MANAGEMENT REPORT General information Merko Ehitus is a leading building corporation offering integrated 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%). On April 5 2007 AS Merko Ehitus acquired 75% holding of OÜ Fort Ehitus (Registry Code 10722444). Principal activities of OÜ Fort Ehitus are hydraulic engineering and pile works. The holding was acquired in order to strengthen competence of the group in the field of pile works and hydraulic engineering construction (http://www.baltic.omxgroup.com/market/?pg=news&news_id=213583). Business operations Group's revenue for the first nine months in 2007 were 3863.6 million kroons, which constitutes an annual increase of 25.8%. 62.1% of the sales originated from Estonia, 23.4% from Latvia and 14.5% from Lithuania. As compared with the respective period in 2006, company's sales in Lithuania increased by 57.2%, in Estonia by 24.6% and in Latvia by 14.6%. Group's revenue in the third quarter of 2007 were 1367.9 million having increased by 9.5 million kroons as compared to the same period in 2006. The seasonality of road construction works had a positive effect on the revenue and, similarly, underperformance in sales of housing projects had a negative impact on the revenue. Companies of the Group 9M 2007 consolidated revenue (sales outside the Group) were (in thousand kroons and euros): 9M 2007 9M 2006 EEK EUR EEK EUR Estonian companies AS Merko Ehitus (parent company) 1 608 086 102 775 1 310 319 83 745 AS Gustaf (75% partnership) 111 062 7 098 71 762 4 586 OÜ Gustaf Tallinn (80% partnership) 102 936 6 579 97 740 6 247 AS Merko Tartu (66% partnership) 181 502 11 600 172 451 11 022 Tallinna Teede AS (100% partnership) 253 327 16 191 206 762 13 214 OÜ Woody (100% partnership) 198 125 12 662 167 745 10 721 Latvian company SIA Merks (100% partnership) 779 876 49 843 713 260 45 586 Lithuanian company UAB Merko Statyba (100% partnership) 525 819 33 606 330 445 21 119 Compared to 9M 2006 the cost of goods sold increased by 30.5% and the marketing and general administration costs 28.6% forming respectively 87.7% and 3.7% of the sales. Increase in expenses exceeding the growth in income led to a lower gross margin of 12.3% as compared to 15.5% in 2006. Also, the operating profit margin fell from 11.8% to 8.6%. The net profit of the Group for 9M 2007 was 358.0 million kroons, with a yearly growth of 6.8%. Due to the decrease of the gross and operating profit margin, the net profit margin decreased during the reference period from 10.9% to 9.3%. Group's net cash flow of the first 9 months of the year was -554.4 million kroons, including cash flow from operating activities -647.6 million kroons, from investing activities -52.9 million kroons and financing activities +146.2 million kroons. The cash flow from operating activities were mostly influenced by the change in inventories arising from development activities (-569.2 million kroons) and change in trade receivables related to operating activities (-234.4 million kroons). The negative cash flow of the period was covered with additional loans (net cash flow of the period from borrowings +275.1 million kroons) and liquid assets of the Group. Construction market Stricter loan terms of banks and negative prospects on the future economic growth have decreased companies' investments enthusiasm and several projects have been postponed for coming years. Despite strong growth during the first six months of 2007 (own account construction works increased by 51.9% in Lithuania, 45.9% in Latvia and 31.1% in Estonia in current prices as compared to the first half of 2006), the prevailing trend of decreasing economic growth in the area is likely to cause slow down also in the construction sector. Construction prices continued soaring during the 3rd quarter, increasing by 23.8% in Latvia, by 14.6 % in Lithuania and by 12.1% in Estonia, including labour costs increase of 40.4% in Latvia and 21.1% in Estonia as compared to the same period in 2006. However, simultaneous decrease in demand and better availability of building materials and workforce are likely to create better environment for stabilizing construction prices in the near future. Pessimistic and lethargic mood was prevailing in the housing market. The number of apartments put on the market increased and prices in different parts of the region differed more clearly. The selling period of apartments is now longer due to changes in the market. Reduced financial resources and ability to handle liquidity risks due to the longer selling period will be the challenges for developers in near future. Companies' strong capitalization and availability of internal liquid resources will have a crucial influence to companies further succeed. The ratios and calculation methods characterizing the operating activities of the Group 2007 9 months 2006 9 months Net profit margin 9,3 % 10,8 %* Operating profit margin 8,6 % 11,8 % Return on equity per annum 27,9 % 36,5 % Return on assets per annum 13,5 % 17,7 % Current ratio 2,1 2,0 Equity ratio 47,0 % 47,5 % General expenses to sales 3,7 % 3,7 % Staff costs to sales 9,5 % 7,4 % Average number of full-time employees 995 841 * less extraordinary profit Net profit margin: Net profit* / Sales Operating profit margin: Operating profit / Sales Return on equity: Net profit x 4/3* / Average equity during the period* Return on assets: Net profit x 4/3* / 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 30.09.2007, the number of employees in the Group's service was 1099, including 1064 full-time employees. The number of the Group's employees increased by 26.2% (228 new employees were recruited). The gross remuneration paid to full-time personnel in 9 months 2007 amounted to 290.6 million kroons an increase of 51.5% compared to previous year. Shares and shareholders The shares of Merko Ehitus are listed in the main list of Tallinn Stock Exchange. In 2007 9M the number of transactions with Merko Ehitus' shares was 3841, during which 4.5 million shares changed ownership and the turnover of the transactions was 1588.3 million kroons. The cheapest bargain with a share was 289.78 kroons and highest 402.12 kroons per share. The closing share price with a state of 28.09.2007 was 293.22 kroons. INCOME STATEMENT III quarter 2007 consolidated, unaudited in thousand EEK and EUR EEK EUR IIIq 2007 IIIq 2006 IIIq 2007 IIIq 2006 Revenue 1 367 855 1 358 336 87 422 86 813 Cost of goods sold (1 198 290) (1 140 620) (76 585) (72 899) GROSS PROFIT 169 565 217 716 10 837 13 914 Marketing expenses (7 788) (4 196) (498) (268) Administrative and general expenses(42 725) (34 178) (2 731) (2 184) Other operating income 2 856 4 612 183 295 Other operating expenses (1 393) (1 919) (89) (123) OPERATING PROFIT 120 515 182 035 7 702 11 634 Financial income and expenses from stocks of subsidiaries 0 2 324 0 149 Financial income and expenses from stocks of associate comp. and joint ventures 8 711 7 640 557 488 Financial income and expenses from other long-term financial investments 0 2 0 0 Interest expense (7 827) (7 562) (500) (483) Foreign exchange gain (3 317) (872) (212) (56) Other financial income 4 225 1 656 270 106 Other financial expenses (68) (0) (4) (0) Total financial income and expenses 1 724 3 188 111 204 PROFIT BEFORE TAX 122 239 185 223 7 813 11 838 Corporate income tax expense (3 267) (14 871) (209) (950) NET PROFIT FOR CURRENT PERIOD 118 972 170 352 7 604 10 888 incl. net profit attributable to equity holders of the parent company 116 023 166 314 7 415 10 630 minority interest 2 949 4 038 188 258 Earnings per share for profit attributable to the equity holders of the parent company (basic and diluted, in EEK and EUR) 6,55 9,40 0,42 0,60 INCOME STATEMENT 9M 2007 consolidated, in thousand EEK and EUR EEK EUR 9M 2007 9M 2006 9M 2007 9M 2006 Revenue 3 863 605 3 071 042 246 929 196 275 Cost of goods sold (3 388 412) (2 596 357) (216 559) (165 937) GROSS PROFIT 475 193 474 685 30 370 30 338 Marketing expenses (20 244) (15 469) (1 294) (989) Administrative and gen. expenses (124 180) (96 831) (7 937) (6 189) Other operating income 5 345 14 659 342 937 Other operating expenses (4 338) (15 493) (277) (990) OPERATING PROFIT 331 776 361 551 21 204 23 107 Financial income and expenses from stocks of subsidiaries 0 2 325 0 149 Financial income and expenses from stocks of associate comp. and joint ventures 61 486 12 116 3 930 774 Financial income and expenses from other long-term financial investments 0 7 0 0 Interest expense (14 355) (10 265) (917) (656) Foreign exchange gain (3 179) (3 766) (203) (241) Other financial income 9 295 5 245 594 336 Other financial expenses (70) (0) (4) (0) Total financial income and expenses 53 177 5 662 3 400 362 PROFIT BEFORE TAX 384 953 367 213 24 604 23 469 Corporate income tax expense (18 346) (25 650) (1 173) (1 639) NET PROFIT FOR CURRENT PERIOD 366 607 341 563 23 431 21 830 incl. net profit attributable to equity holders of the parent company 358 024 335 275 22 882 21 428 minority interest 8 583 6 288 549 402 Earnings per share for profit attributable to the equity holders of the parent company (basic and diluted, in EEK and EUR) 20,23 18,94 1,29 1,21 BALANCE SHEET AS OF 30.09.2007 consolidated, in thousand EEK and EUR EEK EUR 30.09.2007 31.12.2006 30.09.2007 31.12.2006 ASSETS Current assets Cash and cash equivalents 120 199 676 143 7 682 43 213 Trade and other receivables 1 342 235 860 531 85 785 54 998 Inventories 1 912 072 1 356 734 122 204 86 712 Assets held for sale 0 733 0 47 Total current assets 3 374 506 2 894 141 215 671 184 970 Non-current assets Long-term financial investments 274 937 215 866 17 571 13 796 Investment property 9 358 3 900 598 249 Property, plant and equipment 170 140 90 445 10 874 5 781 Intangible assets 13 097 10 177 837 650 Total non-current assets 467 532 320 388 29 880 20 476 TOTAL ASSETS 3 842 038 3 214 529 245 551 205 446 LIABILITIES AND OWNERS' EQUITY Current liabilities Borrowings 365 198 283 792 23 340 18 138 Trade and other payables 1 092 718 1 100 264 69 837 70 320 Government grants 1 482 1 498 95 96 Short-term provisions 88 445 33 517 5 653 2 142 Total current liabilities 1 547 843 1 419 071 98 925 90 696 Non-current liabilities Loans, bonds and finance lease liabilities 382 307 159 336 24 434 10 183 Other long-term payables 10 440 10 351 667 662 Long-term customer prepayments 49 608 12 925 3 171 826 Total non-current liabilities 442 355 182 612 28 272 11 671 Total liabilities 1 990 198 1 601 683 127 197 102 367 Equity Minority interest 27 662 18 904 1 768 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 (9 639) (5 751) (616) (368) Retained earnings 1 639 117 1 404 993 104 759 89 796 Total equity attributable to equity holders of the parent company 1 824 178 1 593 942 116 586 101 871 Total equity 1 851 840 1 612 846 118 354 103 079 TOTAL LIABILITIES AND EQUITY 3 842 038 3 214 529 245 551 205 446 Alar Lagus Member of Board +372 6 805 109