8.1. Key factors affecting the performance of the Company

The Company's performance is subject to a number of factors, including state-regulated electricity and heat tariffs, the price of the main fuel (gas), and the system of taxation. Another factor that has a considerable influence on the Company’s activities is the seasonal nature of demand for its products and the water level in rivers in the regions where the Company operates.

Tariff regulation

The electricity and capacity tariffs for TGC-1 as a participant of the wholesale market are subject to approval by the FTS of the Russian Federation. In line with Government Order No. 205 of 07.04.07, the share of electricity supplied at state-regulated prices (tariffs) in the total amount of electricity produced under the approved forecast balance sheet for 2007 was at least 70% since 01 January 2009 and at least 50% since 01 July 2009.

The heat tariffs are subject to approval by the regional regulatory bodies of Saint Petersburg, Leningrad Region, the Republic of Karelia, and the Murmansk Region.

Fuel costs

The generating facilities of TGC-1 are mainly fuelled by natural gas, which accounts for 93.4% of the fuel costs (not including Murmanskaya CHPP). Gas is supplied to the Company by Peterburgregiongaz.

The Company uses both within-limit gas (the gas supplied within the limits prescribed for regions at prices that are subject to approval by the FTS of the RF) and above-limit gas. The average weighted price of gas has increased by 6% compared to 2008.

By the end of 2009, the share of fuel costs amounted to 40.4% of the total amount of Company’s operating costs. The amount of fuel costs increased by RUR 614 mn (+4.6%) as compared to the 2008 level, totalling RUR 13,890 mn. This rise in fuel costs is due to an increase in prices in 2009.

Seasonal nature of demand

Electricity output from the Company’s power plants changes with the demand for electricity, which varies depending on the season, time of day, weather conditions, air temperature, daylight hours, and day of the week (whether the day is a weekend holiday or a weekday).

The need for supply from particular power plants depends both on the demand for electricity and the structure of generating facilities in the area served by a given power plant (subject to the system reliability requirements).

Water levels

This factor affects the electricity output from the HPPs located in the Republic of Karelia, the Leningrad Region, and the Murmansk Region and plays the key role in determining the performance of the Company’s Kolsky and Karelsky branches. In 2009, high-water level was reported at HPPs of Nevsky Branch.

Taxation

TGC-1 is one of the largest taxpayers in the following four territories of the Russian Federation: St. Petersburg, the Leningrad Region, the Republic of Karelia, and the Murmansk Region. In terms of tax amounts and charges due to the budget, the Company is classified as one of the largest taxpayers, and its taxes are administered by the Interregional Tax Inspectorate for Largest Taxpayers No. 4 since 2006.

In 2009, the net profit of TGC-1 totalled RUR 3,366 mn. For that period, the Company paid RUR 3,212 mn in taxes, including RUR 1,342 mn transferred to the Federal Budget and RUR 1,870 mn paid to the regional and local budgets. As a result of the implementation of the investment program, the Company applied for a refund of RUR 1,887 mn in VAT from the Federal Budget.



8.2. Accounting policy

The accounting policy adopted by TGC-1 in the form of an accounting framework consisting of accounting principles, procedures, and practices is worked out with the aim to ensure the maximum level of detail, accuracy, and reliability in reporting day-to-day financial and management data, subject to the relevant industry-specific and organization-specific requirements.

The financial accounting and tax reporting principles chosen by TGC-1 are subject to approval by the General Director and are applied in a consistent manner starting from the registration of the Company.

Financial statements are prepared in TGC-1 in accordance with Federal Law No. 129-FZ of 21 November 1996 on accounting, the Russian Financial Accounting and Reporting Regulation as approved by Russian Ministry of Finance order No. 34n of 29 July 1998 (hereinafter referred to as Regulation No. 34n), and the detailed Chart of Accounts worked out on the basis of the Chart of Accounts for Purposes of Financial Accounting and the Guidelines on how to use it as approved by Russian Ministry of Finance order No. 94n of 31 October 2000, subject to the relevant industry-specific and organization-specific requirements.

For the purpose of financial accounting and tax reporting, the Company has developed documentation rules and a documentation schedule determining when to prepare the statements. The documentation schedule specifies when, how, and in which manner to submit source accounting and other documents to the Central Accounting Office from other departments and divisions of the Company, its branches, representative offices, and other units.

The basic financial accounting and reporting rules are based on the Russian Financial Accounting and Reporting Regulation, subject to some region-specific requirements.

The annual financial statements of the Company are subject to review and approval by the General Shareholder Meeting and are submitted within the schedule and to the addresses indicated in article 15 of Federal Law No. 129-FZ of 21 November 1996 entitled “On Accounting”.

The content of the accounting and tax reporting registers, internal accounting forms is confidential.

Documents on cash flow-related (cash in bank accounts and in the organization’s cashier’s office) business operations need to be signed by the General Director of the Company and the Chief Accountant, as well as other persons properly authorized by them in accordance with letters of authority.

Accounting of property, liabilities, and business operations is permitted to be carried out in amounts rounded to a full rouble amount. The differences in amounts that appear in this case are reported alongside financial performance indicators.

An inventory of property and liabilities is maintained in accordance with article 12 of Federal Law No. 129-FZ of 21 November 1996 on accounting and the Methodology Guide for Inventories of Property and Financial Liabilities as approved by Russian Ministry of Finance order No. 49 of 13 June 1995.

Property inventories, including inventories of leased properties, are maintained locally by branches and organizational units, which are responsible for use and operation of those properties. The procedure for and schedule of the annual inventory of properties and liabilities are determined by an order of the General Director of the Company.

Fixed assets

Accounting for the Company’s fixed assets is conducted in compliance with the Statute on Accounting 6/01, enacted by the Russian Finance Ministry Order No. 26n of 30 March 2001. Depreciation of fixed assets is linear and is based on the period of use of these facilities.

If the General Director decides so, the Company may re-evaluate groups of uniform fixed assets once a year at their current (replacement) cost by means of direct recalculation, based on documented market prices.

Intangible assets

Accounting of intangible assets is conducted in compliance with Statute on Accounting 14/2007, enacted by the Russian Finance Ministry Order No. 153n of December 27, 2007. Depreciation of intangible assets is linear, based on the period of use of these assets.

Depreciation deductions on intangible assets are reported in the financial statements by means of accumulating the relevant amounts on balance sheet account 05 “Depreciation of Intangible Assets”.

Financial investments

Financial investments are reported in the financial statements in accordance with Statute on Accounting 19/02 as approved by the Russian Ministry of Finance order No. 126n of 10 December 2002.

Upon disposal of financial investments which cannot be measured at fair value, the initial value of each item recognized in the accounting records on financial investments is applied.

All costs attributable to asset acquisitions recognized as financial investments, regardless of their scale, are reported in the initial value of financial investments.

Material and industrial inventories

Material and industrial inventories are reported in the financial statements in accordance with Statute on Accounting 5/01 as approved by the Russian Ministry of Finance order No. 44n of June 9, 2001.

Analytical accounting of materials is carried out by the real-time accounting (balance) method. Contractual prices are used as book prices.

Future costs

Future costs are evenly spread, in accordance with an accounting statement, over the period in which they are will be incurred. The duration of such a period is determined at the time when the future costs are recognized in the financial statements.

Settlements, other assets and liabilities

Accounts receivable are reported in the amount of invoices presented for payment at reasonable prices and rates. Other receivables and payment claims are recognized in the financial statements using the prices specified in the relevant contracts.

A reserve for bad debts is set up once a year after the conduct of an annual inventory, but prior to the preparation of the entity’s annual financial statements.

Other assets of the Company, its branches, representative offices, and organizational units are valued at their actual costs at the time of reporting.

Accounts payable for raised credits and loans are recognized and reported in the financial statements inclusive of the interest due at the end of the reporting period.

Deferred tax assets and liabilities are netted in the financial statements as a single amount.

Financial performance

Revenues from goods and products sales, receipts from work done and services rendered are recognized by activities.

Proceeds from ordinary activities are revenues from electricity and heat sales, as well as from other activities. Costs of ordinary activities are reported in the financial statements in accordance with Statute on Accounting 10/99 “Entity’s Costs”, subject to industry-specific production and sale (of goods, works, services) recognition practices, using the cost itemization and distribution principles adopted by the Company.

Costs incurred in R&D and engineering projects

Costs incurred in R&D and engineering projects are recognized in the financial statements in accordance with Statute on Accounting 17/02 as approved by the Russian Ministry of Finance order No. 115n of 19 November 2002.

Events after the reporting date which have or may have an effect on the Company’s financial performance are recognized in the financial statements through disclosure of the relevant information in an explanatory note.

The manner in which to disclose information about discontinued operations, including operations that are discontinued due to reorganization of the Company (e.g. in case of unbundling or a spin-off), in the financial statements is set out in Statute on Accounting 16/02 as approved by the Russian Ministry of Finance order No. 66n of 2 July 2002.

The Company calculates and pays taxes and duties in accordance with the applicable laws on taxes and duties of the Russian Federation, the applicable laws on taxes and duties of the relevant territories of the Russian Federation, and the applicable regulations of local taxation authorities.

The accounting policy of the Company may be amended, if a change occurs in the tax laws of the Russian Federation or the relevant accounting and tax reporting regulations.

All amendments to the accounting policy must be well-reasoned and properly documented (as an order document).



8.3. Financial performance analysis



Revenues

In 2009, the Company generated revenue through heat, electricity, and capacity sales on the wholesale, retail and export markets as well as through other products and sales of services.

At the end of 2009 the revenue of TGC-1 increased by 23.3% compared to 2008, totalling RUR 38,372 mn. This rise in total revenue is due to an increase in sales in the unregulated market sector following the ongoing capacity market liberalization and increase in heat power tariffs and useful heat output.


 



Revenue from electricity and capacity sales

At the end of 2009 the revenue from electricity and capacity sales grew by 25.8% compared to 2008 and amounted to RUR 22,258 mn compared to RUR 17,692 mn in the previous year. The share of the revenue from electricity and capacity sales in the regulated sector of the wholesale market in the structure of the total revenue of TGC-1 dropped by 9 percentage points compared to 2008 and reached 23.6% (RUR 9,063 mn). While the share of the revenue from sales in the competitive sector reached 29.7% or RUR 11,401 mn, which resulted in a 76.1% rise relative to the level of 2008.

The revenue from export electricity sales and retail sales totalled RUR 1,687 mn and RUR 107 mn respectively, resulting in a 4.4% and 0.3% increase of the share in the Company's total revenue.

Revenue from heat power sales

At the end of 2009, the revenue from heat power sales grew by 22.3% compared to 2008 and amounted to RUR 15,136 mn against RUR 12,380 mn in the previous year. This rise in the revenue from heat sales is largely due to a rise in average heat tariffs of 19.5% relative to the level of 2008 and an increase of the useful heat output.

In 2009, the share of the revenue from heat sales in the Company's total revenue reduced by 0.4%, accounting for just 39.4%.

Revenue from other products, works and services sales

At the end of 2009, the revenue from other products, works and services sales reduced by 7.3% compared to 2008 and amounted to RUR 978 mn compared to RUR 1,055 mn in the previous year. Revenue from other products, works, and services sales was mainly driven by the service of connecting consumers to the heating grid. In 2009, the share of other products, works and services sales in the total revenue of the Company amounted to 2.6%, thus declining by 0.8% compared to 2008.

Gross margin

As at the end of 2009 the gross margin of the Company reached 10.03% compared to 4.95% in 2008. The cause of such an increase is the rapid rate of revenue growth that outstrips the rate at which the costs of production and products, works, and services sales are rising.

Costs

In 2009, the products, works, and services production and sale costs amounted to RUR 34,524 mn, including RUR 34,405 mn in core activities costs and RUR 119 mn in non-core activities costs.

The electricity (RUR 18,400 mn) and heat (RUR 16,005 mn) costs account for the largest portion of the total production costs.

Compared to 2008 core activities costs grew by RUR 5,027 mn.

This change in the production costs was largely due to an increase of the cost of purchased power and capacity resulting from fulfilment of exports, liabilities under unregulated contracts and the start of operations of the capacity market in the second half of 2008.

The following factors also influenced the production costs:








Profit

In 2009, profit from sales increased by RUR 2,308 mn, totalling RUR 3,847 mn. Profit before taxes amounted to RUR 4,313 mn. Taxes on profits and other similar duties reached RUR 581 mn, and the total of deferred tax liabilities amounted to RUR 366 mn. Hence, in 2009, the Company's total net profit was RUR 3,366 mn, increasing by RUR 3,135 mn compared to 2008.



8.4. Financial analysis



Asset structure

As of 31 December 2009 the balance sheet total of TGC-1 was RUR 93,281 mn. Non-current assets account for 79.7% of the Company's total assets with fixed assets representing the major part of non-current assets (46.7%). The increase of non-current assets share in total assets is a result of the expansion of TGC-1 facilities in 2009. Compared to 2008 the cost of fixed assets increased by RUR 6,681 mn following commissioning of new fixed assets as a result the implementation of TGC-1 investment program.

Construction in progress accounts for 30.8% of the assets. In 2009, this figure increased by 96.1% indicating that new facilities were being built to be put in service in 2010 in accordance with the TGC-1 investment program.

Long-term financial investments amount to 1.7% of the balance sheet total, while other non-current assets of the Company and income-bearing investments in tangible assets account for 0.5% and 0.0001% of the balance sheet total respectively.

The overall share of current assets in the total assets is 20.3%. By the end of 2009 the Company's current assets dropped by 25.1% compared to 2008 due to a considerable decrease (by 34%) of short-term accounts receivable, short-term financial investments (by 4.4%) and cash funds (by 57.1%).

The drop in the value of reserves on the balance sheet is a result of fuel consumption growth due to extremely low winter temperatures in 2009.

As of 31 December 2009, the Company has RUR 66,462 mn in net assets. This amount represents a cost estimate of the entity’s property after formal or actual settlement of accounts with third parties. Therefore, the amount of net assets reflects the part of the Company’s assets that can be distributed among the owners of the Company in the event of liquidation. As of December 31, 2009, the authorized capital of the Company totals RUR 38,543 mn, which is less than the value of the Company’s net assets. This is in line with the requirements established in article 35 of the law on joint stock companies”. Hence, one can describe the Company as a strong player in the forward market.

Accounts receivable

As of December 31, 2009 total current accounts receivable amounted to RUR 13,322 mn, which is 34% less compared to 2008. Reduction in accounts receivable is due to advances paid to construction companies under TGC-1 investment program.




Liabilities structure

The Company's liabilities are reflected in the Capital and Reserves, Long-Term Liabilities, and Short-Term Liabilities sections of the balance sheet. According to the financial statements as of 31 December 2009, the third section of the balance sheet – Capital and Reserves – accounts for the largest part of the balance sheet total, amounting to 71.2 % or RUR 66,462 mn, of which RUR 38,543 mn (41.3%), are in the authorized capital.

Non-current liabilities are shown in items Borrowings and Banking Loans amounting, according to the balance sheet, to RUR 8,498.5 mn, or 9.1%. deferred tax liabilities are RUR 1,864.5 mn, or 2%.

Short-term liabilities include short-term loans and credits, which account for 7.3% of the balance sheet total or RUR 6,838.6 mn, and the amounts reported in the accounts payable row of the Short-Term Liabilities section, which make up 10% of the balance sheet total or RUR 9,287 mn.


 

As of 31 December 2009, short-term accounts payable total RUR 9,287 mn, which is 6.2% less than the level of debt in the previous year. Accounts payable to suppliers and contractors amount to 80.96% of total short-term accounts payable, and advances received account for 9.47%.

Reduction in the total amount of accounts payable is a result of the decrease in accounts payable to construction organizations and reduction of total advances received for connection to TGC-1 heating grids.


 

In 2009, the Company's loan portfolio increased from RUR 4,791.6 mn to RUR 15,337 mn due to the Company's raising funds for financing its investment program. The major part of the portfolio are loans in roubles issued by Russian banks. In July 2009, TGC-1 placed a bond issue of series 02 for a total of RUR 5 bn on MICEX with redemption in 2014. The bonds were placed at the rate of 16.99% per annum with a two-year put option.

As at the end of 2009, total share of long-term borrowings in the credit portfolio of the Company amounted to 55.3%. Total amount of interests charged was RUR 1,300 mn per annum, including RUR 704.5 mn in capitalized interests resulting from fixed assets construction using credit funds. Weighted average interest rates in 2009 reached 12.93% over 8.13% in 2008. Growth in rates was a result of worsening situation on the global and Russian financial markets.