MegaFon Annual Report 2014 Report Annual

Meeting the challenge Annual Report 2014 Contents

Strategic report Governance Financial statements Meeting the challenge 02 Our approach to Governance 74 Independent auditors’ report 93 At a glance 12 Board of Directors 76 Consolidated statement Geographic presence 14 Management Board 78 of comprehensive income 94 Highlights 16 Leadership 80 Consolidated statement Chairman’s statement 18 Accountability and effectiveness 85 of financial position 96 Our business model 20 Other corporate governance issues 86 Consolidated statement Our strategy 22 Shareholders’ equity 88 of changes in equity 97 Chief Executive’s review 24 Directors’ responsibility statement 91 Consolidated statement Market overview 27 of cash flows 98 Review of operations 34 Notes to the consolidated financial Financial review 51 statements 99 Sustainability 54 Risk and risk management 62 Additional information Glossary 144 Contacts 145 Disclaimer statements 146

We are committed to meeting the challenges we face in everything we do. While we operate in a dynamic market characterised by opportunity, we recognise that it contains a range of challenges – Meeting maintaining growth and leadership, sustaining the challenge innovation, delivering value – that require world- class performance across our business. We are inspired by the Olympic ideals and confident in our ability to compete effectively.

Approved by Annual General Shareholders Our development as one of ’s leading Meeting of MegaFon PJSC on 30 June 2015 businesses is reflected in Preliminarily approved by the Board our achievements. Our strong business model of Directors of MegaFon OJSC1 on 28 April 2015 and clear strategy have resulted in a highly

Chief Executive Officer I.V. Tavrin competitive positioning and consistent value generation for stakeholders.

Chief Accountant L.N. Strelkina

1 On 30 April 2015 the Company’s name was changed to MegaFon PJSC in accordance with the resolution of 20 April 2015. Strategic report Governance Financial statements Additional information 01

ir..com Go online Annual Report 2014 MegaFon MegaFon Resilient and efficient growth Read more on pages 04-05 Dynamic and culture strong team spirit Read more on pages 08-09 Our extensive retail network includes more than 8,000 third- owned-and-operated, mono-brand party MegaFon and Euroset stores Total year-on-year revenue year-on-year Total growth for FY 2014 stores 8,087 +5.9%

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of the population, the population, of 2

We areWe a leading /LTE operator, providing 4G services to 51%

Total numberTotal of our subscribersmobile as December of 31 2014 in 72 Russian regions 4G Disciplined investment in business development business in investment Disciplined Read more on pages 06-07 Leadership in innovation Read more 02-03 pages on Russian population as of the latest census in October 2010. Data includes subscribers of the Company in Russia and subscribersCJSCof its in the subsidiaries: Republic of Abkhazia ‘TT mobile’ and CJSC ‘OSTELEKOM’ in the Republic CJSC of Tajikistan, in the Republic ‘AQUAFON-GSM’ of South Ossetia.

2  Figures in this report may vary from similar figures quoted in previous1 material due to updated calculations.

In focus 72.2m Meeting the challenge… …through leadership in innovation

Maintaining our leadership position depends on our ability to effectively predict market trends, develop technology and embrace the current and future needs of our customers.

Innovation is therefore at the heart of our business, and our track record of successful innovation reflects our ability to meet the challenges of our dynamic and rapidly developing market.

02 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information 03

Annual Report 2014 MegaFon MegaFon 72 regions Russian with access to 4G/LTE MegaFon services

The leading 4G provider in Russia >270 stations base 4G setwere up Sochi in to provide quality network operations LTE- Advanced the in to world 1st launch commercially LTE-Advanced 5.8m devices 4G-enabled MegaFon on registered network asof December 2014 31 Meeting the challenge… …through resilient and efficient growth

We are clearly focused on delivering profitable growth, and we have a strong record of consistent competitive achievement. We aim to continue growing our market share through investment in products and services, thereby delivering superior value and returns to all our stakeholders.

04 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information 05

Annual Report 2014 MegaFon MegaFon 26.1% OIBDA-CAPEX/revenue – for FYindicator 2014 amongthe highest ‘Big three’ companies c.300,000 subscribers from more than countries 70 used roaming services provided by MegaFon during the Sochi Olympics Strong Strong financial performance +5.9% revenue growth year-on-year 44% margin for FYOIBDA 2014 Meeting the challenge… …through disciplined investment in business development

Investment is at the core of our growth strategy. We have a robust investment programme focused around best-in-class network development, technological innovation and customer support which drives our commitment to sustainable value generation for customers, partners, investors and employees alike.

06 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information 07 Annual Report 2014 MegaFon MegaFon RUB 56.5bn CAPEXtotal spent 2014 in RUB 10bn invested by MegaFon into preparation for the Sochi Olympic and Games Paralympic Continuous Continuous network roll-out and modernisation to the bestprovide service quality 166,453 km fibre-optic extensive communication network in Russia +84% 4G of Number increased stations by 84% to 18,636 units 2014 in Meeting the challenge… …through a dynamic culture and strong team spirit

We have a dynamic workforce that is characterised by a strong team spirit and connected by common values and principles. We have an ethical culture of transparency, honesty and openness which has enabled us to build a leading business whose achievements we all share in, and which enables us to celebrate success wherever it happens.

08 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information 09 Annual Report 2014 MegaFon MegaFon

HR-Brand award The MegaFon corporate received MegaNet portal the HR-Brand award 25,000 25,000 volunteers communicatingwere with each other free charge of during the Sochi Olympics using a special tariff from plan MegaFon

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Our are people of the core at our business 30,854 employees of one is MegaFon the largest and most attractive employers in Russia annual ‘Point of Destinationannual of ‘Point programme– Our Client’ theover last years eight 20,000 20,000 employees have taken part the in According to the new methodology, the number of employees includes full-timeexcluding and temporary those on maternity employees, leave and outsourced employees, and represents the annual time average. 1  Meeting the challenge Delivering world-class support for a major international event…

MegaFon was the Mobile Communications Partner for the XXII Winter Olympic and XI Paralympic Games in Sochi, creating a bespoke mobile network infrastructure and providing high-quality communication services for the most connected Winter Olympics ever.

LTE-Advanced >950 Data transmission speed of up to Base stations were built by 300 Mbit/s on the LTE-Advanced MegaFon for the Sochi Olympics network was demonstrated during the Sochi Olympics 660 terabytes Data traffic used by the 20 Mbps participants and guests Average speed of 4G mobile of the Sochi Olympic and internet at the Sochi Olympics Paralympic Games >220 km Smotri+ Length of FOCL built for the The application was among the Sochi Olympics top free applications on the App Store and Google Play with 600,000 users during the Olympics

10 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information 11

Annual Report 2014

MegaFon MegaFon

The 2014 Olympics Sochi in had 4G technology by provided MegaFon

1st operator to launch HSPA+ 1st internet service and deploy HD Voice HSPA+

3G operator to launch1st a nationwide 3G network in Russia LTE-Advanced LTE-Advanced operator the in to commercially world 1st launch the fastest data network, mobile operator the in to launch world and 1st super-fast supporting routers of sales speeds LTE-Advanced Mobile-TV operator Russia in 1st to introduce ‘Mobile-TV’ 4G operator 1st to launch a 4G network in Russia

5G signed a We memorandum of withunderstanding Huawei on the joint 5G of development Russia in technology

MMS operator 1st Europein to ‘MMS’ launch

We are proud the of achievementsWe we achievement record of long-term …based on a track- a on …based MegaFon as madehave developing in We intend to continue to intend breaking new groundWe and our market leading through innovative and creative thinking, enhancing the experience our customers of and one the of operators our market, in leading creativity innovation, for reputation a with and ambition. delivering value to our stakeholders. At a glance A year of innovation

MegaFon is one of Russia’s largest mobile operators in terms of revenue and subscribers. We provide services in all market segments, including voice, data and other mobile and fixed-line telecommunications services, digital TV and IP telephony. We also have subsidiaries in Tajikistan, Abkhazia and South Ossetia.

Our extensive Our broad service Our respected networks portfolio brand Our advanced infrastructure enables us to Our high-quality services, all targeting real MegaFon is one of Russia’s most deliver a wide range of high-quality mobile customer needs, extend far beyond voice, prominent brands, built on a heritage of services throughout Russia. MegaFon invests mobile and fixed-line data transfer. We also innovation, market-leadership and targeted continuously in improving service quality, and provide a range of value-added services to sponsorship. In 2014, we had the highest in 2014 we reached all our infrastructure retail customers, business and government score in ‘Power of Brand’ among the top development targets. We expanded our clients and other four Russian telecom operators. Our key network into new regions and increased service providers. We work with corporate unique brand attributes were: ‘the fastest the total number of base stations by 19.5% clients to develop and provide bespoke internet’, ‘the highest quality of mobile to 103,128 units. Our 2G and 3G networks business solutions. We have a consumer internet’ and ‘the innovative operator, cover 93.1% and 83.5% of the population hardware business, selling handsets and operator of the future’. Our General Mobile respectively.1 At the end of 2014, our 4G other devices. Our MegaLabs subsidiary, Partnership at the 2014 Winter Olympics services were available in 72 Russian regions meanwhile, specialises in developing and Paralympics in Sochi further enhanced and in 14 out of the 15 largest cities with innovative solutions in M2M, financial our profile. a population exceeding 1 million citizens. services, media, content and the cloud. Read more on page 50 Read more on page 40 Read more on page 34

1 Based on MegaFon estimates. 12 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information 13

Annual Report 2014 Innovative, affordable hardware MegaFon MegaFon Read more on page 36 We aimWe to improve our customers’ lives at a reasonable cost with every device we sell. data-enabled affordable Our and tablets are enabling customers to access innovative services that open up new opportunities for them right across Russia. The wide range of 4G-enabled devices, including almost 200 models of routers, modems, dongles and other devices (including different colours), which we offer in our MegaFon Retail stores, is making it easy to access the new world of 4G.

Mbit/s Huawei on the 5G technology of development LTE-Advanced with a mobile internet speed withup of to a mobile LTE-Advanced 300 May Placement Series of BO-04 exchange bonds for a total amount RUB of 15bn June network seven-year Signing of modernisation contract with Huawei Prepayment 90% of consideration of for Scartel/ Upgrade MegaFon of ordinary shares to the MOEX quotation QL 1 list ‘Highest’ July 50% of acquisition Completed interest Euroset in August Launch Login supporting of 3 tablet sales of technology 3G November a memorandumSigning of understanding of with for the and Games Paralympic Olympic Sochi, in where up lived to its it commitmentprovide to high-quality communications services Commercial launch the of fastest data network mobile – February MegaFon acted as General Communications Partner Key eventsKey of 2014 Exceptional people The commitment and accountability of MegaFon’s employees are what makes our business so successful. Attracting and retaining the best possible talent is behind force driving mission-critical the ourall training and personal development activities. As December of 31 we 2014, employed 30,854 people. Read more on page 56

Our retail network Read more on page 48 MegaFon’s own retail chain numbers 2,047 Russia. across stores owned-and-operated Their presence complements a network stores franchised MegaFon-branded of and the nationwide Euroset chain, which we own in partnership with VimpelCom. theseTogether, are the primary places in which we come into face-to-face contact with customers, adding value and friendly the through brand our enhancing the issues, of resolution speedy and delivery of professional advice and high standards service. of Geographic presence Driving continuous development

Customer numbers by region

11.7 m 10.4 m 5.9 m region North-West region Urals region

Murmansk

Petrozavodsk Belomorsk St Petersburg Arkhangelsk

Salekhard Pskov Ukhta Moscow Kotlas Kostroma Nadym Syktyvkar Nyagan Noyabrsk Nizhny Novgorod Surgut Belgorod Lazarev Voronezh Poronaysk Tyumen Rostov-on-Don Krasnodar Volgograd Chelyabinsk Yuzhno-Sakhalinsk Sochi Omsk Abkhazia Astrakhan Taishet Irkutsk Tajikistan Chita Barnaul South Ossetia Makhachkala Abakan

10.5 m 15.5 m 4.5m Caucasus region Volga region Central region

14 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information

– – 15 61% 0.1m 29% 22% 5.8m 0.5m 2.2m 1.1bn 0.7bn 0.3bn 0.2bn 100% 2.6bn 0.3bn 27.7m 0.15m 69.7m 0.07m 0.03m 55.3bn 0.003m 310.8bn

Annual Report 2014

MegaFon MegaFon CAPEX in 2014, RUB 4G-enabled devices devices 4G-enabled registered on network, units Revenues, RUB Mobile internet users devices 4G-enabled registered on network, units Revenues, RUB CAPEX in 2014, RUB CAPEX in 2014, RUB Mobile internet users 4G-enabled devices devices 4G-enabled registered on network, units Revenues, RUB Market share by customer Market share by customer devices 4G-enabled registered on network, units Revenues, RUB TT mobile base Customer Market share by customer Mobile internet users Abkhazia AQUAFON-GSM base Customer South Ossetia OSTELECOM base Customer Mobile internet users CAPEX in 2014, RUB Russia MegaFon base Customer Market share by customer Tajikistan Poronaysk Yuzhno-Sakhalinsk Existing fibre-optic network fibre-optic Existing construction under network Fibre-optic

Key Lazarev Lazarev Vladivostok Khabarovsk m m

5.0 Siberia region Chita

4.9 East Far region We remain focusedWe on increasing the quality the of services and improving Russia across connections through the modernisation and 4G, 3G of 2G networks.

Irkutsk Taishet Abakan Abakan Krasnoyarsk Noyabrsk msk o T Nadym Surgut naul Novosibirsk Tyumen Bar Salekhard Salekhard Omsk Nyagan Nyagan Ukhta Chelyabinsk Syktyvkar Yekaterinburg Murmansk Arkhangelsk Ufa Ufa Belomorsk Tajikistan Kotlas Nizhny Novgorod Kostroma Kazan w o Volgograd Samara Petrozavodsk Petrozavodsk Voronezh Astrakhan osc M Makhachkala St Petersburg St Petersburg Pskov n-Don Belgorod o - a i v sto o Sochi bkhaz R South Ossetia South Ossetia A Krasnodar Highlights Dedicated to performance

2014 was another successful year, in which we delivered strong financial performance and confirmed our leading position in mobile data and 4G/LTE services.

Superior operating performance1…

Non-financial highlights

Subscribers Users of mobile internet Data services penetration m people m people %

68.1 69.7 39.8 62.6 27.7 37.0 25.2 33.6 21.0

2012 2013 2014 2012 2013 2014 2012 2013 2014

ARPU2 ARPDU 3G and 4G base stations3

RUB per month RUB per month Number of stations

209 319 326 321 56,787 181 164 43,4044

30,010

2012 2013 2014 2012 2013 2014 2012 2013 2014

1 All figures disclosed under non-financial highlights refer to our Russian operations. 2 Total wireless services revenues, including interconnection and roaming charges but excluding connection revenues, for a given period divided by average number of wireless subscribers in the period, divided by number of months in the period. 3 In units for Russia only. 4 Verified data for 2013. 16 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information 17 4 11.7% 1 0 36.7 2 Annual Report 2014 3 17.4% 1 0 51.6 2

Mbps MegaFon MegaFon 5

2 16.3% 1 0 44.4 2 RUB bn + Net profit margin, % Net profit Speeds up of to 300 4 4 44.0% 22.3% 1 1 0 0 138.5 2 70.2 2 New service launched 4G/LTE-Advanced We in Februaryin 2014 3 3 44.6% 27.7% 1 1 0 0 132.6 2 82.3 2

2 2 26.0% 43.0% 1 1 0 0 117.1 70.8 2 2 Free cash flow RUB bn + Free cash flow to Revenue, % OIBDA RUB bn + OIBDA margin, % 4 4 17.9% 1 1 0 0 56.5 2 314.8 2 3 3 15.9% 1 1 0 0 47.1 2 297.2 2

2 2

16.6% 1 1 0 0 45.2 272.3 2 2 Profit for the year attributable to equity holders of the Company.

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Financial highlights …translating into financials solid CAPEX RUB bn + CAPEX to Revenue, % Revenue RUB bn Chairman’s statement Committed to our goals

We have made strong progress during the year, and remain committed to achieving our strategic goals and to maintaining international best practices in corporate governance.

“Despite the ongoing macroeconomic turbulence we faced, MegaFon delivered a robust performance in 2014 that I believe gives grounds for considerable optimism about the future.” Sergey V. Soldatenkov Chairman of the Board

2014 was in many ways a challenging year, with economic turbulence in Russia following the fall-out of a sharp decline in the price of oil and events in Ukraine. The latter events led to the imposition of Western sanctions against Russia, which gave rise to a variety of foreign currency and liquidity issues.

However, very few of these issues directly impacted our Company. Indeed, we were able during the year to make a number of key strategic decisions which have enabled us to adjust our business to the new challenges, achieve strong financial and operational results and consolidate our leading position in the Russian telecoms market. Indeed, I believe that our focus on our strategic priorities is already contributing to the clarity of vision and understanding of our unique strengths and opportunities that will support our sustainable success in years to come.

It was also a year in which we successfully reasserted our commitment to quality customer service and enhanced our brand visibility through our prominent involvement in the 2014 Sochi Winter Olympics. Through our investment in mobile infrastructure and services specially developed, configured and adapted for the Olympics, we played a key role in enabling millions of viewers to enjoy the dramatic spectacle of the Games. We were proud to be a part of the first 4G-enabled games in the history of the Olympic movement.

18 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information 19 Annual Report 2014 MegaFon MegaFon Sergey V. Soldatenkov Sergey V. Chairman of the Board Outlook Overall,despite the ongoing macroeconomic turbulence we faced, MegaFon delivered a robust performance that in 2014 I believe gives a better base going forward. The year progressive and resilient the proves by gone nature of our business, and I am confident in our abilities to rise to the challenges that ahead. lie Above all, I believe we have the people, systems, and processes in place to anotherdeliver successful further year of sustainable growth. I would like to thank those all who contributed to our positive performance in including 2014, our shareholders, our managers and our employees. I firmly believe that we can together achieve all similar success once again in 2015. Dividends MegaFon first paid dividends and in 2012, wein continued 2014 to evolve our dividend payment practice to meet Company needs expectations. investor to respond and ourAt Annual General Shareholder Meeting on 30 June we 2014, approved the payment of a final dividend for the financial 2013 year of RUB 64.51 per share GDR). (or In total, the Company paid out RUB 46.4 billion in dividends for the financial 2013 year which, including the interim 2013 Q1 dividend previously paid implied in July 2013, an aggregate distribution of RUB per 74.85 share GDR). (or canYou read more about our dividend payment system and the taxation of dividends on page 90. Strategic direction Strategic strategic ongoing Company’s The MegaFon’s always is development overarching priority, and this is particularly the case during a turbulent period such as This2014. conferred particular importance on the two strategic summit sessions we convened during the year at which we defined the key business areas for MegaFon and set priorities for the future. I believe the outcomes of these sessions will prove to be key drivers of our future direction. As an innovative business, we recognise that we must be able to respond rapidly and decisively to new growth opportunities and adjust smoothly to the demands of a fast-changing environment. Thisrecognition was the catalyst behind the decision we announced last year to develop a second core business that we can use opportunities new realise and identify to for leveraging our existing activities and current subscriber base. These include the development of B2C fixed broadband in key regions and the pursuit of new value-added and machine-to-machine as such services, geo-services, communications, IP mobile finance, cloud solutions and more. will We keep you advised of our progress in this area, which I am confident will provide future our for further foundations strong growth. These measures have enabled us to bolster our corporate governance system and improve the transparency of our business, helping to maintain trust among investors and other stakeholders and reaffirming the overall integrity of our operations. As we have in previous years, we continued to follow global best practice in 2014. didWe this in several important ways: designating two of our Directors as Corporate our re-appointing independent; Secretary; improving information insider control additional developing protection; and transactions; related-party over Committeesestablishing ensure relevant to the Board of Directors has the support it requires to discharge its duties. I am pleased to report that during the year Moscow the reached shares MegaFon’s Stock Exchange’s highest quotation list, A2, less than three years after the Company was first listed. While this shows our business is moving in the right direction, it is just one step in our process of continuous development and we recognise that there remains further room for improvement. As a listed company, MegaFon depends on rigorous governance to underpin its business growth ambitions. This fact ensured that was 2014 also a busy and eventful year from a governance perspective, during which my fellow Directors on the Board and I continued to develop our corporate governance system to keep up-to-date with changing requirements. compliance and disclosure For example, we have been working to ensure that the Company complies with the provisions of the New Corporate Governance Code which was approved by the Central Bank of Russia in March 2014. Since our listing on the London Stock Exchange (LSE), we also need to comply with the Disclosure and Transparency Rules of the UK Financial Conduct Authority for ‘standard’ companies and the LSE Listing Rules, and we devoted considerable effort to ensuring our all systems and additional these to aligned were processes transparency requirements. Governance developments Governance Sergey Soldatenkov was MegaFon’s CEO until 2012, 2012, until CEO Sergey was MegaFon’s Soldatenkov and when Ivan to he Tavrin handed the role over took up Chairman the of position the of Board. Our business model Customers at the heart of our business

Our clients Effective financial management to create value

Consumers Corporate Cash flow Investments

72.2m subscribers

Government Operators Dividends Free cash flow

Customers at the heart of our business

Our value propositions to clients

Best network and product Best distribution Best customer experience

Services Devices Network Retail Brand Our people and innovations and tariffs experience

Best core and Growing data Increased Focus on data sales Brand awareness Boosting new products usage network capacity and developing and loyalty service quality controlled retail network

20 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information 21

Annual Report 2014

Customers MegaFon MegaFon We knowWe that our activities matter to our customers. That is why we do everything we can to exceed their expectations, meeting their ever-growingdemand for products and services as they become increasingly important aspects of day-to- day life. believe We our future is extremely attractive and that our strategy is the right one to deliverthe growth that we and our shareholders for. aiming are Tailored services provide tailored We services to meet the needs of our customer segment

We are always seeking to strengthen to seeking always are We our market position by reinvesting cash flow into the business. Because of our determination that investors should receive an appealing return, we also distribute a significant proportion of our cash in the form of dividends. For these reasons, free cash flow is one of our most important KPIs. deployWe the reinvested capital in a number of ways to support growth and make the business more competitive. and roll-out network ongoing include These infrastructural marketing enhancements, initiatives, strategic acquisitions, product constantly and development, service and improving quality service. of Reinvestment reinvestWe our cash business in flow growth and our strengthening market position Revenue primaryOur source of revenue is from paymentssubscriber Payments from our subscribers are our main source of revenue. have We designed exposure mitigate structure to revenue our to credit risk and support a stable cash flow. With these aims in mind, we provide our retail and SME customers with prepaid services and restrict the offer of post-paid plans to major corporate and government bodies. Under our licences to provide different telecoms services across Russia, we serve subscriber segments including private retail customers, corporates, government telecommunication other and institutions operators. strategy. We are always seeking strengthen to are always We market our position strategy. our cash backby reinvesting theflow into business. Our business model is built around our growth built andOur is business reinvestment model Our strategy Maintaining leadership in efficient growth

Strategic priorities KPIs

Best product • Revenue • Revenue: RUB 314.8 billion (up 5.9%) • Economic instability • Retain the revenue at the same Continue growing • Maintain leadership in mobile data • Mobile data revenue (Russia) • Mobile data revenue: RUB 67.2 billion (up 33.3%) in Russia level as in 2014 • Maintain revenue growth from • Mobile data service user base • Mobile data service user base: 28.3 million • Reduced disposable • Launch of 4G+ in new cities faster than the value-added services • VAS revenue subscribers (up 10.0%) income among clients • Continue developing bundles market in core • VAS revenue: RUB 37.3 billion (stable) • Increased competition including Tele2 and RTK business areas Best distribution • Share of new subscribers acquired • 8,087 stores within retail network (stable) joint venture • Develop strong data-enabled device • Continue the ‘smart development’ through the controlled retail network1 • >71% of all new subscribers acquired through portfolio of the retail network with focus on • Number of data-enabled devices sold in the controlled retail network (up 2 p.p.) • Continue renovation of owned-and- active subscriber base growth the Company’s controlled retail network • 3.8 million smartphones and tablets sold (up 68.2%)2 operated points of sale Best experience • Active subscriber base • 72.2 million active subscribers (up 3.0%) • Deliver excellence initiatives • Retain customers through excellence to improve customer experience of end-to-end customer experience • Monitor customer satisfaction index (‘CSI’) and link it to the technical network KPIs

Corporate business • Share of B2B, B2G and B2O revenue • 15.1% (up 0.7 p.p.) • Economic instability • Implement the updated corporate Leverage secondary • Leverage potential in B2B, B2G and in Russia strategy as a basis for consistent B2O business segments, increasing • Increased competition business development through all core businesses their ‘weight’ within the Company • Potential changes in corporate segments Fixed business • Fixed business revenue • RUB 22.2 billion (up 10.4%) legislation in B2G segment • Increase delivered synergies between • Leverage and realise synergies between • Launch of Fixed-to-Mobile (FMC) • Launch of WireFire, a double-play FMC service the fixed line, fixed broadband and fixed broadband and mobile businesses products and services (OTT TV and broadband) mobile businesses New businesses • New businesses revenue • RUB 4.1 billion (up 89%) • Focus on high-priority new business • Leverage opportunities in new businesses • On-time delivery of new products streams (OTT TV, Mobile finance and through development and delivery of M2M services) innovative products synergetic to the • Continue developing innovative core business new products and services through MegaLabs, the Company’s R&D unit

Best performance • OIBDA margin • 44.0% (in line with the Company’s outlook for 2014) • Ruble weakening • Maintain OIBDA margin not less Deliver best-in-class • Identify and deliver continuous • Implementation of operational • Price reduction by than 40% operational improvements excellence initiatives competitors and consequent efficiency in the downward pressure on management of the Best network • CAPEX/Revenue % • 17.9% (up 2 p.p.) margins and profitability • Develop 3G/LTE/LTE-A networks • Continue to actively develop network • Coverage (% of Russian population) • 4G coverage – 51%3 (up 15.1 p.p) • Improve service quality business and service quality, combined with • Deliver expected capital expenditures high efficiency in the range of RUB 165-180 billion for 2013-2015, as previously announced by the Company during the IPO Best management system • Implementation of developed • Developed a framework for the management system • Develop people strategy • Develop management system management system focused on value creation focused on value creation • Employee motivation

22 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information 23

Annual Report 2014 MegaFon MegaFon Develop people strategy Deliver excellence initiatives initiatives excellence Deliver experience customer improve to (‘CSI’) index satisfaction customer Monitor and link it to the technical network KPIs between synergies delivered Increase the fixed line, fixed broadband and businesses mobile Focus on high-priority new business streams (OTT Mobile TV, finance and Retain the revenue at the same level as in 2014 Launch of 4G+ in new cities Continue developing bundles Implement the updated corporate strategy as a basis for consistent business development through all corporate segments services) M2M Continue developing innovative new products and services through MegaLabs, the Company’s R&D unit Maintain OIBDA margin not less than 40% Develop 3G/LTE/LTE-A networksImprove service quality expenditures expected capital Deliver in the range billion for of RUB 165-180 announced previously as 2013-2015, by the Company during the IPO Develop strong data-enabled device Develop portfolio owned-and- of renovation Continue operated points of sale • • • • • • • • • • • • • • Actions for 2015 • •

Economic instability in Russia disposable Reduced income among clients competition Increased including and RTK Tele2 venture joint Economic instability in Russia competition Increased Potential changes in legislation in B2G segment weakeningRuble by reduction Price consequent and competitors on pressure downward margins and profitability • • • • • • • • Risks

2

(up 15.1 p.p) (up 15.1 3 Developed a framework for the management system creation value on focused 44.0% (in line with the Company’s outlook for 2014) (up 2 p.p.) 17.9% 4G coverage – 51% RUB 4.1 billion (up 89%)RUB 4.1 15.1% (up 0.7 p.p.) (up 0.7 15.1% RUB 22.2 billion (up 10.4%) Launch of WireFire, a double-play FMC service (OTT TV and broadband) 72.2 million active subscribers (up 3.0%) subscribers (up 10.0%) (up subscribers revenue:VAS billion RUB (stable) 37.3 8,087 stores within retail network (stable) of new all subscribers>71% acquired through the controlled retail network (up 2 p.p.) 3.8 million smartphones and tablets sold (up 68.2%) Revenue: RUB billion (up 5.9%) 314.8 Mobile data revenue: billion RUB (up 33.3%) 67.2 Mobile data service user base: 28.3 million Includes the Company’s own sales network MegaFon Retail, third party points-of-sale stores operating under the MegaFon brand and Euroset stores. Includes MegaFon branded equipment (smartphones and tablets only) sold in 2014 in theRussian controlled population retail network as of the latest and third-party census in October equipment 2010. sold in MegaFon Retail.

2 3 1 • • • • • • • • • • • • • Progress in 2014 • • • Our strategy focuses on generating strong cash flows through revenue growth, network high development, quality service and efficiency. operational 1

Number of data-enabled devices sold in the Company’s controlled retail network Implementation of developed system management motivation Employee Active subscriber base subscriber Active Share of B2B, B2G and B2O revenue Fixed business revenue Launch of Fixed-to-Mobile (FMC) products and services revenue businesses New On-time delivery of new products OIBDA margin operational of Implementation initiatives excellence CAPEX/Revenue % Coverage (% of Russian population) Revenue Mobile data revenue (Russia) base user service data Mobile VAS revenue Share of new subscribers acquired through the controlled retail network • • • • • • • • • • • • • • • • • •

Develop management system system management Develop creation value on focused Retain customers through excellence excellence through customers Retain experience customer end-to-end of Leverage potential in B2B, B2G and increasing segments, business B2O their ‘weight’within the Company Leverage and realise synergies between fixed broadband and mobile businesses Leverage opportunities in new businesses through development and delivery of innovative products synergetic to the businesscore continuous deliver and Identify improvements operational network develop actively to Continue and service combined quality, with high efficiency Maintain leadership in mobile data Maintain revenue growth from value-added services Continue the ‘smartdevelopment’ of the retail network with focus on growth base subscriber active Best management system Best • • Corporate business • business Fixed • businesses New • performanceBest • Best network • Best productBest • • distribution Best • experience Best Chief Executive’s review Meeting the challenge

“Our revenue growth rate in 2014 was the fastest among the ‘Big three’ operators in Russia.” Ivan Tavrin Chief Executive Officer

In 2014 MegaFon delivered a solid operational and financial performance. During a period of economic instability and uncertainty in Russia, we implemented well-timed measures to help weather the storm and mitigate potential risks. We know that in the year ahead, only the most disciplined operators will be able to succeed, and we go into 2015 determined to maintain our leading market position through our commitment to continuous improvement.

Our performance In 2014, MegaFon demonstrated financial resilience despite the considerable economic turmoil seen during the second half of the year, and managed to achieve results that were fully consistent with the guidance throughout the year for both revenue and OIBDA.

Our projections for revenue growth were the highest among telecoms operators in Russia and were not revised once during 2014. The Company’s revenues for the year increased by 5.9% compared to 2013, reaching RUB 314.8 billion, and meeting our lowest projected estimate for the year.

24 MegaFonMegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information 25

Annual Report 2014 MegaFon MegaFon nine times more than and in 2013 sales of 4G smartphones three times more. stimulateTo higher mobile data usage we promoted sales of affordable branded strong a is MegaFon devices. data-enabled player in this category, providing branded smartphones budget customised and and tablets that meet customers’ quality expectations. we launched In 2013, the first budget Login smartphones and tablets, creating a revolution in the market, and in we2014, launched sales of the MegaFon Login 3 tablet at the lowest market price. The MegaFon Login initially 3, priced at RUB 1,990, achieved record sales from the moment it launched, and for the last five months of the year was a bestseller in our MegaFon Retail chain. Our customised devices also sold well during the with year, 3.4 million units sold in total, up on 5.7% Sales2013. of customised smartphones exceeded 650,000 units and customised tablets 640,000 units, which is 26% and higher respectively, times, ten almost than a year ago. In recognition of these developments, and of our 4G leadership generally, Telecom Daily announced that in 2014 MegaFon in speeds internet fastest the provides eight Russian cities with a population of over one million people, including Moscow, Nizhny Novgorod and Samara. On the back of extensive 4G/LTE network development in Russia and the growing popularity of 4G devices, across the 4G device portfolio in our retail network, we 200 4G-enabled around offer currently models. During our 2014, sales of 4G devices went up twofold, reaching million 1.7 devices, while sales of 4G tablets grew Mobile data revenueMobile growth year-on-year Leading the field in mobile data During we enjoyed 2014 our leading position in mobile data. MegaFon has been a leader in mobile data transmission since 2008, and thisin 2014 continued to be a key growth driver with revenue from mobile data services increasing by 33.3% year-on-year and representing of total 21.3% revenue compared managed We in 2013. to 17.0% to achieve a 39.2% market share in mobile data revenue among the ‘Big three’ operators in Russia. weIn focused 2014 our effort on the further development of our networks and expansion of our fibre-optic cable line infrastructure, ensuring we offer a broad spectrum of network capacity and strengthen To customers. our to services our preeminent position in 4G/LTE, in 2014 we added 23 regions to our 4G network coverage and, as of the year-end, our 4G services, were available in a total of 72 federal regions. Our 4G penetration 4G-enabled million 3 from doubled, also devices registered on our network in 2013 to 5.8 million devices in while 2014, data (DSU) subscriber per traffic transmission we In also 2014 was began up 64.1%. to focus on LTE-roaming and during the year coverage roaming our expand to managed to 37 popular travelling destinations by concluding contracts with the 37 operators markets. those serving In February we commercially 2014 launched LTE-Advanced, network, fastest world’s the and started offering internet access at speeds of 150-300 Mb/s in Moscow, St. Petersburg and Chelyabinsk. the At moment of launch, the MegaFon network was recognised by GSA (Global Supplier Association) as the fastest commercial mobile network in the world. This year we are planning to continue deployment of this network in the biggest Russian cities. Also, to access the LTE-Advanced network, we MegaFon branded our of sales launched Space router and became the first operator in the world to do this. +33.3%

Total revenue growth Total in line year-on-year, with FY guidance In 2014 weIn took 2014 steps enabling us to be well-prepared for possible market uncertainties and cater for our medium- term requirements in terms of the financing of our further infrastructure development. signedWe financing agreements with and Corporation Bank Development China Finnvera for the purchase of equipment and services from Huawei and Nokia Siemens entered also and respectively, Networks, Ericsson contracts with long-term into and construction the for Huawei and modernisation of our network based on the total cost of ownership concept. In fact, we were one of a few corporate borrowers to bond ruble domestic the tap successfully market, and overall we ended the year with sufficient liquidity, a stable leverage OIBDA-CAPEX highest the and position, indicator in the industry – RUB 82 billion. Our net profit decrease of 28.8% year- on-year was due to a non-cash foreign exchange loss incurred primarily as a result of the considerable ruble depreciation in the fourth quarter of the However, year. a number of management decisions taken asin 2014 part of our overall long-term risk us allowed strategy management In particular, early payment of our US dollar obligation relating to the Euroset transaction, the refinancing of our USD- the for obligation deferred denominated Scartel acquisition in and 2014, a proactive CAPEX helped to management, approach losses. our minimise to In fact, our revenue growth rate was in 2014 the fastest among the ‘Big three’ operators in Russia. also We managed to maintain a high level of OIBDA and OIBDA profitability for the through year, our revenue growth and close attention to operating costs. OIBDA was up 4.4% in Russia, which is our core segment, and our OIBDA margin of 44.5% was the highest in the industry. to substantially mitigate the broader currency fluctuations. these of impact +5.9% Chief Executive’s review

Meeting the challenge continued

Commitment to service quality Maximising subscribers’ experience in all Looking ahead: 2015 and beyond and customer experience areas of our services was certainly a key Looking ahead, we know that 2015 is likely Delivering exceptional client service focus in 2014. We invested significantly in to be a challenging year. Our strategic remained a major strategic priority for attracting and retaining new customers. We priorities for 2015 include retaining our MegaFon in 2014. We continued to leverage rolled out a number of products and tariffs leadership position in mobile internet our unrivalled competitive and technological to ensure MegaFon remains an accessible and other key business areas; continuing advantage to deliver the highest quality and affordable option. By the end of the our development of innovative products services and products to our customers. year we increased our mobile subscriber and services in line with customer needs; This commitment was reflected in our base by 3.0% year-on-year to 72.2 million retention and continuous expansion investment in premium network coverage subscribers, with our total number of of our subscriber base; rationalising during 2014, with CAPEX up 20% on 2013 customers in Russia up 2.4% to 69.7 million; our expenditures and improving our levels, and in our completion of planned the number of data service users in Russia, operational efficiencies; and improving infrastructure developments despite the meanwhile, went up 10%, reaching almost our internal business processes, including market situation. 40% of the total customer base. implementation of the unified billing system.

Nowhere was our commitment to service During the year, we continued to put much We will also continue our efforts to enhance quality more evident than during the 2014 effort on improving customer service via the quality of our network and maintain Winter Olympics in Sochi. For this purpose our MegaFon Retail chain, call centres our leading coverage and capacity. Having we invested heavily in the deployment of and client account tools. We introduced invested significant amounts in 3G and 4G mobile infrastructure, building this from a new 24/7 virtual service called ELENA, network rollout over the last few years, we scratch, completing everything on deadline, which uses speech recognition to help are currently at such an advanced stage and installing over 220 km of fibre-optic solve customer problems and answer of technological development that we are cable and constructing more than 950 base questions, launched a brand-new site for now prioritising expenditure in efficient stations, including over 270 4G stations. our corporate and government clients, and network development and infrastructure As a result of our efforts, the Sochi Winter revealed a dedicated mobile account service maintenance rather than investing heavily Olympics were officially the ‘most mobile’ application to replace numerous outdated in next generation technology. In fact, Olympics Games in history. Once again, applications. As a result of our effort aimed CAPEX increases in 2014 were more related MegaFon proved itself a reliable partner at delivering customer excellence, we to Russian currency fluctuations and in a major international event, and we are retained the highest Net Promoter Score1 instability than outright investment. proud of the part we played in delivering in the industry at the year-end and were exceptional quality to the millions of people named by our clients the leader in client- I would like to personally thank all who enjoyed the Games via our networks, oriented businesses among domestic our dedicated employees, whose hard services and products. What’s more, these telecommunication companies. work, ingenuity and skill helped us investments enabled us to strengthen achieve another successful year. I would MegaFon’s brand and increase brand also like to thank the members of the recognition and visibility on a global stage. Board of Directors and my colleagues in management, as well as our shareholders, for their ongoing commitment and support.

Ivan Tavrin Chief Executive Officer

1 According to the research conducted for Q4 2014 by independent agency Synovate Comcon. 26 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information 27 4 168.2% 1 0 889.9 2 7 Annual Report 2014 3 170.0% 1 0 873.9 2 MegaFon MegaFon Other major players in the 6 technology the (or ‘Internet of 5 2 161.3% 1 0 829.7 2 Company’s estimates based on data of AC&M Consulting. TMT Consulting report, ‘Russian telecommunications telecommunications ‘Russian report, Consulting TMT 2014-2020’. market M2M refers to technologies that enable wireless and wired systems to communicate with other devices of the same type. Company’s estimates based on data of AC&M revenue. wireless for Consulting  GSMA Intelligence.

1,2 3 4,6 5 7 Mobile business in Russia RUB bn + Penetration, % During the new year, market trends included the development of M2M (machine-to- machine) Things’) and Big Data – two key areas of the marketVAS where MegaFon is developing innovative products and services and transmission. data monetise to working As described elsewhere in this report, second-largest the currently is MegaFon mobile telecoms operator in Russia in terms of revenueand subscriber base, with a 29.0% market share in total mobile subscribers. Russian mobile market include MTS, the country’s largest telecoms operator; VimpelCom, the third-largest operator in Russia; a joint and venture Tele2, between Russia, and Tele2 which has fourth-largest operator the as emerged in Russia (for more information, see Key Competitors on page During 33). the theyear, ‘Big three’ players continued to dominate the market with an aggregate 83.6% share in terms of subscribers.

4 Another cause 3 In 2014, theIn 2014, telecommunications market was affected by two major developments: the introduction of a new version of the law ‘On Communications’, and the adoption of the mobile number portability (MNP) principle. The updated law ‘On Communications’ means mobile operators must now receive user consent for the provision of value-added services (VAS) (‘Advice on charge’). This new measure has already impacted the revenue VAS of mobile operators and may restrict revenue growth in the future. The introduction of the MNP principle, which now enables mobile users to retain their mobile numbers when changing from one mobile network operator to another. MegaFon is the main beneficiary of this process with 35% of total numbers in. ported of the slowdown was the continuing decline of the fixed-line segment, as reachedin 2014 RUB billion. 1,655 environment economic uncertain the While makes it difficult to forecast market trends, TMT Consulting anticipates a growth rate Despite in 2015. of 1% a general decline in purchasing power and a likely reduction in geographical the constructionnetwork paces, expansion of 3G and 4G is expected to be the main growth driver in the year ahead, data in increase corresponding a with along offerings. bundled and consumption well as the saturationof traditionally broadband as such segments dynamic internet According and Pay-TV. to TMT Consulting, the overall volume of the market telecommunications Russian Mobile business Mobile theAt end of December Russia 2014, had approximately 240.7 million mobile subscribers, million down compared 2.1 to the end Mobile of 2013. penetration in 2014 was 168.2%, down p.p. on 1.8 2013. in 2013 toin 3% 2013 in 2014. The Russian telecoms market in 2014 market telecommunications Russian The witnessed a slowdown in resulting 2014, from a decreased rate of growth within the mobile sector – the largest telecom segment and market driver – from 5%

), while 2

(CAGR (Compound Annual 1

The global mobile industry continues to grow rapidly, supported by the development of higher-speed networks and increasing adoption of mobile devices. theAt end of the 2014, total number of unique mobile subscribers reached 3.6 billion The global telecoms market telecoms global The A vibrant and growing market growing and A vibrant Market overview Growth Rate) 2008-2014 at 9.8% The increasing penetration of data-enabled data-enabled of penetration increasing The devices, popularity of heavy-data traffic, like video, games and file downloads, and OTT services lead to higher mobile data traffic usage. According to Cisco, in the 2014, global mobile data traffic grew by 69% to reach 2.5 exabytes per month, with mobile video traffic exceeding 50% of total mobile traffic. This is predicted to increase to more than 24 exabytes per month in 2019. the penetration rate was at 50%. With increasing demand for mobile data, lowering prices and an astonishing breadth of data mobile devices, data-enabled available transmission has become the main driver 2.2 billion with in 2015 one billion – upgrades as smartphones purchased generating over US$300 billion in sales. The global marketis currently witnessing a shift to mobile broadband networks on the back of faster deployment of 4G/LTE networks worldwide. According to GSMA, 2G remains the dominant technology in terms of the number of connections, but its proportion has fallen from 90% of total connections in 2008 to around 60% by the end of This 2014. decline is likely to accelerate by 2020with 2G connections accounting for only a thirdof the total connection base. The share of 3G/4G in total connections is predicted to increase from 40% of the global total to in almost 2014 70% in 2020. This shift also takes place on the back of higher adoption of smartphones and other advanced devices. Deloitte predicts that the base will increase from billion to in 1.8 2014 of growth for global mobile operators. Market overview

A vibrant and growing market continued

Voice services Data services Mobile data market in Russia14 Voice is the largest traditional segment Data remained the fastest growing RUB bn of the mobile market in Russia, and voice segment and the primary source of revenue communications continued to represent the growth for mobile operators in Russia biggest share of MegaFon’s total revenue during 2014. Data is certainly a major in 2014, generating RUB 162.3 billion.8 growth area in Russia, where there are 176.7 However, total voice revenues declined currently 99 million mobile data users10 – in 2014 as a result of market saturation, an increase of 10% compared to 2013. 135.1 migration of subscribers to bundled tariffs, Indeed, for the past ten years the structure growing mobile data usage – with key of data usage in Russia has changed. 100.0 market players focusing on 3G and LTE Experts predict that by the end of 2018 the network development, and increased price mobile data subscriber base will exceed competition. The share of voice revenues in 150 million11 and the number of LTE total wireless revenues of mobile operators subscribers will increase to 20 million, decreased to 66.2% (down 3.1 p.p. vs 2013). up from 7 million in 2014.12 2012 2013 2014 9 In 2014, the Russian mobile data market Mobile voice market in Russia 13 RUB bn grew by around 31% to RUB 176.7 billion, and the share of mobile data in total MegaFon is very well positioned to take wireless revenues of mobile increased from advantage of data service growth and 15.5% in 2013 to 19.9% in 2014. The main traffic consumption due to the wide market drivers are the increasing adoption coverage of its 4G network and high 599.9 605.8 of data-enabled devices, rapid expansion data speeds provided. According to data 589.2 of 3G/4G networks and popularity of from the Federal Service for Supervision heavy content. According to Cisco, mobile in the Sphere of Telecom, Information internet traffic in Russia grew by 89% Technologies and Mass Communications, in 2014 (52 times the rate of 2009). On the total number of active 4G base stations average, every user of a data-enabled device at the end of 2014 increased by 3.4 times – consumed 372 megabytes of traffic per up to 42,047 units from 12,364 units in 2013. month in 2014. The monthly traffic usage by MegaFon holds 44% of the total number tablet owners increased by more than 220%, of base stations and provides 4G services 2012 2013 2014 while for smartphone owners it increased by in 72 Russian regions. more than 90%. Cisco forecasts that mobile data traffic in Russia will reach 1.4 exabytes Value-added services per month by 2019. Other key drivers of the The VAS segment remained the third mobile data market include the development largest segment of the wireless market of M2M solutions (or the ‘Internet of Things’) with a 13.9% share (down from 15.2% and geolocation services. in 2013). The traditional VAS segment comprises short messaging and mobile However, for those operators providing content services. During 2014, VAS mobile data services, revenue growth revenues in these areas remained flat or does not currently correlate with data decreased for most telecoms operators traffic growth. The slower rate of mobile due to the introduction of a new regulation data revenue growth is attributable to the designed to restrict the flow of automated promotion of bundled tariff plans among SMS messages to subscribers (see page 32). Russian mobile operators and packaged In 2014, the VAS segment decreased data tariff options: the more traffic by around 7% to RUB 123.9 billion. available in the package, the lower the cost of each megabyte of traffic.

8 Voice includes revenues from local subscribers, which includes monthly fees, airtime revenues, own subscriber roaming and connection fees; wireless interconnection revenues; roaming charges to other 9, 11, 13, 14 AC&M Consulting. wireless operators and other wireless revenues. 10,12, 17 J’son & Partners Consulting. 28 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information 29

21 4 4 1 1 0 0 529.6 123.9 2 2 22, 23 20 Annual Report 2014 3 3 1 1 0 0 585.5 133.0 2 2 MegaFon MegaFon 2 2 1 1 0 0 576.3 129.9 2 2 Looking ahead, market trends point to the increased provision of single account bundled solutions, and the development of digital TV and OTT data transmission via the internet. Fixed-line business Fixed-line broadband has been a key focus area for Russian wireless operators over the past few years. MegaFon has continued business, broadband strengthen its to expand backbone capacity, and streamline its fixed-line assets. Market consolidation in this area has also seen further expansion of B2B/B2G fixed-line services among the all major telecoms operators in Russia. Competition in the fixed-line market is particularly strong in the Moscow region, where penetration is over 80% and there are more than 300 active providers. Fixed-line market in Russia RUB bn VAS market in Russia RUB bn

19

with a share of of 6-7% 18 Telecomza.ru figures). 2013 and (2012 iKS-Consulting TMT Consulting (2014 figure). Excluding payments via USSD. AC&M AC&M Consulting.  the total e-commerce market in Russia. Experts calculate that the mobile finance market volume doubled in while 2014, the e-commerce market grew by 25-30% in During2014. the MegaFon year, continued to develop its mobile finance services, and the volume of mobile payments made by its customers exceeded RUB billion in 2014. 12 20 21 22 23 19 MegaFon also continues to develop Big Data services as a high-margin and high added-value business for corporate and government customers, and as a means of improving operational efficiencies (for more information, see page 45). and were expected to reach US$2.5 billion in This 2014. growth is being driven by devices digital of adoption increased the the and consumption, content for adapted ongoing development and offering of mobile content. Mobile video files are the leaders in terms of consumer demand. According to forecasts by Cisco, the mobile traffic generated by video might increase 20-fold in Russia. Through its mobile TV (MegaFon MegaFon application, TV) SMOTRI+ and continues to be a major digital media content provider. Other markets VAS include OTT service vendor solutions such as iMessage (Apple), Google Hangouts (Google), Skype solutions third-party and (Microsoft), such as WhatsApp and Viber. Through its its provides MegaFon service, MultiFon customers with the opportunity to make calls over the internet to any number in the world, send MMS and SMS messages, and receive a usage chart. Mobile finance is one of the rapidly developing segments of the market. VAS According different to sources, the m-commerce market is estimated at US$1-1.5 billion

17

as 16 of total 15 GSMA Intelligence. by AnalyticResearchGroup. by Company’s estimates based on data provided Cisco. 

18 15 16 Beyond the traditional areas, the VAS service portfolio is diversifying into new services, M2M include These niches. market or the ‘Internet of Things’. According to GSMA, as of December there 2014, were 243 million cellular M2M connections whichglobally, accounted for 3% As our mobile business continues to grow, we are we business continues grow, to As our mobile focused on expanding network our 4G/LTE enhance to across Russia throughthe people of lives the ongoing transmission. data capacity and connectivity of quality, are also becoming more popular in the retail segment. J’Son & Partners Consulting predicts that the Russian M2M market will grow approximately 45% per year between while globally and 2013 2017, the M2M market is expected to increase trillionto US$19 in the next decade This segment is a young but rapidly growing area within the global and Russian telecommunications markets. Now M2M solutions are mainly dedicated to satisfying the needs of corporate clients, but they connections (up from According in 2012). 1% to Cisco, in Russia, the number of mobile- connected M2M modules grew 1.5-fold in and2014 reached million units. 17 Another key area VAS is digital media content, which comprises information video) and game (e.g. entertainment and content. According to estimates by J’son & Partners Consulting, Russia is one of the largest world’s players in the global digital media content market, with a share of 2%. Sales of digital media content via the internet and other remote channels were at approximately US$2 billion in 2013 MegaFon is making product and service development in this area a major strategic priority through its innovation unit, MegaLabs. It is focusing on scalable products with API and packaged products such as M2M monitoring, as well as offerings such as Car Fleet Monitoring and Employee Monitoring (see page 44 for details). new technologies continue to stimulate data traffic (particularly in Mobile Health). According to Cisco, M2M traffic in Russia might increase 45-fold from to 2019 2014 at a CAGR of 114%. Market overview

A vibrant and growing market continued

Voice services Fixed-line broadband access Fixed-line broadband access In 2014, the collective revenues of all market in Russia, B2B/B2G segments30 market in Russia, B2С segment32 Russian operators providing fixed-line RUB bn, Penetration %31 RUB bn, Penetration % telephony services decreased by 7% to 70.0% 51.7% 24 68.0% RUB 171.4 billion compared to 2013. 65.0% 47.0% Annual revenues from local services, which 42.0% account for 74% of the fixed-line voice 59.0 116.7 segment, decreased by 4.6%, while ‘zonal 55.3 110.5 communications’ revenues fell by 14.7% to 51.5 101.4 RUB 21.8 billion – the most notable drop during the year. This fall in revenue was due to the migration of users to mobile networks with comparable communication tariffs and free on-net calling as well as the increasing popularity of OTT services.

Despite MegaFon’s primary focus on 2012 2013 2014 2012 2013 2014 mobile services, it currently provides fixed-line voice services for corporate and government clients and will continue The Russian broadband internet market Pay-TV to extend this offer in the future. is highly competitive – with 65%29 of the Russia is one of the biggest players in the market volume in revenue terms controlled global Pay-TV market. Due to the rapid Broadband internet access by top-five players. The Moscow region’s growth of digital technologies and the The growth of the Russian broadband market is even more competitive due to expansion of satellite operators, the Pay-TV market is slowing. In 2014, the broadband a high level of saturation. According to market structure has changed significantly market volume increased by 6.4% compared iKS-Consulting, MegaFon is among the in recent years. Market growth has been to 2013, totalling RUB 176 billion. Of this top five operators within this segment in dynamic but uneven, and over the past few total, RUB 117 billion was generated by the Moscow region, with a 10% market years satellite television has emerged as B2C users (compared to 111 billion in share, in terms of subscriber base. Indeed, the absolute growth leader in this area. 2013),25 with the number of B2C users NETBYNET, our wholly-owned subsidiary, The IPTV segment has developed rapidly, totalling 28.9 million households.26 As a is one of the main players in the Moscow despite a relatively small proportion of result, broadband internet penetration in market and the largest in terms of revenue. total Pay-TV subscribers (12% at the end the B2C segment reached 51.7%. Overall, Despite the high saturation of this market of 2014), and cable television has now broadband internet penetration in Russia (above 80%) and increasing competition, lost its leadership position to satellite TV is higher than the world’s average (which NETBYNET’s attractive offers (such as due to segment stagnation. According to is 43.6% according the International WiFire solutions linked to one account) iKS-Consulting, 37.7 million households in Telecommunication Union), but lower and general expansion are helping MegaFon Russia are subscribed to cable, satellite or that the average level of penetration to increase its market share. IPTV, with penetration above 68%, while in developed countries (78%).27 the total market volume amounted to Looking ahead, the market growth rate RUB 61.2 billion having demonstrated Overall, the subscriber growth rate was is likely to continue decreasing, mainly a 12% year-on-year increase. 4.5%, almost half that of 2013 (7.7%). This due to the rapid expansion of wireless slowdown is largely explained by market technologies and increasing price Currently, all six of the largest Russian saturation in large and medium-sized cities; competition. Indeed, iKS-Consulting telecommunications holding companies the expansion of wireless technologies predicts that by 2019 subscriber growth offer Pay-TV services, with five of these (primarily LTE); the reduced rate of network will be about 1%, with the bulk of new offering bundled service packages. construction by Russia’s largest operators; broadband subscriptions coming from small However, these service bundles don’t go and increasing price competition. The B2B/ and medium-sized cities, where fixed-line beyond ‘triple play’, which traditionally B2G broadband subscriber base reached networks are currently being built. includes fixed telephony, broadband 1.5 million in 2014. The market has reached internet access and Pay-TV. To address this saturation point, with penetration increasing issue, in early 2015 MegaFon’s subsidiary from 65% in 2012 to 70% in 2014.28 NETBYNET launched a mobile-inclusive ‘Quad-play’ under its WiFire offering. 24, 25, 26, 27, 29, 30, 32 iKS-Consulting. 28, 31 TMT Consulting. 30 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information 31 4 4 1 1 0 0 5.0 16.8 27.5 9.1 2 27.0 242.1 75.7 2 37 Smartphones Smartphones USB modems Annual Report 2014 35 36 3 3 1 1 0 0 2 5.8 22.0 19.3 6.8 2 41.3 185.4 78.1 MegaFon MegaFon 2 2 1 1 Tablets Mobile phones Mobile phones Tablets 0 0 3.2 6.1 29.3 12.7 67.6 137.0 49.5 2 2 Mobile device sales in Russia Units, m Mobile device sales in Russia: Mobile device sales in growth and structure RUB bn

data-enabled devices, to the detriment detriment the to devices, data-enabled USB-modems Sales of USB-modems in Russia are decreasing, with tablets with SIM-cards and mobile routers fast becoming the products of choice in this area. Indeed, on average, tablets consume three to four times less data traffic than modems which efficiency. network improves significantly The growth in popularity of portable of notebook sales, has impacted demand for USB-modems. For example, USB- modem sales in the Svyaznoy retail chain decreased to by in approximately 2014 16% units. 500,000 Tablet PCs accordingIn 2014, to estimates based on GfK analytics, in Russia more than 9 million tablets were sold. Although this is 34% more than market in 2013, growth slowed down dramatically due to general saturation and market maturity. In total, the turnover of tablet computers amounted to approximately RUB billion. 75.7 market penetration, however, Tablet reached record levels in with 2014, one tablet for every three smartphones sold in Russia, compared to one for every five worldwide. According to Svyaznoy retail chain, this trend is most likely a result of the growing popularity of low-end models and local ‘B-brands’. Indeed, by the end of2014, 65% of tablets sold in Russia were B-brand products, with three in four costing less than RUB 10,000. Market growth is likely to slow further with in 2015, pockets of growth anticipated in small towns where market maturity has not yet been reached.

– up 30% on 34 while the average priceof a mobile 33 Company’s estimates based on data provided by International institute of marketing research ‘GfK Rus’ LLC. Verified data. Verified GfK Rus, Company’s estimates. The segment of NFC-smartphones (Near Field Communication technology-enabled) is rapidly growing. According to Svyaznoy estimates, the total share of NFC- smartphones in total smartphone sales amounted in tounit 16% terms and 35% in monetary terms. With further development of payment systems, the usage of NFC NFC-enabled for demand and technology smartphones are expected to grow. 2013. The2013. increase in sales was primarily the result of the growing popularity of mobile internet access and the reduced average cost of devices, as well as the generally positive dynamics of the mobile phone market as a whole. phone declined by 26%. Overall, sales of smartphones in Russia increased by 43% in unit terms compared in2014 to 2013, and the smartphone market as a whole amounted to RUB 242 billion 36 37 33, 34, 35 Mobile phones and smartphones and phones Mobile According to estimates based on GfK analytics, the in 2014 Russian mobile and smartphone market amounted to 44.3 million devices, million up from 41.3 within 2013, smartphones accounting for 62% of total sales. During the the year, average cost of a smartphone decreased by 9%, The increasing affordability of mobile services, the need for ‘heavy’ content (video and music), and the expansion of stimulate to continued transmission data sophisticated data-enabled for demand and high-functioning devices in 2014. Equipment sales Equipment Market overview

A vibrant and growing market continued

Regulatory developments Inter-operator cooperation Opportunities in 2015 MegaFon’s market and operating During the year, the Government Looking ahead to 2015, key opportunities environment is continually impacted by Communications Commission of the facing our business include: regulatory developments. When monitoring Ministry of Communications discussed • Technological neutrality: To help the regulatory issues that are most amending existing regulations regarding accelerate the development of 3G and relevant to our business, we follow best inter-operator cooperation. 4G in Russia, the State Commission for practice and ensure our responses are Radio Frequencies (SCRF) has introduced timely, informed and effective. In January 2015, the decision was made the principle of technology neutrality for to change these regulations on a step- the 900 MHz and 1,800 MHz bands. This SMS spam by-step basis. This decision was taken at principle allows operators to develop In 2014 the Russian Government passed a meeting at the Government’s Analytical any communications technology over a law designed to tackle the issue of SMS Centre attended by representatives of the available frequency bands and will have spam. The new law prohibits automated Executive Office, heads of federal executive an impact on the telecommunications sending of SMS messages to subscribers, bodies, and heads of landline and mobile market – particularly as the SCRF plans as well as sending messages via numbers operator companies. The first stage of this to extend the principle to other frequency which do not correspond to the Russian development will involve taking measures ranges in 2015. These developments numbering system, or which contravene to determine a single price for a call service are likely to increase competition for inter-network cooperation agreements within a constituent entity of the Russian MegaFon, although we view renewed with foreign communications operators. Federation. It will also involve simplifying focus on this principle not only as a risk The sending of SMS messages is now the requirements concerning traffic transfer but as an opportunity to provide better- dependent upon subscribers’ consent at relevant connection levels. quality services to our customers through and the contract with the operator. Since the extended frequency range. coming into force, the new law has led At the second stage, in around two years’ • Joint use of radio frequencies’ to a significant reduction in the quantity time, authorities will consider possible spectrum: The State Duma is considering of SMS spam sent over the MegaFon methods of regulating inter-operator amendments to the Telecommunications communication network. cooperation among landline and mobile Law concerning the possibility of joint communications, taking into account the use of radio frequencies’ spectrum. This Telephony services technological, financial and socio-economic initiative will provide more effective use In 2014, new regulations were passed consequences of such changes. of radio frequency resources and help regarding the Rendering Telephony Services. all operators to improve the quality The implementation of these government These regulations govern landline and of their services. initiatives may result in decreased call service mobile communications simultaneously and • VoLTE: In December 2014, the Ministry of rates and communications services costs. contain a number of novelties for the field. Mass Communications began to develop In particular, the regulations govern the We are also aware that there are a range regulatory measures relating to the use MNP (Mobile Number Portability) procedure of other regulatory developments facing of the IMS (IP Multimedia Subsystem) and concerning the subscriber numbers of our industry that we need to monitor and VoLTE (Voice over LTE) technologies in government and municipal customers. prepare for. For more information on how the public telephone network. Transition we address these evolving challenges, to IP is considered a major driver of Federal communications mobile radio telephony, and the proposed Additionally, rights were established please see our Risk Management section on pages 62-73. changes could result in the creation of a for federal bodies to connect to the single communications network based Government’s data communications on IP correspondence to advanced global network, which is to be administered by standards. The changes could also lead one of the communications operators. This to a decrease in the costs of voice traffic, new regulatory initiative could result in an increase of ROI in the LTE network and MegaFon losing its B2G market share in the a convergence of services and commercial provision of communications services to cooperations with OTT providers. federal customers. However, during 2014 we retained all of our key government clients and public procurement contracts.

32 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information 33 39 38 29.0% 29.8% 30.9% 32.7% Annual Report 2014 2014 2014 Others Others MTS MTS 12.6% 16.3% MegaFon MegaFon 23.8% 24.9% MegaFon VimpelCom MegaFon VimpelCom Key Russian players by subscribers Key Russian players by revenue Key Russian players by

Rostelecom Russia: and Tele2 in 2014, state-controlled the Rostelecom, telecoms company which provides mainly wireline services, completed a deal to create a joint venture with Russia, Tele2 a private company operating in Russia since 2003. During the Rostelecom year, also fully completed the transfer of mobile assets to the joint venture. As a result, market mobile fourth-largest federal the player operating under the brand name created. was Tele2 in Russia; MTS: founded in the 1993, largest wireless telecoms operator in Russia; VimpelCom: founded in 1992, the third- largest wireless telecoms operator • Our strategic approach centres on to improvement and innovation continuous create competitive advantage and deliver profitable growth. Our core focus remains the leveraging of our infrastructure and strong position in the mobile data market to monetise data transmission. are We also focused on developing new and innovative whileVAS, taking a prudent approach to CAPEX spending and maximising operational efficiencies. Looking ahead, we aim to further consolidate our leadership in 4G/LTE, and deepen customer loyalty through high-quality of provision ongoing the Strategy and innovation and Strategy services. tailored and Key competitors Key include: competitors key MegaFon’s • •

In 2015, the In 2015, Government Company’s estimates based on data provided by AC&M Consulting. The working group of the Chamber of Commerce is discussing principles of the new regulation of governmental concept The supervision. and control of the new law is to switch to a risk- oriented modelof regulation, which may the administrativesignificantly lower the including businesses, on burden telecommunications sector. DATA MVNO: plans to pass regulatory acts permitting the use of virtual data networks when transfer data and telematic rendering services, as well as virtual mobile radio telephony communications in the TETRA network with frequencies lower than 300-400 and 800-900 MHz. These opportunities expand will developments for operators providing MVNO services. Governmental control and supervision: 38, 39  • • Review of operations Services and products

One of our core commitments is to offer high-quality, convenient services at affordable prices. Through our competitively-priced tariffs and devices, we enable customers to access the services and products they need at prices they can afford.

Mobile voice The marketing campaigns with special According to research In 2014, our voice communications remained price offerings for Vse vklyucheno S for the largest segment of our business and RUB 150/month held in August-October conducted by TelecomDaily generated RUB 164.9 billion.1 The share of and Vse vklyucheno XS for RUB 99/month voice revenue in total revenue declined from held in December enabled us to increase in November-December 2014, 57.6% in 2013 to 52.4% in 2014. This was the share of the Vse vklyucheno bundled MegaFon provides the fastest due to a number of factors, including: tariff line in total sales and attract new a general trend of migration of subscribers customers. We also refined our ‘Perekhodi data transmission in LTE to bundled tariffs, higher mobile data usage, na 0’ (‘Switch to Zero’) tariff providing free increasing popularity of OTT content, on-net calls within the region of residence. networks in eight Russian ongoing price competition, and our decision cities with populations over to discontinue the active targeting of We continued to develop offerings for our seasonal guest workers in Russia. corporate and government clients. We 1 million. upgraded our ‘Corporate Unlimited’ tariff Despite the fall in revenue, mobile voice plan packs to offer higher amounts of communication remains an in-demand available voice and mobile data traffic, as service and a part of everyday life in modern well as making incoming calls for roaming In February 2014, we launched 4G/LTE- Russia. As such, we are committed to the in Europe free on the premium version of Advanced – the latest standard in mobile ongoing development of this segment. this pack. We also expanded our convergent internet services. As of the year-end, Furthermore, the potential for high levels of service offerings for corporate clients, LTE-Advanced services were available in gross margin remain strong for voice services. which are now provided in 49 Russian three major cities. Our 4G/LTE-Advanced regions, and comprise services, which network delivers data transmission speeds In 2014, our full-year blended ARPU facilitate the management of voice calls, of 300 MB per second, and during network amounted to RUB 321 (down 1.5% year- call forwarding and other communication testing with Ericsson in early 2015 we on-year). Our voice traffic increased by technologies. reached speeds of up to 450 MB per second. 2.2% year-on-year, but due to the faster Simultaneously, we launched sales of our growth of data users in the total subscriber Mobile data branded router MegaFon Space, which base, our blended minutes of use (MOU) Mobile data remains the key growth driver supports LTE-Advanced speeds. decreased by 2.9% year-on-year and stood for our business. In 2014, we focused on at 334. developing our 4G and 3G network by In January 2014, we started providing 4G/ expanding the coverage and improving LTE international roaming services. At During the year, our primary focus was the the quality of communication, stimulating the year-end, we managed to open LTE- promotion of bundled tariffs, as well as higher mobile data usage through special roaming in 37 countries, including half of the the ongoing unification and federalisation price offerings and upgrades of our data European countries and popular travelling of tariff plans designed to attract new tariff options, and promoting data-enabled destinations. The countries in which our subscribers and boost voice traffic. In 2014, devices in our controlled retail channels. customers can now access 4G/LTE roaming we were actively promoting our bundled account for about 60% of our internet traffic tariff line ‘Vse vklyucheno’ (‘Everything As of the year-end, our 4G network, the overseas. included’), which represents a package of largest in Russia, comprised 18,636 base voice minutes, messages and mobile data stations, and our 4G services were available traffic to stimulate users of traditional to 51%2 of the country’s population – in tariffs to switch to tariff packages. 14 out of 15 large cities with a population over one million citizens and in 72 Russian regions. As of 31 December, 5.8 million 4G-enabled devices were registered on the MegaFon network. During the year, MegaFon data users generated more than 290 petabytes of 4G traffic.

1 Voice includes revenues from local subscribers which includes monthly fees, airtime revenues, own subscriber roaming and connection fees; wireless interconnection revenues; roaming charges to other wireless operators and other wireless revenues. 2 Russian population as of the latest census in October 2010. 34 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information 35 Annual Report 2014 MegaFon MegaFon attractive tariff offerings stimulating use of our 4G services on the back of intensive network development and expansion of coverage, increasing popularity of and Russia products in data-consuming data-enabled of sales of stimulation devices through controlled retail channels. As of the end of the 2014, share of data- enabled devices on the MegaFon network increased to 45.6% compared to 37.5% a year earlier. For more information on the promotion and sales of data-enabled devices, see page 36. Krasnoyarsk Novosibirsk Omsk In 2014, weIn 2014, achieved a strong increase in DSU (monthly average data services usage year-on-year per user), up 64.1% to 2,603 Mb/month. Our ARPDU (average monthly revenue per data services user) increased by year-on-year 15.5% to RUB 209. Overall, in our 2014, mobile data revenue increased by 33.3% year-on-year and represented of total 21.3% revenue compared This in 2013. was to 17.0% achieved due to the expansion of our data user base, active marketing efforts and * Yekaterinburg

Chelyablinsk Perm Ufa

Nizhny Novgorod Kazan St. Petersburg Moscow Samara

Volgograd

Total mobile data mobile Total users, 39% total of subscriber base

MegaFon 4G/LTE services availability MegaFon 4G/LTE network built and legalised Cities with a population of more than 1 million people

4G services will be commercially launched in 2015.  * Key MegaFon 4G network roll-out map Rostov-on-Don

Our overall data service user base expanded, at a faster rate than the overall subscriber base, to reach 28.3 million users as of the year-end. The number of data service users in Russia increased by 10% million accountingto 27.7 foraround 40% of our overall subscriber base in Russia. This increase was the result of numerous data higher stimulating at aimed initiatives usage and the switch of ‘pure’ voice users to data, including special price offerings for selected internet tariff options. 28.3m Review of operations

Services and products continued

4 An Olympic first with MegaFon branded devices sold our 4G network 4.5% 0.5% 4% 3% 19% 16% The 2014 Sochi Winter Olympic Games 2% was the first ever Winter Olympics to make 4G speeds available. MegaFon 2014 2013 19% provided continuous communication 57% via its 4G/3G/2G networks and high-speed internet for participants 75% and guests, having developed the necessary infrastructure from scratch and constructed more than 950 base Feature phones Smartphones Tablets Modems Routers stations. The density of base stations in the 2 square kilometre Olympic park was the highest in the world. During the Games, we tested our LTE- Mobile devices We concentrated our efforts on expanding Advanced network with a speed of up The sale of our branded (customised) our offering of portable data-enabled to 300 Mbps. Participants and guests affordable data-enabled devices is one of devices. In August 2014, we launched our of the Sochi Olympic and Paralympic the key elements of our marketing efforts new budget branded device – the MegaFon Games generated 660 terabytes of to promote higher data usage among Login 3 tablet. MegaFon Login 3 runs on data traffic. customers. Through our diversified branded Android 4.4.4; it is faster, smarter and more devices portfolio, including five models of productive than its predecessors, and has a branded smartphones and three models larger memory capacity and an IPS display which provides a better viewing angle and DSU3 of branded tablets, we encourage our ‘pure’ Mb/month voice users to switch to mobile internet image quality. Indeed, following a hugely usage, and our advanced data users to successful media and launch campaign, it migrate to our high-speed networks. has fast become one of our most popular MegaFon sells the following types of own-branded products, with total sales 2,603 branded mobile devices: smartphones, exceeding 330,000 units over a five-month tablets, WiFi routers and modems. period. In 2014, we also launched a customised smartphone under the Alcatel During the year, sales of branded brand using the FireFox operational system. 1,586 (customised) devices in all retail channels increased 5.7% year-on-year to 3.4 million In 2014, sales of branded (customised) 1,068 devices, with the share of sales made via smartphones and tablets, as part of total MegaFon Retail up from 51% in 2013 to 56% sales of branded (customised) data-enabled in 2014. Sales of smartphones increased devices in all retail channels, increased from 26% to 650,600 units, while sales of tablets 19% in 2013 to 38% in 2014. 2012 2013 2014 grew almost tenfold to 640,500 units. With the roll-out of our 4G network, in 2014 we also undertook efforts to promote sales of branded 4G-enabled devices. As a result, the share of 4G devices as part of the total number of customised data-enabled devices sold in controlled retail channels increased from 24.1% in 2013 to 44.0% in 2014.5

3 Total number of megabytes transferred during a given period divided by average number of data subscribers during the period, divided by number of months in the period. 4 Sales of branded devices via controlled retail channels, including MegaFon Retail, Euroset and franchised stores. 5 Verified data. 36 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information 37

Annual Report 2014 MegaFon MegaFon We launchedWe a new service for corporate clients, called ‘Internet for Business’. This service allows employers to control their staff’s use of mobile web content and web- non-corporate to restricts access resources of blocking The resources. based (which is pre-set by the supplier) prevents corporate mobile devices from becoming infected, helps to regulate employee social media activities, and protects users from leakages. data focusedWe on developing our M2M service, (machine-to-machine) Monitoring which is primarily for corporate subscribers. This service allows our clients to control location movements, the monitor and equipment and devices of condition and via a SIM-card transmitting mobile data. It is particularly useful for companies engaged in vehicle tracking and passenger security. and energy logistics, transportation, MegaLabsIn 2014, designed a special M2M Monitoring platform, an integrated platform for creating telemetric systems for remote and data collecting and monitoring management. the At end of we 2014, had more than million 1.2 M2M users (SIM-cards) more(a than 1.5-fold increase compared to a year which, ago), according to our estimates, constituted c.20% of the Russian M2M market share. For more information on M2M Monitoring, see page 45. The development of our content delivery network (CDN) was another key B2B highlight during the MegaFon year. offers its clients customised CDN solutions to meet different needs, content-related such as guaranteeing delivery of content remoteto regions, publishing streamlining video files during online broadcasts, ensuring accessibility during peak hours, and providing high-speed transmission, etc. alsoWe offer a network with a free capacity of more than 200 Gbps to provide stable extreme loads. under operations

named Best European Project at the Global Carrier 2014 Awards During we focused 2014 on increasing the quality of service for our all clients. For SME B2B clients (small-to-medium size enterprises), we improved the availability of representative our increasing by services our offices in Russia by almost 100 stores, bringing the total to more than 2,000 at the end continued of We 2014. to expand our network of dedicated call centres and managed to reduce maximum customer standby time to 30 seconds, which is the best indicator in the sector. also We created a 24/7 Federal Centre for Corporate Client Services which is designed to deal with written communications and querieswithin 24 hours, and we implemented new a system of employee training and testing to help enhance client service quality. Online, we created a brand new website for which b2b.megafon.ru, clients, corporate includes the all necessary information on offerings, customer service and tariff plan choices, while in our branches we introduced an upgraded personal account/ client area for corporate clients. Also in we 2014, continued to develop a range of new products and initiatives. We tariffupgraded Unlimited’ ‘Corporate our plan packs to offer a higher amount of available voice and mobile data traffic, as well as making incoming calls for roaming in Europe free on the premium version of this pack. DREAM

B2B/B2G mobile B2B/B2G mobile year-on-year in 2014 data revenue growth

Due to our continuous effort to improve our customer service and offerings, our in 2014 B2B and B2G segment delivered a strong performance: wireline revenue increased by grew revenue mobile year-on-year, 18.5% year-on-yearby 12.7% and mobile data revenue increased by 56.4% year-on-year. In 2014, ourIn 2014, B2X customerbase continued to expand. year At end, the number of reached services our using persons/devices almost 6.9 million. In the B2B and B2G segments we managed to acquire several large and medium-sized corporate clients and government bodies, some of whom became our clients via the MNP (mobile number portability) process. Across our B2X portfolio, we provide a wide range of services and offer flexible tariffs to organisations of varying size and need, with a focus on connecting employees and managing corporate SIM-cards and devices. As part of our commitment in this area, we strive to improve our B2B, B2G and B2O service quality and deliver flexible customer to precisely tailored solutions requirements. MegaFon offers a range of mobile and fixed-line B2X telecommunication services, B2O and B2G B2B, the encompassing market segments. B2X telecommunication services +56.4% Review of operations

Services and products continued

Our CDN is built on widely-distributed Fixed-line communications WiFire is a dynamic package of services, server infrastructure designed to ensure for the mass market including wireless digital TV and WiFi uninterrupted delivery of user content Our service offering to customers goes for households. Due to a flexible tariff to remote regions at exceptionally high beyond mobile to encompass fixed-line model, our customers are not limited to speeds. With the CDN, users benefit from broadband internet, Pay-TV and fixed-line standardised offerings, and can choose a server response time of 20 milliseconds telephone services. In 2014, we focused on the most suitable mix of services available or less, whereas conventional servers can achieving organic growth in those areas at different prices. All services are often take up to 200 milliseconds. where we already operate, and integrating available under one account. In late 2013, the assets we acquired in 2013 and NETBYNET received an MVNO licence Our CDN solutions are essential to the throughout the year. to provide both fixed-line and mobile successful delivery of ‘heavy content’ (music, internet services under one account (Fixed videos etc.), and our clients in this area include All our broadband fixed-line assets Mobile Convergence). Under this licence, large Russian content providers such as are integrated under the umbrella of NETBYNET is permitted to use MegaFon’s Wargaming and VGTRK, software suppliers, NETBYNET, a Russian broadband telecom network infrastructure, which in early 2015 online movie theatres, TV channels, online operator and wholly-owned subsidiary enabled us to launch a new service under stores and games developers. acquired in 2011. In 2014, NETBYNET the WiFire offering: a high-speed LTE continued to expand its presence in the key mobile internet called WiFire Mobile. In 2014, we also continued to develop markets and enter new territories through As a result, NETBYNET clients can now get our DREAM project. The DREAM (Diverse both organic growth and acquisitions. a triple-play offering and choose from four Route for European and Asian Markets) During the year, we acquired several local available tariff plans with different mobile infrastructure enables us to optimise fixed-line and Pay-TV assets in the Moscow data speeds. connectivity to Europe, and by the end of region and the North-West federal region. 2014 we had six DREAM clients, including Moreover, we continued to focus on the During the year, through organic growth, major international operators such as China consolidation of MegaFon’s broadband integration and acquisitions, our fixed-line Telecom, China Unicom, Deutsche Telecom assets on a single ‘platform’, and, therefore, communications coverage significantly and Interoute. DREAM was also named transferred certain companies, previously increased and reached approximately Best European Project at the Global Carrier owned by MegaFon, to NETBYNET. 3.6 million households in total by the end Awards 2014. For more information on NETBYNET also manages the operations of the year. The fixed-line subscriber base DREAM, see page 41. of certain MegaFon’s fixed-line subsidiaries exceeds 940,000 B2C customers with in North-West region. These assets the total number of Pay-TV B2C users During the year, we continued to develop strengthen our position in the market increasing to 156,500 – up 36% – and the fixed mobile convergence (FMC), our and enable us to provide better services number of broadband customers increasing package of convergence services. These to our subscribers. Unification of internal to almost 660,300 users. During the year, allow our corporate and government clients procedures and processes enables us to we saw the increase of the total amount all over Russia to use the same type of implement the process of integration of of fixed-line data traffic per user, which services in networks of different types, as newly acquired assets within three months was linked to higher consumption of OTT FMC removes differences between fixed on average. content: video, audio files, and online games. and mobile networks. Our offerings to corporate customers include services such In 2014, we focused on network Looking ahead, our fixed-line strategy as hotlines, office zones, numbers starting development, improvement of service for 2015 will involve the promotion of with 8-800, short dialing and others. quality and modernisation of integrated the WiFire product line, the expansion assets. During the year, we expanded of our presence in other regions and the Additionally, we attracted a range of new the channel capacity in most regions of completion of our programme of fixed-line large-sized corporate and government presence, upgraded a significant part asset integration. clients, including Transaero, QIWI and of the telecommunications equipment RBC; the federal state unitary enterprise and developed the network using FTTB Rosmorport, the Pension Fund of the technology. In 2014, we launched a new Russian Federation, EMERCOM of Russia, call centre in Cheboksary, which enables the Russian Federal Treasury and the NETBYNET to maintain high standards of Ministry of Internal Affairs, among others. service quality with a growing subscriber In 2014, MegaFon was named best base, and introduced our new WiFire product. communications services provider in the B2G segment at the All-Russian Forum & Exhibition, ‘GOSZAKAZ-2014’.

38 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information 39

Annual Report 2014 MegaFon MegaFon 4G roaming A major development in our roaming programme during was 2014 the launch of 4G/LTE international roaming in January. Offering high speeds of mobile data transmission even when overseas, our 4G/ optionsLTE aredesigned to be convenient and cost-effective. Prices per 1 Mb of traffic are the same as on our 3G networks, enabling customers to access high-speed internet expenses. huge incurring without abroad During we 2014, managed to open 4G/LTE roaming in 37 countries, including half of the countries in Europe and popular travelling one in launches with Starting destinations. or two countries a month at the beginning of the we were year, adding a new country every week by late As 2014. of the year-end we confirmed our position as one of the leadingworld’s telecom operators in terms of LTE-roaming coverage. The countries in which our customers can now access 4G/ roamingLTE account for approximately 60% of our internet traffic overseas.

During the the internet Olympics fastest mobile was available not only to our subscribers to only but not also was available roaming. The serviceinter-network was used by from different 70 people countries. to subscribers of other telecom operators subscribersto through other of telecom To help customersTo better control their and travelling when expenses data mobile shock’, ‘bill roaming against them protect we launchedour ‘Internet za granitsey’ (‘Internet abroad’) tariff in June. A unique tariff option within the Russian market, ‘Internet za granitsey’ allows subscribers to access the internet in any country at a manageable expense. There is no subscription fee, and the cost of mobile data usage is fixed depending on the country of location and the amount of traffic chosen Mb or 30 Mb (10 per day). The client accountis charged only if a subscriber uses mobile data on a particular andday, mobile internet access is blocked if the daily traffic limit is reached. Due to the macroeconomic situation in Russia and the depreciation of the ruble, wein did 2014 have to increase of all our roaming tariffs, as settlements with foreign operators/counteragents are made in foreign currencies. also We balanced our roaming tariffs in line with the market average. However, we still offer the lowest prices in European roaming among our federal peers. Our 4G/LTE roamingOur 4G/LTE is countries 37 in available 37 Also in January, we launched our ‘Vsya Russia’)Rossiya’ tariff (‘All option on a national level for those who travel within Russia but outside their region of residence. Under the tariff, the first subscription is free, as are incoming all calls from any and calls outgoing Additionally, number. are numbers Russia-registered to SMS provided at an attractive price. In 2014, weIn 2014, continued to develop new roaming offers to ensure our customers and communication high-quality receive internet services – and are able to control the on are they when – expenses their move. In January, we launched our ‘Ves mir’ (‘Around the World’) tariff option on a national level for those who travel outside Russia. a fixed At daily subscription fee, this option offers 30 free incoming minutes per regardless day, of whether they are used in one go or separately, with the major benefit providing genuine of transparency in roaming costs. This option enables us to stimulate usage of other roaming services tariff options. and MegaFon is one of the top world’s five providers of roaming availability, as our roaming services are available across Russia and in more than 220 countries worldwide. Roaming Review of operations Infrastructure

4G/LTE We take great pride in the fact that we VoLTE technology to support advanced were the first of the ‘Big three’ operators to launch 4G mobile communication services voice services in Russia. Our 4G/LTE network was first deployed in Novosibirsk in 2012, and since then we have worked hard to expand its In 2014, we tested our new VoLTE (Voice over Long Term Evolution) technology reach and quality. in Moscow and St. Petersburg using equipment made by the Chinese company Huawei. The VoLTE technology enables customers to make voice calls without During 2014, we extended our 4G network leaving the 4G network, provides connection set-up speeds of less than one second, coverage to an additional 23 regions. allows ‘seamless’ connectivity across 4G, 3G and 2G and enables high-quality voice At year-end, MegaFon’s 4G services were transmission. VoLTE will be commercially launched across all regions of our 4G/LTE available to 51% of the Russian population. presence as soon as all necessary approvals are received. This includes 14 out of 15 cities with a population of more than 1 million (up from 11 in 2013) and a total of 72 federal regions. 3G In addition, we worked to eliminate local By the end of December 2014, we had Since becoming the first Russian mobile 3G network congestion and reduce cut-off also completed the construction of base operator to launch a 3G network in 2008, calls, while continuing to improve network stations in two more regions; 4G services we have maintained our position as a 3G quality in office buildings and at corporate are expected to be launched in these market leader in terms of base station clients’ premises. By the end of the year we regions during 2015. As of the end of 2014, numbers and network coverage. had achieved progress against key quality the number of 4G base stations had grown indicators across all Russian operations, In 2014, 3G remained the technology of to 18,636 units (up 84% year-on-year). reaching an average 3G call set-up success choice for data transmission among Russian rate of 99.52%, with drop-call rate down In February 2014, we commercially mobile customers. During the year, our 3G to 0.52%. launched the LTE-Advanced standard, strategy was to retain our strong position offering super high-speed internet in the regions where we have historically Number of MegaFon base stations transmission to our customers. We based performed well and to improve network Units quality and capacity in other key areas. the roll out of LTE-Advanced on our existing Growth 19.5% base station infrastructure. During the year, Overall, our aim was to develop our network we launched LTE-Advanced in three large and retain our average rate of 3G data cities: Moscow and St. Petersburg with transmission speed. 18,636 speeds up to 300 Mbit per second (Mbps), During the year we continued to improve 10,106 38,151 and in Chelyabinsk with speeds up to 150 our 3G capacity and modernise our network 33,298 Mbps. We plan to extend the geographical infrastructure. In certain regions, we reach of LTE-Advanced in 2015. introduced DC-HSPA technology which 46,341 allows subscribers to increase their data 42,929 MegaFon’s 4G/LTE roll-out in Russia transfer rate. We also optimised network Number of regions signalling and maintenance/administrative traffic, leading to increased opportunities for data transfer. Overall, in 2014 we extended 2013 2014 72 our total number of 3G base stations to 68 38,151 units (up 15% year-on-year). 58 60 2G 3G 4G

1Q 2014 2Q 2014 3Q 2014 4Q 2014

40 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information

41

Khorgos

/ / Almaty Annual Report 2014 MegaFon MegaFon Shymkent

IP/MPLS network, as well as 100G coherent transponders on the DWDM network. Due to the development of our own backbone networks in Russia and abroad in the 2014, total capacity of our rented backbone channels did not increase during the However, the year. consumption of traffic by backbone network clients increased by 60%. During the we increased year, to 67% the share of base stations in cities interconnected through fibre-optic lines. We also grew by 8% theshare of communities connected to the backbone by FOCLto 58%. The key trend in developing our backbone network was in 2014 the usage of high-speed 100G interfaces on the Aktobe Uralsk / / Samara Saratov Nizhny Novgorod Belgorod Voronezh

Tula

/ / Orel Moscow St. Petersburg

/

/ Backbone and backhaul networks Developing our backbone and backhaul networks is part of our commitment to meeting the increasing needs of customers. Increasing capacity in line with traffic forecasts and developing a greater operational presence remain our key areas of focus here. During we 2014, increased the length of our backbone fibre-optic communications line (FOCL) by more than 8,300 increase). km 7.4% (a A major highlight in our backbone development was the launch of the second stage of MegaHighway, a high-speed, to DWDM-based designed network 100G facilitate the movement of international traffic between Europe and Asia. Our work enabledin 2014 us to protect DREAM client traffic on the Russian part of the MegaHighway route, thereby reducing the cost of arranging channels in this area.

/ /

Minsk

/ / Vilnius Bratislava Vienna Berlin MegaFon Backbone MegaFon DREAM route DREAM route Transit trunk line (via TransBaltic Gateway) Transit trunk line (via Belarus) Cross-border links am-Main

Frankfurt-

DREAM route Key During the we also year, continued to participate in national projects designed to extend 2G mobile coverage to remote regions of the country. Working to targets set by the Ministry of Communications, we helped to expand mobile coverage across federal transportation routes and took part in a range of initiatives to help enhance service quality. Overall, we in extended 2014 the number of our 2G base stations to units46,341 (up 8% year-on-year). We continuedWe to develop our 2G network with the primary aim of maintaining our voice traffic levels. This development was carried out on a targeted basis to address local issues, and on a larger scale to upgrade our existing 2G network to improve the quality of voice traffic. By the end of the year we achieved a 2G call set-up success with a drop-callrate of rate 97.13%, down to 0.82%. This progress is particularly important in preparation for the re-farming of the radio frequency spectrum. 2G In our development of network of our development infrastructure,In want we to customersprovide with the quickest and most convenient means communication. of Our strategy focused is on achieving the highest penetration 4G of services, expanding networkour 4G/LTE and quality and continuing coverage, to improve our existing and improve to 3G backbone infrastructure. Review of operations

Infrastructure continued

Network quality MegaFon’s backbone infrastructure In 2014, we implemented a set of measures Leading the way in to improve communications quality. We Growth 7.4% delivered a major upgrade to our packet- the Moscow region based traffic billing system; we also carried out the planned extension of the 121,102 radio subsystem and both domains of the The Moscow region continues to be 112,783 mobile network commutation subsystem. a key area of focus for our network Meanwhile, technology improvements development. MegaFon currently were made to our radio access networks has the most extensive network in 67% 62% to optimise their parameters. We also Moscow and the Moscow region with tested and deployed the SON system, some 20,000 base stations (20% of which enables automatic adjustments to the total) including more than 4,500 logical and physical parameters of the radio 4G base stations (25% of the total). network without any manual intervention. In the region, we have built a network allowing ‘seamless’ connectivity for 2013 2014 Looking ahead, we are planning further our subscribers across 4G, 3G and 2G. Backbone Share of BS technological improvements to our radio FOCL, km interconnected network, and a major upgrade of our traffic Approximately 60% of our subscribers via FOCL, % network to increase the throughput of data use mobile internet. In 2014, the transmission channels. amount of data transmitted by MegaFon subscribers increased Global Network Operational Centre 2.4-fold. Increasing network In recent years we have been developing our new Global Network Operational Centre Each year we strive to improve capacity through (GNOC), which is enabling us to improve coverage in Moscow and the Moscow FOCL extension network quality by centralising those region, increasing service reliability operational and maintenance activities and quality. We enhanced our ability that can be managed remotely. Previously, to control network quality through our Investing in the construction of our our network operation was managed by Federal Centre of Network Monitoring, own backbone FOCL is a key part of eight regional hubs and several centres mobile measuring units and our infrastructure strategy. Through of competence, including our IP/MPLS information received from subscribers the extension of our FOCL, we aim to (Multi-Protocol Label Switching) backbone, (via call centres, our hotline, email increase our mobile network capacity our national and long-distance telephone and social networks). This resulted and improve data speeds across 4G, network, and national and international in improvement across several key 3G and fixed broadband technologies roaming. With the launch of the GNOC, we indicators: as of December 2014, for – particularly in the Far Eastern have integrated these hubs into a single example, the call set-up success rate Region and Eastern Siberia. In 2014 we network operation centre located across increased to 99.24% for 3G and the expanded the regional FOCL in the Far two sites – St. Petersburg (NOC West) and drop-call rate fell to 0.43% for 3G. East by 40%; new lines were launched Samara (NOC East). In 2014, we came close in the Trans-Baikal Region, Sakhalin to completing the integration of our regional any communications issues. In 2014, we area, Irkutsk Region, Khabarovsk branches in the GNOC. By year-end, the deployed the new Fault Management area and other eastern regions. GNOC included almost 200,000 network System in cooperation with IBM and the At the end of year, the total length objects and elements under new Network Resource Inventory System, of FOCL in the Far Eastern branch its management. provided by NEC. We also completed reached 15,400 km; and with more the centralisation of our Trouble Ticket The two NOC sites share the overall than 60% of MegaFon’s urban base System, which is based on Hewlett Packard workload and can back up each other in stations linked to the FOCL in the software. In late 2014, the GNOC, as a high- the event of catastrophic failure. The GNOC East, this expansion programme will level technology environment, processed on uses umbrella OSSs (Operation Support lay the foundations for further average more than 12 million notifications Systems) to ensure efficient 24/7 network 4G/LTE development in the more and messages and solved around 2,500 quality control and a timely reaction to remote regions of Russia. defects a day.

42 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information 43

Annual Report 2014 MegaFon MegaFon During the the year, first stage of project reduction the in resulted implementation of internal access systems from nine to one, while annual technical support costs decreased eightfold. plan We to finalise the process in 2015-2016. out rolled programmes IT-related Other in 2014 includedin 2014 the implementation of a centralised system for controlling network and IT incidents, faults and planned maintenance works as well as monitoring SLAs.

In order to improve the efficiencies of our operating reduce and processes business costs, we are in the process of deploying a centralised system for the management of employee access to IT resources from all access includes system new This branches. control mechanisms, interfaces, reporting and support services. The aim of the project is to bring together local all access control initiatives into a single federal system.

in thein number of 4G base stations Year-on-year growth Year-on-year Building Olympic infrastructure Olympic Building For the Sochi 2014 Winter Olympic Games, MegaFon created the bespoke Olympic Park telecommunications infrastructure from scratch. As a result of our work and highest the boasted kilometres) square 2 (measuring Park Olympic the investment, density of base stations anywhere in the world. In preparation for the Games, MegaFon installed over 220 km of fibre-optic cable and constructed more than 950 base stations, including over 270 4G stations, in Sochi. As a result, the Sochi Winter Olympics were officially the ‘most mobile’ Olympic Games in history. +84% For example, we implemented an system administration task automated for B2B sales, creating a unified sales process linked to HP Service Manager, MegaGIS. and System Management SFA alsoWe implemented unified a accounting report library based on our Corporate Data Warehouse, and we plan to start generating accounting reports for Head Office and source centralised one from branches help us protectTo important internal and corporate information, we are developing a unified system, Mobile Device Manager, to help manage, monitor and secure the mobile devices (corporate and personal) of certain employees who have access to confidential data. Also in we 2014, completed the Company-wide launch of our infrastructure service, (VDI) desktop virtual which allows employees all remote access to a virtual workplace via a two-stage authentication process. over In 2014, 4,000 employees used the VDI service. The development of our IT capabilities is vital to helping us address a large number of business issues and increase our operational efficiency. During we 2014, to designed initiatives of range a launched enhance our IT systems and infrastructure. in 2015. Information technology Information Review of operations Innovative products and VAS

To ensure we maintain our leadership position in this area, in 2011 we founded MegaLabs – our wholly-owned subsidiary that focuses exclusively on researching and developing innovative Value-added services (VAS) for our subscribers. Today, MegaLabs employs 206 technical experts and professionals working in project management, product marketing, application and system development, customer research and industry collaboration.

In 2014 we changed the direction of MegaLabs to concentrate development on a narrower set of products that will help us achieve our strategic goals in the market. The MegaLabs product range now has seven key offerings across business and consumer-facing segments. We also transferred traditional VAS products to MegaFon headquarters, restructured our personnel where necessary and centralised functions, such as marketing and advertising, at head office level; these moves allowed us to reduce our operating costs considerably. Video services An important development during the year In 2014, we continued to deliver solutions In 2014 we streamlined our Content and was the expansion of our MegaFon TV designed to stimulate data traffic growth Media products into a new platform, application, which enables users to watch and to enable us to further monetise Video Services, which focuses on two key feature films, shows and more than 100 data, enhance profitability and increase products – SMOTRI+ and MegaFon TV. Russian and foreign channels on demand customer loyalty. Throughout the year we During the year, the users of these two on their smartphone, tablet, computer launched numerous innovative products products, including both MegaFon and or SMART TV. In 2014, we extended this and services, and developed our capabilities non-MegaFon subscribers, generated service to non-MegaFon subscribers in M2M, cloud, mobile advertising and 4.3 petabytes of traffic. and launched complimentary products, TV services, which have strengthened including an LG SMART TV, MegaFon TV 2.0 our position as one of the leading Russian Following the success of SMOTRI+, a mobile beta and an online video recording service. telecommunications companies. Indeed, application that broadcasted live games This led to approximately 30,000 active the total number of downloads of MegaFon from the Sochi Winter Olympics, in 2014 MegaFon TV users. applications doubled and reached 4 million. we expanded this platform for additional sporting events, including the Brazilian World Cup and the World Hockey Cup. We offered the free app to all MegaFon and non-MegaFon subscribers allowing them to enjoy live matches, webcasts, replays and statistical information. In 2014, SMOTRI+ received 1.5 million installations, while during the Olympics it gained over 70,000 simultaneous viewers. The success of SMOTRI+ was confirmed by the Apple Store, which named it one of the best apps of 2014.

44 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information

45

Annual Report 2014 MegaFon MegaFon Big Data Big Data is a technology enabling users to accumulate, process and analyse extra- large data sets to derive new knowledge and improve the efficiency of operations. It represents a very promising growth area for telecommunication companies, as it investment their improve to them enables their efficiency better-developing through and activities, retail infrastructure and products for value-added new develop to customers. corporate and individual MegaFon also offers B2C geolocation geolocation B2C offers also MegaFon MegaFon and Radar including services, enables programme Radar Our Navigation. subscribers tolocate both their own and any other SIM-card, while MegaFon Navigation provides the ability to determine the location of people colleagues, (family, friends). Currently, the subscriber base for exceeds services geolocation two these one million people. Another B2C product is the SMS-Socket, which allows users to remotely control electric systems within their house through a GSM-equipped device. For example, air conditioning, heating, hot computer power, lightswater, and plant watering systems can be managed remotely, either through an automatic schedule or via SMS.

Anotherkey M2M offering is our Car Fleet Monitoring service, which enables corporate clients to monitor and track their vehicle fleets in real time. Through a combination of software and hardware, installed in vehicles and company control rooms, clients can monitor mileage, idle time and fuel consumption. Through this service our customers can save up to 30% of their costs due to reduced vehicle misuse. This solution has the added benefit that customers can connect to the service without having to replace their existing SIM-cards. In 2014 we expanded the equipment range on our Car Fleet Monitoring service and reduced subscription costs by 20%. Our Employee Monitoring service also continued to prove popular in A large 2014. number of clients using this service are taxi organisations who benefit from high-speed mobile internet on board their vehicles in order to control employees’ movements. Through our service, clients can identify employees who are the closest to a certain deviations. route highlight and destination They can also pinpoint employees’ locations through interactive maps, customise receive and schedules location their automatically-generated reports via email. theIn 2014 number of customers using this service doubled. we In launched 2014 a new service combining both employee and vehicle monitoring. Furthermore, enhancements scheduled technological for implementation will enable in 2015 us to provide unparalleled M2M capabilities for businesses.

services. For our B2B customers, in September 2014 we launched our M2M Monitoring platform, which was unveiled in six branches. This offering is for major integrators who manage a pool of SIM-cards and need to carry out the remote control and online M2M equipment. M2M of management Monitoring enables them to transmit data information gather and devices between be can It condition. and location their on adapted to any industry and provides flexible functionality and a user-friendly interface to meet the SIM-card management needs of this business segment. M2M services enable MegaFon to monetise monetise to MegaFon enable services M2M infrastructure and transmission data its expand its services to subscribers. At the end of MegaFon 2014, had more than million1.2 M2M users (SIM-cards), which, constituted estimates, our to according an approximate 20% share of the Russian M2M market in terms of subscriptions to M2M In recent years MegaFon has been closely scrutinising developments in the M2M geo-services and (machine-to-machine) individual implementing while markets, and corporate existing for solutions individual customers. This has enabled us to develop the requisite competencies to launch our out-of-the-box products in monitoring: through our B2B solutions in Car Fleet Monitoring and Employee Monitoring; our B2C solutions in Radar and services;Navigator integrated scalable solutions through our M2M Monitoring platform; and our ‘smart house’ product SMS-Socket. MegaFon’s geo-services enable subscribers subscribers enable geo-services MegaFon’s to locate family members, employees and machines, and offers secure SIM-cards and management, and monitoring telematics as well as data gathering systems. M2M and geo-services Our success in Meeting the Challenge is closely linked to our leadership our to linked closely Our Meeting success is in the Challenge services and value-added products (VAS) Our innovation. innovative, in andare enhance designed to lives experiences, providing our subscribers’ speed of and transform to access levels unrivalled everyday interactions, and information. data of and consumption activities Review of operations

Innovative products and VAS continued

Having set up a Big Data unit in 2011, In 2013, MegaFon was the first Russian MegaFon is developing Big Data as a new MegaFon continues to expand utilisation mobile operator to present geospatial high-margin and high added-value business of Big Data to improve business efficiencies. analytics for urban planning and retail for corporate and government customers. This strategy spans several years and location optimisation. This service, which The Company’s large-scale access to data involves using Big Data to: assess regional is the only service of its kind in Russia, provides unprecedented insight into the demand for new base stations; improve applies Big Data analysis to effectively population’s structure and how people network operational efficiencies through plan urban environments and can be used interact with urban infrastructures. This online identification of bottlenecks and by businesses to address their commercial is of particular benefit to businesses reduction of fault-correction time; improve needs. The data is anonymous and and urban planners, providing faster and the billing system through preventing aggregated, with no involvement from more efficient analysis while reducing accidents and promptly processing external organisations, while the service is costs. Indeed, MegaFon became the first customer requirements and claims; and legally compliant, as analysing equipment Russian mobile operator to sign a contract carry out mobile fraud counteraction. loads and extrapolating anonymous with the Government of Moscow and the Big Data, via in-depth analysis of subscriber data doesn’t require subscriber consent. Institute of Moscow City Master Plan, to needs and behaviour patterns, enables MegaFon’s large market share enables provide structural population and urban us to develop personalised products and us to ensure that data sets used in the infrastructure analysis. Reports are services, and communicate with subscribers analysis are sufficient to create highly provided monthly and enhance the efficacy at the right time and in the right place. accurate representative models. Unlike of transport and construction development. In 2014, the overall contribution from the conventional research techniques that are implementation of Big Data services to time and cost-heavy, MegaFon’s geospatial We are currently initiating partnerships MegaFon’s B2C mobile revenue exceeded analytics provide the same insight as with other cities, offering them services one percentage point. traditional research methods, at a lower to evaluate their own infrastructure use. cost and with greater efficiency. In addition, we are expanding our range of Big Data offerings by developing unique products for government, retail, transport, architecture, financial services and infrastructure development companies.

Cloud and IT solutions In 2014 we launched MegaDisk, our secure and easy cloud solution which now allows unlimited storage and data syncing on PC, Mac, Android and iOS smartphones. This service is free to all MegaFon clients and enables users to combine and access files across multiple internet-connected devices.

With the launch of MegaDisk, which was initially piloted in 2013, MegaFon became the first mobile operator to offer a service of this kind in Russia. In 2014 MegaDisk was launched in all branches which considerably increased the volume of users to 14,150.

46 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information

47 Annual Report 2014 MegaFon MegaFon Convergent services Our convergent services, primarily focused on B2B clients, are provided in 49 Russian regions and comprise services which facilitate the management of voice calls, call forwarding and other communication technologies. Made from any network and terminated to another type of traffic, such as a fixed mobile number or IP connection, our key voice services include: short dialling, hotlines, office space, quick dial codes, call numbers starting with ‘8-800’, MultiFon stations. telephone automatic mobile and services convergent MegaFon’s of Use grew significantly in year-on-year, 2014: the volume of usersincreased by while 18%, the number of corporate clients grew by 25%. Mobile advertising advertising Mobile Our mobile advertising division, created to develop innovative mobile advertising products and services, continued to perform well in Our 2014. Mobile Notification, a B2B behalf on information disseminating service of companies, enables businesses to reach their target audiences quickly and directly to inform them about products, services and special offers. This service is very popular among our corporate clients in the banking sector, who use it to inform their transactions. completed about customers ourIn 2014, total revenue from mobile reached Notification Mobile and advertising almost RUB 2.6 billion. ourIn 2014, revenue from convergent services provided to corporate clients increased by 35%, exceeding RUB 350 million. Financial services and services financial mobile MegaFon’s products enable our subscribers to conduct a wide range of personal banking and accounting tasks through their mobile phones and tablets. the In 2014, average monthly number of users of our Mobile Payment service grew by 63% year-on- reachingyear, three million people. Total revenue from our mobile financial services www. product, Money MegaFon (including www.money.megafon. oplata.megafon.ru, ru, mobile payments via USSD commands and others), which enable users to make easy and secure mobile transfers, reached almost RUB 1 billion. continuedWe to expand our Terminal Payment Network, a federal network of owned-and-operated our across terminals retail network. Within this,self-service terminals enable customers to top-up their accounts and pay for a number of services with 0% commission. As of the end of 2014, the total number of terminals installed reached 848 units. MegaFon In 2014, was the first of the official agents of the Moscow Metro to offer the opportunity to top up cards Troika (e-wallets) in the terminals. efforts our generated year Throughout the strong results, with total payment volumes exceeding RUB billion, excluding 12 payments via USSD commands (short SMS).

In addition, we developed a new interface and concept of the B2B Online Cloud, a single access interface for business-to- all business products. a comprehensivea communications service enabling customers to deploy a corporate virtual network and provide each employee with necessary all services, was launched in Moscow, Ural and Siberian branches. In 2014 weIn continued 2014 to focus on creating agile products and software, an approach which aims to maximise customer satisfaction by enabling later changes to be incorporated within the development process. During the we continued year, to develop products for MegaFon’s B2B clients: Online Conferences, our service for video conferences and seminars, was launched in the Moscow and Volga branches in with 2014, a lighter subscription model released federally; Virtual Office, Review of operations Subscriber satisfaction

Controlled sales network increased by 11% and came to 6.2 million In 2014, MegaFon and LLC Apple Rus (a Through our subsidiary, MegaFon Retail, new subscribers, while subscriptions Russian affiliate of Apple Computers Inc) we are committed to developing our own through Euroset accounted for 16% of the concluded a three-year agreement for sales network. This network of owned- total amount of subscriptions compared the distribution of various smartphone and-operated stores is a hugely valuable to 18% in 2013. models. The sales of Apple products in resource for MegaFon, helping us to controlled retail during the year exceeded retain existing subscribers and attract The sale of data-enabled devices1 155,700 units. new customers. As of the end of 2014, we (including branded devices), and especially had 2,047 MegaFon Retail points-of-sale, the sale of affordable devices, remained We also actively developed our online sales while our controlled retail sales network the key priority for our retail network. channels and our online shop, which offers included 1,985 franchised stores (or third- In MegaFon Retail, we offer more than a wide range of retail services including the party points-of-sale operating under the 600 models of smartphones and more sale of equipment and accessories. During MegaFon brand), up from 1,700 in 2013, than 100 models of tablets (including the year, we enhanced the integration of and 4,055 Euroset stores. Euroset is a different colours), including 200 models the online shop with our other websites, nationwide retail store system in which of budget smartphones (up to RUB 5,000), redesigned key sections of the online shop we acquired a 50% interest in 2012. and 45 models of budget tablets (up to and adapted it to all types of mobile devices RUB 10,000). During the year, we actively and computers. We also launched two In 2014, we focused on improving our client promoted sales of affordable data-enabled special sections, ‘Devices’ and ‘iPhone’, services and boosting the popularity of devices through special price offerings for and redesigned the ordering process, which the MegaFon Retail brand. To this end, different models (including branded ones) enabled us to decrease the number of we increased the share of our controlled with our mobile data tariff options included. pending orders by 15%. sales network (for both B2C and B2B sales) to 71%, up from 69% in 2013, which As a result of our active marketing efforts, During the year, more than 300,000 new should enable us to ensure service quality in 2014, we increased our assortment of MegaFon subscribers were secured through and increase the scope of our service smartphones by 20% and tablets twofold. the MegaFon online shop, up 38.5% from operations. Additionally, we continued The number of total devices (including 2013. In 2014, we completed almost 320,000 to improve the efficiency of our internal customised devices) sold by MegaFon orders, including sales of SIM-cards, and processes and procedures; we also updated Retail increased by 12.8% year-on-year, sold more than 130,000 smartphones and and improved our brand-book and point-of- up to 6.1 million units.2 The total sales tablets, which is two times higher than a sale signs, and elaborated and launched of data-enabled devices made through year ago. The share of 4G-enabled devices a new line of branded in-store equipment. MegaFon Retail grew by 35%, while sales of sold via the online shop in total device sales We also continued to develop our MegaGuru smartphones increased 33% to 2.74 million increased fivefold from 11% in 2013 to 44% service, which helps customers to set up units, and sales of tablets increased almost in 2014. Meanwhile the total turnover of equipment and provides technical advice on fivefold to 0.7 million units. MegaFon Retail’s our online shop amounted to more than how to use devices. MegaGuru is available market share in sales of smartphones and RUB 1.7 billion in 2014, which is three times in 80 cities, and in 2014 our MegaGuru tablets increased from 8.5% in 2013 to higher than a year ago. specialists met more than 360,000 client 9.4%3 in 2014, while share in sales of tablets requests. Overall, our main brand priority grew from 2.2% to 7.7%. Looking ahead to 2015, we plan to continue was communicating the integrated nature relocating our owned-and-operated of the MegaFon Retail chain and reminding With the development of 4G networks stores, as well as our franchised mono- customers that we provide both on-and- in Russia, the popularity of 4G-enabled brand stores, into the most strategically offline services for product sales devices increased in 2014. Through important areas. We will continue to and consultation. MegaFon Retail, we offer almost 200 improve store design, layout, showcases, models of 4G-enabled devices (including leaflets and other equipment and materials In 2014, we continued to increase the different colours). The total number of 4G to ensure the MegaFon in-store experience number of new MegaFon subscribers devices (including customised devices) sold is comfortable and pleasurable for our coming through direct sales and the through the MegaFon Retail chain more customers. We will also launch new self- MegaFon Retail network – the share of than doubled and reached 22% of all sales care products and enhance integration of new connections (both B2C and B2B) made of data-enabled devices, with the share online and offline retail channels. through MegaFon Retail went up from of 4G-enabled smartphones and tablets 35% in 2013 to 37% in 2014 to reach almost in total sales of smartphones and tablets 12.8 million new subscriptions. The number increasing from 3% in 2013 to 7% in 2014. of subscriptions through franchised stores 1 Includes smartphones, tablets, modems and routers. 2 Net of returns of products. 3 Company estimates based on data provided by GfK Rus. 48 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information 49 Annual Report 2014 MegaFon MegaFon In 2013, we incorporatedIn 2013, first call resolution (FCR) into our KPIs to improvecustomer service and motivate call centre employees to deal with client requests quicker and more efficiently. our In 2014, FCR rate was 78.3%. The introduction of this indicator enabled us to raise our customer centre call to relation in levels satisfaction employee competence and ability to resolve customer issues at the first attempt. In order to improve our remote customer care, we in launched 2014 a new 24/7 virtual service called ELENA, which uses speech recognition to help solve customer problems and answer questions. Currently processing 15,000 calls a day on average, ELENA is proving more popular with customers than tone input via keypad Indeed, response). voice (interactive IVR following the launch of this service new the while increased, automation subscriber number of return calls to IVR decreased. Our website plays a key role in delivering quality customer care and subscriber core improving and updating By services. sections of our website, we aim to increase customer interaction with our commercial site, megafon.ru. the In 2014, average number of unique visits to megafon.ru grew more than 1.5-fold to reach 6.8 million per month, compared to 4.4 million in 2013 (in December there 2014 were 6.3 million unique visitors, compared million to 5.7 visitors in December 2013).

for outgoing calls compared to 22% months12 previously. We alsoWe continued to create a call centre operations management hub. As part of the process of billing solution integration, we are developing a distributed single client service queue which will expand simultaneously with the growth of our subscriber base. Upon completion, our all call centres will be integrated within the single queue. theIn 2014, measures we implemented in previous years enabled us to reduce costs and improve call centre efficiency. The average cost per one minute of service for the year down was RUB from 7.0, RUB 7.1 in 2013. Another key development was in 2014 the expansion and centralisation of our telemarketing functions. opened We a second federal telemarketing hub in Novosibirsk, which is focused on our eastern operations, and we began the regional telemarketing closing process of branches. The growth of our telemarketing capacity enabled us to increase the number of calls processed per quarter from million1.5 in Q4 to 2.8 2013 million in Q4 In2014. addition, the conversion rate for incoming calls to sales increased to 13% compared to and 9% in 2013, to 34%

Our call centres are staffed by dedicated MegaFon employees who provide advice and information with subscribers Call centres and subscriber services Investing communication, significantly in customer care and service quality is a vital part of our approach to subscriber satisfaction. to help them make informed choices about tariff plans and other services. theAt end of the we 2014, had eight call centres spread across separate 13 sites. In 2014, ourIn 2014, independent dealer network, which includes stores of local dealers, Russian stores, retail electronic multi-brand Post outlets, and others, increased by 3,000 points-of-sale and amounted to more than 45,000 stores. However, with our focus on increasing the number of new through coming subscribers MegaFon our controlled retail network, the share of new connections (both B2C and B2B) from decreased retail uncontrolled from to in 29% 2013 expect in We 31% 2014. that the trend of reducing the share of the independent dealer network in total sales in favour of our controlled retail channels will continue also We in 2015. predict that, given in situation macroeconomic challenging the Russia, only large federal players (including the Russian Post, federal telecom retail chains – including the Svyaznoy network – and electronic retail chains) will keep their position in the mobile retail market. In addition to controlled points-of-sale, we have a number of retail channels through which we sell our products and services to customers. Inthe past, we have also relied on a large number of independent and multi-brand stores, but with the development of our controlled retail network’s dealer independent the channels share of total sales has been decreasing. Other retail sales channels Review of operations

Subscriber satisfaction continued

To enhance our customer-oriented web We also continued to develop our online We continued with our efforts to increase functionality, in April 2014 we launched a account services: adoption of pre-paid bundled tariffs by brand new version of Online Client Account • For our customers travelling across our subscribers. Bundled tariffs offers a services in our Moscow branch, with further Russia and abroad we have a MegaFellow subscriber a complex of mobile services rollout in the Central and North-West Traveller shortcut service providing in one pack at a fixed favourable price. We branches. With a modern interface and customer information on tariffs, charges launched a number of initiatives to promote upgraded platform, the new Online Client and options when abroad such tariffs, including marketing campaigns Account service employs user-friendly • We facilitated a process of return with celebrities and special price offerings. features with adaptive layout for computer, for missed payments and launched smartphone and tablet devices. Through automated functionality, which allows For our corporate clients, we continued to the online service improvement, we aim customers to transfer payment to the promote the message that our customer- to acquire new subscribers and increase right number without visiting a point- tailored solutions will speed up and simplify satisfaction for existing customers. As of of-sale their business processes, helping them to December 2014, 2.6 million subscribers • Following regulatory changes regarding be more flexible and efficient. We launched signed in to both the new and old versions the provision of content on request, we a new website designated exclusively for of the Service, which is a 21% increase launched a shortcut service providing corporate clients with comprehensive compared to December 2013. customers with information on all types information on services, tariffs and client of subscriptions support. We also focused on active In addition to the new Online Client Account • Following further 4G network promotion of services for corporate clients service, during the year we also launched development, we launched a shortcut in our controlled retail channels. a dedicated mobile account service service providing customers with application to replace numerous outdated information regarding 4G compatibility Underpinning our marketing initiatives in applications. The new application was for SIM-cards and devices 2014 was a comprehensive visual brand launched for iPhone in April 2014 and for refresh. Our objective here was to increase Android in October 2014. By year-end, the Brand and marketing brand recognition and differentiate number of downloads of the new app for In 2014, we focused our marketing activity our brand profile, thereby reducing our both platforms reached 760,000. on further promoting our mobile data dependence on competitors’ pricing services and data-enabled products strategies and helping to increase customer Social media is an important area of following the launch of the high-speed loyalty and expand our subscriber base. interest and activity for MegaFon, and in LTE-Advanced network, continuous roll-out To achieve this, we enhanced the brand’s 2014 we further extended our customer of our 4G network, and the launch and visual elements and delineated its scope to care programme in social networks. With development of LTE-roaming. create consistency across our advertising a presence on Vkontakte, Odnoklassniki, portfolio. We believe that the development Twitter, Facebook and LinkedIn, we To stimulate higher data usage and of our brand image over the long term improved the efficiency of our operations adoption of data-enabled devices, we will supplement the short-term impact of in this area, handling 50% more client implemented several initiatives. They promotional advertising and increase our requests via social networks compared to included further promotion of bundled return on marketing investment. 2013. This will enable us to increase public tariffs with higher data components, special interest in MegaFon and expand our social Overall, at the end of 2014 we had the campaigns in internet tariff options to 4 media audience further. promote a switch of ‘pure’ voice users to highest score in the ‘Power of brand’ mobile data usage: ‘Internet XS’ for half among the top four Russian telecom the price and ‘Internet S’ at a favourable operators. Our key unique brand attributes price; and the launch of sales of our Login 3 were: ‘the fastest internet’, ‘the highest 3G-enabled tablet. quality of mobile internet’ and ‘the innovative operator, operator of the future’. Our marketing initiatives for MegaFon We will continue to capitalise on these tablets, involving campaigns with high- strengths in 2015 to achieve our strategic profile celebrities, noticeably increased the objectives. Indeed, our brand perception volume of tablets in our subscriber base was supported by our high-profile and our revenues from these devices. These involvement in the 2014 Winter Olympics in positive results were further consolidated Sochi where, among other achievements, by our competitive edge and reputation as we enabled the ‘most mobile’ Olympic the fastest internet provider in Russia. Games in history.

4 According to ‘Business Analytics’ research. 50 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information

51 for the 1

Annual Report 2014 MegaFon MegaFon Certain prior year amounts have been reclassified to conform to the presentation adopted in 2014.

year was RUB 269.5 billion, compared to RUB 259.0 billion or a 4.0% in 2013, increase on a yearly basis, on the back of overall subscriber base expansion of 3.0% year-on- year and solid growth in mobile data revenue. Mobile data revenue continued tobe one of our main revenue streams, increasing 33.3% year-on-year to billion RUB and 67.2 accounting for of total 21.3% revenue, as compared This in 2013. increase to 17.0% was the result of data user base growth (2.5 million additions during the year), active marketing efforts and attractive tariff offerings stimulating use of our 4G services on the back of intensive network development and expansion of coverage, devices data-enabled of sales of stimulation through our controlled retail channels (the share of data-enabled devices on the MegaFon network exceeded 45%), data-consuming of popularity increasing products in Russia, and our acquisition of Scartel MegaFon in 2013. remained the top mobile operator among the ‘Big three’ in terms of mobile data revenue in Russia with a 39.2% market share. revenueVoice declined by year-on- 3.7% year due to the migration of subscribers to bundled tariffs, the discontinued active targeting of seasonal guest workers, and price competition. Despite regulatory changes introducing ‘advice on which charge’, came into effect in and 2014, the ongoing substitution of SMS services, revenue from remained VAS stable and essentially at the level achieved in 2013. 1 Mobile revenues revenue mobile Consolidated

+32% +5.9% +4.5% +0.20x -14.7% -28.8% -5.7 p.p. -5.7 -0.6 p.p. Change, y-o-y 51.6 82.3 2013 0.78x 297.2 132.6 103.2 17.4% 44.6% 36.7 2014 70.2 314.8 136.2 138.5 0.98x 11.7% 44.0% half of2014. Net debt was RUB 136.2 billion as Decemberof 31 compared 2014, to RUB 103.2 billion at the end of 2013. This increase was due primarily to the consideration deferred the of refinancing due in respect of our Scartel 2013 acquisition, which was paid in June 2014, and the revaluation of our net foreign the to due debt currency denominated depreciation of the ruble in 2014. Free cash flow for the year decreased by year-on-year14.7% from RUB 82.3 billion toin RUB 2013 70.2 billion, mainly as a result of the substantial increase in our ensuring at aimed expenditures capital network’s premium quality and coverage, including expansion of our 4G footprint. During the 2014, Russian market accounted for the majority of our business, comprising 98.7% of our total consolidated revenue Consolidated OIBDA increased by 4.5% year- on-year to RUB 138.5 billion, in line with our targets for the Our year. OIBDA margin reached 44.0%, compared to 44.6% in 2013. This 0.6 p.p. decrease was due to a growing share of lower margin sales of handsets and wireline services in total revenue, as well costs administrative and general higher as relating to network rollout. Net profit decreased by 28.8% year-on-year to RUB billion; 36.7 this was primarily a result of FX losses related to the significant depreciation of the ruble in the second for the year.

Net profitNet margin Net debt, RUB billion Free cash RUB flow, billion Revenue, RUB billion Our consolidated revenue grew by 5.9% year-on-year to in RUB 2014 billion, 314.8 mainly driven by strong growth in mobile data revenue, increased sales of equipment wireline higher and accessories and revenue. MegaFon In 2014, was the second largest mobile operator in terms of consolidated revenue in Russia with a market share32.1% among the ‘Big three’ operators. Consolidated key financial indicators financial key Consolidated despite turbulent macroeconomic conditions in the latter half of the of the turbulent in macroeconomic year. despite conditions latter half Our leading position in the Russian mobile market and financial resilience allowed us to achieve results that were consistent with our guidance throughout the year for both revenue and OIBDA. were We able to generate steady cash flows while ensuring affordable products and tariffs and high- quality services to our customers. For the second time in the Company’shistory as a public company we paid dividends to our shareholders fully in line with our dividend policy while maintaining a comfortable level leverage.of OIBDA, RUB billion Net profit, RUB billion This review is based on MegaFon’s MegaFon’s on based is review This IFRS results for the months 12 to December31 have We 2014. included financial results from our majority-owned operating subsidiaries in Tajikistan, Abkhazia and South Ossetia in our figures.consolidated In 2014, MegaFon once again delivered a stable financial performance a stable MegaFon once again delivered 2014, In

Financial review Delivering consistent financial performance Net debt/LTM OIBDA, times OIBDA margin Financial review

Delivering consistent financial performance continued

Fixed-line revenues2 Capital expenditures (CAPEX) CAPEX Wireline revenues3 increased 10.4% year- MegaFon’s CAPEX increased by 19.8% to RUB bn + CAPEX to Revenue, % on-year to RUB 22.2 billion. This growth RUB 56.5 billion, representing 17.9% of total 17.9% was mainly attributable to the successful revenue. However, in the fourth quarter 16.6% 15.9% expansion of our B2B and B2G client base. CAPEX decreased by 14.2% year-on-year to 56.5 In support of this growth, we also continued RUB 20.5 billion due to our spreading of capital to strengthen our broadband business, expenditures more evenly throughout the year. 45.2 47.1 expand backbone capacity, and streamline Overall, our CAPEX remains in line with the our fixed-line assets. industry in terms of our CAPEX-to-sales ratio.

Handsets and accessories During 2014, we continued to execute our Sales of handsets and accessories investment strategy and met our guidance increased 27.5% year-on-year, reaching on CAPEX despite foreign exchange RUB 23.1 billion. This growth was driven fluctuations in the second half of the year. primarily by the active promotion of Our increase in CAPEX was mainly the MegaFon-branded and customised result of our efforts to broaden our network 2012 2013 2014 products and sales of equipment through coverage, including 4G footprint, increase MegaFon Retail, including sales of heavy network capacity and improve service data-usage Apple products. quality. Indeed, we continued to invest in Our OIBDA-CAPEX indicator decreased those areas where future ‘smart’ growth by 4.0% year-on-year in 2014 to can be achieved, such as network capacity RUB 82.0 billion despite higher capital increase, 4G/LTE network rollout, network spending throughout the year. Our OIBDA- quality control and monitoring, and the CAPEX was the highest among the replacement of obsolete and energy ‘Big three’ operators in Russia. inefficient radio equipment.

Consolidated revenue growth bridge RUB bn Growth 5.9%

16.8 0.0 2.1 5.0 314.8 297.2 23.1 18.1 (6.3) 22.2 20.1 37.3 37.3 67.2 50.4

171.3 164.9

Handsets and accessories Wireless revenue Wireline +4.0% VAS Data +33.3% -3.7% 0.0% +10.4% +27.5% Voice Revenue Data Voice VAS Wireline Handsets Revenue 2013 services and 2014 accessories 2 Fixed-line revenue means wireline revenue. year-on-year growth 3 Certain prior year amounts have been reclassified to conform to the presentation adopted in 2014. 52 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information 53 9% 11% 76% 11% 14% Annual Report 2014 2013 2013 MegaFon MegaFon 21% 54% 3% 5 years and longer Also in early Moody’s Investor 2015, Service credit MegaFon’s downgraded (Moody’s) rating from This Baa3 downgrade to Ba1. also reflected Moody’s earlier downgrade sovereignof Russia’s credit rating, and subsequent lowering country of Russia’s rating ceilings, levels. to Ba1 were outlooks MegaFon’s However, upgraded to Stable by both Moody’s and confirmingS&P, our overall financial highest-rated the also is strength. MegaFon telecom company and one of the highest- rated corporates in Russia. 6 4 years EUR 7 62% 20% 3 years USD swapped 24% 12% 2014 2014 2 years USD 20% 21% 24% 15% 2% in the amount of RUB billion at an 15 5 1 year RUB attractive coupon rate of 9.45% per annum. In fact, we were one of the few corporate borrowers to successfully tap the domestic ruble bond market in 2014. Credit rating Credit MegaFon’s creditIn 2014/15, rating was impacted by sovereign Russia’s credit rating. In February following 2015, its downgrade and Standard rating, sovereign Russia’s of RatingsPoor’s Services (S&P) affirmed MegaFon’s local currency rating at BBB-. At MegaFon’s downgraded S&P time, same the foreign currency rating to BB+, following constraints imposed by the agency’s Transfer Russia. of assessment Convertibility and In May MegaFon 2014, placed 10-year bonds Breakdown of MegaFon’s debt maturity profile Breakdown of MegaFon’s debt by currency

33% HKD

4 21% USD 46% RUB Liquidity is calculated as the sum of Cash and cash investments. Short-term and equivalents The coupon will be re-set, and the holders of the bonds will have a put, on the first anniversary of the placement. On a nominal basis. Including structured and plain vanilla FX swaps on a nominal basis. 7 5  6 4 In December MegaFon 2014, drew RUB billion of the 15 RUB 30 billion available under our existing VTB facility. This pre- emptive withdrawal of funds was designed anticipated hikes rate interest mitigate to and covers most of our scheduled ruble maturities also We in 2015. signed a financing agreement with China Development Bank Corporation and an export credit facility backed by Finnvera, the Finnish export credit agency, to finance the purchase of and Huawei from services and equipment for respectively, Networks, Siemens Nokia network development, allowing us to cater requirements. term medium our for By the end of the 2014, Company had sufficient liquidity and a stable leverage position of 0.98x Net Debt/LTM OIBDA. Most of our liquidity was kept in hard currencies to mitigate foreign exchange risks, and despite continued we situation market volatile the to enjoy access to funding and support from our major financing counterparties, while monitoring developments all and taking necessary stepsto mitigate anyadverse impacts. The Company has access to sufficient to untapped facilities credit meet current liabilities and finance CAPEX. Liquidity and financial stability Liquidity split by currency Sustainability A proactive, nationwide approach

Our approach to sustainability However, by adopting a proactive, initiative- Stakeholder interaction Mobile communications unite people driven approach to sustainability, our In the development of our social, across the globe and play an integral role efforts go beyond our legal obligations. environmental and charitable initiatives, in the daily lives of millions of MegaFon We endorse and develop projects carefully we take great care to define our core subscribers. As a leading provider of this designed to tackle acute problems stakeholders and determine those issues vital public service to all the regions of within our society, whether focussing which most matter to them. Through regular Russia, we have significant responsibilities on local communities or country-wide engagement and consultation, we ensure – to the state, to more than 72 million challenges. We also encourage employee that our stakeholders feel listened to and subscribers in Russia and abroad initiatives to deliver positive change. Our that our sustainability programmes reflect and to society as a whole. It is these sustainability goals complement our their wishes, needs and expectations. responsibilities that define our approach company mission to overcome barriers to to sustainable development. voice and data transmission and to unite Customers Russia from a communications perspective. We conduct our relationships with As our company grows, so do our social In 2014, the rating agency Reputation customers in a cooperative, fair and obligations. We understand that the reaffirmed MegaFon’s AA(s)-rating for its responsible way. We provide effective success of our business is determined not corporate social responsibility policies and customer support and amicable complaints only by market share, network expansion performance. This continued high ranking resolution, and we are firmly committed and financial growth, but by the impact we reflects our adoption of and adherence to the to the principles of responsible marketing. make on our society. This means fulfilling necessary regulatory practices in this field. Additionally, we ensure our customers our commitments to all our stakeholders, benefit from continuous service, information whether customers, employees, local security and access to vital services, as well communities, shareholders, the state as health and safety protection and the or our industry and business partners. dissemination of information and knowledge.

Throughout our business, we adhere to applicable legal requirements, maintain accepted moral and ethical standards, endorse transparent conduct, support environmental initiatives and respect human rights. Our sustainability activities are also guided by international regulations and standards, including the United Nations Global Compact, the Social Charter of Russian Business, ISO 26000 (Guidelines on Social Responsibility), and the Global Reporting Initiative (GRI) recommendations.

54 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information 55 Annual Report 2014 MegaFon MegaFon Industry and business partners Industry business and competition fair transparency, support We Russia’s within anti-corruption and engage We industry. telecommunications in industry-wide processes, and through our own activities we aim to encourage sustainability in investment increased among corporate our partners. Committed to sustainability Sustainable development is an integral part of MegaFon’s business strategy. Our commitment to thisshapes activity across the business, influencing our approach to innovation and the products we develop. MegaFon’s Chief Executive Officer, Board of Directors and Management Board collectively guide the strategic leadership behind our approach to sustainability, while selected employees adopt responsibility for initiatives and programmes implementing that reflect our strategy.

Shareholders Our corporate culture and governance are based on the principles of social reflected is approach This responsibility. in our relations with shareholders, whose rights we respect and uphold equally at times. all The state In acknowledgement of the importance of our activities to the state, in areas all of our work we are fully compliant with Russian initiatives, nationwide supporting By law. we contribute to the modernisation of infrastructure telecommunications Russia’s and the development of an information in support provide we Additionally, space. safety public protect emergencies, national and play an active role in social investment. As our business continues to expand throughout regions all within Russia, we are local with relationships strong developing access providing to addition In communities. investments social our technologies, new to also improve quality of life by delivering preserving opportunities, educational and environment the protecting heritage, sustainability. endorsing Local communities communities Local Employees Employees environment working a provides MegaFon characterised by social dialogue, work safety and personal development. Our interactions with employees are founded in acceptable relations, labour fair and mutual of provision the and conditions working benefits.social As MegaFon grows, so do our responsibilities – both our to As MegaFon so do grows, responsibilities our stakeholders and the general public. These responsibilities underpin our approach investment sustainable to and form partan integral do business. how we of Sustainability Our people – the future of our business

MegaFon strives to foster a corporate As part of our effort to explore new Employee engagement survey culture that promotes employee educational opportunities, in 2014 we In order to deepen our understanding of engagement and responsibility, while increased our provision of distance learning our people’s needs, views and motivations, providing a supportive environment with courses, including new training in Finance in 2014 we conducted an employee survey rewarding opportunities for professional and English language. We also expanded across all functions and levels of the development. the scope and capabilities of MegaPortal; Company, with participation by 6,600 a single electronic system to simplify and employees. Following the survey, 1,292 In 2014, MegaFon had 30,854 employees.1 facilitate remote learning. These distance managers received individual reports learning tools are proving popular among evaluating their management style, Training and development our employees while meeting the challenges team environment and recommendations We believe our employees should have of our regionalised presence. In addition, for development. consistent access to training and we launched an online educational system development opportunities, wherever to improve and assess retail employees’ The values of all components of MegaFon’s they are based. knowledge of our products and services. organisational climate, both current and expected, were in the upper quartile, which We also believe that by developing 2014 marks the eighth anniversary is indicative of a leading company, while employees’ professional, managerial and of our internal field visits programme 67% of managers were found to create leadership skills, we will further unlock the ‘Point of destination – Our Client’, whereby an environment that positively influences potential of our people and our company. employees gain first-hand experience as employees’ results. In 2014 we launched a number of new in-store consultants for one day. To date, training initiatives as part of our systematic 20,000 employees, including CEO Ivan According to the survey, our employees and integrated approach to professional Tavrin, have taken part in the programme, have ambitious objectives, high development. providing customers with specialist expectations, an appetite for responsibility knowledge and receiving direct feedback and a desire to understand their role in To strengthen our leadership, we and insight. achieving Company goals. In addition, implemented the Development Centre – employees’ expectations correlated with a comprehensive programme designed Career opportunities their current situation in five out of six to assess management professionals’ MegaFon encourages employees to evaluation criteria. knowledge and devise tailored development enhance their potential through the plans. We also provided supplementary considerable opportunities available on Internal communications change management training for our senior our open job-posting system. To support Communicating informatively and management. this progression, we give priority to transparently is key to ensuring that our internal candidates when recruiting employees are aware of developments For our corporate business development for management-level vacancies. within the Company. In 2014, we employees, we enhanced our corporate implemented a range of changes across education and development system Motivation our internal communications channels to MegaAcademy to offer a wide range of MegaFon recognises the importance of streamline our communications process courses. Meanwhile, following changes motivated employees and we strive to and better meet business requirements. within our Infrastructure business and the incentivise employees accordingly. Pay We employed a range of platforms, from creation of Global Network Operations reviews take place annually and reflect intranet and web-magazine to events centres, we provided additional training for individual performance and market salaries. and surveys, to assess and enhance our our technical employees to increase their In 2014, the average salary at MegaFon corporate culture. expertise and efficiency. increased around 4% year-on-year. We also enhanced the precision of our frontline During the year, we transitioned a number In addition, all MegaFon employees, short-term incentives system. of our corporate publications to electronic including those from our subsidiaries, format, including Our MegaFon, and created undertook training in anti-corruption. a single information space through our weekly news digest for corporate business development. This allowed us to be more environmentally sustainable while streamlining our communications platform.

1 According to the new methodology, number of employees includes full-time and temporary employees, excluding maternity leave and outsourced employees, and represents the annual time average. Number of employees for 2013 and 2012 changed for 29,318 and 31,450, respectively. 56 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information 57

Annual Report 2014 Corporate culture Corporate MegaFon MegaFon Focus on customers and and customers on Focus efficiency New vision is supported by new continuously are which values, implemented People engagement as a key success factor • • •

We will continueWe to unify and simplify business processes within the company, with the special focus on federalsation to provide higher level of service quality only inthe declaration of our values but of IT systems and creation of federal centres competencies, of with the ability to entire Company not dependent on location. physical People engagement is the essential factor for the establishment and operation of effective management model. plan We to develop a people strategy, using all available tools: improve goal setting and motivation systems, develop employees styles, management and competencies opportunities. career facilitate will integrateWe this changed approach into MegaFon’s corporate culture – not Through well. as them to adherence our in a value-oriented approach and efficient management model, we can achieve our goal of efficient growth leadership.

Timely and transparent transparent and Timely goals Company’s of cascading to individual level targets system bonus Transparent linked to performance results for all employees project and Cross-functional KPIs and SLAs facilitating business end-to-end critical processes KPI management system management KPI • • •

Vision: leadership in efficient growth of changes across the Company. areWe working to create a company management model, which will ensure the responsibility of areas transparency of at every level of governance and in every function. In parallel we continue to business optimal transparent, on focus SLAs, cross-functional including processes, which will help faster decision-making, result and co-operation cross-functional achievement. The portfolio of critical initiatives iscreated with rigorous monitoring of implementation process by the top management inorder to transition. proper ensure Achieving leadership through efficiency In order to realise further improvements, system management a develops MegaFon creation. value on oriented Our vision is leadership in efficient growth. do this, To we aim to establish value on based system management a will and engagement people creation, therefore continue to implement a series competencies Employees and

Increase in productivity and and productivity in Increase competences of strengthening Creation of federal centres of services and competencies Company entire supporting internal on focus Stronger and rate candidates fill development people in-house • • •

and business processes business and Clear areas of responsibility by levels and functions leading to faster decision making Further optimisation and business- of unification processes Federalisation of IT systems services and Organisational structure • • • In 2014, weIn 2014, alsoinitiated a new approach to live communicationsevents. Specifically, we evolved our bi-annual leadership with discussion, panel a into presentation Minister guestsspecial Nikiforov, Nikolai Konik, Leonid and Communications for ComNews. This improved of Editor-in-Chief format facilitated greater dialogue and engagement for the 3,500-employee to pertinent topics addressing audience, enhanced we Additionally, industry. our our employee connectivity: besides video we broadcasting, online and conferencing introduced mobile device connection for the audience and SMS voting capabilities. We alsoWe upgraded the design, functionality and accessibility our corporate of portal, and streams news consolidating MegaNet, making it simpler to build webpages for business unitsand projects. This innovative approach to communication was rewarded when MegaNet receivedthe HR Brand of the prize. Year Dedicated and motivated are employees our key the bestand invest develop identify, asset. We the in industry.talent Sustainability Focusing on environmental sustainability

Being a responsible business means While increasing the energy efficiency of Resource conservation harmonising commercial, social and our base stations, equipment and offices, and waste management environmental interests. At MegaFon, we are aware that this electric energy MegaFon’s use of modern technology for we believe that scientific and technological still derives primarily from non-renewable document management enables us to progression should serve to protect sources. Accordingly, we are gradually improve efficiency while simultaneously rather than endanger the natural transitioning to alternative energy systems reducing paper. We decrease paper environment. Accordingly, throughout that minimise our environmental impact. consumption through our uniform our Company’s history we have not only library module and the use of electronic complied with environmental laws but Use of fuel and energy resources in 2014 documents and memo systems. also sought to safeguard the environment Cost, wherever possible, preserving it for future Consumption ‘000 RUB Furthermore, during conferences and generations. Year-on-year, we continue Fuel and workshops we encourage employees to reduce the impact of our operations on industrial fluids to avoid hard copy material. We also the environment. Gas (including promote day-to-day use of electronic- condensate), ‘000 m3 403 1,152 based communications instead of paper, Energy conservation and efficiency Technical and sustainable printing or photocopying MegaFon strives to conserve resources, equipment settings. specifically electricity, thermal energy, Fuel, water and paper. By optimising our climate In 2014, to further decrease our paper ‘000 litres 2,735 55,385 control equipment according to the season footprint, we continued transitioning to Oil and processed we save heat and reduce thermal loss in integrated electronic systems for the fluids, litres 3,902 920 winter. Additionally, our offices use heating, preparation, retention, archiving and ventilation and air conditioning systems Utilities services signing of documents. In addition, we with recuperative heat-exchange and Electricity, also communicated the majority of our self-cooling functions to minimise energy ‘000 kW*h 1,031,563 2,684,029 subscriber correspondence electronically. expenditure. Heat, Gcals 3,543 3,405 Health and safety When constructing base stations, we utilise When constructing our network we new energy technologies to reduce our strictly adhere to all national guidelines power consumption. By installing climate and standards relating to our mobile control with air-conditioning unit rotation, infrastructure equipment and base stations. we have substantially extended the Our mobile equipment and base stations service life of our base stations by evening are certified and comply with obligatory out equipment wear. When designing requirements allowing to minimise effect and installing our data centres, we also on health and quality of life. use suppliers that adhere to the highest environmental standards.

As part of our holistic approach to energy conservation, MegaFon encourages all employees to take responsibility for energy use in the workplace. We ensure that lighting, office and HVAC equipment Our environmental initiatives underpin are switched off after working hours. our commitment to improving the world in In addition, we install our offices with fluorescent rather than incandescent which our employees and subscribers live lamps. We also encourage employees to use individual light sources and minimise and work, and preserving our environment additional electrical equipment where for future generations. possible.

58 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information 59

Annual Report 2014 MegaFon MegaFon Supporting Paralympic athletes athletes Paralympic Supporting One of MegaFon’s most important areas of social activity is providing support for Paralympic sports. In addition to our role as a General Partner of the Games, we are also a General Partner of the Russian Paralympic Committee, as well as the 2010, and 2014 Russian2012, 2016 Paralympic teams, and a General Partner of the Russian national ice-sledge hockey team. As part of our sponsorship, we in purchased 2014 new equipment and organised training camps and tournaments for our athletes. Our support and investment in the Russian national ice-sledge hockey team bore fruit when the team was rewarded with silver medals for its debut performance. In we2014, provided an annual investment of million. willRUB continue We 7.5 providing support for Paralympic sports for the next three years. Engaging the public the Engaging During in 2014, order to facilitate nationwide contests national three held we engagement to enable children with disabilities from throughout Russia to visit the Games. One contest involved the design of postcards which MegaFon printed and participants. Games the to presented In partnership with the Russian Olympic Committee and Sport-FM, we also provided students across Russia with insight into the Olympics through class visitations by famous athletes. These visits took place Krasnoyarsk, Novokuznetsk, in schools in Omsk,Tula, Tyumen and Yaroslavl.

Specially for the WinterOlympic and Paralympic Games in Sochi, 2014 MegaFon developed a special project – MegaFaces pavilion. This is an installation, which brings to life selfies of visitors and participants of the Games via the transformation of their facesinto huge moving sculptures with the help actuators.of 11,000 Over 140,000 fans’ faces from over all the world were shown on the MegaFaces facade during the Olympic Games in Sochi. For this project MegaFon was awarded the Grand-prix of Cannes Lions. Olympic engagement Olympic employees our Engaging Our ambitious hospitality programme meant that more than 800 employees were able to visit the Olympics through contests and bonus schemes. Meanwhile, employeesall with children with disabilities were given the opportunity to visit the Paralympics, enabling 40 children and their parents to attend. During the four years of preparation for the Games, our employees were actively involved in our ‘Create Olympics’ Your initiative, in which 30,000 people participated. The success of this project was recognised nationally when we won an award from ‘People Investor’, honouring our commitment to investing in people. Sochi Olympics and Paralympics General and sponsor as role MegaFon’s Mobile Partner of the Olympic 2014 and Paralympic Winter Games in Sochi was one of our most significant social investment projects in recent years. Beginning in 2009, we invested RUB billion to 10 support the success of the Games in Sochi. As a General Mobile Partner, we implemented an ambitious programme of social initiatives, including creation of a 4G mobile network infrastructure for the Olympic and Paralympic Games in Sochi making this the first and Olympics’, ever also ‘4G developed mobile applications to enhance the public’s Olympics experience.

Award-winning social initiative With a strong presence across Russia, we respond to organisations first the of one are to national emergencies. also We support our employees and their relatives in times hardship.of We approachWe social investment with a dual focus. Firstly, we support projects that strengthen sports, culture, arts and for particularly opportunities, educational vulnerable groups. Secondly, we invest in charities that support orphaned children, help people with disabilities and assist in treating young people who are seriously ill. We believeWe MegaFon should generate value not only in the form of dividends for shareholders, but for societyas well. Indeed, charitable activities have always held an integral role in our corporate responsibility. we In 2014, allocated RUB million 150 to social initiatives throughout Russia and implemented more than 50 projects in 80 cities. At MegaFonAt we aim to harmonise our interests the with aspirations commercial of society. Our sustainability goals are and challenges societal address to oriented help create a sustainable future for Russia. A responsible corporate citizen Sustainability

A responsible corporate citizen continued

Investing in sport To reinforce the future of sports in Russia, in 2014 we supported the Boccia Federation in their search for and development of high-potential athletes to compete internationally. During the year, MegaFon assisted athlete participation in the Defi Sportif Boccia World Open in Montreal, the Boccia World Open in Povoa, the World Championship in Beijing, the Polska Boccia and the Russian Cup. As a result of our support, 120 athletes partook in Russian competitions, 33 in international Sport for children During the year, we also continued our competitions and 14 in training events. Russia’s future health and prosperity support of a national youth hockey MegaFon also helped organise the Boccia depend on our younger generation. By initiative, the Goalkeeper School project. Russian Cup. fostering talent among Russia’s youth This consisted of a series of workshops in and promoting health and sports, MegaFon Nizhny Novgorod, during which NHL goalie, In addition to the Paralympics, we also is helping secure our country’s future. Stanley Cup winner and world champion implemented a number of programmes Ilya Bryzgalov provided training and across Russia for wheelchair-using athletes The Company’s ‘The Future Depends on guidance for young hockey goalkeepers. and to rehabilitate adults and children with You’ project is an open Russian football disabilities. We support regular events and championship for children. Held among We believe that every tournament, competitions for people with disabilities and teams from children’s homes and boarding sporting event or workshop we organise their families across a wide range of sports schools since 2005, we consider this event provides young people with the tools and – from horse riding to athletics, swimming, as important as more prestigious national opportunities to make positive life choices. darts and more. sporting competitions. In 2014, 573 teams By involving young people in sport, we of children from 72 cities in Russia, South are more likely to see future generations In 2014 we also organised wheelchair Ossetia, Tajikistan, Latvia and Abkhazia leading healthy, active lives and possibly tennis tournaments, including the ITF took part in ‘The Future Depends on You’. even excelling at a competitive level. Series MegaFon Dream Cup international Since its inception, more than 21,000 paralympic tennis tournament, the ITF children in 1,300 teams have participated, Professional sport Zelenograd Open international tennis and in 2015, the programme will celebrate In addition to youth sports teams, we also tournament, and the Moscow Cup Open 4, its ten-year anniversary. support the Russian Biathlon Union, the in partnership with the Charitable Fund for Continental Hockey League and the Russian Persons with Locomotive System Disability. In 2013 the Ministry of Education and Hockey Federation. In 2014, MegaFon Science, the Ministry of Sport and the sponsored the Russian Football Union, We also jointly developed a skiing Football Union of Russia joined the as well as Russia’s national, youth and rehabilitation programme for disabled organising committee and in 2014 we women’s hockey teams, and the All-Russian children and adults in Russia, and we implemented official regulations to cover Federation of Rhythmic Gymnastics. initiated physical activity programmes to this programme. MegaFon is also an official partner of the enable disabled children to engage in active International Fencing Federation, and a lifestyles in the Republic of Bashkortostan, partner of the Russian National Volleyball Vladivostok, Yuzhno-Sakhalinsk, Federation. Chita, Ulan-Ude, Irkutsk, Yakutsk and Blagoveshchensk.

60 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information 61

Annual Report 2014 MegaFon MegaFon Creating a barrier-free Creating a barrier-free environment Since MegaFon 2010, has embarked on the ‘barrier-free environment’ project. the barriers minimise to This aims disabilities with people by encountered in their daily life and to increase problems. these of awareness Each of our 8,000 stores have salespeople trained in servicing disabled customers. In addition, we are equipping our stores with ramps, handrails, automatic doors, call buttons and elevators to improve disability access. So more far, than 48% of our stores have been adapted to meet disability needs. In the Krasnodar Territory, where the Paralympic Games were held, more than 76% of stores have been adapted, while in Sochi, 97% of stores have been modified with these improvements. Future investment Future we aimIn 2015, to increase our number of social investment projects to 60, with a charitable budget of RUB million. 150 In addition to continuing our range of ongoing projects, we will also hold the first training conference for charitable funds and non- profits, in partnership with Mail.ru and Metalloinvest. More than 140 organisations from acrossRussia will participate in the event, with the opportunity to deliver business to presentations five-minute representatives. community As a result of our sustainable investment efforts in three 2014, of our social projects were nominated for five awards. These included the PROsport Awards and event.ru’s Event of the nomination Year for our football tournament, The Future Depends on You.

Investing in our culture promoting and heritage Russian Preserving its cultureis an important part of improving the lives of our subscribers and the general public. we In 2014, provided charitable support to the State Academic Bolshoi Theatre, facilitating the production of several new performances. Since 2009 we have also helped modernise and fund restoration for the Polytechnic Museum enabling Moscow, of exhibitions, festivals, public education programmes and further development. we began a five-year In 2011, commitment to invest RUB 30 million in the Polytechnic Museum annually. which has 28 educational applications for children, as well as anti-virus protection. To enhance medical progress, MegaFon MegaFon progress, medical enhance To supported developments in the early diagnosis of myocardial infarction in the Krasnoyarsk Territory, providing its data transmission network for remote (electrocardiogram)ECG consulting. The opened has experience this of success up possibilities for utilising networks and mobile technology in future large-scale public health projects. Since 2009, we have educated children, teachers and parents in mobile literacy throughout Russia, including how to protect themselves from online dangers. safeguardTo children, we developed the restricting service, Internet Children’s access to undesirable content across 500 million websites, with up to 100,000 websites updated we In also 2014 daily. provided equipment and mobile services for lessons in 20 schools, reaching more than 1,600 pupils, to educate students in using the internet and highlighting programmes development. intellectual for In addition, through the joint project MegaFon Everybody’, for ‘Education provided free 4G modems and internet access to enable remote learning for children with disabilities. This initiative reached 950 children years aged 10-14 in the Volgograd, Kaluga, Moscow, Novosibirsk, Ryazan and Samara Regions and the Tatarstan Republic. also We launched a new touch tablet, Login 3,

for education and medical advancement, medical and education for users. vulnerable safeguarding while Educating throughEducating technology Our business operates in most of the regions throughout Russia and our social investments reflect this. foster We strong and communities local with relationships expand their access to new technologies, We opportunities. educational and services launched our own line of Login smartphones and touch tablets to increase communication channels across Russia and provide services to those who previously lacked access. We initiatives, sustainable our deepened also aimed at facilitating technology as a tool Since MegaFon 2010, has supported resources, internet social of festival the organised Opportunities’, Equal of ‘World by the charity ‘One Country’. This festival highlights websites, social networks and forums dedicated to helping people with disabilities. the In 2014, Company also provided grants 14 to develop online resources, with prizes awarded to winners and festival participants. To facilitateTo this, we have developed special tariffs for subscribers with hearing impairments and a dedicated website for those with impaired vision. This provides information about our services in an optimised form, using appropriate font sizes, colours and screen backgrounds. MegaFon consistently strives to improve improve to strives consistently MegaFon the quality of life for people with disabilities. Through our for ‘Access All’ programme, challenges the of awareness increase we disabled people face on a daily basis and these barriers. eliminate seek to Access for All We believe that businesses also improve should believe We so charitable our activities form ansociety, part responsibility. integral our social of Risk management Approach to risk management

Good risk management policies and Our ERM system comprises three levels Our risk management process is continually processes have certainly become of risk analysis and discussion: 1) regular reviewed by the Audit Committee and increasingly important since the IPO in 2012, discussions with every internal function Internal Audit. The Committee evaluates and during 2014 we continued to make based on interviews and questionnaires, the effectiveness of our risk management progress in this area. 2) cross-function workshops and systems and makes recommendations for brainstorming sessions, and 3) meetings of risk response and systems improvement. Our approach to risk management the Risk Committee (including top Company During 2014, we continued to develop managers) based at our Headquarters and Our risk management levels and flow of a well-structured, tailored and explicit in the branches. responsibilities are set out in the diagram risk management system through the opposite. adoption of new risk management At all three levels, risks are regularly structures, policies and processes. In 2013, reviewed in terms of their potential impact We strive to comply with international risk we successfully completed the rollout of on the Company’s business. This review management standards, and in 2014 we our enterprise risk management (ERM) process then helps us to shape and prepare continued to develop our risk management programme across all branches. This a Company register of key risks, including system in order to expand its scope process was accompanied by training for legal, market, political and macroeconomic and improve its overall compliance and employees and the implementation of risk risks, and a set of appropriate mitigation effectiveness. As part of our effort to be identification and mitigation procedures. measures. The register and mitigation more compliant with ISO 31000:2009, the In 2014, we continued to broaden the procedures are discussed, amended as international risk management standard, Company’s risk management system necessary, and approved by the Head we performed an assessment and identified and enhance our risk culture framework. Office Risk Committee, which holds its areas for further development, including As part of these improvements, the meetings twice a year. The approved risk risk culture. mitigation actions are then forwarded risk management reports that go to 1 management now include a risk dashboard, to branches, departments and relevant We define ‘risk culture’ as the norms of which affords managers a clear view of individuals. As of 2014, the risk mitigation behaviour for individuals and groups within changes within the corporate risk profile, process is conducted electronically which an organisation that determine collective and gives them the opportunity to review allows us to exercise stricter control over ability to identify and understand, openly mitigation activities and understand the implementation of approved measures discuss and act upon, the organisation’s emerging issues in key risk areas. We also and helps to increase the efficiency of risk current and future risks. We believe that use a range of probabilistic and stochastic identification and mitigation. managing risks is essential to achieving models to help forecast risk. corporate goals; however, the prevailing risk culture within an organisation can have a major impact on how well the organisation manages its risks.

1 Definition is in line with the guidance of the Institute of Risk Management. 62 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information 63

Annual Report 2014 MegaFon MegaFon Branch Risks by Head Office Risk Committee (Branch) Branch Risks Coordinator Approval of Branch Risks Internal Audit Department

CFO CFO (Head Office) (Head Office) (Head Office) Audit Committee Head Office Risks Audit Committee Board of Directors Risk Management Function Heads of Business Functions Heads of Business Functions Risk Committee (Head Office) Risk Committee (Head Office) Competency: this requires that the risk function is given a defined remit and leadership support in order to support risks, manage who employees those a special structure of risk champions is created, and employees all are trained to competently identify and manage risks. that requires this Decision-making: information about risks is used in the decision-making process within the to willingness Company’s the Company, take on risk is communicated, and senior management performance is linked to risk taking. • •

Coordinator/ Project Risks Project Risks SAP risks, fraud risks, etc.) Business Process Risks/ (tax risks, network maintenance risks, Business Function Coordinator Risk identification levels Risk management Reporting Levels of risk identification Tone at theTone top: this requires that senior managers act as role models in the discussion of risk and risk tolerance, actively seek information about risk events and recognise those who help to identify and unveil risks. Governance: this requires that risk accountabilities are included in employees’ job descriptions and targets, timely communication about risks is encouraged, and risks all are regarded as opportunities to improve and learn. • We areWe developing our risk culture model, which is based on four main aspects: • MegaFon’s successand strength the in market is MegaFon’s underpinned by a robust risk management system. Risk management Principal risks and uncertainties

Geopolitical risks Sanctions Description and potential impact Mitigation measures Several entities and individuals in Russia are Neither the Company, nor the telecom industry already subject to sanctions arising from the are currently directly subject to any sanctions, conflict in Ukraine, and there is a risk of heightened and we do not currently anticipate such sanctions sanctions and a widening of the circle of parties being imposed. subject to them. The fact that essentially all of our operations are in, and essentially all of our revenues are derived from, the Russian Federation should help minimise the impact on our operations and financial results of any such sanctions. Liquidity risk Description and potential impact We have implemented a number of measures Deterioration of Russian corporates’ access to allowing us to partly mitigate this risk: western capital markets and higher domestic • Aligning the credit portfolio with our business refinancing interest rates may limit our access needs, so that over 60% of our borrowings to capital and increase our cost of borrowing. are now denominated in rubles, while another 15% are covered by cross-currency hedging Additional sanctions could lead to restrictions on arrangements. Our FX portion of the portfolio access to clearing systems or specific transaction is represented by cheap and ‘long’ ECA-type freezes, which would affect our international financings. payments. • More than 55% of the amounts outstanding become due in 3 years or later providing us Mitigation measures sufficient headroom to refinance through the Despite a volatile market situation, we continue current elevated interest rates environment. to enjoy access to funding and support from our • Diversification of currency deposits – the bulk existing major financing counterparts while, at the of our funds were converted into and are now held same time, we are successfully cultivating other in rubles and Hong Kong dollars. financing sources to mitigate the adverse impact • Tightening of our cash deposit policies – limiting of any cutback in our existing sources. the number of banks with which we deposit funds to top-tier Russian and Chinese banks. • Changing our practice for intra-group settlements and loans so that they are denominated in rubles or alternate currencies. The majority of our significant intra-group financings have now been switched into rubles. Relationships with Description and potential impact Mitigation measures vendors and suppliers Additional sanctions might be imposed on In order to treat this risk, we have done a thorough equipment, software and services supplied from analysis of vendors that might be at risk, evaluated the EU and US. the possible impact, analysed possible alternatives and developed a list of substitutes and other measures to counter the impact of such sanctions.

64 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information 65 Annual Report 2014 MegaFon MegaFon

Mitigation measures Mitigation MegaFon’s downgrade, recent the Notwithstanding ratings remain one of the highest among Russian corporates and this fact, along with our ability to deliver strong financial performance, is anticipated to continue to underpin our access to funding. Furthermore, unlike many corporates, our existing facilities do nothave any interest rate step-up mechanisms tied to changes in our credit ratings. measures Mitigation According to our internal analysis, the wireless market is more resilient in an economic crisis as consumers tend to be dependent on mobile and internet services, and as a result do not consider decreasing their spending on these services. haveWe entered into long-term contracts with Networks Siemens Nokia and Ericsson Huawei, and construction continued the assure to modernisation of our network. haveWe also signed financing agreements with China Development Bank Corporation and Finnvera for the purchase of equipment and services from respectively, Networks, Siemens Nokia and Huawei for network development, allowing us to cater for requirements. medium-term our Mitigation measures Mitigation areWe closely monitoring the situation, and expect to undertake appropriate measures if this risk materialises. If additional sanctions are imposed, there is a possibility that Law No. 213-FZ, which is currently mainly aimedat strategic companies in the defence industry, may be extended to strategic companies in other sectors, such as our Company, which has already been designated as a strategic economic company.

Description and potential impact potential and Description impact potential and Description Description and potential impact potential and Description Lowering prices, oil a weaker Russian currency and rising inflation could negatively impact the Russian economy, leading to reduced consumer purchasing power and a decrease in household consumption, potentially resulting in lower revenues from telecoms services. A macroeconomic slowdown might also lead to the withdrawal of investment in certain projects, which would slow our network growth. Russia has been and may be further subject to a sovereign credit rating downgrade by certain agencies. rating credit international MegaFon’s credit ratings may be constrained by either sovereign credit ratings on Russia, or the agencies’ country ceilings for Russian corporates, as the Company’s business is concentrated predominantly Russia. in Thus, a downgrade sovereign of Russia’s credit rating has resulted and may further result in a which rating, corporate MegaFon’s of reduction could lead to increases in the cost of borrowing. On 22 Bank July 2014 Accounts Opening Law No. 213-FZ came into force. According to the law, certain strategic companies may open accounts, maintain deposits and purchase bank securities in Russian banks as determined by the Central Bank of the Russian Federation and/or by the these performing when Further, Government. companies such banks, foreign with transactions thereof. authorities the notify to required are Macroeconomic risks Macroeconomic Risk of macroeconomic slowdown Credit ratings Credit Geopolitical risks continued Bank accounts of strategic companies Here we describe we Here the risks principal face we and describe responsein the measures developed mitigation have we impact. theseto overall their risksminimise help to In itsIn business MegaFon encounters a number risks. of Risk management

Principal risks and uncertainties continued

Industry risks Competition Description and potential impact Mitigation measures Mobile business, which provides the bulk of our MegaFon is the second largest Russian mobile revenue, is one of the most developed areas operator by subscriber base and revenue. We of the Russian telecommunications sector. have licences to provide GSM, 3G and 4G services The mobile market in Russia is characterised throughout the country. Due to our unrivalled by high penetration (168.2% in 20141) and spectrum advantage and coverage, we occupy a tough competition, with all operators trying to leading position in the 4G/LTE market – a position increase existing customer loyalty and attract that has been reinforced through our acquisition of new subscribers through service excellence and Scartel/Yota in 2013. attractive offers. At the end of 2014, our 3G services were available Our key competitors are the federal operators, in all Russian regions, while our 4G services were MTS and VimpelCom. available in 72 regions. We also have a strong retail network, including 2,047 owned-and-operated In 2014, Rostelecom also completed the final stage stores and 1,985 franchised stores, allowing us to of a deal to create a new national mobile operator control our distribution and deliver high-quality – Tele2, which is a joint venture with Tele2 Russia. services to customers. As part of this deal, Rostelecom transferred all its mobile assets to Tele2. The strength of our networks and 4G/LTE leadership, together with our retail reach, means Tele2 has announced its plans regarding the we are well positioned to manage the competition further roll-out of 3G/4G networks in Russia in 2015. risks and challenges within the Russian market. The company expects to start providing 3G/4G data services in the Moscow region in mid-2015. We believe the Company’s solid presence in the telecom market, unrivalled spectrum advantage, MTS and VimpelCom have decided to jointly strong track-record in 4G and 3G network develop their 4G/LTE networks. development, and smart approach to CAPEX allocation and cost optimisation will enable us to Evolving business models in our market may lead withstand any competitive pressure from these to changes in market structure and dynamics. developments. Failure to anticipate and respond to these, and to make consequent adjustments to our model may affect our customer relationships, service offerings and market position and result in a negative impact on our operating results. Technological Description and potential impact Mitigation measures developments The Russian telecommunication industry is We intend to maintain pace with technological experiencing significant changes due to the rapid progress and new industry standards by adopting development of new technologies and standards the latest technology, and to develop more (LTE, LTE-A, etc.). As a result, many operators effective and innovative products and services. are at risk of their services becoming outdated and uncompetitive. We also intend to capitalise on the fact that we remain one of the few telecommunications providers in Russia with a 3G network in every region, and to take advantage of the 4G/LTE licence we received in July 2012 covering the whole of Russia. Additionally, our acquisition of Scartel/Yota has enabled us expand our 4G/LTE network and achieve an unrivalled spectrum advantage.

1 Source: AC&M-Consulting. 66 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information 67

Annual Report 2014 MegaFon MegaFon at favourable prices; development of new sales channels such as online platforms and call centres; launch ofLTE-roaming and MegaDisk cloud storage; switch to a 12-month revenue sharing scheme with most of our independent dealers; and analysis of reasons behind customer moves to other service providers under the MNP programme. introduction of several initiatives to improve the introduction including service, customer of quality of the 24/7 ‘virtual consultant’ service ELENA; expansion of tariff offerings and services Mitigation measures Mitigation Our aim is to increase our value and integrate any new acquisitions or assets to achieve maximum synergy. analyse We our asset portfolio to ensure the efficient integration of acquisitions and the revenue and cost related of realization intended synergies, as well as the active development of the operations. acquired • • • • In addition, we have a specialised system for fraud management, called ‘HP This FMS’. allows for attempts of prevention and detection real-time to cause damage to our assets or records, and a second system for identifying illegal termination of international traffic on our network. weIn 2014, continued our efforts to prevent fraud and offered new anti-fraud services to our customers. During the we identified year, 1.44 million cases of fraud. As a result of our anti- fraud with associated losses the actions, fraud amounted of to revenue, 0.013% which is lower than also We in 2013. recovered RUB 223.6 million of the total amount lost, and prevented potential damage million. The overall economicof RUB 1,411.6 effect of our fraud management efforts accounted for 0.48% of the Company’s revenue. Additionally, during the year we implemented several initiatives aimed at improving customer service quality and reducing churn including: • • Description and potential impact potential and Description impact potential and Description Description and potential impact potential and Description Mitigation measures Mitigation haveWe a special division for managing fraud. This MegaFon’s with accordance in operates division ‘Fraud Management Strategy’, which identifies and defends against known and newly emerging forms of fraud. It also analyses subscribers’ international roaming activity, which is now a requirement for all operators under a resolution of the International Association. GSM MegaFon may continue to expand its business business its expand to continue may MegaFon strategic and combinations business through alliances. Should there be any element of failure in integrating or managing any acquired company or strategic alliance, thereis a risk that management’s attention will be diverted away from other business acquisition potential any addition, In concerns. could negatively affect our financial position and credit ratings or dilute the value of existing shares. MegaFon may incur losses caused by intentional acts by unscrupulous counterparties and subscribers. alsoWe risk losing subscribers who become victims damage. reputational associated with fraud, of Mitigation measures Mitigation inIn 2014, order to maintain the loyalty of our existing customers, amongst other things, we continued to improve the quality of our communication services through further rollout of our 4G/LTE network. also We continued our 3G network modernisation programme and adopted a system. management fault new Like other Russian operators, we have a significant churn rate.Given the competitive mobile MNP of introduction and Russia in environment (mobile number portability) in it is 2014, vital that strengthen and customers existing retain can we their loyalty. Telecommunication risks fraud Business combinations and alliances strategic Industry risks continued Churn Risk management

Principal risks and uncertainties continued

Regulatory risks General Russia’s mobile telecommunications industry is governed by federal laws on Communications, Personal Data, Information, Information Technology and Information Protection, as well as numerous related regulations and standards.

The terms of the applicable legislation and regulations are sometimes unclear, conflicting and subject to change, while the work of regulatory bodies is not always transparent or predictable. All of this entails risks for market participants.

We monitor all changes in the legislative and regulatory framework, in order to make changes to business processes to comply with current legal and regulatory requirements. Transfer pricing Description and potential impact Mitigation measures In 2012, amended Russian transfer pricing In order to comply with these new rules, we have legislation took effect. The amended transfer carried out a range of measures to align the pricing pricing rules appear to be extremely elaborate and policy of the Company with the amended transfer provide for an increased range of methods used to pricing legislation and, therefore, to mitigate monitor the prices under controlled transactions, the risk. the list of which was also extended. Taxpayers must inform the tax authorities about all controlled In particular, since 2012 we have implemented and transactions (transactions with related parties and have been continuing to improve the Company’s some types of transactions with unrelated parties) internal procedures, including the internal system performed by them, while the tax authorities have for the identification of controlled transactions, the ability to make transfer pricing adjustments for the purposes of compliance with the transfer and impose additional tax liabilities in respect pricing legislation. of controlled transactions, provided that prices applied by the taxpayers under such transactions In addition, we have formed a consolidated group of are not at arm’s length. taxpayers within our corporate Group. Transactions within consolidated group of entities are not subject These new rules might involve the risk of additional to transfer pricing control. tax liabilities imposed by the tax authorities. Accordingly, we believe that the Company’s transfer pricing policy and practice complies with the transfer pricing legislation. Controlled foreign Description and potential impact Mitigation measures companies Following the message of the Russian President Starting from 2014, we have been monitoring the ‘on de-offshorisation of the Russian economy’, at status of the CFC rules’ enactment and have been the end of 2014 the Russian Parliament passed a implementing a wide range of measures to mitigate law ‘On controlled foreign companies’ (CFC rules), the possible risks. which came into force on 1 January 2015. The CFC rules provide for Russian taxation of the retained We have developed internal procedures to profits of foreign companies and non-corporate identify those companies in our Group which may structures (including trusts) controlled by Russian be treated as controlled foreign companies. We tax residents (companies and individuals). Russian have further developed a step-by-step plan in taxpayers (controlling parties) must inform the tax relation to such companies and the schedule for authorities of the foreign companies controlled preparation and filing of the required documents by them, while the tax authorities may impose with the tax authorities. In order to comply with additional tax liabilities on taxpayers failing to the new legislation we continue to improve internal include the retained profit of their foreign controlled procedures in accordance with official directives companies in their taxable base. and clarifications provided by the competent authorities.

68 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information 69

Annual Report 2014 MegaFon MegaFon entire frequency range. entire Mitigation measures Mitigation regardWe technological neutrality not only as a risk, but also as an opportunity because it will allow us to provide better quality services to our customers as a result of making available our measures Mitigation regarding regulation existing the Amendments of inter-operator relationships between mobile operators and fixed operators are planned for 2017. areWe in the process of developing a series of measures in order to mitigate the potential risk. the of consequences negative Mitigation measures Mitigation So MegaFon far, has not faced difficulties in obtaining or renewing any licences or permits, or in gaining access to adequate spectrum or numbering capacity. ensure To this continues, we will work ensure and regulator the with constructively that we meet of all the conditions of our licence affecting our regulations other and agreements activities. The implementation of these government initiatives initiatives government these of implementation The may result in a decrease in rates for call services and, respectively, a decrease in revenues from communication services. The SCRF plans to continue this work and to extend the principle of technological neutrality in 2015 to technology allow LTE to be deployed in other frequency ranges. Description and potential impact potential and Description Description and potential impact potential and Description Description and potential impact potential and Description In 2014, theIn 2014, Government Communications Commission of the Ministry for Communications of the Russian Federation discussed the issue of amending the existing regulation of operator traffic for requirements to regard with cooperation transfer procedures in communications networks networking. for requirements and In spite of the fact that at this stage the amendments, the in interference government involved which pricing of traffic services by applying equal rates to different types of call services for all pronounced been have operators, communications regulatory government ungrounded, economically bodies continue to develop new regulations in the field of operator relationships. Thereare a number of other regulatory initiatives being proposed at various levelsof government which, Technological neutrality can potentially increase of spite in future the in MegaFon for competition by made requirements investment significant the the State Commission for Radio Frequencies of the (SCRF). Federation Russian In December the 2013, SCRF approved the principle of technological neutrality for UMTS technologies in the 900 MHz frequency band and for LTE technology in the 1,800 MHz frequency band, and in for technology2014 LTE in the 900 MHz frequency band.The expressed objective of this is to stimulate the development of 3G and 4G technologies in the country, because this now means that the operators who have 2G licenses for 900 MHz and 1,800 MHz to frequencies these use now may frequencies deploy 3G and 4G technologies. Since MegaFon’s main activity is providing providing is activity main MegaFon’s Since suspension revocation, services, telecommunications or non-renewal of our licences could have a significant impact on our business. The Company also uses facilities which are finite in number or frequency spectrum radio the and including extent, numbering resources, and their unavailability for any reason could adversely affect our operations. if implemented, could have a negative effect on our business, operations and prospects. areWe carefully monitoring these possible developments to ensure that, if any are adopted, their final form will minimise any potential adverse impact on our business.

Changes in in Changes inter-operator relationships Technological Technological neutrality Other regulatoryOther issues and activities Regulatory risks continued revocation, of Risk or suspension of non-renewal our licences Risk management

Principal risks and uncertainties continued

Regulatory risks continued Data communications Description and potential impact Mitigation measures network On 24 November 2014 the Government of the Services that are rendered to federal government Russian Federation amended the procedure for bodies represent a significant part of the services organising the data communications networks provided by the Company in the B2G market. of federal government bodies. We are carefully monitoring the possibilities of Such bodies have now been given the right to modifying the procedure in question and developing connect to data communications networks measures in order to minimise possible market which are part of the infrastructure of share losses. government services administered by one of the communications operators. The implementation of this regulatory initiative could result in the Company’s loss of the B2G segment of the data transfer and telematics services market. Communication Description and potential impact Mitigation measures quality Legislation in the Russian Federation currently The chances that minimum parameters for does not contain provisions specifically requiring communication quality will be required in the compliance by communication services with medium term are not significant. However, even minimum quality parameters. The regulator’s if the regulator changes its current approach, the current philosophy is that the quality of Company believes that it will be able to ensure communication services will be assured as long its services comply with any such minimum as a subscriber has the right to select their parameters. communication operator, based on operators’ mandatory provision of information about service quality. MVNO Description and potential impact Mitigation measures At present, Russian law does not require an Although we consider the risk of sudden changes in operator of cellular communications systems to the regulator’s approach to the regulation of MVNO offer virtual operators access to its infrastructure. relations in the Russian Federation insignificant, In June 2014, the Government Communications the Company cannot entirely exclude this Commission issued a decision stating that it did not possibility, which could adversely affect MegaFon’s deem it necessary to set requirements for cellular and its subsidiaries’ operation. phone operators in terms of entering into contracts with virtual operators, including the regulation of commercial terms and procedures for mutual settlements.

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Annual Report 2014 MegaFon MegaFon Mitigation measures Mitigation areWe carefully monitoring these possible developments to ensure that, if any of them are implemented, we will develop measures to minimise any potentially adverse impact on our business. measures Mitigation areWe developing complex measures to relating costs additional of risk the mitigate to the reconstruction and shifting of overhead communications lines. are We also developing measures to prevent any breaches of network integrity or safety. Mitigation measures Mitigation fullyWe comply with the current legislation, in as much as the personal data of of all our subscribers is processed within the territory of the Russian Federation. In addition, we believe that we will be able to comply fully with the additional requirements. If the draft law is passed, the Company will be monitor to equipment expensive acquire to required internet users’ use of third party content (including games). In addition, an increase in the cost of communications services to transfer data and to provide telematic communications services is to expected.be Considering the factthat compensation for moving the lines is not supposed to beprovided for in the budget, this initiative could result in significant expense for operators, decreased communications services communications increased and quality, costs. Finally, in August the 2014, Government of the for requirement a introduced Federation Russian the mandatory identification of users of non- recurring services of access to the internet in public access points. It is expected that in the upcoming years further legislative changes in the field of processing internet users’ personal data will follow.

Description and potential impact potential and Description Description and potential impact potential and Description Description and potential impact potential and Description In 2013-2014, theIn 2013-2014, administrations of a number of requiring initiatives adopted cities Russian large overhead lines of communication to be buried underground. In particular, the in 2014 Government of Moscow adopteddraft a resolution ‘concerning approval of the Procedure of Locating Overhead Lines of Power Supply and Communications in the City of which Moscow’, actually prohibits the overhead location of communications lines. The likelihood of the draft resolution being formally Nevertheless, high. extremely as regarded is adopted it is expected that the requirement for re-location of communications lines will only apply to the historical city centre and near large highways. The Ministry of Culture ofRussia has proposed a draft law providing for a global licence for internet usersto access third party content (audio, visual, and written), under which internet users will be given the right to download and use such content, with the cost of such use being charged to the subscriber by the internet access provider and being paid by the provider to the owner of the content any(or organisation managing the owners’ rights on a collective basis). In its latest version the draft law creates a significant risk that the communications operators will become directly liable for payments due to the content owners. In 2014, significantIn 2014, changes in the field of processing internet users’ personal data were made. In particular, a law was passed according to which the recording, filing, accumulation, storage, of data personal extraction of and clarification, Russian citizens must be carried out using database servers located within the territory of Russia starting from 1 September 2015. A procedure to limit access to information on the internet processed in violation of the legislation in the field of personal data was also introduced. Shifting overhead communication lines underground to Global licence Regulatory risks continued Personal data on the internet Risk management

Principal risks and uncertainties continued

International compliance General MegaFon’s ordinary shares are traded on the London Stock Exchange (LSE) in the form of global depository receipts (GDR). Therefore the Company is subject to a variety of regulatory regimes in the UK, particularly the regulations of the UK Financial Conduct Authority and the London Stock Exchange, which generally govern a company’s ongoing disclosure obligations and its relations with investors. MegaFon’s ordinary shares are also traded on the Moscow Stock Exchange, to whose regulations the Company is also subject. Insider information Description and potential impact Mitigation measures protection risk As a public company, MegaFon is obliged to We cannot fully protect ourselves against the ensure the security of insider information. Insider risk of improper disclosure of insider information information is information which is directly or since modern information systems cannot provide indirectly linked to the Company’s operations and/ a 100% security guarantee against deliberate or its securities, and which has not been publicly wrongful acts. disclosed and which may have an impact on the share price. However, as a mitigation measure we have developed an insider information protection system. Under Russian and UK law, the Company and its This includes the adoption of special internal employees have responsibilities to ensure proper procedures, and the introduction of technical usage and protection of insider information. Failure safeguards, training programmes and tests for to discharge these responsibilities could result in employees. financial and reputational damage. The Company’s Audit Committee oversees the execution of these measures, which are designed to ensure that all shareholders and investors are treated equally in their access to data and information. Disclosure and other Description and potential impact Mitigation measures securities-related As a publicly-traded company, we are exposed To limit the extent of losses or costs incurred by our risks to the risk of claims against our Directors and Directors, our officers or the Company as a result top managers from regulatory authorities, of legal claims, we have purchased a Directors’ shareholders and investors for improper and/or and Officers’ (D&O) Liability Policy covering these untimely disclosure of information affecting the risks. This covers claims, mistakes and omissions Company’s business, operations or prospects that could potentially occur in the course of regular as well as disclosure of incomplete, confusing management activity. or contradictory information. We also have a separate Public Offering of Securities Insurance (POSI) Policy, which provides cover against claims arising specifically in relation to the 2012 IPO.

72 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information 73

Annual Report 2014 MegaFon MegaFon and available cash; in June we paid 2014 off 90% of the total consideration in respect of the Scartel bonds ruble newly-issued using acquisition wein settled July 2014 our remaining US dollar transaction Euroset the of respect in obligations using the Company’s treasury shares. – – We continuedWe to implement the Company’s hedging programme approved by the Board of Directors we In 2014, hedgedin 2013. US$650 million of our foreign debt with long-term cross-currency structured and derivatives. swaps refinancedWe the Company’s largest FX liabilities which totalled approximately billion,US$1.66 as follows: – – As a result, as of the end of the 2014, share of our over for accounted financings ruble-denominated 60% of our debt portfolio, while another of 15% our debt portfolio was covered by cross-currency arrangements.hedging furtherWe expanded the amount of our bank deposits held in foreign currencies other than the US dollar and euro, in order to offset the P&L effect of FX differences and cater for our CAPEX OPEX and needs. FX-denominated Mitigation measures Mitigation weIn continued 2014 our strategy of limiting our exposure to floating rate funding instruments. As a result, of our only 14% debt portfolio has a floating rate of interest, while the Company has no ruble- to tied rates interest with facilities denominated the key rate of the Central Bank of Russia. The major part of the Company’s funding portfolio is long-term and has been sourced at compelling rates.interest More than 55% of the amounts outstanding become due in three years or later providing us the through refinance to headroom sufficient environment. rate interest elevated current In 2014, weIn 2014, continued to pro-actively manage our currency exchange risk, taking several steps allowing us to significantly reduce our open currency position: • • • Description and potential impact potential and Description Description and potential impact potential and Description Mitigation measures Mitigation assessedWe every counterparty (vendor, service provider, etc) to re-set payment terms in rubles, or fix a specific exchange rate for the purpose of payments under the contracts. For contracts which remain denominated in foreign currencies (in respect to both CAPEX and OPEX), we have implemented additional controls in order to ensure that the transactions are cost-effective and that real value is being provided. Interest-rate risk is the risk of incurring financial losses from adverse fluctuations in interest rates including liabilities, and obligations on payable items off the balance sheet. Any increase in rates could increase the cost of raising new financing for the Company’s operations financing existing where and, investments and carries a floating rate, the cost of servicing such financing. In late we 2014, saw a surge in ruble funding costs across the market as the Central Bank of Russia increased its key rate from 5.5% p.a. early in the year p.a. at theto end 17.0% of the year. Part of our capital expenditures, borrowings, andliabilities costs (roaming, interconnection, frequency fees, etc) are denominated in foreign currencies, particularly the US dollar and the euro. The recent ruble depreciation (the ruble depreciated from 32.66 per US dollar as at 1 January to 2014 56.26 per US dollar as December at 31 and 2014, has continued to decline since then) could increase these expenses in ruble terms, creating exchange rate losses and thereby reducing our net income. Furthermore, since the Company’s borrowings consist of loans denominated in both rubles and foreign currencies, should the ruble fall further against the US dollar and/or the euro, we could experience difficulties repaying or refinancing any borrowings. non-ruble Interest rate risks Financial risks Foreign currency/ risks rate exchange Governance Our approach to governance

The Board of Directors and the CEO take Our approach to corporate governance To help us put these principles into practice, ultimate responsibility for corporate is guided by our Corporate Governance we have developed a clear governance governance at the Company. Corporate Principles. These Principles are designed to structure. Its key elements are: governance also guarantees a balancing help us ensure that all of our shareholders • The General Meeting of Shareholders of the interests of shareholders and our are treated equally and can exercise their • The Board of Directors, and its management. As part of our commitment to rights, and that we operate in compliance committees: continuous improvement, we are constantly with national and international legislation ––Audit Committee looking at ways to improve and enhance and norms. Our Corporate Governance ––Remuneration and HR Development our corporate governance policies and Principles are: Committee procedures. • protection of the legitimate rights and ––Finance and Strategy Committee interests of all shareholders; • Corporate Secretary Building and maintaining trust • equal treatment of all shareholders; • The Management Board As part of our commitment to excellence • transparency in corporate activities • CEO and industry leadership, we maintain high for shareholders, investors and other • The Revision Commission standards of corporate governance. Observing interested parties; • The Internal Audit Department these standards is essential to our reputation • respect for all our stakeholders, including as a business. We believe that transparency employees and subscribers; Our corporate governance structure in our management and decision-making • independence of the Board of Directors ensures support of the aforementioned processes, as well as full and timely in decision-making; and principles. disclosure of Company activities, enable us • following best practice as well as legal to grow in an effective and sustainable way. norms in conducting business.

MegaFon’s corporate governance structure

General Meeting of Shareholders

Revision Commission

Board of Directors

Remuneration and Finance and Audit HR Development Strategy Committee Committee Committee

Chief Executive Officer

Internal Audit Department

Management Board

Key Reports to Appoints Appoints based on the recommendations Elects Recommendations of the Audit Committee

74 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information 75 1 Annual Report 2014 MICL 100% 100% 100% 100% Scartel VAS Media PSKOV CNT PSKOV MegaFon MegaFon 3 51% 100% 100% 100% RC ISS Metrocom Auxiliary MegaFon Finance MegaFon Smarts Volgograd 51% 75% 100% 100% Web Plus Web TT Mobile MegaLabs RNIC – JAO Innovative & VAS 51% 75% 50% 100% Euroset Telecom Nakhodka stelecom O RNIC – Kurgan

51% 50% – Vladimir – 100% 100% 2 Aquafon NETBYNET Innovative & VAS Retail Wireline and BB Wireless MegaFon Retail MegaFon RNIC MegaFon Investments (Cyprus) Limited, holds 3.92% stake in MegaFon. in stake 3.92% holds Limited, (Cyprus) Investments MegaFon Centre. Information & Navigation Regional Regional Centre for Information and Satellite Services. 2 3 1 Subsidiaries and dependent companies companies dependent and Subsidiaries December 2014 as 31 of The integrity, success and our sustainability of The integrity, Company are founded upon good corporate governance. Corporate governancebuild we how is and trust maintain among employees, our investors, local communities and other key stakeholders. Governance Board of Directors

Sergey V. Soldatenkov Sergey Soldatenkov was born in 1963. He Percentage of the Company’s ordinary Chairman of the Board of holds a degree in Radio Engineering from the shares held: nil. Directors Leningrad Institute of Aviation Instrument Engineering. He was previously the Company’s On 21.05.2013 Sergey Soldatenkov acquired Member of the Remuneration and Chief Executive Officer (CEO), a position he 79,506 Company GDRs. HR Development Committee held from April 2003 to April 2012. Member of the Audit Committee Key attributes: vast experience working MegaFon Board member since May 2012. in Russian telecoms sector.

Percentage share ownership in the Company: 0.0128%.

Vladimir Y. Streshinsky Vladimir Streshinsky was born in 1969. Percentage of the Company’s ordinary Member of the Board of Directors He graduated from the Moscow Institute shares held: nil. of Physics and Technology in 1992. He is Chairman of the Finance and currently CEO of USM Advisors LLC. On 17.04.2014 Vladimir Streshinsky acquired Strategy Committee 75,767 Company GDRs. Member of the Remuneration and MegaFon Board member since June 2008. HR Development Committee Key attributes: in-depth knowledge and Percentage share ownership in the understanding of business strategy and Company: 0.012%. finance.

Lord Paul Myners Lord Myners was born in 1948. He graduated Percentage of the Company’s ordinary Independent Member of the from the University of London with an honours shares held: nil. Board of Directors degree in Education. He is currently Chairman of the London School of Economics and On 05.03.2014 Lord Paul Myners acquired Chairman of the Remuneration Political Science and a non-executive Director 3,000 Company GDRs. and HR Development Committee at RIT Capital Partners. Key attributes: broad sector experience, MegaFon Board member since March 2013. extensive knowledge of finance, politics and governance. Percentage share ownership in the Company: 0.000484%.

Carl Peter Christian Luiga Christian Luiga was born in 1968. He holds a Percentage of the Company’s ordinary Member of the Board of Directors Bachelor of Economics from the University of shares held: nil. Stockholm. He has been Senior Vice President Member of the Finance and and Chief Financial Officer at TeliaSonera AB Key attributes: extensive knowledge Strategy Committee since April 2014. Mr Luiga is also Chairman of finance and corporate control. of the Board of Fintur Holding B.V.

MegaFon Board member since March 2014.

Percentage share ownership in the Company: nil.

76 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information 77

Annual Report 2014 MegaFon MegaFon in-depth knowledge knowledge in-depth nil. nil. nil. nil. nil. of technology and telecoms sectors and skills. management excellent of international telecoms sector. MegaFon Board member since March 2014. Percentage share ownership in the Company: ordinary Company’s the of Percentage held: shares attributes:Key ordinary Company’s the of Percentage held: shares Key attributes: knowledge in-depth Percentage share ownership in the Company: ordinary Company’s the of Percentage held: shares Key attributes: in background strong experience extensive administration, business in international telecoms sector.

nil. Jan Rudberg was born in 1945. He is a graduate of the Gothenburg School of Business Administration. Since 2003 he has been a Corporate Advisor to, and is now Chairman Hogia of, AB. Mr Rudberg is also Chairman of the Board of KCELL JSC and a member of the Board of Iletsisim Turkcell A.S.Hizmetleri MegaFon Board member since June 2010. Kenneth Karlberg was born in 1954. He is a graduate of the Senior Officer Programme at the Swedish Military Academy. He is currently the owner and Managing Director of KarNet AB. since member Board MegaFon 2013. September Percentage share ownership in the Company: Sergey Kulikov was born in In 1976. 1999, he graduated from the Military University of the Ministry of Defence of the Russian Federation. In 2009, he graduated from the Russian Academy of Public Service under the President of the Russian Federation and holdsa degree in State and Municipal Management. In 2011, a received and thesis his presented Kulikov Mr Candidate of Economic Sciences degree at the Military Academy of the General Staff of the RF Armed Forces. He is an Executive Director of Rostech State Corporation. Mr Kulikov is also a member of the Russian Foundation for Technological Development. Jan Erik Rudberg Independent Member of the Board of Directors Chairman of the Audit Committee Kenneth Karlberg Member of the Board of Directors Member of the Audit Committee Sergey A. Kulikov Member of the Board of Directors Member of the Finance and Strategy Committee Governance Management Board1

Ivan Tavrin Gevork Vermishyan Anna Serebryanikova CEO and Management Board Chairman Chief Financial Officer Chief Legal and Government Relations Officer Ivan Tavrin was born in 1976. He graduated Gevork Vermishyan was born in 1978. He from the Moscow State Institute for graduated from the Financial University Anna Serebryanikova was born in 1974. International Relations in 1998 with a under the Government of the Russian She graduated with honours from the diploma in Law. He has been a member of Federation in the faculty of International Law faculty of Moscow State University the Management Board since 7 March 2012. Economic Relations. He was appointed Chief and holds a Masters of Law degree from He was First Deputy CEO of MegaFon until Financial Officer of MegaFon in July 2011. Manchester University. 20 April 2012, when he became the CEO He has been a member of the Management and Chairman of the Management Board. Board since November 2011. In 2008, Ms Serebryanikova was elected by the Board of Directors as the Company’s Percentage share ownership in the Percentage share ownership in the Corporate Secretary and appointed Chief Company: 0.0447%. Company: 0.000968%. Legal Officer of the Company, serving in this role until 2012 when her responsibilities Percentage of the Company’s ordinary Percentage of the Company’s ordinary were expanded and her title was changed shares held: nil. shares held: 0.000968%. to Chief Legal and Government Relations Officer. In June and July 2013 Mr Tavrin acquired On 6 March 2014 and 17 March 2014 a total of 277,000 GDRs. Mr Vermishyan acquired a total of 6,000 Percentage share ownership in the ordinary shares. Company: nil. Alexander Bashmakov Chief Strategy and Procurement Officer Mikhail Dubin Percentage of the Company’s ordinary Executive Director for Consumer Business nil. Alexander Bashmakov was born in 1984. shares held: He graduated from the Economics Faculty Mikhail Dubin was born in 1978. He holds a Evgeny Chermashentsev of the Ural State Technical University with degree in International Economics from the Director of Infrastructure a major in Marketing. He joined MegaFon Financial University under the Government in March 2012, and since October of that of the Russian Federation and a degree Evgeny Chermashentsev was born in 1977. year has acted as Director of Strategy. In and a doctorate in Economics. He joined He graduated from Saratov State University early 2013, he was also appointed Chief MegaFon in July 2010 as the First Deputy named after Chernyshevsky N.G. He has Procurement Officer. He has been Member General Director for Strategic Development been a member of the Management Board of the Management Board since June 2013. and has been a member of the Management since October 2012. He has been Director Board since November of that year. In for Corporate Business Development since Percentage share ownership in the October 2012 he was appointed Executive May 2012, and Director of Infrastructure Company: nil. Director for Consumer Business. since November 2013.

Percentage of the Company’s ordinary Percentage share ownership in the Percentage share ownership in the shares held: nil. Company: nil. Company: nil.

Anait Gasparian Percentage of the Company’s ordinary Percentage of the Company’s ordinary Director for Corporate Development shares held: nil. shares held: nil. Anait Gasparian was born in 1981. She holds a degree in Economics from the St. Petersburg State University. She was appointed Director for Corporate Development at MegaFon in April 2012, and has been a member of the Management Board since October of that year.

Percentage share ownership in the Company: nil.

Percentage of the Company’s ordinary shares held: nil. 1 As at 31 December 2014. 78 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information 79

Annual Report 2014 MegaFon MegaFon nil. nil. nil. Vlad Wolfson Vlad Head Corporate of Business Development Vlad Wolfson was He born in 1977. graduated from the Kyiv National University andof Trade Economics in Ukraine, and the University of Haifa in Israel. He joined MegaFon as in Director2012 of Corporate Sales, and in December was 2013 appointed Head Corporate of Business Development. He has been Member of the Management Board since June 2014. Percentage share ownership in the Company: ordinary Company’s the of Percentage shares held: nil. Dmitry Kononov Director of Investor Relations and Stanislav Frolov Director of Caucasus Operations Stanislav Frolov was born in 1975. He graduated from Voronezh State University and from the All-Russian Extramural Institute of Finance and Economics. He joined the MegaFon Head Office in He 2012. was appointed Director of Caucasus Operations in September and 2012, has been a member of 2012. October since Board Management the Percentage share ownership in the Company: ordinary Company’s the of Percentage shares held:nil. Mergers Acquisitions & Dmitry Kononov was born in 1964. He Colorado of University the from graduated Denver in 1989. In 2008 Mr Kononov was appointed Director for Mergers & Acquisitions, and he in also 2012 became Director of Investor Relations. He hasbeen a Member of the Management Board since June 2014. Percentage share ownership in the Company: ordinary Company’s the of Percentage shares held: nil. 2

nil. nil. nil. nil. nil. and the Moscow region. Moscow the and Stolichny Operations spans Moscow

2 Percentage of the Company’s ordinary Company’s the of Percentage shares held: nil. Alexei Tyutin Alexei Director of Siberia Operations Alexei Tyutin was born in 1963. He holds Construction Civil and Industrial in degrees from the Mikoyan Kuibyshev Institute of Engineering and Construction, and in Economic and Social Planning from the Samara Institute of Economics. He is Operations Siberia of Director MegaFon’s and has been a member of the Management Board since June 2009. Percentage share ownership in the Company: Percentage of the Company’s ordinary Company’s the of Percentage held: shares Alexey Semenov Director of North-West Operations Alexey Semenov was born in 1982. He graduated from the State Economic Academy of Samara. He has been Director of North-West Operations since August and 2012 a member of the 2012. October since Board Management Percentage share ownership in the Company: ordinary Company’s the of Percentage held: shares Konstantin Likhodedov Konstantin Director of Stolichny Operations Konstantin Likhodedov was born in 1976. He graduated from the St. Petersburg State University of Finance and Economics. He joined MegaFon in June He 2012. has been a member of the Management Board since October and 2012 is Director of Stolichny Operations. Percentage share ownership in the Company: nil. nil. nil. nil. nil. nil. Percentage share ownership in the Company: ordinary Company’s the of Percentage held: shares Director of East Far Operations Andrey Levykin was born in 1973. He graduated from Samara State Technical University and has a degree in Mechanical Director appointed was He Engineering. of East MegaFon’s Far Branch in September He has 2013. been a member of 2013. October since Board Management the Andrey Levykin Percentage of the Company’s ordinary Company’s the of Percentage held: shares Percentage share ownership in the Company: Pavel KorchaginPavel Operations Volga of Director Pavel Korchagin was born in 1960. He graduated from the Bauman Moscow State Technical University with a degree in Automated Systems. He was appointed Director of Central Operations in September and has 2011 been a member of the Management Board since November of that In January year. he was 2015 appointed Director of Volga Operations by the Board of Directors resolution (Minutes No. 220 (284) dated 24 December 2014). Percentage of the Company’s ordinary Company’s the of Percentage held: shares Percentage share ownership in the Company: Director of Urals Operations Valery Velichko was born in 1970. He is a graduate of the Dzerzhinsky Higher Institute of Border Defence, the Ministry of Internal Affairs’ Special Police School in Bryansk and Ural Academy for State Service. He has been a member of the Management Board since He hasJune been 2011. Director of Urals Operations since April 2011. Valery Velichko Governance Leadership

In keeping with the Joint Stock Companies In between AGMs, we sometimes hold Composition of the Board of Directors Law and the MegaFon Charter, our principal extraordinary general meetings (EGMs). In 2014, the Company’s Board of Directors governance bodies are the General Meeting The decision to do so is made by the Board consisted of seven members, including two of Shareholders, the Board of Directors, of Directors – either on its own initiative or independent Directors. the Management Board and the General at the request of the Revision Commission, Director (CEO). the Auditor, or shareholders holding at least Up until 17 March 2014 the Board of 10% of voting shares. In 2014, the Company Directors consisted of the following: General Meeting of Shareholders held four extraordinary shareholder • Sergey V. Soldatenkov (Chairman) The General Meeting of Shareholders is meetings: three of which were held via • Curt Per-Arne Blomquist our main governing mechanism. Under the absentee ballot, and one of which was • Berndt Kenneth Karlberg Company’s Charter and applicable Russian held face-to-face. • Lord Paul Myners legislation, shareholders are required to • Jan Erik Rudberg approve a number of measures, such as the For more details on EGMs held and • Vladimir Y. Streshinsky distribution of profits and approval of major decisions taken at EGMs in 2014 please • Jan David Erixon transactions. All relevant procedures for the go to: http://ir.megafon.com/general_ Meeting are set out in the Regulations on shareholders_meetings/extraordinary_ Since 17 March 2014 the Board of Directors the General Meeting of Shareholders, which general_shareholders has consisted of the following: are available on the Company’s website • Sergey V. Soldatenkov (Chairman) at http://ir.megafon.com/corporate_ Board of Directors • Berndt Kenneth Karlberg governance/charter_amendments/by- The role of the Board • Sergey A. Kulikov laws_and_other_internal_documents/ The Board of Directors exercises overall • Carl Peter Christian Luiga supervision of the Company’s activities • Lord Paul Myners We hold an Annual General Meeting (AGM) through setting business development • Jan Erik Rudberg once a year. This must take place no earlier priorities and defining the Company’s • Vladimir Y. Streshinsky than two months and no later than six strategy. The Board’s main purpose is to months after the end of the fiscal year. The enhance the efficiency and transparency Board of Directors meetings 2014 AGM was held on 30 June 2014. The of the Company’s internal control During 2014, the Board of Directors held key actions taken at the 2014 AGM were: mechanisms, improve its monitoring system 17 meetings (six face-to-face and 11 by • approval of the Company’s 2013 Annual and the accountability of its management absentee ballot), as well as two strategy Report; bodies, while protecting and promoting sessions. During these meetings the Board • approval of the annual financial the rights of all shareholders. took a number of decisions related to the statements, including the profit and overall management of the Company, loss statement of the Company; The full powers of the Board are set out including but not limited to: • decisions regarding distribution of profits in detail in the Company Charter and the • identification of the Company’s key and losses, including a dividend payment Regulations on the Board of Directors, development priorities and focus areas, (declaration) based on the 2013 financial which are available on the Company’s as well as the Company’s strategy; year results, determination of the amount website: http://ir.megafon.com/corporate_ • improvement of the Corporate of dividend to be paid upon shares, and governance/charter_amendments/bylaws_ Governance system; the payment method and procedure; and_other_internal_documents/ • review of the Company’s budget and • election of the Company’s Board business plan; of Directors; • review of operations and plans of the • approval of the size of, and election Company’s branches and subsidiaries; of the Company Management Board; • review of changes to Russian Federation • appointment of the Company’s Auditor; Law; • election of the Revision Commission of • review of the 2014 Winter Olympics the Company; in Sochi; • determination of the amount of fees to • review of MegaLabs CJSC performance in be paid and the amount of expenses to 2013 and plans for 2014; be reimbursed at year-end 2013 to those • review of the Scartel integration; Board members who did not receive • analysis of CAPEX spending and compensation during the year. recommendations to the Company’s management; • approval of the Company’s transactions.

80 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information 81

Annual Report 2014 MegaFon MegaFon determine the Company’s strategic of review including direction, fulfilment reports on management objectives; strategic of agree the Company’s annual budgets and business plans and oversee their implementation; management cash Company’s the oversee policies and liquidity position; review, and approve the terms of transactions; M&A proposed review the terms of borrowings and make for approval their on recommendations the Board of Directors; review the terms of large transactions and transactions with a cumulative value exceeding US$50,000,000 and make for approval their on recommendations the Board of Directors. Vladimir Streshinsky Y. (Chairman) Sergey A. Kulikov Carl Peter Christian Luiga approval of the budget 2014 and business plan; review and approval of the approach to acquisition of new assets by the subsidiaries; Company’s review of the Company’s related-party approval the including transactions, of loans between the Company and its subsidiaries; cumulative a with transactions of review value exceedingUS$50,000,000, facilityincluding: agreements between on agreements Banks, and Company the the supply of telecom equipment, target profit forwards and revolver options. Finance and Strategy Committee The Finance and Strategy Committee exercises control over the strategic development, business planning, budgeting Company. the of processes investment and principal responsibilitiesThe Committee’s are to: • • • • • • theIn 2014, following Board Members were elected to the Finance and Strategy Committee: • • • tenIn 2014, meetings of the Finance and Strategy Committee were held. The key actions taken were: in 2014 • • • •

analysis of tax exposures and results of tax audits; the of operation and identification risk system; management risk Company’s development of the internal control and systems; management risk implementation of the anti-bribery policy within the Company; monitoring of the Company’s compliance with the laws of the Russian Federation and the UK regarding disclosures and reporting; implementation of the Company’s Code Ethics; and Conduct Business of approval of the annual internal audit plan; consideration of the internal audit reports; implementation of a personal data protection system in the Company; interested- of consideration making and party transactions for approval their on recommendations the Board of Directors. review of operation of internal controls; Jan Erik Rudberg (Chairman) Berndt Kenneth Karlberg Sergey Soldatenkov V. A detailed list of interested-party of list detailed A transactions approved by the Board of Directors is in available 2014 at: https:// ir.megafon.com/ai/document/6154/file/ MegaFon_AR_2014_Statutory_Disclosure_ materials.pdf • • • • • • • • • • In 2014, tenIn 2014, meetings of the Audit Committee were held. The key actions taken were: in 2014 • As December of 31 the 2014, following Board Members were members of the Audit Committee: • • • make recommendations regarding regarding recommendations make external auditors and fees; resolve issues arising during audits; and review the work and performance of internal Auditors; analyse the effectiveness of internal reports and review controls; Revision the from recommendations Committee and internal Auditors; and procedures effectiveness the of review of internalcontrol overthe Company’s activities; operational and financial management risk evaluate continuously for recommendations make and systems; improvement; systems and response risk oversee the development and implementation of the Company’s insider and systems; protection information oversee the execution of the action plan to improve personal data protection. Audit Committee Finance and Strategy Committee Development HR and Remuneration Committee The Committee’s principal responsibilitiesThe Committee’s are to: • • • • Audit Committee The Board’s Audit Committee is responsible for issues all relating to internal and external Company audits. MegaFon’s three principal Board Board principal three MegaFon’s Committees provide oversight and strategic planning in three areas of concern to the Board of Directors. They are: • • • Committee members are selected upon election of a new Board of Directors. Board Committees Governance

Leadership continued

Remuneration and HR Development Board members’ independence and Board remuneration Committee balance Our Board members are remunerated for The key functions of the Remuneration In compliance with criteria established the performance of their duties. The amount and HR Development Committee are to: by Russian law, we endeavour to identify of remuneration is approved by the General • assess the performance of the Company’s those members of our Board who may Meeting of Shareholders and depends on Board of Directors; be considered independent. After election the actual hours worked in • review and make recommendations on all members of the Board of Directors the previous year. performance targets of the Company, and go through a process to determine make recommendations to the Board on their compliance with the criteria of In 2014, the AGM approved the amount bonuses and incentive plans independence stipulated in the Code of of remuneration of the Board and payment for top management; Corporate Governance. In the final stage practice. • review remuneration strategies and of this process the Board evaluates make recommendations to the Board of whether the candidates can be considered The total amount paid to Board members Directors on employee bonus schemes; independent and makes a final decision in 2014 was RUB 48 million. • review HR processes for motivating on their independence. employees and achieving challenging targets, superior results and maximum Following these procedures, in 2014 profit; the Board of Directors confirmed Jan • review specific HR initiatives and projects; Erik Rudberg and Lord Paul Myners as • review regular and ad hoc surveys of independent Directors. employee performance and attitudes. The other members also reflect the In 2014, the following Board Members were diversity and balance of the Board – elected to the Remuneration and Kenneth Karlberg and Carl Peter Christian HR Development Committee: Luiga have been elected to the Board as • Lord Paul Myners (Chairman) representatives of TeliaSonera, and Sergey • Sergey V. Soldatenkov V. Soldatenkov, Vladimir Y. Streshinsky and • Vladimir Y. Streshinsky Sergey A. Kulikov have been elected to the Board as representatives of the Company’s In 2014, five meetings of the Remuneration controlling shareholder, USM Holdings Ltd. and HR Development Committee were held. The key actions taken in 2014 were: We also refer to the relevant provisions • reporting to the Board of Directors of the UK Corporate Governance Code on the results of the 2013 Employees’ which, although not binding on us, provide Satisfaction Survey; additional guidance in determining the • assessment of the performance of the independence of Board members. Company’s CEO and the top management team; Breakdown of remuneration for 2014 • implementation of the talent Remuneration, RUB million management and development Non- programmes; Independent independent • review of the CEO’s options plan and Chairman of members of members of the short-term incentive programme for the Board the Board of the Board of management, with recommendations Remuneration type of Directors Directors Directors made to the Board of Directors. Salary 3 35 8 Benefits 0 0 0 Reimbursement of expenses 0 2 0 Bonus 0 0 0 Long-term incentives 0 0 0 Pension 0 0 0 Total remuneration 3 37 8

82 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information 3 0 0 83 173 413 237 RUB million Annual Report 2014 MegaFon MegaFon In October the 2012, Board of Directors incentive long-term three-year a approved programme for key executive and senior level employees. Under thisscheme participants are awarded phantom share options, which vest in April-May and 2014 April-May These 2015. options are settled in cash upon vesting, based on the difference between the base per price of US$17.86 share and the weighted average price of the Company’s GDRs on the London Stock Exchange from January 15 March to 15 in the year the option vests. A total of 7 million phantom share options may be awarded under the plan. In February 2013 a total phantom of 2,133,000 share options were granted to certain key executive and senior level employees. In May 2014, 788,400 phantom share options vested and were exercised. Benefits expenses of Reimbursement incentives long-term and Bonus Pension remuneration Total Salary Remuneration of the Management Management the of Remuneration Board and CEO The Board of Directors decides the structure and the level of the remuneration for the executive management. The total amount of payments to members of the and remuneration for Board Management reimbursement of expenses was in 2014 million. RUB 413 Management the to paid Remuneration Board in 2014 type Remuneration The CEO and the Management Board The CEOis the principal executive officer of Management the with Together MegaFon. Board, he manages the Company’s current operations. The CEO is elected by and reports to the General Meeting of Shareholders. He also reports to the Board Directors.of Ivan Tavrin was elected CEO in April 2012. Previously, from 2003 to April Sergey 2012, Soldatenkov was the CEO of MegaFon (he has beenChairman ofthe Board of Directors since June 2012). Providing leadership support to the CEO, executive the is Board Management the collegial management body at MegaFon. It is responsible for aspects all of operational fall which those from apart management, within the remit of the General Meeting of Shareholders and the Board of Directors. The size and composition of the annually approved are Board Management at the General Meeting of Shareholders the from recommendations on based CEO. The CEO is the Chairman of the Board. Management The current Corporate Secretary is Elena Breeva, who was elected in November 2013 and re-elected in The 2014. Corporate Secretary also acts as the Company’s controller who is responsible for insider security. and control information The Corporate Secretary is elected by the Board of Directors and reports to it. for requirements stringent has MegaFon the person elected to this position. Today, the role of the Corporate Secretary goes administrative traditionally its beyond far remit. It is increasingly outward-focused, and engagement investor incorporating corporate communications. The Corporate Secretary responsible is for effective communication with our shareholders, and organises the work of the Board of Directors and the Board committees. The Corporate Secretary ensures that the Company’s management bodies strictly follow their mandates, and management, the executive the helps Board of Directors and the shareholders interact more effectively. The Corporate Secretary acts as the guarantor of the compliance by the procedures with management Company’s and principles that ensure the exercise of rights and legitimate interests of Company shareholders. Corporate Secretary Governance

Leadership continued

In March 2015, the Board of Directors In March 2014, the Board of Directors of the In August 2013, the Company’s Board of approved an amendment to the terms Company approved an amendment to the Directors approved a long-term motivation of the programme to change the basis terms of the plan to accelerate the vesting and retention programme for key executive for determining the base price and the of Mr Tavrin’s final options to acquire a 2.5% and senior level employees. In the weighted-average price of the Company’s interest in the Company, permitting the aggregate, a total of 7,000,000 phantom shares for the awards outstanding on remaining options to be exercised at any share options may be awarded (equal to 31 December 2014 whose remaining time after 1 May 2014. In addition, the Board 1.1% of the share capital of the Company) payment is due in April-May 2015. Under agreed to remove a restriction on Mr Tavrin at the base price of US$24.25 per share. the amendment, the base price will be holding more than 5% of the authorised The plan has a three-year duration. The denominated in rubles and will be set at share capital of the Company at any time share options awarded vest in April-May 555 rubles per share and the weighted- prior to May 2017. On 30 December 2014, 2015 and April-May 2016 and will be settled average price of the Company’s shares will Mr Tavrin exchanged his 2.5% interest in the in cash. Payments shall be made on the be based on prices on the Moscow Stock Company and the 15,500,000 unexercised basis of the difference between the base Exchange over the period from 15 January options (for the acquisition of a 2.5% price and the weighted average price of 2015 to 15 March 2015. interest in the Company) for an interest the Company’s GDRs on the London Stock in USM Group. Exchange from 15 January to 15 March of In November 2012, the Board of Directors the relevant year of vesting. In June 2014, also approved a long-term incentive a total of 2,192,000 phantom share options programme for the CEO. Under the terms were granted to certain key executive of the programme, Mr Tavrin was given the and senior level employees under this right, exercisable until May 2017, to buy programme. from our subsidiary, MegaFon Investments (Cyprus) Limited, shares representing in the aggregate a 5% interest in MegaFon at a price equal to the IPO price, or US$20 per share. Mr Tavrin exercised his option to acquire shares representing a 1.25% interest in each of 2012 and 2013.

84 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information 85 Annual Report 2014 MegaFon MegaFon External audit engageWe independent external auditors to audit our annual and review our These statements. financial quarterly auditors must be approved by the General Meeting of Shareholders based upon of Board the from recommendation a Directors. On 30 June the 2014, Company’s AGM approved Ernst & Young LLC as its external auditor. The auditor was paid the amount of RUB 56 million for audit services and RUB 39 million for non-audit services, Ernst & Young being engaged to perform the latter services based upon a determination that the firm was best placed to undertake these due to its knowledge of the business, or because the services were related to its function. audit

updating codes and standards relating relating standards and codes updating to the internal control system and its functioning; regular monitoring of the quality of execution; procedures control regular surveys among key business effectiveness the on owners process analysis of business processes and related risks and whether the internal functions effectively system control processes; these in annual testing of key control procedures on a sample basis. of internal control; In 2014, weIn 2014, continued to improve our the analysed We system. control internal system in terms of its alignment with best practice and updated the internal control methodology COSO 2013. The results of actions all implemented are submitted to the Board of Directors’ Audit Committee, the Company’s top external Company’s the and management auditor. Internal control over financial reporting haveWe an internal control system which represents a set of organisational and instructions policies, measures, the ensure to designed procedures statements financial reliable of preparation and to comply with statutory regulatory area. this in requirements The effectiveness of our internal control system is maintained through the following actions: • • • • •

Internal Audit The Internal Audit team reports administratively to the CEO, and functionally to the Audit Committee of the Board of Directors. Its operations are based on the Regulations on Internal Audit approved by the Board of Directors, as well as the International Standards for the Auditing. Internal of Practice Professional The Company’s branches and MegaFon Retail also have Internal Audit teams, which, in turn, report to the Internal Audit team at the Company’s headquarters. The Internal Audit team provides assurance to, and advises on the Company’s operational processes, procurement, including customer construction, investment, service, processes for external and internal security information and IT and reporting, systems, as well as participating in the internal procedures. various of development http://ir.megafon.com/corporate_ governance/revision_commission/ More information on the Revision Revision the on information More Commission is available at: The current members of the Revision Commission are Pavel Kaplun (Chairman), Managing Director, Headof Investment and Analytical Department of USM Advisors LLC; Yuri Zheimo, Director of Internal Audit Senior Haavisto, Sami and MegaFon; at Business Controller at TeliaSonera Eurasia. The Revision Commission Our Revision Commission is elected by the General Meeting of Shareholders and is controlling and monitoring for responsible activity. economic and financial MegaFon’s The Commission’s members cannot be members of the Board or other executive bodies of the Company. There can also be no more than three members at any one time.

Effectiveness andaccountability underpin our corporate governance measures. To ensure we are effective and accountable in our operations, we have a number of internal organisations and mechanisms in place. Accountability and effectiveness Governance Other corporate governance issues

Financial markets In March 2014, the Central Bank of Russia 2. Improving insider information regulatory compliance adopted a new Corporate Governance protection systems Compliance is the foundation of our Code – one of the most significant events MegaFon needs to prevent the unlawful corporate governance system. We comply in corporate governance during the year. use of the large amounts of non-public with regulations relating to joint-stock The new version of the Code is a result of information it generates on a regular basis. companies, including the provisions of the joint efforts of market regulators, the In 2012, the Board of Directors adopted Russia’s Joint Stock Company Act. Since Moscow Stock Exchange, international specific Russian legislative requirements our listing on the London Stock Exchange organisations, investors and issuers, to prevent such unlawful use. In 2013, the (LSE), we shall now comply with the and international and Russian corporate Company established internal procedures UK Companies Act, the Disclosure and governance experts. The new Code contains to improve its ability to meet these Transparency Rules of the UK Financial best practice standards and is designed to requirements, enabling it to: Conduct Authority for ‘standard’ take Russian companies to the next level • restrict access to information; companies, and the LSE Listing Rules. of corporate governance. • designate locations for storing and reviewing information; For each fiscal year ending 31 December, The Code’s recommendations are primarily • protect IT systems against the loss we publish audited consolidated financial aimed at public companies and major of key data and access by third parties; statements prepared in accordance with government-controlled companies. Certain • implement techniques to protect insider IFRS. We also provide unaudited, condensed standards and recommendations of the information. consolidated financial statements prepared Code have already been included in the in accordance with IFRS at the end of the new Listing Rules of the Moscow Stock The Company, under the supervision of the first, second and third fiscal quarters. Exchange. Audit Committee, continued to improve its We place announcements of our financial insider information protection system – Information on MegaFon’s compliance results, as well as notices of upcoming for example, by introducing new technical with the Russian new Corporate General Meetings of Shareholders and other safeguards and quarterly reviews of insider Governance Code as well as how our important and price-sensitive information, information protection tools. on the London Stock Exchange website governance practices in 2014 compared via an information distribution system to the recommendations of the Corporate In 2014, we created and started (RNS) and official information agency in Governance Code can be found at: implementing a number of special technical Russia – Interfax. These announcements http://ir.megafon.com/ai/document/6154/ insider information protection systems, are followed by the publication of press file/MegaFon_AR_2014_Statutory_ which ensure protection and control over releases on our corporate website at Disclosure_materials.pdf insider information flow on the mobile http://ir.megafon.com/news/capital_ devices of the Company’s insiders, as well market_releases/ and/or www.corp. Corporate governance developments as control over the entire spectrum of megafon.ru/investors/disclosure/. We in 2014 potentially dangerous devices and network also publish, via authorised agencies in During 2014 we continued to improve and communications. Russia and the UK, as mentioned above, upgrade our corporate governance system information required by Russia’s Federal to keep pace with our disclosure and We have continued to provide training Law on the Securities Market and the compliance responsibilities. We did this by: programmes and tests to engage Regulation on Information Disclosure by Company employees with this business- Issuers of Securities. This information is 1. Developing additional control over critical issue. The remote educational also available on our corporate website. related-party transactions course and the tests are obligatory for In 2014, a MegaFon working group employees included on the insider list. continued our efforts to optimise control The actual test comprises 36 questions over related-party transactions by: on theory and practice that can only be • requiring non-affiliation representations, answered satisfactorily if the participant where applicable, in contracts; is familiar with the subject matter, • conducting audits of related-party thereby encouraging employees to study transactions once a year; and understand the relevant legislative • improving the detection of related- requirements. party transactions, and speeding up the processes by which they are approved by our governing bodies.

86 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information

87

Annual Report 2014 MegaFon MegaFon Anti-corruption policy Anti-corruption adhering for reputation its values MegaFon of standards recognised internationally to ethics and integrity in business, as well as the in regulation anti-corruption specific Russian Federation, such as the Federal Law ‘On Countering Corruption’ and the the of Recommendations’ ‘Methodical Ministry of Labour and Social Security, adopted In addition, in 2013. we in 2014 joined the Anti-CorruptionCharter of Russian business. Following the adoption of our Anti-bribery Policy the in in 2012, 2013 Board of Directors adopted the Code of Business Conduct and Ethics which emphasised attitudethe ‘zero-tolerance’ Company’s towards corrupt and unethical behaviour. These policies and notice of the Company’s other among disseminated, are position things, through the Company’s website. and Gifts MegaFon’s Additionally, Hospitality Policy provides guidance on MegaFon all by met be to requirements the employees before accepting gifts from, or making gifts to, suppliers or other third parties. weIn 2014, focused on the internal procedures that are necessary for compliance with these policies. We conducted training of employees in MegaFon’s headquarters as well as in branches and subsidiaries on the Anti- bribery Policy and the Gifts and Hospitality Policy. new All employees are also given such training. haveWe a ‘Direct Line’ through which MegaFon employees and other stakeholders can receive guidance as to whether a particular action is deemed corrupt, or can anonymously) required, if (and, discreetly report violations. Through this Direct Line employees can also get advice on the terms of the Code of Business Conduct and Ethics. Direct Line usage statistics and information on the most important issues is communicated to the Audit Committee.

Major transactions Major no concluded MegaFon 2014, In transactions which qualify as ‘major transactions’, (as defined by Article 78 of Federal Law No. 208-FZ On Joint-Stock Companies). Industry and business partners areWe committed to combating corruption and ensuring fair competition. As a part of these efforts, we adopted a Code of Business Conduct and Ethics and in 2013 an Anti-corruption Policy a year earlier. believeWe that our corporate responsibility efforts make us an attractive counterparty for our current and potential partners. Related-party transactionsRelated-party specifically are transactions Related-party governedby Chapter XI of Federal Law No. 208-FZ ‘On Joint Stock Companies’. in transactions provisions, these Under which the shareholders, the Board of are members Board individual or Directors, by approved be must parties interested either the Board of Directors or the General Meeting of Shareholders. The approval depends on the nature of the transaction, and is subject to the requirement that the interested member(s) of the Board of Directors or the interested shareholder(s) transaction. the on vote not does/do interested-party MegaFon’s of list A transactions approved by the Board of Directors in is provided 2014, on the Company’s website, at http:// ir.megafon.com/ai/document/6154/file/ MegaFon_AR_2014_Statutory_Disclosure_ materials.pdf

governance polices adopted a new version of the regulations Board; Management the on improved our information disclosure procedures; optimised the process of remuneration for the Board of Directors; in line with best practice, this issue will no longer be on agendas. meeting shareholder Adopting new corporate Identifying independent Board Members To reinforceTo our commitment to good corporate governance, we: in 2014 • • • areWe confident these measures will governance corporate strengthen our transparency the of enhance and processes our operations. For more information about these developments, please visit: http:// ir.megafon.com/ai/document/6154/file/ MegaFon_AR_2014_Statutory_Disclosure_ materials.pdf 4.  3. Using the criteria set out in the relevant Russian regulation, the Board ofDirectors identified two independent members of the Board. Following the approval in 2014 of the Code of Corporate Governance by the Central Bank of Russia, the criteria Board of independence the identifying for members have been significantly expanded. Despite the fact that the provisions theof Corporate Code of Governance are advisory, the Company uses these criteria determining in the independence of members of the Board of Directors (for more information see page 76). We rolledWe outeducational tools and our enhance to designed materials employees’ understanding of the principles of insider information protection as well as of methods of insider information processing and security. On our internal corporate website, for example, our Controller continues to host a regular blog, interesting most the on articles posting cases of legal practice relating to insider information in Russia and the UK and answering questions from internal users. alsoWe made a short educational film, which gives a general overview on the information. insider of protection Governance Shareholders’ equity

Charter capital Shareholder structure • In December 2014, the holding of USM MegaFon’s charter capital consists of As of 31 December 2014, MegaFon is increased from 53.82% to 56.32% as 620,000,000 ordinary registered uncertified controlled by USM Group, which holds a result of a transaction between the shares, each with a par value of RUB 0.1. 56.32% of the Company’s authorised Company’s CEO Ivan Tavrin and USM It is authorised to issue an additional capital. The holding of USM Group Group under which Mr Tavrin transferred 100,000,000,000 ordinary shares. It has in MegaFon changed compared to to USM Group, as part of the settlement no preferred shares. All ordinary registered 31 December 2013 as a result of the for his acquisition of a stake in USM uncertified shares have been combined following actions: Group, MegaFon shares representing into one issue whose state number is • In July 2014, the interest of USM Group a 2.5% interest in the Company which 1-02-00822-J. The government does not increased from 50%+100 shares to had been acquired by him earlier under hold shares in the charter capital. 53.65% as a result of the completion the CEO long-term incentive plan. The of the settlement for the acquisition terms of the transaction also provided In November 2012, MegaFon held an by the Company of a 50% interest in for the transfer to USM Group of options initial public offering (IPO) on the London Euroset. MegaFon used its shares held to purchase an additional 2.5% interest and Moscow Stock Exchanges. The issue by its subsidiary MegaFon Investments in the Company which were awarded to price was US$20 per ordinary share or Cyprus Limited (MICL). As a result of this, Mr Tavrin pursuant to the CEO long-term global depositary receipt (GDR) (each GDR the percentage interest of MICL in the incentive plan. These options can be representing one ordinary share). The total Company’s share capital went from 7.57% exercised in whole or in part at US$20 per offering size was US$1.8 billion, including to 3.92%. share at any time prior to May 2017. the overallotment option (2,153,000 • In December 2014, Telecominvest ordinary shares and 89,326,500 GDRs). This Holdings Limited (a USM Group company) As of 31 December 2014, the interest of implied a market capitalisation for MegaFon purchased 1,029,464 GDRs and ordinary TeliaSonera remained unchanged from the on the listing date of US$11.2 billion. shares in the market, which resulted in end of 2013, at 25.17%; the interest of MICL USM’s interest increasing from 53.65% decreased from 7.57% at the end of 2013 to to 53.82%. 3.92%; following the transaction with USM Group discussed above, the holding of the CEO Ivan Tavrin was reduced to 0.0447%; and the free-float accounted for 14.59%.

MegaFon equity structure as of 31 December 2014

MegaFon Investments USM Group TeliaSonera Group (Cyprus Limited) Free float

56.32% 25.17% 3.92% 100% 14.59%

The chart above indicates the effective equity capital structure which may be inconsistent with the architecture of the formal ownership through special purpose entities which, for the sake of simplicity, are not shown above.

88 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information 89 Annual Report 2014 MegaFon MegaFon

Dividend policy MegaFonIn 2012, paid dividends for the first time in the Company’s history (previously, net income was always reinvested in business development). In accordance with the Company’s dividend policy approved in the2012, General Meeting of Shareholders approves the amount of dividend to be by recommendation a on based disbursed, the Board of Directors (following preliminary determinations by the The CEO). amount will depend on the financial results, the cash needed by the Company to develop its business, implement its strategy and meet its obligations, and any other factors that the Board of Directors believes relevant, including the impact on the Company’s ratings. credit investment-grade The Company aims to pay at least 50% of adjusted net profit or 70% of adjusted cash flow (whichever is greater) in dividends percentages pay-out target The annually. may be adjusted upwards or downwards by the Board of Directors as needed to maintain a capital structure based on a net debt/adjusted OIBDA ratio of 1.2–1.5. 01/12/14 -7.1%

33.5

-25.7% -48.5% -58.9% 13.78 13.78 01/11/14

31.12.2014

01.01.2014 – 01/10/14

01/09/14

01/08/14 01/07/14

52-week US$ low, per share priceYear-end (at close Decemberon 31 2014), US$ per share 52-week high, US$ per share MegaFon GDRs on the LSE In the year 1 JanuaryDecember to 31 2014, the price of MegaFon GDRs demonstrated a downward trend in line with the MSCI Russia index. As December of 31 the 2014, GDR price had decreased by 58.9%. 01/06/14

820 804 01/05/14 MFON MOEX (indexed) MICEX index (indexed) 1,138.5 31.12.2014

01.01.2014 – 01/04/14

01/03/14 01/02/14

MFON LSE MSCI Russia (indexed) 01/01/14 52-week RUB low, share priceYear-end (at close RUB per share 52-week high, RUB per share on 30 December 2014), MegaFon ordinary shares on the on shares ordinary MegaFon Moscow Stock Exchange In the year 1 JanuaryDecember to 31 2014, demonstrated shares ordinary MegaFon a downward trend mainly due to pressure from geopolitical issues in Russia. As of December31 the 2014, price of MegaFon’s ordinary shares had decreased by 25.7%. US$10 US$15 US$25 US$20 US$30 US$35 US$45 US$40 MegaFon share performance price 2014 in Governance

Shareholders’ equity continued

Payment of dividends Taxation of dividends Special rules apply to shareholders that As of 1 January 2014, considerable changes Based on the Russian tax legislation hold MegaFon shares or GDRs through were made to the regulatory framework dividend income received by the foreign nominee holders. In this case, the for the payment of dividends in Russia. shareholders is subject to Russian depository withholds income tax at the This meant that, in July 2014, MegaFon’s income tax at the following rates: general rates prescribed by the Russian dividends for the 2013 financial year were • tax at the rate of 9%3 is payable on the Tax Code or by the Double Tax Treaty (if paid out for the first time in line with a new dividend income received by companies applicable). Should the Double Tax Treaty ‘cascade system’: and individuals that are Russian tax provide for an additional reduction in the • The payment of dividends for the 2013 residents; tax rate in the case of certain criteria being financial year in the total amount of • tax at the rate of 15% is payable on the met, a reduced rate is not applied. Prior to RUB 40 billion (RUB 64.51 per share (or dividend income received by non-Russian the payment of dividends, nominee holders GDR)) was approved at the AGM held on tax residents (both companies and must provide the depository with the 30 June 2014 and 11 July 2014 was set individuals). This rate may be reduced aggregated information of the shareholders, as the record date for the determination in accordance with the provisions of the who hold MegaFon shares and/or GDRs. of shareholders entitled to receive effective Double Tax Treaties concluded Failure to provide such information may dividends. This implied a total dividend between Russia and the countries of result in a punitive 30%4 rate of withholding pay-out in the amount of RUB 46.4 billion residence of the beneficial owners of tax applied by the depository. (RUB 74.85 per share (or GDR)) for the full dividends. year 2013, including the Q1 2013 interim Shareholders may make claims for the dividend previously paid in July 2013. The above tax is to be determined, withheld refund of excess tax withheld and paid • The dividends were transferred to direct and paid to the Russian Treasury by the to the Russian Treasury by the tax agent shareholders and registered nominee tax agent upon each payment of dividends, by providing the Russian tax authorities holders listed in the Company’s register i.e. by MegaFon in relation to the dividends with documents confirming their right to a as shareholders. paid to the shareholders (e.g., Sonera reduced rate of income tax. Such a refund • The registered nominee holders Holding B.V.), rights to the shares of claim may be filed within 3 years following then distributed the dividends to the which are accounted for in the Company’s the year of dividend payment. sub-nominees, trustees and direct securities register, and by the Russian shareholders listed in their registers. The depositary in other cases. MegaFon intends to comply with the sub-nominees (such as Bank of New York legislation affecting the payment of Mellon, a depositary for the Company’s To benefit from a reduced tax rate dividends as directed by its professional GDR issuance program) then paid out envisaged by a Double Tax Treaty, a foreign advisers. In the absence of satisfactory dividends to those persons listed in their shareholder must provide the tax agent evidence that a different rate of withholding registers as shareholders. with a certificate confirming his residence tax is applicable, MegaFon intends to in the country which concluded the relevant withhold tax on dividend payments, Dividend history Double Tax Treaty with Russia. Such if applicable, at the standard rates set a certificate must be duly notarised by out above. Year 2012 2013 the competent authority and provided Dividend period Q2-Q4 FY to the tax agent prior to the date of MegaFon recommends that shareholders Total payment, dividend payment. consult with their tax advisers as to how RUB bn 33.59 46.41 they may minimise their exposure to DPS, RUB 54.17 74.85 Russian withholding tax on dividends Record date 21/05/2013 11/07/2014 to which they may be entitled. Price, CoB, RUB 1,066.30 1,043.40 Dividend yield¹ 5.1% 7.2% Dividend pay- out ratio² 96% 90%

1 Calculated based on closing price as of the record date of a MegaFon ordinary share traded on the MOEX. 2 Total dividend as a percentage of profit for the same dividend period attributable to equity holders of the Company in accordance with IFRS. 3 Following amendments to Russian tax legislation effective from 1 January 2015, the income tax rate applicable in relation to dividends received by Russian tax residents in 2015 and thereafter has increased from 9% to 13%. 4 Following amendments to Russian tax legislation effective from 1 January 2015, the 30% tax rate will no longer be applicable to dividend income received in 2015 and beyond. Therefore, tax agents should apply general tax rates provided by the Russian Tax Code and Double Tax Treaties. 90 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information 91 Annual Report 2014 MegaFon MegaFon

The consolidated financial statements, prepared in accordance with International Financial Reporting December31 Standards and and 2014 2013, also as for of the years ended on those dates, including the consolidated statements of financial position,consolidated statements of comprehensive income, cash flows, changes in equity and notes to the consolidatedpresent financial fairly, in material all statements, respects, the state of affairs of MegaFon in accordance with International Financial Reporting Standards. The Business Review contained in MegaFon’s Annual Report for gives 2014 a fair view of the performance of the business, and specifically the operational results of MegaFon, of its efforts to meet its strategic objectives, and of the risksthe and business, uncertainties as well as other events faced by which in the near future may have an impact on the operations of the Company. Sergey V. Soldatenkov Sergey V. Chairman of the Board 2.  On behalf of the Board  1. The Board of MegaFon confirms that to the best of its knowledge: The Directors are responsible forpreparing annual accounts for each of the financial years of the Company, and to ensurepresent that fairly, in material all they respects, the assets, liabilities, financial position and profit or loss of the Company.

statement Directors’ responsibility responsibility Directors’ Governance Financial statements

Independent auditors’ report 93 Consolidated statement of comprehensive income 94 Consolidated statement of financial position 96 Consolidated statement of changes in equity 97 Consolidated statement of cash flows 98 Notes to the consolidated financial statements 99 1. General 99 2. Basis of preparation 99 3. Basis of consolidation 99 4. Significant accounting policies 100 5. Significant accounting judgments, estimates and assumptions 107 6. Standards issued but not yet effective 109 7. Equity 111 8. Group information 112 9. Business combinations 112 10. Investments in associates and joint ventures 114 11. Segment information 116 12. Income taxes 116 13. Earnings per share 118 14. Property and equipment 119 15. Intangible assets 120 16. Impairment test 122 17. Financial assets and liabilities 124 18. Non-financial assets and liabilities 130 19. Inventory 131 20. Trade and other receivables 132 21. Cash and cash equivalents 132 22. Assets held for sale 133 23. Provisions 133 24. Trade and other payables 133 25. Share-based compensation 134 26. Long-term incentive programme 136 27. Sales and marketing expenses 136 28. General and administrative expenses 136 29. Related parties 137 30. Financial risk management 138 31. Commitments, contingencies and uncertainties 141 32. Events after the reporting date 143

92 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information 93

Annual Report 2014 MegaFon MegaFon +7 (495)+7 705 9700 (495)+7 755 9700 (495)+7 755 9701 59002827 ООО «Эрнст энд Янг» Россия, Москва 115035, Садовническая наб., стр. 77, 1 Тел.: Факс: ОКПО: +7 (495)+7 705 9700 (495)+7 755 9700 (495)+7 755 9701 ErnstYoung & LLC 1 bld. 77, Nab., Sadovnicheskaya Moscow, Russia 115035, Tel: Fax: www.ey.com/ru 10 March10 2015 /s/ Ernst and Young LLC In our opinion, the consolidated financial statements present fairly,in material all respects, the financial position of OJSCand MegaFon its subsidiaries as December at 31 and 2014, its financial performance and cash flows for the year then Standards. ended Reporting in Financial accordanceInternational with Opinion We believeWe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidatedstatements. financial The procedures selected depend on the auditor’s judgment, including the assessment of the risksof the of material consolidated misstatement financial statements, whether due to fraud or error. In making those risk assessments, thecontrol auditor relevant considers to the entity’s internal preparation and fair presentation of the consolidated financial statements in orderprocedures to design audit that are appropriate in the circumstances, but not for the purpose of expressing an opinion on theinternal effectiveness control. An audit of the also entity’s includes evaluating the appropriateness of accounting policies used and the reasonablenessaccounting estimates of significant made by management, as well as evaluating the overall presentation of the consolidated financial statements. Auditor’s responsibilityAuditor’s Our responsibility is to express an opinion on these consolidated financial plan and requirements ethical statements with comply we that require standards Those based Auditing. on on our Standards audit. International with conducted We accordance our audit in and perform the audit to obtain reasonable assurance about whether the consolidated financial statementsmisstatement. are free from material Management’s responsibility for the consolidated financial statements financial consolidated the for responsibility Management’s Management is responsible for the preparation and fair presentation of these consolidated financial statementsInternational in accordance Financial with Reporting Standards, and for such internal control as management determines ispreparation necessary of consolidated to enable the financial statements that are free frommaterial misstatement, whether due to fraud or error. The Board of Directors and Shareholders of OJSC MegaFon haveWe audited the accompanying consolidated financial statements of OJSC MegaFon and its subsidiaries, whichconsolidated comprise the statement of financial position as December of 31 and 2014, the consolidated statement ofcomprehensive income,statement ofchanges in equity and statement of cash flows for the year then ended, and a summary of significantand other accounting explanatory policies information. Independent auditors’ report auditors’ Independent Consolidated statement of comprehensive income (in millions of Rubles)

Years ended 31 December Note 2014 2013 Revenues Services 291,656 279,087 Sales of equipment and accessories 23,139 18,142 Total revenues 314,795 297,229

Operating expenses Cost of services 63,148 58,480 Cost of equipment and accessories 21,481 16,912 Sales and marketing expenses 27 16,456 18,687 General and administrative expenses 28 75,190 70,558 Depreciation 14 47,431 44,851 Amortisation 15 7,827 6,131 Loss on disposal of non-current assets 1,437 1,200 Total operating expenses 232,970 216,819

Operating profit 81,825 80,410

Finance costs 17 (13,792) (12,184) Finance income 1,155 1,888 Share of loss of associates and joint ventures 10 (516) (202) Other non-operating loss 29 (1,370) (81) (Loss)/gain on financial instruments, net 17 (50) 269 Foreign exchange loss, net 17 (16,884) (2,914)

Profit before tax 50,368 67,186 Income tax expense 12 13,368 15,416

Profit for the year 37,000 51,770 The accompanying notes are an integral part of these consolidated financial statements.

94 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information 95 91 89 162 (52)

118 136 2013 (188) 51,718 51,600 51,608 Years ended Years 31 December 63 63 274 (46) 297 2014 (991) Annual Report 2014 (1,288) 36,726 36,055 36,009 MegaFon MegaFon 17 13 13 Note The accompanying notes are an integral part of these consolidated financial statements. Consolidated statement of comprehensive income comprehensive of statement Consolidated (in millions of Rubles, except per share amounts) Earnings per share, Rubles Basic, profit for the year attributable to ordinaryequity holders of the Company Total comprehensive income/(loss) for the year the for income/(loss) comprehensive Total Attributable to equity holders of the Company interest non-controlling to Attributable Other comprehensive income/(loss) to be reclassified to profit or loss in subsequent periods: Foreign currency translation difference, net of tax Other comprehensive income/(loss) comprehensive Other Diluted, profit for the year attributable to ordinary equity holders of the Company Attributable to non-controlling interest non-controlling to Attributable Total comprehensive Total income forthe net year, of tax Profit for the year Attributable to equity holders of the Company Netother comprehensive loss to be reclassified to profit or loss in subsequent periods Net movement on cashflow hedges, net of tax Consolidated statement of financial position (in millions of Rubles)

As of 31 December 2013 Note 2014 restated* Assets Non-current assets Property and equipment 14 224,655 220,272 Intangible assets, other than goodwill 15 57,427 58,848 Goodwill 9, 15 32,292 31,899 Investments in associates and joint ventures 10 34,944 35,460 Non-current financial assets 17 2,863 425 Non-current non-financial assets 18 2,053 1,300 Deferred tax assets 12 782 3,673 Total non-current assets 355,016 351,877

Current assets Inventory 19 6,484 8,376 Current non-financial assets 18 5,161 5,960 Prepaid income taxes 12 3,713 2,777 Trade and other receivables 20 16,260 12,493 Other current financial assets 17 48,887 39,296 Cash and cash equivalents 21 22,223 9,939 Total current assets 102,728 78,841 Assets held for sale 22 – 1,516 Total assets 457,744 432,234

Equity and liabilities Equity Equity attributable to equity holders of the Company 7 157,689 138,034 Non-controlling interests 144 271 Total equity 157,833 138,305

Non-current liabilities Loans and borrowings 17 156,319 130,825 Other non-current financial liabilities 17 1,270 20,838 Non-current non-financial liabilities 18 1,712 1,170 Provisions 23 4,958 5,355 Deferred tax liabilities 12 19,572 17,752 Total non-current liabilities 183,831 175,940

Current liabilities Trade and other payables 24 36,622 35,636 Loans and borrowings 17 51,149 21,184 Other current financial liabilities 17 7,658 40,785 Current non-financial liabilities 18 20,493 19,490 Income taxes payable 12 158 894 Total current liabilities 116,080 117,989

Total equity and liabilities 457,744 432,234 * Certain amounts do not correspond to the 2013 financial statements and reflect adjustments made, refer to Notes 4 and 9. The accompanying notes are an integral part of these consolidated financial statements.

96 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information 97 51 (52) 689 Total (132) (132) (991) (233) 1,178 4,869 equity 51,718 51,770 37,000 37,000 21,339 36,009 157,833 (38,428) 138,305 (36,968) 117,873 – – – – – – 51 (44) 518 (46) 274 162 118 144 271 Non- (132) (132) (233) (320) interests controlling Annual Report 2014 – – – – (8) 689 (671) Total 1,178 4,869 51,608 21,339 36,726 51,600 36,055 36,055 (38,428) (36,968) 157,689 117,355 117,355 138,034 MegaFon MegaFon – – – – – – – – – (8) (8) (73) 689 561 543 (671) (554) (671) Other 1,178 capital (Note 7) reserves – – – – – – – – (122) 5,138 51,608 36,726 (38,428) 51,608 36,726 36,726 (36,968) Retained earnings 143,468 143,468 161,422 157,986 157,986 – – – – – – – – – – – – – – Capital surplus 12,567 12,567 12,567 12,567 12,567 12,567 – – – – – – – – – – – – 5,545 16,201 Amount (39,133) (17,387) (33,588) – – – – – – – – – – – – Treasury shares Treasury shares shares Number of (7,750,000) (22,641,056) Attributable to equity holders of the Company 24,299,033 54,690,089 46,940,089 – – – – – – – – – – – – – – 526 526 526 Amount – – – – – – – – – – – – – – Ordinary shares shares shares Number of 620,000,000 620,000,000 620,000,000 620,000,000 620,000,000 7 7 10 17 25 25 25 Note As of December 31 2014 Dividends to non- to Dividends controlling interests Contribution of non- of Contribution controlling interest Settlement of convertible debt Share-based Share-based compensation Dividends Total comprehensive comprehensive Total income As of December 31 2013 Other comprehensive comprehensive Other loss Net profitNet Dividends to non- to Dividends controlling interests Sale of treasury shares upon exercise of stock options Sale of interest in Synterra-Media Share-based Share-based compensation Total comprehensive comprehensive Total income Dividends Consolidated statement of changes in equity changes in of statement Consolidated (in millions of Rubles) The accompanying notes are an integral part of these consolidated financial statements. Other comprehensive comprehensive Other loss As of 1 January 2013 Net profitNet Consolidated statement of cash flows (in millions of Rubles)

Years ended 31 December Note 2014 2013 Operating activities Profit before tax 50,368 67,186 Non-cash adjustment to reconcile profit before tax to net cash flows: Depreciation 14 47,431 44,851 Amortisation 15 7,827 6,131 Loss on disposal of non-current assets 1,437 1,200 Loss/(gain) on financial instruments, net 17 50 (269) Net foreign exchange loss 16,884 2,914 Share of loss of associates and joint ventures 10 516 202 Change in impairment allowance for receivables and other non-financial assets 28 1,398 2,037 Finance costs 13,792 12,184 Finance income (1,155) (1,888) Equity-settled share-based compensation 25 689 1,178 Other non-operating loss 1,370 81 Working capital adjustments: (Increase)/decrease in inventory 1,900 (3,050) (Increase)/decrease in trade and other receivables (6,048) 1,154 (Increase)/decrease in current non-financial assets (416) 2,078 Increase/(decrease) in trade and other payables (3,684) 3,947 Decrease in current non-financial liabilities (236) (851) Change in VAT, net 2,122 (3,103) Income tax received 427 2,393 Income tax paid (10,052) (16,344) Interest received 1,183 1,687 Interest paid, net of interest capitalised 17 (11,190) (9,025) Net cash flows from operating activities 114,613 114,693

Investing activities Purchase of property, equipment and intangible assets (58,146) (43,022) Proceeds from sale of property and equipment 751 2,514 Acquisition of subsidiaries, net of cash acquired 9 (189) (15,219) Payment of deferred and contingent consideration 17 (36,330) (5,878) Net change in short-term demand deposits 17 165 (14,148) Proceeds from sale of Synterra-Media, net of cash 17 – 76 Net cash flows used in investing activities (93,749) (75,677)

Financing activities Proceeds from borrowings, net of fees paid 17 48,522 32,200 Repayment of borrowings 17 (23,178) (31,193) Dividends paid to equity holders of the Company 7 (38,428) (36,968) Dividends paid to non-controlling interests (132) (132) Payment of liability for marketing related licences 15 (184) (539) Proceeds from exercise of stock options 25 – 4,869 IPO transaction fees paid – (212) Other 51 403 Net cash flows used in financing activities (13,349) (31,572)

Net increase in cash and cash equivalents 7,515 7,444 Net foreign exchange difference 4,769 108 Cash and cash equivalents at beginning of year 9,939 2,387 Cash and cash equivalents at end of year 22,223 9,939 The accompanying notes are an integral part of these consolidated financial statements.

98 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information 99 Annual Report 2014 MegaFon MegaFon Basis of consolidation Basis of preparation General When necessary, adjustments are made to thefinancial statements of subsidiaries to bring their accounting accountingGroup’s policies in line policies. with the intra-group All assets and liabilities, equity, income, expenses and cash flows relating to transactionsbetween members of the Group are eliminated in full on consolidation. Profit or loss and each component of other comprehensive income (“OCI”) are attributed to the equity holders of thenon-controlling Company and to the interests, even if this results in the non-controlling interests having a deficit balance. Subsidiaries are consolidated from the date of acquisition, being the date on which the Group obtains control, and continueconsolidated to be until the date when such control ceases. The financial statements of the subsidiaries are preparedperiod for as the the same parent reporting company, using consistent accounting policies. 3. The consolidated financial statements comprise the financial statements of the Company and its subsidiaries as December of 31 2014. The consolidated financial statements were authorised for issue by the Company’s Chief Executive Officer March (“CEO”)on 10 and 2015. Chief Accountant The consolidated financial statements have been prepared on a historical cost basis, unless disclosed otherwise.financial The consolidated statements are presented in millions of Rubles, except for per share amounts which are in Rubles or unless otherwise indicated. 2. These consolidated financial statements have been prepared in accordance with International Financial Reportingissued by the Standards International (“IFRS”) Accounting as Standards Board (“IASB”). In August USM 2014 Holdings Limited a non-public (“USMHL”), entity and the parent company of the USM Group, announced a restructuring amongst its shareholders. As a result of this restructuring the voting interest held byenabled Mr Alisher him Usmanov, to control which USMHL, previously has been reduced to a 48% voting interest. As December of 31 the 2014, Group is primarily owned by USM Group, an indirect controlling shareholder, and TeliaSonera Group, another major shareholder with significant influence over the Group, whose parent is a publicly owned Swedish company. In November MegaFon 2012 completed an initial public offering (“IPO”) and listed its ordinary shares on the Moscow Exchangeordinary and its shares represented by Global Depositary Receipts, or GDRs, on the London Stock Exchange, in each“MFON”. case under the symbol In Russia, MegaFon has constructed and continues to operate a nationwide wireless communications networkbandthat GSM operates 900/1800 on standard. the dual In May 2007 the Group was awarded a licence that expires in May for 2017 the provision of 3G wirelesstelephony services based on IMT-2000/UMTS standards throughout the entire territory of Russia. the In Julya licence 2012 Group which was awarded expires in July 2022 for the provision of fourth-generation technology (“4G”) services under the Long Evolution(“LTE”) Term standard throughout the entire territory of Russia. As December of 31 the 2014, Group is providing and expandingalmost 3G services of all the regions in in which it operates throughout Russia and, following its acquisition of LLC Scartel (“Scartel”)(Note provides 9), in October 4G services 2013 in 72 regions of Russia. The Group also holds licences for local and long-distance telephony services,transmission, data broadband access services, and communication channels leasing covering the entire territoryown land-line of Russia. and leased The satellite Group transmission has its network capacities. MegaFon isleading a integrated telecommunications operator in Russia and provides a broad range of voice, data and othertelecommunication services retail to customers, businesses, government clients and other telecommunication services providers. 1. 1. Open Joint Stock Company MegaFon (“MegaFon”, the “Company” and, together with its consolidated subsidiaries, the “Group”) is a company incorporated under the laws of the Russian Federation (“Russia”) and registered in the Unified State Registerunder of Legal number Entities 1027809169585. Its registered office is at 30Kadashevskaya Embankment, Russian Moscow, 115035, Federation. Notes to the consolidated financial statements financial the to Notes consolidated (in millions of Rubles) Notes to the consolidated financial statements continued

4. Significant accounting policies Business combinations and goodwill The Group applies the acquisition method of accounting and recognises the assets acquired, the liabilities assumed and any non-controlling interest in the acquired company at the acquisition date, measured at their fair values as of that date.

Determining the fair value of assets acquired and liabilities assumed requires management’s judgment and often involves the use of significant estimates and assumptions, including assumptions with respect to future cash inflows and outflows, discount rates, licence and other asset useful lives and market multiples, among other items. Results of subsidiaries acquired and accounted for by the acquisition method have been included in operations from the relevant date of acquisition.

Any contingent consideration to be transferred by the Group is recognised at fair value at the acquisition date. Subsequent changes in the fair value of the contingent consideration classified as an asset or liability that is a financial instrument within the scope of IAS 39, Financial Instruments: Recognition and Measurement, are recognised in accordance with IAS 39 in the statement of comprehensive income. If the contingent consideration is not within the scope of IAS 39, it is measured in accordance with the appropriate IFRS. Contingent consideration that is classified as equity is not re-measured and subsequent settlement is accounted for within equity.

Goodwill represents the excess of the consideration transferred plus the fair value of any non-controlling interest in the acquired company at the acquisition date over the fair values of the identifiable net assets acquired, and is not amortised, but tested for impairment at least annually.

Acquisition-related costs are expensed as incurred and included in general and administrative expenses.

After initial recognition, goodwill is measured at cost less any accumulated impairment losses. For the purpose of impairment testing, goodwill acquired in a business combination is allocated from the acquisition date to each of the cash-generating units (“CGUs”), or groups of CGUs, that is expected to benefit from the synergies of the combination. Each CGU or any group of CGUs to which the goodwill is allocated represents the lowest level within the entity at which the goodwill is monitored for internal management purposes.

Combination of entities under common control To account for business combinations between entities under common control the Group uses the acquisition method of accounting as defined in IFRS 3, Business Combinations (“acquisition method”), if the transaction has substance from the perspective of the Group. Otherwise the pooling-of-interest method is used. When evaluating whether the transaction has substance, the Group considers the following factors: the purpose of the transaction, the involvement of outside parties in the transaction such as non-controlling interests or other third parties, whether or not the transaction is carried out at fair value, the existing activities of the entities involved in the transaction, and whether or not it is bringing entities together into a reporting entity that did not exist before.

Associates and joint ventures Investments in associates and joint ventures which are jointly controlled entities are accounted for using the equity method of accounting and are initially recognised at cost. The Group’s share of the profits and losses of these companies is included in the ‘share of profit of associates and joint ventures’ line in the accompanying consolidated statements of comprehensive income with a corresponding adjustment to the carrying amount of the investment.

Unrealised gains on transactions between the Group and its associates or joint ventures are eliminated only to the extent of the Group’s interest in the associates or joint ventures. Unrealised losses are also eliminated unless the transaction provides evidence of an impairment of the asset transferred. Accounting policies of associates or joint ventures have been changed where necessary to ensure consistency with the policies adopted by the Group.

Foreign currency transactions and translation The Group’s consolidated financial statements are presented in Rubles, which is also the functional currency of OJSC MegaFon and its principal subsidiaries.

Foreign currency transactions are translated into the functional currency using the exchange rates prevailing at the dates of the transactions or fair value measurement where items are re-measured to their fair value. Foreign exchange gains and losses resulting from the settlement of such transactions and from the translation at year end exchange rates of monetary assets and liabilities denominated in foreign currencies are recognised in the ‘Foreign exchange gain/(loss), net’ line in profit or loss.

The assets and liabilities of foreign operations are translated into Rubles at the rate of exchange prevailing on the reporting date and their statements of comprehensive income are translated at exchange rates prevailing on the dates of the transactions. The exchange differences arising on the translation are recognised in OCI.

The functional currency of TT-Mobile, the Company’s 75% owned subsidiary in Tajikistan, is the US dollar as a majority of its revenues, costs, property and equipment purchases, debt and trade liabilities is either priced, incurred, payable or otherwise measured in US dollars.

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Annual Report 2014 MegaFon MegaFon Loyalty programme Roaming rebates Multiple element arrangements (a) The Group operates loyalty a programme which allows customers to accumulate awards for usage of the cellular Group’s network. The revenue from provision of content is presented net of related costs when the Group acts as an agent of the contentgross providers revenues while and related costs are recorded when the Group is a primary obligor in the arrangement. Wireline revenue The Group earns wireline revenues for usage of its fixed-line network, which include payments from individual,subscribers corporate for local and and government long-distance telecommunications and data transfer services. Charges areof traffic based upon processed), usage (e.g. minutes period of time (e.g. monthly service fees) or other established fee schedules. Wireline revenuesinterconnection also include charges from wireless and wireline operators for terminating calls on the wireline Group’s networks.contracts Revenue from service is recognised when the services are rendered. Billings received in advance of service being renderedas revenue are deferred as the service and recognised is rendered. Wireless revenue The Group earns wireless revenues for usage of its cellular system, which include airtime charges from contractmonthly and contract prepaid subscribers, fees, interconnect fees from other wireless and wireline operators, roaming charges, datafor value transfer added services charges, (“VAS”). Interconnect and charges revenue includes revenues from wireless and wireline operators thatterminating was earned from traffic from other operators. Roaming revenues include revenues from customers whocoverage roam outside area and their revenues selected from home other mobile carriers for roaming by their customers using the network of theMMS, Group. provision include VAS SMS, of content and media and commissions for mobile payments. The awards can then be redeemed for free services or products, subject to a minimum number of awards being obtained. The portion of the amounts receivable from and payable to its roaming partners in its consolidated statement of financialrebates position. earned Amounts from and of given to roaming partners are included in trade and other receivables and payables (Notesin the accompanying 20, respectively, 24), consolidated statement of financial position. Service revenue Service revenue is generally recognised when the services are rendered. In these financial statementshas the been presentation changed so of as service to present revenue wireless and wireline revenue combined, in line with the trend of continued integrationservices. of these The Group recognises revenue when the amount of revenue can be reliably measured, when it is probable that futurewill flow economic to the applicable benefits entity and when specific criteria have been met for each of the activities Group’s as described below. The Groupbases its estimate of return on historical results, taking into consideration the type of customer, the type of transactionof each arrangement. and the specifics Revenue recognition Revenue Revenue is measured at the fair value of the consideration received or receivable, and represents amounts receivableand for the services sale of goods in the ordinary course of the activities, Group’s net of value added taxes, returns and discounts. The Group takes into account the terms of the various roaming discount agreements in order to determine the appropriate presentation The Group enters into roaming discount agreements with a number of wireless operators. According to the agreementscommitted the to provide Group is and entitled to receive a discount that is generally dependent on the volume of roaming traffic generatedrespective by the subscribers. The Group uses actual traffic data to estimate the amounts of rebates toare be received adjusted or and granted. updated Such on a regular estimates basis. The Group accounts for discounts received as a reduction of roaminggranted expenses as a reduction and rebates of roaming revenue. (c) The Group enters into multiple element arrangements in which a customer may purchase a combination of equipmentmodems, (e.g. USB handsets) and telecommunication services (e.g. airtime, data, and other services). The Group allocates considerationreceived from subscribers to the separate units of accounting based on their relative fair values but not exceedingconsideration the contractual receivable for the delivered element. Revenues allocated to the delivered equipment and related costs arein recognised the accompanying consolidated statements of comprehensive income at the time of sale provided that other conditionsrecognition for revenue are met. Amounts allocated to telecommunication services are deferred and recognised as revenuerendering over the the services. period of (b) of consideration received is allocated to the awards based on their fair value and deferred until the award credits are redeemedThe Group or expire. estimates the fair value of awards to a customer by applying a statistical analysis. Notes to the consolidated financial statements continued

4. Significant accounting policies (continued) Sales of equipment and accessories Revenue from the sale of equipment and accessories is recognised when the significant risks and rewards of ownership of the goods have passed to the buyer, usually on delivery of the goods.

Dealer commissions Dealer commissions for connection of new subscribers are expensed as incurred (Note 27).

The Group’s third party dealer arrangements call for provision of post-sales services and revenue sharing. As a result, dealer commissions are recognised as the services are performed, generally during a twelve-month period from the date a new subscriber is activated.

Advertising costs Advertising costs are expensed as incurred (Note 27).

Government pension funds The Group contributes to the local state pension funds and social funds on behalf of its employees. The contributions are expensed as incurred. Contributions for the years ended 31 December 2014 and 2013 were 5,112 and 4,599, respectively.

Taxes Current income tax The tax expense for the year comprises current and deferred tax. Tax is recognised in profit or loss, except to the extent that it relates to items recognised in OCI or directly in equity. In this case, the tax is also recognised in OCI or directly in equity, respectively.

The current income tax is calculated on the basis of the tax laws enacted or substantively enacted at the reporting date in the countries in which the Company and its subsidiaries operate and generate taxable income. Management periodically evaluates positions taken in tax returns with respect to situations in which the applicable tax regulation is subject to interpretation. If the applicable tax regulation is subject to interpretation, it establishes a provision where appropriate on the basis of amounts expected to be paid to the tax authorities.

Deferred income tax Deferred income tax is recognised using the liability method, on temporary differences arising between the tax bases of assets and liabilities and their carrying amounts in the financial statements. However, deferred income tax is not accounted for if it arises from initial recognition of an asset or liability in a transaction other than a business combination that at the time of the transaction affects neither accounting nor taxable profit or loss. Deferred income tax is determined using tax rates and laws that have been enacted or substantively enacted at the reporting date and are expected to apply when the related deferred income tax asset is realised or the deferred income tax liability is settled.

Deferred income tax assets are recognised only to the extent that it is probable that future taxable profit will be available against which the temporary differences can be utilised. Deferred income tax is provided on temporary differences arising on investments in subsidiaries and associates, except for deferred income tax liability where the timing of the reversal of the temporary difference is controlled by the Group and it is probable that the temporary difference will not reverse in the foreseeable future.

Value-added tax Value added tax (“VAT”) related to revenues is generally payable to the tax authorities on an accrual basis when invoices are issued to customers. VAT incurred on purchases may be offset, subject to certain restrictions, against VAT related to revenues, or can be reclaimed in cash from the tax authorities under certain circumstances.

Management periodically reviews the recoverability of VAT receivables and believes the amount reflected in the consolidated financial statements is fully recoverable within one year (Note 18).

Segment reporting Operating segments are reported in a manner consistent with the internal reporting provided to the chief operating decision-maker (“CODM”). The CODM is responsible for allocating resources and assessing performance of the operating segments. The Company’s CEO has been designated as the CODM.

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Annual Report 2014 MegaFon MegaFon 3 to 20 years 7 to 49 years 3 to 7 years All otherAll borrowing costs are expensed in the period in which theyoccur. Borrowing costs consist of interest and other costsGroup that incurs the in connection with the borrowing of funds. Leases in which a significant portion of the risks and rewards of ownership are retained by the lessor are classifiedPayments as operating made under leases. operating leases (net of any incentives received from the lessor) are charged to profit or lossbasis on a straight over the period line of the lease. A leased asset is depreciated over the lesser of the lease term or the useful life of the asset. Leases Finance leases, that is, leases that transfer substantially the all risks and benefits incidental to ownershipGroup, of the are capitalised leased item to the at the commencement of the lease at the fair value of the leased property at the if lower, present or, value of the minimum lease payments. Lease payments are apportioned between finance charges and reductiona constant of the lease rate liability of interest so as on to the achieve remaining balance of the liability. Finance charges are recognised in finance costs within profit or loss. The present value of the expected cost for the decommissioning of an asset after its use is included in the cost of thePlease respective refer to ‘Significant asset. accounting policies – Provisions’, and below, Note 23 for further information about the provision Repair and maintenance costs are expensed as incurred. The cost of major renovations and other subsequent expenditurethe carrying is included amount in of the asset or recognised as a separate asset, as appropriate, onlywhen itis probable thatassociated future with economic the benefits item will flow to the Group and the cost of the item can be measured reliably. costs Borrowing Borrowing costs directly attributable to the acquisition, construction or production of qualifying a that asset necessarily during the takes construction a substantial period phase of time are capitalised as part of property and equipment until the asset is ready for use. The assets’ residual values, useful lives and depreciation methods are reviewed, and adjusted if appropriate, at each reporting date. theAt time of retirement or other disposition of property or equipment, the cost and accumulated depreciation areaccounts removed from and any the resulting gain or loss is recorded in profit or loss. Buildings and structures Vehicles, office and other equipment Leasehold improvements are depreciated over the shorter of the lease term or the estimated useful lives of theincludes assets. renewals The lease when term such renewals are reasonably certain. liabilities. decommissioning for Telecommunications network The estimated useful lives are as follows: Property and equipment equipment Property and Property and equipment is stated at cost, less accumulated depreciation and impairment, if Cost any. includes costs all attributable directly to bringing the asset to the location and condition for its intended use. Depreciation is recorded onthe a straight-line estimated basis over useful life of the asset. Notes to the consolidated financial statements continued

4. Significant accounting policies (continued) Intangible assets Intangible assets acquired separately are measured on initial recognition at cost. The cost of intangible assets acquired in a business combination is their fair value as of the date of acquisition. Following initial recognition, intangible assets are carried at cost less accumulated amortisation and impairment, if any. Intangible assets consist principally of operating licences, frequencies, software, marketing related licences and customer base.

The useful lives of intangible assets are assessed as either finite or indefinite. The Group does not have intangible assets with indefinite useful lives, other than goodwill. All intangible assets, except for 2G standard wireless licences, are amortised on a straight-line basis over the following estimated useful lives:

4G operating licences 20 years Other operating licences 10 years Frequencies 10 to 12 years Software 2 to 5 years Marketing related intangible assets 4 to 5 years Customer base 4 to 19 years Other intangible assets 1 to 10 years

2G licences are amortised on a sum-of-the-years’-digits basis over a period of 10 years (Note 15).

The Group continues to evaluate the amortisation periods to determine whether events or circumstances warrant revised amortisation periods. Additionally, the Group considers whether the carrying value of such assets should be impaired based on the expected future economic benefits.

Impairment of non-financial assets Assets, including goodwill, that have indefinite useful lives are not subject to amortisation and are tested annually for impairment. Assets that are subject to depreciation or amortisation are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. An impairment loss is recognised for the amount by which the asset’s or CGU’s carrying amount exceeds its recoverable amount. The recoverable amount is the higher of (1) an asset’s or CGU’s fair value less costs to sell and (2) value in use. The recoverable amount is determined for each individual asset, unless the asset does not generate cash inflows that are largely independent of those from other assets or groups of assets.

Impairment losses relating to continuing operations are recognised in profit or loss in the expense categories which are consistent with the function of the impaired asset.

For assets other than goodwill, an assessment is made at each reporting date to determine whether there is an indication that previously recognised impairment losses no longer exist or have decreased. If such indication exists, the Group estimates the asset’s or CGU’s recoverable amount. A previously recognised impairment loss is reversed only if there has been a change in the assumptions used to determine the asset’s recoverable amount since the last impairment loss was recognised. The reversal is limited so that the carrying amount of the asset does not exceed its recoverable amount, nor exceed the carrying amount that would have been determined, net of depreciation, had no impairment loss been recognised for the asset in prior years. Such reversal is recognised in profit or loss.

Goodwill impairment reviews are undertaken annually as of 1 October or more frequently if events or changes in circumstances indicate potential impairment. Impairment is determined for goodwill by assessing the recoverable amount of each CGU (or group of CGUs) to which the goodwill relates. When the recoverable amount of the CGU is less than its carrying amount, an impairment of associated goodwill is recognised immediately as an expense and is not subsequently reversed.

For associates and joint ventures accounted for using the equity method, at each reporting date the Group determines whether there is objective evidence that the investment in the associate or joint venture is impaired. If there is such evidence, the Group calculates the amount of impairment as the difference between the recoverable amount of the associate or joint venture and its carrying value, then recognises the loss as ‘Share of profit of associates and joint ventures’ within profit or loss.

Non-current assets held for sale Non-current assets are classified as assets held for sale (“AHFS”) and stated at the lower of carrying amount and fair value less costs to sell if their carrying amount is recovered principally through a sale transaction rather than through continuing use and the sale is considered highly probable.

Inventory Inventory, which primarily consists of telephone handsets, portable electronic devices, accessories and USB modems, is stated at the lower of cost and net realisable value. Cost is determined using the weighted-average cost method. Net realisable value is the estimated selling price in the ordinary course of business less the estimated costs necessary to make the sale.

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Annual Report 2014 MegaFon MegaFon Cash-settled transactions The cost of cash-settled transactions, such as phantom stock options under the and 2012 long-term 2013 incentive plansmeasured (Note 25), is initially at fair value at the grant date using an appropriate valuation model.This fair value is expensed over the periodthe until vesting date with recognition of a corresponding liability. The liability is re-measured to fair value at each reportingincluding date up the to, and settlement date, with changes in fair value recognised in employee benefits and related social charges expense (Note 28). is reflected as additional share dilution in the computation of diluted earnings per share. Re-measurements of the defined benefit liability are recognised in profit or loss when they occur. The Group operates another long-term employee benefits programme (Note 26) which is accounted for in accordanceEmployee with benefits. IAS 19, These benefits are unfunded. The amount recognised as a liability for other long-termpresent employee value benefits of the defined is the benefit obligation at the end of the reporting period. determine To the present value of the definedobligation benefit and the related current service cost, the Group attributes the cost of benefits to years of service ona pro-rata basis. Other long-term employee benefits Share-based compensation compensation Share-based Equity-settled transactions The cost of equity-settled transactions, such as stock options under the CEO long-term incentive plan (Notevalue 25), is determined at the date when by the the fair grant is made using an appropriate valuation model. That cost is recognised, together with a correspondingincrease in other reserves in equity, over the period in which the service conditions are fulfilled in employee benefitscharges and related social expense (Note 28). No expense is recognised for awards that do not ultimately vest. The dilutive effect of outstanding options Decommissioning liabilities The Group has certain legal obligations related to rented sites for base stations and masts, which include requirementsthe real estate to restore upon which the base stations and masts are located upon their being decommissioned. Decommissioningdetermined costs by calculating are the present value of the expected costs to settle the obligation using estimated cashas flows, part and of the are recognised cost of the particular asset. The cash flows are discounted at the current pre-tax rate that reflectsthe decommissioning the risks specific liability. The unwinding to of the discount is expensed in profit or loss as finance costs. The estimatedof decommissioning future costs are reviewed annually and adjusted as appropriate. Changes in estimated liability resulting fromestimated revisions future of the costs or in the discount rate applied are added to or deducted from the cost of the asset. Provisions are measured at the present value of the expenditures expected to be required to settle the obligationreflects using a pre-tax current rate that market assessments of the time value of money and the risks specific to the obligation. Anyto passage increase of time in the is recognised provision due as finance costs. Provisions Provisions are recognised when the Group haspresent a legal or constructive obligation as a result of past events, itoutflow is probable of resources that an will be required to settle the obligation, and the amount can be reliably estimated. Provisions are losses. not operating future recognised for Diluted earnings per share are computed by dividing adjusted net profit available to shareholders by the weighted-averageordinary number of shares outstanding during the period increased to include the number of additional ordinaryconversion shares of the all that potentially would be issued dilutive securities on the into ordinary shares. Potentially dilutive securities include instruments. debt outstanding convertible and stock options a deduction, net of tax, from the proceeds. equity. No gain or loss is recognised in profit or loss on the purchase, sale, issue or cancellation of the own Group’s equity instruments.Any difference between the carrying amount and the consideration received upon any subsequent sale is recognised in equity. share per Earnings Basic earnings per share (“EPS”) are computed by dividing net profit available to shareholders of the Company by the weighted-averagenumber of ordinary shares outstanding for the period. Treasury shares Treasury The Company’s own issued equity instruments that are reacquired (treasury shares) are recognised at cost and deducted from Ordinary shares Ordinary shares are classified as equity. Incremental costs directly attributable to the issue of new shares are shown in equity as Cash and cash equivalents Cash and cash equivalents comprise cash on hand and deposits in banks with original maturities of three months or less. Notes to the consolidated financial statements continued

4. Significant accounting policies (continued) Financial instruments Initial recognition and measurement Financial assets and financial liabilities within the scope of IAS 39 are recognised initially at fair value plus transaction costs that are directly attributable to the acquisition or issue of the financial asset or financial liability, except for a financial asset or financial liability accounted for at fair value through profit or loss, in which case transaction costs are expensed.

Subsequent measurement of financial assets and liabilities The subsequent measurement of financial assets and liabilities depends on their classification as described below:

Fair value through profit or loss Derivatives, including separated embedded derivatives, are classified as held for trading and accounted for at fair value through profit or loss unless they are designated as effective hedging instruments. Financial assets and liabilities accounted for at fair value through profit or loss are carried in the consolidated statement of financial position at fair value with changes in fair value being recognised in profit or loss, in the ‘foreign exchange gain/(loss)’, ‘finance costs’ or ‘gain/(loss) on financial instruments’ lines, depending on the nature of the changes.

Loans and receivables (assets) and loans and borrowings (liabilities) Loans and receivables are non-derivative financial assets with fixed or determinable payments that are not quoted in an active market. After initial measurement, loans and receivables and loans and borrowings are subsequently measured at amortised cost using the effective interest rate (“EIR”) method. Amortised cost is calculated by taking into account any discount or premium on acquisition and fees or costs that are an integral part of the EIR. The amortisation based on EIR is included in profit or loss.

De-recognition of financial assets A financial asset is de-recognised when the rights to receive cash flows from the asset have expired; or the Group has transferred its rights to receive cash flows from the asset or has assumed an obligation to pay the received cash flows in full without material delay to a third party under a ‘pass-through’ arrangement; and either (a) the Group has transferred substantially all the risks and rewards of the asset, or (b) the Group has neither transferred nor retained substantially all the risks and rewards of the asset, but has transferred control of the asset.

Impairment of financial assets A financial asset or a group of financial assets is impaired and impairment losses are incurred if there is objective evidence of impairment as a result of an event that occurred subsequent to the initial recognition of the asset. The Group assesses at each reporting date whether there is objective evidence that a financial asset or group of assets may be impaired. For assets carried at amortised cost, the impairment loss is the difference between the asset’s carrying amount and the present value of estimated future cash flows at the original EIR (excluding future expected credit losses that have not yet been incurred). The carrying amount of the asset is reduced through the use of an allowance account and the amount of the loss is recognised in profit or loss. Financial assets together with the associated allowance are written off when there is no realistic prospect of future recovery and all collateral has been realised or has been transferred to the Group. If, in a subsequent year, the amount of the estimated impairment loss increases or decreases because of an event occurring after the impairment was recognised, the previously recognised impairment loss is increased or reduced by adjusting the allowance account. If a write-off is later recovered, the recovery is credited to the relevant costs in profit or loss.

De-recognition of financial liabilities A financial liability is de-recognised when the obligation under the liability is discharged, cancelled or expires. When an existing financial liability is replaced by another from the same lender on substantially different terms, or the terms of an existing liability are substantially modified, such an exchange or modification is treated as the de-recognition of the original liability and the recognition of a new liability. The difference in the respective carrying amounts is recognised within profit or loss.

Fair value of financial instruments The fair value of financial instruments that are traded in active markets at each reporting date is determined by reference to quoted market prices or dealer price quotations, without any deduction for transaction costs. For financial instruments not traded in an active market, the fair value is determined using appropriate valuation techniques, which include using recent arm’s length market transactions; reference to the current fair value of another instrument that is substantially the same; a discounted cash flow analysis; or other valuation models.

The Group uses the following hierarchy for determining and disclosing the fair value of financial instruments by valuation technique:

Level 1: quoted (unadjusted) prices in active markets for identical assets or liabilities;

Level 2: other techniques for which all inputs which have a significant effect on the recorded fair value are observable, either directly or indirectly;

Level 3: techniques which use inputs that have a significant effect on the recorded fair value that are not based on observable market data.

106 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information 107

Annual Report 2014 MegaFon MegaFon Significant accounting judgments, estimates and assumptions The Group estimates the fair value of awards under customer loyalty programmes by applying statistical techniques.include making Inputs assumptions to the models about expected redemption rates,the mix of products that will be available for redemptioncustomer preferences. in the future Such and estimates are subject to significant uncertainty. Allocation of each separable component of a bundled offer based on the individual components’ relative fair values also judgment. and involvesestimates Management also makes judgments about the reporting of revenue on a net versus gross basis, depending oninvolvement an analysis of as the either Group’s principal or agent. Revenue recognition The Group sells services to other operators in different countries and across borders. Management has torevenue make estimates recognition, relating relying to to some extent on information from other operators on values amounts charged. the dispute of parties services other the where instances in outcome delivered. final the of estimates Management also makes The key assumptions concerning the future and other key sources of estimation uncertainty at the reportingrisk of causing date that a material have adjustment a significant to the carrying amounts of assets and liabilities within the next financialThe Group year based are described its assumptions below. and estimates on parameters available when the consolidated financial statementsExisting circumstances were prepared. and assumptions about future developments, however, may change due to marketarising changes beyond or circumstances the control of the Group. Such changes are reflected in the assumptions when they occur. Critical accounting estimates 5. assumptions and estimates judgments, make to management required statements financial consolidated these of preparation The that affect the amounts reported in the consolidated statement of financial position and the consolidatedincome. statement Actual results, of comprehensive however, could differ from those estimates. The effective portion of changes in the fair value of derivatives that are designatedand qualify as cash flow hedges are recognised in The Group has derivatives which it designated as cash flow hedges and derivatives which it did not designate as hedgesthe (Note inception At 17). of a hedge relationship, the Group formally designates and documents thehedge relationship to whichto apply hedge the Group accounting wishes and the risk management objective and strategy for undertaking the hedge.highly Such effective hedges are expected in achieving to offsetting be changes in cash flows and are assessed on an ongoing basis to determinebeen highly that effective they actually throughout have the financial reporting periods for which they were designated. Derivative financial instruments and hedge accounting Derivative financial instruments which include currency and interest rate swaps are initially recognisedfinancial in the consolidated position at fair statement value on the date of a derivative contract is entered into and are subsequently re-measuredvalues at their are fair obtained value. Fair from quoted market prices and discounted cash flow models as appropriate. Derivatives are includedassets within at fair financial value through profit or loss when fair value is positive and within financial liabilities at fair value through profitfair value or is negative. loss when Certain derivatives embedded in other financial instruments are treated as separaterisks derivatives and characteristics when their economic are not closely related to those of the host contract and the combined instrumentwith is not changes measured in fair at fair value value, being recognised in profit or loss. IAS 32 Offsetting 32 IAS Financial Assets and Financial Liabilities (Amendments) The amendments to IAS 32, Offsetting Financial Assets and Financial Liabilities, specify thatset-off an entity if that has right a legally is enforceable not contingent righton a future to event and that right is enforceable both in the normal course of businessof the and default, in the event insolvency or bankruptcy of the entity and counterparties. all The amendments are effective1 January and 2014, for are annual to be applied periods retrospectively. beginning As a result of adoption of the amendments, the trade Group’s and other receivablesand trade and other payables have increased as December of 31 respectively, and December 2014 31 and because 1,761, by 2013 2,180 the criteria for offsetting were not met (Notes 20, In 24). particular, the current bankruptcy legislation in Russia doesthis not allow offsetting has an impact on if the scheme of settlements determined by the law. The Group uses derivatives to manage interest rate and foreign currency risk exposures. The Group does not hold or issue derivatives Changes in accounting policies and disclosures During the 2014 Group applied the following amendments for the first time: OCI. The gain or loss relating to the ineffective portion is recognised immediately in profit or loss. For derivative instrumentsnot designated as that hedges are or do not qualify as hedged transactions, the changes in the fair value are reported in the profit or loss. purposes. trading for Notes to the consolidated financial statements continued

5. Significant accounting judgments, estimates and assumptions (continued) Business combinations The Group has made acquisitions of other businesses in the past (Note 9). The identification of assets acquired and liabilities assumed as a result of those acquisitions as well as the allocation of any contingent consideration between the identified assets and liabilities based on their fair values and quantification of resulting goodwill required significant judgment and estimates. Those estimates were based on comparative market information, entity-specific future cash flow projections, discount rates, terminal growth rates and other assumptions.

Impairment of non-financial assets The Group tests goodwill for impairment annually and more often if impairment indicators exist, and tests other long-lived assets for impairment when circumstances indicate there may be a potential impairment (Note 16). Estimating recoverable amounts of assets and CGUs is based on management’s evaluations, including determining the appropriate CGUs and estimates of applicable multiples, if the market approach is used, or future cash flows, discount rates, terminal growth rates, and assumptions about future market conditions, if the income approach is used. Allocation of the carrying value of the assets being tested between individual CGUs also requires judgment.

Depreciation and amortisation Depreciation and amortisation expenses are based on management’s estimates of residual value, the depreciation method used and the useful lives of property and equipment and intangible assets. Estimates may change due to technological developments, competition, changes in market conditions and other factors, and may result in changes in estimated useful lives and depreciation and amortisation charges. Critical estimates of useful lives of intangible assets are impacted by estimates of average customer relationship based on churn, remaining licence period and expected developments in technology and markets. The actual economic lives of long-lived assets may be different from the estimated useful lives. A change in estimated useful lives is accounted for prospectively as a change in accounting estimate.

To determine the accounting model for the 4G operating licences acquired in the Scartel business combination (Note 9) the Group has evaluated additional factors, such as the ability to extend the Group’s licences or obtain new licences and frequencies for a new standard, and international telecommunications carriers’ practices of estimating the value of similar licences. The Group determined the useful life of 4G operating licences to be 20 years and applied a straight-line method of amortisation.

Deferred tax assets and uncertain tax positions The Group assesses the recoverability of deferred tax assets based on estimates of future earnings (Note 12). The ability to recover these taxes depends ultimately on the Group’s ability to generate taxable earnings over the period for which the deferred tax assets remain deductible. The recognition of tax assets and liabilities depends on a series of factors, including estimates as to the timing and realisation of deferred tax assets and the projected tax payment schedule.

Actual Group income tax receipts and payments could differ from the estimates made by the Group as a result of changes in tax legislation or unforeseen transactions that could affect tax balances. The expected resolution of uncertain tax positions is based upon management’s judgment of the likelihood of sustaining a position taken through tax audits, tax courts and/or arbitration, if necessary. Circumstances and interpretations of the amount or likelihood may change through the settlement process.

Fair value of financial instruments Where the fair value of financial assets and financial liabilities recorded in the consolidated statement of financial position and disclosed in the notes cannot be derived from active markets, their fair value is determined using valuation techniques including the discounted cash flow model. The inputs to these models are taken from observable markets where possible, but where this is not feasible, a degree of judgment is required in establishing fair values. The judgments include considerations of inputs such as liquidity risk, credit risk and volatility. Changes in assumptions about these factors could affect the reported fair value of financial instruments.

Share-based payments The Group measures the cost of equity-settled and cash-settled share-based payment transactions with employees by reference to the fair value of the equity instruments at the date at which they are granted. For cash-settled awards the fair value is re-measured every reporting period. Estimating fair value for share-based payment transactions requires a determination of the most appropriate valuation model, which is dependent on the terms and conditions of the grant. This estimate also requires determination of the most appropriate inputs to the valuation model including the expected life of the share option, volatility and dividend yield and making assumptions about them. The assumptions and models used for estimating fair value for share-based payment transactions are disclosed in Note 25.

Decommissioning provision The Group records a provision for decommissioning obligations associated with restoration of rented sites where base stations are installed (Note 23). In determining the fair value of the provision, assumptions and estimates are made in relation to discount rates, the expected cost to dismantle and remove the asset from the site, including long-term inflation forecasts, and the expected timing of those costs.

108 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information 109 Annual Report 2014 MegaFon MegaFon Standards issued but not yet effective Retrospectively to each prior reporting period presented and the entity may elect any of the following practicalFor expedients: completed contracts, an entity need not restate contracts that begin and end within the same annualFor completed reporting contracts period. that have variable consideration, an entity may use the transaction price at the datecompleted the contract rather than was estimating variable consideration amounts in the comparative reporting periods.For reporting all periods presented before the date of initial application, an entity need not disclose the amount of thetransaction allocated to remaining price performance obligations and an explanation of when the entity expects to recognise that amount as revenue. Retrospectively with the cumulative effect of initially applying this standard recognised at the date of initial application. If an entity The amount by which each financial statement line item is affected in the current reporting period by thecompared application to the of IFRS as guidance 15 that was in effect before the change. An explanation of the reasons for significant changes. Step 1: IdentifyStep 1: the contract(s) with a customer, Step 2: Identify the performance obligations in the contract, Step Determine 3: the transaction price, Step 4: Allocate the transaction price to the performance obligations in the contract, Step 5: Recognise revenue when as) the (or entity satisfies a performance obligation. The amendments are effective for annual periods beginning on or after 1 January Early 2016. adoption is permitted.the amendments The Group will adopt from 1 January The 2016. amendments will not impact the financial Group’s statements. IAS and IAS 16 38 – Clarification of Acceptable Methods of Depreciation and Amortisation In May the 2014, IASB issued amendments to IAS Property, 16, Plant and Equipment, and IAS 38, Intangible Assets, whichuse clarify of revenue-based that the methods to calculate the depreciation of an asset is not appropriate because revenue generatedincludes by the an activity use of an asset that generally reflects factors other than the consumption of the economic benefits embodied in the asset. IFRS 11 AccountingIFRS 11 for Acquisitions of Interests in Joint Operations – Amendments to IFRS 11 In May the 2014, IASB issued amendments Joint Operations, to IFRS 11, which require the acquirer of an interest in a joint operation in which the activity constitutes a business, as defined in IFRS Business 3, Combinations, to apply of all the principlescombinations on business accounting in IFRS 3 and other IFRSs except for those principles that conflict with the guidance In addition, in IFRSacquirer 11. the should disclose the information required by IFRS 3 and other IFRSs for business combinations. The amendmentsfor annual periods are effective beginning on or after 1 January Early 2016. adoption is permitted. The Group will adopt the amendments1 January from The 2016. amendments are not expected to have a material effect on the financial Group’s statements. 1. • • • 2. elects this transition method it also should provide the additional disclosures in reporting periods that of: includeapplication the date of initial • • The Group is currently evaluating the possible effect of the Standard on its financial statements and the bestas the date transition for itsadoption, method as well to be used. An entity should apply the amendments in this Standard using one of the following two methods: • • • • For a public entity, the Standard is effective for annual reporting periods beginningon or after 1 January Early application 2017. permitted. is • The core principle of the guidance is that an entity should recognise revenue to depict the transfer of promised goodscustomers or services in an to amount that reflects the consideration to which the entity expects to be entitled achieve in exchangeTo that core for principle, those goods an entity or services. should apply the following steps: In May the 2014 IASB issued IFRS Revenue 15, from Contracts with Customers, a common revenue recognition guidance thatthe replaces following previous revenue recognition standards: IAS Revenue, Construction 18, IAS 11, Contracts, IFRIC Customer 13, LoyaltyProgrammes, IFRIC Agreements 15, for the Construction of Real Estate, IFRIC Transfers 18, of Assets from Customers, andRevenue SIC-31, – Barter Transactions Involving Advertising Services. IFRS 15 RevenueIFRS 15 from Contracts with Customers 6. The standards and interpretations that are issued, but not yet effective, up to the date of issuance of the financialand Group’s areapplicable statements, to the Group are disclosed below. The Group intends to adopt these standards when they become effective below. otherwise stated unless Notes to the consolidated financial statements continued

6. Standards issued but not yet effective (continued) IFRS 9 Financial Instruments In July 2014 the IASB completed its process to replace IAS 39, Financial Instruments: Recognition and Measurement, with the issuance of the final amendments to IFRS 9.

The IASB divided its project to replace IAS 39 into three main phases.

• Phase 1: classification and measurement of financial assets and financial liabilities. In November 2009 the IASB issued the chapters of IFRS 9 relating to the classification and measurement of financial assets. Those chapters require financial assets to be classified on the basis of the business model within which they are held and their contractual cash flow characteristics. In October 2010 the IASB added to IFRS 9 requirements related to the classification and measurement of financial liabilities. In July 2014 the IASB made limited amendments to the classification and measurement requirements in IFRS 9 for financial assets.

• Phase 2: impairment methodology. In July 2014 the IASB added to IFRS 9 the impairment requirements related to the accounting for expected credit losses on an entity’s financial assets and commitments to extend credit.

• Phase 3: hedge accounting. In November 2013 the IASB added to IFRS 9 the requirements related to hedge accounting.

IFRS 9 (July 2014) is effective for annual periods beginning on or after 1 January 2018. Earlier application is permitted. IFRS 9 (July 2014) should be applied retrospectively in accordance with IAS 8, Accounting Policies, Changes in Accounting Estimates and Errors. IFRS 9 (July 2014) should not be applied to items that have been derecognised at the date of initial application.

The Group will adopt IFRS 9 (July 2014) from 1 January 2018. The Group is evaluating the effect of the standard on its financial statements.

Improvements to IFRSs (September 2014) In September 2014, as a result of the Annual Improvements to IFRSs 2012-2014 Cycle, the IASB issued a number of amendments to:

• IFRS 5, Non-Current Assets Held for Sale and Discontinued Operations (changes in methods of disposal), • IFRS 7, Financial Instruments: Disclosures (servicing contracts), • IAS 19, Employee Benefits (discount rate: regional market issue), • IAS 34, Interim Financial Reporting (disclosure of information ‘elsewhere in the interim financial report’).

The amendments introduced relatively minor changes to clarify guidance in existing standards. The amendments are effective for annual periods beginning on or after 1 January 2016. The Group will adopt the amended standards from 1 January 2016. The Group does not expect these amendments to have a material impact on the Group’s financial position or performance.

Sale or Contribution of Assets between an Investor and its Associate or Joint Venture – Amendments to IFRS 10 and IAS 28 In September 2014 the IASB issued Sale or Contribution of Assets between an Investor and its Associate or Joint Venture – Amendments to IFRS 10 and IAS 28, which contains narrow-scope amendments to IFRS 10, Consolidated Financial Statements, and IAS 28, Investments in Associates and Joint Ventures. The main consequence of the amendments is that full gain or loss is recognised when a transaction involves a business (whether it is held in a subsidiary or not). A partial gain or loss is recognised when a transaction involves assets that do not constitute a business, even if those assets are held in a subsidiary.

The amendments are effective for annual periods beginning on or after 1 January 2016. Early adoption is permitted. The Group does not expect these amendments to have a material impact on the Group’s financial position or performance.

IAS 1 Disclosure Initiative In December 2014 the IASB issued Disclosure Initiative – Amendments to IAS 1, which gave more guidance on disclosing information in the financial statements, presenting the line items and aggregating information in the financial statements, including the notes, ordering and grouping of the notes. The amendments are effective for annual periods beginning on or after 1 January 2016. The Group will adopt them from that date. The amendments affect presentation and disclosure only and have no impact on the Group’s financial position or performance.

110 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information

111 (73) 136 136 561 297 689 543

(144) (968) (554)

1,178

capital

reserves Total other Total – – – – – – – 15 15 15 fund Annual Report 2014 Reserve – – – – – – – MegaFon MegaFon (23) (23) (23) interests with non- with controlling Transactions – – – – 175 689 799 (554) 1,178 1,488 reserve Share-based compensation – – – – – 136 297 172 (261) (125) Cash flow hedge reserve hedge – – – – – 21 (144) (968) (123) Foreign (1,091) reserve currency translation Equity Foreign currency translation Foreign As of December 31 2013 Foreign currency translation Foreign As of 1 January 2013 Other capital reserves Foreign currency translation reserve is used to record exchange differences arising from the translation of the financial statements The disaggregation of other capital reserves and changes of other comprehensive income by each type of reserve in equity is shown below: Share-based compensation reserve is used to recognise the value of equity-settled share-based payment transactions provided A reserve fund has been established according to the requirements of Russian law and is used to cover the Company’slosses, of its bonds redemption and re-purchase of its own shares in the absence of other capital resources. Cash flow hedge reserve is used to record the accumulated impact of derivatives designated as cash flow hedges (Note 17). Reserve on transactions with non-controlling interests is used to record differences arising as a result ofinterests transactions that do not with result non-controlling in a loss of control. of the amount due to Garsdale Services Investment Limited (“Garsdale”) by using its treasury shares (Notes 29). 10, payment dividend Annual On 28 June the 2013 Annual General Meeting of Shareholders of the Company approved the payment of a dividend in the Rubles amount per54.17 ordinary of share GDR) (or for the second, third and fourth quarters of On 2012. thesame date the shareholders alsoapproved the payment of an interim dividend for the first quarter in of the 2013 amount of 10.34 Rubles per ordinary share GDR). (or operations. foreign of to employees, including key management personnel, as part of their remuneration (Note 25). The number of treasury shares was reduced at 16,201 by carrying (or 22,641,056 value) following in July 2014 the settlement Group’s Share capital Share As December of 31 and the 2014 2013, Company had 620,000,000 fully paid and issued authorised ordinary shares with a par Rubles, value of comprised0.1 of 24,299,033 treasury shares December (31 46,940,089) 2013: and 595,700,967 December (31 573,059,911) 2013: outstanding shares. In addition, the Company had 100,000,000,000 authorised ordinary shares withnot issued Rubles, a par value which as of December 0.1 of 31 were and 2014 2013. 7. On 30 June the 2014, Annual General Meeting of Shareholders of the Company approved a final dividend for the financial 2013 yearamount in the of 64.51 Rubles per ordinary share GDR). (or The total dividend payout wasin 2014 38,428. After taking into account the interimdividend for the first quarter paid of 2013 total in 2013, dividends paid with respect to the financial 2013 year amounted Rubles to 74.85 The total sum allocated to these dividend payments was 36,968, and payment of the dividends was made in July 2013. per ordinary share GDR). (or Change in fair value of cash flow hedges (Note 17) Sale of treasury shares upon exercise of stock 25) (Note options 25) (Note compensation Share-based Change in fair value of cash flow hedges (Note 17) Share-based compensation (Note 25) (Note compensation Share-based As of December 31 2014 Notes to the consolidated financial statements continued

8. Group information The consolidated financial statements of the Group include the following significant subsidiaries and joint ventures of OJSC MegaFon:

Country of % equity interest Legal entity Principal activities incorporation 2014 2013 OJSC MegaFon Retail subsidiary Retail Russia 100 100 LLC NetByNet Holding subsidiary Broadband internet Russia 100 100 LLC Scartel (Note 9) subsidiary Wireless services Russia 100 100 LLC Yota subsidiary Wireless services Russia – 100 LLC MegaFon Finance subsidiary Financing Russia 100 100 MegaFon Investments (Cyprus) Limited subsidiary Transactions with treasury shares Cyprus 100 100 LLC Euroset-Retail (Note 10) joint venture Retail Russia 50 50

LLC Yota was merged into LLC Scartel during 2014.

The Company holds interests in material subsidiaries through a number of intermediary holding companies.

9. Business combinations Scartel On 1 October 2013 MegaFon acquired 100% of the shares of Maxiten Co Limited, which holds a 100% interest in a group of subsidiaries (together “Scartel”) that provide 4G telecommunication services under the brand “Yota”, from the Group’s controlling shareholder Garsdale, for a consideration of 55,736 comprised of (1) US$ 1,180 million deferred consideration (38,331 at the exchange rate as of 1 October 2013), of which 50% plus interest at 6% per annum was payable in one year from the date of acquisition and the other 50% plus interest at 6% per annum in two years after the acquisition; (2) settlement of Scartel’s indebtedness to Telecominvest Holdings Limited, an indirect subsidiary of Garsdale, in the amount of US$ 477 million (15,483 at the exchange rate as of the payment date) and (3) an effective settlement of a pre-existing cash advance of 1,069 for future services and accounts receivable of 853 for lease of the Group’s telecommunications network due from Scartel as of the acquisition date.

On 24 June 2014 the Group prepaid in cash approximately 90% of the deferred consideration due to Garsdale for the acquisition of Scartel, including principal and accrued interest, in the amount of 37,925 (Note 29).

The reasons for the acquisition were to gain a significant increase in network capacity and quality which will strengthen the Group’s leadership position in the fast growing mobile data market through enhanced overall service offering and customer experience; to enable the Group to carry out its 4G rollout with reduced capital and operating expenditures per unit of data transmission capacity because of its enhanced spectrum position; and to realise considerable cash flow savings in network rollout and maintenance driven principally by elimination of significant current and future operating costs.

The acquisition of Scartel was accounted for using the acquisition method (Note 5). The valuation of certain acquired assets and liabilities assumed was not finalised as of the date the 2013 consolidated financial statements were authorised for issue; thus, the net assets recognised in the 31 December 2013 financial statements were based on a provisional assessment of their fair value while the Group sought an independent valuation for certain tangible and intangible assets of Scartel.

112 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information 7

42 113 52 374 150 231 (76) 277 381 278 297 (118) Final Total (232) (728) (236) 7,935 (1,288) 2,237 (5,794) (3,590) 12,300 44,387 47,801 59,551 55,736 (11,750) amounts 2 1 – – – – – – – – – – 78 49 92 30 79 92 188 (84) 369 (76) (461) (369) 1,072 period (1,533) Annual Report 2014 Telecom 12 Dec 2014 12 adjustments Measurement Moscow region CJSC Advantage MegaFon MegaFon 52 2 – 278 297 (118) 39 26 60 (232) (728) 99 7,566 (55) 154 (83) 2,237 (1,288) (3,590) (5,886) 43,315 13,833 48,170 60,012 55,736 55,736 (11,842) amounts Provisional Telecom 17 Oct17 2014 CJSC Express Moscow region 2 – – – 20 60 22 60 38 LLC AstonLLC 30 Jun 2014 Moscow region – 33 36 43 10 110 133 (69) 143 5 Feb 2014 LLC Tele MIGLLC Tele Novy Urengoy Total identifiableTotal net assets at fair value The Group recognised Scartel acquisition-related costs as general and administrative expenses in the amount of 188 for the year ended The goodwill recognised is attributable primarily to expected synergies from the acquisition and the value toworkforce be attributed of Scartel. to the The entire goodwill recognised from the Scartel acquisition has been allocated to the integratedservices telecommunication group of CGUs (Note 16). The Group has consolidated the financial position and the results of operations of Scartel from 1 October If the 2013. acquisitionplace at the had beginning taken of the profit year, for the year for the Group would have been 44,622. In 2014, theIn 2014, valuation of certain assets was updated and the acquisition date fair value of the assets changed. The comparative 2013 information was restated to reflect the adjustments to the provisional amounts. The resulting changescharges in depreciation from the and acquisition amortisation date December to 31 were 2013 not material. December31 in the 2013 consolidated statement of comprehensive income. Trade andTrade other payables liabilities non-financial Current Non-current non-financial liabilities non-financial Non-current Provisions acquisition on arising Goodwill Purchase consideration transferred Purchase consideration Deferred tax liabilities Trade and other receivables other and Trade Intangible assets (Notes 15) 5, Inventories assets non-financial Current Cash and cash equivalents cash and Cash Liabilities borrowings and Loans The table below represents the allocation of the purchase price to the acquired net assets based on their estimated fair values. 2014 acquisitions2014 theIn 2014, Group acquired 100% ownership interests in a number of alternative wireline and broadband internet serviceregions providers of the in certain Russian Federation for a total purchase consideration of 381. Date of acquisition Values as at the date of acquisition are as follows: Assets Property and equipment (Note 14) Non-current assets Non-current Region of operations of Region Cash Contingent consideration is mainly due within one year from the date of acquisition. Non-current liabilities Non-current Current liabilities Contingent consideration Contingent Cash Total identifiableTotal net assets/(liabilities) at fair value transferred: Purchase consideration Goodwill Goodwill Notes to the consolidated financial statements continued

10. Investments in associates and joint ventures

% equity 31 December Investee interest 2014 2013 LLC Euroset-Retail (“Euroset”), joint venture 50 34,762 35,278 LLC News Tube, associate 38 182 182 Total 34,944 35,460

Euroset On 6 December 2012 the Group and Garsdale acquired a 50% interest in Euroset via their jointly-owned subsidiary Lefbord, in which they each held a 50% stake. Pursuant to a sale and purchase agreement with Garsdale, the Group was required to purchase on or before 6 December 2013 (with the possibility for this obligation to be deferred until 6 December 2015) Garsdale’s interest in Lefbord for US$ 535 million (16,491 at the exchange rate as of 6 December 2012), plus interest at the rate of 8% per annum, plus any earn-out related payments made by Garsdale to Lefbord. The purchase price could be increased by any additional contributions made to Lefbord by Garsdale and reduced by any payments received by Garsdale from Lefbord. The Group had, at its discretion, the option to settle this obligation in cash or in its ordinary shares to be valued at the weighted-average market price for MegaFon GDRs for the six-month period prior to the purchase date which had been recognised as a financial asset through profit or loss (Note 17).

Based on the terms of the obligation to acquire Garsdale’s 50% interest in Lefbord, the Group made the judgment that, with respect to both Lefbord and Euroset, Garsdale is its de facto agent and therefore that the Group obtained access to future economic benefits and effectively controlled Lefbord from December 2012 and that, via Lefbord, it held 50% of Euroset, rather than only 25%, from December 2012. Accordingly, the Group consolidated Lefbord and classified the obligation payable to Garsdale (“convertible debt instrument”) as other current financial liability in the consolidated statement of financial position from December 2012 (Note 17). The transactions referred to above result in the holding by the Group of a 50% interest in Euroset. The remaining 50% of Euroset is indirectly owned by VimpelCom, a Russian telecommunications operator. Lefbord and VimpelCom exercise joint control over Euroset with each having substantive approval rights allowing them to effectively participate in all of the significant decisions of Euroset.

The liability and purchased put option components of the convertible debt instrument were accounted for separately. The fair value of the put option asset was 1,611 immediately prior to the decision about settlement described below.

In December 2013 the obligation to purchase Garsdale’s interest in Lefbord was deferred for one year. On 9 July 2014 the Group elected to complete the purchase earlier and to settle the amount due to Garsdale for its interest in Euroset. At the date of settlement, the total amount due to Garsdale for its 50% interest in Euroset was US$ 657 million (22,628 at the exchange rate as of the date of settlement). The Group also elected to settle the amount due to Garsdale in treasury shares and, as stipulated in the sale and purchase agreement, the treasury shares were valued at the weighted-average market price for the Company’s GDRs for the immediately preceding six-month period. Following the transaction, the number of treasury shares was reduced by 22,641,056 (or 16,201 at carrying value) (Note 7).

The Group measured the treasury shares transferred to Garsdale at the carrying value of the liability to Garsdale as of the date the liability was extinguished, or 22,628, reduced by the fair value of the purchased put option asset on the date preceding the date of the decision to accelerate settlement of the liability, or 1,611 (less tax effect of 322). The net effect of settlement of 5,138 is recognised directly in retained earnings. This transaction was accounted for as transaction with shareholders acting in their capacity of a controlling party at carrying value through equity.

The Euroset joint venture is accounted for using the equity method in the consolidated financial statements. The primary reason for the investment in Euroset was to realise benefits from synergies related to a reduction of subscriber acquisition costs of the Group due to implementation of a revenue sharing model, procurement savings and prominent marketing of MegaFon services in Euroset outlets.

114 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information – 115 (37) 2013 2013 50% 50%

(404) (202) (367) 5,455 69,149 (7,034) 42,717 15,264 35,278 30,527 20,977 (10,021) 20,014 (21,567) (38,622) Year ended ended Year 31 December 31 December 2014 2014 50% 50% (516) (239) (792) Annual Report 2014 (1,031) (1,371) 14,748 17,135 68,780 34,762 (6,928) (6,928) (8,660) 29,495 12,711 20,014 38,934 (22,326) (22,326) (39,285) MegaFon MegaFon The reconciliation of summarised financial information of Euroset to the carrying amount of the interest Group’s below: presented in the joint venture is Assets assets Non-current Cash and cash equivalents equivalents cash and Cash Other current assets Income tax expense Income Loss and total comprehensive loss of the joint venture The share Group’s in the joint venture The Group’s share of the loss and total comprehensive loss of the joint venture Loss before tax before Loss Carrying amount of the interest Group’s The composition of the share Group’s of loss of the joint venture accounted for using the equity method is as follows: Total identifiable net assets net identifiable Total Liabilities liabilities financial Non-current liabilities non-current Other Other current liabilities Current financial liabilities Current financial Excess of the consideration transferred over the share Group’s in the fair value of identifiable net assets The share Group’s of identifiable net assets The share Group’s in the joint venture Notes to the consolidated financial statements continued

11. Segment information The Group manages its business primarily based on eight geographical operating segments within Russia, which provide a broad range of voice, data and other telecommunication services, including wireless and wireline services, interconnection services, data transmission services and value added services (“VAS”). The CODM (Note 4) evaluates the performance of the Group’s operating segments based on revenue and operating income before depreciation and amortisation (“OIBDA”). Total assets and liabilities are not allocated to operating segments and not analysed by the CODM.

Operating segments with similar economic characteristics have been aggregated into an integrated telecommunication services segment, which is the only reportable segment. Around 1% of the Group’s revenues and results are generated by segments outside of Russia. No single customer represents 10% or more of the consolidated revenues.

Reconciliation of consolidated OIBDA to consolidated profit before tax for the years ended 31 December:

2014 2013 OIBDA 138,520 132,592 Depreciation (47,431) (44,851) Amortisation (7,827) (6,131) Loss on disposal of non-current assets (1,437) (1,200) Finance costs (13,792) (12,184) Finance income 1,155 1,888 Share of loss of associates and joint ventures (516) (202) Other non-operating loss (1,370) (81) (Loss)/gain on financial instruments, net (50) 269 Foreign exchange loss, net (16,884) (2,914) Profit before tax 50,368 67,186

12. Income taxes The following presents the significant components of the Group’s income tax expense for the years ended 31 December:

2014 2013 Current income tax: Current income tax charge 9,069 16,212 Adjustments recognised for current tax of prior periods (648) 669 Deferred tax 4,947 (1,465) Income tax expense 13,368 15,416

Income tax is calculated at 20% of taxable profit for the years ended 31 December 2014 and 2013, respectively.

The reconciliation between the average effective income tax rate and the applicable Russian enacted statutory tax rate is as follows:

2014 2013 Statutory income tax rate 20.0% 20.0% Deferred tax assets write-off 3.0% – Non-deductible expenses 2.9% 1.5% Effect of intra-group transactions 1.6% 1.6% Effect of income tax preferences (0.7%) (0.2%) Other (0.3%) – Effective income tax rate 26.5% 22.9%

The increase in effective income tax rate during 2014 is primarily attributable to derecognition of deferred tax assets related to the investment in Euroset and the acquisition of Scartel as well as an increase in the effect of non-deductible expenses. The effect of intragroup transactions, in the table above, represents taxable intra-group income.

116 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information – (9)

117 10 65 721 198 376 2013 2013 2013 (166) (571) (698) (400) (260)

1,985 2,706 1,465 (1,465) (9,760) (5,794) (14,079) – for the years Statement of of Statement (profit and loss) 322 (86) 111 711 658 770 2014 2014 2014 908 384 806 (135) (861) comprehensive income 1,664 4,947 4,947 2,322 2,253 Annual Report 2014 (4,947) (18,790) (14,079) MegaFon MegaFon (48) 781 733 725 2013 (235) 1,184 3,673 2,706 (Note 9) (9,368) (17,752) (14,079) restated (10,557) December position as of 31 (45) 378 782 727 622 2014 (127) (624) Statement of financial 2,322 (9,233) (12,810) (18,790) (19,572) Balance at end of year Translation adjustment of foreign operations foreign of adjustment Translation Tax benefit/(expense)Tax during the year Change through equity (Note 10) Acquisition of subsidiaries (Note 9) Deferred tax relates to the following: Balance at beginning of year Scartel Property and equipment Property and MegaFon Retail MegaFon Balance at end of year Unrecognised deferred tax assets in the consolidated statement of financial position as December of 31 and 2014 amounted 2013 to Reconciliation of net deferred tax liabilities for the years ended December 31 is as follows: In order to utilise tax losses the Group is able to implement appropriate tax planning strategies depending on the resultssubsidiaries of these in subsequent periods. The tax planning strategies may include, among others, merging of theOJSC respective MegaFon which subsidiaries is expected with to have sufficient pretax income to utilise the accumulated tax losses of these subsidiaries. 2,202 and 463, respectively. An increase in unrecognised deferred tax assets is due to the difference betweenbases the of the accounting Euroset and investment tax which is not expected to be realised due to lack of appropriate taxable profits.related The remaining to unused part tax losses. is loss Tax carry-forwards available for utilisation by the Group expire in 2018-2024. Intangible assetsIntangible Derivative financial instruments financial Derivative Loss carry-forwards Revenue recognition Revenue Accrued employee benefits Accrued expenses Accrued Investments in joint ventures and subsidiaries and ventures joint in Investments Other movements and temporary differences and movements Other The Group recognised deferred tax assets in respect of the tax losses of the following subsidiaries: Deferred tax (benefit)/expense tax Deferred Reflected in the statement of financial position as follows: tax assets Deferred The Group recognises deferred tax assets in respect of tax losses carried forward to the extent thatfuture realisation taxable of tax profit losses is probable. against Deferred taxassets related to tax losses of the subsidiaries Group’s are recognisedplanning based on opportunities the tax that would be implemented, if necessary, to prevent unused tax losses. Net deferred tax liabilities Deferred tax liabilities Notes to the consolidated financial statements continued

13. Earnings per share The following table sets forth the computation of basic and diluted EPS for the years ended 31 December:

2014 2013 Numerator: Net profit attributable to equity holders of the Company 36,726 51,608 Add back: interest expense and foreign exchange loss on convertible debt instrument and gain on revaluation of purchased put option (Note 10) – 1,120 Net profit attributable to equity holders of the Company, adjusted 36,726 52,728

Denominator: Weighted-average ordinary shares outstanding 583,915,212 570,151,007 Effect of dilutive securities: Employee stock options (Note 25) 3,652,843 5,532,897 Assumed debt conversion (Note 10) – 18,454,992 Weighted-average diluted shares outstanding, adjusted 587,568,055 594,138,896

EPS – basic, Rubles 63 91 EPS – diluted, Rubles 63 89

118 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information – – 119 212 458 238 Total (212) (255) 5,019 1,405 9,492 (1,728) (2,591) 11,801 43,145 49,841 12,300 (47,431) (11,378) (16,359) (44,851) 416,973 416,973 499,914 499,914 454,789 224,655 220,272 (234,517) (201,424) (275,259) – – – – – – – – – – – – 7 42 (323) (287) 1,102 2,760 2,760 (1,265) Annual Report 2014 49,841 43,082 28,106 28,106 24,059 26,242 26,242 (40,249) (52,527) in-progress in-progress Construction – – – – – 2 MegaFon MegaFon 63 88 (69) 370 777 777 (689) 2,187 1,371 1,339 3,397 5,474 5,745 (1,738) (1,460) (3,391) (3,822) 26,748 24,310 23,062 (16,013) (21,274) (18,565) and other equipment Vehicles, office – – 4 90 (38) 212 176 176 297 438 808 (212) (317) (438) 1,405 2,971 2,591 (3,154) (4,541) (1,405) (4,364) 65,709 68,757 43,702 64,007 43,548 (16,530) (25,055) (20,459) structures Buildings and Buildings – – – – – – 225 238 (148) 7,824 2,332 8,994 (8,915) (1,585) 46,159 35,471 10,024 (10,480) (39,676) network (36,488) 378,167 378,167 304,143 304,143 149,237 142,873 338,366 (168,881) (195,493) (228,930) Telecommunications Property and equipment Additions Cost as of: 1 January 2013 14. Property and equipment is as follows: Acquisitions (Note 9) Disposals Transfer to AHFS (Note 22) Additions Put into use Acquisitions (Note 9) Translation December31 as 2013 restated (Note 9) Disposals Transfer from AHFS (Note 22) Put into use Translation December31 2014 Disposals Transfer to AHFS (Note 22) Translation December31 2014 Disposals Charge for the year Transfer from AHFS (Note 22) Depreciation as of: 1 January 2013 Translation December31 2013 Charge for the year Net book value: December31 2013 Assets purchased under certain contracts with deferred payment terms in the amount of 1,252 950) (2013: arerelated pledged liabilities. as security for the December31 2014 Included in construction in-progress are advances to suppliers of network equipment and of 1,601 2,673 as December at 31 and 2014 2013, respectively. Notes to the consolidated financial statements continued

15. Intangible assets Intangible assets are as follows:

Marketing Other related Other 4G operating operating intangible Customer intangible licences licences Frequencies Software assets base assets Total Cost as of: 1 January 2013 – 18,795 5,309 9,486 3,535 2,889 6,277 46,291 Additions – 28 1,323 2,063 – – 585 3,999 Acquisitions (Note 9) 42,879 – – 556 – 844 108 44,387 Disposals – (7) (427) (495) – (153) (628) (1,710) Transfer – (2) – 21 – (28) 9 – Translation – 17 – – – – – 17

31 December 2013 as restated (Note 9) 42,879 18,831 6,205 11,631 3,535 3,552 6,351 92,984

Additions – 87 1,298 3,633 137 – 1,476 6,631 Acquisitions (Note 9) – – – – – – 38 38 Disposals – (14) (344) (588) (226) – (566) (1,738) Transfer – – (71) – – – 71 – Translation – 162 – – – – 3 165

31 December 2014 42,879 19,066 7,088 14,676 3,446 3,552 7,373 98,080

Amortisation as of: 1 January 2013 – (14,955) (1,731) (5,881) (2,184) (951) (3,598) (29,300) Charge for the year (524) (791) (607) (2,469) (682) (288) (770) (6,131) Disposals – 1 341 437 – 29 499 1,307 Translation – (12) – – – – – (12)

31 December 2013 (524) (15,757) (1,997) (7,913) (2,866) (1,210) (3,869) (34,136) Charge for the year (2,144) (702) (783) (2,424) (720) (543) (511) (7,827) Disposals – – 248 552 140 – 516 1,456 Translation – (143) – – – – (3) (146)

31 December 2014 (2,668) (16,602) (2,532) (9,785) (3,446) (1,753) (3,867) (40,653)

Net book value: 31 December 2013 42,355 3,074 4,208 3,718 669 2,342 2,482 58,848 31 December 2014 40,211 2,464 4,556 4,891 – 1,799 3,506 57,427

Weighted- average remaining amortisation period, years 19 7 6 2 – 3 7 15

120 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information

14 121 2013 7,935 31,899 23,950

19 374 2014 Annual Report 2014 31,899 32,292 32,292 MegaFon MegaFon several 2G licences, a nationwide 3G licence, a nationwide 4G licence to use 2.5–2.7 GHz spectrum MHz band) (10x10 awarded to OJSC MegaFon in and 2012, a nationwide 4G licence to use 2.5–2.7 GHz spectrum (30x30MHz band) acquired in the Scartel business combination (Note 9). Goodwill The changes in the carrying value of goodwill, net of accumulated impairment losses of nil, for the years ended December 31 are as and follows: 2014 2013 Other intangible assets The Group accelerated amortisation of numbering capacity due in 2013 to the introduction of mobile number portability in Russia. Marketing related intangible assets primarily represent the rights and licences to use Olympic symbols and thePartner title of the General of the Games Mobile acquired in 2009 from the Organisational Committee of the XXII 2014 Olympic Winter GamesWinter and XI Paralympic Games in Sochi. The assets have been fully amortised December by 31 2014. Marketing related intangible assets Scartel, the Company’s subsidiary since October was 2013, licensed to use the 2.5–2.7 GHz spectrum (30x30 MHz band),three a frequency times broader band than the Company’s 4G frequency band licensed in and 2012, any of its competitors’ licences in Russia. Theselicences are 4G amortised on a straight-line basis over their estimated useful lives of 20 years. 2G licences are amortised on a sum-of-the-years’-digits basis over a period years of 10 which reflects the pattern in which the economicbenefits of these operating licences are expected to be consumed or otherwise used up and assumes a gradual decrease in the number Nationwide 3G and 4G licences were obtained by OJSC MegaFon at nominal cost in 2007 and respectively, 2012, but require the Company meetto certain conditions, including capital commitments and coverage requirements (Note31). • • • These licences are integral to the wireless operations of the Group and any inability to extend existing licences on theterms same could or comparable materially affect the business. Group’s While operating licences are issued for a fixed period, renewals of these licencespreviously had occurred routinely and at nominal cost. The Group determines that there are currently no legal, regulatory,competitive, contractual, economic or other factors that could result in delays in licence renewal, or even an outright refusal to renew. of 2G subscribers (Note December 31 5). At the 2014 weighted-average period until the next renewal date of 2G licences is approximately years. 1.5 As of 1 January the 2013 gross book value and accumulated amortisation of numbering capacity were and 1,839 1,622, respectively. • Operating licences primarily consist of: Operating licences and frequencies and licences Operating Operating licences and frequencies provide the Group with the exclusive right to utilise a certain radio services. frequency communication wireless spectrum to provide Balance at end of year Acquisitions (Note 9) adjustmentsMeasurement period Balance at beginning of year Notes to the consolidated financial statements continued

16. Impairment test (a) Goodwill The Group performs its annual goodwill impairment test as of 1 October of each year using data that is appropriate at that time. The test has been further updated as at 31 December 2014 considering the external indicators observed in the market at the end of 2014.

The Group considers the relationship between market capitalisation and its book value, among other factors, when reviewing for indicators of impairment. As of 31 December 2014, the market capitalisation of the Group was not below the book value of its equity.

As a result of the annual test, no impairment of goodwill was identified in 2014 or 2013.

Goodwill acquired through business combinations has been allocated to related CGUs and groups of CGUs as follows:

31 December 2013 restated 2014 (Note 9) Integrated telecommunication services (group of CGUs) 25,262 17,327 Broadband internet CGU 6,812 6,419 Other 218 218 Total allocated goodwill 32,292 23,964

Unallocated: Scartel (Note 9) – 7,935 Total goodwill 32,292 31,899

In assessing whether goodwill has been impaired, the carrying values of the CGUs (including goodwill) were compared with their estimated recoverable amounts.

Integrated telecommunication services (group of CGUs) The recoverable amount of the integrated telecommunication services group of CGUs has been determined based on its fair value less costs to sell (Level 3). The fair value was estimated based on a multiple of earnings, which is 4 times OIBDA, which represents a lower point of the range observed in the market for acquisitions of similar businesses. The fair value was reduced by 5% as an estimate of costs to sell the business.

Management believes that a change in any of these key assumptions which currently could be reasonably anticipated would not cause the aggregate carrying amount of the integrated telecommunication services group of CGUs to exceed the aggregate recoverable amount of this unit.

Broadband internet CGU The recoverable amount of the broadband internet CGU has been determined based on its value in use. The value in use was estimated using cash flow projections from financial budgets approved by senior management covering 2015 and further seven-year projections. Due to a less favourable economic environment foreseen for the next two years, the extended forecast period has been used for testing to take into account different growth rates forecasted in the long term.

The calculation of value in use for the broadband internet unit is most sensitive to the following assumptions: average monthly revenue per user (“ARPU”), discount rates, market share in Moscow, salary growth index and capital expenditures (“CAPEX”) to revenues ratio. The key assumptions used in the forecast are as follows:

31 December 2014 2013 Growth/(reduction) of ARPU for retail customers during the forecast period by 5.0% (3.0%) Pre-tax discount rate 16.3% 12.9% Market share in Moscow (in terms of retail customer base) 7.1% 8.0% Annual salary growth rate during the forecast period 7.5% 4.5-7.1% CAPEX/Revenue ratio from 2018 10.5% 10.0-10.5%

Revenue growth is projected based on market share, traffic growth and other factors.

122 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information 123

Annual Report 2014 MegaFon MegaFon 3.5% 2.9% 17.9% 15.1% 10.1% 17.8% 14.6% 48.0% Investment in Euroset joint venture ability to realise synergy related to savings on dealers’ commissions in the long run, discount rate applied for synergy effect estimation, annual dealer commission savings as compared to pre-deal market rates. The recoverable amount of investment has been determined based on its value in use. The value in use was estimated usingprojections cash flow from financial budgets approved by senior management covering and 2015 further seven-year projections,of synergy including effects estimates from the dealer Group’s commission savings which were incorporated into the purchase cost ofacquisition the investment of Euroset, for the as the primary reason for the investment in Euroset was to realise benefits from synergiesof subscriber related acquisition to a reduction costs of the Group due to implementation of a revenue sharing model, procurement savingsmarketing and prominent ofMegaFon services in Euroset outlets. Due to a less favourable economic environment foreseen for the next two years, As a result of the test, no impairment of investment has been identified. (b) Following the adverse changes in economic environment and the decline in the market observed at the end an of 2014 impairmenthas been performed test for the investment in Euroset as December at 31 2014. Pre-tax discount rate applied for synergy effects estimation • • • The key assumptions used in the forecast as December at 31 are 2014 as follows: The assessment of value in use for the investment is most sensitive to the following assumptions: Dealer commission savings are estimated based on the level of market commissions prior to the acquisition of share in Eurosetdecrease and the of the dealer Group’s commission put into effect after the deal. The management Group’s expects to realise the synergieslong term. in the Growth of ARPU for retail customers during the forecast period reducing to Pre-tax discount rate increasing to Market share in Moscow reducing to Annual salary growth rate during the forecast period increasing to CAPEX/Revenue ratio from increasing 2018 to Thereare no reasonably possible changes in other assumptions that could result in impairment for the broadband internet unit. the extended forecast period has been used for testing to take into account different growth rates forecasted in the long term. Euroset pre-tax discount rate Annual dealer commission savings The discount rate applied for synergy effects estimation represents the current market assessmentand the investee, of the risks taking specific into consideration to the Group the time value of money and individual risks of the underlying assetsincorporated that have not been in the cash flow estimates. The discount rate calculation is based on the specific circumstancesinvestee of the Group and is derived and the from their The WACC. takes WACC into account both debt and equity. The cost of equity is derived from the expected return on investment by the and Group’s Euroset investors. The cost of debt is based on the interest-bearing borrowingsGroup and the Euroset is obliged to service. Segment-specific risk is incorporated by applying individual beta factors.evaluated The beta annually factors based are on publicly available market data. Sensitivity changes to in key assumptions The estimated recoverable amount of the broadband internet unit exceeds its carrying value The by 2,015. following changesassumptions in the key made independently, with other all assumptions constant, would result in impairment for the broadbandinternet unit: Annual salary growth is projected based on inflation estimates. The discount rate represents the current market assessment of the risks specific to the taking CGU, into considerationof money and individual the time risks value of the underlying assets that have not been incorporated in the cash flow estimates.calculation The discount is based rate on the specific circumstances of the Group and its operating segments and is derived fromcost of capital its weighted (“WACC”). The takes average WACC into account both debt and equity. The cost of equity is derived from the expected returnon investment by the investors. Group’s The cost of debt is based on the interest-bearing borrowings the Group is obliged to service.Segment-specific risk is incorporated by applying individual beta factors. The beta factors are evaluated annuallyavailable based market on publicly data. Notes to the consolidated financial statements continued

16. Impairment test (continued) Sensitivity to changes in key assumptions The estimated recoverable amount of the investment exceeds its carrying value by 5,012. The following changes in the key assumptions made independently, with all other assumptions constant, would result in impairment for the investment in Euroset:

Pre-tax discount rate applied for synergy effects estimation increasing to 16.6% Euroset pre-tax discount rate increasing to 19.8% Annual dealer commission savings reducing to 44.0%

The key management judgment underlying this impairment model is whether the above synergies can be realised in perpetuity. If related synergies are not realised and sustained, a significant impairment loss would be recorded.

There are no reasonably possible changes in other assumptions that could result in impairment for the investment.

17. Financial assets and liabilities Financial assets

31 December 2013 restated 2014 (Note 4) Trade and other receivables (Note 20) 16,260 12,493

Other financial assets: Financial assets at fair value through profit or loss: Cross-currency swap not designated as hedge 1,533 300 Euroset settlement put option (Note 10) – 1,176 Total financial assets at fair value through profit or loss 1,533 1,476

Financial assets at fair value through OCI: Cross-currency swap designated as cash flow hedge 2,082 125 Total financial assets at fair value through OCI 2,082 125

Loans and receivables: Short-term bank deposits in Rubles 15,730 3,855 Short-term bank deposits in HK dollars 27,458 – Short-term bank deposits in US dollars 4,346 34,265 Bank promissory notes 601 – Total loans and receivables 48,135 38,120

Total other financial assets 51,750 39,721 Other current financial assets (48,887) (39,296) Other non-current financial assets 2,863 425

Total financial assets 68,010 52,214 Total current financial assets (65,147) (51,789) Total non-current financial assets 2,863 425

124 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information – – – 125 128 337 209 177 950 283 2013 (Note 4) 30,604 (21,184) 39,198 61,623 35,636 20,678 20,838 20,838 46,063 46,063 75,342 75,342 (97,605) restated 213,295 (40,785) 151,663 130,825 152,009 249,268 – – 31 December 5 16 33 16 215 248 150 2014 7,257 1,252 1,270 8,928 Annual Report 2014 37,364 (7,658) 95,140 95,140 74,964 74,964 36,622 36,622 216,132 (51,149) (95,429) 157,589 157,589 156,319 253,018 207,468 MegaFon MegaFon Bank loans Bank Equipment financings Ruble bonds Ruble Deferred consideration for Scartel (Note 9) Long-term accounts payable 9) (Note consideration Contingent Due to employees and related social charges, non-current Interest rate swaps designated as cash flow hedges hedges flow cash as designated Cross-currency swaps Convertible debt instrument (Note 10) hedge as designated not Cross-currency swap Liability for marketing related licences (Note 15) Financial liabilities Trade and Trade other payables (Note 24) Financial liabilities at amortised cost: Loans and borrowings: Total currentTotal loans and borrowings

Total loansTotal and borrowings non-currentTotal loans and borrowings Other financial liabilities at amortised cost: financialTotal liabilities at amortised cost financialTotal liabilities at fair value through profit and loss Financial liabilities at fair value through OCI: other financialTotal liabilities Other current financial liabilities Other financialliabilities at fair value: Financial liabilities at fair value through profit or loss:

Total financialTotal liabilities at fair value through OCI Total financialTotal liabilities Other non-current financial liabilities non-currentOther financial Total non-currentTotal financial liabilities Total currentTotal financial liabilities Notes to the consolidated financial statements continued

17. Financial assets and liabilities (continued) Loans and borrowings Principal amounts outstanding under loans and borrowings are as follows:

Weighted-average 31 December interest rate Maturity 2014 2013 Bank loans: Ruble loans – fixed rates 9.48% 2015-2020 92,072 73,579 US dollar loans – floating rates LIBOR+2.53% 2015 3,375 1,963 Total bank loans 95,447 75,542

Equipment financings: Ruble loans – fixed rates 10.00% 2015-2018 734 – US dollar loans – fixed rates 2.27% 2015-2022 9,521 7,202 US dollar loans – floating rates LIBOR+2.30% 2015-2022 61,339 35,241 Euro loans – fixed rates 3.74% 2015 310 613 Euro loans – floating rates EURIBOR+2.05% 2015-2019 3,785 3,552 Total equipment financings 75,689 46,608

2022-2024 with a put Ruble bonds 8.68% option in 2015-2018 36,751 30,000

Total 207,887 152,150 Total current (50,299) (20,483) Total non-current 157,588 131,667

Ruble revolving credit facilities In July 2014 the Group signed a three-year revolving credit facility agreement for up to 12,000. To date, no amount has been drawn under this credit facility.

In December 2014 the Group drew 15,000 under its existing 30,000 revolving credit facility agreement. The tranche has a term of two years. The funds will be used to finance current activities and, in particular, to provide additional liquidity to mitigate revaluation risks for short-term, foreign currency denominated liabilities.

Equipment financing facilities In February 2014 the Group signed a new credit facility agreement for up to US$ 150 million (8,439 at the exchange rate as of 31 December 2014). The credit facility must be used to finance purchases of equipment and related services and requires the Group to make semi-annual payments, plus accrued interest, during the period from 2014 to 2022. An equivalent of 2,684 at the year-end exchange rate has been drawn and is outstanding at 31 December 2014 under this credit facility.

In October 2014 the Group signed a new loan facility agreement for up to 1,350. The loan facility agreement must be used to finance purchases of equipment. At 31 December 2014, 734 has been drawn under this loan facility.

In December 2014 the Group signed a Term Loan Facility Agreement for up to US$ 500 million (28,129 at the exchange rate as of 31 December 2014), with a seven-year-tenor. The proceeds will be used to finance purchases of equipment and related services (Note 31). To date, no amount has been drawn under this loan facility.

Ruble bonds On 20 May 2014 the Group placed its Series BO-04 Ruble denominated exchange bonds, in an aggregate principal amount of 15,000. The bonds are due for repayment in full in May 2024 subject to a put option exercisable by the bond holders on the first anniversary of the placement. The coupon rate was set at 9.45% per annum, paid semiannually, and will be revised in one year from the bonds’ placement. The net proceeds of the bonds were used to partially repay the liability for deferred consideration for Scartel (Note 29).

On 14 October 2014 the Group re-purchased 8,249,296 Series 05 bonds (out of 10,000,000 initially issued in October 2012) at their nominal value of 1,000 Rubles each under a mandatory put option exercisable by the bond holders following a coupon rate reset on 24 September 2014. At 31 December 2014 the bonds are kept in treasury and may be further placed in the market should the Group decide to. The rest of the Series 05 bonds will continue trading in the market with a coupon rate of 9.85% p.a. for a period of eighteen months, after which the rate will be subject to further reset and the bonds will be subject to a further put option.

126 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information 127 495 9,079 3,502 Rubles 19,347 12,581 18,852 Millions, Millions,

11 107 576 278 December31 2013 Annual Report 2014 original Millions, currency – MegaFon MegaFon 4,276 Rubles 26,104 25,879 25,879 30,380 Millions, – 76 460 464 December31 2014 original Millions, currency Euro Original currency US Dollar Dollar US US Dollar US US Dollar US designated as cash flow hedge not designated as cash flow hedge designated as cash flow hedge designated as cash flow hedge Interest rate swaps: The Group had the following outstanding interest rate swaps and cross-currency swaps stated at their notional amounts: Hedging activities and derivatives and activities Hedging In the normal course of business, the Group is exposed to certain risks related to fluctuations in interest ratesexchangeand foreign rates. currency The Group uses derivative contracts, primarily interest rate swaps and foreign currency swaps, to manage those risks. Capitalised borrowing costs borrowing Capitalised Interest capitalised was (out of the 1,789 total interest expense and 1,382 of 15,581) (out of the total interest expense of 13,566) Covenant requirements The majority of financing facilities contain restrictive covenants, which, among other things, with permittedability to incur exceptions, debt, encumber limit the Group’s assets, undertake mergers and acquisitions and make material changeswithout in the nature prior of consent the business from the required majority of lenders. In addition, these financing facilities require covenants.financial the Group to meet various for the years ended December 31 and respectively. 2014 2013, The rate used to determine the amount of borrowing costs eligible for capitalisation for was the 7.2% years ended December 31 and 2014 The 2013. interest capitalised has been paid in cash during the respective periods.

Total interestTotal rate swaps Cross-currency swaps:

Total cross-currency swaps cross-currency Total Accordingly, December at 31 the 2014 Group had two cross-currency swap agreements in place that were not designated as cash flow hedges. The terms of the swap agreement did not meet the requirements for hedge accounting, therefore the Group haslosses reported from the gains all change and in fair value of this derivative financial instrument directly in the consolidated profit and loss. Derivatives not designated as hedging instruments In March the 2014 Group entered into a cross-currency swap agreement with a notional amount of US$ at the 243 million exchange (13,671 rate as December of 31 that 2014) limits the exposure from changes in US dollar exchange and interest rates on certain long-term debt. The swap has been designated and qualified as a cash flow hedge of foreign currency risk. There has been no ineffectivereporting period. portion in the Cross-currency swap designated as a cash flow hedge December 31 At the 2014 Group had a fixed-to-fixed rate cross-currency swap agreement in place that limits theexposure in US from dollar exchange changes rates on certain long-term debt. The interest rate swaps have been designated and qualified as cash flow hedges of interest rate risk. There has beenportion no ineffective in the reporting period. Interest rate swaps involve the receipt of variable-rate amounts from a counterparty in exchange for the Grouppayments making fixed-rate over the life of the agreements without the exchange of the underlying principal amount of long-term debt. Cash flow hedges of interest rate risk The objective Group’s in using interest rate derivatives is to add certainty and stability to its interest expense and to manageto interest its rate exposure movements. accomplish To this objective, the Group primarily uses interest rate swaps as part of its interest strategy. management rate risk Notes to the consolidated financial statements continued

17. Financial assets and liabilities (continued) The table below presents the effect of the Group’s derivative financial instruments designated as cash flow hedges on the consolidated statements of comprehensive income for the years ended 31 December:

2014 2013 Interest rate swaps: Amount of loss recognised in cash flow hedge reserve (61) (48) Amount of loss reclassified from accumulated cash flow hedge reserve into finance costs 216 139 Deferred tax on movements in OCI (31) 34 124 125

Cross-currency swap: Amount of gain/(loss) recognised in cash flow hedge reserve 1,981 (2) Amount of gain reclassified from accumulated cash flow hedge reserve into foreign exchange loss, net (1,899) (47) Amount of loss reclassified from accumulated cash flow hedge reserve into finance costs 134 63 Deferred tax on movements in OCI (43) (3) 173 11

Total in OCI 297 136

At 31 December 2014, the amount recorded in OCI which is expected to be reclassified to profit and loss in the next twelve months is 604 (gain), the remaining gain of 1,305 is expected to affect the earnings in 2016-2017.

(Loss)/gain on financial instruments Gains and losses on other financial instruments are recognised in profit and loss as follows:

2014 2013 Change in fair value of financial instruments measured through profit or loss: Euroset settlement put option 435 58 Cross-currency swaps not designated as hedges (485) (52) Gain from settlement of Synterra contingent consideration – 263 Total (loss)/gain on financial instruments, net (50) 269

On 2 August 2013 the Group settled the contingent consideration which was due under the sale and purchase agreement dated 2 June 2010 for the acquisition of CJSC Synterra. In full settlement, the Group transferred to the sellers its 60% interest in CJSC Synterra-Media (a provider of telecommunication services to TV broadcasters), its 100% interest in CJSC Absolut (the owner of the Group’s head office building in Moscow) and a cash payment of US$ 7 million (231 at the exchange rate as of 2 August 2013). The resulting gain of 263 was recognised in the consolidated statement of comprehensive income within profit and loss.

Foreign exchange loss Net foreign exchange loss recognised for the years ended 31 December arose from the following financial assets and liabilities denominated in foreign currencies:

2014 2013 Financial assets: Loans and receivables 14,031 1,842 Cash and cash equivalents 4,769 108 Trade and other receivables 191 10 Other financial assets 3,824 414

Financial liabilities: Loans and borrowings (30,617) (3,449) Trade and other payables (3,282) 13 Other financial liabilities (5,800) (1,852)

Total foreign exchange loss, net (16,884) (2,914)

128 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information

129 – – – 125 177 128 950 300 209 283 2013 1,176 1,851

39,198 38,120 20,678 39,721 29,980 216,126 124,523

Fair valueFair – – – – 5 31 December 16 33 215 150 Annual Report 2014 601 2014 7,257 1,533 1,252 2,082 47,534 51,750 34,664 161,981 205,573 MegaFon MegaFon – – –

125 177 950 300 209 128 283 2013 1,176 1,516 39,198 38,120 20,678 30,604 39,721 121,405 213,632 213,632 – – – – 5 31 December 16 33 Carrying amount Carrying 215 150 601 2014 7,257 1,252 2,082 1,533 47,534 51,750 37,364 170,104 216,396 216,396 Level 2 Level 3 Level 2 Level 2 Level 2 Level 3 Level 2 Level 1 Level 3 Level 3 Level 2 Level 3 Level 3 Level 2 Level 3 Level 2 Level 2

Cross-currency swap not designated as hedge as designated not Cross-currency swap Euroset settlement put option option put settlement Euroset Cross-currency swap designated as cash flow hedge flow cash as designated Cross-currency swap Short-term bank deposits bank Short-term Bank promissory note promissory Bank borrowings and Loans Ruble bonds Ruble Contingent consideration Contingent instrument debt Convertible (Due to Garsdale for Euroset, Note 10) Long-term accounts payable Liability for marketing related licences Deferred consideration for Scartel for consideration Deferred Cross-currency swaps designated as cash flow hedges hedges flow cash as designated Cross-currency swaps Cross-currency swap not designated as hedge as designated not Cross-currency swap hedges flow cash as designated swaps Interest-rate Financial assets: Financial assets at fair value through profit or loss: Fair valuesFair Set outbelow is a comparison by class of the carrying amounts and fair values of the financial Group’s instruments and certain non-financial assets that are carried in the financial statements:

Financial assets at fair value through OCI: Loans and receivables at amortised cost: financialTotal assets Financial liabilities: Financial liabilities at amortised cost: Assets held for sale

Total financialTotal liabilities

Financial liabilities at fair value through profit or loss: Financial liabilities at fair value through OCI: The Group, in connection with its current activities, is exposed to various financial risks, such as foreignand currency credit risks. risks, The Group interest manages rate risks these risks and monitors their exposure on a regular basis (Note 30). Interest-rate swaps and cross-currency swaps are valued using valuation techniques which employ the use of marketThe observable most frequently inputs. applied valuation techniques include swap models, using present value calculations. The modelsinputs incorporate including various the credit quality of counterparties, foreign exchange spot and forward curves. rate rates, interest and currencies respective the yield between curves spreads currency basis of the respective currencies, December31 was 2014 assessed to be insignificant. Fair valuesFair of the loans Group’s and borrowings, except for market quoted bonds, are determined by using a discounted cash flow methodusing a discount rate that reflects the issuer’s borrowing rate as at the end of the reporting period. The own non-performance risk as at The Group, using available market information and appropriate valuation methodologies, where they exist, has determinedfairvalues of its the financial estimated instruments. However, judgment is necessarily required to interpret market data to determinefairvalue. the Accordingly, estimated the estimates presented herein are not necessarily indicative of the amounts the Group could realisemarket in a current exchange. While management has used available market information in estimating the fair value of its financialmarket instruments, information may not the be fully reflective of the value that could be realised in the current circumstances. Management has determined that cash, short-term deposits, trade receivables, trade payables, bank overdraftsliabilities approximate and other current their carrying amounts largely due to the short-term maturities of these instruments. Due to employees and related social charges, non-current Notes to the consolidated financial statements continued

17. Financial assets and liabilities (continued) The following tables summarise the valuation of financial assets and liabilities measured at fair value on a recurring basis by the fair value hierarchy:

Euroset Cross- Total Interest rate/ Total settlement currency financial cross-currency financial put option swaps assets swaps liabilities 31 December 2014 Level 1 – – – – – Level 2 – 3,615 3,615 (264) (264) Level 3 – – – – – Total as of 31 December 2014 – 3,615 3,615 (264) (264)

31 December 2013 Level 1 – – – – – Level 2 – 425 425 (337) (337) Level 3 1,176 – 1,176 – – Total as of 31 December 2013 1,176 425 1,601 (337) (337)

During the years ended 31 December 2014 and 31 December 2013 there were no transfers between levels of the fair value hierarchy.

The table below presents a reconciliation of the beginning and ending balances of financial instrument having fair value measurements based on significant unobservable inputs (Level 3) for the years ended 31 December:

Euroset settlement put option 2014 2013 Balance at beginning of year 1,176 1,118 Realised gains/(losses) recognised in profit or loss – – Unrealised gains recognised in profit or loss (gain on financial instruments line) 435 58 Settlements (Note 10) (1,611) – Balance at end of year – 1,176

18. Non-financial assets and liabilities Current non-financial assets are as follows:

31 December 2014 2013 Prepayments for services 2,473 2,113 VAT receivable 1,274 2,857 Deferred costs 1,096 478 Prepaid taxes, other than income tax 235 231 Prepayments for inventory 83 281 Total current non-financial assets 5,161 5,960

Non-current non-financial assets are as follows:

31 December 2014 2013 Deferred costs, non-current 1,581 968 Long-term advances 472 332 Total non-current non-financial assets 2,053 1,300

130 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information 51 131 61 475 287 359 750 2013 2013 2013 1,013 1,205 8,376 5,396 1,170 1,759 4,581 3,064 10,035 19,490 31 December 31 December 31 December 16 76 617 310 433 327 2014 2014 2014 1,156 3,968 6,484 1,712 1,573 1,573 1,894 1,309 1,309 5,596 Annual Report 2014 11,414 20,493 MegaFon MegaFon Inventory Current non-financial liabilities are as follows: USB modems USB SIM-cards Handsets 19. Inventory is as follows: Electronic devices and accessories Other Deferred revenue Advances from customers from Advances Total inventory Total The amount of inventory write-down to net realisable value and other inventory losses recognised in the ‘Cost of equipmentaccessories’ and line in the statement of comprehensive income for the year ended December 31 is 2,202 2014 1,560). (2013: Other current liabilities currentTotal non-financial liabilities Advance received for sale of property and equipment VAT payable Current portion of deferred revenue deferred of portion Current payable,Taxes other than income tax Non-current non-financial liabilities are as follows: Other non-current liabilities non-current Other liabilities non-current non-financial Total Notes to the consolidated financial statements continued

20. Trade and other receivables Trade and other receivables are as follows:

31 December 2013 restated 2014 (Note 4) Local subscribers 7,154 5,245 Interconnection charges 4,398 3,612 Rebates receivable 1,917 1,605 Dealers 1,731 1,921 Content providers 521 114 Property and equipment sold 462 226 Roaming charges receivable 440 414 Other receivables 1,159 818 Impairment allowance (1,522) (1,462) Total trade and other receivables 16,260 12,493

The ageing analysis of financial assets that are neither past due nor impaired is as follows:

31 December 2013 restated 2014 (Note 4) Neither past due nor impaired 14,342 11,047 Past due but not impaired: Less than 30 days 703 722 30-90 days 768 457 More than 90 days 447 267 Total trade and other receivables 16,260 12,493

The following table summarises the changes in the impairment allowance for trade and other receivables for the years ended 31 December:

2014 2013 Balance at beginning of year 1,462 1,259 Change in the impairment allowance 1,216 1,163 Accounts receivable written off (1,156) (960) Balance at end of year 1,522 1,462

21. Cash and cash equivalents Cash and cash equivalents are as follows:

31 December 2014 2013 Cash at bank and on hand in Rubles 4,264 1,984 US dollars 4,866 119 HK dollars 1,919 – Euros 110 36 Short-term bank deposits in Rubles 2,411 1,549 US dollars 5,825 6,251 HK dollars 2,828 – Total cash and cash equivalents 22,223 9,939

132 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information

133

934 663 232 722 368 256 256 268 2013 2013 968 588 5,916 1,677 5,724 1,366 1,366 2,754 5,355 3,800 2,827 2,827 2,384 (1,445) (Note 4) 10,989 35,636 restated – 31 December 571 570 832 627 289 2014 2014 640 548 1,105 1,661 1,708 3,971 1,362 1,362 5,078 5,355 5,355 4,875 2,379 4,958 Annual Report 2014 (1,234) 11,243 36,622 36,622 MegaFon MegaFon Assets held for sale Trade andTrade other payables Provisions 23. Decommissioning provision The following table describes the changes to the decommissioning provision for the years ended December: 31 22. In December the 2013 Group decided to sell its office building in with the carrying value of 1,405 at the date of classificationas held for sale (Note Following 14). the slowdown in the real estate market, in December the 2014, Group decided to change the initial plan and retain the building. Accordingly, the building has been reclassified from assets held for sale back to property and equipment. The Group recognised depreciation that would have been accumulated had the asset not been classified as held for sale in the amount of 33 in the consolidated statement of comprehensive income for the year ended December 31 2014. Advertising Roaming charges payable given rebates Roaming Equipment suppliers Trade andTrade other payables are as follows: 24. charges Interconnection Due to employees Dealers utilities and Rent Social charges rental Channels providers Content Network repairs and maintenance Balance at beginning of year Inventory Other payables Other Revisions in estimated cash flows tradeTotal and other payables Acquisitions (Note 9) Additions Unwinding discount of Balance at end of year Revisions in estimated cash flows during the years ended December 31 and 2014 in the 2013 table above mainly relate to a decrease in expected decommissioning costs per item, as well as an increase in discounting rate and long-term inflation forecast,buildings which and structures also reduced cost in property and equipment (Note 14). Notes to the consolidated financial statements continued

25. Share-based compensation Long-term incentive programme 2013 In August 2013 the Company’s Board of Directors approved a long-term motivation and retention program for certain key executive and senior level employees under which the parties selected to participate are awarded phantom share options. In the aggregate, the value ascribed to the full package of phantom share options for which options may be awarded is 1.1% of the share capital of the Company (equal to 7,000,000 phantom shares) at the base price of US$ 24.25 per share. The plan has a three-year duration and the awarded share options vest in April-May 2015 and April-May 2016 and are settled in cash upon vesting. Payments shall be made on the basis of the difference between the base price and the weighted-average price of the Company’s shares in the period between 15 January and 15 March of the relevant year of vesting. Vesting of the options is generally contingent upon the recipient’s continuing employment with the Group.

In June 2014 a total number of 2,192,000 phantom share options were granted to certain key executive and senior level employees under the 2013 long-term incentive programme.

The respective awards are classified as a liability. The fair value of the options has been estimated using the Monte Carlo model. The fair value of each grant is estimated at the end of each reporting period. The expected volatility is estimated based on the average historical volatility of publicly traded guideline companies over the period equal to the expected life of the options granted. The dividend yield is included in the model based on expected dividend payments. The risk free rate is determined on the basis of U.S. Treasury yield curve rates with a remaining term to maturity equal to the expected life of the options. The expected term of the options equals their vesting term as the options are settled in cash at the end of the vesting period.

The fair value of options outstanding at 31 December 2014 is 8 Rubles per option. The carrying amount of the liability relating to these awards at 31 December 2014 is 5. The employee benefits expense recognised during the year ended 31 December 2014 in the consolidated statement of comprehensive income is 5, including related social charges.

Long-term incentive programme 2012 In October 2012 the Company’s Board of Directors approved a long-term motivation and retention programme for certain key executive and senior level employees under which the parties who are selected to participate are awarded phantom share options. In the aggregate, the value ascribed to the full package of phantom share options available for award is 1.1% of the share capital of the Company (equal to 7,000,000 phantom shares) at the base price of US$ 17.86 per share. The plan has a three-year duration and the awarded share options vest in April-May 2014 and April-May 2015 and are settled in cash upon vesting, based on the difference between the base price and the weighted-average price of the Company’s shares in the period between 15 January and 15 March in the relevant year of vesting. Vesting of the options is generally contingent upon the recipient’s continued employment with the Group.

In February 2013 a total number of 2,133,000 phantom share options were granted to certain key executive and senior level employees under the 2012 long-term incentive programme.

The respective awards are classified as a liability. The valuation technique is described in ‘Long-term incentive programme 2013’ above.

The following table illustrates the major assumptions of the Monte Carlo model for the options for the years ended 31 December:

31 December 2014 2013 Expected term, years 0.2 0.3-1.3 Expected volatility 59% 24%-26% Expected dividend yield 7.0% 7.5% Risk free interest rate 0.07% 0.21%

In May 2014, 788,400 phantom share options vested and were exercised. During the year ended 31 December 2014, using its discretion under the plan, Group management permitted employees leaving the Group, who were considered deserving, to exercise a total of 45,000 options, notwithstanding the requirements of the plan set forth above.

134 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information – – – 135

options options (60,000) (60,000) (88,000) (28,400) (833,400) 2,133,000 Number of Number of 1,123,200 (7,750,000) (7,750,000) 1,985,000 15,500,000 15,500,000 15,500,000 23,250,000 Annual Report 2014 MegaFon MegaFon The following table summarises the share price and number of options: Exercised at US$ 23.88 (735 Rubles) per option Outstanding as of 1 January 2013 The awards are classified as equity. The following table summarises the share prices and number of options: Pursuant to the plan, Mr Tavrin was also given three options to buy up to a further 1.25% of the total issued shares on each of hisemployment anniversary dates in May May and 2013, 2014 May atthe 2015 IPO price. The options can be exercised, in whole or in part, On 4 March the 2014 Board of Directors of the Company agreed unanimously to amend the terms of the CEO long-term incentiveto accelerate plan and the vesting final two of Mr Tavrin’s options to acquire a 1.25% interest in the Company, so that the all remaining options may now be exercised at any time after 1 May The 2014. change resulted in an additional employee benefits charge of 380 for the December year31 ended due 2014 to the accelerated vesting, including incremental fair value recognised in the amount in the of 111, first half of 2014. In addition, the Board agreed to remove a restriction on Mr Tavrin holding more than 5% of the authorised share capital of theany Company time prior to at May 2017. As part of a long-term incentive plan approved by the Company’s Board of Directors in November Mr 2012, Ivan Tavrin, the CEO of the Company, agreed to purchase, within 30days of the IPO, of the 7,750,000 Group’s ordinary Group’s shares 1.25% (or of the total issued shares) at the IPO price of US$ 20 per share. Mr Tavrin exercised the option in December 2012. on those dates or subsequently, when any up till May unexercised 2017, portion will lapse. Their exercise is subject continued to Mr Tavrin’s employment with the Group and Mr Tavrin holding at least a 1.25% interest in the Company on the relevant exercise date. Mr Tavrin exercised the first of these three options in May and 2013 transferred a consideration of 4,869 to the Group. Outstanding as of December 31 2013 Exercisable as December of 31 2013 Outstanding as of December 31 2014 Exercisable as December of 31 2014 On 30 December Mr Tavrin exchanged 2014 his 2.5% interest in the Company and the 15,500,000 unexercised options for an interest in USMHL (Note 29). CEO long-term incentive plan Granted in February 2013 Exercised at US$ Rubles) 33.52 per (1,091 option Forfeited Outstanding as of December 31 2013 Exercisable as December of 31 2013 Exercised at US$ 29.34 Rubles) (1,045 per option Forfeited Outstanding as of December 31 2014 Exercisable as December of 31 2014 The fair value of options outstanding December at 31 458) is nil (2013: 2014 Rubles per option. The carrying amount of the liability relatingto these awards December at 31 493) is nil (2013: as 2014 options became out-of-money due to reduction in the Company’s US Dollar- denominated share price. The respective reversal of liability has reduced the employee benefits expense December31 recognised in the 2014 consolidated during the statement year ended of comprehensive income by 557 (2013: 186 expense), including related social charges. Notes to the consolidated financial statements continued

26. Long-term incentive programme In April 2008 the Group’s Board of Directors approved a long-term motivation and retention programme. Under this programme certain key executive and senior level employees are eligible for cash benefits that depend on the increases in the Company’s value which is based on a formula driven calculation. These benefits vest every two years over a four-year period and are contingent upon the recipient’s continuing employment with the Group and an increase in the value of the Group as calculated. These benefits are accounted for as other long-term employee benefits with accrued liabilities included in trade and other payables (Note 24) and non-current financial liabilities (Note 17) in the accompanying consolidated financial statements as of 31 December 2014 and 2013 in the amounts of 80 and 320, respectively. Current service costs and related social charges recognised as employee benefits cost under the programme for the years ended 31 December 2014 and 2013, included in general and administrative expenses (Note 28), totalled 10 and 176, respectively.

27. Sales and marketing expenses Sales and marketing expenses for the years ended 31 December are as follows:

2014 2013 Advertising 6,598 8,797 Dealer commissions for connection of new subscribers 5,864 5,805 Cash collection and other commissions 3,994 4,085 Total sales and marketing expenses 16,456 18,687

During the year ended 31 December 2014, advertising costs reflect the de-recognition of approximately 1,200 of amounts accrued in previous periods.

28. General and administrative expenses General and administrative expenses for the years ended 31 December are as follows:

2014 2013 Employee benefits and related social charges 27,605 27,866 Rent 15,711 13,184 Operating taxes 6,828 7,106 Network repairs and maintenance 6,231 5,622 Radio frequency fees 5,488 4,163 Utilities 5,061 4,372 Office maintenance 2,227 1,882 Change in the impairment allowance account for trade and other receivables and advances to suppliers 1,398 2,037 Professional services 1,025 1,213 Vehicle costs 805 696 Materials and supplies 244 194 Insurance 65 81 Other expenses 2,502 2,142 Total general and administrative expenses 75,190 70,558

136 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information

72 20 137

149 184 276 764 465 293 240 2013 2013

1,145 1,129 1,469 1,233 3,507 60,717 60,275 3 31 December 31 December 13 31 167 379 838 638 780 388 883 2014 2014 For the years ended 8,117 1,817 7,476 1,274 3,974 1,036 Annual Report 2014 MegaFon MegaFon Related parties 29. The following tables provide the total amount of transactions that have been entered into with related partieswith and balances them for the of accounts relevant financial years: Services from USM Group Services from TeliaSonera Group The Group is a member of the Not-for-profit Partnership “Development, Innovations, Technologies” (the “Partnership”) which was established by companies in the USM Group. The Partnership is required to incur education, science and otherto social maintain costs certain as well as social infrastructure assets in Skolkovo Innovation Centre which are not owned by MegaFonconsolidated and not recorded statement in the of financial position. The Group accrued 1,089 of contributions made to the Partnership during nil) (2013: 2014 Amounts due to USM Group mainly represent the convertible debt instrument related to its investment in Euroset and 17) 10, the made deferred (Notes in 2012 consideration for the Scartel acquisition (Notes On 17). 24 9, June the 2014 Group prepaid in cash approximately 90% of the deferred consideration due to Garsdale for the acquisition of Scartel, including principal and accrued On the 9 July 2014 37,925. Group interest, settled in the the amount amount of due to Garsdale for its interest in Euroset with its own shares pursuant to the termsof the convertible debt instrument. On 1 October MegaFon 2013 acquired Scartel (Note Before 9). that date, Scartel was a related party of the Group as both MegaFonScartel and were indirect subsidiaries of Garsdale. The Group has entered into an agreement with Telecominvest, a member of the USM Group, for provision of legal and personnel serviceseffective and in 2013 In 2014. addition, the Group purchased billing system and related support services from PeterService,member of the another USM Group, in the amount of and 1,979 1,880 during and respectively. 2014 2013, USM Group The outstanding balances and transactions with USM Group relate to operations with Garsdale, the parent, Group’s owner USMHL, of Garsdale, an and indirect their consolidated subsidiaries. Terms and conditions of transactions with related parties related transactions with of conditions and Terms Outstanding balances at the years ended December 31 and 2014 are 2013 unsecured. There have been no guarantees providedfor or received any related party receivables or payables. As December of 31 and the 2014 2013, Group has not recorded any impairment ofreceivables relating to amounts owed by related parties. This assessment is undertaken each financialyear by examiningrelated the party financial and position the market of the in which the related party operates. Revenues from TeliaSonera Group Euroset from Revenues Due from USM Group Due from TeliaSonera Group and 1,826 subsequently in January 2015. Revenues from USM Group Services from Euroset from Services Due to TeliaSonera Group Due to Euroset Due from Euroset from Due Due to USM Group Notes to the consolidated financial statements continued

29. Related parties (continued) TeliaSonera Group The outstanding balances and transactions with TeliaSonera Group relate to operations with various companies in the TeliaSonera Group. Revenues and cost of services principally related to roaming agreements between MegaFon and members of the TeliaSonera Group located outside Russia and a wireline interconnection agreement with TeliaSonera International Carrier Russia.

Euroset Euroset is the Group’s joint venture with OJSC VimpelCom (Note 10). The Group has a dealership agreement with Euroset which qualifies as a related party transaction.

Compensation to key management personnel Members of the Board of Directors and the Management Board of the Company are the key management personnel. The amounts recognised as employee benefits expense to key management personnel of the Group for the years ended 31 December are as follows:

2014 2013 Short-term employee benefits 603 632 Share-based compensation (Note 25) 593 1,491 Long-term incentive programme (Note 26) 12 63 Total 1,208 2,186

30. Financial risk management The Group’s principal financial liabilities, other than derivatives, comprise loans and borrowings, and trade and other payables. The main purpose of these financial liabilities is to finance the Group’s operations. The Group has trade and other receivables, and cash and short- term deposits that derive directly from its operations. The Group also enters into derivative transactions.

The Group is exposed to market risk, credit risk and liquidity risk. The Group’s senior management oversees the management of these risks. The Group’s senior management is supported by the Finance and Strategy Committee of the Board of Directors that advises on financial risks and the appropriate financial risk governance framework for the Group. The Finance and Strategy Committee provides assurance to the Group’s senior management that the Group’s financial risk-taking activities are governed by appropriate policies and procedures and that financial risks are identified, measured and managed in accordance with the Group’s policies. All derivative activities for risk management purposes are carried out by specialist teams that have the appropriate skills, experience and supervision. It is the Group’s policy that no trading in derivatives for speculative purposes shall be undertaken.

The Company’s Board of Directors reviews and agrees policies for managing each of these risks, which are summarised below.

Market risk Market risk is the risk that the fair value of future cash flows of a financial instrument will fluctuate because of changes in market prices. Market price risks that mostly impact the Group comprise two types of risk: interest rate risk and currency risk. Financial instruments affected by market risk include: loans and borrowings, deposits and derivative financial instruments.

The sensitivity analyses in the following sections relate to the position as of 31 December in 2014 and 2013. The sensitivity analyses have been prepared on the basis that the amount of net debt, the ratio of fixed-to-floating interest rates of the debt and derivatives and the proportion of financial instruments in foreign currencies are all constant and on the basis of the hedge designations in place at 31 December 2014 and 2013.

Interest rate risk Interest rate risk is the risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in market interest rates. The Group’s exposure to the risk of changes in market interest rates relates primarily to the Group’s long-term debt obligations with floating interest rates.

The Group manages its interest rate risk by having a balanced portfolio of fixed and variable rate loans and borrowings. To manage this, the Group enters into interest rate swaps, in which the Group agrees to exchange, at specified intervals, the difference between fixed and variable rate interest amounts calculated by reference to an agreed-upon notional principal amount. These swaps are designated to hedge underlying debt obligations.

At 31 December 2014, after taking into account the effect of interest rate swaps, approximately 86% of the Group’s borrowings are at a fixed rate of interest (2013: 86%).

138 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information 7 5 (5) (7) 139 profit Effect on beforetax -3 -2 +3 +2 Annual Report 2014 decrease decrease Increase/ in basis points MegaFon MegaFon US Dollar US US Dollar US US Dollar US Dollar US In accordance with the policies, Group’s the Group does not enter into any treasury management transactions of a speculative nature. Overall, the share of Ruble loans (including the effect of cross-currency swaps) amounted to 65% as December of 31 (76% December 2014 31 at 2013). During and the 2014 2013, Group entered into three long-term cross-currency swaps (Note These 17). derivative financial instrumentswere used to limit exposure to changes in foreign currency exchange rates on certain of the long-term Group’s debts denominatedforeign currencies in (Note 17). To minimiseTo its foreign exchange exposure to fluctuations in foreign currency exchange rates, the Group is migratingcurrency most of its linked foreign costs to Ruble based costs to balance assets and liabilities and revenues and expenses denominatedto manage the in Rubles. foreign In order currency risk the Group is also focused on increasing the proportion of Ruble loans throughactivities. refinancing and hedging To the extentTo permitted by Russian the law, Group keeps part of its cash and cash equivalents in US dollar and Euro interest bearingaccounts to manage against the risk of Ruble decline or devaluation, and also to match its foreign currency liabilities. A significant portion of the liabilities Group’s is denominated in US dollars or Euro. If the Ruble continued to decline dramatically againstthe US dollar or Euro, this could negatively impact the earnings. Group’s Foreign currency risk Foreign currency risk is the risk that the fair value or future cash flows of a financial instrument will fluctuateforeign because exchangeof changes rates. in The exposure Group’s to the risk of changes in foreign exchange rates relates primarily to the financing Group’s activities (when cash deposits and loans and borrowings are denominated in a different currency from the functional Group’s currency). Interest rate sensitivity rate Interest The following table demonstrates the sensitivity to a reasonably possible change in interest rates on loans andimpact borrowings, of hedge after accounting. the With other all variables held constant, the profit Group’s before tax is affected throughrate the borrowings, impact on as floating follows: Year endedYear December 31 2014 Year endedYear December 31 2013 The analysis is prepared assuming the amount of variable rate liability outstanding at the balance sheet date waswhole outstanding for the year.

Notes to the consolidated financial statements continued

30. Financial risk management (continued) Foreign currency sensitivity The following table demonstrates the sensitivity to a reasonably possible change in the US dollar, HK dollar and Euro exchange rates, with all other variables held constant, of the Group’s profit before tax (due to changes in the fair value and future cash flows of monetary assets and liabilities including non-designated foreign currency derivatives) after the impact of hedge accounting. The Group’s exposure to foreign currency changes for all other currencies is not material.

Change in Effect on foreign profit exchange rates before tax Year ended 31 December 2014 US Dollar +30% (18,372) US Dollar -30% 18,372 Euro +30% (1,307) Euro -30% 1,307 HK Dollar +30% 9,644 HK Dollar -30% (9,644)

Year ended 31 December 2013 US Dollar +10% (5,078) US Dollar -10% 5,078 Euro +10% (462) Euro -10% 462

The movement in the pre-tax effect is a result of a change in the fair value of derivative financial instruments not designated in a hedging relationship and monetary assets and liabilities denominated in currencies other than the functional currency of the Company. Although the derivatives have not been designated in a hedge relationship, they act as a commercial hedge and will offset the underlying transactions when they occur.

Credit risk Credit risk is the risk that a counterparty will not meet its obligations under a financial instrument or customer contract, leading to a financial loss. The Group is exposed to credit risk from its operating activities (primarily for trade receivables) and from its financing activities, including deposits with banks and financial institutions and other financial instruments.

The Group deposits available cash with various banks in the Russian Federation. Deposit insurance is either not offered or only offered in de minimis amounts in respect of bank deposits within the Russian Federation. To manage the concentration of credit risk, the Group allocates available cash to domestic branches of international banks and a limited number of Russian banks. A majority of these Russian banks are either owned or controlled by the Russian government.

The Group extends credit to certain counterparties, principally international and national telecommunications operators, for roaming services, and to certain dealers. The Group minimises its exposure to the risk by ensuring that credit risk is spread across a number of counterparties, and by continuously monitoring the credit standing of counterparties based on their credit history and credit ratings reviews. Other preventative measures to minimise credit risk include obtaining advance payments, bank guarantees and other security.

The maximum exposure to credit risk at the reporting date is the carrying value of each class of financial assets disclosed in Note 17. The Group evaluates the concentration of risk with respect to trade receivables as low, as its customers are located in several jurisdictions and industries and operate in largely independent markets. Concentrations of credit risk with respect to trade receivables are limited given that the Group’s customer base is large and unrelated. Due to this management believes there is no further credit risk provision required in excess of the normal impairment allowance for trade and other receivables.

Liquidity risk The Group monitors its risk relating to a shortage of funds using a recurring liquidity planning tool. The Group’s objective is to maintain a balance between continuity of funding and flexibility through the use of bank loans. Approximately 24% of the Group’s loans and borrowings will mature in less than one year at 31 December 2014 (2013: 13%) based on the carrying value of borrowings reflected in the financial statements. The Group assessed the concentration of risk with respect to refinancing its debt and concluded it to be low.

As of 31 December 2014 and 2013, the Group has a net current liability position. The Group believes it will continue to be able to generate significant operating cash flows and that adequate access to sources of funding and significant amount of available credit lines are sufficient to meet the Group’s requirements. Additionally, the Group can defer capital expenditures if necessary in order to meet short- term liquidity requirements. Accordingly, Group management believes that cash flows from operating and financing activities will be sufficient for the Group to meet its obligations as they become due.

140 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information

141 177

384 263 263 Total 1,025

7,257 1,281 22,101 33,875 42,096 36,622 36,622 197,198 250,967 296,856 296,390 296,390 – – – – – – – – – 54 5 years 43,274 Annual Report 2014 43,274 23,036 23,090 More than – – – – – – – – MegaFon MegaFon 27 289 78,125 74,523 74,234 78,152 4-5 years – – – – – – 72 543 1,200 21,627 48,510 85,361 86,561 86,561 70,752 1-3 years – 312 193 177 263 1 year 7,257 31,180 22,101 33,875 20,469 36,622 64,445 108,307 Less than than Less 108,587 108,587 Commitments, contingencies and uncertainties and contingencies Commitments,

Trade and Trade other payables December31 2014 borrowings and Loans The table below summarises the maturity profile of the financial Group’s liabilities based on contractual undiscounted payments. to the other operators. It is currently not able to reasonably estimate the amount of the cost of clearing military frequencies. 4G/LTE roll-out until the network is fully deployed, to clear frequencies currently allocated to the military at its own cost and to compensateother operators for surrendering frequencies in an aggregate amount the In 2012, of 401. Company has fully paid the compensation due In the July 2012, Federal Service for Supervision in Communications, Information Technologies and Mass Media granted OJSC MegaFon Under the terms and conditions ofthis licence, the Company is obligated to provide 4G/LTE services in each population centre50,000 with inhabitants over in Russia The by 2019. Company is also obligated to make capital expenditures of at least 15,000 annually toward the 4G/LTE licence capital commitments a licence and allocated frequencies to provide services under the 4G/LTE standard in Russia. Russian operating environment operating Russian 31. Russia continues economic reforms and development of its legal, tax and regulatory frameworks as required by a marketeconomy. Collateral The Group did not pledge collateral as security for its financial liabilities December at 31 except or 2013, 2014 assets purchased under deferred payment terms (Note 14). Some loan agreements also have covenants based on Net debt to OIBDA ratios. The Group believes it has complied with parties. external the all by imposed capitalrequirements The Net debt to OIBDA ratio is an important measure to assess the capital structure in light of the need to maintainNet a strong debt represents credit rating. the carrying amount of interest-bearing loans and borrowings less cash and cash equivalentscurrent bank and current deposits. and As non- December of 31 the 2014 Net debt to OIBDA ratio was 0.98 0.77). (2013: Capital includes equity attributable to the shareholders. Group’s The primary objective of the capital Group’s managementit maintains is to ensure a healthy that credit rating and healthy capital ratios in order to secure access to debt and capital markets at times all shareholder and maximise value. The Group manages its capital structure and makes adjustments to it in light of changes in economic conditions. theIn 2014, Russian economy was negatively impacted by a significant drop in crude prices oil and a significant devaluation of theRuble, Russian as well as sanctions imposed on Russia by several countries. In December the 2014, Ruble interest rates increased significantlyafter the Central Bank of Russia raised its key rate to The 17%. combination of the above resulted in reduced access to capital,higher a cost of capital, increased inflation and uncertainty regarding economic growth, which could negativelyfinancial affect position, the future results Group’s of operations and business prospects. Management circumstances. current the believes in business itis taking appropriate Group’s the of sustainability measures to support the Capital management Capital The future stability of the Russian economy is largely dependent upon these reforms and developments andeconomic, the effectiveness financial and monetary of measures undertaken by the government. Deferred consideration Deferred Long-term accounts payable liabilities financial Derivative December31 Total 2014 December31 2013 borrowings and Loans consideration Deferred Trade andTrade other payables Convertible debt instrument debt Convertible Long-term accounts payable Derivative financial liabilities financial Derivative Liability for marketing related licences December 31 Total 2013 Notes to the consolidated financial statements continued

31. Commitments, contingencies and uncertainties (continued) Equipment purchases agreements In April 2014 and December 2014, the Group entered into two separate seven-year agreements with two suppliers to purchase equipment and software for 2G/3G/4G network construction and modernisation. The software usage agreements contain various termination options, however the Group is specifically committed under the agreements to pay at least three years’ worth of fees plus 50-60% worth of fees for years four-seven for each base station in use as at the date of termination after taking into account fees already paid. The amount of the commitments at 31 December 2014 is 9,206.

Social infrastructure expenses From time to time, the Group may determine to maintain certain social infrastructure assets which are not owned by the Group and not recorded in the consolidated financial statements as well as to incur education, science and other social costs. Such activities may be conducted in collaboration with non-governmental organisations. These expenses are presented in other non-operating loss in the consolidated statement of comprehensive income.

Taxation Russian tax, currency and customs legislation, including transfer pricing legislation, are subject to varying interpretations and changes, which can occur frequently. Management’s interpretation of such legislation as applied to transactions and activities of the Group may be challenged by the relevant regional and federal authorities. Recent events within Russia suggest that the tax authorities are taking a more assertive position in their interpretation and enforcement of the legislation and assessments and as a result, it is possible that transactions and activities that have not been challenged in the past may now be challenged. Therefore, significant additional taxes, penalties and interest may be assessed. Fiscal periods remain open to review by the authorities in respect of taxes for the three calendar years preceding the current year. Under certain circumstances reviews may cover longer periods.

Russian transfer pricing legislation, which came into force on 1 January 2012, allows the Russian tax authorities to control transaction prices for the purpose of taxation and impose additional profits tax liabilities in respect of certain transactions if the transaction price differs from the market level of prices. Because of the lack of clarity in the current Russian transfer pricing legislation and the absence of court precedent, consequences of litigations with the Russian tax authorities with respect to the level of prices applied by the Group cannot be reliably assessed. However, those consequences might affect the Group’s consolidated financial statements.

In 2014 a law “On controlled foreign companies” (“CFC rules”) aimed at the fiscal stimulation of decreasing the number of the entities registered abroad in the Russian economy were issued, and took effect on 1 January 2015. Under CFC rules retained profits of foreign companies and non-corporate structures controlled by Russian tax residents (companies and individuals) may be subject to Russian taxation. Russian taxpayers (controlling parties) must inform the tax authorities of the foreign companies controlled by them, while the tax authorities may impose additional tax liabilities to the taxpayers failing to include retained profit of the foreign controlled companies in their taxable base, where necessary.

The Group’s management believes that its interpretation of the relevant legislation is appropriate and is in accordance with the current industry practice and that the Group’s tax, currency and customs positions will be sustained. However, the interpretations of the relevant authorities could differ.

As of 31 December 2014 the Group’s management estimated the possible effect of additional taxes, before fines and interest, if any, on these consolidated financial statements, if the authorities were successful in enforcing different interpretations, in the amount of up to approximately 925.

Operating lease commitments The Group normally enters into operating leases with a term not exceeding one year. Accordingly, the Group’s operating lease commitments at 31 December 2014 approximate the annual rent expense (Note 28).

Litigation The Group is not a party to any material litigation, although in the ordinary course of business, some of the Group’s subsidiaries may be party to various legal and tax proceedings, and subject to claims, certain of which relate to the developing markets and evolving fiscal and regulatory environments in which they operate. In the opinion of management, the Group’s and its subsidiaries’ liabilities, if any, in all pending litigation, other legal proceedings or other matters, will not have a material effect on the financial condition, financial performance or liquidity of the Group.

142 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information 143 Annual Report 2014 MegaFon MegaFon Events after the reporting date Long-term incentive programme 2012 MarchOn 10 the 2015 Board of Directors of the Company approved an amendment to the terms of the Long-term incentive programme (Note2012 25) to change the base price and the strike price for the awards outstanding as December at 31 with 2014 a payment dueApril-May in so that 2015, the base price is denominated in Rubles and becomes 555 Rubles per share, and the weighted-average price of the Company’s shares is based on prices on the Moscow Exchange over the period between January 15 and March 15 in the relevant yearof vesting. As a result of the change the fair value of options outstanding March at 10 increased 2015 to approximately 440 Rublesoption. per On 25 February Moody’s Investor 2015 Service (“Moody’s”) downgraded the credit Group’s rating from The Baa3 rating to Ba1. action reflected the earlier downgrade by Moody’s of the sovereign Russia’s credit rating and subsequent lowering country of Russia’s ratingceilings levels. to Ba1 Credit ratings Credit On 5 February Standard 2015 and Ratings Poor’s Services (“S&P”) took several actions on the credit Group’s ratings, following its downgrade of the sovereign rating on Russia. S&P affirmed the local currency rating of the Group at the BBB-S&P downgraded level. the At same time, the foreign Group’s currency rating to BB+, explaining that thisaction reflected Russia. of constraints assessment Convertibility and imposedTransfer by the agency’s 32. Glossary

4G/LTE – fourth generation of wireless technology which provides greater access to data and services through enhanced download and upload speeds and enhanced use of spectrum.

ARPU (Average Monthly Revenue Per User) is calculated for a given period by dividing the aggregate of the Company’s wireless services revenues from local subscribers, revenues from data transfer services and from VAS, revenues from interconnection charges and revenues from roaming charges to other operators for the same period by the average number of its Subscribers during that period, and further dividing the result by the number of months in that period.

ARPDU (Average Monthly Revenue Per Data Services User) is calculated for a given period by dividing the Company’s data services revenues for a given period by the average number of its data services users during that period, and further dividing the result by the number of months in that period.

Big Data represents the Information assets characterized by such a high volume, velocity and variety to require specific technology and analytical methods for its transformation into value.

Capital Expenditures (CAPEX) comprises the cost of purchases of new equipment, new construction, acquisition of new or upgrades to software and other intangible assets, and purchases of other long-term assets, together with related costs incurred prior to the intended use of the applicable assets, all accounted for as of the earliest time of payment or delivery. Long-term assets obtained through business combinations are not included in the calculation of capital expenditures.

Data services user is defined as a Subscriber who has used any of the Company’s data transfer services within the preceding three months.

DSU (Monthly Average Data Services Usage per User) is calculated by dividing the total number of megabytes transferred by our network during a given period by the average number of data services users during such period and dividing the result by the number of months in such period.

FOCL – fiber-optic communication lines.

Free Cash Flow (FCF) means cash from operating activities, less cash paid for purchases of property, plant and equipment and intangible assets, increased by proceeds from sales of property, plant and equipment and interest paid. It is a financial measure which should be considered as supplementary but not as an alternative to the information provided in the Company’s financial statements. This metric measures the Company’s ability to generate cash after accruals required to maintain and expand the Company’s assets.

Machine to Machine (M2M) refers to technologies that allow both wireless and wired systems to communicate with other devices of the same type.

MOU (Monthly Average Minutes of Use per User) is calculated by dividing the total number of minutes of usage (including both outgoing and incoming calls) during a given period by the average number of Subscribers during such period and dividing the result by the number of months in such period.

Net cash/Net debt position means the difference between (a) cash, cash equivalents, and principal amount of deposits and (b) principal amount of loans and borrowings less unamortised debt issuance fees. It is a financial measure which should be considered as supplementary but not as an alternative to the information provided in the Company’s financial statements. The Company believes that this metric provides useful information as to the liquidity position of the Company after debt repayments.

Net Profit is profit for the period attributable to equity holders of the Company.

OIBDA (Operating Income Before Depreciation and Amortisation) is a financial measure which should be considered as supplementary, but not as an alternative to the information provided in the financial statements of the Company. OIBDA margin means OIBDA as a percentage of revenue. The Company believes that OIBDA provides a better measure of the Company’s actual operational results including our ability to finance capital expenditures, acquisitions and other investments and our ability to incur and service debt. While it does not take into account depreciation of property and equipment, amortisation of intangible assets and gain/(loss) from disposal of non-current assets, which are considered as operating expenses in IFRS, these expenses primarily represent non-cash charges related to long-lived assets acquired or constructed in prior periods.

Wireless Subscriber is defined as each SIM card that is connected to the network and is ‘active’, that is, that has had at least one chargeable traffic event (that is, use of voice, VAS or data transfer services) within the preceding three months, whether chargeable to the Subscriber or to a third party (for example, interconnection charges payable by other operators). Where an individual person holds more than one SIM card, each SIM card is included as a separate Subscriber.

144 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information 145 Annual Report 2014 MegaFon MegaFon On 30 April 2015 the Company’s name was changed to MegaFon in accordance PJSC with the resolution EGM’s of 20 April 2015. 1 

GDR Depositary:GDR Bank of New York Mellon Barclays101 Street, 22nd Floor West New York, NY 10286, USA http://www.bnymellon.com/ Web: 3050 571 (212) Fax: +1 2135/2734/2269Dividends 815 4888/2723 (212) 815 +1 Holders +1(212) Shareowner Services 888 BNY ADRS Company Registrar: CJSC Computershare Registrar FCSM licence of Russia No. 10–000–1–000252 (indefinite). Centre Business Tower Kutuzoff 8 Ivana Franko, Russia Moscow 121108 (495) 926-8160 +7 Tel: (495)Fax: 926-8178 +7 http://www.computershare-reg.ru/ Web: Company’s Auditor: Company’s Ernst & Young LLC Avrora Business Park 77 Sadovnicheskaya emb., bldg. Moscow Russia 1, 115035, (495) 755-9700 +7 Tel: (495)Fax: 755-9701 +7 Web: http://www.ey.com Dmitry Kononov Director, Investor Relations and M&A + 7(926) 200-6490Tel: [email protected] Email: Information for investors: Information for shareholders: shareholders: for Information Corporate Secretary – Elena Breeva (499)Telephone: 755-2155 +7 (499)Fax: 755-2100 +7 [email protected] Email: Head office: Head Russia 115035, Moscow emb., Kadashevskaya 30 (499) 755-2155 +7 Tel: (499)Fax: 755-2175 +7 [email protected] E-mail: www.megafon.ru Web: Full name: Open Joint Stock Company MegaFon¹ MegaFon OJSC Short name: Contacts Disclaimer

Certain statements and/or other information included in this document may not be historical facts and may constitute “forward looking statements” within the meaning of Section 27A of the U.S. Securities Act of 1933 and Section 2(1) (e) of the U.S. Securities Exchange Act of 1934, as amended. The words “believe”, “expect”, “anticipate”, “intend”, “estimate”, “plans”, “forecast”, “project”, “will”, “may”, “should” and similar expressions may identify forward looking statements but are not the exclusive means of identifying such statements. Forward looking statements include statements concerning our plans, expectations, projections, objectives, targets, goals, strategies, future events, future revenues, operations or performance, capital expenditures, financing needs, our plans or intentions relating to the expansion or contraction of our business as well as specific acquisitions and dispositions, our competitive strengths and weaknesses, the risks we face in our business and our response to them, our plans or goals relating to forecasted production, reserves, financial position and future operations and development, our business strategy and the trends we anticipate in the industry and the political, economic, social and legal environment in which we operate, and other information that is not historical information, together with the assumptions underlying these forward looking statements. By their very nature, forward looking statements involve inherent risks, uncertainties and other important factors that could cause our actual results, performance or achievements to be materially different from results, performance or achievements expressed or implied by such forward-looking statements. Such forward-looking statements are based on numerous assumptions regarding our present and future business strategies and the political, economic, social and legal environment in which we will operate in the future. We do not make any representation, warranty or prediction that the results anticipated by such forward-looking statements will be achieved, and such forward-looking statements represent, in each case, only one of many possible scenarios and should not be viewed as the most likely or standard scenario. We expressly disclaim any obligation or undertaking to update any forward-looking statements to reflect actual results, changes in assumptions or in any other factors affecting such statements.

146 MegaFon Annual Report 2014 Strategic report Governance Financial statements Additional information 147 Annual Report 2014 MegaFon MegaFon Notes Notes

148 MegaFon Annual Report 2014 Designed and produced by Instinctif Partners www.instinctif.com MegaFon Annual Report 2014