Arco Vara AS Interim Report (unaudited) for third quarter and nine months 2015

General information

As at 30 09 2015, the group comprised 25 companies, this is one more than at the end of year 2014. On 31 July 2015, was registered a real estate fund in Bulgaria named Arco Real Estate Fund REIT, with starting capital of 256 thousand euros. The group holds 70% interest in the fund.

Significant subsidiaries

¹ - Non-controlling interest in Arco Real Estate SIA and Arco Real Estate Fund REIT equals to the group’s total non-controlling interest

Key Performance Indicators

·     In nine months 2015, the group’s revenue was 8.6 million euros, exceeding by 156% the revenue of 9 months 2014, when revenue amounted to 3.3 million euros. In Q3, revenue was 2.1 million euros (in Q3 2014: 1.2 million euros). The increase of the group’s revenue comes from Development division, where revenue amounted to 6.5 million euros in nine months 2015 (in 9 months 2014: 1.3 million euros). The revenue of Service division has remained on the same level: 2.4 million euros in 9 months of both years: 2015 and 2014. Q3 2015 revenue of Service division increased by 8% compared to Q3 of previous year. The sales figures of brokerage and valuation services shows growth second quarter in a row, after the falling trend in second half of year 2014 and in the beginning of year 2015.

·     In nine months 2015, the group’s operating profit (=EBIT) was 1.4 million euros and net profit 0.9 million euros, a year ago the same figures were 1.1 million euros and 0.4 million euros respectively. Moreover, the result of 2014 was impacted by two single events with total effect of 1.2 million euros on profit: gain from the sale of a subsidiary and reversal of inventory write-down. In Q3, operating profit was 0.3 million euros and net profit amounted to 0.2 million euros. In Q3 2014, the group had operating profit of 0.6 million euros and net profit of 0.4 million euros.

·     For 30 September 2015, equity to assets ratio has been risen up to 40.3%. At 31 December 2014, the figure was 33.5%.

·     The group’s net loans have decreased by 2.2 million euros in nine months 2015, down to 11.1 million euros as at 30 September 2015. As at 30 September 2015, the weighted average annual interest rate of loans was 5.1%. This is a decrease by 0.7 percentage points compared to 31 December 2014.

·     In nine months 2015, were sold 73 apartments, 6 commercial spaces and one residental plot (of which 12 apartments, one commercial space and one plot in Q3) in projects developed in the group. In nine months 2014, were sold only 4 apartments and 4 plots (of which one apartment and 4 plots in Q3).

Cash flows

FORMULAS USED

Earnings per share (EPS) = net profit attributable to owners of the parent / (weighted average number of ordinary shares outstanding during the period – own shares)
Invested capital = current interest-bearing liabilities + non-current liabilities + equity (at end of period)
Net loans = current interest-bearing liabilities + non-current liabilities – cash and cash equivalents – short-term investments in securities (at end of period)
Return on invested capital (ROIC) = past four quarters’ net profit / average invested capital
Return on equity (ROE) = past four quarters’ net profit / average equity
Return on assets (ROA) = past four quarters’ net profit / average total assets
Number of staff at period-end = number of people working for the group under employment or authorization (service) contracts

   Group Chief Executive’s review

Against all expectations, the third quarter turned out to be better than the second. We completed all activities planned for the third quarter but we did not expect it to turn profit. Profit was generated by the sale of existing completed development products, which was faster than planned and for a higher price, and a disciplined approach to expenses. If we are to conclude anything from this, then it’s been proven in practice that with a quarterly revenue of a minimum of two million euros, Arco Vara can earn a small loss (12 thousand in Q2) or also profit (0.2 million in Q3). However, considering absolute activity volumes and them being fairly small, the difference is not the sort to dwell on further. Our bigger objective is to double the current revenue and profit of the company by the end of 2018 at the latest.

The important questions for the management are:

(i)             what will the fourth quarter be like,

(ii)            what will 2016 as a whole be like, and

(iii)           what will 2017 be like, when the group should just begin to reap the benefits of 2013-2016.

The fourth quarter

The fourth quarter is important because this is when the final and third stage (block D) of the Manastirski building is completed in Sofia with 88 apartments and business premises on sale and rent. Depending on the speed of delivering apartments and formalizing sales transactions, block D forms the final result of the year of the entire group and is also the financial basis for continued developments in Sofia. The expected revenue of the entire block D is about 5 million euros, part of which remains in 2015, the majority in the first quarter of 2016 and a certain part is carried over in sales until the end of 2016. With block D, the pleasing part is that as of the end of September, over 80% of apartments were covered with preliminary sales contracts (over 65% at the end of Q2).  

The fourth quarter will also involve renovating and dividing the office premises (GLA over 5,400 m2) into 7 separate rental areas in the Madrid Blvd building in Sofia and finding new tenants for them. The lease contract with the current long-term large tenant ended in September due to the tenant needing increased space, which could not be resolved in the Madrid building for purely technical reasons. The revenue from office premises in the Madrid building forms over 50% of the rental revenue of the entire building and therefore, finding new tenants is very important for generating profit. At the same time, the Arco rental apartments and business premises in the building generate enough rental revenue, therefore servicing the interests of bank loans encumbering the building does not weigh down the group.

An important issue in the fourth quarter is also commencing the Kodulahe apartment development project in Tallinn (formerly Paldiski mnt 70c, www.kodulahe.ee). Arco Vara has not developed anything in Tallinn into a completed product since 2013. The volume of the first stage of the Kodulahe development project is over 8,700 above-ground square metres with 125 apartments and 5 business premises on sale. Funding Kodulahe and starting construction is a great challenge for us, considering the increasing competition on the Tallinn apartment market as well as Arco Vara being relatively small compared to the size of the project. In regards to increasing competition, we are empasasing the fact that our product has a unique location and it is priced rather aggressively in regards to the current prices on the market. The relatively small size of Arco Vara is expressed in the fact that the total amount of assets of the group is approximately 25 million euros. 10 million of this is equity, which in turn is divided between three large developments. Two of those three are located in Sofia (Madrid Blvd and Manastirski Livadi or its continued project in Iztok) and one – Kodulahe – in Tallinn. 10 million euros is probably also the minimum equity to continuously carry three large development projects, area under construction of each of which exceeds 10,000 m2.                      

The last important event we are waiting for is completing the transaction of obtaining the plot in the Iztok region in Sofia. This can also be postponed until the beginning of 2016. Iztok is our continued project in Sofia regarding Manastirski Livadi.

Events which have already taken place in the fourth quarter include Arco Vara exiting the development projects in (i) Tallinn, Instituudi tee 7-9 and (ii) Pärnu, Suur-Sepa 20. The difference between purchase and sale price of these properties was motivating for us and also confirmed that the preliminary design projects and business plans created by our development team have added value to the projects.

Currently, we are predicting revenue of Arco Vara to exceed 11 million euros and net profit to exceed 1 million euros in 2015.

2016

In 2016, we should see the continuation of three large development projects, where we earn rental revenue in the Madrid Blvd building and are likely to increase the number of apartments for rent. The goal is to earn annual rent of over one million euros per year from the building. In the Manastirski project, we will sell the last apartments and start to develop Iztok (GSA > 7,000 m2), where construction works should begin in the second half of the year. Thirdly, the first stage construction of Kodulahe project should be almost completed by the end of 2016.

In 2016, we also want to initiate the Arco real estate fund in Bulgaria and the first bigger development project in Sofia in its framework, where Arco Vara would hold the role of trustee and shareholder. We must use the readiness of the Bulgarian capital market and the current visible achievements of Arco Vara as an apartment developer on the local market. At present, the proceedings to obtain the corresponding licence are underway.              

The year should also fit establishing detailed plans for the projects at Liimi 1b and Lehiku tee 21-23 in Tallinn. In the service division, the year 2016 will be important due to a transfer to new organization strategy in management, training and software developments. Managing customer relations, marketing and measuring the efficiency of work processes will change. Arco Vara must become the most human-centred real estate company, in this way contrasting to an object- or transaction-centred real estate company. Considering our nearly a hundred thousand customer contacts and the potential of our people, this is definitely useful for our clients and through this, also for the shareholders of the group. 

Financially, the income statement of 2016 holds a larger proportion in cranes and a smaller proportion in sales transactions, as we are mostly in the phase of development. Sales revenue is largely coming from the service division, rent of Madrid Blvd and the sale of apartments at Manastirski Livadi. The sale of development projects which are outside the main focus of the group is also possible, but only if we achieve value added with our work in developing the properties and the buyers are prepared to approve of this with the transaction price.   

2017

In 2017, the three large development projects mentioned above (Madrid Blvd, Kodulahe, Iztok Parkside) continue, and a  fourth development project has been added to them depending on our success in earning profit and the commencement of ARCO REIT in Sofia.

The total revenue of these three development project should reach 20 million euros in 2017, which would double the active volume of the group. At least the same should also be expected from profit. Here, I should note that this is not a limit of our current thinking and setting of goals.      

SERVICE DIVISION

In Q3 2015, revenue of service division was 852 thousand euros (in Q3 2014: 791 thousand euros), that included intra-group revenue of 107 thousand euros (in Q3 2014: 93 thousand euros). Revenue of service division from main services (real estate brokerage and valuation services) was 2,180 thousand euros decreased by 8 thousand euros compared to the same period of previous year. At the same time, third quarter revenue from main services increased by 5% compared to Q3 2014. Revenue continues to increase in Bulgaria, seeing a 41% increase if compared 9 months of both years and 34% increase if third quarters are compared. In Q3, revenue of Estonian agency increased second quarter in a row, exceeding by 21% in third quarter the figures of Q3 2014. The revenue from main services is still strongly decreasing in Latvian real estate agency: by 23% if compared 9 months periods and by 22% if third quarters are compared.

Revenue of real estate agencies from brokerage and valuation

During nine months 2015, the Estonian and Latvian agencies have operated on a loss: 68 thousand and 51 thousand euros, respectively. In nine months 2014, Estonian and Latvian agencies had net profit of 31 thousand euros and 62 thousand euros, respectively. The decrease in profitability of Estonian agency is caused by significant increase of marketing and IT expenses: the goal is set to reach higher level in revenues and accordingly growth of profit. Revenues will increase with the help of wider reputation and bigger number of contacts, customer oriented data processing and smarter work environment. Bulgarian agency’s net profit was 138 thousand euros in nine months 2015 (in 9 months 2014: 81 thousand euros) and 27 thousand euros in Q3 2015 (in Q3 2014: 15 thousand euros).

In addition to brokerage and valuation services, the service division also provides real estate management services as well as accommodation service in Bulgaria. The revenue from real estate management was 104 thousand euros in 9 months 2015, 77 thousand euros of which was intra-group revenue (in 9 months 2014: 124 thousand and 86 thousand euros, respectively). Revenue from accommodation services amounted to 105 thousand euros in first nine months of 2015, of which 50 thousand euros in Q3 (in 9 months 2014: 55 thousand and 20 thousand euros). The sales of accommodation service have shown nice growth in 2015, especially in Q3. 

The number of staff in service division has been decreased to 157 employees as at 30 September 2015, which is 19 people less compared to year end 2014.

DEVELOPMENT DIVISION

In 9 months 2015, revenue of development division totalled 6,544 thousand euros (in 9 months 2014: 1,289 thousand euros), of which 487 thousand euros in Q3 2015 (in Q3 2014: 487 thousand euros). The big leap in revenues comes from the sale of properties in the group’s own development projects, amounting to 5,713 thousand euros in nine months 2015 (compared to only 485 thousand euros in 9 months 2014).

Most of the remaining revenue of development division consist of rental income from commercial and office premises in Madrid Blvd building in Sofia, amounted to 234 thousand euros in Q3 2015 and 708 thousand euros in 9 months (in Q3 2014: 234 thousand euros and 9 months 2014: 718 thousand euros). In Q4, some decrease in rental income is expected due to conclusion of rental agreements and there is ongoing renovation and preparation works of rental spaces to meet new tenants. The rental income is planned to recover on the previous level in Q2 2016.  

In nine months 2015, operating profit of development division was 1,598 thousand euros, of which 377 thousand euros in Q3.  In nine months 2014, was earned 696 thousand euros of operating profit, of which 632 thousand euros in Q3.

In Q3 2015, has been continued the apartment sales of Manastirski Livadi project. In Q3 2015, were sold 9 apartments and one commercial space in the project, including two last apartments from first stage (named also as block C). In nine months, total of 70 apartments and 6 commercial spaces have been sold in Bulgaria. As at 30 September 2015, 3 apartments and 2 commercial spaces from second stage of the project remained in stock, out of 135 in total.

As at 30 September 2015, 66 apartments out of 80 and one commercial space out of 8 have been presold in third stage of Manastirski Livadi project. Three more apartments have been pre-sold in October. The apartment building will be ready and permit for use is scheduled for December.

28 apartments remained unsold in Madrid Blvd complex. 16 apartments and all parking places, out of all Madrid Blvd unsold apartments, are rented out.

Three apartments in Bishumuiza-1 project and one Marsili residental plot were sold in Latvia in Q3. There remains the last apartment unsold in Bisumuisa-1 project as well as 14 residental plots in Marsili.

In Estonia, there were concluded design works of the first stage apartment building (with 125 apartments and 5 commercial spaces) in Kodulahe project. Permit for construction of apartment building was obtained at the end of September. At the publishing date of the interim report, there was ongoing construction procurement and arranging the financing. The construction of the apartment building should start in December 2015, after the construction procurement and financing arrangements will succeed. The marketing of apartments started at the end of Q3.

In June 2015, a smaller land plot in Suur-Sepa street, in centre town of Pärnu, was acquired as an addition to the group’s land bank. The plot is suitable for apartment building. After preparing preliminary design the plot was sold profitably at the beginning of October. Also at the beginning of October, the group sold another smaller development: Instituudi road residental development project, acquired in February 2014. The latter project was also up-valued with the preliminary design. Selling smaller projects bears the goal of focusing on most important projects in Estonia and Bulgaria.

As at 30 September 2015, 5 people were employed in development division, the same as at the end of year 2014.

SUMMARY TABLE OF ARCO VARA’S PROJECTS AS AT 30 SEPTEMBER 2015

Note: Value presented inbetween < > means future target value as the project is in early (S1, S2) development stage and the building rights or the design have not been finished yet. The table does not reflect sellable or lettable volumes below grade including parking spaces and storages.   

Description of stages

S1: Land plot acquired
S2: Building Rights Procedure
S3: Design and Preparation Works
S4: Construction
S5: Marketing and Sale
S6: Facility Management and/or Lease

PEOPLE

As at 30 September 2015, 170 people worked for the group (189 as at 31 December 2014). Employee remuneration expenses in nine months 2015 amounted to 1.9 million euros (in 9 months 2014: 1.8 million euros).

The remuneration of the member of the management board/chief executive and the members of the supervisory board of the group’s parent company including social security charges in first nine months 2015 amounted to 83 thousand euros (76 thousand euros in 9 months 2014).

MANAGEMENT BOARD AND SUPERVISORY COUNCIL

The management board of Arco Vara AS has one member. Since 22 October 2012, the member of the management board and chief executive of Arco Vara AS has been Tarmo Sild. The mandate of the chief executive was prolonged by 3 years (until October 2018) on the supervisory board meeting held in September 2015.

At 30 September 2015, the supervisory board of Arco Vara AS has 5 members. As at the end of 2014, the supervisory board had 7 members. On 10 February 2015, extraordinary shareholders meeting recalled previous supervisory board and elected new supervisory board with 5 members: Hillar-Peeter Luitsalu, Allar Niinepuu and Rain Lõhmus (re-elected from the previous board), and Steven Yaroslav Gorelik and Kert Keskpaik (newly elected to the new board). The members of previous supervisory board Toomas Tool, Arvo Nõges, Aivar Pilv and Stephan David Balikn will not continue in new board.

More information on key persons of Arco Vara you can find on company’s corporate web page www.arcorealestate.com.

DESCRIPTION OF THE MAIN RISKS

Credit risk

The group’s credit risk arises mainly from two sources: real estate development activities and reliability of the banks where bank deposits are placed. As on real estate transactions a lot of counterparty financing goes through banks, co-operation with financing banks is common to mitigate counterparty risk. And not all cash and cash equivalents are placed on the same banking group. As a consequence, the group considers credit risk as substantially mitigated.

Liquidity and interest rate risks

The base currency of all of the group’s loan agreements is euro and the base interest rate is 3 or 6 months EURIBOR. As a result, the group is exposed to developments on the international capital markets. The group does not use hedging instruments to mitigate its long-term interest rate risk. In nine months 2015, the group’s interest-bearing liabilities have decreased by 2.7 million euros and at 30 September 2015 amounted to 12.3 million euros, of which 1.8 million euros is due within next 12 months. At the same time, the group’s cash and cash equivalents totalled 1.2 million euros as at 30 September 2015. In 9 months 2015, interest payments on interest-bearing liabilities totalled 0.6 million euros. The group’s weighted average loan interest rate was 5.1% as at 30 September 2015. This is a decrease by 0.7 percentage points in nine months 2015. The main reason for the decrease of average interest rate is the premature redemption of bonds in February 2015. The bonds bore higher than average interest rate. Marginal effect had also the decrease of EURIBOR rates down to zero-level.

Currency risk

Purchase and sales contracts of provided services are mostly signed in local currencies: euros (EUR) or Bulgarian lev (BGN). Real estate sales are mostly nominated in euros, as a result of which the group’s assets and liabilities structure does not denote a significant currency risk. The group is not protected against currency devaluations. Most liquid funds are held in demand or short-term deposits denominated in euros.

Share and shareholders

Arco Vara AS has issued a total of 6,117,012 ordinary shares with nominal value of 0.7 euros per share. The shares are freely traded on NASDAQ OMX Tallinn stock exchange. As at 30 September 2015, the company had 1,620 shareholders (at 31 December 2014: 1,668) including 1,395 individuals as shareholders. The share price closed at 1.06 euros. The price has increased by 28% within nine months 2015 (closing price at the end of 2014 was 0.828 euros). During the period, the highest price per share was 1.29 euros and lowest price 0.83 euros. As at 30 September 2015, market capitalization of shares amounted to 6,484 thousand euros and P/E ratio of the share was 4.9 (at 31 December 2014: 5,065 thousand euros and 5.5, respectively).

¹ - Steven Yaroslav Gorelik is active as fund manager in three investment funds holding interest in Arco Vara (Firebird Republics Fund Ltd, Firebird Avrora Fund Ltd and Firebird Fund L.P) of 692,750 shares (total of 11.3% interest). 

Consolidated statement of comprehensive income

Consolidated statement of financial position

Consolidated statement of cash flows

Consolidated statement of changes in equity

         Marek Pontus
         CFO
         Arco Vara AS
         Ph: +372 614 4662
         marek.pontus@arcovara.ee
         http://www.arcorealestate.com