Annual report 2017

Financial review

Basis of Preparation of Financial review

The Board of Director's Financial Review refers to the group of companies controlled by PRADA spa (the "Company"), parent company of the Prada Group (the "Group"). This Review should be read in conjunction with the Consolidated financial statements and the related Notes, which are an integral part thereof.

On May 31, 2017 the Company's General Meeting approved By-Law Article 27, which changed the end of the annual reporting period from January 31 to December 31. For the past few years the proportion of consolidated revenues from the wholesale channel, whose seasonality is concentrated in the middle and at the end of the calendar year, has decreased considerably while that of the retail channel has grown. Therefore, the reasons for changing the end of the reporting period in 2004 to January are no longer applicable.

As a result of the change in the reporting date, the Prada Group's 2017 Statement of Profit or Loss prepared in accordance with IFRS ("2017 IFRS Statement of Profit or Loss") refers to the eleven-month period ended December 31, 2017. Since comparison with the previous IFRS Statement of Profit or Loss for the twelve months ended January 31, 2017 ("2016 IFRS Statement of Profit or Loss") does not provide a proper understanding of the Group's business and financial performance, management has prepared a "Pro-Forma Statement of Profit or Loss" that refers to the twelve months ended December 31, both for 2017 and 2016.

The comments reported herein regarding revenues and operating results refer to the "Pro-Forma Statement of Profit or Loss", whereas those regarding assets, liabilities and equity refer to the IFRS-based Consolidated financial statements as of December 31, 2017 and January 31, 2017.

Consolidated Statement of Profit or Loss of eleven-month period IFRS and twelve-month period pro-forma

IFRS

pro-forma

pro-forma

(amounts in thousands of Euro)

eleven months period ended December

31, 2017

%

twelve months period ended December

31, 2017

%

twelve months period ended December

31, 2016

%

Net Sales

2,696,644

98.4%

3,008,280

98.4%

3,126,015

98.6%

Royalties

44,451

1.6%

48,195

1.6%

44,440

1.4%

Net revenues

2,741,095

100.0%

3,056,475

100.0%

3,170,455

100.0%

Cost of goods sold

(710,399)

-25.9%

(810,885)

-26.5%

(888,805)

-28.0%

Gross margin

2,030,696

74.1%

2,245,590

73.5%

2,281,650

72.0%

Operating expenses

(1,714,818)

-62.6%

(1,885,570)

-61.7%

(1,876,064)

-59.2%

EBIT

315,878

11.5%

360,020

11.8%

405,586

12.8%

Interest and other financial expenses, net

(6,731)

-0.2%

(6,168)

-0.2%

(19,250)

-0.6%

Dividends from investments

670

0.0%

670

0.0%

2,252

0.1%

Income before taxation

309,817

11.3%

354,522

11.6%

388,588

12.3%

Taxation

(91,800)

-3.3%

(105,284)

-3.4%

(122,405)

-3.9%

Net income for the period

218,017

8.0%

249,238

8.2%

266,183

8.4%

Net income - Non-controlling interests

296

0.0%

313

0.0%

5,953

0.2%

Net income - Group

217,721

7.9%

248,925

8.1%

260,231

8.2%

Basic and diluted earnings per share (in Euro per share)

0.085

0.097

0.104

Depreciation, amortization and impairment

209,913

7.7%

227,960

7.5%

228,927

7.2%

EBITDA

525,791

19.2%

587,979

19.2%

634,513

20.0%

key financial information

IFRS

IFRS

IFRS

Change

(amounts in thousands of Euro)

December 31

2017

January 31

2017

January 31

2016

Dec. 2017

vs.

Jan. 2017

Net operating working capital

546,205

556,351

665,156

(10,146)

Net invested capital

2,969,909

3,086,089

3,212,172

(116,180)

Net financial position surplus/(deficit)

(103,738)

18,441

(114,795)

(122,179)

Group shareholders’ equity

2,844,652

3,080,502

3,080,340

(235,850)

Average number of employees

12,112

12,326

12,414

(214)

Net operating cash flows (*)

446,517

631,850

368,465

(185,333)

(*) figure relates to the eleven-month period for December 31, 2017 and to the twelve-month period for previous years

2017 highlights

During the year, the Prada Group focused on a series of initiatives designed to bolster its commercial performance with strategic prospects of increasing volumes and profitability in the medium term.

With this goal in mind, the Group rebalanced the merchandise mix at stores to feature newer products developed thanks to the creative talents of the design team, inspired, as always, by experimentation with shapes, materials and production techniques. The new mix concerns all product categories and is supported by numerous efforts to further enhance the shopping experience and strengthen relationships with the customers. Further progress was made on the 2016 plan to update the concept of Prada and Miu Miu stores according to the brands' new aesthetic codes; Church's stores are next in line for restyling. Meanwhile, the Group’s sales plan was supported by bold action on the digital front even as physical retail remained at the center of its omnichannel strategy. During the year the Group strengthened its partnerships with the major online sales operators. Moreover, the direct e-commerce channel is growing: it has been enlarged in scope and the new graphic and functional version of the prada.com website, unveiled in December in China, will be gradually expanded to all countries in 2018. The new platform is designed to provide a shopping experience reconceived down to the smallest details, while integrating with brick & mortar stores and social networks. The digital strategy has also involved sizable investments in advertising and communications, in the form of additional media content for social networks and the online world in general.

+

In various markets the Group has been busy promoting "pop-up" events: temporary displays in the world's most prestigious shopping malls that launch new products and emphasize brand identity. The pop-up concept, which will be expanded and evolve throughout 2018, brings in valuable information on consumption patterns that are immediately transferred to the management and stocking of retail stores.

The market's response to the range of marketing initiatives has been encouraging yet varied, both geographically and in terms of products. Overall, sales trends for the year indicate gradual volume growth over the months, and on the profitability front, a greater contribution of full-price items with respect to 2016. These signals reinforce management's confidence in the ability to achieve the medium/long-term goals.

With respect to manufacturing, additional investments were made with a view to strengthening and optimizing production and distribution. The new cutting facility and materials warehouse in Valvigna (Tuscany) is fully up and running and has been expanded to include all manufacturing support operations, for a current workforce of 700. Also in Tuscany, the Group has completed the second part of the new logistics hub, the central facility from which Prada and Miu Miu merchandise is shipped to all corners of the globe, and has opened a third cutting facility. This latter investment is part of a broader project aimed at keeping a crucial phase of the production process within company walls, for the sake of ensuring top quality. The new manufacturing facilities enable to obtain important benefits in terms of controls over processes and quality, and they stand out for their advanced technologies and the utmost consideration for the work environment.

2017 was a year of special strategic projects regarding image and customer relations. In October the Group reopened Rong Zhai Residence, an old Liberty-style mansion, following a long, elaborate restoration; it is now the Group’s cultural venue in China. Late in the year, Prada officialized its run for the 36th America's Cup, where it will sponsor the Luna Rossa team and take on an additional, first-time role as naming and presenting sponsor of the entire sailing competition.

Considerable investments were made in various business areas in 2017. At the same time it was possible to achieve an operating profit in line with that of the previous period.

Analysis of Pro-forma net revenues

pro-forma

pro-forma

(amounts in thousands of Euro)

twelve months

ended

December 31

2017

twelve months

ended

December 31

2016

% change

Net Sales

3,008,280

98.4%

3,126,015

98.6%

-3.8%

Royalties

48,195

1.6%

44,440

1.4%

8.4%

Net revenues

3,056,475

100%

3,170,455

100%

-3.6%

pro forma

pro forma

(amounts in thousands of Euro)

twelve months

ended

December 31

2017

twelve months

ended

December 31

2016

% change

Net Sales by geographical area

Europe

1,169,679

38.9%

1,182,373

37.8%

-1.1%

Americas

431,843

14.4%

455,802

14.6%

-5.3%

Asia Pacific

972,888

32.3%

984,352

31.5%

-1.2%

Japan

336,810

11.2%

394,191

12.6%

-14.6%

Middle East

92,924

3.1%

104,695

3.4%

-11.2%

Other countries

4,136

0.1%

4,602

0.1%

-10.1%

Total

3,008,280

100%

3,126,015

100%

-3.8%

Net Sales by brand

Prada

2,461,246

81.8%

2,512,648

80.4%

-2.0%

Miu Miu

459,338

15.3%

515,312

16.5%

-10.9%

Church's

70,999

2.4%

80,535

2.6%

-11.8%

Other

16,697

0.5%

17,520

0.5%

-4.7%

Total

3,008,280

100%

3,126,015

100%

-3.8%

Net Sales by product line

Leather goods

1,702,824

56.6%

1,793,492

57.4%

-5.1%

Footwear

624,598

20.8%

681,617

21.8%

-8.4%

Clothing

623,988

20.7%

592,560

19.0%

5.3%

Other

56,870

1.9%

58,346

1.8%

-2.5%

Total

3,008,280

100%

3,126,015

100%

-3.8%

Net sales by channel

Net Sales of direct operated stores (DOS)

2,443,697

81.2%

2,648,843

84.7%

-7.7%

Sales to Independent customers and franchisees

564,583

18.8%

477,172

15.3%

18.3%

Total

3,008,280

100%

3,126,015

100%

-3.8%

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The pro-forma retail sales for the twelve months ended December 31, 2017 show a decrease of 7.7% at current exchange rates and 5.8% at constant exchange rates. The trend in the second half of the year shows less decline in all markets, especially in Asia-Pacific, where sales in the final months show an increase compared with the same period of 2016. The number of directly operated stores, with 25 openings and 23 closures, rose from 623 at December 31, 2016 to 625 at December 31, 2017.

Sales from the wholesale channel grew by 18.3% at current exchange rates and by 19% at constant rates. Growth in this channel benefited from partnerships forged in 2016 with leading online retailers ("e-tailers"), and from an important increase in purchasing carried out early in the year by the retail partner in the Asia-Pacific region.

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Net sales in the Asia-Pacific market were substantially in line with 2016 (-1.2% at current exchange rates and +0.8% at constant exchange rates). Greater China produced net sales of Euro 645.9 million in the pro-forma twelve-month period, up by 4.6% at current exchange rates and 7.7% at constant exchange rates.

Net sales in Europe, down by 1.1% at current exchange rates and by 0.1% at constant exchange rates, were consistent with those of 2016. The decline in tourism due to the stronger Euro had an adverse effect on sales in the major countries in the region.

Net sales in the Americas fell by 5.3% at current exchange rates (-3.9% at constant rates). The performance in this region was affected by declines in both tourist flows and local demand.

Japan reported a 14.6% decrease in net sales compared with the same period of the prior year (-10.6% at constant exchange rates). The downturn in local demand impacted the results of the period.

Net sales in the Middle East, which suffered from an adverse geopolitical context, fell by 11.2% at current exchange rates (-9.4% at constant exchange rates).

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Clothing sales rose by 5.3% (+7.3% at constant exchange rates). This product segment experienced growth in all regions except Japan, where it had a modest contraction.

Sales of leather goods fell by 5.1% (-3.4% at constant exchange rates). The downward trend improved gradually over the year thanks to the increasingly important contribution of new handbag models. In addition, sales of travel bags and accessories performed well.

Footwear sales fell by 8.4% (-6.7% at constant exchange rates). The decline, which coincides with an important internal reorganization of the division, lessened steadily over the year.

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The Prada brand generated net sales in line with those of the prior year at constant exchange rates (-2% at current exchange rates and -0.3% constant exchange rates). Over the twelve-month period, clothing sales improved steadily and the declines reported for footwear and leather goods in the first part of the year diminished. Overall the brand achived a growth trend in the last months of 2017 compared with the same months a year earlier.

Miu Miu sales fell by 10.9% at current exchange rates (-9.1% at constant exchange rates), as they were affected by store closings in the initial months of 2017 and numerous restyling projects. The decrease was particularly significant in Europe and in Japan, whereas it was modest in Asia-Pacific.

Sales of Church's brand products fell by 11.8% (-8.6% at constant exchange rates), mainly as a result of the reorganization of the wholesale distribution channel. Most of the contraction occurred in the European market.

"Other brands" refers to sales of Marchesi 1824 brand patisserie products, which rose from the prior period, and of the Car Shoe footwear, which decreased in both distribution channels.

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In the pro-forma twelve-month period ended December 31, 2017, licensing agreements generated royalties of Euro 48.2 million, an increase of 8.4% compared with the same period of 2016 due primarily to the success of the new fragrances.

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December 31, 2017

January 31, 2017

December 31, 2016

Owned

Franchises

Owned

Franchises

Owned

Franchises

Prada

394

25

387

25

390

23

Miu Miu

167

9

171

9

172

8

Church's

57

-

54

-

54

-

Car Shoe

4

-

5

-

5

-

Marchesi

3

-

3

-

2

-

Total

625

34

620

34

623

31

December 31, 2017

January 31, 2017

December 31, 2016

Owned

Franchises

Owned

Franchises

Owned

Franchises

Europe

229

4

220

4

220

4

Americas

112

-

113

-

115

-

Asia Pacific

184

25

187

25

188

22

Japan

79

-

78

-

78

-

Middle East and Africa

21

5

22

5

22

5

Total

625

34

620

34

623

31

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The gross margin grew from 72% of net revenues for the 2016 pro-forma twelve-month period to 73.5% for the same period of 2017. The exchange rate trend and a more favorable sales mix in terms of full-price sales versus discounted sales were largely responsible for the improvement. The 2017 operating expenses rose slightly from those of 2016. The increase was attributable mainly to advertising and communication initiatives, such as more expenditure for acquiring digital and other media space, pop-up events and the initiative related to the Rong Zhai venue in Shanghai.

pro-forma

pro-forma

(amounts in thousands of Euro)

twelve months ended

December 31

2017

% of net revenues

twelve months ended

December 31

2016

% of net revenues

Product design and development costs

130,468

4.3%

123,456

3.9%

Advertising and communications costs

184,752

6.0%

172,995

5.5%

Selling costs

1,399,273

45.8%

1,388,985

43.8%

General and administrative costs

171,077

5.6%

190,628

6.0%

Total Operating expenses

1,885,570

61.7%

1,876,064

59.2%

EBITDA for the twelve months ended December 31, 2017 was Euro 588 million, or 19.2% of net sales, falling by 80 basis points compared with the same pro-forma period of 2016.

EBIT for the twelve months ended December 31, 2017 was Euro 360 million, or 11.8% of net sales, down from Euro 405.6 million or 12.8% of net sales for the previous period.

The net finance expenses were reduced by the strengthening of the Euro currency occurred during 2017 resulting in foreign exchange gains on financial items.

The effective tax rate was 29.6%, down slightly from the 2016 rate. The benefit ensuing from lower Italian and U.S. income tax rates was offset by a less favorable geographical sales mix and the negative effect of the United States tax reform on deferred taxation.

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Analysis of the statement of financial position

The following table reclassifies the statement of financial position to provide a better view of net invested capital.

(amounts in thousands of Euro)

December 31

2017

January 31

2017

January 31

2016

Non-current assets (excluding deferred tax assets)

2,565,359

2,599,620

2,586,841

Trade receivables, net

289,973

285,504

254,183

Inventories, net

569,929

526,941

692,672

Trade payables

(313,697)

(256,094)

(281,699)

Net operating working capital

546,205

556,351

665,156

Other current assets (excluding items of financial position)

212,102

275,384

260,983

Other current liabilities (excluding items of financial position)

(233,181)

(224,536)

(234,496)

Other current assets/(liabilities), net

(21,079)

50,848

26,487

Provision for risks

(61,815)

(82,323)

(69,233)

Post-employment benefits

(61,444)

(67,211)

(69,405)

Other long-term liabilities

(174,706)

(187,322)

(171,364)

Deferred taxation, net

177,389

216,126

243,690

Other non-current assets/(liabilities)

(120,576)

(120,730)

(66,312)

Net invested capital

2,969,909

3,086,089

3,212,172

Shareholder's equity – Group

(2,844,652)

(3,080,502)

(3,080,340)

Shareholder's equity – Non-controlling interests

(21,519)

(24,028)

(17,037)

Total Consolidated shareholders' equity

(2,866,171)

(3,104,530)

(3,097,377)

Long-term financial payables

(638,954)

(547,628)

(519,772)

Short-term financial, net surplus/(deficit)

535,216

566,069

404,977

Net financial position surplus/(deficit)

(103,738)

18,441

(114,795)

Shareholders’ equity and net financial position

(2,969,909)

(3,086,089)

(3,212,172)

Net Debt to Consolidated equity ratio

3.5%

n.a

3.6%

As of December 31, 2017, the Group has net invested capital of Euro 2,969.9 million, net financial indebtedness of Euro 103.7 million and total Consolidated Shareholder's equity of Euro 2,866.2 million.

Non-current assets, consisting essentially of property plant, equipment and intangible assets, remained approximately the same because the reduction of Euro 209.9 million attributable to depreciation, amortization and impairment and the foreign exchange losses of Euro 58 million were practically offset by capital expenditure of Euro 250.7 million. The capital expenditure is detailed below:

(amounts in thousands of Euro)

eleven months ended

December 31

2017

twelve months ended

January 31,

2017

Area retail

110,026

151,218

Area manufacturing, logistics and corporate

140,638

100,289

Total

250,664

251,507

Capital expenditure was invested in the retail area primarily for store restyling and relocation projects, and also for the store openings of the period. Other capital expenditure was used to complete activities begun in 2015 under a three-year plan to tighten control over the production process by gradually insourcing the most sensitive manufacturing phases and streamlining the logistics operations. Capital expenditure was used in the corporate area to expand and remodel offices and for the IT infrastructure of the industrial, retail and digital areas.

The net working capital as of December 31, 2017 is Euro 546.2 million, slightly below that of January 31, 2017:

  • trade receivables are fairly consistent;
  • inventories rose by Euro 43 million due to the planned expansion of the product range at the stores;
  • trade payables, essentially linked to the dynamics regarding inventory, rose by Euro 57.6 million.

Other current assets, net, decreased by Euro 71.9 million mainly as a result of lower tax credits due to the netting of current tax liabilities with advances paid in the previous year.

Other non-current liabilities, net, are approximately the same because the decrease in deferred tax assets was offset by a reduction of the risk provisions.

During the year the Group paid dividends to PRADA spa, shareholders for an amount of Euro 307.1 million.

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The following table provides details of the Group’s net financial position.

(amounts in thousands of Euro)

December 31

2017

January 31

2017

January 31

2016

Bonds - non-current

-

(130,000)

(130,000)

Bank borrowing – non-current

(638,954)

(417,628)

(390,475)

Total financial payables – non-current

(638,954)

(547,628)

(520,475)

Bonds - current

(130,000)

-

-

Financial payables and bank overdrafts - current

(222,971)

(151,211)

(270,766)

Payables to parent company and related parties - current

(4,423)

(4,934)

(4,858)

Total financial payables – current

(357,394)

(156,145)

(275,624)

Total financial payables

(996,348)

(703,773)

(796,099)

Financial receivables from related parties – non-current

-

-

703

Cash and cash equivalents

892,610

722,214

680,601

Total financial receivables and cash and cash equivalents - current

892,610

722,214

680,601

Total financial receivables and cash and cash equivalents

892,610

722,214

681,304

Net financial surplus/(deficit), total

(103,738)

18,441

(114,795)

Net financial surplus/(deficit) excluding related party balances

(99,315)

23,375

(110,640)

Net financial surplus/(deficit)/EBITDA ratio (*)

-17.7%

n.a.

-14.3%

(*) The ratio of Net financial deficit at December 31, 2017 on EBITDA was determined taking into account the EBITDA pro-forma for the 12 months of 2017

The net financial position as of December 31, 2017 is indebtedness of Euro 103.7 million, whereas it was a positive Euro 18.4 million as of January 31, 2017. In the eleven months ended December 31, 2017, the Group distributed dividends for an amount of Euro 307.1 million, paid investments for Euro 211.6 million, and generated net cash flow from operating activities of Euro 446.5 million. In the second half of the year the major currencies depreciated against the Euro, reducing the net financial position by Euro 50 million due to the significance of the foreign subsidiaries’ cash holdings against indebtedness that is essentially in Euro.

In consideration of its financial requirements and the favorable credit market conditions, the Group extended the time horizon of its bank borrowings by replacing short-term credit lines with long-term loans. Financing was obtained in the form of a Euro 200 million loan and a Euro 100 million loan, a new credit line in Japan of approximately Euro 81.5 million (JPY 11 billion), of which Euro 25.9 million (JPY 3.5 billion) was used, and a Euro 16.7 million loan in the Middle East.

The total amount of undrawn lines of credit as of December 31, 2017 is Euro 681 million.

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Risk factors
Risk factors regarding the international luxury goods market

The performance of the luxury goods market is influenced by the general economy. Accordingly, the Group’s business performance is exposed to global macroeconomic risks due to its international scale. An unfavorable global economy could adversely affect the propensity to spend on luxury goods and have a negative impact on the Group's operations, results, cash flows and financial condition.

Moreover, a substantial portion of the Group’s sales originates from purchases of products by customers on trips abroad. Consequently, unfavorable economic conditions, social or geopolitical situations leading to instability, and natural disasters resulting in lower travel volumes have in the past, and could in the future, negatively impact the Group’s business and results.

The Group believes that the full control of its value chain and a global retail presence enable to mitigate the risk that conditions such as these could influence significantly the consolidated sales.

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The Prada Group's brands have always been associated with beauty, creativity, tradition and excellent quality. Prada’s ability to protect its brands and other intellectual property rights means safeguarding these fundamental assets that are responsible for the success of the brands and the brand positioning.

The Group protects its brands, designs, patents and websites by registering them and obtaining legal protection for them in all countries throughout the world. The Group actively opposes all forms of counterfeiting and intellectual property infringement by adopting strong, systematic measures worldwide. The wholesale, retail, online and off-line markets are monitored daily in close collaboration with customs authorities and police.

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The Group’s success in the international luxury goods business is linked to the image and distinct character of its brands. These features depend on many factors, such as the style and design of the products, the quality of the materials and production techniques used, the image and locations of DOS, careful selection of licensees, communications activities and the general corporate profile.

Preserving the image and prestige acquired by its brands in the fashion and luxury business is an objective that the Prada Group pursues by monitoring meticulously each internal and external phase of the value chain. This allows to constantly ensure undisputed quality and uphold Group's reputation, while constantly pursuing innovation in styles, products and communications in order to convey messages that are always consistent with the strong brand identities.

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The Group’s success is reliant on its ability to create and define fashion and product trends, and to anticipate shifts in consumer tastes and luxury market trends in a timely manner.

The Group pursues those objectives dedicating great effort in the creative activities of its style office and throughout the whole product design and product development department.

This business area comprises approximately 1,000 individuals working in the design division, where a mix of nationalities, cultures and talents contribute to creativity, and in the development division, where craft skills combined with solid manufacturing processes enable the Group to continue to compete and keep abreast of emerging consumer trends and lifestyles.

Another fundamental way for understanding the evolution of costumes is represented by the close collaboration with the words of culture and art.

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Risks specific to the PRADA Group

The possibility for the Group to improve its business performance depends on the successful implementation of its strategy for each brand, translated primarily in the continuous support and development of retail sales.

The Group provides support to the retail network by offering leather goods, clothing and footwear that reflect the brand positioning, accompanied by store management geared toward making the buying experience unique. The restyling of the store layout and revamping of concepts aim to further expand the capacity to attract customers. The performance of the retail channel is also supported by localized marketing initiatives intended to enhance the identity of the brands and emphasize the unique features that distinguish the style and craftsmanship of the products.

Moreover, the implementation of the omnichannel strategy has paved the way for medium to long-term business development based on product quality, high-performance innovation, and distribution and communication channels that are constantly evolving and in line with the needs of the new generations of consumers.

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The Group’s success depends on the contribution of key individuals who have played an essential role in the Group's expansion and who have substantial experience in the fashion and luxury goods business. Its success also depends on Prada’s ability to attract and retain people who are qualified in the design, marketing, merchandising and distribution of the products.

The Group considers its management structure to be capable of ensuring business continuity, and has recently implemented a long-term incentive plan to retain key employees so that they will continue to cover the roles essential to the achievement of the challenging objectives that the Group constantly sets itself.

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While the Group designs, controls and produces in-house the majority of its prototypes, samples and most sophisticated products, it outsources the production of its other finished products to external manufacturers with appropriate expertise and capacity and centralizes, moreover, the management of all raw materials.

The Group has implemented a strict inspection and quality control process for all outsourced production and contractually requires its contract manufacturers to comply with all regulations on brand ownership and other intellectual property rights. Moreover, the Group demands compliance with applicable regulations concerning labor, social security, and occupational health and safety. The Group also requires its contract manufacturers to read the Prada Group Code of Ethics and comply with the principles set forth therein. Risk of contractual non-compliance is mitigated by a control system based on procedures that define internal responsibilities for the assessment of the suppliers' ethical, technical and financial soundness.

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Credit risk is defined as the risk of financial loss caused by the failure of a counterparty to meet its contractual obligations. The maximum risk to which an entity is exposed is represented by all the financial assets recognized in the financial statements. The Group considers its credit risk to involve primarily trade receivables generated from the wholesale channel and liquid assets. The Group manages credit risk and mitigates the related effects through its business and financial strategies.

With respect to trade receivables, credit risk is managed by monitoring and checking the reliability and solvency of customers.

Concerning liquid assets, the risk of default substantially relates to bank deposits, which represent the Group's most widely-used financial product for investing its operating cash flows, in keeping with its low-risk policy. Default risk is mitigated by the allocation of cash holdings to bank deposits that are diversified in terms of counterparty (always investment-grade), country and currency, and by the consistently short-term period. The residual portion of liquid assets consists of cash and bank accounts. The Group considers no significant risk to exist on these kinds of liquid assets given that they are used for operating activities and business processes and, consequently, the number of independent parties involved is fragmented.

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Liquidity risk refers to difficulty that the Group could have in meeting its financial obligations. The Directors are responsible for managing liquidity risk, whereas the Corporate Finance management, which reports to the CFO, is responsible for optimizing financial resources.

The Directors consider the current funds and credit lines, in addition to those that will be generated by operating and financing activities, to be sufficient for enabling the Group to meet its requirements from investing activities, manage working capital, make punctual loan repayments and pay dividends as planned.

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The Group's tax risks, which may derive from non-compliance or incorrect interpretation of the regulations, are constantly monitored within the internal control system and, in particular, within the tax control framework implemented by the Group. Thanks to such system of management of fiscal risks, the Group was admitted to the Collaborative Compliance Regime (as provided for by the Italian Legislative Decree n. 128/2015).

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The Prada Group operates in a complex regulatory environment and so is exposed to the following legal risks:

  • risks associated with non-compliance with the Rules Governing the Listing of Securities on the Stock Exchange of Hong Kong or with other laws or regulations in force in Hong Kong that the Company must observe since it is listed on the Stock Exchange of Hong Kong Limited;
  • risks associated with non-compliance with laws and regulations applicable to the Company due to the listing on the Irish Stock Exchange of the bond notes issued in August 2013;
  • risks associated with occupational health and safety under Italian Legislative Decree 81/08 and equivalent regulations in force in other countries;
  • possible legal penalties for wrongful acts pursuant to Italian Law 231/2001 as subsequently amended;
  • possible events that could adversely affect the reliability of the annual financial statements and the protection of assets;
  • changes in international tax rules applicable in the various countries where the Group operates;
  • possible manufacturing compliance risks regarding Italian and international laws and regulations for finished goods distributed and raw materials and consumables used.

The Group involves various divisions and uses external experts as necessary to keep its processes and procedures constantly updated in order to comply with changing rules and regulations, thereby reducing legal and regulatory risk to an acceptable level. Monitoring activities are performed by divisional managers, auditors, and special entities and committees such as the Supervisory Board, Internal Control Committee and Industrial Compliance Committee.

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The Group has a vast international presence, and therefore is exposed to the risk that changes in currency exchange rates could adversely impact revenue, costs, margins and profit. In order to hedge the foreign exchange risk, the Group enters into derivative contracts designed to fix the value in Euro (or other functional currency) of the identified future cash flows. The future cash flows consist primarily of inflows of trade and financial receivables and outflows of trade payables. They refer mainly to PRADA spa, the Group's parent company and worldwide distributor of Prada and Miu Miu brand products.

The management of foreign exchange risk is described in more detail in the Notes to the Consolidated financial statements.

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Interest rate risk is the risk that future cash flows could be affected by interest rate fluctuation. In order to hedge this risk, which refers mainly to PRADA spa, the Group uses derivatives (such as interest rate swaps) to convert variable-rate debt into fixed-rate debt or debt within a specified range of rates.

The management of interest rate risk is described in more detail in the Notes to the Consolidated financial statements.

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Data is processed using information systems whose governance model ensures that:

  • information is adequately protected against the risk of unauthorized access and disclosure (including with means to protect personal privacy and proprietary information), improper information modification or destruction (including accidental loss), and use that is incompatible with the job assigned;
  • data is processed in accordance with the applicable laws and regulations.

With reference to the specific legislative and regulatory developments on this matter, the Group has set up organizational and operational safeguards for the adaptation of the processes and procedures aimed at adopting the appropriate security measures to minimize the risks of non-compliance.

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Other information

Information on the Group’s transactions and balances with related parties is provided in the Notes to the Consolidated financial statements, insofar as required by IFRS, and in the Board of Directors' Report and Corporate Governance Report, insofar as required by the Hong Kong Stock Exchange rules.

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The Group uses certain financial measures (“non-IFRS measures”) to measure its business performance and to help readers understand and analyze its statement of financial position. Although they are used by the Group's management, the measures are not universally or legally defined and are not regulated by the IFRS adopted to prepare the Consolidated financial statements. Other companies operating in the luxury goods business might use the same measures, but with different calculation criteria, so non-IFRS measures should always be read in conjunction with the related notes, and may not be directly comparable with those used by other companies.

The Prada Group used the following non-IFRS measures in this Annual Report:

EBITDA: Earnings Before Interest, Taxation, Depreciation and Amortization, i.e. "consolidated net income for the period” adjusted to exclude “interest and other financial costs/(income) and dividends from investments”, “taxes on income” and "depreciation, amortization and impairment".

EBIT: Earnings Before Interest and Taxation, i.e. “consolidated net income for the period” adjusted to exclude “interest and other financial income/(costs) and dividends from investments” and “taxes on income”.

Net Financial Position: Short-term and long-term financial payables due to third parties and related parties, including lease obligations, net of cash and cash equivalents and short-term and long-term financial receivables due from third parties and related parties.

Free cash flows: net cash flows generated by operating activities, net of cash flows used in investing activities.

The following table sets forth the EBITDA and EBIT of the past two periods.

pro-forma

pro-forma

(amounts in thousands of Euro)

twelve months ended

December 31

2017

twelve-month period ended December

31, 2016

Consolidated net income for the period

249,238

266,183

Taxes on income

105,284

122,405

Interest and other financial (income)/expense and

dividends from investments

5,498

16,998

EBIT (Earnings Before Interest and Taxation)

360,020

405,586

Depreciation, amortization and impairment

227,960

228,927

EBITDA (Earnings Before Interest, Taxation, Depreciation and Amortization)

587,979

634,513

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Research and development activities are described within section "The Prada Group" of this Annual Report, especially in the paragraph on creativity. The design and product development costs for the 2017 twelve-month period pro-forma amounted to Euro 130.5 million, as above reported in this Financial Review.

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At December 31, 2017 the Group does not hold treasury shares, as reported in the section relating to the Report on Corporate Governance.

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No significant events.

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Outlook

The Group will continue to nurture its creativity with its unique way to observe the contemporary society and to interpret market trends to meet customers’ expectations, while respecting the iconic heritage of the Group’s world renowned brands. Improving the productivity of its global retail network and further strengthening the integration between offline and online will remain one of the key priorities for the Group.

Management, supported by the encouraging results achieved in the first months of 2018, is confident that the year to come would mark the beginning of a new sustainable long-term growth period.

Milan; March 9, 2018