By the end of 2014, Lenenergo received uncovered loss in the amount of RUB 7,968 mln. Its formation was equally affected both by the need to create a provision for impairment of investments in the amount of RUB 8,607 mln due to the problems of Tavrichesky Bank, and formation of lost income across St. Petersburg in the amount of RUB 5,111 mln due to the incorrect tariff balance decision, creation of valuation reserves in the structure of other expenses and write-off on the losses of the costs on cases lost in court and related to disagreements with third-party grid organizations totaling RUB 3,752 mln.

Lenenergo defends the legitimacy of its positions on tariff decisions and disagreements with third-party grid organizations, both in court and in pre-trial settlement of disputes in the Federal Tariff Service of Russia. Considering changes in the regulatory legal acts of the Russian Federation in 2013-2014 governing the subjects of disagreements, as well as judicial practice in similar disagreements developed at present time, the Company believes that all disputes will be resolved in its favor with a high degree of probability.

In October 2014, Lenenergo was instructed to prepare the list of priority actions to ensure its financial sustainability for 2015-2019. To fulfill this assignment, the Company formed and reviewed, and the Board of Directors took into consideration (Minutes #25 of 06.03.2015) the List of priority actions to ensure financial sustainability of Lenenergo for 2015-2019.

The actions are aimed at addressing the main factors of negative influence on the financial and economic standing of the Company since its reform (since 2005).

The list of priority actions includes some key activities.

The growth rate of electricity transmission tariffs will be determined by the implementation of the CAPEX program of Lenenergo in the necessary volume, compensation of negative “smoothing” and lost revenue generated by the regional regulators in the tariff regulation, including as a result of the overstatement of customer contract demand by the regulator of St. Petersburg.

In 2013-2014, in calculations for electricity transmission services with third-party grid companies there were disagreements regarding the volume and cost of services rendered. Currently, most of the disagreements are settled in court.

Most disagreements are due to the amendments introduced to the current legislation of the Russian Federation on the application of the type of electricity transmission tariffs (single-rate or double-rate) and use in the calculation of the amount of capacity (contract or actual), as well as the inability to execute the contract in respect of approval of all significant conditions stipulated by the legislation of the Russian Federation. The most significant differences emerged in the settlements with JSC St. Petersburg Electric Networks (amounting to RUB 2.14 bn w/o VAT for 2013-2014), JSC Petrodvortsovaya Grid (amounting to RUB 0.39 bn w/o VAT for 2013-2014) and JSC United Energy Company (amounting to RUB 0.87 bn w/o VAT for 2013-2014).

In addition, for some companies we have a situation whereby despite existence of the individual tariffs approved for the company, contracts on rendering of electricity transmission services are not signed with Lenenergo. For example, in May 2013 Vsevolozhsk Enterprise of Electric Networks (hereinafter VEEN) unilaterally terminated the contract with Lenenergo, but a new contract is still not signed. Thus, VEEN insists on payment for electricity transmission services in the absence of a contract. As a consequence, the dispute will be settled in court.

Currently, the disagreements which have arisen in calculations for electricity transmission services between Lenenergo and third-party grid organizations will be settled in court, the risk of write-off of provisions or their recovery depends on the court decision. Final judicial practice has not yet formed — there are both positive and negative judicial decisions for Lenenergo.

In connection with the existing disagreements Lenenergo creates significant provisions for liabilities to third-party grid organizations, which certainly adversely affects the financial result of the Company.

The problem of non-payment by retail companies is relevant for Lenenergo. In 2014, the monthly average receivables of retail companies towards Lenenergo amounted to 82% of the average monthly charge for electricity transmission services (in 2013 the indicator was 15%).

The main reason for the increase in accounts receivable in 2014 is untimely execution by retail companies of the scheduled payments for electricity transmission services under the contract owing to the reduction of payment discipline of consumers. In particular, a high percentage of non-payment in the budgetary organizations and management companies, and also debt growth at the industrial enterprises due to the impact of the deterioration of macroeconomic indicators of the Russian Federation was recorded.

Currently, the imperfection of the legislation in terms of interaction of network of organizations with contractors allows the latter to use the tools of delayed payments, thus does not give adequate mechanisms to counter the growth of receivables to the network organizations.

The actions of Lenenergo to ensure timely collection of debts in claim action does not always lead to its decrease as the debtors repaying the debt of the “old” periods (on the basis of court decisions entered into force), accumulated arrears on “new” periods.

In order to reduce the current level of receivables and improving payment discipline of energy supply companies Lenenergo uses the following tools:

• accurate work of the system for monitoring the debts of retail companies. The analytical database for accounting and control of receivables on retail companies — consumers of electricity transmission services was created;
• settlement of disagreements in the pretrial order;
• preparation of claims and debt collection in court;
• restructuring of debts;
• assignment of debt.

At the regional level Lenenergo conducts work together with guaranteeing suppliers to address the issues of non-payment by end consumers.

The debt on loans and credits as of 31.12.2014 was RUB 49,558 mln, and the y-o-y increase amounted to RUB 16,393 mln, or 49%.

The growth in the Company’s debt was due to the execution of large-scale Capex program.

To ensure the smooth financing of the Capex program for 2014, the Company attracted RUB 22,682 mln of loans and credits, including RUB 14,174 mln to finance its Capex program and RUB 8,508 mln for the refinancing purposes.

The basic indicator used to measure the level of debt acceptable to the Company is Debt/EBITDA — the indicator of the Company’s debt load, its ability to repay existing obligations. The value of this ratio should not exceed 3. However, due to significant lost income and the use of the “smoothing” mechanism when establishing electricity transmission tariffs an excess of this value is possible.

According to the methodology of RAB-regulation of the rate of return on invested capital is 11%, respectively, the level of interest rates on borrowings should not exceed this value.

At present, the terms of the monetary market of long-term loans to corporate borrowers remains inaccessible and short-term interest rates are at the level of 17-20% per annum, depending on the credit quality of the borrower.

Due to the unfavorable situation in the financial markets we do not plan for public borrowing.

According to the list of priority measures to ensure the financial stability of Lenenergo for 2015-2019 approved by the Board of Directors on 03.03.2015 (Minutes #25 of 06.03.2015), the volume of financing of the Capex program of Lenenergo for 2015-2019 was reduced by RUB 46,119 mln compared with the Capex program of Lenenergo for 2014-2019 approved by Order #562 of the Ministry of Energy of Russia of 29.08.2014, and will amount to RUB 110,481 mln.

The purpose of adjustment of the Capex program is reducing the debt load of the Company in the face of rising interest rates and the lack of appropriate sources in the model of RAB-regulation to maintain investment loans.

The decrease in financing the Capex program will reduce the volume of loans by RUB 63,816 mln.

Funding of the adjusted Capex program is planned through own and borrowed sources. The volume of financing of by equity funds is RUB 85,217 mln, and the amount of financing by borrowings is RUB 25,264 mln.

The own sources of Capex program are depreciation (44.4% of the total financing of the Capex program), net profit from transmission activities and other activities" (9.7%), calculations by property (6.6%), funds from the additional issue of shares (1%), and VAT refund (15.5%).

The attracted sources are credit funds, which amount to 9.8% of the total funding, advances on TC (12.5%) and budgetary funds (0.5%).

In order to improve our internal efficiency in 2015 we plan to cut costs relative the Company’s business plan by RUB 1,894 mln:

• cost reduction in the wage fund (cost, expenses from profit) due to the revision of the system of incentive payments, bonuses and allowances for RUB 355 mln;
• cost reduction in the targeted program of repairs due to the transfer of most of works that are scheduled to execute by contractors for the execution by the Company for RUB 202 mln;
• decrease in other controllable costs through renegotiation of existing contracts, rejection of part of the services for RUB 139 mln;
• reduction in property tax due to the planned use of tax concessions in St. Petersburg from 2015 for RUB 1,020 mln;
• decrease in the share of other expenses from profit at the expense of refusal from conducting cultural and educational activities, provision of charity care, lowering the cost of participation in workshops, meetings, waiver of a number of consulting services, reduction of administrative costs for RUB 179 mln.

In accordance with the development Strategy of the power grid complex of the Russian Federation approved by the decree of the RF Government of 03.04.2013, #511 JSC Rosseti approved the Methods of calculating the effect of lowering the cost of service per unit of electrical equipment for 2013-2018 (Order of 22.10.2013, #100-r). The 2015 target is to reduce operating costs given the level of inflation in 2012 in anticipation of unit maintenance of electrical equipment installed at the rate of 10%. The expected effect of the implementation of the program of performance management will be 17.5% (the excess of the preset level will be 7.5%).

• Protecting the Company’s interests under the long-term regulation of electricity transmission tariffs and developing cost-based payment for technological connection of applicants proceeding from ensuring break-even of the Company’s regulated activities.
• Solving the problem of extension of the regulation period until 2019 to implement the Capex program of Lenenergo to the required extent while reducing the tariff load on consumers.
• Ensuring optimal performance of the Company’s financial stability and increase in the market capitalization of the Company.
• Optimization of costs and implementation of key performance indicators of the Company (the task of the Ministry of energy of the Russian Federation and JSC Rosseti to reduce the cost of service per unit of electrical equipment in the prices of 2012 by 5-15%).

The corporate governance of Lenenergo is based on the compliance and adherence to the best Russian and international standards. In 2014, the Board of Directors of the Bank of Russia approved the corporate governance Code recommended for application by joint stock companies, whose securities are admitted to trading. The Company performed the assessment of compliance with the principles and recommendations set out in the Code.

In 2015, we aim to obtain better results, an improvement of corporate governance Lenenergo plan was developed for this purpose and was presented as part of the Report on compliance with the corporate governance Code.

In order to conform with legislation and consolidate the recommendations of the corporate governance Code within the company’s legal documents, we have developed a new draft edition of the Company Charter, as well as projects of new edition internal documents governing activities and procedures of payment of remuneration to the governing and control bodies of Lenenergo. The Board of Directors considered these documents and submitted them for approval to the annual General Shareholder Meeting.

The Company has organized the work, not only on full disclosure of information in accordance with the requirements of the legislation, but also additional information in the form of IR-releases, presentations, analyses, etc. for shareholders, investors and other stakeholders. Information policies of Lenenergo are based on the best Russian and international practice of disclosure that take into account the interests of all stakeholders: shareholders, investors, partners and customers. We focus not only on the completeness, but also on the quality of disclosed information that was repeatedly praised by professional market participants of securities. In particular, in 2014, the annual report of Lenenergo was ranked first amongst the enterprises of the electric grid sector, became the third amongst companies with a market capitalization of up to RUB 10 bn at the XVII annual contest of annual reports organized by the Moscow Exchange and the media group RCB and took pride in 14th place out of 140 in the rating Agency “Expert RA” and joined the group of leaders that have received a rating of 5 stars. Lenenergo has been repeatedly included in the list of winners of annual reports for best disclosure of information and best annual report in 2010, 2012 and 2013.

In 2014, we successfully completed the issue of additional ordinary shares of Lenenergo — 523,753,525.97 ordinary shares of the Company were placed. As part of the issue we managed to attract RUB 3,174 bn for financing the renovation Program of cable network 6-110 kV in St. Petersburg. The additional issue of shares was carried out in strict accordance with the requirements of the current legislation of the Russian Federation, the normative legal acts of the Bank of Russia, the FFMS of Russia and the Company Charter. Shareholders were provided with the opportunity to participate in the issue by making payment for the Company’s additional ordinary shares by cash and assets.

Currently, the main shareholders of the Company — JSC Rosseti and the city of St. Petersburg — discuss the next issue of additional shares of Lenenergo. In the execution of the Decree of the Government of the Russian Federation of 20 June 2013, #518 About the Program of Preparation for the FIFA World Cup in the Russian Federation in 2018, JSC Rosseti is going to contribute in the charter capital of Lenenergo federal funds for the construction of CL 110 kV Krestovskaya — Vasileostrovskaya to the amount of RUB 1.2 bn.

In 2014, in order to protect its property interests, Lenenergo launched a pilot project for the establishment of protected zones of electric grid facilities with data entry in the State cadastre of real estate in accordance with the RF Government Decree of 24.02.2009, #160 About the Procedure of Establishment of Protected Zones of Electric Grid Facilities and Special Conditions of Use of Land Plots Located Within Such Zones.

At the end of 2014, we completed 99% of the volume of works on establishment of protected zones of 35-110 kV overhead lines, as well as including a substantial amount of information in the State cadastre of real estate on the boundaries of protected zones of 0.4-10 kV overhead lines (1.023.12 km), 10 kV substations (456 units) and 35-110 kV substations (162 units).

By the end of 2014, as a result of the policy of asset management, the Company’s revenue from the sale of non-core assets and delivery of objects in rent was up 20% compared to 2013 and amounted to RUB 145 mln. Measures for the sale of non-core assets and optimization of the use of the property complex of the Company will be continued in 2015.

One of the key objectives is to reduce operating expenses, including the cost of property rent. Within this, negotiations were held with key lessors of Lenenergo and proposals on revision of essential conditions of lease contracts in respect of reduction of existing rent rates, cancellation of indexation, changes in the terms of payment and set-off of deposits (advance payments) were sent. Some of the contractors have agreed to the proposed changes and additional agreements were concluded. In 2015, it is planned to implement measures aimed at optimizing the placement of personnel in rented and own office premises that will allow you to reclaim a portion of the rented premises and to reduce the cost of rent. Refusal to rent of buildings/premises at high rent rates and placement of staff in the premises at lower rates will also reduce the rental costs.

Among the priorities for 2015 and subsequent years for Lenenergo is the consolidation of power grid assets within implementation of the development Strategy of the electric grid complex of the Russian Federation approved by the RF Government. In the framework of consolidation of electric grid assets for the period from 2011 to 2014 over 378 km of overhead and cable power transmission lines, substations of various voltage classes for the total installed capacity of more than 412 MVA were purchased in the property and acquired in temporary use.