2010 12 months and IV quarter consolidated unaudited interim report

Tallinn, Estonia, 2011-02-22 08:00 CET (GLOBE NEWSWIRE) -- 2010 12 months and IV quarter consolidated unaudited interim report

MANAGEMENT REPORT

General information

AS Merko Ehitus operates in Estonia, Latvia and Lithuania as a construction group providing integrated construction solutions. 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%) and AS Tartu Maja Betoontooted (25%).

At the regular meeting of shareholders held on 3 June 2010 Jaan Mäe was removed from the position of a Member of the Supervisory Board in connection with the restructuring of the company’s managerial structure in the course of which he was elected a Member of the Management Board of AS Merko Ehitus.

On 21 December 2010 the Supervisory Board of AS Merko Ehitus decided to appoint Viktor Mõisja who had previously held the position of the Head of the Concreting Department to the Management Board of the company. Viktor Mõisja took office on 21 December 2010 and was made accountable for the spheres of quality management and inspection. In addition, Viktor Mõisja will represent AS Merko Ehitus at the court hearing that began at the Harju County Court on 10 January 2011 where AS Merko Ehitus and its subsidiaries will be prosecuted for offering bribes (i.e. gift certificates of a tourism agency in the value of 2556 Euros and an architectural book titled “Talurahva arhitektuur”). An accused legal entity must be represented in court by a Member of its Management Board.

On 22 December 2010 AS Merko Ehitus established a fully owned subsidiary in Ukraine called LLC Merko Ukraine (registration code 37458687). The establishing process was a mere formality the aim of which was to create a legal platform in order to start doing business on the local market. With this move, Merko Ehitus wishes to confirm its strategic interest in entering the Ukrainian market. The company established will mainly specialize in the managing of construction projects in Ukraine.

Due to the extensive changes in the economic environment and on the construction market, the management and supervisory boards of AS Merko Ehitus have reviewed the corporate strategy and established the group’s strategic targets for 2010 to 2015.

The strategy covers the period from this year until the end of 2015. All the main principles and some of the financial targets, such as the minimum equity ratio, must be applied or met throughout the defined period.

The detailed strategy is based on the following estimates and assumptions about Baltic economy:

• There will be no economic growth in 2010; the construction sector will experience a fall by max. 10%;
• In the coming years (2011 and 2012), economic growth will not exceed 3%, as estimated by different experts;
• The main clients in the coming years will come from the public sector where focus will be on infrastructure projects co-financed by the EU funds;
• Since the public sector lacks the financial means for investment, there will be more extensive application of PPP (public private partnership) models;
• There will be more projects related to the improvement of energy performance;
• There will be more activity on the apartment market, compared to the slump in recent years;
• There will be an increased demand for industrial facilities;
• The availability of credit/loans will improve;
• Starting 2011, unemployment rates will decrease and the retail business will enter the phase of recovery.

AS Merko Ehitus strategic targets:

• The vision of AS Merko Ehitus is to provide its clients with high-quality construction services in various fields.
• AS Merko Ehitus aims to be the leading construction company on its home market – in the Baltic countries.
• In addition to the home market, AS Merko Ehitus has identified Ukraine (especially Kiev) and St. Petersburg in Russia as its prospective markets.
• Outside of the above-mentioned markets, the company will only provide construction/development services for clients that Merko has cooperated with in the past or that require a facility similar to previous construction/development projects successfully executed by Merko.
• In 2015, turnover from Estonian operations would constitute approx. 35% of the consolidated turnover; turnover from Latvian operations, Lithuanian operations, and other markets would account for approx. 30%, 25% and 10%, respectively, of the consolidated turnover. The division of profit between the different markets is expected to be more or less similar to the division of turnover.
• In addition to current construction and design-engineering services, the company will offer an even more comprehensive service covering the entire process, from helping to find the suitable plot of land to helping the client obtain financing.

 AS Merko Ehitus long-term financial targets:

• To ensure that the average annual return on equity (ROE) of the group between 2011 and 2015 is at least 15%;
• To ensure that the group’s equity ratio is at least 40% throughout the entire period.

 In order to fulfil our targets:

1. We will look for opportunities to acquire holdings in successful companies, especially in Lithuania and Latvia.
2. We will restructure the group’s management system with the help of the following methods, above all:

• We will add a fifth member to the management board; their responsibilities will initially include foreign markets and development activities;
• We will launch several new activities in order to improve horizontal cooperation between the different companies in the group, and in order to utilise the engineering know-how and management expertise (acquired in different countries) in the different functions of the group;
• As the final outcome of the restructuring, we envision a publicly traded holding company which has divisions in all countries where the group has permanent operations, controlled through locally registered entities.

    3. We will preserve the core of the motivational system, which has proved to be effective so
        far, and will enhance the system in line with our set targets.

Operating results

Group’s revenue for the year 2010 was EUR 171.9 million (EEK 2689.9 million). 72.3% of the sales originated from Estonia, 25.1% from Latvia and 2.6% from Lithuania. As compared to with the year 2009, Group’s sales decreased by 15.4% incl. by 10.9% in Estonia, by 27.1% in Latvia and by 5.1% in Lithuania.

Group’s revenue for the IV quarter 2010 was EUR 45.6 million (EEK 714.3 million), which constitutes an annual decrease of EUR 8.5 million (EEK 133.6 million).

In 2010, the Group concluded new contracts for a total value of EUR 290 million (EEK 4.54 billion), whereas the total value of contracts concluded in Q4 was EUR 79 million (EEK 1.24 billion). The largest construction contracts concluded in 2010 have been the reconstruction of Ülemiste traffic junction (EUR 41.4 million), construction of the E20 Loo-Maardu road section (EUR 18.5 million), the water management project of the city of Maardu for the construction of the water and sewerage pipelines and facilities of the residential area of Muuga (EUR 13.3 million), construction of the Iru Waste energy block (EUR 12.6 million) and renovation of the common water supply of the Kohtla-Järve area (EUR 7.8 million). As of 31 December 2010, the Group’s backlog of construction contracts in progress amounted to EUR 200 million (EEK 3.13 billion).

The group’s own residential development projects and construction works related to property investments are not reported in the Group’s contract portfolio. On 13 July 2010 UAB Merko Statyba, a subsidiary of AS Merko Ehitus, concluded a contract with a Vilnius city real estate company regarding the construction and 25-year rental of a Balsiu school building. The estimated investment of the project is EUR 10 million and the building needs to be ready to welcome its new students on 1 September 2011. In August 2010, the Group signed a contract with Lasnamäe City District Government to lease 2405 sq. metres of office premises to the City District Government for 15 years, starting August 2011.

In 2010, 233 apartments were sold for a total cost of EUR 17.9 million (EEK 280.7 million) excluding value-added tax; this is a perfectly good result considering market conditions. As of 31.12.2010 Group held in inventories unsold 63 completed apartments in total cost EUR 4.9 million (EEK 77.1 million) and 424 apartments in the construction stage in total cost EUR 16.3 million (EEK 255.7 million). In the III quarter of 2010, Merko Ehitus started constructing a new apartment building with 93 apartments in Tallinn at Tartu mnt 50 and in IV quarter a new apartment building with 15 apartments in Tallinn at Kristiina 12. New apartments will be completed in the IV quarter of the year 2011. SIA Merks restarted its development project with 116 apartments in Riga, in the Skanstes area. The investment necessary for completing the project is EUR 3 million (EEK 46.9 million) and the construction works of the objects are planned to be completed in 2011 Q1. In 2010, the Group depreciated inventories by EUR 1.6 million (EEK 24.9 million) and cancelled previous depreciations by a total of EUR 0.6 million (EEK 9.0 million).

The consolidated revenue of the Group’s most important companies

Due to the decrease in volumes and the significant rise in input prices (several projects ended up in loss), the share of cost of goods sold in total costs increased, meaning that the gross profit margin fell from 10.9% to 7.3% compared to the previous year and. In 2010, the group’s marketing and general administrative costs decreased by 15.1%. The economizing measures taken to reduce costs helped to decrease marketing and administrative expenses, with the EUR 1.1 million (EEK 16.4 million) decrease in labour costs, EUR 0.6 million (EEK 9.1 million) decrease in office expenses and communication services, EUR 0.6 million (EEK 8.6 million) decrease in construction tenders and EUR 0.3 million (EEK 4.7 million) decrease in advertising and sponsoring were the most significant factors. Regardless of the general decrease in the marketing and general administrative expenses, the expenses on consultations and legal assistance increased, as compared to the previous year, by EUR 0.3 million (EEK 5.0 million), which is largely due to legal disputes related to procurement proceedings.

Group’s earnings before taxes in 2010 were EUR 1.8 million (EEK 27.7 million), which means a decrease by EUR 5.9 million (EEK 92.2 million) compared to 2009. The net profit in the period was EUR 1.2 million (EEK 18.9 million); representing a EUR 6.2 million (EEK 97.2 million) or 83.7% decrease. The fall in profits was affected by revenue, the reduced profitability of the construction and property development sectors. Since construction prices rose faster than expected, the company was forced to significantly adjust the estimated cost of contracted works. That is also the main reason for the EUR 4.0 million (EEK 62.4 million) loss in Q4. The cyclical nature of development projects did not have a significant impact on performance in the second half of 2010.

In 2010 Group’s change in short-term investments and pecuniary means amounted to EUR -36.3 million (EEK -567.6 million) and as of 31 December 2010, the Group had EUR 12.5 million (EEK 195.7 million) of funds on the Group’s bank accounts and deposits. Group’s cash flows from operating activities were EUR -7.3 million (EEK -113.4 million), from investment activities EUR -6.5 million (EEK -101.7 million) and from financing activities EUR -22.5 million
(EEK -352.5 million). The cash flows from operating activities of the reporting period were mostly affected by change in trade and other payables related to operating activities EUR +6.3 million (EEK +98.4 million), change in inventories EUR +5.6 million (EEK +87.5 million) and change in receivables and liabilities related to construction contracts recognised under the stage of completion method EUR -23.4 million (EEK -365.5 million). From investment activities cash flows balance of granted/received loans totalled EUR -4.0 million (EEK -62.1 million), purchase of real-estate investments totalled EUR -2.6 million (EEK -41.0 million) and purchase of property, plant and equipment totalled EUR -0.8 million (EEK -12.6 million). Of the cash flow from financing activities, EUR -12.4 million (EEK -194.7 million) was used to dividend payment, EUR -10.8 million (EEK -168.2 million) for loan repayments and EUR 1.4 million (EEK -22.6 million) for finance lease principal payments.

The ratios and methodology for calculating the financial ratios describing the Group’s main operations

Net profit margin: Net profit* / Revenue
Profit before taxes margin: Profit before taxes / Revenue
Operating profit margin: Operating profit / Revenue
Gross profit margin: Gross profit / Revenue
EBITDA margin: (Operating profit + Depreciation and impairment charge) / Revenue
Return on equity: Net profit* / Average equity during the period*
Return on assets: Net profit* / Average assets during the period
Equity ratio: Owners equity* / Total assets
Current ratio: Current assets / Current liabilities
Quick ratio: (Current assets – Inventories) / Current liabilities
General expense ratio: General expenses / Revenue
Gross remuneration ratio: Gross remuneration / Revenue

* attributable to equity owners of the parent

Construction market

In 2010, the construction market was characterised by three key-words – low demand, intense competition and rapid increase in input prices.

Boosted by a general economic upturn, the Baltic construction market showed signs of recovery in Q4: compared to Q4 2009, volumes increased by 17.7% in Lithuania and remained on the same level in Latvia. A similar trend (+0.3%) could be observed in the Q3 performance of the Estonian construction market (Information about market performance in Q4 2010 will be published on 1 March 2011). Although there was some improvement in individual quarters, the overall result for 2010 was a fall in market volume, by 9.2% in Lithuania and by 20.1% in Latvia. The Estonian market had a 17.9% decrease in the first nine months. Most of the new contracts have come from the public sector and are financed by EU structural funds. Private-sector clients still lack confidence about the future, resulting in virtually no interest in new buildings/facilities. The rental market is improving – rental prices have stabilised and the amount of available premises has decreased, whereas investors are showing greater interest in projects with rental income and in undeveloped lots.

In 2010, there was an improvement on the residential property market in Estonia and Lithuania, with an increase in both the number of transactions and the average price. The upturn in residential property prices and the signs of economic stabilisation have motivated people to take action, after a long period of postponing the purchase of a home. The positive trend is the result of improved financing options, especially the lower level of required self-financing and lower interest rates for end-consumers. A temporary sales boost in the residential property sector has encouraged developers to reconsider their postponed projects and to prepare new business plans and file loan applications. Despite the surge of optimism among developers, the launch of new projects still comes with big risks – the rise in construction prices clearly exceeds the rise in selling prices, which hampers the profitability of development projects. Therefore, we estimate that the number of new developments will remain small in the near future and the supply of residential properties will decrease. Based on decreased supply and rising construction prices, we predict that the prices of residential properties will continue to rise over the next 12 months.

Strong global demand has increased the cost of inputs in the construction sector; prices have risen for materials as well as equipment rental. The strong demand in the Central-European and Scandinavian construction sector offers a good alternative for local workers – but when they take up employment abroad, it makes labour here more costly. With the higher cost of inputs and many sub-contractors focusing on foreign markets, construction services have become significantly more expensive in the last six months. Compared to 2009 when the construction market was at its low point, construction prices have increased by 20-25%. The high volatility of prices complicates cost-estimation for new projects and makes it difficult to complete projects within the planned budget. It means an additional risk for fixed-price contracting and puts price pressure on profitability. These factors contributed greatly to the group’s lower-than-expected performance in Q4.

On the main contracting market, companies continue submitting of tenders featuring sums below their actual service costs in order to secure new orders while participating at invitations to tender, which results in the withdrawal of tenders or termination of contracts. In general, the victim in situations like these is the contracting entity from whom the launching of new procurement proceedings requires additional time and funds. It often happens that companies that submit such tenders complete the costly preparatory work, make a considerable profit from it and then leave the construction site. When new procurement proceedings are launched it then comes clear that the actual cost of the incomplete work exceeds the cost of the work the previous contractor failed to complete manyfold. Unhealthy competition is promoted by the indifference of contracting entities and their fear of catching the eye of the public with unsuccessful procurements. Merko Ehitus does not approve of such practices and intends to stand by its commitments in the future as well. As of 31.12.2010 the funds allocated to cover unprofitable projects throughout the group amounted to EUR 2.2 million (EEK 34.8 million).

Employees and remuneration

In 31.12.2010, the number of employees in the Group’s service was 923, including 878 full-time employees. The Group increased the number of its personnel by 31.5% or 221 employees in a year. The gross remuneration paid to employees in 2010 amounted to EUR 16.0 million (EEK 250.4 million) a decrease of 10.2% compared to previous year. The smaller amount of performance pay, due to the fall in the group’s profitability contributed to the fall in the group’s labour costs.

Members of the Supervisory and Management Board of AS Merko Ehitus

Supervisory Board

Members of the supervisory board have been elected by the general meeting of shareholders. The supervisory board shall plan the activities of the company, organize the management of the company and supervise the activities of the board. The supervisory board consists of 4 members.

Tõnu Toomik – Born on 8 March 1961. Finished current Raatuse Gymnasium in Tartu (formerly Tartu Secondary School No. 3) and graduated from Tallinn University of Technology in the specialty of industrial and civil engineering.
Started in AS Merko Ehitus in 1993 as the project manager. In the years 1997-2008 was the chairman of the management board of AS Merko Ehitus, responsible for the management and development of the activities of the company. Since August 2008 the chairman of the supervisory board of AS Merko Ehitus.

Teet Roopalu – Born on 30 August 1949. Finished Tallinn Secondary School No. 10 (currently Nõmme Gymnasium) and graduated from the economic faculty of Tallinn University of Technology in the specialty of construction economics and organisation. Has worked in the construction companies, incl. as a financial director; managed the economic activities in EKE system as the chief economist; as the bank director and also been involved in designing. Since November 2002 in Merko Ehitus, responsible for the financial and legal sector in Merko Ehitus. Belongs to the supervisory boards of several subsidiaries and associated companies of Riverito and Merko Ehitus.

Indrek Neivelt – Born on 17 March in 1967. Graduated from the class specialized in mathematics-physics of Tallinn Secondary School No. 1 (Gustav Adolf Gymnasium), the specialty of civil engineering and management of Tallinn University of Technology and the specialty of banking and finances of Stockholm University with the Master's degree.
Having worked in Hansapank in different positions during 1995-2005, the last six years of it as the general director of the group and the chairman of the management board. Since 2005 the chairman of the supervisory board of Bank Saint Petersburg and also the member of the supervisory board of other different companies. Since October 2008 the member of the supervisory board of AS Merko Ehitus.

Olari Taal – Born on 7 August 1953. Olari Taal finished Varstu Secondary School in 1971 and graduated from Tallinn University of Technology as the civil engineer in 1976. He has managed Tartu Elamuehituskombinaat /Tartu Housing Plant/ (Tartu Maja) and Eesti Hoiupank. He has served the Republic of Estonia as the Minister of Construction, Minister of Economic Affairs, Minister of the Interior and as the member of the 10th composition of the Parliament. Since October 2008 Olari Taal is the member of the supervisory board of AS Merko Ehitus.

Management Board

The management board is a directing body of the company which represents and directs the company. The management board shall, in directing, adhere to the lawful orders of the supervisory board. The management board is required to act in the most economically purposeful manner. Since 21 December 2010 the management board consists of 6 members.

Tiit Roben – Born on 5 January 1966. Finished the current Mustamäe Gymnasium (formerly Tallinn Secondary School No. 44) and graduated from Tallinn University of Technology in the specialty of industrial and civil engineering.
Worked as the project manager in AS Merko Ehitus in the years 1998-2002. In the years 2002-2008 worked in E.L.L. Kinnisvara AS, the company of AS Riverito, since 2005 the member of the management board of the company, development director. Since August 2008 the chairman of the management board of AS Merko Ehitus, responsible for the management and development of the activities of the company.

Jaan Mäe – Born on 26 September 1964. Finished Viljandi Secondary School no. 5 and graduated from Tallinn University of Technology in the specialty of industrial and civil engineering. Since December 1997 in AS Merko Ehitus, have been the object manager, project manager, division manager and member of the management board. In the years 2006-2010 - member of the supervisory board of AS Merko Ehitus and several other companies belonging to the group. Since June 2010 - member of the management board of AS Merko Ehitus, being responsible for the achievement of the objectives set in the development sector, and the chairman of the supervisory board of the Latvian and Lithuanian subsidiaries.

Alar Lagus – Born on 15 February 1969. Finished Rapla Secondary School and graduated from the chemical faculty of Tallinn University of Technology in the specialty of public catering organisation and technology. Pursuant to the graduation from the university worked for ten years at the different positions in Hansapank. Since 2004 works as the manager of the financial sector of Merko Ehitus and is responsible for the company's financial and managerial accounting and investor relations.

Veljo Viitmann – Born on 13 March 1962. Finished Türi Secondary School and graduated from the civil engineering faculty of Tallinn University of Technology in the specialty of transport engineering and bridges. Since 1994 in AS Merko Ehitus and is responsible for the preparation of the tenders for the new projects.

Andres Agukas – Born on 15 July 1965. Finished Pärnu-Jaagupi Secondary School and graduated from Tallinn University of Technology in the specialty of transport engineering. Started in Merko Ehitus on 2 February 1998 as the first employee of the civil engineering sector. Since October 2005 is responsible as the member of the management board for the whole sector of construction service.

Viktor Mõisja – Born on 1 January 1951. Graduated from the Tallinn University of Technology in 1976, having acquired the education of a civil engineer. Viktor Mõisja has been working in AS Merko Ehitus since the establishing of the company, mainly as the Head of the Concreting Department. Since 21 December 2010 is responsible as the member of the management board for the spheres of quality management and inspection.

Share

The shares of Merko Ehitus are listed in the main list of NASDAQ OMX Tallinn Stock Exchange. In 2010 4490 transactions with the shares of Merko Ehitus were performed in the course of which 1.7 million shares were traded and the total monetary value of transactions was EUR 13.1 million (EEK 204.8 million). The lowest share price was EUR 5.05 (EEK 79.0) and the highest price was EUR 9.89 (EEK 154.7) per share. The closing share price as of 30.12.2010 was EUR 9.05 (EEK 141.6). AS Merko Ehitus market value as of 30.12.2010 was EUR 160 million (EEK 2.5 billion).

STATEMENT OF COMPREHENSIVE INCOME 12M 2010
consolidated, unaudited, in thousand EEK and EUR

STATEMENT OF COMPREHENSIVE INCOME Q4 2010
consolidated, unaudited, in thousand EEK and EUR

STATEMENT OF FINANCIAL POSITION AS OF 31.12.2010
consolidated, unaudited, in thousand EEK and EUR

Alar Lagus
Member of Management Board
+372 6 805 109
alar.lagus@merko.ee