Merko Ehitus
Quarterly report

2016 12 months and IV quarter consolidated unaudited interim report

Tallinn, Estonia, 2017-02-09 07:00 CET --  

COMMENTARY OF THE CHAIRMAN OF THE MANAGEMENT BOARD

Merko Ehitus posted revenue of EUR 252 million in 2016, remaining on par with the last year; the net profit amounted to EUR 6.1 million. The group continued to implement its long-term apartment-building strategy, investing a total of EUR 73 million in residential development. The company's Management Board proposes to pay 119% of retained earnings – EUR 0.41 per share – in dividends to shareholders.

The group’s management considers the last year complicated, in which despite active residential construction in the Baltic capitals, the construction market as a whole failed to show any growth. Public investments in infrastructure objects have also remained in a slump for several years. The group’s infrastructure construction volumes were lagging behind expectations in 2016. The management estimates that to cover the expenditure, the prices bid in procurements are very low in the current market situation, and do not endorse any growth in the construction capacity of civil engineering projects on the construction market in general. The growth in residential development and private sector orders allowed Merko Ehitus to maintain revenue on last year's level, but at the same time the management is not satisfied with the profitability on the construction service segment. Price competition in buildings construction procurements is extremely tight, slimming down the margins and forcing both main contractors and contracting entities to take huge risks. The management considers that efficiency and management of contractual risks is becoming increasingly important. The group’s results for 2016 were also affected by the delay in the launch of construction on several major objects. We were only able to actively continue with these projects at the end of the year.

The group’s management confirms to make an effort to maintain lead position in Estonia in terms of both main contracting and apartment development, and we see opportunities to boost profit by enhancing internal efficiency. The strategy of growing beyond Estonian borders will also continue to be pursued – while nearly one-third of our business is currently carried out abroad, we have set our sights on the corresponding target of 50%. Even though the construction service revenue posted in the Latvian and Lithuanian market in 2016 has decreased to some extent, compared to the previous period – a circumstance attributable to the completion of several major projects at the end of 2015 – we have gradually enhanced our capacity and improved our position on the main contracting markets of these countries. In Latvia, we remain competitive in most private and public sector procurements. In Lithuania, we hold the biggest market share among international orders, and are planning active participation in public procurements. In Norway, our long-term objective is to develop the capacity for major construction projects and gain the clients' trust as a company operating on the local market.

In 2016, the group posted revenue of EUR 252.0 million, net profit of EUR 6.1 million and profit before taxes of EUR 7.3 million. The revenue for Q4 2016 amounted to EUR 78.6 million, net profit to EUR 1.4 million and profit before taxes to EUR 1.6 million. In 2016, the group signed new construction contracts in the total amount of EUR 202.4 million, of which EUR 61.9 million in Q4. As at 31 December 2016, the group's secured order book amounted to EUR 269.6 million. Major objects still in progress in Q4 included T1 shopping centre, Maakri Quarter, Telia's head office in WoHo Quarter and the Tallinn Airport tramway in Tallinn, passenger terminal of Riga International Airport in Riga and Kauno/Algirdo residential and office complex in Vilnius.

Real estate development remains a key business area for the group, generating nearly 30% of the group's revenue in 2016. In 2016, we invested a total of nearly EUR 73 million in residential development, including EUR 53.6 million in apartment construction and EUR 19.1 million in new land plots in order to secure our long-term apartment-building strategy. We acquired new land plots in the heart of Tallinn and Vilnius in Q4. The apartment markets of Tallinn and Vilnius continue to be in a good shape. Riga has yet to achieve the expected potential, but Merko remains relatively well-positioned for any growth in demand. In general, the management is very pleased with the results of apartment sales, having gained the apartment buyers trust and demonstrated the value of the Merko brand as the developer, builder and seller of living environments and apartments. Depending on the market dynamics, Merko is planning to launch the construction of 650–700 new apartments in the Baltic countries this year, investing nearly EUR 45 million in work-in-progress and new development projects.

In 2016, the group sold 493 apartments for a total of EUR 56.6 million (w/o VAT), compared to the 403 apartments and EUR 61.4 million (w/o VAT) in 2015. In Q4, 225 apartments were sold in the total amount of EUR 27.0 million (w/o VAT). Merko launched the construction of 344 apartments in 2016, plus the Galiezers and Rinktines projects launched at the beginning of 2017, with a total of 216 apartments. Major development projects currently under construction by Merko include Tartu mnt 52, Noblessner Homeport and Paepargi apartment buildings in Tallinn, Skanstes Parks and Gaiļezers in Riga and the Rinktines Urban in Vilnius.

The Management Board of AS Merko Ehitus proposes to pay EUR 7.3 million (EUR 0.41 per share) in dividends to shareholders at the expense of retained earnings, with the dividend rate for 2016 thus amounting to 119%. The group’s management has made the proposal to pay dividends to shareholders above the current dividend policy rate, considering the return on equity posted in 2016, the group's investment capacity and the outlook for growth of the construction market. The management remains hopeful that the engineering construction volumes will continue to grow, even though the projects will not be actually launched before the second half of 2017, or later.

OVERVIEW OF THE 12 MONTHS AND IV QUARTER RESULTS

PROFITABILITY

Net profit in 12M 2016 was EUR 6.1 million (12M 2015: EUR 10.0 million), having decreased by 38.8% compared to the same period last year and net profit margin decreased to 2.4% (12M 2015: 4.0%). Q4 net profit was EUR 1.4 million (Q4 2015: EUR 4.4 million), having decreased by 68.3% in the annual comparison. Profit before tax in 12M 2016 was EUR 7.3 million (12M 2015: EUR 11.7 million), which is equivalent to a profit before tax margin of 2.9% (12M 2015: 4.7%). Q4 profit before tax was EUR 1.6 million (Q4 2015: EUR 4.7 million).

REVENUE

Revenue in 12M 2016 was EUR 252.0 million (12M 2015: EUR 251.0 million), which has increased by 0.4% compared to last year. Q4 revenue was EUR 78.6 million (Q4 2015: EUR 66.4 million). The share of revenue earned outside Estonia has decreased in 12M 2016 amounted to 32% (12M 2015: 38%) and the share of revenue earned in Estonia has increased to 68% (12M 2015: 62%). The number of apartments (493 units, incl. 21 apartments in joint ventures) sold in 12 months of 2016 has increased by 22.3% and the revenue from apartment sales (EUR 56.6 million) has decreased by 7.8% (12 months of 2015: 403 units, revenues of EUR 61.4 million).

CASH POSITION

At the end of the reporting period, the group had EUR 33.5 million in cash and cash equivalents and equity EUR 122.8 million (51.6% of total assets). Comparable figures as at 31 December 2015 were accordingly EUR 39.9 million and EUR 125.7 million (59.5% of total assets). As at 31 December 2016 the group had net debt of EUR 12.5 million (31 December 2015: negative EUR 8.7 million).

SECURED ORDER BOOK

As at 31 December 2016, the group’s secured order book had grown to EUR 269.6 million (31 December 2015: EUR 246.9 million). In 12M 2016, group companies signed new contracts in the amount of EUR 202.4 million (12M 2015: EUR 247.0 million). Q4 2016 new contracts signed in amount of EUR 61.9 million (Q4 2015: EUR 94.8 million).

PROPOSAL FOR DISTRIBUTION OF PROFITS

The Management Board proposes to distribute to shareholders EUR 7.3 million (EUR 0.41 per share) in dividends from retained earnings in 2017. This is equivalent to a 119% dividend rate for 2016.

OPERATING RESULTS

Revenue and operating profit

Merko Ehitus group generated a total of EUR 252.0 million in revenue in 12 months of 2016 (12 months of 2015: EUR 251.0 million). 48.6% of the revenue was generated in Estonian construction service, 20.9% in other home markets construction service and 30.5% in and real estate development segment (12 months of 2015: 43.3% in Estonian construction service, 28.7% in other home markets construction service and 28.0% in real estate development segment). Compared to the 12 months of 2015 the group revenue has remained essentially on the same level. The revenue was slightly below management's expectations mainly due to a somewhat slower than expected launch of several large-scale projects in the first half of the year. This is above all due to circumstances on the customer side as the design work and obtaining related approvals has kept construction from being launched at the expected rate in a number of projects across the Baltics. Another factor is the generally lower number of large-scale projects with respect to the comparison period. Compared to the 12 months of the previous year in the 12 months of 2016 the share of other home markets construction service revenue in the group’s revenue has decreased from 28.7% to 20.9% and the share of Estonian construction service has increased from 43.3% to 48.6%. Revenue in Q4 2016 was EUR 78.6 million, in spite of the continuing general downtrend in the Baltic construction market, which has inceased by 18.3% compared to the previous year (Q4 2015: EUR 66.4 million). The main changes in the revenue structure compared to the same period last year lie in the growth in revenue from Estonian construction services’ general construction projects and in the increase in the sales revenue of construction services from joint venture projects and a one-off increase in revenues from immovable properties in the real estate development segment. At the same time, revenue is down from Estonian construction services’ civil engineering projects and in the other home markets constructions service segment. This trend has been in line with the group’s expectations, considering the distribution of the secured order book as at the end of 2015 and the slump in new construction orders in Latvia and Lithuania. The sales revenue earned in Norway is a new component in the group’s turnover this year.

In 12 months of 2016 the group’s operating profit from development and construction activities totalled EUR 7.7 million (12 months of 2015: EUR 12.5 million) and in Q4 2016 EUR 1.6 million (Q4 2015: EUR 4.9 million). The 12 months operating profit margin (3.1%) has decreased by 1.9 pp compared to the same period last year (12 months of 2015: 5.0%). The group’s aim is to preserve the profitability both in the Estonian but also other home markets construction service domain in spite of the prevailing competition situation on the construction market and the decrease in sales volumes in regard to previously higher-margin civil engineering projects, which was supported by somewhat of a drop in input prices, but which may not continue. Considering the small size of the Estonian market, the current situation – where 4-6 large-scale building construction projects have been launched simultaneously – means occasionally limited capability for subcontractors to carry out work or to do so under reasonable conditions, which in turn puts pressure on the general contractors’ margins. Operating profit margin has also been impacted to some extent by the recovery in profitability in the real estate development segment, which depends largely on the price of the land as part of the total specific project expenses and is thus different on a project basis. The level of operating profit compared to that of last year was additionally influenced by higher marketing, general and administrative expenses, mainly due to the additional activity in Norway, where the group is investing into capability to build a project management system in order to solidify prospects of concluding larger general contracting agreements in the years ahead. The increase in marketing and general administrative expenses in Latvia can be attributed to the costs incurred on maintaining the team against the drop in project volumes, and the corresponding expenses in Lithuania to the change in classification of certain expenditure items.

The scarcity of projects and the ever-tightening competition in the construction sector poses a great challenge in the maintaining of the current level of operating profit in all segments. The number of companies participating in tenders and the risk of low pricing bids is high in all three Baltic states.

Profit before tax and net profit

In 12 months of 2016, the group’s profit before tax totalled EUR 7.3 million (12 months of 2015: EUR 11.7 million) and net profit attributable to equity holders of the parent was EUR 6.1 million (12 months of 2015: EUR 10.0 million). Group’s profit before tax margin was 2.9% (12 months of 2015: 4.7%) and the net profit margin was 2.4% (12 months of 2015: 4.0%). Both the group’s profit before tax (EUR 7.3 million) and the profit before tax margin (2.9%) have decreased compared to the same period last year (12 months of 2015: EUR 11.7 million and 4.7%, respectively).

In Q4 of 2016, the group’s pre-tax profit totalled EUR 1.6 million and net profit was EUR 1.4 million as compared to the pre-tax profit of EUR 4.7 million and net profit of EUR 4.4 million in Q4 of 2015. Similarly to the 12 months of 2016 group’s quarterly profit before tax (EUR 1.6 million) and the quarterly profit before tax margin (2.0%) have decreased compared to the same period last year (Q4 2015: EUR 4.7 million and 7.0%).

In the second quarter of 2016, the group paid EUR 9.0 million in dividends, which incurred additional income tax expense in the amount of EUR 0.6 million. The situation in the second quarter of 2015 was alike, when the group paid EUR 7.3 million in dividends, with the exception that then the group incurred additional income tax expense in the amount of EUR 0.9 million.

Business segments

The group operates mainly in Estonian, Latvian and Lithuanian market through its subsidiaries. By purchasing a majority shareholding the group has formed the basis for entering the Norwegian market starting from Q1 2016. Depending on the country the group provides construction services and real estate development services across the following business segments: Estonian construction service (incl. construction services on project basis in Finland), other home markets construction service (incl. construction services in Latvia, Lithuania and Norway) and real estate development. The group’s segment structure is aligned with group’s management structure.

Estonian construction service (incl. construction services on project basis in Finland) and other home markets construction service (incl. construction services in Latvia, Lithuania and Norway) segments include all projects of the respective countries pertaining to construction services:

• General construction consists of the construction of different buildings, from commercial and office buildings, retail and entertainment centres to public sector and residential and specialised industrial buildings. Group companies provide strategic consulting and quality complete solutions as part of the general contracting service of construction according to the customer's requirements: preparation, design, construction, interior and warranty service. In the field of general construction, the group operates in all three Baltic countries and starting from Q1 2016 also in Norway.

• The civil engineering projects the group constructs include port, waste management and road structures (bridges, tunnels, overpasses, roads), electrical construction of up to 330 kV, various environmental protection structures, water treatment plants, both open-cut and trenchless construction of water and sewerage pipelines and other various engineering projects. Complex and unique engineering projects require specialised knowledge and a good partnership with the customer and local authorities. In this area the group operates in Estonia and Latvia.

• In the road construction division, the group carries out road construction and builds the associated infrastructure, road maintenance and maintenance repair. In the area or road construction the group operates only in Estonia.

Real estate development is based on the development of real estate in the ownership of the group, encompassing development of apartment projects, long-term investments into real estate and real estate projects executed for business purposes, and to a minor extent also real estate maintenance and lease. In this segment, similarly to before, the group recognises projects being developed in all of the different countries.

Estonian construction service

The Estonian construction services segment consists of various services in the field of general construction, civil engineering (including construction of electrical and external networks) and road construction and construction services on project basis in Finland.

In the 12 months of 2016, the revenue of the Estonian construction service segment was EUR 122.4 million (12 months of 2015: EUR 108.6 million), having increased by 12.7% from the same period last year. The 12 months revenue includes revenue from Finnish projects in the amount of EUR 0.6 million (12 months of 2015: EUR 2.8 million). The revenues have clearly decreased in the field of civil engineering and increased in the field of general construction. The increase in revenue in the segment is primarily influenced by the fact that several large-scale general construction projects launched in 2015. The Estonian construction service segment revenues for 12 months 2016 were 48.6% of the group’s revenue, forming the largest proportion in the group’s revenue, having increased by 12.2% in the yearly comparison.

In this segment, the group earned a gross profit of EUR 7.6 million for 12 months (12 months of 2015: EUR 10.4 million). In 12 months of 2016, the gross margin of the Estonian construction service segment was 6.2%, which decreased by approximately 1/3 compared to the 12 months of 2015 (9.6%), mainly due to the scarcity of projects in the field of civil engineering. We do not consider this as a satisfactory result, despite the close competition on the Estonian construction services market, in a situation where new contracts have not been concluded in the desired level at new procurements, especially at public procurements, and where the construction market volumes have decreased. We are continually critically monitoring any changes in the volume of work-in-progress and also constantly improving the efficiencies of internal project management processes. We have reduced and re-allocated staff within the group and, in order to maintain the efficiency of the cost base, made preparations with the aim for responding to further market changes.

Our major projects in the fourth quarter in Tallinn included the design and construction works of office building located at Mustamäe tee 3, Maakri Kvartal business complex, Tallink Tennis Centre, BAUHAUS DIY store, T1 shopping centre and Poordi st 1 residential and commercial building, construction of the airport tram line infrastructure, construction work on the passenger walkway at Vanasadama Harbour quay no. 5 and the renovation of quays 6 and 7 at Vene-Balti Harbour. Additionally the construction works of Viru Infantry Battalion technology park buildings and facilities, Juuliku road junction and road section at Tallinn roundabout and the road maintenance works done under the service agreement with Tallinn had a significant impact.

Other home markets construction service

The Other home markets construction service segment consists of general construction work in Latvia, Lithuania and stating from the first quarter of 2016 also in Norway and provision of civil engineering services in Latvia.

The revenue of the other home markets construction service segment amounted to EUR 52.7 million in the 12 months of 2016 (12 months of 2015: EUR 72.0 million), which is 26.8% less than in the 12 months of 2015. If the other home markets construction service segment revenues of 12 months of 2015 formed 28.7% of the group’s revenue, then during 12 months of the current year the segments revenues have decreased to 20.9%. The change in this percentage was in line with expectations, considering the lower level of new contracts signed in Latvia and Lithuania during 2015 and the 2015 comparison base, where large-scale projects were finished in Latvia, such as Liepaja Concert Hall and Polipaks NT manufacturing and logistics centre.

The 12 month gross profit of the other home markets construction service segment amounted to EUR 2.2 million (12 months of 2015: EUR 4.8 million) and the gross profit margin was 4.1% (12 months of 2015: 6.7%), which decreased by 38.5% compared to the same period previous year. Merko’s strategic position in Latvia is currently strong, as we are now among the leading general contractors there and see opportunities for growing our business volumes. In Lithuania, we are continuing on our strategic plan to focus first and foremost on external customers who make up the predominant part of the group’s Lithuanian construction contracts portfolio. In Norway, the group is performing smaller-scale agreements, but we are actively working on building project management capability and systems to conclude larger general contracting agreements in the years ahead. The group’s continued focus is on increasing the revenues outside Estonia.

In the fourth quarter of 2016, the main ongoing projects included in the other home markets construction service segment were the construction works of Kauno/Algirdo residential complex with office premises in Vilnius, the construction works of the second phase of the passenger terminal in Riga International Airport, the construction works of apartment building Magdalēnas nami and Kaļķu 20 apartement building in Riga.

Real estate development

The real estate development segment includes residential construction, the development of apartment projects, long-term real estate investments and commercial real estate projects.

The group sold a total of 493 apartments (incl. 21 apartments in joint ventures) in 12 months of 2016 at the total value of EUR 56.6 million (excl. VAT), compared to 403 apartments and EUR 61.4 million in 12 months of 2015. In Q4 of 2016 a total of 225 apartments (incl. 21 apartments in joint ventures) were sold at the total value of EUR 27.0 million (excl. VAT), (Q4 2015: 155 apartments and EUR 18.8 million). In 12 months of 2016, the group has earned EUR 9.2 million of revenue from the sale of immovable properties (12 months of 2015: EUR 6.6 million). Q4 2016 revenue from the sale of immovable properties was EUR 0.5 million (Q4 2015: EUR 4.4 million). The construction service revenue from projects developed by joint ventures in 12 months of 2016 was EUR 7.7 million (12 months of 2015: EUR 0.5 million). Q4 2016 revenue from the sale of construction service to projects developed by a joint ventures was EUR 2.4 million (Q4 2015: EUR 0.3 million).

Although in 12 months of 2016 real estate development segment revenues have increased by 9.2% compared to the same period last year, then despite approximately a 1/5 of more apartments sold, the revenues from apartment sales have decreased by approximately 10%. The decline is primarily influenced by sales of apartments in a more exclusive development in the reference period where the sales price per apartment was higher than the apartments sold during 2016. The group's apartment sales were in line with the expectations. By the end of the year, we succeeded in eliminating all administrative hindrances related to the issue of permits of use in Latvia and Lithuania, allowing to deliver to the buyers more apartments than forecasted at the end of Q3.

In the 12 months of 2016 the share of revenue from the real estate development segment formed as anticipated 30.5% of the group’s total revenue (12 months of 2015: 28.0%), having increased in a year by 8.8%.

The 12-month gross profit of the real estate development segment amounted to EUR 9.2 million (12 months of 2015: EUR 7.8 million) and the gross profit margin was 12.0% (12 months of 2015: 11.0%), which increased by 8.8% compared to the same period previous year. The profitability of the apartment development projects varies by project and depends greatly on the cost structure of the specific project, incl. the land acquisition price. The profitability of the apartments sold in the 12 months of 2016 was higher than in the reference period, but on the other hand the sector’s gross profit of the 12 months was also significantly influenced by the fact that the one-time effect of revenues from the sale of immovable properties that are strategically not needed by the group, the profitability of which is not comparable with a situation where the value of land is increased by passing through all phases of the development process. In the 12 months of 2016, the gross profit margin has also been reduced, in comparison with 2015, by the significant growth in the volume of construction service projects developed by joint ventures, where the profit from construction has been generated in the course of construction and the profit from development is realised at a later stage, upon sale of apartments to the final customer, based on the equity method.

At the end of the period, group’s inventory comprised 220 apartments where a preliminary agreement had been signed: 62 completed apartments (42 in Estonia, 10 in Latvia and 10 in Lithuania) and 158 apartments under construction (140 in Estonia and 18 in Latvia). The sale of these apartments had not yet been finalised and delivered to customers, because the development site is still under construction or the site was completed at the end of the reporting period and the sales transactions have not all been finalised yet.

As at 31 December 2016, the group had a total of 314 apartments for active sale (as at 31 December 2015: 497 apartments), for which there are no pre-sale agreements and of which 158 have been completed (95 in Estonia, 30 in Latvia and 33 in Lithuania) and 156 are under construction (88 in Estonia and 68 in Latvia). The slight decrease in the number of apartments on active sale as at 31 December 2016, compared to 31 December 2015 is mainly due to the lower volume of projects launched in the current year.

In 12 months of 2016, we launched the construction of a total of 344 new apartments in the Baltic states (12 months of 2015: 574 apartments).

After the balance sheet date, the Group has also launched two apartment development projects:

• in Latvia the construction of Gaiļezera nami residential development with 96 apartments at Mežciems district in Riga, located between Līduma, Gaiļezera and Hipokrāta streets;
• In Lithuania the construction of Rinktinės Urban residential development project with 120 apartments in the city centre of Vilnius, located at the corner of Rinktinės and Ceikiniu streets.

In the 12 months of this year, the group has invested a total of EUR 53.6 million (12 months of 2015: EUR 42.4 million) in new development projects launched in 2016 as well as projects already in progress from previous year.

We will continue to invest in residential real estate projects and in 2017, the group plans to launch the construction of approximately 650-700 (incl. 60-160 apartments in joint ventures) new apartments in the Baltic states. In 2016, construction was started on 344 apartments, which is about 150 units less than the level planned in early 2016 (500-550 new apartments) mainly due to the delay in receiving building permits for projects. The investment level in 2017 in both development projects initiated in the previous years and new projects to be launched in 2017 is in the range of EUR 45 million (2016: EUR 53.6 million invested).

One of our objectives is to keep a moderate portfolio of land plots to ensure stable inventory of property development projects considering the market conditions. At 31 December 2016, the group's inventories included land plots with the development potential, where the construction works have not started, of EUR 63.2 million (31.12.2015: EUR 58.0 million).

In the 12 months of 2016, the group has purchased new land plots at an acquisition cost of EUR 19.1 million purposes (12 months of 2015: acquired different new land plots in Tallinn, Estonia at an acquisition cost of EUR 6.6 million and in Vilnius, Lithuania at an acquisition cost of EUR 5.1 million). In Q4 of 2016, the group acquired the Pakraščio street immovable property in the city centre of Vilnius, Lithuania at an acquisition cost of EUR 2.3 million, where nearly 200 apartments will be developed in the years ahead; in the area located between Veerenni, Tehnika and Vana-Lõuna streets in Tallinn a development area of approximately 12 hectares at an acquisition cost of EUR 16.8 million, which allows the construction of approximately 1,600 apartments. The purchase of the Veerenni land plot constitutes one of the group's biggest investments in the last 5 years, and serves to reinforce the group's long-term strategy in Estonia. The construction of the first buildings on the site is scheduled to be launched at the end of 2017. Depending on the apartment market dynamics, the entire development area can be built up within 10-15 years.

The comparison period development activities investments additionally include the signing of a notarised contract of sale of registered immovable in Q1 2015, under which all of the real estate governed by an option agreement in Tallinn were realised for total of EUR 4.0 million. In Q2 2015 AS Merko Ehitus group 50% joint venture Kodusadam OÜ additionally signed a contract for the acquisition of approximately 1.7 hectares of land in the Noblessner quarter, an historically prestigious industrial area in Tallinn with great potential, for development purpose to build approximately 200 apartments. The first apartment building in the development project, Staapli 4, is now under construction and will be completed by the end of 2017.

Based on its long-term strategy, the group will continue investing in land plots, and is searching for new land plots with development potential, in 2017 above all, in Estonia and Lithuania.

In the second quarter of 2016, the group completed the competition for an international development and architectural concept for the Latvian Zakusala development area (close to 1,500 apartments). A total of eleven entries came in from Estonia, Norway, Poland and Latvia. The competition was organised based on the regulations handed down by the Latvian Architects Union. Six entries from among the works submitted met the qualifications. A five-member jury picked an entry by RUUME arhitekti (https://ruumearhitekti.wordpress.com/), a practice of young Latvian architects, as the winner. The group will continue preparations in order to launch construction in the development area in 3-5 years’ time.

Secured order book

As at 31 December 2016, the group’s secured order book (without own developments) amounted to EUR 269.6 million as compared to EUR 246.9 million as at 31 December 2015, having increased by approximately 10% in the annual comparison. The secured order book excludes the group's own residential development projects and construction work related to developing real estate investments.

In 12 months of 2016, EUR 202.4 million worth of new contracts were signed (without own developments) as compared to EUR 247.0 million in same period last year. The value of new contracts signed (without own developments) in the fourth quarter of 2016 amounted to EUR 61.9 million (Q4 2015: EUR 94.8 million).

After the balance sheet date, the group concluded two large construction contracts:

• On 11 January 2016, AS Merko Ehitus group company UAB Merko Statyba and PK INVEST UAB, part of AS Pro Kapital Grupp group, entered into a contract to perform the design and construction works of the residential complex in Šaltiniu Namai quarter, located at 10 Aguonui street, Vilnius. The contract value is EUR 10.8 million. The works are scheduled for completion by January of 2019.
• On 24 January 2016, AS Merko Ehitus Eesti – a subsidiary of AS Merko Ehitus – signed a contract with AS Mainor Ülemiste, the developer of Ülemiste City, to perform the design and construction works of Öpiku maja second office building, located at Sepise 9/Valukoja 8, Tallinn, Estonia. The value of the contract is approximately EUR 15.5 million. The works are scheduled for completion in the second half of 2018.

Of the contracts signed in the 12 months of 2016, private sector orders accounted for the majority proportion, which is also represented in the group’s secured order book as at the end of the reporting period, where private sector orders from projects in progress constitute approximately 70% (31.12.2015: approximately 80%). Apart from a few large-scale procurements where Merko companies were not as optimistic as our competitors in bidding at a low price, the share of government contracts in the 12 months of 2016 has been very modest. The group continues to focus on comprehensive design and construction contracts. In this regard, five important contracts were signed in the 12 months of 2016 (incl. none in Q4 2016).

The portfolio of contracts stands relatively strong compared to the same period of the last few years (31.12.2015: EUR 246.9 million; 31.12.2014: EUR 179.1 million). Yet aside from individual larger-scale agreements in Estonia, the secured order book balance is not satisfactory. This is particularly the case in regard to public procurements in Estonia. Considering the beginning phase of the current EU funding period, the volume of public procurements has stayed at the previous year’s level and at the moment we predict that the volume of public procurements will start to increase in 2017.

Traditionally the share of Estonian construction activity has been the highest in the group's revenues. Given the weak growth outlook of the Estonian construction market, the group's goal is to increase the volume of construction orders from outside Estonia. Thus, we will continue to identify and strengthen the groups competitive advantages and are closely monitoring the development and opportunities both in the Baltic states and the Nordic countries. In the last few years, the group has taken part in various individual Finnish, Swedish and Norwegian construction procurements in a selective and project-based manner in order to gain experience and regarding the conditions and requirements set out in these countries for qualifying for construction company procurements, as well as assess the risks so as to evaluate potential competitive advantages for entering these markets. In March 2016, the group concluded a transaction through which it acquired a controlling holding in Peritus Entreprenør AS, a Norwegian construction company that provides general construction services. In 2016, the group will continue implementing its chosen strategy with the goal of increasing revenue earned on new markets, focusing above all on the Norwegian market and taking part in a project-based manner in Finnish and Swedish construction procurements as well.

Cash flows

As at 31 December 2016 the group had cash equivalents in the amount of EUR 33.5 million (31.12.2015: EUR 39.9 million). The group's cash level is lower compared to the same period last year; still, the financial position is continually strong, as the group has not utilised its credit lines of existing overdrafts and loan agreements.

The 12-month cash flow from operating activity was negative at EUR 12.0 million (12 months of 2015: positive EUR 7.4 million), cash flow from investing activity was negative at EUR 0.6 million (12 months of 2015: negative EUR 0.8 million) and the cash flow from financing activity was positive at EUR 6.3 million (12 months of 2015: negative EUR 18.3 million).

The cash flow from operating activity was mostly influenced by the EBITDA (operating profit adjusted with depreciation and amortisation) EUR 11.2 million (12 months of 2015: EUR 15.5 million), by the positive change in receivables and liabilities related to construction contracts recognised under the stage of completion method EUR 3.7 million (12 months of 2015: positive change of EUR 2.2 million), by the negative change in the provisions EUR 0.5 million (12 months of 2015: negative change of EUR 1.5 million), by the negative change in trade and other receivables related to operating activities EUR 18.0 million, incl. a net change in financing co-financed projects of EUR 0.0 million and VAT prepayment related to Veerenni development area aquisition in the amount of EUR 3.4 million, which was returned in January of 2017 (12 months of 2015: positive change of EUR 10.0 million, incl. a negative change in financing co-financed projects of EUR 4.2 million), by the negative change in inventory EUR 14.1 million, incl. negative cash flow from purchase of new land plots in the amount of EUR 19.1 million and positive cash flow from sale of immovable properties in the amount of EUR 8.7 million (12 months of 2015: positive change of EUR 10.9 million, incl. negative cash flow from purchase of new land plots in the amount of EUR 11.7 million and positive cash flow from sale of immovable properties in the amount of EUR 5.4 million), by the positive change in trade and other payables related to operating activities EUR 8.9 million (12 months of 2015: negative change of EUR 27.2 million, incl. significant negative outflow from the realization of an option agreement in the amount of EUR 4.0 million but also from the advances for real estate development projects), interest received EUR 1.5 million (12 months of 2015: EUR 1.8 million), interest paid EUR 0.7 million (12 months of 2015: EUR 0.9 million) and by the corporate income tax paid EUR 1.7 million (12 months of 2015: EUR 1.8 million).

To support cash flows arising from operating activity, the group has been cautious in raising additional external capital, including factoring. At the same time, the debt ratio has remained at a moderate level (19.3% as at 31.12.2016; 14.8% as at 31.12.2015).

Cash flows from investment activities include negative cash flow from the acquisition of non-current asset in the amount of EUR 3.0 million (12 months of 2015: EUR 0.8 million) and the positive cash flow from the sale of non-current assets in the amount of EUR 1.1 million (12 months of 2015: EUR 0.3 million). The group mainly invested in non-current assets for the purpose of renewing its fleet of machinery in the road construction segment. Cash flows from investment activities in 12 months of 2015 was also positively impacted by the acquisition of majority shareholding in subsidiary Peritus Entreprenør AS (related to the offering of construction services on Norwegian market) in the amount of EUR 1.2 million. Cash flows from investing activities in 2015 also include an additional contribution to the share capital of the joint venture OÜ Unigate in the amount of EUR 0.4 million.

The largest single negative item in cash flows from financing was the dividend payment of EUR 9.0 million (12 months of 2015: EUR 7.3 million). Cash flows from financing activities in 2015 also a one-time share capital reduction payment to the shareholders in the amount of EUR 4.1 million. Project specific loans obtained using investment property as collateral were repaid in the amount of EUR 0.6 million (12 months of 2015: positive cash flow in the net amount of EUR 0.6 million, incl. refinancing of an investment loan in the amount of EUR 1.2 million). Net of loans received and loans repaid in connection with development projects amounted to positive cash flow of EUR 3.9 million (12 months of 2015: net negative cash flow of EUR 4.6 million) and finance lease principal repayments of EUR 0.9 million (12 months of 2015: EUR 2.2 million). In addition, over the 12 months of 2016, the group made repayments in the amount of EUR 2.0 million to related party Järvevana OÜ pursuant to the terms and conditions of an overdraft agreement between the parties. The group has not used bank loans to finance all ongoing development projects – and this is the case particularly in Estonia, where many advance sales were agreed in the early phase of construction. If all of the new land plots acquired by the group both in the 12 months of 2015 were financed in full from the group’s resources without drawing on external funding, then at the end of 2016 EUR 12.5 million was engaged in short-term loan from the parent company AS Riverito to purchase the Veerenni development area. The loan was refinanced at the beginning of 2017 with long-term loans from various credit institutions.

The Q4 2016 cash flow from operating activity was negative at EUR 0.9 million (Q4 2015: positive EUR 23.4 million), cash flow from investing activity was negative at EUR 0.6 million (Q4 2015: negative EUR 0.7 million) and the cash flow from financing activity was positive at EUR 14.3 million (Q4 2015: negative EUR 2.8 million).

The quarterly cash flows from operating activities were negative primarily as a result of the EUR 16.8 million investment into Veerenni development area and short-term VAT prepayment related to the investment in the amount of EUR 3.4 million (which was refunded in January 2017). On the negative side the quarterly cash flows was additionally influenced by investments into ongoing apartment development projects in the amount of EUR 8.8 million, which was partially offset by a slightly higher than usual positive cash flow from the sale of apartments.

The third quarter cash flows from investment activities included a negative cash flow from the purchase of non-current asset in the amount of EUR 1.1 million and a positive cash flow in the amount of EUR 0.5 million from the sale of non-current assets, which were both mainly related to the renewal of equipment in the road construction segment.

The quarterly cash flow from financing activities was positive mainly due to short-term loan received from parent company AS Riverito to finance the acquisition of Veerenni development are in the amount of EUR 12.5 million.

Dividends and dividend policy

The distribution of dividends to the shareholders of the company is recorded as a liability in the financial statements as of the moment when the payment of dividends is approved by the company’s shareholders.

At the meeting held on 8 April 2013, the Management Board and Supervisory Board of AS Merko Ehitus reviewed the company’s strategic development trends and approved the long-term financial objectives until 2018, under which a new objective of paying the shareholders 50-70% of the annual profit as dividends was established. The achievement of this objective is an important priority for the group.

The annual general meeting of shareholders of AS Merko Ehitus held at 27 April 2016 approved the Supervisory Board’s proposal to pay the shareholders the total amount of EUR 9.0 million (EUR 0.51 per share) as dividends from net profit brought forward, which is equivalent to a 90% dividend rate and a 6.0% dividend yield for the year 2015 (using the share price as at 31 December 2015), (comparable figures in 2015 were accordingly: EUR 7.3 million (EUR 0.41 per share) as dividends, which is equivalent to a 58% dividend rate and a 5.7% dividend yield (using the share price as at 31 December 2014)).

According to the Estonian Income Tax Law §50 section 1¹ AS Merko Ehitus can pay certain portion of dividends without any additional income tax expense and liabilities occurring due to previously received and taxed distribution of profits from subsidiaries. Taking into account the dividends already paid to the parent company by the subsidiaries during 2016, the group incurred additional income tax expense in connection with the disbursement of dividends of EUR 0.6 million (Q2 2015: EUR 0.9 million) in Estonia in the second quarter of 2016.The dividend payment to the shareholders took place on 20 May 2016.

The Management Board proposes to pay the shareholders EUR 7.3 million as dividends from net profits brought forward (EUR 0.41 per share) in 2017, which is equivalent to a 119% dividend rate and a 4.5% dividend yield for the year 2016 (using the share price as at  31  December  2016). The  proposal  to  pay  dividends  beyond  the  established  dividend  policy  rate  is  based  on  the  return on equity posted in 2016, the group's strong liquidity position, which has ensured investment capability and the prospects of the construction market, where the volumes of civil engineering procurements are expected to rise in the near future but projects will not be actually started until the end of 2017 or later.Taking into account the dividends already paid to the parent company and planned to be paid by foreign subsidiaries in early 2017, the group will incur income tax expenses of approximately EUR 0.9 million in 2017 in Estonia in connection with disbursement of dividends.

Ratios
(attributable to equity holders of the parent)

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
unaudited

in thousand euros

CONSOLIDATED STATEMENT OF FINANCIAL POSITION
unaudited

in thousand euros

Interim report and the investor presentation are attached to the announcement and are also published on NASDAQ Tallinn and Merko’s web page (group.merko.ee).

Signe Kukin
Group CFO
AS Merko Ehitus
+372 650 1250
signe.kukin@merko.ee

AS Merko Ehitus (group.merko.ee) group consists of Estonia’s leading construction company AS Merko Ehitus Eesti, the Latvian-market-oriented SIA Merks, UAB Merko Statyba that is operating on the Lithuanian market, Peritus Entreprenør AS construction company in Norway and the real estate development business unit along with real estate holding companies. As at the end of 2016, the group employed 797 people and the company’s 2016 revenue was EUR 252 million.