Market announcement

Title

2014 III quarter and nine months consolidated interim report (unaudited)

Message

This announcement includes Nordecon AS’s consolidated financial statements for
the third quarter and nine months of 2014 (unaudited), overview of the key
events influencing the period’s financial result, outlook for the market and
description of the main risks. 

Interim report is attached to the announcement and is also published on NASDAQ
OMX Tallinn and Nordecon’s web page
(http://www.nordecon.com/root/en/for-investor/financial-reports/interim-reports)
. 

Period’s investor presentation are attached to the announcement and are also
published on Nordecon’s web page
(http://www.nordecon.com/root/en/for-investor/investor-presentations). 


Condensed consolidated interim statement of financial position



EUR’000                                            30 September      31 December
                                                           2014             2013
--------------------------------------------------------------------------------
ASSETS                                                                          
--------------------------------------------------------------------------------
Current assets                                                                  
Cash and cash equivalents                                 7,704           12,575
Trade and other receivables                              34,652           28,101
Prepayments                                               1,429            1,923
Inventories                                              26,346           23,785
Total current assets                                     70,131           66,384
Non-current assets                                                              
Investments in equity-accounted investees                   771              566
Other investments                                            26               26
Trade and other receivables                              11,253           10,645
Investment property                                       3,560            3,549
Property, plant and equipment                             9,033            9,030
Intangible assets                                        14,590           14,494
Total non-current assets                                 39,233           38,310
TOTAL ASSETS                                            109,364          104,694
                                                                                
LIABILITIES                                                                     
Current liabilities                                                             
Loans and borrowings                                     26,396           23,875
Trade payables                                           30,252           26,372
Other payables                                            6,539            7,982
Deferred income                                           3,053            6,102
Provisions                                                  508              913
Total current liabilities                                66,748           65,244
Non-current liabilities                                                         
Loans and borrowings                                      3,976            3,303
Trade payables                                              155              156
Other payables                                               96               96
Provisions                                                  969              969
Total non-current liabilities                             5,196            4,524
TOTAL LIABILITIES                                        71,944           69,768
                                                                                
EQUITY                                                                          
Share capital                                            20,692           19,657
Treasury shares                                          -1,582                0
Share premium                                               547                0
Statutory capital reserve                                 2,554            2,554
Other reserves                                               20                0
Translation reserve                                         423             -298
Retained earnings                                        12,365           10,681
Total equity attributable to owners of the               35,019           32,594
 parent                                                                         
Non-controlling interests                                 2,401            2,332
TOTAL EQUITY                                             37,420           34,926
TOTAL LIABILITIES AND EQUITY                            109,364          104,694

Condensed consolidated interim statement of comprehensive income



EUR’000                           Q3 2014  Q3 2013   9M 2014   9M 2013      2013
--------------------------------------------------------------------------------
Revenue                            53,492   59,236   120,936   134,733   173,651
--------------------------------------------------------------------------------
Cost of sales                     -48,913  -53,083  -112,145  -125,307  -162,342
Gross profit                        4,579    6,153     8,791     9,426    11,309
                                                                                
Marketing and distribution            -76     -142      -420      -281      -452
 expenses                                                                       
Administrative expenses            -1,535   -1,240    -4,006    -3,567    -4,922
Other operating income                129      154       270       360       464
Other operating expenses             -225     -292      -256      -351    -1,096
Operating profit                    2,872    4,633     4,379     5,587     5,303
                                                                                
Finance income                        160      124       486       507       668
Finance costs                        -359     -329    -1,581      -887    -1,027
Net finance costs                    -199     -205    -1,095      -380      -359
                                                                                
Share of profit/loss of               186      120       208       197      -170
 equity-accounted investees                                                     
                                                                                
Profit before income tax            2,859    4,548     3,492     5,404     4,774
Income tax expense                    -63      -51      -242       -95      -135
Profit for the period               2,796    4,497     3,250     5,309     4,639
                                                                                
Other comprehensive income                                                      
Items that may be reclassified                                                  
 subsequently to profit or loss                                                 
Exchange differences on               -89       82       721        49       106
 translating foreign operations                                                 
Total other comprehensive             -89       82       721        49       106
 income/expense                                                                 
TOTAL COMPREHENSIVE INCOME          2,707    4,579     3,971     5,358     4,745
                                                                                
Profit attributable to:                                                         
- Owners of the parent              2,386    4,409     2,607     5,137     4,642
- Non-controlling interests           410       88       643       172        -3
Profit for the period               2,796    4,497     3,250     5,309     4,639
                                                                                
Total comprehensive income                                                      
 attributable to:                                                               
- Owners of the parent              2,297    4,491     3,328     5,186     4,748
- Non-controlling interests           410       88       643       172        -3
Total comprehensive income for      2,707    4,579     3,971     5,358     4,745
 the period                                                                     
                                                                                
Earnings per share attributable                                                 
 to owners of the parent:                                                       
Basic earnings per share (EUR)       0.08     0.14      0.08      0.17      0.15
Diluted earnings per share (EUR)     0.08     0.14      0.08      0.17      0.15

Condensed consolidated interim statement of cash flows



EUR’000                                                        9M 2014   9M 2013
--------------------------------------------------------------------------------
Cash flows from operating activities                                            
--------------------------------------------------------------------------------
Cash receipts from customers1                                  131,291   136,517
Cash paid to suppliers2                                       -118,250  -125,826
VAT paid                                                        -3,907    -2,419
Cash paid to and for employees                                 -14,618   -13,403
Income tax paid                                                   -177        -2
Net cash used in operating activities                           -5,661    -5,133
                                                                                
Cash flows from investing activities                                            
Paid on acquisition of property, plant and equipment              -284      -315
Paid on acquisition of intangible assets                           -14         0
Proceeds from sale of property, plant and equipment                185       191
Acquisition of a subsidiary                                       -719         0
Acquisition of investments in associates                             0      -350
Cash from liquidation of investments in associates                   1         0
Loans provided                                                    -275      -377
Repayment of loans provided                                        106       202
Dividends received                                                   4         4
Interest received                                                    4       359
Net cash used in investing activities                             -992      -286
                                                                                
Cash flows from financing activities                                            
Proceeds from loans received                                    10,551    10,243
Repayment of loans received                                     -5,887    -3,760
Payment of finance lease liabilities                            -1,110    -1,310
Interest paid                                                     -654      -736
Dividends paid                                                    -940      -107
Other payments made                                               -175         0
Net cash from financing activities                               1,785     4,330
                                                                                
Net cash flow                                                   -4,868    -1,089
                                                                                
Cash and cash equivalents at beginning of period                12,575    10,231
Effect of exchange rate fluctuations on cash and cash               -3        -2
 equivalents                                                                    
Decrease in cash and cash equivalents                           -4,868    -1,089
Cash and cash equivalents at end of period                       7,704     9,140

1 Line item Cash receipts from customers includes VAT paid by customers.

2 Line item Cash paid to suppliers includes VAT paid


Financial review

Financial performance

Nordecon group ended the first nine months of 2014 with a gross profit of 8,791
thousand euros (9M 2013: 9,426 thousand euros) and a gross margin of 7.3% (9M
2013: 7.0%). Most of the period’s profit was earned in the third quarter when
performance was not impacted by adverse weather conditions and the fixed costs
of a technological standstill that typically characterise the beginning of the
year. In contrast to the previous year, profit was not undermined by
loss-making contracts and all segments succeeded in either maintaining or
improving their profit margins. 

The Group’s management has highlighted the expected fall in demand and the
ensuing rise in competitive pressure in previous periods already (see also the
chapters Order book, Description of the main risks and Outlooks of the Group’s
geographical markets) and has enforced measures for maintaining and, possibly,
improving profitability in a situation where volumes decrease. We are aware
that rises in input prices pose a risk for long-term contracts and continue to
prioritize a contract’s anticipated profitability over revenue growth or
retention. 

The Group’s administrative expenses for the first nine months of 2014 totalled
4,006 thousand euros, 12% up on a year ago (9M 2013: 3,567 thousand euros). The
ratio of administrative expenses to revenue (12 months rolling) was 3.4% (9M
2013: 2.8%). Administrative expenses have grown through a rise in payroll
expenses and the provisions recognised in the third quarter based on the
Group’s performance indicators. Our cost-control measures continue to yield
strong results – administrative expenses remain below the target ceiling, i.e.
4% of revenue. 

Operating profit for the first nine months amounted to 4,379 thousand euros (9M
2013: 5,587 thousand euros) while EBITDA was 5,743 thousand euros (9M 2013:
7,088 thousand euros). 

Adverse movements in the euro/hryvna exchange rate gave rise to exchange losses
that were significantly larger than those of previous periods. The Ukrainian
hryvna weakened by around 33%, which meant that Group entities whose functional
currency is the hryvna had to re-measure their euro-denominated liabilities.
The Group’s exchange losses, which are reported within finance costs, totalled
817 thousand euros (9M 2013: an exchange loss of 43 thousand euros). The same
exchange loss gave rise to a positive 721 thousand-euro change in the
translation reserve reported in equity (9M 2013: a positive change of 49
thousand euros) and the net effect of the exchange loss on the Group’s net
assets was 96 thousand euros (9M 2013: a positive net effect of 6 thousand
euros). 

As a result, the Group’s net profit amounted to 3,250 thousand euros (9M 2013:
5,309 thousand euros) of which the profit attributable to owners of the parent,
Nordecon AS, was 2,607 thousand euros (9M 2013: 5,137 thousand euros). 

Cash flows

Operating activities for the first nine months of 2014 resulted in a net cash
outflow of 5,661 thousand euros (9M 2013: a net outflow of 5,133 thousand
euros). In a situation where operating activities generate a profit, negative
operating cash flow results primarily from a mismatch between the projects’
actual stage of completion (recognised revenue) and the amounts billed to
customers. Cash inflow is also reduced by the amounts retained under the terms
of construction contracts, which are released when construction activity ends.
Retentions extend from 5% to 10% of the volume of a contract, being comparable
to the profit margin. In addition, we continue to work on our own housing
development projects but the cash flows of such projects are negative until
sales commence. Projects completed in the previous year with higher than
expected profit margins have also resulted in larger performance bonuses and
accompanying tax charges. Operating cash flows continue to be influenced by a
mismatch in settlement terms: the ones agreed with customers are long and in
the case of public procurement mostly extend from 45 to 56 days while
subcontractors generally have to be paid within 21 to 45 days. 

Investing activities resulted in a net cash outflow of 992 thousand euros (9M
2013: a net outflow of 286 thousand euros). The largest one-off outflows
resulted from a loan of 250 thousand euros to an entity of AS Nordic
Contractors group (see note 14), a payment of 180 thousand euros made to
purchase the remaining shares in the subsidiary AS Eston Ehitus from the
non-controlling shareholders and acquisition of a further stake in Eurocon OÜ
for 539 thousand euros (see note 15). 

Financing activities resulted in a net cash inflow of 1,785 thousand euros (9M
2013: a net inflow of 4,330 thousand euros). Loan receipts exceeded loan
repayments by 4,664 thousand euros compared with 6,483 thousand euros a year
ago. The change is mainly attributable to changes in the Group’s overdraft
balances. 

Finance lease payments declined slightly year over year. Dividends distributed
in the period totalled 940 thousand euros (9M 2013: 107 thousand euros). 

At 30 September 2014, the Group’s cash and cash equivalents totalled 7,704
thousand euros (30 September 2013: 9,140 thousand euros). Management’s comments
on liquidity risks are presented in the chapter Description of the main risks. 

Key financial figures and ratios



Figure/ratio                         9M 2014     9M 2013     9M 2012        2013
--------------------------------------------------------------------------------
Revenue (EUR’000)                    120,936     134,733     117,054     173,651
Revenue change                        -10.2%       15.1%       13.4%        8.9%
Net profit (EUR’000)                   3,250       5,309       1,988       4,639
Profit attributable to owners of       2,607       5,137       1,630       4,642
 the parent (EUR’000)                                                           
Weighted average number of        30,756,728  30,756,728  30,756,728  30,756,728
 shares                                                                         
Earnings per share (EUR)                0.08        0.17        0.05        0.15
                                                                                
Administrative expenses to              3.3%        2.6%        3.4%        2.8%
 revenue                                                                        
Administrative expenses to              3.4%        2.8%        3.3%        2.8%
 revenue (rolling)                                                              
                                                                                
EBITDA (EUR’000)                       5,743       7,088       3,735       7,639
EBITDA margin                           4.7%        5.3%        3.2%        4.4%
Gross margin                            7.3%        7.0%        5.1%        6.5%
Operating margin                        3.6%        4.1%        1.8%        3.1%
Operating margin excluding gains        3.5%        4.0%        1.4%        2.9%
 on sale of real estate                                                         
Net margin                              2.7%        3.9%        1.7%        2.7%
Return on invested capital              6.5%        8.9%        4.6%        9.5%
Return on equity                        9.0%       16.1%        6.8%       14.2%
Equity ratio                           34.2%       27.0%       25.7%       33.4%
Return on assets                        3.0%        4.4%        1.8%        4.3%
Gearing                                33.4%       42.8%       41.1%       23.5%
Current ratio                           1.05        1.12        1.08        1.02
                                     30 Sept     30 Sept     30 Sept      31 Dec
                                        2014        2013        2012        2013
--------------------------------------------------------------------------------
Order book (EUR’000)                  92,455      85,765     146,070      64,286
--------------------------------------------------------------------------------





Revenue change = (revenue for the    Operating margin excluding gains on sale of
 reporting period/revenue for the     real estate = ((operating profit - gains  
 previous period) – 1*100             on sale of non-current assets – gains on  
Earnings per share (EPS) = net        sale of real estate)/revenue) *100        
 profit attributable to owners of    Net margin = (net profit for the           
 the parent / weighted average        period/revenue)*100                       
 number of shares outstanding        Return on invested capital = ((profit      
Administrative expenses to revenue    before tax + interest expense)/ the       
 = (administrative expenses/          period’s average (interest-bearing        
 revenue)*100                         liabilities + equity))*100                
Administrative expenses to revenue   Return on equity = (net profit for the     
 (rolling) = (past four quarters’     period/ the period’s average total        
 administrative expenses/past four    equity)*100                               
 quarters’ revenue)*100              Equity ratio = (total equity/ total        
EBITDA = operating profit +           liabilities and equity)*100               
 depreciation and amortisation +     Return on assets = (net profit for the     
 impairment losses on goodwill        period/ the period’s average total        
EBITDA margin =                       assets)*100                               
 (EBITDA/revenue)*100                Gearing = ((interest-bearing liabilities – 
Gross margin = (gross                 cash and cash equivalents)/               
 profit/revenue)*100                  (interest-bearing liabilities +           
Operating margin = (operating         equity))*100                              
 profit/revenue)*100                 Current ratio = total current assets/ total
                                      current liabilities                       
--------------------------------------------------------------------------------

Performance by geographical market

In the first nine months of 2014, around 6% of the Group’s revenue was
generated outside Estonia compared with 2% in the first nine months of 2013. 



         9M 2014  9M 2013  9M 2012  2013
----------------------------------------
Estonia      94%      98%      99%   95%
----------------------------------------
Finland       4%       2%       1%    5%
Ukraine       2%       0%       0%    0%

Finnish revenues comprise revenue from concrete works performed in the building
construction segment. The contribution of the Finnish market has increased year
over year through growth in Finnish revenues, which has been amplified by a
year over year decrease in the Group’s total revenue. The contribution of the
Ukrainian market has increased because we started work under a building
construction contract. Still, foreign revenues for the year as a whole will
probably not prove significantly larger than those of 2013. 

Geographical diversification of the revenue base is a consciously deployed
strategy by which we mitigate the risks resulting from excessive concentration
on a single market. Our strategy foresees increasing foreign operations in the
longer term; for further information, see the chapter Strategic agenda for
2014-2017. Our vision of the Group’s operations in foreign markets is described
in the chapter Outlooks of the Group’s geographical markets. 

Performance by business line

Segment revenues

The Group strives to maintain the revenues of its operating segments (Buildings
and Infrastructure) in balance as this helps disperse risks and provides better
opportunities for continuing construction operations in stressed circumstances
where one segment may experience shrinkage. 

Our revenue for the first nine months of 2014 amounted to 120,936 thousand
euros, a 10% decrease from the 134,733 thousand euros generated in the nine
months of 2013. A year ago, we were working on three large road construction
projects of around 70 million euros whose contribution to the period’s revenue
was considerable. Also, a year ago the volume of projects supported by the EU
structural funds was larger. We drew attention to the fact that the volume of
such projects would decline last year already. The revenues of the Buildings
segment increased as expected through a rise in both the number and average
cost of contracts secured from the private sector. 

Consequently, the revenues of our two operating segments, Buildings and
Infrastructure, for the first nine months of 2014 amounted to 76,690 thousand
euros and 40,951 thousand euros respectively. The corresponding figures for the
first nine months of 2013 were 52,294 thousand euros and 79,587 thousand euros
(see note 8). 



Operating segments*  9M 2014  9M 2013  9M 2012  2013
----------------------------------------------------
Buildings                63%      38%      42%   41%
----------------------------------------------------
Infrastructure           37%      62%      58%   59%

* In the directors’ report the Ukrainian buildings segment and the EU buildings
segment, which are disclosed separately in the financial statements as required
by IFRS 8 Operating Segments, are presented as a single segment. 

In the directors’ report, projects have been allocated to operating segments
based on their nature (i.e. building or infrastructure construction). In the
segment reporting presented in the financial statements, allocation is based on
the subsidiaries’ main field of activity (as required by IFRS 8 Operating
Segments). In the financial statements, the results of a subsidiary that is
primarily engaged in infrastructure construction are presented in the
Infrastructure segment. In the directors’ report, the revenues of such a
subsidiary are presented based on their nature. The differences between the two
reports are not significant because in general Group entities specialise in
specific areas except for the subsidiary Nordecon Betoon OÜ that is involved in
both building and infrastructure construction. The figures for the parent
company are allocated in both parts of the interim report based on the nature
of the work. 

Sub-segment revenues

In the revenue structure of the Buildings segment, the contribution of public
buildings has decreased while the contributions of industrial and warehouse
facilities and apartment buildings have increased. The contribution of
commercial buildings has remained stable. The segment’s main revenue
contributors were contracts on the construction of commercial buildings in
Tallinn (the Stroomi shopping centre, an office building in Ülemiste City and
Eesti Loto Maja (a commercial building)) and Narva (an extension to the ASTRI
shopping centre). In Pärnu, we started the reconstruction of Estonia Spa. We
expect the investment activity of private sector customers to remain robust and
the contribution of the sub-segment to remain at a similar or even higher level
throughout the year. 

In the industrial and warehouse facilities sub-segment there has been a
structural shift. In previous years, most of the revenue resulted from
agricultural projects undertaken with the EU investment support. To date, the
share of EU-supported projects has decreased visibly and the main contributors
are warehouse facilities and logistics centres (e.g. the Smarten logistics
centre). The work done for companies engaged in heavy industry has increased as
well. Estonia’s economic growth is slowing but this has not yet had a negative
impact on the long-cycle investment plans launched by companies in 2012 and
2013. Accordingly, we expect the revenues of the sub-segment to remain stable. 

The competitive situation in the public buildings sub-segment is particularly
challenging: it is hard to win a contract without taking excessive risks but
our current policy is to avoid such risks. The largest projects of the period
were the construction of the Translational Medicine Centre of the University of
Tartu, the academic building of the NCO School of the Estonian National Defence
College, phase V of St Paul’s Church in Tartu and the Võru State Secondary
School. The first two were completed by the end of the reporting period. If
competition remains fierce, the contribution of the sub-segment is likely to
decline. 

Our apartment building revenues resulted mostly from general contracting. Major
revenue contributors were an apartment building at Pirita tee 26 and phase I in
the construction of the Tondi residential quarter in Tallinn. We have been
successful in selling the last apartments in our Tigutorn development project
where only one apartment is still for sale. We continue to sell apartment
ownerships in phase I and build phase II of our Magasini 29 development project
in Tallinn (www.magasini.ee) and have re-launched real estate development in
Tartu where two new buildings with a total of 35 apartments will be completed
in Tammelinn by the end of 2014 (www.tammelinn.ee). 



Revenue distribution within Buildings segment  9M 2014  9M 2013  9M 2012  2013
------------------------------------------------------------------------------
Commercial buildings                               43%      47%      24%   45%
------------------------------------------------------------------------------
Industrial and warehouse facilities                37%      29%      28%   29%
Public buildings                                    6%      20%      44%   21%
Apartment buildings                                14%       4%       4%    5%

In the first nine months of 2014, the main revenue source in the Infrastructure
segment was road construction. The average cost of the sub-segment’s contracts
has fallen and operating volumes are not going to rise to the level of 2013
because procurement of large-scale design and construction work has been
replaced by smaller-scale reconstruction and repair work. Nevertheless, the
contribution of the sub-segment will remain the strongest, partly thanks to
road maintenance services delivered under long-term contracts in the Järva and
Hiiu counties and the Keila maintenance area. 

In specialist engineering, a major project was the construction of the Sõpruse
bridge boat harbour in Tartu. There is currently no information about any major
projects that might require hydraulic engineering work this year. The revenues
of the sub-segment may increase through other complex engineering work but
relevant revenue flows are likely to be irregular. 

The decline in EU support due to the change of budget periods has had a strong
impact on our environmental engineering and utility network construction (other
engineering) revenues, which have decreased more rapidly than the revenues of
other sub-segments. It is likely that the contributions of the two sub-segments
will see further contraction because a relatively large portion of their
revenue for the first nine months of 2014 resulted from long-term contracts
secured in the previous period. Most new contracts are small. 



Revenue distribution within Infrastructure       9M 2014  9M 2013  9M 2012  2013
 segment                                                                        
--------------------------------------------------------------------------------
Road construction and maintenance                    74%      56%      49%   54%
--------------------------------------------------------------------------------
Specialist engineering (including hydraulic           3%       8%      15%    8%
 engineering)                                                                   
Other engineering                                    15%      24%      31%   26%
Environmental engineering                             8%      12%       5%   12%

Order book

At 30 September 2014, our order book (backlog of contracts signed but not yet
performed) stood at 92,455 thousand euros, an 8% increase compared with a year
ago. Both the Buildings and the Infrastructure segment increased their order
books. 

The order book of the Infrastructure segment grew by 5% thanks to work secured
by the road construction sub-segment. In other sub-segments of the
Infrastructure segment order books shrank. The largest decreases occurred in
contracts signed for the construction of utility networks (other engineering
sub-segment) and environmental engineering as in the last year of the EU
2007-2013 budget period allocations of relevant investment support were
expectedly smaller. The backlog of hydraulic engineering work decreased as
well. 

The order book of the Buildings segment grew by around 9%. The order book of
the commercial buildings sub-segment grew substantially, mostly thanks to a
rise in private sector investments. 



                      9M 2014  9M 2013  9M 2012    2013
-------------------------------------------------------
Order book (EUR’000)   92,455   85,765  146,070  64,286

At the reporting date, contracts secured by the Buildings segment and the
Infrastructure segment accounted for 70% and 30% of our order book respectively
(30 September 2013: 69% and 31% respectively). The distribution is typical of
the past year but radically different from the preceding periods when the
figures for the two segments were more or less equal. It is likely that
building construction contracts will continue to dominate the order book in the
next few years. In the current EU budget period (2014-2020) investments in
infrastructure construction, which to date have mostly been made with the
support of the EU structural funds, will not be as large as in 2007-2013. In
particular, this applies to 2014, which is becoming a switchover year between
two budget periods, where most efforts are directed at preparatory
administrative activities required for enabling the investments. Hence, we
expect the revenues of the Infrastructure segment to decline in 2014 (for
further information, see the Business risks section of the chapter Description
of the main risks). 

We believe that in a situation where the market is expected to shrink, our
priority, at least in the current year, cannot be increasing the Group’s
revenue or maintaining it at the level of 2013. Instead, the main focus must be
on improving profitability. Compared with the end of 2013, our order book has
grown by 44%. 

Between the reporting date (30 September 2014) and the date of release of this
report, Group companies have secured additional construction contracts in the
region of 7,939 thousand euros. 

People

Staff and personnel expenses

In the first nine months of 2014, the Group (the parent and the subsidiaries)
employed, on average, 751 people including 364 engineers and technical
personnel (ETP). Workforce has decreased compared with a year ago due to
shrinkage in operating volumes. 

Average number of the Group’s employees (at the parent and the subsidiaries)



               9M 2014  9M 2013  9M 2012  2013
----------------------------------------------
ETP                364      360      372   357
----------------------------------------------
Workers            387      424      417   400
Total average      751      784      789   757

The Group’s personnel expenses for the first nine months of 2014 including all
taxes totalled 14,357 thousand euros, 6% up on the comparative period when the
figure was 13,584 thousand euros. The rise is mostly attributable to an
increase in basic salaries as well as payment of project-based performance pay.
Personnel expenses (also for the comparative period) include the provisions
made in the third quarter for performance bonuses that may be paid based on the
Group’s performance indicators. 

The service fees of the members of the council of Nordecon AS for the first
nine months of 2014 amounted to 166 thousand euros and associated social
security charges totalled 55 thousand euros (9M 2013: 120 thousand euros and 40
thousand euros respectively). 

The service fees of the members of the board of Nordecon AS amounted to 411
thousand euros and associated social security charges totalled 136 thousand
euros (9M 2013: 195 thousand euros and 64 thousand euros respectively). 

The fees (also for the previous year) include the provisions made in the third
quarter for performance bonuses that may be paid based on the Group’s
performance indicators. 

Labour productivity and labour cost efficiency

The period’s nominal labour productivity declined because revenue decreased and
bonus payments made in the context of increased profitability grew. In
comparative periods, the proportion of performance bonuses in the Group’s
personnel expenses was significantly smaller. In addition, basic salaries have
increased. 

We measure the efficiency of our operating activities using the following
productivity and efficiency indicators, which are based on the number of
employees and personnel expenses incurred: 



                                               9M 2014  9M 2013  9M 2012    2013
--------------------------------------------------------------------------------
Nominal labour productivity (rolling),           218.8    231.6    213.0   229.4
 (EUR’000)                                                                      
--------------------------------------------------------------------------------
Change against the comparative period            -5.5%     8.7%    22.5%    9.9%
                                                                                
Nominal labour cost efficiency (rolling),          7.5      9.5     10.4     8.4
 (EUR’000)                                                                      
Change against the comparative period           -21.9%    -8.3%    18.5%  -11.6%





Nominal labour productivity (rolling) = (past four quarters’ revenue) / (past   
 four quarters’ average number of employees)                                    
Nominal labour cost efficiency (rolling) = (past four quarters’ revenue) / (past
 four quarters’ personnel expenses)                                             
--------------------------------------------------------------------------------

Description of the main risks

Business risks

The main factors, which affect the Group’s business volumes and profit margins,
are competition in the construction market and changes in the demand for
construction services. 

Compared with a year ago, competition for public sector contracts has
intensified visibly. The volume of public sector investments decreased in 2013
and the prospects of maintaining volumes in 2014 are not good. There is strong
competitive pressure on builders’ bid prices although input prices mostly
continue to climb. Competition is particularly fierce in the building
construction segment. We acknowledge the risks inherent in the execution of
contracts concluded in an environment of stiff competition. Securing a
long-term construction contract at an unreasonably low price in a situation
where input prices cannot be lowered noticeably and competition is fierce
involves high risk, because the contract may quickly start generating a loss.
Thus, in price-setting we currently prioritize profitability over increasing or
retaining the revenue figure. 

In the next periods, demand for construction services will be driven by public
sector investments. In previous years, a major share of investments was made
with the assistance of allocations from the EU structural funds that were
determined, both in terms of size and timing, by the EU financial framework
2007-2013. In general, the amounts allocated to Estonia under the current EU
financial framework (2014-2020) are known (5.9 billion euros) but the volume
and schedule of investments involving construction work have not yet been
finalised. According to information released to date, the overall volume of
construction-related investments is going to decline compared with the previous
budget period and 2014 will become a so-called ‘gap’ year between the two
budget periods, where most efforts are directed at preparatory administrative
activities required for enabling the investments. 

In light of the above, it is likely that in 2014 our business volumes will
shrink, particularly in the Infrastructure segment where the proportion of
public sector investments has been the largest. Our action plan foresees
redirecting our resources (including some of the labour of the Infrastructure
segment) to increasing the proportion of contracts secured from the private
sector. According to our business model, Nordecon operates in all segments of
the construction market. Therefore, we are somewhat better positioned than
companies that operate in only one narrow (particularly some infrastructure)
segment. 

Our primary goal is to maintain profitability even when construction volumes
shrink. Thanks to decisions adopted in previous periods, we will not have to
undertake any extensive restructuring when construction volumes change. 

The Group’s business is also influenced by the fact that construction
operations are seasonal. The impacts of seasonal fluctuations are the strongest
in the Infrastructure segment where a lot of work is done outdoors (road and
port construction, earthwork, etc). To disperse the risk, we secure road
maintenance contracts that generate year-round business. Our business strategy
is to counteract seasonal fluctuations in infrastructure operations with
building construction that is less exposed to seasonality. Thus, we endeavour
to keep the two segments in balance (see also the chapter Performance by
business line). In addition, where possible, our companies implement
appropriate technical solutions that allow working efficiently even in
changeable weather conditions. 

Operational risks

To manage their daily construction risks, Group companies purchase contractors’
all risks insurance. Depending on the nature of the project and the requests of
the customer, both general frame agreements and special, project-specific
contracts are used. In addition, as a rule, subcontractors are required to
secure performance of their obligations with a bank guarantee provided to a
Group company or the Group retains part of the amount payable until the
completion of the contract. To remedy builder-caused deficiencies, which may be
detected during the warranty period, Group companies create warranty provisions
based on their historical experience. At 30 September 2014, the Group’s
warranty provisions (including current and non-current ones) totalled 1,096
thousand euros. The comparative figure for a year ago was 998 thousand euros. 

In addition to managing risks directly related to construction operations, in
recent years we have sought to mitigate the risks inherent in preliminary
activities. In particular, we have focused on the bidding process, i.e.
compliance with the procurement terms and conditions, and budgeting. The errors
made in the planning stage are usually irreversible and, in a situation where
the price is contractually fixed, may result in a direct financial loss. 

Financial risks

Credit risk

In the period, the Group did not incur any major credit losses. The credit risk
exposure of the Group’s receivables continued to be low because the share of
public sector customers is significant and the customers’ settlement behaviour
is monitored on an ongoing basis. The main indicator of the realization of
credit risk is settlement default that exceeds 180 days coupled with no
activity on the part of the debtor that would confirm the intent to settle. 

In the first nine months of 2014, impairment losses incurred on receivables
amounted to 10 thousand euros (9M 2013: 261 thousand euros). 

Liquidity risk

The Group remains exposed to higher than usual liquidity risk resulting from a
mismatch between the long settlement terms demanded by customers (mostly 45 to
56 days) and increasingly shorter settlement terms negotiated by subcontractors
(mostly 21 to 45 days). The Group counteracts the differences in settlement
terms by using factoring where possible. 

At the reporting date, the Group’s current assets exceeded its current
liabilities 1.05-fold (30 September 2013: 1.12-fold). Factors influencing the
ratio include reclassification of loans provided to the Group’s Ukrainian
associates to non-current assets and the fact that generally banks do not
refinance interest-bearing liabilities for a period exceeding 12 months. 

The political situation in Ukraine remains tense and we believe that
realization of our Ukrainian investment properties may take longer than
originally expected. Accordingly, at the reporting date loan receivables from
our Ukrainian associates of 10,632 thousand euros were classified as
non-current assets. 

Interest-bearing liabilities account for a significant proportion of our
current liabilities. In accordance with IFRS EU, loan commitments have to be
classified into current and non-current liabilities based on the contractual
conditions effective at the reporting date. To date, banks have refinanced the
Group’s liabilities for periods not exceeding 12 months, which is why a
substantial portion of loans are classified as current liabilities although it
is probable that some borrowings (particularly overdraft facilities) will be
refinanced again when the 12 months have passed. 

At the reporting date, the Group’s cash and cash equivalents totalled 7,704
thousand euros (30 September 2013: 9,140 thousand euros). 

Interest rate risk

The Group’s interest-bearing liabilities to banks have both fixed and floating
interest rates. Finance lease liabilities have mainly floating interest rates.
The base rate for most floating-rate contracts is EURIBOR. At 30 September
2014, the Group’s interest-bearing loans and borrowings totalled 30,372
thousand euros, a decrease of 12,156 thousand euros year over year. An
important factor that contributed to the decrease was a decline in factoring.
Interest expense for the period amounted to 762 thousand euros, 21 thousand
euros down from a year ago. 

The main source of the Group’s interest rate risk is the possibility of a rapid
upsurge in the base rate of floating interest rates (EURIBOR, EONIA or the
creditor’s own base rate). In light of the Group’s relatively heavy loan burden
this would cause a significant increase in interest expense, which would have
an adverse impact on profit. We mitigate the risk by pursuing a policy of
entering, where possible, into fixed-rate contracts when the market interest
rates are low. As regards the loan products offered by banks, observance of the
policy has proved difficult and most new contracts have a floating interest
rate. The Group does not use derivative financial instruments to hedge its
interest rate risk. 

Currency risk

As a rule, the prices of construction contracts and subcontracts are fixed in
the currency of the host country, i.e. in euros (EUR) and Ukrainian hryvnas
(UAH). 

At the beginning of 2014, the political and economic environment in Ukraine
became strained due to the conflict between Ukraine and Russia, which caused
the exchange rate of the hryvna to tumble. Although in the third quarter the
fall began to slow, by the reporting date the hryvna had weakened against the
euro by around 33%. For the Group’s Ukrainian subsidiaries, this meant
additional exchange losses on the translation of their euro-denominated loan
commitments into the local currency. Relevant exchange losses totalled 817
thousand euros (9M 2013: an exchange loss of 43 thousand euros). 

Exchange gains and losses on financial instruments are reported within Finance
income and Finance costs in the statement of comprehensive income. Translation
of receivables and liabilities related to operating activities did not give
rise to any exchange gains or losses. 

The reciprocal receivables and liabilities of the Group’s Ukrainian and
non-Ukrainian entities (items connected with the construction business that are
denominated in hryvnas) do not give rise to any material exchange losses. Nor
do the loans provided to the Group’s Ukrainian associates in euros give rise to
exchange losses that ought to be recognised in the Group’s financial
statements. 

The Group has not acquired any derivatives to hedge its currency risk.


Outlooks of the Group’s geographical markets

Estonia

Processes and developments characterising the Estonian construction market

· In 2014 public sector investment will decrease in connection with the change
of the EU budget periods because implementation of measures requires time.
Although during the 2014-2020 financial framework allocations to Estonia will
increase to 5.9 billion euros (2007-2013: 4.6 billion euros), support payments
from the structural funds that influence the construction market will not
increase significantly. Instead, compared with the previous budget period,
there will be an increase in allocations to projects not related to tangible
assets. 

Investments made by the largest public sector customers (state-owned real
estate company Riigi Kinnisvara AS and the National Road Administration), which
will reach the stage of conclusion of a construction contract in 2014 will
either not increase significantly or may even decrease. As a result, the
Estonian construction market (particularly segments related to infrastructure
construction) will shrink. The situation will be somewhat alleviated by private
customers’ increasing investment in building construction. 

· The construction market will see further consolidation, particularly in the
field of general contracting in building construction where the number of
medium-sized operators (annual turnover of around 15-40 million euros) is still
too large, but the process will be slower than expected. Based on the past
three years’ experience it is likely that stiff competition and insufficient
demand will induce some general contractors to go slowly out of business or
shrink in size rather than merge with another or exit the market. However, it
is also increasingly common that two to four smaller players that are seeking
ways to remain in business will form a consortium to bid for major procurement
contracts, meet tendering terms and secure the required funding. 

· Competition will increase in all segments of the construction market. We see
a rise in the average number of bidders for a contract and there is already a
notable gap between the lowest bids made by the winners and the average bids.
The situation is somewhat similar to 2009 when anticipation of a fall in demand
caused a rapid decline in construction prices, which triggered a slide in the
prices of many construction inputs. However, there are currently no massive
decreases in input prices and companies that are banking on this in the bidding
phase may run into difficulty. Construction prices and thus also profit margins
are under strong competitive pressure. 

· In new housing development, the success of a project depends on the
developer’s ability to control the input prices included in the business plan
and thus to set an affordable sales price. Although the overall situation is
improving steadily, the offering of new residential real estate cannot be
increased dramatically because the prices of new apartments are relatively high
compared with the standard of living and the banks’ lending terms remain
strict. Similarly to previous periods, successful projects include those that
create or fill a niche. 

· The contracts signed with public sector customers continue to impose tough
conditions on construction companies: extensive obligations, strict sanctions,
various financial guarantees, long settlement terms, etc. Contractors cannot
implement more optimal solutions identified in the construction phase that
would reduce the construction or operating costs of the asset without sanctions
because procurement terms do not allow this. In a situation where public
procurement is based on underbidding, the above factors increase the risks of
all market participants. Still, compared to two or three years ago, the
situation has improved and in some respects procurement terms have become more
reasonable for construction companies. 

· The prices of construction inputs will remain relatively stable. In the short
term, weakening demand may lower local subcontracting prices. However, taking
into account the subcontractors’ financial and human resources, the decline
cannot be substantial or long-lasting. In some areas, price fluctuations are be
unpredictable and, thus, notably greater and hard or even impossible to
influence (oil and metal products, certain materials and equipment). 

· Shortage of skilled labour (including project and site managers) will
persist. This will undermine not so much the companies’ performance
capabilities as the quality of carrying out the construction process, i.e.
delivering the service. Shrinkage in construction volumes in Estonia may
increase labour supply but not substantially. Labour migration to the Nordic
countries will remain steady and although those markets (particularly the
Finnish one) may also shrink, the number of job seekers that will return will
not increase considerably. Accordingly, the basic wage of construction-sector
employees will not decrease. Instead, the rise in the cost of living is
creating pressure for a wage increase. 

Latvia and Lithuania

In our opinion, the Latvian construction market, which was hit by a severe
downturn a few years ago, has not regained sufficient stability and similarly
to the Estonian market in 2014 it will probably see shrinkage in public sector
demand. Accordingly, it is unlikely that we will enter the Latvian construction
market permanently in 2014. 

In the next few years we may undertake some projects in Latvia through our
Estonian entities, involving partners where necessary. Undertaking a project
assumes that it can be performed profitably. The decision does not change our
strategy for the future, i.e. the objective of operating in our neighbouring
construction markets through local subsidiaries. 

The operations of our Lithuanian subsidiary, Nordecon Statyba UAB, are
suspended. We are monitoring market developments and may resume our Lithuanian
operations on a project basis. Temporary suspension of operations does not
cause any major costs for the Group and does not change our strategy for the
future, i.e. the objective of operating in the Lithuanian construction market
through local subsidiaries. 

Ukraine

The Group prefers to operate in Ukraine as a general contractor and project
manager that serves foreign private sector customers in the segment of building
construction. Even though the political situation in Ukraine shows signs of
improvement, it continues to restrict adoption of business decisions by
construction market participants. Regardless of this, we will continue our
business in Ukraine in 2014 and our current Ukrainian order book is
significantly larger than in the comparative period. We continue to monitor the
situation in the Ukrainian construction market closely and will restructure our
operations as appropriate. We also continue to seek opportunities for exiting
our two conserved real estate projects or signing a construction contract with
a potential new owner. 

Finland

In the Finnish market, we have been offering mainly subcontracting services in
the field of concrete works but based on experience gained, we have also
started to deliver some more complex services. The local concrete works market
provides opportunities for competing for projects where the customer wishes to
purchase all concrete works from one reliable partner. Nevertheless, we will
maintain a rational approach and will avoid taking excessive risks. We are not
planning to penetrate any other segments of the Finnish construction market
(general contracting, project management, etc). 

Nordecon is a group of construction companies whose core business is
construction project management and general contracting in the buildings and
infrastructures segment. Geographically the Group operates in Estonia, Ukraine
and Finland. The parent of the Group is Nordecon AS, a company registered and
located in Tallinn, Estonia. In addition to the parent company, there are more
than 10 subsidiaries in the Group. The consolidated revenue of the Group in
2013 was 174 million euros and net profit 4.6 million euros. Currently Nordecon
Group employs more than 700 people. Since 18 May 2006 the company's shares have
been quoted in the main list of the NASDAQ OMX Tallinn Stock Exchange. 




         Andri Hõbemägi
         Nordecon AS
         Head of Investor Relations
         Tel: +372 6272 022
         Email: [email protected]
         www.nordecon.com