Contents 0–1
Contents
2 Address of the Chief Executive Officer to the Shareholders
6 MegaFon’s Network Coverage Area
8 The Company’s Key Performance Indicators in 2007 and Its Position within the Industry
12 About the Company 12 Shareholders Equity of OJSC “MegaFon” 14 Governance of the Company 15 Board of Directors of OJSC “MegaFon” 16 Sole and Collegiate Executive Bodies of OJSC “MegaFon” 18 Basic Risk Factors Related to Operations of OJSC “MegaFon”
22 Report by the Board of OJSC “MegaFon” on the Results of the Company’s Development in its Priority Directions 22 Corporate Finance Management 23 HR Management 23 Administration and Quality Management 24 Meetings of the Board of Directors of OJSC “MegaFon” 25 Report on Payment of Declared (Accrued) Dividends under Shares of OJSC “MegaFon”
28 Operations 28 Marketing 29 Sales and Customer Care 30 Value-Аdded Services 32 Technology Development 34 Special Programs 35 International Projects
35 Information on Compliance with the Corporate Code by OJSC “MegaFon”
36 Annual Accounting Statements of OJSC “MegaFon” for 2007
42 Consolidated Financial Statements for 2007
73 Annexes 73 Annex 1. Corporate Events 74 Annex 2. Basic Provisions of the Corporate Code Reflected in the Company’s Internal Documents Address of the Chief Executive Officer to the Shareholders 2–3
Sergey Soldatenkov Chief Executive Officer
Address of the Chief Executive Officer In spring 2007, MegaFon demonstrated the best tender results – 560 points – and became to the Shareholders the holter of №1 UMTS license. Just 6 months later we summarized our theoretical investigations and practical experience from UMTS network operating in Tajikistan Dear Ladies and Gentlemen, and developed the first commercial product for 3G users in Russia. The first UMTS network in Russia started to work in Saint-Petersburg and Leningrad oblast on October 24, 2007. I am pleased to present to you the Annual Report of OJSC “MegaFon” (referred to hereinafter also as “Company” or “MegaFon”), which summarizes the outstanding In 2007, we continued to improve the international corporate credit ratings of MegaFon. The rating agencies, Moody’s и S&P, upgraded the Company’s rating on the basis of their results of the Company in 20071. review of operating and financial performance of the Company during the reporting year. Last year we received the revenue of 5.72 BUSD, a 53% increase over 2006. Our 2007 EBITDA We expect that in 2008 the Russian economy will continue to grow, income of Russian of 2.9 BUSD is 58% better than the prior year. EBITDA margin in 2007 was 51%. Net income in consumers will grow as well, which will ensure good prospects for higher profitability 2007 of 1.4 BUSD was 70% higher than last year. Net cash flow in 2007 amounted to 885 MUSD, of mobile communications. Given this solid economic background, we believe that the which is 3.5 times increase over last year2. Russian mobile market will remain in relative terms one of the most dynamic and fastest- growing emerging markets in the world. Our intention is to provide for priority growth The subscriber base grew by 6 mln and approached 35.7 mln customers at the end of 2007, in the Russian Federation with the purpose of further enhancement of our competitive thus, we increased the Russian market share from 19.5% to 20.5%. position and improvement of our financials. More significantly, in 2007 MegaFon overtook “The Big Three” competitors in terms of the growth rate We hope you are pleased with our operating and financial performance in 2007, and with of Russian revenue both in absolute terms (1.8 BUSD) and in relative terms (49%). We increased our your continuing support, we intend to pursue our consistent strategy to grow successfully share in aggregate revenue of the Big Three mobile operators in Russia from 29% to 31%. We raised and profitably, further increasing the value of the Company. our Russian EBITDA share among the three largest operators from 28% to 31%.
In 2007, MegaFon completed the coverage of the licensed territory. Construction of the network in the republics of Altai and Tyva enabled MegaFon to become the only mobile operator in Russia with network that operates in all RF subjects.
1. Hereinafter in this Report the date refers to the Company , its 100%-owned subsidiaries, and CJSC “TTmobile”.
2. Until December 31, 2006, the Company used US Dollars as the currency used in preparation of US GAAP financial statements. Starting from January 01, 2007, the Company changed its reporting currency from US Dollars to Rubles due to the fact that the Ruble is the basic currency for the Company’s operations. For the sake of comparisons to prior periods the information in this report is presented in US Dollars. Financial information for 2007 presented in this Report in USD was obtained as a result of the convenience translation methodology under which 2007 financial data was recalculated in USD at the official exchange rate of the RF Central Bank as of the end of the reporting period. –5
6 MegaFon’s Network Coverage Area
8 The Company’s Key Performance Indicators in 2007 and Its Position within the Industry MegaFon’s Network Coverage Area 6–7
MegaFon’s Network Coverage Area Total number of subcribers 35 655 937 mln The Company’s Key Performance Indicators in 2007 8–9
The Company’s Key Performance Indicators in 2007 Subscriber Base Distribution among the Regions: and Its Position within the Industry
In 2007, the subscriber base of MegaFon grew by 20%: from 29.7M as of January 1, 2007 to 35.7M as of December 31, 2007. North-West Moscow During the same period MegaFon’s market share grew from 19.5 % to 20.5 %. The Company’s share in the revenue of the Big Three for 2007 is 31 % of total revenue of the three major Russian operators. Volga
North Caucasus The MegaFon’s share in the revenue of the Big Three in Russia in 2006 and 2007: Center Urals Far East The MegaFon’s share in the revenue The MegaFon’s share in the revenue Siberia Tajikistan of the Big Three in Russia in 2006 of the Big Three in Russia in 2007
29.1 36.5% 31.0 34.7% It became possible to achieve such results due to centralization of commercial activity of the regional subsidiaries and the NW Branch of OJSC “MegaFon”, in particular, through shifting focus in the structure of our marketing offers to stimulating the growth of on-net traffic. As a result the clients got attractive prices for on-net calls, and we got an opportunity to increase our business efficiency by decreasing the share of outgoing calls to networks of other operators – in 2007 the share of on-net traffic increased on average from 5% to 15%. The Company’s marketing policy in 2007 was focused on stimulating usage of services. Our offers became more popular, convenient, and 34.4% 34.3% interesting.
MegaFon is still growing faster than other Big Three operators. The Company’s growth rates of subscriber base and that of revenue are above the growth rates of subscriber base in the entire market (14% for 2007) and are higher than the revenue growth rates in the industry. –11
12 About the Company
22 Report by the Board of OJSC “MegaFon” on the Results of the Company’s Development in its Priority Directions About the Company 12–13 Shareholders Equity of OJSC “MegaFon”
2. Sonera Holding B.V. – legal entity under the law of the Kingdom of the Netherlands; About the Company legal address: Rodezand 34k, 3011 AN, Rotterdam, the Netherlands; owner of 1,612,001 common registered shares of the Company that is 26.0 % of voting shares and charter OJSC “MegaFon” started its operations on June 17, 1993, after incorporation capital of the Company; of CJSC “North West GSM”, on the basis of which OJSC “MegaFon” was established in 2002. In 1994 MegaFon began to provide cellular 3. Open Joint Stock Company “CТ-Mobile” – legal entity under the law of the Russian telecommunication services in the North-West region of the Russian Federation; legal address: Kuzovatkina street, 14, Nignevartovsk 628611 Khanti-Mansiiski- Federation. UGRA Autonomous Region, Russia; owner of 1,556,194 common registered shares of the Company that is 25.1 % of voting shares and charter capital of the Company; In August 2001, OJSC “Telecominvest”, Telia Group (Sweeden), Sonera Holding B.V. (the Netherlands), LLC “CT-Mobile”, and IPOC International Growth Fund Limited signed 4. IPOC International Growth Fund Limited – legal entity under the law of the Bermudas; the agreement on merging CJSC “North West GSM”, CJSC “Sonic Duo” and eight regional location: Richmond House,12 Par-La-Ville Road, 5th Floor, Hamilton, HM08, Bermuda; mobile operators for the purposes of establishing a nationwide mobile operator under owner of 496,003 common registered shares of the Company that is 8.0 % of voting shares the single brand of “MegaFon”. and charter capital of the Company;
Early in 2007, Company completed the reorganization of its 100% subsidiaries, 5. Telia International AB – legal entity under the law of Sweden; legal address: CJSC “Volzhsky GSM” and “CJSC “Mobicom-Kirov”, in the form of merger into Marbackagatan 11, 12386 Farsta, Stockholm, Sweden; owner of 394,953 common OJSC “MCS-Povolzhie” (09.01.2007) and CJSC “Ural GSM” (01.01.2007) respectively, registered shares of the Company that is 6.37 % of voting shares and charter capital 100% subsidiaries of the Company. of the Company;
The license portfolio of the Company and its 100%-owned subsidiaries covers the entire 6. Telia International Management AB – legal entity under the law of Sweden; legal address, territory of the Russian Federation with a population over 145 million. As of December Marbackagatan 11, SE-12386 Farsta, Sweden; owner of 107,247 common registered shares 31, 2007, OJSC “MegaFon” had commercial operations in 85* subjects of the Russian of the Company that is 1.73 % of voting shares and charter capital of the Company; Federation. Subjects of Federation are combined into eight “enlarged regions”, called macro regions. 7. Limited Liability Company “Contact-С” – legal entity under the law of the Russian Federation; legal address: Kalinina street 9, Priozersk, 188760, Leningrad region, Russia; * Since March 1, 2008 the Russian Federation consists of 83 subjects. owner of 93,003 common registered shares of the Company that is 1.5 % of voting shares and charter capital of the Company.
Shareholders Equity of OJSC “MegaFon”
The shareholders equity of OJSC “MegaFon” as of December 31, 2007, was 62,000,020 (Sixty Two Million and Twenty) rubles divided into 6,200,002 (Six Million Two Hundred Thousand and Two) common registered shares each with face value of 10 (Ten) rubles.
The first issue of the Company’s shares took place in 1995 when 10,000 (Ten Thousand) shares were issued with face value of 100 (One Hundred) rubles. In 1997, the Company placed its second and third issues. In 2002, 3,100,001 (Three Million One Hundred Thousand and One) shares were placed during the forth issue.
In 2003, by the order of the Federal Commission for the Securities Market all issues of common registered uncertified shares of the Company were combined, and the single state number 1-02-00822-J was assigned hereto.
Currently, the shareholders of OJSC “MegaFon” are leading Russian and foreign companies operating in the field of telecommunications:
1. Open Joint Stock Company “Telecominvest” – legal entity under the law of the Russian Federation; legal address: 54 Nevski av., St Petersburg 191011 Russia; owner of 1,940,601 common registered shares of the Company that is 31.3 % of voting shares and charter capital of the Company; Governance of the Company 14–15 Board of Directors of OJSC “MegaFon”
Governance of the Company Board of Directors of OJSC “MegaFon”
In its decision-making and corporate governance the Company complies In 2007, the following persons served on the Board of Directors with the Civil Code of the Russian Federation, the Law “On Joint Stock of OJSC “MegaFon”: Companies”; the Law “On Securities Market”; the Corporate Governance Code (recommended by Federal Commission on Securities Market in 2002). 1. Aimo Eloholma has been the Board member of OJSC “MegaFon” since June 2003; during 2006 and 2007 he acted as the Chairman. Since 2003 he had been Deputy CEO and OJSC “MegaFon” is the parent company of the MegaFon Group consisting of subsidiaries managing director of Sonera Corporation and President of TeliaSonera International. in the Russian Federation and abroad. OJSC “MegaFon” is in charge for the budgeting, At present he is the head of international operations in TeliaSonera International. He was strategic planning, procurement, finances, and investor relations. All business operations the Executive Vice-President for fixed communications in Sonera Corporation in 1999-2001. and processes of the Company are centralized. MegaFon has the following decision-making Mr Eloholma graduated from Helsinki Technological University with MS degree in electrical bodies: engineering.
• General Shareholders Meeting; 2. Gorokhov Maxim Yurievich had been the Board member of OJSC “MegaFon” since • Board of Directors; June 30, 2004 till January 19, 2005 and was re-elected as member of the Board of OJSC • Management Board; “MegaFon” on November 18, 2005. Mr. Gorohov has been CEO of OJSC “Telecominvest” • Chief Executive Officer (CEO). since 2002. Mr.Gorohov graduated from Leningrad Polytechnic Institute named after Kalinin in 1988 with a degree in mechanics and management processes. Each 100%-owned operating subsidiary of OJSC “MegaFon” has the following governance bodies: 3. Kastritsa Maria Leonidovna has been the Board member of OJSC “MegaFon” since November 27, 2006. Ms. Kastritsa is the Head of representative offices • General Shareholders Meeting, or the Sole Shareholder (OJSC “MegaFon”); of “J.P.Galmond & Co” in Moscow and St.Petersburg. Ms. Kastritsa graduated from Russian • Board of Directors; State University named after Gertsen (St.Petersburg), and St. Petersburg University • General Director. of Foreign Economic Affairs, Economics and Law.
On December 20, 2007, in most of MegaFon’s subsidiaries a decision was made to dismiss 4. Mohamed Amersi had been the Board member of OJSC “MegaFon” since January 19, the Board of Directors and terminate early the authorities of the Board members for the 2005 to November 18, 2005, was re-elected to the Board of Directors of OJSC “MegaFon” purpose of implementing the direct governance system. New Charters were approved under on June 29, 2006, at the same time he was the Board member in Gramercy Communications which the functions and authority of the Boards of the subsidiaries were delegated to their Partners and acted as CEO of Emergent Telecom Ventures. Mr. Amersi graduated from Sole Shareholder. Sheffield University and Cambridge University with a bachelor’s degree in law.
CJSC “TTmobile”, in which MegaFon owns 75% of the charter capital, has the following 5. Alexander E. Okun has been the Board member of OJSC “MegaFon” since June 30, 2004. governance bodies: Since 2003 he has been the Managing Director of “Kaskol UK Ltd.” From 1999 to 2003 he was the Managing Director of Eagle International, advisor to CIBC Oppenheimer World • General Shareholders meeting; Equity Fund. Mr. Okun graduated from the Leningrad State Electrical Engineering University • Board of Directors; with a degree in electrical engineering. • General Director. 6. Per Olof Sjostedt was elected member of the Board of OJSC “MegaFon” on June 29, 2005; The Company’s management provides corporate governance over CJSC “TTmobile” at the same time Mr Sjostedt acts as Senior Vice-President for TeliaSonera AB. via representation in the Board of Directors (the Board of Directors of CJSC “TTmobile” From 1998 to 2001 he had been CEO of Ericsson Russia, from 2003 to 2004 he had been includes the representatives of the Management Board of OJSC “MegaFon”). the Regional Manager in Emerson Network Power. Mr. Sjostedt graduated from Royal Institute of Technology. The parent company and the subsidiaries are separate legal entities. The legal support, accounting, and taxation of each subsidiary are executed in compliance with the laws and 7. Rytkonen Esko Juhani has been the Board member of OJSC “MegaFon” since June 29, regulations existing in each respective region according to the decisions of governance 2005, at the same time he has been the Senior Vice-President for TeliaSonera Finland Oyj. bodies in the subsidiaries. From 1998 to 2003 Mr Rytkonen had acted as Director for Finance for Sonera Oyj. Mr Rytkonen graduated from Helsinki School of Economics with a degree in international business administration.
During 2007 no members of the Board of OJSC “MegaFon” owned any shares of OJSC “MegaFon”. Sole and Collegiate Executive Bodies of OJSC “MegaFon” 16–17
Sole and Collegiate Executive Bodies of OJSC “MegaFon” 6. Edward Ostrovsky has been a member of the Management Board member and Deputy CEO for Implementation of Special Programs and Cooperation with State Bodies The collegiate executive body of OJSC “MegaFon” is the Management Board. It is elected in OJSC “MegaFon”. From 1993 to 2002 he was Deputy Minister for communications by the General Shareholders Meeting following the recommendations of the Chief Executive and informatization in the Ministry of Communications of the Russian Federation. Officer. The meetings of the Management Board take place whenever required. Mr. Ostrovsky graduated from Military Academy of Communications with a degree in The Management Board members are responsible for current management and communications technology. At present he is Vice-president of International Academy administration of OJSC “MegaFon”. The Chairman of the Management Board represents of Telecommunications. He was awarded the title of the Hero of Russia. OJSC “MegaFon” and acts as the sole executive body of OJSC “MegaFon” (Chief Executive Officer). 7. Lubov Rudnitskaya has been a member of the Management Board member and Chief Accountant of OJSC “MegaFon” since August 20, 2002. From 2000 to 2002 she was Senior Names, qualifications and other information concerning each Management Board member acting Adviser to Chairman of Managing Board of CJSC “Russian Industrial Bank”. Since 2002 she in 2007 are listed below: was the Chairwoman of Managing Board of CJSC “Russian Industrial Bank”. 1. Sergey Soldatenkov has been the Chief Executive Officer of OJSC “MegaFon” since April Ms Rudnitskaya graduated from St Petersburg State University holding a degree in political 2003 and Chairman of the Management Board of OJSC “MegaFon”. Since 1997, economy. Mr. Soldatenkov has been Board member of OJSC “Telecominvest”. From 2000 to 2002 Mr. Soldatenkov had been the Chairman of the Management Board and Board member 8. Larisa Tkachuk has been a member of the Management Board and Chief Commercial of OJSC “North-West Telecom”. He was also the Board member in OJSC “Lensvyaz”, Officer of OJSC “MegaFon” since March 14, 2005. From 2002 to 2004 she was Head of CJSC “Delta Telecom” (from 1995) and CJSC “Telecombank” (from 1998). In 2000 Sales and Marketing Department of OJSC “MegaFon”, she used to work as the Director Mr. Soldatenkov was elected member of the Board of OJSC “St Petersburg Telegraph”. for Marketing in Representation Office of International Communications Services Corp. From 2000 to 2001 he had been the Board member of “St Petersburg Bank of Ms Tkachuk graduated from the National Technical University with a degree in Industrial Reconstruction and Development”. In 2004 Mr. Soldatenkov was elected the chairman marketing. of the Board of CJSC “Sonic Duo”, CJSC “Mobikom-Center”, CJSC “Mobikom-Kavkaz”, CJSC “Ural GSM”, CJSC “Mobikom-Kirov”, CJSC “Mobikom-Novosibirsk”, CJSC “Mobikom- During 2007, members of the Management Board did not own any shares of OJSC Khabarovsk”, CJSC “Volzhsky GSM”, OJSC “MSS-Povolzhie”. Mr. Soldatenkov graduated “MegaFon”. In 2007, the total amount of remuneration to the person who is the Sole from Leningrad University of Aviation Instruments with a degree in Radio engineering. Executive Body of OJSC “MegaFon”, members of the Collegiate Executive Body of OJSC “MegaFon” and members of the Board of OJSC “MegaFon” was 144,756,553.57 rubles. 2. Victor Kvitsinsky has been a member of the Management Board member and Deputy There are no options or other similar programs for executives in the Company. CEO for technology and development since March 14, 2005. From 2000 to 2004 he was Head of department of electric communications of Ministry for Telecommunications and Informatization of the Russian Federation, from 1999 to 2000 he was Technical director of CJSC “Peterstar”. Mr. Kvitsinsky graduated from Leningrad Institute of Telecommunications named after V.Ulianov (Lenin).
3. Andis Locmelis has been a member of the Management Board since June 2007. In November 2006 he was appointed Chief Financial Officer of OJSC “MegaFon”. From 2004 to 2006 Mr. Locmelis was Financial Director and Management Board member of “Lattelecom Group” (Riga, Latvia). From 1999 to 2004 he was Director for Finance and Information Technologies, Management Board member of “ALDARIS” (Riga, Latvia). In 2001 Mr. Locmelis got an MBA degree.
4. Igor Nikodimov has been a member of the Management Board and Deputy CEO for Foreign Economic Affairs and Administration of OJSC “MegaFon” since July 2002. He was CEO and member of “North-West GSM” Board from September 1998, Deputy CEO of “North- West GSM” from 1997 to 1998 and Director for Administration of “North-West GSM” from 1994 to 1998. He graduated from the Institute of Textile and Light Industry named after S.Kirov in St. Petersburg, and St. Petersburg State Telecommunications University with a degree in Communication Lines and Switching Systems, he is the candidate of technical sciences.
5. Alexey Nichiporenko has been a member of the Management Board since November 2002. In October 2004 he was appointed Chief Operating Officer after two years of being Deputy CEO for technology and development of OJSC “MegaFon”. From 2001 to 2002 he was CEO of CJSC “Sonic Duo” and from 2000 to 2001 – Director for corporate development of Telecominvest. Mr. Nichiporenko graduated from Admiral Makarov State Maritime Academy of St. Petersburg with a degree in Radio Engineering and St. Petersburg International Management University. Basic Risk Factors Related to Operations of OJSC “MegaFon” 18–19
Moreover, both competitors of the Company have registered their shares in the form Basic Risk Factors Related to Operations of OJSC “MegaFon” of American depository receipts at the New York Stock Exchange. The competitors have access to foreign capital markets, meaning that in future they might have better financing opportunities than the Company has. Influence of Possible Aggravation of Situation in the Company’s Sector on its Performance. Risks Related to Sector’s Technological Development Technologies develop fast in the mobile telephony sector, and the standards evolve In the last few years, the cellular communication sector has been one of the most fast- constantly. The Company’s success is partially dependent on the ability to quickly single developing Russian industries. The situation in this sector is unlikely to aggravate in the out and use the most promising new technologies, as well as on the ability to abandon near future. obsolete technologies. In this respect, one of the most important problems the Company In 2007, the total amount of subscribers in Russia grew by 21 mln, getting to 173 million encounters is the necessity to: at the end of 2007. According to the estimates of the analytical company ACM-Consulting, the level of mobile penetration in Russia reached 119% as of the end of 2007. • effectively integrate new and advanced technologies; • continue to develop the technical experience; At the same time, the relative growth rate of the subscriber base continued to decrease • respond to other technological changes. by 69%, 21% and 13% in 2005-2007, respectively, which should lead to a more severe struggle to attract new subscribers and retain old ones. This is the main factor that may Four of the main competing wireless communication standards licensed and operating potentially lead to the aggravation of the situation in the sector. in Russia at the present are as follows: GSM-900/1800, which is used by the Company, MTS, VimpelCom, and several regional operators; Digital Advanced Mobile Phone System, It should be noted that the influence of this factor on the Company is mitigated by the which operates in the 800 MHz range (DAMPS); NMT-450 which operates in the 450 MHz fact that the Company is one of the three largest cellular communications operators range (Scandinavian mobile phone); and CDMA (Multiple access with code division). in the Russian market and is constantly increasing its market share. Together with its GSM networks operate in the majority of Russian regions. Rossvyaznadzor may provide subsidiaries, the Company holds licenses for providing communications services additional licenses for any wireless communication standards, including GSM, in the in the GSM standard throughout Russia. regions where the Company operates. Issuing additional licenses for building networks in already existing wireless communication standards or implementing new wireless Expected actions of the Company in the event the competition becomes more severe communication technologies in any region where the Company operates may increase include: increasing the subscriber base through timely expansion of its networks, the competition considerably. developing telecommunications infrastructure, implementing new types of services. Special attention is also paid to the retaining of old subscribers, loyalty program was In 2007, the Company received a license to provide cellular communication services developed, which is valid for the subscribers of the Company and its subsidiaries, of the third generation (3G). In 2007, 3G network was commercially launched by North- working under MegaFon brand. West Branch of the Company.
Constructing the Company’s telecommunications network is fraught with risks and Besides, the technologies currently used by the Company may become obsolete or suffer uncertainty which may postpone provision of services within certain territories and increase competition from new technologies. In particular, third-generation communication based the cost of constructing the necessary infrastructure. In addition to the Company’s ability on the UMTS standards considerably surpasses the existing second-generation standards to provide for equipment supplies on commercially attractive terms, such risks include such as GSM. Correspondingly, the Company’s success in the future may partially depend regulations for use of telecommunications equipment in public communications networks upon the governmental policy and regulation of the third-generation communication and commissioning new facilities. In particular, all types of equipment are subject standards. The Company may also meet with competition from the direction of other to mandatory state certification. communication technologies. Suppliers of traditional wire telephone communications services may become competitors as their services become more advanced. In the future Probable steps of the Company towards eliminating these risks: further development the Company may also encounter competition from IP-telephony-based voice transmission of the logistics system, more severe control over compliance with all the rules, norms, communication, especially when combines with the appearing wireless communication and standards regulating the use of telecommunications equipment in public technologies such as WiMax. communications networks and commissioning new facilities. Impact of Changes in Conditions of Interacting with Other Communications Operators Impact of Stronger Competition in the Company’s Sector In order to provide communication services in 2007 the Company concluded agreements The Company’s main competitors are two national mobile communications operators of network interconnection (internetworking) with owners of the existing networks. – OJSC MTS and OJSC VimpelCom. They have established relations with each other These agreements allow the Company to switch local, long-distance, and international calls and a number of other key operators, and continue to develop these relations, which may that originate in the Company’s networks and terminate in the networks of other operators provide them with a significant competitive advantage. AFK Systema, a Russian holding and vice versa. company that has invested into several telecoms companies, informed that it owns 52.8% of the voting stock of MTS. Telenor, a leading Norwegian communication operator, said that Significant increase of the Company’s expenses on network interconnection or the it owns 26.6% voting shares of VimpelCom, while Alpha-Group, a Russian holding company limitation of the Company’s access to internetworking may adversely affect the Company’s with operations in the power and telecommunications sectors of the Russian economy, ability to provide services. Moreover, the Company’s counterparties under each informed that it holds 35.8% voting shares of VimpelCom. New competitors or alliances internetworking agreement currently have the right to repudiate these agreements of competitors may quickly take over a significant market share. and may use it. Basic Risk Factors Related to Operations of OJSC “MegaFon” 20–21
Influence of the Risk of Uncertainty Regarding the Telecom Market Regulation Risks Related to Changes of Interest Rates On January 1, 2004, a new Law “On Communications” came into force in Russia. In order to continue its development, the Company needs to perform considerable capital Even though a number of regulatory documents necessary for the new Law’s investments, build and develop its telecommunication networks. Maintenance of the implementation have not yet been adopted, on January 1, 2006 the new rules for Company’s positions in the telecom market shall require large additional investment connecting telecommunication networks and their interaction approved by Resolution No spending. The Company needs to attract additional financing to satisfy its financial needs. 161 of the Government of Russia dated March 28, 2005, became effective. Growth of interest rates on the market may force the Company to attract more expensive These rules govern relations between communication operators and make one of the funds to finance its investment program and day-to-day operations. principal regulatory documents in the domain of telecommunications regulation. If the Company is unable to receive sufficient funds on commercially viable terms, it may The Company received and implemented the License to provide the local and intrazonal need to considerably cut the expenses on developing its telecommunication networks, telephone communications services within the territory of its operation. In this connection, which may adversely affect its market share and operating performance. the risk of possible negative impact on the Company activities related to the direct numbering capacity as a result of changes in the Rules is low. At the same time, a rise of interest rates shall reduce the cost of servicing the already existing loans with fixed rates (e.g. bonded loans). On July 1, 2006, changes made to Article 54 of the Federal Law on Communications became effective. As per these changes, a subscriber shall not pay for telephone connection Hence, the influence of interest rates upon the Company’s activities is very significant. established as a result of another subscriber’s call. Rates for the inter-zone telephone In the event of this factor’s (upsurge of interest rates on national-currency obligations) connection between users of the local and cellular telephone connection were approved negative influence the Company intends to make borrowings in foreign currency, as the by the Federal Tariffs Service upon introduction of this principle. The principle “calling interest rate on such credits is more stable (there are agreements to this effect with credit party pays” is widely used all over the world and is fair for the most subscribers. Rates organizations). for the inter-zone telephone connection between users of the local and cellular telephone connection have been approved by the Federal Tariffs Service upon introduction of this principle. In this connection, the Company signed the supplement agreements on price change with all main counterparties. The risk that the price change will adversely affect the Company activities was mitigated by the competent marketing policy of the Company.
Risks Related to Possible Change of Prices for Raw Materials, Services Used by the Company in its Business (Separately in Domestic and External Markets), Their Impact upon the Company’s Performance The Company acquires special expensive equipment for the purposes of network expansion and telecommunications infrastructure development. Possible increase in prices on equipment and services used by the Company in its activities may adversely affect the Company’s financial indicators, since it would lead to a cost rise and, consequently – to profit reduction.
Risks Related to Changes in the Global Economy The Russian economy is sensitive to market declines and deceleration of the global economy. Since Russia is one of the leading world natural gas and oil producers and exporters, its economy is especially sensitive to natural gas and oil prices in the world markets. If the continuing US crisis in the market of unsecured liabilities under immovable assets mortgages and general instability in financial markets and loan markets result in decelerated growth or recession in US economy, this may reduce the demand and prices for natural gas and oil, which in its turn may decelerate the growth of the Russian economy or cause its collapse. These events may significantly limit the Company’s access to capital and have an adverse effect on the financial state of the Company’s subsidiaries and, consequently, its business.
Financial Risks The inflation affects the ruble rate against foreign currencies and may result in an increase in a number of the Company expenses expressed in foreign currency. Such costs include lease payments, cost of equipment and intangible assets (including the software and licenses for use of the software) acquired from foreign providers, costs relating to servicing of credits and loans in foreign currency and also consulting services nominated in foreign currency. The Company will not be able to raise its tariffs to the level ensuring current operation margin because of tough competition. Accordingly, high inflation in Russia may increase expenditures of the Company and reduce operating profit. Report by the Board of OJSC “MegaFon” 22–23 Corporate Finance Management HR Management Administration and Quality Management
Report by the Board of OJSC “MegaFon” on the Results of the HR Management Company’s Development in its Priority Directions MegaFon’s success in 2007 is the result of performance of its 17,000 employees and well-balanced policy of HR management. In 2007, the priority activities of OJSC “MegaFon” were as follows: Personnel Number Growth in MegaFon Group • Stronger financial position, growth of earnings and revenues; • Retaining ARPU, improving margins • Increasing market share, improving customer loyalty; 3500 5582 8652 11690 15890 16795 • Corporate culture development. 20000
15000 Corporate Finance Management 10000 2007 marks another exciting year for our Finance function. We continued to improve our international corporate credit rating. All the major international credit rating agencies, 5000 both Moody’s and S&P, upgraded us a full notch after they conducted their regular annual operational and financial reviews during the last year. 0 2002 2003 2004 2005 2006 2007 We are pleased that our 2007 operating cash flow exceeded $900 million which is $645 million higher than in 2006. Our operating cash surplus allowed us to further reduce approximately $180 million of our debt and also to invest about $600 million in short term One of the priority areas of Company’s activities in the field of HR management investments, which earned us significant interest income. is development of corporate culture, which provides framework for implementation of a project “Branded Customer Service”. In the course of this project over 3 500 employees Our banking relationships continue to improve in spite of the recent turmoil in the global took part in sessions “The Future Begins Today” aimed at corporate culture development. financial and credit markets. Terms and conditions on our existing credit facilities continue The project will continue in 2008 and cover all MegaFon employees. to improve. In recognition of our strong operational and financial performance, our bankers allowed us to amend and restate all our existing loan agreements, which released all Research conducted in 2007 by Boston Consulting Group revealed that MegaFon’s upstream guarantees and significantly improved major terms and conditions. corporate culture allowed reaching high results due to total participation of employees and realization of personal responsibility for the result. Over the course of the year, MegaFon closed $185million of credit facilities from various international sources. Specifically, in April 2007, we amended our credit facility with Nordic In 2007, about 11 MUSD were invested into training and development. The highest priority Investment Bank, converting the facility into a revolving loan facility, and adding other banks was the programs aimed at development and realization of leadership potential and deeper to the lending group. In October 2007, the Company entered into a 7-year credit facility cooperation of the Company’s management. agreement with China Development Bank and Bayerische Landesbank (“China Development Bank II Credit”) for $85 million with interest at LIBOR plus 1.1%. Our goal for 2007 is to The Company began to pay more attention to non-material stimulation through recognition continue to actively manage and refine our liability profile. We also aim to maintain prudent of achievements of its employees. and conservative financial policies and leverage levels, moving us further closer to investment grade ratings. In 2007, employees salaries were brought in line with the corporate grade system and uniform policy of compensation management in OJSC “MegaFon”; this allowed to increase significantly salary fund management efficiency and to take measures to increase competitiveness of the compensation to employees as compared to average market level in different regions of Russia.
Administration and Quality Management
In 2007, OJSC ”MegaFon” successfully passed two audits by Lloyd Register Quality Assurance, international independent certification company, and thus proved its compliance with ISO 9001:2000 international standards. Meetings of the Board of Directors 24–25 Report on Payment of Declared (Accrued) Dividends under Shares of OJSC “MegaFon”
The Board of Directors Storage agreement № 3200140096 30.11.2007 S.Soldatenkov, Meetings of the Board of Directors of OJSC “MegaFon” №73(137) as of 26.10.2007. between OJSC “MegaFon” and CJSC “Ural A.Nichiporenko, GSM” (monthly payment at amount of RUR L.Tkachuk, 75 520, including VAT). A.Locmelis, During 2007, the Board of Directors of OJSC “MegaFon” had 16 meetings: D.Malyshev 11 meetings in joint presence, and 5 absentee meetings.
In 2007, OJSC “MegaFon” did not close any major transactions. The Charter of the Company Supplemental agreement № 1 to lease 29.10.2007 S.Soldatenkov, does not provide for any other transactions to which the procedures for major transactions agreement № 35 between OJSC “MegaFon” A.Nichiporenko, approval would apply. and CJSC “Mobicom-Khabarovsk” as of L.Tkachuk, 01.01.2007. А.A.Locmelis, Y.Zhuravel List of transactions with vested interest closed by OJSC “MegaFon” in the reporting year, with specification of an interested party (parties), material conditions for each transaction Supplemental agreement № 2 to lease 29.10.2007 S.Soldatenkov, and Company’s management body that made the decision on its approval: agreement № 30 between OJSC “MegaFon” A.Nichiporenko, and CJSC “Mobicom-Kavkaz” as of L.Tkachuk, Management body 01.01.2007. A.Krainik that made decision Material conditions of the agreement Effective date Interested parties on transaction approval Supplemental agreement № 1 to lease 29.10.2007 S.Soldatenkov, agreement № 29 between OJSC “MegaFon” A.Nichiporenko, Extraordinary General Loan Agreement between OJSC “MegaFon” 15.03.2007 S.Soldatenkov, and CJSC “Sonic Duo” as of 01.01.2007. L.Tkachuk, Shareholders Meeting and CJSC “Mobicom-Center” at total A.Nichiporenko, I.Parfenov as of 12.03.2007. amount of USD 77 000 000, including VAT. L.Tkachuk, A.Eremkin The Board of Directors Loan Agreement № 145/Б between 07.02.2007 S.Soldatenkov, № 62(126) as of 31.01- OJSC “MegaFon” and CJSC “Mobicom- A.Nichiporenko, Loan Agreement between OJSC “MegaFon” 15.03.2007 S.Soldatenkov, 01.02.2007. Novosibirsk” at total amount of USD L.Tkachuk, и CJSC “Sonic Duo” at total amount of USD A.Nichiporenko, 40 000 000, including VAT. A.Gorshkov 200 000 000, including VAT. L.Tkachuk, I.Parfenov Loan Agreement № 146/Б between 07.02.2007 S.Soldatenkov, OJSC “MegaFon” and CJSC “Mobicom- A.Nichiporenko, Loan Agreement between OJSC “MegaFon” 15.03.2007 S.Soldatenkov, Khabarovsk” at total amount of USD L.Tkachuk, and CJSC “Mobicom-Kavkaz” at total A.Nichiporenko, 14 000 000, including VAT. Y.Zhuravel amount of USD 300 000 000, including L.Tkachuk, VAT. A.Krainik The Board of Directors Granting guarantee by OJSC “MegaFon” to 04.09.2007 S.Soldatenkov, №69(133) as of 27.06.2007. OJSC АКB “Svyaz-Bank”, CJSC “ТTmobile” I. Nikodimov, , Loan Agreement ДОГ№144-Б between 15.03.2007 S.Soldatenkov, as beneficiary at total amount of RUR A.Nichiporenko, OJSC “MegaFon” and OJSC “MCS - A.Nichiporenko, 128 750 000, including VAT. L.Tkachuk, Povolzhie” at total amount of USD L.Tkachuk, G. Kaumov 140 000 000, including VAT. V.Ermakov The Board of Directors Supplemental agreement № 1 to lease 01.09.2007 S.Soldatenkov, Extraordinary General Supplemental agreement № 1 to loan 29.12.2007 S.Soldatenkov, №71(135) as of 29.08.2007. agreement № 32 between OJSC “MegaFon” A.Nichiporenko, Shareholders Meeting agreements №141/Б and 133/Б between A.Nichiporenko, и CJSC “Ural GSM” as of 01.01.2007, L.Tkachuk, as of 30.11.2007. OJSC “MegaFon” and CJSC “Sonic Duo”. L.Tkachuk, including VAT. A.Locmelis, A.Locmelis, D.Malyshev V.Ermakov Supplemental agreement № 3 to lease 01.11.2007 S.Soldatenkov, Supplemental agreement № 3 to lease 01.11.2007 S.Soldatenkov, agreement № 30 between OJSC “MegaFon” A.Nichiporenko, agreement № 31 between OJSC “MegaFon” A.Nichiporenko, and CJSC “Mobicom-Kavkaz” as of L.Tkachuk, and OJSC “MCS-Povolzhie” as of L.Tkachuk, 01.01.2007. A.Locmelis, 01.01.2007. A.Locmelis, A.Krainik V.Ermakov Storage agreement №3200128636 S.Soldatenkov, between OJSC “MegaFon” and CJSC 15.10.2007 A.Nichiporenko, Supplemental agreement № 2 to lease 01.11.2007 S.Soldatenkov, “Mobicom-Novosibirsk” (valid till L.Tkachuk, agreement № 32 between OJSC “MegaFon” A.Nichiporenko, 15.10.2009, monthly payment of RUR A.Locmelis, and CJSC “Ural GSM” as of 01.01.2007. L.Tkachuk, 40 828, including VAT) A.Gorshkov A.Locmelis, D.Malyshev Storage agreement №3200129985 01.11.2007 S.Soldatenkov, between OJSC “MegaFon” and CJSC A.Nichiporenko, Annual General Shareholders Supplemental agreement № 2 to lease 02.10.2007 S.Soldatenkov, “Mobicom-Khabarovsk” (valid till L.Tkachuk, Meeting as of 28.06.2007. agreement № 31 between OJSC “MegaFon” A.Nichiporenko, 01.11.2009, monthly payment of RUR A.Locmelis, and OJSC “MCS - Povolzhie” L.Tkachuk, 23 600 ). Y.Zhuravel as of 01.01.2007. V.Ermakov Supply agreement № 08-1 for 09.01.2007 S.Soldatenkov, The Board of Directors Purchase agreement of office furniture 31.10.2007 S.Soldatenkov, telecommunications equipment between A.Nichiporenko, №73(137) as of 26.10.2007. № А7-УСЛ-31 between OJSC “MegaFon” A.Nichiporenko, OJSC “MegaFon” and CJSC “Sonic Duo” L.Tkachuk, and CJSC “Sonic Duo” at total amount of L.Tkachuk, at total amount of RUR 1 605 000 000, A.Locmelis, RUR 6 934 942, including VAT. A.Locmelis, including VAT. I.Parfenov I.Parfenov Report on Payment of Declared (Accrued) Dividends under Shares of OJSC “MegaFon”
Dividends upon 2007 operating results of OJSC “MegaFon” were not declared and were not paid. –27–27
28 Operations
35 Information on Compliance with the Corporate Code by OJSC “MegaFon”
36 Annual Accounting Statements of OJSC “MegaFon” for 2007 Operations 28–29 Marketing Sales and Customer Care
Operations Sales and Customer Care
Marketing In 2007, MegaFon continued to implement initiatives aimed at increasing the quality of services and subscriber base loyalty: In 2007, MegaFon continued unification of marketing proposals on the whole territory of service taking into account competitive advantage and subscribers needs, as a result the • in addition to the existing 199 offices, 45 new sales and customer care offices were following federal proposal were prepared and launched in the market: opened, total amount of processed customer requests is over 26 mln;
• Tariff plan “Student” • operational CRM, allowing to process customer requests better and analyze the quality • Tariff plan “MegaFon-Modem” of rendered services; self-service channels became popular (IVR, WEB, USSD), due to which • Tariff plan “Home” the number of requests (excluding requests for the balance) exceeded 2 bln; • Tariff option “Communications Geography” • Bundles of minutes and SMS • Quality committees, which consolidate the needs of subscribers and monitor their • Tariff plan for small business “Firmenny (Corporate) Tariff” satisfaction under new projects of the Company, were created in subsidiaries • Tariff plan “Business Trip” and the NW Branch of OJSC “MegaFon”. • Tariff plan “Territory” • Tariff option “Call Geography” • information centers (in addition to their service function) started to sell products and • First federal promotion to attract corporate clients “Let Them Talk” services of MegaFon’s network, the total number of requests throughout 2007 exceeded 112 mln; With “Home” tariff plan the Company finished creation of a logical line of base tariff plans and in the conditions of high market saturation started to develop and launch special • motivation program for employees participating in customer care is operating in all niche proposals, where first of all “Student” and “MegaFon-Modem” tariff plans should be the subsidiaries and the NW Branch of OJSC “MegaFon”. mentioned. During 2007, the Company continued to implement commercial projects aimed at increasing The Company started to pay a lot of attention to promotion of value-added services, which the efficiency of its distribution channels: is reflected in the launch of “MMS, GPRS-WAP and GPRS-Internet Test Package” that allows subscribers to learn new services. • starting from the end of 2007, the Company launched the internet-shop www.shop. megafon.ru, allowing subscribers’ selecting the telephone number according to their In 2007, tariff options “Geography of Communications” and “Geography of Calls”, as well preferences. One of the convenient additional options – delivering SIM-cards to the address as bundles of minutes and SMS became a natural development of MegaFon innovative tariff of the customer. Due to this project MegaFon’s subscriber base increased by tens of policy under which for yet another year the Company’s subscribers can create their own tariff thousands of new clients; according to their preferences. • federal merchandising project was launched that allowed improving significantly the work Development of the business market became one of the priorities in 2007. The idea used at of retail and interaction with partners; the mass market – creation of special niche proposals – was also implemented in products for business clients. Tariff plans “Business Trip” and “Territory” meet the demands of • at the beginning of 2007 the brand-book was created for MegaFon’s branded shops; corporations with branches in different subjects of the Russian Federation. “Firmenny Tariff” allowed attracting small businesses, earlier uncovered segment of the corporate market. • together with partners 85 new branded shops were opened, their total number is 410; Tariff option “Business Trip” became one of the innovative proposals for MegaFon business clients – now tariffs can be tuned not only in home region, but also in roaming. • during 2007, multiple joint campaigns with partners were conducted, as well as a set of measures on increasing dealer network loyalty, which allowed MegaFon to become In 2007, the Company conducted the first federal campaign to attract corporate clients the leader of the Russian market in terms of net subscriber adds. (“Let Them Talk”), which allowed positioning the Company as an operator “for business”, offering flexible and innovative solutions for all segments of the corporate market. Value-Added Services 30–31
2007 VAS Revenue Structure – Regions Value-Added Services
2007 became a landmark for the Company. The first Russian 3G network was Moscow North Caucasus commercially launched in the NW Branch, which means that the services on the basis of data technologies – one of main strategic priorities of MegaFon North-West – were upgraded to a new level of quality. Volga During 2007, new multimedia services were implemented and customary services were Urals Center improved, both types of services are aimed at meeting the customer demands. Siberia Far East
• Since the beginning of the year each new subscriber of MegaFon can use data services and MMS services via Try & Buy system. Services that generated most of VAS revenue in 2007 included SMS peer to peer – 57%, • The pilot federal project, MP3-shop, selling full-tracks, with new billing mechanisms and data transmission (GPRS, CSD) – 21%. was launched in Moscow region.
• Multi-user online (MMORPG) JAVA-games are being developed.
• WEB-portal MegaFonRPO received a new advanced design.
• By the end of 2007, RBT service was being provided to over 3 million users.
• In 2007, a new promising move was initiated – mobile advertising.
• “Mobile TV” service was launched for commercial use on the whole territory of network coverage.
• At the end of 2007 a joint project with Nokia was started – MegaSync (synchronization of handset e-mail, contacts and calendar). Data transmission services was the fastest growing sector. During the year GPRS traffic • As a result of 2007, MegaFon is leading among the Big Three operators in terms grew three-fold and was over 400 GB. of VAS ARPU, which was $ 1.9. The Company also spent some of its effort on implementation in some regions of a number In 2007, the best results of VAS revenue were demonstrated by CJSC “Sonic Duo” of new services such as “Live Balance”, “Mobile TV”, dynamic voice mail, federal package (MegaFon- Moscow), NW branch OJSC “MegaFon” (MegaFon-North West), CJSC “Mobicom- of IN services for corporate customers. Kavkaz” (MegaFon-North Caucasus) and OJSC “MCS-Povolzhie” (MegaFon-Povolzhie). Technology Development 32–33
Technology Development In 2008, it is planned to launch into commercial use the fragments of 3G network that are currently on the final stage of construction on the territory of 17 RF subjects in the The main results of the Company’s technical development in 2007 include continuing North-West and 14 RF subjects in some other Federal Districts, while in the North West significant level of investment into the construction of the network infrastructure over Federal District alone there will be over 1000 BS integrated into use. the entire coverage area of MegaFon network. Based on License №38950 “Intra-Zonal Communication Services”, in 2006 a network for rendering intra-zonal communications services was constructed and launched for commercial use in Saint Petersburg. Growth of equipment quantities during the period: In compliance with License №49431 “Communication Services for Cable Broadcasting”, Growth for Growth for Growth for Equipment 2005, % 2006, % 2007, % installation of the relevant equipment was completed for the purposes of rendering a wide range of services on the territory of the North-West Federal District, including mobile TV services, and work is being conducted on launching it into commercial use. HLR, quantity 11,5 17,2 5,9 HLR, capacity (kSubs) 60,9 34,9 9,1 Based on License №53194 “Communication Services for Providing Communication MSC, quantity 32,4 10,2 10,2 Channels” that was received pursuant to prolongation of License №22964 dated MSC, capacity (kSubs) 60,4 32,5 25,2 01.08.2002, we continued leasing communications channels on the territory of Archangelsk, Vologda, Leningrad and Murmansk regions, Republic of Karelia and BSC, quantity 52,3 25,2 23,0 St. Petersburg. BSC, capacity 127,1 26,6 30,8 BS sites 54,6 36,4 26,7 In order to implement its License №44514 “ILD and DLD Communication Services” BS racks 61,1 41,8 28,8 we took effort to launch commercial use of ILD and DLD networks on the territory Sectors 70,5 41,2 26,1 of the Russian Federation. TXR 88.1 46.5 31.5 Based on Licenses №44199 “Data Transmission Communications Services for Rendering Voice Information” and №44200 “Data Transmission Communication Services, Except for Data Transmission Communication Services for Rendering Voice Information”, on the Base station sites construction dynamics territory of North-West Federal District we constructed a scaled high efficiency IP-MPLS data transmission network that uses 10 Gigabit Ethernet communication channels and allows to transmit different types of traffic, while providing the required QoS level and 2005 2005 2005 2007 Region yearend yearend yearend growth, % high level of failure-resistance.
Moscow 1510 2000 2400 20,0 The main activities of OJSC “MegaFon” and its subsidiaries in 2007 were provided by North-West 2213 2622 2986 13,9 additional numbering resource in terms of license for ILD and DLD services, as well as Center 1058 1643 2346 42,8 extending the list of services provided to subscribers: 15 codes of OKS№7 signalization North Caucasus 1589 1995 2254 13,0 points, 10 000 numbers in DEF=8 (800) codes. For implementation of license for local Povolzhie 1828 2584 3448 33,4 and zone communications there are over 125 000 numbers in АВС codes, 255 codes of OKS№7 signalization points. In order to provide future development of its GSM Ural 1027 1416 1782 25,8 mobile communication networks, MegaFon received additional numbering resource Siberia 577 862 1148 33,2 of one million numbers in DEF code. Far East 417 816 1290 58,1 Total in MegaFon network 10219 13938 17654 26,7
As of December 31, 2007, the Company’s mobile network included 17 654 base station sites. 19 switches, 502 base station controllers were in use. The growth in base station sites for 2007 was 26.7%.
In 2007, the efficiency of network technological equipment increased simultaneously with improvement of the service quality.
In 2007, MegaFon won the first place at tender for 3G license. At the end of October 2007, in terms of realization of License №50788 “Mobile Communication Services” (IMT2000/UMTS standard), MegaFon became the first among the Russian GSM- operators to start rendering 3G services, providing unique advantages of 3G communications to its subscribers on the territory of St. Petersburg and Leningrad region. Special Programs 34–35 International Projects Information on Compliance with Corporate Code by OJSC “MegaFon”
In 2007, MegaFon expanded its GSM roaming geography up to 200 countries, as well as GPRS and CAMEL roaming – up to 100 countries. confidential and open wireless communications, including services to Administration of the President of the Russian Federation, Ministry of Defense of Russia, etc. GSM GPRS CAMEL 3G (incoming) The number of consumers of special services significantly increased among commercial Agreements Commercial Agreements Commercial Commercial Commercial structures, including “Norilsk Nickel”, Mosvodokanal, security agencies of FSUE (operators/ partners (operators/ partners partners partners countries) (operators/ countries) (operators/ (operators/ (operators/ “Security”, “Satro-Paladin”, Jablotron, “Security complex”, “Golf stream”, countries, countries) countries) countries) “Cesar Sattelite”, “Bayard”, AnvantTech, etc., banks and other commercial structures. incl. satellite service) 2006 year end 500/186 427/190/198 359/162 130/89 129/80 – International Projects 200 year end 533/191 464/196/203 409/170 169/104 167/105 429/173 By the end of 2007, the mobile operator CJSC “TT mobile”, a subsidiary of OJSC “MegaFon” operating on the territory of Tajikistan, was rendering services to approximately 140 000 commercial subscribers (about 14% of Tadjik telecom In 2007, MegaFon was the first among Russian operators to provide GPRS roaming for market). its subscribers in all European countries, GSM/GPRS/CAMEL roaming in home network in all RF subjects, and began to provide incoming 3G roaming services to subscribers CJSC “TT mobile” provides mobile services in GSM 900/1800 and 3G-UMTS standards, of its Russian and foreign partners. and holds licenses for telematic and data transmission services (including IP- telephony). Distinctive advantages of the CJSC “TT mobile” include: high communication In 2007, the roaming management system that allows optimizing costs for outgoing quality standard, wide range of value-added services, professionalism, as well as high international roaming of MegaFon network was launched into use. level of responsibility and care for each customer and their interests.
In 2007, the annual growth of aggregate roaming services (intranet and internet) was By the end of 2007 the network of CJSC “TT mobile”, consisting of 295 BS, covered 8%. The aggregate turnover of intranet roaming services increased by 17% during 2007. approximately 15% of the country territory with about 73% Tajik population. Major contribution to this indicator was made by international outgoing roaming, which increased by 37% as compared to 2006. Due to the development of MegaFon network in the regions, in 2007 there remained the trend to replace the national roaming with the intra-net one. The volumes of incoming roaming came close to stabilization – the growth was 6%. Annual growth of GPRS services in roaming in 2007 was 260% (up to US$ 2.7 M) for outgoing international roaming, and 220% (up to $ 2.1 M) for incoming international Information on Compliance with Corporate Code roaming. by OJSC “MegaFon”
In order to protect the rights and guarantee the interests of its shareholders and potential investors, OJSC “MegaFon” complies with the key provisions of the Corporate Special Programs Code recommended by the FCSM on April 04, 2002, by its Directive №421/p; it also pursues the best world corporate governance practices. Key provisions of the In 2007, the number of subscribers of Special Federal Subsystem of Confidential Mobile Corporate Code reflected in the Company’s internal documentation are disclosed in Communications and Special Network of Data Transmission more than doubled. Annex 2. We were successful in rendering confidential and common mobile services during important national events (Summit “Russia – EU”, elections to RF State Duma of the fifth convocation, joint military exercise of “2007 Peace Mission” member states of the Shanghai Cooperation Organization, antiterrorist exercises in Moscow, Leningrad Region etc.).
In 2007, MegaFon provided Special Federal Subsystem of Confidential Mobile Communications and Special Network of Data Transmission services to the benefit of Administration of the President of the Russian Federation, Federal Protective Service of Russia, Federal Security Service of Russia, Ministry of Internal Affairs of Russia, STSI of Russia, Ministry for Emergency Situations of Russia, State Inspectorate for Minor Courts of Ministry for Emergency Situations of Russia, State Fire Inspectors of Ministry for Emergency Situations of Russia, Main Directorate of Administrating Punishment, Rosatom and other agencies. The Company won 7 tenders for rendering services of Annual Accounting Statements 36–37
Annual Accounting Statements of OJSC “MegaFon” for 2007 the amounts and disclosures in the financial statements concerning the financial and business operations of the audited entity; assessing the compliance with accounting principles and rules used in the preparation of financial statements, and significant Independed auditor’s reporton financial statements of OJSC “MegaFon” estimates made by management of the audited entity; as well as the evaluation of the overall to the shareholders and Board of Directors of OJSC “MegaFon” financial statement presentation. We believe that our audit provides a reasonable basis for our opinion on the fairness, in all material respects, of these financial statements and on compliance of accounting procedures insofar as they relate to the preparation of financial Details of the auditing firm statements in accordance with the legislation of the Russian Federation.
Name: ERNST & YOUNG LLC In our opinion, the accounting procedures at OJSC “MegaFon”, insofar as they relate to the preparation of financial statements in 2007, complied with the requirements Address: Russia 115035, Moscow, Sadovnicheskaya naberezhnaya, 77, building 1 of Federal Law on Accounting No. 129-FZ of 21 November, 1996, in all material respects, and the aforementioned financial statements referred to above have been prepared in Certificate of an entry made to the Uniform State Register of Legal Entities Concerning accordance with the aforementioned Law and present fairly, in all material respects, a Legal Entity Registered Before July 1, 2002; date of the entry – December 5, 2002, the financial position of OJSC “MegaFon” as of 31 December, 2007 and the results of its series 77 No. 007367150, registered by the Moscow Registration Chamber State Institution operations for the period from 1 January through 31 December, 2007 in accordance with at No. 108.877 on June 20, 2002, Main State Registration Number 1027739707203. regulations of the Russian Federation insofar as they relate to the preparation of financial statements. Audit License No. Е002138, approved by Order No. 223 of the Russian Ministry of Finance dated September 30, 2002, for a term of five years, prolonged till 30 September, 2012 by The accompanying financial statements are not intended to present the financial position Order No. 573 of the Russian Ministry of Finance dated September 30, 2007. and results of operations in accordance with accounting principles and practices generally accepted in countries and jurisdictions other than the Russian Federation. Accordingly, Membership of an accredited professional auditors’ association – ERNST & YOUNG LLC the accompanying financial statements are not designed for those who are not informed is a member of Non-profit Partnership “The Institute of Professional Accountants of Russia” about accounting principles, procedures and practices in the Russian Federation. (“IPAR”).
March 26, 2008 Details of the audited entity
Name: OJSC “MegaFon” Mikhail Kapitanov Address: 115035, Moscow, Kadashevskaya naberezhnaya, 30 Partner Information about the State Register of Legal Entities Concerning a Legal Entity: No. АОЛ-5192 on June 17,1993 Dmitry Lobachev We have audited the accompanying financial statements of OJSC “MegaFon” for the period Auditor’s qualification certificate from 1 January through 31 December, 2007, which are comprised of the balance sheet, the statements of income, changes in the shareholders’ equity, cash flows, and the related No. K002839 (general audit), not limited in tim appendix to the balance sheet and the explanatory notes to the financial statements, inclusive of sections 4-29. The management of OJSC “MegaFon” is responsible for the compliance of accounting procedures, preparation and presentation of these financial statements. Our responsibility is to express an opinion on the fairness, in all material respects, of these statements and on compliance of accounting procedures insofar as they relate to the preparation of financial statements in accordance with the legislation of the Russian Federation based on our audit.
We conducted our audit in accordance with the Federal Law on Auditing Activity, the Federal Rules (Standards) on Auditing, the Rules (Standards) for Auditing Activities, as approved by the Committee on Auditing Activity under the President of the Russian Federation, and International Standards on Auditing.
The audit was planned and performed to obtain reasonable assurance about whether the financial statements are free of material misstatements. The audit was performed on a selective basis and included an examination, on a test basis, of evidence supporting Balance sheet 38–39
At beginning At end Balance sheet Capital and Liabilities Line code of reporting year of reporting year as of December, 31, 2007 Codes 1234 Form No.1 under OKUD code 0710001 III. Equity and Reserves Date (yy/mm/dd) 2007 12 31 Charter capital 410 62 000 62 000 Company OJSC “MegaFon” under OKPO code 31090505 Treasury shares 411 – – Taxpayer Identification Number TIN 7812014560 Additional capital 420 2 351 126 2 246 430 Reserve capital 430 3 100 3 100 Type of activity under OKVED code 64.20 including: reserves established Legal/ownership form OJSC under OKOPF/OKFS codes 47 34 in accordance with legislation 431 3 100 3 100 Monetary unit: RR thds under OKEI code 384 reserves established in accordance with charter documents 432 – – Locations (address) 115035 Moscow, Kadashevskaya, 30 Date Retained earnings (loss) 470 24 106 154 29 071 810 of approval TOTAL for Section III 490 26 522 380 31 383 340 Date of sending IV. Long-Term Liabilities (receipt) Loans and borrowings 510 41 512 312 57 304 206 Deferred tax liabilities 515 271 471 328 654 Other long-term liabilities 520 0 – Assets At beginning At end Line code of reporting year of reporting year TOTAL for Section IV 590 41 783 783 57 632 860 1234 V. Short-Term Liabilities Loans and borrowings 610 10 327 075 11 371 736 I. Non-current assets Accounts payable 620 3 858 539 5 245 363 Intangible assets 110 166 022 112 939 including: trade accounts payable 621 1 395 846 2 482 445 Fixed assets 120 13 638 487 15 956 003 accrued payroll 622 52 438 61 581 Construction in progress 130 3 321 993 4 543 234 рayable to state non-budgetary funds 623 15 314 14 145 Income-bearing investments in tangible assets 135 30 112 629 34 862 772 taxes and levies payable 624 315 984 368 235 Long-term financial investments 140 17 093 957 18 609 284 other payables 625 296 229 540 909 Deferred tax assets 145 170 236 333 804 advances received 626 1 782 728 1 778 048 Other non-current assets 150 2 809 700 2 499 512 Dividends payable 630 – – TOTAL for Section I 190 67 313 024 76 917 548 Deferred income 640 53 743 38 770 II. Current assets Reserves for future expenses 650 – – Inventory 210 206 296 196 376 Other short-term liabilities 660 – – including: raw materials, consumables and other similar assets 211 75 058 63 767 TOTAL for Section V 690 14 239 357 16 655 869 livestock 212 – – Balance 700 82 545 520 105 672 069 work in progress 213 – – Statement of off-balance-sheet items Leased fixed assets 910 321 660 329 270 inished goods and goods for resale 214 – – including capital leases 911 – – dispatched goods 215 – – Inventory items accepted into custody 920 – 19 071 prepaid expenses 216 131 238 132 609 Goods accepted on commission 930 – – other inventory and costs 217 – – Bad debts written-off to losses 940 464 422 754 079 Value added tax on purchased assets 220 322 730 538 797 Assets received as collateral for liabilities Accounts receivable (where settlement is expected and payments 950 150 479 024 67 792 243 in over 12 months after the reporting date) 230 1 615 178 1 833 794 Assets pledged as collateral for liabilities including trade receivables 231 – – and payments 960 8 100 349 8 191 936 other 232 1 615 178 1 833 794 Depreciation of housing assets 970 – – Accounts receivable (where settlement is expected Depreciation of land improvement within 12 months after the reporting date) 240 5 621 456 6 182 560 and other similar assets 980 – – ncluding trade receivables 241 2 285 261 2 166 441 Intangible assets obtained for use 990 – – other 242 3 336 195 4 016 119 Short-term financial investments 250 5 851 805 18 724 080 Cash 260 1 615 031 1 278 914
Other current assets 270 – – CEO Chief TOTAL for Section II 290 15 232 496 28 754 521 S.V. Soldatenkov Accountant L. B. Rudnitskaya (signature) (full name) (signature) (full name) BALANCE 300 82 545 520 105 672 069 “26” March 2008 “26” March 2008 –41–41
42 Consolidated Financial Statements for 2007
73 Annexes Consolidated Financial Statements Years ended December 31, 2007 and 2006 with Report of Independent Auditors
Report of Independent Auditors The Board of Directors and Shareholders OJSC MegaFon
Consolidated Financial Statements Years ended December 31, 2007 and 2006 We have audited the accompanying consolidated balance sheets of OJSC MegaFon and subsidiaries (“the Contents Company”) as of December 31, 2007 and 2006, and the related consolidated statements of income, share- holders’ equity, and cash flows for the years then ended. These financial statements are the responsibility of 1 Report of Independent Auditors 43 the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those Consolidated Financial Statements standards require that we plan and perform the audit to obtain reasonable assurance about whether the finan- cial statements are free of material misstatement. We were not engaged to perform an audit of the Company’s 2 Consolidated Balance Sheets 44 internal control over financial reporting. Our audits included consideration of internal control over financial 3 Consolidated Statements of Income 45 reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the 4 Consolidated Statements of Cash Flows 46 purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial report- 5 Consolidated Statements of Shareholders’ Equity 47 ing. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence 6 Notes to Consolidated Financial Statements 48 supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consoli- dated financial position of OJSC MegaFon and subsidiaries at December 31, 2007 and 2006, and the consoli- dated results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States.
Ernst & Yong LLC
Moscow, Russia
April 17, 2008
42... 43... Consolidated Balance Sheets Consolidated Statements of Income (in millions of Rubles, except share amounts) (in millions of Rubles)
(Note 2) (Note 2) December 31 December 31 Note 2006 2007 2007 Note 2006 2007 2007 Convenience Convenience translation, translation, Assets thousands US $ thousands US $ Current assets: Revenues (including related party amounts of 1,605 in 2007 Cash and cash equivalents 3 6,965 4,259 $ 173,510 and 1,826 in 2006) 16, 21 101,115 140,393 $ 5,719,541 Short-term investments 569 21,710 884,455 Cost of services, excluding depreciation and amortization (including related party amounts of 1,435 in 2007 and 2,475 in 2006) 17, 21 17,442 26,304 1,071,612 Accounts receivable, net of allowance for doubtful accounts of 222 in 2007 and 143 in 2006 4 4,740 5,443 221,745 Gross margin 83,673 114,089 4,647,929 Accounts receivable, related parties 21 418 104 4,237 Sales and marketing expenses 18 11,066 13,647 555,972 Inventories 457 468 19,066 Operating expenses (including related party amounts VAT receivable 3,322 2,372 96,634 of 680 in 2007 and 841 in 2006) 19, 21 22,507 28,854 1,175,498 Deferred tax assets 20 739 1,111 45,262 Depreciation and amortization 6, 7 18,393 24,187 985,366 Prepayments and other current assets 5 2,469 3,704 150,898 Operating income 31,707 47,401 1,931,093 Total current assets 19,679 39,171 1,595,807 Other income and expenses: Property, plant and equipment, net 6 87,600 102,817 4,188,714 Interest expense 2,866 2,476 100,871 Intangible assets, net 7 13,740 12,745 519,225 Change in fair value of derivative financial instruments (C-loans) 777 –– Other non-current assets 8 1,680 1,764 71,864 Other income, net (273) (1,164) (47,421) Total assets 122,699 156,497 $ 6,375,610 Net foreign exchange gain 13 (2,358) (490) (20,003) Liabilities and shareholders’ equity Total other expenses, net 1,012 822 33,447 Current liabilities: Accounts payable 9 4,553 5,436 $ 221,460 Income before income taxes and minority interest 30,695 46,579 1,897,646 Accounts payable and accruals to equipment suppliers 2,387 3,061 124,704 Provision for income taxes 20 8,684 12,633 514,662 Accounts payable, related parties 21 586 519 21,144 Minority interest in earnings/(loss) of a subsidiary 22 (20) (815) Subscribers’ prepayments 5,515 5,794 236,045 Net income 21,989 33,966 $ 1,383,799 Deferred revenue, current portion 1,238 499 20,329 Accrued liabilities 10 2,663 3,790 154,403 Loans from shareholders, current portion 12 – 433 17,640 Debt, current portion 11 7,496 10,130 412,691 Other current liabilities 143 260 10,592 Total current liabilities 24,581 29,922 1,219,008 Debt, net of current portion 11 31,893 26,003 1,059,349 Loans from shareholders 12 3,241 2,877 117,208 Other non-current liabilities 14 1,945 2,632 107,226 Deferred tax liabilities 20 1,449 1,228 50,028 Total liabilities 63,109 62,662 2, 552,819 Commitments and contingencies 23 – –– Minority interest 55 35 1,426 Shareholders’ equity: 15 Common stock (par value of 10 Rubles, 6,200,002 shares authorized, issued and outstanding) 581 581 23,670 Reserve fund 17 17 693 Additional paid-in capital 13,875 13,875 565,261 Retained earnings 45,309 79,591 3,242,496 Accumulated other comprehensive loss 2 (247) (264) (10,755) Total shareholders’ equity 59,535 93,800 3,821,365 Total liabilities and shareholders’ equity 122,699 156,497 $ 6,375,610
The accompanying notes are an integral part of The accompanying notes are an integral part of 44... these consolidated financial statements. Consolidated Financial Statements these consolidated financial statements. 45... Consolidated Statements of Cash Flows Consolidated Statements of Shareholders’ Equity (in millions of Rubles) (in millions of Rubles, except share amounts)
(Note 2) (Note 2) Years ended December 31, Common stock 2006 2007 2007 Shares Amount Reserve Additional Retained earnings Accumulated Comprehen- Total Convenience translation, fund paid-in other compre- sive income thousands US $ capital hensive loss (loss)
Cash flows from operating activities: Balances as of December 31, 2005 6,200,002 581 17 13,875 23,320 ––37,793 Net income 21,989 33,966 $ 1,383,799 Comprehensive income Adjustments to reconcile net income to net cash provided by operating activities: Net income – –– – 21,989 – 21,989 21,989 Depreciation and amortization 18,393 24,187 985,366 Foreign currency translation Net foreign exchange gain (2,358) (490) (20,003) adjustment – –– – – (224) (224) (224) Minority interest in net earnings/(loss) of a subsidiary 22 (20) (815) Total comprehensive income – –– –– – 21,765 – Provision for deferred income taxes (856) (593) (24,158) Effect of adoption of SFAS No.158, Change in fair value of derivative financial instruments (C-loans) 777 –– (net of tax effect of zero) – –– – – (23) (23) Amortization of deferred finance charges and other non-cash items 1,257 1,182 48,154 Balances as of December 31, 2006 6,200,002 581 17 13,875 45,309 (247) 59,535 Decrease/(increase) in: Comprehensive income Accounts receivable (2,221) (590) (24,036) Net income – –– – 33,966 – 33,966 33,966 Accounts receivable, related parties (326) 122 4,970 Pensions costs (net of tax effect Inventories 120 (43) (1,752) of zero) – –– – – (17) (17) (17) VAT receivable 738 951 38,743 Total comprehensive income – –– –– – 33,949 – Prepayments and other current assets (654) (1,172) (47,747) Effect of adoption of FIN No.48 – –– – 316 – 316 Increase/(decrease) in: Accounts payable 1,874 668 27,214 Balances as of December 31, 2007 6,200,002 581 17 13,875 79,591 (264) 93,800 Accounts payable, related parties 145 172 7,007 Deferred revenue 739 (734) (29,903) Subscribers’ prepayments 742 279 11,366 Accrued liabilities 299 1,125 45,834 Net cash provided by operating activities 40,680 59,010 2,404,039 Cash flows from investing activities: Purchases of property, plant and equipment and intangible assets (33,203) (35,894) (1,462,303) Proceeds from sale of property, plant and equipment – 218 8,881 Increase in short-term investments (569) (21,172) (862,537) Other non-current assets 475 (47) (1,915) Net cash used in investing activities (33,297) (56,895) (2,317,874) Cash flows from financing activities: Proceeds from long-term debt 7,238 6,305 256,863 Repayments of long-term debt and C-loans (15,076) (10,812) (440,476) Deferred finance charges paid (154) (176) (7,170) Capital lease principal repayments (106) (10) (407) Net cash used in financing activities (8,098) (4,693) (191,190) Effect of exchange rate changes on cash and cash equivalents (192) (128) (5,216) Net decrease in cash and cash equivalents (907) (2,706) (110,241) Cash and cash equivalents at the beginning of the year 7,872 6,965 283,751 Cash and cash equivalents at the end of the year 6,965 4,259 $ 173,510 Supplemental cash flow information: Cash paid during the year for income taxes 9,885 14,013 $ 570,883 Cash paid during the year for interest, net of amounts capitalized 2,512 2,532 103,152 Non-cash financing and investing activities: Equipment purchased under credit (See Note 11) 954 1,835 74,757
The accompanying notes are an integral part of The accompanying notes are an integral part of 46... these consolidated financial statements. Consolidated Financial Statements these consolidated financial statements. 47... Notes to Consolidated Financial Statements Notes to Consolidated Financial Statements December 31, 2007 and 2006 (in millions of Rubles, unless otherwise indicated) (continued)
2. Summary of Significant Accounting Policies
The principal accounting policies adopted for the preparation of the accompanying consolidated financial statements are set out below.
Basis of Presentation
1. Description of Business The statutory accounting records of the Company and its subsidiaries, except for TT-Mobile, are maintained in Rubles and are prepared in accordance with the accounting requirements provided for under Russian law and accounting practices. The accounting records of TT-Mobile are maintained in the local currency and in Open joint stock company (or “OJSC”) MegaFon (the “Company” or “MegaFon”) is a provider of a broad range accordance with the accounting practices of the Republic of Tajikistan. These financial statements have been of wireless telecommunications services to businesses, other telecommunications service providers and retail prepared in accordance with accounting principles generally accepted in the United States of America (“US subscribers. GAAP”). The accompanying financial statements differ from statutory financial statements used in Russia and The Company and its subsidiaries have operating licenses for all Federal Districts of the Russian Federation, the Republic of Tajikistan because they reflect certain adjustments, recorded in the entities’ accounts, which covering 100% of its population. MegaFon has built and is expanding a nationwide mobile communications are necessary to present the financial position, results of operations and cash flows in accordance with US network that operates on the dual band GSM-900/1800 standard. The Company is also operating an IMT-2000 UMTS network in St. Petersburg. GAAP. The principal adjustments are related to revenue recognition, deferred taxation, consolidation, account- ing for derivatives, and valuation and depreciation of property, plant and equipment and intangible assets. In April 2007, the results of the tender for the 3G licenses were announced. MegaFon was one of three compa- nies that were granted a federal license allowing them to provide 3G services in Russia. In accordance with the conditions of the license, the Company must start commercial exploitation of the 3G technology in 86 regions As further discussed in “Foreign Currency Translation Methodology” below, effective January 1, 2007, the at various dates over the period from May 2008 through May 2010. Company’s reporting currency changed from the US dollar to the Ruble. As at December 31, 2007, MegaFon included the following operating entities:
Ownership in- Date operations Basis of Consolidation Company terest Region / License area started MegaFon: The Company consolidates all entities for which it has voting or effective control. All significant intra-group balances and transactions are eliminated in consolidation. (NW GSM branch) N/A St. Petersburg and St. Petersburg region December 1994 Subsidiaries: Management Estimates Sonic Duo 100% 100% Moscow and Moscow Region November 2001 MCS Povolzhie 100% Volzhsky Federal District August 1999 The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts Mobicom Center 100% Central Federal District December 2002 of revenues and expenses during the reporting period. Actual results may differ from those estimates. The Ural GSM 100% Urals Federal District June 2002 most significant estimates with regard to the accompanying consolidated financial statements relate to the Mobicom Caucasus 100% Southern Federal District January 2001 useful lives of tangible and intangible assets, deferred revenue, asset retirement obligation, fair value of de- rivative financial instruments, income tax provision and recoverability of deferred taxes. Mobicom Novosibirsk 100% Siberian Federal District December 2003 Mobicom Khabarovsk 100% Far East Federal District March 2004 TT-Mobile 75% Republic of Tajikistan October 2001 Foreign Currency Translation Methodology
The Company’s functional currency is the Ruble as the largest portion of its revenues, capital expenditures and During January 2007, Volzhsky GSM and Mobicom Kirov were merged with and into MCS Povolzhie and Ural operating costs are denominated in Rubles. The Company changed its functional currency from the US dollar GSM, respectively. to the Ruble effective January 1, 2006.
Until December 31, 2006, the Company continued to use the US dollar as its reporting currency. Effective January 1, 2007, the Company changed its reporting currency from the US dollar to the Ruble, since this is the currency of the prime economic environment in which substantially all operations of the Company are conducted.
Prior period comparative financial statements have been recast to the Ruble using a methodology consistent with Statement of Financial Accounting Standards (“SFAS”) No. 52, “Foreign Currency Translation”. All assets and liabilities were translated using the December 31, 2006 exchange rate. Shareholders’ equity was trans- lated at the applicable historical rates. Income and expenses were translated using the quarterly average ex- change rates. The objective of this procedure is to present comparative financial statements as if the Company had always used the Ruble as its reporting currency.
The US dollar amounts disclosed in the accompanying consolidated financial statements are presented solely for the convenience of the reader and have been translated at the exchange rate of 24.5462 Rubles per US dol- lar as of December 31, 2007, the exchange rate determined by the Central Bank of the Russian Federation as of such date. This translation should not be construed as representing that the Ruble amounts actually represent or have been, or could be, converted into US dollars at that exchange rate or at any other rate of exchange. 48... 49... Notes to Consolidated Financial Statements Notes to Consolidated Financial Statements (continued) (continued)
2. Summary of Significant Accounting Policies (continued) 2. Summary of Significant Accounting Policies (continued)
Cash and Cash Equivalents Intangible Assets
Cash represents cash on hand and in the Company’s bank accounts. Cash equivalents represent short-term Intangible assets represent numbering capacity, capitalized licenses and other intangible assets. cash deposits held at banks with an original maturity of three months or less. Cash equivalents are carried at cost, which approximates fair value. The Company and its subsidiaries have numerous operating licenses granted by the Ministry of Telecommuni- cations and Information of the Russian Federation. License costs represent either an allocation of the purchase price to licenses acquired in business combinations or payments made to government organizations to receive Short-Term Investments the licenses. License costs are capitalized and amortized on a straight-line basis over their expected useful lives of ten to twelve years from the date operations commenced in the license area. Management believes Short-term investments represent investments in notes receivable and time deposits, which have original that all existing operating licenses will be renewed in the future without substantial cost. The licenses expire maturities in excess of three months but less than twelve months. These investments are accounted for at between 2008 and 2013. cost, which approximates fair value. The carrying amount of short-term investments is reduced to recognize any decline in value which is other than temporary. Numbering capacity represents payments made to acquire access to telephone numbers and the use of tele- phone lines. Numbering capacity costs are amortized over periods up to six years using the straight-line method. Accounts Receivable Other intangible assets are amortized on a straight-line basis over their estimated useful lives, generally from Accounts receivable are stated net of an allowance for accounts identified as doubtful. The Company provides two to ten years. an allowance for doubtful accounts based on management’s periodic review of accounts receivable, including an assessment of the delinquency of these account balances. All intangible assets are subject to periodic review for indications of impairment.
Inventories Property, Plant and Equipment
Inventories are stated at the lower of cost or market value. Cost is determined using the first in – first out Property, plant and equipment are carried at cost, less accumulated depreciation. Cost includes all costs di- (“FIFO”) method. Inventories are mainly comprised of SIM-cards and prepaid phone cards. rectly attributable to bringing the asset to working condition for its intended use. Interest expense incurred during the construction phase of a project is capitalized as part of property, plant and equipment until the proj- ect is completed and the asset is placed into service. Depreciation is recorded on a straight-line basis so as to Value-Added Tax amortize the cost of the assets over their expected useful lives. The expected useful lives are as follows:
Value-added taxes (“VAT”) related to revenues are generally payable to the tax authorities on an accrual basis Buildings and structures 7 to 20 years when invoices are issued to customers and dealers. VAT incurred for purchases may be reclaimed or offset, Switching equipment, including billing systems 3 to 7 years subject to certain restrictions, against VAT related to revenues. VAT related to purchases which are not cur- Base stations, including software 7 years rently reclaimable as of the balance sheet dates are recognized in the balance sheets on a gross basis as VAT Other network equipment 5 to 7 years receivable. Vehicles and office equipment 3 to 5 years
VAT receivable in turn may be recoverable from the tax authorities via an offset against future VAT payable to Leasehold improvements are amortized over the shorter of the lease term or the estimated useful lives of the the tax authorities on MegaFon’s revenue or via direct cash receipts from the tax authorities. assets. The lease term includes renewals when such renewals are reasonably assured.
Management reviews the recoverability of the balance of VAT receivable and believes that the amounts re- The cost of maintenance, repairs, and replacement of minor items of property, plant and equipment are ex- flected in the financial statements are fully recoverable within one year with the exception of 57 and 44 which pensed. Betterments of property are capitalized. Upon sale or retirement of property, plant and equipment, are therefore classified as noncurrent assets at December 31, 2007 and December 31, 2006, respectively (see the cost and related accumulated depreciation are removed from the accounts. Any resulting gains or losses Note 8). are included in the determination of operating results.
In 2007 and 2006, the Company revised its estimates of useful lives and residual values of certain equipment. Deferred Finance Charges These revisions were reflected through an additional charge to depreciation, which resulted in a decrease of net income for 2007 and 2006 by approximately 1,139 and 421, respectively. These revisions represent the Commissions, arrangement and commitment fees and related legal fees paid to secure a firm commitment outcome of a comprehensive management analysis of the estimated future usage, residual values and timing from lenders, premiums paid to secure vendor financing, and other direct debt issuance costs incurred in of disposal of these assets. connection with new borrowings are deferred and amortized over the terms of the related loans, using the effective-interest method. Costs capitalized in connection with revolving credit facilities are amortized on a straight-line basis over the period the revolving line of credit is active.
50... 51... Notes to Consolidated Financial Statements Notes to Consolidated Financial Statements (continued) (continued)
2. Summary of Significant Accounting Policies (continued) 2. Summary of Significant Accounting Policies (continued)
Property, Plant and Equipment (continued) Revenue Recognition (continued)
Subscription Fees The Company accounts for asset retirement obligations in accordance with SFAS No. 143, “Accounting for The Company recognizes monthly subscription fees as revenue in the month when the service is provided. Asset Retirement Obligations.” SFAS No. 143 requires entities to record the fair value of a legal liability for an asset retirement obligation in the period it is incurred. This cost is initially capitalized and amortized over Usage Charges and Value Added Services Fees the remaining useful life of the asset. Once the obligation is ultimately settled, any difference between the Usage charges consist of fees based on airtime or data services used by the subscriber. The Company recognizes final cost and the recorded liability is recognized as a gain or loss on disposition. The Company has certain revenues related to usage charges and value-added services in the period when the services are rendered. legal obligations related to rented sites for base stations and masts, which fall within the scope of SFAS No. 143. These legal obligations include requirements to restore the real estate upon which the base stations and For prepaid subscribers, the Company recognizes revenues for services provided to subscribers with negative masts are located. (i.e., debit) account balances only upon subsequent collection of the cash from such subscribers.
The Company annually evaluates whether there are any indicators which suggest that the estimated cash The Company presents revenue from some value-added services (e.g., content services) on a gross basis when flows underlying the liability have changed materially. If such indicators exist the Company re-estimates the the Company is responsible for providing the content and on a net basis when the content service provider is timing and amount of the cash flows and accounts for the effect of such changes in accordance with the provi- responsible for providing the content. sions of SFAS No. 143. Prepaid Phone Cards Prepaid phone cards allow subscribers to make a predetermined monetary amount of wireless phone calls Impairment of Long-Lived Assets and/or take advantage of other services, such as short messages and sending or receiving of faxes. At the time that the prepaid phone card is purchased, the receipt of cash is recorded as a subscriber prepayment. The Company periodically evaluates the recoverability of the carrying amount of its longlived assets in accor- Revenues are recognized in the period when services are actually rendered. Unused value relating to phone dance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”. Whenever events cards is recognized as revenue when the prepaid phone card expires. or changes in circumstances indicate that the carrying amounts of those assets may not be recoverable, the Company compares the undiscounted net cash flows estimated to be generated by those assets to the carrying Roaming Fees amount of those assets. The Company charges roaming fees (generally on a per-minute basis) to other wireless operators for “guest” roamers utilizing MegaFon’s network. The Company recognizes revenues from roaming fees in the period When these undiscounted cash flows are less than the carrying amounts of the assets, the Company will re- when the services are rendered. cord impairment losses to write-down the asset to fair value, measured by the discounted estimated net future Interconnection fees cash flows expected to be generated from the assets. During the years ended December 31, 2007 and 2006, The Company rents telecommunication channels to the other telecommunications operators in Russia. Also, no such impairments have occurred. the Company charges other operators for terminating traffic on the Company’s network (see Note 17). The Company records these charges as interconnection revenue. The Company recognizes revenue from rent and for termination of traffic in the month when the services are provided. Subscribers’ Prepayments Connection Fees Amounts received from subscribers in advance of services being provided are deferred and recognized as Connection fees consist of non-refundable charges received from subscribers at the time of service initiation. revenues when the services are provided. The Company defers revenue from initial connection fees and recognizes them as revenue over the estimated average subscriber lives. These estimated average subscriber lives differ by region and by type of tariff plans and range from six to twenty months. Interest Free Loans from Shareholders Other The Company accounts for interest free loans from non-controlling shareholders in accordance with Account- The Company provides technical support to the other telecommunication operators in Russia. The Company ing Principles Board Opinion No. 21 “Interest on Receivables and Payables”. Accordingly, these loans are recognizes revenue from technical support in the month when the services are rendered. Also, the Company recorded at their estimated present values based on the Company’s incremental borrowing rate. The related sells a relatively small quantity of handsets and accessories. The Company recognizes revenues from the sale imputed interest is recorded as additional paid-in capital in the statements of shareholders’ equity. The accre- of handsets and accessories upon the transfer of handsets and accessories to a customer. tion of imputed interest is included as interest expense in the accompanying statements of income. Arrangements with Multiple Deliverables Certain of the Company’s commercial arrangements constitute a contractual arrangement with multiple de- Revenue Recognition liverables. In accordance with the Emerging Issues Task Force Consensus No. 00-21, “Revenue Arrangements with Multiple Deliverables”, the Company allocates the consideration received from a subscriber to the sepa- Revenues are categorized as follows: rate units of accounting inherent in the contract based on their relative fair values.
• Revenue from subscribers, including subscription fees, usage charges, fees for value-added services and Discounts and Commissions to Dealers the fees charged to subscribers for roaming outside MegaFon’s network; Dealers purchase service contracts and prepaid phone cards from the Company at a discount and resell them • Roaming fees charged to other wireless operators for guest roamers utilizing MegaFon’s network; to subscribers at prices set by the Company. Also, dealers collect payments for services from subscribers • Revenue from interconnection charges; and remit them to the Company. In turn, the Company pays dealers a commission which is determined as a • Connection fees; and percentage of amounts collected. The respective discounts and commissions are recorded as a part of sales • Other: technical support, sales of handsets and accessories. and marketing expenses.
Revenues are stated net of VAT charged to customers. 52... 53... Notes to Consolidated Financial Statements Notes to Consolidated Financial Statements (continued) (continued)
2. Summary of Significant Accounting Policies (continued) 2. Summary of Significant Accounting Policies (continued)
Revenue Recognition (continued) Income Taxes (continued)
Also, the Company pays dealers a commission for each subscriber connected, depending on region, class On January 1, 2007, the Company adopted the provisions of Financial Accounting Standards Board (“FASB”) or type of subscriber connected and other factors, including average revenue per subscriber for certain time Interpretation (“FIN”) No. 48, “Accounting for Uncertainty in Income Taxes – an interpretation of FASB State- periods. The Company recognizes the entire estimated commission payable when the subscriber is connected ment No. 109”. FIN No. 48 clarifies the accounting for uncertainty in income taxes recognized in financial by the dealer. statements in accordance with SFAS No. 109. FIN No. 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN No. 48 also provides guidance on de-recognition, classification, interest and penal- Advertising Costs ties, accounting in interim periods, disclosure, and transition. In addition, FIN No. 48 states that income taxes should not be accounted for under the provisions of SFAS No. 5, “Accounting for Contingencies”. Advertising costs are expensed as incurred (see Note 18). The adoption of FIN No. 48 resulted in a cumulative effect adjustment increasing the opening balance of retained earnings as of January 1, 2007 by approximately 316. As of December 31, 2007, an asset in the amount of 497 Retirement Benefit Obligations was recorded, of which 182 and 315 are included in other current and non-current assets, respectively.
Both the Company and its subsidiaries are legally obliged to make defined contributions to the National Pen- Although the Company believes it is more likely than not that all recognized income tax benefits would be sion Fund, managed by the Russian Federation Social Security (a defined contribution plan). The Company has sustained upon examination, the Company has recognized certain income tax benefits that have a reasonable no legal or constructive obligation to pay future benefits under this plan. Its only obligation is to pay contribu- possibility of being successfully challenged by the tax authorities (also see Note 23). If these income tax posi- tions as they fall due. The Company’s contributions relating to defined contribution plans are calculated as a tions are successfully challenged by the tax authorities, this could result in a reduction in total unrecognized percentage of employees’ compensation and expensed in the year to which they relate. Contributions to the tax benefits of up to 160. However, the Company does not believe that it is reasonably possible that this will National Pension Fund for the years ended December 31, 2007 and 2006 were 959 and 740, respectively. occur.
Additionally, the Company has a noncontributory defined benefit pension plan that covers approximately The Company recognizes accrued interest and penalties related to unrecognized tax benefits in income taxes. half of the employees at one of its locations. The net pension benefit obligation and the related periodic net As of December 31, 2007, the tax years ended December 31, 2005, 2006 and 2007 remained subject to ex- pension cost are based on, among other things, assumptions of the discount rate, estimated return on plan amination by the tax authorities. assets, salary increases and the mortality of participants. Before December 31, 2006, actuarial gains and losses were deferred and amortized over future periods. As of December 31, 2006 the Company adopted the provisions of SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Concentration of Credit Risk Plans—an amendment of FASB Statements No. 87, 88, 106, and 132(R)”. SFAS No. 158 requires the Company to recognize the funded status of a defined benefit plan as an asset or liability in the statement of financial Financial instruments that potentially subject the Company to concentration of credit risk consist primarily position and to recognize changes in that funded status in the year in which the changes occur through other of cash, cash equivalents, short-term investments and accounts receivable. The Company deposits available comprehensive income. The adoption of SFAS No. 158 at December 31, 2006 resulted in an adjustment to ac- cash with various banks, including Svyazbank, a related party (see Notes 3 and 21). Deposit insurance is cumulated other comprehensive income of 23. either not offered or only offered in de minimis amounts in respect of bank deposits within Russia. To man- age the credit risk, MegaFon allocates its available cash to a limited number of Russian banks and domestic branches of international banks. Some of these Russian banks are state owned. Management periodically Income Taxes reviews the credit worthiness of the banks in which it deposits cash.
Provision is made in the financial statements for taxation of profits in accordance with Russian legislation cur- The Company extends credit to certain counterparties, principally international and national telecom opera- rently in force. The Company accounts for income taxes under the liability method in accordance with SFAS No. tors, for roaming services, and to certain dealers, and establishes an allowance for doubtful accounts for spe- 109, “Accounting for Income Taxes”. Under the liability method, deferred income taxes reflect the future tax cific accounts that it believes represent a potentially significant credit risk. The Company generally requires its consequences of temporary differences between the tax and financial statement basis of assets and liabilities subscribers to prepay for services, except for corporate subscribers that it deems reliable. and are measured using enacted tax rates applied to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change Starting in 2005, a significant portion of the Company’s collection of cash from subscribers is handled by a in the tax rates is recognized in income in the period that includes the enactment date. A valuation allowance single “master” dealer who, for a commission, produces and sells payment cards to sub-dealers, and collects is provided when it is more likely than not that some or all of the deferred tax assets will not be realized in the and remits to the Company the funds received from the subdealers. Payments are due to the Company not future. These evaluations are based on the reversals of the various taxable temporary differences, tax-plan- later than 16 days after the payment cards are shipped to the sub-dealers. Because of the additional credit risk ning strategies and expectations of future taxable income. which this arrangement presents, management regularly monitors the status of receivables from this “master” dealer to ensure that settlements are made when they become due (see Note 4). As of January 1, 2007 and December 31, 2007, the Company did not have unrecognized income tax benefits which are more than inconsequential. A significant portion of Company’s sales and purchases of roaming and interconnection services is performed with related parties. Respective payables and receivables are not significant (see Note 21). The Company does not provide for deferred taxes on the undistributed earnings of its subsidiaries, as such earnings are not anticipated to be distributed in a taxable manner.
54... 55... Notes to Consolidated Financial Statements Notes to Consolidated Financial Statements (continued) (continued)
2. Summary of Significant Accounting Policies (continued) 2. Summary of Significant Accounting Policies (continued)
Comprehensive Income (Loss) New Accounting Pronouncements (continued)
SFAS No. 130, “Reporting Comprehensive Income”, requires the reporting of comprehensive income in addi- In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interest in Consolidated Financial State- tion to net income. Comprehensive income is defined as net income plus all other changes in net assets from ments, an amendment of ARB No. 51” (“SFAS No. 160”), which will change the accounting and reporting for non-owner sources. minority interests, which will be recharacterized as noncontrolling interests and classified as a component of equity within the consolidated balance sheets. The requirements of SFAS No. 160 will be effective for the year The components of accumulated other comprehensive loss, net of tax, are as follows: beginning January 1, 2009. The Company is currently evaluating the impact of adopting SFAS No. 160 on its financial statements. Foreign currency Accumulated translation Defined benefit other compre- adjustment pension plan hensive loss 3. Cash and Cash Equivalents Balance as of December 31, 2005 ––– Change for the period 224 23 247 Cash and cash equivalents are comprised of: Balance as of December 31, 2006 224 23 247 Change for the period – 17 17 December 31, 2006 December 31, 2007 Balance as of December 31, 2007 224 40 264 Bank deposits and cash on hand 2,767 2,723 Time deposits 4,198 1,536 Total cash and cash equivalents 6, 965 4,259 Derivative Instruments and Hedging Activities
Time deposits as of December 31, 2007 and 2006 have an interest yield from 2.2% to 9.5% and from 2% to The Company follows the provisions of SFAS No. 133, “Accounting for Derivative Instruments and Certain Hedg- 7.25%, respectively, and have original maturities of 90 days or less. These deposits can be withdrawn before ing Activities”, as amended. SFAS No. 133, as amended, requires that all derivative instruments be recorded their maturity dates without penalties. on the balance sheet at their respective fair values. On the date a derivative contract is executed, and depend- ing on the specific facts and circumstances, this derivative may be designated as a fair value hedge, cash flow As of December 31, 2007 and 2006, 678 and 535 of cash and cash equivalents were on deposit with Svyaz- hedge or foreign currency hedge of net investment in a foreign operation. For derivative instruments bank, a related party (see Notes 2 and 21).
that are not designated as hedges or do not qualify as hedged transactions, the changes in the fair value are reported in the statement of income. The Company does not hold or issue derivatives for trading purposes. 4. Accounts Receivable
Comparative Information Accounts receivable are comprised of:
Certain prior year amounts and disclosures have been reclassified to conform to the 2007 presentation. December 31, 2006 December 31, 2007 Subscribers 326 691 449 New Accounting Pronouncements Roaming (other wireless operators) 456 The “master” dealer (see Note 2) 1,249 730 In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements”, which clarifies the definition Other dealers 1,359 1,539 of fair value, establishes guidelines for measuring fair value, and expands disclosures regarding fair value Interconnection 1,379 2,166 measurements. SFAS No. 157 does not require any new fair value measurements and eliminates inconsisten- cies in guidance found in various prior accounting pronouncements. SFAS No. 157 is effective for the year Other 114 90 beginning January 1, 2008. The Company is currently evaluating the impact of adopting SFAS No. 157 on its Less allowance for doubtful accounts (143) (222) financial statements. Total accounts receivable, net 4,740 5,443
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities, Including an Amendment to SFAS No. 115”. SFAS No. 159 permits companies to elect to measure many financial instruments and certain other items at fair value. SFAS No. 159 does not affect any existing accounting standards that require certain assets and liabilities to be carried at fair value. SFAS No. 159 is effective for the year beginning January 1, 2008. The Company is currently evaluating the impact of adopting SFAS No. 159 on its financial statements.
In December 2007, the FASB issued SFAS No. 141R, “Business Combinations” (“SFAS No. 141R”), which es- tablishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in an acquiree, in- cluding the recognition and measurement of goodwill acquired in a business combination. The requirements of SFAS No. 141R will be effective for the year beginning January 1, 2009. The Company is currently evaluating the impact of adopting SFAS No. 141R on its financial statements.
56... 57... Notes to Consolidated Financial Statements Notes to Consolidated Financial Statements (continued) (continued)
5. Prepayments and Other Current Assets 6. Property, Plant and Equipment (continued)
Prepayments and other current assets are comprised of: In 2007, the Company decided to replace certain telecommunications equipment. Most of this equipment remained in use as of December 31, 2007 and is expected to be de-installed during 2008. As part of the ar- December 31, 2006 December 31, 2007 rangement to replace the equipment, certain of this equipment will be sold. In connection with the decision Prepaid taxes 1,142 1,997 to replace the equipment, the Company re-evaluated the remaining useful lives of such equipment, resulting in the useful lives being re-set to periods ranging from 18 to 24 months as of April 1, 2007. Subsequently, Advances for advertising 132 129 in October 2007, the Company revised its estimates of the remaining useful lives of such equipment, result- Advances for other services 620 753 ing in useful lives being re-set to periods ranging from 9 to 21 months. In connection with these revisions Other current assets 575 825 the Company recorded additional depreciation expense of 809 for the year ended December 31, 2007. After taking into account this additional depreciation, the net book value of the assets to be sold as of December Total prepayments and other current assets 2,469 3,704 31, 2007 was approximately 173. Equipment which will be replaced, but which was still in use as of December 31, 2007, was classified as property, plant and equipment. The acceleration of depreciation expense had the Advances for other services mainly relate to interconnection, network maintenance, rent prepayments for sales effect of decreasing net income by 615 for the year ended December 31, 2007, net of income tax. offices and base station facilities, office maintenance and advances to dealers. Prepaid taxes mainly relate to prepaid income taxes, which amounted to 1,827 and 1,085 as of December 31, 2007 and 2006, respectively. Asset Retirement Obligations The following table describes the changes to the Company’s asset retirement obligations liability:
6. Property, Plant and Equipment 2006 2007 Asset retirement obligations at the beginning of the year 599 1,740 Property, plant and equipment are comprised of: Liability recognized during the year 364 637 Buildings, Vehicles, Revision in estimated cash flows 691 (335) structures Telecommuni- computers, and leasehold cations office and other Construction Accretion expense 86 214 improvements network equipment in-progress Total Liability settled in the current period – (21) Cost: Asset retirement obligations at the end of the year 1,740 2,235 At December 31, 2006 9,225 93,394 6,777 12,999 122,395 Additions – – – 37,296 37,296 Transfers 6,175 26,660 2,629 (35,464) – 7. Intangible Assets Disposals (75) (3,328) (219) (174) (3,796) At December 31, 2007 15,325 116,726 9,187 14,657 155,895 Intangible assets are comprised of: Amortization expense for the year ended December 31, 2006 was 2,493. Accumulated depreciation: At December 31, 2006 1,366 30,643 2,786 – 34,795 Other Operating Numbering intangible Charges 1,049 18,208 2,410 – 21,667 licenses capacity assets Total Disposals (28) (3,202) (154) – (3,384) Cost: At December 31, 2007 2,387 45,649 5,042 – 53,078 At December 31, 2006 18,916 2,135 3,240 24,291 Net book value Additions 4 14 1,507 1,525 at December 31, 2007 12,938 71,077 4,145 14,657 102,817 Disposals – (11) (176) (187) Net book value at December 31, 2006 7,859 62,751 3,991 12,999 87,600 At December 31, 2007 18,920 2,138 4,571 25,629 Accumulated amortization: Depreciation expense for the year ended December 31, 2006 was 15,900. At December 31, 2006 7,640 1,799 1,112 10,551 Charges 1,624 233 663 2,520 Included in construction in-progress are advances to suppliers of network equipment of 1,943 and 1,226 as of Disposals – (11) (176) (187) December 31, 2007 and 2006, respectively. At December 31, 2007 9,264 2,021 1,599 12,884 Software and licenses for base stations and billing systems are included in the balances of telecommunications Net book value network assets. The net book value is 4,494 and 4,437 as of December 31, 2007 and 2006, respectively. at December 31, 2007 9,656 117 2,972 12,745 Net book value Interest capitalized was 804 (out of the total interest expense of 3,280) and 808 (out of the total interest ex- at December 31, 2006 11,276 336 2,128 13,740 pense of 3,674) for the years ended December 31, 2007 and 2006, respectively. Amortization expense for the next five years is expected to be as follows: 2008 – 2,429; 2009 – 2,128; 2010 – 1,984; 2011 – 1,811 and 2012 – 1,722.
58... 59... Notes to Consolidated Financial Statements Notes to Consolidated Financial Statements (continued) (continued)
8. Other Non-Current Assets 11. Long-Term Loans Long-term loans are comprised of: Other non-current assets are comprised of: December 31, 2006 December 31, 2007 December 31, 2006 December 31, 2007 Nordea and Bayerische Hypo- und Vereinsbank AG loan (1) 817 416 VAT receivable 44 57 Ruble Bonds (2) 4,500 3,000 Deferred finance charges (see Note 11) 1,479 1,086 Eurobonds (3) 9,874 8,296 Other 157 621 Sberbank loans (4) 2,522 1,508 Total other non-current assets 1,680 1,764 Citibank International Plc., ING BHF-Bank Aktiengesellschaft, and ING Bank N.V. loans (5) 4,144 2,732 Bayerische Landesbank, Bayerische Landesbank Filiale Di 9. Accounts Payable Milano, Commerzbank Aktiengesellschaft, Citibank N.A. London branch, and ING Bank N.V. loans (6) 11,449 11,507 Accounts payable are comprised of: Citibank N.A. London branch and ING Bank N.V. loan (7) 2,902 6,500 December 31, 2006 December 31, 2007 China Development Bank, Citibank International Plc., Roaming 369 374 and Citibank N.A. London branch loan (8) 1,343 – Interconnection 2,052 2,130 China Development Bank and Bayerische Landesbank (9) – 126 Dealers 689 1,118 Japan Bank for International Cooperation, Citibank N.A. Other accounts payable 1,443 1,814 Tokyo branch and Calyon Tokyo branch loan (10) 1,013 1,105 Total accounts payable 4,553 5,436 Nordic Investment Bank loan (11) 395 368 Other loans (12) 430 575 Total long-term loans 39,389 36,133 10. Accrued Liabilities Less current portion 7,496 10,130
Accrued liabilities are comprised of: Non-current portion 31,893 26,003 December 31, 2006 December 31, 2007 Loan repayments over the four-year period beginning on January 1, 2008 are as follows: Accrued taxes 1,222 1,801
Salary and social contributions 701 1,415 2008 2009 2010 2011 Total Accrued interest 328 195 Total 10,130 14,336 4,527 7,140 36,133 Other accrued liabilities 412 379 Total accrued liabilities 2,663 3,790 Lenders whose loans mature after 2011 (see Notes 11(6), (9), (10), (11)) may be entitled to require the early prepayment of the outstanding amount of these loans if the Company elects to repay certain specific loans from shareholders maturing in 2011 (see Note 12). The maturity table above assumes such prepayment of these loans.
At December 31, 2007, the Company’s debt was denominated in the following currencies:
Borrowing currency Millions of Rubles Rubles 4,508 4,508 US dollars (in millions) 660 16,208 Euros (in millions) 429 15,417 Total long-term loans 36,133
(1) Nordea and Bayerische Hypo- und Vereinsbank AG (Nordea/HVB) In November 2004, the Company entered into a loan agreement with Nordea/HVB for approximately $51 mil- lion (1,434 at the exchange rate as of November 30, 2004). The loan is guaranteed by EKN, a Swedish export credit agency. This loan bears interest at LIBOR plus 0.8% and is repayable over the period from 2005 to 2008. The loan also requires the Company to meet various financial and non-financial covenants. Deferred financing costs of 41 were capitalized in connection with this loan.
60... 61... Notes to Consolidated Financial Statements Notes to Consolidated Financial Statements (continued) (continued)
11. Long-Term Loans (continued) 11. Long-Term Loans (continued)
(2) Ruble Bonds (7) Citibank N.A. London branch and ING Bank N.V. and Nokia Corporation (“Finnvera III Credit”) In April 2004, the Company issued 1.5 billion of Ruble bonds. The bonds were issued at face value bearing In June 2006, the Company entered into the Finnvera III Credit for 218 million Euros (7,407 at the exchange interest at an annual rate of 9.28% payable semi-annually. The Company redeemed these bonds at their ma- rate as of June 30, 2006) with interest at approximately 4.3%. This loan is guaranteed by Finnvera, a Finnish turity in April 2007. export credit agency. A payment of 6.5 million Euros (225 at the exchange rate as of date of payment) of insur- ance premium was required to obtain this guarantee and is capitalized as deferred finance charges as each In April 2005, the Company issued 3 billion of Ruble bonds. The bonds were issued at face value bearing inter- payment is made. The Finnvera III Credit can only be used for purchases of Nokia Corporation equipment. The est at an annual rate of 9.25% payable semiannually. The Company redeemed these bonds at their maturity amounts drawn under the Finnvera III Credit are repayable semi-annually from 2007 through 2011. in April 2008. (8) China Development Bank, Citibank International Plc. and Citibank N.A. London branch (“China Develop- (3) Eurobonds ment Bank Credit”) In December 2004, MegaFon S.A. issued $375 million (10,406 at the exchange rate as of December 31, 2004) In December 2005, the Company entered into a credit facility agreement with China Development Bank, Ci- of loan participation notes (the Eurobonds) at face value with interest at 8% payable semi-annually. The Euro- tibank International Plc. and Citibank N.A. London branch (“China Development Bank Credit”) for $51 million bonds mature in December 2009. The proceeds from the Eurobonds were used to finance a loan from MegaFon (1,468 at the exchange rate as of December 31, 2005) with interest at LIBOR plus 2.5%. The proceeds under S.A. to the Company on substantially the same terms and conditions as the Eurobonds. Deferred financing the credit facility can only be used for purchases of Huawei equipment. The amounts drawn under the China costs of 178 were capitalized in connection with this loan. Development Bank Credit were repayable semi-annually from 2007 through 2011. In December 2007, the Company early repaid the total amount outstanding under the credit facility. In July and August 2007, the Company purchased a total $37 million face value of its Eurobonds (950 at the ex- change rates as of the transaction dates) for approximately 990. In connection with this Eurobonds repurchase, (9) China Development Bank and Bayerische Landesbank (“China Development Bank II Credit”) the Company recognized a loss in the amount of approximately 30 for the year ending December 31, 2007. In October 2007, the Company entered into a credit facility agreement with China Development Bank and Bayerische Landesbank (“China Development Bank II Credit”) for $85 million (2,102 at the exchange rate as (4) Sberbank of October 31, 2007) with interest at LIBOR plus 1.1%. The proceeds under the credit facility can only be used The Company has entered into several credit line agreements with Sberbank. As of December 31, 2006, the in- for purchases of Huawei equipment. Amounts drawn under this credit facility are repayable from 2009 through terest on outstanding Sberbank loans ranged from 8.5% to 9%. In August 2007, the interest rate was reduced 2014 in semi-annual installments. to 7.5% under all credit line agreements with Sberbank. The loans are repayable at various dates from 2006 to 2010. As of December 31, 2007, 1,608 remained undrawn under the Sberbank credit line agreements. As of December 31, 2007, the Company has an amount due to Huawei of 126. As the Company intends to repay this amount using the proceeds from the China Development Bank II Credit, the Company has classified the (5) Citibank International Plc. and ING BHF-Bank Aktiengesellschaft and Siemens AG (“Hermes Credit”); amount due to Huawei as long-term debt in the accompanying balance sheet as of December 31, 2007. Citibank International plc. and ING Bank N.V. and Ericsson AB (“EKN Credit”); Citibank International plc. and ING Bank N.V. and Nokia Corporation (“Finnvera Credit”) (10) Japan Bank for International Cooperation, Citibank N.A. Tokyo branch and Calyon Tokyo branch In October 2003, the Company entered into the Hermes Credit for 75.4 million Euros (2,629 at the exchange rate In January 2006, the Company entered into a credit facility agreement with Japan Bank for International Co- as of October 31, 2003) with interest at approximately 4%. This credit line can only be used for purchases of operation, Citibank N.A. Tokyo branch and Calyon Tokyo branch (“JBIC Credit”) for $50 million (1,406 at the Siemens AG equipment. The loan is guaranteed by Hermes, a German export credit agency. A payment of 4.8 mil- exchange rate as of January 31, 2006) with interest at 6.87% for Tranche A in the amount of $30 million and lion Euros (167 at the exchange rate as of date of payment) was required to obtain this guarantee and has been LIBOR plus 0.45% for Tranche B in the amount of $20 million. The proceeds under JBIC Credit can only be used capitalized as deferred finance charges. The Hermes Credit is repayable semiannually from 2004 through 2011. for purchases of NEC Corporation equipment or limited local content. The amounts drawn under the JBIC Credit are repayable semi-annually from 2008 through 2012. In May 2004, the Company entered into the EKN Credit and the Finnvera Credit for approximately $54 million and $135 million (1,549 and 3,913 at the exchange rate as of May 31, 2004), respectively, with interest at ap- (11) Nordic Investment Bank proximately 4%. The EKN and Finnvera credit lines can only be used for purchases of Ericsson and Nokia equip- In October 2004, the Company entered into a credit agreement with Nordic Investment Bank for $30 million ment, respectively. The loans are guaranteed by EKN, a Swedish export credit agency, and Finnvera, a Finnish (863 at the exchange rate as of October 31, 2004). In June 2006, the Company amended this credit agreement, export credit agency, respectively. A payment of $14 million (406 at the exchange rate as of date of payment) increasing the amount of the facility from $30 million to $50 million (1,354 at the exchange rate as of June 30, was made to obtain these guarantees, which has been capitalized as deferred finance charges. These credits 2006). The amounts drawn under the Nordic Investment Bank Credit are repayable semi-annually from 2007 are repayable semiannually from 2004 through 2009. through 2012 and bear interest at LIBOR plus 0.85-2.20% depending on the Fitch, S&P and Moody’s interna- tional corporate ratings received by the Company. (6) Bayerische Landesbank and Commerzbank Aktiengesellschaft and Siemens AG (“Hermes II Credit”); Bayerische Landesbank, Commerzbank Aktiengesellschaft and Bayerische Landesbank Filiale Di Milano and Siemens Mobile Communications Spa (“SACE Credit”); Citibank, N.A. London branch, ING Bank N.V. and In April 2007, the Company amended its credit agreement with Nordic Investment Bank, increasing the amount several other financial institutions and Nokia Corporation (“Finnvera II Credit”) of the facility from $50 million to $100 million (2,569 at the exchange rate as of April 30, 2007), converting the In June 2005, the Company entered into (1) the Hermes II Credit for 185 million Euros (6,387 at the exchange credit facility into a revolving loan facility (“Revolving Loan Facility”), and adding other banks to the lending rate as of June 30, 2005) with interest at Euribor plus 0.35%, (2) the SACE Credit for 74.5 million Euros (2,572 group. at the exchange rate as of June 30, 2005) with interest at approximately 4% and (3) the Finnvera II Credit for $321.5 million (9,217 at the exchange rate as of June 30, 2005) with interest at approximately 4%. As of December 31, 2007, $85 million (2,086 at the exchange rate as of December 31, 2007) remained un- drawn under the Nordic Investment Bank credit line agreements. These loans are guaranteed by Hermes, a German export credit agency, SACE, an Italian export credit agency and Finnvera, a Finnish export credit agency, respectively. A payment of $45.2 million (1,288 at the exchange (12) Other rate as of date of payment) in the aggregate was made to obtain these guarantees, which has been capitalized The Company has entered into other credit agreements as follows – Svyazbank, a related party, for two loans as deferred finance charges. under which an aggregate of 391 is outstanding, and which bear interest at 11% and 12%; Transcontinental Mobile Investment Ltd. (see Note 21), for $2 million (63 at the exchange rate as of August 31, 2002) with The Hermes II, SACE and Finnvera II Credits can only be used for purchases of Siemens AG, Siemens Mobile interest at 6%; and Huawei Technologies for $5.5 million (134 at the exchange rate as of December 31, 2007) Communications Spa and Nokia Corporation equipment, respectively. The amounts drawn under the Hermes without interest. These loans have varying maturities ranging from 2006 to 2012. II and the SACE Credits are repayable semi-annually from 2006 through 2015. The amounts drawn under the Finnvera II Credit are repayable semi-annually from 2005 through 2010. 62... 63... Notes to Consolidated Financial Statements Notes to Consolidated Financial Statements (continued) (continued)
11. Long-Term Loans (continued) 12. Loans from Shareholders (continued)
Covenant Requirements (1) Telecominvest In 2001-2003, the Company entered into several loan agreements with Telecominvest aggregating $28.2 mil- The Nordea/HVB, Eurobonds, Hermes, EKN, Finnvera, Hermes II, Finnvera II, SACE, Finnvera III, China Develop- lion (691 at the exchange rate as of December 31, 2007) and bearing interest at 6-10%. The original maturities ment Bank, JBIC, and Nordic Investment Bank credit agreements (see Notes 11(1), (3), (5), (6), (7), (8), (9), (10) of the loans were in 2004-2009. These loans were extended and amended in November 2004 as discussed and (11) above) place various restrictions on the Company related to incurrence of debt, negative pledges, above. mergers and acquisitions, and changes in the business without prior consent from the lenders. The agree- ments also require the Company to meet various financial and non-financial covenants. (2) TeliaSonera In 2001-2003, the Company received several loans from TeliaSonera affiliated entities aggregating $45 mil- Undrawn Credit Facilities lion (1,105 at the exchange rate as of December 31, 2007) with interest at 0-10%. The original maturities of the loans were in 2004-2009. The loans were extended and amended in November 2004 as discussed above. In August 2006, the Company entered into a revolving credit facility with UniCredit Bank (former International (3) IPOC Moscow Bank) for 4 billion Rubles with an interest rate which depends on the tenor of the loan selected on In 2003, the Company received loans from IPOC aggregating $16 million (394 at the exchange rate as of De- each drawdown. However, the interest rate cannot exceed 8.25% (“UniCredit Bank Revolving Credit”). The cember 31, 2007) with interest at 6% that had an original maturity of July 2004. The loans were extended and amounts drawn under the UniCredit Bank Revolving Credit are to be repaid no later than two years from the amended in November 2004 as discussed above. date the amounts are drawn. The final maturity is in August 2011. As of December 31, 2007, the UniCredit Bank Revolving Credit remains undrawn. (4) CT Mobile In 2001, Sonic Duo received three Ruble denominated interest-free loans from CT Mobile aggregating 624. The loans have no stated maturity. The first two loans with an aggregate principal of 527 are callable by CT Mobile not 12. Loans from Shareholders earlier than December 31, 2008 and the third loan is callable by CT Mobile not earlier than December 31, 2030.
Long-term loans from shareholders are comprised of: Effective September 2004, the interest rate on these loans was changed to the 6-month LIBOR rate plus 4%. Interest accruing after September 2004 will not be capitalized but will be payable together with principal at December 31, 2006 December 31, 2007 maturity. Telecominvest (1) 955 947 TeliaSonera (2) 1,395 1,402 13. Derivative Financial Instruments IPOC (3) 534 527 CT Mobile (4) 357 434 1) C-loans Total long-term loans 3,241 3,310 Under the C-loan agreements, each of the European Bank for Reconstruction and Development and Interna- tional Finance Corporation advanced $12 million (371 at the exchange rate as of February 28, 2002) in the ag- Less current portion – 433 gregate to Sonic Duo. In connection with the acquisition of Sonic Duo in February 2002, the Company assumed Non-current portion 3,241 2,877 the liability under these C-loan agreements.
Shareholder loan repayments over the five-year period beginning on January 1, 2008 are as follows: The C-loan agreements provided that the repayment amount of the loans would be equal in the aggregate to 3.5528% of the fair value of MegaFon at the applicable repayment date (or 1.7764% of MegaFon’s fair value Year for each lender). 2008 527 Under the agreements, the loans were to have been repaid no later than December 31, 2009. Repayment of the loans was also required upon the occurrence of certain events. 2009-2010 – 2011 2,876 The Company accounted for the C-loans in accordance with SFAS No. 133, “Accounting for Derivative Instru- ments and Hedging Activities”, as amended. In 2002, a liability equal to the excess of the fair value of the C- 2012 – loans over $12 million (371 at the exchange rate as of February 28, 2002) was included in the purchase price After 2012 97 allocation. Subsequent changes in the fair value of the C-loans were recorded in the consolidated statement of Total repayments 3,500 income. During 2006, the fair value of the C-loans increased by 185. Less unamortized discount (190) In July 2006, the Company fully prepaid the C-loans in the amount of $188 million (5,052 at the exchange rate Total long-term loans 3,310 as of July 31, 2006).
In November 2004, the Company signed an amendment to existing loan agreements with Telecominvest, Te- liaSonera and IPOC which capitalized (i.e., included in the underlying loans) the accrued but unpaid interest on certain loans and extended the maturity of all of these loans to the earlier of September 30, 2011 or a date ninety days after the payment in full of the Hermes, EKN and Finnvera Credits (see Note 11(5)). Also, the repayment of these shareholder loans is subordinated to the Nordea/HVB, Hermes, EKN, Finnvera, Hermes II, Finnvera II, SACE, Finnvera III, China Development Bank, JBIC, and Nordic Investment Bank credit agreements (see Notes 11(1), (5), (6), (7), (8), (9), (10), (11)) and also to the Eurobonds (see Note 11(3)).
64... 65... Notes to Consolidated Financial Statements Notes to Consolidated Financial Statements (continued) (continued)
13. Derivative Financial Instruments (continue) 16. Revenues (continued)
2) Foreign Currency Swap Agreements On March 4, 2006, amendments to the Telecommunications Law were approved which introduced the Calling During July – September 2006 and May – June 2007, the Company entered into several long-term fixed-to- Party Pays rules (“CPP Rules”) which became effective as of July 1, 2006. Under the CPP Rules, all incoming fixed cross-currency swaps. These derivative financial instruments are used to limit exposure to changes in calls on fixed and mobile lines in Russia became free of charge, and only the fixed-line or mobile operators foreign currency exchange rates on certain long-term indebtedness denominated in foreign currencies. originating the call may charge the subscriber for the call. To compensate for this loss of revenue from sub- scribers, beginning from July 1, 2006 the Company began charging other operators for terminating traffic on The swaps effectively converted, using the then-effective foreign currency exchange rates, some of the Com- the Company’s network, and these charges are included in revenues from interconnection charges. pany’s outstanding fixed-rate long-term US dollar and Euro denominated loans (specifically the EKN, Finnvera, Finnvera II and Finnvera III credit agreements) into synthetically equivalent Ruble long-term loans with fixed rates ranging from 3.95% to 6.65%. The carrying amount of such long-term loans as of December 31, 2007 17. Cost of Services was approximately $217 million and 117 million Euro (9,512 at the exchange rate as of December 31, 2007). Cost of services for the years ended December 31 are comprised of: For accounting purposes, the Company has chosen not to designate these swaps as hedging instruments and, therefore reports all gains and losses from the change in fair value of these derivative financial instruments directly in the consolidated statement of income as part of net foreign exchange gain. 2006 2007 Interconnection charges 14,670 23,472 These derivative financial instruments were recorded at fair value as of December 31, 2007 and included in Cost of SIM-cards 1,189 877 other non-current assets in the amount of 191, other current liabilities in the amount of 260, and in other non- Roaming expenses 1,583 1,955 current liabilities in the amount of 176. Total cost of services 17,442 26,304
14. Other Non-current Liabilities Included in interconnection charges for 2006 and 2007, are charges from other mobile and fixed-line opera- tors for terminating traffic which originated on the Company’s network under the CPP Rules introduced begin- Other non-current liabilities are comprised of: ning from July 1, 2006.
December 31, 2006 December 31, 2007 18. Sales and Marketing Expenses Asset retirement obligations (see Note 6) 1,740 2,235 Obligation under defined benefit pension plan 138 191 Sales and marketing expenses for the years ended December 31 are comprised of: Other non-current liabilities 67 206 Total other non-current liabilities 1,945 2,632 2006 2007 Advertising 4,389 5,971 Commissions to dealers for connection of new subscribers 4,453 4,946 15. Shareholders’ Equity Commissions to dealers for distribution of prepaid cards and cash collection from subscribers 2,224 2,730 The reserve fund, an element of Russian corporate law, represents a portion of the Company’s earnings des- Total sales and marketing expenses 11,066 13,647 ignated to create a reserve to cover future losses. The balance of the reserve fund is not available for divi- dends. 19. Operating Expenses In accordance with Russian legislation, dividends may only be declared to the shareholders of the Company from accumulated undistributed and unreserved earnings as shown in the Company’s Russian statutory fi- Operating expenses for the years ended December 31 are comprised of: nancial statements. OJSC MegaFon had 29,072 of undistributed and unreserved earnings as at December 31, 2007. In addition, the Company’s share in the undistributed and unreserved earnings of MegaFon’s subsidiar- ies was 69,594 as at December 31, 2007. 2006 2007 Salaries and social charges 6,745 8,797 Rent 3,780 5,522 16. Revenues Network repair and maintenance 2,741 3,186
Revenues for the years ended December 31 are comprised of: Operating taxes 2,777 3,818 2006 2007 Materials and supplies 1,024 381 Revenues from local subscribers 90,669 119,331 Office maintenance 858 1,222 Roaming charges to other wireless operators 2,564 2,342 Professional services 590 766 Revenues from interconnection charges 7,239 17,885 Radio frequency fees 916 1,695 Connection fees 332 370 Insurance 275 291 Other revenues 311 465 Other expenses, net 2,801 3,176 Total revenues 101,115 140,393 Total operating expenses 22,507 28,854
66... Rent represents expenses related to the operating lease of premises for offices, base stations and switches. 67... Notes to Consolidated Financial Statements Notes to Consolidated Financial Statements (continued) (continued)
20. Income Taxes 20. Income Taxes (continued)
Provision for income taxes for the years ended December 31 are comprised of: Management believes that no valuation allowance against the deferred tax asset in respect of the loss carry- forwards is required based on the Company’s plans to carry out the legal merger of all of the Company’s 2006 2007 subsidiaries with the Company that would allow the Company to use the loss carry-forwards of loss-making subsidiaries against taxable profits of profit-making subsidiaries. Current income taxes 9,540 13,226 Less deferred income tax benefit 856 593 Total income taxes 8,684 12,633 21. Related Party Transactions
Income taxes represent the Company’s provision for profit tax. Profit tax is calculated at 24% of taxable profit The Company has entered into certain transactions with its shareholders and their affiliates. The outstanding in 2007 and 2006, in accordance with the laws of the Russian Federation. receivable/(payable) balances and the annual revenues and expenses as of and for the years ended December 31, 2007 and 2006 are comprised of the following: The reconciliation between the provision for income taxes reported in the consolidated financial statements versus the provision for income taxes computed by applying the Russian enacted statutory tax rate to the December 31, 2006 December 31, 2007 income before income taxes and minority interest is as follows: Accounts receivable, related parties TeliaSonera (1) 19 35 2006 2007 Skylink (7)) 162 – Provision for income taxes computed on income before Mezhregion Transit Telecom (8) 183 – income taxes and minority interest at statutory rate 7,367 11,179 Other 54 69 Change in the fair value of C-loans (Note 13) 185 – Total accounts receivable, related parties 418 104 Non-deductible expenses 1,059 1,151 Accounts payable, related parties Foreign exchange gain (56) 3 Peterservice (6) 299 461 Other differences 129 300 Mezhregion Transit Telecom (8) 214 – Provision for income taxes reported in the consolidated Other 73 58 financial statements 8,684 12,633 Total accounts payable, related parties 586 519 2006 2007 The deferred tax balances were calculated by applying the presently enacted statutory tax rate of 24% applicable to the periods in which the temporary differences between the tax basis of assets and liabilities and the amounts Revenues reported in the accompanying consolidated financial statements are expected to reverse. Deferred taxes in the TeliaSonera (1) 217 182 accompanying consolidated financial statements as of December 31 are comprised of the following: Turkcell Iletisim (3) 69 64 Mezhregion Transit Telecom (8) 1,001 706 2006 2007 Skylink (7) 397 391 Deferred tax assets: Other 142 262 Revenue recognition 467 366 Total revenues, related parties 1,826 1,605 Fixed assets and other intangible assets 699 938 Cost of services Loss carry-forwards 974 831 TeliaSonera (1) 56 48 Other 558 778 Turkcell Iletisim (3) 68 87 Globus Telecom (8) 57 – Total deferred tax assets 2,698 2,913 Petersburg Transit Telecom (4) 257 – Deferred tax liabilities: Mezhregion Transit Telecom (8) 1,846 1,000 Deferred finance charges 204 95 Skylink (7) 80 83 Licenses 2,668 2,288 Other 111 217 Other 536 647 Total cost of services, related parties 2,475 1,435 Total deferred tax liabilities 3,408 3,030 Operating expenses Net deferred tax liabilities 710 117 Telecominvest (2) 159 129 Add current deferred tax assets 739 1,111 J.P. Galmond & Co (5) 17 13 Total long-term net deferred tax liabilities 1,449 1,228 Peterservice (6) 289 222 Mezon Invest (9) 102 34 For Russian income tax purposes, certain subsidiaries of the Company have accumulated tax losses incurred Absolut (9) 78 91 in 2001 – 2007 which may be carried forward for ten years to use against their future income. Their use is not Kelly Services (10) 146 159 restricted in 2008 or in future years. As of December 31, 2007, these subsidiaries had tax losses available for Other 50 32 carry-forward aggregating approximately 3,463 with a related tax benefit of 831 which expire as follows: 2012 – 28, 2013 – 35, 2014 – 161 and 2015 – 437, 2016 – 111 and 2017 - 59. Total operating expenses, related parties 841 680
68... 69... Notes to Consolidated Financial Statements Notes to Consolidated Financial Statements (continued) (continued)
(1) TeliaSonera - primarily settlements on roaming services. 23. Commitments and Contingencies
(2) Telecominvest - payments for delivery of invoices to customers. Operating Environment While there have been improvements in the Russian economy over the past few years, such as an increasing (3) Turkcell Iletisim - primarily settlements on roaming services. Turkcell Ilitisim is an affiliate of TeliaSonera. gross domestic product and a reducing rate of inflation, Russia remains in a continuing process of economic reform and development of its legal, tax and regulatory frameworks, all of which are required in order for it to (4) Petersburg Transit Telecom - primarily fees for interconnection and rent of digital channels (included in cost develop a stable market economy. of services). Petersburg Transit Telecom was a wholly-owned subsidiary of Telecominvest. In January 2007, Telecominvest sold its entire interest in Petersburg Transit Telecom to a third party. Further growth and the positive development of the Russian economy are largely dependent on these reforms and developments being implemented and the effectiveness of economic, financial and monetary measures (5) J. P. Galmond & Co - payments for legal services. The legal firm is affiliated (through its principal) with undertaken by the Russian government. Telecominvest and IPOC. Taxation (6) Peterservice - primarily installation and maintenance of information and billing systems (purchase of billing Russian tax, currency and customs legislation are subject to varying interpretations and changes which can systems from Peterservice in the amount of 1,202 and 845 in 2007 and 2006, respectively). Peterservice is an occur frequently. Management’s interpretation of such legislation as applied to the transactions and activity affiliate of Telecominvest. of the Company may be challenged by the relevant regional and federal authorities. Recent events within the Russian Federation suggest that the tax authorities are taking a more assertive position in their interpreta- (7) Skylink - settlements on roaming and telecommunications services. Skylink is an affiliate of IPOC. tion and enforcement of the legislation and assessments and as a result, it is possible that transactions and In August 2007, entities affiliated with IPOC sold its entire interest in Skylink to a third party. activities that have not been challenged in the past may now be challenged. Therefore, significant additional taxes, penalties and interest may be assessed. It is not practical to determine the amount of claims that may (8) Globus Telecom, Mezhregion Transit Telecom - payments for telecommunications services. These compa- be asserted, if any, or the likelihood of any unfavorable outcome. Fiscal periods remain open to review by the nies are affiliates of Telecominvest and IPOC. In 2005 - 2006, their interests in Globus Telecom were sold to authorities in respect of taxes for the three calendar years preceding the current year. Under certain circum- a third party. In June 2007, entities affiliated with IPOC sold its entire interest in Mezhregion Transit Telecom stances reviews may cover longer periods. to a third party. Based on tax examinations of other telecommunications companies operating in Russia, tax authorities are (9) Mezon Invest and Absolut - payments for rent. Mezon Invest and Absolut are affiliates of Telecominvest and currently focusing on a number of specific areas, which include, but are not limited to revenues from intercon- IPOC. In May 2007, entities affiliated with IPOC sold its entire interest in Mezon Invest to a third party. nection charges. As a result of such examinations, tax authorities are claiming additional taxes which are cur- rently being disputed in the courts by these Russian telecommunications companies. (10) Kelly Services - payments for outsourcing of personnel. This company is an affiliate of one of the members of the Board of Directors. In November 2007, the Company received a final assessment from the tax inspectorate in connection with the examination of tax returns of OJSC MegaFon for 2004 through 2006. The assessment claims additional taxes Telecominvest and IPOC are also affiliated with the ultimate parent of one of the shareholders of Svyazbank amounting to 315 mainly in respect of income tax and VAT, including fines and penalties, for interconnection (see Notes 2, 3 and 11), where the Company regularly maintains deposit accounts. settlements. In November 2007, the Company paid this amount to the respective federal and local budgets. Nonetheless in January 2008, the Company appealed this decision in the Moscow Arbitration Court. In the As described in Note 12, the Company has loans from the following shareholders: Telecominvest, TeliaSonera, opinion of the Company’s management, it is more likely than not that the Company will sustain its position as IPOC and CT Mobile. The Company also has a loan from Transcontinental Mobile Investment Ltd., which was an a result of the court proceedings. affiliate of CT Mobile at the time that the loan was incurred, but which CT Mobile asserts was not an affiliate in 2007 and 2006. Moreover, certain of the Company’s subsidiaries are currently undergoing tax audits by the tax authorities. It is possible that as a result of such audits material tax claims similar to those issued to OJSC MegaFon may In connection with loans from shareholders, the Company recognized interest expense of 271 and 283 during arise. the years ended December 31, 2007 and 2006, respectively. Management believes that the Company and its subsidiaries are in compliance with the tax laws affecting its operations; however, the risk remains that governmental authorities could take differing positions with regard 22. Guarantees to interpretative issues.
Litigation The Company issued guarantees to several banks for loans to certain employees through January 2013. As The Company is not a party to any material litigation, although some of its subsidiaries have been sued as a of December 31, 2007, the amount outstanding under these loans is 69. The Company would be required to result of disputes arising in the ordinary course of their business and operations. perform under the applicable guarantee if any of the employees does not repay the principal, interest, or make any other payment specified in his or her loan agreement. Management believes that the fair value of these Management believes that the ultimate resolution of the matters mentioned above will not have a material guarantees and its related potential liability are de minimis. effect on the Company’s financial statements.
Minimum Lease Payment under Operating Leases Future minimum lease payments under non-cancelable operating leases with terms of one year or more, as of
70... 71... Notes to Consolidated Financial Statements Annex 1. (continued)
Corporate Events
December 31, 2007, are as follows: 2008 – 100, 2009 – 49, 2010 – 31, 2011 - 31, 2012 - 8. 24. Fair Value of Financial Instruments and Risk Management Date Summary
The following methods and assumptions were used to estimate the fair value of each class of financial instru- ments for which it is practicable to estimate fair value: January 2007 The Company completed the reorganization of its 100% subsidiaries, CJSC “Volzhsky GSM” and “CJSC “Mobicom-Kirov”, in the form of merger into OJSC “MCS - Povolzhie” and CJSC “Ural GSM”, respectively, 100% subsidiaries of the Company Cash, Cash Equivalents and Short-Term Investments The carrying amount approximates their fair value because of the short maturity of those items. January 2007 The Board of Directors approved the Charters of the Board’s Audit Committee and the Remuneration Committee Long-Term Debt The fair value of long-term debt is estimated based on market interest rates for the same or similar issues, or April 2007 The Regulations on the Corporate Secretary were approved. The position of the Corporate based on the current rates offered to the Company for debt of the same remaining maturities. Secretary was introduced in the Company, and the Office of the Corporate Secretary was formed; Ms. Anna Goriainova was elected Corporate Secretary of the Company Derivative Financial Instruments The fair values of the derivative financial instruments are determined using estimated discounted cash flows. April 2007 Cable Broadcasting license was obtained. Based on this license, the Company has the right to legally render Mobile TV services and charge its subscribers for it separately The estimated fair values of the Company’s financial instruments at December 31 are as follows:
2006 2007 May 2007 Under the tender for 3G license, the Company won the Lot №1 and obtained the license for rendering UMTS services (third generation) Carrying Carrying amount Fair value amount Fair value June 2007 The Company entered the Russian Union of Industrialists and Entrepreneurs; the Company Cash and cash equivalents 6,965 6,965 4,259 4,259 takes part in the work and meetings of the Union on a regular basis Short-term investments 569 569 21,710 21,710 Long-term debt 42,630 42,979 39,443 39,579 June 2007 he Annual General Shareholders Meeting of OJSC “MegaFon” took place. The shareholders approved the Annual Report and Annual Accounting Statements of the Company; they also Derivative financial instruments re-elected the Board of Director, the Revision Commission and the Management Board, (foreign currency swaps) 99 99 245 245 and elected the Auditor of the Company. At the Annual General Shareholders Meeting the shareholders also approved eight amendments to the Charter of OJSC “MegaFon” reflecting The Company, using available market information and appropriate valuation methodologies, where they exist, the most recent changes in the law on joint-stock companies has determined the estimated fair values of financial instruments. However, judgment is necessarily required to interpret market data to determine the estimated fair value. Accordingly, the estimates presented herein are June 2007 The Company entered the pan-world non-commercial organization not necessarily indicative of the amounts the Company could realize in a current market exchange. While man- “The TeleManagement Forum” agement has used available market information in estimating the fair value of financial instruments, the mar- ket information may not be fully reflective of the value that could be realized in the current circumstances. July 2007 After official commercial launch of its mobile network in Altai the Company became the first Russian mobile operator to cover the entire 100% of its licensed territory The Company, in connection with its current activities, is exposed to various financial risks, such as foreign currency risks, interest rate risks and credit risks. The Company manages these risks and monitors their ex- posure on a regular basis. September- The consultants of Mercuri Urval conducted assessment of operations of the Board as November 2007 compared to the previous year – the consultant’s evaluation was quite favorable
October 2007 The Company entered the market of fixed-lime communications, started construction of the LD/LDI network, initiated the project “Home Zone”
November- The rating agencies Standard&Poors and Moody’s upgraded the Company’s ratings to BB+ December 2007 and Ba2, respectively.
July, December 2007 All guarantees under the Company’s facility agreements were eliminated
October-December 2007 Launch of the project “The Future Begins Today” targeted at development, communication and promotions of MegaFon brand’s values
November 2007 The Company launched into commercial use the first Russian 3G network in Saint-Petersburg
December 2007 All companies of MegaFon Group completed transition to SAP/R3, thus improving the formation of the financial statements
December 2007 New uniform charters were developed and introduced in all the subsidiaries of the Company
72... 73... Annex 2. Basic Corporate Code Provisions Reflected in the Company’s Internal Documents
General Shareholders Meeting
Company’s Board of Directors
1. Shareholders shall have a possibility to In effect Article 11.13 of the Charter: study the list of persons who have the right “Upon the demand of a person included on 6. Authority of the board of directors for annual In effect Article 12.2. of the Charter to participate in General Shareholders the list of persons authorized to participate approval of business-plan of a joint-stock includes approval of budget and business- Meeting starting from the date of the Notice in the General Shareholders Meeting and company must be set forth in the charter of plan as well as significant changes and/or on holding general shareholders meeting till vested with not less than one percent of the joint-stock company additions to them into the competence of the closing the general shareholders meeting votes, the Company shall be obligated to Board of Directors. that is held in joint presence, or till the provide such list for review. ” deadline for submitting voting ballots if the 7. The charter should contain the right of the In effect Article 12.2. of the Charter general shareholders meeting is held in the board of directors in a joint-stock company to includes into the competence of the board form of absentee voting establish requirements to qualification and of directors establishment of the amounts of level of remuneration for general director, remuneration and compensation to be paid 2. Shareholders shall have a possibility to In effect Before general shareholders meeting members of management board, heads to the General Director of the Company and study the information (materials) that materials to it are sent via e-mail to each of main structural units of the joint-stock members of the Management Board, as well must be provided during preparation for shareholder participating in such meeting company as recommendations relating to the amount of general shareholders meeting via electronic remuneration and compensation to be paid to communication means, including Internet the members of the Auditing Commission of the Company and for the services of an auditor.
According to Article 13.7.11. of the Charter compensation payable to the personnel for 3. Shareholders shall have a possibility to In effect Article 11.19 of the Charter: its work in the Company shall be within the include an issue on the agenda of the “The proposal on inclusion of an issue expenditure limits established for this purpose general shareholders meeting or demand on the agenda of the General Meeting of in the business plans and/or budgets of the convocation of general shareholders meeting Shareholders and the proposal of candidates Company as approved by the Board of Directors without submitting an extract from the shall be submitted in writing with indication Shareholders Register, if its rights for the of the name (company name) of the shares are recorded in the shareholders proposing Shareholder(s), the amount and 8. There must be minimum 3 independent Not in effect The Company’s Board of Directors has 2 register system, and if shareholder’s rights category (type) of shares owned by him and directors in the board of a joint-stock independent directors as defined by the for the shares are recorded in a depository shall be signed by such Shareholder(s).” company as defined by the Corporate Code Corporate Code. account, a statement from such depository account shall be sufficient for execution of the above rights 9. Board of directors of a joint-stock company In effect 4. Charter or other internal corporate Not in effect The specified persons are generally present must not include persons who were found documents of a joint-stock company must at general shareholder meetings of the guilty of committing crimes in the sphere of have a requirement on mandatory presence Company, however there are no provisions business or crimes against the state, interests of the chief executive officer, members of in the Charter or other internal corporate of government and local authorities or who management board, members of board of documents that provide for their mandatory were subjected to administrative punishment directors, members of revision commission presence at general shareholder meetings. for offences in the sphere of business or in and auditor of the joint-stock company at the field of finance, taxes and charges or stock general shareholders meeting market
5. Procedure for registration of participants In effect Article 7.4. of Regulations on General in general shareholder meeting must be Shareholder Meeting: included in internal corporate documents of “The Chairman of the General Meeting of a joint-stock company Shareholders shall register the shareholders 10. Board of directors of a joint-stock company In effect according to the list of persons having the must not include persons who are right to participate in the General Meeting participants, general director (manager), of Shareholders. Registration must be member of governance body or employee of completed within one hour. After the a legal entity that is in competition with the completion of the registration the Chairman joint-stock company of the General Meeting of Shareholders shall announce the presence or absence of the 11. Charter of a joint-stock company must have a In effect Article 11.41. of the Charter: quorum. In the event the General Meeting of requirement regarding election of the board “Election of the Board of Directors shall be Shareholders has a quorum, the Chairman of directors by cumulative voting made by General Shareholders Meeting with opens the General Meeting of Shareholders cumulative voting.” and runs it according to the approved Agenda” Article 5.1. of the Regulations on Corporate Secretary sets forth that the Corporate Secretary shall ensure registration of participants in the general shareholder meeting. 74... 75... 12. Internal documents of a joint-stock company In effect Article 5.2. 18. There must be a committee of the Board In effect Audit Committee duties include must include the duty of the board of of the Regulations on the Board of Directors (Audit Committee) that recommends an recommending independent auditors to the directors to abstain from actions that will or sets forth that the Board members must “be auditor of a joint-stock company to the board Board of Directors before they are appointed, may result in conflict between their interests loyal to the Company, that is to abstain from of directors and interacts with the auditor as well as interacting with them and the and the interests of the joint-stock company, using his position in the Company in the and the revision commission of the joint- Company’s Revision Commission. and if such conflict arises, the duty to interests of other persons; act reasonably stock company disclose information about such conflict and in good faith regardipany’s business; inform the Company in proper time about 19. Establishing a committee of the Board In effect The Company has active Remuneration his affiliation and changes in it; inform (Personnel & Remuneration Committee) that Committee the Board of Directors about prospective shall identify criteria for selecting candidates transactions in which he may be considered to the board of directors and prepare the as an interested party. remuneration policy of the joint-stock company
13. Internal documents of a joint-stock company Not in effect Board members of the Company do not must include the duty of the Board members own any securities of the Company or its to notify the Board in writing about any subsidiaries, and securities of the Company The Company has active Remuneration Committee intention to make transactions with or its subsidiaries are not traded in the stock securities of the joint-stock company where market. 20. A joint-stock company must have a collegiate In effect Article 13.1. they are Board members or its subsidiaries executive body (management board) of the Charter states that the Management (affiliates), as well as the duty to disclose Board of the Company is a collective information about the transactions with such executive body securities that have been closed by them 21. Charter or internal documents of a joint- In effect Article 13.1. stock company must include the provision of the Charter provides that the Management 14. Internal documents of a joint-stock company In effect Article. 7.2. that sets forth the requirement for the Board shall take a decision on receiving must have the requirement to hold meetings of the Regulations on the Board of Directors management board to approve transactions and/or providing loans by the Company. of the Board of directors minimum once states that “Meetings of the Board of with real property and loans received by the every six weeks Directors shall be held periodically in joint-stock company, if such transactions accordance with the operation plan approved are not major transactions and they are not at the meeting of the Board of Directors ”. included into day-to-day business activities The operation plan provides for minimum 5 of the joint-stock company meetings in the form of joint presence during 6 months. 22. Executive bodies must not include persons, In effect who are participants, general director (manager), member of governance body 15. Board meetings of a joint-stock company In effect There were 16 meetings of the Board during or employee of a legal entity that is in must be held minimum once in six weeks 2007. competition with the joint-stock company during the year, for which the annual report is prepared 23. Executive bodies of a joint-stock company In effect must not include persons who were found 16. Internal documents of a joint-stock company In effect Article 9 guilty of committing crimes in the sphere must contain the procedures of holding the of the Regulations on the Board of Directors of business or crimes against the state, board meetings includes information about procedures of interests of government and local authorities holding the Board meetings. or who were subjected to administrative punishment for offences in the sphere of business or in the field of finance, taxes and 17. Internal documents of a joint-stock company In effect Article 5.1 charges or stock market. If the executive must include the rights of the board of the Regulations on the Board of Directors functions are performed by a management members to receive information required provides for Board member’s right to request company or by an administrator, the for performance of their functions from any information about the Company’s general director and members of executive the executive bodies and heads of main operations from its officers. board of the management company or structural units of the joint-stock company, the administrator must comply with the and include responsibility for not providing Article 5.4. requirements that are made to the general such information of the above Regulations sets forth the director and members of executive board of Company’s duty to provide for access to the joint-stock company requested information and documents for the Board member within five days since the date of respective request.
76... 77... Secretary of the Company
24. A joint-stock company must have a special In effect The Corporate Secretary acts on the officer (secretary of the company) who basis of the Regulations on the Corporate provides that governance bodies and officers Secretary that was approved by the Board on of the joint-stock company comply with 05.04.2007. mandatory procedures securing execution of rights and legal interests of the company’s shareholders
25. Charter or internal documents of a joint-stock In effect Procedures for appointing the Company’s company must include the procedures for Corporate Secretary are set forth in Article appointing (electing) the secretary of the 3 of the Regulations on the Corporate company and the duties of the company’s Secretary. Duties of the Corporate Secretary secretary are specified in Articles 5-10 of the Regulations on the Corporate Secretary.
26. Charter of a joint-stock company must have Not in effect Requirements to a candidate corporate the requirements for a candidate secretary of secretary are specified in Article 4 of the the company Regulations on the Corporate Secretary.
Disclosure of Information
27. A joint-stock company must have a web-site In effect Information about joint-stock companies and in Internet and information about the joint- all significant events is disclosed at: www. stock company must be disclosed in this megafon.ru web-site on a regular basis
78...