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SISTEMA
ANNUAL REPORT 2005
g / / g
7,593.55,733.9
3,759.9
2,982.02,462.0
1,626.7
534.4411.2
387.0
Revenue ($, million)
2005
2004
2003
2005
2004
2003
OIBDA* ($, million)
Net income ($, million)
13,090.98,823.3
6,818.7
Assets ($, million)
3,233.61,422.2
989.3
Shareholders' equity($, million)
56.450.8
47.8
Earnings per share($)
Financial Highlights
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12.7% Technology 77.6% Telecommunications
5.4% Insurance
1.0% Real Estate
0.7% Mass Media
1.4% Banking
2.7% Retail
3.7% Other Businesses
561.54 Technology 9,696.64 Telecommunications
581.45 Insurance
331.79 Real Estate
81.91 Mass Media
1,114.87 Banking
146.28 Retail
2,009.13 Other Businesses
* OIBDA represents operating income before depreciation and amortization. OIBDA is not a measure of financial performance under U.S. GAAP.
** Before eliminations of intersegment revenue.*** Before intersegment eliminations.
Assets by segments***($, million)
Revenue by segments**
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Sistema's Mission
4
ANNUAL REPORT / 2005
Sistema’s MissionWe create leading businessesin the service sectors, primarily in the field of technology.Our mission is to serve the interests of both ourshareholders and society as a whole.
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Sistema's Mission
5
SISTEMA
In order to succeed in its mission,
Sistema invests its financial, intellectual
and management resources in the
development of its businesses and
the growth of the Russian
economy.
In this Annual Report, we describe
how Sistema has worked to fulfill
this mission during 2005.
In presenting this Annual Report, we
would like to emphasize that Sistema's
results should ultimately be judged
by how much they have contributed
to fulfilling the corporation's stated
mission.
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Letter from theChairman of the
Board of Directors
ANNUAL REPORT / 2005
“While we act as a Russiancompany, we nonethelessunderstand that we must
build the business in an environment
of global competition.
But only clear nationalleadership allows us to gobeyond the borders of our
country. And only the ability to truly compete in
the global marketplace canstrengthen our
national leadership.”
Vladimir Evtushenkov Chairman of the Board of Directors
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It has been little more than a year since Sistema made its successful debut on the London Stock
Exchange. But this was a breakthrough year in every sense for the corporation. The new opportuni-
ties and requirements that come along with the status of a public company have significantly
changed the nature of our business.
The intense scrutiny of the investment community, careful adherence to international standards of
business and alignment with best global practices in management have led us to undertake a thor-
ough revision of our current potential and to more precisely define our strategy. This new outlook
and new level of responsibility has allowed us to raise the bar even higher when establishing the
goals set before the corporation.
Sistema has always focused on building companies that are leaders in their area of business. Our
debut in global capital markets, coupled with the fact that we operate in an open economic envi-
ronment, means we have changed our very understanding of the term ”leadership.” Today, in order
to be at the forefront, it is no longer enough to maintain consistent organic growth and complete
successful M&A deals. One also needs to define new points of growth and foresee the appearance of
new breakthrough markets, generate promising ideas and generate synergies. It is just such an
approach that has led us to make several large-scale wagers.
We have bet on the INNOVATIVE nature of our development. Sistema has always worked in technology
services and developed hi-tech production. But today we are looking at the wider field of innovation:
it is no longer just an important component of our businesses, but a business in itself. The scientific
and innovative base created within the corporation is dedicated both to stimulating R&D within
Sistema's divisions and to the creation of a fully fledged venture investment wing of the corporation.
It is our belief that promising, fast-growth sectors will come into being only on a base of innovation.
It is these sectors that can become the foundation of the technological leadership of Russia.
We have bet on INTEGRATION. The consolidation of fixed-line operators under the single Comstar-UTS
brand was the beginning of this process. The next logical step is the creation, through convergence
technology, of a single diversified group on a common technological and management platform within
Sistema Telecom. The introduction of a single umbrella telecommunications brand (a first in the Russian
marketplace) is an important step down this road. The process of integration will move forward with the
further blurring of boundaries between telecommunications and multimedia services.
We have bet on international EXPANSION. The Russian market remains the clear priority for Sistema
and we act as a national company. We nonetheless understand that we must build the business in an
environment of global competition. Only clear national leadership allows us to go beyond the bor-
ders of our country. But only the ability to truly compete in the global marketplace can strengthen
our national leadership. Sistema has already moved past the borders of the CIS and entered the mar-
kets of Central and Eastern Europe. In addition, we continue to study opportunities in Asia, the
Middle East and other attractive markets.
We understand that the trust of investors is the foundation for growing the capitalization of the cor-
poration and we are continuing to perfect our corporate governance practices. We hope that the
investment community will fully appreciate the appearance of a new independent director on
the Board of Directors. Stephan Newhouse, who was formerly president of investment bank Morgan
Stanley, is a person whose authority is difficult to overestimate.
We wish to acknowledge all of those who have accompanied us during this brilliant and fascinating
year: our employees, partners, investors and shareholders. We look into the future with optimism.
And we hope that we will build the future together with you.
Letter from the Chairman of the Board of Directors
7
SISTEMA
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Letter from thePresident
ANNUAL REPORT / 2005
Alexander Goncharuk President
“Leadership is impossible without
leaders. Our main trump card and primary
resource in the fight for efficiency is people.
We take pride in the fact that the corporation
has raised a whole generation of managers
who have set the highest standards of business in
Russia. They are the oneswho create value
for Sistema.”
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Letter from thePresident
9
SISTEMA
Sistema's shareholders have set ambitious goals for the management of the corporation. This latest stage
of the corporation’s development means the high expectations of investors have been added to these
goals.
What do shareholders expect of us?
High rates of business growth — while maintaining profitability.
Entry into new territories — without risking presence in existing areas.
Development of emerging, promising sectors — without a reduction in profitability in mature sectors.
Conquering new markets — without losing established, leading positions in existing markets.
Acquisition of additional assets — while increasing the manageability of the whole asset portfolio.
Sistema's management is doing all that it can to ensure that the expectations of investors are met.
The net profit of the corporation increased by 30.0% in 2005.
Total assets grew by 48.4%.
The capitalization of the corporation grew by more than a third.
How was all of this made possible? Moreover, upon what foundation are we building our future?
I would describe the position of the management in a single word: EFFICIENCY.
The first principle is to ”stake” ourselves only on existing and potential LEADERS. We conducted a
painstaking analysis of our portfolio and established clear priorities. Subsequently, we concentrat-
ed our investment and managerial resources on the most promising business areas. For example, our
newly established leadership in the cable television market will provide a base for development in
the extremely promising sector of multi-media services.
The second principle is to strictly delimit the criteria for success for our operational companies
according to ORGANIC GROWTH and M&A. Thus the consolidated revenues of the corporation attrib-
utable to organic growth rose last year by 27.7%. In the Technology division, organic growth
accounted for 60% of revenue growth.
The third principle is a BALANCED PORTFOLIO. Sistema is still predominantly a telecommunications cor-
poration. Nonetheless, we are developing other promising areas. Due to the rapid growth in these sec-
tors, the share of revenues from these businesses reached 22.4%, of which 12.7% came from Technology.
The careful MANAGEMENT OF FINANCIAL RESOURCES is the fourth rule. When the timeframe for the
privatization of Svyazinvest, for which the company had earmarked funds from the IPO, was again
delayed, we made the decision to acquire minority shareholdings in very profitable and highly liq-
uid oil assets in Bashkortostan. Today we are working with our colleagues in Bashkortostan to
increase the capitalization of this business by establishing a vertically integrated holding.
The fifth rule is TRANSPARENCY in ownership and management structures. The corporation’s prepa-
ration for its IPO represents the most significant stage of RESTRUCTURING undertaken by Sistema to
date. This received a uniformly high evaluation from the marketplace. The redistribution of author-
ity between the corporate center and the business divisions is the next step in the optimization of
the management structure of the corporation.
Finally and most importantly, leadership is not possible without LEADERS. Our trump card and great-
est resource in the fight for greater efficiency is people. We take pride in the fact that the corpora-
tion has raised a whole generation of managers. These managers possess the highest standards of
leadership in the Russian business world. They are the ones who create value for Sistema. It is for
them that the corporation has developed a full-range of options programs in MTS and Sitronics.
We do not doubt the ability of our team to succeed and we hope to share this success with our investors.
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BOARD OF DIRECTORS
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Vladimir EvtushenkovChairman of the Board
Alexander GoncharukPresident
Vyacheslav KopievDeputy Chairman of the Board
Dmitry ZubovDeputy Chairman of the Board
Evgeny NovitskyDirector
Sergey DrozdovSenior Vice President,
Head of the Property Complex
Alexander LeivimanDirector
Nikolai MikhailovNon-Executive Director
Alexander GorbatovskyNon-Executive Director Ron Sommer
Non-Executive Director
Stephan NewhouseNon-Executive Director
Board of DirectorsSISTEMA
ANNUAL REPORT / 2005
Board of DirectorsSISTEMA
SISTEMA
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SISTEMAANNUAL REPORT / 2005
KEYMANAGEMENT
Key Management
Alexander Gorbunov Acting First Vice President
Head of Strategy & Development
Alexey BuyanovSenior Vice President
Head of Finance and Investment
Sergey DrozdovSenior Vice President
Head of Property
Ruslan AlmakaevVice President
Head of Economic
and Information SecuritySergey ChereminVice President
Head of External Relations
Denis MuratovVice President
Head of Innovation and Science
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ANNUAL REPORT / 2005
1Strategy
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SISTEMA
Our strategy:The creation of leading companies in fast-growingmarkets and the constantsearch for new areas of growth.
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Strategy
18
ANNUAL REPORT / 2005
Alexander Gorbunov
Acting First Vice President, Head of Strategy & Development
EFFICIENCY INNOVATION EXPANSION RESTRUCTURING TRANSPARENCY
”THE BUSINESS OF BUILDING BUSINESSES”The basis of Sistema's strategy is to build market-leading businesses
in the most promising service-oriented industries. This ”Business of
Building Businesses” develops through the skilful combination of
organic growth and the effect of mergers and acquisitions (M&A).
Through this approach, the corporation continues to grow rapidly,
requiring additional investment resources. We were able to success-
fully attract investment through the IPO and are now working active-
ly to bring the corporation's subsidiary companies to the interna-
tional capital markets. In February 2006, Comstar-UTS placed its
shares on the London Stock Exchange. The placement of Sistema-
Hals and Sitronics shares is likely in the near future. Looking forward,
the corporation envisions other subsidiary companies trading on
international financial markets.
Beginning in 2004, the corporation concentrated its efforts on the
development of its key businesses: those that were already market
leaders and those with the clear potential to become leaders in their
sectors in the foreseeable future. These companies were best posi-
tioned to grow together with dynamically evolving markets benefit-
ing from rising consumer purchasing power and the broader growth
of the economy. Sistema provides these businesses with the
resources needed for development and enables them to become lead-
“Sistema sets the bar high for its businesses,expecting them to occupyleading positions in their sectors through
organic growthand M&A deals. ”
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ers. Other businesses with strong promise that do not yet demonstrate the highest potential expected by
Sistema cannot depend on priority financing of investment from the corporation and must fund their
development from their internal resources. Areas that do not meet the expectations of shareholders and
do not demonstrate signs of future leadership potential are gradually being restructured or sold. This
strategy ensures that Sistema’s financial and management resources are used with maximum efficiency.
The successful combination of dynamic organic growth and quality M&A deals was reflected in Sistema's
strong 2005 financial results. Through organic growth the revenues of Sistema's existing businesses grew
by 27.7% or $1.58 billion. The acquisition of new companies accounted for $279 million growth in the
consolidated revenues of the corporation. After the integration of these businesses, they will strength-
en the market positions of the key business areas of the corporation.
The successful IPO on the LSE brought the corporation substantial resources for investment. Sistema
gained the ability to undertake a wide range of M&A transactions to strengthen core business areas. But
increased deal activity has not changed the fundamental strategic goals. Sistema carefully approaches
M&A targets: they must create shareholder value, be well structured and logically integrate within exist-
ing company structures. The corporate center provides the general rules in the area of M&A for the busi-
ness areas. Using these as a framework, each business area carries out its strategy while taking into
account the specifics of its industry.
The fruitfulness of the policy of finding the right combination of organic growth and M&A was clearly
displayed in 2005 at SITRONICS, which integrates the corporation's high technology businesses in IT and
electronics. Following comprehensive restructuring in 2004, the revenues of SITRONICS almost doubled
in 2005. Organic growth accounted for 60% of this and, accordingly, 40% was contributed by M&A.
We are actively making deals in businesses in which shifts in strategy are necessary. For example, during
2005, the corporation conducted a comprehensive restructuring in the Media business area. Lower mar-
gin businesses in mature sectors, such as newspapers and print distribution, were sold. At the same time,
assets were acquired in fast-growth market segments. In particular, UCN, Russia's largest network of
regional cable operators, was acquired. The company is capable in the near term of becoming the core for
the consolidation of regional cable operators. The corporation is investing to transfer the company to the
latest technology platforms. This technology allows the company to provide a wide range of multimedia
services to consumers. The corporation anticipates explosive growth in this sector.
During 2005, the restructuring of the corporation's assets in the fixed-line telecommunications sphere
was successfully completed. Comstar-UTS was able to raise more than $1 billion for investment on the
London Stock Exchange in a successful IPO in early 2006. The scale of the transaction was the second
largest of a Russian company in the international markets to date, after only Sistema’s IPO. Sistema’s IPO
remains the largest IPO in Russian history.
The combination of organic growth and M&A allows Sistema to rapidly grow the scale of its business and
capitalization. The strongest business areas are able to go to financial markets independently in order to
attract needed investment resources. In turn, the corporation can get a fair price for its assets and can
focus on investing in the next wave of leading businesses.
”The Business ofBuilding Businesses”
19
SISTEMA
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Strategy
20 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
ANNUAL REPORT / 2005
FINANCIAL MANAGEMENT FOR LONG-TERM STABILITY The successful February 2005 initial public offering of the corpo-
ration's shares on the London Stock Exchange has created new
possibilities for the financial management of the corporation. At
the same time, it has presented new challenges. Disciplined and
prudent financial management has been a hallmark of the corpo-
ration's strategy since it was founded. This approach is strictly
applied on both the corporate and subsidiary level. Sistema main-
tains stringent control over all aspects of financial activity in an
effort to ensure the long-term financial stability of the group.
During 2005, the liquid financial resources at the disposal of the
corporation increased thanks to the IPO and by high and growing
dividends from MTS and other operating companies. In the inter-
ests of the shareholders, these funds must be invested profitably.
But they must not be diverted over the long term in view of the
need to conduct M&A activity. Therefore, the focus of the finan-
cial management of the corporation in 2005 was to find a solution
for these contradictory goals: to ensure the optimal balance
between having liquid funds on hand and making investments in
short- and medium-term financial instruments with the highest
possible returns. A careful approach to finding such a solution
allowed Sistema to strengthen the financial component of its
activity. This was recognized by the international ratings agen-
cies. In March, S&P increased its rating on the corporation to BB-.
In April, Fitch raised its rating on Sistema to B+.
The achievement of a stable financial position at Sistema is also
made possible by the observance of some basic principles in its
financial strategy.
Alexey Buyanov
Senior Vice President, Head of Finance and Investment
”Financial
transparencyis the cornerstone of thefinancial policy of the corporation.”
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Sistema’s Financial Transparency
Long before 2005, Sistema had made financial transparency a cornerstone of its financial management.
The corporation has prepared consolidated, audited reporting according to US GAAP standards since
1997. The corporation began disclosure of its financial reporting to the investment community in 2003.
During the same year a dedicated investor relations department was also created with a highly qualified
team of professionals. Sistema disclosed information on its financial results on a semi-annual basis from
2003 to 2005, and began reporting on a quarterly basis during the second half of 2005. During early
2006, the corporation began to transfer financial reporting at its key operating subsidiaries to US GAAP
or IFRS standards. A number of these companies already disclose their financial reporting as stand-
alone enterprises. There are also plans to increase the number of reporting segments at the corporation
during 2006.
Debt Management
To ensure the continued strong financial position of the corporation, Sistema has always paid par-
ticular attention to managing the size and structure of its debt obligations. The corporation seeks
to maintain an optimal capital structure and ensure continued access to liquid funds on the most
attractive possible terms. Between 2002 and 2003, the corporation increased the share of publicly
traded debt instruments in the corporation's overall indebtedness from 21% to more than 60%. This
ensured more favorable borrowing terms and longer average maturity periods that better corre-
sponded with the average period required to achieve return on investment in the corporation's proj-
ects, which varies between three to five years.
Control Over Consolidated Borrowing
Sistema strictly controls the levels of borrowing by its subsidiaries. This has become particularlyimportant because the corporation's subsidiaries increasingly have independent access to loans andsubsidiary borrowing has increased significantly in recent years. The corporation has establishedstrict criteria to ensure an optimal structure of consolidated borrowing. For example, the level ofconsolidated debt should not exceed 3.5 times the consolidated EBITDA.
Budgeting and Planning
Budgeting at the corporation is based on a ”bottom-up” approach. The procedure for compiling
budgets is the same for all of Sistema's business areas. Each area compiles a yearly budget that goes
to the corporate budget commission for approval. Then Sistema consolidates and approves the budg-
et on the corporate level. The corporation carefully tracks the results of each business area and eval-
uates their success in meeting the strategic goals set before them.
Planning at the corporation is based on one- and five-year time horizons. Beginning in 2005,
Sistema has been developing five-year financial economic plans according to US GAAP accounting
standards. This has raised financial planning and controls to a qualitatively new level. The corpora-
tion's planning takes into account the growing ability of business areas to finance their own devel-
opment and attract significant financial resources. The February 2006 IPO of Comstar-UTS is one
example. Another is the issuance of Eurobonds by SITRONICS. The move of subsidiaries towards inde-
pendently raising finance will become the key development in financial management and planning
in the coming years.
Financial Managementfor Long-Term Stability
21
SISTEMA
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Strategy
22 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
ANNUAL REPORT / 2005
“The formula for effective
restructuring:maximum volume of business with minimal number of companies and structures.”
Sergey Drozdov
Senior Vice President, Head of Property
STRUCTURING ASSETS TO CREATE MARKET LEADERS The restructuring of assets has been one of the key goals of man-
agement throughout the history of the corporation. This goal
stems directly from the long-term strategy of Sistema: the con-
centration of financial and management resources for the devel-
opment of companies that are market leaders and companies that
have a clear leadership potential. The aim of restructuring is to
form business units with transparent and efficient vertical owner-
ship and management structures. These units should be able to
develop and independently attract funding from the financial
markets. The most significant work on restructuring was accom-
plished during 2004 in preparation for Sistema's IPO. The compa-
ny identified priority core business areas, consolidated assets
within each area and disposed of certain non-core assets. The
effect of this restructuring was quickly apparent in the high eval-
uation by investors, as reflected by Sistema's capitalization.
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The IPO did not mark the end of restructuring. This is a constant process and integral to the real-
ization of Sistema's strategy. The activity of each subsidiary is regularly analyzed to identify oppor-
tunities for consolidation to extract synergies or create new structures capable of independently
borrowing and entering the financial markets in order to fund their own long-term development.
Assets that are acquired through M&A undergo analysis both before and after purchase. In the
course of the analysis, it is determined how efficiently new structures can be integrated into exist-
ing business areas. Whenever possible, new assets are broken into separate business units and inte-
grated into business areas as affiliated structures. The restructuring of assets must be accompanied
by management restructuring to ensure the most efficient use of management resources.
The first aim of restructuring is to maintain the maximum turnover of business with the minimum
number of companies. A clear example of this approach is the successful consolidation of all of
Sistema's fixed-line telecommunications operators under the aegis of Comstar United TeleSystems.
As a result of the consolidation, the structure of the business was simplified while management was
centralized and strengthened. This paved the way for the company's IPO in February 2006. A similar
process has been completed recently at Sistema-Hals, which has become the head company in the
Real Estate business area.
A basic principle of restructuring is strengthening vertical ownership. The corporation uses every
opportunity to buy out minority shareholdings and concentrate ownership rights for the companies
in its key businesses. Ideally, these companies will all become subsidiary structures of the head
company in each business area.
In 2005, Sistema continued to dispose of non-core business areas. The corporation sold its share-
holding in Kamov Holding which was 49.5% owned by Kamov OJSC. Also, a number of low-margin
media businesses were sold. This freed up additional financial and management resources for
strengthening strategic business areas. The process of strengthening and uniting businesses con-
tinues. In 2006, Olympic Sistema was integrated into Intourist, the head company in the Tourism
business area.
Hand in hand with restructuring is the evolution of a new management model within the corpora-
tion. A process of delegating authority from Sistema to the management companies and business
areas is underway, in particular in the area of property restructuring. The corporation has set the
goal for itself of providing each strategic business area with the management resources and assets
needed in order to become independent structures ahead of future debuts in the international
financial markets. In the future, each of the business areas will itself engage in the restructuring of
assets under its control.
Structuring Assets toCreate Market Leaders
23
SISTEMA
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Strategy
24
ANNUAL REPORT / 2005
EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
”The unique quality of the corporation consists of the fact that all of our business is, in principle, built throughthe introduction of
innovation.”
Denis Muratov
Vice President, Head of Innovation and Science
POLICY OF INNOVATION — SISTEMA’SCOMPETITIVE EDGE From the moment it was founded, innovative technologies have
driven the ideas and organization of Sistema. The corporation is
the only player in the service sector of Russia and the CIS that not
just systematically invests in innovation but views it as an inde-
pendent business area.
Each of the company's main business areas are in knowledge
intensive industries. Innovation as a core principle of develop-
ment allows Sistema to stay several steps ahead of the market-
place. This spirit of innovation is one of the core competitive
advantages of Sistema.
To drive innovative development, the corporation founded a new
subdivision called Intellect-Telecom, which performs scientific
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research and development in the telecommunications sphere. Intellect-Telecom develops technology
for all of Sistema’s telecommunications units, including fixed-line and mobile communications, as
well as convergent services where traditionally separate telecommunications segments meet. Similar
research and development subdivisions are being established in all of Sistema's divisions.
In addition, the goals of the corporation include creation of technology infrastructure to support
the management programs of each business area. The research and development subdivisions are
also responsible for implementing these goals.
For Russia, a major obstacle to the transition from an economy based on raw materials to an innova-
tion-based economy is the absence of an infrastructure that can turn ideas into finished products.
Therefore a major step taken by the corporation to address this need is the decision to create a fully
fledged venture investment business area. The Sistema Venture Fund will be fully engaged in iden-
tifying the right projects and organizing investment to develop new, innovative technology.
We believe that leadership and profit growth in maturing markets such as mobile telephony require
new technology rather than simply new approaches in marketing. New technology developed in-
house or acquired through partnerships with international companies offers the potential to create
new markets and reshape mature ones.
All of Sistema's subsidiary companies are engaged in the business of innovation. The Technology busi-
ness area posted 92.8% year-on-year sales growth in 2005. Few companies in the Russian market can
boast such a blistering rate of development. The divisions of SITRONICS work in two main directions,
both acquiring world-leading technology and developing their own intellectual property.
SITRONICS is integrated into the world-wide network of technology development through joint-ven-
ture enterprises established with global companies such as Siemens and Giesecke & Devrient and
strategic partnerships with Oracle, Cisco, Intel and Motorola. In 2005, SITRONICS acquired the exclu-
sive rights to manufacture modules using Infineon technology in Russia and the countries of the
CIS. As the Center of the Russian microelectronics industry, SITRONICS produces smart-cards togeth-
er with Giesecke & Devrient, the world's largest maker of such products. Siemens has an interest in
SITRONICS's development of security technology through the joint-enterprise Center for Innovative
Developments, which was created in 2005.
Sistema's Media business area uses the latest technology to create multi-media content and deliver
it to the consumer. The company is implementing a project for broadband ADSL access and IP tele-
vision, which substantially expands the service offering and number of TV programs offered to the
final consumer. Sistema Mass Media is planning the commercial launch of digital mobile technology
on the DVB-H platform. Users will be able to tune in television on mobile devices such as telephones,
pocket PCs and notebook computers.
One of the most important issues for innovative business areas is training. In August 2005, Sistema
signed a strategic agreement with the Lomonosov Moscow State University to create a new
Department for Innovative Business. The first group of students will begin classes in the new depart-
ment in the fall of 2006.
Policy of Innovation —Sistema’s CompetitiveEdge
25
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Strategy
26 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
ANNUAL REPORT / 2005
”No fast-growing company can build its strategy in today's environment without taking into account the impact of
globalization.”
Sergey Cheremin
Vice President, Head of External Relations
INTERNATIONAL COOPERATION ANDEXPANSION IN GLOBAL MARKETSSistema began its operations in 1993 with a focus on the Russian
market. Today, the corporation rightly calls itself the largest con-
sumer services company in the former Soviet Union. In 2005, the
corporation confirmed its ambitions as a global player with its IPO
on the London Stock Exchange. During that year, the corporation
continued its expansion into new markets.
The corporation combines two fundamental principles in its
development in overseas markets: partnership and expansion.
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InternationalCooperation and Expansion in Global Markets
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SISTEMA
Sistema cultivates partnerships with leading Russian and international companies, financial insti-
tutions and governments on the national and regional level. These ties, built on ”strategic trust,”
are one of the most important factors in the corporation’s success.
Partnerships with leading international players combine Sistema's knowledge of the Russian market
and the industrial and management know-how of leading global players. The partnership between
Deutsche Telekom (DT) and Mobile TeleSystems (MTS) was one of the factors that turned MTS into
the national leader. Cooperation with German company Allianz AG allowed ROSNO insurance com-
pany to introduce international standards of conducting business.
The corporation's Technology business area has gained from synergies in SITRONICS' cooperation
with Oracle, Cisco, Intel and Motorola.
The effectiveness of Sistema's policy of expanding in the markets of the CIS has been confirmed by
the development of the mobile communications segment. Mobile TeleSystems's assets in the CIS
(including Ukraine, Belarus, Turkmenistan and Uzbekistan) account for around 30% of the compa-
ny’s business.
The corporation is working actively in European markets. SITRONICS owns Strom Telecom, the largest
telecommunications equipment and services provider in Central and Eastern Europe. In June 2006,
SITRONICS acquired 51% of the shares of Greek company Intracom Telecom. Strom Telecom has high-
ly competitive product lines in the areas of NGN, billing systems and switching equipment. Intracom
Telecom’s specialities include wireless networks and data exchange systems. The combined poten-
tial of these two companies brings the SITRONICS’ business to a qualitatively new level.
The corporation carefully studies the potential of both regional and global markets. Sistema is
reviewing possibilities in markets such as China, Egypt, India, Serbia and Vietnam. In the summer of
2006, Sistema opened a representative office in India which provides additional opportunities for
the development of business partnerships in that country.
Sistema is implementing its strategy of entering international markets in close cooperation with
government institutions and business associations. The corporation is an active member of the
Russian Union of Industrialists and Entrepreneurs and the Trade-Industrial Chamber of the Russian
Federation as well as bilateral organizations which aim to develop contacts with the business com-
munities of other countries. Sistema is working fruitfully with the Russian-Arabic Business
Committee, the Russian-Chinese Business Committee and the Russian-Saudi Business Committee.
The corporation is also part of the non-commercial partnership Russian-Indian Business Committee
and is part of the Russo-British Chamber of Commerce.
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Strategy
28 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
ANNUAL REPORT / 2005
“Today we already knowwho will be leading thecorporation in 10 years. We are seeing the emergence of future
leaders at every level of the company.”
Ruslan Almakaev
Vice President, Head of Economic and Information Security
EFFECTIVE MANAGEMENT OF HUMANCAPITAL IS THE FOUNDATION FORSISTEMA’S SUCCESSThe corporation's achievements directly depend on the approxi-
mately 90,000 employees who work at Sistema and its subsidiary
companies. The corporation’s business relies on the innovative
and intellectual potential of people whose knowledge and profes-
sionalism underpins its development. Sistema is always looking
for talent and develops its personnel to sustain its leadership in
innovation. Corporate culture is becoming one of the decisive fac-
tors in ensuring the achievement of the the company’s commercial
goals.
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The corporation views investment in the development of personnel at every level as a strategically
vital task. In 2005, a new Corporate Coordination Center was created at the corporate level to help
the human resource departments of subsidiary companies optimize their work. The Center helps
human resources directors find promising employees. The Center is also creating a ”personnel
reserve,” which is a database of future leaders and innovative managers. This greatly simplifies the
recruitment of employees for the corporation's business areas.
Sistema's new project, the ”Leadership Program for the Employee Reserve,” is directed at fostering
future leaders. Participants in the program undertake training abroad, test their knowledge through
internships and receive professional consultation in career planning. Through these types of pro-
grams, the corporation is creating a new generation of leaders able to work effectively in high tech-
nology businesses.
In order to develop the potential of its employees, Sistema conducts regular reviews which serve to
set goals and aid career planning. The review process also ensures employee feedback and creates a
transparent process for evaluating personnel.
The constant development of qualifications is a key factor in increasing the value of the human cap-
ital of the corporation. For the last five years, the corporation has run the Educational and
Methodology Center. The majority of business areas have their own educational centers. In mid-
2006, Sistema signed a long-term agreement with the Lomonosov Moscow State University to create
a Faculty for Innovative Business.
In 2005, the corporation launched a program to provide grants for young scientists. Sistema has cre-
ated committees of young scientists and specialists on the enterprise level. This helps the corpora-
tion find the optimal way to divide management and scientific resources between business areas.
Sistema's human resource policy on the corporate and subsidiary level aims to challenge every
employee to make full use of their talents and professional qualities to achieve the corporation's
goals. Sistema carefully defines what is expected from employees while offering a comprehensive
and specific program that provides opportunities for managers and employees to access training and
continuing education programs to improve their professional qualifications. Other benefits, includ-
ing provision of medical insurance and private pension contributions, allow employees to pursue
their ambitions while feeling secure about their future.
In 2005, Sistema continued to develop its motivational option programs for employees. These pro-
grams exist for managers of the corporation itself as well as in business areas, including MTS and
SITRONICS. In mid–2006, Comstar-UTS developed an option scheme for managers that is unprece-
dented in its scope.
Effective Managementof Human Capitalis the Foundation forSistema’s Succes
29
SISTEMA
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Strategy
30 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
ANNUAL REPORT / 2005
EVENT OF THE YEAR Sistema’s IPO on the London Stock Exchange remains the largest ever Russian
placement to date
On February 9, 2005, Sistema completed the initial public offering (IPO) on the London Stock
Exchange of 16.5% of its shares in the form of global depositary receipts (GDRs). The IPO book was
2.6 times oversubscribed and raised $1.35 billion. Following the exercise of an overallotment or
”greenshoe” option by the global coordinators of the offering, Credit Suisse First Boston and Morgan
Stanley, the total free float of the corporation's shares reached 19%, and the total funds raised were
$1.56 billion. Sistema's GDRs are listed under the symbol ”SSA.”
The IPO was the largest such transaction by a Russian company in history and valued the corpora-
tion at $8.2 billion. The IPO’s success provided an endorsement of Sistema's diversified, consumer-
oriented businesses by the global investment community. It also silenced skeptics who believed that
Russia's investment potential was largely limited to oil, gas and mineral extraction. Going forward,
the share price of Sistema's GDRs provide a continuing outside assessment of the corporation's per-
formance and outlook.
In the 15 months between Sistema's IPO and the publication of the Corporation's Financial and
Operational Results for the year ending December 31, 2005, the market capitalization of the compa-
ny grew by 40% from $8.2 billion to $11.4 billion.
The IPO marked Sistema's successful transition from a privately held corporation to a public one with
a global shareholder base. But the listing also validated a strategy put in place many years before,
aimed at preparing the company to meet the strict disclosure requirements necessary to access glob-
al debt and equity markets to provide finance growth. These steps included the preparation of con-
solidated, US GAAP accounts starting in 1997 and the publication of the company's list of share-
holders in 2001. The company's transparency allowed Sistema to issue its first Eurobond worth $350
million in April 2003 and a second Eurobond in January 2004, also worth $350 million.
The successful IPO of Sistema has started a new chapter in the history of the corporation. The pro-
ceeds of the offering provide Sistema with funds for carefully selected mergers and acquisitions.
These deals aim to strengthen each of Sistema's core business areas. Other acquisitions provide
short- to medium-term opportunities to increase the value of shareholder funds while the corpora-
tion prepares for possible future large acquisitions, such as the privatization of the Svyazinvest
holding of regional fixed-line companies.
The IPO also confirms Sistema's status as a truly global player. While Russia and the CIS will remain
the central focus of the activities of Sistema and its subsidiaries, the corporation's strategy also
envisions further expansion of its presence abroad. Sistema, a publicly traded company with a glob-
al investor base, has increased its profile on the global stage. As an internationally listed corpora-
tion, Sistema's history, accounts and strategy are available for global business and government part-
ners to see.
Sistema's presence in the global capital markets continued to expand in 2006. In early February, the
corporation's fixed-line subsidiary Comstar-UTS raised $1 billion in an IPO on the London Stock
Exchange. It was the second largest IPO ever of a Russian company on this trading platform.
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Event of the Year
31
SISTEMA
At the end of February 2006, another high technology subsidiary of the corporation, SITRONICS,
issued a $200 million Eurobond. These transactions allow the corporation's subsidiaries to raise
funds to finance their own growth and benefit from strong demand on behalf of global investors for
exposure to fast-growing consumer markets in Russia and the CIS.
Sistema has also linked its future to dynamically developing financial markets in Russia. The corpo-
ration was included in the ”B” List of the Moscow Stock Exchange (MSE) in November 2004 under
the symbol ”SIST.” Sistema's shares are also included in the ”B” list of the Russian Trading System
(RTS) under the symbol ”AFKS”. The trading of ordinary shares on Russian exchanges has enhanced
the liquidity of Sistema's shares.
Sistema's successful IPO has also provided new challenges for the corporation. The obligations
placed on publicly listed companies continue to evolve. Sistema takes part in a continuous dialogue
with the global investment community. The corporation's top management regularly meets with
investors and brokerage analysts and these discussions provide an invaluable opportunity to share
knowledge and experience.
The IPO challenges Sistema and each subsidiary to meet and exceed their goals over the short-,
medium- and long-term. As a publicly listed corporation, Sistema's performance is judged by the
global investment community in comparison to other leading global players in the technology and
consumer services sector.
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Strategy
32 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
ANNUAL REPORT / 2005
TARGETS AND GOALSA careful balancing of quantitative and qualitative targets and goals allows Sistema to efficiently plan
the development of the corporation.
Quantitative Targets
The corporation provides precise quantitative and qualitative targets and goals for each business area
and for each employee. The use of key performance indicators (KPIs) provides personnel with a clear-
cut understanding of what the corporation expects of them. Sistema undertakes constant monitor-
ing of the performance of the corporation as a whole, as well as the activity of each business area.
For its business units, Sistema uses a measure of performance called the Criteria Base. This system
consists of key efficiency indicators that measure the performance of each business unit. These indi-
cators allow the corporation to evaluate how each business unit is progressing toward meeting its tar-
gets and goals. These indicators provide detailed measures of the efficiency and growth dynamic in
each business area.
Along with the Criteria Base, the activity of the corporation is regulated by the budget, which is the
fundamental element of yearly planning. Quantitative goals placed before the business areas are for-
mulated against the most aggressive scenario of development: only in this way is it possible to main-
tain leadership in fast-growing, highly competitive consumer markets.
Quantitative Goals
DiversificationThe corporation's goal is to grow the share of non-telecommunications assets in aggregated revenue,
OIBDA and profit. Significant progress was made in certain business areas in 2005. The Technology
area represented 12.7% of total revenues in 2005, compared to 8.7% in 2004. Retail increased its share
year-on-year from 1.4% to 2.7%. This diversification allows greater exposure to fast-growth markets
and limits the impact of any future negative developments in the telecommunications segment.
Predictable cash flowsSistema's cash flows have been difficult to predict as the corporation has entered fast-growing mar-
kets. However, in the last three years, the corporation has undertaken asset restructuring and M&A
activity that now permits the prediction of the contribution from each business area with a high
degree of precision.
Financial stability Sistema's long-term financial stability is built on prudent financial management and tight limits on
level of debt. Due to this policy, Sistema has acquired the ability to raise financing on the most attrac-
tive terms.
LeadershipSistema’s mission is the development of market-leading businesses. The corporation has undisputed
leadership in its key Telecommunications, Technology, Insurance and Retail business areas. The goal
of the corporation is for each remaining business area to achieve leadership in its respective market.
Corporate cultureThe corporation fosters a team-based management culture where key executives share agreed tech-
niques and methodology.
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Risks
33
SISTEMA
RISKSThe consumer sectors of Russia and the CIS, where the corporation conducts its core business, have
grown impressively in recent years. Nonetheless, the sector carries with it substantial risks that may
affect the pace of development at the corporation's subsidiaries. Therefore, the evaluation and man-
agement of these risks is an important element in the strategy of Sistema. This approach allowed
Sistema to endure the 1998 Russian financial crisis with minimal losses.
The risks which could affect the corporation's business are diverse. These risks reflect the emergence
of processes and factors beyond the control of Sistema.
A Slowing in Russian Growth Rates
GDP growth rates in Russia and the CIS significantly outpace those in the US and Western Europe.
High oil prices on international markets continue to be the largest single factor fuelling Russia's cur-
rent economic growth. This growth has led to higher real and disposable spending power among
Russian consumers and driven demand for the services provided by Sistema's subsidiaries. A substan-
tial fall in world oil prices could cause economic growth to falter. The subsequent drop in consumer
spending power could have a negative impact on the corporation's activities.
Economic Stability in the CIS
As the share of revenues generated by Sistema's activities in the CIS increases, the corporation is also
exposed to economic risks in these markets. Market reforms in these countries have been carried out
to varying degrees and, like Russia, several CIS economies are exposed to the risk of a decline in world
prices for oil and gas.
Political Risks
Russia still has a number of political groups that do not share the current government's approach to
the market economy and current reforms. Should those groups be able to wield greater influence over
government policy, this could pose a risk to the economy and the status of private-sector companies.
Similar risks exist in other CIS markets.
Exchange Rate Risks
Sistema faces exchange rate risks linked to changes in the value of the ruble, as well as the hryvnia
and the euro, to the US dollar. As a result of inflation in Russia and other markets where it operates,
the corporation links its monetary assets and transactions to the US dollar. Also, a significant share
of the corporation's capital expenditures and operating and borrowing costs are dominated in US dol-
lars. In Russia and Ukraine, many of the corporation's services are priced in US dollar equivalents.
Interest Rate and Other Borrowing Risks
Future changes in interest rates in Russia could substantially alter the cost of loans and raising addi-
tional capital. Sistema has a number of capital intensive businesses, and therefore changes in the cost
of borrowing could have a negative impact on the corporation. Also, if Russia's sovereign debt rating
were lowered, the corporate debt ratings of Sistema could be affected, making borrowing in interna-
tional debt markets more costly.
Investors, partners and other interested persons should consult detailed risk summaries for Sistema
contained in the Management's Discussion and Analysis of Financial Condition and Results of
Operations.
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ANNUAL REPORT / 2005
2CORPORATE GOVERNANCE
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SISTEMA
The status of public company requires Sistema to observe global standards of corporate governance.
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Corporate Governance
36 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
ANNUAL REPORT / 2005
STRUCTURE OF CORPORATE GOVERNANCE
Secretariat of the Board of Directors,
Corporate Secretary
Nominations and CompensationCommittee
Corporate GovernanceCommittee
Strategy Committee
Audit Committee
Investor Relations CommitteeStrategy & DevelopmentComplex
Finance and InvestmentsComplex
Property Complex
External CommunicationsComplex
Economic and InformationSecurity Complex
Science and InnovationComplex
Legal Department
Corporate Accountant
Department for InternalControl and Audit
Administrative Department
Finance and InvestmentsCommittee
Budget Commission
Shareholders
General Meeting of Shareholders
Chairman of the Board of Directors
President
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Structure of Corporate Governance
37
SISTEMA
Sistema's structure of corporate governance is constantly evolving. As the section on ”Principles of
Corporate Governance” demonstrates, innovation is integral to ensuring the corporation continues
to be a leader in the field of corporate governance, business transparency and disclosure about the
activity of the corporation. The Board of Directors believed it was vital to codify the essential prin-
ciples of governance of the corporation and its structure in the Code of Corporate Governance and
the Corporate Charter. This ensures that the corporation will continue to observe the highest stan-
dards of governance, as managers make decisions in accordance with prescribed rules.
The Code of Corporate Governance was approved by the Board of Directors in July 2004. This Code
does not contain general formulas and general ideas. Rather, it concretely and clearly formulates
the highest ethical requirements that the corporation has taken upon itself in its dealings with its
shareholders, managers, personnel and other key audiences. The full text of the Code is available,
along with other key normative documents, in English at www.sistema.com.
Sistema has developed and confirmed at the Board of Directors level the rules that establish a basis
for all management bodies, including the Annual and Extraordinary General Meetings of
Shareholders, the Board of Directors, President, Executive Management and the Audit Commission.
In addition, there are clear regulations in effect governing information disclosure, dividend policies,
procedures for internal control, the composition of Board-level committees, procedures for meetings
of the Board of Directors, management of risks, incentives for managers, procedures for the prepara-
tion and contracting of large transactions and corporate events.
The Board of Directors, subordinate to the General Meeting of Shareholders, is the key element in the
corporation's corporate governance system. It carries out five primary management functions: the
definition of the corporation's development strategy; placing these goals before executive manage-
ment and ensuring their execution; the efficient management of assets; the appointment of key
managers; and the continued improvement of corporate governance.
The development strategy consists of concrete tasks in accordance with precise quantitative and qual-
itative goals. For example, the corporation's portfolio strategy consists of a detailed list of business
areas and ratios which clearly define their level of diversification. The strategic goals of financial man-
agement goals are accompanied by qualitative indicators that characterize financial stability.
There is a list of senior management positions in the corporation and subsidiary companies that
requires the approval of the Board of Directors in order to receive the appointment.
The Board of Directors closely follows the results of all of Sistema's business areas while also over-
seeing their internal control and audit functions.
Five committees exist on the Board of Director level for addressing key issues affecting the corpora-
tion's development. These committees are: Strategy and Development, Audit, Appointments and
Compensation, Corporate Governance and Investor Relations. The Committee for Investor Relations
was established in 2005. Its creation reflects the efforts of the corporation to constantly improve
the norms and procedures of corporate governance.
Information disclosure is another primary value for Sistema. The corporation aims to disclose infor-
mation about its activities in a regular and timely manner to all of its stakeholders. The corpora-
tion's websites (in both English and Russian) provide the company’s latest operational and financial
news releases, as well as comprehensive details about the management of the company. At the same
time they are posted on the site, news releases are simultaneously disclosed in English and Russian
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Corporate Governance
38 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
ANNUAL REPORT / 2005
via the main news information systems and other disclosure systems mandated by stock exchange
listing rules. In addition, the corporation aims to ensure that it makes all necessary filings with the
relevant organizations regulating the securities markets.
As a result of the IPO on the London Stock Exchange in February 2005, Sistema has acquired a large
number of new shareholders in different countries around the world. Because of this, issues of inter-
action with shareholders have required ever greater attention from the corporation. The corporation
aims to create conditions that are conducive for shareholder participation in the management of the
company. The corporation uses specialized international and domestic agencies to research the com-
position and structure of its shareholder base. This allows the corporation to find new ways to keep
shareholders informed of the latest developments and is especially important for providing com-
plete information about issues on the agenda of Annual General Meetings. Also, during regular
investor ”roadshows” following results announcements, management has the opportunity to meet
with a number of investors. These meetings are another important way of ensuring continued dia-
logue between management and current and potential investors.
The dividend policy of the corporation is coordinated with the investment policy so that sharehold-
ers can extract maximum profit from increases in the value of the company while Sistema and its
businesses are provided with long-term investment.
In 2005, Sistema's Board of Directors approved an Ethical Code which supplements and provides fur-
ther clarification of the rules described in the Code of Corporate Governance. The corporation is con-
stantly improving its governance structure in accordance with new goals that appear before the
business. But the basic principles and values of its fundamental documents are intrinsic parts of
Sistema's success story and they will not change.
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Principles of CorporateGovernance
39
SISTEMA
PRINCIPLES OF CORPORATE GOVERNANCE The structure of Sistema's corporate governance, described in the previous section, is defined by the
company's charter. But the fundamental principle of corporate governance at Sistema is innovation.
Corporate governance is not a static concept. Rather, it evolves along with legislation and is led by
the expectations of the Russian and international investment community and changes in Russian
legislation. Sistema is committed to transparency and continually improving communications with
its investors. Innovation also means regular changes in personnel on both the Board of Directors and
in executive management to bring in fresh ideas and practices.
Innovation in corporate governance means that the requirements the corporation sets for itself will
always be stricter than accepted practice. Sistema's goal is to set an example for other companies in
its field. Corporate governance became an area of considerable attention in the Russian business
world about five years ago. Even then, Sistema was a leader in many areas according to many param-
eters. The corporation introduced high standards of corporate governance in advance of accessing
international financial markets. But the main factor was the belief among Sistema's leaders that
adherence to the standards of civilized corporate governance increased the efficiency of the com-
pany. Openness allowed shareholders, business partners, regulators and employees to offer feed-
back. This process in turn led to a productive exchange of views which drove further improvements
in the structure of governance.
Following the principles of transparency in conducting business, the corporation has prepared con-
solidated financial reporting according to US GAAP standards since 1997. These accounts are audit-
ed by one of the leading international accounting firms, Deloitte & Touche. In 1997, Sistema also
appointed its first independent director. In 2001, the Board of Directors created its first oversight
committee. The Committee for Strategic Development was required because of the corporation's
rapid rate of growth. In 2002, the corporation disclosed the names of its main shareholders. In 2003,
Sistema created an International Advisory Council at the Board level, in recognition of the fact that
the corporation’s innovative business would lead it to develop actively beyond Russia's borders.
All of these moves would eventually be required for the corporation's IPO. Putting these elements
into place long before they were required by Russian legislation built trust in the corporation among
potential investors and regulators. It also made the preparation for the IPO much more straightfor-
ward and required less time. Sistema's efforts in improving its corporate governance received recog-
nition at the beginning of 2005 when the Russian Institute of Directors and Expert RA assigned
Sistema a national rating of ”B++.” At the end of 2005, the corporation's rating was reviewed and
raised to the level ”A.”
In 2005 and 2006, the Board of Directors appointed two new independent directors. In June 2005,
Ron Sommer was appointed. He formerly served as Chairman of the Board of Deutsche Telekom,
which was a shareholder of Sistema's Mobile TeleSystems subsidiary. Mr. Sommer brings invaluable
experience in running a global telecommunications business as well as considerable experience in
Russia. Stephan Newhouse, a former president of Morgan Stanley, joined the Board of Directors later
that year. Mr. Newhouse brings the very highest level of expertise in preparing, structuring and exe-
cuting large, cross-border transactions, as well as profound expertise in financial management.
In 2006, Sistema implemented a number of important management changes. These changes reflect
the corporation's long-standing practice of appointing and rotating key executives when the com-
pany enters a new stage of development.
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In February 2006, Vladimir Evtushenkov, who had served as President of the corporation, was elect-
ed Chairman of the Board of Directors. Alexander Goncharuk, who served as President of Sistema
Telecom and the CEO of SITRONICS from 2003 to 2006, was appointed President of Sistema. In addi-
tion, the corporation undertook a number of major appointments in strategic business areas. Sergey
Shchebetov was appointed CEO of Sistema Telecom. Alexander Gorbunov was appointed Acting First
Vice-President, Head of Strategy and Development of Sistema. Evgeny Utkin was appointed CEO of
SITRONICS and Mikhail Dunaev was appointed CEO of Sistema Mass Media.
In April 2006, Mobile TeleSystems appointed Leonid Melamed as MTS' acting President and CEO.
Mr. Melamed previously served as General Director of the ROSNO Insurance Group. He has been replaced
in that role by Levan Vasadze, previously First Vice President and Head of Strategy and Development at
Sistema. Vsevolod Rozanov, who previously served as Chief Financial Officer of Comstar-UTS, was moved
over to the same post at MTS. In July 2006, Maxim Entyakov took the post of CEO of Detsky Mir Center.
Corporate Governance
40 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
ANNUAL REPORT / 2005
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CREDIT RATINGSSistema conducts a policy of prudent financial management at both the corporate and subsidiary
level. This policy ensures the long-term financial stability of the corporation. Such stability is meas-
ured by the main international ratings agencies and these ratings play a major role in the corpora-
tion's ability to obtain external financing. Ratings agencies consider a number of key factors in
determining the financial stability of the corporation, including total debt, current obligations,
existing liquidity and future liquidity needs and cash flow. Ratings may also be viewed as an out-
side evaluation of the corporation's overall strategy and its position versus its rivals in core business
areas. Ratings also take into account corporate governance structures in place and protection for
minority shareholders.
The following credit ratings had been assigned as of the end of June 2006 for the corporation:
Issuer Ratings Agency Date Assigned Rating Outlook
Sistema S&P 24 March 2005 ВВ- Stable
Sistema Fitch 28 April 2006 В+ Positive
Sistema Moody's 19 November 2003 В1 Stable
In addition, the credit ratings of subsidiary companies also play a major role. They reflect an assess-
ment of the creditworthiness of a subsidiary and the ability of each subsidiary to raise capital.
Issuer Ratings Agency Date Assigned Rating Outlook
MTS Moody's 10 November 2001 Ba3 Stable
MTS S&P 24 March 2005 ВВ- Stable
SITRONICS Fitch 14 February 2006 В- Stable
SITRONICS Moody's 16 February 2006 В3 Stable
MGTS S&P 24 March 2005 ВВ- Stable
MGTS Moody's 20 January 2006 Ba3 Stable
МBRD Moody's 15 December 2004 В1 Stable
MBRD Fitch 14 April 2006 В Stable
Credit Ratings
41
SISTEMA
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ANNUAL REPORT / 2005
3CORPORATE INFORMATION
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SISTEMA
Transparency in ownership structure and governance is a foundation of our business.
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CorporateInformation
44 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
ANNUAL REPORT / 2005
GENERAL INFORMATION Sistema Joint Stock Financial Corporation was registered at the Moscow Registration Chamber on
July 16, 1993. The corporation is registered at Prechistenka Street 17/8/9, Building 1, Moscow,
119034, Russian Federation.
The charter capital of the corporation is 868,500,000 rubles and consists of 9,650,000 ordinary shares
with a nominal value of 90 rubles.
Sistema's shares are listed on the London Stock Exchange in the form of global depositary receipts
(GDRs) under the symbol ”SSA.” Fifty GDRs represent one ordinary share.
Sistema's shares are included in the ”B” List of the Russian Trading System, under the symbol
”AFKS.” In 2004, Sistema's shares were also included in the ”B” list of the Moscow Stock Exchange
(MSE) under the ticker ”SIST.”
As of the end of 2005, a number of debt obligations issued by subsidiaries of the corporation traded
on the financial market:
Currency Annual interest rate ($, thousands)(Actual as of December 31, 2005) 2005 2004
Sistema Capital Notes USD 8.9% 350,000 350,000
Sistema Finance Notes USD 10.3% 349,285 348,808
MTS Finance Notes due 2012 USD 8% 399,052 –
MTS Finance Notes due 2010 USD 8.4% 400,000 400,000
MTS Finance Notes due 2008 USD 9.8% 400,000 400,000
MBRD Bonds USD 8.6% 150,000 –
MGTS Bonds RUR 8.3%–10.0% 104,230 90,094
Detsky Mir Center Bonds RUR 8.5% 39,954 –
Micron Bonds RUR – – 6,293
Total Corporate Bonds 2,192,521 1,595,195
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SHAREHOLDER STRUCTURE The graph presented below indicates the shareholding structure of Sistema as of March 30, 2006.
At that time, the corporation had 30 registered shareholders, including 25 direct owners and 5 nom-
inees. The identities of the corporation's GDR holders are generally not reported to the corporation.
However, the corporation undertakes a regular procedure of researching the identity of its share-
holders. This allows Sistema to provide as much information as possible to the largest number of
shareholders.
Shareholder Structure
45
SISTEMA
0.2% S. Drozdov
2% A. Goncharuk
3% E. Novitsky
V. Evtushenkov 62.1%4.4% Others
19% GDR holders
2.1% Zelnik Holdings Limited V. Kopiev 0.1%
A. Gorbatovsky 2.4%
D. Zubov 1.3%
A. Leiviman 3.4%
Shareholder Structure
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CorporateInformation
46 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
ANNUAL REPORT / 2005
SHARE PRICE PERFORMANCEOn February 9, 2005, Sistema completed the initial public offering (IPO) on the London Stock Exchange of16.5% of its shares in the form of 79.6 million global depositary receipts (GDRs). The IPO book was 2.6 timesoversubscribed and raised $1.35 billion. Sistema's GDRs are listed on the London Stock Exchange under thesymbol ”SSA.” Fifty GDRs represent one ordinary share.
Following the exercise of an overallotment option by Credit Suisse First Boston and Morgan Stanley, theglobal coordinators of the offering, for the sale of 11,945,000 additional shares, or an additional 2.5% ofSistema's shares, the total free float of the corporation's shares reached 19%, and the total funds raised were$1.56 billion.
Previously, in October 2004, the Russian Federal Securities Market Commission had approved the inclusionof Sistema's ordinary shares on the quoted lists of the RTS and the Moscow Stock Exchange (MSE). Sistema'sshares were included in the ”B” List of the Russian Trading System at the end of October, under the symbol”AFKS.” In November 2004, Sistema's shares were included in the ”B” list of the Moscow Stock Exchange(MSE) under the ticker ”SIST.” Until mid–2005, however, trading liquidity was relatively limited on Russianexchanges. Following the start of active trading in June 2005, Sistema's ordinary shares were included inthe MSE index.
In May 2005, Morgan Stanley Capital Investment (MSCI), a leading investor in international capital marketsand provider of financial market ratings, announced the inclusion of Sistema's GDRs and MobileTeleSystems's American depositary receipts (ADRs) in its index.
On February 9, 2005, the first day of trading, Sistema's GDRs shares closed at $17.45. On the last day of trad-ing of the year, the shares closed at $23.50. The shares reached a yearly high of $26.75 on October 4, 2005.The shares followed a strong upward dynamic over the course of the year, linked to both the company's per-formance and broader optimism about the Russian economy. Sistema, as one of the few internationally list-ed Russian consumer sector entities, has seen its share price fluctuate in response to broader political andeconomic news regarding the country.
The corporation is covered by analysts from a number of Russian and international investment banks. A listof covering analysts, including contact details, is published on www.sistema.com and regularly updated.
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25
30
02.0501.05 03.05 04.05 05.05 06.05 07.05 08.05 09.05 10.05 11.05 12.05
$
Sistema GDR price performance
g / / g
ASSET STRUCTURE The table below outlines Sistema's participation in the capital of its largest subsidiary and affiliated
structures and its voting interests as of December 31, 2005. The corporation's asset structure has
changed significantly in recent years in line with Sistema's strategy of restructuring and consolidating
its ownership in key subsidiaries. The table reflects the completion of restructuring at SITRONICS in the
Technology segment at the end of 2005. It should be noted that Sistema's beneficial ownership and vot-
ing interest in Comstar-UTS, following the IPO of Comstar-UTS on the London Stock Exchange in
February 2006, fell to 59%.
Segment Company Beneficial VotingOwnership Interest
Main Business Areas
Telecommunications MTS and subsidiaries 53% 53%
Comstar-UTS and subsidiaries 100% 100%
Sky Link 50% 50%
MTT 43% 50%
Technology SITRONICS and subsidiaries 78% 78%
Insurance ROSNO and subsidiaries 49% 51%
Banking MBRD 95% 99%
East-West United Bank 49% 49%
Real Estate Sistema-Hals and subsidiaries 100% 100%
Retail Detsky Mir 75% 75%
Detsky Mir Center and subsidiaries 100% 100%
Media Sistema Mass Media and subsidiaries 100% 100%
Tourism Intourist and subsidiaries 72% 72%
Radio and Space Technology RTI Systems and subsidiaries 100% 100%
Other Businesses
Pharmaceuticals Medical Technological Holding 67% 67%
and Biotechnology
Medical Services MEDSI 69% 74%
Financial Investments
Oil Business Bashneft 21% 25%
Ufimsky NPZ 22% 26%
Novoil 26% 28%
Ufaneftekhim 18% 22%
Ufaorgsintez 22% 25%
Bashnefteproduct 17% 19%
Asset Structure
47
SISTEMA
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ANNUAL REPORT / 2005
4SOCIAL RESPONSIBILITY
g / / g
SISTEMA
We see the creation of anew quality of life as ourresponsibility to society.
g / / g
Social Responsibility
50 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
ANNUAL REPORT / 2005
PRINCIPLES OF SOCIAL RESPONSIBILITY The principles of social responsibility are central to Sistema's business. This year, the corporation is
publishing its first-ever comprehensive Social Responsibility Report. This section represents a brief
overview of Sistema's important ongoing work in this area.
We believe that the most effective social investment depends on the harmonious combination of the
interests of business and society. Sistema links its social activities with the goals of the corporation,
its mission and business strategy. The main social programs of Sistema rely on technological leader-
ship and are directed toward the creation of a new quality of life.
We invest resources in science-led projects and invest funds in science and education, innovative
structures and the introduction of new technologies. The activity of the corporation enables the
transition of the Russian economy from one based on raw materials to one based on services. This
leads to qualitative changes in the standard of living for society as a whole and for each citizen.
Consequently, Sistema integrates the principles of corporate social responsibility into its practices.
Sistema understands corporate social responsibility as its position on a range of economic and social
issues facing Russia and the world today. Social responsibility, in the broadest understanding of the
term, means fulfilling obligations before its customers, business partners, employees and the citi-
zens of the towns, regions and countries where the corporation does business.
Social responsibility toward employees means, in particular, providing them with additional bene-
fits. Voluntary pension contributions and medical insurance provide employees and their families
with faith in the future. The responsibility of the corporation to its partners is reflected in the
observance of the highest principles of business ethics. Working with Sistema, representatives of the
international business and investment communities see a Russian partner demonstrating the high-
est levels of business conduct.
The corporation takes the impact of its activities on the surrounding communities and environment
into account and is constantly working on appropriate procedures to deal with these aspects of its
business. Sistema is convinced that new technology is crucial in dealing with the many issues sur-
rounding Russia's economic growth in an efficient and ecologically friendly way. The creation of effi-
cient Russian technologies also creates the opportunity to develop new industries and export the
country's know-how.
At Sistema, particular attention is paid to supporting education and scientific research in Russia.
This is part of the company's strategy for developing innovation. The activities of the corporation
contribute to the diversification of the Russian economy and reduce dependence on the oil and gas
sectors. Sistema is working in cooperation with government and charitable and private-sector
organizations to create an environment for innovation and to ensure Russia's participation in glob-
al technological development. At the corporate level, this means an increase in the number of
skilled workers as well as the introduction of technologies that will create new businesses and con-
sumer markets for Sistema's products.
g / / g
Principles of SocialResponsibility
51
SISTEMA
Sistema has adopted internationally recognized principles of sustainable development and corporate
social responsibility and integrates them into its business practices. In 2002, the corporation became
one of the first companies in Russia to sign the Global Compact of the United Nations (UN-GC).
In 2003, Sistema joined the World Business Council for Sustainable Development (WBCSD). As with
other WBCSD members, the corporation has committed itself to maintain a high level of transparen-
cy and responsibility in all aspects of its business. Within Russia, Sistema works in partnership with
government bodies to develop procedures and standards in a range of areas, from human resources
to providing a helping hand to the less fortunate.
The directors and management of Sistema invite readers to read carefully through the corporation's
Social Responsibility Report to learn more about the company's strategy in this area, its achieve-
ments in 2005 and its plans for the future.
g / / g
ANNUAL REPORT / 2005
5BUSINESSES
_ _ g / / g
SISTEMA
The core assets ofSistema are concentratedin dynamically developing sectors of the economy.
_ _ g / / g
Businesses
54 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
ANNUAL REPORT / 2005
DYNAMICThe consolidated revenues of the Sistema Telecom business area grew by 27.6%to $5.89 billion in 2005, outpacing the market for the fifth year in a row.
MTS remains number onemobile telephony provider in Russia and the CIS. Itsnumber of subscribers grewby 24 million in 2005.
FOCUS OF THE YEARComstar UTS concluded theconsolidation of assets andoccupied the leading positionin the fixed-line market.
Sergey Schebetov
CEO, Sistema Telecom
_ _ g / / g
Telecommunications
55
SISTEMA
TELECOMMUNICATIONSMarketplace
The telecommunications market remains one of the most dynamic sectors in the Russian economy.
The sector's significant growth potential is apparent in all key sectors of the telecommunications busi-
ness. For example, Russian mobile telephony penetration in 2005 stood at 78% compared to 96%
in Western Europe. Fixed-line penetration was 24% compared to the Western European level of 47%.
Internet penetration stood at just 8% compared to 52% in Western Europe and broadband penetration
was 2% compared to 29%1.
According to data from the Russian Ministry of Information Technologies and Communications, the total
volume of the Russian telecommunications market grew 24% in 2005 to $23.3 billion. Markets in the
CIS countries are also creating new prospects for development in an environment of rapid economic
growth and relatively low penetration of telephony services. However, the market continues to see
strong competition in both the wireless and fixed-line sectors and continuous innovation is required
to win and retain market leadership.
Business
Sistema's strategy is focused on long-term leadership in the telecommunications market. Sistema
Telecom, the management company in the Telecommunications business area, is developing busi-
nesses in all of the main segments of the communications market: fixed and mobile telephony,
internet, data exchange and transit traffic.
Wireless CommunicationsMobile TeleSystems (MTS) is Sistema's largest asset in the wireless communications market and the
leading cellular operator in Eastern Europe. MTS is one of the top-10 companies in the world in terms
of subscriber numbers. The company is present in Russia (its share in value terms is 35%2)
Turkmenistan, Ukraine and Uzbekistan. At the end of 2005, MTS had a consolidated subscriber base
of 58.2 million, 24 million of which were new subscribers added during 2005. 17.7 million of these
subscribers were added in Russia.
Sistema is MTS's largest shareholder, with 52.8% of its shares. The company is listed on the New York
Stock Exchange and has a freefloat of 46.7% of its shares. Deutsche Telekom, formerly one of the
largest shareholders of the company, sold its remaining 10.1% shareholding in 2005. The move has
enhanced the liquidity of MTS's shares in Russia.
Fixed-LineComstar-UTS is Sistema Telecom's integrated holding which manages the fixed-line business area
of Sistema. In addition, following the merger of a number of Moscow-based alternative fixed-line
operators controlled by Sistema, these carriers now operate under the Comstar-UTS brand.
At the end of 2005, Sistema restructured its assets in the fixed-line segment. As a result of this
restructuring, Comstar-UTS gained a controlling stake in Moscow City Telephone Network (MGTS)
and MTU Intel. Following the restructuring, Comstar-UTS became the market leader in the fixed-line
segment, providing a full range of telecommunications services. MGTS provides fixed-line services
1 Source: Pyramid research; mobile and fixed-line figures for September 2005, Internet and broadband figures for 1H 20052 Source: AK&M, as of end of Q3 2005
_ _ g / / g
and a line of high-value residential services is being developed under the Stream brand and Comstar-UTS
services corporate clients.
MGTS is the largest operator in Moscow with a number capacity of more than 4.3 million. It is one
of the largest fixed-line operators in Europe. The company operates in an environment of regulated
tariffs (which grew 17% in 2005) and MGTS is continually upgrading its network infrastructure.
MTU-Intel is a provider of broadband multi-service networks and pay TV. The broadband internet
access business has more than 283,000 clients and 14,000 television subscribers. The company
launched an in-house entertainment offering under the Stream brand in mid–2005, with more than
100 television channels, pay-per-view, gaming and other options.
Results
Consolidated revenues in the Telecommunications segment grew by 27.6% to $5.89 billion in 2005.
The level of sales growth outpaced the overall rate of the telecommunications market for the fifth
year in a row. To further strengthen this capacity, the corporation undertook a wide-scale restruc-
turing of its fixed-line assets, turning Comstar-UTS into the market leader. The restructuring
allowed Comstar-UTS to undertake a successful initial public offering on the London Stock Exchange
in February 2006, raising $1 billion for the further development of the company.
At MTS, dynamic revenue and earnings growth, international expansion and maintenance of market
share were accompanied by ongoing restructuring aimed at buying out minority shareholders in sub-
sidiaries and transformation of subsidiaries into affiliates.
MTS was the primary contributor to revenue growth in the Telecommunications segment of Sistema.
Subscriber growth in Russia and the CIS was the main revenue driver. Total subscriber numbers grew
from 34.2 million at the end of 2004 to 58.2 million at the end 2005. MTS's consolidated revenues
increased by 28% year-on-year to $5.01 billion, compared to $3.92 billion in 2004. Net income
increased by 14% to $1.13 billion in 2005. In May 2005, the company announced a dividend recom-
mendation of 5.75 rubles per ordinary share (approximately $1.03 per ADR) or approximately 40%
of its 2004 net profit under US GAAP.
Comstar-UTS's consolidated revenues increased by 31% year-on-year to $907.6 million for the full
year, compared to $695.1 million in 2004. This growth was primarily organic, with businesses
acquired during the year contributing $32.6 million to revenues in 2005. Net income increased by
39% year-on-year to $105.9 million. At the end of 2005, Comstar-UTS had a 28.6% share of the
Moscow telecom market, serving 4.8 million lines and 41% of the Moscow residential broadband
market.
The corporation sees the growth of the share of non-telecommunications assets as a long-term strat-
egy. However, in order to diversify exposure to a range of fast-growth consumer segments, the
Telecommunications business area remains a vital part of the corporation. The segment's share of
the corporation's aggregated revenues decreased to 77.6% in 2005 from 80.5% in 2004. This was due
to accelerated organic growth and significant acquisitions in other business areas.
The accomplishments of 2005 and early 2006 set the stage for the rollout of a new brand identity
uniting Sistema's telecommunications businesses. The new brand is aimed at all target audiences,
including clients, employees and investors. The graphic symbol of the brand is an egg, symbolizing
unity and universality, hope, trust, growth and innovation. The brand is intended to create a single
Businesses
56 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
ANNUAL REPORT / 2005
_ _ g / / g
face for the telecommunications area of Sistema and ensure that it is clearly identifiable in the mar-
ketplace. The brand should become a symbol of quality of service in the eyes of consumers, person-
nel and the investment community.
Telecommunications
57
SISTEMA
0
2,000
4,000
6,000
0
1,000
2,000
3,2
47
.6 4,6
16
.7 5,8
92
.9
1,1
03
.3 1,6
30
.3
1,9
33
.3
FY 2003 FY 2004 FY 2005
FY 2003 FY 2004 FY 20050
5,000
10,000
5,2
04
.7
7,1
86
.3 9,6
96
.7
FY 2003 FY 2004 FY 2005
Revenues$5,892.9 million
Operating Income$1,933.3 million
Assets$9,696.6 million
Employees1
47,500
Revenues
Operating Income Assets
Key Figures
1 Source: DirectInfo, Comstar-UTS
_ _ g / / g
Businesses
58 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
ANNUAL REPORT / 2005
DYNAMICRevenues in the Technologybusiness area increased by93% year-on-year, reaching$961.1 million.
FOCUS OF THE YEARThe Technology business areaexpanded its presence in theglobal marketplace, with oper-ations distributed acrossCentral and Eastern Europe.
SITRONICS consolidated itsownership in key subsidiaries.
Evgeny Utkin
President, SITRONICS
_ _ g / / g
TECHNOLOGY Marketplace
Sistema's Technology business is represented by SITRONICS, which is decisively moving into fast-grow-
ing markets for high-tech products and solutions. During 2004 and 2005, these segments experienced
dynamic growth, demonstrating their considerable potential.
Telecommunications EquipmentThe volume of the Russian market for telecommunications equipment was $3.35 billion in 2004,
according to research by consultancy J'son and Partners. This amount includes only equipment and
assemblies for telecommunications operators and excludes sales to other businesses and end users.
Sales of equipment to wireless communications providers accounted for 58% of the market and the
remainder was accounted for by sales of equipment for fixed-line and OSS/billing.
Information TechnologyRussia's information technology (IT) market was estimated to have grown by 35.2% to $9.57 billion
in 2004, according to market research group IDC. IDC also estimates that the average annual growth
rate of the IT-services market will be 24.5% between 2005 and 2009, growing to $5.7 billion.
Microelectronic ComponentsThe global market for microelectronics continues to recover from the sharp fall in sales in the sector seen
in 2001 and 2002. According to data collected by World Semiconductor Trade Statistics, the world market
for semi-conductors grew by 28% in 2004 to $213 billion, compared to $166 billion in 2003. Evaluations
published by Electronics Publishing House show that the Russian market for microelectronics continues
to outpace global growth rates, posting annual growth of 18% to 20%. The largest consumers of micro-
electronic components in the Russian market are producers of industrial electronics, communications
equipment makers and the defense industry.
Consumer electronicsInternational research and consulting company Strategy Analytics estimates that global demand for
flat-screen televisions increased by 66% to 17.5 million units in 2005. According to Russian research
group IT Research, sales of LCD televisions in Russia reached 102,800 units in Q2 2005 and 164,000 units
in Q3 2005, worth $102.2 million and $167.0 million in value terms respectively.
Sales of plasma televisions in Q2 2005 were 20,600 units and 35,000 units in Q3 2005, worth $72.9
million and $109.9 million in value terms respectively.
Looking at the market for GSM and CDMA devices, Russian market research company
RosBusinessConsulting estimates the Russian market was worth $5.5 billion in 2005. Marketing group
Sotovik calculates that the volume of the GSM market surpassed 36 million units in 2005, with a value
of $5.7 billion.
Business
SITRONICS’ goal is to become the largest high-technology enterprise in Russia, the CIS and Eastern
Europe. It seeks to do this through both organic growth and strategic mergers and acquisitions. The
optimal combination of these two tactics will strengthen its position in Russia while driving expansion
in international markets. In order to achieve its long-term goals, SITRONICS has concentrated its
efforts on four key business areas: the development of solutions for New Generation Networks (NGN)
Technology
59
SISTEMA
_ _ g / / g
for telecommunications operators, systems integration, the production of smartcards and microchips
and the further development of its SITRONICS umbrella brand for consumer electronics.
The development of telecommunications hardware and software solutions takes place under the Strom
Telecom brand and it accounts for around 25% of sales in the Technology business of Sistema. The cor-
poration is developing this area further through acquisitions and strategic alliances with leading inter-
national equipment manufacturers. SITRONICS is also concentrating on the expansion of its sales
beyond Russia. The development of its products in Russia and Eastern Europe give it a major competi-
tive advantage due to lower production costs and proximity to consumers of service infrastructure.
SITRONICS's systems integration business is built around the base of the Ukrainian group Kvazar-Micro,
51% of which was acquired by the corporation in 2004. Kvazar-Micro has operations in several Central
and Eastern European countries. The company has solid potential for building strong market share in
the systems integration business in Russia, the CIS and Eastern Europe. SITRONICS aims to turn Kvazar-
Micro into the leading IT company in Central and Eastern Europe with a focus on high-margin services
such as systems integration and consulting.
The microelectronics division of SITRONICS is based in Zelenograd, where production capacity and
skilled engineering and technical personnel are concentrated. SITRONICS is strengthening its position
in the domestic market as a leading supplier of solutions for the defense industry and other sectors.
SITRONICS is strengthening its position in the Russian Smart-Card market, with the aim of diversifica-
tion of production and increasing profitability.
In the consumer electronics field, SITRONICS has made considerable progress in cutting production
costs and increasing the price competitiveness of its products. However, its business is not just about
cost competition and it continues to enhance its R&D capacity in this division. Strategic partnerships
with outside electronics producers provide another way to combine a competitive advantage in price
with leading-edge global technology.
Results
In 2005, corporation dramatically demonstrated its ability to restructure and integrate newly
acquired assets into an existing business to create a market leader in an innovation-driven business
environment. The Technology segment was one of Sistema's fastest growing business areas in 2005.
Revenues grew 92.8% year-on-year to $961.1 million in 2005 compared to $498.4 million in 2004
with OIBDA more than tripling year-on-year to $155.6 million.
Systems integration accounted for 49.1% of revenue in the Technology segment during 2005.
The volume of IT services rose 60.1% to $472.0 million in 2005 from $293.5 million a year earlier.
The Consumer Electronics subdivision saw turnover more than triple to $188.0 million in 2005 from
$51.6 million in 2004. The microelectronic solutions business reported 10.6% year-on-year revenue
growth to $59.6 million. Revenues from the info-communications business of SITRONICS grew
by 105.5% in 2005 and amounted to $246.6 million.
Outside of its core business areas, SITRONICS continued to develop its promising Integrated Security
Systems division. The division includes Videofon, which contributed $6.4 million in revenues to the
Technology segment.
During 2005, the corporation strengthened its ownership in key Technology divisions as part of its
strategy of buying out minority interests and strengthening vertical ownership and management
structures in its core businesses. Sistema increased its shareholding in Strom Telecom to 100% dur-
ing the year. Sistema also purchased a further 53% equity stake in Kvant, a personal computer and
components maker, concentrating 88% of the shares in the enterprise in its hands.
Businesses
60 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
ANNUAL REPORT / 2005
_ _ g / / g
Technology
61
SISTEMA
1 As of August 1, 2006
0
500
1,000
-30
0
30
60
90
120
150
85
.9 49
8.4
96
1.1
-3.4
45
.9 14
3.5
FY 2003 FY 2004 FY 2005
FY 2003 FY 2004 FY 20050
300
600
10
3.6
30
6.2
56
1.6
FY 2003 FY 2004 FY 2005
Revenues$961.1 million
Operating Income$143.5 million
Assets$561.5 million
Employees1
10,500
Revenues
Operating Income Assets
Key Figures
_ _ g / / g
Businesses
62 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
ANNUAL REPORT / 2005
DYNAMICIn 2005, revenues in theInsurance business area grewby 36.2%, reaching $408.9 million.
The volume of non-life premiumsgrew by more than 40% during2005.
In 2005, ROSNO delivered growthat twice the rate of the marketas a whole.
FOCUS OF THE YEARROSNO was the first company inthe Russian market to offer itsclients full accompaniment onthird-party liability insurance(OSAGO).
Levan Vasadze
CEO, ROSNO
_ _ g / / g
INSURANCEMarketplace
Insurance has been one of the fastest growing sectors of the Russian economy in recent years.
Between 2003 and 2005, total premiums grew to $17.33 billion from $14.14 billion, according to data
from the Russian Federal Service for Insurance Oversight (FSIO). Today the insurance industry
accounts for approximately 3.0-3.5% of Russia's gross domestic product. Compared to ratios in
Central and Eastern European markets, as well as to Western Europe, the market has enormous fur-
ther potential. Russia's rapid economic growth is stimulating demand from companies and organi-
zations for a wide range of insurance products. At the same time, the retail sale of policies to indi-
viduals is also growing rapidly. Still, it is difficult to precisely measure the size of the insurance mar-
ket because of the presence of ”pseudo-insurance” schemes that are aimed at optimizing tax pay-
ments and not actually presenting insurers with any actuary risk.
In 2005, the insurance market began to consolidate, as regulators imposed a tighter legal framework
and revoked licenses from companies that did not meet charter capital requirements. Currently,
1,073 insurance companies are active in the market. Ten companies accounted for 57% of all premi-
ums, excluding mandatory medical insurance, according to FSIO data for 2005.
Business
ROSNO represents the business of the corporation in the insurance sphere and is one of the largest
players in the market. As a market leader, it can only benefit from the consolidation process.
ROSNO's regional network is made up of 100 affiliates united by 10 territorial directorates. More
than seven million people and more than 50,000 enterprises and organizations use ROSNO insurance
products. For the last several years, the company has consistently been one of the leaders of the
insurance market. Voluntary medical insurance, mandatory automobile and KASKO insurance and
property insurance historically have been the largest contributors to gross premiums written.
ROSNO provides more than 100 types of obligatory and voluntary insurance. The company’s strate-
gy envisions the further strengthening of its leading position and an increase in the company's
share of the insurance market by providing clients with high-quality service. ROSNO is a successful
example of international partnership for Sistema. Allianz AG, a leading German insurer, holds 47.2%
of ROSNO’s shares. In 2004, Allianz and Sistema launched two new joint projects: Allianz ROSNO
Asset Management and Allianz ROSNO Life Insurance.
ROSNO has extensive mandatory reinsurance protection in place to manage risks. Partners of the
company in reinsurance include Allianz, Hannover Re, SCOR, Munich Re, Swiss Re and Russia’s largest
reinsurance companies. ROSNO also works with the broking agents of Lloyd's corporation. Russia's
Expert RA rating agency has awarded ROSNO the top A++ rating for four consecutive years.
Results
In 2005, the Insurance segment's main financial and operational indicators confirmed ROSNO's
strong position in the insurance market. Company revenues increased by 36.2% year-on-year to
$408.9 million in 2005, from $281.6 million (this excludes the operations of subsidiary company
Leader, which was sold in December 2005). Gross premiums jumped 26.1% year-on-year to $463.4
million, from $367.6 million. ROSNO's net premiums earned increased by 31.5% year-on-year to
$364.8 million, from $277.5 million.
Insurance
63
SISTEMA
_ _ g / / g
Growth during 2005 was driven primarily by the non-life business, continued expansion and diver-
sification of the customer base and expanded service offerings. Growth in non-life premiums
(excluding re-insurance) was over 40%, nearly twice the growth rate of the market as a whole. In
order to further diversify its premium portfolio, ROSNO focused on sales of policies to individuals,
which accounted for 32% of premiums in 2005. The company successfully placed investment funds
in Allianz ROSNO Asset Management. The segment's share of Sistema group revenues was approxi-
mately 5%.
ROSNO continued to upgrade its customer service quality across the board with continued training and
assessment. In November 2005, the company launched a new call center which enables most clients to
find needed information or to be connected with the right staff member within just 30 seconds.
The company received the ”Gold Brand of the Year/EFFIE” in 2005. The company also won the
”National Brand” award for the Insurance Company segment in 2005 for a second time.
Businesses
64 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
ANNUAL REPORT / 2005
_ _ g / / g
Insurance
65
SISTEMA
0
250
500
0
17.5
35.0
18
7.9 3
00
.2 40
8.9
17
.1
30
.2
28
.4
FY 2003 FY 2004 FY 2005
FY 2003 FY 2004 FY 20050
300
600
26
5.7
45
2.8 5
81
.5
FY 2003 FY 2004 FY 2005
Revenues$408.9 million
Operating Income$28.4 million
Assets$581.5 million
Employees1
3,564
1 As of August 1, 2006
Revenues
Operating Income Assets
Key Figures
_ _ g / / g
Businesses
66 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
ANNUAL REPORT / 2005
DYNAMICThe value of Real Estate projectportfolio increased nearlythree-fold to $709 million.
FOCUS OF THE YEARThe successful completion ofrestructuring Sistema's realestate holdings into single vertically integrated structure.
In 2005, Sistema-Hals developed the concept of thesuper-regional mall ”Hals-Mart”and won 2005 HYPERSTATEAwards prize for this project.
Felix Evtushenkov
President, Sistema-Hals
_ _ g / / g
REAL ESTATEMarketplace
Sistema has been present in Russia's construction and property sector since the mid-1990s. The cor-
poration’s commitment to consolidate its presence in this market has paid off. In 2005, the market
continued to boom, not only in Moscow but in a large number of regional cities. Changes in the legal
environment for development have created favorable business conditions. In particular, the issues
surrounding the ownership of land underneath properties have been resolved. Economic growth is
driving demand in a number of property market segments. Russian and international companies
require world-class office space. The middle class is prepared to invest money in modern housing
with modern infrastructure and families are increasingly seeking ecologically cleaner areas outside
of cities.
Despite the ongoing boom, however, the market still has room to grow. Modern shopping space per
capita in Moscow was just 50% the level in London in 2005, according to research by Jones Lang
LaSalle. Average residential values rose 233% between 2000 and 2005. The level of empty office
space in Moscow in 2004 and 2005 was practically zero and leasing prices were higher than in
Western Europe. Sistema's superior project management experience and access to capital has
allowed it to gain maximum benefit from a growing market.
Business
Sistema-Hals is Sistema's vertically integrated subsidiary in the Real Estate sector. Commercial real
estate was one of the first areas of investment for Sistema. As part of asset restructuring during
2004 and 2005, the corporation's real estate portfolio was transferred to Sistema-Hals, which had
previously operated as a developer of commercial property and elite housing. Now operating as the
legal owner of the corporation's property portfolio as well as a project management company,
Sistema-Hals has considerably increased its capitalization and ability to attract finance for devel-
opment. The ability to successfully manage its own property as well as conduct deals for acquisition
and sale of assets has significantly increased the value of the project portfolio of the company.
The company's major competitive advantage in Russia's real-estate sector is its ability to manage
projects across practically every market segment, including construction of high-quality office prop-
erty and business-class housing, large multi-functional centers and transportation infrastructure
facilities. It has completed more then 20 major projects, with past clients including Dresdner,
Daimler-Chrysler and Samsung. While Sistema's projects have been concentrated in the Moscow mar-
ket, the company is prepared to expand its presence in Russia's regions.
Results
In April 2006, Sistema announced the results of the regular valuation of its portfolio in the Property
business area, which was conducted by Cushman & Wakefield Stiles & Riabokobylko. The report indicat-
ed that the value of Sistema's real estate portfolio had increased nearly three-fold to $709.2 million in
2005, compared to $238.5 million in 2004.
A large portion of the segment's development projects were not yet completed at the end of the year,
and therefore revenues in the real estate business were down 32.0% from $115.3 million in 2004 to
$78.4 million in 2005. Consequently, operating income for the period declined to $10.4 million from
$23.5 million in 2004.
In 2005, Sistema-Hals moved forward on the construction of the Pokrovskie Gates Class-A office and
hotel complex in central Moscow. The total floor space of the project is more than 24,000 square meters,
Real Estate
67
SISTEMA
_ _ g / / g
with office space accounting for 14,772 square meters. This project is unique in Moscow in that two
physically separate spaces, an office complex and hotel, will be managed as a single object.
The office building under development at Nastasinsky Pereulok in the center of Moscow has a floorspace
of around 8,000 square meters. The new Class-A office complex is targeted at major Russian and inter-
national companies. Since the building is located in a historic part of Moscow, the project has been
designed to fully fit into the surrounding architectural landscape.
In July 2005, construction began on a new business-class living complex in Moscow called Izumrudnaya
Dolina (Emerald Valley). The project will see the construction of two 19-story towers with a common
parking area. The planned total floorspace of the complex is 29,910 square meters. The project is
planned to be completed in Q2 2007.
In August 2005, Sistema-Hals completed and handed over all 89 houses in a new cottage development
called ForestVille in the Moscow Region. The 15 hectare village is located 22 kilometers from the Moscow
Ring Road. Its infrastructure includes a shop, a cafe-bar, playgrounds, a sauna and a pharmacy.
Businesses
68 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
ANNUAL REPORT / 2005
_ _ g / / g
Real Estate
69
SISTEMA
0
60
120
0
12.5
25.0
39
.1
11
5.3
78
.5
10
.3
23
.5
10
.3
FY 2003 FY 2004 FY 2005
FY 2003 FY 2004 FY 20050
200
4002
22
.9
33
1.8
FY 2003 FY 2004 FY 2005
n/a
Revenues$78.4 million
Operating Income$10.3 million
Assets$331.7 million
Employees1
1,000
1 As of August 1, 2006
Revenues
Operating Income Assets
Key Figures
_ _ g / / g
Businesses
70 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
ANNUAL REPORT / 2005
DYNAMICRevenues in the Retail business area grew more than2.5 times to $208 million.
The division began activedevelopment of small retailstores based on a new format.
FOCUS OF THE YEAR The number of Detsky Mirstores doubled in 2005.
A $40 million bond placementwas conducted at the end of2005.
Maxim Entyakov
CEO, Detsky Mir Center
_ _ g / / g
RETAILMarketplace
Sistema's retail business is operated through Detsky Mir Center and owns the leading retailer of chil-
dren's goods in Russia, which operates under the same name. Detsky Mir, which means Children's
World, is one of Russia's oldest, most recognized and most trusted retail brands, with a 50-year his-
tory.
The growth in demand for children's products is driven by Russia's continued economic growth and
the steady improvement in household disposable income. In 2005, the market for children's goods
was worth $7 billion and is projected to grow to $11 billion by 2008. Children under 14 years of age
represent 18.1% of Russia's population.
Patterns of purchasing children's products depend on the level of income enjoyed by a particular
family. For wealthier parents, representing 20% to 25% of the population, time is at a premium.
Parents seek a one-stop shopping experience offering high levels of service, comfort and the avail-
ability of a wide choice of products from well-known companies. Children in this segment have sig-
nificant pocket money and are crucial in dictating shopping decisions and have a high level of brand
awareness. Consumers on more limited incomes represent 45% to 60% of the population. They are
price sensitive and their demand is limited to a narrower range of necessary goods.
Expectant parents are another distinct consumer category. Research demonstrates that they formu-
late purchasing preferences ahead of the arrival of their first child.
Business
Sistema became a shareholder in Detsky Mir in 1996 and runs the business through Detsky Mir
Center. While the chain struggled during the 1990s due to the restructuring of the economy, Sistema
has spearheaded an aggressive expansion of the chain and established consistent revenue and earn-
ings growth. Detsky Mir's flagship store in Moscow is located in central Lubyanka Square, on the
same site it has occupied since 1957.
As of December 31, 2005, the corporation operated 22 stores in Moscow and 23 stores in the regions,
with total retail space of more than 58,000 square meters. Stores are located in high-traffic locations
and popular shopping centers that are accessible by public transportation. This is an important con-
sideration as the level of automobile ownership in Russia continues to trail levels in Central and
Eastern Europe. Store leases are generally negotiated on a five- to ten-year basis.
Sistema is planning the further expansion of Detsky Mir. It is opening new stores in Moscow and
other cities, and the building housing the central store at Lubyanka will be modernized. The strate-
gic goal of the company is to expand to the countries of the CIS. The corporation is also reviewing
the possibility of expansion of the network through franchising.
As Russia's most trusted retailer of children's goods, the Detsky Mir group of companies continues
to develop an ever more satisfying shopping experience across the chain with the refurbishment
of existing stores and development of improved shopping formats. Due to its increased size and
the backing of Sistema, Detsky Mir Center has been able to move away from intermediaries and enter
into direct relationships with international suppliers. As a result, this allows Detsky Mir to offer a
more attractive pricing proposition to its shoppers while at the same time expanding the number
of products available at each store.
Retail
71
SISTEMA
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Results
In 2005, Detsky Mir Center grew rapidly through store openings and acquisitions. Revenues more
than doubled year-on-year to $208.0 million from $79.3 million in 2004. Detsky Mir opened 25 new
retail outlets during 2005. Total retail space exceeded 58,000 square meters. The company made a
number of acquisitions, including Chudo-Ostrov, Vyrastai-ka and S-Toys businesses, with revenues
of $10.0 million, $0.9 million and $53.7 million respectively.
The Detsky Mir group of companies undertook a range of marketing initiatives during 2005 and the
number of shoppers entering the chain's stores reached 1 million per year. The majority of these
shoppers were regular customers of the chain. During 2005, the company created a new small format
chain called Vyrastai-ka.
Detsky Mir constantly works to improve customer service on the store and company level. In 2005
the chain completed a program aimed at creating a universally high and consistent level of service
across all of its stores. An integrated Call Center was also put into operation in 2005. This permits
customers to get information on the hours and product assortment at any store. In addition, a new
consumer internet portal for parents and children was launched at www.detmir.ru.
Logistics remained a key focus in 2005, reflecting the major expansion in store numbers in the
Moscow area and Russia's regions as well as the significantly greater number of suppliers. Detsky Mir
undertook a wide-ranging re-engineering of its Distribution Center. The personnel composition was
changed and training programs were introduced. Storage and processing times were significantly
reduced to reflect the new demands and the number of Just-in-Time deliveries increased. Further
expansion of the Distribution Center is planned for 2006 as Detsky Mir intends to continue new store
openings.
In December 2005, Detsky Mir Center placed ruble denominated bonds on the Moscow Interbank
Currency Exchange (MICEX), raising 1,150 million rubles (approximately $40 million) with a term
of 9.5 years and a coupon of 8.5%. Around a quarter of the funds raised will be directed to refi-
nancing debt on more favorable terms. The remainder of the funds will be directed toward contin-
ued expansion of the chain, including new acquisition and leases.
Businesses
72 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
ANNUAL REPORT / 2005
_ _ g / / g
Retail
73
SISTEMA
0
125
250
0
6
12
55
.5 79
.3 20
8.0
6.8
9.0 1
0.5
FY 2003 FY 2004 FY 2005
FY 2003 FY 2004 FY 20050
75
1505
2.7
14
6.3
FY 2003 FY 2004 FY 2005
n/a
Revenues$208.0 million
Operating Income$10.4 million
Assets$146.3 million
Employees1
4,115
1 As of August 1, 2006
Revenues
Operating Income Assets
Key Figures
_ _ g / / g
Businesses
74 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
ANNUAL REPORT / 2005
DYNAMICRevenues in the Banking business area grew by 62% to $106.8 million in 2005.
The number of retail customersexceeded 90,000 and corporateclients numbered over 6,000.
FOCUS OF THE YEARSistema consolidated 99% of the shares of the MoscowBank for Reconstruction andDevelopment.
The successful roll-out of retailbanking business in 2005, withbanking divisions opened in seven regions.
Sergey Zaitsev
CEO, MBRD
_ _ g / / g
BANKINGMarketplace
Since 2004, Sistema's banking business, the Moscow Bank for Reconstruction and Development, has
aggressively expanded into the country's fast-growing retail banking sector. Russia's macroeconom-
ic growth has fostered the development of both the corporate and retail banking sectors. At the
same time, Russia's banking sector remains extremely fragmented, with a large number of small
banks and ”treasury” banks.
In 2005, the Central Bank of the Russian Federation, acting as the regulator of the sector, developed
and implemented a deposit guarantee program for individual clients at banks that had completed a
special certification process. The law ”On Credit Histories” came into effect on June 1, 2005 and gave
further momentum for the development of the sector. This legislation allows the development
of consumer credit for consumers at lower interest rates, including mortgages, automobile finance
and lending.
Russia's banking sector still has considerable room to grow when measured against peers in Central
and Eastern Europe. In 2005, total deposits in Russia were equal to 7% of gross domestic product
(GDP), one of the lowest rates in the region. According to international investment bank Nomura,
the comparable figure in Romania is 19%, 39% in Hungary, 44% in Turkey, 74% in Slovenia and 120%
in the European Union. The market for corporate lending has also not reached the limits of its
growth potential. The volume of loans to GDP in Russia was 11%, compared to 18% in Bulgaria and
Romania, 19% in Poland, 34% in Turkey, 52% in Czech Republic and 102% in the European Union.
Business
Sistema's primary finance and banking business is MBRD. Previously, the MBRD acted primarily as an
in-house treasury function for Sistema. Today, however, MBRD is a full-fledged universal bank, offer-
ing a full range of services to corporate and consumer clients.
In 2004, MBRD launched a program for the development of its retail banking business, using a busi-
ness model developed with the participation of international consulting firm Deloitte & Touche CIS.
During that year, the MBRD opened its first retail outlets in Moscow and created its first affiliates in
the Russian cities of Krasnodar and Yekaterinburg. By the end of 2005, the bank operated in Moscow
and seven Russian regions. The volume of revenues from intra-group operations dropped throughout
the year. The total number of retail customers exceeded 90,000 and the number of corporate clients
exceeded 6,000.
MBRD offers another opportunity for Sistema to develop consumer services across its business areas
and to gain access to the more than 60 million customers served by the corporation. Sistema is
developing internet and mobile access for customers and offers a range of banking services to exist-
ing clients in other business areas. The SMS BankInfo service, launched in 2004, allows customers to
obtain information about credit and debit card transactions and bank balances via mobile phone.
Results
The Banking business area demonstrated strong revenue growth of 62.4% year-on-year to $106.8 mil-
lion from $65.7 million in 2004. Growth during 2005 was due to the strong growth in corporate lend-
ing and the aggressive expansion of the new retail business. As of year end, MBRD's retail network
included 12 branches and 41 sub-branches in Moscow and Russia's regions.
Banking
75
SISTEMA
_ _ g / / g
Loans issued to retail customers increased seven-fold during the year. Operating costs also increased
due to the costs of the retail expansion, and the operating margin consequently fell from 17.8%
to 11.9%.
During 2005, Sistema acquired a further 13.0% stake in MBRD for a total consideration of $10 mil-
lion, increasing its voting power in the bank to 99%. In March 2005, MBRD completed an issue of
Loan Participation Notes for the first time for a total of $150 million. The issue was organized via
Dresdner Bank AG, which issued to MBRD a credit for the entire amount. These notes reach maturi-
ty in three years. In March 2006, MBRD issued $60.0 million 8.9% Loan Participation Notes to finance
a subordinated loan. The notes mature in March 2016 and are listed on the Luxembourg Stock
Exchange.
Businesses
76 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
ANNUAL REPORT / 2005
_ _ g / / g
Banking
77
SISTEMA
0
60
120
0
7.5
15.0
57
.5
65
.7
10
6.8
2.6
11
.7 12
.7
FY 2003 FY 2004 FY 2005
FY 2003 FY 2004 FY 20050
600
1,200
59
5.5 75
7.9 1
,11
4.9
FY 2003 FY 2004 FY 2005
Revenues$106.7 million
Operating Income$12.7 million
Assets$1,114.8 million
Employees1
1,585
1 As of August 1, 2006
Revenues
Operating Income Assets
Key Figures
_ _ g / / g
Businesses
78 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
ANNUAL REPORT / 2005
DYNAMICIn 2005, revenues from the Media business area grewby 45%.
FOCUS OF THE YEARIn 2005, Sistema Mass Mediatook the leading position inthe Russian market for pay TV.
The film Match Point, pro-duced by Thema Productionsin 2005, was nominated foran Oscar.
Mikhail Dunaev
CEO, Sistema Mass Media
_ _ g / / g
MEDIAMarketplace
Today, the corporation's Media business segment area operates in the pay TV and multi-media serv-
ices sectors, including cable television. This is a new and fast-developing market in Russia. The total
volume of the pay TV market was estimated in May 2006 to be 4.6 million households. During 2005,
this number was estimated at 2.5 to 3.0 million households, with a market volume of $300 million
per year. Pay TV penetration is 8.8% of the population, compared to the Central and Eastern
European average of 65%.
Cable television operators and content providers have forecast that the Russian cable television
market will grow by more than 30% per year. Today, the market is segmented in the following man-
ner. A number of cable operators are ”Social Package” providers linked to municipal TV networks and
providing only a basic package of five to 15 channels and average revenue per user (ARPU) of only
around $1 per month. Commercial providers offer a ”Basic Package” of 20-60 channels and have
ARPU of $3.5 per month. There is the potential for growing ARPU in this segment closer to the average
Central and Eastern European level of $10.5 per month. Russian premium providers are aiming for ARPU
levels of $25.0 per month. Against the background of sustained growth in the Moscow market, region-
al markets are also showing significant growth in demand for cable and satellite television with a
wide choice of channels and services.
Business
The corporation manages its media businesses through the Sistema Mass Media (SMM) holding com-
pany. Until 2005, SMM was active in advertising and print distribution, and was also engaged in pub-
lishing, film production and news services. In 2005, in accordance with the strategy of asset restruc-
turing, a number of low margin businesses were sold. The decision was made to focus primarily on
high-revenue, high technology areas in the media business, such as the development of infrastruc-
ture and content for pay-TV and multi-media services.
SMM is not confining its distribution and content operations to the Moscow market. At the end of
2005 and early 2006, the holding acquired the regional operators United Cable Networks (UCN) and
Regional Cable Networks (RCN). These acquisitions made SMM the leader in the Russian market for
regional cable television.
In 2005, SMM also entered the segment for mobile television with the acquisition of 74.0% of the
company Tsifrovoe Teleradioveshanie (Digital Television and Radio Broadcasting). Mobile television
is still a market in the early stages of development, both in Russia and globally. Nonetheless, it
offers potential for synergies between Sistema's Media and Telecommunications business segments.
One of SMM’s key areas of development is film production. SMM owns a 75% stake in Thema
Production, which produces films for the international market that feature internationally
acclaimed actors.
Sistema also owns an advertising and public relations agency called Maxima. Russia's advertising
market has been one of the fastest growing in the world in recent years. The corporation continues
to study the possibilities for expanding its business into other fast-growth media market segments.
Results
Consolidated revenues from the Media business area grew by 44.8% to $52.4 million in 2005, com-
pared to $36.2 million in 2004. Operating income was $7.1 million in 2005, compared to an operat-
Media
79
SISTEMA
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ing loss of $0.9 million in 2004. Revenue growth was driven primarily by the addition of the newly
acquired regional cable networks.
During 2005, Sistema undertook a wide-scale asset restructuring in the business area. The corpora-
tion conducted a range of deals for the sale of a number of print and distribution assets, including
Nasha Pressa, Stolichnaya Pressa, Concern Radio Center, Credo Service and Gloros Stolitsa. The acqui-
sition of the Esta cable television business and CTV, a digital television broadcasting company, con-
tributed $7.2 million to the Media segment’s revenue. Esta brought SMM 217,000 cable subscribers in
three Russian regions. Its business includes 40,000 Moscow pay TV subscribers under the Kosmos-TV
brand.
In May 2005, Sistema launched STREAM-TV, the first ADSL-based in-house entertainment offering
ever launched in Russia. The STREAM-TV package offers customers access to over 80 Russian and
international television channels, four specialty channels (Drive, Hunting and Fishing, Health and
Wellbeing and Retro), pay-per-view and video-on-demand services as well as internet, networked
games and digital radio. The company has made a range of subscription options available starting at
$9.95 per month, with the flexibility to add new channels individually or in packages for time peri-
ods ranging from a day to a month. This flexibility, along with the option for consumers to pay for
the equipment package upfront or by installment plan over three years, makes STREAM-TV attrac-
tive to millions of Russian consumers seeking digital multimedia content. It creates scope for ARPU
growth by allowing consumers to add content on a flexible basis.
STREAM-TV is a joint project between SMM and Comstar-UTS, Sistema's primary fixed-line telecom-
munications business. It demonstrates the scope for synergized brands across the corporation.
SMM's focus in 2005 on fast-growth segments demonstrates the ability of Sistema to effectively
restructure assets. Acquisitions in the Media business area have enabled SMM to build a market-
leading business in the Pay-TV sector in Russia.
Businesses
80 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
ANNUAL REPORT / 2005
_ _ g / / g
Media
81
SISTEMA
0
30
60
-5
0
5
10
35
.2
36
.2
52
.4
-4.4
-0.9
7.1
FY 2003 FY 2004 FY 2005
FY 2003 FY 2004 FY 20050
50
1003
7.1
81
.9
FY 2003 FY 2004 FY 2005
n/a
Revenues$52.4 million
Operating Income$7.1 million
Assets$81.9 million
Employees1
1,657
1 As of August 1, 2006
Revenues
Operating Income Assets
Key Figures
_ _ g / / g
Businesses
82 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
ANNUAL REPORT / 2005
DYNAMICAssets in the Tourism businessarea grew by more than3.5 times to $90.27 million in2005.
FOCUS OF THE YEARIn 2005 Intourist moved forward in its goal to become a universal tour operator.
The acquisition of MegapolyusAviacharter has expanded thecapability of Intourist to pro-vide logistics and transportservices.
Alexander Arutyunov
President, Intourist
_ _ g / / g
TOURISMMarketplace
Sistema is represented in the tourism market by Intourist. The company conducts its activity across
the tourist business: the organization of overseas tours for Russian citizens, the reception of foreign
tourists and domestic tourism within Russia. While related, each segment is subject to its own devel-
opment dynamic. Overall, the tourism industry in Russia continues to boom. Expert forecasts sug-
gest the value of the market will grow at an average annual rate of 15% annually through 2010.
Growth in per capita disposable income is a major factor encouraging Russians to travel domestical-
ly and abroad. Competition on domestic airline routes has made domestic travel both more afford-
able and flexible, and has influenced the price of travel on Russia's railways as well. World class
hotels and resorts are being built in traditional domestic destinations such as the Black Sea coast.
For Russians traveling abroad, the number of tour operators has multiplied in recent years, offering
greater choice and price competition.
At the same time, Russia's political and economical stability has encouraged inbound tourism
attracted by Russia's rich historical and cultural legacy. Still, the growth in inbound tourism has
been limited by a lack of modern tourism infrastructure, such as international quality hotels,
in many Russian regions. In Russia's most modern cities and popular destinations, Moscow and
St Petersburg, a number of hotels in the mid-market segment have been closed in the last few years.
A very limited supply of rooms has led to a rise in prices. Despite these challenges, the inbound seg-
ment grew on average by 19% between 2001 and 2004. A new tourist infrastructure development
plan has been put into place by the Russian government and the country has stepped up interna-
tional campaigns promoting tourism in the country.
Business
Intourist was founded in 1929. In Soviet times, it was the monopoly provider of tourist services. In
1992, the assets of Intourist were restructured, which resulted in the company retaining only its
international and domestic tour operators. All of the other assets, including hotels and tour buses,
were put under the control of the Russian government.
Today, Intourist aims to turn the company into a universal operator on the tourist market, offering
clients a full range of services. The activity of the company comprises three key areas. The first is
tour operating services, including both inbound and outbound tourism, and corporate services.
Intourist serves more than 400,000 foreign and Russian tourists annually and is actively developing
a network of tour product sales offices. Currently, the company has six affiliate companies overseas,
15 sales offices in Moscow, 46 affiliate companies in Russia's regions and 25 franchised agencies. In
the future, these numbers will continue to grow.
A second key area is the hotel business. The development of a hotel network in Russia and abroad is
being managed by the Intourist Hotel Group. This company is acquiring and taking over manage-
ment of hotels across the country. This is part of fulfilling a strategic goal set by the shareholders.
The hotel segment will develop as an independent business area within the framework of Intourist.
The third area is transportation services. Auto transportation is operated by the company
Inturautoservice. Charter programs are operated by the company Megapolyus Aviacharter, which
was acquired at the end of 2005. Each of these areas has considerable growth potential.
Tourism
83
SISTEMA
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In an environment of ever increasing competition, the company stands out by offering the highest
level of service. At the same time, Intourist strives to maintain the highest standards of financial
and operational transparency.
In 2005, Sistema undertook the restructuring of Intourist with the goal of consolidating ownership
and creating an efficient, vertically integrated structure. In January 2005, Intourist announced
issue of new stock to its existing shareholders. The Moscow City Government purchased the first
tranche of 3,120,516,875 shares in exchange for a 40% stake in Kosmos Hotel, a 1,000-room hotel
complex situated in Moscow, with a fair value of the contributed ownership interest of $20.1 million.
In April 2005, Sistema paid the equivalent of $47.7 million for the remaining 6,961,052,632 additional
shares of Intourist.
Sistema and its affiliated companies control over 71.58% of the Group. GAO Moskva, the second prin-
cipal shareholder, is owned by the Moscow City Government and is focused on the development of
Moscow hospitality infrastructure, including hotels and historic places.
Results
Intourist served 421,000 clients in 2005. The group posted 1.5% revenue growth in 2005, with rev-
enues growing to $98.04 million in 2005 compared to $96.59 million in 2004. The slowing in revenue
growth was due to a 4% reduction in revenues from the domestic tourism area. The outbound seg-
ment, by contrast, grew by 5%.
During 2005, Intourist underwent a significant restructuring program aimed at improving its man-
ageability and increasing the efficiency of its activity. A number of unprofitable regional operating
offices were closed. This restructuring work continues in 2006. It is planned that over 40 regional
subsidiary structures will be converted into affiliates.
Intourist won a tender in 2005 to provide travel services for the Russian-Arab Business Union. It also
received recognition in 2005 of its efforts to increase its product offerings and strengthen its brand.
The independent international firm Superbrands Ltd awarded Intourist the status ”Superbrand of
the Russian Consumer Market.” The Moscow City Committee for Tourism named Intourist a ”Travel
Star” for its ”Invaluable Contribution to the Development of Tourism in Moscow and Russia and High
Quality of Service.”
The group has put in place a three-year development plan aimed at both modernizing and expand-
ing its network of sales offices to 500 offices by 2008. New IT systems are also being deployed to
integrate into a single information space the sales network and regional offices with the Head
Office. As the mid-range hotel category is expected to see the strongest growth in the next five
years, Intourist aims to acquire and manage a number of hotels in key markets including Moscow,
St Petersburg, the Black Sea coast, the Crimea and other key destinations, with the aim of achieving
a 15% market share in the three-star plus category of hotels.
Businesses
84 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
ANNUAL REPORT / 2005
_ _ g / / g
Tourism
85
SISTEMA
0
50
100
0
1.5
3.09
6.6
98
.0
2.8
1.3
FY 2003 FY 2004 FY 2005
FY 2003 FY 2004 FY 20050
50
1002
5.9
90
.3
FY 2003 FY 2004 FY 2005
n/a
n/a n/a
Revenues$98.0 million
Operating Income$1.3 million
Assets$90.7 million
Employees1
3,300
1 As of August 1, 2006
Revenues
Operating Income Assets
Key Figures
_ _ g / / g
Businesses
86 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
ANNUAL REPORT / 2005
DYNAMICRevenues grew by more than 330% year-on-year to $124.2 million in 2005.
FOCUS OF THE YEARThe company expanded itsproduct range, with the ability to provide complex, high-value turn-key systemsthat maintain national securi-ty, such as radar systems.
New acquisitions strengthenedthe position of RTI Systems inkey segments of the market.
Sergey Boev
CEO, RTI Systems
_ _ g / / g
RADIO AND SPACE TECHNOLOGY Marketplace
Sistema's radio and space technology division includes RTI Systems and its subsidiaries. The com-
pany carries out the design and production of radars and radar systems, aerospace control systems
and power equipment building.
In the area of radio equipment, the primary customer for the company is the Ministry of Defense of
the Russian Federation. The volume of government defense contracts was approximately 215 billion
rubles ($7.7 billion) in 2005. 50% of the budget (around $3.9 billion) went to the creation of new
equipment (R&D). Around 4.2% of the general R&D budget ($160 million) consists of the market for
long-range radar systems. The RTI Systems occupies 90% of this sub-segment and is the undisput-
ed leader in Russia. The market for long-range radar between 2005 and 2008 will grow by 38% as
government policy in the area of defense is directed at created new radar complexes. Therefore, the
leading position in this segment will allow the company to maintain a strong organic growth rate.
The market for short-range systems, where the company is also successfully advancing its products,
makes up around 6.5% of the total R&D budget or $250 million and is dynamically developing. This
market will grow by approximately 20% between 2005 and 2008. The company's main goal in the
near-term is to significantly expand its presence in the short-range radar segment.
In the second half of 2005, a new division was formed, Aerospace and Terrestrial Control Systems, with-
in the company. The domestic market for these products is around $3.0 billion and the sub-segments
in which the company operates occupy around 14.3% of this market (approximately $430 to $450 mil-
lion). The main factor for growth in these sub-segments is high domestic demand and strong export
potential. In the period of 2005 to 2008, growth is estimated at approximately 46%. The main goal
of the company in the next few years is to expand its presence in the domestic and overseas mar-
kets. This appears fully realizable, and in the beginning of 2005 yet another major player, DMZ-
Kamov, joined the division.
The formation of the Power Equipment Building division began in the first quarter of 2006 after the
acquisition of UralElektro. The company entered the relatively small market for equipment, which
has volumes of approximately $430 million. The main goal in the next few years is to complete the
formation of this division and then enter the market for large systems projects in this sector of the
economy, which is expected to see growth to more than $8 billion.
The volume of defense exports, according to FinAm, amounted to $6.126 billion in 2005, the large
majority of which (85%, or $5.2 billion) was attributable to the state-run Rosobonexport. RTI's
exports were $15.1 million. Today, the export portfolio of the company has contracts worth $26.0
million.
Business
RTI Systems and its subsidiary companies bring together leading Russian enterprises with strong
track records in management of large-scale projects in the high-technology sphere and considerable
research and production potential.
As part of Sistema's strategy of consolidating and restructuring assets, Sistema has combined a num-
ber of subsidiary businesses into RTI Systems to create a market leader in the fast-growing radio and
aerospace technology market segments. The three main business areas were formed in 2005 and in
2006 RTI's main business areas will be restructured along a clear divisional structure.
Radio and SpaceTechnology
87
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88 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
ANNUAL REPORT / 2005
During 2005, a number of subsidiaries were added to RTI as the corporation's main holding in this
business area. These included Yaroslavksy Radio Factory, MTU Saturn and Defense Construction
Bureau Planeta. These enterprises substantially strengthen the position of RTI in the market for
space and terrestrial control systems.
Acquisitions and consolidation have allowed RTI to significantly expand its product line. It is now
able to offer satellite and aviation communications systems and rescue and recovery devices. RTI is
able to offer ”turn-key” systems for creating specialized satellite communications networks and is
developing similar radar stations that are already functional upon leaving the factory. Preliminary
testing of these systems began in December 2005.
Results
Revenues in the Radio and Space Technology segment grew more than three-fold in 2005 to $124.2
million, from $37.1 million in 2004. OIBDA in the business grew nearly four-fold to $10.7 million
year-on-year.
RTI Systems and its subsidiaries were successful in a number of high-profile tenders in 2005. In June
2005, RTI Systems won the open competition for the supply and installation of satellite communi-
cations equipment held by the Ministry of Finance of the Republic of Sakha (Yakutiya) and in
December 2005 the project was put into operation.
In October 2005, as part of the IX International Exhibition Interpolytech 2005, RTI's subsidiary
Yaroslavksy Radio Factory was named a laureate in the ”National Security” category for its portable
KVARTs-N radio location equipment. The KVARTs-N is a civilian version of the popular P-168-1K and
is designed to function in urban areas. The device received a high evaluation from President Vladimir
Putin for its results in test conditions.
In March 2006, after the reporting period, Concern RTI purchased a 50% plus one share in
UralEleketro and 100% share in UralElektro-K for $5.4 million. Both companies are producers of elec-
tronic equipment and the acquisitions further bolster RTI's competitive edge in the market.
Businesses
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89
SISTEMA
Radio and SpaceTechnology
0
75
150
0
5
103
7.1
12
4.2
2.5
9.9
FY 2003 FY 2004 FY 2005
FY 2003 FY 2004 FY 2005FY 2003 FY 2004 FY 2005
n/a
n/a0
40
801
9.1
69
.5
n/a
Revenues$124.2 million
Operating Income$9.8 million
Assets$69,5 million
Employees1
7,458
1 As of August 1, 2006
Revenues
Operating Income Assets
Financial Highlights
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OTHER BUSINESS AREAS In addition to its core business areas, Sistema maintains a small number of other companies in fast-grow-
ing areas of the economy. These companies represent investments in areas with long-term promise or
that can serve short- to medium-term financial investments that permit the corporation to increase
shareholder capital. These businesses do not occupy a large portion of management time or financial
resources.
Medsi
Sistema manages its medical services business through Medsi and Medsi-P. Medsi provides ambula-
tory and primary care services to patients over 15-years-old while Medsi-P specializes in pediatrics.
Medsi is a full-service medical center for providing diagnostics and ambulatory care. In addition, the
center provides specialist care in its dedicated Diabetes Center, 40-plus Health Center and the
Center for Extracorporeal Healing.
MEDSI Ltd's key areas of business in 2005 included participation in the voluntary medical insurance
sector in Moscow, provision of medical services at Moscow hotels through a network of mini-clinics,
medical screening and vaccinations at Moscow enterprises, medical services through direct contract
with businesses and individuals and the sale of medicines through the center's pharmacy. During
the year, MEDSI cared for 21,338 patients and provided 761,600 services.
MEDSI-P began opened in May 2005 and is located in a separate building in the center of Moscow.
It meets the very latest world standards for a medical care institution. The center has more than
120 doctors in eight departments. A Scientific Committee, composed of leading researchers and aca-
demics from the Russian Academy of Medical Sciences, oversees research work on current pediatric
issues and has introduced of the latest methods in preventive treatments and pediatric care. In 2005,
MEDSI-P cared for 3,250 patients and provided 32,842 services.
Binnofarm
Binnofarm was created in March 2006 when Sistema decided to create a single holding for its pharma-
ceutical and biotechnology assets. During 2005, the business was run through two main subsidiaries,
Medical-Technological Holdings (MTH) and NPO Orgsintez-1. The business segment was also involved in
equipping hospitals under construction in Moscow with medical equipment. Alexander Bakhutashvili
was named head of the new Binnofarm pharmaceutical holding and brings a wide range of experience
across the industry, from R&D and marketing of new medicines to branded generics to wholesale trade
in medicines.
In 2005, MTH began the first industrial production of a vaccine for hepatitis B. The company completed
clinical testing and registered a children's form of the vaccine. Presently, MTH is one of the only enter-
prises in Russia conducting full-cycle vaccine production from substance to final form product. Some
250,000 doses were produced during the year and MTH became a full-fledged biotechnology company.
In addition, MTH produced three million doses of medicines in ampoule form, including nitroglycerin,
polioxides, cyclopheron and thymodepressin. The company began to implement plans to expand the
nomenclature of immunobiological medicines produced, which it sees as the basis for its development
in the future.
In 2005, Orgsintez-1 completed a production plan developed on the basis of a state tender agreement to
make central nervous system analgesics, including promedol and fentanyl. The company also conduct-
ed work to expand the portfolio of these medicines.
Businesses
90 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
ANNUAL REPORT / 2005
_ _ g / / g
Binnofarm's plans include the launch of new, Good Manufacturing Practice compliant production facil-
ities for making medicines in various forms, including aerosols, injected forms, hard forms, infusions and
bio-generics. The holding is working to expand its product portfolio, creation of new trademarks and
deployment of a national network of medical representatives. R&D will be focused on developing new
medicines. M&A activities will focus on obtaining intellectual property, research skills and creating cost
synergies.
Financial Investments
In August 2005, Sistema acquired minority shareholdings in six raw oil processing and oil extracting
companies located in the Russian Republic of Bashkortostan. Later, the corporation increased its
shareholdings in these assets. The total acquisition costs were around $600 million. The acquisition
of the shareholdings does not represent any change in Sistema's strategic focus on core business
areas involving Russia's consumer sector. Rather, the corporation views the acquisitions as an oppor-
tunity to invest shareholder's funds for the short- to medium-term while waiting for M&A deals to
boost its key businesses. One example is future participation in the privatization of the state fixed-
line operator Svyazinvest.
As of the end of 2005, Sistema had 20.77% of the charter capital of oil extracting company Bashneft
(amounting to 25% of the voting shares). It has a 25.62% stake of the charter capital of Novoil
(28.17% of the voting shares), 18.19% of the charter capital of Ufaneftekhim (22.43% of the voting
shares) and 22.46% of the charter capital of Ufimskiy NPZ (25.5% of the voting shares), all of which
are oil processing companies. In addition, Sistema had acquired 17.21% of the charter capital of
Bashkirnefteprodukt (18.57% of the voting shares), a company involved in the retail sale of oil prod-
ucts, and 21.53% of the charter capital (24.87% of the voting shares) of oil chemicals company
Ufaorgsintez.
The companies occupy a leading position in the oil-energy market in the region. They operate across
the production chain, from oil extraction to oil chemicals. The combined assets represent the third-
largest player in the Russian market for oil processing. The shares of all of the companies are quot-
ed and traded on the Russian Trading System. The shares were acquired from Bashkirskiy Capital,
which currently owns controlling shareholdings in all of the companies. Bashkirskiy Capital
approached Sistema with the offer to purchase the shareholding in order to make use of the corpo-
ration's long-standing experience in restructuring businesses.
Sistema's experts are working with Bashkirskiy Capital to create a transparent, vertically integrated
holding with the goal of maximizing the shareholder value of each company and the holding as a
whole. The restructuring will include the introduction of international best practice in corporate
governance and financial management and reporting.
Sistema's management believes that participation in these companies provides the corporation with
the ability to make efficient use of shareholder funds, and to benefit from additional revenue from
the dynamic development of the oil sector.
Other Business Areas
91
SISTEMA
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CONTACTSSistema Joint-Stock Financial Corporation
Andre Bliznyuk
Head of Capital Markets
Phone: +7 (495) 730 1543
Irina Potekhina
Head of PR
Phone: +7 (495) 730 7188
10 Leontievsky Pereulok
125009 Moscow, Russia
Phone: +7 (495) 629 0600
Fax: +7 (495) 232 3391
www.sistema.com
Contacts
92 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
ANNUAL REPORT / 2005
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Notes
93
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JSFC SISTEMA
FINANCIAL REPORT 2005
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INDEPENDENT AUDITORS’ REPORT
TO THE SHAREHOLDERS OF JSFC SISTEMA:
We have audited the accompanying consolidated balance sheets of JSFC Sistema and subsidiaries (the “Group”)
as of December 31, 2005 and 2004 and the related consolidated statements of operations and comprehensive
income, changes in shareholders’ equity, and cash flows for the years then ended. These financial statements
are the responsibility of the Group’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
of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit includes consideration of internal
control over financial reporting as a basis for designing audit procedures that are appropriate in the circum-
stances, but not for the purpose of expressing an opinion on the effectiveness of the Group’s internal control over
financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evi-
dence supporting the amounts and disclosures in the financial statements. An audit also includes assessing
the accounting principles used and significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, based on our audits, such financial statements present fairly, in all material respects, the consol-
idated financial position of the Group as of December 31, 2005 and 2004, and the consolidated results of its oper-
ations and its cash flows for the years then ended in conformity with accounting principles generally accepted
in the United States of America.
April 21, 2006
3
INDEPENDENT AUDITORS’ PERORT
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JSFC SISTEMA AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS DECEMBER 31, 2005 AND 2004
(Amounts in thousands of U.S. dollars, except share amounts)
Notes 2005 2004
ASSETS
CURRENT ASSETS:
Cash and cash equivalents 5 $ 482,647 $ 503,747
Short-term investments 6 594,196 202,580
Loans to customers and banks, net 7 568,502 379,310
Insurance-related receivables 8 149,589 130,278
Accounts receivable, net 9 442,643 327,921
Prepaid expenses, other receivables
and other current assets, net 10 578,152 230,460
VAT receivable 495,191 345,999
Inventories and spare parts 11 482,909 276,832
Deferred tax assets, current portion 25 123,681 73,592
Total current assets 3,917,510 2,470,719
Property, plant and equipment, net 12 5,876,124 4,448,045
Advance payments for non-current assets 233,761 181,281
Investments in affiliated companies 13 914,203 206,520
Other investments 14 150,000 –
Goodwill 2 330,932 174,341
Licenses, net 15 615,042 666,934
Other intangible assets, net 16 886,272 594,315
Debt issuance costs, net 23 82,662 27,267
Deferred tax assets 25 33,472 3,482
Other non-current assets 17 50,872 50,424
TOTAL ASSETS $ 13,090,850 $ 8,823,328
Consolidated balance sheets
4 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
JSFC SISTEMA AND SUBSIDIARIES
_ g g / / g
JSFC SISTEMA AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS DECEMBER 31, 2005 AND 2004 (continued)
(Amounts in thousands of U.S. dollars, except share amounts)
Notes 2005 2004
LIABILITIES AND SHAREHOLDERS’ EQUITY
CURRENT LIABILITIES:
Accounts payable $ 594,816 $ 361,016
Bank deposits and notes issued 18 496,829 326,861
Insurance-related liabilities 19 412,328 344,460
Taxes payable 125,474 117,888
Deferred tax liabilities, current portion 25 28,149 22,071
Accrued expenses, subscriber prepayments and other current liabilities 20 993,344 770,192
Short-term loans payable 21 637,769 221,103
Current portion of long-term debt 23 520,310 340,938
Total current liabilities 3,809,019 2,504,529
LONG-TERM LIABILITIES:
Capital lease obligations, net of current portion 22 6,682 3,412
Long-term debt, net of current portion 23 3,202,629 2,494,522
Subscriber prepayments, net of current portion 24 163,897 156,233
Deferred tax liabilities, net of current portion 25 237,916 228,977
Postretirement benefits obligation 26 16,217 11,513
Total long-term liabilities 3,627,341 2,894,657
Deferred revenue 27 125,700 130,913
TOTAL LIABILITIES 7,562,060 5,530,099
Minority interests in equity of subsidiaries 2,295,147 1,851,027
Commitments and contingencies 31 – –
SHAREHOLDERS’ EQUITY:
Share capital (9,650,000 and 8,100,000 shares issued 28 30,057 25,090
and outstanding as of December 31, 2005 and 2004,
respectively, with par value of 90 Russian rubles)
Additional paid-in capital 3,4 1,479,743 198,882
Retained earnings 1,696,276 1,170,620
Accumulated other comprehensive income 27,567 47,610
TOTAL SHAREHOLDERS’ EQUITY 3,233,643 1,442,202
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY $ 13,090,850 $ 8,823,328
See notes to consolidated financial statements.
Consolidated balance sheets
5
CONSOLIDATED FINANCIAL STATEMENTS
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JSFC SISTEMA AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME FOR THE YEARS ENDED
DECEMBER 31, 2005 AND 2004
(Amounts in thousands of U.S. dollars, except share and per share amounts)
Notes 2005 2004
Sales $ 7,143,386 $ 5,415,491
Revenues from financial services 450,163 318,459
TOTAL REVENUES 7,593,549 5,733,950
Cost of sales, exclusive of depreciation and amortization (2,877,169) (2,044,827)
shown separately below
Financial services related costs, exclusive of depreciation (342,018) (201,631)
and amortization shown separately below
TOTAL COST OF SALES (3,219,187) (2,246,458)
Selling, general and administrative expenses (1,414,313) (1,010,288)
Depreciation and amortization (1,024,592) (797,274)
Other operating expenses, net (71,392) (44,529)
Equity in net income of investees 78,033 27,121
Gain on disposal of interests in subsidiaries 15,326 2,184
OPERATING INCOME 1,957,424 1,664,706
Interest income 66,132 18,061
Interest expense, net of amounts capitalized (225,684) (213,943)
Currency exchange and translation (loss)/gain (13,913) 12,620
Income before income tax, minority interests, extraordinary 1,783,959 1,481,444
gain and cumulative effect of a change in accounting principle
Income tax expense 25 (512,993) (445,731)
Income before minority interests, extraordinary gain $ 1,270,966 $ 1,035,713
and cumulative effect of a change in accounting principle
Consolidated statements
of operations and comprehensive
income
6 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
JSFC SISTEMA AND SUBSIDIARIES
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JSFC SISTEMA AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME FOR THE YEARS ENDED
DECEMBER 31, 2005 AND 2004 (continued)
(Amounts in thousands of U.S. dollars, except share and per share amounts)
Notes 2005 2004
Minority interests $ (740,514) $ (589,014)
Income before extraordinary gain and cumulative effect 530,452 446,699
of a change in accounting principle
Extraordinary gain 3 3,956 –
Cumulative effect of a change in accounting principle 2 – (35,472)
(net of income tax effect of nil)
NET INCOME $ 534,408 $ 411,227
Other comprehensive income/(loss):
Unrealized gain on securities available for sale, 1,622 1,967
net of income tax effect of nil
Change in fair value of interest rate swaps, net 1,701 (257)
of income tax effect of $537 and $245, respectively
Translation adjustment, net of minority interests of $26,757 2 (23,368) 29,979
and $28,582, respectively, and income tax effect of nil
Comprehensive income $ 514,363 $ 442,916
Weighted average number of common shares outstanding 9,475,980 8,100,000
Earnings/(loss) per share, basic and diluted:
Income before extraordinary gain and cumulative effect $ 56.0 $ 55.1
of a change in accounting principle
Extraordinary gain 0.4 –
Cumulative effect of a change in accounting principle – (4.3)
Net income 56.4 50.8
See notes to consolidated financial statements.
Consolidated statements of operations and comprehensive income
7
CONSOLIDATED FINANCIAL STATEMENTS
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JSFC SISTEMA AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 2005 AND 2004
(Amounts in thousands of U.S. dollars)
2005 2004
OPERATING ACTIVITIES:
Net income $ 534,408 $ 411,227
Adjustments to reconcile net income to net cash provided by operations:
Extraordinary gain (3,956) –
Depreciation and amortization 1,024,592 797,274
Loss on disposals of property, plant and equipment 15,638 1,551
Long-term investments impairment – 3,070
(Gain)/loss on disposal of interests in subsidiaries (15,326) 1,862
Cumulative effect of a change in accounting principle – 35,472
Minority interests 740,514 589,014
Equity in net income of investees (78,033) (27,121)
Deferred income tax benefit (105,920) (58,903)
Provision for doubtful accounts receivable 59,564 29,809
Allowance for loan losses 62,054 13,810
Inventory obsolescence expense 10,875 5,868
Changes in operating assets and liabilities,
net of effects from purchase of businesses:
Trading securities (306,567) 27,142
Loans to banks 86,254 (25,661)
Insurance-related receivables (47,837) 31,111
Accounts receivable (181,033) (101,567)
Prepaid expenses, other receivables and other current assets (343,342) 66,240
VAT receivable (149,192) (67,558)
Inventories (200,444) (112,269)
Accounts payable 311,936 54,110
Insurance-related liabilities 127,255 51,985
Taxes payable 6,566 (1,997)
Accrued expenses, subscriber prepayments and other liabilities 218,510 171,966
Postretirement benefits obligation 4,704 7,636
Net cash provided by operations 1,771,220 1,904,071
INVESTING ACTIVITIES:
Purchases of property, plant and equipment (2,095,235) (1,498,098)
Purchases of intangible assets (372,552) (164,577)
Purchases of businesses, net of cash acquired (540,404) (338,906)
Proceeds from disposals of subsidiaries, net of cash disposed 12,862 649
Purchases of long-term investments (796,990) (76,217)
Proceeds from sale of long-term investments 13,053 6,850
Purchases of short-term investments (839,516) (142,696)
Proceeds from sale of short-term investments 662,847 180,650
Proceeds from sale of property, plant and equipment 4,179 7,807
Net increase in loans to customers (319,174) (39,898)
Net cash used in investing activities (4,270,930) (2,064,436)
Consolidated statements
of cash flows
8 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
JSFC SISTEMA AND SUBSIDIARIES
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JSFC SISTEMA AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2005 AND 2004 (continued)
(Amounts in thousands of U.S. dollars)
2005 2004
FINANCING ACTIVITIES:
Proceeds from/(principal payments on) short-term borrowings, net 408,707 (263,981)
Net increase in deposits from customers 112,663 150,876
Net increase in bank promissory notes issued 50,511 12,838
Proceeds from grants 3,360 3,285
Proceeds from capital transactions of subsidiaries – 9,445
Proceeds from long-term borrowings, net of debt issuance costs 1,357,125 1,458,082
Principal payments on long-term borrowings (526,852) (868,347)
Principal payments on capital lease obligations (4,468) (7,924)
Payments to shareholders of subsidiaries (198,333) (108,165)
Dividends paid (8,752) (5,162)
Proceeds from issuance of common stock, net of issuance costs 1,284,649 –
Net cash provided by financing activities $ 2,478,610 $ 380,947
(DECREASE)/INCREASE IN CASH AND CASH EQUIVALENTS $ (21,100) $ 220,582
CASH AND CASH EQUIVALENTS, beginning of the year 503,747 283,165
CASH AND CASH EQUIVALENTS, end of the year $ 482,647 $ 503,747
CASH PAID DURING THE YEAR FOR:
Interest $ (204,171) $ (265,779)
Income taxes (708,505) (487,447)
NON-CASH INVESTING AND FINANCING ACTIVITIES:
Property, plant and equipment contributed free of charge $ 6,259 $ 13,597
Equipment acquired through vendor financing 2,533 20,714
Equipment acquired under capital leases 7,738 6,393
In addition, non-cash investing activities for the years ended December 31, 2005 and 2004 included acquisitions and dispositions of subsidiaries
and affiliates, as described in Notes 3 and 4.
See notes to consolidated financial statements.
Consolidated statements of cash flows
9
CONSOLIDATED FINANCIAL STATEMENTS
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JSFC SISTEMA AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2005 AND 2004
(Amounts in thousands of U.S. dollars)
Share Additional Retained Accumulated Totalcapital paid-in earnings other compre-
capital hensive income
Balances at January 1, 2004 $ 171 $ 189,934 $ 789,474 $ 15,921 $ 995,500
Capital transactions of subsidiaries, net of minority – 8,948 – – 8,948
interest of $2,628 and income tax of nil (Note 4)
Unrealized gain on securities available for sale, – – – 1,967 1,967
net of income tax of nil
Change in fair value of interest rate swaps, net – – – (257) (257)
of income tax effect of $64
Translation adjustment, net of minority interest – – – 29,979 29,979
of $28,582 and income tax of nil
Dividends declared – (5,162) – (5,162)
Increase of par value of shares 24,919 – (24,919) – –
Net income – – 411,227 – 411,227
Balances at January 1, 2005 $ 25,090 $ 198,882 $ 1,170,620 $ 47,610 $ 1,442,202
Issuance of common stock (Note 28) 4,967 1,279,682 – – 1,284,649
Disposal of a subsidiary, net of income tax – 1,179 – – 1,179
of nil (Note 4)
Unrealized gain on securities available – – – 1,622 1,622
for sale, net of income tax effect of nil
Change in fair value of interest rate swaps, – – – 1,701 1,701
net of income tax effect of $537
Translation adjustment, net of minority interest – – – (23,368) (23,368)
of $26,757 and income tax of nil (Note 2)
Dividends declared (Note 28) – – (8,752) – (8,752)
Net income – – 534,408 – 534,408
Balances at December 31, 2005 $ 30,057 $ 1,479,743 $ 1,696,276 $ 27,567 $ 3,233,643
See notes to consolidated financial statements.
Consolidatedstatements of changes in shareholders’ equity
10 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
JSFC SISTEMA AND SUBSIDIARIES
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JSFC SISTEMA AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2005 AND 2004
(Amounts in thousands of U.S. dollars, except share and per share amounts or if otherwise stated)
1. DESCRIPTION OF BUSINESS
The financial statements of JSFC Sistema and subsidiaries (the “Group”) reflect the consolidation of separate
financial statements of operating entities related by means of direct or indirect ownership of a majority voting
interest by the Group’s holding company, JSFC Sistema. Most of the consolidated entities and the parent compa-
ny are incorporated in the Russian Federation (“RF”).
The controlling shareholder of JSFC Sistema is Vladimir P. Evtushenkov. Minority holdings are held by certain top
executives or former top executives of the Group. Commencing from February 2005, 19% of outstanding shares
of the Group are traded on the London Stock Exchange in the form of GDRs (Note 28).
The principal activities of the significant entities of the Group are as follows:
Operating Entities Short Name Principal activity
JSFC Sistema JSFC Sistema Investing and financing activities
Telecommunications Segment:
MTS and subsidiaries Comstar-UTS MTS Wireless telecommunication services
and subsidiaries Comstar-UTS Fixed-line telecommunication services, data
transmission and internet services
Technology Segment:
Concern SITRONICS and subsidiaries SITRONICS Production and marketing of integrate circuits,
wafers, electronic devices and consumer eletronics,
research and development. IT and systems integration,
computer hardware and software distribution
Insurance Segment:
ROSNO and subsidiaries ROSNO Medical, property, casualty, life and personal
insurance and reinsurance, administration of state
medical insurance programs
Banking Segment:
Moscow Bank for Reconstruction MBRD Banking activities, securities transactions and
and Development and subsidiaries foreign currency transactions
Notes to consolidatedfinancial statements
11
CONSOLIDATED FINANCIAL STATEMENTS
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The principal activities of the significant entities of the Group are as follows (continued):
Operating Entities Short Name Principal activity
Real Estate Segment:
Sistema-Hals and subsidiaries Sistema-Hals Development and marketing of real estate
projects in Moscow
Mass Media Segment:
Sistema Mass Media and subsidiaries Sistema Production and distribution of periodicals,
Mass Media publishing activities, broadcasting, advertising
Retail Segment:
Detsky Mir and subsidiaries Detsky Mir Retail trading in Moscow and other Russian
cities, rent of premises
Detsky Mir-Center and subsidiaries DM-Center
Other businesses:
VAO Intourist and subsidiaries Intourist Sale of tour packages in the RF and abroad
Concern RTI Systems and subsidiaries Concern RTI Manufacturing of radiotechnical equipment, research
and development
ECU GEST Holding S.A. and subsidiaries Sistema Investing in real estate projects, financing activities
International
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation — The accompanying consolidated financial statements have been prepared in conform-
ity with the accounting principles generally accepted in the United States of America (“U.S. GAAP”). The Group’s
Russian entities maintain accounting records in Russian rubles in accordance with the requirements of Russian
accounting and tax legislation. The accompanying financial statements differ from the financial statements pre-
pared for statutory purposes in Russia in that they reflect certain adjustments, appropriate to present the finan-
cial position, results of operations and cash flows in accordance with U.S. GAAP, which are not recorded in
the accounting books of the Group’s entities.
Principles of Consolidation — The consolidated financial statements include the accounts of JSFC Sistema,
as well as entities, where JSFC Sistema has operating and financial control through direct or indirect ownership
of a majority voting interest. The consolidated financial statements also include accounts of variable interest
entities where the Group is a primary beneficiary. All significant intercompany transactions, balances and unre-
alized gains (losses) on transactions have been eliminated.
Notes to consolidatedfinancial statements
12 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
JSFC SISTEMA AND SUBSIDIARIES
_ g g / / g
The beneficial ownership interest of JSFC Sistema and proportion of voting power of the Group in the significant
subsidiaries as of December 31, 2005 and December 31, 2004 are as follows:
Operating entities Ownership interest Proportion of voting power2005 2004 2005 2004
MTS and subsidiaries: 53%(1) 51%(1) 53% 51%
Ukrainian Mobile Communications (“UMC”) 53%(1) 51%(1) 100% 100%
Telecom XXI Merged(3) 51%(1) Merged 100%
Kuban-GSM Merged(3) 51%(1) Merged 100%
Telecom-900 Merged(3) 51%(1) Merged 100%
SCS-900 53%(1) 51%(1) 100% 100%
FECS-900 53%(1) 51%(1) 100% 100%
Uraltel 53%(1) 51%(1) 100% 100%
ReCom 53%(1) 27%(1) 100% 54%
BM-Telecom 53%(1) 51%(1) 100% 100%
TAIF-Telcom 53%(1) 51%(1) 100% 100%
Dontelecom Merged(3) 51%(1) Merged 100%
Sibchallenge 53%(1) 51%(1) 100% 100%
Tomsk Cellular Communications 53%(1) 51%(1) 100% 100%
Primtelefon 53%(1) 51%(1) 100% 100%
Uzdunrobita 39%(1) 37%(1) 74% 74%
Gorizont-RT 53%(1) 39%(1) 100% 76%
Telesot-Alania 53%(1) 27% 100% 53%
Barash 53%(1) n/a 100% n/a
Comstar-UTS and subsidiaries: 100%(1) (2) 77%(1) 100% 100%
MGTS 46%(1) 46% 56% 56%
MTU-Inform 99%(1) 76%(1) 99% 99%
Telmos 100%(1) 62%(1) 100% 80%
MTU-Intel 100%(1) 87%(1) 100% 100%
Golden Line 100%(1) 87%(1) 100% 100%
Tymenneftegazsvyaz 75%(1) n/a 89% n/a
Concern SITRONICS and subsidiaries: 78% 78% 78% 78%
STROM telecom 78%(1) 52%(1) 100% 67%
Kvazar-Micro 40%(1) 50%(1) 51% 51%
NIIME and Micron (“Micron”) 60%(1) 60%(1) 77% 76%
SITRONICS 78%(1) 78% 100% 100%
ROSNO 49%(1) 49%(1) 51% 51%
MBRD 95%(1) 82%(1) 99% 86%
Intourist 72% 91% 72% 91%
DM-Center 100% 100% 100% 100%
Detsky Mir 75%(1) 75%(1) 75% 75%
Sistema-Hals 100%(1) 100%(1) 100% 100%
Concern RTI 100% 100% 100% 100%
ECU GEST 100% 99% 100% 99%
(1) — Including indirect ownership.(2) — Based on the number of outstanding shares. (3) — Subsidiaries of MTS merged with MTS in July 2005.
Notes to consolidatedfinancial statements
13
CONSOLIDATED FINANCIAL STATEMENTS
_ g g / / g
Accounts of newly-acquired subsidiaries have been consolidated in the Group’s financial statements from
the beginning of the year, in which the control was acquired, with preacquisition earnings of an interest pur-
chased during the year included in minority interest in the consolidated statement of operations.
Consolidation of Variable Interest Entities — In December 2003, the Financial Accounting Standards Board
(“FASB”) issued a revision to Interpretation No. 46, “Consolidation of Variable Interest Entities, an Interpretation
of ARB No. 51” (“FIN 46R” or the “Interpretation”). FIN 46R clarifies the application of Accounting Research
Bulletin (“ARB”) No. 51, “Consolidated Financial Statements”, to certain entities in which equity investors do not
have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity
to finance its activities without additional subordinated financial support. FIN 46R requires the consolidation
of these entities, known as variable interest entities (“VIEs”), by the primary beneficiary of the entity. The pri-
mary beneficiary is the entity, if any, that will absorb a majority of the entity’s expected losses, receive a major-
ity of the entity’s expected residual returns, or both. Among other changes, the revisions of FIN 46R (a) clarified
some requirements of the original FIN 46, which had been issued in January 2003, (b) eased some implementa-
tion problems, and (c) added new scope exceptions.
Following the adoption of FIN 46R in the consolidated financial statements for the year ended December 31, 2004,
the Group reevaluated the relationships with certain of its related parties: Promtorgcenter, Notris, Laminea,
Finescort-M, Kuntsevo-Invest, Putney Assets and Mosdachtrest. Kuntsevo-Invest and Mosdachtrest are engaged
in construction activities of the Group. Promtorgcenter, Notris, Laminea, Finescort-M and Putney Assets hold
equity interests in and provide financing through loans to other entities of the Group. Mosdachtrest was
accounted for under the equity method for the periods prior to January 1, 2004. The Group determined that
these entities were variable interest entities and that it was their primary beneficiary. Accordingly, the Group
has consolidated these companies effective January 1, 2004. All intercompany balances have been eliminated in
consolidation and the results of these VIEs have been included in the Group’s consolidated statement of opera-
tions and statement of cash flows for the years ended December 31, 2005 and 2004. In accordance with the pro-
visions of FIN 46R, the Group recorded a charge for the cumulative effect of this accounting change of $35.5 mil-
lion, net of income tax of nil, in the year ended December 31, 2004. This charge reflects the cumulative impact
to the Group’s results of operations had these VIEs been consolidated since their inception.
Use of Estimates — The preparation of financial statements in conformity with U.S. GAAP requires management
to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure
of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues
and expenses of the reporting period. Actual results could differ from those estimates.
Examples of significant estimates include the allowance for doubtful accounts, the recoverability of intangible
assets and other long-lived assets, and valuation allowances on deferred tax assets.
Concentration of Business Risk — The Group’s principal business activities are within the RF. Laws and regu-
lations affecting businesses operating in the RF are subject to rapid changes, which could impact the Group’s
assets and operations.
Foreign Currency Translation — The Group follows a translation policy in accordance with Statement on
Financial Accounting Standards (“FAS”) No. 52, “Foreign Currency Translation”.
Management has determined that the functional currency of MGTS, ROSNO, Micron, Detsky Mir, DM-Center,
Sistema Mass Media and Concern RTI is the Russian ruble (“RUR”). Commencing January 1, 2005, RUR was deter-
mined as MBRD’s functional currency following the increased ratio of RUR-denominated transactions in MBRD’s
operations. The functional currency of UMC is the Ukrainian hryvnia (“UAH”) and the functional currency
of STROM telecom is the Czech krona. Management believes that U.S. dollar (“USD”) is the appropriate functional
currency for the other subsidiaries of the Group due to the pervasive use of the U.S. dollar in their operations.
Notes to consolidatedfinancial statements
14 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
JSFC SISTEMA AND SUBSIDIARIES
_ g g / / g
The Group has selected the USD as its reporting currency and translates into USD financial statements of sub-
sidiaries with functional currencies other than USD. Assets and liabilities are translated at the exchange rates
current at the balance sheet date, while income and expense items are translated at average rates of exchange
prevailing during the period. The resulting translation adjustment loss in the amount of $23.4 million for
the year ended December 31, 2005 and translation adjustment gain in the amount of $30.0 million for the year
ended December 31, 2004, net of minority interests of $26.8 million and $28.6 million, respectively, were record-
ed as a separate component of other comprehensive income.
The ruble is not a fully convertible currency outside of the territory of the Russian Federation. The translation
of RUR denominated assets and liabilities into USD for the purpose of these financial statements does not indi-
cate that the Group could or will in the future convert the reported values of the assets and liabilities into USD.
Revenue Recognition — The Telecommunications Segment of the Group earns revenues from the provision
of wireless and wireline telecommunication and data transmission services and usage of its exchange networks
and facilities. Segment revenues consist of (i) usage charges, (ii) monthly subscription fees, (iii) service activa-
tion and connection fees, (iv) revenues from use of prepaid phone cards, (v) charges for value-added telecom-
munication services, (vi) roaming fees charged to other operators for guest roamers utilizing the Group’s network
and (vii) equipment sales. The Group records revenues over the periods they are earned as follows:
(i) Revenues derived from wireless and wireline telephone usage and data transmission are recognized
as the services are provided.
(ii) Monthly telephone and network service fees are recognized in the month during which the telephone serv-
ices are provided to customers.
(iii) Upfront fees received for installation and activation of wireless, wireline and data transmission services
(“connection fees”) are deferred and recognized over the expected subscriber relationship period. MTS calcu-
lates an average expected term of the subscriber relationship for each region in which it operates and amor-
tizes regional connection fees accordingly. Average expected subscriber life ranged from 20 to 76 months
in the year ended December 31, 2004 and from 12 to 60 months in the year ended December 31, 2005.
The effect of change in estimate in the year ended December 31, 2005 was not material. The customer rela-
tionship period for residential wireline voice phone subscribers is 15 years. For all other categories of sub-
scribers, except for residential subscribers of broadband internet services, the customer relationship period
is estimated at 3 to 5 years. Average expected subscriber life for residential subscribers of broadband inter-
net services was 3 years in the year ended December 31, 2004. Effective July 1, 2005, the Group has changed
its estimates of average subscriber lives for residential subscribers of the broadband internet services from
3 years to 1 year. The effect of this change in estimate in the year ended December 31, 2005 was an increase
in net income of approximately $4.0 million, net of income tax.
(iv) The Group recognizes revenues from prepaid phone cards in the period when customer uses time under
the phone card. Unused time on sold cards is not recognized as revenues until the related services have
been provided to the customer or the card has expired. Revenues under prepaid service tariff plans, where-
by a customer may purchase a package that allows a connection to the Group’s wireless network and a pre-
determined allotment of wireless phone calls and/or other services offered by the Group, are allocated
between connection fees and service fees based on their relative fair values.
(v) Revenues derived from value-added telecommunication services are recognized in the period when
the services are provided to customers.
(vi) The Group charges roaming per-minute fees to other wireless operators for their subscribers utilizing
the Group’s networks. Revenues derived from roaming services are recognized as services are provided.
(vii) The Group sells handsets and accessories to customers who are entering into contracts for service and
as separate distinct transactions. The Group recognizes revenues from the handsets and accessories when
title passes to the customer. Estimated returns are recorded as a direct reduction of sales at the time
the related sales are recorded. In Ukraine, the Group also from time to time sells handsets at prices below
cost. The Group recognizes these subsidies in cost of equipment when sale is recorded.
Notes to consolidatedfinancial statements
15
CONSOLIDATED FINANCIAL STATEMENTS
_ g g / / g
Local telephone services, provided by MGTS, totaling approximately 4% and 5% of the consolidated revenues
for the years ended December 31, 2005 and 2004, respectively, are regulated tariff services, and changes in rate
structure are subject to the Federal Tariff Service approval.
Prior to January 1, 2005, MGTS was required to grant discounts ranging from 20% to 100% on installation and
monthly fees to certain categories of residential subscribers, such as pensioners, military veterans and disabled
individuals, and was entitled to reimbursement from the federal budget for these discounts. Due to the lack
of certainty of reimbursement, MGTS accounted for such revenues upon collection. According to the new Law
on Communications, effective January 1, 2005, all MGTS’ subscribers are required to pay the full price for resi-
dential service, and those entitled to discounts are to receive reimbursement from the government rather
than discounts from MGTS. The amount of discounts provided by MGTS for the year ended December 31, 2004 was
$26.3 million.
The Technology Segment of the Group earns revenues from (i) manufacturing and distribution of IT and telecom-
munication equipment, consumer electronics and other electronic devices, and semiconductor products;
(ii) manufacturing and distribution of software products; and (iii) system integration services. The Group records
revenues over the periods they are earned as follows:
(i) Revenues from manufacturing and distribution of equipment and semiconductor products are recognized
when the product has been delivered, risk of loss has passed to the buyer, collection of the resulting receiv-
able is probable, persuasive evidence of an arrangement exists, and the price to the buyer is fixed or deter-
minable. Because of frequent sales price reductions and rapid technology obsolescence in the Technology
Segment, sales made to dealers under agreements allowing price protection and/or right of return
are deferred until the dealers sell the merchandise.
The Group enters into arrangements with certain manufacturers and distributors of consumer electronics devices
to perform assembly of their products at the Group’s facilities. In those cases where the Group buys components
from and subsequently sells the assembled devices to the same counterparty, the Group records only the net
amount retained as its revenues.
(ii) The Group’s arrangements with end users of its telecommunication and other software products include sales
of software licenses, as well as installation, training and postcontract support services. These arrangements
are accounted for in accordance with the Statement of Position (“SOP”) No. 97-2, “Software Revenue
Recognition”. The aggregate arrangement fee is allocated to each of the undelivered elements in an amount
equal to its fair value with the residual of the arrangement fee allocated to the delivered elements. Fair val-
ues are based upon vendor-specific objective evidence. Fees allocated to each element of an arrangement
are recognized as revenue when the following criteria have been met: (a) a written contract for the delivery
of an element has been executed, (b) the Group has delivered the product to the customer, (c) the fee receiv-
able is fixed or determinable, and (d) collectibility of the resulting receivable is deemed probable. If evidence
of fair value of the undelivered elements of the arrangement does not exist, all revenue from the arrange-
ment is deferred until such time evidence of fair value does exist, or until all elements of the arrangement
are delivered. Fees allocated to postcontract support are recognized as revenue ratably over the support peri-
od. Fees allocated to other services are recognized as revenue as services are performed.
During the years ended December 31, 2005 and 2004, the Group did not sell installation, training or postcontract
support services, as well as upgrades or enhancements to existing software products, separately from other ele-
ments of its software arrangements. The vendor-specific objective evidence of fair value of installation, training
and postcontract support services, as well as upgrades or enhancements to existing products, has been estab-
lished by management having the relevant authority. The management believes that it is probable that
the established price (based on rates per hour) for such services will not change before their separate introduc-
tion into the marketplace.
Notes to consolidatedfinancial statements
16 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
JSFC SISTEMA AND SUBSIDIARIES
_ g g / / g
(iii) The Group’s arrangements with its customers regarding system integration services typically include mul-
tiple elements, such as equipment and software, installation services and postcontract support. A multiple-
element arrangement is separated into more than one unit of accounting if all of the following criteria are
met: (a) the delivered items have value to the customer on a standalone basis; (b) there is objective and
reliable evidence of the fair value of the undelivered items; (c) if the arrangement includes a general right
of return relative to the delivered items, delivery or performance of the undelivered items is considered
probable and substantially in the control of the Group. If evidence of fair value of the undelivered elements
of the arrangement does not exist, all revenue from the arrangement is deferred until such time evidence
of fair value does exist, or until all elements of the arrangement are delivered. Fees allocated to postcon-
tract support are recognized as revenue ratably over the support period. Fees allocated to other services
are recognized as revenue as services are performed.
Premiums on written non-life insurance of the Insurance Segment are recognized on a pro-rata basis over
the term of the related policy coverage, normally not exceeding 1 year. The unearned premium provision repre-
sents that portion of premiums written relating to the unexpired term of the policy. Premiums from traditional
life and annuity policies with life contingencies are recognized as revenue when due from the policyholder.
Interest income of the Banking Segment is recognized on accrual basis. Loans are placed on non-accrual status
when interest or principal is delinquent for a period in excess of 90 days, except when all amounts due are fully
secured by cash or marketable securities and collection proceedings are in process. Interest income is not rec-
ognized where recovery is doubtful. Loans are written off against allowance for loan losses in case of uncol-
lectibility of loans and advances, including through repossession of collateral.
In the year ended December 31, 2005, revenues on the construction-type contracts of the Real Estate Segment
were recognized using the percentage of completion method in accordance with SOP 81-1 “Accounting
for Performance of Construction-Type and Certain Production-Type Contracts”. Progress towards completion
is measured by percentage of costs incurred to date to the estimated total costs at completion for each contract
(the “cost-to-cost” method). The Group carries the projects at cost until the project is at least 30% complete,
as on most of its contracts the Group is not able to reliably estimate costs to complete the project and contrac-
tual revenues until the project is 30% complete. The Group does not recognize revenues on contracts until rea-
sonably dependable estimates of costs to complete the project and contractual revenues can be made. Revenues
on other types of contracts of the Real Estate Segment are recognized in accordance with FAS 66, “Accounting
for Sales of Real Estate”.
Prior to January 1, 2005, the Group recognized revenues on construction-type contracts using the completed
contract method as reasonably dependable estimates of the extent of progress towards completion, contract rev-
enues and contracts costs in most cases could not be made. The change in accounting principle effective January
1, 2005 was accounted for retroactively. The effect of the change for the year ended December 31, 2004 was
an increase in sales of $22.7 million, an increase in cost of sales of $24.7 million, an increase in selling, general
and administrative expenses of $0.6 million, a decrease in depreciation and amortization expenses of $2.6 mil-
lion and increase in retained earnings of $6.2 million.
In arrangements where the Group acts as an agent, including travel agency arrangements and arrangements
to administer construction projects, only the net agency fee is recognized as revenue.
The other Group’s entities recognize revenues when products are shipped or when services are rendered to cus-
tomers.
Notes to consolidatedfinancial statements
17
CONSOLIDATED FINANCIAL STATEMENTS
_ g g / / g
Cash and Cash Equivalents — Cash and cash equivalents include cash on hand, amounts on deposit in banks,
cash invested temporarily in various instruments with maturities of three months or less at time of purchase and
minimum reserve deposits with the Central Bank of the Russian Federation. Short-term interbank loans origi-
nated by MBRD with original maturities of three months or less are included in loans to customers and banks.
Financial Instruments — The Group’s financial instruments include cash, short-term and long-term invest-
ments, receivables, payables and debt. Except as described below, the estimated fair value of such financial
instruments as of December 31, 2005 approximated their carrying value as reflected in the consolidated balance
sheet. The fair value of the Group’s publicly traded long-term notes as of December 31, 2005 ranged from 101.3%
to 106.6% of the principal amount. As of December 31, 2005, fair value of other fixed rate debt, including capi-
tal lease obligations and variable rate debt approximated carrying value.
From time to time, in its acquisitions the Group uses derivative instruments, consisting of put and call options
on all or part of the minority stakes of acquired companies, to defer payment of the purchase price and provide
optimal acquisition structuring. In addition, in December 2004, the Group entered into two variable-to-fixed
interest rate swap agreements to manage its exposure to changes in fair value of future cash flows of its variable-
rate long term debt, which is caused by interest rate fluctuations. In March 2005 and October 2005, the Group
also entered into several short-term USD forward agreements to hedge the fair value of its investments in ruble-
denominated financial instruments. The Group does not use derivatives for trading purposes.
The Group accounts for derivative instruments in accordance with FAS No. 133, “Accounting for Derivative
Instruments and Hedging Activities” and FAS No. 149, “Amendment of Statement 133 on Derivative Instruments
and Hedging Activities”. All derivatives, including some embedded derivatives, are measured at fair value and
recognized as either assets or liabilities on balance sheets. The Group’s interest rate swap and foreign currency
forward agreements are designated as a cash flow hedge and the hedging relationship qualifies for hedge
accounting. The effective portion of the change in fair value of interest rate swap agreements is, accordingly,
recorded in other comprehensive income and reclassified to interest expense when the hedged debt affects
the interest expense. Changes in fair value of other derivative instruments are recognized in net income as those
instruments were not designated as hedges.
At the inception of the hedge and on a quarterly basis, the Group performs an analysis to assess whether changes
in cash flows of its interest rate swap agreements are deemed highly effective in offsetting changes in cash flows
of the hedged debt. If at any time the correlation assessment will indicate that the interest rate swap agree-
ments are no longer effective as a hedge, the Group will discontinue hedge accounting and all subsequent
changes in fair value will be recorded in net income.
MBRD also enters into sale and purchase back agreements (“repos”) and purchase and sale back agreements
(“reverse repos”) in the normal course of its business. A repo is an agreement to transfer a financial asset
to another party in exchange for cash or other consideration and a concurrent obligation to reacquire the finan-
cial assets at a future date for an amount equal to the cash or other consideration exchanged plus interest.
Assets sold under repos are retained in the financial statements and a consideration received is recorded in lia-
bilities as collateralized deposit received. A reverse repo is an agreement to purchase assets and resell them at a
future date with accrued interest received. Assets purchased under reverse repos are recorded in the financial
statements as cash received on deposit which is collateralized by securities or other assets. In December 2005,
JSFC Sistema entered into a repurchase operation on sale and purchase back of approximately 11% of Comstar-
UTS shares. The respective repurchase was completed in February 2006 (Note 21).
Accounts Receivable — Accounts receivable are stated at their net realizable value after deducting an
allowance for doubtful accounts. Such provisions reflect either specific cases of delinquencies or defaults or esti-
mates based on evidence of collectibility.
Notes to consolidatedfinancial statements
18 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
JSFC SISTEMA AND SUBSIDIARIES
_ g g / / g
Loans to Customers and Banks — Loans to customers and banks arise out of operations of the Banking
Segment. The determination of the allowance for losses in respect of loans provided by MBRD is based on an
analysis of the loan portfolio and reflects the amount, which, in the judgment of management of the Group, is
adequate to provide for losses inherent in the loan portfolio. A specific provision is made as a result of a detailed
appraisal of risk assets.
Management’s evaluation of the allowance is based on MBRD’s past loss experience, known and inherent risks
in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any
underlying collateral and current economic conditions. It should be understood that estimates of loan losses
involve an exercise of judgment. While it is possible that in particular periods MBRD may sustain losses, which
are substantial relative to the allowance for loan losses, it is the judgment of management that the allowance
for loan losses is adequate to absorb losses inherent in the loan portfolio.
Insurance-related Receivables — Insurance-related receivables include receivables arising from insurance
operations and advances to health care providers under voluntary and obligatory medical insurance programs.
Receivables arising from insurance operations consist of outstanding direct premiums due from policyholders,
outstanding assumed premiums due from ceding companies and receivables due from claims ceded.
Policy Acquisition Costs — Policy acquisition costs represent costs of the acquisition or renewal of insurance
policies by ROSNO. They are deferred as an asset and are amortized over the period for which costs are expected
to be recoverable out of associated revenues. Deferred acquisition costs are included in other receivables and pre-
paid expenses, net of the unexpired risk provision, that is recognized when unearned premiums are insufficient
to meet claims and expenses, which may be incurred after the end of the financial year.
Subscriber Acquisition Costs — Subscriber acquisition costs represent the direct costs paid for each new sub-
scriber. The Group expenses these costs as incurred.
Inventories and Spare Parts — Inventories and spare parts are stated at the lower of cost or market. The cost
of MGTS’ inventories (including mostly spare parts) is computed on an average cost basis. Cost of goods for resale
held by retail businesses of the Group is determined using the retail method. Other subsidiaries of the Group
account for their inventories using the first-in-first-out (“FIFO”) cost method.
Cost of raw materials includes cost of purchase, customs duties, transportation and handling costs. Work-in-
progress and finished goods are stated at production cost which includes direct production expenses and manu-
facturing overheads. Project costs include the accumulated costs of projects contracted with third parties, net
of related progress billings. The entities of the Group periodically assess their inventories for obsolete or slow
moving stock.
Vendor Programs — Funds received by SITRONICS from its vendors for price protection, vendor rebates, mar-
keting, training, product returns and promotion programs are recorded when earned as adjustments to product
costs, revenue, or selling, general and administrative expenses according to the nature of the program.
Value-Added Taxes (“VAT”) — Value-added taxes related to sales are payable to the tax authorities on an
accrual basis based upon invoices issued to the customer. VAT incurred for purchases may be reclaimed, subject
to certain restrictions, against VAT related to sales. VAT related to purchase transactions that are not reclaimable
as of the balance sheet dates are recorded as VAT receivable in the accompanying financial statements.
Property, Plant and Equipment — For subsidiaries acquired by the Group through business combinations
accounted for by the purchase method, property, plant and equipment (“PP&E”) was assigned their fair values at
the acquisition date. If fair values of the identifiable net assets of the acquired entities exceeded acquisition
cost, the fair values of non-current assets held by the acquired entities at the acquisition date, including PP&E,
were reduced by such excess. All subsequent additions to PP&E have been recorded at cost.
Notes to consolidatedfinancial statements
19
CONSOLIDATED FINANCIAL STATEMENTS
_ g g / / g
Cost includes major expenditures for improvements and replacements, which extend useful lives of the assets
or increase their revenue generating capacity. Repairs and maintenance are charged to the statement of opera-
tions as incurred.
Capital leases are recorded at the lower of the fair market value of the asset or the present value of future min-
imum lease payments. The discount rate used in determining present value of the minimum lease payments
is the Group’s incremental borrowing rate, unless (1) it is practicable to learn the implicit rate computed by
the lessor and (2) the implicit rate is less than the Group’s incremental borrowing rate. If both of those condi-
tions are met, the interest rate implicit in the lease is used.
Depreciation is computed under the straight-line method utilizing estimated useful lives of the assets as follows:
Buildings 20–50 years
Leasehold improvements Lesser of the estimated useful
life or the term of the lease
Switches and transmission devices 10–31 years
Network and base station equipment 5–12 years
Other property, plant and equipment 3–15 years
Items of property, plant and equipment that are retired or otherwise disposed of are eliminated from the con-
solidated balance sheet along with the corresponding accumulated depreciation. Any gain or loss resulting from
such retirement or disposal is included in the determination of consolidated net income.
Construction-in-progress and equipment for installation are not depreciated until an asset is placed into service.
As a result of numerous restatements of financial statements for the fiscal year ended December 31, 2004, by U.S.
public companies and publication of a letter by the Chief Accountant of the U.S. Securities and Exchange
Commission (“SEC”) regarding the interpretation of longstanding lease accounting principles, MTS has corrected
its accounting practices for the leasehold improvements in the fourth quarter of 2004. The primary effect of this
accounting correction was to accelerate to earlier periods depreciation expenses with respect to certain compo-
nents of previously capitalized leasehold improvements.
These corrections resulted in a net cumulative charge to net income of $17.7 million in the fourth quarter
of 2004, of which $10.9 million relates to the years 1998 through 2003. The net cumulative charge is comprised
of a $44.5 million increase in depreciation expense related primarily to depreciation of capitalized leasehold
improvements for base stations; a decrease of $1.4 million in the equity net income from the MTS-Belarus also
related to depreciation of capitalized leasehold improvements expenses for base stations positions; increase
of $11.0 million related to additional deferred tax benefit due to the change in accounting base for property,
plant and equipment; and decrease in minority interest of $17.2 million.
All components of the net charge are non-cash and do not impact historical or future cash flows or the timing
of payments under the related leases.
Asset Retirement Obligations — In accordance with FAS No. 143, “Accounting for Asset Retirement
Obligations”, the Group calculates an asset retirement obligation and an associated asset retirement cost when
the Group has a legal obligation in connection with the retirement of tangible long-lived assets. The Group’s
obligations under FAS No. 143 arise from certain of its leases and relate primarily to the cost of removing equip-
ment from such lease sites. As of December 31, 2005, the estimated asset retirement obligations were not signif-
icant to the Group’s consolidated financial position and results of operations.
Notes to consolidatedfinancial statements
20 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
JSFC SISTEMA AND SUBSIDIARIES
_ g g / / g
License Costs — Costs of licenses for providing telecommunication services are capitalized as a result of (a) pur-
chase price allocated to licenses acquired in business combinations (Note 3) and (b) licenses purchased directly
from government organizations, which require license payments.
Current operating licenses of the Group do not provide for automatic renewal upon expiration. As the Group and
the telecommunications industry do not have sufficient experience with the renewal of licenses, license costs
are being amortized, subject to periodic review for impairment, on the straight-line basis over the initial term
of the license without consideration of possible future renewals commencing from the date such license area
becomes commercially operational.
Goodwill and Other Intangible Assets — Goodwill represents the excess of the cost of business acquired over
the fair value of identifiable net assets at the date of acquisition. Goodwill is reviewed annually for impairment
or whenever it is determined that the impairment indicators exist. The Group determines whether an impairment
has occurred by assigning goodwill to the reporting unit identified in accordance with FAS No. 142, “Goodwill and
Other Intangible Assets”, and comparing the carrying amount of the reporting unit to the fair value of
the reporting unit. If a goodwill impairment has occurred, the Group recognizes a loss for the difference between
the carrying amount and the implied fair value of goodwill. No material impairment of goodwill was identified
in the years ended December 31, 2005 and 2004.
The carrying amount of goodwill attributable to each reportable operating segment with goodwill balances and
changes therein, are as follows:
(000’s)Telecom- Insurance Corporate Total
munications and Other
Balance as of January 1, 2004 $ 71,363 $ – $ 635 $ 71,998
Purchase price allocation 101,002 1,341 – 102,343
Balance as of December 31, 2004 172,365 1,341 635 174,341
Purchase price allocation 156,591 – – 156,591
Balance as of December 31, 2005 $ 328,956 $ 1,341 $ 635 $ 330,932
Other intangible assets represent acquired customer bases, trademarks, roaming contracts with other telecommu-
nications operators, telephone numbering capacity, rights to use radio frequencies, rights to use premises and var-
ious purchased software costs. Trademarks and telephone numbering capacity with unlimited contractual life are
not amortized, but are reviewed, at least annually, for impairment in accordance with the provisions of FAS No. 142.
Acquired customer bases commencing January 1, 2005, are amortized over the estimated average subscriber life
from 32 to 60 months. In the year ended December 31, 2004, the average subscriber life ranged from 20 to 76 months.
Telephone numbering capacity with limited contractual life and the rights to use premises are being amortized
over their contractual lives, which vary from five to twenty years. Rights to use radio frequencies are amortized
over the period of the contractual life from three to fifteen years. Software costs and other intangible assets
are being amortized over three to fifteen years. All finite-life intangible assets are being amortized using
the straight-line method.
Investments — The Group’s share in net assets and net income of certain entities, where the Group holds
20 to 50% of voting shares and has the ability to exercise significant influence over their operating and finan-
cial policies (“affiliates”) is included in the consolidated net assets and operating results using the equity
method of accounting. Due to the Group’s day-to-day involvement in the affiliates’ business activities,
the Group’s share of their income is recorded within the operating income.
Notes to consolidatedfinancial statements
21
CONSOLIDATED FINANCIAL STATEMENTS
_ g g / / g
Investments in corporate shares where the Group owns more than 20% of voting shares, but does not have
the ability or intent to control or exercise significant influence over operating and financial policies,
are accounted for at cost of acquisition. Management periodically assesses realizability of the carrying values
of such investments and records impairment charges, if required.
Trading securities held by the Group are stated at market value. Unrealized holding gains and losses for trading
securities are included in earnings.
The Group also purchases promissory notes for investing purposes. These notes are carried at cost and the dis-
count against the nominal value is accrued over the period to maturity. A provision is made, based on manage-
ment assessment, for notes that are considered uncollectible.
Debt Issuance Costs — Debt issuance costs are amortized using the effective interest method over the terms
of the related loans. Debt issuance costs amounted to $82.7 million and $27.3 million, net of accumulated amor-
tization of $28.7 million and $11.7 million as of December 31, 2005 and 2004, respectively.
Impairment of Long-lived Assets — The Group periodically evaluates the recoverability of the carrying amount
of its long-lived assets in accordance with FAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived
Assets”. Whenever events or changes in circumstances indicate that the carrying amounts of those assets may
not be recoverable, the Group compares undiscounted net cash flows estimated to be generated by those assets
to the carrying amount of those assets. When these undiscounted cash flows are less than the carrying amounts
of the assets, the Group records impairment losses to write the asset down to fair value, measured by the esti-
mated discounted net future cash flows expected to be generated from the use of the assets. Management is not
aware of any indicators of impairment occurred relating to the Group’s investments in long-lived assets during
the years ended December 31, 2005 and 2004.
Bank Deposits and Notes Issued — Bank deposits and notes issued arise out of operations of the Banking
Segment and include deposits from banks and customers and promissory notes issued.
Insurance-related Liabilities — Insurance-related liabilities arise out of the operations of the Insurance
Segment and include the unearned premium provision, loss provision for outstanding claims, undisbursed funds
of the Government Fund for Obligatory Medical Insurance (“GFOMI”), accumulated under an obligatory medical
insurance program, prepaid insurance and reinsurance premiums and liabilities under deposit type insurance
contracts (policies in force under which the Group does not assume insurance risk).
ROSNO provides for losses on outstanding claims on an individual case basis for the estimated cost of claims noti-
fied but not settled as at the balance sheet date. Provision is also made for the ultimate cost of claims, includ-
ing claims incurred but not reported, or not fully reported. This provision is actuarially determined by line
of business, and includes assumptions based on prior years claims experience. The loss provision for life insur-
ance is actuarially determined based upon mortality, morbidity and interest rate assumptions applied to all life
insurance policies in force as at year-end.
Unexpired risk provision is recognized when unearned premiums are insufficient to meet claims and expenses,
which may be incurred after the end of the financial year. The Group does not consider anticipated investment
income in making determination whether a premium deficiency exist.
GFOMI carries out an obligatory medical insurance program to provide RF citizens with free of charge medical
services via certain appointed insurers, including ROSNO, which has contracted with GFOMI to administer a por-
tion of this program. ROSNO receives advances from GFOMI and makes payments to medical centers in respect
of services provided by them to policyholders. Any funds received from GFOMI by ROSNO, which are not paid out
for medical services, are retained and recorded as a liability. These funds may be spent by the Group only
Notes to consolidatedfinancial statements
22 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
JSFC SISTEMA AND SUBSIDIARIES
_ g g / / g
on the provision of the medical facilities and care, as presently defined under the program. ROSNO does not
assume any insurance risk under this program.
Deferred Revenue — Telecommunication equipment and transmission devices, installed at the newly con-
structed properties in Moscow, have been historically transferred to MGTS free of charge. These assets are capi-
talized by the Group at their market value at the date of transfer. Simultaneously deferred revenue is recorded
in the same amount, which is amortized as a reduction of the depreciation charge in the consolidated statement
of operations over the contributed assets’ life.
Deferred grant revenue represents funds contributed to the Group, which usage is restricted. Deferred grants
are released to income when the conditions of the grant are substantially met.
Income Taxes — Income taxes of the Group’s Russian entities have been computed in accordance with RF laws.
Income tax rate in the RF equals 24%. In July 2004, amendments to Russian income tax legislation were enacted
to increase, effective January 1, 2005, the income tax rate on dividends paid within Russia to 9% (previously 6%).
The foreign subsidiaries of the Group are paying income taxes in their jurisdictions. Income tax rate in
the Ukraine and in the Czech Republic equals 25% and 26%, respectively.
Deferred income taxes are accounted for under the liability method and reflect the tax effect of all significant
temporary differences between the tax bases of assets and liabilities and their reported amounts in the accom-
panying consolidated financial statements. A valuation allowance is provided for deferred tax assets if it is more
likely than not that these items will either expire before the Group will be able to realize the benefit, or
the future deductibility is uncertain.
Stock-based Compensation — MTS accounts for stock options issued to employees, non-employee directors and
consultants following the requirements of FAS No. 123, “Accounting for Stock-Based Compensation” and FAS
No. 148, “Accounting for Stock Based Compensation — Transition and Disclosure, an amendment to FASB Statement
No. 123”. Under the requirements of these statements, MTS elected to use intrinsic value of options on the meas-
urement date as a method for accounting for compensation to employees and non-employee directors.
Compensation to consultants is measured based on the fair value of options on the measurement date as deter-
mined using a binomial option-pricing model.
In 2000, MTS established a stock bonus plan and stock option plan for selected officers, key employees and key
advisors. During its initial public offering in 2000, MTS allotted 9,966,631 shares of it common stock to fund
its option plan.
MTS made grants pursuant to its stock option plan to employees and directors of MTS. These options generally
vest over a two year period from the date of the grant, contingent on continued employment of the grantee with
MTS. A summary of the status of MTS’ option plan is presented below:
Shares Weighted averageexercise price, USD
Outstanding as of January 1, 2004 4,797,410 1.87
Granted 1,665,256 5.95
Exercised (2,726,966) 1.49
Forfeited (204,730) 1.92
Outstanding as of December 31, 2004 3,530,970 4.09
Granted 1,778,694 6.89
Exercised (1,801,622) 2.43
Forfeited (320,802) 5.25
Outstanding as of December 31, 2005 3,187,240 6.47
Notes to consolidatedfinancial statements
23
CONSOLIDATED FINANCIAL STATEMENTS
_ g g / / g
As of December 31, 2005, MTS had the following stock options outstanding:
Exercise price Number of shares Remaining weightedaverage life (years)
5.95 1,417,546 0.54
6.89 1,769,694 1.54
3,187,240
None of the options granted in 2004 and 2005 outstanding at December 31, 2005 were exercisable.
According to the terms of MTS’ option plan, the exercise price of the options equals the average market share
price during the hundred day period preceding the grant date. The difference in the exercise price of the option
and market price at the date of grant is shown as unearned compensation in the consolidated statements
of changes in shareholders’ equity and is amortized to expense over the vesting period of the option. This
amount historically had been insignificant to the consolidated financial statements.
The fair value of options granted during the two years in the period ended December 31, 2005 were estimated
using the binomial option pricing model using the following assumptions:
2005 2004
Risk free rate 4.7% 4.5%
Expected dividend yield 3% 3%
Expected volatility 40.0% 48.8%
Expected life (years) 2 2
Fair value of options (per share) $ 1.74 $ 2.36
If the Group had elected to recognize compensation costs based on the fair values of options at the date
of the grant, net income and earnings per share amounts would have been as follows:
2005 2004
Net income as reported $ 534,408 $ 411,227
Pro-forma effect of the application (907) (545)
of fair value method of accounting
Pro-forma net income $ 533,501 $ 410,682
Earnings per share — basic and diluted
As reported $ 56.4 $ 50.8
Pro-forma $ 56.3 $ 50.7
In accordance with the Russian legislation, MTS’ Board members and key employees may be considered insiders
with respect to the Group and thus may be restricted from selling their shares.
Retirement and Postretirement Benefits — Subsidiaries of the Group contribute to the local state pension
funds and social funds, on behalf of all their employees.
In Russia, all social contributions, including contributions to the pension fund, are substituted with a unified
social tax (“UST”) calculated by the application of a regressive rate from 26% to 2% (from 35.6% to 2% before
Notes to consolidatedfinancial statements
24 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
JSFC SISTEMA AND SUBSIDIARIES
_ g g / / g
January 1, 2005) of the annual gross remuneration of each employee. UST is allocated to three social funds,
including the pension fund, where the rate of contributions to the pension fund varies from 20% to 2% (from
28% to 2% before January 1, 2005) depending on the annual gross salary of each employee. These contributions
are expensed as incurred.
In Ukraine and Czech Republic, the subsidiaries of the Group are required to contribute a specified percentage
of each employee payroll (in Ukraine — up to a fixed limit) to pension fund, unemployment fund and social
security fund. The contributions are expensed as incurred.
In addition, MGTS has historically offered its employees certain benefits upon and after retirement. The cost
of such benefits is recognized during an employee’s years of active service (Note 26). The Group accounts for
pension plans following the requirements of FAS No. 87, “Employers’ Accounting for Pensions” and FAS No. 132R,
“Employers’ Disclosure about Pensions and Other Postretirement Benefits, an amendment of FASB Statements
No. 87, 88 and 106”. The Group’s contributions to the plan assets are managed by Pension Fund Sistema, a sub-
sidiary of Sistema.
Borrowing Costs — Borrowing costs are recognized as an expense in the period in which they are incurred.
Borrowing costs for assets that require a period of time to get them ready for their intended use are capitalized
and amortized over the related assets’ estimated useful lives. The capitalized borrowing costs for the years ended
December 31, 2005 and 2004 amounted to $56.2 million and $34.0 million, respectively.
Advertising Costs — Advertising costs are expensed as incurred. Advertising costs for the years ended
December 31, 2005 and 2004 were $270.0 million and $168.5 million, respectively, and were reflected as a compo-
nent of selling, general and administrative expenses in the accompanying consolidated statements of operations.
Earnings per Share — Basic earnings per share (“EPS”) have been determined using the weighted average num-
ber of shares outstanding during the years ended December 31, 2005 and 2004. Diluted EPS reflect the potential
dilution of MTS’ stock options, granted to employees.
Distributions to Shareholders — Distributable retained earnings of the Group are based on amounts extracted
from statutory accounts of individual entities and may significantly differ from amounts calculated on the basis
of U.S. GAAP.
New Accounting Pronouncements — In September 2004, the SEC staff issued the EITF Topic D-108,
“Use of the Residual Method to Value Acquired Assets Other Than Goodwill”, which requires the companies to use
the direct value method to determine the fair value of the intangible assets acquired in business combinations
completed after September 29, 2004. The SEC staff also announced that companies that currently apply the resid-
ual value approach for valuing intangible assets with indefinite useful lives for purposes of impairment testing must
use the direct value method by no later than the beginning of their first fiscal year after December 15, 2004.
The adoption of the above SEC guidance did not have a material impact on the Group’s financial position
or results of operations.
In December 2004, the Financial Accounting Standards Board (“FASB”) issued FAS No. 123R, “Share-Based
Payment” (“FAS No. 123R”), a revision of FAS No. 123, “Accounting for Stock-Based Compensation”. FAS No. 123R
supersedes Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees” and
requires all entities to recognize compensation cost in an amount equal to the fair value of share-based payments
grant-date to employees. That cost is recognized over the period during which an employee is required to pro-
vide service in exchange for an award of equity instruments. The Group will adopt FAS No. 123R for the year end-
ing December 31, 2006. The Group does not expect the adoption of FAS No. 123R to have a material impact on
its financial position or results of operations.
Notes to consolidatedfinancial statements
25
CONSOLIDATED FINANCIAL STATEMENTS
_ g g / / g
In December 2004, the FASB issued FAS No. 153, “Exchanges of Nonmonetary Assets”, an amendment
of APB Opinion No. 29, “Accounting for Nonmonetary Transactions”. FAS No. 153 eliminates the exception from
fair value measurement for nonmonetary exchanges of similar productive assets set in the APB Opinion No. 29
and replaces it with a general exception for exchanges that do not have commercial substance. FAS No. 153 spec-
ifies that a nonmonetary exchange has commercial substance if the future cash flows of the entity are expected
to change significantly as a result of the exchange. FAS No. 153 is effective prospectively for nonmonetary
exchanges occurring after June 15, 2005. The adoption of FAS No. 153 did not have a material impact on
the Group’s financial position or results of operations.
In March 2005, the FASB issued Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations —
an interpretation of FASB Statement No. 143”. This Interpretation clarifies that the term “conditional asset
retirement obligation” as used in FASB Statement No. 143, “Accounting for Asset Retirement Obligations”, refers
to a legal obligation to perform an asset retirement activity, in which the timing and (or) method of settlement
are conditional on a future event that may or may not be within the control of the entity. The obligation to per-
form the asset retirement activity is unconditional even though uncertainty exists about the timing and (or)
method of settlement. Uncertainty about the timing and (or) method of settlement of a conditional asset retire-
ment obligation should be factored into the measurement of the liability when sufficient information exists
to make a reasonable estimate of the fair value of the obligation. Interpretation No. 47 is effective for the Group
beginning January 1, 2006. The Group is currently in the process of assessing the impact of Interpretation No. 47
on its consolidated financial position and results of operations.
In March 2005, the SEC released Staff Accounting Bulletin 107, “Share-Based Payments”, or SAB 107. The inter-
pretations in SAB 107 express views of the SEC staff regarding the interaction between FAS No. 123R and certain
SEC rules and regulations, and provide the SEC staff’s views regarding the valuation of share-based payment
arrangements for public companies. In particular, SAB 107 provides guidance related to share-based payment
transactions with nonemployees, the transition from nonpublic to public entity status, valuation methods
(including assumptions such as expected volatility and expected term), the accounting for certain redeemable
financial instruments issued under share-based payment arrangements, the classification of compensation
expense, non-GAAP financial measures, first-time adoption of FAS No. 123R in an interim period, capitalization
of compensation cost related to share-based payment arrangements, the accounting for income tax effects
of share-based payment arrangements upon adoption of FAS No. 123R, the modification of employee share
options prior to adoption of FAS No. 123R.
In May 2005, the FASB issued FAS No. 154, “Accounting Changes and Error Corrections”, which replaces APB
Opinion No. 20, “Accounting Changes” and FAS No. 3, “Reporting Accounting Changes in Interim Financial
Statements”. FAS No. 154 changes the requirements for the accounting and reporting of a change in accounting
principle and is applicable to all voluntary changes and to changes required by an accounting pronouncement
if such pronouncement does not specify transition provisions. FAS No. 154 requires retrospective application
to the prior periods’ financial statements of changes in accounting principle. In cases when it is impracticable
to determine the period-specific or cumulative effects of an accounting change, the statement provides that
the new accounting principle should be applied as of the earliest period for which retrospective application
is practicable or, if impracticable to determine the effect of a change to all prior periods, prospectively from
the earliest date practicable. This Statement is effective for accounting changes and corrections of errors made
in fiscal years beginning after December 15, 2005.
In June 2005, the Emerging Issues Task Force (“EITF”) reached a consensus on EITF Issue No. 05-2, “The Meaning
of ‘Conventional Convertible Debt Instrument’ in EITF Issue No. 00-19, ‘Accounting for Derivative Financial
Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock”. Issue No. 00-19 is used to evaluate
whether embedded derivatives should be bifurcated under FASB Statement No. 133, “Accounting for Derivative
Instruments and Hedging Activities”, as amended. Specifically, Statement 133 provides guidance as to when
an issuer is required to bifurcate a conversion option that is embedded in convertible debt. However,
Notes to consolidatedfinancial statements
26 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
JSFC SISTEMA AND SUBSIDIARIES
_ g g / / g
Issue 00-19 does not define “conventional convertible debt instrument”. Given the development of numerous
contractual terms that may be included in a convertible debt instrument, it was not clear when a convertible
debt instrument is “conventional”. The consensus reached by EITF No. 05-2 is effective for new instruments
entered into and instruments modified in reporting periods after June 29, 2005. The Group does not anticipate
the adoption of EITF No. 05-2 to have a material impact on its financial position and results of operations.
In June 2005, the EITF reached a consensus on EITF Issue No. 05-6, “Determining the Amortization Period
for Leasehold Improvements”. As part of a business combination, the acquiring entity will often assume existing
lease agreements of the acquired entity and acquire the related leasehold improvements. The issues are whether
the “lease term” should be reevaluated at consummation of a purchase business combination and whether
the amortization period for acquired leasehold improvements should be reevaluated by the acquiring entity in
a business combination. The consensus reached by EITF No. 05-6 is effective for leasehold improvements that
are purchased or acquired in reporting periods beginning June 29, 2005. The Group does not anticipate the adop-
tion of EITF No. 05-6 to have a material impact on its financial position and results of operations.
In October 2005, the FASB issued FASB Staff Position (“FSP”) FAS 13-1, “Accounting for Rental Costs Incurred dur-
ing a Construction Period”. Under the provisions of FSP FAS 13-1, lessees may not capitalize rental costs incurred
on building or ground operating leases during a construction period. Instead, rental costs should be expensed on
a straight-line basis starting at the beginning of the lease term, i.e., when the lessee takes possession of or is
given control of the leased property. The provisions of FSP FAS 13-1 are effective for the Group for the year end-
ing December 31, 2006. The Group is currently assessing the impact of FSP FAS 13-1 on its consolidated financial
position and results of operations.
In February 2006, the FASB issued FAS No. 155, “Accounting for Certain Hybrid Financial Instruments, an amend-
ment to FAS No. 133 ‘Accounting for Derivative Instruments and Hedging activities’ and FAS No. 140 ‘Accounting
for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities”. FAS No. 155 addresses appli-
cation of FAS No. 133 to beneficial interests in securitized financial assets and permits to remeasure fair value
for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurca-
tion, requires to evaluate interests in securitized financial assets to identify interests that are freestanding
derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation,
amends FAS No. 140 to eliminate the prohibition on a qualifying special purpose entity from holding a derivative
financial instrument that pertains to a beneficial interest other than another derivative financial instrument,
and clarifies certain other derivatives classification issues. This Statement is effective for all financial instru-
ments acquired or issued after the beginning of an entity’s first fiscal year that starts after September 15, 2006,
and is not expected to have a material impact on the Group’s financial position and results of operations.
Reclassifications — Certain other reclassifications of prior years’ amounts have been made to conform
to the presentation adopted for the year ended December 31, 2005.
Notes to consolidatedfinancial statements
27
CONSOLIDATED FINANCIAL STATEMENTS
_ g g / / g
3. ACQUISITIONS
Acquisition of Minority Interest in ReCom
In December 2005, MTS purchased 46.1% minority stake in ReCom for $110.0 million in cash. Previously MTS
owned 53.9% of ReCom; as a result of the transaction, MTS’ ownership in the subsidiary increased to 100.0%.
The acquisition was accounted for using the purchase method. The allocation of purchase price increased record-
ed license cost by $43.9 million, customer base cost by $15.0 million and resulted in recognition of goodwill in
the amount of $16.2 million.
Goodwill is mainly attributable to economic potential of the market assuming low regional penetration level
as of the date of acquisition. License costs are amortized over the remaining contractual terms of the licenses
of approximately 3 to 8 years and customer base is amortized over the average subscriber’s life of approximate-
ly 60 months.
Barash Communication Technologies Inc. (“BCTI”) Acquisition
In June 2005, MTS entered into an agreement to acquire 100.0% of the outstanding stock of BCTI, which is a lead-
ing cellular operator in Turkmenistan with a customer base of approximately 59,100 subscribers (unaudited).
BCTI holds a license to provide GSM-900/1800 services for the whole territory of Turkmenistan and a license
for provision of AMPS services. The agreement provided for the acquisition of a 51.0% stake and included a for-
ward commitment to complete the acquisition of the remaining 49.0% stake within eight months of the date
of the original agreement subject to certain conditions.
MTS acquired the 51.0% stake in BCTI for cash consideration of $28.2 million, including a finder’s fee of $2.5 mil-
lion. The Group accounted for the purchase of the remaining 49.0% stake in BCTI as a financing of the minority
interest and, consequently, consolidated 100.0% of the subsidiary starting from June 30, 2005. In November 2005,
MTS completed the acquisition of the remaining 49.0% stake in BCTI for a cash consideration of $18.5 million.
This acquisition was accounted for using the purchase method. The purchase price allocation for the acquisition
was as follows:
(000’s)
Current assets $ 7,808
Non-current assets 3,804
License costs 50,503
Deferred taxes (10,862)
Current liabilities (4,566)
Purchase price $ 46,687
In accordance with certain provisions of the license agreement, the Group shares certain percentage of net prof-
it derived from the operations of the BCTI branch located in Turkmenistan with the Government of Turkmenistan.
The amount of shared net profit is calculated based on the financial statements prepared in accordance with local
GAAP subject to certain adjustments. The Group shared 49% of net profit since the date of acquisition and until
December 21, 2005, and 20% of net profit commencing December 21, 2005.
Gorizont-RT Acquisition
In December 2004, MTS completed acquisition of a 76.0% stake in Gorizont-RT, a mobile phone operator in
the Republic of Sakha (Yakutia) in the Far East of Russia, for a cash consideration of $53.2 million. Gorizont-RT
holds licenses to provide GSM-900/1800 services in the Republic of Sakha (Yakutia). The Gorizont-RT’s customer
base as at the date of acquisition was approximately 100,000 subscribers (unaudited).
Notes to consolidatedfinancial statements
28 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
JSFC SISTEMA AND SUBSIDIARIES
_ g g / / g
The acquisition was accounted for using the purchase method. The purchase price allocation was as follows:
(000’s)
Current assets $ 3,820
Non-current asset 17,501
License costs 26,362
Customer base cost 1,050
Trademark 153
Goodwill 20,214
Current liabilities (4,949)
Non-current liabilities (529)
Deferred taxes (6,814)
Minority interest (3,604)
Purchase price $ 53,204
Goodwill is mainly attributable to economic potential of the market assuming low regional penetration level as of
the date of acquisition. License costs are amortized over the remaining contractual terms of the licenses of approx-
imately 10 years and customer base is amortized over the average subscriber’s life of approximately 60 months.
In June 2005, MTS acquired the remaining 24.0% stake in Gorizont-RT, increasing its ownership to 100.0%.
The purchase price paid was $13.5 million. The acquisition was accounted for using the purchase method. The
allocation of purchase price increased recorded license cost by $7.5 million.
Sibintertelecom Acquisition
In November 2004, MTS acquired a 93.53% stake in Sibintertelecom, a mobile phone operator in Chita region and
Aginsk-Buryatsk District in the Far East of Russia, for a cash consideration of $37.4 million. Sibintertelecom
holds license to provide 900 MHz services in Chita region and Aginsk-Buryatsk District. Sibintertelecom is
the sole mobile service provider in these two regions with a total population of 1.23 million. The company’s cus-
tomer base as at the date of acquisition was approximately 100,000 subscribers (unaudited).
The acquisition was accounted for using the purchase method. The purchase price allocation was as follows:
(000’s)
Current assets $ 5,939
Non-current asset 6,966
License costs 29,555
Customer base cost 1,488
Trademark 465
Goodwill 10,376
Current liabilities (9,523)
Deferred taxes (7,668)
Minority interest (190)
Purchase price $ 37,408
Notes to consolidatedfinancial statements
29
CONSOLIDATED FINANCIAL STATEMENTS
_ g g / / g
Goodwill is mainly attributable to economic potential of the market assuming low regional penetration level
as of the date of acquisition. License costs are amortized over the remaining contractual terms of the licenses
of approximately 5 years for Chita region and 7 years for Aginsk-Buryatsk District and customer base is amor-
tized over the average subscriber’s life of approximately 44 months.
In December 2005, MTS acquired the remaining 6.47% stake in Sibintertelecom, which resulted in increase
of MTS’ ownership in Sibintertelecom to 100.0%. The amount paid for the stake was $2.8 million. The acquisi-
tion was accounted for using the purchase method. The allocation of purchase price increased recorded license
cost by $1.4 million.
Telesot Alania Acquisition
In December 2004, MTS purchased a 52.5% stake in Telesot Alania, a GSM mobile phone operator in the Republic
of North Ossetia in the southern part of Russia, for a cash consideration of $6.2 million. Telesot Alania holds
license to provide 900/1800 MHz services in the Republic of North Ossetia in the southern part of Russia. Telesot
Alania’s customer base as at the date of acquisition was approximately 54,000 subscribers (unaudited).
The acquisition was accounted for using the purchase method. The purchase price allocation was as follows:
(000’s)
Current assets $ 2,229
Non-current asset 5,085
License costs 3,606
Customer base cost 90
Current liabilities (767)
Deferred taxes (887)
Minority interest (3,110)
Purchase price $ 6,246
License costs are amortized over the remaining contractual terms of the licenses of approximately 2 years and
customer base is amortized over the average subscriber’s life of approximately 60 months.
In December 2005, MTS acquired the remaining 47.5% equity stake in Telesot-Alania, increasing its ownership in
the company to 100.0%. In accordance with the purchase agreement, the purchase price amounted to $32.6 mil-
lion, of which $9.0 million was paid in cash in December 2005 and $23.6 million was recorded as a liability as
of December 31, 2005, and included in other payables in the consolidated balance sheet. The liability was fully
settled in February 2006. The acquisition was accounted for using the purchase method of accounting. The pre-
liminary allocation of purchase price increased recorded license cost by $2.7 million and $26.3 million was rec-
ognized as goodwill. Goodwill is mainly attributable to economic potential of the market assuming low regional
penetration level as of the date of acquisition. The purchase price allocation for this acquisition has not yet been
finalized at the date of these financial statements.
Uzdunrobita Acquisition
In July 2004, MTS entered into an agreement to acquire 74.0% of Uzbekistan mobile operator JV Uzdunrobita
(“Uzdunrobita”) for a cash consideration of $126.4 million, including transaction costs of $5.4 million.
Acquisition was completed in August 2004. Uzdunrobita holds licenses to provide GSM-1800 mobile communica-
tion services on the whole territory of Uzbekistan, which has a population of approximately 25.2 million.
Uzdunrobita’s customer base as of the date of acquisition was approximately 230,000 subscribers (unaudited).
Notes to consolidatedfinancial statements
30 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
JSFC SISTEMA AND SUBSIDIARIES
_ g g / / g
The acquisition was accounted for using the purchase method. The purchase price allocation for the acquisition
was as follows:
(000’s)
Current assets $ 5,950
Non-current assets 67,293
License costs 40,861
Customer base cost 958
Trademark 3,622
Goodwill 46,470
Current liabilities (14,705)
Non-current liabilities (1,356)
Deferred taxes (6,384)
Minority interest (16,308)
Purchase price $ 126,401
Goodwill is mainly attributable to economic potential of the market assuming low penetration level as of
the date of acquisition. License costs are amortized over the remaining contractual terms of the licenses
of approximately 12 years and customer base is amortized over the average remaining subscriber’s life of approx-
imately 39 months.
MTS also entered into put and call option agreements with the existing shareholders of Uzdunrobita to acquire the
remaining 26.0% of common shares of the company. The exercise period for the put and call option is 48 months
from the acquisition date. The put and call option agreements stipulate a minimum purchase price of $37.7 mil-
lion plus 5% per annum commencing from the acquisition date. Fair value of the option was $5.9 million and
$4.0 million at December 31, 2005 and 2004, respectively, and was included in other current assets on the accom-
panying consolidated balance sheets.
Kvazar-Micro Acquisition
In July 2004, the Group purchased 51.0% of Kvazar-Micro Corporation B.V. (“Kvazar-Micro”) for a cash consider-
ation of $28.0 million, including a contribution to the share capital of Kvazar-Micro of $18.0 million. Kvazar-
Micro business is based in Ukraine and includes distribution of computer hardware and software, IT and systems
integration. Through acquisition of Kvazar-Micro, the Group added IT and system integration business division
to its Technology Segment.
The acquisition was accounted for using the purchase method. The purchase price allocation was as follows:
(000’s)
Current assets $ 68,718
Non-current asset 3,635
Trademark 3,211
Customer contracts and the related customer relationships 13,864
Current liabilities (43,485)
Non-current liabilities (4,068)
Minority interest (13,875)
Purchase price $ 28,000
Notes to consolidatedfinancial statements
31
CONSOLIDATED FINANCIAL STATEMENTS
_ g g / / g
Customer contracts and the related customer relationships acquired are amortized over the remaining contrac-
tual terms of approximately 36 months. Trademarks have unlimited contractual lives and are reviewed, at least
annually, for impairment.
Primtelefon Acquisition
In June 2004, MTS purchased 50.0% of Far-Eastern operator Primtelefon for a cash consideration of $31.0 million,
increasing its effective ownership to 100.0%, as 50.0% of Primtelefon’s shares were controlled through Vostok
Mobile, a wholly-owned subsidiary of MTS. Primtelefon holds licenses to provide GSM-900/1800 mo-bile cellular
communications in the Far East region of Russia. The company’s subscriber base as of the date of acquisition of
the controlling stake was approximately 216,000 subscribers (unaudited).
The acquisition was accounted for using the purchase method. The purchase price allocation was as follows:
(000’s)
Current assets $ 11,041
Non-current assets 16,809
License costs 21,891
Current liabilities (7,488)
Non-current liabilities (5,671)
Deferred taxes (5,582)
Purchase price $ 31,000
License costs acquired are amortized over the remaining contractual terms of the licenses of approximately
7 years and customer base is amortized over the average remaining subscriber’s life of approximately 41 months.
Energy companies in the Republic of Bashkortostan
In August 2005, the Group completed acquisition of minority shareholdings in six energy companies in the
Republic of Bashkortostan for a total cash consideration of $469.6 million. The acquired shareholdings included
19.9% of the shares of each of Novoil, Ufimsky NPZ, Ufaneftekhim, ANK Bashneft and Ufaorgsintez and 18.6% of
Bashnefteproduct.
In October 2005, the Group increased its stakes in five of the companies, for a total cash consideration of $143.7 mil-
lion. Sistema’s shareholding in Novoil increased to 28.2%, in Ufimsky NPZ to 25.5%, in Ufaneftekhim to 22.4%,
in ANK Bashneft to 25.0% and in Ufaorgsintez to 24.9%.
The Group’s share in net assets and net income of the acquired companies is included in the consolidated net
assets and operating results using the equity method of accounting.
Acquisition of an Additional Stake in MTS
In December 2005, the Group increased its ownership interest in VAST to 100.0% for a total cash consideration
of $160.0 million. Prior to the acquisition VAST was a joint venture, where Sistema had 51% ownership interest
and 50% voting power. VAST owns 3% stake in MTS.
In addition, in October–December 2005, the Group acquired on the open market 0.8% common shares of MTS
for a total cash consideration of $115.5 million.
As a result of these transactions, Sistema’s voting power in MTS increased by 2.3% to 52.8%.
Notes to consolidatedfinancial statements
32 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
JSFC SISTEMA AND SUBSIDIARIES
_ g g / / g
The acquisition was accounted for using the purchase method. The preliminary allocation of purchase price
increased recorded trademark cost by $87.9 million, customer base cost by $7.2 million, numbering capacity cost by
$2.1 million, license cost by $17.2 million, and resulted in recognition of goodwill in the amount of $113.0 million.
The purchase price allocation for this acquisition has not yet been finalized at the date of these financial state-
ments. Goodwill is mainly attributable to the economic potential of the markets where MTS is operating.
Other Acquisitions
In December 2005, MTS acquired an additional 74.0% stake in MTS-Tver for $1.4 million. As a result of the trans-
action, MTS’ ownership in the company increased to 100.0%.
In December 2005, Comstar-UTS acquired 100.0% shares of Conversiya Svyaz and Overta, two alternative fixed-
line operators in the Saratov region, for $9.0 million in cash and $1.0 million in a deferred cash payment.
In December 2005, Comstar-UTS acquired 100.0% shares of CTK Contrast Telecom, an alternative fixed-line oper-
ator in the Moscow region, for $5.5 million in cash. CTK Contrast-Telecom provides local fixed-line voice service,
data transmission, internet access and a range of value-added services and operates a proprietary telecommuni-
cations network, controlling about 25.0% of the local wireline telephony market and over 50.0% of the internet
access market in Sergiev Posad.
In December 2005, Comstar-UTS acquired 100.0% of Unitel, an alternative fixed-line operator in the Moscow
region, for a total cash consideration of $4.5 million, including refinancing of its debts.
In December 2005, the Group acquired 75.0% stake in Upravlenie i Leasing for a cash consideration of $5.1 mil-
lion. Upravlenie i Leasing is engaged in provision of cable TV broadcasting services, data transmission and local
telephone services in Ekaterinburg. The Group was granted a call option to purchase the remaining 25.0% stake
in Upravlenie i Leasing for a cash consideration agreed upon by the parties as of the date of option exercise.
In November 2005, the Group acquired 100.0% stake in Euro Dawn, the owner of 74.0% of Digital TV Broadcasting,
for a cash consideration of $7.0 million. Digital TV Broadcasting is the holder of licenses for aerial, digital, mul-
tiprogram television broadcasting and transmission of additional information. The Group was granted an exclu-
sive right of first refusal to purchase the remaining 26.0% stake in Digital TV Broadcasting.
In October 2005, Comstar-UTS acquired 89.4% of the ordinary shares and 31.9% of preferred shares
of Tyumenneftegazsvyaz, an alternative fixed-line telecommunication services provider operating in the Tyumen
region, as well as in the autonomous districts of Khanty Mansi and Yamalo Nenets, for $9.0 million in cash.
In September 2005, Comstar-UTS completed the purchase of 45.0% stake in Metrocom, an alternative fixed-line
operator in Saint-Petersburg, for a total cash consideration of $22.5 million, including the refinancing of a loan
previously obtained by Metrocom. The acquisition is expected to enhance Comstar-UTS business operations
through regional development.
In August and September 2005, Detsky Mir acquired a retail network operating under the brand “Vyrastai-ka”,
S-Toys, a children’s toys wholesale company, and Chudo-Ostrov Neva, children’s goods retailer based in Saint-
Petersburg, for a total cash consideration of approximately $2.0 million. The retail network owns 4 stores in
Moscow and 6 stores in Saint-Petersburg, specializing in selling toys for children.
In August 2005, Sistema Mass Media acquired ESTA group, a Russian cable television operator in MMDS standard,
for a total cash consideration of approximately $8.6 million. Esta group owns cable networks in Tver, Kaluga and
several other cities, and provides services to approximately 217,000 customers (unaudited).
Notes to consolidatedfinancial statements
33
CONSOLIDATED FINANCIAL STATEMENTS
_ g g / / g
In July 2005, as a part of implementation of the SITRONICS’ restructuring plan, the Group re-acquired
a 33.0% stake in STROM telecom for $19.8 million. The fair value of the acquired net assets as of the date of
this transaction was determined to be in excess of the purchase price. The allocation of purchase price decreased
cost of the manufacturing plant and inventories by $3.9 million and $3.6 million, respectively. The remaining
excess of the fair value of net assets acquired over the purchase price comprised $4.0 million and was recorded
as an extraordinary gain in the consolidated statement of operations.
In May 2005, the Group acquired 54.0% stake in MTU Saturn for a cash consideration of $1.5 million. MTU Saturn
operates in the business of design and installation of electric systems. In June 2005, the Group acquired
51.0% stake in Yaroslavl Radio Plant, producer of commercial payload for satellites and professional communica-
tions facilities, for a cash consideration of $6.1 million.
In April 2005, the Group acquired an additional 53.0% stake in Kvant, a personal computers and components
manufacturer located in Zelenograd, for a total consideration of $6.0 million, increasing the Group’s voting power
to 88.0%. The Group utilized Kvant’s facilities to enhance its home-appliance and computer assembling activity
and integrate it into Technology business segment.
In February 2005, MTS completed the acquisition of 74.9% stake in Sweet-Com for a cash consideration of $2.0 mil-
lion. Sweet-Com is a holder of 3.5 GHz radio frequency allocation for Moscow region. Sweet-Com is providing
wide-band radio access services for the “last mile” based on the Radio-Ethernet technology. The acquisition was
accounted for using purchase method of accounting. As the result of the purchase price allocation the Group
recorded license cost of $2.4 million.
In February 2005, the Group acquired 20.0% minority stake in Telmos from Rostelecom for a cash consideration
of $8.5 million, increasing the Group’s voting power in Telmos to 100.0%.
In February 2005, MTS acquired 74.0% stake in MTS-Komi Republic increasing its ownership to 100.0%. The con-
sideration paid under the transaction amounted to $1.2 million.
In February 2005, the Group completed acquisition of 13.0% stake in MBRD. The total consideration amounted
to $10.0 million, including cash payment of $2.1 million and promissory notes in the amount of $7.9 million.
As a result of this transaction, the Group’s voting power in MBRD increased to 99.0%. In June 2005, the Group
contributed $20.9 million to the share capital of MBRD by purchasing 130,000 newly issued shares of MBRD’s
common stock in a closed subscription.
In June 2004, the Group acquired from Vneshtorgbank 5.0% share in East-West United Bank, a bank incorporat-
ed in Luxembourg, for a cash consideration of $1.7 million. In November 2004, the Group acquired from
Vneshtorgbank 14.0% share in East West United Bank for a cash consideration of $5.3 million, increasing its own-
ership to 49.0%.
In October 2004, ROSNO acquired from RAO UES 100.0% stake in Leader. The value of consideration equaled
$3.0 million. Leader is an insurance company selling primarily property insurance to energy companies. During
2002–2004, the Group assumed reinsurance from Leader and performed operational management of this company.
In October 2004, ROSNO acquired 100.0% stake in Deutsche Investment Trust for a cash consideration of $2.4 mil-
lion. The allocation of purchase price increased goodwill by $1.3 million. The goodwill is mainly attributable
to the assembled workforce.
In September 2004, MTS exercised its option to acquire the remaining 47.3% of common shares and 50.0% of pre-
ferred shares in TAIF-Telcom for a cash consideration of $63.0 million, increasing its ownership to 100.0%.
The Group received title to the acquired shares in October 2004. The purchase price allocation increased record-
Notes to consolidatedfinancial statements
34 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
JSFC SISTEMA AND SUBSIDIARIES
_ g g / / g
ed license costs by $35.8 million, increased acquired customer base by $4.2 million; goodwill was recorded in
the amount of $21.2 million. Goodwill is mainly attributable to economic potential of the market.
In September 2004, the Group acquired 29.8% stake in Mezhregionalny Transit Telecom (“MTT”), operator of a
nation-wide transit network providing telecommunication services and network interconnection for mobile and
fixed network operators throughout Russia, for cash consideration of $39.8 million, increasing its ownership
interest in MTT to 44.8%. In October 2004, the Group purchased an additional 0.2% stake in MTT for cash con-
sideration of $0.1 million. As a result, by December 31, 2004, the Group’s ownership interest in MTT increased
to 45.0%. In February 2005, the Group acquired an additional 5.0% equity stake in MTT for a cash consideration
of $6.4 million, increasing its voting interest in MTT to 50.0%.
In August 2004, MTS acquired the remaining 50.0% stakes in Astrakhan Mobile and Volgograd Mobile, increasing
its ownership to 100.0%, for a cash consideration of $1.1 million and $2.9 million, respectively. Astrakhan Mobile
holds a 800/1800 MHz licenses covering Astrakhan region (population of approximately 1 million) and Volgograd
Mobile holds a 800/1800 MHz licenses covering Volgograd region (population of approximately 2.7 million).
As of July 31, 2004, two companies provided AMPS/DAMPS services to approximately 10,000 subscribers (unau-
dited). The acquisition was accounted for using the purchase method. The allocation of purchase price for
the first and second stakes in both companies resulted in increase in license costs by $16.5 million.
In August 2004, MTS acquired 49.0% minority stake in UDN-900 for $6.4 million in cash. This acquisition
increased MTS’ ownership in UDN-900 to 100.0%. The allocation of purchase price increased recorded license cost
by $0.3 million. UDN-900 provides GSM 900 services under the MTS brand in Udmurtia Republic (population
1.6 million). UDN-900’s subscriber base as of July 31, 2004 was 219,760 (unaudited).
In April 2004, MTS acquired additional 7.5% stake in MSS, a company, which operates in the Omsk region, for
$2.2 million in cash. This acquisition increased MTS’s ownership in MSS to 91.0%. The acquisition was accounted
for using the purchase method. The allocation of purchase price increased recorded license costs by $1.1 million.
In April 2004, MTS acquired 40.0% stake in FECS-900 for a cash consideration of $8.3 million, increasing its own-
ership in FECS-900 to 100.0%. The acquisition was accounted for using the purchase method. The allocation
of purchase price increased recorded license costs by $4.1 million.
In April and May of 2004, MTS acquired the remaining stakes in the following subsidiaries:
• 35.0% of MTS-NN (a service provider in Nizhny Novgorod) for $0.5 million, and
• 49.0% of Novitel (handsets dealer in Moscow) for $1.3 million.
Both acquisitions increased Group’s share in the respective companies to 100.0%. The acquisitions were account-
ed for using the purchase method. The allocation of purchase price increased recorded goodwill by $1.8 million.
In March 2004, MTS acquired 11.0% stake in SCS-900 for a cash consideration of $8.5 million, increasing its own-
ership in SCS-900 to 99.5%. The acquisition was accounted for using the purchase method. The allocation of pur-
chase price increased recorded license costs by $2.6 million.
During the year ended December 31, 2004, ROSNO repurchased 3.4% of its outstanding shares from a director
of the Group for cash consideration of $5.6 million. The transaction resulted in a reduction of additional paid-in
capital of the Group by $1.3 million, net of minority interest of $2.6 million. Later in the same period the Group
acquired from ROSNO 1.75% of its shares for $2.8 million in cash. The remaining treasury shares were sold by
ROSNO to an affiliate of Allianz AG. In December 2004, ROSNO issued 10.9 million new shares, 5.6 million of which
were purchased by the Group for a cash payment of $9.8 million. The rest of the newly issued shares were sold
to Allianz AG. As a consequence of these transactions, the Group’s ownership interest in ROSNO reached 49.0%.
Notes to consolidatedfinancial statements
35
CONSOLIDATED FINANCIAL STATEMENTS
_ g g / / g
Pro forma results of operations (unaudited)
The following pro forma financial data for the years ended December 31, 2005 and 2004 give effect to the acqui-
sitions of BCTI, ReCom, MTS, Uzdunrobita, Kvazar-Micro, Sibintertelecom, Telesot Alania and Gorizont-RT,
as if they had occurred as of January 1, 2004:
(000’s)2005 2004
Net revenues $ 7,593,549 $ 5,766,738
Income before cumulative effect of a change in accounting principle 553,549 459,937
Net income 557,505 424,465
Earnings per share, basic and diluted: $ 58.83 $ 52.40
The pro forma information is based on various assumptions and estimates. The pro forma information is not nec-
essarily indicative of the operating results that would have occurred if the Group’s acquisitions had been con-
summated at the beginning of the respective period, nor is it necessarily indicative of future operating results.
The pro forma information does not give effect to any potential revenue enhancements or cost synergies or other
operating efficiencies that could result from the acquisitions.
4. DISPOSITIONS AND CAPITAL TRANSACTIONS OF SUBSIDIARIES
In December 2005, the Group disposed of its ownership interest in Concern CMM, a subsidiary operating in mass
media business, to a related party for free. The transaction resulted in an increase of additional paid-in capital
of $1.2 million.
In December 2005, ROSNO sold its interest in Leader, a subsidiary operating in insurance business, for the total
cash consideration of approximately $6.0 million. The transaction resulted in recognition of loss from disposal
of $0.2 million.
In November 2005, the Group sold its interests in TV-Project, a subsidiary operating in media business for a total
cash consideration less than $0.1 million. The transaction resulted in recognition of gain from disposal of
$2.5 million. The assets and operations of the subsidiary were not material for the Group.
In November 2005, the Group sold its interests in Kamov Holding for the total cash consideration of approxi-
mately $11.8 million. Kamov Holding held 49.5% stake in Kamov, a helicopter producer. The transaction result-
ed in gain from disposal of $1.0 million.
In September 2005, the Group sold its interest in Concern RadioCenter for a total cash consideration of approxi-
mately $0.9 million. The transaction resulted in recognition of gain from disposal of $0.4 million. The assets and
operations of this subsidiary were not material for the Group.
In August 2005, the Group sold its interests in Nasha Pressa and Stolichnaya Pressa, the subsidiaries operating in
media business for the total cash consideration of approximately $3.0 million. The transaction resulted in recog-
nition of gain from disposal of $2.9 million. The assets and operations of these subsidiaries were not material
for the Group.
In February 2005, the Group sold its interests in Credo Service and Gloros Stolitsa, the subsidiaries operating in
media business for the total cash consideration of less than $0.1 million. The transaction resulted in recognition
of loss from disposal of $0.5 million. The assets and operations of these subsidiaries were not material for
the Group.
Notes to consolidatedfinancial statements
36 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
JSFC SISTEMA AND SUBSIDIARIES
_ g g / / g
In January 2005, Intourist announced issue of new stock to its existing shareholders. Moscow Government pur-
chased the first tranche of 3,120,516,875 shares in exchange for a 40% stake in Cosmos Hotel, a 1000-room hotel
complex situated in Moscow. In April 2005, Sistema paid an equivalent of $47.7 million for the remaining
6,961,052,632 newly-issued shares of Intourist. Upon completion of this transaction, Sistema’s ownership inter-
est in Intourist decreased to 72%. During the year ended December 31, 2005, the Group purchased an additional
3.4% share of Cosmos Hotel on the open market for a total cash consideration of $0.9 million.
In October 2004, the Group disposed of its 24% shareholding in MCC to SkyLink, the Group’s affiliate, for cash con-
sideration of $0.7 million.
In August 2004, the Group sold 83.5% of common shares of its subsidiary P-Com to SkyLink for cash considera-
tion of $16.0 million. The transaction resulted in recognition of loss from disposal of $1.9 million. Revenues
of P-Com were excluded from the Group’s consolidated revenues effective January 1, 2004, and the Group’s share
in P-Com’s earnings for the year ended December 31, 2004 was recorded using the equity method of accounting.
In August 2004, the Group sold its interest in Sofora, a subsidiary operating in media business, to a third party
for cash consideration of $1.1 million. The transaction resulted in recognition of a gain from disposal of $1.3 mil-
lion. Sofora’s assets and operations were not material for the Group.
In July 2004, the Group sold 33.0% of common shares of its subsidiary STROM telecom to a party related to STROM
telecom’s management for cash consideration of $2.0 million. The transaction resulted in recognition of loss
from disposal of $1.2 million.
During the year ended December 31, 2004, the Group sold its interests in Petrovskoye Podvorye and Ordynka
to related parties. These transactions resulted in an increase of additional paid-in capital by approximately
$10.3 million, net of minority interests of $2.6 million.
5. CASH AND CASH EQUIVALENTS
Cash equivalents amounting to $154.2 million and $113.6 million as of December 31, 2005 and 2004, respective-
ly, are comprised primarily of term deposits with banks and bank promissory notes with original maturities less
than 90 days. Within this amount, $2.4 million and $3.8 million, as of December 31, 2005 and 2004, respectively,
represent the Group’s deposits with East-West United Bank, an affiliate of the Group. As of December 31, 2005
and 2004, the Group had $17.1 million and $5.6 million, respectively, in current accounts with East-West
United Bank.
Also included in cash as of December 31, 2005 and 2004, are $19.6 million and $10.9 million, respectively, which
represent the MBRD’s minimum reserve deposit, required by the Central Bank of Russian Federation.
Notes to consolidatedfinancial statements
37
CONSOLIDATED FINANCIAL STATEMENTS
_ g g / / g
6. SHORT-TERM INVESTMENTS
Short-term investments as of December 31, 2005 and 2004 consisted of the following:
(000’s)2005 2004
Trading securities:
RF Eurobonds $ 5,013 –
Corporate bonds 206,655 $ 36,669
Municipal bonds 54,959 12,622
Corporate shares 16,414 11,541
Other trading securities 16,588 9,141
299,629 69,973
Other short-term investments:
Promissory notes and deposit certificates from third parties 135,099 35,546
Promissory notes from and loans to related parties 49,162 13,028
Bank deposits with original maturities exceeding 90 days 104,649 80,743
Other short-term investments 5,657 3,290
294,567 132,607
Total $ 594,196 $ 202,580
Corporate bonds are denominated in RUR and represent bonds issued by major Russian companies with maturi-
ty dates from 2006 to 2009 and coupon rates of 7-20% per annum.
Corporate shares are liquid publicly traded shares of Russian companies. They are reflected at period-end market
value based on last trade prices obtained from Moscow Interbank Currency Exchange (“MICEX”).
The weighted average interest rate on promissory notes from third parties both as of December 31, 2005 and 2004
was 8%, while promissory notes from related parties were mostly interest-free. Deposit certificates bear a weight-
ed average interest rate of 5% as of December 31, 2004, compared to 6% as of December 31, 2005. Most of
the notes and certificates mature within 1 year.
The effective interest rates on bank deposits with original maturities exceeding 90 days as of December 31, 2005
were 4% for RUR-denominated deposits and 7% on deposits in USD. Included in bank deposits as of Decem-
ber 31, 2005 and 2004 are deposits with East-West United Bank equivalent to $46.5 million and $53.0 million,
respectively, bearing interest of 2%.
Notes to consolidatedfinancial statements
38 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
JSFC SISTEMA AND SUBSIDIARIES
_ g g / / g
7. LOANS TO CUSTOMERS AND BANKS, NET
Loans to customers and banks, net of an allowance for loan losses, as of December 31, 2005 and 2004 consisted
of the following:
(000’s)2005 2004
Loans to customers $ 589,521 $ 227,668
Loans to banks 81,424 173,179
670,945 400,847
Less allowance for loan losses (102,443) (21,537)
Total $ 568,502 $ 379,310
Loans to customers as of December 31, 2005 and 2004 included loans to related parties of $47.8 million and
$93.3 million, respectively.
8. INSURANCE-RELATED RECEIVABLES
Insurance-related receivables as of December 31, 2005 and 2004 consisted of the following:
(000’s)2005 2004
Receivables from insurance operations $ 102,422 $ 104,834
Advances to health care providers 47,167 25,444
Total $ 149,589 $ 130,278
9. ACCOUNTS RECEIVABLE, NET
Accounts receivable, net of provision for doubtful accounts, as of December 31, 2005 and 2004 consisted of the
following:
(000’s)2005 2004
Trade receivables $ 512,217 $ 370,988
Less: provision for doubtful accounts (69,574) (43,067)
Total $ 442,643 $ 327,921
Included in trade receivables as of December 31, 2005 and 2004 are receivables for services provided and goods
shipped to the Group’s affiliates and other related parties in the amounts of $30.0 million and $42.2 million,
respectively. Management anticipates no losses in respect of receivables from related parties and accordingly no
provision has been created in respect thereof.
Notes to consolidatedfinancial statements
39
CONSOLIDATED FINANCIAL STATEMENTS
_ g g / / g
10. PREPAID EXPENSES, OTHER RECEIVABLES AND OTHER CURRENT ASSETS, NET
Prepaid expenses, other receivables and other current assets, net of provision for doubtful accounts, asof December 31, 2005 and 2004 consisted of the following:
(000’s)2005 2004
Prepaid expenses and advances to suppliers $ 369,078 $ 134,087Security deposit under repurchase agreement (Note 21) 42,000 –Prepaid taxes 39,868 22,746Deferred policy acquisition costs 31,122 26,203Restricted cash 8,503 3,268Uzdunrobita put-call option 5,956 –Receivables for sale of Micron shares 4,870 5,052Other 80,674 43,168Less: provision for doubtful accounts (3,919) (4,064)
Total $ 578,152 $ 230,460
Policy acquisition costs’ amortization charge for the years ended December 31, 2005 and 2004 was $81.9 millionand $42.7 million, respectively.
11. INVENTORIES AND SPARE PARTS
Inventories and spare parts as of December 31, 2005 and 2004 consisted of the following:
(000’s)2005 2004
Raw materials and spare parts $ 171,026 $ 97,427Project costs — construction, net of progress billings 142,572 55,394Finished goods and goods for resale 131,959 89,123Work-in-progress 37,352 34,888
Total $ 482,909 $ 276,832
12. PROPERTY, PLANT AND EQUIPMENT, NET
Property, plant and equipment, net of accumulated depreciation, as of December 31, 2005 and 2004 consistedof the following:
(000’s)2005 2004
Land $ 16,792 $ 37,944Buildings and leasehold improvements 740,786 547,629Switches, transmission devices, network and base station equipment 4,182,957 3,284,977Other plant, machinery and equipment 689,884 443,860Construction in-progress and equipment for installation 1,766,778 1,080,900
7,397,197 5,395,310
Less: accumulated depreciation (1,521,073) (947,265)
Total $ 5,876,124 $ 4,448,045
Depreciation expense for the years ended December 31, 2005 and 2004 amounted to $630.1 million and $510.1 mil-lion, respectively.
Notes to consolidatedfinancial statements
40 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
JSFC SISTEMA AND SUBSIDIARIES
_ g g / / g
13. INVESTMENTS IN AFFILIATED COMPANIES
Investments in affiliated companies as of December 31, 2005 and 2004 consisted of the following:
(000’s)2005 2004
Voting power, Carrying Voting power, Carrying% value % value
Shares of energy companies various $ 636,865 – –
in the Republic of Bashkortostan (Note 3)
MTT (Note 3) 50% 73,984 45% $ 49,205
MTS Belarus 49% 66,288 49% 27,699
Cosmos Hotel (Note 4) 43% 21,614 – –
East-West United Bank 49% 17,749 49% 16,518
Metrocom (Note 3) 45% 12,774 – –
ZETA Telecom 49% 6,338 49% 6,699
Cosmos TV 50% 4,100 50% 4,100
SkyLink 50% 3,200 50% 16,011
Loans to MTS Belarus – 41,341 – 51,894
Loans to SkyLink – 16,809 – 19,316
Acquired debt of Cosmos TV – 1,000 – 1,000
Other investments and loans to investees various 12,141 various 14,078
Total $ 914,203 $ 206,520
Investments in affiliates as of December 31, 2005 included $41.3 million in loans to MTS Belarus and $16.8 mil-
lion in loans to SkyLink bearing interest at 3% to 11% per annum.
Based on projected cash flows of MTS Belarus and SkyLink, the Group has concluded that no impairment of
the Group’s investments in MTS Belarus and SkyLink has occurred as of December 31, 2005.
14. OTHER INVESTMENTS
In December 2005, MTS acquired a 51.0% stake in Tarino Limited (“Tarino”) for $150.0 million in cash. Tarino was
at that time the indirect owner, through its wholly-owned subsidiaries, of Bitel LLC, a Kyrgyz company holding
a GSM-900/1800 license for the entire territory of Kyrgyzstan.
Concurrently with the purchase of 51.0% stake, MTS entered into a put and call option agreement with the share-
holder of Tarino to acquire the remaining 49.0% interest in Tarino. The call option is exercisable by the Group
from November 2005 to November 2006, and the put option is exercisable by the seller from November 2006
to December 2006. The put and call option price is $170.0 million. The put and call option was recorded at fair
value, which approximated nil at December 31, 2005, in the consolidated balance sheet.
After a decision of the Kyrgyz Supreme Court on December 15, 2005, Bitel’s offices were seized by a third party.
The Group could not re-gain operating control over Bitel’s operations in 2005 and therefore accounted for its
51.0% investment in Bitel at cost as of December 31, 2005.
On March 3, 2006, Mr. Glenn Harrigan, the court-appointed receiver of Fellowes International Holdings Limited
(“Fellowes”), a British Virgin Islands corporation, which alleges rights on Bitel, filed a claim with the Supreme
Court of the Kyrgyz Republic seeking a review and reversal of the Supreme Court’s ruling of December 15, 2005,
in favor of Fellowes upholding a first instance court’s decision, whereby the shares in Bitel were transferred
Notes to consolidatedfinancial statements
41
CONSOLIDATED FINANCIAL STATEMENTS
_ g g / / g
to Fellowes. Mr. Harrigan seeks a reversal of the Kyrgyz Supreme Court ruling on the grounds that the persons
who had represented Fellowes before the Kyrgyz Supreme Court were not authorized to represent Fellowes.
Fellowes is not affiliated with MTS. MTS will continue to vigorously assert its rights with respect to Bitel in the
courts of Kyrgyzstan.
Currently, MTS is working with Tarino Limited’s 49% shareholder to recover ownership and operational control of
Bitel. Also, there is an ongoing litigation in the British Virgin Islands and arbitration in the United Kingdom
related to Tarino’s ownership of Bitel. These matters are likely to be subject of continued and/or new legal dis-
putes and litigation, including concerning the agreements with respect to Tarino Limited. It is not possible at
this time to predict the outcome or resolution of any such disputes or litigation; however, MTS believes that its
position is meritorious. The Group’s management believes that no impairment of its investment in Bitel has
occurred as of December 31, 2005.
15. LICENSES, NET
Licenses, net of accumulated amortization, as of December 31, 2005 and 2004 consisted of the following:
(000’s)2005 2004
Operating licenses $ 1,000,390 $ 891,876
Less: accumulated amortization (385,348) (224,942)
Total $ 615,042 $ 666,934
Amortization expense for licenses for the years ended December 31, 2005 and 2004 amounted to $194.3 million
and $160.5 million, respectively.
The estimated amortization expense for each of the five succeeding years and thereafter is as follows:
(000’s)
Year ended December 31,
2006 $ 209,143
2007 163,889
2008 103,184
2009 43,687
2010 38,641
Thereafter 56,498
$ 615,042
Actual amortization expense to be reported in future periods could differ from these estimates as a result of new
licenses acquisitions, changes in useful lives and other relevant factors.
Notes to consolidatedfinancial statements
42 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
JSFC SISTEMA AND SUBSIDIARIES
_ g g / / g
16. OTHER INTANGIBLE ASSETS, NET
Intangible assets, other than goodwill and licenses, net of accumulated amortization, as of December 31, 2005
and 2004 consisted of the following:
2005 2004Gross Accumu- Net Gross Accumu- Net
carrying lated carrying carrying lated carrying value amorti- value value amorti- value
zation zation
Amortized intangible assets:
Acquired customer base $ 200,931 (121,876) 79,055 $ 152,060 $ (78,491) $ 73,569
Radio frequencies 130,839 (31,227) 99,612 115,493 (31,494) 83,999
Numbering capacity with finite 901,812 (339,463) 562,349 517,532 (148,398) 369,134
contractual life, rights to use premises,
software and other
1,233,582 (492,566) 741,016 785,085 (258,383) 526,702
Unamortized intangible assets:
Trademarks 126,176 – 126,176 45,376 – 45,376
Numbering capacity with indefinite 19,080 – 19,080 22,237 – 22,237
contractual life
Total intangible assets $ 1,378,838 (492,566) 886,272 $ 852,698 $ (258,383) $ 594,315
Amortization expense recorded on other intangible assets for the years ended December 31, 2005 and 2004 amount-
ed to $203.8 million and $129.9 million, respectively. The estimated amortization expense for each of the five suc-
ceeding years and thereafter is as follows:
(000’s)
Year ended December 31,
2006 $ 206,124
2007 185,326
2008 152,989
2009 98,132
2010 29,137
Thereafter 69,308
$ 741,016
Actual amortization expense to be reported in future periods could differ from these estimates as a result of new
intangible assets acquisitions, changes in useful lives and other relevant factors.
Notes to consolidatedfinancial statements
43
CONSOLIDATED FINANCIAL STATEMENTS
_ g g / / g
17. OTHER NON-CURRENT ASSETS
Other non-current assets as of December 31, 2005 and 2004 consisted of the following:
(000’s)2005 2004
Loans, promissory notes and deposits with related parties $ 15,265 $ 20,309
Loans, promissory notes and deposits with third parties 5,423 8,513
Mutual investment funds 11,168 9,942
Other 19,016 11,660
Total $ 50,872 $ 50,424
Loans and promissory notes from related parties are mostly RUR denominated and interest-free. Majority of such
loans and promissory notes mature in 2007.
18. BANK DEPOSITS AND NOTES ISSUED
Bank deposits and notes issued as of December 31, 2005 and 2004 consisted of the following:
(000’s)2005 2004
Term deposits $ 294,711 $ 132,694
Promissory notes issued 111,788 61,159
Deposits repayable on demand 90,330 133,008
Total $ 496,829 $ 326,861
Bank deposits and notes issued as of December 31, 2005 and December 31, 2004 include deposits from and prom-
issory notes issued to related parties for $1.9 million and $8.4 million, respectively.
19. INSURANCE-RELATED LIABILITIES
Insurance-related liabilities as of December 31, 2005 and 2004 consisted of the following:
(000’s)2005 2004
Unearned premium provision, net of reinsurance $ 167,446 $ 64,589
Loss provision, net of reinsurance 89,571 76,641
Undisbursed GFOMI funds 80,071 45,719
Other insurance-related liabilities 75,240 57,511
Total $ 412,328 $ 344,460
Usage of GFOMI funds, in the amount of $80.1 million, accumulated and undisbursed by ROSNO as of
December 31, 2005, is limited to payments for medical facilities and care provided to RF citizens by medical cen-
ters under GFOMI’s obligatory medical insurance program.
Notes to consolidatedfinancial statements
44 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
JSFC SISTEMA AND SUBSIDIARIES
_ g g / / g
20. ACCRUED EXPENSES, SUBSCRIBER PREPAYMENTS AND OTHER CURRENT LIABILITIES
Accrued expenses, subscriber prepayments and other current liabilities as of December 31, 2005 and 2004 con-
sisted of the following:
(000’s)2005 2004
Subscriber prepayments, current portion (Note 24) $ 472,673 $ 391,880
Payroll and other accrued expenses 236,454 112,878
Accrued interest on loans 77,746 63,809
Customers’ advances 46,974 59,146
Current portion of capital lease obligations (Note 22) 3,220 4,926
Dividends payable 2,137 6,237
Tax and legal provision 35,020 23,633
Other 119,120 107,683
Total $ 993,344 $ 770,192
21. SHORT-TERM LOANS PAYABLE
Short-term loans payable as of December 31, 2005 and 2004 consisted of the following:
Currency Annual interest rate (000’s)(Actual at Decem- 2005 2004
ber 31, 2005)
Citibank N.A., ING Bank N.V. and Raiffeisen AG USD LIBOR+0.8%–2.3% $ 200,000 –
(5.3%–6.8%)
ING Bank N.V. USD LIBOR+0.8% (5.1%) 150,000 –
Deutsche Bank USD LIBOR+1.9% (6.6%) 132,000 –
ABN Amro Bank USD LIBOR+3.0% (7.5%) 49,816 –
Donau-Bank USD 9.0% 34,230 –
Commerzbank Eurasia USD LIBOR+5.0% (9.8%) 20,000 $ 20,000
Dresdner Bank USD LIBOR+1.3% (6.1%) 14,000 –
West LB USD LIBOR+6.8% (10.6%) 10,400 5,000
Sberbank RUR 12.0% 903 10,248
Credit Suisse First Boston USD LIBOR+2.2% (6.9%) – 140,000
Vneshtorgbank EUR 11.0% – 7,501
Loans and promissory notes Various Various 6,943 21,422
payable to related parties
Other Various Various 19,477 16,932
Total $ 637,769 $ 221,103
Notes to consolidatedfinancial statements
45
CONSOLIDATED FINANCIAL STATEMENTS
_ g g / / g
Citibank N.A., ING Bank N.V. and Raiffeisen AG — In December 2005, UMC signed an agreement with
Citibank N.A., ING bank N.V. and Raiffeisen Zentralbank Osterreich AG, for a $200.0 million aggregated loan facil-
ity to be made available in two tranches of $103.0 million and $97.0 million. Each tranche is payable in four
equal installments within a year after the signing date. These funds will be used for general corporate purposes,
including financing of capital expenditure and refinancing of existing indebtedness. The amount outstanding
under the first tranche is guaranteed by MTS. The first and the second tranches bear interest at LIBOR+0.8% and
LIBOR + 2.3% per annum, respectively. The commitment fee is calculated on a daily basis at the rate of 45% of
the applicable margin established for each tranche. As of December 31, 2005, the outstanding balances under
the loan were $103.0 million and $97.0 million, respectively. The loan is subject to certain restrictive covenants
including financial ratios and covenants limiting MTS’ ability to convey or dispose its properties and assets.
Management believes that as of December 31, 2005, MTS is in compliance with all existing covenants. In March
2006, MTS guaranteed the amount outstanding under the second tranche and the lenders agreed to reduce
the interest rate applicable to it to LIBOR+0.8% per annum.
ING Bank N.V. — In November 2005, MTS Finance entered into a credit facility agreement with ING Bank N.V.
which allows it to borrow up to $150.0 million. These funds will be used for general corporate purposes. The loan
bears interest of LIBOR +0.8% per annum. The arrangement fee totaled $0.8 million. The loan is subject to cer-
tain restrictive covenants including, but not limited to, certain financial ratios. Management believes that as
of December 31, 2005, MTS is in compliance with all existing covenants. The facility matures in six months after
the first utilization of available loan amount. As of December 31, 2005, $150.0 million were outstanding under
the facility.
Deutsche Bank — In December 2005, in connection with the planned Comstar-UTS initial public offering,
the Group entered into a share repurchase transaction with Deutsche Bank AG to sell 30,530,000 shares
of Comstar-UTS in accordance with the terms of the Global Master Repurchase Agreement for the amount
of $132.0 million. Pursuant to the terms of the agreement, the shares were to be repurchased by Sistema before
February 22, 2006 (Note 32). Concurrently, the Group placed the security deposit of $42.0 million in cash with
Deutsche Bank AG (Note 10). The interest rate on the loan is determined as LIBOR + 1.9% (6.6% as of Decem-
ber 31, 2005) per annum applied to the difference between the initial margin and the loan amount.
ABN Amro Bank — In August 2005, several subsidiaries of SITRONICS entered into loan agreements with
ABN Amro Bank, limited to $50.0 million. The loans bear interest of LIBOR + 3.0% per annum (7.5% as of
December 31, 2005) and mature in 2006. The outstanding balance under these loans as of December 31, 2005 was
$49.8 million. The loans are subject to certain restrictive covenants, including, but not limited to, limitations on
the incurrence of additional indebtedness, restrictions to pay dividends, any merger, consolidation or disposition
of assets and compliance with certain financial ratios. Management believes that as of December 31, 2005 sub-
sidiaries of SITRONICS are in compliance with these covenants.
Donau-Bank — In 2005, several subsidiaries of SITRONICS entered into loan agreements with Donau-Bank, all
of them bearing interest of 9.0% per annum. The short-term loan facilities mature in 2006. The outstanding bal-
ance under these loans as of December 31, 2005 was $34.2 million.
Commerzbank Eurasia — In November 2003, Sistema-Hals entered into a loan agreement with Commerzbank
Eurasia for the amount of $20.0 million. The loan bears interest at LIBOR+5.0% (7.4% as of December 31, 2005)
and was due in March 2005. The loan was extended to March 2006. The loan is guaranteed by JSFC Sistema.
Dresdner Bank — In December 2004, JSFC Sistema entered into a loan agreement with Dresdner Bank for
the amount of $14.0 million bearing interest of LIBOR + 1.3% (6.1% as of December 31, 2005) per annum. The
loan was repaid in March 2006.
Notes to consolidatedfinancial statements
46 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
JSFC SISTEMA AND SUBSIDIARIES
_ g g / / g
West LB — In December 2004, Sistema-Hals entered into a loan agreement with West LB. The loan bears inter-
est of LIBOR + 6.8% (9.4% as of December 31, 2005) per annum and was due in December 2005. The loan was
extended to December 2006. The outstanding balance of the loan was $10.4 million as of December 31, 2005. The
loan is guaranteed by MGTS.
Sberbank — The Group has entered into several short-term loans with Sberbank. The outstanding balance under
the loans as of December 31, 2005 was $0.9 million. These loans bear interest of 12.0%.
Credit Suisse First Boston — In October 2004, MTS entered into a short-term loan facility with Credit Suisse
First Boston for a total amount of $140.0 million. Amounts outstanding under the loan agreement bore interest
of LIBOR+ 2.2% (4.8% as of December 31, 2005). The loan was fully repaid in April 2005.
Vneshtorgbank — In December 2004, Kamov Holding entered into a loan agreement with Vneshtorgbank
for the amount of EUR 5.5 million. The loan bore interest at 11.0% and was fully repaid in June 2005.
22. CAPITAL LEASE OBLIGATIONS
Capital lease obligations as of December 31, 2005 and 2004 consisted of the following:
(000’s)2005 2004
Capital lease obligations $ 9,902 $ 8,338
Less: current portion of capital lease obligations (Note 20) (3,220) (4,926)
Total $ 6,682 $ 3,412
During 2002–2005, the Group entered into several lease agreements for telecommunication equipment and vehi-
cles. Most of the agreements expire in 2006-2008 and assume transfer of ownership for leased assets to the Group
at the end of the lease term.
The net book value of leased assets comprised $24.7 million and $20.3 million as of December 31, 2005 and 2004,
respectively. Interest expense on the leases recorded within income from continuing operations, was $0.6 mil-
lion and $1.9 million for the years ended December 31, 2005 and 2004, respectively. Future minimum payments
under the lease agreements are disclosed in Note 31.
Notes to consolidatedfinancial statements
47
CONSOLIDATED FINANCIAL STATEMENTS
_ g g / / g
23. LONG-TERM DEBT
Long-term debt as of December 31, 2005 and 2004 consisted of the following:
Currency Annual interest rate (000’s)(Actual at December 31, 2005) 2005 2004
Sistema Capital Notes USD 8.9% $ 350,000 $ 350,000
Sistema Finance Notes USD 10.3% 349,285 348,808
MTS Finance Notes due 2012 USD 8% 399,052 –
MTS Finance Notes due 2010 USD 8.4% 400,000 400,000
MTS Finance Notes due 2008 USD 9.8% 400,000 400,000
MBRD Bonds USD 8.6% 150,000 –
MGTS Bonds RUR 8.3%–10.0% 104,230 90,094
DMC Bonds RUR 8.5% 39,954 –
Micron Bonds RUR – – 6,293
Total Corporate Bonds $ 2,192,521 $ 1,595,195
Syndicated Loan USD LIBOR +2.5% (7.2%) $ 460,000 $ 600,000
HSBC Bank plc USD LIBOR +0.4% (5.1%) 171,816 77,003
and ING BHF-BANK AG
EBRD USD LIBOR +3.1% (7.8%) 139,387 150,000
Citibank International plc USD LIBOR +0.3% (5.0%) 111,009 –
and ING Bank N.V.
Commerzbank AG, ING Bank AG USD LIBOR +0.3% (5.0%) 92,826 –
and HSBC Bank plc
ABN AMRO N.V. USD, EUR LIBOR +0.4% (5.1%) 83,179 –
EURIBOR +0.4% (3.0%)
Barclays Bank USD LIBOR +0.1%–0.2% 80,086 –
(4.8%–4.9%)
Vneshtorgbank USD, EUR LIBOR +4.9% (9.6%), 66,027 16,981
EURIBOR +5.0%–5.4%
(7.6–8.0%), 8.5%
HSBC Bank plc, USD LIBOR +0.3% (5.0%) 63,338 –
ING Bank Deutschland AG
and Bayerische Landesbank
ING BHF-BANK and EUR EURIBOR +0.7% (3.3%) 43,168 63,851
Commerzbank AG
Commerzbank (Eurasia) USD LIBOR +0.4%–3.5% (5.1%–6.1%) 34,071 27,213
Citibank USD LIBOR +1.6% (6.3%) 21,584 15,144
ABN AMRO Bank USD LIBOR +3.0% (7.5%) 20,000 –
ING-Bank (Eurasia) USD LIBOR +2.3%–4.2% (6.8%–8.7%) 20,000 46,667
Commerzbank Belgium S.A./N.V USD LIBOR +0.4% (5.1%) 13,314 –
Credit Suisse Bank USD LIBOR +2.8% (7.5%) 12,990 –
Raiffeisenbank USD – – 19,684
Vendor Financing Various Various 16,260 33,181
Loans from related parties Various Various 26,594 86,432
Other Various Various 54,769 104,109
3,722,939 2,835,460
Less amounts maturing within one year (520,310) (340,938)
Total $ 3,202,629 $ 2,494,522
Notes to consolidatedfinancial statements
48 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
JSFC SISTEMA AND SUBSIDIARIES
_ g g / / g
Corporate Bonds — In January 2004, Sistema Capital, a wholly-owned subsidiary of the Group domiciled in
Luxembourg, issued $350.0 million of 8.9% notes, due in January 2011. The notes are fully and unconditionally
guaranteed by JSFC Sistema. Interest payments on the notes are due semi-annually in January and July of each
year, commencing July 2004. On or prior to January 2007, the Group may redeem up to 35% of the notes with
the net proceeds of offerings of JSFC Sistema’s common equity at 108.9% of the principal amount. The notes are
listed on the London Stock Exchange. In January 2007, the holders of the notes may require Sistema Capital
to redeem their notes at 100% of the principal amount thereof, together with accrued interest. In addition, these
notes provide the holders with a right to require Sistema Capital to redeem all of the notes outstanding at 101%
of the principal amount of the notes plus accrued interest upon any change in control.
In April 2003, Sistema Finance, a wholly-owned subsidiary of the Group, issued $350.0 million of 10.3% notes,
due in April 2008, at 99.5% of par. These notes are secured by 193,473,900 shares of common stock of MTS.
The notes are listed on the Luxembourg Stock Exchange. JSFC Sistema is a guarantor of the notes. Interest on
the notes is payable semi-annually in arrears. These notes are subject to certain restrictive covenants including,
but not limited to, limitations on the incurrence of additional indebtedness, restrictions on mergers or consoli-
dations, limitations on liens and dispositions of assets and limitations on transactions with affiliates. In addi-
tion, these notes provide the holders with a right to require Sistema Finance to redeem all of the notes out-
standing at 101% of the principal amount of the notes plus accrued interest upon any change in control.
In January 2005, MTS Finance, a beneficially wholly-owned subsidiary of MTS, issued $400.0 million 8.0% unse-
cured notes at 99.7%. These notes are fully and unconditionally guaranteed by MTS and mature in January 2012.
MTS Finance is required to make interest payments on the notes semi-annually in arrears in January and July,
commencing in July 2005. The notes are listed on the Luxembourg Stock Exchange. The cash proceeds were
$398.9 million, the related debt issuance costs in amount of $2.5 million were capitalized.
In October 2003, MTS Finance issued $400.0 million notes bearing interest at 8.4% at par. The cash proceeds, net
of issuance costs of approximately $4.6 million, amounted to $395.4 million. These notes are fully and uncondi-
tionally guaranteed by MTS and will mature in October 2010. MTS Finance is required to make interest payments
on the notes semi-annually in arrears in April and October of each year, commencing April 2004. The notes
are listed on the Luxembourg Stock Exchange.
In January 2003, MTS Finance issued $400.0 million 9.8% notes at par. These notes are fully and unconditional-
ly guaranteed by MTS and mature in January 2008. MTS Finance is required to make interest payments
on the notes semi-annually in arrears in January and July, commencing July 2003. The notes are listed
on the Luxembourg Stock Exchange. Proceeds received from the notes were $400.0 million and related debt
issuance costs of $3.9 million were capitalized.
Subject to certain exceptions and qualifications, the indentures governing MTS’ notes contain covenants limit-
ing MTS’ ability to incur debt; create liens; lease properties sold or transferred by MTS; enter into loan transac-
tions with affiliates; merge or consolidate with another person or convey its properties and assets to another
person; and sell or transfer any of its GSM licenses for Moscow, St. Petersburg, Krasnodar and Ukraine license
areas. In addition, if MTS experiences certain types of mergers, consolidations or other changes in control, note-
holders will have the right to require MTS to redeem the notes at 101% of their principal amount, plus accrued
interest. MTS is also required to take all commercially reasonable steps necessary to maintain a rating of
the notes from Moody’s or Standard & Poor’s. The notes also have cross default provisions with publicly traded
debt issued by JSFC Sistema. If MTS fails to meet these covenants, after certain notice and cure periods, the note-
holders can accelerate debt to be immediately due and payable. Management believes that MTS is in compliance
with all restrictive provisions as of December 31, 2005.
In March 2005, MBRD entered into a loan agreement with Dresdner Bank AG in the amount of $150.0 million.
The loan bears an interest of 8.6% per annum and is due in March 2008. To finance the loan to MBRD, Dresdner
Notes to consolidatedfinancial statements
49
CONSOLIDATED FINANCIAL STATEMENTS
_ g g / / g
Bank AG issued Loan Participation Notes that were admitted to trade on the Luxembourg Stock Exchange.
Interest payments on the loan are due semi-annually in March and September of each year, commencing
in September 2005. Loan agreement contains certain restrictive covenants including, but not limited to, limita-
tions on mergers, liens and dispositions of assets and transactions with the Group’s subsidiaries and affiliates.
In May 2005, MGTS issued 5-year RUR-denominated bonds in the amount of RUR 1,500 million (equivalent
of $52.1 million as of December 31, 2005). The bonds carry a coupon of 8.3% per annum. MGTS made an uncon-
ditional offer to repurchase the bonds at par value in May 2007.
In April 2004, MGTS issued 5-year RUR-denominated bonds in the amount of RUR 1,500 million (equivalent
of $52.1 million as of December 31, 2005). The bonds carry a coupon of 10.0% per annum. MGTS made an uncon-
ditional offer to repurchase the bonds at par value in April 2006.
In February 2003, MGTS issued 2-year RUR denominated bonds in the amount of 1,000 million RUR (equivalent
of $34.7 million as of December 31, 2005). The bonds carry coupon of 12.3% during the first year of trading and
17.0% during the second year. MGTS fully repaid the bonds in February 2005.
In December 2005, Detsky Mir-Center issued RUR denominated bonds in the amount of 1,150 million RUR (equiv-
alent of $40.0 million as of December 31, 2005) maturing in May 2015. The bonds carry coupon of 8.5% per
annum. The principal of the notes is fully and unconditionally guaranteed by Moscow City. Concurrently,
JSFC Sistema pledged to Moscow City real estate and shareholdings for the amount of approximately $62.8 mil-
lion. DMC is required to make interest payments on the notes semi-annually in arrears in June and December
of each year, commencing June 2006.
In July 2003, Micron issued RUR denominated bonds with face value of RUR 300.0 million (equivalent of $10.4 mil-
lion as of December 31, 2005) due in January 2005. Interest was payable semi-annually. The interest rate was set
at 15% per annum, and two-thirds of the interest payments were covered by the municipal government.
The Group fully repaid the bonds in January 2005.
Syndicated Loan — In July 2004, MTS entered into a $500.0 million syndicated loan agreement with interna-
tional financial institutions: ING Bank N.V., ABN AMRO Bank N.V., HSBC Bank plc, Raiffeisen Zentralbank Oster-
reich AG, Bank Austria Creditanstalt AG, Commerzbank AG and others. The credit facility bears interest
at LIBOR +2.5% (7.2% as of December 31, 2005) per annum and matures in three years. The proceeds were used
by MTS for corporate purposes, including refinancing of its existing indebtedness. In September 2004, MTS
extended total amount available under the syndicated loan facility for an additional $100.0 million to the total
amount of $600.0 million. Commitment fee for the syndicated loan facility amounted to $0.5 million. Debt
issuance costs of $10.2 million were capitalized. As of December 31, 2005 and 2004, the outstanding balances
under the syndicated loan facility were $460.0 million and $600.0 million, respectively. The loan facility is sub-
ject to certain restrictive covenants including, but not limited to, certain financial ratios. Management believes
that as of December 31, 2005, MTS was in compliance with all existing covenants.
HSBC Bank plc and ING BHF-BANK AG — In October 2004, MTS entered into two credit facility agreements with
HSBC Bank plc and ING BHF-BANK AG for the total amount of $121.4 million. The facilities also allow uncom-
mitted additional borrowing up to $36.5 million. In April 2005, the lenders agreed to increase the amount of
available credit facility by $28.3 million. The funds received under the facilities were used to purchase telecom-
munication equipment and software from Siemens AG and Alcatel SEL AG for technical upgrade and expansion of
network. The facility bears interest at LIBOR +0.4% (5.1% as of December 31, 2005) per annum. A commitment
fee of 0.2% per annum and an arrangement fee of 0.3% is payable in accordance with the loan agreement. The
principal and interest amounts are to be repaid in seventeen equal half-year installments, starting July 2005 for
the first agreement and September 2005 for the second one. The debt issuance costs in the amount of $25.9 mil-
Notes to consolidatedfinancial statements
50 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
JSFC SISTEMA AND SUBSIDIARIES
_ g g / / g
lion were capitalized. As of December 31, 2005 and 2004, the outstanding balances under these agreements were
$171.8 million and $77.0 million, respectively. The facilities mature in July and September 2013 and are subject
to certain restrictive covenants, including, but not limited to, covenants restricting MTS’ ability to convey or dis-
pose its properties and assets to another person. Management believes that as of December 31, 2005, MTS was in
compliance with all existing covenants. The unused amount under the credit facility as of December 31, 2005 was
$3.8 million.
EBRD — In December 2004, MTS entered into a credit line agreement with the European Bank for Reconstruction
and Development (“EBRD”) for the total amount of $150.0 million. The facility bears interest at LIBOR + 3.1%
(7.8% as of December 31, 2005) per annum. Commitment fee of 0.5% per annum is payable in accordance with
the credit agreement. The final maturity of this agreement is December 2011. The debt issuance costs in
the amount of $1.5 million were capitalized. As of December 31, 2005 and 2004, the balances outstanding under
the loan were $138.5 million and $150.0 million, respectively. The loan is subject to certain restrictive covenants
including, but not limited to, certain financial ratios. Management believes that as of December 31, 2005, MTS
was in compliance with all existing covenants.
Citibank International plc and ING Bank N.V. — In December 2005, MTS signed an agreement with Citibank
International plc and ING Bank N.V. for $130.8 million committed credit facility and a $36.6 million uncommit-
ted additional facility. These funds will be used to purchase telecommunication equipment from Ericsson AB.
The loan bears interest of LIBOR +0.3% per annum. An arrangement fee of 0.2% of the original facility amount
and an agency fee of $0.01 million per annum are payable in accordance with the agreement. Commitment fee
is 0.1% per annum on the undrawn facility. The loan is subject to certain covenants, including, but not limited
to, covenants restricting MTS’ ability to convey or dispose its properties and assets to another person.
Management believes that as of December 31, 2005, MTS was in compliance with all existing covenants. The facil-
ities are repayable on a biannual basis in equal installments over nine years. As of December 31, 2005, the balance
outstanding under these facilities was $111.0 million. The unused amount under the credit facility as of
December 31, 2005 was $19.7 million.
Commerzbank AG, HSBC Bank plc and ING Bank AG — In October 2005, MTS entered into an agreement with
Commerzbank AG, HSBC Bank plc and ING Bank Deutschland AG for a $125.8 million commited credit facility.
The agreement also allows to borrow up to $28.3 under an uncommitted additional facility. These funds will
be used to purchase telecommunication equipment from Siemens AG. The loan bears interest of LIBOR + 0.3%
(5.0% as of December 31, 2005) per annum. An arrangement fee of 0.2% flat on the original facility amount and
$0.01 million per annum will be paid in accordance with the agreement. The commitment fee is 0.1% per annum
on the undrawn facility. The facilities are repayable on a biannual basis in equal installments over nine years.
The loan is subject to certain covenants, including, but not limited to, covenants restricting MTS’ ability to con-
vey or dispose its properties and assets to another person. Management believes that as of December 31, 2005,
MTS was in compliance with all existing covenants. As of December 31, 2005, the balance outstanding under
the loan was $92.8 million. The unused amount under the credit facility as of December 31, 2005, was $33.0 million.
ABN AMRO N.V. — In November 2004, MTS signed a loan agreement with ABN AMRO Bank N.V. for $56.6 million
and euro 8.4 million ($9.9 million at December 31, 2005). In March 2005, the agreement was amended to expand
the euro facility up to euro 31.3 million (equivalent of $37.2 million at December 31, 2005). These funds were
used to acquire telecommunication equipment from Ericsson AB to expand the network. The loan is repayable
on a biannual basis in equal installments over nine years and has an interest rate of LIBOR + 0.4% (5.1% as
of December 31, 2005) and EURIBOR +0.4% (3.0% as of December 31, 2005) per annum. The debt issuance costs
in the amount of $9.8 million were capitalized. The loan is subject to certain covenants, including, but not lim-
ited to, covenants restricting MTS’ ability to make any substantial change to general nature or scope of its busi-
ness. Management believes that as of December 31, 2005, MTS was in compliance with all existing covenants.
As of December 31, 2005 and 2004, $83.2 million and nil, respectively, were outstanding under the facility.
Notes to consolidatedfinancial statements
51
CONSOLIDATED FINANCIAL STATEMENTS
_ g g / / g
Barclays Bank plc — In February 2005, MTS entered into a credit facility with Barclays Bank plc to finance
the acquisition of equipment from Motorola Limited. The facility allows borrowing up to $25.7 million and
uncommitted additional borrowing of up to $64.3 million. In December 2005, the agreement with Barclays Bank
plc was amended to increase the amount of available uncommitted additional facility by $23.3 million. The orig-
inal facility bears interest of LIBOR +0.2% (4.8% as of December 31, 2005) per annum and additional uncommit-
ted facilities bear interest of LIBOR + 0.1% (4.9% as of December 31, 2005) per annum. An arrangement fee
of 0.4% of the original facility amount and of 0.4% flat on each additional commitment facility amount is
payable in accordance with the agreement. The commitment fee is 0.2% per annum. The debt issuance costs
in the amount of $10.4 million were capitalized. The facilities are redeemable in equal semi-annual installments
by January 2014. The loan is subject to certain covenants, including, but not limited to, covenants restricting
MTS’ ability to convey or dispose its properties and assets to another person. Management believes that
as of December 31, 2005, MTS was in compliance with all existing covenants. As of December 31, 2005, the out-
standing balance under the facility was $80.1 million. The unused amount under the credit facility as
of December 31, 2005, was $31.7 million.
Vneshtorgbank — In December 2005, Sistema-Invest, a subsidiary of the Group, entered into a credit facility
with Vneshtorgbank. The facility allows borrowing up to $600.0 million. The facility bears interest of 8.5% per
annum. The commitment fee is 0.2% per annum on the undrawn facility. As of December 31, 2005, the out-
standing balance under the facility was $50.0 million. The available amount under the credit facility as
of December 31, 2005 was $550.0 million. The facility is collateralized by pledge of 19.9% of the shares of each
of Novoil, Ufimsky NPZ, Ufaneftekhim, ANK Bashneft and Ufaorgsintez and 18.57% of Bashnefteproduct (Note 3).
The facility is subject to certain restrictive covenants, including, but not limited to, any merger, consolidation or
disposition of assets, which can deteriorate Sistema-Invest’s solvency. Management believes that as of Decem-
ber 31, 2005 Sistema-Invest was in compliance with these covenants.
In March 2005, MGTS entered into a credit agreement with Vneshtorgbank for an amount of euro 5.3 million
(equivalent of $6.2 million as of December 31, 2005) to finance acquisition of equipment. The loan matures
in September 2010 and bears interest at EURIBOR +5.0% (7.6% as of December 31, 2005) per annum. Equipment
with approximate carrying value of $5.7 million is pledged to collateralize the outstanding balance under
the agreement. As of December 31, 2005, the amount outstanding under the agreement was $6.2 million.
In July 2004, MGTS entered into two credit agreements for a total amount of euro 7.3 million (equivalent
of $8.6 million as of December 31, 2005) to finance acquisition of equipment. The loans mature in January 2010
and bear interest at the highest of EURIBOR + 5.4% (8.0% as of December 31, 2005) or 7.5%. Equipment with
approximate carrying value of $7.6 million is pledged to collateralize the outstanding balance under the agree-
ment. As of December 31, 2005, the amount outstanding under these credit agreements was $6.9 million.
During the year ended December 31, 2002, MGTS received a number of loans from Vneshtorgbank maturing
in 2006 to finance working capital. As of December 31, 2005, $2.9 million was outstanding under these loans.
The loans are collateralized by equipment with approximate carrying value of $3.3 million. The weighted aver-
age interest rate on the loans outstanding as of December 31, 2005 was 9.6% per annum.
HSBC Bank plc, ING Bank Deutschland AG and Bayerische Landesbank — In November 2005, MTS entered
into a credit facility with HSBC Bank plc, ING Bank Deutschland AG and Bayerische Landesbank. The facility
allows borrowing of up to $123.8 million and up to $17.3 million of uncommitted additional borrowing. The
funds received will be used to finance the acquisition of telecommunication equipment from Alcatel SEL AG. The
loan bears interest of LIBOR + 0.3% (5.0% as of December 31, 2005) per annum. An arrangement fee of 0.2% of
the original facility amount and an agency fee of $0.01 million per annum is payable in accordance with the
agreement. The commitment fee is 0.1% per annum on the undrawn facility. The debt issuance costs in the amount
of $19.3 million were capitalized. The loan is subject to certain covenants, including, but not limited to,
Notes to consolidatedfinancial statements
52 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
JSFC SISTEMA AND SUBSIDIARIES
_ g g / / g
covenants restricting the MTS’ ability to convey or dispose its properties and assets to another person.
Management believes that as of December 31, 2005 MTS was in compliance with all existing covenants. The facili-
ties are repayable on a biannual basis in equal installments over nine years. As of December 31, 2005, the out-
standing amount under the credit facility was $63.3 million. The amount of available credit facility as of December
31, 2005 was $60.5 million.
ING BHF-BANK and Commerzbank AG — In December 2003, UMC entered into a сredit facility with ING BHF
Bank and Commerzbank AG to finance the acquisition of telecommunication equipment from Siemens AG. The aggre-
gate amount available under this credit facility is euro 47.4 million (equivalent of $56.3 million as of December 31,
2005). In 2004, the agreement was amended to increase the amount available under the facility by euro 9.2 million
(equivalent of $10.9 million as of December 31, 2005). The loan is guaranteed by MTS and bears interest at EURI-
BOR +0.7% (3.3% as of December 31, 2005) per annum. The amount outstanding is redeemable in ten equal semi-
annual installments starting July 2004. At December 31, 2005 and 2004, the amounts outstanding under the loan
were $43.2 million and $63.9 million, respectively.
Commerzbank (Eurasia) — InvestSvyazHolding, a subsidiary of the Group, entered into a number of credit
facilities with Commerzbank (Eurasia) for a total amount of $38.5 million as of December 31, 2005. The facilities
bear interest of LIBOR +0.4%–3.5% per annum (5.1%–8.2% as of December 31, 2005). As of December 31, 2005,
approximately $34.1 million was outstanding under these facilities. The facilities are fully and unconditionally
guaranteed by MGTS.
Citibank — In 2003-2005, MGTS entered into four credit facilities with Citibank for a total amount of $25.1 mil-
lion. All facilities bear interest of LIBOR + 1.6% (6.3% as of December 31, 2005) per annum and are repayable
in 8 semi-annual installments every six months with the last payments in 2008-2010. The facilities were received
to finance acquisitions of equipment from STROM telecom. The facilities are collaterized by equipment with
an approximate carrying value of $16.9 million, a deposit of $2.3 million in Citibank and are guaranteed
by Export Guarantee and Insurance Corporation of the Czech Republic. As of December 31, 2005, the amount out-
standing under these facilities was $21.6 million.
The loans are subject to certain restrictive covenants including, but not limited to, certain financial ratios.
The written approval of Citibank is required for MGTS to obtain borrowings individually exceeding $30.0 million
(apart from Sberbank loan, Raiffeisenbank loan and MGTS bonds) or alienate more than 10% of its assets.
Management believes that as of December 31, 2005, MGTS was in compliance with all existing covenants.
ABN AMRO Bank — In September 2005, Comstar-UTS entered into a credit line agreement with ABN AMRO Bank,
limited to $20.0 million. The credit line bears interest of LIBOR +3.0% (7.5% as of December 31, 2005) per annum
and is repayable in seven equal consecutive installments with the last payment in September 2007. The credit
line was opened to finance acquisitions. The credit line is fully and unconditionally guaranteed by MTU-Inform.
As of December 31, 2005, the amount outstanding under the credit line was $20.0 million. The credit line is sub-
ject to certain restrictive covenants including, but not limited to, limitations on the amount of dividends paid,
loans issued to parties other than Sistema Telecom, acquisitions and investments made at terms different from
market and certain financial ratios. Management believes that as of December 31, 2005, Comstar-UTS was in com-
pliance with all existing covenants.
ING Bank (Eurasia) — In September 2003, UMC entered into a $60.0 million syndicated credit facility with ING
Bank (Eurasia), Standard Bank and Commerzbank AG with an interest rate of LIBOR + 2.3%–4.2% per annum
(6.8%–8.7% as of December 31, 2005). The loan is fully and unconditionally guaranteed by MTS. The proceeds
were used by UMC to refinance its existing indebtedness. The loan is payable in eight equal quarterly install-
ments starting from September 2004. As of December 31, 2005 and 2004, $20.0 million and $46.7 million were
outstanding, respectively, under this credit facility.
Notes to consolidatedfinancial statements
53
CONSOLIDATED FINANCIAL STATEMENTS
_ g g / / g
Commerzbank Belgium S.A./N.V. — In October 2004, MTS entered into a loan agreement with Commerzbank
Belgium S.A./N.V. The aggregate amount available under the agreement is $18.3 million. The loan proceeds were
used to finance the purchase of telecommunication equipment from Alcatel Bell N.V. The loan bears interest
of LIBOR + 0.4% per annum (5.1% as of December 31, 2005). A commitment fee at rate of 0.2% per annum and
flat management fee of 0.3% on the loan amount is payable in accordance with the terms of agreement. Related
debt issuance costs of $1.3 million were capitalized. As of December 31, 2005 and 2004, the outstanding balance
under the loan was $13.3 million and nil, respectively. The available amount under the credit facility as of
December 31, 2005 was $5.0 million.
Credit Suisse Bank — In December 2004, JSFC Sistema entered into a credit facility agreements with Credit
Suisse Bank (Zurich) for the total amount of $14.0 million. The funds were used to purchase an aircraft for
administrative use. The facility bears interest at LIBOR + 2.8% (7.5% as of December 31, 2005) and matures in
2015. As of December 31, 2005 and 2004, the balance outstanding under the facility was $13.0 million and nil,
respectively.
Raiffeisenbank — In November 2002, JSFC Sistema entered into a credit line with Raiffeisenbank (Austria) lim-
ited to $20.0 million, bearing interest of LIBOR +5%–7% per annum and maturing in 2007. A building with fair
value of $16.8 million was pledged under this credit line. As of December 31, 2005, the loan was fully repaid.
Vendor Financing — Foreign suppliers of telecommunication equipment provide non-collateralized commercial
credit (vendor financing) to the Group denominated in various currencies on short-term and long-term bases,
mostly interest free.
The schedule of repayments of long-term debt over the five-year period beginning on December 31, 2005
is as follows:
(000’s)
Year ended December 31,
2006 $ 520,310
2007 341,619
2008 1,039,942
2009 113,470
2010 604,032
Thereafter 1,103,566
Total $ 3,722,939
In December 2004, MTS entered into two variable-to-fixed interest rate swap agreements with ABN AMRO Bank
N.V and HSBC Bank plc to hedge MTS’ exposure to variability of future cash flows caused by change in LIBOR
related to the syndicated loan. MTS agreed with ABN AMRO to pay a fixed rate of 3.3% and receive a variable
interest of LIBOR on $100.0 million for the period from October 2004 to July 2007. MTS agreed with HSBC Bank
plc to pay a fixed rate of 3.3% and receive a variable interest of LIBOR on $150.0 million for the period from
October 2004 to July 2007. These instruments qualify as cash flow hedges under the requirements of FAS No. 133,
as amended by FAS No. 149. As of December 31, 2005, the Group recorded an asset of $3.6 million in relation
to these contracts in the accompanying consolidated balance sheet and an income of $2.8 million, net of tax
of $0.8 million, as other comprehensive income in the accompanying consolidated statement of changes
in shareholders equity in relation to the change in fair value of these agreements. In 2005, there were no
amounts reclassified from other comprehensive income to income due to hedge ineffectiveness.
Notes to consolidatedfinancial statements
54 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
JSFC SISTEMA AND SUBSIDIARIES
_ g g / / g
24. SUBSCRIBER PREPAYMENTS
Subscriber prepayments as of December 31, 2005 and 2004 consisted of the following:
(000’s)2005 2004
Current portion (Note 20)
Connection fees $ 83,333 $ 83,021
Advances and customers’ deposits 389,340 308,859
472,673 391,880
Non-current portion
Connection fees 163,897 156,233
Total $ 636,570 $ 548,113
25. INCOME TAX
The Group’s provision for income taxes for the years ended December 31, 2005 and 2004 was:
(000’s)2005 2004
Current provision $ 618,913 $ 504,634
Deferred benefit (105,920) (58,903)
Total income tax expense $ 512,993 $ 445,731
The provision for income taxes is different from that which would be obtained by applying the statutory income
tax rate of 24% to net income before income tax, minority interests and cumulative effect of a change in
accounting principle. The items causing this difference are as follows:
(000’s)2005 2004
Income tax provision computed on income from $ 428,150 $ 355,546
continuing operations before taxes at statutory rate
Adjustments due to:
Change in valuation allowance (1,366) 234
Non-deductible items 61,334 50,951
Non-taxable items (5,775) (7,584)
Taxable losses not carried forward 36,820 32,007
Currency exchange and translation differences (9,714) 21,496
Effect of rates different from standard 3,544 (6,919)
Income tax expense $ 512,993 $ 445,731
Notes to consolidatedfinancial statements
55
CONSOLIDATED FINANCIAL STATEMENTS
_ g g / / g
The tax effects of temporary differences that give rise to the deferred tax assets and liabilities are presented
below:
(000’s)2005 2004
Deferred tax assets
Subscriber and customer prepayments $ 86,300 $ 76,364
Property, plant and equipment 71,650 60,963
Intangible assets 25,966 1,878
Deferred revenues 25,007 24,581
Allowance for doubtful accounts and loans receivable 31,414 14,559
Accrued expenses 57,381 27,293
Tax losses carried forward 1,324 8,930
Other 17,813 14,223
316,855 228,791
Less: valuation allowance (371) (8,908)
Total deferred tax assets $ 316,484 $ 219,883
Deferred tax liabilities
Intangible assets (231,838) (234,879)
Property, plant and equipment (118,784) (111,930)
Undistributed earnings of subsidiaries and affiliates (23,345) (25,220)
Debt issuance costs (19,839) (6,544)
Other (31,590) (15,284)
Total deferred tax liabilities $ (425,396) $ (393,857)
Net deferred tax assets, current $ 123,681 $ 73,592
Net deferred tax assets, long-term $ 33,472 $ 3,482
Net deferred tax liabilities, current $ (28,149) $ (22,071)
Net deferred tax liabilities, long-term $ (237,916) $ (228,977)
As of December 31, 2004, MTS had taxable loss carryforward in the amount of $29.9 million related to operations
of Rosico, that resulted in deferred tax assets in the amounts of $7.2 million. While Rosico was merged into MTS
in June 2003, the Group recorded a valuation allowance for the entire amount of the available tax loss carry-
forward related to Rosico as of December 31, 2004, as MTS had not yet performed all procedures necessary to
determine what amounts will be available for deductions in the future as of that date. As of December 31, 2005,
the possibility of the claim for the tax loss carryforward was assessed as remote and therefore deferred tax asset
was written off against the valuation allowance.
Deferred tax assets relating to tax losses carried forward in the amount of $1.3 million as of December 31, 2005
expire in 2012 and are attributable to MTU-Inform.
The Group does not record a deferred tax liability related to undistributed earnings of its subsidiaries, except for
MTS, as it intends to permanently reinvest these earnings. Deferred tax liability on distributions of MTS is record-
ed in accordance with MTS’s dividend policy.
Notes to consolidatedfinancial statements
56 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
JSFC SISTEMA AND SUBSIDIARIES
_ g g / / g
26. POSTRETIREMENT BENEFITS
MGTS has historically provided certain benefits to employees upon their retirement and afterwards. Currently
the main features under the defined benefit pension program include the following:
Monthly Regular Pension — Employees retiring with at least fifteen years of service receive lifetime payments
varying from RUR 3,600 (equivalent of USD 125 as of December 31, 2005) to RUR 50,400 (equivalent of USD 1,751
as of December 31, 2005) per year depending on employee’s actual years of service and qualification;
Death-in-Service — Lump-sum payment of RUR 15,000 (equivalent of USD 521 as of December 31, 2005),
payable upon death of an employee, irrespective of past service;
Lump-sum upon Retirement — Lump-sum payment upon retirement of employees with at least five years of
service varying from RUR 3,700 (equivalent of USD 129 as of December 31, 2005) to RUR 22,200 (equivalent
of USD 771 as of December 31, 2005) depending on employee’s actual years of service;
Monthly Telephone Subsidy — Qualifying pensioners (those who served more than 30 years at MGTS) get 50%
subsidy (approximately USD 3.5 per month as of December 31, 2005) for their monthly telephone bills
from MGTS;
Death-while-pensioner — MGTS pays lump-sum benefits to relatives of deceased pensioners of up to
RUR 10,000 (equivalent of USD 347 as of December 31, 2005).
MGTS’ pension obligations are measured as of December 31. The following are the key assumptions used in deter-
mining the projected benefit obligation and net periodic pension expense:
Discount rate 9.2%
Future salary increases 9.2%
Future pension increases 0.0%
Average life expectancy of members from date of retirement 17 years
The change in the projected benefit obligation and the change in plan assets are presented in the following
table:
(000’s)2005 2004
Projected benefit obligation, beginning of the year $ 13,550 $ 6,034
Service cost 2,914 1,601
Interest cost 1,441 634
Plan amendments – 4,488
Actuarial losses 2,117 855
Benefit payments (668) (433)
Currency translation effect (487) 371
Projected benefit obligation, end of the year 18,867 13,550
Less: fair value of plan assets (2,650) (2,037)
Unfunded status of the plan, end of the year $ 16,217 $ 11,513
Notes to consolidatedfinancial statements
57
CONSOLIDATED FINANCIAL STATEMENTS
_ g g / / g
The increase in projected benefit obligation due to plan amendment in the year ended December 31, 2004 relates
to the increase in the base rate used to determine the monthly payments to the retired employees. The changes
in the projected benefit obligation due to actuarial losses for the years ended December 31, 2005 and 2004 relate
primarily to the changes in the discount rate and employees turnover assumptions.
The accumulated benefit obligation as of December 31, 2005 and 2004 was $16.2 million and $11.5 million,
respectively. The components of the net periodic benefit costs for the years ended December 31, 2005 and 2004
are as follows:
(000’s)2005 2004
Service cost $ 2,914 $ 1,601
Interest cost 1,441 634
Net periodic benefit cost $ 4,355 $ 2,235
The Group’s management expects contributions to the plan during the year ended December 31, 2006 to amount
to $0.9 million.
The future benefit payments to retirees under the defined benefit plan are expected as follows:
(000’s)
Year ended December 31,
2006 $ 4,499
2007 1,436
2008 1,370
2009 1,310
2010 1,257
2011–2015 4,365
Thereafter 1,980
Total $ 16,217
The plan assets for lifetime payments to employees retiring after January 1, 2004, are managed by Sistema
Pension Fund, a subsidiary of the Group.
27. DEFERRED REVENUE
Deferred revenue is comprised of property, plant and equipment contributions and grants received by the Group
and as of December 31, 2005 and 2004 was as follows:
(000’s)2005 2004
Deferred revenue at the beginning of the year $ 130,913 $ 115,363
Contributions received during the year 6,369 21,530
Currency translation effect (4,693) 1,044
137,937
Deferred revenue amortized (6,889) (7,024)
Deferred revenue at the end of the year $ 125,700 $ 130,913
Notes to consolidatedfinancial statements
58 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
JSFC SISTEMA AND SUBSIDIARIES
_ g g / / g
In 2000 the Group was awarded a grant for construction of a manufacturing facility for production of medicines
(vaccines and infusion dissolvents) in the Moscow region. The grant facility of $20.1 million was received in full
during 2001 and 2000. The grant is repayable to the grantor (state organization) during the period to 2010.
These contributions are accounted for as deferred revenues.
28. SHARE CAPITAL
At January 1, 2004, JSFC Sistema had 68,325,000 voting common shares authorized and 8,100,000 shares issued
and outstanding with par value of 0.1 RUR.
In July 2004, JSFC Sistema increased the par value of its shares to 90.0 RUR. As a result of this transaction,
the share capital of the Group increased and retained earnings decreased by $24.9 million.
On February 11, 2005, JSFC Sistema completed an initial public offering of 1,550,000 common shares, with a nom-
inal value of 90 RUR per share in the form of 77,500,000 global depositary receipts (“GDRs”), with 50 GDRs rep-
resenting one share. On February 14, 2005, JSFC Sistema’s GDRs were admitted to trade on the London Stock
Exchange. Proceeds from the offering, net of underwriting discount and other direct costs, were $1,284.6 million.
Simultaneously, certain shareholders of the Group sold 42,663 common shares in the form of 2,133,150 GDRs.
In addition, shareholders exercised their option to sell additional 238,900 shares in the form of 11,945,000 GDRs.
In December 2005, the controlling shareholder of the Group disposed of 1% of shares of JSFC Sistema in favor
of four of the top managers of the Group. The Group did not record any expense in relation to this transaction,
as it was not aimed at the retention of, or improved performance by the employees.
In June 2005, JSFC Sistema declared dividends for the year ended December 31, 2004, amounting to $8.8 million.
In August 2005, the Board of Directors of JSFC Sistema approved its dividend policy, which describes recommen-
dations on the size of dividends, as well as Sistema’s obligations on dividend payments and relevant disclosures.
The policy determines the recommended dividend rate at 2% of the Group’s consolidated net income.
29. SEGMENT INFORMATION
FAS No. 131, “Disclosures about Segments of an Enterprise and Related Information”, established standards
for reporting information about operating segments in financial statements. Operating segments are defined
as components of an enterprise engaging in business activities about which separate financial information
is available that is evaluated regularly by the chief operating decision maker or group in deciding how to allo-
cate resources and in assessing performance.
The Group’s operating segments are: Telecommunications, Technology, Insurance, Banking, Маss Media, Real
Estate, Retail, Corporate and Other. The Group’s management evaluates performance of the segments based on
both operating income and net income before minority interests and cumulative effect of an extraordinary gain
and a change in accounting principle.
Intercompany eliminations presented below consist primarily of the following items: intercompany sales trans-
actions, elimination of gross margin in inventory and other intercompany transactions conducted under the nor-
mal course of operations.
Notes to consolidatedfinancial statements
59
CONSOLIDATED FINANCIAL STATEMENTS
_ g g / / g
An analysis and reconciliation of the Group’s business segment information to the respective information
in the consolidated financial statements for the years ended December 31, 2005 and 2004 is as follows:
(000’s)Telecommunications Technology Insurance
For the Year ended December 31, 2005
Net sales to external customers (a) 5,892,232 665,680 371,936
Intersegment sales 651 295,453 36,924
Income from equity affiliates 66,382 16 239
Interest income 32,386 715 –
Interest expense (148,681) (10,155) –
Net interest revenue (b) – – –
Depreciation and amortization (989,210) (12,044) (4,373)
Operating income/(loss) 1,933,269 143,517 28,417
Income tax expense (444,975) (31,705) (11,175)
Income/(loss) before minority interests, extraordinary gain 1,352,892 101,892 19,679
and cumulative effect of a change in accounting principle
Investments in affiliated companies 214,259 – –
Segment assets 9,696,648 561,546 581,452
Cash and cash equivalents 157,088 83,339 109,954
Indebtedness (c) (3,088,284) (116,335) (955)
Capital expenditures 2,339,371 30,512 8,417
For the Year ended December 31, 2004
Net sales to external customers (a) 4,615,846 396,912 275,510
Intersegment sales 856 101,515 24,684
Income/(loss) from equity affiliates 27,324 – 191
Interest income 30,202 197 –
Interest expense (134,816) (6,876) –
Net interest revenue (b) – – –
Depreciation and amortization (783,668) (3,484) (3,378)
Operating income/(loss) 1,630,305 45,918 30,168
Income tax expense (405,772) (10,594) (8,646)
Income/(loss) before minority interests extraordinary gain 1,133,354 27,199 21,074
and cumulative effect of a change in accounting principle
Investments in affiliated companies 165,724 – –
Segment assets 7,186,266 306,186 452,761
Cash and cash equivalents 370,938 39,685 127,610
Indebtedness (c) (2,143,237) (84,673) (522)
Capital expenditures 1,538,321 11,882 14,079
(a) — Interest income and expenses of the Insurance and Banking segments are presented as revenues from financial services
in the Group’s consolidated financial statements.
(b) — The Banking Segment derives a majority of its revenue from interest. In addition, management primarily relies on net interest revenue,
not the gross revenue and expense amounts, in managing that segment. Therefore, only the net amount is disclosed.
(c) — Represents the sum of short-term and long-term debt, including vendor financing, and capital lease obligations.
Notes to consolidatedfinancial statements
60 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
JSFC SISTEMA AND SUBSIDIARIES
_ g g / / g
Notes to consolidatedfinancial statements
61
CONSOLIDATED FINANCIAL STATEMENTS
(000’s)Banking Mass Media Real Estate Retail Corporate and Other Total
78,228 26,137 73,552 207,972 277,812 7,593,549
28,557 26,291 4,896 36 5,782 398,590
1,231 – – – 10,165 78,033
– 260 660 148 43,874 78,043
– (1,393) (5,702) (2,266) (81,126) (249,323)
13,046 – – – – 13,046
(1,555) (4,540) (2,104) (1,618) (9,148) (1,024,592)
12,722 7,070 10,399 10,445 (39,425) 2,106,414
(3,967) (1,174) (4,248) (2,712) (13,037) (512,993)
8,755 3,814 2,315 5,649 (111,582) 1,383,414
17,749 469 2,397 – 679,329 914,203
1,114,875 81,905 331,793 146,284 2,009,138 14,523,641
95,260 4,899 10,010 6,846 216,961 684,357
(150,000) (49,881) (211,152) (70,346) (1,315,680) (5,002,633)
5,170 28,423 18,571 8,971 44,882 2,484,317
42,950 33,282 113,086 79,344 177,020 5,733,950
22,788 2,935 2,256 – – 155,034
1,097 – – 156 (1,647) 27,121
– 6 127 23 4,821 35,376
– (330) (3,574) (1,478) (86,085) (233,159)
11,713 – – – – 11,713
(1,119) (680) (1,049) (1,336) (2,560) (797,274)
11,691 (938) 23,463 9,039 (64,224) 1,685,482
(1,338) (187) (2,646) (1,845) (14,703) (445,731)
12,693 163 16,161 6,499 (172,269) 1,044,874
16,519 – 102 504 23,671 206,520
757,902 37,064 222,918 52,687 664,646 9,680,430
84,404 3,257 4,090 1,190 73,785 704,959
(11,547) (41,202) (163,089) (12,226) (1,008,343) (3,464,839)
3,032 2,472 27,191 4,083 25,926 1,626,986
_ g g / / g
The reconciliation of segment operating income to the consolidated income from continuing operations before
income tax, minority interests, extraordinary gain and cumulative effect of a change in accounting principle
and reconciliation of segment assets to the consolidated segment assets are as follows:
(000’s)2005 2004
Total segment operating income $ 2,106,414 $ 1,685,482
Intersegment eliminations (148,990) (20,776)
Interest income 66,132 18,061
Interest expense (225,684) (213,943)
Currency exchange and translation (loss)/gain (13,913) 12,620
Consolidated income before income tax, minority interests, $ 1,783,959 $ 1,481,444
extraordinary gain and cumulative effect of a change
in accounting principle
Total segment assets $ 14,523,641 $ 9,680,430
Intersegment eliminations (1,432,791) (857,102)
Consolidated assets $ 13,090,850 $ 8,823,328
Total segment indebtedness $ 5,002,633 $ 3,464,839
Intersegment eliminations (632,023) (399,938)
Consolidated indebtedness $ 4,370,610 $ 3,064,901
For the years ended December 31, 2005 and 2004, the Group’s revenues derived from Ukraine were $1,673.8 mil-
lion and $1,115.3 million, respectively. Long-lived assets of the Group’s entities domiciled in Ukraine were
$1,398.4 million and $849.4 million as of December 31, 2005 and 2004, respectively.
The Group’s revenues derived from Czech Republic, Uzbekistan, Turkmenistan and other countries were not sig-
nificant in relation to the Group’s consolidated revenues for the years ended December 31, 2005 and 2004.
For the years ended December 31, 2005 and 2004, the Group did not have revenues from transactions with a sin-
gle external customer amounting to 10% or more of the Group’s consolidated revenues.
Notes to consolidatedfinancial statements
62 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
JSFC SISTEMA AND SUBSIDIARIES
_ g g / / g
30. RELATED PARTY TRANSACTIONS
The Group provides services to and purchases services from affiliates and companies related by means of common
control. During the years ended December 31, 2005 and 2004, the Group entered into transactions with related
parties as follows:
(000’s)2005 2004
Sale of goods and services $ (24,114) $ (131,820)
Telecommunication services provided (4,487) (10,497)
Revenues from financial services (4,506) (2,052)
Consulting services provided – (1,799)
Telecommunication services purchased 41,181 15,751
Interest expense – 4,998
Finance services related costs – 1,510
Purchases of goods for resale 9,807 2,612
Other 2,105 2,238
Related party balances as of December 31, 2005 and 2004 are disclosed in the corresponding notes to the finan-
cial statements.
31. COMMITMENTS AND CONTINGENCIES
Operating Leases — The Group leases land, buildings and office space mainly from municipal organizations
through contracts, which expire in various years through 2049.
Future minimum rental payments under capital and operating leases in effect as of December 31, 2005, are as fol-
lows:
(000’s)Capital leases Operating leases
Year ended December 31,
2006 $ 3,220 $ 85,851
2007 4,101 40,237
2008 2,946 30,031
2009 44 24,726
2010 41 17,677
Thereafter 2 64,446
Less: amount representing interest (452) –
Total $ 9,902 $ 262,968
Capital Commitments — As of December 31, 2005, MTS had executed non-binding purchase agreements in
the amount of approximately $388.2 million to subsequently acquire property, plant and equipment.
In December 2003, MGTS announced its long-term investment program for the period from 2004 to 2012 provid-
ing for extensive capital expenditures including expansion and full digitalization of the Moscow telephone net-
work. The program was approved by the resolution of Moscow City Government of December 16, 2003. At the
inception of the investment program, capital expenditures were estimated to be approximately $1,600 million
and include reconstruction of 350 local telephone stations and installation of 4.3 million of new phone numbers.
Notes to consolidatedfinancial statements
63
CONSOLIDATED FINANCIAL STATEMENTS
_ g g / / g
In December 2005, MGTS entered into an agreement to acquire telecommunication equipment and related serv-
ices from ECI Telecom (Israel). The vendor financing amounting to $2.3 million will bear interest of LIBOR +4%
and be repayable in nine equal quarterly installments starting October 2006.
In July 2003, Sistema-Hals entered into an agreement with Siemens Real Estate to develop an office building in
Moscow, which will become Siemens AG headquarters in Russia. Under this agreement Sistema-Hals is responsi-
ble for obtaining all necessary permits, planning and overall control of the construction process. The building
is expected to be completed in 2006. The cost of the project is estimated at approximately euro 116.5 million
(equivalent of $138.4 million as of December 31, 2005). Siemens will pay to Sistema-Hals euro 126.7 million
(equivalent of $150.5 million as of December 31, 2005).
Additionally, Sistema-Hals entered into construction agreements with various third party subcontractors
for a total amount of $62.3 million.
Organizator, a subsidiary of Sistema-Hals, acts as a project manager on a number of construction projects which
will be completed subsequent to the balance sheet date. The estimated cost to complete these projects as
of December 31, 2005, is as follows (including Organizator’s fee based on a percentage of project costs incurred):
(000’s)Estimated costs
to complete
Construction of Krasnopresnensky Prospekt from Moscow Ring Highway (“MKAD”) $ 1,253,024
to Marshala Zhukova Prospekt (includes tunnel, bridge and roads)
Highway off ramps and connection between MKAD and the Moscow “third ring” road 60,339
Road construction from the “third ring” to “Moscow City” development site 41,353
Lefortovo tunnel 46,833
Residential premises relocation on 3rd Magistralnaya Str. 56,051
Other Commitments — In August 2005, the Group entered into a binding agreement with the other sharehold-
er of SkyLink, the Group’s affiliate, to protect the other shareholder from losses in case the joint venture does
not reach certain targets in terms of customer base, cash flows and earnings. If SkyLink does not reach certain
quantitative targets by the first half of 2007, the Group will have at the discretion of the other shareholder to
purchase the 50% share in SkyLink for a total cash consideration of $200.0 million, or reimburse the other share-
holder in the amount determined as $200.0 million multiplied by the percentage of deviation from the agreed
quantitative targets.
Operating Licenses — Since the commencement of MTS’ operations in 1994, a number of wireless telecommu-
nication licenses for the Russian Federation were issued to MTS and its now consolidated subsidiaries. These
license agreements stipulate that certain fixed “contributions” be made to a fund for the development
of telecommunication networks in the Russian Federation. According to the terms of licenses, such contributions
were to be made during the license period upon the decision and as defined by the Board of Directors of
the Association of GSM-900 Operators (“the Association”). The Association is a nongovernmental, not-for-profit
association, and their Board of Directors comprises representatives of the major cellular communications compa-
nies, including MTS. On January 1, 2004, a new Federal Law on Communications came into effect in the Russian
Federation. According to the Law the Group was required to update operating licenses as requirements to make
certain fixed contributions discussed above have been abandoned with the new Law on Communications. As of
December 31, 2005, MTS’ potential liability according to the terms of licenses, that still provide for the payment
of such fees, could total approximately $18.1 million.
Notes to consolidatedfinancial statements
64 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
JSFC SISTEMA AND SUBSIDIARIES
_ g g / / g
The Association has not adopted any procedures enforcing such payments and no such procedures have been
established by Russian legislation. To date, MTS has not made any such payments pursuant to any of the current
operating licenses issued to MTS and its consolidated subsidiaries. Further, the management of MTS believes that
MTS will not be required to make any such payments in the future. In relation to these uncertainties, the Group
has not recorded a contingent liability in the accompanying consolidated financial statements.
Each of the Group’s wireless telecommunication licenses, except the licenses covering the Moscow license area,
contains a requirement for service to be commenced and for subscriber number and territorial coverage targets
to be achieved by a specified date. The Group has met these targets or received extensions to these dates in those
regional license areas in which the Group has not commenced operations. The management believes that
the Group is in compliance with all material terms of its licenses.
The Group’s telecommunication licenses do not provide for automatic renewal. The Group has limited experience
with the renewal of its existing licenses. However, management believes that the licenses required for the
Group’s operations will be renewed upon expiration.
Issued Guarantees — As of December 31, 2005, MTS has issued guarantees to third party banks for the loans
taken by MTS-Belarus, an equity investee, for the total amount of $9.0 million. The guarantees expire by
April 2007.
MBRD guaranteed loans for several companies, including related parties, which totaled $30.5 million as of
December 31, 2005.
The issued guarantees are recorded at fair value in the accompanying consolidated balance sheet.
These guarantees would require payment by the Group only in the event of default on payment by the respec-
tive debtor. Under these guarantees the Group could be potentially liable for a maximum amount of $39.5 mil-
lion in case of the borrower’s default under the obligations. As of December 31, 2005, no event of default has
occurred under any of the guarantees issued by the Group.
Minimum Capital Requirements — The Law on Insurance in Russia sets minimum capital requirements for
insurance organizations, depending on the type of insurance they are underwriting. The minimum capital
requirement for insurance organizations conducting reinsurance operations is set at 120.0 million RUR (equiva-
lent of $4.2 million as of December 31, 2005). As of December 31, 2005, ROSNO’s statutory share capital amount-
ed to 1,069.0 million RUR (equivalent of $37.2 million as of December 31, 2005).
The Central Bank of Russia sets minimum capital requirements for banks. The minimum capital requirement is set
at euro 5.0 million for each newly-founded bank. As of December 31, 2005, MBRD’s share capital amounted
to 998.0 million RUR (equivalent of $34.8 million as of December 31, 2005).
Contingencies — The Russian economy, while deemed to be of market status starting from 2002, continues
to display certain traits consistent with that of an emerging market. These characteristics have in the past
included higher than normal inflation, insufficient liquidity of the capital markets, and the existence of curren-
cy controls which cause the national currency to be illiquid outside of Russia. The continued success and stabil-
ity of the Russian economy will be subject to the government’s continued actions with regard to legal, and eco-
nomic reforms.
The new Federal Law on Communications sets the legal basis for the telecommunications business in Russia and
defines the status that state bodies have in the telecommunications sector. In addition, the law created a uni-
versal service fund (“USF”) charge, which became effective May 3, 2005, calculated as 1.2% of revenue from serv-
Notes to consolidatedfinancial statements
65
CONSOLIDATED FINANCIAL STATEMENTS
_ g g / / g
ices provided to customers, excluding interconnection and other operators’ traffic routing revenue. The Group
has incurred approximately $35.6 million in USF charges for May through December 2005 which is recorded in
other operating expenses. In addition, a recent amendment to the Federal Law on Communications which is
planned to become effective July 1, 2006, will implement the “calling party pays”, or CPP, principle prohibiting
mobile operators from charging their subscribers for incoming calls. Generally, operators charge subscribers for
incoming calls. Under the new system, fixed-line operators will begin charging their subscribers for such calls
and transfer a percentage of the charge to mobile operators terminating such calls while mobile operators will
not. The introduction of CPP may have a negative impact on the Group’s service revenues depending on the set-
tlement rate between mobile and fixed-line operators set by the government. While the impact of this regulato-
ry change at this point is uncertain due to the insufficient information made available to the market by the regu-
lator, management believes it will not have a material adverse effect for the Group.
The Russian government has also issued several implementing acts under the Law on Communications, such
as Resolution No. 87, dated February 18, 2005, approving the list of the types of licensed telecommunication
activities, and Resolution No. 68, dated February 11, 2005, regarding the rules applicable to the state registration
of telecommunication infrastructure such as real property. However, it is presently not yet clear how these reg-
ulations would be implemented. Thus, the uncertainty related to the Law on Communications continues.
Russia currently has a number of laws related to various taxes imposed by both federal and regional govern-
mental authorities. Applicable taxes include value added tax (“VAT”), corporate income tax (profits tax), a num-
ber of turnover-based taxes, and payroll (social) taxes, together with others. Laws related to these taxes have
not been in force for significant periods, in contrast to more developed market economies; therefore, the gov-
ernment’s implementation of these regulations is often inconsistent or nonexistent. Accordingly, few precedents
with regard to tax rulings have been established. Tax declarations, together with other legal compliance areas
(for example, customs and currency control matters), are subject to review and investigation by a number
of authorities, which are enabled by law to impose extremely severe fines, penalties and interest charges.
These facts create tax risks in Russia that are more significant than typically found in countries with more devel-
oped tax systems.
In March 2005, the Russian tax authorities audited MTS compliance with tax legislation for the year ended
December 31, 2002. Based on the results of this audit, the Russian tax authorities assessed that 372,152 thou-
sand rubles (approximately $13.4 million as at December 31, 2004) of additional taxes, penalties and fines were
payable by MTS. MTS has prepared and filed with the Arbitrary Court of Moscow a petition to recognize the tax
authorities’ resolution as partially invalid. The amount of disputed taxes and fines equals 281,504 thousand
rubles (approximately $10.1 million). MTS already passed three court hearings with positive results, while one
sitting still remains.
In the course of performing tax audit of UMC in respect to the period from October 1, 2002 to June 30, 2004,
the tax authorities expressed their opinion that the contributions payable to the Pension Fund in respect of
the consumption of telecommunication services by customers (6% of the value of services) should be included
in the taxable base for VAT purposes. Inclusion of such amounts ultimately results in an increase in the VAT lia-
bility of UMC in respective tax reporting periods. The maximum exposure on UMC’s VAT position resulting from
such treatment equals to $9.0 million plus penalties amounting to $4.5 million, which were claimed by the tax
authorities upon their recent tax audit.
The Pension Fund contributions were introduced in July 1999. Management believes that VAT was not applicable
to the Pension Fund contributions and this point was not raised by the tax authorities in tax audits completed
for the periods from July 1999 to July 2002. Also the management considers that UMC was in line with the indus-
try practice. In 2005, UMC initiated a litigation case in respect of this issue against the tax authorities, and has
received favorable rulings from the courts of two instances, which are expected to become subject to further appeal
Notes to consolidatedfinancial statements
66 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
JSFC SISTEMA AND SUBSIDIARIES
_ g g / / g
from the tax authorities. The maximum exposure of this risk on UMC’s VAT position as of December 31, 2005 amounts
to $38.1 million, which includes the amounts claimed by the tax authorities described above plus additional VAT
charges for the period from the last date of the period audited by tax authorities and resulting penalties.
MTS’ operations in Turkmenistan are subject to certain restrictions in accordance with local regulatory environ-
ment including, but not limited to, hard currency sale on the local market and hard currency repatriation.
The effect of those restrictions on the financial statements is not material.
Generally, tax declarations remain open and subject to inspection for a period of three years following the tax
year. As of December 31, 2005, tax declarations of the Group for the preceding three fiscal years were open to fur-
ther review.
In the ordinary course of business, the Group may be party to various legal and tax proceedings, and subject
to claims, certain of which relate to the developing markets and evolving fiscal and regulatory environments in
which the Group operates. In the opinion of management, the Group’s liability, if any, in all pending litigation,
other legal proceeding or other matters will not have a material effect upon the financial condition, results
of operations or liquidity of the Group.
Management believes that it has adequately provided for tax liabilities in the accompanying consolidated finan-
cial statements; however, the risk remains that relevant authorities could take differing positions with regard
to interpretive issues and the effect could be significant.
In the first half of 2005, MGTS filed seven claims in the Moscow Arbitration Court against the Ministry of Labor
and Social Development of the Russian Federation for the recovery of losses it incurred in connection with
the provision of communications services in 2003 to 2004 to Russian veterans at a reduced rate. Pursuant to
the Federal Law on Veterans, MGTS is seeking full reimbursement from federal funds totaling approximately
$15.8 million. In the second half of 2005, the Arbitration Court ruled in favor of MGTS for the full amount.
Although writs of execution have been obtained with respect to four of the seven claims, MGTS has not yet
received any payments and, accordingly did not reflect any potential cash receipts in the accompanying finan-
cial statements.
32. SUBSEQUENT EVENTS
Acquisitions
In January 2006, Sistema Mass Media acquired GK Sendi, an internet provider in Nizhny Novgorod, and
Informservis, a cable television operator in the same region, for a cash consideration of $6.3 million. The Group
intends to use the companies’ assets for the development of its digital TV network.
In December 2005, Comstar-UTS made an unconditional purchase offer to the holders of common shares of MGTS.
The offer price was set at RUR 490 (equivalent of $17.1 as of December 31, 2005) per one common share of MGTS.
Shareholders of MGTS could accept this offer within 30 days of receipt of official notification. In February 2006,
Comstar-UTS announced the results of its public share purchase offer to MGTS common stock shareholders.
For the first two months of 2006, Comstar-UTS acquired 3,363,332 MGTS ordinary shares, representing 4.21%
of its outstanding ordinary shares, during the offer period for a total cash consideration of RUR 1,600 million
(equivalent of $58.4 million). In March 2006, Comstar-UTS further purchased 3.82% of MGTS common stock from
minority shareholders for $71.5 million. As a result, Comstar-UTS’ voting power and ownership interest in MGTS
increased to 63.7% and 53.0%, respectively.
In March 2006, Comstar-UTS made the second public unconditional share purchase offer to MGTS’ shareholders.
The offer price was set at RUR 490 (equivalent of $17.1 as of December 31, 2005) per one common share of MGTS.
Shareholders of MGTS could accept this offer within 30 days of the receipt of official notification.
Notes to consolidatedfinancial statements
67
CONSOLIDATED FINANCIAL STATEMENTS
_ g g / / g
In February 2006, ROSNO acquired a 51% stake in Medexpress, provider of voluntary medical insurance in
the north-western region of the RF, for a cash consideration of $6.6 million. The Group plans to develop
Medexpress operations and use its distribution facilities as an additional channel for sale of ROSNO’s products.
In February 2006, Sistema Mass Media and ECU GEST acquired 90% and 10% shares, respectively, in JIR Broadcast
and JIR Inc., holders of 100% stock in United Cable Networks (“UCN”) for a total cash consideration of $145.9 mil-
lion, including the refinancing of the debt previously obtained by JIR Broadcast and JIR Inc. UCN is a pay TV and
broadband service provider in Russia, operating in 17 metropolitan areas throughout Russian Federation with
724,000 subscribers (unaudited).
In March 2006, Detsky Mir completed acquisition of 99% stake in Tireks Development, an owner of a 30% minor-
ity share in Dom Igrushki, a subsidiary of the Group, for a cash consideration of $2.4 million.
In March 2006, Intourist purchased a 20% equity interest in Cosmos Hotel for approximately $20.0 million. Upon
completion of this transaction, Intourist became a controlling shareholder of Cosmos Hotel with 61.8% stake
in its capital.
In March 2006, Concern RTI purchased a 50% +1 share in UralEleketro and 100% share in UralElektro-K for a cash
consideration of $5.4 million. Both companies are producers of electronic equipment.
Debt Issuance
In February 2006, Sitronics Finance S.A. issued 3-year $200.0 million notes at 99.7% of par with an annual
coupon of 7.9%. The notes are fully and unconditionally guaranteed by Concern SITRONICS.
In January 2006, MTS entered into a credit facility agreement with HSBC Bank plc. The facility allows borrowing
of up to $100.0 million. The funds received will be used for general corporate purposes. The loan bears interest
of LIBOR +0.8% per annum. An arrangement fee in the amount of $0.6 million should be paid in accordance with
the agreement. The facility should be repaid by July 2006.
In March 2006, MBRD issued $60.0 million 8.9% Loan Participation Notes to finance a subordinated loan.
The notes mature in March 2016. MBRD is required to make interest payments semi-annually in arrears in March
and September, commencing in September 2006. The notes are listed on the Luxembourg Stock Exchange.
In April 2006, MTS signed a syndicated loan facility with international financial institutions, including Bank
of Tokyo-Mitsubishi UFJ, Ltd., Bayerische Landesbank, HSBC Bank plc, ING Bank N.V., Raiffeisen Zentralbank
Osterreich AG, Sumitomo Mitsui Banking Corporation Europe Limited. The facility allows MTS to borrow up
to $1,330.0 million and is available in two tranches of $630.0 million and $700.0 million. The proceeds will be
used by MTS for general corporate purposes, including acquisitions and refinancing of existing indebtedness.
The first tranche bears interest of LIBOR + 0.8% per annum and matures in April 2009. The second tranche
matures in April 2011, bears interest of LIBOR +1.0% per annum within the first three years and LIBOR +1.2% per
annum thereafter and is repayable in 13 equal quarterly installments, commencing in April 2008. The loan is sub-
ject to certain restrictive covenants, including, but not limited to, certain financial ratios, limitations on dispo-
sitions of assets and limitations on transactions with associates.
Notes to consolidatedfinancial statements
68 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
JSFC SISTEMA AND SUBSIDIARIES
_ g g / / g
Other
In January 2006, the Group contributed $200.0 million to the share capital of Concern SITRONICS by purchasing
the additional issue of its shares. This contribution increased the Group’s share in Concern SITRONICS from 78.0%
to 94.5%.
In February 2006, Comstar-UTS completed its initial public offering of 139,000,000 newly issued shares, and in
addition, the Group sold 7,500,000 ordinary shares, in the form of global depository receipts (“GDRs”), with each
GDR representing 1 share of common stock. The proceeds from Comstar-UTS IPO amounted to $1,060 million.
Upon completion of the IPO, the Group repurchased 7.3% of Comstar-UTS ordinary shares from Deutsche Bank
sold earlier under a repurchase transaction (Note 21).
In March 2006, the Group announced two management incentive programs for its employees. Under the first pro-
gram, JSFC Sistema transferred 14.7% of Concern SITRONICS stock to Concern SITRONICS’ subsidiary, for estab-
lishment of a stock option plan for the top management of Concern SITRONICS. Under the second program,
Sistema Finance, a subsidiary of the Group, purchased 44,564 shares of JSFC Sistema in the open market for a
total cash consideration of $50.9 million. The shares are intended to be used for a share option program for
Sistema top management.
In March 2006, the Russian registration authority approved the merger of nine wholly-owned MTS subsidiaries in
Russia into MTS. The subsidiaries are Gorizont-RT, TAIF-Telcom, MTS-RTK, Sibchallenge, Tomsk Cellular
Communications, BM Telekom, FECS-900, SCS-900 and Uraltel. The merger was completed in line with MTS’ strat-
egy to consolidate administratively all its majority-owned subsidiaries and improve management efficiency.
In March 2006, the Group’s Board of Directors approved the purchase of 66% share in WaveCrest Group Enter-
prises Ltd. for cash consideration equivalent to $34.5 million. WaveCrest Group is a voice services provider in both
the retail and wholesale telecommunications, domiciled in Great Britain.
Notes to consolidatedfinancial statements
69
CONSOLIDATED FINANCIAL STATEMENTS
_ g g / / g
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS The following is a discussion of our financial condition and results of operations as of and for the years ended
December 31, 2004 and 2005, and of the material factors that we believe are likely to affect our consolidated finan-
cial condition. You should read this section together with our audited consolidated financial statements for the years
ended December 31, 2004 and 2005, including the notes to those financial statements. In addition, this discussion
contains forward looking statements that involve risk and uncertainties. Our actual results may differ materially
from those discussed in forward looking statemens as a result of various factors. Our reporting currency is the
U.S. dollar and our consolidated financial statements have been prepared in accordance with U.S. GAAP.
OVERVIEW
We are the largest private sector consumer services group of companies in Russia and the CIS with a combined
customer base of over 60 million customers in Russia and the CIS. Our business is developing, managing and real-
izing the value of market-leading businesses in fast-growing service-based industries. We operate in a select
number of service-based industries offering the potential for rapid growth of our businesses. In our consolidat-
ed financial statements, we report our results in eight segments: Telecommunications; Technology; Insurance;
Banking; Retail; Real Estate; Mass Media and Other Businesses (which comprises our miscellaneous businesses
together with our other operations and central corporate functions). Given the scale, scope and market position
of our existing operations, we are uniquely positioned to exploit the growth in consumer and corporate pur-
chasing power in the countries in which we operate. Our consolidated revenues reached $7,593.5 million for the
year ended December 31, 2005 and $5,734.0 million for the year ended December 31, 2004. Our total assets have
grown to $13,090.9 million as of December 31, 2005, as compared to $8,823.3 million as of December 31, 2004.
Net income before extraordinary gain and cumulative effect of accounting changes was $530.5 million for the
year ended December 31, 2005, compared to $446.7 million for the year ended December 31, 2004. Net income
for the year ended December 31, 2005 amounted to $534.4 million as compared to $411.2 million in the year
ended December 31, 2004.
Our revenues and total assets have increased through organic growth, as well as through acquisitions. Our major
acquisitions during the year ended December 31, 2005 included Barash Communication Technologies, Inc.
(“BCTI”), a leading provider of cellular services in the Republic of Turkmenistan; controlling stakes in MTS Komi,
and MTS-Tver; Tyumenneftegazsvyaz, an alternative fixed-line telecommunications operator in the Tyumen
region; Kvant, a manufacturer of personal computers and computer components; Yaroslavl Radio Plant and MTU-
Saturn, producers of radio and satellite equipment; ESTA, cable TV operator in Tver and Kaluga; Upravlenie
i Leasing, provider of cable TV broadcasting services in Ekaterinburg; Digital TV, holding licenses for aerial, digi-
tal, multiprogram television broadcasting; S-Toys, a children’s toys wholesale company; Vyrastai-ka and Chudo-
Ostrov Neva, children’s goods retail networks and others. During this period we also increased our ownership
shares in MTS, MTT, MBRD, Telmos, STROM telecom, Recom, Telesot-Alania, Sibintertelecom and Gorizont-RT
through acquisition of minority holdings and purchase of newly issued stock. Revenue growth in existing busi-
nesses for 2005 was $1,580.1 million, or 85.0% of total revenue growth as compared to 2004. The consolidation
of BCTI, MTS Komi, MTS-Tver, Tyumenneftegazsvyaz, S-Toys, Yaroslavl Radio Plant, MTU-Saturn, Kvant and others
in 2005 contributed a total of $279.4 million to the increase. The Telecommunications Segment’s share of our
aggregated revenues continued to decline, from 80.5% in the year ended December 31, 2004 to 77.6% in the year
ended December 31, 2005.
In August and October 2005, we acquired the minority stakes in six oil producing and refining companies in
Bashkortostan for a total cash consideration of $613.3 million. The acquired shareholdings included 25.0% in
ANK Bashneft, 28.2% in Novoil, 25.5% in Ufimsky NPZ, 22.4% in Ufaneftekhim, 24.9% in Ufaorgsintez and 18.6%
in Bashnefteproduct.
70 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
Consolidated Financial Statements
_ g g / / g
We require substantial funds to support our operations, primarily for increasing network capacity and develop-
ing networks in our Telecommunications Segment. Our cash outlays for capital expenditures in 2005 and 2004
were $3,012.7 million (including $540.4 million paid for purchases of businesses) and $2,009.5 million (includ-
ing $338.9 million paid for purchases of businesses), respectively. We have financed our cash requirements
through our operating cash flows, borrowings and the initial public offering of our common shares. Net cash pro-
vided by operating activities in 2005 and 2004 was $1,771.2 million and $1,904.1 million, respectively. The pro-
ceeds from long-term borrowings for the years ended December 31, 2005 and 2004 amounted to $1,357.1 million
and $1,458.1 million, respectively. As of December 31, 2005, we had indebtedness of $4,370.6 million, including
capital lease obligations, and our interest expense for 2005 was $225.7 million, net of amounts capitalized. In
February 2005, we raised $1,284.6 million in cash through the initial public offering of 1,550,000 common shares,
equivalent to 77,500,000 global depositary receipts (GDRs). The GDRs on our common stock were admitted to
trade on the London Stock Exchange on February 14, 2005.
We continue to capitalize on our competitive advantages to build market-leading businesses in select sectors
which exploit the growth in consumer and corporate purchasing power in the Russian and CIS markets.
We employ a disciplined approach to our investment decisions with the aim of maximizing returns for our share-
holders. Our internal performance benchmarks require that our businesses achieve certain operational, revenue
and profitability targets, which also reflect the nature of these individual businesses. Progress against these tar-
gets is monitored and used to develop annual budgets, long-term business plans and capital allocation strategies.
During the year ended December 31, 2005, our portfolio structure has been improved along two dimensions —
concentrating our support on development of our core industries and restructuring of our existing businesses
with an aim to make it streamlined and to absorb all existing synergies. Examples of such activities would include
the sale of Kamov Holding, our helicopter distribution business; the sale of our traditional media assets, which is
no longer a core strategic area of our media business and the latest sale of Leader in the insurance sector.
In some of our segments such as Telecom and Technology we developed international expansion. Though we still
consider our natural prime markets Russian and CIS countries, but to support our positions on such highly com-
petitive market we strive to become global players, which requires international expansion to achieve the scale
and access to new client base and technologies. Additionally, following our strategy to concentrate on the busi-
nesses with high technology component we accelerated our development in the business lines requiring signif-
icant know-how. A number of strategic alliances were put in place which should provide us access to cutting
edge global technologies.
In the year ended December 31, 2005, we have reiterated our positioning as a diversified business focused on the
consumer sector. With ongoing growth across our portfolio, we remain committed to investing in market-lead-
ing businesses in the service sector, where growth continues to be driven by improving macro picture resulting
in increasing spending power of our customers. We believe that through our geographical and sectoral diversifi-
cation we are best positioned to capture this growth. Our fundamental goal remains unchanged — we plan to
continue to invest in profitable growth in the areas of our expertise, and grow both organically and through
mergers and acquisitions, as well as ensure the most efficient use of our available resources.
71
Consolidated Financial Statements
_ g g / / g
The following table illustrates our ownership interests in our principal consolidated subsidiaries and equity
holdings as of December 31, 2005.
Segment Company Beneficial Voting interest(2)
Ownership(1)
Telecommunications MTS and subsidiaries 53% 53%
Comstar-UTS and subsidiaries(3) 100% 100%
SkyLink 50% 50%
MTT 43% 50%
Technology Concern SITRONICS and subsidiaries 78% 78%
Insurance ROSNO and subsidiaries 49% 51%
Banking MBRD 95% 99%
East-West United Bank 49% 49%
Real Estate Sistema-Hals and subsidiaries 100% 100%
Retail Detsky Mir 75% 75%
Detsky Mir Center and subsidiaries 100% 100%
Mass Media Sistema Mass Media and subsidiaries 100% 100%
Other Businesses
Travel Services Intourist and subsidiaries 72% 72%
International Operations ECU GEST and subsidiaries 100% 100%
Radio and Space Technology RTI Systems and subsidiaries 100% 100%
Pharmaceuticals Medical Technological Holding 69% 74%
and Biotechnology
(1) ‘’Beneficial ownership’’ represents the percentage of ownership interests of the relevant entity that are beneficially owned by Sistema, directlyor indirectly, based on Sistema’s proportionate ownership of the relevant entity through its consolidated subsidiaries. Our ownership interests inthe subsidiaries presented above are calculated based on shares owned by us as well as shares owned by certain companies affiliated but not ownedby us, which we are required to consolidate under U.S. GAAP (FIN 46R). Excluding the ownership interests of these affiliated companies, our ben-eficial ownership interests in certain subsidiaries listed above would have been lower by the following amounts: Concern SITRONICS (2.2%),MBRD (24.4%), Detsky Mir (4.5%), Sistema-Hals (1.0%). (2) ‘’Voting interest’’ represents the percentage of ownership interests of the relevant entity that Sistema or any of its consolidated subsidiaries hasthe power to vote. (3) The restructuring and unification of businesses comprising Comstar-UTS has been completed by December 31, 2005.
MACROECONOMIC FACTOR AFFECTINGS OUR RESULTS OF OPERATIONS
Most of our operations are based in Russia. As a result, Russian macroeconomic trends and country-specific risks
significantly influence our performance. In recent years, Russia has been able to overcome the consequences of
the 1998 financial crisis. Below is a summary of several key macroeconomic factors that may have a substantial
impact on our business:
Years ended December 31,2004 2005
GDP growth 7.1% 6.4%
Consumer price index 11.7% 10.9%
Unemployment rate 8.2% 7.7%
Nominal exchange rate (rubles per U.S. dollar)(1) 28.7 28.3
Real ruble appreciation against U.S. dollar(2) 18.6% 12.5%
Sources: Central Bank of Russia, Goskomstat, EIU, Russian Ministry of Economic Development. (1) The average of the exchange rates on the last business day of each full month during the relevant period. (2) Real ruble appreciation against U.S. dollar is a consumer price index adjusted for nominal exchange rate changes over the same period.
72 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
Consolidated Financial Statements
_ g g / / g
GDP growth rates in Russia remain relatively high compared to North America and Europe. The Russian economy
growth is primarily attributable to the high proportion of oil and oil products in its export revenues and the high
oil prices on the international markets. The higher disposable income of the Russian population has stimulated
demand for the services provided by our main businesses, such as telecommunications, insurance, banking and
retail. The continuation of growth in Russian GDP and real and disposable income in Russia is subject to the influ-
ences of various political groups whose interests may not be aligned with those of the current government and to
the ability of the government to continue to progress economic and regulatory reforms currently underway.
ACQUISITIONS AND DIVESTITURES
During the years under review, we have completed a number of acquisitions and divestitures, several of which
have had a significant impact on our results of operations and financial condition. We consolidate revenues and
expenses of newly acquired entities from the beginning of the year in which we obtain a controlling interest.
Earnings attributable to these entities for the portion of the year prior to the date upon which we obtained a
controlling interest are included in minority interests.
Due to the number of significant transactions completed during the periods under review, period-to-period com-
parisons of our results of operations need to be considered in the light of the impact of such transactions.
Below is a list of our major acquisitions during the years ended December 31, 2004 and December 31, 2005.
Company Principal activity Date of Stake Acquiring Purchase acquisition acquired entity price(1)
(in millions)
Year ended December 31, 2004
SCS-900 Mobile operator March 2004 11.0% MTS $ 8.5
in Siberian region
FECS-900 Mobile operator April 2004 40.0% MTS 8.3
in Far East region
Primtelefon Mobile operator June 2004 50.0% MTS 31.0
in Far East region
Kvazar-Micro Distributor of computer July 2004 51.0% ECU GEST 28.0
components and system
integrator in Ukraine
Uzdunrobita Mobile operator August 2004 74.0% MTS 121.0
in Uzbekistan
UDN-900 Mobile operator August 2004 49.0% MTS 6.4
in Udmurtia Republic
TAIF-Telcom Mobile operator in September 2004 47.3% MTS 63.0
the Tatarstan Republic
and Volga region
MTT Nationwide transit September and 30.0% ECU GEST, 39.9
network operator October 2004 Hurdsfield,
Sistema
Sibintertelecom Mobile operator November 2004 93.5% MTS 37.4
in Far East region
Telesot Alania Mobile operator in December 2004 52.5% MTS 6.2
the Republic of North Ossetia
Gorizont-RT Mobile operator in December 2004 76.0% MTS 53.2
the Republic of Sakha (Yakutia)
$ 402.9
(1) Excluding acquisition-related costs.
73
Consolidated Financial Statements
_ g g / / g
Company Principal activity Date of Stake Acquiring Purchase acquisition acquired entity price(1)
(in millions)
Year ended December 31, 2005
Telmos Fixed-line operator February 2005 20.0% Sistema $ 8.5
MBRD Banking February 2005 13.3% Sistema 10.0
MTT Nationwide transit February 2005 5% Hurdsfield 6.4
network operator
Kvant Personal computers April 2005 53.0% Concern 6.0
and components SITRONICS
manufacturer
BCTI Mobile operator in June and 100.0% MTS 46.7
Turkmenistan November 2005
Gorizont-RT Mobile operator in June 2005 24.0% MTS 13.5
the Republic
of Sakha (Yakutia)
Yaroslavl Radio Plant Producer of commercial June 2005 51.0% Concern RTI 6.1
payload for satellites
and professional
communications facilities
STROM telecom Intergated solutions July 2005 33.0% Concern 19.8
provider for wireless SITRONICS
and fixed networks
ESTA Cable television operator August 2005 100.0% Sistema 8.6
Mass Media
Metrocom Alternative fixed-line September 2005 45.0% Comstar-UTS 22.5
operator in St. Petersburgh
Tyumenneftegassvyaz Alternative October 2005 89.4% Comstar-UTS 9.0
fixed-line
telecommunications
services provider
Eurodawn/Digital TV Aerial, digital, November 2005 74.0% Mardenhead 7.0
multiprogram
television broadcasting
Bashneft, Ufaneftekhim, Oil producing and August and 18.6%– Sistema- 613.3
Novoil, Ufimsky NPZ, refining companies October 2005 28.2% Invest
Ufaorgsintez, in Bashkortostan
Bashnefteproduct
MTS Mobile operator in October and 2.3% Sistema 275.5
Russia and CIS December 2005
Upravlenie i Leasing Provider of cable December 2005 75.0% Sistema 5.1
TV broadcasting services Mass Media
CTK Contrast Telecom Alternative fixed-line December 2005 100.0% Comstar-UTS 5.5
operator in Moscow region
Conversia Svyaz Alternative fixed-line December 2005 100.0% Comstar-UTS 10.0
and Overta operators in Saratov region
Telesot Alania Mobile operator in December 2005 47.5% MTS 32.6
the Republic of North Ossetia
ReCom Mobile operator in Orel December 2005 46.1% MTS 110.0
$ 1,216.1
(1) Excluding acquisition-related costs.
74 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
Consolidated Financial Statements
_ g g / / g
RECENT ACQUISITIONS
In January 2006, Sistema Mass Media acquired GK Sendi, an internet provider in Nizhny Novgorod, and
Informservis, a cable television operator in the same region, for a cash consideration of $6.3 million. We intend
to use the companies’ assets for the development of digital TV network.
In December 2005, Comstar-UTS made an unconditional purchase offer to the holders of common shares of MGTS.
The offer price was set at RUR 490 (equivalent of $17.1 as of December 31, 2005) per one common share of MGTS.
Shareholders of MGTS could accept this offer within 30 days of receipt of official notification. In February 2006,
Comstar-UTS announced the results of its public share purchase offer to MGTS common stock shareholders. For the
first two months of 2006, Comstar-UTS acquired 3,363,332 MGTS ordinary shares, representing 4.21% of its out-
standing common shares, for a total cash consideration of RUR 1,600 million (equivalent of $58.4 million). In
March 2006, Comstar-UTS further purchased 3.82% of MGTS common stock from minority shareholders for
$71.5 million. As a result, Comstar-UTS’ voting power and ownership interest in MGTS increased to 63.7% and
53.0%, respectively.
In February 2006, ROSNO acquired a 51% stake in Medexpress, provider of voluntary medical insurance in
the north-western region of the RF, for a cash consideration of $6.6 million. ROSNO plans to develop Medexpress
operations and use its distribution facilities as an additional channel for sale of ROSNO products.
In February 2006, Sistema Mass Media and ECU GEST acquired 90% and 10% shares, respectively, in JIR Broadcast
and JIR Inc., holders of 100% stock in United Cable Networks (“UCN”) for a total cash consideration of
$145.9 million including refinancing of its debts. UCN is a pay TV and broadband service provider in Russia, oper-
ating in 17 metropolitan areas throughout Russian Federation with 724,000 subscribers.
In March 2006, Intourist purchased a 20% equity interest in Cosmos Hotel for approximately $20.0 million. Upon
completion of this transaction, Intourist became a controlling shareholder of Cosmos Hotel with 61.8% stake in
its capital.
In March 2006, Concern RTI purchased a 50% +1 share in UralEleketro and 100% share in UralElektro-K for a cash
consideration of $5.4 million. Both companies are producers of electronic equipment.
In March 2006, Detsky Mir completed acquisition of 99% stake in Tireks Development, an owner of a 30% minor-
ity share in Dom Igrushki, a subsidiary of the Detsky Mir, for a cash consideration of $2.4 million.
DIVESTITURES
In January 2005, Intourist announced issue of new stock to its existing shareholders. Moscow Government pur-
chased the first tranche of 3,120,516,875 shares in exchange for a 40% stake in Cosmos Hotel, a 1000-room hotel
complex situated in Moscow. In April 2005, Sistema paid an equivalent of $47.7 million for the remaining
6,961,052,632 newly-issued shares of Intourist. Upon completion of this transaction, Sistema’s ownership inter-
est in Intourist decreased to 72%. During the year ended December 31, 2005, Intourist purchased an additional
3.4% share of Cosmos Hotel on the open market for a total cash consideration of $0.9 million.
As a part of our business restructuring activities, we disposed of several low-margin media assets. During the year
ended December 31, 2005, we sold our interests in, print distributors Nasha Pressa and Stolichnaya Pressa, radio
operator Concern RadioCenter and certain other media subsidiaries for a total cash consideration of $4.1 million.
These transactions resulted in recognition of an aggregate gain from disposal of $5.3 million and an increase of
additional paid-in capital of $1.2 million.
In November 2005, we sold the interest in Kamov Holding for a total cash consideration of approximately
$11.8 million. Kamov Holding held 49.5% stake in Kamov, a helicopter producer. The transaction resulted in gain
from disposal of $1.0 million.
75
Consolidated Financial Statements
_ g g / / g
In December 2005, ROSNO sold its interest in Leader, a subsidiary operating in insurance business, for a total cash
consideration of approximately $6.0 million. The transaction resulted in recognition of loss from disposal of
$0.2 million.
CONSOLIDATED FINANCIAL RESULTS OVERVIEW
The following table sets forth a summary of our financial results for the years ended December 31, 2005 and
2004. This financial information should be read in conjunction with our consolidated financial statements.
Years ended December 31,2004 % of revenue 2005 % of revenue
(Amounts in thousands, except percentages)
Revenues $ 5,733,950 100.0% $ 7,593,549 100.0%
Costs of sales, exclusive of depreciation (2,246,458) (39.2) (3,219,187) (42.4)
and amortization shown separately below
Selling, general and administrative expenses (1,010,288) (17.6) (1,414,313) (18.6)
Depreciation and amortization (797,274) (13.9) (1,024,592) (13.5)
Net other operating expenses (44,529) (0.8) (71,392) (0.9)
Income from equity investees 27,121 0.5 78,033 1.0
Net gain on disposal of subsidiaries 2,184 0.0 15,326 0.2
Operating income(1) $ 1,664,706 29.0% $ 1,957,424 25.8%
Interest income 18,061 0.3 66,132 0.9
Interest expense (213,943) (3.7) (225,684) (3.0)
Income tax (445,731) (7.8) (512,993) (6.8)
Foreign exchange gain/(loss) 12,620 0.2 (13,913) (0.2)
Income before minority interests, $ 1,035,713 18.1% $ 1,270,966 16.7%
extraordinary gain and cumulative
effect of accounting changes
Minority interests (589,014) (10.3) (740,514) (9.8)
Extraordinary gain – – 3,956 0.1
Cumulative effect of a change (35,472) (0.6) – –
in accounting principle
Net income $ 411,227 7.2% $ 534,408 7.0%
OIBDA(2) $ 2,461,980 42.9% $ 2,982,016 39.3%
(1) Operating income is calculated as revenues less operating costs, plus income from equity investees and net gain on sale of subsidiaries. Operatingcosts include costs of sales, selling, general and administrative expenses and depreciation and amortization, as well as other operating expenses(net of other operating income). (2) OIBDA represents operating income before depreciation and amortization. OIBDA is not a measure of financial performance under U.S. GAAP. Youshould not consider it an alternative to net income as a measure of operating performance or to cash flows from operating activities as a measureof liquidity. Our calculation of OIBDA may be different from the calculation used by other companies and therefore comparability may be limited.We believe that OIBDA provides useful information to investors because it is an indicator of the strength and performance of our ongoing businessoperations, including our ability to fund discretionary spending such as capital expenditures, acquisitions of subsidiaries and other investments andour ability to incur and service debt. While depreciation and amortization are considered operating costs under U.S. GAAP, these expenses primari-ly represent non-cash current period allocation of costs associated with long-lived assets acquired or constructed in prior periods.
The following tables set forth a summary of revenues and operating income by reporting segment for the years
ended December 31, 2004 and 2005. In our comparison of period-to-period results of operations, in order to ana-
lyze changes, developments and trends in revenues by reference to individual segment revenues, we present our
revenues on an aggregated basis, which is revenues after elimination of intra-segment (between entities in the
same segment) transactions, but before inter-segment (between entities in different segments) eliminations.
Amounts attributable to individual companies, where appropriate, are shown prior to both intra-segment and
inter-segment eliminations.
76 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
Consolidated Financial Statements
_ g g / / g
Revenues by segment:
Years ended December 31,2004 % of revenue 2005 % of revenue
(Amounts in thousands, except percentages)
Telecommunications $ 4,616,702 80.5% $ 5,892,883 77.6%
Technology 498,427 8.7 961,133 12.7
Insurance 300,194 5.2 408,860 5.4
Banking 65,738 1.1 106,785 1.4
Real Estate 115,342 2.0 78,448 1.0
Retail 79,344 1.4 208,008 2.7
Mass Media 36,217 0.6 52,428 0.7
Other Businesses(1) 177,020 3.1 283,594 3.7
Aggregated Revenue $ 5,888,984 102.7% $ 7,992,139 105.2%
Eliminations(2) (155,034) (2.7)% (398,590) (5.2)%
Total $ 5,733,950 100.0% $ 7,593,549 100.0%
(1) Other Businesses includes our travel services, radio and space technology, pharmaceuticals and biotechnology businesses together with ourother operations and central corporate functions. (2) Eliminations of inter-segment revenue.
Operating income by segment:
Years ended December 31,2004 % of operating 2005 % of operating
incom incom(Amounts in thousands, except percentages)
Telecommunications $ 1,630,305 97.9% $ 1,933,269 98.8%
Technology 45,918 2.8 143,517 7.3
Insurance 30,168 1.8 28,417 1.5
Banking 11,691 0.7 12,722 0.6
Real Estate 23,463 1.4 10,399 0.5
Retail 9,039 0.5 10,445 0.5
Mass Media (938) (0.1) 7,070 0.4
Other Businesses(1) (64,224) (3.9) (39,425) (2.0)
Aggregated Operating Income $ 1,685,482 101.2% $ 2,106,414 107.6%
Eliminations(2) (20,776) (1.2)% (148,990) (7.6)%
Total $ 1,664,706 100.0% $ 1,957,424 100.0%
(1) Other Businesses includes our travel services, radio and space technology, pharmaceuticals and biotechnology businesses together with ourother operations and central corporate functions. (2) Eliminations of inter-segment operating income.
77
Consolidated Financial Statements
_ g g / / g
YEAR ENDED DECEMBER 31, 2005 COMPARED TO YEAR ENDED DECEMBER 31, 2004
Revenues
Our aggregated revenues increased by 32.4% to $7,593.5 million for the year ended December 31, 2005 from
$5,734.0 million for the year ended December 31, 2004.
The growth in our revenues was attributable to the growth in our Telecommunications Segment of $1,276.2 mil-
lion, in our Technology Segment of $462.7 million, in our Insurance Segment of $108.7 million, in our Banking
Segment of $41.0 million, in our Retail Segment of $128.7 million, in our Mass Media Segment of $16.2 million
and in our Other Businesses Segment of $106.6 million. Revenues of our Real Estate Segment declined by
$36.9 million from $115.3 million for the year ended December 31, 2004 to $78.4 million for the year ended
December 31, 2005.
The consolidation of BCTI, S-Toys, Kvant and Tyumenneftegazsvyaz contributed $33.4 million, $53.7 million,
$18.3 million and $17.8 million, respectively, to the increase in aggregated revenues for the year ended
December 31, 2005.
The Telecommunications Segment continued to be the largest revenue contributor for the year ended December 31,
2005, though its share of the aggregated revenues decreased to 77.6% from 80.5% for the year ended December 31,
2004 owing to accelerated growth and significant acquisitions in our other segments. Revenues of MTS and
Comstar-UTS grew by $1,092.8 million and $212.5 million, or by 27.9% and 30.6%, respectively, compared to the
year ended December 31, 2004. This increase was primarily due to the significant growth in MTS’ subscriber base
from 34.2 million as of December 31, 2004 to 58.2 million as of December 31, 2005. The increase in Comstar-UTS’
revenues is primarily explained by the rise in subscription fees for residential and corporate subscribers by MGTS
that took effect in October 2004 and October 2005.
The increase in revenues of our Technology Segment was attributable to the organic growth of infocommunica-
tion technologies, consumer electronics and information technologies divisions. Revenues of infocommunica-
tion technologies and information technologies divisions for the year ended December 31, 2005 increased by
$115.8 million and $178.5 million, or by 113.8% and 60.8%, respectively, compared with the year ended
December 31, 2004. Revenues of infocommunication technologies division increased mainly owing to sales of
billing systems to MTS, UMC, a subsidiary of MTS, and MGTS.
Revenues from our Insurance Segment grew by $108.7 million, or 36.2%, for the year ended December 31, 2005, com-
pared with the year ended December 31, 2004, due to promotion of new insurance products and the expansion of the
client base following the overall growth of the insurance market in Russia and acquisition of new subsidiaries.
Our Real Estate Segment revenues decreased by $36.9 million as there were fewer sales of completed office build-
ings or residential property in the year ended December 31, 2005 compared to the year ended December 31, 2004.
Revenues from our Mass Media Segment grew by $16.2 million, or 44.8%, for the year ended December 31, 2005,
compared with the year ended December 31, 2004 due to acquisitions of new subsidiaries in the regions.
Revenues from our Retail Segment grew by 162.2%, or $128.7 million, for the year ended December 31, 2005, com-
pared with the year ended December 31, 2004 primarily due to the acquisition of S-Toys, children’s toys whole-
sale company, and increase in number of stores.
Our radio and space technology business was the largest contributor to the growth in our Other Businesses
Segment, with an increase in revenues of $87.2 million for the year ended December 31, 2005, compared with the
year ended December 31, 2004. The increase in revenues of radio and space technology segment for the year
ended December 31, 2005 was primarily due to acquisitions of new companies.
78 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
Consolidated Financial Statements
_ g g / / g
Operating costs
Operating costs include costs of sales, selling, general and administrative expenses and depreciation and amor-
tization, as well as other operating expenses (net of other operating income).
For the year ended December 31, 2005, our gross margin (before deducting the depreciation and amortization
expenses) decreased to 57.6% from 60.8% for the year ended December 31, 2004, primarily as a result of the
growth of operations in non-telecom segments which have significantly lower margins in comparison to
Telecommunications Segment, while the gross margin in our Telecommunications Segment decreased from 68.9%
for the year ended December 31, 2004 to 67.9% for the year ended December 31, 2005.
Our selling, general and administrative expenses increased to 18.6% of revenues for the year ended December 31,
2005 from 17.6% of revenues for the year ended December 31, 2004, primarily due to an increase of advertising
expenses and dealers’ commission incurred by MTS. Depreciation and amortization decreased to 13.5% of rev-
enues in the year ended December 31, 2005 from 13.9% in the year ended December 31, 2004.
Operating income
Operating income is revenues less operating costs, plus income from equity investees and net gain on disposal of
subsidiaries.
Our consolidated operating income margin was 25.8% for the year ended December 31, 2005, compared with
29.0% for the year ended December 31, 2004. MTS continued to be the main contributor to the operating mar-
gin with $1,661.2 million, or 78.9% of aggregated operating income, for the year ended December 31, 2005.
Interest
Our consolidated interest expense for the year ended December 31, 2005 increased by 5.5% to $225.7 million
from $213.9 million for the year ended December 31, 2004, primarily owing to the increase in our indebtness by
$1,305.7 million as of December 31, 2005 compared to December 31, 2004.
Income before minority interests, extraordinary gain
and cumulative effect of a change in accounting principle
Consolidated income before minority interests, extraordinary gain and cumulative effect of a change in account-
ing principle increased by 22.7% to $1,271.0 million for the year ended December 31, 2005 from $1,035.7 million
for the year ended December 31, 2004. To arrive at this measure, we add interest income and foreign exchange
gain to, and deduct foreign exchange loss, interest expense and income taxes from operating income. Income
margin prior to minority interests, extraordinary gain and cumulative effect of a change in accounting principle
was 16.7% for the year ended December 31, 2005, compared with 18.1% for the year ended December 31, 2004.
Minority interests
Minority interests in net income of our subsidiaries for the year ended December 31, 2005 increased to
$740.5 million from $589.0 million for the year ended December 31, 2004, due to an increase of our net income,
partially offset by the effects of our acquisitions of minority stakes in our subsidiaries.
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SEGMENT FINANCIAL RESULTS OVERVIEWThe following analysis concentrates on our eight reporting segments: Telecommunications, Technology,
Insurance, Banking, Mass Media, Real Estate, Retail and Other Businesses. We include the discussion of our trav-
el services, radio and space technology, pharmaceuticals and biotechnology businesses together with our other
operations and central corporate functions, under the Other Businesses Segment.
Segment results are presented after elimination of intra-segment transactions, but prior to elimination of trans-
actions between segments.
TELECOMMUNICATIONS
We divide our Telecommunications Segment into two divisions: wireless services (MTS and its subsidiaries) and
fixed-line communications (Comstar-UTS and its subsidiaries).
The following table presents the results of operations for our Telecommunications Segment for the periods under
review:
Years ended December 31,2004 % of revenue 2005 % of revenue
(Amounts in thousands, except percentages)
Revenues $ 4,616,702 100.0% $ 5,892,883 100.0%
Costs of sales, exclusive of depreciation (1,437,354) (31.1) (1,892,102) (32.1)
and amortization shown separately below
Selling, general and administrative expenses (763,583) (16.5) (1,078,508) (18.3)
Depreciation and amortization (783,668) (17.0) (989,210) (16.8)
Net other operating income/(expenses) (29,116) (0.6) (66,176) (1.1)
Income from equity investees 27,324 0.6 66,382 1.1
Operating income $ 1,630,305 35.3% $ 1,933,269 32.8%
OIBDA(1) $ 2,413,973 52.3% $ 2,922,479 49.6%
(1) OIBDA represents operating income before depreciation and amortization. OIBDA is not a measure of financial performance under U.S. GAAP. Youshould not consider it an alternative to net income as a measure of operating performance or to cash flows from operating activities as a measureof liquidity. Our calculation of OIBDA may be different from the calculation used by other companies and therefore comparability may be limited.We believe that OIBDA provides useful information to investors because it is an indicator of the strength and performance of our ongoing businessoperations, including our ability to fund discretionary spending such as capital expenditures, acquisitions of subsidiaries and other investments andour ability to incur and service debt. While depreciation and amortization are considered operating costs under U.S. GAAP, these expenses primari-ly represent non-cash current period allocation of costs associated with long-lived assets acquired or constructed in prior periods.
Year ended December 31, 2005 compared to year ended December 31, 2004
Revenues Telecommunications Segment revenues increased by 27.6% to $5,892.9 million for the year ended December 31,
2005 compared to $4,616.7 million for the year ended December 31, 2004. MTS and Comstar-UTS contributed
$1,092.8 million and $212.5 million, respectively, to the growth in revenues.
Wireless services Revenues of MTS for the year ended December 31, 2005 were $5,011.0 million, an increase of 27.9% compared to
$3,918.2 million for the year ended December 31, 2004. This increase was primarily attributable to the signifi-
cant growth in MTS’ subscriber base from 34.2 million as of December 31, 2004 to 58.2 million as of December 31,
2005, including 44.2 million in Russia, 13.3 million in Ukraine, 0.6 million in Uzbekistan and 0.1 million in
Turkmenistan. The growth was attributable to MTS’ sales and marketing efforts and the expansion of its network,
as well as improving general economic conditions and income levels in Russia and Ukraine. The increase in rev-
enues from subscriber growth was partially offset by a decrease in tariffs in the Moscow license area and other
80 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
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highly competitive license areas, an increase of mass-market subscribers in MTS’ subscriber mix and its continu-
ing expansion into the regions of Russia outside the Moscow license area where tariffs are lower. As a result, aver-
age monthly service revenue per subscriber in Russia decreased by 36.4% from $11 per subscriber for the year
ended December 31, 2004 to $7 per subscriber for the year ended December 31, 2005.
For the year ended December 31, 2005, MTS’ service revenues and connection fees increased by $1,142.0 million,
or by 30.1%, to $4,942.3 million from $3,800.3 million for the year ended December 31, 2004 due to growth in
the number of its subscribers, as explained above. Revenues from sales of handsets and accessories decreased by
$18.0 million, or 20.7%, for the year ended December 31, 2005, compared to the year ended December 31, 2004,
due to a decline in the average selling price for handsets and a decrease of number of sold handsets.
Fixed-line communications Comstar-UTS’s revenues increased by $212.5 million, or by 30.6%, to $907.6 million for the year ended Decem-
ber 31, 2005 from $695.1 for the year ended December 31, 2004 mostly as a result of growth in MGTS’ tariffs and
in the number of active lines.
MGTS’ revenues grew by 33.0% in the year ended December 31, 2005 to $639.6 million, compared to $480.8 mil-
lion for the year ended December 31, 2004. Revenues from residential subscribers increased by 40.6% in the year
ended December 31, 2005, compared to the year ended December 31, 2004, and reached $241.0 million. This
increase was primarily due to an increase in monthly subscription fees effective October 2004 and October 2005.
The number of active lines increased from 4.2 million as of December 31, 2004 to 4.3 million as of December 31,
2005. Revenues from corporate subscribers increased by 17.3% compared to the year ended December 31, 2004,
to $189.6 million. Revenues from operators increased by 41.5% compared to the year ended December 31, 2004,
to $209.0 million.
Operating income The operating income margin of the Telecommunications Segment was 32.8% in the year ended December 31,
2005, compared to 35.3% in the year ended December 31, 2004. This decline was primarily attributable to the
decrease in the operating income margin of MTS.
MTS’ operations contributed $1,661.2 million to our operating income from wireless services for the year ended
December 31, 2005.
MTS’ operating income margin was 33.2% for the year ended December 31, 2005, compared to 37.1% for the year
ended December 31, 2004. The decrease in MTS’ operating income margin is due to increased cost of sales, adver-
tising and marketing expenses and depreciation and amortization expenses as a percentage of revenues.
Comstar-UTS’ operating income margin for the year ended December 31, 2005 was 29.6%, compared to 25.0% for
the year ended December 31, 2004, primarily due to increase in tariffs of MGTS.
Income from equity investees Income from equity investees accounted for $66.4 million and $27.3 million for the years ended December 31,
2005 and December 31, 2004, respectively. The increase in income from equity investees is primarily caused by
the growth in the net income of MTS Belarus and MTT, contributing $38.6 million and $26.3 million, respective-
ly, for the year ended December 31, 2005.
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TECHNOLOGY
As of December 31, 2005, our subsidiaries in the Technology Segment operated along four main divisions: info-
communication technologies (STROM telecom, its subsidiaries and Mediatel), microelectronic components
(Micron, VZPP-Micron, NIITM), consumer electronics (SITRONICS, Elion, Elaks, Kvant, Koncel and Videofon) and
information technologies (Kvazar-Micro and subsidiaries).
The following table presents the operating results of our Technology Segment for the periods under review:
Years ended December 31,2004 % of revenue 2005 % of revenue
(Amounts in thousands, except percentages)
Revenues $ 498,427 100.0% $ 961,133 100.0%
Costs of sales, exclusive of depreciation (405,671) (81.4) (750,985) (78.1)
and amortization shown separately below
Selling, general and administrative expenses (39,657) (8.0) (48,348) (5.0)
Depreciation and amortization (3,484) (0.7) (12,044) (1.3)
Net other operating expenses (3,697) (0.7) (6,255) (0.7)
Income from equity investees – – 16 0.0
Operating income 45,918 9.2% 143,517 14.9%
OIBDA(1) 49,402 9.9% 155,561 16.2%
(1) OIBDA represents operating income before depreciation and amortization. OIBDA is not a measure of financial performance under U.S. GAAP. Youshould not consider it an alternative to net income as a measure of operating performance or to cash flows from operating activities as a measureof liquidity. Our calculation of OIBDA may be different from the calculation used by other companies and therefore comparability may be limited.We believe that OIBDA provides useful information to investors because it is an indicator of the strength and performance of our ongoing businessoperations, including our ability to fund discretionary spending such as capital expenditures, acquisitions of subsidiaries and other investments andour ability to incur and service debt. While depreciation and amortization are considered operating costs under U.S. GAAP, these expenses primari-ly represent non-cash current period allocation of costs associated with long-lived assets acquired or constructed in prior periods.
Year ended December 31, 2005 compared to year ended December 31, 2004
Revenues The revenues of our Technology Segment increased by $462.7 million, or by 92.8%, to $961.1 million for the year
ended December 31, 2005. Revenues of infocommunication technologies division, which includes STROM telecom
and Mediatel, grew by 105.5% to $246.6 million, or 25.7% of the total segment revenues in the year ended
December 31, 2005, compared to $120.0 million, or 24.1% of the segment revenues in the year ended Decem-
ber 31, 2004. The increase of revenues in the infocommunication technologies division was primarily attributa-
ble to the sales of billing systems and hardware to our Telecommunications Segment. Revenues of information
technologies division increased by 60.8% to $472.0 million, or 49.1% of the total segment revenues in the year
ended December 31, 2005, compared to $293.5 million, or 58.9% of the segment revenues for the year ended
December 31, 2004. The increase of revenues in the information technologies division was attributable both to
growth in the system integration business, primarily as a result of the division’s entry into the Russian market,
and to volume growth in the IT components distribution business, primarily in the Russian and Ukrainian mar-
kets. Revenues of the microelectronic components division increased by 10.6% to $59.6 million, or 6.2% of seg-
ment revenues in the year ended December 31, 2005 compared to $53.9 million, or 10.8% of the segment rev-
enues in the year ended December 31, 2004. The consumer electronics division demonstrated considerable
growth in the year ended December 31, 2005, with revenues increasing to $188.0 million, or 19.6% of the seg-
ment revenues from $51.6 million, or 10.4% of the segment revenues, for the year ended December 31, 2004. The
increase of revenues in the consumer electronics division was a result of the increased sales of consumer elec-
tronics under various brands, including the SITRONICS umbrella brand, during the year ended December 31, 2005.
82 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
Consolidated Financial Statements
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Operating income Operating income increased to $143.5 million, or 14.9% of segment revenues, for the year ended December 31,
2005 from an operating income of $45.9 million in the year ended December 31, 2004. The increase in operating
income was primarily attributable to the sales of billing systems to our Telecommunication Segment. Info-
communication technologies division continued to be the main contributor to the operating margin with
$128.8 million, or 89.8% of the segment’s operating income, for the year ended December 31, 2005. For the year
ended December 31, 2004, operating income of infocommunication technologies division was $36.3 million or
79.1% of the segment’s operating income. Information technologies division contributed $7.0 million to the seg-
ment’s operating income for the year ended December 31, 2005, compared to $1.5 million for the year ended
December 31, 2004. Consumer electronics division and microelectronic components division contributed
$4.4 million and $6.1 million, respectively, to the segment’s operating income for the year ended December 31,
2005, compared to $3.1 and $7.2 million, respectively, for the year ended December 31, 2004. Operating loss of
Concern SITRONICS, the holding company of our Technology Segment, increased from $2.2 million for the year
ended December 31, 2004, to $2.8 million for the year ended December 31, 2005.
INSURANCE
Our Insurance Segment is represented by ROSNO. ROSNO’s principal activities are non-life and life insurance, as
well as insurance-related services, such as obligatory insurance. ROSNO’s corporate clients are primarily in the
telecommunications, oil and gas, banking, retail and manufacturing sectors.
The following table presents the results of operations of our Insurance Segment for the periods under review:
Years ended December 31,2004 % of revenue 2005 % of revenue
(Amounts in thousands, except percentages)
Revenues from insurance services $ 300,194 100% $ 408,860 100%
Insurance services related costs, exclusive (192,338) (64.1) (290,901) (71.1)
of depreciation and amortization shown
separately below
Selling, general and administrative expenses (76,408) (25.5) (90,070) (22.0)
Depreciation and amortization (3,378) (1.1) (4,373) (1.1)
Other operating income 1,907 0.6 4,883 1.2
Net loss on disposal of subsidiary – – (221) (0.1)
Income from equity investees 191 0.1 239 0.1
Operating income $ 30,168 10.0% $ 28,417 7.0%
Voluntary medical insurance, motor own damage insurance and property insurance historically have been the
largest contributors to our gross premiums written, or GPW. The share of voluntary medical insurance in GPW
increased to 26.0% in the year ended December 31, 2005 compared to 24.7% in the year ended December 31, 2004.
Revenues from property insurance increased from 11.0% of the total GPW for the year ended December 31, 2004 to
24% for the year ended December 31, 2005. The share of GPW for motor own damage insurance in the total GPW
increased from 17.0% in the year ended December 31, 2004 to 22.8% in the year ended December 31, 2005.
The adjustments necessary to reconcile GPW to revenue derived from the relevant policies are set forth in change
in provision in unearned premiums, net of reinsurance, in the table below.
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The table below provides a breakdown of our Insurance Segment revenues by business line.
Years ended December 31,2004 2005
Voluntary medical insurance 90,704 120,621
Motor third-party liability 1,946 1,312
Motor own damage insurance 62,458 105,571
Property 40,563 109,467
General third-party liability 8,359 13,166
Marine, aviation and transport 19,871 19,101
Personal accident 6,634 9,711
Other non-life liability 7,556 12,502
Life insurance 1,767 6,130
Obligatory motor third-party liability 43,080 58,305
Reinsurance inwards 84,622 7,469
Total gross premiums written 367,560 463,355
Reinsurance outwards (40,105) (57,525)
Change in provision in unearned premiums, net of reinsurance (49,921) (41,054)
Net premiums earned 277,534 364,776
Commission income 4,507 1,981
Medical services income 6,396 10,945
Net (loss)/gain on operations with securities (1,865) 17,864
Interest income 7,282 13,294
Other income 6,340 –
Total revenue $ 300,194 $ 408,860
Year ended December 31, 2005 compared to the year ended December 31, 2004
Revenues In the year ended December 31, 2005, our Insurance Segment revenues grew by $108.7 million, or 36.2%, com-
pared to the year ended December 31, 2004. Voluntary medical insurance, motor own damage and property insur-
ance together accounted for $335.7 million, or 72.4% of GPW for the year ended December 31, 2005. GPW on
obligatory motor third-party liability insurance accounted for $58.3 million, or 12.6%, of our GPW for the year
ended December 31, 2005.
GPW on property insurance increased to $109.5 million for the year ended December 31, 2005, or by 169.9%, com-
pared to $40.6 million for the year ended December 31, 2004. The growth is due to expansion in property insur-
ance operations and to the fact that GPW on energy business, being a part of reinsurance inwards in 2004, was
classified as GPW on property insurance in the year ended December 31, 2005, as ROSNO started insuring RAO
UES’s property risks directly.
Overall, GPW increased by 26.0%, to $463.4 million in the year ended December 31, 2005, in comparison with
$367.6 million in the year ended December 31, 2004 owing to expansion of insurance operations.
Non-insurance revenues increased to $44.1 million in the year ended December 31, 2005 from $22.7 million in
the year ended December 31, 2004, or by 94.5%, due to growth of revenues from investment activities, mainly
attributed to dynamic growth of the Russian stock market.
Operating income The operating income of our Insurance Segment decreased to $28.4 million in the year ended December 31, 2005
from $30.2 million in the year ended December 31, 2004, due to an increase in the share of insurance services
84 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
Consolidated Financial Statements
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related costs as a percentage of revenues to 71.1 % in the year ended December 31, 2005 from 64.1 % in the year
ended December 31, 2004. The increase is explained by the rise in customers’ acquisition costs following the
growth of the number of policies written, and write-off of certain uncollectible accounts. The operating income
margin decreased to 7.0% in the year ended December 31, 2005 from 10.0% in the year ended December 31, 2004.
Total assets The total assets of our Insurance Segment increased to $581.5 million as of December 31, 2005 from $452.8 mil-
lion as of December 31, 2004, or by 28.4%. This growth is primarily attributable to an increase in bank deposits
of $64.5 million, in receivables from insurance operations of $10.1 million, and in investment in municipal and
corporate bonds of $79.4 million.
BANKING
Our Banking Segment is represented by MBRD, which provides a broad range of services. Historically, MBRD main-
ly performed treasury functions for companies in or related to our consolidated group. Accordingly, MBRD’s rev-
enues were previously primarily derived from our subsidiaries and related parties. We are currently focusing on
developing and expanding MBRD’s retail banking business in Moscow and major cities throughout Russia. As of
December 31, 2005, the bank operated in Moscow and eight regions, whereas three regional offices were launched
in the year ended December 31, 2005. The volume of revenues from our subsidiaries and related parties as a per-
centage of total MBRD revenues was declining throughout the year ended December 31, 2005 as a consequence
of the expansion of third-party operations.
The following table summarizes MBRD’s financial performance for the periods indicated:
Years ended December 31,2004 % of revenue 2005 % of revenue
(Amounts in thousands, except percentages)
Revenues from financial services $ 65,738 100% $ 106,785 100%
Including:
Revenues from consolidated companies 22,788 34.7 28,557 26.7
Revenues from related parties 1,971 3.0 4,506 4.2
Financial services related costs, exclusive (31,075) (47.3) (65,469) (61.3)
of depreciation and amortization
shown separately below(1)
Selling, general and administrative expenses (22,950) (34.9) (28,270) (26.5)
Depreciation and amortization (1,119) (1.7) (1,555) (1.5)
Income from equity investees 1,097 1.7 1,231 1.2
Operating income $ 11,691 17.8% $ 12,722 11.9%
(1) Includes interest expense on deposits.
Year ended December 31, 2005 compared to the year ended December 31, 2004
Revenues For the year ended December 31, 2005, compared with the year ended December 31, 2004, MBRD’s revenues
increased by 62.4%, to $106.8 million. Interest income grew by $36.2 million in the year ended December 31,
2005 and amounted to $93.4 million. This growth was primarily attributable to interest on loans to customers.
As of December 31, 2005, loans to customers, net of allowances for loan losses, increased by 72.4% compared with
December 31, 2004 to $765.9 million, including $220.5 million, or 28.8%, of inter-company loans and $47.8 mil-
lion, or 6.2%, of loans to our related parties. As of December 31, 2005, the weighted average interest on inter-
company loans was 11.2% on U.S. dollar-denominated loans (which totaled $139.1 million) and 10.8% for ruble-
85
Consolidated Financial Statements
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denominated loans (which totaled $81.4 million). The weighted average interest rate on U.S. dollar-denominat-
ed loans to related parties was 12.2% (which totaled $33.0 million) and 10.5% for ruble-denominated loans
(which totaled $14.8 million). Loans to third-party customers, net of allowance for loan losses, increased by
$314.9 million to $497.6 million as of December 31, 2005 as compared to $182.7 million as of December 31, 2004.
The weighted average interest rate on loans to third-party customers was 12.4% for ruble-denominated loans
and 11.9% for U.S. dollar-denominated loans as of December 31, 2005.
Non-interest income increased to $13.4 million in the year ended December 31, 2005 from $8.5 million in the
year ended December 31, 2004 primarily due to the growth in commissions received and gain on foreign exchange
operations.
Operating income Banking Segment’s operating income increased by 8.8% and amounted to $12.7 million in the year ended
December 31, 2005, compared to $11.7 million for the year ended December 31, 2004. An increase in the volume
of MBRD’s operating expenses following the expansion of retail business, as well as interest accrued on additional
debt in the year 2005 resulted in the decrease of operating income margin.
Income from equity investees Income from equity investees of $1.2 million recorded in the operating income of the segment in the year ended
December 31, 2005 represents our share of the net income of East-West United Bank located in Luxembourg.
Total assets Total assets of the Banking Segment increased to $1,114.9 million as of December 31, 2005 from $757.9 million
as of December 31, 2004 primarily owing to the increase in loans issued to customers to $765.9 million as of
December 31, 2005 compared to $444.3 million as of December 31, 2004. In March 2005, MBRD for the first time
completed an issue of loan participation notes for the total amount of $150.0 million. The issue was organized
via Dresdner Bank AG, which issued to MBRD a loan for the respective amount. The notes were admitted to trade
on the Luxembourg Stock Exchange. Additional funds secured from the open market, as well as from Sistema,
allowed the bank to expand its loan portfolio.
REAL ESTATE
In our Real Estate Segment, represented by Sistema-Hals and its subsidiaries, we are a leading real estate owner,
developer and manager predominantly focused on the Moscow market in the segments of Class A and B offices,
elite housing, cottages and land development. We have been in the real estate business since the early 1990s,
making real estate one of our first businesses. Since 1994, we have successfully completed more than 20 projects
totaling over 150,000 sq.m. of space.
Years ended December 31,2004 % of revenue 2005 % of revenue
(Amounts in thousands, except percentages)
Revenues $ 115,342 100.0% $ 78,448 100.0%
Cost of sales, exclusieve of depreciation and (73,333) (63.6) (36,685) (46.8)
amortization shown separately below
Selling, general and administrative expenses (14,686) (12.7) (31,295) (39.9)
Depreciation and amortization (1,049) (0.9) (2,104) (2.7)
Net other operating (expenses)/income (2,811) (2.4) 2,035 2.6
Operating income $ 23,463 20.3% $ 10,399 13.3%
86 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
Consolidated Financial Statements
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Year ended December 31, 2005 compared to year ended December 31, 2004
RevenuesReal Estate Segment revenues decreased by $36.9 million, to $78.4 million, in the year ended December 31, 2005
compared to the year ended December 31, 2004. The reason for the decrease is the continued construction of real
estate projects during the year ended December 31, 2005, which resulted in no sales of construction projects in
that period while for the year ended December 31, 2004 four construction projects were completed and sold. We
record revenues using the percentage of completion method upon conclusion of a legally binding agreement for
sale and at least 30% completion of construction, prior to finalization of such agreement or if the project is less
than 30% complete, no revenues or income are recorded in the statement of operations. In 2006, we expect that
several of our projects will be successfully completed.
Operating incomeOperating income of the Real Estate Segment for the year ended December 31, 2005 decreased to $10.4 million
from $23.5 million in the year ended December 31, 2004. The decrease resulted from completion and sale of sev-
eral real estate projects during the year ended December 31, 2004 and the absence of such sales owing to con-
tinued construction in the year ended December 31, 2005.
Total assetsTotal assets of the Real Estate Segment increased from $222.9 million as of December 31, 2004 to $331.8 million
as of December 31, 2005, or by 48.8%. This growth is primarily due to an increase of a number of construction
projects in the segment’s portfolio.
RETAIL
We operate our Retail Segment through Detsky Mir-Center, the leading retailer of children’s goods in Russia.
Detsky Mir is among the most recognized brands in Russia. As of December 31, 2005, we operated twenty two
stores in Moscow, including the flagship Detsky Mir store in the center of Moscow, and twenty three stores out-
side Moscow with a total retail space of 58,367 sq.m. We plan to further expand retail operations by opening new
stores in Moscow and other Russian cities and to undertake a significant refurbishment of our flagship store.
Years ended December 31,2004 % of revenue 2005 % of revenue
(Amounts in thousands, except percentages)
Revenues $ 79,344 100.0% $ 208,008 100.0%
Cost of sales, exclusive of depreciation and (43,927) (55.4) (142,752) (68.6)
amortization shown separately below
Selling, general and administrative expenses (24,505) (30.9) (53,245) (25.6)
Depreciation and amortization (1,336) (1.7) (1,618) (0.8)
Net other operating (expenses)/income (693) (0.9) 52 (0.0)
Income from equity investees 156 0.2 – –
Operating income $ 9,039 11.4% $ 10,445 5.0%
87
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RevenuesIn our Retail Segment, revenues increased by 162.2%, to $208.0 million, for the year ended December 31, 2005 from
$79.3 million for the year ended December 31, 2004. The increase was mostly generated by revenues of acquired com-
panies which contributed $83.1 million and our new retail outlets added the rest of the increase. Starting January 1,
2005, our retail business started to develop wholesale activity which contributed approximately $67.0 million to the
growth. In 2005, the margin of the wholesale operations was relatively low and fluctuated between 1% and 5%, which
resulted in overall gross margin decrease in the segment from 44.6% in 2004 to 31.4% in 2005.
Operating incomeOperating income of the Retail Segment for the year ended December 31, 2005 increased to $10.4 million, from
$9.0 million in the year ended December 31, 2004. The increase resulted from a significant growth of sales dur-
ing the year ended December 31, 2005, which was partially offset by a decrease in gross margin described above.
MASS MEDIA
We operate our Mass Media Segment through Sistema Mass Media, a holding company that is active in three main
areas: advertising, print distribution and other media, which includes a number of companies that operate in
other segments such as publishing, film production and news services. Following a strategic review of our media
assets, we primarily focus on developing distribution platforms and content for pay-TV and multi-media servic-
es initially in Moscow and subsequently in other parts of Russia. Starting from the year ended December 31, 2005,
our Mass Media Segment is actively developing cable television network throughout Russia.
Years ended December 31,2004 % of revenue 2005 % of revenue
(Amounts in thousands, except percentages)
Revenues $ 36,217 100.0% $ 52,428 100.0%
Cost of sales, exclusive of depreciation (30,183) (83.3) (33,045) (63.0)
and amortization shown separately below
Selling, general and administrative expenses (6,187) (17.1) (11,405) (21.8)
Depreciation and amortization (680) (1.9) (4,540) (8.7)
Net other operating (expenses)/income (2,339) (6.5) (2,226) (4.2)
Net loss on disposal of subsidiaries 2,234 6.2 5,858 11.2
Operating income/(loss) $ (938) (2.6)% $ 7,070 13.5%
RevenuesMass media revenues increased to $52.4 million, or by 44.8%, during the year ended December 31, 2005 compared
to $36.2 million for the year ended December 31, 2004, primarily due to growth of sales in Thema Production,
which contributed approximately $7.7 million to the increase, purchase of ESTA and Upravlenie I Leasing with
total revenues amounting to approximately $6.4 million and $3.5 million, respectively. In addition, we com-
menced operations in Ukraine through establishing direct subsidiaries, Maxima Kiev and Lingway, which con-
tributed $8.0 million and $0.8 million, respectively, to the total revenues of mass media business. The increase
was partially offset by disposal of our print distribution companies, Nasha Pressa and Stolichnaya Pressa.
Operating incomeOperating income of the Mass Media Segment for the year ended December 31, 2005 increased to 13.5% of total
revenues, or $7.1 million, from an operating loss of $0.9 million in the year ended December 31, 2004. This is
mostly explained by the gain on disposal of our print distribution, publishing and radio companies of $5.9 mil-
lion and expansion of film-production operations.
88 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
Consolidated Financial Statements
_ g g / / g
OTHER BUSINESSES
In this segment we include our travel services, radio and space technology, pharmaceuticals and biotechnology
businesses together with our other operations and central corporate functions. Thus, costs of our corporate
function are included in the operating costs of this segment. These costs amounted to $35.4 million for the year
ended December 31, 2005, compared to $41.7 million in the year ended December 31, 2004.
Years ended December 31,2004 % of revenue 2005 % of revenue
(Amounts in thousands, except percentages)
Revenues $ 177,020 100.0% $ 283,594 100.0%
Cost of sales, exclusive of depreciation (136,611) (77.2) (220,084) (77.6)
and amortization shown separately below
Selling, general and administrative expenses (85,236) (48.2) (141,296) (49.8)
Depreciation and amortization (2,560) (1.4) (9,148) (3.2)
Net other operating (expenses)/income (15,140) (8.6) 27,654 9.8
(Loss)/income from equity investees (1,647) (0.9) 10,165 3.6
Net loss on disposal of subsidiaries (50) 0.0 9,690 3.4
Operating loss $ (64,224) (36.3)% $ (39,425) (13.9)%
Our radio and space technology division consists of Concern RTI Systems and its subsidiaries and affiliates. This
division is primarily involved in the design and production of radars and radar systems, space control systems
and telecommunication equipment for both governmental agencies and corporate clients.
Our travel services business consists of Intourist, a Moscow-based tour operator. Intourist is one of the leading
Russian providers of travel and leisure services and operates its business through more than 40 Russian and sev-
eral foreign subsidiaries.
Our miscellaneous businesses consist of pharmaceuticals and biotechnology, international operations and sport.
Year ended December 31, 2005 compared to year ended December 31, 2004
Revenues Total operating revenues of the Other Businesses Segment increased to $283.6 million for the year ended
December 31, 2005, compared to $177.0 million for the year ended December 31, 2004.
The total operating revenues of our radio and space technology division for the year ended December 31, 2005
were $124.2 million compared with $37.0 million for the year ended December 31, 2004, representing growth of
235.3%. The growth in revenues is explained by consolidation of NIIDAR that was not previously consolidated
due to certain governmental restrictions, acquisition of new companies (Yaroslavsky Radio Plant, MTU Saturn,
Planeta) and increase in the volume of contracts with governmental agencies.
The total operating revenues of our travel services business for the year ended December 31, 2005 were $98.0 mil-
lion compared with $96.6 million for the year ended December 31, 2004, representing growth of 1.5%. During the
year ended December 31, 2005, the number of inbound tourists served decreased to 141 thousand, or by 14.0%
compared to the year ended December 31, 2004, while the number of outbound tourists increased to 208 thou-
sand, or by 16.9%, compared to the year ended December 31, 2004.
Operating loss In the Other Businesses Segment, operating losses decreased in the year ended December 31, 2005 to $39.4 mil-
lion from $64.2 million in the year ended December 31, 2004, primarily due to the decrease in charity expenses
and recognition of income from equity investments in oil producing and refining companies in Bashkortostan in
the year ended December 31, 2005.
89
Consolidated Financial Statements
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In our radio and space technology division, operating margin increased to 8.0% during the year ended December
31, 2005, compared to an operating margin of 6.8% in the year ended December 31, 2004.
In our travel services business operating margin slightly decreased to 1.3% during the year ended December 31,
2005, compared to an operating margin of 2.9% in the year ended December 31, 2004.
TELECOMMUNICATIONS OPERATING DATA
Our revenues and operating income for the years ended December 31, 2005 and 2004 were influenced by trends
in the principal businesses included in our Telecommunications Segment: MTS and Comstar-UTS. The following
discussion contains certain operating data relating to each of the principal businesses in our
Telecommunications Segment.
MTS
The following tables show the number of MTS’ subscribers and average monthly service revenue per subscriber as
of the dates indicated.
At December 31,2004 2005
(Amounts in millions, except average monthly service revenue per subscriber)
Subscribers(1)
Russia 26.54 44.22
Ukraine 7.37 13.33
Uzbekistan 0.31 0.58
Turkmenistan n/a 0.07
Total 34.22 58.20
Average monthly service revenue per subscriber
Russia $ 11 $ 7
Ukraine $ 12 $ 9
(1) MTS defines a ‘’subscriber’’ as an individual or organization whose account shows chargeable activity within 61 days (or 183 days in the case ofthe “Jeans” and “SIM-SIM” brand tariffs) and whose account does not have a negative balance for more than this period. Prior to October 1, 2004,UMC used a 90-day period for such purposes with respect to its “Jeans” and “SIM-SIM” subscribers.
As of December 31, 2005, MTS’ subscriber base increased to 58.2 million, or by 70.1% compared to December 31,
2004. An increase in subscriber base is primarily explained by the growth of number of customers in existing sub-
sidiaries rather than the growth in the subscriber base by acquisitions of new companies. MTS’ organic growth in
revenues amounted to $1,056.9 million, or 27.0% in the year ended December 31, 2005 as compared to the year
ended December 31, 2004, while MTS’ acquisitions contributed $35.9 million to our revenues for the year ended
December 31, 2005.
Average monthly service revenue per subscriber in Russia fell from $11 in the year ended December 31, 2004 to
$7 in the year ended December 31, 2005, due to the continued decrease in tariffs in the Moscow license area, an
increase of mass-market subscribers in MTS’ subscriber mix and its continued expansion into the regions of
Russia outside of the Moscow license area where tariffs are lower. In 2005, more than a half of MTS’ subscriber
growth occurred outside of the Moscow license area. However, as a result of competition and the tariff structure
in the Russian regions outside of the Moscow license area, MTS’ average revenue per subscriber in the Russian
regions remains lower than in the Moscow license area, though costs are generally lower there as well. MTS gen-
erally expects to see a continued decline in average monthly service revenue per subscriber due to the intro-
duction of lower tariff plans in connection with its marketing efforts.
90 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
Consolidated Financial Statements
_ g g / / g
UMC has experienced subscriber growth from 7.4 million subscribers as of December 31, 2004 to 13.3 million sub-
scribers as of December 31, 2005, and we expect this trend to continue, assuming the Ukrainian economy con-
tinues to grow. Average monthly service revenue per subscriber decreased in the year ended December 31, 2005
as a result of an extensive marketing campaign focused on penetration to the mass-market.
Subscriber ChurnWe define our churn as the total number of subscribers who cease to be a subscriber during the period (whether
involuntarily due to non-payment or voluntarily, at such subscriber’s request), expressed as a percentage of the
average number of our subscribers during that period. We view the subscriber churn as a measure of market com-
petition and customer dynamics. The following table shows our Russian and Ukrainian subscriber churn for the
periods indicated.
Years ended December 31,2004 2005
Subscriber churn(1)
Russia 27.5% 20.7%
Ukraine 15.8% 21.8%
MTS’ subscriber churn in Russia decreased from 27.5% in the year ended December 31, 2004 to 20.7% in the year
ended December 31, 2005 as a result of MTS marketing initiatives, targeted to raise subscriber loyalty. Although
its subscriber churn in Russia decreased for the year ended December 31, 2005, MTS believes that subscriber
churn is highly dependent on competition and the number of mass-market subscribers in its overall subscriber
mix. Mass-market subscribers generally choose to prepay their mobile phone usage by purchasing prepaid pack-
ages and are more likely to switch providers to take advantage of low-tariff promotions. As a result, competition
for these subscribers will likely lead to sustained downward pressure on tariffs. The other reasons for potential
increases in subscriber churn are the absence of service contracts with subscribers in Russia that contain mini-
mal periods of usage and the absence of connection fees, which generally prevent a subscriber’s early churn.
Churn, as MTS uses it, includes internal churn within its subscriber base, i.e., MTS’ subscribers switching between
different tariff plans we offer.
Comstar-UTS
Comstar-UTS had more than 493,000 residential subscribers in its alternative fixed-line communications segment
as at December 31, 2005, of which the number of broadband subscribers increased by 143% year on year. The
number of dial-up subscribers declined by 45% in 2005, which was in line with the general market trend of sub-
scribers switching to broadband services. Pay-TV services were provided to subscribers with the commercial
launch of StreamTV in September 2005. The pay-TV subscriber base grew strongly during the fourth quarter and
had reached nearly 6,700 by the end of the year.
The corporate client base in the alternative fixed-line telecommunications segment grew to more than 38,000
subscribers as at December 31, 2005. The numbering capacity in the alternative fixed-line telecommunications
segment was 628,600 numbers by the year end, whilst the number of ADSL and data transmission channels
increased by 36% during the year. Local connections still account for the majority of the traffic. The ratio
between the volume of local calls and international and inter-city connections (long-distance calling) was 6:1,
which reflects the structure of both the corporate client and operator markets.
The total numbering capacity in the traditional fixed-line telecommunications segment was 4,637,383 numbers,
of which over 3.5 million numbers were provided to residential subscribers and more than 728,000 numbers were
provided to corporate subscribers. Comstar-UTS provided traditional fixed-line telecommunication services to
3,536,479 residential customers and more than 76,000 corporate customers as at December 31, 2005.
91
Consolidated Financial Statements
_ g g / / g
Alternative Fixed-Line Business
Years ended December 31,2004 2005
Number of subscribers 478,666 531,726
Residential subscribers 451,059 493,231
Broadband subscribers 102,516 249,585
Dial-up subscribers 343,691 190,095
Voice subscribers 4,852 46,860
Pay-TV subscribers – 6,691
Corporate subscribers 27,258 38,017
Operators 349 478
Active telephone lines
Corporate subscribers 116,842 134,985
Operators 102,445 112,038
Mobile operators 303,574 325,572
Residential subscribers 7,683 8,260
Total 530,544 580,855
Installed capacity/telephone lines 588,600 628,600
ADSL and data transmission channels 19,701 26,814
Traditional Fixed-Line Business
Years ended December 31,2004 2005
Number of current subscribers
Residential subscribers 3,472,661 3,536,479
Corporate subscribers 76,407 76,042
Operators 222 213
Total 3,549,290 3,612,734
Active telephone lines
Residential subscribers 3,472,661 3,536,479
Corporate subscribers 723,611 728,329
Total 4,196,272 4,264,808
Installed capacity/telephone lines 4,491,055 4,637,383
Access nodes/lines rented
Corporate subscribers 31,154 30,846
Operators 170,736 182,049
Total 201,890 212,895
92 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
Consolidated Financial Statements
_ g g / / g
LIQUIDITY AND CAPITAL RESOURCES
We use a variety of sources to finance our operations, both external and internal. In addition to net cash provid-
ed by operations, our companies use short- and long-term borrowings to fund capital expenditures and strategic
investments. Short- and long-term funding sources may change with time, but currently include notes issued in
the international and Russian capital markets and credit facilities with international and Russian banks, denom-
inated in both rubles and foreign currencies. In January 2004, January and March 2005, we (including MTS) raised
approximately $350.0 million, $400.0 million and $150.0 million, respectively, through U.S. dollar-denominated
bond offerings in the international capital markets. MTS repaid its $300.0 million notes in May 2004 with the pro-
ceeds of a short-term bridge loan and operating cash flows. In September 2004, MTS entered into a $600.0 million
syndicated loan facility provided by international financial institutions. MTS partially repaid its indebtedness
under the syndicated loan facility which amounted to $460 million as of December 31, 2005. In December 2004,
MTS repaid 10.95% notes due in 2004 in principal amount of $300 million. In October, November and December
2005 we drew through both short- and long-term credit facilities approximately $92.8 million, $213.3 million and
$493.0 million, respectively, including $132.0 million received under the share repurchase agreement with
Dresdner Bank AG in connection with the planned Comstar-UTS initial public offering.
Our parent company, JSFC Sistema, is a holding company with direct operations mostly limited to certain functions
for our group, including budgeting, corporate finance, strategic development and public relations. The ability of
JSFC Sistema to repay its debts depends primarily upon the receipt of dividends, distributions and other payments
from our subsidiaries, proceeds from the sale of subsidiaries and from additional borrowings. In February 2005,
JSFC Sistema completed its initial public offering on the London Stock Exchange. The amount of proceeds, net of
related expenses, equaled to $1,284.6 million. We invested a significant portion of the proceeds from the offering
in the purchase of minority shareholdings in six energy companies in the Republic of Bashkortostan, while the
remaining amount was invested in corporate and municipal bonds and in other short-term securities.
We expect to repay all long-term debts as they become due from our operating cash flows or through re-financings.
See Notes 21, 22 and 23 to our audited consolidated financial statements for a description of our indebtedness.
Working Capital
Working capital is defined as current assets less current liabilities. As of the date hereof, we believe our working
capital is sufficient for our present requirements. As of December 31, 2005, we had a positive working capital of
$108.5 million, compared to a deficit of $33.8 million as of December 31, 2004.
Our working capital turned to positive following the proceeds from the initial public offering of JSFC Sistema.
Credit Ratings
Our credit ratings impact our ability to obtain short- and long-term financing, and the cost of such financing. In
determining our credit ratings, the rating agencies consider a number of factors, including our operating cash
flows, total debt outstanding, commitments, interest requirements, liquidity needs and availability of liquidity.
Other factors considered may include our business strategy, the condition of our industry and our position with-
in the industry. Although we understand that these and other factors are among those considered by the rating
agencies, each agency might calculate and weigh each factor differently.
93
Consolidated Financial Statements
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The credit ratings of our parent company and our subsidiaries as of the date of this document were as follows:
Name of issuer Rating Agency Date of Rating Long-term Debt Rating Outlook / Watch
Sistema Standard & Poor’s March 24, 2005 BB- Stable
Sistema Fitch April 28, 2006 B+ Positive
Sistema Moody’s November 19, 2003 B1 Stable
MTS Moody’s December 10, 2001 Ba3 Stable
MTS Standard & Poor’s March 24, 2005 BB- Stable
SITRONICS Fitch February 14, 2006 B- Stable
SITRONICS Moody’s February 16, 2006 B3 Stable
MGTS Standard & Poor’s March 24, 2005 BB- Stable
MGTS Moody’s January 20, 2006 Ba3 Stable
MBRD Fitch April 14, 2006 B Stable
MBRD Moody’s December 14, 2004 B1 Stable
None of our existing indebtedness has any triggers related to our credit ratings.
Capital Requirements
We need funding to finance the following:
• capital expenditures, consisting of purchases of property, plant and equipment and intangible assets;
• acquisitions;
• repayment of debt;
• changes in working capital; and
• general corporate activities, including dividends.
We anticipate that capital expenditures, acquisitions and repayment of long-term debt will represent the most
significant uses of funds for several years to come.
Our capital expenditures in the years ended December 31, 2004 and December 31, 2005 were $1,627.0 million and
$2,484.3 million, respectively. We expect to continue to finance most of our capital expenditure needs through
our operating cash flows, and to the extent required, to incur additional indebtedness through borrowings or
additional capital raising activities. Historically, a significant portion of our capital expenditures has been relat-
ed to the installation and build out of our telecommunication networks and expansion into new license areas.
Our future expenditures may be higher, in particular if licenses relating to new telecommunication technologies
become available and our investment program for expansion and full digitalization of the Moscow public switch
telephone network will be implemented. We expect that capital expenditures will remain a large portion of our
cash outflows in connection with the continued installation and build-out of our networks.
In addition to our capital expenditures, we spent $338.9 million and $540.4 million in the years ended Decem-
ber 31, 2004 and December 31, 2005, respectively, to acquire businesses. We may continue to expand our business
through acquisitions. Our cash requirements relating to potential acquisitions can vary significantly based on
market opportunities.
We expect to refinance most of our existing debt when it becomes due. In May 2004, MTS retired $300.0 million in
principal amount of its Floating Rate Notes due August 2004 with the proceeds of a $200.0 million short-term
bridge loan from Credit Suisse First Boston International and operating cash flows. This $200.0 million bridge loan
was repaid from MTS’ operating cash flows and drawings on the syndicated loan facility described above. In
December 2004, MTS repaid its 10.95% notes due 2004 in principal amount of $300.0 million from further draw-
ings on the syndicated loan facility.
94 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
Consolidated Financial Statements
_ g g / / g
Capital Resources
We plan to finance our capital requirements through operating cash flows and financing activities, as described
above. We do not depend on off-balance sheet financing arrangements.
At December 31, 2005, our debt was comprised of the following:
Currency Annual interest rate December 31, 2005(Actual at December 31, 2005) (In thousands)
Sistema Capital Notes USD 8.9% $ 350,000
Sistema Finance Notes USD 10.3% 349,285
MTS Finance Notes due 2012 USD 8.0% 399,052
MTS Finance Notes due 2010 USD 8.4% 400,000
MTS Finance Notes due 2008 USD 9.8% 400,000
MBRD Bonds USD 8.6% 150,000
MGTS Bonds RUR 8.3%-10.0% 104,230
DMC Bonds RUR 8.5% 39,954
Total Corporate Bonds 2,192,521
Syndicated Loan USD LIBOR +2.5% (7.2%) 460,000
Citibank N.A., ING Bank N.V. and Raiffeisen AG USD LIBOR +0.8%–2.3% (5.3%–6.8%) 200,000
HSBC Bank Plc and ING BHF-BANK AG USD LIBOR +0.4% (5.1%) 171,816
ING Bank N.V. USD LIBOR +0.8% (5.1%) 150,000
EBRD USD LIBOR +3.1% (7.8%) 139,387
Deutsche Bank USD LIBOR +1.9% (6.6%) 132,000
Citibank International Plc and ING Bank N.V. USD LIBOR +0.3% (5.0%) 111,009
Commerzbank AG, ING Bank AG and HSBC Bank plc USD LIBOR +0.3% (5.0%) 92,826
ABN AMRO N.V. USD, LIBOR +0.4% (5.1%) 83,179
EUR EURIBOR +0.4% (3.0%)
Barclays Bank USD LIBOR +0.1%–0.2% (4.8%–4.9%) 80,086
Vneshtorgbank USD, LIBOR +4.9% (9.6%), 66,027
EUR EURIBOR +5.0%–5.4%
(7.6–8.0%), 8.5%
HSBC Bank Plc, ING Bank Deutschland AG USD LIBOR +0.3% (5.0%) 63,338
and Bayerische Landesbank
ABN AMRO Bank USD LIBOR +3.0% (7.5%) 49,816
ING BHF Bank and Commerzbank AG EUR EURIBOR +0.7% (3.3%) 43,168
Donau-Bank USD 9.0% 34,230
Commerzbank (Eurasia) USD LIBOR +0.4%–3.5% (5.1%–6.1%) 34,071
Citibank USD LIBOR +1.6% (6.3%) 21,584
ABN AMRO Bank USD LIBOR +3.0% (7.5%) 20,000
ING-Bank (Eurasia) USD LIBOR +2.3%–4.2% (6.8%–8.7%) 20,000
Commerzbank Eurasia USD LIBOR +5.0% (9.8%) 20,000
Dresdner Bank USD LIBOR +1.3% (6.1%) 14,000
Commerzbank Belgium S.A./N.V. USD LIBOR +0.4% (5.1%) 13,314
Credit Suisse Bank USD LIBOR +2.8% (7.5%) 12,990
West LB USD LIBOR +6.8% (10.6%) 10,400
Vendor financing Various Various 16,260
Loans and promissory notes from related parties Various Various 33,537
Other Various Various 75,149
4,360,708
Less amounts maturing within one year (1,158,079)
Total $ 3,202,629
95
Consolidated Financial Statements
_ g g / / g
The following table presents the aggregate scheduled maturities of debt principal outstanding as of
December 31, 2005:
Payments due in the year ended December 31, (In thousands)
2006 $ 1,158,079
2007 341,619
2008 1,039,942
2009 113,470
2010 604,032
Thereafter 1,103,566
Total $ 4,360,708
In addition, we had capital lease obligations in the amount of $9.9 million as of December 31, 2005. The terms
of our material debt obligations and capital lease obligations are described in Notes 21, 22 and 23, respectively,
to our audited consolidated financial statements.
Our ability to incur further indebtedness is limited by the covenants in our outstanding notes, including (i) con-
solidated indebtedness to consolidated EBITDA test (as defined in the indenture relating to the notes), (ii) MTS’
debt/cash flow incurrence test. The covenants in our outstanding notes also limit our ability to grant liens on
our properties and to enter into mergers, acquisitions, sales and sale-leaseback transactions.
The following table presents a summary of our cash flows and cash outlays for capital expenditures and acquisi-
tions of subsidiaries:
Year ended December 31,2004 2005(Amounts in thousands)
Cash flows
Net cash provided by operating activities $ 1,904,071 $ 1,771,220
Net cash used in investing activities (2,064,436) (4,270,930)
Net cash (used in)/provided by financing activities 380,947 2,478,610
Net increase/(decrease) in cash 220,582 (21,100)
Cash outlays for
Capital expenditures(1) (1,670,599) (2,472,255)
Acquisition of subsidiaries, net of cash acquired (338,906) (540,404)
(1) Includes acquisition of property, plant and equipment, intangible assets and principal payments on capital lease obligations.
During the periods under review, our operating activities generated positive cash flows due to expansion through
organic growth and acquisitions. During the same periods, our investing activities generated negative cash flows
due primarily to increases in capital expenditures in connection with the development of our telecommunications
network and the acquisitions of new businesses. We expect for the foreseeable future to continue to use cash in
investing activities as we continue to expand our telecommunications network in the Moscow region, into the
regions outside of Moscow and into other CIS countries. We also intend to continue to expand our business through
acquisitions. We intend to finance our future investments primarily through net cash flows from operations and the
incurrence of additional indebtedness. The availability of financing is influenced by many factors, including our
profitability, operating cash flows, debt levels, contractual restrictions and market conditions. For the year ended
December 31, 2005 our financing activities generated positive cash flows following the receipt of proceeds from our
initial public offering in February 2005 and increase of borrowings needed to finance our investing activities.
96 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
Consolidated Financial Statements
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Liquidity
As of December 31, 2005 and December 31, 2004, we had total cash and cash equivalents of $482.6 million and
$503.7 million, respectively. In addition, as of December 31, 2005 and December 31, 2004, we had short-term invest-
ments of $594.2 million and $202.6 million, respectively, mostly in corporate and municipal bonds and bank deposits.
For details of external financing refer to Notes 21, 22 and 23 to our audited consolidated financial statements.
For subsequent events related to our external financing, refer to Note 32 to our audited consolidated financial
statements.
Because most of our operating subsidiaries are incorporated in Russia, their ability to pay dividends to us is lim-
ited by provisions of Russian law. For example, Russian law requires that, among other things, dividends can only
be paid in an amount not exceeding net profits as determined under Russian accounting standards. In addition,
dividends may only be paid if the value of the company’s net assets is not less than the sum of the company’s
charter capital, the company’s reserve fund and the difference between the liquidation value and the par value
of the issued and outstanding preferred stock of the company, if any, as determined under Russian accounting
standards.
In August 2005, the Board of Directors of JSFC Sistema approved its dividend policy, which describes recommen-
dations on the size of dividends as well as JSFC, Sistema’s obligations on dividend payments and relevant dis-
closures. The policy determines the recommended dividend rate at 2% of our consolidated net income.
In May 2006, MTS’s Board of Directors recommended to the shareholders to approve cash dividends of RUR 7.6
(equivalent of $0.28 as of the announcement date) per share for the year ended December 31, 2005, for the total
of approximately $562.0 million, which is to be approved by the Shareholders’ meeting of MTS. This is an increase
by 39.6% from $402.6 million announced and paid for the year ended December 31, 2004.
Competition
We operate in some of the most competitive industries in Russia, including telecommunications, technology,
insurance and banking. Our businesses confront aggressive pricing practices, evolving customer demand patterns
and changing technologies.
For example, in the Telecommunications Segment, our wireless business is subject to increasing competition from
a number of existing and emerging companies, resulting in pricing pressures and lower margins. We compete with
at least one other mobile cellular operator in each of our markets. The competition has evolved in recent years
to exist primarily between MTS, VimpelCom and MegaFon, each of which has effective national coverage in
Russia. Competition is based largely on local tariff prices and secondarily on network coverage and quality, the
level of customer service provided, roaming and international tariffs and the range of services offered.
We compete with a number of alternative fixed-line operators servicing Moscow, Saint-Petersburg and other com-
mercial centers. Intensifying competition in Moscow’s alternative carrier market has resulted in increasing pres-
sure on prices and profitability for all operators. Smaller companies with insufficient scale and limited resources
are focusing on niche segments of the market while large players act as market consolidators. As a result, the
alternative carrier market is presently dominated by two large operators: the companies comprising Comstar-UTS
and the companies forming the Golden Telecom group.
97
Consolidated Financial Statements
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Market risks
Foreign Currency Risk The following tables show, for the periods indicated, certain information regarding the exchange rate between the
ruble and the U.S. dollar, based on data published by the Central Bank of Russia. These rates may differ from the
actual rates used in preparation of our financial statements and other financial information provided herein.
Rubles per U.S. dollarHigh Low Average(1) Period End
Year ended December 31,
2001 30.30 28.16 29.22 30.14
2002 31.86 30.14 31.39 31.78
2003 31.88 29.25 30.61 29.45
2004 29.45 27.75 28.73 27.75
2005 29.00 27.46 28.32 28.78
(1) The average of the exchange rates on the last business day of each full month during the relevant period.
The following tables show, for the periods indicated, certain information regarding the exchange rate between
the hryvnia and the U.S. dollar, based on data published by the National Bank of Ukraine. These rates may dif-
fer from the actual rates used in preparation of our financial statements and other financial information pro-
vided herein.
Hryvnias per U.S. dollarHigh Low Average(1) Period End
Year ended December 31,
2001 5.43 5.27 5.37 5.30
2002 5.33 5.30 5.33 5.33
2003 5.33 5.33 5.33 5.33
2004 5.33 5.31 5.32 5.31
2005 5.31 5.05 5.11 5.05
(1) The average of the exchange rates on the last business day of each full month during the relevant period.
Our principal exchange rate risk involves changes in the value of the ruble, hryvnia and the euro relative to the
U.S. dollar. As a result of inflation in Russia and Ukraine, we link our monetary assets and transactions, when
possible, to the U.S. dollar.
A significant part of our capital expenditures and operating and borrowing costs are either denominated in
U.S. dollars or tightly linked to the U.S. dollar exchange rate. These mostly include salaries, capital expenditures
and borrowings. In order to hedge against a significant portion of this risk, we also denominate tariffs for our
unregulated telecommunication services in Russia, which are payable in rubles, in units linked to the U.S. dollar
and require accounts to be settled at the official rate of the Russian Central Bank on the date of payment.
If the ruble or the hryvnia decline against the U.S. dollar and tariffs for our telecommunication services cannot
be maintained for competitive or other reasons, our operating margins could be adversely affected and we could
have difficulty repaying or refinancing our U.S. dollar-denominated indebtedness. Our investment in monetary
assets denominated in rubles and hryvnias is also subject to risk of loss in U.S. dollar terms. In particular, we are
unable economically to hedge the risks associated with our ruble and hryvnia bank or deposit accounts.
Generally, as the value of the ruble or the hryvnia declines, our net ruble and hryvnia monetary asset position
results in currency remeasurement losses.
98 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
Consolidated Financial Statements
_ g g / / g
A portion of our capital expenditures and operating and borrowing costs are denominated in euro. These include
capital expenditures and certain borrowings. We currently do not hedge against the risk of decline in the
U.S. dollar against the euro because settlements denominated in euros are not significant.
In December 2004, MTS entered into two variable-to-fixed interest rate swap agreements to manage its exposure
to changes in fair value of future cash flows of its variable-rate long term debt, which is caused by interest rate
fluctuations. In March and October 2005, we also purchased several short-term USD forward agreements to hedge
the fair value of its investments in ruble-denominated financial instruments. Interest rate swap is designated as
a cash flow hedge, while currency exchange forward agreements are classified as a fair value hedge. Both hedge
instruments have been effective through the year ended December 31, 2005.
Inflation and Exchange Rates The Russian economy has been characterized by high rates of inflation:
Year Inflation rate
2001 18.6%
2002 15.1%
2003 12.0%
2004 11.7%
2005 10.9%
The Ukrainian economy has been characterized by varying rates of inflation:
Year Inflation rate
2001 6.1%
2002 (0.6)%
2003 8.2%
2004 12.3%
2005 10.3%
Over the past several years, the rate of increase in the consumer price index in Russia has steadily declined, due
to conservative fiscal and monetary policies and the resulting federal budget surpluses. However, inflation
remains high in comparison to developed countries.
We link the unregulated tariffs of our telecommunications business to the U.S. dollar. While a majority of our costs
are denominated in U.S. dollars or are closely tied to the U.S. dollar, certain of our costs, including salaries and
utility costs, are sensitive to rises in the general price level in Russia. During the year ended December 31, 2004
the ruble appreciated against the U.S. dollar, both in terms of the nominal exchange rate and real appreciation,
whereas in the year ended December 31, 2005 the ruble depreciated against U.S. dollar. We would expect increas-
es in ruble-denominated costs, driven by real appreciation of the ruble to put pressure on our margins. While we
could seek to raise our prices and tariffs to compensate for such increases in costs, competitive pressures may not
permit increases that are sufficient to preserve our operating margins. Accordingly, high rates of inflation in
Russia relative to the nominal rate of devaluation could materially adversely affect our results of operations.
Interest Rate Risk We are exposed to variability in cash flow risk related to our variable interest rate debt and exposed to fair value
risk related to our fixed-rate notes. As of December 31, 2005, approximately $1,959.0 million, or 44.8% of our total
indebtedness, including capital leases, was variable interest rate debt, while $2,411.6 million, or 55.2% of our total
indebtedness, including capital leases, was fixed interest rate debt. In December 2004, we entered into two interest
rate swap agreements with respect to $250.0 million of variable-rate indebtedness. We continue to consider other
financial instruments available to us on the market to mitigate exposure to variability in the interest rates.
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Consolidated Financial Statements
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For indebtedness with variable interest rates, the table below presents principal cash flows and related weighted
average interest rates by contractual maturity dates as of December 31, 2005.
Contractual Maturity Dates as of December 31, 2005: December 31,
Currency 2006 2007
Syndicated Loan USD 280,000 180,000
HSBC Bank plc and ING BHF-BANK USD 28,960 32,274
EBRD USD 24,002 23,077
Citibank N.A., ING Bank N.V. and Raiffeisen AG USD 200,000 –
ING Bank N.V. USD 150,000 –
Deutsche Bank USD 132,000 –
Citibank International plc and ING Bank N.V. USD 6,530 13,060
Barclays Bank USD 9,680 9,558
ABN AMRO Bank USD 49,816 20,000
HSBC Bank plc, ING Bank Deutschland AG and Bayerische Landesbank USD 3,726 7,452
ABN AMRO N.V. USD 6,288 6,288
Commerzbank (Eurasia) USD – 591
Citibank USD 5,523 6,203
Commerzbank (Eurasia) USD 20,000 –
ING-Bank (Eurasia) USD 20,000 –
Dresdner Bank USD 14,000 –
West LB USD 10,400 –
Commerzbank Belgium S.A./N.V. USD 2,663 2,663
Credit Suisse USD 1,059 1,095
Vneshtorgbank USD 1,961 959
Total USD variable debt 966,608 303,220
Weighted average USD interest rate 6.2% 5.8%
ING BHF-BANK and Commerzbank AG EUR 12,334 12,334
ABN AMRO N.V. EUR 4,109 4,109
Vneshtorgbank EUR 2,967 2,967
Total EUR variable debt 19,410 19,410
Weighted average EUR interest rate 3.8% 3.8%
100 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
Consolidated Financial Statements
We would experience an additional interest expense of approximately $14.7 million in the year ended
December 31, 2006, $8.1 million in the year ended December 31, 2007, $5.9 million in the year ended December 31,
2008, $4.7 million in the year ended December 31, 2009 and $3.7 million in the year ended December 31, 2010 on
an annual basis as a result of a hypothetical increase in the LIBOR/EURIBOR by 1% over the current rate as
of December 31, 2005. The fair value of our publicly traded long-term notes as of December 31, 2005 ranged from
101.3% to 106.6% of the principal amount. At December 31, 2005, the fair value of our other debt approximated
its book value. We have not experienced significant changes in the market risks associated with our debt obliga-
tions in the table above subsequent to December 31, 2005.
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Consolidated Financial Statements
December 31,2008 2009 2010 Thereafter Total Average rate at December 31, 2005
– – – – 460,000 LIBOR +2.5% (7.2%)
32,274 32,274 32,274 106,586 264,642 LIBOR +0.3%–0.4% (5.0%–5.1%)
23,077 23,077 23,077 23,077 139,387 LIBOR +3.1% (7.8%)
– – – – 200,000 LIBOR +0.8%–2.3% (5.3%–6.8%)
– – – – 150,000 LIBOR +0.8% (5.1%)
– – – – 132,000 LIBOR +1.9% (6.6%)
13,060 13,060 13,060 52,239 111,009 LIBOR +0.3% (5.0%)
9,685 10,430 10,429 30,304 80,086 LIBOR +0.1%–0.2% (4.8%–4.9%)
– – – – 69,816 LIBOR +3.0% (7.5%)
7,452 7,452 7,452 29,804 63,338 LIBOR +0.3% (5.0%)
6,288 6,288 6,288 18,864 50,304 LIBOR +0.4%(5.1%)
– – – 33,480 34,071 LIBOR +0.4%–3.5% (5.1%–6.1%)
6,203 3,655 – – 21,584 LIBOR +1.6% (6.3%)
– – – – 20,000 LIBOR +5.0% (9.8%)
– – – – 20,000 LIBOR +2.3%–4.2% (6.8%–8.7%)
– – – – 14,000 LIBOR +1.3% (6.1%)
– – – – 10,400 LIBOR +6.8% (10.6%)
2,663 2,663 2,662 – 13,314 LIBOR +0.4% (5.1%)
1,095 1,095 1,093 7,553 12,990 LIBOR +2.8% (7.5%)
– – – – 2,920 LIBOR +4.9% (9.6%)
101,797 99,994 96,335 301,907 1,869,861
5.5% 5.5% 5.4% 5.4% 5.8%
12,334 6,166 – – 43,168 EURIBOR +0.65% (3.29%)
4,109 4,109 4,109 12,330 32,875 EURIBOR +0.35% (3.0%)
2,967 2,967 1,239 – 13,107 EURIBOR +5.0%–5.4% (7.6%–8.0%)
19,410 13,242 5,348 12,330 89,150
3.8% 3.6% 3.2% – 3.7%
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CRITICAL ACCOUNTING POLICIES Critical accounting policies are those policies that require the application of management’s most challenging,
subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that
are inherently uncertain and may change in subsequent periods. Critical accounting policies involve judgments
and uncertainties that are sufficiently sensitive to result in materially different results under different assump-
tions and conditions. We believe that our most critical accounting policies are those described below.
CONSOLIDATION OF VARIABLE INTEREST ENTITIES
In December 2003, Financial Accounting Standards Board (“FASB”) issued a revision to Interpretation No. 46,
“Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51” (“FIN 46R” or the “Interpretation”).
FIN 46R clarifies the application of Accounting Research Bulletin (“ARB”) No. 51, “Consolidated Financial
Statements”, to certain entities in which equity investors do not have the characteristics of a controlling finan-
cial interest or do not have sufficient equity at risk for the entity to finance its activities without additional sub-
ordinated financial support. FIN 46R requires the consolidation of these entities, known as variable interest enti-
ties (“VIEs”), by the primary beneficiary of the entity. The primary beneficiary is the entity, if any, that will
absorb a majority of the entity’s expected losses, receive a majority of the entity’s expected residual returns, or
both. Among other changes, the revisions of FIN 46R (a) clarified some requirements of the original FIN 46, which
had been issued in January 2003, (b) eased some implementation problems, and (c) added new scope exceptions.
Following the adoption of FIN 46R, we reevaluated the relationships with our related parties: Promtorgcenter,
Notris, Laminea, Finescort-M, Kuntsevo-Invest, Putney Assets and Mosdachtrest. Kuntsevo-Invest and
Mosdachtrest are engaged in our construction activities; Promtorgcenter, Notris, Laminea, Finescort-M and
Putney Assets possess shareholdings and provide financing through intercompany loans to our other entities.
Mosdachtrest was accounted for under equity method for the periods prior to January 1, 2004. We determined
these entities were variable interest entities and that we were their primary beneficiary. Accordingly, we con-
solidated these companies effective January 1, 2004. All intercompany balances have been eliminated in con-
solidation and the results of these VIEs have been included in the consolidated statement of operations and
statement of cash flows for the years ended December 31, 2005 and 2004. In accordance with the provisions of
FIN 46R, we recorded a charge for the cumulative effect of this accounting change of $35.5 million, net of income
tax of nil, in the year ended December 31, 2004. This charge reflects the cumulative impact to our results of oper-
ations had these VIEs been consolidated since their inception.
REVENUE RECOGNITION
Telecommunications
Telecommunications Segment earns revenues from the provision of wireless telecommunication services, local
telephone and data transmission services and usage of its local exchange networks and facilities. Revenues are
recognized on an accrual basis, when services are actually provided or title to equipment passes to the customer,
regardless of when the resulting monetary or financial flow occurs. Segment revenue sources consist of the fol-
lowing: (a) monthly subscription fees, (b) usage fees, (c) value-added telecommunication service fees, (d) roam-
ing fees charged to other operators for guest roamers utilizing our network, (e) connection fees, (f) revenues
from use of prepaid phone cards and (g) sales of handsets and accessories.
We defer initial connection fees paid by subscribers for the first time activation of network service, as well as one
time activation fees received for connection to various value-added services. These fees are recognized as rev-
enue over the estimated average subscriber life. We periodically review our estimates of the expected subscriber
relationship period.
102 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
Consolidated Financial Statements
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Technology
The Technology Segment earns revenues from (a) manufacturing and distribution of IT and telecommunication
equipment, consumer electronics and other electronic devices, and semiconductor products; (b) manufacturing
and distribution of software products; and (c) system integration services. Revenues are recognized on an accru-
al basis, when services are actually provided or title to equipment passes to the customer, regardless of when the
resulting monetary or financial flow occurs:
Revenues from manufacturing and distribution of equipment and semiconductor products are recognized when
the product has been delivered, risk of loss has passed to the buyer, collection of the resulting receivable is prob-
able, persuasive evidence of an arrangement exists, and the price to the buyer is fixed or determinable.
In those cases where we buy components from and subsequently sell the assembled devices to the same coun-
terparty, we record only the net amount retained as our revenues.
The Technology Segment’s arrangements with end users of its telecommunication and other software products
include sales of software licenses, as well as installation, training and postcontract support services. These
arrangements are accounted for in accordance with the Statement of Position (“SOP”) No. 97-2, “Software
Revenue Recognition”. The aggregate arrangement fee is allocated to each of the undelivered elements in an
amount equal to its fair value with the residual of the arrangement fee allocated to the delivered elements. Fair
values are based upon vendor-specific objective evidence.
During the years ended December 31, 2005 and 2004, we did not sell installation, training or postcontract sup-
port services, as well as upgrades or enhancements to existing software products, separately from other elements
of our software arrangements. The vendor-specific objective evidence of fair value of installation, training and
postcontract support services, as well as upgrades or enhancements to existing products, has been established
by management having the relevant authority. The management believes that it is probable that the established
price (based on rates per hour) for such services will not change before their separate introduction into the mar-
ketplace.
Insurance
Premiums written on non-life insurance of the Insurance Segment are recognized on a pro-rata basis over the
term of the related policy coverage, normally not exceeding 1 year. The unearned premium provision represents
that portion of premiums written relating to the unexpired term of the policy. Premiums from traditional life and
annuity policies with life contingencies are recognized as revenue when due from the policyholder.
Banking
Interest income of the Banking Segment is recognized on an accrual basis. Loans are placed on non-accrual sta-
tus when interest or principal is delinquent for a period in excess of 90 days, except when all amounts due are
fully secured by cash or marketable securities and collection proceedings are in process. Interest income is not
recognized where recovery is doubtful. Loans are written off against allowance for loan losses in the case of
uncollectibility of loans and advances, including through repossession of collateral.
Real Estate
Revenues on the construction-type contracts of the Real Estate Segment are recognized using the percentage of
completion method in accordance with AICPA Statement of Position 81-1 “Accounting for Performance of
Construction-Type and Certain Production-Type Contracts”. Progress towards completion is measured by per-
centage of costs incurred to date to the estimated total costs at completion for each contract (the “cost-to-cost”
method). We carry the projects at cost until the project is at least 30% complete, as on most of its contracts we
are not able to reliably estimate costs to complete the project and contractual revenues until the project is 30%
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Consolidated Financial Statements
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complete. We do not recognize revenues on contracts until reasonably dependable estimates of costs to complete
the project and contractual revenues can be made. Revenues on other types of contracts of the Real Estate
Segment are recognized in accordance with Statement on Financial Accounting Standards (“FAS”) No. 66,
“Accounting for Sales of Real Estate”.
Prior to January 1, 2005, we recognized revenues on construction-type contracts using the completed contract
method as reasonably dependable estimates of the extent of progress towards completion, contract revenues and
contracts costs in most cases could not be made. The change in accounting principle effective January 1, 2005
was accounted for retroactively. The effect of the change for the year ended December 31, 2004 was an increase
in sales of $22.7 million, an increase in cost of sales of $24.7 million, an increase in selling, general and admin-
istrative expenses of $0.6 million, a decrease in depreciation and amortization expenses of $2.6 million and an
increase in retained earnings of $6.2 million.
Other businesses
In arrangements where we act as an agent, including travel agency arrangements and arrangements to adminis-
ter construction projects, only the agency fee is recognized as revenue.
MANAGEMENT ESTIMATES
The preparation of our consolidated financial statements in conformity with U.S. GAAP requires management to
make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of con-
tingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and
expenses of the reporting period. Actual results could differ from those estimates.
Examples of significant estimates include the allowance for doubtful accounts, the recoverability of intangible
assets and other long-lived assets, and valuation allowances on deferred tax assets.
License Costs and Other Intangible Assets
We capitalize the cost of licenses acquired in business combinations and directly from the government. As the
telecommunication industries in Russia, Ukraine, Uzbekistan and Turkmenistan do not have sufficient experi-
ence with renewal of licenses or extensions of license terms, we amortize each license on a straight-line basis
over the term of the license commencing from the date such license becomes commercially operational. We
review these licenses and their remaining useful life and, if necessary, revise the useful lives based on our actu-
al utilization. The estimated useful lives of licenses may vary depending on market or regulatory conditions, and
any revision to the estimated useful lives may result in a write off or an increase in amortization costs.
Most of our current licenses provide for payments to be made to finance telecommunications infrastructure
improvements, which in the aggregate could total approximately $18.1 million, as of December 31, 2005.
According to the terms of licenses, such contributions are to be made during the license period upon the deci-
sion and as defined by the Board of Directors of the Association of GSM-900 Operators (the “Association”). The
Association is a nongovernmental, not-for-profit association, and their Board of Directors comprises representa-
tives of the major cellular communications companies, including MTS. The Association has not adopted any pro-
cedures enforcing such payments and no such procedures have been established by Russian legislation. To date,
MTS has not made any such payments pursuant to any of the current operating licenses issued to MTS and its
consolidated subsidiaries. Further, the management of MTS believes that MTS will not be required to make any
such payments in the future. In relation to these uncertainties, we have not recorded a contingent liability in
the accompanying consolidated financial statements.
Other intangible assets represent acquired customer base, trademarks, roaming contracts with other telecommu-
nications operators, telephone numbering capacity, rights to use premises and various purchased software costs.
Trademarks and telephone numbering capacity with unlimited contractual life are not amortized, but are
104 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
Consolidated Financial Statements
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reviewed, at least annually, for impairment in accordance with the provisions of FAS No. 142, ‘’Goodwill and Other
Intangible Assets.’’
Acquired customer base is amortized over the estimated average subscriber life. Deferred telephone numbering
capacity costs with limited contractual life and the rights to use premises are being amortized over their con-
tractual lives, which vary from five to twenty years. Software costs and other intangible assets are amortized over
three to five years. All finite-life intangible assets are amortized using the straight-line method.
Useful Lives of Property, Plant and Equipment
We calculate depreciation expense for property, plant and equipment on a straight-line basis over their estimat-
ed useful lives. We establish useful lives for each category of property, plant and equipment based on our assess-
ment of the use of the assets and anticipated technology evolution. We review and revise if appropriate the
assumptions used in the determination of useful lives of property, plant and equipment at least on an annual
basis.
Impairment of Long-Lived Assets
We periodically evaluate the recoverability of the carrying amount of our long-lived assets in accordance with
FAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”. Whenever events or changes in
circumstances indicate that the carrying amounts of those assets may not be recoverable, we compare undis-
counted net cash flows estimated to be generated by those assets to the carrying amount of those assets. When
these undiscounted cash flows are less than the carrying amounts of the assets, we record impairment losses to
write the asset down to fair value, measured by the estimated discounted net future cash flows expected to be
generated from the use of the assets.
Translation Methodology
We follow a translation policy in accordance with FAS No. 52, “Foreign Currency Translation”.
Management has determined that the functional currency of MGTS, ROSNO, Kuban-GSM, CSC, Detsky Mir, DM-
Center, Sistema Mass Media and Concern RTI is the Russian ruble. Commencing January 1, 2005, MBRD’s func-
tional currency was changed to ruble following the increased ratio of ruble-denominated transactions in the
MBRD’s operations. The functional currency of UMC is the Ukrainian hryvnia and the functional currency of
STROM telecom is the Czech krona. Management believes that USD is the appropriate functional currency for our
other subsidiaries due to the pervasive use of the U.S. dollar in their operations.
TAXATION
We are subject to a variety of taxes levied in the Russian Federation, including income taxes, payroll taxes, VAT,
property taxes and other, and our foreign subsidiaries are subject to taxation in their respective jurisdictions.
The taxation system in Russia is subject to frequent changes, varying interpretations and inconsistent enforce-
ment at the federal, regional and local levels. In some instances, new tax regulations have been given retroactive
effect, while under the Tax Code only laws benefiting the taxpayer may have retroactive effect. In addition to
our substantial tax burden, these conditions complicate our tax planning and related business decisions. For
example, tax laws are unclear with respect to the deductibility of certain expenses and at times we have taken
a position that may be considered aggressive by tax authorities, but that we consider to be in compliance with
current law. Tax declarations, together with other legal compliance areas (for example, customs and currency
control matters), are subject to review and investigation by a number of authorities, which are enabled by law to
impose extremely severe fines, penalties and interest charges. These facts create tax risks in Russia that are more
significant than those typically found in countries with more developed tax systems.
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Consolidated Financial Statements
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The new Federal Law on Communications sets the legal basis for the telecommunications business in Russia and
defines the status that state bodies have in the telecommunications sector. In addition, the law created a uni-
versal service fund (“USF”) charge, which became effective May 3, 2005, calculated as 1.2% of revenue from serv-
ices provided to customers, excluding interconnection and other operators’ traffic routing revenue. In addition,
a recent amendment to the Federal Law on Communications which is planned to become effective July 1, 2006,
will implement the “calling party pays”, or CPP, principle prohibiting mobile operators from charging their sub-
scribers for incoming calls. Generally, operators charge subscribers for incoming calls. Under the new system,
fixed-line operators will begin charging their subscribers for such calls and transfer a percentage of the charge
to mobile operators terminating such calls while mobile operators will not. The introduction of CPP may have a
negative impact on our service revenues depending on the settlement rate between mobile and fixed-line oper-
ators set by the government. While the impact of this regulatory change at this point is uncertain due to the
insufficient information made available to the market by the regulator, we believe it will not have a material
adverse effect for us.
The Russian government has also issued several implementing acts under the Law on Communications, such as
Resolution No. 87, dated February 18, 2005, approving the list of the types of licensed telecommunication activ-
ities, and Resolution No. 68, dated February 11, 2005, regarding the rules applicable to the state registration of
telecommunication infrastructure such as real property. However, it is presently not yet clear how these regula-
tions would be implemented. Thus, the uncertainty related to the Law on Communications continues.
Russia currently has a number of laws related to various taxes imposed by both federal and regional govern-
mental authorities. Applicable taxes include value added tax (“VAT”), corporate income tax (profits tax), a num-
ber of turnover-based taxes, and payroll (social) taxes, together with others. Laws related to these taxes have
not been in force for significant periods, in contrast to more developed market economies; therefore, the gov-
ernment’s implementation of these regulations is often inconsistent or nonexistent. Accordingly, few precedents
with regard to tax rulings have been established. Generally, tax declarations remain open and subject to inspec-
tion for a period of three years following the tax year. As of December 31, 2005, our tax declarations for the pre-
ceding three fiscal years were open to further review.
In the ordinary course of business, we may be party to various legal and tax proceedings, and subject to claims,
certain of which relate to the developing markets and evolving fiscal and regulatory environments in which we
operate. We consider that our liability, if any, in all pending litigation, other legal proceeding or other matters
will not have a material effect upon our financial condition, results of operations or liquidity. We have ade-
quately provided for tax liabilities in our financial statements; however, the risk remains that the authorities
could take a different position with regard to interpretive issues.
Income Taxes
Income taxes of our Russian entities have been computed in accordance with RF laws. Income tax rate in the RF
equals 24%. In July 2004, amendments to Russian income tax legislation were enacted to increase, effective
January 1, 2005, the income tax rate on dividends paid within Russia to 9% (previously 6%). Our foreign sub-
sidiaries are paying income taxes in their jurisdictions. Income tax rates in the Ukraine and in the Czech
Republic equal 25% and 26%, respectively.
Deferred income taxes are accounted for under the liability method and reflect the tax effect of all significant
temporary differences between the tax bases of assets and liabilities and their reported amounts in the accom-
panying consolidated financial statements. A valuation allowance is provided for deferred tax assets if it is more
likely than not that these items will either expire before we will be able to realize the benefit, or the future
deductibility is uncertain.
106 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
Consolidated Financial Statements
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Value-added Tax
Value-added taxes related to sales are payable to the tax authorities on an accrual basis based upon invoices
issued to the customer. VAT incurred for purchases may be reclaimed, subject to certain restrictions, against VAT
related to sales. VAT related to purchase transactions that are not reclaimable as of the balance sheet dates are
recorded as VAT receivable in the accompanying financial statements. During the years ended December 31, 2005
and 2004 the VAT rate in Russia was 18%.
New Accounting Pronouncements
In September 2004, the SEC staff issued the EITF Topic D-108, “Use of the Residual Method to Value Acquired
Assets Other Than Goodwill”, which requires the companies to use the direct value method to determine the fair
value of the intangible assets acquired in business combinations completed after September 29, 2004. The SEC
staff also announced that companies that currently apply the residual value approach for valuing intangible
assets with indefinite useful lives for purposes of impairment testing must use the direct value method by no
later than the beginning of their first fiscal year after December 15, 2004. The adoption of the above SEC guid-
ance did not have a material impact on our financial position or results of operations.
In December 2004, the Financial Accounting Standards Board (“FASB”) issued FAS No. 123R, “Share-Based
Payment” (“FAS No. 123R”), a revision of FAS No. 123, “Accounting for Stock-Based Compensation”. FAS No. 123R
supersedes Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees” and
requires all entities to recognize compensation cost in an amount equal to the fair value of share-based payments
grant-date to employees. That cost is recognized over the period during which an employee is required to pro-
vide service in exchange for an award of equity instruments. We will adopt FAS No. 123R for the year ending
December 31, 2006. We do not expect the adoption of FAS No. 123R to have a material impact on its financial
position or results of operations.
In December 2004, the FASB issued FAS No. 153, “Exchanges of Nonmonetary Assets”, an amendment of APB
Opinion No. 29, “Accounting for Nonmonetary Transactions”. FAS No. 153 eliminates the exception from fair
value measurement for nonmonetary exchanges of similar productive assets set in the APB Opinion No. 29 and
replaces it with a general exception for exchanges that do not have commercial substance. FAS No. 153 specifies
that a nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to
change significantly as a result of the exchange. FAS No. 153 is effective prospectively for nonmonetary
exchanges occurring after June 15, 2005. The adoption of FAS No. 153 did not have a material impact on our
financial position or results of operations.
In March 2005, the FASB issued Interpretation No. 47, “Accounting for Conditional Asset Retirement
Obligations — an interpretation of FASB Statement No. 143”. This Interpretation clarifies that the term “condi-
tional asset retirement obligation” as used in FASB Statement No. 143, “Accounting for Asset Retirement
Obligations”, refers to a legal obligation to perform an asset retirement activity, in which the timing and (or)
method of settlement are conditional on a future event that may or may not be within the control of the enti-
ty. The obligation to perform the asset retirement activity is unconditional even though uncertainty exists about
the timing and (or) method of settlement. Uncertainty about the timing and (or) method of settlement of a con-
ditional asset retirement obligation should be factored into the measurement of the liability when sufficient
information exists to make a reasonable estimate of the fair value of the obligation. Interpretation No. 47 is
effective for us beginning January 1, 2006. We are currently in the process of assessing the impact of
Interpretation No. 47 on our consolidated financial position and results of operations.
In March 2005, the SEC released Staff Accounting Bulletin 107, “Share-Based Payments” (“SAB 107”). The inter-
pretations in SAB 107 express views of the SEC staff regarding the interaction between FAS No. 123R and certain
SEC rules and regulations, and provide the SEC staff’s views regarding the valuation of share-based payment
arrangements for public companies. In particular, SAB 107 provides guidance related to share-based payment
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transactions with nonemployees, the transition from nonpublic to public entity status, valuation methods
(including assumptions such as expected volatility and expected term), the accounting for certain redeemable
financial instruments issued under share-based payment arrangements, the classification of compensation
expense, non-GAAP financial measures, first-time adoption of FAS No. 123R in an interim period, capitalization
of compensation cost related to share-based payment arrangements, the accounting for income tax effects of
share-based payment arrangements upon adoption of FAS No. 123R, the modification of employee share options
prior to adoption of FAS No. 123R.
In May 2005, the FASB issued FAS No. 154, “Accounting Changes and Error Corrections”, which replaces APB
Opinion No. 20, “Accounting Changes” and FAS No. 3, “Reporting Accounting Changes in Interim Financial
Statements”. FAS No. 154 changes the requirements for the accounting and reporting of a change in accounting
principle and is applicable to all voluntary changes and to changes required by an accounting pronouncement if
such pronouncement does not specify transition provisions. FAS No. 154 requires retrospective application to the
prior periods’ financial statements of changes in accounting principle. In cases when it is impracticable to deter-
mine the period-specific or cumulative effects of an accounting change, the statement provides that the new
accounting principle should be applied as of the earliest period for which retrospective application is practica-
ble or, if impracticable to determine the effect of a change to all prior periods, prospectively from the earliest
date practicable. This Statement is effective for accounting changes and corrections of errors made in fiscal years
beginning after December 15, 2005.
In June 2005, the EITF reached a consensus on EITF Issue No. 05-6, “Determining the Amortization Period for
Leasehold Improvements”. As part of a business combination, the acquiring entity will often assume existing
lease agreements of the acquired entity and acquire the related leasehold improvements. The issues are whether
the “lease term” should be reevaluated at consummation of a purchase business combination and whether the
amortization period for acquired leasehold improvements should be reevaluated by the acquiring entity in a
business combination. The consensus reached by EITF No. 05-6 is effective for leasehold improvements that are
purchased or acquired in reporting periods beginning June 29, 2005. We do not anticipate the adoption of
EITF No. 05-6 to have a material impact on our financial position and results of operations.
In October 2005, the FASB issued FASB Staff Position (“FSP”) FAS 13-1, “Accounting for Rental Costs Incurred dur-
ing a Construction Period”. Under the provisions of FSP FAS 13-1, lessees may not capitalize rental costs incurred
on building or ground operating leases during a construction period. Instead, rental costs should be expensed on
a straight-line basis starting at the beginning of the lease term, i.e., when the lessee takes possession of or is
given control of the leased property. The provisions of FSP FAS 13-1 are effective for us for the year ending
December 31, 2006. We are currently assessing the impact of FSP FAS 13-1 on our consolidated financial position
and results of operations.
In February 2006, the FASB issued FAS No. 155, “Accounting for Certain Hybrid Financial Instruments, an amend-
ment to FAS No. 133 ‘Accounting for Derivative Instruments and Hedging activities’ and FAS No. 140 ‘Accounting
for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities”. FAS No. 155 addresses appli-
cation of FAS No. 133 to beneficial interests in securitized financial assets and permits to remeasure fair value
for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurca-
tion, requires to evaluate interests in securitized financial assets to identify interests that are freestanding
derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation,
amends FAS No. 140 to eliminate the prohibition on a qualifying special purpose entity from holding a derivative
financial instrument that pertains to a beneficial interest other than another derivative financial instrument,
and clarifies certain other derivatives classification issues. This Statement is effective for all financial instru-
ments acquired or issued after the beginning of an entity’s first fiscal year that starts after September 15, 2006,
and is not expected to have a material impact on our financial position and results of operations.
108 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
Consolidated Financial Statements
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OFF-BALANCE SHEET ARRANGEMENTS
Obligations under Guarantee Contracts
As of December 31, 2005, MTS has issued guarantees to third party banks for the loans taken by MTS-Belarus, an
equity investee, for the total amount of $9.0 million. The guarantees expire by April 2007.
MBRD guaranteed loans for several companies, including related parties, which totaled $30.5 million as of
December 31, 2005.
These guarantees would require payment by us only in the event of default on payment by the respective debtor.
Under these guaranteegХwe could be potentially liable for a maximum amount of $39.5 million in case of the
borrower’s default under the obligations. As of December 31, 2005, no event of default has occurred under any
of the guarantees issued by us.
Obligations under Derivative Contracts
In connection with MTS’ acquisition of 74% of the shares in Uzdunrobita in August 2004, it entered into put and
call option agreements with the existing shareholders of Uzdunrobita to acquire the remaining 26% of the
shares. The exercise period for the option is 48 months from the acquisition date. The put and call option agree-
ments stipulate a minimum purchase price of $37.7 million plus 5% per annum commencing from the acquisition
date. The fair value of the put option was approximately $5.9 million as of December 31, 2005.
Other Obligations
In August 2005, we entered into a binding agreement with the other shareholder of SkyLink, our affiliate, to pro-
tect the other shareholder from losses in case the joint venture does not reach certain targets in terms of cus-
tomer base, cash flows and earnings. If SkyLink does not reach certain quantitative targets by the first half
of 2007, we will have at the discretion of the other shareholder to purchase the 50% share in SkyLink for a total
cash consideration of $200.0 million, or reimburse the other shareholder in the amount determined as
$200.0 million multiplied by the percentage of deviation from the agreed quantitative targets.
109
Consolidated Financial Statements
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Tabular Disclosure of Contractual Obligations
We have various contractual obligations and commercial commitments to make future payments, including debt
agreements, lease obligations and certain committed obligations. The following table summarizes our future
obligations (including interest) under these contracts due by the periods indicated as of December 31, 2005:
January 1, January 1, January 1, January 1, January 1, January 1, Total2006– 2007– 2008– 2009– 2010– 2011–
December 31, December 31, December 31, December 31, December 31, thereafter2006 2007 2008 2009 2010
(Amounts in thousands)
Contractual obligations:
Notes payable 246,935 192,435 1,047,847 104,689 537,660 855,406 2,984,972
Bank loans 1,202,421 389,745 173,341 138,915 171,340 331,114 2,406,876
Capital lease 3,220 4,101 2,946 44 41 2 10,354
Operating leases and 85,851 40,237 30,031 24,726 17,677 64,446 262,968
services agreements
Committed investments:
Purchases of property, 388,200 – – – – – 388,200
plant and equipment
Construction contracts 62,300 – – – – – 62,300
Total 1,988,927 626,518 1,254,165 268,374 726,718 1,250,968 6,115,670
As of December 31, 2005, MTS had executed non-binding purchase agreements in the amount of approximately
$388.2 million to subsequently acquire property, plant and equipment.
In December 2003, MGTS announced its long-term investment program for the period from 2004 through 2012.
The program provides for total capital expenditures of approximately $1.6 billion during the years 2004-2012,
including for the expansion and full digitalization of the Moscow telephone network, the reconstruction of 350
local telephone stations and the installation of 4.3 million new phone numbers. We expect to finance approxi-
mately 50% of the capital expenditures under the investment program.
In July 2003, Sistema-Hals entered into an agreement with Siemens Real Estate to develop an office building in
Moscow, which will become the Siemens AG headquarters in Russia. Under this agreement Sistema-Hals is
responsible for obtaining all necessary permits, planning and overall control of the construction process. The
building is expected to be completed in 2006. The cost of the project is estimated at approximately euro 116.5
million (equivalent of $138.4 million as of December 31, 2005). Siemens will pay to Sistema-Hals euro 126.7 mil-
lion (equivalent of $150.5 million as of December 31, 2005).
Additionally, Sistema-Hals entered into construction agreements with various third party subcontractors for a
total amount of $62.3 million.
110 EFFECIENCY INNOVATION RESTRUCTURING TRANSPARENCY EXPANSION
Consolidated Financial Statements
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RECENT FINANCING ACTIVITIES
Comstar-UTS Initial Public Offering
In February 2006, Comstar-UTS completed its initial public offering of 139,000,000 newly issued shares, and in
addition, we sold 7,500,000 ordinary shares of Comstar-UTS, in the form of Global Depository Receipts (“GDRs”),
with each GDR representing 1 share of common stock. The gross proceeds from Comstar-UTS IPO amounted to
$1,060 million. Upon completion of the IPO, we repurchased Comstar-UTS’ ordinary shares from Deutsche Bank
sold earlier under a repurchase transaction.
Financing
In February 2006, Sitronics Finance S.A. issued 3-year $200.0 million notes at 99.7% of par with an annual
coupon of 7.9%. The notes are fully and unconditionally guaranteed by Concern SITRONICS.
In January 2006, MTS entered into a credit facility agreement with HSBC Bank plc. The facility allows borrowing
of up to $100.0 million. The funds received will be used for general corporate purposes. The loan bears interest
of LIBOR +0.8% per annum. An arrangement fee in the amount of $0.6 million should be paid in accordance with
the agreement. The facility should be repaid by July 2006.
In March 2006, MBRD issued $60.0 million 8.9% Loan Participation Notes to finance a subordinated loan. The
notes mature in March 2016. MBRD is required to make interest payments semi-annually in arrears in March and
September, commencing in September 2006. The notes are listed on the Luxembourg Stock Exchange.
In April 2006, MTS signed a syndicated loan facility with international financial institutions, including Bank of
Tokyo-Mitsubishi UFJ, Ltd., Bayerische Landesbank, HSBC Bank plc, ING Bank N.V., Raiffeisen Zentralbank Oster-
reich AG, Sumitomo Mitsui Banking Corporation Europe Limited. The facility allows MTS to borrow up to $1,330.0
million and is available in two tranches of $630.0 million and $700.0 million. The proceeds will be used by MTS
for general corporate purposes, including acquisitions and refinancing of existing indebtedness. The first
tranche bears interest of LIBOR+0.8% per annum and matures in April 2009. The second tranche matures in April
2011, bears interest of LIBOR +1.0% per annum within the first three years and LIBOR +1.2% per annum there-
after and is repayable in 13 equal quarterly installments, commencing in April 2008. The loan is subject to cer-
tain restrictive covenants, including, but not limited to, certain financial ratios, limitations on dispositions of
assets and limitations on transactions with associates.
111
Consolidated Financial Statements
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