costs Total consideration paid Net assets acquired: Current assets Long-term assets Current liabilities assumed Long-term liabilities assumed Net assets acquired Excess consideration paid over net assets acquired Allocation of excess consideration paid over net assets acquired Intangible assets – Banner – Other Goodwill $ 250.4 3.2 253.6 41.4 36.9 (43.6) (13.1) 21.6 $ 232.0 $ $ 24.0 1.9 206.1 232.0 2008 AN N UAL R E PORT 33 Sale of 61 Properties to Crombie REIT On April 22, 2008, the Company’s real estate division sold 61 properties to Crombie REIT. Included in the proceeds are additional Class B Units of Crombie Limited Partnership (which are convertible on a one for one basis into Units of Crombie REIT). The investment in Class B Units maintained the Company’s interest in Crombie REIT at approximately 47.8 percent after Crombie REIT issued additional units as a result of the underwriting banks exercising their over-allotment option. The Company’s investment in Crombie REIT is accounted using the equity method. Details of the sale are as follows: ($ in millions) Proceeds Cash Investment in Crombie REIT Book value of property and equipment sold Early extinguishment of long-term debt Transaction costs Other costs Gain before income taxes and deferral Income taxes Gain before deferral Deferral of gain Net gain $ 373.5 55.0 428.5 238.9 18.5 6.5 12.5 276.4 152.1 7.8 144.3 (144.3) $ Nil As part of the transaction, Sobeys entered into new lease agreements (the “Sobeys Leases”) with respect to their occupancy in a portion of the 61 commercial properties. The Sobeys Leases have terms of between 17 and 23 years (except for three leases which have an outside date of 12 years) (the “Outside Date”). Each Sobeys Lease is based on an initial term of two years and thereafter alternating between successive periods of three years and two years until the applicable Outside Date. The Outside Date may be extended at Sobeys’ option by up to four consecutive further periods of ﬁve years each. The minimum rents under the Sobeys Leases will range from $8 per square foot to $14 per square foot with rental increases every ﬁve years. 34 E M PI R E COM PANY LI M ITE D MANAG E M E NT’S DISCUSSION AN D ANALYSIS Operational Changes Listed below is a summary of events that impacted the ﬁscal year 2008 operating results and which affect the comparability of information for the 13-week and 52-week periods ended May 3, 2008 versus the 13-week and 52-week periods ended May 5, 2007: On June 15, 2007, Empire acquired approximately 18.3 million common shares of Sobeys, increasing its ownership position from 72.1 percent at May 5, 2007 to 100.0 percent on June 15, 2007. The privatization of Sobeys resulted in a weighted average ownership interest of 97.0 percent in ﬁscal 2008 as compared to a weighted average ownership interest of 71.8 percent in ﬁscal 2007. Sobeys’ sales in ﬁscal 2008 were positively inﬂuenced by the acquisition of Achille de la Chevrotière Ltée and its associated companies (“ADL”) which closed on August 27, 2006 and the acquisition of Thrifty Foods which closed on September 12, 2007. These acquisitions increased ﬁscal 2008 sales by $454.7 million. Sobeys continued to experience declines in its tobacco sales. Late in the second quarter of ﬁscal 2007, a major Canadian tobacco supplier began to sell and distribute directly to certain Sobeys’ customers. A decline in wholesale tobacco sales impacted fourth quarter ﬁscal 2008 revenues by $15.6 million relative to the same quarter in the prior ﬁscal year and ﬁscal 2008 sales by $117.2 million relative to the prior year. Revenues for residential real estate were negatively impacted compared to last year by sales related to the Martello condominium project which was completed in the prior ﬁscal year. For the 52 weeks ended May 5, 2007, Martello revenues equalled $37.9 million. Revenues from the Martello Condominium project did not have a material impact on the 13 weeks ended May 5, 2007. Empire Theatres changed its ﬁscal year-end from the last Thursday in April to the last Thursday in December effective December 28, 2006. This change in Empire Theatres’ ﬁscal year-end was made to align with industry practice. Empire’s ﬁscal year ended May 3, 2008 contains 12 months of operations while the ﬁscal year ended May 5, 2007 contained 11 months of operations. The additional month of operations impacted revenues by approximately $10.0 million in the ﬁscal year. Also impacting comparability year-over-year are costs related to Sobeys’ business process and system initiative, business rationalization, and privatization costs as outlined under the section titled “Fiscal 2008 Operating Performance by Division – Food”. The reader should note that management explains the impact of the above events when discussing the operating results for the food retailing division, the real estate division and investments and other operations. 2008 AN N UAL R E PORT 35 Consolidated Operating Results The consolidated ﬁnancial overview provided below reports on the ﬁnancial performance for ﬁscal 2008 relative to the last two ﬁscal years. Summary Table of Consolidated Financial Results ($ in millions, except per share information) Consolidated revenue Operating income Operating earnings Capital gains and other items, net of tax 52 Weeks Ended 52 Weeks Ended 53 Weeks Ended May 3, 2008 % of Revenue May 5, 2007 (1) % of Revenue May 6, 2006 (2) % of Revenue $ 14,065.0 100.00% $ 13,366.7 100.00% $ 13,063.6 100.00% 472.6 242.8 73.0 3.36% 1.73% 0.52% 431.1 200.1 5.7 3.23% 1.50% 0.04% 491.4 202.0 94.8 3.76% 1.55% 0.72% 2.27% Net earnings $ 315.8 2.25% $ 205.8 1.54% $ 296.8 Basic earnings per share Operating earnings Capital gains and other items, net of tax Net earnings Basic weighted average number of shares outstanding (in millions) Diluted earnings per share Operating earnings Capital gains and other items, net of tax Net earnings Diluted weighted average number of shares outstanding (in millions) $ $ $ $ 3.69 1.11 4.80 65.6 3.69 1.11 4.80 65.7 $ $ $ $ 3.05 0.09 3.14 65.5 3.04 0.09 3.13 65.7 $ $ $ $ 3.08 1.45 4.53 65.5 3.07 1.44 4.51 65.7 Dividends per share $ 0.66 $ 0.60 $ 0.56 (1) Amounts have been restated to reﬂect a change in accounting policy with respect to deferred charges. Please see the section entitled “Accounting Policy Changes – Deferred Charges” in this MD&A. (2) Amounts have been restated as a result of a reclassiﬁcation and change in accounting policy with respect to the Company’s adoption of EIC-156 in the ﬁrst quarter of ﬁscal 2007. Please see the sections entitled “Accounting Policy Changes – Vendor Consideration” under Accounting Policy Changes in this MD&A. 36 E M PI R E COM PANY LI M ITE D MANAG E M E NT’S DISCUSSION AN D ANALYSIS Management’s Explanation of Fiscal 2008 Annual Consolidated Results The following is a review of Empire’s consolidated ﬁnancial performance for the 52-week periods ended May 3, 2008 compared to May 5, 2007. Revenue and ﬁnancial performance of each of the Company’s businesses (food retailing, real estate, and investments and other operations) are discussed in detail in the section entitled “Fiscal 2008 Operating Performance by Division” in this MD&A. Revenue The consolidated revenue for ﬁscal 2008 was $14.06 billion, an increase of $698.3 million or 5.2 percent compared to ﬁscal 2007. Growth in Sobeys’ sales of $736.1 million and in investments and other operations’ revenue of $21.0 million Revenue Table was offset by a $58.8 million reduction in revenue from the real estate division. The decline in real estate division revenue was anticipated and reﬂects a slowdown in residential lot sales along with the completion of the Martello condominium project during the prior ﬁscal year. For a list of items that impacted revenue comparability refer to the “Operational Changes” section of this MD&A on page 35. Excluding the impact of the acquisition of Thrifty Foods, the decline in wholesale tobacco sales, and the sales impact related to the Martello project, Empire’s consolidated sales growth would have been 2.2 percent for the fourth quarter. Adjusting for the same items in addition to the acquisition of ADL as discussed, Empire’s consolidated sales growth would have been 2.9 percent for the ﬁscal year. The table below presents the impact of the above items on ﬁscal 2008 revenue growth. 52 Weeks Ended ($ in millions) May 3, 2008 May 5, 2007 $ Change % Change Financially reported sales Add (deduct) the impact of: Impact of wholesale tobacco decline Impact of ADL and Thrifty acquisitions Impact of Martello revenues Impact of Theatres’ year-end change(1) Subtotal $ 14,065.0 $ 13,366.7 $ 698.3 5.2% 117.2 (454.7) 37.9 (10.0) (309.6) $ 388.7 2.9% (1) The impact for Theatres’ revenue, reﬂected in the above table, represents the additional four weeks of revenue for ﬁscal 2008 as a result of Empire Theatres’ ﬁscal year-end change. Please refer to the section entitled “Fiscal 2008 Operating Performance by Division” for an explanation of the change in revenue by division. Consolidated Operating Earnings Consolidated Operating Earnings $ IN MILLIONS $ PER SHARE FULLY DILUTED 242.8 3.69 200 150 100 50 4.00 3.00 2.00 1.00 FISCAL YEAR 04 05 06 07 08 FISCAL YEAR 04 05 06 07 08 2008 AN N UAL R E PORT 37 Operating Income Earnings before Capital Gains and Other Items Consolidated operating income, deﬁned as operating earnings before minority interest, interest expense, income taxes and capital gains and other items, in ﬁscal 2008 totalled $472.6 million compared to $431.1 million last year, an increase of $41.5 million or 9.6 percent. The increase in operating income is the result of a $68.0 million increase in operating income contribution from the food retailing division, offset by an $8.5 million decrease in operating income from investments and other operations (net of corporate expenses) and an $18.0 million decrease in real estate division operating income. Included in food retailing division operating income for ﬁscal 2008 were $6.8 million of pre-tax costs incurred by Sobeys related to its business process and system initiative and severance associated with rationalization efforts, partially offset by the reversal of a portion of rationalization costs related to two distribution centres in Québec. Sobeys incurred $49.1 million of pre-tax costs related to its business process and system initiative and business rationalization during ﬁscal 2007. Please refer to the section entitled “Fiscal 2008 Operating Performance by Division” for an explanation of the change in operating income for each division. Interest Expense For the 52 weeks ended May 5, 2008, consolidated interest expense equalled $105.8 million, versus $60.1 million in the prior year. The $45.7 million increase in ﬁscal 2008 interest expense compared to last ﬁscal year is primarily due to higher funded debt amounts. Consolidated funded debt increased $661.5 million to $1,573.5 million at the end of ﬁscal 2008 compared to $912.0 million at the end of ﬁscal 2007. The increase in funded debt was largely the consequence of long-term debt incurred to ﬁnance the privatization of Sobeys and the acquisition of Thrifty Foods, partially offset by application of the proceeds from the sale of the liquid investment portfolio in the ﬁrst quarter and the sale of 61 properties to Crombie REIT, as mentioned, to reduce indebtedness. The sale of the 61 properties had a minimal impact on interest expense given that it occurred 11 days prior to the end of the ﬁscal year. Income Taxes The effective income tax rate for ﬁscal 2008 was 30.3 percent versus 31.1 percent last year. The main reason for the ﬁscal year decrease is due to reductions in the Canadian federal and certain provincial statutory income tax rates and the application of those lower rates to future tax balances. Minority Interest Minority interest for the ﬁscal year equalled $12.8 million compared to $55.4 million in the prior year. The decrease is largely the result of Empire increasing its ownership position in Sobeys to 100.0 percent on June 15, 2007 resulting in a weighted average ownership position of 97.0 percent in ﬁscal 2008 as compared to a weighted average ownership position in Sobeys of 71.8 percent in ﬁscal 2007. For the 52 weeks ended May 3, 2008, earnings before capital gains and other items amounted to $242.8 million ($3.69 per share) compared to $200.1 million ($3.04 per share) in the prior year. The $42.7 million or 21.3 percent increase is the result of the $41.5 million increase in operating income, the $42.6 million decrease in minority interest and the decrease in income taxes of $4.3 million; offset by the $45.7 million increase in interest expense as discussed. Capital Gains and Other Items For the full ﬁscal year, the Company recorded capital gains and other items, net of tax, of $73.0 million as compared to $5.7 million last year. The increase was largely the result of the sale of marketable securities in the ﬁrst quarter of ﬁscal 2008 which generated a capital gain, net of tax, of $81.9 million, partially offset by an impairment loss provision on certain commercial property and also on asset-backed commercial paper (“ABCP”), as discussed below. Based on estimated fair values of commercial properties held by the real estate division, it was determined that the carrying value of one commercial property was impaired. Accordingly, the Company recorded a pre-tax impairment charge in the fourth quarter of $6.0 million to reduce the carrying value on this property to estimated fair value. Also during the fourth quarter, Sobeys increased its pre-tax impairment loss provision on ABCP by $4.5 million (from $3.0 million previously recorded to $7.5 million), representing 25 percent of the $30.0 million of ABCP held by Sobeys. The Company estimated the impairment loss using a discounted cash ﬂow approach. The ABCP investment has been reclassiﬁed as a long-term asset rather than cash and cash equivalents due to the uncertainty as to the timing of collection. During the fourth quarter, on April 22, 2008, Empire’s real estate division closed the sale of 61 retail properties to Crombie REIT. The selling price for the 61 properties was $428.5 million. In accordance with Canadian GAAP, the gain on this transaction of $144.3 million has been accounted for as a reduction in the carrying value of Crombie REIT because the purchaser is a related party. This differs from International Financial Accounting Standards, which will be adopted during the ﬁrst quarter of ﬁscal 2012 and, upon adoption, will require that the net gain relating to the 52.2 percent non-Empire ownership of Crombie REIT to be recorded as an increase in retained earnings. Net Earnings Net earnings for the 52 weeks ended May 3, 2008 totalled $315.8 million ($4.80 per share) as compared to $205.8 million ($3.14 per share) recorded last ﬁscal year, an increase of $110.0 million or 53.4 percent. The increase in net earnings for ﬁscal 2008 compared to ﬁscal 2007 reﬂects the increase in earnings before capital gains and other items of $42.7 million as well as the increase in capital gains and other items of $67.3 million as discussed. 38 E M PI R E COM PANY LI M ITE D MANAG E M E NT’S DISCUSSION AN D ANALYSIS Fiscal 2008 Operating Performance by Division Food Retailing Highlights Sobeys acquired Thrifty Foods in September 2007 for a total consideration of $253.6 million. Sobeys achieved ﬁscal 2008 sales growth of $736.1 million or 5.6 percent and same-store sales growth of 2.8 percent. Continued progress in system-wide business process optimization and rationalization initiatives. Total capital expenditures equalled $481.2 million in ﬁscal 2008. Opened, or replaced 44 corporate and franchised stores, acquired 22 stores, expanded 31 stores, rebannered/ redeveloped 60 stores and closed 67 stores. To assess its ﬁnancial performance and condition, Sobeys’ management monitors a set of ﬁnancial measures, which evaluate sales growth, proﬁtability and ﬁnancial condition. The primary ﬁnancial performance and condition measures for Sobeys are set out below. 52 Weeks Ended May 3, 2008 May 5, 2007 (1) Sales growth Same-store sales growth Earnings per share growth (basic) Return on equity Funded debt to total capital Funded debt to EBITDA Property and equipment 5.6% 2.8% 16.3% 10.0% 35.6% 1.7x 2.5% 2.4% (8.9%) 9.1% 23.7% 1.2x purchases (in millions) $ 481 $ 447 (1) Amounts have been restated as a result of a reclassiﬁcation with respect to deferred charges. Please see the section entitled “Accounting Policy Changes – Deferred Charges” in this MD&A. The table below presents sales, operating income and net earnings contribution to Empire by Sobeys: ($ in millions) Sales Operating income Net earnings 52 Weeks Ended May 3, 2008 52 Weeks Ended May 5, 2007 Year-over-Year $ Change % Change $ 13,768.1 359.0 186.6 $ 13,032.0 $ 291.0 119.6 736.1 68.0 67.0 5.6% 23.4% 56.0% Food Retailing Revenue Food Retailing Operating Income $ IN MILLIONS $ IN MILLIONS 13,768.1 359.0 12 ,000 9,000 6,000 3,000 320 240 16 0 80 FISCAL YEAR 04 05 06 07 08 FISCAL YEAR 04 05 06 07 08 2008 AN N UAL R E PORT 39 Revenue In ﬁscal 2008, Sobeys achieved sales of $13.77 billion, an increase of $736.1 million or 5.6 percent over ﬁscal 2007. During the ﬁscal year, same-store sales (sales from stores in the same locations in both reporting periods) increased by 2.8 percent. Same-store sales growth does not include wholesale sales. Sales growth for the year was driven by Sobeys continued implementation of sales and merchandising initiatives and sustained competitive pricing across the country, coupled with an increase in retail selling square footage resulting from new stores, enlargements and the acquisition of Achille de la Chevrotière Ltée on August 27, 2006 and Thrifty Foods on September 12, 2007. Total store square footage increased by 3.0 percent in ﬁscal 2008 as a result of the opening of 44 new or replacement stores, the acquisition of 22 stores and the expansion of 31 stores. There were 67 stores closed in ﬁscal 2008. Sobeys experienced declines in its wholesale tobacco sales during ﬁscal 2008. Wholesale tobacco sales declined $117.2 million in ﬁscal 2008 compared to ﬁscal 2007. Margins on tobacco sales are signiﬁcantly lower than on other products; therefore, the loss of these sales did not have a material impact on earnings. As shown in the table below, excluding the impact of the wholesale tobacco decline, the acquisition of ADL on August 27, 2006 and the acquisition of Thrifty Foods on September 12, 2007, Sobeys’ sales growth would have been 3.1 percent in ﬁscal 2008. 52 Weeks Ended ($ in millions) May 3, 2008 May 5, 2007 $ Change % Change Sobeys’ ﬁnancially reported sales $ 13,768.1 $ 13,032.0 $ 736.1 5.6% Add (deduct) the impact of: Impact of wholesale tobacco decline Impact of ADL and Thrifty Foods acquisitions Subtotal 117.2 (454.7) (337.5) $ 398.6 3.1% Business Process and System Initiative, Business Rationalization and Privatization Costs Included in earnings for ﬁscal 2008, and also impacting year-over-year earnings variances for Sobeys, were costs related to Sobeys’ business process and system initiative as well as business rationalization and privatization costs. As you can see from the table below, in total, these costs had a $6.8 million pre-tax impact on earnings ($49.1 million pre-tax in ﬁscal 2007). ($ in millions) 13 Weeks Ended May 3, 2008 13 Weeks Ended May 5, 2007 52 Weeks Ended May 3, 2008 52 Weeks Ended May 5, 2007 Business process and system initiative costs Rationalization costs Total costs $ $ – (0.5) (0.5) $ $ 4.9 5.6 10.5 $ $ 8.6 (1.8) 6.8 $ $ 30.3 18.8 49.1 40 E M PI R E COM PANY LI M ITE D MANAG E M E NT’S DISCUSSION AN D ANALYSIS A description of these costs is as follows: Operating Income Sobeys’ operating income equalled $359.0 million during ﬁscal 2008, a 23.4 percent increase from last year’s $291.0 million. Sobeys’ recorded operating margin in the ﬁscal year was 2.64 percent compared to 2.23 percent in the prior year. The $68.0 million increase in Sobeys’ operating income in ﬁscal 2008 was largely the result of Sobeys’ commitment to competitive pricing, innovation and cost management initiatives and lower spending in ﬁscal 2008 on business process and system initiatives and business rationalization costs. Included in food retailing division operating income in ﬁscal 2007 were $49.1 million of pre-tax costs incurred by Sobeys related to its business process, system initiative and rationalization costs as compared to $6.8 million of such costs in ﬁscal 2008. Also impacting ﬁscal 2008 operating income was a $37.0 million increase in depreciation and amortization expense, reﬂecting Sobeys’ continued capital investments. 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 Food retailing division net earnings contribution in ﬁscal 2008 amounted to $186.6 million compared to $119.6 million last year, a $67.0 million or 56.0 percent increase. The earnings increase largely reﬂects the $68.0 million improvement in operating income and the $42.6 million reduction in minority interest, offset by, the $5.1 million impairment charge, net of tax, on asset-backed commercial paper as discussed, a $24.0 million increase in interest expense due to higher funded debt levels and higher income tax expense of $14.5 million. Business process and system initiative costs – For the 52 weeks ended May 3, 2008, $8.6 million ($30.3 million in ﬁscal 2007) of pre-tax costs ($nil for the 13 weeks ended May 3, 2008 and $4.9 million for the 13 weeks ended May 5, 2007) were incurred related to Sobeys business process and system initiative. The business process and system initiative costs primarily included labour, implementation and training costs associated with the business process and system implementation. Atlantic business rationalization costs – During the third quarter of ﬁscal 2007, Sobeys completed a rationalization of administrative functions in Atlantic Canada. In addition to asset write-offs, in excess of 100 people were impacted by this rationalization; however, a number of these people were redeployed into Sobeys’ retail store network. Pre-tax costs of $7.9 million were incurred during ﬁscal 2007 as a result of this rationalization. There were no further rationalization costs incurred by Sobeys Atlantic region in ﬁscal 2008. Ontario distribution network rationalization – On November 21, 2006, Sobeys announced plans to build a new distribution centre in Vaughan, Ontario. Utilizing automation technology, the new facility is expected to signiﬁcantly increase Sobeys’ warehouse and distribution capacity while reducing overall distribution costs and improving service to its store network and customers. During ﬁscal 2007, Sobeys recognized $5.3 million of severance costs associated with this rationalization. There was $0.5 million of costs incurred in ﬁscal 2008. Subsequent to year end additional severance costs of approximately $4.6 million have been incurred and will be recognized in the ﬁrst quarter of ﬁscal 2009. This new distribution centre, when opened in early ﬁscal 2010, is expected to provide annual distribution cost savings in excess of the costs incurred in the third quarter and any additional business rationalization or restructuring costs incurred leading up to its opening. Québec distribution network rationalization – In ﬁscal 2007, Sobeys completed the closure of two small facilities, one in Anjou and one in the Abitibi region of Québec. Rationalization costs related to these facilities of $5.6 million were incurred in the fourth quarter of ﬁscal 2007. During ﬁscal 2008, $3.5 million of these costs were reversed as a result of changes in management’s estimate of the expected costs. It is expected that the annualized savings associated with this closure will be approximately $5.0 million. 2008 AN N UAL R E PORT 41 Real Estate Highlights The successful completion of the sale of 61 properties to Crombie REIT for total proceeds of $428.5 million and an economic gain of $144.3 million. Another strong year for residential operations with an operating income contribution of $50.7 million. A 12.0 percent total investment return from Crombie REIT since the initial public offering in March 2006. Real estate division funded debt to total capital decreased to 22.0 percent in ﬁscal 2008 from 39.8 percent last year. Real estate management assesses its ﬁnancial performance and condition through monitoring of key ﬁnancial measures. The primary ﬁnancial performance and condition measures are set out below. 52 Weeks Ended May 3, 2008 May 5, 2007 Total square footage (in millions) Funds from operations ($ in millions) Return on equity(1) Funded debt to total capital 0.8 5.7 $ 64.4 17.7% 22.0% $ 74.6 17.5% 39.8% (1) Return on Equity is calculated as earnings available for common shareholders divided by average common shareholders’ equity. The table below presents revenue, operating income, capital gains and other items, net earnings and funds from operations for the real estate division’s commercial operations and residential operations. 52 Weeks Ended ($ in millions) May 3, 2008 May 5, 2007 $ Change % Change Revenue Commercial Residential Inter-segment Operating income Commercial Residential Capital gains and other items (net of tax) Commercial Residential Net earnings Commercial(1) Residential Funds from operations Commercial Residential $ $ $ $ $ $ $ $ $ $ 75.4 85.2 160.6 (34.9) 125.7 49.3 50.7 100.0 (3.5) (0.6) (4.1) 20.1 34.7 54.8 29.1 35.3 64.4 $ $ $ $ $ $ $ $ $ $ 72.7 146.1 218.8 (34.3) 184.5 46.8 71.2 118.0 0.7 (0.7) – 21.0 46.8 67.8 26.8 47.8 74.6 $ $ $ $ $ $ $ $ $ $ 2.7 (60.9) (58.2) (0.6) (58.8) 2.5 (20.5) (18.0) (4.2) 0.1 (4.1) (0.9) (12.1) (13.0) 2.3 (12.5) (10.2) 3.7% (41.7%) (26.6%) 1.7% (31.9%) 5.3% (28.8%) (15.3%) (600.0%) (14.3%) – (4.3%) (25.9%) (19.2%) 8.6% (26.2%) (13.7%) (1) There were net capital losses and other items, net of tax, of $4.1 million included in net earnings for ﬁscal 2008 ($nil in ﬁscal 2007). 42 E M PI R E COM PANY LI M ITE D MANAG E M E NT’S DISCUSSION AN D ANALYSIS Revenue Real estate division revenues, net of inter-segment transactions, amounted to $125.7 million in ﬁscal 2008 as compared to $184.5 million in the prior year. The $58.8 million reduction in revenue from the real estate division was anticipated as a result of an expected slowdown in residential lot sales and the completion of the Martello condominium project in the prior ﬁscal year. Revenue from residential operations was $85.2 million in ﬁscal 2008 compared to $146.1 million last year, a $60.9 million or 41.7 percent decrease. Included in residential operations revenue for ﬁscal 2007 was $37.9 million of revenue related to the Martello condominium project. Excluding the impact of the Martello project, residential operations revenues declined by $23.0 million or 15.7 percent compared to last year. In the previous year management cautioned that the pace of growth experienced in residential lot sales in ﬁscal 2007 was not sustainable over the long-term. Management further cautions that residential lot sales are likely to slow from the level experienced in ﬁscal 2008. Commercial property revenues, net of inter-segment transactions, for ﬁscal 2008 equalled $40.5 million, an increase of $2.1 million or 5.5 percent compared to revenues of $38.4 million reported last year. Operating Income During ﬁscal 2008, real estate division operating income declined $18.0 million or 15.3 percent compared to last year as the result of a $20.5 million decrease in residential operating income, offset by a $2.5 million increase in commercial operating income. The decline in operating income generated by residential operations was expected given the exceptional residential lot sales activity experienced in Western Canada in ﬁscal 2007 compared to current economic conditions. Capital Gains and Other Items Capital losses and other items, net of tax, for the real estate division totalled $4.1 million in ﬁscal 2008 (ﬁscal 2007 – $ nil). The difference over last year is primarily related to the impairment charge taken on one commercial property during ﬁscal 2008 as discussed. Net Earnings Real estate division net earnings contribution in ﬁscal 2008 amounted to $54.8 million compared to $67.8 million last year, a $13.0 million or 19.2 percent decrease. The earnings decline largely reﬂects the $18.0 million reduction in operating income as discussed, the $4.1 million impairment charge, net of tax, on one commercial property as discussed, offset by a $0.9 million reduction in interest expense due to lower long-term debt levels and lower income tax expense of $8.2 million. Funds from Operations Funds from real estate operations in ﬁscal 2008 of $64.4 million decreased $10.2 million or 13.7 percent compared to last year as a result of a decrease in residential funds from operations of $12.5 million due to lower operating earnings, partially offset by higher commercial funds from operations of $2.3 million due to higher operating earnings. Real Estate Revenue $ IN MILLIONS Real Estate Funds from Operations $ IN MILLIONS 240 180 120 60 160.6 60 45 30 15 64.4 29.1 35.3 FISCAL YEAR 04 05 06 07 08 FISCAL YEAR 04 05 06 07 08 COMMERCIAL RESIDENTIAL 2008 AN N UAL R E PORT 43 Investments and Other Operations Highlights A $21.0 million or 14.0 percent increase in revenue as a result of record revenues for wholly-owned Empire Theatres. The change in Empire Theatres’ ﬁscal year-end to December 31st, to align with industry practice, accounted for $10.0 million of the revenue increase. During the ﬁrst quarter the liquid investment portfolio was sold for proceeds of $278.0 million, resulting in an after-tax capital gain of $81.9 million. These funds were used to support the cost of privatizing Sobeys. Maintained a 27.6 percent interest in Wajax which contributed $20.4 million in equity earnings in ﬁscal 2008 and an investment total return of 14.0 percent. Investment Value At the end of ﬁscal 2008, Empire’s total investments, excluding its investment in Genstar U.S. investments and in Crombie REIT, carried a market value of $155.0 million on a cost base of $33.2 million, resulting in an unrealized gain of $121.8 million (2007 – $219.3 million). The table below presents a reconciliation of the consolidated balance sheet investments, both equity and cost, to those related to the investment and other operations division: ($ in millions) Investments, at cost Investments, at equity Total Investments Less: Crombie REIT Less: Genstar U.S.(1) Plus: Hedge Value May 3, 2008 May 5, 2007 $ $ Market Value 1.6 429.6 431.2 275.9 0.3 – $ Cost Value 1.6 41.4 43.0 9.5 0.3 – Unrealized Gain Market Value Cost Value Unrealized Gain – 388.2 388.2 266.4 – – $ $ 283.1 434.0 $ 189.7 142.8 717.1 278.1 1.3 3.5 332.5 109.3 1.3 – 93.4 291.2 384.6 168.8 – 3.5 $ 155.0 $ 33.2 $ 121.8 $ 441.2 $ 221.9 $ 219.3 (1) Assumes market value equals book value. During ﬁscal 2008 realized capital gains on the sale of investments totalled $100.9 million compared to $6.2 million of realized capital gains in the prior year. The Company sold all its portfolio investments, excluding its 27.6 percent interest in Wajax, during in the ﬁrst quarter of ﬁscal 2008 to provide funds for the privatization of Sobeys. Funds generated from this sale amounted to $278.0 million in the ﬁrst quarter. The total unrealized gain position at the end of ﬁscal 2008 was $121.8 compared to $219.3 million at the end of ﬁscal 2007. The decrease of $97.5 million in the unrealized gain position is primarily attributed to realized investment capital gains during the ﬁscal year of $100.9 million. Realized capital gains for ﬁscal 2008, plus unrealized capital gains combined to equal $222.7 million at the end of the ﬁscal year. This compares to a total realized gain on investment sales plus unrealized capital gains at the end of ﬁscal 2007 of $225.5 million. Investments and Other Operations Revenue Investments and Other Operations Operating Income* $ IN MILLIONS $ IN MILLIONS 160 120 80 40 171.2 32 24 16 8 24.4 FISCAL YEAR 04 05 06 07 08 FISCAL YEAR 04 05 06 07 08 * BEFORE CORPORATE EXPENSES 44 E M PI R E COM PANY LI M ITE D MANAG E M E NT’S DISCUSSION AN D ANALYSIS Portfolio Composition At ﬁscal year end, May 3, 2008, Empire’s investment portfolio (excluding cash, Crombie REIT and Genstar U.S.) consisted of: ($ in millions Cdn.) Wajax Other Canadian equities U.S. equities Preferred shares & other Hedge value Total Unrealized Gain (Loss) Unrealized Gain (Loss) $ Market Value 153.4 – – 1.6 – % of Total 99.0% $ 0.1% – 1.0% – $ Cost 31.6 – – 1.6 – $ May 3, 2008 121.8 – – – – May 5, 2007 122.4 92.2 1.2 – 3.5 $ May 6, 2006 159.9 68.8 (29.8) – 15.4 $ 155.0 100.0% $ 33.2 $ 121.8 $ 219.3 $ 214.3 The table below presents investments and other operations’ (net of corporate expenses) ﬁnancial highlights for the 52 weeks ended May 3, 2008 compared to the same period last year. 52 Weeks Ended ($ in millions) May 3, 2008 May 5, 2007 $ Change Revenue Investment income Operating income Capital gains and other items, net of tax Net Earnings Revenue Investments and other operations’ revenue, primarily generated by Empire Theatres, equalled $171.2 million for ﬁscal 2008 versus $150.2 million last year. There are 52 weeks of revenue included in ﬁscal 2008 compared to 48 weeks last year from Empire Theatres as a result of the change in the Company’s year-end date. As previously discussed, the additional four weeks of Theatre operations included in this ﬁscal year impacted revenues by approximately $10.0 million. Adjusting for this impact, investments and other operations’ revenue increased by 7.3 percent in ﬁscal 2008. Investment Income Investment income (excluding equity earnings from Crombie REIT and Genstar’s U.S. investments) equalled $20.9 million in ﬁscal 2008, a decrease of $9.0 million over the $29.9 million recorded last year. The decline was the result of lower dividend income of $8.5 million reﬂecting the sale of the portfolio investments in the ﬁrst quarter as mentioned and equity earnings from Wajax that were $0.5 million lower than last year. $ 171.2 $ 150.2 $ 20.9 13.6 82.2 29.9 22.1 5.7 $ 74.4 $ 18.4 $ 21.0 (9.0) (8.5) 76.5 56.0 Capital Gains and Other Items Capital gains, net of tax, realized from investment sales in ﬁscal 2008 amounted to $82.2 million compared to $5.7 million last year. The bulk of the capital gains, net of tax, in ﬁscal 2008 relates to the sale of common equity investments in the ﬁrst quarter to assist in funding the privatization of Sobeys as discussed. Net Earnings Investments (net of corporate expenses) and other operations contributed $74.4 million to Empire’s consolidated ﬁscal 2008 net earnings compared to an $18.4 million net earnings contribution last year. The increase is primarily the result of the higher realized investment capital gains as discussed. 2008 AN N UAL R E PORT 45 Quarterly Results of Operations The following table is a summary of selected ﬁnancial information from the Company’s consolidated ﬁnancial statements (unaudited) for each of the eight most recently completed quarters. Results by Quarter ($ in millions, except per share information) Revenue Operating income Operating earnings(2) Capital gains (losses) Fiscal 2008 Fiscal 2007(1) Q4 (13 Weeks) May 3, 2008 Q3 (13 Weeks) Feb. 2, 2008 Q2 (13 Weeks) Nov. 3, 2007 Q1 (13 Weeks) Aug. 4, 2007 Q4 (13 Weeks) May 5, 2007 Q3 (13 Weeks) Feb. 3, 2007 Q2 (13 Weeks) Nov. 4, 2006 Q1 (13 Weeks) Aug. 5, 2006 $ 3,557.8 136.2 73.6 $ 3,503.0 90.7 48.9 $ 3,484.8 118.2 59.9 $ 3,519.4 127.5 60.4 $ 3,350.4 124.0 64.1 $ 3,281.9 $ 3,353.5 $ 3,380.9 121.2 53.3 113.0 49.8 72.9 32.9 and other items, net of tax (7.1) (0.3) (1.5) 81.9 0.7 (1.0) 6.0 – Net earnings Per share information, diluted Operating earnings Capital gains (losses) $ $ 66.5 $ 48.6 $ 58.4 $ 142.3 $ 64.8 $ 31.9 $ 55.8 $ 53.3 1.12 $ 0.73 $ 0.91 $ 0.92 $ 0.98 $ 0.49 $ 0.76 $ 0.81 and other items, net of tax (0.11) 0.01 (0.02) 1.24 0.01 (0.01) 0.09 – Net earnings $ 1.01 $ 0.74 $ 0.89 $ 2.16 $ 0.99 $ 0.48 $ 0.85 $ 0.81 Diluted weighted average number of shares outstanding (in millions) 65.7 65.7 65.7 65.7 65.7 65.7 65.7 65.7 (1) Amounts have been restated as a result of a reclassiﬁcation with respect to deferred charges. Please see the section entitled “Accounting Policy Changes – Deferred Charges” in this MD&A and “Accounting Policy Changes – Vendor Consideration” in this MD&A. (2) Operating earnings is net earnings before capital gains (losses) and other items, net of tax. Revenue and operating earnings growth have been inﬂuenced by the Company’s investing activities including the privatization of Sobeys, the competitive environment, general industry trends and by other risk factors as outlined in this MD&A. 46 E M PI R E COM PANY LI M ITE D MANAG E M E NT’S DISCUSSION AN D ANALYSIS Fourth Quarter Results Summary Table of Consolidated Financial Results for the Fourth Quarter ($ in millions, except per share information) 13 Weeks Ended May 3, 2008 % of Revenue 13 Weeks Ended May 5, 2007 % of Revenue Revenue Operating income Operating earnings Capital gains (losses) and other items, net of tax Net earnings Basic earnings per share Operating earnings Capital gains (losses) and other items, net of tax Net earnings Basic weighted average number of shares outstanding (in millions) Diluted earnings per share Operating earnings Capital gains (losses) and other items, net of tax Net earnings Diluted weighted average number of shares outstanding (in millions) $ 3,557.8 100.00% $ 3,350.4 100.00% 3.70% 1.91% 0.02% 1.93% 136.2 73.6 (7.1) 66.5 1.12 (0.11) 1.01 65.6 1.12 (0.11) 1.01 65.7 $ $ $ $ $ 3.83% 2.07% -0.20% 1.87% 124.0 64.1 0.7 64.8 0.98 0.01 0.99 65.6 0.98 0.01 0.99 65.7 $ $ $ $ $ The following is a review of ﬁnancial performance for the 13 weeks ended May 3, 2008 compared to the 13 weeks ended May 5, 2007. Revenue Revenue for the fourth quarter was $3.56 billion compared to $3.35 billion last year, a $207.4 million or 6.2 percent increase. As shown in the following table, excluding the decline in wholesale tobacco sales and the Thrifty Foods acquisition, revenue growth would have been 2.2 percent for the fourth quarter. 13 Weeks Ended ($ in millions) May 3, 2008 May 5, 2007 $ Change % Change Financially reported sales Add (deduct) the impact of: Impact of Thriftys acquisition Impact of wholesale tobacco decline Subtotal $ 3,557.8 $ 3,350.4 $ 207.4 6.2% (148.6) 15.6 (133.0) $ 74.4 2.2% Food retailing division revenue increased by $236.9 million or 7.3 percent compared to the fourth quarter of ﬁscal 2007. Same-store sales increased 2.6 percent during the fourth quarter of ﬁscal 2008. The growth in retail sales was a direct result of the continued implementation of sales and merchandising initiatives across the country, coupled with the increased retail selling square footage from new stores, enlargements and the acquisition of Thrifty Foods on September 12, 2007. As outlined above, sales were positively impacted in the quarter by the acquisition of Thrifty Foods and negatively impacted by the decline in wholesale tobacco sales. Excluding the impact of the Thrifty Foods acquisition and the wholesale tobacco decline, Sobeys’ sales growth would have been 3.2 percent on a comparable 13-week basis. 2008 AN N UAL R E PORT 47 Real estate operations reported fourth quarter revenues (net of inter-segment transactions) of $33.8 million, a decrease of $32.2 million or 48.8 percent compared to the fourth quarter last year. Commercial property revenue growth remained ﬂat while revenue from residential operations decreased by $32.2 million or 56.7 percent. The decline in residential operations revenue was expected; management had previously cautioned that residential lot sales in Western Canada particularly in the Calgary and Edmonton, Alberta markets, was not sustainable at the rates observed in ﬁscal 2007. Revenue from investments and other operations in the fourth quarter equalled $43.4 million, an increase of $2.7 million or 6.6 percent over the fourth quarter last year. This is primarily related to higher revenue contribution from Empire Theatres. and the application of those lower rates to future tax balances, related to the real estate operations. This resulted in a lower effective income tax rate for the fourth quarter of ﬁscal 2007. Minority Interest In the fourth quarter of ﬁscal 2008, Empire recorded minority interest expense of $1.3 million compared to $14.1 million in the fourth quarter last year. The decrease of $12.8 million in minority interest is primarily the result of Empire increasing its ownership position in Sobeys to 100.0 percent on June 15, 2007, resulting in a weighted average ownership position in the fourth quarter of 100.0 percent as compared to a weighted average ownership position in Sobeys at the end of the fourth quarter last year of 72.1 percent. Operating Income Consolidated operating income in the fourth quarter of ﬁscal 2008 totalled $136.2 million compared to $124.0 million in the fourth quarter last year, an increase of $12.2 million or 9.8 percent. The increase in operating income was the result of a $29.3 million or 39.1 percent increase in operating income contribution from the food retailing division, a $1.8 million or 62.1% increase in operating income contribution from investments and other operations, partially offset by a decrease in real estate division operating income of $18.9 million or 41.0 percent. In the fourth quarter last year, Sobeys incurred $10.5 million of pre-tax costs related to its business process and system initiative and rationalization costs. Residential real estate operating income amounted to $15.6 million, a $19.0 million decrease from the fourth quarter last year. The decline is attributed to slowing of residential lot sales in Western Canada, particularly in the Calgary and Edmonton, Alberta markets. Commercial real estate operating income of $11.6 million increased $0.1 million from the same quarter last year. Interest Expense The $13.1 million increase in fourth quarter consolidated interest expense compared to the same quarter last year is the result of increased funded debt. Funded debt increased $661.5 million to end the ﬁscal year at $1,573.5 million compared to $912.0 million at the end of ﬁscal 2007. This increase was largely the consequence of long-term debt incurred to ﬁnance the privatization of Sobeys and the acquisition of Thrifty Foods as mentioned. Income Taxes The effective income tax rate for the fourth quarter was 31.0 percent versus 28.6 percent in the fourth quarter last year. The main reason for this increase is in the fourth quarter of ﬁscal 2007, the Canadian government approved a reduction in the Canadian federal and certain provincial statutory income tax rates Earnings before Capital Gains and Other Items The $9.5 million or 14.8 percent increase in earnings before capital gains and other items over the prior year was the result of the $12.2 million improvement in operating income and the $12.8 million reduction in minority interest, offset by the $13.1 million increase in interest expense and a $2.4 million increase in income taxes, as discussed. Capital Gains and Other Items The Company reported capital losses and other items, net of tax, of $7.1 million in the fourth quarter compared to capital gains and other items, net of tax, of $0.7 million last year. In the fourth quarter of ﬁscal 2008, it was determined that the carrying value of one commercial property was impaired. Accordingly, the Company recorded an impairment charge of $6.0 million ($4.1 million after tax) to reduce the carrying value on this property to estimated fair value. Also during the fourth quarter, Sobeys increased its pre-tax impairment loss provision on ABCP by $4.5 million (from $3.0 million previously recorded to $7.5 million), representing 25 percent of the $30.0 million of ABCP held by Sobeys. The Company estimated the impairment loss using a discounted cash ﬂow approach. The ABCP investment has been reclassiﬁed as a long-term asset rather than cash and cash equivalents due to the uncertainty as to the timing of collection. Net Earnings Consolidated net earnings, including capital gains and other items, net of tax, totalled $66.5 million ($1.01 per share, basic) in the fourth quarter, an increase of $1.7 million or 2.6 percent over the fourth quarter last year. 48 E M PI R E COM PANY LI M ITE D MANAG E M E NT’S DISCUSSION AN D ANALYSIS Financial Condition Capital Structure and Key Financial Condition Measures The Company’s ﬁnancial condition at the end of ﬁscal 2008 remained healthy as indicated by the following ﬁnancial condition measures. ($ in millions, except per share and ratio calculations) Shareholders' equity Book value per share Minority interest Bank indebtedness Long-term debt, including current portion(1) Funded debt to total capital Net debt to capital ratio(2) Debt to EBITDA Interest coverage Total assets (1) Includes liabilities related to assets held for sale. (2) Net debt to total capital reduces funded debt by cash and cash equivalents. May 3, 2008 2,382.3 36.14 37.6 92.1 1,481.4 39.8% 36.7% 2.02x 4.47x 5,706.9 $ $ May 5, 2007 (Restated) May 6, 2006 (Restated) $ 2,131.1 $ 32.31 588.6 30.1 881.9 30.0% 22.5% 1.30x 7.17x 5,241.5 $ $ 1,965.2 29.77 585.4 98.6 809.8 31.6% 22.4% 1.33x 5.86x 5,051.5 Shareholders’ Equity Book value per common share was $36.14 at May 3, 2008, compared to $32.31 at May 5, 2007 and $29.77 at May 6, 2006. The increase in book value largely reﬂects the Company’s earnings growth. The Company’s share capital on May 3, 2008 consisted of: Preferred shares, par value $25 each, issuable in series 2002 Preferred shares par value $25 each, issuable in series Non-Voting Class A shares, without par value Class B common shares, without par value, voting Employees Share Purchase Plan Authorized Number of Shares Issued and Outstanding Number of Shares 2,772,300 992,000,000 259,107,435 40,800,000 258,200 – 31,484,498 34,260,763 $ Millions $ 6.5 185.1 7.6 199.2 (3.5) $ 195.7 2008 AN N UAL R E PORT 49 Total Non-Voting Class A and Class B common shares outstanding at May 3, 2008 equalled 65,745,261, 10,461 shares higher than the previous ﬁscal year-end, May 5, 2007. There were 31,484,498 Non-Voting Class A and 34,260,763 Class B common shares outstanding at May 3, 2008. During ﬁscal 2008, 300,000 Class B common shares were exchanged for 300,000 Non-Voting Class A shares of Empire. Empire had 99,349 options outstanding at May 3, 2008, compared to no options outstanding at May 5, 2007. There were 27,674 options exercised during the ﬁscal 2007, compared to no options exercised in the current ﬁscal year. During ﬁscal 2008, the Company purchased for cancellation 41,800 Series 2 Preferred shares for $1.0 million; 31,900 preferred shares were purchased for cancellation in ﬁscal 2007 for $0.8 million. The Company plans to purchase on a best efforts basis for cancellation an additional 158,200 Series 2 Preferred shares by the end of calendar 2008. During the ﬁscal year, 10,461 Non-Voting Class A shares were issued under Empire’s share purchase plan to certain ofﬁcers and employees for $0.4 million compared to 46,047 Non-Voting Class A shares issued in ﬁscal 2007 for $1.0 million. During ﬁscal 2007, Empire purchased 46,047 Non- Voting Class A shares for cancellation. No Non-Voting Class A shares were purchased for cancellation in ﬁscal 2008. As at June 26, 2008, the Company had total Non-Voting Class A and Class B common shares outstanding of 31,484,498 and 34,260,763, respectively. Dividends paid to Non-Voting Class A and Class B common shareholders amounted to $43.2 million in ﬁscal 2008 ($0.66 per share) versus $39.5 million ($0.60 per share) in ﬁscal 2007. Subsequent to ﬁscal year-end, on June 26, 2008 the Company announced an increase in the dividend rate to $0.70 per share annually. Share Price $ PER SHARE Book Value Per Share $ PER SHARE Common Dividends Per Share $ PER SHARE 39.25 36.14 0.66 40 30 20 10 32 24 16 8 0.60 0.45 0.30 0.15 FISCAL YEAR 04 05 06 07 08 FISCAL YEAR 04 05 06 07 08 FISCAL YEAR 04 05 06 07 08 Liabilities Historically, Empire has ﬁnanced a signiﬁcant portion of its assets through the use of long-term debt. Longer-term assets are generally ﬁnanced with ﬁxed rate, long-term debt, thereby reducing both interest rate and reﬁnancing risk. Total long-term debt (including the current portion of long-term debt) at May 3, 2008 was $1,481.4 million, representing 94.1 percent of Empire’s total funded debt of $1,573.5 million. Funded debt increased $661.5 million from the previous ﬁscal year, May 5, 2007 ($912.0 million). The signiﬁcant increase over last ﬁscal year is the result of debt incurred to fund the privatization of Sobeys as discussed earlier, as well as the additional long-term debt used to fund the acquisition of Thrifty Foods, partially offset by proceeds from the sale of 61 properties to Crombie REIT in the fourth quarter. Since last ﬁscal year-end, the consolidated funded debt to total capital ratio has increased 9.8 percentage points to 39.8 percent as a result of the higher debt levels as discussed. Management expects the funded debt to capital ratio to decline in ﬁscal 2009 as a result of equity growth and a plan to generate free cash ﬂow, which will be used to reduce bank debt. The majority of Empire’s funded debt is long-term in nature. 50 E M PI R E COM PANY LI M ITE D MANAG E M E NT’S DISCUSSION AN D ANALYSIS The long-term debt is segmented by division as follows: Long-term debt ($ in millions) May 3, 2008 May 5, 2007 May 6, 2006 Food retailing Real estate Investments and other operations Total $ 1,010.2 50.7 420.5 $ 1,481.4 $ $ $ 612.7 228.1 41.1 490.0 261.0 58.8 881.9 $ 809.8 DBRS and S&P placed Sobeys’ credit ratings under review when the privatization of Sobeys was announced. On July 20, 2007, DBRS downgraded their rating on Sobeys’ Medium Term Notes from BBB (high) to BBB (low). The trend remained negative. On July 31, 2007, S&P also downgraded Sobeys’ credit ratings from BBB (low) to BB (high). S&P also kept a negative trend in place. Interest coverage for ﬁscal 2008 was 4.5 times, down from the 7.2 times reported for the ﬁscal year ended May 5, 2007. The decline in the interest coverage compared to ﬁscal 2007 was the result of the increased interest expense related to the additional borrowings to fund the Sobeys privatization and the acquisition of Thrifty Foods as previously discussed. Empire and its subsidiaries have provided covenants to its lenders in support of various ﬁnancing facilities. All covenants were complied with for the 52 weeks ended May 3, 2008 and for ﬁscal 2007. Funded Debt to Total Capital Interest Coverage PERCENTAGE TIMES 40 30 20 10 39.8 6.0 4.5 3.0 1.5 4.47 FISCAL YEAR 04 05 06 07 08 FISCAL YEAR 04 05 06 07 08 Financial Instruments Empire utilizes interest rate instruments from time to time to prudently manage its exposure to interest rate volatility and also to ﬁx future long-term debt maturities that are expected to be reﬁnanced. At May 3, 2008, there were four interest rate hedges in place with Empire or one of its operating companies. On June 18, 2007, Empire entered into two delayed ﬁxed rate interest swaps. The ﬁrst swap in an amount of $200.0 million is three years in duration and carries a ﬁxed interest rate of 4.998 percent. The second swap in an amount of $200.0 million is for a period of ﬁve years at a ﬁxed interest rate of 5.051 percent. Both swaps became effective on July 23, 2007. Empire later transferred the second swap to Sobeys. Empire Theatres entered into two interest rate swaps on December 27, 2006, which ﬁxed the interest rate on $20.0 million of the ﬂoating rate debt at 4.28 percent, plus a stamping fee for a ﬁve-year term. These swaps ﬁxed the interest rate on approximately 74 percent of Empire Theatres’ total indebtedness, all of which is borrowed at ﬂoating rates. The fair value of these interest rate swaps at year-end was negative $20.0 million. The Company also uses forward contracts to ﬁx the exchange rate on some of its expected requirements for Euros and U.S. dollars. As of May 3, 2008, Sobeys had an asset of $2.3 million relating to the value of ﬁve Euro forward contracts. There were no outstanding U.S. dollar forward contracts. Empire and its subsidiaries utilize hedging instruments as deemed appropriate to mitigate risk exposure, not for speculative purposes. 2008 AN N UAL R E PORT 51 Liquidity and Capital Resources Empire’s liquidity remained strong at May 3, 2008 as a result of the following sources: Cash and cash equivalents on hand; Unutilized bank credit facilities; Availability of long-term debt ﬁnancing; and Cash generated from operating activities. At May 3, 2008, cash and cash equivalents equalled $191.4 million versus $294.9 million at May 5, 2007. At the end of ﬁscal 2008, on a non-consolidated basis, Empire maintained authorized bank lines for operating, general and corporate purposes of $650.0 million, of which $399.7 million or 61.5 percent were utilized. On a consolidated basis, Empire’s authorized bank credit facilities exceeded borrowings by $690.8 million at May 3, 2008, versus $661.0 million at May 5, 2007. The Company anticipates that its capital resources will meet its ﬁnancial and liquidity requirements over the next year, including capital expenditures, dividends and scheduled debt repayments. The following table highlights major cash ﬂow components for the 13 weeks and 52 weeks ended May 3, 2008 compared to the 13 weeks and 52 weeks ended May 5, 2007. Major Cash Flow Components ($ in millions) 13 Weeks Ended May 3, 2008 13 Weeks Ended May 5, 2007 52 Weeks Ended May 3, 2008 52 Weeks Ended May 5, 2007 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 ﬁnancing activities 66.5 105.7 172.2 92.0 264.2 211.7 (407.6) $ 64.7 127.7 192.4 84.0 276.4 (149.3) (35.6) $ 315.5 354.1 669.6 (26.1) 643.5 (1,367.5) 620.5 $ 205.4 382.6 588.0 (149.2) 438.8 (424.8) (60.2) Increase (decrease) in cash and cash equivalents $ 68.3 $ 91.5 $ (103.5) $ (46.2) Operating Activities Fourth quarter cash ﬂows from operating activities equalled $264.2 million compared to $276.4 million in the comparable period last year. The decrease of $12.2 million is largely attributed to an increase in the net change in non-cash working capital of $8.0 million and an increase in net earnings available for common shareholders of $1.8 million as discussed, offset by a decrease in items not affecting cash of $22.0 million. Non-Cash Working Capital (Quarter-Over-Quarter) In ﬁscal 2008, operating activities generated cash ﬂow of $643.5 million compared to $438.8 million last year. The increase of $204.7 million is primarily the result of the $123.1 million increase in net change in non-cash working cash ﬂow and earnings for common shareholders increasing by $110.1 million, offset by a $28.5 million decrease in items not affecting cash, primarily due to the reduction in minority interest. The following tables present non-cash working capital changes on a quarter-over-quarter basis and on a year-over-year basis. ($ in millions) Receivables Inventories Prepaid expenses Accounts payable and accrued liabilities Income taxes receivable (payable) Impact of reclassiﬁcations on working capital(1) $ May 3, 2008 316.3 820.2 62.0 (1,322.4) (15.5) 37.5 $ Feb. 2, 2008 313.4 847.0 61.7 (1,246.1) (0.7) 14.8 Q4 F2008 vs. Q3 F2008 Increase (Decrease) in Cash Flows Q4 F2007 vs. Q3 F2007 Increase (Decrease) in Cash Flows $ $ (2.9) 26.8 (0.3) 76.3 14.8 (22.7) 1.6 15.3 0.5 84.1 (21.5) 4.0 Total $ (101.9) $ (9.9) $ 92.0 $ 84.0 52 E M PI R E COM PANY LI M ITE D MANAG E M E NT’S DISCUSSION AN D ANALYSIS Non-Cash Working Capital (Year-Over-Year) ($ in millions) Receivables Inventories Prepaid expenses Accounts payable and accrued liabilities Income taxes receivable (payable) Impact of reclassiﬁcations on working capital(1) $ May 3, 2008 316.3 820.2 62.0 (1,322.4) (15.5) 42.4 $ May 5, 2007 312.3 757.5 51.4 (1,260.3) 3.6 12.4 Year-Over-Year Increase (Decrease) in Cash Flows $ (4.0) (62.7) (10.6) 62.1 19.1 (30.0) Total $ (97.0) $ (123.1) $ (26.1) (1) Reclassiﬁcations primarily relate to business acquisitions and rationalization costs. The net change in non-cash working capital of $92.0 million in the fourth quarter was largely due to a $76.3 million increase in payables, a $26.8 million decrease in inventories and an increase in income taxes payable of $14.8 million compared to the third quarter ended February 2, 2008. The decrease in inventory is primarily related to lower inventory requirements in the food retailing division following the December selling season. The increased accounts payable and accrued liabilities largely reﬂects higher accounts payable and accrued liabilities at Sobeys due to a general increase as a result of increased operations. The decrease in taxes payable compared to the third quarter reﬂects the timing of tax remittances. Year-over-year non-cash working capital decreased $26.1 million. This is primarily the result of a $62.7 million increase in inventories, a $10.6 million increase in prepaid expenses and a $4.0 million increase in receivables, partially offset by a decrease in income taxes receivable of $19.1 million and a $62.1 million increase in accounts payable and accrued liabilities compared to the fourth quarter of last year. The increase in inventories and related accounts payable and accrued liabilities is correlated to Sobeys’ higher sales volumes, the Thrifty’s acquisition and the increased square footage in its expanded store network. Investing Activities In the fourth quarter of ﬁscal 2008, the Company generated cash from investing activities of $211.7 million compared to cash used in investing activities of $149.3 million in the fourth quarter last year. The fourth quarter investing activities this year beneﬁted from proceeds of $373.5 million related to the sale of 61 properties to Crombie REIT, which was partially offset by a net increase in investments, primarily Crombie REIT, of $54.2 million. Investment in property, equipment and other assets totalled $150.3 million in the fourth quarter versus $141.3 million in the same quarter last year. For the ﬁscal year, cash used in investing activities increased $942.7 million to total $1,367.5 million. This was primarily the result of the purchase of Sobeys’ shares to privatize the Company for a cash outlay of $1,065.7 million, cash used in business acquisitions, primarily Thrifty Foods, of $263.2 million and an increase in the cash used to purchase property and equipment of $40.5 million, partially offset by cash proceeds from sale of property to Crombie REIT of $373.5. Consolidated purchases of property, equipment and other assets totalled $549.4 million compared to $508.9 million last ﬁscal year. The table below presents capital expenditures over the last two ﬁscal years by division. ($ in millions) May 3, 2008 May 5, 2007 Food retailing Real estate Investments $ 481.2 47.3 $ 446.7 16.0 and other operations 20.9 46.2 Total $ 549.4 $ 508.9 2008 AN N UAL R E PORT 53 The table below outlines the number of stores Sobeys invested in or closed during ﬁscal 2008 compared to ﬁscal 2007. Sobeys’ Corporate and Franchised Store Construction Activity # of Stores Opened/Acquired/Relocated Expanded Rebannered/Redeveloped Closed 13 Weeks Ended May 3, 2008 13 Weeks Ended May 5, 2007 52 Weeks Ended May 3, 2008 52 Weeks Ended May 5, 2007 15 10 9 17 7 3 13 9 66 31 60 67 77 24 49 38 The following table shows Sobeys’ square footage changes for the 13 weeks and 52 weeks ended May 3, 2008 by type. Sobeys’ Square Footage Changes Square Feet (in thousands) Q4 F08 vs. Q3 F08 Q4 F08 vs. Q4 F07 Opened Relocated Acquired Expanded Closed Net Change 153 48 – 50 124 127 477 364 571 172 794 790 At May 3, 2008, Sobeys’ square footage totalled 27.2 million square feet, a 3.0 percent increase over the 26.4 million square feet in operation at the end of the fourth quarter of last year. Capital expenditures for the real estate division equalled $47.3 million in ﬁscal 2008 ($16.0 million in ﬁscal 2007) as a result of ongoing property developments and land additions. The signiﬁcant increase in capital expenditures underlines ECL Developments’ commitment to acquire attractive sites for grocery-anchored shopping plaza development. Capital spending by investments and other operations equalled $20.9 million in ﬁscal 2008 ($46.2 million in ﬁscal 2007) primarily as a result of a reduction in expenditures to invest in selected oil and gas properties in Alberta through Kepec. The majority of the capital spending in ﬁscal 2008 was to modernize and develop various movie theatre locations. Financing Activities Financing activities during the fourth quarter used $407.6 million of cash compared to $35.6 million of cash used in the comparable period of ﬁscal 2007. Net repayments of funded debt amounted to $390.3 million in the fourth quarter (repayments of $445.9 million net of issuances of $55.6 million) compared to net repayments of $19.0 million (repayments of $40.9 million net of issuances of $21.9 million) in the fourth quarter of ﬁscal 2007. In the fourth quarter of ﬁscal 2008, the proceeds from the sales of 61 properties to Crombie REIT were used to repay long-term debt as discussed. For the ﬁscal year, ﬁnancing activities increased cash by $620.5 million compared to a $60.2 million decline last year largely due to the issuance of long-term debt. In ﬁscal 2008, the net increase in funded debt amounted to $654.3 million (issuances of $1,161.8 million net of repayments of $507.5 million) compared to net repayments of $10.7 million (repayments of $171.5 million net of issuances of $160.8 million) in ﬁscal 2007. The additional long-term debt added in ﬁscal 2008 was related to the privatization of Sobeys and the acquisition of Thrifty Foods. A portion of this newly issued debt was later repaid with proceeds from the sale of 61 properties to Crombie REIT as discussed. The Company added net long-term debt of $592.3 million in ﬁscal 2008 versus $56.6 million added last year. Food Retailing Capital Expenditures Real Estate Capital Expenditures $ IN MILLIONS $ IN MILLIONS 481.2 400 300 200 100 47.3 60 45 30 15 FISCAL YEAR 04 05 06 07 08 FISCAL YEAR 04 05 06 07 08 54 E M PI R E COM PANY LI M ITE D MANAG E M E NT’S DISCUSSION AN D ANALYSIS Accounting Policy Changes Accounting standards adopted during ﬁscal 2008: Accounting Changes In July 2006, the Canadian Institute of Chartered Accountants (“CICA”) issued section 1506 of the CICA Handbook, “Accounting Changes”, which describes the criteria for changing accounting policies, along with the accounting and disclosure for changes in accounting policies, changes in accounting estimates and corrections of errors. These changes came into effect for ﬁscal periods beginning on or after January 1, 2007 and were applicable as of the Company’s ﬁrst quarter of ﬁscal 2008. Financial Instruments On May 6, 2007, the Company implemented the CICA Handbook Sections 3855, “Financial Instruments – Recognition and Measurement”, 3865, “Hedges”, 1530, “Comprehensive Income”, 3251, “Equity” and 3861, “Financial Instruments – Disclosure and Presentation”. These standards have been applied without restatement of prior periods. The transitional adjustments resulting from these standards were recognized in the opening balances of retained earnings and accumulated other comprehensive income. Financial Instruments – Recognition and Measurement Section 3855, “Financial Instruments – Recognition and Measurement” requires the Company to initially recognize all of its ﬁnancial assets and liabilities, including derivatives and embedded derivatives in certain contracts, at fair value adjusted on transition as appropriate, and measured subsequently in accordance with the classiﬁcation chosen. Non-ﬁnancial derivatives must be recorded at fair value on the consolidated balance sheet unless they are exempt from derivative treatment based upon expected purchase, sale or usage requirements. This standard also requires the Company to classify ﬁnancial assets and liabilities according to their characteristics and management’s choices and intentions related thereto for the purposes of ongoing measurements. Classiﬁcation choices for ﬁnancial assets include: a) held for trading – measured at fair value with changes in fair value recorded in net earnings; b) held to maturity – recorded at amortized cost with gains and losses recognized in net earnings in the period that the asset is derecognized or impaired; c) available-for-sale – measured at fair value with changes in fair value recognized in other comprehensive income for the current period until realized through disposal or impairment; and d) loans and receivables – recorded at amortized cost with gains and losses recognized in net earnings in the period that the asset is derecognized or impaired. Classiﬁcation choices for ﬁnancial liabilities include: a) held for trading – measured at fair value with changes in fair value recorded in net earnings and b) other – measured at amortized cost with gains and losses recognized in net earnings in the period that the liability is no longer recognized. Subsequent measurement for these assets and liabilities are based on either fair value or amortized cost using the effective interest method, depending upon their classiﬁcation. Any ﬁnancial asset or liability can be classiﬁed as held for trading as long as its fair value is reliably determinable. In accordance with the new standard, the Company’s ﬁnancial assets and liabilities are generally classiﬁed and measured as follows: Asset/Liability Cash Cash equivalents Receivables Mortgages, loans and other receivables Investments Derivative other assets and liabilities Non-derivative other assets and liabilties Bank indebtedness Accounts payable and accrued liabilities Long-term debt Classification Held for trading Held for trading Loans and receivables Loans and receivables Available-for-sale Held for trading Held to maturity Other liabilities Other liabilities Other liabilities Measurement Fair value Fair value Amortized cost Amortized cost Fair value Fair value Amortized cost Amortized cost Amortized cost Amortized cost Other balance sheet accounts, including, but not limited to, inventories, prepaid expenses, investments (at equity), property and equipment, assets held for sale, intangibles, goodwill, current and future long-term income taxes, employee future beneﬁts obligation and minority interest are not within the scope of the new accounting standard as they are not ﬁnancial instruments. Transaction costs, other than those related to ﬁnancial instruments classiﬁed as held for trading which are expensed as incurred, are added to the fair value of the ﬁnancial asset or ﬁnancial liability on initial recognition and amortized using the effective interest method. 2008 AN N UAL R E PORT 55 Embedded derivatives are required to be separated and measured at fair values if certain criteria are met. Under an election permitted by the new standard, management reviewed contracts entered into or modiﬁed subsequent to May 3, 2003 and determined that the Company does not currently have any signiﬁcant embedded derivatives in its contracts that require separate accounting treatment. Section 3855 also requires that obligations undertaken through issuance of a guarantee that meets the deﬁnition of a guarantee pursuant to Accounting Guideline 14, “Disclosure of Guarantees”, be recognized at fair value at inception. No subsequent re-measurement at fair value is required unless the ﬁnancial guarantee qualiﬁes as a derivative. Management reviewed and determined that identiﬁed guarantees were immaterial. The fair value of a ﬁnancial instrument is the amount of the consideration that would be agreed upon in an arm’s length transaction between knowledgeable, willing parties who are under no compulsion to act. To estimate the fair value of each type of ﬁnancial instrument various market value data and other valuation techniques were used as appropriate. The fair value of cash approximated its carrying value. The fair value of currency swaps was estimated based on discounting of the forward rate at the reporting date compared to the forward rate in the contract. The fair value of interest rate swaps was estimated by discounting net cash ﬂows of the swaps using forward interest rates for swaps of the same remaining maturities. The fair value of energy contracts was estimated based on changes in forward commodity rates. Hedges Section 3865, “Hedges” replaces Accounting Guideline 13, “Hedging Relationships”. The requirements for identiﬁcation, designation, documentation and assessment of effectiveness of hedging relationships remain substantially unchanged. Section 3865 addresses the accounting treatment of qualifying hedging relationships and the necessary disclosures and also requires all derivatives in hedging relationships to be recorded at fair value. The Company has cash ﬂow hedges which are used to manage exposure to ﬂuctuations in foreign currency exchange rates, variable interest rates and energy prices. For cash ﬂow hedges, the effective portion of the change in fair value of the hedging item is recorded in other comprehensive income. To the extent the change in fair value of the derivative is not completely offset by the change in fair value of the hedged item, the ineffective portion of the hedging relationship is recorded immediately in net earnings. Amounts accumulated in other comprehensive income are reclassiﬁed to net earnings when the hedged item is recognized in net earnings. When a hedging instrument in a cash ﬂow hedge expires or is sold, or when a hedge no longer meets the criteria for hedge accounting, any cumulative gain or loss in accumulated other comprehensive income relating to the hedge is carried forward until the hedged item is recognized in net earnings. When the hedged item ceases to exist as a result of its expiry or sale, or if an anticipated transaction is no longer expected to occur, the cumulative gain or loss in accumulated other comprehensive income is immediately reclassiﬁed to net earnings. Signiﬁcant derivatives include the following: Foreign currency forward contracts for the primary purpose of limiting exposure to exchange rate ﬂuctuations relating to expenditures denominated in foreign currencies. These contracts are designated as hedging instruments for accounting purposes. Accordingly, the effective portion of the change in the fair value of the forward contracts are accumulated in other comprehensive income until the variability in cash ﬂows being hedged is recognized in earnings in future accounting periods. Electricity contracts to manage the cost of electricity designated as cash ﬂow hedges of anticipated transactions. The portion of gain or loss on derivative instruments designated as cash ﬂow hedges that are deferred in accumulated other comprehensive income is reclassiﬁed into other income/expense when the product containing the hedged item impacts earnings. Hedge ineffectiveness was immaterial for the current ﬁscal year. Interest rate swaps designated as cash ﬂow hedges to manage variable interest rates associated with some of the Company’s debt portfolio. Hedge accounting treatment results in interest expense on the related debt being reﬂected at hedged rates rather than variable interest rates. Comprehensive Income In accordance with Section 1530, “Comprehensive Income”, the Company reported a new ﬁnancial statement entitled “Consolidated Statements of Comprehensive Income”, which is comprised of net earnings and other comprehensive income. Other comprehensive income represents the change in shareholders’ equity from transactions and other events from non-owner sources and includes unrealized gains and losses on ﬁnancial assets that are classiﬁed as available-for-sale, and changes in the fair value of the effective portion of cash ﬂow hedging instruments. The accumulated other comprehensive income (i.e. the portion of comprehensive income not already included in net earnings) is being presented as a separate line in shareholders’ equity. In accordance with the new standard, $0.6 million relating to unrealized losses resulting from the translation of self-sustaining foreign operations which had previously been classiﬁed as cumulative translation adjustment within shareholders’ equity is now presented within accumulated other comprehensive income. Equity Section 3251, “Equity”, which replaced Section 3250, “Surplus”, establishes standards for the presentation of equity and changes in equity during the reporting period and requires the Company to present separately equity components and changes in equity arising from: i) net earnings; ii) other comprehensive income; iii) other changes in retained earnings; iv) changes in contributed surplus; v) changes in share capital; and vi) changes in reserves. 56 E M PI R E COM PANY LI M ITE D MANAG E M E NT’S DISCUSSION AN D ANALYSIS Financial Instruments – Disclosure and Presentation Section 3861, “Financial Instruments – Disclosure and Presentation”, which replaced Section 3860, of the same title, establishes standards for the presentation of ﬁnancial instruments and non-ﬁnancial derivatives, and identiﬁes the information that should be disclosed about them. The following table summarizes the transition adjustments recorded upon implementation: ($ in millions) Transition Adjustments Consolidated Balance Sheet Investments Other assets Other liabilities Long-term debt Future income taxes Minority interest Accumulated other comprehensive income $ 94.4 (4.5) 2.5 2.7 (18.5) 0.6 (77.2) Deferred Charges The Company adopted CICA Section 3855, “Financial Instruments – Recognition and Measurement”, effective as of the ﬁrst quarter of ﬁscal 2008. Concurrent with issuance of this section, Section 3070, “Deferred Charges”, was withdrawn. As a result, the Company reviewed its deferred costs classiﬁcations included with other assets and determined that the following changes were necessary: Deferred Store Marketing Deferred store marketing costs, primarily comprised of store renovation and expansion costs, were reclassiﬁed and included with equipment, ﬁxtures and vehicles as part of the Company’s property and equipment balance sheet group. Prior year balances were reclassiﬁed which resulted in an increase in property and equipment and a decrease in other assets of $106.2 million at May 5, 2007 as well as an increase in depreciation expense and decrease in cost of sales, selling and administrative expenses of $25.3 million for the year ended May 5, 2007. There is no impact on net earnings or earnings per share as a result of this change. Deferred Repositioning Costs Effective for the ﬁrst quarter of ﬁscal 2008, the Company changed its accounting policy for the treatment of certain deferred costs associated with major repositioning or branding efforts of the Company. Due to the withdrawal of the primary source of GAAP, Section 3070, “Deferred Charges”, the Company looked to other sources of existing and proposed GAAP for guidance in determining its future policy for such costs. Based on this review, the Company determined, in setting the new policy, that it would be more appropriate to expense these types of costs in the period incurred as it provides more relevant information on expenditures associated with repositioning and branding efforts. This change in accounting policy was applied retrospectively resulting in a $9.1 million decrease in other assets, a $3.2 million decrease in long-term future tax liabilities, and a $4.3 million decrease in earnings (net of minority interest of $1.6 million) at May 5, 2007. The effect for the year ended May 5, 2007 is a $9.1 million increase in cost of sales, selling and administrative expenses, a $3.2 million decrease in income taxes and $0.06 decrease in basic and diluted earnings of per share. The effect for the year ended May 3, 2008, was a $3.6 million decrease in cost of sales, selling and administrative expenses, a $1.2 million increase in income taxes and an increase in basic and diluted earnings of $0.04 per share. The following accounting standards have been implemented during ﬁscal 2007: Vendor Consideration During the ﬁrst quarter of ﬁscal 2007, the Company implemented on a retroactive basis, Emerging Issues Committee Abstract 156 (“EIC-156”), “Accounting by a Vendor for Consideration Given to a Customer (including a Reseller of the Vendor’s Products)”. This abstract requires a vendor to generally record cash consideration given to a customer as a reduction to the selling price of the vendor’s product or services and reﬂect it as a reduction of revenue when recognized in the statement of earnings. Prior to the implementation of EIC-156, the Company recorded certain sales incentives paid to independent franchisees, associates and independent accounts in cost of sales, selling and administrative expenses on the statement of earnings. Accordingly, the implementation of EIC-156 on a retroactive basis resulted in a reduction in both sales and cost of sales, selling and administrative expenses. As reclassiﬁcations, these changes did not impact net earnings or earnings per share. Future Changes in Accounting Policies Inventories In June 2007, the CICA issued Section 3031, “Inventories”, which has replaced existing Section 3030 with the same title. The new Section establishes that inventories should be measured at the lower of cost and net realizable value, with guidance on the determination of cost. This standard is effective for interim and annual ﬁnancial statements relating to ﬁscal years beginning on or after January 1, 2008 and is applicable for the Company’s ﬁrst quarter of ﬁscal 2009. The Company has evaluated the impact of this new standard and does not expect the adoption of this standard to have a signiﬁcant impact on its ﬁnancial statement disclosures and statement of earnings. 2008 AN N UAL R E PORT 57 Capital Disclosures In October 2006, the CICA issued Section 1535, “Capital Disclosures”. This section establishes standards for disclosing information about an entity’s capital and how it is managed. The standard is effective for interim and annual ﬁnancial statements relating to ﬁscal years beginning on or after October 1, 2007 and is applicable for the Company’s ﬁrst quarter of ﬁscal 2009. The Company does not expect that the adoption of this standard will have a signiﬁcant impact on its ﬁnancial statement disclosures. Financial Instruments – Disclosure and Financial Instruments – Presentation Section 3862 “Financial Instruments – Disclosure” and Section 3863, “Financial Instruments – Presentation”, replace Section 3861, “Financial Instruments – Disclosure and Presentation”. Section 3862 requires increased disclosures regarding the risks associated with ﬁnancial instruments such as credit risk, liquidity risk and market risks and the techniques used to identify, monitor and manage these risks. Section 3863 carries forward standards for presentation of ﬁnancial instruments and non-ﬁnancial derivatives and provides additional guidance for the classiﬁcation of ﬁnancial instruments between liabilities and equity. These standards are effective for interim and annual ﬁnancial statements relating to ﬁscal years beginning on or after October 1, 2007 and are applicable for the Company’s ﬁrst quarter of ﬁscal 2009. The Company does not expect the adoption of these standards to have a signiﬁcant impact on its ﬁnancial disclosures and results of operations. Goodwill and Intangible Assets In February 2008, the CICA issued Section 3064, “Goodwill and Intangible Assets”, which replaced existing Section 3062, “Goodwill and Other Intangible Assets” as Section 3450, “Research and Development”. The new standard provides guidance on the recognition, measurement, presentation and disclosure of goodwill and intangible assets. This standard is effective for interim and annual ﬁnancial statements relating to ﬁscal years beginning on or after October 1, 2008 and is applicable for the Company’s ﬁrst quarter of ﬁscal 2010. The Company is currently evaluating the impact of this new standard. International Financial Reporting Standards In January 2006, the Canadian Accounting Standards Board announced its decision requiring all publicly accountable entities to report under International Financial Reporting Standards. This decision establishes standards for ﬁnancial reporting with increased clarity and consistency in the global marketplace. These standards are effective for interim and annual ﬁnancial statements relating to ﬁscal years beginning on or after January 1, 2011 and are applicable for the Company’s ﬁrst quarter of ﬁscal 2012. The Company is currently evaluating the impact of these new standards. Critical Accounting Estimates The preparation of ﬁnancial statements in accordance with Canadian GAAP requires management to make estimates and assumptions that affect the reported amounts and disclosures made in the consolidated ﬁnancial statements and accompanying notes. Certain of these estimates require subjective or complex judgments by management that may be uncertain. Some of these items include inventories, carrying value of commercial properties, goodwill, employee future beneﬁts, asset backed commercial paper, and income taxes. Changes to these estimates could materially impact the ﬁnancial statements. These estimates are based on management’s best knowledge of current events and actions that the Company may undertake in the future. Actual results could differ from these 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 beneﬁts obligation. Signiﬁcant assumptions used to calculate the pension and employee future beneﬁts obligation 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 ten 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 rates are determined on April 30th every year. For ﬁscal 2008, the discount rate used for calculation of pension and other beneﬁt plan expense was 5.25 percent (ﬁscal 2007 – 5.0 percent). The expected long-term rate of return on plan assets for pension beneﬁt plans for each of ﬁscal 2008 was 7.0 percent (ﬁscal 2007 – 7.0 percent). The expected growth rate in health care costs was 9.0 percent for ﬁscal 2008 58 E M PI R E COM PANY LI M ITE D MANAG E M E NT’S DISCUSSION AN D ANALYSIS (ﬁscal 2007 – 10.0 percent). The cumulative growth rate in health care costs to 2016 is expected to be 5.0 percent. The expected future growth rate is evaluated on an annual basis. The table below outlines the sensitivity of the 2008 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 obligation or beneﬁt plan expenses. ($ in millions) Expected long-term rate of return on plan assets Impact of: 1% increase Impact of: 1% decrease Discount rate(2) Impact of: 1% increase Impact of: 1% decrease Growth rate of health care costs(3) Impact of: 1% increase Impact of: 1% decrease Pension Plans Other Benefit Plans Benefit Obligations Benefit Cost (1) Benefit Obligations Benefit Cost(1) 7.00% (2.4) 2.4 5.25% 0.4 (0.8) $ $ $ $ 5.25% (29.5) 33.1 $ $ 5.25% (17.1) 20.6 9.00% 19.1 (15.4) $ $ $ $ 5.25% (0.7) 0.8 9.00% 1.9 (1.5) $ $ $ $ (1) Reﬂects the impact on the current service cost, the interest cost and the expected return on assets. (2) 5.5 percent for the Employee Pension Plan and the Post Retirement Beneﬁt Plan. (3) Gradually decreasing to 5.0 percent in 2016 and remaining at that level thereafter. Goodwill and Long-Lived Assets Goodwill is not amortized and is assessed for impairment at the reporting unit level. This is done, at a minimum, 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 judgment. 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. Valuation of Inventories Inventories are valued at the lower of cost and estimated net realizable value. Signiﬁcant estimation or judgment is required in the determination of (i) inventories counted and adjusted to cost and (ii) estimated inventory reductions due to spoilage, shrinkage and allowances, occurring between the last physical inventory count and the balance sheet date. 2008 AN N UAL R E PORT 59 Inventory shrinkage, which is calculated as a percentage of the related inventory, is evaluated throughout the year and provides for estimated inventory shortages from the last physical count to the balance sheet date. To the extent that actual losses experienced vary from those estimated, inventories, operating income and consolidated earnings may be impacted. Controls and Procedures Empire’s management, with the participation of the Chief Executive Ofﬁcer (“CEO”) and Chief Financial Ofﬁcer (“CFO”), has reviewed and evaluated the Corporation’s disclosure controls and procedures (as that term is deﬁned in Multi- National Instrument 52-109) as of May 3, 2008. Based on that evaluation, the CEO and CFO have concluded that the design and operation of the system of disclosure controls and procedures was effective. Internal Controls Over Financial Reporting Empire’s management, with the participation of the CEO and CFO, has reviewed and evaluated the design of the Corporation’s internal controls over ﬁnancial reporting (as that term is deﬁned in MI 52-109) as of May 3, 2008. Internal controls over ﬁnancial reporting are designed to provide reasonable assurance regarding the reliability of the Company’s ﬁnancial reporting and its preparation of ﬁnancial statements for external purposes in accordance with Canadian GAAP. All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to ﬁnancial reporting. In addition, management has evaluated whether there were changes in our internal controls over ﬁnancial reporting during the interim period ended May 3, 2008 that have materially affected, or are reasonably likely to materially affect, our internal controls over ﬁnancial reporting. As a result of this evaluation, management reports that there have been no changes in the Company’s internal controls over ﬁnancial reporting during the 52 weeks ended May 3, 2008 that have materially affected, or are reasonably likely to materially affect, our internal controls over ﬁnancial reporting. Therefore, Empire’s CEO and CFO have concluded that the design of its internal controls over ﬁnancial reporting is effective. Related Party Transactions The Company rents premises from Crombie REIT. In addition, Crombie REIT provides administrative and management services to the Company. The rental payments are at fair value and the charges incurred for administrative and management services are on a cost recovery basis. The Company has non-interest bearing notes payable to Crombie REIT in the amount of $19.6 million. On October 2, 2006, the Company sold two commercial properties to Crombie REIT for cash proceeds of $32.4 million, which was fair market value. Since the sale was to an equity accounted investment, no gain was recorded on the sale. Other Matters Asset Backed Commercial Paper On April 22, 2008, the Company sold 61 commercial properties to Crombie REIT, for cash proceeds of $373.5 million plus additional Class B Units in Crombie Limited Partnership totalling $55.0 million, which was fair market value. In accordance with Canadian GAAP, the gain on this transaction of $144.3 million has been accounted for as a reduction in the carrying value of Crombie REIT because the purchaser is a related party. As of May 3, 2008, the Company held third-party ABCP with an original cost of $30.0 million that was in default. The ABCP was rated by the Dominion Bond Rating Service (“DBRS”) as R-1 (high), the highest credit rating for commercial paper since the ABCP are backed by AAA (high) rated assets. The $30.0 million of ABCP held by the Company is entirely made up of collateralized 60 E M PI R E COM PANY LI M ITE D MANAG E M E NT’S DISCUSSION AN D ANALYSIS debt obligations. Collateralized debt obligations are a type of asset-backed security that is created by a portfolio of ﬁxed- income assets which may include pools of bonds, credit card debt, commercial mortgage-backed securities and other loans. In the second quarter of ﬁscal 2008, a global disruption in the market for such commercial paper resulted in a constraint on the liquidity of ABCP. DBRS placed certain of the ABCP “Under Review with Developing Implications” following an announcement on August 16, 2007 that a consortium representing banks, asset providers and major investors had agreed in principle to a long-term proposal and interim agreement regarding the ABCP (commonly referred to as “the Montreal Proposal”). On September 6, 2007 a pan-Canadian committee (“the Committee”) consisting of major investors was formed to oversee the proposed restructuring process of the ABCP. As of May 3, 2008, all of the ABCP held by the Company were part of the Montreal Proposal. Under this proposal, the affected ABCP would be converted into term ﬂoating rate notes maturing no earlier than the scheduled termination dates of the underlying assets. The Montreal Proposal called for the investors to continue to roll their ABCP during the standstill period. On December 23, 2007, a formal restructuring proposal was established to address the global disruption experienced with third-party ABCP. On April 25, 2008, note holders voted in favour of the restructuring proposal, which will provide investors with new long-term notes that will more closely match the maturity dates of the underlying assets and the cash ﬂows they are expected to generate and was approved on June 5, 2008 by the Ontario Superior Court of Justice. On March 20, 2008, the Committee issued an Information Statement containing details about the proposed restructuring. Based on this and other public information it is estimated that the $30.0 million of ABCP in which the Company has invested in is represented by a combination of leveraged collateralized debt, synthetic assets and traditional securitized assets. The Company will, on restructuring, receive replacement senior Class A-1 and Class A-2 and subordinate Class B and Class C long-term ﬂoating rate notes with maturities of approximately eight years and nine months. The Company expects to receive replacement notes with par values as follows: ($ in millions) Class A-1: Class A-2: Class B: Class C: Total : $ 8.2 17.8 3.1 0.9 $ 30.0 The replacement notes are expected to obtain an AA rating while the replacement subordinate notes are likely to be unrated. The valuation technique used by the Company to estimate the fair value of its investment in ABCP at May 3, 2008 incorporates probability weighted discounted cash ﬂows considering the best available public information regarding market conditions, prevailing yields, credit spreads and other factors that a market participant would consider for such investments. The assumptions used in determining the estimated fair value reﬂect the details included in the Information Statement issued by the Committee and the risks associated with the long-term ﬂoating rate notes. Interest rates and credit losses vary by each of the different replacement long-term ﬂoating rate notes to be issued as each has different credit ratings and risks. Interest rates and credit losses also vary by the different probable cash ﬂow scenarios that have been modeled. Discount rates vary dependent upon the credit rating of the replacement long-term ﬂoating rate notes. Discount rates have been estimated using Government of Canada benchmark rates plus expected spreads for similarly rated instruments with similar maturities and structure. An increase in the estimated discount rates of 1 percent would reduce the estimated fair value of the Company’s investment in ABCP by approximately $5.0 million. Maturities vary by different replacement long-term ﬂoating rate notes as a result of the expected maturity of the underlying assets. These investments were initially and continue to be classiﬁed as held-to-maturity instruments by the Company and were carried at an amortized cost. Due to the lack of liquidity and a yield on these instruments, a pre-tax impairment loss of $7.5 million or 25 percent of the original cost was recorded during ﬁscal 2008. It is possible that the amount ultimately recovered may differ from the estimate. The Company continues to investigate the implications of the default and the remedies available. In addition, these investments have been reclassiﬁed as long-term under other assets rather than current assets due to the uncertainty as to the timing of collection. Continuing uncertainties regarding the value of assets which underlie the ABCP, the amount and timing of cash ﬂows and the outcome of the restructuring process could give rise to a further material change in the value of the Company’s investment in ABCP which could impact the Company’s near term earnings. The Company believes it has sufﬁcient credit facilities to satisfy its ﬁnancial obligations as they come due and does not expect there will be a material adverse impact on its business as a result of this current third-party ABCP liquidity issue. 2008 AN N UAL R E PORT 61 Guarantees and Commitments The following illustrates the Company’s signiﬁcant contractual obligations over the next ﬁve ﬁscal years and thereafter. Gross obligations excluding lease income ($ in millions) 2009 2010 2011 Long-term debt Capital leases Operating leases $ 47.2 13.2 300.9 $ 20.4 12.0 281.8 $ 536.3 11.1 263.9 $ 2012 18.0 8.0 247.5 2013 Thereafter Total $ 265.7 4.9 234.5 $ 530.9 7.3 1,862.8 $ 1,418.5 56.5 3,191.4 Total contractual obligations $ 361.3 $ 314.2 $ 811.3 $ 273.5 $ 505.1 $ 2,401.0 $ 4,666.4 Operating leases, net of expected lease income received by the Company ($ in millions) 2009 2010 2011 2012 2013 Thereafter Total $ 219.1 $ 204.4 $ 191.3 $ 179.6 $ 172.6 $ 1,483.2 $ 2,450.2 Franchise Afﬁliates Other Sobeys has guaranteed certain bank loans contracted by franchise afﬁliates. As at May 3, 2008, these loans amounted to $1.3 million (May 5, 2007 – $2.9 million). At May 3, 2008, the Company was contingently liable for letters of credit issued in the aggregate amount of $60.3 million (May 5, 2007 – $48.5 million). Upon entering into the lease of its new Mississauga distribution centre in March 2000, Sobeys 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 12 years with an aggregate obligation of $37.5 million (May 5, 2007 – $40.4 million). At the time of the sale of assets of Serca Foodservice Inc. to SYSCO Corp., the lease of the Mississauga distribution centre was assigned to and assumed by a subsidiary of the purchaser and SYSCO Corp. agreed to indemnify and hold Sobeys harmless from any liability it may incur pursuant to its guarantee. During the second quarter of ﬁscal 2008, Sobeys entered into an additional guarantee contract. Under the terms of the guarantee, should a franchise afﬁliate be unable to fulﬁll their lease obligation, Sobeys would be required to fund the greater of $5.0 million or 9.9 percent of the unfulﬁlled obligation balance. As at May 3, 2008 the amount of the guarantee was $5.0 million. Sobeys also has guaranteed certain equipment leases of its franchise afﬁliates. Under the terms of the guarantee should a franchise afﬁliate be unable to fulﬁll its lease obligation, Sobeys would be required to fund the difference of the lease commitments up to a maximum of $70.0 million reduced from $100.0 million during the second quarter of ﬁscal 2008 on a cumulative basis. Sobeys approves each of the contracts. The aggregate, annual, minimum rent payable under the guaranteed operating equipment leases for ﬁscal 2009 is approximately $18.1 million. The guaranteed lease commitments over the next ﬁve ﬁscal years are: ($ in millions) 2009 2010 2011 2012 2013 Thereafter Guaranteed Lease Commitments $ $ $ $ $ $ 18.1 13.6 12.5 10.1 7.7 1.8 62 E M PI R E COM PANY LI M ITE D MANAG E M E NT’S DISCUSSION AN D ANALYSIS Designation For Eligible Dividends The new dividend regime for the favourable tax treatment of “eligible dividends” has been brought into effect by Bill C-28 which came into effect on February 21, 2007. Passage of this bill has important implications for corporations paying eligible dividends. To be eligible dividends, dividends paid on or after February 21, 2007, must be designated as such as the time of payment. Contingencies Empire has, in accordance with the administrative position of the Canada Revenue Agency, included the appropriate language on its website to designate the dividends paid by Empire as eligible dividends unless otherwise designated. In the ordinary course of business, the Company is subject to ongoing audits by tax authorities. While the Company believes that its tax ﬁling positions are appropriate and supportable, from time to time certain matters are reviewed and challenged by tax authorities. On June 21, 2005, Sobeys received a notice of reassessment from Canada Revenue Agency (“CRA”) for the ﬁscal years 1999 and 2000 related to the Goods and Services Tax (“GST”). CRA asserts that Sobeys was obliged to collect GST on the sales of tobacco products to status Indians. The total tax, interest and penalties in the reassessment were $13.6 million. Sobeys has reviewed this matter, has received legal advice, and believes it was not required to collect GST. During the second quarter of ﬁscal 2006, Sobeys ﬁled a Notice of Objection with CRA. Accordingly, Sobeys has not recorded in its statement of earnings any of the tax, interest or penalties set-out in the notice of reassessment. Sobeys has deposited with CRA funds to cover the total tax, interest and penalties in the reassessment and has recorded this amount as a long-term receivable from CRA pending resolution of the matter. The Company and a subsidiary have been reassessed in respect to the tax treatment of gains realized on the sale of shares in Hannaford Bros. Co. (“Hannaford”) in ﬁscal 2001. In the event that the tax authorities are successful in respect of the Hannaford transaction, which the Company believes is unlikely, the maximum potential exposure in excess of provisions taken is approximately $22.8 million. The Company has appealed the reassessments in respect of the sale of Hannaford shares. The Company expects that it will be substantially successful on its appeals of each of these reassessments. The Company also believes that the ultimate resolution of these matters will not, in any event, have a material impact on earnings because it has made adequate provisions for each of these matters. Should the ultimate outcome materially differ from the provisions established, the effective tax rate and earnings of the Company could be materially affected, negatively or positively, in the period in which the matters are resolved. During the fourth quarter, the Company settled other outstanding disputes with CRA. Payments of $28.4 million were covered by existing provisions resulting in no impact on net earnings. The Company entered into an agreement with Crombie REIT to fund certain property redevelopments and originally issued and recorded a note payable to Crombie REIT in the amount of $39.6 million related thereto. The Company has agreed to pay for all additional costs and expenses required for the redevelopment of those properties. In the event that the redevelopment costs are less than $39.6 million, the savings will be paid to the Company. 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. Risk Management Through its operating companies and its equity-accounted investments, Empire is exposed to a number of risks in the normal course of business that have the potential to affect operating performance. The Company has operating and risk management strategies and insurance programs to help minimize these operating risks. Empire has adopted an annual enterprise risk management assessment which is overseen by the Company’s senior management and reported to the Board and Committees of the Board. The enterprise risk management framework sets out principles and tools for identifying, evaluating, prioritizing and managing risk effectively and consistently across Empire. Sobeys has adopted an annual enterprise risk management assessment which is overseen by the Sobeys’ Leadership Committee and reported to the Board and Committees of the Board. The enterprise risk management framework sets out principles and tools for identifying, evaluating, prioritizing and managing risk effectively and consistently across Sobeys. 2008 AN N UAL R E PORT 63 Competition Financial Empire’s food retailing 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 through regionally managed operations. 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 ﬁve distinct formats, sizes, and banners, to meet anticipated needs of its customers in order to enhance proﬁtability by region and by target market. Empire’s real estate operations, through ECL, 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: (i) acquire a prospective property in compliance with our investment criteria; (ii) lease space in its properties and (iii) maximize rents charged and minimize 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. Continued growth of rental income is dependant on renewing expiring leases and ﬁnding new tenants to ﬁll vacancies at market rental rates, thereby 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 2008, our real estate operations encountered generally positive economic conditions with relatively stable occupancy levels and healthy rental renewal rates. During ﬁscal 2008, capitalization rates remained relatively low which impacted the number of potential properties that generate an attractive return on investment. Genstar faces competition from other residential land developers in securing attractive sites for new residential lot development. Although Genstar does hold land for future development, given the relatively low level of interest rates and continued strong demand for new home construction in many of Genstar’s markets, it faces signiﬁcant competition when looking to acquire new land for future development. Empire and its operating companies have adopted a number of key ﬁnancial policies to manage ﬁnancial risk. Risks can also arise from changes in the rules or standards governing accounting or ﬁnancial reporting. The Company employs numerous professionally accredited accountants throughout its ﬁnance group. In the ordinary course of managing its 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. Interest Rate Risk Interest rate risk is the potential for ﬁnancial loss arising from changes in interest rates. The majority of the Company’s long-term debt is at ﬁxed interest rates or hedged with interest rate swaps. Bank indebtedness and approximately 30 percent of the Company’s long-term debt is exposed to interest rate risk due to ﬂoating rates. Insurance Empire and its subsidiaries are self-insured on a limited basis with respect to certain operational risks and also purchase excess insurance coverage from ﬁnancially stable third-party insurance companies. In addition to maintaining comprehensive loss prevention programs, the Company maintains management programs to mitigate the ﬁnancial impact of operational risks. Human Resources Empire is exposed to the risk of labour disruption in its operating companies. Labour disruptions pose a moderate operational risk, as Sobeys operates an integrated network of more than 22 distribution centres across the country for the food retailing division. Sobeys has good relations with its employees and unions and does not anticipate any material labour disruptions in ﬁscal 2009. However, Sobeys has stated that it will accept the short-term costs of a labour disruption to support a steadfast commitment to 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 to better serve its customers. The ability of the Company to properly develop, train and retain its employees with the appropriate skill set could affect the Company’s future performance. There is always a risk associated with the loss of key personnel. Succession plans have been identiﬁed for key roles including the depth of management talent throughout the Company and its subsidiaries which is reviewed annually by the Human Resources Committee. 64 E M PI R E COM PANY LI M ITE D MANAG E M E NT’S DISCUSSION AN D ANALYSIS Business Continuity The Company is subject to unexpected events and natural hazards which could cause sudden or complete cessation of its day to day operations. One such unexpected and natural hazard is the risk of a pandemic. Sobeys is working with industry and government sources to develop a pandemic preparedness plan. Responsibility for business continuity planning has been designated to the Human Resources Committee of Empire’s Board of Directors. Environmental, Health and Safety The Company is continually enhancing its programs in areas of environmental, health and safety and is in 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. Empire and Sobeys have 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. 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 Sobeys’ 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 the storage and distribution of its 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, including the risk of realization of beneﬁts, 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. The Company’s Board of Directors have 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. Real Estate The Company utilizes a capital allocation process which is focused on obtaining the most attractive real estate locations for its retail grocery stores as well as for its commercial property 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 these 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. The Company mitigates the risk of not being in compliance with the various laws, rules and regulations by monitoring for newly adopted activities, improving technology systems and controls, improving internal controls to detect and prevent errors and overall, application of more scrutiny to ensure compliance. 2008 AN N UAL R E PORT 65 Operations Foreign Currency The success of Empire is closely tied to the performance of Sobeys’ retail stores. Franchise afﬁliates operate approximately 53 percent of Sobeys’ retail stores. Sobeys relies on the franchise afﬁliates and corporate store management 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 store 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. Supply Chain Sobeys is exposed to potential supply chain disruptions that could result in shortages of merchandise in its retail store network. Sobeys mitigates this risk through effective supplier selection and procurement practices along with a reliance on the efﬁcient maintenance and evolution of its supply and logistics chain to sustain and meet growth objectives. Seasonality The Company’s operations as they relate to food, speciﬁcally inventory levels, sales volume and product mix, are impacted to some degree by certain holiday periods in the year. Product Costs Sobeys is a signiﬁcant purchaser of food product which may be at risk of cost inﬂation given rising commodity prices and other costs of production to food manufacturers. Should rising cost of product materialize in excess of expectations and should Sobeys not be able to offset such cost inﬂation through higher retail prices and/or other cost savings, there could be a negative impact on sales and margin performance. Sobeys has various procurement and merchandising programs in place to mitigate this risk. Utility and Fuel Prices The Company is a signiﬁcant consumer of electricity, other utilities and fuel. Unanticipated cost increases in these items could negatively affect the Company’s ﬁnancial performance. The Company has various consumption and procurement programs in place to minimize utility risk. Foreign Operations Empire does not directly carry out foreign operations; however, Sobeys does have certain foreign operations. Sobeys’ foreign operations are limited to a small number of produce brokerage ofﬁces based in the United States. 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. 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 dollar, the Euro, and the U.S. dollar. U.S. dollar purchases of product by the food retailing division represent approximately three percent of Sobeys’ total annual purchases with Euro purchases limited to speciﬁc contracts for capital expenditures. Sobeys has processes in place to use forward contracts with high quality counter-parties to ﬁx the exchange rate on some of its expected requirements for Euros and U.S. dollars. Ethical Business Conduct Any failure of the Company to adhere to its policies, the law or ethical business practices could signiﬁcantly affect its reputation and brands and could therefore negatively impact the Company’s ﬁnancial performance. The Company’s framework for managing ethical business conduct includes the adoption of a Code of Business Conduct and Ethics which directors and employees of the Company are required to acknowledge and agree to on a regular basis and, as part of an independent audit and security function, maintenance of a whistle-blowing hotline. Information Management The integrity, reliability and security of information in all its forms are critical to the Company’s daily and strategic operations. Inaccurate, incomplete or unavailable information and/or inappropriate access to information could lead to incorrect ﬁnancial and/or operational reporting, poor decisions, privacy breaches and/or inappropriate disclosure or leaks of sensitive information. Information management is identiﬁed as a risk in its own right, separate from the technology risk. The Company recognizes that information is a critical enterprise asset. Currently, the information management risk is being managed at the Regional and National levels through the development of policies and procedures pertaining to security access, system development, change management and problem and incident management. With a view to enhancing and standardizing the controls to manage the information management risk, the Company is developing corporate operating policies which establish minimum standards for the usage, security and appropriate destruction of information. Furthermore, enterprise metrics are being identiﬁed to assist in monitoring signiﬁcant information management risks. Capital Allocation The risk associated with capital allocation is high for a holding company, especially due to the amount of capital invested in the operating companies. It is important to ensure the capital allocation decisions result in appropriate return on capital. The Company has a number of strong mitigation strategies in place regarding the allocation of capital, including the board review of capital allocation decisions. The Company has established prudent hurdle rates for capital investments that are evaluated through a strong due diligence process. 66 E M PI R E COM PANY LI M ITE D MANAG E M E NT’S DISCUSSION AN D ANALYSIS Access to Capital Access to capital risk refers to Empire being unable to obtain required capital at reasonable terms, given the prevailing market conditions. There are several factors that impact the level of inherent risk: the state of the capital markets; the level of capital required; the credit rating assigned by the rating agencies and the availability of credit from the banks. Empire mitigates these risks by maintaining strong relationships with its banks and access to the capital markets. 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. Management is clearly focused on directing its energy and capital towards growing the long-term sustainable value of its food retailing, real estate and related businesses. In doing so we remain committed to: a) supporting Sobeys in its goal to be the widely recognized as the best food retailer in Canada; b) the proﬁtable growth of our real estate business as it develops new properties to be vended, preferably, to Crombie REIT; and c) capitalizing on opportunities afforded as a result of the existing strong relationships between our food retailing and our real estate businesses. Finally, we intend to further reduce our consolidated funded debt over the coming year through the prudent management of our working capital and capital outﬂows in each operating company. Food Retailing 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. This includes continuing to build on the transformation process and improving the customers’ in-store experience and our productivity. The challenge as we move throughout ﬁscal 2009 will be to respond effectively to a potential cost of goods inﬂationary environment while competition remains intense. We must manage any increased costs in a way that will continue to provide fair value to the consumer while at the same time not disrupting our earnings position or interrupting our growth potential. Our keen focus on costs and productivity affords us a competitive advantage in this environment and, while we have made progress in line with our expectations, further sales per square foot across our system is achievable and we expect continued improvement in ﬁscal 2009. Sobeys plans to focus on its workforce management and in-store programs in ﬁscal 2009 in order to further improve store productivity. These key customer driven initiatives will assist Sobeys retail store network in delivering the best food shopping experience, building on the strong foundation that has been already been put in place. We will stay the course to earn broader acknowledgement as the very best food retailing business in Canada. Real Estate Division Empire’s real estate management group will continue its policy of maximizing and prudently reinvesting its cash ﬂow to further strengthen its property portfolio. With respect to residential real estate, we remain committed to our investment in Genstar and are very supportive of its management and strategy. We do caution that residential selling activity may well experience a slow down in our ﬁscal 2009, particularly given the recent credit market turbulence and its impact on the housing market generally. With regard to the commercial property development, management looks forward to continuing its strong relationship with Sobeys and to pursuing attractive opportunities to jointly develop locations with Sobeys. Our goal is to accelerate growth in the property pipeline available for sale each year to Crombie REIT which holds the right of ﬁrst refusal on the sale of any Empire property. Our teams will work closely with Sobeys, including newly-acquired Thrifty Foods, to develop properties that expand the growth potential for both food retailing and Crombie REIT. In fact, the distinguishing advantage inherent in Empire’s real estate business today is the combination of strengths brought to the business by Sobeys with its substantial in-house expertise in selecting commercial locations, Crombie REIT with its decades of management expertise, and the development expertise within our real estate division. As a result of our combined real estate knowledge and expertise, we are conﬁdent in our ability to steer our investment capital to locations with the greatest opportunity for economic proﬁt and in doing so will adhere to a set of disciplined investment criteria. In summary, management is conﬁdent that the strength of our relationships with Sobeys and Crombie REIT, combined with our strict investment discipline, will prove to be a sustainable competitive advantage and positively correlate to the enhancement of Empire’s shareholder value. 2008 AN N UAL R E PORT 67 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 other 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 before minority interest, interest expense and income taxes. EBITDA is calculated as EBIT plus depreciation and amortization. Operating earnings is calculated as net earnings before capital gains and other items, net of tax. Funds from operations are calculated as operating earnings plus depreciation and amortization. Interest coverage is calculated as operating income divided by interest expense. Funded debt is all interest bearing debt, which includes bank loans, bankers’ acceptances, long-term debt and liabilities relating to assets held for sale. Total capital is calculated as funded debt plus shareholders’ equity. Same-store sales are sales from stores in the same locations in both reporting periods. The following table reconciles Empire’s funded debt and total capital to GAAP measures reported on the balance sheets as at May 3, 2008, May 5, 2007 and May 6, 2006, respectively: ($ in millions) May 3, 2008 May 5, 2007 May 6, 2006 Bank indebtedness Long-term debt due within one year Liabilities relating to assets held for sale Long-term debt Funded debt Total shareholders’ equity Total capital $ 92.1 60.4 6.4 1,414.6 1,573.5 2,382.3 $ 30.1 82.5 6.8 792.6 912.0 2,131.1 $ 98.6 95.4 7.1 707.3 908.4 1,965.2 $ 3,955.8 $ 3,043.1 $ 2,873.6 Additional ﬁnancial information relating to Empire, including the Company’s Annual Information Form, can be found on the Company’s website or on the SEDAR website for Canadian regulatory ﬁlings at www.sedar.com. Dated: June 26, 2008 Stellarton, Nova Scotia, Canada 68 E M PI R E COM PANY LI M ITE D MANAG E M E NT’S DISCUSSION AN D ANALYSIS 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 prepared 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. Management of the Company has established and maintains a system of internal control that provides reasonable assurance as to the integrity of the consolidated ﬁnancial statements, the safeguarding of Company assets, and the prevention and detection of fraudulent ﬁnancial reporting. 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 26, 2008 Paul V. Beesley Executive Vice President and Chief Financial Ofﬁcer June 26, 2008 AUDITORS’ REPORT To the shareholders of Empire Company Limited We have audited the consolidated balance sheets of Empire Company Limited as at May 3, 2008 and May 5, 2007, and the consolidated statements of earnings, comprehensive income, retained earnings, accumulated other comprehensive loss and cash ﬂows for the 52 week ﬁscal years then ended. 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 3, 2008 and May 5, 2007, and the results of its operations and its cash ﬂows for the ﬁscal years then ended in accordance with Canadian generally accepted accounting principles. Chartered Accountants New Glasgow, Canada June 16, 2008 2008 AN N UAL R E PORT 69 CONSOLIDATED FINANCIAL STATEMENTS Consolidated Balance Sheets (in millions) Assets Current Cash and cash equivalents Receivables Mortgages, loans and other receivables (Note 6) Income taxes receivable Inventories Prepaid expenses Investments (realizable value $1.6; 2007 – $283.1) Investments, at equity (realizable value $429.6; 2007 – $434.0) (Note 5) Mortgages, loans and other receivables (Note 6) Other assets (Note 7) Property and equipment (Note 8) Assets held for sale (Note 9) Intangibles (less accumulated amortization of $21.3; 2007 $11.7) (Note 10) Goodwill Liabilities Current Bank indebtedness (Note 11) Accounts payable and accrued liabilities Income taxes payable Future income taxes (Note 17) Long-term debt due within one year (Note 12) Liabilities relating to assets held for sale (Note 9) Long-term debt (Note 12) Employee future beneﬁts obligation (Note 24) Future income taxes (Note 17) Other long-term liabilities (Note 13) Minority interest Shareholders’ Equity Capital stock (Note 14) Contributed surplus Retained earnings Accumulated other comprehensive loss Commitments and contingent liabilities (Note 22) Approved on behalf of the Board Director Director See accompanying notes to the consolidated ﬁnancial statements 70 E M PI R E COM PANY LI M ITE D CONSOLI DATE D FI NANCIAL STATE M E NTS May 3, 2008 May 5, 2007 Restated (Note 1) $ 191.4 316.3 18.7 – 820.2 62.0 1,408.6 1.6 41.4 56.3 175.5 2,457.3 60.3 346.8 1,159.1 $ 294.9 312.3 14.5 3.6 757.5 51.4 1,434.2 189.7 142.8 65.1 151.7 2,409.1 24.1 38.2 786.6 $ 5,706.9 $ 5,241.5 $ 92.1 1,322.4 15.5 32.9 60.4 6.4 1,529.7 1,414.6 110.7 125.5 106.5 37.6 3,324.6 195.7 0.5 2,207.6 (21.5) 2,382.3 $ 30.1 1,260.3 – 40.4 82.5 6.8 1,420.1 792.6 102.1 130.4 76.6 588.6 3,110.4 196.1 0.3 1,935.3 (0.6) 2,131.1 $ 5,706.9 $ 5,241.5 Consolidated Statements of Retained Earnings 52 Weeks Ended (in millions) Balance, beginning of year as previously reported Adjustment due to change in accounting policy (Note 1) Balance, beginning of year as restated Net earnings Dividends Preferred shares Common shares Premium on common shares purchased for cancellation (Note 14) May 3, 2008 May 5, 2007 Restated (Note 1) $ 1,939.6 $ (4.3) 1,935.3 315.8 (0.3) (43.2) – 1,771.0 – 1,771.0 205.8 (0.4) (39.5) (1.6) Balance, end of year $ 2,207.6 $ 1,935.3 See accompanying notes to the consolidated ﬁnancial statements Consolidated Statements of Accumulated Other Comprehensive Loss 52 Weeks Ended (in millions) Balance, beginning of year Transition adjustment as of May 6, 2007 (Note 1) Adjusted balance, beginning of year Acquired comprehensive loss from purchase of minority interest in Sobeys Inc. Other comprehensive (loss) income for the year Balance, end of year See accompanying notes to the consolidated ﬁnancial statements May 3, 2008 May 5, 2007 $ $ (0.6) 77.2 76.6 (0.6) (97.5) $ (21.5) $ (1.1) – (1.1) – 0.5 (0.6) 2008 AN N UAL R E PORT 71 Consolidated Statements of Earnings 52 Weeks Ended (in millions except per share amounts) Revenue Operating expenses Cost of sales, selling and administrative expenses Depreciation and amortization Investment income (Note 15) Operating income Interest expense Long-term debt Short-term debt Capital gains and other items (Note 16) Earnings before income taxes and minority interest Income taxes (Note 17) Current Future Earnings before minority interest Minority interest Net earnings Earnings per share (Note 4) Basic Diluted Weighted average number of common shares outstanding, in millions Basic Diluted See accompanying notes to the consolidated ﬁnancial statements May 3, 2008 May 5, 2007 Restated (Note 1) $ 14,065.0 $ 13,366.7 13,322.3 304.6 12,707.9 269.2 438.1 34.5 472.6 100.6 5.2 105.8 366.8 87.7 454.5 120.8 5.1 125.9 328.6 12.8 315.8 4.80 4.80 65.6 65.7 389.6 41.5 431.1 54.1 6.0 60.1 371.0 7.1 378.1 104.8 12.1 116.9 261.2 55.4 205.8 3.14 3.13 65.6 65.7 $ $ $ $ $ $ 72 E M PI R E COM PANY LI M ITE D CONSOLI DATE D FI NANCIAL STATE M E NTS Consolidated Statements of Comprehensive Income 52 Weeks Ended (in millions) Net earnings Other comprehensive income, net of income taxes Reclassiﬁcation of gains on available-for-sale ﬁnancial assets to earnings Unrealized losses on derivatives designated as cash ﬂow hedges Reclassiﬁcation of loss on derivative instruments designated as cash ﬂow hedges to earnings Share of comprehensive loss of entities accounted using the equity method Foreign currency translation adjustment May 3, 2008 May 5, 2007 Restated (Note 1) $ 315.8 $ 205.8 (78.7) (14.0) (0.6) (4.6) 0.4 (97.5) – – – – 0.5 0.5 Comprehensive income $ 218.3 $ 206.3 See accompanying notes to the consolidated ﬁnancial statements 2008 AN N UAL R E PORT 73 Consolidated Statements of Cash Flows 52 Weeks Ended (in millions) Operating Activities Net earnings Items not affecting cash (Note 18) 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. (Note 2) Proceeds from sale of property to Crombie REIT (Note 3) Purchase of property and equipment Proceeds on disposal of property and equipment Mortgages, loans and other receivables Increase in other assets Business acquisitions, net of cash acquired of $10.2 (Note 25) Cash ﬂows used in investing activities Financing Activities Increase (decrease) in bank indebtedness (Decrease) increase in construction loans Issue of long-term debt Repayment of long-term debt Minority interest Repurchase of preferred shares Issue of Non-Voting Class A shares Repurchase of Non-Voting Class A shares Common dividends Cash ﬂows from (used in) ﬁnancing activities 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 3, 2008 May 5, 2007 Restated (Note 1) $ 315.8 354.1 (0.3) 669.6 (26.1) 643.5 138.3 (1,065.7) 373.5 (549.4) 52.2 4.6 (57.8) (263.2) (1,367.5) 62.0 (1.1) 1,099.8 (507.5) 11.1 (1.0) 0.4 – (43.2) 620.5 (103.5) 294.9 $ 205.8 382.6 (0.4) 588.0 (149.2) 438.8 185.4 (48.6) – (508.9) 68.9 5.1 (30.8) (95.9) (424.8) (68.5) 1.2 159.6 (103.0) (8.3) (0.8) 1.0 (1.9) (39.5) (60.2) (46.2) 341.1 $ 191.4 $ 294.9 74 E M PI R E COM PANY LI M ITE D CONSOLI DATE D FI NANCIAL STATE M E NTS NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS MAY 3, 2008 (In millions except share capital) Note 1 Summary of Signiﬁcant Accounting Policies Basis of consolidation Empire Company Limited (the “Company”) is a diversiﬁed Canadian company whose key businesses include food retailing, real estate and corporate investment activities. These consolidated ﬁnancial statements have been prepared in accordance with Canadian generally accepted accounting principles (“GAAP”), and include the accounts of the Company, all subsidiary companies, including 100% owned Sobeys Inc. (“Sobeys”), and certain enterprises considered variable interest entities (“VIEs”) where control is achieved on a basis other than through ownership of a majority of voting rights. 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. The Company’s ﬁscal year ends on the ﬁrst Saturday in May. As a result of this, the ﬁscal year is usually 52 weeks but results in a duration of 53 weeks every ﬁve to six years. Changes in accounting policies Adopted during ﬁscal 2008 Accounting changes In July 2006, the Canadian Institute of Chartered Accountants (“CICA”) issued section 1506 of the CICA Handbook, “Accounting Changes”, which describes the criteria for changing accounting policies, along with the accounting and disclosure for changes in accounting policies, changes in accounting estimates and correction of errors. These changes came into effect for ﬁscal periods beginning on or after January 1, 2007 and were applicable as of the Company’s ﬁrst quarter of ﬁscal 2008. Financial instruments On May 6, 2007, the Company implemented the CICA Handbook Sections 3855, “Financial Instruments – Recognition and Measurement”, 3865, “Hedges”, 1530, “Comprehensive Income”, 3251, “Equity”, and 3861, “Financial Instruments – Disclosure and Presentation”. These standards have been applied without restatement of prior periods. The transitional adjustments resulting from these standards were recognized in the opening balances of retained earnings and accumulated other comprehensive income. Financial instruments, recognition and measurement Section 3855 requires the Company to initially recognize all of its ﬁnancial assets and liabilities, including derivatives and embedded derivatives in certain contracts, at fair value adjusted on transition as appropriate, and measured subsequently in accordance with the classiﬁcation chosen. Non-ﬁnancial derivatives must be recorded at fair value on the consolidated balance sheet unless they are exempt from derivative treatment based upon expected purchase, sale or usage requirements. This standard also requires the Company to classify ﬁnancial assets and liabilities according to their characteristics and management’s choices and intentions related thereto for the purpose of ongoing measurements. Classiﬁcation choices for ﬁnancial assets include: a) held for trading – measured at fair value with changes in fair value recorded in net earnings; b) held to maturity – recorded at amortized cost with gains and losses recognized in net earnings in the period that the asset is derecognized or impaired; c) available-for-sale measured at fair value with changes in fair value recognized in other comprehensive income for the current period until realized through disposal or impairment; and d) loans and receivables – recorded at amortized cost with gains and losses recognized in net earnings in the period that the asset is no longer recognized or impaired. Classiﬁcation choices for ﬁnancial liabilities include: a) held for trading – measured at fair value with changes in fair value recorded in net earnings and b) other – measured at amortized cost with gains and losses recognized in net earnings in the period that the liability is no longer recognized. Subsequent measurement for these assets and liabilities are based on either fair value or amortized cost using the effective interest method, depending upon their classiﬁcation. Any ﬁnancial asset or liability can be classiﬁed as held for trading as long as its fair value is reliably determinable. In accordance with the new standard, the Company’s ﬁnancial assets and liabilities are generally classiﬁed and measured as follows: Asset/Liability Cash Cash equivalents Receivables Mortgages, loans and other receivables Investments Derivative other assets and liabilities Non-derivative other assets and liabilties Bank indebtedness Accounts payable and accrued liabilities Long-term debt Classification Held for trading Held for trading Loans and receivables Loans and receivables Available-for-sale Held for trading Held to maturity Other liabilities Other liabilities Other liabilities Measurement Fair value Fair value Amortized cost Amortized cost Fair value Fair value Amortized cost Amortized cost Amortized cost Amortized cost 2008 AN N UAL R E PORT 75 Other balance sheet accounts, including, but not limited to, inventories, prepaid expenses, investments (at equity), property and equipment, assets held for sale, intangibles, goodwill, current and long-term future income taxes, employee future beneﬁts obligation and minority interest are not within the scope of the new accounting standards as they are not ﬁnancial instruments. Transaction costs, other than those related to ﬁnancial instruments classiﬁed as held for trading which are expensed as incurred, are added to the fair value of the ﬁnancial asset or ﬁnancial liability on initial recognition and amortized using the effective interest method. Embedded derivatives are required to be separated and measured at fair values if certain criteria are met. Under an election permitted by the new standard, management reviewed contracts entered into or modiﬁed subsequent to May 3, 2003 and determined that the Company does not currently have any signiﬁcant embedded derivatives in its contracts that require separate accounting treatment. Section 3855 also requires that obligations undertaken through issuance of a guarantee that meets the deﬁnition of a guarantee pursuant to Accounting Guideline 14, “Disclosure of Guarantees”, be recognized at fair value at inception. No subsequent re-measurement at fair value is required unless the ﬁnancial guarantee qualiﬁes as a derivative. Management reviewed and determined that identiﬁed guarantees were immaterial. The fair value of a ﬁnancial instrument is the amount of the consideration that would be agreed upon in an arm’s length transaction between knowledgeable, willing parties who are under no compulsion to act. To estimate the fair value of each type of ﬁnancial instrument various market value data and other valuation techniques were used as appropriate. The fair value of cash approximated its carrying value. The fair value of currency swaps was estimated based on discounting of the forward rate at the reporting date compared to the forward rate in the contract. The fair value of interest rate swaps was estimated by discounting net cash ﬂows of the swaps using forward interest rates for swaps of the same remaining maturities. The fair value of energy contracts was estimated based on changes in forward commodity rates. Hedges Section 3865, “Hedges”, replaces Accounting Guideline 13, “Hedging Relationships”. The requirements for identiﬁcation, designation, documentation and assessment of effectiveness of hedging relationships remain substantially unchanged. Section 3865 addresses the accounting treatment of qualifying hedging relationships and the necessary disclosures and also requires all derivatives in hedging relationships to be recorded at fair value. The Company has cash ﬂow hedges which are used to manage exposure to ﬂuctuations in foreign currency exchange rates, variable interest rates and energy prices. For cash ﬂow hedges, the effective portion of the change in fair value of the hedging item is recorded in other comprehensive income. To the extent the change in fair value of the derivative is not completely offset by the change in fair value of the hedged item, the ineffective portion of the hedging relationship is recorded immediately in net earnings. Amounts accumulated in other comprehensive income are reclassiﬁed to net earnings when the hedged item is recognized in net earnings. When a hedging instrument in a cash ﬂow hedge expires or is sold, or when a hedge no longer meets the criteria for hedge accounting, any cumulative gain or loss in accumulated other comprehensive income relating to the hedge is carried forward until the hedged item is recognized in net earnings. When the hedged item ceases to exist as a result of its expiry or sale, or if an anticipated transaction is no longer expected to occur, the cumulative gain or loss in accumulated other comprehensive income is immediately reclassiﬁed to net earnings. Signiﬁcant derivatives include the following: (1) Foreign currency forward contracts for the primary purpose of limiting exposure to exchange rate ﬂuctuations relating to expenditures denominated in foreign currencies. These contracts are designated as hedging instruments for accounting purposes. Accordingly, the effective portion of the change in the fair value of the forward contracts are accumulated in other comprehensive income until the variability in cash ﬂows being hedged is recognized in earnings in future accounting periods. (2) Electricity contracts to manage the cost of electricity designated as cash ﬂow hedges of anticipated transactions. The portion of gain or loss on derivative instruments designated as cash ﬂow hedges that are deferred in accumulated other comprehensive income is reclassiﬁed into other income/expense when the product containing the hedged item impacts earnings. Hedge ineffectiveness was immaterial for the current ﬁscal year. (3) Interest rate swaps designated as cash ﬂow hedges to manage variable interest rates associated with some of the Company’s debt portfolio. Hedge accounting treatment results in interest expense on the related debt being reﬂected at hedged rates rather than variable interest rates. Comprehensive income In accordance with Section 1530 , “Comprehensive Income”, the Company has reported a new ﬁnancial statement entitled “Consolidated Statements of Comprehensive Income”, which is comprised of net earnings and other comprehensive income. Other comprehensive income represents the change in shareholders’ equity from transactions and other events from non-owner sources and includes unrealized gains and losses on ﬁnancial assets that are classiﬁed as available-for-sale, and changes in the fair value of the effective portion of cash ﬂow hedging instruments. The accumulated other comprehensive income (i.e. the portion of comprehensive income not already included in net earnings) is being presented as a separate line in shareholders’ equity. In accordance with the new standard, $0.6 relating to unrealized losses resulting from the translation of self-sustaining foreign operations which had previously been classiﬁed as cumulative translation adjustment within shareholders’ equity is now presented within accumulated other comprehensive income. 76 E M PI R E COM PANY LI M ITE D NOTES TO TH E CONSOLI DATE D FI NANCIAL STATE M E NTS Equity Section 3251, “Equity”, which replaced Section 3250, “Surplus”, establishes standards for the presentation of equity and changes in equity during the reporting period and requires the Company to present separately equity components and changes in equity arising from: i) net earnings; ii) other comprehensive income; iii) other changes in retained earnings; iv) changes in contributed surplus; v) changes in share capital; and vi) changes in reserves. Financial instruments – disclosure and presentation Section 3861, “Financial Instruments – Disclosure and Presentation”, which replaces 3860, of the same title, establishes standards for the presentation of ﬁnancial instruments and non-ﬁnancial derivatives, and identiﬁes the information that should be disclosed about them. The following table summarizes the transition adjustments recorded upon implementation: Transition Adjustments Consolidated Balance Sheet Investments Other assets Other liabilities Long-term debt Future income taxes Minority interest Accumulated other comprehensive income $ 94.4 (4.5) 2.5 2.7 (18.5) 0.6 (77.2) Deferred charges The Company adopted CICA Section 3855 effective as of the ﬁrst quarter of ﬁscal 2008. Concurrent with the issuance of this section, Section 3070, “Deferred Charges”, was withdrawn. As a result, the Company reviewed its deferred costs classiﬁcations included with other assets and determined the following changes were necessary: Deferred store marketing – Deferred store marketing costs, primarily comprised of store renovation and expansion costs, were reclassiﬁed and included with equipment, ﬁxtures and vehicles as part of the Company’s property and equipment balance sheet group. Prior year balances were reclassiﬁed which resulted in an increase in property and equipment and a decrease in other assets of $106.2 at May 5, 2007 as well as an increase in depreciation expense and decrease in cost of sales, selling and administrative expenses of $25.3 for the year ended May 5, 2007. There is no impact on net earnings or earnings per share as a result of this change. Deferred repositioning costs – Effective for the ﬁrst quarter of ﬁscal 2008, the Company changed its accounting policy for the treatment of certain deferred costs associated with major repositioning or branding efforts of the Company. Due to the withdrawal of the primary source of GAAP, Section 3070, “Deferred Charges”, the Company looked to other sources of existing and proposed GAAP for guidance in determining its future policy for such costs. Based on this review, the Company determined, in setting the new policy, that it would be more appropriate to expense these types of costs in the period incurred as it provides more relevant information on expenditures associated with repositioning and branding efforts. This change in accounting policy was applied retrospectively resulting in a $9.1 decrease in other assets, a $3.2 decrease in long-term future tax liabilities, and a $4.3 decrease in earnings (net of minority interest of $1.6) at May 5, 2007. The effect for the year ended May 5, 2007 is a $9.1 increase in cost of sales, selling and administrative expenses, a $3.2 decrease in income taxes and a $0.06 decrease in basic and diluted earnings per share. The effect for the year ended May 3, 2008 was a $3.6 decrease in cost of sales, selling and administrative expenses, a $1.2 increase in income taxes and an increase in basic and diluted earnings of $0.04 per share. Adopted during ﬁscal 2007 Vendor consideration During the ﬁrst quarter of ﬁscal 2007, the Company implemented, on a retroactive basis, Emerging Issues Committee Abstract 156 (“EIC-156”), “Accounting by a Vendor for Consideration Given to a Customer (including a Reseller of the Vendor’s Products)”. This abstract requires a vendor to generally record cash consideration given to a customer as a reduction to the selling price of the vendor’s products or services and reﬂect it as a reduction of revenue when recognized in the statement of earnings. Prior to the implementation of EIC-156, the Company recorded certain sales incentives paid to independent franchisees, associates and independent accounts in cost of sales, selling and administrative expenses on the statement of earnings. Accordingly, the implementation of EIC-156 on a retroactive basis resulted in a reduction in both sales and cost of sales, selling and administrative expenses. As reclassiﬁcations, these changes did not impact net earnings or earnings per share. Future changes in accounting policies Inventories In June 2007, the CICA issued Section 3031, “Inventories”, which has replaced existing Section 3030 with the same title. The new Section establishes that inventories should be measured at the lower of cost and net realizable value, with guidance on the determination of cost. This standard is effective for interim and annual ﬁnancial statements relating to ﬁscal years beginning on or after January 1, 2008 and is applicable for the Company’s ﬁrst quarter of ﬁscal 2009. The Company has evaluated the impact of this new standard and does not expect the adoption of this standard to have a signiﬁcant impact on its ﬁnancial statement disclosures and statement of earnings. 2008 AN N UAL R E PORT 77 Capital disclosures Cash and cash equivalents In October 2006, the CICA issued Section 1535, “Capital Disclosures”. This section establishes standards for disclosing information about an entity’s capital and how it is managed. The standard is effective for interim and annual ﬁnancial statements relating to ﬁscal years beginning on or after October 1, 2007 and is applicable for the Company’s ﬁrst quarter of ﬁscal 2009. The Company does not expect that the adoption of this standard will have a signiﬁcant impact on its ﬁnancial statement disclosures. Financial instruments – disclosure and ﬁnancial instruments – presentation Section 3862, “Financial Instruments – Disclosure” and Section 3863, “Financial Instruments – Presentation”, replace Section 3861, “Financial Instruments – Disclosure and Presentation”. Section 3862 requires increased disclosures regarding the risks associated with ﬁnancial instruments such as credit risk, liquidity risk and market risks and the techniques used to identify, monitor and manage these risks. Section 3863 carries forward standards for presentation of ﬁnancial instruments and non- ﬁnancial derivatives and provides additional guidance for the classiﬁcation of ﬁnancial instruments between liabilities and equity. These standards are effective for interim and annual ﬁnancial statements relating to ﬁscal years beginning on or after October 1, 2007 and are applicable for the Company’s ﬁrst quarter of ﬁscal 2009. The Company does not expect the adoption of these standards to have a signiﬁcant impact on its ﬁnancial disclosures and results of operations. Goodwill and intangible assets In February 2008, the CICA issued Section 3064, “Goodwill and Intangible Assets”, which replaced existing Section 3062, “Goodwill and Other Intangible Assets” and Section 3450, “Research and Development”. The new standard provides guidance on the recognition, measurement, presentation and disclosure of goodwill and intangible assets. This standard is effective for interim and annual ﬁnancial statements relating to ﬁscal years beginning on or after October 1, 2008 and is applicable for the Company’s ﬁrst quarter of ﬁscal 2010. The Company is currently evaluating the impact of this new standard. International ﬁnancial reporting standards In January 2006, the Canadian Accounting Standards Board announced its decision requiring all publicly accountable entities to report under International Financial Reporting Standards. This decision establishes standards for ﬁnancial reporting with increased clarity and consistency in the global marketplace. These standards are effective for interim and annual ﬁnancial statements relating to ﬁscal years beginning on or after January 1, 2011 and are applicable for the Company’s ﬁrst quarter of ﬁscal 2012. The Company is currently evaluating the impact of these new standards. Cash and cash equivalents are deﬁned as cash, treasury bills and guaranteed investments with a maturity less than 90 days at date of acquisition. Inventories Warehouse inventories are valued at the lower of cost and net realizable value with cost being determined on a ﬁrst-in, ﬁrst-out or a moving average cost basis. Retail inventories are valued at the lower of cost and net realizable value. Cost is determined using moving average cost 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. Property and equipment Property and equipment is recorded at net book value, being original cost less accumulated depreciation and any writedowns for impairment. 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, ﬁxtures and vehicles Buildings Leasehold 3 – 20 years 10 – 40 years improvements Lesser of lease term and 7 – 10 years Property and equipment is reviewed for impairment whenever events or changes in circumstances indicate that the carrying value of property and equipment may not be recoverable. The assets are impaired when the carrying value exceeds the sum of the undiscounted future cash ﬂows expected from use and eventual disposal. If property and equipment is determined to be impaired, the impairment loss is measured at the excess of the carrying value over fair value. Assets to be disposed are classiﬁed as held for sale and are no longer depreciated. Assets held for sale are recognized at the lower of book value and fair value less cost of disposal. The Company follows the full cost method of accounting for its exploration and development of petroleum and natural gas reserves. Costs initially capitalized are depleted and depreciated using the unit-of-production method based on production volumes, before royalties, in relation to the Company’s share of estimated proved petroleum and natural gas reserves. 78 E M PI R E COM PANY LI M ITE D NOTES TO TH E CONSOLI DATE D FI NANCIAL STATE M E NTS 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 $1.5 (2007 – $1.5). (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 2007 or 2008. (c) Development properties and land held for future development A subsidiary company capitalizes interest, real estate taxes and other expenses to the extent that they relate to properties for immediate development. To the extent that the resulting carrying value exceeds its fair market value, the excess is charged against income. The carrying costs on the balance of properties held for future development are capitalized as incurred. An amount of $0.8 (2007 – $0.7) was capitalized during the year. Leases Leases meeting certain criteria are accounted for as capital leases. The imputed interest is charged against income. If the lease contains a term that allows ownership to pass to the Company, or there is a bargain purchase option, the capitalized value is depreciated over the estimated useful life of the related asset. Otherwise, the capitalized value is depreciated on a straight-line basis over the lesser of the lease term and its estimated useful life. Capital lease obligations are included in the long-term debt of the Company and are reduced by rental payments net of imputed interest. All other leases are accounted for as operating leases. Lease allowances and incentives received are recorded as other long-term liabilities and amortized as a reduction of lease expense over the term of the lease. Real estate lease expense is amortized straight-line over the entire term of the lease including free rent 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. 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 not amortized but rather are subject to an annual impairment review or more frequently if circumstances exist that might indicate their value is impaired. Should the carrying value exceed the fair value of goodwill or intangible assets (e.g. trademarks) the carrying value will be written down to the fair value. Intangibles Intangibles arise on the purchase of a new business, existing franchises, and the acquisition of pharmacy prescription ﬁles. Amortization is recorded on limited life intangibles on a straight-line basis, over the estimated useful life of the intangible as follows: Franchise rights/agreements Brand names Patient ﬁles Other 10 – 20 years 10 – 15 years 10 years 5 – 23 years Assets held for sale Certain land and buildings have been listed for sale and reclassiﬁed as “Assets held for sale” in accordance with CICA Handbook Section 3475, “Disposal of Long-lived Assets and Discontinued Operations”. These assets are expected to be sold within a twelve month period. Assets held for sale are valued at the lower of book value and fair value less cost of disposal. Liabilities assumed upon sale of assets or debts to be repaid as part of a sale transaction are also classiﬁed as “Liabilities relating to assets held for sale”. Store opening expenses Opening expenses of new stores and store conversions are written off on a straight-line basis during the ﬁrst year of operation. Future income taxes 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 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, rental revenue arising from the sale of subsidiaries and gains on sale leaseback transactions. Deferred revenue is being taken into income on a straight-line basis over the term of the related agreements and included in other long-term liabilities. 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 in accumulated other comprehensive income. Other assets and liabilities denominated in foreign currencies are translated into Canadian dollars at the foreign currency exchange rate in effect at each period end date. Exchange gains or losses arising from the translation of these balances denominated in foreign currencies are recognized in operating income. Revenues and expenses denominated in foreign currencies are translated into Canadian dollars at the average exchange rate for the period. 2008 AN N UAL R E PORT 79 Revenue recognition Vendor allowances Food sales are recognized at the point-of-sale. Sales include revenues from customers through corporate stores operated by the Company and consolidated VIEs, and revenue from sales to non-VIE franchised stores, afﬁliated stores and independent accounts. Revenue received from non-VIE franchised stores, afﬁliated 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 retail sales. Real estate revenue is recognized in accordance with the lease agreements with tenants on a straight-line basis. Pension beneﬁt plans and other beneﬁt plans The cost of the Company’s pension beneﬁts for deﬁned contribution plans are expensed at the time active employees are compensated. 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 plan amendments and increases in the obligation related to past service is amortized on a straight-line basis over the expected average remaining service life (“EARSL”) of active members, except for the Company’s Supplemental Executive Retirement Plan for which the impact is amortized over no more than 5 years. The actuarial gains and losses and the impact of changes in the actuarial basis in excess of 10 percent 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. 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. The Company recognizes these allowances as a reduction of cost of sales, selling and administrative expenses and related inventories in accordance with EIC-144 “Accounting by a Customer (including a Reseller) for Certain Consideration Received from a Vendor”. Certain allowances from vendors are contingent on the Company achieving minimum purchase levels. These allowances are recognized when it is probable that the minimum purchase level will be met and the amount of allowance can be estimated. As of the year ended May 3, 2008, the Company has recognized $5.1 (2007–$2.4) of allowances in income where it is probable that the minimum purchase level will be met and the amount of allowance can be estimated. 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. Certain of these estimates require subjective or complex judgements by management that may be uncertain. Some of these items include the valuation of inventories, goodwill, employee future beneﬁts, valuation of asset-backed commercial paper and income taxes. Changes to these estimates could materially impact the ﬁnancial statements. These estimates are based on management’s knowledge of current events and actions that the Company may undertake in the future. Actual results could differ from these estimates. 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 determined based on the treasury stock method which assumes that all outstanding stock options with an exercise price below the average market price are exercised and the assumed proceeds are used to purchase the Company’s common shares at the average market price during the year. 80 E M PI R E COM PANY LI M ITE D NOTES TO TH E CONSOLI DATE D FI NANCIAL STATE M E NTS Note 2 Privatization of Sobeys Inc. On April 26, 2007, the Company and Sobeys jointly announced that they had entered into an arrangement agreement (the “Arrangement”) pursuant to which the Company would acquire all of the outstanding common shares of Sobeys that it did not then own at a price of $58.00 per share. The Arrangement required various approvals to comply with applicable corporate and securities laws. The Sobeys shareholders approved the Arrangement at a special shareholders’ meeting held on June 9, 2007 by the requisite majority; the Supreme Court of Nova Scotia gave its sanction to the Arrangement on June 13, 2007; the Arrangement became effective upon registration of the ﬁnal Court order with the Nova Scotia Registry of Joint Stock Companies at the close of business on June 15, 2007, at which time the Company acquired all the outstanding shares of Sobeys that it did not previously own. Subsequently, the Sobeys common shares ceased trading on the Toronto Stock Exchange, and were delisted at the close of business on June 18, 2007. The acquisition was accounted for using the purchase method with operating results being included in the consolidated ﬁnancial statements since the acquisition date. Management carried out a detailed analysis and changes were made to the preliminary allocation of the excess consideration paid over net assets acquired as disclosed in previous quarters of ﬁscal 2008. The measurement and allocation of tangible assets, ﬁnite and inﬁnite intangible assets, and goodwill was completed during the fourth quarter of ﬁscal 2008. The ﬁnal purchase price allocation, incorporating management’s assessment of fair value, is as follows: Consideration Cash Acquisition costs Total consideration paid Carrying amount of net assets acquired Excess consideration paid over net assets acquired Allocation of excess consideration paid over net assets acquired Property and equipment Accrued beneﬁt asset Employee future beneﬁts obligation Amortizable intangible assets Indeﬁnite-life intangible assets Goodwill Future income taxes Accumulated other comprehensive loss $ 1,061.7 4.0 1,065.7 576.5 $ 489.2 $ 81.7 (13.1) (3.8) 49.9 243.7 165.2 (35.0) 0.6 $ 489.2 The acquisition was ﬁnanced by funds of $278.0, received primarily from sale of certain portfolio investments, and by advances of $787.7 under new credit facilities (see Note 12). 2008 AN N UAL R E PORT 81 Note 3 Sale of Property to Crombie REIT On April 22, 2008, the Company’s real estate segment sold 61 commercial properties to Crombie Real Estate Investment Trust (“Crombie REIT”). Included in the proceeds were additional Class B Units of Crombie REIT (which are convertible on a one for one basis into Units of Crombie REIT). The investment in Class B Units will maintain the Company’s interest in Crombie REIT at 47.8%. The Company’s investment in Crombie REIT is accounted using the equity method. Under Canadian GAAP, the gain on sale was not included in net earnings; rather the gain (net of income taxes) reduced the carrying value of the Company’s equity investment in Crombie REIT. Details of the sale are as follows: Proceeds Cash Investment in Crombie REIT Book value of property and equipment sold Early extinguishment of long-term debt Transaction costs Other costs Gain before income taxes and deferral Income taxes Current Future Gain before deferral Deferral of gain Net gain $ 373.5 55.0 428.5 238.9 18.5 6.5 12.5 276.4 152.1 27.0 (19.2) 7.8 144.3 (144.3) $ Nil As part of the transaction, Sobeys entered into new lease agreements (the “Sobeys Leases”) with respect to their occupancy in a portion of the 61 commercial properties. The Sobeys Leases have terms of between 17 and 23 years (except for 3 leases which have an outside date of 12 years) (the “Outside Date”). Each Sobeys Lease is based on an initial term of two years and thereafter alternating between successive periods of three years and two years until the applicable Outside Date. The Outside Date may be extended at Sobeys’ option by up to four consecutive further periods of ﬁve years each. The minimum rents under the Sobeys Leases will range from $8 per square foot to $14 per square foot with rental increases every ﬁve years. Note 4 Earnings Per Share Earnings applicable to common shares is comprised of the following: Operating earnings Capital gains and other items, net of income taxes of $14.7 (2007 – $1.4) $ Net earnings Preferred share dividends 2008 2007 Restated (Note 1) $ 242.8 73.0 315.8 (0.3) 200.1 5.7 205.8 (0.4) Earnings applicable to common shares $ 315.5 $ 205.4 82 E M PI R E COM PANY LI M ITE D NOTES TO TH E CONSOLI DATE D FI NANCIAL STATE M E NTS Earnings per share is comprised of the following: Operating earnings Capital gains and other items Basic earnings per share Operating earnings Capital gains and other items Diluted earnings per share Note 5 Investments, at Equity Wajax Income Fund (27.6% interest) Crombie REIT (47.8% interest) U.S. residential real estate partnerships The Company’s carrying value of its investment in Wajax Income Fund is as follows: Balance, beginning of year Equity earnings Share of comprehensive loss Distributions received Balance, end of year The Company’s carrying value of its investment in Crombie REIT is as follows: Balance, beginning of year Equity earnings Share of comprehensive loss Distributions received Interest received in Crombie REIT Deferral of gains on sale of property Balance, end of year $ $ $ $ $ $ $ $ $ 2008 2007 Restated (Note 1) 3.69 1.11 4.80 3.69 1.11 4.80 $ $ $ $ 3.05 0.09 3.14 3.04 0.09 3.13 May 3, 2008 May 5, 2007 31.6 9.5 0.3 41.4 $ $ 32.2 109.3 1.3 142.8 May 3, 2008 May 5, 2007 $ 32.2 19.7 (0.2) (20.1) 31.6 $ 33.1 20.6 – (21.5) 32.2 May 3, 2008 May 5, 2007 $ 109.3 13.6 (6.8) (17.0) 55.0 (144.6) 112.8 11.6 – (15.1) – – $ 9.5 $ 109.3 2008 AN N UAL R E PORT 83 Note 6 Mortgages, Loans and Other Receivables Loans receivable Mortgages receivable Other Less amount due within one year May 3, 2008 May 5, 2007 $ $ 58.1 0.6 16.3 75.0 18.7 56.3 $ $ 62.7 0.6 16.3 79.6 14.5 65.1 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. Note 7 Other Assets Deferred ﬁnancing costs Deferred purchase agreements Accrued beneﬁt asset (Note 24) Asset-backed commercial paper Restricted cash Derivative assets Other May 3, 2008 May 5, 2007 $ $ 0.6 35.9 58.2 22.5 3.9 2.3 52.1 7.0 31.1 68.4 – 5.7 – 39.5 $ 175.5 $ 151.7 Asset-backed commercial paper As of May 3, 2008, the Company held third-party asset-backed commercial paper (“ABCP”) with an original cost of $30.0 that was in default. The ABCP was rated by the Dominion Bond Rating Service (“DBRS”) as R-1 (high), the highest credit rating for commercial paper since the ABCP are backed by AAA (high) rated assets. The $30.0 of ABCP held by the Company is entirely made up of collateralized debt obligations. Collateralized debt obligations are a type of asset-backed security that is created by a portfolio of ﬁxed-income assets which may include pools of bonds, credit card debt, commercial mortgage-backed securities and other loans. In the second quarter of ﬁscal 2008, a global disruption in the market for such commercial paper resulted in a constraint on the liquidity of ABCP. DBRS placed certain of the ABCP “Under Review with Developing Implications” following an announcement on August 16, 2007 that a consortium representing banks, asset providers and major investors had agreed in principle to a long-term proposal and interim agreement regarding the ABCP (commonly referred to as “the Montreal Proposal”). On September 6, 2007 a pan-Canadian committee (“the Committee”) consisting of major investors was formed to oversee the proposed restructuring process of the ABCP. As of May 3, 2008, all of the ABCP held by the Company were part of the Montreal Proposal. Under this proposal, the affected ABCP would be converted into term ﬂoating rate notes maturing no earlier than the scheduled termination dates of the underlying assets. The Montreal Proposal called for the investors to continue to roll their ABCP during the standstill period. On December 23, 2007, a formal restructuring proposal was established to address the global disruption experienced with third-party ABCP. On April 25, 2008, note holders voted in favour of the restructuring proposal, which will provide investors with new long-term notes that will more closely match the maturity dates of the underlying assets and the cash ﬂows they are expected to generate and was approved on June 5, 2008 by the Ontario Superior Court of Justice. 84 E M PI R E COM PANY LI M ITE D NOTES TO TH E CONSOLI DATE D FI NANCIAL STATE M E NTS On March 20, 2008, the Committee issued an Information Statement containing details about the proposed restructuring. Based on this and other public information it is estimated that the $30.0 of ABCP in which the Company has invested in is represented by a combination of leveraged collateralized debt, synthetic assets and traditional securitized assets and the Company will, on restructuring, receive replacement senior Class A-1 and Class A-2 and subordinate Class B and Class C long-term ﬂoating rate notes with maturities of approximately eight years and nine months. The Company expects to receive replacement notes with par values as follows: Class A-1 Class A-2 Class B Class C $ 8.2 17.8 3.1 0.9 $ 30.0 The replacement notes are expected to obtain an AA rating while the replacement subordinate notes are likely to be unrated. The valuation technique used by the Company to estimate the fair value of its investment in ABCP at May 3, 2008, incorporates probability weighted discounted cash ﬂows considering the best available public information regarding market conditions, prevailing yields, credit spreads and other factors that a market participant would consider for such investments. The assumptions used in determining the estimated fair value reﬂect the details included in the Information Statement issued by the Committee and the risks associated with the long-term ﬂoating rate notes. Interest rates and credit losses vary by each of the different replacement long-term ﬂoating rate notes to be issued as each has different credit ratings and risks. Interest rates and credit losses also vary by the different probable cash ﬂow scenarios that have been modeled. Discount rates vary dependent upon the credit rating of the replacement long-term ﬂoating rate notes. Discount rates have been estimated using Government of Canada benchmark rates plus expected spreads for similarly rated instruments with similar maturities and structure. An increase in the estimated discount rates of 1 percent would reduce the estimated fair value of the Company’s investment in ABCP by approximately $5.0. Maturities vary by different replacement long-term ﬂoating rate notes as a result of the expected maturity of the underlying assets. These investments were initially and continue to be classiﬁed as held-to-maturity instruments by the Company and are carried at amortized cost. Due to the lack of liquidity and a yield on these instruments, a pre-tax impairment loss of $7.5 (25 percent of the original cost) was recorded during ﬁscal 2008. It is possible that the amount ultimately recovered may differ from the estimate. The Company continues to investigate the implications of the default and the remedies available. In addition, these investments have been reclassiﬁed as long-term other assets rather than current assets due to the uncertainty as to the timing of collection. Continuing uncertainties regarding the value of assets which underlie the ABCP, the amount and timing of cash ﬂows and the outcome of the restructuring process could give rise to a further material change in the value of the Company’s investment in ABCP which could impact the Company’s near term earnings. The Company believes it has sufﬁcient credit facilities to satisfy its ﬁnancial obligations as they come due and does not expect there will be a material adverse impact on its business as a result of this current third party ABCP liquidity issue. Cash ﬂow hedges Financial derivatives assigned as part of a cash ﬂow hedging relationship are classiﬁed as either an other asset or other liability as required based on their fair value determination. 2008 AN N UAL R E PORT 85 Note 8 Property and Equipment Food retailing segment Land Land held for development Buildings Equipment, ﬁxtures and vehicles Leasehold improvements Construction in progress Assets under capital leases Real estate and other segments Land Land held for development Buildings Equipment Leasehold improvements Construction in progress Petroleum and natural gas costs Total Food retailing segment Land Land held for development Buildings Equipment, ﬁxtures and vehicles Leasehold improvements Construction in progress Assets under capital leases Real estate and other segments Land Land held for development Buildings Equipment Leasehold improvements Construction in progress Petroleum and natural gas costs Cost Accumulated Depreciation May 3, 2008 Net Book Value $ 261.6 61.7 839.0 2,281.4 448.2 164.4 99.3 4,155.6 6.9 63.4 63.9 76.9 56.3 10.0 82.1 $ – – 206.6 1,449.8 253.4 – 42.7 1,952.5 – – 30.2 37.3 15.5 – 22.3 $ 261.6 61.7 632.4 831.6 194.8 164.4 56.6 2,203.1 6.9 63.4 33.7 39.6 40.8 10.0 59.8 359.5 105.3 254.2 $ 4,515.1 $ 2,057.8 $ 2,457.3 Cost Accumulated Depreciation May 5, 2007 Net Book Value Restated (Note 1) $ 188.7 93.1 673.2 2,012.3 397.9 109.3 83.1 3,557.6 78.8 26.8 377.3 72.7 52.4 21.8 78.7 708.5 $ – – 161.7 1,256.7 243.9 – 34.5 1,696.8 – – 102.2 32.6 12.1 – 13.3 160.2 $ 188.7 93.1 511.5 755.6 154.0 109.3 48.6 1,860.8 78.8 26.8 275.1 40.1 40.3 21.8 65.4 548.3 Total $ 4,266.1 $ 1,857.0 $ 2,409.1 86 E M PI R E COM PANY LI M ITE D NOTES TO TH E CONSOLI DATE D FI NANCIAL STATE M E NTS Note 9 Assets Held for Sale Included in assets held for sale are commercial properties from the various segments with a net carrying value of $60.3 (2007 – $24.1). Included in liabilities related to these assets held for sale is $6.4 (2007 – $6.8). These assets are listed for potential sale to outside parties and it is expected that these properties will be disposed of in the next twelve months. Note 10 Intangible Assets Brand names Franchise rights/agreements Patient ﬁles Private labels Other Note 11 Bank Indebtedness May 3, 2008 May 5, 2007 $ $ 199.1 36.2 18.8 59.5 33.2 346.8 $ $ 0.5 20.4 9.6 – 7.7 38.2 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. On November 15, 2007, Sobeys established and utilized a new unsecured non-revolving credit facility of $30.0 which matured on May 15, 2008 and subsequently extended to August 15, 2008. The interest rate is ﬂoating and may be tied to the bankers’ acceptance rate, Canadian prime rate or London InterBank Offered Rate (“LIBOR”). Note 12 Long-term Debt First mortgage loans, average interest rate 9.8%, due 2008-2026 Medium Term Notes, interest rate 5.8%, due October 6, 2036 Medium Term Notes, interest rate 6.1%, due October 29, 2035 Medium Term Notes, interest rate 7.2%, due February 26, 2018 Debentures, average interest rate 10.3%, due 2008-2016 Notes payable and other debt primarily at interest rates ﬂuctuating with the prime rate Credit facility, ﬂoating interest rate tied to bankers’ acceptance rates, due June 8, 2010 Credit facility, ﬂoating interest rate tied to bankers’ acceptance rates, due July 23, 2012 Credit facility, ﬂoating interest rate tied to bankers’ acceptance rates, due November 8, 2010 Construction loans, interest rates ﬂuctuatingwith the prime rate Unamortized ﬁnancing costs Capital lease obligations, net of imputed interest Less amount due within one year May 3, 2008 May 5, 2007 $ $ Total 72.2 125.0 175.0 100.0 75.4 154.2 395.0 250.0 75.0 0.5 (3.8) 56.5 1,475.0 60.4 $ 1,414.6 $ Total 155.6 125.0 175.0 100.0 88.8 179.4 – – – 1.6 – 49.7 875.1 82.5 792.6 2008 AN N UAL R E PORT 87 Long-term debt is secured by land and buildings, speciﬁc charges on certain assets and additional security as described in Note 11. Capital lease obligations are secured by the related capital lease asset. During the year, in relation to the privatization of Sobeys, the Company entered into new credit facilities (the “Credit Facilities”) consisting of a $950.0 unsecured revolving term credit maturing June 8, 2010 (subject to annual one-year extensions at the request of the Company) and a $50.0 unsecured non-revolving credit that matured on June 30, 2007. The Credit Facilities are subject to certain ﬁnancial covenants. Interest on the debt varies based on the designation of the loan (bankers’ acceptances (“BA”) rate loans, Canadian prime rate loans, U.S. base rate loans or LIBOR loans), ﬂuctuations in the underlying rates, and in the case of the BA rate loans or LIBOR loans, the margin applicable to the ﬁnancial covenants. On June 18, 2007, the Company entered into two delayed ﬁxed rate interest swaps. The ﬁrst swap, in an amount of $200.0, is for a period of three years at a ﬁxed interest rate of 5.00%. The second swap, in an amount of $200.0, is for a period of ﬁve years at a ﬁxed interest rate of 5.05%. Both swaps became effective on July 23, 2007. On June 27, 2007, pursuant to the terms of the Credit Facilities, the Company and Sobeys ﬁled notice with the lenders requesting the establishment of a new $300.0 ﬁve-year credit in favour of Sobeys at the same interest rate and substantially on the same terms and conditions as the Credit Facilities. At July 23, 2007, Sobeys drew down $300.0 from its new credit facility, the proceeds of which were used to pay a dividend to the Company. The Company used the proceeds from the dividend to reduce its indebtedness under the Credit Facilities and the Credit Facilities were reduced to $650.0 accordingly. On that date, the Company also transferred the second swap to Sobeys. In the fourth quarter, the Credit Facilities were further reduced to $395.0. Note 13 Other Long-term Liabilities Deferred lease obligation Deferred revenue Accrued beneﬁt liability (Note 24) Derivative liabilities Other On July 30, 2007, Sobeys exercised an option under its new credit facility to increase the size of the credit from $300.0 to $600.0. At the same time, Sobeys terminated its previously existing $300.0 operating credit which would have expired on December 20, 2010. At May 3, 2008, $275.0 of this new credit facility was drawn down; $250.0 has been classiﬁed as long-term debt and $25.0 has been classiﬁed as bank indebtedness. Sobeys has also issued $41.7 in letters of credit against the facility at May 3, 2008. On November 8, 2007, Sobeys established and drew down on a new unsecured revolving credit facility of $75.0. The maturity date is November 8, 2010. The interest rate is ﬂoating and may be tied to the bankers’ acceptance rate, Canadian prime rate or LIBOR. During ﬁscal 2008, the Company increased its capital lease obligation by $8.9 (2007 – $5.6) with a similar increase in assets under capital lease. These additions are non-cash in nature, therefore have been excluded from the statement of cash ﬂow. Debt retirement payments and capital lease obligations in each of the next ﬁve ﬁscal years and thereafter are: 2009 2010 2011 2012 2013 Thereafter Long-Term Debt Capital Leases $ 47.2 20.4 536.3 18.0 265.7 530.9 $ 13.2 12.0 11.1 8.0 4.9 7.3 May 3, 2008 May 5, 2007 $ $ 53.2 5.3 23.5 21.7 2.8 $ 106.5 $ 41.3 6.5 25.7 – 3.1 76.6 88 E M PI R E COM PANY LI M ITE D NOTES TO TH E CONSOLI DATE D FI NANCIAL STATE M E NTS Note 14 Capital Stock Authorized Preferred shares, par value of $25 each, issuable in series. Series 2 cumulative, redeemable, rate of 75% of prime. 2002 Preferred Shares, par value of $25 each, issuable in series. Non-Voting Class A shares, without par value. Class B common shares, without par value, voting. 2,772,300 992,000,000 259,107,435 40,800,000 No. of Shares May 3, 2008 May 5, 2007 Issued and outstanding Preferred shares, Series 2 Non-Voting Class A Class B common Employees share purchase plan During the year, the Company purchased for cancellation 41,800 (2007 – 31,900) Series 2 preferred shares for $1.0 (2007 – $0.8). During the year, 10,461 (2007 – 18,373) Non-Voting Class A shares were issued under the Company’s share purchase plan to certain ofﬁcers and employees for $0.4 (2007 – $0.8), 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. Under the Long-Term Incentive Plan 99,349 options were issued. Options allow holders to purchase Non-Voting Class A shares at $43.96 per share. Options expire in December 2015. Loans receivable from ofﬁcers and employees of $3.5 (2007 – $3.6) 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 111,971 (2007 – 125,265) Non-Voting Class A shares. The market value of the shares at May 3, 2008 was $4.4 (May 5, 2007 – $5.3). Note 15 Investment Income Dividend and interest income Share of earnings of entities accounted using the equity method $ 258,200 31,484,498 34,260,763 $ 6.5 185.1 7.6 199.2 (3.5) 7.5 184.5 7.7 199.7 (3.6) $ 195.7 $ 196.1 During the year, 300,000 Class B common shares were exchanged for 300,000 Non-Voting Class A shares. During ﬁscal 2007, under a normal course issuer bid, the Company purchased for cancellation 46,047 Non-Voting Class A shares. The purchase price was $1.9 of which $1.6 of the purchase price (representing the premium on common shares purchased for cancellation) was charged to retained earnings. During ﬁscal 2007, 27,674 options were exercised for $0.2. These options allowed holders to purchase Non-Voting Class A shares at $6.555 per share. 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. 2008 1.2 33.3 34.5 $ $ $ $ 2007 9.7 31.8 41.5 2008 AN N UAL R E PORT 89 Note 16 Capital Gains and Other Items Gain on sale of investments Other items Change in fair value of Canadian third party asset-backed commercial paper (Note 7) Reduction of book value of real estate assets $ 2008 100.9 0.3 (7.5) (6.0) 87.7 $ $ $ 2007 6.2 0.9 – – 7.1 Note 17 Income Taxes 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: Income tax expense according to combined statutory rate of 31.9% (2007 – 32.2%) Increase (decrease) in income taxes resulting from Rate changes effect on timing differences Non-taxable dividends and equity earnings Capital gains and other items May 3, 2008 income tax expense attributable to net earnings consists of: Operations Capital gains and other items May 5, 2007 income tax expense attributable to net earnings consists of: Operations Capital gains and other items Current 102.2 18.6 120.8 104.9 (0.1) 104.8 $ $ $ $ 2008 2007 Restated (Note 1) $ 116.8 $ 119.7 (5.5) (0.1) 111.2 14.7 125.9 Future 9.0 (3.9) 5.1 10.6 1.5 12.1 $ $ $ $ $ (2.0) (2.2) 115.5 1.4 116.9 Total 111.2 14.7 125.9 115.5 1.4 116.9 $ $ $ $ $ 90 E M PI R E COM PANY LI M ITE D NOTES TO TH E CONSOLI DATE D FI NANCIAL STATE M E NTS The tax effect of temporary differences that give rise to signiﬁcant portions of future income taxes are presented below: Property and equipment Investments Future employee beneﬁts obligation Restructuring provisions Pension contributions Deferred costs Deferred credits Goodwill and intangibles Other Future income taxes – current liabilities Future income taxes – non-current liabilities May 3, 2008 May 5, 2007 $ $ $ $ 125.9 8.1 (30.9) (8.4) 12.6 3.2 48.8 29.8 (30.7) 158.4 32.9 125.5 158.4 $ $ $ $ 108.0 38.9 (34.9) (11.6) 18.6 1.0 54.8 10.2 (14.2) 170.8 40.4 130.4 170.8 In the ordinary course of business, the Company is subject to ongoing audits by tax authorities. While the Company believes that its tax ﬁling positions are appropriate and supportable, from time to time certain matters are reviewed and challenged by the tax authorities. Note 18 Supplementary Cash Flow Information a) Items not affecting cash Depreciation and amortization Future income taxes Amortization of other assets Provision on asset-backed commercial paper Minority interest Stock-based compensation Long-term lease obligation Employee future beneﬁts obligation Rationalization costs (Note 27) Reduction of book value of real estate assets b) Other cash ﬂow information Net interest paid Net income taxes paid 2008 2007 Restated (Note 1) 304.6 5.1 5.1 7.5 12.8 2.5 11.9 4.8 (6.2) 6.0 354.1 103.9 157.5 $ $ $ $ 269.2 12.1 19.1 – 44.4 1.4 16.1 4.8 15.5 – 382.6 58.9 168.2 $ $ $ $ 2008 AN N UAL R E PORT 91 Note 19 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: Assets Liabilities Equity and advances Revenues Expenses Income before income taxes Cash provided (used) Operating activities Investing activities Financing activities Note 20 Segmented Information Revenue Food retailing Real estate Commercial Inter-segment Residential Investment and other operations Elimination May 3, 2008 May 5, 2007 $ $ $ $ $ $ $ 139.4 67.8 71.6 139.4 2008 88.7 36.8 51.9 74.8 (14.6) (2.3) 57.9 $ $ $ $ $ $ $ 136.3 72.7 63.6 136.3 2007 111.8 41.7 70.1 68.7 (34.2) 3.3 37.8 2008 2007 $ 13,768.1 $ 13,032.0 40.5 34.9 85.2 160.6 171.2 38.4 34.3 146.1 218.8 150.2 14,099.9 (34.9) 13,401.0 (34.3) $ 14,065.0 $ 13,366.7 92 E M PI R E COM PANY LI M ITE D NOTES TO TH E CONSOLI DATE D FI NANCIAL STATE M E NTS Operating income Food retailing Real estate Commercial Residential Investment and other operations Corporate expenses Identiﬁable assets Food retailing Goodwill Real estate Investment and other operations (including goodwill of $40.1; 2007 – $40.1) Depreciation and amortization Food retailing Real estate Investment and other operations Capital expenditures Food retailing Real estate Investment and other operations 2008 2007 Restated (Note 1) $ 359.0 $ 291.0 49.3 50.7 24.4 (10.8) 46.8 71.2 31.6 (9.5) $ 472.6 $ 431.1 May 3, 2008 May 5, 2007 Restated (Note 1) $ 4,026.7 1,119.0 5,145.7 282.0 279.2 $ 3,422.4 746.5 4,168.9 609.4 463.2 $ 5,706.9 $ 5,241.5 2008 2007 Restated (Note 1) 276.2 5.4 23.0 304.6 $ $ 240.6 6.8 21.8 269.2 2008 2007 Restated (Note 1) 481.2 47.3 20.9 549.4 $ $ 446.7 16.0 46.2 508.9 $ $ $ $ The Company operates principally in two business segments: food retailing and real estate. The food retailing segment consists of distribution of food products in Canada. The real estate segment consists of development and ownership of both commercial and residential properties. Commercial real estate is mainly land held for development of food anchored retail strip plazas. Residential real estate is the development of housing lots for resale. Inter-segment transactions are at market values. 2008 AN N UAL R E PORT 93 Note 21 Financial Instruments Credit risk There is no signiﬁcant concentration of credit risk. The credit risk exposure is considered normal for the business. Fair value of ﬁnancial instruments The book value of cash and cash equivalents, receivables, loans and mortgages, bank indebtedness, and accounts payable and accrued liabilities approximate fair values at May 3, 2008. The fair value of all investments is $431.2 (May 5, 2007 – $717.1). The total fair value of long-term debt is estimated to be $1,409.1 (May 5, 2007 – $907.5). The fair value of variable rate long-term 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 current rate offered for debt of similar maturities and credit quality. Derivative ﬁnancial instruments Derivative ﬁnancial instruments are recorded on the consolidated balance sheet at fair value unless the derivative instrument is a contract to buy or sell a non-ﬁnancial item in accordance with the Company’s expected purchase, sale or usage requirements, referred to as a “normal purchase or normal sale”. Changes in the fair values of derivative ﬁnancial instruments are recognized in earnings unless it qualiﬁes and is designated as an effective cash ﬂow hedge or a normal purchase or normal sale. Normal purchases and normal sales are exempt from the application of the standard and are accounted for as executory contracts. Changes in fair value of a derivative ﬁnancial instrument designated as a cash ﬂow hedge are recorded in other assets and liabilities with the effective portion recorded in accumulated other comprehensive income. The following table summarizes the fair value of ﬁnancial assets and ﬁnancial liabilities classiﬁed as held-for-trading, including non-ﬁnancial derivatives, recognized in net earnings for the year ended May 3, 2008, before income taxes and minority interest. Designated as Held-for-Trading Required to be Classified as Held-for-Trading Cash and cash equivalents Interest rate swaps Foreign currency forwards Commodity swaps $ 191.4 – – – $ – (20.0) 2.3 (1.7) During the year, only the interest rate swaps resulted in an earnings impact. A loss in value of $0.9 was recorded in interest expense. Interest rate risk Interest rate risk is the potential for ﬁnancial loss arising from changes in interest rates. The majority of the Company’s long- term debt is at ﬁxed interest rates or hedged with interest rate swaps. Bank indebtedness and approximately 30 percent of the Company’s long-term debt is exposed to interest rate risk due to ﬂoating rates. Foreign exchange risk Bank indebtedness includes $4.0 Canadian that is denominated in U.S. dollars and it acts as a partial hedge to the foreign exchange ﬂuctuations inherent in the residual value of certain equipment. The Company uses forward contracts to ﬁx the exchange rate on some of its expected requirements for Euros and U.S. dollars. Amounts received or paid related to instruments used to hedge foreign exchange, including any gains and losses, are recognized in the cost of purchases. Note 22 Commitments and Contingent Liabilities Guarantees and commitments At May 3, 2008 the Company was contingently liable for letters of credit issued in the aggregate amount of $60.3 (May 5, 2007 – $45.8). Sobeys has guaranteed certain bank loans contracted by franchise afﬁliates. As at May 3, 2008 these loans amounted to approximately $1.3 (May 5, 2007 – $2.9). During the second quarter of ﬁscal 2008 Sobeys entered into an additional guarantee contract. Under the terms of the guarantee, should a franchise afﬁliate be unable to fulﬁll their lease obligation, Sobeys would be required to fund the greater of $5.0 or 9.9 percent of the unfulﬁlled obligation balance. As at May 3, 2008 the amount of the guarantee was $5.0. Sobeys has guaranteed certain equipment leases of its franchise afﬁliates. Under the terms of the guarantee should a franchise afﬁliate be unable to fulﬁl their lease obligation, Sobeys would be required to fund the difference of the lease commitments up to a maximum of $70.0, reduced from $100.0 during the second quarter of ﬁscal 2008, on a cumulative basis. Sobeys approves each of the contracts. 94 E M PI R E COM PANY LI M ITE D NOTES TO TH E CONSOLI DATE D FI NANCIAL STATE M E NTS The aggregate, annual, minimum rent payable under the guaranteed operating equipment leases for ﬁscal 2009 is approximately $18.1. The guaranteed lease commitments over the next ﬁve ﬁscal years are: Guaranteed Lease Commitments 2009 2010 2011 2012 2013 Thereafter $ $ $ $ $ $ 18.1 13.6 12.5 10.1 7.7 1.8 The net aggregate, annual, minimum rent payable under operating leases for ﬁscal 2009 is approximately $219.1 ($300.9 gross less expected sub-lease income of $81.8). The commitments over the next ﬁve ﬁscal years are: 2009 2010 2011 2012 2013 Thereafter Net Lease Obligation $ 219.1 $ 204.4 $ 191.3 179.6 $ $ 172.6 $ 1,483.2 Gross Lease Obligation $ 300.9 281.8 $ 263.9 $ $ 247.5 $ 234.5 $ 1,862.8 Upon entering into the lease of its Mississauga distribution centre in March 2000, Sobeys guaranteed to the landlord the performance, by Serca Foodservice, of all its obligations under the lease. The remaining term of the lease is 12 years with an aggregate obligation of $37.5 (2007 – $40.4). 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 harmless from any liability it may incur pursuant to its guarantee. Contingencies On June 21, 2005, Sobeys received a notice of reassessment from Canada Revenue Agency (“CRA”) for ﬁscal years 1999 and 2000 related to the Goods and Services Tax (“GST”). CRA asserts that Sobeys was obliged to collect GST on sales of tobacco products to status Indians. The total tax, interest and penalties in the reassessment was $13.6. Sobeys has reviewed this matter, has received legal advice, and believes it was not required to collect GST. During the second quarter of ﬁscal 2006, Sobeys ﬁled a Notice of Objection with CRA. Accordingly Sobeys has not recorded in its statement of earnings any of the tax, interest or penalties in the notice of reassessment. Sobeys has deposited with CRA funds to cover the total tax, interest and penalties in the reassessment and has recorded this amount as a long-term receivable from CRA pending resolution of the matter. The Company and a subsidiary have been reassessed in respect to the tax treatment of gains realized on the sale of shares in Hannaford Bros. Co. (“Hannaford”) in ﬁscal 2001. In the event that the tax authorities are successful in respect of the Hannaford transaction, which the Company believes is unlikely, the maximum potential exposure in excess of provisions taken is approximately $22.8. The Company has appealed the reassessments in respect of the sale of Hannaford shares. The Company expects that it will be substantially successful on its appeals of each of these reassessments. The Company also believes that the ultimate resolution of these matters will not, in any event, have a material impact on earnings because it has made adequate provisions for each of these matters. Should the ultimate outcome materially differ from the provisions established, the effective tax rate and earnings of the Company could be materially affected, negatively or positively, in the period in which the matters are resolved. During the fourth quarter, the Company settled other outstanding disputes with CRA. Payments of $28.4 were covered by existing provisions resulting in no impact on net earnings. The Company entered into an agreement with Crombie REIT to fund certain property redevelopments and originally issued and recorded a note payable to Crombie REIT in the amount of $39.6 related thereto. The Company has agreed to pay for all additional costs and expenses required for the redevelopment of those properties. In the event that the redevelopment costs are less than $39.6, the savings will be paid to the Company. 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. 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. 2008 AN N UAL R E PORT 95 Note 23 Related Party Transactions The Company rents premises from Crombie REIT. In addition, Crombie REIT provides administrative and management services to the Company. The rental payments are at fair value and the charges incurred for administrative and management services are on a cost recovery basis. The Company has non-interest bearing notes payable to Crombie REIT in the amount of $19.6. Note 24 Employee Future Beneﬁts On October 2, 2006, the Company sold two commercial properties to Crombie REIT for cash proceeds of $32.4, which was fair market value. Since the sale was to an equity accounted investment, no gain was recorded on the sale. The company has a number of deﬁned beneﬁt and deﬁned contribution plans providing pension and other retirement beneﬁts to most of its 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. The Company uses April 30th as an actuarial valuation date and May 1st as a measurement date for accounting purposes for its deﬁned beneﬁt pension plans. Retirement Pension Plan Senior Management Pension Plan Other Benefit Plans Deﬁned contribution plans Most Recent Valuation Date Next Required Valuation Date May 1, 2007 May 1, 2007 April 30, 2006 May 1, 2010 May 1, 2010 April 30, 2009 The total expense and cash contributions for the Company’s deﬁned contribution plans are as follows: 2008 2007 $ $ 18.6 14.5 96 E M PI R E COM PANY LI M ITE D NOTES TO TH E CONSOLI DATE D FI NANCIAL STATE M E NTS Deﬁned beneﬁt plans Information about the Company’s deﬁned beneﬁts plans, in aggregate, is as follows: Accrued beneﬁt obligation Balance, beginning of year Current service cost, net of employee contributions Interest cost Employee contributions Beneﬁts paid Past service costs Actuarial (gains) losses Balance, end of year Plan assets Market value, beginning of year Actual return on plan assets Employer contributions Employee contributions Beneﬁts paid Surplus payments to members Market value, end of year Funded status Deﬁcit Unamortized past service cost Unamortized actuarial losses Accrued benefit asset (liability) Expense Current service cost, net of employee contributions Interest cost Actual return on plan assets Actuarial (gains) losses Past service costs Surplus payments to members Income before adjustments Expected vs actual return on plan assets Recognized vs actual past service costs Recognized vs actual actuarial gains (losses) Net expense (income) Classiﬁcation of accrued beneﬁt asset (liability) Other assets Other liabilities Accrued benefit asset (liability) Pension Benefit Plans 2008 Pension Benefit Plans 2007 Other Benefit Plans 2008 Other Benefit Plans 2007 $ $ $ $ $ $ $ $ $ $ 288.7 2.2 13.9 0.3 (20.5) 0.1 (15.6) 269.1 283.3 (13.0) 2.5 0.3 (20.5) (0.1) 252.5 (16.5) 0.4 50.8 34.7 2.2 13.9 13.0 (15.6) 0.1 0.1 13.7 (32.2) 0.1 16.0 (2.4) 58.2 (23.5) 34.7 $ $ $ $ $ $ $ $ $ $ 269.3 2.3 14.9 0.3 (18.6) – 20.5 288.7 267.2 27.9 6.5 0.3 (18.6) – 283.3 (5.4) 0.5 47.6 42.7 2.3 14.9 (27.9) 20.4 – – 9.7 9.4 0.2 (19.3) – 68.4 (25.7) 42.7 $ $ $ $ $ $ $ $ $ $ 116.6 2.7 6.1 – (3.5) – (5.5) 116.4 – – 3.4 – (3.4) – – (116.4) 0.6 5.1 (110.7) 2.6 6.1 – (5.5) – – 3.2 – 0.1 5.0 8.3 – (110.7) (110.7) $ $ $ $ $ $ $ $ $ $ 114.1 2.5 5.9 – (3.8) – (2.1) 116.6 – – 3.8 – (3.8) – – (116.6) 1.0 13.5 (102.1) 2.5 5.9 – (2.1) – – 6.3 – 0.1 2.2 8.6 – (102.1) (102.1) 2008 AN N UAL R E PORT 97 Included in the accrued beneﬁt obligation at year-end are the following amounts in respect of plans that are not funded: Accrued benefit obligation $ 21.8 $ 20.9 $ 110.7 $ 102.1 Pension Benefit Plans 2008 Pension Benefit Plans 2007 Other Benefit Plans 2008 Other Benefit Plans 2007 The signiﬁcant actuarial assumptions adopted in measuring the Company’s accrued beneﬁt obligations are as follows (weighted-average assumptions as of May 3, 2008): Pension Benefit Plans 2008 Pension Benefit Plans 2007 Other Benefit Plans 2008 Other Benefit Plans 2007 Discount rate Expected long-term rate of return on plan assets Rate of compensation increase 5.25% 7.00% 4.00% 5.00% 7.00% 4.00% 5.25% 5.25% For measurement purposes, a 9.0 percent ﬁscal 2008 annual rate of increase in the per capita cost of covered health care beneﬁts was assumed. The cumulative rate expectation to 2016 is 5.0 percent. The expected average remaining service period of the active employees covered by the pension beneﬁt plans ranges from 10 to 11 years with a weighted average of 10 years at year end. The expected average remaining service period of the active employees covered by the other beneﬁt plans range from 11 to 16 years with a weighted average of 14 years at year end. The table below outlines the sensitivity of the ﬁscal 2008 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 impact on the accrued beneﬁt obligations or beneﬁt plan expenses. Expected long-term rate of return on plan assets Impact of: 1% increase 1% decrease Discount rate(2) Impact of: 1% increase 1% decrease Growth rate of health costs(3) Impact of: 1% increase 1% decrease Pension Plans Other Benefit Plans Benefit Obligations 5.25% (29.5) 33.1 $ $ Benefit Cost(1) 7.00% (2.4) 2.4 5.25% 0.4 (0.8) $ $ $ $ Benefit Obligations Benefit Cost(1) 5.25% (17.1) 20.6 9.00% 19.1 (15.4) $ $ $ $ 5.25% (0.7) 0.8 9.00% 1.9 (1.5) $ $ $ $ (1) Reﬂects the impact on the current service cost, the interest cost and the expected return on assets. (2) 5.5% for the Employee Pension Plan and the Post Retirement Beneﬁt Plan. (3) Gradually decreasing to 5.0% in 2016 and remaining at that level thereafter. 98 E M PI R E COM PANY LI M ITE D NOTES TO TH E CONSOLI DATE D FI NANCIAL STATE M E NTS 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 Foreign currency hedges 2008 2.91% 25.51% 70.26% 0.26% 1.06% 2007 2.43% 18.20% 78.55% 0.22% 0.60% Total investments 100.00% 100.00% Within these securities are investments in Empire Company Limited Non-Voting Class A shares. The market value of these shares at year end are as follows: 2008 % of Plan Assets $ 80.8 9.0% $ 2007 92.2 % of Plan Assets 9.3% Note 25 Business Acquisitions Sobeys acquires franchisee stores and prescription ﬁles. The results of these acquisitions have been included in the consolidated ﬁnancial results of the Company, and were accounted for through the use of the purchase method. As illustrated in the table below, the acquisition of certain franchise stores resulted in the acquisition of intangible assets. The method of amortization of limited life intangibles is on a straight- line basis over the estimated useful life of the intangible. Franchisees Inventory Property and equipment Intangibles Goodwill Other assets (liabilities) Cash consideration Prescription ﬁles Intangibles Cash consideration 2008 2007 6.6 5.1 5.9 1.2 (1.5) 17.3 2.5 2.5 $ $ $ $ 4.9 2.4 3.3 0.9 0.3 11.8 4.9 4.9 $ $ $ $ On September 12, 2007, Sobeys acquired all the assets and assumed certain liabilities of Thrifty Foods (“Thrifty”) for an amount of $253.6. The assets acquired include 20 full-service supermarkets, a main distribution centre and a wholesale division on Vancouver Island and the lower mainland of British Columbia. The acquisition was accounted for using the purchase method with the results of Thrifty being consolidated since the acquisition date. Management carried out a detailed analysis and changes were made to the preliminary allocation of the excess consideration paid over net assets acquired as disclosed in previous quarters of ﬁscal 2008. The measurement and allocation of ﬁnite and inﬁnite intangible assets and goodwill (approximately $174.0 of which is deductible for tax) was completed during the fourth quarter of ﬁscal 2008. 2008 AN N UAL R E PORT 99 The ﬁnal purchase price allocation, incorporating management’s assessment of fair value, is as follows: Consideration Cash Acquisition costs Total consideration paid Net assets acquired Current assets Long-term assets Current liabilities assumed Long-term liabilities assumed Total net assets acquired Excess consideration paid over net assets acquired Allocation of excess consideration paid over net assets acquired Intangible assets – Banner – Other Goodwill $ $ $ $ 250.4 3.2 253.6 41.4 36.9 (43.6) (13.1) 21.6 232.0 24.0 1.9 206.1 232.0 During the ﬁrst two quarters of ﬁscal 2007, the Company increased its ownership interest in Sobeys from 70.3% to 72.1% 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 $48.6, goodwill increased by $13.0 and minority interest decreased by $35.6. On August 27, 2006, Sobeys acquired substantially all of the food distribution assets of Achille de la Chevrotière Ltée and its associated companies (“ADL”) for an amount of $79.2. The assets acquired include 25 owned or franchised retail store operations, other wholesale supply agreements and distribution facilities in Rouyn-Noranda, Québec. Sixteen of the franchised retail store operations are considered VIEs under the Company’s policy (see Note 28). They have been included in the consolidated results of the Company. The acquisition was accounted for using the purchase method with the results of ADL being consolidated since the acquisition date. The ﬁnal purchase price allocation, which has incorporated management’s assessment of fair value, is as follows: Consideration Cash Acquisition costs Total consideration paid Net assets acquired Current assets Long-term assets Current liabilities assumed Long-term liabilities assumed Total net assets acquired Excess consideration paid over net assets acquired Allocation of excess consideration paid over net assets acquired Intangible assets – Agreements – Other Goodwill 100 E M PI R E COM PANY LI M ITE D NOTES TO TH E CONSOLI DATE D FI NANCIAL STATE M E NTS $ $ $ $ 75.8 3.4 79.2 28.0 27.7 (20.0) (4.6) 31.1 48.1 6.3 0.5 41.3 48.1 Note 26 Stock-based Compensation Deferred share units Stock option plan Members of the Board of Directors may elect to receive all or any portion of their fees in Deferred Share Units (“DSUs”) in lieu of cash. The number of DSUs received is determined by the market value of the Company’s Non-Voting Class A shares on each director’s fee payment date. Additional DSUs are received as dividend equivalents. DSUs 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 an Empire Company Limited Non-Voting Class A share at the time of the redemption. On an ongoing basis, the Company values the DSU obligation at the current market value of a corresponding number of Non-Voting Class A shares and records any increase in the DSU obligation as an operating expense. At May 3, 2008, there were 64,877 (May 5, 2007 – 66,435) DSUs outstanding. During the year, the stock-based compensation expense was $0.5 (2007 – $0.6). During ﬁscal 2008, the Company granted options under the Stock Option plan for employees of the Company whereby options are granted to purchase Non-Voting Class A Shares. Options allow holders to purchase Non-Voting Class A Shares at $43.96 per share and expire in December 2015. The options vest over four years with 50 percent of the options vesting only if certain ﬁnancial targets are attained in a given ﬁscal year. These options have been treated as stock-based compensation. During ﬁscal 2008, 99,349 options were granted. The compensation cost relating to the ﬁscal 2008 was determined to be $0.2 with amortization of the cost over the vesting period. The total increase in contributed surplus in relation to the Stock Option compensation cost for ﬁscal 2008 is $0.2. The compensation cost was calculated using the Black-Scholes model with the same assumptions as detailed above for the share purchase loans. Share purchase loans Phantom performance option plan The Company has a Share Purchase Loan plan for employees of the Company whereby loans are granted to purchase Non- Voting Class A Shares. These loans have been treated as stock- based compensation in accordance with EIC Abstract 132. The compensation cost relating to the Share Purchase Loans was determined to be $0.1 (2007 – $0.2) with amortization of the cost over six years. The total increase in contributed surplus in relation to the Share Purchase Loan compensation cost for ﬁscal 2008 is $0.1 (2007– $0.1). The contributed surplus balance was reduced by $0.1 in relation to shares issued under the Share Purchase Loan that have been treated as stock-based compensation that became fully vested with the employee during ﬁscal 2008. Shares become vested when the employees’ outstanding loan balance is reduced. The compensation cost was calculated using the Black-Scholes model with the following assumptions: Expected life Risk-free interest rate Expected volatility Dividend yield 2008 6 years 3.50% 20.1% 1.5% 2007 7 years 4.40% 19.7% 1.4% In June 2007, the Board of Directors approved a Phantom Performance Option Plan for eligible employees of Sobeys. Under the plan, units are granted at the discretion of the Board based on a notional equity value of Sobeys tied to a speciﬁed formula. The units have a three-year vesting period with a third of the units vesting each year. As the notional fair value of Sobeys changes, the employees are entitled to the incremental increase in the notional equity value over a ﬁve-year period. The Company recognizes a compensation expense equal to the increase in notional value over the original grant value on a straight-line basis over the vesting period. After the vesting period, any increase in incremental notional equity value is recognized as a compensation expense immediately. This is recorded as a liability until settlement and is re-measured at each interim and annual reporting period of the Company. At the end of ﬁscal 2008, 518,579 units were outstanding and the Company recognized $0.1 (May 5, 2007 – $Nil) of compensation expense associated with this Plan during ﬁscal 2008. 2008 AN N UAL R E PORT 101 Note 27 Business Rationalization Costs During the third quarter of ﬁscal 2007, Sobeys completed a rationalization of administrative functions and also began to incur rationalization costs associated with the development of a new grocery distribution centre in Vaughan, Ontario. These costs primarily relate to severance and ﬁxed asset and inventory write- offs. In the fourth quarter of ﬁscal 2007, Sobeys also recorded additional rationalization costs related to the closure of two distribution facilities in Quebec of which $3.5 was reversed in ﬁscal 2008 as a result of changes in management’s estimates of the expected costs. During the ﬁrst quarter of ﬁscal 2008, Sobeys incurred additional administrative rationalization costs. Subsequent to year-end additional severance costs of approximately $5.6 have been incurred and will be recognized in the ﬁrst quarter of ﬁscal 2009. Additional rationalization costs are anticipated and will be quantiﬁed and disclosed throughout ﬁscal 2009 as they are available. The costs associated with the organizational change are recorded as incurred as cost of sales, selling and administrative expenses in the statement of earnings, before tax, as follows: Severance Other costs Asset write-offs Severance Other costs Asset write-offs Liability at May 5, 2007 Incurred Fiscal 2008 12.1 – – 12.1 $ $ (1.8) – – (1.8) $ $ Paid 4.4 – – 4.4 Incurred Incurred Liability at May 3, 2008 $ $ 5.9 – – 5.9 Total Incurred and Fiscal 2007 Fiscal 2008 Anticipated Anticipated 14.3 1.1 3.4 18.8 $ $ (1.8) – – (1.8) $ $ 5.6 – – 5.6 $ $ 18.1 1.1 3.4 22.6 $ $ $ $ 102 E M PI R E COM PANY LI M ITE D NOTES TO TH E CONSOLI DATE D FI NANCIAL STATE M E NTS Warehouse and Distribution Agreement The Company has an agreement with an independent entity to provide warehouse and distribution services for one of its distribution centres. The terms of the agreement with this entity require the Company to consolidate its results with those of the Company pursuant to AcG-15. Note 28 Variable Interest Entities Variable interest entities are deﬁned under AcG-15, “Consolidation of Variable Interest Entities” 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. The Company has identiﬁed the following entities as VIEs: Franchise Afﬁliates The Company has identiﬁed 292 (May 5, 2007 – 271) franchise afﬁliate stores 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. Note 29 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. 2008 AN N UAL R E PORT 103 ELEVEN YEAR FINANCIAL REVIEW Years Ended(1) 2008 2007 Restated 2006 Restated 2005 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 gains (losses) 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 on a Fully Diluted Basis ($ per share) Operating earnings Capital gains (losses) and other items, net of tax Net earnings Dividends Non-Voting Class A shares Class B common shares Book value Share Price, Non-Voting Class A Shares ($ per share) High Low Close Diluted weighted average number of shares outstanding (in millions) $ 14,065.0 472.6 105.8 125.9 12.8 $ 13,366.7 431.1 60.1 116.9 55.4 $ 13,063.6 491.4 83.8 153.1 67.1 $ 12,435.2 463.7 86.7 131.2 63.6 242.8 – 242.8 73.0 315.8 14.0% 5,706.9 1,414.6 2,382.3 3.69 1.11 4.80 0.660 0.660 36.14 55.19 35.40 39.25 65.7 200.1 – 200.1 5.7 205.8 10.1% 5,241.5 792.6 2,131.1 3.04 0.09 3.13 0.600 0.600 32.31 45.25 39.49 42.33 202.0 – 202.0 94.8 296.8 16.2% 5,051.5 707.3 1,965.2 3.07 1.44 4.51 0.560 0.560 29.77 44.35 33.37 43.29 182.9 – 182.9 3.7 186.6 11.4% 4,929.2 727.4 1,709.0 2.78 0.05 2.83 0.480 0.480 25.87 38.00 24.25 36.66 65.7 65.7 65.7 (1) Fiscal years ended April 30th, except ﬁscal 2005, which ended May 7, 2005, ﬁscal 2006, which ended May 6, 2006, ﬁscal 2007, which ended May 5, 2007, and ﬁscal 2008, which ended May 3, 2008, 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 gains (losses) and other items, net of tax. 104 E M PI R E COM PANY LI M ITE D 2004 2003 2002 2001 2000 1999 1998 $ 11,284.0 422.8 92.4 111.0 58.5 163.3 – 163.3 9.2 172.5 11.6% $ 10,624.2 $ 444.4 93.7 120.0 67.5 159.3 – 159.3 (6.0) 153.3 11.4% 4,679.7 913.0 1,567.6 4,519.3 923.1 1,418.5 2.47 0.14 2.61 0.400 0.400 23.67 29.50 23.10 26.65 2.42 (0.09) 2.33 0.330 0.330 21.41 33.25 23.70 23.85 9,926.5 416.2 111.6 104.8 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 0.214 0.214 19.47 33.30 15.75 28.88 $ 9,331.1 341.1 145.8 131.9 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 0.170 0.170 16.82 18.25 13.88 17.00 $ 9,100.1 309.7 159.6 68.1 32.9 78.8 5.9 84.7 2.1 86.8 13.3% 4,171.0 1,332.0 602.8 1.10 0.03 1.13 0.140 0.140 8.73 16.98 12.33 16.05 $ 5,362.7 184.4 112.6 49.1 9.2 59.0 1.1 60.1 74.9 135.0 21.7% 4,023.5 1,391.8 737.5 0.78 1.00 1.78 0.136 0.136 9.03 16.27 12.50 13.00 $ 2,912.2 108.6 76.8 17.9 – 56.1 8.1 64.2 23.6 87.8 17.9% 1,907.2 616.5 558.3 0.85 0.32 1.17 0.121 0.116 7.06 14.25 7.80 13.63 65.8 65.8 65.7 65.6 75.6 75.0 73.9 2008 AN N UAL R E PORT 105 GLOSSARY Adjusted debt Net debt to total capital Funded debt plus the capitalized value of operating lease payments, which is calculated as six times net annual operating lease payments Adjusted debt to capital Adjusted debt divided by the sum of adjusted debt and shareholders’ equity Book value per share Shareholders’ equity less preferred shares divided by Non-Voting Class A shares and Class B common shares outstanding Capital expenditure Payments made for the acquisition of property and equipment Funded debt less cash and cash equivalents divided by funded debt less cash and cash equivalents plus shareholders’ equity Operating earnings Net earnings before capital gains (losses) and other items, net of tax Operating income Operating earnings before minority interest, interest expense and income taxes Operating margin Operating income divided by sales Private label EBITDA Operating income plus depreciation and amortization A brand of products that is marketed, distributed and owned by the Company Expanded stores Renovated stores Stores that undergo construction resulting in a square footage increase during the year Stores that undergo construction, resulting in no increase in square footage Funded debt Return on equity All interest bearing debt, which includes bank loans, bankers’ acceptances, long-term debt and liabilities relating to assets held for sale Net earnings available for common shares divided by average common shareholders’ equity Same-store sales Funds from operations Sales from stores in the same location in both reporting periods Operating earnings plus depreciation and amortization Hedge A ﬁnancial instrument used to manage foreign exchange, interest rate or energy or other commodity risk by making a transaction which offsets the existing position Interest coverage Operating income divided by interest expense Total capital Funded debt plus shareholders’ equity VIE (Variable Interest Entity) An entity that does not have sufﬁcient equity at risk to ﬁnance its activities without additional subordinated ﬁnancial support, or where the equity holders lack the overall characteristics of a controlling ﬁnancial interest Letters of credit Weighted average number of shares Financial instruments issued by a ﬁnancial institution to guarantee the Company’s payments to a third party The number of Non-Voting Class A shares plus Class B common shares outstanding adjusted to take into account the time the shares are outstanding in the reporting period 106 E M PI R E COM PANY LI M ITE D SHAREHOLDER AND INVESTOR INFORMATION 31,484,498 34,260,763 Outstanding Shares As of June 26, 2008 Non-Voting Class A shares Class B common shares, voting Transfer Agent CIBC Mellon Trust Company Investor Correspondence P.O. Box 7010 Adelaide Street Postal Station Toronto, Ontario M5C 2W9 Telephone: (800) 387-0825 E-mail: enquires@cibcmellon.com Bankers Bank of Montreal Bank of Nova Scotia Bank of Tokyo-Mitsubishi Canadian Imperial Bank of Commerce National Bank of Canada Rabobank Royal Bank of Canada TD Canada Trust Solicitors Stewart McKelvey Halifax, Nova Scotia Auditors Grant Thornton, LLP New Glasgow, Nova Scotia Multiple Mailings If you have more than one account, you may receive a separate mailing for each. If this occurs, please contact CIBC Mellon Trust Company at (800) 387-0825 to eliminate the multiple mailings. Empire Company Limited Head Ofﬁce: 115 King St. Stellarton, Nova Scotia B0K 1S0 Telephone: (902) 755-4440 Fax: (902) 755-6477 Internet: 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 Communication 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 Shareholders’ Annual General Meeting September 11, 2008, at 11:00 a.m. (ADT) Empire Studio 7 Cinemas 610 East River Road New Glasgow, Nova Scotia Stock Exchange Listing The Toronto Stock Exchange Stock Symbols Non-Voting Class A shares – EMP.A Preferred shares: Series 2 – EMP.PR.B Average Daily Trading Volume (TSX) 57,951 Dividend Record and Payment Dates For Fiscal 2008 Record Date July 15, 2008 October 15, 2008* January 15, 2009* April 15, 2009* * Subject to approval by Board of Directors Payment Date July 31, 2008 October 31, 2008* January 30, 2009* April 30, 2009* Front Cover: Mélanie Mignault, Deli Counter Manager, and Francine Côté, Cashier, IGA extra, Mascouche, Québec; Sobeys customer; Kathleen DeVargas, Administration Manager, Woodchester Sobeys; Graeme Ogilvie, Assistant Grocery Manager, Mississauga Sobeys; Stan Malecki, Vice President Development, ECL Developments Ltd. Back Cover: Ray Bourbonnais, Vice President Development, ECL Developments Ltd. and Thrifty Foods; Marissa Coleman, Meat Manager, Mississauga Price Chopper; Shelly MacInnis, Cashier, Crystal MacLean, Owner/Operator, and Darrell Gero, Meat Manager, Foodland, Westville, Nova Scotia; Jonathan Lavergne, Warehouse Clerk, Sobeys Québec Trois-Rivières Distribution Centre. m o k i f a r G : g n i t n i r P s r e t e i P n a i r B : y h p a r g o t o h P l a p i c n i r P 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 : l a i r o t i d E d n a n g i s e D (cid:36) (cid:48) (cid:46) (cid:49) (cid:34) (cid:47) (cid:58) (cid:1) (cid:45) (cid:42) (cid:46) (cid:42) (cid:53) (cid:38) (cid:37) www.empireco.ca

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