The purpose of this report on the Management’s Discussion and Analysis of Results is to help readers understand Grupo Herdez operations and results.

Grupo Herdez is a leader in the processed food sector and one of the main players in the ice cream category in Mexico, as well as a leader in the Mexican food category in the United States. The business management is divided into three segments: Preserves, Frozen, and Exports. The results from MegaMex, our partnership with Hormel in the United States, are posted under Equity investment in associates.

The main growth opportunities for all segments of the Company are in household penetration, reducing distribution gaps, innovating based on understanding the consumer and segmentation, and increasing traffic in Nutrisa stores.

In 2018, consolidated net sales reached a record $20,971 million, 4.5% higher than the previous year, mainly as a result of price increases. Growth during the year was lower than the average from previous years as a result of: i) customers streamlining inventory; and ii) the impact of the relocation of the freezers in the Frozen division during the second quarter of the year.

Net sales in the Preserves segment grew 3.1%, to $16,455 million. The categories with the highest growth were: jams, mole, home-style salsa, pasta and tea. This year, the main growth drivers were continuous household penetration, launching premium versions in various categories, and packaging differentiation.

In terms of performance by channel, the modern and the institutional channels surpassed average growth. In the modern channel, the Company’s products were able to capitalize on seasons of high consumption, such as Lent and summer, as a result of a differentiated portfolio, while in the institutional channel, growth was driven by an increased customer base.

The Frozen division reached $2,985 million in net sales in 2018, 3.6% higher than in 2017, driven by the growth of Helados Nestlé in the modern and convenience channels. At Nutrisa, same-store sales were driven by the average ticket, which grew 10%.

Export sales reached $1,531 million, 24.5% higher than 2017 due to a growth in volume, price increases and the strong American dollar.

At year-end, Preserves represented 79%, Frozen 14% and Exports 7% of total net sales.

The consolidated gross margin in 2018 was 39.3%, with no changes year-over-year, as a result of price increases that offset the spike in prices for certain raw materials, and a favorable product mix, mainly in the Preserves segment, where the margin remained stable.

In the Frozen segment, the gross margin increased 1.4 percentage points to 63.9%, as a result of increased sales, as well as increased productivity at Helados Nestlé. Meanwhile, the Export segment, the gross margin increased 90 basis points to 14.2% as a result of higher sales.

Consolidated overhead expenses dropped 30 basis points to 25.6% as a proportion of net sales due to lower advertising expenses, which compensated for an increase in logistics and storage expenditure during the year.

In turn, the 2018 operating margin reached 14.3%, 40 basis points higher than 2017, benefited by the improvement of 2.4 percentage points in the Frozen segment. This was the result of higher sales during the second half-year period, as well as the reduction of 50 basis points in overhead expenses that resulted from optimizing expenses in advertising and promotion.

Net financing cost rose to $491 million, 1.4% lower than the previous year, which is mainly due to the benefit of higher interest earned related to a higher average cash amount and increased interest rates, as well as lower interest paid resulting from the capitalization of corporate debt during the first half of 2017.

Equity in income of associates totaled $916 million in 2018, 9.8% higher than in 2017. This is due to outstanding results from MegaMex: i) net sales grew 9.0%, driven by performance in the guacamole and salsa categories; ii) gross and operating margins grew 4.9 and 3.7 percentage points, respectively, due to lower avocado costs; iii) the EBITDA margin was 18.3%, 3.3 percentage points higher than in 2017; and iv) net profit grew to $1,774 million, 12.1% higher than the previous year, benefited in part by an easy benchmark during the first three quarters of 2018 due to the lower tax rate in the United States.

Consolidated net income grew 11.9% to $2,424 million, while majority net profit grew 10.5%. It is important to note that the effective tax rate dropped 1.5 percentage points to 29.2% in 2018, from 30.7% in 2017, mainly due to the tax benefit in the equity in income of associates.

This year, EBITDA was $3,517 million, while the margin grew 20 basis points to 16.8%. This expansion was due to the improved product mix, as well as lower overhead expenses in the Preserves and Frozen segments.

Net asset investment totaled $496 million and was mainly allocated to infrastructure maintenance, freezer acquisition, and Helados Nestlé distribution trucks.

As of December 31, 2018, the cash position totaled $2,027 million, representing growth of 36.5% compared to 2017. This is mainly the result of the $300 million for working capital that was obtained by issuing stock exchange certificates in May and recovery of taxes. At year-end, total debt was $6,638 million, or $287 million more than 2017. The debt is 100% Peso-denominated with an interest rate mix that is 75% fixed and 25% variable, including interest rate derivative financial instruments.

Consolidated net debt to EBITDA was 1.3 times, while net debt to consolidated stockholders’ equity was 0.25 times.

The cash flow was $2,115 million, 3.5% more than in 2017, which allowed us to finance investment in assets, meet financing commitments, pay dividends, and acquire treasury stock. This was possible despite a negative effect on working capital, since inventory turnover increased to 8 days and accounts receivable to 5, due to the entry of electronic invoicing. This was partially offset by an increase of 6 days in the turnover for accounts payable.

Of the $1,000 million authorized by the Shareholders’ Meeting for treasury stock acquisition, as of March 26, 2019, we had a remainder of $595 million. In 2018, we repurchased 7.1 million shares, equivalent to $287 million.

Starting on January 1, 2019, in accordance with International Financial Reporting Standard 16 – Leases, which establishes the principles for identification, measurement, presentation and disclosure information about the right to use an asset, lease liabilities and, after January 1, 2019, changes in depreciation and in financial cost, the financial statements must include changes related to the accounting presentation of this item. In the cash flow statement, lease payments that have been identified as a financial liability shall be a financing activity cash flow (previously considered operating cash flow).

Starting with the report of the results from the first quarter of 2019, lease payments will be capitalized in the balance sheet as a right to use an asset and future payment liability, expressed as net payment at present value for the duration of all contracts. In the Statement of Income, lease expenses will be eliminated, and the additional depreciation related to these assets with right of use shall be added, and the interest expense shall be identified in the financial cost.

In view of the above, and based on the information currently available, the group estimates that it will identify assets with right of use and lease liabilities of $910 million as of January 1, 2019. Subsequently, at year-end, we estimate a net carrying value for that asset of $630 million. Of that amount, one-half is associated with Nutrisa store leases, and the rest corresponds to real estate contracts, transportation and equipment in the rest of the business segments.

In turn, in the Statement of Income, this will have a non-material effect on operating income and consolidated net profit. However, the effect on EBITDA will be approximately 10%.

In summary, we estimate the following impacts in 2019: a benefit of $54 million in operating income, which rose to 1%, a befit of $330 million in EBITDA, which represents approximately 10%, and a reduction of $29 million in consolidated net income, due to an increase of $83 million in interest paid. As a result of the above, we do not expect any significant changes in the leverage ratios.