Results of operations – for the year 2014

Financial highlights of 2014

In 2014 the Group continuously focused on providing high quality service to our clients and service excellence.

The sales revenues of the Group in 2014 have been relatively flat compared to the same period in 2013, increasing 0.3% to 53.24 mln euros. The decreased sales from storm water and fire hydrants services within and outside the main service area by 10.9% or 0.42 mln euros to 3.48 mln euros was compensated with higher water and sewage sales revenues, which increased by 1.8% or 0.83 mln euros to 47.35 mln euros.

The gross profit in 2014 increased 0.9% or 0.26 mln euros mainly due to slightly increased revenues and broadly flat expenses.

The operating profit from the Group’s main business activity increased by 0.1% to 24.54 mln euros during the twelve months of 2014 compared to the twelve months of 2013. As revenues have been relatively flat, increasing only 0.3% or 0.15 mln euros, increase in revenues is eliminated by the increase in administration costs, which in itself were highly impacted by higher legal charges related to ongoing tariff dispute. 2014 and 2013 results were also impacted highly by the pollution tax issues the Group has faced in both years. Excluding the pollution tax one off negative impacts of 1.27 mln euros in 2014 and 1.13 mln euros in 2013, extra construction profit of 0.29 mln euros in 2014 and 0.25 mln euros in 2013, the operating profit was 0.7% or 0.18 mln euros higher amounting to 25.81 mln euros compared to 25.63 mln euros in 2013.

Statement of comprehensive income

Sales

In 2014, the Group’s total sales increased year-on-year by 0.3% to 53.24 mln euros. Lower sales from storm water services within and outside the main service area by 10.9% or 0.42 mln euros to 3.48 mln euros was compensated with higher water and sewage sales revenues, which increased by 1.8% or 0.83 mln euros to 47.35 mln euros.

91.3% of sales comprise of revenues from water and wastewater services to domestic and commercial customers within and outside of the service area, 5.8% of sales are the fees received from the City of Tallinn for operating and maintaining the storm water system and fire hydrants and 2.9% from other works and services. There is no considerable seasonality in the Group’s operation.

Sales of water and wastewater services were 48.19 mln euros, 2.0% increase compared to 2013, resulting from the changes in sales volumes as described below.

Within the service area, sales to residential customers were at 24.15 mln euros, increasing by 2.2% year-on-year. As revenues from apartment blocks form the biggest share of our residential sales, the biggest increase came also from this client group. Sales to commercial customers increased by 0.2% to 19.09 mln euros. Sales to customers outside of the service area increased by 4.9% to 4.52 mln euros compared to 2013. It was mostly affected by water and wastewater services sales, as storm water sales decreased by 15.1% or 0.07 mln euros. Over pollution fees received were 0.84 mln euros, 14.3% increase compared to 2013.

The sales from operation and maintenance of storm water and fire-hydrants system in the main service area have decreased by 10.3% to 3.07 mln euros in 2014 due to lower volumes compared to the same period in 2013. According to the terms and conditions of the contract, revenues reflect actual volumes treated and costs for treating the storm water.

The sales of construction activities and design services have decreased by 19.3% to 0.93 mln euros in 2014 compared to 2013, partly due to mild winter of 2013 which allowed extra construction works.

Cost of Goods Sold and Gross Margin

The cost of goods sold for the main operating activity was 22.40 mln euros in 2014, decrease of 0.11 mln euros or 0.5% from the equivalent period in 2013. The cost decrease is mainly the result of decreased construction services costs (0.17 mln euros) and electricity costs (0.36 mln euros), balanced by the increase in pollution tax expenses (0.29 mln euros).

Total direct production costs (water abstraction charges, chemicals, electricity and pollution taxes) decreased by 0.01 mln euros or 0.1%. Increased pollution tax expense, the reasons for which are explained below, has the major impact on the increased direct production costs. Other changes came from a combination of increase in regulated prices and tax rates, movements in treatment volumes that affected the variable costs and lower prices, together with the following additional factors:

• Water abstraction charges increased only by 0.06 mln euros or 6.0% to 1.06 mln euros in 2014, driven mainly by 5% raise in tax rates (worth 0.05 mln euros).
• Total chemical costs remained broadly flat, increasing 0.003 mln euros or 0.2% to 1.74 mln euros. Costs change was mainly influenced by the increase in dosage used in sewage treated, which was balanced by decrease in treated volumes and chemicals price. Chemical costs were lower also in water treatment due to the better raw water quality.
• Electricity costs in total decreased by 0.36 mln euros or 10.6% in 2014 compared to 2013. Lower electricity costs are mostly derived from the decrease in treatment volumes and used unit costs, worth 0.21 mln euros. Additional positive effect came from decreased electricity price worth 0.15 mln euros.
• Pollution tax increased by 0.29 mln euros or 15.5% in 2014. The pollution tax cost in 2013 was largely impacted by the incidents in the Wastewater Treatment Plant in the 2nd quarter of 2013 for which the Group received a partial insurance compensation in the 4th quarter of 2013 (worth 0.15 mln euros). In addition, the Group released the one-off expense provision in the beginning of 2013 related to storm water outlet issues occurred in 2012. In 2014, pollution tax costs were largely impacted by the change in Group’s water permit. In the 1st and 2nd quarter of 2014 the Group had higher pollution tax costs as concentration limits for heavy metals in treated effluent were reduced 400 times, due to which the Group was not technically able to meet the limit requirements, despite of the fact that the efficiency in treating the effluent continued to be very high. In the revised water permit the concentration limits for heavy metals have been removed. Starting from the 3rd quarter of 2014 the Group’s problems were resolved with the issuance of a revised water permit. Eliminating the aforementioned one-off effects from both years, the pollution tax would have increased by 0.15 mln euros or 19.7%. The pollution tax increased due to the increase in pollutants concentration (worth 0.07 mln euros) and overall increase in tax rates by 15% (worth 0.11 mln euros) was balanced by the decrease in volumes (worth 0.04 mln euros).

Other cost of goods sold (staff costs, depreciation, construction services and other cost of goods sold) in the main operating activity decreased by 0.10 mln euros or 0.7%. 0.17 mln euros or 18.2% of the decrease in fixed costs is related to construction services and design, as construction services projects in 2014 came to an end earlier than in 2013. The remaining decrease is related to lower repair and maintenance carried out in 2014. Decrease in construction and maintenance services is balanced by the increase in depreciation costs.

As a result of all of the above, the Group’s gross profit for 2014 was 30.84 mln euros, which is an increase of 0.26 mln euros or 0.9%, compared to the gross profit of 30.58 mln euros for 2013. Excluding the pollution tax one-off negative impact of 1.27 mln euros in 2014 and 1.13 mln euros in 2013, extra construction profit of 0.29 mln euros in 2014 and 0.25 mln euros in 2013, the underlying gross profit was 1.5% or 0.46 mln euros higher, amounting to 31.97 mln euros compared to 31.50 mln euros in 2013.

Other Operating Costs

In 2014, the General administration expenses increased in total 0.46 mln euros or 9.0% year-on-year to 5.52 mln euros, mainly due to higher consultation and legal fees related to the ongoing tariff dispute.

Other income/expenses

Other net expenses decreased to a net expense of 0.04 mln euros, compared to 0.08 mln euros net expense in 2013. The result in 2014 has been influenced by lower amount of doubtful receivables than in 2013.

Operating profit

As a result of the above factors, the Group’s operating profit from main services for 2014 totalled 24.54 mln euros compared to 24.51 mln euros in 2013, which shows an increase of 0.03 mln euros or 0.1%. Total operating profit for 2014 was 24.83 mln euros, an increase of 0.07 mln euros. Year-on-year the operating profit for 2014 has increased by 0.3%.

As already mentioned before, the underlying operating profit from main services, without the impact of increased pollution tax, construction profit and government grants, for 2014 was 25.81 mln euros, a 0.18 mln euros or 0.7% increase compared to 2013.

Financial expenses

The Group’s net financial expenses amounted to 2.10 mln euros in 2014, which is a negative change of 1.90 mln euros compared to 0.20 mln euros financial expenses in 2013. The decline is largely related to the change in the non-monetary revaluation of the fair value of the SWAP contracts and negative decline from interest income revenues.

The standalone SWAP agreements have been signed to mitigate the majority of the long term floating interest risk, the interest SWAP agreements are signed for 75 mln euros and 20 mln euros are still with floating interest rate. At this point in time, the estimated fair value of the SWAP contracts is negative, totalling 1.84 mln euros. Effective interest rate (incl. SWAP interests) in 2014 was 3.10%, amounting in the interest costs of 2.98 mln euros, compared to the effective interest rate of 3.23% and the interest costs of 3.11 mln euros in 2013.

Interest income has decreased in 2014 by 0.25 mln euros or 36.6%.

Profit before tax and net profit

The Group’s profit before taxes for 2014 was 22.73 mln euros, which is 1.83 mln euros lower than the profit before taxes of 24.56 mln euros for 2013, resulting mainly from flat revenues, increased pollution tax costs and an increase in professional fees and financial expenses as described above.

The Group’s profit after taxes for the 2014 was 17.94 mln euros, which is 1.99 mln euros lower than the profit after taxes of 19.94 mln euros for 2013.

Statement of financial position

In the twelve months of 2014 the Group invested 11.07 mln euros into fixed assets. As of 31 December 2014, non-current fixed assets amounted to 157.48 mln euros and total non-current assets amounted to 158.34 mln euros. (31. December 2013: 152.25 mln euros and 155.50 mln euros respectively).

The reduction in receivables and prepayments of 6.75 mln euros to 8.26 mln euros is mainly related to collection of the money for network extension program that was finished in the end of 2012. As the payment terms are longer, the collection for the program can be seen until March 2015.

Compared to the year end of 2013 the current liabilities have decreased by 2.39 mln euros to 8.83 mln euros. The movement is mainly related to the decrease in current portion of long-term borrowings in the amount of 1.98 mln euros. As a result of the refinancing of 20 mln euro loan, the current portion of the loan balance was reclassified to the long term liabilities. The liabilities were also affected by the change of the fair value of derivatives, having an impact on the current liabilities in the amount of 0.74 mln euros.

The Group’s loan balance has remained stable at 95 mln euros. As mentioned before, in May 2014, the Company replaced its loan from NIB with the new loan in the amount of 20 mln euros. In December 2014, the Company amended two loans, extending the maturity date from 2015 to 2020. The weighted average interest risk margin for the total loan facility is 1.04%.

The Group has a total debt/total assets level as expected of 57.6%, in range of 55%-65%, reflecting the Group’s equity profile. This level is consistent with the same period in 2013 when the total debt/total assets ratio was 57.0%.

Biggest share of the rest of the long term liabilities is deferred income from connection fees amounting to 12.57 mln euros (2013: 10.14 mln euros).

In the 4th quarter of 2011 the Group recorded and noted an exceptional contingent liability, which could cause an outflow of economic benefits of up to 36.0 mln euros. In the 4th quarter of 2014 the Group re-evaluated the liability, which now stands at 40.1 mln euros, as per note 3 to the accounts.

Cash flow

As of 31 December 2014, the cash position of the Group is strong. At the end of December 2014 the cash balance of the Group stood at 38.56 mln euros, which is 18.8% of the total assets (2013: 31.79 mln, which is 15.7% of the total assets).

The biggest contribution to the cash flows comes from the main operations. During the twelve months of 2014, the Group generated 31.45 mln euros of cash flows from operating activities, an increase of 1.65 mln euros compared to the corresponding period in 2013.

Underlying operating profit still continues to be the main contributor to operating cash flows. The collection of receivables continues to be very strong, being on average 99.86%.

The Group’s cash flows from investing activities have been positive for past three years. In the twelve months of 2014 net cash flows from investing activities resulted in a cash inflow of 1.32 mln euros, a decrease of 2.05 mln euros compared to an inflow of 3.37 mln euros in the twelve months of 2013. This is made up as follows:

In the twelve months of 2014 the investments in fixed assets have increased 0.46 mln euros, compared to 2013 amounting to 9.65 mln euros.

The compensations received for the construction of pipelines were 10.52 mln euros in the twelve months of 2014, an increase of 2.64 mln euros compared to the same period in 2013. Most of the cash collected for pipes is related to the sewage network extension program which was ended in 2012. The collections will still continue till March 2015. In 2013 the loan from Maardu Vesi was collected in full. The Group has not given out any new loans.

In the twelve months of 2014, cash outflow from financing amounted to 26.00 mln euros, which is 0.68 mln euros more than in the same period of 2013, mainly due to increased dividend payment and dividend income tax payment by 0.76 mln euros, balanced slightly by lower interest and financing costs by 0.08 mln euros.

Employees

At the end of 2014, the total number of employees was 321 compared to 304 at the end of 2013. The full time equivalent (FTE) was respectively 307 in 2014 compared to the 292 in 2013. The management continues to work actively for the efficiencies in processes to balance the increase in individual salaries and cost pressure from the market with more productive company structure.

The total salary cost was 7.01 mln euros, including 0.21 mln euros for the Management and Supervisory Council members. The off balance sheet potential salary liability would be up to 0.09 mln euros if the Council would want to replace the Management Board members.

Dividends

Dividend allocation to the shareholders is recorded as the liability in the financial statement of the Company at the time when the profit allocation and dividend payment is confirmed by the annual general meeting of shareholders.

According to the dividend policy, which is also published on Company’s website, the Company will maintain dividends to shareholders at the same amount in real terms, i.e. dividends will be increased in line with inflation each year.

On the annual general meeting of shareholders held on 20th May 2014, 90 cents dividends per share and the total dividend pay-out in the amount of 18.00 mln euros was approved. It is in accordance with the Company’s dividend policy. Compared to 2013 dividends of 87 cents per share, the increase is equal to the inflation.

Dividends were paid out on 13th of June 2014.
Dividend pay-outs in last four years have been as follows:

Share performance

AS Tallinna Vesi is listed on OMX Main Baltic Market with trading code TVEAT and ISIN EE3100026436.

Pension funds holdings in the Company shares dropped in the end of 2014, after Nordea bank took over management of Ergo Life insurance funds and liquidated its holdings in companies listed on the Estonian market. At the end of 2014 the pension funds owned 1.54% of the total shares compared to 2.56% at the end of 2013.

As of 31 December 2014, the closing price of the AS Tallinna Vesi share was 13.10 euros, which is a 10.1% increase (in 2013: 29.3%) compared to the closing price of 11.90 euros at the beginning of the year. During the same period the OMX Tallinn index decreased by 7.7% (2013: 11.4%).

In 2014, 4 962 deals with the Company’s shares were concluded (2013: 5 469 deals) during which 1 239 thousand shares or 6.2% exchanged their owners (2013: 1 853 thousand shares or 9.3%).

The turnover of the transactions was 3 192 thousand euros lower than in 2013, amounting to 15 947 thousand euros. The share price has shown an increase despite of the on-going contractual debate.

Corporate structure

At the end of the year, as of 31 December 2014, the Group consisted of 2 companies. The subsidiary Watercom OÜ is wholly owned by AS Tallinna Vesi and consolidated to the results of the Company.

Future actions & risks

Legal claim for breach of international treaty

In May 2014, the Supervisory Council of the Company gave notice of potential international arbitration proceedings against the Republic of Estonia for breaching the undertakings it is required to abide by in the bilateral investment treaty.

In October 2014, AS Tallinna Vesi and its shareholder United Utilities (Tallinn) B.V have commenced international arbitration proceedings against the Republic of Estonia for breach of the Agreement on the Encouragement and Reciprocal Protection of Investments between the Kingdom of The Netherlands and the Republic of Estonia.

The claim was filed as despite of three years of intensive negotiations to try and reach an amicable settlement, that has not happened.

Additional details surrounding this claim can be found via the following links:

https://newsclient.omxgroup.com/cdsPublic/viewDisclosure.action?disclosureId=609264&messageId=754810
https://newsclient.omxgroup.com/cdsPublic/viewDisclosure.action?disclosureId=627851&messageId=779160

Disclosure of relevant papers and perspectives

The Company has published its tariff application and all relevant correspondence with the Competition Authority (hereinafter CA) on its website www.tallinnavesi.ee and to the Tallinn Stock Exchange, and will keep its investors informed of all future developments regarding the further key developments regarding the processing of the tariff application.

In opposite to the Company the CA has requested the Court procedures to be closed. Based on misleading information submitted by the CA the Court approved the CA’s request. AS Tallinna Vesi has reapplied for open proceedings.

At this point in time the Company is unable to say what is going to happen to the tariffs before Court judgments and outcome of an arbitration. The outcome and lengths of the Court proceedings and arbitration is outside the control of the Company.