MANAGEMENT REPORT General information AS Merko Ehitus operates in Estonia, Latvia and Lithuania as a construction group providing integrated construction solutions. Largest companies of the Group are SIA Merks (100%), UAB Merko Statyba (100%), Tallinna Teede AS (100%), AS Gustaf (75%), OÜ Gustaf Tallinn (80%), AS Merko Tartu (66%), OÜ Woody (100%) and AS Tartu Maja Betoontooted (25%). On 2 April 2009, AS Merko Ehitus and its 100% subsidiary OÜ Rae Tehnopark made a merger agreement with a view of ensuring better transparency of AS Merko Ehitus group and facilitating reporting (http://www.nasdaqomxbaltic.com/market/?pg=news&news_id=234355). At 3 April 2009, a suspicion was elaborated which was earlier submitted against AS Merko Ehitus in relation to the giving of a bribe to Ivo Parbus. While the suspicion submitted at 17 December 2008 stated that the bribe was given for the purpose of accelerating the proceedings with the plans of seven properties, then according to the elaboration of 3 April, the number of properties decreased to three. Concerning the plans for the remaining four properties, a suspicion on the same bribe object was submitted against OÜ Woody, OÜ Metsailu and OÜ Constancia that are subsidiaries of AS Merko Ehitus. In addition to Estravel's gift coupon of EEK 25 thousand, the suspected bribe of AS Merko Ehitus also includes book "Eesti Talurahva Arhitektuur" costing EEK 410. The suspicion submitted against the subsidiaries mentions Estravel's gift coupon of EEK 25 thousand, a book costing EEK 410 and Estravel's gift coupon of EEK 15 thousand as the bribe. The suspects consider the suspicions to be unfounded (http://www.nasdaqomxbaltic.com/market/?pg=news&news_id=232461). On 28 September 2009, the Supervisory Board of AS Merko Ehitus approved the proposal of the Management Board for affording up to EEK 300 million of the company's funds to clients in co-financing of new construction contracts as well as financing the purchase of new real property, within the next 12 months. The Management Board of Merko Ehitus must adhere to the following priorities in the investment activities: 1) Participation in public sector PPP projects; 2) Provision of co-financing for public sector construction projects funded by the EU; 3) Co-financing of development projects with good potential, by providing up to 30% of the project cost, on the condition that the project has an effective business plan and that external financing has been secured; 4) Acquisition of residential properties with good potential in larger cities. Preferred properties: those with a moderate work volume and a valid detailed plan, located in a developed residential environment. Capitalisation and good liquidity are competitive advantages of Merko Ehitus upon judgement of the Supervisory Board and that should be used daringly to achieve commercial aims. On 2 December 2009, Tallinna Teede AS, a wholly owned subsidiary of AS Merko Ehitus, acquired the 100-percent holding in the company AS Vooremaa Teed from the Republic of Estonia. The purchase price of the company was EEK 47 989 570. The principal activity of AS Vooremaa Teed is road construction and maintenance in Jõgeva County. Pursuant to the development plan of Tallinna Teede AS, the company was acquired in order to facilitate expansion into the road maintenance market and to establish a road construction division in central Estonia. The acquisition of AS Vooremaa Teed also allows the better utilisation of the existing resources of Tallinna Teede AS, and creates synergy for portfolio expansion (http://www.nasdaqomxbaltic.com/market/?pg=details&instrument=EE3100098328&list= 2&tab=news&news_id=238295). On 18 December 2009, AS Merko Ehitus acquired the 100% holding in the company OÜ Tähelinna Kinnisvara (registry code 10723293) from AS E.L.L. Kinnisvara. The purchase price of the company was EEK 51.9 million. The company OÜ Tähelinna Kinnisvara was established in 2001. The principal activity of the company is property development and investments. The company owns a six-storey office building Järvevana tee 9G, Tallinn; the building was completed in 2003 and houses the headquarters of AS Merko Ehitus (http://www.nasdaqomxbaltic.com/market/?pg=details&instrument=EE3100098328&list= 2&tab=news&news_id=238554). Operating results Group's revenue for the year 2009 was EEK 3181.2 million. 68.6% of the sales originated from Estonia, 29.1% from Latvia and 2.3% from Lithuania. As compared to with the year 2008, company's sales increased in Latvia by 2.3% and decreased in Lithuania by 91.3% and in Estonia by 24.6%. Group's revenue for the IV quarter 2009 was EEK 847.8 million, which constitutes an annual decrease of EEK 253.7 million. The fall in revenue in this period was caused by the reduced unit prices in construction and the continued decrease in demand in the construction sector, caused by the overall recession. In 2009, the Group sold 280 apartments in total cost of EEK 338.5 million (without VAT). As of 31.12.2009 Group held in inventories unsold 187 completed apartments in total cost EEK 224.4 million and 441 apartments in the construction stage in total cost EEK 210.8 million. In Q4, Merko Ehitus began the construction of three new apartment buildings in Tallinn (with 109 flats in total). As at 31 December 2009, the group's backlog of construction contracts in progress amounted to EEK 1.3 billion. Companies of the Group 12M 2009 consolidated revenue (sales outside the Group) were (in thousand kroons and euros): 12M 2009 12M 2008 EEK EUR EEK EUR Estonian companies AS Merko Ehitus (parent company) 1 689 327 107 968 1 861 553 118 975 AS Gustaf (75% partnership) 44 131 2 820 142 558 9 111 OÜ Gustaf Tallinn (80% partnership) 61 126 3 907 140 930 9 007 AS Merko Tartu (66% partnership) 72 073 4 606 308 732 19 732 Tallinna Teede AS (100% partnership) 275 423 17 603 432 273 27 627 OÜ Woody (100% partnership) 25 000 1 598 79 803 5 100 Latvian company SIA Merks (100% partnership) 925 985 59 181 878 295 56 133 Lithuanian company UAB Merko Statyba (100% partnership) 70 915 4 532 797 902 50 995 In one year, the Group's cost of goods sold decreased by 29.9% and marketing and general administrative expenses by 18.5%. The economizing measures taken to reduce costs helped to decrease marketing and administrative expenses, with the EEK 9.8 million decrease in labour costs, EEK 12.0 million decrease in consultation/legal aid, EEK 9.0 million decrease in advertising and sponsoring and EEK 14.8 million decrease in other costs were the most significant factors. Despite the vigorous measures, the group's cost-cutting rate failed to keep up with the fall in revenue - thus, the cost of goods sold in the period increased to 89.1% and marketing and administrative costs to 6.3%. The group's earnings before taxes in 2009 were EEK 119.9 million, which means a decrease by EEK 212.9 million compared to 2008. The net profit in the period was EEK 116.2 million; representing an EEK 183.0 million or 61.2% decrease. The fall in earnings was affected by revenue, the reduced profitability of the construction and property development sectors, and the extraordinary expenses resulting from changes in the economic conditions. In 2009, the group suffered an 90.7 million loss due to the depreciation of development projects (incl. properties for sale by EEK 66.9 million; work in progress by EEK 3.7 million, and finished goods by EEK 20.1 million); and a further EEK 8.0 million due to the depreciation of non-current assets and EEK 13.8 million loss from the write-off of uncollectible accounts. The Group's earnings before taxes were EEK 232.4 million before extraordinary write-offs. The seasonality of the construction field and the cyclic nature of property development did not have a significant impact on the financial performance. Group's priorities in 2009 were positive cash flow and liquidity. In 2009 Group's total cash flows amounted to EEK -156.3 million, of which the cash flows from operating activities totalled EEK +368.4 million, from investment activities EEK -198,7 million and from financing activities EEK-326.0 million. The cash flows from operating activities of the reporting period were mostly affected by change in inventories EEK +338.9 million, change in liabilities and prepayments related to operating activities EEK -306.3 million and operating profit EEK +132.0 million. From investment activities cash flows EEK -138.2 million from purchase of other financial investment, EEK -62.1 million investment in subsidiaries, EEK -20.1 million from balance of granted/received loans, EEK +32.0 million from received interests and EEK -13.2 million from purchase of property, plant and equipment. Of the cash flow from financing activities, EEK -243.9 million was used to repay loans and EEK -64.7 million was paid as dividends. As of 31 December 2009, the Group has EEK 760.6 million of funds on the Group's bank accounts and deposits. The ratios and calculation methods characterizing the operating activities of the Group 2009 12 months 2008 12 months 2008 12 months Net profit margin 3,7 % 6,4 % 9,9 % Profit before taxes margin 3,8 % 7,1 % 10,7 % Operating profit margin 4,2 % 7,0 % 9,5 % Gross profit margin 10,9 % 16,3 % 14,1 % EBITDA margin 5,3 % 7,8 % 10,0 % Return on equity per annum 5,5 % 14,6 % 30,2 % Return on assets per annum 3,1 % 7,7 % 15,3 % Equity ratio 60,5 % 53,7 % 51,5 % Current ratio 2,3 2,8 2,4 Quick ratio 1,2 1,3 1,0 General expense ratio 6,3 % 5,8 % 4,5 % Gross remuneration ratio 8,8 % 8,8 % 7,4 % Net profit margin: Net profit* / Revenue Profit before taxes margin: Profit before taxes / Revenue Operating profit margin: Operating profit / Revenue Gross profit margin: Gross profit / Revenue EBITDA margin: (Operating profit + Depreciation and impairment charge) / Revenue Return on equity: Net profit* / Average equity during the period* Return on assets: Net profit* / Average assets during the period Equity ratio: Owners equity* / Total assets Current ratio: Current assets / Current liabilities Quick ratio: (Current assets - Inventories) / Current liabilities General expense ratio: General expenses / Revenue Gross remuneration ratio: Gross remuneration / Revenue *attributable to equity owners of the parent Construction market The year 2009 was a year of full-blown recession. Domestic consumption decreased, unemployment increased and the budgetary balance of the public sector was problematic. National statistics offices have published the GDP figures for Q4 2009 and reported negative economic growth (compared to Q4 2008): -17.7% in Latvia, -13.0% in Lithuania and -9.4% in Estonia. In Estonia, this recession seems to have bottomed out in Q4 2009, and in Latvia and Lithuania it will bottom out in the first half of 2010. Although the economy as a whole may recover in 2010, the construction sector will see the fall continue in 2010. In 2009, construction volumes fell by 47.7% in Latvia and by 53.7% in Lithuania compared to 2008. Statistics Estonia will publish this data on 1 March 2010, but the fall in Estonia is estimated to be around 37 to 40 percent. The situation on the construction market remains difficult. Due to the decrease in volumes and the resulting stiffer competition, construction rates have fallen back to the level of 2005. To win new contracts, companies submit tenders with prices far below the direct expenses and hope to make up for the difference as prices fall in the future. This approach is definitely not sustainable. It means increased business risks for the contractors, execution risks for the clients and credit risks for potential suppliers. We believe that the fall in construction rates has now stopped and there is no reserve for a further fall. With the prices bottoming out and the subsequent potential increase in construction rates, there are additional risks for long-term (12 months or more) fixed price building contracts, as the price pressure threatens the profitability of these projects. The absence of financing options, the conservative policies of creditors and the lack of positive expectations mean that there is virtually no investment by the local private sector. Expansion plans have been postponed indefinitely and the private sector is focusing on cost and cash flow management. Since construction rates are low, there has been some activity on the small-scale contracting (i.e. repair) market, where external financing is usually not necessary and projects are mostly financed from savings. We have noticed an increased interest from foreign investors in investing in this region, but this is also very theoretical and not yet proved by real transactions. Most of the new construction projects launched are in the field of infrastructure and environmental facilities, financed by the public sector and the EU's structural funds. The decrease in the private sector's revenue and the fall in consumption have significantly damaged the public sector's revenue base and financial means. In Q4 2009, the Estonian residential property market showed first signs of recovery as there was an increase in the number of transactions as well as in average prices. Buyers who had postponed purchasing a home to wait for prices to fall have now realised that the fall in home prices cannot last forever and that their selection diminishes the longer they wait. The good price level has once again made the Estonian property market attractive for foreign capital. As a rule, foreign capital does not depend on the local loan market, and thus transactions are much more likely to come through. In the last eighteen months, there has been a great fall in prices (by 40 to 50%) which levelled out in Q3 2009. This has made the banks much more aggressive. It is now much safer for banks to finance new residential properties. The loans granted under the new terms help to improve the banks' revenue base and compensate the negative effect of bad loans. As a result of the abovementioned trends, the financing situation has improved in recent months, especially in terms of the down payment required and the interest margin for end consumers. In Q4, several Estonian property developers, including Merko Ehitus, launched new small-scale development projects. At the same time, the volume of these projects is insignificant, and therefore it is likely that the fall in supply will continue. There is a limited availability of financing for long-term projects; the cost of credit is high, and the requirements for obtaining credit are unrealistic. Therefore, we do not expect any new rental projects to emerge. As for rental projects, the key words are still the same: dealing with the fall in rental income, the accounts payable, and liquidity issues. The outlook for the fast recovery of the market is grim. Employees and remuneration In 31.12.2009, the number of employees in the Group's service was 702, including 682 full-time employees. The Group reduced the number of its personnel by 27.2% or 262 employees in a year. The gross remuneration paid to employees in 2009 amounted to EEK 278.9 million a decrease of 31.7% compared to previous year. The smaller amount of performance pay, due to the fall in the group's profitability, and the reduced staff levels also contributed to the fall in the group's labour costs. Shares and shareholders Share information ISIN EE3100098328 Short name of the security MRK1T Stock Exchange List Baltic Main List Nominal 10.00 EEK Total no of securities issued 17 700 000 No of listed securities 17 700 000 Listing date 11.08.2008 The shares of Merko Ehitus are listed in the main list of NASDAQ OMX Tallinn Stock Exchange. In 2009 3862 transactions with the shares of Merko Ehitus were performed in the course of which 2.8 million shares were traded and the total monetary value of transactions was EEK 146.8 million. The lowest share price was EEK 28.95 and the highest price was EEK 90.44 per share. The closing share price as at 30.12.2009 was EEK 78.55. AS Merko Ehitus market value as at 31.12.2009 was EEK 1.39 billion. STATEMENT OF COMPREHENSIVE INCOME 12M 2009 consolidated, unaudited, in thousand EEK and EUR EEK EUR 12M 2009 12M 2008 12M 2009 12M 2008 Revenue 3 181 209 4 653 933 203 316 297 441 Cost of goods sold (2 835 169) (4 045 306) (181 200) (258 542) GROSS PROFIT 346 040 608 627 22 116 38 899 Marketing expenses (47 094) (43 921) (3 009) (2 807) Administrative and gen. expenses (154 000) (202 820) (9 842) (12 963) Other operating income 14 408 9 529 921 609 Other operating expenses (27 326) (43 333) (1 746) (2 769) OPERATING PROFIT 132 028 328 082 8 440 20 969 Financial income and expenses from stocks of subsidiaries - 1 418 - 91 Financial income and expenses from stocks of associate companies and joint ventures (18 222) (4 565) (1 165) (292) Financial income and expenses from other long-term financial investments (8 867) - (567) - Interest expense (23 478) (18 392) (1 501) (1 175) Foreign exchange gain 1 209 (6 942) 77 (444) Other financial income 38 307 34 405 2 448 2 199 Other financial expenses (1 119) (1 297) (71) (83) Total financial income and expenses(12 170) 4 627 (779) 296 PROFIT BEFORE TAX 119 858 332 709 7 661 21 265 Corporate income tax expense (8 496) (26 339) (543) (1 684) NET PROFIT FOR FINANCIAL YEAR 111 362 306 370 7 118 19 581 incl.equity holders of the parent 116 166 299 140 7 424 19 119 minority interest (4 804) 7 230 (306) 462 OTHER COMPREHENSIVE INCOME Exchange differences on translating foreign subsidiaries (2 266) (7 465) (145) (477) COMPREHENSIVE INCOME 109 096 298 905 6 973 19 104 incl.equity holders of the parent 113 900 291 675 7 279 18 642 minority interest (4 804) 7 230 (306) 462 Earnings per share for profit attributable to the equity holders of the parent (basic and diluted, in EEK and EUR) 6,56 16,90 0,42 1,08 STATEMENT OF COMPREHENSIVE INCOME Q4 2009 consolidated, unaudited, in thousand EEK and EUR EEK EUR Q4 2009 Q4 2008 Q4 2009 Q4 2008 Revenue 847 830 1 101 566 54 186 70 403 Cost of goods sold (779 438) (1 080 425) (49 815) (69 051) GROSS PROFIT 68 392 21 141 4 371 1 352 Marketing expenses (14 129) (17 801) (903) (1 138) Administrative and general expenses(36 645) (45 600) (2 342) (2 914) Other operating income 4 306 842 275 53 Other operating expenses (23 466) (30 815) (1 499) (1 969) OPERATING PROFIT (1 542) (72 233) (98) (4 616) Financial income and expenses from stocks of subsidiaries - 1 418 - 91 Financial income and expenses from stocks of associate companies and joint ventures (10 178) (5 749) (650) (367) Financial income and expenses from other long-term financial investments (8 867) - (567) - Interest expense (4 355) (5 950) (278) (380) Foreign exchange gain (56) 417 (4) 26 Other financial income 13 606 16 536 870 1 057 Other financial expenses 7 (10) 0 (1) Total financial income and expenses (9 857) 6 682 (629) 428 PROFIT BEFORE TAX (11 399) (65 551) (727) (4 188) Corporate income tax expense (4 166) (21 240) (266) (1 357) NET PROFIT FOR FINANCIAL YEAR (7 233) (44 311) (461) (2 831) incl. equity holders of the parent (2 736) (44 733) (175) (2 858) minority interest (4 497) 422 (286) 27 OTHER COMPREHENSIVE INCOME Exchange differences on translating foreign subsidiaries (1 234) 1 696 (79) 108 COMPREHENSIVE INCOME (8 467) (42 615) (540) (2 723) incl. equity holders of the parent (3 970) (43 037) (254) (2 750) minority interest (4 497) 422 (286) 27 Earnings per share for profit attributable to the equity holders of the parent (basic and diluted, in EEK and EUR) (0,15) (2,53) (0,01) (0,16) STATEMENT OF FINANCIAL POSITION AS OF 31.12.2009 consolidated, unaudited, in thousand EEK and EUR EEK EUR 31.12.2009 31.12.2008 31.12.2009 31.12.2008 ASSETS Current assets Cash and cash equivalents 359 732 515 191 22 991 32 927 Shortterm financial investments 400 916 262 759 25 623 16 793 Trade and other receivables 723 301 784 540 46 226 50 141 Inventories 1 479 001 1 817 486 94 527 116 158 Assets held for sale - 173 - 11 Total current assets 2 962 950 3 380 149 189 367 216 030 Non-current assets Long-term financial investments 243 958 260 036 15 592 16 619 Investment property 16 552 12 002 1 058 767 Property, plant and equipment 266 276 197 094 17 018 12 597 Intangible assets 24 238 11 807 1 549 755 Total non-current assets 551 024 480 939 35 217 30 738 TOTAL ASSETS 3 513 974 3 861 088 224 584 246 768 LIABILITIES AND OWNERS' EQUITY Current liabilities Borrowings 447 569 206 657 28 605 13 208 Trade and other payables 787 719 972 330 50 344 62 144 Short-term provisions 37 702 32 317 2 410 2 065 Total current liabilities 1 272 990 1 211 304 81 359 77 417 Non-current liabilities Long-term borrowings 76 316 531 396 4 878 33 962 Long-term payables to suppliers 10 653 8 824 681 564 Long-term suppliers advance payments 5 - 0 - Total non-current liabilities 86 974 540 220 5 559 34 526 Total liabilities 1 359 964 1 751 524 86 918 111 943 Equity Minority interest 27 129 34 633 1 734 2 213 Equity attributable to equity holders of the parent company Share capital 177 000 177 000 11 312 11 312 Statutory reserve capital 17 700 17 700 1 131 1 131 Currency translation differences(14 816) (12 550) (947) (802) Retained earnings 1 946 997 1 892 781 124 436 120 971 Total equity attributable to equity holders of the parent 2 126 881 2 074 931 135 932 132 612 Total equity 2 154 010 2 109 564 137 666 134 825 TOTAL LIABILITIES AND EQUITY 3 513 974 3 861 088 224 584 246 768 Alar Lagus Member of Board +372 6 805 109 alar.lagus@merko.ee