Annual Report 2005 2005 Aeroflot made rapid progress towards membership of the SkyTeam global airline alliance Aeroflot became the first Russian airline to pass the IATA (IOSA) operational safety audit Aeroflot annual report 2005 Contents KEY FIGURES > 3 CEO’S ADDRESS TO SHAREHOLDERS> 4 MAIN EVENTS IN 2005 > 6 IMPLEMENTING COMPANY STRATEGY: RESULTS IN 2005 AND PRIORITY TASKS FOR 2006 Strengthening market positions > 10 Creating conditions for long-term growth > 10 Guaranteeing a competitive product > 11 Raising operating efficiency > 11 Developing the personnel management system > 11 Tasks for 2006 > 11 AIR TRAFFIC MARKET Global air traffic market > 14 The passenger traffic market in Russia > 14 Russian airlines: main events in 2005 > 15 Market position of Aeroflot Group > 15 CORPORATE GOVERNANCE Governing bodies > 18 Financial and business control > 23 Information disclosure > 25 BUSINESS IN 2005 Safety > 28 Passenger traffic > 30 Cargo traffic > 35 Cooperation with other air companies > 38 Joining the SkyTeam alliance > 38 Construction of the new terminal complex, Sheremetyevo-3 > 40 Business of Aeroflot subsidiaries > 41 Aircraft fleet > 43 IT development > 44 Quality management > 45 RISK MANAGEMENT Sector risks > 48 Financial risks > 49 Insurance programs > 49 Flight safety risk management > 49 PERSONNEL AND SOCIAL RESPONSIBILITY Personnel > 52 Charity activities > 54 Environment > 55 SHAREHOLDERS AND INVESTORS Share capital > 58 Securities > 59 Dividend history > 61 Important events since December 31, 2005 > 61 FINANCIAL REPORT Statement of management’s responsibilities for the preparation and approval of the consolidated financial statements for the year ended December 31, 2005 > 64 Financial results > 65 Independent auditors’ report > 70 Consolidated statement of income > 71 Consolidated balance sheet > 72 Consolidated statement of cash flows > 73 Consolidated statement of changes in shareholders’ equity > 75 Notes to the consolidated financial statements > 76 APPENDIXES Main terms of interested party transaction > 104 Glossary of terms and abbreviations > 105 Operational statistics > 106 Aeroflot Group representative offices > 110 Route network of the Aeroflot Group > 114 General information > 116 Key figures Business performance Unit 2005 2004 2003 2002 2001 Traffic revenue USD millions 2,079.9 1,735.5 1,369.0 1,244.3 1,221.1 Total revenue USD millions 2,539.6 2,158.8 1,716.0 1,563.0 1,558.0 Operating income USD millions 297.2 240.5 168.5 162.3 51.9 Net income USD millions 189.8 172.1 126.7 89.3 20.1 Shareholders' equity (as of December 31) USD millions 558.9 402.9 281.2 164.8 77.7 Capital expenditures USD millions 204.1 324.3 217.7 60.4 82.2 Personnel in airline sector (average) 17,064 16,808 15,854 16,049 16,287 Capital market figures Earnings per share US cents 17.9 15.9 11.4 8.0 1.8 P/E ratio (as of December 31) 8.3 7.9 6.0 4.3 19.7 Market capitalization (as of December 31) USD millions 1,566.0 1,368.0 766.3 383.2 395.4 Traffic statistics Passengers carried millions 8.1 7.3 6.4 5.9 6.2 Cargo tons carried thousands 151.5 148.9 116.9 111.9 103.8 Revenue passenger kilometers billions 22.5 21.6 18.9 18.3 19.6 Revenue ton kilometers billions 2.9 2.8 2.3 2.2 2.3 Passenger load factor % 68.4 68.2 68.8 68.2 65.7 Weight load factor % 58.1 58.4 57.0 56.5 53.7 Available ton kilometers per employee thousands 292.8 287.6 257.3 244.2 266.5 in airline sector Aircraft (as of December 31) 118 114 106 121 129 Aeroflot annual report 2005 CEO’s address to shareholders Dear Shareholders, Results for 2005 in the Russian civil aviation industry force a new assessment of our busi- ness outlook and working practices. After 12–14% annual growth in the number of passengers carried by Russian airline com- panies during 2001-2004, passenger traffic growth in 2005 was only 3.9%, and most of that came from international charter flights and not from regular carrying. Passenger traffic on the Russian domestic market grew by only 1.8%. These figures reflect stagnation in the air- line industry, which had inevitable impact on our business. Causes of the stagnation are well-known: headlong growth of fuel prices, expansion of for- eign carriers on the Russian market, growth of prices for services of monopolistic compa- 4 nies in the aviation business, as well as administrative reform which is still continuing with respect to our sector. Aeroflot was seriously affected in 2005 by suspension of operations with Il-96-300 aircraft, but still managed to carry out all of its duties to passengers. In such difficult conditions, where the “rules of the game” were changing almost monthly, Aeroflot had to pursue an extremely flexible policy, reacting appropriately to negative factors as they arose and taking measures to minimize the consequences. The company often found itself forced into “emergency management” techniques, adapting traffic capacities and schedules and making non-standard decisions in order to deal with non-standard situations. These extra efforts have been rewarded. The company is in a strong position. We have drasti- cally reduced the Company's debt portfolio. We have been successful in limiting growth of costs and ensuring financial stability. Profit of Aeroflot Group in 2005 was USD 189.8 million. Investor confidence in Aeroflot is demonstrated by rapid growth of Aeroflot's share price and market capitalization, offering satisfaction to our shareholders. Several events in 2005 deserve special mention in view of their importance for Company development. First and foremost, construction work finally started last July on a new terminal at Sheremetyevo Airport. The work is proceeding to schedule, and we are resolutely committed to completing and commissioning Sheremetyevo-3 in November 2007. Final completion of the project will give Moscow a fully-fledged modern air transport hub and raise competitive- ness of Aeroflot. The new terminal will unite internal, international and CIS carrying, and will realize Russia's transit potential. We view the new terminal and the existing international ter- minal, Sheremetyevo-2, as a unified entity. Important decisions were taken in 2005 on acquisition of new, highly efficient aircraft for our fleet. We have contracted 12 new craft in the A320/321 family (five A320s and seven A321s). Seven of the new planes will join our fleet this year and the others at the start of 2007. We have also contracted two B767s, which will arrive this year. The expansion program is ongo- ing: the Company fleet of B767s will be increased this year and in 2007; we will invest in a new generation of high-quality long-haul aircraft to enter service in 2010-2011; and we will continue to make extensive use of B767s until aircraft of the new generation are commis- sioned. We have contracted 30 short-haul RRJs (Russian Regional Jets), built by Sukhoi Civil Aviation, for short-haul purposes. These planes will start to enter the company fleet in 2008. Aeroflot continued to implement new technologies last year, and the main achievement was installation of the Sabre ticket sales and booking system. Preparations for launch of Sabre lasted over a year and there were teething problems. These problems have been resolved. We rate installation of Sabre as a success and it has given us a number of clear competitive advantages. We are introducing Internet bookings, and will soon be able to accept ticket pay- ment by credit card over the Internet. CEO’s address to shareholders These are steps on the way to introduction of e-ticketing. Aeroflot already has the technical capabilities and software to launch a full system of e-ticketing. But, unfortunately, this cannot be done without relevant steps by government to create a suitable legal and regulatory tax framework. We are doing our best to speed up this process. In October 2005 Aeroflot successfully underwent the IATA Operational Safety Audit (IOSA), becoming the first Russian compa- ny to receive the IOSA stamp of approval. We worked consistently and methodically in 2005 to achieve one of Aeroflot's main strategic objectives — membership of the SkyTeam global airline alliance. Much difficult work was carried out to make our procedures compatible with SkyTeam tech- nologies. We reached a number of codesharing agreements with SkyTeam members, agreed joint use of VIP lounges and did much to combine our frequent flyer programs. Aeroflot ensured that it meets SkyTeam standards in IT, conduct of business, air- port service and other areas. The lessons of 2005 have made it clear that we are living in a new economic reality, characterized by high prices for aviation fuel and increasing competition. We are confident that the Company board has made the right decision in choosing a development strategy, which positions Aeroflot as a network airline and focuses on expansion of transit carrying. We believe that this strategy is the most promising for Group development. Aeroflot's budget and business plan, approved at the end of last year, call for expansion of operations and revenue in 2006. Achievement of the plan requires faster growth of revenues compared with costs. The Company has analyzed various scenar- ios, all assuming a highly competitive environment in 2006, and has taken appropriate decisions for optimization of the route network. 5 Increase of passenger traffic compared with 2005 will be concentrated in regions, which offer the highest margins. The Company has reserves for improving key indicators: the Sabre ticketing system will be used to improve revenue manage- ment, and performance will be helped by membership of the SkyTeam alliance and high quality of service to our passengers.