MANAGEMENT REPORT General information Merko Ehitus is a leading building corporation offering integral solutions since 1990, with branches currently in Estonia, Latvia and Lithuania. Largest companies of the Group are SIA Merks (100%), UAB Merko Statyba (100%), Tallinna Teede AS (100%), AS Gustaf (75%), OÜ Gustaf Tallinn (80%), AS Merko Tartu (66%), OÜ Woody (100%) and AS Tartu Maja Betoontooted (25%). Business operations The sales of Merko Ehitus Group for 6 months in 2007 was 2495.8 million kroons, with a 45.7% rise within a year. The capacity of activities carried out outside Estonia rise from 34.1% to 38.1% of the Group's sales. 61.9% of revenue was earned in Estonia, 23.3% in Latvia and 14.8% in Lithuania. Compared to 6 months in 2006 the sales grew 36.8% in Estonia, 54.6% in Latvia and 77.7% in Lithuania. In 2nd quarter of 2007 the Group's sales was 1480.9 million kroons, which exceeds the numbers of 2006 for the same period by 26.8%, which is 312.8 million kroons more. The growth of sales was supported by the general growth of the construction market, the construction activities have been facilitated by warm winter and the cyclicity of the realization of housing construction. Companies of the Group 6M 2007 consolidated revenue (sales outside the Group) were (in thousand kroons and euros): 6M 2007 6M 2006 EEK EUR EEK EUR Estonian companies AS Merko Ehitus (parent company) 1 020 003 65 190 885 811 56 614 AS Gustaf (75% partnership) 70 117 4 481 44 629 2 852 OÜ Gustaf Tallinn (80% partnership) 65 958 4 215 60 126 3 843 AS Merko Tartu (66% partnership) 111 607 7 133 86 743 5 544 Tallinna Teede AS (100% partnership) 118 159 7 552 72 333 4 623 OÜ Woody (100% partnership) 182 716 11 678 25 558 1 633 Latvian company SIA Merks (100% partnership) 507 653 32 445 346 009 22 114 Lithuanian company UAB Merko Statyba (100% partnership) 342 945 21 918 190 832 12 196 Within a year the cost of goods sold grew 50.4% and the marketing and general administration costs 27.0% forming respectively 87.8% and 3.8% of the sales. Due to the faster than expected increase of the prices on labour force and materials, the gross profit margin of the Group decreased from 15.0% to 12.2% and the operating profit margin from 10.6% to 8.5% as compared to the six months of the year 2006. The net profit of the Group for 6M 2007 was 242.0 million kroons, with a yearly growth of 43.2%. Due to the decrease of the gross and operating profit margin, the net profit margin decreased during the reference period from 9.9% to 9.7%. A positive influence to the profitability of the period was expressed by the successful sales of housing and financial income from associated companies. The net cash flow of the Group of the first half of the year was -481.6 million kroons, including cash flow from operating activities -410.2 million kroons, from investing activities -33.8 million kroons and financing activities -37.6 million kroons. The cash flow from operating activities were mostly influenced by the change in inventories arising from the development activities (-289.5 million kroons) and change in trade receivables related to operating activities (-219.0 million kroons). The negative cash flow of the period was covered with additional loans (net cash flow of the period from loans +117.1 million kroons) and liquid funds of the Group. Construction market The second quarter of the year 2007 did not bring along any significant changes in the construction market, good demand prevailed and the fast increase of the construction volumes and prices continued in the sector. The sector continues to have a complicated situation with the labour force, the tender is limited and the increase of the labour costs is continuing. As compared to the 2nd quarter in 2006, construction costs increased by 29.1% in Latvia, 15.2% in Estonia and 13.9% in Lithuania including the respective 47.9% and 26.5% increase in labor costs in Latvia and Estonia. Stabilization of prices took place in housing market and offer of new apartments increased significantly in the second quarter of the year. As a result of the changes that have taken place in the environment and seasonality of the real estate market, the sales periods of the apartments extended. The increased offer improves significantly the choices of the buyers and sets higher requirements for the developers in terms of the quality of the infrastructure and general quality of the projects, and brings along the differentiation of prices. The developers who have liquid funds have better outlook to managing extended sales periods and poorer financing possibilities. The outlook of the nearest future of the sector is good. The greatest risk for the further development of the sector is the increase of the prices of the construction services that have lasted for a long time and deterioration of the general interest environment and financing conditions of the real estate sector. The ratios and calculation methods characterizing the operating activities of the Group 2007 6 months 2006 6 months Net profit margin 9,7 % 9,9 % Operating profit margin 8,5 % 10,6 % Return on equity per annum 29,3 % 29,6 % Return on assets per annum 14,2 % 13,4 % Current ratio 2,1 1,8 Equity ratio 47,7 % 42,0 % General expenses to sales 3,8 % 4,3 % Staff costs to sales 10,1 % 8,6 % Average number of full-time employees 948 831 Net profit margin: Net profit / Sales Operating profit margin: Operating profit / Sales Return on equity: Net profit x 2* / Average equity during the period* Return on assets: Net profit x 2* / Average assets during the period Current ratio: Current assets / Current liabilities Equity ratio: Owners equity* / Total assets General expenses to sales: General expenses / Sales Staff costs to sales: Staff costs / Sales * calculated from the share of the parent company's shareholders In 30.06.2007, the number of employees in the Group's service was 1062, having increased by 95 employees in last quarter, including 1026 full-time employees. The gross remuneration paid to full-time personnel in 6M 2007 amounted to 190.3 million kroons an increase of 53.5% compared to previous year. Shares and shareholders The shares of Merko Ehitus are listed in the main list of Tallinn Stock Exchange. In 2007 6M the number of transactions with Merko Ehitus' shares was 3021, during which 3.9 million shares changed ownership and the turnover of the transactions was 1362.5 million kroons. The cheapest bargain with a share was 289.78 kroons and highest 400.71 kroons per share. The closing share price with a state of 30.06.2007 was 367.70 kroons. INCOME STATEMENT II quarter 2007 consolidated, unaudited in thousand EEK and EUR EEK EUR IIq 2007 IIq 2006 IIq 2007 IIq 2006 Revenue 1 480 887 1 168 131 94 646 74 657 Cost of goods sold (1 303 771) (985 730) (83 326) (63 000) GROSS PROFIT 177 116 182 401 11 320 11 657 Marketing expenses (6 851) (5 139) (438) (328) Administrative and general expenses(45 845) (30 184) (2 930) (1 929) Other operating income 387 11 433 25 731 Other operating expenses (1 907) (10 335) (122) (661) OPERATING PROFIT 122 900 148 176 7 855 9 470 Financial income and expenses from stocks of subsidiaries 0 2 0 0 Financial income and expenses from stocks of associate companies and joint ventures 45 943 1 273 2 936 81 Financial income and expenses from other long-term fin. investments 0 2 0 0 Interest expense (3 795) (3 281) (243) (210) Foreign exchange gain 3 585 (1 696) 229 (108) Other financial income 1 814 2 123 116 136 Other financial expenses (1) (0) (0) (0) Total financial income and expenses 47 546 (1 577) 3 038 (101) PROFIT BEFORE TAX 170 446 146 599 10 893 9 369 Corporate income tax expense (14 197) (10 780) (907) (689) NET PROFIT FOR CURRENT PERIOD 156 249 135 819 9 986 8 680 incl. net profit attributable to equity holders of the parent company 153 550 134 238 9 814 8 579 minority interest 2 699 1 581 172 101 Earnings per share for profit attributable to the equity holders of the parent company (basic and diluted, in EEK and EUR) 8,68 7,58 0,55 0,48 INCOME STATEMENT 6M 2007 consolidated, in thousand EEK and EUR EEK EUR 6M 2007 6M 2006 6M 2007 6M 2006 Revenue 2 495 751 1 712 707 159 507 109 462 Cost of goods sold (2 190 123) (1 455 737) (139 974) (93 039) GROSS PROFIT 305 628 256 970 19 533 16 423 Marketing expenses (12 456) (11 273) (796) (720) Administrative and general expenses(81 456) (62 653) (5 206) (4 004) Other operating income 2 490 12 818 159 819 Other operating expenses (2 945) (13 574) (188) (868) OPERATING PROFIT 211 261 182 288 13 502 11 650 Financial income and expenses from stocks of subsidiaries 0 2 0 0 Financial income and expenses from stocks of associate companies and joint ventures 52 775 4 476 3 373 286 Financial income and expenses from other long-term fin. investments 0 6 0 0 Interest expense (6 528) (5 475) (417) (350) Foreign exchange gain 138 (2 895) 9 (185) Other financial income 5 070 3 589 324 230 Other financial expenses (2) (0) (0) (0) Total financial income and expenses 51 453 (297) 3 289 (19) PROFIT BEFORE TAX 262 714 181 991 16 791 11 631 Corporate income tax expense (15 079) (10 780) (964) (689) NET PROFIT FOR CURRENT PERIOD 247 635 171 211 15 827 10 942 incl. net profit attributable to equity holders of the parent company 242 000 168 961 15 467 10 798 minority interest 5 635 2 250 360 144 Earnings per share for profit attributable to the equity holders of the parent company (basic and diluted, in EEK and EUR) 13,67 9,55 0,87 0,61 BALANCE SHEET AS OF 30.06.2007 consolidated, in thousand EEK and EUR EEK EUR 30.06.2007 31.12.2006 30.06.2007 31.12.2006 ASSETS Current assets Cash and cash equivalents 193 299 676 143 12 354 43 213 Trade and other receivables 1 314 375 860 531 84 003 54 998 Inventories 1 643 326 1 356 734 105 028 86 712 Assets held for sale 0 733 0 47 Total current assets 3 151 000 2 894 141 201 385 184 970 Non-current assets Long-term financial investments 265 901 215 866 16 995 13 796 Investment property 9 406 3 900 601 249 Property, plant and equipment 154 615 90 445 9 882 5 781 Intangible assets 12 621 10 177 806 650 Total non-current assets 442 543 320 388 28 284 20 476 TOTAL ASSETS 3 593 543 3 214 529 229 669 205 446 LIABILITIES AND OWNERS' EQUITY Current liabilities Borrowings 285 220 283 792 18 229 18 138 Trade and other payables 1 151 307 1 100 264 73 581 70 320 Government grants 1 501 1 498 96 96 Short-term provisions 77 225 33 517 4 936 2 142 Total current liabilities 1 515 253 1 419 071 96 842 90 696 Non-current liabilities Loans, bonds and finance lease liabilities 281 588 159 336 17 997 10 183 Other long-term payables 9 318 10 351 596 662 Long-term customer prepayments 49 903 12 925 3 189 826 Total non-current liabilities 340 809 182 612 21 782 11 671 Total liabilities 1 856 062 1 601 683 118 624 102 367 Equity Minority interest 24 713 18 904 1 579 1 208 Equity attributable to equity holders of the parent company Share capital 177 000 177 000 11 312 11 312 Statutory reserve capital 17 700 17 700 1 131 1 131 Currency translation adjustment (5 025) (5 751) (321) (368) Retained earnings 1 523 093 1 404 993 97 344 89 796 Total equity attributable to equity holders of the parent company 1 712 768 1 593 942 109 466 101 871 Total equity 1 737 481 1 612 846 111 045 103 079 TOTAL LIABILITIES AND EQUITY 3 593 543 3 214 529 229 669 205 446 Alar Lagus Member of Board +372 6 805 109