Empire Company
Annual Report 2009

Plain-text annual report

CLEARLY FOCUSED ON OUR STRENGTHS EmpirE Company LimitEd 2009 Annual Report A LEgACY OF CREAtiNg vALUE Empire Company Limited’s primary goal and focus continues to be the achievement of long- term sustainable value creation through cash flow and income growth and equity appreciation. Through direct ownership and equity participation, Empire strives to continue this legacy by focusing on businesses that we know and understand, namely food retailing, real estate and corporate investments. 52 Weeks Ended May 2, 2009 52 Weeks Ended May 3, 2008 52 Weeks Ended May 5, 2007 * $ 15,015.1 $ 14,065.0 $ 13,366.7 $ 262.9 3.0 265.9 3.99 0.05 4.04 39.14 0.70 $ 242.8 73.0 315.8 3.69 1.11 4.80 36.14 0.66 $ 200.1 5.7 205.8 3.04 0.09 3.13 32.31 0.60 2009 Financial Highlights ($ in millions, except per share amounts) Operations Revenue Operating earnings Capital gains (losses) and other items, net of tax Net earnings Per Share Information Operating earnings (fully diluted) Capital gains (losses) and other items, net of tax Net earnings (fully diluted) Book value Dividends *Restated OPE RATING EAR N INGS $ I N M I LLIONS 2 8 0 210 14 0 70 DIVIDE N DS $ PE R SHAR E VALU E OF INVESTM E NT OF $10 0 MADE 10 YEARS AGO $ 0 . 8 0 0 . 6 0 0 . 4 0 0 . 20 4 0 0 3 0 0 20 0 10 0 FY 99 00 01 02 03 04 05 06 07 08 09 FY 99 00 01 02 03 04 05 06 07 08 09 FY 99 00 01 02 03 04 05 06 07 08 09 10-Year Operating Earnings CAGR 15.9% 10-Year DPS CAGR 17.8% EMPIRE EMPIRE S&P/TSX INDEX S&P/TSX INDEX 10-Year Total Return CAGR 15.5% letter to shareholders FOCUSED ON OUR STRENGTHS With the privatization of Sobeys Inc. in June 2007, the primary focus of Empire’s energy and capital solidified in support of our core food retailing and related real estate operations with a corresponding material reduction in our corporate investments segment. Our increased focus on food retailing (Sobeys Inc.) and related real estate has enhanced Empire’s operating earnings. Empire achieved record financial results in fiscal 2009 largely as a result of continued improvement in operational performance by Sobeys. Revenue grew by 6.8 percent to $15.02 billion while operating earnings increased by 8.3 percent to $262.9 million or $3.99 per share. This improved operational performance, combined with a modest equity issuance completed in April 2009, strengthened our financial position, with the ratio of funded debt to capital falling to 32.7 percent from 39.8 percent at the start of the fiscal year. Paul D. Sobey President and CEO Empire Company Limited letter to shareholders A passion for food Sobeys’ determination to “out-food”, “out-fresh”, “out-service” and “out-market” those who choose to compete with us has resulted in solid same-store sales growth and sales per square foot increases. Food retailing During fiscal 2009, ECL Developments continued Sobeys achieved record operating performance in fiscal to expand its property development pipeline and is on 2009 with a sales increase of $996.7 million or 7.2 percent, plan with a total of 18 grocery-anchored plazas under same-store sales growth of 5.2 percent and a net earnings development (1.7 million square feet of gross leasable area) increase of $32.8 million or 16.7 percent. The strong at fiscal year-end. We view ECL Developments as an performance of Sobeys is built upon its focus and integral component of the ongoing growth of our food determination to be widely recognized as the best food retailing business. Through ECL Developments, we intend retailer in the country. to continue the internal property development of grocery- During the year, Sobeys continued to modernize its anchored plazas and free-standing grocery stores by retail network, improved operational execution, enhanced capitalizing on the knowledge and expertise within our food productivity and continued to introduce innovative product retailing and real estate businesses. and service offerings. In fiscal 2009, Sobeys recorded Crombie REIT recorded solid operating performance in industry leading same-store sales growth and sales per fiscal 2009 with operating income contribution to Empire square foot increases, evidence that Sobeys’ unwavering of $19.8 million, up 45.6 percent. This increase is the focus on food is a winning strategy. result of purchasing 61 properties from subsidiaries of Empire in April 2008, as well as continued same-property Real estate net operating income growth. Our consolidated real estate performance is not strictly comparable to last year as last year’s performance included Sobey Leased Properties’ operations, the principal components of which were sold to Crombie REIT in April 2008, with the remainder transferred to Sobeys. Adjusting for this, there are three components to our real estate business: our commercial property development company, ECL Developments; our 47.4 percent interest in Crombie REIT; and our 35.7 percent interest in Genstar Development Partnership, our residential property operation. 2 Empire Company Limited The NBA live in 3D Fans experienced the first live 3D theatrical event in Canada when Empire Theatres broadcast the NBA All-Star Saturday Night exclusively at its Empress Walk location in Toronto in February, 2009.  With respect to our residential property operation, long-term value creation. Empire’s shareholders have been Genstar contributed $23.2 million of net earnings in well-served by the Company’s focus on its core businesses fiscal 2009 versus $34.7 million last year. This decline and approach to building long-term value and we intend to was expected and, given the slow down in the housing stay the course. market, we expect that its contribution will decline further in fiscal 2010. Genstar has a strong management team A key to our success and is well capitalized. It is in an excellent position to take Empire’s success and sustainability has been made possible advantage of new development opportunities and is well by the skill and dedication of our executive and operating positioned for future growth once the cycle improves. management teams and the contributions of more than 90,000 employees at Empire and its related companies, Investments and other operations including its franchisees and affiliates. They have been During fiscal 2009, our wholly-owned Empire Theatres instrumental in creating successful organizations and that business continued to benefit from strong theatre attendance, success has in turn created winning environments. On behalf same theatre revenue growth and enhanced operational of the Board of Directors and our shareholders, we offer a improvements. The continued growth in Empire Theatres’ sincere thanks for their ongoing efforts and dedication. revenue and operating income is due to a steady stream With the valued guidance of our Board, and the continuing of popular movie releases, combined with the dedication patronage of our customers, and support of our affiliates, and efforts of our people at improving the movie-going suppliers and investors, we are confident that Empire will experience. The implementation of new technologies such continue to prosper in the years ahead. as digital cinema and RealD 3D, along with alternative programming, has enriched the entertainment experience for our customers. Wajax Income Fund had an excellent start to our fiscal year; however, as the economy weakened the company prudently reduced its monthly distribution. Wajax is a very well managed company with a strong competitive position in its chosen markets. We remain confident that it will prosper as economic conditions improve. Looking forward Our focus in fiscal 2010 will remain centred on operational excellence and prudent capital management. Our actions will continue to support the profitable growth of our core food retailing business and we look forward to capitalizing on real estate opportunities that align with building Paul D. Sobey President and CEO Empire Company Limited June 26, 2009 core businesses with an integrated strategy FOOD RETAIlING Profile Profile Sobeys Inc. owns or franchises more than 1,300 stores in every province across Sobeys Inc. owns or franchises more than 1,300 stores in every province across Canada under retail banners that include Sobeys, IGA, IGA extra, Foodland, 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 Price Chopper and Thrifty Foods, as well as Lawtons Drug Stores. Our five core retail food formats are designed to ensure that we have the right offering in the retail food 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 right-sized stores for each individual market we serve – from our full service format to the convenience format, each tailored to satisfy the unique occasion-based to the convenience format, each tailored to satisfy the unique occasion-based food shopping needs of our customers. food shopping needs of our customers. Competitive strengths Competitive strengths ➤ Our passionate “best in food” focus supported by our fresh food expertise. ➤ Our passionate “best in food” focus supported by our fresh food expertise. ➤ Our customer focus and superior service delivery. ➤ Our customer focus and superior service delivery. ➤ Our committed and knowledgeable regional and local market management teams, ➤ Our committed and knowledgeable regional and local market management teams, affiliates and store operators. affiliates and store operators. ➤ Our investment in innovation including our Compliments private label brand. ➤ Our investment in innovation including our Compliments private label brand. ➤ Our enhanced supply chain, back shop processes, systems and tools that support ➤ Our enhanced supply chain, back shop processes, systems and tools that support our employees’ ability to serve the needs of our customers. our employees’ ability to serve the needs of our customers. Key performance indicators Key performance indicators F OOD R ETAILING R EVE N U E $ I N M I LLIONS F OOD R ETAILING OPE RATING INCOM E $ I N M I LLIONS 16 , 0 0 0 12 , 0 0 0 8 , 0 0 0 4 , 0 0 0 14,764.8 4 0 0 3 0 0 20 0 10 0 401.4 FISCAL YEAR 05 06 07 08 09 FISCAL YEAR 05 06 07 08 09 Strategic priorities Strategic priorities We are determined to be widely recognized as the best food retailer in Canada. We are determined to be widely recognized as the best food retailer in Canada. Our focus in fiscal 2009 remained on three key imperatives: Our focus in fiscal 2009 remained on three key imperatives: ➤ Continued improvement in operational execution through the engagement and ➤ Continued improvement in operational execution through the engagement and development of our employees; development of our employees; ➤ Reducing our cost base and improving productivity throughout our organization; and ➤ Reducing our cost base and improving productivity throughout our organization; and ➤ Innovation of the product and services offered to our customers. ➤ Innovation of the product and services offered to our customers. 4 Empire Company Limited REAl ESTATE From left to right: Gary Finklestein, Vice From left to right: Gary Finklestein, Vice President, Ontario and Québec, Crombie REIT; President, Ontario and Québec, Crombie REIT; Scott Doan, Director Real Estate & Property Scott Doan, Director Real Estate & Property Management, Sobeys Ontario; and Jean Louis Management, Sobeys Ontario; and Jean Louis LaFontaine, Director Development – Québec, LaFontaine, Director Development – Québec, ECL Developments ECL Developments Profile Profile Empire’s real estate business includes commercial and residential property operations. Empire’s real estate business includes commercial and residential property operations. Our commercial real estate operations are focused on the development of food-anchored Our commercial real estate operations are focused on the development of food-anchored shopping plazas through a 100 percent ownership interest in ECL Developments Limited shopping plazas through a 100 percent ownership interest in ECL Developments Limited and ownership of retail and office properties through a 47.4 percent ownership interest in and ownership of retail and office properties through a 47.4 percent ownership interest in Crombie REIT. The focus of our residential operations is on land development, predominantly Crombie REIT. The focus of our residential operations is on land development, predominantly through a 35.7 percent ownership interest in Genstar Development Partnership. through a 35.7 percent ownership interest in Genstar Development Partnership. Competitive strengths Competitive strengths ➤ Our knowledge, experience and management strength in real estate. ➤ Our knowledge, experience and management strength in real estate. ➤ The close working relationship with Sobeys and Crombie REIT that enables Empire ➤ The close working relationship with Sobeys and Crombie REIT that enables Empire to optimize the development of food-anchored shopping plazas across Canada. to optimize the development of food-anchored shopping plazas across Canada. ➤ The preferential development agreement between our commercial real estate ➤ The preferential development agreement between our commercial real estate division and Crombie REIT. This agreement reduces risk and enhances opportunities division and Crombie REIT. This agreement reduces risk and enhances opportunities for both businesses. for both businesses. ➤ Our residential property operation, through Genstar, has attractive land holdings ➤ Our residential property operation, through Genstar, has attractive land holdings primarily in Western Canada and a proven, experienced management team. primarily in Western Canada and a proven, experienced management team. Key performance indicators Key performance indicators R EAL ESTATE R EVE N UE 1 $ I N M I LLIONS R EAL ESTATE FU N DS FR OM OPE RATIONS 1 $ I N M I LLIONS 20 0 15 0 10 0 5 0 FISCAL YEAR 05 06 07 08 6 0 4 5 3 0 15 38.5 23.2 15.3 FISCAL YEAR 05 06 07 08 09 73.9 54.6 19.3 09 RESIDENTIAL COMMERCIAL RESIDENTIAL COMMERCIAL (1) Fiscal 2005-2008 have been restated to exclude Sobey Leased Properties which was sold on April 22, 2008. (1) Fiscal 2005-2008 have been restated to exclude Sobey Leased Properties which was sold on April 22, 2008. Strategic priorities Strategic priorities Real estate development at Empire is focused on establishing both certainty and Real estate development at Empire is focused on establishing both certainty and a healthy pace of growth for Sobeys and Crombie REIT. Our strategy rests firmly a healthy pace of growth for Sobeys and Crombie REIT. Our strategy rests firmly on Sobeys’ substantial in-house expertise in selecting commercial locations, ECL on Sobeys’ substantial in-house expertise in selecting commercial locations, ECL Developments’ property development capabilities and Crombie REIT’s operational Developments’ property development capabilities and Crombie REIT’s operational excellence. At all times we are guided by criteria that exemplify Empire’s investment excellence. At all times we are guided by criteria that exemplify Empire’s investment discipline and tradition of building assets to own for the long-term. discipline and tradition of building assets to own for the long-term. 2009 Annual Report 5 food retailing FOCUSED ON FOOD The strength of Sobeys’ performance in a challenging While our presence as a national grocer continues to economic and competitive environment affirms the power grow, our approach remains distinctly local. Across the and potential of our unwavering focus on food. We remain country we have regional management teams, and affiliate determined to “out-food”, “out-fresh”, “out-service” and franchise owners and store operators who understand the “out-market” those who choose to compete with us for a unique characteristics, cultures and occasion-based needs of larger share of Canadian consumers’ food requirements. our customers. Our employees are trained and encouraged Our focus allowed us to deliver solid financial and operating to take an active role in identifying local preferences to results in fiscal 2009, while we continue to build a healthy optimize store-level merchandising decisions. We take pride and sustainable retail food business and infrastructure in the quality, value and convenience of our meat, deli, for the long term. seafood, bakery, produce and prepared food offerings and we thrive on serving our customers in ways they value most. Bill McEwan, President and CEO, Sobeys Inc. (left) with Justine Lorimer, Sobeys Deli Clerk, Pictou, Nova Scotia A modern retail network been enhanced by the $1.3 billion invested in our store During fiscal 2009, Sobeys continued to benefit from network and infrastructure since the start of fiscal 2007. the significant investments and upgrades made over the We continue to modernize our distribution facilities past several years in our stores, distributions centres, to support growth in our retail network. The recent opening business systems and processes, and in the engagement of our new distribution centre in Vaughan, Ontario is and training of our employees, who are the key to our expected to significantly improve Sobeys’ supply chain growth and success. efficiencies while enhancing service levels to the Over the past fiscal year, we have invested more than majority of stores within the province. The new facility $382 million to expand and improve the quality of our incorporates WITRON Integrated Logistics Inc.’s fully retail square footage, opening or relocating 47 new stores, automated warehouse and picking system which has been expanding 11 stores and closing 52 stores, for a net proven to significantly reduce distribution costs, order increase of 258,000 square feet across the country. Our selection time and errors while increasing load integrity operating results and key performance improvements have and efficiency. Same-Store SaleS +5.2% driven by our unwavering focus on food 2009 Annual Report 7 food retailing Improved execution In fiscal 2009, we continued the transformation of our business process and information systems to support our food-focused strategy. Over several years we have made significant progress standardizing back shop functions. These changes have allowed us to leverage technology investments and significantly improve the efficiency of all facets of our business. During the past year, the third wave of SMART retailing – our ongoing operational excellence and productivity program – continued to drive incremental improvements. The expansion of our higher-margin fresh departments including prepared meals, deli and bakery, has been effective at increasing customer appeal, transaction size and sales per square foot. The disciplines of SMART retailing have equipped our people with the means to keep labour and product costs under control while carefully monitoring the ever-shifting demand for our fresh and prepared products. Understanding our customers We earn the patronage of our shoppers based on the quality, value and consistency of our product and service offerings. Our Club Sobeys and AIR MILES® customer loyalty programs reward our customers’ patronage and serve as a means to collect and gain important insight into their buying habits and preferences. The launch of Club Sobeys and Club Sobeys MasterCard in Ontario and Western Canada combined with the AIR MILES® Reward Program that we have offered to consumers in Atlantic Canada and Québec for a number of years, makes shopping at Sobeys an even more rewarding experience right across the country. Customer response to the new Club Sobeys program has exceeded our expectations with the program meeting its annual objectives within six weeks of its launch in September 2008. Late in fiscal 2009, we expanded our AIR MILES® program to also include Foodland stores in Atlantic Canada. Employees such as Sylvie Gendron take pride in the quality, value and convenience of our fresh food offerings. 8 Empire Company Limited Sobeys rewards customers through our recently launched Club Sobeys and Club Sobeys MasterCard in Ontario and Western Canada and our AIR MIlES® Reward Program in Atlantic Canada and Québec. These comprehensive rewards programs also serve as a means to gain insight into the buying habits and preferences of our customers. Solid growth Today, more of our store network is at a standard of operation that we consider current. Invest ments in equipment, décor, shelving, point of sale systems and in-store fresh food preparation facilities have improved the selling, productivity and customer service elements within our stores. Consequently more customers are shopping more often and buying more on each trip resulting in a sustained increase in sales per square foot. SOB EYS’ SAM E-STOR E SALES G R OW TH % SOB EYS’ SALES PE R SQUAR E F OOT $ 6 . 0 4 . 5 3 . 0 1. 5 5.2 11.00 10 .00 9.00 8.00 10.73 FISCAL YEAR 05 06 07 08 09 FISCAL YEAR 05 06 07 08 09 AIR MILES® is a registered trademark of AIR MILES International Trading B.V. Used under license by LoyaltyOne, Inc. 2009 Annual Report 9 Compliments innovations Sobeys built upon its reputation for excellence in prepared meals with the introduction of Compliments and Gourmet Minute prepared meal products produced by a world class manufacturer, Fleury Michon. food retailing Inspired to innovate Operational excellence, cost and productivity improvements and engaging our people are at the very core of our focus and determination to be widely recognized as the best food retailer in the country. Sobeys’ reputation for excellence in prepared meals has proven to be a significant benefit in an uncertain economy as consumers seek alternatives to dining out. In fiscal 2009, we continued to build upon our leadership in this area with the introduction of Compliments and Gourmet Minute prepared meal products produced by a world class manufacturer, Fleury Michon. These premium quality products have been available at grocery stores across Europe for years and we believe the great quality and value will resonate with Canadian shoppers. Customer response has been very positive and we expect to roll out these exceptional products across much of our retail network in the year ahead. Ready for challenges ahead Sobeys has been able to continue to grow sales and profitability in an intensely competitive market, but we have no appetite for complacency. We are excited about our opportunities for continued sales, earnings and market share growth. We are aware that today’s business climate will challenge even the best-run companies and that while the retail food business may be recession resistant, it is by no means recession proof. We intend to innovate, execute and grow in a manner consistent with our intention to grow shareholder value by being widely recognized as the best food retailer in the country – period. Bill McEwan President and CEO Sobeys Inc. June 26, 2009 10 Empire Company Limited Sobeys Urban Fresh, Jasper Avenue, Edmonton, Alberta Our five core retail food formats ensure that we have the right offering in the right-sized stores for each community we serve. LEARN MORE Sobeys.com/club-sobeys Compliments.ca Compliments.ca/inspired-magazine 2009 Annual Report 11 real estate A SUSTAINAblE COMPETITIvE ADvANTAGE During fiscal 2009, the real estate division accelerated With respect to residential real estate operations, as the pace of its development in close cooperation we expected, Genstar’s contribution to Empire’s operating with Sobeys and Crombie REIT. We believe this strategic income declined in fiscal 2009 as a result of diminishing partnership represents a significant and sustainable activity in new home construction. However, we are competitive advantage. confident that this investment will continue to yield solid At the heart of this advantage is an integrated real estate returns over the long term. strategy focused on food-anchored commercial property development. Sobeys brings valued site selection expertise Going forward for commercial locations, with ECL Developments as We are confident that Empire will continue to generate value the developer for the sites. Crombie REIT, in which we from its real estate assets throughout the economic cycle. currently have a 47.4 percent equity interest, has in turn the Our real estate development activities are focused on a very operational expertise to further optimize value creation. defensive sector of the commercial real estate market and Our growth strategy is disciplined with every investment we are working closely with the Sobeys’ food retailing team. decision guided by pre-established criteria, including: The unique and integrated relationship that ECL Developments has with Sobeys and Crombie REIT promises to deliver long-term sustainable value. We will continue to take advantage of the opportunities generated by this unique relationship. Frank C. Sobey President ECL Properties Limited June 26, 2009 ➤ Great property location; ➤ Disciplined cost controls; ➤ Beneficial competitive effect for Sobeys; and ➤ Satisfactory return on investment. This investment discipline, combined with coast-to-coast exposure and regional intelligence, enhances our potential for success, even in the toughest environment. Steady results from our investments Our interest in Crombie REIT continued to generate solid operating results in fiscal 2009 with operating income contribution to Empire increasing 45.6 percent. There was improvement in operating performance from existing properties and profitable growth from new acquisitions. At the end of March, 2009, the overall occupancy rate at Crombie REIT’s properties was a healthy 94.2 percent. 12 Empire Company Limited ProJeCt PIPelINe 1.7million square feet 18 projects Today, our growing retail development pipeline consists of 18 projects in Ontario, Québec and Atlantic Canada with more than 1.7 million square feet of gross leasable area. More than 90 percent of our current projects under development will be anchored by a Sobeys business. In the year ahead, we plan to invest up to $100 million in additional development opportunities to support Sobeys’ growth. LEARN MORE Empireco.ca Crombiereit.com Genstar.com Frank C. Sobey (left), President, ECL Properties Limited with Donald E. Clow, President, ECL Developments Limited long-term progress bUIlDING ENDURING vAlUE 00 March 01 January 02 March FISCAL 2000 REVENUE ($ IN MILLIONS) $9,100.1 Empire repurchases 5.5 million Non-Voting Class A shares for $187 million. The real estate division purchases a 35.7% interest in Genstar Development Partnership for $29 million. Sobeys sells its Serca Foodservice operation to SYSCO for $411 million. July Empire sells its 25% investment in Hannaford Bros. Co. for $1.2 billion. 03 – 04 February 04 Sobeys acquires Commisso’s Food Markets for $61 million and the real estate division acquires Commisso’s real estate assets for $42.5 million. OPER ATING EARNINGS ($ IN MILLIONS) $84.7 BOOK VALUE ($ PER SHARE) $8.73 14 Empire Company Limited Empire’s ability to build shareholder value is based on investments in the businesses we understand best – food retailing and related real estate. With a focus on meeting the everyday needs of Canadian shoppers, these businesses have helped Empire achieve steady performance, particularly in the recent difficult economic environment. We are confident they will continue to provide abundant opportunity for growth in the years ahead. BooK ValUe CaGr 18% from 2000 to 2009 08 April Empire sells 61 properties for $428.5 million to Crombie REIT. 05 June Wajax converts to an income trust. Empire sells 2.875 million units, for a $25.6 million gain. September Empire Theatres acquires 27 movie theatres for $83 million. 06 March 07 June Crombie REIT completes its initial public offering. Empire sells 44 properties to the REIT for $468.5 million and retains a 48.3% ownership interest. August Sobeys acquires Achille de la Chevrotière Ltée, which included 25 stores in northern Québec and Ontario as well as a distribution centre in Rouyn-Noranda for $79.2 million. Empire acquires the outstanding common shares of Sobeys that it did not own for $1.06 billion, achieving 100% ownership. September Sobeys acquires Thrifty Foods for $253.6 million. At the time, Thrifty’s assets included 20 full-service supermarkets, a distribution centre and a wholesale division on Vancouver Island and the lower mainland of British Columbia. REVENUE ($ IN MILLIONS) $15,015.1 OPER ATING EARNINGS ($ IN MILLIONS) $262.9 BOOK VALUE ($ PER SHARE) $39.14 09 April Empire issued 2,713,000 Non-Voting Class A shares at $49.75 per share for total net proceeds to Empire of approximately $129 million. Proceeds from this equity issue, coupled with strong cash generation from Sobeys, helped reduce Empire’s ratio of debt to capital to 32.7 percent from 39.8 percent at the start of the fiscal year. 2009 Annual Report 15 corporate governance AT THE HEART OF lONG-TERM SUCCESS Empire’s strengthened focus on its food retailing and related debt to capital ratio stands at 32.7 percent and we are real estate continued to pay dividends for our investors confident in our ability to fund our core businesses despite in fiscal 2009. We achieved another year of record financial today’s uncertain economy. performance and delivered total shareholder return of We also continued to advance the effectiveness of your 25 percent. Board. Empire’s Board has strong representation from our The performance of Sobeys was key. Sobeys’ deter mination largest investors and the valued presence of independent to be widely recognized as the best food retailer in Canada directors with a wide range of experience and skill. There is is delivering solid results. Our customers are enjoying the a healthy dynamic in our deliberations that has not only benefits of a modern retail grocery network – with more stores provided valuable advice and counsel for management, but now reflecting current standards, an increasingly efficient excellent stewardship for shareholders. distribution network, as well as business processes and systems In closing, I would like to extend my appreciation to the that enhance profitability through operational excellence. management and employees of Empire and its operating We also continued to make solid progress in our real companies for posting another record performance in fiscal estate division. ECL Developments has established a 2009. It is their efforts that make it possible to reward the breadth of capabilities and a pipeline of properties with loyalty and confidence of our customers and investors. impressive speed and Crombie REIT posted another solid year of operational performance. Empire’s performance in fiscal 2009 is evidence that our strategy is sound and we are executing on all fronts. Our financial performance has also resulted in a reduction in our leverage over the past year, with consolidated net funded debt at the end of fiscal 2009 of $1.07 billion, down from a peak of $1.75 billion following the privatization of Sobeys and the acquisition of Thrifty Foods. Our funded Robert P. Dexter Chair Empire Company Limited June 26, 2009 1 16 2 3 4 5 6 7 8 9 10 Empire Company Limited Recognizing proven capability During 2009, Rob Sobey received the ICD.D designation from the Institute of Corporate Directors upon completion of the Directors Education Program. Rob is currently CEO of Lawtons Drug Stores and was recently chosen by Atlantic Business Magazine as CEO of the Year for Atlantic Canada in 2009. Rob has served on numerous volunteer boards and is currently a Governor of Nova Scotia College of Art and Design and a Trustee on the Board of Queen’s University. Rob recently served as Chairman of both the Art Gallery of Nova Scotia and the Nova Scotia Community College. Empire Company limited board of Directors 1 David F. Sobey New Glasgow, Nova Scotia Director since 1963. 7 Marcel Côté 13 Karl R. Sobey Montreal, Québec Director since 2007. Halifax, Nova Scotia Director since 2001. LEARN MORE Empireco.ca/governance 2 Christine Cross Thundridge, Hertfordshire, United Kingdom Director since 2007. 3 Bill McEwan New Glasgow, Nova Scotia Director since 2007. 4 John L. Bragg Collingwood, Nova Scotia Director since 1999. 5 Mel Rhinelander Toronto, Ontario Director since 2007. 6 Robert G. C. Sobey Stellarton, Nova Scotia Director since 1998. 8 John R. Sobey 14 Malen Ng Pictou County, Nova Scotia Director since 1979. Toronto, Ontario Director since 2007. 9 Frank C. Sobey 15 Paul D. Sobey Stellarton, Nova Scotia Director since 2007. Pictou County, Nova Scotia Director since 1993. 10 David Leslie Toronto, Ontario Director since 2007. 11 Stephen J. Savidant Calgary, Alberta Director since 2004. 12 Donald R. Sobey Pictou County, Nova Scotia Director since 1963. 16 David S. Ferguson Atlanta, Georgia Director since 2007. 17 Edward C. Harsant Woodbridge, Ontario Director since 2003. 11 12 13 14 15 16 17 Robert P. Dexter Chair, Empire Company Limited Halifax, Nova Scotia – Director since 1987. the bigger picture RESPONSIbIlITY: A lASTING COMMITMENT Proudly serving our communities is more than a statement of what we do – it’s at the very foundation of who we are. In 2009, the management, employees, franchisees and affiliates within Empire, Sobeys, ECL Properties and Empire Theatres supported hundreds of charities and causes across Canada at a corporate, regional and personal level. Many are directly related to our businesses, including dozens of health and food-related programs, such as food banks. But our reach is broad, extending to the arts, education, environment and healthcare. A greener community Empire’s focus on community is further shaped by our Knowing that sustainability is a journey, we are also commitment to improving our environmental performance acting upon opportunities to achieve bigger results more through reasonable, practical, environmentally responsible quickly by: business practices that are in the long-term best interests of our shareholders, employees, customers, suppliers and communities. We strive to have every employee, manager and franchisee committed to managing our operations in a manner that minimizes our environmental impact. We are also committed to continually assessing, monitoring and enhancing our operational procedures and management systems so that our efforts to minimize our environmental ➤ Sharing best practices and insights across regions; ➤ Accelerating evaluation and adoption of new technologies and solutions; ➤ Developing national targets and policies; ➤ Defining common measurement metrics, and deploying tools for easier data capture, tracking, and reporting by all business units; and ➤ Participating in industry environmental initiatives. impact are effective. Further, we are committed to Our goal is to integrate sustainability into all aspects promoting a culture of environmental awareness across of our business. our real estate and food retailing networks. Sobeys is working within our industry and with various levels of government to establish and comply with environmental standards related to waste diversion and store energy consumption. In fiscal 2009, we established quantifiable sustainability objectives. 18 Empire Company Limited We are committed to establishing a culture of awareness and managing our food retailing and real estate operations in a manner that minimizes environmental impact. We are making significant progress in the following areas: LEED®-certified buildings Improving energy efficiency Reducing waste The IGA store in Saint-Pascal Our efforts to conserve energy The sustainable use of resources de Kamouraska was the first are ongoing as we continuously includes waste reduction and LEED*-certified supermarket in challenge ourselves and our waste diversion through recycling, Canada, and a second store and suppliers to identify innovative ways reuse, and composting organic a distribution centre in Québec to reduce the energy requirements matter. Many of our stores are in the process of obtaining LEED certification. This LEED at our stores and distribution and distribution centres have centres. The energy consumption reduced costs and increased experience has had an influence in our recently expanded head revenue by diverting cardboard, on our building decisions, office building, which is in the even where LEED certification process of obtaining LEED certification, has not increased despite a 60% increase in space. sustainable business. plastic and metal from waste to recycling – evidence of the benefits of becoming a more is not possible. *Leadership in Energy * and Environmental Design LEED is a registered trademark of the U.S. Green Building Council. 2009 Annual Report 19 the bigger picture Frank H. Sobey Awards for Excellence in Business Studies 2009 scholarship recipients From left to right: Graham Watts, University of Prince Edward Island; Myra Freeman, Fund Director; Michael Harris, Memorial University; David F. Sobey, Fund Chair; Thor Jensen, University of New Brunswick; Aaron Murphy, Saint Mary’s University; Bob Brown, Fund Director; Katie Brewer, Cape Breton University; and Paul Sobey, Fund Director. Missing from the photo is Ashley Hannon, Acadia University. The Sobey legacy Empire’s commitment to investing in our future is closely One of our scholarship programs is the Frank H. Sobey tied to the legacy of the Sobey family. Funding from the Awards for Excellence in Business Studies that annually Sobey Foundation and the Empire group of companies, presents six $10,000 awards to full-time business school as well as contributions from the Sobey family, support a students attending Atlantic universities. The candidates are variety of heathcare, educational and community-based nominated by the Deans of Business at each university initiatives across Canada. Several scholarship programs based on academic standing, entrepreneurial interest, assist young people in their individual effort to attain extracurricular and community activities, employment history the education so necessary to succeed today, while support and career aspirations. for the capital campaigns at several universities enhances the quality of education in Canada. Sobey Art Award Vancouver artist Tim Lee was the winner of the 2008 Sobey Art Award. Working with photography, video, text and sculpture, Tim’s work both replicates and re-imagines significant moments in art history and popular culture. The $70,000 Sobey Art Award is Canada’s premier art award recognizing and supporting contemporary artists under the age of 40. For more information visit www.sobeyartaward.ca. LEARN MORE Sobeyartaward.ca Top40award-canada.org 20 Empire Company Limited Top 40 under 40™ Developing Jason Potter, President Operations for Sobeys Atlantic tomorrow’s leaders region, (pictured above) was recognized as one of Canada’s During fiscal 2009, Top 40 Under 40™ for 2008. This national award honours Sobeys Inc. began training young Canadians for their vision, leadership, innovation, chartered accountants through an innovative professional achievement and community involvement. Jason has worked program developed in partnership with the Institute of with Sobeys since 1992 in progressively senior operations Chartered Accountants of Nova Scotia (ICANS). Diane and mer chandising roles. His commitment extends beyond Cameron (above right), Director, General Accounting and Sobeys into the community where he serves as Chair of the Reporting, was instrumental in Sobeys becoming one Grocery Industry Foundation Together (GIFT) in Atlantic of a select group of leading corporations across Canada Canada. GIFT Atlantic makes a meaningful difference in to provide CA designation training in industry. As an the lives of children by contributing more than $500,000 enhancement to the program, Sobeys created a mentoring to children’s charities in Atlantic Canada each year. This is program that pairs CA students such as Jennifer Sheppard the second year in a row that a Sobeys employee has (above left) with an experienced CA such as Diane. received the award. ™ The Caldwell Partners Helping kids coast-to-coast As corporate sponsors, Empire Theatres and Sobeys Inc. assist Kids Help Phone in raising funds for bilingual, confidential and anonymous phone and online counselling and support service for children and youth across Canada. During fiscal 2009, Empire Theatres raised more than $85,000 through initiatives such as the first national Movie Day for Kids Help Phone, the Being There for Kids Dinner, the annual Walk for Kids Help Phone and in-theatre coin box programs at all theatre locations. In addition to fundraising support, Empire Theatres helps raise awareness of Kids Help Phone through in-theatre advertising. Sobeys’ support of Kids Help Phone has focused primarily on the annual Being There for Kids Dinner, which last year raised more than $1.2 million for this vitally important service. 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 Corporate Secretary Officers of Operating Companies Sobeys Inc. Robert P. Dexter Chair Bill McEwan President and Chief Executive Officer François Vimard Chief Financial Officer Jason Potter President Operations, Sobeys Atlantic Marc Poulin President Operations, Sobeys Québec David Jeffs President Operations, Sobeys Ontario Sylvain Prud’homme President Operations, Sobeys West Dennis Folz Chief Human Resources 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 Stuart G. Fraser President and Chief Executive Officer Paul W. Wigginton Vice President, Finance and Chief Financial Officer 22 Empire Company Limited management’s discussion and analysis Table of Contents 24 Forward-Looking Information 41 Financial Condition 25 Non-GAAP Financial Measures 25 Empire’s Strategic Direction 25 Overview of the Business Food Retailing Real Estate Investments and Other Operations 27 Operational Changes 27 Consolidated Operating Results 28 Management’s Explanation of Fiscal 2009 Annual Consolidated Results Revenue Operating Income Interest Expense Income Taxes Earnings before Capital Gains and Other Items Capital Gains and Other Items Net Earnings 30 Outlook 31 Fiscal 2009 Operating Performance by Division Food Retailing Real Estate Investments and Other Operations 38 Quarterly Results of Operations Capital Structure and Key Financial Condition Measures Shareholders’ Equity Liabilities Financial Instruments 44 Liquidity and Capital Resources Operating Activities Investing Activities Financing Activities Guarantees and Commitments Free Cash Flow 49 Accounting Policy Changes 51 Critical Accounting Estimates 53 Disclosure Controls and Procedures 53 Internal Controls over Financial Reporting 53 Related-Party Transactions 54 Subsequent Events 54 Other Matters 55 Designation for Eligible Dividends 55 Contingencies 55 Risk Management 59 Employee Future Benefit Obligations 59 Non-GAAP Financial Measures CONSOLIDATE D R EVE N U E $ I N M I LLIONS CONSOLIDATE D OPE RATING EAR N INGS $ I N M I LLIONS CONSOLIDATE D SHAR E HOLDE RS’ EQU ITY $ I N M I LLIONS 16 , 0 0 0 12 , 0 0 0 8 , 0 0 0 4 , 0 0 0 15,015.1 2 8 0 210 14 0 70 262.9 2 , 8 0 0 2 ,10 0 1, 4 0 0 70 0 2,683.5 FISCAL YEAR 05 06 07 08 09 FISCAL YEAR 05 06 07 08 09 FISCAL YEAR 05 06 07 08 09 2009 Annual Report 23 management’s discussion and analysis MAy 2, 2009 (In MIllIons exCepT shARe CApITAl) 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 2, 2009, as compared to the 52 weeks ended May 3, 2008. 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 manage- ment. 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 2, 2009, as compared to the 52 weeks ended May 3, 2008. 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 2009 Annual Report, on page 100, is a glossary of terms used throughout this MD&A. The information contained in this MD&A is current to June 26, 2009, 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, financial condition, results of operations, cash flows, performance, business prospects and opportunities. All statements other than statements of historical facts included in this MD&A, including statements regarding the Company’s objectives, plans, goals, strategies, future growth, financial condition, results of opera- tions, cash flows, performance, business prospects and opportunities, may constitute forward-looking information. Forward-looking information and statements are identified by words or phrases such as “anticipates”, “expects”, “believes”, “estimates”, “intends”, “could”, “may”, “plans”, “predicts”, “projects”, “will”, “would”, “foresees”, “remain confident that” and other similar expressions or the negative of these terms. These statements are based on Empire management’s reasonable assumptions and beliefs in light of the information currently available to them. The forward-looking information contained in this MD&A is presented for the purpose of assisting the Company’s security holders in understanding its financial position and results of operation as at and for the periods ended on the dates presented and the Company’s strategic priorities and objectives and may not be appropriate for other purposes. By its very nature, forward-looking information requires the Company to make assumptions and is subject to inherent risks and uncertainties, which give rise to the possibility that the Company’s predictions, forecasts, expectations or conclusions will not prove to be accurate, that the Company’s assumptions may not be correct and that the Company’s objectives, strategic goals and priorities will not be achieved. Although the Company believes that the predictions, forecasts, expectations or conclusions reflected in the forward-looking information are reasonable, it can give no assurance that such matters will prove to have been correct. Such forward-looking information is not fact but only reflections of management’s estimates and expectations. These forward-looking statements are subject to uncertainties and other factors that could cause actual results to differ materially from such statements. These factors include but are not limited to: changes in general industry, market and economic conditions, competition from existing and new competitors, energy prices, supply issues, inventory management, changes in demand due to seasonality of the business, interest rates, changes in laws and regulations, operating efficiencies and cost saving initiatives. In addition, these uncer tainties and risks are discussed in the Company’s materials filed with the Canadian securities regulatory authorities from time to time, including the Risk Management section of this MD&A. Empire cautions that the list of important factors is not exhaustive and other factors could also adversely affect our results. Readers are urged to consider the risks, uncertainties and assumptions carefully in evaluating the forward-looking information and are cautioned not to place undue reliance on such forward-looking information. Forward-looking statements may not take into account the effect on the Company’s business of transactions occurring after such statements have been made. For example, dispositions, acquisitions, asset write-downs or other changes announced or occurring after such statements are made may not be reflected in forward-looking statements. The forward-looking information in this MD&A reflects the Company’s expectations as of June 26, 2009, and is subject to change after this date. 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 applicable securities laws. 24 empire Company limited Management’s Discussion and Analysis non-GAAp Financial Measures There are measures included in this MD&A that do not have a standardized meaning under 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 manage- ment 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 consis tency 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 100.0 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 47.9 percent ownership interest in Crombie REIT. Subsequent to year-end, on June 25, 2009, Crombie REIT closed a bought-deal public offering of units at a price of $7.80 per unit. In satisfaction of its pre-emptive right with respect to the public offering, the Company subscribed for $30.0 million of Class B Units (which are convertible on a one-for-one basis into units of Crombie REIT). Consequently the Company’s interest in Crombie REIT was reduced from 47.9 percent to 47.4 percent. The results of Sobey Leased Properties Limited (“Sobey Leased Properties” or “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 opera tions include wholly-owned ETL Canada Holdings Limited (“Empire Theatres”); Kepec Resources Limited (“Kepec”), a party to 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 $15 billion in annual revenue and approximately $5.9 billion in assets, Empire and its related companies employ over 90,000 people, including its franchisees and affiliates. Food Retailing Empire’s food retailing division is carried out through its wholly-owned subsidiary, Sobeys. Sobeys conducts business through more than 1,300 retail grocery stores (corporately owned and franchised) which operate 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. Sobeys’ financial contribution to Empire reflects Empire’s weighted average ownership of 100.0 percent for fiscal 2009 and weighted average ownership of 96.9 percent for fiscal 2008. 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 2009 Annual Report 25 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 expanding 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 extra, Foodland, Price Chopper and Thrifty Foods. During the fiscal year, Sobeys opened, replaced, expanded, renovated, acquired and/or converted the banners in 74 stores (2008 – 157 stores). In fiscal 2009, Sobeys continued to execute a number of initiatives in support of its food- focused strategy, including product and service innovations, productivity initiatives and business process, supply chain and system upgrades. Real estate Empire’s real estate division includes commercial and residential operations. Our commercial operations are focused on the development of food-anchored shopping plazas through wholly-owned ECL, which includes wholly-owned ECL Developments and a 47.4 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 division’s financial results between commercial property operations consisting of ECL, and residential property operations which consists primarily of Genstar. 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 guided by pre-established criteria, including: Great property location; Disciplined cost controls; Beneficial competitive effect for Sobeys; and Satisfactory return on investment. ECL Developments is focused on the expansion of its development pipeline through the identification of attractive Investments and other operations The third component of Empire is investments and other operations, consisting primarily of a 27.6 percent ownership interest in Wajax, wholly-owned Empire Theatres and Kepec. The market value of Empire’s equity accounted investment in Wajax at the end of fiscal 2009 was $71.3 million (2008 – $153.4 million), representing an unrealized gain of $40.3 million (2008 – $121.8 million). commercial real estate locations to be successfully developed from an economic standpoint, for preferential sale to Crombie REIT or, in absence of their interest, to a third party. ECL Developments has approximately 1.7 million square feet of gross leasable area (“GLA”) under development as at fiscal year-end, as compared to approximately 1.2 million square feet at the end of last fiscal year. This increase is due to property acquisitions made in fiscal 2009. Our property pipeline is comprised of 18 properties located in Nova Scotia, New Brunswick, Quebec and Ontario. The properties are primarily retail plazas with approximately 60 percent of the GLA located outside of Atlantic Canada. More than 90 percent of the projects currently under development will be anchored by a Sobeys business. The properties are anticipated to be made available to Crombie REIT over the next one to four years. Pursuant to a development agreement with Crombie REIT dated March 23, 2006, between ECL and Crombie REIT, ECL provides Crombie REIT with a preferential right to acquire all property developments proposed to be undertaken by ECL Developments. ECL also has a non-competition agreement with Crombie REIT dated March 23, 2006, 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. The Empire group of companies will continue to work closely with Crombie REIT to identify development opportunities. Other operations include wholly-owned Empire Theatres, the second largest movie exhibitor in Canada which, as of May 2, 2009, owned or had an interest in 51 locations representing 377 screens, and Kepec. 26 empire Company limited Management’s Discussion and Analysis operational Changes Listed below is a summary of events that impacted the fiscal year 2009 operating results and which affect the comparability of information for the 13-week and 52-week periods ended May 2, 2009 versus the 13-week and 52-week periods ended May 3, 2008: 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 100.0 percent in fiscal 2009 as compared to a weighted average ownership interest of 96.9 percent in fiscal 2008. The weighted average ownership of Sobeys was 100.0 percent in the fourth quarter of fiscal 2009 and the same quarter last year. Sobeys’ sales in fiscal 2009 were positively influenced by the acquisition of Thrifty Foods, which closed on September 12, 2007. The assets acquired included 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. For additional details of the acquisition, see Note 26 of the audited annual consolidated fiscal 2009 financial statements. Fiscal 2009 included a full year of sales from Thrifty Foods compared to fiscal 2008 which reported Thrifty Foods from when it was acquired on September 12, 2007 until May 3, 2008. This acquisition impacted sales recorded in fiscal 2009 by $224.8 million. There was no impact on the comparability of the fourth quarter of fiscal 2009 to the same quarter last year. On April 22, 2008, the Company’s real estate division, through Sobey Leased Properties, sold 61 properties to 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 maintained the Company’s interest in Crombie REIT at approximately 48 percent. The Company subsequently sold the remaining SLP assets to Sobeys. The Company’s investment in Crombie REIT is accounted for using the equity method. Details of the sale are outlined in Note 3 of the audited annual consolidated financial statements of the Company for fiscal 2008. This transaction reduced commercial real estate revenue by $20.6 million in fiscal 2009 compared to fiscal 2008 and by $4.9 million in the fourth quarter of fiscal 2009 compared to the same quarter last year. Also impacting comparability are year-over-year costs related to Sobeys’ business process and system initiatives, business rationalization, and privatization costs as outlined under the section titled “Fiscal 2009 Operating Performance by Division – Food Retailing”. 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. Consolidated operating Results highlights Sobeys opened, acquired or replaced 47 corporate and franchised stores, expanded 11 stores, rebannered/ redeveloped 16 stores and closed 52 stores. Revenue of $15.02 billion, up $950.1 million or 6.8 percent. Sobeys same-store sales increased 5.2 percent. Earnings before capital gains (losses) and other items of $262.9 million, up $20.1 million or 8.3 percent. Net earnings of $265.9 million ($4.04 per share), a $49.9 million or 15.8 percent decrease. Successfully completed the issuance of 2,713,000 Non- Voting Class A shares (including the 200,000 issued under the over-allotment option) at $49.75 per share for net proceeds of $129.1 million, which was used to reduce indebtedness at the holding company level. 2009 Annual Report 27 The consolidated financial overview provided below reports on the financial performance for fiscal 2009 relative to the prior two fiscal years. Summary Table of ConSolidaTed f inanCial r eSulTS 52 Weeks Ended ($ in millions, except per share information) May 2, 2009 % of Revenue May 3, 2008 % of Revenue May 5, 2007(1) % of Revenue Revenue Operating income Operating earnings Capital gains (losses) and other items, net of tax $ 15,015.1 100.00% $ 14,065.0 100.00% $ 13,366.7 100.00% 468.1 262.9 3.12 1.75 472.6 242.8 3.36 1.73 431.1 200.1 3.23 1.50 3.0 0.02 73.0 0.52 5.7 0.04 Net earnings $ 265.9 1.77% $ 315.8 2.25% $ 205.8 1.54% Basic earnings per share Operating earnings Capital gains (losses) and other items, net of tax Net earnings Basic weighted average number $ 4.00 $ 3.69 $ 3.05 0.05 $ 4.05 1.11 $ 4.80 0.09 $ 3.14 of shares outstanding (in millions) 65.7 65.6 65.6 Diluted earnings per share Operating earnings Capital gains (losses) and other items, net of tax Net earnings Diluted weighted average number $ 3.99 $ 3.69 $ 3.04 0.05 $ 4.04 1.11 $ 4.80 0.09 $ 3.13 of shares outstanding (in millions) 65.8 65.7 65.7 Dividends per share $ 0.70 $ 0.66 $ 0.60 (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 the fiscal 2008 annual MD&A contained on pages 27 to 68 of the fiscal 2008 Annual Report. Management’s explanation of Fiscal 2009 Annual Consolidated Results The following is a review of Empire’s consolidated financial performance for the 52-week period ended May 2, 2009 compared to the 52-week period ended May 3, 2008. 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 2009 Operating Performance by Division” in this MD&A. Revenue The consolidated revenue for fiscal 2009 was $15.02 billion, an increase of $950.1 million or 6.8 percent compared to fiscal 2008. Growth in Sobeys’ sales of $996.7 million and in investments and other operations’ revenue of $8.1 million was offset by a $54.7 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 and the sale of 61 commercial properties to Crombie REIT in the fourth quarter of last fiscal year. Excluding the impact of the acquisition of Thrifty Foods, Empire’s consolidated sales growth would have been 5.2 percent for the fiscal year. For a list of items that impacted revenue comparability refer to the “Operational Changes” section of this MD&A. Please refer to the section entitled “Fiscal 2009 Operating Performance by Division” for an explanation of the change in revenue by division. 28 empire Company limited Management’s Discussion and Analysis operating Income For the full fiscal year, Empire recorded operating income of $468.1 million, a decrease of $4.5 million or 1.0 percent from the prior year. Please refer to the section entitled “Fiscal 2009 Operating Performance by Division” for an explanation of the change in operating income for each division. The contributors to the change in consolidated operating Interest expense income from last fiscal year are as follows: Sobeys’ operating income contribution to Empire in fiscal 2009 totalled $401.4 million, an increase of $42.4 million or 11.8 percent from the $359.0 million recorded last year. Included in Sobeys’ fiscal 2009 operating income contribu- tion to Empire was a $25.6 million increase in depreciation and amortization expense, reflecting Sobeys’ continued capital investment. Residential property operating income contribution in fiscal 2009 was $33.6 million, a decrease of $17.1 million from the $50.7 million recorded last year as a result of lower residential lot sales in Western Canada. Commercial property operating income in fiscal 2009 was $22.3 million compared to $49.3 million last fiscal year. The $27.0 million decline is primarily attributed to the sale of certain Sobey Leased Properties’ assets (61 properties) to Crombie REIT on April 22, 2008, as Sobey Leased Properties accounted for operating income of $30.0 million last fiscal year. The reduction in operating income from Sobey Leased Properties was partially offset through increased equity accounted earnings from Empire’s interest in Crombie REIT which contributed $19.8 million to operating income in fiscal 2009 versus a $13.6 million contribution last year. Investments and other operations, net of corporate expenses, contributed operating income of $10.8 million in fiscal 2009 compared to a $13.6 million contribution last fiscal year. Equity accounted earnings generated from the Company’s interest in Wajax amounted to $18.5 million versus $19.7 million last year. Operating income generated from other investments and operations, net of corporate expenses, amounted to negative $7.7 million as compared to negative $6.1 million last year. For the 52 weeks ended May 2, 2009, consolidated interest expense equalled $80.6 million, versus $105.8 million in the prior year. The $25.2 million decrease in fiscal 2009 interest expense compared to last fiscal year is primarily due to lower funded debt levels which are principally related to: (i) cash proceeds of $373.5 million received on the sale of certain Sobey Leased Properties’ assets in the fourth quarter last fiscal year; (ii) free cash flow generation by Sobeys which served to reduce its funded debt; and (iii) lower average interest rates on unhedged floating rate indebtedness. The proceeds from the $135 million equity issuance which closed April 24, 2009 also served to reduce funded debt; however, it had a modest impact on lowering annual interest expense as the equity issue closed approximately one week prior to the end of the fiscal year. Consolidated funded debt decreased $270.6 million to $1,302.9 million at the end of fiscal 2009 compared to $1,573.5 million at the end of fiscal 2008, a 17.2 percent decrease. Income Taxes The effective income tax rate for fiscal 2009 was 30.0 percent versus 30.3 percent last year. In the third quarter of fiscal 2008, the Canadian Government approved general federal corporate income tax rate reductions ranging from 1.0 percent to 3.5 per cent by January 2012. These rate reductions, along with recently enacted changes in certain provincial jurisdictions, lowered both the current year income tax rate and the effective rate applied to future timing differences. This resulted in a lower overall effective income tax rate in fiscal 2009 as compared to fiscal 2008. CONSOLIDATE D OPE RATING EAR N INGS $ I N M I LLIONS CONSOLIDATE D OPE RATING EAR N INGS $ PE R SHAR E FU LLY DI LUTE D 2 8 0 210 14 0 70 262.9 4 . 0 0 3 . 0 0 2 . 0 0 1. 0 0 3.99 FISCAL YEAR 05 06 07 08 09 FISCAL YEAR 05 06 07 08 09 2009 Annual Report 29 earnings before Capital Gains and other Items For the 52 weeks ended May 2, 2009, earnings before capital gains and other items amounted to $262.9 million ($3.99 per share) compared to $242.8 million ($3.69 per share) in the prior year. The $20.1 million or 8.3 percent increase is the result of the $25.2 million decrease in interest expense and the $4.5 million decrease in minority interest, partially offset by the $4.5 million decrease in operating income and the $5.1 million increase in income taxes. The table below presents Empire’s segmented earnings before capital gains (losses) and other items, by division for the 52 weeks ended May 2, 2009, compared to the 52 weeks ended May 3, 2008. ($ in millions) Food retailing(1) Real estate Investments & other operations Consolidated 52 Weeks Ended May 2, 2009 52 Weeks Ended May 3, 2008 Year-over-Year ($) Change Year-over-Year (%) Change $ 229.1 36.7 (2.9) $ 191.7 58.9 (7.8) $ $ 262.9 $ 242.8 $ 37.4 (22.2) 4.9 20.1 19.5% (37.7%) 62.8% 8.3% (1) Adjusted for the impact of the amortization and depreciation of various items related to the privatization of Sobeys in June 2007. Capital Gains and other Items net earnings Net earnings for the 52 weeks ended May 2, 2009 totalled $265.9 million ($4.04 per share) as compared to $315.8 million ($4.80 per share) recorded last fiscal year, a decrease of $49.9 million or 15.8 percent. The decrease in net earnings for fiscal 2009 compared to fiscal 2008 reflects the decrease in capital gains and other items of $70.0 million, partially offset by the increase in earnings before capital gains and other items of $20.1 million as discussed. For the full fiscal year, the Company recorded capital gains and other items, net of tax, of $3.0 million as compared to $73.0 million last year. Capital gains and other items, net of tax, in fiscal 2009 were primarily related to the sale of non-core real estate assets for gains of $5.9 million, net of tax, offset by an increase in the provision on asset backed commercial paper (“ABCP”) equal to $3.1 million, net of tax, taken by Sobeys in the third quarter. Capital gains and other items, net of tax, in fiscal 2008 were 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 ABCP held by Sobeys, as discussed in detail in the section entitled “Other Matters” of this MD&A. outlook Management’s primary objective continues to be to maximize the long-term sustainable value of Empire through enhancing 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 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 sold, 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, Empire intends to further reduce our consolidated funded debt over the coming year through the prudent management of 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 a strong management team, improving the customers’ in-store experience and improving our productivity. 30 empire Company limited Management’s Discussion and Analysis Sobeys plans to focus on its workforce management and merchandising initiatives in fiscal 2010 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 already been put in place. Real estate Division Empire’s real estate management group will continue to maximize and prudently reinvest its cash flow to further strengthen its property portfolio. 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 all Sobeys regions and divisions 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 site selection expertise for commercial locations, Crombie REIT with its decades of management expertise, and the robust 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. With respect to residential real estate, Empire remains committed to its investment in Genstar and is very supportive of its management and strategy. Management does caution that earnings contribution from Genstar is trending substantially lower. Genstar in our view continues to be well capitalized and, with a very capable management team, is favourably positioned to capitalize on new profitable growth opportunities. Investments and other operations With respect to Wajax, we expect lower comparative results in calendar 2009. Wajax management advised that they believe their earnings will be lower in calendar 2009 and accordingly reduced monthly distributions to $0.20 per unit. Wajax in our view continues to be well capitalized and, with a very capable management team, is favourably positioned to capitalize on new profitable growth opportunities. Fiscal 2009 operating performance by Division Food Retailing HigHligHTS Sobeys achieved fiscal 2009 sales growth of $996.7 million or 7.2 percent and same-store sales growth of 5.2 percent. Total capital expenditures equalled $382.7 million in fiscal 2009. Opened, acquired or replaced 47 corporate and franchised stores, expanded 11 stores, rebannered/redeveloped 16 stores and closed 52 stores. Funded debt to total capital improved to 31.2 percent at the end of fiscal 2009 compared to the 35.6 percent reported at the end of fiscal 2008. To assess its financial performance and condition, Sobeys’ management monitors a set of financial measures, which evaluate sales growth, profitability and financial condition. The primary financial performance and condition measures for Sobeys are set out below. 52 Weeks Ended May 2, 2009 May 3, 2008 Sales growth Same-store sales growth Return on equity Funded debt to total capital Funded debt to EBITDA Property and equipment 7.2% 5.2% 11.3% 31.2% 1.4x 5.6% 2.8% 10.0% 35.6% 1.7x purchases ($ in millions) $ 383 $ 489 2009 Annual Report 31 The table below presents sales, operating income and net earnings contribution to Empire by Sobeys: ($ in millions) Sales Operating income(1) Net earnings(1) 52 Weeks Ended May 2, 2009 52 Weeks Ended May 3, 2008 Year-over-Year ($) Change Year-over-Year (%) Change $ 14,764.8 401.4 226.0 $ 13,768.1 $ 359.0 186.6 996.7 42.4 39.4 7.2% 11.8% 21.1% (1) Adjusted for the impact of the amortization and depreciation of various items related to the privatization of Sobeys in June 2007. revenue In fiscal 2009, Sobeys achieved sales of $14.76 billion, an increase of $996.7 million or 7.2 percent over fiscal 2008. During the fiscal year, same-store sales (sales from stores in the same locations in both reporting periods) increased by 5.2 percent. Sales growth for the year was driven by Sobeys increased retail selling square footage from new stores and enlargements, coupled with the continued implementation of sales and merchandising initiatives, a full year of sales reported by Thrifty Foods versus approximately eight months of sales reported last year and retail food inflation. Sobeys expects sales growth to continue in fiscal 2010 as a result of on-going capital investment in its retail store network, and continued offering, merchandising, pricing and operational execution improvements across the country. As shown in the table below, excluding the impact of the acquisition of Thrifty Foods on September 12, 2007, Sobeys’ sales growth would have been 5.6 percent in fiscal 2009. ($ in millions) Sobeys’ financially reported sales Impact of Thrifty Foods acquisition 52 Weeks Ended May 2, 2009 52 Weeks Ended May 3, 2008 ($) Change (%) Change $ 14,764.8 $ 13,768.1 $ 996.7 (224.8) $ 771.9 7.2% 5.6% Total store square footage increased by 1.1 percent in fiscal 2009 as a result of the opening of 47 new or replacement stores and the expansion of 11 stores. There were 52 stores closed in fiscal 2009. buSineSS ProCeSS and i nformaTion SySTemS TranSformaTion and r aTionalizaTion CoSTS Sobeys continues to make significant progress in the implemen- tation 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 by focusing on the significant opportunity to upgrade information processing and decision support capabilities. The systems and processes that F OOD R ETAILING R EVE N U E $ I N M I LLIONS F OOD R ETAILING OPE RATING INCOM E $ I N M I LLIONS 16 , 0 0 0 12 , 0 0 0 8 , 0 0 0 4 , 0 0 0 14,764.8 4 0 0 3 0 0 2 0 0 10 0 401.4 FISCAL YEAR 05 06 07 08 09 FISCAL YEAR 05 06 07 08 09 32 empire Company limited Management’s Discussion and Analysis were implemented were developed over several years and were focused on standardizing and streamlining the “back shop” in support of Sobeys’ food-focused strategy. These changes allow Sobeys to leverage technology investments, improve efficiencies and are expected to lower costs over the long term. Sobeys completed the implementation of this system in Ontario during the third quarter of fiscal 2007 and in Western Canada during the second quarter of fiscal 2008. The business process and system initiative costs primarily included labour, implementation and training costs associated with these initiatives. There were no costs incurred in the fourth quarter of the current or prior year related to these initiatives. For the 52 weeks ended May 2, 2009, there were no pre-tax costs incurred related to these initiatives ($8.6 million in the 52 weeks ended May 3, 2008). The implementation of these initiatives support all aspects of the business including operations, merchandising, distribution, human resources and finance. They are important enablers of further initiatives including a new distribution facility in Ontario that was announced on November 21, 2006. When it begins operations in the first quarter of fiscal 2010, the new distribution centre, located in Vaughan, Ontario, will utilize automation technology and equipment, and significantly increase Sobeys’ warehouse and distribution capacity while reducing overall distribution costs and improving service to its store network and customers. During fiscal 2009, Sobeys recognized $6.9 million of severance costs (2008 – $0.5 million) related to the development of this automated facility, which included the severance costs associated with a resulting rationalization of certain administrative functions in Ontario. The new distribution centre is expected to provide annual distribution savings in excess of these costs and any additional business rationalization or restructuring costs incurred leading up to its opening. During the first quarter of fiscal 2008, Sobeys also performed a rationalization of administrative functions in its national and regional departments. An additional $3.8 million of rationalization costs were incurred in fiscal 2009 (2008 – negative $1.8 million). The reversal in fiscal 2008 was the result of changes in management’s estimate of expected costs. The total pre-tax costs of the above initiatives can be summarized as follows: ($ in millions) 13 Weeks Ended May 2, 2009 13 Weeks Ended May 3, 2008 52 Weeks Ended May 2, 2009 52 Weeks Ended May 3, 2008 Business process and system initiative costs Rationalization costs Total costs $ $ – 1.6 1.6 $ $ – $ – $ (0.5) (0.5) $ 10.7 10.7 $ 8.6 (1.8) 6.8 oPeraTing inCome Sobeys reported operating income of $406.1 million during fiscal 2009, an 11.6 percent increase from last year’s $363.8 million. Sobeys’ fiscal 2009 operating income includes a $24.7 million increase in depreciation and amortization expenses, reflecting Sobeys’ commitment to continued capital investments. Sobeys recorded operating income margin in the fiscal year was 2.75 percent compared to 2.64 percent in the prior year. Sobeys will continue to focus on disciplined cost management initiatives, supply chain and retail productivity improvements and migration of best practices across its regions and divisions to continue to fuel and fund investments to drive sales and improve margins over time. After adjusting for the impact of the amortization and depreciation of various items related to the privatization as discussed, Sobeys’ operating income contribution to Empire in fiscal 2009 was $401.4 million compared to a contribution of $359.0 million in fiscal 2008. Sobeys’ operating income margin for fiscal 2009 after adjusting for the above items equalled 2.72 percent compared to 2.61 percent for fiscal 2008. neT earningS Sobeys reported net earnings of $229.2 million in fiscal 2009 compared to $196.4 million last year, a $32.8 million or 16.7 percent increase. The earnings increase largely reflects the $42.3 million improvement in operating income which included a $24.7 million increase in depreciation and amortization, a $3.1 million provision, net of tax, related to ABCP in fiscal 2009 compared to a $6.3 million provision, net of tax, in fiscal 2008, and a $0.2 million decrease in interest expense; partially offset by an increase in income taxes of $10.9 million and an increase in minority interest expense of $2.0 million. Adjusting for the impact of the depreciation and amortization related to the privatization and the related tax impact, as well as for the change in Empire’s weighted average ownership position in Sobeys (100.0 percent for fiscal 2009 compared to 96.9 percent for fiscal 2008), the food retailing division contributed net earnings of $226.0 million to Empire for fiscal 2009, an increase of $39.4 million or 21.1 percent over the $186.6 million recorded in fiscal 2008. 2009 Annual Report 33 Real estate HigHligHTS The sale of non-core properties for capital gains, net of tax, of $5.9 million. A 45.6 percent increase in operating income from Crombie REIT compared to fiscal 2008, largely as a result of the acquisition of 61 Sobey Leased Properties assets in the fourth quarter of fiscal 2008. Operating income from Genstar of $33.6 million in fiscal 2009 compared to $50.7 million reported in fiscal 2008. Real estate management assesses its financial performance and condition through monitoring of key financial measures. The primary financial performance and condition measures are set out below. 52 Weeks Ended May 2, 2009 May 3, 2008 Funds from Operations ($ in millions) Return on Equity(1) Funded Debt to Total Capital Development Pipeline $ 38.5 17.8% 25.6% $ 64.3 17.7% 22.4% (in millions of square feet) 1.7 1.2 (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, net earnings and funds from operations for the real estate division’s commercial operations and residential operations. 52 Weeks Ended ($ in millions) May 2, 2009 May 3, 2008 ($) Change (%) Change Revenue Residential Sobey Leased Properties(1) Other Commercial Inter-segment Elimination Operating income Residential Sobey Leased Properties(1) Crombie REIT(2) Other Commercial Net earnings Residential Commercial Funds from operations(3) Residential Commercial $ $ $ 54.6 – 16.4 2.9 73.9 (2.9) 71.0 33.6 – 19.8 2.5 $ $ 85.2 20.6 19.9 34.9 160.6 (34.9) $ 125.7 $ $ $ 50.7 30.0 13.6 5.7 (30.6) (20.6) (3.5) (32.0) (86.7) 32.0 (54.7) (17.1) (30.0) 6.2 (3.2) $ 55.9 $ 100.0 $ (44.1) $ $ $ $ 23.2 19.4 $ 34.7 20.1 $ 42.6 $ 54.8 $ (11.5) (0.7) (12.2) 23.2 15.3 $ 38.5 $ 35.3 29.0 64.3 $ (12.1) (13.7) $ (25.8) (35.9%) (100.0%) (17.6%) (91.7%) (54.0%) 91.7% (43.5%) (33.7%) (100.0%) 45.6% (56.1%) (44.1%) (33.1%) (3.5%) (22.3%) (34.3%) (47.2%) (40.1%) (1) On April 22, 2008, Sobey Leased Properties sold 61 properties to Crombie REIT with the remaining assets of Sobey Leased Properties transferred to Sobeys. (2) Equity accounted earnings in Crombie REIT during the fiscal year. (3) Operating earnings plus depreciation and amortization. 34 empire Company limited Management’s Discussion and Analysis revenue Real estate division revenues, net of elimination, amounted to $71.0 million in fiscal 2009 as compared to $125.7 million in the prior year. The $54.7 million reduction in revenue from the real estate division was anticipated as a result of an expected slowdown in residential lot sales and the sale of 61 Sobey Leased Properties’ assets to Crombie REIT in the fourth quarter of fiscal 2008. Revenue from residential operations was $54.6 million in fiscal 2009 compared to $85.2 million last year, a $30.6 million or 35.9 percent decrease. Commercial property revenues, net of elimination, for fiscal 2009 equalled $16.4 million, a decrease of $24.1 million or 59.5 percent compared to revenues of $40.5 million reported last year. oPeraTing inCome During fiscal 2009, real estate division operating income declined $44.1 million or 44.1 percent compared to last year as the result of a $30.0 million decrease in operating income from Sobey Leased Properties, a $17.1 million decrease in residential operating income, a $3.2 million decrease in commercial operating income, partially offset by an increase in equity earnings from Crombie REIT of $6.2 million. The decline in operating income generated by residential operations was anticipated given management’s expectation for a housing market slowdown in Western Canada. The decline in operating income generated by Sobey Leased Properties was expected given the sale of 61 properties to Crombie REIT in the fourth quarter of fiscal 2008. CaPiTal gain S (loSSeS) and oTH er iTem S Capital gains and other items, net of tax, for the real estate division totalled $5.9 million in fiscal 2009 (fiscal 2008 – capital losses and other items, net of tax, of $4.1 million). Capital gains in fiscal 2009 relate primarily to the sale of non-core properties while the capital losses in fiscal 2008 relate primarily to the impairment charge taken on one commercial property. neT earningS Real estate division net earnings contribution in fiscal 2009 amounted to $42.6 million compared to $54.8 million last year, a $12.2 million or 22.3 percent decrease. The earnings decline largely reflects the $44.1 million reduction in operating income as discussed, partially offset by a $12.6 million reduction in interest expense due to lower long-term debt levels, an increase in capital gains and other items, net of tax, of $10.0 million, and lower income tax expense of $9.3 million. fundS from oPeraTionS Funds from real estate operations in fiscal 2009 of $38.5 million decreased $25.8 million or 40.1 percent compared to last year as a result of a decrease in commercial funds from operations of $13.7 million and a decrease in residential funds from operations of $12.1 million. The decrease in both residential and commercial funds from operations is due primarily to the decrease in operating income for the reasons previously mentioned. R EAL ESTATE R EVE N UE 1 $ I N M I LLIONS R EAL ESTATE FU N DS FR OM OPE RATIONS 1 $ I N M I LLIONS 20 0 15 0 10 0 5 0 FISCAL YEAR 05 06 07 08 6 0 4 5 3 0 15 38.5 23.2 15.3 FISCAL YEAR 05 06 07 08 09 73.9 54.6 19.3 09 RESIDENTIAL COMMERCIAL RESIDENTIAL COMMERCIAL (1) Fiscal 2005 – 2008 have been restated to exclude Sobey Leased Properties which was sold on April 22, 2008. 2009 Annual Report 35 Investments and other operations HigHligHTS On April 24, 2009, Empire successfully completed the issuance of 2,713,000 Non-Voting Class A shares (including the 200,000 issued under the over-allotment option) at $49.75 per share for net proceeds of $129.1 million, which were used to reduce indebtedness at the holding company level. Maintained a 27.6 percent interest in Wajax which contributed $18.5 million in equity earnings in fiscal 2009. Reduced funded debt by $156.9 million compared to the end of fiscal 2008. Empire Theatres’ revenue in fiscal 2009 increased by 6.1 percent compared to fiscal 2008. inveSTmenT value At the end of fiscal 2009, Empire’s total investments, excluding its investment in Genstar U.S. and in Crombie REIT, carried a market value of $72.4 million (May 3, 2008 – $155.0 million) on a cost base of $32.1 million (May 3, 2008 – $33.2 million), resulting in an unrealized gain of $40.3 million (May 3, 2008 – $121.8 million). The decrease in unrealized gain was primarily related to a decrease in Wajax’s unit price from $33.50 per unit as of May 3, 2008 to $15.58 per unit as of May 2, 2009. The table below presents a reconciliation of the consolidated balance sheet investments, both equity and cost, to those related to the investment and other operations division: ($ in millions) Investments Investments, at equity Total investments Less: Crombie REIT Less: Genstar U.S.(1) (1) Assumes market value equals book value. $ Market Value 1.1 254.4 255.5 175.6 7.5 May 2, 2009 May 3, 2008 Carrying Value Unrealized Gain Market Value Carrying Value Unrealized Gain $ $ 1.1 18.8 19.9 (19.7) 7.5 – 235.6 235.6 195.3 – $ 1.6 $ 1.6 $ 429.6 431.2 275.9 0.3 41.4 43.0 9.5 0.3 – 388.2 388.2 266.4 – $ 72.4 $ 32.1 $ 40.3 $ 155.0 $ 33.2 $ 121.8 INVESTM E NTS AN D OTH E R OPE RATIONS R EVE N U E $ I N M I LLIONS INVESTM E NTS AN D OTH E R OPE RATIONS OPE RATING INCOM E* $ I N M I LLIONS 20 0 15 0 10 0 5 0 179.3 3 2 24 16 8 22.8 FISCAL YEAR 05 06 07 08 09 FISCAL YEAR 05 06 07 08 09 *B E FOR E COR PORATE EXPE NSES 36 empire Company limited Management’s Discussion and Analysis PorTfolio Com PoSiTion At fiscal year end, May 2, 2009, 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 Market Value % of Total Cost Unrealized Gain (Loss) May 2, 2009 Unrealized Gain (Loss) May 3, 2008 $ 71.3 98.5% $ 31.0 $ 40.3 $ 121.8 $ – – – – – – – – 1.1 – 1.5% – 1.1 – – – – – – – May 5, 2007 122.4 92.2 1.2 – 3.5 Total $ 72.4 100.0% $ 32.1 $ 40.3 $ 121.8 $ 219.3 The table below presents investments and other operations’ (net of corporate expenses) financial highlights for the 52 weeks ended May 2, 2009 compared to the 52 weeks ended May 3, 2008. 52 Weeks Ended ($ in millions) May 2, 2009 May 3, 2008 ($) Change Revenue $ 179.3 $ 171.2 $ 8.1 Operating income Wajax Other operations, net of corporate expenses Total operating income Operating earnings Capital gains (losses) and other items, net of tax 18.5 (7.7) 10.8 (2.9) 0.2 19.7 (6.1) 13.6 (7.8) 82.2 (1.2) (1.6) (2.8) 4.9 (82.0) (%) Change 4.7% (6.1%) (26.2%) (20.6%) 62.8% (99.8%) Net earnings $ (2.7) $ 74.4 $ (77.1) (103.6%) revenue Investments and other operations’ revenue, primarily generated by Empire Theatres, equalled $179.3 million for fiscal 2009 versus $171.2 million last year, an increase of $8.1 million or 4.7 percent. inveSTmenT i nCome Investment income (excluding equity earnings from Crombie REIT and Genstar U.S.) equalled $19.0 million in fiscal 2009, a decrease of $1.9 million from the $20.9 million recorded last year. The decline was the result of a decrease in dividend income of $0.7 million from fiscal 2008 reflecting the sale of the portfolio investments in the first quarter of fiscal 2008 as mentioned and a decrease in equity earnings from Wajax of $1.2 million from last year. CaPiTal gain S and oTH er iTem S Capital gains and other items, net of tax, realized from investment sales in fiscal 2009 amounted to $0.2 million compared to $82.2 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 and other operations, net of corporate expenses, contributed negative $2.7 million to Empire’s consolidated fiscal 2009 net earnings compared to a $74.4 million net earnings contribution last year. The decrease is primarily the result of the capital gains related to the sale of the liquid portfolio in the first quarter of fiscal 2008 as discussed. 2009 Annual Report 37 Quarterly Results of operations The following table is a summary of selected financial information from the Company’s consolidated financial statements (unaudited) for each of the eight most recently completed quarters. Results by Quarter Fiscal 2009 Fiscal 2008 ($ in millions, except per share information) Q4 (13 Weeks) May 2, 2009 Q3 (13 Weeks) Jan. 31, 2009 Q2 (13 Weeks) Nov. 1, 2008 Q1 (13 Weeks) Aug. 2, 2008 Q4 (13 Weeks) May 3, 2008 Q3 (13 Weeks) Feb. 2, 2008 Q2 (13 Weeks) Nov. 3, 2007 Q1 (13 Weeks) Aug. 4, 2007 Revenue $ 3,709.0 $ 3,800.0 $ 3,727.9 $ 3,778.2 $ 3,557.8 $ 3,503.0 $ 3,484.8 $ 3,519.4 Operating income 111.6 115.6 113.4 127.5 136.2 90.7 118.2 127.5 Operating earnings(1) Capital gains (losses) and other items, net of tax 64.4 65.0 63.2 70.3 73.6 48.9 59.9 60.4 (0.8) (3.5) 2.5 4.8 (7.1) (0.3) (1.5) 81.9 Net earnings $ 63.6 $ 61.5 $ 65.7 $ 75.1 $ 66.5 $ 48.6 $ 58.4 $ 142.3 Per share information, diluted Operating earnings Capital gains (losses) and other items, net of tax $ 0.97 $ 0.99 $ 0.96 $ 1.07 $ 1.12 $ 0.74 $ 0.91 $ 0.92 (0.01) (0.05) 0.04 0.07 (0.11) – (0.02) 1.24 Net earnings $ 0.96 $ 0.94 $ 1.00 $ 1.14 $ 1.01 $ 0.74 $ 0.89 $ 2.16 Diluted weighted average number of shares outstanding (in millions) 66.0 65.7 65.7 65.7 65.7 65.7 65.7 65.7 (1) Operating earnings are 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. 38 empire Company limited Management’s Discussion and Analysis summary Table of Consolidated Financial Results for the Fourth Quarter ($ in millions, except per share information) 13 Weeks Ended May 2 , 2009 % of Revenue 13 Weeks Ended May 3, 2008 % 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) $ 3,709.0 100.00% $ 3,557.8 100.00% 3.83 2.07 (0.20) 1.87% 111.6 64.4 (0.8) 63.6 0.98 (0.01) 0.97 65.9 0.97 (0.01) 0.96 66.0 $ $ $ $ $ 3.01 1.74 (0.02) 1.71% $ $ $ $ $ 136.2 73.6 (7.1) 66.5 1.12 (0.11) 1.01 65.6 1.12 (0.11) 1.01 65.7 Dividends per share $ 0.175 $ 0.165 The following is a review of financial performance for the 13 weeks ended May 2, 2009 compared to the 13 weeks ended May 3, 2008. revenue Revenue for the fourth quarter was $3.71 billion compared to $3.56 billion last year, a $151.2 million or 4.2 percent increase. Revenues for the food retailing division increased by $170.8 million or 4.9 percent compared to the fourth quarter of fiscal 2008. Same-store sales increased 4.6 percent during the fourth quarter of fiscal 2009. The growth in retail sales was a result of increased retail selling square footage from new stores and enlargements, coupled with the continued implementation of sales and merchandising initiatives, improved consistency of store-level execution and retail food price inflation. Real estate operations reported fourth quarter revenues, net of elimination, of $10.5 million, a decrease of $23.3 million or 68.9 percent compared to the fourth quarter last year. Commercial property revenue decreased by $6.8 million or 73.9 percent while revenue from residential operations decreased by $16.5 million or 67.1 percent. The decline in both residential and commercial operations’ revenues was expected. Empire management had previously cautioned that residential lot sales in Western Canada, particularly in the Calgary and Edmonton, Alberta markets, were not sustainable at the levels observed in fiscal 2008. The decline in commercial operations’ revenue is due primarily to the sale of 61 properties to Crombie REIT in the fourth quarter of fiscal 2008. Revenue from investments and other operations in the fourth quarter equalled $47.1 million, an increase of $3.7 million or 8.5 percent over the fourth quarter last year. This is primarily related to higher revenue contribution from Empire Theatres. oPeraTing inCome Consolidated operating income in the fourth quarter was $111.6 million, a decrease of $24.6 million or 18.1 percent from the $136.2 million recorded in the fourth quarter last year. The contributors to the change in consolidated operating income from the fourth quarter last year are as follows: Sobeys’ operating income contribution to Empire in the fourth quarter totalled $102.6 million, a decrease of $1.7 million or 1.6 percent from the $104.3 million recorded in the fourth quarter last year. Included in Sobeys’ fourth quarter fiscal 2009 operating income contribution to Empire was a $5.4 million increase in depreciation and amortization expense, reflecting Sobeys’ continued capital investment. Residential property operating income contribution in the fourth quarter was $3.8 million, a decrease of $11.8 million from the $15.6 million recorded in the fourth quarter last year as a result of lower residential lot sales activity in Western Canada. 2009 Annual Report 39  Commercial property operating income for the quarter earningS before CaPiTal gainS (loSSeS) was $4.9 million compared to $11.6 million in the fourth quarter last fiscal year, a decline of $6.7 million. This decline is primarily attributed to the sale of certain Sobey Leased Properties’ assets (61 properties) to Crombie REIT on April 22, 2008, as Sobey Leased Properties accounted for operating income of $8.2 million in the fourth quarter last fiscal year. The reduction in operating income from Sobey Leased Properties was partially offset by increased equity accounted earnings from Crombie REIT which contributed $4.9 million to operating income in the fourth quarter versus a $3.1 million contribution in the fourth quarter last year. Investments and other operations, net of corporate expenses, contributed operating income of $0.3 million in the fourth quarter compared to $4.7 million in the fourth quarter last year. Equity accounted earnings generated from the Company’s 27.6 percent interest in Wajax amounted to $2.6 million in the fourth quarter versus $5.0 million in the fourth quarter last year. Operating income generated from other operations, net of corporate expenses, amounted to negative $2.3 million as compared to negative $0.3 million in the fourth quarter last year. inTereST exPenSe Interest expense in the fourth quarter amounted to $18.8 million, a decrease of $8.7 million or 31.6 percent from the $27.5 million recorded in the same quarter last year. The decrease in interest expense is primarily due to the lower funded debt for the reasons previously discussed. inCome TaxeS The effective income tax rate for the fourth quarter was 29.7 percent versus 31.1 percent in the fourth quarter last year. Statutory enacted future income tax rate reductions have lowered the overall effective income tax rate for the fourth quarter of fiscal 2009 compared to the fourth quarter of fiscal 2008. and oTH er iTem S For the 13 weeks ended May 2, 2009, Empire recorded earnings before capital gains (losses) and other items of $64.4 million ($0.97 per share) versus $73.6 million ($1.12 per share) last year, a $9.2 million or 12.5 percent decrease. The decline in earnings before capital gains (losses) and other items is the result of a $24.6 million reduction in operating income, partially offset by an $8.7 million reduction in interest expense, a decrease in income taxes of $6.2 million and a decrease in minority interest of $0.5 million. CaPiTal loSSeS and oTH er iTem S The Company reported capital losses and other items, net of tax, of $0.8 million in the fourth quarter compared to capital losses and other items, net of tax, of $7.1 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 of fiscal 2008, 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 ABCP is discussed in detail in the section entitled “Other Matters” of this MD&A. neT earningS Consolidated net earnings in the fourth quarter equalled $63.6 million ($0.96 per share) as compared to $66.5 million ($1.01 per share) last year, a decrease of $2.9 million or 4.4 percent. The decrease in net earnings is due to the $9.2 million decrease in earnings before capital losses and other items, offset by the decrease in capital losses and other items, net of tax, of $6.3 million. 40 empire Company limited Management’s Discussion and Analysis Financial Condition Capital structure and Key Financial Condition Measures The Company’s financial condition at the end of fiscal 2009 remained healthy as indicated by the following financial condition measures. ($ in millions, except per share and ratio calculations) Shareholders’ equity Book value per share Bank indebtedness Long-term debt, including current portion(1) Funded debt to total capital Net funded debt to capital ratio(2) Funded debt to EBITDA(3) EBITDA to interest expense(3) Total assets (1) Includes liabilities related to assets held for sale. (2) Net funded debt to total capital reduces funded debt by cash and cash equivalents. (3) Calculation uses trailing 12-month EBITDA and interest expense. May 2, 2009 2,683.5 39.14 45.9 1,257.0 32.7% 28.5% 1.64x 9.84x 5,898.0 $ $ $ $ $ $ $ $ $ May 3, 2008 2,382.3 36.14 92.6 1,480.9 39.8% 36.7% 2.02x 7.35x $ $ $ $ May 5, 2007 2,131.1 32.31 30.1 881.9 30.0% 22.5% 1.30x 11.65x $ 5,732.9 $ 5,241.5 shareholders’ equity Book value per common share was $39.14 at May 2, 2009, compared to $36.14 at May 3, 2008 and $32.31 at May 5, 2007. The increase in book value largely reflects the Company’s earnings growth and the $135 million equity issue on April 24, 2009 as discussed. The Company’s share capital on May 2, 2009 consisted of: Authorized Number of Shares Issued and Outstanding Number of Shares ($ in millions) 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 2,682,100 992,000,000 259,107,435 40,800,000 168,000 – 34,197,498 34,260,763 $ Employees’ Share Purchase Plan 4.2 – 316.1 7.6 327.9 (3.4) $ 324.5 On April 24, 2009, the Company closed a bought-deal public offering of Non-Voting Class A shares at a price of $49.75 per share. The underwriters elected to exercise their over-allotment option in full, resulting in a total of 2,713,000 shares being issued for net proceeds of $129.1 million. Total Non-Voting Class A and Class B common shares outstanding at May 2, 2009 equalled 68,458,261, an increase of 2,713,000 shares from the previous fiscal year-end, May 3, 2008 as a result of the Non-Voting Class A shares issued in the fourth quarter of fiscal 2009, as discussed. There were 34,197,498 Non-Voting Class A and 34,260,763 Class B common shares outstanding at May 2, 2009. During fiscal 2008, 300,000 Class B common shares were exchanged for 300,000 Non-Voting Class A shares of Empire. During fiscal 2009, 189,967 options (2008 – 92,766 options) were issued under Empire’s Long-Term Incentive Plan. The options issued in fiscal 2009 allow the holder to purchase 2009 Annual Report 41 Non-Voting Class A shares at $40.26 per share (2008 – $43.96 per share). Empire had 282,733 options outstanding at May 2, 2009 compared to 92,766 options outstanding at May 3, 2008. The outstanding options expire in June 2015 and in June 2016. There were no options exercised during fiscal 2009 or fiscal 2008. During fiscal 2009, the Company purchased for cancellation 90,200 Series 2 Preferred shares for $2.3 million compared to 41,800 preferred shares that were purchased for cancellation in fiscal 2008 for $1.0 million. The Company plans to purchase, on a best efforts basis, an additional 100,000 Series 2 Preferred shares for cancellation by the end of calendar 2009. During fiscal 2009, there were no Non-Voting Class A shares issued under Empire’s Employee Share Purchase Plan compared to 10,461 Non-Voting Class A shares issued in fiscal 2008 for $0.4 million. No Non-Voting Class A shares were purchased for cancellation in either fiscal 2009 or fiscal 2008. As at July 23, 2009, the Company had total Non-Voting Class A and Class B common shares outstanding of 34,197,498 and 34,260,763, respectively as well as 445,132 options to acquire Non-Voting Class A shares. Dividends paid to Non-Voting Class A and Class B common shareholders amounted to $46.1 million in fiscal 2009 ($0.70 per share) versus $43.2 million ($0.66 per share) in fiscal 2008. Subsequent to fiscal year-end, on June 26, 2009 the Company announced an increase in the dividend rate to $0.74 per share annually. SHAR E PR ICE $ PE R SHAR E BOOK VALU E PE R SHAR E $ PE R SHAR E COMMON DIVIDE N DS PE R SHAR E $ PE R SHAR E 4 8 3 6 24 12 49.00 4 8 3 6 24 12 39.14 0 .72 0 . 5 4 0 . 3 6 0 .18 0.70 FISCAL YEAR 05 06 07 08 09 FISCAL YEAR 05 06 07 08 09 FISCAL YEAR 05 06 07 08 09 liabilities At the end of fiscal 2009, the Company’s total long-term debt (including the current portion long-term debt) was $1,257.0 million, representing 96.5 percent of Empire’s total funded debt of $1,302.9 million. Funded debt has decreased by $270.6 million from the $1,573.5 million reported at the end of fiscal 2008. The ratio of funded debt to total capital improved to 32.7 percent from 39.8 percent at the end of fiscal 2008. The significant decrease in funded debt over the end of the previous fiscal year is primarily the result of repaying debt with the net proceeds from the $135 million equity issue completed on April 24, 2009 along with the use of free cash flow generated by Sobeys to reduce its funded debt. Historically, Empire has financed a significant portion of its assets through the use of long-term debt. Longer-term assets are generally financed with fixed rate, long-term debt, thereby reducing both interest rate and refinancing risk. The long-term debt is segmented by division as follows: Long-term debt (including current portion) ($ in millions) Food retailing Real estate Investments and other operations Total $ May 2, 2009 954.0 39.6 263.4 May 3, 2008 $ 1,010.2 $ 50.1 420.6 May 5, 2007 612.7 228.1 41.1 $ 1,257.0 $ 1,480.9 $ 881.9 42 empire Company limited Management’s Discussion and Analysis For additional disclosure on Empire’s bank indebtedness and long-term debt, see Note 11 and 12 to the Company’s annual audited consolidated financials statements for fiscal 2009 as detailed on page 79 of the Company’s 2009 Annual Report. In June 2007, both Standard & Poors (“S&P”) and Dominion Bond Rating Service (“DBRS”) placed Sobeys’ credit ratings under review when the privatization of Sobeys was announced. Upon completion of their reviews in the first quarter of fiscal 2008, S&P and DBRS downgraded Sobeys’ credit rating to BB+ with a negative trend and BBB– with a negative trend, respectively. During the first quarter of fiscal 2009, based on Sobeys’ improved fundamentals, both agencies changed their trends from negative to stable. Subsequent to fiscal year-end, both rating agencies improved their trends to positive from stable. Empire’s EBITDA to interest expense ratio in fiscal 2009 was 9.8 times, an improvement from the 7.4 times recorded in fiscal 2008. The increase in the EBITDA to interest expense ratio compared to fiscal 2008 was the result of the decline in interest expense related to the repayment of funded debt as discussed. Empire and its subsidiaries have provided covenants to its lenders in support of various financing facilities. All covenants were complied with during fiscal 2009 and for fiscal 2008. FU N DE D DE BT TO TOTAL CAPITAL PE RCE NTAG E E B ITDA TO INTE R EST EXPE NSE TI M ES 4 0 3 0 20 10 32.7 12 9 6 3 9.84 FISCAL YEAR 05 06 07 08 09 FISCAL YEAR 05 06 07 08 09 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 2, 2009, there were four interest rate hedges in place with Empire and 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. The fair value of these four interest rate swaps at May 2, 2009 was negative $36.3 million. The Company also uses forward contracts to fix the exchange rate on some of its expected requirements for Euros and U.S. dollars (“USD”). As of May 2, 2009, due to an appreciation of the Euro relative to the Canadian dollar (“CAD”), Sobeys had recognized an asset of $0.4 million representing the fair value of one Euro denominated forward currency contract. In July 2008, Sobeys entered into a floating-for-floating currency swap with a fixed rate of $1.015 CAD/USD to mitigate the currency risk associated with a USD denominated variable rate lease. The terms of the swap match the lease terms. As of May 2, 2009, Sobeys recognized an asset of $1.3 million relating to this instrument. To mitigate the risk of changes in the market price of electricity, Sobeys uses financial derivative swap contracts with varying maturities as hedges against the rising costs. As of May 2, 2009, Sobeys recognized a liability of $3.5 million relating to these instruments. Empire and its subsidiaries utilize hedging instruments as deemed appropriate to mitigate risk exposure, not for speculative purposes. 2009 Annual Report 43 liquidity and Capital Resources Empire’s liquidity remained strong at May 2, 2009 as a result of the following sources: Cash and cash equivalents on hand; Unutilized bank credit facilities; and Cash generated from operating activities. The Company anticipates that these sources of liquidity will be sufficient to meet expected cash outflows over the next year. At May 2, 2009, consolidated cash and cash equivalents were $231.6 million versus $191.4 million at the prior fiscal year-end on May 3, 2008. At the end of the fourth quarter of fiscal 2009, on a non-consolidated basis, Empire maintained an authorized bank line for operating, general and corporate purposes of $650 million, of which approximately $248 million or 38 percent was utilized. Empire’s non-consolidated credit facility of $650 million matures on June 8, 2010. It is Empire’s intention to renew or replace this credit facility prior to its maturity. However, given the current credit environment, the terms of the renewed or replacement credit facility may not be as favourable as those of the in-place facility. On a consolidated basis, Empire’s authorized bank credit facilities exceeded borrowings by approximately $930 million at May 2, 2009 compared to $691 million at May 3, 2008. Given the recent developments in the financial markets, the Company’s access to new avenues of credit, both short-term and long-term, may be limited for the foreseeable future. The Company anticipates that the above mentioned in-place sources of liquidity will adequately meet its short-term and long-term financial requirements. The Company mitigates potential liquidity risk by ensuring its various sources of funds are diversified by term to maturity and source of credit. The following table highlights major cash flow components for the 13 and 52 weeks ended May 2, 2009 compared to the 13 and 52 weeks ended May 3, 2008. ($ in millions) 13 Weeks Ended May 2, 2009 13 Weeks Ended May 3, 2008 52 Weeks Ended May 2, 2009 52 Weeks Ended May 3, 2008 Earnings for common shareholders Items not affecting cash $ Net change in non-cash working capital Cash flows from operating activities Cash flows (used in) from investing activities Cash flows (used in) from financing activities 63.6 94.7 158.3 42.1 200.4 (135.1) (58.0) $ 66.5 $ 105.7 172.2 93.0 265.2 210.7 (407.6) 265.8 346.1 611.9 46.3 658.2 (404.1) (213.9) $ 315.5 360.1 675.6 (45.7) 629.9 (1,353.9) 620.5 Increase (decrease) in cash and cash equivalents $ 7.3 $ 68.3 $ 40.2 $ (103.5) operating Activities Fourth quarter cash flows from operating activities equalled $200.4 million compared to $265.2 million in the comparable period last year. The decrease of $64.8 million is due to a decline in the net change in non-cash working capital of $50.9 million, a decline in the items not affecting cash of $11.0 million and a decline in net earnings available for common shareholders of $2.9 million. In fiscal 2009, cash flows from operating activities equalled $658.2 million compared to $629.9 million last year. The increase of $28.3 million is attributed to an increase in the net change in non-cash working capital of $92.0 million, partially offset by a decrease in net earnings available for common shareholders of $49.7 million and a decrease in items not affecting cash of $14.0 million. 44 empire Company limited Management’s Discussion and Analysis The following tables present non-cash working capital changes on a quarter-over-quarter basis and on a year-over-year basis. non-CaSH Working CaP iTal (QuarTer-over-QuarTer) ($ in millions) Receivables Inventories Prepaid expenses Accounts payable and accrued liabilities Income taxes receivable (payable) Impact of reclassifications on working capital(1) $ May 2, 2009 318.7 842.8 70.8 (1,487.1) 4.9 (3.8) $ Jan. 31, 2009 294.5 860.7 37.1 (1,391.7) (12.2) – 13 Weeks Ended May 2, 2009 Increase (Decrease) in Cash Flows 13 Weeks Ended May 3, 2008 Increase (Decrease) in Cash Flows $ $ (24.2) 17.9 (33.7) 95.4 (17.1) 3.8 (2.3) 26.8 (0.3) 76.7 14.8 (22.7) Total $ (253.7) $ (211.6) $ 42.1 $ 93.0 (1) Reclassifications primarily relate to business acquisitions and rationalization costs and the adoption of the new inventory policy further explained on page 49 of this annual report. non-CaSH Working CaP iTal (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 2, 2009 318.7 842.8 70.8 (1,487.1) 4.9 13.0 52 Weeks Ended May 2, 2009 Increase (Decrease) in Cash Flows $ (27.6) (22.6) (8.8) 138.7 (20.4) (13.0) $ May 3, 2008 291.1 820.2 62.0 (1,348.4) (15.5) – Total $ (236.9) $ (190.6) $ 46.3 (1) Reclassifications primarily relate to business acquisitions and rationalization costs and the adoption of the new inventory policy further explained on page 49 of this annual report. The net change in non-cash working capital of $42.1 million in the fourth quarter was largely due to a $95.4 million increase in payables, a $17.9 million decrease in inventories and the impact of reclassifications on working capital of $3.8 million, partially offset by an increase in prepaid expenses of $33.7 million, an increase in receivables of $24.2 million and an increase in income taxes receivable of $17.1 million. 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 increase in prepaid expenses largely reflects the increase recorded in the food retailing division as a result of the prior quarter ending before the first of the month. The increase in taxes receivable compared to the third quarter reflects the timing of tax remittances. Year-over-year non-cash working capital increased $46.3 million. This is primarily the result of a $138.7 million increase in accounts payable and accrued liabilities, partially offset by a $27.6 million increase in receivables, a $22.6 million increase in inventories, an increase in income taxes receivable of $20.4 million, a $13.0 million impact of reclassifications on working capital and a $8.8 million increase in prepaid expenses compared to the prior year. The increase in inventories and related accounts payable and accrued liabilities is necessary to support Sobeys’ higher sales volumes due to the increased amount of square footage in its expanded store network. The increase in inventory is partially offset by the adoption of the new inventory policy as explained in the “Accounting Policy Changes” section of this MD&A. The impact of this policy on cash flow is reflected in the impact of reclassifications on working capital. 2009 Annual Report 45 Investing Activities Cash used in investing activities of $135.1 million in the fourth quarter compares to cash flows generated from investing activities of $210.7 million in the fourth quarter last fiscal year. The change in cash from investing activities of $345.8 million was largely the result of proceeds of $373.5 million from the sale of 61 properties to Crombie REIT in the fourth quarter last year, an increase in cash used in business acquisitions of $21.3 million and an increase in loans and other receivables of $15.5 million, partially offset by a decline in the cash used for investments of $57.9 million and a decrease in the purchase of property and equipment of $22.9 million. For the 52 weeks ended May 2, 2009, cash used in investing activities of $404.1 million was $949.8 million lower than last fiscal year. The decrease in cash used in investing activities was largely the result of the privatization of Sobeys in the first quarter of last fiscal year for $1,065.7 million, the decrease in cash used for business acquisitions by $221.8 million (primarily the acquisition of Thrifty Foods in the second quarter of last year for $243.4 million), the decrease of $119.7 million in property and equipment purchases, a decrease in cash invested in other assets by $54.9 million and an increase in proceeds on disposal of property and equipment by $25.8 million, partially offset by proceeds of $373.5 million from the sale of 61 properties to Crombie REIT in the fourth quarter last fiscal year, the decrease in cash from investments of $135.5 million and a decrease in cash from loans and other receivables of $29.1 million. Consolidated purchases of property and equipment totalled $126.6 million in the fourth quarter of fiscal 2009 compared to $149.5 million in the fourth quarter last year. Consolidated purchases of property and equipment totalled $431.0 million in fiscal 2009 compared to $550.7 million in the same period last year. The decline in both the current quarter and the fiscal year is largely associated with fewer stores opened, acquired or expanded relative to the prior year. The table below outlines the number of stores Sobeys invested in during the fourth quarter of fiscal 2009 compared to the same quarter of fiscal 2008, as well as for the 52 weeks ended May 2, 2009 compared to the 52 weeks ended May 3, 2008. SobeyS’ Cor PoraTe and f ranCHiSed STore ConSTruCTion aCTiviT y # of Stores Opened/Acquired/Relocated Expanded Rebannered/Redeveloped Closed 13 Weeks Ended May 2, 2009 13 Weeks Ended May 3, 2008 52 Weeks Ended May 2, 2009 52 Weeks Ended May 3, 2008 13 3 2 20 15 10 9 17 47 11 16 52 66 31 60 67 F OOD R ETAILING CAPITAL EXPE N DITU R ES $ I N M I LLIONS R EAL ESTATE CAPITAL EXPE N DITU R ES $ I N M I LLIONS 4 8 0 3 6 0 24 0 120 382.7 6 0 4 5 3 0 15 36.9 FISCAL YEAR 05 06 07 08 09 FISCAL YEAR 05 06 07 08 09 46 empire Company limited Management’s Discussion and Analysis The following table shows Sobeys’ square footage changes for the 13 and 52 weeks ended May 2, 2009 by type. SobeyS’ SQuare f ooTage CHangeS Square Feet (in thousands) May 2, 2009 vs. Jan. 31, 2009 May 2, 2009 vs. May 3, 2008 Opened Relocated Acquired Expanded Closed Net Change 221 16 – 41 (199) 79 773 82 33 103 (733) 258 At May 2, 2009, Sobeys’ square footage totalled 27.5 million square feet, a 1.1 percent increase over the 27.2 million square feet in operation at the end of the fourth quarter of last year. Capital expenditures for the real estate division equalled $36.9 million in fiscal 2009 ($47.3 million in fiscal 2008) as a result of ongoing property developments and land additions. Capital spending by investments and other operations equalled $11.4 million in fiscal 2009 ($22.2 million in fiscal 2008) 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 2009 and fiscal 2008 was to modernize and develop various movie theatre locations. Financing Activities Financing activities during the fourth quarter of fiscal 2009 used $58.0 million of cash compared to $407.6 million in the same quarter last year. The reduction of $349.6 million in cash flows from financing activities when compared to the same quarter last year is primarily the result of: (i) a decrease in the repay- ment of long-term debt of $246.4 million; (ii) the issuance of Non-Voting Class A shares in the fourth quarter of fiscal 2009 for net proceeds of $129.1 million; partially offset by an increase in bank indebtedness of $7.4 million in the fourth quarter of fiscal 2009 compared to an increase in bank indebtedness of $35.0 million in the same quarter last year. Financing activities during the 52 weeks ended May 2, 2009 used $213.9 million of cash compared to $620.5 million of cash generated from financing activities in the same period last year. The variance of $834.4 million in cash flows from financing activities in the 52 weeks ended May 2, 2009 when compared to the same period last year is primarily the result of: (i) a decrease in long-term debt issuance of $1,033.0 million; (ii) a decrease in bank indebtedness of $46.7 million during the fiscal year-to-date compared to an increase in bank indebtedness of $60.9 million in the same period last year; partially offset by (i) a decrease in repayment of long-term debt of $199.8 million; and (ii) the issuance of Non-Voting Class A shares in the fourth quarter of fiscal 2009 for net proceeds of $129.1 million. As discussed above, on April 24, 2009 Empire closed the issuance of 2,713,000 Non-Voting Class A shares (including the 200,000 shares issued under the over-allotment option) on a bought-deal basis with a syndicate of underwriters at a price of $49.75 per share. The total net proceeds raised of $129.1 million (gross proceeds of $135.0 million) were used to repay a portion of Empire’s non-consolidated bank facility. Guarantees and Commitments The following illustrates the Company’s significant contractual obligations, over the next five fiscal years and thereafter. groSS obligaTionS exCluding leaSe inCome ($ in millions) Long-term debt Capital leases Operating leases Third Parties Related Parties 2010 2011 2012 2013 2014 Thereafter Total $ 117.8 $ 305.9 $ 21.8 $ 216.8 $ 25.0 $ 512.0 $ 1,199.3 15.2 13.4 10.6 6.6 3.9 11.0 60.7 270.0 38.4 246.2 37.6 228.7 34.5 215.5 34.0 203.9 35.4 1,354.3 407.0 2,518.6 586.9 Total operating leases 308.4 283.8 263.2 249.5 239.3 1,761.3 3,105.5 Total contractual obligations $ 441.4 $ 603.1 $ 295.6 $ 472.9 $ 268.2 $ 2,284.3 $ 4,365.5 oPeraTing leaS eS, neT of exPeCTed leaS e inCome reCeived by TH e ComPany ($ in millions) Third Parties Related Parties 2010 2011 2012 2013 2014 Thereafter Total $ 196.7 38.4 $ 176.3 37.6 $ 162.6 34.5 $ 154.2 34.0 $ 147.7 35.4 $ 965.3 407.0 $ 1,802.8 586.9 $ 235.1 $ 213.9 $ 197.1 $ 188.2 $ 183.1 $ 1,372.3 $ 2,389.7 2009 Annual Report 47 franCHiSe affiliaTeS Sobeys has guaranteed certain bank loans contracted by franchise affiliates. As at May 2, 2009, these loans amounted to $0.5 million (May 3, 2008 – $1.3 million). During 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 $6.0 million or 9.9 percent (2008 – $5.0 million or 9.9 percent) of the authorized and outstanding obligation. As at May 2, 2009, the amount of the guarantee was $6.0 million (May 3, 2008 – $5.0 million). Sobeys 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. During the third quarter of fiscal 2009, Sobey entered into an additional credit enhancement in the form of a standby letter of credit for certain independent franchisees for the purchase and installation of equipment. Under the terms of the contract, should a franchisee affiliate be unable to fulfill their lease obligation or other remedy, Sobeys would be required to fund the greater of $4.0 million or 10 percent of the authorized and outstanding obligation annually. Under the terms of the agreement, Sobeys is required to obtain a letter of credit in the amount of the outstanding guarantee, to be revisited each calendar year. This credit enhancement allows Sobeys to provide favourable financing terms to certain independent franchisees. The contract terms have been reviewed and Sobeys has determined that there were no material implications with Free Cash Flow respect to the consolidation of VIEs. As of May 2, 2009, the amount of the guarantee was $4.0 million. The aggregate, annual, minimum rent payable under the guaranteed operating equipment leases for fiscal 2010 is approximately $25.5 million. The guaranteed lease commitments over the next five fiscal years are: ($ in millions) 2010 2011 2012 2013 2014 Thereafter Guaranteed Lease Commitments $ 25.5 14.8 16.7 11.4 4.2 2.0 oTHer At May 2, 2009, the Company was contingently liable for letters of credit issued in the aggregate amount of $55.3 million (May 3, 2008 – $60.3 million). Upon entering the lease of its new Mississauga, Ontario distribution centre in March 2000, Sobeys guaranteed to the landlord the performance by Serca Foodservice Inc. all of its obligations under the lease. The remaining term of the lease is 11 years with an aggregate obligation of $34.6 million (May 3, 2008 – $37.5 million). At the time of the sale of assets of Serca Foodservice Inc. to SYSCO Corp., the lease of the Mississauga distribution centre was assigned to and assumed by a subsidiary of the purchaser and SYSCO Corp. agreed to indemnify and hold Sobeys harmless from any liability it may incur pursuant to its guarantee. Free cash flow (see Non-GAAP measures section at the end of this MD&A) is used to measure the change in the Company’s cash available for additional investing, dividends and/or debt reduction. The following table reconciles free cash flow to GAAP cash flows used in operating activities for the 13 and 52 week periods ended May 2, 2009 and May 3, 2008. ($ in millions) 13 Weeks Ended May 2, 2009 13 Weeks Ended May 3, 2008 52 Weeks Ended May 2, 2009 52 Weeks Ended May 3, 2008 Cash flow from operating activities Less: Property and equipment purchases Free cash flow $ $ 200.4 126.6 73.8 $ $ 265.2 149.5 115.7 $ $ 658.2 431.0 227.2 $ $ 629.9 550.7 79.2 Free cash flow generation in the fourth quarter of fiscal 2009 was $73.8 million compared to free cash flow of $115.7 million in the fourth quarter last year. The $41.9 million decrease in free cash flow from the fourth quarter last fiscal year was due to a $64.8 million decrease in cash flow from operations, partially offset by a $22.9 million decrease in property and equipment purchases. For the 52 weeks ended May 2, 2009, free cash flow equalled $227.2 million, an increase of $148.0 million over the free cash flow recorded for the same period last year. The improvement is due to a $28.3 million increase in cash flow from operating activities and a decrease of $119.7 million in property and equipment purchases. 48 empire Company limited Management’s Discussion and Analysis Accounting policy Changes aCCounTing STandardS adoPTed during fiSCal 2009 In June 2007, the Canadian Institute of Chartered Accountants (“CICA”) issued Section 3031 of the CICA Handbook, “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, including allocation of overheads and other costs incurred in bringing the inventories to their present location and condition. Costs such as storage costs are specifically excluded from the cost of inventories and are expensed in the period incurred. The standard also requires the use of either first-in, first-out or weighted average cost formula to measure the cost of inventories of similar nature and use. Techniques, such as the retail method, used to measure the cost of inventory may be used if the results approximate cost. This standard is effective for interim and annual financial statements relating to fiscal years beginning on or after January 1, 2008. The Company applied the standard to the opening inventory for the fiscal year beginning May 4, 2008 and adjusted retained earnings by the difference in the measurement of cost in opening inventory of a similar nature and use (prior periods were not restated). Following adoption of Section 3031, warehouse inventories are valued at the lower of cost and net realizable value with cost being determined on a weighted average cost basis. Retail inventories are valued at the lower of cost and net realizable value. Cost is determined using a weighted average cost using either the standard cost method or a retail method. The retail method uses the anticipated selling price less normal profit margins, on a weighted average cost basis. Real estate inventory of residential properties is valued at the lower of cost and net realizable value. The cost of inventories is comprised of directly attributable costs and includes the purchase price plus other costs incurred in bringing the inventories to their present location and condition, such as freight. The cost is reduced by the value of rebates and allowances received from vendors. The Company estimates net realizable value as the amount that inventories are expected to be sold, taking into consideration fluctuations of retail price due to seasonality less estimated costs necessary to make the sale. Inventories are written down to net realizable value when the cost of inventories is estimated to not be recoverable due to obsolescence, damage or declining selling prices. When circumstances that previously caused inventories to be written down below cost no longer exist or when there is clear evidence of an increase in retail selling price, the amount of the write-down previously recorded is reversed. Costs that do not contribute to bringing inventories to their present location and condition, such as storage and administrative overheads, are specifically excluded from the cost of inventories and are expensed in the period incurred. The initial impact of measuring inventories under the new standard is a decrease to the carrying amount of opening inventories as at May 4, 2008 of $27.9 million and a decrease in income taxes payable of $6.4 million. Opening retained earnings have been adjusted by $21.5 million, equal to the change in opening inventories, net of tax. The cost of inventory recognized as an expense during the fourth quarter and fiscal 2009 was $2,740.7 million and $11,232.5 million, respectively. The cost of inventories recog- nized as an expense during the fourth quarter and fiscal 2009 includes $11.4 million and $45.5 million respectively for the write-down of inventories below cost to net realizable value. There were no reversals of inventories written down previously. 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 (see Note 15 to the audited annual consolidated fiscal 2009 financial statements). The adoption of Section 1535 did not have an impact on the Company’s financial results or position. 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”. 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 (see Note 22 to the audited annual consolidated fiscal 2009 financial statements). 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. In accordance with the transitional provision of Section 3862, comparative information about the nature and extent of risks arising from financial instruments is not required in the year of adoption. 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 and has no significant impact on the Company’s financial statements. Financial Instruments – Recognition and Measurement In January 2009, the CICA issued Emerging Issue Committee Abstract 173 (“EIC 173”), “Credit Risk and the Fair Value of Financial Assets and Financial Liabilities”. EIC 173 requires that 2009 Annual Report 49 a company take into account its own credit risk and the credit risk of its counterparty in determining the fair value of financial assets and financial liabilities. This Abstract must be applied retrospectively without restatement of prior periods to all financial assets and liabilities measured at fair value in interim and annual financial statements for periods ending on or after January 20, 2009. The adoption of EIC 173 did not have a significant impact on the Company’s financials results, position or disclosures. The following accounting standards were implemented during fiscal 2008: On May 6, 2007 the Company adopted CICA Sections 3855, “Financial Instruments – Recognition and Measurement”, 3865, “Hedges”, 1530, “Comprehensive Income”, 3251, “Equity” and 3861, “Financial Instruments – Disclosure and Presentation”. These standards were applied without restatement of prior periods and the transitional adjustments resulting from these standards were recognized in the opening balances of retained earnings and accumulated other comprehensive income. The following table summarizes the transition adjustments recorded upon implementation of financial instruments: ($ in millions) Consolidated Balance Sheet Investments Other assets Other liabilities Long-term debt Future income taxes Minority interest Accumulated other comprehensive income Transition Adjustments $ 94.4 (4.5) 2.5 2.7 (18.5) 0.6 (77.2) Upon adoption of Section 3855, Section 3070 was withdrawn. As a result, the Company reviewed its accounting policy for deferred charges. This change in accounting policy was applied retrospectively resulting in a $4.3 million decrease in retained earnings at May 3, 2008. fuTure C HangeS in aCC ounTing PoliCieS 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 well 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. Business Combinations, Consolidated Financial Statements and Non-controlling Interests In January 2009, the CICA issued three new accounting standards which are based on the International Accounting Standards Board’s International Financial Reporting Standard 3 “Business Combinations”. Section 1582, “Business Combinations”, which replaces Section 1581 with the same title, aims to improve the relevance, reliability and comparability of the information provided in financial statements about business combinations. This Section is to be applied prospectively to business combinations for which the acquisition date is on or after January 1, 2011 and assets and liabilities that arose from business combinations that preceded the adoption of this standard should not be adjusted upon adoption. Section 1601, “Consolidated Financial Statements”, and Section 1602, “Non-controlling Interests”, replace Section 1600, “Consolidated Financial Statements”, and establish standards for the preparation of consolidated financial statements and accounting for a non-controlling interest in a subsidiary in consolidated financial statements subsequent to a business combination. These standards apply to interim and annual consolidated financial statements beginning on or after January 1, 2011. Earlier adoption of all three standards is permitted as of the beginning of a fiscal year, however if an entity chooses to early adopt all three standards must be adopted concurrently. The Company is currently evaluating the impact of these new standards. International Financial Reporting Standards On February 13, 2008, the Accounting Standards Board of Canada announced that GAAP for publicly accountable enterprises will be replaced by International Financial Reporting Standards (“IFRS”). IFRS must be adopted for interim and annual financial statements related to fiscal years beginning on or after January 1, 2011, with restatement of comparative periods. Accordingly, the conversion from GAAP to IFRS will be applicable to the Company’s reporting for the first quarter of fiscal 2012 for which the current and comparative information will be prepared under IFRS. The Company has launched an internal initiative to govern the conversion process and is currently evaluating the potential impact of the conversion to IFRS on its financial statements. At this time, the impact on the Company’s future financial position and results of operations is not reasonably determinable or estimable. The Company expects the transition to IFRS to impact accounting, financial reporting, internal control over financial reporting, information systems and business processes. The Company has developed a formal project governance structure including a structured steering committee, as well as providing regular progress reports to senior management, 50 empire Company limited Management’s Discussion and Analysis including the Audit Committee. The Company has also completed a diagnostic impact assessment, which involves a high level review of the major differences between current GAAP and IFRS, as well as establishing an implementation guideline. In accordance with this guideline, the Company has established a staff training program and is in the process of completing analysis of the key decision areas and making recommendations on the same. 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, stock based compensation, valuation of ABCP, customer loyalty programs 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 b enefiTS 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 The Company will continue to assess the impact of the transition to IFRS and to review all of the proposed and ongoing projects of the International Accounting Standards Board to determine their impact on the Company. Additionally, the Company will continue to invest in training and resources throughout the transition period to facilitate a timely conversion. 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 2009, the discount rate used for calcula- tion of pension and other benefit plan expense was 6.25 percent and 6.00 percent, respectively (fiscal 2008 – 5.25 percent for both plans). The expected long-term rate of return on plan assets for pension benefit plans for each of fiscal 2009 was 7.0 percent (fiscal 2008 – 7.0 percent). The expected growth rate in health care costs was 9.0 percent for fiscal 2009 (fiscal 2008 – 9.0 percent). The cumulative growth rate in health care costs to 2019 is expected to be 5.0 percent. The expected future growth rate is evaluated on an annual basis. 2009 Annual Report 51 The table below outlines the sensitivity of the 2009 key economic assumptions used in measuring the accrued benefit plan obligation 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 Obligation Benefit Cost(1) Benefit Obligation Benefit Cost(1) 7.00% (2.0) 2.0 6.25% 0.2 (0.5) $ $ $ $ 6.25% $ $ (25.9) 29.1 6.00% (15.1) 18.1 9.00% 14.5 (12.2) $ $ $ $ 6.00% (0.9) 1.0 9.00% 1.8 (1.4) $ $ $ $ (1) Reflects the impact on the current service cost, the interest cost and the expected return on assets. (2) 6.00 percent for the Employee Pension Plan and the Post Retirement Benefit Plan. (3) Gradually decreasing to 5.00 percent in 2019 and remaining at that level thereafter. goodWill and long-lived aSS eTS Goodwill is not amortized and is assessed for impairment at the reporting unit level. This is done annually at a minimum. 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 calcula- tion 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. 52 empire Company limited Management’s Discussion and Analysis valuaTion of i nvenTorieS 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 at retail and adjusted to cost and (ii) estimated inventory reductions due to spoilage and shrinkage occurring between the last physical inventory count and the balance sheet date, and (iii) estimated inventory provisions associated with vendor allowances and internal charges. Changes or differences in any of these estimates may result in changes to inventories on the consolidated balance sheet and a charge or credit to operating income in the consolidated statement of earnings. 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. Disclosure Controls and procedures Management is responsible for establishing and maintaining disclosure controls and procedures (“DC&P”). This is done to provide reasonable assurance that material information relating to Empire is made known to management by others, particularly during the period in which the annual filings are being prepared, and that information required to be disclosed by the Company and its annual filings, interim filings and other reports filed or submitted by it under securities legislation is recorded, processed, summarized and reported within the time periods specified in securities legislation. The CEO and CFO have evaluated the effectiveness of the Company’s DC&P and have concluded as at May 2, 2009 that Empire’s DC&P were designed and operating effectively, and that there were no material weaknesses relating to the design or operation of the DC&P. Internal Controls over Financial Reporting Management is responsible for establishing and maintaining adequate internal control over financial reporting (“ICFR”) to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAP. The control framework management used to design and assess the effectiveness of ICFR is The Internal Control Integrated Framework published by the Committee of Sponsoring Organization of the Treadway Commission (“COSO”). The CEO and CFO have evaluated the effectiveness of Empire’s ICFR and have concluded as of May 2, 2009 that Empire’s ICFR was designed and operating effectively, and that there were no material weaknesses relating to the design or operations of the ICFR. There have been no changes in the Company’s ICFR during the period beginning on February 1, 2009 and ended on May 2, 2009 that have materially affected, or are reasonably likely to materially affect, Empire’s ICFR. Due to inherent limitations common to all ICFR and DC&P, Management acknowledges that its ICFR and DC&P may not prevent or detect all misstatements. In addition, Management’s evaluation of ICFR and DC&P can provide only reasonable, not absolute, assurance, that misstatements will be detected when resulting from fraud or error. 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 ($58.7 million in fiscal 2009) and the charges incurred for administrative and management services are on a cost recovery basis ($3.0 million in fiscal 2009). The Company has non- interest bearing notes payable to Crombie REIT in the amount of $10.5 million. 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 of Crombie REIT totalling $55.0 million, which was fair market value. In accordance with 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. See Note 3 to the Company’s annual audited financial statements for fiscal 2009 as detailed on page 74 of the Company’s 2009 Annual Report for more information. 2009 Annual Report 53  On December 30, 2008, the Company entered into an agreement to provide Crombie REIT with additional financing through a $20.0 million demand loan facility with substantially the same terms and conditions that govern Crombie REIT’s floating rate revolving credit facility. On December 30, 2008, the Company had advanced $10.0 million to Crombie REIT under this facility. On January 29, 2009, the $10.0 million advance was repaid in full. On February 12, 2009, coincident with Crombie REIT completing mortgage financing on eight properties with a Schedule I Canadian bank, Empire provided Crombie REIT with additional financial support through subordinate mortgages on the eight properties totalling $6.2 million. The terms and conditions of the subordinate mortgages are substantially the same as those governing the first mortgages from the Schedule I bank with one exception: the interest rate on the second mortgages from the Company will be 50 basis points higher than the interest rate charged on the first mortgages from the Schedule I bank. Concurrent with placing the $6.2 million in mortgage financing, the authorized amount of the demand loan facility between Empire and Crombie REIT was reduced from $20.0 million to $13.8 million. subsequent events On June 12, 2009, Sobeys repaid, although did not cancel, the $75.0 million credit facility which matures on November 8, 2010. On June 25, 2009, Crombie REIT closed a bought-deal public offering of units at a price of $7.80 per unit. In satisfaction of its pre-emptive right with respect to the public offering, the Company subscribed for $30.0 million of Class B Units (which are convertible on a one-for-one basis into units of Crombie REIT). Consequently the Company’s interest in Crombie REIT was reduced from 47.9 percent to 47.4 percent. other Matters aSSeT baCked CommerCial PaPer At the end of fiscal 2009, the Company included in other assets $30.0 million (2008 – $30.0 million) of third-party ABCP against which the Company has taken a pre-tax impairment provision in the amount of $12.2 million (2008 – $7.5 million). On January 21, 2009, the Company derecognized the existing available for sale assets and received restructured ABCP MAV II notes: A1 – $7.8 million, A2 – $17.5 million, B – $3.2 million, C – $0.9 million and $0.6 million of tracking notes (the “restructured notes”) as designated in the Montreal Accord as well as accrued interest. The A1 and A2 notes received an A rating from DBRS. The remaining notes have not yet been rated. The restructured notes are floating rate notes with expected payouts in January 2017. Accrued interest owed from August 2007 to the restructuring date is expected in two payments; the first was received on January 23, 2009 for $1.0 million and a second interest payment for the remainder is expected to be received at a future date. The Company has classified these notes as held for trading and as a result will be calculating the fair value of the notes at each reporting period. The Company updated its analysis of the fair value of the restructured notes, including factors such as estimated cash flow scenarios and risk adjusted discount rates, and an additional pre-tax provision, of $3.7 million, net of interest On July 23, 2009, Sobeys finalized an agreement to sell and leaseback a retail support centre located in Milton, Ontario to a third party. Proceeds on the sale will be $51.0 million resulting in a pre-tax gain of $5.6 million. A long-term lease agreement has been agreed to for the use of the property with the gain being amortized over the term of the lease. received, was recorded. The total charge for impairment is approximately 41 percent (2008 – 25 percent) of the original value of the ABCP and the Company does not believe the fair value of these restructured notes is materially different. Discount rates vary depending upon the credit rating of the restructured 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. The Company has performed a sensitiv- ity analysis on estimated discount rates used in the fair value analysis and determined that a change of one percent would result in a pre-tax change in the fair value of these investments of approximately $1.3 million (2008 – $2.0 million). 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 future 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. 54 empire Company limited Management’s Discussion and Analysis Designation for eligible Dividends The new dividend regime for the favourable tax treatment of “eligible dividends” came into effect on February 21, 2007 as a result of Bill C-28. 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 at the time of payment. Contingencies Empire has, in accordance with the administrative position of the CRA, 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 CRA for fiscal years 1999 and 2000 related to Lumsden Brothers Limited (a wholesale subsidiary of the Company) and the Goods and Service Tax (“GST”). The reassessment related to GST on sales of tobacco products to status Indians. CRA asserts that Sobeys was obliged to collect GST on the sales of these tobacco products to status Indians. The total tax, interest and penalties in the reassessment amounts to $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 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 an other long-term receivable from CRA pending resolution of the matter. The Company and a subsidiary had been reassessed in respect to the tax treatment of gains realized on the sale of shares in Hannaford Bros. Co. (“Hannaford”) in fiscal 2001. The Company had appealed the reassessments in respect of the Hannaford shares. Subsequent to May 2, 2009, the Company and CRA concluded negotiations and jointly requested a court order which, if approved, would result in a reduction of income tax expense of approximately $17.0 million in the first quarter of fiscal 2010. 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 of Directors 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. ComPeTiTion 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 2009 Annual Report 55 benefits of national scale and regional management deployment, 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 2009, our real estate operations encountered challenging economic conditions. However, real estate operations maintained relatively stable occupancy levels and healthy rental renewal rates. During fiscal 2009, capitalization rates were negatively impacted by general economic slowdown and the tightening in the credit markets 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, it faces significant competition when looking to acquire new land for future development. finanCial 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. liQuidiTy r iSk Liquidity risk is the risk that the Company may not have cash available to satisfy financial obligations as they come due. The Company actively maintains committed credit facilities to ensure that it has sufficient available funds to meet current and foreseeable future financial requirements at a reasonable cost. The Company monitors capital markets and the related economic conditions. Market conditions allowing, the Company will access debt capital markets for various long-term debt maturities and as other liabilities come due or as assessed to be appropriate in order to minimize risk and optimize pricing. inTere ST r aTe r iSk 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 20 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 reSour CeS 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 23 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 2010. However, Sobeys has stated that it will accept the short-term costs of a labour disruption to support a 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. 56 empire Company limited Management’s Discussion and 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 deligated to the Human Resources Committee of Empire’s Board of Directors. 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. 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 and SeCuriTy 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. TeCH nology The Company and each of its operating companies are committed to improving their respective operating systems, tools and procedures to become more efficient and effective. The implementation of major information technology projects carries with it various risks, including the risk to 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 has 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 aCC ounTing 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 2009 Annual Report 57 detect and prevent errors and overall, application of more scrutiny to ensure compliance. 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. oPeraTionS Empire’s success is closely tied to the performance of Sobeys’ network of 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 strategies and programs. 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. uTiliT y 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 operate outside of Canada, however Sobeys does maintain a small produce brokerage office in the United States. As Empire does not consider this operation to be material, the Company does not have any material risks associated with foreign operations. foreign Curren Cy 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 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 Com- pany’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. 58 empire Company limited Management’s Discussion and Analysis 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 allo CaTion 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 an appropriate return on capital. The Company has a number of strong mitigation strategies in place regarding the allocation of capital, including review by the Board of Directors. employee Future Benefit obligations The Company has established prudent hurdle rates for capital investments that are evaluated through a strong due diligence process. 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. eConomiC environmenT Management continues to closely monitor economic conditions, including interest rates, inflation, employment rates and capital markets. Management believes that although a weakening economy has an impact on all businesses and industries, the Company has an operational and capital structure that is sufficient to meet its ongoing business needs. Due to recent losses caused by current capital market activities, the Company was required to contribute $5.8 million (2008 – nil) to its registered defined benefit plans in the fourth quarter of fiscal 2009. The Company expects to contribute approximately $4.1 million in fiscal 2010 to these plans. The Company continues to assess the impact of the capital markets on its funding requirement. non-GAAp Financial Measures There are measures included in this MD&A that do not have a standardized meaning under GAAP and therefore may not be comparable to similarly titled measures presented by other publicly traded companies. The Company includes these measures because it believes certain investors use these measures as a means of assessing financial performance. Empire’s definition of the non-GAAP terms are as follows: Operating income or earnings before interest and taxes (“EBIT”) is calculated as operating earnings before minority interest, interest expense and income taxes. Earnings before interest, taxes, depreciation and amortization (“EBITDA”) is calculated as EBIT plus depreciation and amortization. Operating earnings is calculated as net earnings before capital gains (losses) and other items, net of tax. Return on equity is calculated as net earnings divided by average equity for the reporting period. Funds from operations is calculated as operating earnings plus depreciation and amortization. Funded debt is all interest bearing debt, which includes bank loans, bankers’ acceptances, long-term debt and debt related to assets held for sale. Total capital is calculated as funded debt plus shareholders’ equity. Same-store sales are sales from stores in the same locations in both reporting periods. Free cash flow is calculated as cash flows from operating activities, less property and equipment purchases. 2009 Annual Report 59 The following table reconciles Empire’s funded debt and total capital to GAAP measures reported on the balance sheets as at May 2, 2009, May 3, 2008 and May 5, 2007: ($ in millions) Bank indebtedness Long-term debt due within one year Liabilities relating to assets held for sale Long-term debt Funded debt Less: cash and cash equivalents Net funded debt Total shareholders’ equity Total capital under management $ May 2, 2009 45.9 133.0 – 1,124.0 1,302.9 (231.6) 1,071.3 2,683.5 $ May 3, 2008 92.6 60.4 6.4 1,414.1 1,573.5 (191.4) 1,382.1 2,382.3 $ May 5, 2007 30.1 82.5 6.8 792.6 912.0 (294.9) 617.1 2,131.1 $ 3,754.8 $ 3,764.4 $ 2,748.2 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: July 23, 2009 Stellarton, Nova Scotia, Canada 60 empire Company limited Management’s Discussion and 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, 2009 Paul V. Beesley Executive Vice President and Chief Financial Officer June 26, 2009 auditors’ report To the shareholders of Empire Company Limited We have audited the consolidated balance sheets of Empire Company Limited as at May 2, 2009 and May 3, 2008, 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 2, 2009 and May 3, 2008, 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, 2009 (except for Note 30 (b) which is as of June 25, 2009 and Note 30 (c) which is as of July 23, 2009) 2009 Annual Report 61 consolidated financial statements Consolidated Balance sheets (in millions) aSSeTS Current Cash and cash equivalents Receivables Loans and other receivables (Note 6) Income taxes receivable Inventories Prepaid expenses Investments (realizable value $1.1; 2008 – $1.6) Investments, at equity (realizable value $254.4; 2008 – $429.6) (Note 5) Loans and other receivables (Note 6) Other assets (Note 7) Property and equipment (Note 8) Assets held for sale (Note 9) Intangibles (Note 10) Goodwill liabiliTie S Current Bank indebtedness (Note 11) Accounts payable and accrued liabilities Income taxes payable Future income taxes (Note 18) 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 25) Future income taxes (Note 18) Other long-term liabilities (Note 13) Minority interest SHare HolderS’ eQ uiTy Capital stock (Note 14) Contributed surplus Retained earnings Accumulated other comprehensive loss Guarantees, commitments and contingent liabilities (Note 23) Subsequent events (Note 30) Approved on behalf of the Board Director Director See accompanying notes to the consolidated financial statements 62 empire Company limited Consolidated Financial statements May 2, 2009 May 3, 2008 $ 231.6 318.7 55.8 4.9 842.8 70.8 1,524.6 1.1 18.8 75.3 151.4 2,601.5 8.5 345.4 1,171.4 $ 191.4 291.1 69.9 – 820.2 62.0 1,434.6 1.6 41.4 56.3 175.5 2,457.3 60.3 346.8 1,159.1 $ 5,898.0 $ 5,732.9 $ 45.9 1,487.1 – 42.7 133.0 – 1,708.7 1,124.0 118.4 89.5 135.0 38.9 3,214.5 324.5 1.7 2,405.8 (48.5) 2,683.5 $ 92.6 1,348.4 15.5 32.9 60.4 6.4 1,556.2 1,414.1 110.7 125.5 106.5 37.6 3,350.6 195.7 0.5 2,207.6 (21.5) 2,382.3 $ 5,898.0 $ 5,732.9 Consolidated statements of Retained earnings 52 Weeks Ended (in millions) Balance, beginning of year as previously reported Adjustment due to implementation of new accounting standard (Note 1) Adjustment due to change in accounting policy (Note 1) Balance, beginning of year as restated Net earnings Dividends Preferred shares Common shares Balance, end of year See accompanying notes to the consolidated financial statements May 2, 2009 May 3, 2008 $ 2,207.6 (21.5) – 2,186.1 265.9 (0.1) (46.1) $ 1,939.6 – (4.3) 1,935.3 315.8 (0.3) (43.2) $ 2,405.8 $ 2,207.6 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 for the year Balance, end of year See accompanying notes to the consolidated financial statements May 2, 2009 May 3, 2008 $ $ (21.5) – (21.5) – (27.0) (48.5) $ $ (0.6) 77.2 76.6 (0.6) (97.5) (21.5) 2009 Annual Report 63 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 16) Operating income Interest expense Long-term debt Short-term debt Capital gains and other items (Note 17) Earnings before income taxes and minority interest Income taxes (Note 18) 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 2, 2009 May 3, 2008 $ 15,015.1 $ 14,065.0 14,261.1 324.8 13,322.3 304.6 429.2 38.9 468.1 75.9 4.7 80.6 387.5 2.8 390.3 129.6 (13.5) 116.1 274.2 8.3 265.9 4.05 4.04 65.7 65.8 $ $ $ 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 $ $ $ 64 empire Company limited Consolidated Financial statements 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, net of income taxes of $nil (2008 – $(17.7)) Unrealized losses on available-for-sale financial assets, net of income taxes of $(0.1) (2008 – $nil) Unrealized losses on derivatives designated as cash flow hedges, net of income taxes of $(7.3) (2008 – $(6.3)) Reclassification of loss on derivative instruments designated as cash flow hedges to earnings, net of income taxes of $1.5 (2008 – $(0.3)) Share of comprehensive loss of entities accounted using the equity method, net of income taxes of $(7.3) (2008 – $(2.4)) Foreign currency translation adjustment May 2, 2009 May 3, 2008 $ 265.9 $ 315.8 – (78.7) (0.4) (16.2) 3.5 (14.1) 0.2 (27.0) – (14.0) (0.6) (4.6) 0.4 (97.5) Comprehensive income $ 238.9 $ 218.3 See accompanying notes to the consolidated financial statements 2009 Annual Report 65 Consolidated statements of Cash Flows 52 Weeks Ended (in millions) oPeraTing aCTiviTie S Net earnings Items not affecting cash (Note 19) Preferred dividends Net change in non-cash working capital Cash flows from operating activities inveSTing aCTiviTie S Net (increase) 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 Loans and other receivables Increase in other assets Business acquisitions, net of cash acquired of $nil (2008 – $10.2) (Note 26) Cash flows used in investing activities finanCing aCTiviTie S (Decrease) increase in bank indebtedness Issue of long-term debt Repayment of long-term debt Minority interest Repurchase of preferred shares Issue of Non-Voting Class A shares (Note 14) Common dividends Cash flows (used in) from financing activities Increase (decrease) in cash and cash equivalents Cash and cash equivalents, beginning of year Cash and cash equivalents, end of year See accompanying notes to the consolidated financial statements May 2, 2009 May 3, 2008 $ $ 265.9 346.1 (0.1) 611.9 46.3 658.2 (1.9) – – (431.0) 78.0 (4.9) (2.9) (41.4) (404.1) (46.7) 66.8 (307.7) (7.0) (2.3) 129.1 (46.1) (213.9) 40.2 191.4 231.6 $ $ 315.8 360.1 (0.3) 675.6 (45.7) 629.9 133.6 (1,065.7) 373.5 (550.7) 52.2 24.2 (57.8) (263.2) (1,353.9) 60.9 1,099.8 (507.5) 11.1 (1.0) 0.4 (43.2) 620.5 (103.5) 294.9 191.4 66 empire Company limited Consolidated Financial statements notes to the consolidated financial statements MAy 2, 2009 (In M I llIons exCepT pe R shAR e AMoUnTs, K ey RATI os An D pe RCenTAG e AM oUnTs) 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 percent 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, the fiscal year is usually 52 weeks but results in a duration of 53 weeks every five to six years. CHangeS in aCCounTing P oliCieS ADopTe D DURI nG FI sCAl 2009 Inventories In June 2007, the Canadian Institute of Chartered Accountants (“CICA”) issued Section 3031 of the CICA Handbook, “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, including allocation of overheads and other costs incurred in bringing the inventories to their present location and condition. Costs such as storage costs are specifically excluded from the cost of inventories and are expensed in the period incurred. The standard also requires the use of either first-in, first-out or weighted average cost formula to measure the cost of inventories of similar nature and use. Techniques, such as the retail method, used to measure the cost of inventory may be used if the results approximate cost. This standard was effective for interim and annual financial statements relating to fiscal years beginning on or after January 1, 2008. The Company applied the standard to the opening inventory for the fiscal year beginning May 4, 2008 and adjusted retained earnings by the difference in the measurement of cost in opening inventory of a similar nature and use (prior periods were not restated). Following adoption of Section 3031, warehouse inventories are valued at the lower of cost and net realizable value with cost being determined on a weighted average cost basis. Retail inventories are valued at the lower of cost and net realizable value. Cost is determined using a weighted average cost using either the standard cost method or a retail method. The retail method uses the anticipated selling price less normal profit margins, on a weighted average cost basis. Real estate inventory of residential properties is valued at the lower of cost and net realizable value. The cost of inventories is comprised of directly attributable costs and includes the purchase price plus other costs incurred in bringing the inventories to their present location and condition, such as freight. The cost is reduced by the value of rebates and allowances received from vendors. The Company estimates net realizable value as the amount that inventories are expected to be sold taking into consideration fluctuations of retail price due to seasonality less estimated costs necessary to make the sale. Inventories are written down to net realizable value when the cost of inventories is estimated to not be recoverable due to obsolescence, damage or declining selling prices. When circumstances that previously caused inventories to be written down below cost no longer exist or when there is clear evidence of an increase in retail selling price, the amount of the write-down previously recorded is reversed. Costs that do not contribute to bringing inventories to their present location and condition, such as storage and administrative overheads, are specifically excluded from the cost of inventories and are expensed in the period incurred. The initial impact of measuring inventories under the new standard is a decrease to the carrying amount of opening inventories as at May 4, 2008 of $27.9 and a decrease in income taxes payable of $6.4. Opening retained earnings has been adjusted by $21.5, equal to the change in opening inventories net of tax. The cost of inventory recognized as an expense during fiscal 2009 was $11,232.5. The cost of inventories recognized as an expense during fiscal 2009 includes $45.5 for the write-down of inventories below cost to net realizable value. There were no reversals of inventories written down previously. 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 (see Note 15). The adoption of Section 1535 did not have an impact on the Company’s financial results or position. 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”. 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 (see Note 22). Section 3862 requires increased disclosures regarding the risks associated with financial instruments such as credit risk, liquidity risk and market risk and the techniques used to identify, monitor and manage 2009 Annual Report 67 these risks. In accordance with the transitional provision of Section 3862, comparative information about the nature and extent of risks arising from financial instruments is not required in the year of adoption. 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 and has no significant impact on the Company’s financial statements. Financial instruments – recognition and measurement In January 2009, the CICA issued Emerging Issue Committee Abstract 173 (“EIC 173”) “Credit Risk and the Fair Value of Financial Assets and Financial Liabilities”. EIC 173 requires that a company take into account its own credit risk and the credit risk of its counterparty in determining the fair value of financial assets and financial liabilities. This Abstract must be applied retrospectively without restatement of prior periods to all financial assets and liabilities measured at fair value in interim and annual financial statements for periods ending on or after January 20, 2009. The adoption of EIC 173 did not have a material impact on the Company’s financial results, financial position or disclosures. ADopTe D DURI nG FI sCAl 2008 On May 6, 2007, the Company adopted CICA Sections 3855, “Financial Instruments – Recognition and Measurement”, 3865, “Hedges”, 1530, “Comprehensive Income”, 3251, “Equity” and 3861, “Financial Instruments – Disclosure and Presentation”. These standards were applied without restatement of prior periods and the transition adjustments resulting from these standards were recognized in the opening balances of retained earnings and accumulated other comprehensive income. 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) Upon adoption of Section 3855, Section 3070, “Deferred Charges”, was withdrawn. As a result, the Company reviewed its accounting policy for deferred charges. This change in accounting policy was applied retrospectively, resulting in a $4.3 decrease in retained earnings at May 3, 2008. FUTURe ChAn Ges I n ACCoUnTI nG polICIes 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. Business combinations, consolidated financial statements and non-controlling interests In January 2009, the CICA issued three new accounting standards which are based on the International Accounting Standards Board’s International Financial Reporting Standard 3, “Business Combinations”. Section 1582, “Business Combinations”, which replaces Section 1581 with the same title, aims to improve the relevance, reliability and comparability of the information provided in financial statements about business combinations. This Section is to be applied prospectively to business combinations for which the acquisition date is on or after January 1, 2011 and assets and liabilities that arose from business combinations that preceded the adoption of this standard should not be adjusted upon adoption. Section 1601, “Consolidated Financial Statements”, and Section 1602, “Non-controlling Interests”, replace Section 1600, “Consolidated Financial Statements”, and establish standards for the prepara- tion of consolidated financial statements and for accounting for a non-controlling interest in a subsidiary in consolidated financial statements subsequent to a business combination. These standards apply to interim and annual consolidated financial statements beginning on or after January 1, 2011. Earlier adoption of all three standards is permitted as of the beginning of a fiscal year, however if an entity chooses to early adopt all three standards must be adopted concurrently. The Company is currently evaluating the impact of these new standards. CAsh An D CAsh e QUIvAlenTs 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 In fiscal 2009, as a result of the implementation of CICA Section 3031, “Inventories”, which replaced Section 3030 of the same name, warehouse inventories are valued at the lower of cost and net realizable value with cost being determined on a weighted average cost basis. Retail inventories are valued at the lower of cost and net realizable value. Cost is determined using a weighted average cost using either the standard cost method 68 empire Company limited notes to the Consolidated Financial statements or a retail method. The retail method uses the anticipated selling price less normal profit margins, on a weighted average cost basis. Real estate inventory of residential properties is valued at the lower of cost and net realizable value. The cost of inventories is comprised of directly attributable costs and includes the purchase price plus other costs incurred in bringing the inventories to their present location and condition, such as freight. The cost is reduced by the value of rebates and allowances received from vendors. The Company estimates net realizable value as the amount that inventories are expected to be sold taking into consideration fluctuations of retail price due to seasonality less estimated costs necessary to make the sale. Inventories are written down to net realizable value when the cost of inventories is estimated to not be recoverable due to obsolescence, damage or permanent declines in selling prices. When circumstances that previously caused inventories to be written down below cost no longer exist or when there is clear evidence of an increase in retail selling price, the amount of the write-down previously recorded is reversed. Costs that do not contribute to bringing inventories to their present location and condition, such as storage and administrative overheads, are specifically excluded from the cost of inventories and are expensed in the period incurred. In fiscal 2008, warehouse inventories were valued at the lower of cost and net realizable value with cost being deter- mined on a first-in, first-out or a weighted average cost basis. Retail inventories were valued at the lower of cost and net realizable value. Cost was determined using weighted average cost or the retail method. In fiscal 2009 and 2008, real estate inventory consisting of residential properties is valued at the lower of cost and net realizable value. lonG-lIve D AsseT s Long-lived assets are reviewed for impairment when events or changes in circumstances indicate that the book value of the assets may not be recoverable, as measured by comparing their net book value to the estimated undiscounted future cash flows generated by their use. Impaired assets are recorded at the lower of carrying and fair value, determined principally using discounted future cash flows expected from their use and eventual disposition, with the impairment loss charged to cost of sales, selling and administrative expenses. pRope RTy AnD eQUI pM enT 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. CApITAlIzATIon oF C osTs (a) Construction projects Certain subsidiary companies 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 $3.1 (2008 – $1.5). (b) Development properties and land held for future development Interest, real estate taxes and other expenses are expensed, with the exception of property taxes which are capitalized during the construction period. Capitalization of all costs ceases when the development property is substantially complete and ready for productive use, at which time the properties are classified as commercial properties. No amounts were capitalized in fiscal 2009 ($0.8 in fiscal 2008). DeF eRReD ChARGes Deferred store marketing costs, primarily comprised of store renovation and expansion costs, are included with equipment, fixtures and vehicles as part of the Company’s property and equipment balance sheet group. sToR e openInG expenses Opening expenses of new stores and store conversions are written off on a straight-line basis during the first year of operation. 2009 Annual Report 69 leAses GooDwIll 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. AsseTs helD F oR 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 and are no longer productive assets with no interest to develop them for future use. 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”. 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 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 its 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. FInAn CIAl I nsTRUMenTs The Company is required to recognize and measure all of its financial assets and liabilities, including derivatives and embedded derivatives in certain contracts, at fair value except for loans and receivables, held to maturity financial assets and other financial liabilities which are measured at cost or amortized cost. Derivatives and 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. The Company classifies 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 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. Any financial asset or liability can be classified as held for trading as long as its fair value is reliably determinable. 70 empire Company limited notes to the Consolidated Financial statements The Company’s financial assets and liabilities are generally classified and measured as follows: Asset/Liability Cash and cash equivalents Receivables Loans and other receivables Investments Derivative other assets and liabilities Non-derivative other assets and liabilities Bank indebtedness Accounts payable and accrued liabilities Long-term debt Classification 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 Amortized cost Amortized cost Fair value Fair value Amortized cost Amortized cost Amortized cost Amortized cost 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. Guarantees Obligations undertaken through issuance of a guarantee that meets the definition of a guarantee pursuant to Accounting Guideline 14, “Disclosure Guarantees”, are recognized at fair value at inception with no subsequent re-measurement at fair value required unless the financial guarantee qualifies as a derivative. Hedges 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. 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 market value determination. 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. CUsToMeR loyAlTy pRoGRAMs A Club Sobeys loyalty card program (the “Program”) was launched during fiscal 2009. The Program allows members to earn points on their purchases in certain Sobeys stores. As well, a Club Sobeys credit card entitles the customer to earn points for their purchases on the credit card. Members can redeem these points, in accordance with the Program rewards schedule, for discounts on future grocery purchases, purchase products or services or elect to convert the points into Aeroplan miles which is a loyalty program run by a third party. When points are earned by Program members, the Company records an expense in its consolidated statement of earnings and establishes a liability for future redemptions by multiplying the number of points issued by the estimated cost per point. The Program liability is included in accrued liabilities on the Company’s consolidated balance sheet. The actual cost of Program redemptions is charged against the liability account. 2009 Annual Report 71 The estimated cost per point is determined based on many factors, primarily related to the expected future redemption patterns and associated costs. The Company monitors, on an ongoing basis, trends in redemption rates (points redeemed as a percentage of points issued) and net cost per point redeemed and adjusts the estimated cost per point based upon expected future activity. Any difference in the cost per point is recognized in cost of sales, selling and administrative expenses in the Company’s consolidated statement of earnings. To the extent that estimates differ from actual experience, the Program expense could be higher or lower. The Company continues to evaluate and revise certain assumptions used to calculate the Program liability, based on redemption experience and expected future activity. An AIR MILES® reward program is also used by the Company. AIR MILES® are earned by certain Sobeys customers based on purchases in stores. The cost of this program is expensed as incurred as cost of sales, selling and administrative expenses in the consolidated statement of earnings. FUTUR e InCoM e TAxes The Company uses the asset and liability method of accounting for income taxes, under which future tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Future tax assets and liabilities are measured using enacted or substantively enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on future tax assets and liabilities of a change in tax rates is recognized in income in the year that includes the date of enactment or substantive enactment. DeF eRReD 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. FoR eIGn 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. RevenUe Re CoGnITI on 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 B eneFIT pl Ans An D oThe R B eneFIT pl Ans 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 changes in plan amendments is amortized on a straight-line basis over the expected average remaining service life (“EARSL”) of active members. For pension benefit plans, the actuarial gains and losses and the impact of changes in the actuarial basis in excess of 10 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. For the Company’s Supplemental Executive Retirement Plan (“SERP”), the impact of changes in the plan provisions are amortized over five years. ven DoR AllowAnCes The Company receives allowances from certain vendors whose products are purchased for resale. Included in these vendor programs are allowances for volume purchases, exclusivity allowances, listing fees and other allowances. 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”. 72 empire Company limited notes to the Consolidated Financial statements 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 2, 2009, the Company has recognized $5.7 (2008 – $5.1) 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 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, stock-based compensation, valuation 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 share- holders’ 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 to measure and allocate the of asset-backed commercial paper, loyalty programs and income taxes. Changes to these estimates could materially impact the financial statements. These estimates are based on manage- ment’s best knowledge of current events and actions that the Company may undertake in the future. Actual results could differ from these estimates. eARnInGs peR shAR e 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. excess consideration paid over net assets acquired. The final purchase price allocation, incorporating management’s assessment of fair value, was 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/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, received primarily from sale of certain portfolio investments, and by advances of $787.7 under new credit facilities (see Note 12). 2009 Annual Report 73 noTe 3 sale of property to Crombie R eIT 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 maintained the Company’s interest in Crombie REIT at 47.8 percent. 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 were 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). 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. 74 empire Company limited notes to the Consolidated Financial statements 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 $(0.2) (2008 – $14.7) Net earnings Preferred share dividends Earnings applicable to common shares Earnings per share is comprised of the following: Operating earnings Net capital gains and other items Basic earnings per share Operating earnings Net capital gains and other items Diluted earnings per share noTe 5 Investments, at equity Wajax Income Fund (27.6% interest) Crombie REIT (47.9% 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 2009 262.9 3.0 265.9 (0.1) 265.8 4.00 0.05 4.05 3.99 0.05 4.04 $ $ $ $ $ $ 2008 242.8 73.0 315.8 (0.3) 315.5 3.69 1.11 4.80 3.69 1.11 4.80 $ $ $ $ $ $ May 2, 2009 May 3, 2008 $ $ 31.0 (19.7) 7.5 $ 18.8 $ 31.6 9.5 0.3 41.4 May 2, 2009 May 3, 2008 $ $ 31.6 18.5 (0.5) (18.6) $ 31.0 $ 32.2 19.7 (0.2) (20.1) 31.6 2009 Annual Report 75 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 noTe 6 loans and other Receivables Loans receivable Mortgages receivable Other Less amount due within one year May 2, 2009 May 3, 2008 $ $ 9.5 19.8 (20.8) (21.8) – (6.4) (19.7) $ 109.3 13.6 (6.8) (17.0) 55.0 (144.6) $ 9.5 May 2, 2009 May 3, 2008 $ $ 65.5 21.2 44.4 131.1 55.8 $ 75.3 $ 58.1 26.4 41.7 126.2 69.9 56.3 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 purchase agreements Accrued benefit asset (Note 25) Asset-backed commercial paper Restricted cash Derivative assets Other May 2, 2009 May 3, 2008 $ $ 37.2 63.1 17.8 3.6 1.7 28.0 35.9 58.2 22.5 3.9 2.3 52.7 $ 151.4 $ 175.5 aSSeT-baCked CommerCial PaPer Included in other assets is $30.0 (2008 – $30.0) of third-party asset-backed commercial paper (“ABCP”) against which the Company has taken a pre-tax impairment provision in the amount of $12.2 (2008 – $7.5). On January 21, 2009, the Company derecognized the existing available-for-sale assets and received restructured ABCP MAV II notes: A1 – $7.8, A2 – $17.5, B – $3.2, C – $0.9 and $0.6 of tracking notes (the “restructured notes”) as designated in the Montreal Accord as well as accrued interest. The A1 and A2 notes received an A rating from the Dominion Bond Rating Service. The remaining notes have not yet been rated. The restructured notes are floating rate notes with expected payouts in January 2017. Accrued interest owed from August 2007 to the restructuring 76 empire Company limited notes to the Consolidated Financial statements date is expected in two payments; the first was received on January 23, 2009 for $1.0 and a second interest payment for the remainder is expected to be received at a future date. The Company has classed these notes as held for trading and as a result will be fair valued at each reporting period. The Company updated its analysis of the fair value of the restructured notes, including factors such as estimated cash flow scenarios and risk-adjusted discount rates, and an additional pre-tax provision, net of interest received, of $3.7 was recorded in fiscal 2009. The total charge for impairment is approximately 41 percent (2008 – 25 percent) of the original value of the ABCP. Discount rates vary depending upon the credit rating of the restructured 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. The Company has performed a sensitivity analysis on estimated discount rates used in the fair value analysis and determined that a change of one percent would result in a pre-tax change in the fair value of these investments of approximately $1.3 (2008 – $2.0). 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 future 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. noTe 8 property and equipment Food 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 Cost Accumulated Depreciation May 2, 2009 Net Book Value $ 270.7 57.2 909.8 2,286.4 488.2 227.1 113.8 4,353.2 6.5 57.5 72.9 80.9 59.1 54.1 83.9 $ – – 238.0 1,471.2 288.2 – 52.1 2,049.5 – – 25.1 42.5 19.7 – 29.8 $ 270.7 57.2 671.8 815.2 200.0 227.1 61.7 2,303.7 6.5 57.5 47.8 38.4 39.4 54.1 54.1 414.9 117.1 297.8 $ 4,768.1 $ 2,166.6 $ 2,601.5 2009 Annual Report 77 Food 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 Accumulated Depreciation May 3, 2008 Net Book Value $ $ – – 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 $ Cost 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 82.1 359.5 105.3 254.2 $ 4,515.1 $ 2,057.8 $ 2,457.3 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 $8.5 (2008 – $60.3). Included in liabilities related to these assets held for sale is $nil (2008 – $6.4). 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 Intangibles Brand names Franchise rights/agreements Loyalty programs Patient files Private labels Other $ Cost 201.0 52.8 11.4 26.6 59.5 26.2 $ 377.5 $ 78 empire Company limited notes to the Consolidated Financial statements Accumulated Amortization May 2, 2009 Net Book Value $ 5.3 13.4 – 6.6 – 6.8 32.1 $ $ 195.7 39.4 11.4 20.0 59.5 19.4 345.4 Brand names Franchise rights/agreements Loyalty programs Patient files Private labels Other noTe 11 Bank Indebtedness Cost Accumulated Amortization May 3, 2008 Net Book Value $ 201.0 $ 46.7 11.4 23.4 59.5 26.1 1.9 10.5 – 4.6 – 4.3 $ 199.1 36.2 11.4 18.8 59.5 21.8 $ 368.1 $ 21.3 $ 346.8 As security for certain bank loans, the Company has provided an assignment of certain marketable securities and, in certain subsidiaries and joint ventures, 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 was subsequently extended to August 15, 2008 and October 14, 2008. On October 22, 2008, Sobeys established a new unsecured revolving term credit facility of $30.0 replacing the non-revolving facility that matured on October 14, 2008. This facility matured January 15, 2009, and was subsequently extended to April 15, 2009. This facility had not been utilized and was not renewed; however, any interest payable would have fluctuated with changes in the bankers’ acceptance rate, Canadian prime rate or London InterBank Offered Rate (“LIBOR”). noTe 12 long-Term Debt May 2, 2009 Total May 3, 2008 Total First mortgage loans, average interest rate 9.6%, due 2009-2026 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 10.1%, due 2009–2016 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 Unamortized financing costs Capital lease obligations, net of imputed interest $ 71.5 125.0 175.0 100.0 62.6 146.2 244.0 200.0 75.0 (3.0) 60.7 $ 72.2 125.0 175.0 100.0 75.4 154.2 395.0 250.0 75.0 (3.8) 56.5 Less amount due within one year 1,257.0 133.0 1,474.5 60.4 $ 1,124.0 $ 1,414.1 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 fiscal 2008, 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 2009 Annual Report 79 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 4.998%. The second swap, in an amount of $200.0, is for a period of five years at a fixed interest rate of 5.051%. 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. At May 2, 2009, the Credit Facilities have been reduced to $244.0 (May 3, 2008 – $395.0). 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 2, 2009, $200.0 (May 3, 2008 – $250.0) of this new credit facility has been drawn down and classified as long-term debt and $Nil (May 3, 2008 – $25.0) has been drawn down and classified as bank indebtedness. Sobeys has also issued $40.1 in letters of credit against the facility at May 2, 2009 ($41.7 at May 3, 2008). On November 8, 2007, Sobeys established and utilized a new unsecured revolving credit facility of $75.0. The maturity date is November 8, 2010. The interest rate is floating and fluctuates with the bankers’ acceptance rate, Canadian prime rate or LIBOR. During fiscal 2009, the Company increased its capital lease obligation by $12.6 (2008 – $8.9) 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: Long-Term Debt Capital Leases $ $ 117.8 305.9 21.8 216.8 25.0 512.0 15.2 13.4 10.6 6.6 3.9 11.0 May 2, 2009 May 3, 2008 $ $ 54.4 7.8 24.3 39.8 8.7 53.2 5.3 23.5 21.7 2.8 $ 135.0 $ 106.5 2010 2011 2012 2013 2014 Thereafter noTe 13 other long-Term liabilities Deferred lease obligation Deferred revenue Accrued benefit liability (Note 25) Derivative liabilities Other 80 empire Company limited notes to the Consolidated Financial statements 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. 2,682,100 992,000,000 259,107,435 40,800,000 No. of Shares May 2, 2009 May 3, 2008 Issued and outstanding: Preferred shares, Series 2 Non-Voting Class A Class B common Employees’ share purchase plan $ 168,000 34,197,498 34,260,763 4.2 316.1 7.6 327.9 (3.4) $ 6.5 185.1 7.6 199.2 (3.5) $ 324.5 $ 195.7 On April 24, 2009, the Company closed a bought-deal public offering of Non-Voting Class A shares at a price of $49.75 per share. The underwriters elected to exercise their over-allotment option in full resulting in a total of 2,713,000 shares being issued for net proceeds of $129.1. During the year, the Company purchased for cancellation 90,200 (2008 – 41,800) Series 2 preferred shares for $2.3 (2008 – $1.0). During the year, nil (2008 – 10,461) Non-Voting Class A shares were issued under the Company’s share purchase plan to certain officers and employees for $nil (2008 – $0.4), 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 189,967 (2008 – 92,766) options were issued. Options allow holders to purchase Non-Voting Class A shares at $40.26 (2008 – $43.96) per share. Options expire in June 2015 and in June 2016. Loans receivable from officers and employees of $3.4 (2008 – $3.5) 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 110,148 (2008 – 111,971) Non-Voting Class A shares. The market value of the shares at May 2, 2009 was $5.5 (May 3, 2008 – $4.4). 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. noTe 15 Capital Management The Company’s objectives when managing capital are: (i) to ensure sufficient liquidity to support its financial obligations and execute its operating and strategic plans; (ii) to minimize the cost of capital while taking into consideration current and future industry, market and economic risks and conditions; (iii) to maintain an optimal capital structure that provides necessary financial flexibility while also ensuring compliance with any financial covenants; and (iv) to maintain an investment grade credit rating with each rating agency that assesses the credit worthiness of Sobeys Inc. No changes were made to these objectives in the current year. The Company monitors and makes adjustments to its capital structure, when necessary, in light of changes in economic conditions, the objectives of its shareholders, the cash requirements of the business and the condition of capital markets. 2009 Annual Report 81 The Company considers its total capitalization to include all interest bearing debt, including bank loans, bankers’ acceptances, long-term debt (including the current portion thereof) and shareholders’ equity, net of cash. The calculation is set out in the following table: Bank indebtedness Long-term debt due within one year Liabilities relating to assets held for sale Long-term debt Funded debt Less cash and cash equivalents Net funded debt Shareholders’ equity Capital under management May 2, 2009 May 3, 2008 $ 45.9 133.0 – 1,124.0 1,302.9 (231.6) 1,071.3 2,683.5 $ 92.6 60.4 6.4 1,414.1 1,573.5 (191.4) 1,382.1 2,382.3 $ 3,754.8 $ 3,764.4 Although the Company does not include operating leases in its definition of capital, the Company does give consideration to its obligations under operating leases when assessing its total capitalization. The primary investments undertaken by the Company include additions to the selling square footage of its store network via the construction of new, relocated and expanded stores, including related leasehold improvements and features and the purchase of land bank sites for future store construction. The Company makes capital investments in information technology and its distribution capabilities to support an expanding store network. In addition, the Company makes capital expenditures in support of its real estate and other operations. The Company largely relies on its cash flow from operations to fund its capital investment program and dividend distributions to its shareholders. This cash flow is supplemented, when necessary, through additional debt or the issuance of additional capital stock. Management monitors certain key ratios to effectively manage capital: Funded debt to total capital (1) Funded debt to EBITDA(2) EBITDA to interest expense (1) Total capital is funded debt plus shareholders’ equity. May 2, 2009 May 3, 2008 32.7% 1.64x 9.84x 39.8% 2.02x 7.35x (2) EBITDA and interest expense are comprised of EBITDA and interest expense for each of the 52 week periods then ended. EBITDA (operating income plus depreciation and amortization) is a non-GAAP financial measure. Non-GAAP financial measures do not have standardized meanings prescribed by GAAP and therefore may not be comparable to similar measures presented by other reporting issuers. As part of existing debt agreements, two financial covenants are monitored and communicated, as required by the terms of credit agreements, on a quarterly basis by management to ensure compliance with the agreements. The covenants are: (i) adjusted total debt/EBITDA – calculated as funded debt plus letters of credit, guarantees and commitments divided by EBITDA (for previous 52 weeks); and (ii) debt service coverage ratio – calculated as EBITDA divided by interest expense plus repayments of long-term debt (all amounts are based on previous 52 weeks). The Company was in compliance with these covenants during the year. 82 empire Company limited notes to the Consolidated Financial statements noTe 16 Investment Income Dividend and interest income Share of earnings of entities accounted using the equity method noTe 17 Capital Gains and other Items Gain on sale of investments Gain on sale of property Other items Change in fair value of Canadian third party asset-backed commercial paper (Note 7) Reduction of book value of real estate assets 2009 0.5 38.4 38.9 $ $ 2008 1.2 33.3 34.5 2009 2008 – 7.5 (1.0) (3.7) – 2.8 $ 100.9 0.9 (0.6) (7.5) (6.0) $ 87.7 $ $ $ $ noTe 18 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 29.9% (2008 – 31.9%) Increase (decrease) in income taxes resulting from Rate changes effect on timing differences Non-taxable dividends Capital gains and other items 2009 2008 $ 116.0 $ 116.8 0.3 – 116.3 (0.2) $ 116.1 $ (5.5) (0.1) 111.2 14.7 125.9 2009 Annual Report 83 May 2, 2009 income tax expense attributable to net earnings consists of: Operations Capital gains and other items May 3, 2008 income tax expense attributable to net earnings consists of: Operations Capital gains and other items Current 128.9 0.7 129.6 Future (12.6) (0.9) (13.5) $ $ Current Future 102.2 18.6 120.8 $ $ 9.0 (3.9) 5.1 $ $ $ $ Total 116.3 (0.2) 116.1 Total 111.2 14.7 125.9 $ $ $ $ The tax effect of temporary differences that give rise to significant portions of future income taxes is 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 2, 2009 May 3, 2008 $ $ $ $ 119.4 6.5 (33.3) (7.6) 14.4 (4.9) 37.4 34.0 (33.7) 132.2 42.7 89.5 132.2 $ $ $ $ 125.9 8.1 (30.9) (8.4) 12.6 3.2 35.7 29.8 (17.6) 158.4 32.9 125.5 158.4 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. 84 empire Company limited notes to the Consolidated Financial statements noTe 19 supplementary Cash Flow Information a) Items not affecting cash Depreciation and amortization Future income taxes (Gain) loss on disposal of assets Amortization of other assets Provision on asset-backed commercial paper Equity in earnings of other entities, net of dividends received Minority interest Stock-based compensation Long-term lease obligation Employee future benefits obligation Rationalization costs (Note 28) Reduction of book value of real estate assets b) Other cash flow information Net interest paid Net income taxes paid noTe 20 Joint ventures 2009 2008 $ $ $ $ 324.8 (13.5) (5.1) 3.2 3.7 2.4 8.3 1.2 7.1 7.7 6.3 – 346.1 80.5 117.2 $ 304.6 5.1 1.3 5.1 7.5 4.7 12.8 2.5 11.9 4.8 (6.2) 6.0 360.1 103.9 157.5 $ $ $ 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 May 2, 2009 May 3, 2008 $ $ $ $ $ $ $ 116.7 26.5 90.2 116.7 2009 58.3 23.9 34.4 35.4 (5.3) (9.7) 20.4 $ $ $ $ $ $ $ 139.4 67.8 71.6 139.4 2008 88.7 36.8 51.9 74.8 (14.6) (2.3) 57.9 2009 Annual Report 85 noTe 21 segmented Information Revenue Food retailing Real estate Sobey Leased Properties Limited Other commercial Inter-segment Residential Investment and other operations Elimination Operating income Food retailing Real estate Sobey Leased Properties Limited Crombie REIT Other commercial Residential Investment and other operations Wajax Income Fund Other operations, net of corporate expenses Identifiable assets Food retailing Goodwill Real estate Investment and other operations (including goodwill of $40.8; May 3, 2008 – $40.1) Inventories Food retailing Real estate – residential Other operations 86 empire Company limited notes to the Consolidated Financial statements 2009 2008 $ 14,764.8 $ 13,768.1 – 16.4 2.9 54.6 73.9 179.3 20.6 19.9 34.9 85.2 160.6 171.2 15,018.0 (2.9) 14,099.9 (34.9) $ 15,015.1 $ 14,065.0 2009 2008 $ 401.4 $ 359.0 – 19.8 2.5 33.6 18.5 (7.7) 30.0 13.6 5.7 50.7 19.7 (6.1) $ 468.1 $ 472.6 May 2, 2009 May 3, 2008 $ 4,279.0 1,130.6 5,409.6 223.1 265.3 $ 4,052.7 1,119.0 5,171.7 282.0 279.2 $ 5,898.0 $ 5,732.9 May 2, 2009 May 3, 2008 $ $ 750.7 90.4 1.7 842.8 $ 731.9 86.6 1.7 $ 820.2 Depreciation and amortization Food retailing Real estate Investment and other operations Capital expenditures Food retailing Real estate Investment and other operations 2009 2008 301.8 1.8 21.2 324.8 $ 276.2 5.4 23.0 $ 304.6 2009 2008 382.7 36.9 11.4 431.0 $ 481.2 47.3 22.2 $ 550.7 $ $ $ $ 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 the development of food-anchored retail strip plazas. Residential real estate is the development of housing lots for resale. Inter-segment transactions are recorded at amounts equivalent to transactions with outside parties. noTe 22 Financial Instruments CrediT ri Sk Credit risk is the risk of an unexpected loss if a customer or counterparty to a financial instrument fails to meet its contractual obligations. The Company’s financial instruments that are exposed to concentrations of credit risk are primarily ABCP (Note 7), accounts receivable, loans and other receivables, derivative contracts and guarantees. The Company’s maximum exposure to credit risk corre- sponds to the carrying amount for all loans and receivables, the fair market value of derivative contracts represented on the balance sheet and guarantee contracts for franchise affiliates. The Company mitigates credit risk associated with its trade accounts receivable, loans and other receivables through established credit approvals, limits and a regular monitoring process. The Company generally considers the credit quality of its financial assets that are neither past due or impaired to be solid. The Company regularly monitors collection performance and pledged security for all of its accounts receivable, loans and other receivables to ensure adequate payments are being received and adequate security is available. Pledged security can vary by agreement, but generally includes inventory, fixed assets including land and/or building, as well as personal guarantees. Credit risk is further mitigated due to the large number of customers and their dispersion across geographic areas. The Company only enters into derivative contracts with Canadian chartered banks to minimize credit risk. Receivables are substantially comprised of balances due from independent accounts, franchisee or affiliate locations as well as rebates and allowances from vendors. The due date of these amounts can vary by agreement but in general balances over 30 days are considered past due. The aging of the receivables is as follows: 0 – 30 days 31 – 90 days Greater than 90 days Total receivables before allowance for doubtful accounts Less: allowance for doubtful accounts May 2, 2009 $ 248.9 32.5 68.5 349.9 (31.2) Receivables $ 318.7 Interest earned on past due accounts is recorded as a reduction to cost of sales, selling and administrative expenses in the statement of earnings. Loans and other receivables are all current as of May 2, 2009. 2009 Annual Report 87  Allowance for doubtful accounts is reviewed at each balance sheet date. An allowance is taken on accounts receivable from independent accounts, as well as accounts receivable, loans and other receivables from franchise or affiliate locations, and is recorded as a reduction to its respective receivable account on the balance sheet. The Company updates its estimate of allowance for doubtful accounts based on past due balances from independent accounts and based on an evaluation of recoverability net of security assigned for franchise or affiliate locations. Current and long-term accounts receivable, loans and other receivables are reviewed on a regular basis and are written-off when collection is considered unlikely. The change in allowance for doubtful accounts is recorded as cost of sales, selling and administrative expenses in the statement of earnings and is presented as follows: 52 Weeks Ended May 2, 2009 Allowance, beginning of year Provision for losses Recoveries Write-offs Allowance, end of year $ $ 28.7 11.6 (2.4) (6.7) 31.2 liQuidiTy riSk Liquidity risk is the risk that the Company may not have cash available to satisfy financial liabilities as they come due. The Company actively maintains committed credit facilities to ensure that it has sufficient available funds to meet current and foreseeable future financial requirements at a reasonable cost. The Company monitors capital markets and the related conditions. Market conditions allowing, the Company will access debt capital markets for various long-term debt maturities and as other liabilities come due or as assessed to be appropriate in order to minimize risk and optimize pricing. The following table summarizes the carrying amount and the contractual maturities of both the interest and principal portion of significant financial liabilities on an undiscounted basis as at May 2, 2009: 2010 2011 2012 2013 2014 Thereafter Total Accounts payable Bank indebtedness Interest rate swaps payable(1) Long-term debt $ $ 1,487.1 45.9 20.7 205.3 $ – – 13.6 372.7 – – 11.0 82.8 $ – – 2.6 261.8 $ – – – 62.5 $ – – – 1,044.3 $ 1,487.1 45.9 47.9 2,029.4 (1) Represents the payable fixed interest (will be partially offset by the floating interest received). fair value of finanCial inSTrumenTS The fair value of a financial instrument is the estimated amount that the Company would receive or pay to settle the financial assets and financial liabilities as at the reporting date. The book value of cash and cash equivalents, receivables, loans and other receivables, and accounts payable and accrued liabilities approximate fair values at the balance sheet date. The fair value of the variable rate long-term debt is assumed to approximate its carrying amount. The fair value of other long-term liabilities has been estimated by discounting future cash flows at a rate offered for debt of similar maturities and credit quality. 88 empire Company limited notes to the Consolidated Financial statements The following table summarizes the classification of the Company’s financial instruments, as well as their carrying amounts and fair values: Held for Trading (Required) Held for Trading (Designated) Available- Loans and for-Sale Receivables Other Financial Liabilities Total Carry Amount Fair Value May 2, 2009 Financial assets Cash and cash equivalents Receivables Loans and other receivables Investments Other assets(1) $ $ – – – – 1.7 $ 231.6 – – – 21.4 $ – – – 1.1 – $ – 318.7 131.1 – – – – – – – – $ 231.6 318.7 131.1 1.1 23.1 $ 231.6 318.7 131.1 1.1 23.1 $ 705.6 $ 705.6 Total financial assets $ 1.7 $ 253.0 $ 1.1 $ 449.8 $ Financial liabilities Bank indebtedness Accounts payable and accrued liabilities Long-term debt Other long-term liabilities(2) $ – $ – $ – $ – $ 45.9 $ 45.9 $ 45.9 – – 39.8 – – – – – – – – – 1,487.1 1,257.0 – 1,487.1 1,257.0 39.8 1,487.1 1,168.8 39.8 Total financial liabilities $ 39.8 $ – $ – $ – $ 2,790.0 $ 2,829.8 $ 2,741.6 (1) The total carrying value of financial assets included in other assets is $23.1. (2) Only the derivative liability portion is presented here. May 3, 2008 Financial assets Cash and cash equivalents Receivables Loans and other receivables Investments Other assets(1) Held for Trading (Required) Held for Trading (Designated) Available- for-Sale Loans and Receivables Other Financial Liabilities Total Carry Amount Fair Value $ – – – – $ 191.4 $ – – – 2.3 26.4 – – – 1.6 – $ – $ 291.1 126.2 – – – – – – – – $ 191.4 $ 191.4 291.1 126.2 291.1 126.2 1.6 28.7 1.6 28.7 $ 639.0 $ 639.0 Total financial assets $ 2.3 $ 217.8 $ 1.6 $ 417.3 $ Financial liabilities Bank indebtedness Accounts payable and accrued liabilities Long-term debt Other long-term liabilities(2) $ – $ – $ – $ – $ 92.6 $ 92.6 $ 92.6 – – 21.7 – – – – – – – – – 1,348.4 1,348.4 1,480.9 1,480.9 – 21.7 1,348.4 1,415.0 21.7 Total financial liabilities $ 21.7 $ – $ – $ – $ 2,921.9 $ 2,943.6 $ 2,877.7 (1) The total carrying value of financial assets included in other assets is $28.7. (2) Only the derivative liability portion is presented here. 2009 Annual Report 89 derivaTive finanCial inSTrumenTS Derivative financial instruments are recorded on the consoli- dated balance sheet at fair value unless the derivative instru- ment 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 instru- ments 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. inTere ST raTe riSk Interest rate risk is the potential for financial loss arising from changes in interest rates. Financial instruments that potentially subject the Company to interest rate risk include financial liabilities with floating interest rates. The majority of the Company’s long-term debt is at a fixed interest rate or hedged with interest rate swaps. Bank indebtedness and approximately 20 percent of the Company’s long-term debt is exposed to interest rate risk due to floating rates. Net earnings is sensitive to the impact of a change in interest rates on the average balance of interest bearing financial liabilities during the period. For the year ending May 2, 2009, the Company’s average floating-rate indebtedness was $772.2 of which $420.0 has been hedged with interest rate swaps. Accordingly, a difference of 0.25 percent in the applicable interest rate would impact net earnings by $0.6 and other comprehensive income by $1.5. foreign CurrenCy exCHange riSk The Company conducts the vast majority of its business in Canadian dollars. The Company’s foreign currency exchange risk principally relates to purchases made in U.S. dollars. In addition, the Company also 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. The Company estimates that a 10 percent increase (decrease) in applicable foreign currency exchange rates would impact net earnings by $6.1 and other comprehensive income by $1.6. CommodiTy PriCe riSk Commodity price risk is the risk that the fair value of certain financial instruments or the Company’s future cash flows will fluctuate as a result of changes in the market price of commodi- ties. The Company has attempted to mitigate commodity price risk to electricity prices through the use of financial derivative swap contracts while closely monitoring other commodity prices to determine the appropriate course of action. The Company estimates that a 10 percent increase (decrease) in applicable commodity prices would impact other comprehensive income by $0.6. noTe 23 Guarantees, Commitments and Contingent liabilities guaranTee S and C ommiTmenTS At May 2, 2009, the Company was contingently liable for letters of credit issued in the aggregate amount of $55.3 (May 3, 2008 – $60.3). Sobeys has guaranteed certain bank loans contracted by franchise affiliates. As at May 2, 2009, these loans amounted to approximately $0.5 (May 3, 2008 – $1.3). During 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 $6.0 or 9.9 percent (2008 – $5.0 or 9.9 percent) of the authorized and outstanding obligation. The terms of the guarantee contract are reviewed annually each August. As at May 2, 2009, the amount of the guarantee was $6.0 (May 3, 2008 – $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. During the third quarter of fiscal 2009, Sobeys entered into an additional credit enhancement contract in the form of a standby letter of credit for certain independent franchisees for the purchase and installation of equipment. Under the terms of the contract should a franchisee affiliate be unable to fulfill their lease obligation or other remedy, Sobeys would be required to fund the greater of $4.0 or 10 percent of the authorized 90 empire Company limited notes to the Consolidated Financial statements and outstanding obligation annually. Under the terms of the agreement, Sobeys is required to obtain a letter of credit in the amount of the outstanding guarantee, to be revisited each calendar year. This credit enhancement allows Sobeys to provide favorable financing terms to certain independent franchisees. The contract terms have been reviewed and Sobeys determined that there were no material implications with respect to the consolidation of VIEs. As at May 2, 2009, the amount of the guarantee was $4.0. The aggregate, annual, minimum rent payable under the guaranteed operating equipment leases for fiscal 2010 is approximately $25.5. The guaranteed lease commitments over the next five years are: 2010 2011 2012 2013 2014 Thereafter Third Parties $ 25.5 14.8 16.7 11.4 4.2 2.0 The net aggregate, annual, minimum rent payable under operating leases for fiscal 2010 is approximately $235.1 ($308.4 gross less expected sub-lease income of $73.3). The commitments over the next five fiscal years are: 2010 2011 2012 2013 2014 Thereafter Third Parties Related Parties Net Lease Obligation Gross Lease Obligation Net Lease Obligation Gross Lease Obligation $ 196.7 176.3 162.6 154.2 147.7 965.3 $ 270.0 246.2 228.7 215.5 203.9 1,354.3 $ 38.4 37.6 34.5 34.0 35.4 407.0 $ 38.4 37.6 34.5 34.0 35.4 407.0 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 of its obligations under the lease. The remaining term of the lease is 11 years with an aggregate obligation of $34.6 (2008 – $37.5). 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 had been reassessed in respect to the tax treatment of gains realized on the sale of shares in Hannaford Bros. Co. (“Hannaford”) in fiscal 2001. The Company had appealed the reassessments in respect of the sale of Hannaford shares. Subsequent to May 2, 2009, the Company and CRA concluded negotiations and jointly requested a court order which, if approved, would result in a reduction of income tax expense of approximately $17.0 in the first quarter of fiscal 2010. 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. 2009 Annual Report 91 The Company has agreed to indemnify its directors and There are various claims and litigation, which the Company officers and particular employees in accordance with the Company’s policies. The Company maintains insurance policies that may provide coverage against certain claims. 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. noTe 24 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 provided Crombie REIT with fixed rate second mortgages in the amount of $6.2. The second mortgages have a weighted average interest rate of 5.38% with a maturity date of March 2014. In addition, the Company has non-interest bearing notes payable to Crombie REIT in the amount of $10.5. noTe 25 employee Future Benefits The Company has a number of defined benefit and defined contribution plans providing pension and other retirement benefits to most of its employees. oTHer benefiT P lanS The Company also offers certain employee post-retirement and post-employment benefit plans which are not funded and include health care, life insurance and dental benefits. defined ConTribuTion P enSion 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 P enSion 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. Most Recent Valuation Date Next Required Valuation Date May 1, 2008 May 1, 2008 May 1, 2008 May 1, 2011 May 1, 2011 May 1, 2011 Retirement Pension Plan Senior Management Pension Plan Other Benefit Plans defined ConTribuTion P lanS The total expense and cash contributions for the Company’s defined contribution plans are as follows: 2009 2008 $ 19.1 18.6 92 empire Company limited notes to the Consolidated Financial statements defined benefiT P lanS Information about the Company’s defined benefits plans, in aggregate, is as follows: Pension Benefit Plans 2009 Pension Benefit Plans 2008 Other Benefit Plans 2009 Other Benefit Plans 2008 $ 288.7 $ $ 116.6 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 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 (gains) Accrued benefit asset (liability) Expense Current service cost, net of employee contributions Interest cost Actual return on plan assets Actuarial gains Past service costs Surplus payments to members Expense (income) before adjustments Expected vs. actual return on plan assets Recognized vs. actual past service costs Recognized vs. actuarial gains (losses) Net expense (income) Classification of accrued benefit asset (liability) Other asset Other liability Accrued benefit asset (liability) $ $ $ $ $ $ $ $ $ $ 269.1 1.8 14.3 0.3 (20.2) 0.2 (15.7) 249.8 252.5 (36.4) 5.8 0.3 (20.1) – 202.1 (47.7) 0.4 86.1 38.8 1.8 14.3 36.4 (15.6) 0.1 – 37.0 (53.4) 0.1 18.0 1.7 63.1 (24.3) 38.8 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 $ $ $ $ $ $ $ $ $ 116.4 3.8 6.7 – (3.3) – (15.1) 108.5 – – 3.3 – (3.3) – $ $ 2.7 6.1 – (3.5) – (5.5) 116.4 – – 3.4 – (3.4) – – $ $ $ $ – $ (108.5) 0.6 (10.5) $ (116.4) 0.6 5.1 $ (118.4) $ (110.7) $ $ $ $ 3.8 6.6 – (15.0) – – (4.6) – 0.1 15.5 11.0 – (118.4) (118.4) $ $ $ $ 2.6 6.1 – (5.5) – – 3.2 – 0.1 5.0 8.3 – (110.7) (110.7) 2009 Annual Report 93 Included in the accrued benefit obligation at year-end are the following amounts in respect of plans that are not funded: Accrued benefit obligation $ 24.3 $ 23.5 $ 118.4 $ 110.7 Pension Benefit Plans 2009 Pension Benefit Plans 2008 Other Benefit Plans 2009 Other Benefit Plans 2008 The significant actuarial assumptions adopted in measuring the Company’s accrued benefit obligation are as follows (weighted-average assumptions as of May 2, 2009): Pension Benefit Plans 2009 Pension Benefit Plans 2008 Other Benefit Plans 2009 Other Benefit Plans 2008 Discount rate Expected long-term rate of return on plan assets Rate of compensation increase 6.25% 7.00% 4.00% 5.25% 7.00% 4.00% 6.00% 5.25% For measurement purposes, a 9 percent fiscal 2009 annual rate of increase in the per capita cost of covered health care benefits was assumed. The cumulative rate expectation to 2019 is 5 percent. The EARSL 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 EARSL of the active employees covered by the other benefit plans range from 11 to 15 years with a weighted average of 14 years at year end. The table below outlines the sensitivity of the fiscal 2009 key economic assumptions used in measuring the accrued benefit plan obligation and related expense 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 obligation or benefit plan expense. 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 Obligation 6.25% $ $ (25.9) 29.1 Benefit Cost(1) 7.00% (2.0) 2.0 6.25% 0.2 (0.5) $ $ $ $ Benefit Obligation Benefit Cost(1) 6.00% (15.1) 18.1 9.00% 14.5 (12.2) $ $ $ $ 6.00% (0.9) 1.0 9.00% 1.8 (1.4) $ $ $ $ (1) Reflects the impact on the current service cost, the interest cost and the expected return on assets. (2) 6.00% for the Employee Pension Plan and the Post Retirement Benefit Plan (3) Gradually decreasing to 5.00% in 2019 and remaining at that level thereafter. 94 empire Company limited notes to the Consolidated Financial statements The asset mix of the defined benefit pension plans as at year end is as follows: Cash and short-term investments Bonds, debentures, fixed income pooled funds and real estate funds Equities and pooled equities fund Accrued interest and dividends Foreign currency hedges 2009 3.43% 36.09% 60.52% 0.21% (0.25%) 2008 2.91% 25.51% 70.26% 0.26% 1.06% 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: 2009 % of Plan Assets 2008 % of Plan Assets $ 104.4 13.7% $ 80.8 9.0% noTe 26 Business Acquisitions Sobeys acquires franchisee and non-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 and non-franchise stores resulted in the acquisition of intangible assets. The method of amortization of limited life intangibles is on a straight-line basis over its estimated useful life. Franchisees Inventory Property and equipment Intangibles Goodwill Other assets (liabilities) Cash consideration Prescription files Intangibles Net assets acquired Less promissory note issued Cash consideration 2009 2008 $ $ 8.7 5.9 7.6 14.3 0.9 37.4 3.2 40.6 (3.5) 37.1 $ $ 6.6 5.1 5.9 1.2 (1.5) 17.3 2.5 19.8 – 19.8 ETL Canada Holdings Limited (a subsidiary of the Company) acquired all of the outstanding shares of an incorporated joint venture already co-owned by the Company for cash consideration of $4.3. The acquisition was accounted for using the purchase method with net identifiable assets recorded at $3.6 (including intangible assets of $0.2) and goodwill at $0.7. 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 2009 Annual Report 95 method with the results of Thrifty being consolidated since the acquisition date. Management carried out a detailed analysis to measure and allocate the excess consideration paid over net assets acquired. The final purchase price allocation, incorporating management’s assessment of fair value, was 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 noTe 27 stock-Based Compensation deferred SHare uniTS 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 correspond- ing number of Non-Voting Class A shares and records any increase in the DSU obligation as an operating expense. At May 2, 2009, there were 84,195 (May 3, 2008 – 64,877) DSUs outstanding. During the year, the compensation expense was $1.8 (2008 – $0.5). SToCk oPTion P lan During fiscal 2009, the Company granted an additional 189,967 options under the stock option plan for employees of the Company whereby options are granted to purchase Non-Voting Class A Shares. These options allow holders to purchase Non-Voting Class A Shares at $40.26 per share and expire in June 2016. The options vest over four years with 50 percent of the options vesting only if certain financial 96 empire Company limited notes to the Consolidated Financial statements $ $ $ $ 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 targets are attained in a given fiscal year. These options have been treated as stock-based compensation. The compensation cost relating to the year was determined to be $1.2 (2008 – $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 was $1.2. The compensation cost was calculated using the Black-Scholes model with the following assumptions: Expected life Risk-free interest rate Expected volatility Dividend yield 8 years 3.50% 20.1% 1.75% SHare PurCHaSe Plan The Company has a share purchase 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 Company’s current practice is to use only the stock option plan to provide long-term incentive for employees. As a result, outstanding loans under the stock purchase plan will be repaid at the employees’ option, but no later than the expiry date of the loans which were originally set for 10 years. PHanTom PerformanCe oPTion P lan 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. Upon implementation, the units had a three year vesting period with 33.3 percent of the units vesting each year. Subsequent issuances have a four year vesting period with 25.0 percent 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 change in notional value over the original grant value on a straight-line basis over the vesting period. After the vesting period, any change in incremental notional equity value is recognized as a compensation expense immediately. This is recorded as an accrued liability until settlement and is remeasured at each interim and annual reporting period of the Company. As at May 2, 2009, 1,069,413 (May 3, 2008 – 518,579) units were outstanding and the Company recognized $6.1 (2008 – $0.1) of compensation expense associated with this plan. noTe 28 Business Rationalization Costs For the year ended May 2, 2009, severance costs of $10.7 (2008 – $(1.8)) have been incurred and recognized. The costs associated with the organizational change are recorded as incurred as cost of sales, selling and administrative expenses in the statement of earnings. The liability as of May 2, 2009 is $12.2 (May 3, 2008 – $5.9). Costs incurred as of May 2, 2009 were $27.7. noTe 29 variable Interest entities Variable interest entities are defined under Accounting Guideline 15 (“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 VIEs expected losses and its expected residual returns. The Company has identified the following entities as VIEs: franCHiSe affiliaTeS The Company has identified 271 (May 3, 2008 – 292) 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. WareHouSe and diSTribuTion a greemenT 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 30 subsequent events a) On June 12, 2009, Sobeys repaid, although did not cancel, the $75.0 credit facility which matures on November 8, 2010. Crombie REIT). Consequently the Company’s interest in Crombie REIT was reduced from 47.9% to 47.4% . b) On June 25, 2009, Crombie REIT closed a bought-deal public offering of units at a price of $7.80 per unit. In satisfaction of its pre-emptive right with respect to the public offering, the Company subscribed for $30.0 of Class B Units (which are convertible on a one-for-one basis into units of c) On July 23, 2009, Sobeys finalized an agreement to sell and leaseback a retail support centre located in Milton, Ontario to a third party. Proceeds on the sale will be $51.0 resulting in a pre-tax gain of $5.6. A long-term lease agreement has been agreed to for the use of the property with the gain being amortized over the term of the lease. noTe 31 Comparative Figures Comparative figures have been reclassified, where necessary, to reflect the current year’s presentation. 2009 Annual Report 97 eleven-year financial review Years Ended(1) 2009 2008 2007 Restated 2006 Restated 2005 2004 2003 2002 2001 2000 1999 Financial Results ($ 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) $ 15,015.1 468.1 80.6 116.1 8.3 262.9 – 262.9 3.0 265.9 10.5% 5,898.0 1,124.0 2,683.5 3.99 0.05 4.04 0.700 0.700 39.14 55.05 35.00 49.00 65.8 $ 14,065.0 $ 13,366.7 $ 13,063.6 $ 12,435.2 $ 11,284.0 $ 10,624.2 $ 9,926.5 $ 9,331.1 $ 9,100.1 $ 5,362.7 472.6 105.8 125.9 12.8 242.8 – 242.8 73.0 315.8 14.0% 5,732.9 1,414.1 2,382.3 3.69 1.11 4.80 0.660 0.660 36.14 55.19 35.40 39.25 431.1 60.1 116.9 55.4 200.1 – 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 42.33 491.4 83.8 153.1 67.1 202.0 – 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 65.7 65.7 65.7 65.7 65.8 65.8 65.7 65.6 75.6 463.7 86.7 131.2 63.6 182.9 – 182.9 3.7 186.6 11.4% 4,929.2 727.4 1,709.0 2.78 0.05 2.83 0.480 0.480 25.87 38.00 24.25 36.66 422.8 92.4 111.0 58.5 163.3 - 163.3 9.2 172.5 11.6% 2.47 0.14 2.61 0.400 0.400 23.67 29.50 23.10 26.65 444.4 93.7 120.0 67.5 159.3 - 159.3 (6.0) 153.3 11.4% 2.42 (0.09) 2.33 0.330 0.330 21.41 33.25 23.70 23.85 416.2 111.6 104.8 50.0 123.5 8.7 132.2 63.7 195.9 16.4% 2.00 0.97 2.97 0.214 0.214 19.47 33.30 15.75 28.88 341.1 145.8 131.9 34.3 78.5 10.0 88.5 491.5 580.0 69.1% 1.33 7.49 8.82 0.170 0.170 16.82 18.25 13.88 17.00 309.7 159.6 68.1 32.9 78.8 5.9 84.7 2.1 86.8 13.3% 1.10 0.03 1.13 0.140 0.140 8.73 16.98 12.33 16.05 4,679.7 913.0 1,567.6 4,519.3 923.1 1,418.5 4,318.0 975.0 1,290.6 4,254.3 1,107.2 1,115.0 4,171.0 1,332.0 602.8 4,023.5 1,391.8 737.5 184.4 112.6 49.1 9.2 59.0 1.1 60.1 74.9 135.0 21.7% 0.78 1.00 1.78 0.136 0.136 9.03 16.27 12.50 13.00 75.0 (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, fiscal 2008, which ended May 3, 2008, and fiscal 2009, which ended May 2, 2009, 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 fiscal 2002. (3) Operating earnings equals net earnings before capital gains (losses) and other items, net of tax. 98 empire Company limited 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 Share Price, Non-Voting Class A Shares ($ per share) Book value High Low Close Diluted weighted average number of shares outstanding (in millions) 468.1 80.6 116.1 8.3 262.9 – 262.9 3.0 265.9 10.5% 5,898.0 1,124.0 2,683.5 3.99 0.05 4.04 0.700 0.700 39.14 55.05 35.00 49.00 65.8 472.6 105.8 125.9 12.8 242.8 – 242.8 73.0 315.8 14.0% 5,732.9 1,414.1 2,382.3 3.69 1.11 4.80 0.660 0.660 36.14 55.19 35.40 39.25 431.1 60.1 116.9 55.4 200.1 – 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 42.33 491.4 83.8 153.1 67.1 202.0 – 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 (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, fiscal 2008, which ended May 3, 2008, and fiscal 2009, which ended May 2, 2009, 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 fiscal 2002. (3) Operating earnings equals net earnings before capital gains (losses) and other items, net of tax. Years Ended(1) 2009 2008 2005 2004 2003 2002 2001 2000 1999 2007 Restated 2006 Restated $ 15,015.1 $ 14,065.0 $ 13,366.7 $ 13,063.6 $ 12,435.2 $ 11,284.0 $ 10,624.2 $ 9,926.5 $ 9,331.1 $ 9,100.1 $ 5,362.7 65.7 65.7 65.7 65.7 65.8 65.8 65.7 65.6 75.6 463.7 86.7 131.2 63.6 182.9 – 182.9 3.7 186.6 11.4% 4,929.2 727.4 1,709.0 2.78 0.05 2.83 0.480 0.480 25.87 38.00 24.25 36.66 422.8 92.4 111.0 58.5 163.3 - 163.3 9.2 172.5 11.6% 444.4 93.7 120.0 67.5 159.3 - 159.3 (6.0) 153.3 11.4% 416.2 111.6 104.8 50.0 123.5 8.7 132.2 63.7 195.9 16.4% 341.1 145.8 131.9 34.3 78.5 10.0 88.5 491.5 580.0 69.1% 309.7 159.6 68.1 32.9 78.8 5.9 84.7 2.1 86.8 13.3% 184.4 112.6 49.1 9.2 59.0 1.1 60.1 74.9 135.0 21.7% 4,679.7 913.0 1,567.6 4,519.3 923.1 1,418.5 4,318.0 975.0 1,290.6 4,254.3 1,107.2 1,115.0 4,171.0 1,332.0 602.8 4,023.5 1,391.8 737.5 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 2.00 0.97 2.97 0.214 0.214 19.47 33.30 15.75 28.88 1.33 7.49 8.82 0.170 0.170 16.82 18.25 13.88 17.00 1.10 0.03 1.13 0.140 0.140 8.73 16.98 12.33 16.05 0.78 1.00 1.78 0.136 0.136 9.03 16.27 12.50 13.00 75.0 2009 Annual Report 99 glossary BooK vAlUe peR shARe opeRATInG eARnInGs Shareholders’ equity less preferred shares divided by Non-Voting Class A shares and Class B common shares outstanding Net earnings before capital gains (losses) and other items, net of tax CAGR Compound Annual Growth Rate CApITAl expenDITURes opeRATInG InCoMe Operating earnings before minority interest, interest expense and income taxes Payments made for the acquisition of property and equipment opeRATInG MARGIn Operating income divided by sales eBITDA Operating income plus depreciation and amortization pRIvATe lABel expAnDeD sToRes A brand of products that is marketed, distributed and owned by the Company Stores that undergo construction resulting in a square footage increase during the year RenovATeD sToRes FUnDeD DeBT All interest bearing debt, which includes bank loans, bankers’ acceptances, long-term debt and liabilities relating to assets held for sale Stores that undergo construction, resulting in no increase in square footage Roe (ReTURn on eQUITy) Net earnings available for common shares divided by average common shareholders’ equity FUnDs FRoM opeRATIons Operating earnings plus depreciation and amortization sAMe-sToRe sAles 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 leTTeRs oF CReDIT Financial instruments issued by a financial institution to guarantee the Company’s payments to a third party neT DeBT To ToTAl CApITAl Funded debt less cash and cash equivalents divided by funded debt less cash and cash equivalents plus shareholders’ equity Sales from stores in the same location in both reporting periods 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 we IGhTe D AveRAGe nUMBeR oF shAR es 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 100 empire Company limited shareholder and investor information Empire Company Limited Head Office: 115 King St. Stellarton, Nova Scotia B0K 1S0 Telephone: (902) 755-4440 Fax: (902) 755-6477 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, 2009, 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) 88,262 Dividend Record and Payment Dates for Fiscal 2010 Record Date Payment Date July 15, 2009 October 15, 2009* January 15, 2010* April 15, 2010* * Subject to approval by Board of Directors July 31, 2009 October 30, 2009* January 29, 2010* April 30, 2010* 34,197,498 34,260,763 Outstanding Shares As of June 26, 2009 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. a d a n a C n o i t a r o p r o C l l i r r e M : g n i t n i r P e r o o M n i v r a M , 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 C O M P A N Y L I M I T E D At Sobeyscareers.com it is all about “Careers that fit your life”. Launched in 2009, the site allows visitors to explore the endless opportunities and benefits offered by a career in our stores, distribution centres and offices. www.empireco.ca 

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