Market announcement

Title

2014 fourth quarter and twelve months consolidated interim report (unaudited)

Message

This announcement includes Nordecon AS’s consolidated financial statements for
the fourth quarter and twelve 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                                       31 December 2014  31 December 2013
ASSETS                                                                          
Current assets                                                                  
Cash and cash equivalents                                8,802            12,575
Trade and other receivables                             23,243            28,101
Prepayments                                              1,201             1,923
Inventories                                             25,391            23,785
Total current assets                                    58,637            66,384
Non-current assets                                                              
Investments in equity-accounted investees                  694               566
Other investments                                           26                26
Trade and other receivables                             11,211            10,645
Investment property                                      3,549             3,549
Property, plant and equipment                            9,319             9,030
Intangible assets                                       14,633            14,494
Total non-current assets                                39,432            38,310
TOTAL ASSETS                                            98,069           104,694
                                                                                
LIABILITIES                                                                     
Current liabilities                                                             
Loans and borrowings                                    20,588            23,875
Trade payables                                          26,858            26,372
Other payables                                           7,552             7,982
Deferred income                                          1,796             6,102
Provisions                                                 799               913
Total current liabilities                               57,593            65,244
Non-current liabilities                                                         
Loans and borrowings                                     3,145             3,303
Trade payables                                             109               156
Other payables                                              96                96
Provisions                                                 759               969
Total non-current liabilities                            4,109             4,524
TOTAL LIABILITIES                                       61,702            69,768
                                                                                
EQUITY                                                                          
Share capital                                           20,692            19,657
Own (treasury) shares                                   -1,582                 0
Share premium                                              547                 0
Statutory capital reserve                                2,554             2,554
Translation reserve                                        771              -298
Retained earnings                                       11,714            10,681
Total equity attributable to owners of the              34,696            32,594
 parent                                                                         
Non-controlling interests                                1,671             2,332
TOTAL EQUITY                                            36,367            34,926
TOTAL LIABILITIES AND EQUITY                            98,069           104,694


Condensed consolidated interim statement of comprehensive income

EUR’000                                     Q4 2014  Q4 2013  12M 2014  12M 2013
Revenue                                      40,353   39,220   161,289   173,651
Cost of sales                               -39,331  -36,716  -151,476  -162,342
Gross profit                                  1,022    2,504     9,813    11,309
                                                                                
Marketing and distribution expenses            -138     -171      -558      -452
Administrative expenses                      -1,650   -1,439    -5,656    -4,922
Other operating income                          489      104       792       464
Other operating expenses                        -87     -745      -376    -1,096
Operating profit/loss                          -364      253     4,015     5,303
                                                                                
Finance income                                  252      161       738       668
Finance costs                                  -720     -140    -2,301    -1,027
Net finance costs/income                       -468       21    -1,563      -359
                                                                                
Share of profit/loss of equity-accounted       -123     -343        85      -170
 investees                                                                      
                                                                                
Profit/loss before income tax                  -955      -69     2,537     4,774
Income tax                                        3      -40      -239      -135
Profit/loss for the period                     -952     -109     2,298     4,639
                                                                                
Other comprehensive income                                                      
Items that may be reclassified                                                  
 subsequently to profit or loss                                                 
Exchange differences on translating             348       56     1,069       106
 foreign operations                                                             
Total other comprehensive income                348       56     1,069       106
TOTAL COMPREHENSIVE INCOME/EXPENSE             -604      -53     3,367     4,745
                                                                                
Profit/loss attributable to:                                                    
- Owners of the parent                         -651       58     1,956     4,642
- Non-controlling interests                    -301     -167       342        -3
Profit/loss for the period                     -952     -109     2,298     4,639
                                                                                
Total comprehensive income/expense                                              
 attributable to:                                                               
- Owners of the parent                         -303      114     3,025     4,748
- Non-controlling interests                    -301     -167       342        -3
Total comprehensive income/expense for the     -604      -53     3,367     4,745
 period                                                                         
                                                                                
Earnings per share attributable to owners                                       
 of the parent:                                                                 
Basic earnings per share (EUR)                -0.02     0.00      0.06      0.15
Diluted earnings per share (EUR)              -0.02     0.00      0.06      0.15


Condensed consolidated interim statement of cash flows

EUR’000                                                       12M 2014  12M 2013
Cash flows from operating activities                                            
Cash receipts from customers1                                  192,701   204,768
Cash paid to suppliers2                                       -163,690  -175,465
VAT paid                                                        -5,429    -5,131
Cash paid to and for employees                                 -19,384   -18,647
Income tax paid                                                   -184       -99
Net cash from operating activities                               4,014     5,426
                                                                                
Cash flows from investing activities                                            
Paid on acquisition of property, plant and equipment              -355      -458
Paid on acquisition of intangible assets                           -13         0
Proceeds from sale of property, plant and equipment                189       317
Acquisition of a subsidiary                                       -737         0
Acquisition of investments in associates                           -44      -616
Cash from liquidation of investments in associates                   1         0
Loans provided                                                    -292      -922
Repayment of loans provided                                        227       245
Dividends received                                                   4         4
Interest received                                                    7       616
Net cash used in investing activities                           -1,013      -814
                                                                                
Cash flows from financing activities                                            
Proceeds from loans received                                     7,815     3,440
Repayment of loans received                                    -11,194    -2,970
Payment of finance lease liabilities                            -1,432    -1,670
Interest paid                                                     -852      -945
Dividends paid                                                    -940      -121
Other payments made                                               -168         0
Net cash used in financing activities                           -6,771    -2,226
                                                                                
Net cash flow                                                   -3,770     2,346
                                                                                
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/increase  in cash and cash equivalents                 -3,770     2,346
Cash and cash equivalents at end of period                       8,802    12,575

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 2014 with a gross profit of 9,813 thousand euros (2013:
11,309 thousand euros) and a gross margin of 6.1% (2013: 6.5%). Profitability
grew in the Buildings segment and dropped slightly in the Infrastructure
segment. 

The Group’s management was conscious of 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 enforced measures for maintaining profitability in a
situation where volumes decrease. We are aware that potential rises in input
prices pose a risk for long-term contracts and continue to prioritize a
contract’s expected profitability over revenue growth or retention. 

The Group’s administrative expenses for 2014 totalled 5,656 thousand euros,
14.9% up on the year before (2013: 4,922 thousand euros). The ratio of
administrative expenses to revenue was 3.5% (2013: 2.8%). The main factors that
contributed to growth in administrative expenses were a rise in payroll
expenses and recognition of a performance pay provision based on the Group’s
financial indicators. Our cost-control measures continued to yield strong
results – administrative expenses remained below the target ceiling, i.e., 4%
of revenue. 

Operating profit for 2014 amounted to 4,015 thousand euros (2013: 5,303
thousand euros) and EBITDA (including the effect of goodwill) was 5,585
thousand euros (2013: 7,639 thousand euros). 

Adverse movements in the euro/hryvnia exchange rate gave rise to exchange
losses that were significantly larger than those of previous periods. The
Ukrainian hryvnia weakened by around 44%, which meant that Group entities whose
functional currency is the hryvnia had to re-measure their euro-denominated
liabilities. The Group’s exchange losses, which are reported within finance
costs, totalled 1,299 thousand euros (2013: 144 thousand euros). In financial
accounting, the same exchange loss gave rise to a positive 1,069 thousand-euro
change in the translation reserve reported in equity (2013: a change of 106
thousand euros) and the net effect of the exchange loss on the Group’s net
assets was 230 thousand euros (2013: 38 thousand euros). 

Thus, the Group’s net profit amounted to 2,298 thousand euros (2013: 4,639
thousand euros) of which the profit attributable to owners of the parent,
Nordecon AS, was 1,956 thousand euros (2013: 4,642 thousand euros). 

Cash flows

Operating activities of 2014 resulted in a net cash inflow of 4,014 thousand
euros (2013: a net inflow of 5,426 thousand euros). During the year, the Group
signed several contracts with private sector customers which do not require the
customer to make advance payments. Absence of advance payments has become quite
common also in the case of public sector contracts. Amounts retained from
invoices issued during the construction period that are released only when
construction activity ends also reduce cash inflow. Retentions account for
5-10% of the value of a contract. Besides, cash inflow is undermined by the
construction of own housing development projects. Projects completed by the
Group with higher than expected profit margins 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. We counter
the cyclicality by using factoring services and overdraft facilities provided
for financing our working capital needs. 

Investing activities resulted in a net cash outflow of 1,013 thousand euros
(2013: a net outflow of 814 thousand euros). The largest non-recurring 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 for purchasing
the remaining shares in the subsidiary AS Eston Ehitus from the non-controlling
shareholders and payments of 557 thousand euros for increasing the Group’s
ownership interest in Eurocon OÜ (see note 15). 

Financing activities resulted in a net cash outflow of 6,771 thousand euros
(2013: a net outflow of 2,226 thousand euros). Loan repayments exceeded loan
receipts by 3,379 thousand euros whereas in 2013 loan receipts exceeded
repayments by 470 thousand euros. The changes are mainly attributable to
changes in the Group’s overdraft balances and repayments made under long-term
investment loans. Finance lease and interest payments declined slightly.
Dividends distributed in 2014 totalled 940 thousand euros (2013: 121 thousand
euros). 

At 31 December 2014, the Group’s cash and cash equivalents totalled 8,802
thousand euros (31 December 2013: 12,575 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                                        2014        2013        2012
Revenue (EUR’000)                                161,289     173,651     159,422
Revenue change                                     -7.1%        8.9%        7.9%
Net profit (EUR’000)                               2,298       4,639       1,926
Profit attributable to owners of the parent        1,956       4,642       1,477
 (EUR’000)                                                                      
Weighted average number of shares             30,756,728  30,756,728  30,756,728
Earnings per share (EUR)                            0.06        0.15        0.05
                                                                                
Administrative expenses to revenue                  3.5%        2.8%        3.4%
                                                                                
EBITDA (EUR’000)*                                  5,585       7,639       4,833
EBITDA margin                                       3.5%        4.4%        3.0%
Gross margin                                        6.1%        6.5%        5.2%
Operating margin                                    2.5%        3.1%        1.7%
Operating margin excluding gains on sale of         2.3%        2.9%        1.4%
 real estate                                                                    
Net margin                                          1.4%        2.7%        1.2%
Return on invested capital                          5.8%        9.5%        5.2%
Return on equity                                    6.4%       14.2%        6.6%
Equity ratio                                       37.1%       33.4%       27.1%
Return on assets                                    4.0%        4.3%       33.7%
Gearing                                            24.8%       23.5%       41.1%
Current ratio                                       1.02        1.02        1.08
As at 31 December                                   2014        2013        2012
Order book (EUR’000)                              83,544      64,286     127,259

* EBITDA for 2014 includes expenses of 192 thousand euros (2013: 348 thousand
euros) from write-down of goodwill and income of 414 thousand euros from the
acquisition of negative goodwill. 

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



Performance by geographical market

In 2014, around 6% of the Group’s revenue was generated outside Estonia
compared with 5% in 2013. 

         2014  2013  2012
Estonia   94%   95%   98%
Finland    4%    5%    2%
Ukraine    2%    0%    0%

Finnish revenues comprise revenue from concrete works performed in the building
construction segment. The contribution of the Finnish market has decreased
slightly and the contribution of the Ukrainian market where we started work
under a new building construction contract has increased. 

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

We strive to maintain the revenues of our operating segments (Buildings and
Infrastructure) in balance as this helps disperse risks and provides better
opportunities for continuing construction operations also in stressed
circumstances where one segment may experience noticeable shrinkage. 

In 2014, Nordecon’s revenues totalled 161,289 thousand euros, 7% down from the
173,651 thousand euros generated in 2013. The decline is mainly attributable to
the Infrastructure segment that saw shrinkage across all sub-segments, mostly
because the projects supported by the EU structural funds came to an end and
contract volumes dropped sharply. The revenue of the Buildings segment grew as
expected through a rise in both the number and average cost of contracts
secured from the private sector. We drew attention to the change already at the
end of the previous financial year. 

Accordingly, in 2014 the revenues of our two operating segments, Buildings and
Infrastructure, amounted to 105,145 thousand euros and 51,585 thousand euros
respectively. The corresponding figures for 2013 were 71,694 thousand euros and
98,550 thousand euros (see note 8). 

Operating segments*  2014  2013  2012
Buildings             65%   41%   42%
Infrastructure        35%   59%   58%

* 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 decreased and that of commercial buildings declined slightly whereas
the contributions of industrial and warehouse facilities and apartment
buildings increased. The segment’s largest revenue contributors were contracts
for the construction of commercial buildings in Tallinn (the Stroomi shopping
centre, an office building in Ülemiste City and the Eesti Loto building) and
Narva (an extension to the ASTRI shopping centre). In Pärnu, the Group is
reconstructing 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 also in the next financial year. 

The industrial and warehouse facilities sub-segment saw a structural shift. In
previous years, most of the revenue resulted from agricultural projects
undertaken with the EU investment support. In 2014, the share of EU-supported
projects decreased visibly and the main contributors were warehouse facilities
and logistics centres (e.g., the Smarten logistics centre). The work done for
companies engaged in heavy industry increased as well. We do not expect the
revenues of the sub-segment to increase in 2015. 

The competitive situation in the public buildings sub-segment is extremely
challenging: it is hard to win a contract without taking risks but our current
policy is to avoid various risks. The largest projects of the year 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. Construction of the state secondary school will continue in 2015. If
competition remains fierce, the revenue of the sub-segment is likely to
decline. 

Our apartment building revenues resulted mostly from general contracting. Major
revenue contributors were the apartment buildings at Pirita tee 26 and in
Kentmanni street and phase I of the Tondi residential quarter in Tallinn. The
contribution of our own development projects also continues to increase. At the
year-end, we completed two new apartment buildings with a total of 35
apartments in the Tammelinn district of Tartu. Sales of the apartments have
been highly successful: by the year-end, 17 apartments were sold
(www.tammelinn.ee). We have started preparations for the construction of phase
II of the development. Most of the apartments in the Tigutorn apartment
building (our other development project in Tartu) have been sold - at the
year-end, only one apartment was still for sale. In Tallinn, we continue to
sell apartment ownerships in phase I and build phase II of our Magasini 29
development project (www.magasini.ee). 

Revenue distribution within Buildings segment  2014  2013  2012
Commercial buildings                            42%   45%   26%
Industrial and warehouse facilities             33%   29%   35%
Public buildings                                 7%   21%   36%
Apartment buildings                             18%    5%    3%

In 2014, the main revenue source in the Infrastructure segment was road
construction. The average size of the sub-segment’s contracts has decreased
considerably and volumes are not going to regain the level of 2013 because
procurement of large-scale design and construction work has been replaced by
smaller reconstruction and repair projects. Still, the contribution of the
sub-segment will remain the strongest, partly thanks to the performance of
long-term road maintenance 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
investments in projects requiring hydraulic engineering work. The revenues of
the sub-segment may increase through other complex engineering work but
relevant revenues are likely to be irregular. 

The decline in EU support due to the change of budget periods had a strong
impact on our environmental engineering and utility network construction (other
engineering) revenues, which decreased more rapidly than the revenues of other
sub-segments. It is unlikely that the contributions of these sub-segments will
remain stable in 2015. Instead, it is likely that their volumes will continue
to contract because in 2014 a relatively large portion of their revenue
resulted from long-term contracts secured in the previous period. Most new
contracts are small. 

Revenue distribution within Infrastructure segment        2014  2013  2012
Road construction and maintenance                          72%   54%   51%
Specialist engineering (including hydraulic engineering)    2%    8%   15%
Other engineering                                          19%   26%   27%
Environmental engineering                                   7%   12%    7%

Order book

At 31 December 2014, our order book (backlog of contracts signed but not yet
performed) stood at 83,544 thousand euros, a 30% 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 51% through work secured
by the road construction sub-segment. There is a substantial amount of work
signed but not yet performed under two large road construction projects - one
in Tartu (design and construction work under construction package 5 of the
Tartu western bypass) and the other one in Keila (reconstruction of  the
Keila-Valkse section of national road no. 8 Tallinn – Paldiski, km 24.9-29.5).
In other sub-segments of the Infrastructure segment order books shrank
considerably. The largest decrease occurred in environmental engineering but
the decline in hydraulic engineering was steep as well. 

The order book of the Buildings segment grew by around 23%. The commercial
buildings sub-segment increased its order book substantially, mostly thanks to
a rise in private sector investment. A substantial portion of work signed but
not yet performed by the commercial buildings sub-segment is made up of the
construction of a business building in Viimsi (Viimsi Keskus), a business
building at Veerenni 24, an office building in Ülemiste City and the Eesti Loto
building as well as the reconstruction of Estonia Spa. 

                        2014    2013     2012
Order book (EUR’000)  83,544  64,286  127,259

At the reporting date, contracts secured by the Buildings segment and the
Infrastructure segment accounted for 73% and 27% of the Group’s order book
respectively (2013: 77% and 23% respectively). The distribution is typical of
the past year but radically different from earlier years when the figures for
the two segments were more or less equal. It is likely that the order book will
continue to reflect the change for 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. The new EU budget period is likely to have an impact
on the construction sector at the end of 2015 at the earliest. Hence, we expect
the revenues of the Infrastructure segment to decline in 2015 (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 likely to shrink and
competition continues to be fierce, the main challenge is to maintain the
Group’s revenue and profitability. 

Between the reporting date (31 December 2014) and the date of release of this
report, Group companies have secured additional construction contracts in the
region of 5,678 thousand euros. 



People

Staff and personnel expenses

In 2014, the Group (the parent and the subsidiaries) employed, on average, 732
people including 357 engineers and technical personnel (ETP). Workforce
decreased compared with 2013 due to shrinkage in operating volumes. 

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

               2014  2013  2012
ETP             357   357   367
Workers         375   400   397
Total average   732   757   764

The Group’s personnel expenses for 2014 including all taxes totalled 20,099
thousand euros, 3% down from 2013 when the figure was 20,664 thousand euros.
The slight decrease is attributable to a decline in the number of staff. 

In 2014, the service fees of the members of the council of Nordecon AS amounted
to 141 thousand euros and associated social security charges totalled 47
thousand euros (2013: 141 thousand euros and 47 thousand euros respectively).
The provision for their performance bonuses, made based on the Group’s
performance indicators, amounted to 113 thousand euros and associated social
security charges totalled 37 thousand euros (2013: 14 thousand euros and 4
thousand euros respectively). 

The service fees of the members of the board of Nordecon AS amounted to 262
thousand euros and associated social security charges totalled 87 thousand
euros (2013: 195 thousand euros and 65 thousand euros respectively). The
provision for their performance bonuses, made based on the Group’s performance
indicators, amounted to 387 thousand euros and associated social security
charges totalled 128 thousand euros (2013: 51 thousand euros and 17 thousand
euros respectively). 

Labour productivity and labour cost efficiency

The period’s nominal labour productivity dropped because the Group’s revenue
decrease exceeded the decline in the number of staff. The main factors that
lowered nominal labour cost efficiency were payment of performance bonuses and
a rise in basic salaries. 

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: 

                                                   2014    2013   2012
Nominal labour productivity (rolling), (EUR’000)  220.4   229.4  208.7
Change against the comparative period             -4.0%    9.9%   3.2%
                                                                      
Nominal labour cost efficiency (rolling), (EUR)     8.0     8.4    9.5
Change against the comparative period             -4.8%  -11.6%  -8.6%



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 has grown visibly in almost all segments
of the construction market. In 2014, public sector investment plummeted and it
is not likely to recover noticeably in 2015. There is strong competitive
pressure on builders’ bid prices in a situation where input prices have been
relatively stable. Competition is particularly fierce in general building and
utility network construction. 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 significantly and competition is
fierce is risky because negative developments in the economy may quickly render
the contract onerous. Thus, in price-setting we currently prioritize a
reasonable balance of contract performance risks over plain revenue growth. 

Demand for construction services will remain heavily dependent on the volume of
public sector investment, which in turn depends on the co-financing received
from the EU structural funds.  Total support allocated to Estonia during the
current EU budget period (2014-2020) amounts to 5.9 billion euros, exceeding
the figure of the previous financial framework, but the amounts earmarked for
construction work are substantially smaller. In the construction market, the
effects of the EU funding are not likely to kick in before the end of 2015. 

In light of the above, we do not expect any significant business growth in
2015. It is probable that the volumes of the Infrastructure segment will shrink
moderately but the decline should be counterbalanced by increasing activity in
the Buildings segment. 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 infrastructure) segment. 

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 31 December 2014, the Group’s warranty
provisions (including current and non-current ones) totalled 1,162 thousand
euros. The figure for the comparative period was 1,546 thousand euros. 

In addition to managing the 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 2014, impairment losses on receivables amounted to 14 thousand euros (2013:
305 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 1.02-fold (31 December 2013: 1.02-fold). The key factors which
influence the current ratio are the classification of the Group’s loans to its
Ukrainian associates as non-current items and the banks’ general policy not to
refinance interest-bearing liabilities for a period exceeding 12 months. 

The political situation in Ukraine remains unstable and we believe that
realization of our Ukrainian investment properties may take longer than
originally expected. Accordingly, at the reporting date the Group’s loan
receivables from its Ukrainian associates of 10,767 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 8,802
thousand euros (31 December 2013: 12,575 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 31 December 2014,
the Group’s interest-bearing loans and borrowings totalled 23,733 thousand
euros, a decrease of 3,445 thousand euros year over year. An important factor
that contributed to the decrease was settlement of short-term bank loans and a
decline in the use of factoring services. Interest expense for 2014 amounted to
1,001 thousand euros, 54 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 derivatives 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 hryvnias
(UAH). 

At the beginning of 2014, the political and economic environment in Ukraine
deteriorated due to the differences between Ukraine and Russia, which caused
the exchange rate of the hryvnia to tumble. During the year, the hryvnia
weakened against the euro by around 44%. 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 1,299 thousand euros (2013: an exchange loss of 144 thousand
euros). Exchange gains and losses on financial instruments are reported in
Finance income and Finance costs in the statement of comprehensive income.
Translation of receivables and liabilities from 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 hryvnias) 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 derivatives to hedge its currency risk.



Outlooks of the Group’s geographical markets

Estonia

Processes and developments characterising the Estonian construction market

·   In 2015 public sector investments will not grow markedly and the extent to
which they can be realised is still unclear. Although during the 2014-2020 EU
budget period allocations to Estonia will increase to 5.9 billion euros
(2007-2013: 4.6 billion euros), support payments that influence the
construction market will not increase. Instead, compared with the previous
budget period, there will be a rise in allocations not designed for tangible
assets. 

Investments made by the largest public sector customers (e.g., state-owned real
estate company Riigi Kinnisvara AS and the National Road Administration) which
will reach signature of a construction contract in 2015 will either not
increase significantly or will decrease. As a result, the Estonian construction
market (particularly segments related to infrastructure construction) will
remain in a relative slump. The situation will be somewhat alleviated by the
positive level of private sector investments in building construction. 

·   The protracted and painful process of construction market consolidation
will continue, 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 too large, but more slowly 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 or exit the market. In our
opinion, one of the factors that is slowing down the change is the customers’
(particularly the public sector customers’) desire to apply increasingly laxer
tendering requirements in order to increase competition and thus lower the
price even though this increases the risks related to security, quality,
adherence to deadlines and the builder’s liability. 

·   Competition will increase in all segments of the construction market. The
average number of bidders for a contract has increased and there is a wide gap
between the lowest bids made by the winners and the average bids. The situation
is somewhat similar to 2009 when expectations of shrinkage in demand prompted a
fall in construction prices, which triggered a slide in the prices of many
construction inputs. However, currently we do not see any downshift 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. 

·   There is an increasing contrast between the stringent terms of public
sector contracts, which encumber the builder with extensive obligations, strict
sanctions, various financial guarantees, long settlement terms, etc., and the
accommodating tendering requirements. Low qualification requirements and the
precondition of making a low bid have made it easier to win a contract but have
heightened the risks taken by the customers in respect of contract performance
and delivery. 

·   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 large 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 weaken the quality of the construction service/process
rather than the companies’ performance capabilities. Shrinkage in Estonian
construction volumes may increase labour supply but not substantially. Labour
migration to the Nordic countries will remain steady and even though Nordic
construction volumes (particularly in Finland) will also decline, the number of
job seekers that will return will not increase considerably. This sustains
pressure for a wage increase. 

Latvia and Lithuania

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 2015 it will probably be adversely affected by shrinkage in public
sector demand. Accordingly, it is unlikely that we will enter the Latvian
construction market permanently in 2015. 

In the near term 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

In Ukraine, we prefer to provide general contracting and project management
services to foreign private sector customers in the segment of building
construction. However, due to the market situation, we have also signed a few
contracts with local investors on the premise that the terms may not involve
any unjustified or uncontrollable risks. The unstable political and economic
situation hinders adoption of business decisions but construction activity in
Kiev has not halted. In 2015, the Group will continue its business in the Kiev
region and our current Ukrainian order book is significantly larger than a year
ago. Despite the ongoing armed conflict in eastern Ukraine, for Nordecon the
market situation in Kiev has not deteriorated compared with a year or two ago.
Difficult times have reduced the number of inefficient local (construction)
companies and when the economic situation normalises we will have much better
prospects for increasing our operations. We monitor the situation in the
Ukrainian construction market closely and consistently and are ready to
restructure our operations if necessary. Should the crisis spread to Kiev
(currently highly unlikely), we can suspend our operations immediately. We
continue to seek opportunities for exiting our two conserved real estate
projects or signing a construction contract with a prospective 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, have also started
to deliver some more complex services. The local concrete works market allows
competing for projects where the customer wishes to source 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