AVTOVAZ Group* Operating Highlights for 2004 Vehicle unit sales by JSC AVTOVAZ 2004 2003 Change 000’s units 000’s units % Domestic market 630 626 + 0.6 Export market 92 92 Total 722 718 + 0.6 Assembly kit unit sales 301 203 + 48 RR million RR million Net sales 160,536 130,772 + 23 Operating income 9,496 5,941 + 60 Consolidated Statement of Operations** Year ended 31 December 2004 2003 Change RR million RR million % Net sales 160,536 130,772 + 23 Cost of sales (133,687) (110,120) + 21 Gross profit 26,849 20,652 + 30 Interest expenses (3,451) (3,416) + 1 Other expenses, net (18,823) (14,285) + 32 Net income for the year 4,575 2,951 + 55 Consolidated Balance Sheet** At 31 December 2004 2003 Change RR million RR million % Cash and cash equivalents 11,966 6,871 + 74 Other current assets 42,048 37,364 + 12 Non-current assets 111,845 107,829 + 4 Total liabilities 82,369 72,562 + 13 Minority interest 1,616 1,290 + 25 Total shareholders’ equity 81,874 78,212 + 5 AVTOVAZ | 2004 JSC AVTOVAZ’s share price and dividend development *** For the year ended 31 December 2004, RR 2003, RR Change, % Share price Ordinary share Closing (weighted average) 775.95 774.7 + 0.16 Annual high (weighted average) 896.33 906.42 - 1.11 Annual low (weighted average) 622.32 582.06 + 6.92 Preference share Closing (weighted average) 773.94 471.88 + 64.01 Annual high (weighted average) 823.30 525.68 + 56.62 Annual low (weighted average) 474.91 339.77 + 39.77 Dividends per ordinary share 23 6.0 + 383.33 per preference share 23 95.0 - 75.79 * The AVTOVAZ Group mentioned hereinafter is the parent company (JSC AVTOVAZ or the “Company”) and all of its subsidiaries and associated companies. The references “we”, “us”, “AVTOVAZ”, the Company etc., may be applied to both the AVTOVAZ Group and JSC AVTOVAZ depending on the context. ** Financial information was extracted from Consolidated IFRS Financial Statements of the AVTOVAZ Group. *** Share price information shown here and below represents weighted average prices of shares of JSC AVTOVAZ at the Moscow Inter-bank Currency Exchange (MICEX). Contents Address of the Chairman of the Board of Directors of JSC AVTOVAZ I 4 Message of the President – General Director of JSC AVTOVAZ I 8 Five-year financial review of the AVTOVAZ Group I 12 Board of Directors, Board of Management, Management structure I 22 1 Corporate Governance 3 Financial Report Mission and strategic tasks I 30 Management’s discussion and analysis of Code of corporate conduct I 31 financial condition and results of operations I 80 Share capital I 33 The Company’s risks I 84 Subsidiaries and associated companies I 37 4 Financial Statements 2 Business Review Auditors’ report I 88 Production I 40 Consolidated Financial Statements I 89 Logistic support I 44 Environmental protection I 47 Quality I 50 Sales I 53 Customer service I 59 Research and development I 61 Employee and social protection I 72 Address of the Chairman of the Board of Directors Increasing competitiveness is the imperative of our time In 2004 the 22 millionth vehicle rolled off the AVTOVAZ assembly line. This is equivalent to the all-Russia park of passenger vehicles and indicates the vital role of JSC AVTOVAZ in making our country an automotive empire. At present Russia holds 12th place worldwide in production of passenger vehicles and the part played by JSC AVTOVAZ is crucial. Over 2004 AVTOVAZ's share in production of passenger vehicles within Russia amounted to 62 %, this taken together with automotive kits supplied to assembly lines of other Russian plants increases our participation in Russian automotive industry to over 82 %. 2004 was a successful year as indicated by our operating highlights all of which exceeded those of 2003, and confirmed the leading position of JSC AVTOVAZ within the Russian automotive industry. However, we should realize that the strong operational results of 2004 high are the accumulated result of the development strategy we have been implementing over a period of years. During this period new factors and trends developed within the global and Russian automotive industries that represent serious risks and threats to AVTOVAZ's market position. Consequently we must critically re-examine our priorities. World market factors Striving to cut costs, American and European developing markets and consumers with manufacturers move their facilities on to average income. The South Korean group of The Russian automotive market is set within countries with low labour costs. Following this companies Hyundai developed a competitive a world market gripped by severe competitive trend China displays a vigorous growth in strategy based on a dual principle – struggle for survival. In 2004 manufacturers production of vehicles (according to 2004 “affordable quality” (good quality vehicles at around the world produced 60 million results it holds the 4th place after the USA, affordable prices) and expanding into passenger vehicles, whereas overall Japan and Germany). To date Chinese developing markets. According to 2004 production capacity was 20 million units automotive manufacturers develop ambitious results Hyundai is the leader in sales of more. This excess manufacturing capacity plans for promoting their goods on world foreign-made vehicles on the Russian drives the increasing struggle to win cus- markets, such as the USA, Europe and market. Pursuing a similar strategy, Renault tomers. Many famous automotive companies Russia. This requires close consideration. launches its Renault Logan model to the are suffering losses under pressure from Searching for new market niches Russian market by means of JV Avtoframos. competitors. international companies refocus on AVTOVAZ | 2004 4 Russian market factors Increasing pressure from globalization is distorting the Russian economy. The raw material sector is becoming more and more a servant of the world economy, and as a result the competitive position of large Russian manufacturing companies is declining. The lack of efficient mechanisms for state investment in the economy results in surplus income from raw material exports being accumulated in state foreign exchange reserves. This leads to the strengthening of the rouble exchange rate, which in turn has a negative impact on the competitiveness of Russian manufacturers. The global growth in prices for metal and energy, together with the process of Russian prices drawing ever closer to world level, results in an increase in our domestic production costs by comparison to our foreign competitors. Furthermore, as a result of the increase in availability of credit sales, expensive vehicles have become more available to average Russian customers. Each third vehicle sold on the domestic market in 2004 cost over USD 15,000. As a consequence, the competitive price advantage of JSC AVTOVAZ’s vehicles has decreased significantly. Accordingly, JSC AVTOVAZ is faced with the unavoidable necessity of improving its competitive position. Today, simply relying on a development strategy mainly based upon competitive price advantage is insufficient. It is necessary to search for additional Vladimir V. Kadannikov competitive advantages. Chairman of the Board of Directors, Below are some key priorities for addressing JSC AVTOVAZ this issue. 5 Address of the Chairman of the Board of Directors Closer to our customers Towards world techniques and methods of work organizing, standards of quality and such causes of losses as loose In 2005 JSC AVTOVAZ is planning to discipline, irresponsibility and low employee complete the restructuring of its service-sales At present a common practice for the morale. Neither AVTOVAZ itself, nor our network to a one-level supply system Russian automotive industry is operating a suppliers are an exception here. Over the last designed to improve efficiency of sales and certified system of quality management of few years restructuring AVTOVAZ's meet European service quality requirements. standard ISO 9001:2000. The next step is management system we have significantly Our service-sales network is to become implementing ISO/TU 16949, which becomes improved the economic analysis behind closer to its customers and not lag behind especially important for supply chain managerial decisions on reduction of costs. It our competitors’. Our price strategy is to be management. Only 15 % of our suppliers are is necessary to continue managing resources supported by the competitive advantage of in compliance with world quality standards. and costs of the Company and its supply integrated and high-quality services delivered We will be able to compete on foreign chain, to intensify the economic monitoring of to customers once they have bought our markets and the domestic market (which in processes and to compare our key vehicles. This will be accompanied by a wide effect has become an international one) only performance indicators with our competitors’. range of payment (credit) terms on purchase, if we live up to world quality requirements. It and prompt and high-quality after sales is necessary to increase the efficiency of More innovation service. AVTOVAZ’s audit of its suppliers’ work and to A major element of our strategy continues to eliminate bureaucracy in improving quality. Security, environmental and consumer be cultivating customers’ loyalty. In this area Quality management systems must not be a requirements for passenger vehicles are suppliers of foreign-made vehicles to the “paper tiger”, but bring results that will satisfy constantly being updated. JSC AVTOVAZ is Russian market now offer a trade-in service our customers. We are about to reach a increasing its investments in research and (the customer’s old vehicle is taken in higher level of quality by implementing a new development to comply with updated exchange for a new vehicle, with a system of assembling Kalina model vehicles. requirements. In 2004 investments in R&D, corresponding discount in the price), which is For us all, suppliers and manufacturers, the pre-production and start-up work grew by rather popular in world practice.