2014 ANNUAL REPORT

TABLE OF CONTENTS

Sistema today 2 Corporate governance system 91

History timeline 4 Corporate governance principles 92

Company structure 8 General Meeting of shareholders 94

President’s speech 10 Board of Directors 96

Strategic Review 11 Commitees of the Board of Directors 99

Strategy 12 President and the Management Board 101

Sistema’s financial results 20 Internal control and audit 103

Shareholder capital and securities 24 Development of the corporate 104 governance system in 2014 Our investments 27 Remuneration 105 MTS 28 Risks 106 Detsky Mir 34 Sustainable development 113 Medsi Group 38 Responsible investor 114 Lesinvest Group (Segezha) 44 Social investment 115 Bashkirian Power Grid Company 52 Education, science, innovation 115 RTI 56 Culture 117 SG-trans 60 Environment 119 MTS Bank 64 Society 121 RZ Agro Holding 68 Appendices 124 Targin 72

Binnopharm 76

Real estate 80

Sistema Shyam TeleServices 84

Sistema Mass Media 88

1 SISTEMA TODAY

Established in 1993, today Sistema including telecommunications, companies. Sistema’s competencies is a large private investor operating utilities, retail, high tech, pulp and focus on improvement of the in the real sector of the Russian paper, pharmaceuticals, healthcare, operational efficiency of acquired economy. Sistema’s investment railway transportation, agriculture, assets through restructuring and portfolio comprises stakes in finance, mass media, tourism, attracting industry partners to predominantly Russian companies etc. Sistema is the controlling enhance expertise and reduce from various sectors of economy, shareholder in most of its portfolio financial risks.

>13 >20 >150 000 sectors years employees

of operations of history jobs created

Sectors of operations

Telecom HighTech Consumer Pulp&Paper Oil services Banking Energy Other

60% 17% 9% 4% 3% 2% 2% 3%

Transportation Healthcare and Real estate Agriculture Tourism services pharmaceuticals

Note: Based on aggregate income from assets Contribution to national development

RUB 100 Over RUB 700 RUB 62.8 billion million billion Payments to the Social and charity Investment in existing federal and regional investment in and new assets in budgets in 2014 2014 2014

2 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS Shareholder value

Efficient management Experienced Transparent risk corporate management governance

Strong Clear government strategy relations

High level of Financial expertise stability

Shareholder capital structure Financial

V. Evtushenkov stability GDR Programme (LSE) Ordinary shares 19% Revenue for 2014 (Moscow Exchange) 64.2% RUB 631.9 billion 16.8%

Adjusted OIBDA for 2014

Note: including the shares held by insiders, management RUB and members of the Board of Director and ordinary shares on Sistema Group’s balance sheet. 165.2 billion

The company’s shares are traded on the London Stock Dividends received in 2014 Exchange (LSE) as Global Depositary Receipts (GDRs), with one GDR representing 20 ordinary shares. Its Global Depositary Receipts are listed on the LSE under ticker symbol SSA. The RUB company’s shares are also listed on the Moscow Exchange 55.6 billion under ticker symbol AFKS.

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT 3 HISTORY TIMELINE

1993-1995 1996-2002 2003-2004

1993 Sistema JSFC Sistema acquires a 40.4% stake Sistema acquires control of is founded. in MTS and starts its development Comstar (50%) and Kosmos TV in partnership with Deutsche (50%) in a transaction totalling Telekom. approximately US$ 35 million.

Sistema actively consolidates assets in the core sectors of Russia’s economy, acquiring assets in During VimpelCo’s IPO on the New As a result of consolidation, telecommunications, electronics, York Stock Exchange, raising US$ Comstar-OTS received a 99% tourism, retail, oil and gas, 110.8 million Sistema, sells its stake controlling stake in MTU-Inform, construction and real estate. in VimpelCom. 100% stake in Telmos, 100% stake in MTU-Intelm and 55.62% stake in MGTS. This event became a milestone in the consolidation MTS completes an IPO on the New Sistema invests in MGTS, of alternative communication York Stock Exchange, generating operators under our control to establishes Vimpel US$ 323 million. Communications and Sistema- create a united digital operator. Hals, as well as project management companies.

Sistema creates an insurance holding on the basis of ROSNO and attracts a strategic partner – Allianz AG, one of the largest insurance groups in the world. As a result of this transaction, Sistema received a 49% stake in ROSNO and Allianz AG received 47.2%.

4 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS 2005 2006 2007-2008

Sistema launches its IPO on the IPO of Comstar-OTS. Sistema Sistema acquires a 100% stake London Stock Exchange, raising launches an IPO for Comstar- in American Hospital Group and US$ 1.56 billion. OTS, raising US$ 1 billion on the a 100% stake in the Medexpress London Stock Exchange. chain of clinics, later merged into Medsi Group.

Sistema buys minority stakes in Bashkir oil and energy companies Sistema-Hals launches its IPO, (together, the «BashTEK compa- raising US$ 409 billion on the Sistema successfully exits from nies»), including Bashneft and London Stock Exchange. Bashenergo, for a total amount of insurance business by selling about US$ 600 million. 47.4% of ROSNO to Allianz, with an option for Allianz to buy the remaining 3% over the next several years. Sistema actively develops bank- ing business and increases its stake in the Moscow Bank for Reconstruction and Development Sistema increases its stake in (MBRD) to 98.9%. Later, MBRD SITRONICS to 60% and launches consolidated 66% of the shares in an IPO on the London Stock East-West United Bank. Exchange, raising US$ 2.35 billion. SITRONICS is established as a result of development and consolidation of high-tech assets Sistema first acquires a 10% by Sistema. and then a 41% stake in Shyam Telelink Ltd and enters into a call option agreement allowing it to increase its stake from 51% to 74%. The transaction was worth US$ 46.74 million.

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT 5 2009-2010 2011 2012

Sistema establishes RTI, a company consolidating Sistema’s Sistema consolidates its telecom high-tech business, including Sistema acquires a 100% assets and sells its 50.91% Concern RTI Systems and stake in SG-trans, the largest stake in Comstar-OTS to MTS SITRONICS. independent LPG transport in a transaction worth about operator in Russia, for US$ 1.32 billion. RUB 22.77 billion.

Sistema transitions from the Sistema acquires controlling operating holding model to the Medsi Group commences merger stakes in BashTEK companies investment company model. of assets with the Medical Centre for US$ 2 billion, increasing for the Mayor and Government of its shareholding in Bashneft Moscow. In exchange for a 25% to 76.5%. stake, Medsi received 3 hospitals, Rosimushchestvo acquires 14% 3 health resorts and 3 outpatient of SSTL for US$ 647 million as clinics. Thus, Medsi Group a result of an additional issue of became a full-service medical Sistema exits from real estate shares. company. construction business. VTB Bank acquires a controlling stake in Sistema-Hals. Later, Sistema completed the sale VAO Intourist and Thomas Cook RTI buys a 50% stake in NVi- of the remaining shares Group Plc complete a transaction sion Group and increases its in Sistema-Hals. to form a joint venture based stake in SITRONICS to 100%. on the tour operator and retail SITRONICS was delisted from business of Intourist. Thomas the London Stock Exchange Cook purchased a 50.1% stake for on August 23, 2012 Sistema buys a 49% stake in NK a total of US$ 45 million. Later, RussNeft in a transaction worth Thomas Cook increased its stake less than $100 million. in the JV to 75%. Sistema sells power generation assets of Bashkirenergo to Inter RAO UES for RUB 11.2 billion. Sistema sells 24.4% of MGTS to MTS for RUB 10.56 billion, completing consolidation of its telecom assets. Sistema and Louis-Dreyfus family members form a farming joint venture in Russia. The JV combines both parties’ Sistema makes its first invest- agricultural assets, totalling ments in the agricultural sector by approximately 90,000 hectares. acquiring a 100% stake in Don- skoe for RUB 476.5 million and a 100% stake in First Cavalry Army Stud Farm for RUB 303 million. Both land clusters are located in the Rostov Region with a com- bined land of 39,000 hectares.

6 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS KEY EVENTS

2013 2014

Sistema sells its 49% stake in NK In April 2014, Sistema acquired Sistema expands its footprint in RussNeft for US$ 1.2 billion. a 10.8% stake in OZON for US$ the retail sector. In October 2014, 75 million. MTS also acquired a Sistema buys a 40% stake in the 10.8% stake at the same price. holding company which owns the assets of Concept Group, Sistema acquires 51% of one of the leaders in the Russian Business-Nedvizhimost, which retail clothing market in terms of owns 76 properties with a total In July 2014, Sistema pays revenue growth, in a transaction area of 178,000 sq m, from MGTS- RUB 19.9 billion in dividends. This worth about RUB 1 billion. The Nedvizhimost for RUB 3.2 billion. translates to a dividend yield of documents signed provide for an Later, Sistema purchased the around 5% as of the payout date. option for Sistema to increase remaining 49% for RUB 3.1 billion. its shareholding in Concept Group to the controlling level within three years.

MTS-Bank issues additional shares for RUB 13.1 billion. Sistema purchased 2,474,818 ordinary shares for RUB 9.46 billion. MTS purchased 952,000 ordinary shares Sistema begins investment in for RUB 3.64 billion. Sistema invests in oil service forestry and pulp and paper assets by acquiring 100% of industries. Bashneft-Service Assets (later renamed Targin) from Bashneft In September 2014, LLC LesInvest, for RUB 4.1 billion. part of the Group, acquired 100% In December 2014 by the court Siste- shares of OJSC Segezha Pulp ma transfered all its shares in Bash- and Paper Mill from the Bank of neft to the Government. In February Moscow and 100% of shares of LLC 2015 the Moscow Arbitration Court The Board of Directors of Derevoobrabotka-Proekt (Group upheld the claim of the Corporation Sistema approves a new incentive of companies). The net external to the LLC Ural-Invest and decided programme, based on share price debt of the acquired assets is equal to recover losses from the defendant performance and cash flow at the to zero (see p. 44). The Group of in favor of Sistema. In March 2015 Corporate Centre level. companies is the largest producer Sistema and LLC Ural-Invest signed of sack paper and paper sacks in a settlement agreement under which Russia and the second largest man- the fund transfers RUB 46.5 billion ufacturer of paper sacks in Europe. to the Corporation, of which RUB 4.6 billion invested in the fund charita- ble projects. Later on Sistema has received additional compensation of RUB 12.9 billion. In 2014, Sistema increased its stake in NVision Group to 100%.

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT 7 1. Основные логотипы Основной цвет pantone 647c 1.1. Допустимый цвет pantone 195c.

Использовать только после согласования с представителями АФК «Система»!

2. Допустимые варианты логотипов

Используются при невозможности размещения основного варианта. (на перетяжках, в ряду одинаковыхCOMPANY по высоте логотипов STRUCTURE компаний и т. д.) Использовать только после согласования с представителями АФК «Система»!

2.1. Допустимые варианты логотипов 53% 87% RZ Agro 50% Group Используются при физической невозможности воспроизведения мелкой текстовой части логотипа. Over RUB Over (ручки, шильдики, значки и т. д.) 195 billion 104 mln worth of assets 100,000 Использовать только послеsubscribers согласования с представителями АФК hectares«Система»! of land

99% 91% 100%

Over 80,000 km 49 109 mln of power drilling rigs, store visits per year grids 180 crews

75% 50% 74% 3. Допустимые цветовые решения company of JSFC Sistema

Использовать только послеOver согласования с представителямиOver АФК «Система»! 6 mln doses mln 34,000 Черный 6 «Выворотка»of railcars under of Hepatitis B на белой плашке (при пестром фоне) visits per year management vaccine per year серый элемент марки – 50% черного цвета

8 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS World-wide reach of activities and diversified asset structure enable Sistema JSFC to achieve sustainable operating and financial performance.

86% 66% Real estate 100%

11.8 mln 2,617 388,000 m2 under design and subscribers rooms under construction and over management 442,000 m2 under management

SSTL 57% 85% 10.8%

HSD services in over Mikron has developed a 21million 800 proprietary 65 nm unique users Indian cities and towns chip technology monthly

100% 40%

4.5 mln m3 342 of allowable cut stores

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT 9 PRESIDENT’S SPEECH

32% in the previous year. industry. With vast felling area, low production costs, and proximity of export markets, LesInvest Group, Russia’s biggest producer of sack One of the key assets in our paper and paper sacks and Europe’s portfolio is Detsky Mir, Russia’s second largest paper sack maker, best-known children’s goods brand, has significant growth potential. demonstrated the third largest We intend to further enhance revenue and highest growth rate of its value, create new jobs and all the Group’s assets. Detsky Mir’s modernize production facilities. value increases each year, and the Last year, Sistema also entered company continues to retain its the e-commerce and fashion retail leading industry position, with over market by acquiring interests in 330 stores across Russia. OZON Holdings Limited and Concept Group. 2014 was a challenging year both Our company RTI develops high- in corporate and macroeconomic tech assets in the microelectronics With more than 20 years of terms. In this period, Sistema faced and defence industries, as well as experience operating in Russia, we numerous operational and strategic smart IT systems. The initiatives have proved that Sistema has the pressures and I am pleased to we have implemented to optimise capacity and expertise to create see the Group has successfully the business and increase its value for all the stakeholders not navigated these obstacles, financial stability in 2014 have led to only during periods of growth, demonstrating the resilience of a considerable improvement in the but also in times of volatility and our business model and acquiring Group’s returns. uncertainty. Meeting our social invaluable experience, which will responsibilities is a core element of assist us in our future development. Last year Sistema continued to our business strategy, and we are actively develop its healthcare committed to developing our people, In addition to external business Medsi, which generated a investing in talent and diligence, as macroeconomic factors, Sistema 4% year-on-year revenue growth, well as fostering regional innovation was, undoubtedly, affected by the in rouble terms, despite the closure and social development. situation surrounding Bashneft for redevelopment of some medical last year. Following litigation, facilities during the year. Medsi’s As we look into 2015, Sistema Sistema transferred the asset to strategy is currently focused on remains in a strong financial the state, subsequently obtaining increasing its market share in the position. We have a stable and cash compensation as a good-faith medium term, both by constructing growing dividend flow from current buyer. The events had a significant new treatment facilities and investments, a much reduced impact on our portfolio, but it did increasing patient loyalty. corporate costs and a process not change the essence of our of vigorous assessment of each business and our competencies. We Our Indian business, SSTL, has opportunity on its financial merits. are still a unique Russian company largely delivered on its financial With these fundamentals in place, that employs efficient management, targets and we expect that it will we believe Sistema is well placed the right strategic decisions and a near OIBDA breakeven in 2015 as to capitalise on new investment professional team to turn distressed we continue to reduce its reliance opportunities and we look forward and complicated assets into leaders on Sistema. Whilst numerous to delivering value to the Group’s in their respective industries. regulatory challenges continue shareholders in the coming year. to persist, the latest licensing In 2014, we have achieved solid rounds have shown both demand results, with consolidated revenues and price increase in the 800 mhz growing by 7.2%. Ten out of our spectrum that SSTL operates in. thirteen biggest assets increased This is encouraging and may create their revenues; eleven out of strategic opportunities as the sector thirteen achieved positive OIBDA; outlook improves and evolves. nine showed positive net income and paid dividends. Developing In 2014, we continued our search for assets’ share of Sistema’s total attractive investment opportunities Mikhail Shamolin revenue grew to 41% in 2014 from in Russia, investing in the pulp and President of Sistema

10 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS STRATEGIC REVIEW

Strategy 12

Financial results 20

Shareholder capital and securities 24 STRATEGY Mission

Long-term growth of shareholder value through efficient management of the asset portfolio and achievement of high returns on investment.

High Lower returns on investment investment risk

Diversified and balanced portfolio in the Unique expertise on the Russian fundamental segments of the Russian market and a strong management economy and balanced contribution of team assets to the total value

Value creation • Shareholder • New model dividends investments Resources: • Expert evaluation and experience The model of Sistema as an • Financial Se investment company envisages o arc resources n 1 ppo h io rt fo creation of shareholder value at u r c ni in • Management lo ti v l e e resources through constant reinvestment of a s s l t a m t capital - accumulation of cash from i e • Reputational p n a t resources incoming dividends and monetisation C of assets, distribution of the received profit in form of dividends among Sistema’s shareholders, Sistema JSFC 4 2 New reinvestment in existing assets and investments: new investment projects in order to n i e u • Strategy receive further income. M g l o in a development n w v e o r ti r e za G ld • Business ti o on eh optimization ar sh • Synergy with 3 the Group companies • Management • Profit on sales efficiency • Dividend yield • Preparation for monetization

12 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS Components of successful growth

Our Our principles Our Our business of operation strategy efficiency

Creation of value Lean and Science No cash – by leveraging competitive applications no reward: competencies: structure: to create art: • Assessment and • Managing assets • Internal rate of return • Remuneration of development of business according to the principle on investments above investment managers strategies for our assets of deal origination and weighted-average cost fully depends on cash without involvement in industry expertise of of capital (IRR>WACC) generated by their operations portfolio managers with a 5-7-year payback portfolio for Sistema period • Monitoring of M&A • A team of • Cash may be received opportunities in current strategic experts, • Focus on investment from dividends or and new sectors macroeconomists with a positive net cash monetisation and communication flow • Development and professionals • Current dividends from implementation of asset • Acquiring assets with MTS are not included monetisation plans an acceptable debt level in calculation of (Debt/OIBDA < 3.0x) for remuneration • Hiring efficient preserving the Group’s management for stable financial situation • Remuneration is paid companies under our after deducting the control • Keeping consolidated portfolio’s expenses and Debt/EBITDA at 2x the Central Bank’s rate • Providing comprehensive support to our assets in • Payout to shareholders attracting financial and of up to 30% of profit other resources • Increasing operational efficiency of acquired assets through restructuring and attracting industry partners to increase expertise and share financial risks

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT 13 Investment strategy Medium-term goals of Sistema as an investment company

• Generating a substantial cash • Balancing investment portfolio • Restructuring and supporting flow at Hold Co through portfolio with export-oriented industrial portfolio companies operating in monetisation and dividends from companies in Russia that may segments that are most sensitive subsidiaries, as well as by finding become a source of foreign to changes in the economic and benefiting from unique currency liquidity situation investment opportunities in Russia • Building industry leaders in private healthcare, high technology and microelectronics, pulp and paper industry, in order to maximise returns on shareholder capital

Investment criteria

Sectors and Business industries: geography: sectors, that are primarily Russia and complementary to the CIS; current investments monitoring of and enable the use other geographical of the competence opportunities from of Corporation and the viewpoint of implementation of diversification of synergy with the current market outlets and portfolio; currency risk new, economically attractive industries subject to availability of expert evaluation or industry partner

Scope of assets: large and medium assets ensuring leadership in the market due to synergetic effects, opportunities for industry consolidation and successful implementation of investment and operating strategy

14 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS Sistema JSFC Investment Vision

Industry Key industry Strategy Sistema JSFC characteristics investment vision Telecommunications • Slowing down Develop to Sistema JSFC views MTS as a strategic asset in Russia growth of the mobile obtain stable that is generating high dividend income. communications market dividend flow In order to achieve the targets on dividend • Growing penetration of flow, MTS will continue to develop actively data transfer services the data transfer services, focus its • Growth in the OTT marketing efforts on holding its leading services segment positions in Russia and explore potential for synergies with other businesses of Sistema JSFC Group, including, MTS Bank and Ozon Holding, to get competitive advantages on the market.

More about the operating strategy see p. 28 Children’s goods • The sector is resistant Grow business Sistema JSFC views Detsky Mir as a retail to deterioration of volume to promising asset that has already achieved macroeconomic situation obtain dividend significant results and is able to bring • Low market concentration income; and in substantial returns on capital in the with opportunities for possible partial form of dividends or by means of partial consolidation sale given the monetization. favourable • Demographic situation conditions Since the children’s goods retail sector is will continue promotion resistant to economic recessions, Sistema of growth of consumer JSFC is planning active development of expenditures on children’s goods the Detsky Mir chain and opening about 40 new stores in 2015.

More about the operating strategy see p. 34 Private healthcare • High growth rate of Grow business Sistema JSFC sees a high potential of the Russian private volume and the Russian private healthcare market healthcare services introduce the development and is building up the federal market best practices network providing high-quality healthcare • Government support to in healthcare and rehabilitation services for the country the sector citizens. • Low market concentration During the next two years, Medsi will with opportunities for focus its efforts on expanding business consolidation scale by constructing new medical centers, introducing new healthcare technologies and further improving of the quality of services.

More about the operating strategy see p. 38

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT 15 Industry Key industry Strategy Sistema JSFC characteristics investment vision Wood processing • The ruble rate Develop the Sistema JSFC acquired assets of GC industry depreciation and large asset by LesInvest at the end of 2014. transport leverage reduce restructuring the competitiveness of and optimizing Sistema JSFC is planning to ensure importers of business; return on capital by optimizing of current • Rated wood cutting of getting on the business, improving controllability and Russia exceeds in three dividend flow transparency, as well as subsequently times the felling volume in the medium expanding production (in particular, paper sacks and plywood). • Export-oriented industry term with the largest great of More about the operating strategy currency returns see p. 44 Electric grid business • Steady and slight growth Further develop The strategy of electric grid assets of power consumption – the business is focused on growth of business by by 0.4% in 2014 after successful modernizing of equipment, building • In autumn 2013, tariffs of transition to of modern grids using Smart Grid natural monopolies for RAB regulation components and developing the region 2014 were frozen of tariffs, infrastructure. Sistema JSFC intends to maintain a develop the business by consolidating • In 2014 tariff growth was limited at the rate of 3.8% steady dividend and subsequently modernizing flow of regional assets.

The company transition to the 10-year tariff regulation using the return-on- investment (RAB) method will enable effective long-term business development planning and is aimed to improve its investment attractiveness. The company expects to invest over 29 bln. rub. in the electric grid sector of the Republic for the 10-year term.

More about the operating strategy see p. 52 Railway • The segment of Develop LNG In 2015, Sistema JSFC will focus on transportation liquefied gases (LNG) transportation supporting SG-trans current business transportation shows the segment and and achieving operational objectives. highest stability in the maintain Maintaining of profitability will be achieved sector profitability by efficient wagon fleet management and • LNG transportation optimization of leasing agreements. volume has grown by 8% in 2014, while bulk More about the operating strategy oil cargo transportation see p. 60 volumes by 2% in total

16 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS Industry Key industry Strategy Sistema JSFC characteristics investment vision Pharmaceuticals • The market volume Expand product Sistema JSFC is planning to develop the has grown by 9.3% in portfolio and pharmaceutical business by implementing monetary terms in 2014 establish large-scale projects on launching new • Share of foreign partnership production lines and procurement of third- producers in the Russian with an industry party products. Gain in product portfolio by market is over 70% expert partnership with international companies will contribute in increase of production • Russia has launched the programme for import capacity utilization, Binnopharm is substitution also planning to upscale production by participating in the programme for import • Starting from 2014, the substitution. government may limit participation of foreign More about the operating strategy companies in government see p. 76 tenders

High Technologies • The government demand Improve the In 2014, Sistema JSDC has begun for high-tech products is economic restructuring JSC RTI high-tech assets growing performance of in order to improve the economic • Growing demand for the business, performance of the business and achieve intelligent transport develop own a stable dividend flow in the medium systems intellectual term. The main development focus will products and be on the segments of defense industry, • Development of microelectronics will be achieve a microelectronics and intelligent IT supported by the import steady dividend systems. RTI is planning to increase substitution programme flow in the its profitability by growing intellectual medium term property share in finished products, to increase production of microchips by extending cooperation with the government and to focus on new products in the aerospace industry.

More about the operating strategy see p. 54

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT 17 Industry Key industry Strategy Sistema JSFC characteristics investment vision Oilfield services • Industry consolidation Develop Investments in Targin have a significant with the biggest players promising growth potential by modernization of • Increase of volumes of segments the vehicle fleet to increase profitability, horizontal drilling of high-tech introduction of new technologies drilling, to diversify range of services and • Demand for high-tech improve the optimization of business and its structure. oilfield services profitability Sistema JSFC is planning to attract an of business industry partner to extend Targin expert and potential evaluation. partnership with an industry More about the operating strategy expert see p. 72

Banking sector • Increased cost of funding Develop Sistema JSFC investment strategy in the • Tougher regulation of and support banking business provides for growth retail lending the banking of shareholder capital returns while business, maintaining the high level of MTS Bank • For the first time in provide financial stability. several years, corporate effective risk lending grew faster than management Under current economic conditions, retail lending Sistema JSFC is focused on improvement of the risk management system and growing of Bank’s customer deposits. Sistema JSFC also sees a growth potential for the banking business in the synergy with MTS.

More about the operating strategy see p. 54 Real estate • Due to an unprecedented Construct and Sistema JSFC is planning construction volume of commissioned develop the and monetization of residential real estate real estate in 2014, the most liquid assets, as well as aggregation of office office real estate market real estate real estate assets and increase in revenue now has a surplus assets and from management and leasing and • Subsidizing of the monetize by property management, which will be used mortgage rate will leasing and to finance new projects and will enable to support the residential sales pay portfolio dividends. real estate market More about the operating strategy see p. 80

18 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS Industry Key industry Strategy Sistema JSFC characteristics investment vision Telecommunications • • Three largest Indian Reduce In 2015, we plan to continue with financial in India operators have taken up expenditures rehabilitation of the Indian business 58% of the market for the and significantly reduce its need in • Competition in the data business financing of its operating activity on the transfer services segment funding part of Sistema JSFC. In case of resolved is growing and resolve regulatory issues regarding frequency regulatory spectrum use, Sistema JSFC may • In 2015, a new auction for several frequency bands issues consider opportunities of partnership with was held, including for an industry expert. 800 MHz, where SSTL operates More about the operating strategy see p. 84 Media assets • Rate of growth of the Search for Sistema JSFC investment strategy Russian media market is new promising in regard to media assets of SMM is slowing down markets focused on creating conditions for entry • Ownership ratio of foreign and develop into emerging markets in the new digital companies in any Russian convergent environment, developing new digital mass media company has media services and digital media. Successful been limited to 20% products in implementation of the strategy will • The government is partnership contribute in maximum use of current stimulating telecasting with other competitive advantages of Sistema Group of the Russian content on Sistema Group as a whole. the part of state companies More about the operating strategy see p. 88 Agriculture • Export-oriented industry Expand the The strategy of agriculture business with a high share of land bank and development proposes further expansion currency returns develop export of the land bank by strategic acquisitions • Russia became the channels and partners attracting . The targeted world’s third largest regions are Rostov region, Stavropol wheat producer in 2014 territory and Krasnodar territory. Sistema JSFC is also planning to develop export • Russia’s wheat output in comparison with the channels and such segments as seeds previous year grew up by production and sale and contracted 13% as compared with the harvest works. global growth of 1% More about the operating strategy see p. 68

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT 19 Sistema’s financial results

(US$ millions) FY 2014 FY 2013 Change

Revenues 16,585.0 18,502.0 (10.4%)

Adjusted OIBDA 4,438.3 5,570.2 (20.3%)

Operating income 1,738.4 3,566.6 (51.3%)

Adjusted operating income 2,146.1 2,936.7 (26.9%)

Net (loss)/ income attributable to Sistema (4,087.6) 2,257.5 -

Adjusted net income attributable to Sistema 1,194.9 1,623.5 (26.4%)

(RUB millions) FY 2014 FY 2013 Change

Revenues 631,865 589,251 7.2%

Adjusted OIBDA 165,171 177,400 (6.9%)

Operating income 60,876 113,588 (46.4%)

Adjusted operating income 78,353 93,527 (16.2%)

Net (loss)/ income attributable to Sistema (232,556) 71,898 -

Adjusted net income attributable to Sistema 44,194 51,706 (14.5%)

Note: The reporting currency of the Group’s US GAAP consolidated financial statements is the US dollar. Here and hereafter, the financial information in Russian roubles has been presented for the users’ convenience and is not derived from audited financial statements. Financial figures in US dollars were converted to roubles using following approach: amounts from the statement of financial position – using closing rates as of the reporting dates, amounts from the income statement – using average rates of the reporting periods except for significant transactions / accruals, which were converted using exchange rate as of date of a transaction /accrual or actual rouble amounts for transactions/accruals nominated in roubles.

Following its transfer to the Russian full year of 2014 were impacted by loss from the deconsolidation of Federation in December 2014 of the rouble depreciating significantly Bashneft, US$ 290.0 million loss shares in Bashneft, Bashneft’s against the US dollar. from the impairment of long-lived results are treated as a disposal, assets in India (SSTL) and US$92.5 reported as discontinued operations In 2014, Sistema recognised loss million of accrued provisions and excluded from the Group’s from certain one-off items, which for cash and deposits in Delta financial results for all periods significantly impacted the company’s Bank (MTS). presented. The Group’s financial financial results. The largest one- results for the fourth quarter and the off items include: US$ 5.0 billion

20 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS Revenues

Sistema’s consolidated revenues from all the Group’s companies, quarter of 2014). Ten of Sistema’s 13 in rouble terms increased by 7.2% particularly from MTS, Detsky mir, as major assets demonstrated revenue year-on-year in 2014 despite the well as Targin (acquired in the third growth in 2014 in rouble terms. challenging economic environment, quarter of 2013) and the pulp and and reflect a strong contribution paper business (acquired in the third

Revenues by sectors*

Telecom HighTech Consumer Pulp&Paper Oil services Banking Energy Other

61% 17% 9% 4% 3% 2%2%2%

* Based on aggregate revenues of 4Q 2014

As of the fourth quarter of 2014, LesInvest already contributed RUB contributed approximately RUB 16 the Company began consolidating 7.2 billion and RUB 1.1 billion to the billion to the Group’s revenue growth LesInvest into the Group’s financial Group’s consolidated revenue and for the full year of 2014. results. In the fourth quarter of 2014, OIBDA. The consolidation of Targin

Revenue analysis, RUB bln

+7.2 +13.7 +9.4 631.9 +12.3 589.3

Revenue MTS revenue Growth at other assets Detsky mir Consolidation of Revenue 2013 growth and consolidation of revenue LesInvest 2014 Targin, net growth in 4Q

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT 21 OIBDA

The Group’s adjusted OIBDA due to accrued provisions for the companies reported positive adjusted decreased by 6.9% year-on-year loan portfolio to individuals at MTS OIBDA in the reporting year. in rouble terms in 2014, mainly Bank. Eleven of Sistema’s 13 major

OIBDA analysis, RUB bln

+2.1 +1.5 +1.1 177.4 –1.1 165.2 –15.8 OIBDA Destky mir Decreased Consolidation of Decreased OIBDA Decrease in OIBDA 2013 OIBDA loss LesInvest of other assets, MTS Bank 2014 growth of SSTL in 4Q net OIBDA

Net income

In 2014, adjusted consolidated net billion) worth of foreign exchange Bashneft’s net profit for the period income attributable to Sistema losses. Nine of Sistema’s 13 major of ownership: US$ 1.2 billion in 2014 decreased by 14.5% year-on- companies reported net income and US$ 1.1 billion in 2013. year in rouble terms, mainly due in 2014. The Group’s net income to US$ 548.6 million (RUB 21.1 includes Sistema’s share in

Capital expenditures

Capital expenditures increased by Group’s capital expenditures, RUB bln 21.4% YoY mainly driven by MTS due to US dollar appreciation. Active construction and modernisation of medical facilities at MEDSI added RUB 3 bln to capital expenditures 21.4% of the Group in 2014. Other largest contributors to the Group’s CAPEX are RTI, BPGC, Detsky mir and real 115.8 estate projects. 95.4 The Group’s SG&A expenses MTS 81.6 92.6 MTS grew by 6.2% YoY, which is lower than the rate of inflation. Corp RTI 3.0 4.0 RTI Centre’s SG&A increased by 4.9% YoY in 2014, mainly due to one-off BPGC 3.1 3.3 BPGC optimisation costs in 4Q 2014 and Other 7.7 non-cash accruals for incentive 3.0 Medsi programme in 2014. In 2015, 12.9 Other Sistema plans to reduce its SG&A by 25-30%. 2013 2014

22 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS Group’s debt

A 35% increase in consolidated to hedge risks of low liquidity in the The Group’s debt currency profile debt was mainly due to the dollar future on the back of market situation. remained largely stable. A large part appreciating against the rouble and In October 2014, MTS signed an of US dollar denominated debt relates MTS increased obligations. agreement with Sberbank of Russia to to MTS and the Corporate Centre, open a non-revolving line of credit for obligations of Sistema’s other Russian MTS debt increased due to borrowing a total amount of RUB 50 billion and subsidiaries are largely denominated of additional funds at attractive terms maturity in September 2021. in roubles.

Group’s debt, RUB bln Group’s debt by currency 464.9 4% 4% 56.7

344.3 68.8 33.9 MTS 47.3 USD 51.5 RTI 59% 66% RUB 40.2 Corporate Centre Other currencies 292.1 Other assets 218.7 37% 30%

2013 2014 2013 2014

Debt at Corporate level

The Corporate Centre’s debt with maturity in 2019. Corp Centre’s 40 bln. In 2015, Sistema plans to increased due to dollar appreciation cash position amounted to RUB 28.8 repay RUB 2.8 bln of rouble bonds against the rouble. The Corporate bln , 70% of Sistema’s cash was and RUB 12.2 bln of loans from Centre’s obligations in US dollars are denominated in US dollars. Net debt banks (RUB 8.6 bln had already been mostly represented by Eurobonds at Corporate level amounted to RUB repaid after the reporting period).

Corporate Centre’s debt, RUB bln Corporate Centre’s debt by currency

59% Cash 66% USD position 68.8 RUB Debt 51.5 41.8 28.8 34% 41%

2013 2014 2013 2014

* Including highly liquid financial instruments

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT 23 SHAREHOLDER CAPITAL AND SECURITIES

Sistema’s shareholders*

Evtushenkov V.P. Deutsche Bank (GDR programme) National Settlement Depositary (Moscow Exchange) Sistema Finance Investments (Ordinary shares)** Sistema Holding Limited (ГДР)** Other***

0.8% 1.4% 64.2% 17.6% 9.5% 6.5%

Sistema has 9,650,000,000 ordinary Sistema’s shares are included in the admitted to trading on the Moscow shares outstanding, with a par value benchmark indices of the Moscow Exchange, that can be used as of RUB 0.09 each. The company’s Exchange (MICEX Index and RTS investment vehicles by Russian shareholder capital amounts to Index). These are capitalisation- Pension Funds. Sistema’s shares RUB 868,500,000. Sistema had its weighted composite indices are included in equity sub-index and IPO in February 2005 and was listed calculated based on prices of the 50 bond sub-index. on the London Stock Exchange most liquid stocks of major Russian under ticker symbol SSA. The issues from Russia’s key sectors. Sistema’s GDRs are also included company’s shares are traded on the in MSCI Russia Index. This serves London Stock Exchange as Global Sistema’s shares are also included to confirm international recognition Depositary Receipts (GDRs) with in MICEX Financial Services Index of the company and strengthen one GDR representing 20 ordinary (a sector index). Sector Indices are its reputation among the largest shares. Its ordinary shares are capitalisation-weighted indices institutional investors with traded on the Moscow Exchange calculated based on prices of the index strategies. under ticker symbol AFKS. most liquid shares of Russian Sistema’s free float on the London issuers operating in the relevant Shares of MTS, Sistema’s subsidiary, Stock Exchange is approximately sector, which are admitted to are traded on the New York Stock 19% and 16.8% of the shares are trading on the Moscow Exchange Exchange as ADRs (ticker: MBT). Its traded on the Moscow Exchange and are included in the Broad ordinary shares are traded on the (including positions of insiders, Market Index. Moscow Exchange under ticker sym- shares owned by management and bol MTSS. Chairman of the Board members of the Board of Directors, The Moscow Exchange’s multi- of Directors of Sistema Vladimir and ordinary shares on Sistema’s asset indices are composite indices Evtushenkov, with 64.19% of shares, Group balance sheet). comprised of stocks and bonds is Sistema’s principal shareholder.

Number of outstanding shares amounts 9,650,000,000 Ordinary shares with nominal value of RUB 0.09 The share capital amounts RUB 868.5 million

* As of December 23, 2015 *Shares and GDRs owned by Sistema Group *** Shares held by insiders (management, members of the Board of Directors and others)

24 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS Sistema’s shareholders*

Sistema’s GDRs and ordinary shares Sistema’s GDRs dropped by 83.8% Sistema’s GDRs reached a high of significantly decreased in the sec- between January 1, 2014 and Jan- US$ 32.08 on January 10, 2014 and ond half of 2014 due to the situation uary 1, 2014. The closing price of a low of US$ 1.88 on December 16, around Bashneft and changes in Sistema’s GDR on the London Stock 2014. The average daily trading vol- macroeconomic conditions. The rou- Exchange on the first trading day of ume on the London Stock Exchange ble depreciated against the US dollar 2014 was US$ 31.25 with a market in 2014 was 997,240 GDRs. by 75.3% in 2014, Brent oil price fell capitalisation of US$ 15,078 million, by 44.5% in 2014. while on the last trading day it was Between January 1, 2015 and March US$ 5.21 with a market capitali- 31, 2015, Sistema’s GDRs gained sation of US$ 2,514 million. Siste- 42% and its ordinary shares rose by ma’s ordinary shares decreased by 57%, while RTS Index was up 11.3%. 74.5% in 2014, RTS index lost 45.2% The company’s market capitali- for the year. sation as of March 31, 2015, was USD$ 3.6 billion.

Ordinary shares

250 50 45 200 40

35 RUB per share 150 30 25 Volume in mill. of shares 100 20 15 50 10 5

12.2013 01.2014 02.2014 03.2014 04.2014 05.2014 06.2014 07.2014 08.2014 09.2014 10.2014 11.2014 12.2014 01.2015 02.2015 03.2015

Trading volume Ordinary shares RTS Index

Global depositary receipts

10 000 35

9 000 30 8 000 $US for GDR 7 000 25

6 000 20 Volume in thous. of GDR 5 000 15 4 000

3 000 10 2 000 5 1 000

12.2013 01.2014 02.2014 03.2014 04.2014 05.2014 06.2014 07.2014 08.2014 09.2014 10.2014 11.2014 12.2014 01.2015 02.2015 03.2015

Trading volume GDR of Sistema JSFC

* Source: Bloomberg

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT 25 Dividends 556 Sistema’s dividend policy aims to provide a regular and sizeable divi- Dividend yield of Sistema dend flow, while allowing the compa- in 2010-2014 ny to maintain the financial flexibility 5.0% to take advantage of attractive invest- Dividends, ment opportunities in the future. 300 US$ mln Dividends are declared on the basis of results from the previous financial 3.1% period, and the company’s dividend policy is for annual dividends to be a Yield minimum of 10% of the corporation’s 87 consolidated net income under US 17 0.7% 82 GAAP (net of any special dividends 0.0% paid). In addition, in the event of a 0.8% large asset sale for cash, special div- idends will be declared in an amount 2010 2011 2012 2013 2014 of at least 10% of the net gain from such a transaction, as determined by the Board of Directors. Under In June 2014, the Annual General payment has been determined on the Russian law, the total amount of div- Meeting of Shareholders approved basis of Sistema’s full year 2013 US idends with respect to any year may the total amount of dividend payment GAAP net income and the corporate not exceed the company’s annual on Sistema’s shares for 2013 at RUB centre’s net gain from the sale of stake unconsolidated net income deter- 19.9 billion, representing a payment of in RussNeft in July 2013. In July 2014, mined in accordance with Russian RUB 2.06 per ordinary share (RUB 41.2 Sistema paid out record dividends, Accounting Standards (RAS). per GDR). The total proposed dividend corresponding to dividend yield of 5%.

BOND PORTFOLIO

Debt profile at the holding company • Eurobonds issued in May 2012 The bonds mature in 15 years. In level includes rouble bonds and with a par value of US$ 500 million addition, bondholders have the right Eurobonds. As of December 31, 2014, and a coupon rate of 6.95% (semi- to redeem their bonds at the point of Sistema had two rouble bond issues annual payments), maturing on expiration, 18 months from the date and one Eurobond issue: May 17, 2019 the bonds were placed.

• 3-series rouble bonds with a par In 2014, Sistema repaid its 2-series Placement of exchange bonds was value of RUB 19 billion maturing rouble bond issue with a par value of the first market transaction in the on November 24, 2016 and with a RUB 20 billion. Russian market since the turn coupon rate of 8.75% (semi-annual of 2014 among BB credit rating payments) In February 2015, Sistema completed corporate borrowers, as well as the placement of RUB 10 billion the first market transaction in the • 4-series amortised rouble bonds Series BO-01 unconvertible interest- corporate segment in 2015. The with a par value of RUB 19.5 billion bearing bonds with a par value of successful placement showed the maturing on March 15, 2016 and RUB 1,000 at the rate of 17% per attractiveness of Sistema JSFC with a coupon rate of 7.65% (semi- annum. Coupon payments will securities and interest to the current annual payments) be made on a semi-annual basis. investment strategy.

26 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS OUR INVESTMENTS

MTS 28

Detsky Mir 34

Medsi group 38

LesInvest group (Segezha) 44

Bashkirian Power Grid Company 52

RTI 56

SG-trans 60

MTS Bank 64

RZ agro holding 68

Targin 72

Binnopharm 76

Real estate 80

Sistema Shyam Teleservices 84

Sistema mass media 88 MTS

Mobile TeleSystems (MTS) is a Ukraine, Turkmenistan and leading telecom operator in Russia Uzbekistan. The company also and the CIS countries. Together provides fixed telephony and pay- with its subsidiaries, MTS provides TV services in Moscow (MGTS), services to about 104m mobile in all federal districts of Russia subscribers in Russia, Armenia, and in Ukraine.

Management President – A.A. Dubovskov Chairman of the Board of Directors – R. Sommer

Sistema’s Revenue Number of Market share in Position in Russian effective subscribers data segment mobile market ownership 53% 410.8 104 37% №1 RUB bln mln

Industry* The growth rate of the Russian Operators’ revenues from data services telecom market slowed down in 2014 to 2.7% compared to 5% in in Russia, mln RUB 2013, mainly due to the decline in 176,806 the growth rate of the mobile market from 5% to 3%. The penetration of OTT 139,713 services (Skype, WhatsApp, Viber, etc.) continues to increase and has reached 99,994 13% in Moscow. This trend is expected to result in a further downturn in the 75,636 mobile voice market as part of mobile 53,026 voice usage continues to be replaced by Voice over IP (VoIP) and SMS is replaced by iMessaging.

2010 2011 2012 2013 2014

* According to company data and information from ACM-Consulting, TMT-Consulting, iKS-Consulting and Svyaznoy.

28 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS Data communication services continue to drive growth in the mobile business Subscriber base in Russia, m through incentives to increase smart- phone and tablet penetration, promo- 243 240 tion of packaged “voice&data” plans, development of data communication networks and distribution channels. In 231 2014, the penetration rate for data ser- 228 vices in Russia reached 60%. Over the Subscribers last three years, data traffic in Russia in Russia, has grown sevenfold, with LTE traffic 219 mln accounting for 12% of total traffic as of December 2014. MTS market According to expert estimates, the share broadband access (BBA) subscrib- er base in Russia totalled 28.9 mln 32.6% 30.7% 30.9% 31.0% 31.0% households in 2014. The fixed BBA market in 2014 increased by 5.1%. In 2015, the BBA and pay-TV markets will remain highly competitive, with 2010 2011 2012 2013 2014 3-4 players in every large city of Rus- sia. The growth in the BBA subscriber base will be mainly driven by churn Over 2014, the sales of mobile fluctuations in the rouble exchange from competitors. According to fore- phones and smartphones in Russia rate against foreign currencies and casts, the number of BBA subscribers increased by 6% to 44m units with lower growth in retail lending, push- in 2015 may increase by 3.7% to 29.96 the share of smartphones in total ing up the costs of imported telecom mln households. phone sales reaching 64%. The equipment and international roam- market is characterised by a fall in ing and interconnect costs of tele- The pay TV market in Russia grew by the average smartphone price with com operators. Therefore, rates for 6.1% in 2014 to RUB 57 bn, with the an increase in the share of low cost premium international roaming and number of pay-TV subscribers rising models in total sales to 60-65%. voice calls are expected to increase. by 8.3% to 37.8 mln. The TV market re- The growth of tablet unit sales also mains among the fastest growing mar- slowed down to 33% in 2014 year- The majority of markets where MTS kets due to the development of hybrid on-year compared to 125% growth operates will continue to be exposed and satellite TV. In 2015, growth rates in 2013; however, in monetary to currency risks In 2015. Besides, of the pay TV market and subscriber terms, sales remained stable. there is the risk of a decline base in Russia are predicted to slow in consumption in the telecom down from 4.2% to 3.8%, respectively, In 4Q 2014, the financial results of market, especially for international with a penetration rate of above 70%. telecom companies were affected by roaming services.

MTS revenues by geographies, bln RUB 410.8 Steady growth in 2014 398.4 378.2 9% 11% 11% MTS remains the leader in total Russia. MTS also leads in mobile revenues and OIBDA among the data revenue with a 38.8% market Russian «Big Three» operators, share among the «Big Three» as 91% with the lowest churn rate in 2014 of the end of 2014 and a 35.9% 89% 89% and a 7.5% year-on-year growth year-on-year increase in data in the mobile subscriber base in revenue in 2014. 2012 2013 2014 * Calculated from company press releases. Revenue in Russia ** mobile subscriber base in Russia for the 2010-2013 includes MTS subscribers recorded on the basis of 6-month activity. From the 3rd quarter of 2014 MTS has moved to the account of subscribers Revenue in other countries based on 3-month activity, the data for 2014 include a 3-month MTS subscribers.

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT 29 MTS revenues in Russia by services, bln RUB

Mobile revenue Fixed-line revenue Other revenue

291 62.5 21.4

In 2014, MTS continued active The 4G network was launched into The launch of a small cell investments in the construction of commercial operation in 76 Russian deployment project in large Russian 3G and 4G data networks along with regions compared to 15 regions at cities will enable MTS to increase modernization and expansion of 3G the end of 2013, with MTS leading the LTE network speeds and networks in strategic regions and in terms of the number of Russian capacity and improve radio coverage quality improvement projects imple- regions covered by LTE networks as in locations where mobile Internet mented in Moscow and Saint-Pe- of the end of 2014. usage is particularly high. At the tersburg. According to Speedtest first stage, MTS will implement the data, MTS has the best data down- In Moscow, MTS focused on the project in Moscow (200 cells) and load speeds and the lowest network quality of data services, which Saint Petersburg. lag in Russia. In Moscow, according resulted in a 10-fold growth in LTE to Speedtest user measurements, traffic with over half of the total MTS’s LTE networks have the high- Internet (smartphone) traffic being est data download speeds, following generated by LTE users. the large-scale construction of net- works undertaken in 2013-2014.

MTS LTE coverage map in Russia

Regions of LTE coverage in 2013 The launch of LTE networks in 2014 The launch of LTE networks in 2015

In 2014, fixed broadband access apartments or 90% of households in channels. MGTS also successfully was the main driver of growth in Moscow. The number of MTS GPON implemented a video surveillance the subscriber base and revenues users reached 1.1 bln. The number project for the elections to the in fixed-line business, coming from of fixed BBA and GPON TV users in Moscow Duma in September 2014. new connections and increase the corporate segment was up 50%. in average monthly revenue Total Internet traffic in the MGTS Large-scale projects implemented per user (ARPU). network grew by 45% for the year. in 2014 include the launch of MVNO on MTS network, which MGTS GPON (GigabitPON) network In 2014 MGTS implemented several provided subscribers with access to with digital TV signal and home contracts for connecting transport packaged services, including fixed- Internet with the speed of up to 1 hubs in the capital, student hostels, line Internet, telephony and pay GB/s became available in 3.5 mln and traffic lights to high-speed data TV; mobile Internet and voice calls;

30 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS and mobile TV. Implementation of Operational strategy IMS (IP Multimedia Subsystem) was completed in Moscow, which enables the operator to launch its infrastructure facilities, non- own OTT services. transport monitoring (people, trouble notification). Deterioration of macroeconomic 15,000 conditions and the political situation base stations Development of new sales channel in Ukraine in 2Q 2014 has led (LTE/3G/2G) built in 2014 formats will take place at ОZON to a drop in the consumption of Holding, the largest multi-brand communication services by MTS- player engaged in online sales of Ukraine subscribers, especially operator products. In 2015, MTS data and content delivery services. 76 will launch its service and product Starting from August 2014, MTS- offerings, sale of SIM cards and regions with LTE Ukraine ceased services in the subscriber equipment, payments coverage Crimea for technical reasons. from MTS account using Ozone applications, etc. in real time.

Key events MTS will continue to actively develop data services as the most • In April 2014 MTS acquired a 10.8% promising business segment and 4,245 stake in OZON Holdings Limited, deploy multiband LTE networks with one of Russia’s largest e-com- frequency aggregation at a later retail stores merce businesses, for US$ 75 mil- stage. In 2015, MTS plans to provide lion. Sistema also acquired a 10.8% 4G network coverage in all Russian including stake in OZON at the same price. regions. Construction of micro cells will be continued in locations • In May 2014, MTS became the with massive web traffic along with 2,919 only Russian telecom brand to be installation of indoor base stations included in the BRANDZ™ Top 100 in large cities. SON (self-organizing MTS brand stores Most Valuable Global Brands for the network) implemented in Moscow seventh time, ranked 9th among the since 2014 will also be deployed world’s 10 most valuable telecom in other Russian regions. As for brands. Its brand value increased by construction and modernisation of 14.5% over the year to US$ 12.18 bln. fixed-line networks based on target According to the 2015-2018 technologies, MTS plans to connect development strategy for financial • I In July 2014, MTS signed a settle- over 90% households with FTTB services offered by MTS and MTS ment agreement with the Republic (fiber-to-building) technology. Bank, the share of MTS subscribers of Uzbekistan to resume opera- in the bank’s client portfolio is tions in the country, under which In response to OTT market trends, expected to expand from 2% to 7%. MTS received a 50.01% stake in from mid 2015, MTS plans to The key focus in the development of UMS. The network was launched launch its own IP telephony and financial services in 2015 will be on on December 1, 2014. messaging service based on Rich the launch of a single digital wallet Communication Suite technology for MTS customers, development • In November 2014, MTS in partner- (similar to Skype, Viber, WhatsApp). of NFC services and launch of new ship with Sistema Mass Media an- Work on the Big Data project - products: digital signature on a SIM nounced plans to launch satellite search for additional revenue card, virtual card, money transfer TV services under the MTS brand. opportunities and improvement of service, expansion of fee-based The services will be available for operational efficiency by using IT financial services (insurance, railway 95% of the country’s population. assets – MTS data storages - will be and air tickets). continued. • In December 2014, MTS signed a The MTS strategy for foreign partnership agreement with Vimpel- According to the M2M service markets is aimed at maintaining and Com to jointly plan, develop and use strategies for 2015-2017, work will strengthening its leadership position LTE networks in certain Russian be carried out in the following 5 in the broadband internet segment, regions. Under the agreement, areas: motor vehicle monitoring building and upgrading networks, between 2014 and 2016, MTS will de- and dispatching, insurance improving efficiency, expanding the velop shared mobile data networks telematics, security and search frequency band, developing new in 19 regions, while VimpelCom will systems, monitoring of residential growth points: mobile advertising, construct networks in 17 regions. and commercial properties and mobile commerce, М2М, Big Data.

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT 31 Financial results of MTS

RUB million 2014 2013 Change

Revenue 410,758 398,443 3.1%

OIBDA 171,812 176,299 (2.5%)

Operating income 98,698 114,866 (14.1%)

Net income attributable to Sistema 27,725 42,270 (34.4%)

Capital expenditures 92,599 81,575 13.5%

Net debt 230,651 188,086 22.6%

MTS retained its leading position MTS mobile subscriber among the Big Three operators in the Russian telecom market base, mln 104.1 in 2014, both in terms of revenue 74.6 Russia and profitability. MTS’ revenue in rouble terms increased by 3.1% 20.2 Ukraine year-on-year in 2014, as a result of the continued development of its 99.8 1.7 Turkmenistan data services and subscriber base 2.2 growth. The total subscriber base Armenia increased by 4.1% to 104.1 million 0.2 Uzbekistan customers as of December 31, 2014. 5.3 Belarus 2013 2014 In February 2015, MTS’ subsidiary MTS Ukraine won a tender for a nationwide licence for 3G Revenue per user and minutes of usage at MTS telecommunication services in the in Russia 1950-1965 MHz/2140-2155 MHz 372 spectrum ranges. Granted for a term of 15 years, the licence cost UAH 2.715 billion. In accordance 359 with the conditions stipulated in the tender papers, MTS is required ARPU, RUB to launch 3G services in all of the regional centres across Ukraine 339 339 MoU, min within 18 months upon allocation of the licence.

2013 2014

32 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS In 2014, MTS’ capital expenditures throughout Russia, and the ongoing Sberbank of Russia to open a non- of RUB 92.6 billion slightly exceeded deployment of GPON in Moscow, as revolving credit facility for a total the target of RUB 90 billion due well as network modernization in amount of RUB 50bn maturing in to prepayments to the vendors in other markets of operations. September 2021. anticipation of further depreciation of the rouble. MTS debt increased due to additional The high proportion of rouble- borrowings made on attractive denominated debt mitigates the risks Key projects include the terms to hedge the risks of low associated with currency volatility enhancement of 3G networks in liquidity in the future. In October and enhances the company’s Russia, roll-out of LTE/4G networks 2014, MTS signed an agreement with financial stability.

MTS debt profile Debt by instruments

Loans Bonds

62% 38%

Debt by currency*

RUB USD EUR

75% 24% 1%

* The debt structure by currency includes risks of currency hedging in the amount of US$ 675.3 million at the end 4th quarter of 2014

As of December 31, 2014, MTS MTS Free Cash Flow, RUB bln Ukraine, a subsidiary of MTS, held US$ 90.2 million in current accounts and deposits in Delta Bank, the fourth largest bank in Ukraine. In December 2014, Delta Bank delayed customer payments and put limits on cash withdrawals. In March 2015, the National Bank of Ukraine adopted a Free cash resolution declaring Delta Bank to flow be insolvent. The Group recognised 159.9 a provision for cash and deposits 159.5 in Delta Bank in the financial Operating 73.7 statements for 2014. 57.0 cash flow

2013 2014

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT 33 DETSKY MIR

The Detsky Mir Group is the largest Kazakhstan, the early development children’s goods retailer in Russia chain ELC in Russia and the online and the CIS. The Group includes the stores detmir.ru and elc-russia.ru. Detsky Mir retail chain in Russia and

Management President – V.S. Chirakhov Chairman of the Board of Directors – C. A. Baxter

Sistema’s Revenue Number Visits Like-for-like sales effective of stores per year growth in roubles ownership 99% 45.4 322 >109 +13.6% RUB bln mln

Industry*

In 2014, the market of children’s Disposable Children Market for children’s income goods goods kept growing despite a goods during the crisis slowdown in Russia’s economy. Spending per Food Similar to food retail, the market period (2008-2009), capita retail for children’s goods is resistant RUB per capita to macroeconomic challenges, 10.8% as was clearly demonstrated by 3.9% 5.7% 9.9% the financial crisis of 2008-2009 when the population’s spending on children’s goods rose by 9% –7.8% –6.0% (outpaced only by spending on food –21.1% with 11%). Replacement of so-called –30.0% uncivilised retail (open-air markets, Restaurants GDP in nominal kiosks, fairs) by modern formats terms and market consolidation by the Electronics GDP in real terms largest players continued in 2014. Detsky Mir retained its leadership in 2014 with its market share rising In 2014, the market for children’s to a rise in birth rates. According to from 8.1% to 10.0%. goods increased by 3.2% in rouble Rosstat, Russia had a record num- terms. In 2015, experts expect market ber of births in 2014 (1.9 million). By growth to slow down to 2.7%, however, resolution of the Russian Government demographics will continue to drive up the Maternity Capital Programme was spending on children’s goods. The gov- extended to 2017, which will probably ernment’s support of family and moth- have a positive effect on the birth rates erhood, including the Maternity Capital in 2015-2016 through additional finan- Programme, contributes significantly cial support provided to families. * RosInter, M-Video, Synovate Comcon, X5 Retail Group, Rosstat.

34 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS Birth and death rates convergence, % per 1,000 habitants

Birth rate Death rate

16.4 15.9 16.1 15.1 14.6 14.5 14.1 14.2 13.5 13.3 13.2

12.0 12.3 12.5 12.6 13.3 13.0 10.2 10.4 10.2 10.3 11.3

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Steady growth in 2014 Key events

In 2014, Detsky Mir continued to were designed in a new concept • In August 2014, the flagship Detsky improve business efficiency. Key providing for a large number of play Mir store was opened in the centre projects implemented during areas, which was first implemented of Moscow in Vozdvizhenka St. With the reporting year include the in the Mega – Belaya Dacha mall in a total area of 7,000 m2, the store construction of Detsky Mir’s December 2013. Ten largest stores became the largest children’s warehouse in the Moscow region, in the chain were remodelled to the goods store in Russia, and also the introduction of a unified SAP new concept. a leader in the Detsky Mir chain IT platform and the launch of a in terms of customer traffic and 7,000 sq.m. flagship store in the sales in two months after opening. centre of Moscow, which became Detsky Mir’s share in total the biggest children’s goods store children’s retail market • In December 2014, Vladimir in Russia. In 2014, the company Chirakhov, CEO of Detsky Mir, opened 56 new Detsky Mir stores became the company’s minority and 16 ELC stores*. 10% shareholder, with a 1.08% stake, 8.1% as part of a long-term incentive programme. Detsky mir stores 7.1% and retail space • In August and December 2014, Detsky Mir paid out RUB 2.5 bln in dividends based on performance 322 in 2013 and 9 months of 2014. 252 216 2012 2013 2014

390 The key growth segments in 2014 291 320 were toys and baby products where the market share of Detsky Mir in 2014 rose from 13.2% to 16.3% and 2012 2013 2014 from 9.2% to 11.9%, respectively. These two categories are expected to remain the key growth areas in Amount Retail space, 2015. Thus, according to a forecast of stores ‘000 sq m by Synovate Comcon, in 2015 the The retail space of Detsky Mir market share of Detsky Mir in the expanded by 22% in 2014 to 390,000 toys category will reach 19.7% m2 from 320,000 a year earlier. All and in the baby products category newly launched Detsky Mir stores it will expand to 13.1%. * ELC stores – stores selling learning toys

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT 35 Operational strategy

In 2015, Detsky Mir expects to see of other retailers on the back of positive effects from the measures the deteriorating macroeconomic taken to improve operational conditions. №1 efficiency: the launch of a unified SAP platform, modernisation of In 2015, Detsky Mmir expects to on the market for cashier services, opening of a open 60 new stores. The affordable children’s goods in Russia new warehouse in Bekasovo and price policy will remain the chain’s introduction of a new concept. priority in 2015 and subsequent 2 years, which will help to attract 7,000 м In July 2015, it is planned to launch new customer and increase loyalty the company’s own warehouse among the existing clientele. Online the largest toy store for 70,000 pallets, which will sales will remain the key driver of in Russia significantly increase the speed Detsky Mir’ development as a multi- of deliveries. This, in turn, will channel retailer. All initiatives which considerably increase inventory were launched in the pilot format, turnover and inventory management namely, electronic kiosks, online efficiency. The company will application for smartphones, in- 123% continue opening new stores in store pick-up service will be actively growth in the online cities with a population of at least used to maximise the customer store’s revenue 50,000 people and replacing chains interaction efficiency. 38% gross profit margin 1.6х Net debt/OIBDA

36 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS Financial results of Detsky mir

RUB million 2014 2013 Change

Revenue 45,446 36,001 26.2%

OIBDA 4,910 2,771 77.2%

Operating income 4,170 2,137 95.1%

Net income attributable to Sistema 2,043 1,299 57.2%

Net debt 7,866 5,062 55.4%

Detsky mir revenue A minor decrease in gross margins Detsky mir’s OIBDA in rouble terms in 2014 was due to the rouble de- grew by 77.2% year-on-year in and OIBDA margin preciation against global currencies 2014. The OIBDA margin increased and the need to maintain affordable to 10.8% in 2014 compared to prices at our stores, which ensured 7.7% in 2013, reflecting improved additional incoming traffic. operating efficiency. Detsky 45,446 mir’s SG&A expenses declined Double-digit growth of like-for-like as a percentage of revenues to 36,001 sales resulted from a competitive 29.4% in 2014, compared to 31.8% price policy, marketing activities and in the previous year. improved merchandising. Retailer’s net debt is at a The key driver of like-for-like sales comfortable level – Net debt/OIBDA 10.8% growth was increase in traffic, i.e. amounted to 1.6. The company’s inflow of new customers and higher debt is denominated in roubles. conversion. Opening of new stores in 7.7% the new format, an attractive loyalty programme and competitive prices will encourage like-for-like sales growth in the future. 2013 2014

Revenue, mln RUB

OIBDA margin Like-for-like growth of Detsky mir

Detsky mir saw its rouble revenues increase by 26.2% year-on-year in 2014 to RUB 45.4 billion as a Like-for-like result of double-digit growth in traffic growth like-for-like sales and high revenue 12.40% 13.60% growth in the stores opened in Like-for-like 2012 and 2013. Like-for-like sales 8.20% sales growth increased by 13.6% year-on-year 7.90% in rouble terms. 2013 2014

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT 37 MEDSI GROUP

Medsi Group is a leading provider №1 provider of private healthcare in Russia, of private offering a complete range of 1 preventive, diagnostic and treatment healthcare services as well as rehabilitation services in services for children and adults. Russia

Management President – E.A. Brusilova Chairman of the Board of Directors – M.V. Shamolin

Sistema’s Revenue Number Patient visits Healthcare effective of doctors per year facilities ownership 75% 9.8 1,842 >6 230,000 RUB bln mln m2

Industry*

The market for private healthcare more developed in the capital. crease in the number of private clin- services in Russia demonstrated Over the last 5 years, the private ics and a higher quality of services double-digit growth in 2014 and healthcare market grew more than compared to free public healthcare reached RUB 530 bln. The com- twofold, reflecting a considerable in- and shadow healthcare services. bined effect of structural market changes and the government’s Private healthcare market in Russia, bln RUB initiatives will continue to support the development of the private healthcare sector. The trend to- 29% 28% 98 wards consolidation, and reduction 25% 91 in the number of public healthcare facilities, which emerged in 2013, 17% Market will continue in 2015. value, RUB bln 85 7% 7% In 2014, the Moscow market held 51 66 28% of legal private healthcare 41 Growth market, which is primarily due rate, % 2011 2012 2013 2014 2015 2016 to the fact that the VHI (voluntary health insurance) segment is much Fact Forecast

* Sources: Biznesstat, analysis of the Company.

38 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS The value of the VHI segment, which by a high concentration of large business environment in Russia. has historically been showing high corporations and dynamic growth The economic downturn results in a growth rates, amounted to almost of businesses that are the main reduction in the scope and options of RUB 100 bln in 2014, up 50% from customers of insurance companies. VHI programmes and, in some cases, 2009. The Moscow market, which VHI being denied to some employees. accounts for more than 60% of the The VHI segment exhibits a strong total VHI market, is characterised correlation with the economic and In the next year, the healthcare industry will mainly be shaped by ongoing reforms stimulating Voluntary medical insurance market in Russia, RUB bln the public and private sectors to consolidate their efforts to further 13% 13% develop the healthcare market in the 58 60 61 country. There is a tendency towards 11% engaging private clinics to provide Market services under OHI (obligatory health 11% value, insurance) programmes; initiatives RUB bln are being proposed to enable patients 53 41 47 3% to pay extra on top of the fees covered 2% Growth by OHI or set off their expenses rate, % against VHI and to grant certain 2011 2012 2013 2014 2015 2016 benefits to healthcare facilities. Fact Forecast Moreover, the government is taking measures aimed at curbing under-the-counter payments for medical services, which currently Steady growth in 2014 account for about 25% of the entire healthcare market. Medsi is the largest federal chain share by revenues amounted to 2% of clinics, serving more than 6 mln in Russia and over 6% in Moscow patients every year. Its market in 2014.

MEDSI medical facilities Moscow 1 clinical diagnostic centre 16 clinics 25 Moscow 3 hospitals Bryansk 1 2 sanatoriums 1 N.Novgorod 1 Nyagan 3 welness centres Perm 1 Nizhnevartovsk 1 Regions 1 Yalta 7 clinics 1 sanatorium (Yalta) Barnaul 1

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT 39 In 2014, the construction of the Last year, four inefficient loss- completed in 2014, the company second flagship clinical and making clinics were closed in the launched a large-scale investment diagnostic centre with a total regions; however, Medsi continued programme to modernise its area of 22,000 m2 was started at its development in Moscow by assets and install new high-tech Krasnaya Presnya. The centre will opening a new clinic for outpatient equipment, introduce new medical offer a complete range of outpatient primary and diagnostic care. services and modern treatment and diagnostic medical services, methods, and establish cross sales as well as inpatient treatment and After the integration with SUE within the Group by providing a full rehabilitation services. Medical Centre assets was range of medical services.

Patient visits growth at MEDSI, mln Number of surgeries

+135% 6.0 6.0 7,838 5.0 4.1 +19% 3.4 3,336 2,797

2010 2011 2012 2013 2014 2012 2013 2014

Medsi started implementation of The introduction of new high- The refurbishment of its asset the first reconstruction phase at the precision diagnostic equipment base has enabled Medsi to obtain hospital in Otradnoe in collaboration and modern surgical applicances licenses and quotas for high-tech with Royal Philips and works to resulted in substantial shifts in medical care (HTMC) under the state convert one of its outpatient clinics the quantity, quality and scope of programmes from the beginning into a modern children’s healthcare provided medical care. of 2015. centre in cooperation with Vamed. Improved efficiency of clinical The key initiative for the Group’s hospitals is largely due to the im- business efficiency improvement plementation of new technologies; in 2014 was restructuring in particular, the company gradu- of the management system, ally transitioned to a laparoscopic granting additional powers and approach which is now used in responsibilities to key assets and most surgeries, thereby increasing at the same time optimising the the patient flow and reducing the motivation system. In addition, the duration of their stay in the hospi- company continued to improve tal. As a result, the total number of business efficiency by introducing a surgeries performed increased by cutting-edge unified IT system and 135%, while the occupancy rate in expanding medical space in two clinical hospitals in Otradnoe and existing clinics. Botkinsky proezd reached 43% and 65%, respectively. In the near future, the company will implement invasive arrhythmology and open a full-ser- vice pain management clinic.

40 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS Key events

• In November 2014, Elena • In January 2015, at the World new joint initiative to set up a new Brusilova was appointed President Economic Forum in Davos, Medsi unique training centre on the basis of Medsi Group. and Royal Phillips announced a of Medsi’s assets.

Operational strategy

The company’s strategy is focused currently cooperating with all major The decline in the purchasing on organic growth and selective insurance companies. Maintaining power caused by the deterioration investments in the most successful and increasing the insurance flow of the macroeconomic environment and efficient healthcare assets. through new products and flexible is affecting the private healthcare The key long-term drivers for pricing, despite the challenging segment. The most significant growth inlcude investment economic situation, is also one of drop in demand is expected in the projects scheduled for 2015, such the company’s KPIs. Qualifying for regions with a low average income as launching the clinical and state quotas on high-tech medical per capita. diagnostic centre on Krasnaya care (HTMC) and providing services Presnya, completing modernisation under obligatory health insurance of the surgery, intensive care and programmes at affordable sterilisation units in the hospital rates, will present additional in Otradnoe, creating a radiology opportunities for Medsi. unit in Otradnoe, renovating the outpatient clinic in Khoroshevsky The company’s optimisation proezd and creating a specialised programme provides for creating children’s clinic on its basis. an efficient and manageable business process chain. A new In addition to the large-scale unified information system to be investment programme, the implemented in 2015-2016 will company will increase its patient help cut the managing company’s flow and improve operational and expenses through automation. In management efficiency. Strong 2014, the incentive system for the emphasis will be placed on the operational staff and management retail segment: the marketing was updated to include a variable promotion programme for services component linked to individual and clinics started in 4Q 2014 will performance and financial and be continued in 2015. Medsi is operating KPIs.

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT 41 Financial results of Medsi

RUB millions 2014 2013 Change

Revenue 9,767 9,362 4.3%

OIBDA 866 1,408 (38.5%)

Operating income 382 970 (60.6%)

Net income attributable to Sistema 533 1,011 (47.3%)

Net debt (1,003) (4,415) 77.3%

Medsi’s rouble revenues grew by The share of individual contracts in contributors to the Group’s revenue. 4.3% year-on-year in 2014, reflect- the company’s revenues decreased In 2014, they accounted for 88.1% of ing an 0.7% rise in the number by 2.0 p.p. to 22%, while the share MEDSI’s revenue. This growth was of patient visits to 6.035 million, represented by insurance compa- largely driven by a strong increase and a 4.0% increase in the aver- nies and legal entities increased to in the revenue generated by CDC age bill in rouble terms, which 42% and 11%, respectively. on Belorusskaya, which increased totalled RUB 1,618. by 12.9% (with an OIBDA margin of Healthcare facilities in Moscow and 45.9%) and accounted for 20.4% of the Moscow region were the biggest the Group’s total revenue in 2014. MEDSI’s revenue by assets

CDC on Belorusskaya Hospitals Clinics Other

20.4% 12.4% 58.5% 8.7%

MEDSI’s revenue by clients

Insurance companies Corporate clients Individuals State contract Other

42% 22% 24% 11% 1%

42 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS In 2014, the Group’s selling, general MEDSI’s CAPEX in 2014 totalled MEDSI’s CAPEX, and administrative expenses (SG&A) RUB 2,981.1 million, a more rose by 22.5%, due to an increase in than eight-fold increase over the mln RUB personnel expenses and growth of previous year. advertising and marketing expens- es. Increase of personnel expenses In 2014, Medsi launched three +770.7% reflected MEDSI’s management investment projects in Moscow, system redesign and introduction of including the construction of a new functional areas and business new clinical and diagnostic centre 2,981 units. Growth of advertising expenses in Krasnaya Presnya, which will resulted from the Group’s stepped- include an adult and children’s in- up marketing activities targeting indi- patient hospital. This new clinical vidual customers to improve utilisa- and diagnostic centre is scheduled tion rates across its medical assets to open in the second half of and increase brand awareness. The 2015. The company also started SG&A/revenue ratio grew to 17.4% the renovation of its clinics in versus 14.8% in the previous year. In Otradnoe and on Khoroshevskoye 342 the reporting period, OIBDA declined highway, the latter is to be by 38.5% versus 2013 to RUB 866 converted into a specialised million, OIBDA margin was 8.9%. children’s clinic. 2013 2014

SG&A expenses of As of 31 December 2014, the roubles. Most of MEDSI’s debt (67%) MEDSI, mln RUB Group’s total debt stood at RUB is made up by long-term liabilities 2,352.3 million versus RUB 2,397.3 with maturing in 3-5 years. As aof million at the end of 2013. All liabili- the end of 2014, MEDSI had a net +22.5% ties of the Group are denominated in cash position of RUB 1,003 million.

1,695 MEDSI’s debt, mln RUB

-1,9% 1,384 6,813

17.4% 3,355 14.8% 2,397 2,352

2013 2014 2013 2014

SG&A/Revenue Total debt

SG&A Cash position

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT 43 LESINVEST GROUP (SEGEZHA)

LesInvest Group is a vertically LesInvest Group manufactures integrated pulp and paper pulp and paper products, paper company with a full cycle of sacks, birch plywood, chipboard, timber harvesting and advanced and fibreboard. wood processing operations.

Management President – S.A. Pomelov Chairman of the Board of Directors – A.M. Uzdenov

Sistema’s Revenue Number of Share of effective plants in Russia export ownership and Europe sales 100% 24.7 9+8 61% RUB bln

Industry* Sack paper Consumption of unbleached paper, mln tonnes

The share of sack paper in the global paper packaging consumption 7.5 amounts to 3%. The global sack +2% paper market is dominated by +2% –1% CAGR unbleached sack paper, accounting +2% for 87%. +2% 6.8 Over the next 5 years, the global 6.5 6.6 6.7 6.6 market for unbleached paper is expected to grow at 2% annually, 2010 2011 2012 2013 2014 2020 with consumption growth to Fact Forecast be led by Asia, Latin America and the Middle East. China producers occupy 41% of the Only 21% of paper produced globally

* Source: LesInvest, Vision Hunters, RISI, Enter unbleached paper global market, (in Europe, Russia, North America) Vision, BNP Paridas UNECE, Bloomberg, Morgan however, this paper is of low quality. corresponds to these standards and Stanley, Russian Ministry of Industry and Trade, Rosstat, Federal Customs Service, Pöyry, Federal Paper quality depends on the avail- delivers high profitability. Forestry Agency, NETLA, Food and Agriculture ability of coniferous wood feedstock. Organization.

44 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS Paper sacks In 2014, the consumption of paper Production of paper sacks in Russia, mln sacks in Russia was 841 mln pieces with 32% share of import (the main 917 importers are Ukraine, Poland, 841 Germany). The market is expected 803 to grow by 1.5% annually through 780 2020 and is local in its nature (with 700 723 geographic proximity between consumers and producers), which is due to lead time and short hauling 575 distance benefits. 541 562 CAGR 562 +1,5% About 86% of consumers are 554 manufacturers of building materials (cement and dry mixtures).

238 241 266 146 160

2010 2011 2012 2013 2014 2020

Fact Forecast

Import Production in Russia

Plywood World production of plywood, mln m3

The global production of birch ply- wood is approximately 5.9 mln m3. +9% 121 The largest reserves of feedstock +8% (birchlogs) for plywood production 108 +8% are concentrated in Russia, which 99 accounts for 53% of global market. 92 Birch plywood is a premium segment, 85 growing 4% annually and generating a steady growth in demand and prices. CAGR +3%

The largest consumers of birch 102 113 plywood are Europe (36%), Russia 87 93 (27%) and Asia (25%). The key growth 79 driver for the birch plywood market is development of shipbuilding, construction and machine building industries, where birch plywood is non-substitutable. CAGR 5.4 5.4 5.7 5.9 +4% 7.7 High growth in birch plywood 2010 2011 2013 2014 2020 consumption is predicted for both the mature European and North Fact Forecast American markets and emerging markets in Asia and the Middle East. Birch plywood Plywood (coniferous, tropical etc)

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT 45 Fibreboard

Consumption of FB (fibreboard), Production of timber products in Russia MDF (medium density fibreboard), (fiberboards, MDF, HDF), ‘000 m3 HDF (high density fibreboard) in Russia totals 3,438,000 m3, with approximately 24% being imported. Production in Russia is 2,743,000 m3 with only 5% being exported. The Russian market is highly fragmented with unmet demand for high-quality boards of 500,000 m3. The share of low- quality board produced by outdated CAGR equipment in Russia is still high 2,743 +1% 2,908 (21%). The main consumers of 2,468 2,579 2,612 wood boards are manufacturers 2,056 of furniture and doors (57%); the construction industry consumes approximately 39% of the output. Total consumption growth through 2020 is expected at 1% per.

2010 2011 2012 2013 2014 2020 Fact Forecast

Sawn timber Out of the 21.4 mln m3 of soft 3 sawn timber produced in Russia, Production and export of sawn timber in Russia, mln m approximately 1 mln m3 per year is consumed within the country and over 90% is exported, mainly to China (32%). The sawn timber market is not saturated with top-5 companies occupying only 10% of the market in Europe and 7% in Russia. The bulk of consumption growth is expected to 22.7 22.0 take place in China, USA, Russia and 21.0 20.6 21.7 21.4 20.8 19.1 17.7 18.5 19.3 19.5 is estimated at 1.2% per year.

Stagnation in the European market may lead to a drop in sawn timber prices in the short run, while in Asia prices are expected to rise, 2010 2011 2012 2013 2014 2020 reflecting growing construction rates Fact Forecast and positive GDP growth. The main consumer of sawn timber is the construction industry. Production Export

The largest sawn timber producers are located in the Irkutsk and Arkhangelsk regions as well as in the Krasnoyarsk territory.

46 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS Forest resources

Worldwide forest resources amount Allowable and actual cut in Russia, mln m3 to 527 bln m3; 16% of them are locat- ed in Russia with its world’s largest coniferous forests of 46.3 bln m3. Russia has a high growth potential with the annual allowable cut of 669 mln m3, which is three times 633 669 669 CAGR 669 higher than the actual cut. +4% 251 176 195 203

India and China are among 2010 2013 2014 2020 countries that have a deficit of forest resources, while Russia, Brazil and Fact Forecast Finland have a potential for growth in wood harvesting. Allowable cut Actual cut

Business of LesInvest Group

On September 29, 2014, Les- ble volumes and win new custom- management team, which includes Invest, a subsidiary of Sistema ers. In 2014, LesInvest focused on professionals with high expertise in JSFC, completed a transaction the reorganisation of the procure- the industry. to acquire 100% of Segezha ment system, logistics services, Pulp and Paper Mill and 100% of which enabled the company to re- In the second half of 2014, on the back Derevoobrabotka-Proekt. duce wood harvesting costs and to of growth in foreign currency sales, improve the terms of wood supply which account for 61% of the Group’s In 2014, the company conducted contracts. LesInvest Group imple- total revenue, and a weakening rouble, negotiations with the key customers mented a new efficient business the advantages of LesInvest Group and successfully secured contracts model, modified the organisational over its key competitors both in Russia for 2015, managing to maintain sta- structure and formed a new top and abroad increased substantially.

Segezha Pulp and Paper Mill – sack paper

Sack paper accounts for 17% of exporter supplying products Segezha Paper Plant. Sack the Group’s total revenue and to Egypt, Indonesia, Pakistan, approximately for 25% of its foreign Mexico, Malaysia, Vietnam. In 2015, paper export, ‘000 tonnes currency revenue. LesIinvest costs, which are mostly denominated in local currency, will 199 Segezha PPM is ranked number receive an additional competitive 195 four globally and number one in advantage before the importers in Russia in the production of high-end the form of more attractive pricing unbleached sack paper of European and low transport costs. quality. Around 45% of produced paper is supplied to the converting In 2015, LesInvest Group plans to 180 plants of the Group producing implement an investment project paper sacks in Russia, Europe for modernisation of Segezha PPM, and Turkey. Its market share of which is expected to increase the unbleached paper production in sack paper output by 44% to 366,000 Russia is 70%. The mill is a major tonnes by 2017. 2012 2013 2014

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT 47 Segezha Packaging – paper sacks Segezha Packaging is a Kyrgyzstan. Approximately 49.6% of Export of paper sacks, mln manufacturer of high-quality sacks, sacks manufactured at the plants in which has one plant in Russia, six Europe and Turkey are supplied to plants in Europe (Netherlands, Spain, Belgium, France, Hungary, Germany, Denmark, Czech Georgia, USA and Iraq. 372 380 Republic, Romania, Italy) and two plants in Turkey. In 2015, LesInvest Group started an investment project to increase the Segezha Packaging is ranked conversion capacity for production number one in Russia and number of paper sacks in Russia. In 2016, two in Europe by the production supported by import substitution of high-end paper sacks. Own policy, production and sales are 32 45 resource base allows to control the expected to grow by 28%. The cost of production. 11% of sacks company also plans to increase 2013 2014 produced in Russia are exported maintenance capital expenditures to Kazakhstan, Uzbekistan and for the plants in Europe and Turkey. Russia Europe, Turkey

Vyatka Plywood Mill – birch plywood, fibreboard

Vyatka Plywood Mill is the fourth In 2015, LesInvest Group will launch Sawn timber largest producer of birch plywood an investment programme to LesInvest Group is a vertically production Russia. Thanks to its build new production facilities in integrated company, which also advantageous geographic location the Vologda and Kirov regions. By owns timber sawing facilities (North-West of Privolzhsky Federal 2020, the company expects to see a making it possible to achieve District), the company is able to threefold increase in production of synergies between the Group’s supply products worldwide. The birch plywood. business segments. LesInvest company uses wood feedstock Group holds a 1.4% share of total certified by the FSC (Forest sawn timber production in Russia Stewardship Council – international Fibreboard and a 3% share in the North- organisation which created a system For Vyatka Plywood Mill, fibreboard Western Federal District, where for certification of environmentally is a complementary product received major producers are located. and socially responsible forest in the process of plywood production, management). Approximately 56% enabling the company to efficiently The bulk of the Group’s of the products are exported to recycle waste. The share of Vyatka sawn timber is produced by Turkey, Germany, Netherlands, Plywood Mill in the Russian fibreboard Sokol Woodworking Plant, France, USA and other countries. market is 5%. All products are sold Segezha Woodworking Plant domestically. and Onega Woodworking Plant. Export of plywood, The share of export is 95%, ‘000 m3 Fibreboard production, products are supplied to the UK, running m2 Egypt, France and Belgium. 53 52 23,872 In 2015, LesInvest Group plans 44 to construct a new boiler 22,815 plant at Onega WWP. In-house heat production will enable the company to reduce gas consumption and benefit from 20,274 cost reduction.

2012 2013 2014 2012 2013 2014

48 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS Complete house sets Wood feedstock

Sokol WWP is the only company Wood feedstock is a major cost item In 2015, LesInvest will continue in Russia producing high-quality in the cost structure of LesInvest’s implementation of the investment laminated veneer lumber (LVL) and product portfolio (30% to 60%). Own project to renew its fleet of complete house sets. The plant holds resource base allows the Group to lumber trucks, logging and a 15% share of the LVL market in control the cost of production and auxiliary equipment. Investments Russia. Sokol WWP is ranked num- guarantees feedstock secutiry. The are also planned to build forest ber one in Russia by the production Group includes 15 wood harvesting roads. These steps will allow it to of complete house sets and LVL. The companies located in the Republic substantially increase the utilisation average annual growth rate of this of Karelia, Kirov, Vologda and of allowable cut. market is expected at around 4.5% Arkhangelsk Regions. The annual through 2020. LVL is an export prod- allowable cut for LesInvest Group is uct which is supplied to Italy, Ger- 4.5 mln m3. many, France, Slovenia and Japan. In 2015, LesInvest Group plans to build a new boiler house at Sokol WWP.

Key events

• On September 29, 2014, LesInvest • In February 2014, «Sokolsky • As a result of the 2014 LesInvest LLC, a subsidiary of Sistema JSFC, DOK» won the award of Lesprom won the All-Russian forest industry completed a transaction to acquire Awards-2014 for the project award Lesprom Awards in the 100% of Segezha PPM and 100% of «Residence of Father Christmas» category Business Strategy of the Derevoobrabotka-Proekt. in the Olympic Sochi in the category Year. (The award was established in «Design of wood». The construction 2002 by the online trading system • In 2014, LesInvest Group implement- of the residence took 110 cubic Lesprom Network and it is the ed the Wood Supply Project to renew meters of timber. The palace was only professional award in the logging and auxiliary equipment at built in the coastal area of the park Russian forest industry). The award key production facilities of the Group. near the Iceberg Ice Palace, which ceremony was not only an annual held the Olympic figure skating meeting place for representatives of • The head office of LesInvest Group competitions. the state, forest industry companies was relocated from Moscow to and the leading media but also one Petrozavodsk (Republic of Karelia). • In 2014, «Sokolsky CBK» in the of the key events in the business This relocation will create additional competition of the Golden Mercury community of Russia. jobs in Karelia and increase contri- National Prize was awarded a butions to the Republic’s budget. diploma as «The best company- exporter in the production of • In 2014, «Segezha Packaging» consumer goods». (Russia) signed a contract with IKEA to supply paper consumer packag- • In 2014, Vyatka FC made the first ing (bags with handles). In 2015 it is deliveries of birch plywood in Saudi planned to increase the volume of Arabia, UAE and Australia. supply by 30%. №4 №1 №2 №4 №1 in Russia in Russia in Europe in the world in Russia by production of birch plywood by production by production of of high-quality high-end paper unbleached sacks sack paper №1 in Russia

by LVL production

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT 49 Financial Results of LesInvest*

Financial results, RUB bln Sistema JSFC consolidates the results of LesInvest in Q4 2014. 24.7 LesInvest’s revenue and OIBDA in Q4 2014 brought RUB 7.2 bln and RUB 20.8 20.9 1.1 bln to the Group, respectively.

In 2014, due to measures aimed at optimizing the business, LesInvest 12.9% improved the OIBDA margin from 10.2% 11.4% 11.4 pct in 2013 up to 12.9 pct 3.2 in 2014. In general, the growth 2.1 2.4 in revenue was affected by the depreciation of the ruble against the 2012 2013 2014 US dollar and euro, given that more than 61 pct of LesInvest’s revenue accounts for exports sales. Over 42 pct of all export sales are exports Revenue OIBDA OIBDA margin to European countries.

Revenue by geography

Russia Export

39% 61%

UK Austria Germany UAE Estonia Indonesia Sweden France Finland Other

15% 12% 8% 7% 6% 6% 6% 5% 5% 30%

The depreciation of the ruble had production cost of pouch paper The production cost of birch a positive impact and improved reduced from 510 euro/ton to 394 plywood at the Vyatka Plywood the LesInvest’s competitive euro/ton – it is the lowest figure Factory reduced from 280 euro/ advantage in the market. Thus, the among LesInvest’s competitors. cu.m to 232 euro/cu.m.

Revenue by segments

Logging Sacks and sack paper Dendrochemistry Plywood and slabs Housebuilding and glued beam Lumber Other

4% 62% 4% 17% 3% 10% 2%

* Based on the management reporting data

50 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS In 2014, the production segment of The logging segment showed in in 2014. Last year, this segment pouch paper and paper bags brought increase by 7 pct in 2014 thanks to saw an increase in market the most of the Group’s revenue – review and optimization of current prices and reduction in rates 65 pct. Operative marketing-control contracts, including through elimi- of commission fees. of market prices, elimination of the nation of intermediaries. In addition, excessive number of agents in chain high-value assortments were sold Revenue from wood chemistry sales and increased demand for and export supplies were increased. segment increased in 2014 by 34 pct bleached and unbleached paper in mainly due to the grown in demand Europe allowed for raising prices Revenue from housing construction for some products and, as a result, in Q3 2014, which in turn resulted and LVL segment grew by 9 pct increase in sales volume. in increase in revenue from pouch paper sales by 24 pct. During 2014, due to an increase demand in the market, production of high-tech Production Cost paper – the highest cost-effective product among all types of paper – Production cost for sack paper, EUR/tonnes was actively developing. 654 In 2014, the revenue from paper 555 510 bags has also increased by 14 pct 474 471 owing to growth of construction materials production and 394 increased demand for this product in the market. The segment profitability rose through the development of manufacture of high-margin products for dry construction mixtures.

The revenue of plywood production Segezha Segezha plant China Mondi Mondi Horizon/Kehra Plant (after RUB (Steti), (Frantschach), Estonia segment makes 10 pct in the depreciation) Europe Europe Group’s total revenue, and it increased by 13 pct in 2014. More than 50 pct of this product were exported. The growth of the segment Production cost for birch plywood, EUR/m3 revenue and profitability was also supported by the depreciation 491 500 of the ruble.

Increase in revenue from fiberboard 361 is due to increase both in sales 280 260 volume of goods manufactured and 232 215 accumulated inventories as well as to rise in market prices. Granting the deferral of payment for laminated chip boards made it possible to maintain the sales volumes, as well as to sell the accumulated stock. Vyatka Vyatka plywood Sveza Sveza (Russia) Latvia Poland Finland plywood plant (after RUB (Russia) (after RUB plant depreciation) depreciation) The revenue from the Timber segment accounts for 10 pct in the total revenue, and in 2014 it increased by 20.1 pct, which was Own lumbering helps control competitors. Production cost of due to rising market prices and the the cost of wood raw material, pouch paper and birch veneer is one currency exchange rate. giving additional advantages over of the lowest in the global market.

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT 51 BASHKIRIAN POWER GRID COMPANY

Bashkirian Power Grid Company the Urals, and power transmission (BPGC) is a large regional company and distribution services to providing electricity transmission consumers in the Republic of services between central Russia and Bashkortostan.

Management CEO – A.Y. Makarov Chairman of the Board of Directors – F.V. Evtushenkov

Sistema’s Revenue Metering Circuit Transformer effective devices length capacity ownership 91% 13.8 88,000 >80,000 >21,000 RUB bln km MVA

Industry* One of the main trends in Electricity production and consumption in Russia, the power utilities industry is a moderate growth rate of bln kVt*h demand for electricity, balanced 1,054 with an increased efficiency 1,045 1,046 1,049 of consumption. Electricity 1,021 consumption in Russia grew by 1,025 0.4% in 2014 to 1,035.2 bln kW*h, 1,038 1,035 1,041 while power generation increased 1,031 1,040 only by 0.1% to 1,046.3 bln kW*h. 1,009

There is a considerable shift in de- 2010 2011 2012 2013 2014 2015 mand - while in rural areas elec- Forecast tricity consumption is declining, its Production Consumption consumption in large cities is grow- ing considerably. At the same time, within the cities, a decline in electric- way. Such changes in the geography ity consumption in industrial zones of demand for electricity create the is offset by its growth in areas where need to support underutilised elec- construction of office, commercial tric grids and invest in power grids * Source of information: official site or residential properties is under- on the new sites. of JSC "SO UPS".

52 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS Electricity production and consumption in Republic of Bashkortostan, bln kVt*h

24.2 25 25.4 25.7 26.4 26.2

25.2 25.5 24.3 22.4 22.2 18.1

2010 2011 2012 2013 2014 2015 Fact Forecast Production Consumption

As a state-regulated business, the and support companies operating in for 2015 was capped at 3.8%. At the power grid business is affected by the construction materials sector, same time, according to the regional frequent changes in legislation. In wood processing, metal and mining department of Rosstat, the inflation the autumn of 2013, the Russian and chemical industries. In these rate in Bashkortostan in 2014 was Government froze the tariffs of natu- sectors, the costs of monopoly ser- 11.2%, which is higher than in the ral monopolies for 2014, which, first vices account for 11% to 21% of total previous five years. of all, was aimed to curb inflation costs. In 2014, the increase in tariffs

Steady growth in 2014

BPGC is among the ten largest pow- In 2014, BPGC continued installing grid business. In 2014, the company er grid companies in Russia in terms electricity meters (Automatic continued to acquire and lease of transmitted power, and holds a System for Commercial Measuring abandoned and municipal power leading position relative to other ter- of Power Consumption) as part grids. In particular, comprehensive ritorial grid companies (TGCs), that of the the programme aimed at preparatory work was carried out to are part of Interregional Distribution improving the performance of privatise power grid assets in Ufa Grid Company (IDGC), in terms of the existing power grid assets. During and Kumertau. total length of transmission lines in the project implementation, operation and the number of substa- BPGC installed over 88,000 tions, transformer substations and meters, resulting in a substantial Number of new distribution points. reduction of actual power losses. connections per The company also implemented Circuit length and new IT systems to automate year project reporting and progress 19,790 transformer capacity tracking, ensure the efficiency and 17,180 85,714 85,959 transparency of business processes. 82,257 In 2014, BPGC was also developing 12,948 4,742 non-regulated activities and established BPGC Engineering LLC, which acts as EPC contractor for a 4,597 number of power grid infrastructure 4,583 facilities in the Republic of Bashkortostan.

2012 2013 2014 One of the priorities in BPGC’s activities is consolidation of power Transformer capacity, MVA grid assets in the Republic of Bashkortostan to expand the power 2012 2013 2014 Circuit length, km

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT 53 BPGC’s investment programme in Republic of Bashkortostan, improv- The modernisation programme is 2014 amounted to RUB 3.3 bln. The ing energy efficiency at production designed to create conditions for company’s capital investments in facilities and meeting the demand ensuring reliable power supply to 2014 were directed towards devel- for electric power and capacity consumers and reducing harmful oping the grid infrastructure in the in the long- and medium term . environmental impacts.

Key events

• In 2014, BPGC’s subsidiary, opportunity for distribution grid • In 2014 the preliminary feasibility Bashkirenergo LLC, became companies to plan development study for the comprehensive the first power company in Rus- programmes over the long-term, modernization of the electric sia to switch to a 10-year tariff as well as to improve their ser- grid infrastructure Ufa with regulation and to determine its vice quality and offer predictable elements of Smart Grid was rates based on return on invested tariffs. The 10-year regulation completed. The pilot project capital (RAB), while rates of other period will enable both energy (1.5% of the total project) will power companies are set for no consumers and energy providers be implemented in April and more than 5 years. Regulation to effectively implement long-term May 2015 for the network of tariffs by return on invested business development planning in which it is in need to capital has a number of advan- with the aim of enhancing their provide the maximum level of tages for power grid companies, investment appeal. Investments automation and observability. consumers and the country as a into the Republic of Bashkorto- The main part of the project whole. These include incentives stan’s electricity sector will total will be implemented until to reduce costs, solid invest- more than RUB 29 billion for the the end of 2020. ments with favourable rates, an 10-year period.

Operational strategy The key objectives of BPGC are to a Data Centre (DC) and a Grid Smart Grid project in Ufa and TGC ensure reliable power supply to con- Control Centre (GCC). Key strategic consolidation. As for the company’s sumers and improve the operational areas include implementation development in the non-regulated efficiency of the business. of the long-term equipment segments, the engineering company upgrade programme, efficient tariff plans to replicate the Smart Grid In 2015, BPGC will proceed with its investments, reduction of operational technology in all of BPGC’s assets efficiency improvement programme losses. The company also plans and provide IT and communication in order to reduce losses and create to complete the main part of the services to customers.

Structure of capital expenditures

Reconstruction New construction Other investments

37% 31% 37%

54 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS Financial results of BPGC

RUB millions 2014 2013 Change

Revenue 13,778 13,271 3.8%

OIBDA 5,267 5,651 (6.8%)

Operating income 3,444 3,981 (13.5%)

Net income attributable to Sistema 2,701 2,786 (3.1%)

Capital expenditures 3,262 3,054 6.8%

BPGC’s revenue grew by 3.8% year- BPGC is a debt-free company. Its capital expenditures grew by 6.8% on-year in 2014, reflecting organic to RUB 3.3 billion in 2014. growth in electricity consumption and an increase in technological connections to the power grids. Distribution grids Transmission grids Boiler tariffs for transmission services were frozen in 2014. 20,936 19,683

Power consumption in 2014 was up 3.2% year-on-year, largely as a result of acceleration of power 20,680 connections. BPGC acquired 19,790 19,080 new consumers in 2014, 15.2% more than in 2013.

BPGC’s OIBDA in rouble terms declined by 6.8% year-on-year in 2014. This mainly resulted from a 20,192 18,514 rise in operating expenses in 2014 compared to 2013, as well as from the recognition of income from one- off transactions in 2013, including the disposal of fixed assets and 8.8% 8.7% 1.7% 1.6% accrued penalties for late customer 8.2% 1.5% payments.

Distribution grid losses increased from 8.27% in 2013 to 8.46% in 2014, as BPGC started to operate electric grid systems previously owned by 2012 2013 2014 2012 2013 2014 territorial grid operators (OJSC Rosenergoatom Concern and LLC Teploelektroset) from the second Productive supply, mln kWh Productive supply, mln kWh half of 2014, in addition to the grids Losses Losses already in operation.

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT 55 RTI

RTI Group is a major Russian of radio communication and space industrial holding, which develops technology, threat monitoring and and manufactures high-tech control solutions, microelectronics products and infrastructure solutions and system integration. RTI was using proprietary microelectronic established by Sistema and the technologies. RTI subsidiaries Bank of Moscow in February 2011. have their own R&D infrastructure RTI Group includes RTI Systems and implement projects of unique Concern, NIIME and Mikron, and complexity and scale in the fields NVision Group.

Management President – S.F. Boev Chairman of the Board of Directors – E.M. Primakov

М | B | Т

Sistema’s Revenue Transport Micro-chips Employees effective tickets exported ownership produced 84.7% 70.9 300 731 20,000 RUB bln mln mln

Industry* The defence segment is expected Russia’s government defence to see a considerable growth in demand for high-tech products. spending, trln RUB In accordance with the approved 3.3 3.1 3.2 2.5 National Arms Programme through 2.1 2020, budgetary defence spending will total about RUB 20 trln. Up to 70% of this amount is expected to be invested in procurement of new defence systems and equipment. 2013 2014 2015 2016 2017 Fact Forecast

The Russian microelectronics mar- applications, which account for main demand drivers are the semi- ket in 2014 is estimated at over US$ about 40% of the domestic micro- conductor segment and the telecom 2 bln, which is only 1% of the global electronics market. In the future, sector, which, given the import sub- market. Mass civil market segments the microelectronics industry will be stitution programme, the imposed in Russia are dominated by foreign supported by the growing demand sanctions and devaluation of the companies. Russian microelectron- for RFID (Radio Frequency Identifi- national currency, is likely to boost ics companies mainly manufacture cation) based solutions, including the demand for Russian microelec- products for military and special orders from the government. The tronic products.

* Source: the main directions of budgetary policy for 2015 and the planning period of 2016 and 2017, RTI analysis

56 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS The Russian market of information Information and Communication technologies market and communication technologies in general showed strong growth with services for government and companies, bln RUB the main consumers being the top 910 20 largest Russian companies. The 735 780 830 average annual growth rate in this 721 market is forecast to stand at 10% until 2017, with the segment of in- tegrated security systems being the 2013 2014 2015 2016 2017 most attractive one. Fact Forecast

Steady growth in 2014

RTI develops assets in the defence industry, microelectronics and RTI Group’s system integration. In 2014, Sistema structure Sistema 50% –0.5 share developed and started implementing a restructuring plan for RTI’s high- tech assets to improve its operating 84.7% efficiency and profitability.

In particular, Sistema completed the RTI transaction to purchase the shares of NVision Group («NVision») and became the sole shareholder of this company. NVision is now headed by a 97% 63% 50% +0.5 share new management team. The system integration segment was severely hit by the economic downturn in Russia RTI Concern Systems Micron NVision Group in 2014, which also affected the finan- cial results of ths business. In 2014, Sistema launched an initiative aimed at streamlining its business and cut- for construction of radar stations. activities in a number of promising ting costs. NVision managed to retain RTI has a big portfolio of national areas, including the development its position in its traditional markets defence orders and the Defence of complex robotised energy and and maintained relationships with Solutions BU generates the highest transportation systems. such anchor customers as MTS, profit margin in the Group. VimpelCom, FGC (UES). Besides, The head company in RTI’s Micro- the company increased its customer Moreover, RTI develops its own electronics Solutions BU is NIIME base by adding such major custom- R&D competencies and pays a lot and Mikron («Mikron»). Mikron is the ers as the Moscow Department of of attention to the development largest microelectronics manufac- Information Technologies, Transneft, of R&D initiatives. In 2014, RTI turer in Russia, up to 50 mln of its Severstal, Special Economic Zones, started pre-project research and microchips per month are exported regional governments, etc. development of proprietary aero- to Europe, USA and South-East Asia. space systems (ASSs), which will RTI’s Defence Solutions BU demon- enable the company to enter new Currently, Mikron is implementing strated the highest growth rates promising markets. A programme ca. 40 R&D projects aimed at de- with revenues rising by almost 30% of cooperation between RTI and veloping nearly 100 new products, in 2014. This growth was driven by the Russian Academy of Sciences some of which are to be launched active implementation of contracts provides for a broad range of joint in the near future.

RTI Group’s revenue structure

Defence solutions ICS Microelectronics Complex security systems Other

50% 28% 16% 3% 3%

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT 57 In February 2014, Mikron completed tems, the world’s leader in e-design the development of its proprietary innovations, for chip design software No. 5 in terms of 65 nm chip technology and is now using 90 nm technology. microchip sales actively carrying out R&D work on among full cycle the 45 nm technology. Micron Group In 2014 Mikron: manufacturers in has set up a complete production Europe chain from chip development to • Supplied over 2 mln chips for pre- the final product, which allows it to vious-generation travel passports produce the entire range of high- and 800,000 chips for biometric tech products for the mass market: travel passports; 500 intelligent chip cards – smart cards, transport and other RFID cards (us- • Developed 32 types of integrated types of microchips ing Radio Frequency Identification circuits for industrial and com- in production technology), SIM cards, chip bank mercial applications; cards, social cards and other iden- tification documents, new products • Launched production of 51 inte- for industrial electronics. The com- grated circuits for various appli- pany supplies products to 400 cus- cations; tomers in Russia and 100 customers 3,500 in other countries. Moscow Metro, • Supplied 300 mln transport tickets; State Company Transportation customers Organizer from Saint Petersburg, • Exported 713 mln chips. state transportation companies in Kazan, Magnitogorsk, Tyumen, In 2014, RUSNANO acquired a Nizhny Novgorod are among Mikron 25.1% stake in Mikron as a result 60 Group’s customers. of conversion of its share in Sitron- countries of ics-Nano – a joint project between exports In March 2014, Mikron obtained a RUSNANO and Mikron to set up the licence from Cadence Design Sys- manufacturing of 90 nm microchips.

Key events

• In February 2014, Mikron became • In May 2014, Mikron became a • In December, Mikron produced a member of the OSPT (Open partner of the Silicon Trust interna- first Elbrus-2СМ processors man- Standard for Public Transport) Al- tional marketing programme, which ufactured with 90nm technology. liance, which was created in 2010 comprises more than 20 compa- Based on these processors, MCST by the leaders of the payment in- nies, including the world’s micro- plans to start production of com- dustry to develop new-generation electronics industry leaders such as pact motherboards «Monokub-M». fare payment systems. Gemalto, Giesecke & Devrient and Infineon Technologies.

Financial results of RTI

RUB millions 2014 2013 Change

Revenue 70,892 69,923 1.4%

Adjusted OIBDA 4,564 3,908 16.8%

Adjusted operating income 1,267 839 51.1%

Adjusted net loss attributable to Sistema (4,416) (670) -

Net debt 37,907 29,748 27.4%

58 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS In 2014, RTI’s rouble revenues increased by 1.4% year-on-year as a result of revenue growth at the Defence Solutions BU and the Microelectronics Solutions BU.

RTI Group’s revenue, were put on experimental combat the Information and Communication bln RUB duty during the reporting period. Technologies BU. 70.9 Rouble revenue at the Microelec- RTI’s adjusted OIBDA in rouble terms tronics Solutions BU grew by 4.1% increased by 16.8% year-on-year in 69.9 year-on-year in 2014, reflecting 2014 and by 23.6% year-on-year in higher sales of integrated circuits the fourth quarter, following revenue as a result of an increase in demand growth. The OIBDA margin of De- for home technology in the current fence Solutions BU exceeded 15% 2013 2014 economic environment. Thus, in and the OIBDA margin of Micro- 2014, Mikron produced more than 2.8 electronics Solutions BU increased In 2014, the Defence Solutions BU million chips for passports, delivered to 11%. The OIBDA loss of the delivered a 29.0% year-on-year 300 million transport tickets, and Information and Communication increase in rouble revenue, following exported 713 million chips. The reve- Technologies BU was reduced from the accelerating execution of radar nue growth in both BUs was, howev- RUB 2.5 billion in 2013 to RUB 0.8 station construction contracts, which er, offset by decreased revenues at billion in 2014.

Key segments results Defense solutions Microelectronics Information and Communi- solutions cation Technologies 32.2 10.2 24.9 33.3 9.8 24.1 17% 15% 11% 10% –2,5 –0,8

2013 2014 2013 2014 2013 2014

Revenue, bln rub Revenue, bln rub Revenue, bln rub Adj OIBDA margin Adj OIBDA margin Adj OIBDA,bln RUB

Growth of debt in 2014 was mainly due to from large state-owned banks against the tively zero interest rate). The debt related increased liabilities relating to the loans guarantees of the Defence Ministry and to state defence contracts accounted for received under state defence contracts with full compensation of interest (effec- 50.1% of the total debt amount.

Sales by geography Asia-Pacific Central and Eastern Europe Russia and CIS (excl. Ukraine) Ukraine

93% 3% 2%2%

Sales by currency

RUB USD UAH Other

83% 11% 3% 3%

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT 59 SG-TRANS

SG-trans is a leading railcar opera- under management in 2014. Siste- tor in Russia, accounting for about ma has been developing the trans- 40% of the county’s LPG tank car portation business in collaboration fleet. SG-trans owns a diversified with its industry partner Unirail fleet with more than 34,000 rail cars since late 2012.

Management President – A.R. Taicher Chairman of the Board of Directors – A.M. Uzdenov

Sistema’s Revenue Share of Number of rail Share of Russia’s effective Russia’s LPG cars under LPG transportation ownership tank car fleet management market 50% 20.4 40% 34.0 30% RUB bln thousand

Industry*

The fall in railway transportation (LPG) – one of the main segments over the year. The share of SG-trans volumes in 2014 was 0.8% compared of ST-trans – grew by 8% in 2014, in the LPG transportation market to a decrease of 2.8% in the previous while oil cargo volumes rose by 2% in 2014 was 30%. year. However, the negative trend is expected to continue due to the unfavourable market LPG gross production in Russia**, mln tonnes environment in 2014. 22.4 As in 2013, open-car shipments of 20.1 18.3 goods such as building materials, 16.4 17.3 ferrous and non-ferrous metal ore demonstrated the largest decrease. Transportation of fertilizers, grains and timber rose considerably, reflecting increased attractiveness of exports due to the rouble depreciating against the US dollar and favourable export prices. Freight volumes of liquefied gases 2010 2011 2012 2013 2014

* Source of information: Russian Railways, Cortes, Petromarket ** According to preliminary company data.

60 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS Despite the stagnation of driven by the increasing demand down as export attractiveness will transportation in certain segments, for petrochemical products and decrease amid falling prices and there is still a surplus of rail launch of new production facilities. reduced investments in the oil and car fleet in the market, mainly However, the growth rate will slow gas sector. attributable to state-owned rail car manufacturers, which is partially LPG transportation volumes on the Russian offset by a gradual replacement of old fleet by private carriers. Railways network, mln tonnes 18.5 19.4 The daily leasing rate for open rail 16.8 cars in December 2014 dropped by 15 15.8 approximately 25% year-on-year to RUB 425-450, for oil & petroleum tank cars it fell by 30% to RUB 600 per day, while the rate for LPG tank cars lowered only by 5% to RUB 1,400 per day.

The LPG transportation segment is expected to grow in 2015, 2010 2011 2012 2013 2014

Steady growth in 2014

In 2014, company management to the leasing companies earlier tracts. About 60% of the contracts of focused its efforts on streamlining than planned, which made it possi- SG-trans are long-term in nature, operational processes and optimis- ble to reduce cash outflows caused securing a strong market position. ing the rolling stock to meet cus- by a drop in leasing rates and In 2014, SG-trans customer base tomer requirements and to respond to reduce debt. exceeded 100 clients, including to the current market conditions. major oil and gas market players In particular, the leasing portfolio The company increased its own such as SIBUR, Bashneft, SANORS, was streamlined and part of the oil fleet of LPG tank cars to meet its NOVATEK, Rosneft. In 2014, Tatneft and petroleum fleet was returned obligations under long-term con- Group became SG-trans’ client.

Operated fleet size and composition

Oil tank cars LPG carriers LPG carriers Other

12,438 17,395 4,135 72

In addition, SG-trans successfully of low spot rates to rent additional rented rail cars in the total fleet operates in the sector of the loose railcars to facilitate volume commit- under management increased from and bulk cargo, providing services ments, as this was more efficient 12% at the end 2013 to 24% at the to metal and mining companies. The than purchasing railcars in current end of 2014. company chose to take advantage market conditions. The share of

According to preliminary company data.

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT 61 Growth of rail car fleet Operational strategy managed by SG-Trans In September 2014, Sistema ap- management will focus on main- 34,040 proved an updated development taining and expanding contracts 31,655 strategy for SG-trans, reflecting with current customers. 26,463 the new market environment. The main emphasis will be placed on In 2015, SG-trans may purchase new reducing costs and debt. Oil and rail cars, provided that favourable liquefied gas transportation will opportunities are presented and the remain the company’s target seg- demand for such cars is guaranteed. ment. Special attention will be paid Key investments will be made in the to financial discipline and cash company’s own railway infrastructure 2012 2013 2014 management efficiency. In 2015, and IT to reduce operating expenses.

In 2014, the company established a repair management business segment and concluded repair contracts with five companies. In 2014, SG-trans repaired about 4,000 rail cars. As part of an effort to cut costs the company purchases the most expensive components directly from producers.

SG-trans loading volumes, ktonnes

20,536 18,771

11,092

2012 2013 2014

Key events

• In January 2014, the consolidation >100 60% of SG-trans, Financial Alliance and Bashneft-trans was successfully customers of long-term completed. contracts

62 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS Financial results of SG-trans*

RUB millions 2014 2013 Change

Revenue 20,429 20,119 1.5%

OIBDA 6,253 6,016 3.9%

Net income attributable to Sistema 261 439 (40.5%)

Net debt 21,700 28,010 (22.5%)

Despite the unfavourable trends in management’s efforts were directed The railcar fleet under SG-trans’ the railway freight industry, SG- towards streamlining operational management increased by 7.5% trans increased its revenue by 1.5% processes and optimising the rolling year-on-year to 34 thousand units YoY, which was driven by increased stock to meet customer requirements (including 17.4 thousand of LPG shipping volumes for LPG, crude oil and to respond to the current market cars). The share of leased cars in and petroleum products. OIBDA rose conditions. Thus, the leasing portfo- the total fleet rose from 12% as of by 3.5% YoY as a result of railcar fleet lio was reduced and some of the oil the end of 2013 to 24% as of the optimisation and improved repair and and petrol rail cars were returned to end of 2014. Railcars in ownership maintenance management. the leasing companies earlier than accounted for 51% of the total fleet. planned, which made it possible to re- Net income fell year-on-year due to duce cash outflows caused by a drop a rise in interest expenses. In 2014, in leasing rates and to decrease debt.

SG-trans turnover, SG-trans debt mln tonnes*km profile 35,674 23.9 22.1

31,941 12.0 12.0 18,564 Leasing

Bank loans 5.3 10.1 11.9 5.3

2012 2013 2014 2012 2013 2014

* Sistema owns 50% of SG-Trans shares and does not consolidate this company in financial results. Data for 2013 are presented in accordance with US GAAP.

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT 63 MTS-BANK

MTS Bank is engaged in banking ac- systemically important operator in the tivities in Russia providing a complete payment, lending and savings market, range of financial services to individu- the bank has a strong position among als and corporate customers. Being a Russia’s largest banks.

Management President – I.V. Filatov (before March 2015 – M.M. Chaikin) Chairman of the Board of Directors – A.V. Abugov

Sistema’s Assets Gross loan Total Capital effective portfolio capital adequacy ratio ownership (N1.0) 87% 196.3 111.9 27.7 16.95% RUB bln RUB bln RUB bln

* Industry The past year was a challenging one for the financial sector. The increase Assets of the banking sector, in the CBR’s key interest rate from 77.6 5.5% p.a. to 17.0% p.a. and a sharp trln RUB rise in interest rates on other funding 23% 57.4 sources substantially increased the 19% 35% cost of borrowing. The slowdown in 15% economic growth rates prevented the 41.6 Russian banks from compensating 33.8 49.5 16% for this increase by active operations, 29.4 putting serious pressure on their revenues and capital levels. 2009 2010 2011 2012 2013 2014

Assets, trln RUB Growth rate According to the year-end results, the consumer lending sector Key Central Bank rate, % 17.00% demonstrated slower growth compared to the previous years. In addition to higher interest rates and slower economic growth, consumer lending was affected by tighter regulations introduced by the CBR, 8.75% a decline in real household income 7.75% 8.00% and gloomier consumer sentiment. 5.50% As a result, retail lending growth 8.25% rates dropped by half against 2013 and transactional risks increased considerably in all segments by the 2009 2010 2011 2012 2013 2014 end of the year.

* CBR

64 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS The situation in the corporate raising forced Russian companies to results, corporate lending grew lending segment is slightly different. borrow more actively in the domestic faster than retail for the first time in The restrictions on foreign fund- market. According to the year-end the last few years.

Growth rate of retail lending 11.3 40% 38% 10

7.7 30% 13% 11% 5.6 3.6 4 13%

2009 2010 2011 2012 2013 2014

Retail loans, trln RUB Growth rate

Corporate lending growth 32% rates 26% 29.6 22.5 13% 20 17.7 13% 14.1 13% 13% 12.5

2009 2010 2011 2012 2013 2014

Corporate loans, trln RUB Growth rate

Steady growth in 2014

Over the last three years, MTS Number of cards issued Bank strengthened its position as a by MTS Bank, mln 217 reliable savings institution. Following 224 the expansion of its regional office 191 network, the retail deposit portfolio grew by 23% year-on-year despite Plastic cards the negative market trends. issued, mln 163 32 15 22 29 Credit cards issued, mln 2011 2012 2013 2014

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT 65 The retail business imposes very strict requirements on bank capital. Capital adequacy ratio (N1), MTS Bank Over 2014, MTS Bank increased its capital more than twofold: at the beginning of 2015, the Bank’s equity 17.58% was RUB 27 bln against RUB 12 bln at the beginning of 2012. The largest increase in capital took place in 2014 and during an additional share issue, which was subsequently purchased 13.59% by MTS and Sistema and generated 13.26% RUB 13.1 bln for MTS Bank. 11.95% 11.38% 12.18%

01.01.2010 01.01.2011 01.01.2012 01.01.2013 01.01.2014 01.01.2015

In response to the deterioration which testifies to the bank’s mortgage loans and loans to of the macroeconomic conditions, reliability. SMBs (small and medium-sized the Bank adjusted its retail and businesses) for an amount at least corporate credit policies to reduce MTS Bank is included in the list equal to 1% of the Bank’s portfolio credit risks. In 2014, the Bank of banks that may receive state on a monthly basis. pursued a conservative provisioning funds from the Deposit Insurance policy, which will be also continued Agency for recapitalisation. Through In 2014, the Bank started issuing in 2015. In 2014, the Bank took participation in the programme, the China UnionPay cards. By joining timely measures to reduce costs Bank will be able to rise over RUB China UnionPay, the Bank substan- and optimise the retail office 7 bln for Tier 2 capital on attractive tially minimised the risks associated network. terms for a 3-year period. The with the processing of its payments main condition of the programme and was able to make attractive The CBR granted accreditation is that the recipient bank should propositions to sole traders and pri- to MTS Bank to provide financial provide loans to sectors that vate individuals in the Russian Far services to the companies operating are strategically important for East, who actively cooperate with in priority and strategic industries, the Russian economy, and grant suppliers from China.

Key events Operational strategy

• In March 2015, Fitch Ratings which was started in 2012, resulted confirmed the rating of MTS Bank in explosive growth in the retail at В+ with a stable outlook. assets portfolio, including the credit TOP-50 card segment. Over the last three • According to the 2014 year-end years the household loan portfolio results, MTS Bank was ranked Russian banks increased more than threefold with number eight among plastic card an annual growth rate of 62%. issuers. In 2012, MTS Bank completed MTS Bank’s strategy is aimed • In December 2014, MTS Bank rebranding and started the at development of retail lending successfully completed an implementation of its strategy and transactional services for additional share issue, raising based on synergies with MTS. The individuals segment. However, the RUB 13.1 bln. business model restructuring, Bank does not seek to turn into

66 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS a retail monoliner and maintains moderate growth rates in the target Capital adequacy ratio (N1) of Russian banks corporate segments, having kept its portfolio of corporate borrowers. 17.6% MTS Bank 17.1% ING Bank (Eurasia) The Banks’ operational strategy BNP Paribas provides for greater cooperation 16.2% with the mobile operator MTS. 15.5% TKS Bank MTS Bank already widely uses 15.1% CitiBank the operator’s retail chain and IT 15.0% Home Credit Finance infrastructure. In the future, the 14.2% MCB Bank and MTS intend to share a Unicredit Bank common database under the Big 13.7% Data Project in order to mitigate 13.5% Rosbank risks, boost sales and speed up 12.5% Gazprombank product development. 12.4% Raiffeisen Bank 12.3% Promsvyazbank 17.6% 11.7% VTB 24 11.6% Uralsib Result of MTS Bank 11.5% Sberbank

Financial results of MTS Bank

RUB millions 2014 2013 Change

Revenue 26,565 28,763 (7.6%)

Operating (loss)/income (15,252) 604 -

Net income/(loss) attributable to Sistema (11,212) 598 -

In 2014, MTS Bank’s revenues to lower revenues reported in the grew by 4.9% in 2014, gross loan decreased by 7.6% year-on-year in fourth quarter amid unfavourable portfolio increased by 3.1%. rouble terms. This was largely due market conditions. Interest income

Assets and loan portfolio, Interest and commission income, RUB bln RUB bln

220.4 220.7 24 25.1 198.5 183.8 4.6 4.4 2013 2013 2014 Interest income Commission income 2014

Assets The bank reported a net loss in interbank financing). MTS Bank has the fourth quarter and in 2014 due a conservative provisioning policy Credit portfolio to increased provisions for the and demonstrates high stability loan portfolio to individuals, which ratios. Its provisions/retail loans amounted to RUB 73 billion or 39% ratio amounted to 28% compared of total loan portfolio (including to 16% in 2013.

* CBR

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT 67 AGRICULTURE RZ Agro Sistema’s business in the agricultural sector is represented by RZ Agro (50%) and the Group of companies «Step». Group

RZ Agro Holding («RZ Argo») – is Sistema JSFC and members of the GC «Step» unites five farms located one of the largest producers of grain Louis-Dreyfus family. Currently it in the Krasnodar region, with a land and oil-bearing crops in the south comprises six farms grouped into bank to manage - 26.3 thousand of Russia with a land bank of 99 three regional clusters in the Rostov hectares. thousand ha, jointly controlled by Region and the Stavropol Territory.

Management RZ Agro: GC «Step»: CEO – S. MacFarlane CEO – K. Averin Chairman of the Board of Directors - T. Schultz Chairman of the Board of Directors – A. Uzdenov

Sistema’s effective Sistema’s effective Gross RZ Agro ownership in RZ Agro ownership in GC «Step» harvest land bank 50% 85% >470 125 ‘000 tonnes тыс. га

Industry* As a result of a steady growth of Russia, gross production of main producers (after China and India) grain exports over the last few years, crops – grain, oil-bearing plants, with 9% shares. Wheat production Russia, which has 9% of the world’s sugar beet, vegetables and fruit – in Russia grew by 13%, while the arable land, regained its status as grew considerably. growth in the total worldwide one of the largest global exporters. production in 2014 was only 1%. In 2014, grain exports from Russia The 100 mln tonne grain harvest totalled 27 mln tonnes, including became one of the largest in the last 20 mln tonnes of wheat, or 12% of 20 years. Wheat production amounted global wheat exports. In 2014, owing to 59 mln tonnes, placing Russia to favourable weather conditions in among the three largest global

Gross harvest volume of grain in Russia, mln tonnes 100 89 31% 88 29% 58 66 23% 28% 27 25 27 7% 17,7 16

2010 2011 2012 2013 2014

Gross harvest Export % of export

* Source: USDA, International Grains Council.

68 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS According to a forecast by the the same rate – around 1.5% per year, breeding industries. Production International Grains Council, in 2015- driven by the continuous expansion growth will be primarily driven by an 2020 global grain consumption and of the world’s population and rising improvement in crop yields. production will grow at approximately demand from the food and livestock

Wheat production and consumption forecast, mln tonnes CAGR stock ~1,5% 2,066 2,071 2,037 2,043 2,007 2,015 1,988 1,978 1,987 1,960 1,988 1,960 22% 21% 20% 20% 19% 19%

2014/15 2015/16 2016/17 2017/18 2018/19 2019/20 Forecast Production Consumption Stock / Consumption, %

RZ Agro Group operates in the So- of winter barley and approximately 9.5 mln tonnes of grain and grain thern and North Caucasian Federal 35% of oil-bearing crops produced legumes, almost 3 mln tonnes more Districts – Russia’s key grain pro- in Russia. In 2014, the grain produc- than last year. It was a record harvest ducing regions, which account for ers in Rostov Region, where the RZ of the last 24 years. about 70% of winter wheat, over 95% Agro Group has five farms, harvested RZ Agro today The total land bank under RZ Agro’s of land in its ownership. Around farms grouped into three territorial management is 99 thousand ha, 91% of RZ Agro land is under production clusters: Rostov-East, including 65 thousand ha (66%) cultivation. The Group includes six Rostov-South and Stavropol-West.

Lipetsk Tambov Land bank Saratov by clusters Kursk Voronezh (99,000 ha) Belgorod Volgograd

1 Rostov East 2 Rostov South 3 Stavropol cluster cluster cluster 1 • 43 kha • 47 kha • 10 kha • 3 farms • 2 farms Rostov-­on- • 1 farm • 30% freehold • close to Azov sea port 2 Don • 39% freehold, • 70% long term lease • 98% under freehold • 61% mid-term leases (maturity 13 years) (maturity 3 years Krasnodar 3 Stavropol

Novorossiysk port

RZ Agro is a highly specialised corn, pea, sugar beet. Livestock RZ Argo has developed and im- farm holding. In 2014, crop farming breeding is represented by First plemented a long-term crop rota- generated 98% of its total income. Cavalry Army Stud Farm – a famous tion plan, with minor adjustments The main crop types grown are horse breeding farm maintaining a made annually depending on the winter wheat, barley, sunflower, nucleus herd and having the largest expected profitability of crops and number of Budyonny horses. previous harvest.

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT 69 Structure of cultivated area in 2014

Winter grain Summer grain Sunflower Other oil-making Forage crops Legumes Sugar beet Par

48 13 8 8 4 4 1 14

In 2014, special attention was paid In 2014, RZ Agro carried out direct were made to install monitoring to soil condition diagnostics and grain deliveries to Egypt, Georgia, and security systems, such as fuel climate monitoring; soil remediation Armenia, Turkey, Iran, Saudi Arabia, consumption monitoring, video and land productivity improvement; South Africa. surveillance, fencing and automated implementation of technologies accounting. that help to adopt production to RZ Agro actively expands its pool of climatic changes, especially to counterparties by establishing part- In 2014, a new grain quality drought conditions. Starting from nership relations with end consum- laboratory was set up and outfitted the 2013/2014 production year, ers in the importing countries and on with modern equipment at SP certain drought-resistant crops the domestic market. To this end, co- Novotroitskoe (part of the Stavropol- such as camelina and sorghum operation is being strengthened with West cluster) along with a new were included in the crop rotation the Russian Export Insurance Agency electronic weighing scale with a schemes in the Rostov-East cluster. (EXIAR). Domestic sales (68%) are maximum capacity of 80 tonnes. The mainly made to medium-sized ex- quality laboratory at Krasnaya Zvezda RZ Agro sells approximately 90% porters and large trading houses and (Rostov-East cluster) received a new of its products on the international directly to domestic consumers. device for express analysis of grain. and domestic markets. The remaining 10% is used as seeds and Re-equipment of production is one of The company prepared a five- to pay land rent. RZ Agro’s priorities. In 2014, 13 new year production re-equipment units of modern tillage machinery programme for 2015-2020. The key Over the last four years, RZ Agro (cultivators, harrows), 4 sowing objectives are to continue replacing managed to increase its sales 5-fold machines, 1 tractor, 2 loaders, and old machinery with modern high- with the share of direct exports rising other agricultural machinery were performance units and to upgrade from 14% in 2011 to 32% in 2014. purchased. Additionally, investments the fleet and equipment.

GC "Step" today

In the second half of 2014, Sistema, enterprises located in the 6.7 tonnes/ha. The high (Class 3) via its wholly owned subsidiary Krasnodar Territory with a land export quality and proximity to Krasnodar-Argo, acquired another bank of 26.3 thousand ha under export ports enable the enterprises agricultural asset - Stepppe management. In 2014, the average to obtain maximum selling prices Group comprising five agricultural wheat yield at the enterprises was for their products.

Operational strategy

Management of agricultural assets duction and management expenses • grain procurement and trading is carried out through a cluster by using modern agricultural tech- (target procurement programme – approach, whereby self-sufficient nologies and implementing modern up to 500,000 tonnes per year); clusters of 30,000-50,000 ha of cost monitoring systems. • seed production and sale pro- closely located land areas work Sistema’s management focuses on gramme; together to optimise operating and the development of related activi- investment costs. • harvesting contracting (crop ties to enhance business efficiency. harvesting services in the north Operational strategy aims to in- Focus areas include: regions). crease crop yields and optimise pro-

70 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS Financial results of RZ Agro

RUB million 2014 2013 Change

Revenue 2 387 895 166.7%

OIBDA 735 (150) -

Operating income/(loss) 594 (241) -

Net income/(loss) attributable to Sistema 182 (187) -

Revenue of RZ Agro increased by 167% YoY driven by a record harvest of 300, 000 tonnes in 2014.

Gross harvest volumes, In 2014, RZ Agro developed its own RZ Agro exported wheat to Egypt, ‘000 tonnes export channels – the share of direct Georgia, Armenia, Turkey, Iran and export sales increased to 32% in 2014. other countries. 16.3 Key operating statistics 26.8 2012 2013 2014 (5 clusters) (5 clusters) (6 clusters)

Total land bank , ha 89,000 89,000 100,000

Freehold land ratio,% 15% 68% 66%

14.4 Cultivated land ratio, % 89% 89% 91% 18.6 Production (all crops), kmt 134 141 300 Wheat yield, t/ha 2.8 3.0 4.5 188.7

96.9 Export sales of RZ Agro 32%

2013 2014 22%

Wheat Barley 18% 68% Sunflower 14% 78% 82% Crop yield of wheat grew by 50% to 4.5 tonnes/ha, yield of barley in- 86% creased by 80% to 3.4 tonnes/ha, yield of sunflower also grew by 28% 2011/2012 2012/2013 2013/2014 2014/2015 to 2.3 tonnes/ha. The OIBDA margin Forecast expanded to 30.8%. Direct export Indirect export

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT 71 TARGIN

Targin is a major Russian oilfield Group consists of a managing services holding operating in the company and subsidiaries Republic of Bashkortostan, Nenets providing drilling, well repair and Autonomous District, Western workover, mechanical maintenance and Eastern Siberia. Targin and transportation services. TARGIN

Management President – K.F. Zakirov Chairman of the Board of Directors – F.V. Evtushenkov.

Sistema’s effective Revenue Transport Annual wells Employees ownership vehicles commissioning

100% 23.5 5,010 193 18,000 RUB bln

Industry*

The global oilfield services market Revenue of oil service companies in Russia, US$ bln reached US$ 150 bln in 2014, with Russia capturing about 17% of the market. According to expert Intensification 2.2 forecasts, over the next five years, the market may grow by 33%. The share of foreign companies in the Russian oilfield services market Geophysics 3.9 is about 18%, more than half of it is held by Schlumberger, a global oilfield services company. Targin’s share of the Russian market is Well servicing 4.4 around 2.7%.

Drilling 15.4

* Sources: RU-Energy, Delloitte, Vedomosti, Kommersant.

72 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS Drilling services occupy over half of for major Russian oil companies. own oilfield service divisions. The the Russian oilfield services market. Simultaneously, foreign players acquisition of Orenburg Drilling In 2014, Europe, the US and Can- started withdrawing from the Rus- Company and Weatherford’s drilling ada imposed sanctions restricting sian market, which may slow down operations by Rosneft will consider- access to drilling and production the implementation of new projects. ably increase the market share held technologies in Arctic environment These events forced Russian oil by domestic service divisions. and to offshore and shale projects companies to start developing their

Key players of Russia’s drilling market in 2014

Eurasia Drilling Surgutneftegaz Siberian Service Company Weatherford Ru-Energy Other

29% 24% 5% 5% 5% 32%

2014 was also marked by a trend Oil well drilling in Russia dropped by The demand for high-tech oilfield towards active market consolidation. 7% in H1 2014 for the first time since services is continuously growing. Closing of the transaction on the financial crisis of 2008-2009. The competitiveness of independent purchase of Russian drilling This drop is also associated with the service companies in the market industry leader Eurasia Drilling transition to horizontal drilling with is determined by the availability Company (EDC) by a global company its volumes increasing by 63%. The of cutting-edge technologies and Schlumberger will increase the share of horizontal drilling in Russia highly productive multi-functional concentration of players in the grew from 10% to 25% since 2011. equipment. market in the near future. Currently, only 20% of oil is extracted by tertiary recovery methods such as hydraulic fracturing and drilling multilateral wells. Steady growth in 2014

Sistema acquired Targin at the end formed four new workover crews, Rouble loans were obtained of 2013 and carried out work to purchased five mobile drilling rigs from Russia’s largest banks at modernise and restructure the busi- (160 tonnes each) and a 320 tonne comfortable terms to finance the ness in 2014. The completed consol- drilling rig, and upgraded five rigs investment programme. idation of the Group companies in (250 tonnes each). In addition, it accordance with the one segment – bought more than 290 units of In 2015, 60% of investment pro- one company principle will enable it special equipment, over 100 units gram will be directed at production to reduce costs in future periods. of process equipment for various development. The largest projects purposes and other. Approximately include acquisition of four drilling Implementation of the approved 40% of capital expenditure in 2014 rigs, two backfill equipment fleets investment programme will improve was invested in production devel- and two fleets of coiled tubing units the company’s technological infra- opment, with about 63% of the total with nitrogen pumping equipment, structure to a level in line with best cost spent on the drilling segment. modernisation of one drilling rig and industry practice in just a few years. Investment projects are financed purchase of over 150 specialised Capital expenditures totalled RUB with the company’s own (32%) and equipment units. 3.7 billion, through which Targin borrowed funds (68%).

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT 73 Geographical scope

2,100 people Drilling 42 drilling crews

2,200 people Moscow WRR* 175 WRR crews 8 FPCP** crews

Mechanical 4,200 people service 2 plants

9,100 people Transport > 5,100 units of equipment

One of the objectives of Targin was to diversify its client base Operational strategy following reorientation of the company from Bashneft’s oilfield Targin’s strategy focuses on increas- services division. In 2014, in addition ing its market share and diversifying to Bashneft, the company also its client base by providing a full cycle provided services to Rosneft and its of high-tech drilling services. The 130 subsidiaries, Gazpromneft, Slavneft- Drilling segment plans to develop well Megionneftegaz, and others. construction services and new service types of oilfield Bashneft accounted for about 77% of areas in line with the development of services the company’s revenues in 2014. Russia’s oil and gas industry.

In 2014, Targin commenced The well repair and workover seg- project in Serbia under a well ment requires implementation of 290 repair contract. After successful new technologies and services for drilling and completion of the first stage, the emergency response and develop- repair crews number of crews for the project may ment of enhanced oil recovery and be increased. Drilling services are other techniques. also planned for the future. The key objective of the Logistics In 2014, Targin started a project to segment is to maintain the fleet age provide integrated services involving structure in line with the require- the preparation of wells for hydraulic ments of the main customers. The fracturing. key target is the transition from conventional transportation service to transport logistics.

* WRR - Wells repairs and renewals ** FPCP - Flexible pump and compressor pipes

74 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS Financial results of Targin

RUB millions 2014 2013 Change

Revenue 23,549 24,435 -3.6%

OIBDA 3,008 1,901 58.3%

Operating income 1,731 1,136 52.3%

Net income attributable to Sistema 1,032 459 124.8%

Sistema acquired Targin in October the Group’s consolidated revenue and During 2014, Targin’s business 2013. During 2014, Targin contributed OIBDA, respectively. OIBDA margin was restructured and its operating RUB 23.5 billion and RUB 3.0 billion to grew from 7.8% to 12.8%. facilities underwent reconstruction. Capital expenditures totalled RUB 3.7 billion, through which Targin Operational results Operational results in formed four new workover crews, purchased five mobile drilling rigs in the Drilling the Well Repair and (160 tonnes each) and a 320 tonne segment Workover segment drilling rig, and upgraded five rigs (250 tonnes each). In addition, it 1 158 bought more than 290 units of special 193 1 138 equipment, over 100 units of process equipment for various purposes and other. Approximately 40% of capital expenditure in 2014 was invested in production development, with about 63% of the total cost spent on the drilling segment.

161 167 175 RUB 23.5 bln 408 407 Revenue 2013 2014 2013 2014 12.8% Drilling volumes, Workover, th m khours OIBDA margin Commissioned wells Crews

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT 75 BINNOPHARM

Binnopharm is a pharmaceutical diseases (oncologic, haematologic, company that operates one of Rus- contagious and respiratory diseases). sia’s largest full-cycle manufacturing facility, producing biotech drugs in Binnopharm Group includes Ali- line with the international quality um Plant - a modern complex for standard GMP (Good Manufacturing production of infusion solutions – company of JSFC Sistema Practice). The priority areas of the and distribution company Binno- company’s activities include devel- pharm Distribution, which sells opment and commercialisation of both Binnopharm’s and third-party drugs for treating socially significant pharmaceuticals.

Management CEO – A.N. Chupin Chairman of the Board of Directors – D.L. Zubov

Sistema’s Revenue Area of Area of Supplied doses effective Binnopharm Alium of Hepatitis B ownership plant plant vaccine 74% 2.5 32,000 19,000 5.4 RUB bln m2 m2 mln

Industry*

The Russian pharmaceutical market Volume of Russian pharmaceutical market remains one of the fastest growing and share of foreign players, mln RUB markets in the world. According to DSM Group, the total market size 1,142.0 increased by 9.3% in value terms 1,045.2 in 2014 to RUB 1.14 trn, with the 920.0 commercial segment increasing 824.0 by 10.8% and hospital segment by 735.0 10.0% in monetary terms, while the 857.0 778.2 additional pharmacological support 686.0 segment contracted by 0.9%. 524.0 598.0

211.0 226.0 234.0 267.0 285.0 2010 2011 2012 2013 2014

* DCM Group Russian producers Foreign producers

76 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS Most of the year-on-year growth Volume of state procurements in pharmacy in the Russian market came from increases in product selling prices; and share of Russian players, bln RUB in physical terms, the market contracted by 3.6%. According to 285 estimates by the Russian Ministry 267 of Health, the market share held by 226 234 foreign manufacturers in 2014 was 211 over 70% in monetary terms.

The key focus of the import 79% substitution programme is placed 76% 85% on increasing the share of Russian 77% 77% manufacturers in the pharmaceutical industry. The most important event in 2014 in the state control over the industry was a resolution prepared 23% 24% 24% 21% 15% by the Ministry of Industry and Trade, banning the admission of foreign 2010 2011 2012 2013 2014 drugs to government tenders in case Fact Forecast two or more bids are received from Russian manufacturers. Russian producers Foreign producers

Another important event in the sector in 2014 was the entry into Binnopharm’s business in 2014 force of Federal law “On contract system in the area of state Binnopharm Group procurement” and the government’s transition to the Federal Contracting System, which had a short-term Binnopharm effect of reduction in regional purchasing volumes. State-of-the-art biotech production, meeting the Experts are mostly positive on GMP and ISO standards with area of 32 thousand square meters the outlook for the domestic pharmaceutical market. According 20 thousand square meters of classified to the latest forecasts by DSM premises Group, market volumes will grow by Strong R&D department with a number of around 9% in 2015 versus 2014. The biotech products in a pipeline growth in the commercial segment is expected at about 10%, and in the state segment at about 6%. Most of that growth will be provided Alium Binnopharm Distribution by the Russian pharmaceuticals, facilitated by the import substitution programme. • I.V. generics production • Presence in nearly 30 corresponded to GMP regions across Russia requirements • Sales of third-party • Located in 5 km from Moscow products, mainly in ring road the hospital segment (government procurement) • An overhaul project in 2013-2014 - replacing the filling line bottling • Direct contract with big from glass bottles to modern international companies plastic containers • Sale of Binnopharm’s • Current production capacity: products 14.4 mln plastic bottles per year; launched in September 2014

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT 77 In 2014, Binnopharm’s results In 2014, Binnopharm continued The expected revenue fall due to were affected by the government’s deliveries of Regevac (a hepatitis structural changes was offset by transition to the Federal Contracting B vaccine) under government adequate optimisation measures: System. After the relevant law took contracts. The delivery volume in selling, administrative and man- effect, regional purchases of drugs 2014 dropped by 1.8 mln doses from agement expenses were reduced by were virtually frozen, resulting the previous year to 5.4 mln, which RUB 70 mln, and thus the ratio of in more than 45% reduction in also contributed to the decline in the these expenses to revenue remained Binnopharm’s distribution revenues company’s revenue. at the level of the previous year. in the first half of 2014.

Binnopharm’s annual output capacity, mln pcs

Tablets Capsules Ampoules Aerosols Syringes up up up up up to1,400 to 45 to 80 to20 to 18

Binnopharm actively cooperates with ViiV Healthcare and Fresenius Kabi). In 2014, a new drug, Beklometazon foreign manufacturers under the ex- In early 2015, Binnopharm’s facility (aerosol for treatment of lung isting contract production agreements started repackaging operations for diseases), was registered, the market and plans to enter into new ones Ketosteril – one of the key products in for this product in Russia is estimated (among the company’s partners are Fresenius Kabi’s Russian portfolio. at RUB 500 mln per year.

Key events

• In February 2014, Binnopharm continue ViiV drug production at • In December 2014, Alexey launched a new syringe line for Binnopharm’s facilities up to the Chupin was appointed CEO of production of pre-filled syringes. end of 2016. Binnopharm. The line has an annual capacity of 18 mln of syringes. Registration of • In September 2014, Binnopharm • In December 2014, Binnopharm’s Binnopharm’s biotech products in launched its upgraded filling line aerosol product line was expanded the new form is in progress. for infusion solutions at the Alium following the registration of plant. Binnopharm also signed Beklometazol; development and • In March 2014, the company new cooperation agreements registration of new drugs are signed an agreement with with international pharmaceutical underway. ViiV Healthcare Trading to companies.

78 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS Operational strategy

The key objective of the company’s of clinical research for its own forms will be ensured through im- operational strategy is to expand biotech drugs – Interferon α2β, plementation of contract production the company’s own drug portfolio Erythropoietin α will be carried projects with foreign pharmaceuti- and efficiently utilise its main out in 2015. Binnopharm actively cal companies and commencement production units: biotech production works on the list of drugs to of Binnopharm’s generic drugs facility, aerosol line, lines for develop in the medium term, both production. Alium Plant is currently production of solid drug forms by the in-house R&D department producing simple infusion solu- and infusion solutions. and through technology transfer tions – dextroglucose and sodium by obtaining production licenses chloride. In 2015, the plant will start Binnopharm will continue producing for the new drugs. production of amylum and intrave- Regevak B vaccine, erythropoietin β, nous generics that do not require interferon ingredient. Furthermore, Utilisation of the lines producing clinical trials and may be registered the second and third phases aerosol and solid pharmaceutical by the end of 2015.

Financial results of Binnopharm

RUB millions 2014 2013 Change

Revenue 2,485 3,321 (25.2%)

OIBDA 322 652 (50.7%)

Operating income 136 425 (68.1%)

Adjusted net income attributable to Sistema 4 285 (98.5%)

Binnopharm’s rouble revenue Binnopharm’s sales In 2014, Binnopharm’s OIBDA declined by 25.2% year-on-year in decreased following a decline in 2014 and by 33.1% year-on-year in of Regevak revenue and gross profit. A drop the fourth quarter. The results were in revenue was expected due impacted by the entry into force of 538 to structural changes, but this the Federal law “On the Contract was supported by corresponding System in the State and Municipal optimisation measures, which led Procurement of Goods, Works to Binnopharm’s SG&A expenses and Services” and government’s 350 falling by RUB 70 million in 2014. transition to the federal contract The SG&A/revenue ratio therefore system which practically put remained at the same level freeze on regional procurement 970 as in 2013. of medicines and resulted in a temporary decrease of revenues 600 from Binnopharm’s distribution business by more than 45% in the first half of 2014. However, 2013 2014 government procurement of drugs is generally expected to increase in 2015. Furthermore, Binnopharm Sales of Regevak B, will participate in the government’s mln rub import substitution programmes for Supply of Regevak B, drugs as a local manufacturer. thousands doses

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT 79 REAL ESTATE

This business area is represented most and Mosdachtrest. Sistema’s with further monetisation through by a number of companies, in- strategy in real estate business is rent income, development and sale. cluding the following key players: focused on increasing the value of Leader-Invest, Business -Nedvizhi- the portfolio under management

Management

Leader-Invest: Business-Nedvizhimost: Mosdachtrest: CEO – E.G. Rubtsov CEO – I.V. Shabdurasulov CEO – S.V. Gavrilenko Chairman of the Board Chairman of the Board Chairman of the Board of Directors – F. V. Evtushenkov of Directors – L.A. Monosov of Directors – S.A. Drozdov

Sistema’s Under Under Cottages effective design and management ownership construction 100% >388 >442 >60.1 ‘000 m2 ‘000 m2 ‘000 m2

Industry* In 2014, new residential space Deals with real estate in Moscow, commissioned in Moscow increased for 5 years to 3.2 mln m2 from 3.1 mln m2 21,251 18,650 in 2013. Between January and October 2014, 135,370 real estate transactions were made on the 35,282 market, which is only 7% lower than 12,107 35,725 the record of 2013. 4,555 1,402 31,961 24,770 19,798

145,775 135,370 96,656 85,650 91,224

2010 2011 2012 2013 2014

Purchase and sale Mortgage Share participation agreement

Sources: Rosreestr, AHML, Knight Frank, ILM

80 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS Early 2015 saw a decline in segment will be the construction However, the anti-crisis measures purchasing activity due to a rise of comfort class housing where taken by the Russian Government to in mortgage interest rates and the share of mortgage-based subsidise mortgage interest rates toughening of requirements for transactions is about 60%. are expected to support the market borrowers. The most badly-hit in the second half of 2015.

Weighted-average mortgage rate for 5 years 14.6% 14.6% 14.4% 14.3% 13.6% 13.5% 13.4% 13.1% 12.8% 12.7% 12.6% 12.4% 12.4% 12.3% 12.2% 12.2% 12.2% 12.2% 12.2% 12.1% 12.1% 12.0% 11.9% 13.5% 13.5% 113.1% 12.7% 11.1% 11.1% 11.1% 11.0% 10.8%

The interest rate on ruble loans 9.8% 9.8% 9.8% 9.7% 9.7% 9.7% 9.7% 9.6% 9.6% 9.6% 9.6% 9.5% 9.4%

The interest rate on foreign currency loans 9.3%

I II III IV I II III IV I II III IV I II III IV I II III IV I II III ‘09 ‘09 ‘09 ‘09 ‘10 ‘10 ‘10 ‘10 ‘11 ‘11 ‘11 ‘11 ‘12 ‘12 ‘12 ‘12 ‘13 ‘13 ‘13 ‘13 ‘14 ‘14 ‘14 It is most likely that in 2015 the Office real estate, competition among developers will increase and the market will become commissioned in 2014, a buyer’s market: the quality of ‘000 m2 properties offered in the primary 1,366 market is expected to increase along High volatility in currency markets with active promotion campaign. in late 2014 resulted in a decline in average rental rates by 10% to The office property market hit a 707 650 15% depending on the class of record high in new space delivery properties. (1.4 mln m2), which is almost two times more than in 2013. The 9 vacancy rate grew by 29% for A class space and 17% for B class space Class А Class B+ Class B- Average amid depressed demand caused by general economic crisis. Dollar- denominated rental rates fell by Rent rates more than 10%. Class А

2 Class В During 2014, 1.29 mln m of office 850 space was rented or bought out, 15% lower than in 2013. The activity 830 833 800 of tenants and investors slowed 760 710 690 down by the end of 2014, and in 2015 670 685 the demand for office space may continue falling. 455 480 483 492 400 430 410 410

2008 2009 2010 2011 2012 2013 2014 2015 2016

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT 81 The planned increase in new space According to the 2014 end year results, The Moscow premium rental market delivery in 2014-2016 (almost 3 mln the demand for rent of premium in 2015 will depend on two key m2) amid slack demand may lead to real estate dropped by 9% year-on- factors: geopolitical situation and a further increase in vacancy rate year. The main reasons for the fall in currency exchange rates. to 30% on average, decline in rental demand for properties of this category rates by 10% and toughening of are the general economic situation as competition among the landlords. well as the practice of setting rental rates in foreign currency prevailing in the market.

Steady growth in 2014

Sistema’s real estate assets are In April 2014, Sistema acquired six properties located in the centre grouped into several distinct an additional 49% stake in Busi- of Moscow with a total area over areas – real estate management, ness-Nedvizhimost for RUB 3.1 22,000 m2, which were cleared from development, and management of bln, bringing its stake to 100%. the MGTS equipment. Serebryany Bor real estate – which Business Nedvizhimost owns 76 are represented by Business- real estate sites located across In 2014, Business-Nedvizhimost Nedvizhimost, Leader-Invest and Moscow which cover a total area completed the sale of a property in Mosdachtrest, respectively. of approximately 178,000 m2 and Moscow’s downtown and entered were used by MGTS as automat- into a new project together with Leader-Invest is a development ic telephone stations (ATS) prior a co-investor partner for the company investing in construction to the implementation of GPON construction of a residential building of residential property (comfort, (Gigabit-capable Passive Optical with a total area of 13,000 m2 and business, premium and deluxe Network) technology. aggregate apartment space of 6,300 classes in the Central Moscow) and m2. The project will be completed in commercial property. Business-Nedvizhimost provides the first quarter of 2016. professional and management ser- As at the end of 2014, the vices both for its own commercial Mosdachtrest is a management development project portfolio held real estate and that of its partners, company focusing on the rental by Leader-Invest included 13 real including renting and selling of and maintenance of cottages estate objects with a combined buildings. Business-Nedvizhimost (Serebryany Bor, Barvikha, area of 388,000 m2. Six of these owns a unique pool of real estate Zhavoronki, Trudovaya) and office properties with a combined properties: mansions in the centre premises in Moscow. The total area of 103,000 m2 are under of Moscow, office and retail prop- cottage area as at the end of 2014 construction. In 2014, Leader- erties, business centres located was over 60,100 m2. Invest continued implementation virtually in every district of Mos- of the project for the construction cow, industrial and warehousing In 2014, Mosdachtrest approved of an office building in Nagatino properties in Moscow and Moscow the architectural concept for iLand with a total area of 31,000 Region. The total portfolio of prop- reconstruction of buildings m2. The company successfully erties under management as at the and performed repair work in completed work on renovation of end of 2014 was over 442,000 m2. Serebryany Bor cottages. three buildings (former automatic telephone exchanges) totalling In 2014, a detailed operational 28,000 m2 in area and signed programme was developed for contracts to participate in shared- further commercialisation of the equity construction of 6,600 m2 buildings previously occupied by of apartments worth RUB 1.4 bln ATS. During 2014, the company in total. partially renovated premises in

82 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS Key events

• In April 2014, Sistema acquired an • In early 2015, Business additional 49% stake in Business- -Nedvizhimost acquired a 51% Nedvizhimost for RUB 3.1 bln. stake in Rent-Nedvizhimost for RUB 3.8 bln.

Operational strategy

In accordance with the set 41,800 m2. Also, there is a plan for The operational strategy of objectives, in 2015 Leader-Invest Business -Nedvizhimost to transfer Mosdachtrest in 2015 will focus on plans to put into operation three 16 properties with a combined area maintaining a steady rental cash projects totalling 11,300 m2 in area of 179,000 m2 to Leader-Invest for flow as well as reconstruction and start construction of four real development in 2015. and monetisation of cottages in estate objects with a total area of Serebryany Bor.

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT 83 SISTEMA SHYAM TELESERVICES

Sistema Shyam TeleServices Ltd. providing telecom services in India (SSTL) is a CDMA mobile operator under the MTS brand.

Management CEO – D.V. Shukov Chairman of the Board of Directors – R. Sommer

Sistema’s Revenue Regions of Subscribers Data services effective operations in subscribers ownership India 56.7% 220.7 9 9.1 1.6 US$ mln mln mln

Industry*

The telecom market in India Data services segment is the major growing by 114%, and 2G network continued to grow steadily in 2014, driver in the industry’s development. traffic growing by modest 41%. Over with most of its growth coming from During 2014, traffic generated by the year, the share of 3G services GSM subscribers and accelerated 2G and 3G broadband services grew as a percentage of total telecom development of the data services. by 74%, with 3G network traffic services rose from 42% to 52%. As of December 2014, the total subscriber base in the country reached a historical high of 971 mln with the total penetration of 77.6%. Data services penetration in India 5.6% The active subscriber base grew by 9.2% over the year.

CDMA subscriber base and market share contracted by 1.1%. Although 3.3% several companies left the market in 2012-2013, there are still 12 mobile operators in the country, including 8 GSM operators, 3 GSM/ CDMA operators and one CDMA operator (SSTL). The top three 0.96% 1.1% 1.2% operators in India (Bharti Airtel, Vodafone and Idea) strengthened their positions in 2014 with a combined market share based on subscriber base exceeding 58%. 2010 2011 2012 2013 2014

* Source: TRAI, Statista.com

84 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS 15% each quarter, the current Smartphones penetration penetration rate is only 22%. The aggressive growth is supported in India 34% by active promotion of low-priced handsets. 30% 27% Operators in India are starting to develop and promote 4G (LTE) networks and services in the 22% market. With about 5.5 mln 4G subscriber terminals purchased in the country, only 85 thousand of them are active. The competition in 14% the data services segment should become tougher considering the scheduled launch of LTE by RJIO 9% and growing market activity of 3G 5% operators.

2011 2012 2013 2014 2015 2016 2017

Fact Forecast

The 900 and 1800 MHz licenses auction terms, the starting prices in the country, the Government of of Airtel, Vodafone, Idea Cellular for 800 MHz frequencies were India prepared draft regulations on and Reliance Telecom will expire almost twice as high as the price the spectrum sale and spectrum in 2015-2016 in 18 districts. In this quoted at the last auction in March sharing by operators; however, connection, the Indian Ministry 2013. SSTL did not participate these regulations are not expected of Communications held a new in the auction. to be finalised and approved auction in March 2015 for a number until the second quarter of 2015 of frequency bands, including 800 To provide more efficient utilisation at the earliest. MHz used by SSTL. According to the of the limited frequency resources

Steady growth in 2014

In 2014, SSTL’s revenue in Indian SSTL subscriber base rupees grew by 10% from 2013, with a 33.6% increase in the revenue 8.5 from data transmission services - of 7.4 company’s key area of development. The share of data revenue in total sales grew from 27% to 47%. 1.3 1.6

2013 2014

Voice subscribers, mln Data subscribers, mln

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT 85 In March 2014, SSTL introduced viewers, marking a new record in sales model in Gurgaon and New one of the cheapest rate plans in viewing on Youtube in India. Delhi, a pilot project in Kerala India for data services, presented its providing distributors with loans own Internet movie theatre called SSTL was able to rapidly develop to purchase voice devices and data MTS Movies, where the subscribers its data services by introducing transmission equipment, and a can watch movies free of charge, measures to streamline and model for sharing revenue with and conducted an active marketing improve sales efficiency. This distributors in Delhi. campaign, with the MTS Internet included implementing a pilot Baby video watched by 25 mln of project to launch SSTL’s distribution

Key events Operational strategy • In July 2014, SSTL started The key strategic objective of growth in the data segment, active selling a new innovative device SSTL in 2015 is to achieve OIBDA monetisation of voice services and (Mblaze PowerWifi) – a mobile breakeven. SSTL will focus on optimisation of company costs. Wi-Fi router with high-capacity storage battery and smartphone recharging function.

• In October 2014, SSTL launched a new advertising campaign GB Festival and started promotion of a new line of data rate plans, thus strengthening its position as a price leader.

• In 2014, for the third year in a row, the MTS brand was included in the list of Brand Equity 50 Most Trusted Service Brands in India. The brand was also recognised as the most innovative brand in the telecom sector in India and ranked among the top three most recognizable brands of mobile Internet providers.

86 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS Financial results of SSTL

US$ millions 2014 2013 Change

Revenue 220.7 209.4 5,4%

Adjusted OIBDA (81.5) (146.5) -

Adjusted operating loss (141.8) (210.2) -

Adjusted loss attributable to Sistema (129.7) (225.1) -

Net debt 544.0 568.6 (4.3%)

SSTL’s revenues increased by 5.4% VAS accounted for 46.9% of the opera- In 2014, SSTL significantly narrowed year-on-year in 2014, mainly as a result tor’s total revenue in the fourth quarter its year-on-year adjusted OIBDA loss of development of its data segment. of 2014, compared to 34.5% in the by 44.3% through its cost optimisa- Non-voice revenues from both data and corresponding period of 2013. tion programme despite the active marketing campaign it conducted in the fourth quarter of 2014. SSTL results in local currency 3,520 3,508 3,188 3,348 3,427 2,909 2,844 2,996

47% 43% 35.7% 34.4% 34.5% 34.5% 34.5% 38.6%

I '13 II '13 III '13 IV '13 I '14 II '14 III '14 IV '14

Revenue, mln rupees Share of non-voice revenues

SSTL operating results 115 117 117 95 97 107 81 89

414 363 373 416 401 401 295 328

I '13 II '13 III '13 IV '13 I '14 II '14 III '14 IV '14

ARPU (rupees) MOU (min)

As of December 31, 2014, SSTL’s wire- er base grew by 23.0% year-on-year by 6% year-on-year to 396 minutes. less (voice and data) subscriber base in 2014 to 1.6 million. In the fourth Blended mobile ARPU in rupees grew totalled 9.0 million. The data subscrib- quarter, subscribers’ MOU increased by 26% year-on-year to INR 122.

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT 87 SISTEMA MASS MEDIA

Sistema Mass Media (SMM) is one telecom operators. SMM owns and of Russia’s leading media holdings manages STREAM TV Company that manages media assets in pay JSC («Stream TV»), RA Maxima JSC TV, advertising, digital content («Maxima»), TsTC LLC («TsTV»), and distribution and VAS services for Stream LLC («Stream»).

Management President – G.Sh. Khasianova Chairman of the Board of Directors – A.V. Abugov

Sistema’s Revenue Audience Own TV Pay TV effective channels subscribers ownership 86% 3,4 30,2 9 11,8 RUB bln mln mln

Industry* Russia’s multimedia market in Pay-TV market in Russia 2014 was affected by the overall slowdown in economic growth 40.9 rates and changes in the geopoliti- 37.1 35.1 cal situation. 31.9 In the segment of TV content pro- 28.7 duction, changes in the geopolitical situation caused a decline in sales 75% of Russian content in Ukraine and, 64% 68% as a result, a fall in profitability 58% of Russian producers. The neg- 53% ative effect was partially offset by the growth of the Russian pay TV market. Due to the rapid growth of digital technologies, the market ex- perienced considerable changes in terms of subscriber base structure, 2011 2012 2013 2014 2015 with the share of cable TV subscrib- ers dropping from 52% to 49%. Pay-Tv subscriber base, mln

* Association of Russian Communication Pay-TV penetration Agencies, ZenithOptimedia, company data.

88 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS In 2014, the federal Law «On Mass of foreign TV channels broadcast via exceeding 25% regained this right. Media» was amended to include cable networks and public media provisions which capped the stake holdings with foreign participation. The most promising segments in the that can be held by foreign compa- industry under the current condi- nies in any Russian media at 20%. Advertising on non-terrestrial tions are still represented by digital The law affects the following three channels has been banned with media and Internet advertising using groups of market players: represen- effect from January 1, 2015; how- new audience targeting and analysis tative offices of foreign publishing ever, in February 2015, commercial tools and technologies. holdings in Russia, Russian versions channels with a foreign content not

Steady growth in 2014 Key events

In 2014 work to optimise Sistema’s In 2014, Stream LLC launched a • In March 2014, Gyulnara media assets and improve their new area – mobile advertising Khasianova was appointed SMM efficiency continued, allowing SMM and distribution of А2Р messages President. to generate a net profit despite the with information and service general deterioration of the situation content based on its own • In April 2014, ORK signed a in the industry. proprietary solution. The successful contract to launch a full-cycle implementation of the strategy film production project under the Stream TV channels maintain their ensured considerable growth of order of Rossiya Channel. leadership position in the market revenue and OIBDA. The revenue in terms of average annual reach grew by approximately 60% to • In October 2014, Okhota i Кybalka in the majority of niche groups. RUB 1.3 bln, while OIBDA reached (Hunting and Fishing) TV channel The company has been actively RUB 330 mln, with the increase in owned by TVC Stream won in the expanding its subscriber base in the OIBDA margin from 7% in 2013 to «Best Lifestyle Channel» category Russian and CIS markets: in 2014, 26% in 2014. at the Golden Ray Awards. its subscriber base grew by 10.3% to 11.8 mln. • In December 2014, SMM took TC Stream subscriber control over Stream LLC. In 2014, Stream LLC, which provides a universal multimedia base, mln entertainment service, actively developed in cooperation with MTS 10.7 11.8 the following services launched in 2013: GOOD’OK (RBT – replacing the usual ringback tone sound 7.7 with music), MTS-Info (information services for MTS subscribers), MTS Puls (application with entertainment content for mobile phones). The GOOD’OK service was also launched for subscribers of MTS Ukraine and MTS Belarus in 2014. Primary sales of RBT service to MTS Russia subscribers grew by 31% over the year. 2012 2013 2014

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT 89 Operational strategy

SMM’s strategy aims to further In the situation of changes in Stream’s development strategy improve efficiency and profitability market conditions, Stream TV will envisages further development of in traditional areas and launch new focus on retaining current positions value-added services (VAS) for MTS business areas in digital media and and increasing distribution in the and development of mobile adver- online advertising. CIS markets. The company plans to tising services (A2P) in partnership launch and promote an international with MTS. version of the Hunting and Fishing Channel and special versions of channels for foreign markets.

Financial results

RUB millions 2014 2013 Change

Revenue 3,366 3,498 (3.8%)

OIBDA 977 1,454 (32.8%)

Operating profit 308 199 54.7%

Net income attributable to Sistema 95 15 554.0%

Net debt 292 204 43.1%

Revenue of SMM in rubles fell by year and by 65.0% year on year in advertising budgets led to a fall in 3.8% for the full 2014 and by 28.1% the fourth quarter of 2014. Decrease demand for TV series) as well as year on year in the fourth quarter. in revenues and OIBDA was due the loss of the market of Ukraine OIBDA in rubles decreased in 2014 to a general deterioration of the for the re-sale and distribution by 32.8% compared to the previous situation in the industry (reducing of television series.

90 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS CORPORATE GOVERNANCE SYSTEM

Corporate Governance Principles 92

Corporate Governance Structure 93

General Meeting of Shareholders 94

Board of Directors 96

Commitees of the Board of Directors 99

President and the Management Board 101

Internal Control and Audit 103

Development of the Corporate 104 Governance System in 2014

Remuneration 105

Risks 106 Corporate Governance Principles

Maintaining the system of corporate reporting, control and audit, risk The Corporation’s main governance governance and transparency management. bodies are: the General Meeting of at the level of the world’s best shareholders, the Board of Directors, practices is one of the crucial Sistema’s principles and procedures the President and the Management elements of the strategy of Sistema of corporate governance are Board. The Board of Directors and as an investment company. High set forth in its Charter and a the President have committees that quality of corporate governance number of publicly available conduct a more in-depth analysis of and informational transparency internal regulations. Together the proposed solutions in specific enable the company to attract these documents define the areas and develop recommendations partners and investors and increase structure and competence of the for the governance bodies return on equity by taking more Corporation’s governance and of Sistema. efficient managerial decisions. The control bodies. The Corporate Corporation’s corporate governance Governance and Ethics Code sets The existing organizational structure system is based on the following forth additional commitments of of the Corporation that was adopted core principles: Sistema in the area of transparency, in December 2013, including the social responsibility, and ethical adjustments and amendments made • transparency and clarity of all business principles. later, reflects Sistema’s operation processes for investors and in accordance with investment partners; Sistema makes every effort to bring company model. its corporate governance practices • a transparent dividend policy; in line with the recommendations • an active and professional Board of specified by the Bank of Russia in Directors; the Corporate Governance Code (Letter of the Bank of Russia No. • investment decisions made in 06-52/2463* dated April 10, 2014) compliance with the established and the guidelines set out in the procedures; UK Corporate Governance Code.** The consistency of Sistema’s • the attention of the Board of corporate governance practices Directors to all transactions with with the standards set out in the related parties; Corporate Governance Code and • an active role of the Board of the UK Corporate Governance Code Directors in the strategic planning is analyzed in Annexes 9.7 and 9.8 process; to this report. Where corporate governance practices at Sistema • development of corporate deviate from the recommendations * The text of the Corporate Conduct Code governance in portfolio companies. is available at the following address: set forth in the above documents, http://www.cbr.ru/sbrfr_new/files/legislation/ the Corporation clarifies how the letters/2014/Inf_apr_1014.pdf Sistema is guided by these balance of interests is otherwise ** The text of the UK Corporate Governance principles in all of its activities, maintained in accordance Code is available at the following address: http:// including strategic and financial with the applicable standards www.frc.org.uk/Our-Work/Publications/Corporate- -Governance/UK-Corporate-Governance-Code- management, HR and social policy, of corporate governance. -September-2012.aspx

92 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS Corporate Governance Structure of Sistema JSFC*

Secretariat of the Chairman of the Board of Directors Board of Internal Control and Audit Directors Department Executive Vice-President – Secretariat of the Board Chairman of Board of Directors Head of Department of Directors V.P. Evtushenkov

Secretariat President, of the President Chairman of Management Board

Management Board

First Vice-President, Finance Senior Vice-President, and Investment Division Security and IT Department Vice-President Senior Vice-President, Executive Vice-President – Head of Division Head of Department

Investment portfolio Corporate Governance Division Administrative Department Senior Vice-President, Head of Administration – Head of Division Head of Department

Legal Division Vice-President, Head of Division

Corporate Communications Division Vice-President, Head of Division

Strategy Division Vice-President, Head of Division

Human Resources Division Vice-President, Head of Division * As of 31 December 2014.

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT 93 GENERAL MEETING OF SHAREHOLDERS

Principles of operation

The General Meeting of shareholders ers are respected and all applicable official website (www.sistema.ru; is the supreme governance body of legal requirements, as well as best www.sistema.com). Along with the Sistema. Its operation is governed by international practices in corporate notice of the forthcoming meeting, the laws of the Russian Federation governance, are observed. shareholders get voting ballots. The on joint-stock companies, as well as venues of Sistema’s General Meet- the provisions of the Corporation’s Information and materials for the ings of shareholders are always Charter and bylaws. The General meeting are made available to the located in the vicinity of the Corpora- Meeting procedure aims to make shareholders in Russian and in Eng- tion’s headquarters. sure that the rights of the sharehold- lish and are published on Sistema’s

Observance of shareholders' rights

Sistema aims to ensure maximum Global Equity Services, thus providing a guarantee for the protection of the shareholders’ right Trust and Securities Services, protection of the rights of all the to participate in running the Cor- Email: [email protected] shareholders of the Corporation. poration and receiving profit. The fundamental rights of a shareholder The votes of GDR holders, Holders of material blocks of in this respect are the rights to par- information about whom has been shares are entitled to make ticipate in the work of the General disclosed to the depositary, are proposals on the agenda of the Meeting of shareholders and to vote collected by Deutsche Bank AG via General Meeting of shareholders on the items on the agenda, and clearing systems and are included and nominate candidates to the also the right to receive dividends. in the general voting ballot of the Corporation’s governance and depositary, with all votes cast for control bodies*. Proposals on the To secure the right of the share- the proposed draft resolution, agenda of the Annual General holders to take part in the work against it, and abstentions specified. Meeting of shareholders of Sistema of the general meeting, a notice are accepted in writing within 100 of Sistema’s General Meetings of Each shareholder can also attend days after the end of the financial shareholders, as well as voting bal- General Meetings of shareholders in year**. Candidates nominated to lots, are circulated to all the share- person or through a representative the governance and control bodies holders at least 30 days before the and vote on the agenda items of the Corporation are preliminarily meeting, and all materials covering directly at the Meeting. interviewed by the Nomination, the agenda items are published on Remuneration and Corporate the Company’s website in Russian An important guarantee of the Governance Committee of the Board and in English (www.sistema.ru; shareholder’s right to participate of Directors of Sistema. www.sistema.com). The ballot may in running the Corporation is the be filled out by the shareholder in right to access documents that the advance and mailed to Sistema to Company is obliged to retain in line the address specified in the ballot. with the provisions of the Federal . In this case the vote of the share- Law On Joint-Stock Companies. To holder will be taken into account exercise this right, a shareholder * Holders of 10 and more % of the Company's voting shares also have the right to request an when counting the voting results. should send a written request to Extraordinary General Meeting of shareholders to the Corporate Secretary of Sistema be conducted.

Depositary receipt holders may vote asking for access to the documents ** If an Extraordinary General Meeting of on the agenda items of shareholder that the shareholder wishes to see. shareholders is conducted with its agenda containing an item on the election of the Board of meetings by proxy through Deutsche When a shareholder is granted Directors, holders of sufficient blocks of shares Bank AG, which is used as the access to confidential documents, have the right to nominate candidates to the Board of Directors. Proposals to this effect must depositary bank for Sistema’s GDR such a shareholder makes a be received by the Company no later than 30 days programme: written non-disclosure obligation before the date of such a meeting.

94 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS For the purposes of observance Directors in advance along with opportunity to dispose of their of the shareholders’ rights to the the date on which the shareholder shares taking into account the Company’s profit the Corporation register is to be made for the expected dividend payments. announces the amount of dividends purposes of the payment. Therefore, recommended by the Board of the shareholders always have the

Dividend policy

To determine the recommended be at least 10% of the group’s by the Corporation’s investment amount of dividends payable, the net income generated during the transactions over the same period Corporation’s Board of Directors previous financial year as per (special dividend). This approach abides by the dividend policy reports prepared in compliance allows the Corporation to pay approved in October 2011. In with international accounting predictable amounts of dividends. compliance with this policy, the standards and at least 10% of amount of dividends payable shall the net cash income generated

General Meetings held in 2014 and their results

Quorum at General Meetings of Shareholders for three years

83.66% 82.39% 81.60%

79.18% 76.55%

EGM dated AGM dated EGM dated AGM dated AGM dated 14/06/2012 30/06/2012 01/11/2012 29/06/2013 28/06/2014

The Annual General Meeting of the As resolved by the Annual General The Annual General Meeting of shareholders of Sistema was held on Meeting of shareholders and shareholders approved CJSC 28 June 2014. The AGM (1) approved recommended by the Corporation’s Deloitte and Touche CIS as the Company’s annual report Board of Directors, RUB 19, 879m Sistema’s auditor for 2014 to and annual financial statements, were allocated to pay dividends, perform the audit according to the including the profit and losses which equalled RUB 2.06 per Russian Accounting Standards account for 2013, (2) determined one ordinary share of Sistema. and the US GAAP. The auditor was the amount, procedure, forms and The amount of dividends was selected following an open tender timelines of dividend payments on determined in compliance with the organized by the Audit, Finance and the company’s shares, (3) elected current dividend policy. Dividends Risk Committee of the Board of members of the Board of Directors, increased by 115% compared with Directors of Sistema. (4) elected members of the Auditing the amount paid in 2013.* Commission, (5) and approved the In 2014, Sistema did not convene auditors of the Corporation. any Extraordinary General Meetings.

* In 2013, RUB 9,264m were allocated for dividends, equalling RUB 0.96 per one share of Sistema JSFC.

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT 95 BOARD OF DIRECTORS

The Board of Directors of Sistema appraises executive performance The Board of Directors of Sistema is responsible for strategic and assesses risks, approves effective as of 31 December 2014 was management of the Corporation principles for corporate governance elected at the Annual General Meet- and plays the key role in organising procedures, approves transactions ing of the Company’s Shareholders an effective system of corporate and controls the work of the on 28 June 2014, and its membership governance: it determines the Corporation in general. The terms remained unchanged compared to strategy, works out strategic and of reference of the Board of the previous year. The Board of Di- financial development plans, Directors are set out in the Charter rectors of Sistema has 13 members. sets the principles for investing, of Sistema. Independent members of the Board of Directors form a majority.

Members of the Board of Directors of Sistema elected on June 28, 2014

Vladimir Evtushenkov Alexander Goncharuk David Yakobachvili Sergey Boev Brian Dickie Chairman of the Board Deputy Chairman of the Deputy Chairman of the Non-executive member Independent Director of Directors Board of Directors Board of Directors Non-executive member Independent Director

Dmitry Zubov Robert Kocharyan Jeannot Krecké Peter Mandelson Munnings Roger Non-executive member Independent Director Independent Director Independent Director Independent Director

Mark Holtzman Serge Tchuruk Mikhail Shamolin Independent Director Independent Director Executive member, President and CEO

96 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS Composition of Board of Directors

Executive member (Mikhail Shamolin) Non-executive member (S. Boev, A. Goncharuk, D. Zubov.) Independent Director (B. Dickie, R. Kocharyan, J. Krecké, P. Mandelson, R. Munnings, M. Holtzman, S. Tchuruk, D. Yakobachvili)

61% 31% 8%

Meetings of the Board of Directors approved work plan for the year. The on a routine basis. Additional sessions In 2014 the Board of Directors held work plan of the Board of Directors are organized whenever an urgent 10 meetings: eight scheduled regular is developed proceeding from the matter needs to be considered. Board meetings, and two extraordinary logics of the strategic planning and meetings, one of which was held in the reporting cycle of Sistema. Reports on Forming the work plan of the Board form of absentee voting. The Board and discussions of additional matters of Directors and including additional of Directors reviewed a total of 100 (such as transactions) are included in items into the plan falls within the agenda items in 2014: agendas of scheduled Board meetings remit of the Board Chairman.

2014 2013 Number of in-person meetings 9 8 Number of letter ballots 1 1 Number of items in accordance with the BoD work plan 39 43 Number of items reviewed at Board meetings 100 105

Subjects reviewed by the Board of Directors in 2014

Business strategies, investments, new types of activities Personnel appointment, HR policy Corporate governance and securities Approval of transactions Approval of internal documents Participation in affiliates, groups, unions; branch offices Financial reports, planning and audit Functional strategies

27% 7% 12% 21% 1% 17% 6% 9%

In 2014 the agenda of the Board governance. The Board of Direc- be given to strategy and corporate of Directors was mainly related to tors’ focus on these areas proceeds governance of portfolio compa- business strategy, approval of trans- from the nature of the Corporation’s nies, portfolio strategy, analysis actions (including shareholdings in operation as an investment compa- of new investment opportunities portfolio companies) and corporate ny, when particular attention should and transactions.

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT 97 Preparation for the meetings and quorum of the Board of Directors

The procedure of preparation for the the possibility to comfortably form meeting, so that they can discuss meetings of the Board of Directors their own position for the voting. the items on the agenda of the is aimed at ensuring an efficient use The majority of main agenda items Board and inquire about the voting of the time and experience of the must be previewed at the meetings positions of the parties in an Board members in order to enable of Committees of the Board of informal environment. them to take important decisions Directors of the Corporation. on the Corporation’s strategic Sessions of the Board of Directors development. Materials on the Members of the Sistema Board of normally take place with high agenda are provided to the Board Directors meet with the speakers attendance of the Board members. of Directors of Sistema 10 days and the management at a business The average quorum of meetings in before meetings, which gives them dinner the evening before the 2014 was 91.5%.

Participation of the Sistema Board members in meetings of the Board of Directors and its committees in 2014*

Board of Strategy Audit, Finance Nomination, Ethics and Investor Directors Committee and Risk Remuneration Control Relations Committee and Corporate Committee and Dividend Governance Policy Committee Committee Participation in meetings V. Evtushenkov 9/10** 8/11

S. Boev 9/10 6/11 10/13 4/7

A. Goncharuk 7/10 4/11 5/8 3/7

B. Dickie 10/10 0/3 3/3 7/7

D. Zubov 10/10 8/8

R. Kocharyan 10/10 5/8 8/8 6/7

J. Krecké 10/10 8/8 7/7

P. Mandelson 8/10 11/13 5/7

R. Munnings 10/10 13/13 8/8 7/7 7/7

M. Holtzman 7/10 12/13 5/7

S. Tchuruk 9/10 1/3 2/5 6/7

M. Shamolin 10/10 10/11 5/5 1/7

D. Iakobachvili 10/10 6/8 13/13 7/7

* The membership of the Board of Directors is given as of 31 December 2014.

** The first number denotes the number of meetings attended by the Board member, the second number stands for the total number of meetings the member could potentially participate in.

98 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS Commitees of the Board of Directors Nomination, Remuneration and Corporate Governance Committee R. Kocharyan A. Goncharuk J. Krecké, Committee Chairman, B. Dickie, D. Zubov, R. Munnings.

Independent Director Non-Executive Director

67% 33%

The main tasks • preliminary consideration of the -- to the boards of directors of • management’s performance evalua- candidates: portfolio companies; tion and determination of parameters -- to the board of directors; -- to the position of corporate sec- of awarding bonuses to employees; -- to the top management posi- retary of the Corporation; • systems of corporate governance tions in the Corporation and • the policy of motivation and compen- of the Corporation and portfolio portfolio companies; sation for the Corporation employees; companies, protection of rights and interests of shareholders. Meetings and issues considered in 2014 8 meetings, considered 26 issues

formation of a system of motivation, performance evaluation and awarding bonuses to employees corporate governance and protection of shareholders’ rights preliminary consideration of the candidates

12 6 6

Audit, Finance and Risk Committee R. Munnings S. Boev, P. Mandelson, S. Tchuruk, Committee Chairman, M. Holtzman, D. Iakobachvili

Independent Director Non-Executive Director

83% 17%

The main tasks • Preparation and audit of the finan- • assessment of the risk manage- • internal audit; cial statements of the Corporation, ment system and compliance with • warning system on potential cases control of these processes: applicable legal requirements in of fraud; • interaction with the external audi- the area of financial reporting, • preliminary assessment of large tors of the Corporation; auditing and planning; transactions and transactions with • budget process and financial modeling; interested parties.

Meetings and issues considered in 2014 13 meetings, considered 74 issues

Evaluation of individual transactions Preparation and audit of financial statements The process of financial planning and risk management External auditors Processes of internal control, audit and warning systems for potential cases of fraud Organizational and other matters

35 15 8 6 2 8

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT 99 Strategy Committee V. Evtushenkov S. Boev, A. Goncharuk, D. Iakobachvili, Committee Chairman, R. Kocharyan, M. Shamolin, M. Hecker

Independent Director Non-Executive Director Management

29% 42% 29%

The main tasks • strategy development for portfolio • reviewing mergers and acquisitions • all projects of the Group companies; and major investment projects; with substantial Government • strategic planning methodology • all mergers and acquisitions in the participation. review; Group with monetary value of more • preliminary approval of the than US$ 100 million; strategy and the strategic • all projects of the Group associated objectives of the Corporation; with entering new markets;

Meetings and issues considered in 2014 11 meetings, considered 12 issues, all questions on the development strategy of the portfolio companies.

Ethics and Control Committee A. Goncharuk S. Boev, B. Dickie, R. Munnings, Committee Chairman, R. Kocharyan, S. Tchuruk

Independent Director Non-Executive Director

67% 33%

The main tasks • internal control and audit (together • function of corporate security; • anti-corruption system in the with the Audit, Finance and Risk • monitoring of compliance with the Corporation and Group companies. Committee); Code of Ethics;

Meetings and issues considered in 2014 7 meetings, considered 16 issues.

internal audits of the internal control and audit and quality control environment functional strategy and internal control in the field of internal control and security anti-corruption system organizational matters

6 4 2 4

Investor Relations and Dividend Policy Committee D. Iakobachvili J. Krecké, P. Mandelson, M. Holtzman, Committee Chairman, R. Munnings, M. Shamolin

Independent Director Management

83% 17%

The main tasks • maintaining effective relationships • the dividend policy of Sistema, • protect the rights and interests of with the financial community including the formation of the shareholders. and public authorities as well recommendations to the Board of as increasing the investment Directors in respect of the amount attractiveness of Sistema of dividends payable; securities;

100 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS PRESIDENT AND THE MANAGEMENT BOARD

• In 1996-1997, he completed an Execu- The President of Sistema is a tive Programme in Finance and Man- permanent chief executive officer agement at the University of Pennsyl- whose main function is executive vania’s Wharton School of Business. management and settlement of relevant matters outside the remit of • In 1998-2004, he worked at the the General Meeting of shareholders, international consulting company Board of Directors and Management McKinsey&Co. Board for the purposes of ensuring profit of the Corporation, as well • In 2004-2005, he held the position as observance of its shareholders’ of the Managing Director for the rights and legitimate interests. The Ferroalloys Division at Interpipe President reports to the Board of Corp (Ukraine). Directors and the General Meeting of the Corporation’s shareholders. • In 2004-2005, he held the position of the Managing Director for the From 10 March 2011, Sistema’s Mikhail Shamolin Ferroalloys Division at Interpipe President is Mikhail Shamolin. On 15 President of Sistema, Corp (Ukraine). March 2014, the Board of Directors Chairman of the Management Board took the decision to extend his • In 2005-2011, he was Vice President appointment as the Corporation’s • Mikhail was born in 1970 for Sales and Customer Service, President for three years. in Moscow. then Vice President, Head of MTS Russia and President of MTS. • In 1992, he graduated from the Moscow Automobile and Road • Appointed President of Sistema on Technical Institute. 10 March 2011. On 15 March 2014, the Board of Directors reappointed • In 1993, graduated from the Mr Shamolin President and Chair- Russian Presidential Academy man of the Management Board of of Public Administration. Sistema for a three-year term.

Sistema’s Management Board In 2014, the Management Board of 2. Preparation of forecasts of determines the methods of the Company held 24 meetings and and reports on the execution implementing the development considered 33 agenda items in the of quarterly, semi-annual, and strategy of the Corporation, works following key areas: annual budgets. out development plans, sets investment procedures and controls 1. Preliminary review of matters to be 3. Strategic planning at the their observance, appraises the submitted to the Board of Directors, Corporation and S/As, including performance of the personnel, and including: the establishment of top-down pre-considers items submitted to the indicators of the strategic Corporation’s Board of Directors. • the Corporation’s investment planning cycle. policy and priority investment areas; 4. Debt and borrowings management. • development strategy and value creation for key portfolio assets 5. Risk management and of Sistema; preparation of risk maps.

• internal control and audit; 6. Monitoring and management of investment projects. • HR policy;

• corporate social responsibility.

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT 101 Members of Sistema's Management Board

Mikhail Shamolin Anton Abugov Christopher Alan Baxter Elena Vitchak Chairman of the Management First Vice-President, Investment Senior Vice-President, Vice-President, Board, President and CEO portfolio manager Investment portfolio manager Head of HR Department

Sergey Drozdov Felix Evtushenkov Leonid Monosov Oleg Mubarakshin Senior Vice-President, Head of the First Vice-President, Investment Vice-President, Investment Vice-President, Head of the Legal Corporate governance division portfolio manager portfolio manager functional division

Vsevolod Rozanov Andrei Terebenin Ali Uzdenov Michael Hecker Senior Vice-President, Senior Vice-President, Senior Vice-President, Vice-President, Chief Financial Officer Investment portfolio manager Investment portfolio manager Head of Strategy

After the end of the reporting period, Board, after being appointed Vice time relieved of the responsibilities in February 2015, Nikolay Vasilkov President, Head of Strategy Function. of a Management Board member. became member of the Management Michael Hecker was at the same

Changes in the top management in 2014 A number of changes in the top management of the Company took place in 2014: A. Buyanov 25 June 2014 was relieved of his duties as First Vice President. A. Terebenin 22 May 2014 was appointed Senior Vice President and relieved of his duties as Vice President, Head of the Corporate Communications Function. А. Chupin 07 May 2014 was relieved of his duties as Vice President. D. Khidasheli 30 September 2014 was relieved of his duties as Vice President. M. Hecker 12 February 2014 was appointed Vice President, Head of Strategy Function. A. Shlyakhturov 10 September 2014 was transferred from the position of Executive Vice President, Head of the Security and IT Department to the position of the Advisor to the Chairman of the Board of Directors. V. Shukshin 10 September 2014 was appointed Executive Vice President, Head of the Security and IT Department.

102 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS INTERNAL CONTROL AND AUDIT

The process of internal control To perform its key tasks, the Internal The Internal Control and Audit is implemented at all levels of Control and Audit Department Department has all the resources the Corporation’s management, carries out the following functions: and authority required to perform the including the Board of Directors, above functions. Board Committees, the Corporation’s • performing independent audits of management and the Internal individual operations, processes, The Internal Control and Audit Control and Audit Department. and units; Department closely interacts with the Corporation’s external • assessing the efficiency of the auditors, coordinates work and Internal audit at the Corporation and internal control system; Sistema Group companies is the scope offers consultations in the course of of responsibility of the Internal Control • assessing the efficiency of the risk preparing the Department’s annual and Audit Department that functionally management system; audit plan with regard to assessment reports to the Board of Directors and of the efficiency of internal control administratively to the President. Head • assessing the corporate over financial accounts, and also of the Department is appointed and governance system, preventing during discussion and assessment of dismissed by the President following a violation of law and the identified risks. resolution passed by the Corporation’s Corporation’s regulations, Board of Directors after preliminary ensuring observance of In 2014, the Internal Control and approval of the Board’s Ethics and professional and ethical standards, Audit Department conducted 65 Control Committee. Head of the De- and preparing recommendations scheduled and unscheduled audits partment is a certified internal auditor for improvement thereof; to assess the efficiency of internal and has more than 15 years of experi- control and risk management • developing recommendations to ence in the field. systems. Audits performed by remedy deficiencies identified and the Internal Control and Audit monitoring remediation thereof; The main tasks of the Internal Department did not uncover any Control and Audit Department are: • examining and evaluating weaknesses or risks that could documents provided with regard affect the sustainability of the • helping shareholders and the to specific investment projects Corporation’s business as a whole. management improve the internal for compliance with current control system by performing regulations; performing scheduled Reports on results of activities regular audits of efficiency of the and unscheduled monitoring performed by the Internal Control Corporation’s internal control, of performance against project and Audit Department in H1 2014 and risk management, and corporate targets; FY2014 were submitted to the Audit, governance systems; Finance and Risk Committee and to • ensuring uninterrupted functioning the Ethics and Control Committee • contributing to the achievement of of the whistleblowing programme; of Sistema’s Board of Directors*. the Corporation’s strategic goals in The Department’s report for FY2014 the most efficient ways possible; • administering investigations, was reviewed by Sistema’s Board of including internal ones; • supplying the management and the Directors. shareholders of the Corporation • monitoring compliance with the with objective information on Corporation’s internal regulations; In December 2014, in accordance existing internal risks and their with requirements of the Listing probability; • monitoring execution of Rules of the Moscow Exchange, the assignments issued by the Corporation’s Board of Directors • enhancing the awareness of the Management Board and the approved the Policy on internal audit Corporation’s management about President of the Corporation; at Sistema, which defines the goals, the performance of Sistema Group objectives and powers of the Internal companies; • monitoring and investigating Control and Audit Department. instances potentially qualifying • controlling the achievement of the as disciplinary violation and/or goals of the shareholders of the violation of execution discipline Corporation and Sistema Group and/or conflict in the Corporation companies. or Sistema Group companies. * Joint meetings of the Committees.

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT 103 After the end of the reporting period, Corporation. Notably, the Policy on • division of responsibilities and in February 2015, the Board of the internal control system defines: powers between entities of Directors approved the Policy on the internal control system the internal control system. This top • the goals and objectives of the (management, the Internal level documents sets forth the key internal control system; Control and Audit Department, the Board of Directors and Board principles of organisation of internal • principles of functioning of the Committees). control as an ongoing and integrated internal control system; process, which involves all divisions and governance bodies of the • the structure of the internal control system and the list of its entities;

External Audit

In compliance with the decision of the performs annual assessment of the tiations will be held with the auditor Board’s Audit and Finance Commit- quality of audit services. If the quality about the price of auditing services for tee, the following procedures have of services provided by the current the next period. However, to ensure been developed at the Corporation auditor is deemed insufficient, the Au- impartiality and objectivity of the audi- for selecting external consultants for dit Committee arranges a tender for tor, the Audit and Finance Committee the purposes of audit of the financial selection of a new auditor. If the qual- of Sistema has decided that a tender and accounting reports of Sistema. ity of services provided by the current for auditing services shall be held at The Audit and Finance Committee auditor is deemed sufficient, nego- least once in every five years.

DEVELOPMENT OF THE CORPORATE GOVERNANCE SYSTEM IN 2014

In 2014, 13 members were elected All independent directors Moscow Stock Exchange, thus to the Corporation’s Board of have extensive practical work confirming their status as the first Directors, out of whom eight meet experience and solid reputation class securities in the Russian the independence criteria of the in the international professional market, attesting to the high Moscow Exchange and the Russian community, which means that their assessment of Sistema’s corporate Corporate Governance Code. The judgment in the capacity of Board governance standards and granting following independent directors members will not be influenced access to a broader range of were elected to the Board: by the management or individual investors. shareholders. One of the Board • David Iakobachvili; members has vast experience in the In view of the above, the audit of financial statements. Corporation assumed additional • Brian Dickie; commitments to maintain the • Robert Kocharyan; Independent directors make up corporate governance system at the majority of the Board, which the high level and bring some of • Jeannot Krecké; ensures the required level of its components in compliance objectivity and independence from with the new requirements of • Peter Mandelson; the influence of the Corporation’s the Listing Rules of the Moscow • Roger Munnings; executive bodies in the course of Exchange. In December 2014, the decision-making by the Board. Board of Directors approved new • Marc Holtzman; versions of the terms of reference In June 2014, the Corporation’s of some Board Committees and the • Serge Tchuruk. ordinary shares were included in Corporate Secretary and adopted the first (top) quotation list of the a new Policy on internal audit. The

104 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS introduced amendments formalised Reference of the General Meeting i.e. RUB 2.06 per ordinary share, the functions of Board Committees of Shareholders and the Terms of which corresponds to a dividend and the Corporate Secretary that Reference of the Board of Directors yield of ca. 5.22% per annum. The are directly specified in the Listing in the near term. sum of dividends was determined Rules and introduced provisions in compliance with the current on the procedure of appointment In June 2014, Sistema’s Annual dividend policy, which was applied of head of the Internal Control and General Meeting of shareholders for the second successive year. Audit Department. The Corporation approved payment of dividends also plans to amend the Terms of in the amount of RUB 19,879m,

Remuneration

Remuneration and compensations The Policy on remuneration and employment and corporate relations payable to members of Sistema’s compensations payable to members between the Corporation and its Board of Directors are calculated on of the Board of Directors of the Cor- management; the basis of the Policy on remuner- poration also envisages standard lia- ation and compensations payable to bility insurance for Board members. No extra compensation above the members of the Board of Directors level stipulated by labour laws of of the Corporation, approved by the The Corporation does not provide the Russian Federation is paid to resolution of the General Meeting of loans to Board members. the President or other senior ex- shareholders of Sistema on 30 June ecutives in case of termination 2006 (Minutes No.1-06) as amended The short-term (up to 1 year) incen- of employment. by the resolution of the General Meet- tive scheme for the top managers ing of the shareholders of Sistema on of Sistema in 2014 consisted of the Sistema does not pay remuneration 16 February 2009 (Minutes No.1-09). following elements: to members of executive bodies for The Policy provides for the payment of serving on the Management Board. the following to the Board members: • a fixed monthly salary determined in line with the internal system of The Corporation does not grant loans • fixed amounts for participation in job categories (grades); to senior executives. meetings of the Board of Directors and its Committees, including re- • bonuses paid for project imple- Top executives of the Corpora- imbursement of expenses related mentation and generating cash in- tion were paid a total of RUB to participation in meetings of the come. Remuneration is paid based 2,746,764,517 in fixed salary and Board of Directors; on workers’ individual performance bonuses for the calendar year 2014. and positive cash flow generated Payments to top executives under the • fixed amounts for acting in the by projects of Investment Portfolios long-term incentive programme in capacity of the Chairman or a and Functions and Departments of the form of the Corporation’s shares Deputy Chairman of the Board of Sistema. Payments may amount to totalled RUB 1,659,419,767 in 2014, Directors, and for chairing Board up to 20% of cash income exceed- including RUB 1,559,140,150 for Committees; ing the target. years 2013 and 2012.

• based on the performance during In 2014, the three-year long-term in- Remuneration paid to the members a year, members of the Board of centive programme for Sistema’s top of Sistema’s Board of Directors Directors get additional perfor- management (2012-2014) was com- in 2014 totalled RUB 334,447,900. mance-related remuneration in pleted. Its members were allocated Board members also received reim- the form of a fixed amount, half the last shares due for distribution bursement of their expenses in- of which is payable in shares for the last period of the programme. curred in connection with their duties (US$ 250,000 - 325,000); amounting to RUB 3,608,900. The long-term incentive system for • also, if the capitalisation of the top management of Sistema was Corporation has grown over the extended for another three-year peri- year, members of the Board of od (2015-2017). The programme is Directors get additional remuner- aimed at increasing Sistema’s share- ation amounting to 0.1% of the holder value and creating additional incremental capitalisation. incentives for maintaining long-term

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT 105 RISKS

The key risk factors related to Sistema

The Corporation may face a variety The risk management system of will be achieved and to ensure that of risks in the course of its business Sistema is based on a two-level the level of risk will be kept within operations. The main risks that the approach to risk management, the limits that are acceptable for the Corporation may encounter are the namely, detection of risks in shareholders and the management consequences of the processes and subsidiaries and affiliates and in the of the Corporation. The integrated factors that Sistema has little or no Corporation and their integration risk management system (ERM) influence on. Hence, efficient as- for assessing their influence on operating at Sistema was built sessment and management of risks the Group in general. The main in compliance with international remain an important component of objective is to provide a reasonable standards, recommendations and the strategy of Sistema. guarantee that the strategic goals best practices in risk management.

Corporation

Risk assessment Information on risks Risk Monitoring Risk reporting identification

At subsidiaries level Risk mitigation

Risk assessment

Risk МониторингRisk assessment Риск identification Limits, Risk СнижениеМониторингRisk assessment Риск regulations, etc. identification

Risk СнижениеMonitoring Risk reporting identification

Risk mitigation

The integrated risk management system (ERM) implemented in the Corporation envisages the presence of the following components and procedures:

• identification of risks at all levels Company’s key financial indicators of the management (from the top (Monte Carlo modelling); to the line management), which includes finding the risk owner and • development of plans to mitigate making a risk passport; identified risks at all management levels; • primary assessment of the materiality of identified risks and • regular risk monitoring and their analysis (VaR methodology); control;

• ranging of risks by management • preparation of reports on the levels; company’s risks.

• assessment of the aggregate influence of material risks on the

106 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS Risk management Link with the decision-making process process

Within ERM Key management processes processes

Strategic planning • Dynamic financial planning Risk appetite • Overview of risk-adjusted strategic options • Portfolio optimisation based on risk-gain ratio

Risk assessment

Performance management Limits and Risk Monitoring Risk reporting • Investment management thresholds identification • Risk-adjusted performance measures

Risk reduction

Budget/CAPEX • Criteria based on the risk at the annual budgeting • Risk-based criteria for large projects

Interaction with stakeholders Risk-adjusted • Understanding and coordination of risk appetite ROI of all stakeholders • Rating management

As part of quarterly ERM procedures Quarterly monitoring of the mechanisms are being widely the risk managers of Sistema Corporation’s risks is performed applied (including insurance), Group compile risk registers for at the level of the Management financial risk control and response subsidiaries and a consolidated risk Board and the Risk Sub-Committee procedures are being improved. register for the Group, prioritise operating under the umbrella of the At the Corporation level particular risks and aggregate them into Finance and Investment Committee attention is given to the risks of portfolios, develop a risk map and of Sistema by reviewing the effects investment projects starting from analyse its key trends, conduct an of the mitigation and response the stage of project origination up analysis of the impact that material measures taken and by reassessing to the stage of completion. The risk risks have on the financial results the already identified and/or new management systems of subsidiaries of specific subsidiaries and Sistema risks, as well as by evaluating their are currently at different stages of Group as a whole, using simulation potential impact on the financial development depending on the time and financial modelling methods. results of the Corporation and of their introduction. These systems Sistema Group as a whole. are being gradually improved in In order to deal with the risks accordance with the plans approved included in the risk register of The top management of Sistema earlier. As new assets are added to Sistema Group the company presents a regular risk management Sistema’s portfolio, individual plans developed risk management report to the Audit, Finance and Risk are developed in order to implement (mitigation) and response plans for Committee of the Board of Directors risk management systems specific subsidiaries, which may of Sistema. Sistema’s Board of depending on the specific needs of be extended, adjusted and then Directors review risk management such assets. The risk management approved by the risk committees of reports on a biannual basis. processes of subsidiaries are the respective companies. monitored by the Corporation The Group’s risk management via Sistema’s representation in system keeps developing and collective governance and executive improving. Various risk mitigation bodies of S/As.

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT 107 External risks

The risks related to changes in the business is conducted in the Russian Armenia, the Republic of Belarus, political and economic situation Federation. Moreover, many of the Ukraine, Uzbekistan, Turkmenistan in Russia are material to Sistema Corporation’s subsidiaries operate and India, which are also character- because most of the Corporation’s in the emerging markets, including ized by the risks listed below.

Economic risks

• The business of Sistema is inex- • Capital flight from Russia and • If in the medium term sanctions tricably linked with the state of the downgrading of the sovereign are maintained and the access of the global economy and financial credit rating by international rating Russian banks and businesses to markets and heavily depends on agencies, as well as restrictions foreign debt remains restricted, this the Russian economy in particu- introduced for foreign companies may significantly increase the current lar, which in its turn relies on the in Russia as a result of sanctions, liquidity deficit in the market and export of oil, gas and other com- may have a negative impact on the result in further interest rate rises. modities. Further weakening of the joint ventures (partnerships) and rouble against the US dollar and new investment projects of the • An unfavourable macroeconomic Euro amid a slump in the oil prices, Group’s companies. Growing infla- environment in many countries of imposed sanctions and increased tion may result in higher expenses Sistema’s operations may make it capital flight from Russia may and, therefore, put pressure on necessary to reevaluate goodwill result in a rise in costs and a drop profit margins and also affect the for some of the assets. in revenues or impede the achieve- domestic demand for products of ment of financial targets and Sistema Group’s companies. • Foreign currency control and repayment of debt by the Group’s restrictions on capital repatriation subsidiaries. may adversely affect the business of Sistema Group and reduce the value of Sistema’s investment in Russia.

Political and social risks

• The influence of geopolitical • The risks of inter-state conflicts risks has significantly intensified have significantly risen compared as protectionism and economic with the beginning of 2014, both in sanctions are increasingly being terms of their probability and the used as a tool for achieving effect that they may produce on geopolitical goals. various areas.

Legal risks and uncertainty

The risks related to weaknesses in • Relative unpredictability of shareholders. Russia’s accession the Russian regulatory framework legislative and administrative to the World Trade Organisation include, to various degrees, the decisions and court rulings and a may result in certain legislative following. lack of means that could make the and other changes in the markets understanding of such legislative of Sistema’s operations. • Possible discrepancies, ambiguity decisions and court rulings easier. and anomalies in: (1) federal • The shareholder responsibilities laws; (2) orders, directives • There is no clarity about the provided for by the corporate and regulations issued by the influence of the Federal Law «On laws of the Russian Federation Russian President, Government Strategic Foreign Investment» and may result in Sistema being and federal ministers; (3) and the new Customs Treaty of Russia, held financially liable for its regional and local laws, rules and Belarus and Kazakhstan on subsidiaries. requirements. Sistema’s business and its foreign

108 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS • If minority shareholders of • If the Russian Federal Anti-mo- • Failure to formally comply Sistema’s subsidiaries contest nopoly Service (FAS) concludes with certain requirements of past or future related-party that Sistema or one of its mate- the Russian law may result in transactions or other transactions rial subsidiaries has acquired or Sistema or one of its subsidiaries or vote against related-party founded a new company in vio- incorporated in Russia being transactions or other transactions lation of the anti-monopoly law forced to carry out liquidation, in the future, this will limit or has otherwise violated com- their ownership structure may be Sistema’s operational capacity. petition laws, this may result in called into question and early debt administrative sanctions. repayment claims may be made.

Taxation system of the Russian Federation

• The Russian law on transfer • On 1 January 2015 new rules As a result of the need to apply pricing may make it necessary to were introduced relating to the new taxation rules the Group’s introduce adjustments to the price taxation of undistributed profits of companies may face new tax lia- setting system of Sistema Group’s controlled foreign companies, the bilities arising due to the uncer- companies and result in additional concept of a beneficiary owner, tax tainty around interpretation of the tax obligations with regard to residence of legal entities and in- tax law and the lack of previous controlled transactions. direct sale of properties in Russia. law enforcement practice.

Risks related to the operations of Sistema

There is no certainty that from consumers, successful of not finding relevant targets the business strategy will be development of technologies, or their not being available for successfully implemented. efficient management of acquisition, a risk of insufficient spending, timely completion of or inadequate due diligence of • The key components of the development and introduction the target company’s operations business strategy include of new products and services and/or financial situation, risks of development of a balanced and by the Group’s companies, the assets being overvalued and diversified asset portfolio in successful differentiation of the overpaid for and, consequently, sectors and regions where Sistema companies’ offers from their of occurrence of financial risks has competitive advantages, rivals and perception of the goods exceeding expectations and and also proactive management by the market. discovery of financial liabilities not of the investment portfolio found earlier. and involvement of leading The company may face international and Russian partners. difficulties in generating • Acquisition of additional Despite having a well-formulated businesses may also put additional strategy, Sistema cannot guarantee profits from acquisitions, pressure on the Corporation’s achievement of the established integration, disposal or cash flows, especially if the goals, efficient management of the restructuring of assets. acquisition is paid for in cash. portfolio companies or taking up of Besides, if an acquisition deal is new investment opportunities. not closed or closed with delays, • Sistema grows its business it may negatively affect Sistema’s • The success of Sistema’s via new acquisitions, sale and achievement of its strategic growth strategy depends on numerous restructuring of assets. The goals and have a substantial factors, including obtaining of process of taking investment negative impact on the current the necessary permits from the opportunities in the market entails business, operational results, authorities, sufficient demand certain risks, including the risks financial situation and prospects.

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT 109 • Moreover, Sistema may encounter Sistema’s ability to service • absence of external sources problems of integrating assets its debt largely depends of financing; into the existing structure, their • changes in the terms of existing optimal management or necessary on the cash flows from its agreements on financing; restructuring. These risks include subsidiaries. inability to efficiently assimilate • emergence of new business and integrate operating assets Sistema’s financial performance opportunities or investment in and personnel of the acquired largely depends on the ability of existing businesses, in case of company into the business, its subsidiaries to generate cash sizable investments; inability to establish and integrate flows needed to service its financial • a slower than planned growth all the necessary control systems liabilities, including repayment of of revenue; and mechanisms, including with debt and interest and any other regard to facilities and agreements borrowing in the future. From time • deterioration of the economic related to logistics and distribution, to time, the Group companies’ situation in the countries of conflicts between majority and abilities to make such payouts may Sistema’s operations. minority shareholders, hostility be limited as a result of regulatory, and/or unwillingness to cooperate tax or other restrictions. Disposal Covenants might limit the on the part of the acquired asset’s of one of the Group’s core assets ability to raise debt financing, management, potential loss of reduces the Group’s materiality and carry out investment customers of the acquired asset. the amount of expected dividend flow from subsidiaries, which along programmes or participate • Potential disposals of assets with tightening of bank funding may in various businesses. carry certain risks related to have a negative impact on servicing potential inability to execute the current liabilities and hinder access Sistema’s bank loan agreements transaction or undervaluation of to debt financing in the future. and agreements of some of its S/As the sold asset, liabilities arising on bank loans and debt securities from the sale of asset, failure to The success of Sistema in contain certain restrictive covenants. meet deadlines for transaction many respects depends These covenants put restrictions closure or loss of synergy on attraction of additional debt between existing assets. Besides, on the success of its core financing, encumbrance of property execution of such transactions, asset, MTS. with pledges, sale of assets and including restructuring, merger of transactions with affiliates. Such businesses or financial resources Sistema’s financial performance covenants may result in restriction depends on a combination of in many respects depends on the of Sistema’s operations, including necessary conditions, including success of its core asset, MTS. If financing of capital expenses, or limit corporate and government MTS fails to generate the necessary the possibilities for timely repayment consents. There is no certainty income, it may impinge on Sistema’s of debt or payments on liabilities. that such deals will be completed ability to service its debt liabilities If operations of subsidiaries are on the announced terms and secure growth and business restricted, their revenue may decline, or closed at all. expansion through restructuring and which, in turn, may limit Sistema’s acquisition of assets. Consequently, opportunities for using such revenue Sistema’s ability to maintain the risks and events that may have to service the debt or finance its its competitiveness and a material detrimental effect on subsidiaries. Moreover, mergers MTS, its operating results, financial and restructuring of subsidiaries, implement its business standing and prospects may, in turn, in certain circumstances, disposal strategy in many respects have a material detrimental effect of assets may lead to breach of depends on the management on Sistema, its operating results, restricting covenants under such financial standing or prospects. subsidiaries’ loan agreements, which and key employees. may bring about acceleration of such In the event of problems with loans or reclassification of long-term • The top management team fund raising or financing, loans into short-term loans. is the key to implementing Sistema’s strategy. Moreover, Sistema’s operations would further success of the investment be curtailed accordingly. portfolios and their ability to efficiently implement a common Future financial receipts and cash strategy, including plans of growth flows from Sistema’s subsidiaries and increase of scale, will to a and affiliates may not be sufficient large degree depend on the efforts to cover the planned expenses in the of individual management teams event of contingencies, such as: working with the specific assets.

110 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS Licences and permits between federal and local laws, the companies in Russia and other required for Sistema Group privatisation of many companies countries, including but not could be challenged, including limited to competition in terms companies’ business may the possibility of discriminatory of price, product and service be deemed invalid, revoked, challenges. quality. Inability of Sistema rescinded or not prolonged, Group companies to compete • If the legitimacy of privatisation of a efficiently may have a material or contain encumbrances company is contested, and Sistema negative impact on the business, that restrict Sistema’s is unable to defend its stand in the performance, financial situation operations. dispute, there is a risk of losing and prospects. a stake in such company or its assets, which may have a material Sistema depends on the Operations of Sistema Group adverse effect on the business, ability to maintain its brand companies are regulated by various financial situation, performance government bodies and agencies as or development prospects of the quality and reputation. pertains to obtaining and renewing Corporation.. licences, approvals and permits and • Developing and maintaining also the need to constantly abide by The business of Sistema brand awareness for the Group existing legislation, regulations and is regulated by the anti- companies is a crucial component standards. Regulating authorities of shaping the public opinion about to a large extent rely on their own corruption laws under their existing and future products judgment when interpreting and the jurisdictions in which and services. Sistema believes that implementing requirements of it operates, including the the importance of company brand applicable laws, regulations and is growing steadily at the highly standards, issuing and extending anti-corruption laws of competitive markets. Successful licences, approvals, sanctions and the Russian Federation development and improvement permits and monitoring compliance and the Foreign Corrupt of brand awareness to a large with licence requirements. There is extent depends on the efficiency no guarantee that existing licences Practices Act of the USA, of marketing operations and the and permits, including those issued and may be regulated by the companies’ ability to provide to the Group’s companies, will be UK Bribery Act 2010, and useful and quality products and extended, new licences and permits services at competitive prices. will be issued or that the companies violations of applicable laws The efforts to develop the brand will be able to comply with the terms may lead to penalties and may be incommensurate with of corresponding licences. There is reputational risks. actual revenues which may be no guarantee either that any of the insufficient to cover expenses on existing or future licences or permits such activities. will not be suspended or revoked on • Any investigation into potential some or other grounds. Any of these violations of the FCPA, the circumstances can have material UK Bribery Act or other anti- negative consequences for the corruption laws of the US, the UK business of Sistema. or other jurisdictions may affect the reputation, business, financial If ambiguity of privatisation situation and performance of laws is used to challenge Sistema. Sistema’s property rights to All segments where its privatised subsidiaries, Sistema operates are open and the company is unable to competition on the part to defend its position, there of other companies. is a risk of losing its share in such assets or subsidiaries. • Operations in the segments of telecommunications, high technology, banking, retail, media, • Sistema’s portfolio contains tourism, private healthcare several privatised assets. Since the services and pharmaceuticals Russian laws on privatisation are are exposed to the influence rather ambiguous, inconsistent of economic and other factors. and conflicting with other laws, Each segment exhibits for example, there are conflicts strong competition between

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT 111 EVENTS RELATED TO THE DECONSOLIDATION OF BASHNEFT

The civil proceedings In December 2014, Bashneft Shares Criminal proceedings brought against Sistema were transferred to the Russian relating to the privatization and Sistema-Invest Federation. of Bashneft In December 2014, Sistema as On September 24, 2014, a civil claim a good faith buyer filed a claim In April 2014, a criminal was filed with the Arbitrazh (Com- with the Arbitrazh Court for the investigation was commenced in mercial) Court of the City of Mos- recovery of damages from LLC respect of Mr. Ural Rakhimov (the cow (“Arbitrazh Court”) by the First Ural-Invest (“Ural-Invest”), suffered son of Mr. Murtaza Rakhimov, who Deputy General Prosecutor of Russia by Sistema as a result of loss of the was the President of the Republic seeking to return shares of JSOC Bashneft Shares. of Bashkortostan during the period “Bashneft” (Bashneft”) held by Siste- when the BashTEK companies ma and its wholly owned subsidiary In February 2015, the Arbitrazh were privatized) and Mr. Levon Sistema-Invest (“Bashneft Shares”) Court ruled in favour of Sistema’s Airapetyan. These persons have to the Russian Federation (the “Civil claim for the recovery of RUB 70.7 been accused of misappropriating Claim”). The Civil Claim asserted billion damage from Ural-Invest. Bashneft via an illegal privatization that the privatization of Bashneft was process and have also been unlawful as Bashneft was originally In March 2015, Sistema and accused of legalization with respect the property of the Russian Federa- Ural-Invest signed a settlement to Bashneft. tion and, as a result, the authorities agreement. In accordance with of the Republic of Bashkortostan the terms of the settlement On September 16, 2014, the majority were not legally entitled to privat- agreement, all the property owned shareholder and Chairman of the ize Bashneft without obtaining the by Ural-Invest, i.e. cash assets of Board of Directors of Sistema, Mr. requisite consents from the Russian approximately RUB 46.5 billion, will Vladimir Evtushenkov was charged Federal authorities. be transferred to Sistema. with legalization of assets that were wrongfully acquired by other On November 7, 2014, the Arbitrazh Given the social importance persons, and placed under house Court issued a written decision, rul- of the projects of the URAL arrest. ing in favour of the Civil Claim. charitable fund (“Fund”), which is affiliated with Ural-Invest, and in In December 2014, Mr. Vladimir On November 12, 2014, Sistema’s accordance with the terms of the Evtushenkov was released Board of Directors considered and settlement agreement Sistema from house arrest and is now decided not to appeal the deci- will invest RUB 4.6 billion of the participating as normal in business sion of the Arbitrazh Court, but funds receivable from Ural-Invest of Sistema Group, as the Chairman rather focus on filing claims for to the Fund’s socially important of Sistema’s Board of Directors. the recovery of damages from the charitable projects. counterparties and/or their legal successors (LLC Ural-Invest) which On March 30, the Arbitrazh Court sold the Bashneft Shares to Sistema approved the settlement agreement and Sistema-Invest. signed by Sistema and Ural-Invest.

112 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS SUSTAINABLE DEVELOPMENT

Responsible investor 114

Social investment 115

Education, science, innovation 115

Culture 117

Environment 119

Society 121

Responsibility towards employees 122 Responsible investor

Sistema has substantial influence the UNO’s aegis in response to against the background of social on the development of many sectors growing concerns involved in the interests and gives consideration of the Russian economy and society interplay of environmental and to environmental, social, and in general. The Corporation abides social issues as well as issues corporate governance (ESG) factors by the Principles for Responsible of corporate governance and underpinning the development of Investment developed by an investment practices. The Company market sectors and regions its international investor group under measures up its business goals portfolio companies operate in.

Matrix of Interested Parties

High СотрудникиEmployees ShareholdersАкционеры и and инвесторы investors

CustomersКлиенты ГосударствоGovernment

MassСМИ media

МестныеLocal communities сообщества

ПартнерыPartners

ПоставщикиSuppliers Degree of influence on the corporation business НКОNon-profit и общественные and social КонкурентыCompetitors organisationsорганизации Low Low Degree of interest on behalf of Sistema High

Sistema's core documents governing sustainable development Reports on corporate social Ethics Code responsibility are reviewed annually Regulates the standards of corporation Corporate Social by the Board of Directors, who relations and ensures open, honest and ethical determines strategic goals and Responsibility Policy business conduct of Sistema assesses the efficiency of social The key strategic investment made. Sistema’s management tool Corporate Communications for sustainable Function and specialised units of the development of the Corporation’s subsidiaries manage Company. Determines Corporate Code of Conduct corporate social responsibility and the basic principles, Defines commitments voluntarily assumed prepare and publish related non- fields and priorities for by the Corporation in addition to the stakeholder relationship requirements of effective law in terms of finance reports. management) transparency, openness and anti-corruption procedures

114 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS Social investment

• awareness; An important component of Siste- address social needs at the same ma’s corporate social responsibility • culture and art; time. 2014 was the year when the is charity promoted in line with the • preservation of religious and his- Corporation reached a whole new social investment concept, i.e., a torical heritage; level of synergies in corporate social purposeful long-term social policy responsibility: its subsidiaries and linking strategic interests of the • healthcare and social security; affiliates took active part in joint corporation and its shareholders • fitness and sports. projects promoting high technol- with society’s needs. The basic ogies, human development, and principles of charity efforts as well On top of that, subsidiaries pursue education of the youth, as well as as areas to be addressed are out- their own CSR and charity projects. volunteer campaigns, the corner- lined in the Policy Sistema’s Charity In the last three years (2012, 2013, stones of Sistema’s social policy. Work. The key body in charge of the and 2014), Sistema Group’s total Corporation’s charity and social spending on charity and social re- projects is Sistema Charitable Foun- sponsibility exceeded RUB 5.3 bln. dation (Sistema CF), who accumu- RUB lates funds allocated from profits of The Corporation seeks to consist- > mln subsidiaries for general corporate ently deepen integration of its CSR 4,5 programmes. The Foundation works projects and improve their efficiency total amount of expenses in the following key focus areas: through combined effort of all com- on charity and social panies of the Sistema Group. These responsibility projects for • science; companies increasingly use projects three years • education; designed to develop business and

Education, science, innovation

Sistema’s broadest-scale project Strategic Initiatives (ASI), and more logical creativity. The ASI’s supervi- in education and science is Lift than 500 partner organisations. sory board (chaired by the Russian to the Future, a nationwide young The programme uses a special president V.Putin) recommended the talent development programme procedure for talent screening and project for replication in various re- launched in 2011 with the support development and intends to provide gions of Russia (administrations of of the Russian Ministry of Educa- students with early career guidance 19 regions of Russia signed related tion and Science, the Agency for and inspire scientific and techno- cooperation agreements).

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT 115 2014 became the year of Technologies, Telecommunications, Group. The Corporation also offered establishment of four talent high Transport Technologies, a career guidance programme for schools for science and research Healthcare & Pharmaceuticals, participants of Lift to the Future, in the Moscow, Smolensk, and Microelectronics, etc., to be reviewed children of employees of S/As, Vladimir regions and Bashkortostan. by expert contest judges. Master and students of sponsored child School and university students classes, lectures, contests, and welfare centres and schools by submitted 370 innovation projects in conferences for school and university organising tours to MTS, MTS Bank, Environment & Natural Resources, students involved representatives MGTS, Detsky Mir, Mikron, Stream, Power Engineering, Information of most companies of the Sistema and BPGC.

Lift to the Future

regions ths winners 19 of Russia >30 64 admitted for traineeship participants of innovation in European hi-tech >150 ths project contests enterprises project participants academic 95 contests 270 mentors 500 holders held among school and college provided with grants to organise students since the beginning projects for school students in of the Programme scholarship of the Programme various regions of Russia

In December 2014 Sistema and its subsidiaries MTS and SSTL held colleges and a first-ever Russian-Indian Youth startups >400 Physicists in many countries tried to Innovation Summit in New Delhi tackle the problem, aiming to create 1968 the world's first fusion reactor. THe beST AVAilAble Tachomac enabled scientists to dedicated to latest technologies reproduce nuclear fusions similar to participating in the mAcHiNe foR those observed on the Sun. and prospects of international coNTRolled contest since its start NucleAR fuSioN cooperation in telecom innovations. The summit was supported by the Russian Embassy in India. MTS hosts Telecom Idea, a contest of >600 projects new ‘smart’ IT solutions helping city environments become more submitted by young scientists for comfortable, eco-friendly, and potential use in business; some of accessible for all social groups. them successfully implemented

After four years in Russia, in 2014 To get power today, we mostly burn oil, gas, aiming to create the world's first fusion and coal. However, the planet's oil and gas reactor. one method showing promise was reserves are limited, and with ever-growing tochamac, special contraptions for magnetic the contest was extended to India power consumption, they may be almost plasma confinement. These enabled scientists exhausted within 30-50 years. besides, oil to reproduce nuclear fusions similar to those and gas are not just fuels, they are valuable observed on the Sun. for the first time. The summit also involved an feedstocks used to produce a variety of The first tochamac was developed and chemicals, proteins, and other useful demonstrated in 1968 by a group of physicists substances. lead by lev Artsimovich, fellow of the what kind of progress should power interactive culture and technology engineering now aim for? within the universe, Soviet Academy of Sciences. The name of there is colossal energy released from the the device is an acronym of the Russian full interior of the Sun and stars in nuclear name translated as "Toroidal cHamber with exhibition From Russia with fusions. using such power on planet earth mAgnetic coils". might seem nothing more than fantasy The tochamac is still perceived as the best at first: it would require temperatures of available machine for controlled nuclear Progress dedicated to outstanding millions and millions of degrees. Physicists in fusion, and it is hoped it will provide mankind Russian inventions. many countries tried to tackle the problem, with inexhaustible energy.

116 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS MTS and MGTS are partners of the infrastructure. The Corporation New Technology School project is among the shareholders of Technopark Sarov originated by the IT Department Technopark Sarov (co-run with of Moscow and designed to Rosatom and RUSNANO) designed RUB broaden the use of information and for innovation projects to be carried bln communication technologies (ICT) out at the VNIIEF Russian Federal 1.5 in education. Nuclear Centre for the benefit of in aggregate revenue of the Russian economy. Technopark’s companies as VivaCell-MTS supported Armenian of the end of 2014 schools in setting up Creativity In October 2013 Sistema CF Labs, modern classrooms equipped first provided support to Valdai with interactive blackboards, latest International Discussion Club, computers and movable furniture a convention in Sochi bringing resident specially designed for individual together more than 800 54companies and group use. representatives of the global academic community, including at Technopark Sarov (with Sistema takes active part in the professors from major universities over 600 employees) development of national innovation of nearly 50 countries.

Culture

Sistema pursues several sizeable initiatives in culture and arts aiming to preserve and promote national cultural and historical legacy. Sistema CF supports numerous theatre, music, and art projects, as well as leading performance teams and museums.

Its charity recipients include over 20 institutions and foundations active in the field of culture, including the Nikolay Petrov Foundation, the Benois Centre, the Valery Gergiev Foundation, the Foundation for Support of Church Construction in Moscow, the Valaam Convent & Nature Reserve, and the Field of Prokhorovka Museum of Armoured Vehicles.

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT 117 The largest recipient of the Corporation’s long-term social investments is the Russian Museum, Sistema’s partner since 2003. Support of the Sistema CF allows the museum to carry out large-scale exhibition, editorial, art restoration, and educational projects. In particular, the museum is currently building an extensive interregional and international network of ‘virtual branches’ to make the vast collection of Russian arts accessible to the mainstream audience. The number of new museum branches doubled in 2013-2014. In 2014 the museum opened 28 information and education centres based in libraries, museums, and learning institutions in St Petersburg, Angarsk, Arkhangelsk, Volsk, Izhevsk, Ishim, Kaluga, Kostomuksha, Kondopoga, Petrozavodsk, Pikalyovo, Saransk, Russian Museum Sortaval, Yuzhno-Sakhalinsk, and locations in Turkey and Finland. A new cooperation agreement The Russian Museum between Sistema and the currently operates Russian Museum on financing of various museum’s projects was signed. It is termed «virtual until 2023 and contemplates branches» financing in amount of 158

(119 – in Russia, 37 – abroad RUB The West wing of St Michael’s 2 – in the mln Castle (the Engineers’ Castle) 300 Antarctica) in St Petersburg now hosts an «e-museum», a state-of-the-art multi media centre providing access to the Russian Museum’s rich art collection via latest technologies. of the multi media Sistema helps the museum to 4,000 centre in 2011-2014 constantly upgrade the centre’s visitors hard- and software to maintain its high-tech status. The various projects performed by the Russian Museum in 2014 with support from events Sistema include new multi media 4,700 127 programmes, books on Russian participants arts, and the VIIth international organised in Imperial Garden of Russia festival. of video the multi media conference calls theatre

images exhibited in the multi 600 media centre’s gallery

118 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS Since 2009 Sistema has been Another project that made great sponsoring the annual May Festival progress in 2014 is Mobile Library, mobile of Children’s Films organising an innovative social learning project libraries free charity shows of Russia’s originated by MTS and involving the >400 best motion pictures and cartoons installation of «virtual» bookshelves opened in just 8 for children. The programme in libraries and other broad access regions of Central is designed to develop modern institutions allowing users to down- Russia in 2014 learning methods and provide load masterpieces of the Russian leisure experience to children from and foreign literature, including orphanages and social boarding those from school curricula, on schools, disabled children, and mobile devices using QR codes. MTS ths families with foster children. pursues the Mobile Library project >10 books in over 30 regions of Russia, as well as Ukraine and Belarus. of a combined volume that would take almost 300 years to read have been downloaded by mobile library users Environment

The Corporation’s • implementation of energy-saving principles; environmental • safe waste reclamation; efforts are • protection of the atmosphere; focused on: • protection of water and land resources; • environmental education of the younger generation.

Sistema and its subsidiaries are reduce their environmental impact, environment protection principles actively involved in environmental improve the ecology and enhance and complies with all relevant laws efforts in regions where they environmental consciousness. The and regulations. operate, working to gradually Corporation rigorously abides by

The amount of resources used* Resource type Used for 2014 Thermal energy 2,738.12 Gcal 3,422,652.91 RUB Electrical energy 3,491 thous. kWh 13,266,014.45 RUB Water 16,470 m3 438,275.64 RUB

Sistema participated in financing Companies whose activities are LesInvest Group, the biggest forest of the Republic of Bashkiria’s directly related to natural resources user in the European part of Russia, water programme. The programme management or have an impact on is certified to FSC**, which, among embraced 20 districts and 8 public health pay special attention other things, envisages forest cities of Bashkiria and envisaged to environmental safety. Notably, restoration and close cooperation reconstruction and major repairs Targin has introduced an HSE with environmental organisations of existing and construction of new (health, safety and environment) and local communities. water intakes, conduits and water system that enables it to work supply systems, drilling of wells safely at a customer’s facilities and and installation of water towers, helps to preserve the environment. mainly in remote rural areas where In 2014 the system was first they are often the only source certified by ISO 9001, ISO 14001, of drinking water. and OHSAS - 18001.

* Data for 2014 according to the Corporate Center ** FSC (Forest Stewardship Council) is an independent international organisation who has created a certification system for environmentally and socially responsible forest management.

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT 119 In 2014, the pilot project for safe disposal of batter- ies and electronic waste >3,000 94% was launched at 300 sales outlets in Moscow and the Sistema Group employees of forest lands Moscow region. leased by Sistema are FSC-certified The project was took part in the then carried out corporate Saturday in 10 Russian cities. clean-up

Reforestation, ha programme promoting environment It has already become a good conservation principles since 2012. tradition for Sistema employees 12,427 to volunteer to clean up public 12,380 In 2014 MTS organised its first areas in cities and natural sites by national open eco lesson Mobile organising spring Saturday clean- Technology for Ecology as part of ups in Moscow and other regions. 11,929 the Green Schools programme sup- ported by the inter-regional public Since 2010, Sistema has been organisation EKA Green Movement supporting projects of the Russian of Russia. During the lesson, teach- Geographic Society. In 2014 it ers and volunteers at more than supported the Society’s first 1,000 Russian schools talked about nationwide festival involving all the role of modern technologies in of its 85 regional divisions at the 2012 2013 2014 environment protection. Central House of Artists in Moscow. The week-long festival attracted In Armenia, VivaCell-MTS together about 60,000 visitors, including The amount of the Group’s with the Foundation for the many children and teenagers who reforestation work is growing year Preservation of Wildlife and Cultural also participated in the event’s rich after year: In 2014, the area where Assets (FPWC) launched a number educational programme. planting and combined reforestation of innovative projects seeking to work took place grew by 4.2% develop alternative energy sources vs 2012. and introduce environment-friendly solutions in rural areas. Medsi Group strictly complies with Russian sanitary regulations on The Corporation is also involved in hospital waste handling. Medsi preservation of biological diversity, clinics take regular steps to prevent notably, by supporting the Eurasian hospital-acquired infections and Center for Leopard Studies and ensure epidemiological safety Preservation and particularly one of of their patients and employees. its key projects, the Leopard Land Bacteriological tests show a definite national park. Thus, in 2014 it spon- improvement in the epidemic safety sored biochemical works in the park of Medsi clinics in recent years. and the development of technology infrastructure, fire control, and an MTS’ retail outlets now serve electronic database of the Amur as drop-off stations for used leopard population. Sistema also batteries to be disposed as contributed to a leopard-themed per high environmental safety education campaign targeting standards. The campaign runs local communities, including under the title Discard It Right school students of the Khasansky and fits into a broader Eco Office municipality (Primorye).

120 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS Society

In 2014, the Sistema Charitable teer theater, whose actors stage In just 2014, the number of Foundation began shaping a corpo- educating performances for the volunteers at the Sistema Group rate volunteer movement as a tool employees’ children and inmates of grew by almost 2.5 times, from of non-financial charity. Volunteers orphanages. Detsky Mir joined this 3,300 to 8,000. Employees of all from Sistema supported tens of project in 2014. BPGC arranged an Sistema Group companies took part cultural, social, educational and educational show on electrical safe- in New Year charity campaigns, sports projects in various regions ty staged by the Bashkirian State with over 2,000 employees acting where the Group operates. MTS Puppet Theater in Belebei, Kumer- as volunteers. has launched a corporate volun- tau, Neftekamsk and Ufa.

The Wishing Tree Charity Performances Theater Season

In 2014, 200 volunteers bought Every December, the Sistema employees bought New Year gifts for children Sistema Charitable tickets for Town Musicians of at orphanages and helped Foundation organises Bremen, a musical. to organise holiday parties charity performances for for them. disadvantaged children.

New Year celebrations were Children from 17 orphanages The project reached out to over attended by children from and from poor families from 300 children from orphanages, the Moscow region, Vladimir, Moscow, the Moscow region children from large families Torzhok, Emmaus, Tula, and the Tver region attended and disabled children from the Ryazan, Noginsk and Udomlya. the charity performances. Moscow and Tver regions.

In summer 2014, the Sistema aid, including living essentials and signed to promote rules of useful Charitable Foundation sponsored vaccines. and safe use of the world wide web the purchase and delivery of among younger schoolchildren, a large relief consignment for The Group’s companies work hard their parents and teachers, as well refugees from Ukraine. Employees to implement social and educating as Internet for All, a programme of all group companies joined the programmes for the benefit of their teaching older people to use the Foundation’s initiative, contributing customers. MTS pursues Children Internet and adapt in the informa- over 200 cu m of humanitarian and the Internet, a programme de- tion-oriented society.

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT 121 Responsibility towards The project has been implemented in most cities of employees Russia and Belarus, its total audience exceeding Sistema is one of Russia’s biggest and most attractive employers, employing over 150,000 people 300,000 in Russia (0.4% of the workforce) and other countries it operates people in. The Corporation uses the best HR management practices and fully complies with labour legislation of countries it works in, MTS and MGTS support the For several years, SSTL has been offering its employees competitive Children Online help line, has by involved in an initiative to end polio remuneration and social benefits now received over 10,000 calls in India, working hard to increase (health and life insurance, sports and processed over 2,500 e-mails general awareness about polio events, etc.). regarding safe use of the Internet vaccination through promotional by minors. text messages and other channels of communication. In the past three For social aid to employees, In September 2014, BPGC signed years, subscribers of MTS India employees’ children and an agreement with the Bashkirian received 20m texts reminding them retirees in 2014 Company Education Ministry on joint to get their shots. As a result of allocated implementation of initiatives to this large-scale programme, on prevent children’s electrical injuries 27 March 2014 the World Health as part of the Safe Childhood Organisation certified India polio- RUB project. Bashkirenergo’s employees free, and UNICEF is now considering mln gave electric safety lessons at 221 this model for use in Africa. 220 schools of the republic. Sistema encourages the In November 2014, Medsi launched development of Russian sports a unique project under the slogan by supporting the country’s Following the Corporation’s Be Healthy with Medsi promoting a Olympic and Paralympic teams, transition to the investment healthy lifestyle among corporate as well as sports schools and company model, the Board of customers and partners of the com- clubs for children and the young. Directors approved a new incentive pany. Within this programme, Med- In November 2014, Sistema system designed to ensure si’s best doctors and fitness instruc- and the Russian Paralympic profitability of investment and tors offer lectures and consultations Committee organised treatment monetisation of created value for on such issues as handling chronic and rehabilitation of athletes each individual project and for fatigue and stress, pregnancy and in the Republic of Altay, at the the Corporation in general. The work, children’s health, etc. unique Altay Resort belonging incentive programme is geared to the Intourist Hotel Group. The towards value creation and/or Healthcare, support of the disabled Sistema Charitable Foundation also implementation of projects, as and promotion of sports are among supported the Moscow Olympro well as financial self-sufficiency of priorities of Sistema’s social policy. team of the Vozrozhdenie club, project teams. The new incentive Renovation of a rehabilitation center which participated in the 12th mechanism provides the best way for children with cerebral palsy at International Football Tournament to align the interests of Sistema’s the Martha and Mary Convent of for Amputees that took place in management and shareholders. Mercy began in 2014. Since 2008, Sochi. Sistema sponsored the The incentive system for the senior the Sistema Charitable Foundation establishment of a family camp for management first launched in has provided a total of RUB 100m the Moscow equestrian club for the 2010 is based on changes in the for the Convent’s restoration. This disabled in Yevpatoria (Crimea), price of Sistema shares and total unique project supported by the where children underwent a unique shareholder return (TSR). The Moscow City Government and the course of rehabilitation through programme’s participants may Russian Orthodox Church will help exercise. Sistema’s subsidiaries receive additional bonuses linked to improve the quality of life of are also actively involved in to increase of the Corporation’s families with disabled children that promotion of sports at regional capitalisation in the form of ordinary are in need of continuous care. and national levels. shares.

122 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS The Corporation has a system in the survey. The measures taken of internal career lifts. In 2014, by Sistema improved employee Sistema and MTS traditionally Sistema launched the Talent engagement by 14% compared win leading positions in Bank project that is designed to to 2013, reaching the level of the Russian employer ratings. search for, develop and rotate top world’s most successful companies. In 2014: managers of subsidiaries that have Almost all areas and parameters high potential and high motivation of the survey demonstrated for growth. In 2014, over 100 a positive trend. senior managers from the Group’s companies underwent remote and in-person assessment. Based on its results, 53 managers were selected to start a development Sistema confirmed its programme in 2015. previously won A.hr grade («High level of employer Yet another HR initiative that was appeal») in Expert RA’s launched in 2014 is the School of employer rating In-House Coaches. The project seeks to create a pool of efficient corporate coaches to develop key business skills and competencies of medium and junior management using the best expertise in the sphere.

Important tools of non-financial by 14% motivation and employee Sistema won the special engagement promotion are employee engagement nomination award Best corporate volunteering and sports increased Corporate Mass Media movements. The central sports compared to 2013 and System in the Best event of the year was the 12th reached the level of Corporate Media 2014 Summer Games, which united over the most successful competition 3,000 employees from 60 companies companies in the world of Sistema Group from different regions of Russia, the CIS and India.

Sistema conducts annual engagement surveys to give its Sistema’s Board Chairman ranks employees an opportunity to among the top 10 business leaders share their thoughts on the most of Russia according to Kommersant important issues and give feedback, and the Russian Managers’ MTS won the #1 position to find out the company’s strengths Association. Sistema’s president was in HeadHunter’s annual and areas that need improvement ranked 1st among CEOs of diversified Employers of Russia and development and to determine holding companies in Russia’s rating for a second priorities when planning HR events Top 1000 Best Managers 2014. Yet consecutive year, and for the next year. The Corporation another six of the company’s top was also included in sets itself ambitious goals and managers were named best in their HeadHunter’s list of top looks up to the most successful respective professional categories Russian employers of the international companies. In 2014, (finance and investment, corporate young about 28,000 employees took part governance, HR, GR, PR, IT).

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT 123 SISTEMA JSFC AND SUBSIDIARIES

Consolidated Financial Statements As of December 31, 2014 and 2013 and for the Years Then Ended

INDEPENDENT AUDITORS’ REPORT 125

CONSOLIDATED FINANCIAL STATEMENTS AS OF 126 DECEMBER 31, 2014 AND 2013 AND FOR THE YEARS THEN ENDED:

Consolidated statements of financial position as 126 of December 31, 2014 and 2013

Consolidated statements of operations and comprehensive 128 income for the years ended December 31, 2014 and 2013

Consolidated statements of cash flows for the years ended 130 December 31, 2014 and 2013

Consolidated statements of changes in shareholders’ equity 132 for the years ended December 31, 2014 and 2013

Notes to the consolidated financial statements 134 INDEPENDENT AUDITORS’ REPORT

To the Board of Directors and Corporation and its subsidiaries, in shareholders’ equity for the Shareholders of Sistema Joint Stock which comprise the consolidated years then ended, and the related Financial Corporation statements of financial position as notes to the consolidated financial of December 31, 2014 and 2013, and statements and appendix thereto. We have audited the accompanying the related consolidated statements consolidated financial statements of operations and comprehensive of Sistema Joint Stock Financial income, cash flows and changes

Management’s Responsibility for the Consolidated Financial Statements

Management is responsible for the accepted in the United States of of the consolidated financial preparation and fair presentation America; this includes the design, statements that are free from of these consolidated financial implementation, and maintenance material misstatement, whether due statements in accordance with of internal control relevant to the to fraud or error. accounting principles generally preparation and fair presentation

Auditors’ Responsibility

Our responsibility is to express the consolidated financial statements. An audit also includes evaluating an opinion on these consolidated The procedures selected depend on the appropriateness of accounting financial statements based on our the auditor’s judgment, including the policies used and the reasonableness audits. We conducted our audits in assessment of the risks of material of significant accounting estimates accordance with the Russian Federal misstatement of the consolidated made by management, as well as Auditing Standards and auditing financial statements, whether due evaluating the overall presentation of standards generally accepted in the to fraud or error. In making those the consolidated financial statements. United States of America. Those risk assessments, the auditor standards require that we comply considers internal control relevant We believe that the audit evidence with ethical requirements and plan to the entity’s preparation and fair we have obtained is sufficient and and perform the audit to obtain presentation of the consolidated appropriate to provide a basis for our reasonable assurance about whether financial statements in order to audit opinion. the consolidated financial statements design audit procedures that are are free from material misstatement. appropriate in the circumstances, but not for the purpose of expressing an An audit involves performing opinion on the effectiveness of the procedures to obtain audit evidence entity’s internal control. Accordingly, about the amounts and disclosures in we express no such opinion.

Opinion In our opinion, the consolidated April 2, 2015 Certificate of registration in the Unified State Register financial statements referred to above Moscow, Russian Federation № 1027700003891 of 11.11.2002, issued by Moscow present fairly, in all material respects, Inspectorate of the Russian Ministry of Taxation № 46. Raikhman M.V., Partner Address: Building 1, 13 Mokhovaya street, Moscow, the financial position of Sistema Joint 125009, Russia. Stock Financial Corporation and its (Certificate no. 01-001195 dated Independent Auditors: ZAO Deloitte & Touche CIS Certificate of state registration № 018.482, issued by subsidiaries as of December 31, 2014 January 14, 2013) the Moscow Registration Chamber on 30.10.1992. and 2013, and the results of their Certificate of registration in the Unified State Register № 1027700425444 of 13.11.2002, issued by Moscow operations and their cash flows for Interdistrict Inspectorate of the Russian Ministry of Taxation № 39. the years then ended in accordance The Entity: Sistema Joint Stock Financial Corporation Certificate of membership in “NP “Audit Chamber of with accounting principles gener- Russia” Certificate of state registration № 025.866, ally accepted in the United States issued by the Moscow Registration Chamber on (auditors’ SRO) of 20.05.2009 № 3026, ORNZ of America. 16.07.1993. 10201017407.

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT APPENDICES 125 CONSOLIDATED STATEMENTS OF FINANCIAL POSITION AS OF DECEMBER 31, 2014 AND 2013 (Amounts in thousands of U.S. dollars, except share and per share amounts)

Notes 2014 2013

ASSETS

CURRENT ASSETS: Cash and cash equivalents $ 1,288,722 $ 1,537,492 Short-term investments 8 479,341 1,562,547 Assets from banking activities, current portion (including cash and cash equivalents of $843,715 and $1,132,368) 7 2,180,196 3,898,740 Accounts receivable 9 1,163,092 1,630,593 VAT receivable 236,438 335,289 Inventories and spare parts 11 1,244,509 1,131,302 Deferred tax assets 21 245,571 330,388 Other current assets 10 832,060 1,084,547 Current assets of Bashneft 2 - 3,054,728

Total current assets 7,669,929 14,565,626

NON-CURRENT ASSETS: Property, plant and equipment 12 7,191,394 11,151,341 Advance payments for non-current assets 84,560 162,978 Goodwill 13 817,537 1,327,779 Other intangible assets 14 1,721,389 2,162,700 Investments in affiliates 16 356,018 365,266 Assets from banking activities, net of current portion 7 1,374,367 2,554,229 Debt issuance costs 42,267 78,348 Deferred tax assets 21 392,866 297,419 Long-term investments 17 316,625 249,071 Other non-current assets 703,525 714,458 Non-current assets of Bashneft 2 - 9,619,779

Total non-current assets 13,000,548 28,683,368

TOTAL ASSETS $ 20,670,477 $ 43,248,994

См. Примечания к консолидированной финансовой отчетности и приложение к ним.

126 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS Notes 2014 2013 LIABILITIES AND EQUITY

CURRENT LIABILITIES: Accounts payable $ 1,584,251 $ 1,943,133 Liabilities from banking activities, current portion 18 2,180,491 3,864,415 Taxes payable 290,635 490,564 Deferred tax liabilities 21 64,947 114,192 Subscriber prepayments, current portion 390,736 620,281 Accrued expenses and other current liabilities 19 1,315,656 1,567,890 Short-term loans payable 129,938 40,836 Current portion of long-term debt 20 1,598,770 2,102,911 Current liabilities of Bashneft 2 - 2,663,432 Total current liabilities 7,555,424 13,407,654 LONG-TERM LIABILITIES: Long-term debt, net of current portion 20 6,534,055 8,375,161 Subscriber prepayments, net of current portion 59,064 101,240 Liabilities from banking activities, net of current portion 18 167,860 772,525 Deferred tax liabilities 21 787,631 902,591 Asset retirement obligations 28 53,715 83,809 Postretirement benefits obligations 45,344 53,943 Property, plant and equipment contributions 41,358 74,174 Other long-term liabilities 475,713 443,032 Non-current liabilities of Bashneft 2 - 3,734,024 Total long-term liabilities 8,164,740 14,540,499

TOTAL LIABILITIES 15,720,164 27,948,153 Commitments and contingencies 30 - - Redeemable noncontrolling interests 29 792,766 805,130 SHAREHOLDERS’ EQUITY: Share capital (9,650,000,000 shares issued; 9,435,902,596 and 9,274,755,045 shares outstanding with par value of 0.09 Russian Rubles, respectively) 24 30,057 30,057 Treasury stock (214,097,404 and 375,244,955 shares with par value of 0.09 Russian Rubles, respectively) (246,351) (426,715) Additional paid-in capital 2,604,913 2,616,608 Retained earnings 4,210,623 8,993,469 Accumulated other comprehensive loss 24 (3,743,402) (906,718) Total shareholders’ equity 2,855,840 10,306,701 Non-redeemable noncontrolling interests 1,301,707 4,189,010 TOTAL EQUITY 4,157,547 14,495,711 TOTAL LIABILITIES AND EQUITY $ 20,670,477 $ 43,248,994

See notes to the consolidated financial statements and appendix thereto.

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT APPENDICES 127 CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME FOR THE YEARS ENDED DECEMBER 31, 2014 AND 2013 (Amounts in thousands of U.S. dollars, except share and per share amounts)

Notes 2014 2013

Sales $ 15,886,775 $ 17,623,153 Revenue from banking activities 698,182 878,832 TOTAL REVENUES 16,584,957 18,501,985 Cost of sales, exclusive of depreciation and amortization shown separately below (7,460,524) (7,907,148) Cost related to banking activities, exclusive of depreciation and amortization shown separately below (760,084) (523,960) Selling, general and administrative expenses (3,431,075) (3,896,207) Depreciation and amortization (2,292,118) (2,633,548) Taxes other than income tax (193,122) (239,814) Equity in results of affiliates 73,124 29,866 Impairment of goodwill 15 - (258,048) Impairment of other assets 15 (864,629) (804,545) Gain on disposal of investment in RussNeft 4 - 1,200,000 Gain from reentry into Uzbekistan 6 181,305 - Gain on Bitel case resolution 30 - 371,100 Other operating expenses (99,385) (273,109) OPERATING INCOME 1,738,449 3,566,572 Interest income 212,774 182,447 Interest expense (811,346) (960,136) Change in fair value of derivative instruments - 30,199 Foreign currency transaction loss (548,596) (298,264) Income before income tax 591,281 2,520,818 Income tax expense 21 (453,417) (842,107) Net income excluding Bashneft $ 137,864 $ 1,678,711 Income of Bashneft operations, net of tax effect of $427,716 and $455,637 2 1,517,054 1,540,489 Loss on deconsolidation of Bashneft, net of tax effect of nil 2 (4,969,011) - NET (LOSS) / INCOME (3,314,093) 3,219,200 Noncontrolling interests (773,539) (961,672) NET (LOSS) / INCOME ATTRIBUTABLE TO SISTEMA JSFC (4,087,632) 2,257,528 Including: From continuing operations (278,161) 1,102,161 From Bashneft operations and its deconsolidation (3,809,471) 1,155,367 OTHER COMPREHENSIVE (LOSS)/INCOME, NET OF TAX Currency translation loss $ (3,886,388) $ (885,770) Unrealized (loss)/gain on available-for-sale securities (52,099) 32,200 Unrealized gain on derivatives 72,899 45,499 Unrecognized actuarial gain 172 5,310 Other comprehensive (loss)/income, net of tax (3,865,416) (802,761) TOTAL COMPREHENSIVE (LOSS)/INCOME $ (7,179,509) $ 2,416,439

См. Примечания к консолидированной финансовой отчетности и приложение к ним.

128 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS Notes 2014 2013

Including:

Attributable to noncontrolling interests (255,193) 738,912 Attributable to Sistema JSFC (6,924,316) 1,677,527 Weighted average number of common shares outstanding – basic and diluted 9,350,539,484 9,239,817,019 Earnings per share, basic and diluted, U.S. cent (Loss)/earnings per share from continuing operations (2.98) 11.93 (Loss)/earnings per share from Bashneft operations and its deconsolidation (40.74) 12.50 Total (loss)/earnings per share attributable to Sistema JSFC shareholders (43.72) 24.43

CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 2014 AND 2013 (Amounts in thousands of U.S. dollars)

2014 2013

CASH FLOWS FROM OPERATING ACTIVITIES: Net (loss) / income $ (3,314,093) $ 3,219,200 Income of Bashneft operations (1,517,054) (1,540,489) Loss on deconsolidation of Bashneft 4,969,011 - Net income excluding Bashneft 137,864 1,678,711 Adjustments to reconcile net income to net cash provided by operations: Depreciation and amortization 2,292,118 2,633,548 Equity in results of affiliates (73,124) (29,866) Deferred income tax expense 36,338 140,292 Foreign currency transaction loss 548,596 298,264 Gain from disposal of investment in RussNeft - (1,200,000) Gain on Bitel case resolution, net of cash received of $125,000 - (246,100) Gain on reentry into Uzbekistan (181,305) - Gain on disposal of property, plant and equipment (26,731) (7,226) Gain on disposal of subsidiaries (139,082) - Amortization of connection fees (23,019) (60,309) Allowance for loan losses 260,417 212,081 Dividends received from affiliates 70,369 65,247 Non-cash compensation to employees 79,430 54,158 Impairment of goodwill - 258,048 Impairment of other assets 864,629 804,545 Other non-cash items 19,937 (15,057)

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT APPENDICES 129 CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 2014 AND 2013 (CONTINUED) (Amounts in thousands of U.S. dollars)

2014 2013

Changes in operating assets and liabilities, net of effects from purchases of businesses: Trading securities 267,153 (406,687) Accounts receivable (44,241) (240,586) VAT receivable (17,192) (174,951) Inventories and spare parts (490,362) (171,320) Other current assets (114,574) (93,381) Accounts payable 560,603 533,948 Subscriber prepayments (11,593) 110,112 Taxes payable (5,394) 109,503 Accrued expenses and other current liabilities 281,592 (54,127) Net cash from operating activities excluding Bashneft 4,292,429 4,198,847 Net cash from operating activities of Bashneft 2,755,291 2,629,988 Net cash provided by operating activities 7,047,720 6,828,835

CASH FLOWS FROM INVESTING ACTIVITIES: Payments for purchases of property, plant and equipment (2,362,652) (2,455,276) Proceeds from sale of property, plant and equipment 80,332 39,592 Payments for purchases of intangible assets (539,930) (539,117) Payments for businesses, net of cash acquired (392,409) (34,664) Proceeds from sale of subsidiaries, net of cash disposed 150,000 561,402 Purchase of investments in affiliated companies (201,582) (63,753) Payments for purchases of long-term investments (836,916) (105,000) Proceeds from sale of long-term investments 511,227 1,286,292 Payments for purchases of short-term investments (1,327,702) (1,337,304) Proceeds from sale of short-term investments 1,622,718 1,047,317 Payments for purchases of other non-current assets - (44,879) Increase in restricted cash - (15,819) Net decrease/(increase) in loans to customers of the banking segment 664,089 (70,458) Net cash used in investing activities excluding Bashneft (2,632,825) (1,731,667) Net cash used in investing activities of Bashneft (net of cash disposed of $961,733) (3,256,540) (1,158,995) Net cash used in investing activities $ (5,889,365) $ (2,890,662)

См. Примечания к консолидированной финансовой отчетности и приложение к ним.

130 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS 2014 2013

CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from/(principal payments on) short-term borrowings, net $ 185,838 $ (231,036) Net decrease in deposits from customers of the banking segment (701,620) (177,105) Proceeds from long-term borrowings 2,850,171 1,900,322 Principal payments on long-term borrowings (2,274,350) (2,539,405) Acquisition of noncontrolling interests in existing subsidiaries (67,432) (299,184) Dividends paid (1,198,028) (1,225,440) Proceeds from capital transactions with shares of existing subsidiaries 41,141 69,002 Net cash used in financing activities excluding Bashneft (1,164,280) (2,502,846) Net cash provided by/(used in) financing activities of Bashenft 885,338 (580,164) Net cash used in financing activities (278,942) (3,083,010) Effect of foreign currency translation on cash and cash equivalents (1,938,436) (293,247) Net (decrease)/increase in cash and cash equivalents (1,059,023) 561,916 Cash and cash equivalents at the beginning of the year, including Bashneft 3,191,460 2,629,544 (включая денежные средства и их эквиваленты АНК «Башнефть») 2,132,437 3,191,460 Less: cash and cash equivalents of Bashneft at the end of the year - (521,600) Cash and cash equivalents at the end of the year $ 2,132,437 $ 2,669,860 Comprising: Non-banking activities 1,288,722 1,537,492 Banking activities 843,715 1,132,368 CASH PAID DURING THE YEAR FOR: Interest, net of amounts capitalized $ (876,692) $ (1,160,300) Income taxes (377,298) (735,797) NON-CASH INVESTING AND FINANCING ACTIVITIES: Acquisition of intangible assets - 670,300 Equipment and licenses acquired under capital leases 203,904 223,628 Amounts owed for capital expenditures 401,206 124,826 Payables related to business acquisitions 1,760 345

See notes to the consolidated financial statements and appendix thereto.

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT APPENDICES 131 CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY FOR THE YEARS ENDED DECEMBER 31, 2014 AND 2013 (Amounts in thousands of U.S. dollars, except share amounts)

Share capital Treasury stock Accumulated Non-redeemable Redeemable Additional Retained other compre- Shareholders’ non-controlling non-controlling Shares Amount Shares Amount paid-in capital earnings hensive Loss equity interests Total equity interests

Balances at January 1, 2013 9,650,000,000 30,057 (440,425,038) (501,109) 2,859,491 7,110,467 (326,717) 9,172,189 4,109,505 13,281,694 731,661 Net income/(loss) - - - - - 2,257,528 - 2,257,528 1,021,588 3,279,116 (59,916) Other comprehensive (loss)/income ------(580,001) (580,001) (229,192) (809,193) 6,432 Settlements under long-term motivation program - - 65,180,083 74,394 (13,262) - - 61,132 - 61,132 - Accrued compensation cost - - - - 54,158 - - 54,158 - 54,158 - Business combinations, disposals and capital transactions of subsidiaries - - - - (283,779) - - (283,779) 237,429 (46,350) 27,547 Change in fair and redemption value of noncontrolling interests - - - - - (99,406) - (99,406) - (99,406) 99,406 Dividends declared by Sistema JSFC - - - - - (275,120) - (275,120) - (275,120) - Dividends declared by subsidiaries ------(950,320) (950,320) - Balances at December 31, 2013 9,650,000,000 30,057 (375,244,955) (426,715) 2,616,608 8,993,469 (906,718) 10,306,701 4,189,010 14,495,711 805,130

Net (loss)/income - - - - - (4,087,632) - (4,087,632) 852,476 (3,235,156) (78,937) Other comprehensive (loss)/ income ------(5,128,557) (5,128,557) (974,348) (6,102,905) (54,384) Settlements under long-term motivation program - - 122,129,298 132,811 (141,239) - - (8,428) - (8,428) - Accrued compensation cost - - - - 79,430 - - 79,430 - 79,430 - Business combinations, disposals and capital transactions of subsidiaries - - 39,018,253 47,553 50,114 - - 97,667 (491,574) (393,907) - Change in fair and redemption value of noncontrolling interests - - - - - (120,957) - (120,957) (120,957) 120,957 Dividends declared by Sistema JSFC - - - - - (574,257) - (574,257) (574,257) - Dividends declared by subsidiaries ------(889,068) (889,068) - Deconsolidation of Bashneft ------2,291,873 2,291,873 (1,384,789) 907,084 Balances at December 31, 2014 9,650,000,000 30,057 (214,097,404) (246,351) 2,604,913 4,210,623 (3,743,402) 2,855,840 1,301,707 4,157,547 792,766

See notes to the consolidated financial statements and appendix thereto.

132 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS Share capital Treasury stock Accumulated Non-redeemable Redeemable Additional Retained other compre- Shareholders’ non-controlling non-controlling Shares Amount Shares Amount paid-in capital earnings hensive Loss equity interests Total equity interests

Balances at January 1, 2013 9,650,000,000 30,057 (440,425,038) (501,109) 2,859,491 7,110,467 (326,717) 9,172,189 4,109,505 13,281,694 731,661 Net income/(loss) - - - - - 2,257,528 - 2,257,528 1,021,588 3,279,116 (59,916) Other comprehensive (loss)/income ------(580,001) (580,001) (229,192) (809,193) 6,432 Settlements under long-term motivation program - - 65,180,083 74,394 (13,262) - - 61,132 - 61,132 - Accrued compensation cost - - - - 54,158 - - 54,158 - 54,158 - Business combinations, disposals and capital transactions of subsidiaries - - - - (283,779) - - (283,779) 237,429 (46,350) 27,547 Change in fair and redemption value of noncontrolling interests - - - - - (99,406) - (99,406) - (99,406) 99,406 Dividends declared by Sistema JSFC - - - - - (275,120) - (275,120) - (275,120) - Dividends declared by subsidiaries ------(950,320) (950,320) - Balances at December 31, 2013 9,650,000,000 30,057 (375,244,955) (426,715) 2,616,608 8,993,469 (906,718) 10,306,701 4,189,010 14,495,711 805,130

Net (loss)/income - - - - - (4,087,632) - (4,087,632) 852,476 (3,235,156) (78,937) Other comprehensive (loss)/ income ------(5,128,557) (5,128,557) (974,348) (6,102,905) (54,384) Settlements under long-term motivation program - - 122,129,298 132,811 (141,239) - - (8,428) - (8,428) - Accrued compensation cost - - - - 79,430 - - 79,430 - 79,430 - Business combinations, disposals and capital transactions of subsidiaries - - 39,018,253 47,553 50,114 - - 97,667 (491,574) (393,907) - Change in fair and redemption value of noncontrolling interests - - - - - (120,957) - (120,957) (120,957) 120,957 Dividends declared by Sistema JSFC - - - - - (574,257) - (574,257) (574,257) - Dividends declared by subsidiaries ------(889,068) (889,068) - Deconsolidation of Bashneft ------2,291,873 2,291,873 (1,384,789) 907,084 Balances at December 31, 2014 9,650,000,000 30,057 (214,097,404) (246,351) 2,604,913 4,210,623 (3,743,402) 2,855,840 1,301,707 4,157,547 792,766

See notes to the consolidated financial statements and appendix thereto.

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT APPENDICES 133 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2014 AND 2013 (Amounts in thousands of U.S. dollars, unless otherwise stated)

1. BASIS OF PREPARATION

Sistema Joint Stock Financial and the majority of its consolidated Company. The rest of the shares are Corporation (the “Company”, together subsidiaries are incorporated in the listed on the London Stock Exchange in with its subsidiaries, the “Group”) Russian Federation (“RF”). the form of Global Depositary Receipts invests in, and manages a range (“GDRs”) and on the Moscow Exchange. of companies which operate in the The controlling shareholder of the telecommunications, oil and energy, Company is Vladimir P. Evtushenkov. Below are the Group’s significant high technology, banking, timber, real Minority holdings are held by certain entities and their principal activities as of estate and other sectors. The Company top executives and directors of the December 31, 2014:

Beneficial ownership Significant entities Short name Principal activity as of December 31,

2014 года 2013 года Sistema Joint Stock Financial Sistema Investing and financing Corporation Mobile TeleSystems MTS Telecommunications 53% 53% SistemaShyamTeleS SSTL Telecommunications 57% ervicesLimited 57% MTS Bank MTS Bank Banking 87% 87% RTI RTI Technology 85% 85% Detsky mir-Center Detsky mir Retail trading 99% 100% Medsi Medsi Healthcare services 75% 75% Targin Targin Oilfield services 100% 100% Bashkirian Power Grid Company (Note 5) BPGC Energy transmission 91%(1) 79%(1) LesInvest (Note 3) LesInvest Timber 100% - Leader-Invest Leader-Invest Real estate 100% 100%

Voting interests as of December 31, 2014 and 2013 – 93%.

The accompanying consolidated appropriate to present the financial Management considers that certain financial statements have been position, results of operations and accounting estimates and assumptions prepared in conformity with cash flows in accordance with U.S. relating to business combinations accounting principles generally GAAP, which are not recorded in and disposals, property, plant and accepted in the United States of the accounting books of the Group’s equipment, intangible assets and America (“U.S. GAAP”). The Group’s entities. goodwill, provisions and contingent entities maintain accounting liabilities and impairment are the records in the local currencies of In determining and applying Group’s critical accounting estimates the countries of their domicile in accounting policies, judgement is accordance with the requirements often required in respect of items A discussion of these estimates of respective accounting and tax where the choice of specific policy, together with the summary of the legislation. The accompanying accounting estimate or assumption Group’s significant accounting financial statements differ from could materially affect the reported policies is provided in appendix A1 the financial statements prepared results of operations or financial to the notes to these consolidated for statutory purposes in that position of the Group. financial statements. they reflect certain adjustments,

134 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS 2. DECONSOLIDATION OF BASHNEFT n September 2014, a civil claim void. In November 2014, the court ruled Bashneft was deconsolidated and was filed with the Moscow Court in favour of the plaintiff and ordered the the carrying amount of its assets and of Arbitration by the Prosecutor transfer of the Bashneft shares held by liabilities. The Group also removed General’s Office of the Russian the Group to the Russian Federation. the amount previously accumulated Federation seeking the transfer to The transfer of the shares took place in in the translation adjustment the Russian Federation of all shares December 2014. component of equity and attributable in Bashneft held by the Group. The to Bashneft and reported it as part civil claim asserted that the transfer The Group deconsolidated Bashneft in of the loss on transfer of Bashneft of Bashneft from the property of the December 2014 and recognized a loss shares to the Russian Federation. Russian Federation into the property upon loss of control, measured as of Bashkortostan in 1992-1993 the difference between the carrying The loss on deconsolidation had been unlawful, as no requisite amount of noncontrolling interests of Bashneft recognized in the consent had been obtained from the in the former subsidiary (including consolidated statement of operations federal authorities, and therefore all accumulated other comprehensive and comprehensive income for the subsequent transactions with Bashneft income attributable to the year ended December 31, 2014 is shares should be considered null and noncontrolling interests) at the date measured as follows:

Net assets as at deconsolidation date $ 4,061,927 Noncontrolling interests (1,384,789) Accumulated currency translation adjustment 2,291,873 - Loss on deconsolidation of Bashneft $ 4,969,011 Noncontrolling interests - Loss on deconsolidation of Bashneft $ 4,969,011 Tax effect - Loss on deconsolidation of Bashneft, net of tax 4,969,011

Bashneft results were separately presented in the consolidated statements of operations and comprehensive income for the years ended December 31, 2014 and 2013 as follows: 2014 2013 Revenues $ 16,224,383 $ 17,783,111 Income from Bashneft, before income taxes 1,944,770 1,996,126 Income tax expense (427,716) (455,637) Income from Bashneft, net of tax effect 1,517,054 1,540,489

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT APPENDICES 135 Additionally, the assets and liabilities pertaining to Bashneft have been presented separately within the consolidated statement of financial position as of December 31, 2013 as follows:

Cash and cash equivalents $ 625,417 Accounts receivable 593,016 Inventories and spare parts 716,847 Other current assets 2,659,069 Intragroup balances (1,539,621) Current assets of Bashneft $ 3,054,728 Property, plant and equipment 8,794,360 Other non-current assets 941,695 Intragroup balances (116,276) Non-current assets of Bashneft $ 9,619,779 Accounts payable (1,351,326) Debt, current portion (367,147) Other current liabilities (1,096,320) Intragroup balances 151,361 Current liabilities of Bashneft $ (2,6 63,432)

Debt, long-term portion (2,419,639) Other long-term liabilities (1,344,437) Intragroup balances 30,052 Long-term liabilities of Bashneft $ (3,734,024)

he Group retains no continuing seller of the Bashneft shares to the March 2015 the Moscow Court of involvement with Bashneft after it Group. In February 2015, the сourt Arbitration approved the settlement has been deconsolidated, other than upheld the Group’s claim. In March agreement between the Group and routine transactions in the normal 2015, the Group and Ural-Invest Ural-Invest. The transfer of assets course of business. signed a settlement agreement. did not occur as of the date of the In accordance with its terms, all issuance of the consolidated financial In December 2014, the Group filed assets owned by Ural-Invest of RUB statements and therefore the Group a claim with the Moscow Court 46.5 billion, will be transferred to did not recognize the gain in the of Arbitration for the recovery of the Group, which will invest RUB consolidated statement of operations RUB 70.7 billion losses from Ural- 4.6 billion of this amount into the and comprehensive income. Invest, a legal successor of the projects of Ural charitable fund. In

136 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS 3. BUSINESS COMBINATIONS

Business combinations in 2014 with their subsidiaries – “LesInvest improving operating efficiency and Group”), a leading manufacturer upgrading production facilities. LesInvest – In September 2014, of sack paper and paper sacks and The following table summarizes LesInvest, a wholly owned subsidiary exporter of timber products and ply consideration paid and the amounts of the Group, acquired 100% of wood, for a total cash consideration of the assets acquired and liabilities the share capital of OJSC Segezha of $287 million. The Group sees high assumed that were recognized at the Pulp and Paper Mill and LLC growth potential for the LesInvest acquisition date: Derevoobrabotka-Proekt (together Group business, to be unlocked by

Property, plant and equipment $ 110,917 Inventories 109,876 Deferred tax assets 76,047 Other assets 117,367 Accounts payable and other liabilities (127,000) Cash consideration paid $ 287,207

The purchase price allocation of had not completed the valuation reflect the allocation of the purchase LesInvest Group was not finalized of individual assets and liabilities price based on a preliminary fair as of the date of these consolidated of LesInvest Group. The Group’s value assessment of the assets financial statements, as the Group consolidated financial statements acquired and liabilities assumed.

Other acquisitions

The information on other business combinations which took place in 2014 is summarized below:

Acquiree Principal Date Interest Acquiring Purchase activity of acquisition acquired segment price

SMARTS-Ivanovo Mobile operator December 100% MTS 7,480 SMARTS-Ufa Mobile operator December 100% MTS 7,040 Penza-GSM Mobile operator December 100% MTS 34,121 Step Group Grain production December 85% Corporate 63,965

Total $ 112,606

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT APPENDICES 137 The following table summarizes the amounts of the assets acquired and liabilities assumed relating to such acquisitions at the acquisition date:

Current assets $ 25,935 Property, plant and equipment 78,467 Rights to use radio frequencies 25,759 Goodwill 29,247 Other non-current assets 5,061 Current liabilities (32,722) Non-current liabilities (9,546) Noncontrolling interests (9,595) Purchase price $ 112,606

The purchase price allocations of based on a preliminary fair value from combining the operations of SMARTS-Ivanovo, SMARTS-Ufa and assessment of the assets acquired MTS and acquired companies. Penza-GSM were not finalized as of and liabilities assumed. The excess of the date of these financial statements the consideration paid over the value In December 2014, Krasnodar Agro, as the Group had not completed the of net assets in the amount of $29 a wholly owned subsidiary of the valuation of the individual assets of million was preliminarily allocated Group, acquired 85% of the voting each entity. The Group’s consolidated to goodwill which was attributable to shares of the five grain producers in financial statements reflect the the MTS segment. Goodwill is mainly Krasnodar region (Step Group). allocation of the purchase price attributable to the expected synergies

Pro forma results of operations (unaudited)

The following pro forma financial acquisition of LesInvest Group as if it data for the years ended December had occurred as of January 1, 2013: 31, 2014 and 2013 give effect to the 2014 2013

Revenues $ 17,130,212 $ 19,199,485 Net income (3,346,547) 3,052,629

The pro forma information is give effect to any potential revenue The following amounts of revenue and based on various assumptions and enhancements or cost synergies earnings of LesInvest Group since the estimates. The pro forma information or other operating efficiencies that acquisition date in September 2014 is neither necessarily indicative of could result from the acquisitions. are included into the consolidated the operating results that would have The actual results of operations of statement of operations and occurred if the Group acquisitions these companies are included into comprehensive income for the year had been consummated as of the consolidated financial statements ended December 31, 2014: January 1, 2013, nor is it necessarily of the Group only from the respective indicative of future operating results. dates of acquisition. The pro forma information does not

2014

Net revenues $ 151,227 Net income 14,178

The results of operations of other business combinations, individually of operations. acquired businesses have not been and in aggregate, were not material included because the effects of these to the Group’s consolidated results

138 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS Business combinations in 2013

SITRONICS-Nano – In May 2013, the option to acquire RUSNANO’s As a result of the transactions, Group acquired an additional 12.3% shares in Sitronics-Nano for RUB 6.1 the Group obtained control over ownership interest in SITRONICS- billion plus 7.63% p.a. at any time till SITRONICS-Nano and accounted Nano, previously an affiliate, from November 1, 2017. RUSNANO had a for this business combination by RUSNANO for cash consideration put option to sell its remaining shares applying the acquisition method. of RUB 2 billion ($61.1 million at the in SITRONICS-Nano for RUB 8.1 billion The following table summarizes the acquisition date) increasing its voting not earlier than October 31, 2016 and consideration paid for SITRONICS- interest to 62.1%. Simultaneously, not later than November 1, 2017. Nano and the assets acquired and the Group and RUSNANO amended This acquisition allowed the Group to liabilities assumed recognized at the existing call and put option secure its rights for use of 180 and 90 acquisition date, as well as the fair agreements. Under the amended nanometre equipment that has been value of the noncontrolling interests in agreements, the Group had a call leased from SITRONICS-Nano. the investee:

Current assets $ 73,231 Net investment in the lease 518,916 Current liabilities (76,700) Non-current liabilities (18,829) Noncontrolling interests (187,164) 309,454 Fair value of previously held interest (248,309) Cash consideration $ 61,145

As part of this business within other operating expenses, In May 2014, following the issuance combination, the Group recognised net in the consolidated statement of additional shares in Mikron, a a revaluation gain resulting from of operations and comprehensive subsidiary of RTI, such put and call the remeasurement of its previously income. The fair value of previously option agreements between the held interest. The difference in the held interest and the noncontrolling Group and ROSNANO were amended amount of $22.4 million between the interests in SITRONICS-Nano were (Note 5). fair value of previously held interest estimated based on the amount of and the carrying value of the Group’s consideration in the transaction investment has been recorded described above.

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT APPENDICES 139 4. DISPOSALS

Disposals in 2014 which was acquired in 2012 was split In July 2013, the Group further sold into two legal entities: SG-trading additional 15% of SG-trans to Unirail, NIIDAR-Nedvizhimost – In 2014, which comprised the non-core non- a shareholder of Financial Alliance, the Group sold its 100% interest in transportation assets and SG-trans for a cash consideration of RUB 2.5 NIIDAR-Nedvizhimost, a subsidiary of which retained all the core transport billion ($76.4 million) with no gain RTI which managed rental property, assets. In April 2013 the Group sold or loss recognized as a result of this for a total cash consideration of a 70% stake in SG-trans to Financial transaction. $150.0 million. As a result of this Alliance, an affiliate of the Group, for transaction, the Group recognized cash consideration of RUB 12 billion RussNeft – In July 2013, the Group gain on disposal of subsidiaries ($380.2 million at the disposal date), sold its 49% stake in RussNeft, of $139.1 million, included in thereby reducing its direct ownership the Group’s affiliate, for cash other operating expenses in the in SG-trans from 100% to 30%. consideration of $1,200 million. Prior consolidated statement of operations to the disposal, the Group has been and comprehensive income. Upon disposal, the Group accounting for this investment using deconsolidated SG-trans and the equity method. As of the disposal accounted for its remaining date, the carrying value of the Group’s Disposals in 2013 interest using the equity method. investment in RussNeft was nil. As a result of the transaction, Accordingly, the Group recognized a SG-trans – During 2013, the Group the Group recognized a gain $1,200 million gain on this disposal completed a reorganisation of its of $4.0 million in the consolidated being the difference between the transportation assets. As a result statement of operations and consideration received and the of the reorganization, SG-trans, comprehensive income. carrying value of investment disposed.

5. CAPITAL TRANSACTIONS OF SUBSIDIARIES

Transactions in 2014 Business-Nedvizhimost – In April accounted for directly in equity 2014, MTS sold a 49% stake in and resulted in a decrease of MTS Bank – In December 2014, the Business-Nedvizhimost, a company noncontrolling interests by $13.8 Group participated in additional share which owns and manages a real million and a decrease of additional issue of MTS Bank for $309.0 million. estate portfolio in Moscow, to the paid-in capital by $24.0 million. The transaction resulted in no change Company for $91.8 million. This in noncontrolling interests and transfer of ownership interest within additional paid-in capital. the Group resulted in an increase Transactions in 2013 of noncontrolling interests and a Mikron – In May 2014, Mikron issued decrease of additional paid-in capital Business-Nedvizhimost – In additional shares representing 25.1% by $47.4 million. December 2013, MTS sold a 51% of its share capital in exchange stake in Business-Nedvizhimost for 37.7% interest in SITRONICS- NVision – In January 2014, the to the Company for RUB 3.2 billion Nano, owned by OJSC RUSNANO. Group acquired an additional 38.75% ($98.5 million as of the transaction Upon completion of the transaction, stake in NVision from minority date). This transfer of ownership the Group’s effective ownership in shareholders for $82.5 million, $37.5 interest within the Group resulted Mikron decreased to 53.0%. The million of which was paid in cash in an increase of noncontrolling transaction was accounted for and $45.0 million in the Company’s interests and a decrease of additional directly in equity and resulted in a treasury shares. Upon completion paid-in capital by $42.7 million. decrease of noncontrolling interests of this transaction, the Group’s and an increase of additional ownership in NVision was 88.75%. RTI – In December 2013, RTI issued paid-in capital by $44.1 million. The transaction was accounted for 4,687,500,000 common shares with par Simultaneously, the Group and directly in equity and resulted in an value of 1 Russan ruble which were RUSNANO substituted their existing increase of noncontrolling interests acquired by existing shareholders, put and call option agreements on by $42.0 million and a decrease of the Company and the Bank of RUSNANO’s share in SITRONICS- additional paid-in capital by $121.8 Moscow, for cash consideration of Nano for new put and call option million. In December 2014, the Group RUB 6.0 billion ($183.9 million as of agreements on its 25.1% share in acquired the remaining 11.25% the purchase date) in proportion to Mikron. The terms of the option stake in NVision for approximately their existing ownership interests. agreements remained unchanged. $10.0 million. The transaction was The Bank of Moscow received a put

140 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS option to sell its 703,125,000 shares for 1 RUB. In October 2013, the (“Rosnedra”) the Trebs and Titov acquired upon their issuance to the Company acquired a 100% stake in oilfield license was transferred from Group at a price of $27.5 million SITRONICS-N from RTI for RUB 1.0 Bashneft to its subsidiary Bashneft- plus 8.25% p.a. not earlier than billion ($31.0 million as at transaction Polyus. This transaction resulted December 26, 2016 and not later than date). This transaction resulted in an in an increase in noncontrolling December 26, 2018. As a result of this increase of noncontrolling interests interests in the amount of $113.0 put option, the Group classified the and a decrease of additional paid-in million with a corresponding underlying noncontrolling interests as capital by $11.0 million. decrease in the Group’s constructive redeemable. obligation to OJSC LUKOIL in the Mikron – In August 2013, Mikron amount of $139.1 million and an Targin – In September 2013, the issued 691,962 ordinary shares which increase in additional paid-in capital Company acquired a 100% stake in were purchased by the RF for cash by $26.1 million. Bashneft Services Assets, (renamed consideration of RUB 465 million to Targin in July 2014) from Bashneft ($14.1 million). This transaction Sistema-Invest – In May 2014, the for RUB 4.1 billion ($126.8 million was accounted for directly in equity reorganization of CJSC Sistema- as at transaction date). This transfer and resulted in an increase of Invest (“Sistema-Invest”) was of ownership interest within the noncontrolling interests by $5.2 completed. 38,139,925 ordinary Group resulted in a decrease of million and an increase of additional shares of Bashneft previously held noncontrolling interests and an paid-in capital by $8.9 million. by CJSC Bashneft-Invest, wholly- increase of additional paid-in capital owned subsidiary of Bashneft created by $24.4 million. MTS Bank – In April 2013, MTS through a spinoff from Sistema- acquired a 25.0945% stake in MTS Invest, and 8,885,866 preferred shares MTS – In September-December Bank through the purchase of bought back from the shareholders 2013, the Group acquired 0.6% of its additional share issuance for were cancelled. The transactions MTS ordinary shares on the open RUB 5 billion ($123 million). Upon were accounted for directly in market for $120.0 million. The completion of the transaction, the equity and resulted in a decrease of transaction was accounted for directly Group’s effective ownership in MTS noncontrolling interests by $694.6 in equity and resulted in a decrease Bank decreased from 99% to 87%. million and an increase of additional of noncontrolling interests by $23.0 This transfer of ownership interest paid-in capital by $199.4 million. million and a decrease of additional within the Group resulted in an The Group’s ownership in Bashneft paid-in capital by $97.0 million. increase of noncontrolling interests increased from 75.0% to 78.8% and in and a decrease of additional paid-in BPGC – from 79.3% to 91.0%. Detsky mir – In September 2013, capital by $105 million. Detsky mir purchased 25%+1 of its Ufaorgsintez – In March 2014, own shares from Sberbank for cash pursuant to the terms of a voluntary consideration of $140.0 million. The Capital transactions of tender offer originally announced transaction was accounted for directly in December 2013, Ufaorgsintez in equity and resulted in a decrease Bashneft and its subsidiaries completed the acquisition of of noncontrolling interests by $5.4 its ordinary shares for a total million and a decrease of additional UPC – In September 2014, the consideration of $26.5 million. As paid-in capital by $134.6 million. Group terminated a contract for the a result, the Group’s ownership in The Group took a long-term loan acquisition of a 98% stake in UPC Ufaorgsintez increased from 76.8% to from Sberbank to fund the purchase. from Bashneft. As a consequence of 86.5%. The transaction was accounted Simultaneously the Group has this transaction, Bashneft obtained for directly in equity and resulted in a pledged these shares to Sberbank as control over UPC. This resulted in the decrease of noncontrolling interests security against the loan. Group’s ownership in UPC decreasing by $49.5 million and an increase of from 99.0% to 78.0% and the additional paid-in capital by $22.5 SITRONICS-N – In September 2013, Group’s ownership in Ufaorgsintez million. the Group undertook restructuring decreasing from 86.5% to 78.7%. of certain RTI assets. Upon These transactions resulted in an UPC – In September 2013, the completion of a series of transactions, increase of noncontrolling interests Company acquired a 98% stake in SITRONICS, a subsidiary of RTI, spun in the amount of $4.8 million and a United Petrochemical Company off two companies, SITRONICS-N and decrease of additional paid-in capital (“UPC”) from Bashneft for RUB RTI Microelectronics, with allocation by $20.9 million. 6.2 billion ($192.0 million as at of all its major assets and liabilities transaction date), which resulted in a to these companies. To complete the Bashneft-Polyus – On 23 May 2014, decrease of noncontrolling interests restructuring process a 100% stake in in accordance with an order from and an increase of additional paid-in SITRONICS was sold to SITRONICS-N the Federal Agency for Subsoil Use capital by $41.4 million.

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT APPENDICES 141 6. ВREENTRY INTO UZBEKISTAN

Following unsuccessful tenders on Mobile Systems LLC (“UMS”), with and recognized a gain from reentry sale of Uzdunrobita equipment, the such entity having no legal connection into Uzbekistan pursuant to the representatives of the Republic of to the previously liquidated entity, Settlement Agreement in the amount Uzbekistan and MTS commenced Uzdunrobita. UMS was granted 2G, of $181 million. negotiations in relation to the 3G and LTE licenses and received return of MTS to the market. In frequencies, numbering capacity and The Group has determined that the July 2014, MTS signed a settlement other permits required for the launch Settlement Agreement primarily agreement with the Republic of of operations. addressed two separate elements – Uzbekistan eliminating all mutual the elimination of all mutual claims claims (“Settlement Agreement”). In September 2014, a 50.01% and guarantees granted to MTS in International arbitration proceedings ownership interest in UMS was connection with its reentry into the between MTS and the Republic transferred to the Group by a state- Republic of Uzbekistan. The Group of Uzbekistan in the International owned enterprise established and concluded that the aforementioned Center for Settlement of Investment managed by the State committee consideration of $181 million related Disputes, Member of the World Bank for communications, development to, in its entirety, a financial incentive Group (ICSID), were discontinued of information systems and to encourage the reentry into the following the submission of a joint telecommunications technologies Republic of Uzbekistan and as such, application by the both parties. of the Republic of Uzbekistan, which recognition in continuing operations retained the remaining 49.99% was appropriate. No element was The government authorities provided in UMS.The Group concluded allocated to the non-satisfaction and certain guarantees to MTS in that, upon receiving the 50.01% elimination of mutual claims as this relation to the protection of any ownership interest, the Group was deemed to have minimal value. future investment in the Republic of obtained control over UMS and Uzbekistan to encourage the return of consolidated the entity. The Group The following table summarizes the MTS to the market. estimated the fair value of the amounts of the assets and liabilities entity’s assets and liabilities, as well recognized at the date of obtaining Also, the Republic of Uzbekistan as the noncontrolling interests in control, as well as the fair value of the established a legal entity, Universal UMS as of the date of the transfer, noncontrolling interests at that date:

Property, plant and equipment $ 119,211 Intangible assets 132,333 Other non-current assets 31,610 Noncontrolling interests (101,849) Gain from reentry into Uzbekistan $ 181,305

142 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS 7. ASSETS FROM BANKING ACTIVITIES

Assets from banking activities, net of an allowance for loan losses, as of December 31, 2014 and 2013 consisted of the following:

2014 2013 Cash and cash equivalents $ 843,715 $ 1,132,368 Loans to customers 2,597,696 4,842,982 Investments in securities (trading) 368,567 551,513 Loans to banks 131,919 161,229 Investments in securities (available-for-sale) 87,652 154,356 Other investments 85,956 127,096 Less: allowance for loan losses (560,942) (516,575) Assets from banking activities, net 3,554,563 6,452,969 Less: amounts maturing after one year (1,374,367) (2,554,229) Assets from banking activities, current portion $ 2,180,196 $ 3,898,740

Major categories of loans to customers as of December 31, 2014 and 2013 comprise the following:

2014 2013 Corporate customers $ 1,294,744 $ 2,739,345 Individuals 1,302,952 2,103,637

Total $ 2,597,696 $ 4,842,982

As of December 31, 2014, 79.7% and 0.6% of the balance of loans to corporate customers and individuals, respectively, were evaluated individually for impairment (2013: 80.0% and 0.5%).

The following table presents the effective average interest rates by category of loans as of December 31, 2014 and 2013:

2014 2013

RUB USD Other RUB USD Other Loans to customers - corporate customers 10.5% 8.8% 9.2% 10.8% 7.0% 9.8% - individuals 19.0% 4.4% 6.5% 23.4% 8.3% 4.2% Loans to banks 7.9% 0.01% 0.01% 4.5% 0.1% 0.1%

The movement in the allowance for loan losses in 2014 and 2013 was as follows:

2014 2013 Allowance for loan losses, beginning of the year $ 516,575 $ 329,803 Additions charged to operating results less recovery of allowance 423,121 248,032 Amounts written off against the allowance (162,705) (37,185) Currency translation adjustment (216,049) (24,075) Allowance for loan losses, end of the year $ 560,942 $ 516,575

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT APPENDICES 143 8. SHORT-TERM INVESTMENTS

Short-term investments as of December 31, 2014 and 2013 consisted of the following:

2014 2013 Bank deposits with original maturities exceeding three months $ 202,644 $ 647,077 Trading securities 97,550 499,437 Available-for-sale securities 74,149 354,838 Promissory notes and loans 104,998 61,195

Total $ 479,341 $ 1,562,547

Promissory notes and loans to third parties are primarily denominated in USD and bear interest rates varying from 4.0% to 6.0% as of December 31, 2014.

The effective interest rates on bank deposits with original maturities exceeding three months as of December 31, 2014 are between 1.0% and 5.3% (December 31, 2013: 4.2% and 14.0%).

9. ACCOUNTS RECEIVABLE

Accounts receivable, net of provision for doubtful accounts, as of December 31, 2014 and 2013 consisted of the following:

2014 2013 Trade receivables $ 1,246,580 $ 1,808,403 Less: provision for doubtful accounts (83,488) (177,810)

Total $ 1,163,092 $ 1,630,593

Write-off of trade receivables against provision for doubtful accounts in 2014 and 2013 amounted to $134.7 million and $96.5 million respectively.

10. OTHER CURRENT ASSETS

Other current assets as of December 31, 2014 and 2013 consisted of the following:

2014 2013 Prepaid expenses and other receivables $ 564,594 $ 763,791 Tax advances and overpayments 121,360 136,164 Advances paid to third parties 242,184 246,727 928,138 1,146,682 Less: provision for doubtful accounts (96,078) (62,135)

Total $ 832,060 $ 1,084,547

144 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS 11. INVENTORIES AND SPARE PARTS

Inventories and spare parts as of December 31, 2014 and 2013 consisted of the following:

2014 2013 Finished goods and goods for resale $ 405,243 $ 593,500 Raw materials and spare parts 232,248 377,292 Work-in-progress 89,506 151,434 Costs and estimated earnings in excess of billings on uncompleted contracts 531,052 116,984 1,258,049 1,239,210 Less: long-term portion (13,540) (107,908)

Total $ 1,244,509 $ 1,131,302

12. PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment, net of accumulated depreciation, as of December 31, 2014 and 2013 consisted of the following:

2014 2013 Switches, transmission devices, network and base station equipment $ 9,066,682 $ 14,083,007 Buildings and leasehold improvements 1,392,585 2,166,179 Power and utilities 496,303 760,686 Other plant, machinery and equipment 1,495,420 2,620,291 Construction in progress and equipment for installation 897,260 1,576,285 Land 148,238 160,973 13,496,488 21,367,421

Less: accumulated depreciation (6,305,094) (10,216,080)

Total $ 7,191,394 $ 11,151,341

Depreciation expense for the years ended December 31, 2014 and 2013 amounted to $1,778.6 million and $2,089 million respectively. Impairments of property, plant and equipment for the years ended December 31, 2014 and 2013 amounted to $290.4 million and $285.9 million respectively (Note 15).

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT APPENDICES 145 13. GOODWILL

The carrying amounts of goodwill attributable to each reportable segment are as follows:

MTS SSTL RTI MTS Bank Other Total Balance as of January 1, 2013 Gross amount of goodwill 1,441,836 339,059 278,449 67,919 95,636 2,222,899 Accumulated impairment loss (48,261) (339,059) - (67,919) - (455,239) $ 1,393,575 $ - $ 278,449 $ - $ 95,636 $ 1,767,660

Impairment (Note 15) - - (258,048) - - (258,048) Disposals (722) - - - (67,816) (68,538) Currency translation adjustment (93,958) - (17,210) - (2,127) (113,295)

Balance as of December 31, 2013 Gross amount of goodwill 1,343,717 300,047 254,291 63,068 25,693 1,986,816 Accumulated impairment loss (44,822) (300,047) (251,100) (63,068) - (659,037)

$ 1,298,895 $ - $ 3,191 $ - $ 25,693 $ 1,327,779

Business combinations (Note 3) 29,247 - - - - 29,247 Currency translation adjustment (524,502) - (1,335) - (13,652) (539,489)

Balance as of December 31, 2014 Gross amount of goodwill 829,716 293,424 147,937 36,691 12,041 1,319,809 Accumulated ( impairment loss 26,076) (293,424) (146,081) (36,691) - (502,272)

$ 803,640 $ - $ 1,856 $ - $ 12,041 $ 817,537

146 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS 14. OTHER INTANGIBLE ASSETS

Intangible assets other than goodwill as of December 31, 2014 and 2013 consisted of the following:

2014 2013 Gross Accumu­lated Net Gross Accumu­lated Net carrying amortization carrying carrying amortization carrying value value value value Amortized intangible assets: Billing and telecommunication software $ 974,142 (603,303) 370,839 1,053,559 (580,156) 473,403 Operating licenses 704,536 (214,352) 490,184 768,488 (157,778) 610,710 Radio frequencies 203,419 (101,034) 102,385 301,042 (149,954) 151,088 Acquired customer base and customer relationships 225,495 (136,714) 88,781 468,497 (247,643) 220,854 Software and other 855,003 (376,890) 478,113 973,084 (481,941) 491,143 2,962,595 (1,432,293) 1,530,302 3,564,670 (1,617,472) 1,947,198 Unamortized intangible assets: Trademarks 184,811 - 184,811 206,135 - 206,135 Numbering capacity with indefinite contractual life 6,276 - 6,276 9,367 - 9,367

Total $ 3,153,682 (1,432,293) 1,721,389 3,780,172 (1,617,472) 2,162,700

Impairments of intangible assets other than goodwill for the years ended December 31, 2014 and 2013 amounted to $nil and $298.2 million respectively (Note 15).

Amortization expense recorded on other intangible assets for the years ended December 31, 2014 and 2013 amounted to $513.5 million and $544.6 million, respectively. The estimated amortization expense for the five years ending December 31, 2019 and thereafter is as follows:

Year ending December 31, 2015 $ 367,272 2016 306,060 2017 214,242 2018 122,424 2019 61,212 Thereafter 459,092 $ 1,530,302

Actual amortization expense to be reported in future periods could differ from these estimates as a result of new intangible assets acquisitions, changes in useful lives and other relevant factors.

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT APPENDICES 147 15. IMPAIRMENT OF OTHER ASSETS

Impairment of other assets recognized by the Group in the years ended December 31, 2014 and 2013 comprised the following:

2014 2013 Impairment of long-lived assets in India $ 290,438 $ - Impairment of 180 and 90 nm equipment and intangible assets - 357,906 Impairment of system integration intangible assets - 125,747 Impairment of other long-lived assets 175,386 106,753 Impairment of available-for-sale securities 135,000 - Provision for cash and deposits in Delta Bank (Ukraine) 92,517 - Provision for doubtful accounts 103,625 134,392 Inventory obsolescence 30,442 46,504 Other 37,221 33,243

Total impairments of other assets $ 864,629 $ 804,545

Impairment of 180 and 90 nm costs, market conditions, asset ages, carrying value and determined the equipment and intangibles assets – asset utilization and other relevant impairment loss. The impairment loss As of December 31, 2013 the information. The key assumptions was allocated to the carrying values Group carried out a review of the used in the fair value calculations of the long-lived assets, but not below recoverable amount of long-lived included pre-tax discount rate of their individual fair values. The Group assets used in the production of 25.0%-56.3% depending on the estimated the fair value of the assets microchips. As a result of this business line (2013: 21.5%-43.8%), primarily using an income approach impairment review, an impairment compound annual growth rate during based on unobservable inputs (“Level charge of $357.9 million was the projected twelve-year period of 3” of the hierarchy established by recognized in the consolidated 21.8% (2013: 11.7%), growth rate U.S. GAAP guidance), with the key statement of operations and after that period of 2.3% (2013: 2.3%). assumptions including a discount rate comprehensive income for the year of 16.5% and 3-7% of revenue royalty ended December 31, 2013, which Impairment of system integration payments for the trademark. The was allocated to the RTI segment. intangible assets – During the year decline in the fair value of the NVision ended December 31, 2013, the Group reporting unit and its intangible As of December 31, 2014, the identified indicators that the carrying assets, as well as fair value changes Group identified indicators that the amounts of long-lived assets for other assets and liabilities in the carrying amounts of 180 and 90 attributable to NVision, a subsidiary two-step goodwill impairment test, nm equipment with a total carrying of RTI, may not be recoverable. resulted in an implied fair value of value of $108.4 million may not These indicators included lower than goodwill being substantially below its be recoverable. These indicators expected revenue and profitability carrying value. included lower than expected levels and downward revisions to revenue and profitability levels. management’s forecasts for the As a result of the impairment review, The Group carried out review that NVision business. for certain intangible assets with supported the carrying value of the a carrying value of $129.1 million equipment and indicated that no Subsequent to its acquisition by the the Group concluded that the fair additional impairment is required. Group in 2012, NVision experienced value amounted to $3.3 million and a significant decrease in purchases recorded an impairment charge of The estimated fair value of such made by its key customers and, as $125.7 million in the consolidated long-lived assets was determined a result, revenue forecasts were statement of operations and based on unobservable inputs (“Level substantially reduced as compared to comprehensive income for the year 3” of the hierarchy established those existing at the acquisition date. ended December 31, 2013. The by U.S. GAAP guidance). When Based on the revised forecasts, the Group also recorded an impairment calculating the future cash flows Group determined that the carrying charge on goodwill of $258.0 million used in the assessment of the value of the NVision asset group based on its implied fair value. The fair value of long-lived assets, the exceeded its undiscounted cash relevant impairment charges were Group considered historical and flows. The Group then compared the allocated to the RTI segment. projected revenue and operating fair value of the asset group to its

148 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS Provision for cash and deposits bank in Ukraine. In December be insolvent. The Group treated Delta in Delta Bank (Ukraine) – As of 2014, Delta Bank delayed customer Bank’s insolvency as a recognized December 31, 2014, MTS Ukraine, a payments and put limits on cash subsequent event and provided subsdiary of MTS, held $90.2 million withdrawals. In March 2015, the against the full amount of deposited in current accounts and deposits National Bank of Ukraine adopted a funds ($90.2 million) and related in Delta Bank, the fourth largest resolution declaring Delta Bank to interest ($2.3 million).

16. INVESTMENTS IN AFFILIATES

Investments in affiliates as of December 31, 2014 and 2013 consisted of the following:

2014 2013 Voting power Carrying value Voting power Carrying value MTS Belarus 49.0% $ 107,237 49.0% $ 165,174 OZON 21.6% 91,080 - SG-trans (2013: SG-trans and Financial Alliance, Note 4) 50.0% 83,555 50.0% 133,551 Concept Group 40.0% 18,913 - Other 55,233 66 541

Total $ 356,018 $ 365,266

Investment in OZON – In April method goodwill, mainly attributable operating budget, require seven 2014, the Group acquired a 21.6% to the expected synergies from out of nine votes; such operating of ownership interest in OZON commercial arrangements and co- decisions represent participating Holdings Limited (“OZON”), a branding programs. rights of the shareholders. leading Russian e-commerce As a consequence of this, the Group company, through an additional Investment in Concept Group – has concluded that it does not have share issuance for $150.0 million. In October 2014, the Group acquired control over the investee and The Group has the right to nominate a 40% of ownership interest in has therefore adopted the equity two out of eight representatives to Rangecroft Ltd, a holding company method of accounting for the board of directors. Management of Concept Group, one of Russia’s this investment. concluded that, upon completion of leading fashion clothing retailers, the acquisition, the Group gained for $26.0 million, and obtained a Merger of SG-trans and Finance significant influence over OZON and call option to acquire another 14.2% Alliance – In January 2014, SG-trans therefore adopted equity method of of its share capital exercisable till and Finance Alliance merged into a accounting for this investment. The October 2017. In accordance with single legal entity named SG-trans. Group also obtained a call option for the shareholders agreement, the The Group retained 50% beneficial an additional 4.6% stake in OZON Group has the right to nominate interest in the newly established entity. exercisable through August 2015. three out of nine representatives to The difference between the equity the board of directors and, if the call The financial position and results of investment carrying amount of $91 option is exercised, up to five of the operations of significant affiliates as of million and underlying equity in net nine representatives. A number of and for the year ended December 31, assets as of December 31, 2014 of key operating decisions for Concept 2014 were as follows: $26.0 million represents equity- Group, including an approval of an

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT APPENDICES 149 The financial position and results of operations of significant affiliates as of and for the year ended December 31, 2014 were as follows:

(unaudited) MTS Belarus OZON SG-trans Concept Group Total assets $ 303,315 192,860 641,193 91,607 Total liabilities (94,102) (71,403) (453,119) (65,646) Net income/(loss) 194,317 (77,690) 12,059 5,792

The financial position and results of operations of significant Group affiliates as of and for the year ended December 31, 2013 were as follows:

(unaudited) MTS Belarus Financial Alliance(1)

Total assets $ 379,050 1,480,703 Total liabilities (96,580) (1,185,979) Net income/(loss) 145,975 13,435

(1) Including SG-trans amounts.

17. LONG-TERM INVESTMENTS

Long-term investments as of December 31, 2014 and 2013 consisted of the following: 2014 2013 Bank deposits $ 242,006 $ 90,727 Loans and notes 51,400 129,638 Other 23,219 28,706

Total $ 316,625 $ 249,071

The effective interest rates on long-term investments as of December 31, 2014 were between 6.2% and 6.3% for EUR denominated investments (2013: 6.0% – 8.6%).

150 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS 18. LIABILITIES FROM BANKING ACTIVITIES

Liabilities from banking activities as of December 31, 2014 and 2013 consisted of the following:

2014 2013 Term deposits $ 1,567,548 $ 2,561,569 Deposits repayable on demand 537,365 1,859,832 Promissory notes issued and other liabilities 243,438 215,539 2,348,351 4,636,940 Less: amounts maturing within one year (2,180,491) (3,864,415) Total liabilities from banking activities, net of current portion $ 167,860 $ 772,525

As of December 31, 2014 the fair value of liabilities from banking activities amounted to $2,270 million; as of December 31, 2013 – approximated their carrying value.

The following table presents the effective average interest rates by categories of bank deposits and notes issued as of December 31, 2014 and 2013:

2014 2013 RUB USD Other RUB USD Other Term deposits: - corporate customers 14.5% 3.0% 2.9% 7.4% 1.8% 2.1% - individuals 10.0% 3.7% 3.4% 9.7% 3.7% 2.3%

Promissory notes issued 8.0% - - 7.3% - -

Deposits repayable on demand: - corporate customers 0.5% - - 4.9% - - - individuals 0.5% 0.1% 0.2% 0.6% 0.07% 0.1%

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT APPENDICES 151 19. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES

Accrued expenses and other current liabilities as of December 31, 2014 and 2013 consisted of the following:

2014 2013 Customers’ advances $ 546,793 $ 350,896 Accrued payroll 267,971 430,946 Accruals for services 210,924 328,050 Accrued interest on loans 51,805 74,621 Financial instruments at fair value 47,086 13,199 Dividends payable 1,369 6,729 Other 189,708 363,449

Total $ 1,315,656 $ 1,567,890

20. LONG-TERM DEBT

Long-term debt as of December 31, 2014 and 2013 consisted of the following:

2014 2013 Loans from banks and financial institutions $ 5,049,820 $ 5,447,071 Notes and corporate bonds 2,781,512 4,888,603 Capital leases 239,401 80,506 Loans from related parties 37 64 Vendor financing 16,662 31,871 Other borrowings 45,393 29,957 8,132,825 10,478,072

Less: amounts maturing within one year (1,598,770) (2,102,911)

Total $ 6,534,055 $ 8,375,161

The schedule of repayments of long-term debt for the next five years and thereafter is as follows:

Year ended December 31 2015 $ 1,598,770 2016 1,185,257 2017 1,469,871 2018 1,022,949 2019 1,148,236 Thereafter 1,707,742

Total $ 8,132,825

152 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS Loans from banks and financial institutions – Loans from banks and financial institutions as of December 31, 2014 and 2013 consisted of the following:

Interest rate (as at Maturity December 31, 2014) 2014 2013

USD-DENOMINATED: Calyon, INGBank, NordeaBank, 2015-2020 LIBOR+1.15% (1.51%) $ RaiffeisenZentralbankOsterreich 673,698 798,440 China Development Bank 2015-2018 LIBOR+1.5% (1.86%) 179,421 187,497 Bank of China 2015-2021 LIBOR+1.5%-3.5% 170,552 170,615 (1.86%-3.86%) SkandinavskaEnskildaBanken 2015-2017 LIBOR+0.23%-1.8% 91,987 129,494 (0.59%-2.16%) Bank of Moscow 2015 LIBOR+7.5% (7.76%) 82,552 82,552 HSBC Bank and ING BHF Bank - 12,022 Other 14,230 27,223 1,212,440 1,407,843 EUR-DENOMINATED: Credit Agricole Corporate Bank, BNP 2015-2018 EURIBOR+1.65% (1.82%) 33,649 47,574 Paribas Bank of Moscow 2015-2017 EURIBOR+5.0% (5.15%) 27,333 - LBBW 2015-2017 EURIBOR+1.52% (1.69%) 16,995 25,630 BankofChina - 74,403 Other 12,187 14,398 90,164 162,005 RUB-DENOMINATED: Sberbank 2015-2021 8.45%-15.0% 3,007,244 2,922,817 Gazprombank 2015-2018 9.0%-10.6% 253,170 294,439 Raiffeisenbank 2015-2016 Mosprime+1.45%-5.25% 149,568 71,891 (23.42%-29.02%), 9.45% Bank of Moscow 2015-2018 CBR+3.0% (11.25%); 128,993 256,258 Mosprime+4.5%-8.85% (28.27%-31.02%); VTB 2015-2018 9.0%-22.75% 86,461 77,571 Unicredit 2016 Mosprime+5.2% (12.17%); 37,179 73,248 10.1-10.4% Alfa-Bank 2015 9.75%-14.18% 27,143 92,486 Credit bank of Moscow 2016 19.0% 8,888 30,554 Other 30,928 53,560 3,729,574 3,872,824 Other currencies 17,642 4,399

Total $ 5,049,820 5,447,071

The fair value of loans from banks contractual terms of the debt including the current portion, and financial institutions, including instruments (“Level 2” of the amounted to $4,730 million; as of the current portion, is estimated hierarchy established by the U.S. December 31, 2013 – approximates using discounted cash flows and GAAP guidance). As of December their carrying value. market-based expectations for 31, 2014 the fair value of loans from interest rates, credit risk and the banks and financial institutions,

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT APPENDICES 153 Notes and corporate bonds – Notes and corporate bonds as of December 31, 2014 and 2013 consisted of the following:

2014 2013 Carrying Carrying Currency Interest rate Fair value value value

MTS International 2020 USD 8.625% $ 601,019 $ 623,140 $ 747,634 MTS International 2023 USD 5.00% 369,641 478,500 500,000 Sistema International 2019 USD 6.95% 338,193 464,979 487,854 MTS OJSC Notes due 2020 RUB 8.15% 253,296 266,627 458,306 SSTL 2019 INR 15.75% 202,111 202,111 206,795 MTS OJSC Notes due 2023 RUB 8.25% 133,313 177,751 305,538 MTS OJSC Notes due 2017 RUB 8.70% 151,181 171,894 294,191 Sistema JSFC Bonds due 2016 RUB 8.75% 113,840 145,949 329,790 MTS OJSC Notes due 2015 RUB 7.75% 131,364 134,045 230,567 Sistema JSFC Bonds due 2016 RUB 7.65% 60,376 65,271 406,985 MTS OJSC Notes due 2016 RUB 8.75% 29,851 31,780 54,627 DM-Center Bonds due 2015 RUB 8.50% 16,238 16,418 35,137 MTS OJSC Notes due 2018 RUB 12.00% 2,298 2,419 117,442 MTS OJSC Notes due 2014 RUB - - - 416,098 Sistema JSFC Bonds due 2014 RUB - - - 296,544

Other 531 628 1,095

Total $ 2,403,252 $ 2,781,512 $ 4,888,603

All Group RUB-denominated notes claimed by the noteholders, where The Group discloses such notes in and corporate bonds are traded on a subsequent sequential coupon is the aggregated maturities schedule Moscow Exchange. announced. The notes therefore can in the reporting periods when the be defined as callable obligations noteholders have the unilateral right USD-denominated notes issued under the FASB authoritative to demand repurchase. The dates of by MTS International due 2020 and guidance on debt, as the holders the announcement for each particular 2023 and Sistema International due have the unilateral right to demand note issue are as follows: 2019 are traded on the Irish Stock repurchase of the notes at par Exchange. The fair values of notes value upon announcement of new and corporate bonds are based on the coupons. The FASB authoritative MTS OJSC Notes December due 2018 2015 market quotes as of December 31, guidance on debt requires callable 2014 at the exchanges which they are obligations to be disclosed as MTS OJSC Notes November due 2020 2015 traded on. maturing in the reporting period when the demand for repurchase MTS OJSC Notes March due 2023 2018 In certain instances the Group could be submitted disregarding has an unconditional obligation to the expectations of the Group about repurchase notes at par value if the intentions of the noteholders.

154 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS Available credit facilities – As of December 31, 2014, the Group’s total available unused credit facilities amounted to $1,344.2 million and related to the following credit lines:

Maturity Interest rate Available till Available amount Sberbank 2015 – 2018 9.3%-18% 2015 – 2018 766,013 CitiBank Europe 2024 LIBOR 6M+0.9%; 2015 300,009 Gazprombank 2016 – 2021 9.75%-25% 2016 – 2021 198,291 ING BankEurasia 2015 Mosprime/LIBOR/ EURIBOR + 1.50% 2015 44,438 Other 35,468

Total $ 1,344,219

Covenants – Loans and notes by the Group and their further debt in its consolidated statement payable by the Group are subject disposition (Note.2) gave certain of financial position as of December to various restrictive covenants, lenders the right to call the debt 31, 2014. As of December 31, 2014, including, but not limited to under several loan agreements. the Group also had $138.5 million compliance with certain financial The lenders waived their rights of its RUB-denominated long- ratios, limitations on dispositions to demand early repayment with term debt which was presented of assets and transactions within regard to these covenant violations within current liabilities in the the Group and retention of prior to the issuance date of these consolidated statement of financial principal telecom licenses. The consolidated financial statements, position because of non-compliance adverse court’s ruling in respect and the Group retained noncurrent with certain financial ratios by its of the Bashneft shares owned classification for this long-term subsidiaries.

21. INCOME TAX

The Group’s income tax expense for the years ended December 31, 2014 and 2013 was as follows:

2014 2013 Current provision $ 417,079 $ 619,643 Deferred income tax expense 36,338 222,464

Total $ 453,417 $ 842,107

Income tax expense calculated by applying the Russian statutory income tax rate of 20% to income from continuing operations before income tax differs from income tax expense recognized in the consolidated statements of operations and comprehensive income as a consequence of the following adjustments: 2014 2013 $ 118,256 $ 504,164 Adjustments due to: Equity in earnings of subsidiaries 147,678 144,647 Other non-deductible expenses 98,094 129,330 Change in valuation allowance 165,819 148,909 Settlements with tax authorities 11,553 (9,108) Effect of rates different from standard (43,477) (44,044) Currency exchange and translation differences (5,685) (10,828) Non-taxable income (21,491) - Other (17,330) (20,963)

Income tax expense $ 453,417 $ 842,107

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT APPENDICES 155 The tax effects of temporary differences that give rise to the deferred tax assets and liabilities are presented below:

2014 2013 Deferred tax assets: Tax losses carried forward $ 1,088,645 $ 855,851 Accrued expenses and accounts payable 165,569 248,061 Property, plant and equipment 243,112 152,210 Intangible assets 143,917 182,846 Other 111,686 209,147 1,752,929 1,648,115 Less: valuation allowance (1,194,858) (996,221) Total deferred tax assets 558,071 651,894

Deferred tax liabilities: Property, plant and equipment (348,206) (534,109) Intangible assets (219,907) (218,014) Undistributed earnings of subsidiaries and affiliates (124,444) (208,995) Other (79,655) (79,751)

Total deferred tax liabilities $ (772,212) $ (1,040,869) Net deferred tax assets, current portion $ 245,571 $ 330,388 Net deferred tax assets, long-term portion 392,866 297,419 Net deferred tax liabilities, current portion (64,947) (114,192) Net deferred tax liabilities, long-term portion (787,631) (902,591)

The Group has the following balances for income tax losses carried forward as of December 31, 2014 and 2013: Jurisdiction Period for 2014 2013 carry-forward

India 2015-2020 $ 521,547 $ 483,680 Russia 2015-2024 442,370 246,870 Luxembourg не ограничен 124,728 125,301

Total $ 1,088,645 $ 855,851

Management has established valuation allowances against certain deferred tax assets, which are less likely than not to be realized in future periods. In evaluating the Group’s ability to realize its deferred tax assets, the Company considers all available positive and negative evidence, including operating results, ongoing tax planning, and forecasts of future taxable income on a jurisdiction by jurisdiction basis. The valuation allowance as of December 31, 2014 and 2013 relates to the following deferred tax assets:

2014 2013 Tax losses carried forward $ 850,118 $ 689,731 Sale of investment in Svyazinvest 51,103 65,996 Impairment of long-lived assets in SSTL 128,286 70,194 Other 165,351 170,300

Total $ 1,194,858 $ 996,221

156 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS 22. HEDGING ACTIVITIES

The Group regularly enters into cross-currency interest rate swap variable interest rate and currency variable-to-fixed interest rate swap agreements. These contracts hedged exchange rate for 21.7% of its USD- agreements to manage exposure to the risk of both interest rate and and Euro- denominated bank loans changes in variable interest rates currency fluctuations and assumed and Eurobonds outstanding as of related to its debt obligations. The periodic exchanges of both principal December 31, 2014. instruments qualify for cash flow and interest payments from RUB- hedge accounting under U.S. GAAP. denominated amounts to USD- and The following table presents Each interest rate swap matches the Euro- denominated amounts to be the fair value of the Group’s exact maturity dates of the underlying exchanged at a specified rate. The derivative instruments designated debt allowing for highly-effective rate was determined by the market as hedges in the consolidated hedges. Interest rate swap contracts spot rate upon issuance. Cross- statements of financial position outstanding as of December 31, 2014 currency interest rate swap contracts December 31, 2014 and 2013. mature in 2015, 2018 and 2020 mature in 2019-2020. The Group entered into cross-currency interest In addition to the above, the Group rate swap agreements designated to has also entered into several manage the exposure of changes in

Location 2014 2013 ASSETS Cross-currency interest rate swaps Other non-current assets $ 389,915 $ 55,760 Interest rate swaps Other non-current assets 142 367

Total 390,057 56,127 LIABILITIES Interest rate swaps Accrued expenses and other current liabilities (47,086) (13,199)

Total $ (47,086) $ (13,199)

The following table presents the effect of the Group’s derivative instruments designated as hedges (i.e. gain/(loss) recognized) in the consolidated statements of operations and comprehensive income for the years ended December 31, 2014 and 2013. The amounts presented include the ineffective portion of derivative instruments and the amounts reclassified into earnings from accumulated other comprehensive income.

Location 2014 2013 Interest rate swaps, including i neffective portion of 4,503 and (879) Interest income / (expense) $ 6,012 $ (5,778) Cross-currency interest rate swaps, including ineffective portion of (60,252) and nil Foreign currency transaction loss / (gain) 397,901 (24,397)

Total $ 403,913 $ (30,175)

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT APPENDICES 157 The following table presents the effect of the Group’s agreements designated as hedges in accumulated other comprehensive income for the years ended December 31, 2014 and 2013 (net of tax).

2014 2013 Accumulated gain, beginning of the year $ 46,210 $ 807 Fair value adjustments 376,582 21,697 Reclassified into earnings (303,683) 23,706 $ Accumulated gain $ 119,109 46,210

As of December 31, 2014, the outstanding hedging instruments were highly effective. $18.0 million of accumulated gain is expected to be reclassified into net income during the next twelve months.

Cash inflows and outflows related to hedging instruments were included in cash flows from operating and financing activities in the consolidated statements of cash flows for the years ended December 31, 2014 and 2013.

158 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS 23. FAIR VALUE MEASUREMENTS

The following fair value hierarchy table presents information regarding the Group’s assets and liabilities measured at fair value on a recurring basis as of December 31, 2014 and 2013:

Fair value measurements using Quoted prices in active Significant other Significant markets for identical observable inputs unobservable Total fair assets (Level 1) (Level 2) inputs (Level 3) value DECEMBER 31, 2014 Assets at fair value: Trading securities $ 466,117 $ - $ - $ 466,117 Available-for-sale securities 158,370 - 3,431 161,801 Derivative instruments - 390,057 - 390,057

Total assets 624,487 390,057 3,431 1,017,975

Liabilities at fair value: Derivative instruments (12,128) (59,933) - (72,061) Contingent consideration - - (1,760) (1,760) Redeemable noncontrolling interests - - (56,734) (56,734)

Total liabilities $ (12,128) $ (59,933) $ (58,494) $ (130,555)

DECEMBER 31, 2013 Assets at fair value: Trading securities $ 1,050,950 $ - $ - $ 1,050,950 Available-for-sale securities 248,534 253,255 7,405 509,194 Derivative instruments 1,575 56,127 - 57,702

Total assets 1,301,059 309,382 7,405 1,617,846

Liabilities at fair value: Derivative instruments - (12,863) - (12,863) Contingent consideration - - (336) (336) Redeemable noncontrolling interests - - (89,583) (89,583)

Total liabilities $ $ (12,863) $ (89,919) $ (102,782)

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT APPENDICES 159 24. SHARE CAPITAL

As of December 31, 2014 and 2013, the Company had 9,650,000,000 voting common shares with a par value of RUB 0.09 issued, of which 9,435,902,596 and 9,274,755,045 shares were outstanding, respectively.

Dividends declared by the Company in the years ended December 31, 2014 and 2013 are as follows:

2014 2013 Dividends declared (including dividends on treasury shares of $16,842 and $8,080 respectively) 591,099 283,200

Accumulated other comprehensive loss – The following table represents components of accumulated other comprehensive loss balance, net of taxes, as of December 31, 2014 and 2013:

2014 2013 Accumulated currency translation loss $ (5,402,999) $ (1,516,611) Unrealized (loss)/gain on available-for-sale securities (14,499) 37,600 Unrealized gain on derivatives 119,109 46,210 Unrecognized actuarial gain 9,553 9,381

Total accumulated other comprehensive loss $ (5,288,836) $ (1,423,420) Less: amounts of accumulated other comprehensive loss attributable to noncontrolling interests 1,545,434 516,702

Total accumulated other comprehensive loss attributable to Sistema JSFC $ (3,743,402) $ (906,718)

25. SEGMENT INFORMATION

As a diversified holding company, Group’s reportable segments are See Note 1 for a description of the the Company invests in a range MTS, SSTL, MTS Bank, RTI and activities of each operating segment of companies which meet its Corporate. The Other category of the Group. The accounting policies investment and return criteria. The includes other operating segments of the reportable segments are the Chief Operating Decision Maker including Targin, BPGC, LesInvest, same as the Group’s accounting is the Company’s Management Sistema Mass-media, Detsky mir, policies described in appendix A1.to Board. Information reported to the Intourist, Medsi, Binnopharm, the notes to the financial statements. Company’s Management Board for Sitronics-N, Leader-Invest and Segment profit represents the the purpose of resource allocation SG-trans, none of which meets operating income/(loss). and the assessment of segment the quantitative thresholds for performance is focused on each determining reportable segments. individual investment holding. The

160 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS Financial information by reportable segment is presented below: Total For the year ended MTS reportable December 31, 2014 MTS RTI Bank SSTL Corporate segments Other Total Net sales to external customers(a) 10,837,126 1,528,287 698,182 220,717 49,967 13,334,279 3,250,678 16,584,957 Intersegment sales 28,521 316,820 17,263 - 25,391 387,995 37,242 425,237 Equity in results of affiliates(b) (37,940) - - - - (37,940) (24,477) (62,417) Чистый процентный доход / (расход) (в) (377,575) - - (377,575) (377,575) Depreciation and amortization 1,934,339 85,796 17,735 60,374 14,274 2,112,518 179,600 2,292,118 Operating income/(loss) 2,765,484 172,070 (396,963) (431,828) (546,842) 1,561,921 286,744 1,848,665 Interest income 120,926 42,160 - 7,477 106,825 277,388 50,609 327,997 Interest expense 435,117 143,175 - 90,277 135,031 803,600 73,809 877,409 Income tax expense/ (benefit) 533,856 33,831 (61,779) - (127,264) 378,644 74,773 453,417 Investments in affiliate 152,262 36 - - 100,448 252,746 95,815 348,561 Segment assets 11,014,182 2,125,279 3,882,609 485,465 1,949,713 19,457,248 3,201,538 22,658,786 Indebtedness(d) 5,191,423 841,307 - 568,170 1,223,056 7,823,956 438,807 8,262,763 Capital expenditures (e) 2,314,951 105,052 27,592 43,296 28,099 2,518,990 383,592 2,902,582

Total For the year ended MTS reportable December 31, 2013 MTS RTI Bank SSTL Corporate segments Other Total Net sales to external customers(a) 12,488,877 1,685,546 878,832 209,432 46,237 15,308,924 3,193,061 18,501,985 Intersegment sales 21,884 509,963 24,301 - 36,742 592,890 18,115 611,005 Equity in results of affiliates(b) 77,615 (1,696) - - - 75,919 (40,165) 35,754 Net interest revenue/ (expense) (c) - - 40,678 - - 40,678 - 40,678 Depreciation and 2,244,014 96,374 19,152 63,666 14,378 2,437,584 195,964 2,633,548 amortization Operating income/(loss) 3,662,740 (776,878) 18,954 (210,185) 834,945 3,529,576 84,721 3,614,297 Interest income 87,704 45,045 - 9,522 116,328 258,599 45,791 304,390 Interest expense 486,636 138,020 - 121,513 159,215 905,384 129,802 1,035,186 Income tax expense/ (benefit) 720,893 (80,025) (2,645) - 140,376 778,599 63,508 842,107 Investments in affiliates 153,168 - - - 45,210 198,378 166,886 365,264 Segment assets 15,218,084 2,530,299 6,919,610 847,342 3,572,805 29,088,140 3,250,757 32,338,897 Indebtedness(d) 6,682,047 1,228,635 - 596,641 1,574,531 10,081,854 437,054 10,518,908 Capital expenditures (e) 2,561,310 95,009 21,379 45,765 73,224 2,796,687 197,706 2,994,393

(a) Interest income and expense of MTS Bank are presented as revenues from financial services and cost of financial services, correspondingly, in the Group’s consolidated financial statements. (b) Equity in results of affiliates of MTS segment for the year,2014 includes $135 million of its share of the earnings of MTS Bank and Stream, which is further eliminated on consolidation (2013: $5 million). (c) Represents the net interest result of the Group’s banking activities. In reviewing the performance of MTS Bank, the chief operating decision maker reviews the net interest result, rather than the gross interest amounts. (d) Represents the sum of short-term and long-term debt. (e) Represents purchases of property, plant and equipment and intangible assets.

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT APPENDICES 161 The following table summarizes dividends to Corporate, declared in 2014 and 2013:

2014 2013 Bashneft $ 818,456 $ 1,162,041 MTS 744,460 635,369 Other 89,903 49,084

The reconciliation of segment operating income to the consolidated income from continuing operations before income tax expense and a reconciliation of segment assets to the consolidated assets are as follows:

2014 2013 Operating income – reportable segments $ 1,561,921 $ 3,529,576 Operating income – other 286,744 84,721 1,848,665 3,614,297 Intersegment eliminations (110,216) (47,725)

Operating income $ 1,738,449 $ 3,566,572

Interest income 212,774 182,447 Change in fair value of derivative financial instruments - 30,199 Interest expense (811,346) (960,136) Foreign currency transaction loss (548,596) (298,264)

Income from continuing operations before income tax $ 591,281 2,520,818

2014 2013 Total assets – reportable segments $ 19,457,248 $ 29,088,140 Total assets – Bashneft - 12,674,507 Total assets – other 3,201,538 3,250,757 22,658,786 45,013,404

Intersegment eliminations (1,988,309) (1,764,410)

Total assets $ 20,670,477 $ 43,248,994

For the years ended December 31, 2014 and 2013, the Group did not have revenues from transactions with a single external customer amounting to 10% or more of the Group’s consolidated revenues. For the years ended December 31, 2014 and 2013 the Group’s revenues outside of the RF were as follows:

2014 2013 Ukraine $ 818,456 $ 1,162,041 India 272,863 253,196 Armenia 186,120 156,883 Central and Eastern Europe 107,372 40,997 Other 154,753 210,661

Total $ 1,534,816 $ 1,944,147

162 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS As of December 31, 2014 and 2013, the Group’s long-lived assets located outside of the RF were as follows:

2014 2013 Ukraine $ 332,987 $ 755,373 India 320,604 710,225 Armenia 288,308 354,840 Central and Eastern Europe 68,369 34,953 Other 87,870 111,887

Total $ 1,098,138 $ 1,967,278

26. RELATED PARTY TRANSACTIONS

The Group sells goods and provides services to and purchases goods and services from its related parties on normal commercial terms. During the years ended December 31, 2014 and 2013, the Group entered into transactions with related parties as follows:

2014 2013 Sales $ 17,220 $ 14,921 Revenue from banking activities 34 51 Cost related to banking activities (48,385) (30,370) Cost of sales (45,595) (1,188) Selling, general and administrative expenses (515) (12,110)

As of December 31, 2014 and 2013, the related party balances were as follows:

2014 2013 Assets: Short-term investments $ 5,212 $ 9,840 Accounts receivable, net 5,469 1,362 Other current assets 27,083 4,907 Long-term investments 36,174 17,402 Liabilities: Accounts payable (4,134) (890) Liabilities from banking activities (541,556) (526,056) Accrued expenses and other current liabilities (3,411) (646) Long-term debt $ (37) (64)

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT APPENDICES 163 27. SHARE-BASED COMPENSATION

The Company and several of its disclosed here. A discussion has expense of $79.4 million and $54.2 subsidiaries operate share-based been included below of the plans million in the consolidated statement compensation plans in order to operated at the Company level. of operations and comprehensive compensate their employees. This income for the years ended December is done through either “equity” Sistema JSFC share-based long- 31, 2014 and 2013, respectively. The plans, in which employees may term motivation program – In 2014 fair value of awards granted was exercise their options for shares, or and 2013 the Company’s Board measured based on the fair value of “phantom” plans, which generally of Directors established two-year the Company’s ordinary shares. allow employees to receive cash motivational programs for senior and compensation which varies mid-level management. Participants depending on the share price that of the programs upon fulfillment of the options are linked to. certain performance conditions and subject to continuing employment All such plans, including those of with the Group will be granted MTS, are immaterial to the Group ordinary shares in the Company. As and consequently have not been a result, the Group recognized an

28. ASSET RETIREMENT OBLIGATIONS

As of December 31, 2014 and 2013, the estimated present value of the Group’s asset retirement obligations and change in liabilities were as follows:

2014 2013 Balance, beginning of the year $ 83,809 $ 90,986 Liabilities incurred in the current period 1,900 9,257 Property dispositions (1,067) - Accretion expense 6,559 2,963 Revisions in estimated cash flows 677 (13,840) Currency translation adjustment (38,163) (5,557) Balance, end of the year $ 53,715 $ 83,809 Current portion - - Long-term portion 53,715 83,809 Balance, end of the year $ 53,715 $ 83,809

The Group’s asset retirement obligations relate primarily to the cost of removing telecommunication equipment from sites. Revisions in estimated cash flows are attributable to changes in economic assumptions, such as inflation rates.

The Group recorded the long-term portion of asset retirement obligations as a separate line item in the consolidated statements of financial position, the current portion – as a component of accrued expenses and other current liabilities.

164 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS 29. REDEEMABLE NONCONTROLLING INTERESTS

Redeemable noncontrolling interests as of December 31, 2014 and 2013 consisted of the following:

2014 2013 SSTL $ 720,000 $ 688,000 K-Telecom, MTS subsidiary in Armenia 56,734 89,583 RTI (Note 5) 16,032 27,547

Total $ 792,766 $ 805,130

The Group is a party to a put option $777 million or its market value at that interests in SSTL at the redemption agreement to acquire the RF’s 17.14% date determined by an independent value and presented this as temporary interest in SSTL during one year appraiser. The Group accounted equity in its consolidated statements of beginning March 2016 at the higher of for the redeemable noncontrolling financial position.

30. COMMITMENTS AND CONTINGENCIES

Operating leases – The Group leases ended December 31, 2014 and 2013, Future minimum rental payments land, buildings and office space mainly respectively, is included in selling, under operating leases in effect as of from municipal organizations through general and administrative expenses. December 31, 2014, are as follows: contracts which expire in various years Rental expense under operating leases through 2068. amounting to $204.6 million and $238.1 million for the years ended December Rental expense under operating 31, 2014 and 2013 respectively, is leases amounting to $641.0 million included in cost of sales. and $678.5 million for the years

Year ended December 31 2015 $ 282,393 2016 204,009 2017 202,489 2018 204,662 2019 199,758 Thereafter 303,487

Total $ 1,396,798

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT APPENDICES 165 Capital commitments – As of 2014, tax declarations of certain accrual for unrecognized income December 31, 2014, the Group had companies of the Group in Russia for tax benefits, potential penalties and executed purchase agreements the preceding three fiscal years were interest recorded in accordance with of approximately $840.0 million open for further review. the authoritative guidance on income to acquire property, plant and taxes totaled $6.1 million and $18.8 equipment and intangible assets. The Group purchases supplemental million as of December 31, 2014 and software from foreign suppliers of 2013, respectively. However, the risk Guarantees – As of December 31, telecommunications equipment in remains that the relevant authorities 2014, MTS Bank and its subsidiaries the ordinary course of business. could take differing positions with guaranteed loans for several The Group’s management believes regard to interpretive issues and the companies, including related parties, that customs duties are calculated effect could be significant. which totaled $217.2 million. These in compliance with applicable guarantees would require payment by legislation. However there is a risk With regard to matters where the Group only in the event of default that the customs authorities may practice concerning payment of taxes on payment by the respective debtor. take a different view and impose is unclear, management estimated additional customs duties. possible tax exposure to be $21 As of December 31, 2014, no event million and $nil as of December 31, of default has occurred under any of Pricing of revenue and expenses 2014 and 2013, respectively. the guarantees issued by the Group. between each of the Group’s subsidiaries and various discounts Operating environment – Starting Commitments on loans and unused and bonuses to the Group’s from March 2014, sanctions have credit lines – As of December 31, subscribers in the course of been imposed in several tranches 2014, MTS Bank and its subsidiaries performing its marketing activities by the U.S. and the E.U. on certain had $126.9 million of commitments may be subject to transfer pricing Russian officials, businessmen and on loans and unused credit lines rules. The Group’s management companies. Following the decline available to its customers. believes that taxes payable are in oil prices in 2014 and early 2015, calculated in compliance with the Russia, which is the main market Taxation – Russia currently has a applicable tax regulations relating of the Group’s operations, has number of laws related to various to transfer pricing. However there experienced significant economic taxes imposed by both federal and is a risk that the tax authorities instability, characterized by the regional governmental authorities. may take a different view and substantial depreciation of the Applicable taxes include VAT, impose additional tax liabilities. As Russian rouble, growth of interest corporate income tax, a number of of December 31, 2014 and 2013, rates caused by the decision of turnover-based taxes, and payroll no provision was recorded in the the Central Bank of the Russian (social) taxes. Laws related to these consolidated financial statements in Federation to significantly increase taxes have not been in force for respect of such additional claims. its key interest rate, a forecasted significant periods, in contrast to decline in gross domestic product more developed market economies; In November 2014, the Russian and a significant decline in the value therefore, the government’s legislation was amended to introduce of shares traded on the Russian implementation of these regulations the concept of “controlled foreign stock exchanges. International credit is often inconsistent or nonexistent. companies” and the new tax regime agencies downgraded Russia’s long- Accordingly, few precedents with for such entities. It is expected that term foreign currency sovereign regard to tax rulings have been the adoption of the new rules will rating with a negative outlook. established. Tax declarations, generally lead to an increase in the Neither the Company, nor any of together with other legal compliance administrative and, in certain cases, its subsidiaries are subject to the areas (for example, customs and tax burden for the Russian entities current sanctions, and the Group currency control matters), are that have subsidiary structures does not appear on the U.S. or E.U. subject to review and investigation by incorporated outside the Russian lists of sanctioned parties. However, a number of authorities, which are Federation. The management does there is significant uncertainty enabled by law to impose extremely not believe the law can materially regarding the extent or timing of any severe fines, penalties and interest impact the Group’s tax obligations as potential further economic or trade charges. These facts create tax risks of December 31, 2014. sanctions. Any continuing economic in Russia that are more significant and political instability could have than those typically found in countries Management believes that it a negative impact on the Group’s with more developed tax systems. has adequately provided for tax operating results. and customs liabilities in the Generally, according to Russian tax accompanying consolidated financial Although the Group’s reporting legislation, tax declarations remain statements. As of December 31, currency is the U.S. dollar, it open and subject to inspection for 2014 and 2013, the provision accrued generates most of its revenues in a period of three years following amounted to $53.3 million and $69.6 Russian roubles, which is also the the tax year. As of December 31, million, respectively. In addition, the functional currency of its principal

166 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS operating subsidiaries. Therefore, LTE license – In July 2012, the $51 million in damages, interest the Group’s reported results of Federal Service for Supervision and other costs, that had been operations are significantly impacted in the Area of Communications, previously provided for in relation by the fluctuations in the exchange Information Technologies and Mass to the dispute with Nomihold. rate between the U.S. dollar and the Media allocated MTS the necessary The Group also recognized a gain Russian rouble, which depreciated license and frequencies to provide of $150 million with respect to against the U.S. dollar by 42% in LTE telecommunication services the settlement payment in the 2014, and was on average 17% in Russia. Under the terms and consolidated statement of operations lower than the average value of the conditions of the LTE license, the and comprehensive income for the Russian rouble compared to the Group is obligated to fully deploy year ended December 31, 2013. U.S. dollar during 2013. Also, given LTE networks within seven years, that most of the Group’s revenues commencing from January 1, 2013 Restriction on transactions with the are generated in Russian roubles, and deliver LTE services in each shares of BPGC and Ufaorgsintez – the Group faces exchange rate risk population center with over 50,000 In 2014, in the course of a litigation, relating to payments that the Group inhabitants in Russia by 2019. Also, which the Group is not a party to, must make in currencies other than the Group is obligated to invest the court imposed restrictions on the Russian rouble. at least 15 billion rubles ($266.6 transactions with the shares of million using December 31, 2014 BPGC and Ufaorgsintez, owned by During 2014, a deterioration in the exchange rate) annually toward the the Group. The restrictions do not political environment in Ukraine, LTE roll-out until the network is fully limit the Group’s voting rights, rights the second largest market of deployed. Management believes that to receive dividends or any other the Group’s operations, has led as of December 31, 2014 the Group is shareholders rights. to general instability, economic in compliance with these conditions. deterioration and armed conflict Investigations into former operations in the eastern portion of Ukraine. Bitel – In June 2013, an agreement in Uzbekistan – In March 2014, The deterioration has further was reached between Altimo, Altimo the Group received requests for exacerbated the country’s already Holdings, MTS and its subsidiary the provision of information from weak macroeconomic trends, MTS Finance, Nomihold and other the United States Securities and which have led to reduced credit associated parties to settle all Exchange Commission and the ratings, significant depreciation of disputes that have arisen from the United States Department of its national currency and increased Group’s investment in Bitel made Justice relating to an investigation inflation. In 2014, the Ukrainian in 2005. The agreement covered of the Group’s former subsidiary Parliament adopted a law allowing matters involving a number of in Uzbekistan. The Group cannot for the imposition of sanctions parties and legal proceedings, predict the outcome of the against countries, persons and including those in the Isle of Man, investigations, including any fines companies deemed by the Ukrainian London, Luxembourg and other or penalties that may be imposed, government to threaten Ukrainian jurisdictions. Pursuant to the and such fines or penalties could be national interests, national security, agreement, all proceedings between significant. sovereignty or the territorial integrity the parties and their associated of Ukraine. The National Bank of parties were discontinued and Other – In the ordinary course of Ukraine passed a decree prohibiting waived, and MTS received a total business, the Group is a party to Ukrainian companies from paying payment of $150 million. All parties various legal proceedings, and subject dividends to foreign investors. These made the necessary submissions to to claims, certain of which relate to circumstances, combined with the respective courts and tribunals the developing markets and evolving continued political and economic to document the settlement, fiscal and regulatory environments instability in Ukraine, could result in which, among other actions, fully in which the Group operates. In the a negative impact on our business, discharged any and all outstanding opinion of management, the Group’s including the Group’s financial obligations under the award liability, if any, in all pending litigation, position and results of operations. previously rendered by the London other legal proceedings or other For example, such risks apply to the Court of International Arbitration matters will not have a material effect Group’s funds deposited in Ukrainian (LCIA) against MTS Finance in 2011, upon the financial condition, results banks, the liquidity of which is as well as settled the tripartite of operations or liquidity of the Group. negatively affected by the economic LCIA arbitration between MTS, MTS Management estimates the range of downturn. As of December 31, 2014, Finance and Nomihold and a tort reasonably possible losses, if any, in the Group held $376.9 million in action filed by Nomihold against MTS all pending litigations or other legal current accounts and deposits in in the English Courts. proceedings being up to $28.0 million. Ukrainian banks, including $90.2 million in Delta Bank (Note15) (fully Upon concluding the settlement provided as of December 31, 2014) agreement, the Group released a and $25.1 million in Kyivska Rus provision of $221 million, comprising Bank (Note 31). $170 million set by the LCIA plus

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT APPENDICES 167 31. SUBSEQUENT EVENTS

For the purpose of the accompanying terms of the license MTS-Ukraine Insolvency of Kyivska Rus Bank – consolidated financial statements, is required to launch provision of 3G In March 2015, the National Bank subsequent events have been services in all of the regional centers of Ukraine adopted a resolution evaluated through April 2, 2015. across Ukraine within 18 months declaring Kyivska Rus Bank upon allocation of the license. (Ukraine) to be insolvent. As of Acquisition of 3G license in December 31, 2014, the Group held Ukraine – In February 2015, MTS- Bond placement – In February $25.1 million in deposits in the Ukraine won a tender to acquire a 2015, the Company completed bank. Management determined that nationwide license for the provision the placement of Series BO-01 insolvency of the bank did not provide of 3G telecommunications services. unconvertible interest-bearing RUB- evidence related to conditions The license with the cost of UAH denominated bonds for the total existing as of December 31, 2014, 2,715 million ($156.9 million at the amount of RUB 10 billion ($160.3 and therefore considered to be a acquisition date) has been granted million at the date of the placement) nonrecognized subsequent event. for 15 years. In accordance with the at the coupon rate of 17% per annum.

A1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of consolidation – All significant intercompany transac- operations. The consolidated financial statements tions, balances and unrealized gains include the accounts of the Company, and losses on transactions have been Foreign currency – Management has as well as entities where the Company eliminated. determined that the functional cur- has operating and financial control, rencies of most of the Group’s operat- most often through the direct or indirect Use of estimates – The preparation ing subsidiaries are the currencies of ownership of a majority voting interest. of consolidated financial statements the countries of Those ventures where the Group exer- in conformity with U.S. GAAP requires their domicile. cises significant influence but does not management to make estimates and have operating and financial control are assumptions that affect the reported In preparing the financial statements accounted for using the equity meth- amounts of assets and liabilities and of the entities within the Group, od. Investments in which the Group disclosure of contingent assets and transactions in currencies other than does not have the ability to exercise liabilities at the date of the financial the entities’ functional currency are significant influence over operating statements and the reported amounts recognized at the rates of exchange and financial policies are accounted for of revenues and expenses of the prevailing on the dates of the trans- under the cost method and included in reporting period. Actual results could actions. At each balance sheet date, long-term investments in the consoli- differ from those estimates. monetary assets and liabilities that dated statements of financial position. are denominated in foreign curren- The consolidated financial statements Significant estimates for the Group in- cies are retranslated at the rates also include accounts of variable inter- clude the allowances for doubtful ac- prevailing at that date. Non-monetary est entities (“VIEs”) in which the Group counts, customer loans and deferred items carried at fair value that are is deemed to be the primary beneficiary. tax assets, the valuation of goodwill denominated in foreign currencies An entity is generally a VIE if it meets and other long-lived assets, asset are translated at the rates prevailing any of the following criteria: (i) the entity retirement obligations, unrecognized at the date when the fair value was has insufficient equity to finance its income tax benefits, redeemable determined. Non-monetary items that activities without additional subordinat- noncontrolling interests, derivative are measured in terms of historical ed financial support from other parties, instruments, share-based compen- cost in a foreign currency are not (ii) the equity investors cannot make sation, assets acquired and liabilities restated. significant decisions about the entity’s assumed in business combinations, operations or (iii) the voting rights of the recoverability of investments, and The Group has selected USD as its some investors are not proportion- the estimates of oil and gas reserves. reporting currency. The Group’s as- al to their obligations to absorb the sets and liabilities are translated into expected losses of the entity or receive Concentration of business risk – USD at exchange rates prevailing on the expected returns of the entity and The Group’s principal business activ- the reporting period end date. Rev- substantially all of the entity’s activities ities are in the RF, Ukraine and India. enues, expenses, gains and losses involve or are conducted on behalf of Laws and regulations affecting busi- are translated into USD at average the investor with disproportionately nesses operating in these countries exchange rates prevailing during the few voting rights. are subject to rapid changes, which reporting period. Equity is translated could impact the Group’s assets and at the applicable historical rates. The

168 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS resulting translation gain or loss is of new subscribers, installation and A total expected loss on a contract recorded as a separate component of activation of wireless, wireline and is recognised immediately in other comprehensive income. data transmission services (“connec- profit or loss. tion fees”) are deferred and recog- On the disposal of a subsidiary nized over the estimated average Contract expenses are recognised as whose financial statements are subscriber life, as follows: incurred unless they create an asset prepared in a currency other than the related to future contract activity. reporting currency of the Group, all Mobile subscribers 1 -12.5 yearsт Residential wireline of the accumulated currency transla- voice phone subscribers 15 years The sales of software products and tion adjustments in respect Residential subscribers system integration services are of that operation attributable of broadband generally multiple-element arrange- to the Group are reclassified to internet service 1 year ments, involving the provision of profit or loss. Other fixed related services, including custom- line subscribers 3-5 yearsт ization, implementation and inte- As of December 31, 2014, the official MTS calculates an average life of gration services, as well as ongoing exchange rate of the Russian Ruble, mobile subscribers for each region support and maintenance provided to the functional currency of most of the in which it operates and amortizes customers. Group’s subsidiaries, determined by connection fees based on the aver- the Central Bank of the RF was RUB age life specific to that region. A multiple-element arrangement is 56.26 for 1 USD (RUB 32.73 for 1 USD separated into more than one unit as of December 31, 2013). Incentives provided to customers of accounting if all of the following are usually offered on signing a new criteria are met: (a) the delivered Revenue recognition – Generally, contract or as part of a promotional items have value to the customer on revenues are recognized when all of offering. Incentives representing the a standalone basis; and (b) the ar- the following conditions have been reduction of the selling price of the rangement includes a general right met: (i) there is persuasive evidence service (free minutes and discounts) of return relative to the delivered of an arrangement; (ii) delivery has are recorded in the period to which items, delivery occurred; (iii) the fee is fixed and they relate, when the respective reve- or performance of the undelivered determinable; and (iv) collectability of nue is recognized, as a reduction to items is considered probable the fee is reasonably assured. Rev- both accounts receivable and reve- and substantially in the control enue amounts are presented net of nue. However, if the sales incentive is of the Group. value-added taxes. a free product or service delivered at the time of sale, the cost of the free If evidence of the fair value of the Revenues under arrangements product or service is classified as undelivered elements of the arrange- specific to the respective reportable an expense. In particular, the Group ment does not exist, segments of the Group are recognized sells handsets at prices below cost to as follows: contract subscribers. Such subsidies all revenue from the arrangement are recognized in the cost of sales. is deferred until such time that evidence of fair value does exist, or until all elements of the arrange- MTS ment are delivered. Fees allocated to RTI post-contract support are recognized Revenues derived from wireless, local as revenue on a pro rata basis over telephone, long distance, data and Revenues from the long-term con- the support period. Fees allocated video services are recognized when tracts are recognised using the to other services are recognized as services are provided. This is based percentage-of-completion method of revenue as services are performed. upon either usage (minutes of traffic accounting, measured by the percent processed, volume of data trans- of contract costs incurred to-date In cases where extended payment mitted) or period of time (monthly to estimated total contract costs. terms exist, license and related cus- subscription fees). The completed-contract method is tomization fees are recognized when used for a single contract or a group payments are due, unless a history of Content revenue is presented net of of contracts for which reasonably collection, without providing conces- related costs when MTS acts as an dependable estimates cannot be sions, has been established under agent of the content providers while made or for which inherent hazards comparable arrangements. the gross revenue and related costs make estimates doubtful. Provisions are recorded when MTS is a primary for estimated losses on construction When sale agreements provide price obligor in the arrangement. contracts in progress are made in protection to the dealer, the revenue their entirety in the period in which is deferred until the dealer sells the Upfront fees received for connection such losses are determined. merchandise to a third party due

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT APPENDICES 169 to the frequent sales price reductions equivalents of $777.2 million and Assets and liabilities related to and rapid technology obsolescence. $1,211.8 million as of December 31, multiple derivative contracts with one 2014 and 2013, respectively, which counterparty are not offset by the Where certain products of this seg- primarily comprise term deposits Group. ment are sold with a product return with banks and bank promissory right, a reserve is established. In notes with original maturities of The Group does not use financial in- addition other post-contract support three months or less. struments for trading or speculative obligations are accrued at the time purposes. of sale. Restricted cash – Restricted cash includes cash and cash equivalents Fair value of financial instruments – restricted by agreements with third The fair value of certain financial MTS Bank parties for special purposes. instruments approximates their carrying value due to the short-term Revenues from interest bearing as- Financial instruments – The Group’s nature of these amounts, namely sets are recognized on an accrual ba- financial instruments include cash cash and cash equivalents, short- sis using the effective interest meth- and cash equivalents, short-term term investments, accounts receiva- od. The effective interest method is a investments, accounts receivable, ble and accounts payable, short-term method of calculating the amortized derivative financial instruments, debt and assets and liabilities from cost of a financial asset or a financial financial assets and liabilities from banking activities which are included liability (or group of financial assets banking activities, accounts payable in current assets and liabilities. or financial liabilities) and of allocat- and short-term and long-term debt. ing the interest income or interest Fair value measurements – The expense over the relevant period. Hedging activities – The Group uses Group reviews its fair value hierarchy derivative instruments, including classifications quarterly. Changes The effective interest rate is the rate swap, forward and option contracts in significant observable valuation that exactly discounts estimated fu- to manage foreign currency and inputs identified during these reviews ture cash receipts (including all fees interest rate risk exposures. may trigger reclassification of fair on points paid or received that form value hierarchy levels of financial as- an integral part of the effective inter- The Group designates derivatives as sets and liabilities. During the years est rate, transaction costs and other either fair value hedges or cash flow ended December 31, 2014 and 2013 premiums or discounts) through the hedges in case the required criteria no reclassifications occurred. expected life of the debt instrument, are met. Changes in the fair value of or (where appropriate) a shorter derivatives that are designated and A three-level valuation hierarchy has period, to the net carrying amount on qualify as fair value hedges are record- been established under U.S. GAAP initial recognition. ed in the consolidated statement of for disclosure of fair value measure- operations and comprehensive income ments. The valuation hierarchy is Regulated services – Regulated together with any changes in the fair based on the transparency of inputs tariff services provided by the Group value of the hedged asset or liability to the valuation of an asset or liability primarily consist of local fixed-line that is attributed to the hedged risk. as of the measurement date. The telephone services and services three levels are defined as follows: rendered to other operators, such as The effective portion of changes in traffic charges, connection fees and the fair value of derivatives that are • Level 1 – inputs to the valuation line rental services, provided by MTS designated and qualify as cash flow methodology are quoted prices in certain regions of RF, and energy hedges are recognized in accumu- (unadjusted) for identical assets or transmission services provided by lated other comprehensive loss. liabilities in active markets; BPGC. Changes in the rate structure Gains and losses associated with the for such services are subject to the related hedged items are recognized • Level 2 – inputs to the valuation Federal Tariff Service approval. Rev- in the consolidated statements of methodology include quoted pric- enues from regulated tariff services operations and comprehensive in- es for similar assets and liabilities represented approximately 5.5% and come, depending on their nature. The in active markets, and inputs that 6.0% of the consolidated revenues for gain or loss relating to the ineffective are observable for the asset or the years ended December 31, 2014 portion is recognized immediately in liability, either directly or indirectly, and 2013, respectively. the consolidated statement of oper- for substantially the full term of ations and comprehensive income. the financial instrument; Cash and cash equivalents – Cash For derivatives that do not meet the equivalents include demand deposits conditions for hedge accounting, • Level 3 – one or more inputs to the and other highly liquid investments gains and losses from changes in the valuation methodology are unob- with an original maturity of three fair value are included in the consol- servable and significant to the fair months or less. Within the cash and idated statement of operations and value measurement. cash equivalents balance are cash comprehensive income (Note 22).

170 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS Accounts receivable – Accounts re- Loss forecast models are utilized The cost of raw materials includes ceivable are stated at their net realiz- for portfolios of homogeneous loans the cost of purchase, customs duties, able value after deducting a provision which consider a variety of factors transportation and handling costs. for doubtful accounts. Such provision including, but not limited to, historical Work-in-progress and finished goods reflects either specific cases of de- loss experience, anticipated defaults or are stated at production cost which linquencies or defaults or estimates foreclosures based on portfolio trends, includes direct production expenses based on evidence of collectability. delinquencies and credit scores, and and manufacturing overheads. Costs estimated loss factors by loan type. and estimated earnings in excess of Assets from banking activities – As- The remaining loan portfolios are re- billings on uncompleted contracts sets from banking activities comprise viewed on an individual loan basis. include the accumulated costs of assets (cash and cash equivalents, projects contracted with third parties, loans, investments and other) involved Loans subject to individual reviews net of related progress billings. The in operations of MTS Bank. Impair- are analyzed and segregated by risk Group periodically assesses its inven- ment losses on loans to customers according to the Group’s internal risk tories and spare parts for obsolete or and banks are included in the allow- rating scale. These risk classifications, slow-moving stock. ance for loan losses. The allowance for in conjunction with an analysis of histor- loan losses represents management’s ical loss experience, current economic Value-added taxes – Value-added best estimate of probable credit losses conditions and performance trends taxes (“VAT”) related to sales are inherent in the lending portfolios as within specific portfolio segments, and payable to the tax authorities on of the reporting period end. Loans any other pertinent information result an accrual basis based on invoices that are not individually reviewed are in the estimation allowances for loan issued to the customer. VAT incurred evaluated as a group using reserve losses. An allowance for loan losses for purchases may be reclaimed, factor percentages based on historic is established for individually impaired subject to certain restrictions, loss experience and qualitative factors. loans. A loan is considered impaired against VAT related to sales. VAT Loans deemed to be uncollectible are when, based on current information related to purchase transactions that charged against the allowance for loan and events, it is probable that the Group will be reclaimed against future sales losses. Correspondingly, recoveries of will be unable to collect all amounts are recorded as VAT receivable in the amounts previously charged as uncol- due, including principal and interest, accompanying financial statements. lectible are credited to the allowance according to the contractual terms of for loan losses. A provision for loan the agreement. Individually impaired Property, plant and equipment – losses is charged to the consolidated loans are measured based on the Property, plant and equipment are statement of operations and compre- present value of payments expected to stated at historical cost. Cost includes hensive income based on manage- be received, or for loans that are solely major expenditures for improvements ment’s evaluation of the estimated dependent on the collateral for repay- and replacements, which extend use- losses, after giving consideration to ment, the estimated fair value of the ful lives of the assets or increase their the net chargeoffs which have been collateral. If the recorded investment in revenue generating capacity. Repairs incurred in the Group’s loan portfolio. impaired loans exceeds the measure and maintenance, including preventa- of estimated fair value, an allowance tive maintenance, are charged to the The Group performs detailed reviews is established as a component of the consolidated statement of opera- of its lending portfolios on a periodic allowance for loan losses. tions and comprehensive income as and systematic basis to identify in- incurred. herent risks and to assess the overall Inventories and spare parts – Invento- collectability of those portfolios. The ries comprise raw materials, work-in- The cost of major overhauls and allowance on certain homogene- progress, finished goods and goods for replacements, which extend useful ous loan portfolios, which generally resale. Inventory and spare parts are lives of the assets or increase their consist of consumer and mortgage stated at the lower of cost or market revenue generating capacity, are cap- loans, is based on an evaluation of value. Inventory is accounted for using italized to the cost of the assets. aggregated portfolios of homogene- either first-in, first-out or the weight- ous loans, generally by loan type. ed-average cost method.

Depreciation for property, plant and equipment is computed under the straight-line method utilizing estimated useful lives of the assets as follows:

Buildings 20-50 years Leasehold improvements Lesser of the estimated useful life or the term of the lease Switches and transmission devices 7-31 years Network and base station equipment 4-12 years Power and utilities 3-47 years Other plant, machinery and equipment 3-25 years

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT APPENDICES 171 Whilst there are certain assets within Goodwill – Goodwill is determined as Trademarks and numbering capacity the Group that have useful lives longer the excess of the consideration trans- with indefinite contractual life are not than those presented above, these ferred plus the fair value of any noncon- amortized, but are reviewed, at least assets are quantitatively insignificant trolling interests in the acquiree at the annually, for impairment. in comparison to the overall Group acquisition date over the fair values of balance for each category. As such, the identifiable net assets acquired. The If the fair value of the intangible asset the Group has taken the approach of excess of the fair values of the identifia- is less than its carrying value, an reporting the useful economic lives ble net assets acquired over the cost of impairment loss is recognized in an which most faithfully represent the the business combination plus the fair amount equal to the difference. The majority of assets, in order to provide value of any noncontrolling interests in Group also evaluates the remaining a more reasonable range that more the acquiree at the acquisition date is useful life of its intangible assets that closely relates to the Group norm. As- credited to income (“negative goodwill”). are not subject to amortization on an sets held under capital leases are ini- annual basis to determine whether tially recognized as assets of the Group Goodwill is not amortized to oper- events and circumstances continue at their fair value at the inception of a ations, but instead is reviewed for to support an indefinite useful life. If lease or, if lower, at the present value impairment at least annually. an intangible asset that is not being of minimum lease payments. The amortized is subsequently determined discount rate used in determining the At first step, the Group asseses qual- to have a finite useful life, that asset is present value of the minimum lease itative factors to determine whether tested for impairment. payments is the Group’s incremental it is more likely than not that goodwill borrowing rate, unless (1) it is prac- is impaired as a basis for determining Investments – The Group’s share in ticable to determine the implicit rate whether it is necessary to perform the the net assets and net income of cer- computed by the lessor; and (2) the quantitative impairment test. Goodwill tain entities, where the Group has the implicit rate is less than the Group’s is than reviewed for impairment by ability to exercise significant influence incremental borrowing rate. If both of comparing the carrying value of each over their operating and financial those conditions are met, the interest reporting unit’s net assets (including policies (“affiliates”) is included in the rate implicit in the lease is used. allocated goodwill) to the fair value consolidated financial statements of the reporting unit. If the reporting using the equity method of accounting. Items of property, plant and equip- unit’s carrying amount is greater than The Group’s share in the net income ment that are retired or otherwise its fair value, the next step is per- of affiliates is included within operat- disposed of are eliminated from the formed whereby the implied fair value ing income, given that the Group has consolidated statement of financial that relates to the reporting unit’s day-to-day involvement in the business position along with the corresponding goodwill is compared to the carrying activities and they are considered to accumulated depreciation. Any gain value of the reporting unit’s goodwill. be integral to the Group’s business. or loss resulting from such retirement The Group recognizes a goodwill Other-than-temporary decreases in or disposal is included in the determi- impairment charge for the amount by the value of investments in affiliates nation of net income. which the carrying value of goodwill are recognized in net income. exceeds the fair value. Construction in progress and equip- All other equity investments, which ment for installation are not depre- Other intangible assets – Other consist of investments for which the ciated until an asset is placed into intangible assets include billing and Group does not have the ability to service. telecommunication software and oth- exercise significant influence, are er software, operating licenses, ac- accounted for under the cost method Asset retirement obligations – quired customer bases and customer or at fair value. Investments in private The Group calculates asset retirement relationships, radio frequencies, companies are carried at cost, less obligations and an associated asset trademarks and telephone numbering provisions for other-than-temporary retirement cost when the Group has a capacity. impairment in value. For public com- legal or constructive obligation in con- panies that have readily determinable nection with the retirement of tangible All finite-life intangible assets are fair values, the Group classifies its eq- long-lived assets. amortized using the straight-line uity investments as available-for-sale method utilizing estimated useful or trading. For available-for-sale Business combinations – Acquisitions lives of the assets as follows: securities, the Group records these of businesses from third parties are investments at their fair values with accounted for using the acquisition Billing unrealized holding gains and losses and telecommunication method, with assets and liabilities of included in the consolidated state- softwareе 1-20 years an acquired entities being measured ment of operations and comprehen- Operating licenses 3-20 years at their fair values as at the date of sive income/(loss), net of any related acquisition. Noncontrolling interests Acquired customer base 1-8 years tax effect. For trading securities, are measured at fair value. Acquired radio frequencies 2-15 years the Group records the investment at Software and other 1-10 years fair value. Unrealized holding gains

172 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS and losses for trading securities are “MGTS”), a fixed line operator and 50% likely of being realized based on a included in earnings. subsidiary of the Group, by the Mos- cumulative probability assessment of cow City Government free of charge. the possible outcomes. The Group purchases promissory notes These assets are capitalized by the for investing purposes. These notes are Group at their market value at the date The Group recognizes interest and carried at cost and the discount against of transfer. Simultaneously, deferred penalties relating to unrecognized tax the nominal value is accrued over the revenue is recorded in the same benefits within income taxes. period to maturity. A provision is made, amount and is amortized as a reduc- based on management assessment, tion of the depreciation charge in the Treasury stock – If the Group re- for notes that are considered uncol- consolidated statement of operations acquires the Company’s own equity lectible. The notes are classified as and comprehensive income over the instruments, those instruments held-to-maturity. contributed assets’ life. (“treasury shares”) are recognized as Investments which are expected to be Income taxes – Income taxes of the a deduction of equity at cost, being the realized within twelve months after the Group’s Russian entities have been consideration paid to reacquire the statement of financial position date are computed in accordance with RF laws. shares. No gain or loss is recognized classified as short-term investments. The corporate income tax rate in the in profit or loss on the purchase, sale, Other investments are classified as RF is 20%. The income tax rate on issue or cancellation of the Compa- long-term investments. dividends paid within Russia is 9% or ny’s own equity instruments. Such 0% subject to meeting certain condi- treasury shares may be acquired Debt issuance costs – Debt issuance tions. The foreign subsidiaries of the and held by the Company or by other costs are recorded as an asset and Group are paying income taxes in their subsidiaries of the Group. amortized using the effective interest respective jurisdictions. method over the terms of the Share-based compensation – The related loans. Deferred tax assets and liabilities are Group calculates and records the fair recognized for differences between value of equity instruments, such Impairment of long-lived assets other the carrying amounts of assets and as stock options or restricted stock, than goodwill and indefinite lived liabilities in the consolidated finan- awarded to employees for services re- intangible assets – The Group periodi- cial statements and the tax bases of ceived and recognizes such amounts cally evaluates the recoverability of the assets and liabilities that will result in in the consolidated statement of op- carrying amount of its long-lived assets. future taxable or deductible amounts. erations and comprehensive income. Whenever events or changes in cir- The deferred tax assets and liabili- The fair value of the equity instru- cumstances indicate that the carrying ties are measured using the enacted ments is measured on the date they amounts of those assets may not be tax laws and rates applicable to the are granted and is recognized over the recoverable, the Group compares the periods in which the differences are period during which the employees undiscounted net cash flows estimated expected to affect taxable income. are required to provide services in to be generated by those assets to the Deferred tax assets are reduced by exchange for the equity instruments carrying amount of those assets. When a valuation allowance when, in the (Note 27). Share-based compensa- these undiscounted cash flows are opinion of management, it is more tion expense includes the estimated less than the carrying amounts of the likely than not that some portion or all effects of forfeitures. Such estimates assets, the Group records impairment of the deferred tax assets will not be are adjusted over the requisite service losses to write the asset down to fair realized. In making such determina- period to the extent actual forfeitures value, measured by the estimated dis- tion, the Group considers all available differ, or are expected to differ from counted net future cash flows expected positive and negative evidence, includ- such estimates. Changes in estimat- to be generated from the use of the ing future reversals of existing taxable ed forfeitures are recognized in the assets (Note 15). temporary differences, projected period of change and also impact the future taxable income, tax plan- amount of expense to be recognized Liabilities from banking activities – ning strategies and recent financial in future periods. Liabilities from banking activities operations. include deposits from banks and For share-based compensation that customers, promissory notes issued Uncertain tax positions are recognized include a component that will be and other liabilities that arise out of in the consolidated financial statements settled in cash, and a component that operations of MTS Bank. for positions which are not considered is settled in equity, the Group accounts more likely than not of being sustained for the awards separately, based on Property, plant and equipment based on the technical merits upon their substance. For the component contributions – Telecommunication examination by the tax authorities. that is settled in cash, the awards gen- equipment and transmission devices, The measurement of the tax benefit erally are accounted for as liabilities installed at newly constructed prop- recognized in the consolidated financial with compensation cost recognized erties in Moscow, have been histor- statements is based upon the largest over the service (vesting) period of the ically transferred to OJSC Moscow amount of tax benefit that, in man- award based on the fair value of the City Telephone Network (hereinafter, agement’s judgment, is greater than award remeasured at each reporting

CORPORATE GOVERNANCE SYSTEM SUSTAINABLE DEVELOPMENT APPENDICES 173 period. For the component that is Borrowing costs – Borrowing costs outstanding during the year, adjusted settled in equity, compensation cost are recognized as an expense in the for the dilutive effect of all potential is measured based on the fair value period in which they are incurred. shares that were outstanding during of the award on the date of grant and Borrowing costs for assets that the year. Such potentially dilutive the compensation cost is recognized require a period of time to get them shares are excluded when the effect over the service (vesting) period of the ready for their intended use are capi- would be to increase diluted earnings award. talized and amortized over the related per share or reduce the diluted loss assets’ estimated useful lives. per share. Retirement and postretirement benefits – Subsidiaries of the Group Advertising costs – Advertising costs Distributions to shareholders – contribute to local state pension are expensed as incurred. Advertising Distributable retained earnings of the funds and social funds, on behalf of costs for the year ended December Group are based on amounts ex- their employees. 31, 2014 and 2013 were $266.0 million tracted from the standalone statutory and $328.7 million, respectively, and accounts of the Company (based on In Russia all social contributions paid were reflected as a component of the Russian accounting standards) during the year ended December 31, selling, general and administrative and may significantly differ from 2014 are represented by payments to expenses in the accompanying con- consolidated amounts calculated on governmental social funds, includ- solidated statements of operations the basis of U.S. GAAP. ing the Pension Fund of the Russian and comprehensive income. Federation, the Social Security Fund Reclassifications and revisions – of the Russian Federation and the Redeemable noncontrolling Certain comparative information Medical Insurance Fund of the Rus- interests – From time to time, in order presented in the consolidated financial sian Federation. to optimize the structure of business statements for the year ended De- acquisitions and to defer payment of cember 31, 2013 has been revised in In the Ukraine, subsidiaries of the the purchase price the Group enters order to achieve comparability with the Group are required to contribute a into put and call option agreements presentation used in the consolidated specified percentage of each employ- to acquire noncontrolling interests in financial statements for the year ended ee’s payroll up to a fixed limit into a the existing subsidiaries. As these put December 31, 2014. Such reclassifica- pension fund, an unemployment fund and call option agreements are not tions and revisions were not significant and a social security fund. The con- freestanding, the underlying shares of to the Group financial statements, tributions are expensed as incurred. such put and call option agreements except for presentation of the loss on are classified as redeemable secu- deconsolidation of Bashneft (Note 2). In addition to the above, MGTS have rities and are accounted for at either defined benefit plans to provide their redemption value or the fair value of Recently adopted accounting pro- employees certain benefits upon and redeemable noncontrolling interests nouncements – Effective January 1, after retirement. The net period cost as of the reporting date. The fair value 2014, the Group adopted Accounting of the Group’s defined benefit plans is of redeemable noncontrolling inter- Standards Update (“ASU”) 2013-05, measured on an actuarial basis using ests is assessed based on discounted Parent’s Accounting for the Cumu- the projected unit credit method and future cash flows of the acquired entity lative Translation Adjustment upon several actuarial assumptions. The (“Level 3” significant unobservable Derecognition of Certain Subsidiaries recognition of expense for defined inputs of the hierarchy established by or Groups of Assets within a Foreign benefit plans is significantly impacted U.S. GAAP guidance). Any changes Entity or of an Investment in a For- by estimates made by management in redemption value of redeemable eign Entity, ASU 2013-07, Liquidation such as discount rates used to value noncontrolling interests are accounted Basis of Accounting and ASU 2013- certain liabilities, expected return on for in the Group’s retained earnings. 11, Presentation of an Unrecognized assets, mortality rates, future rates of Redeemable noncontrolling interests Tax Benefit When a Net Operating compensation increase and other re- are presented as temporary equity Loss Carryforward, a Similar Tax lated assumptions. Gains and losses in the consolidated statement of finan- Loss, or a Tax Credit Carryforward occur when actual experience differs cial position. Exists. The adoption of these amend- from actuarial assumptions. If such ments did not have a material impact gains or losses exceed ten percent Earnings per share – Basic earn- on the Group’s consolidated balance of the greater of plan assets or plan ings per share (“EPS”) is based on sheet or results of operations. liabilities the Company amortizes net income attributable to the Group those gains or losses over the aver- divided by the weighted average Transition to International Financial age remaining service period of the number of shares outstanding Reporting Standards –To conform employees. during the year. with the Russian legislation, the Group will prepare its consolidated financial The Group records in the statement Diluted EPS is based on net income statements for the year ended Decem- of financial position the funded sta- attributable to the Group adjusted in ber 31, 2015 in accordance with Inter- tus of its pension plans based on the certain circumstances, divided by the national Financial Reporting Standards projected benefit obligation. weighted average number of shares (“IFRS”).

174 ABOUT COMPANY PRESIDENT’S SPEECH STRATEGIC REVIEW OUR INVESTMENTS CONTACTS

Investor Relations Department +7 495 730-66-00 +7 495 692-22-88 Press Center +7 495 730-71-88

Inquiry Desk +7 495 737-01-01

Address

13, Mokhovaya Str., Moscow 125009 DISCLAIMER

Certain statements in this report date or to reflect the occurrence of may contain assumptions or fore- unanticipated events. Many fac- casts in respect to forthcoming tors could cause Sistema’s actual events within Sistema. The words results to differ materially from “expect”, “estimate”, “intend”, “will”, those contained in our projections “could” and similar expressions or forward-looking statements, identify forward-looking statements. including, among others, deteriorat- We wish to caution you that these ing economic and credit conditions, statements are only predictions and our competitive environment, risks that actual events or results may associated with operating in Rus- differ materially. We do not intend to sia, rapid technological and market update these statements to reflect change in our industries, as well as events and circumstances occur- many other risks specifically related ring after the above-mentioned to Sistema and its operations.

JSFC Sistema 13, Mokhovaya Str., Moscow 125009 Tel. +7 (495) 692 2288 [email protected] www.sistema.com © JSFC Sistema 2015. All rights reserved