Market announcement

Title

2017 IV quarter and 12 months consolidated interim report (unaudited)

Message

This announcement includes Nordecon AS’s consolidated financial statements for
the fourth quarter and twelve months of 2017 (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
Tallinn and Nordecon’s web page
(http://www.nordecon.com/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/for-investor/investor-presentations). 



Condensed consolidated interim statement of financial position

EUR ‘000                                      31 December 2017  31 December 2016
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
ASSETS                                                                          
Current assets                                                                  
Cash and cash equivalents                                8,915             9,786
Trade and other receivables                             35,193            21,055
Prepayments                                              1,642             1,644
Inventories                                             23,230            22,992
Total current assets                                    68,980            55,477
Non-current assets                                                              
Investments in equity-accounted investees                1,888             1,640
Other investments                                           26                26
Trade and other receivables                              8,950            10,816
Investment property                                      4,929             4,929
Property plant and equipment                            12,566            11,111
Intangible assets                                       14,639            14,623
Total non-current assets                                42,998            43,145
TOTAL ASSETS                                           111,978            98,622
                                                                                
LIABILITIES                                                                     
Current liabilities                                                             
Borrowings                                              16,197             6,297
Trade payables                                          34,824            29,811
Other payables                                           6,887             5,389
Deferred income                                          3,651             4,128
Provisions                                                 533               753
Total current liabilities                               62,092            46,378
Non-current liabilities                                                         
Borrowings                                              13,955            13,102
Trade payables                                              98                98
Other payables                                              71               117
Provisions                                               1,273               881
Total non-current liabilities                           15,397            14,198
TOTAL LIABILITIES                                       77,489            60,576
                                                                                
EQUITY                                                                          
Share capital                                           18,263            19,720
Own (treasury) shares                                   -1,349            -1,550
Share premium                                              589               564
Statutory capital reserve                                2,554             2,554
Translation reserve                                      1,995             1,549
Retained earnings                                       11,086            13,091
Total equity attributable to owners of the              33,138            35,928
 parent                                                                         
Non-controlling interests                                1,351             2,118
TOTAL EQUITY                                            34,489            38,046
TOTAL LIABILITIES AND EQUITY                           111,978            98,622



Condensed consolidated interim statement of comprehensive income

EUR ‘000                                    Q4 2017  Q4 2016      2017      2016
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
Revenue                                      56,478   49,759   231,387   183,329
Cost of sales                               -54,551  -47,371  -222,692  -172,350
Gross profit                                  1,927    2,388     8,695    10,979
                                                                                
Marketing and distribution expenses            -175     -134      -623      -413
Administrative expenses                      -1,561   -1,477    -6,936    -6,106
Other operating income                            9      214       107       362
Other operating expenses                        -11      -75      -141      -614
Operating profit                                189      916     1,102     4,208
                                                                                
Finance income                                   99      127     2,901       463
Finance costs                                  -844     -303    -1,570    -1,088
Net finance costs/income                       -745     -176     1,331      -625
                                                                                
Share of profit/loss of equity-accounted        -33     -108       485       609
 investees                                                                      
                                                                                
Profit/loss before income tax                  -589      632     2,918     4,192
Income tax expense                             -402      -14    -1,193      -259
Profit/loss for the period                     -991      618     1,725     3,933
                                                                                
Other comprehensive income                                                      
Items that may be reclassified                                                  
 subsequently to profit or loss                                                 
Exchange differences on translating             187      -51       446       191
 foreign operations                                                             
Total other comprehensive income/expense        187      -51       446       191
TOTAL COMPREHENSIVE INCOME/EXPENSE             -804      567     2,171     4,124
                                                                                
Profit/loss attributable to:                                                    
- Owners of the parent                       -1,590      607     1,388     3,044
- Non-controlling interests                     599       11       337       889
Profit/loss for the period                     -991      618     1,725     3,933
                                                                        
Total comprehensive income attributable                                 
 to:                                                                    
- Owners of the parent                       -1,403      556     1,834     3,235
- Non-controlling interests                     599       11       337       889
Total comprehensive income/expense for the     -804      567     2,171     4,124
 period                                                                         
                                                                                
Earnings per share attributable to owners                                       
 of the parent:                                                                 
Basic earnings per share (EUR)                -0.05     0.02      0.04      0.10
Diluted earnings per share (EUR)              -0.05     0.02      0.04      0.10
                                                                                

Condensed consolidated interim statement of cash flows

EUR ‘000                                                         2017      2016
-------------------------------------------------------------------------------
-------------------------------------------------------------------------------
Cash flows from operating activities                                           
Cash receipts from customers1                                 264,891   214,871
Cash paid to suppliers2                                      -239,592  -179,312
VAT paid                                                       -6,971    -7,217
Cash paid to and for employees                                -22,593   -20,208
Income tax paid                                                  -605      -197
Net cash used in/from operating activities                     -4,870     7,937
                                                                               
Cash flows from investing activities                                           
Paid on acquisition of property, plant and equipment             -343      -148
Paid on acquisition of intangible assets                           -5       -25
Proceeds from sale of property, plant and                          49       160
equipment                                                                      
Acquisition of a subsidiary                                         0       -15
Disposal of investments in subsidiaries and a joint venture     2,744         6
Loans provided                                                    -45       -81
Repayment of loans provided                                     1,739        55
Dividends received                                                153       153
Interest received                                                 368         2
Sale of own shares                                                153         0
Net cash from investing activities                              4,813       107
                                                                               
Cash flows from financing activities                                           
Proceeds from loans received                                    9,207     2,847
Repayment of loans received                                    -1,123    -2,262
Finance lease principal paid                                   -2,252    -2,478
Interest paid                                                    -752      -695
Dividends paid                                                 -4,497    -1,068
Reduction of share capital                                     -1,384      -923
Net cash used in financing activities                            -801    -4,579
                                                                               
Net cash flow                                                    -858     3,465
                                                                               
Cash and cash equivalents at beginning of period                9,786     6,332
Effect of movements in foreign exchange rates                     -13       -11
Decrease/increase in cash and cash equivalents                   -858     3,465
Cash and cash equivalents at end of period                      8,915     9,786

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 year 2017 with a gross profit of 8,695 thousand euros
(2016: 10,979 thousand euros) and a gross margin of 3.8% (2016: 6.0%). The
weakening of the gross margin resulted mainly from the Buildings segment where
gross margin dropped to 4.0% (2016: 7.5%). Above all, the year-on-year decrease
in gross margin was attributable to growth in input prices, particularly
materials and labour. Our performance is increasingly influenced by the
insufficient availability of skilled labour and, consequently, the shortage of
subcontractors in the building construction segment. In particular, this
applies to housing construction, where the number of assets being built is high
for the Estonian market. The situation enables subcontractors to raise their
prices, which puts pressure on general contractors’ profit margins. The decline
in the Group’s gross margin is also attributable to the loss of the Swedish
subsidiary that incurred some interior work costs in the final stage of its
first construction contract which could not be sufficiently accurately
estimated in the new market. The performance of the Infrastructure segment
improved compared to 2016, its gross margin rising to 4.1% (2016: 3.9%). At the
beginning of the year, we finalised the merger of two subsidiaries engaged in
the infrastructure business, Järva Teed AS and Hiiu Teed OÜ, and Nordecon AS’s
road maintenance and machinery division. The restructuring, undertaken to
streamline our infrastructure operations and increase the Group’s overall
competitiveness, has justified itself and helped the Infrastructure segment
improve its profitability and deliver revenue growth. Despite stiff competition
and the continuing rise in input prices, we expect that in 2018 the Group’s
profitability will improve compared to 2017. 

Administrative expenses for 2017 totalled 6,936 thousand euros (2016: 6,106
thousand euros). Compared 2016, administrative expenses grew substantially,
mainly through the termination benefits paid to two members of the board of
Nordecon AS that stepped down and the council’s decision to increase the number
of the company’s board members. Despite changes on the board, structural
streamlining, and sustained investment in foreign markets which in the start-up
phase is inevitably accompanied by planned growth in administrative expenses,
our cost-control measures continued to produce good results and we were able to
keep administrative expenses below the target ceiling of 4% of revenue. The
ratio of administrative expenses to revenue was 3.0% (2016: 3.3%). 

Operating profit for 2017 amounted to 1,102 thousand euros (2016: 4,208
thousand euros). EBITDA amounted to 3,123 thousand euros (2016: 6,017 thousand
euros). 

Finance income for the year amounted to 2,901 thousand euros (2016: 463
thousand euros). A significant share of finance income resulted from the sale
of investments in the joint venture Unigate OÜ and the subsidiaries Paekalda 2
OÜ, Paekalda 3 OÜ, Paekalda 7 OÜ and Paekalda 9 OÜ, which generated gain of
2,527 thousand euros. 

In 2017, the Ukrainian currency weakened against the euro by around 15%, which
meant that Group entities whose functional currency is the hryvnia had to
restate their euro-denominated liabilities. Exchange losses reported in finance
costs totalled 451 thousand euros of which the portion resulting from the
weakening of the hryvnia amounted to 416 thousand euros (2016: 195 thousand
euros). The exchange losses increased the translation reserve in equity by 446
thousand euros (2016: 191 thousand euros) and the net effect of the exchange
differences on the Group’s net assets was a gain of 5 thousand euros (2016: a
loss of 4 thousand euros). Net profit was also influenced by the write-down of
loans related to two Ukrainian real estate development projects by 448 thousand
euros (2016: nil euros), recognised in the fourth quarter within finance costs.
The investments were written down in connection with the weakening of the
hryvnia. 

The Group’s net profit amounted to 1,725 thousand euros (2016: 3,933 thousand
euros), of which net profit attributable to owners of the parent, Nordecon AS,
was 1,388 thousand euros (2016: 3,044 thousand euros). 

Cash flows

In 2017, operating activities produced a net cash outflow of 4,870 thousand
euros (2016: a net inflow of 7,937 thousand euros). Although cash receipts from
customers exceeded cash paid to suppliers, operating cash flow proved negative
due to VAT paid and payments made to and for employees. Operating cash flow
continues to be influenced by the fact that the contracts signed with both
public and private sector customers do not require them to make advance
payments while we have to make prepayments to subcontractors, materials
suppliers, etc. Cash inflow is also lowered by contractual retentions, which
extend from 5 to 10% of the contract price and are released at the end of the
construction period only. 

Investing activities resulted in a net cash inflow of 4,813 thousand euros
(2016: an inflow of 107 thousand euros). Cash flows from investing activities
were strongly influenced by the sale of the investment in the joint venture
Unigate OÜ for 2,744 thousand euros and loan principal and interest of 1,461
thousand euros and 329 thousand euros respectively collected through the
transaction. Investments in property, plant and equipment and intangible assets
totalled 348 thousand euros (2016: 173 thousand euros) and dividends received
amounted to 153 thousand euros (2016: 153 thousand euros). Own shares sold
during the reporting period generated income of 153 thousand euros (2016: nil
euros). 

Financing activities generated a net cash outflow of 801 thousand euros (2016:
an outflow of 4,579 thousand euros). Our financing cash flow is strongly
influenced by loan and finance lease transactions. Proceeds from loans received
amounted to 9,207 thousand euros, consisting of development loans received and
the use of overdraft facilities (2016: 2,847 thousand euros). Loan repayments
totalled 1,123 thousand euros (2016: 2,262 thousand euros) consisting of
scheduled repayments of long-term investment and development loans. Finance
lease payments decreased slightly, amounting to 2,252 thousand euros (2016:
2,478 thousand euros). Dividends paid in 2017 totalled 4,497 thousand euros
(2016: 1,068 thousand euros). Payments made to owners on the reduction of share
capital totalled 1,384 thousand euros (2016: 923 thousand euros). 

At 31 December 2017, the Group’s cash and cash equivalents totalled 8,915
thousand euros (31 December 2016: 9,786 thousand euros). Management’s
commentary on liquidity risks is presented in the chapter Description of the
main risks. 

Key financial figures and ratios

Figure/ratio for the period                         2017        2016        2015
--------------------------------------------------------------------------------
Revenue (EUR ‘000)                               231,387     183,329     145,515
Revenue change                                     26.2%       26.0%       -9.8%
Net profit (EUR ‘000)                              1,725       3,933         174
Net profit attributable to owners of the           1,388       3,044         179
 parent (EUR ‘000)                                                              
Weighted average number of shares             30,913,031  30,756,728  30,756,728
Earnings per share (EUR)                            0.04        0.10        0.01
Administrative expenses to revenue                  3.0%        3.3%        3.5%
EBITDA (EUR ‘000)                                  3,123       6,017       5,769
EBITDA margin                                       1.3%        3.3%        4.0%
Gross margin                                        3.8%        6.0%        6.2%
Operating margin                                    0.5%        2.3%        2.7%
Operating margin excluding gain on asset            0.5%        2.2%        2.4%
 sales                                                                          
Net margin                                          0.7%        2.1%        0.1%
Return on invested capital                          5.9%        8.5%        2.1%
Return on equity                                    4.8%       10.6%        0.5%
Equity ratio                                       30.8%       28.6%       40.1%
Return on assets                                    1.6%        4.2%        0.2%
Gearing                                            32.7%       16.7%       25.5%
Current ratio                                       1.11        1.20        1.03
                                                                                
As at 31 December                                   2017        2016        2015
--------------------------------------------------------------------------------
Order book (EUR ‘000)                            144,122     131,335     125,698
--------------------------------------------------------------------------------


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



Performance by geographical market

In 2017, Nordecon earned around 6% of its revenue outside Estonia, compared
with 7% in 2016. In terms of foreign markets, the strongest revenue contributor
was Sweden where we provided general contractor’s services under three
contracts. The share of Ukrainian revenues remained stable. In Ukraine, we are
providing general contractor’s services under three building construction
contracts and one infrastructure construction contract. Our Finnish revenues
resulted from concrete works in the building construction segment. 

         2017  2016  2015
-------------------------
-------------------------
Estonia   94%   93%   96%
Sweden     3%    4%    0%
Ukraine    2%    2%    3%
Finland    1%    1%    1%

Geographical diversification of the revenue base is a consciously deployed
strategy by which we mitigate the risks resulting from excessive reliance on
one market. However, conditions in some of our selected foreign markets are
also volatile and have a strong impact on our current results. Increasing the
contribution of foreign markets is one of Nordecon’s strategic targets. Our
vision of the Group’s foreign operations 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 in more challenging
circumstances, for example when the operating volumes of a sub-segment decline
sharply. 

Nordecon’s revenues for 2017 totalled 231,387 thousand euros, a roughly 26%
increase on the 183,329 thousand euros generated in 2016. Although revenues
increased in both the Buildings and the Infrastructure segment, the main growth
driver was the Buildings segment where growth was underpinned by a rise in the
volume of contracts secured from the private sector. The scarcity in
infrastructure construction projects, which is affecting the entire Estonian
construction market (and the Group’s chosen strategy), has also left its mark
on our revenue structure. 

In 2017, our Buildings segment and Infrastructure segment generated revenue of
174,447 thousand euros and 56,335 thousand euros respectively. The
corresponding figures for 2016 were 134,554 thousand euros and 45,817 thousand
euros (see note 8). The Group’s order book has a similar structure: at the
year-end, 75% of contracts secured but not yet performed was attributable to
the Buildings segment (31 December 2016: 76%). 

Operating segments*  2017  2016  2015
-------------------------------------
-------------------------------------
Buildings             74%   73%   64%
Infrastructure        26%   27%   36%

* 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 period under review, the largest revenue source in the Buildings segment
continued to be the apartment buildings sub-segment, where we earned most of
the revenue as a general contractor. In Estonia, a substantial share of our
apartment building projects is located in Tallinn. In 2017, the largest of them
were the Meerhof 2.0 apartment building complex at Pirita tee 20a and apartment
buildings at Sõjakooli 12 (phase 1) and Virbi 10. The contribution of foreign
markets sustained growth. In Ukraine, we continued to build a residential
quarter in the city of Brovary in the Kiev region. In Sweden, we completed the
construction of two apartment buildings and continued the design and
construction of a third, an 8-floor apartment building in Stockholm. 

We continued work on our own housing development projects (reported in the
apartment buildings sub-segment) in Tartu and Tallinn. In Tartu, we completed
the construction and sale of apartment buildings in phases 5 and 6 and began
building phase 7 (the last but one) of the Tammelinn project
(www.tammelinn.ee). In Tallinn, we completed the construction of the fifth and
last terraced house in our Magasini 29 development project (www.magasini.ee)
and two apartment buildings with a total of 30 apartments in Hane street. We
continue to sell apartments in both of our Tallinn projects. The period’s
housing development revenues totalled 6,533 thousand euros (2016: 5,216
thousand euros). In carrying out development activities, we monitor closely
potential risks in the housing development market that stem from rapid growth
in the supply of new housing and growth in input prices. 

The revenues of the industrial and warehouse facilities sub-segment grew year
on year. The largest projects were the construction of Harmet’s production and
warehouse facilities at Kumna, near Tallinn, a co-generation plant at Kehra,
and the Metsä Wood plywood factory and an extension to the Metaprint production
plant in Pärnu. A strong contributor to the sub-segment’s revenue growth was a
rise in work secured from the agricultural sector. The largest assets built for
the agricultural sector included the Kogula, Saimre, and Kirbla cattle sheds. 

The revenues of the commercial buildings sub-segment grew considerably compared
with 2016. We completed the renovation of the machinery hall of the historical
Luther furniture factory into a modern office building and the construction of
the office and commercial complex Viimsi Äritare. We continued to build an
office building at Lõõtsa 12, the Öpiku B building and a multi-storey car park
at Lõõtsa 11 in Ülemiste City and the Martens house in Pärnu. 

The revenue contribution of the public buildings sub-segment decreased compared
with 2016. The revenues of this sub-segment have been strongly influenced by
growth in the state’s investment in national defence. In 2017, we delivered to
the customers the building of Ugala Theatre in Viljandi, the Lintsi warehouse
complex, and a depot, infrastructure for armoured vehicles, a canteen and a
barracks at the Tapa military base. 

Based on the order book of the Buildings segment, we expect that in 2018 the
share of the commercial buildings and public buildings sub-segments in the
Group’s total revenue will increase compared to 2017. 

Revenue breakdown in the Buildings segment  2017  2016  2015
------------------------------------------------------------
Apartment buildings                          30%   34%   22%
Industrial and warehouse facilities          26%   20%   12%
Commercial buildings                         25%   16%   50%
Public buildings                             19%   30%   16%

The revenue of the Infrastructure segment grew by around 22% year on year,
driven by road construction and maintenance which has dominated the segment for
a long time and increased its revenue by around 20%. In contrast to two
previous years, when most of the segment’s revenues resulted from small or
medium-sized reconstruction or rehabilitation projects, in 2017 we had four
large contracts: the construction of a 2+1 road (a road with passing lanes) on
the Ääsmäe-Kohatu section of the Tallinn-Pärnu-Ikla road secured at the end of
2016 and the reconstruction of the Haabersti intersection in Tallinn, the
construction of a 2+1 road on the Valmaotsa–Kärevere section of the
Tallinn–Tartu–Võru–Luhamaa road, and the reconstruction of a section of the
Tallinn ring road (km 0.6-2.8) secured in 2017. We continued to render road
maintenance services in Järva and Hiiu counties and the Keila and Kose
maintenance areas in Harju county. A substantial share of the period’s revenues
also resulted from forest road improvement services provided to the State
Forest Management Centre. 

The contracts of the environmental engineering and other engineering (utility
network construction) sub-segments are small and significant growth of their
revenues is unlikely. In recent years, we have not done any work in the
specialist engineering sub-segment, where we used to perform mainly hydraulic
engineering projects, as the procurement of such work tends to be irregular. 

Revenue breakdown in the Infrastructure segment           2017  2016  2015
--------------------------------------------------------------------------
--------------------------------------------------------------------------
Road construction and maintenance                          86%   86%   81%
Other engineering                                           8%    9%   14%
Environmental engineering                                   6%    5%    4%
Specialist engineering (including hydraulic engineering)    0%    0%    1%
                                                                          

Order book

At 31 December 2017, the Group’s order book (backlog of contracts signed but
not yet performed) stood at 144,122 thousand euros, around 10% up on 2016. Both
the Buildings and the Infrastructure segment increased their order books by
around 10%. In the fourth quarter, we secured new contracts of 49,683 thousand
euros. 

As at 31 December         2017     2016     2015
------------------------------------------------
Order book (EUR ‘000)  144,122  131,335  125,698

At the reporting date, contracts secured by the Buildings segment and the
Infrastructure segment accounted for 75% and 25% of the Group’s order book
respectively (31 December 2016: 76% and 24% respectively). 

In the Buildings segment, the strongest order book growth was delivered by
commercial buildings which increased its order book by around 53% year on year.
Growth was mainly driven by the construction of a multi-storey car park at
Sepise 8 in Ülemiste City and the design and construction of a 14-floor
commercial and residential building at Mustamäe tee 3 in the WoHo quarter in
Tallinn. The sub-segment’s order book has also grown through two major
contracts secured in the second half of 2017 in Ukraine: one for the
construction of a 7-floor office building in the Unit City innovation park in
Kiev and the other for the construction of a 6-floor office building in the
LvivTech.City innovation park in Lviv. The order books of the public buildings
and the industrial and warehouse facilities sub-segments have also grown
somewhat. A significant share of the order book of the public buildings
sub-segment is made up of contracts for the construction of buildings for the
Estonian Academy of Security Sciences and Abja Health Centre that were secured
in the third quarter and contracts for the construction of infrastructure for
armoured vehicles and two barracks at the Tapa military base that were secured
in the fourth quarter. A major share of the order book of the industrial and
warehouse facilities sub-segment is made up of contracts for the construction
of the Metsä Wood plywood factory in Pärnu and phase 4 of the Ekseko pig farm.
The order book of the apartment buildings sub-segment has decreased by around
32%. A large share of the order book of the apartment buildings sub-segment is
made up of contracts signed in 2017 for the construction of an eight-floor
apartment building (Väsby Terrass) in Sweden and the design and construction of
three apartment buildings at Kakumäe in Tallinn. In addition, we continue to
build five apartment buildings in the city of Brovary in Kiev region in
Ukraine. 

The order book of the Infrastructure segment is supported by growth in
contracts signed by the road construction and maintenance sub-segment whose
order book accounts for 86% of the segment’s total order book. The largest
projects in the road construction order book are the contracts signed in 2017
for the reconstruction of the Haabersti intersection in Tallinn, the
reconstruction of a section of the Tallinn ring road (km 0.6-2.8) and the
construction of a 2+1 road on the Valmaotsa–Kärevere section of the
Tallinn–Tartu–Võru–Luhamaa road. We continue to provide road maintenance
services in three road maintenance areas: Järva, Hiiu, and Kose. The order book
of the environmental engineering sub-segment has grown through a contract
signed for the construction of a water treatment plant in Kiev, Ukraine.
Although according to our projections in 2018 public investments will not
increase substantially, our order book as at the reporting date allows us to
expect that in 2018 the revenue of the Infrastructure segment will grow
slightly compared to 2017 (for further information, see the Business risks
section of the chapter Description of the main risks). 

Based on the order book and known developments in our selected markets, we
expect that the Group’s revenue for 2018 will remain at the same level as in
2017. In an environment of stiff competition, we avoid taking unjustified risks
whose realisation in the contract performance phase may have an adverse impact
on our results. Despite this, where suitable opportunities arise, we strive to
increase the portfolio to counteract market-triggered margin compression. Our
policy is to keep fixed costs under control and monitor market developments. 

Between the reporting date (31 December 2017) and the date of release of this
report, Group companies have secured additional construction contracts in the
region of 4 136 thousand euros. 



People

Employees and personnel expenses

In 2017, the Group (the parent and the subsidiaries) employed, on average, 735
people including 426 engineers and technical personnel (ETP). The number of
employees, particularly the ETP staff, has increased year on year by around 7%
in connection with growth in the Group’s business operations. 

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

               2017  2016  2015
-------------------------------
-------------------------------
ETP             426   381   356
Workers         309   303   334
Total average   735   684   690

Our personnel expenses for 2017, including all taxes, totalled 22,872 thousand
euros (2016: 20,401 thousand euros), a roughly 12% increase year on year. The
growth in personnel expenses is mainly attributable to a larger headcount but
pay rises have also played a role. 

The service fees of the members of the council of Nordecon AS for 2017 amounted
to 167 thousand euros and associated social security charges totalled 55
thousand euros (2016: 138 thousand euros and 45 thousand euros respectively). 

The service fees of the members of the board of Nordecon AS amounted to 1,001
thousand euros and associated social security charges totalled 330 thousand
euros (2016: 350 thousand euros and 116 thousand euros respectively). The
figures include termination benefits of 550 thousand euros paid to two board
members in the third quarter and associated social security charges of 182
thousand euros (2016: nil euros). In addition, the board’s compensation has
grown because the number of board members has increased. 

Labour productivity and labour cost efficiency

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: 

                                          2017   2016   2015
------------------------------------------------------------
------------------------------------------------------------
Nominal labour productivity, (EUR ‘000)  314.9  267.8  210.9
Change against the comparative period    17.6%  27.0%  -4.3%
                                                            
Nominal labour cost efficiency, (EUR)     10.1    9.0    8.0
Change against the comparative period    12.6%  12.8%  -0.6%

Nominal labour productivity = revenue / average number of employees
Nominal labour cost efficiency = revenue / personnel expenses      
-------------------------------------------------------------------

The Group’s nominal labour productivity and labour cost efficiency increased
year on year, mainly through revenue growth (see the section Employees and
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. 

Competition continues to be stiff in all segments of the construction market
and in 2018 public investment is not expected to grow substantially compared
with 2017. Thus, builders’ bid prices are under strong competitive pressure in
a situation where the prices of construction inputs have been trending upwards
moderately but consistently for several quarters. Bidders for contracts include
not only rival general contractors but also former subcontractors. This is
mainly attributable to the state and local governments’ policy to keep the
qualification requirements of public procurement tenders low, which sometimes
results in the sacrifice of quality and adherence to deadlines to the lowest
possible price. We acknowledge the risks inherent in the performance of
contracts signed in an environment of stiff competition and rising input
prices. Securing a long-term construction contract at an unreasonably low price
in a situation where input prices cannot be lowered noticeably and competition
is tough is risky because negative developments in the economy may quickly
render the contract onerous. In setting our prices in such an environment, we
focus on ensuring a reasonable balance of contract performance risks and tight
cost control. 

Demand for construction services continues to be strongly influenced by the
volume of public 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. Although the
amount exceeds the figure for the previous financial framework, the amounts
earmarked for construction work are substantially smaller than in the previous
budget period. Projects supported by the EU during the 2014-2020 financial
framework had a visible impact on the construction sector in 2017 and in the
following years the process is expected to accelerate. 

In the light of the above factors, we expect that in 2018 our business volumes
will remain at the same level as in 2017. Our action plan foresees flexible
resource allocation aimed at finding more profitable contracts and performing
them effectively. According to its business model, Nordecon operates in all
segments of the construction market. Therefore, we are somewhat better
positioned than companies that operate in one narrow (and in the current market
situation particularly some infrastructure) segment. 

Our business is also influenced by seasonal changes in weather conditions,
which have the strongest impact on infrastructure construction 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 strategy is to counteract the seasonality of
infrastructure operations with building construction that is less exposed to
seasonal fluctuations. Our long-term goal is to be flexible and keep our two
operating segments in relative balance (see also the chapter Performance by
business line). Where possible, our entities implement different technical
solutions that allow working efficiently also in changeable 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
insurance 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 due until
the contract has been completed. To remedy construction deficiencies which may
be detected during the warranty period, Group companies create warranty
provisions based on their historical experience. At 31 December 2017, the
Group’s warranty provisions (including current and non-current ones) totalled
1,262 thousand euros (31 December 2016: 1,212 thousand euros). 

In addition to managing the risks directly related to construction operations,
in recent years we have also 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

During the period, we recognised credit losses of 37 thousand euros. A year
earlier, credit losses totalled 547 thousand euros, comprising impairment
losses on trade receivables of 138 thousand euros and impairment losses on
other receivables of 409 thousand euros. The overall credit risk exposure of
receivables is low because the solvency of prospective customers is evaluated,
the share of public sector customers is large, and customers’ settlement
behaviour is consistently monitored. The main indicator of the realisation of
credit risk is settlement default that exceeds 180 days along with no activity
on the part of the debtor that would confirm the intent to settle. 

Liquidity risk

The Group remains exposed to higher than usual liquidity risk. At the reporting
date, the Group’s current assets exceeded its current liabilities 1.11-fold (31
December 2016: 1.20-fold). The key factor which influences the current ratio is
the classification of the Group’s loans to its Ukrainian associates as
non-current assets and the banks’ general policy not to refinance
interest-bearing liabilities (particularly overdrafts) for a period exceeding
twelve months. 

Because the political and economic situation in Ukraine is still complicated,
we believe that the Group’s Ukrainian investment properties cannot be realised
in the short term. Accordingly, at the reporting date the Group’s loans to its
Ukrainian associates of 8,492 thousand euros were classified as non-current
assets. 

For better cash flow management, we use overdraft facilities and factoring by
which we counter the mismatch between the settlement terms agreed with
customers and subcontractors. Under IFRS EU, borrowings have to be classified
into current and non-current based on contract terms in force at the reporting
date. As at 31 December 2017, the Group’s short-term borrowings totalled 16,197
thousand euros, including factoring liabilities of 5,648 thousand euros. Based
on our prior experience with banks, we expect that out of the above amount
contracts of 13,288 thousand euros will be extended when their maturity dates
arrive. 

At the reporting date, the Group’s cash and cash equivalents totalled 8,915
thousand euros (31 December 2016: 9,786 thousand euros). 

Interest rate risk

Our 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. During the period,
interest-bearing borrowings grew by 10,612 thousand euros year on year.
Factoring liabilities and use of overdraft facilities increased whereas loan
and finance lease liabilities decreased slightly (see also the section
Liquidity risk). At 31 December 2017, interest-bearing borrowings totalled
29,990 thousand euros (31 December 2016: 19,399 thousand euros). Interest
expense for 2017 amounted to 655 thousand euros (2016: 681 thousand euros). 

The main source of interest rate risk is a possible rise in the variable
component of floating interest rates (EURIBOR, EONIA or the creditor’s own base
rate). In the light of the Group’s relatively heavy loan burden, this would
cause a significant rise 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 loan products offered by banks, observance of the policy has proved
difficult and most new contracts have a floating interest rate. We have entered
into a derivative contract to manage the risks resulting from changes in the
interest rates of the finance lease contract for the acquisition of a new
asphalt concrete plant. 

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), Ukrainian hryvnias
(UAH), and Swedish kronas (SEK). 

The exchange rate of the hryvnia has been unstable because the political and
economic environment in Ukraine continues to be complicated due to the conflict
between Ukraine and Russia which broke out at the beginning of 2014. Moreover,
at the beginning of 2015 the National Bank of Ukraine decided to discontinue
determining the national currency’s indicative exchange rate. In 2017, the
hryvnia weakened against the euro by around 15%. For our Ukrainian subsidiary,
this meant additional foreign exchange losses from the translation of
euro-denominated loans into the local currency. Relevant exchange losses
totalled 416 thousand euros (2016: 195 thousand euros). Exchange gains and
losses on financial instruments are recognised in Finance income and Finance
costs respectively. Translation of receivables and liabilities from operating
activities did not give rise to any exchange gains or losses. 

Our Ukrainian and non-Ukrainian entities’ reciprocal receivables and
liabilities which are related to the construction business and denominated in
hryvnias do not give rise to exchange losses. Nor do the loans provided to the
Ukrainian associates in euros give rise to exchange losses that ought to be
recognised in the Group’s accounts. 

In 2017, the Swedish krona weakened against the euro by around 3%. Due to
adverse movements in the krona/euro exchange rate, the translation of operating
receivables and payables resulted in an exchange loss of 15 thousand euros
(2016: 18 thousand euros). The exchange loss has been recognised in Other
operating expenses. The translation of a loan provided to the Swedish
subsidiary in euros into the local currency gave rise to an exchange loss of 35
thousand euros (2016: nil euros). This exchange loss has been recognised in
Finance costs. 

We have not acquired derivatives to hedge our currency risk.



Outlooks of the Group’s geographical markets

Estonia

Processes and developments characterising the Estonian construction market

  -- In 2018, public investment should grow slightly. However, it is still
     unclear for companies in which segments of the construction market and to
     what extent the state will be able to realise its investment plans.
     Although in the 2014-2020 EU budget period the support allocated to Estonia
     will increase to 5.9 billion euros (2007-2013: 4.6 billion euros), the
     portion that will influence the construction market will not increase.
     Instead, compared with the previous period, there will be a rise in
     allocations to intangible areas.
  -- In the context of the market in general, 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 2018 will not increase
     substantially. The Ministry of Defence has been a positive exception for
     builders as its needs and activity in carrying out new procurement tenders
     and placing orders through a single agency, the Centre for Defence
     Investment, have made a significant contribution to market revival. Hence,
     the Estonian construction market as a whole (particularly infrastructure
     construction segments) will remain relatively stable.
  -- The long and painful process of construction market consolidation will
     continue, albeit slowly. In particular, this applies to general contracting
     in building construction where the number of medium-sized general
     contractors (annual turnover of around 15-40 million euros) is too large.
     Based on the experience of the last major crisis it is likely that in an
     environment of stiff competition and rising input prices some general
     contractors may run into difficulties which will be passed on to several
     other market participants.
  -- Competition remains stiff across the construction market, intensifying in
     different segments in line with market developments. The rise in the
     average number of bidders for a contract reflects this. It is clear that in
     the new environment of rising input prices that has emerged in the past
     year, efficiency is the key to success. Regrettably, the number of
     materials producers, suppliers, and subcontractors that are trying to
     survive or succeed in a difficult environment by dishonest means, e.g., by
     supplying goods with concealed defects or considerably lower quality than
     the one recorded in the product certificate, has increased quite rapidly.
     If the trend continues, both construction service providers and
     end-customers will have to apply strict and thorough quality control
     measures to make sure that the outcome meets their expectations. Unfair
     competition is putting visible pressure on prices and the quality of the
     construction service. Unfortunately, the problem is also underpinned by the
     customers’ (including state institutions’ and state-owned companies’)
     increasing tendency to lower the bidders’ qualification requirements and
     prioritise quality more on paper than in practice.
  -- In new housing development, the success of a project depends on the
     developer’s ability to control the input prices included in its business
     plan and set sales prices that are affordable for prospective buyers.
     Despite the market situation, the housing market sustained growth also in
     2017, accounting for a somewhat disproportionately large share of the total
     construction market and thus amplifying associated risks.
  -- There is a growing contrast between the stringent terms of public
     contracts, which require the builder to agree to extensive obligations,
     strict sanctions, various financial guarantees, long settlement terms,
     etc., and the modest participation requirements. Lenient qualification
     requirements and the precondition of making a low bid have made it
     relatively easy for an increasing number of builders to win a contract but
     have heightened the risks taken by customers in terms of funding, deadlines
     and quality during the contract performance phase and the subsequent
     warranty period.
  -- The past year has brought a rise in the prices of construction inputs,
     particularly in building construction. At first, general contractors tried
     to absorb the cost increase by making margin concessions but their capacity
     for doing this has been practically exhausted. The construction market
     includes an increasing number of areas where changes in the environment
     (including materials producers’ rapid and successful entry into foreign
     markets) may trigger a sharp price increase. The rise in housing
     construction has lengthened the supply terms of various essential materials
     and services considerably, making it impossible to carry out all processes
     in the former optimistic timeframes. As a result, activities require more
     extensive planning or may need to be postponed.
  -- The persisting shortage of skilled labour (including project and site
     managers) is restricting companies’ performance capacities, affecting
     different aspects of the construction process, including quality. Labour
     migration to the Nordic countries will remain steady and the number of job
     seekers who return to the Estonian construction market is not likely to
     increase considerably. All of the above sustains pressure for a wage
     increase, particularly in the category of the younger and less experienced
     workforce whose mobility and willingness to change jobs is naturally
     higher.

Ukraine

In Ukraine, we mainly offer general contracting and project management services
to private sector customers in the segment of building construction. Political
and economic instability continues to restrict the adoption of business
decisions but construction activity in Kiev and the surrounding area has not
halted. In 2018, we will continue our Ukrainian operations primarily in the
Kiev region but the preparations made in western Ukraine are also bearing
fruit: in October 2017, we signed a large-scale contract in Lviv. Based on our
order book, we expect that in 2018 it may be possible that our Ukrainian
business volumes will increase compared to 2017. Despite the military conflict
in eastern Ukraine, for Nordecon the market situation has not deteriorated
compared with a year or two ago. Hard times have reduced the number of
inefficient local (construction) companies and when the economy normalises we
will have considerably better prospects for increasing our operations and
profitability. The Ukrainian government’s recent crackdown on cash-in-hand work
is definitely a step in the right direction, which in the long term should
improve our position in the Ukrainian construction market. We assess the
situation in the Ukrainian market regularly and critically and are ready to
restructure our operations as and when necessary. Should the crisis in eastern
Ukraine spread (which at the date of release of this report is highly
unlikely), we can suspend our operations immediately. We continue to seek
opportunities for exiting our two real estate projects, which have been put on
hold, or signing a construction contract with a prospective new owner. 

Finland

In Finland, we have provided mainly subcontracting services in the concrete
work segment but, based on experience gained, have started preparations for
expanding into the general contracting market. The local concrete work market
allows competing for projects where the customer wishes to source all concrete
works from one reliable partner. Our policy is to maintain a rational approach
and avoid taking excessive risks. 

Sweden

We entered the Swedish market in July 2015, when we acquired a 100% stake in
SWENCN AB, a company registered in the Kingdom of Sweden. In the Swedish
market, we intend to offer mainly the construction of residential and
non-residential buildings, particularly in central Sweden. On gaining
experience in the new market, we have prioritised quality and the observance of
deadlines and have therefore accepted lower profitability. As regards our
longer-term goals and the plan to build a viable and strong organisation that
would compete successfully in the Swedish market, we are positive about the
developments so far and see potential for sustaining business growth and
operating profitably in a large market when we have been able to stabilise
order book growth at the desired level. 



Nordecon (www.nordecon.com) 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, Finland and Sweden. The parent of the Group is Nordecon AS, a
company registered and located in Tallinn, Estonia. The consolidated unaudited
revenue of the Group in 2017 was 231 million euros. Currently Nordecon Group
employs close to 740 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