Board of Directors' Report on the State of the Company's Affairs for the Year Ended December 31, 2017 Shufersal Ltd. Director’s Report For the Year Ended December 31, 2017 1 Board of Directors' Report on the State of the Company's Affairs for the Year Ended December 31, 2017 Shufersal Ltd. Contents 1. Explanations of the Board to the Company's Business Affairs 1.1 Principal data regarding the business affairs of the Company 1.1.1 Description of operating segments reported as business segments in the consolidated financial statements of the Company 1.1.2 Management’s discussion of principal results for 2017 1.1.3 Dividend 1.2 Analysis of results of operations 1.2.1 Analysis of the results for 2017 as compared to 2016 1.2.2 Analysis of the results for 2016 as compared to 2015 1.2.3 Analysis of the results for the three months ended December 31, 2017 as compared to the corresponding period last year 1.2.4 Condensed consolidated income statement and consolidated statements of comprehensive income for 2017 by quarters and for the fourth quarter of 2016 1.3 Financial position, liquidity and sources of finance 1.3.1 Cash flow – Analysis of the results for 2017 as compared to 2016 1.3.2 Cash flow – Analysis of the results for 2016 as compared to 2015 1.3.3 Liquid asset balances and financial ratios 1.3.4 Board of Directors’ discussion of the Company’s liquidity in view of the working capital deficit as at December 31, 2017 2. Market Risk Exposure and Management 2.1 Company officer responsible for market risk management 2.2 Supervision over market risk management policy and its implementation 2.3 Description of market risks 2.3.1 Consumer Price Index risks 2.3.2 Foreign currency risks 2.3.3 Interest rate risks 2.3.4 Israeli capital market risks 2.4 Company policy regarding market risk management 2.5 Linkage bases report 2.6 Sensitivity tests 2 Board of Directors' Report on the State of the Company's Affairs for the Year Ended December 31, 2017 Shufersal Ltd. 3. Corporate governance 3.1 Activities of the Board of Directors and its committees 3.2 Directors having accounting and financial expertise 3.3 Process of approval of the financial statements 3.4 Disclosure regarding the internal auditor of the Company 3.5 Disclosure regarding the fees of the independent auditors 3.6 Contribution to the community 4. Directives regarding disclosures pertaining to the financial reporting of the Company 4.1 Disclosure regarding events subsequent to the date of the statement of financial position 5. Specific disclosure for holders of bonds Annex: Information regarding a very material valuation. 3 Board of Directors' Report on the State of the Company's Affairs for the Year Ended December 31, 2017 Shufersal Ltd. We hereby submit the Directors' Report of Shufersal Ltd. (hereinafter – "Shufersal" or "the Company") for the year 2017 (hereinafter – "2017" or "the reporting period")1, in accordance with the Securities Regulations (Periodic and Immediate Reports), 1970, (hereinafter –"the reporting regulations"). Shufersal together with its subsidiaries and associate companies are hereinafter called “the Shufersal Group” or “the Group”. 1. Explanations of the Board to the State of the Company's Affairs 1.1 Principal data regarding the business affairs of the Company Shufersal is the owner of the largest supermarket chain in Israel, which operates 272 branches throughout the country in a few formats over a total area of approximately 4872 thousand square meters and operates 5 online storage facilities3 over an area of 13 thousand square meters4. The Company employs about 12.5 thousand employees (calculated positions) and has annual sales of about NIS 11.8 billion. As at December 31, 2017 and the date of issuing this report, the controlling shareholder of the Company is Discount Investment Corporation Ltd. In December 2017 the Company completed the acquisition of the entire issued share capital of New Pharm Drugstores Ltd. (“New Pharm”), which as at the date of the report has 63 branches (7 of which are under concessions) with a wide national spread. 1.1.1 Description of operating segments reported as business segments in the consolidated financial statements of the Company The Company operates in four operating segments that are reported as business segments in the Company’s financial statements, the retail segment, the real estate segment, the loyalty program credit card management segment and as from December 31, 2017 also the New Pharm segment. In this respect it is noted that in view of the date the New Pharm transaction was completed as aforesaid, as far as New Pharm is concerned the financial statements include only the balances of New Pharm’s balance sheet items and not operating data. For details regarding the aforesaid operating segments, see Note 32 to the Company’s consolidated financial statements for 2017 (hereinafter – “the financial statements”). 1.1.2 Management’s discussion of principal results for 2017 The Company’s results for 2017 were affected by several matters: The Company continued the development of its digital platforms, mainly the “Shufersal Online” system, including continuing to open dedicated storage facilities for that distribution channel. In 2017, the significant growth of sales through Shufersal Online continued, and the sales constituted about 11.5% of the Company’s total sales (compared with 8.8% in 2016). Continued development and strengthening of the private label including launching products in existing and new categories. This year, the private label accounted for 21.3% of all retail sales, which is a significant increase relative to that metric in 2016 (19.5% of total retail sales). Real estate streamlining continued including adaptation of selling areas. Development of the Company’s income-producing real estate activity continued. The Company took advantage of its accessibility to available sources of financing which included raising money by an issuance of ordinary shares of the Company for a total consideration (gross) of NIS 355 million and entering into agreements with three banking institutions to provide the Company guaranteed credit facilities in the total amount of NIS 300 million. The Company’s logistics center in Shoham became fully active. 1 For purposes of this report, “the reporting date” or “the date of the report” is the date of the statement of financial position (December 31, 2017) unless stated otherwise or implied otherwise by the context of the matter. 2 Not including branches spread over 10,000 square meters that are closed for renovations as at the date of the report. 3 As at the date of issuing the report, there are 4 online storage facilities following the closing in January 2018 of one online storage facility owned by the Company 4 Dedicated storage facilities for the online marketing of products through the Company’s website. 4 Board of Directors' Report on the State of the Company's Affairs for the Year Ended December 31, 2017 Shufersal Ltd. The minimum wage was raised. The acquisition of New Pharm. 1.1.3 Dividend On April 4, 2017, the Company distributed a dividend in the amount of NIS 160 million. On March 25, 2018, subsequent to the date of the statement of financial position, the Company’s Board of Directors declared the distribution of a cash dividend in the total amount of NIS 160 million. The said dividend did not require court approval, and as at the date of this report it has not yet been paid. See Note 34.B to the financial statements for details. As at December 31, 2017, the Company’s “profits” for purposes of the profit test pursuant to Section 302 of the Companies Law, 1999 (“the Companies Law”) amounted to about NIS 646 million, where a dividend distribution by the Company, to the extent the Company’s Board of Directors decides to make such a distribution, will be in accordance with the Companies Law and subject to the distribution conditions provided therein, to the restrictions provided in the terms of the bonds that were issued by the Company (see Section 5 hereunder and Note 17 to the financial statements) and to all other provisions of law. 5 Board of Directors' Report on the State of the Company's Affairs for the Year Ended December 31, 2017 Shufersal Ltd. 1.2 Analysis of the Results of Operations 1.2.1 Analysis of the results for 2017 as compared to 20165 Results of operations 2017 2016 % NIS millions % NIS millions Revenues 11,852 11,842 Gross profit 25.8% 3,059 24.7% *2,925 Selling, marketing, administrative and general expenses 21.9% (2,596) 21.2% *(2,506) Operating profit before other income 3.9% 463 3.5% 419 Other income (expenses), net (20) 1 Increase in fair value and gain on sale of investment property, net 36 26 Operating profit after other income 479 446 Financing expenses, net (124) (118) Share in profit of investee accounted for under the equity method 5 2 Profit before taxes on income 360 330 Taxes on income (85) (68) Profit for the year 275 262 * See Note 2.G to the financial statements regarding reclassification. Retail segment revenues amounted to NIS 11,809 million in 2017 compared with NIS 11,798 million in the previous year, a 0.1% increase that reflects the same level of revenues as in the previous year. Store sales in 2017 decreased by 0.3% compared with the previous year. The difference between the change in revenue and in sales is mainly attributed to a change in franchiser activity6. Same store7 sales decreased by 0.6%.