Results of operations for the 1st quarter 2013

MANAGEMENT REPORT

Contractual Highlights

• AS Tallinna Vesi tariffs continue to be on the same level based on temporary injunction granted by the Court 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).
• At the end of May 2012 the District Court ruled that AS Tallinna Vesi’s Services Agreement, that was part of the international privatisation, is a public law contract, overturning the Competition Authority’s claim that the tariff mechanism specified in the Services Agreement is allegedly a civil law agreement that the company cannot rely on in an administrative court.  AS Tallinna Vesi firmly believes that the terms and conditions of the international privatisation contract that has been deemed a public law contract should not be broken simply by transferring the duties of the regulator from one state institution (the City of Tallinn) to a different state institution (the Competition Authority). A public law contract should enjoy the protection of the Estonian legal system, should the contract not honoured then the company will have a claim against the Estonian state.
• AS Tallinna Vesi would like all its shareholders to be fully aware of the facts that the Company was privatised in 2001 with the full support and knowledge of the Estonian national government, with written confirmations from the Prime Minister, the Minister of Finance, and the Competition Authority itself regarding the key terms of the agreements, and utilising the expertise and guidance of the European Bank for Reconstruction and Development (EBRD). In addition to approving the framework of the privatisation the State of Estonia directly benefited as the sovereign guarantee it had been required to provide to EBRD to secure the then municipal AS Tallinna Vesi’s loans was passed to the Strategic Investor on privatisation. As this privatisation and these loans were EBRD sponsored projects, then the state of Estonia was required to object if the project did not comply with the PWSSA, it is noteworthy that it did not, in fact it voted in favour of both the privatisation and loan re-financing.
• During the 1^st quarter of 2013 initial court proceedings commenced. AS Tallinna Vesi believes in open and transparent regulation and requested open court proceedings. On the other hand, the Competition Authority believes its methodology to be a “business secret” hence it requested closed court proceedings. On 20^th of March 2013 the Administrative Court rules that the court proceedings would be partially closed, meaning that there could be no public discussion of the Competition Authority’s methodology, whilst all other aspects of the hearing will be  held in open proceedings, i.e all information can be made available to the public.
• Discussion of the complaint submitted to the EU Commission is on-going.
• Average real return on capital invested at privatization is 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.

RESULTS OF OPERATIONS - FOR THE 1^st QUARTER 2013

Financial highlights of 1^st quarter 2013

In the 1^st quarter of 2013 the Company’s underlying performance was good and stable, continuously focused on the improvement of operational performance and customer service.

During the three months of 2013 the Company’s total sales decreased, year on year, by 2.3% to 12.7 mln euros. Sales of water and wastewater treatment were down by 1.5% to 11.7 mln euros compared to the three months of 2012. These decreases in sales are due to lower sales volumes during 2013, as the 1^st quarter in 2013 was one day shorter than the comparative period in 2012.

The operating profit from the Company’s main business activity decreased by 0.7 mln euros or 10.4% to 6.2 mln euros during the three months of 2013 compared to the three months of 2012. As a comparison Total operating profit decreased by 11.4% during the same period as a result of completion of the sewage extension construction program in 2012, and therefore there were no revenues from government grants in 2013.

The Company’s profit before taxes for the first quarter in 2013 was 6.2 mln euros, which is a 0.1 mln euros or 1.5% decrease compared to the relevant period in 2012. The Company’s net profit for first quarter of 2013 was 6.2 mln euros, which is 0.1 mln euros or 1.5% smaller than the net profit of 6.3 mln euros in the equivalent period in 2012.

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

ROE – Net profit / Total equity

Current ratio – Current assets / Current liabilities

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

Profit and Loss Statement

1^st quarter 2013

Sales

In the 1^st quarter of 2013 the Company’s total sales decreased, year on year, by 2.3% to 12.7 mln euros. 91% of sales comprise of sales of water and treatment of wastewater to domestic and commercial customers within and outside of the service area, 5% of sales from fees received from the City of Tallinn for operating and maintaining the storm water system and 4% from other works and services.

Sales of water and wastewater services were 11.7 mln euros, a 1.5% decrease compared to the 1^st quarter of 2012, resulting from the decrease in sales volumes as described below.

Within the service area, sales to residential customers were at 5.9 mln euros, a 2.0% decrease year on year. Sales to commercial customers increased by 0.8% to 4.6 mln euros, mainly due to industrial customers. Sales to customers outside of the main service area decreased by 8.7% to 1.0 mln euros in the 1^st quarter of 2013. Over pollution fees received were 0.18 mln euros, a 2.3% increase compared to the 1^st quarter of 2012.

As result of same tariffs billable in 2013 compared to 2012 the sales volumes reflect the same variances in main services area as prescribed above.

Outside service area sales volumes were 18.8% lower than in the 1^st quarter of 2012. The main factor in this decrease was lower storm water volumes balanced by some increase in sewerage service due to connection of small areas in neighbouring municipalities. This resulted in a sales decrease year on year by 8.7%; the sales decrease is lower than volumes decrease as storm water tariffs are lower than sewage tariffs.

The sales from the operation and maintenance of the storm water and fire-hydrant system in the main service area decreased by 17.4% to 0.73 mln euros in the 1^st quarter of 2013 compared to the same period in 2012. According to the terms and conditions of the contract revenues reflect actual volumes treated and costs for treating the storm water, therefore this cost pass through has no impact on profits.

Cost of Goods Sold and Gross profit

The cost of goods sold for the main operating activity was 5.2 mln euros in the 1^st quarter of 2013, an increase of 0.36 mln euros or 7.5% from the equivalent period in 2012. The cost increase is mainly the result of released provisions positive effect in the first quarter of 2012 in the amount of 0.44 mln euros.

Total variable costs increased by 0.49 mln euros or 37.3% year on year, without the impact of one off provision release the real increase of variable costs was 0,06 mln euros or 3,3%. The change came from a combination of increase in prices and tax rates and movements in treatment volumes that affected the variable costs together with the following additional factors:

• Water abstraction charges increased only by 0.01 mln euros or 2.5% to 0.25 mln euros in the 1^st quarter of 2013, despite of 5% increase in tax rates mainly due to positive impact from 1.1% less leakages than 2012 and smaller production volumes.
• Total chemical costs increased by 0.06 mln euros or 15.1% to 0.42 mln euros. Chemicals costs increased due to an increase in chemicals price worth 0.04 mln euros (0.03 mln euros coming from methanol price increase by 20%) and increased coagulant usage due to bad raw water quality amounting to 0.01 mln euros.
• Electricity costs in total stayed flat in the 1^st quarter of 2013 compared to the 1^st quarter of 2012. Increased electricity prices, which on average have increased 3% with an adverse effect of 0.03 mln euros, have been balanced by positive effect of decreased treatment volumes.
• Pollution tax increased by 0.43 mln euros or 200.9% in the 1^st quarter of 2013, mainly related to released provision in the first quarter of 2012. Pollution tax increase due to the 15% increase in tax rates was balanced by improved pollutants removal process and decrease in volumes.

To mitigate the external price risk of maintenance services the Company switched from outsourcing to insourcing in various areas in the 3^rd quarter of 2012. Total fixed cost of goods sold in the main operating activity decreased by 0.13 mln euros or 3.8%.

As a result of all of the above the Company’s gross profit for the 1^st quarter of 2013 was 7.5 mln euros, which is a decrease of 0.7 mln euros, or 8.1%, compared to the gross profit of 8.2 mln euros for the 1^st quarter of 2012.

Other Operating Costs

Marketing expenses and General administration expenses stayed mostly flat during the 1^st quarter of 2013 compared to the corresponding period in 2012, with the exception of overall salary costs increase by 0.07 mln euros.

Other net income/expenses

Other net income decreased by 0.05 mln euros or 156.3% to a net expense of 0.02 mln euros, compared to 0.03 mln euros net income in the 1^st quarter of 2012.

In previous years the majority of the income in Other net income/expenses has been related to constructions and government grants. As the major programs were almost entirely completed by end of 2011, the revenues from this activity have ceased. In the 1^st quarter of 2013 there were no profits from constructions and government grants compared to a net income of 0.08 mln euros in the 1^st quarter of 2012.

The rest of the other income/expenses totalled an expense of 0.02 mln euros in the 1^st quarter of 2013 compared to an expense of 0.05 mln euros in the 1^st quarter of 2012.

Operating profit

As a result of above factors the Company’s operating profit from main services for the 1^st quarter of 2013 totalled 6.2 mln euros compared to 6.9 mln euros in the corresponding quarter in 2012. In total the Company’s operating profit for all activities for the 1^st quarter of 2013 was 6.2 mln euros, which shows a decrease of 0.70 mln euros compared to an operating profit of 6.9 mln euros achieved in the 1^st quarter of 2012. Year on year the operating profit for the 1^st quarter has decreased by 11.4%.

Financial expenses

Net Financial expenses/income were 0.06 mln euros in the 1^st quarter of 2013, which is a decrease of 0.70 mln euros in expenses compared to -0.64 mln euros net expenses in the 1^st quarter of 2012. In 2012 the financial costs were mainly impacted from the non-cash revaluation of the fair value of swap agreements, in the 1^st quarter of 2012 the revaluation impact was negative by 0.22 mln euros and in the relevant quarter of 2013 the revaluation impact was positive by 0,56 mln euros.

The standalone 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 euros and 20 mln euros is thereby still with floating interest rate. At this point in time the estimated fair value of the swap contracts is negative, totalling 4.0 mln euros.

Effective interest rate (incl. swap interests) in the 1^st quarter of 2013 was 3.28%, amounting in the interest costs of 0.78 mln euros, compared respectively to 3.39% and 0.82 mln euros in the 1^st quarter of 2012.

Profit Before and After Tax

The Company’s profit before and after taxes for the 1^st quarter of 2013 was 6.2 mln euros, which is 0.09 mln euros lower than the profit before and after taxes of 6.3 mln euros for the 1^st quarter of 2012, resulting from the movements in fair value of financial instruments and released provisions as described above.

Balance sheet

In the three months of 2013 the Company invested 0.95 mln euros into fixed assets. As of 31 March 2013 non-current fixed assets amounted to 150.0 mln euros and total non-current assets amounted to 155.7 mln euros.

Current assets increased by 8.0 mln euros to 50.6 mln euros in the three months mainly due to increased cash at bank. In the three months of 2013, cash at bank increased by 8.6 mln euros.

Current liabilities decreased by 0.56 mln euros to 9.3 mln euros in the three months due to decreased customer prepayments, payments to suppliers and fair value of financial instruments – the latter being a technical transaction rather than an increase in current liabilities. 

The Company has a Total debt/Total assets level as expected of 55.9%, in range of 55%-65%, reflecting the beginning of the year equity profile. This level is consistent with the same period in 2012 when the total debt/total assets ratio was 57.0%.

Long-term liabilities stood at 106.1 mln euros at the end of March 2013, consisting mainly of the outstanding balance of three long-term bank loans totalling 95 mln euros. The first repayment of loans or refinancing should take place at the end of 2014. The weighted average interest margin for the total loan facility is 0.96%. The rest of long term liabilities reflect mainly the accounting record of deferred income from connection fees.

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 13 to the accounts. Considering that the court proceedings are continuously on-going, the Management has not changed the evaluation of the contingent liability. 

Cash flow

During the three months of 2013, the Company generated 8.3 mln euros of cash flows from operating activities, an increase of 0.96 mln euros compared to the corresponding period in 2012. 2013 operating cash flows were above 2012 cash flows mainly due to changes in trade debtors and payables. Underlying operating profit still continues to be the main contributor to operating cash flows.

In the three months of 2013 net cash flows from investing activities resulted in a cash inflow of 1.0 mln euros, a decrease of 0.21 mln euros compared to an inflow of 1.2 mln euros in the three months of 2012. This is mainly due to lower capex spent on assets acquisitions and compensations for construction of pipelines.

In the three months of 2012 the cash outflows related to the fixed asset investments were 1.6 mln euros compared to 1.7 mln euros spent in the same period of 2012, a decrease of 0.08 mln euros. The compensations received for the construction of pipelines were 2.4 mln euros in the three months of 2013, a decrease of 0.42 mln euros compared to same period in 2012. In 2013 the Company did not give further loans to AS Maardu Vesi. In 2012 the loan granted to AS Maardu Vesi amounted to 0.23 mln EUR.

In the three months of 2013, cash outflow from financing amounted to 0.76 mln euros due to interests paid and loan financing costs, which is 0.04 mln euros more than in the same period of 2012.

As a result of all of the above factors, the total cash inflow in the three months of 2013 was 8.6 mln euros compared to a cash inflow of 7.9 mln euros in 2012. Cash and cash equivalents stood at 32.5 mln euros as of 31 March 2013, which is 9.9 mln euros higher than at the corresponding period of 2012.

Employees

At the end of the 1^st quarter of 2013, the total number of employees was 309 compared to 310 at the end of the 1^st quarter of 2012. The full time equivalent (FTE) was respectively 295 in 2013 compared to the 298 in 2012. 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 December 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 2013 AS Tallinna Vesi shareholders, with a direct holding over 5%, were:

Parvus Asset Management owned in total 1.10% of the shares of the Company as per Company’s best information as of 31 March 2013. As Parvus has reduced their holding in the Company pension funds have continued to increase their portfolios during the 1^st quarter of 2013, owning 2.43% of the total shares compared to 1.25% at the end of 1^st quarter 2012.

At the end of the quarter, 31 March 2013, the closing price of the AS Tallinna Vesi share was 10.40 euros, which is a 13.04% increase compared to the closing price of 9.20 euros at the beginning of the quarter. During the same period the OMX Tallinn index rose by 14.17%. In the 1^st quarter the Company’s share price was mainly impacted by the on-going contractual debate, interim court decisions and impending dividend payment announcement.

Operational highlights in 1^st quarter 2013

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 on-going.

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.

In opposite to the Company the CA has requested the Court procedures to be closed. Based on misleading information submitted by the CA the Court approved the CA’s request. ASTV has reapplied for open proceedings.

Still, at this point in time the Company is unable to say what is going to happen to the tariffs before Court judgments and what would be the next steps by the European Commission. The outcome and lengths of the Court proceedings is outside the control of the Company.

Additional information:

Ian John Alexander Plenderleith

Chairman of the Management Board

+372 6262 201

ian.plenderleith@tvesi.ee

         Ian John Alexander Plenderleith
         Chairman of the Management Board
         +372 6262 201
         ian.plenderleith@tvesi.ee