TABLE OF CONTENTS INTRODUCTION ............................................................................................................................ 1 REPORT BY THE PRESIDENT OF THE MANAGEMENT BOARD ...................................................... 3 SUPERVISORY BOARD REPORT .................................................................................................. 7 2014 HIGHLIGHTS BY MARKETS .............................................................................................. 11 OPERATION AND PERFORMANCE HIGHLIGHTS ....................................................................... 12 MERCATOR GROUP PROFILE AND ORGANIZATION .................................................................. 13 MERCATOR GROUP ACTIVITIES ............................................................................................... 16 KEY EVENTS ............................................................................................................................ 18 CORPORATE GOVERNANCE STATEMENT ................................................................................ 22 MERCATOR GROUP BUSINESS STRATEGY ................................................................................ 29 BUSINESS REPORT ...................................................................................................................... 33 SALES AND MARKETING ......................................................................................................... 35 REAL ESTATE MANAGEMENT AND RETAIL NETWORK DEVELOPMENT ..................................... 42 EFFECT OF ECONOMIC CONDITIONS AND COMPETITION ON MERCATOR GROUP OPERATIONS IN 2014 .................................................................................................................................. 45 2014 PERFORMANCE ANALYSIS .............................................................................................. 50 RISK MANAGEMENT ............................................................................................................... 59 FINANCIAL MANAGEMENT ..................................................................................................... 73 MERCATOR SHARE AND INVESTOR RELATIONS ....................................................................... 75 SUSTAINABILITY REPORT ............................................................................................................ 79 RESPONSIBILITY TO CUSTOMERS ............................................................................................ 81 RESPONSIBILITY TO EMPLOYEES ............................................................................................. 83 RESPONSIBILITY TO NATURAL ENVIRONMENT ........................................................................ 90 RESPONSIBILITY TO SOCIAL ENVIRONMENT ............................................................................ 96 RESPONSIBILITY TO SUPPLIERS ............................................................................................. 100 RESPONSIBILITY TO QUALITY ................................................................................................ 102 FINANCIAL REPORT ................................................................................................................... 105 Management Responsibility Statement ...................................................................................... 107 FINANCIAL REPORT OF THE MERCATOR GROUP .................................................................... 109 Consolidated balance sheet ........................................................................................................ 111 Consolidated income statement ................................................................................................. 112 Consolidated statement of comprehensive income ................................................................... 113 Consolidated statement of changes in equity ............................................................................. 114 Consolidated cash flow statement .............................................................................................. 116 Notes to the consolidated financial statements ......................................................................... 118 Independent Auditor's Report .................................................................................................... 183 FINANCIAL REPORT OF THE COMPANY POSLOVNI SISTEM MERCATOR, D.D. ......................... 185 Balance sheet .............................................................................................................................. 187 Income statement ....................................................................................................................... 188 Statement of comprehensive income ......................................................................................... 189 Statement of changes in equity................................................................................................... 190 Proposal on the allocation of distributable profit ....................................................................... 192 Cash flow statement .................................................................................................................... 193 CONTACTS AT MERCATOR GROUP ............................................................................................. 195 INTRODUCTION REPORT BY THE PRESIDENT OF THE MANAGEMENT BOARD 2014 – a year of tradition, a year of changes The year 2014 will go down in Mercator's history as a major milestone in its corporate history. In the year when we celebrated the company's venerable 65th anniversary and nostalgically honoured its achievements resulting from effort, courage, and ideas of the past generation, we also turned a new page and started to write the story of the Best Neighbour's future. In 2014, Mercator Group revenue amounted to EUR 2.65 billion, which is 4.1% less than in 2013. In 2014, we continued to implement our measures for restructuring of non-core activities. We pursued the plan of optimizing the number of employees and exceeded the planned cost optimization, closing down of some underperforming units of the M Tehnika and Modiana program, and divestment of hospitality services to a third-party. Additionaly, the drop in revenue is also a result of the transfer of retail units in the markets of Croatia and Bosnia and Herzegovina to Konzum, higher revenue was generated in Serbia due to transfer of retail units of Idea to Mercator. Financial restructuring resulted in additional expenses that had a negative effect on Mercator Group results, especially in the first quarter of 2014. Impairment of intangible assets, being part of the consolidation process, also negatively affected the operating results, along with other integration expenses. Independently of the integration process, Mercator Group reappraised its real property held in respective markets, which also resulted in a decrease of its value and brought further negative effect on the results for the fiscal year. The year of financial stabilization After over a year and a half of exacting negotiations and searching for a mutually satisfactory solution with 57 creditor banks from 9 different jurisdictions, Mercator Group successfully completed in 2014 one of the most complex and challenging processes of long-term financial restructuring in this part of Europe. It took place in a period of harsh economic conditions and extensive revitalization measures in both the domestic and in international banking systems, simultaneously with the restructuring of business and sales processes within the Mercator Group. Following a delay, the debt restructuring process was successfully completed in June 2014. From a long-term aspect, the completion of the restructuring process brought financial stability for Mercator, and an opportunity for further pursuit of business restructuring activities. At the same time, the agreement was a sign of confidence in the company and its efforts to improve its operations and performance, and recognition by the financial and the broad business community. This in turn fuelled the motivation for new achievements. Positive effects of Mercator's financial restructuring process are not restricted to the Mercator Group, however. With its complexity and extent, the process that involved over 150 legal and financial experts and which generated over 20 thousand pages of documentation, represents one of the most important development stages in financial restructuring process management in our region. It introduced new knowledge and experience to our business environment, which will have a profound effect on future management of both the banking sector and the broad business and economic environment in our region in the long run. The year of ownership stabilization 2014 was also the year when the ownership structure of Mercator, d.d., was finally stabilized, following numerous attempts to sell the company, which had had negative effects for its operations in the past. In the second half of the year, the companies Agrokor, d.d., and Agrokor Investments B.V. acquired the majority interest of 88.10% of the company Poslovni sistem Mercator, d.d. This was certainly an important step in the 3 consolidation of the retail industry in the area of our operations, resulting in the formation of the largest retail chain in the region, of which Mercator is a part. Through synergistic effects and management