Arco Vara AS unaudited consolidated interim report for second quarter and 6 months 2016

General information

Arco Vara AS and other entities of Arco Vara group (hereafter together ‘the group’) are engaged in real estate development and services related to real estate. The group regards Estonia, Latvia and Bulgaria as its home markets. The group has two business lines: Service division and Development division.

The Service division is engaged in real estate brokerage, valuation, management and consulting as well as in short-term investment in residential real estate. The Service division offers to the group additional value by generating analytical data on market demand and supply, also behaviour of potential clients. Analytical data allows making better decisions on real estate development: on purchase of land plots, planning and designing, pricing end products also on timing the start of construction.

The Development division develops complete living environments and commercial real estate. Fully developed housing solutions are sold to the end-consumer. In some cases the group is developing also commercial properties until they start generating cash flow for two possible purposes: for the support of the groups’ cash flows or for resale. The group is currently holding completed commercial properties that generate rental income.

As at 30 June 2016, the group comprised 23 companies, which is two less than at the end of year 2015. On 19 February 2016, the group’s subsidiary Fineprojekti OÜ was deregistered in Estonian Commercial Register, the liquidation process was started in 2014. The liquidation also resulted in derecognition of Romanian subsidiary Arco Capital Real Estate SRL from the group’s structure. In Q1 2016, the group’s interest in Bulgarian real estate fund Arco Real Estate Fund REIT was increased from 70% up to 100% and the share capital of the fund was additionally increased by 77 thousand euros. In April 2016, the group sold 100% subsidiary Arco BB EOOD in Bulgaria and in May 2016 the group purchased 100% subsidiary Iztok Parkside EOOD in Bulgaria. None of these transactions had significant impact on the group’s net assets. 

Significant subsidiaries

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

Key Performance Indicators

·     In Q2 2016, the group’s revenue was 2.1 million euros, exceeding by 1.7% the revenue of Q2 2015. Revenue increased by 1.1% in Development division and by 5.1% in Service division. The group’s revenue of 7.2 million euros for the 6 months 2016 exceeded by 10.7% the revenue of comparative period of year 2015. The growth of revenue comes from Development division, where revenue increased by 12.5% up to 5.8 million euros for 6 months 2016 (6 months 2015: 5.2 million euros). The revenue of Service division amounted to 1.6 million euros in 6 months 2016, increased by 0.6% compared to 6 months 2015.

·     In 6 months 2016, the group’s operating profit (=EBIT) was 1.2 million euros and net profit 0.9 million euros. In 6 months 2015, the same figures were 1.1 million euros and 0.7 million euros respectively. The group’s operating profit comes from Development division, amounting to 1.5 million euros for 6 months 2016 (in 6 months 2015: 1.2 million euros). In second quarter 2016, the group ended with operating loss (=EBIT) of 0.1 million euros and net loss of 0.2 million euros. In Q2 2015, the group earned operating profit of 0.2 million euros and net profit figure was practically on zero level.

·     The group has continued to decrease debt burden in 2016. Net loans have decreased by 2.1 million euros in first 6 months 2016 down to the level of 9.9 million euros as at 30 June 2016. Total loans and borrowings amounted 10.8 million euros at 30 June 2016, decreased by 1.9 million euros in 6 months. As at 30 June 2016, the weighted average annual interest rate of loans was 5.7%. This is an increase by 0.7 percentage points compared to 31 December 2015.

·    In Q2 2016, 5 apartments, 3 commercial spaces and 4 land plots were sold in projects developed in the group (in Q2 2015, 13 apartments were sold). In 6 months 2016, 73 apartments, 5 commercial spaces and 4 land plots were sold (in 6 months 2015: 61 apartments and 5 commercial spaces).

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)
Diluted earnings per share (Diluted EPS) = net profit attributable to owners of the parent / (weighted average number of ordinary shares outstanding during the period + number of all potentially issued 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
Current ratio = current assets / current liabilities
Quick ratio = (current assets - inventory) / current liabilities
Financial leverage = total assets / equity
Number of staff at period-end = number of people working for the group under employment or authorization (service) contracts

Group Chief Executive’s review

Arco Vara completed during Q2 several steps towards achieving its short-term goal - to double its volume of operations and profit by the end of 2018. Figuratively speaking, this progress can be seen in cranes that have been or will be set up. The numbers in the second-quarter earnings report are modest and overheads mean that the bottom line is negative. As I have said earlier, the numbers are set to remain modest until the end of the third quarter 2017. It is important to look at the internal dynamics of the group that forms a foundation for the upcoming results of 2017, 2018 and subsequent years.  In Q2, we moved forward with such development projects that customers want and can afford to buy.

Key developments: Kodulahe and Iztok Parkside

Construction of phase one of the Kodulahe residential development in Tallinn has progressed as planned and presales are meeting our expectations. We intend to continue at the same pace, which means that all 130 apartments and commercial spaces of the first phase become sold out by the end of 2017 or in Q1 2018. Along with the construction of the building and development of the recognizable future living environment, there has been a noticeable increase in the customers' interest.

In the Iztok Parkside project in Sofia we completed the acquisition transaction of the property. Design works are in schedule. Obtaining the detail plan from Sofia municipality has taken a little longer, but was nearing completion by end of Q2. In Q3, we expect the detail plan to enter into force. We also expect to execute financing contract with the bank and obtaining of a building permit so that both actual construction works and presales can start already by the end of the year.  Sales revenue of Iztok Parkside will appear in the income statement of Q1 2018.

Expected profit margin of both projects remains unchanged. The target return on equity (ROE) is 20% per year. In the development of both projects the critical part is to find such financing solutions that will allow - when demand is sufficient - to continue uninterrupted development of the second phase of Kodulahe, as well as the development of Project X in Sofia, a successor project to Iztok Parkside.    

Madrid Blvd

We were too optimistic in our forecast for new tenants for office spaces. Although the location of our building, quality of premises on offer and the rental price are competitive, the flexibility of tenants in moving from their existing space and terminating the existing contracts is more limited than we thought. The number of first time tenants entering the market in Sofia is relatively limited. Therefore, the rental income of Q2 is not satisfactory. No new rental agreements were concluded, and the vacancy rate of the building remains unchanged. Rental income earned at present from the building's commercial space, rental apartments and two office spaces is slightly lower than the interest expense of the Piraeus bank loan. However, negotiations with several tenants are at a stage where we expect a significant reduction in the vacancy by end of Q3. As at the end of the year, the building's free cash flow and impact on the income statement should be positive.  

In Q2 we sold and delivered four apartments and some parking spaces in the Madrid Blvd building. Therefore, the balance of the outstanding bank loan on the building decreased to below EUR 9.5 million by the date of publication of the interim report. At the date of the interim report, the stock of vacant apartments on sale has decreased to 6 units. The remaining apartments (15) are rented out.

Other developments

In Q2 we started preparations for taking several land plots in the group's land bank into active development in order to strengthen the results in 2017 and 2018. We sold Viimsiranna properties. In addition, one property in Tartu may be exchanged with an immovable suitable for residential development in the same city. The property at Liimi 1b in Tallinn will be either sold off or we will develop it ourselves into cashflow-generating estate. The detail plan for the Lehiku tee property in Tallinn has been approved and we hope that it will enter into force by end of the year. Our land bank has some other untapped resources that could become active in the coming years in connection with the increase in Tallinn's population.       

Service Division

The results of the Service Division as a whole are still not satisfactory for the Management. Our business in Bulgaria is profitable, and we opened already a second representative office in Sofia. However, in Latvia and Estonia we are losing money. The company's goal is to be the most human-focused real estate company, which requires some changes in staff thinking, especially in the thinking of brokers who are focusing narrowly on the property sales. It’s “bricks versus people” change in the thinking. The positive in Estonia is that the revenues of the appraisal services have grown beyond expectations and, taken alone, are profitable.  In Estonia as a whole we also see that the structure of revenues is gradually benefitting brokers and appraisers who are professionals only, and dedicated and consolidated under the Arco Vara brand. The Management Board still expects the Estonian unit to become profitable by the end of 2016 at the latest. In order to become profitable, we must increase revenues (brokerage efficiency) at the present fixed costs base.

With regard to the Latvian service unit should be noted that the group's opportunities to influence the management of that company are limited since the group is not its sole owner and several important decisions can be made with consensus only.    

Forecast for the year

As at the end of the first quarter, the Management maintains its previous annual forecast: 2016 sales revenue of 10.3 million euros and net profit of 0.8 million euros. We will be driving through the whole 2016 on the results of Q1. The quarters that follow will add sales revenue, brokerage transactions, issued expert opinions and building of new apartments, but also slightly erode the profit earned during Q1, because of continuous overheads. 

Developments in Arco Vara home markets

Sofia

In Sofia, real estate market is in stable growth phase. In first half of year 2016, 7% more (compared to the same period of year 2015) real estate transactions have been concluded. The total value of new mortgages set had increased by 19% in the same period. There have been issued more construction permits in Sofia, but also in Plovdiv, the second-largest city in Bulgaria. 5% raise in real estate prices is forecasted for the whole year 2016. The real estate market benefits also from the decrease of interest rates on mortgaged loans staying mainly between 4.25% and 5.25% during first half of 2016. Based on experience of the group’s brokerage agency the typical traded one-bedroom apartment in Sofia is between 55-65 square meters in size and between 850-1,000 euros per one square meter of sellable area. The most popular two-bedroom apartment is between 85-100 square meters in size and between 800-900 euros per one square meter of sellable area.

Tallinn

In second quarter 2016, 2,261 apartment sale-purchase agreements were concluded in Tallinn. This is 9.9% more than Q1 2016 while 1.3% less than Q2 2015. In 6 months 2016, 4,318 apartment sale-purchase agreements were concluded in Tallinn, increased by 2.3% compared to the same period of last year. In Q2 2016, median price on apartment sales in Tallinn was 1,516 euros per square meter, increased by 3.1% compared to previous quarter and increased by 3.6% compared to Q2 2015. Based on transaction statistics we can consider Tallinn apartment market as stable with slightly growing trend in sale prices. In last year, transaction activity and prices have increased more in districts bordering city centre like North Tallinn, Kristiine, also Mustamäe. Apartment market is strongly impacted by new developments, which motivate people to change their living place, but on the same time increased offer makes the clients more demanding.

SERVICE DIVISION

In Q2 2016, revenue of the group’s service division was 850 thousand euros (in Q2 2015: 809 thousand euros), that included intra-group revenue of 129 thousand euros (in Q2 2015: 117 thousand euros). Service division revenue was practically the same if 6 months periods were compared: 1,598 thousand euros in 6 months 2016 and 1,588 thousand euros in 6 months 2015. Revenue of service division from main services (real estate brokerage and valuation services) has increased in 2016 if compared with the same period of 2015: growing by 9% if comparing second quarters and 3% if comparing 6 months periods. Revenue from main services has increased in Estonian and Latvian brokerage agency and decreased in Bulgarian agency. The drop in the revenue of Bulgarian agency can be attributed to the decreased income from mediating the sales of the group’s own properties.

In 6 months 2016, Estonian and Latvian agencies have operated on a loss: 119 thousand euros and 18 thousand euros respectively (in 6 months 2015, had a loss of 40 thousand euros and 48 thousand euros respectively). Bulgarian agency had net loss of 2 thousand euros in 6 months 2016, but earned net profit of 111 thousand euros in 6 months 2015.

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 56 thousand euros in 6 months 2016, 48 thousand euros of which was intra-group revenue (in 6 months 2015: 82 thousand and 57 thousand euros, respectively). Revenue from accommodation services amounted to 64 thousand euros in 6 months 2016 (in 6 months 2015: 55 thousand euros). 

The number of staff in service division has been increased to 172 employees in first six months of 2016, this is 7 people more compared to year end 2015. The number of staff is increased mainly in Bulgaria.

DEVELOPMENT DIVISION

In Q2 2016, revenue of development division totalled 1,403 thousand euros (in Q2 2015: 1,382 thousand euros) including revenue of 969 thousand euros (Q2 2015: 791 thousand euros) from the sale of properties in the group’s own development projects. In 6 months 2016, development division revenue amounted to 5,815 thousand euros, which is 12.5% more compared to 6 months 2015 then revenue was 5,170 thousand euros.

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 88 thousand euros in Q2 2016 and 163 thousand euros in 6 months 2016 (in 2015: 237 thousand euros in Q2 and 474 thousand euros in 6 months). Rental income has decreased compared to previous year due to conclusion of rental agreement with anchor tenant in Q3 2015 and the renovation works of rental spaces in Q4 2015. The rental space that was previously rented out for one anchor tenant is now divided into 7 separate spaces. The search of new tenants is ongoing, the first rental agreement was concluded in Q2 2016. The rental income is planned to recover close to the previous level by the end of year 2016.  

In 6 months 2016, operating profit of development division was 1,491 thousand euros, of which 105 thousand euros was earned in Q2. In 6 months 2015, the operating profit was 1,221 thousand euros, of which 255 thousand euros in Q2.  

During Q2 2016, the construction of first stage apartment building (with 125 apartments and 5 commercial spaces) in the group’s biggest development project Kodulahe continued in Tallinn.  By the publishing date of the interim report, presale agreements for 41 apartments and one commercial space have been concluded. The construction of the apartment building should finalize at the beginning of summer 2017.

In Q2 2016, sale of last apartments and commercial spaces in Manastirski Livadi project in Sofia have been continued. During the quarter, one apartment (the last one for the whole project) and 4 commercial premises were sold. As at 30 June 2016, 4 commercial spaces and some parking places remained unsold in the project.

As at 30 June 2016, 22 apartments remained unsold in Madrid Blvd complex in Sofia. In Q2 2016, 4 apartments were sold and after the reporting period another one. 15 apartments, out of all Madrid Blvd unsold apartments, are rented out as accommodation service. Unsold 105 parking places are also rented out.

In May 2016, the group finalized the purchase of a company Iztok Parkside EOOD. As a result, the group’s development portfolio has new development project in Iztok district in Sofia. By the date of publishing the interim report, detail plan for the project’s property has been established. It is expected, that City Government of Sofia should adopt the plan in Q3 2016. In q2 2016, design contest was carried out, which foresees construction of three apartment buildings with 68 apartments and 7,070 square meters of apartments’ sellable area. The construction should start in Q4 2016 and apartment buildings should be completed by the end of year 2017.

In second quarter, two Marsili residential plots were sold. 12 plots remained unsold, on one of which has been concluded presale agreement - the final sale should be concluded in Q3 2016.

As at 30 June 2016, 5 people were employed in development division, the same number as at the end of year 2015.
 

SUMMARY TABLE OF ARCO VARA’S ACTIVE PROJECTS AS AT 30 JUNE 2016

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. The table does not provide complete overview of the group’s land bank.   

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 June 2016, 185 people worked for the group (178 as at 31 December 2015). Employee remuneration expenses in first 6 months 2016 amounted to 1.4 million euros (in 6 months 2015: 1.3 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 6 months 2016 amounted to 57 thousand euros (54 thousand euros in 6 months 2015). 

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.

The supervisory board of Arco Vara AS has 5 members. Since 10 February 2015, supervisory board comprise: Hillar-Peeter Luitsalu (the chairman), Allar Niinepuu, Rain Lõhmus, Steven Yaroslav Gorelik and Kert Keskpaik.

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

Strategic risk

Most of the group’s equity is placed in real estate development. The group is focused mainly on residential real estate development where development cycle lasts for years consisting of detail planning, designing, construction and sale - starts from purchase of land plot and finishes with the sale of end products to customers. The equity is invested mainly in starting phase of the cycle (purchase of land) on the assumption that there will be a demand for certain products in the future. Considering that the demand for development product is largely based on forecast and not on transaction then the main risk for the group is investing equity to the development product for which there is no demand in the future.

For mitigating the risk: (i) the group invests equity into different development project in different markets (in 2016, in Sofia and Tallinn), (ii) monitoring current demand and supply in its home markets and (iii) makes efforts to narrow the time between moment of investment and moment of the demand is rising - signing pre-agreements with clients, purchases land without using equity or postpones it using project financing alternatives there equity placement is not necessary. 

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 first 6 months 2016, the group’s interest-bearing liabilities have decreased by 1.9 million euros and at 30 June 2016 amounted to 10.8 million euros, of which only 0.1 million euros is due within next 12 months. At the same time, the group’s cash and cash equivalents totalled 0.9 million euros as at 30 June 2016 (at 31 December 2015: 0.7 million euros). In 6 months 2016, interest payments on interest-bearing liabilities totalled 0.4 million euros (in 6 months 2015: 0.5 million euros). The group’s weighted average loan interest rate was 5.7% as at 30 June 2016. This is an increase by 0.7 percentage points compared to the end of year 2015. The reason for the increase is bonds issued in January 2016, the bonds bear significantly higher than average interest rate.

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 Tallinn stock exchange. The share price closed at 1.07 euros as at 30 June 2016. The price has decreased by 7% within 6 months 2016 (closing price at the end of 2015 was 1.15 euros). During the period, the highest traded price per share was 1.15 euros and lowest price 1.01 euros. As at 30 June 2016, market capitalization of shares amounted to 6,545 thousand euros, P/E ratio of the share was 10.7 and P/B ratio 0.63 (at 31 December 2015: 7,035 thousand euros, 15.8 and 0.73, respectively).

Structure of shareholders

As at 30 June 2016, Arco Vara had 1,536 shareholders (at 31 December 2015: 1,600) including 1,327 individuals as shareholders (at 31 December 2015: 1,381 individuals) who jointly owned 13.5% (at 31 December 2015: 12.7%) interest out of all Arco Vara shares. 

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). 

Condensed consolidated interim financial statements

Consolidated statement of comprehensive income

Consolidated statement of financial position

Consolidated statement of cash flows

Consolidated statement of changes in equity

         Contact information:
         Marek Pontus
         CFO
         Arco Vara AS
         Tel: +372 614 4662
         marek.pontus@arcovara.ee
         www.arcorealestate.com