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Management's Discussion and Analysis of Financial Condition And MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS IN Q3 2014 November 28th, 2014 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion of our financial condition and results of operations should be read in conjunction with our audited consolidated financial statements for the year ended December 31st, 2013 and with our unaudited consolidated financial statements for the periods ended September 30th, 2013 and September 30th, 2014 and the related notes. Our consolidated financial statements have been prepared in accordance with IFRS. This discussion includes forward-looking statements based on assumptions about our future business that involve risks and uncertainties. The forward-looking statements are not historical facts, but rather are based on our current expectations, estimates, assumptions and projections about our industry, business and future financial results. Our actual results could differ materially from those contained in the forward-looking statements. For most relevant accounting policies please refer to Note 1 of our FY 2013 consolidated statements and the forefront part of the unaudited consolidated quarterly financial statements for the period ended September 30th 2014. Important Notice: The Management’s discussion and analysis of financial condition and results of operations in this document refers to the Agrokor Group and all its Restricted Subsidiaries (“Agrokor” or “Company”). Restricted Subsidiaries are all Agrokor’s subsidiaries which form the Agrokor Group excluding Poslovni sistem Mercator d.d. (“Mercator”). Pursuant to the indenture governing our Senior Secured Notes due 2019 and 2020 and our other financial arrangements which are in general in line with the indentures, Mercator has been designated as an Unrestricted Subsidiary of Agrokor. All information regarding Mercator can be found on their IR website http://www.mercatorgroup.si/en/investor-relations/. Overview The first nine months were marked by extremely bad weather conditions notably throughout spring and summer. These conditions resulted in severe floods in spring across the Primary Markets whilst it jeopardized the touristic season in Croatia. On top of that the macroeconomic conditions remained challenging whereby GDPs contracted further which put additional pressure on consumption. Our financial results for this period ought to be observed in this context. Nevertheless, we have managed to maintain our sales with only a minor drop in profitability. On a consolidated basis our sales increased by 0.4 per cent from HRK 22,384.6 million to HRK 22,474.0 million. EBITDA decreased by 1.5 per cent, from HRK 2,173.2 million to 2,141.5 million, while EBITDA margin decreased from 9.7 per cent to 9.5 per cent. During nine months of 2014 we have continued to focus on increasing and/or maintaining our market shares across both of our divisions through proactive measures in the form of effective marketing strategies, investments in prices and adequate product portfolio management which also included various portfolio extensions. We further continued to focus on cost optimization and efficiency improvement measures coupled with further systematization and reorganization of the companies across the Group. Retailing and Wholesale division contributed with 76.4 per cent of total consolidated sales and posted a slight decline of 0.2 per cent compared to the previous year with sales decreasing from HRK 17,211.7 million to HRK 17,179.8 million. Division’s EBITDA decreased from HRK 1,111.6 million to HRK 1,088.9 million representing a 2.0 per cent decrease with EBITDA margin remaining at the same level of 6.11 per cent when compared to the same period last year. Food Manufacturing and Distribution division generated 19.7 per cent of the total consolidated sales. Sales in this division decreased by 2.8 per cent compared to the same period last year, from HRK 4,555.0 million to HRK 4,429.1 million. Division’s EBITDA also decreased, from HRK 1,157.1 million to HRK 1,076.0 million with EBITDA margin declining from 13.4 per cent to 13.1 per cent predominantly due to poor weather conditions and drop in edible oil prices. Other Businesses2 division posted a significant increase in sales in Q3 2014 of 29.0 per cent, from HRK 610.4 million to HRK 787.2 million. This division contributed 3.5 per cent of the consolidated sales. EBITDA however posted a decrease of 16.2 per cent from HRK 74.0 million to HRK 62.0 million with EBITDA margin also declining from 5.3 per cent to 3.8. The increase in sales was the result of an increase in volumes related to the 1 Margin on divisional basis is on unconsolidated sales 2 Excluding Agrokor Holding 2 need to source commodities needed for both, our agriculture and meat business but also for external buyers, as the floods had a detrimental impact on a range of agricultural commodities across the region. Key highlights of Group Results and Strategy Slight increase in top line (+0.4 per cent at actual exchange rates, +0.7 per cent at constant exchange rates) In the overall context of a rough touristic season and persisting challenging macro environment our consolidated sales increased by 0.4 per cent (+0.7 per cent at constant exchange rates) compared to the same period last year and amounted to HRK 22,474.0 million (HRK 22,543.0 million at constant exchange rates). Maintaining market shares across the region We have also managed to maintain or even increase our market shares and keep our leadership positions across most of our businesses. We managed to further improve our offering as we continued to tailor our pricing policies, marketing activities through promotions and innovations as well as product assortment to be able to cope with overall environment. M&A and other activities Agrokor d.d. acquired management control of Mercator in September 2014, following the acquisition of the initial stake of 53.2 per cent at the end of June 2014 and the subsequent MTO which expired on September 1st. Agrokor started with the consolidation of Mercator from September 30th, 2014. Agrokor owned 3.040.597 shares as at September 30th, 2014 which represented 80.8 per cent of Mercator's share capital. Pursuant to the indenture governing our Senior Secured Notes due 2019 and 2020 and our other financial arrangements which are generally in line with the indentures, Mercator has been designated as an unrestricted subsidiary of Agrokor. Recent Developments Moody’s has confirmed our rating and the stable outlook in September. In October Agrokor Investments B.V. converted the subordinated loan to Mercator in the amount of EUR 200 million into equity. Following this conversion Agrokor Investments B.V. owns 38.2 per cent of Mercator’s equity. Agrokor is the major single shareholder owning 49.9%. We have sold our fleet maintenance business to Emil Frey Group, which has entered the regional markets in October 2013 and have plans to further expand their activities. The sale of other non-core businesses and assets is ongoing. Performance of divisions Retailing and Wholesale Generally the retail environment across the Primary markets is still facing adverse trends. As a response to these conditions, throughout the first nine months we have continued refurbishing our existing network, with emphasis on convenience stores, adjusting the private label offering and further leveraging our customer-centric retailing capabilities which enabled us to tailor competitive pricing policies and focus further on customer care while offering the best value for money proposition to our faithful customers. Retailing and Wholesale division in first nine months of 2014 posted 0.7 per cent decrease in sales on unconsolidated basis, from HRK 18,118.1 million to HRK 17,991.0 million, with an EBITDA decrease of 2.0 per cent, from HRK 1,111.6 million to HRK 1,088.9 million. EBITDA margin decreased by 8 bps. The 3 somewhat weaker figures are the result of bad weather conditions, pressures from competition as well as negative exchange rate movements, predominantly of Serbian dinar. Acquisition of Mercator – integration process Among regular operational activities, the third quarter of 2014 saw the beginning of the integration activities following the completion of the acquisition of Mercator. The integration process has been structured such that the overall business in Croatia and Bosnia and Herzegovina will be carried on by Konzum (Konzum Croatia and Konzum Bosnia and Herzegovina) whereas the business in Serbia will be carried on by Mercator (Mercator Serbia). The operating businesses will be subject to leasing arrangements whereby Mercator’s stores in Croatia and Bosnia and Herzegovina will be leased out to Konzum Croatia and Bosnia and Herzegovina, respectively, whilst iDEA’s stores in Serbia will be leased out to Mercator Serbia. By doing so, Mercator Croatia, Mercator Bosnia and Herzegovina and iDEA in Serbia will become property management companies. Croatia Croatian food retail market is still impacted by challenging macroeconomic environment and the continuation of negative trends. The strategy of repositioning our portfolio of convenience stores is proving to be successful and it is an important factor in managing and attenuating the impact of unfavourable trends present in the retail industry in the country. We have also implemented a new pricing campaign across the chain which proved to be successful as seen from the positive developments of our market share. We have also continued with enhancing our bakery and meat assortment in line with best practice. In the competitive landscape there haven’t been major changes within the top 10 players which account for roughly 76 per cent. Our Wholesale business experienced a slight decrease as we deliberately decided to reduce our sales to certain customers which were significantly affected by the difficult macro environment which consequently resulted in an increase of their risk profile as well as due to decrease in HoReCa channel as a result of bad weather conditions during the touristic season.
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