Improving Financial Performance through Enhanced Efficiency

This report outlines Federal Grid’s financial position and operating results as of 31 December 2015 and should be reviewed together with the Company’s financial statements for 2015, including the explanatory notes thereto, issued in accordance with the Russian Accounting Standards (RAS).

Federal Grid’s RAS-based financial statements for 2015 are available in Appendix 11 to the Annual Report

Forward-looking statements
This report contains forward-looking statements regarding the financial position and results of operations of Federal Grid Company and its consolidated entities. All statements other than statements of historical fact are forward-looking statements. Forward-looking statements are statements of future expectations based on the management’s current views and assumptions that are subject to risks and uncertainties that could cause actual results and events to differ materially from those expressed in or implied by these forward-looking statements.

Forward-looking statements include, among other things, statements of possible market risks that may affect our business and statements of the management’s expectations, predictions, estimates, forecasts, plans and assumptions. Such forwardlooking statements can be identified by the use of conditional or forward-looking terminology such as “imply”, “anticipate”, “assume”, “may”, “estimate”, “expects”, “intend”, “could be”, “plan”, “goals”, “view”, “likely”, “project”, “will”, “strive”, “achieve”, “risks”, “tasks”, “should” or similar words and expressions.

There are a number of factors that could affect our future activities and cause actual results to differ materially from those contained in the forward-looking statements, including but not limited to: (а) environmental and financial risks; (b) change in demand for the Company’s products; (c) change in currency exchange rates; (d) risks associated with failure to find appropriate property and assets for acquisition and to succeed in negotiations and complete such transactions; (e) reserve evaluation; (f) loss of market share and industry competition; (g) economical and financial market conditions in various countries and regions; (h) political risks, delay or acceleration of project implementation, cost estimation; and (i) change in trade conditions.

Federal Grid’s performance in 2015 demonstrates the improvement of its operating efficiency attributable to the growth of its earning and cost optimisation under tariff increase constrains.

Revenue, Full Cost and Net Profit, RUB million

Revenue Federal Grid’s revenue in 2015 increased by 2.6% versus 2014, including the increment of RUB5.396 million from technological connection services due to completed connection of power plants and the regulator’s introduction of a technological connection fee that compensates the investment component of services rendered.

The revenue from electricity transmission services fell by RUB895 million, including because in 2015 direct consumers started paying for power transmission services based on actual capacity (previously payments were based on committed capacity).

Full cost Main factors that contributed to the full cost change in 2015 as compared with 2014 are as follows:

• Electric power/capacity cost increase by RUB2,523 million (21. 4%) mainly (RUB2,473 million) due to changes in the grid operating modes
• Property tax increase by RUB1,848 million (34.2%) that is explained by the phased elimination of property tax relief for transmission lines from January 1, 2013 in accordance with Federal Law “On Amendment of RF Tax Code Section II” No. 202-FZ dated 29 November 2012
• RUB1,007 million (25.6%) reduction in the scope and cost of repair and maintenance performed by contractors under the Company’s operating efficiency improvement programme
• Increase of power transit costs by RUB745 million (37. 3%) due to the RUB devaluation (power transit is performed via grids abroad) and respective adjustment of the transit tariff
• Reduction of depreciation costs by RUB949 million due to revision of useful life for fixed assets
• Reduction in labour costs and mandatory social charges, property insurance, rent and security costs as a part of the Company’s cost optimisation and operating efficiency improvement programme

Structure of actual revenue for maintaining the Company’s grids in 2015

Management expenses Main factors that contributed to the change in management expenses in 2015 as compared with 2014 are the following:

• Increase in depreciation charges mostly due to registration of intangible assets
• Growth of labour costs including insurance payments due to the increase in marginal base subject to a higher tax rate (30%) from RUB624 thousand to RUB711 thousand as well as introduction of mandatory medical insurance charges on total payments (previously there were no charges on payments in excess of the set base)
• Reduction of other management expenses mostly related to the upkeep of property (lease, insurance, security, other)

Irrespective of high inflation rate in 2015 (15.5%), management expenses remain at the level of 2014 (variance is only 0.6%). Without property tax and depreciation charges there is a trend of management expenses reduction by 1.3% in 2015versus 2014.

Cost management programme To increase the efficiency of Federal Grid’s operations and optimise production and management costs and their structure, the Company developed a comprehensive Programme for Improving Efficiency of Operations approved as a part of the Federal Grid Business Plan for 2015–2019.

According to the 2015 performance results, the Company fulfilled the operating efficiency improvement targets set for 2015:

• OPEX reduced by 40.1% as compared with 2012 (the aggregate OPEX reduction effect as a part of the Cost Management Programme reached RUB14,100 million)
• OPEX reduction against 2012 was more prominent than envisaged in the Strategy of the RF Electric Grid Complex Development pursuant to RF Government Directive No. 511-р dated 03.04.2013
• The Company’s earned net profit reached RUB17,870 billion.

For the purpose of RF Government Directive No. 2303p-P13 dated 16 April 2015 to reduce OPEX by 2–3% annually, the Board of Directors of Federal Grid approved the Methodology for Calculation and Evaluation of Key Performance Indicators for Federal Grid’s Senior Management and set the OPEX reduction KPI for 2015 at no less than 14.2% as compared to 2014. In 2015, the Company managed to reduce OPEX by 24% as against 2014.

The Company was able to reach the above results thanks to the following:

• Reduction in the cost of purchases
• Reduction in costs under long-term agreements (supply of transformer oil, protective clothing, inputs; maintenance services for compressors; clean-up of transmission line right-of-way; ESS maintenance and repair)
• Reduction in the value of security contracts
• Reduction in the value of IT services contracts (signing of amendments to reduce the cost but preserve the same scope of services)
• Headcount optimisation

Other income and expenses Other income in 2015 increased by RUB9,307 million versus 2014. Main factors thereto: booking of gains from the revaluation of JSC INTER RAO stock (the loss from stock revaluation was booked in 2014) and fixed assets, and increase in earnings in the form of interest from placement of free funds at deposits. Other expenses fell by RUB2,444 million irrespective of the growth of interest payable and provisions for bad debt and investment impairment because the number of promissory notes purchase/repayment transactions reduced and the loss from PJSC INTER RAO stock revaluation was booked in 2014.

EBITDA Adjusted earnings before interest, profit tax, depreciation and amortisation (EBITDA) increased by RUB4,064 million (4.1%) as compared with the same period of 2014 and reached RUB103,667 million.

Net profit (loss) In 2015, Federal Grid earned net profit of RUB17,870 million