Results of operations for the 1st quarter of 2012

MANAGEMENT REPORT

Contractual Highlights

• The court granted temporary injunction for the period of court proceedings to protect the Company from the unilateral breach of privatization agreement by Estonian Authorities (more information available at end of the paper from section Contractual tariff debate)
• Due to the fact that the 2011 tariff application and current tariff disputes are almost identical the court has now combined both cases together.
• No court date has yet been established to hear the court case regarding the legality of the tariffs established by the privatisation contract.
• Discussion of the complaint submitted to the EU Commission is ongoing
• Average real return on capital invested at privatization still 6.2% since 2001

The Company has continuously stated its belief in fully transparent regulation and its willingness to enter into meaningful and evidence-based dialogue that takes into account the privatization contract signed in 2001.

Year on Year Financial Highlights – 1^st Quarter of 2012

• Sales from water & waste water services in main service area increased by 2.7 %
• Reported total operating profit from main services has increased by 0.5% impacted by lower profits from construction activities
• Operating profit from main services increased by 4.2 %
• Net profit for the period is 21% lower compared to 2011 due to adverse variance from non-cash evaluation of fair value of swap agreements
• The Supervisory Council submitted the proposal to AGM to pay 0.84 EUR dividends per share in 2012, total dividend payment would be 16.8 mln EUR. AGM will decide on dividend payment on 22 May 2012 and the proposed dividend payment date is 15 June 2012, the list of shareholders entitled to receive dividends is proposed to be fixed on 5 June at 23.59.

RESULTS OF OPERATIONS - FOR THE 1^st QUARTER 2012

Overview of the financial statements

In the 1^st quarter of 2012 the Company’s underlying performance was good and stable, continuously focused on the improvement of operational performance and customer service. During the 1^st quarter of 2012 the sales increased by 4.7% mainly due to even increase from all commercial sectors supported by slight increase from domestic sector. As result of excellent operational performance and related efficiencies the gross profit increased by 8.8% in the 1^st quarter of 2012 and the operating profit from main business activities increased by 4.2%. Total operating profit increased by 0.5% during the same period as a result of completion of considerably smaller proportion of the construction program than in 1^st quarter of 2011. The profit before taxes decreased by 21.0% in the 1^st quarter of 2012, being impacted by non-cash negative movement in fair value of financial instruments opposed to positive movement in 1^st quarter of 2011.

Gross profit margin – Gross profit / Net sales

Operating profit margin – Operating profit / Net sales

Net Profit margin – Net Profit / Net sales

ROA – Net profit /Total Assets

Debt to Total capital employed – Total Liabilities / Total capital employed

Main business – water and wastewater activities, excl. connections profit and government grants

Profit and Loss Statement

1^st quarter 2012

Sales

In the 1^st quarter of 2012 the Company’s total sales increased, year on year, by 4.7% to 13.0 mln EUR. 92% of sales comprise of sales of water and treatment of wastewater to domestic and commercial customers within and outside of the service area, 6% of sales from fees received from the City of Tallinn for operating and maintaining the storm water system and 2% from other works and services.

Sales of water and wastewater services were 11.9 mln EUR, a 4.6% increase compared to the 1^st quarter of 2011, resulting from the rise in sales volumes as described below.

Within the service area, sales to residential customers increased by 1.4% to 6.1 mln EUR. Sales to commercial customers increased by 4.5% to 4.6 mln EUR, an increase in all commercial sectors signifying recovery from the recession period. Sales to customers outside of the service area increased by 33.1% to 1.1 mln EUR in the 1^st quarter of 2012. Over pollution fees received were 0.18 mln EUR, a 14.0% decrease compared to the 1^st quarter of 2011.

In the 1^st quarter of 2012, the volumes sold to residential customers increased by 1.4% year on year.

The volumes sold to commercial customers inside the service area have risen, reflecting a 4.3% increase compared to the same period in 2011. The sales volumes increased evenly across all commercial sectors in the 1^st quarter of 2012.

Outside service area sales volumes were 49.0% higher than in the 1^st quarter of 2011. The main factor in this increase was higher storm water volumes in the 1^st quarter of 2012 compared to 2011, resulting in sales increase year on year by 33.1%. Sales increase is lower than volumes increase as storm water tariffs are considerably lower than sewage tariffs.

The sales from the operation and maintenance of the storm water and fire-hydrant system increased by 3.4% to 0.88 mln EUR in the 1^st quarter of 2012 compared to the same period in 2011. This is in accordance with the terms and conditions of the contract whereby the storm water and fire hydrant costs are invoiced based on actual costs and volumes treated.

Cost of Goods Sold and Gross Margin

The cost of goods sold for the main operating activity was 4.8 mln EUR in the 1^st quarter of 2012, a decrease of 0.07 mln EUR or 1.5% from the equivalent period in 2011. The cost decrease was mainly the result of the release of a one-off provision worth 0.44 mln EUR described at the pollution tax variance analysis below. Total underlying cost of goods sold increased by 0.36 mln EUR or by 7.4%, mainly due to the increase in variable costs.

Although total variable costs decreased by 0.11 mln EUR, primarily for the reason described above, underlying variable costs increased by 0.33 mln EUR or 23.1% year on year. This was mainly due to high storm water volume in the combined sewerage and storm water system  that led to increased wastewater treatment volumes by 19.1% (worth 0.22 mln EUR), that mainly affected the variable costs together with the following additional factors:

• Tax rate on special use of water increased by 7.5% on average, total cost increase by 6.2% or 0.01 mln EUR to 0.24 mln EUR in the 1^st quarter of 2012, in combination of increased rates and sales volumes, partly balanced by reduced leaking ratio.
• Chemicals costs increased in extra to the volume impact mainly due to 20.5% higher methanol price worth 0.03 mln EUR. Total chemical costs were 0.37 mln EUR, a 0.12 mln EUR or 47.2% increase compared to the corresponding period in 2011.
• Electricity costs were the most impacted by storm water volumes, but had also considerable hit from increase in electricity rates, which on average have increased 20.3% with an adverse effect of 0.16 mln EUR in extra to the adverse impact from the increased volumes. Electricity costs in total increased by 0.26 mln EUR or 37.9% in the 1^st quarter of 2012 compared to the 1^st quarter of 2011.
• The pollution tax cost was the most impacted by the fact that the Company released a one-off provision that was established for pollution incident in Maardu and was related to storm water outlet not fully in control of the Company.

Eliminating the 0.44 mln EUR provision the pollution tax would have been 20.9% lower than in the 1^st quarter of 2011. Improved nitrogen removal reduced the pollution tax by 0.11 mln EUR, but the effect was partly balanced by the increased volumes and 14% increase in tax rates. Underlying pollution tax payable was 0.22 mln EUR compared to 0.28 mln EUR in the 1^st quarter of 2011.

The excellent nitrogen removal is the result of the environmental project that was implemented to mitigate the nitrogen treatment and tax risks discussed throughout the 2010 and 2011. The project was completed by the Company in the beginning of the 3^rd quarter of 2011 when we finished the construction and implemented the additional stage in sewage treatment process.

Fixed cost of goods sold in the main operating activity were well controlled by the Company, cost increase 0.03 mln EUR or 1.0% year on year being well below the CPI increase as result of implemented efficiency measures.

As a result of all of the above the Company’s gross profit for the 1^st quarter of 2012 was 8.2 mln EUR, which is an increase of 0.66 mln EUR, or 8.8%, compared to the gross profit of 7.5 mln EUR for the 1^st quarter of 2011.

Other Operating Costs

All cost groups were affected by various level increases in salary cost, being impacted by the transfer of costs between the groups due to minor rearrangements in the organization, but also by redundancy compensations. Total salary bill has increased by 3.1% in the 1^st quarter of 2012 compared to the same period of 2011, which is below the 2011 CPI of 5.0%.

Marketing expenses increased by 0.02 mln EUR to 0.22 mln EUR during the 1^st quarter of 2012 compared to the corresponding period in 2011 only due to discussed change in salary costs.

In the 1^st quarter of 2012 the General administration expenses increased by 0.18 mln EUR year on year to 1.1 mln EUR. In extra to the discussed increase in salary cost the General administration expenses increased mainly due to the increase in legal consultancies acquired in the process of tariff dispute.

Other net income/expenses

In the 1^st quarter of 2012 Other net income was 0.03 mln EUR, a 0.43 mln EUR negative variance in the 1^st quarter of 2012 compared to the 1^st quarter of 2011.

The majority of the income in Other net income/expenses has been related to constructions and government grants in previous years. The drivers for this income stream were the networks extension program and the connections activity in Tallinn. As the major programs are close to completion in the 1^st half of 2012, the revenues from this activity have already dropped and will continue to drop throughout the year. Income and expenses from constructions and government grants totaled a net income of 0.08 mln EUR in the 1^st quarter of 2012 compared to a net income of 0.32 mln EUR in the 1^st quarter of 2011.

The rest of the other income/expenses totaled an expense of 0.05 mln EUR in the 1^st quarter of 2012 compared to an income of 0.15 mln EUR in the 1^st quarter of 2011 that was mainly related to a one-off extraordinary debt collection.

As a result of all these factors the Company’s operating profit from main services for the 1^st quarter of 2012 totaled 6.9 mln EUR compared to 6.6 mln EUR in the corresponding quarter in 2011. In total the Company’s operating profit for all activities for the 1^st quarter of 2012 was 6.9 mln EUR, an increase of 0.04 mln EUR compared to an operating profit of 6.9 mln EUR achieved in the 1^st quarter of 2011. Year on year the operating profit for the 1^st quarter has increased by 0.5%.

Financial expenses

Net Financial revenues/expenses were 0.64 mln EUR in the 1^st quarter of 2012, which is a negative variance of 1.7 mln EUR or 159.9% compared to the net revenues in the 1^st quarter of 2011. In both years the financial costs were mainly impacted from the non-cash revaluation of the fair value of swap agreements, in the 1^st quarter of 2011 the revaluation impact was positive by 1.5 mln EUR and in the relevant quarter of 2012 the revaluation impact was negative by 0.22 mln EUR.

The swap agreements have been signed to mitigate the majority of the long term floating interest risk, the interest swap agreements are signed for 75 mln EUR and 20 mln EUR is thereby still with floating interest rate. At this point in time the estimated fair value of the swap contracts is negative, totaling 4.7 mln EUR.

Effective interest rate in the 1^st quarter of 2012 was 3.39%, amounting in the interest costs of 0.82 mln EUR, compared to 2.84% and in the amount of 0.68 mln EUR in the 1^st quarter of 2011. This reflects the euribor increase and adverse impact from swap agreements that became effective in the 2^nd quarter of 2011.

Profit Before Tax

The Company’s profit before taxes for the 1^st quarter of 2012 was 6.3 mln EUR, which is 1.7 mln EUR lower than the profit before taxes of 8.0 mln EUR for the 1^st quarter of 2011. The profit before tax has mainly been suppressed by the described revaluation of interest swap agreements.

Balance sheet

In the 1^st quarter the total assets have increased by 6.2 mln EUR that is characteristic for the Company’s traditional cash generation and capex spend profile throughout the year.

Current assets increased by 9.5 mln EUR to 44.4 mln EUR in the three months of the year. Cash at bank increased by 7.9 mln EUR and the customer receivables increased by 1.7 mln EUR as result of the reclassification of accrued income related to financing of long term construction projects from non-current assets to current assets.

During the three months of 2012 the Company invested 1.5 mln EUR into fixed assets. Non-current assets were 153.8 mln EUR at 31 March 2012.

Current liabilities decreased by 0.44 mln EUR to 8.0 mln EUR in the three months of the year, due to decrease in Trade payables, reflecting capex payables profile throughout the year.

The Company has a Total debt/Total assets level as expected of 57.0%, in the target range of 50%-60%, reflecting the pre-dividend increase in Equity of 6.3 mln EUR.

Long-term liabilities stood at 105.0 mln EUR at the end of March 2012, consisting mainly of the outstanding balance of three long-term bank loans and supplemented by deferred income from connection fees. The total 95 mln EUR loan capital is recorded within long term liabilities in accordance with the signed loan agreements. The first repayment of loans or refinancing should take place at the end of 2013. The weighted average interest margin for the total loan facility is 0.82%.

Considering that the court proceedings are continuously ongoing, the Management has not changed the evaluation of the contingent liability.  In the 4^th quarter of 2011 the Company recorded an exceptional contingent liability, which could cause an outflow of economic benefits of up to 36.0 mln euros, as per note 3 to the annual accounts.

Cash flow

During the three months of 2012, the Company generated 6.6 mln EUR of cash flows from operating activities, a decrease of 2.5 mln EUR compared to the corresponding period in 2011. 2012 operating cash flows were below 2011 cash flows mainly due extraordinary payments of overdue debt in 1^st quarter of 2011. Underlying operating profit still continues to be the main contributor to operating cash flows.

In the three months of 2012 net cash inflows from investing activities were 1.2 mln EUR, an increase of 3.2 mln EUR compared to an outflow of 2.0 mln EUR in the 1^st quarter of 2011, mainly due to lower capex spent on network extension. At the end of 1^st quarter of 2012 the cash outflows related to the fixed asset investments were 1.7 mln EUR compared to 3.8 mln EUR spent in the same period of 2011. The compensations received for the construction of pipelines were 2.7 mln EUR in the 1^st quarter of 2012, an increase of 0.77 mln EUR compared to same period in 2011. In 2012 the Company also gave the 0.23 mln EUR loan to Maardu according to the Operating agreement signed in 2008.

As a result of all of the above factors, the total cash inflow in the three months of 2012 was 7.9 mln EUR compared to a cash inflow of 7.2 mln EUR in the three months of 2011. Cash and cash equivalents stood at 22.6 mln EUR as at 31 March 2012 which is 2.2 mln EUR higher than at the corresponding period of 2011.

Employees

At the end of the 1^st quarter of 2012, the total number of employees was 310 compared to 315 at the end of the 1^st quarter of 2011. The full time equivalent (FTE) was respectively 298 in 2012 compared to the 301 in 2011. The management continues to work actively for the efficiencies in processes to balance the increase in individual salaries and cost pressure from the market with more productive company structure.

Corporate structure

At the end of the quarter, 31 March 2012, the Group consisted of 2 companies. The subsidiary Watercom OÜ is wholly owned by AS Tallinna Vesi and consolidated to the results of the Company.

Share performance

AS Tallinna Vesi is listed on NASDAQ OMX Main Baltic Market with trading code TVEAT and ISIN EE3100026436.

As of 31 March 2012 AS Tallinna Vesi shareholders, with a direct holding over 5%, were:

Parvus Asset Management owned in total 6.09% of the shares of the Company as per Company’s best information as of 31 March 2012.

At the end of the quarter, 31 March 2012, the closing price of the AS Tallinna Vesi share was 7.41 EUR, which is a 17.81% increase compared to the closing price of 6.29 EUR at the beginning of the quarter. During the same period the OMX Tallinn index rose by 13.45%. In the 1^st quarter the Company’s share price was mainly impacted by the ongoing contractual debate and interim court decisions.

Operational highlights in 1^st quarter of 2012

• In the 1^st quarter of 2012, the operational and quality indicators of AS Tallinna Vesi have been on the highest level ever and indicate continuous improvement. Compared to 1^st quarter 2011, the most remarkable improvements have been in removing pollution from the wastewater discharged into the Baltic Sea and in wastewater, service quality and customer communication indicators. For example:
  • The quality indicators for water quality have so far been on the highest level ever, from taken samples 100% were fully in accordance with the norms, outperforming considerably the required standard 95% at customers’ taps.
  • Total number of sewage blockages has decreased by 33%.
  • Total time of interruptions has decreased by 8%.
  • The leakage level is below 17%, over 4% less than in 2011.
  • Compared to the 1^st quarter of 2011, the biofilter has enabled to reduce the volume of discharge of nitrogen by 51.2%.
  • More details on operating performance can be found from /LINK to TSE/

Key contractual events

Contractual tariff debate

Tariffs are still frozen on the 2010 level despite of the fact that on 9 November 2010 the Company submitted its tariff application for a 3.5% tariff increase from 1 January 2011, which was contractually agreed in the privatisation contract to the Competition Authority (CA), the new price checker. The tariff application is fully in accordance with the law and the best practice regulation for privatized utilities, such as that favoured by Ofwat in the UK and recommended by the World Bank for privatized utilities.

On 2^nd May the CA informed the Company about the rejection of the tariff application. The CA completely ignored the privatization contract and did not perform any analysis of the contractual and financial performance of the Company during the period after privatization.  The CA is arguing that the Company’s profitability is too high using their own recommendatory and unverified methodology.

The Company has calculated that the average real return on invested capital from 2001 till 2012 has been 6.2% and the Company has also had these returns independently verified by the international economics consulting company, Oxera. The annual return on capital invested is in accordance with the returns allowed by Ofwat the UK regulator over this same period[1], and the return permitted by the Dutch Energy regulator Energiekamer, which allowed a real rate of return of 6% in its regulatory determination of September 2010.

The Company and its investors cannot accept such a unilateral breach of the privatization terms and contract by Estonian Authorities and the Company submitted an appeal to the court on 2 June 2011. 

Regrettably the CA decided not to wait for the court ruling regarding the legality of the privatization contract and on 10 October 2011 the CA sent a prescription to the company asking it to reduce its current tariffs by 29%. The Company lodged another claim against the prescription and asked for the temporary injunction from the Estonian court. The court granted the temporary injunction for the period of court proceedings on 6 February 2012 and this decision was confirmed by next level court on 2^nd of March. The ruling cannot be appealed any further and due legal process must now take its course.

On 6^th of February The outcome and lengths of the Court proceedings is outside the control of the Company.

Complaint to European Commission

In parallel, on 10^th December 2010 AS Tallinna Vesi lodged a complaint to the European Commission regarding certain measures adopted by the Estonian authorities. The company believes these measures unilaterally alter the terms of AS Tallinna Vesi's privatization regime, and without any objective justification, any form of meaningful prior discussion, or willingness to engage in dialogue. Therefore they violate EU rules on the freedom of establishment and the free movement of capital (articles 49 and 63 TFEU). The process is ongoing.

Disclosure of relevant papers and perspectives

The Company has published its tariff application and all relevant correspondence with the CA on its website (http://www.tallinnavesi.ee/?op=body&id=728) and to the Tallinn Stock Exchange and will keep its investors informed of all future developments regarding the further key developments regarding the processing of the tariff application. Still, at this point in time the Company is unable to say what is going to happen to the tariffs as it is unclear at the moment how the CA intends to respond to the Court and what would be the next steps by the European Commission.

Additional information:

Siiri Lahe

Chief Financial Officer

+372 6262 262

siiri.lahe@tvesi.ee

         Siiri Lahe
         Chief Financial Officer
         +372 6262 262
         siiri.lahe@tvesi.ee