Leon's Furniture Ltd. Annual Report 2016

Plain-text annual report

L e o n ’ s F u r n i t u r e L i m i t e d | 2 0 1 6 A n n u a l R e p o r t WHERE it matters MOST 2016 Annual Report Leon’s Furniture Limited After 107 years and still growing strong, Leon’s is Canada’s largest retailer of furniture, appliances and home electronics with more than $2.53 billion in annual sales, six leading banners, an expanding online presence, and 305 stores from Vancouver Island to Newfoundland and Labrador. 1 WHERE it matters MOST Leon’s unmatched retail and distribution networks, growing online presence, and full spectrum of after-sales services, set us apart from industry competitors and close to the lives of our customers no matter where, when or how they wish to deal with us. Financial Highlights ($ in thousands, except per share amounts) Revenue Income before income taxes Net income Cash generated from operations Dividends paid Per common share Net income Cash flow generated from operations Dividends declared Shareholders’ equity at year end 2016 2015 % Change $ 2,143,736 114,188 83,591 164,648 28,649 $ 2,031,718 101,419 76,629 58,483 28,465 $ $ $ $ 1.17 $ 2.30 $ 0.40 $ 9.20 $ 1.08 0.82 0.40 8.43 5.5% 12.6% 9.1% 181.5% 0.6% 8.3% 180.5% – 9.1% 2016 2015 Revenue Net Income Shareholders’ Equity 2016 2015 2016 2015 5.5% GROWTH 9.1% GROWTH 9.1% GROWTH (per share) For an extensive look at our 5-Year Review please see page 11. 2 Leon’s Furniture Limited | 2016 Annual Report CHIEF EXECUTIVE OFFICER’S MESSAGE CLOSE to our CUSTOMERS 2016 was a year of continued progress for the Leon Group of Companies. We strengthened the market-leading positions of our retail divisions, harmonized the management of our businesses following the completion of our enterprise information system, and opened seven new Leon’s stores, extending the banner to British Columbia for the first time. In addition we opened a new Brick store in Moncton, New Brunswick and a new Appliance Canada store in the Greater Toronto Area. Leon’s achieved record financial results during another challenging year in the Canadian retail industry. System-wide sales reached $2.53 billion, including $388 million of franchise sales, compared to $2.41 billion, including $376 million of franchise sales, in 2015. As a result of strong merchandising and promotional activity, same-store sales increased by 4.1 percent, despite slow growth in the Canadian economy and continued weakness in consumer spending. Earnings outpaced sales growth, rising 9.1 percent to record net income of $83.6 million or $1.17 per share, as we took advantage of our enterprise information system continued to gain efficiencies and minimize expenses. We also continued to strengthen the balance sheet, retiring $50 million in long-term debt associated with the acquisition of The Brick. 2016 IN REVIEW One of the year’s most significant developments was the quickening pace of the integration that has taken place since Leon’s acquired The Brick in 2013. We have favoured a deliberately measured approach to the union of these two Canadian retailing icons, taking our time to get to know each other, share best practices, and foster input and buy-in for our strategic initiatives. At the same time, we have been careful to preserve the qualities that distinguish Leon’s and The Brick in the marketplace by ensuring both divisions continue to operate independently with regard to merchandising and marketing strategies. This pace of integration began to pick up momentum in 2016, as we were able to leverage the benefits of the enterprise information system completed at the end of 2015. With the full benefit of this system, we have gained a unified perspective on our business and a common language to use in the way we measure and manage it. This has helped us build a stronger corporate culture in support of key objectives and allowed us to work more effectively to improve our financial and operating performance. Yet greater potential synergies still lie ahead in the integration of our distribution system. Our vision is to create a unified national network that will efficiently serve customers of both divisions, including our online operations. In August 2017, we are scheduled to open a 434,000 sq. ft. distribution centre in Delta, British Columbia. This state-of-the- art facility will represent our first trial of the shared distribution concept, meeting the needs of 35 Brick locations in the province as well as our first four Leon’s stores in British Columbia. These new Leon’s locations in Abbottsford, Langley, Richmond and Victoria were the result of a transaction in which we acquired eight leases from Sears Canada in February 2016. Also related to this transaction were three new Leon’s locations, one Appliance Canada location which opened in the Greater Toronto Area, and one Brick store which opened in Moncton, New Brunswick during the year. All of these new stores are well located in busy and growing communities. Revenue 2016 2015 5.5% GROWTH Where it Matters Most 3 4 Ours is still a highly fragmented industry, comprised of hundreds of regional and independent operators, and it is expected to consolidate significantly in the years ahead. Leon’s Furniture Limited | 2016 Annual Report5 Today, we are proud to have the most expansive retail network in the industry. It now includes 305 stores from Vancouver Island to Newfoundland and Labrador. We are also Canada’s #1 commercial retailer of conventional and luxury appliances through our Appliance Canada and Midnorthern Appliance stores. Despite this unprecedented scale, Leon’s has abundant room to grow. Although we are Canada’s largest retailer of furniture, appliances and home electronics, we hold less than a 20 percent share of our market. Ours is still a highly fragmented industry, comprised of hundreds of regional and independent operators, and it will continue to consolidate in the years ahead. We also see opportunity to expand Leon’s in Western Canada and The Brick in Atlantic Canada where these banners are relatively unrepresented. Supporting this store network is our increasingly important online presence through leons.ca, thebrick.com, and furniture.ca, which now features more than 16,000 stylish home décor products. These popular websites are part of an omni-channel marketing strategy that is making it easy for customers to deal with us wherever, whenever and however they choose. Complementing our retail networks are several related businesses that allow our customers to get everything related to their purchases from Leon’s, including financing insurance, warranty protection and after-sales service and repair. TransGlobal Service "TGS", formerly the service and repair division of The Brick, is now the largest operation of its kind in Canada, servicing and repairing appliances for all major manufacturers across the country. In 2016, TGS expanded into the fast growing direct-to-consumer market. All of our closely related businesses are profitable and well positioned in their respective industries with the potential to make growing contributions to the Company’s earnings in the years ahead. Through subsidiary Murlee Holdings Limited and Leon’s Holdings (1967) Limited, we also possess 271 acres of land and a 3.6 million square foot portfolio of commercial real estate, much of it in prime urban locations, with enormous unrealized value and development potential. Where it Matters Most6 For the past 107 years, through many economic cycles, we have always tried to deliver the best combination of selection, service and value to our customers. THE YEAR AHEAD Our expectations for the Canadian economy in 2017 are continued slow growth given high levels of consumer debt and continued relative weakness in commodity prices. The U.S. economy will likely be stronger, which could serve a catalyst for the Canadian economy later in the year. Whatever the macro- economic climate, we will continue to develop our business where it matters most to our customers. For the past 107 years, through many economic cycles, we have always tried to deliver the best combination of selection, service and value to our customers. In 2017, that commitment will be reflected in all that we do, from our distinctive marketing and merchandising programs to the many initiatives aimed at surfacing incremental efficiencies in our retail businesses. We will also continue to invest in the complementary distribution channels and services that have helped make Leon’s the most complete retailer in our industry. In closing, on behalf of our President of the LFL Group Eddy Leon, and myself, we would like to thank our many talented and dedicated executives, including Mr. Mike Walsh, whose presidential leadership continues to improve our Leon’s Division and Mr. Dave Freeman, who was appointed President of The Brick in November 2016. A 35-year veteran of the Company, Dave is an experienced retailer who served most recently as Senior Vice President of Operations. We would also like to extend our appreciation to the corporate and franchise store management teams and all of the associates throughout our businesses. Thanks to their dedication, we are gaining momentum as a single, culturally integrated organization with the two most powerful brands in the business. We still have further to go in this journey but with your continued support, we look forward to reporting on our progress in the months ahead. Sincerely, "Terrence T. Leon" Terrence T. Leon Chief Executive Officer Leon’s Furniture Limited | 2016 Annual Report 7 Where it Matters Most8 Leon’s Furniture Limited | 2016 Annual Report 1 ACROSS the COUNTRY 35 4 1 53 6 5 1 1 11 3 2 8 2 1 71 47 3 4 107 Years of History 1909 1973 1974 1983 1985 The A. Leon Co. opens for business on King Street in Welland, Ontario. Leon’s introduces “big-box” retailing to Canada with the opening of our first warehouse showroom in Weston, Ontario. The opening of our 10th store in Laval, Québec marks Leon’s expansion beyond Ontario. Leon’s extends its presence to smaller centres with the introduction of the first franchise store in Kingston, Ontario. Leon’s opens its first store in Atlantic Canada in Saint John, New Brunswick. 9 2017 Scheduled to open in 2017, our new state-of-the-art distribution centre in British Columbia will serve the joint requirements of all Leon’s and The Brick locations in the province. NATIONWIDE 305 STORES 202 The Brick 86 Leon’s Furniture 11 United Furniture Warehouse/ Brick Clearance Centres 2 4 United Furniture Warehouse Appliance Canada 3 1 1 16 11 2 4 3 5 2011 2012 2013 2014 2016 Leon’s opens four new corporate stores, and two new franchise locations, including our first franchise store in Québec. Leon’s secures sites for four new corporate stores, three of which opened in 2013. Leon’s acquires The Brick creating Canada’s largest home furnishing, appliance and electronics retailer, with a network of over 300 stores from coast to coast. Leon’s acquires minority interest in online commerce provider, Blueport Investors LLC, with exclusive rights to the tradename and URL furniture.ca in Canada. Leon’s opens 9 new stores during the year, including the first four Leon’s stores in British Columbia. As a result, customers can shop at Leon’s and The Brick in every province of Canada. Where it Matters Most10 STRONG Communities Leon’s has always believed in giving something back to the communities that are home to our stores and continue to make us a prosperous and growing company. Our Leon’s and The Brick divisions share a long-standing tradition of supporting the communities that are home to our operations, both corporately, and through the volunteer efforts, resources and financial contributions of our stores and associates across the country. The largest recipients of Leon’s support are health care facilities. Leon’s believes there are no better causes than the physical and mental welfare of our customers, friends, and families. In this regard, several of the country’s outstanding hospitals receive significant contributions annually. Along with the hospitals, there are a number of health associations, children’s charities, societies and foundations that are supported. Leon’s also assists the local communities served by its store network with financial contributions, as well as the volunteer efforts of our associates who contribute hundreds of hours of service across this country each year. The Brick division shares a similar focus on improving the health and well-being of the communities that are home to its store network. In 2016, this could be seen in the support of the Children’s Miracle Network®, which raises funds and awareness for 170 member hospitals, 12 of which are in Canada. Donations stay local to fund critical treatments and health care services, paediatric medical equipment and research. We are also proud to sponsor Breakfast for LearningTM, which works with schools across Canada to help them start and operate programs that have provided more than 638 million meals to more than three million Canadian children since the program started in 1992. You can learn more about our support for these and other important causes at www.leons.ca and www.thebrick.com. ™ Leon’s Furniture Limited | 2016 Annual Report5-Year Review Leon’s results include operations of The Brick Ltd. from March 28, 2013. 11 Income Statistics ($ in thousands, except amounts per share) 2016 2015 2014 2013 2012 Revenue Cost of sales Gross profit Operating expenses Income before income taxes Provision for income taxes Net income Common shares outstanding (’000s) Earnings per common share Percent annual change in sales Net income as a percentage of sales $ $2,143,736 1,228,499 2,031,718 1,145,593 2,008,480 1,131,651 1,721,874 959,307 915,237 801,049 114,188 30,597 83,591 71,696 1.17 5.5% 3.9% $ $ 886,125 784,706 101,419 24,790 76,629 71,218 1.08 1.2% 3.8% 876,829 773,695 103,134 27,610 75,524 70,899 1.07 16.6% 3.8% 28,370 762,567 669,297 93,270 24,878 68,392 70,612 0.97 152.4% 4.0% 28,247 682,163 398,704 283,459 219,776 63,683 16,901 46,782 70,033 0.67 (0.1%) 6.9% 28,047 Dividend declared $ 28,691 28,501 Balance Sheet Statistics ($ in thousands, except amounts per share) 2016 2015 2014 2013 2012 Shareholders’ equity Total assets Purchase of capital assets Working capital Shareholders’ equity per common share Common share price range on the Toronto Stock Exchange High Low $ 659,553 1,611,662 25,689 120,563 9.20 600,402 $ 549,105 $ 497,764 $ 1,583,463 22,756 65,419 8.43 1,563,476 16,562 46,931 7.74 1,565,356 18,984 16,246 7.05 452,187 588,178 17,897 226,208 6.46 $ $ 18.75 13.08 19.38 $ 12.61 $ 17.90 $ 13.41 $ 14.75 $ 11.62 $ 13.47 10.55 Revenue $2,143,736 ($ in thousands) Net Income $83,591 ($ in thousands) 2,250, 000 2,000, 000 1,750, 000 1,500, 000 1,250, 000 1,000, 000 750,000 500,000 250,000 0 90,000 80,000 70,000 60,000 50,000 40,000 30,000 20,000 10,000 0 Shareholders’ Equity (per share) $9.20 ($ per share) 10 9 8 7 6 5 4 3 2 1 0 12 13 14 15 16 12 13 14 15 16 12 13 14 15 16 Where it Matters Most In more than 300 stores from coast to coast, and through a rapidly growing online presence, Leon’s Furniture Limited offers an unbeatable combination of service, selection and value to Canadian customers, no matter how, when or where they wish to find us. MANAGEMENT’S DISCUSSION & ANALYSIS 13 For the quarters and years ended December 31, 2016 and 2015. The following Management’s Discussion and Analysis (“MD&A”) is prepared as at February 23, 2017 and is based on the consolidated financial position and operating results of Leon’s Furniture Limited/Meubles Leon Ltée (the “Company”) as of December 31, 2016 and for the year ended December 31, 2016. It should be read in conjunction with the fiscal year 2016 consolidated financial statements and the notes thereto. For additional detail and information relating to the Company, readers are referred to the fiscal 2016 quarterly financial statements and corresponding MD&As which are published separately and available at www.sedar.com. Cautionary Statement Regarding Forward-Looking Statements This MD&A is intended to provide readers with the information that management believes is required to gain an understanding of Leon’s Furniture Limited’s current results and to assess the Company’s future prospects. This MD&A, and in particular the section under heading “Outlook”, includes forward-looking statements, which are based on certain assumptions and reflect Leon’s Furniture Limited’s current plans and expectations. These forward-looking statements are subject to a number of risks and uncertainties that could cause actual results and future prospects to differ materially from current expectations. Some of the factors that can cause actual results to differ materially from current expectations are: a further drop in consumer confidence; dependency on product from third party suppliers, further changes to the Canadian bank lending rates; and a further weakening of the Canadian dollar vs. the US dollar. Given these risks, uncertainties and the integration risk associated with the acquisition of The Brick Ltd. (“The Brick”), investors should not place undue reliance on forward-looking statements as a prediction of actual results. Readers of this report are cautioned that actual events and results may vary. Financial Statements Governance Practice The consolidated financial statements of the Company have been prepared in accordance with the International Financial Reporting Standards (“IFRS”) as issued by the International Accounting Standards Board (“IASB”). The amounts expressed are in Canadian dollars. Per share amounts are calculated using the weighted average number of shares outstanding before and after considering the potential dilutive effects of the convertible debentures and the management share purchase plan for the applicable period. The Audit Committee of the Board of Directors of Leon’s Furniture Limited reviewed the MD&A and the consolidated financial statements, and recommended that the Board of Directors approve them. Following review by the full Board, the fiscal year 2016 consolidated financial statements and MD&A were approved on February 23, 2017. 14 1. BUSINESS OVERVIEW Leon’s Furniture Limited is the largest network of home furniture, appliances and electronics, and mattress stores in Canada. Our retail banners include: Leon’s; The Brick; The Brick Mattress Store; The Brick Clearance Centre; and United Furniture Warehouse (“UFW”). Finally, the combination of The Brick’s Midnorthern Appliance banner alongside with the Appliance Canada banner, makes the Company the country’s largest commercial retailer of appliances to builders, developers, hotels and property management companies. The Company operates three websites: leons.ca, thebrick.com and our newest website furniture.ca. The Company’s repair service division, Trans Global Services (“TGS”), provides household furniture, electronics and appliance repair services to its customers. TGS has contracts to support several manufacturers’ warranty service work in addition to servicing a number of individual programs offered by other dealers. This division also performs work for products sold with extended warranties and is an integral part of the retail offering. These extended warranties, underwritten by the Company’s wholly owned subsidiaries, are offered on appliances, electronics and furniture to provide coverage that extends beyond the manufacturer’s warranty period by up to five years. The warranty contracts provide both repair and replacement service depending upon the nature of the warranty claim. The Company’s wholly-owned subsidiaries Trans Global Insurance Company (“TGI”) and its sister company, Trans Global Life Insurance Company (“TGLI”) also offer credit insurance on the customer’s outstanding financing balances. This credit insurance coverage includes life, dismemberment, disability, critical illness, and involuntary unemployment. These credit insurance policies are underwritten by TGI and TGLI as they are licensed as insurance companies in all Canadian provinces and territories. The Company has foreign operations in Asia, through its wholly owned subsidiary First Oceans Trading Corporation. These operations relate to the Company’s import and quality control program for sourcing products from Asia for resale in Canada through its retail operations. Leon’s has 305 retail stores from coast to coast in Canada under the various banners indicated below. Banner 2015 Opening Closing 2016 Number of Stores as at December 31, Number of Stores as at December 31, Leon’s banner corporate stores Leon’s banner franchise stores Appliance Canada banner stores The Brick banner corporate stores1 The Brick banner franchise stores2 The Brick Mattress Store banner locations UFW banner stores UFW and The Brick Clearance Centre banner stores Total number of stores 1 Includes the Midnorthern Appliance banner 2 Includes one UFW Franchise 2. NON-IFRS FINANCIAL MEASURES 44 36 3 113 67 22 2 14 301 7 – 1 2 – 4 – – (1) – – (1) (3) (2) – (3) 14 (10) 50 36 4 114 64 24 2 11 305 The Company uses financial measures that do not have standardized meaning under IFRS and may not be comparable to similar measures presented by other entities. The Company calculates the non-IFRS measures by adjusting certain IFRS measures for specific items the Company believes are significant, but not reflective of underlying operations in the period, as detailed below: Non-IFRS Measure Adjusted net income Adjusted income before income taxes Adjusted earnings per share – basic Adjusted earnings per share – diluted Adjusted EBITDA IFRS Measure Net income Income before income taxes Earnings per share – basic Earnings per share – diluted Net income Adjusted Net Income • severance charges in the period, a non-recurring expense Leon’s calculates comparable measures by excluding the effect of: included in the Company’s SG&A; and • the mark-to-market adjustments included in the Company’s selling, general and administration (“SG&A”) income statement line item, related to the net effect of USD-denominated forward contracts and an interest rate swap on the Company’s term credit facility. In accordance with the Company’s corporate treasury policy, the Company uses forward currency contracts to manage the risk associated with its USD-denominated purchases and an interest rate swap to manage interest rate risk on its term credit facility which began in 2014; • non-recurring prior period tax adjustments from 2015 relating to the acquisition of The Brick. Management believes excluding from income the effect of these mark-to-market valuations and changes thereto, until settlement, better aligns the intent and financial effect of these contracts with the underlying cash flows. Similarly, excluding from income the effect of non-recurring expenses better reflects Leon’s normalized SG&A as a percentage of revenue in the period. Leon’s Furniture Limited | 2016 Annual Report 15 The following is a reconciliation of reported net income to adjusted net income, basic and diluted earnings per share to adjusted basic and diluted earnings per share: ($ in thousands) Net income For the three months ended December 31 For the years ended December 31 2016 2015 2016 2015 $ 37,233 $ 30,187 $ 83,591 $ 76,629 After-tax mark-to-market loss (gain) on financial derivative instruments After-tax severance charge Prior period tax adjustment (2,488) – – 3,025 – (2,623) 1,943 1,228 – (268) – (2,623) Adjusted net income Basic earnings per share Diluted earnings per share Adjusted basic earnings per share Adjusted diluted earnings per share Adjusted EBITDA $ $ $ $ $ 34,745 $ 30,589 $ 86,762 $ 73,738 0.52 0.46 0.48 0.43 $ $ $ $ 0.42 $ 0.38 $ 0.43 $ 0.39 $ 1.17 1.05 1.21 1.08 $ $ $ $ 1.08 0.97 1.04 0.93 Adjusted earnings before interest, income taxes, depreciation and amortization, mark-to-market adjustment due to the changes in the fair value of the Company’s financial derivative instruments and any non-recurring charges to income (“Adjusted EBITDA”) is a non-IFRS financial measure used by the Company. The Company considers Adjusted EBITDA to be an effective measure of profitability on an operational basis and is commonly regarded as an indirect measure of operating cash flow, a significant indicator of success for many businesses. Adjusted EBITDA is a non- IFRS financial measure used by the Company. The Company’s Adjusted EBITDA may not be comparable to the Adjusted EBITDA measure of other companies, but in management’s view appropriately reflects Leon’s specific financial condition. This measure is not intended to replace net income, which, as determined in accordance with IFRS, is an indicator of operating performance. The following is a reconciliation of reported net income to adjusted EBITDA: ($ in thousands) Net income Income tax expense Net finance costs Depreciation and amortization Severance charge Mark-to-market loss (gain) on financial derivative instruments Prior period tax adjustment Adjusted EBITDA Same Store Sales Same store sales are defined as sales generated by stores that have been open or closed for more than 12 months on a fiscal year basis. Same store sales is not an earnings measure recognized by IFRS, and does not have a standardized meaning prescribed by IFRS, but it is a key indicator used by the Company to measure performance against prior period results. Same store sales as discussed in this MD&A may not be comparable to similar measures presented by other issuers, however this measure is commonly used in the retail industry. We believe that disclosing this measure is meaningful to investors because it enables them to better understand the level of growth of our business. Total System Wide Sales Total system wide sales refer to the aggregation of revenue recognized in the Company’s consolidated financial statements plus the franchise sales occurring at franchise stores to their customers which are not included in the revenue figure presented in the Company’s consolidated financial statements. Total system wide sales is not a measure recognized by IFRS, and does not have a standardized meaning prescribed by IFRS, but it is a key indicator used by the Company to measure performance against prior period results. Therefore, total system wide sales as For the three months ended December 31 For the years ended December 31 2016 2015 2016 2015 $ 37,233 $ 30,187 $ 83,591 $ 76,629 13,600 3,526 10,654 – (3,407) – 7,273 4,243 11,053 – 4,137 (2,623) 30,597 14,481 41,235 1,700 2,662 – 24,790 17,627 41,738 – (368) (2,623) $ 61,606 $ 54,270 $ 174,266 $ 157,793 discussed in this MD&A may not be comparable to similar measures presented by other issuers. We believe that disclosing this measure is meaningful to investors because it serves as an indicator of the strength of the Company’s overall store network, which ultimately impacts financial performance. Franchise Sales Franchise sales figures refer to sales occurring at franchise stores to their customers which are not included in the revenue figures presented in the Company’s consolidated financial statements, or in the same store sales figures in this MD&A. Franchise sales is not a measure recognized by IFRS, and does not have a standardized meaning prescribed by IFRS, but it is a key indicator used by the Company to measure performance against prior period results. Therefore, franchise sales as discussed in this MD&A may not be comparable to similar measures presented by other issuers. Once again we believe that disclosing this measure is meaningful to investors because it serves as an indicator of the strength of the Company’s brands, which ultimately impacts financial performance. Management’s Discussion & Analysis 16 3. RESULTS OF OPERATION Consolidated operating results for the quarters ended December 31, 2016 and December 31, 2015 ($ in thousands except % and per share amounts) 2016 2015 Total system wide sales(1) Franchise sales(1) Revenue Cost of sales Gross profit Gross profit margin as a percentage of revenue Selling, general and administration expenses (excluding mark-to-market impact and severance charge)(1) SG&A as a percentage of revenue Income before net finance costs and income tax expense Net finance costs Income before income taxes (excluding mark-to-market impact and severance charge)(1) Income tax expense Adjusted net income(1) Adjusted net income(1) as a percentage of revenue After-tax mark-to-market loss (gain) on financial derivative instruments(1) After-tax severance charge(1) Prior period tax adjustment(1) $ 704,742 $ 116,361 670,357 110,128 $ 588,381 329,876 258,505 43.93% 207,554 35.28% 50,951 (3,526) 47,425 12,680 34,745 5.91% (2,488) – – 560,229 310,255 249,974 44.62% 204,134 36.44% 45,840 (4,243) 41,597 11,008 30,589 5.46% 3,025 – (2,623) For the three months ended December 31 $ Increase (Decrease) % Increase (Decrease) 34,385 6,233 28,152 19,621 8,531 5.1% 5.7% 5.0% 6.3% 3.4% 3,420 1.7% 5,111 717 5,828 1,672 4,156 11.1% (16.9%) 14.0% 15.2% 13.6% (5,513) (182.2%) – Net income $ 37,233 $ 30,187 $ 7,046 23.3% Basic weighted average number of common shares Basic earnings per share Adjusted basic earnings per share(1) Diluted weighted average number of common shares Diluted earnings per share Adjusted diluted earnings per share(1) Common share dividends declared Convertible, non-voting shares dividends declared (1) Non-IFRS financial measures. Refer to section 2 in this MD&A for additional information. Same Store Sales (1) ($ in thousands except %) Same store sales(1) (1) Non-IFRS financial measures. Refer to section 2 in this MD&A for additional information. Fourth Quarter Overall Performance R E V E N U E For the three months ended December 31, 2016, revenue was $588,381,000 compared to $560,229,000 in the prior year’s fourth quarter. Revenue increased $28,152,000 or 5.0% between the comparative quarters as we continued to see growth in most product categories. S A M E S T O R E S A L E S Overall, same store corporate sales increased 1.1%. G R O S S P R O F I T The gross margin for the fourth quarter 2016 decreased slightly from 44.62% to 43.93% compared to the prior year’s fourth quarter. 0.52 $ 0.48 $ 71,820,999 $ $ 82,989,568 0.46 $ 0.43 $ 71,215,941 0.42 $ 0.43 $ 82,363,520 $ $ 0.38 $ 0.39 $ $ $ 0.10 0.20 $ $ 0.10 0.20 23.8% 11.6% 21.1% 10.3% 0.10 0.05 0.08 0.04 – – For the three months ended December 31 2016 2015 $ Increase % Increase $ 560,541 $ 554,241 $ 6,300 1.1% S E L L I N G , G E N E R A L A N D A D M I N I S T R AT I O N E X P E N S E S Selling, general and administration expenses of $207,554,000 increased $3,420,000 for the fourth quarter 2016 compared to the fourth quarter of 2015. Compared to the prior year quarter, the change is due to an increase in advertising expenditures in order to further promote our brands and increase sales and the increase of store pre-opening costs from opening nine new stores and a distribution centre. I N C O M E TA X E X P E N S E Due to a prior period tax adjustment in the fourth quarter of 2015, the income tax expense increased by $1,672,000. N E T I N C O M E A N D E A R N I N G S P E R S H A R E As a result of the above, net income for the fourth quarter of 2016 was $37,233,000, $0.46 per fully diluted common share ($30,187,000, $0.38 per fully diluted common share in 2015) an increase of $0.08 per common share or 21.1%. Leon’s Furniture Limited | 2016 Annual Report Consolidated operating results for the years ended December 31, 2016, 2015 and 2014 17 For the years ended December 31 ($ in thousands except % and per share amounts) Total system wide sales (1) Franchise sales (1) Revenue Cost of sales Gross profit Gross profit margin as a percentage of revenue Selling, general and administration expenses (excluding mark-to-market impact and severance charge)(1) SG&A as a percentage of revenue Income before net finance costs and income tax expense Net finance costs Income before income taxes (excluding mark-to-market impact and severance charge)(1) Income tax expense Adjusted net income(1) Adjusted net income(1) as a percentage of revenue After-tax mark-to-market loss (gain) on financial derivative instruments(1) After-tax severance charge(1) Prior period tax adjustment(1) Basic weighted average number of common shares Basic earnings per share Adjusted basic earnings per share(1) Diluted weighted average number of common shares Diluted earnings per share Adjusted diluted earnings per share(1) 2016 2015 $ Increase (Decrease) % Increase (Decrease) 2015 2014 $ Increase (Decrease) % Increase (Decrease) $ 2,531,573 387,837 $ 2,407,512 375,794 2,143,736 1,228,499 2,031,718 1,141,706 $ 124,061 12,043 112,018 86,793 915,237 890,012 25,225 5.2% 3.2% 5.5% 7.6% 2.8% $ 2,407,512 375,794 $ 2,383,324 374,844 $ 2,031,718 1,141,706 2,008,480 1,131,651 890,012 876,829 24,188 950 23,238 10,055 13,183 1.0% 0.3% 1.2% 0.9% 1.5% 42.69% 43.81% 43.81% 43.66% 782,206 36.49% 133,031 (14,481) 118,550 31,788 86,762 4.05% 1,943 1,228 – 771,334 10,872 1.4% 37.96% 118,678 (17,627) 14,353 3,146 12.1% (17.8%) 101,051 27,313 17,499 4,475 73,738 13,024 17.3% 16.4% 17.7% 771,334 37.96% 118,678 (17,627) 101,051 27,313 73,738 756,936 37.69% 119,893 (16,759) 103,134 27,610 75,524 3.63% 3.76% 14,398 1.9% (1,215) (868) (1.0%) 5.2% (2,083) (297) (1,786) (2.0%) (1.1%) (2.4%) 3.63% (268) – (2,623) (825.0%) 2,211 1,228 2,623 (268) – (2,623) – – – (268) – (2,623) Net income $ 83,591 $ 76,629 $ 6,962 9.1% $ 76,629 $ 75,524 $ 1,105 1.5% 71,695,955 1.17 $ 1.21 $ 71,217,958 1.08 $ 1.04 $ 83,081,832 1.05 $ 1.08 $ 82,364,539 0.97 0.93 0.40 0.20 $ $ $ $ $ $ $ $ 0.09 0.17 0.08 0.15 – – 8.3% 16.3% 8.2% 16.1% 71,217,958 1.08 $ 1.04 $ 70,898,590 1.07 $ 1.07 $ 82,364,539 0.97 $ 0.93 $ 82,177,519 0.96 $ 0.96 $ $ $ 0.40 0.20 $ $ 0.40 0.20 $ $ $ $ 0.01 (0.03) 0.01 (0.03) – – 0.9% -2.8% 1.0% -3.1% Common share dividends declared Convertible, non-voting shares dividends declared $ $ 0.40 0.20 (1) Non-IFRS financial measures. Refer to section 2 in this MD&A for additional information. Same Store Sales (1) ($ in thousands except %) Same store sales(1) 2016 2015 $ Increase % Increase $ 2,086,388 $ 2,004,986 $ 81,402 4.1% For the years ended December 31 (1) Non-IFRS financial measures. Refer to section 2 in this MD&A for additional information. Year to Date Overall Performance R E V E N U E For the year ended December 31, 2016, revenue was $2,143,736,000 compared to $2,031,718,000 for the prior year. Revenue increased $112,018,000 or 5.5% for the comparative year. S A M E S T O R E S A L E S Overall, same store corporate sales increased 4.1%. G R O S S P R O F I T The gross margin for the year ended December 31, 2016 decreased slightly from 43.81% to 42.69% compared to the prior year. S E L L I N G , G E N E R A L A N D A D M I N I S T R AT I O N E X P E N S E S For the year, selling, general and administration expenses of $782,206,000 were up $10,872,000 or 1.4% as compared to 2015. The increase was mainly the result of incremental selling costs as SG&A expenses as a percentage of revenue in 2016 were 36.49% as compared to 37.96% in the prior year. Additional marketing dollars were also spent in an attempt to generate higher consumer traffic into our stores and this dollar increase was offset by operating efficiencies especially relating to delivery expenses. N E T I N C O M E A N D E A R N I N G S P E R S H A R E As a result of the above, net income for the year was $83,591,000, $1.05 per fully diluted common share ($76,629,000, $0.97 per fully diluted common share in 2015), an increase of $0.08 per common share or 8.2%. Management’s Discussion & Analysis 18 4. SUMMARY OF CONSOLIDATED QUARTERLY RESULTS The table below highlights the variability of quarterly results and the impact of seasonality on the Company’s results. The Company’s profitability is typically lower in the first half of the year, since retail sales are traditionally higher in the third and fourth quarters. ($ in thousands, except per share data) Quarter Ended December 31 Quarter Ended September 30 Quarter Ended June 30 Quarter Ended March 31 2016 2015 2016 2015 2016 2015 2016 2015 Total system wide sales(1) Franchise sales(1) Revenue Net income Adjusted net income(1) Basic earnings(loss) per share Fully diluted earnings(loss) per share Adjusted basic earnings per share(1) Adjusted fully diluted per share(1) $ $ $ $ 704,742 116,361 588,381 37,233 34,745 0.52 0.46 0.48 0.43 $ $ $ $ 670,357 110,128 560,229 30,187 30,589 0.42 0.38 0.43 0.39 673,897 98,173 575,724 34,111 31,300 0.48 0.42 0.44 0.39 $ $ $ $ $ $ $ $ 646,078 97,217 548,861 27,340 24,739 0.38 0.34 0.35 0.31 606,453 90,269 516,184 16,959 15,547 0.24 0.21 0.22 0.20 $ $ $ $ 580,771 87,832 492,939 14,996 15,675 0.21 0.19 0.22 0.20 546,483 83,036 463,447 (4,712) 5,170 (0.07) (0.07) 0.07 0.07 510,305 80,616 429,689 4,106 2,735 0.06 0.06 0.04 0.04 $ $ $ $ $ $ $ $ $ $ $ $ (1) Non-IFRS financial measure. Refer to section 2 in this MD&A for additional information. 5. FINANCIAL POSITION ($ in thousands) Total assets Total non-current liabilities A S S E T S Total assets at December 31, 2016 of $1,611,662,000 were $28,199,000 higher than the $1,583,463,000 reported at December 31, 2015. The principal components of this net change are the following: • $36,126,000 increase in cash and cash equivalents • $10,310,000 increase in trade receivables • $22,878,000 decrease in income taxes receivable • $4,840,000 increase in inventory • $7,718,000 decrease in property, plant and equipment • $6,750,000 decrease in intangible assets • $14,028,000 increase in restricted marketable securities and available-for-sale financial assets 6. LIQUIDITY AND CAPITAL RESOURCES December 31, December 31, December 31, 2016 2015 2014 $ 1,611,662 525,605 $ 1,583,463 543,455 $ 1,563,476 590,055 The increase is primarily the result of the increase in cash, cash equivalents, restricted marketable securities and available-for-sale financial assets offset by the net change in cash and non-cash working capital primarily income taxes receivable. As well, there was the decrease in property, plant and equipment and intangibles as a result of the depreciation and amortization being greater than the purchases of fixed assets and intangibles. N O N - C U R R E N T L I A B I L I T I E S Non-current liabilities of $525,605,000 were $17,850,000 lower than the $543,455,000 reported at December 31, 2015. The reduction is primarily tied to the Company further reducing its loans and borrowings by an equivalent amount. The following table provides a summarized statement of cash flows for the quarters and years ended December 31, 2016 and December 31, 2015. For the three months ended December 31 For the years ended December 31 Source (Use) of Cash ($ in thousands) 2016 2015 $ Increase (Decrease) 2016 2015 $ Increase (Decrease) Cash provided by operating activities before changes in non-cash working capital items Changes in non-cash working capital items Cash provided by operating activities Investing activities Financing activities $ $ 53,646 8,792 62,438 (12,882) (26,514) $ 47,275 (20,600) 26,675 (9,508) (36,492) 6,371 29,392 35,763 (3,374) 9,978 $ 133,410 31,238 164,648 (38,307) (90,215) $ 132,909 (74,426) 58,483 (24,509) (72,015) $ 501 105,664 106,165 (13,798) (18,200) Increase (decrease) in cash and cash equivalents $ 23,042 $ (19,325) $ 42,367 $ 36,126 $ (38,041) $ 74,167 Leon’s Furniture Limited | 2016 Annual Report 19 C A S H F L O W F R O M O P E R AT I N G A C T I V I T I E S Cash from operating activities consist primarily of net income adjusted for certain non-cash items, including depreciation and amortization and the effect of changes in non-cash working capital items, primarily receivables, inventories, deferred acquisition costs, accounts payable, income taxes payable, customer deposits and deferred rent liabilities and lease inducements. In the fourth quarter of 2016, cash flow from operating activities increased $35,763,000 compared to the prior year’s quarter. The increase is the result of the change in non-cash working capital, primarily as a result of the changes in inventory. Traditionally, there is an increase of inventory during the fourth quarter to fulfil sales orders; however, given the openings of a distribution centre and nine new stores, inventory levels increased in the third quarter of 2016 as opposed to the fourth quarter of 2016. In fiscal 2016, cash provided by operating activities increased $106,165,000 from fiscal 2015. The increase is the result of the change in non-cash working capital, primarily as a result of the changes and income taxes receivable. C A S H U S E D I N I N V E S T I N G A C T I V I T I E S Investing activities relate primarily to capital expenditures and the purchase and sale of available-for-sale financial assets. In the fourth quarter of 2016, cash used in investing activities increased $3,374,000 compared to the prior year’s quarter. The change is primarily the result of increased purchases of available- for-sale financial assets net of proceeds on sale of available-for- sale financial assets. In fiscal 2016, cash used in investing activities increased by $13,798,000 from fiscal 2015. The change is primarily the result of increased purchases of available-for-sale financial assets net of proceeds on sale of available-for-sale financial assets. C A S H U S E D I N F I N A N C I N G A C T I V I T I E S Financing activities consist primarily of cash used to pay dividends and the loans and borrowings used to acquire The Brick. In the fourth quarter of 2016, financing activities changed by $9,978,000 compared to the prior year’s quarter. The change relates to the reduction of the Company’s loans and borrowings. In fiscal 2016, cash used in financing activities of $90,215,000 increased $18,200,000 from fiscal 2015. The change relates to the increased repayment of the $20,000,000 of the term loan in 2016. A D E Q U A C Y O F F I N A N C I A L R E S O U R C E S At December 31, 2016, the Company’s current assets exceeded its current liabilities by $120,563,000 and its cash and cash equivalents, restricted marketable securities and available-for-sale financial assets were $99,664,000 compared to $49,510,000 at December 31, 2015. Under the Company’s Senior Secured Credit Agreement, we had unused borrowing capacity of $49.5 million as at the end of December 31, 2016 and $99.5 million as at the end of December 31, 2015. The Company believes that its financing resources together with its continuing profitable results from operations will provide a sound liquidity and working capital position throughout the next twelve months. C O N T R A C T U A L C O M M I T M E N T S ($ in thousands) Contractual Obligations Long term debt Operating leases(1) Trade and other payables Finance lease liabilities $ Total 375,489 477,386 214,838 14,333 Payments Due by Period Under 1 year 1–3 years 3–5 years $ 34,437 $ 90,850 214,838 2,086 231,345 $ 149,342 6,000 $ 108,191 – – 3,739 3,853 More than 5 years 103,707 129,003 – 4,655 Total Contractual Obligations $ 1,082,046 $ 342,211 $ 384,426 $ 118,044 $ 237,365 (1) The Company is obligated under operating leases to future minimum rental payments for various land and building sites across Canada. 7. OUTLOOK 9. RELATED PARTY TRANSACTIONS With the expansion of nine new retail locations, and our expanded web presence ecommerce, we expect to see continued growth in sales for 2017. Along with the growth in sales, we intend to maintain gross margins and continue to drive efficiencies. At December 31, 2016, we had no transactions with related parties as defined in IAS 24, Related Party Disclosures, except those pertaining to transactions with key management personnel in the ordinary course of their employment. 8. OUTSTANDING COMMON SHARES 10. CRITICAL ASSUMPTIONS At December 31, 2016, there were 71,855,866 common shares issued and outstanding. During the year ended December 31, 2016, 138,928 convertible, non-voting series 2009 shares and 312,989 convertible, non-voting series 2013 shares were converted into common shares. For details on the Company’s commitments related to its redeemable shares, please refer to Note 15 of the 2016 consolidated financial statements. Use of Estimates and Judgments Management has exercised judgment in the process of applying the Company’s accounting policies. The preparation of consolidated financial statements in accordance with IFRS requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the consolidated balance sheet dates and the reported amounts of revenue and expenses during the reporting period. Estimates and other judgments are Management’s Discussion & Analysis 20 continuously evaluated and are based on management’s experience and other factors, including expectations about future events that are believed to be reasonable under the circumstances. Actual results could differ from those estimates. The following discusses the most significant accounting judgments and estimates that the Company has made in the preparation of the consolidated financial statements. E X T E N D E D W A R R A N T Y R E V E N U E R E C O G N I T I O N The Company offers extended warranties on certain merchandise. Management has applied judgment in determining the basis upon and period over which to recognize deferred warranty revenue. I N V E N T O R I E S The Company estimates the net realizable value as the amount at which inventories are expected to be sold by taking into account fluctuations of retail prices due to prevailing market conditions. If required, inventories are written down to net realizable value when the cost of inventories is estimated to not be recoverable due to obsolescence, damage or declining sales prices. Reserves for slow moving and damaged inventory are deducted in the Company’s valuation of inventories. Management has estimated the amount of reserve for slow moving inventory based on the Company’s historic retail experience. I M PA I R M E N T O F AVA I L A B L E - F O R - S A L E F I N A N C I A L A S S E T S A N D M A R K E TA B L E S E C U R I T I E S The Company exercises judgment in the determination of whether there are objective indicators of impairment with respect to its available-for-sale financial assets and marketable securities. This includes making judgments as to whether a potential impairment is either significant or prolonged with respect to equity securities held. I M PA I R M E N T O F P R O P E R T Y, P L A N T A N D E Q U I P M E N T The Company exercises judgment in the determination of cash- generating units (“CGUs”) for purposes of assessing any impairment of property, plant and equipment, as well as in determining whether there are indicators of impairment present. Should indicators of impairment be present, management estimates the recoverable amount of the relevant CGU. This estimation requires assumptions about future cash flows, margins and discount rates. I M PA I R M E N T O F G O O D W I L L A N D I N TA N G I B L E A S S E T S The Company tests goodwill and indefinite life intangible assets at least annually and reviews other long-lived intangible assets for any indication that the asset might be impaired. Significant judgments are required in determining the CGUs or groups of CGUs for purposes of assessing impairment. Significant judgments are also required in determining whether to allocate goodwill to CGUs or groups of CGUs. When performing impairment tests, the Company estimates the recoverable amount of the CGUs or groups of CGUs to which goodwill and indefinite life intangible assets have been allocated using a discounted cash flow model that requires assumptions about future cash flows, margins and discount rates. P R O V I S I O N S The Company exercises judgment in the determination of recognizing a provision. The Company recognizes a provision when it has a present legal or constructive obligation as a result of a past event and a reliable estimate of the obligation can be made. Significant judgments are required to be made in determining what the probable outflow of resources will be required to settle the obligation. Materiality In preparing this MD&A and the information contained herein, management considers the likelihood that a reasonable investor would be influenced to buy or not buy, or to sell or hold securities of the Company if such information were omitted or misstated. This concept of materiality is consistent with the notion of materiality applied to financial statements and contained in IFRS. Recent Accounting Pronouncements A C C O U N T I N G S TA N D A R D S A N D A M E N D M E N T S I S S U E D B U T N O T Y E T A D O P T E D In July 2014, the IASB issued the final amendments to IFRS 9, Financial Instruments (“IFRS 9”), which provides guidance on the classification and measurement of financial assets and liabilities, impairment of financial assets, and general hedge accounting. The classification and measurement portion of the standard determines how financial assets and financial liabilities are accounted for in financial statements and, in particular, how they are measured on an ongoing basis. The amended IFRS 9 introduced a new, expected-loss impairment model that will require more timely recognition of expected credit losses. In addition, the amended IFRS 9 includes a substantially reformed model for hedge accounting, with enhanced disclosures about risk management activity. The new standard is effective for annual periods beginning on or after January 1, 2018, with earlier adoption permitted. The Company is in the process of evaluating the impact of adopting these amendments on the Company’s consolidated financial statements. IFRS 15, Revenue from Contracts with Customers (“IFRS 15”), was issued in May 2014, which will replace IAS 11, Construction Contracts, IAS 18, Revenue Recognition, IFRIC 13, Customer Loyalty Programmes, IFRIC 15, Agreements for the Construction of Real Estate, IFRIC 18, Transfers of Assets from Customers, and SIC-31, Revenue – Barter Transactions Involving Advertising Services. IFRS 15 provides a single, principles based five-step model that will apply to all contracts with customers with limited exceptions, including, but not limited to, leases within the scope of IAS 17, Leases (“IAS 17”); financial instruments and other contractual rights or obligations within the scope of IFRS 9, IFRS 10, Consolidated Financial Statements and IFRS 11, Joint Arrangements (“IFRS 11”). In addition to the five-step model, the standard specifies how to account for the incremental costs of obtaining a contract and the costs directly related to fulfilling a contract. The incremental costs of obtaining a contract must be recognized as an asset if the entity expects to recover these costs. The standard’s requirements will also apply to the recognition and measurement of gains and losses on the sale of some nonfinancial assets that are not an output of the entity’s ordinary activities. IFRS 15 is required for annual periods beginning on or after January 1, 2018. Earlier adoption is permitted. The Company has started the process of reviewing contracts with customers and other areas of the standard primarily the sale of non-financial assets such as property, plant and equipment. In January 2016, the IASB issued IFRS 16, Leases, which will replace IAS 17. The new standard will be effective for fiscal years beginning on or after January 1, 2019. Earlier application is permitted. Under the new standard, all leases will be on the balance sheet of lessees, except those that meet limited exception criteria. As the Company has significant contractual Leon’s Furniture Limited | 2016 Annual Report21 obligations in the form of operating leases (note 25) under the existing standard, there will be a material increase to both assets and liabilities upon adoption of the new standard. The Company is analyzing the new standard to determine its impact on the Company’s consolidated financial statements. A D O P T I O N O F N E W, R E V I S E D O R A M E N D E D A C C O U N T I N G S TA N D A R D S The Company has adopted the amended IFRS pronouncements listed below as at January 1, 2016, in accordance with the transitional provisions outlined in the respective standard. In May 2014, the IASB issued amendments to IFRS 11 to address the accounting for acquisitions of interests in joint operations. The amendments address how a joint operator should account for the acquisition of an interest in a joint operation in which the activity of the joint operation constitutes a business. IFRS 11, as amended, now requires that such transactions shall be accounted for using the principles related to business combinations accounting as outlined in IFRS 3, Business Combinations. The amendments are to be applied prospectively and are effective for annual periods beginning on or after January 1, 2016, with earlier application permitted. As at January 1, 2016, the Company adopted the amendments, and there was no impact on the consolidated financial statements. In May 2014, the IASB issued amendments to IAS 16, Property, Plant and Equipment (“IAS 16”) and IAS 38, Intangible Assets (“IAS 38”) to clarify acceptable methods of depreciation and amortization. The amended IAS 16 eliminates the use of a revenue-based depreciation method for items of property, plant and equipment. Similarly, amendments to IAS 38 eliminate the use of a revenue-based amortization model for intangible assets except in certain specific circumstances. The amendments are to be applied prospectively and are effective for annual periods beginning on or after January 1, 2016, with earlier application permitted. As at January 1, 2016, the Company adopted the amendments, and there was no impact on the consolidated financial statements. IAS 1, Presentation of Financial Statements, was amended in December 2014 to clarify guidance on materiality and aggregation, the presentation of subtotals, the structure of financial statements and the disclosure of accounting policies. The Amendment is effective for years beginning on or after January 1, 2016. The Company is analyzing the new standard to determine its impact, if any, on the Company’s consolidated financial statements. As at January 1, 2016, the Company adopted the amendments, and there was no material impact on the consolidated financial statements. 11. RISKS AND UNCERTAINTIES Careful consideration should be given to the following risk factors. These descriptions of risks are not the only ones facing the Company. Additional risks and uncertainties not presently known to Leon’s, or that the Company deems immaterial, may also impair the operations of the Company. If any of such risks actually occur, the business, financial condition, liquidity, and results of the Company could be materially adversely affected. Readers of this MD&A are also encouraged to refer to Leon’s Annual Information Form (“AIF”) dated March 27, 2017 which provides information on the risk factors facing the Company. The March 27, 2017 AIF can be found online at www.sedar.com. Sensitivity to General Economic Conditions The household furniture, mattress, appliance and home electronics retailing industry in Canada has historically been subject to cyclical variations in the general economy and to uncertainty regarding future economic prospects. The Company’s sales are impacted by the health of the economy in Canada as a whole, and in the regional markets in which the Company operates. The Company’s sales and financial results are subject to numerous uncertainties, due to the last global economic crisis in 2008. Although the economy responded positively with a modest recovery in 2010 through to 2014, at present, the outlook for the retailing industry continues to remain uncertain, and weakness in sales or consumer confidence could continue resulting in an increasingly challenging operating environment. Maintaining Profitability & Managing Growth There can be no assurance that the Company’s business and growth strategy will enable it to sustain profitability in future periods. The Company’s future operating results will depend on a number of factors, including (i) the Company’s ability to continue to successfully execute its strategic initiatives, (ii) the level of competition in the household furniture, mattress, appliance and home electronics retailing industry in the markets in which the Company operates, (iii) the Company’s ability to remain a low-cost retailer, (iv) the Company’s ability to realize increased sales and greater levels of profitability through its retail stores, (v) the effectiveness of the Company’s marketing programs, (vi) the Company’s ability to successfully identify and respond to changes in fashion trends and consumer tastes in the household furniture, mattress, appliance and home electronics retailing industry, (vii) the Company’s ability to maintain cost effective delivery of its products, (viii) the Company’s ability to hire, train, manage and retain qualified retail store management and sales professionals, (ix) the Company’s ability to continuously improve its service to achieve new and enhanced customer benefits and better quality, and (x) general economic conditions and consumer confidence. Financial Condition of Commercial Sales Customers & Franchisees Through its commercial sales division, the Company sells products and extends credit to high rise and condominium builders who purchase large quantities of products. The Company also sells products and extends credit to its franchisees. Negative changes in the financial condition of a significant commercial sales customer or a franchisee could impact on the Company’s receivables and ultimately result in the Company having to take a bad-debt write-off in excess of allowance for bad debts. The occurrence of such an event could have a material adverse effect on the Company’s business, financial condition, liquidity and results of operations. Competition The household furniture, mattress, appliance and home electronics retailing industry is highly competitive and highly fragmented. The Company faces competition in all regions in which its operations are located by existing stores that sell similar products and also by stores that may be opened in the future by existing or new competitors in such markets. The Company competes directly with many different types of retail stores that sell many of the products sold by the Company. Such competitors include (i) department stores, (ii) specialty stores (such as specialty electronics, appliance, or mattress Management’s Discussion & Analysis22 retailers), (iii) other national or regional chains offering household furniture, mattresses, appliances and home electronics, and (iv) other independent retailers, particularly those associated with larger buying groups. The highly competitive nature of the industry means the Company is constantly subject to the risk of losing market share to its competitors. As a result, the Company may not be able to maintain or to raise the prices of its products in response to competitive pressures. In addition, the entrance of additional competitors to the markets in which the Company operates, particularly large furniture, appliance or electronics retailers from the United States could increase the competitive pressure on the Company and have a material adverse effect on the Company’s market share. The actions and strategies of the Company’s current and potential competitors could have a material adverse effect on the Company’s business, financial condition, liquidity and results of operations. 12. CONTROLS AND PROCEDURES Disclosure Controls & Procedures Management is responsible for establishing and maintaining a system of disclosure controls and procedures to provide reasonable assurance that all material information relating to the Company is gathered and reported on a timely basis to senior management, including the Chief Executive Officer and Chief Financial Officer so that appropriate decisions can be made by them regarding public disclosure. Based on the evaluation of disclosure controls and procedures, the CEO and CFO have concluded that the Company’s disclosure controls and procedures were effective as at December 31, 2016. Internal Controls over Financial Reporting Management is also responsible for establishing and maintaining adequate internal control over financial reporting to provide reasonable assurance regarding the reliability of financial reporting and the preparation of consolidated financial statements for external purposes in accordance with IFRS. The Company’s internal control over financial reporting may not prevent or detect all misstatements because of inherent limitations. As required by National Instrument 52-109 (“NI 52-109”), management, including the CEO and CFO, evaluated the design and operation of the Company’s internal control over financial reporting as defined in NI 52-109 as at December 31, 2016. In making this assessment, the Company used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control-Integrated Framework (2013). Based on this assessment, the CEO and the CFO concluded that the Company maintained effective internal control over financial reporting as of December 31, 2016. Changes in Internal Controls over Financial Reporting Management has also evaluated whether there were changes in the Company’s internal control over financial reporting that occurred during the period beginning on January 1, 2016 and ended on December 31, 2016 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting. The Company has determined that no material changes in internal controls have occurred during this period. Leon’s Furniture Limited | 2016 Annual Report23 MANAGEMENT’S RESPONSIBILITY FOR FINANCIAL REPORTING The accompanying consolidated financial statements are the responsibility of management and have been approved by the Board of Directors. The accompanying consolidated financial statements have been prepared by management in accordance with International Financial Reporting Standards. Financial statements are not precise since they include certain amounts based upon estimates and judgments. When alternative methods exist, management has chosen those it deems to be the most appropriate in the circumstances. Leon’s Furniture Limited/Meubles Leon Ltée (“Leon’s” or the “Company”) maintains systems of internal accounting and administrative controls, consistent with reasonable costs. Such systems are designed to provide reasonable assurance that the financial information is relevant and reliable and that Leon’s assets are appropriately accounted for and adequately safeguarded. The Board of Directors is responsible for ensuring that management fulfils its responsibilities for financial reporting and is ultimately responsible for reviewing and approving the financial statements. The Board carries out this responsibility through its Audit Committee. The Audit Committee is appointed by the Board and reviews these consolidated financial statements; considers the report of the external auditors; assesses the adequacy of the internal controls of the Company; examines the fees and expenses for audit services; and recommends to the Board the independent auditors for appointment by the shareholders. The Committee reports its findings to the Board of Directors for consideration when approving these consolidated financial statements for issuance to the shareholders. These consolidated financial statements have been audited by Ernst & Young, the external auditors, in accordance with Canadian generally accepted auditing standards on behalf of the shareholders. Ernst & Young has full and free access to the Audit Committee. “Terrence T. Leon” “Dominic Scarangella” Terrence T. Leon CEO Dominic Scarangella Executive Vice President and CFO 24 INDEPENDENT AUDITORS’ REPORT TO THE SHAREHOLDERS OF LEON’S FURNITURE LIMITED/MEUBLES LEON LTÉE We have audited the accompanying consolidated financial statements of Leon’s Furniture Limited/Meubles Leon Ltée, which comprise the consolidated statements of financial position as at December 31, 2016 and 2015, and the consolidated statements of income, comprehensive income, changes in shareholders’ equity and cash flows for the years then ended, and a summary of significant accounting policies and other explanatory information. Management’s Responsibility for the Consolidated Financial Statements Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with International Financial Reporting Standards, and for such internal control as management determines is necessary to enable the preparation of consolidated financial statements that are free from material misstatement, whether due to fraud or error. Auditors’ Responsibility Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with Canadian generally accepted auditing standards. Those standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on the auditors’ judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, the auditors consider internal control relevant to the entity’s prepar- ation and fair presentation of the consolidated financial state- ments 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 account- ing policies used and the reasonableness of accounting esti- mates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that the audit evidence we have obtained in our audits is sufficient and appropriate to provide a basis for our audit opinion. Opinion In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of Leon’s Furniture Limited/Meubles Leon Ltée as at December 31, 2016 and 2015, and its financial performance and its cash flows for the years then ended in accordance with International Financial Reporting Standards as issued by the International Accounting Standards Board. “Ernest & Young LLP” Chartered Professional Accountants Licensed Public Accountants Toronto, Canada February 23, 2017 Leon’s Furniture Limited | 2016 Annual ReportCONSOLIDATED STATEMENTS OF FINANCIAL POSITION Consolidated Financial Statements 25 As at December 31 As at December 31 2016 2015 $ $ 43,985 16,600 39,079 128,142 2,042 308,801 7,643 775 7,859 18,691 22,960 117,832 24,920 303,961 8,329 473 $ 547,067 $ 505,025 8,225 13,128 315,500 17,984 311,464 390,120 8,174 6,214 13,093 323,218 18,496 318,214 390,120 9,083 $ 1,611,662 $ 1,583,463 $ 214,838 $ 5,468 12,641 117,990 1,421 7,183 39,839 25,000 2,124 206,076 5,343 7,266 112,446 1,954 7,141 49,380 50,000 – $ 426,504 $ 439,606 214,436 93,520 10,474 105,289 503 11,380 90,003 237,357 92,628 11,895 95,775 880 8,858 96,062 $ 952,109 $ 983,061 $ 39,184 $ 7,089 613,426 (146) 34,389 7,089 558,526 398 $ 659,553 $ 600,402 $ 1,611,662 $ 1,583,463 ($ in thousands) ASSETS Current assets Cash and cash equivalents [NOTES 5 AND 22] Restricted marketable securities [NOTE 22] Available-for-sale financial assets [NOTE 22] Trade receivables [NOTE 22] Income taxes receivable Inventories [NOTE 6] Deferred acquisition costs [NOTE 7] Deferred financing costs Total current assets Other assets Deferred acquisition costs [NOTE 7] Property, plant and equipment [NOTE 8] Investment properties [NOTE 9] Intangible assets [NOTE 10] Goodwill [NOTE 10] Deferred income tax assets [NOTE 20] Total assets LIABILITIES AND SHAREHOLDERS’ EQUITY Current liabilities Trade and other payables [NOTE 11] Provisions [NOTE 12] Income taxes payable Customers’ deposits Finance lease liabilities [NOTE 13] Dividends payable [NOTE 16] Deferred warranty plan revenue Loans and borrowings [NOTE 14] Other liabilities Total current liabilities Loans and borrowings [NOTE 14] Convertible debentures [NOTE 14] Finance lease liabilities [NOTE 13] Deferred warranty plan revenue Redeemable share liability [NOTE 15] Deferred rent liabilities and lease inducements Deferred income tax liabilities [NOTE 20] Total liabilities Shareholders’ equity attributable to the shareholders of the Company Common shares [NOTE 16] Equity component of convertible debentures [NOTE 14] Retained earnings Accumulated other comprehensive (loss) income Total shareholders’ equity Total liabilities and shareholders’ equity The accompanying notes are an integral part of these consolidated financial statements. On behalf of the Board: “Mark J. Leon” Mark J. Leon Director “Peter Eby” Peter Eby Director 26 CONSOLIDATED STATEMENTS OF INCOME ($ in thousands) Revenue [NOTE 17] Cost of sales [NOTE 6] Gross profit Selling, general and administration expenses [NOTE 18] Net finance costs [NOTE 19] Net income before income tax Income tax expense [NOTE 20] Net income Weighted average number of common shares outstanding Basic Diluted Earnings per share [NOTE 21] Basic Diluted Dividends declared per share Common Convertible, non-voting The accompanying notes are an integral part of these consolidated financial statements. Year ended December 31 Year ended December 31 2016 2015 $ 2,143,736 $ 1,228,499 2,031,718 1,141,706 $ 915,237 $ 890,012 786,568 770,966 128,669 (14,481) 114,188 30,597 119,046 (17,627) 101,419 24,790 $ 83,591 $ 76,629 71,695,955 83,081,832 71,217,958 82,364,539 $ $ $ $ 1.17 1.05 0.40 0.20 $ $ $ $ 1.08 0.97 0.40 0.20 Leon’s Furniture Limited | 2016 Annual Report Consolidated Financial Statements 27 CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME ($ in thousands) Net income for the year Other comprehensive income, net of tax Other comprehensive income to be reclassified to profit or loss in subsequent years: Unrealized gains on available-for-sale financial assets arising during the year Reclassification adjustment for net losses included in profit for the year Change in unrealized losses on available-for-sale financial assets arising during the year Comprehensive income for the year ($ in thousands) Net income for the year Other comprehensive income, net of tax Other comprehensive income to be reclassified to profit or loss in subsequent years: Unrealized losses on available-for-sale financial assets arising during the year Reclassification adjustment for net gains included in profit for the year Change in unrealized losses on available-for-sale financial assets arising during the year 2016 Tax effect Year ended December 31 Net of tax 2016 $ 83,591 $ – $ 83,591 280 (946) 113 (235) 167 (711) (666) (122) (544) $ 82,925 $ (122) $ 83,047 2015 Tax effect Year ended December 31 Net of tax 2015 $ 76,629 $ – $ 76,629 (77) 5 (72) (22) 1 (21) (55) 4 (51) Comprehensive income for the year $ 76,557 $ (21) $ 76,578 The accompanying notes are an integral part of these consolidated financial statements. 28 CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY ($ in thousands) As at December 31, 2015 Comprehensive income Net income for the year Change in unrealized losses on available-for-sale financial assets arising during the year $ Total comprehensive income Transactions with shareholders Dividends declared Management share purchase plan [NOTE 15] Total transactions with shareholders Equity component of convertible debentures Accumulated other comprehensive income (loss) Common shares Retained earnings Total 7,089 $ 34,389 $ 398 $ 558,526 $ 600,402 – – – – – – – – – – 4,795 4,795 – 83,591 83,591 (544) (544) – 83,591 (544) 83,047 – – – (28,691) – (28,691) (28,691) 4,795 (23,896) As at December 31, 2016 $ 7,089 $ 39,184 $ (146) $ 613,426 $ 659,553 ($ in thousands) As at December 31, 2014 Comprehensive income Net income for the year Change in unrealized losses on available-for-sale financial assets arising during the year Total comprehensive loss Transactions with shareholders Dividends declared Management share purchase plan [NOTE 15] Total transactions with shareholders Equity component of convertible debentures Accumulated other comprehensive income (loss) Common shares Retained earnings Total $ 7,089 $ 31,169 $ 449 $ 510,398 $ 549,105 – – – – – – – – – – 3,220 3,220 – 76,629 76,629 (51) (51) – – – – 76,629 (28,501) – (28,501) (51) 76,578 (28,501) 3,220 (25,281) As at December 31, 2015 $ 7,089 $ 34,389 $ 398 $ 558,526 $ 600,402 The accompanying notes are an integral part of these consolidated financial statements. Leon’s Furniture Limited | 2016 Annual Report CONSOLIDATED STATEMENTS OF CASH FLOWS ($ in thousands) OPERATING ACTIVITIES Net income for the year Add (deduct) items not involving an outlay of cash Depreciation of property, plant and equipment and investment properties Amortization of intangible assets Amortization of deferred warranty plan revenue Net finance costs Deferred income taxes Gain on sale of property, plant and equipment and investment properties (Gain) loss on sale of available-for-sale financial assets Net change in non-cash working capital balances related to operations [NOTE 26] Cash received on warranty plan sales Consolidated Financial Statements 29 Year ended December 31 Year ended December 31 2016 2015 $ 83,591 $ 76,629 33,802 7,433 (59,118) 14,481 (4,945) (28) (897) $ 74,319 $ 31,238 59,091 33,694 8,044 (55,180) 17,627 (5,317) (1,072) 1,514 75,939 (74,426) 56,970 Cash provided by operating activities $ 164,648 $ 58,483 INVESTING ACTIVITIES Purchase of property, plant and equipment and investment properties [NOTES 8 & 9] Purchase of intangible assets [NOTE 10] Proceeds on sale of property, plant and equipment and investment properties Purchase of available-for-sale financial assets Proceeds on sale of available-for-sale financial assets Interest received Cash used in investing activities FINANCING ACTIVITIES Repayment of finance leases Dividends paid Decrease of employee loans-redeemable shares [NOTE 15] Repayment of term loan [NOTE 14] Finance costs paid Interest paid Cash used in financing activities Net increase (decrease) in cash and cash equivalents during the year Cash and cash equivalents, beginning of year Cash and cash equivalents, end of year The accompanying notes are an integral part of these consolidated financial statements. (25,689) (683) 145 (29,981) 16,184 1,717 (22,756) (4,956) 4,464 (8,093) 5,524 1,308 $ (38,307) $ (24,509) (1,884) (28,649) 4,418 (50,000) (775) (13,325) (1,936) (28,465) 3,699 (30,000) – (15,313) $ (90,215) $ (72,015) 36,126 7,859 (38,041) 45,900 $ 43,985 $ 7,859 30 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Amounts in thousands of Canadian dollars, except share amounts and earning per share) 1. REPORTING ENTITY Use of estimates and judgments Leon’s Furniture Limited (“Leon’s” or the “Company”) was incorporated by Articles of Incorporation under the Business Corporations Act on February 28, 1969. Leon’s is a retailer of home furnishings, mattresses, appliances and electronics across Canada. Leon’s is a public company listed on the Toronto Stock Exchange (TSX – LNF, LNF.DB) and is incorporated and domiciled in Canada. The address of the Company’s head office and registered office is 45 Gordon Mackay Road, Toronto, Ontario, M9N 3X3. The Company’s business is seasonal in nature. Retail sales are traditionally higher in the third and fourth quarters. 2. BASIS OF PRESENTATION Statement of compliance These consolidated financial statements have been prepared in accordance with International Financial Reporting Standards (“IFRS”) as issued by the International Accounting Standards Board (“IASB”). These consolidated financial statements were approved by the Board of Directors for issuance on February 23, 2017. Basis of measurement The consolidated financial statements have been prepared under the historical cost convention, except for available-for-sale financial assets and derivative instruments and the initial recognition of assets acquired and liabilities assumed in business combinations, which are measured at fair value. Functional and presentation currency Items included in the consolidated financial statements are measured using the currency of the primary economic environment in which the Company operates (the functional currency). These consolidated financial statements are presented in Canadian dollars, which is the Company’s functional and presentation currency and is also the functional currency of each of the Company’s subsidiaries. Management has exercised judgment in the process of applying the Company’s accounting policies. The preparation of consolidated financial statements in accordance with IFRS requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the consolidated balance sheet dates and the reported amounts of revenue and expenses during the reporting period. Estimates and other judgments are continuously evaluated and are based on management’s experience and other factors, including expectations about future events that are believed to be reasonable under the circumstances. Actual results could differ from those estimates. The following discusses the most significant accounting judgments and estimates that the Company has made in the preparation of the consolidated financial statements. Extended warranty revenue recognition The Company offers extended warranties on certain merchandise. Management has applied judgment in determining the basis upon and period over which to recognize deferred warranty revenue. Inventories The Company estimates the net realizable value as the amount at which inventories are expected to be sold by taking into account fluctuations of retail prices due to prevailing market conditions. If required, inventories are written down to net realizable value when the cost of inventories is estimated to not be recoverable due to obsolescence, damage or declining sales prices. Reserves for slow moving and damaged inventory are deducted in the Company’s valuation of inventories. Management has estimated the amount of reserve for slow moving inventory based on the Company’s historic retail experience. Impairment of marketable securities The Company exercises judgment in the determination of whether there are objective indicators of impairment with respect to its marketable securities. This includes making judgments as to whether a potential impairment is either significant or prolonged with respect to equity securities held. Leon’s Furniture Limited | 2016 Annual Report31 Impairment of property, plant and equipment The Company exercises judgment in the determination of cash-generating units (“CGUs”) for purposes of assessing any impairment of property, plant and equipment, as well as in determining whether there are indicators of impairment present. Should indicators of impairment be present, management estimates the recoverable amount of the relevant CGU. This estimation requires assumptions about future cash flows, margins and discount rates. Impairment of goodwill and intangible assets The Company tests goodwill and indefinite life intangible assets at least annually and reviews other long-lived intangible assets for any indication that the asset might be impaired. Significant judgments are required in determining the CGUs or groups of CGUs for purposes of assessing impairment. Significant judgments are also required in determining whether to allocate goodwill to CGUs or groups of CGUs. When performing impairment tests, the Company estimates the recoverable amount of the CGUs or groups of CGUs to which goodwill and indefinite life intangible assets have been allocated using a discounted cash flow model that requires assumptions about future cash flows, margins and discount rates. Provisions The Company exercises judgment in the determination of recognizing a provision. The Company recognizes a provision when it has a present legal or constructive obligation as a result of a past event and a reliable estimate of the obligation can be made. Significant judgments are required to be made in determining what the probable outflow of resources will be required to settle the obligation. 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The significant accounting policies used in the preparation of these consolidated financial statements are as follows: Basis of consolidation The financial statements consolidate the accounts of Leon’s Furniture Limited and its wholly owned subsidiaries: Murlee Holdings Limited, Leon Holdings (1967) Limited, King and State Limited, Ablan Insurance Corporation, The Brick Ltd., The Brick Warehouse LP, United Furniture Warehouse LP, First Oceans Trading Corporation, and Trans Global Warranty Corporation. Subsidiaries are all those entities over which the Company has control. Control is achieved when the Company is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee. The existence and effect of potential voting rights that are currently exercisable or convertible and rights arising from other contractual arrangements are considered when assessing whether the Company controls another entity. Subsidiaries are fully consolidated from the date on which control is transferred to the Company and de-consolidated from the date that control ceases. The Company reassesses whether or not it controls an investee if facts and circumstances indicate that there are changes to one or more of the three elements of control. All inter-company transactions and balances have been appropriately eliminated. Business combinations The Company applies the acquisition method in accounting for business combinations. The cost of an acquisition is measured as the aggregate of the consideration transferred measured at the acquisition date fair value. Transaction costs that the Company incurs in connection with a business combination are expensed in the period in which they are incurred. Segment reporting The Company has two operating segments, Leon’s and The Brick, both in the business of the sale of home furnishings, mattresses, appliances and electronics in Canada. The Company’s chief operating decision-maker, identified as the Chief Executive Officer, monitors the results of operating segments for the purpose of allocating resources and assessing performance. Leon’s and The Brick operating segments are aggregated into a single reportable segment because they show a similar long-term economic performance (gross margin), have comparable products, customers and distribution channels, operate in the same regulatory environment, and are steered and monitored together. Accordingly, there is no reportable segment information to provide in these consolidated financial statements. Foreign currency translation Foreign currency transactions are translated into the respective functional currency of the Company’s subsidiaries using the exchange rate at the dates of the transactions. Merchandise imported from the United States and Southeast Asia, paid for in U.S. dollars, is recorded at its equivalent Canadian dollar value upon receipt. U.S. dollar trade payables are translated at the year-end exchange rate. The Company is subject to gains and losses due to fluctuations in the U.S. dollar. Foreign exchange gains and losses resulting from translation of U.S. dollar accounts payable are included in the consolidated statements of income within cost of sales. Any foreign exchange gains and losses on monetary available- for-sale financial assets are recognized in the consolidated statements of income, and other changes in the carrying amounts are recognized in other comprehensive income. For available-for-sale assets that are not monetary items, the gain or loss that is recognized in other comprehensive income includes any related foreign exchange component. Fair value measurement The Company measures certain financial instruments at fair value upon initial recognition, and at each balance sheet date. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The fair value measurement is based on the presumption that the transaction to sell the asset or transfer the liability takes place either in the principal market for the asset or liability; or, in the absence of a principal market, in the most advantageous market for the asset or liability that is accessible. The fair value of an asset or liability is measured using the assumptions that market participants would use, assuming that market participants act in their economic best interest. Financial assets and liabilities A financial asset or liability is recognized if the Company becomes a party to the contractual provisions of the asset or liability. A financial asset or liability is recognized initially (at trade date) at its fair value plus, in the case of a financial asset or liability not at fair value through profit or loss, transaction costs that are directly attributable to the acquisition or issue of Notes to the Consolidated Financial Statements32 the instrument. Financial assets and liabilities carried at fair value through profit or loss are initially recognized at fair value and transaction costs are expensed in the consolidated statements of income. After initial recognition, financial assets are measured at their fair values except for loans and receivables, which are measured at amortized cost using the effective interest method. After initial recognition, financial liabilities are measured at amortized cost. The Company classifies its financial assets and liabilities according to their characteristics and management’s choices and intentions related thereto for the purposes of ongoing measurement. Classifications that the Company has used for financial assets include: a) b) Available-for-sale – financial assets that are non-derivatives that are either designated in this category or not classified in any other category and include marketable securities, which consist primarily of quoted bonds, equities and debentures. These assets are measured at fair value with the changes in fair value recognized in other comprehensive income for the current year until realized through disposal or impairment; Loans and receivables – non-derivative financial assets with fixed or determinable payments that are not quoted in an active market. Loans and receivables include trade receivables and are recorded at amortized cost with gains and losses recognized in the consolidated statements of income in the period that the asset is no longer recognized or impaired; and c) Derivative instruments – financial assets which are classified as fair value through profit and loss. Classifications that the Company has used for financial liabilities include: a) Other financial liabilities – measured at amortized cost with gains and losses recognized in the consolidated statements of income in the period that the liability is no longer recognized; and b) Derivative instruments – financial liabilities which are classified as fair value through profit and loss. Financial assets are derecognized if the Company’s contractual rights to the cash flows from the financial asset expire or if the Company transfers the financial asset to another party without retaining control or substantially all of the risks and rewards of ownership of the asset. Financial liabilities are derecognized if the Company’s obligations specified in the contract expire or are discharged or cancelled. Impairment of financial assets The Company assesses at the end of each reporting period whether there is objective evidence that a financial asset or group of financial assets is impaired. A financial asset or group of financial assets is impaired and impairment losses are incurred only if there is objective evidence of impairment as a result of one or more events that have occurred after the initial recognition of the asset (a loss event) and that loss event has an impact on the estimated future cash flows of the financial asset or group of financial assets that can be reliably estimated. The amount of the loss is measured as the difference between the asset’s carrying amount and the present value of estimated future cash flows discounted at the financial asset’s original effective interest rate. The asset’s carrying amount is reduced and the amount of the loss is recognized in the consolidated statements of income. If, in a subsequent period, the amount of the impairment loss decreases and the decrease can be related objectively to an event occurring after the impairment was recognized, the reversal of the previously recognized impairment is recognized in the consolidated statements of income. Derivative instruments Financial derivative instruments in the form of interest rate swaps and foreign exchange forwards are recorded at fair value on the consolidated balance sheets. Fair values are based on quoted market prices where available from active markets, otherwise fair values are estimated using valuation methodologies, primarily discounted cash flows taking into account external market inputs. Derivative instruments are recorded in current or non-current assets and liabilities based on their remaining terms to maturity. All changes in fair value of the derivative instruments are recorded in net income. Cash and cash equivalents Cash and cash equivalents include cash on hand, balances with banks and short-term market investments with a remaining term to maturity of less than 90 days from the date of purchase. Trade receivables Trade receivables are amounts due for goods sold in the ordinary course of business. If collection is expected in one year or less, they are classified as current assets. If not, they are presented as non-current assets. Trade receivables are initially recognized at fair value and subsequently measured at amortized cost using the effective interest method, less provision for impairment. Inventories Inventories are valued at the lower of cost, determined on a first-in, first-out basis, and net realizable value. The Company receives vendor rebates on certain products based on the volume of purchases made during specified periods. The rebates are deducted from the inventory value of goods received and are recognized as a reduction of cost of sales upon sale of the goods. Incentives received for a direct reimbursement of costs incurred to sell the vendor’s products, such as marketing and advertising funds, are recorded as a reduction of those related costs in the consolidated statements of income; provided certain conditions are met. Property, plant and equipment Property, plant and equipment are initially recorded at cost. Historical cost includes expenditures that are directly attributable to the acquisition of items. Subsequent costs are included in the asset’s carrying amount or recognized as a separate asset, as appropriate, only when it is probable that future economic benefits associated with the asset will flow to the Company and the cost can be measured reliably. When significant parts of an item of property, plant and equipment are required to be replaced at intervals, the Company derecognizes the replaced part and recognizes the new part with its own associated useful life and depreciation. Normal repair and maintenance expenditures are expensed as incurred. Leon’s Furniture Limited | 2016 Annual Report33 Land and construction in progress are not depreciated. Depreciation on other assets is provided over the estimated useful lives of the assets using the following annual rates: Buildings Equipment Vehicles Computer hardware Building improvements Over the remaining lease term 30 to 50 years 3 to 30 years 5 to 20 years 5 years Leased assets are depreciated over the shorter of the lease term and their useful lives unless it is reasonably certain that the Company will obtain ownership by the end of the lease term. The Company allocates the amount initially recognized in respect of an item of property, plant and equipment to its significant parts and depreciates separately each such part. Residual values, method of depreciation and useful lives of items of property, plant and equipment are reviewed annually by the Company and adjusted, if appropriate. Gains and losses on disposal of property, plant and equipment are determined by comparing the proceeds with the carrying amount of the asset and are included as part of selling, general and administration expenses in the consolidated statements of income. Leases Leases that transfer substantially all of the risks and rewards of ownership to the lessee are classified as finance leases. All other leases are classified as operating leases. In determining whether a lease should be classified as an operating or finance lease, management must consider specific criteria. The inputs to these classification criteria require judgment in the following areas: assessing whether an option to purchase exists and if that option will be exercised, determining the economic life of the leased asset, and determining whether the present value of minimum lease payments amounts to at least substantially all of the fair value of the leased asset. This assessment is subject to a significant degree of judgment. T H E C O M PA N Y A S L E S S E E Finance lease Assets held under finance leases are initially recognized as assets of the Company at the commencement of the lease at the lower of their fair value or the present value of the minimum lease payments. Subsequent to initial recognition, the asset is accounted for in accordance with the accounting policy applicable to that asset. A corresponding liability to the lessor is included in the consolidated statements of financial position as a finance lease liability. Minimum lease payments made under finance leases are apportioned between the finance costs and the reduction of the outstanding finance lease liability using the effective interest method. The finance cost, net of lease inducements, is allocated to each period during the lease term so as to produce a constant periodic rate of interest on the remaining balance of the finance lease liability. Contingent lease payments arising under finance leases are recognized as an expense in the period in which they are incurred. Operating lease For real estate operating leases, any related rent escalations are factored into the determination of rent expense to be recognized over the lease term. The total operating lease payments to be made over the lease term are recognized in income on a straight-line basis over the lease term. Lease incentives received are recognized as an integral part of the total lease expense over the lease term. Contingent rental expenses arising under operating leases are recognized as an expense in the period in which they are incurred. Investment properties Assets that are held for long-term rental yields or for capital appreciation or both, and that are not occupied by either the Company or any of its subsidiaries, are classified as investment properties. Investment properties are measured initially at cost, including related transaction costs. Subsequent to initial recognition, investment properties are carried at cost and depreciated over the estimated useful lives of the properties: Buildings Building improvements Over the remaining lease term 30 to 50 years Land held by the Company and classified as investment property is not depreciated. Subsequent expenditures on investment properties are capitalized to the properties’ carrying amount only when it is probable that future economic benefits associated with the expenditures will flow to the Company and the cost of the item can be measured reliably. All other repairs and maintenance costs are expensed when incurred. When part of an investment property is replaced, the carrying amount of the replaced part is derecognized. If an investment property becomes owner occupied, it is reclassified as property, plant and equipment. Goodwill and intangible assets G O O D W I L L Goodwill is the residual amount that results when the purchase price of an acquired business exceeds the sum of the amounts allocated to the tangible and intangible assets acquired, less liabilities assumed, based on their fair value. Goodwill is assigned at the date of the business acquisition. The Company assesses at least annually, or at any time if an indicator of impairment exists, whether there has been an impairment loss in the carrying value of goodwill and it is carried at cost less accumulated impairment losses. Impairment losses on goodwill are not reversed. Goodwill is allocated to CGUs or groups of CGUs that are expected to benefit from the business combination for the purpose of impairment testing. A group of CGUs represents the lowest level within the Company at which goodwill is monitored for internal management purposes. I N TA N G I B L E A S S E T S Intangible assets acquired separately are measured on initial recognition at cost. The cost of intangible assets acquired in a business combination is their fair value at the date of acquisition. Following initial recognition, intangible assets are carried at cost less any accumulated amortization and accumulated impairment losses. Internally generated intangibles, excluding capitalized development costs, are not capitalized and the related expenditure is reflected in profit or loss in the period in which the expenditure is incurred. The useful lives of intangible assets are assessed as either finite or indefinite. Notes to the Consolidated Financial Statements 34 Intangible assets with finite useful lives are amortized on a straight-line basis over their estimated useful lives as follows: Customer relationships Brand name (Appliance Canada) 10 years Non-compete agreement Computer software Favourable lease agreements 8 years 8 years 3 to 7 years Over the lease term including renewal options Impairment of non-financial assets The Company considers at each reporting date whether there is an indication that an asset may be impaired. If impairment indicators are found to be present, or when annual impairment testing for an asset is required, the non-financial assets are assessed for impairment. Impairment losses are recognized immediately in income to the extent an asset’s carrying amount exceeds its recoverable amount. The recoverable amount is the higher of an asset’s fair value less costs to sell and value in use. In assessing value in use, estimated future cash flows are discounted to their present value using a pre-tax discount rate that reflects current market assessments of the time value of money and the risks specific to the asset for which the estimates of future cash flows have not been adjusted. Goodwill and indefinite life intangible assets are tested annually in the fourth quarter of the year, or when circumstances indicate that the carrying value may be impaired. The assessment of recoverable amount for goodwill and indefinite life intangible assets involves assumptions about future conditions for the economy, capital markets, and specifically, the retail sector. As such, the assessment is subject to a significant degree of measurement uncertainty. For the purpose of impairment testing, assets that cannot be tested individually are grouped together into the smallest group of assets that generate cash inflows from continuing use that are largely independent of the cash inflows of other assets or groups of assets. For the Company, store-related CGUs are defined as individual stores or regional groups of stores within a geographic market. For the Company’s corporate assets that do not generate separate cash inflows, the recoverable amount is determined for the CGU to which the corporate asset belongs. Where a reasonable and consistent basis of allocation can be identified, corporate assets are allocated to an individual CGU; otherwise, they are allocated to the smallest group of CGUs for which a reasonable and consistent allocation basis can be identified. Impairment losses recognized in respect of CGUs are allocated to reduce the carrying amounts of the assets in the CGUs on a pro rata basis. Impairment losses recognized in prior periods are assessed at each reporting date for any indication that the loss has decreased or no longer exists. An impairment loss is reversed if there has been a change in the estimates used to determine the recoverable amount and the reversal is recognized in income. An impairment loss is reversed only to the extent that the asset’s carrying amount does not exceed the carrying amount that would have been determined, net of depreciation or amortization, if no impairment loss had been recognized. Income taxes The Company computes an income tax expense. However, actual amounts of income tax expense only become final upon filing and acceptance of the tax return by the relevant taxation authorities, which occur subsequent to the issuance of the annual consolidated financial statements. Additionally estimation of income taxes includes evaluating the recoverability of deferred income tax assets based on an assessment of the ability to use the underlying future tax deductions before they expire against future taxable income. The assessment is based on existing tax laws and estimates of future taxable income. To the extent estimates differ from the final tax return, income would be affected in a subsequent period. Income tax expense for the period comprises current and deferred income tax. Income tax is recognized in the consolidated statements of income except to the extent it relates to items recognized in other comprehensive income or directly in equity, in which case the related tax is recognized in equity. Levies other than income taxes, such as taxes on real estate, are included in occupancy expenses. C U R R E N T I N C O M E TA X Current income tax expense is based on the results of the year as adjusted for items that are not taxable or not deductible. Current income tax is calculated using tax rates and laws that were substantively enacted at the end of the reporting period. Management periodically evaluates positions taken in tax returns with respect to situations in which applicable tax regulation is subject to interpretation. It establishes provisions where appropriate on the basis of amounts expected to be paid to the tax authorities. D E F E R R E D I N C O M E TA X Deferred income tax is recognized, using the liability method, on temporary differences arising between the tax bases of assets and liabilities and their carrying amounts in the consolidated statements of financial position. Deferred income tax is determined using tax rates and laws that have been enacted or substantively enacted by the consolidated statement of financial position dates and are expected to apply when the related deferred income tax asset is realized or the deferred income tax liability is settled. Deferred income tax assets are recognized only to the extent that it is probable that future taxable profit will be available against which the temporary differences can be utilized. Deferred income tax assets and liabilities are offset when there is a legally enforceable right to offset current income tax assets against current income tax liabilities and when the deferred income tax assets and liabilities relate to income taxes levied by the same taxation authority where there is an intention to settle the balances on a net basis. Trade and other payables Trade and other payables are obligations to pay for goods or services that have been acquired in the ordinary course of business from suppliers. Trade and other payables are classified as current liabilities if payment is due within one year or less. Provisions Provisions are recognized only in those circumstances where the Company has a present legal or constructive obligation as a result of a past event, when it is probable that an outflow of resources will be required to settle the obligation and a reliable estimate of the amount can be made. Provisions are measured at the present value of the expenditures expected to be required to settle the obligation using a pre-tax discount rate that reflects current market assessments of the time value of money and the risks specific to the obligation. Leon’s Furniture Limited | 2016 Annual Report 35 U N PA I D I N S U R A N C E C L A I M S F R A N C H I S E O P E R AT I O N S The provision for unpaid claims includes adjustment expenses and an estimate of the future settlement of claims, both reported and unreported, that have occurred on or before the reporting date on the insurance contracts the Company has underwritten. The provision is actuarially determined on an annual basis using assumptions of loss emergence, payment rates, interest, and expected expenses associated with the adjustment and payment of such claims. The provision includes appropriate charges for risk and uncertainty and is measured on a discounted basis. As this provision is an estimate, the amount of actual claims may differ from the recorded amount. The provisions are derecognized when the obligation to pay a claim no longer exists. U N PA I D W A R R A N T Y C L A I M S Warranty repairs related to warranty plans sold separately are recorded as claims expense at the time the customer reports a claim. For these warranties, a provision for unpaid warranty claims is established for unpaid reported claims. The provision for unpaid claims is based on estimates, and may differ from actual claims paid. The Company also provides a standard warranty for certain products. For these warranties, a provision for warranty claims is recognized when the underlying products are sold. The amount of the provision is estimated using historical experience and may differ from actual claims paid. P R O D U C T R E T U R N S The Company has a return policy allowing customers to return merchandise if not satisfied within 7 days. The provision for product returns is based on sales recognized prior to the year end. The amount of the provision is estimated using historical experience and actual experience subsequent to the year end and may differ from the actual returns made. Loans and borrowings Long-term debt is classified as current when the Company expects to settle the debt in its normal operating cycle or the debt is due to be settled within 12 months after the date of the consolidated statement of financial position. Share capital Common shares are classified as equity. Incremental costs directly attributable to the issuance of new shares are shown in equity as a deduction, net of income tax, from the proceeds. Revenue recognition Revenue comprises the fair value of consideration received or receivable for the sale of goods and services in the ordinary course of the Company’s activities. Revenue is shown net of sales tax. The Company recognizes revenue when the amount of revenue can be reliably measured and it is probable that future economic benefits will flow to the Company. In addition to the above general principles, the Company applies the following specific revenue recognition policies: S A L E O F G O O D S A N D R E L AT E D S E R V I C E S Revenue from the sale of goods and related services is recognized either when the customer picks up the merchandise ordered or when merchandise is delivered to the customer’s home. Any payments received in advance of delivery are deferred and recorded as customers’ deposits. The Company records a provision for sales returns and price guarantees based on historical experience and actual experience subsequent to the year end. Leon’s franchisees operate principally as independent owners. The Company charges each franchisee a royalty fee based on a percentage of the franchisee’s gross revenue. The Company supplies inventory for amounts representing landed cost plus a mark-up. The royalty income and sales to franchises, net of costs, is recorded by the Company on an accrual basis and presented within revenue. I N S U R A N C E C O N T R A C T S A N D R E V E N U E The Company issues insurance contracts through its subsidiaries: Trans Global Insurance Company (“TGI”) and Trans Global Life Insurance Company (“TGLI”). The Company provides credit insurance on balances that arise from customers’ use of their private label financing card. The Company provides group coverage for losses as discussed in note 23, thereby providing protection to many customers who do not carry other similar insurance policies. Insurance contracts are contracts where the Company (the “insurer”) has accepted significant insurance risk from another party (the “policyholders”) by agreeing to compensate the policyholders if a specified uncertain future event (the “insured event”) adversely affects the policyholders. As a general guideline, the Company determines whether it has significant insurance risk by comparing benefits paid with benefits payable if the insured event did not occur. Once a contract has been classified as an insurance contract, it remains an insurance contract for the remainder of its term, even if the insurance risk reduces significantly during this period, unless all rights and obligations are extinguished or expire. Investment contracts can, however, be reclassified as insurance contracts after inception if insurance risk becomes significant. Premiums on insurance contracts are recognized as revenue over the term of the policies in accordance with the pattern of insurance service provided under the contract. U N E A R N E D I N S U R A N C E R E V E N U E At each reporting period date, the insurance revenue received by the Company in regards to the unexpired portion of policies in force is deferred as unearned insurance revenue. Any amount of unearned insurance revenue is included in the consolidated statements of financial position within deferred warranty plan revenue. The Company performs an unearned insurance revenue adequacy test on an annual basis to determine whether the carrying amount of the unearned insurance revenue needs to be adjusted (or the carrying amount of deferred acquisition costs adjusted), based upon a review of the expected future cash flows. If these estimates show that the carrying amount of the unearned insurance revenue (less related deferred acquisition costs) is inadequate, the deficiency is recognized in net income by setting up a provision for insurance revenue deficiency. Unearned insurance revenue is calculated based on assumptions of loss emergence, payment rates, interest, and expected expenses associated with the adjustment and payment of claims. Unearned insurance revenue is derecognized when the obligation to pay no longer exists. D E F E R R E D W A R R A N T Y P L A N R E V E N U E Warranties, underwritten by the Company’s wholly owned subsidiaries, are offered on all products sold by the Company and franchisees to provide coverage that extends beyond the Notes to the Consolidated Financial Statements36 manufacturer’s warranty period by up to five years. Warranties are sold to customers when they make their original purchase and take effect immediately. The warranty contracts provide both repair and replacement services depending upon the nature of the warranty claim. The Company’s extended warranty plan revenues are deferred at the time of sale and are recognized as revenue over the term of the warranty plan in a pattern matching the estimated future claims expense. D E F E R R E D A C Q U I S I T I O N C O S T S Acquisition costs are comprised of commissions, premium taxes and other expenses that relate directly to the writing or renewing of warranty and insurance contracts. These costs are deferred only to the extent that they are expected to be recovered from unearned premiums and are amortized over the period in which the revenue from the policies is earned. All other acquisition costs are recognized as an expense when incurred. Costs incurred on warranty plan sales, including sales commissions and premium taxes, are recorded as deferred acquisition costs. These costs are amortized to income in the same pattern as revenue from warranty plan sales is recognized. Changes in the expected pattern of consumption are accounted for by changing the amortization period and are treated as a change in an accounting estimate. Deferred acquisition costs are derecognized when the related contracts are either settled or disposed of. S A L E O F G I F T C A R D S Revenue from the sale of gift cards is recognized when the gift cards are redeemed (the customer purchases merchandise). Revenue from unredeemed gift cards is deferred and included in trade and other payables. R E N TA L I N C O M E O N I N V E S T M E N T P R O P E R T I E S Rental income arising on investment properties is accounted for on a straight-line basis over the lease term and is presented within revenue. Store pre-opening costs Store pre-opening costs are expensed as incurred. Borrowing costs Borrowing costs are expensed in the period in which they occur. Borrowing costs consist of interest and other costs that the Company incurs in connection with the borrowing of funds. Earnings per share Basic earnings per share have been calculated using the weighted average number of common shares outstanding during the year. Diluted earnings per share are calculated using the “if converted” method. The dividends declared on the redeemable share liability under the Company’s Management Share Purchase Plan (the “Plan”) are included in net income for the year. The redeemable shares convertible under the Plan are included in the calculation of diluted number of common shares to the extent the redemption price was less than the average annual market price of the Company’s common shares. 4. ADOPTION OF ACCOUNTING STANDARDS AND AMENDMENTS Accounting standards and amendments issued but not yet adopted In July 2014, the IASB issued the final amendments to IFRS 9, Financial Instruments (“IFRS 9”), which provides guidance on the classification and measurement of financial assets and liabilities, impairment of financial assets, and general hedge accounting. The classification and measurement portion of the standard determines how financial assets and financial liabilities are accounted for in financial statements and, in particular, how they are measured on an ongoing basis. The amended IFRS 9 introduced a new, expected-loss impairment model that will require more timely recognition of expected credit losses. In addition, the amended IFRS 9 includes a substantially reformed model for hedge accounting, with enhanced disclosures about risk management activity. The new standard is effective for annual periods beginning on or after January 1, 2018, with earlier adoption permitted. The Company is in the process of evaluating the impact of adopting these amendments on the Company’s consolidated financial statements. IFRS 15, Revenue from Contracts with Customers (“IFRS 15”), was issued in May 2014, which will replace IAS 11, Construction Contracts, IAS 18, Revenue Recognition, IFRIC 13, Customer Loyalty Programmes, IFRIC 15, Agreements for the Construction of Real Estate, IFRIC 18, Transfers of Assets from Customers, and SIC-31, Revenue – Barter Transactions Involving Advertising Services. IFRS 15 provides a single, principles based five-step model that will apply to all contracts with customers with limited exceptions, including, but not limited to, leases within the scope of IAS 17, Leases (“IAS 17”); financial instruments and other contractual rights or obligations within the scope of IFRS 9, IFRS 10, Consolidated Financial Statements and IFRS 11, Joint Arrangements (“IFRS 11”). In addition to the five-step model, the standard specifies how to account for the incremental costs of obtaining a contract and the costs directly related to fulfilling a contract. The incremental costs of obtaining a contract must be recognized as an asset if the entity expects to recover these costs. The standard’s requirements will also apply to the recognition and measurement of gains and losses on the sale of some nonfinancial assets that are not an output of the entity’s ordinary activities. IFRS 15 is required for annual periods beginning on or after January 1, 2018. Earlier adoption is permitted. The Company has started the process of reviewing contracts with customers and other areas of the standard primarily the sale of non-financial assets such as property, plant and equipment. In January 2016, the IASB issued IFRS 16, Leases, which will replace IAS 17. The new standard will be effective for fiscal years beginning on or after January 1, 2019. Earlier application is permitted. Under the new standard, all leases will be on the balance sheet of lessees, except those that meet limited exception criteria. As the Company has significant contractual obligations in the form of operating leases (note 25) under the existing standard, there will be a material increase to both assets and liabilities upon adoption of the new standard. The Company is analyzing the new standard to determine its impact on the Company’s consolidated financial statements. Leon’s Furniture Limited | 2016 Annual Report37 Adoption of new, revised or amended accounting standards 5. CASH AND CASH EQUIVALENTS The Company has adopted the amended IFRS pronouncements listed below as at January 1, 2016, in accordance with the transitional provisions outlined in the respective standard. In May 2014, the IASB issued amendments to IFRS 11 to address the accounting for acquisitions of interests in joint operations. The amendments address how a joint operator should account for the acquisition of an interest in a joint operation in which the activity of the joint operation constitutes a business. IFRS 11, as amended, now requires that such transactions shall be accounted for using the principles related to business combinations accounting as outlined in IFRS 3, Business Combinations. The amendments are to be applied prospectively and are effective for annual periods beginning on or after January 1, 2016, with earlier application permitted. As at January 1, 2016, the Company adopted the amendments, and there was no impact on the consolidated financial statements. In May 2014, the IASB issued amendments to IAS 16, Property, Plant and Equipment (“IAS 16”) and IAS 38, Intangible Assets (“IAS 38”) to clarify acceptable methods of depreciation and amortization. The amended IAS 16 eliminates the use of a revenue-based depreciation method for items of property, plant and equipment. Similarly, amendments to IAS 38 eliminate the use of a revenue-based amortization model for intangible assets except in certain specific circumstances. The amendments are to be applied prospectively and are effective for annual periods beginning on or after January 1, 2016, with earlier application permitted. As at January 1, 2016, the Company adopted the amendments, and there was no impact on the consolidated financial statements. IAS 1, Presentation of Financial Statements, was amended in December 2014 to clarify guidance on materiality and aggregation, the presentation of subtotals, the structure of financial statements and the disclosure of accounting policies. The Amendment is effective for years beginning on or after January 1, 2016. The Company is analyzing the new standard to determine its impact, if any, on the Company’s consolidated financial statements. As at January 1, 2016, the Company adopted the amendments, and there was no material impact on the consolidated financial statements. As at December 31, 2016 2015 Cash at bank and on hand $ 43,985 $ 7,859 6. INVENTORIES The amount of inventory recognized as an expense for the year ended December 31, 2016 was $1,186,850 [2015 – $1,107,166], which is presented within cost of sales in the consolidated statements of income. There were $550 inventory write-downs [2015 – $nil] recognized as an expense during 2016. There were no inventory write-downs recognized in prior periods reversed [2015 – $2,396]. As at December 31, 2016, the inventory mark-down provision totalled $7,993 [2015 – $7,443]. 7. DEFERRED ACQUISITION COSTS Balance at December 31, 2014 Costs of new policies sold Policy sales costs recognized Balance at December 31, 2015 Cost of new policies sold Policy sales costs recognized $ $ 16,050 10,070 (4,698) 21,422 5,360 (6,011) Balance at December 31, 2016 $ 20,771 Reported as: Current Non-current Balance at December 31, 2015 Current Non-current $ $ 8,329 13,093 21,422 7,643 13,128 Balance at December 31, 2016 $ 20,771 Notes to the Consolidated Financial Statements 38 8. PROPERTY, PLANT AND EQUIPMENT As at December 31, 2016: Opening net book value Additions Disposals Depreciation Closing net book value As at December 31, 2016: Cost Accumulated depreciation Land Buildings Equipment Vehicles Building Improvements Leased Property Leased Equipment Total $ $ 85,051 1,203 – – 86,254 $ 110,996 523 – (5,849) 105,670 $ 41,818 9,279 (101) (9,225) 41,771 $ 14,738 8,816 (14) (3,233) 20,307 60,066 5,595 (2) (12,965) 52,694 $ 9,516 – – (1,131) 8,385 $ 1,033 273 – (887) $ 323,218 25,689 (117) (33,290) 419 315,500 86,254 – 239,897 (134,227) 144,208 (102,437) 40,432 (20,125) 227,154 (174,460) 20,766 (12,381) 11,611 (11,192) 770,322 (454,822) Net book value $ 86,254 $ 105,670 $ 41,771 $ 20,307 $ 52,694 $ 8,385 $ 419 $ 315,500 Land Buildings Equipment Vehicles Building Improvements Leased Property Leased Equipment Total As at December 31, 2015: Opening net book value Additions Disposals Depreciation Closing net book value As at December 31, 2015: Cost Accumulated depreciation $ 84,133 944 (26) – 85,051 85,051 – $ $ 116,722 416 (2) (6,140) 110,996 $ 41,904 9,055 (41) (9,100) 41,818 $ $ 8,379 8,591 (62) (2,170) 14,738 70,370 3,440 – (13,744) 60,066 $ 10,647 – – (1,131) 9,516 1,897 – – (864) 1,033 $ 334,052 22,446 (131) (33,149) 323,218 239,374 (128,378) 147,333 (105,515) 36,766 (22,028) 224,492 (164,426) 20,766 (11,250) 11,338 (10,305) 765,120 (441,902) Net book value $ 85,051 $ 110,996 $ 41,818 $ 14,738 $ 60,066 $ 9,516 $ 1,033 $ 323,218 Included in the above balances as at December 31, 2016 are assets not being amortized with a net book value of approximately $437 [2015 – $1,464], being construction in progress. Also included are fully depreciated assets still in use with a cost of $178,949 [2015 – $146,768]. 9. INVESTMENT PROPERTIES As at December 31, 2016: Opening net book value Additions Disposal Depreciation Closing net book value As at December 31, 2016: Cost Accumulated depreciation Net book value As at December 31, 2015: Opening net book value Additions Disposal Depreciation Closing net book value As at December 31, 2015: Cost Accumulated depreciation Net book value Land Buildings Building Improvements Total $ $ $ 10,946 – – – 10,946 10,946 – $ $ 6,692 – – (435) 6,257 858 – – (77) 781 $ 18,496 – – (512) 17,984 17,333 (11,076) 1,097 (316) 29,376 (11,392) 10,946 $ 6,257 $ 781 $ 17,984 $ 12,519 – (1,573) – 10,946 10,946 – $ 8,798 – (1,625) (481) 6,692 $ 675 310 (63) (64) 858 21,992 310 (3,261) (545) 18,496 17,333 (10,641) 2,554 (1,696) 30,833 (12,337) $ 10,946 $ 6,692 $ 858 $ 18,496 The estimated fair value of the investment properties portfolio as at December 31, 2016 was approximately $44,800 [2015 – $44,800]. This recurring fair value disclosure is categorized within Level 3 of the fair value hierarchy (note 22 for definition of levels). The Company used an independent valuation specialist to determine the fair value of The Brick division’s investment properties of $11,200. The remaining disclosed fair value of $33,600 was compiled internally by management based on available market evidence. Leon’s Furniture Limited | 2016 Annual Report 10. INTANGIBLE ASSETS AND GOODWILL Customer relationships Brand name and franchise agreement Non-compete agreement Computer software Favourable lease agreements Total 39 As at December 31, 2016: Opening net book value Additions Amortization $ 3,281 $ – (625) 266,500 – $ (250) Closing net book value 2,656 266,250 As at December 31, 2016: Cost Accumulated amortization Net book value As at December 31, 2015: Opening net book value Additions Amortization Closing net book value As at December 31, 2015: Cost Accumulated amortization $ $ – $ – – – – – $ 13,957 683 (3,520) 11,120 34,476 $ 318,214 683 (7,433) – (3,038) 31,438 311,464 24,002 (12,882) 46,049 (14,611) 345,551 (34,087) 7,000 (4,344) 268,500 (2,250) 2,656 $ 266,250 $ – $ 11,120 $ 31,438 $ 311,464 4,156 $ – (875) 3,281 $ 266,750 – (250) 266,500 125 $ – (125) – $ 11,946 4,956 (2,945) 13,957 $ 38,325 – (3,849) 34,476 321,302 4,956 (8,044) 318,214 7,000 (3,719) 268,500 (2,000) 1,012 (1,012) 23,319 (9,362) 46,049 (11,573) 345,880 (27,666) Net book value $ 3,281 $ 266,500 $ – $ 13,957 $ 34,476 $ 318,214 Amortization of intangible assets is included within selling, general and administration expenses on the consolidated statements of income. The following table presents the details of the Company’s indefinite-life intangible assets: The Brick brand name (allocated to Brick division) The Brick franchise agreements (allocated to Brick division) As at December 31, 2016 2015 $ 245,000 $ 21,000 245,000 21,000 $ 266,000 $ 266,000 The Company currently has no plans to change The Brick store banners and expects these assets to generate cash flows over an indefinite future period. Therefore, these intangible assets are considered to have indefinite useful lives for accounting purposes. The Brick franchise agreements have expiry dates with options to renew. The Company’s intention is to renew these agreements at each renewal date indefinitely and without significant cost. The Company expects the franchise agreements and franchise locations will generate cash flows over an indefinite future period. Therefore, this asset is also considered to have an indefinite useful life. The following table presents the details of the Company’s finite-life intangible assets: Leon’s division brand name Brick division customer relationships Brick division favourable lease agreements Computer software As at December 31, 2016 $ 250 $ 2,656 31,438 11,120 2015 500 3,281 34,476 13,957 $ 45,464 $ 52,214 Notes to the Consolidated Financial Statements 40 For the purpose of the annual impairment testing, goodwill is allocated to the following CGU groups, which are the groups expected to benefit from the synergies of the business combinations and to which the goodwill is monitored by the Company: Appliance Canada (included within the Leon’s division) Brick division Total goodwill Impairment tests As at December 31, 2016 2015 $ 11,282 378,838 $ 11,282 378,838 $ 390,120 $ 390,120 The Company performed impairment tests of goodwill, brand and franchise agreements intangible as at December 31, 2016 and December 31, 2015 in accordance with the accounting policy as described in note 3. The recoverable amount of the CGUs was determined based on value-in-use calculations. These calculations used cash flow projections based on financial budgets approved by management covering a one-year period. Cash flows beyond the one-year period are extrapolated using the estimated growth rates stated below. The key assumptions used for the value-in-use calculation as at December 31, 2016 and December 31, 2015 were as follows: Growth rate Pre-tax discount rate 2016 2.0% 8.9% 2015 2.0% 9.3% The impairment tests performed resulted in no impairment of the goodwill as at December 31, 2016 and December 31, 2015. 11. TRADE AND OTHER PAYABLES Trade payables Other payables 12. PROVISIONS Balance as at December 31, 2015 Provisions made during the year Provisions used during the year Balance as at December 31, 2016 As at December 31, 2016 2015 $ 185,927 $ 28,911 175,933 30,143 $ 214,838 $ 206,076 Unpaid insurance claims Unpaid warranty claims Product returns $ 1,696 1,402 (1,573) 200 $ 277 (198) $ 1,908 296 (179) Other 1,539 100 – $ 1,525 $ 279 $ 2,025 $ 1,639 $ $ $ Total 5,343 2,075 (1,950) 5,468 Unpaid insurance claims Unpaid warranty claims The provision for unpaid insurance claims represents the estimated amounts necessary to settle all outstanding claims, as well as claims that are incurred but not reported, as of the reporting date. Unpaid claims are determined using generally accepted actuarial practices, according to the standards established by the Canadian Institute of Actuaries. The establishment of the provision for unpaid claims, measured on a discounted basis, relies on the judgment and estimates of the Company based on historical precedent and trends, on prevailing legal, economic, social and regulatory trends and on expectations as to future developments. The process of determining the provisions necessarily involves risks that the actual results will deviate, perhaps materially, from the best estimates made. The provision for unpaid warranty claims represents the estimated amounts necessary to settle unpaid reported claims for warranty plans sold and all outstanding claims for certain products where the Company provides a standard warranty. The estimates are necessarily subject to uncertainty and are selected from a range of possible outcomes. The provisions are increased or decreased as additional information affecting the estimates becomes known during the course of claims settlement. All changes in estimates are recorded in cost of sales in the current year. Product returns The provision for product returns represents the Company’s estimate of amounts the Company expects to incur regarding its product return policies. The estimate is based on sales recognized prior to the end of the reporting period, historical information, management judgment and actual experience subsequent to the end of the reporting period. Leon’s Furniture Limited | 2016 Annual Report 41 13. FINANCE LEASE LIABILITIES Leasing arrangements The Company leases a distribution centre and vehicles under a number of finance lease agreements. The lease term on the distribution centre and vehicles do not exceed 20 years and 8 years, respectively. The Company’s obligations under finance Finance lease liabilities Finance lease liabilities are payable as follows: leases are secured by the leased assets. The Company’s distribution centre lease has renewal and escalation clauses as part of the general lease conditions. The escalation clauses expected to occur have been included in the determination of this finance lease liability. Less than one year Between one and five years More than five years $ Reported as: Current Non-current Future Minimum lease payments 2,086 7,592 4,655 14,333 $ 2016 Present value of minimum lease payments Future Minimum lease payments $ 1,421 $ 5,917 4,557 2,729 $ 7,751 6,581 11,895 17,061 Interest 665 1,675 98 2,438 1,421 10,474 $ 11,895 2015 Present value of minimum lease payments 1,954 5,668 6,227 13,849 1,954 11,895 13,849 Interest 775 $ 2,083 354 3,212 $ 14. LOANS AND BORROWINGS Convertible debentures On March 28, 2013 (“Issuance Date”), the Company closed an offering in which the shareholders of The Brick purchased $100,000 principal amount of 3% convertible unsecured debentures due on March 28, 2023 (“Maturity Date”). Interest is due semi-annually in arrears on June 30 and December 31 in each year. The convertible debentures are convertible, at the option of the holder, at any time during the period between the ninetieth day prior to the fourth anniversary of the Issuance Date and the third business day prior to the Maturity Date in whole or in multiples of one thousand dollars, into fully paid common shares of the Company at the conversion rate of 79.12707 common shares per one thousand dollars principal amount of debentures subject to certain adjustments. The Company has the right to settle the convertible debentures in cash or shares during any time subsequent to the fourth anniversary of the Issuance Date and on the Maturity Date. There are additional conversion options available to debenture holders in the event of an increase in the Company’s dividend rate or in the event of a change in control of the Company. The convertible debentures are unsecured obligations of the Company and are subordinated in right of payment to all of the Company’s senior indebtedness. The Company will accrete the carrying value of the convertible debentures of $93,520 to their contractual face value of $100,000 through a charge to net income over their term. This charge will be included in finance costs. Carrying value of convertible debentures as at December 31, 2014 Accretion expense for the year ended December 31, 2015 Carrying value of convertible debentures as at December 31, 2015 Accretion expense for the year ended December 31, 2016 Carrying value of convertible debentures as at December 31, 2016 $ $ 91,773 855 92,628 892 93,520 The effective interest rate for the convertible debentures is 4.2% and includes accretion expense and semi-annual coupon payments. Notes to the Consolidated Financial Statements 42 Bank indebtedness On January 31, 2013, a Senior Secured Credit Agreement (“SSCA”) was obtained to fund the acquisition of The Brick. The Company completed an amendment to the existing SSCA on November 25, 2016. After giving effect to the amendment, the total credit facility was reduced from $500,000 to $300,000, with the term credit facility being reduced from $400,000 to $250,000 and the revolving credit facility being reduced from $100,000 to $50,000. The revolving credit facility continues to include a swing- line of $20,000. Under the terms of the SSCA, amounts borrowed must be repaid in full by November 25, 2019. Bank indebtedness bears interest based on Canadian prime, London Interbank Offered Rate (“LIBOR”) and Bankers’ Acceptance (“BA”) rates plus an applicable standby fee on undrawn amounts. Transaction costs in the amount of $775 have been deferred and are being amortized. The Company has the ability to choose the type of advance required. Interest is based on the market rate plus an applic- able margin. Currently, the Company has entered into a 32-day BA with a cost of borrowing of 2.68% that was renewed on December 30, 2016. The term credit facility is repayable in yearly amounts of $25,000 commencing on December 31, 2017. The Company can prepay without penalty amounts out- standing under the facilities at any time. The agreement includes a general security agreement which constitutes a lien on all personal property of the Company. In addition to this, there are financial and non-financial covenants related to the credit facility. As at December 31, 2016, the Company is in full compliance of these financial and non-financial covenants. 15. REDEEMABLE SHARE LIABILITY Authorized 1,224,000 convertible, non-voting, series 2009 shares 306,500 convertible, non-voting, series 2012 shares 1,485,000 convertible, non-voting, series 2013 shares 740,000 convertible, non-voting, series 2014 shares 880,000 convertible, non-voting, series 2015 shares Issued and fully paid 480,088 series 2009 shares [December 31, 2015 – 619,016] 228,936 series 2012 shares [December 31, 2015 – 233,616] 1,093,783 series 2013 shares [December 31, 2015 – 1,406,772] 623,188 series 2014 shares [December 31, 2015 – 740,000] 795,000 series 2015 shares [December 31, 2015 – 880,000] Less employee share purchase loans As at December 31, 2016 2015 $ 4,249 $ 2,841 12,458 9,379 10,701 (39,125) 5,478 2,899 16,024 11,137 11,845 (46,503) $ 503 $ 880 Under the terms of the Plan, the Company advanced non-interest bearing loans to certain of its employees in 2009, 2012, 2013, 2014 and 2015 to allow them to acquire convertible, non-voting series 2009 shares, series 2012 shares, series 2013, series 2014 shares and series 2015 shares, respectively, of the Company. These loans are repayable through the application against the loans of any dividends on the shares with any remaining balance repayable on the date the shares are converted to common shares. Each issued and fully paid for series 2009 and series 2012 share may be converted into one common share at any time after the fifth anniversary date of the issue of these shares and prior to the tenth anniversary of such issue. Each issued and fully paid for series 2013, series 2014 and 2015 series share may be converted into one common share at any time after the third anniversary date of the issue of these shares and prior to the tenth anniversary of such issue. The series 2009, series 2012, series 2013, series 2014 and 2015 series shares are redeemable at the option of the holder for a period of one business day following the date of issue of such shares. The Company has the option to redeem the series 2009 and series 2012 shares at any time after the fifth anniversary date of the issue of these shares and must redeem them prior to the tenth anniversary of such issue. The Company has the option to redeem the series 2013, series 2014 and 2015 series shares at any time after the third anniversary date of the issue of these shares and must redeem them prior to the tenth anniversary of such issue. The redemption price is equal to the original issue price of the shares adjusted for subsequent subdivisions of shares plus accrued and unpaid dividends. The purchase prices of the shares are $8.85 per series 2009 share, $12.41 per series 2012 share, $11.39 per series 2013 share, $15.05 per series 2014 share and $13.46 per series 2015 share. Dividends paid to holders of series 2009, 2012, 2013, 2014 and 2015 shares of approximately $598 [2015 – $676] have been used to reduce the respective shareholder loans. The preferred dividends are paid once a year during the first quarter. Leon’s Furniture Limited | 2016 Annual Report During the year ended December 31, 2016, nil series 2005 shares [2015 – 251,080], 138,928 series 2009 shares [2015 – 95,984] and 312,989 series 2013 shares [2015 – nil] were converted into common shares with a stated value of approximately $nil [2015 – $2,370], $1,229 [2015 – $850] and $3,566 [2015 – $nil], respectively. During the year ended December 31, 2016, the Company cancelled 4,680 series 2012 shares [2015 – 14,280], 116,812 series 2014 shares [2015 – nil] and 85,000 series 2015 shares 16. COMMON SHARES Authorized Authorized – Unlimited common shares Issued 71,855,866 common shares [2015 – 71,403,949] 43 [2015 – nil] in the amount of $58 [2015 – $177], $1,758 [2015 – $nil] and $1,144 [2015 – $nil], respectively. Employee share purchase loans have been netted against the redeemable share liability, as the Company has the legally enforceable right of set-off and the positive intent to settle on a net basis. As at December 31, 2016 2015 $ 39,184 $ 34,389 During the year ended December 31, 2016, nil series 2005 shares [2015 – 251,080], 138,928 series 2009 shares [2015 – 95,984] and 312,989 series 2013 shares [2015 – nil] were converted into common shares with a stated value of approximately $nil [2015 – $2,370], $1,229 [2015 – $850] and $3,566 [2015 – $nil], respectively. As at December 31, 2016, the dividends payable were $7,183 [$0.10 per share] and as at December 31, 2015 were $7,141 [$0.10 per share]. 17. REVENUE Sale of goods by corporate stores Income from franchise operations Extended warranty revenue Insurance sales revenue Rental income from investment property Total 18. EXPENSES BY NATURE Salaries and benefits Depreciation of property, plant and equipment and investment properties Amortization of intangible assets Operating lease payments Years ended December 31, 2016 2015 $ 2,060,563 $ 1,953,221 20,233 45,378 11,461 1,425 23,748 47,771 10,193 1,461 $ 2,143,736 $ 2,031,718 Years ended December 31, 2016 2015 $ $ $ $ 358,505 $ $ $ 94,044 $ 33,802 7,433 350,166 33,694 8,044 91,945 Notes to the Consolidated Financial Statements 44 19. NET FINANCE COSTS Interest expense on finance lease obligations Interest expense on term credit facilities and revolving credit facilities Interest expense on convertible debentures Finance income Total 20. INCOME TAX EXPENSE Years ended December 31, 2016 2015 $ 786 $ 12,349 3,891 (2,545) 925 14,247 3,855 (1,400) $ 14,481 $ 17,627 (a) The major components of income tax expense for the years ended December 31 are as follows: Consolidated statements of income 2016 2015 Current income tax expense: Based on taxable income of the current year Deferred income tax expense: Origination and reversal of temporary differences Impact of change in tax rates/new tax laws Income tax expense reported in the consolidated statements of income (b) Reconciliation of the effective tax rates are as follows: $ 35,542 35,542 $ 30,107 30,107 (4,945) – (4,945) (5,317) – (5,317) $ 30,597 $ 24,790 Income before income taxes $ 114,189 $ 101,420 2016 2015 Income tax expense based on statutory tax rate Increase (decrease) in income taxes resulting from non-taxable items or adjustments of prior year taxes: Non-deductible items Non-taxable portion of capital gain Tax expense relating to deferred rate reductions File/provided differences Remeasurement of deferred tax asset for rate changes Income exempt from tax Other Income tax expense reported in the consolidated statements of income 30,510 26.72% 26,998 26.62% 725 (7) 66 (485) (18) (137) (57) 0.63% (0.00%) 0.06% (0.42%) (0.02%) (0.12%) (0.05%) 115 – 577 (620) 104 (438) (1,946) 0.11% 0.00% 0.57% (0.61%) 0.10% (0.43%) (1.91%) $ 30,597 26.80% $ 24,790 24.45% (c) Deferred income tax balances and reconciliation are as follows: (i) Deferred income tax relates to the following: Deferred income tax assets (liabilities) Deferred tax assets Deferred tax liabilities Total deferred income tax assets (liabilities) December 31, 2016 December 31, 2015 $ 8,174 (90,003) $ (81,829) $ $ 9,083 (96,062) (86,979) Leon’s Furniture Limited | 2016 Annual Report 45 (ii) Deferred income movements are as follows: Deferred warranty plan Deferred financing fees Deferred acquisition costs Property, plant and equipment Intangible assets Deferred rent liabilities Finance lease liabilities Transition for partnership deferral Unused tax losses Other Mark to market Net deferred income tax expense – statements of income Movement in convertible debenture Net deferred income tax expense (benefit) – equity Balance, beginning of year $ 1,524 $ (80) 2,668 (18,519) (77,584) 1,632 3,692 – 79 2,308 (143) (84,423) (2,556) (2,556) 2016 Consolidated Balance, end of year 1,781 354 962 (17,395) (77,178) 2,125 3,170 – 58 6,274 576 $ Expense (benefit) 257 434 (1,706) 1,124 406 493 (522) – (21) 3,761 719 4,945 (79,273) – – (2,556) (2,556) $ Other – – – – – – – – – 205 – 205 – – Total deferred income tax expense (benefit) $ (86,979) $ 205 $ 4,945 $ (81,829) Deferred warranty plan Deferred financing fees Deferred acquisition costs Property, plant and equipment Intangible assets Deferred rent liabilities Finance lease liabilities Transition for partnership deferral Unused tax losses Other Mark to market Net deferred income tax expense – statements of income Movement in convertible debenture Net deferred income tax expense (benefit) – equity Balance, beginning of year $ 1,285 $ (397) 4,528 (22,825) (74,506) 1,095 4,110 (5,387) 104 2,451 (45) (89,587) (2,556) (2,556) 2015 Consolidated Balance, end of year 1,524 (80) 2,668 (18,519) (77,584) 1,632 3,692 – 79 2,308 (143) (84,423) (2,556) (2,556) Expense (benefit) 239 $ 317 (1,860) 4,306 (3,078) 537 (418) 5,387 (25) 11 (98) 5,318 – – $ Other – – – – – – – – – (154) – (154) – – Total deferred income tax expense (benefit) $ (92,143) $ (154) $ 5,318 $ (86,979) 21. EARNINGS PER SHARE Earnings per share are calculated using the weighted average number of common shares outstanding. The weighted average number of common shares used in the basic earnings per share calculations amounted to 71,695,955 for the year ended December 31, 2016 [2015 – 71,217,958]. The following table reconciles the net income for the year and the number of shares for the basic and diluted earnings per share calculations: Net income for the year for basic earnings per share Net income for the year for diluted earnings per share Weighted average number of common shares outstanding Dilutive effect Diluted weighted average number of common shares outstanding Basic earnings per share Diluted earnings per share Years ended December 31, 2016 2015 $ 83,591 $ 86,924 76,629 79,899 71,695,955 71,217,958 11,385,877 11,146,581 83,081,832 82,364,539 $ $ 1.17 $ 1.05 $ 1.08 0.97 Notes to the Consolidated Financial Statements 46 22. FINANCIAL INSTRUMENTS AND FINANCIAL RISK MANAGEMENT Classification of financial instruments and fair value The classification of the Company’s financial instruments, as well as their carrying amounts and fair values, are disclosed in the tables below. As at December 31, 2016 Loans and receivables Cash and cash equivalents Trade receivables Available-for-sale Restricted marketable securities Available-for-sale financial assets Investment properties Other financial liabilities Trade and other payables Provisions Finance lease liabilities Loans and borrowings Convertible debentures Redeemable share liability Derivative instruments Other liabilities As at December 31, 2015 Loans and receivables Cash and cash equivalents Trade receivables Available-for-sale Restricted marketable securities Available-for-sale financial assets Investment properties Derivative instruments Other assets Other financial liabilities Trade and other payables Provisions Finance lease liabilities Loans and borrowings Convertible debentures Redeemable share liability Measurement Total Carrying Amount Fair Value Fair Value Hierarchy Fair value $ Amortized cost 43,985 128,142 Fair value $ Fair value Amortized cost 16,600 39,079 17,984 $ $ Amortized cost $ Amortized cost Amortized cost Amortized cost Amortized cost Amortized cost 214,838 $ 5,468 11,895 239,436 93,520 503 43,985 128,142 16,600 39,079 44,800 214,838 5,468 11,895 239,436 140,000 503 Level 1 Level 2 Level 1 Level 2 Level 3 Level 2 Level 2 Level 2 Level 2 Level 2 Level 2 Fair value $ 2,124 $ 2,124 Level 2 Measurement Total Carrying Amount Fair Value Fair Value Hierarchy Fair value $ 7,859 $ Amortized cost 117,832 Fair value $ Fair value Amortized cost 18,691 $ 22,960 18,496 7,859 117,832 18,691 22,960 44,800 Level 1 Level 2 Level 1 Level 2 Level 3 Fair value $ 539 $ 539 Level 2 Amortized cost Amortized cost Amortized cost Amortized cost Amortized cost Amortized cost $ 206,076 $ 5,343 13,849 287,357 92,628 880 206,076 5,343 13,849 287,357 125,000 880 Level 2 Level 2 Level 2 Level 2 Level 2 Level 2 The fair value hierarchy of financial instruments measured at fair value, as at December 31, 2016, includes financial assets of $60,585, $167,221 and $44,800 for Levels 1, 2 and 3, respectively, and financial liabilities of $nil, $614,264 and $nil for Levels 1, 2 and 3, respectively. The carrying amounts of the Company’s trade receivables and trade and other payables approximate their fair values due to their short-term nature. The carrying amounts of the Company’s finance lease liabilities approximate their fair values because the interest rate applied to measure their carrying amount approximates current market inter- est rates. The carrying amounts of the Company’s loans and borrowings approximate their fair values since they bear interest at rates comparable to market rates at the end of the reporting period. The fair values of available-for-sale financial assets and restricted marketable securities that are traded in active markets are determined by reference to their quoted closing price or dealer price quotations at the reporting date. For financial instruments that are not traded in active markets, the Company determines fair values using a combination of discounted cash flow models and comparison to similar instruments for which market observable prices exist. As at December 31, 2016, the fair value of the convertible debentures was determined using their closing quoted market price (not in thousands of dollars) of $140.00 per $100.00 of face value [2015 – $125.00 per $100.00 of face value]. For the convertible debentures at December 31, 2016, fair value is calculated based on the face value of the convertible debentures of $100,000. The fair values of derivative assets and liabilities are estimated using industry standard valuation models. Where applicable, these models project future cash flows and discount the future amounts to a present value using market based observable Leon’s Furniture Limited | 2016 Annual Report 47 inputs including interest rate curves, foreign exchange rates and forward and spot prices for currencies. The Company maintains a notional $100,000 [2015 – $100,000] in interest rate swaps that mature by the fourth quarter of 2019 on which it pays a fixed rate of 1.895% and currently receives 1 month BA rate. The Company also maintains other financial derivatives which comprise of foreign exchange contracts, with maturities that do not exceed past the first quarter of 2018. At December 31, 2016, a $2,124 unrealized loss was recorded in other liabilities [2016 – $539 unrealized gain]. Fair values of financial instruments reflect the credit risk of the Company and counterparties when appropriate. Fair value hierarchy The Company uses a fair value hierarchy to categorize the inputs used to measure the fair value of financial assets and financial liabilities, the levels of which are 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 (that is, as prices) or indirectly (that is, derived from prices). Level 3: Inputs for the asset or liability that are not based on observable market data (that is, unobservable inputs). Financial risk management The Company’s activities expose it to a variety of financial risks: credit risk, liquidity risk and market risk (including interest rate risks, currency risk and other price risk). Risk management is carried out by the Company by identifying and evaluating the financial risks inherent within its operations. The Company’s overall risk management activities seek to minimize potential adverse effects on the Company’s financial performance. C R E D I T R I S K Credit risk is the risk of financial loss to the Company if a customer or counterparty to a financial instrument fails to meet its contractual obligations. The following table summarizes the Company’s maximum exposure to credit risk related to financial instruments. The maximum credit exposure is the carrying value of the asset, net of any allowances for impairment. Cash and cash equivalents Restricted marketable securities Available-for-sale financial assets Trade receivables Carrying Amount 2016 2015 $ $ 43,985 16,600 39,079 128,142 7,859 18,691 22,960 117,832 $ 227,806 $ 167,342 Generally, the carrying amount on the consolidated statements of financial position of the Company’s financial assets exposed to credit risk represents the Company’s maximum exposure to credit risk. No additional credit risk disclosure is provided, unless the maximum potential loss exposure to credit risk for certain financial assets differs significantly from their carrying amount. The Company’s main credit risk exposure is from its trade receivables. For the Company, trade receivables are comprised principally of amounts related to its commercial sales, to its franchise operations, and to vendor rebate programs. For commercial trade and other receivables, credit risk is mitigated through customer agreements specifying payment terms and credit limits. For franchise trade receivables, personal guarantees are obtained. As well, liens are placed against the goods and the Company may repossess goods for non-payment. Credit risk is also limited due to the large number of customers and their dispersion across geographic areas and market sectors (i.e. retail, commercial, and franchise). Accordingly, the Company believes it has no significant concentrations of credit risk related to trade receivables. In addition, trade receivables are managed and analyzed on an ongoing basis to control the Company’s exposure to bad debts. The Company assesses the adequacy of the allowance for impairment quarterly, taking into account historical experience, current collection trends, the age of receivables, and when warranted and available, the financial condition of specific counterparties. The Company focuses on receivables outstanding for greater than 90 days in assessing the Company’s credit risk and records a reserve, when required, to mitigate that risk. When collection efforts have been exhausted, specific balances are written off. As at December 31, 2016, there are no financial assets that the Company deems to be impaired or that are past due according to their terms and conditions, for which allowances have not been recorded. The Company’s trade receivables totalled $128,142 as at December 31, 2016 [2015 – $117,832]. The amount of trade receivables that the Company has determined to be past due [which is defined as a balance that is more than 90 days past due] is $6,412 as at December 31, 2016 [2015 – $4,827]. The Company’s provision for impairment of trade receivables, established through ongoing monitoring of individual customer accounts, was $2,539 as at December 31, 2016 [2015 – $1,959]. The majority of the Company’s retail sales are funded through cash, traditional credit cards and private label credit cards carried on a non-recourse basis by third parties. Accordingly, fluctuations in the availability and cost of credit may have an impact on the Company’s retail sales and profitability. The Company manages credit risk for its cash and cash equivalents by maintaining bank accounts with major Canadian banks and investing only in highly rated Canadian and U.S. securities that are traded on active markets and are capable of prompt liquidation. Notes to the Consolidated Financial Statements 48 L I Q U I D I T Y R I S K Liquidity risk is the risk that an entity will encounter difficulty in meeting obligations associated with financial liabilities. The purpose of liquidity risk management is to maintain sufficient amounts of cash and cash equivalents, and authorized credit facilities, to fulfil obligations associated with financial liabilities. To manage liquidity risk, the Company prepares budgets and cash forecasts, and monitors its performance against these. Management also monitors cash and working capital efficiency given current sales levels and seasonal variability. The Company measures and monitors liquidity risk by regularly evaluating its cash inflows and outflows under expected conditions through cash flow reporting such that it anticipates certain funding mis- matches and ensures the cash management of the business within certain tolerable levels. These cash flow forecasts are reviewed on a weekly basis by management. The Company mitigates liquidity risk through continuous monitoring of its credit facilities and the diversification of its funding sources, both in the short term as well as the long term. The following tables summarize the Company’s contractual maturity for its financial liabilities, including both principal and interest payments: As at December 31, 2016 Trade and other payables Finance lease liabilities Loans and borrowings Convertible debentures Redeemable share liability As at December 31, 2015: Trade and other payables Finance lease liabilities Loans and borrowings Convertible debentures Redeemable share liability Carrying Amount Contractual Cash Flows Under 1 Year 1-3 Years 3-5 Years More than 5 Years Remaining term to maturity $ $ 214,838 11,895 239,436 93,520 503 214,838 14,333 256,782 118,707 503 $ $ $ 214,838 2,086 31,437 3,000 – – 3,739 225,345 6,000 – $ – 3,853 – 6,000 – – 4,655 – 103,707 503 $ 560,192 $ 605,163 $ 251,361 $ 235,084 $ 9,853 $ 108,865 Carrying Amount Contractual Cash Flows Under 1 Year 1-3 Years 3-5 Years More than 5 Years Remaining term to maturity $ $ 206,076 13,849 287,357 92,628 880 $ 206,076 17,061 300,311 121,707 880 $ 206,076 2,729 58,480 3,000 – $ – 3,933 241,831 6,000 – $ – 3,818 – 6,000 – – 6,581 – 106,707 880 $ 600,790 $ 646,035 $ 270,285 $ 251,764 $ 9,818 $ 114,168 The contractual cash flows have been included in the tables above based on the contractual arrangements that exist at the reporting date and do not factor in any assumptions for early repayment. The amount and timing of actual payments may be materially different. Contractual cash flows presented in the above maturity analysis table for finance lease liabilities, loans and borrowings and convertible debentures include principal repayments, interest payments, and other related cash payments. As the carrying amounts of these liabilities are measured at amortized cost, the future contractual cash flows do not agree to the carrying amounts. The Company’s credit facilities and convertible debentures are further discussed in note 14. The Company’s future obligations under operating leases are discussed in note 25. Market risk Market risk is the risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in market prices. Market risk is comprised of three types of risk: interest rate risk, currency risk, and other price risk. (a) Interest rate risk Interest rate risk is the risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in market interest rates. The Company is exposed to cash flow risk on the term credit facility and the revolving credit facility, and to fair value risk on the finance lease liabilities and convertible debentures due to fluctuations in interest rates. Fair value risk related to the finance lease liabilities and convertible debentures impacts disclosure only as these items are carried at amortized cost on the consolidated statements of financial position. As well, the Company’s revenues depend, in part, on supplying financing alternatives to its customers through third party credit providers. The terms of these financing alternatives are affected by changes in interest rates. Therefore, interest rate fluctuations may impact the Company’s financing costs for retail sales financed using these alternatives, and may also impact the Company’s revenues where customers’ buying decisions are impacted by their ability or desire to use these financing alternatives. ( i ) I N T E R E S T R AT E S E N S I T I V I T Y A N A LY S I S The Company’s net income is sensitive to the impact of a change in interest rates on the average indebtedness under the term credit facility and the revolving credit facility during the year. For the year ended December 31, 2016, the Company’s average indebtedness under the term credit facility was $265,000 [2015 – $305,000] and under the revolving credit facility was $7,500 [2015 – $10,500]. Accordingly, a change during the year ended December 31, 2016 of a one percentage point increase or decrease in the applicable interest rate would have impacted the Company’s net income by approximately $2,000 [2015 – $2,385]. Leon’s Furniture Limited | 2016 Annual Report 49 (b) Currency risk (c) Other price risk The Company is exposed to foreign currency fluctuations since certain merchandise is paid for in U.S. dollars. This risk is offset to the extent that foreign currency costs are included in product costs when setting retail prices. Accordingly, the Company does not believe it has significant foreign currency risk with respect to its inventory purchases made in U.S. dollars. 23. INSURANCE CONTRACT RISK Certain subsidiaries of the Company are responsible for the insurance business and monitoring and managing the financial risks related to the Company’s insurance operations. This is done through internal risk assessment reporting and by compliance with regulatory requirements. Trans Global Life Insurance Company provides group insurance coverage for life, accident and sickness covering personal credit card debt; and group coverage for life, accident and sickness covering other personal short-term debt. Trans Global Insurance Company provides group coverage for loss of income and property covering personal credit card debt; group coverage for loss of income and property covering other personal short-term debt; and four and five-year term commercial property coverage. The principal risks faced under insurance contracts are that (i) the actual claims and benefit payments or the timing The Company is exposed to fluctuations in the market prices of its portfolio of restricted marketable securities that are classified as available-for-sale financial assets. Changes in the fair value of these financial assets are recorded, net of income taxes, in accumulated other comprehensive income as it relates to unrecognized gains and losses. The risk is managed by the Company and its investment managers by ensuring a conservative asset allocation. thereof, differ from expectations. This risk is influenced by the frequency of claims, severity of claims, actual benefits paid and subsequent development of claims; (ii) the risk of loss arising from expense experience being different than expected; and (iii) the risk arising due to policyholder experiences (lapses) being different than expected. The Company’s objective with respect to this risk is to ensure that sufficient reserves are available to cover these liabilities. The overall risk of the insurance operations is managed by diversifying across a large portfolio of insurance contracts and limiting the benefits that the policyholder stands to receive. The Company, therefore, has a defined maximum exposure which enables it to effectively manage the overall risk. These maximum benefits are limited to $25 per occurrence. 24. CAPITAL MANAGEMENT The Company’s objectives when managing capital are to: • ensure sufficient liquidity to support its financial obligations and execute its operating and strategic plans; and • utilize working capital to negotiate favourable supplier agreements both in respect of early payment discounts and overall payment terms. The capital structure of the Company has not changed from the prior fiscal year. The capital structure currently includes finance lease liabilities, convertible debentures, term credit facility and borrowing capacity available under the revolving credit facilities (note 14). As at December 31, 2016, $49,531 is available to draw on under our $50,000 revolving credit facility, as the borrowing capacity is reduced by ordinary letters of credit of $469 primarily with respect to buildings under construction or being completed [2015 – $486]. Current portion of finance lease liabilities Current portion of loans and borrowings Convertible debentures Finance lease liabilities Loans and borrowings Total shareholders’ equity Total capital under management As at December 31, 2016 2015 $ $ 1,421 25,000 93,520 10,474 214,436 659,553 1,954 50,000 92,628 11,895 237,357 600,402 $ 1,004,404 $ 994,236 Notes to the Consolidated Financial Statements 50 Under the Senior Secured Credit Agreement, the financial and non-financial covenants are reviewed on an ongoing basis by management to monitor compliance with the agreement. The Company was in compliance with these key covenants as at December 31, 2016. The Board of Directors reviews and approves any material transactions out of the ordinary course of business, including proposals on acquisitions or other major investments or divestitures, as well as capital and operating budgets. Based on current funds available and expected cash flow from operating activities, management believes that the Company has sufficient funds available to meet its liquidity requirements at any point in time. However, if cash from operating activities is lower than expected or capital costs for projects exceed current estimates, or if the Company incurs major unanticipated expenses, it may be required to seek additional capital. The Company is not subject to any externally imposed capital requirements, other than with respect to its insurance subsidiaries. Restriction on the distribution of capital from Trans Global Insurance Company and Trans Global Life Insurance Company For purposes of regulatory requirements for TGI and TGLI, capital is considered to be equivalent to their respective statement of financial position equity. Regulatory requirements stipulate that TGI must maintain minimum capital of at least $3,000 and TGLI must maintain minimum capital of at least $5,000. In addition, the Company is subject to the regulatory capital requirements defined by The Office of the Superintendent of Insurance of Alberta and the Insurance Act of Alberta (the “Act”). Notwithstanding that a company may meet the supervisory target standard, The Office of the Superintendent of Insurance of Alberta may direct a company to increase its capital under the Act. As at December 31, 2016, TGI’s Minimum Capital Test ratio was 494% [2015 – 472%], which is in compliance with the requirements of The Office of the Superintendent of Insurance of Alberta and the Act. As at December 31, 2016 TGLI’s Minimum Continuing Capital and Surplus Requirements ratio was 655% [2015 – 501%], which is in compliance with the requirements of The Office of the Superintendent of Insurance of Alberta and the Act. 25. COMMITMENTS AND CONTINGENCIES (a) The Company leases a number of retail stores and trucks under operating leases. Generally, the retail store leases have rent escalation terms and renewal options to extend. The Company is obligated under these operating leases for future minimum annual rental payments as follows: No later than 1 year Later than 1 year and no later than 5 years Later than 5 years $ $ 90,850 257,533 129,003 477,386 (b) The future minimum lease payments receivable under non-cancellable operating leases for certain land and buildings classified as investment property are as follows: No later than 1 year Later than 1 year and no later than 5 years Later than 5 years $ $ 1,974 4,266 4,395 10,635 (c) Pursuant to a reinsurance agreement relating to the extended warranty sales, the Company has pledged available-for-sale financial assets amounting to $16,600 [2015 – $18,691]. (d) In the normal course of operations, the Company is party to a number of lawsuits, claims and contingencies. Accruals are made in instances where it is probable that liabilities have been incurred and where such liabilities can be reasonably estimated. Although it is possible that liabilities may be incurred in instances for which no accruals have been made, the Company does not believe that the ultimate outcome of these matters will have a material impact on its financial position. 26. CONSOLIDATED STATEMENTS OF CASH FLOWS (a) The net change in non-cash working capital balances related to operations consists of the following: Years ended December 31, 2016 2015 Trade receivables Inventories Other assets Deferred acquisition costs Trade and other payables Provisions Income taxes payable/receivable Customers’ deposits Other liabilities Deferred rent liabilities and lease inducements $ (10,310) (4,840) (2,011) 651 9,264 125 28,169 5,544 2,124 $ (5,661) (37,333) (22) (5,372) 8,643 767 (52,253) 14,741 – 2,522 31,238 $ 2,064 (74,426) $ (b) Supplemental cash flow information: Years ended December 31, 2016 2015 Income taxes paid $ 31,100 $ 82,565 Leon’s Furniture Limited | 2016 Annual Report 51 27. RELATED PARTY TRANSACTIONS Balances and transactions between the Company and its subsidiaries, which are related parties of the Company, have been eliminated on consolidation. Key management compensation Key management includes the Directors and the five senior executives of the Company. The compensation expense paid to key management for employee services during each year is shown below: Years ended December 31, 2016 2015 Salaries and other short-term employee benefits $ 6,215 $ 5,665 28. COMPARATIVE FINANCIAL STATEMENTS The comparative consolidated financial statements have been reclassified from statements previously presented to conform to the presentation of the 2016 consolidated financial statements. 29. SUBSEQUENT EVENTS On January 31, 2017, the Company completed a transaction with The Beedie Development Group (“Beedie”) to purchase an undivided 50% ownership interest in 23.49 acres of land in Delta, British Columbia that is currently being developed by the Company and Beedie into an approximately 434,000 square foot distribution centre to be occupied by the Company in the second half of fiscal year 2017. The Company will account for this transaction as a joint operation. Notes to the Consolidated Financial Statements 52 CORPOR ATE & SHAREHOLDER INFORMATION Officers Mark J. Leon Chairman of the Board Terrence T. Leon CEO Edward F. Leon President and COO Dominic Scarangella Executive Vice President and CFO John A. Cooney Vice President, Legal and Corporate Secretary Board of Directors Mark J. Leon Toronto Terrence T. Leon Toronto Edward F. Leon King City Joseph M. Leon II Mississauga Peter B. Eby Private Investor, Toronto Alan J. Lenczner Barrister, Partner in Lenczner Slaght, Toronto Mary Ann Leon Financial Executive, Toronto Frank Gagliano Vice Chairman, St. Joseph Communications, Toronto Corporate Office 45 Gordon Mackay Road Toronto, Ontario M9N 3X3 (416) 243-7880 Auditors Ernst & Young LLP Toronto Registrar and Transfer Agent CST Trust Company Listing Leon’s shares are listed on the Toronto Stock Exchange Ticker Symbol is LNF Annual General Meeting Thursday, May 11, 2017 2:00PM Old Mill Toronto Humber Room 21 Old Mill Road Toronto, Ontario M8X 1G5 Leon’s Furniture Limited | 2016 Annual ReportL e o n ’ s F u r n i t u r e L i m i t e d | 2 0 1 6 A n n u a l R e p o r t Our customers can find everything we offer at our stores and more, including the same high standards for delivery, service and guaranteed pricing, through our growing online stores. leons.ca / brick.com / furniture.com

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