CORPORATE PROFILE China Mengniu Dairy Company Limited and its subsidiaries manufacture and distribute quality dairy products in China. As one of the l

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2 CORPORATE PROFILE China Mengniu Dairy Company Limited and its subsidiaries manufacture and distribute quality dairy products in China. As one of the leading dairy product manufacturers in China, Mengniu offers a diversified product portfolio, including liquid milk products (such as UHT milk, milk beverages and yogurt), ice cream, milk formula and other dairy products (such as cheese). During the first half of 2014, Mengniu remained first in market share of liquid milk, UHT dairy products and chilled dairy products, according to Nielsen Company. In March 2014, Mengniu became a Hang Seng Index constituent, making it the first blue chip Chinese dairy product manufacturer. UHT

3 CONTENT 2 Corporate Information 4 Highlights 6 Management Discussion and Analysis 31 Report of the Directors 40 Independent Review Report 42 Interim Condensed Consolidated Statement of Profit or Loss 44 Interim Condensed Consolidated Statement of Comprehensive Income 45 Interim Condensed Consolidated Statement of Financial Position 48 Interim Condensed Consolidated Statement of Changes in Equity 50 Interim Condensed Consolidated Statement of Cash Flows 53 Notes to Interim Condensed Consolidated Financial Statements

4 CORPORATE INFORMATION Board of Directors Executive Directors Ms. SUN Yiping (Chief Executive Officer) Mr. BAI Ying Mr. WU Jingshui (resigned on 26 March 2014) Non-Executive Directors Mr. NING Gaoning (Chairman) Mr. YU Xubo (Vice-Chairman) Mr. NIU Gensheng Mr. MA Jianping (resigned on 26 March 2014) Ms. LIU Ding (Vice-Chairwoman) Mr. Finn S. HANSEN Mr. Christian NEU Independent Non-Executive Directors Mr. JIAO Shuge (alias JIAO Zhen) (Vice-Chairman) Mr. Julian Juul WOLHARDT Mr. LIU Fuchun (resigned on 26 March 2014) Mr. ZHANG Xiaoya Mr. Andrew Y. YAN (resigned on 26 March 2014) Mr. WU Kwok Keung Andrew Dr. LIAO Jianwen (appointed on 26 March 2014) Senior Management Mr. ZHANG Ping Mr. LU Jianjun Mr. YAO Haitao Mr. LIU Shengli Mr. Jesper Fournaise COLDING Ms. ZHAI Mei Mr. WANG Yansong Mr. KWOK Wai Cheong Chris (Qualified Accountant & Company Secretary) Stock Code Hong Kong Stock Exchange 2319 Investor Relations Contact Ms. Willow WU 29th Floor, Block A, IFC No. 8A Jianguomenwai Avenue Chaoyang District Beijing, China Website: Finn S. HANSEN Christian NEU Julian Juul WOLHARDT Jesper Fournaise COLDING A29 info@mengniuir.com 2 China Mengniu Dairy Company Limited Interim Report 2014

5 CORPORATE INFORMATION Place of Business in Hong Kong Suite 1602, 16th Floor, Top Glory Tower 262 Gloucester Road, Causeway Bay Hong Kong Registered Office Maples Corporate Services Limited P.O. Box 309 Ugland House Grand Cayman KY Cayman Islands Principal Share Registrar Royal Bank of Canada Trust Company (Cayman) Limited 4th Floor, Royal Bank House 24 Shedden Road, George Town Grand Cayman KY Cayman Islands Hong Kong Branch Share Registrar Computershare Hong Kong Investor Services Limited 46th Floor, Hopewell Center 183 Queen s Road East, Wanchai Hong Kong Legal Advisors As to Hong Kong Law Sullivan & Cromwell As to Cayman Islands Law Maples and Calder Asia Principal Bankers Agricultural Bank of China Bank of China BNP Paribas Industrial Commercial Bank of China Standard Chartered Bank The Hongkong and Shanghai Banking Corporation Limited Auditors Ernst & Young Investor Relations Consultant Strategic Financial Relations (China) Limited Maples Corporate Services Limited P.O. Box 309 Ugland House Grand Cayman KY Cayman Islands Royal Bank of Canada Trust Company (Cayman) Limited 4th Floor, Royal Bank House 24 Shedden Road, George Town Grand Cayman KY Cayman Islands Maples and Calder Asia 3

6 HIGHLIGHTS For the six months ended 30 June (Unaudited) Change RMB 000 RMB 000 Restated* % * Revenue 25,835,834 20,667, % Gross profit 8,381,818 5,518, % Profit attributable to owners of the Company for the period 1,048, , % Earnings per share (RMB) Basic % Diluted % * Certain amounts stated above do not correspond to the interim condensed consolidated financial statements as at 30 June 2013 but reflect the adjustments made as described in Note 9 to the Interim Financial Statements. * 9 Mengniu has achieved stable growth through continuous innovations in terms of marketing, business model and products, expansion of sales channels and streamlining the product portfolio Mengniu has made efforts in integrating the businesses with its strategic partners and refining its business coverage by focusing on the development of UHT, chilled and milk formula businesses, with a view to becoming an innovation-led food company offering nutrition and health With an aim of establishing a win-win ecosystem, Mengniu has strengthened its efforts to build milk sources. Milk sources provided by ranches and scaled farms reached 94%, maintaining the top spot in the industry 94% With clear brand value and product positioning, Mengniu has built its brand image through the branding campaign A Drop of Goodness and increased spending in digital media. Star brands and opportunity brands performed notably well Data from Nielsen Company reveals that Mengniu s liquid milk, UHT dairy products and chilled dairy products retained their leading position in terms of market share The dairy industry posted steady growth. In particular, liquid milk (including UHT milk, milk beverages and yogurt) maintained growth momentum with a clear trend of gravitating towards the high-end segment UHT 4 China Mengniu Dairy Company Limited Interim Report 2014

7 HIGHLIGHTS Revenue by Product Mix For the six months ended 30 June RMB Million Revenue by Product Mix in Liquid Milk Segment For the six months ended 30 June RMB Million , , , , , , , , , , , Liquid Milk Ice Cream UHT Milk UHT Milk Beverages Yogurt Milk Formula Other Dairy Products 5

8 MANAGEMENT DISCUSSION AND ANALYSIS Market Review In the first half of 2014, the tight supply of raw milk has turned around and the dairy industry has continued to steadily grow. In particular, liquid milk (including UHT milk, milk beverages and yogurt) maintained growth momentum with a clear trend towards the high-end segment, while organic milk, lactobacillus drinks and UHT yogurt witnessed strong growth. Meanwhile, the growth of the milk formula industry has slowed down in the first half of the year. To ensure the safety of dairy products and restore consumer confidence, the PRC government is tightening regulations over the dairy industry. In the long run, the dairy industry in China should develop on a healthy and orderly track and the trend of weeding out the weak players will continue to strengthen. UHT Currently, the per capita consumption of dairy products in the PRC is less than one-third of the world s average. With the accelerated urbanization, increase in disposable income and rise of awareness among consumers, the total consumption of dairy products in the PRC is expected to keep on increasing and the consumption structure is expected to undergo transformation and upgrade. The immense development potential has attracted capital inflows into dairy-related industries. During the period, the supply of domestic raw milk increased while the price of raw milk declined in contrast with the price hike last year. The decrease in the cost of raw milk helped downstream dairy enterprises improve their gross margins. Business Review In 2013, with the strong support from its major shareholder COFCO Group, Mengniu forged a number of mergers and acquisitions as well as strategic partnerships. In the first half of 2014, Mengniu undertook integration of its businesses with its strategic partners and continued to strive for innovation in its marketing, business model and products. Mengniu also improved its management efficiency by streamlining processes, systems and products, while developing an open and transparent culture by enhancing internal and external communications and transparency. According to the data released by Nielsen Company, Mengniu remained first in market share of liquid milk, UHT dairy products and chilled dairy products during the first half of Star brands such as Milk Deluxe, Yoyi C, Fruit Milk Drink, Champion and Future Star continued to lead the market with high popularity among consumers, while opportunity brands, including Just Yoghurt and Deluxe, and the new product Minion Banana Milk maintained strong sales growth. C 6 China Mengniu Dairy Company Limited Interim Report 2014

9 MANAGEMENT DISCUSSION AND ANALYSIS Mengniu was recognized by the industry, capital market and media for its overall sound performance. During the period, Mengniu was ranked as one of the Best 50 Performers in China at the Global Entrepreneur Annual Conference. Mengniu was included among the Global Dairy Top 20 list released by Rabobank for the sixth consecutive year and was in the Fortune China 500 for the fifth consecutive year. Mengniu also received the Best Investor Relations award from Institutional Investor, one of the most influential financial magazines. The award was assessed and selected by polling more than 800 buy-side fund managers, researchers and more than 600 sell-side analysts. This prestigious accolade testifies to the strong confidence of international investors in the future development of Mengniu. Best Moreover, Mengniu was selected as one of the 2013 Top 100 Chinese Light Industry Enterprises, the Top 100 Enterprises for Marketing Capability and the Top Ten Enterprises in the Chilled Beverage Industry in China by the China National Light Industry Council and ranked 102 nd among China s 500 Most Valuable Brands compiled by the World Brand Lab with a brand value of RMB billion. Strategic Cooperation and Integration Chilled business: Danone S.A. and its subsidiaries (collectively known as the Danone Group ) As at 27 March 2014, Mengniu has completed placing its shares to Danone Group, the world s largest fresh dairy enterprise. With its shareholding in Mengniu raised from 4.0% to 9.9% of the enlarged share capital, Danone Group has become the second largest strategic shareholder of Mengniu. In June, Mengniu and Danone Group established a joint venture, Inner Mongolia Mengniu Danone Dairy Co. Ltd., ( Mengniu Danone ) with a view to integrating their chilled dairy business in China. As one team, Mengniu Danone shares the same vision of becoming the leader of the chilled dairy industry in China, with the target of increasing the per capita consumption and market share, while offering consumers safe and high-quality products through a more diversified product portfolio Danone S.A. Danone Danone Danone4.0% 9.9% Danone 7

10 MANAGEMENT DISCUSSION AND ANALYSIS Mengniu Danone has streamlined the product structure and focused on the marketing of three high-margin brands Yoyi C and Champion under Mengniu and Bio under Danone Group. Apart from reinforcing the product strengths, Mengniu Danone has also actively conducted new product research and development to meet the needs of different consumers. Moreover, Mengniu Danone has enhanced its operating efficiency and lowered its operating costs by improving the asset utilization ratio, strengthening economies of scale and prudently managing its costs and capital expenditure. C Danone Since February, the operations experts of Danone Group in the Asia-Pacific region have been dispatched to the chilled plant in Ma anshan City, Anhui Province to collaborate with Mengniu in launching the efficiency enhancement project, with a view to keeping food safety and quality abreast of the international standards. Key performance indicators have also been established to gradually enhance operational practices in all of the plants. The Ma anshan plant has been upgraded in accordance with the global production and quality management standards of Danone Group. Since early June, certain products under Bio have been produced at the Ma anshan plant. With the Ma anshan plant as the pilot project, Mengniu plans to train the staff at other chilled plants with a view to bringing the operating efficiency of Mengniu s plants to world class levels. Danone Danone In the second half of the year, Mengniu Danone will gradually upgrade all of its chilled plants to international operation standards by implementing seven key projects, including upgrading operating efficiency from good to great, quality management training, improvement in product research and development, new product innovation and improvement, sales breakthrough in key markets for chilled products, breakthrough in key strategic products as well as bolstering of its reputation. 8 China Mengniu Dairy Company Limited Interim Report 2014

11 MANAGEMENT DISCUSSION AND ANALYSIS Arla Foods On 26 April, the China-Denmark Milk Technology Cooperation Center the first national dairy project led by the ministries of agriculture of China and Denmark formally debuted in the COFCO Nutrition and Health Research Institute in Beijing. Arla China Innovation Center, which focuses on developing cheese products for Chinese consumers, was also inaugurated at the same time and place. The China-Denmark Milk Technology Cooperation Center, already in operation, and the newly established Arla China Innovation Center marked another milestone in the close collaboration among the COFCO Group, Mengniu and Arla Foods. The location of the two centers at the COFCO Nutrition and Health Research Institute facilitates the three parties in consolidating their experiences and resources, thereby further strengthening their collaboration. Mengniu will conduct further research and innovation in food nutrition and health with the aid of the research strengths that COFCO Group has accumulated over the years. By introducing advanced Danish technologies in dairy breeding, product processing and packaging, Mengniu strives to produce and provide safe, tasty and high-quality products to consumers. Arla Arla Arla Arla As the exclusive distributor of Arla Foods in the PRC, Mengniu principally cooperates with Arla Foods in the import business. During the period, Mengniu has significantly reduced the number of products under Arla Foods and optimized its brand structure while introducing its cheese and butter products. Mengniu will launch UHT milk for kids imported from Arla Foods in August. Mengniu and Arla Foods entered into an agreement, pursuant to which Arla Foods will endorse the high-end Merla series under the Scient brand of Yashili by cooperating with Yashili in a new infant milk formula series, Arla Merla, which is expected to be introduced to the Chinese market through direct import by the end of the year. Arla Arla Arla Arla ArlaUHTArla Arla Arla 9

12 MANAGEMENT DISCUSSION AND ANALYSIS Milk formula business: Yashili International Holdings Ltd ( Yashili, stock code: 1230) With control over 76.58% of the equity interest in Yashili, Mengniu aims at turning Yashili into its infant nutrition product platform. During first half of 2014, Yashili has reformed its marketing model by actively implementing a membership system with the support of a technical and data platform. The reform is intended to rationalize the product value chain, increase interaction with consumers, solidify the professional foundation of its operations and enhance its capability of service precision with a view to expanding the customer base and reinforcing its market position % Meanwhile, Yashili has actively explored and streamlined its channels and specifically strengthened the development of the mother and baby channel and network, thereby increasing market share in that channel. Yashili has also set up an e-commerce team to expand the e-commerce and online shopping business and has developed products exclusively for the e-commerce channels in order to create a new growth point. In the second half of the year, Yashili is continuing the reform of its marketing model, expanding sales channels, building up a sophisticated brand portfolio as well as enhancing product research and development, overseas project construction, internal optimization and performance assessment management, thereby enlarging its market share and raising its profitability. Plant-based nutrition product business: The WhiteWave Foods Company ( WhiteWave ) On 6 January 2014, Mengniu and WhiteWave, a packaged food and beverage company in North America, announced that they would acquire 100% of the equity interests in Yashili (Zhengzhou) Nourishment Co., Ltd. ( Yashili Zhengzhou ) for a consideration of RMB million. The WhiteWave Foods CompanyWhiteWave WhiteWave % 10 China Mengniu Dairy Company Limited Interim Report 2014

13 MANAGEMENT DISCUSSION AND ANALYSIS Mengniu and WhiteWave have completed the acquisition of Yashili Zhengzhou through a joint-stock company established at the end of April, with Mengniu and WhiteWave holding 51% and 49% of the joint-stock company respectively. The joint-stock company is mainly engaged in the manufacturing, packaging and distribution of nutrition products in the PRC. Since early April, the joint-stock company has been engaged in preparation works for factory production, conducting technical upgrades for Yashili Zhengzhou. The joint-stock company has also embarked on product research and development as well as devising brand positioning and marketing strategies. Plantbased protein beverages are planned to be launched by the end of the year to explore the high-end plant-based protein beverage market in the PRC and enrich Mengniu s product lines. Quality Management The four carriages of Mengniu s quality management system, namely the quality and safety management system and three quality management centers on milk sources, operations and sales respectively, continued to ensure end-to-end food quality and safety. With a unified direction and key focus, the four carriages have coordinated to form an inspection team across milk source suppliers and the retail-market in order to identify and solve problems on a timely basis. WhiteWave51% 49% The quality and safety management system and the quality management center on milk sources have worked closely together to foster the establishment and operation of the milk source technical standard system. A set of industrial standards has been set up by standardizing and improving seven aspects, including regional risk, source suppliers, safety of milk sources, factory management, laboratory capabilities, control over substandard milk and supplier management. To improve milk quality, Mengniu has helped dairy farmers perfect the proportion of dairy cows and fodder by adjusting the formula and conducting experiments and tests. Mengniu has also adopted a uniform pricing model for all suppliers and conducted assessment to further ensure the quality of raw milk, with an aim to provide consumers with a drop of goodness. The quality management center on operations has improved efficiency through implementing numerous quality innovations and refinements without compromising quality. For instance, the raw milk microorganism quick testing machine can significantly reduce the substandard products, and the commercial sterile quick testing method can substantially decrease the testing time. 11

14 MANAGEMENT DISCUSSION AND ANALYSIS The quality management center on sales has strengthened the training and assessment of frontline staff through an online examination platform to ensure that safety operational standards have been put into practice. Besides, Mengniu has embarked on establishing a quality management system over its chilled cold-chain business at retail end. The review of the warehouse management and cold-chain business has been completed, while the resources allocation, consumer management, key performance indicator management and marketing work have been initiated. Raw Milk Sourcing Mengniu continued to refine the structure of milk sources and ensure the quality of raw milk with the aim of strengthening the product quality from its sources. Mengniu s milk sources provided by ranches and scaled farms reached 94%, maintaining the top spot in the industry. 94% With an aim of establishing a win-win ecosystem, Mengniu has facilitated the development of milk source bases in China towards an intensive, scaled and modernized way in order to create its strategic core assets. New reforms were implemented to best match milk sources with production capacity and product structure. The proportion of small- and medium-sized ranches was increased to facilitate the upgrading of milk source bases. With reference to Arla Gaarden s ranch management model, Mengniu has also assisted suppliers in enhancing their operations and breeding efficiency through aligning with international standards. A resource platform was set up to help the suppliers select high-quality vendors and lower their procurement costs. Through the platform, Mengniu also strengthened its upstream quality control and ensured the quality of its raw milk. Arla Gaarden Mengniu has also established a model ranch with reference to the ranch management experience of Arla Foods, as seen in the construction of cowsheds and optimized management of milking. To raise the management level of ranches, Mengniu also set up the University of Ranchers, the first-institution-of-its-kind, to provide theoretical and practical training to the managerial staff of largeand medium-sized ranches. Arla 12 China Mengniu Dairy Company Limited Interim Report 2014

15 MANAGEMENT DISCUSSION AND ANALYSIS Sales Channels Mengniu has continued to implement and refine the sales operations model comprising Center Business Unit ( CBU ), Regional Business Unit ( RBU ) and branch company direct operations. The number of frontline staff has been increased to reinforce sales terminal management with an aim to strengthen CBU s control over the channels and retail-end. Certain major sales regions were further divided to extend the market coverage and deepen the penetration of RBU in order to better support distributors in third- and fourth-tier cities to improve their sales performance. Branch companies were further consolidated to raise the profitability and retail-end service capabilities in firstand second-tier cities. Mengniu has gradually established regional marketing and operational centers in Beijing, Tianjin, Chengdu and Hohhot by establishing regional sales platforms and setting up regional subsidiaries. In the meantime, by focusing on enhancing the overall operational capability of distributors and streamlining the sales channel segmentation, Mengniu bolstered the quality and expansion effectiveness of its channels. Center Business UnitCBU Regional Business UnitRBU CBU RBU Mengniu has adopted an innovative and a proactive approach towards modern sales channels. The three-level key account (KA) service team includes the headquarters-based client team, the regional team and the distributor team. Through this new structure, the KA team has extended its role from a supplier of products to a strategic partner of retailers through cooperation in the management of product categories to enhance the service and efficiency of KA team s support. Besides, the development of the KA-EPOS intelligent data system has led to considerable labor cost savings and created a sophisticated data-based sales management model for Mengniu. Key Account KAKAKA KA KA-EPOS Horizontally, Mengniu has also developed catering and special channels to expand its sales network. Moreover, Mengniu has proactively launched the e-commerce business and its products have already covered the mainstream e-commerce platforms. Mengniu s e-commerce platform has played a crucial role in new product promotion and consumer insights, which was conducive to precision marketing and lowering marketing costs. 13

16 MANAGEMENT DISCUSSION AND ANALYSIS Branding Strategy In response to market evolution, Mengniu continued to streamline the number of products and optimize its brand structure by categorizing the brands into star brands, backbone brands, profit contributor brands and opportunity brands. Mengniu pooled more resources to promote its key products and interact precisely and profoundly with targeted consumers. Through consuming Mengniu s products and visiting Mengniu s plants, consumers understanding of and trust in Mengniu s brand was enhanced. Adhering to its brand value and product positioning, Mengniu has actively built the brand image of its parent brand and interpreted the brand proposition Little Happiness Matters through A Drop of Goodness. In terms of media advertising, in view of the trends of media development and the media habits of targeted consumer groups, Mengniu has increased its investment in digital media, which has effectively enhanced the return on investment. By tapping mobile network and social media, Mengniu has extensively interacted with consumers and fully benefited from the positive effect of relationship chain dissemination on brand enhancement. The successful use of new media has greatly reinforced the creative branding activities of Mengniu. During the period under review, Mengniu has garnered several major advertising awards for its successful brand marketing activities, including the China Advertisement Effectiveness Case Award, The 6 th China Advertisers JinYuan Award (Network category) Silver, The Tiger Roar Award for Traditional Media in China (Beverage category) Outstanding Achievement Award and 2014 Content Marketing: Best Sound Effect for Variety Show Contents Gold For Fruit Milk Drink, partnering with the popular variety show I Am a Singer of Hunan Satellite TV, Mengniu went far beyond the conventional practice of embedded advertising by tactfully combining the brand elements with the show. High engagement with consumers using new media effectively promoted the image of the brand. After the campaign, the Weibo followers of Fruit Milk Drink increased to 2.4 million and more than 620,000 interactions were recorded on its WeChat account, doubling the average in the industry. Both the market share and brand awareness were significantly enhanced China Mengniu Dairy Company Limited Interim Report 2014

17 MANAGEMENT DISCUSSION AND ANALYSIS Taking advantage of the fast-growing opportunity for pro-biotic beverages, Mengniu launched the The Detox Team Summoning Order marketing campaign for Yoyi C on TV, outdoor and digital platforms. The campaign was to promote the product feature of healthy exercise for the intestines with 30 billion active C bacteria. By targeting six groups of people who may need intestine exercises and making use of cute bottles, The Detox Team quotes and creative videos, this campaign succeeded in attracting wide attention and participation as well as boosting the brand influence, setting a very successful example of content marketing. C300C Just Yoghurt is Mengniu s key high-end UHT yogurt product. Its brand philosophy of zero additives was widely promoted on a number of online and offline platforms. On 18 May, Mengniu attracted more than 110,000 participants in ten cities in the PRC to set a Guinness World Record for the Yogurt Tasting Survey with the Most Participants, which has earned Just Yoghurt and the parent brand Mengniu positive market feedback. Management System Adhering to its Five-Year Strategic Plan, Mengniu has introduced the state-of-the-art SAP system to boost its management capabilities in six aspects precision marketing and in-depth sales channel management; integrated management platform for business and finance; responsive synergetic system for production, supply and sales; integrated quality management and refined quality tracking; rational industrial planning as well as efficient management on procurement and logistics. The aim of the SAP system is to enhance operating efficiency and its competitiveness SAP The SAP project includes an Enterprise Resource Planning (ERP) system, a Customer Relationship Management (CRM) system, an Advanced Planning Optimization (APO) system, a Distributor Management System (DMS), a Sales Force Automation (SFA) system, a Transportation Management System (TMS) and a Business Intelligence (BI) system. The project is being implemented in three stages, with the first phase focusing on ERP and CRM. SAP(ERP) (CRM) (APO) (DMS)(SFA)(TMS) (BI) ERPCRM In March, the trial run of the ERP system was completed in some of the plants. This has yielded benefits such as integrating Mengniu s operations and finances, enhancing effectiveness and providing data support to management for quick analysis and decision-making. The ERP system was first used in four major product categories, namely UHT, chilled, ice cream and yogurt, by monitoring the eight systems of milk sources, procurement, planning, production, sales, logistics, quality and finance. ERP ERP 15

18 MANAGEMENT DISCUSSION AND ANALYSIS Trial operation of the CRM 2.0 system was also finished in certain key sales regions in the same month. The sales management professionalism of Mengniu was greatly enhanced through more thorough management in sales task planning and promotion expenses, and multi-dimensional analysis of the profits and losses of the Mengniu brand. The trial operations have covered the management of sales network, customer portal, planning task and promotion expense, etc. Financial Review Revenue Mengniu continued its adjustments to its internal structure and streamlining its product portfolio in order to utilize resources more effectively on key brands. These efforts have yielded significant results with the support of innovative marketing initiatives. As the Group has carried out a series of reforms to stimulate organic growth, in addition to the revenue contribution of RMB1,545.7 million from Yashili given that it was consolidated into Mengniu since August 2013, the Group s revenue for the six months ended 30 June 2014 grew by 25.0% year-on-year to RMB25,835.8 million (2013: RMB20,667.9 million). Excluding Yashili, the Group s revenue rose by 17.5% to RMB24,290.1 million. The products with a greater contribution to revenue growth were Milk Deluxe, Future Star, Fruit Milk Drink, Yoyi C and Champion, while Yoyi C, Champion and Just Yoghurt achieved strong growth. Gross Profit Raw milk prices dropped from the high levels recorded at the beginning of the year due to the increase in domestic supply of raw milk. The decrease of the costs of raw milk, together with the price increase of Mengniu s products at different times since the beginning of last year, led to further growth of the Group s gross profit for the period. The Group has been proactively grasping the trends of market development. Efforts were made to restructure product portfolio and develop high-margin products. As a result, the gross profit of the Group for the six months ended 30 June 2014 increased to RMB8,381.8 million (2013: RMB5,518.8 million), while gross margin reached 32.4%, an increase of 5.7 percentage points as compared with the same period last year. Excluding Yashili, the Group s gross profit was RMB7,548.6 million, while gross margin rose 4.4 percentage points year-on-year to 31.1%. CRM %17.5% C C % %4.4 The gross profit contribution from Yashili to the Group for the period amounted to RMB833.2 million (2013: N/A) China Mengniu Dairy Company Limited Interim Report 2014

19 MANAGEMENT DISCUSSION AND ANALYSIS Operating Expenses The Group has modified its strategies on expenditures in response to market conditions. As a result, operating expenses rose to RMB7,415.4 million (2013: RMB4,744.2 million), representing approximately 28.7% (2013: 23.0%) of the Group s revenue. Excluding Yashili, the Group s operating expenses were RMB6,716.8 million, representing 27.7% of the revenue excluding Yashili. Due to the greater investment in sales channels in response to market competition, selling and distribution expenses increased by 54.9% to RMB5,897.1 million (2013: RMB3,806.9 million), and its percentage to the Group s revenue increased to 22.8% (2013: 18.4%). Excluding Yashili, the selling and distribution expenses of the Group were RMB5,325.2 million, representing 21.9% of the revenue excluding the contribution of Yashili, up 3.5 percentage points year-on-year % 23.0% % 54.9% %18.4% %3.5 The Group s continued increase in its investment in digital media and offline marketing activities led to an increase in advertising and promotion expenses of 111.8% to RMB2,860.6 million (2013: RMB1,350.9 million) for the period, and its percentage to the Group s revenue increased to 11.1% (2013: 6.5%). Excluding Yashili, the Group s advertising and promotion expenses rose by 98.1% to RMB2,675.7 million, representing 11.0% of the revenue excluding Yashili s contribution, up 4.5 percentage points year-onyear % % 6.5% 98.1% %4.5 Administrative and other operating expenses increased by 62.0% to RMB1,518.2 million (2013: RMB937.3 million), and its percentage to the Group s revenue increased to 5.9% (2013: 4.5%). Excluding Yashili, the Group s administrative and other operating expenses was RMB1,391.6 million, representing 5.7% of the revenue excluding Yashili s contribution, up 1.2 percentage points year-onyear. The increase was mainly a result of the increase in provision for inventory of raw materials, the grant of restricted shares and the negative impact resulted from fluctuations in foreign exchange rate. Profit from Operating Activities and Net Profit Despite the growth in revenue and gross profit being partially offset by the increase in cost and operating expenses, the Group s earnings before interest, taxes, depreciation and amortization (EBITDA) increased by 35.8% to RMB2,041.9 million (2013: RMB1,503.6 million), while the EBITDA margin grew to 7.9% (2013: 7.3%). Excluding Yashili s contribution, the Group s EBITDA was RMB1,793.4 million, and the EBITDA margin rose to 7.4%. 62.0% %4.5% % 1.2 (EBITDA) 35.8% EBITDA 7.9%7.3% EBITDA17.934EBITDA 7.4% 17

20 MANAGEMENT DISCUSSION AND ANALYSIS Profit attributable to owners of the Company amounted to RMB1,048.6 million (2013: RMB749.5 million), representing a yearon-year growth of 39.9%. In particular, the profit contribution from Yashili to the Group amounted to RMB117.6 million. Basic earnings per share amounted to RMB0.540 (2013: RMB0.419), representing a year-on-year increase of 28.9%. Capital Expenditure During the six months ended 30 June 2014, the capital expenditure (CAPEX) of the Group amounted to RMB1,485.1 million (2013: RMB3,715.4 million), representing a 60.0% decrease year-onyear. The CAPEX for the first half of 2013 included an amount of RMB2,537.0 million for the acquisition of equity interests in China Modern Dairy Holdings Ltd (stock code: 1117). The CAPEX of the current period was used for: construction of production plants and procurement of equipment amounting to RMB1,387.1 million; purchase of biological assets amounting to RMB40.18 million and the equity investment expenses amounting to RMB57.8 million. The Group has adopted a prudent policy in its CAPEX so as to lay a solid foundation for future development. Excluding Yashili, the CAPEX of the Group was RMB1,077.2 million. 39.9% % % ,0185, The CAPEX of Yashili amounted to RMB407.9 million, which was mainly used for the construction of the plant in New Zealand. Working Capital, Financial Resource and Capital Structure The Group s net cash inflow from operating activities decreased to RMB1,546.5 million (2013: RMB2,331.6 million). The decrease was primarily attributable to an increase in raw material inventory. As of 30 June 2014, the Group s net borrowings (cash and bank deposits net of total bank loans and bonds) amounted to RMB1,307.9 million (31 December 2013: net borrowings of RMB4,595.5 million). Excluding Yashili, the Group s net borrowings were RMB1,759.7 million. On 27 March 2014, Mengniu announced the completion of the placement of shares to Danone Group with proceeds of HK$5,152.5 million (approximately US$665.0 million), which were used to repay the related outstanding amount of loans for the acquisition of Yashili and other outstanding corporate debts in order to improve Mengniu s capital structure. As of 30 June 2014, the Group s outstanding bank loans and bonds were reduced to RMB9,984.6 million (31 December 2013: RMB11,697.0 million). Excluding Yashili, the Group s outstanding bank loans and bonds amounted to RMB9,430.3 million (31 December 2013: RMB11,697.0 million) Danone China Mengniu Dairy Company Limited Interim Report 2014

21 MANAGEMENT DISCUSSION AND ANALYSIS In May, the Group has closed a US$200 million 3-year syndicated loan facility. The facility marks the Group s debut in the offshore syndicated loans market. The funds were used for refinancing the existing debts of the Group. The total equity of the Group was RMB23,230.5 million as of 30 June 2014 (31 December 2013: RMB18,011.1 million), while the debt-to-equity ratio (total bank loans and bonds over total equity) was 43.0% (31 December 2013: 65.0%). The Group s finance costs amounted to RMB176.2 million (2013: RMB33.71 million), accounting for approximately 0.7% of the Group s revenue (2013: 0.2%). Excluding Yashili, the Group s finance costs were RMB173.4 million, representing 0.7% of the revenue excluding Yashili, up 0.5 percentage point year-on-year. Products Mengniu has actively adjusted and optimized its product portfolio based on the market situation. Apart from developing mid-range to high-end dairy products to increase profitability, Mengniu has also continued to rationalize its brands to concentrate resources on building star and opportunity brands. Mengniu has forged stronger collaboration with its leading international counterparts in order to develop the businesses with high potential, namely yogurt, milk formula and nutrition products, thereby advancing its products to the forefront of the market % 65.0% ,3710.7% 0.2% %0.5 19

22 MANAGEMENT DISCUSSION AND ANALYSIS Mengniu s principal businesses comprise liquid milk, ice cream, milk formula and other dairy products. Their performance during the period is as follows: Product category Financial performance Highlights Key products Liquid milk UHT milk UHT Revenue amounted to RMB21,764.8 million (2013: RMB18,262.5 million), accounting for 84.2% of Mengniu s total revenue (2013: 88.3%) %88.3% Revenue amounted to RMB12,737.4 million (2013: RMB10,940.8 million), accounting for 58.5% (2013: 59.9%) of the liquid milk segment revenue % 59.9% Launch of Future Star Kid Organic Milk, which is produced from 100% organic ranches containing 1.5 times more high-quality DHA algal oil without any additives, artificial color, preservatives or sugar, to differentiate from the highly homogenous market for children s milk products and reinforce the high-end image of Future Star; introduction of two flavored milk products, namely Future Star Kid Walnut Milk and Future Star Kid Strawberry Milk, to suit children s tastes 100% 1.5DHA Milk Deluxe Prime Ranch Pure Milk Just Yoghurt Awakening Youth Milk Future Star Kid Milk Arla Foods Organic Pure Milk Minion Banana Milk Arla 20 China Mengniu Dairy Company Limited Interim Report 2014

23 MANAGEMENT DISCUSSION AND ANALYSIS Product category Financial performance Highlights The target consumers of Awakening Youth Milk are health aware middle-aged and elderly who enjoy life. A packaging upgrade for Awakening Youth Strengthener and Energiser Milk in March. The package with pictures of grandparents interacting with their grandchildren, has an inner layer of metal foil, enhancing the brand image and value. The new packaging was well received by consumers Repositioning of XinYangDao as a lactose-free functional milk product targeting people with lactose intolerance and discomfort with milk; a packaging upgrade for the three product versions, namely whole milk, low-fat milk and nutritious milk The packaging featuring Minion, a popular cartoon figure, Minion Banana Milk has successfully captured young consumers with its innovative design and was tops in first month sales volume among all newly launched products Key products 21

24 MANAGEMENT DISCUSSION AND ANALYSIS Product category Milk beverages Yogurt Ice cream Financial performance Revenue amounted to RMB5,826.2 million (2013: RMB4,732.1 million), accounting for 26.8% (2013: 25.9%) of the liquid milk segment revenue %25.9% Revenue amounted to RMB3,201.2 million (2013: RMB2,589.6 million), accounting for 14.7% (2013: 14.2%) of the liquid milk segment revenue %14.2% Revenue amounted to RMB1,988.4 million (2013: RMB1,954.4 million), accounting for 7.7% (2013: 9.5%) of the total revenue %9.5% Highlights Yoyi C recorded outstanding performance with double-digit growth in sales C Portrait of Latte as the Milk Deluxe among all flavored milk products; introduction of four-pack package in July Launch of Bio Fruity MIXI together with Danone Group in June which targets the high-potential convenience store channel. With strawberry, mixed berries and tropical fruit flavors, Bio Fruity MIXI introduces fresh fruit taste in yogurt anytime, anywhere Danone An upgrade for Champion from blue to platinum packaging. With the double benefits of adjusting intestinal bacteria and boosting the immune system, Champion s health products have been approved and certified by the China Food and Drug Administration Milk Stick, launched at the end of 2013, gained high popularity among young consumers for its lovely packaging Key products Fruit Milk Drink Suan Suan Ru Latte Yoyi C Miao Miao Milk C Champion Future Star Kid Yogurt Junlebao Bio Deluxe Mood for Green Ice Crystal Cup Ice + Milk Stick + 22 China Mengniu Dairy Company Limited Interim Report 2014

25 MANAGEMENT DISCUSSION AND ANALYSIS Product category Milk formula Other dairy products Financial performance Revenue amounted to RMB1,933.8 million (2013: RMB394.1 million), accounting for 7.5% (2013: 1.9%) of the total revenue %1.9% Revenue amounted to RMB148.8 million (2013: RMB56.9 million), accounting for 0.6% (2013: 0.3%) of the total revenue , %0.3% Highlights Following Oushi, Mengniu introduced its second infant milk formula brand, Milex, in June to enter the midrange to high-end infant milk formula market. Made 100% from prime milk sources of five major ranches in Northern Europe, Milex is tailored for Chinese infants for easy digestion and absorption, adjusting intestinal functions and boosting the immune system Launch of the upgraded infant milk formula of Yashili -golden+ Stage, with lactotransferrin a core immunoglobulin found in breast milk added on top of the basic formula of -golden Stage to make the nutrition and taste close to breast milk and strengthen the immune system of babies; exclusive for online sales -+- A packaging upgrade for Kids Cheese Sticks, the bestselling cheese product of Arla Foods Arla Key products Arla Baby&Me Oushi Yashili Super -golden Stage Milex Arla Baby&Me - Future Star Kids Cheese Sticks European Fromage Frais European Fermented Milk 23

26 MANAGEMENT DISCUSSION AND ANALYSIS Mengniu s products, including Pure Milk, Low Fat High Calcium Milk, Milk Deluxe, Fruit Milk Drink and Yoyi C are available in four overseas markets, namely Hong Kong, Macau, Mongolia and Singapore. All four markets recorded stable growth. Production Mengniu s allocation of production capacity is based on market potential and product strategy. As of June 2014, Mengniu has 31 production bases across the country, with a total production capacity of 8.04 million tons (December 2013: 7.77 million tons). The enhancement of production capacity was mainly achieved by increasing the existing production capacity through reforming the production lines and technical upgrades, as well as the expansion of the production scale of Shijiazhuang Junlebao Dairy Co., Ltd. ( Junlebao ). Social Responsibility While focusing on swift development, Mengniu has also put great efforts on contributing to the community in many areas, including environmental protection, charity events and promotion of industrial development and exchange of information. Mengniu s long-term efforts on corporate social responsibility have added significant value to the brand. C China Mengniu Dairy Company Limited Interim Report 2014

27 MANAGEMENT DISCUSSION AND ANALYSIS Environmental protection Environmental protection is an inevitable trend for the sustainable development of the dairy industry. Mengniu has promoted the Green Golden Industry Chain by achieving emissions and pollution reduction in each production process. To turn one-way production into a green cycle, Mengniu has built up a green industry chain from milk sources to the dining table through biogas power generation, sewage treatment, recycled breeding, rainwater collection, barren mountain greening, ecological grassland construction and recycling of environmentally-friendly packaging materials. From 2015 onwards, Mengniu s high-tech sewage treatment plant will provide reclaimed water to the thermal power plant nearby to be used as recirculating cooling water and desulfurization water. The recovered water will be reused at the Helin (Headquarters) Plant in Inner Mongolia to achieve zero sewage discharge. Besides, Mengniu has participated in the tree planting activity of the first Green Bank in China to help protect the environment. Charity events Immediately after the earthquake in Ya an City, Sichuan Province in 2013, Inner Mongolia Mengniu Dairy (Group) Company Limited, a subsidiary of Mengniu, has donated RMB10 million to Sichuan Charity Federation in support of restoration and reconstruction in Sichuan. In the first half of 2014, after paying site visits and communicating with Meishan City Board of Education, Sichuan Province, Mengniu decided to use the donations to reconstruct two schools. In particular, RMB8 million is to be used to fund the construction of a library and arts complex at Che Cheng Secondary School (Su Temple Middle School, Taihe Branch) in Dongbo District, Meishan City. With a gross floor area of 9,748 m 2, the complex is to be named as Mengniu Arts Building upon completion. The remaining RMB2 million is to be used to fund the construction of Zhao He Primary School in Liujiang Town, Hongya County, Meishan City. The facilities are to comprise a teaching and learning complex of 1,100 m 2, a student canteen of 300 m 2, a sports ground and ancillary facilities. The school is to be renamed as Mengniu Primary School upon completion. 1, , ,

28 MANAGEMENT DISCUSSION AND ANALYSIS On the afternoon of 3 August 2014, a 6.5-magnitude earthquake struck Longtoushan Town, Ludian County, Zhaotong City in Yunnan Province. With the disaster relief experience gained from the Wenchuan earthquake and Ya an earthquakes in Sichuan and the Yushu earthquake in Qinghai, Mengniu immediately initiated the disaster response mechanism, setting up an earthquake emergency aid team. Arrangements were made at the locality on that night to deliver relief materials to the disaster site. By the next day, the first batch of more than 2,000 cartons of milk was sent to the afflicted areas. So far, Mengniu has donated nearly 10,000 cartons of milk ,000 As for charity, Mengniu values personal and sustainable participation above mere donation of money and resources. Mengniu strongly believes that participants can gain meaningful insight only from personal experience, which would inspire continuous dedication to charitable works. As part of the Most Beautiful to Have You Have a Lecture in My Hometown lecture series in 2014, Mengniu worked with the executives of its partners and dignitaries to give more than 37 lectures in rural primary schools, covering football, music, judo, paper cutting, inspirations and traditional opera, etc. Happy Gift, including water pumps, electronic pianos and stationery, were also distributed. Through such programs, Mengniu hopes to encourage more people to help the teachers and students of rural primary schools in their own hometown. 37 Rural Education in China through the Lens is an extension of the large-scale charity campaign Looking for Teachers with the Most Beautiful Hearts in Rural Areas. By taking pictures of rural schools in different districts, ten experienced Chinese photographers captured the current status of rural education in China with their cameras, so as to spur the interest of more people in the charity. 10 On the internet, Mengniu has bolstered its interaction and communication with consumers through the platform Your Question, Our Responsibility. Off the internet, Mengniu has continued to organize factory visits for consumers and has welcomed nearly 500,000 visitors in total. Moreover, in light of consumers concern over the safety of domestically produced dairy products, Mengniu, as a leading dairy manufacturer in China, has launched a popular science project Milk Power with China Dairy Industry Association to disseminate accurate scientific knowledge about milk in order to enhance the awareness and understanding of consumers in dairy products China Mengniu Dairy Company Limited Interim Report 2014

29 MANAGEMENT DISCUSSION AND ANALYSIS Promotion of industrial development and exchange The dairy industry in China is undergoing modernization. One way in which Mengniu has contributed to the process is by taking the initiative to help dairy farmers raise their technical and ranch management levels. Ranchers with 300 to 3,000 milkable cows are crucial to the dairy farming industry in China. Mengniu has selected 100 ranchers to attend the University of Ranchers. Among these, 30 outstanding ranchers may be promoted to enroll in the advanced talent training program and obtain a certificate of completion jointly issued by the University of Ranchers, the Technology System in Dairy Industry, the Ministry of Agriculture and China Agricultural University. From a practical aspect, Mengniu has collaborated with the China-Denmark Milk Technical and Cooperation Center to invite experts with practical experience to evaluate the problems faced by ranches and propose solutions in order to enhance ranch efficiency. Outstanding ranchers may have the opportunity to further their studies in the ranches in Denmark and Israel, where boast the most advanced breeding techniques and internationalized management , The 100 ranchers also entered into the Social Responsibility Codes for Ranchers, pursuant to which they undertook to abide by the law, respect their staff and commit themselves in technical innovation, green ecology, ethical treatment of animals and achieving a win-win situation, thereby striking a balance between social responsibility and scientific breeding. This project is the first large-scale trial of the ISO 26000, the international standard on social responsibility, in the dairy farming industry. Mengniu will cooperate with the top performers selected from these 100 ranchers to establish a model ranch, which will drive the development of nearby ranches. In addition, Mengniu has also designed a special assessment system Star Ranch Assessment to perform digital document management on the current conditions and development of the ranches. For this upstream industry chain, Mengniu has not only provided technical support at the early stages and staff training at the later stages, but has also assisted ranchers in obtaining more favorable and even interest-free funds by guaranteeing their bank loans and credit facilities. Mengniu has facilitated the modernization of ranches by aligning its own interests with those of ranchers. 100 ISO