Empire Company Annual Report 2018

Plain-text annual report

Annual Report 2018 Trusted by Canadian Families Empire Company Limited COMPANY PROFILE Empire Company Limited (TSX: EMP.A) is a Canadian company headquartered in Stellarton, Nova Scotia. Empire’s key businesses are food retailing and related real estate. With approximately $24.2 billion in sales and $8.7 billion in assets, Empire and its subsidiaries, franchisees and afﬁ liates employ approximately 120,000 people. Financial Highlights ($ in millions, except per share amounts) Sales Operating income (loss) Adjusted operating income(1) EBITDA(1) Adjusted EBITDA(1) Net earnings (loss)(2) per share (fully diluted) Adjusted net earnings(1)(2) per share (fully diluted) Book value per common share(1) Dividends per share 52 weeks ended May 5, 2018 52 weeks ended May 6, 2017 53 weeks ended May 7, 2016 $ 24,214.6 $ 23,806.2 $ 24,618.8 346.5 601.7 785.7 1,014.7 159.5 0.59 344.3 1.27 13.62 0.42 333.0 378.5 777.2 796.9 158.5 0.58 191.3 0.70 13.40 0.41 (2,418.5) 713.7 (1,944.7) 1,161.4 (2,131.0) (7.78) 410.2 1.50 13.23 0.40 SALES ($ IN BILLIONS) ADJUSTED NET EARNINGS (1)(2) ($ IN MILLIONS) DIVIDENDS ($ PER SHARE) 25 20 15 10 5 0 CAGR (3) 5.6% 2008 2018 600 CAGR (3) 500 400 300 200 100 0 3.6% 2008 2018 0.5 CAGR (3) 6.7% 0.4 0.3 0.2 0.1 0 2008 2018 (1) See “Non-GAAP Financial Measures & Financial Metrics” section of the Management’s Discussion and Analysis (“MD&A”). (2) Net of non-controlling interest. (3) Compound annual growth rate. ABOUT THE COVER: This year’s cover image is taken from a Sobeys TV ad called “Hit Send on Summer.” A father and daughter plan a family backyard celebration and prepare the food they picked up at Sobeys, while keeping in touch with mom to see when she will be home from work to join the party. The ad is part of our “Get More Summer” campaign, which aims to inspire Canadians to make the most of every moment with their families. Annual Report 2018 TRUSTED BY CANADIAN FAMILIES For 111 years, our customers have been at the heart of our business. Canadians know they can trust us to provide the fresh, quality products they need to nurture their families. We are proud to be ranked as the most trusted grocer in Canada.* * 2018 Leger Corporate Reputation Study. Sobeys was ranked as the most admired company in the grocery/convenience store category, and sector champion for honesty and transparency. 1 Empire Company Limited Message from the CEO “ We want to be the best, most innovative and customer-focused retailer in Canada. We want customers to think of us first when they shop for groceries.” — MICHAEL MEDLINE On May 4th last year, Empire set out to rewrite the fundamentals of the Company through an ambitious three-year transformation program. Michael Medline, President & CEO of Empire Company Limited and its wholly-owned subsidiary Sobeys Inc., talks candidly about the transformation progress and the Company’s bold plans to take back market share, thrill its customers and excite its shareholders. Q. Michael, it has been 18 months since you started at Empire. Has the Company made the progress you expected? Yes. I am very pleased with the progress we’ve made on our journey to turning around our company. In fact, we are a little bit ahead of where I thought we would be at this point. In the last 18 months we have stabilized the Company and found our bearings. We transformed our structure, sharpened our leadership team, stopped the market share bleeding, stabilized our margins, and improved our SG&A, EPS and EBITDA. Beyond the foundational changes, we also made strategic decisions to seize opportunities and set the Company up for future success. We announced the decision to expand discount to the West and invested in a partnership with Ocado to build the finest e-commerce solution in Canada. Q. You are one year into a three year transformation, Project Sunrise. Are you delivering on the commitments that you have made? Our first year of Project Sunrise was a success. We are on track to take out at least $500 million of costs from our business on a run rate basis by the end of fiscal 2020. As expected, in fiscal 2018, we successfully realized 20% of our $500 million target, the majority of those savings coming from our organizational restructuring. 80% 20% improvement in adjusted net earnings savings realized towards total three-year target of $500 million Annual Report 2018 Completing the restructuring of our organization was a very important milestone for us. We have moved from a byzantine regional structure to a new, efﬁ cient operating model that drives our business on a national basis, while acknowledging differences across regions. This work was tough, but it was necessary. I’m pleased we are seeing more stability as the team settles in to the new structure. But what I’m really excited about is that our new structure will now allow us to go for sales and tonnage, and earn back our market share. It’s time we set our sights on the big prize – sales. We are pivoting from being laser-focused on stabilizing our business to making strategic decisions for the future and mobilizing our plans for growth. Q. When you think about the future for Empire and Sobeys, what does it look like? I think about what this company can and will be most every waking hour of my day. We have not strayed from the vision that we set out for this company a year ago. We want to be the best, most innovative and customer-focused retailer in Canada. We want customers to think of us ﬁ rst when they shop for groceries. And I want our employees to feel the pride of working for a company that is making a difference in the lives of our customers. Are we there yet? Not at all, but we’re making tangible progress. We have a lot of hard work in front of us. But, a year in, I am more conﬁ dent than ever that we now have the foundation, the strategy, the tactics and, most importantly, the team to execute on this vision. WIN IN OUR S TORES We are committed to providing a great customer experience and carrying the items that customers want most. We are working to thrill our customers and strengthen their connection with our brand. 3 Empire Company Limited MESSAGE FROM THE CEO Q. What are your strategic priorities for ﬁ scal 2019? We have ﬁ ve strategic priorities for ﬁ scal 2019: – First, we have to continue our focus on Project Sunrise. And by that, I mean really starting to leverage the scale of our new structure in ﬁ scal 2019 to take more costs out of the business and get ready to go after sales and incremental margin. – Second, we’ll continue to bolster our brand. We need to be clearer about what we stand for to strengthen the emotional connection with consumers and continue to earn their conﬁ dence as their most trusted destination for their groceries. – Third, we absolutely need to win in our stores. The customer experience from the ﬁ rst steps into our conventional stores right through to the checkout experience needs to be great – not just good, great. And then we have two speciﬁ c opportunities around which we have built solid strategies: – Our fourth priority is to expand discount, pushing west with our FreshCo banner and converting up to 25% of our Safeway and Sobeys stores in a market that is ripe for a discount offer. – And ﬁ nally, we are playing to win grocery e-commerce in Canada, through our exclusive deal with Ocado to bring the world’s ﬁ nest grocery e-commerce platform to our customers. Q. What does ‘Winning in our Stores’ look like in ﬁ scal 2019? Each of our strategies includes a myriad of activities to thrill our customers. In this case, the top initiatives for ﬁ scal 2019 include the work we are doing to review our product categories, from top to bottom, to ensure we carry the items that customers want most. Next, the product must be on the shelf when the customer Five Strategic Priorities Reset our Foundation Successful completion of Sunrise by end of ﬁ scal 2020 Bolster our Brand Strengthen the emotional connection to our banner brands Win in our Stores Improve service and offering in our conventional stores Enhance Discount Expand discount to Western Canada and reﬁ ne our FreshCo model Win E-commerce Launch home delivery through Ocado partnership We will continue to improve our service and product offering in our stores to give customers the best possible experience. 4 Annual Report 2018 120,000 team members in over 900 communities across Canada “ Our culture is rooted in a commitment to putting our customers ﬁ rst, supporting one another and supporting the communities we serve. I guarantee you that these cultural attributes aren’t about to change.” for us to strengthen our company to win in the future. We need to hold leaders more accountable for results and foster more of a culture of innovation. Q. Do you have any ﬁ nal comments? I couldn’t end any conversation about our business without expressing my profound thanks to our customers, our Board of Directors and my teammates across the country. Sobeys has been built over the last ﬁ ve generations, community by community. Thank you to our customers in the over 900 communities that we serve coast-to-coast for visiting our stores. Thank you to our Board for their strong governance and support as we transform Sobeys; special thanks to Jim Dickson, our Chair, for his ongoing dedication to our company. Thanks goes to my 120,000 colleagues; I have been so impressed and encouraged by the determination and commitment of the team at every level of the organization as we forge a new future for our company. It’s really hard work. It’s massive change – they have shown heart and tenacity. Sincerely, signed “Michael Medline” MICHAEL MEDLINE President and Chief Executive Ofﬁ cer, Empire Company Limited June 27, 2018 comes looking for it. We have a signiﬁ cant focus on service levels to the stores and we’re seeing improvements; customers need to trust that everything on their list is on our shelves. And ﬁ nally, we’re investing more capital to refresh some of our conventional stores in ﬁ scal 2019. Q. You recently announced changes to your executive team. How will this better position the Company for the future? The key leadership changes we made really sharpen our focus on our ﬁ ve priorities and for the next phases of our transformation. The changes place strong leaders in key operations and merchandising roles and, for the ﬁ rst time, create a truly national merchandising team. We’ve also built Empire’s e-commerce and discount leadership for the long term. This leadership team will deliver results and strengthen our company to win in the future. Q. Do you see the Sobeys culture changing, and what is most important to keep? Sobeys’ culture is one of the things that attracted me to this great company. There is so much about the rich history of this family company that makes it a truly iconic, Canadian business and a great place to work. Our culture is rooted in a commitment to putting our customers ﬁ rst, supporting one another and supporting the communities we serve. I guarantee you that these cultural attributes aren’t about to change. They will remain foundational to everything we do. However, there are certainly some aspects of our culture that we need to continue to develop in order E- COMMERCE PL ATFORM Our world-class e-commerce offering will redeﬁ ne convenience for grocery customers. We will build on the success of our discount model by expanding the FreshCo banner in Western Canada. 5 Empire Company Limited Message from the Chair “ The Board will continue to work with the executive team on every step of the journey to provide counsel and oversight throughout the transformation of the business.” — JAMES M. DICK SON Fiscal 2018 was an exciting and transformational year for Empire Company Limited. During Michael Medline’s ﬁ rst full year as our President and CEO, he and his team have increased sales and reduced expenses, while also signiﬁ cantly improving operating margins, proﬁ tability and earnings per share. Remarkably, these improvements were accomplished against a backdrop of major change as Sobeys rebuilt its complex regional operational structure into a more efﬁ cient, national, functionally-led team. The majority of ofﬁ ce employees at Sobeys ﬁ nished ﬁ scal 2018 in new roles or with new responsibilities. In addition, our team has set in motion key strategic initiatives such as the push west with our company’s FreshCo banner, and Sobeys’ exclusive agreement with Ocado to bring the world’s very best integrated grocery e-commerce platform to Canada. The leadership team is now well-poised to unlock the Company’s national scale, deliver signiﬁ cant cost savings and revitalize our relationsh savings and revitalize our relationship with our customers. p And yet, our company’s progress is And yet, our company’s progress is not just evident in its ﬁ nancial results. It is showing up in a new energy and focus across the broad leadership team. It is translating into up in a new energy and focus acros improvements in Sobeys’ corporate reputation as reﬂ ected in Leger’s 2018 ranking of improvements in Sobeys’ corporat Canada’s 100 Most Admired Companies. It is palpable in the renewed conﬁ dence with Canada’s 100 Most Admired Comp which the team is tackling strategic priorities and building a stronger foundation for which the team is tackling strategic future growth. future growth. 13 of our 14 directors are independent More than 1⁄3 of our directors are women Annual Report 2018 We were pleased to welcome Sharon Driscoll to our Board in January 2018. Sharon has senior ﬁ nancial experience at well-known Canadian retailers in the grocery, pharmacy and general merchandising segments. As an executive at a company operating innovative online marketplaces, Sharon strengthens our Board with e-commerce expertise at a time when online food retailing is becoming increasingly important to our business. With Thanks On behalf of the Board, I extend my appreciation to all the people in Empire’s and Sobeys’ operations, and our franchisees and afﬁ liates. I would also like to thank the Sobey family for their commitment to long-term value creation, and all of Empire’s shareholders for your ongoing support and conﬁ dence. Sincerely, signed “James M. Dickson” JAMES M. DICK SON Chair, Empire Company Limited June 27, 2018 Change of this magnitude and duration requires strong governance. The Board of Directors is responsible for stewardship of the Company and, as such, we are overseeing the strategic plan and its execution. We established our Transformation Oversight Committee with a mandate to oversee the transformation effort, monitor progress and review management’s strategies for mitigating the risks inherent in any initiative of this size. The Board also tied a portion of executive compensation to the successful completion of certain of those strategic initiatives. With the foundation in place, Michael Medline and our leadership team have set their focus on bolstering the brand, improving our conventional store offering, enhancing and expanding our successful discount model, and preparing to launch an e-commerce offering that will be superior to anything available today in the Canadian market. To date, our Board has been very satisﬁ ed that the strategic plan reﬂ ects the bold steps that the Company must take, and that leadership is demonstrating great focus and capability in successfully managing the transformation. One year into this major transformation, we believe Empire is already a much stronger company with a brighter future. Strong Governance I am proud to chair a Board that is highly engaged, experienced and diverse. The slate of directors we are proposing for election at this year’s annual general meeting consists of individuals with experience in the food business, retail, ﬁ nance, e-commerce and consumer businesses. All of our directors are independent except for our CEO. Nine new independent directors have joined within the past six years, resulting in strong board renewal. In addition, the Board is fortunate to have ﬁ ve members of the Sobey family, each of whom has, in the past, served in senior level positions within Empire or Sobeys. Both the Board and the Empire leadership team remain committed to diversity and gender balance at all levels of the Company. We believe a range of skills, perspectives and backgrounds lead to more effective governance. This year, over a third of our nominees for election as directors are highly capable and accomplished women. 7 Empire Company Limited Integral Part of Our Communities Proudly serving our communities is a deeply held core value at Sobeys. A great example of that pride shines through in our national partnership with Special Olympics – from providing employment opportunities to individuals with intellectual disabilities, to developing one of the most innovative nutrition programs in the global Special Olympics movement, to proudly co-presenting the Special Olympics Canada Summer Games 2018. Special Olympics Canada Summer Games 2018 At Sobeys we think of ourselves as Special Olympics’ #BiggestFans and could not be more excited to be one of the biggest supporters of this year’s Canada Summer Games. Hosted in Antigonish, Nova Scotia – just down the road from our Stellarton head ofﬁ ce – busloads of employees will make their way to the Games as part of our ‘Fans in the Stands Cheer Squad’. Sobeys will also make some noise at ‘Sobeys Square’ in the middle of the action, with activities, entertainment, videos and food sampling for visitors, athletes and coaches alike. As we celebrate every moment, big and small, the Sobeys team will provide more than 10,000 meals and snacks to the 900 athletes, 290 coaches and ofﬁ cials, and 600 volunteers. Making Better Nutrition Possible for Special Olympics Athletes Year-Round Empowering Special Olympics athletes to live healthier lives has been a mission for Sobeys from the earliest days of our national partnership. To that end, Sobeys and Special Olympics teamed up to create a truly innovative nutrition program, developed speciﬁ cally to address the unique health risks experienced by many individuals with intellectual disabilities. Our Better Food Nutrition Sessions are hands-on, fun and interactive workshops for Special Olympians, led by more than 100 Sobeys employee volunteers across the country. With a focus on quick and easy recipes and nutrition education, our goal is to reach over 20,000 athletes, caregivers and coaches by the end of 2019. EMPLOYEE PROFILE Michael Jacques Sobeys is proud to co-present the Special Olympics Canada 2018 Summer Games in Antigonish, Nova Scotia. Gary, a Sobeys Vancouver, BC employee and Nutrition Session volunteer, says “Being part of an organization that helps educate our athletes on nutrition is exciting, fulﬁ lling and something I really identify with.” As extraordinary young people go, Michael Jacques is one for the books! Diagnosed with autism and an intellectual disability at a young age, today Michael is an advocate, guest speaker, valued employee at Sobeys, a Special Olympics athlete, and the author of Can’t Read, Can’t Write, Here’s My Book. – an inspiring and heartwarming autobiography of looking past disabilities to ﬁ nd purpose in promoting inclusion. Michael is an ally for the Re:Action4Inclusion initiative, touring the province of Ontario and talking to students about the impact they could have in their own schools by being more accepting of others’ differences. He is also a member of Community Living Ontario’s Board of Directors. Since 2010, Michael has been a valued member of the team at his local Sobeys in the Niagara region of Ontario. As much as Michael shares his love of his job and thanks Sobeys for giving him the opportunity, the store team is just as thankful to Michael for building their understanding of how to create diverse and inclusive teams, supporting all and celebrating different abilities. Fellow employees help Michael with new ways to do his job such as colour-coding product codes and using numbers to help him memorize different sections of the store. “ My job does not feel like a job; it feels like a family.” — MICHAEL JACQUES 8 Annual Report 2018 Directors of Empire Company Limited Cynthia Devine (2)(5)(7) Toronto, Ontario Director since 2013 Chief Financial Ofﬁ cer, Maple Leaf Sports & Entertainment James M. Dickson Halifax, Nova Scotia Director since 2015 Sharon Driscoll (1) Vancouver, British Columbia Director since 2018 Gregory Josefowicz (3) Fennville, Michigan, USA Director since 2016 Sue Lee (3) Calgary, Alberta Director since 2014 Chair of Empire Company Limited Chief Financial Ofﬁ cer, Ritchie Bros. Auctioneers Inc. Corporate Director Corporate Director Counsel, Stewart McKelvey William Linton (4)(5)(7) Toronto, Ontario Director since 2015 Corporate Director Michael Medline Toronto, Ontario Director since 2017 Martine Reardon (1) New York, New York, USA Director since 2017 Frank C. Sobey(5) Pictou County, Nova Scotia Director since 2007 John R. Sobey (1) Pictou County, Nova Scotia Director since 1979 President & Chief Executive Ofﬁ cer, Empire Company Limited and Sobeys Inc. Corporate Director Chairman, Crombie REIT Corporate Director Karl R. Sobey (3) Halifax, Nova Scotia Director since 2001 Paul D. Sobey (5) Pictou County, Nova Scotia Director since 1993 Rob G. C. Sobey (3)(5) Stellarton, Nova Scotia Director since 1998 Martine Turcotte (1)(6)(8) Verdun, Québec Director since 2012 Corporate Director Corporate Director Corporate Director Vice Chair, Québec, BCE Inc. and Bell Canada (1) Audit Committee member (2) Audit Committee chair (3) Human Resources Committee member (4) Human Resources Committee chair (5) Corporate Governance Committee member (6) Corporate Governance Committee chair (7) Nominating Committee member (8) Nominating Committee chair To learn more, please visit www.empireco.ca/governance 9 Empire Company Limited Management’s Discussion & Analysis TABLE OF CONTENTS Forward-Looking Information Overview of the Business Food Retailing Summary Results – Fourth Quarter Sales Gross Proﬁ t Operating Income EBITDA Finance Costs Income Taxes Net Earnings Operating Results – Full Year Sales Gross Proﬁ t Operating Income EBITDA Finance Costs Income Taxes Net Earnings Financial Performance by Segment Food Retailing 11 12 12 Investments and Other Operations 13 14 14 14 15 15 15 16 16 16 17 17 17 17 18 18 18 18 18 Investments and Other Operations 19 20 20 21 21 22 22 Quarterly Results of Operations Liquidity and Capital Resources Operating Activities Investing Activities Financing Activities Free Cash Flow Employee Future Beneﬁ t Obligations Guarantees and Commitments 22 23 10 23 23 24 25 Consolidated Financial Condition Key Financial Condition Measures Shareholders’ Equity Accounting Standards and Policies Changes to Accounting Standards Adopted During Fiscal 2018 25 25 Future Standards Critical Accounting Estimates 27 Disclosure Controls and Procedures 28 Internal Control Over Financial Reporting Related Party Transactions Key Management Personnel Compensation Indemnities Contingencies Risk Management Designation for Eligible Dividends Non-GAAP Financial Measures & Financial Metrics Financial Measures Food Segment Reconciliations Financial Metrics 28 29 29 29 30 30 35 35 35 37 38 Annual Report 2018 The following is Management’s Discussion and Analysis (“MD&A”) of the consolidated ﬁ nancial results of Empire Company Limited (“Empire” or the “Company”) (TSX: EMP.A) and its subsidiaries, including wholly-owned Sobeys Inc. (“Sobeys”) for the 13 and 52 weeks ended May 5, 2018 compared to the 13 and 52 weeks ended May 6, 2017. The MD&A should be read in conjunction with the Company’s audited consolidated ﬁ nancial statements and notes thereto for the 52 weeks ended May 5, 2018, and the 52 weeks ended May 6, 2017. Additional information about the Company, including the Company’s Annual Information Form, can be found on SEDAR at www.sedar.com or on the Company’s website at www.empireco.ca. The audited consolidated ﬁ nancial statements and the accompanying notes are prepared in accordance with International Financial Reporting Standards (“IFRS”) as issued by the International Accounting Standards Board (“IASB”) and are reported in Canadian dollars (“CAD”). These consolidated ﬁ nancial statements include the accounts of Empire and its subsidiaries and structured entities (“SEs”) which the Company is required to consolidate. The information contained in this MD&A is current to June 27, 2018, unless otherwise noted. FORWARD-LOOKING INFORMATION This document contains forward-looking statements which are presented for the purpose of assisting the reader to contextualize the Company’s ﬁ nancial position and understand management’s expectations regarding the Company’s strategic priorities, objectives and plans. These forward-looking statements may not be appropriate for other purposes. Forward-looking statements are identiﬁ ed by words or phrases such as “anticipates”, “expects”, “believes”, “estimates”, “intends”, “could”, “may”, “plans”, “predicts”, “projects”, “will”, “would”, “foresees” and other similar expressions or the negative of these terms. These forward-looking statements include, but are not limited to, the following items: • The Company’s expectations regarding the impact of Project Sunrise, including expected cost savings and efﬁ ciencies resulting from this transformation initiative, and the expected timing of the realization of ﬁ scal 2019 in-year incremental beneﬁ ts, which could be impacted by several factors, including the time required by the Company to complete the project as well as the factors identiﬁ ed under the heading “Risk Management”; • The Company’s expectations regarding the implementation of its online grocery shopping business including the timing of launching the business, the overall customer response to the service and the performance of its business partner, Ocado Group plc (“Ocado”); • The Company’s expectations regarding the impact of healthcare reform that came into effect on April 1, 2018 which may be impacted by factors described under the headings “Healthcare Reform” and “Risk Management – Drug Regulation, Legislation and Healthcare Reform”; • The Company’s expectations regarding the impact of minimum wage increases in Ontario and Alberta, other incremental impacts of the Fair Workplaces, Better Jobs Act, 2017 (“Bill 148”) and the Company’s ability to mitigate the ﬁ nancial impact of these increases which may be impacted by factors described under the heading “Minimum Wage Increases”; • The Company’s expected contributions to its registered deﬁ ned beneﬁ t plans, which could be impacted by ﬂ uctuations in capital markets; • The Company’s assessment that its operational and capital structure is sufﬁ cient to meet its ongoing business requirements, which could be impacted by changes in the current economic environment; and • The Company’s expectation that its cash and cash equivalents on hand, unutilized credit facilities and cash generated from operating activities will enable the Company to fund future capital investments, pension plan contributions, working capital, current funded debt obligations and ongoing business requirements, and its belief that it has sufﬁ cient funding in place to meet these requirements and other short and long-term obligations, all of which could be impacted by changes in the economic environment. By its nature, forward-looking information requires the Company to make assumptions and is subject to inherent risks, uncertainties and other factors which may cause actual results to differ materially from forward-looking statements made. For more information on risks, uncertainties and assumptions that may impact the Company’s forward-looking statements, please refer to the Company’s materials ﬁ led with the Canadian securities regulatory authorities, including the “Risk Management” section. Although the Company believes the predictions, forecasts, expectations or conclusions reﬂ ected in the forward-looking information are reasonable, it can provide no assurance that such matters will prove correct. 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. The forward-looking information in this document reﬂ ects the Company’s current expectations and is subject to change. The Company does not undertake to update any forward-looking statements that may be made by or on behalf of the Company other than as required by applicable securities laws. 11 Empire Company Limited MANAGEMENT’S DISCUSSION & ANALYSIS OVERVIEW OF THE BUSINESS Empire’s key businesses and ﬁ nancial results are segmented into two separate reportable segments: (i) Food retailing and (ii) Investments and other operations. With approximately $24.2 billion in annualized sales and $8.7 billion in assets, Empire and its subsidiaries, franchisees and afﬁ liates employ approximately 120,000 people. FOOD RETAILING Empire’s Food retailing segment is carried out through Sobeys, a wholly-owned subsidiary. Proudly Canadian, with headquarters in Stellarton, Nova Scotia, Sobeys has been serving the food shopping needs of Canadians since 1907. Sobeys owns, afﬁ liates or franchises more than 1,500 stores in all 10 provinces under retail banners that include Sobeys, Safeway, IGA, Foodland, FreshCo, Thrifty Foods and Lawtons Drugs as well as more than 350 retail fuel locations. Strategic Focus(1) The Company has established a strategy that is designed to address an evolving retail environment while remaining focused on customer needs and improving the Company’s overall service offering. The strategy will evolve as the Company continues to reorganize and transform to a nationally led and focused organization. (i) Resetting the Foundation In the fourth quarter of ﬁ scal 2017, the Company launched Project Sunrise, a comprehensive three year transformation intended to simplify the organizational structure and reduce costs. The transformation is expected to result in at least $500.0 million in annualized cost savings by the end of ﬁ scal 2020. In ﬁ scal 2018, beneﬁ ts realized by the Company from the transformation initiative, were comprised of organizational design cost reductions, improvements in store operations and cost reductions from strategic sourcing. The in-year beneﬁ t was approximately 20% of the total target, the majority of which was achieved in the second half of the year. For ﬁ scal 2019, management expects that beneﬁ ts will be derived from the annualized effect of initiatives during ﬁ scal 2018, plus other operational initiatives. Management estimates up to a further 30% of the Company’s target can be achieved during the year. The majority of the incremental beneﬁ t would accrue to the Company in the second half of ﬁ scal 2019. Organizational Structure Changes Changes in the Company’s organizational structure included collapsing multiple independent regional businesses into a national, functionally-led structure, simplifying how the Company does business and enabling it to leverage its scale. The transformation initiative is intended to address the complex organizational structure that has resulted in signiﬁ cant duplication and lack of clear, deﬁ ned accountabilities. This initiative will reduce costs as a result of reduced headcount and consistent processes, and will result in an increased level of authority and scope for leadership, allowing for more nimble and responsive decision making to support the needs of customers and capitalize on changes in the marketplace. The Company incurred costs of $23.5 million and $209.0 million for the 13 and 52 weeks ended May 5, 2018, respectively, related to this transformational initiative. This phase of the Company’s three year transformation is complete. Cost beneﬁ ts related to this phase, which are included in the total beneﬁ ts estimate of at least $500.0 million, are expected to meet or exceed management’s expectations. (ii) Bolstering the Brand The Company is focused on improving customer connection with its banner brands and differentiating these brands in a highly competitive marketplace. Management has undertaken a comprehensive review of its customers and the relative positioning of its categories and store banners and is developing long-term strategic initiatives that will be implemented over the next several years. (iii) Improved Service and Offering in Conventional Stores Conventional stores will remain a key area of focus as management continues to evaluate and prioritize destination product categories designed to provide customers with the products they want at competitive prices while improving overall customer experience in conventional store banners. (1) This section constitutes forward-looking information described under the “Forward-Looking Information” section of this MD&A. 12 Annual Report 2018 (iv) Enhance Discount Discount continues to be a high growth area in food retailing. Sobeys is reﬁ ning its existing discount model and in ﬁ scal 2018 announced plans to expand its discount banner to Western Canada. The Company will convert up to 25% of its 255 Safeway and Sobeys full service format stores in Western Canada to its FreshCo banner over the next ﬁ ve years with the ﬁ rst discount stores opening by the third quarter of ﬁ scal 2019. In addition to the expansion of discount format stores to Western Canada, the Company is updating the branding of the current FreshCo banner with four pilot stores launching in London, Ontario during the ﬁ rst quarter of ﬁ scal 2019. (v) Win E-commerce In January 2018, Sobeys announced it had signed an agreement with Ocado, an industry-leading grocery e-commerce company, to launch a central pick, home delivery online grocery shopping business. Management expects this online business will participate in the rapidly growing online grocery shopping channel. Sobeys and Ocado are developing the ﬁ rst Customer Fulﬁ llment Centre (“CFC”) in the Greater Toronto Area with delivery to customers expected in the Spring of 2020. Sobeys and Ocado expect to deploy additional CFCs in Canada’s major urban centres. Other Signiﬁ cant Items Minimum Wage Increases The Company expects to incur increased labour costs as a result of minimum wage increases in Ontario and Alberta and other effects associated with Bill 148 that was passed into law in Ontario on November 27, 2017. Management was successful in mitigating the ﬁ nancial impact of these increased labour costs in ﬁ scal 2018 and continues to develop further plans to mitigate the full year impacts for ﬁ scal 2019 onward. However, there is some risk that the Company may not be able to fully offset the effects on earnings considering the short transition period of the cost increases. The Company estimates the unmitigated ﬁ nancial impact of the minimum wage increases, and other impacts including wage parity could be up to $90 million in ﬁ scal 2019. Commercial Bread Investigation The Canadian Competition Bureau is currently investigating the practices of certain suppliers and retailers, including the Company, with regard to the supply and sale of commercial bread in Canada beginning in 2001. The Company is fully cooperating with the Competition Bureau. Based on the information available to date, the Company does not believe that it or any of its employees have violated the Competition Act. Class action lawsuits have been ﬁ led against the Company, the suppliers and other retailers regarding the allegations. While both the Competition Bureau investigation and the class action lawsuits are in the early stages, at this time the Company does not believe that they will have a material adverse effect on the Company’s business or ﬁ nancial condition. Healthcare Reform On January 29, 2018, additional healthcare reform was introduced by the pan-Canadian Pharmaceutical Alliance with the Canadian Generic Pharmaceutical Association that came into effect on April 1, 2018. This resulted in the price reduction of almost 70 high volume generic drugs. The Company estimates that the effect, prior to any mitigation, of these changes may be to reduce annual income before taxes by up to $40 million. INVESTMENTS AND OTHER OPERATIONS Empire’s Investments and other operations segment, as of May 5, 2018, included: 1. A 41.5% (40.3% fully diluted) equity accounted interest in Crombie Real Estate Investment Trust (“Crombie REIT”), an Ontario registered, unincorporated, open-ended real estate investment trust. Crombie REIT is one of the country’s leading national retail property landlords with a strategy to own, operate and develop a portfolio of high quality grocery and drug store anchored shopping centres, freestanding stores and mixed use developments primarily in Canada’s top urban and suburban markets; and 2. A 40.7% equity accounted interest in Genstar Development Partnership, a 48.6% equity accounted interest in Genstar Development Partnership II, a 39.0% equity accounted interest in GDC Investments 4, L.P., a 42.1% equity accounted interest in GDC Investments 6, L.P., a 39.0% equity accounted interest in GDC Investments 7, L.P., a 37.1% equity accounted interest in GDC Investments 8, L.P., and a 49.0% equity accounted interest in The Fraipont Partnership (collectively referred to as “Genstar”). 13 Empire Company Limited MANAGEMENT’S DISCUSSION & ANALYSIS SUMMARY RESULTS – FOURTH QUARTER 13 Weeks Ended ($ in millions, except per share amounts) May 5, 2018 May 6, 2017 $ Change % Change Sales Gross proﬁ t(1) Operating income Adjusted operating income(1) EBITDA(1) Adjusted EBITDA(1) Finance costs, net Income tax expense Non-controlling interest Net earnings(2) Adjusted net earnings(1)(2) Basic earnings per share Net earnings(2) Adjusted net earnings(1)(2) Basic weighted average number of shares outstanding (in millions) Diluted earnings per share Net earnings(2) Adjusted net earnings(1)(2) Diluted weighted average number of shares outstanding (in millions) 1.5% 2.1% 80.1% 55.0% 26.8% 24.0% (8.3)% 735.7% (10.7)% 140.7% 85.3% $ 5,886.1 1,451.3 110.6 139.7 217.8 240.4 25.4 11.7 2.5 71.0 93.0 $ $ $ $ 0.26 0.35 271.8 0.26 0.35 272.2 $ $ $ $ $ 5,798.9 1,420.9 61.4 90.1 171.7 193.9 27.7 1.4 2.8 29.5 50.2 0.11 0.18 271.7 0.11 0.18 271.7 $ $ $ $ $ 87.2 30.4 49.2 49.6 46.1 46.5 (2.3) 10.3 (0.3) 41.5 42.8 0.15 0.17 0.15 0.17 Dividend per share $ 0.1050 $ 0.1025 (Consolidated operating results as a % of sales) Gross margin(1) Adjusted operating income(1) EBITDA(1) Adjusted EBITDA(1) Adjusted net earnings(1)(2) Same-store sales(1) growth (decline) Same-store sales growth (decline), excluding fuel Effective income tax rate (1) See “Non-GAAP Financial Measures & Financial Metrics” section of this MD&A. (2) Net of non-controlling interest. Sales 13 Weeks Ended May 5, 2018 May 6, 2017 24.7% 2.4% 3.7% 4.1% 1.6% 24.5% 1.6% 3.0% 3.3% 0.9% 13 Weeks Ended May 5, 2018 May 6, 2017 0.5% 0.0% 13.7% (1.1)% (1.6)% 4.2% Sales increased by 1.5% for the 13 weeks ended May 5, 2018. Food inﬂ ation was positive which contributed to the increase in sales, although same-store sales were consistent with last year. Sales were affected by an aggressive industry promotional environment and the effect of winding down 10 underperforming stores in British Columbia. These stores are scheduled to close in the ﬁ rst quarter of ﬁ scal 2019. Excluding related businesses, same-store sales for food increased and estimated food tonnage sold was consistent with last year. Gross Proﬁ t Gross proﬁ t increased by 2.1% compared to last year due to increases in sales and stable margins as management focused on improved store execution and promotional strategies, in addition to stabilizing and improving margin rates which still continues. Gross margin increased from 24.5% to 24.7% in the fourth quarter of ﬁ scal 2018. 14 Annual Report 2018 Operating Income ($ in millions) Consolidated operating income Sobeys contribution Investments and other operations Crombie REIT Real estate partnerships Other operations, net of corporate expenses 13 Weeks Ended May 5, 2018 May 6, 2017 $ Change $ 95.2 $ 52.5 $ 42.7 10.8 3.3 1.3 15.4 $ 110.6 $ 7.7 4.9 (3.7) 8.9 61.4 3.1 (1.6) 5.0 6.5 $ 49.2 For the 13 weeks ended May 5, 2018, operating income increased mainly as a result of improvements in sales and margins, beneﬁ ts related to Project Sunrise and other cost efﬁ ciencies and a gain on sale of assets to Crombie REIT. These results were partially offset by expenses related to Project Sunrise and increases in incentive compensation accruals due to improved performance. Operating income from the Investments and other operations segment increased primarily as a result of improved earnings from Crombie REIT and other operations. The increase in income from other operations can be attributed primarily to losses incurred in the prior year including a dilution loss and a loss on disposal of property. ($ in millions) Operating income Adjustments: Costs related to Project Sunrise Intangible amortization associated with the Canada Safeway acquisition West business unit store closures Distribution centre restructuring Network rationalization Historical organizational realignment reversals 13 Weeks Ended May 5, 2018 May 6, 2017 $ Change $ 110.6 $ 61.4 $ 49.2 22.3 6.5 0.3 – – – 29.1 15.8 6.5 – 4.3 3.0 (0.9) 28.7 90.1 0.4 49.6 $ Adjusted operating income $ 139.7 $ EBITDA EBITDA and adjusted EBITDA increased in the 13 weeks ended May 5, 2018 as a result of improvements in sales, beneﬁ ts related to Project Sunrise and the gain on sale of assets to Crombie REIT. Adjusted EBITDA as a percentage of sales increased from 3.3% to 4.1% as a result of efﬁ ciencies realized from Project Sunrise and improved gross margins. ($ in millions) EBITDA Adjustments: Costs related to Project Sunrise West business unit store closures Distribution centre restructuring Network rationalization Historical organizational realignment reversals Adjusted EBITDA Finance Costs 13 Weeks Ended May 5, 2018 May 6, 2017 $ Change $ 217.8 $ 171.7 $ 46.1 22.3 0.3 – – – 22.6 15.8 – 4.3 3.0 (0.9) 22.2 $ 240.4 $ 193.9 $ 0.4 46.5 For the 13 weeks ended May 5, 2018, net ﬁ nance costs decreased primarily due to a decrease in interest expense caused by repayment of $100.0 million Series C Medium term notes during the quarter. In addition, net borrowing levels, primarily drawn on Empire’s credit facility were lower in the fourth quarter of ﬁ scal 2018 compared to last year further decreasing interest expense. Adjusted interest coverage(1) increased to 6.5 times from 3.5 times in the fourth quarter of ﬁ scal 2018 as a result of an increase in adjusted operating income and lower ﬁ nancing costs. (1) See “Non-GAAP Financial Measures & Financial Metrics” section of this MD&A. 15 Empire Company Limited MANAGEMENT’S DISCUSSION & ANALYSIS Income Taxes The effective income tax rate for the 13 weeks ended May 5, 2018 was 13.7% compared to 4.2% in the same quarter last year. The current year’s effective tax rate is lower than the statutory rate primarily due to an internal reorganization that the Company undertook during the quarter to simplify its corporate structure resulting in an increase in the rate applied to deferred tax assets and gains on the sale of retail properties to Crombie REIT. The prior period’s effective rate was lower than the statutory rate due to the remeasurement of the Company’s deferred income tax provision and the impact of capital gain transactions. Net Earnings The following is a reconciliation of adjusted net earnings: ($ in millions, except per share amounts) May 5, 2018 May 6, 2017 $ Change 13 Weeks Ended Net earnings(1) EPS(2) (fully diluted) Adjustments (net of income taxes): Costs related to Project Sunrise Intangible amortization associated with the Canada Safeway acquisition West business unit store closures Distribution centre restructuring Network rationalization Historical organizational realignment reversals Adjusted net earnings(1) Adjusted EPS (fully diluted) $ $ $ $ 71.0 0.26 17.0 4.8 0.2 – – – 22.0 93.0 0.35 Diluted weighted average number of shares outstanding (in millions) 272.2 (1) Net of non-controlling interest. (2) Earnings per share (“EPS”). OPERATING RESULTS – FULL YEAR ($ in millions, except per share amounts) 52 Weeks Ended May 5, 2018 52 Weeks Ended May 6, 2017 53 Weeks Ended May 7, 2016 Sales Gross proﬁ t Operating income (loss) Adjusted operating income EBITDA Adjusted EBITDA Finance costs, net Income tax expense Non-controlling interest Net earnings (loss)(1) Adjusted net earnings(1) Basic earnings per share Net earnings (loss)(1) Adjusted net earnings(1) Basic weighted average number of shares outstanding (in millions) Diluted earnings per share Net earnings (loss)(1) Adjusted net earnings(1) Diluted weighted average number of shares outstanding (in millions) $ 24,214.6 5,900.5 346.5 601.7 785.7 1,014.7 110.5 56.2 20.3 159.5 344.3 $ $ $ $ 0.59 1.27 271.8 0.59 1.27 $ 23,806.2 5,707.2 333.0 378.5 777.2 796.9 118.0 42.5 14.0 158.5 191.3 $ 24,618.8 5,957.6 (2,418.5) 713.7 (1,944.7) 1,161.4 137.4 (441.3) 16.4 (2,131.0) 410.2 $ $ $ $ 0.58 0.70 271.9 0.58 0.70 $ $ $ $ (7.78) 1.50 273.9 (7.78) 1.50 274.0 0.40 Dividend per share $ 0.42 $ 0.41 $ 16 272.1 272.0 $ $ 29.5 0.11 $ $ 41.5 0.15 11.3 4.7 – 3.1 2.2 (0.6) 20.7 50.2 0.18 271.7 1.3 42.8 0.17 $ $ 2018 Compared to 2017 $ Change % Change 1.7% 3.4% 4.1% 59.0% 1.1% 27.3% (6.4)% 32.2% 45.0% 0.6% 80.0% 408.4 193.3 13.5 223.2 8.5 217.8 (7.5) 13.7 6.3 1.0 153.0 0.01 0.57 0.01 0.57 $ $ $ $ $ $ $ Annual Report 2018 (Consolidated operating results as a % of sales) Gross margin Adjusted operating income EBITDA Adjusted EBITDA Adjusted net earnings(1) Same-store sales growth (decline) Same-store sales growth (decline), excluding fuel Effective income tax rate (1) Net of non-controlling interest. Sales 52 Weeks Ended May 5, 2018 52 Weeks Ended May 6, 2017 53 Weeks Ended May 7, 2016 24.4% 2.5% 3.2% 4.2% 1.4% 24.0% 1.6% 3.3% 3.3% 0.8% 24.2% 2.9% (7.9)% 4.7% 1.7% 52 Weeks Ended May 5, 2018 52 Weeks Ended May 6, 2017 53 Weeks Ended May 7, 2016 0.8% 0.5% 23.8% (2.1)% (2.2)% 19.8% (0.2)% 0.3% 17.3% Sales increased by 1.7% for the 52 weeks ended May 5, 2018, as same-store sales were higher in most areas of the country, driven by more disciplined pricing strategies compared to signiﬁ cant deﬂ ationary pricing strategies in the prior year. Food inﬂ ation was positive, contributing to the increase in sales. Gross Proﬁ t Gross proﬁ t increased by 3.4% compared to last year due to increases in sales and stable margins as management focused on improved store execution and promotional strategies in addition to stabilizing and improving margin rates which still continues. Gross margin increased from 24.0% to 24.4% in ﬁ scal 2018. Operating Income For the 52 weeks ended May 5, 2018, operating income increased mainly as a result of improvements in sales and margins, beneﬁ ts related to Project Sunrise and other cost efﬁ ciencies and a gain on sale of assets to Crombie REIT. These results were partially offset by expenses related to Project Sunrise and increases in incentive compensation accruals due to improved performance. ($ in millions) Operating income Adjustments: Costs related to Project Sunrise Intangible amortization associated with the Canada Safeway acquisition West business unit store closures Distribution centre restructuring Gain on disposal of manufacturing facilities Historical organizational realignment costs Network rationalization reversals 52 Weeks Ended May 5, 2018 May 6, 2017 $ Change $ 346.5 $ 333.0 $ 13.5 207.8 26.2 21.2 – – – – 255.2 15.8 25.8 – 9.6 (7.5) 3.4 (1.6) 45.5 Adjusted operating income $ 601.7 $ 378.5 $ 209.7 223.2 EBITDA EBITDA increased in the 52 weeks ended May 5, 2018, mainly a result of the previously mentioned factors impacting operating income. ($ in millions) EBITDA Adjustments: Costs related to Project Sunrise West business unit store closures Distribution centre restructuring Gain on disposal of manufacturing facilities Historical organizational realignment costs Network rationalization reversals 52 Weeks Ended May 5, 2018 May 6, 2017 $ Change $ 785.7 $ 777.2 $ 8.5 207.8 21.2 – – – – 229.0 15.8 – 9.6 (7.5) 3.4 (1.6) 19.7 209.3 217.8 17 Adjusted EBITDA $ 1,014.7 $ 796.9 $ Empire Company Limited MANAGEMENT’S DISCUSSION & ANALYSIS Finance Costs For the 52 weeks ended May 5, 2018, net ﬁ nance costs decreased primarily due to a decrease in interest expense caused by repayment of $100.0 million Series C Medium term notes and a signiﬁ cant decrease in Empire’s credit facility balance in ﬁ scal 2018 compared to ﬁ scal 2017. Adjusted interest coverage increased to 6.2 times from 3.7 times during the same period in the prior year as a result of increased adjusted operating income. Income Taxes The effective income tax rate for the 52 weeks ended May 5, 2018 increased to 23.8% compared to 19.8% for the 52 weeks ended May 6, 2017. The increase in the effective rate compared to the prior year is primarily attributable to deferred tax expense related to a tax reorganization undertaken by Crombie REIT during the ﬁ rst quarter, partially offset by a recovery in the fourth quarter as a result of an internal reorganization undertaken to simplify its corporate structure, as well as a gain on sale of retail properties to Crombie REIT. Furthermore, Project Sunrise expenses impacted the mix of earnings between legal entities and tax jurisdictions contributing to a higher average effective tax rate in the current year. In the prior year, the effective tax rate of 19.8% was lower than the Company’s statutory rate due to tax consequences for properties sold to Crombie REIT on a tax deferred basis. The substantive enactment of legislation to modify the tax treatment of eligible capital expenditures in prior years also contributed to the lower effective tax rate. Net Earnings The following is a reconciliation of adjusted net earnings: ($ in millions, except per share amounts) Net earnings(1) EPS(2) (fully diluted) Adjustments (net of income taxes): Costs related to Project Sunrise Intangible amortization associated with the Canada Safeway acquisition West business unit store closures Distribution centre restructuring Gain on disposal of manufacturing facilities Historical organizational realignment costs Network rationalization reversals Adjusted net earnings(1) Adjusted EPS (fully diluted) Diluted weighted average number of shares outstanding (in millions) (1) Net of non-controlling interest. (2) Earnings per share (“EPS”). FINANCIAL PERFORMANCE BY SEGMENT FOOD RETAILING 52 Weeks Ended May 5, 2018 May 6, 2017 $ Change $ $ 159.5 0.59 $ $ 158.5 0.58 $ $ 1.0 0.01 150.1 19.2 15.5 – – – – 184.8 344.3 1.27 272.1 $ $ $ $ 11.3 18.8 – 6.9 (5.5) 2.5 (1.2) 32.8 191.3 0.70 272.0 152.0 153.0 0.57 $ $ The following is a review of Empire’s Food retailing segment’s ﬁ nancial performance for the 52 weeks ended May 5, 2018 compared to the 52 weeks ended May 6, 2017 and 53 weeks ended May 7, 2016. The following ﬁ nancial information is Sobeys’ contribution to Empire as the amounts are net of consolidation adjustments. For further analysis of these adjustments, see the “Operating Results – Full Year” section. ($ in millions) Sales Gross proﬁ t Operating income (loss) Adjusted operating income EBITDA Adjusted EBITDA Net earnings (loss)(1) Adjusted net earnings(1) (1) Net of non-controlling interest. 18 52 Weeks Ended May 5, 2018 52 Weeks Ended May 6, 2017 53 Weeks Ended May 7, 2016 2018 Compared to 2017 $ Change % Change $ $ 24,214.6 5,900.5 273.6 528.8 712.5 941.5 116.5 301.3 $ 23,806.2 5,707.2 259.3 304.8 703.2 722.9 112.7 145.5 $ 24,618.8 5,957.6 (2,509.2) 623.0 (2,036.0) 1,070.1 (2,193.3) 347.9 408.4 193.3 14.3 224.0 9.3 218.6 3.8 155.8 1.7% 3.4% 5.5% 73.5% 1.3% 30.2% 3.4% 107.1% Annual Report 2018 To assess its ﬁ nancial performance and condition, Sobeys’ management monitors a set of ﬁ nancial measures which evaluate sales growth, proﬁ tability and ﬁ nancial condition, and are set out below. ($ in millions) Sales growth (decline) Same-store sales growth (decline) Same-store sales growth (decline), excluding fuel Return on equity(2) Funded debt to total capital(2) Funded debt to adjusted EBITDA(2) Property, equipment and investment property purchases(3) 52 Weeks Ended May 5, 2018 52 Weeks Ended May 6, 2017 53 Weeks Ended May 7, 2016(1) 1.7% 0.8% 0.5% 5.4% 37.1% 1.7x 239.6 $ (3.3)% (2.1)% (2.2)% 4.9% 39.5% 2.4x 470.8 2.9% (0.2)% 0.3% (55.4)% 46.0% 2.1x 616.2 $ $ (1) Amounts have been reclassiﬁ ed to correspond to the current and comparable period presentation on the consolidated balance sheets. (2) See “Non-GAAP Financial Measures & Financial Metrics” section of this MD&A. (3) This amount reﬂ ects property, equipment and investment property purchases by Sobeys, excluding amounts purchased from the Company and its wholly-owned subsidiaries. INVESTMENTS AND OTHER OPERATIONS ($ in millions) Operating income Crombie REIT Real estate partnerships Other operations, net of corporate expenses Operating Income 52 Weeks Ended May 5, 2018 May 6, 2017 $ Change $ $ 39.5 33.9 (0.5) $ 41.5 35.1 (2.9) $ 72.9 $ 73.7 $ (2.0) (1.2) 2.4 (0.8) For the 52 weeks ended May 5, 2018, operating income remained consistent as a result of stable equity earnings from Crombie REIT and the Real estate partnerships. Investment Portfolio At May 5, 2018, Empire’s investment portfolio, including equity accounted investments in Crombie REIT and Genstar, consisted of: Fair Value May 5, 2018 Carrying Value Unrealized Gain Fair Value May 6, 2017 Carrying Value Unrealized Gain $ 777.1 $ 448.5 $ 328.6 $ 883.6 $ 459.1 $ 424.5 ($ in millions) Investment in associates Crombie REIT(1) Canadian real estate partnerships(2) U.S. real estate partnerships(2) Investment in joint ventures Canadian Digital Cinema 90.7 23.2 90.7 23.2 – – – 143.0 36.8 143.0 36.8 9.5 9.5 – – – Partnership(2) 9.4 9.4 (1) Fair value is calculated based on the closing price of Crombie REIT units traded on the Toronto Stock Exchange as of May 4, 2018. (2) Assumes fair value equals carrying value. $ 900.4 $ 571.8 $ 328.6 $ 1,072.9 $ 648.4 $ 424.5 19 Empire Company Limited MANAGEMENT’S DISCUSSION & ANALYSIS QUARTERLY RESULTS OF OPERATIONS ($ in millions, except per share amounts) Sales EBITDA(1) Operating income Net earnings (loss)(2) Per share information, basic Net earnings (loss)(2) Q4 (13 Weeks) May 5, 2018 Q3 (13 Weeks) Feb. 3, 2018 Q2 (13 Weeks) Nov. 4, 2017 Q1 (13 Weeks) Aug. 5, 2017 Q4 (13 Weeks) May 6, 2017 Q3 (13 Weeks) Feb. 4, 2017 Q2 (13 Weeks) Nov. 5, 2016 Q1 (13 Weeks) Aug. 6, 2016 Fiscal 2018 Fiscal 2017 $ 5,886.1 $ 6,029.2 $ 6,026.1 $ 6,273.2 $ 5,798.9 $ 5,889.8 $ 5,930.9 $ 6,186.6 238.3 126.6 65.4 113.0 2.6 (23.6) 217.8 110.6 71.0 238.8 125.2 54.0 216.1 108.1 58.1 179.4 68.6 30.5 187.8 76.4 33.1 171.7 61.4 29.5 $ 0.26 $ 0.21 $ (0.09) $ 0.20 $ 0.11 $ 0.11 $ 0.12 $ 0.24 Basic weighted average number of shares outstanding (in millions) 271.8 271.7 271.8 271.5 271.7 271.1 271.6 271.7 Per share information, diluted Net earnings (loss)(2) $ 0.26 $ 0.21 $ (0.09) $ 0.20 $ 0.11 $ 0.11 $ 0.12 $ 0.24 Diluted weighted average number of shares outstanding (in millions) 272.2 272.2 271.8 271.6 271.7 271.7 272.2 271.7 (1) EBITDA is reconciled to net earnings (loss) for the current and comparable period in the “Non-GAAP Financial Measures & Financial Metrics” section of this MD&A. (2) Net of non-controlling interest. For the most recent eight quarters, results have ﬂ uctuated overall with sales consistently improving compared to the same period in the prior year. Sales include ﬂ uctuations in quarter-to-quarter inﬂ ationary and deﬂ ationary market pressures. The Company does experience some seasonality, as evidenced in the results presented above, in particular during the summer months and over the holidays when retail sales trend higher and can result in stronger operating results. The sales, EBITDA, operating income and net earnings (loss), net of non-controlling interest, have been inﬂ uenced by one-time adjustments, other investing activities, the competitive environment, cost management initiatives, food price and general industry trends and by other risk factors as outlined in the “Risk Management” section. LIQUIDITY AND CAPITAL RESOURCES The table below highlights signiﬁ cant cash ﬂ ow components for the relevant periods. For additional detail, please refer to the consolidated statement of cash ﬂ ows in the Company’s consolidated ﬁ nancial statements for the 52 weeks ended May 5, 2018. ($ in millions) May 5, 2018 May 6, 2017 $ Change May 5, 2018 May 6, 2017 $ Change 13 Weeks Ended 52 Weeks Ended Cash ﬂ ows from operating activities $ Cash ﬂ ows from (used in) investing activities 313.5 $ 225.8 $ 87.7 $ 879.7 $ 708.5 $ 171.2 33.1 (73.3) 106.4 (39.4) (35.7) (3.7) Cash ﬂ ows used in ﬁ nancing activities Increase (decrease) in cash and cash equivalents (176.8) (148.5) (28.3) (419.7) (730.2) 310.5 $ 169.8 $ 4.0 $ 165.8 $ 420.6 $ (57.4) $ 478.0 20 Annual Report 2018 Operating Activities Cash ﬂ ows from operating activities for the 13 weeks ended May 5, 2018 increased primarily as a result of an increase in net earnings from improved operations, increased distributions in equity investments and net change in non-cash working capital. The increase in cash ﬂ ows from operating activities for the 52 weeks ended May 5, 2018 was attributable to increased distributions by equity investments and net change in non-cash working capital. This was partially offset by one-time Project Sunrise costs incurred in ﬁ scal 2018. Investing Activities The table below outlines details of investing activities of the Company during the 13 and 52 weeks ended May 5, 2018 compared to the 13 and 52 weeks ended May 6, 2017: ($ in millions) Investment Increase in investments Property, equipment and 13 Weeks Ended 52 Weeks Ended May 5, 2018 May 6, 2017 $ Change May 5, 2018 May 6, 2017 $ Change $ – $ (0.4) $ 0.4 $ – $ (0.4) $ 0.4 investment property purchases Proceeds on disposal of assets Additions to intangibles Loans and other receivables Tenant inducements Other assets and other long-term liabilities Business acquisitions Interest received Proceeds on redemption of investment Cash ﬂ ows from (used in) investing activities (76.1) 113.2 (7.9) (0.4) – 3.7 (0.6) 1.2 – (91.8) 36.8 (20.1) (1.5) – 3.3 (0.2) 0.6 – 15.7 76.4 12.2 1.1 – 0.4 (0.4) 0.6 – (239.8) 217.2 (48.2) 6.1 – 2.9 (3.8) 1.9 24.3 (460.7) 425.7 (53.8) 12.3 58.8 2.7 (21.9) 1.6 – 220.9 (208.5) 5.6 (6.2) (58.8) 0.2 18.1 0.3 24.3 $ 33.1 $ (73.3) $ 106.4 $ (39.4) $ (35.7) $ (3.7) For the 13 weeks ended May 5, 2018, cash from (used in) investing activities increased compared to prior year as a result of an increase in proceeds on the sale of assets due to Sobeys entering into an agreement with Crombie REIT to sell a portfolio of 11 properties, nine of which were leased back. For the 52 weeks ended May 5, 2018, the increase in cash used in investing activities was a result of decreased proceeds on disposal of assets due to a sale leaseback agreement entered into with Crombie REIT in ﬁ scal 2017 to sell and leaseback 19 retail properties and a 50% interest in each of its three automated distribution centres. The agreement also included a large volume of tenant inducements that further increased cash inﬂ ows from investing activities in ﬁ scal 2017. This was offset by reduced capital spend in ﬁ scal 2018. The Company spent approximately $288.0 million in capital expenditures which includes acquisitions of property, equipment and investment properties as well as additions to intangibles which was below the estimate of $350.0 million. The table below outlines details of investments by Sobeys in its store network during the 13 and 52 weeks ended May 5, 2018 compared to the 13 and 52 weeks ended May 6, 2017. # of stores Opened/relocated/acquired Expanded Rebannered/redeveloped Closed in the normal course of operations 13 Weeks Ended 52 Weeks Ended May 5, 2018 May 6, 2017 May 5, 2018 May 6, 2017 9 3 2 8 16 – 7 11 41 11 24 40 66 8 25 40 21 Empire Company Limited MANAGEMENT’S DISCUSSION & ANALYSIS The following table shows Sobeys’ square footage changes for the 13 and 52 weeks ended May 5, 2018, by type: Square feet (in thousands) Opened Relocated Acquired Expanded Closed in the normal course of operations Net change 13 Weeks Ended 52 Weeks Ended May 5, 2018 May 5, 2018 124 34 – 19 (125) 52 338 97 – 91 (375) 151 At May 5, 2018, Sobeys’ square footage totaled 39.4 million, a 0.5% increase compared to 39.2 million square feet operated at May 6, 2017. Financing Activities Cash used in ﬁ nancing activities increased during the 13 weeks ended May 5, 2018 compared to last year primarily due to the repayment of long-term debt, speciﬁ cally the repayment of the $100.0 million Series C Medium term notes in the fourth quarter of ﬁ scal 2018. The cash used in ﬁ nancing activities during the 52 weeks ended May 5, 2018 decreased in ﬁ scal 2018 primarily due to the repayment of $300.0 million in senior unsecured notes during ﬁ scal 2017. Free Cash Flow Management uses free cash ﬂ ow(1) as a measure to assess the amount of cash available for debt repayment, dividend payments and other investing and ﬁ nancing activities. ($ in millions) May 5, 2018 May 6, 2017 $ Change May 5, 2018 May 6, 2017 $ Change 13 Weeks Ended 52 Weeks Ended Cash ﬂ ows from operating activities $ Add: proceeds on disposal of property, equipment and 313.5 $ 225.8 $ 87.7 $ 879.7 $ 708.5 $ 171.2 investment property 113.2 36.8 Less: property, equipment and investment property purchases (76.1) (91.8) 76.4 15.7 217.2 425.7 (208.5) (239.8) (460.7) 220.9 183.6 Free cash ﬂ ow $ 350.6 $ 170.8 $ 179.8 $ 857.1 $ 673.5 $ (1) See “Non-GAAP Financial Measures & Financial Metrics” section of this MD&A. Free cash ﬂ ow increased for the 13 weeks ended May 5, 2018 compared to the 13 weeks ended May 6, 2017 primarily due to improved operating earnings and an increase of proceeds on the sale of property to Crombie REIT. Sobeys entered into an agreement with Crombie REIT to sell a portfolio of 11 properties, nine of which were leased back. Free cash ﬂ ow increased for the 52 weeks ended May 5, 2018 compared to the 52 weeks ended May 6, 2017 due to lower levels of capital investments as management was assessing future strategic priorities and improved operating activities. This was partially offset by proceeds received from the disposition of real estate assets to Crombie REIT in the prior year. Employee Future Beneﬁ t Obligations For the 52 weeks ended May 5, 2018, the Company contributed $9.3 million (2017 – $9.8 million) to its registered deﬁ ned beneﬁ t pension plans. The Company expects to contribute approximately $26.7 million to these plans in ﬁ scal 2019. 22 Annual Report 2018 Guarantees and Commitments The following table presents the Company’s commitments and other obligations that will come due over the next ﬁ ve ﬁ scal years as at May 5, 2018. ($ in millions) 2019 2020 2021 2022 2023 Thereafter Total Commitments Long-term debt(1) Finance lease liabilities(2) Third-party operating leases, as lessee(3) Related party operating leases, as lessee(3) Contractual obligations Operating leases, as lessor $ 520.1 $ 7.3 22.6 $ 6.2 52.1 $ 4.2 7.1 $ 2.6 6.3 $ 1,028.7 $ 1,636.9 36.0 13.1 2.6 256.0 246.0 224.0 200.1 171.8 939.0 2,036.9 166.2 949.6 (14.2) 165.0 439.8 (13.0) 165.9 446.2 (11.7) 159.9 369.7 (10.8) 161.0 341.7 (10.5) 1,696.7 2,514.7 3,677.5 (62.4) 6,224.5 (122.6) Contractual obligations, net $ 935.4 $ 426.8 $ 434.5 $ 358.9 $ 331.2 $ 3,615.1 $ 6,101.9 (1) Principal debt repayments. (2) Present value of minimum lease payments (future minimum lease payments less interest). (3) Net of sub-lease income. For further information on guarantees and commitments, please see Note 15 and Note 23 of the Company’s audited annual consolidated ﬁ nancial statements for the 52 weeks ended May 5, 2018. CONSOLIDATED FINANCIAL CONDITION Key Financial Condition Measures ($ in millions, except per share and ratio calculations) May 5, 2018 May 6, 2017 May 7, 2016(1)(2) Shareholders’ equity, net of non-controlling interest Book value per common share(3) Long-term debt, including current portion Funded debt to total capital Net funded debt to net total capital(3) Funded debt to adjusted EBITDA Adjusted EBITDA to interest expense(3) Current assets to current liabilities Total assets Total non-current ﬁ nancial liabilities $ 3,702.8 $ 13.62 $ 1,666.9 31.0% 21.9% 1.6x 10.5x 0.8x $ 8,662.0 $ 1,929.9 $ $ $ $ $ 3,644.2 13.40 1,870.8 33.9% 31.3% 2.3x 7.7x 0.9x 8,695.5 2,502.1 $ $ $ $ $ 3,623.9 13.23 2,367.4 39.5% 36.7% 2.0x 10.2x 1.0x 9,138.5 2,735.9 (1) Amounts have been reclassiﬁ ed to correspond to the current period presentation on the consolidated balance sheets. (2) Amounts have been restated. See “Changes to Accounting Policies Adopted During Fiscal 2017” section of the ﬁ scal 2017 annual MD&A for further detail. (3) See “Non-GAAP Financial Measures & Financial Metrics” section of this MD&A. For the 52 weeks ended May 5, 2018, Dominion Bond Rating Service (“DBRS”) upgraded Sobeys’ trend from negative to stable, while Standard and Poor’s (“S&P”) remained unchanged. Sobeys’ credit metrics and ﬁ nancial proﬁ le continue to improve due to stronger operating performance and stable ﬁ nancial leverage. Rating Agency DBRS S&P Credit Rating (Issuer rating) Trend/Outlook BB (high) BB+ Stable Stable On June 2, 2017, Sobeys entered a new, senior, unsecured non-revolving credit facility for $500.0 million. The facility bears ﬂ oating interest tied to Canadian prime rate or bankers’ acceptance rates. The facility is intended to be used to repay long-term debt due in calendar 2018. The Company believes that its cash and cash equivalents on hand, unutilized bank credit facilities and cash generated from operating activities will enable the Company to fund future capital investments, pension plan contributions, working capital, current funded debt obligations and ongoing business requirements. The Company also believes it has sufﬁ cient funding in place to meet these requirements and other short and long-term ﬁ nancial obligations. The Company mitigates potential liquidity risk by ensuring various sources of funds are diversiﬁ ed by term to maturity and source of credit. 23 Empire Company Limited MANAGEMENT’S DISCUSSION & ANALYSIS The Company’s ﬁ nancing facilities include certain ﬁ nancial and non-ﬁ nancial covenants. All covenants were complied with for the 13 and 52 weeks ended May 5, 2018. For additional information on Empire’s long-term debt, see Note 15 of the Company’s audited annual consolidated ﬁ nancial statements for the 52 weeks ended May 5, 2018. Shareholders’ Equity The Company’s share capital was comprised of the following on May 5, 2018: Authorized 2002 Preferred shares, par value of $25 each, issuable in series Non-Voting Class A shares, without par value Class B common shares, without par value, voting Number of Shares May 5, 2018 May 6, 2017 991,980,000 768,105,849 122,400,000 991,980,000 768,105,849 122,400,000 Issued and outstanding ($ in millions) Number of Shares May 5, 2018 May 6, 2017 Non-Voting Class A shares, without par value Class B common shares, without par value, voting Shares held in trust Total 173,547,591 98,138,079 (308,504) $ 2,038.2 7.3 (6.0) $ 2,037.8 7.3 (10.7) $ 2,039.5 $ 2,034.4 The Company’s share capital on May 5, 2018 compared to the same period in the last ﬁ scal year is shown in the table below. (Number of Shares) Non-Voting Class A shares Issued and outstanding, beginning of year Issued during year Issued and outstanding, end of year Shares held in trust, beginning of year Purchased for future settlement of equity settled plans Issued for future settlement of equity settled plans Shares held in trust, end of year 52 Weeks Ended May 5, 2018 May 6, 2017 173,537,901 9,690 173,537,901 – 173,547,591 173,537,901 (555,409) (5,683) 252,588 (308,504) – (555,409) – (555,409) Issued and outstanding, net of shares held in trust, end of year 173,239,087 172,982,492 Class B common shares Issued and outstanding, beginning of year Issued during year Total issued and outstanding, end of year 98,138,079 – 98,138,079 – 98,138,079 98,138,079 The outstanding options at May 5, 2018 were granted at prices between $15.60 and $30.87 and expire between June 2018 and June 2025 with a weighted average remaining contractual life of 5.20 years. Stock option transactions during ﬁ scal 2018 and 2017 were as follows: Balance, beginning of year Granted Exercised Expired Forfeited Balance, end of year 2018 2017 Number of Options 4,949,863 1,338,980 (122,805) (749,971) (729,912) $ Weighted Average Exercise Price 24.27 19.43 22.26 25.92 23.45 $ Number of Options 3,655,322 1,642,700 – – (348,159) 4,686,155 $ 22.81 4,949,863 $ Weighted Average Exercise Price 25.94 20.40 – – 23.51 24.27 Stock options exercisable, end of year 2,301,032 2,110,743 For the 52 weeks ended May 5, 2018, the Company paid common dividends of $114.0 million (2017 – $111.3 million) to its equity holders. This represents a payment of $0.42 per share (2017 – $0.41 per share) for common shareholders. 24 Annual Report 2018 As at June 26, 2018, the Company had Non-Voting Class A and Class B common shares outstanding of 173,548,969 and 98,138,079, respectively. Options to acquire 4,686,155 Non-Voting Class A shares were outstanding as of May 5, 2018 (May 6, 2017 – 4,949,863) which represents 1.7% (May 6, 2017 – 1.8%) of the outstanding Non-Voting Class A and Class B common shares. During the second quarter of ﬁ scal 2017, the Company established a trust fund to facilitate the purchase of Non-Voting Class A shares for the future settlement of vested units under the Company’s equity settled stock-based compensation plans. Contributions to the trust fund and the Non-Voting Class A shares purchased are held by AST Trust Company (Canada) as trustee. The trust fund is an SE and as such the accounts of the trust fund are included on the consolidated ﬁ nancial statements of the Company. The following represents the activity of shares held in trust: Shares held in trust Balance, beginning of year Purchased Issued Balance, end of year Number of Shares May 5, 2018 May 6, 2017 $ (555,409) (5,683) 252,588 $ (10.7) (0.1) 4.8 (308,504) $ (6.0) $ – (10.7) – (10.7) ACCOUNTING STANDARDS AND POLICIES The audited consolidated ﬁ nancial statements were prepared using the same accounting policies as disclosed in the Company’s annual consolidated ﬁ nancial statements for the year ended May 6, 2017 with the exception of the following: Changes to Accounting Standards Adopted During Fiscal 2018 (i) Statement of Cash Flows In January 2016, the IASB issued Disclosure Initiative Amendments to IAS 7, “Statement of cash ﬂ ows”. These amendments require entities to provide additional disclosures that enable users of ﬁ nancial statements to evaluate changes in liabilities arising from ﬁ nancing activities, including changes arising from cash and non-cash changes. These amendments became effective during the ﬁ rst quarter of ﬁ scal 2018 and had no material impact on the Company’s consolidated ﬁ nancial statements. A reconciliation of long-term debt has been presented on Note 15 of the Company’s consolidated ﬁ nancial statements. (ii) Share-based Payment In June 2016, the IASB issued amendments to IFRS 2, “Share-based payment”. The amendments provide clariﬁ cation around the effects of vesting conditions on cash-settled share-based payment transactions, classiﬁ cation of share-based payment transactions with net settlement features and modiﬁ cation of the terms and conditions of a share-based payment that changes the classiﬁ cation of the transaction. These amendments are effective for annual periods beginning on or after January 1, 2018. The Company early adopted these amendments in the ﬁ rst quarter of ﬁ scal 2018. Future Standards (i) Financial Instruments In July 2014, the IASB issued IFRS 9, “Financial instruments” (“IFRS 9”), which replaces IAS 39, “Financial instruments: recognition and measurement” (“IAS 39”) and related interpretations. IFRS 9 provides revised guidance on the classiﬁ cation and measurement of ﬁ nancial assets and ﬁ nancial liabilities, including impairment. IFRS 9 also introduces a new hedge accounting model and amendments to clarify the treatment of modiﬁ cations of ﬁ nancial liabilities. The standard is effective for annual periods beginning on or after January 1, 2018 and is to be applied retrospectively, with the exception of the hedging component which is to be applied prospectively. Early adoption is permitted, however, the Company did not elect to do so. The standard will be applied in ﬁ scal 2019, and the Company does not expect a signiﬁ cant adjustment to its consolidated ﬁ nancial statements as a result of the adoption of this standard, as outlined below. Classiﬁ cation and Measurement IFRS 9 requires ﬁ nancial assets to be classiﬁ ed and measured based on both the business model for managing the asset and the nature of the cash ﬂ ows. The classiﬁ cation and measurement of ﬁ nancial liabilities remains largely unchanged from IAS 39. The application of the new classiﬁ cation requirements under IFRS 9 are not expected to result in a signiﬁ cant adjustment to the Company’s consolidated ﬁ nancial statements. Impairment IFRS 9 introduces a new expected credit loss (“ECL”) impairment model. It is no longer necessary for a triggering event to have occurred before credit losses are recognized. Under the IFRS 9 ECL model, the Company will recognize upfront impairment losses based on past events, current conditions, and reasonable and supportable forecasts affecting collectability. The application of the ECL model under IFRS 9 is not expected to result in a signiﬁ cant adjustment to the Company’s consolidated ﬁ nancial statements. 25 Empire Company Limited MANAGEMENT’S DISCUSSION & ANALYSIS Hedge Accounting IFRS 9 introduces a new hedge accounting model that aligns hedge accounting relationships with corresponding risk management activities. The new hedge accounting requirements are not expected to result in a signiﬁ cant adjustment to the Company’s consolidated ﬁ nancial statements. Modiﬁ cation of Financial Liabilities In October 2017, the IASB issued “Prepayment features with negative compensation” as an amendment to IFRS 9. The amendment clariﬁ es the accounting treatment for modiﬁ cations of ﬁ nancial liabilities and requires a ﬁ nancial liability measured at amortized cost to be remeasured when a modiﬁ cation occurs. Any resulting gain or loss is required to be recognized in proﬁ t or loss at the date of modiﬁ cation. The amendment is effective for annual periods beginning on or after January 1, 2018 and is to be applied retrospectively. The Company does not expect this amendment to result in a signiﬁ cant adjustment to the Company’s consolidated ﬁ nancial statements. Disclosure Financial instrument disclosures continue to fall within the scope of IFRS 7 “Financial instruments: disclosures” (“IFRS 7”). IFRS 7 has been amended by IFRS 9 to include additional qualitative and quantitative disclosure requirements. The Company intends to apply these amendments in ﬁ scal 2019. The amendments are not expected to result in a signiﬁ cant adjustment to the Company’s consolidated ﬁ nancial statement disclosures. (ii) Revenue In May 2014, the IASB issued IFRS 15, “Revenue from contracts with customers” (“IFRS 15”). IFRS 15 replaces IAS 18, “Revenue” (“IAS 18”), IAS 11, “Construction contracts”, and some revenue related interpretations. IFRS 15 establishes a new control-based revenue recognition model and provides a comprehensive framework for recognition, measurement and disclosure of revenue from contracts with customers, excluding contracts within the scope of the standards on leases, insurance contracts and ﬁ nancial instruments. The new standard is effective for annual periods beginning on or after January 1, 2018 and is to be applied retrospectively. Early adoption is permitted, however, the Company did not elect to do so. In April 2016, the IASB published clariﬁ cations to IFRS 15 which addresses three topics (identifying performance obligations, principle versus agent considerations, and licensing) as well as provides some transition relief for modiﬁ ed and completed contracts. The implementation timelines for these clariﬁ cations are consistent with IFRS 15. The Company expects to adopt IFRS 15 in ﬁ scal 2019 on a full retrospective basis and does not expect the implementation to result in a signiﬁ cant adjustment to the Company’s consolidated ﬁ nancial statements. (iii) Leases In January 2016, the IASB issued IFRS 16, “Leases” (“IFRS 16”), which replaces IAS 17, “Leases” (“IAS 17”) and related interpretations. IFRS 16 introduces a balance sheet recognition and measurement model for lessees, eliminating the distinction between operating and ﬁ nance leases. Lessors will continue to classify leases as operating and ﬁ nance leases. The standard is effective for annual periods beginning on or after January 1, 2019. IFRS 16 allows for early adoption for companies that apply IFRS 15, but the Company does not intend to do so. For leases where the Company is the lessee, the IFRS 16 transition requirements provide the option of adopting a full retrospective approach or a modiﬁ ed retrospective approach with optional practical expedients available. The Company has performed preliminary modeling as part of its assessment of IFRS 16 transition approaches, and intends to adopt the standard on a modiﬁ ed retrospective basis. The Company continues to ﬁ nalize its approach on the use of the optional practical expedients. The Company expects that the adoption of IFRS 16 will have a material impact on its consolidated ﬁ nancial statements, given the current operating lease commitments held under IAS 17 as a lessee. New assets and liabilities will be recognized on the balance sheet for the Company’s operating property and equipment leases. On the statement of earnings, the Company will replace the current straight-line lease expense recognized in operating expenses with depreciation for right-of-use assets and ﬁ nance expense on lease liabilities. The presentation of lease related cash ﬂ ows on the statement of cash ﬂ ows will also change, with no change to the amount of cash exchanged as part of the underlying lease transaction. The Company continues to evaluate the impact of this standard on its consolidated ﬁ nancial statements. (iv) Investments in Associates and Joint Ventures In October 2017, the IASB issued an amendment to IAS 28 “Investments in associates and joint ventures” to clarify that an entity must apply IFRS 9 to long-term interests in an associate or joint venture that form part of the net investment in the associate or joint venture where the equity method is not applied. The amendment is effective for annual periods beginning on or after January 1, 2019. The Company is assessing the potential impact of this amendment. 26 Annual Report 2018 (v) Annual Improvements 2015–2017 The IASB issued amendments to IFRS 3 “Business combinations”, IFRS 11 “Joint arrangements”, IAS 12 “Income taxes” and IAS 23 “Borrowing costs” in December 2017. These amendments are effective for annual periods beginning on or after January 1, 2019. The Company is assessing the potential impacts of these amendments. Critical Accounting Estimates The preparation of consolidated ﬁ nancial statements, in conformity with generally accepted accounting principles (“GAAP”), requires management to make estimates, judgments and assumptions that affect the amounts reported in the consolidated ﬁ nancial statements and accompanying notes. Certain of these estimates require subjective or complex judgments by management that may be uncertain. Some of these items include the valuation of inventories, goodwill, employee future beneﬁ ts, stock-based compensation, estimates of provisions, impairments, customer loyalty programs, useful lives of property, equipment, investment property and intangibles for purposes of depreciation and amortization, and income taxes. Changes to these estimates could materially impact the ﬁ nancial statements. These estimates are based on management’s best knowledge of current events and actions the Company may undertake in the future. Management regularly evaluates the estimates and assumptions it uses. Actual results could differ from these estimates. Impairments of Goodwill and Long-Lived Assets Management assesses impairment of non-ﬁ nancial assets such as investments in associates and joint ventures, goodwill, intangible assets, property and equipment, and investment property. In assessing impairment, management estimates the recoverable amount of each asset or cash-generating unit (“CGU”) based on expected future cash ﬂ ows. When measuring expected future cash ﬂ ows, management makes assumptions about future growth of proﬁ ts which relate to future events and circumstances. Actual results could vary from these estimated future cash ﬂ ows. Estimation uncertainty relates to assumptions about future operating results and the application of an appropriate discount rate. Goodwill is subject to impairment testing on an annual basis. The Company performed its annual assessment of goodwill impairment during its third quarter. However, if indicators of impairment are present, the Company will review goodwill for impairment when such indicators arise. In addition, at each reporting period, the Company reviews whether there are indicators that the recoverable amount of long-lived assets may be less than their carrying amount. Goodwill and long-lived assets were reviewed for impairment by determining the recoverable amount of each CGU or groups of CGUs to which the goodwill or long-lived assets relate. Management estimated the recoverable amount of the CGUs based on the higher of value-in-use (“VIU”) and fair value less costs of disposal (“FVLCD”). The VIU calculations are based on expected future cash ﬂ ows. When measuring expected future cash ﬂ ows, management makes key assumptions about future growth of proﬁ ts which relate to future events and circumstances. Estimation uncertainty relates to assumptions about future operating results and the application of an appropriate discount rate. Actual results could vary from these estimates which may cause signiﬁ cant adjustments to the Company’s goodwill or long-lived assets in subsequent reporting periods. Pension Beneﬁ t Plans and Other Beneﬁ t Plans The cost of the Company’s pension beneﬁ ts for deﬁ ned contribution plans are expensed at the time active employees are compensated. The cost of deﬁ ned beneﬁ t pension plans and other beneﬁ t plans is accrued based on actuarial valuations, which are determined using the projected unit credit method pro-rated on service and management’s best estimate of salary escalation, retirement ages, and expected growth rate of health care costs. Current market values are used to value beneﬁ t plan assets. The obligation related to employee future beneﬁ ts 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. To the extent that plan amendments increase the obligation related to past service, the Company will recognize a past service cost immediately as an expense. In measuring its deﬁ ned beneﬁ t liability, the Company will recognize all of its actuarial gains and losses immediately into other comprehensive income. The key assumptions are disclosed in Note 17 of the Company’s consolidated ﬁ nancial statements. Income Taxes Deferred income tax assets and liabilities are recognized for the future income tax consequences attributable to temporary differences between the ﬁ nancial statement carrying values of assets and liabilities and their respective income tax bases. Deferred income tax assets or liabilities are measured using enacted or substantively enacted income tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The calculation of current and 27 Empire Company Limited MANAGEMENT’S DISCUSSION & ANALYSIS deferred income taxes requires management to make estimates and assumptions and to exercise a certain amount of judgment. The ﬁ nancial 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 deferred 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 ﬁ lings 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 deferred income tax balances on the consolidated balance sheets. Valuation of Inventories Inventories are valued at the lower of cost and estimated net realizable value. Signiﬁ cant estimation or judgment is required in the determination of (i) estimated inventory provisions associated with vendor allowances and internal charges; (ii) estimated inventory provisions due to spoilage and shrinkage occurring between the last physical inventory count and the balance sheet dates; and (iii) inventories valued at retail and adjusted to cost. Changes or differences in any of these estimates may result in changes to inventories on the consolidated balance sheets and a charge or credit to operating income in the consolidated statements of earnings. Provisions Provisions are recognized when there is a present legal or constructive obligation as a result of a past event, for which it is probable that a transfer of economic beneﬁ ts will be required to settle the obligation, and where a reliable estimate can be made of the amount of the obligation. Provisions are discounted using a pre-tax discount rate that reﬂ ects the current market assessments of the time value of money and the risks speciﬁ c to the liability, if material. Business Acquisitions For business acquisitions, the Company applies judgment on the recognition and measurement of assets and liabilities assumed and estimates are utilized to calculate and measure such adjustments. In measuring the fair value of an acquiree’s assets and liabilities, management uses estimates about future cash ﬂ ows and discount rates. Any measurement changes after initial recognition would affect the measurement of goodwill, except for deferred taxes. Supply Agreements The Company has various long-term supply agreements for products, some of which contain minimum volume purchases. Signiﬁ cant estimation and judgment is required in the determination of (i) future operating results; and (ii) forecasted purchase volumes. When measuring whether a provision is required based on the expected future cash ﬂ ows associated with fulﬁ lling the contract, management makes assumptions which relate to future events and circumstances. Actual results could vary from these estimated future cash ﬂ ows. Disclosure Controls and Procedures Management of the Company, which includes the President & Chief Executive Ofﬁ cer (“CEO”) and Chief Financial Ofﬁ cer (“CFO”), is responsible for establishing and maintaining Disclosure Controls and Procedures (“DC&P”) to provide reasonable assurance that material information relating to the Company is made known to management by others, particularly during the period in which the annual ﬁ lings are being prepared, and that information required to be disclosed by the Company and its annual ﬁ lings, interim ﬁ lings and other reports ﬁ led or submitted by it under securities legislation is recorded, processed, summarized and reported within the time periods speciﬁ ed in securities legislation. The CEO and CFO have evaluated the effectiveness of the Company’s DC&P and, based on that evaluation, the CEO and CFO have concluded that the Company’s DC&P was effective as at May 5, 2018 and that there were no material weaknesses relating to the design or operation of the DC&P. Internal Control Over Financial Reporting Management of the Company, which includes the CEO and CFO, is responsible for establishing and maintaining Internal Control over Financial Reporting (“ICFR”), as that term is deﬁ ned in National Instrument 52-109, “Certiﬁ cation of Disclosure in Issuers’ Annual and Interim Filings.” The control framework management used to design and assess the effectiveness of ICFR is “Internal Control Integrated Framework (2013)” published by the Committee of Sponsoring Organizations of the Treadway Commission. The CEO and CFO have evaluated the effectiveness of the Company’s ICFR and, based on that evaluation, the CEO and CFO have concluded that the Company’s ICFR was effective as at May 5, 2018 and that there were no material weaknesses relating to the design or operation of the ICFR. There have been no changes in the Company’s ICFR during the period beginning February 4, 2018 and ended May 5, 2018 that have materially affected, or are reasonably likely to materially affect, the Company’s ICFR. 28 Annual Report 2018 RELATED PARTY TRANSACTIONS The Company has related party transactions with Crombie REIT and key management personnel. The Company holds a 41.5 percent ownership interest in Crombie REIT and accounts for its investment using the equity method. The Company leased certain real property from Crombie REIT during the year at amounts which in management’s opinion approximate fair market value that would be incurred if leased from a third party. Management has determined these amounts to be fair value based on the signiﬁ cant number of leases negotiated with third parties in each market it operates. The aggregate net payments under these leases, which are measured at exchange amounts, totaled approximately $199.7 million (2017 – $195.8 million). Crombie REIT provides administrative and management services to the Company on a fee for service basis pursuant to a Management Agreement effective January 1, 2016. The Management Agreement replaces the previous arrangement where charges incurred were on a cost recovery basis. On July 4, 2017, Crombie REIT redeemed its 5.00% Series D Convertible Unsecured Subordinate Debentures. In exchange for its investment in the Series D convertible debentures, the Company received $24.3 million in principal and interest payments. There was no gain or loss recognized on the redemption. During the year ended May 5, 2018, the Company received interest from Crombie REIT of $0.2 million (2017 – $1.2 million). On April 6, 2018, Sobeys and its wholly-owned subsidiaries entered into an agreement with Crombie REIT to sell a portfolio of 1 properties, nine of which were leased back. Total cash proceeds to the Company and its wholly-owned subsidiaries from this transaction were $88.1 million, resulting in a pre-tax gain of $13.2 million. On September 29, 2017, Sobeys sold a property to Crombie REIT for cash consideration of $6.4 million. This resulted in a pre-tax gain of $0.2 million. On June 29, 2016, Sobeys and its wholly-owned subsidiaries entered into an agreement with Crombie REIT to sell and leaseback a portfolio of 19 retail properties and a 50 percent interest in each of its three automated distribution centres, as well as the sale of two parcels of development land which were previously owned by Empire. Crombie REIT also invested approximately $58.8 million in renovations or expansions of ten Sobeys retail locations already in Crombie REIT’s portfolio. In addition to cash, Crombie REIT issued to a subsidiary of the Company $93.4 million in value of Crombie Limited Partnership (“CLP”) Class B units with attached Crombie REIT special voting units at a price of $14.70 per unit. The subsidiary of the Company subsequently sold its CLP Class B units to Empire on a tax deferred basis. Total cash proceeds to the Company and its wholly-owned subsidiaries from these transactions with Crombie REIT and Empire were $323.8 million, resulting in a pre-tax loss of $0.8 million. Proceeds from the transactions were used to repay the senior unsecured notes. On July 29, 2016, Sobeys, through a wholly-owned subsidiary, sold and leased back an additional property from Crombie REIT for cash consideration of $26.4 million. This resulted in a pre-tax gain of $2.1 million. Sobeys also purchased one property from Crombie REIT for $9.1 million. During ﬁ scal 2014, Sobeys entered into a loan agreement with Crombie REIT to partially ﬁ nance Sobeys’ acquisition of a property in British Columbia. The $11.9 million loan bore interest at a rate of 6.0 percent and had no principal repayments. On May 5, 2017, Sobeys sold the property to Crombie REIT for cash consideration of $31.1 million, resulting in a pre-tax gain of $1.0 million. Proceeds from the transaction were used to repay the loan. KEY MANAGEMENT PERSONNEL COMPENSATION Key management personnel include the Board of Directors and members of the Company’s executive team that have authority and responsibility for planning, directing and controlling the activities of the Company. Key management personnel compensation is comprised of: ($ in millions) Salaries, bonus and other short-term employment beneﬁ ts Post-employment beneﬁ ts Termination beneﬁ ts Share-based payments 52 Weeks Ended May 5, 2018 May 6, 2017 $ $ 13.3 1.5 0.8 9.8 25.4 $ $ 9.7 1.6 8.7 14.8 34.8 Indemnities The Company has agreed to indemnify its directors, ofﬁ cers and particular employees in accordance with the Company’s policies. The Company maintains insurance policies that may provide coverage against certain claims. 29 Empire Company Limited MANAGEMENT’S DISCUSSION & ANALYSIS CONTINGENCIES The Company is subject to claims and litigation arising out of the ordinary course of business operations. The Company’s management does not consider the exposure to such litigation to be material. In the ordinary course of business, the Company is subject to ongoing audits by tax authorities. While the Company believes that its tax ﬁ ling positions are appropriate and supportable, from time to time certain matters are reviewed and challenged by the tax authorities. 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. Project Sunrise On May 4, 2017, the Company announced a major transformation initiative to streamline the organization and enhance the efﬁ ciency of its operations. Failure to execute change management during this transition could result in disruptions to the operations of the business or the ability of the Company to implement and achieve its long-term strategic objectives. The implementation of a major transformation initiative has the ability to create labour strife, negative publicity and business disruption. There is the risk that the Company will not realize the $500.0 million in annualized savings by the completion of the three year reorganization in 2020. Competition Empire’s food retailing business, Sobeys, operates in a dynamic and competitive market. Other national and regional food distribution companies, along with non traditional competitors, such as mass merchandisers, warehouse clubs, and online retailers, represent a competitive risk to Sobeys’ ability to attract customers and operate proﬁ tably in its markets. Sobeys maintains a strong national presence in the Canadian retail food and food distribution industry, operating in over 900 communities in Canada. The most signiﬁ cant risk to Sobeys is the potential for reduced revenues and proﬁ t margins as a result of increased competition. A failure to maintain geographic diversiﬁ cation to reduce the effects of localized competition could have an adverse impact on Sobeys’ operating margins and results of operations. To successfully compete, Sobeys believes it must be customer and market driven, be focused on superior execution and have efﬁ cient, cost-effective operations. It also believes it must invest in its existing store network, as well as its merchandising, marketing and operational execution to evolve its strategic platform to better meet the needs of consumers looking for more affordable, better food options. The Company further believes it must invest in merchandising initiatives to better forecast and respond to changing consumer trends. Any failure to successfully execute in these areas could have a material adverse impact on Sobeys’ ﬁ nancial results. Empire’s real estate operations, through its investment in Crombie REIT, compete with numerous other managers and owners of real estate properties in seeking tenants and new properties to acquire. The existence of competing managers and owners could affect their ability to: (i) acquire property in compliance with their investment criteria; (ii) lease space in their 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 the Company’s ﬁ nancial results and cash ﬂ ows. A failure by Crombie REIT to maintain strategic relationships with developers to ensure an adequate supply of prospective attractive properties or to maintain strategic relationships with existing and potential tenants to help achieve high occupancy levels at each of its properties could adversely affect the Company. Product 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, including pharmaceuticals. 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 signiﬁ cant outbreak of food-borne illness or increased public health concerns in connection with certain food products. Such an event could materially affect Sobeys’ ﬁ nancial performance. Procedures are in place to manage food crises, should they occur. These procedures are intended to identify risks, provide clear communication to employees and consumers and ensure that potentially harmful products are removed from sale 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. However, there can be no assurance that such measures will prevent the occurrence of any such contamination, and insurance may not be sufﬁ cient to cover any resulting ﬁ nancial liability or reputational harm. 30 Annual Report 2018 Drug Regulation, Legislation and Healthcare Reform The Company currently operates 352 in-store pharmacies and 74 freestanding pharmacies which are subject to federal, provincial, territorial and local legislation as well as regulations governing the sale of prescription drugs. Changes or failure to comply with these laws and regulations could have a negative impact on operations, ﬁ nancial performance and reputation. These laws and regulations typically regulate prescription drug coverage for public plans including patient and product eligibility as well as elements of drug pricing and reimbursements including product cost, markup, dispensing fee, distribution allowances and in some provinces the ability to negotiate manufacturers allowances. In some provinces, legislation requires the selling price for prescription drugs to third-party insurance plans and cash customers will not be higher than the price established for the provincial drug plan. In addition to reimbursement, these laws and regulations govern drug approval and distribution, allowable packaging and labeling, marketing, handling, storage and disposal. In ﬁ scal 2018, provincial governments and private plans continued to implement measures to manage the cost of their drug plans, the impact of which varied by province and by plan. The most signiﬁ cant of these measures implemented April 1, 2018 was the signiﬁ cant price reduction of almost 70 high volume generic drugs which was the result of an agreement between the pan-Canadian Pharmaceutical Alliance and the Canadian Generic Pharmaceutical Association on behalf of the federal, provincial and territorial drug plans. The Council of the Federation, a joint collaboration created by the provincial premiers continues to work on cost reduction initiatives within the pharmaceutical sector. In the fall of 2017, actions by the Alberta College of Pharmacy resulted in a ban on the ability of pharmacies to offer inducements on prescription drugs. It is anticipated that healthcare reform and regulation will continue to put pressure on pharmacy reimbursement through changes to patient and drug eligibility, prescription drug pricing including cost, dispensing fee, allowable markup, manufacturer allowance funding, distribution as well as potential restriction around customer inducements. The Company has and will continue to identify opportunities to mitigate the negative impact these changes have on ﬁ nancial performance. Free Trade The Company is susceptible to risks associated with trade relationships between Canada and other countries including the United States. Changes to trade agreements and tariffs between Canada and other countries could increase the costs of certain products and some items could become unavailable thereby having a negative impact on customer experience. While the Company can mitigate these risks to a certain extent through the use of alternative suppliers, international trade by its nature can be unpredictable and the Company may not be able to fully mitigate the negative impact of changes in trade agreements and tariffs. Loyalty Program The Company utilizes a third-party loyalty program to provide additional value to customers. The decisions made by the third party can adversely affect the reputation and ﬁ nancial operations of the Company. Promotional and other activities related to possible changes in the loyalty programs must be effectively managed and coordinated to ensure a positive customer perception. Failure to effectively manage and communicate changes to the loyalty program may negatively impact the Company’s reputation. Human Resources A signiﬁ cant percentage of the Company’s store and distribution centre workforce, particularly in Western Canada, is unionized. While overall the Company has and works to maintain good relationships with its employees and unions, the renegotiation of collective agreements always presents the risk of labour disruption. The Company has consistently stated it will accept the short- term costs of labour disruption to support a commitment to building and sustaining a competitive cost structure for the long term. Any prolonged or widespread work stoppages or other labour disputes could have an adverse impact on the Company’s ﬁ nancial results. 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 identiﬁ ed for key roles including the depth of management talent throughout the Company and its subsidiaries; these plans are overseen by the Human Resources Committee and reviewed at least annually by the Board of Directors. Workplace health and safety is a top priority for the Company, which has robust programs and reporting mechanisms in place designed to ensure regulatory compliance and mitigate the risks associated with workplace injury and illness. Recent announcements of minimum wage increases in several provinces will have an impact on labour costs and the labour force of the Company. 31 Empire Company Limited MANAGEMENT’S DISCUSSION & ANALYSIS Operations The success of Empire is closely tied to the performance of Sobeys’ network of retail stores. Franchisees and afﬁ liates operate approximately 52 percent of Sobeys’ retail stores. Sobeys relies on its franchisees, afﬁ liates 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, franchisees and afﬁ liates agree 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 speciﬁ ed under franchise and operating agreements which expire at various times for individual franchisees and afﬁ liates. Despite these franchise and operating agreements, Sobeys may have limited ability to control a franchisees’ and afﬁ liates’ business operations. A breach of these franchise and operating agreements or operational failures by a signiﬁ cant number of franchisees and afﬁ liates may adversely affect Sobeys’ reputation and ﬁ nancial performance. Technology The Company operates extensive and complex information technology systems that are vital to the successful operation of its business and marketing strategies. Any interruption to these systems or the information collected by them would have a signiﬁ cant adverse impact on the Company, its operations and its ﬁ nancial results. The Company is committed to improving its operating systems, tools and procedures in order to become more efﬁ cient and effective. The implementation of major information technology projects carries with it various risks, including the risk of realization of functionality. Information Management The integrity, reliability and security of information in all its forms is critical to the Company’s daily and strategic operations. Inaccurate, incomplete or unavailable information or inappropriate access to information could lead to incorrect ﬁ nancial and/or operational reporting, poor decisions, privacy breaches or inappropriate disclosure or leaks of sensitive information. Gathering and analyzing information regarding customers’ purchasing preferences is an important part of the Company’s strategy to attract and retain customers and effectively compete. Any failure to maintain privacy of customer information or to comply with applicable privacy laws or regulations could adversely affect the Company’s reputation, competitive position and results of operations. The Company recognizes that information is a critical enterprise asset. Currently, the information management risk is 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. Supply Chain The Company is exposed to potential supply chain disruptions and errors that could result in obsolete merchandise or an excess or shortage of merchandise in its retail store network. A failure to implement and maintain effective supplier selection and procurement practices could adversely affect Sobeys’ ability to deliver desired products to customers and adversely affect the Company’s ability to attract and retain customers. A failure to maintain an efﬁ cient supply and logistics chain may adversely affect Sobeys’ ability to sustain and meet growth objectives and maintain margins. Product Costs Sobeys is a signiﬁ cant purchaser of food product which is at risk of cost inﬂ ation given rising commodity prices and other costs of production to food manufacturers. Should rising costs of product materialize in excess of expectations and should Sobeys not be able to offset such cost inﬂ ation through higher retail prices or other cost savings, there could be a negative impact on sales and margin performance. Economic Environment Management continues to closely monitor economic conditions, including foreign exchange rates, interest rates, inﬂ ation, 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 sufﬁ cient to meet its ongoing business requirements. Liquidity Risk The Company’s business is dependent in part on having access to sufﬁ cient capital and ﬁ nancial resources to fund its growth activities and investment in operations. Any failure to maintain adequate ﬁ nancial resources could impair the Company’s growth or ability to satisfy ﬁ nancial obligations as they come due. The Company actively maintains committed credit facilities to ensure that it has sufﬁ cient available funds to meet current and foreseeable future ﬁ nancial requirements. The Company monitors capital markets and the related economic conditions and maintains access to debt capital markets for long-term debt issuances as deemed prudent in order to minimize risk and optimize pricing. However, there can be no assurance that adequate capital resources will be available in the future on acceptable terms or at all. Interest Rate Fluctuation The Company’s long-term debt objective is to maintain the majority of its debt at ﬁ xed interest rates. Any increase in the applicable interest rates could increase interest expense and have a material adverse effect on the Company’s cash ﬂ ow and results of operations. There can be no assurance that risk management strategies, if any, undertaken by the Company will be effective. 32 Annual Report 2018 Business Continuity The Company may be subject to unexpected events and natural hazards, including severe weather events, interruption of utilities and infrastructure or occurrence of pandemics, which could cause sudden or complete cessation of its day to day operations. The Company has worked with industry and government sources to develop preparedness plans. However, no such plan can eliminate the risks associated with events of this magnitude. Any failure to respond effectively or appropriately to such events could adversely affect the Company’s operations, reputation and ﬁ nancial results. Insurance The Company and its subsidiaries are self-insured on a limited basis with respect to certain operational risks and also purchase excess insurance coverage from ﬁ nancially stable third-party insurance companies. In addition to maintaining comprehensive loss prevention programs, the Company maintains management programs to mitigate the ﬁ nancial impact of operational risks. Such programs may not be effective to limit the Company’s exposure to these risks, and to the extent that the Company is self-insured or liability exceeds applicable insurance limits, the Company’s ﬁ nancial position could be adversely affected. Ethical Business Conduct Any failure of the Company to adhere to its policies, the law or ethical business practices could signiﬁ cantly affect its reputation and brands and could therefore negatively impact the Company’s ﬁ nancial 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 the Company maintains an anonymous, conﬁ dential whistle blowing hotline. There can be no assurance that these measures will be effective to prevent violations of law or ethical business practices. Environmental The Company operates its business locations across the country, including numerous fuel stations. Each of these sites has the potential to experience environmental contamination or other issues as a result of the Company’s operations or the activities of third parties, including neighbouring properties. When environmental issues are identiﬁ ed, any required environmental site remediation is completed using appropriate, qualiﬁ ed internal and external resources. The Company may be required to absorb all costs associated with such remediation, which may be substantial. Sobeys’ retail fuel locations operate underground storage tanks. Environmental contamination resulting from leaks or damages to these tanks is possible. To mitigate this environmental risk, Sobeys engages in several monitoring procedures, as well as risk assessment activities, to minimize potential environmental hazards. These activities mitigate but do not eliminate the Company’s environmental risk, and as such, along with the risk of changes to existing environmental protection regulatory requirements, there remains exposure for negative ﬁ nancial and operational impacts to the Company in future years. Occupational Health and Safety The Company has developed programs to promote a healthy and safe workplace, as well as progressive employment policies focused on the well being of the thousands of employees who work in its stores, distribution centres and ofﬁ ces. These policies and programs are reviewed regularly by the Human Resources Committee of the Board of Directors. Real Estate The Company utilizes a capital allocation process which is focused on obtaining the most attractive real estate locations for its retail stores, as well as for its commercial property and residential development operations, with direct or indirect Company ownership being an important, but not overriding, consideration. The Company 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 the ability to expand existing stores are therefore in large part contingent upon the successful negotiation of operating leases with these developers and the Company’s ability to purchase high potential sites. Legal, Taxation and Accounting Changes to any of the various federal and provincial laws, rules and regulations related to the Company’s business could have a material impact on its ﬁ nancial results. Compliance with any proposed changes could also result in signiﬁ cant cost to the Company. Failure to fully comply with various laws and 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 and rules and regulations by monitoring for newly adopted activities, improving technology systems and controls, improving internal controls to detect and prevent errors and overall application of more scrutiny to ensure compliance. In the ordinary course of business, the Company is subject to ongoing audits by tax authorities. While the Company believes that its tax ﬁ ling positions are appropriate and supportable, from time to time certain matters are reviewed and challenged by the tax authorities. 33 Empire Company Limited MANAGEMENT’S DISCUSSION & ANALYSIS Utility and Fuel Prices The Company is a signiﬁ cant consumer of electricity, other utilities and fuel. The costs of these items have been subject to signiﬁ cant volatility. Unanticipated cost increases in these items could negatively affect the Company’s ﬁ nancial performance. A failure to maintain effective consumption and procurement programs could adversely affect the Company’s ﬁ nancial results. In addition, Sobeys operates a large number of fuel stations. Signiﬁ cant increases in wholesale prices or availability could adversely affect operations and ﬁ nancial results of the fuel retailing business. Credit Rating There can be no assurance that the credit ratings assigned to the various debt instruments issued by Sobeys will remain in effect for any given period of time or that the rating will not be lowered, withdrawn or revised by DBRS or S&P at any time. Real or anticipated changes in credit ratings can affect the cost at which Sobeys can access the capital markets. The likelihood that Sobeys’ creditors will receive payments owing to them will depend on Sobeys’ ﬁ nancial health and creditworthiness. Credit ratings assigned by a ratings agency provide an opinion of that ratings agency on the risk that an issuer will fail to satisfy its ﬁ nancial obligations in accordance with the terms under which an obligation has been issued. Receipt of a credit rating provides no guarantee of Sobeys’ future creditworthiness. Foreign Currency The Company conducts the majority of its operating business in CAD and its foreign exchange risk is mainly limited to currency ﬂ uctuations between the CAD, the Euro and the USD. USD purchases of products represent approximately 4.1 percent of Sobeys’ total annual purchases. Euro purchases are primarily limited to speciﬁ c contracts for capital expenditures. A failure to adequately manage the risk of exchange rate changes could adversely affect the Company’s ﬁ nancial results. Capital Allocation It is important that 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 the Board of Directors’ review of signiﬁ cant capital allocation decisions. Seasonality The Company’s operations as they relate to food, speciﬁ cally inventory levels, sales volume and product mix, are impacted to some degree by certain holiday periods in the year. Foreign Operations The Company has certain foreign operations. The Company’s foreign operations are limited to a produce sourcing operation and residential real estate partnerships based in the United States. Pension Plans The Company has certain retirement beneﬁ t obligations under its registered deﬁ ned beneﬁ t plans. New regulations and market- driven changes may result in the Company being required to make contributions that differ from estimates, which could have an adverse affect on the ﬁ nancial performance of the Company. The Company participates in various multi-employer pension plans, providing pension beneﬁ ts to unionized employees pursuant to provisions in collective bargaining agreements. Approximately 16 percent of the employees of Sobeys and its franchisees and afﬁ liates participate in these plans. The responsibility of Sobeys, its franchisees, and afﬁ liates to make contributions to these plans is limited to the amounts established in the collective bargaining agreements and other associated agreements, however poor performance of these plans could have a negative effect on the participating employees or could result in changes to the terms and conditions of participation in these plans, which in turn could negatively affect the ﬁ nancial performance of the Company. Leverage Risk The Company’s degree of leverage, particularly since the increases to long-term debt facilities to complete the Canada Safeway acquisition, could have adverse consequences for the Company. These include limiting the Company’s ability to obtain additional ﬁ nancing for working capital and activities such as capital expenditures, product development, debt service requirements, and acquisitions. Higher leveraging restricts the Company’s ﬂ exibility and discretion to operate its business by limiting the Company’s ability to declare dividends due to having to dedicate a portion of the Company’s cash ﬂ ows from operations to the payment of interest on its existing indebtedness. Utilizing cash ﬂ ows for interest payments also limits capital available for other purposes including operations, capital expenditures and future business opportunities. Increased levels of debt expose the Company to increased interest expense on borrowings at variable rates thereby limiting the Company’s ability to adjust to changing market conditions. This could place the Company at a competitive disadvantage compared to its competitors that have less debt, by making the Company vulnerable during downturns in general economic conditions and limiting the Company’s ability to make capital expenditures that are important to its growth and strategies. 34 Annual Report 2018 DESIGNATION FOR ELIGIBLE DIVIDENDS “Eligible dividends” receive favourable treatment for income tax purposes. To be considered an eligible dividend, a dividend must be designated as such at the time of payment. Empire has, in accordance with the administrative position of CRA, included the appropriate language on its website to designate the dividends paid by Empire as eligible dividends unless otherwise designated. NON-GAAP FINANCIAL MEASURES & FINANCIAL METRICS There are measures and metrics included in this MD&A that do not have a standardized meaning under GAAP and therefore may not be comparable to similarly titled measures and metrics presented by other publicly traded companies. Management believes that certain of these measures and metrics, including gross proﬁ t and EBITDA, are important indicators of Empire’s ability to generate liquidity through operating cash ﬂ ow to fund future working capital requirements, service outstanding debt and fund future capital expenditures and uses these metrics for these purposes. In addition, management adjusts measures and metrics, including EBITDA and net earnings in an effort to provide investors and analysts with a more comparable year-over-year performance metric than the basic measure by excluding certain items. These items may impact the analysis of trends in performance and affect the comparability of the Company’s core ﬁ nancial results. By excluding these items, management is not implying they are non-recurring. Financial Measures The intent of non-GAAP Financial Measures is to provide additional useful information to investors and analysts. Non-GAAP Financial Measures should not be considered in isolation or used as a substitute for measures of performance prepared in accordance with GAAP. The Company’s deﬁ nitions of the non-GAAP terms included in this MD&A are as follows: • Gross proﬁ t is calculated as sales less cost of sales. • Adjusted operating income is operating income excluding certain items to better analyze trends in performance. These adjustments result in a truer economic representation on a comparative basis. The Company no longer adjusts for items that are insigniﬁ cant to current period results or the comparative period. Adjusted operating income is reconciled to operating income in its respective subsection of the “Summary Results – Fourth Quarter” and “Operating Results – Full Year” sections. Adjusted operating income for the Food Retailing Segment is reconciled to operating income in the “Food Segment Reconciliations” section of this MD&A. • Earnings before interest, taxes, depreciation and amortization (“EBITDA”), is calculated as net earnings, before ﬁ nance costs (net of ﬁ nance income), income tax expense, depreciation and amortization of intangibles. The exclusion of depreciation and amortization of intangibles partially eliminates the non-cash impact from operating income. The following table reconciles net earnings to EBITDA: ($ in millions) Net earnings Income tax expense Finance costs, net Operating income Depreciation Amortization of intangibles EBITDA 13 Weeks Ended 52 Weeks Ended May 5, 2018 May 6, 2017 May 5, 2018 May 6, 2017 $ $ 73.5 11.7 25.4 110.6 85.6 21.6 217.8 $ $ 32.3 1.4 27.7 61.4 88.6 21.7 $ 179.8 56.2 110.5 346.5 351.8 87.4 $ 171.7 $ 785.7 $ 172.5 42.5 118.0 333.0 355.5 88.7 777.2 • Adjusted EBITDA is EBITDA excluding certain items to better analyze trends in performance. These adjustments result in a truer economic representation on a comparative basis. The Company no longer adjusts for items that are insigniﬁ cant to current period results or the comparative period. Adjusted EBITDA is reconciled to EBITDA in its respective subsection of the “Summary Results – Fourth Quarter” and “Operating Results – Full Year” sections. Adjusted EBITDA for the Food Retailing Segment is reconciled to EBITDA in the “Food Segment Reconciliations” section of this MD&A. • Management calculates interest expense as interest expense on ﬁ nancial liabilities measured at amortized cost plus losses on cash ﬂ ow hedges reclassiﬁ ed from other comprehensive income or losses. Management believes that interest expense represents a true measure of the Company’s debt service expense, without the offsetting total ﬁ nance income. 35 Empire Company Limited MANAGEMENT’S DISCUSSION & ANALYSIS The following table reconciles ﬁ nance costs, net to interest expense: ($ in millions) May 5, 2018 May 6, 2017 May 5, 2018 May 6, 2017 13 Weeks Ended 52 Weeks Ended Finance costs, net Plus: ﬁ nance income Less: net pension ﬁ nance costs Less: accretion expense on provisions Interest expense $ $ 25.4 2.3 (3.2) (2.9) $ 27.7 1.0 (2.9) (0.3) $ 110.5 6.0 (11.9) (7.7) 118.0 6.1 (11.5) (9.5) $ 21.6 $ 25.5 $ 96.9 $ 103.1 • Adjusted net earnings are net earnings, net of non-controlling interest, excluding certain items to better analyze trends in performance and ﬁ nancial results. These adjustments result in a truer economic representation of the underlying business on a comparative basis. The Company no longer adjusts for items that are insigniﬁ cant to current period results or the comparative period. Adjusted net earnings is reconciled to net earnings in its respective subsection of the “Summary Results – Fourth Quarter” and “Operating Results – Full Year” sections. Adjusted net earnings for the Food Retailing Segment is reconciled to net earnings in the “Food Segment Reconciliations” section of this MD&A. • Adjusted EPS (fully diluted) is calculated as adjusted net earnings divided by diluted weighted average number of shares outstanding. • Free cash ﬂ ow is calculated as cash ﬂ ows from operating activities, plus proceeds on disposal of property, equipment and investment property, less property, equipment and investment property purchases. Management uses free cash ﬂ ow as a measure to assess the amount of cash available for debt repayment, dividend payments and other investing and ﬁ nancing activities. Free cash ﬂ ow is reconciled to GAAP measures as reported on the consolidated statements of cash ﬂ ows, and is presented in the “Free Cash Flow” section of this MD&A. • Funded debt is all interest bearing debt, which includes bank loans, bankers’ acceptances and long-term debt. Management believes that funded debt represents the best indicator of the Company’s total ﬁ nancial obligations on which interest payments are made. • Net funded debt is calculated as funded debt less cash and cash equivalents. Management believes that the deduction of cash and cash equivalents from funded debt represents a more accurate measure of the Company’s ﬁ nancial obligations after 100% of cash and cash equivalents are applied against the total obligation. • Total capital is calculated as funded debt plus shareholders’ equity, net of non-controlling interest. • Net total capital is total capital less cash and cash equivalents. The following tables reconcile the Company’s funded debt, net funded debt, net total capital and total capital to GAAP measures as reported on the balance sheets as at May 5, 2018, May 6, 2017 and May 7, 2016, respectively: ($ in millions) Long-term debt due within one year Long-term debt Funded debt Less: cash and cash equivalents Net funded debt Total shareholders’ equity, net of non-controlling interest Net total capital ($ in millions) Funded debt Total shareholders’ equity, net of non-controlling interest Total capital May 5, 2018 May 6, 2017 May 7, 2016(1)(2) $ 527.4 1,139.5 $ 1,666.9 (627.9) 1,039.0 3,702.8 134.0 1,736.8 1,870.8 (207.3) 1,663.5 3,644.2 $ 350.4 2,017.0 2,367.4 (264.7) 2,102.7 3,623.9 $ 4,741.8 $ 5,307.7 $ 5,726.6 May 5, 2018 May 6, 2017 May 7, 2016(1)(2) $ 1,666.9 3,702.8 $ 1,870.8 3,644.2 $ 2,367.4 3,623.9 $ 5,369.7 $ 5,515.0 $ 5,991.3 (1) Amounts have been reclassiﬁ ed to correspond to the current period presentation on the consolidated balance sheets. (2) Amounts have been restated. See “Changes to Accounting Policies Adopted During Fiscal 2017” section of the ﬁ scal 2017 annual MD&A for further detail. 36 Annual Report 2018 Food Segment Reconciliations The following tables adjust Sobeys’ contributed operating income, EBITDA, and net earnings, net of non-controlling interest, for items which are considered not indicative of underlying business operating performance: 52 Weeks Ended May 5, 2018 May 6, 2017 $ Change $ 273.6 $ 259.3 $ 14.3 ($ in millions) Operating income Adjustments: Costs related to Project Sunrise Intangible amortization associated with the Canada Safeway acquisition West business unit store closures Distribution centre restructuring Gain on disposal of manufacturing facilities Historical organizational realignment costs Network rationalization reversals Adjusted operating income $ 528.8 $ 304.8 $ 52 Weeks Ended May 5, 2018 May 6, 2017 $ Change $ 712.5 $ 703.2 $ 9.3 ($ in millions) EBITDA Adjustments: Costs related to Project Sunrise West business unit store closures Distribution centre restructuring Gain on disposal of manufacturing facilities Historical organizational realignment costs Network rationalization reversals Adjusted EBITDA $ 941.5 $ 722.9 $ 52 Weeks Ended May 5, 2018 May 6, 2017 $ Change $ 116.5 $ 112.7 $ 3.8 ($ in millions) Net earnings Adjustments: Costs related to Project Sunrise Intangible amortization associated with the Canada Safeway acquisition West business unit store closures Distribution centre restructuring Gain on disposal of manufacturing facilities Historical organizational realignment costs Network rationalization reversals Adjusted net earnings $ 301.3 $ 145.5 $ 207.8 26.2 21.2 – – – – 255.2 15.8 25.8 – 9.6 (7.5) 3.4 (1.6) 45.5 207.8 21.2 – – – – 229.0 15.8 – 9.6 (7.5) 3.4 (1.6) 19.7 150.1 19.2 15.5 – – – – 184.8 11.3 18.8 – 6.9 (5.5) 2.5 (1.2) 32.8 209.7 224.0 209.3 218.6 152.0 155.8 37 Empire Company Limited MANAGEMENT’S DISCUSSION & ANALYSIS Financial Metrics The intent of the following non-GAAP Financial Metrics is to provide additional useful information to investors and analysts. Management uses ﬁ nancial metrics for decision making, internal reporting, budgeting and forecasting. The Company’s deﬁ nitions of the metrics included in this MD&A are as follows: • Same-store sales are sales from stores in the same location in both reporting periods. • Gross margin is gross proﬁ t divided by sales. Management believes that gross margin is an important indicator of cost control and can help management, analysts and investors assess the competitive landscape and promotional environment of the industry in which the Company operates. An increasing percentage indicates lower cost of sales as a percentage of sales. • Adjusted interest coverage is calculated as adjusted operating income divided by interest expense. • Return on equity, as reported by Sobeys, is net earnings for the year attributable to owners of the parent, divided by average shareholder’s equity. • Funded debt to total capital ratio is funded debt divided by total capital. • Net funded debt to net total capital ratio is net funded debt divided by net total capital. Management believes that funded debt to total capital and net funded debt to net total capital ratios represent measures upon which the Company’s changing capital structure can be analyzed over time. Increasing ratios would indicate that the Company is using an increasing amount of debt in its capital structure to fund its operations. • Funded debt to adjusted EBITDA ratio is funded debt divided by trailing four-quarter adjusted EBITDA. Management uses this ratio to partially assess the ﬁ nancial condition of the Company. An increasing ratio would indicate that the Company is utilizing more debt per dollar of adjusted EBITDA generated. • Adjusted EBITDA to interest expense ratio is trailing four-quarter adjusted EBITDA divided by trailing four-quarter interest expense. Management uses this ratio to partially assess the coverage of its interest expense on ﬁ nancial obligations. An increasing ratio would indicate that the Company is generating more adjusted EBITDA per dollar of interest expense, resulting in greater interest coverage. • Book value per common share is shareholders’ equity, net of non-controlling interest, divided by total common shares outstanding. The following table shows the calculation of Empire’s book value per common share as at May 5, 2018, May 6, 2017 and May 7, 2016: ($ in millions, except per share information) Shareholders’ equity, net of minority interest Shares outstanding (basic) Book value per common share May 5, 2018 May 6, 2017 May 7, 2016(1) $ 3,702.8 271.8 $ 13.62 $ $ 3,644.2 271.9 13.40 $ $ 3,623.9 273.9 13.23 (1) Amounts have been restated. See “Changes to Accounting Policies Adopted During Fiscal 2017” section of the ﬁ scal 2017 annual MD&A for further detail. Additional ﬁ nancial information relating to Empire, including the Company’s Annual Information Form, can be found on the Company’s website www.empireco.ca or on the SEDAR website for Canadian regulatory ﬁ lings at www.sedar.com. Approved by Board of Directors: June 27, 2018. Stellarton, Nova Scotia, Canada 38 Annual Report 2018 Consolidated Financial Statements TABLE OF CONTENTS Management’s Statement of Responsibility for Financial Reporting Independent Auditor’s Report Consolidated Financial Statements Consolidated Balance Sheets Consolidated Statements of Earnings Consolidated Statements of Comprehensive Income Consolidated Statements of Changes in Shareholders’ Equity Consolidated Statements of Cash Flows Notes to the Consolidated Financial Statements 40 41 42 42 43 44 45 46 47 39 Empire Company Limited MANAGEMENT’S STATEMENT OF RESPONSIBILIT Y FOR FINANCIAL REPORTING Preparation of the consolidated ﬁ nancial statements accompanying this annual report and the presentation of all other information in the report is the responsibility of management. The consolidated ﬁ nancial statements have been prepared in accordance with International Financial Reporting Standards or Generally Accepted Accounting Principles and reﬂ ect management’s best estimates and judgments. All other ﬁ nancial information in the report is consistent with that contained in the consolidated ﬁ nancial 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 ﬁ nancial statements, the safeguarding of Company assets, and the prevention and detection of fraudulent ﬁ nancial reporting. The Board of Directors, through its Audit Committee, oversees management in carrying out its responsibilities for ﬁ nancial 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 ﬁ nancial management and external auditors to satisfy itself as to reliability and integrity of ﬁ nancial information and the safeguarding of assets. The Audit Committee reports its ﬁ ndings to the Board of Directors for consideration in approving the annual consolidated ﬁ nancial statements to be issued to shareholders. The external auditors have full and free access to the Audit Committee. signed “Michael Medline” signed “Michael Vels” Michael Medline President and Chief Executive Ofﬁ cer Michael Vels Chief Financial Ofﬁ cer June 27, 2018 June 27, 2018 40 Annual Report 2018 INDEPENDENT AUDITOR’S REPORT To the Shareholders of Empire Company Limited We have audited the accompanying consolidated ﬁ nancial statements of Empire Company Limited and its subsidiaries, which comprise the consolidated balance sheets as at May 5, 2018 and May 6, 2017 and the consolidated statements of earnings, comprehensive income, changes in shareholders’ equity and cash ﬂ ows for the 52-week periods ended May 5, 2018 and May 6, 2017, and the related notes, which comprise a summary of signiﬁ cant accounting policies and other explanatory information. Management’s responsibility for the consolidated ﬁ nancial statements Management is responsible for the preparation and fair presentation of these consolidated ﬁ nancial statements in accordance with International Financial Reporting Standards, and for such internal control as management determines is necessary to enable the preparation of consolidated ﬁ nancial statements that are free from material misstatement, whether due to fraud or error. Auditor’s responsibility Our responsibility is to express an opinion on these consolidated ﬁ nancial statements based on our audits. We conducted our audits in accordance with Canadian generally accepted auditing standards. Those standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance about whether the consolidated ﬁ nancial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated ﬁ nancial statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the consolidated ﬁ nancial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity’s preparation and fair presentation of the consolidated ﬁ nancial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the consolidated ﬁ nancial statements. We believe that the audit evidence we have obtained in our audits is sufﬁ cient and appropriate to provide a basis for our audit opinion. Opinion In our opinion, the consolidated ﬁ nancial statements present fairly, in all material respects, the ﬁ nancial position of Empire Company Limited and its subsidiaries as at May 5, 2018 and May 6, 2017 and their ﬁ nancial performance and their cash ﬂ ows for the 52-week periods ended May 5, 2018 and May 6, 2017 in accordance with International Financial Reporting Standards. signed “PricewaterhouseCoopers LLP” Chartered Professional Accountants, Licensed Public Accountants Halifax, Canada June 27, 2018 41 Empire Company Limited CONSOLIDATED BALANCE SHEET As At (in millions of Canadian dollars) ASSETS Current Cash and cash equivalents Receivables Inventories (NOTE 4) Prepaid expenses Loans and other receivables (NOTE 5) Income taxes receivable Assets held for sale (NOTE 6) Loans and other receivables (NOTE 5) Investments Investments, at equity (NOTE 7) Other assets (NOTE 8) Property and equipment (NOTE 9) Investment property (NOTE 10) Intangibles (NOTE 11) Goodwill (NOTE 12) Deferred tax assets (NOTE 13) LIABILITIES Current Accounts payable and accrued liabilities Income taxes payable Provisions (NOTE 14) Long-term debt due within one year (NOTE 15) Provisions (NOTE 14) Long-term debt (NOTE 15) Other long-term liabilities (NOTE 16) Employee future beneﬁ ts (NOTE 17) Deferred tax liabilities (NOTE 13) SHAREHOLDERS’ EQUITY Capital stock (NOTE 18) Contributed surplus Retained earnings Accumulated other comprehensive income Non-controlling interest See accompanying notes to the consolidated ﬁ nancial statements. On Behalf of the Board signed “James Dickson” signed “Michael Medline” James Dickson Director Michael Medline Director 42 May 5, 2018 May 6, 2017 $ 627.9 433.2 1,251.6 126.8 20.9 15.2 20.4 2,496.0 80.6 – 571.8 34.1 2,787.3 93.9 842.0 1,001.9 754.4 $ 207.3 413.6 1,322.2 117.5 25.5 31.9 48.5 2,166.5 82.1 25.1 648.4 43.3 3,033.3 103.0 880.5 1,003.4 709.9 $ 8,662.0 $ 8,695.5 $ $ 2,253.8 53.5 127.6 527.4 2,962.3 129.3 1,139.5 158.6 361.2 141.3 4,892.2 2,039.5 22.9 1,627.9 12.5 3,702.8 67.0 3,769.8 2,230.2 38.4 88.1 134.0 2,490.7 105.8 1,736.8 141.7 374.0 143.8 4,992.8 2,034.4 25.3 1,572.8 11.7 3,644.2 58.5 3,702.7 $ 8,662.0 $ 8,695.5 Annual Report 2018 CONSOLIDATED STATEMENTS OF EARNINGS 52 Weeks Ended (in millions of Canadian dollars, except share and per share amounts) Sales Other income (NOTE 19) Share of earnings from investments, at equity (NOTE 7) Operating expenses Cost of sales Selling and administrative expenses Operating income Finance costs, net (NOTE 21) Earnings before income taxes Income tax expense (NOTE 13) Net earnings Earnings for the year attributable to: Non-controlling interest Owners of the Company Earnings per share (NOTE 22) Basic Diluted Weighted average number of common shares outstanding, in millions (NOTE 22) Basic Diluted See accompanying notes to the consolidated ﬁ nancial statements. May 5, 2018 May 6, 2017 $ 24,214.6 61.2 74.3 $ 23,806.2 48.2 77.5 18,314.1 5,689.5 346.5 18,099.0 5,499.9 333.0 110.5 236.0 56.2 179.8 20.3 159.5 179.8 0.59 0.59 271.8 272.1 $ $ $ $ $ $ $ $ $ $ 118.0 215.0 42.5 172.5 14.0 158.5 172.5 0.58 0.58 271.9 272.0 43 Empire Company Limited CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME 52 Weeks Ended (in millions of Canadian dollars) Net earnings Other comprehensive income (loss) Items that will be reclassiﬁ ed subsequently to net earnings Unrealized gains (losses) on derivatives designated as cash ﬂ ow hedges (net of taxes of $(0.3) (2017 – $0.2)) Unrealized (losses) gains on available for sale ﬁ nancial assets (net of taxes of $0.2 (2017 – $(0.1))) Share of other comprehensive income of investments, at equity (net of taxes of $(0.9) (2017 – $(0.2))) Exchange differences on translation of foreign operations (net of taxes of $(0.4) (2017 – $0.6)) Items that will not be reclassiﬁ ed subsequently to net earnings Actuarial gains (losses) on deﬁ ned beneﬁ t plans (net of taxes of $(4.9) (2017 – $7.9)) (NOTE 17) Total comprehensive income Total comprehensive income for the year attributable to: Non-controlling interest Owners of the Company See accompanying notes to the consolidated ﬁ nancial statements. May 5, 2018 May 6, 2017 $ 179.8 $ 172.5 1.2 (0.8) 2.0 (1.6) 0.8 9.6 190.2 20.3 169.9 190.2 $ $ $ $ $ $ (0.7) 0.3 0.5 1.7 1.8 (20.8) 153.5 14.0 139.5 153.5 44 Annual Report 2018 CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUIT Y (in millions of Canadian dollars) Accumulated Other Contributed Comprehensive Income Surplus Total Attributable to Owners of the Company Retained Earnings Capital Stock Non- controlling Interest Total Equity $ 2,045.1 $ 9.9 $ 1,546.4 $ 3,623.9 $ Balance at May 7, 2016 Dividends declared on common shares Equity based compensation, net Acquisition of shares held in trust (NOTE 18) Capital transactions with structured entities Transactions with owners Net earnings Other comprehensive loss Total comprehensive income for the year – – (10.7) – (10.7) – – – 22.5 $ – 2.8 – – 2.8 – – – – – – – – – 1.8 1.8 (111.3) – – – (111.3) 158.5 (20.8) 137.7 (111.3) 2.8 (10.7) 59.1 $ 3,683.0 (111.3) 2.8 (10.7) – – – – (14.6) (14.6) (119.2) 158.5 (19.0) 139.5 (14.6) (133.8) 14.0 – 14.0 172.5 (19.0) 153.5 Balance at May 6, 2017 $ 2,034.4 $ 25.3 $ 11.7 $ 1,572.8 $ 3,644.2 $ 58.5 $ 3,702.7 Dividends declared on common shares Equity based compensation, net Shares held in trust, net (NOTE 18) Capital transactions with structured entities Transactions with owners Net earnings Other comprehensive income Total comprehensive income for the year – 0.4 4.7 – 5.1 – – – – (2.4) – – (2.4) – – – – – – – – – 0.8 0.8 (114.0) – – (114.0) (2.0) 4.7 – – (114.0) (111.3) 159.5 9.6 169.1 159.5 10.4 169.9 – – – (11.8) (11.8) 20.3 – 20.3 (114.0) (2.0) 4.7 (11.8) (123.1) 179.8 10.4 190.2 Balance at May 5, 2018 $ 2,039.5 $ 22.9 $ 12.5 $ 1,627.9 $ 3,702.8 $ 67.0 $ 3,769.8 See accompanying notes to the consolidated ﬁ nancial statements. 45 Empire Company Limited CONSOLIDATED STATEMENTS OF CASH FLOWS 52 Weeks Ended (in millions of Canadian dollars) Operations Net earnings Adjustments for: Depreciation Income tax expense Finance costs, net (NOTE 21) Amortization of intangibles Net gain on disposal of assets Impairment of non-ﬁ nancial assets, net Amortization of deferred items Equity in earnings of other entities, net of distributions received Employee future beneﬁ ts Increase in long-term lease obligation Increase (decrease) in long-term provisions Equity based compensation, net Net change in non-cash working capital Income taxes paid, net Cash ﬂ ows from operating activities Investment Increase in investments Property, equipment and investment property purchases Proceeds on disposal of assets Additions to intangibles Loans and other receivables Tenant inducements Other assets and other long-term liabilities Business acquisitions Interest received Proceeds on redemption of investment Cash ﬂ ows used in investing activities Financing Issue of long-term debt Repayment of long-term debt Net repayment of credit facilities Interest paid Acquisition of shares held in trust (NOTE 18) Dividends paid, common shares Non-controlling interest Cash ﬂ ows used in ﬁ nancing 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 ﬁ nancial statements. 46 May 5, 2018 May 6, 2017 $ 179.8 $ 172.5 351.8 56.2 110.5 87.4 (37.3) 9.2 7.2 69.1 1.5 11.2 15.8 6.9 88.1 (77.7) 879.7 – (239.8) 217.2 (48.2) 6.1 – 2.9 (3.8) 1.9 24.3 (39.4) 63.7 (188.2) (81.9) (87.4) (0.1) (114.0) (11.8) (419.7) 420.6 207.3 355.5 42.5 118.0 88.7 (21.3) 27.5 12.8 19.9 8.5 13.9 (35.4) 3.3 0.5 (98.4) 708.5 (0.4) (460.7) 425.7 (53.8) 12.3 58.8 2.7 (21.9) 1.6 – (35.7) 55.6 (397.2) (165.0) (87.0) (10.7) (111.3) (14.6) (730.2) (57.4) 264.7 $ 627.9 $ 207.3 Annual Report 2018 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS May 5, 2018 (in millions of Canadian dollars, except share and per share amounts) 1. Reporting entity Empire Company Limited (“Empire” or the “Company”) is a Canadian company whose key businesses are food retailing and related real estate. The Company is incorporated in Canada and the address of its registered ofﬁ ce of business is 115 King Street, Stellarton, Nova Scotia, B0K 1S0, Canada. The consolidated ﬁ nancial statements for the period ended May 5, 2018 include the accounts of Empire, all subsidiary companies, including 100% owned Sobeys Inc. (“Sobeys”), and certain enterprises considered structured entities (“SEs”), where control is achieved on a basis other than through ownership of a majority of voting rights. Investments in which the Company has signiﬁ cant inﬂ uence and its joint ventures are accounted for using the equity method. As at May 5, 2018 the Company’s business operations were conducted through its two reportable segments: Food retailing and Investments and other operations, as further described in Note 25, Segmented Information. The Company’s Food retailing business is affected by seasonality and the timing of holidays. Retail sales are traditionally higher in the Company’s ﬁ rst quarter. The Company’s ﬁ scal year ends on the ﬁ rst Saturday in May. 2. Basis of preparation STATEMENT OF COMPLIANCE The consolidated ﬁ nancial statements have been prepared in accordance with International Financial Reporting Standards (“IFRS” or “GAAP”) as issued by the International Accounting Standards Board (“IASB”). The consolidated ﬁ nancial statements were authorized for issue by the Board of Directors on June 27, 2018. BASIS OF MEASUREMENT The consolidated ﬁ nancial statements are prepared on the historical cost basis, except the following assets and liabilities which are stated at their fair value: ﬁ nancial instruments (including derivatives) at fair value through proﬁ t and loss (“FVTPL”), ﬁ nancial instruments classiﬁ ed as available for sale and cash settled stock-based compensation plans. Assets held for sale are stated at the lower of their carrying amount and fair value less costs to sell. USE OF ESTIMATES AND JUDGMENTS The preparation of the consolidated ﬁ nancial statements requires management to make judgments, estimates and assumptions that affect the amounts reported on the consolidated ﬁ nancial statements and accompanying notes. Estimates and underlying assumptions are reviewed on an ongoing basis. Revisions to accounting estimates are recognized in the period in which the estimates are revised and in any future periods affected. The Company has applied judgment in its assessment of the appropriateness of consolidation of SEs, the appropriateness of equity accounting for its investments in associates and joint ventures, the classiﬁ cation of leases and ﬁ nancial instruments, the level of componentization of property and equipment, the determination of cash generating units (“CGUs”), the identiﬁ cation of indicators of impairment for property and equipment, investment property, intangible assets and goodwill, the recognition and measurement of assets acquired and liabilities assumed, and the recognition of provisions. Estimates, judgments and assumptions that could have a signiﬁ cant impact to the amounts recognized on the consolidated ﬁ nancial statements are summarized below. Estimates are based on management’s best knowledge of current events and actions the Company may undertake in the future. Actual results could differ from these estimates. (A) INVENTORIES Inventories are valued at the lower of cost and estimated net realizable value. Signiﬁ cant estimation or judgment is required in the determination of (i) estimated inventory provisions associated with vendor allowances and internal charges; (ii) estimated inventory provisions due to spoilage and shrinkage occurring between the last physical inventory count and the balance sheet dates; and (iii) inventories valued at retail and adjusted to cost. (B) IMPAIRMENT Management assesses impairment of non-ﬁ nancial assets such as investments in associates and joint ventures, goodwill, intangible assets, property and equipment, and investment property. In assessing impairment, management estimates the recoverable amount of each asset or CGU based on expected future cash ﬂ ows. When measuring expected future cash ﬂ ows, management makes assumptions about future growth of proﬁ ts which relate to future events and circumstances. Actual results could vary from these estimated future cash ﬂ ows. Estimation uncertainty relates to assumptions about future operating results and the application of an appropriate discount rate. Impairment losses and reversals are disclosed on the consolidated ﬁ nancial statements in Notes 9, 10, 11 and 12. 47 Empire Company Limited NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Goodwill is subject to impairment testing on an annual basis. The Company performed its annual assessment of goodwill impairment during its third quarter. However, if indicators of impairment are present, the Company will review goodwill for impairment when such indicators arise. In addition, at each reporting period, the Company reviews whether there are indicators that the recoverable amount of long-lived assets may be less than their carrying amount. Goodwill and long-lived assets were reviewed for impairment by determining the recoverable amount of each CGU or groups of CGUs to which the goodwill or long-lived assets relate. Management estimated the recoverable amount of the CGUs based on the higher of value-in-use (“VIU”) and fair value less costs of disposal (“FVLCD”). The VIU calculations are based on expected future cash ﬂ ows. When measuring expected future cash ﬂ ows, management makes key assumptions about future growth of proﬁ ts which relate to future events and circumstances. Estimation uncertainty relates to assumptions about future operating results and the application of an appropriate discount rate. Actual results could vary from these estimates which may cause signiﬁ cant adjustments to the Company’s goodwill or long-lived assets in subsequent reporting periods. (C) EMPLOYEE FUTURE BENEFITS Accounting for the costs of deﬁ ned beneﬁ t pension plans and other post-employment beneﬁ ts requires the use of a number of assumptions. Pension obligations are based on current market conditions and actuarial determined data such as medical cost trends, mortality rates, and future salary increases. A sensitivity analysis and more detail of key assumptions used in measuring the pension and post-employment beneﬁ t obligations are disclosed in Note 17. (D) INCOME TA XES Assumptions are applied when management assesses the timing and reversal of temporary differences and estimates the Company’s future earnings to determine the recognition of current and deferred income taxes. Judgments are also made by management when interpreting the tax rules in jurisdictions where the Company operates. Note 13 details the current and deferred income tax expense and deferred tax assets and liabilities. (E) BUSINESS ACQUISITIONS For business acquisitions, the Company applies judgment on the recognition and measurement of assets acquired and liabilities assumed, and estimates are utilized to calculate and measure such adjustments. In measuring the fair value of an acquiree’s assets and liabilities management uses estimates about future cash ﬂ ows and discount rates. Any measurement changes after initial recognition would affect the measurement of goodwill. (F) PROVISIONS Estimates and assumptions are used to calculate provisions when the Company estimates the expected future cash ﬂ ows relating to the obligation and applies an appropriate discount rate. (G) SUPPLY AGREEMENTS The Company has various long-term supply agreements for products, some of which contain minimum volume purchases. Signiﬁ cant estimation and judgment is required in the determination of (i) future operating results; and (ii) forecasted purchase volumes. When measuring whether a provision is required based on the expected future cash ﬂ ows associated with fulﬁ lling the contract, management makes assumptions which relate to future events and circumstances. Actual results could vary from these estimated future cash ﬂ ows. 3. Summary of significant accounting policies (A) BASIS OF CONSOLIDATION The ﬁ nancial statements for the Company include the accounts of the Company and all of its subsidiary undertakings up to the reporting date. Subsidiaries, including SEs, are all entities the Company controls. All subsidiaries have a reporting date within six weeks of the Company’s reporting date. Where necessary, adjustments have been made to reﬂ ect transactions between the reporting dates of the Company and its subsidiaries. Control exists when the Company has existing rights that give it the current ability to direct the activities that signiﬁ cantly affect the entity’s returns. The Company reassesses control on an ongoing basis. 48 Annual Report 2018 SEs are entities controlled by the Company which were designed so that voting or similar rights are not the dominant factor in deciding who controls the entity. SEs are consolidated if, based on an evaluation of the substance of its relationship with the Company, the Company concludes that it controls the SE. SEs controlled by the Company were established under terms that impose strict limitations on the decision making powers of the SEs management and that results in the Company receiving the majority of the beneﬁ ts related to the SEs operations and net assets, being exposed to the majority of risks incident to the SEs activities, and retaining the majority of the residual or ownership risks related to the SEs or their assets. All intercompany transactions, balances, income and expenses are eliminated in preparing the consolidated ﬁ nancial statements. Earnings or losses and other comprehensive income or losses of subsidiaries acquired or disposed of during the period are recognized from the effective date of acquisition, or up to the effective date of disposal, as applicable. Non-controlling interest represents the portion of a subsidiary’s earnings and losses and net assets that is not held by the Company. If losses in a subsidiary applicable to a non-controlling interest exceed the non-controlling interest in the subsidiary’s equity, the excess is allocated to the non-controlling interest except to the extent that the majority has a binding obligation and is able to cover the losses. (B) BUSINESS ACQUISITIONS Business acquisitions are accounted for by applying the acquisition method. The acquisition method involves the recognition of the acquiree’s identiﬁ able assets and liabilities, including contingent liabilities, regardless of whether they were recorded on the ﬁ nancial statements prior to acquisition. The acquiree’s identiﬁ able assets, liabilities, and contingent liabilities that meet the conditions for recognition under IFRS 3, “Business combinations”, are recognized at their fair value at the acquisition date, except for: (i) deferred tax assets or liabilities and liabilities or assets related to employee beneﬁ t arrangements which are recognized and measured in accordance with International Accounting Standard (“IAS”) 12, “Income taxes”, and IAS 19, “Employee beneﬁ ts”, respectively; and (ii) assets (or disposal groups) that are classiﬁ ed as held for sale in accordance with IFRS 5, “Non-current assets held for sale and discontinued operations”, which are measured and recognized at fair value less costs to sell. Goodwill arising on acquisition is recognized as an asset and represents the excess of acquisition cost over the fair value of the Company’s share of the identiﬁ able net assets of the acquiree at the date of the acquisition. Any excess of identiﬁ able net assets over the acquisition cost is recognized in net earnings or loss immediately after acquisition. Transaction costs related to the acquisition are expensed as they are incurred. (C) FOREIGN CURRENCY TRANSLATION Assets and liabilities of foreign operations with a different functional currency than the Company are translated at exchange rates in effect at each reporting period end date. The revenues and expenses are translated at average exchange rates for the period. Cumulative gains and losses on translation are shown in accumulated other comprehensive income or loss. Monetary assets and liabilities denominated in foreign currencies are translated into Canadian dollars at the foreign currency exchange rate in effect at each reporting period end date. Non-monetary items are translated at the historical exchange rate at the date of transaction. Exchange gains or losses arising from the translation of these balances denominated in foreign currencies are recognized in operating income or loss. Revenues and expenses denominated in foreign currencies are translated into Canadian dollars at the average foreign currency exchange rate for the period. (D) CASH AND CASH EQUIVALENTS Cash and cash equivalents are deﬁ ned as cash and guaranteed investments with a maturity less than 90 days at date of acquisition. (E) INVENTORIES 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 retail method. The retail method uses the anticipated selling price less normal proﬁ t margins, on a weighted average cost basis. 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 ﬂ uctuations 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 not estimated to 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 speciﬁ cally excluded from the cost of inventories and are expensed in the period incurred. 49 Empire Company Limited NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (F) INCOME TA XES Tax expense recognized in net earnings or loss comprises the sum of deferred income tax and current income tax not recognized in other comprehensive income or loss. Current income tax assets and liabilities are comprised of claims from, or obligations to, ﬁ scal authorities relating to the current or prior reporting periods, that are unpaid at the reporting date. Current tax is payable on taxable earnings, which differs from net earnings or loss on the consolidated ﬁ nancial statements. The calculation of current income tax is based on tax rates and tax laws that have been enacted or substantively enacted at the end of the reporting period. Deferred income taxes are calculated using the asset and liability method on temporary differences between the carrying amounts of assets and liabilities and their related tax bases. However, deferred tax is not provided on the initial recognition of goodwill or on the initial recognition of an asset or liability unless the related transaction is a business acquisition or affects tax or accounting proﬁ t. The deferred tax assets and liabilities have been measured using substantively enacted tax rates that will be in effect when the amounts are expected to settle. Deferred tax assets are only recognized to the extent that it is probable that they will be able to be utilized against future taxable income. The assessment of the probability of future taxable income in which deferred tax assets can be utilized is based on the Company’s latest approved forecast, which is adjusted for signiﬁ cant non-taxable income and expenses and speciﬁ c limits to the use of any unused tax loss or credit. If a positive forecast of taxable income indicates the probable use of a deferred tax asset, especially when it can be used without a time limit, that deferred tax asset is usually recognized in full. The recognition of deferred tax assets that are subject to certain legal or economic limits or uncertainties are assessed individually by management based on the speciﬁ c facts and circumstances. Deferred tax assets and liabilities are offset only when the Company has a right and intention to offset current tax assets and liabilities from the same taxation authority. Changes in deferred tax assets or liabilities are recognized as a component of income or expense in net earnings or loss, except where they relate to items that are recognized in other comprehensive income or loss (such as the unrealized gains and losses on cash ﬂ ow hedges) or directly in equity. (G) ASSETS HELD FOR SALE Certain property and equipment have been listed for sale and reclassiﬁ ed as assets held for sale on the consolidated balance sheets. These assets are expected to be sold within a twelve month period. Assets held for sale are valued at the lower of carrying value and fair value less costs to sell. (H) INVESTMENTS IN ASSOCIATES Associates are those entities over which the Company is able to exert signiﬁ cant inﬂ uence but which it does not control and which are not interests in a joint venture. Control is reassessed on an ongoing basis. Investments in associates are initially recognized at cost and subsequently accounted for using the equity method. Acquired investments in associates are also subject to the acquisition method as explained above. However, any goodwill or fair value adjustment attributable to the Company’s share in the associate is included in the amount recognized as investments in associates. All subsequent changes to the Company’s share of interest in the equity of the associate are recognized in the carrying amount of the investment. Changes resulting from the earnings or losses generated by the associate are reported within share of earnings from investments, at equity on the Company’s consolidated statements of earnings or loss. These changes include subsequent depreciation, amortization or impairment of the fair value adjustments of assets and liabilities. Changes resulting from earnings of the associate or items recognized directly in the associate’s equity are recognized in earnings or losses or equity of the Company, as applicable. However, when the Company’s share of losses in an associate equals or exceeds its interest in the associate, including any unsecured receivables, the Company does not recognize further losses, unless it has incurred legal or constructive obligations or made payments on behalf of the associate. If the associate subsequently reports earnings, the Company resumes recognizing its share of those earnings only after its share of the earnings exceeds the accumulated share of losses that had previously not been recognized. Unrealized gains and losses on transactions between the Company and its associates are eliminated to the extent of the Company’s interest in those entities. Where unrealized losses are eliminated, the underlying asset is also tested for impairment losses from a Company perspective. At each reporting period end date, the Company assesses whether there are any indicators of impairment in its investment in associates. For investments in publicly traded entities, carrying value of the investment is compared to the current market value of the investment based on its quoted price at the balance sheet date. For entities which are not publicly traded, value-in-use of the investment is determined by estimating the Company’s share of the present value of the estimated cash ﬂ ows expected to be generated by the investee. If impaired, the carrying value of the Company’s investment is written down to its estimated recoverable amount, being the higher of fair value less cost to sell and value-in-use. 50 Annual Report 2018 In the process of measuring future cash ﬂ ows, management makes assumptions about future growth of proﬁ ts. These assumptions relate to future events and circumstances. The actual results may vary and may cause signiﬁ cant adjustments to the Company’s investments in associates in the subsequent ﬁ nancial years. Each of the associates identiﬁ ed by the Company has a reporting year end of December 31. For purposes of the Company’s consolidated year end ﬁ nancial statements, each of the associates’ results are included based on ﬁ nancial statements prepared as at March 31, with any changes occurring between March 31 and the Company’s year end that would materially affect the results being taken into account. (I) INVESTMENTS IN JOINT VENTURES Investments in joint ventures are joint arrangements whereby the Company and the other parties to the arrangements have joint control and therefore have rights to the net assets of the arrangement. Investments in joint ventures are initially recognized at cost and subsequently accounted for using the equity method. (J) FINANCIAL INSTRUMENTS Financial instruments are recognized on the consolidated balance sheets when the Company becomes a party to the contractual provisions of a ﬁ nancial instrument. The Company is required to initially recognize all of its ﬁ nancial assets and liabilities, including derivatives and embedded derivatives in certain contracts, at fair value. Loans and receivables, held to maturity ﬁ nancial assets and other ﬁ nancial liabilities are subsequently measured at amortized cost. Derivatives and non-ﬁ nancial derivatives must be recorded at fair value on the consolidated balance sheets unless they are exempt from derivative treatment based upon expected purchase, sale or usage requirements. The Company classiﬁ es ﬁ nancial assets and liabilities according to their characteristics and management’s choices and intentions related thereto for the purpose of ongoing measurements. Classiﬁ cation choices for ﬁ nancial assets include: (i) FVTPL – measured at fair value with changes in fair value recorded in net earnings or loss; (ii) held to maturity – recorded at amortized cost with gains and losses recognized in net earnings or loss in the period that the asset is derecognized or impaired; (iii) available for sale – measured at fair value with changes in fair value recognized in other comprehensive income or loss for the current period until realized through disposal or impairment; and (iv) loans and receivables – recorded at amortized cost with gains and losses recognized in net earnings or loss in the period that the asset is no longer recognized or impaired. Classiﬁ cation choices for ﬁ nancial liabilities include: (i) FVTPL – measured at fair value with changes in fair value recorded in net earnings or loss and (ii) other liabilities – measured at amortized cost with gains and losses recognized in net earnings or loss in the period that the liability is derecognized. The Company’s ﬁ nancial assets and liabilities are generally classiﬁ ed and measured as follows: Asset/Liability Cash and cash equivalents Receivables Loans and other receivables Investments Derivative ﬁ nancial assets and liabilities Non-derivative other assets Accounts payable and accrued liabilities Long-term debt Classiﬁ cation Loans and receivables Loans and receivables Loans and receivables Available for sale FVTPL FVTPL Other liabilities Other liabilities Measurement Amortized cost Amortized cost Amortized cost Fair value Fair value Fair value Amortized cost Amortized cost All ﬁ nancial assets are reviewed for impairment at each reporting date, except those classiﬁ ed as FVTPL. Loans and receivables are reviewed for past due balances from independent accounts and based on an evaluation of recoverability net of security assigned for franchisee or afﬁ liate locations. Transaction costs other than those related to ﬁ nancial instruments classiﬁ ed as FVTPL, which are expensed as incurred, are added to or deducted from the fair value of the ﬁ nancial asset or ﬁ nancial liability, as appropriate, on initial recognition and amortized using the effective interest method. Fair value determination is classiﬁ ed within a three-level hierarchy, based on observability of signiﬁ cant inputs, as follows: Level 1 – quoted prices (unadjusted) in active markets for identical assets or liabilities; Level 2 – inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly; or Level 3 – unobservable inputs for the asset or liability. Inputs into the determination of the fair value require management judgment or estimation. If different levels of inputs are used to measure a ﬁ nancial instrument’s fair value, the classiﬁ cation within the hierarchy is based on the lowest level of input that is signiﬁ cant to the fair value measurement. Changes to valuation methods may result in transfers into or out of an investment’s assigned level. 51 Empire Company Limited NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS A ﬁ nancial asset is derecognized when the contractual rights to the cash ﬂ ows from the ﬁ nancial asset expire or if the Company transfers the ﬁ nancial asset to another party without retaining control or substantially all the risks and rewards of ownership of the ﬁ nancial asset. A ﬁ nancial liability is derecognized when its contractual obligations are discharged, cancelled or expire. (K) HEDGES The Company has cash ﬂ ow hedges which are used to manage exposure to ﬂ uctuations in foreign currency exchange and energy prices. For cash ﬂ ow hedges, the effective portion of the change in fair value of the hedging item is recorded in other comprehensive income or loss. To the extent the change in fair value of the derivative does not completely offset the change in fair value of the hedged item, the ineffective portion of the hedging relationship is recorded in net earnings or loss. Amounts accumulated in other comprehensive income or loss are reclassiﬁ ed to net earnings or loss when the hedged item is recognized in net earnings or loss. When a hedging instrument in a cash ﬂ ow 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 or loss relating to the hedge is carried forward until the hedged item is recognized in net earnings or loss. 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 or loss is immediately reclassiﬁ ed to net earnings or loss. Financial derivatives assigned as part of a cash ﬂ ow hedging relationship are classiﬁ ed as either an other asset or other long-term liability as required based on their fair value determination. Signiﬁ cant derivatives include the following: (i) Foreign currency forward contracts and foreign currency swaps for the primary purpose of limiting exposure to exchange rate ﬂ uctuations relating to the purchase of goods or expenditures denominated in foreign currencies. Certain of these contracts are designated as hedging instruments for accounting purposes. Accordingly, the effective portion of the change in the fair value of the contracts is accumulated in other comprehensive income or loss until the variability in cash ﬂ ows being hedged is recognized in earnings or loss in future accounting periods. (ii) Electricity forward contracts for the primary purpose of limiting exposure to ﬂ uctuations in the market prices of electricity. These contracts are designated as hedging instruments for accounting purposes. Accordingly, the effective portion of the change in fair value of the contracts is accumulated in other comprehensive income or loss until the variability in cash ﬂ ows being hedged is recognized in earnings or loss in future accounting periods. (iii) Natural gas forward contracts for the primary purpose of limiting exposure to ﬂ uctuations in the market prices of natural gas. These contracts are designated as hedging instruments for accounting purposes. Accordingly, the effective portion of the change in fair value of the contracts is accumulated in other comprehensive income or loss until the variability in cash ﬂ ows being hedged is recognized in earnings or loss in future accounting periods. (L) PROPERT Y AND EQUIPMENT Owner-occupied land, buildings, equipment, leasehold improvements, and assets under construction are carried at acquisition cost less accumulated depreciation and impairment losses. Buildings that are leasehold property are also included in property and equipment if they are classiﬁ ed as a ﬁ nance lease. Such assets are depreciated over their expected useful lives (determined by reference to comparable owned assets) or over the term of the lease, if shorter. When signiﬁ cant parts of property and equipment have different useful lives, they are accounted for as separate components. Depreciation is recorded on a straight-line basis from the time the asset is available or when assets under construction become available for use over the estimated useful lives of the assets as follows: Buildings Equipment Leasehold improvements 10 – 40 years 3 – 20 years Lesser of lease term and 7 – 20 years Depreciation has been included within selling and administrative expenses on the consolidated statements of earnings. Material residual value estimates and estimates of useful life are reviewed and updated as required, or annually at a minimum. Gains or losses arising on the disposal of property and equipment are determined as the difference between the disposal proceeds and the carrying amount of the assets and are recognized in net earnings or loss within other income. If the sale is to a Company’s investment, at equity, a portion of the gain or loss is deferred and reduces the carrying value of the investment. 52 Annual Report 2018 (M) INVESTMENT PROPERT Y Investment properties are properties which are held either to earn rental income or for capital appreciation or for both, rather than for the principal purpose of the Company’s operating activities. Investment properties are accounted for using the cost model. The depreciation policies for investment property are consistent with those described for property and equipment. Any gain or loss arising from the sale of an investment property is immediately recognized in net earnings or loss, unless the sale is to an investment, at equity, in which case a portion of the gain or loss is deferred and would reduce the carrying value of the Company’s investment. Rental income and operating expenses from investment property are reported within other income and selling and administrative expenses, respectively, on the consolidated statements of earnings. (N) LEASES Leases are classiﬁ ed as ﬁ nance leases whenever the terms of the lease transfer substantially all the risks and rewards of ownership to the lessee. All other leases are classiﬁ ed as operating leases. (i) The Company as lessor Rental income from operating leases is recognized on a straight-line basis over the term of the relevant lease. Initial direct costs incurred in negotiating and arranging an operating lease are added to the carrying amount of the leased asset and recognized on a straight-line basis over the lease term. (ii) The Company as lessee Assets held under ﬁ nance leases are initially recognized as assets of the Company at their fair value at the inception of the lease or, if lower, at the present value of the minimum lease payments. The corresponding liability to the lessor is included on the consolidated balance sheets as a ﬁ nance lease obligation in long-term debt. Lease payments are apportioned between ﬁ nance charges and reduction of the lease obligation to achieve a constant rate of interest on the remaining balance of the liability. Finance charges are recognized in net earnings or loss immediately. Contingent rentals are recognized as expenses in the periods in which they are incurred. Lease allowances and incentives are recognized as other long-term liabilities. The aggregate beneﬁ t of incentives is recognized as a reduction of rental expense on a straight-line basis over the term of the lease. Real estate lease expense is amortized on a straight-line basis over the entire term of the lease. (iii) Sale and leaseback transactions A sale and leaseback transaction involves the sale of an asset and the leasing back of the same asset. If a sale and leaseback transaction results in a ﬁ nance lease for the Company, any excess of sales proceeds over the carrying amount is recognized as deferred revenue and amortized over the term of the new lease. Any proﬁ t or loss in a sale and leaseback transaction resulting in an operating lease that is transacted at fair value is recognized immediately. If the sale price is above fair value, the excess over fair value is deferred and amortized over the term of the new lease. (O) INTANGIBLES Intangibles arise on the purchase of a new business, existing franchises, software, and the acquisition of pharmacy prescription ﬁ les. They are accounted for using the cost model whereby capitalized costs are amortized on a straight-line basis over their estimated useful lives, as these assets are considered ﬁ nite. Useful lives are reviewed annually and intangibles are subject to impairment testing. The following useful lives are applied: Deferred purchase agreements Franchise rights/agreements Lease rights Off market leases Prescription ﬁ les Software Other 5 – 10 years 10 years 5 – 10 years Lesser of lease term and 40 years 15 years 3 – 7 years 5 – 10 years Amortization has been included within selling and administrative expenses on the consolidated statements of earnings. Subsequent expenditures made by the Company relating to intangible assets that do not meet the capitalization criteria are expensed in the period incurred. Included in intangibles are brand names, loyalty programs, and private labels, the majority of which have indeﬁ nite useful lives. Intangibles with indeﬁ nite useful lives are measured at cost less any accumulated impairment losses. These intangibles are tested for impairment on an annual basis or more frequently if there are indicators that intangibles may be impaired. 53 Empire Company Limited NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (P) GOODWILL Goodwill represents the excess of the purchase price of the business acquired over the fair value of the underlying net tangible and intangible assets acquired at the date of acquisition. (Q) IMPAIRMENT OF NON-FINANCIAL ASSETS Goodwill and indeﬁ nite life intangibles are reviewed for impairment at least annually by assessing the recoverable amount of each CGU or groups of CGUs to which the goodwill or indeﬁ nite life intangible relates. The recoverable amount is the higher of FVLCD and VIU. When the recoverable amount of the CGU(s) is less than the carrying amount, an impairment loss is recognized immediately in net earnings or loss. Impairment losses related to goodwill cannot be reversed. Long-lived tangible and intangible assets are reviewed each reporting period for impairment when events or changes in circumstances indicate that the carrying value of the assets may not be recoverable. If such an indication exists, the recoverable amount of the asset is estimated in order to determine the extent of the impairment loss (if any). The recoverable amount is the higher of FVLCD and VIU. Where the asset does not generate cash ﬂ ows that are independent from other assets, the Company estimates the recoverable amount of the CGU(s) to which the asset belongs. The Company has determined a CGU to be primarily an individual store. Corporate assets such as head ofﬁ ces and distribution centres do not individually generate separate cash inﬂ ows and are therefore aggregated for testing with the stores they service. When the recoverable amount of an asset (or CGU) is estimated to be less than its carrying amount, the carrying amount of the asset (or CGU) is reduced to the recoverable amount. An impairment loss is recognized immediately in selling and administrative expenses on the consolidated statements of earnings. Where an impairment loss subsequently reverses, other than related to goodwill, the carrying amount of the asset (or CGU) is increased to the revised estimate, but is limited to the carrying amount that would have been determined if no impairment loss had been recognized in prior years. A reversal of impairment loss is recognized immediately in net earnings or loss. (R) CUSTOMER LOYALT Y PROGRAMS The AIR MILES® loyalty program is used by the Company. AIR MILES® are earned by Sobeys customers based on purchases in stores. The Company pays a per point fee under the terms of the agreement with AIR MILES®. (S) PROVISIONS Provisions are recognized when there is a present legal or constructive obligation as a result of a past event, for which it is probable that a transfer of economic beneﬁ ts will be required to settle the obligation, and where a reliable estimate can be made of the amount of the obligation. Provisions are discounted using a pre-tax discount rate that reﬂ ects the current market assessments of the time value of money and the risks speciﬁ c to the liability, if material. Where discounting is used, the increase in the provision due to passage of time (“unwinding of the discount”) is recognized within ﬁ nance costs, net on the consolidated statements of earnings. (T) BORROWING COSTS Borrowing costs are primarily comprised of interest on the Company’s debts. Borrowing costs directly attributable to the acquisition, construction or production of a qualifying asset are capitalized as a component of the cost of the asset to which it is related. All other borrowing costs are expensed in the period in which they are incurred and are reported within ﬁ nance costs. (U) DEFERRED REVENUE Deferred revenue consists of long-term supplier purchase agreements and gains on sale and leaseback transactions relating to certain ﬁ nance leases. Deferred revenue is included in other long-term liabilities and is taken into income on a straight-line basis over the term of the related agreements. (V) EMPLOYEE BENEFITS (i) Short-term employment beneﬁ ts Short-term employee beneﬁ ts include wages, salaries, compensated absences, proﬁ t-sharing and bonuses expected to be settled within 12 months from the end of the reporting period. Short-term employee beneﬁ ts are measured on an undiscounted basis and are recorded as selling and administrative expenses as the related service is provided. (ii) Post-employment beneﬁ ts The cost of the Company’s pension beneﬁ ts for deﬁ ned contribution plans are expensed at the time active employees are compensated. The cost of deﬁ ned beneﬁ t pension plans and other beneﬁ t plans is accrued based on actuarial valuations, which are determined using the projected unit credit method pro-rated on service and management’s best estimate of salary escalation, and retirement ages. 54 Annual Report 2018 The liability recognized on the consolidated balance sheets for deﬁ ned beneﬁ t plans is the present value of the deﬁ ned beneﬁ t obligation at the reporting date less the fair market value of plan assets. Current market values are used to value beneﬁ t plan assets. The obligation related to employee future beneﬁ ts 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. Re-measurements, comprising of actuarial gains and losses and the return on plan assets (excluding amounts in net interest), are recognized immediately on the consolidated balance sheets with a corresponding charge to retained earnings through other comprehensive income or loss in the period in which they occur. Re-measurements are not reclassiﬁ ed to net earnings or loss in subsequent periods. Past service costs are recognized in net earnings or loss on the earlier of the date of the plan amendment or curtailment, and the date that the Company recognizes restructuring-related costs. Service cost on the net deﬁ ned beneﬁ t liability, comprising current service costs, past-service costs, gains and losses on curtailments and non-routine settlements, is included in selling and administrative expenses. Net interest expense on the net deﬁ ned beneﬁ t liability is included in ﬁ nance costs, net. (iii) Termination beneﬁ ts Termination beneﬁ ts are recognized as an expense at the earlier of when the Company recognizes related restructuring costs and when the Company can no longer withdraw the offer of those beneﬁ ts. (W) REVENUE RECOGNITION Sales are recognized at the point-of-sale. Sales include revenues from customers through corporate stores operated by the Company and consolidated SEs, and revenue from sales to non-SE franchised stores, afﬁ liated stores and independent accounts. Revenue received from non-SE franchised stores, afﬁ liated 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. (X) VENDOR ALLOWANCES The Company receives allowances from certain vendors whose products are purchased for resale. Included in these vendor programs are allowances for volume purchases, exclusivity allowances, listing fees, and other allowances. The Company recognizes these allowances as a reduction of cost of sales and related inventories. Certain allowances are contingent on the Company achieving minimum purchase levels and these allowances are recognized when it is probable that the minimum purchase level will be met, and the amount of allowance can be estimated. (Y) INTEREST AND DIVIDEND INCOME Interest income and expenses are reported on an accrual basis using the effective interest method. Dividend income is recognized when the right to receive payment has been established. (Z) EARNINGS PER SHARE Basic earnings per share is calculated by dividing the earnings available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted earnings per share is calculated by adjusting the weighted average number of common shares outstanding for the dilutive effect of employee stock options and performance share units. When a loss is recorded, the weighted average number of shares used for the purpose of basic and diluted loss per share is equal, as the impact of all potential common shares would be anti-dilutive. (AA) STOCK-BASED COMPENSATION The Company operates both equity and cash settled stock-based compensation plans for certain employees. All goods and services received in exchange for the grant of any stock-based payments are measured at their fair values. Where employees are rewarded using stock-based payments, the fair values of employees’ services are determined indirectly by reference to the fair value of the equity instruments granted (Note 26). 55 Empire Company Limited NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (AB) CHANGES TO ACCOUNTING STANDARDS ADOPTED DURING FISCAL 2018 (i) Statement of cash ﬂ ows In January 2016, the IASB issued Disclosure Initiative Amendments to IAS 7, “Statement of cash ﬂ ows”. These amendments require entities to provide additional disclosures that enable users of ﬁ nancial statements to evaluate changes in liabilities arising from ﬁ nancing activities, including changes arising from cash and non-cash changes. These amendments became effective during the ﬁ rst quarter of ﬁ scal 2018 and had no material impact on the Company’s consolidated ﬁ nancial statements. A reconciliation of long-term debt has been presented in Note 15. (ii) Share-based payment In June 2016, the IASB issued amendments to IFRS 2, “Share-based payment”. The amendments provide clariﬁ cation around the effects of vesting conditions on cash-settled share-based payment transactions, classiﬁ cation of share-based payment transactions with net settlement features and modiﬁ cation of the terms and conditions of a share-based payment that changes the classiﬁ cation of the transaction. These amendments are effective for annual periods beginning on or after January 1, 2018. The Company early adopted these amendments in the ﬁ rst quarter of ﬁ scal 2018. (AC) FUTURE STANDARDS (i) Financial instruments In July 2014, the IASB issued IFRS 9, “Financial instruments” (“IFRS 9”), which replaces IAS 39, “Financial instruments: recognition and measurement” (“IAS 39”) and related interpretations. IFRS 9 provides revised guidance on the classiﬁ cation and measurement of ﬁ nancial assets and ﬁ nancial liabilities, including impairment. IFRS 9 also introduces a new hedge accounting model and amendments to clarify the treatment of modiﬁ cations of ﬁ nancial liabilities. The standard is effective for annual periods beginning on or after January 1, 2018 and is to be applied retrospectively, with the exception of the hedging component which is to be applied prospectively. Early adoption is permitted, however, the Company did not elect to do so. The standard will be applied in ﬁ scal 2019, and the Company does not expect a signiﬁ cant adjustment to its consolidated ﬁ nancial statements as a result of the adoption of this standard, as outlined below. Classiﬁ cation and measurement IFRS 9 requires ﬁ nancial assets to be classiﬁ ed and measured based on both the business model for managing the asset, and the nature of the cash ﬂ ows. The classiﬁ cation and measurement of ﬁ nancial liabilities remains largely unchanged from IAS 39. The application of the new classiﬁ cation requirements under IFRS 9 are not expected to result in a signiﬁ cant adjustment to the Company’s consolidated ﬁ nancial statements. Impairment IFRS 9 introduces a new expected credit loss (“ECL”) impairment model. It is no longer necessary for a triggering event to have occurred before credit losses are recognized. Under the IFRS 9 ECL model, the Company will recognize upfront impairment losses based on past events, current conditions, and reasonable and supportable forecasts affecting collectability. The application of the ECL model under IFRS 9 is not expected to result in a signiﬁ cant adjustment to the Company’s consolidated ﬁ nancial statements. Hedge accounting IFRS 9 introduces a new hedge accounting model that aligns hedge accounting relationships with corresponding risk management activities. The new hedge accounting requirements are not expected to result in a signiﬁ cant adjustment to the Company’s consolidated ﬁ nancial statements. Modiﬁ cation of ﬁ nancial liabilities In October 2017, the IASB issued “Prepayment features with negative compensation” as an amendment to IFRS 9. The amendment clariﬁ es the accounting treatment for modiﬁ cations of ﬁ nancial liabilities and requires a ﬁ nancial liability measured at amortized cost to be remeasured when a modiﬁ cation occurs. Any resulting gain or loss is required to be recognized in proﬁ t or loss at the date of modiﬁ cation. The amendment is effective for annual periods beginning on or after January 1, 2018 and is to be applied retrospectively. The Company does not expect this amendment to result in a signiﬁ cant adjustment to the Company’s consolidated ﬁ nancial statements. Disclosure Financial instrument disclosures continue to fall within the scope of IFRS 7 “Financial instruments: disclosures” (“IFRS 7”). IFRS 7 has been amended by IFRS 9 to include additional qualitative and quantitative disclosure requirements. The Company intends to apply these amendments in ﬁ scal 2019. The amendments are not expected to result in a signiﬁ cant adjustment to the Company’s consolidated ﬁ nancial statement disclosures. 56 Annual Report 2018 (ii) Revenue In May 2014, the IASB issued IFRS 15, “Revenue from contracts with customers” (“IFRS 15”). IFRS 15 replaces IAS 18, “Revenue” (“IAS 18”), IAS 11, “Construction contracts”, and some revenue related interpretations. IFRS 15 establishes a new control-based revenue recognition model and provides a comprehensive framework for recognition, measurement and disclosure of revenue from contracts with customers, excluding contracts within the scope of the standards on leases, insurance contracts and ﬁ nancial instruments. The new standard is effective for annual periods beginning on or after January 1, 2018 and is to be applied retrospectively. Early adoption is permitted, however, the Company did not elect to do so. In April 2016, the IASB published clariﬁ cations to IFRS 15 which addresses three topics (identifying performance obligations, principle versus agent considerations, and licensing) as well as provides some transition relief for modiﬁ ed and completed contracts. The implementation timelines for these clariﬁ cations are consistent with IFRS 15. The Company expects to adopt IFRS 15 in ﬁ scal 2019 on a full retrospective basis and does not expect the implementation to result in a signiﬁ cant adjustment to the Company’s consolidated ﬁ nancial statements. (iii) Leases In January 2016, the IASB issued IFRS 16, “Leases” (“IFRS 16”), which replaces IAS 17, “Leases” (“IAS 17”) and related interpretations. IFRS 16 introduces a balance sheet recognition and measurement model for lessees, eliminating the distinction between operating and ﬁ nance leases. Lessors will continue to classify leases as operating and ﬁ nance leases. The standard is effective for annual periods beginning on or after January 1, 2019. IFRS 16 allows for early adoption for companies that apply IFRS 15, but the Company does not intend to do so. For leases where the Company is the lessee, the IFRS 16 transition requirements provide the option of adopting a full retrospective approach or a modiﬁ ed retrospective approach with optional practical expedients available. The Company has performed preliminary modeling as part of its assessment of IFRS 16 transition approaches, and intends to adopt the standard on a modiﬁ ed retrospective basis. The Company continues to ﬁ nalize its approach on the use of the optional practical expedients. The Company expects that the adoption of IFRS 16 will have a material impact on its consolidated ﬁ nancial statements, given the current operating lease commitments held under IAS 17 as a lessee. New assets and liabilities will be recognized on the balance sheet for the Company’s operating property and equipment leases. On the statement of earnings, the Company will replace the current straight-line lease expense recognized in operating expenses with depreciation for right-of-use assets and ﬁ nance expense on lease liabilities. The presentation of lease related cash ﬂ ows on the statement of cash ﬂ ows will also change, with no change to the amount of cash exchanged as part of the underlying lease transaction. The Company continues to evaluate the impact of this standard on its consolidated ﬁ nancial statements. (iv) Investments in associates and joint ventures In October 2017, the IASB issued an amendment to IAS 28 “Investments in associates and joint ventures” to clarify that an entity must apply IFRS 9 to long-term interests in an associate or joint venture that form part of the net investment in the associate or joint venture where the equity method is not applied. The amendment is effective for annual periods beginning on or after January 1, 2019. The Company is assessing the potential impact of this amendment. (v) Annual improvements 2015–2017 The IASB issued amendments to IFRS 3 “Business combinations”, IFRS 11 “Joint arrangements”, IAS 12 “Income taxes” and IAS 23 “Borrowing costs” in December 2017. These amendments are effective for annual periods beginning on or after January 1, 2019. The Company is assessing the potential impacts of these amendments. 4. Inventories The cost of inventories recognized as an expense during the year was $18,314.1 (2017 – $18,099.0). The Company recorded $1.5 (2017 – $3.5) as an expense for the write-down of inventories below cost to net realizable value for inventories on hand as at May 5, 2018. There were no reversals of inventories written down previously (2017 – $ nil). 57 Empire Company Limited NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 5. Loans and other receivables Loans receivable Notes receivable and other Less amount due within one year May 5, 2018 May 6, 2017 $ $ 64.1 37.4 101.5 20.9 $ 80.6 $ 64.8 42.8 107.6 25.5 82.1 Loans receivable represent long-term ﬁ nancing to certain retail associates. These loans are primarily secured by inventory, ﬁ xtures and equipment; bear various interest rates, and have repayment terms up to 10 years. The carrying amount of the loans receivable approximates fair value based on the variable interest rates charged on the loans. Included in notes receivable and other as at May 5, 2018, is $11.8 (2017 – $13.2) due from a third party related to equipment sales. 6. Assets held for sale As at May 5, 2018, assets held for sale relates to land, buildings and equipment expected to be sold in the next 12 months. These assets were previously used in the Company’s retail and retail support operations. During ﬁ scal 2018, Sobeys sold nine properties to third parties. Total proceeds from these transactions were $56.7, resulting in a pre-tax gain of $8.5 which has been recognized on the consolidated statements of earnings. During ﬁ scal 2017, Sobeys sold 13 properties and leased back four from third parties. Total proceeds from these transactions were $66.9, resulting in a pre-tax gain of $4.5 which has been recognized on the consolidated statements of earnings. On June 29, 2016, Sobeys and its wholly-owned subsidiaries closed an agreement with Crombie Real Estate Investment Trust (“Crombie REIT”), an entity in which the Company has a 41.5% ownership, to sell and leaseback a portfolio of 19 retail properties and a 50% interest in each of its three automated distribution centres, as well as the sale of two parcels of development land which were previously owned by Empire (Note 27). 7. Investments, at equity Investment in associates Crombie REIT Canadian real estate partnerships U.S. real estate partnerships Investment in joint ventures Canadian Digital Cinema Partnership (“CDCP”) Total May 5, 2018 May 6, 2017 $ $ 448.5 90.7 23.2 459.1 143.0 36.8 9.4 9.5 $ 571.8 $ 648.4 The fair value of the investment in Crombie REIT, which is based on a published price quoted on the stock exchange, is as follows: Crombie REIT May 5, 2018 May 6, 2017 $ 777.1 $ 883.6 The Canadian and U.S. real estate partnerships and CDCP are not publicly listed on a stock exchange and hence published price quotes are not available. The Company owns 61,864,162 Class B LP units and attached special voting units of Crombie REIT, along with 909,090 REIT units, representing a 41.5% (2017 – 41.5%) economic and voting interest in Crombie REIT. Crombie REIT has instituted a distribution reinvestment plan (“DRIP”) whereby Canadian resident REIT unitholders may elect to have their distributions automatically reinvested in additional REIT units. The Company is enrolled in the DRIP. 58 Annual Report 2018 The Company’s carrying value of its investment in Crombie REIT is as follows: Balance, beginning of year Equity earnings Share of comprehensive income Distributions, net of DRIP Deferral of gains on sale of property Reversal of deferred gain on sale of property to unrelated party Interest acquired in Crombie REIT Balance, end of year The Company’s carrying value of its investment in Canadian real estate partnerships is as follows: Balance, beginning of year Equity earnings Distributions Balance, end of year The Company’s carrying value of its investment in U.S. real estate partnerships is as follows: Balance, beginning of year Equity earnings Distributions Foreign currency translation adjustment Investment Dilution loss (NOTE 19) Balance, end of year The Company’s carrying value of its investment in CDCP is as follows: Balance, beginning of year Equity earnings Distributions Balance, end of year May 5, 2018 May 6, 2017 $ $ 459.1 39.5 2.9 (43.7) (9.3) – – 366.8 41.5 0.7 (42.8) (2.2) 1.7 93.4 $ 448.5 $ 459.1 May 5, 2018 May 6, 2017 $ $ 143.0 24.6 (76.9) $ 90.7 $ 148.5 28.2 (33.7) 143.0 May 5, 2018 May 6, 2017 $ $ 36.8 9.3 (21.7) (1.2) – – $ 23.2 $ 50.2 6.9 (20.1) 1.1 0.4 (1.7) 36.8 May 5, 2018 May 6, 2017 $ $ $ 9.5 0.9 (1.0) 9.4 $ 9.4 0.9 (0.8) 9.5 The following amounts represent the revenues, expenses, assets, and liabilities of Crombie REIT as at and for the 12 months ended March 31, 2018, as well as a reconciliation of the carrying amount of the Company’s investment in Crombie REIT to the net assets attributable to unitholders of Crombie REIT: Revenues Expenses Earnings before income taxes Income (loss) from continuing operations Other comprehensive income Total comprehensive income (loss) March 31, 2018 March 31, 2017 $ $ $ $ 415.4 323.4 92.0 36.7 6.7 43.4 $ $ $ $ 407.2 305.7 101.5 (28.3) 1.3 (27.0) 59 Empire Company Limited NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Assets Current Non-current Total Liabilities Current Non-current Total Unitholders’ net assets REIT Units Class B LP Units Less total REIT Units outstanding as at March 31, 2018 Cumulative changes since acquisition of Crombie REIT Variances in timing of distributions Issue costs related to Class B LP Units Deferred gains (net of depreciation addback) Dilution gains Write off of portion of AOCI on dilution of interest in Crombie REIT Crombie REIT tax reorganization – deferred tax adjustment Carrying amount attributable to investment in Class B LP Units REIT Units owned by Empire Cumulative equity earnings on REIT Units Cumulative distributions on REIT Units March 31, 2018 March 31, 2017 $ 22.9 4,026.7 $ 35.7 3,916.6 $ 4,049.6 $ 3,952.3 $ 359.1 2,234.9 $ 205.1 2,363.2 $ 2,594.0 $ 2,568.3 $ 872.3 583.3 1,455.6 (872.3) $ 830.5 553.5 1,384.0 (830.5) 4.6 12.6 (172.4) 38.6 0.7 (31.7) 435.7 13.8 3.4 (4.4) 4.5 12.6 (163.4) 38.6 0.7 – 446.5 13.8 2.4 (3.6) Empire’s carrying amount of investment in Crombie REIT $ 448.5 $ 459.1 The Company has interests in various Canadian real estate partnerships ranging from 40.7% to 49.0% which are involved in residential property developments in Ontario and Western Canada. The following amounts represent the revenues, expenses, assets, and liabilities of the Canadian real estate partnerships as at and for the 12 months ended March 31, 2018: Revenues Expenses Net earnings from continuing operations Net earnings from discontinued operations Net earnings Current assets Current liabilities Net assets Carrying amount of investment March 31, 2018 March 31, 2017 $ $ $ 161.9 103.2 58.7 – 58.7 $ $ $ 131.6 77.9 53.7 15.4 69.1 March 31, 2018 March 31, 2017 $ $ $ 270.3 61.7 208.6 90.7 $ $ $ 330.4 36.1 294.3 143.0 The Company has interests in various U.S. real estate partnerships ranging from 37.1% to 42.1% which are involved in residential property developments in the United States. 60 Annual Report 2018 The following amounts represent the revenues, expenses, assets, and liabilities of the U.S. real estate partnerships as at and for the 12 months ended March 31, 2018: Revenues Expenses Net earnings Current assets Current liabilities Net assets Carrying amount of investment 8. Other assets Deferred lease assets Derivative assets Deferred ﬁ nancing costs Other Total March 31, 2018 March 31, 2017 $ $ 67.7 44.6 23.1 $ $ 51.9 34.3 17.6 March 31, 2018 March 31, 2017 $ $ $ 67.3 5.2 62.1 23.2 $ $ $ 104.7 6.0 98.7 36.8 May 5, 2018 May 6, 2017 $ $ 18.5 – 1.8 13.8 34.1 $ $ 20.3 1.1 5.5 16.4 43.3 9. Property and equipment May 5, 2018 Land Buildings Equipment Leasehold Improvements Assets Under Construction Total Cost Opening balance Additions Additions from business acquisitions Transfers Disposals and write downs $ 537.8 2.5 $ 1,313.3 9.4 $ 2,427.3 101.5 $ 700.3 13.4 $ 348.1 147.9 $ 5,326.8 274.7 – (16.6) (12.5) – 27.2 (40.6) 1.3 221.1 (203.8) – 39.8 (52.6) – (417.2) – 1.3 (145.7) (309.5) Closing balance $ 511.2 $ 1,309.3 $ 2,547.4 $ 700.9 $ 78.8 $ 5,147.6 Accumulated depreciation and impairment losses Opening balance Disposals and write downs Transfers Depreciation Impairment losses Closing balance Net carrying value as at May 5, 2018 $ $ – – – – – – $ 448.9 (17.1) (29.7) 59.5 2.4 $ 1,411.3 (188.9) (9.4) 239.8 6.6 $ $ 433.3 (50.2) 2.4 50.9 0.5 $ 464.0 $ 1,459.4 $ 436.9 $ – – – – – – $ 2,293.5 (256.2) (36.7) 350.2 9.5 $ 2,360.3 $ 511.2 $ 845.3 $ 1,088.0 $ 264.0 $ 78.8 $ 2,787.3 61 Empire Company Limited NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS May 6, 2017 Land Buildings Equipment Leasehold Improvements Assets Under Construction Total Cost Opening balance Additions Additions from business acquisitions Transfers Disposals and write downs $ 625.1 10.6 $ 1,295.5 10.6 $ 2,499.3 125.6 $ 703.9 34.6 $ 296.8 299.6 $ 5,420.6 481.0 – (45.8) (52.1) – 32.4 (25.2) 5.6 20.3 (223.5) – 3.3 (41.5) – (246.4) (1.9) 5.6 (236.2) (344.2) Closing balance $ 537.8 $ 1,313.3 $ 2,427.3 $ 700.3 $ 348.1 $ 5,326.8 Accumulated depreciation and impairment losses Opening balance Disposals and write downs Transfers Depreciation Impairment losses Impairment reversals Closing balance Net carrying value as at May 6, 2017 FINANCE LEASES $ $ – – – – – – – $ $ 403.5 (11.5) (7.7) 61.3 3.3 – $ 1,438.0 (214.8) (66.2) 240.5 14.1 (0.3) $ 434.4 (40.3) (15.3) 53.0 1.6 (0.1) $ 448.9 $ 1,411.3 $ 433.3 $ – – – – – – – $ 2,275.9 (266.6) (89.2) 354.8 19.0 (0.4) $ 2,293.5 $ 537.8 $ 864.4 $ 1,016.0 $ 267.0 $ 348.1 $ 3,033.3 The Company has various property leases for store locations classiﬁ ed as ﬁ nance leases with a net carrying value of $9.8 as at May 5, 2018 (2017 – $11.3). These leases are included in Buildings. The Company has equipment leases classiﬁ ed as ﬁ nance leases with a net carrying value of $11.2 as at May 5, 2018 (2017 – $15.8). These leases are included in Equipment. ASSETS UNDER CONSTRUCTION During the year, the Company capitalized borrowing costs of $0.5 (2017 – $2.2) on indebtedness related to property and equipment under construction. The Company used a capitalization rate of 4.7% (2017 – 4.8%). SECURIT Y As at May 5, 2018, the net carrying value of property pledged as security for borrowings is $57.1 (2017 – $62.2). IMPAIRMENT OF PROPERT Y AND EQUIPMENT The Company performed the impairment test for property and equipment and determined recoverable amounts based on VIU calculations using cash ﬂ ow projections from the Company’s latest internal forecasts. Key assumptions used in determining VIU include discount rates, growth rates, and expected changes in cash ﬂ ows. Management estimates discount rates using pre-tax rates that reﬂ ect current market assessments of the time value of money and risks speciﬁ c to the CGUs. Forecasts are projected beyond three years based on long-term growth rates ranging from 2.0% to 5.0%. Discount rates are calculated on a pre-tax basis and range from 9.0% to 12.0%. Impairment losses of $9.5 and reversals of $ nil were recorded during the year ended May 5, 2018 (2017 – $19.0 and $0.4). All impairment losses and reversals relate to the food retailing segment. 62 Annual Report 2018 10. Investment property Investment property is primarily comprised of commercial properties owned by the Company held for income generating purposes, rather than for the principal purpose of the Company’s operating activities. Cost Opening balance Additions Transfers Disposals and write downs Closing balance Accumulated depreciation and impairment losses Opening balance Depreciation Impairment expense Transfers Disposals and write downs Closing balance Net carrying value Fair value May 5, 2018 May 6, 2017 $ $ 119.0 3.0 (5.6) (3.6) 91.4 0.2 29.5 (2.1) $ 112.8 $ 119.0 $ $ $ $ 16.0 1.6 0.4 0.9 – 18.9 93.9 158.2 $ $ $ $ 8.5 0.7 2.3 5.0 (0.5) 16.0 103.0 136.7 The fair value of investment property is classiﬁ ed as Level 3 on the fair value hierarchy. The fair value represents the price that would be received to sell the assets in an orderly transaction between market participants at the measurement date. An external, independent valuation company, having appropriate recognized professional qualiﬁ cations and experience, assisted in determining the fair value of investment property at May 5, 2018 and May 6, 2017. Additions to investment property through acquisition are transacted at fair value and therefore carrying value equals fair value at the time of acquisition. Properties reclassiﬁ ed from property and equipment are valued for disclosure purposes using comparable market information or the use of an external independent valuation company. Rental income from investment property included on the consolidated statements of earnings amounted to $3.0 for the year ended May 5, 2018 (2017 – $3.6). Direct operating expenses (including repairs and maintenance but excluding depreciation expense) arising from investment property that generated rental income amounted to $2.0 for the year ended May 5, 2018 (2017 – $2.3). Direct operating expenses (including repairs and maintenance but excluding depreciation expense) arising from non-income producing investment property amounted to $1.9 for the year ended May 5, 2018 (2017 – $1.0). All direct operating expenses for investment properties are included in selling and administrative expenses on the consolidated statements of earnings. Impairment of investment property follows the same methodology as property and equipment (Note 3(q)). Impairment losses of $0.4 and reversals of $ nil were recorded during the year ended May 5, 2018 (2017 – $2.3 and $ nil). 63 Empire Company Limited NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 11. Intangibles May 5, 2018 Cost Opening balance Additions, separately acquired Transfers Disposals and write downs Deferred Purchase Brand Names Agreements Prescription Files Software Off Market Leases Other Total $ 201.0 $ – – – 151.2 $ 14.7 0.7 (5.6) 303.3 $ – 0.8 – 277.6 $ 14.9 14.0 (18.6) 173.1 $ – (0.2) (0.5) 209.2 $ 1,315.4 31.7 15.5 (29.0) 2.1 0.2 (4.3) Closing balance $ 201.0 $ 161.0 $ 304.1 $ 287.9 $ 172.4 $ 207.2 $ 1,333.6 Accumulated amortization and impairment losses Opening balance Amortization Impairment reversals Transfers Disposals and write downs $ 28.1 $ 0.1 – – – 72.5 $ 15.9 – (1.9) (5.3) 86.6 $ 19.5 (0.7) 1.4 (1.1) 146.2 $ 25.2 $ 76.3 $ 35.6 – (1.6) (18.6) 7.5 – – (0.5) 8.8 – 1.9 (4.3) 434.9 87.4 (0.7) (0.2) (29.8) Closing balance $ 28.2 $ 81.2 $ 105.7 $ 161.6 $ 32.2 $ 82.7 $ 491.6 Net carrying value as at May 5, 2018 $ 172.8 $ 79.8 $ 198.4 $ 126.3 $ 140.2 $ 124.5 $ 842.0 May 6, 2017 Cost Opening balance Additions, separately acquired Additions from business acquisitions Transfers Disposals and write downs Brand Names Deferred Purchase Agreements Prescription Files Software Off Market Leases Other Total $ 201.0 $ – 143.0 $ 10.5 305.2 $ – 258.8 $ 1.1 179.8 $ – 199.5 $ 12.5 1,287.3 24.1 – – – – 0.7 (3.0) 0.5 (1.9) (0.5) – 35.5 (17.8) – 0.5 (7.2) 3.0 0.3 (6.1) 3.5 35.1 (34.6) Closing balance $ 201.0 $ 151.2 $ 303.3 $ 277.6 $ 173.1 $ 209.2 $ 1,315.4 Accumulated amortization and impairment losses Opening balance Amortization Impairment reversals Transfers Disposals and write downs $ 26.1 $ 2.0 – – – 58.9 $ 16.3 – 0.1 (2.8) 68.7 $ 20.5 (0.4) (1.7) (0.5) 128.8 $ 18.9 $ 74.4 $ 35.1 – (0.1) (17.6) 7.0 – 0.5 (1.2) 7.8 – 0.1 (6.0) 375.8 88.7 (0.4) (1.1) (28.1) Closing balance $ 28.1 $ 72.5 $ 86.6 $ 146.2 $ 25.2 $ 76.3 $ 434.9 Net carrying value as at May 6, 2017 $ 172.9 $ 78.7 $ 216.7 $ 131.4 $ 147.9 $ 132.9 $ 880.5 Included in other intangibles at May 5, 2018 are liquor licenses of $5.4 (2017 – $5.4). These licenses have options to renew and it is the Company’s intention to renew these licenses at each renewal date indeﬁ nitely. Therefore, cash inﬂ ows are expected to be generated at each store location for which the license is valid, and these assets are considered to have indeﬁ nite useful lives. Also included in other intangibles as at May 5, 2018 and May 6, 2017 are the following amounts with indeﬁ nite useful lives: Loyalty programs – $11.4 (2017 – $11.4) and Private labels – $59.5 (2017 – $59.5). The Company has also determined that Brand names with a net carrying value of $172.8 (2017 – $172.8) have indeﬁ nite useful lives. All intangibles with indeﬁ nite useful lives relate to the food retailing segment. Impairment of these intangibles is assessed at least annually on the same basis as goodwill (Note 12). Impairment of intangibles follows the same methodology as property and equipment (Note 3(q)). For the year ended May 5, 2018, impairment losses of $ nil (2017 – $ nil) and reversals of $0.7 were recorded (2017 – $0.4). 64 Annual Report 2018 12. Goodwill Opening balance Additions from business acquisitions Impairments Other adjustments Closing balance May 5, 2018 May 6, 2017 $ $ 1,003.4 0.4 – (1.9) 998.7 5.8 (0.9) (0.2) $ 1,001.9 $ 1,003.4 Goodwill arising from business acquisitions is allocated at the lowest level within the organization at which it is monitored by management to make business decisions and should not be larger than an operating segment before aggregation. Therefore, goodwill has been allocated to the following ﬁ ve food retailing operating segments: Atlantic Lawtons Ontario Quebec West Total May 5, 2018 May 6, 2017 $ $ 193.8 17.1 173.0 615.6 2.4 193.8 17.1 172.6 617.5 2.4 $ 1,001.9 $ 1,003.4 IMPAIRMENT OF GOODWILL Goodwill arising on business acquisitions is not amortized but is reviewed for impairment on an annual basis, or more frequently, if indicators that goodwill may be impaired exist. The Company’s annual review of goodwill was performed during the third quarter of ﬁ scal 2018, and resulted in an impairment of $ nil being recorded (2017 – $0.9). In performing the review, the Company determined the recoverable amount of the CGU to which goodwill relates based on FVLCD. The key assumptions used by management to determine the fair value of the CGU includes industry earnings multiples in a range from 7.0 to 14.0 and is classiﬁ ed as Level 2 on the fair value hierarchy. 13. 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: Earnings before income taxes Effective combined statutory income tax rate Income tax expense according to combined statutory income tax rate Income taxes resulting from: Non-deductible items Non-taxable items Change in tax rates and subsidiary rate differential Change in tax legislation Impact of equity investment transaction Other May 5, 2018 May 6, 2017 $ 236.0 27.1% 64.0 $ 215.0 27.0% 58.1 0.1 (2.9) (12.8) – 5.0 2.8 1.3 (4.0) (1.8) (7.7) – (3.4) Total income tax expense, combined effective tax rate of 23.8% (2017 – 19.8%) $ 56.2 $ 42.5 Current year income tax expense attributable to net earnings consists of: Current tax expense Deferred tax recovery: Origination and reversal of temporary differences Change in tax rates Total May 5, 2018 May 6, 2017 $ 109.5 $ 96.3 (40.5) (12.8) $ 56.2 $ (52.0) (1.8) 42.5 65 Empire Company Limited NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Deferred taxes arising from temporary differences and unused tax losses can be summarized as follows: May 5, 2018 Accounts payable and accrued liabilities Employee future beneﬁ ts Equity Goodwill and intangibles Inventory Investments Long-term debt Other assets Other long-term liabilities Property, equipment, and investment property Provisions Partnership deferral reserve Tax loss carry forwards Other Recognized as: Deferred tax assets Deferred tax liabilities May 6, 2017 Accounts payable and accrued liabilities Employee future beneﬁ ts Equity Goodwill and intangibles Inventory Investments Long-term debt Other assets Other long-term liabilities Property, equipment, and investment property Provisions Partnership deferral reserve Tax loss carry forwards Other Recognized as: Deferred tax assets Deferred tax liabilities Recognized in: Other Comprehensive Income and Equity Opening Balance Business Acquisitions Net Earnings $ $ $ $ $ $ $ $ (3.7) 104.6 7.9 248.0 5.1 (34.0) 10.7 (0.4) 27.2 (38.1) 60.0 8.2 170.5 0.1 566.1 709.9 (143.8) $ $ $ $ – (5.2) – – – (1.1) – – – – – – – – (6.3) – (6.3) $ $ $ $ – – – – – – – – – – – – – – – – – Other Comprehensive Income and Equity Opening Balance Recognized in: Business Acquisitions 3.6 91.9 12.3 293.6 4.9 (33.1) 14.2 (0.6) 20.6 (58.4) 86.9 (8.2) 76.6 0.2 504.5 646.2 (141.7) $ $ $ $ – 8.2 – – – (0.2) – – – – – – – – 8.0 8.2 (0.2) $ $ $ $ – – – (0.2) – – – – – – – – – – (0.2) – (0.2) $ $ $ $ $ $ $ $ (5.1) 0.7 (4.1) 36.5 (0.2) (4.8) (3.4) 0.1 2.6 (67.1) 14.4 3.4 81.0 (0.7) 53.3 44.5 8.8 Net Earnings (7.3) 4.5 (4.4) (45.4) 0.2 (0.7) (3.5) 0.2 6.6 20.3 (26.9) 16.4 93.9 (0.1) 53.8 55.5 (1.7) Closing Balance (8.8) 100.1 3.8 284.5 4.9 (39.9) 7.3 (0.3) 29.8 (105.2) 74.4 11.6 251.5 (0.6) 613.1 754.4 (141.3) Closing Balance (3.7) 104.6 7.9 248.0 5.1 (34.0) 10.7 (0.4) 27.2 (38.1) 60.0 8.2 170.5 0.1 566.1 709.9 (143.8) $ $ $ $ $ $ $ $ As at May 5, 2018, the Company had approximately $909.0 of Canadian non-capital tax loss carry forwards, which expire between ﬁ scal 2033 and 2038. The remaining deductible temporary differences do not expire under current income tax legislation. All deferred tax assets (including tax losses and other tax credits) have been recognized in the consolidated balance sheets as it is probable that future taxable income will be available to the Company to utilize the beneﬁ ts of those assets. The amount of deferred tax assets and deferred tax liabilities that are expected to be recovered or settled beyond the next 12 months is $478.1. 66 Annual Report 2018 14. Provisions May 5, 2018 Opening balance Provisions made Provisions used Provisions reversed Change due to discounting Closing balance Current Non-current Total LEASE CONTRACTS Lease Contracts Legal Environmental Restructuring Onerous Contracts $ $ $ $ 29.9 10.3 (11.1) (3.2) 1.9 27.8 12.8 15.0 27.8 $ $ $ $ 6.7 7.4 (4.7) (1.4) – 8.0 8.0 – 8.0 $ $ $ $ $ 49.0 0.9 (1.4) (0.6) 1.5 96.3 149.4 (72.4) (14.4) 4.3 49.4 $ 163.2 2.4 47.0 49.4 $ 101.3 61.9 $ 163.2 $ $ $ $ 12.0 – (0.8) (2.7) – 8.5 3.1 5.4 8.5 $ $ $ $ Total 193.9 168.0 (90.4) (22.3) 7.7 256.9 127.6 129.3 256.9 Lease contract provisions are recorded when the expected beneﬁ ts to be derived by the Company from a contract are lower than the unavoidable costs of meeting the obligations under the contract. The Company records onerous contract provisions for closed store locations where it has entered into a lease contract. The provision is measured at the lower of the expected cost to terminate the lease and the expected net cost of continuing the contract. The net cost is derived by considering both the lease payment and sublease income received. Once the store is closed, a liability is recorded to reﬂ ect the present value of the expected liability associated with any lease contract and other contractually obligated costs. Onerous contract provisions for planned store or distribution centre closures as part of the Company’s rationalization activities are classiﬁ ed as restructuring provisions and are measured and recorded using the same methodology. Discounting of provisions resulting from lease contracts has been calculated using pre-tax discount rates ranging between 7.0% and 9.0%. LEGAL COSTS Legal provisions relate to claims of $8.0 that are outstanding as at May 5, 2018 (2017 – $6.7) that arose in the ordinary course of business. ENVIRONMENTAL COSTS In accordance with legal and environmental policy requirements, the Company has recorded provisions for locations requiring environmental restoration. These provisions relate to decommissioning liabilities recorded for gas station locations owned by the Company and other sites where restoration will be incurred at the net present value of the estimated future remediation costs. Discounting of environmental related provisions has been calculated using pre-tax discount rates ranging between 4.0% and 6.0%. RESTRUCTURING Restructuring provisions relate to the Company’s initiatives to simplify organizational structures and reduce costs. As a result of these initiatives, a $149.4 restructuring provision has been recorded during the ﬁ scal year ended May 5, 2018. Of this amount, $121.0 relates to a single organizational restructuring initiative and is expected to be utilized until ﬁ scal 2021. These costs have been recorded in selling and administrative expenses on the consolidated statement of earnings. Discounting of restructuring related provisions has been calculated using a pre-tax discount rate of 7.0%. ONEROUS CONTRACTS The Company disposed of certain manufacturing facilities in ﬁ scal 2015 and as part of the asset purchase agreement, long-term supply agreements were entered into that contain minimum purchase volume requirements. Under the terms of this asset purchase agreement, should actual purchases for the calendar year ending 2016 differ from minimum volume requirements, the sales price is adjusted up or down based on a volume-driven formula. During the year ended May 6, 2017, the Company paid $55.2 related to these long-term supply agreements where minimum purchase volume requirements for calendar 2016 were not met. The remaining obligation will be recognized until ﬁ scal 2021. Discounting of the sales price adjustment provision has been calculated using a pre-tax discount rate of 7.0%. 67 Empire Company Limited NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 15. Long-term debt First mortgage loans, weighted average interest rate 6.05%, due 2021 – 2033 Medium term notes, Series C, interest rate 7.16%, due February 26, 2018 Medium term notes, Series D, interest rate 6.06%, due October 29, 2035 Medium term notes, Series E, interest rate 5.79%, due October 6, 2036 Medium term notes, Series F, interest rate 6.64%, due June 7, 2040 Series 2013-1 Notes, interest rate 3.52%, due August 8, 2018 Series 2013-2 Notes, interest rate 4.70%, due August 8, 2023 Notes payable and other debt primarily at interest rates ﬂ uctuating with the prime rate Credit facilities due November 4, 2020, ﬂ oating interest rate tied to bankers’ acceptance rates Unamortized transaction costs Finance lease obligations, weighted average interest rate 6.04%, due 2019 – 2040 Less amount due within one year May 5, 2018 May 6, 2017 $ 6.7 – 175.0 125.0 150.0 500.0 500.0 137.1 43.1 1,636.9 (6.0) 36.0 1,666.9 527.4 $ 13.3 100.0 175.0 125.0 150.0 500.0 500.0 139.0 125.0 1,827.3 (8.5) 52.0 1,870.8 134.0 $ 1,139.5 $ 1,736.8 First mortgage loans are secured by land, buildings, and speciﬁ c charges on certain assets. Finance lease obligations are secured by the related ﬁ nance lease asset. Medium term notes and Series 2013-1 and 2013-2 Notes are unsecured. On April 22, 2016, the Company extended the term of its $250.0 credit facility to a maturity date of November 4, 2020. As of May 5, 2018, the outstanding amount of the credit facility was $43.1 (2017 – $125.0). Interest payable ﬂ uctuates with changes in the bankers’ acceptance rate, Canadian prime rate, or the London Interbank Offered Rate (“LIBOR”). On June 2, 2017, Sobeys entered a new, senior, unsecured non-revolving credit facility for $500.0. The facility bears ﬂ oating interest tied to Canadian prime rate or bankers’ acceptance rates. The facility is intended to be used to repay long-term debt due in calendar 2018. Pursuant to an agreement dated April 29, 2016, Sobeys amended and restated its revolving term credit facility (“RT Facility”). The principal amount was increased from $450.0 to $650.0 and Sobeys’ previous non-revolving, amortizing term credit facility was fully repaid and cancelled. As of May 5, 2018, the outstanding amount of the RT Facility was $ nil (2017 – $ nil), and Sobeys issued $39.5 in letters of credit against the RT Facility (2017 – $46.3). Interest payable on the RT Facility ﬂ uctuates with changes in the bankers’ acceptance rate, Canadian prime rate, or LIBOR, and the facility matures on November 4, 2020. The following table reconciles the changes in cash ﬂ ows from ﬁ nancing activities for long-term debt. Opening balance Issuance of debt Repayments Net repayment of credit facilities Total cash ﬂ ow used in long-term debt ﬁ nancing activities Finance lease additions Deferred ﬁ nancing costs Closing balance Principal debt retirement in each of the next ﬁ ve ﬁ scal years is as follows: 2019 2020 2021 2022 2023 Thereafter 68 May 5, 2018 May 6, 2017 $ 1,870.8 $ 2,367.4 63.7 (188.2) (81.9) (206.4) – 2.5 55.6 (397.2) (165.0) (506.6) 7.5 2.5 $ 1,666.9 $ 1,870.8 $ 520.1 22.6 52.1 7.1 6.3 1,028.7 Annual Report 2018 FINANCE LEASE LIABILITIES Finance lease liabilities are payable in each of the next ﬁ ve ﬁ scal years as follows: 2019 2020 2021 2022 2023 Thereafter Total Future Minimum Lease Payments Present Value of Minimum Lease Payments Interest $ $ 9.2 7.8 5.4 3.6 3.5 18.2 47.7 $ $ 1.9 1.6 1.2 1.0 0.9 5.1 7.3 6.2 4.2 2.6 2.6 13.1 $ 11.7 $ 36.0 During ﬁ scal 2018, there were no additions to the Company’s ﬁ nance lease obligation (2017 – $7.5). 16. Other long-term liabilities Deferred lease obligation Deferred revenue Other Total May 5, 2018 May 6, 2017 $ $ 148.2 7.0 3.4 $ 158.6 $ 127.2 9.1 5.4 141.7 17. Employee future benefits The Company has a number of deﬁ ned contribution, deﬁ ned beneﬁ t, and multi-employer plans providing pension and other post-retirement beneﬁ ts to most of its employees. DEFINED CONTRIBUTION PENSION PLANS The contributions required by the employee and the employer are speciﬁ ed. The employee’s pension depends on what level of retirement income (for example, annuity purchase) can be achieved with the combined total of employee and employer contributions and investment income over the period of plan membership, and the annuity purchase rates at the time of the employee’s retirement. DEFINED BENEFIT PENSION PLANS The ultimate retirement beneﬁ t is deﬁ ned by a formula that provides a unit of beneﬁ t for each year of service. Employee contributions, if required, pay for part of the cost of the beneﬁ t, and employer contributions fund the balance. The employer contributions are not speciﬁ ed or deﬁ ned within the plan text, but 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 deﬁ ned beneﬁ t plan typically exposes the Company to actuarial risks such as interest rate risk, mortality risk and salary risk. Interest rate risk The present value of the deﬁ ned beneﬁ t liability is calculated using a discount rate that reﬂ ects the average yield, as at the measurement date, on high quality corporate bonds of similar duration to the plans’ liabilities. A decrease in the market yield on high quality corporate bonds will increase the Company’s deﬁ ned beneﬁ t liability. Mortality risk The present value of the deﬁ ned beneﬁ t plan is calculated by reference to the best estimate of the mortality of plan participants both during and after their employment. An increase in the life expectancy of the plan participants will increase the plan’s liability. Salary risk The present value of the deﬁ ned beneﬁ t plan liability is calculated by reference to the future salary of the plan participants. As such, an increase in the salary of plan participants will increase the plan’s liability. 69 Empire Company Limited NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS The Company uses either January 1 or December 31 as an actuarial valuation date and May 1 as a measurement date for accounting purposes, for its deﬁ ned beneﬁ t pension plans. Retirement Pension Plans Senior Management Pension Plans Other Beneﬁ t Plans MULTI-EMPLOYER PLANS Most Recent Valuation Date Next Required Valuation Date December 31, 2017 December 31, 2016 January 1, 2016 December 31, 2020 December 31, 2019 January 1, 2019 The Company participates in various multi-employer pension plans which are administered by independent boards of trustees generally consisting of an equal number of union and employer representatives. Approximately 16% of employees in the Company and of its franchisees and afﬁ liates participate in these plans. Deﬁ ned beneﬁ t multi-employer pension plans are accounted for as deﬁ ned contribution plans as adequate information to account for the Company’s participation in the plans is not available due to the size and number of contributing employers in the plans. The Company’s responsibility to make contributions to these plans is limited by amounts established pursuant to its collective agreements. The contributions made by the Company to multi-employer plans are expensed as contributions are due. During the year ended May 5, 2018, the Company recognized an expense of $46.3 (2017 – $45.1) in operating income, which represents the contributions made in connection with multi-employer pension plans. During ﬁ scal 2019, the Company expects to continue to make contributions into these multi-employer pension plans. OTHER BENEFIT PLANS The Company also offers certain employee post-retirement and post-employment beneﬁ t plans which are not funded and include health care, life insurance, and dental beneﬁ ts. DEFINED CONTRIBUTION PLANS The total expense, and cash contributions, for the Company’s deﬁ ned contribution plans was $32.1 for the year ended May 5, 2018 (2017 – $32.1). DEFINED BENEFIT PLANS Information about the Company’s deﬁ ned beneﬁ t plans, in aggregate, is as follows: Deﬁ ned beneﬁ t obligation Balance, beginning of year Current service cost, net of employee contributions Interest cost Beneﬁ ts paid Past service costs – plan amendments Past service costs – curtailments Settlements Termination beneﬁ ts Remeasurement – actuarial (gains) losses included in other comprehensive income (loss) Pension Beneﬁ t Plans Other Beneﬁ t Plans May 5, 2018 May 6, 2017 May 5, 2018 May 6, 2017 $ $ 890.3 1.6 27.3 (58.7) – (2.9) 1.3 – $ 871.2 2.3 29.4 (57.7) 1.5 – 1.0 2.8 $ 164.3 3.3 5.3 (5.6) – (0.4) – – 152.6 3.2 5.2 (5.2) – – – – (25.7) 39.8 (8.2) 8.5 Balance, end of year $ 833.2 $ 890.3 $ 158.7 $ 164.3 70 Annual Report 2018 Plan assets Fair value, beginning of year Interest income on plan assets Remeasurement (loss) return on plan assets (excluding amount in net interest) Employer contributions Beneﬁ ts paid Administrative costs Fair value, end of year Funded status Total fair value of plan assets Present value of unfunded obligations Present value of partially funded obligations Pension Beneﬁ t Plans Other Beneﬁ t Plans May 5, 2018 May 6, 2017 May 5, 2018 May 6, 2017 $ 680.6 20.7 $ 687.0 23.1 $ $ – – (19.4) 9.3 (58.7) (1.8) 19.6 9.8 (57.7) (1.2) – 5.6 (5.6) – $ 630.7 $ 680.6 $ – $ – – – 5.2 (5.2) – – Pension Beneﬁ t Plans Other Beneﬁ t Plans May 5, 2018 May 6, 2017 May 5, 2018 May 6, 2017 $ 630.7 (93.2) (740.0) $ 680.6 (95.7) (794.6) $ – (158.7) – $ – (164.3) – Accrued beneﬁ t liabilities $ (202.5) $ (209.7) $ (158.7) $ (164.3) Expenses Current service cost, net of employee contributions Net interest on net deﬁ ned beneﬁ t liability Administrative costs Past service costs – plan amendments Past service costs – curtailments Termination beneﬁ ts Settlement loss Expenses Pension Beneﬁ t Plans Other Beneﬁ t Plans May 5, 2018 May 6, 2017 May 5, 2018 May 6, 2017 $ $ 1.6 6.6 1.8 – (2.9) – 1.3 8.4 $ $ 2.3 6.3 1.2 1.5 – 2.8 1.0 $ 3.3 5.3 – – (0.4) – – $ 15.1 $ 8.2 $ 3.2 5.2 – – – – – 8.4 Current and past service costs have been recognized within selling and administrative expenses, whereas interest costs and return on plan assets (excluding amounts in net interest costs) have been recognized within ﬁ nance costs, net on the consolidated statements of earnings. Actuarial gains and losses recognized directly in other comprehensive income (loss): Pension Beneﬁ t Plans Other Beneﬁ t Plans May 5, 2018 May 6, 2017 May 5, 2018 May 6, 2017 Remeasurement effects recognized in other comprehensive income (loss) Loss (return) on plan assets (excluding amounts in net interest) Actuarial gain – experience changes Actuarial loss – demographic assumptions Actuarial (gain) loss – ﬁ nancial assumptions $ $ 19.4 (4.1) – (21.6) $ (19.6) (1.2) 2.4 38.6 $ – – – (8.2) – (0.1) – 8.6 Remeasurement effects recognized in other comprehensive income (loss) $ 6.3 $ (20.2) $ 8.2 $ (8.5) 71 Empire Company Limited NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS The signiﬁ cant actuarial assumptions adopted in measuring the Company’s accrued beneﬁ t obligations are as follows (weighted-average assumptions as of May 5, 2018): Discount rate Rate of compensation increase Pension Beneﬁ t Plans Other Beneﬁ t Plans May 5, 2018 May 6, 2017 May 5, 2018 May 6, 2017 3.40% 3.50% 3.25% 3.50% 3.40% 3.25% For measurement purposes, a 5.50% ﬁ scal 2018 annual rate of increase in the per capita cost of covered health care beneﬁ ts was assumed (2017 – 5.75%). The cumulative rate expectation to 2020 and thereafter is 5.00%. These assumptions were developed by management under consideration of expert advice provided by independent actuarial appraisers. These assumptions are used in the determination of the Company’s deﬁ ned beneﬁ t obligations and should be regarded as management’s best estimate. However, the actual outcome may vary. Estimation uncertainties exist especially in regard to medical cost trends, which may vary signiﬁ cantly in future appraisals of the Company’s obligations. The table below outlines the sensitivity of the ﬁ scal 2018 key economic assumptions used in measuring the accrued beneﬁ t plan obligations and related expenses of the Company’s pension and other beneﬁ t 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 beneﬁ t obligations or beneﬁ t plan expenses. 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 Beneﬁ t Plans Other Beneﬁ t Plans Beneﬁ t Obligations 3.40% (103.0) 130.2 $ $ Beneﬁ t Cost(1) 3.40% (2.8) 1.3 $ $ Beneﬁ t Obligations 3.40% (19.4) 24.0 5.50% 19.7 (16.3) $ $ $ $ $ $ $ $ Beneﬁ t Cost(1) 3.40% 0.3 (0.4) 5.50% 1.2 (1.0) (1) Reﬂ ects the impact on the current service cost, interest cost, and net interest on deﬁ ned beneﬁ t liability (asset). (2) Based on weighted average of discount rates related to all plans. (3) Gradually decreasing to 5.00% in 2020 and remaining at that level thereafter. The asset mix of the deﬁ ned beneﬁ t pension plans as at year end is as follows: Canadian equity funds Foreign equity funds Fixed income funds Net working capital Total investments May 5, 2018 May 6, 2017 6.6% 14.1% 79.1% 0.2% 8.8% 11.7% 79.2% 0.3% 100.0% 100.0% Within these securities are investments in Empire Non-Voting Class A shares. The pro-rata market value of these shares at year end is as follows: Empire Company Limited Non-Voting Class A shares May 5, 2018 $ 9.9 % of Plan Assets May 6, 2017 1.5% $ 8.9 % of Plan Assets 1.3% All of the securities are valued based on quoted prices (unadjusted) in active markets for identical assets or liabilities or based on inputs other than quoted prices in active markets that are observable for the asset or liability, either directly (as prices) or indirectly (derived from prices). The actual (loss) return on plan assets was $(0.5) for the year ended May 5, 2018 (2017 – $41.5). Management’s best estimate of contributions expected to be paid to the deﬁ ned beneﬁ t pension plans during the annual period beginning on May 6, 2018 and ending on May 4, 2019 is $26.7. 72 Annual Report 2018 18. Capital stock Authorized 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 Number of Shares May 5, 2018 May 6, 2017 991,980,000 768,105,849 122,400,000 991,980,000 768,105,849 122,400,000 Issued and outstanding Number of Shares May 5, 2018 May 6, 2017 Non-Voting Class A shares, without par value Class B common shares, without par value, voting Shares held in trust Total 173,547,591 98,138,079 (308,504) $ 2,038.2 7.3 (6.0) $ 2,037.8 7.3 (10.7) $ 2,039.5 $ 2,034.4 Under certain circumstances, where an offer (as deﬁ ned in the share conditions) is made to purchase Class B common shares, the holders of the Non-Voting Class A shares shall be entitled to receive a follow-up offer at the highest price per share paid, pursuant to such offer to purchase Class B common shares. During ﬁ scal 2018, the Company paid common dividends of $114.0 (2017 – $111.3) to its equity holders. This represents a payment of $0.42 per share (2017 – $0.41 per share) for common share holders. During the second quarter of ﬁ scal 2017, the Company established a trust fund to facilitate the purchase of Non-Voting Class A shares for the future settlement of vested units under the Company’s equity settled stock-based compensation plans. Contributions to the trust fund and the Non-Voting Class A shares purchased are held by AST Trust Company (Canada) as trustee. The trust fund is an SE and as such the accounts of the trust fund are included on the consolidated ﬁ nancial statements of the Company. The following represents the activity of shares held in trust: Shares held in trust Balance, beginning of year Purchased Issued Balance, end of year 19. Other income Net gain on disposal of assets Lease revenue from owned property Dilution losses Total 20. Employee benefits expense Wages, salaries and other short-term employment beneﬁ ts Post-employment beneﬁ ts Termination beneﬁ ts Total Number of Shares May 5, 2018 May 6, 2017 $ (555,409) (5,683) 252,588 $ (10.7) (0.1) 4.8 (308,504) $ (6.0) $ – (10.7) – (10.7) May 5, 2018 May 6, 2017 $ $ 37.3 23.9 – 61.2 $ $ 23.0 26.9 (1.7) 48.2 May 5, 2018 May 6, 2017 $ 3,101.7 36.8 121.6 $ 3,078.3 44.2 14.9 $ 3,260.1 $ 3,137.4 73 Empire Company Limited NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 21. Finance costs, net Finance income Interest income from cash and cash equivalents Fair value gains on forward contracts Investment income Accretion income on loans and other receivables Total ﬁ nance income Finance costs Interest expense on ﬁ nancial liabilities measured at amortized cost Net pension ﬁ nance costs Accretion expense on provisions Total ﬁ nance costs Finance costs, net 22. Earnings per share Weighted average number of shares – basic (Note 18) Shares deemed to be issued for no consideration in respect of stock-based payments Weighted average number of shares – diluted 23. Guarantees, commitments and contingent liabilities GUARANTEES Franchisees and afﬁ liates May 5, 2018 May 6, 2017 $ $ 1.9 3.2 0.2 0.7 6.0 96.9 11.9 7.7 116.5 110.5 $ $ 0.4 3.3 1.2 1.2 6.1 103.1 11.5 9.5 124.1 118.0 May 5, 2018 May 6, 2017 271,783,850 278,417 271,948,133 3,374 272,062,267 271,951,507 Sobeys is party to a number of franchise and operating agreements as part of its business model. These agreements contain clauses which require Sobeys to provide support to franchisee and afﬁ liate operators to offset or mitigate retail store losses, reduce store rental payments, minimize the impact of promotional pricing, and assist in covering other store related operating expenses. Not all of the ﬁ nancial support noted above will apply in each instance as the provisions of the agreements vary. Sobeys will continue to provide ﬁ nancial support pursuant to the franchise and operating agreements in future years. During ﬁ scal 2017, Sobeys had a guarantee contract under the terms of which, should certain franchisees and afﬁ liates be unable to fulﬁ ll their lease obligations, Sobeys would be required to fund the greater of $7.0 or 9.9% of the authorized and outstanding obligation. During the year ended May 6, 2017, the guarantee contract expired. During ﬁ scal 2017, Sobeys had guaranteed certain equipment leases of its franchisees and afﬁ liates. Under the terms of the guarantee, should franchisees and afﬁ liates be unable to fulﬁ ll their equipment lease obligations, Sobeys would be required to fund the difference of the lease commitments up to a maximum of $145.0 on a cumulative basis. During the year ended May 6, 2017, the guarantee contract expired. During ﬁ scal 2009, Sobeys entered into an additional credit enhancement contract in the form of a standby letter of credit for certain franchisees and afﬁ liates for the purchase and installation of equipment. Under the terms of the contract, should franchisees and afﬁ liates be unable to fulﬁ ll their lease obligations or provide an acceptable remedy, Sobeys would be required to fund the greater of $6.0 or 10.0% (2017 – $6.0 or 10.0%) of the authorized and outstanding obligation annually. Under the terms of the contract, Sobeys is required to provide 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 ﬁ nancing terms to certain franchisees and afﬁ liates. The contract terms have been reviewed and Sobeys determined that there were no material implications with respect to the consolidation of SEs. As at May 5, 2018, the amount of the guarantee was $6.0 (2017 – $6.0). 74 Annual Report 2018 Other At May 5, 2018, the Company had entered into letters of credit issued in the aggregate amount of $52.7 (2017 – $62.2) to support the Company’s obligations. Sobeys, through its subsidiaries, has guaranteed the payment of obligations under certain commercial development agreements. As at May 5, 2018, Sobeys has guaranteed $43.5 (2017 – $43.5) in obligations related to these agreements. Upon entering into the lease of its Mississauga distribution centre, in March 2000, Sobeys guaranteed to the landlord the performance, by SERCA Foodservice Inc. (formerly a subsidiary of Sobeys Inc.), of all its obligations under the lease. The remaining term of the lease is two years with an aggregate obligation of $7.4 (2017 – $10.4). 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 the purchaser, and Sysco Corp. agreed to indemnify and hold Sobeys harmless from any liability it may incur pursuant to its guarantee. COMMITMENTS Operating leases, as lessee The Company leases various retail stores, distribution centres, ofﬁ ces, and equipment under non-cancellable operating leases. These leases have varying terms, escalation clauses, renewal options, and bases on which contingent rent is payable. The total net, future minimum rent payable under the Company’s operating leases as of May 5, 2018 is approximately $4,551.6. This reﬂ ects a gross lease obligation of $5,534.0 reduced by expected sub-lease income of $982.4. The net commitments over the next ﬁ ve ﬁ scal years are: 2019 2020 2021 2022 2023 Thereafter Third Parties Related Parties Net Lease Obligation Gross Lease Obligation Net Lease Obligation Gross Lease Obligation $ 256.0 246.0 224.0 200.1 171.8 939.0 $ 366.0 348.5 321.4 290.5 256.4 1,436.5 $ 166.2 165.0 165.9 159.9 161.0 1,696.7 $ 166.2 165.0 165.9 159.9 161.0 1,696.7 The Company recorded $575.6 (2017 – $566.1) as an expense for minimum lease payments for the year ended May 5, 2018 on the consolidated statements of earnings. The expense was partly offset by sub-lease income of $118.3 (2017 – $104.9), and a further $5.3 (2017 – $13.1) of expense was recognized for contingent rent. Operating leases, as lessor The Company also leases most investment properties under operating leases. These leases have varying terms, escalation clauses, renewal options and bases on which contingent rent is receivable. Rental income for the year ended May 5, 2018 was $23.6 (2017 – $26.2) and was recognized within other income on the consolidated statements of earnings. In addition, the Company recognized $0.3 of contingent rent for the year ended May 5, 2018 (2017 – $0.3). The lease payments expected to be received over the next ﬁ ve ﬁ scal years are: 2019 2020 2021 2022 2023 Thereafter Third Parties $ 14.2 13.0 11.7 10.8 10.5 62.4 75 Empire Company Limited NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONTINGENT LIABILITIES On June 21, 2005, Sobeys received a notice of reassessment from Canada Revenue Agency (“CRA”) for ﬁ scal years 1999 and 2000 related to Lumsden Brothers Limited, a wholesale subsidiary of Sobeys, 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 sales of tobacco products to status Indians. The total tax, interest and penalties in the reassessment was $13.6 (2017 – $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 ﬁ scal 2006, Sobeys ﬁ led a Notice of Objection with CRA. The matter is still under dispute and Sobeys has ﬁ led a Notice of Appeal with the Tax Court of Canada. Accordingly, Sobeys has not recorded on its statements of earnings any of the tax, interest or penalties in the notice of reassessment. Sobeys has deposited with CRA funds equal to 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. There are various claims and litigation, with which the Company is involved, 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. In the ordinary course of business, the Company is subject to ongoing audits by tax authorities. While the Company believes that its tax ﬁ ling positions are appropriate and supportable, from time to time certain matters are reviewed and challenged by the tax authorities. 24. Financial instruments CREDIT RISK Credit risk is the risk of an unexpected loss if a customer or counterparty to a ﬁ nancial instrument fails to meet its contractual obligations. The Company’s ﬁ nancial instruments that are exposed to concentrations of credit risk are primarily cash and cash equivalents, receivables, loans and other receivables, derivative contracts and guarantees. The Company’s maximum exposure to credit risk corresponds to the carrying amount for all cash and cash equivalents, loans and receivables, and guarantee contracts for franchisees and afﬁ liates (Note 23). The Company mitigates credit risk associated with its trade receivables and loans receivables through established credit approvals, limits and a regular monitoring process. The Company generally considers the credit quality of its ﬁ nancial assets that are neither past due or impaired to be solid. The Company regularly monitors collection performance and pledged security for all of its receivables and 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, ﬁ xed 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 counterparties that are dual rated by recognized credit rating agencies and have a credit rating of “A” or better to minimize credit risk. Receivables are substantially comprised of balances due from independent accounts, franchisee or afﬁ liate 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 credit losses Less: allowance for credit losses Receivables May 5, 2018 May 6, 2017 $ $ 344.9 24.3 91.5 460.7 (27.5) $ 433.2 $ 342.7 23.3 75.2 441.2 (27.6) 413.6 Interest earned on past due accounts is recorded as a reduction to selling and administrative expenses on the consolidated statements of earnings. Receivables are classiﬁ ed as current on the consolidated balance sheet as of May 5, 2018. 76 Annual Report 2018 Allowance for credit losses is reviewed at each balance sheet date. An allowance is taken on receivables from independent accounts, as well as receivables, loans and other receivables from franchisee or afﬁ liate locations and is recorded as a reduction to its respective receivable account on the consolidated balance sheets. The Company updates its estimate for credit losses based on past due balances from independent accounts and based on an evaluation of recoverability net of security assigned for franchisee or afﬁ liate locations. Current and long-term receivables, loans and other receivables are reviewed on a regular basis and are written-off when collection is considered unlikely. The change in allowance for credit losses is recorded as selling and administrative expenses on the consolidated statements of earnings and is presented as follows: Allowance, beginning of year Provision for losses Recoveries Write-offs Allowance, end of year LIQUIDIT Y RISK May 5, 2018 May 6, 2017 $ $ 27.6 4.1 (1.7) (2.5) $ 27.5 $ 25.9 5.4 (0.4) (3.3) 27.6 Liquidity risk is the risk that the Company may not have cash available to satisfy ﬁ nancial liabilities as they come due. The Company actively maintains a committed credit facility to ensure that it has sufﬁ cient available funds to meet current and foreseeable future ﬁ nancial requirements at a reasonable cost. The Company monitors capital markets and the related conditions, and monitors its cash ﬂ ows in order to assist in optimizing its cash position and evaluate longer term cash and funding requirements. 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 amount and the contractual maturities of both the interest and principal portion of signiﬁ cant ﬁ nancial liabilities on an undiscounted basis as at May 5, 2018: 2019 2020 2021 2022 2023 Thereafter Total Derivative ﬁ nancial liabilities Foreign currency swaps Non-derivative ﬁ nancial liabilities Accounts payable and accrued liabilities Long-term debt $ 2.5 $ 12.9 $ – $ – $ – $ – $ 15.4 2,253.8 595.6 – 87.0 – 112.6 – 64.4 – 64.1 – 1,260.0 2,253.8 2,183.7 Total $ 2,851.9 $ 99.9 $ 112.6 $ 64.4 $ 64.1 $ 1,260.0 $ 4,452.9 FAIR VALUE OF FINANCIAL INSTRUMENTS The fair value of a ﬁ nancial instrument is the estimated amount that the Company would receive to sell ﬁ nancial assets or pay to transfer ﬁ nancial liabilities in an orderly transaction between market participants at the measurement date. The book value of cash and cash equivalents, receivables, current portion of loans and other receivables, and accounts payable and accrued liabilities approximate fair values at the balance sheet dates due to the short term maturity of these instruments. The book value of the long-term portion of loans and other receivables, and investments approximate fair values at the balance sheet dates due to the current market rates associated with these instruments. The fair value of the variable rate long-term debt is assumed to approximate its carrying amount based on current market rates and consistency of credit spread. The fair value of long-term debt has been estimated by discounting future cash ﬂ ows at a rate offered for borrowings of similar maturities and credit quality. The fair value of derivative ﬁ nancial assets and liabilities, classiﬁ ed as Level 2, is estimated using valuation models that utilize market based observable inputs. Management believes that its valuation technique is appropriate. There were no transfers between classes of the fair value hierarchy during the year ended May 5, 2018. The carrying amount of the Company’s ﬁ nancial instruments approximates their fair values with the following exception: Long-term debt Total carrying amount Total fair value May 5, 2018 May 6, 2017 $ 1,666.9 1,707.6 $ $ $ 1,870.8 1,893.0 77 Empire Company Limited NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS As at May 5, 2018, the fair value hierarchy includes ﬁ nancial assets at fair value through proﬁ t or loss of $ nil, $ nil, and $ nil for Levels 1, 2 and 3 respectively (2017 – $ nil, $1.1, and $ nil). As at May 5, 2018, the fair value hierarchy includes ﬁ nancial assets at available for sale of $ nil in Level 1 (2017 – $25.1). As at May 5, 2018, the fair value hierarchy includes ﬁ nancial liabilities at fair value through proﬁ t or loss of $ nil, $0.2, and $ nil for Levels 1, 2 and 3 respectively (2017 – $ nil, $0.9, and $ nil). DERIVATIVE FINANCIAL INSTRUMENTS Derivative ﬁ nancial instruments are recorded on the consolidated balance sheets at fair value unless the derivative instrument is a contract to buy or sell a non-ﬁ nancial 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 ﬁ nancial instruments are recognized in net earnings or loss unless it qualiﬁ es and is designated as an effective cash ﬂ ow 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 ﬁ nancial instrument designated as a cash ﬂ ow hedge are recorded in other assets and other long-term liabilities with the effective portion recorded in other comprehensive income or loss. CASH FLOW HEDGES The Company’s cash ﬂ ow hedges consist principally of foreign currency swaps, electricity sales agreements, and natural gas sales agreements. Foreign exchange contracts are used to hedge future purchases or expenditures of foreign currency denominated goods or services. Electricity and natural gas sales agreements are used to mitigate the risk of changes in market prices of electricity and natural gas. Gains and losses are initially recognized directly in other comprehensive income or loss and are transferred to net earnings or loss when the forecast cash ﬂ ows affect income or expense for the year. As of May 5, 2018, the fair values of the outstanding derivatives designated as cash ﬂ ow hedges of forecast transactions were assets of $ nil (2017 – $1.1) and liabilities of $0.2 (2017 – $0.9). Cash ﬂ ows from cash ﬂ ow hedges are expected to ﬂ ow over the next two years until ﬁ scal 2020, and are expected to be recognized in net earnings or loss over this period, and, in the case of foreign currency swaps, over the life of the related debt in which a portion of the initial cost is being hedged. INTEREST RATE RISK Interest rate risk is the potential for ﬁ nancial loss arising from changes in interest rates. Financial instruments that potentially subject the Company to interest rate risk include ﬁ nancial liabilities with ﬂ oating interest rates. The Company manages interest rate risk by monitoring market conditions and the impact of interest rate ﬂ uctuations on its debt. The majority of the Company’s long-term debt is at ﬁ xed interest rates. Approximately 8.4% (2017 – 23.1%) of the Company’s long-term debt is exposed to interest rate risk due to ﬂ oating rates. Net earnings or loss is sensitive to the impact of a change in interest rates on the average balance of interest bearing ﬁ nancial liabilities during the year. For the year ending May 5, 2018, the Company’s average outstanding unhedged ﬂ oating rate debt was $151.5 (2017 – $493.1). An increase (decrease) of 25 basis points would have impacted net earnings by $0.3 ($0.3) (2017 – $0.9 ($0.9)) as a result of the Company’s exposure to interest rate ﬂ uctuations on its unhedged ﬂ oating rate debt. 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 ﬁ x the exchange rate on some of its expected requirements for foreign currencies. 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 does not consider its exposure to foreign currency exchange risk to be material. The Company has entered into foreign currency forward contracts and foreign currency swaps for the primary purpose of limiting exposure to exchange rate ﬂ uctuations 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 or loss until the variability in cash ﬂ ows being hedged is recognized in net earnings or loss in future accounting periods. The Company estimates that a 10% increase (decrease) in applicable foreign currency exchange rates would impact net earnings by $ nil ($ nil) (2017 – $ nil ($ nil)) and other comprehensive income (loss) by $1.1 ($1.1) (2017 – $1.3 ($1.3)) for foreign currency derivatives in place at year end. 78 Annual Report 2018 During the year ended May 7, 2016, Sobeys entered into seven Euro/Canadian dollar forward contracts at an approximate Canadian dollar value at inception of $68.6. The forward contracts were entered into to hedge and limit exposure to exchange rate ﬂ uctuations relating to future expenditures in Euros. The forward contracts matured on March 1, 2017. MARKET RISK Market risk is the risk that the fair value of investments will ﬂ uctuate as a result of changes in the price of the investment. The Company estimates that a 10% change in the market value of its investments that trade on a recognized stock exchange would impact net earnings by $ nil (2017 – $ nil) and other comprehensive income (loss) by $ nil (2017 – $2.2). 25. Segmented information The Company’s reportable segments are Food retailing and Investments and other operations. The Food retailing segment is comprised of ﬁ ve operating segments: Sobeys West, Sobeys Ontario, Sobeys Quebec, Sobeys Atlantic, and Sobeys Pharmacy Group. These operating segments have been aggregated into one reportable segment, “Food retailing”, as they all share similar economic characteristics such as: product offerings, customer base and distribution methods. The Investments and other operations segment principally consists of investments, at equity, in Crombie REIT, real estate partnerships, and various other corporate operations. Segment results and assets include items directly attributable to a segment as well as those that can be allocated on a reasonable basis. Each of these operating segments is managed separately as each of these segments requires different technologies and other resources as well as marketing approaches. All inter-segment transfers are carried out at arm’s length prices. The measurement policies the Company uses for segment reporting under IFRS 8, “Operating segments”, are the same as those used on its consolidated ﬁ nancial statements. No asymmetrical allocations of income, expense or assets have been applied between segments. All sales are generated by the Food retailing segment. Operating income generated by each of the Company’s business segments is summarized as follows: Segmented operating income Food retailing Investments and other operations Crombie REIT Real estate partnerships Other operations, net of corporate expenses Total May 5, 2018 May 6, 2017 $ 273.6 $ 259.3 39.5 33.9 (0.5) 72.9 41.5 35.1 (2.9) 73.7 $ 346.5 $ 333.0 Segment operating income can be reconciled to the Company’s earnings before income taxes as follows: Total operating income Finance costs, net Total Total assets by segment Food retailing Investments and other operations Total May 5, 2018 May 6, 2017 $ $ 346.5 110.5 236.0 $ $ 333.0 118.0 215.0 May 5, 2018 May 6, 2017 $ 8,010.4 651.6 $ 7,949.9 745.6 $ 8,662.0 $ 8,695.5 79 Empire Company Limited NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 26. Stock-based compensation PERFORMANCE SHARE UNIT PLAN The Company has awarded performance share units (“PSUs”) to certain employees. The number of PSUs that vest under an award, for the most part, is dependent on time and the achievement of speciﬁ c performance measures. Upon vesting, each employee is entitled to receive Non-Voting Class A shares equal to the number of their vested PSUs. The weighted average fair value of $20.75 per PSU issued during the current year was determined using the Black Scholes model with the following weighted average assumptions: Share price Expected life Risk-free interest rate Expected volatility Dividend yield $21.60 2.04 years 1.19% 26.65% 1.95% At May 5, 2018, there were 471,693 (2017 – 861,933) PSUs outstanding. The compensation expense for the year ended May 5, 2018 related to PSUs was $4.3 (2017 – $ nil). STOCK OPTION PLAN During ﬁ scal 2018, the Company granted 1,338,980 options under the stock option plan for employees of the Company whereby options are granted to purchase Non-Voting Class A shares. The weighted average fair value of $3.62 per option issued during the year was determined using the Black Scholes model with the following weighted average assumptions: Share price Expected life Risk-free interest rate Expected volatility Dividend yield $19.43 7.99 years 1.33% 22.44% 2.17% The compensation expense for the year ended May 5, 2018 related to the issuance of options was $2.6 (2017 – $3.3). The total increase in contributed surplus related to stock options during the year ended May 5, 2018 was $2.6 (2017 – $3.3). The outstanding options at May 5, 2018 were granted at prices between $15.60 and $30.87 and expire between June 2018 and June 2025 with a weighted average remaining contractual life of 5.20 years. Stock option transactions during ﬁ scal 2018 and 2017 were as follows: Balance, beginning of year Granted Exercised Expired Forfeited Balance, end of year 2018 2017 Number of Options 4,949,863 1,338,980 (122,805) (749,971) (729,912) $ Weighted Average Exercise Price 24.27 19.43 22.26 25.92 23.45 $ Number of Options 3,655,322 1,642,700 – – (348,159) 4,686,155 $ 22.81 4,949,863 $ Weighted Average Exercise Price 25.94 20.40 – – 23.51 24.27 Stock options exercisable, end of year 2,301,032 2,110,743 80 Annual Report 2018 The following table summarizes information related to stock options outstanding at May 5, 2018: Year Granted 2011 2012 2013 2014 2015 2016 2017 2018 Total Options Outstanding Options Exercisable Weighted Average Remaining Contractual Weighted Average Life(1) Exercise Price Number Exercisable at May 5, 2018 Weighted Average Exercise Price $ 0.15 1.16 2.16 3.16 4.17 5.17 6.18 7.18 $ 17.33 18.13 17.98 26.30 22.44 30.04 20.28 19.46 14,418 10,392 14,262 1,387,806 401,000 179,871 293,283 – 5.20 $ 22.81 2,301,032 $ 17.33 18.13 17.98 26.30 22.44 30.04 20.29 – 25.01 Number of Outstanding Options 14,418 10,392 14,262 1,387,806 530,337 354,659 1,138,136 1,236,145 4,686,155 (1) Weighted average remaining contractual life is expressed in years. DEFERRED STOCK UNIT PLANS In the ﬁ rst quarter of ﬁ scal 2017, the Company implemented a new employee deferred stock unit (“DSU”) plan. The DSUs issued to employees vest dependent on time and the achievement of speciﬁ c performance measures. At May 5, 2018, there were 803,777 (2017 – 578,444) DSUs outstanding related to this plan and the total carrying amount of the liability was $8.2 (2017 – $1.9). The compensation expense for the year ended May 5, 2018 related to DSUs was $7.4 (2017 – $1.9). Members of the Board of Directors may elect to receive all or any portion of their fees in 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 directors’ or employees’ fee payment date. At May 5, 2018, there were 198,240 (2017 – 263,199) DSUs outstanding and the total carrying amount of the liability was $4.9 (2017 – $5.7). During the year ended May 5, 2018, the compensation expense recorded was $2.1 (2017 – $1.5). Under both DSU plans, vested DSUs cannot be redeemed until the employee has left the Company or the holder is no longer a director of the Company, respectively. The redemption value of a DSU equals the market value of an Empire Non-Voting Class A share at the time of redemption. On an ongoing basis, the Company values the DSU obligation at the current market value of a corresponding number of Non-Voting Class A shares and records any increase or decrease in the DSU obligation as selling and administrative expenses. 27. Related party transactions The Company has related party transactions with Crombie REIT and key management personnel. The Company holds a 41.5% ownership interest in Crombie REIT and accounts for its investment using the equity method. The Company leased certain real property from Crombie REIT during the year at amounts which in management’s opinion approximate fair market value that would be incurred if leased from a third party. Management has determined these amounts to be fair value based on the signiﬁ cant number of leases negotiated with third parties in each market it operates. The aggregate net payments under these leases, which are measured at exchange amounts, totaled approximately $199.7 (2017 – $195.8). Crombie REIT provides administrative and management services to the Company on a fee for service basis pursuant to a Management Agreement effective January 1, 2016. The Management Agreement replaces the previous arrangement where charges incurred were on a cost recovery basis. On July 4, 2017, Crombie REIT redeemed its 5.00% Series D Convertible Unsecured Subordinate Debentures. In exchange for its investment in the Series D convertible debentures, the Company received $24.3 in principal and interest payments. There was no gain or loss recognized on the redemption. During the year ended May 5, 2018, the Company received interest from Crombie REIT of $0.2 (2017 – $1.2). On April 6, 2018, Sobeys and its wholly-owned subsidiaries entered into an agreement with Crombie REIT to sell a portfolio of 11 properties, nine of which were leased back. Total cash proceeds to the Company and its wholly-owned subsidiaries from this transaction were $88.1, resulting in a pre-tax gain of $13.2 which has been recognized on the consolidated statements of earnings. On September 29, 2017, Sobeys sold a property to Crombie REIT for cash consideration of $6.4. This resulted in a pre-tax gain of $0.2, which has been recognized in other income on the consolidated statements of earnings. 81 Empire Company Limited NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS On June 29, 2016, Sobeys and its wholly-owned subsidiaries entered into an agreement with Crombie REIT to sell and leaseback a portfolio of 19 retail properties and a 50% interest in each of its three automated distribution centres, as well as the sale of two parcels of development land which were previously owned by Empire. Crombie REIT also invested approximately $58.8 in renovations or expansions of ten Sobeys retail locations already in Crombie REIT’s portfolio. In addition to cash, Crombie REIT issued to a subsidiary of the Company $93.4 in value of Crombie Limited Partnership (“CLP”) Class B units with attached Crombie REIT special voting units at a price of $14.70 per unit. The subsidiary of the Company subsequently sold its CLP Class B units to Empire on a tax deferred basis. Total cash proceeds to the Company and its wholly-owned subsidiaries from these transactions with Crombie REIT and Empire were $323.8, resulting in a pre-tax loss of $0.8 which has been recognized on the consolidated statements of earnings. Proceeds from the transactions were used to repay the senior unsecured notes. On July 29, 2016, Sobeys, through a wholly-owned subsidiary, sold and leased back an additional property from Crombie REIT for cash consideration of $26.4. This resulted in a pre-tax gain of $2.1, which has been recognized on the consolidated statements of earnings. Sobeys also purchased one property from Crombie REIT for $9.1. During ﬁ scal 2014, Sobeys entered into a loan agreement with Crombie REIT to partially ﬁ nance Sobeys’ acquisition of a property in British Columbia. The $11.9 loan bore interest at a rate of 6.0% and had no principal repayments. On May 5, 2017, Sobeys sold the property to Crombie REIT for cash consideration of $31.1, resulting in a pre-tax gain of $1.0, which has been recognized on the consolidated statements of of earnings. Proceeds from the transaction were used to repay the loan. KEY MANAGEMENT PERSONNEL COMPENSATION Key management personnel include the Board of Directors and members of the Company’s executive team that have authority and responsibility for planning, directing and controlling the activities of the Company. Key management personnel compensation is comprised of: Salaries, bonus and other short-term employment beneﬁ ts Post-employment beneﬁ ts Termination beneﬁ ts Share-based payments Total INDEMNITIES May 5, 2018 May 6, 2017 $ $ 13.3 1.5 0.8 9.8 25.4 $ $ 9.7 1.6 8.7 14.8 34.8 The Company has agreed to indemnify its directors, ofﬁ cers and particular employees in accordance with the Company’s policies. The Company maintains insurance policies that may provide coverage against certain claims. 28. Capital management The Company’s objectives when managing capital are: (i) ensure sufﬁ cient liquidity to support its ﬁ nancial 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 ﬁ nancial ﬂ exibility while also ensuring compliance with any ﬁ nancial covenants; and (iv) to maintain an investment grade credit rating with each rating agency that assesses the credit worthiness of the Company. There have been no changes to the Company’s objectives during the year ended May 5, 2018. 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. The Company considers its total capitalization to include all interest bearing debt, including bank loans, long-term debt (including the current portion thereof) and shareholders’ equity, net of cash and cash equivalents. The calculation is set out in the following table: Long-term debt due within one year Long-term debt Funded debt Less cash and cash equivalents Net funded debt Shareholders’ equity, net of non-controlling interest Capital under management 82 May 5, 2018 May 6, 2017 $ 527.4 1,139.5 1,666.9 (627.9) 1,039.0 3,702.8 $ 134.0 1,736.8 1,870.8 (207.3) 1,663.5 3,644.2 $ 4,741.8 $ 5,307.7 Annual Report 2018 Although the Company does not include operating leases in its deﬁ nition 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, renovation, expansion, and improvements to existing stores. These additions and modiﬁ cations to the store network include related leasehold improvements 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 investments and other operations. The Company largely relies on its cash ﬂ ow from operations to fund its capital investment program and dividend distributions to its shareholders. The cash ﬂ ow is supplemented, when necessary, through the incurrence of additional debt or the issuance of additional capital stock. No changes were made to these objectives in the current year. Management monitors certain key ratios to effectively manage the capital structure and debt obligations of the Company: Funded debt to total capital(1) Funded debt to EBITDA(2) EBITDA to interest expense(2) May 5, 2018 May 6, 2017 31.0% 2.1 x 8.1 x 33.9% 2.4 x 7.5 x (1) Total capital is funded debt plus shareholders’ equity, net of non-controlling interest. (2) EBITDA and interest expense are comprised of EBITDA and interest expense for each of the 52 week periods then ended. EBITDA consists of operating income plus depreciation and amortization of intangibles, while interest expense consists of interest expense on ﬁ nancial liabilities measured at amortized cost plus losses on cash ﬂ ow hedges reclassiﬁ ed from other comprehensive income or loss. Under the terms of existing debt agreements, three ﬁ nancial covenants are monitored on a quarterly basis by management to ensure compliance with the agreements. The covenants are: (i) adjusted total debt/EBITDA – calculated as net funded debt plus letters of credit, guarantees and commitments divided by EBITDA (as deﬁ ned by the credit agreements and for the previous 52 weeks); (ii) lease adjusted debt/EBITDAR – calculated as adjusted total debt plus eight times rent divided by EBITDAR (as deﬁ ned by the credit agreements and for the previous 52 weeks); and (iii) debt service coverage ratio – calculated as EBITDA divided by interest expense plus repayments of long-term debt (as deﬁ ned by the credit agreements and for the previous 52 weeks). The Company was in compliance with these covenants during the year. 83 ELEVEN-YEAR FINANCIAL REVIEW Year Ended(1) Financial Results ($ in millions) Sales Operating income (loss) Finance costs, net Income tax expense (recovery) Non-controlling interest Net earnings (loss)(5) Adjusted net earnings(5) Financial Position ($ in millions) Total assets Long-term debt (excluding current portion) Shareholders’ equity(5) Per Share Data on a Fully Diluted Basis ($ per share) Net earnings (loss)(5) Adjusted net earnings(5) Dividends Non-Voting Class A shares Class B common shares Book value Share Price, Non-Voting Class A Shares ($ per share) High Low Close Empire Company Limited 2018 2017 2016 (2)(3) 2015 $ 24,214.6 346.5 110.5 56.2 20.3 159.5 344.3 $ 23,806.2 333.0 118.0 42.5 14.0 158.5 191.3 $ 24,618.8 (2,418.5) 137.4 (441.3) 16.4 (2,131.0) 410.2 $ 23,928.8 742.4 155.1 150.4 17.9 419.0 511.0 8,662.0 1,139.5 3,702.8 8,695.5 1,736.8 3,644.2 9,138.5 2,017.0 3,623.9 11,497.2 2,230.2 5,986.7 0.59 1.27 0.420 0.420 13.62 26.15 18.74 25.01 272.1 0.58 0.70 0.410 0.410 13.40 22.56 15.00 21.50 272.0 (7.78) 1.50 0.400 0.400 13.23 30.79 20.23 21.09 274.0 1.51 1.84 0.360 0.360 21.61 31.60 21.67 29.15 277.2 Diluted weighted average number of shares outstanding (in millions) (1) Fiscal years end the ﬁ rst Saturday in May, consistent with the ﬁ scal year-end of Sobeys Inc. Financial data for ﬁ scal 2008 to 2010, with the exception of the balances noted for ﬁ nancial position for ﬁ scal 2010, were prepared using CGAAP and have not been restated to IFRS. Fiscal 2011 and 2016 are 53-week years. (2) Amounts have been reclassiﬁ ed to correspond to the current period presentation on the consolidated balance sheets. (3) Amounts have been restated. See “Changes to Accounting Policies Adopted During Fiscal 2017” section of the ﬁ scal 2017 annual MD&A for further detail. (4) Certain balances have been reclassiﬁ ed for changes to comparative ﬁ gures for ﬁ scal 2011. See Note 32 to the Company’s ﬁ scal 2012 audited annual consolidated ﬁ nancial statements. (5) Net of non-controlling interest. 84 Annual Report 2018 2014 2013 2012 2011(4) 2010 2009 2008 $ 20,957.8 326.7 131.4 36.3 8.0 235.4 390.6 $ 17,343.9 573.2 55.4 136.4 9.1 379.5 390.7 $ 16,249.1 534.3 59.9 122.3 12.7 339.4 322.7 $ 15,956.8 525.7 75.4 122.0 9.0 400.6 303.2 $ 15,516.2 479.7 72.5 99.1 5.6 301.9 284.5 $ 15,015.1 466.2 80.6 115.4 8.3 264.7 261.7 $ 14,065.0 472.6 105.8 125.9 12.8 315.8 242.8 12,236.6 3,282.1 5,700.5 7,140.4 915.9 3,724.8 6,913.1 889.1 3,396.3 6,518.6 1,090.3 3,162.1 6,248.3 821.6 2,952.4 5,891.1 1,124.0 2,678.8 5,729.4 1,414.1 2,378.8 0.98 1.62 0.347 0.347 20.59 27.75 21.68 22.88 240.6 1.86 1.91 0.320 0.320 18.27 22.88 17.85 22.86 204.2 1.66 1.58 0.300 0.300 16.66 21.00 17.57 19.21 204.2 1.96 1.48 0.267 0.267 15.49 19.71 17.02 18.05 204.6 1.47 1.39 0.247 0.247 14.36 17.98 13.23 17.66 205.4 1.34 1.33 0.233 0.233 13.02 18.26 12.21 16.33 197.4 1.60 1.23 0.220 0.220 12.03 18.40 11.80 13.08 197.2 85 Empire Company Limited SHAREHOLDER AND INVESTOR INFORMATION Empire Company Limited 115 King Street Stellarton, Nova Scotia B0K 1S0 Telephone: (902) 752-8371 Fax: (902) 755-6477 www.empireco.ca Dividend Record and Payment Dates for Fiscal 2019 Record Date July 13, 2018 October 15, 2018* January 15, 2019* April 15, 2019* Payment Date July 31, 2018 October 31, 2018* January 31, 2019* April 30, 2019* * Subject to approval by the Board of Directors. Investor Relations and Inquiries Shareholders, analysts and investors should direct their ﬁ nancial inquiries or requests to: Outstanding Shares As at June 28, 2018 E-mail: investor.relations@empireco.ca Communication regarding investor records including changes of address or ownership, lost certiﬁ cates or tax forms, should be directed to the Company’s transfer agent and registrar, AST Trust Company (Canada). Afﬁ liated Company Web Address www.sobeyscorporate.com Transfer Agent AST Trust Company (Canada) Investor Correspondence P.O. Box 700, Station B Montreal, Québec H3B 3K3 Telephone: 1-800-387-0825 E-mail: inquiries@astﬁ nancial.com Multiple Mailings If you have more than one account, you may receive a separate mailing for each. If this occurs, please contact AST Trust Company (Canada) at 1-800-387-0825 to eliminate the multiple mailings. Shareholders’ Annual General Meeting September 13, 2018 at 11:00 a.m. (ADT) Cineplex Cinemas 612 East River Road New Glasgow, Nova Scotia Non-Voting Class A shares Class B common shares, voting 173,548,969 98,138,079 Stock Exchange Listing The Toronto Stock Exchange Stock Symbol Non-Voting Class A shares – EMP.A Bankers The Bank of Nova Scotia Bank of Montreal MUFG Bank, Ltd. Canadian Imperial Bank of Commerce National Bank of Canada Rabobank Nederland Royal Bank of Canada The Toronto-Dominion Bank Caisse Centrale Desjardins Solicitors Stewart McKelvey Halifax, Nova Scotia Auditor PricewaterhouseCoopers, LLP Halifax, Nova Scotia 86 a d a n a C n i d e t n i r P i m o c . b a r c . w w w s n o i t a c i n u m m o C & n g i s e D b a r i C : n g i s e D www.empireco.ca

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