Grupa Azoty Zakłady Chemiczne Police Group

Transcription

1 Directors Report on the operations of Grupa Azoty Zakłady Chemiczne Police S.A. and the Grupa Azoty Zakłady Chemiczne Police Group Grupa Azoty Zakłady Chemiczne Police Group

2 Contents 1. General information on the Group Organisation Changes in the organisation Company organisational and equity ties Parent s branches (divisions) Management of the Group Parent organisational chart Changes in key management policies Organisational changes at the Parent The Group s workforce Business overview Key information Overview of key products, goods and services Sales markets and supply sources Significant agreements Material related-party transactions on non-arm s length terms Significant events Strategy and development policy Strategy Directions of development Growth prospects and market strategy Key investments in Poland and abroad Key equity investments Feasibility of investment plans Significant R&D achievements Corporate Social Responsibility Policy Financial condition of the Group Assessment of factors and non-typical events having a material impact on operations and financial performance Market overview Key financial and economic data Segment results Operating expenses Structure of assets, equity and liabilities Financial ratios Explanation of differences between actual performance and financial forecasts Management of capital and assets Bank deposits Borrowing agreements concluded or terminated during the financial year Loans advanced Sureties and guarantees received and issued Material off-balance-sheet items Financial instruments Forecast financial position Risks, threats and growth prospects Significant risk factors and threats Strategic management Management of fixed production assets Technical and environmental safety Comprehensive customer support Availability of feedstocks and materials Financial management Grupa Azoty Group s significant external and internal growth factors External factors External factors Parent s equity and other securities and its major shareholders Total number and par value of Parent shares, holdings of Parent shares by supervisory and management personnel, and interests of such persons in the Parent s related entities Grupa Azoty Zakłady Chemiczne Police Group Page 2 of 77

3 7.2. Agreements known to the Parent which may cause future changes in share percentages of existing shareholders and bondholders Control systems for employee share ownership plans Treasury shares held by the Parent, Group companies and persons acting on their behalf Issue, redemption, and repayment of debt and equity securities Use of proceeds from share issues Parent shares Statement of compliance with corporate governance principles Corporate governance code applicable to the Parent and availability of the text of the code to the public Declaration of applying the recommendations contained in the Best Practice for WSE Listed Companies Internal control and risk management systems Shareholding structure Special control powers of security holders Restrictions on voting rights Restrictions on the transferability of securities Rules governing appointment and removal from office of management personnel; powers of such personnel, including their authority to decide on the issue or buy-back of shares Rules governing amendments to the Parent s Articles of Association Operation of the General Meeting Composition, changes and operation of the Company s management and supervisory bodies Remuneration and additional benefits Agreements between the Parent and Management Board members Sponsorship, charitable and similar activities Other material information and events Qualified auditor Litigation Environmental performance Awards and distinctions Events after the end of the reporting period Grupa Azoty Zakłady Chemiczne Police Group Page 3 of 77

4 1. General information on the Group 1.1. Organisation As at December 31st 2016, the Grupa Azoty Zakłady Chemiczne Police Group (the Group ) comprised Grupa Azoty Zakłady Chemiczne Police S.A. (the Parent, the Company ), and: nine subsidiaries (in which the Parent held ownership interests above 50%), including one company in liquidation, one indirect subsidiary, two associates (in which the Parent held ownership interests below 50%), including one company in liquidation bankruptcy. Table 1. Parent s interests in subsidiaries as at December 31st 2016 Name Registered office/address Share capital % of shares held by the Parent directly indirectly Grupa Azoty Police Serwis Sp. z o.o. Koncept Sp. z o.o. Supra Sp. z o.o. Transtech Usługi Sprzętowe i Transportowe Sp. z o.o. Grupa Azoty Africa S.A. ZMPP Sp. z o.o. PDH Polska S.A. African Investment Group S.A. (AFRIG S.A.) Infrapark Police S.A. w likwidacji (in liquidation) Budchem Sp. z o.o. w upadłości likwidacyjnej (in liquidation bankruptcy) Kemipol Sp. z o.o. ul. Kuźnicka 1, Police, Poland ul. Kuźnicka 1, Police, Poland ul. Monopolowa 6, Wrocław, Poland ul. Kuźnicka 1, Police, Poland Route de Ngor Villa No. 12, Dakar, Senegal ul. Kuźnicka 1, Police, Poland ul. Kuźnicka 1, Police, Poland Route de Ngor Villa No. 12, Dakar, Senegal ul. Kuźnicka 1, Police, Poland ul. Moczyńskiego 8/10, Szczecin, Poland ul. Kuźnicka 6, Police, Poland 9, , XOF 132,000 thousand 9, , , XOF 340,000 thousand / , , AFRIG Trade SARL Route de Ngor Villa No. 12, Dakar, Senegal XOF 33,000 thousand Share capital of Infrapark Police S.A. w likwidacji (in liquidation) as disclosed in its balance sheet in accordance with PAS. 2 Share capital of Infrapark Police S.A. w likwidacji (in liquidation) as disclosed in the National Court Register. Grupa Azoty Zakłady Chemiczne Police Group Page 4 of 77

5 Figure 1. Structure of the Group as at December 31st 2016: Grupa Azoty Zakłady Chemiczne Police S.A. Consolidated subsidiaries Non-consolidated subsidiaries Equityaccounted associates 100% Grupa Azoty Police Serwis Spółka z o.o. 100% Supra Agrochemia Spółka z o.o % Budchem Spółka z o.o. w upadłości likwidacyjnej (in liquidation bankruptcy) 100% Koncept Spółka z o.o % Kemipol Spółka z o.o. 100% TR Usługi Sprzętowe i Transportowe Spółka z o.o % Grupa Azoty Africa S.A. S.A. (Senegal) 0.01% 99.98% Zarząd Morskiego Portu Police Spółka z o.o % PDH Polska S.A % Infrapark Police S.A. w likwidacji (in liquidation) 54.90% African Investment Group S.A. (Senegal) 0.10% 100% AFRIG Trade SARL (Senegal) This Directors Report was authorised by the Company s Management Board on April 26th 2017 and replaces the report authorised by the Management Board on March 20th The Directors Report was replaced due to an adjustment to accounting for the acquisition of shares in African Investment Group S.A. After the adjustment, disclosures in Note Correction of prior period error were revised. Grupa Azoty Zakłady Chemiczne Police Group Page 5 of 77

6 The Parent Grupa Azoty Zakłady Chemiczne Police S.A. The Company has for decades been a leading European manufacturer of fertilizers and one of the largest Polish chemical companies. High sales to external markets make it also one of the largest Polish exporters. The Company s advantages include a titanium white unit of a type unique in Poland, the size of its ammonia, phosphoric acid and sulfuric acid production, as well as strong position in compound mineral fertilizers. Internationally, the Company is appreciated not only for its fertilizer production and sales volumes, but also for contributing to the development of the chemical industry and global agriculture. The Company takes CSR very seriously, engaging in projects that support local communities and regional development. Liaising with local authorities, Grupa Azoty Zakłady Chemiczne Police S.A. supports vocational education, with a particular focus on professions useful to the Company. The Company has also established links with higher education institutions, sharing expertise with students writing their theses in chemistry, environmental protection, management and marketing. Some of those students are later employed by the Company. In 2016, the Company took a number of measures to adapt its business to changing market conditions, which helped mitigate the impact of negative market trends. A flexible business strategy and cost optimisation, following an in-depth analysis of the economic viability of individual projects, as well as decisions anticipating any signals of market developments, underpinned the Company s solid performance. In order to diversify sources of the Group s revenue and to secure supplies of propylene the key raw material for the production of OXO alcohols in Grupa Azoty s Oxoplast segment, an investment project has been under way to construct Europe s largest and most advanced Propane Dehydrogenation (PDH) unit with ancillary infrastructure. Group subsidiaries: Grupa Azoty Police Serwis Sp. z o.o. The subsidiary was registered on March 15th 2002 under No by the District Court of Szczecin, 13th Commercial Division of the National Court Register. Its business includes overhauls and services as part of investment projects in the mechanical industry, repairs of process units, construction of installations and apparatuses, including those made of plastics, maintenance services for the mechanical industry, workshop services and treatment of metals, as well as project execution and technical and engineering services (assembly and commissioning) in the area of automation, repairs of instrumentation and control equipment and maintenance of computer control systems, repairs, maintenance and inspections of electrical machinery, measurement and diagnostics services, and inspections and maintenance of medium- and-low voltage electrical equipment and networks. Koncept Sp. z o.o. The subsidiary was registered on September 6th 2001 under No by the District Court of Szczecin, 13th Commercial Division of the National Court Register. The company s business consists in the provision of design services for the construction, assembly, mechanical, electrical, automation and measurement, and technological industries (including preparation of expenditure and investment estimates). The company specialises in design work for the chemical industry (manufacture of ammonia, urea, compound fertilizers, phosphoric and sulfuric acid, and titanium pigment), as well as printing and binding services. Supra Sp. z o.o. The subsidiary was registered on December 29th 2001 under No by the District Court for Wrocław-Fabryczna of Wrocław, 6th Commercial Division of the National Court Register. Its business comprises revitalising post-industrial sites owned by the company and preparing them for execution of investment projects. Transtech Usługi Sprzętowe i Transportowe Sp. z o.o. The subsidiary was registered on April 2nd 2001 under No by the District Court of Szczecin, 13th Commercial Division of the National Court Register. The company s business consists in the provision of transport services (goods transport on lorries with load capacity of up to 24 tonnes, and minibus transport), plant and equipment services (mobile cranes with lifting capacity of up to 65 tonnes, diggers, loaders, bulldozers, and special-use vehicles), workshop services and periodic check-ups. Grupa Azoty Zakłady Chemiczne Police Group Page 6 of 77

7 Grupa Azoty Africa S.A. The subsidiary s operations are to be discontinued. Zarząd Morskiego Portu Police Sp. z o.o. The subsidiary was registered on December 13th 2004 under No by the District Court of Szczecin, 13th Commercial Division of the National Court Register. The Municipality of Police holds a minority interest in the company. The company s business consists in sea port operation, property management, research and development work, sea and inland shipping services, port construction, and coastal water transportation services. The subsidiary is a port authority within the meaning of the Act on Sea Ports and Harbours. PDH Polska S.A. The subsidiary was registered on September 24th 2015 under No by the District Court for Szczecin-Centrum of Szczecin, 13th Commercial Division of the National Court Register. The subsidiary s objective is to construct a Propane Dehydrogenation (PDH) unit with ancillary infrastructure, together with extension of the Police sea port facilities to include a handling terminal for chemicals that would provide the required logistics infrastructure for receiving and storing the raw material and forwarding the product. The PDH unit s target annual output is at least 400,000 tonnes of premium quality propylene. Infrapark Police S.A. w likwidacji (in liquidation) The subsidiary was registered on June 21st 2004 under No by the District Court of Szczecin, 13th Commercial Division of the National Court Register. The minority shareholders are the Municipality of Police, the Szczecin University, and Zachodniopomorska Agencja Rozwoju Regionalnego S.A. The company is in liquidation and is not conducting any business. African Investment Group S.A. (AFRIG S.A.) The subsidiary, with its registered office in Senegal, was entered in the commercial register (RC) under No. SN-DKR-2002-B On August 28th 2013, the Company purchased a majority interest in that subsidiary. At present, the subsidiary s business consists in exploration for phosphate rock under an exploration licence and supervision over the preparation of related documents. AFRIG Trade SARL The subsidiary s operations are to be discontinued. Associates: Budchem Sp. z o.o. w upadłości likwidacyjnej (in liquidation bankruptcy) The associate was registered on October 14th 1999 under No by the District Court of Szczecin, 13th Commercial Division of the National Court Register. The majority shareholder is WB Technika Sp. z o.o. The company is in liquidation bankruptcy and is not conducting any business. Kemipol Sp. z o.o. The associate was registered on October 23rd 1990 under No by the District Court of Szczecin, 13th Commercial Division of the National Court Register. The majority shareholder is Kemira Kemi AB from Sweden. The remaining shares are held by the Company and Bank Ochrony Środowiska S.A. The company s business consists in the production and sale of chemicals for water purification and wastewater treatment. Grupa Azoty Zakłady Chemiczne Police Group Page 7 of 77

8 1.2. Changes in the organisation Share capital increase at PDH Polska S.A. On November 22nd 2016, the Extraordinary General Meeting of PDH Polska S.A. passed a resolution to increase the company s share capital by way of issue of 6,800,000 new shares, of which 6,300,000 were acquired by the Company, and 500,000 by Grupa Azoty S.A. All the shares have been paid for Company organisational and equity ties Grupa Azoty Police Serwis Sp. z o.o. holds one share in African Investment Group S.A. and has the right of representation on the company s Executive Board. African Investment Group S.A. holds one share in Grupa Azoty Africa S.A. As at December 31st 2016, the remaining subsidiaries and associates of the Group did not have any organisational ties with, and did not hold any shares in, other entities Parent s branches (divisions) The Parent does not operate any branches or divisions outside of its principal place of business. 2. Management of the Group 2.1. Parent organisational chart Figure 2.Parent organisational chart as at December 31st 2015 The above chart reflects the Parent s organisational structure as at December 31st On January 13th 2017, an organisational unit called GU Safety Department was established, reporting directly to the President of the Management Board Chief Executive Officer. 3 The Company disclosed the above information in Current Report No 53/2016 Resolution by the Management Board of Grupa Azoty Zakłady Chemiczne Police S.A. concerning acquisition of shares in PDH Polska S.A. of October 26th 2016, Current Report No. 55/2016 Change of Resolution of the Management Board of Grupa Azoty Zakłady Chemiczne Police S.A. concerning acquisition of shares in PDH Polska S.A. of November 8th 2016, Current Report No. 56/2016 Approval of acquisition of shares in PDH Polska S.A. by the Supervisory Board of Grupa Azoty Zakłady Chemiczne Police S.A. of November 14th 2016, and Current Report No. 06/2017 Court registration of subsidiary s share capital increase of February 2nd Grupa Azoty Zakłady Chemiczne Police Group Page 8 of 77

9 2.2. Changes in key management policies In 2016, there were no material changes in the Group s key management policies Organisational changes at the Parent In the reporting period, there were no material organisational changes at the Parent The Group s workforce Table 2. Number of employees at the Grupa Azoty Zakłady Chemiczne Police Group* Employee category As at Dec As at Dec Women Men Women Men Blue collar employees 242 2, ,934 White collar employees Total 600 2, ,570 * Excluding Supra Sp. z o.o. Table 3. Number of employees at the Parent Employee category As at As at Dec Dec Women Men Women Men Blue collar employees 238 1, ,397 White collar employees Total 514 1, ,833 Table 4. Number of employees at consolidated subsidiaries* Employee category As at As at Dec Dec Women Men Women Men Blue collar employees White collar employees Total * Excluding the Parent and Supra Sp. z o.o. Table 5. Number of Group employees: average annual and at the end of 2016* Employee category Average annual At year end Women Men Women Men Blue collar employees 245 1, ,046 White collar employees Total 599 2, ,716 * Excluding Supra Sp. z o.o. Grupa Azoty Zakłady Chemiczne Police Group Page 9 of 77

10 Table 6. Number of employees at the Parent: average annual and at the end of 2016 Employee category Average annual At year end Women Men Women Men Blue collar employees 241 1, ,451 White collar employees Total 517 1, ,902 Table 7. Number of employees at consolidated subsidiaries: average annual and at the end of 2016* Employee category Average annual At year end Women Men Women Men Blue collar employees White collar employees Total * Excluding the Parent and Supra Sp. z o.o. Table 8.8 Employee turnover at the Group from January 1st to December 31st 2016* 2016 Women Men New hires Departures Total * Excluding Supra Sp. z o.o. Table 9.9 Employee turnover at the Parent from January 1st to December 31st Women Men New hires Departures Total 4 69 Table Workforce structure at the Group by education* Item Year Total employment University or equivalent Secondary Vocational Primary Number of employees , , Number of employees , , * Excluding Supra Sp. z o.o. Grupa Azoty Zakłady Chemiczne Police Group Page 10 of 77

11 Table 11. Workforce structure at the Parent by education* Item Year Total employment University or equivalent Secondary Vocational Primary Number of employees , Number of employees , Table 12. Workforce structure at the Group by length of service* Item Year up to 5 years 6-10 years years Number of employees % 9% 19% Number of employees % 12% 18% * Excluding Supra Sp. z o.o. Table 13. Workforce structure at the Parent by length of service Item Year up to 5 years 6-10 years years Number of employees % 10% 21% Number of employees % 10% 20% over 20 years 1,940 59% 1,940 62% over 20 years 1,430 59% 1,473 63% 3. Business overview 3.1. Key information The Group s performance remains strongly correlated with the Parent s market environment. This correlation has been present since the Company commenced its operations. The Parent is a leading chemical producer in the region and a significant one in the EU. Currently, it operates in three segments: Fertilizers, Pigments and Other, through three business units and four support centres: Fertilizers Business Unit Nitro Business Unit Pigments Business Unit Power Centre Logistics Centre Infrastructure Centre Laboratory Analysis Centre Fertilizers Business Unit The Fertilizers Business Unit is the largest organisational unit within the Company in terms of revenue and production volumes. The output includes compound NP, NPK and NS fertilizers, as well as phosphoric and sulfuric acids. The Parent is the largest manufacturer of these compound fertilizers and acids in Poland and one of the largest in Europe. Products of the Fertilizers Business Unit are sold in Poland and on foreign markets (including Europe and South America, as well as Africa and Asia). Key products of the Fertilizers Business Unit are POLIFOSKA and POLIDAP, which are well recognised fertilizer brands in Poland. The POLIFOSKA brand has become a synonym for compound fertilizers in Poland, evoking superior quality and highest performance. The POLIFOSKA brand has a high concentration of pure constituents, chemical uniformity of fertilizer grains and high assimilability of constituents. Nitro Business Unit The Nitro Business Unit is one of Poland s leading manufacturers of ammonia and urea. The products are marketed both on the domestic and export markets. Urea is sold for agricultural and technological applications. An important business line within the unit is the manufacture and sale of Grupa Azoty Zakłady Chemiczne Police Group Page 11 of 77

12 urea solutions: NOXy (AdBlue ), a 32.5% urea solution, and Pulnox, a 40% urea solution. NOXy (AdBlue ) is used in the automotive industry to reduce nitrogen oxides in diesel engines. A steady rise in the consumption of NOXy is expected in Europe in the coming years given the increasingly stringent regulations aimed at reducing atmospheric emissions of exhaust fumes. Pulnox is also used as a reducing agent in vehicle emissions control technologies. It has also found broad applications in large power units which generate harmful substances (such as nitrogen and sulfur oxides) during fossil fuel combustion. Thanks to Pulnox, power and heat producers can meet stringent EU standards on industrial emissions. The Nitro Business Unit s product range is complemented by Likam (ammonia water). These products are manufactured at production plants which are constantly modernised and upgraded, with an emphasis on occupational safety and environmental protection. Pigments Business Unit The principal activity of the Pigments Business Unit is the manufacture and sale of titanium white and associated semi-products: iron sulfate and hydrolytic acid. The Unit is the leader in the domestic market of titanium white and operates a well-developed export network. Titanium dioxide-based pigments, marketed under the TYTANPOL brand, are manufactured using state-ofthe-art technology which meets stringent environmental requirements. The pigments are highly sought after due to their versatility, efficiency, durability, safety in use and non-toxic nature, and their associated products have excellent aesthetic and protective properties. Applications of titanium white include the production of paints and varnishes, printing inks, plastics, papers and laminated materials. The consistent high product quality and professional advice on product use have been recognised the Unit has received many awards and honours such as EUROPRODUKT 2004, MEDAL EUROPEJSKI 2004 (European Medal), the Highest Quality Certificate (2007) and the Teraz Polska Badge of Quality (2012). Power Centre The Power Centre produces heat (in the form of hot steam), electricity and feedwater, and also purchases electricity and heat (steam) for the Company s needs. It operates state-of-the-art generating units, ensuring reliable supplies of heat, electricity and feedwater. The Centre also sells electricity, hot steam and heating water as well as fly ash to external customers, and is also responsible for energy management across the organisation. In addition to this, the Centre generates electricity using high-efficiency co-generation technology, and therefore obtains certificates of origin from co-generation, which are transferable property rights. Logistics Centre The Logistics Centre is responsible for shipping and transport, packaging and distribution, and the operation and maintenance of port infrastructure. In the transport processes, it is important to ensure continuity of supplies, product dispatch handling, transport organisation and services, and operation of ports owned by the Company. There are two port facilities (a sea port and a barge port), which have bulk cargo transshipment wharves and transshipment stations for ammonia and sulfuric acid. The product dispatch process involves efficient fertilizer storage, packaging and distribution. The logistics system handles over 3m tonnes of bulk cargo annually (ca. 1.5m tonnes of feedstock and raw materials and ca. 1.5m tonnes of products). Infrastructure Centre The Infrastructure Centre manages technical infrastructure, auxiliary utility production and distribution, wastewater treatment and waste landfilling. It supports comprehensive management of land, buildings and structures. In production asset management, the Centre carries out inspections required under applicable laws and standards, and manages repairs and maintenance. It is also responsible for procurement and storage of technical materials. The Centre s operations are environmentally friendly, as evidenced by rare flora and fauna species found in areas adjacent to the Company s wastewater treatment plant and phosphogypsum landfill unit. Laboratory Analysis Centre The Laboratory Analysis Centre satisfies all needs of internal customers regarding chemical analyses of feedstock/raw material supplies, implementation of technological processes, quality assessment of semi-finished and finished goods, environmental protection issues, OHS, and implementation of new technical and technological solutions. The Centre also provides similar laboratory services to the Company s external customers. The Laboratory Analysis Centre operates in accordance with the Grupa Azoty Zakłady Chemiczne Police Group Page 12 of 77

13 Integrated Management System in place at the Company based on PN-EN ISO 9001 and PN-EN ISO 14001, PN-EN ISO and PN-EN ISO/IEC 17025: Overview of key products, goods and services The Parent s principal business is the manufacture of fertilizers and nitrogen compounds (PKD Z) and the manufacture of dyes and pigments (PKD Z). Its non-core operations comprise the manufacture of other inorganic basic chemicals (PKD Z) and the manufacture of other chemical products not elsewhere classified (PKD Z). In addition, the Company s Articles of Association provide for the conduct of any activities necessary to ensure proper operation of its business, including procurement of raw materials, as well as product distribution and sales. The Company s main commercial products include: compound fertilizers - NP 4 (MAP, DAP) and NPK 5 mineral fertilizers manufactured using monoand bi-ammonium phosphate and potassium salt, with secondary nutrient additives (sulfur, magnesium) and microelements NS fertilizer - nitrogen-based fertilizer with sulfur and magnesium, a granulated mixture of ammonia sulphate, urea and magnesite nitrogen fertilizer - urea liquid ammonia titanium white - a group of titanium dioxide-based white dyes The Parent produces high volumes of sulfuric and phosphoric acid to obtain semi-finished products for the manufacture of its key commercial products. Using its semi-finished products, by-products and waste products, the Company also manufactures: 32.5% aqueous urea solution for automotive applications - NOXy (AdBlue ) and crystalline urea for its production, hexafluorosilicic acid, dried iron (II) sulfate production Table Parent s production volume by product [tonnes] Product 2016 production volume 2015 production volume % change Compound fertilizers 1,142,399 1,127, % Urea 346, , % Ammonia 476, , % Titanium white 37,171 31, % AdBlue 115, , % Sulfuric acid 700, , % Phosphoric acid 370, , % NP fertilizers - compound fertilizers with two primary nutrients: nitrogen (N) and phosphorus (P) 4 NPK fertilizers - compound fertilizers with three primary nutrients: nitrogen (N), phosphorus (P) and potassium (K) 5 Grupa Azoty Zakłady Chemiczne Police Group Page 13 of 77

14 2016 sales Table 15. Consolidated revenue by segment Segment % change Fertilizers 2,050,048 2,420, % Pigments 308, , % Other 58,901 51, % Total revenue 2,416,984 2,741, % Figure 3. Revenue by main product groups and other sales 5% 2% 1% NPK 7% 13% 12% 48% NP Urea Ammonia Titanium white Other NOXy (AdBlue ) NS 12% In 2016, market prices of the Fertilizer Segment products, especially NPK and DAP fertilizers and ammonia, were trending downwards. Due to the predominant share of this segment, these market trends were reflected in total consolidated revenue from sale of products, merchandise and materials, which amounted to PLN 2,416,984 thousand, down by PLN 324,056 thousand (or 11.82%) from the revenue recorded in A reversal of the market trend in titanium white prices into an upward one and, above all, the restored prevalence of demand over supply and initiatives to bolster titanium white sales, brought about a revenue growth in the Pigments Segment. The highest sales were recorded in the case of compound fertilizers and urea, which jointly generated PLN 1,790,542 thousand in revenue, accounting for 74% of total sales Sales markets and supply sources In the reporting period, domestic sales of the Group s products and services totalled PLN 1,536,801 thousand, down by 4% year on year. The share of exports in the 2016 revenue (at 36%) fell by 5pp compared with the previous year. Domestic and export sales accounted respectively for 67% and 33% of total fertilizer sales. Key export markets included Germany, the United Kingdom, Denmark, the Czech Republic, Venezuela, Brazil, Hungary and Spain. Combined sales to those countries accounted for 76% of total export sales. The domestic share of titanium white sales was 47%, while exports of the product made up the remaining 53%. Key export markets included Germany, Italy, France, Denmark, Sweden, Belgium and the Ivory Coast. Combined sales to those countries accounted for 89% of total export sales. 55% of chemicals sales were to the domestic market, and 45% to export markets. Key export markets included Germany, Slovakia, Sweden, France and Morocco. Combined sales to those countries accounted for 82% of total export sales. Grupa Azoty Zakłady Chemiczne Police Group Page 14 of 77

15 Figure sales by geographical regions 3% 1% 1% Poland 21% Germany Other EU countries South America 11% 63% Africa Other countries No customer/trading partner of the Company accounted for more than 10% of the Parent s revenue in In the case of suppliers, only PGNIG S.A., a gas fuel supplier, exceeded the 10% threshold (11.9%). Sources of strategic raw materials 2016 saw a year-on-year decrease in prices of key raw materials for fertilizer production, including phosphorites, potassium chloride, sulfur, sulfuric acid and natural gas, as well as a decline in average annual prices of titanium-bearing materials used to produce titanium white (although in this case, the trend reversed in the course of the year). Phosphorites From the very beginning of 2016, a downward trend in prices of phosphate fertilizers put constant pressure on phosphorite prices. Consecutive price corrections were recorded in January, April, July and September. Throughout 2016, the reduction of market prices of phosphorites (calculated as the Q price to the Q price) ranged between 12% and 37%. The scale of the price correction differed depending on the supplier, quality of the purchased commodity, and cost of transport. In the case of the leading exporter of Moroccan phosphorites, the market price fell in 2016 by about 24%. Potassium chloride In H1 2016, weak demand for potassium chloride persisted on all global markets, and the downward trend in prices, observed since July 2015, continued. To halt the price decline, the world s largest producers of potassium chloride began to reduce their outputs. Major manufacturers temporarily shut down their production facilities, and one company in Canada even decided on a permanent shutdown. Low prices of agricultural produce and financial crises in some countries markedly limited farmers incomes, and thus their purchasing power. China and India, the largest importers of potassium chloride, had accumulated large stocks in 2015 and did not purchase any additional volumes in the first half of In the middle of the year, importers from China and India signed a number of contracts with the largest producers of potassium chloride, each for delivery of several million tonnes of the product, at prices fixed even until April These contracts halted the price decline, and then stabilised the price of potassium chloride in the second half of the year. At the end of 2016, some suppliers began to raise prices, but without much success. Potassium chloride prices bottomed in December, having declined by about 20% from the beginning of Sulfur On global markets, the price of sulfur, as well as numerous other key commodities, was under downward pressure in The falling trend in sulfur prices, which set in at the beginning of 2015, continued almost throughout Sulfur price reductions in 2016 ranged from 30% to 35% depending on the market, and were mostly attributable to high stocks of sulfur held by refineries, as well as limited purchases of the product by, and resulting pressure from, phosphate fertilizers producers. Grupa Azoty Zakłady Chemiczne Police Group Page 15 of 77

16 The situation changed in Q4 2016, with upward trends observed from October on global markets with the exception of Europe, where the trend was in the opposite direction and the majority of sulfur buyers obtained ten percent price reductions for the fourth quarter of 2016, compared with the third quarter of the year. Meanwhile, the largest producers of sulfur from the Persian Gulf, Canada and Russia raised their export prices for October by 3% to 5%. Producers from the Persian Gulf further increased their prices in November. Despite the decline in fertilizer prices and challenging situation of the phosphate fertilizers industry in China (with 40% of capacities shut down), the price of sulfur imported into China also increased in the fourth quarter of the year. Ilmenite and titanium slag Ilmenite and titanium slag are usually by-products in the processing of iron ores. The 2016 crisis in the steel industry resulted in much weaker demand for iron ore, and consequently in lower production of ilmenite and titanium slag. China was particularly affected, and began to increase its imports of ilmenite, triggering a price hike on global markets. Prices of both ilmenite and titanium slag were further pushed up due to significant production downsizing by most manufacturers. On the representative Chinese market, in Q ilmenite and titanium slag prices hit a level equal to their all-time low recorded before the 2009 crisis. Further into 2016, the trend in the ilmenite and titanium slag market reversed and the prices began to climb back up. At the same time, the average annual price of titanium-bearing materials obtained by the Company in 2016 was lower than in Natural gas In 2016, the European natural gas market was characterised by considerable variation in trends caused by a number of factors, including oil prices, coal prices, outdoor temperatures, political developments, overhaul shutdowns of gas production and transport facilities, as well as terrorist attacks on these facilities. In 2016, the Company continued to diversify its natural gas supply sources. Besides PGNiG S.A., natural gas was purchased from the EU market and on the Polish Power Exchange (POLPX). In total, in 2016 the Group purchased 77.1% of gas from PGNiG S.A., 1.3% on the POLPX, and 21.6% from the EU market. In H2 2016, the share of imports in the volume of gas purchased for the Company s plant in Police was reduced. Reasons for the shift in the gas purchase structure included both organisational changes concerning certain subsidiaries of PGNiG S.A. (take-over of one of the contracts by a Polish entity), and lower prices of domestically sourced gas in the second half of the year Significant agreements Table 16. Agreements significant to the Parent s operations Party Subject matter Agreement Date and number date of current report Value Uralkali Trading SIA Jan Purchase of potassium 288,000 Jan Current Report chloride (323,000*) No. 4/2016 Mar PGNiG Supply & 151,600 Purchase of gas fuel Mar Current Report Trading GmbH (168,167*) No. 13/2016 Apr PGNiG S.A. Purchase of gas fuel Apr Current Report No. 24/ ,000 PGNiG S.A. Purchase of gas fuel Apr Apr ,000 Current Report (905,000*) No. 24/2016 Apr Nitron Group Purchase of potassium 176,000 Apr Current Report Corporation chloride (227,213*) No. 25/2016 Thorø Nielsen A/S Nov Sale of compound fertilizers Nov Current Report and urea No. 54/ ,295 * Total value of contracts signed over the last 12 months or from the date of the most recent current report concerning agreements with this entity. Grupa Azoty Zakłady Chemiczne Police Group Page 16 of 77

17 3.5. Material related-party transactions on non-arm s length terms In 2016, the Group did not enter into any related-party transactions on non-arm s length terms Significant events Payment of dividends The Company s Supervisory Board issued a favourable opinion on the Management Board s recommendation to pay dividends from the net profit for The Company reported on the recommendation in Current Report No. 14/2017 of March 20th In view of the favourable opinion issued by the Supervisory Board, the Management Board will propose that the Annual General Meeting allocate PLN 31,500 thousand from net profit earned in the financial year January 1st December 31st 2016 for payment of dividends to the Company s shareholders. A final decision on the distribution of profit for the financial year 2016 will be made by the Company s Annual General Meeting. 6 Correction of the financial statements The adjustments introduced to the 2016 financial statements as corrections of prior period errors resulted from the Company s detailed examination and analyses of documents held, as well as attempts to obtain additional materials and information, and work related to testing of assets for impairment 7. In view of the fact that an error was found and that the carrying amounts of assets related to African Investment Group S.A. required adjustments, the Company s Management Board resolved to correct those amounts. 8 For a detailed description of the changes, see Section 5.1. of this Report. Key investment project The Group continues to invest in the propylene production (PDH) plant, which, when fully operational, is expected to generate annual revenues of PLN 2bn and provide jobs for up to 200 people. Following completion of the Basic Engineering Package by the technology licensor in December 2015, the project entered the next stage: in a tender process to select a contractor that would prepare the Front End Engineering Design (FEED), two reputable companies Tecnimont and Technip were chosen, both having extensive experience in designing and constructing petrochemical units. Under the contracts concluded with these companies, technical documentation was prepared for the process unit, auxiliary units and associated infrastructure to the extent required to obtain a building permit and providing sufficient basis for the opening of a tender to award an EPC contract to a company which would act as the general contractor responsible for the engineering design, procurement and construction of the project. As regards construction of the port logistics infrastructure, a technical concept for a transshipment and storage terminal was prepared. In the area of environmental protection, PDH Polska S.A. ( PDH ) decided to engage an experienced and reputable external firm to prepare comprehensive documentation concerning the environmental impact of the Project (the port infrastructure and PDH unit) and to obtain a final environmental permit. At the end of January 2017, an environmental impact assessment report was submitted to the Regional Directorate for Environmental Protection in Szczecin. As far as commercial aspects of the Project are concerned, a term sheet was signed with Grupa Azoty Zakłady Azotowe Kędzierzyn S.A. ( Grupa Azoty ZAK ) for an exclusive sale agreement, under which Grupa Azoty ZAK undertook to collect the entire volume of propylene produced by PDH Polska S.A. The propylene will be received by Grupa Azoty Zakłady Azotowe Kędzierzyn S.A. for a period not shorter than seven years from the first delivery date. The estimated propylene sales volume 6 The Company reported on the above developments in Current Report No. 17/2017 Approval by the Supervisory Board of Grupa Azoty Zakłady Chemiczne Police S.A. of dividend recommendation, dated March 31st The Company reported on the issue in Current Report No. 42/2016 Impairment losses on assets related to subsidiary AFRIG S.A., dated July 22nd 2016, in Current Report No. 49/2016 Write-off of assets by subsidiary AFRIG S.A., dated October 12th 2016, and in Current Report No. 64/2016 Indications of impairment of AFRIG S.A. s assets, dated December 22nd The Company announced this in Current Report No. 7/2017 Decision to adjust assets related to AFRIG S.A., dated February 7th Grupa Azoty Zakłady Chemiczne Police Group Page 17 of 77

18 specified in the Term Sheet is 427 thousand tonnes per year, except during the twelve-month startup period. In the reporting period, negotiations were also held with potential propane suppliers with a view to securing supplies of this key production input under long-term contracts. 9 In the reporting period, work was also under way to have the project included in a Special Economic Zone and thus obtain the right to income tax abatement. In December 2016, the Council of Ministers issued a regulation under which the plots assigned to accommodate the PDH unit were included in the Police Subzone of the Pomeranian Special Economic Zone, paving the way for the start of negotiations concerning the grant of a permit to conduct investment activities within the zone. In order to optimise the project implementation strategy, a decision was made in Q to cover all Project components, i.e. the PDH unit, the transshipment and storage terminal and the power substation, with a single integrated EPC contract, allowing for possible changes to Project configuration and broadening its scope to include a polypropylene plant, depending on the results of economic and technical analyses performed as part of a feasibility study started by the Company at the end of Thanks to this solution, the Company will avoid coordination risks in the Project implementation and will improve its negotiating position vis-á-vis banks and thus obtain better conditions of financing. As a result of adoption of the new implementation model, the existing tender to award an EPC contract for the key unit was closed without an award. Also, the Project schedule was updated by way of corporate decisions, so that commercial operation of the unit is due to start in early Public announcement of the tender for the integrated EPC contract took place on January 20th The PDH Project is an important initiative from the point of view of the Polish economy, and thus there is potential for cooperation with regard to its implementation and financing with Polish state and EU institutions. An important aspect from the point of view of cooperation with Polish state institutions is the possible launch of a government programme to deepen the Szczecin-Świnoujście Canal, which would improve the efficiency of the raw material logistics by enabling the accommodation of larger vessels at the port terminal. Declarations of direct support for the PDH Project were received from the Ministry of Maritime Economy and Inland Navigation and the Ministry of Development, and the Project has been included in the National Strategy for Reindustrialisation, making it eligible for more aid programmes. Share capital increase at PDH Polska S.A. On November 22nd 2016, the Extraordinary General Meeting of PDH Polska S.A. passed a resolution to increase the company s share capital by way of issue of 6,800,000 new shares, of which 6,300,000 were acquired by the Company, and 500,000 by Grupa Azoty S.A. All the shares have been paid for 10. On March 29th 2017, the Company s Management Board resolved to acquire up to 5,200,000 new Series C registered shares in PDH Polska S.A. The Company s Supervisory Board approved the acquisition on March 31st. The acquisition will be effected by the Company taking up the new shares in the increased share capital of PDH Polska S.A. 11 Cooperation agreement with West Pomeranian University of Technology The Company and PDH Polska S.A. signed an agreement with the West Pomeranian University of Technology in Szczecin concerning university programmes in the field of chemical and process engineering, specialism in olefin process engineering. Second-cycle full-time studies in chemical and process engineering, specialism in olefin process engineering, will commence in the summer semester of academic year 2016/2017 and will last three semesters. 9 The Company reported on these developments in Current Report No. 66/2016 Term sheet for exclusive propylene sale agreement between PDH Polska S.A. and Grupa Azoty Zakłady Azotowe Kędzierzyn S.A., dated December 28th The Company disclosed the above information in Current Report No 53/2016 Resolution by the Management Board of Grupa Azoty Zakłady Chemiczne Police S.A. concerning acquisition of shares in PDH Polska S.A. of October 26th 2016, Current Report No. 55/2016 Change of Resolution of the Management Board of Grupa Azoty Zakłady Chemiczne Police S.A. concerning acquisition of shares in PDH Polska S.A. of November 8th 2016, Current Report No. 56/2016 Approval of acquisition of shares in PDH Polska S.A. by the Supervisory Board of Grupa Azoty Zakłady Chemiczne Police S.A. of November 14th 2016, and Current Report No. 06/2017 Court registration of subsidiary s share capital increase of February 2nd The Company reported on the above developments in Current Reports No. 16/2017 Resolutions by the Management Board of Grupa Azoty Zakłady Chemiczne Police S.A. concerning acquisition of shares in PDH Polska S.A., dated March 29th 2017, and No. 18/2017 Approval by the Supervisory Board of Grupa Azoty Zakłady Chemiczne Police S.A. of acquisition of shares in PDH Polska S.A., dated March 31st Grupa Azoty Zakłady Chemiczne Police Group Page 18 of 77

19 Elimination of junk contracts In the second half of 2016, the Company eliminated all the junk contracts under which it engaged some of its personnel, and replaced them with proper employment contracts. 4. Strategy and development policy 4.1. Strategy The strategy of the Grupa Azoty Group for identifies the key areas of the Group s production activities, including: mineral fertilizers, energy and chemicals (ammonia and titanium white). Within these business segments, the Grupa Azoty Group will be implementing a number of projects, aimed primarily at enhancing its competitive position. The key focus will be on development of new products and efficiency improvement of existing units. Moreover, in the coming years a number of upgrades are planned with respect to existing units to bring them into compliance with applicable legal requirements, such as the IED Directive Directions of development The main directions of the Company s development are outlined in the Grupa Azoty Group s strategy for In 2014, the key assumptions for operationalisation of the Grupa Azoty Group s strategy for were formulated, turning strategic objectives into measurable financial targets and actions. The operationalisation covers three areas: operational excellence, organic growth, and mergers and acquisitions. The results achieved thanks to consistent implementation of the strategy confirm that the planned objectives are attainable. Operational excellence In 2016, the Azoty PRO Operational Excellence Programme, launched in 2014, was continued. Azoty PRO is a programme for internal development of the Company and the Group, based on the best possible utilisation of assets and human resources. Its goal is to steadily enhance business efficiency through improvement of processes. The initiative is implemented in five areas: production, logistics and procurement, maintenance, energy efficiency and support functions. The first stage of the Operational Excellence Programme covers the period from 2014 to The most significant achievements were made thanks to the following initiatives: Preventive Maintenance and TPM, reduction of gas consumption costs, implementation of uniform rules for managing coal stocks, work organisation efficiency improvement, and improvement of administrative staff work organisation. Organic growth In 2016, the following initiatives designed to fuel organic growth were carried out in the Fertilizers Segment: the ammonia unit was upgraded to reduce the energy consumption in the ammonia production process and to increase its capacities, the phosphoric acid unit was upgraded to enhance production efficiency and improve the quality of the output phosphoric acid, the logistics infrastructure was developed to increase the fertilizer packing capacities and streamline the loading and forwarding of pallets with fertilizers, but also to markedly increase the storage capacity for finished products. In the Pigments Segment, initiatives aligned with the directions set out in the strategy updated in 2014 were continued. The main objective was to increase the share of sales to the strategic customer segment and to concentrate activity on the European market Growth prospects and market strategy In the coming years, the Company will endeavour to strengthen the value of the Group by seeking out new business opportunities and further reinforcing its competitive advantage. More specifically, the Company will strive to: optimise operating expenses and financing structure, increase the utilisation of units, including through reliability and efficiency improvements, reduce the consumption of strategic feedstocks and utilities used in production processes, ensure compliance with environmental and technical safety requirements, streamline inventory management, Grupa Azoty Zakłady Chemiczne Police Group Page 19 of 77

20 develop technologies, ensure efficient project delivery, streamline logistics, increase the efficiency of support processes, increase the value of intellectual capital, and use assets to the best advantage. Growth prospects at the Company are analysed with reference to individual business units, as they compete against leading companies in their respective sectors, operate in different marketplaces, have different customer bases, offer different product ranges, and face different challenges resulting from trends and legal environments in their respective sectors. Titanium white market In the titanium white market, a further growth of its globalisation potential is expected. The adopted strategy outlines a vision of the market expansion where the existing portfolio of products is maintained. Currently, the Company is working to include a new type of titanium white in its portfolio, suitable for the needs of the plastics industry, with high weather resistance and appropriate optical properties. The strategy encompasses a range of activities, including efforts to maintain stable sales of this product category by focusing on strategic customers in the target markets of Poland and Germany. Fertilizer market Development directions in the mineral fertilizer segment, the largest area of the Group s activity, are of key importance for its business. They are driven by a strategy of market penetration and intensification of efforts in the key markets in Poland and Germany based on the existing product portfolio. The Company is consistently adding new liquid and specialty fertilizers to its mix, as well as other products and services for the agricultural sector. The objective of the product portfolio development is to provide customers with a full range of fertilizers based on phosphorus and potassium. Implementation of this strategy requires continued efforts to ensure cost-efficiency of the business. Ammonia and urea market New investment projects are being planned to render ammonia and urea production more costeffective. The upgraded, more energy efficient, ammonia unit, will translate into reduced CO 2 emission costs thanks to increased capacity, with competitiveness of ammonia production maintained. The modernised urea unit will be more efficient, while complying with environmental requirements. Other markets A particularly noteworthy project is the construction of Europe s largest and most advanced PDH propylene production unit. The project will also involve the construction of a chemicals handling terminal at the Company s port in Police. It is intended to diversify the Company s revenue through a broad range of propylene processing options and by selling propylene to external customers. Propylene is used in the manufacture of other key intermediate products necessary to make solvents, acrylic paints and acrylic acid, and plays a role in the production of plastics Key investments in Poland and abroad In 2016, the Group s expenditure on property, plant and equipment and on intangible assets totalled PLN 398,211,000, including PLN 22,814,000 allocated to exploration for and evaluation of mineral resources, and PLN 56,519,000 to the construction of a PDH propylene production unit. Capital expenditure amounted to PLN 339,073,000, and the balance was spent on significant overhaul work. The Parent s expenditure on property, plant and equipment and on intangible assets was PLN 294,085,000. Capital expenditure came to PLN 232,418,000, and comprised: business development: PLN 145,255,000, mandatory investments: PLN 52,396,000, business maintenance: PLN 26,700,000, purchase of finished goods: PLN 8,067,000. Grupa Azoty Zakłady Chemiczne Police Group Page 20 of 77

21 Figure 5. Structure of capital expenditure by type 11% 3% Business development Business development Mandatory Mandatory 23% Business maintenance Business maintenance 63% Purchase of finished goods PDH propylene production unit remaining the Group s main investment project Grupa Azoty is ready to construct Europe s largest and most advanced PDH (propane dehydrogenation) unit in Police. Worth approximately USD 700m, the project will include the construction of a propylene production unit with auxiliary infrastructure, and extension of the Police sea port facilities to include a handling terminal for chemicals that would provide the required logistics infrastructure for receiving and storing the raw material and forwarding the product. The PDH unit s target annual output is at least 400,000 tonnes of premium quality propylene. The project is mainly intended to accomplish the following objectives: to leverage longterm supply and demand trends (a supply gap) in order to achieve a high rate of return on the capital invested and secure a substantial income stream, to diversify the Group s revenue, and to secure the supply of the key raw material used to produce OXO alcohols in Grupa Azoty s existing Oxoplast segment. The project will also enable the use of by-product hydrogen on the ammonia production unit, which will result in cost synergies and environmental benefits. The PDH technology will be supplied by UOP LLC (a Honeywell company), a global supplier of the most innovative industrial solutions. In 2016, the Company launched 40 new investment projects with a total budget of PLN 49,221,000. It also continued 49 investment projects commenced in previous years, with a total 2016 budget amounting to PLN 219,012,000. The most important ones are presented and described below. Exhaust gas treatment unit and upgrade of the EC II CHP plant The objective of the project is to bring the operation of the CHP plant s installations in line with the requirements of Directive 2010/75/EU. Boiler revamping work was completed and a flue gas denox unit was installed. Installation of a flue gas desulfurisation (FGD) unit is well under way. The main FGD equipment has already been delivered. The absorber foundation works have been completed. Final geodetic measurements have been taken. Acceptance activities have been completed for the transformer and distribution substation. The construction of an ammonium sulfate dehydration and loading building has been commenced. Internal lining is being installed in the absorber, and chemical resistant lining in the steel tanks. Desulfurised and non-desulfurised flue gas ducts are also being installed. Project budget: PLN 226,000,000, expected completion: Upgrade of the ammonia unit The unit is being upgraded in order to reduce energy consumption of the ammonia production process and improve the operational reliability of its individual systems. The upgrade will remove bottlenecks and increase the process efficiency. Construction and assembly works on the two production lines and in the common area have been completed. The upgraded Benfield systems have been restarted, and new syngas drying systems have been launched. Works related to control, instrumentation and automation of both production lines have been completed. A second new turbocharger for the syngas compressor has been launched. The unit is undergoing operational finetuning, and an expense report is being prepared for the project. Project budget: PLN 156,900,000, expected completion: Change of the DA-HF phosphoric acid production technology The key objective of the project is to raise the efficiency of phosphoric acid production and improve the acid s quality by reducing impurities and waste generation. The new technology will be Grupa Azoty Zakłady Chemiczne Police Group Page 21 of 77

22 based on a licence granted by Prayon Technologies SA. The detailed design has been completed. The planning permission documentation has been prepared, and a building permit has been obtained. The main apparatus and equipment have been delivered, and suppliers of other equipment and fittings are being contracted with. The contractor selection procedure is being finalised in respect of stage 1 construction works outside the phosphoric acid plant buildings. Commencement of the contractor selection procedure has been announced in respect of stage 2 main construction and installation works, up to and including commissioning of the unit. Project budget: PLN 67,000,000, expected completion: Enhancement of logistics capacity of Z.Ch. POLICE S.A. - stage 2 The project will result in increased fertilizer packing capacity and streamlined loading and forwarding of palletised fertilizers. All construction works have been completed. The key equipment and machinery (Big Bag packaging machines and palletiser) have been delivered and installed. The system is now being commissioned. Project budget: PLN 29,738,000, expected completion: Upgrade of TUP-12 (TG1) turbine generator set and auxiliary equipment This project is intended to improve the reliability, safety, flexibility and quality of the turbine control systems across the operating range. A contractor has been selected to execute the project on an EPC basis. Components of the turbine-generator set have been dismantled and tested as required to determine their wear and tear and to define the scope of work. The upgrade has commenced. Project budget: PLN 16,000,000, expected completion: Upgrade of the floodbank around the phosphogypsum landfill site The project was aimed at enhancing the floodbank integrity and protection of the phosphogypsum landfill site with auxiliary infrastructure, while preventing the recurrence of leaks through the floodbank and the washing away of its slopes. It resulted in improved flood control and safety around the landfill site. All the works were completed in 2016, the floodbank having been sealed with 6,700m of bentonite mat with soil fill up to a height of 2.35m. Project budget: PLN 9,500,000, completed in: Key equity investments On November 8th 2016, the Supervisory Board resolved to approve the acquisition of 6,300,000 new Series B registered shares in PDH Polska Spółka Akcyjna of Police. The share capital of PDH Polska Spółka Akcyjna, with its registered office in Police, amounts to PLN 128,000 thousand, with 96.09% held by the Parent, and the balance by Grupa Azoty S.A. The company was established in connection with the project to construct the PDH propylene production unit with infrastructure. On February 2nd 2017, the District Court for Szczecin-Centrum of Szczecin, 13th Commercial Division of the National Court Register, registered an increase in the PDH Polska Spółka Akcyjna s share capital Feasibility of investment plans Grupa Azoty Zakłady Chemiczne Police S.A. is continuing investment projects commenced in previous years, but is also embarking on new ones. The Company has full capacity to finance its investment projects, which it does by allocating, first of all, its own resources, working capital and funds available under the Grupa Azoty Group s New Financing Agreements, intended to finance the Group s general corporate needs arising from its Strategy and Investment Programme. The available credit limits cover long-term capital expenditure, minimising the risk of the Company s failure to carry out its investment plans. In connection with the PDH project, Grupa Azoty Zakłady Chemiczne Police S.A signed a letter of intent with Grupa Azoty S.A concerning capital involvement in the project. Pursuant to that document, its signatories agree to cooperate in order to provide capital necessary to implement the PDH project and to contribute to PDH Polska s equity to enable the financing of the project; in such capacity, Grupa Azoty is interested in direct involvement in PDH Polska by contributing to its equity, as well as in supporting PDH Polska in acquiring debt capital, working capital and other 12 The Company disclosed that information in Current Report No. 6/2017 Court registration of subsidiary s share capital increase of February 2nd Grupa Azoty Zakłady Chemiczne Police Group Page 22 of 77

23 forms of financing. Financed on a project finance basis, the PDH project will cost approximately USD 700m. Final estimate of the funding requirements for the project will be made after the general contractor is selected. Funds for some environmental protection projects will come from preferential non-bank sources, such as EU funds or national support programmes. The most important environment protection projects run in 2016 include the Exhaust gas treatment unit and upgrade of the EC II CHP plant, financed by the National Fund for Environmental Protection and Water Management. Out of 76 investment projects currently being continued, two are co-financed from preferential sources Significant R&D achievements Research and development work is a key driver of the Company s growth, as it provides knowledge and know-how necessary to develop innovative products and processes or to significantly improve existing ones. The Management Board is strongly committed to R&D and innovation, as evidenced by high levels of expenditure on these areas. Most of the R&D activities were conducted in partnership with research institutions in Poland and abroad saw the commencement of 13 entirely new R&D projects and continuation of 11 projects started in Key R&D projects in 2016 were concerned with: optimising the use of post-hydrolytic sulfuric acid, recovery of valuable components from waste streams, improving the quality of phosphoric acid, environmental assessment of fertilizer lifecycle, expanding the fertilizer portfolio to include new formulas, expanding the pigment portfolio to include a new pigment type applicable in plastics, the possibility of producing NOXy solutions directly from urea solution discharged from the synthesis unit, development of a coal gasification technology for highly efficient production of fuels and electricity, as well as a study of CO 2 removal processes in chemical looping (jointly with Grupa Azoty S.A.). In 2016, the Company focused on projects related to bringing individual fertilizer production processes in line with the requirements of the new fertilizer regulation. Due to the expected reduction of permitted levels of fertilizer contaminants (Cd, Ni, Cr, Pb, As, Hg), the Company expended extra effort to improve the quality of its phosphoric acid. The R&D programme also covered research into the processing and economic use of waste generated in the production of titanium white and phosphoric acid. The possibility of producing NOXy (32.5% urea solution) directly from urea solution discharged from the synthesis unit, an alternative to the currently used NOXy production method, was verified. The new method will reduce the load on the crystallization unit by the amount of urea used in the production of NOXy, thus enhancing the overall throughput and efficiency of the unit and reducing energy consumption. In order to further expand the product portfolio, a new type of titanium white was researched. The work was focused on improving the output pigment properties and on application tests. Research was also undertaken into the production of liquid and speciality fertilizers using semi-finished products and by-products available at the Company Corporate Social Responsibility Policy The Parent takes CSR very seriously, engaging in projects to support local communities and regional development. A socially responsible business cares about all its stakeholders. The Company seeks to respond to the needs of its employees, shareholders, business partners, customers and local communities. As part of its efforts to operate in a responsible and reliable manner, the Company adopted the Grupa Azoty Group s Code of Ethical Conduct, which defines the expected behaviour and practices. The document presents the values and standards essential for ethical business, as well as the principles to be followed by the Group s employees in their daily work. Environmental protection is also a major element of corporate social responsibility. In 2016, the Parent celebrated 20 years of its participation in the Responsible Care programme, focused on environmental, health, and process safety performance. Grupa Azoty Zakłady Chemiczne Police Group Page 23 of 77

24 5. Financial condition of the Group 5.1. Assessment of factors and non-typical events having a material impact on operations and financial performance Effect of one-off events related to the subsidiary AFRIG S.A. on the financial statements Further to Current Report No. 34/2016, a complex, multidimensional process of systematic documentation reviewing and analyses was begun in June 2016 with a view to presenting a reliable measurement of individual assets and liabilities associated with AFRIG S.A., a subsidiary. Analyses and examinations focused primarily on phosphate rock deposits, which represent a material item of the Group s assets, as reported by the Company in Current Report No. 27/2016 of May 30th Documents held by the Company were analysed and examined in detail, attempts were made to obtain additional relevant information, and work related to impairment testing of the assets was performed, as reported by the Company in Current Report No. 64/2016 of December 22nd In the successive quarters of 2016, following completion of individual stages of the reviews and analyses, the Company made adjustments to the asset valuations. In Q2 and Q3 2016, in relation to the subsidiary AFRIG S.A. decisions were made to recognise impairment losses on past due receivables, to write down phosphate rock inventories as having no commercial value, and to write off exploration and evaluation expenditure on the Lam Lam deposits and the non-depreciated value of the Lam Lam field after mining operations in that area were finally discontinued in In August 2016, a decision was received stating that the exploration licence for the Kayar Offshore field (covering ilmenite, rutile, and zirconium) would not be extended; an estimate of the mineral resources made by AFRIG S.A. showed that incurring high exploration expenditure was too risky. In consequence, intangible assets classified as exploration and evaluation assets relating to the Kayar area were written off and charged to costs. With no prospects for profitable production from the mineral sand deposits in the Sud Saint Louis licence area (the key reason behind the project unprofitability was that the identified heavy mineral resources were not sufficient to ensure the project life of more than five to eight years), a decision was made to write off intangible assets classified as exploration and evaluation assets relating to the Saint Louis area. In the opinion of the Management Board, based on a thorough review and analysis of documents it was determined that a material error had been made in the final accounting for the acquisition of shares in AFRIG S.A., which had been presented in the Group s consolidated financial statements for As a result, the Group s consolidated financial statements for 2015 also contained an error. To rectify the situation, corrections of prior period errors were made in the 2016 financial statements. The fundamental error made in the calculations underlying the final accounting for the acquisition was a failure to take into account the need to construct a phosphate beneficiation plant. This led to underestimation of capital expenditure, operating expenses and time required to reach the stage of project completion where it would be possible to launch production of phosphate rock with commercial value. The change was attributable to the lower quality of phosphate rock deposits in the Kebemer area. Since it had been initially assumed that the phosphate rock would have a high content of phosphorous (P 2 O 5 equivalent) and as such would not require traditional flotation beneficiation, but only crushing and screening, natural drying was assumed. However, the drilling campaign carried out between December 2013 and June 2014 in the Kebemer exploration licence area revealed that the field parameters were much worse than initially assumed (thicker overburden and lower phosphate quality). A review of the documentation revealed that the assumed size of the resources in the other field (Lam Lam) was also wrong. To the best of knowledge, the total phosphate rock production from the Lam Lam field, which was discontinued in mid-2014, was thousand tonnes, and not 314 thousand tonnes, i.e. the figure adopted in the final accounting for the acquisition. The above assumptions were changed as part of the correction of accounting for the acquisition. The correction of the erroneous assumptions adopted in the final accounting for the acquisition led to revaluation of the exploration licences presented as the value of mineral deposits (as at August 28th 2013). Following the correction of the accounting for the acquisition of AFRIG S.A. with respect to the acquired exploration licences disclosed under property, plant and equipment as mineral deposits, the net value of acquired assets and assumed liabilities is negative. Grupa Azoty Zakłady Chemiczne Police Group Page 24 of 77

25 Adjustment to the fair value of the acquired assets (mineral deposits) and the deferred tax liabilities related to those assets, resulted in the recognition of goodwill in place of a gain from a bargain purchase. Goodwill of PLN 93,141 thousand, which arose as a result of the correction of the accounting for the acquisition, was allocated to the investment in the phosphate mining facility, identified as a cash-generating unit on acquisition of the majority interest in African Investment Group S.A. To assess the goodwill that arose on the correction of the accounting for the acquisition, the goodwill was tested for impairment as at December 31st The estimated present value of future cash flows determined based on the assumptions made using the then available data was negative. Therefore, an impairment loss was recognised for the full amount of the goodwill. For a detailed description of assumptions made for the purpose of impairment testing of goodwill, see the consolidated financial statements of the Company for the 12 months ended December 31st Considering the financial condition of the subsidiary African Investment Group S.A. (negative equity and actual inability to meet liabilities) and all issues pertaining to the project status, the Company s Management Board determined that the interest in the subsidiary was impaired already as at December 31st On February 7th 2017, the Management Board resolved to recognise a PLN 96,219 thousand impairment loss on the acquired shares in African Investment Group S.A. (together with the acquisition cost), charging it to the balance of retained earnings. The final corrections were disclosed in Current Report No. 7/2017, in which the Company also stated that, with a view to ensuring transparent reporting and communication, obtaining reliable geological documentation of the resources, and, consequently, acquiring among other things reliable scoping studies, AFRIG S.A. decided to apply the Canadian Institute of Mining, Metallurgy and Petroleum s NI standard for reporting of mineral resources, including phosphate rock. Concurrently, steps were taken to clarify the applicable accounting policies where they relate to recognition of expenditure on exploration and evaluation of mineral resources, taking into account the technical feasibility and commercial viability of their extraction, in line with internationally recognised geological standards. Given AFRIG S.A. s lack of creditworthiness and alternative method of project financing, the subsidiary s operating and exploration activities were and continue to be financed with a credit facility from BGŻ BNP Paribas Bank Polska S.A., guaranteed by the Company as the sole surety (the other shareholders do not participate in the financing of AFRIG S.A.), and with liabilities towards the Parent. An analysis of the subsidiary s financial condition showed that it was highly probable that the Company, as the co-borrower under the credit facility contracted by the subsidiary, will have to repay the debt towards the bank as the subsidiary has no sources of revenue. In view of the foregoing, the Company s Management Board decided to recognise a provision for the surety securing credit facilities granted to AFRIG S.A. in the amount corresponding to the facility amounts drawn in each year. Moreover, the Company s Management Board changed the recognition of impairment losses on receivables from the subsidiary. Initially, pursuant to the Management Board s resolution, the impairment loss on the receivables was charged to costs of June The receivables were related to supplies of fertilizers to Senegal in , when the Company was trying to enter the new fertilizer market. After the change, as a prior period error, 50% of the impairment loss was charged to accumulated earnings (deficit), and the balance was recognised in the current year s profit (loss). Such recognition better reflects the fact that the subsidiary s financial condition was indicative of impairment of those receivables already at the end of Based on the knowledge available at the date of preparation of the financial statements for 2015, a portion of the debt was to be repaid by the subsidiary with funds from AFRIG S.A. s debtor. However, in mid 2016 the information that the debtor had instigated court proceedings to challenge its debt was confirmed. Therefore, the subsidiary AFRIG S.A. recognised an impairment loss on the receivables. Accordingly, the Company recognised an impairment loss on the balance of the receivables from the subsidiary. For a description of the changes, see also Section in the Company s financial statements for the 12 months ended December 31st The Company announced this in Current Report No. 42/2016 Impairment losses on assets related to subsidiary AFRIG S.A., dated July 22nd Grupa Azoty Zakłady Chemiczne Police Group Page 25 of 77

26 The Company continues to disclose in its statement of financial position the expenditure incurred, from the date of acquisition of shares in AFRIG S.A., on exploration and evaluation of mineral resources, in the amount of PLN 64,047 thousand (of which PLN 63,224 thousand is attributable to the Kebemer exploration licence area). This results from the continuation of work on examining the geological documentation and the need to obtain a scoping study compliant with international standards, required under the reporting policy implemented by the Group. These activities are expected to be completed in the second half of 2017, and then relevant decisions concerning the project implementation will be made. Table 17. Effect of one-off events related to the subsidiary AFRIG S.A. on the 2016 net profit/(loss) * Grupa Item Azoty POLICE Parent Group Impairment loss on receivables from AFRIG S.A. -21,915 Provision for surety for credit facility granted to AFRIG S.A. -21,273 Impairment losses on AFRIG S.A. s receivables past due for more than one year -20,031 Write-down of phosphate rock inventories presented by AFRIG S.A. under work in progress -10,838 Impairment loss on other receivables prepaid deliveries from AFRIG S.A. -4,727 Recognised provision for liabilities for technical consultancy related to phosphate rock supplies from Senegal -9,411-9,411 Write-off of exploration and evaluation expenditure relating to the Kayar area -900 Write-off of exploration and evaluation expenditure relating to the St. Louis area -4,241 Other adjustments 31 Deferred tax assets/liabilities 581 5,814 Effect on net profit (loss) -44,809-51,512 * Data presented after translation into PLN at the average exchange rate for XOF in Table 18. Effect of one-off events related to the subsidiary AFRIG S.A. on the 2015 net profit/(loss)* Grupa Item Azoty POLICE Parent Group Impairment loss on receivables from AFRIG S.A. -21,915 Provision for surety for credit facility granted to AFRIG S.A. -21,302 Impairment losses on exploration and evaluation expenditure relating to the Lam Lam area -10,222 Deferred tax assets/liabilities -3,407 4,026 Effect on net profit (loss) -13,629-39,191 * Data presented after translation into PLN at the average exchange rate for XOF in Grupa Azoty Zakłady Chemiczne Police Group Page 26 of 77

27 Table 19. Effect of one-off events related to the subsidiary AFRIG S.A. on profit (loss) brought forward as at January 1st 2015* Grupa Azoty Item POLICE Group Write-off of the value of the Kebemer deposits -268,630 Write-off of non-depreciated value of the Lam Lam deposits -2,041 Parent Recognised impairment losses on shares in AFRIG S.A. -96,219 Provision for surety for credit facility granted to AFRIG S.A. -34,098 Deferred tax assets/liabilities 61,704 - Exchange differences on translation -2,977 * Data presented after translation at the historical exchange rate for XOF. Effect on equity -211, ,317 In the consolidated financial statements for 2016, profit before tax includes the following adjustments: Impairment losses on AFRIG S.A. s receivables past due for more than one year, covering 100% of the receivables amount: PLN 20,031 thousand 13, Write-down of phosphate rock inventories presented by AFRIG S.A. as work in progress deemed slow moving inventories for over two years, due to no commercial value of the product: PLN 10,838 thousand 14, Recognised provision for future liabilities for technical consultancy related to phosphate rock supplies from Senegal: PLN 9,411 thousand, allocated to other expenses, PLN 900 thousand write-off of intangible assets classified as exploration and evaluation assets relating to the Kayar area, following the decision not to extend AFRIG S.A. s exploration licence for ilmenite, rutile, and zirconium deposits in the Kayar Offshore field an estimate made by AFRIG S.A. showed that incurring high expenditure on exploration was too risky 15, Write-off of intangible assets classified as exploration and evaluation assets relating to the St. Louis area by AFRIG S.A.: PLN 4,241 thousand. In the consolidated financial statements for 2015, profit before tax includes the following adjustments: PLN 10,222 thousand write-off of intangible assets classified as exploration and evaluation assets relating to the Lam-Lam phosphate rock deposits - charged to costs following discontinuation of production 16. In the Parent s financial statements for 2016, profit before tax includes the following adjustments: Recognised provision for the surety for the credit facility granted to AFRIG S.A.: PLN 21,273 thousand, allocated to finance costs 17, Impairment loss on receivables from AFRIG S.A.: PLN 21,192 thousand, allocated to distribution costs (other expenses by nature) and related interest of PLN 723 thousand, allocated to finance costs 17, Recognised provision for future liabilities for technical consultancy related to phosphate rock supplies from Senegal: PLN 9,411 thousand, allocated to other expenses, Recognised impairment loss on other receivables related to AFRIG S.A. (prepaid deliveries): PLN 4,727 thousand, allocated to other expenses. 14 The Company disclosed this information in Current Report No. 42/2016 Impairment losses on assets related to subsidiary AFRIG S.A., dated July 22nd 2016, and in Current Report No. 49/2016 Write-off of assets at subsidiary AFRIG S.A., dated October 12th The Company disclosed this information in Current Report No. 43/2016 Exploration licences held by subsidiary AFRIG S.A. of August 5th The Company disclosed this information in Current Report No. 49/2016 Write-off of assets at subsidiary AFRIG S.A., dated October 12th 2016, and in Current Report No. 7/2017 Decision to adjust assets related to AFRIG S.A., dated February 7th The Company disclosed this information in Current Report No. 7/2017 Decision to adjust assets related to AFRIG S.A., dated February 7th Grupa Azoty Zakłady Chemiczne Police Group Page 27 of 77

28 In the Parent s financial statements for 2015, profit before tax includes the following adjustments: Recognised provision for the surety for the credit facility granted to AFRIG S.A.: PLN 21,302 thousand, allocated to finance costs 17, Impairment loss on receivables from AFRIG S.A.: PLN 21,192 thousand, allocated to distribution costs (other expenses by nature) and related interest of PLN 723 thousand, charged to finance costs Market overview As in previous years, the financial performance of the Group in the reporting period was strongly correlated with the situation in the Parent s market environment. Factors with the greatest impact on performance in 2016: low prices of grains attributable to high global stocks and expected high yields, large supply and strong price competition on global grain markets sparking a wave of wheat price reductions globally, prices of NPK fertilizers on global markets fell steadily throughout 2016, in 2016, the stocks of NPK fertilizers at producers and distribution chains remained high; towards the end of 2016, several West European manufacturers temporarily stopped production of NPK fertilizers due to high inventory levels. the price of DAP on most markets was on a downward trend, and in December 2016 it reached a level last seen in 2009, increase in global ammonia and urea production capacities (new capacities), 2016 saw continued weak demand for fertilizer and technical-grade ammonia; ammonia started to be supplied from new production units; in October 2016, the price of ammonia fell to a level last seen in 2005, in mid 2016, the price of urea went down to a level last recorded at the end of 2004 and beginning of 2005, in Polish agricultural sector, winter losses on winter grains exceeded 10%, 25% in the case of rapeseed, and 50% in the case of barley, delays in direct payments of EU funds (in spring) and low prices of grains forced farmers to postpone fertilizer purchases, in Poland prices of NPK fertilizers were largely suppressed by low prices of imported NPK fertilizers and high activity of distributors offering the imported product, shutdowns of titanium white capacities in China, limited supply of ilmenite and titanium slag raw materials in titanium white production, lower prices of gas a key raw material in ammonia production. NPK and DAP fertilizers Poland. In 2016, the Polish market recorded a decrease in retail sales of NPK fertilizers, which resulted primarily from farmers poorer financial condition. Delays in direct payments of EU funds (in the spring) coupled with falling prices of grains and other agricultural produce prompted farmers to reduce their purchases of fertilizers and other means of agricultural production. Also farmers uncertainty about the condition of winter crops, varying significantly across Poland, adversely affected the volume of fertilizer purchases in the spring of Increased sales were recorded in the short periods of seasonal peaks in spring and autumn. In Q4 2016, an increase in sales of fertilizers was recorded, driven by advance direct payments to farmers and post-seasonal drop in prices asked by domestic producers. Relative to previous years, there were more farmers purchasing fertilizers in autumn 2016 with payments deferred e.g. until after the 2017 harvest or even until the end of Prices of NPK fertilizers on the Polish market were materially affected by competitive imports (low prices combined with intensive sales and marketing activities by distributors of imported fertilizers). Other markets. In 2016, European manufacturers of NPK fertilizers faced a challenging situation. NPK sales volumes went markedly down year on year, while stocks at manufacturers and distributors remained high. On non-european markets, demand for NPK fertilizers was also limited, coming mainly from the Indian and several South East Asian markets. Only in Russia and Ukraine, demand for NPK fertilizers was strong for most of the year. Towards the end of 2016, several West European manufacturers temporarily stopped production of NPK fertilizers due to high inventory levels. Grupa Azoty Zakłady Chemiczne Police Group Page 28 of 77

29 Prices of NPK fertilizers were on a downward trend on global markets throughout 2016, having gone down by 15% 25% (depending on the type). In 2016, weak demand prevailed on the main DAP markets, i.e. the US, Europe, Brazil, China and India. Numerous large manufacturers have significantly cut production. In China, capacities were utilised at 60%. The weak demand for DAP in China forced Chinese producers to increase exports, which put pressure on global prices. In an attempt to market their products, the world s largest DAP producers were steadily reducing prices to deplete their stocks and sell current output. Figure 6. Monthly average prices of NPK and DAP fertilizers in 2016 [USD/t] DAP NPK Despite limited production, the price of DAP in most markets was gradually declining and in December reached a level last seen in In 2016, DAP prices fell by 20%. Ammonia and urea Reduced output of fertilizers and certain chemicals contributed to the continued weak demand for fertilizer and technical-grade ammonia. While reduced production volumes and equipment failures at numerous manufacturers and exporters had a stabilising effect on the price of ammonia, they did not prevent it from falling. Between January and October 2016, the price of ammonia dropped by 40%, to the lowest level since Further reduction of supply (production unit failures and shutdowns) and supply disruption due to the ongoing conflict between Russia and Ukraine pushed ammonia prices up by 30% in the last two months of the year. Figure 7. Monthly average prices of ammonia and urea in 2016 [USD/t] Urea Ammonia 2016 saw seasonal price hikes and falls on the global urea market. In the first half of 2016, a downward trend in urea prices prevailed, bringing them in mid 2016 to the lowest level since late 2004/early In the second half of the year, the trend largely reversed. The most important driver of market prices was reduced production in China, the largest global urea producer and exporter. In H2 2016, 50% of all China s urea capacities were shut down. In the first half of the year, the urea price went down by 25%, to rebound 25% in the second half. Grupa Azoty Zakłady Chemiczne Police Group Page 29 of 77

30 Titanium white Titanium white prices, which had been in a downward trend from mid 2012, stabilised in H At the beginning of 2016, titanium white prices on European markets reached their lowest levels since The decline was primarily attributable to the excess global production capacity relative to existing demand, particularly in the case of China. Begun in 2015, permanent or temporary shutdowns of production plants caused shortages of titanium white, especially of speciality grades, in the second half of Most capacity shutdowns took place in China, mainly for environmental reasons. As a result, shortages of some grades were recorded, the stocks shrank and producers began to raise prices. In Europe, titanium white prices went up by about 10%. The prices were also driven up by rising prices of raw materials for titanium white production. Figure 8.8 Monthly average prices of titanium white in 2016 [EUR/t] Titanium white Chemicals Apart from titanium white, key chemicals produced for sale by the Company include ammonia, technical-grade urea and iron sulfate. technical-grade urea is used mainly to produce glues for the furniture industry and to prepare the NOXY (AdBlue ) solution. In 2016, the demand for urea used in glue production was stable. In the NOXY segment, despite strong competition, both domestic sales and exports increased, which was attributable to the Grupa Azoty Group s joint strategy for the RedNOX segment (range of products designed to reduce nitric oxide emissions in the automotive and industrial segments): NOXY (32.5% urea solution, Adblue ); Likam (ammonia water); Pulnox (40% technical-grade urea solution). In 2016, the supply of iron sulfate remained high across European markets. Iron sulfate is a byproduct of titanium white and steel production, the outputs of which went down in Sales of current production were supplemented with sales of stocked products. Demand for iron sulfate from the Polish cement industry remained solid; sales of fertilizer-grade iron sulfate grew, too, especially in Q Imports of iron sulfate to Poland increased by 2.7% Key financial and economic data The Group s key achievements in 2016 included: optimum financial performance in a challenging environment, robust gross margin maintained despite adverse market trends, capital expenditure increased by over 60% year on year, lower prices negotiated for all key raw materials, high sales volumes of compound fertilizers, especially in the Polish market, where sales were higher than in any of the past 12 years, 14% year-on-year sales increase in the Pigments Segment, with similarly high volumes last recorded five years ago, positive EBIT of the Pigments Segment, continued work on the key project: Construction of a PDH propylene unit with infrastructure. The Group s performance in 2016, against the general market and competitors, should be viewed as good. The Group s operations were mainly affected by the market environment: 2016 saw a downswing on the fertilizers markets; a cyclical deterioration of the business environment, recurring every several years, brought about a prolonged slump in the market Grupa Azoty Zakłady Chemiczne Police Group Page 30 of 77

31 prices of both products and raw materials, with the decline in raw material prices only partially offsetting the adverse effect of lower product prices on financial performance; The downward trend in the entire fertilizers market resulted in poorer performance of competitors; in 2016, the Group s competitors (Yara, EuroChem, ICL, Acron and PhosAgro) recorded EBIT lower than in A material factor behind the recorded performance were one-off items resulting from the need to reliably present the amounts of assets and financial position of the subsidiary AFRIG S.A. For a detailed description, see Section in the Company s financial statements for the 12 months ended December 31st Financial data for 2015 was restated on account of the changes described in Note 2.3. to the Company s financial statements. In 2016, the Group posted net profit of PLN 69,709 thousand and EBIT of PLN 99,300 thousand. Profit before tax was only 14% lower than in the previous year. At the same time, the Group maintained a high gross margin level, despite the adverse impact of the business environment in which Grupa Azoty Zakłady Chemiczne Police executes its key processes. Table 20. Consolidated financial performance Item change % change Revenue 2,416,984 2,741, , Cost of sales 1,997,325 2,252, , Gross profit 419, ,453-68, Distribution expenses 116,092 97,560 18, Administrative expenses 180, ,668-3, Net profit on sales 122, ,225-83, Other income/(expenses) -23,580-7,285-16, EBIT 99, ,940-99, Finance income/(costs) -14,571-16,696 2, Share of profit (loss) of equity-accounted associates 11,863 10,816 1, Profit before tax 96, ,060-96, Income tax 26,883 41,900-15, Net profit/loss 69, ,160-81, One-off events effect on net profit/loss -44,809-13,629 Net profit/loss, net of one-off events 114, ,789-50, In 2016, the Company took a series of measures to adapt its business to changing market conditions. Decisions made ahead of anticipated changes in the market, based on early warning signals, significantly countered the effects of adverse trends observed on the product markets. The Company s Management Board supported cost optimisation measures, resulting from an in-depth analysis of the rationale for each project, possibility of its modification or rescheduling. A flexible business strategy underpinned high product sales volumes, and helped align the sales strategy with changing situation on individual markets. Particular emphasis was placed on increasing the Group s share in the domestic market of compound fertilizers, which resulted in high sales volumes. The Group s EBITDA was below the previous year s figure mainly due to unfavourable price trends on global fertilizers markets, where the prices of NPK fertilizers were falling steadily throughout 2016 and the DAP price in December 2016 reached the level last recorded in The 2016 performance was additionally adversely affected by one-off events related to the subsidiary AFRIG S.A. The effect of one-off events on EBIT in 2016 amounted to PLN 45,390 thousand, reducing EBIT to PLN 99,300 thousand. Grupa Azoty Zakłady Chemiczne Police Group Page 31 of 77

32 Figure 9. Consolidated EBITDA key drivers 3,981 One-off events effect on EBITDA 10, , ,627 18,532 14, positive effect on EBITDA negative effect on EBITDA 45, , ,898 EBITDA 2015 lower unit cost of products sold lower administrative expenses lower product prices higher selling and distribution expenses lower sales volumes lower net other income EBITDA 2016 In 2016, the Group was working intensively to negotiate lower purchase prices of raw materials used for its products. Effective efforts in raw materials procurement were reflected in lower prices of key materials, including phosphate rock, potassium chloride, ilmenite, sulfur, sulfuric acid, fine coal and natural gas. The active policy with respect to raw materials delivered substantial measurable benefits in terms of cost reduction and, consequently, improved financial performance. Table The Parent s financial performance Item change % change Revenue 2,385,094 2,719, , Cost of sales 1,999,602 2,252, , Gross profit 385, ,856-81, Distribution expenses 117, ,752-1, Administrative expenses 148, ,698-7, Net profit on sales 119, ,406-72, Other income/(expenses) -6,409 1,014-7, EBIT 112, ,420-79, Finance income/(costs) -27,453-27, Profit before tax 85, ,936-79, Income tax 21,561 35,339-13, Net profit/loss 63, ,597-65, One-off events effect on net profit/loss -51,512-39,191 Net profit/loss, net of one-off events 115, ,788-53, In the reporting period, the financial performance of the Group was strongly correlated with the situation in the Parent s market environment. This correlation has been present since the launch of the Company s operations and remains beyond the Company s influence or control. Given the economic developments and global market conditions being much more challenging than in 2015, the Company s gross profit posted in 2016 could not have been better. Also, as part of its streamlining efforts, the Company reviewed and reassessed the need for all its contracts and agreements, which allowed it to reduce administrative expenses by PLN 7,785 thousand compared with The adverse effect of one-off events related to the Senegalese subsidiary AFRIG S.A. reduced the Company s EBIT by PLN 35,330 thousand, to PLN 112,997 thousand Segment results In 2016, the Group s sales performance was primarily affected by conditions on the Fertilizers Segment s market, where a global downturn in product prices was only partially offset by falling prices of key raw materials. Another factor weighing down on the Fertilizers Segment s performance Grupa Azoty Zakłady Chemiczne Police Group Page 32 of 77

33 were the one-off impairment losses and provisions described in Section 5.1 of this Report. In 2016, the prices of NP and NPK fertilizers, as well as of ammonia and urea, were declining. A significant year-on-year improvement in EBIT was recorded for the Pigments Segment. Market fluctuations over the year led at some point to an excess of demand over supply, which supported an increase in sales volumes and lifted market prices after a long period of declines (and although the average annualised price of titanium white was close to its 2015 level, what mattered was the favourable change of the trend). A 14% growth in the Pigments Segment s revenue was attributable to a 14% growth of the titanium white sales volume. In 2016, the Pigments Segment s share in the Group s revenue from external sales increased by 3pp, while the Fertilizers Segment s share declined. Table 22. Consolidated EBIT by segment in 2016 Other Item Fertilizers Pigments Activities Revenue from external sales 2,050, ,035 58,901 Share [%] 85% 13% 2% EBIT 79,303 13,624 6,373 Table 23. Consolidated EBIT by segment in 2015 Item Fertilizers Pigments Other Activities Revenue from external sales 2,420, ,475 51,216 Share [%] 88% 10% 2% EBIT 206,573-13,718 6,085 Table 24. The Parent s EBIT by segment in 2016 Item Fertilizers Pigments Other Activities Revenue from external sales 2,046, ,035 30,544 Share [%] 86% 13% 1% EBIT 84,234 13,541 15,222 Table The Parent s EBIT by segment in 2015 Item Fertilizers Pigments Other Activities Revenue from external sales 2,418, ,477 31,549 Share [%] 89% 10% 1% EBIT 200,386-13,351 5,385 The Fertilizers Segment s EBIT was driven down primarily by lower revenue from sales of phosphate fertilizers, which deteriorated on year-on-year decreases in market prices of those fertilizer products. The effect of the declining product prices was not completely offset by concurrent reductions in the prices of strategic raw materials. In addition, the results on sales of nitrogen fertilizers and ammonia drove the segment s performance down year on year, although to a lesser extent. Ammonia and urea selling prices went down by 30% and 12%, respectively, while natural gas prices fell 28% relative to 2015, which significantly offset the lower product prices. The ammonia and urea sales volumes went down, too, by 17% and 6%, respectively. The segment s revenue decreased by 15% year on year. In the past, a market downturn, like the one observed in 2016, usually brought about a material deterioration of performance; from this perspective, the segment s 2016 performance should be viewed as quite solid. Grupa Azoty Zakłady Chemiczne Police Group Page 33 of 77

34 Figure 10. The Group s revenue by segment Fertilizers Pigments Other Activities 0 Figure 11. The Group s revenue by segment % 2% Fertilizers Pigments Other 85% % 2% Fertilizers Pigments Other 88% The shares of individual segments in total revenue changed slightly year on year: the Fertilizers Segment s share dropped by 3pp, while that of the Pigments Segment grew by 3pp, with the share of other sales unchanged. Fertilizers In 2016, the Fertilizers Segment s revenue amounted to PLN 2,050,048 thousand, accounting for 85% of the Group s revenue. The segment s EBIT was positive at PLN 79,303 thousand. On average, domestic sales accounted for 67% of the segment s total sales. Grupa Azoty Zakłady Chemiczne Police Group Page 34 of 77

35 Figure 12. Consolidated revenue of the Fertilizers Segment Q Q Q Q Q Q Q Q Pigments 2016 saw a marked improvement in the Pigments Segment s market (mainly due to higher sales volumes, supported by strengthening demand, and favourable changes in titanium white prices), which boosted revenue. The Pigments Segment s 2016 revenue totalled PLN 308,035 thousand, which represented 13% of the Company s revenue. Year on year, the segment s revenue increased by 14%. Approximately 53% of the segment s revenue was derived from sales on foreign markets. The segment s EBIT was again positive and much higher than in Figure 13. Consolidated revenue of the Pigments Segment Q Q Q Q Q Q Q Q Other Revenue recorded from Other Activities amounted to PLN 58,901 thousand in 2016, representing 2% of total revenue. The segment s EBIT did not change materially year on year. Sales by product group In 2016, compound fertilizers accounted for the highest share in the Parent s revenue by product group, representing over 61% of total revenue. Relative to 2015, the shares of individual product groups in total revenue changed negligibly. Revenue from sale of compound fertilizers amounted to PLN 1,485,151 thousand in 2016, having gone down 12% year on year. The main cause of the revenue decrease was a 9% drop in the selling prices of compound fertilizers, with a sales volume down by a mere 3%. Grupa Azoty Zakłady Chemiczne Police Group Page 35 of 77

36 Figure 14. Consolidated revenue by product group Compound fertilizers Urea Titanium white Chemicals Other Revenue from sale of urea amounted to PLN 305,392 thousand in 2016 and was 17% lower than in The decline was attributable to lower prices (down 12%) and lower sales volume (down 6%). Revenue from sale of titanium white reached PLN 294,662 thousand in 2016 and was 14% higher than in The sales volume grew by 14%, with the prices unchanged relative to Figure 15. Consolidated revenue by product group % 11% 3% Compound fertilizers Urea 61% Titanium white 13% Chemicals Other % 14% 2% Compound fertilizers Urea Titanium white 14% 61% Chemicals Other Revenue from sale of chemicals (with the predominant share of ammonia) went down by 31% relative to 2015, mostly owing to a lower ammonia price and sales volume (down 30% and 17%, respectively). Revenue recognised under Other Activities accounts for approximately 3% of the Group s total sales and is derived mainly from occasional sales of merchandise and services Operating expenses The Group s operating expenses amounted to PLN 2,279,385 thousand in 2016, having decreased by PLN 185,284 thousand (or 8%) year on year. The most important item here was raw materials and Grupa Azoty Zakłady Chemiczne Police Group Page 36 of 77