2018 first quarter consolidated interim report (unaudited)

This announcement includes Nordecon AS’s consolidated financial statements for the first quarter of 2018 (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 March 2018	31 December 2017
ASSETS
Current assets
Cash and cash equivalents	4,995	8,915
Trade and other receivables	31,640	35,193
Prepayments	2,372	1,641
Inventories	23,868	23,230
Total current assets	62,875	68,980
Non-current assets
Investments in equity-accounted investees	1,368	1,888
Other investments	26	26
Trade and other receivables	9,018	8,950
Investment property	3,549	4,929
Property plant and equipment	12,276	12,566
Intangible assets	14,650	14,639
Total non-current assets	40,887	42,998
TOTAL ASSETS	103,762	111,978
LIABILITIES
Current liabilities
Borrowings	17,470	16,197
Trade payables	31,619	35,926
Other payables	7,251	5,654
Deferred income	5,140	3,651
Provisions	952	664
Total current liabilities	62,432	62,092
Non-current liabilities
Borrowings	7,841	13,955
Trade payables	73	98
Other payables	96	71
Provisions	1,030	1,273
Total non-current liabilities	9,040	15,397
TOTAL LIABILITIES	71,472	77,489
EQUITY
Share capital	18,263	18,263
Own (treasury) shares	-1,349	-1,349
Share premium	589	589
Statutory capital reserve	2,554	2,554
Translation reserve	2,063	1,995
Retained earnings	9,280	11,086
Total equity attributable to owners of the parent	31,400	33,138
Non-controlling interests	890	1,351
TOTAL EQUITY	32,290	34,489
TOTAL LIABILITIES AND EQUITY	103,762	111,978

Condensed consolidated interim statement of comprehensive income

EUR ‘000	Q1 2018	Q1 2017	2017
Revenue	43,662	41,604	231,387
Cost of sales	-43,209	-40,980	-222,692
Gross profit	453	624	8,695
Marketing and distribution expenses	-173	-113	-623
Administrative expenses	-1,671	-1,457	-6,936
Other operating income	17	42	107
Other operating expenses	-77	-88	-141
Operating loss/profit	-1,451	-992	1,102
Finance income	135	103	2,901
Finance costs	-304	-169	-1,570
Net finance costs/income	-169	-66	1,331
Share of loss/profit of equity-accounted investees	-63	47	485
Loss/profit before income tax	-1,683	-1,011	2,918
Income tax expense	-200	-75	-1,193
Loss/profit for the period	-1,883	-1,086	1,725
Other comprehensive income Items that may be reclassified subsequently to profit or loss
Exchange differences on translating foreign operations	68	51	446
Total other comprehensive income	68	51	446
TOTAL COMPREHENSIVE EXPENSE/INCOME	-1,815	-1,035	2,171
Loss/profit attributable to:
- Owners of the parent	-1,806	-1,087	1,388
- Non-controlling interests	-77	1	337
Loss/profit for the period	-1,883	-1,086	1,725
Total comprehensive expense/income attributable to:
- Owners of the parent	-1,738	-1,036	1,834
- Non-controlling interests	-77	1	337
Total comprehensive expense/income for the period	-1,815	-1,035	2,171
Earnings per share attributable to owners of the parent:
Basic earnings per share (EUR)	-0.06	-0.04	0.04
Diluted earnings per share (EUR)	-0.06	-0.04	0.04

Condensed consolidated interim statement of cash flows

EUR ‘000	Q1 2018	Q1 2017
Cash flows from operating activities
Cash receipts from customers1	53,004	45,609
Cash paid to suppliers2	-49,887	-46,567
VAT paid	-1,350	-1,018
Cash paid to and for employees	-5,206	-4,596
Income tax paid	0	-75
Net cash used in operating activities	-3,439	-6,647
Cash flows from investing activities
Paid on acquisition of property, plant and equipment	-66	-33
Paid on acquisition of intangible assets	0	-2
Proceeds from sale of property, plant and equipment	3	0
Loans provided	-6	-21
Repayment of loans provided	3	20
Dividends received	245	147
Interest received	3	27
Net cash from investing activities	182	138
Cash flows from financing activities
Proceeds from loans received	534	3,430
Repayment of loans received	-194	-19
Finance lease principal paid	-450	-480
Interest paid	-170	-147
Dividends paid	-384	-144
Net cash used in/from financing activities	-664	2,640
Net cash flow	-3,921	-3,869
Cash and cash equivalents at beginning of period	8,916	9,786
Effect of movements in foreign exchange rates	0	0
Decrease in cash and cash equivalents	-3,921	-3,869
Cash and cash equivalents at end of period	4,995	5,917

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

² Line item Cash paid to suppliers includes VAT paid.

Financial review
Financial performance
Nordecon Group ended the first quarter of 2018 with a gross profit of 453 thousand euros (Q1 2017: 624 thousand euros) and a gross margin of 1% (Q1 2017: 1.5%). In an environment of stiff competition, gross margin decreased. The Group earned its profit for the period in the Buildings segment where margins declined slightly, slipping to 3.3% (Q1 2017: 4.1%).  Lower profitability is largely attributable to the fact that the Group continues to earn a major share of its revenue from the apartment building business where the ongoing rise in subcontracting prices, particularly labour costs, has the most tangible effect. The performance of the Infrastructure segment was expectedly modest. However, the segment’s loss decreased for the second year in a row. The main reasons for the segment’s loss were lack of self-performed work (major earthworks) during the winter season and a large share of uncovered fixed costs.
Administrative expenses for the first quarter of 2018 amounted to 1,671 thousand euros. Compared with the same period in 2017, administrative expenses grew by around 15% (Q1 2017: 1,457 thousand euros) but the ratio of administrative expenses to revenue (12 months rolling) remained practically the same, amounting to  3.1% (Q1 2017: 3.2%). One of the reasons for higher expenses is the termination benefits paid to a member of the parent company’s board (see also the chapter Employees). However, our cost-control measures continue to produce good results and we have been able to keep administrative expenses below the target ceiling of 4% of revenue.
The Group’s operating loss for the first quarter of 2018 amounted to 1,451 thousand euros (Q1 2017: a loss of 992 thousand euros). EBITDA was negative at 944 thousand euros (Q1 2017: negative at 503 thousand euros).
During the period, finance income and costs continued to be influenced by exchange rate fluctuations in the Group’s foreign markets. Although the Ukrainian hryvnia strengthened against the euro by 2.4% and the Group recognised relevant exchange gain of 62 thousand euros (Q1 2017: a loss of 49 thousand euros), the Swedish krona weakened against the euro by around 4% and the Group recognised an exchange loss of 123 thousand euros (Q1 2017: nil euros) on the translation of a loan provided to the Swedish subsidiary in euros.
The Group’s net loss amounted to 1,883  thousand euros (Q1 2017: a net loss of 1,086 thousand euros), of which net loss attributable to owners of the parent, Nordecon AS, was 1,806 thousand euros (Q1 2017: a net loss of 1,087 thousand euros).
Cash flows
In the first quarter of 2018, operating activities produced a net cash outflow of 3,439 thousand euros (Q1 2017: an outflow of 6,647 thousand euros). Negative operating cash flow is typical of the first quarter and stems from the cyclical nature of the construction business. Larger fixed costs and preparations made for starting more active construction operations in the second quarter, particularly in the infrastructure segment, cause outflows to exceed inflows. In addition, operating cash flow is influenced by a mismatch between the settlement terms agreed with customers and suppliers and the fact that neither public nor private sector customers are required to make advance payments while we have to make prepayments to subcontractors, materials suppliers, etc. We deal with matching customers’ and suppliers’ payment terms on a daily basis, mostly through factoring. In addition to factoring accounts receivable, we have concluded a frame agreement for reverse factoring which enables our subcontractors that do not have sufficient credit standing to obtain a factoring limit from a financing institution to use our limit.
Investing activities produced a net cash inflow of 182 thousand euros (Q1 2017: an inflow of 138 thousand euros). The largest items were payments for property, plant and equipment of 66 thousand euros (Q1 2017: 33 thousand euros) and dividends received of 245 thousand euros (Q1 2017: 147 thousand euros).
Financing activities generated a net cash outflow of 664 thousand euros (Q1 2017: an inflow of 2,640 thousand euros). The largest items were loan, finance lease and dividend payments. Proceeds from loans received amounted to 534 thousand euros, consisting of development loans and overdraft facilities used (Q1 2017: 3,430 thousand euros). Loan repayments totalled 194 thousand euros (Q1 2017: 19 thousand euros) and finance lease payments amounted to 450 thousand euros (Q1 2017: 480 thousand euros). Dividends paid totalled 384 thousand euros (Q1 2017: 144 thousand euros).
At 31 March 2018, the Group’s cash and cash equivalents totalled 4,995 thousand euros (31 March 2017: 5,917 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	Q1 2018	Q1 2017	Q1 2016	2017
Revenue (EUR ‘000)	43,662	41,604	27,731	231,387
Revenue change	4.9%	50.0%	2.3%	26.2%
Net profit/loss (EUR ‘000)	-1,883	-1,086	-409	1,725
Net profit/loss attributable to owners of the parent (EUR ‘000)	-1,806	-1,087	-570	1,388
Weighted average number of shares	30,913,031	30,756,728	30,756,728	30,913,031
Earnings per share (EUR)	-0.06	-0.04	-0.02	0.04
Administrative expenses to revenue	3.8%	3.5%	4.7%	3.0%
Administrative expenses to revenue (rolling)	3.1%	3.2%	3.6%	3.0%
EBITDA (EUR ‘000)	-944	-503	233	3,123
EBITDA margin	-2.2%	-1.2%	0.8%	1.3%
Gross margin	1.0%	1.5%	4.2%	3.8%
Operating margin	-3.3%	-2.4%	-0.8%	0.5%
Operating margin excluding gain on asset sales	-3.3%	-2.4%	-0.8%	0.5%
Net margin	-4.3%	-2.6%	-1.5%	0.7%
Return on invested capital	-2.6%	-1.5%	-0.5%	5.9%
Return on equity	-5.0%	-2.9%	-1.1%	4.8%
Equity ratio	31.1%	35.6%	40.5%	30.8%
Return on assets	-1.9%	-1.1%	-0.5%	1.6%
Gearing	35.3%	29.3%	28.8%	32.7%
Current ratio	1.01	1.01	1.02	1.11
As at	31 March 2018	31 March 2017	31 March 2016	31 Dec 2017
Order book (EUR ‘000)	143,589	130,109	120,702	144,122

Revenue change = (revenue for the reporting period / revenue for the previous period) – 1 * 100 Earnings per share (EPS) = net profit or loss attributable to owners of the parent / weighted average number of shares outstanding Administrative expenses to revenue = (administrative expenses / revenue) * 100 Administrative expenses to revenue (rolling) = (past four quarters’ administrative expenses / past four quarters’ revenue) * 100 EBITDA = operating profit or loss + depreciation and amortisation + impairment losses on goodwill EBITDA margin = (EBITDA / revenue) * 100 Gross margin = (gross profit or loss / revenue) * 100 Operating margin = (operating profit or loss / revenue) * 100

Operating margin excluding gain on asset sales = ((operating profit or loss – gain on sales of non-current assets – gain on sales of real estate) / revenue) * 100 Net margin = (net profit or loss for the period / revenue) * 100 Return on invested capital = ((profit or loss before tax + interest expense) / the period’s average (interest-bearing liabilities + equity)) * 100 Return on equity = (net profit or loss for the period / the period’s average total equity) * 100 Equity ratio = (total equity / total liabilities and equity) * 100 Return on assets = (net profit or loss for the period / the period’s average total assets) * 100 Gearing = ((interest-bearing liabilities – cash and cash equivalents) / (interest-bearing liabilities + equity)) * 100 Current ratio = total current assets / total current liabilities

Performance by geographical market
The contributions of the Group’s foreign markets have remained stable. In the first quarter of 2018, Nordecon earned around 8% of its revenue outside Estonia, compared with 9% in the first quarter of 2017.

	Q1 2018	Q1 2017	Q1 2016	2017
Estonia	92%	91%	93%	94%
Sweden	4%	6%	3%	3%
Finland	1%	2%	1%	1%
Ukraine	3%	1%	3%	2%

The share of Ukrainian revenues has grown substantially compared with the same period last year. In Ukraine, we are providing general contractor’s services under three building construction contracts and one infrastructure construction contract. The share of concrete works performed in the building construction segment has also increased significantly. The share of Swedish revenues has decreased year on year. During the period, we provided general contractor’s services under one construction contract. Our Finnish revenues resulted from concrete works in the building construction segment.
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 chosen 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
Where possible, we strive to maintain the revenues of our operating segments (Buildings and Infrastructure) in balance as this helps diversify risks and provides better opportunities for continuing construction operations in more challenging circumstances where the volumes of one or several sub-segments decline substantially.
Nordecon’s revenues for the first quarter of 2018 totalled 43,662 thousand euros, a roughly 4.9% increase on the 41,604 thousand euros generated in the first quarter of 2017. Both building and infrastructure construction revenues improved. The scarcity of infrastructure projects, which has affected the Estonian construction market in general, has also left its mark on Nordecon’s revenue structure.
In the first quarter of 2018, our Buildings and Infrastructure segments generated revenue of 37,616 thousand euros and 5,941 thousand euros respectively. The corresponding figures for the first quarter of 2017 were 36,711 thousand euros and 4,487 thousand euros (see note 8). Our order book has a similar structure. Although the share of infrastructure construction projects in the Group’s order book has increased to 32% (Q1 2017: 23%), building construction contracts continue to prevail.

Operating segments*	Q1 2018	Q1 2017	Q1 2016	2017
Buildings	86%	89%	88%	74%
Infrastructure	14%	11%	12%	26%

* 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 consolidated financial statements, allocation is based on the subsidiaries’ main field of activity (as required by IFRS 8 Operating Segments). In the consolidated 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 was the commercial buildings sub-segment. Compared with the same period last year, the revenue of the commercial buildings sub-segment grew significantly, by around 49%. The period’s largest projects were in Tallinn: an office building at Lõõtsa 12, the Öpiku B building and a multi-storey car park at Lõõtsa 11 in Ülemiste City, and a 14-floor commercial and residential building in the WoHo quarter at Mustamäe tee 3. We also continued to build Omiva’s logistics centre in Rae parish near Tallinn. Based on the Group’s order book, we expect that in 2018 the revenue of the commercial buildings sub-segment will increase compared with 2017.
The share of revenue generated by the apartment buildings sub-segment decreased compared with a year ago. In Estonia, a substantial share of our apartment building projects is located in Tallinn. In the period under review, the largest of them were the Meerhof 2.0 apartment building complex at Pirita tee 20a and apartment buildings at Sõjakooli 12 (phases II and III) and Lesta 10. Foreign markets continue to contribute a major share of the sub-segment’s revenue. During the period, we continued the construction of a residential quarter in the city of Brovary in the Kiev region in Ukraine and the design and construction of an 8-floor apartment building in the city of Stockholm in Sweden.
We continue work in our own housing development projects (reported in the apartment buildings sub-segment) in Tartu and Tallinn. During the period, we continued the construction of the last two phases of the Tammelinn project in Tartu (www.tammelinn.ee). In Tallinn, we began preparatory work in a new development project at Nõmme tee 97 where we are going to build a 4-floor apartment building with 21 apartments (www.nommetee.ee). We continue to sell apartments in the above development projects in Tartu and Tallinn as well as the projects completed in 2017 at Magasini 29 (www.magasini.ee) and Hane 2 and 2a (www.hane.ee) in Tallinn. The period’s housing development revenues totalled 1,638 thousand euros (Q1 2017: 196 thousand euros). In carrying out our own development activities, we monitor closely potential risks in the housing development market that stem from rapid growth in the supply of new housing and relative growth in input prices.
The revenue contribution of the public buildings sub-segment has decreased compared with the same period last year. However, based on the order book we expect that in 2018 the sub-segment’s revenue will remain at the same level as in 2017. The results of this sub-segment continue to be strongly influenced by the state’s investment in national defence. During the period, we continued to build infrastructure for armoured vehicles and two barracks at the military base at Tapa and an academic building of the Estonian Academy of Security Sciences in Tallinn.
The largest projects in the industrial and warehouse facilities sub-segment are the construction of the Metsä Wood plywood factory in Pärnu and a co-generation plant at Kehra and the reconstruction (phase IV) of the fattening unit of the pig farm of Rakvere Farmid AS (EKSEKO).

Revenue breakdown in the Buildings segment	Q1 2018	Q1 2017	Q1 2016	2017
Commercial buildings	38%	26%	20%	25%
Apartment buildings	25%	33%	28%	30%
Public buildings	23%	28%	35%	19%
Industrial and warehouse facilities	14%	13%	17%	26%

For a long time, the Infrastructure segment has been dominated by the road construction and maintenance sub-segment. In the first quarter of 2018, its share of the revenue of the Infrastructure segment grew even further (compared with Q1 2017). A significant portion of the period’s revenue was generated by two large contracts secured in 2017: the reconstruction of the Haabersti intersection in Tallinn and a section of the Tallinn ring road (km 0.6-2.8). A substantial share of the period’s revenues also resulted from forest road improvement services provided to the State Forest Management Centre. We continued to render road maintenance services in Järva and Hiiu counties and the Kose maintenance area in Harju county. We expect that road construction will remain the main revenue source in the Infrastructure segment through 2018.
The contracts of the environmental engineering and other engineering (utility network construction) sub-segments are small and significant growth of their revenues is unlikely.

Revenue breakdown in the Infrastructure segment	Q1 2018	Q1 2017		Q1 2016		2017
Road construction and maintenance	85%	82%		65%		86%
Other engineering	12%	10%		30%		8%
Environmental engineering	3%	8%		5%		6%

Order book
At 31 March 2018, the Group’s order book (backlog of contracts signed but not yet performed) stood at 143,589 thousand euros, an increase of around 10% compared with the end of the same period in 2017.

As at	31 March 2018	31 March 2017	31 March 2016	31 Dec 2017
Order book (EUR ‘000)	143,589	130,109	120,702	144,122

At the reporting date, contracts secured by the Buildings segment and the Infrastructure segment accounted for 68% and 32% of the Group’s total order book respectively (31 March 2017: 77% and 23% respectively). Compared with 31 March 2017, the order book of the Buildings segment has shrunk by 2% and the order book of the Infrastructure segment has grown by 52%. 
The order book of the Buildings segment has decreased year on year because the order books of the industrial and warehouse facilities and the apartment buildings sub-segments have shrunk by 76% and 23% respectively. The order books of the commercial and the public buildings sub-segments, on the other hand, have increased considerably. The largest, around 70%, year-on-year order book growth was posted by the commercial buildings sub-segment. Growth is 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 as well as the construction of Omniva’s logistics centre in Rae parish near Tallinn. The sub-segment’s order book has also grown through two large contracts signed 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. A significant share of the order book of the public buildings sub-segment, which has grown by 51% year on year, is made up of contracts for the construction of an academic building for the Estonian Academy of Security Sciences in Tallinn and infrastructure for armoured vehicles and two barracks at the Tapa military base that were secured in the second half of 2017.
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 around 89% of the segment’s total order book. The road construction order book comprises the remaining portions of contracts signed in 2017 as well as two new contracts secured in 2018: one for the reconstruction of two sections (km 195.6-205.8 and 207.8-209.2) of the Riga-Pskov road (the Tsiiruli-Missoküla road section) and the other for the construction of the Veskitammi intersection in Laagri, near the border of Tallinn. The Group continues to provide road maintenance services in three road maintenance areas: Järva, Hiiu and Kose. 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 with 2017 (for further information, see the Business risks section of the chapter Description of the main risks).
Based on the Group’s order book and known developments in our chosen 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 would have an adverse impact on our results. Despite this, where suitable opportunities arise, we strive to increase the portfolio to counteract the pressure on margins, which is caused by the market situation. Our preferred policy is to keep fixed costs under control and monitor market developments.
Between the reporting date (31 March 2018) and the date of release of this report, Group companies have secured additional construction contracts in the region of 8,110 thousand euros.

People
Employees and personnel expenses
In the first quarter of 2018, the Group (the parent and the subsidiaries) employed, on average, 691 people including 427 engineers and technical personnel (ETP). The number of employees, particularly workers, has decreased by around 3% year on year because the contract for providing road maintenance services in the Keila maintenance area expired.
Average number of the Group’s employees (at the parent and the subsidiaries)

	Q1 2018	Q1 2017	Q1 2016	2017
ETP	427	413	353	426
Workers	264	303	299	309
Total average	691	716	652	735

The Group’s personnel expenses for the first quarter of 2018, including all taxes, totalled 4,943 thousand euros. In the same period of 2017, personnel expenses amounted to 4,479 thousand euros. The roughly 10% growth in personnel expenses is mainly attributable to pay rises.
The service fees of the members of the council of Nordecon AS for the first quarter of 2018 amounted to 47 thousand euros and associated social security charges totalled 15 thousand euros (Q1 2017: 34 thousand euros and 11 thousand euros respectively).
The service fees of the members of the board of Nordecon AS amounted to 232 thousand euros and associated social security charges totalled 77 thousand euros (Q1 2017: 94 thousand euros and 31 thousand euros respectively). The figures include termination benefits of 93 thousand euros paid to a member of the board and associated social security charges of 31 thousand euros.

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:

	Q1 2018	Q1 2017	Q1 2016	2017
Nominal labour productivity (rolling), (EUR ‘000)	320.4	281.9	216.4	314.9
Change against the comparative period	13.7%	30.4%	-3.6%	17.6%
Nominal labour cost efficiency (rolling), (EUR)	10.0	9.5	8.0	10.1
Change against the comparative period	5.4%	20.7%	-4.4%	12.6%

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)

The Group’s nominal labour productivity and labour cost efficiency increased year on year, mainly through revenue growth.

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 between 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 of the previous financial framework, the amounts earmarked for construction work are substantially smaller than in the previous budget period.
In the light of the above factors, we expect that in 2018 as a whole 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 construction, earthworks, 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 March 2018, the Group’s warranty provisions (including current and non-current ones) totalled 1,011 thousand euros (31 March 2017: 1,176 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, the Group did not incur any credit losses. In the comparative period in 2017, credit losses totalled 30 thousand euros. The overall credit risk exposure of the portfolio 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 continuously 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 1.01-fold (31 March 2017: 1.01-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 8,564 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. At 31 March 2018, the Group’s short-term borrowings totalled 17,470 thousand euros.
At the reporting date, the Group’s cash and cash equivalents totalled 4,995 thousand euros (31 March 2017: 5,917 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 1,652 thousand euros year on year. Factoring and loan liabilities increased whereas finance lease liabilities decreased (see also the section Liquidity risk). At 31 March 2018, interest-bearing borrowings totalled 25,311 thousand euros (31 March 2017: 23,659 thousand euros). Interest expense for the first quarter of 2018 amounted to 174 thousand euros (Q1 2017: 128 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 signed a derivative contract to manage the risks resulting from changes in the interest rate of the finance lease contract of a new asphalt concrete plant acquired in 2016.
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 the first quarter of 2018, the hryvnia strengthened against the euro by around 2.4%. For a Ukrainian subsidiary, this meant additional foreign exchange gain on the translation of its euro-denominated loans into the local currency. Relevant exchange gain amounted to 62 thousand euros (Q1 2017: a loss of 49 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 any exchange gains or losses. Nor do the loans provided to the Ukrainian associates in euros give rise to any exchange gains or losses to be recognised in the Group’s accounts.
In the first quarter of 2018, the Swedish krona weakened against the euro by around 4%. Due to adverse movements in the krona/euro exchange rate, the translation of operating receivables and payables resulted in an exchange loss of 74 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 123 thousand euros. This exchange loss has been recognised in Finance costs. In the comparative period, there were no exchange losses.
We have not acquired derivatives to hedge our currency risk.
Employee and work environment risks
Finding permanent labour is a serious challenge for the entire construction sector and one of the main factors that influences business results. The Group depends extensively on its subcontractors’ ability to ensure the availability of skilled labour. To strengthen Nordecon’s reputation as an employer and make sure that we can find employees also in the future, we collaborate with educational institutions.
As a construction company, we strive to minimise the occupational health and safety risks of people working on our construction sites including both own employees and those of our subcontractors. The goal is to make sure that all measures required by law are applied in full. In addition, the parent company follows the requirements of international occupational health and safety management standard OHSAS 18001. Subcontractors must ensure that their employees follow applicable work safety requirements; the Group’s role is to work with them and create appropriate conditions. 
Environmental risks
Construction activities change landscapes and the physical environment of cities and settlements. The Group’s goal is to do its work and at the same time protect the natural environment as much as possible. Our assets and operations which have the strongest impact on the environment and, thus, involve the highest environmental risk are asphalt plants, quarries and road construction operations. To prevent leaks, spills, pollution, destruction of wildlife and other damage to the environment, we comply with legal requirements. All of our largest construction entities have implemented environmental management standard ISO 14001.
Corruption and ethical risks
As one of the leading construction companies in Estonia, we realise that it is important to be aware of the risks involved in the breach of honest and ethical business practices and to make sure that our entities’ management quality, organisational culture and internal communication emphasise zero tolerance for dishonest, unethical and corrupt behaviour.

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 terms of the market in general, investments made by the largest public sector customers (e.g. the 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 major 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.
• 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 it is expected that the housing market, which accounts for a somewhat disproportionately large share of the total construction market and thus amplifies associated risks, will also sustain growth in 2018.
• 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.
• Recent years have 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 picked up in recent years. In 2018, we will continue our Ukrainian operations primarily in the Kiev region but the long-term preparations made in western Ukraine are also bearing fruit. Based on our order book, it is possible that in 2018 our Ukrainian business volumes will increase compared with 2017. Despite the military conflict in eastern Ukraine, for Nordecon the market situation has improved 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 have been operating in Sweden since July 2015. In the Swedish market, we 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 adherence to 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 revenue of the Group in 2017 was 231 million euros. Currently Nordecon Group employs close to 700 people. Since 18 May 2006 the company's shares have been quoted in the main list of the NASDAQ Tallinn Stock Exchange.

Andri Hõbemägi
Nordecon AS
Head of Investor Relations
Tel: +372 6272 022
Email: andri.hobemagi@nordecon.com
www.nordecon.com

Attachments

• Nordecon_Interim_report_Q1_2018
• Nordecon_investor presentation Q1_2018