OREANDA-NEWS. In the second quarter we continued to change the group’s course in line with the goals and targets set. Our focus is increasingly shifting from cleaning up the statement of financial position and resolving our key issues, which stem from the past, to the future, i.e. re-launching major development operations and enhancing our organisation and work processes. This entails the following:

A. Cleaning up the statement of financial position

We realised the Tivoli project at a public auction. We exited the project without monetary loss even though the revenue raised from the Tivoli properties was smaller than the venture partner’s loan receivable from Tivoli Arendus OU for which Arco Vara had provided a surety guarantee.

We continued to seek solutions for restructuring the Ahtri 3 project. Regrettably, in the second quarter a satisfactory solution could not be found. The parties will sustain their efforts. Until an in-court or out-of-court settlement is reached, we have to be prudent and maintain a provision of 1.9 million euros recognised for the surety guarantee Arco Investeeringute AS has provided to Danske bank to secure the loan liabilities of the group’s associate Arco HCE OU.

We continued to perform the construction contracts signed by Arco Ehitus OU and to date we have completed the Paide project. Only the Kuusalu project still needs to be completed. When construction operations have been discontinued, Arco Ehitus OU will probably remain a group entity because it is involved in a number of pending litigations. None of the lawsuits connected with Arco Ehitus OU is likely to have a significant effect on the group’s operations or profitability.

B. Restructuring

All companies that sell products or services to the end-consumer will belong directly to the parent and will receive the financial resources they need for developing their business straight from the parent. There will be no intra-group holding companies, mixed or unclear managerial accountability or chains of command consisting of more than two links.

We are going to implement integrated production whereby Arco Vara will incorporate into the end-product that is delivered to the consumer all the know-how of its analysts, brokers, appraisers, product designers, project managers and marketing staff. In order to achieve maximum synergies from the new approach, many internal processes will have to be reviewed and changed. Implementation of an integrated production process is time consuming and requires additional investments in data processing.

C. Re-launch of development operations

We completed and put on sale 14 apartments in the Bisumuiza-1 development project in Riga. Our inventory includes another 14 apartments that are awaiting completion.

We started preparations for completing sections A and B in the Manastirski project in Sofia (approx. 130 apartments).

We acquired the entire Paldiski mnt 70c property in Tallinn and initiated a detailed plan process for the construction of at least 300 apartments.

We started preparations for initiating the detailed plan processes for the Liimi 1b and Lehiku street properties in Tallinn.

We made additional investments in the Madrid project in Sofia so as to increase its rental and sales revenues. We are planning to continue relevant investments.

Comments on sales volumes

I am pleased to report that in contrast to the first half of 2012 when over half of the group’s revenue was generated by construction operations, in the first half of 2013 over half of our revenue resulted from development operations. Arco Vara’s business focus has again shifted to real estate development and real estate services.

Shrinkage in sales volumes was a negative inevitability. We expect the downward trend to continue for at least four quarters because we are selling off finished goods (self-developed real estate) more quickly than our stocks can be replenished. This is the effect of previous years’ production gap in our development operations.

As anticipated, we succeeded in increasing our development revenues compared with the first half of 2012. Having refinanced our Bulgarian loans in the first quarter, we could complete sales of the Manastirski and Madrid apartments, which had previously been suspended. As a result, Sofia was the main source of our second-quarter development revenues. However, according to current projections in third and fourth quarter development revenues will decline. Current development operations cannot compensate for the decrease in existing stocks and, thus, also in sales volumes that is going to emerge in the next four quarters.

Construction revenues were also in line with expectations as both Arco Ehitus OU and the customers fulfilled their obligations. At the end of the second quarter, our order backlog in the construction business amounted to approx. 1 million euros, which will translate into revenue in the third or fourth quarter.

An encouraging development was slight sales growth at the Service division, particularly in light of fierce competition in the real estate service sectors in Estonia, Latvia and Bulgaria and the sentiment of the consumers and the financial sector, who are still displaying uncertainty rather than confidence. In Sofia, total second-quarter transaction activity in the real estate market grew by 41% (compared with the first quarter) and Arco Imoti EOOD’s brokerage and valuation revenue increased by 20%. It should be noted that the market is mostly based on local customers. In Riga, revenue growth resulted from valuation services and brokerage fees earned on transactions conducted by non-residents. Local demand for real estate is still weak and local demand for brokerage services is even weaker. Sales volumes in Tallinn and the rest of Estonia remained stable. All units of the Service division are profitable.

Comments on profit

The first half-year proved that the people who make up the organisation of Arco Vara are able to create added value in the real estate sector and to conduct business so that it generates cash.

The group’s target for 2013 was to start earning operating profit. We ended the first quarter with an operating profit as well as a small net profit. In the second quarter we achieved a net profit of half a million euros even without the reversal of the provision set up for the surety guarantee provided to the Tivoli project (1 million euros). Together with the reversal of the provision, our actual net profit was 1.5 million euros.

Despite this, I would still like to underline that in order to change our course for the long term and maintain profitability, we need to increase sales. Growth will be supported by units of the Service division but the main opportunities for growth have to be sought in continuing and expanding development operations. Unfortunately, in recent years there has been a major gap in Arco Vara’s production process, which is now separating our current inventory of completed apartments and plots from the inventory of products that will be completed in the future. Our future inventory is currently in the stage of work in progress and its completion requires capital.

Accordingly, our biggest challenges include raising interim financing for development operations in 2013-2014 and speeding up ongoing development projects so as to fill the gap between our current and future inventory more quickly.

Comments on loan burden

As stated in our previous reports, our loan burden is not going to continue decreasing at the same pace as in the first quarter. In the second quarter the total loan burden decreased somewhat but net loans (loan balance less cash and cash equivalents) grew by 1 million euros to 15.2 million euros. Net loans increased because we took a loan to purchase a property at Paldiski mnt 70c in Tallinn in order to re-launch large-scale development operations. By the date of release of this report, we have initiated a detailed plan process for the property.

Over 80% of our loans are related to the Bulgarian development projects.

We expect an increase in the group’s loan burden in the second half of the year because we are planning to expand our development operations concurrently with the sale of existing stocks but free cash flow from the sale of goods will not be sufficient for this.

Comments on human resources

In the second quarter the number of people working for the group did not change considerably compared with the end of 2012 and we are not planning to make any major changes to personnel or personnel expenses except for those resulting from shrinkage of operations at the Construction division and reinforcement of our marketing, financial management and information processing teams.

KEY PERFORMANCE INDICATORS

Arco Vara group ended the first six months of 2013 with revenue of 7.7 million euros compared with 11.1 million euros for the first half of 2012. Revenue proved 31% smaller than in the comparative period, principally because construction volumes decreased significantly. The Service and Development divisions posted revenue growth, 7% and 5% up on the first six months of the previous year respectively.

The group’s operating profit for the first half-year amounted to 2.0 million euros including 1 million euros from the reversal of a provision. The same period in 2012 ended in an operating loss of 0.6 million euros.

Net profit for the first half-year was 1.5 million euros compared with a net loss of 1.3 million euros incurred in the first half of 2012.

Equity to assets ratio improved notably, being 17.1% at the reporting date (31 December 2012: 10.8%).

The loan burden (net loans) decreased to 15.2 million euros (30 June 2012: 20.9 million euros) and the average interest rate of loans dropped to 5.1% per year.

At the end of the second quarter, the group’s order backlog in the construction business stood at 1.0 million euros compared with 10.3 million euros at the end of the second quarter of 2012. In 2013, the group will duly complete all environmental engineering projects which are in progress. After that, provision of environmental engineering services will be discontinued.

In the first half-year, the group sold 52 apartments and plots in its self-developed projects (2012 HY1: 35).