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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
Form 10-K
(Mark One)
| þ | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the Fiscal Year Ended December 31, 2007
| o | TRANSITION REPORT PURSUANT TO SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission file number: 0-27423
Golden Telecom, Inc.
(Exact name of registrant as specified in its charter)
| Delaware | 51-0391303 | |
| (State of incorporation) | (I.R.S. Employer Identification No.) |
REPRESENTATION OFFICE OF GOLDEN TELESERVICES, INC.
1 Kozhevnichesky Proezd
Moscow, Russia 115114
(Address of principal executive offices)
1 Kozhevnichesky Proezd
Moscow, Russia 115114
(Address of principal executive offices)
(011-7-495) 797-9300
(Registrant’s telephone number)
(Registrant’s telephone number)
| Title of each class: | Name of each exchange on which registered: | |
| Common Stock, $0.01 par value per share | None |
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined by Rule
405 of the Securities Act. Yes þ No o
Indicate by check mark if the registrant is not required to file reports pursuant to Section
13 or Section 15(d) of the Act. Yes o No þ
Indicate by check mark whether the registrant (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation
S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of
the registrant’s knowledge, in definitive proxy or information statements incorporated by reference
in Part III of this Form 10-K or any amendment to this Form 10-K. þ
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated
filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large
accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the
Exchange Act. (Check one):
| Large accelerated filer þ | Accelerated filer o | Non-accelerated filer o (Do not check if a smaller reporting company) |
Smaller reporting company o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of
the Act). Yes o No þ
The aggregate market value of the Registrant’s voting and non-voting common equity held by
non-affiliates of the Registrant as of June 29, 2007 (the last business day of the Registrant’s
most recently completed second fiscal quarter) was $802,940,734 based upon the closing price
reported for such date on the NASDAQ Global Select Market.
The number of outstanding shares of the Registrant’s common stock, par value $0.01 per share,
was 100 as of March 14, 2008.
GOLDEN TELECOM, INC.
FORM 10-K
Year Ended December 31, 2007
FORM 10-K
Year Ended December 31, 2007
TABLE OF CONTENTS
Table of Contents
PART I
ITEM 1. Business
Introduction
We are a leading facilities-based provider of integrated telecommunication and Internet
services in major population centers throughout Russia and other countries of the Commonwealth of
Independent States (“CIS”). We offer voice, data and Internet services to corporations, operators
and consumers using our metropolitan overlay network in major cities throughout Russia, Ukraine,
Kazakhstan and Uzbekistan, and via intercity fiber optic and satellite-based networks, including
approximately 295 combined access points in Russia and other countries of the CIS. In addition, we
offer mobile services in Moscow and Moscow Region, and in the Ukrainian cities of Kiev and Odessa.
We organize our operations into four business segments, as follows:
| • | Business and Corporate Services. Using our fiber optic and satellite-based networks in and between major metropolitan areas of Russia, Ukraine and other countries of the CIS, we provide business and corporate services including voice and data services to corporate clients across all geographical markets and all industry segments, other than telecommunications operators; | ||
| • | Carrier and Operator Services. Using our fiber optic and satellite-based networks in and between major metropolitan areas of Russia, Ukraine and other countries of the CIS, we provide a range of carrier and operator services including voice and data services to foreign and Russian telecommunications and mobile operators; | ||
| • | Consumer Internet Services. Using our fiber optic and satellite-based networks, we provide Internet access to the consumer market and web content offered through a family of Internet portals throughout Russia, Ukraine, Kazakhstan, and Uzbekistan; and | ||
| • | Mobile Services. Using our mobile networks in Moscow and in Kiev and Odessa, Ukraine, we provide mobile services with value-added features, such as voicemail, roaming and messaging services on a subscription and prepaid basis. |
We intend, wherever possible, to offer all of our integrated telecommunication services under
the Golden Telecom brand, although, some services still carry local brands because of recent
acquisitions. Our dial-up Internet services are distributed under the ROL brand in Russia,
Kazakhstan and Uzbekistan and under the Svit-On-Line brand in Ukraine. In addition, we offer WiFi
services in Moscow under the Golden WiFi brand. We also offer broadband Internet access in Moscow,
St. Petersburg, Yaroslavl, Tula, Rostov-on-Don, Saratov, Orenburg, Volgograd and Kaluga under the
Corbina Telecom brand.
See “Corporate History and Development” for information on our recent merger with a subsidiary
of OAO Vimpel Communications (“VimpelCom”).
Business Section Overview
The following subsections within the Business section describe our business strategy, our
current position in the markets in which we operate, our corporate history and development,
regulatory environment, pricing, our customer base, and a detailed review of our service groups by
operating segments. Finally, we provide a summary of the principal environments in which we
operate, the telecommunications markets, the political and economic environments, and the legal,
tax and regulatory regimes in Russia and Ukraine.
Business Strategy
Our objective is to be the leading facilities-based alternative voice, data and Internet
services company in Russia and key markets in the CIS. Our strategy is focused on:
| • | Increase Market Share by Offering Bundled Data and Voice Services over an Integrated Network |
Corporate customers increasingly demand integrated telecommunications solutions from
“one-stop” providers that are able to deliver a full service offering in the geographical areas
in which these corporate customers operate. As a result, we plan to continue to develop and
combine our businesses to create a unified service platform for local access, local exchange,
domestic long distance/international long distance (“DLD/ILD”), data, Internet access and
services via turn-key solutions.
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| • | Deepening and widening of our corporate customer base in Moscow and St. Petersburg |
The corporate market in Moscow and St. Petersburg was identified as the key segment for us
a number of years ago. The solutions created and offered to large corporate clients, including
major multinational corporations and Russian businesses trading with foreign partners, helped us
to create a solid foundation which included up-to-date fiber networks, skilled technicians and a
savvy sales force as well as product capabilities and a reputation for excellent levels of
services. We expect to continue to maintain two distinctive approaches to corporate customers,
focusing on innovation, quality and customer service in the large corporate segment, and
promoting price and efficiency in the small and medium enterprises (“SME”) segment. Our business
in Moscow also benefits greatly from ongoing regional expansion of our clients who continue to
invest in operations outside of Moscow. In helping our customers to establish and expand their
presence in the regions we not only deepen our client relationships but also capture incremental
demand for communication services in Moscow.
| • | Acceleration of our regional expansion to become a national market player in both corporate and retail market segments |
Most of our clients, who run successful businesses, are expanding outside of Moscow,
establishing retail shops and outlets, bank branches, hotels, restaurants and other retail
franchises. We cooperate closely helping them to grow quickly and efficiently by providing the
same level of communication services as we do in Moscow. The infrastructure, which we deploy and
operate in the Russian regions and throughout the CIS, is technologically superior to the
existing telecom lines operated by the incumbents. Our set of licenses, including the
long-distance license, allows us to offer different products and services including corporate
data networks, local and long-distance voice services, Internet, data and call centers. Our
ability to offer the whole range of services to all types of clients throughout the country is
one of our definitive competitive advantages. We also intend to pursue consolidation
opportunities through selective acquisitions that will allow us to expand our geographical
reach, add to our service offerings and improve our market share while maintaining operational
control. We will target complementary opportunities that will enable us to achieve synergies and
economies of scale and seek regional opportunities in major cities where we do not have our own
local network infrastructure.
| • | Becoming a leading provider of broadband access in Russia and the CIS |
In order to meet the growing demand for broadband, we will construct Fiber-to-the-Building
(“FTTB”) networks in 65 cities of Russia and Ukraine with a combined population of 65 million
people of which an estimated 65% live in high rise apartment blocks (“Top-65”). The acquisition
of ZAO Cortec and its subsidiaries (together “Corbina”) was a pivotal step in our broadband
strategy. Corbina pioneered the construction of large scale metropolitan FTTB networks. We also
provide broadband access to residential customers in the fast growing Moscow broadband market
using WiFi technology.
Our Position in the Russian and CIS Markets
We believe that we are well positioned to maintain and consolidate our strong presence in the
Russian and CIS telecommunications markets for the following reasons:
| • | our early market entry and local market experience; | ||
| • | our focus on service, quality and reliability; | ||
| • | our strong infrastructure position in major cities throughout Russia, Ukraine, Kazakhstan and Uzbekistan; | ||
| • | our extensive customer base; and | ||
| • | our extensive range of integrated voice, data and Internet telecommunications services; |
Corporate History and Development
Golden Telecom, Inc., initially a majority owned subsidiary of Global TeleSystems, Inc.
(“GTS”), was incorporated in Delaware in June 1999 in preparation for our initial public offering
(“IPO”) which took place in September 1999. GTS was founded in 1983 as a not-for-profit company
under the name San Francisco/Moscow Teleport, Inc. and was among the first foreign
telecommunications operators in the former Soviet Union, where it began offering data links to the
United States (“US”) in 1986, ILD services in 1992, local access to its networks in 1994 and
cellular services in 1995. At the time of our IPO, GTS contributed substantially all of the assets
that constituted Golden Telecom, Inc.
In September 2002, we purchased the 50% of EDN Sovintel LLC (“Sovintel”) that we did not own
from OAO Rostelecom (“Rostelecom”), the Russian national long distance carrier. As a result of
this purchase, we own 100% of Sovintel. In April 2003, we merged the operations of TeleRoss, our
wholly-owned subsidiary, into Sovintel.
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In August 2003, we acquired 100% of Sibchallenge Telecom LLC (“Sibchallenge”), the leading
alternative wireline operator in Krasnoyarsk, Russia. Sibchallenge owns 100% of ZAO Tel (“Tel”),
an Internet service provider, also based in Krasnoyarsk. In August 2005, we merged the operations
of Sibchallenge, including Tel, into Sovintel.
In December 2003, we acquired 100% of OAO Comincom (“Comincom”), and its wholly-owned
subsidiary, OAO Combellga (“Combellga”), from Nye Telenor East Invest AS (“Telenor”). As part of
this transaction, we issued shares to Telenor representing 19.5% of our shares outstanding after
the acquisition. In December 2004, we merged the operations of Comincom, including Combellga, into
Sovintel.
In February 2004, we acquired 100% of ST-HOLDING s.r.o., a Czech company that owns 50% plus
one share of ZAO Samara Telecom, a telecommunications service provider in Samara, Russia, from ZAO
SMARTS and individual owners. In April 2004, we acquired 100% of OAO Balticom Mobile that owns 62%
of ZAO WestBalt Telecom, an alternative telecommunications operator in Kaliningrad, Russia. In
April 2004, we also acquired the remaining 49% ownership interest that we did not own, in
Uralrelcom LLC, which was merged into Sovintel in August 2005. In May 2004, we acquired 54% of SP
Buzton (“Buzton”), an alternative telecommunications operator in Uzbekistan.
In March 2005, we acquired 75% of Dicom LLC, an early stage wireless broadband enterprise. In
September 2005, we acquired 60% of Sakhalin Telecom LLC (“Sakhalin Telecom”), a fixed line
alternative operator in the Far East region of Russia from VimpelCom. As a result of this
acquisition and combined with our previous ownership in Sakhalin Telecom, we now own 83% of
Sakhalin Telecom. In October 2005, we acquired 100% of ZAO Sochitelecom, a fixed line alternative
operator in the Krasnodar region of Russia. In October 2005, we acquired 100% of Antel Rascom,
Ltd., a British Virgin Islands company that owns 49% of ZAO Rascom (“Rascom”), an infrastructure
and facilities company in the northwest region of Russia. In December 2005, we acquired an
additional 5% of Rascom.
In March 2006, we acquired 70% of ZAO Tatar Intellectual Communications, an Internet service
provider (“ISP”) in the Russian Republic of Tatarstan. In April 2006, we acquired 100% of TTK LLC
(“TTK”), a fixed line alternative operator in the Ivano-Frankovsk region of Ukraine. In June 2006,
we acquired 74% of Kubtelecom LLC, a fixed line alternative operator in the Krasnodar region of
Russia. In August 2006, we acquired 100% of Telcom LLC, a fixed line alternative operator in Nizhny
Novgorod, Russia. In October 2006, we acquired 75% of S-Line LLC (“S-Line”), an early-stage
wireless broadband enterprise in Kiev, Ukraine. In October 2006, we acquired 100% of ZAO Corus ISP,
an ISP in Ekaterinburg, Russia.
In February 2007, we acquired 65% of Fortland Limited (“Fortland”), which owns Kolangon-Optim
LLC (“Kolangon”), an early-stage digital video broadcast enterprise in Russia. In April 2007, we
acquired 100% ownership interest in ZAO Telecommunications Agency, a fixed line alternative
telecommunications operator in Perm. In May 2007, we acquired 100% ownership interest in ICA
Center of Commercial Real Estate LLC, which owns 6,181 square meters of a building in Moscow. In
May 2007, we acquired 51% ownership interest in Corbina. In June 2007 we acquired 100% ownership
interest in ZAO Direct Net Telecommunications and ZAO Satcom Tel, fixed line alternative
telecommunications operators in Moscow and the assets of NDNT, Inc. and NDNT (UK) Limited. In June
2007, we acquired 75% ownership interest in Alcar LLC, an early-stage WiFi enterprise in Russia.
In August 2007, we acquired 75% ownership interest in Satel Tsentr LLC, an early stage WiFi
enterprise in the Moscow region of Russia. In August and September 2007, we acquired remaining 50%
ownership interest of eight fixed line alternative telecommunications operators in various regions
of Russia. In December 2007, we acquired 100% ownership interest in New Telecom Technologies LLC,
a channel rent service provider in Krasnodar, Russia. In December 2007, we acquired 100% ownership
interest in ZAO Bryansktel and BryanskIntel LLC which together form Group BryanskTel, leading
alternative communication carrier in Bryansk, Russia. In December 2007, we acquired 100% ownership
interest in Skat-7 LLC, a fixed line alternative operator, in Cherepovets, Russia.
On December 21, 2007, we entered into an Agreement and Plan of Merger with VimpelCom Finance
B.V. (“Parent”) and Lillian Acquisition, Inc. (“Merger Sub”). Merger Sub commenced a tender offer
to purchase, at a price of $105.00 per share in cash without interest (and less any amounts
required to be deducted and withheld under any applicable law), any and all outstanding shares of
our common stock, par value $0.01 per share on the terms and subject to the conditions specified in
the offer to purchase dated January 18, 2008, as amended and related letter of transmittal (which,
together with any supplements or amendments thereto, collectively constitute the “Offer”). The
Offer closed on February 27, 2008 and we became a majority owned subsidiary of Merger Sub.
On February 28, 2008, together with Merger Sub, we filed a Certificate of Ownership and Merger
pursuant to which the Merger Sub was merged with and into us (the “Merger”). As a result of the
Merger, we will continue as the surviving corporation and will be a direct wholly owned subsidiary
of Parent and an indirect wholly owned subsidiary of VimpelCom.
As a result of the Merger, we no longer fulfill the numerical listing requirements of the
NASDAQ Global Select Market (“NASDAQ”). Accordingly, on February 28, 2008 we requested NASDAQ to
file with the United States Securities and Exchange Commission (“SEC”) a Notification of Removal
from Listing and/or Registration under Section 12(b) of the Exchange Act on Form 25. Pursuant to
Rule 12d2-2 under the Exchange Act, the delisting of our common shares from NASDAQ was effective on
March 10, 2008 and our reporting obligations under Section 12(b) of the Exchange Act were suspended
as of that date. Trading of our Common
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Stock on NASDAQ ceased as of the close of trading on February 28, 2008. Our Common Stock will be
deregistered under Section 12(b) of the Exchange Act no later than ninety days after the date of
the Form 25. We also intend to file with the SEC a Certification on Form 15 under the Exchange Act
to suspend our remaining reporting obligations under the Exchange Act.
Regulatory Environment
Russia
On January 1, 2004, a new Law on Communications (the “Telecommunications Law”) came into
effect in Russia. The Russian government approved in March 2005 new rules for interconnection (the
“Interconnection Rules”) that became effective on January 1, 2006. These Interconnection Rules
contemplate a three-layer interconnection system consisting of DLD/ILD, zonal, and local operators.
Under this structure, end-users have the right to choose a long distance operator, and DLD/ILD
operators will be required to have interconnection points in each of the 88 constituent territories
of the Russian Federation. In addition, the Telecommunications Law created a universal service
fund (“USF”) charge, which became effective on May 3, 2005, calculated as 1.2% of revenue from
telecommunication services provided to end users. We have incurred approximately $7.0 million in
USF charges for the year ended December 31, 2007. On December 29, 2006, the Russian President approved
amendments to the Telecommunications Law setting forth essential criteria of the USF charge. These
amendments became effective on January 1, 2007.
On May 31, 2005, we received a DLD/ILD license in Russia which is valid until May 31, 2012.
We were required under the license to begin providing services and fulfill the network requirements
specified in the Interconnection Rules not later than May 31, 2007. On January 16, 2006, we
announced that the construction of our Federal Transit Network (“FTN”) was complete in compliance
with the Telecommunications Law and our DLD/ILD license. The FTN consists of four international
communications transit nodes, seven intercity communications transit nodes deployed in each federal
district of Russia, and 88 connection points or FTN access nodes located in each constituent
territory of Russia. We have obtained the required governmental permissions for operation of all
the international and intercity communications transit nodes that are part of the FTN. On April
28, 2006, all of the 88 connection points were formally commissioned by Rossvyaznadzor, a
governmental body that reports to the Ministry of Information Technologies and Communications of
the Russian Federation (the “Russian Ministry of Telecommunications”) that is responsible for the
control and the supervision of information technology and communications as well as for
commissioning the long distance networks. In March 2007, Russian President Putin signed an order,
with an immediate effect, to merge Rossvyaznadzor with Rosokhrankultura, a body which protects
culture and supervises media issues. On June 29, 2006, we announced that we entered into
interconnection agreements with all Russian zonal incumbent fixed line telecommunications
operators. On December 15, 2006, the Russian Ministry of Telecommunications granted us access codes
to operate our FTN. On January 29, 2007, we launched DLD/ILD services using our FTN.
To minimize the impact of payments to the incumbent operators, we received licenses to provide
zonal services in all the regions of the Russian Federation. During 2006 and 2007, we started
construction of zonal networks in 28 regions of the Russian Federation. To date, we have completed
construction of zonal networks in 25 Russian regions. However, in those regions where we have not
completed construction of zonal networks, we will be required to act as an agent for zonal
carriers, billing clients for intra-zonal calls and collecting payments on behalf of the zonal
operators.
On March 4, 2006, the Russian President approved amendments to the Telecommunications Law that
introduced calling party pays rules (“CPP Rules”). Effective July 1, 2006, under the CPP Rules,
generally all incoming calls, on fixed and mobile lines, in Russia are free of charge, and only the
fixed line or mobile operators originating the call may charge the customer for the call.
Subscribers of fixed line telephones did not pay for incoming calls and, therefore, the CPP Rules
will not have an impact on fixed-to-fixed line calls, but the CPP Rules impact the fixed-to-mobile
calls as mobile companies traditionally charged for incoming calls in Russia.
On September 26, 2007, the Russian Ministry of Telecommunications issued an order that
designated an additional 10 pairs of access codes which may be assigned to long-distance operators.
This potentially creates conditions for increased competition in the market for domestic and
international long-distance services if new access codes are assigned to new operators.
On October 12, 2007, the Government of the Russian Federation approved amendments to the
existing interconnection rules. Under the new rules, mobile operators can transmit all incoming
calls to direct mobile numbers from the local fixed line networks through their own zonal networks.
Furthermore, the service of interconnection point is no longer considered part of the services of
interconnection and therefore will not be charged.
Ukraine
In April 2006, the National Commission of Communication’s Regulation (“NCCR”) issued a license
for GSM-1800 radio frequency to Golden Telecom (Ukraine) (“GTU”), our subsidiary in Ukraine.
Currently, GTU provides services in Kiev and Odessa. The new license enables GTU to offer mobile
services in 22 out of the remaining 25 regions of Ukraine that GTU does not currently cover.
Payment of the $5.5 million license fee was made on May 10, 2006. In May 2006, we began using the
frequencies and
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submitted registration documents to UkrChastotNadzor, a Ukrainian governmental body that is
responsible for the control and the supervision of the radio frequencies. To date, we have complied
with the license requirements related to the use of allocated radio frequencies by launching
operations in 16 out of 22 regions.
Effective July 15, 2006, the NCCR introduced new tariffs for provision of voice services to
fixed line subscribers. As a result of the tariff re-balancing policy, the tariffs for local calls
and monthly fees increased and tariffs for DLD/ILD calls decreased. Effective November 1, 2006, the
NCCR continued the tariff re-balancing process by increasing the tariffs for local calls and
monthly fees and by decreasing the tariffs for fixed-to-mobile calls. On October 28, 2006, the
Verkhovna Rada approved the amendments to the Ukrainian Law on Telecommunications which changed the
list of the telecommunication service tariffs subject to the public regulation. Under new
regulation, tariffs for DLD/ILD calls were excluded from the public regulation. The amendments also
exclude fixed-to-mobile calls from the public tariff regulation. As a result of these changes, we
expect increased competition from the incumbent operators in DLD/ILD services market.
Effective January 1, 2007, the NCCR introduced new interconnection settlement rules. During
2006, we paid fixed monthly fees for interconnection lines with other operators. However, under the
new rules the settlements will be based on the actual volume of traffic. As a result of these
changes, cost of revenue of our local voice services increased, however, this negative variance is
partially offset by additional revenue stream for the traffic termination to our network.
Customer Base
We compete primarily for high-volume business customers and carriers who require access to
highly reliable and advanced telecommunications facilities to operate their business. Together,
our top five customers accounted for approximately 9% of our consolidated revenues for the year
ended December 31, 2007. No customer accounted for over 5% of our consolidated revenues for the
year ended December 31, 2007. Our largest customer, VimpelCom, accounted for approximately 4% of
our consolidated revenues for the year ended December 31, 2007.
Our principal customer segments are:
Corporate Network Customers. Corporate network customers are typically large multinational,
Russian or Ukrainian companies which require the full range of voice, data and Internet services in
several cities across Russia, Ukraine and other countries of the CIS. While pricing is always a
factor, this segment places more value on network coverage, reliability as defined by service level
agreements, and the ability to design, install and maintain local area networks (“LAN”) and wide
area networks (“WAN”). These customers are willing to make longer-term commitments to integrated
one-stop providers in exchange for higher levels of service.
Corporate End-Users. Corporate end-users are foreign and Russian enterprises with centralized
operations, either in Moscow, Kiev or in the regions. These corporate end-users also require a full
range of voice, data and Internet services, but are more likely to purchase distinct services from
separate suppliers based on price. We attempt to increase business with corporate end users by
providing superior technology and service levels at competitive prices.
Small and Medium Enterprises. We define small and medium enterprises as those business
customers that require a full range of voice, data and Internet services and generally have monthly
billings of less than $2,000.
Fixed-Line Operators. Fixed-line operators are other telecommunications providers, including
other overlay operators operating in Moscow, alternative regional fixed-line operators and local
operators, which we refer to as the local telcos. Price is the primary factor in their purchase
decision, and although long-term contracts are rare, traffic volumes can be large. Voice telephony
is a commodity for customers in this segment.
Cellular Operators. Russian cellular operators purchase large quantities of local numbering
capacity in Moscow that they use in selling cellular services to their customers. Ukrainian
cellular operators distribute large volumes of international and intercity traffic through our
network in Ukraine. Price, availability and quality of service are primary factors in the purchase
decision of these customers.
Mass Market. We define the mass market as households or, in some cases, more narrowly, as
those customers who utilize calling cards or dial-up Internet access. This market segment is
price-sensitive, but quality of service is also important, particularly in the Internet access
market. These customers predominately prepay for such services. In Kiev and Odessa, Ukraine, we
also offer mobile services to the mass market, targeting individuals with above average disposable
income, where price and quality are also primary decision factors.
Our FTN and receipt of access codes will also present new opportunities for growth. Our FTN
provides us with a potential customer base across all geographic zones in the Russian Federation of
up to 2.2 million businesses, 143 million people, of which there are 32 million residential
customers, in the 88 Russian regions. This is an increase from our previous breadth of coverage
which
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only allowed us to reach 25 regions in Russia with up to 0.3 million businesses and a
population of 77.1 million people. With the FTN, we will be able to offer our wide range of
telecommunications services, including DLD/ILD telecommunications services, to every person and all
businesses across Russia’s eleven time zones.
Pricing
Historically, our customers made payments to us in the appropriate local currency, however the
majority of our tariffs were denominated in United States dollars (“USD”) and were indexed to the
USD for settlement purposes. Also, the majority of our operating costs were denominated in USD, but
settled in the appropriate local currency. However, in the second and the third quarters of 2006,
our main operating subsidiary, Sovintel, introduced semi-fixed USD — Russian Rubles (“RUR”)
exchange rate for settlements with the majority of its customers. This rate is effective only if
the official USD exchange rate set by the Central Bank of Russia (“CBR”) is below the fixed level.
If the RUR depreciates against USD so that the CBR exchange rate exceeds the fixed level, Sovintel
will resume applying the CBR exchange rate, or floating rate, for settlements with its customers.
Our Service Groups
This section provides a detailed review of our business on a segment basis and by operating
division. We provide additional information on the services and customers, marketing and pricing,
and competition within each division.
Business and Corporate Services (“BCS”)
BCS Services in Russia
We operate a number of competitive local exchange carriers (“CLECs”) that own and operate
fully-digital overlay networks in a number of major Russian cities. The majority of our services
are provided through our wholly-owned Moscow-based subsidiary Sovintel. We are an integrated
provider of the largest range of telecommunication services available on the Russian market,
including network access and hardware and software solutions including installation, configuration
and maintenance. Our geographical coverage includes all major population centers including Moscow,
St. Petersburg, Nizhny Novgorod, Khabarovsk, Arkhangelsk, Ufa, Vladivostok, Irkutsk, Kaliningrad,
Ekaterinburg, Voronezh, Krasnodar, Tyumen, Volgograd, Samara, Tula, and Krasnoyarsk.
Services and Customers
Local Access Services. Local access services are provided to business customers through the
connection of the customers’ premises to our fiber network, which interconnects to the local public
switched telephone network (“PSTN”) in Moscow, St. Petersburg, Nizhny Novgorod, Khabarovsk, Ufa,
Vladivostok, Novosibirsk, Irkutsk, Kaliningrad, Ekaterinburg, Voronezh, Krasnodar and Krasnoyarsk.
International and Domestic Long Distance Services We provide ILD services to our customers via
our FTN network comprising our own international toll exchanges in European and Asian part of the
Russian Federation in full compliance with regulatory requirements towards networks
interconnection.
DLD services are primarily provided through our federal intercity transmission network,
proprietary and leased capacity between major Russian cities, and through interconnection with
zonal networks and networks of Rostelecom in compliance with state regulation on the
interconnection of telecommunications networks. We offer very small aperture terminal (“VSAT”)
satellite services to customers located in remote areas that cannot be physically connected through
terrestrial cables to our regional long distance switches, as well as to large infrastructure
projects in need of sophisticated and reliable communications systems.
Dedicated Internet and Data Services. We provide our business customers with dedicated access
to the global Internet through our access and backbone networks. We also offer traditional and
high-speed data communications services to business customers who require WAN to link computer
networks in geographically dispersed offices, using frame relay, X.25, asynchronous transfer mode
and Internet protocol technologies. We also provide private line channels to customers who require
high-capacity and high-quality domestic and international point-to-point connections. Private lines
can be used for both voice and data applications.
Integrated Voice and Data Services. The markets where we operate are experiencing a continuing
trend toward routing voice traffic over the Internet using Internet Protocol (“IP”) technology,
known as “Voice over IP” or “VoIP”. We are a leading provider of this service. In addition to using
data networking services for typical LAN to LAN interconnections, many customers will also route
their voice traffic over our frame relay data network to reduce overall telecommunications
expenses. Voice over frame relay involves “packetizing” voice calls using frame relay, a data
transmission protocol, and transporting the voice call over our data network to be “de-packetized”
at the terminating end. The call is finally terminated through normal circuit switching. Packet
switching offers greater cost efficiencies over circuit switching, and offers this division an
opportunity to leverage its data network investment across a greater number of services and
geographic areas. This type of integrated communication solution is also offered by Integrated
Services
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Digital Network (“ISDN”) products where basic services include telephony, fax, data
transmission, Internet access, and video conferencing.
Value-Added Services. We offer an increasing range of value-added services such as dedicated
hosting, co-location and IP, or IP-based Virtual Private Networks (“VPNs”) and we intend to
increase our market position in these services. Our Managed Data Center, which consists of a total
area of 600 square meters, continues to be the leading hosting center in Russia and provides
services to news agencies, financial and entertainment services providers. We enjoy strong sales
synergies between our Managed Data Center products and our IP transit sales efforts. We offer a
variety of information services addressing the needs of financial markets including access to
S.W.I.F.T., Reuters, Bloomberg and MICEX, or the Moscow Inter-bank Currency Exchange. We also have
a Moscow-based Call Center that has a leading position in providing telemarketing, actualization
and Hot Line services for business clients. We offer fixed-to-mobile convergence services in
conjunction with VimpelCom to corporate clients that wish to use their mobile phone as an extension
of their private branch exchange (“PBX”).
Equipment Sales. As part of our integrated service offering, we sell equipment manufactured by
Nortel Networks, Cisco Systems, Alcatel, Siemens, Avaya, Motorola and Ericsson. As part of our
turnkey solutions, we also offer the installation, configuration and maintenance of Nortel Meridian
One products, Norstar key systems, Mercator PBXs and the Passport lines of data equipment. This
close customer contact assists in the marketing of additional services and enhances customer
retention.
Major customers range from large multinational and Russian corporate groups to Russian SMEs
and residential users. Our business customers cover all industry segments including business
centers, hotels, financial institutions, professional services firms, fast moving consumer goods
companies, manufacturers and companies involved in extractive industries. Our customers are located
in all major cities throughout Russia.
Marketing and Pricing
For Sovintel, sales to customers are made through a direct sales force consisting of
approximately 148 account managers in Moscow. Each account manager targets specific customer groups
and industry segments and is supported by specialists in technical sales support, marketing,
customer service and end-user training.
In addition, a team of regional sales managers is responsible for supporting the regional
sales force and maintaining relations with our regional partners. We have a dedicated sales force
in each of our regional branch offices and for other regional cities we have sales incentive plans
with our regional partners.
We train our employees to provide customer service at a level which is comparable to or better
than that provided by Western telecommunications companies. As a result, we believe we have earned
a reputation for providing high-quality telecommunications services through an experienced and
professional customer service staff.
We price our services at a premium compared to those offered by the incumbent local operator
and competitively with other alternative service providers within the market. We offer volume
discounts to customers for exceeding certain defined revenue thresholds. Although we publish
standard tariffs, generally we are not required to obtain regulatory approval to change tariffs.
While pricing competition remains a factor, especially for voice services, many corporate data
networking customers place more value on network coverage, reliability and our ability to design,
install and maintain LANs and WANs. These customers often require integrated solutions, including
connections to offices located in different cities. Depending on the cities involved, there are
often few operators that can provide these services, and accordingly, there is often less pricing
pressure.
Competition
We compete principally on the basis of installation time, network quality, geographical
network reach, customer service, range of services offered and price. While we have a leading
position in this market, we face significant competition from other service providers, including:
| • | Comstar-UTS, a subsidiary of Sistema Telecom, including Moscow City Telephone Network (“MGTS”) for all services provided to corporate customers and the SME market in Moscow; | ||
| • | Equant, trading as Orange Business Services, a subsidiary of France Telecom, for corporate data networking services across Russia; | ||
| • | TransTelecom, currently owned by the Russian Railways, for corporate data networking services across Russia; | ||
| • | Peterstar, an affiliate of Telecominvest, for services provided in St. Petersburg; and |
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| • | Regional subsidiaries of Svyazinvest, a holding group with a majority government ownership, for services provided in St. Petersburg and within Russian regional cities. |
BCS Services in Ukraine
The BCS division of GTU, our mainly Kiev-based CLEC, has constructed and owns a 3,303
kilometer fiber optic network, including 800 kilometers in Kiev, which is interconnected to the
local PSTN in Kiev, to other major metropolitan areas in Ukraine, and to our international gateway.
Data and Internet access services are provided in 183 regional access points in 35 metropolitan
cities in Ukraine using leased terrestrial capacity from Ukrtelecom, the Ukrainian incumbent
operator, and from some alternative providers.
Since the opening of our mobile service operation in Odessa in 2001, we have expanded our
local access service offerings into Odessa, targeting business clients. In the third quarter of
2002, we started offering local access and pre-paid VoIP services in Dnepropetrovsk. Further,
following our regional development strategy, in the second quarter of 2003 we started offering
local access, VoIP and dial-up Internet services in Lviv, and in the second quarter of 2004 we
launched the same service offering in Zaporozhe. The next step of our regional development was the
launch of local access, VoIP and broadband and dial-up Internet services offer in Kharkov in June
2005. During 2006, we launched local access and broadband Internet services in Donetsk and
Ivano-Frankovsk, through the acquisition of TTK. In 2007, we started the deployment and development
of the fixed-mobile convergent (“FMC”) services in Kiev and Odessa.
In the second quarter of 2003, GTU constructed a Metropolitan Area Network (“MAN”) in Kiev
providing a new range of services, including broadband access to Internet and VPN service. In the
fourth quarter of 2004, GTU deployed a MAN in Odessa. In the first quarter of 2004, GTU launched an
IP node in Kiev providing interconnection with international operators via the public Internet and
the possibility to offer new services such as VoIP, VPN and IP phones. During 2005 and 2006, GTU
completed construction of a fully protected international backbone network from Kiev to its points
of presence in Frankfurt, Germany, via three independent border-crossings with Poland and Hungary.
During 2006, we upgraded our nationwide backbone network by installing STM-16 capacity from the
Western part of Ukraine to Kiev via Lviv, Lutsk, Rovno, Zhitomir, and synchronous digital hierarchy
(“SDH”) capacity to the eastern part of Ukraine from Kiev to Kharkov via Chernigov and Sumy. We
have also expanded our leased capacity to Dnepropetrovsk, Donetsk, Odessa, and Zaporozhe and
upgraded it to STM-1 level.
During 2005, in order to expand market penetration and to increase utilization of technical
infrastructure in Ukraine, GTU began to provide wire line local access and broadband Internet
services to residential customers in Kiev. In addition, during 2006, as part of our strategy for
broadband Internet development, GTU launched its FTTB project in Kiev.
As of December 31, 2007, the BCS division of GTU serviced approximately 83,300 telephone lines
for businesses, and connected approximately 26,800 residential
telephone lines, and serviced
approximately 8,500 Internet ports for businesses and had approximately 10,000 residential
broadband Internet ports.
Services and Customers
Local Access Services. Local access services are provided to business customers through the
connection of their premises to GTU’s fiber optic network, which interconnects to the local PSTN in
Kiev, Odessa, Dnepropetrovsk, Lviv, Kharkov, Zaporozhe, Donetsk and 5 other major Ukrainian cities.
International and Domestic Long Distance Services. GTU provides outgoing international voice
services to business customers through its international gateway and direct interconnections with
major international carriers, transmitting traffic to international operators using least-cost
routing. DLD services are primarily provided through our own intercity transmission network,
leased capacity between major Ukrainian cities, and through interconnection with Ukrtelecom’s
network. On September 20, 2005, the NCCR in Ukraine issued an international license (the “Ukrainian
International License”) to GTU. The Ukrainian International License enables GTU to provide
international telecommunications services throughout the entire territory of Ukraine and to lease
the transmission channels to third parties, thereby increasing GTU’s potential as an international
telecommunications carrier.
Dedicated Internet and Data Services. GTU provides a private line service, VPN services, an
integrated voice and data ISDN connection, frame relay, broadband digital subscriber line, and
dedicated Internet services. In 2007, GTU’s main focus was the development of broadband access to
VPN and dedicated Internet services over fiber optic network, required by customers with
high-volume data traffic needs.
Voice over Data Services. GTU is a leading provider of voice over data services in Ukraine.
Our pre-paid cards and VoIP products introduced under the brand “Allo!” held the leading position
in the market with a market share of approximately 50% in Kiev, providing an alternative
international calling solution for corporate and mass market customers. This service is in
stagnation due to the general decrease in ILD tariffs of PSTN and mobile operators.
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Information Services. GTU provides telecommunications services to financial and banking
companies such as S.W.I.F.T. and Western Union, access to processing centers, news services to
companies such as Reuters, as well as conduits to airline reservation systems in Ukraine. We have
been chosen as one of two exclusive last mile providers for Reuter’s services in Ukraine. Our data
center provides server co-location and hosting services for news agencies, financial and
entertainment services providers.
Call Center Services. With the launching of Call Center services at the end of 2002, GTU
captured the leading position in providing telemarketing, actualization and hot line services for
business clients in Kiev.
Residential Telecommunications Services. In December 2004, GTU developed unified telephone and
Internet broadband access services for residential customers. GTU implemented structural changes
that will allow us to serve this market segment in the most effective way. The FTTB project
provides GTU with additional opportunities to gain new customers. By the end of 2007, GTU had
launched 100Mbit/s Internet access service under the well recognized Internet brand Svit-On-Line.
A number of new services, such as VoIP, and other service improvements are expected in 2008.
FMC Services. During 2007, we started the testing and deployment of an FMC platform based on
Huawei solutions. In 2008, GTU expects to launch FMC services.
GTU’s BCS division customers primarily consist of corporate network customers, corporate
end-users, SMEs and high-end residential customers. Pre-paid VoIP and dial-up Internet services are
also offered to the mass market.
Marketing and Pricing
While emphasizing the high customer service quality and reliability of its services for
corporate customers, GTU focuses on the development of its SME and mass market offerings. Sales to
our corporate customers are made through our direct sales force and through various alternative
distribution channels such as sales through agent network. SME and mass market service offerings
are mainly conducted indirectly through alternative distribution channels such as agent networks.
During
2007, GTU introduced different pricing policies for each market segments; customized
pricing model for corporate customers and standardized pricing for SME and mass markets.
Competition
In Kiev, in the voice services market to business end-users, GTU traditionally competes with
Ukrtelecom, multiregional alternative operators of System Capital Management (“SCM”) telecom assets
group, such as Optima, Farlep, and a number of other small operators. During 2007, the competitive
pressure increased as a result of the aggressive marketing policies of Datagroup and Ukrtelecom.
However, we believe that our main advantages: early market entry, clear market
focus and the ability to provide outstanding customer service combined with individual solutions and
integrated voice, data and Internet services, we will be able to
maintain the leading position on the
high-end segments of the corporate market.
The provision of Internet and data services is not licensed in Ukraine. As a result, there is
a high level of competition in the market with approximately 400 Internet Service Provider’s
(“ISPs”) in Ukraine, although consolidation through acquisitions has been observed in the market in
recent years. The main competitors in the corporate market for corporate data are Ukrtelecom, a
majority state-owned operator, and Datagroup, a data and integration services provider. We seek to
be competitive in the corporate networks market by providing excellent geographical coverage, wide
bandwidth, high quality circuits and professional service. GTU maintains its competitiveness in the
Internet market by focusing on a strategy to provide the best value and quality Internet services
for businesses and developing exclusive consumer Internet content.
In the fast growing residential broadband Internet market, we face competition from Ukrtelecom
and Volya-Cable, a cable television provider in Kiev. However, we expect that innovative
technologies, development of FTTB network and exclusive consumer Internet content for the SME and
residential market segments will enable us to support constant growth of our market share in these
market segments.
In addition, we plan to substantially improve the accessibility of our services, market
coverage and attractiveness of our offerings for the customers by FTTB network deployment in
Kharkov, Odessa, Zaporozhe, Lviv, Donetsk and Dnepropetrovsk.
Carrier and Operator Services
Carrier and Operator Services in Russia
The Carrier and Operator Services division in Russia provides a range of carrier and operator
services including voice and data transmission services to foreign and Russian telecommunications
and mobile operators.
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For international telecommunications voice operators, we are an alternative to the incumbent
for the completion of calls terminating in Russia and the CIS and extensions of global private
networks employing leased circuits in the country. For domestic telecommunications voice
operators, we provide termination to Russian and CIS destinations, offer international call
termination and telephone numbers, or subscriber ports. Furthermore, we offer interconnection and
data services, including numbering capacity and IP-centric solutions. Due to the geographic reach
of our network, presence on the local and zonal level in a large number of regions, high volume of
traffic and smart traffic routing, we have a lower cost base than many of our competitors and can
therefore resell any excess transit and termination capacity. During 2007, Russia continued to
show rapid expansion of the mobile networks into the regions including the less developed parts of
northern Russia and Siberia. To capitalize on this expansion and facilitate the development of the
mobile operators, we have completed several projects with VimpelCom, MTS and Megafon in which we
provide satellite based network extension into several locations in Siberia, the Russian Far East
and the Northwest of Russia. We expect this expansion to continue throughout 2008 during which
time we will deploy a network of satellite stations for VimpelCom in the remote areas of Russia.
Additionally, for the wireless operators and smaller voice providers, we provide telephone numbers
which are used under agency agreements to sell their services to their end-users.
Our intra-zonal network in Moscow is integrated into the Moscow city incumbent telephone
network at 78 transit and local exchanges, which allows us to deliver traffic within the local
public network. Further, our network infrastructure is now integrated into the main public city
networks in St. Petersburg, Nizhny Novgorod, Samara, Voronezh, Ekaterinburg, Kaliningrad,
Krasnoyarsk, Perm and Krasnodar.
Our long distance FTN has domestic long distance toll exchanges, 4 international toll
exchanges and is interconnected with all zonal fixed and cellular networks in every region of the
Russian federation. We have completed the construction and commissioned intra-zonal networks in 24
regions of Russia.
For international data networking operators, we provide data connectivity across Russia and
the CIS. We have constructed a data network that covers more than 300 cities across Russia and the
CIS, primarily to serve our Russia-based corporate customers. We also sell data networking services
to customers outside Russia and the CIS through network interconnect agreements with international
data network operators. We interconnect with these global providers at our access points in
Stockholm, London and Frankfurt.
Our data network infrastructure consists of terrestrial and satellite transmission capacity
that we either lease or have purchased via indefeasible rights of use (“IRU”). We currently have
IRUs for STM-64 fiber optic capacity, between Moscow and Stockholm, STM-4 between Stockholm and
London, STM-64 between Moscow, Tula, Voronezh, Rostov and Krasnodar, STM-1 from Ufa to Krasnoyarsk
through Ekaterinburg, Chelyabinsk, Tyumen, Omsk and Novosibirsk with an option to upgrade this line
to STM-4, STM-1 from Krasnodar to Sochi and STM-1 from Vladivostok to Khabarovsk. We also leased
STM-64 fiber optic capacity from Frankfurt to Stockholm. The rest of our domestic terrestrial
capacity is leased. For satellite transmission, we entered into long-term leases primarily with
Intelsat, Intersputnik and New Skies Satellite for capacity which covers Russia and the CIS. For
IP capacity, we use 12Gbit connectivity from Verizon, Cable&Wireless, Level 3 and Global Crossing.
We changed our interconnect technology from SDH to optical Gbit, which allows us to increase uplink
capacity, decrease costs and at the same time have better network utilization. We implemented our
international IP backbone operations with IP routers in Frankfurt and Stockholm, which we connected
to the leading European IP exchange, DECIX. We have our own backbone fiber optic cable links from
Moscow to Ufa, Samara and Saratov via Nizhny Novgorod and Kazan. Furthermore, we completed
cross-border links between Russia and Ukraine.
The Carrier and Operator Services division also provides domestic and international IP transit
services to ISPs in Russia and the CIS. Smaller ISPs can connect to our IP backbone and then use
our network to access the global Internet or Russia-based Internet.
Services and Customers
Voice Services: The Carrier and Operator Services division offers two types of voice services
to its customers: call completion or termination services and the provision of telephone numbers.
For international operators, which include traditional incumbents such as British Telecom and VoIP
operators, we provide call completion to the PSTNs located in Russia and the CIS. Generally, we
interconnect with these operators in London, Stockholm, and Frankfurt or through the public
Internet and receive their traffic in route from foreign operators to Russia and the CIS.
International outbound switched voice traffic is routed by destination, based on either anticipated
return traffic from the foreign operator through non-geographical area codes, or through least-cost
routing. We attempt to direct international traffic through particular foreign operators so as to
balance our settlements paid to and received from foreign operators. Thereafter, we direct all
international outbound, switched voice traffic in excess of that required to achieve the balance of
the bilateral relationships with the lowest cost route.
Domestic operators in Russia and the CIS, including Russian cellular operators, use us for
call completion to the PSTNs located in Russia and the CIS. They also send us international traffic
that we then pass onto the PSTN of international operators. Additionally, we provide zonal, local
interconnection and telephone-numbering capacity to Russian operators who may purchase large blocks
of telephone numbers which they provide to their end-users.
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We also sell equipment and provide installation and maintenance services to cellular
operators. We generally sell a PBX with call center capabilities, but also offer LAN and WAN
equipment. It is our intent to move beyond simply providing call completion to cellular operators
into higher value-added solutions such LAN and WAN solutions. Currently, we provide satellite
communication links to Russian cellular operators. This solution is for remote regions of Russia,
such as Siberia and the Russian Far East. It allows cellular operators to expand in these markets,
since there is still a low cellular penetration rate. Since 2005, we provided cellular operators
with the ability to expand in these markets where the cellular penetration rate is still low.
Our voice services customers include international operators such as Verizon, AT&T, British
Telecom, Cable&Wireless, TeleDenmark, TeliaSonera, T-Systems, Telenor, Telecom Italia Sparkle,
iBasis, and Teleglobe; domestic cellular operators such as VimpelCom, MTS, and Megafon; and
domestic wire line operators such as Macomnet, Metrocom, WestCall and Peterstar.
Data Services: The Carrier and Operator Services division also offers two types of data
services to its customers: data networking services such as frame relay, synchronous digital
hierarchy capacity and IP VPN, and IP transit ports. In addition to providing the underlying
circuit capacity, the provisioning of both types of service also includes the installation and
maintenance of customer premises equipment (“CPE”) such as routers, multiplexers and frame relay
access devices.
Global data network operators sell worldwide data network services to their multinational
clients. Generally, these data network operators constructed extensive networks in the US, Western
Europe and the Asia-Pacific region but have little, if any, infrastructure in Russia and the CIS.
In order to sell a turnkey solution to their customers, the global data network operators need
partners to reach the areas where they do not have their own infrastructure. Through a network
interconnect agreement with us, these global data network operators are able to provide their
clients connectivity to over 300 cities in Russia and the CIS where we have infrastructure. These
global operators market and re-sell our network as if it were their own network. Such cooperation
included a joint project with British Telecom for the construction of Visa International’s access
network in Russia and CIS, which allows Visa International member banks, over 70 in Russia and 25
in the CIS, to access Visa International’s bank processing centers.
Due to our large consumer and corporate customer base for Internet access services, we require
very high IP transit capacity from global providers such as Verizon, Cable&Wireless, Level 3 and
Global Crossing. Currently, we began to implement our own international IP-backbone that will allow
us to peer directly with large traffic aggregators and significantly reduce IP-traffic. We would
execute this through interconnection with Internet Exchanges, starting with DECIX, Germany. In 2008
we plan to interconnect with London and Amsterdam Exchanges for traffic balancing. This capacity
requirement allows us to obtain very favorable pricing from the global providers and, in turn, we
can offer Russian and CIS based ISPs an attractive pricing and quality combination for the resale
of IP services.
Marketing and Pricing
Historically for each telephone number or subscriber port, customers generally pay a one-time
port fee, a flat monthly fee and per minute charges based on usage. However, the new
Telecommunications Law requires all carriers to implement per-minute charges for access to each
other’s network as well as to implement two types of charges for calls passing through network
layers: (1) initiation and transit charges for long distance calls from local networks to regional
and long distance networks, and (2) termination for calls completed from long distance networks to
regional and/or local networks.
On March 4, 2006, the Russian President approved amendments to the Telecommunications Law that
introduced the CPP Rules. Effective July 1, 2006, under the CPP Rules all incoming calls, on fixed
and mobile lines, in Russia are free of charge, and only the fixed-line or mobile operators
originating the call may charge the customer for the call. Previously, subscribers of fixed-line
telephones did not pay for incoming calls and, therefore, the CPP Rules did not have an impact on
fixed-to-fixed line calls, but impacted fixed-to-mobile calls as mobile companies
traditionally charged for incoming calls in Russia.
Fixed-networks voice termination services are still priced per minute according to
destination. There is an increasing trend towards a single price for all destinations in Russia
although the typical pricing has separate rates for Moscow and St. Petersburg and a single rate for
all other cities in Russia. Prices for the CIS countries usually follow a similar pattern; the
major cities have separate rates and then the rest of the particular country is priced at the same
rate. All of these countries have separate rates for traffic termination into cellular networks.
We have been actively expanding the geographic reach of our network in order to capture these high
revenue and margin destinations and have signed several new interconnect agreements in the CIS
countries.
Pricing for data networking services consists of a number of elements: a monthly fee for the
international bandwidth capacity provided, a monthly fee for the access port, a monthly fee for the
last mile connection between our network and the customer location and a monthly maintenance fee
for any CPE that we manage for the end-user. Additionally, there are one-time installation fees
for all of the elements listed above. Customers have the option to purchase the CPE and provide
their own maintenance, however, customers usually prefer a turnkey solution where we manage all
elements and are therefore responsible for all service quality issues.
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Pricing for IP transit services sold to ISPs is either in the form of a flat monthly fee for
an IP port or based on the amount of traffic consumed by the ISP. Typically, the larger ISPs will
opt for a flat monthly fee for a large port connection to our network while the smaller ISPs prefer
to pay per megabyte of IP traffic sent to their network from our network.
Competition
For voice services, our main competitors are long distance carriers Rostelecom and MTT, an
affiliate of Sistema Telecom.
For data networking services, our main competitors are Equant and TransTelecom. Equant’s data
network in Russia is similar to our network; however, their CIS coverage is not as extensive.
Therefore, when a customer needs a route including Russia and the CIS, we have a competitive
advantage. Equant’s global network gives it access to a wider base of corporate customers, but
this advantage is offset, we believe, by the reluctance of Equant’s global competitors such as
Verizon, British Telecom, Cable&Wireless, Infonet and AT&T to use Equant locally to serve their
customers. Thus, to some extent we have access to the corporate clients of Verizon, British
Telecom, Cable&Wireless, Infonet and AT&T that require connectivity to Russia and the CIS.
For IP services, our main domestic competitor is TransTelecom. A number of international IP
transit providers such as Cable&Wireless and TeliaSonera also actively sell global IP transit
services in Russia. In 2002, we entered into a peering agreement with two other Tier 1 Russian
ISPs. According to the terms of this agreement, all Russian ISPs requiring access to these networks
pay traffic charges whereas previously all peering was free. As a result, we are able to earn
additional revenue from our infrastructure investments in Russia and improve our competitive
position via other IP access providers.
Carrier and Operator Services in Ukraine
Services and Customers. The Carrier and Operator Services division in Ukraine operates leased
DLD/ILD networks and is a provider of local access, international and intercity long distance
services in major Ukrainian cities where our switching equipment is located. The network consists
of our gateway international switching center in Kiev, leased and owned international and intercity
fiber optic channels, and regional voice and data switches. For local carriers we provide access
to highly reliable and advanced telecommunication services, WAN, and broadband Internet in all
existing Kiev and regional access points. Internet access services are provided to more than 35
ISPs in Ukraine.
International and Domestic Long Distance Services. International outgoing traffic is terminated
via direct interconnections with international carriers such as AT&T, Deutsche Telekom, Telekom
Austria, TeliaSonera and others. We offer termination services to our international partners for
interconnection with Ukrainian PSTN and mobile networks via direct links with the major fixed and
mobile carriers such as Ukrtelecom, Kyivstar, UMC, Astelit, URS and others.
GTU offers DLD services throughout Ukraine via its owned and leased channels between major
Ukrainian cities as well as through interconnection with Ukrtelecom. GTU holds an intercity
operator’s license allowing it to offer DLD services directly and is interconnected in major
Ukrainian metropolitan areas to facilitate this offering. In September 2003, new amendments to
settlement agreements with Ukrainian fixed-line and mobile operators were signed, which introduced
the CPP principle imposed by the changes in the Ukrainian telecommunication law. These agreements
and the CPP principle remained in force during the year of 2005, 2006 and 2007.
International Internet access is provided via our IP node in Frankfurt and direct IP
interconnection with Level3, Global Crossing and Cable & Wireless.
Fixed-line operators include overlay and wireless local loop operators in Kiev and other major
cities of Ukraine, alternative regional fixed-line and local operators. Ucomline, Velton, ITC
(CDMA-UA), VOLZ and Datagroup are the main fixed-line operators in Ukraine purchasing our
international, long distance and voice services.
A significant portion of our carrier revenue is generated from the Ukrainian cellular
operators’ large volumes of international and long distance traffic. Price and quality of service
are the primary factors in their purchase decision. In 2004, several Ukrainian cellular operators,
including UMC and Kyivstar, received international communications licenses. As a result, a larger
portion of our carrier revenue is generated now by transit fixed-to-mobile traffic via our network.
However, as of the end of 2006 the main volume of the international destinations traffic is
generated by URS (Beeline brand in Ukraine).
Marketing and Pricing
As a carrier for other telecommunication operators, we offer a more attractive pricing
structure for international calls than incumbent operators like Ukrtelecom. Although price is
still the primary factor in the routing decision of the Ukrainian carriers, more of them demand
high quality international voice and data wholesale services, making our offerings even more
attractive. As a result, our traffic volume continues to increase, especially the international
destination traffic and mobile networks in Ukraine.
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In February 2003, the Ukrainian Parliament overrode the President’s veto and adopted an
amendment to the Ukrainian communication law prohibiting all telecommunications operators from
charging their customers for incoming calls, thus introducing the CPP principle, which entered into
effect on September 19, 2003. Concurrently, state regulated tariffs for calls from the PSTN to
mobile networks were introduced allowing operators to receive and share revenue from calls to
mobile networks. In order to implement CPP settlements, we amended our agreements with Ukrtelecom,
other fixed-line carriers and Ukrainian cellular operators establishing agreed access rates for the
calls between fixed-line and mobile networks. These changes became effective in October 2003 and
enabled us to receive a settlement when a fixed line party called a mobile telephone as well as to
receive a portion of revenue when we routed calls from mobile to fixed-line networks.
As a carrier for other ISPs, GTU offers an attractive pricing structure and is able to retain
its significant market share in this segment. GTU expects to strengthen its positions in the
Ukrainian regions due to close cooperation with Ukrtelecom and Ucomline. In data services, market
share growth is expected through the continuous sale of international private line connections,
international multiprotocol label switching connections, and provision of the last mile services in
major Ukrainian cities.
Competition
In Ukraine, the carrier market, dominated by Ukrtelecom, with UMC, Kyivstar, Ucomline
(Farlep-Optima), Velton and Datagroup, is becoming more competitive. In 2004, several Ukrainian
cellular operators received international and intercity communications licenses permitting them to
route their traffic through direct interconnection with local and international operators.
Consumer Services
Services and Customers
Broadband Internet Access. Broadband services development based on the most up-to-date
engineering solutions is one of the company’s strategic lines. Currently, we are focused on the
local infrastructure development in order to bring broadband Internet access services to the mass
market. We use different broadband last mile technologies depending on particular market
conditions.
FTTB Services. In 2007, we started a wide-ranging project on FTTB product launching in
regions. Currently, we offer Internet via FTTB service in Moscow and the Moscow Region, in St.
Petersburg and the Leningrad Region, in Krasnoyarsk, Arkhangelsk, Samara, Voronezh, Saratov,
Volgograd and Rostov-on-Don. As of December 31, 2007, we had approximately 375,200 subscribers in
these cities.
We plan to provide Voice and IPTV services via FTTB. Our nationwide fiber optic cable network
will be used for active rollout of our FTTB network in the regions.
Wireless Internet Access. Golden WiFi is the World’s largest metropolitan wireless network and
includes the greater part of Moscow’s city center and many other areas of the city. Moreover, the
network continues to grow and develop, with new wireless access zones added often. As of March
2008, we have installed more than 15,300 WiFi access nodes in Moscow providing indoor and outdoor
Internet access.
On March 1, 2007, we launched commercial operations of our WiFi network offering prepaid
Internet access to the mass market under Golden WiFi brand. To close the WiFi technology gap and to
increase service availability and quality, we sell equipment called WiFi adapter to our customers.
The present version of the Golden WiFi product includes local city map display with Aport search
results, based on the customer’s geographical position (location based service). Since December
2007, we have been providing International WiFi roaming service in 28 countries.
As of December 31, 2007, we had approximately 68,500 active customers which number is
continuing to increase. Also we had more than 500 indoor WiFi objects in cafes, restaurants, trade
centers, and entertainment centers. Our most recognized partners are Domodedovo Airport, McDonalds,
and Atrium Trade center.
VoIP. Currently, we continue developing and testing new products based on VoIP technology. We
will target VoIP service offerings at the SME/small office and home office and mass markets. VoIP
services will be available for computer, mobile devices and VoIP equipment users.
Dial-up Internet Access. We continue offering dial-up Internet services to consumers in
Russia, Ukraine, Uzbekistan and Kazakhstan. As of December 31, 2007, we had approximately 233,500
active dial-up Internet subscribers. We provide dial-up service under multiple brands, the most
notable, ROL, is our flagship dial-up service. With over 60 locations, including the major markets
in Moscow, St. Petersburg, Kiev and Almaty, we are also the largest ISP in the CIS.
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We plan to continue providing dial-up Internet services in migrating our dial-up Internet
customers onto our new Internet access products such as broadband, DSL and WiFi.
Internet Portals. Further, we provide Russian language content based Internet portals covering
many topics including Internet search, entertainment, education, computer-gaming and city
information specifically for the Russian mass-market. Portals run under different brands and are
used as a marketing channel for both our existing and future customers. In addition, we offer
advertising space on our portals along with integrated web services to a variety of customers who
require online marketing.
Marketing and Pricing
Dial-up Internet Access. In 2007, we increased the average price per hour for our dial-up
service by 22%. This was due to the new requirements from the establishment of the Communication
Federal Law. According to the new requirement we are obligated to pay for the local dial-up traffic
initiation which is the largest part of the service cost.
Wireless Internet Access. We offer three tariff plans for our WiFi service:
| • | “Sometimes” is a rate plan convenient for occasional WiFi users. “Sometimes” allows customers to pay only for time spent accessing the wireless network. Customers prepay for one hour of Internet use and can use it all at once or connect several times until the time expires; | ||
| • | “Day&Night” is a rate plan that offers unlimited wireless access with no limits on traffic or speed for 24 hours; and | ||
| • | “Always” is an unlimited use rate plan for active Internet users. Customers pay a fixed monthly fee and unlimited access is granted to the WiFi network. |
FTTB Services. For FTTB service we offer an unlimited tariff plan and tariff plans which
depend on traffic volume and speed of connection. Unlimited tariff plans offer a convenient
solution for active Internet users that use Internet to download large volumes of data.
Currently, we offer prepaid tariff plans for all mass market services. Our customers can
purchase scratch cards from a point of sales, pay through an electronic payment system, or make a
payment at one of our sales offices. We use our distribution network to communicate with our
subscribers and for trade marketing activities. Moscow and regional subscribers can call our call
center for customer and technical support.
Competition
In Moscow, we have the largest market share of the WiFi market. The remaining market share is
divided between Comstar and Tascom. In 2007, our share in the Russian broadband market was 11%.
Our main competitors in the broadband market are Svyazinvest companies, Comstar UTS, NAFTA and some
other local home networks providers.
Mobile Services
Golden Telecom GSM
We operate a cellular network using GSM-1800 cellular technology in Kiev and Odessa, Ukraine,
where our network covers an area with a population of approximately 3.9 million people. Golden
Telecom GSM launched cellular operations with a license allowing it to offer services in Kiev and
the Kiev region and later it obtained a national operating license and commenced operations in
Odessa. However, during 2001 our mobile operations in Ukraine were under strong competitive
pressure leading to an overall decline in our mobile revenues. In 2002, we evaluated alternative
strategies for our mobile operations, and refocused our mobile operations as an additional service
offered to high-end mass market and business customers. In 2004, we became more active in the
prepaid market. In 2006 and 2007, we faced aggressive competition both from existing carriers and
new market entrants.
In 2006, we acquired a GSM-1800 radio frequency license for an additional 22 regions of
Ukraine. This license provides us with a potential customer base of 38.1 million people, or
approximately 81% of the Ukrainian population, compared with our previous coverage of 5.1 million
people. In 2006, we entered into the agreement with ZAO Ukrainian Radio Systems (“URS”), a
subsidiary of VimpelCom, for the provision of roaming services. This agreement enables our mobile
customers to use the national roaming services of URS’ nationwide network. In addition, we plan to
provide mobile over broadband services in Ukraine. We announced the commencement of construction of
FMC network in Ukraine. The FMC network combines the advantages of fixed-line and mobile
communications and will be the first converging communications network in Ukraine. To date, we have
deployed the FMC network in Kiev and Odessa based on our existing GSM-1800 networks. We expect to
complete network testing and launch commercial operations during second and third quarter in 2008.
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In Russia we provide mobile services in Moscow via a GSM network. During the second half of
2007 we switched our DAMPS customers onto a GSM network. We offer GSM services in Moscow via a
commercial arrangement with VimpelCom. Currently, our high-usage mobile subscriber base in Moscow
is approximately 24,520 customers.
Services and Customers
Mobile Services. We provide two types of mobile services to our clients: a basic service for
prepaid calling card clients and an expanded service for subscription clients, including
international roaming with 164 operators in 82 countries, and value-added services such as
voicemail, call forwarding, conferencing, a broad range of short message service, or SMS, and voice
information services.
Our customer base includes both private and corporate users. The customers’ base changed in
2004 due to the rapid growth of prepaid service users. In December 2005, prepaid subscribers
constituted more than half of our subscriber base. The remaining subscriber base was represented
primarily by the high-end mass market and business customer segments. During 2005, our subscriber
base decreased due to competitive pressures. However, due to aggressive pricing and other
conditions introduced by GTU in December 2005, the subscriber base remained stable during 2006. In
2007, due to aggressive competition and a delay in the FMC launch our subscriber base declined.
Following the launch of the FMC services in 2008, we expect an increase in our market share of the
Ukrainian mobile market.
Marketing and Pricing
Our network has the widest frequency bandwidth allocated to any cellular operator in Kiev,
which allows us to deploy a high quality network throughout the city and thus market ourselves as a
quality service provider. Due to the highly competitive nature of the cellular market in Kiev, our
main focus is to provide flexible and competitive tariff structure in two target markets. We
present our subscription service as an affordable and quality service to private and business
users, which have high level of usage within their home base primary location. Furthermore, we
provide our customers with flexible tariff plans and a variety of basic value-added services. Our
international and roaming tariff plans are still among the most attractive in the Ukrainian mobile
market.
Our marketing strategy for prepaid services is based on providing competitive tariffs for
mass-market users with low traffic volumes.
Our sales force in Kiev consists mainly of direct sales representatives, whereas in Odessa we
use both a direct sales and alternative distribution channels, such as retail dealers. Our strategy
is focused on rapid subscriber growth following the introduction of the FMC services and regional
expansion.
Competition
The Ukrainian cellular market is highly competitive and is dominated by UMC and Kyivstar. In
2007, Astelit, a newcomer to the Ukrainian mobile market, gained 16% of the market share, whereas
URS gained 5% of the market. Besides UMC and Kyivstar, which provide nationwide coverage, Astelit
and URS provide coverage in every city with population of more than fifty thousand people.
Currently, Astelit and URS are actively investing in further network development. On December 31,
2007, the Ukrainian cellular market reached approximately 55.6 million subscribers with 120%
SIM-card penetration rate. Together, UMC and Kyivstar have approximately 79% of the market share.
In 2007, Ukrtelecom introduced a new technology, 3G mobile networks, in Kiev, Kharkov, Odessa,
Lviv, Donetsk and Dnepropetrovsk, under well recognized brand Utel. Ukrtelecom combined its 3G
network with the URS network under a national roaming agreement. During 2008, Ukrtelecom plans to
launch 3G network in 26 major Ukrainian cities. In 2007, Telesystems, a Ukrainian CDMA operator,
launched CDMA-based 3G services with subscriber base of approximately 87,000 customers.
As of December 31, 2007 we had a subscriber base of more than 36,500 customers with average
revenue per month of approximately $15 per user, which currently is the highest average revenue,
per user, on the Ukrainian mobile market.
Website Access to Our Filings
We provide public access to its annual report on Form 10-K, quarterly reports on Form 10-Q,
current reports on Form 8-K, and amendments to these reports filed with the SEC under the
Securities Exchange Act of 1934. These documents may be accessed free of charge on our website at
the following address: http://www.goldentelecom.com. These documents may also be found at the
SEC’s website at http://www.sec.gov. Also, copies of our annual report on Form 10-K will be made
available, free of charge, upon written request.
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Employees
As of December 31, 2007, we and our consolidated subsidiaries employed a total of 10,262
full-time employees and our ventures employed 99 full-time employees. As of December 31, 2006, we
and our consolidated subsidiaries employed a total of 4,218 full-time employees and our ventures
employed 108 full-time employees. Included in the number of full-time employees were 10 and 9
expatriates as of December 31, 2007 and 2006, respectively.
We do not have any collective bargaining agreements with our employees, and we believe that
our relations with our employees are good. We believe our future success will depend on our
continued ability to attract and retain highly skilled and qualified employees.
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Significant Licenses
Our subsidiaries hold the following licenses in Russia, Ukraine, Kazakhstan and Uzbekistan,
which are important to their operations. Renewal applications will be applied for all licenses
expiring in 2008 where necessary.
| License | License Region (s) | License Number | Expiration Date | |||||
| Local Communications Services |
||||||||
| Sovintel | Moscow, St. Petersburg |
44382 | September 21, 2011 | |||||
| GTU | Kiev, Kiev Region, Odessa Region |
364688 | October 12, 2012 | |||||
| GTU | Ukraine (excluding Kiev, Kiev Region,
Odessa, Odessa Region) |
223392 | January 28, 2009 | |||||
| ADS | Nizhny Novgorod Region |
35438 | October 5, 2010 | |||||
| Buzton | Uzbekistan |
0000663 | July 4, 2011 | |||||
| Leased Communications Circuits |
||||||||
| Sovintel | Moscow, Moscow Region, St. Petersburg,
Leningrad Region |
41506 | July 5, 2011 | |||||
| SA-Telcom | Kazakhstan |
001672 | Unlimited | |||||
| Voice Communication Services in Data Transmission Networks |
||||||||
| Sovintel | Russian Federation |
39543 | March 15, 2011 | |||||
| International and National Communications Services |
||||||||
| Sovintel | Russian Federation |
32041 | May 31, 2012 | |||||
| GTU | Kiev, Odessa, Odessa Region, Donetsk,
Donetsk Region, Kharkov, Kharkov Region,
Lvov, Lvov Region, Dnepropetrovsk,
Dnepropetrovsk Region |
223393 | December 31, 2013 | |||||
| GTU | Ukraine (excluding Kiev, Odessa, Odessa
Region, Donetsk, Donetsk Region, Kharkov,
Kharkov Region, Lvov, Lvov Region,
Dnepropetrovsk, Dnepropetrovsk Region) |
223394 | January 28, 2014 | |||||
| Buzton | Uzbekistan |
0000661 | January 14, 2010 | |||||
| Buzton | Uzbekistan |
0000819 | January 14, 2010 | |||||
| Mobile Communications Services |
||||||||
| GTU | Kiev Region |
364703 | July 7, 2014 | |||||
| GTU | Kiev, |
364704 | May 18, 2021 | |||||
| GTU | Ukraine (excluding Kiev, Kiev Region) |
223390 | January 28, 2009 | |||||
| GTU | Kiev Region |
364703 | July 7, 2014 | |||||
| Telematic Services |
||||||||
| Sovintel | Moscow, Moscow Region, St. Petersburg,
Leningrad Region |
27309 | August 18, 2008 | |||||
| ADS | Nizhny Novgorod Region |
37603 | December 23, 2010 | |||||
| Dicom | Moscow, Moscow Region |
40966 | July 5, 2011 | |||||
| SA-Telcom | Kazakhstan |
001817 | Unlimited | |||||
| Intra-zonal Communications Services |
||||||||
| Sovintel | Moscow, St. Petersburg |
45074 | October 24, 2011 | |||||
| ADS | Nizhny Novgorod Region |
35439 | October 5, 2010 | |||||
| Data Transmission Services |
||||||||
| Sovintel | Moscow, Moscow Region, St. Petersburg,
Leningrad Region |
27310 | August 18, 2008 | |||||
| Buzton | Uzbekistan |
0000664 | August 29, 2011 | |||||
| SA-Telcom | Kazakhstan |
0000032 | Unlimited | |||||
| Radio Frequencies |
||||||||
| S-Line | Kiev, Sevastopol, Dnepropetrovsk Region,
Donetsk Region, Kharkov Region, Odessa
Region, |
364700 | April 20, 2016 | |||||
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| License | License Region (s) | License Number | Expiration Date | |||||
Zaporozhye Region, Kiev Region, Lugansk Region, Lvov Region, Poltava
Region, Vinnitsa Region, Zhitomir Region,
Suma Region, Kherson Region, Khmelnitsk
Region, Ivano-Frankovsk Region, Volyn
Region, Zakarpatye Region, Kirovograd
Region, Rovno Region, Ternopol Region,
Cherskassk Region, Chernigov Region,
Chernovets Region, Crimea |
||||||||
| Communications Services for the Purposes of Cable Broadcasting |
||||||||
| Sovintel | Russian Federation |
55387 | Being issued | |||||
| Investelectrosvyaz | Moscow, Moscow Region |
44053 | September 21, 2011 | |||||
| GTU | Kiev |
0206-II | May 18, 2017 | |||||
| Communications Services for the Purposes of TV Broadcasting |
||||||||
| Kolangon-Optim | Moscow, Moscow Region |
42006 | June19, 2011 | |||||
| Kolangon-Optim | St.-Petersburg, Leningrad Region |
43265 | July 28, 2011 | |||||
The Environment in Which We Operate
This section provides an overview of some of the key features of the markets where we operate
and derive substantially all of our revenue. These overviews focus on our two largest markets,
Russia and Ukraine and include:
| • | An overview of the telecommunications markets; | ||
| • | An overview of the political environment; and | ||
| • | An overview of the legal and regulatory regimes. |
Overview of Telecommunications Markets in Russia and Ukraine
The Telecommunications Market in Russia. Prior to the early 1990s, the public
telecommunications network in the former Soviet Union was inefficient, unreliable and
underdeveloped relative to the networks in more-developed countries. In the early 1990s, the
Russian Ministry of Telecommunications, which had formerly controlled the Soviet telecommunications
infrastructure, ceded operational control to a single long distance and international carrier,
Rostelecom, and 80 incumbent regional operators, including four independent city networks in
Moscow, St. Petersburg and two other cities. The local telcos provide local exchange services for
customers within their regions, but since February 2003 they are obligated to provide access to
DLD/ILD services. In the incumbent network DLD calls to and from areas outside the local telcos’
service area, as well as ILD calls, are switched through Rostelecom, which interconnects with the
local telcos to complete DLD calls and with foreign carriers to complete ILD calls.
On June 7, 2003, the Russian President signed the Telecommunications Law which came into
effect on January 1, 2004. The Telecommunications Law clarifies areas, which were poorly defined,
such as interconnect and licensing arrangements, however, certain supporting regulations for the
Telecommunications Law have not been passed. See “Corporate History and Development” in this
section and “Management’s Discussion and Analysis of Financial Condition and Results of Operations”
for a discussion of the effect of the Telecommunications Law on our business, a discussion of our
new DLD/ILD license and the creation of our own FTN designed to satisfy the requirements of our new
license and new numbering capacity and interconnect rules.
The Telecommunications Law introduced the concept of the USF. All telecommunications
companies are expected to contribute to the USF which is designed to support the development of
telecommunications infrastructure which is deemed to be economically unviable but socially
necessary. We are currently paying to the USF 1.2% of our total revenue from telecommunication
services provided to end users. See “Management’s Discussion and Analysis of Financial Condition
and Results of Operations” for a discussion of legislation related to USF charges.
Under the Telecommunications Law, interconnect regulation becomes, in theory, more
transparent. The Telecommunications Law states that any telecommunications operator which has a
significant presence in a given market must provide interconnect arrangements to all operators.
This section of the Telecommunications Law is designed to eliminate the discrimination which is
experienced by telecommunications operators when attempting to interconnect with regional
incumbents.
The Telecommunications Market in Ukraine. The evolution of the telecommunications sector in
Ukraine is similar to that in Russia. Over the last number of years, both incumbent and
alternative CLEC operators in Ukraine completed modernization of their networks in Kiev and in some
other large Ukrainian cities and became more active in service development.
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In contrast to Russia, there has been no privatization of the state-owned telecommunications
sector in Ukraine. Whereas privatization of Ukrtelecom, the Ukrainian incumbent public operator,
was considered crucial for raising funds for the state from 2004-2006, several changes in
priorities and political positioning have resulted in delays. To date, only 7% of Ukrtelecom has
been privatized, to employees and managers. The new Ukrainian government is considering plans for
privatization of 67% of Ukrtelecom’s shares by open auction in 2008. The privatization of
Ukrtelecom should be completed during the first half of 2008.
Since August 2004, the Ministry of Transport and Telecommunications was the regulatory body
that oversaw the Ukrainian telecommunications industry. The Ministry of Transport and
Telecommunications was responsible for licensing, and setting tariff regulations. As of January
2005, National Commission of Telecommunications Regulation received the abovementioned functions.
Ukrtelecom is the main provider of fixed voice telecommunications and Internet services in
Ukraine. Ukrtelecom is a joint stock company owned 93% by the State Property Fund with 31
branches, 27 of which represent the company in each region of Ukraine. Ukrtelecom holds national
transmission networks, along with broadcasting, research and satellite assets. Ukrtelecom also put
into operation a third generation (“3G”) mobile services network under the well-known brand Utel.
Ukrtelecom also owns shares in five other Ukrainian telecommunication companies.
The remaining market is divided between three other major players: GTU, SCM’s telecom assets
group, Datagroup and Volia, the number one broadband and cable TV provider in the Kiev market
(based on DOCSIS technology).
Public switched voice telephony in Kiev is delivered through a layered hierarchy similar to
that used in Moscow. We connect our customers using our local access network with fiber optic and
copper-based facilities, which provide direct interconnection with the Kiev city telephone network.
The Ukrainian mobile telecoms market is currently served by seven operating companies. This
market is highly competitive and dynamic. GTU commenced operations in accordance with its GSM-1800
license in late 1996. During 2007 Ukrtelecom and Telesystems launched 3G mobile services network
and UMC completed rebranding to MTS.
Overview of the Political Environments in Russia and Ukraine
Russia’s Political Environment. Since the dissolution of the Soviet Union in December 1991,
Russia has been in the process of a substantial political transformation. The Russian
Constitution, ratified in 1993, establishes a three-branch governing system that replaced the
Communist Party dominated Soviet system. The three-branch system consists of a powerful executive
branch led by the President, a bicameral legislative branch with an upper assembly, the Federation
Council, and a lower assembly, the State Duma, and a judicial branch, which is still
underdeveloped. On March 14, 2004, Vladimir Putin was elected to a second presidential term.
Under the Russian Constitution, no person may serve more than two terms as President. The last
presidential election was held in March 2008, and Dmitry Medvedev was elected as President. Mr.
Putin has indicated that he may serve as Prime Minister. On December 2, 2007, the State Duma held
elections in which the United Russia party, which was supported by Mr. Putin, received the majority
of the popular vote and will have the majority of the seats in the State Duma.
Ukraine’s Political Environment. Ukraine declared independence from the Soviet Union in 1991.
Since that time, Ukraine has established a three-branch system of government similar to that in
Russia. Following a period of significant political debate, the new Ukrainian Constitution was
ratified in June 1996. Independent Ukraine’s first President, Leonid Kravchuk, led the country
through a period of significant economic and social decline. Following the 1995 presidential
elections, Leonid Kravchuk was succeeded by Leonid Kuchma. Ukraine is one of the few former Soviet
republics to smoothly and peaceably transfer executive power. President Kuchma was re-elected for
another five-year term in November 1999. On January 10, 2005 Victor Yuschenko was declared the
President after a divisive presidential election against Victor Yanukovich. At the end of 2004,
constitutional reform significantly reduced the powers of the Ukrainian President in favor of the
Ukrainian Prime Minister.
Until 2006, half of the members of the Verkhovna Rada (Ukrainian parliament) were elected by
proportional representation and the other half by single-seat constituencies. Starting with the
2006 parliamentary election, all 450 members of the Verkhovna Rada are elected by party-list
proportional representation. In 2006, Ukraine experienced political instability due to tensions
between the President and the Prime Minister following the overturning of a presidential veto on a
law, which gave the Cabinet of Ministers more power.
In 2007, Ukraine experienced continued political struggle for the position of the Prime
Minister and new parliamentary elections took place in the Verkhovna Rada during 2007. In September
2007 previously unscheduled elections to the Verkhovna Rada took place and a new coalitional
government was formed in December 2007. Yuliya Timoshenko was proclaimed the Prime Minister on
December 18, 2007. The leader of Nasha Ukraina Party, Arseniy Yatsenyuk was assigned as the Speaker
of Ukrainian Parliament. Currently, a new coalitional government is expected to make many changes
in political, social and economical areas. Furthermore, in 2007, Ukraine signed all the necessary
documents associated with entering the World Trade Organization (“WTO”) and in February 2008
Ukraine joined the WTO.
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Overview of the Legal and Regulatory Regimes in Russia and Ukraine
Russia’s Legal and Regulatory Regime. After the dissolution of the Soviet Union in December
1991, former President Yeltsin and the Duma enacted legislation in an attempt to develop a legal
framework to guide the transition from a centralized command economy to a more market-oriented
economy. Under pressure from the executive branch, the Duma finally enacted a new Labor Code,
which entered into effect in February 2002 and replaced the Labor Code left over from the Soviet
era. In 2006, there were significant changes to the Labor Code, particularly on the areas that
dealt with senior level management of companies.
Pursuant to the Telecommunications Law and subsequent governmental decrees, the Russian
Ministry of Telecommunications is assigned the authority to regulate and control the development of
the communications industry in Russia. Additional legislation defines the roles of other
communications regulatory bodies, with the Russian Ministry of Telecommunications exercising
responsibility over supervising them. Rossvyaznadzor, which is now a department of the Russian
Ministry of Telecommunications, is empowered to issue licenses and certain permits required for
network operation and for the importation and use of telecommunications equipment. Rossvyaznadzor
conducts periodic inspections to determine an operator’s compliance with the terms and conditions
of its licenses and is authorized to issue orders and instructions requiring operators to bring
their network into compliance with their licenses or to face fines and/or to suspend a license, or
in the case of continued non-compliance, to initiate court proceedings for the revocation of a
license. In addition, entities such as Svyazinvest at the federal level, as well as other entities
in Moscow and St. Petersburg and other administrative regions within Russia exercise significant
control over their respective local telephone networks and may therefore affect the licensing
process.
Legislation and normative acts specific to the telecommunications industry provide the
regulatory framework that guides our operations. The new Telecommunications Law came into effect in
Russia on January 1, 2004, however, some of the supporting regulations have not been enacted. See
“Corporate History and Development” in this section and “Management’s Discussion and Analysis of
Financial Condition and Results of Operations” for a discussion of the effect of the
Telecommunications Law on our business, a discussion of our new DLD/ILD license and the creation of
our own FTN designed to satisfy the requirements of our new license and new numbering capacity and
interconnect rules.
The Telecommunications Law also sets forth general principles for the right to carry on
telecommunications activities, describes government involvement in telecommunications regulation
and operation, establishes the institutional framework involved in regulation and administration of
telecommunications, and deals with various operational matters, such as ownership of networks,
protection of fair competition, interconnection, privacy and liability. Separate legislation and
administrative regulations implement this institutional framework.
Ukraine’s Legal and Regulatory Regime. A primary contributor to the relatively slow pace of reform
in Ukraine has been the absence of a coherent and enforceable legal framework to facilitate
widespread privatization of government assets. However, in 2007, the Ukrainian Cabinet of Ministry
confirmed the list consisted of 28 economic objects, which includes Ukrtelecom, for primary
privatization in 2008.
The regulatory framework governing the telecommunications industry in Ukraine significantly
improved after the new law “On Communications” came into force on December 23, 2003. The new law
sets forth the general principles for telecommunications activities, networks and services,
including the relationships between operators and customers. The new law established two new
executive bodies – the Central Executive Authority in the Communication Sector (“CEACS”) and the
NCCR to replace the former State Committee for Telecommunications.
CEACS retains mostly administrative functions in the telecommunications industry in Ukraine.
CEACS develops draft telecommunications laws and other legal documents, defines and monitors
quality standards in telecommunications services. NCCR retains regulatory functions in
telecommunications and radio-frequency utilization. It is also the central executive body with
special status subordinated to the President of Ukraine. NCCR supervises the observance of
telecommunications law and quality control of telecommunication services. NCCR assigns numbering
capacity, grant licenses, registers services in the telecommunication sector, provides tariff
regulation, and applies sanctions to those that violate laws. On March 29, 2006, documentation
governing the Public Council which is affiliated to the NCCR was approved, intend for the Public
Council to provide an environment where the NCCR would consider public opinion during the
discussion of related issues and decisions making concerning those issues.
The current situation in Ukraine shows that NCCR is not functioning as intended. For part of
2007, NCCR was unable to make any decision on issues over which NCCR had regulatory authority. This
situation led to the change in the Constitution of Ukraine, which states that the President or the
Cabinet of Ministers of Ukraine has authority to form a proper functioning NCCR. Currently the
issue is not solved. The NCCR is an organization which is controlled by the President of Ukraine in
accordance with the new law “On Communications”.
In February 2003, the Ukrainian Parliament adopted an amendment to the law “On Communications”
prohibiting all telecommunications operators from charging their end-user customers for incoming
calls, thus introducing the CPP principle, which
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entered into effect on September 19, 2003. Additionally, on May 14, 2004 a special Order
regulating settlements between fixed, fixed wireless and mobile operators was adopted by the State
Committee for Telecommunications of Ukraine.
In addition to the CPP principle, state regulated tariffs for calls from the public switched
telephone network to mobile networks were introduced, thus allowing mobile operators to receive a
share of revenue from calls made to mobile networks. To effect CPP
settlements on our network, we entered into an agreement with Ukrtelecom that assigned a national destination code
numbering plan to our mobile customers and allowed to reallocate our interconnect numbering
capacity in Kiev and Odessa from our mobile to our fixed network. This agreement became effective
in November 2003 and enabled us to receive a settlement from revenue generated when a fixed line
party calls our mobile customer as well as released direct city numbering capacity for future sale
to CLEC customers.
A new law “On Individual Income Taxation” came into force on January 1, 2004. The law sets the
unified tax rate for personal income at 13% until December 31, 2006, and 15% from January 1, 2007.
On June 24, 2004 the Verkhovna Rada adopted amendments to the law “On Radio Frequency
Resource” determining the procedure of granting frequency licenses and permits for the use of
radio-electronic and emissive facilities, and for frequency distribution. On August 19, 2005 NCCR
adopted new Licensing Conditions for Radio Frequency Resource use. These conditions came into force
on October 30, 2005.
Pursuant to the law “On Communications”, new Licensing Conditions for conducting the activity
in fixed line telecommunications area were adopted by the State Committee for Telecommunications on
June 17, 2004 and came into force on August 16, 2004. Licensing Conditions regulating provision of
mobile services and communication channels were developed and adopted in 2005.
The Ukrainian Cabinet of Ministers also adopted rules, effective January 1, 2005, establishing
the mandatory payments for obtaining numbering capacity.
Amendments to the Law “On levy on obligatory state pension insurance”, effective August 1,
2005, increased the pension levy rate on mobile services from 6% to 7.5%.
On August 5, 2005 NCCR adopted new Regulations for the state numbering capacity regulation.
These Regulations determine the process of allocating and revoking numbering capacity and
principles of numbering capacity utilization by operators. The Regulations came into effect on
September 23, 2005.
On August 9, 2005, the Ukrainian Cabinet of Ministers adopted the Rules regulating the
provision and receiving of telecommunication services. The Rules determine the main requirements
for the provision of all telecommunication services (fixed and mobile telephone services, Internet,
data transmission, circuits lease), rights and obligations of operators and subscribers, and the
settlements process between operators and subscribers.
On January 19, 2006 the Verkhovna Rada approved amendments to the administrative code of
Ukraine according to which administrative liability is used for the breach of conditions and rules
concerning radio electronic means and radiating devices exploitation.
On September 6, 2006 the NCCR approved an Order on mutual settlements between
telecommunication operators for telecommunication network access services for interconnection which
entered into force on January 1, 2007. The Order defines the list of telecommunication network
access services and provides tariffs for access to the telecommunication networks of exclusive
operators. The procedure for calculating tariffs for access services to the telecommunication
networks of other operators is not defined.
On October 28, 2006 the Verkhovna Rada approved amendments to the law “On Communications”
according to which the list of public telecommunication services with regulated tariffs was
changed. Under the new regulation, calls from fixed networks to intercity and international
destinations are not regulated. The law also includes regulations concerning calls from fixed to
mobile networks. Such calls do not belong to public services and are not regulated. Consequently,
fixed line operators can establish tariffs for such services independently. Leading operators will
be able to set tariffs for intercity and international connection services at more competitive
rates than small operators.
On April 5, 2007 the Law “On basic principles of state supervision (control) in the field of
economic activity” was adopted and became effective from January 1, 2008. In general, this law is
expected to have positive impact in regulating the oversight of economic activity.
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ITEM 1A. Risk Factors
Factors That May Adversely Affect Future Results
We may encounter difficulties expanding and operating our business, including the integration of
acquired companies
We have experienced significant growth as a result of acquisitions and expect such growth to
continue. As we grow, it will become increasingly difficult and more costly to manage our business.
Acquisition transactions are accompanied by a number of risks, including risks related to:
| § | The consolidation of the operations and personnel of the acquired companies; | ||
| § | The potential disruption of our ongoing business and distraction of management; | ||
| § | The introduction of acquired technology content or rights into our products and unanticipated expenses related to such integration; | ||
| § | The potential negative impact on reported earnings; | ||
| § | The possibility that revenues from acquired businesses and other synergies may not materialize as anticipated; | ||
| § | The deterioration of relationships with employees and customers as a result of any integration of new management personnel; and | ||
| § | Contingent liabilities associated with acquired businesses, especially in the markets where we operate. |
We may not be successful in addressing these risks or any other problems encountered in
connection with our completed and future acquisitions and our operating results may suffer as a
result of any failure to integrate these businesses with our existing operations.
In addition, we may encounter difficulties in building our networks with respect to:
| § | Delivering services that are technically and economically feasible; | ||
| § | Financing increases in the regional network construction and development area; | ||
| § | Obtaining in a timely manner and maintaining licenses, permissions to operate telecommunications equipment, frequency allocations and other governmental permissions sufficient to provide services to our customers; | ||
| § | Marketing our services in a large geographic area to new potential customers; | ||
| § | Obtaining sufficient interconnect arrangements; | ||
| § | Meeting demands of local special interest groups; | ||
| § | Obtaining compliance certificates for our telecommunications equipment in a timely and cost-efficient manner; and | ||
| § | Obtaining adequate supplies of network equipment. |
Reorganizations in the Ukrainian telecommunications sector may have strengthened the position of
the monopoly incumbent and may encourage unfair competition
In preparation for a large-scale privatization of the telecommunications industry, the
Ukrainian government reorganized the state telecommunications sector so that Ukrtelecom, the state
telecommunications operator, holds all the government’s interests in the telecommunications
industry. The Ukrainian government owns approximately 93% of Ukrtelecom and intends to sell 67% of
its stake in Ukrtelecom in 2008.
The emergence of a single self-regulating Ukrainian telecommunications monopoly may have adverse
financial consequences for us because:
| • | We may have no effective recourse against the state monopoly carrier since the state regulator controls and manages the monopoly carrier and the judiciary system is severely underdeveloped and cannot be relied upon to protect and enforce unfair competition; |
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| • | A single Ukrainian self-regulating monopoly is able to create favorable market conditions for itself and cause unfavorable conditions for us; and | ||
| • | Any subsequent privatization of Ukrtelecom may bring in strong management and resources from a major telecommunications operator, increasing its competitive strengths. |
Failure to obtain sufficient and reliable transmission capacity at reasonable costs could cause us
to incur losses
Historically, we have leased a substantial portion of our network transmission capacity under
agreements that generally have one to three-year fixed terms. We rely on third parties’ ability to
provide data transmission capacity to us. These third parties themselves, in turn, may be
receiving capacity from others. If our lease arrangements deteriorate or terminate and we are
unable to enter into new arrangements or if the entities from which we lease such capacity are
unable to perform their obligations under these arrangements, our cost structure, service quality
and network coverage could be adversely affected.
We currently provide international switched voice, data and IP services in Russia by relying
on Rostelecom and other providers to provide leased transmission capacity within Russia. We rely
on local operators for last-mile access to end-users. These companies may be subject to political
and economic pressures not to lease capacity to foreign operators or competitors. Any changes in
regulation or policies that restrict us from leasing adequate capacity could have an adverse effect
on our business. Local telecommunications operators may, for business reasons or otherwise, resist
giving us access to the last mile.
The failure of Rostelecom, local operators or any other provider to comply with lease
arrangements or our inability to obtain other long-term leases on a timely basis or maintain
existing leases for fiber optic cable or transmission capacity would prevent us from deploying and
operating our network as planned. This could have a material adverse effect on our ability to
operate.
Our ability to provide our services is dependent on securing and maintaining interconnection
agreements with Svyazinvest, Ukrtelecom and other facilities providers
Our ability to provide a telecommunications services depends on our ability to secure and
maintain interconnection agreements with Svyazinvest, Ukrtelecom and other incumbent owners of
networks. Since we do not currently anticipate owning all the facilities we need to operate our
networks, we will always rely on the telecommunications networks of other providers to some degree.
Interconnection is required to complete calls that originate on our networks but terminate outside
our networks, or that originate from outside our networks and terminate on our networks. Our
current interconnection agreements with incumbent operators expire in various years between 2007
and 2014. Currently, we experienced substantial increases in interconnection costs with incumbent
operators. It is possible that in the future our interconnection agreements may not be renewed or
not renewed on a timely basis or on commercially reasonable terms, which may have material adverse
effect on our business. Further, in September 2007, the Russian Ministry of Telecommunications
issued an order that designated an additional 10 pairs of access codes which may be assigned to
long-distance operators; this may increase competition for domestic and international long-distance
services if new access codes are assigned to new operators.
In Russia, we are dependent on Svyazinvest for the provision of leased lines and/or
interconnect circuits used to connect our points of interconnection to our network backbones. A
failure by Svyazinvest to provide such leased lines and/or interconnect circuits in accordance with
our plans, or to satisfy our customers’ demands on certain routes, historically, increased capacity
constraints in our network on certain routes. Although, we believe that these capacity constraints
have been eliminated, we may continue to experience capacity constraints until we increase the
number of interconnection points to our network, which will allow us to route a greater proportion
of traffic over our network.
In Ukraine, to a great extent, we are dependent on Ukrtelecom for the provision of leased
lines and/or interconnect circuits used to connect our indirect access customers throughout
Ukraine. A failure by Ukrtelecom to provide such leased lines and/or interconnect circuits in
accordance with our plans, or to satisfy our customer demand on certain routes, may increase
capacity constraints in our network on certain routes if we are not able to find an alternative
circuit’s provider.
Our network may not be able to support the growing demands of our customers
The uninterrupted operation of our networks is vital to our success. The stability of our
systems depends on our ability to provide sufficient capacity to meet the needs of our customers,
and that, in turn, depends on the integration of suitable technology into our networks. As we
continue to increase both the capacity and the reach of our networks, and as traffic volume
continues to grow, we will face greater demands and challenges in managing our circuit capacity and
traffic management systems. Any prolonged failure of our communications network or other systems or
hardware that causes significant interruptions to our operations could seriously damage our
reputation and result in customer attrition and financial losses.
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We rely to a significant degree on the Russian and Ukrainian networks capability to deliver
our services, and the underdevelopment of such networks may hinder our ability to obtain sufficient
capacity for our traffic volumes, especially as we expand our Internet access business. Moreover,
it is increasingly difficult to expand within Moscow because the existing city network does not
have sufficient capacity, and we may be unable to procure enough telephone numbers and connection
lines for our customers utilizing our services. These factors may have a material adverse effect on
our expansion plans and our ability to provide services to new customers.
Russian companies may be required to adopt a plan of liquidation when their net assets are negative
Under Russian law, in the event where the value of a company’s net assets is less than the
minimum charter capital allowed by law, such company may be required to adopt a decision to
liquidate. In a case where a company declines to approve its liquidation, governmental agencies
responsible for the State registration of companies, as well as other designated State bodies, for
example, the Federal Service for the Financial Markets, are authorized and may bring a lawsuit to
liquidate the company until the expiration of the applicable statute of limitation. Several of our
subsidiaries experienced negative net asset values, which could lead to the legal obligation to
accept a plan of liquidation. Any voluntary or involuntary liquidation of our subsidiaries could
have a material adverse effect on our business.
We may have difficulty scaling and adapting our existing infrastructure to accommodate increased
traffic and technology advances
Most of the telecommunication network infrastructure that we employ and the infrastructure of
local public networks were not originally designed to accommodate levels or types of services we
provide and it is unclear whether current or future anticipated levels of traffic will result in
delays or interruptions in our services. In the future, we may be required to make significant
changes to our infrastructure, including moving to a completely new infrastructure, or invest in
order to upgrade local public networks. If we are required to replace network infrastructure, we
may incur substantial costs and experience delays or interruptions in our operations. If we
experience delays or interruptions in our operations due to inadequacies in our current
infrastructure or as a result of a change in infrastructure, users may become dissatisfied with our
services and switch to a competitor. Any loss of traffic, increased costs, inefficiencies or
failures to adapt to new technologies and the associated adjustments to our infrastructure could
have a material adverse effect on our business.
We are in a competitive industry and our competitors may be more successful in attracting and
retaining customers
The market for our products and services is competitive and we expect that competition,
especially in underdeveloped markets, will continue to increase. As we expand the scope of our
offers, we will encounter a greater number of competitors which provide services in the same
markets. Unfavorable competitive developments could have a material adverse effect on our business.
Our competitors include incumbent Russian and Ukrainian operators, alternative operators,
mobile operators and other large international telecommunications providers doing business in the
CIS. Our competitors may have significant advantages in resources, closer ties to governmental
authorities and longer market presence. These advantages may provide a competitive edge over
alternative providers like us. This type of competition may result in a loss of our customers,
reduced prices and a decline in revenues.
We operate in recently liberalized markets in developing and highly competitive industry. We
expect our competitors to continually improve their products and services while reducing prices.
Our success will depend on our ability to compete effectively in this environment.
The telecommunications market in Russia has historically been dominated by Svyazinvest and in
Ukraine by Ukrtelecom, both former state monopoly telecommunications services providers. These
companies and other established competitors have significant competitive advantages over us which
include:
| § | Greater resources, market presence and network coverage; | ||
| § | Greater brand name recognition, customer loyalty and goodwill; | ||
| § | Control over domestic transmission lines and over access to these lines by other participants; and | ||
| § | Close ties to national and local regulatory authorities which may be reluctant to adopt policies which may increase competition for Svyazinvest or Ukrtelecom. |
Recently, Comstar strengthened its position in the market by receiving approximately $1
billion as a result of its IPO. MGTS is controlled by Comstar. As a result of this control,
Comstar has an advantage in broadband access. In 2006, Comstar purchased a 25% plus one share in
Svyazinvest which means that it may be able to influence the intra-zonal operators which compete
with us.
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Our current billing and management information systems may not be able to meet our future needs
We may encounter difficulties in enhancing our billing and management information systems and
in integrating new technology into such systems. Historically we operated with several systems,
however, currently we are in the process of integrating our billing and management information
systems, which would allow us to bill our customers and to manage other administrative tasks
through unified system. If we are unable to integrate and upgrade our billing and management
information systems to support our integrated operations, our billing may be insufficient, which
could have a material adverse effect on our revenues.
Furthermore, in order to comply with the regulations that became effective January 1, 2006, we
entered into service contracts with the local and intra-zonal operators to act as our regional
agents for the provision of DLD/ILD services. In our operations outside Moscow and St. Petersburg,
we rely on our agents’ billing and information systems to provide information necessary to generate
invoices. Thus, we may encounter risks associated with verification and calculation of volumes of
long-distance services provided to end users, invoicing and revenue recognition. The lack of
regulations of a mandatory provision for local and intra-zonal network subscriber information,
which is shared with long-distance operators, represents a substantial possible risk to us. This
information could be critical to our ability to properly record traffic transit from subscribers,
calculate charges for services rendered, and issue invoices.
Any damage to our network management center or major switching centers could harm our ability
to monitor and manage network operations and generate accurate call detail reports from which we
derive our billing information.
For operations outside Moscow, Kiev and St. Petersburg, we rely on our ventures’ switches to
provide information necessary to generate invoices. We cannot ensure that their systems will meet
our needs or the needs of our customers.
Our ability to integrate and further develop certain acquired businesses will determine our ability
to develop our broadband strategy
In February 2007, we announced the closing of the acquisition of a 65% interest in Fortland,
which owns 100% of Kolangon. Kolangon and its six wholly-owned subsidiaries hold permits to
operate frequencies in the 8 MHz bandwidth in Moscow and St. Petersburg. Kolangon also possesses a
license to provide communications services for the purpose of digital TV broadcasting. The
successful development of this business depends on several factors, including our ability to deploy
transmitters and negotiate with television channels and large content providers to secure access to
content. If we are not able to deploy the transmitters in a timely manner or receive content as we
anticipate, our ability to expand our operations into this market will be disrupted and our
broadband strategy and business could be materially adversely affected.
In May 2007, we completed the acquisition of companies known as Corbina. Corbina offers
several telecommunications services including FTTB broadband Internet services in several Russian
cities. Our ability to develop broadband service offerings in Moscow will depend on our ability to
integrate Corbina into our operations and to continue to build the business. The development of
Corbina’s business will continue to depend on obtaining the necessary permits to install, upgrade
and operate equipment and to commission networks. Any difficulty or inability to fulfill such
tasks could seriously disrupt our broadband business and our ability to develop our broadband
strategy. Our ability to develop broadband service offerings will also depend on our ability to
compete with companies that are substantially owned by local authorities, which are the authorities
that will be granting some of the necessary permits and licenses. Our competitors may also attempt
to disrupt such activities through regulatory action or connections with regulatory agencies. If we
do not successfully integrate and develop Corbina, our ability to further develop our broadband
strategy will be adversely affected and our business could suffer.
The integration of acquired businesses requires significant time and effort of our senior
management, who are also responsible for managing our existing operations. The integration of new
businesses may be difficult for a number of reasons, including differing management styles, systems
and infrastructure and poor records of internal controls. In addition, integrating acquired
companies may require significant capital expenditures. Further, even if we are successful in
integrating our existing and new businesses, expected synergies and cost savings may not
materialize, resulting in lower than expected profit margins. If we do not realize the expected
synergies and cost savings from the integration of newly acquired companies, our financial
condition, results of operations and prospects could be materially adversely affected.
Failure to install our transmitter on Ostankino television tower in Moscow could disrupt our
television and media business plans
Russian Television and Radio Broadcasting Network (“RTRS”) is the Russian agency responsible
for regulating the operations of television towers in the Russian Federation. We are currently
negotiating with RTRS to install a transmitter on the Ostankino television tower. If we are unable
to successfully negotiate with RTRS to allow us to install the transmitter on the Ostankino tower
then we will need to search for alternative towers on which to install our transmitter. Such
searches may be time consuming and may
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force us to revise our business case for our television and media business. Any such revision of
our business plans for television and media could disrupt our current business and future
development plans for offering media and television services and could have a negative impact on
our future performance.
Any unforeseen changes in the tax laws in Russia or Ukraine could have a material adverse effect on
our business
Our Russian tax burden may become greater than the estimated amount that we have expensed to
date and paid or accrued on our balance sheets. Because of the need for additional sources of
budgetary finance, Russian tax authorities are often arbitrary and aggressive in their
interpretation of tax laws and their many ambiguities, as well as in their enforcement and
collection activities. Many companies are often forced to negotiate their tax bills with tax
inspectors who demand higher taxes than applicable law appears to provide. Any additional tax
liability, as well as any unforeseen changes in the tax law, could have a material adverse effect
on our future results of operations or cash flows in a particular period. Under Russian accounting
and tax principles, financial statements of Russian companies are not consolidated for tax
purposes. As a result, each Russian-registered entity in our group pays its own Russian taxes and
we cannot offset the profits or losses in any single entity against the profits and losses in any
other entity. As a result, our overall effective tax rate may increase as we expand our operations,
unless we are able to implement an effective corporate structure that minimizes the effect of these
Russian accounting and tax norms.
We may encounter difficulties in fully complying with applicable laws due to confusion and
contradictions in the laws and legal structures of the countries where we operate
The application of the laws of any particular country is not always clear or consistent. This
is particularly so in Russia, Ukraine and other CIS countries where the legislative drafting has
not always kept pace with the demands of the marketplace. These countries often have commercial
practices and legal and regulatory frameworks that differ significantly from those in the US and
other Western countries. As a result, it is often difficult to ensure that we are in compliance
with changing legal requirements. If we, any of our ventures, or any of our acquired companies are
found to be involved in practices that do not comply with local laws or regulations, then we may be
exposed, among other things, to significant fines, the risk of prosecution or the suspension or
loss of our licenses, frequency allocations, authorizations or various permissions, any of which
could have a material adverse effect on us.
The Russian Ministry of Telecommunications, the Ukrainian Telecommunications Committee and
Russian Rossvyaznadzor, a Russian governmental body that is responsible for the control and
supervision of information technology and communications, frequently check our compliance with the
requirements of the applicable legislation and our telecommunications licenses. We use our best
efforts to comply with all such requirements. However, we cannot assure you that in the course of
future inspections we will not be found to be in violation of the applicable legislation. Any such
finding could have a material adverse effect on our operations. For example, we received a warning
from Rossvyaznadzor that Sovintel should remedy certain alleged violations in traffic routing. The
allegation followed an inspection by Rossvyaznadzor of an independent operator. We reviewed the
allegations and believe that we are in compliance with our licenses; however, we cannot be certain
that Rossvyaznadzor will concur this.
It may be difficult and prohibitively expensive for us to comply with applicable Russian
telecommunications regulations related to state surveillance of communications traffic. Currently,
Ukrainian authorities are also trying to implement state surveillance of communications traffic.
Full compliance with these regulations that allow the state to monitor voice and data traffic may
be overly burdensome, expensive and lead to a drop in quality of service. Noncompliance may lead to
the imposition of fines or penalties on us, or the revocation of our operating licenses. Further,
some customers may decline to utilize the services of a telecommunications provider whose networks
facilitate state surveillance of communications traffic.
On May 31, 2005, we received a DLD/ILD license in Russia which is valid until May 31, 2012. On
January 16, 2006, we announced that the construction of our FTN was completed in compliance with
the Telecommunications Law and our DLD/ILD license was finally confirmed by Rossvyaznadzor on
November 27, 2006. On December 15, 2006, the Russian Ministry of Telecommunications granted us
access codes to operate our FTN. We have obtained the required governmental permissions for
operation of all of the international and intercity communication transit nodes that are part of
the FTN. Prior to the construction of FTN, we provided domestic and international long distance
services pursuant to other licenses. We believe that we offered such services in compliance with
Russian regulations and legislation.
If regulatory agencies and tax authorities consider that our routing of traffic or offering of
DLD/ILD services violated Russian regulations and legislation, we could be subject to license
suspensions, revocations, fines and penalties. Any of these events could have a material adverse
effect on our operations.
Our telecommunications licenses may not be extended or may be suspended or revoked
Our telecommunications licenses expire in various years from 2008 to 2016. If renewed, our
licenses may contain additional obligations, including payment obligations, or may cover reduced
service areas. If our telecommunications licenses for provision of local, intercity, inter-zonal
and international telephone services are not renewed, our business could be adversely affected.
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Furthermore, regulations adopted to strengthen the Telecommunications Law, effective from
January 1, 2006, provide that the Russian Ministry of Telecommunications may amend the conditions
of a license, which can negatively affect our business by increasing our costs for providing
telephone services. Depending on the growth of our business in other license areas, the failure to
have any other particular license renewed could also materially adversely affect our business.
If we fail to fully comply with specific terms of any of our telecommunications licenses
related to line and operational capacity, investment requirements, territorial or other technical
requirements, payment or reporting obligations, local registrations of our telecommunications
licenses, frequency permissions or other governmental permissions or if we provide our services in
a manner that violates applicable law, Rossvyaznadzor may suspend our licenses, frequency
permissions or other governmental permissions. In the case of continued non-compliance,
Rossvyaznadzor may initiate court proceedings for the revocation of our licenses. If any of our
telecommunications licenses are suspended or terminated or if extensions requested are not granted
or action is taken against our company or our subsidiaries to revoke a license, our business could
be adversely affected.
We may fail to obtain renewals or extensions of our frequency allocations for our earth stations
and other radio frequency equipment that we use in our operations
Our frequency allocations for most of our licensed areas expire on the expiration date of our
corresponding licenses. We cannot predict whether we will be able to obtain extensions of our
frequency allocations and whether extensions will be granted in a timely manner and without any
significant additional costs. It is possible we may be required to reallocate our frequencies upon
the expiration of current allocations. Further, frequency allocations may be granted to other
license holders for the same channels as our frequency allocations, this would require us to
coordinate the use of our frequencies with the other license holders and/or experience a loss of
quality in our network.
If we fail to obtain renewals or extensions of our frequency allocations for parts of our
network based on radio frequencies, which expire on various dates, or if other license holders are
granted overlapping frequencies, our business could be adversely affected.
Certain of our loan agreements contain restrictive covenants
Certain of our loan agreements contain covenants which limit our ability to take certain
actions such as to incur and assume debt and require us to maintain certain financial ratios.
Failure to comply with the covenants could cause a default and result in the debt becoming
immediately due and payable, which would materially adversely affect our business, financial
condition and results of operation.
Item 1B. Unresolved Staff Comments
None
Item 2. Properties
Our Representative Office is located in Moscow, Russia. We own and lease various buildings
and space in buildings throughout Russia, Ukraine, Kazakhstan and Uzbekistan. These premises house
our executive, technical and sales offices, customer care and call centers.
At December 31, 2007, our facilities consist of:
| Russia | ||||||||||||||||||||||||
| (excluding | ||||||||||||||||||||||||
| Moscow | Moscow) | Ukraine | Kazakhstan | Uzbekistan | Total | |||||||||||||||||||
| (in square meters) | ||||||||||||||||||||||||
Lease facilities: |
||||||||||||||||||||||||
Office space |
29,282 | 12,799 | 8,628 | 758 | 1,072 | 52,540 | ||||||||||||||||||
Technical premises |
15,753 | 6,810 | 1,864 | 204 | 400 | 25,032 | ||||||||||||||||||
Total |
45,035 | 19,609 | 10,492 | 962 | 1,472 | 77,572 | ||||||||||||||||||
Owned facilities: |
||||||||||||||||||||||||
Office space |
6,181 | 3,512 | 771 | — | 201 | 10,665 | ||||||||||||||||||
Technical premises |
— | 1,834 | — | — | 400 | 1,834 | ||||||||||||||||||
Total |
6,181 | 5,346 | 771 | — | 601 | 12,499 | ||||||||||||||||||
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These leases expire at various dates through 2017 and generally include renewals at our
options.
Beside these office spaces and technical premises, our facilities consist of
telecommunications installations, including switches of various sizes, cables and VSAT and other
transmission devices located throughout the CIS. We also lease various fiber optic capacities and
the right to use digital circuit between Moscow and Stockholm. We believe that our facilities are
adequate for our current needs.
Item 3. Legal Proceedings
None
Item 4. Submission of Matters to a Vote of Security Holders
None
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PART II
Item 5. Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities
a) Market Information
Our common stock has traded on the NASDAQ Global Select Market (“NASDAQ”) since
September 30, 1999 under the symbol “GLDN”. As a result of the merger, we no longer fulfill the
numerical listing requirements of the NASDAQ. Accordingly, on February 28, 2008 we requested NASDAQ
to file with the United States Securities and Exchange Commission (“SEC”) a Notification of Removal
from Listing and/or Registration under Section 12(b) of the Exchange Act on Form 25. Pursuant to
Rule 12d2-2 under the Exchange Act, the delisting of our common shares from NASDAQ was effective on
March 10, 2008 and our reporting obligations under Section 12(b) of the Exchange Act were suspended
as of that date. Trading of our Common Stock on NASDAQ ceased as of the close of trading on
February 28, 2008. Our Common Stock will be deregistered under Section 12(b) of the Exchange Act no
later than ninety days after the date of the Form 25. We also intend to file with the SEC a
Certification on Form 15 under the Exchange Act to suspend our remaining reporting obligations
under the Exchange Act.
| High | Low | |||||||
2006: |
||||||||
First quarter |
$ | 31.60 | $ | 26.13 | ||||
Second quarter |
32.66 | 21.16 | ||||||
Third quarter |
32.45 | 22.05 | ||||||
Fourth quarter |
48.62 | 29.66 | ||||||
2007: |
||||||||
First quarter |
$ | 60.26 | $ | 44.22 | ||||
Second quarter |
61.94 | 47.20 | ||||||
Third quarter |
81.15 | 55.00 | ||||||
Fourth quarter |
114.85 | 80.00 | ||||||
Performance Graph
The graph below matches the cumulative 5-year total return of holders Golden Telecom, Inc.’s
common stock with the cumulative total returns of the NASDAQ Composite index and the NASDAQ
Telecommunications index. The graph assumes that the value of the investment in the company’s
common stock and in each of the indexes (including reinvestment of dividends) was $100 on December
31, 2002 and tracks it through December 31, 2007.
COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*
Among Golden Telecom, Inc., The NASDAQ Composite Index
And The NASDAQ Telecommunications Index
Among Golden Telecom, Inc., The NASDAQ Composite Index
And The NASDAQ Telecommunications Index
| * | $100 invested on 12/31/02 in stock or index-including reinvestment of dividends. Fiscal year ending December 31. |
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Holders
As of March 14, 2008, there was one holder of record of our common stock.
b) Dividends
During 2006, we paid three quarterly dividends of $0.20 per common share, for a total of $0.60
per common share for the year. We did not pay any dividends during 2007. Our dividend policy is
subject to review and revision by our Board of Directors and any future payments will depend upon
our financial condition, our capital requirements and earnings, as well as other factors our Board
of Directors may deem relevant.
c) Recent Sales of Unregistered Securities
In July 2007, we issued 392,988 unregistered shares of our common stock, par value $0.01, to
OAO Rostelecom (“Rostelecom”) for cash consideration of approximately $20.4 million, or $51.95 per
share of common stock, the closing price on the NASDAQ on May 25, 2007. Rostelecom had the right to
acquire these shares under the Shareholders Agreement dated as of August 19, 2003. This right
became exercisable due to our shares being issued as part of the acquisition of ZAO Cortec. No
underwriter or underwriting discount was involved in the offering. The shares of common stock were
not registered under the Securities Act in reliance on an exemption under Section 4(2) thereof.
For information regarding securities issued under our equity participation plans, see “Item
12. Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters – Equity Compensation Plans
Information”
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Item 6. Selected Financial Data
The following selected historical consolidated financial data at December 31, 2003, 2004,
2005, 2006 and 2007 and for all of the years presented are derived from consolidated financial
statements of Golden Telecom, Inc. (the “Company”) which have been audited by Ernst & Young (CIS)
Limited and Ernst & Young LLC, independent registered public accounting firms.
The data should be read in conjunction with the consolidated financial statements, related
notes, and other financial information included in this document.
| For the Years Ended December 31, | ||||||||||||||||||||||||
| 2003 | 2004 | 2005 | 2006 | 2007 | ||||||||||||||||||||
Statement of Operations Data: |
||||||||||||||||||||||||
Revenues |
$ | 360,534 | $ | 583,978 | $ | 667,379 | $ | 854,617 | $ | 1,292,899 | ||||||||||||||
Cost of revenues (excluding
depreciation and amortization) |
181,085 | 300,588 | 347,532 | 474,389 | 741,361 | |||||||||||||||||||
Gross margin |
179,449 | 283,390 | 319,847 | 380,228 | 551,538 | |||||||||||||||||||
Selling, general and administrative
(excluding depreciation and
amortization) |
64,384 | 112,855 | 119,890 | 152,808 | 241,916 | |||||||||||||||||||
Depreciation and amortization |
45,334 | 74,999 | 84,015 | 100,209 | 140,258 | |||||||||||||||||||
Income from operations |
69,731 | 95,536 | 115,942 | 127,211 | 169,364 | |||||||||||||||||||
Equity in earnings of ventures |
4,687 | 278 | 460 | 1,867 | 1,010 | |||||||||||||||||||
Gain on sale of MCT Corp. |
— | — | — | — | 41,283 | |||||||||||||||||||
Interest income (expense), net |
(872 | ) | 559 | 1,677 | 631 | (8,789 | ) | |||||||||||||||||
Foreign currency gain (loss) |
(232 | ) | 660 | (1,212 | ) | 1,697 | 15,652 | |||||||||||||||||
Minority interest |
480 | 1,506 | 2,978 | 4,808 | 7,610 | |||||||||||||||||||
Provision for income taxes |
17,399 | 30,744 | 37,816 | 40,417 | 58,311 | |||||||||||||||||||
Net income before
cumulative effect of change
in accounting principle |
55,435 | 64,783 | 76,073 | 86,181 | 152,599 | |||||||||||||||||||
Cumulative effect of change in
accounting principle |
— | — | — | 681 | — | |||||||||||||||||||
Net income |
55,435 | 64,783 | 76,073 | 85,500 | 152,599 | |||||||||||||||||||
Net income per share before
cumulative effect of change in
accounting principle – basic |
1.95 | 1.79 | 2.09 | 2.36 | 3.93 | |||||||||||||||||||
Cumulative effect of change in
accounting principle |
— | — | — | 0.02 | — | |||||||||||||||||||
Net income per share – basic |
1.95 | 1.79 | 2.09 | 2.34 | 3.93 | |||||||||||||||||||
Weighted average shares – basic |
28,468 | 36,226 | 36,378 | 36,591 | 38,798 | |||||||||||||||||||
Net income per share before
cumulative effect of change in
accounting principle – diluted |
1.90 | 1.77 | 2.08 | 2.35 | 3.91 | |||||||||||||||||||
Cumulative effect of change in
accounting principle |
— | — | — | 0.02 | — | |||||||||||||||||||
Net income per share – diluted |
1.90 | 1.77 | 2.08 | 2.33 | 3.91 | |||||||||||||||||||
Weighted average shares — diluted |
29,107 | 36,553 | 36,605 | 36,717 | 39,034 | |||||||||||||||||||
Cash dividends per common share |
— | 0.80 | 0.80 | 0.60 | — | |||||||||||||||||||
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| At December 31, | ||||||||||||||||||||
| 2003 | 2004 | 2005 | 2006 | 2007 | ||||||||||||||||
| (in thousands) | ||||||||||||||||||||
Balance Sheet Data: |
||||||||||||||||||||
Cash and cash equivalents |
$ | 65,180 | $ | 53,699 | $ | 67,176 | $ | 18,413 | $ | 74,799 | ||||||||||
Property and equipment, net |
283,110 | 347,891 | 407,907 | 552,341 | 979,498 | |||||||||||||||
Investments in and advances to ventures |
251 | 742 | 10,889 | 11,886 | 15,430 | |||||||||||||||
Goodwill and intangible assets, net |
248,843 | 247,570 | 243,129 | 297,084 | 561,067 | |||||||||||||||
Total assets |
729,226 | 805,768 | 882,211 | 1,107,190 | 1,998,891 | |||||||||||||||
Long-term debt, including long-term
capital lease obligations |
3,963 | 1,738 | 2,367 | 1,620 | 233,288 | |||||||||||||||
Minority interest |
2,722 | 11,738 | 19,693 | 31,263 | 94,177 | |||||||||||||||
Shareholders’ equity |
584,279 | 626,381 | 675,103 | 817,176 | 1,215,062 | |||||||||||||||
Refer to Note 6 to the Consolidated Financial Statements for descriptions of recent
acquisitions that impact the comparability of financial information. Other less recent business
combinations and information not disclosed in the footnotes were as follows:
In February 2004, the Company completed the acquisition of 100% ownership interest in
ST-HOLDING s.r.o. (“ST-HOLDINGS”), a Czech company that owns 50% plus one share in ZAO Samara
Telecom, a telecommunications service provider in Samara, Russia from ZAO SMARTS and individual
owners. In April 2004, the Company completed the acquisition of 100% of the common stock in OAO
Balticom Mobile (“Balticom”) that owns 62% of ZAO WestBalt Telecom, an alternative
telecommunications operator in Kaliningrad, Russia. In April 2004, the Company completed the
acquisition of the remaining 49% ownership interest in Uralrelcom LLC that the Company did not
already own. In May 2004, the Company completed the acquisition of a 54% ownership interest in SP
Buzton (“Buzton”), an alternative telecommunications operator in Uzbekistan. These acquisitions
were purchased for approximately $16.0 million in cash. The results of ST-HOLDINGS have been
included in the Company’s consolidated operations since February 1, 2004. The results of Balticom
have been included in the Company’s consolidated operations since April 30, 2004. The results of
Buzton have been included in the Company’s consolidated operations since May 31, 2004.
The Company’s consolidated financial statements reflect the allocation of the purchase price
based on a fair value assessment of the assets acquired and liabilities assumed, and as such, the
Company has assigned approximately $7.4 million to telecommunications services contracts intangible
assets which are amortized over a weighted average period of approximately 10 years. The excess of
the purchase price over the fair value of the net assets acquired of approximately $2.2 million has
been assigned to goodwill and is not deductible for tax purposes. Approximately $1.9 million of
this goodwill has been assigned to Business and Corporate Services reportable segment and
approximately $0.3 million has been assigned to Carrier and Operator Services reportable segment.
In accordance with Statement on Financial Accounting Standard (“SFAS”) No. 141, “Business
Combinations”, and SFAS No. 142, “Goodwill and Other Intangible Assets”, the Company does not
amortize the goodwill recorded in connection with the above acquisitions. The goodwill is tested
for impairment at least annually.
In August 2003, the Company completed the acquisition of 100% of Sibchallenge Telecom LLC
(“Sibchallenge”), a telecommunications service provider in Krasnoyarsk, Russia. The total purchase
price of approximately $15.4 million consisted of cash consideration of approximately $15.0 million
and approximately $0.4 million in direct transaction costs, including an investment banking fee of
$0.3 million paid to Belongers Limited, an affiliate of Alfa, a shareholder of the Company. The
acquisition of Sibchallenge established GTI’s presence in the Krasnoyarsk region. In addition,
Sibchallenge had numbering capacity and interconnect agreements. The Company’s financial statements
reflect the allocation of the purchase price based on a fair value assessment of the assets
acquired and liabilities assumed and, as such, the Company has assigned approximately $11.2 million
to telecommunications service contracts intangible assets. These identified intangible assets are
amortized over a period of 10 years. There was no goodwill recorded as a result of this
transaction. The results of operations of Sibchallenge have been included in the Company’s
consolidated operations since August 31, 2003.
In December 2003, the Company completed the acquisition of 100% of the shares in OAO Comincom
(“Comincom”) from Nye Telenor East Invest, pursuant to a Share Exchange Agreement. The total
purchase price of approximately $195.3 million consisted of approximately $193.5 million in GTI’s
common stock, representing 7,007,794 shares and direct transaction costs of approximately $1.8
million. The purchase consideration has been determined using the closing date of the transaction
as December 1, 2003. Accordingly, the GTI shares issued in consideration are valued based on the
average closing price of the Company’s common stock for the five consecutive trading days between
November 26, 2003 and December 2, 2003, which was $27.61 per share.
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ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Introduction
Management’s discussion and analysis of financial condition and results of operations (“MD&A”)
is provided as a supplement to the accompanying consolidated financial statements and notes to help
provide an understanding of Golden Telecom Inc.’s financial condition, cash flows and results of
operations, for each of the years ended December 31, 2005, 2006, and 2007. This discussion should
be read in conjunction with the “Selected Financial Data” and our Consolidated Financial Statements
and the notes related thereto appearing elsewhere in this Report. MD&A is organized as follows:
Overview
We are a leading facilities-based provider of integrated telecommunication and Internet
services in major population centers throughout Russia and other countries of the Commonwealth of
Independent States (“CIS”). We offer voice, data and Internet services to corporations, operators
and consumers using our metropolitan overlay network in major cities throughout Russia, Ukraine,
Kazakhstan, and Uzbekistan, and via leased channels and inter-city fiber optic and satellite-based
networks, including approximately 295 access points in Russia and other countries of the CIS as of
December 31, 2007, a 2% increase from 289 access points as of December 31, 2006. In addition, we
offer mobile services in Moscow and the Moscow region and the Ukrainian cities of Kiev and Odessa.
We organize our operations into four business segments, as follows:
| • | Business and Corporate Services (“BCS”) Using our fiber optic and satellite-based networks in and between major metropolitan areas of Russia, Ukraine and other countries of the CIS, we provide business and corporate services including voice and data services to corporate clients across all geographical markets and all industry segments, other than telecommunications operators; | ||
| • | Carrier and Operator Services. Using our fiber optic and satellite-based networks in and between major metropolitan areas of Russia, Ukraine and other countries of the CIS, we provide a range of carrier and operator services including voice and data services to foreign and Russian telecommunications and mobile operators; | ||
| • | Consumer Internet Services. Using our fiber optic and satellite-based networks, we provide Internet access to the consumer market and web content offered through a family of Internet portals throughout Russia, Ukraine, Kazakhstan, and Uzbekistan; and | ||
| • | Mobile Services. Using our mobile networks in Moscow and in Kiev and Odessa, Ukraine, we provide mobile services with value-added features, such as voicemail, roaming and messaging services on a subscription and prepaid basis. |
We intend, wherever possible, to offer all of our integrated telecommunication services under
the Golden Telecom brand, although, some services still carry local brands because of recent
acquisitions. Our dial-up Internet services are distributed under the ROL brand in Russia,
Kazakhstan and Uzbekistan and under the Svit-On-Line brand in Ukraine. In addition, we offer WiFi
services in Moscow under the Golden WiFi brand. We also offer broadband Internet access in Moscow,
St. Petersburg, Yaroslavl, Tula, Rostov-on-Don, Saratov, Orenburg, Volgograd and Kaluga under the
Corbina Telecom brand.
Most of our revenue is derived from high-volume business customers and carriers. Our business
customers include large multi-national companies, local enterprises, financial institutions, hotels
and government agencies. We also believe that carriers derive a portion of their business from
high-volume business customers. Thus, we believe that the majority of our ultimate end-users are
businesses that require access to highly reliable and advanced telecommunications facilities to
sustain their operations.
Traditionally, we have competed for customers on the basis of network quality, customer
service and range of services offered. During the past several years, other telecommunications
operators have also introduced high-quality services to the segments of the business market in
which we operate. Competition with these operators is intense, and frequently results in declining
prices for some of our services, which adversely affect our revenues.
In 2007, we continued to experience growth in our main lines of business and benefited from
strong macro-economic growth in the markets where we operate. Despite being faced with challenges
of continued changes in the regulatory and telecommunications environment in Russia and Ukraine, we
remained focused on developing our business through organic growth, acquisitions, and the expansion
of our services.
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Acquisitions
We continue to pursue consolidation opportunities through selective acquisitions that will
allow us to expand our geographical reach, add to our service offerings, and improve our market
share while maintaining operational control. Below is the list of our acquisitions, which occurred
in 2005, 2006 and 2007. Refer to Note 6 in the financial statements included in Item 8 of this
report for more details about acquisitions occurring in 2005, 2006, and 2007.
| Ownership | Purchase | |||||||||||||
| Date of | interest | price | ||||||||||||
| Company | Location | Activity | acquisition | acquired | (in millions)(1) | |||||||||
2005 |
||||||||||||||
Dicom LLC
|
Moscow | Early-stage wireless broadband enterprise |
March 2005 | 75 | % | $ | 0.5 | |||||||
Sakhalin Telecom LLC
|
Far East region of Russia | Fixed line alternative operator |
September 2005 | 60 | % | 5.0 | ||||||||
Antel Rascom Ltd.
|
North West region of Russia | Telecommunications company |
October 2005 | 49 | % | 10.0 | ||||||||
ZAO Sochitelecom
|
Krasnodar region of Russia | Fixed line alternative operator |
October 2005 | 100 | % | 2.1 | ||||||||
Antel Rascom Ltd.
|
North West region of Russia | Telecommunications company |
December 2005 | 5 | % | 1.1 | ||||||||
| $ | 18.7 | |||||||||||||
2006 |
||||||||||||||
ZAO Tatar Intellectual Communications |
Republic of Tatarstan | Internet service provider |
March 2006 | 70 | % | $ | 4.0 | |||||||
TTK LLC
|
Ivano-Frankovsk region of Ukraine | Fixed line alternative operator |
April 2006 | 100 | % | 3.8 | ||||||||
Kubtelecom LLC
|
Krasnodar region of Russia | Fixed line alternative operator |
June 2006 | 74 | % | 14.0 | ||||||||
Telcom LLC
|
Nizhny Novgorod | Fixed line alternative operator |
August 2006 | 100 | % | 1.7 | ||||||||
ZAO Corus ISP
|
Ekaterinburg | Internet Services Provider |
October 2006 | 100 | % | 1.2 | ||||||||
S-Line LLC
|
Kiev | Early-stage wireless broadband enterprise |
October 2006 | 75 | % | 7.5 | ||||||||
| $ | 32.2 | |||||||||||||
2007 |
||||||||||||||
Fortland Limited
|
Moscow | Early-stage digital video broadcast enterprise |
February 2007 | 65 | % | $ | 51.7 | |||||||
ZAO Telecommunication Agency |
Perm | Fixed line alternative telecommunications operator |
April 2007 | 100 | % | 4.5 | ||||||||
ICA Center of
Commercial Real Estate
LLC
|
Moscow | Real estate | May 2007 | 100 | % | 9.8 | ||||||||
ZAO Cortec
|
Moscow | Telecommunications company |
May 2007 | 51 | % | 196.9 | ||||||||
ZAO DirectNet
|
Moscow | Fixed line alternative telecommunications operator |
June 2007 | 100 | % | 1.9 | ||||||||
ZAO Satcom Tel
|
Moscow | Fixed line alternative telecommunications operator |
June 2007 | 100 | % | 0.3 | ||||||||
Alcar LLC
|
Moscow region | WiFi enterprise | June 2007 | 75 | % | 1.9 | ||||||||
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| Ownership | Purchase | |||||||||||||
| Date of | interest | price | ||||||||||||
| Company | Location | Activity | acquisition | acquired | (in millions) | |||||||||
Satel Tsentr LLC
|
Moscow region | Early stage WiFi enterprise |
August 2007 | 75 | % | 1.9 | ||||||||
TeleRoss joint ventures
|
Different regions of Russia | Fixed line alternative telecommunications operators |
August-September 2007 |
50 | % | 2.5 | ||||||||
ZAO Bryansktel
|
Bryansk | Fixed line alternative telecommunications operator |
December 2007 | 100 | % | 2.2 | ||||||||
BryanskIntel LLC
|
Bryansk | Cable TV and local telephony service provider | December 2007 | 100 | % | 3.4 | ||||||||
New Telecom Technologies LLC |
Krasnodar | Provider of integrated telecommunications and Internet services | December 2007 | 100 | % | 1.3 | ||||||||
Skat-7 LLC
|
Cherepovets | Fixed line alternative telecommunications operator |
December 2007 | 100 | % | 7.5 | ||||||||
| $ | 285.8 | |||||||||||||
(1) Including acquisition-related costs and debt assumed
These acquisitions enabled us to realize new opportunities in Russia and Ukraine, which
provided us with strategic and financial benefits associated with a larger customer base and
expanded network coverage, increased our access to critical infrastructure, which included last
mile infrastructure and digital video broadcast technology, and furthered our consumer markets
strategy.
Regulatory Developments
On January 1, 2004, a new Law on Communications (the “Telecommunications Law”) came into
effect in Russia. The Russian government approved in March 2005 new rules for interconnection (the
“Interconnection Rules”) that became effective on January 1, 2006. These Interconnection Rules
contemplate a new three-layer interconnection system consisting of domestic long distance,
international long distance (“DLD/ILD”), zonal, and local operators. Under this structure,
end-users have the right to choose a long distance operator, and DLD/ILD operators will be required
to have interconnection points in each of the 88 constituent territories of the Russian Federation.
In addition, the Telecommunications Law created a universal service fund (“USF”) charge, which
became effective on May 3, 2005, calculated as 1.2% of revenue telecommunication services provided
to end users. We have incurred approximately $7.0 million in USF charges for year ended December
31, 2007. On December 29, 2006, the Russian President approved amendments to the Telecommunications
Law setting forth essential criteria of the USF charge. These amendments became effective on
January 1, 2007.
On May 31, 2005, we received a DLD/ILD license in Russia which is valid until May 31, 2012.
We were required under the license to begin providing services and fulfill the network requirements
specified in the Interconnection Rules not later than May 31, 2007. On January 16, 2006, we
announced that the construction of our Federal Transit Network (“FTN”) was complete in compliance
with the Telecommunications Law and our DLD/ILD license. The FTN consists of four international
communications transit nodes, seven intercity communications transit nodes deployed in each federal
district of Russia, and 88 connection points or FTN access nodes located in each constituent
territory of Russia. We have obtained the required governmental permissions for operation of all
the international and intercity communications transit nodes that are part of the FTN. On April
28, 2006, all of the 88 connection points were formally commissioned by Rossvyaznadzor, a
governmental body that reports to the Ministry of Information Technologies and Communications of
the Russian Federation (the “Russian Ministry of Telecommunications”) that is responsible for the
control and the supervision of information technology and communications as well as for
commissioning the long distance networks. In March 2007, Russian President Putin signed an order,
with an immediate effect, to merge Rossvyaznadzor with Rosokhrankultura, a body which protects
culture and supervises media issues. On June 29, 2006, we announced that we have entered into
interconnection agreements with all Russian zonal incumbent fixed line telecommunications
operators. On December 15, 2006, the Russian Ministry of Telecommunications granted us access codes
to operate our FTN. On January 29, 2007, we launched DLD/ILD services using our FTN.
On March 4, 2006, the Russian President approved amendments to the Telecommunications Law that
introduced calling party pays rules (“CPP Rules”). Effective July 1, 2006, under the CPP Rules,
generally all incoming calls, on fixed and mobile lines, in Russia are free of charge, and only the
fixed line or mobile operators originating the call may charge the customer for the call.
Subscribers of fixed line telephones did not pay for incoming calls and, therefore, the CPP Rules
will not have an impact on fixed-to-fixed line calls, but the CPP Rules impact the fixed-to-mobile
calls as mobile companies traditionally charged for incoming calls in Russia. For the
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year ended December 31, 2007, we have recorded approximately $84.8 million in additional
revenue. However, this increase in revenue was partially offset by approximately $63.8 million in
additional cost of revenue due to the introduction of termination charges to mobile networks.
On September 26, 2007, the Russian Ministry of Telecommunications issued an order that
designated an additional 10 pairs of access codes which may be assigned to long-distance operators.
This potentially creates conditions for increased competition in the market for domestic and
international long-distance services if new access codes are assigned to new operators.
On October 12, 2007, the Government of the Russian Federation approved amendments to the
existing interconnection rules. Under the new rules, mobile operators can transmit all incoming
calls to direct mobile numbers from the local fixed line networks through their own zonal networks.
Furthermore, the service of interconnection point is no longer considered part of the services of
interconnection and therefore will not be charged.
In March 2006, the Ukrainian government submitted to the Ukrainian Parliament (“Verkhovna
Rada”) a draft law introducing a USF charge in Ukraine, calculated as 2% of revenue. In September
2006, this draft law was amended to make a USF charge in Ukraine effective January 1, 2008.
In April 2006, the National Commission of Communication’s Regulation (“NCCR”) issued a license for
GSM-1800 radio frequency to Golden Telecom (Ukraine) (“GTU”), our subsidiary in Ukraine. Currently,
GTU provides services in Kiev and Odessa. The new license will enable GTU to offer mobile services
in 22 out of the remaining 25 regions of Ukraine that GTU does not currently cover. Payment of the
$5.5 million license fee was made on May 10, 2006. In May 2006, we began using the frequencies and
submitted registration documents to UkrChastotNadzor, a Ukrainian governmental body responsible for
the control and the supervision of the radio frequencies. To date, we have complied with the
license requirements related to the use of allocated radio frequencies by launching operations in
16 out of 22 regions.
Effective July 15, 2006, the NCCR introduced new tariffs for provision of voice services to
fixed line subscribers. As a result of the tariff re-balancing policy, the tariffs for local calls
and monthly fees increased and tariffs for DLD/ILD calls decreased. Effective November 1, 2006, the
NCCR continued the tariff re-balancing process by increasing the tariffs for local calls and
monthly fees and by decreasing the tariffs for fixed-to-mobile calls. On October 28, 2006, the
Verkhovna Rada approved the amendments to the Ukrainian Law on Telecommunications which changed the
list of the telecommunication service tariffs subject to the public regulation. Under new
regulation, tariffs for DLD/ILD calls were excluded from the public regulation. The amendments also
exclude fixed-to-mobile calls from the public tariff regulation. As a result of these changes, we
expect increased competition from the incumbent operators in DLD/ILD services market.
Effective January 1, 2007, the NCCR introduced new interconnection settlement rules. During
2006, we paid fixed monthly fees for interconnection lines with other operators. However, under the
new rules the settlements will be based on the actual volume of traffic. As a result of these
changes, cost of revenue of our local voice services increased, however the negative variance is
partially offset by additional revenue stream for the traffic termination to our network.
Other Developments
Historically, our tariffs have been linked to the United States dollar (“USD”). Since early
2000 the Russian ruble (“RUR”) exchange rate against the USD has become relatively stable and has
appreciated in 2005, 2006 and during 2007. In the second and the third quarters of 2006, EDN
Sovintel LLC (“Sovintel”) introduced semi-fixed USD – RUR exchange rate for settlements with the
majority of its customers. This rate is effective only if the official USD exchange rate set by the
Central Bank of Russia (“CBR”) is below the fixed level. If the RUR depreciates against USD so that
the CBR exchange rate exceeds the semi-fixed level, Sovintel will resume applying the CBR exchange
rate, or floating rate, for settlements with its customers. However, most of our direct competitors
continue to link their prices to the USD payable at the CBR exchange rate, so when the RUR
appreciates, their prices effectively become lower in the RUR terms in relation with our prices. As
a result, if the RUR appreciates against USD so that the CBR exchange rate significantly differs
from the fixed level, Sovintel may lower the fixed level in order to respond to the pricing
pressure from its competitors. Following the introduction of the semi-fixed USD – RUR exchange rate
for settlements with its customers, Sovintel introduced the same exchange rate mechanism for
settlements with its employees related to salaries, bonuses and unused vacation accrual effective
August 1, 2006.
In September 2005, we granted stock appreciation rights (“SARs”) to our Chief Executive
Officer (“CEO”) with respect to 200,000 shares of our common stock, at a share price which was the
closing price of our common stock on the NASDAQ Global Select Market (“NASDAQ”) on July 19, 2005
(“CEO Granting Share Price”), which was $29.83, one-third of which vests and becomes nonforfeitable
on each of the first three anniversary dates from September 1, 2005, provided the CEO remains
continuously employed by us until each such relevant date. The SARs become fully vested if there is
a change in control, which occurred in February 2008. If, before February 28, 2009 and during the
CEO’s period of employment with us, the average closing stock price of one share of our common
stock on the NASDAQ, exceeded $50.00 during any thirty day consecutive period, the CEO would be
granted SARs for an
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additional 200,000 shares of our common stock at the CEO Granting Share Price, which SARs would be
fully vested upon issuance. On February 3, 2007, our common stock achieved the $50.00 threshold and
CEO was granted additional fully vested SARs in respect of 200,000 shares of our common stock. The
SARs granted do not have a contractual term. However, all SARs shall be cancelled, and we shall
make a payment to the CEO upon the termination of employment for any reason with respect of the
SARs vested. The SARs provide for a cash only settlement and the related obligation is recorded as
a liability in the consolidated financial statements.
In December 2005, we granted SARs with respect to 851,800 shares of our common stock to senior
management and other employees, of which 104,800 were forfeited by employees who resigned during
2006 and 30,600 were forfeited by employees who resigned during 2007. The SARs were granted
pursuant to the Golden Telecom, Inc. 2005 Stock Appreciation Rights Plan (“2005 SAR Plan”) and the
EDN Sovintel Stock Appreciation Rights Bonus Plan (“Sovintel SAR Plan”) at a share price which is
the lower of: (i) the average between the high and low sales price per share of common stock on the
grant date, or in case no such sale takes place on the grant date, the last date on which a sale
occurred or (ii) the average closing sales price per share of our common stock for the fourteen
trading days immediately preceding such date, which was $26.808 (“Granting Share Price”).
Seventy-five percent of the SAR grant shall be subject to time vesting, one-third of which shall be
and become vested and nonforfeitable on each of the first three anniversary dates from December 12,
2005, provided that the employee remains continuously employed by us until each such relevant date.
The Granting Share Price shall increase by five percent on each anniversary date after December
12, 2005, in association with the SARs that shall be and become vested and nonforfeitable on each
such anniversary date. Twenty-five percent of the SARs granted were subject to performance vesting
upon our common stock achieving a closing trading price of at least $50.00 per share for thirty
consecutive days as determined in our sole discretion. On February 22, 2007, our common stock
achieved the $50.00 threshold and the performance vesting SARs became fully vested. The SARs have a
contractual term of 5 years. The aggregate number of shares of common stock which may be issued
pursuant to the 2005 SAR Plan at the discretion of the grantees shall be 200,000 shares. The SARs
issued pursuant to the Sovintel SAR Plan provide for a cash only settlement. The related obligation
is recorded as a liability in the consolidated financial statements.
In 2006, we granted SARs with respect to 177,000 shares of our common stock to senior
management, of which 10,000 were forfeited by a senior manager who resigned during 2006 and 18,000
were forfeited by senior management who resigned during 2007. The SARs were granted pursuant to the
2005 SAR Plan at the weighted-average exercise price of $27.94.
We established the 1999 Equity Participation Plan of Golden Telecom, Inc. (the “Equity Plan”)
and granted stock options to key employees and members of our the Board of Directors. In April
2007, the Compensation Committee of the Board of Directors recommended and the Board of Directors
approved an amendment to the Equity Plan to increase the number of shares available under the
Equity Plan by 1,000,000. The decision of the Board of Directors was ratified by our shareholders
on May 17, 2007. Under the Equity Plan not more than 5,320,000 shares of common stock (subject to
anti-dilution and other adjustment provisions) are authorized for issuance upon exercise of options
or upon vesting of restricted or deferred stock awards. As of December 31, 2007, there were
1,893,350 securities remaining available for future issuance under the Equity Plan.
On June 27, 2007, the terms of the outstanding SARs issued under the 2005 SAR Plan and the
Sovintel SAR Plan were modified to cap the maximum payout to the employee at the closing sales
price per share of our common stock on the NASDAQ on June 27, 2007, or $53.80. On June 27, 2007,
the participants of the 2005 SAR Plan, the Sovintel SAR Plan, and the SARs granted to the CEO
outside of these plans, were granted 829,950 stock options (one stock option for every capped SAR)
with essentially the same terms as the capped SARs with the exercise price of $53.80. This new
arrangement helped us to minimize potential earnings volatility resulting from movements in the
stock price as the costs related to the stock option plan are not subject to revaluation as of the
end of each reporting period as were the SARs.
On June 28, 2007, our Board of Directors approved and we granted 621,870 options to senior
management and key employees. Under the terms of the Equity Plan the options were granted at a
share price which was the closing sales price per share of the our common stock on the NASDAQ on
the date immediately preceding the date of grant, which was $53.80 (“Option Granting Share Price”).
Seventy-five percent of the options grant shall be subject to time vesting, one-third of which
shall be and become vested and nonforfeitable on each of the first three anniversary dates from the
grant date, provided that the employee remains continuously employed by us until each such relevant
date. The Option Granting Share Price shall increase by five percent on each anniversary date after
the grant date in association with the options that shall be and become vested and nonforfeitable
on each such anniversary date. Twenty-five percent of the options granted are subject to market
condition vesting upon our common stock achieving an average closing trading price of at least
$82.15 per share for thirty consecutive days as determined in our sole discretion. On October 18,
2007, our common stock achieved the $82.15 threshold and the market condition stock options became
fully vested. The options have a contractual term of five years and were to be settled in stock
only, but in connection with our merger in February 2008, the options were converted into the right to
receive $105 in cash less the exercise price. The right to receive cash continue to vest in
accordance with their vesting schedule.
In January 2008, stock options were granted to Corbina’s employees with respect to
3.99% of Corbina’s share capital under the 2007 Corbina Stock Option Plan approved by
Corbina’s Board of Directors at the general shareholder’s meeting on December 11, 2007.
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During the fourth quarter of 2006, we revised our estimate of allowance for doubtful accounts
to reflect changes in the business, recent historical collections experience and other currently
available evidence. The change in accounting estimate increased net income for the year ended
December 31, 2006 by approximately $2.4 million, net of tax (equivalent to $0.07 per common share –
basic diluted).
Sovintel was engaged in litigation with a minority shareholder of Kubtelecom LLC
(“Kubtelecom”) in regard to the shareholder’s claim that the shareholder’s pre-emptive right to
acquire 74% ownership in Kubtelecom was breached. On December 4, 2006, the first instance court
ruled in favor of the minority shareholder. On March 14, 2007, the second instance court ruled in
favor of Sovintel by dismissing the minority shareholder’s claim. The minority shareholder
appealed this ruling and on April 18, 2007, the third instance court ruled in favor of Sovintel.
The shareholder appealed to the Supreme Arbitration Court of the Russian Federation and on July 11,
2007, the court denied the claim. The shareholder apparently failed to meet the deadline of October
18, 2007 to file a new claim with the Supreme Arbitration Court of the Russian Federation. On
December 28, 2007, the minority shareholder filed an application of withdrawal from Kubtelecom as
of which date the 16.54% share of the minority shareholder were transferred to Kubtelecom by
operation of law. Kubtelecom is obligated to pay to the former minority shareholder the value of
the share in the amount of approximately $2.3 million not later than June 30, 2008.
Sovintel is engaged in litigation with the Russian tax inspectorate in regard to claims issued
by the tax inspectorate on September 25, 2006. The Russian tax inspectorate claimed that Sovintel
owes taxes, fines and penalties in the amount of approximately $24.1 million for the years ended
December 31, 2004 and 2005. On October 4, 2006, Sovintel filed a lawsuit against the tax
inspectorate disputing the claims. Court hearings were held between November 8, 2006 and March 19,
2007. On April 3, 2007, the first instance court ruled in favor of Sovintel by dismissing the tax
inspectorate’s claim. On April 28, 2007, the tax inspectorate appealed this decision. On July 16,
2007, the second instance court ruled in favor of Sovintel by dismissing the tax inspectorate’s
claim. The tax inspectorate appealed this decision in the third instance court. The court hearing
of the third instance court held on October 25, 2007 delayed consideration of the case by the third
instance court until April 10, 2008. Currently, we do not consider an unfavorable
outcome probable for this claim.
We were engaged in a regulatory dispute with the NCCR over a license, recorded at
approximately $13.3 million, for wireless broadband radio frequencies issued to S-Line LLC
(“S-Line”), our 75% owned Ukrainian subsidiary. On April 18, 2007, the first instance court ruled
in favor of S-Line obliging the NCCR to re-register the license. NCCR appealed this decision and on
August 3, 2007 the second instance court ruled in favor of NCCR. On August 8, 2007, S-Line filed
an appeal of this decision to the Supreme Administrative Court of Ukraine. On September 11, 2007,
the Supreme Administrative Court of Ukraine upheld the decision of the first instance court
obliging the NCCR to re-register the license. Following the decision of the Supreme Administrative
Court, NCCR took a decision on October 18, 2007 to re-register the license to S-Line and the
license was re-registered shortly thereafter.
In July 2007, we issued 392,988 unregistered shares of common stock, par value $0.01, to OAO
Rostelecom (“Rostelecom”) for cash consideration of approximately $20.4 million, or $51.95 per
share of common stock, the closing price on the NASDAQ on May 25, 2007. Rostelecom had the right to
acquire these shares under the Shareholders Agreement dated as of August 19, 2003. This right
became exercisable because of the shares issued as part of the acquisition of ZAO Cortec and its
subsidiaries (“Corbina”).
In July 2007, TeliaSonera Acquisition Corp. acquired MCT Corp. (“MCT”) in a merger
transaction. GTS Mobile Services, Inc. (“GMS”) owned approximately 22.8% of MCT. GMS tendered its
shares in MCT and received cash consideration of approximately $41.3 million. GMS may receive up to
an additional $7.2 million upon the satisfaction of certain conditions. Our investment in MCT had a
carrying value of zero, therefore the amount received was recorded as a gain in the consolidated
statement of operations.
On December 21, 2007, we entered into an Agreement and Plan of Merger (the “Merger Agreement”)
with VimpelCom Finance B.V. (“Parent”) and Lillian Acquisition, Inc. (“Merger Sub”). Merger Sub
commenced a tender offer to purchase, at a price of $105.00 per share in cash without interest (and
less any amounts required to be deducted and withheld under any applicable law), any and all
outstanding shares of our common stock, par value $0.01 per share (the “Common Stock”) on the terms
and subject to the conditions specified in the offer to purchase dated January 18, 2008, as amended
(the “Offer to Purchase”) and related letter of transmittal (which, together with any supplements
or amendments thereto, collectively constitute the “Offer”). The Offer closed on February 27, 2008
and we became a majority owned subsidiary of Merger Sub.
On February 28, 2008, we and Merger Sub filed a Certificate of Ownership and Merger pursuant
to which the Merger Sub was merged with and into us (the “Merger”). As a result of the Merger, we
will continue as the surviving corporation and will be a direct wholly owned subsidiary of Parent
and an indirect wholly owned subsidiary of OAO Vimpel Communications (“VimpelCom”).
As a result of the Merger, we no longer fulfill the numerical listing requirements of the
NASDAQ. Accordingly, on February 28, 2008, at our request, NASDAQ filed with the SEC a
Notification of Removal from Listing and/or Registration under Section 12(b) of the Exchange Act on
Form 25. Pursuant to Rule 12d2-2 under the Exchange Act, the delisting of the Shares from NASDAQ
was effective on March 10, 2008 and our reporting obligations under Section 12(b) of the Exchange
Act were suspended as of that date. Trading of our Common Stock on NASDAQ ceased as of the close of
trading on February 28, 2008. Our Common Stock will be
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deregistered under Section 12(b) of the Exchange Act no later than ninety (90) days after the date
of the Form 25. We also intend to file with the SEC a Certification on Form 15 under the Exchange
Act to suspend our remaining reporting obligations under the Exchange Act.
Highlights and Outlook
Since early 2000 we have witnessed a recovery in the Russian market, but downward pricing
pressures persist from increased competition and the global trend toward lower telecommunications
tariffs. In 2006 and during 2007, our traffic volume increases exceeded the reduction in tariffs on
certain types of voice traffic. This is a contributing factor to the increases in our revenue in
2006 and during 2007. We expect that this trend of year over year increases in traffic volume will
continue as long as the Russian economy continues to develop at its current pace. Although our
revenue growth is strong, our overall margins continue to be impacted by price increases for
services received from monopolistic incumbent operators and competition from other carriers.
In order to handle additional traffic volumes, to mitigate decline in traffic margins, reduce
our unit transmission costs and ensure sufficient capacity to meet the growing demand for data and
Internet services, we have expanded and will continue to expand our fiber optic capacity along our
heavy traffic and high cost routes. We expect to continue to add additional transmission capacity,
which due to its fixed cost nature, can initially lower the margins, however over time will allow
us to improve or maintain our margins.
In October 2006, we launched a rebranding campaign that featured a change in our logo, color
scheme and slogan “Achieve more!” The new brand is primarily targeted at retail customers and
maintains various products under one “master” brand, driving up general brand recognition and
opportunities for cross-selling. Total costs for the campaign were approximately $2.5 million.
In January 2007, we entered into a lease agreement for STM-64 fiber optic capacity, which
provides for the right of use of eight communication channels between Moscow and Stockholm. We took
the possession of all eight channels by the end of 2007. This contract enables us to connect our
operations between Russia and Sweden. In February 2007, we entered into a lease agreement for STM-1
fiber optic capacity from Ufa to Krasnoyarsk through Ekaterinburg, Chelyabinsk, Tyumen, Omsk and
Novosibirsk with an option to upgrade this line to STM-4 capacity. We took the possession of this
fiber optic capacity on April 1, 2007. This agreement will enable us to connect our operations in
the European part of Russia with our operations in Siberia. In August 2007, we entered into a lease
agreement for STM-1 fiber optic capacity from Krasnodar to Sochi and we took the possession of this
fiber optic capacity in December 2007. In December 2007, we entered into a lease agreement for
STM-1 fiber optic capacity from Vladivostok to Khabarovsk and we plan to take the possession of
this fiber optic capacity in the first quarter of 2008. This agreement will enable us to strengthen
our market presence in far-eastern part of Russia. In January 2008, we entered into a lease
agreement for STM-64 fiber optic capacity, which provides us for the right of use of nine
additional communication channels between Moscow and Stockholm. We plan to take the possession of
these channels in stages throughout the year 2008.
We continue to follow our strategy of regional expansion. The project for the construction of
the Russian inter-city fiber optic link that was launched in the middle of 2004, continued through
the fourth quarter of 2007. To date, we have completed construction of the inter-city fiber optic
cable line from Moscow to Ufa through Nizhny Novgorod and Kazan, under a commercial agreement with
VimpelCom. In addition, we completed construction of the Oktyabrsky to Samara through Togliatti,
Samara to Saratov, and from Samara to Uralsk in northern part of Kazakhstan inter-city fiber optic
links. We completed construction of the fiber optic link between Kamensk-Shakhtinsky in the
southern part of Russia and Lugansk in the eastern part of Ukraine. To date, we invested
approximately $36.4 million in these projects. In September 2006, we entered into an agreement with
VimpelCom which allows us to use the fiber optic cable line from Moscow to Krasnodar through
Voronezh and Rostov-on-Don constructed by VimpelCom. In 2007, we also entered into agreement with
VimpelCom that allows us to use the fiber optical cable line STM-64 from Moscow to Rostov-on-Don,
Volgograd, Saratov, Samara, Nizhniy Novgorod and back to Moscow, as well as STM-1 from Tula to
Kaluga and STM-1 from Moscow to Yaroslavl. Furthermore, by the second quarter of 2008, we will have
the right to use optical cable line STM-4 from Ufa through
Ekaterinburg to Chelyabinsk.
Additionally, in 2007, we started construction of a fiber optic link from Ufa to Perm, which we
plan to complete by the end of the second quarter of 2008. These projects are intended to connect
our operations in the European part of Russia to our backbone network, and we plan to invest a
total of approximately $39.0 million in these and related backbone projects by the end of 2008.
In Ukraine, we completed construction of a national fiber optic STM-16 capacity network,
connecting 16 regional centers with cross border connections to Hungary and Poland. We completed
construction of the fiber optic links from Uzhgorod to Lvov with connection to the Hungarian
border, from Lvov to Kiev through Lutsk, Rovno and Zhitomir, and from Kiev to Kharkov through
Chernigov and Sumy with connection to the Russian border. This network became operational in the
second quarter of 2007.
The fiber optic cable communication lines are new generation networks that enable us to
provide high quality Internet access, data and voice services. Development of our fiber optic
network is part of our broadband access rollout strategy. In addition, it allows us to enter the
long distance communication market and take advantage of our DLD/ILD license. Introduction of our
own fiber optic communication lines, will enable us to optimize and significantly reduce our
expenditures associated with the lease of trunk channels
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from other operators, offer competitive rates on Internet and voice services to the end users in
the regions, and maintain traditionally high quality services offered.
The rapid growth of the telecommunications market in Russia, Ukraine, and the CIS is fueled by
macroeconomic growth and the inflow of direct foreign investment. We anticipate that the economic
growth in these markets will create additional demand for telecommunications services.
Additionally, in line with worldwide trends, we are starting to observe new customer demands for
more sophisticated telecommunications and Internet services as well as for other new technologies.
We are responding to these customer demands by testing and implementing new technologies such as
WiFi, voice over Internet protocol (“VoIP”), Digital Video Broadcast-Terrestrial (“DVB-T”) wireless
local loop and high-speed consumer Internet. Such new technologies will remove some of the barriers
to access that some of our customers currently face. For example, wireless local loop allows us to
connect remote customers to our network by bypassing the incumbents’ wire network and provide
higher quality access.
We continue to seek growth opportunities organically, through selective acquisitions, and
through the development of new product lines. Although, our research indicates that the
telecommunications services sector in business segments in the Moscow and St. Petersburg markets of
fixed telecommunications services will continue to grow, we believe that the bulk of our growth
will come from key regional cities. Recent acquisitions gave us a commercial presence in more than
80 cities including 18 out of the 20 largest cities in Russia, which represents, approximately,
more than 60% of the total fixed-line telecom market in Russia.
To minimize the impact of payments to the incumbent operators, we have received licenses to
provide zonal services in all the regions of the Russian Federation. During 2006 and 2007, we
started construction of zonal networks in 28 regions of the Russian Federation. To date, we have
completed construction of zonal networks in 25 regions, including among others Moscow, St.
Petersburg, Nizhny Novgorod, Kaliningrad, Samara, Sakhalin, Voronezh, Krasnodar, Krasnoyarsk,
Khabarovsk, Primorsky territory, Orel, Sverdlovsk, Leningrad, Tula, Samara, Volgograd and
Irkutsk regions. We started to generate revenues and cost savings from the operations of our zonal
networks in the third quarter of 2007. Furthermore, we received permissions of use for three zonal
transit switches in Tyumen, Volgograd and Bryansk regions in 2007. However, in those regions
where we did not complete construction of zonal networks, we will be required to act as an agent
for zonal carriers, bill clients for intra-zonal calls and collect payments on behalf of the zonal
operators.
We will continue to align the strategy of each of our business segments with market forces in
the countries where we operate. In BCS, our strategy is to maintain and grow our market share
through attractive service offerings supported by excellent customer care. We are focused on
expanding into the regions as well as the fast growing small and medium enterprises (“SME”) and the
small office, home office (“SOHO”) markets. In those cases where the potential SME and SOHO
customer is not on our network, our ability to fully benefit from growth in these market segments
largely depends on the regulatory situation and our ability to obtain access to the copper networks
and other infrastructure of the incumbent operators under reasonable terms and conditions. The
acquisition of Corbina significantly increases our presence in the Moscow SME/SOHO
telecommunications market. In 2007, we introduced the national “800” toll free phone numbers to our
corporate clients and established a 15% market share in Russia within a few weeks of introduction.
On December 25, 2007, we opened a new call center in Kaluga to provide outsourcing services to our
corporate clients, such as incoming call processing, marketing research, telemarketing, and debt
collection services.
Our recently constructed FTN and receipt of access codes also present new opportunities for
growth. Our FTN provides us with a potential customer base of up to 2.2 million businesses, 143
million people, of which 32 million are residential customers, in the 88 Russian regions across all
geographic zones in the Russian Federation. This is an increase from our previous extent of
coverage which only allowed us to reach 25 regions in Russia with up to 0.3 million businesses and
a population of 77.1 million people. We launched our FTN based DLD/ILD services in January 2007,
mainly targeting wholesale customers. Moreover, we started to offer DLD/ILD services to corporate
customers not directly connected to our network. In March 2007, we started offering DLD/ILD
services on a pre-paid basis to residential customers in several regions of Russia. Due to the
existing client base, an effective marketing campaign and a highly-skilled and experienced direct
and indirect sales force, we captured approximately 26% market share of the total DLD/ILD market in
Russia.
In Carrier and Operator Services, our strategy focuses on partnering with more operators in
the regions to enhance our traffic termination capabilities. We have also launched additional
value-added products for our carrier partners that strengthen our leading position in the Russian
and CIS markets. These new products are designed to offer “best quality” voice and data transport
to ensure greater customer loyalty while protecting margins. In December 2007, we signed
partnership agreements with leading European Internet exchangers DECIX in Frankfurt and LINX in
London. These agreements allow us to get an access to Internet traffic exchange points in Europe
and achieve significant cost savings and increase IP traffic of Internet services, provided to our
customers. We plan to sign additional partnership agreements with Internet exchangers in Amsterdam
and New York in 2008.
In Consumer Internet Services, we recognize that new technologies are making their way into
Russia, Ukraine, and the CIS. We expect that broadband competition and replacement will increase in
the future, the dial-up margins will continue to decline over time due to decline in average
revenue per subscriber and as a result of the introduction of origination fees. Broadband rollout
is a cornerstone of our strategy in Consumer Internet Services segment. We continued to develop our
broadband service offerings with
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deployment of broadband solutions in major cities of Russia, Ukraine, Kazakhstan, and Uzbekistan.
We provide broadband services through our broadband networks based on WiFi, Digital Subscriber Line
(“DSL”), and fiber-to-the-building (“FTTB”) technologies. The broadband development enables us to
offer high quality services such as broadband Internet access and voice over broadband which is
packaged with our Aport Internet search engine to offer location-based search services.
As part of our broadband access strategy, we deployed one of the largest commercial WiFi
metropolitan networks in the world. As of March 2008, our WiFi network in Moscow consists of
approximately 15,230 WiFi nodes. We offer wireless high-speed Internet connection that covers most
of the Moscow’s center, where there is a large concentration of businesses, and many other business
areas of the city, which include airports, restaurants, hotels, shopping and entertaining centers.
The Golden WiFi network coverage extends potential market from residential clients to business
travelers and hotels, restaurants and café (“HORECA”) partners. The HORECA category is represented
by our corporate customers that offer free WiFi access to their customers. These corporate clients
use the Golden WiFi service to attract customers and create more traffic for their business.
Furthermore, Corbina offers unlimited wireless access to its Moscow high-speed Home Internet
subscribers as an additional option for a fixed monthly fee, through
the Golden WiFi network. On March
1, 2007, we launched commercial operations of our WiFi network in Moscow and on June 22, 2007 in
St. Petersburg. As of March 2008, we had approximately 82,290 WiFi service customers in Moscow and
St. Petersburg. Further, we plan to provide indoor wireless broadband
coverage in the 21 largest
metropolitan areas in Russia, which include Nizhny Novgorod,
Ekaterinburg, Krasnoyarsk, Sochi,
Novosibirsk, Samara, Krasnodar, Vladivostok, Voronezh, Volgograd, Irkutsk, Kemerovo, and
Krasnodar. In 2007, we began to provide WiFi indoor service in Ufa, Khabarovsk, Novorossiysk, and
Kazan, and as of March 2008, we had approximately 185 customers.
During 2008, we plan to install 1,900 additional access points to extend our network coverage
and enhance the quality of service. By the end of 2008, we expect significant growth in WiFi
customer base, in all customer categories, due to increased service availability, higher brand
awareness, increase in service quality, branding and customization of client equipment.
In December 2007, we signed a partnership agreement with WeRoam, a leading wholesale
aggregator of public Wireless Local Area Network roaming. The agreement significantly extends
WeRoam’s global coverage of public WiFi hotspots through more than 12,700 hotspots of the Golden
Telecom WiFi network throughout Russia. Further, WeRoam provides access to over 35,000 worldwide
wireless hotspots to Golden Telecom’s WiFi customers. Golden Telecom uses the unique smart client
software which identifies the local users and accesses the international WiFi roaming system.
Furthermore, this agreement reinforces Golden Telecom’s WiFi project launched in 2007.
In 2007, we continued the deployment of DSL services in selected regions of Russia and the CIS
where we acquired copper “last mile” network. As of March 2008, we had approximately 64,560
customers which subscribe to DSL services in Russia and in the CIS.
In order to meet the growing demand for broadband services we began to construct FTTB networks
in the top 65 cities of Russia with a combined population of 65 million people of which we will
target approximately 15.6 million households. As of March 2008, we have approximately 391,265
subscribers connected to our FTTB network. We placed into operation a network in Krasnoyarsk,
Nizhny Novgorod, Voronezh, Ekaterinburg, Krasnodar, Samara, Togliatti, Dolgoprudny, Arkhangelsk and
Kiev. We started construction in Kaliningrad and plan to complete deployment of FTTB networks in
Sochi, Vologda, Cherepovets and Orel by the end of 2008. The acquisition of Corbina strengthened
our position in the broadband Internet market. Currently, Corbina’s network covers over 3 million
households in Moscow, St. Petersburg, Yaroslavl, Tula, Rostov-on-Don, Saratov, Orenburg, Volgograd
and Kaluga. Corbina started construction of networks in Lipetsk and six cities in the Moscow
region. Further, Corbina plans to complete the construction of networks in Ivanovo, Kursk, Perm,
Tambov, Chelyabinsk and Kostroma by the end of 2008. As of March 2008, Corbina’s active broadband
Internet subscriber base consists of approximately 388,550 customers.
In October 2006, we acquired S-Line, a Ukrainian company with a license for WIMAX frequencies.
We plan to roll-out WIMAX network in 26 Ukrainian regions, including Kiev, to realize our broadband
Internet strategy in Ukraine. WIMAX technology will be utilized as a last mile solution to provide
broadband users with the wireless Internet access. The network transmission will be realized
through GTU’s fiber optic and leased backbone channels. In October 2007, S-line resolved all legal
issues regarding its WIMAX license and was able to receive the new license. During 2007, S-line
installed one radio node in each region of Ukraine to comply with the regulatory requirements. In January
2008, S-line started roll-out of a WIMAX network in Kiev in trial mode, which is expected to be
completed by the end of the first quarter of 2008. According to the current Ukrainian legislation,
the license must clearly state that the company may use WIMAX technology in conformity with
standard 802.16. Therefore, we are in the process of converting the current license to the new one,
in conformity with standard 802.16. S-line is expected to apply for license conversion in the
second quarter of 2008 after the network roll-out test is completed. The commercial network is
expected to be rolled out in the first quarter and tested in the fourth quarter of 2008. The launch
of commercial WIMAX services in Kiev and seven other largest Ukrainian cities is currently
scheduled for the first quarter of 2009. Broadband Internet service in other regions is expected to
be launched in the second, third and fourth quarters of 2009.
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Our Mobile Services line of business allows us to provide additional services to our wireline
customers in Moscow and Ukraine. In the future, we expect to follow a marketing strategy aimed at
providing fixed-mobile convergent (“FMC”) services to our existing corporate customers.
In April 2006, the NCCR issued a license for GSM-1800 radio frequency to GTU for an additional
22 out of the remaining 25 regions of Ukraine, which we did not cover. This license provides us
with a potential customer base of 38.1 million people, or approximately 81% of the Ukrainian
population, compared with our previous coverage of 5.1 million people. Payment of the $5.5 million
license fee was made on May 10, 2006. In May 2006, we began using the frequencies and submitted
registration documents to UkrChastotNadzor, a Ukrainian governmental body that is responsible for
the control and the supervision of the radio frequencies. To date, we have complied with the
license requirements related to the use of allocated radio frequencies by launching operations in
16 out of 22 regions. On July 13, 2006, we entered into an agreement with ZAO Ukrainian Radio
Systems (“URS”), a subsidiary of VimpelCom, for the provision of roaming services. This agreement
enables our mobile customers to use the national roaming services of URS nationwide network. In
addition, we plan to provide mobile over broadband services in Ukraine. On October 5, 2006, we
announced the commencement of construction of our FMC network in Ukraine. The FMC network combines
the advantages of fixed-line and mobile communications and will be the first converging
communications network in Ukraine. FMC service will be available to corporate, SME and residential
GTU’s customers. FMC will allow customers to utilize one account for fixed and mobile services,
receive mobile Internet access, cross-discounts on voice calls, call forward from fixed to mobile
phones, voice call continuity services and call hold services. We deployed the FMC network in Kiev
and Odessa based on our existing GSM-1800 networks and wireless segments of the FMC network in the
Kiev region, Donetsk, Zaporizhzhya, and Ivano-Frankovsk. During the first quarter of 2008, GTU will
upgrade its GSM network and core fixed-line telephony network. The network equipment to modernize
the core telephony network has been installed and currently in the test process. By the end of the
second quarter of 2008, GTU plans to purchase and install the FMC platform to provide the
previously discussed value added services. The commercial launch of the FMC project is scheduled
for the third quarter of 2008.
In Russia, Corbina provides mobile services in Moscow via a GSM network. During the second
half of 2007, Corbina switched its DAMPS customers onto a GSM network. Corbina offers GSM services
in Moscow via a commercial arrangement with VimpelCom. As of March 2008, Corbina’s high-usage
mobile subscriber base is approximately 24,550 customers.
The Corbina acquisition enabled us to offer quadric-play products to the mass market. We
bundled broadband Internet access, VoIP, Internet protocol television, and mobile virtual network
based services into one offering. In June 2007, we started to offer in trial mode Voice-over-WiFi
services in Moscow. In July 2007, Corbina launched the IPTV service in trial mode. The IPTV
technology is based on a Microsoft platform and allows greater flexibility for features such as
interactive screen with video-on-demand, pay-per-view and other value added services. Bundling of
products will help us to attract new consumers, and provide new solutions and options to current
customers.
The acquisition of Fortland Limited (“Fortland”) enhances our broadband expansion strategy and
will enable us to expand into the media market. Kolangon-Optim LLC (“Kolangon”) holds licenses and
frequencies to provide digital television services in Moscow and St. Petersburg. We also applied
for licenses in other major cities of Russia. These licenses will be used to broadcast digital
television channels with a higher quality of picture and to provide pay-per-view services using the
DVB-T standard in MPEG-4 coding. The combination of access to DVB-T technology with our wide
geographical presence across Russia will provide us with a potential market of up to 14 million
households in 34 major Russian cities including Moscow and Saint Petersburg with a population of
approximately 41 million people. The Fortland acquisition will enable us to deliver approximately
50 pay digital TV and video-on-demand channels. We are currently working on the acquisition and
installation of network equipment on the Oktod and Ostankino towers in Moscow. We plan to begin
deployment of DVB-T transmitters in the second half of 2008 in order to start broadcasting in the
first half of 2009. We plan to consider cooperation with one of the leading Russian media companies
to ensure availability of the high quality content for our television services.
In addition, we are in process of implementing an enterprise resource planning system, which
will help us to transform and harmonize our business processes, mitigate business risks related to
fast growth and support easier and more efficient maintenance of the IT environment.
Critical Accounting Estimates
Accounting estimates are an integral part of the financial statements and require the use of
assumptions, estimates and judgments which are the responsibility of management. Management makes
estimates and judgments based on, among other things, knowledge of operations, markets, historical
trends and likely future changes, similarly situated businesses and, when appropriate, the opinions
of advisors with relevant knowledge and experience. Certain accounting estimates are particularly
sensitive because of their significance to the financial statements, the possibility that future
events affecting them may significantly differ from management’s current judgment and due to the
uncertainty involved in measuring, at a specific point in time, events which are continuous in
nature. We believe the following items represent such particularly sensitive accounting estimates:
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Revenue recognition. We recognize operating revenues as services are rendered or as products
are delivered to customers and installed. Under multiple-delivery contracts, involving a
combination of product delivery, installation and maintenance, connection and service fees,
revenues are recognized based on the relative fair value of the respective amounts. Elements are
grouped if they are inseparable or objective evidence of fair value does not exist. Certain
revenues, such as connection and installation fees, are deferred. We also defer direct incremental
costs related to connection fees, not exceeding the revenue deferred. Deferred revenues are
subsequently recognized over the estimated average customer lives, which are reassessed by us on
annual basis, and such reassessment may impact our future operating results. The assessment is
based on customer churn rates, structured by groups of subscribers’ contracts and business
segments, in which we operate. The estimated life of a customer is currently five years in the BCS
division and Operator and Carrier Services division, and did not change significantly over several
periods of time. We accrue reserves for credit notes to be issued to our customers in the case of
incorrect or late billing, which are reviewed on a regular basis depending on the past experience
of issuing credit notes over years. In determining the recording of revenue, estimates and
assumptions are required in assessing the expected conversion of the revenue streams to cash
collected. We recognize DLD/ILD and zonal revenues from local operators net of payments to these
operators for interconnection and agency fees because local operators establish end-user tariffs
and assume credit risk.
Allowance for doubtful accounts. The allowance estimation process requires management to make
assumptions based on historical results, future expectations, the economic and competitive
environment, changes in the creditworthiness of our customers, and other relevant factors. Any
changes in the underlying assumptions of recoverability of accounts receivable by respective aging
group or certain specific accounts that are excluded from the specific and general allowances could
have a material effect on our current and future results of operations. We assess the adequacy of
our allowance for doubtful accounts each year. In particular, we have certain amounts due to and
from subsidiaries of a European telecommunications operator, which is currently subject to
bankruptcy proceedings. The ultimate resolution of this matter will be affected by a number of
factors including the determination of legal obligations of each party, the course of the
bankruptcy proceedings, and the enforceability of any determinations. We have recognized provisions
based on our preliminary estimate of net exposure on the resolution of these receivables and
payables. If our assessment proves to be incorrect we may have to recognize an additional provision
of up to $2.5 million, net of tax, although management believes that the possibility of such an
adverse outcome is remote. In the fourth quarter of 2007, we decreased the allowance for doubtful
accounts for $0.7 million due to increased cash collection and implementation of efficient
incentive schemes for the sales department, which resulted in improvement of debt recovery. We
believe that the allowance for doubtful accounts is adequate to cover estimated losses in our
accounts receivable balances under current conditions.
Long-lived asset cost recovery. Long-lived assets primarily consist of property and equipment
and intangibles, comprise a significant portion of our total assets. Changes in technology or
changes in our intended use of these assets may cause the estimated period of use or the value of
these assets to change. We perform periodic internal studies using five-year business plans to
confirm the appropriateness of estimated economic useful lives for each category of current
property and equipment. Additionally, long-lived assets, including intangibles, are reviewed for
impairment whenever events or changes in circumstances have indicated that their carrying amounts
may not be recoverable. Estimates and assumptions used in setting useful lives and testing for
recoverability of our long-lived assets, require the exercise of management’s judgment and
estimation based on certain assumptions concerning the expected life of any asset and expected
future cash flows from the use of an asset.
Goodwill and assessment of impairment; commencing from the adoption of Statement on Financial
Accounting Standard (“SFAS”) No. 142, “Goodwill and Other Intangible Assets”, on January 1, 2002,
we perform goodwill impairment testing annually as of October 1 or whenever impairment indicators
exist. This test requires a significant degree of judgment about the future events and it includes
determination of the reporting units, allocation of goodwill to the reporting units and comparison
of the fair value with the carrying amount of each reporting unit. Based on the discounted cash
flow valuations performed in 2007, we concluded that for all reporting units the fair value is in
excess of the respective carrying amounts.
Valuation allowance for deferred tax asset; we record valuation allowances related to tax
effects of deductible temporary differences and loss carry forwards when, in the opinion of
management, it is more likely than not that the respective tax assets will not be realized.
Changes in our assessment of probability of realization of deferred tax assets may impact our
effective income tax rate.
Tax provisions. In the course of preparing financial statements in accordance with US GAAP, we
record potential taxes other than income tax loss provisions under the guidelines of SFAS No. 5,
“Accounting for Contingencies”. In general SFAS No. 5 requires loss contingencies to be recorded
when they are both probable and reasonably estimable. On January 1, 2007, we adopted Interpretation
No. 48 (“FIN No. 48”), “Accounting for Uncertainty in Income Taxes – an interpretation of FASB
Statement No. 109”. The adoption of FIN No. 48 resulted in the cumulative-effect adjustment to the
opening balance of retained earnings as of January 1, 2007 of
$8.5 million. For a detailed
discussion of FIN No. 48 application, see Item 8 “Financial Statements and Supplementary Data”,
Note 2 to our audited consolidated financial statements. In addition, we record other deferred tax
provisions under the guidelines of SFAS No. 109, “Accounting for Income Taxes”. Significant
judgment is required to determine when such provisions should be recorded, and when facts and
circumstances change, when such provisions should be released.
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Business combinations. SFAS No. 141, “Business Combinations”, requires us to recognize the
share in the assets of businesses acquired and respective liabilities assumed based on their fair
values. Our estimates of the fair value of the identified intangible assets of businesses acquired
are based on our expectations of future results of operations of such businesses.
Stock-based compensation. Effective January 1, 2006, we adopted SFAS No. 123R to account for
Share Based Payments. Under SFAS No. 123R, we are required to calculate and record the cost of
equity instruments, such as stock options or restricted stock, awarded to employees for services
received in the income statement. The cost of the equity instruments is to be measured based on
the fair value of the instruments on the date they are granted or, if the number of shares to be
issued or the exercise price is unknown, re-measured at each reporting date and is required to be
recognized over the period during which the employees are required to provide services in exchange
for the equity instruments. The fair value of a SAR is estimated using the Monte Carlo
simulation-based valuation model that incorporates the assumptions of the stock volatility,
risk-free interest rates, dividend yield, employee exercise patterns and forfeiture rates.
Recent Accounting Pronouncements
Fair Value Measurements
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements", which defines fair
value, establishes a framework for measuring fair value in generally accepted accounting
principles, and enhances fair value measurement disclosure. In February 2008, the FASB issued FASB
Staff Position (“FSP”) 157-1, “Application of FASB Statement No. 157 to FASB Statement No. 13 and
Other Accounting Pronouncements That Address Fair Value Measurements for Purposes of Lease
Classification or Measurement under Statement 13” and FSP 157-2, “Effective Date of FASB Statement
No 157"). FSP 157-1 amends SFAS No. 157 to remove certain leasing transactions from its scope. FSP
157-2 delays the effective date of SFAS No. 157 for all non-financial assets and non-financial
liabilities, except for items that are recognized or disclosed at fair value in the financial
statements on a recurring basis (at least annually), until the beginning of the first quarter of
fiscal 2009. The measurement and disclosure requirements related to financial assets and financial
liabilities are effective beginning in the first quarter of fiscal 2008. The adoption of SFAS No.
157 for financial assets and financial liabilities will not have a significant impact on our
financial position or results of operations. However, the resulting fair values calculated under
SFAS No. 157 after adoption may be different from the fair values that would have been calculated
under previous guidance. We are currently evaluating the impact that SFAS No. 157 will have on our
financial position or results of operations when it is applied to non-financial assets and
non-financial liabilities beginning in the first quarter of 2009.
Income Statement Presentation of Taxes Collected from Customers and Remitted to Government
Authorities
In June 2006, the Emerging Issues Task Force reached a consensus on EITF Issue No. 06-03
(“EITF No. 06-03”), “How Taxes Collected from Customers and Remitted to Governmental Authorities
Should Be Presented in the Income Statement (That Is, Gross versus Net Presentation)”. EITF No.
06-03 provides that the presentation of taxes assessed by a governmental authority that is directly
imposed on a revenue-producing transaction between a seller and a customer on either a gross basis
(included in revenues and costs) or on a net basis (excluded from revenues) is an accounting policy
decision that should be disclosed. The provisions of EITF No. 06-03 become effective for fiscal
years beginning after December 15, 2006. The adoption of EITF No. 06-03 did not have any effect on
our consolidated financial position or results of operations.
Fair Value Option
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets
and Financials Liabilities — Including an Amendment of FASB Statement No. 115". This standard
permits measurement of certain financial assets and financial liabilities at fair value. If the
fair value option is
elected, the unrealized gains and losses are reported in earnings at each reporting date.
Generally, the fair value option may be elected on an instrument-by-instrument basis, as long as it
is applied to the instrument in its entirety. The fair value option election is irrevocable, unless
a new election date occurs. SFAS No. 159 requires prospective application and also establishes
certain additional presentation and disclosure requirements. The standard is effective as of the
beginning of the fiscal year that begins after November 15, 2007. We are currently evaluating the
provisions of SFAS No. 159 to determine the potential impact, if any, the adoption will have on our
financial consolidated financial position or results of operations.
Business Combinations
In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (“SFAS
No. 141R”). SFAS No. 141R significantly changes the accounting for business combinations Under SFAS
No. 141R, an acquired entity will be required to recognize all the assets acquired and liabilities
assumed in a transaction at the acquisition date fair value with limited exceptions. SFAS No. 141R
will change the accounting treatment for certain specific acquisition related items including
expensing acquisition related costs as incurred, valuing noncontrolling interests at fair value at
the acquisition date and expensing restructuring costs associated with an acquired business. SFAS
No. 141R also includes a substantial number of new disclosure requirements. SFAS No. 141R is to be
applied prospectively to business combinations for which the acquisition date is on or after
January 1, 2009. We expect
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SFAS No. 141R to have an impact on the accounting for future business
combinations once adopted but the effect is dependent upon the acquisitions that are made in the
future.
Noncontrolling Interests in Consolidated Financial Statements
In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated
Financial Statements—an amendment of Accounting Research Bulletin No. 51 (“SFAS No. 160”). SFAS
No. 160 establishes accounting and reporting standards for ownership interests in subsidiaries held
by parties other than the parent, the amount of consolidated net income attributable to the parent
and to the noncontrolling interest, changes in a parent’s ownership interest, and the valuation of
retained noncontrolling equity investments when a subsidiary is deconsolidated. SFAS No. 160 also
establishes disclosure requirements that clearly identify and distinguish between the interests of
the parent and the interests of the noncontrolling owners. SFAS No. 160 is effective on January 1,
2009. We are currently evaluating the potential impact, if any, the adoption of SFAS No. 160 will
have on the consolidated financial position, results of operations and cash flows.
Results of Operations
The results of our four business segments from the operations of our consolidated entities
combined with the non-consolidated entities where we are actively involved in the day-to-day
management, are shown in Note 16 “Segment Information — Line of Business Data” to our audited
consolidated financial statements. In addition, revenue and costs from related parties are shown
in Note 15 “Related Party Transactions”.
The discussion of our results of operations is organized as follows:
| • | Consolidated Results. Consolidated Results of Operations for the Year Ended December 31, 2007, compared to the Consolidated Results of Operations for the Year Ended December 31, 2006 | |
| • | Consolidated Financial Position. Consolidated Financial Position at December 31, 2007, compared to Consolidated Financial Position at December 31, 2006 | |
| • | Consolidated Results. Consolidated Results of Operations for the Year Ended December 31, 2006, compared to the Consolidated Results of Operations for the Year Ended December 31, 2005 | |
| • | Consolidated Financial Position. Consolidated Financial Position at December 31, 2006, compared to Consolidated Financial Position at December 31, 2005 |
Consolidated Results — Consolidated Results of Operations for the Year Ended December 31, 2007,
Compared to the Consolidated Results of Operations for the Year Ended December 31, 2006
Revenue
Our revenue increased by 51% to $1,292.9 million for the year ended December 31, 2007 from
$854.6 million for the year ended December 31, 2006. The significant increase in revenues reflects
the continued growth of our BCS segment and Carrier and Operator Services segment. In addition, the
increase in our revenues when comparing the years ended December 31, 2006 and 2007 was partially
due to the fact that a significant part of our revenue is denominated in the RUR. We estimate that
the appreciation of the RUR against the USD resulted in an approximate 8.0% increase in our
revenues when comparing the periods ended December 31, 2006 and 2007.
The breakdown of revenue by business segments was as follows:
| Consolidated Revenue | Consolidated Revenue | |||||||
| For the Year | For the Year | |||||||
| Ended December 31, 2006 | Ended December 31, 2007 | |||||||
| (in millions) | ||||||||
REVENUE |
||||||||
Business and Corporate Services |
$ | 487.2 | $ | 718.1 | ||||
Carrier and Operator Services |
309.1 | 479.6 | ||||||
Consumer Internet Services |
48.7 | 77.1 | ||||||
Mobile Services |
9.6 | 18.1 | ||||||
TOTAL REVENUE |
$ | 854.6 | $ | 1,292.9 | ||||
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The breakdown of revenue by geographic regions was as follows:
| Consolidated Revenue | Consolidated Revenue | |||||||
| For the Year | For the Year | |||||||
| Ended December 31, 2006 | Ended December 31, 2007 | |||||||
| (in millions) | ||||||||
REVENUE |
||||||||
Moscow |
$ | 535.6 | $ | 863.2 | ||||
Northwest region of Russia |
79.6 | 113.8 | ||||||
Other regions of Russia and CIS |
185.9 | 269.7 | ||||||
Ukraine |
82.3 | 105.3 | ||||||
Eliminations |
(28.8 | ) | (59.1 | ) | ||||
TOTAL REVENUE |
$ | 854.6 | $ | 1,292.9 | ||||
Business and Corporate Services. Revenue from BCS segment increased by 47% to $718.1 million
for the year ended December 31, 2007 from $487.2 million for the year ended December 31, 2006.
Macro-economic growth in Russia, Ukraine, and the CIS and continuing demand for our
telecommunications solutions are the main factors that contributed in the increase of revenue in
this line of business. Our total number of contracts in this line of business increased from
253,133 on December 31, 2006, to 508,904 on December 31, 2007, an increase of 101%.
Revenue from the BCS division of Sovintel increased by 42% to $561.3 million for the year
ended December 31, 2007 from $395.8 million for the year ended December 31, 2006. BCS voice revenue
increased by approximately $93.3 million due to an increase in international voice traffic of
approximately 24 million minutes and domestic and zonal traffic of approximately 737 million
minutes and increase in the average international traffic rate of 28% to $0.46 per minute for the
year ended December 31, 2007 from $0.36 per minute for the year ended December 31, 2006. Data
revenue increased by $25.5 million due to
increased number of connected channels to 26,316 on December 31, 2007 from 14,739 on December
31, 2006. This increase was partially offset by a decrease of monthly fee per channel from $482 to
$371, which constitutes approximately 93% of total data revenue. Internet revenue increased by
$38.2 million due to increased number of Internet accesses to 23,366 on December 31, 2007 from
14,004 on December 31, 2006. The effect of increased Internet accesses was partially offset by a
decline of Internet access monthly fee from $556 to $487. In 2007, Sovintel recorded approximately
$46.7 million of additional revenue related to the introduction of CPP. BCS revenue in Moscow, our
largest market, increased by $106.8 million, or 37%, to $399.3 million in 2007 from $292.5 million
in 2006. This was due to increased voice minutes and number of channels. The percentage of Moscow
BCS revenue of total Sovintel BCS revenue continued to decrease from approximately 74% in 2006 to
approximately 71% of Sovintel’s total BCS revenue in 2007. This decrease is the result of the
expansion of Sovintel’s BCS business in the Russian regions. Additionally, we experienced a
decrease in the competitive pressures affecting rates. We expect our revenue from BCS Moscow to
continue to grow as we continue to experience significant investment in the Moscow commercial
real-estate market. Our ongoing relationships with Moscow real-estate developers should enable us
to continue to grow the number of trade and business centers where we provide services to end
users.
Refer to the table below for key operating statistics for BCS Moscow.
| (in whole numbers) | ||||||||||||
| BCS Moscow customer statistics on December 31: | 2006 | 2007 | % Change | |||||||||
Total clients |
23,456 | 25,202 | 7 | % | ||||||||
Business centers |
920 | 1,041 | 13 | % | ||||||||
Trade centers |
94 | 133 | 41 | % | ||||||||
Hotels |
53 | 58 | 9 | % | ||||||||
Direct inward dialing lines |
138,000 | 146,230 | 6 | % | ||||||||
Ethernet / Metropolitan Ethernet Network connections |
2,652 | 2,810 | 6 | % | ||||||||
High speed Internet active contracts |
976 | 1,742 | 78 | % | ||||||||
Sovintel regional BCS revenue increased by 57% to $162.1 million in 2007 from $103.3 million
in 2006. The increase in revenue was due to increased voice minutes and number of channels. As a
percentage of total Sovintel BCS revenue, regional BCS revenue increased from approximately 26% in
2006 to approximately 29% of Sovintel’s total BCS revenue in 2007. Sovintel regional BCS business
continues to grow as we assist our customers in developing their businesses in Russian regions
outside of Moscow.
Revenue from our regional Russian entities significantly contributed to overall BCS growth and
increased by 63% to $84.8 million for the year ended December 31, 2007, from $51.9 million for the
year ended December 31, 2006. The main factors of increased revenue were growth of international
and zonal traffic as well as an increase in number of Internet accesses.
Revenue from the BCS division of GTU increased by 20% to $59.7 million for the year ended
December 31, 2007, from $49.8 million for the year ended December 31, 2006. This increase in
revenue was due to a 29% increase in long-distance minutes of use resulting from a 45% increase in
the number of serviced voice lines. Partly offsetting these increasing factors was a 24% decrease
in the average minutes of use per line per month due to more residential, SMEs, and regional
customers in the client base with lower usage of traffic and a 17% decrease in average recurring
revenue per line due to a decrease in tariffs for international destinations.
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Total number of
contracts in this line of business increased from 26,824 on December 31, 2006, to 42,215 on
December 31, 2007, an increase of 57%. Additionally, data and Internet revenue increased by
approximately $3.1 million due to an increase in the number of new ports and circuits connected and
growth in the number of ADSL ports.
Our acquisition strategy also contributed to the overall BCS growth in 2007. Our revenue
increased by approximately $36.9 million due to the acquisition of Corbina in May 2007. Our
regional acquisition strategy has also enabled us to increase our access to last mile
infrastructure, thus enabling us to expand our corporate client base.
Carrier and Operator Services. Revenue from Carrier and Operator Services increased by 55% to
$479.6 million for the year ended December 31, 2007, from $309.1 million for the year ended
December 31, 2006. Our total number of contracts in this line of business grew by 78% to 4,251 as
of December 31, 2007, from 2,388 as of December 31, 2006.
Carrier and Operator Services revenue of Sovintel increased by 59% to $444.4 million for the
year ended December 31, 2007, from $279.5 million for the year ended December 31, 2006. Volume of
international, domestic and zonal traffic significantly increased in 2007. International traffic
rate increased from $0.09 per minute in 2006 to $0.095 per minute in 2007. Domestic traffic rate
also increased from $0.03 per minute in 2006 to $0.06 per minute. In 2007, we experienced a
significant increase in Internet revenue, which was 42% from $19.3 million in 2006 to $27.5 million
in 2007 mainly as a result of introduction of the subscription fee per interconnect Internet access
and an increase of monthly fees, partly offset by continuing decrease of installation fees per
Internet access. During 2007 Sovintel recorded approximately $34.7 million of additional revenue
related to the introduction of CPP. We expect that our revenues in this line of business will
continue to increase in future periods as we expand our termination capabilities and continue to
develop our network.
Revenues
from Carrier and Operator Services of our regional entities increased
by 40% to $43.1 million for the year ended December 31,
2007, from $30.7 million for the year ended December 31,
2006. The increase is mainly explained by the growth in zonal and
local traffic and the number of connected channels.
Revenue for the Carrier and Operator Services division of GTU increased by 71% to $36.7
million for the year ended December 31, 2007, from $21.5 million for the year ended December 31,
2006. Voice revenue increased due to a 247% increase in incoming international minutes of use and
a 155% increase in carriers’ minutes of use, in particular, increase in transit traffic from MTS,
KyivStar and other local carriers. The increase was partly offset by a decrease in average revenue
per minute of use for carriers’ traffic by 50%.
Consumer Internet Services. Revenue from
Consumer Internet Services increased by 58% to $77.1
million for the year ended December 31, 2007, from $48.7 million for the year ended December 31,
2006. Consumer Internet Services revenue increased by approximately
$37.7 million due to the
acquisition of Corbina in May 2007. Corbina provides subscribers with broadband Internet and WiFi
services using our Golden WiFi network. The number of active broadband Internet subscribers of
Corbina (“Homenet”) increased from 157,245 at May 31,
2007 to 282,376 at the December 31, 2007.
The average revenue per user of Homenet during 2007 was approximately $24.21 per month. Our revenue
from consumer dial-up Internet in Sovintel decreased by approximately
$9.7 million between 2007
and 2006. The average revenue per dial-up Internet subscriber
decreased from $6.68 per month for
the year ended December 31, 2006, to approximately $5.70 per month for the year ended December 31,
2007, the number of dial-up Internet subscribers decreased from
401,098 at December 31, 2006, to
233,504 at December 31, 2007. The consumer Internet market in Moscow has become more competitive
due to the increasing availability of other Internet access technologies. Offsetting the decrease
in dial-up revenue was increase in other consumer Internet products, such as consumer broadband
Internet via FTTB or WiFi products. We anticipate that our revenue from consumer broadband will
increase as we embark on our broadband access rollout. Our current and past base of dial-up
Internet subscribers in Moscow and throughout Russia will allow us to specifically target
subscribers that currently use or have previously used our Internet services.
Mobile
Services. Revenue from Mobile Services increased by 89% to $18.1 million for the year
ended December 31, 2007, from $9.6 million for the year ended December 31, 2006. The consolidated
mobile revenue increased by approximately $11.5 million due to the acquisition of Corbina in 2007.
The decline in revenue, in GTU, was primarily due to increased competition in the Ukrainian mobile
market, lack of network coverage and the restrictions on national roaming services, which has led
to significant churn of high usage contract subscribers. Total base
of active subscribers decreased
from 48,448 at December 31, 2006, to 36,565 at December 31, 2007. During 2007, the average revenue
per active subscriber decreased by 7% from approximately $17.13 per month to approximately $15.89
per month primarily due to decreases subscription fees and traffic.
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Expenses
The following table shows our principal expenses for the years ended December 31, 2007 and
December 31, 2006:
| Consolidated Expenses | Consolidated Expenses | |||||||
| For the Year Ended | For the Year Ended | |||||||
| December 31, 2006 | December 31, 2007 | |||||||
| (in millions) | ||||||||
COST OF REVENUE |
||||||||
Business and Corporate Services |
$ | 213.4 | $ | 318.9 | ||||
Carrier and Operator Services |
218.4 | 356.6 | ||||||
Consumer Internet Services |
37.4 | 55.1 | ||||||
Mobile Services |
5.2 | 9.6 | ||||||
Corporate |
— | 1.2 | ||||||
TOTAL COST OF REVENUE |
474.4 | 741.4 | ||||||
Selling, general and administrative |
152.8 | 241.9 | ||||||
Depreciation and amortization |
100.2 | 140.3 | ||||||
Equity in earnings of ventures |
(1.9 | ) | (1.0 | ) | ||||
Gain on sale of MCT Corp. |
— | (41.3 | ) | |||||
Interest income |
(1.2 | ) | (4.3 | ) | ||||
Interest expense |
0.6 | 13.1 | ||||||
Foreign currency (gain)/ loss |
(1.7 | ) | (15.7 | ) | ||||
Minority interest |
4.8 | 7.6 | ||||||
Provision for income taxes |
40.4 | 58.3 | ||||||
Cumulative effect of a change in
accounting principle, net of tax |
$ | 0.7 | $ | — | ||||
Cost of Revenue
Our cost of revenue increased by 56% to $741.4 million for the year ended December 31, 2007
from $474.4 million for the year ended December 31, 2006.
Business
and Corporate Services. Cost of revenue from BCS increased by 49%
to $318.9 million,
or 44% of revenue, for the year ended December 31, 2007 from $213.4 million, or 44% of revenue, for
the year ended December 31, 2006.
Cost of revenue for the BCS division of Sovintel increased by 42% to $246.1 million, or 44% of
revenue, for the year ended December 31, 2007, from $173.9 million, or 44% of revenue, for the year
ended December 31, 2006. The increase in costs is in line with traffic revenue growth in 2007,
which resulted in an increase of traffic termination costs and rent cost of channels. The increase
of traffic volume was partly offset by a decrease of traffic settlement effective long-distance
rate from $0.037 per minute in 2006 to $0.035 per minute in 2007. Total traffic settlement costs
increased from $27.0 million in 2006 to $62.0 million in 2007, channels’ costs grew from $64.0
million in 2006 to $81.0 million. In 2007, Sovintel recorded approximately $18.8 million of
additional costs related to the introduction of CPP.
Cost of revenue for the BCS division of other regional Russian entities increased by $12.9
million or, 54% of revenue, to $37.0 million for the year ended December 31, 2007 from $24.1
million for the year ended December 31, 2006. The increase is mostly caused by traffic settlement
growth.
Cost of revenue for the BCS division of GTU increased by 22% to $26.2 million, or 44% of
revenue, for the year ended December 31, 2007, from $21.4 million, or 43% of revenue, for the year
ended December 31, 2006. The increase in costs was caused by an increase in traffic volume and
number of connections. In addition, settlement rates for local traffic were introduced in January
2007. Monthly fees for interconnect with Ukrtelecom were replaced by settlement rates.
BCS
cost of revenue increased by approximately $18.4 million due to the acquisition of Corbina
in May 2007.
Carrier and Operator Services. Cost of revenue from Carrier and Operator Services increased by
63% to $356.6 million, or 74% of revenue, for the year ended December 31, 2007, from $218.4
million, or 71% of revenue, for the year ended December 31, 2006. We continued to observe pressure
on our operating margins in this line of business, which is attributed to competition and to a
change in our traffic mix.
Cost of revenue for the Carrier and Operator Services division of Sovintel increased by 68% to
$349.1 million, or 79% of revenue, for the year ended December 31, 2007, from $207.8 million, or
74% of revenue, for the year ended December 31, 2006. The increase in costs is due to increased
interconnect costs as a result of our own network expansion and zonal voice network deployment.
Moreover, traffic settlement effective long-distance rate increased from $0.039 per minute in 2006
to $0.046 per minute in 2007. Total traffic settlement costs increased from $143.0 million in 2006
to $274.0 million in 2007, channels’ costs grew from $19.0 million in
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2006 to $23.0 million in
2007. In 2007, Sovintel recorded approximately $32.6 million of additional costs related to the
introduction of CPP.
Cost of revenue for the Carrier and Operator Services division of other regional Russian
entities increased by $9.4 million or 57%, to $25.7 million for the year ended December 31, 2007,
from $16.4 million for the year ended December 31, 2006. The increase is mostly caused by traffic
settlement growth.
Cost of revenue for the Carrier and Operator Services division of GTU increased to $28.4
million, or 77% of revenue for the year ended December 31, 2007, from $14.8 million, or 69% of
revenue for the year ended December 31, 2006. The cost behavior is in line with the revenue growth,
which is a result of significant growth in international traffic volume.
Consumer
Internet Services. Cost of revenue from Consumer Internet Services increased by 47%
to $55.1 million, or 71% of revenue, for the year ended December 31, 2007, from $37.4 million, or
77% of revenue, for the year ended December 31, 2006. Consumer Internet Services cost of revenue
increased by approximately $16.6 million due to the acquisition of Corbina in May 2007.
Mobile
Services. Cost of revenue from Mobile Services increased by 85% to $9.6 million, or 53%
of revenue for the year ended December 31, 2007, from $5.2 million, or 54% of revenue for the year
ended December 31, 2006. Mobile Services cost of revenue increased by approximately $3.0 million
due to the acquisition of Corbina in May 2007.
Gross Margin
Our consolidated gross margin was $551.5 million, or 43% of our revenue for the year ended
December 31, 2007, compared to $380.2 million, or 44% for the year ended December 31, 2006.
Business
and Corporate Services. Gross margin from BCS division was $399.2 million, or 56% of
our revenue for the year ended December 31, 2007, compared to $273.8 million, or 56% of our revenue
for the year ended December 2006. We continue to maintain robust gross margins in this line of
business due to the continued demand for high-volume and high-margin services from our customers.
Carrier
and Operator Services. Gross margin from Carrier and Operator
Services was $123.0 million, or 26% of our revenue for the year ended December 31, 2007, compared to $90.7, or 29% of
our revenue for the year ended December 31, 2006. The decrease in gross margin percentage of
revenue is primarily due to
the impact on Sovintel of increased volume of lower margin traffic and continuing pressure on
our margin in this line of business from our competitors.
Consumer
Internet Services. Gross margin from Consumer Internet Services
was $22.0 million, or
29% of our revenue for the year ended December 31, 2007, compared to $11.3, or 23% of our revenue
for the year ended December 31, 2006. The improvement of gross margin in this segment resulted from
the acquisition of Corbina in 2007, which offers consumer broadband Internet service with a high
gross margin. The effect of an increase in gross margin percentage was partly offset by a decline
of dial-up business activity, which had negative gross margin in 2007.
Mobile
Services. Gross margin from Mobile Services was
$8.5 million, or 47% of our revenue for
the year ended December 31, 2007, compared to $4.4 million, or 46% of our revenue for the year
ended December 31, 2006. The increase was caused by high gross margin of mobile services from
Corbina.
Selling, General and Administrative
Our
consolidated selling, general and administrative expenses increased
by 58% to $241.9
million, or 19% of revenue, for the year ended December 31, 2007, from $152.8 million, or 18% of
revenue, for the year ended December 31, 2006. Ongoing employee related costs such as salaries,
bonuses, insurance and other benefits increased by approximately $54.0 million, primarily due to a
$9.0 million charge recorded in 2007 related to our employee stock option plans, and a 139%
increase in consolidated headcount, and ongoing salary increases.
Consulting and legal fees increased by $8.8
million primarily due to expenses related to the Merger as previously discussed and for
professional services, including audit and audit related fees and tax
compliance. Rent expense increased by approximately
$6.4 million due to an increase of rental rates and rent of additional premises. The increase of
our selling, general and administrative expenses included the effect of the acquisition of Corbina
in 2007 in the amount of approximately $27.6 million. The remaining $19.9 million net increase is
the result of other selling, general and administrative expenses increasing in line with the growth
in our business.
Depreciation and Amortization
Our
depreciation and amortization expenses increased by 40% to $140.3 million for the year
ended December 31, 2007, from $100.2 million for the year ended December 31, 2006. Depreciation
expense increased by $34.3 million, or 43%, primarily due to
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depreciation on capital expenditures
to further develop our network. Amortization expense also increased by $5.7 million, or 27%,
primarily due to amortization on intangible assets arising from acquisitions consummated in 2006
and 2007.
Income from Operations
Our consolidated income from operations was $169.3 million, or 13% of our revenue for the year
ended December 31, 2007, compared to $127.2 million, or 15% for the year ended December 31, 2006.
Business
and Corporate Services. Income from operations from BCS division
was $188.0 million,
or 26% of our revenue for the year ended December 31, 2007, compared to $125.5 million, or 26% of
our revenue for the year ended December 31, 2006.
Carrier and Operator Services. Income from operations from Carrier and Operator Services was
$43.4 million, or 9% of our revenue for the year ended
December 31, 2007, compared to $28.0
million, or 9% of our revenue for the year ended December 31, 2006. The decrease in income from
operations as a percentage of revenue is due to growth of lower margin traffic.
Consumer
Internet Services. Loss from operations from Consumer Internet
Services was $25.4 million for the year ended December 31, 2007, compared to $8.0 million for the year ended December
31, 2006 due to continued decline in dial-up business activity that has not been covered yet by an
increase in WiFi
and FTTB operations. Furthermore, the impact of decline in dial-up subscribers has not
resulted in corresponding decline of costs, which are more fixed in nature.
Mobile
Services. Income from operations from Mobile Services was $2.0 million for the year
ended December 31, 2007, compared to $0.7 million for the year ended December 31, 2006 and
increased due to the acquisition of Corbina.
Gain on Sale of MCT Corp.
In July 2007, GMS sold its 22.8% stake in MCT, following the acquisition of MCT by TeliaSonera
Acquisition Corp. We recorded gain on sale of the investment in the amount of $41.3 million in the
consolidated income statement for the year ended December 31, 2007.
Interest Expense
Our interest expense was $13.1 for the year ended December 31, 2007, compared to $0.6 million
for the year ended December 31, 2006. The increase in interest expense is mainly due to borrowings
under the $275.0 million credit facility with Citibank, which we entered into in January 2007.
Foreign Currency Gain
Our foreign currency gain was $15.7 million for the year ended December 31, 2007, compared
with $1.7 million for the year ended December 31, 2006. The increase in foreign currency gain is
due to the significant appreciation of the RUR against the USD in 2007, which resulted in the
generation of foreign currency gain on our USD denominated financial liabilities. Changes in the
amounts of USD denominated net monetary assets of our Russian subsidiaries also contributed to the
increase in foreign currency gain.
Minority Interest
Our minority interest was $7.6 million for the year ended December 31, 2007, compared to $4.8
million for the year ended December 31, 2006. Minority interest in our earnings increased due to an
increase in earnings and consolidation of recently acquired entities where our ownership interest
is less than 100%.
Provision for Income Taxes
Our charge for income taxes was $58.3 million for the year ended December 31, 2007, compared
to $40.4 million for the year ended December 31, 2006. Our effective tax rate was 27% for the year
ended December 31, 2007, down from 31% for the year ended December 31, 2006. The decrease in our
effective tax rate is primarily due to the zero tax effect on the gain of $41.3 million from the
sale of MCT.
Net Income and Net Income per Share
Our net income for the year ended December 31, 2007 was $152.6 million, compared to a net
income of $85.5 million for the year ended December 31, 2006.
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Our net income per share of common stock increased to $3.93 for the year ended December 31,
2007, compared to a net income per share of $2.34 for the year ended December 31, 2006. The
increase in net income per share of common stock was due to the increase in net income, offset by
an increase in the number of weighted average shares to 38,798,371 in the year ended December 31,
2007, compared to 36,591,097 in the year ended December 31, 2006. The increase in outstanding
shares was a direct result of the issuance of shares as a consideration for the Corbina
acquisition, shares issued to Rostelecom and the employee stock option exercises.
Our net income per share of common stock on a fully diluted basis increased to $3.91 for the
year ended December 31, 2007, compared to a net income per common share of $2.33 for the year ended
December 31, 2006. The increase in net income per share of common stock on a fully diluted basis
was due to the
increase in net income, offset by an increase in the number of weighted average shares
assuming dilution to 39,033,953 the year ended December 31, 2007, compared to 36,716,600 the year
ended December 31, 2006.
Consolidated Financial Position — Significant Changes in Consolidated Financial Position at
December 31, 2007, compared to Consolidated Financial Position at December 31, 2006
Cash and Cash Equivalents
Cash and cash equivalents increased by $56.4 million from $18.4 million at December 31, 2006
to $74.8 million at December 31, 2007, primarily as a result of increased operating cash flow
during the year ended December 31, 2007 and borrowings under the credit facility with Citibank,
which we entered into in January 2007.
Accounts Receivable
Accounts
receivable increased by $56.2 million from $147.7 million at December 31, 2006, to
$203.9 million at December 31, 2007, primarily as a result of the acquisition of Corbina, increased
revenue and the changes in the settlements with local operators.
Property and Equipment
Property and equipment increased by $427.2 million from $552.3 million at December 31, 2006 to
$979.5 million at December 31, 2007, as a result of increased investments in telecommunication
equipment to build out our regional network, partly offset by an increase of accumulated
depreciation of $135.8 million on existing property and equipment.
Goodwill
Goodwill increased by $131.0 million from $180.5 million at December 31, 2006 to $311.5
million at December 31, 2007, as a result of acquisitions, completed in 2007.
Intangible Assets
Our
intangible assets increased by $133.1 million from $116.5 million at December 31, 2006, to
$249.6 million at December 31, 2007, primarily as a result of additional intangible assets recorded
upon the acquisition of Fortland and Corbina, partly offset by increased accumulated amortization
of $33.3 million on existing intangible assets of our consolidated subsidiaries.
Long-Term Debt
Long-term debt increased by $225.2 million from $0.03 million at December 31, 2006 to $225.2
million at December 31, 2007, as a result of borrowed funds under the credit facility with
Citibank. As of December 31, 2007, we had $225.0 million outstanding under this credit facility.
Minority Interest
Our
minority interest increased by $62.9 million from $31.3 million at December 31, 2006, to
$94.2 million at December 31, 2007, due to an increase of minority interest in earnings of
consolidated subsidiaries for the year ended December 31, 2007, and consolidation of Fortland and
Corbina, which were acquired in 2007, where our ownership interest is 65% and 51%, respectively.
Stockholders’ Equity
Shareholders’
equity increased by $397.9 million from $817.2 million at December 31, 2006, to
$1,215.1 million at December 31, 2007, as a result of a $142.1 million share issuance for the
Corbina acquisition,
our net income of $152.6 million in the year ended December 31, 2007, and a $70.7 million
increase in accumulated other comprehensive income, partly offset by
an $8.5 million impact
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of adoption of FIN No. 48 recorded as the cumulative effect adjustment to the opening balance of
retained earnings as of January 1, 2007. Also, shareholders’ equity increased by $20.4 million due
to the purchase of shares by Rostelecom.
Consolidated Results — Consolidated Results of Operations for the Year Ended December 31, 2006,
Compared to the Consolidated Results of Operations for the Year Ended December 31, 2005
Revenue
Our revenue increased by 28% to $854.6 million for the year ended December 31, 2006 from
$667.4 million for the year ended December 31, 2005. The breakdown of revenue by business group was
as follows:
| Consolidated Revenue | Consolidated Revenue | |||||||
| For the Year | For the Year | |||||||
| Ended December 31, 2005 | Ended December 31, 2006 | |||||||
| (in millions) | ||||||||
REVENUE |
||||||||
Business and Corporate Services |
$ | 387.4 | $ | 487.2 | ||||
Carrier and Operator Services |
221.4 | 309.1 | ||||||
Consumer Internet Services |
44.5 | 48.7 | ||||||
Mobile Services |
14.1 | 9.6 | ||||||
TOTAL REVENUE |
$ | 667.4 | $ | 854.6 | ||||
The breakdown of revenue by geographic regions was as follows:
| Consolidated Revenue | Consolidated Revenue | |||||||
| For the Year | For the Year | |||||||
| Ended December 31, 2005 | Ended December 31, 2006 | |||||||
| (in millions) | ||||||||
REVENUE |
||||||||
Moscow |
$ | 436.6 | $ | 535.6 | ||||
Northwest region of Russia |
59.9 | 79.6 | ||||||
Other regions of Russia and CIS |
122.9 | 185.9 | ||||||
Ukraine |
73.8 | 82.3 | ||||||
Eliminations |
(25.8 | ) | (28.8 | ) | ||||
TOTAL REVENUE |
$ | 667.4 | $ | 854.6 | ||||
Business and Corporate Services. Revenue from Business and Corporate Services increased by 26%
to $487.2 million for the year ended December 31, 2006 from $387.4 million for the year ended
December 31, 2005. Macro-economic growth in Russia, Ukraine, and the CIS and continuing demand
for our telecommunications solutions are the main factors that contributed in the increase of
revenue in this line of business. Our total number of contracts in this line of business increased
from 184,206 on December 31, 2005, to 253,133 on December 31, 2006, an increase of 37%.
Revenue from the BCS division of Sovintel increased by 24% to $395.8 million for the year
ended December 31, 2006, from $318.0 million for the year ended December 31, 2005. Sovintel BCS
revenue increased by approximately $12.7 million in 2006 due to the introduction of the semi-fixed
USD-RUR exchange rate for settlements with the majority of its customers. In 2006, Sovintel
recorded approximately $14.6 million of additional revenue related to the introduction of CPP. BCS
revenue in Moscow, our largest market, increased by $46.4 million, or 19%, to $292.5 million in
2006 from $246.1 million in 2005. However, as a percentage of total Sovintel BCS revenue, Moscow
decreased from approximately 77% in 2005 to approximately 74% of Sovintel’s total BCS revenue in
2006. This decrease is the result of the expansion of Sovintel’s BCS business in the Russian
regions. Our BCS Moscow voice revenue continues to grow as we expand our client base and comprises
over half of our total BCS revenue in that market. Additionally, we experienced a decrease in the
competitive pressures affecting rates. In 2006, BCS
Moscow revenue from data and Internet services grew significantly not only due to an increase
in our customer base, but also due to increased business from existing customers. We expect our
revenue from BCS Moscow to continue to grow as we continue to experience significant investment in
the Moscow commercial real-estate market. Our ongoing relationships with Moscow real-estate
developers should enable us to continue to grow the number of trade and business centers where we
provide services to end users. Furthermore, we have implemented a key account program in Moscow to
protect our relationships with our largest clients and to foster cross selling. Additionally, we
expect demand for call center and data center services to continue to demonstrate strong growth in
Moscow. Our revenue from call centers and data centers increased by approximately $3.4 million, or
180%, from years 2005 to 2006. These services now account for approximately $7.7 million in
revenue in BCS Sovintel. Refer to the table below for key operating statistics for BCS Moscow.
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| (in whole numbers) | ||||||||||||
| BCS Moscow customer statistics on December 31: | 2005 | 2006 | % Change | |||||||||
Total clients |
23,013 | 23,456 | 2 | % | ||||||||
Business centers |
791 | 920 | 16 | % | ||||||||
Trade centers |
68 | 94 | 38 | % | ||||||||
Hotels |
48 | 53 | 10 | % | ||||||||
Direct inward dialing lines |
127,000 | 138,000 | 9 | % | ||||||||
Ethernet / Metropolitan Ethernet Network connections |
1,708 | 2,652 | 55 | % | ||||||||
High speed Internet active contracts |
485 | 976 | 101 | % | ||||||||
Sovintel regional BCS revenue increased by 44% to $103.3 million in 2006 from $71.9 million in
2005. As a percentage of total Sovintel BCS revenue, regional BCS revenue increased from
approximately 23% in 2005 to approximately 26% of Sovintel’s total BCS revenue in 2006. Sovintel
regional BCS business continues to grow as we assist our customers in developing their businesses
in Russian regions outside of Moscow.
Revenue from the BCS division of GTU increased by 24% to $49.8 million for the year ended
December 31, 2006, from $40.1 million for the year ended December 31, 2005. This increase in
revenue was due to a 21% increase in the minutes of use resulting from a 53% increase in the number
of serviced voice lines. Partly offsetting these increasing factors was a 1% decrease in the
average rate per minute of use per line per month due to more residential, SMEs, and regional
customers in the client base, and traffic migration to mobile networks. In 2005, GTU began
providing voice services to residential customers and had approximately 9,370 residential customers
as of December 31, 2006, and 4,648 as of December 31, 2005. GTU expects revenue from residential
customers to increase in the future as it expands its network to reach more residential buildings
in Ukraine. Additionally, data and Internet revenue increased by approximately $4.5 million due to
increase in the number of ports in service.
Our acquisition strategy also contributed to the overall BCS growth in 2006. Our revenue
increased by approximately $5.3 million due to the acquisitions of Sakhalin Telecom LLC (“Sakhalin
Telecom”) and ZAO Sochitelecom (“Sochitelecom”) in 2005 and by $4.5 million due to the acquisitions
of ZAO Tatar Intellectual Communications (“Tatintelcom”), TTK LLC (“TTK”), Kubtelecom and Telcom
LLC (“Telcom”)in 2006. Our regional acquisition strategy has enabled us to increase our access to
last mile infrastructure, thus enabling us to expand our corporate client base.
Carrier and Operator Services. Revenue from Carrier and Operator Services increased by 40% to
$309.1 million for the year ended December 31, 2006, from $221.4 million for the year ended
December 31, 2005. Our total number of contracts in this line of business grew by 31% to 2,388 as
of December 31, 2006, from 1,827 as of December 31, 2005.
Carrier and Operator Services revenue from Sovintel increased by 39% to $279.5 million for the
year ended December 31, 2006, from $200.8 million for the year ended December 31, 2005. In
Sovintel, we have expanded our operations with existing partners and added a number of new carriers
in the regions with increased volumes of traffic. Additionally, our revenue from international
traffic increased as we carried larger volumes of lower-margin traffic destined to CIS countries.
We also observed significant increase in Internet traffic. During 2006 Sovintel recorded
approximately $14.8 million of additional revenue related to the introduction of CPP. Sovintel
carrier’s carrier revenue increased by approximately $0.7 million in 2006 due to the introduction
of the semi-fixed USD-RUR exchange rate for settlements with its customers. We expect that our
revenues in this line of business will continue to increase in future periods as we expand our
termination capabilities and continue to develop our network. Following the introduction of the
new Interconnection Rules, we observed less competitive pressure on revenues.
Revenue for the Carrier and Operator Services division of GTU increased by 9% to $21.5 million
for the year ended December 31, 2006, from $19.7 million for the year ended December 31, 2005.
Carrier’s carrier revenue increased due to a 62% increase in transit traffic from local operators
following a decrease of rates to mobile networks and additional revenue from increased traffic
volume from URS. This increase was partially offset by a decrease in the incoming international
minutes of use due to increase in termination rates as a result of changes in VAT regulations.
Carrier and Operator Services revenue increased by approximately $0.3 million due to the
acquisitions of Sakhalin Telecom and Sochitelecom in 2005, and by $3.8 million due to the
acquisitions of Tatintelcom and Kubtelecom in 2006.
Consumer Internet Services. Revenue from Consumer Internet Services increased by 9% to $48.7
million for the year ended December 31, 2006, from $44.5 million for the year ended December 31,
2005. Consumer Internet Services revenue increased by approximately $2.5 million due to the
acquisitions of Sakhalin Telecom and Sochitelecom in 2005, and by $0.5 million due to the
acquisitions of Kubtelecom and ZAO Corus ISP (“Corus”) in 2006. Our revenue from consumer dial-up
Internet decreased by approximately $1.3 million from years 2005 to 2006. The average revenue per
dial-up Internet subscriber decreased from $6.85 per month for the year ended December 31, 2005, to
approximately $6.68 per month for the year ended December 31, 2006, the number of dial-up Internet
subscribers decreased from 422,480 at December 31, 2005, to 401,098 at December 31, 2006. The
demographics of our dial-up subscriber base continue to change as we add regional subscribers and
lose subscribers in Moscow. The consumer
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Internet market in Moscow has become more competitive due
to the increasing availability of other Internet access technologies. Offsetting the decrease in
dial-up revenue was a $5.5 million increase in other consumer Internet products, such as consumer
broadband, primarily from customers outside of Moscow. We anticipate that our revenue from
consumer broadband will increase as we embark on our broadband access rollout. Our current and
past base of dial-up Internet subscribers in Moscow and throughout Russia will allow us to
specifically target subscribers that currently use or have previously used our Internet services.
Mobile Services. Revenue from Mobile Services decreased by 32% to $9.6 million for the year
ended December 31, 2006, from $14.1 million for the year ended December 31, 2005. The decline in
revenue was primarily due to increased competition in the Ukrainian mobile market, lack of network
coverage and the restrictions on national roaming services, which has led to significant churn of
high usage contract subscribers. Active subscribers increased from 47,502 at December 31, 2005, to
48,448 at December 31, 2006, due to a decrease in churn of prepaid services subscribers following
the introduction of the customer loyalty program. However, the average revenue per active
subscriber decreased by 25% from approximately $22.73 per month to approximately $17.13 per month
primarily due to a decrease in the average subscription fee and traffic revenue due to higher share
of prepaid subscribers with lower usage compared to contract subscribers.
Expenses
The following table shows our principal expenses for the years ended December 31, 2006 and
December 31, 2005:
| Consolidated Expenses | Consolidated Expenses | |||||||
| For the Year Ended | For the Year Ended | |||||||
| December 31, 2005 | December 31, 2006 | |||||||
| (in millions) | ||||||||
COST OF REVENUE |
||||||||
Business and Corporate Services |
$ | 165.7 | $ | 213.4 | ||||
Carrier and Operator Services |
145.7 | 218.4 | ||||||
Consumer Internet Services |
29.9 | 37.4 | ||||||
Mobile Services |
6.2 | 5.2 | ||||||
TOTAL COST OF REVENUE |
347.5 | 474.4 | ||||||
Selling, general and administrative |
119.9 | 152.8 | ||||||
Depreciation and amortization |
84.0 | 100.2 | ||||||
Equity in earnings of ventures |
(0.4 | ) | (1.9 | ) | ||||
Interest income |
(2.3 | ) | (1.2 | ) | ||||
Interest expense |
0.6 | 0.6 | ||||||
Foreign currency (gain) loss |
1.2 | (1.7 | ) | |||||
Minority interest |
3.0 | 4.8 | ||||||
Provision for income taxes |
37.8 | 40.4 | ||||||
Cumulative effect of a change in
accounting principle, net of tax |
$ | — | $ | 0.7 | ||||
Cost of Revenue
Our cost of revenue increased by 37% to $474.4 million for the year ended December 31, 2006
from $347.5 million for the year ended December 31, 2005.
Business and Corporate Services. Cost of revenue from BCS increased by 29% to $213.4 million,
or 44% of revenue, for the year ended December 31, 2006 from $165.7 million, or 43% of revenue, for
the year ended December 31, 2005. We continue to maintain robust gross margins in this line of
business due to the continued demand for high-volume and high-margin services from our customers.
Cost of revenue for the BCS division of Sovintel increased by 30% to $173.9 million, or 44% of
revenue, for the year ended December 31, 2006, from $133.6 million, or 42% of revenue, for the year
ended December 31, 2005. The increase in cost of revenue as a percentage of revenue is primarily
due to an increased volume of lower margin products and continuing pressure on our margins in this
line of business from our existing customers. In 2006, Sovintel recorded approximately $6.5 million
of additional costs related to the introduction of CPP, $0.8 million related to our SARs plans, and
$0.7 million related to the introduction of fixed USD-RUR exchange rate for payroll related costs.
Cost of revenue for the BCS division of GTU increased by 5% to $21.4 million, or 43% of
revenue, for the year ended December 31, 2006, from $20.3 million, or 51% of revenue, for the year
ended December 31, 2005. Cost of revenue decreased as a percentage of revenue primarily due to a
decrease in the settlement rates for traffic termination to mobile networks according to the
agreements with Ukrainian Mobile Communications (“UMC”) and Kyivstar GSM effective from the first
quarter of 2006. Additionally, in October 2005, we started routing Internet traffic via our STM-4
channel to Frankfurt bypassing local incumbent operators and reducing Internet transmission costs.
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BCS cost of revenue increased by approximately $2.6 million due to the acquisitions of
Sakhalin Telecom and Sochitelecom in 2005, and by $2.5 million due to the acquisitions of
Tatintelcom, TTK, Kubtelecom and Telcom in 2006.
Carrier and Operator Services. Cost of revenue from Carrier and Operator Services increased by
50% to $218.4 million, or 71% of revenue, for the year ended December 31, 2006, from $145.7
million, or 66% of revenue, for the year ended December 31, 2005. We continue to observe pressure
on our operating margins in this line of business, attributable to competition and to a change in
our traffic mix.
Cost of revenue for the Carrier and Operator Services division of Sovintel increased by 50% to
$207.8 million, or 74% of revenue, for the year ended December 31, 2006, from $138.7 million, or
69% of revenue, for the year ended December 31, 2005. The increase in cost of revenue as a
percentage of revenue is primarily due to an increased volume of lower margin products and
continuing pressure on our margins in this line of business from our existing customers. In 2006,
Sovintel recorded approximately $13.7 million of additional costs related to the introduction of
CPP, $0.6 million related to our SARs plans, and $0.4 million related to the introduction of fixed
USD-RUR exchange rate for payroll related costs.
Cost of revenue for the Carrier and Operator Services division of GTU decreased to $14.8
million, or 69% of revenue for the year ended December 31, 2006, from $15.5 million, or 79% of
revenue for the year ended December 31, 2005. Cost of revenue decreased as a percentage of revenue
primarily due to lower margin incoming international traffic accounting for a smaller portion of
our total wholesale traffic in 2006. In addition, our transmission optimization program enabled us
to reduce costs associated with the lease of trunk channels from other operators.
Carrier and Operator Services cost of revenue increased by approximately $0.6 million due to
the acquisitions of Sakhalin Telecom and Sochitelecom in 2005, and by $2.2 million due to the
acquisitions of Tatintelcom and Kubtelecom in 2006.
Consumer Internet Services. Cost of revenue from Consumer Internet Services increased by 25%
to $37.4 million, or 77% of revenue, for the year ended December 31, 2006, from $29.9 million, or
67% of revenue, for the year ended December 31, 2005. The increase in cost of revenue as a
percentage of revenue was mainly the result of the new settlement rules for interconnection with
other operators. We incurred approximately $2.6 million of origination fees for calls terminated to
our dial-up Internet services network. In addition, network costs not decreasing in line with
revenue declines from dial-up Internet. As regional subscribers account for a larger portion of
our total subscriber base, margins in this line of business have decreased due to incremental
network costs incurred to provide access to regional customers. Furthermore, the impact of a
decline in subscribers in Moscow has not resulted in an immediate decline of network costs, which
are more fixed in nature.
Consumer Internet Services cost of revenue increased by approximately $1.8 million due to the
acquisitions of Dicom LLC, Sakhalin Telecom and Sochitelecom in 2005, and by $0.3 million due to
the acquisitions of Kubtelecom and Corus in 2006.
Mobile Services. Cost of revenue from Mobile Services decreased by 16% to $5.2 million, or 54%
of revenue for the year ended December 31, 2006, from $6.2 million, or 44% of revenue for the year
ended December 31, 2005. The increase in cost of revenue as a percentage of revenue is mainly due
to additional payments for the frequencies received under the new GSM-1800 license and network
costs related to the FMC network development.
Selling, General and Administrative
Our selling, general and administrative expenses increased by 27% to $152.8 million, or 18% of
revenue, for the year ended December 31, 2006, from $119.9 million, or 18% of revenue, for the year
ended December 31, 2005. Ongoing employee related costs such as salaries, bonuses, insurance and
other benefits increased by approximately $28.7 million, or 54%, primarily due to a $18.0 million
charge recorded in 2006 related to our SARs plans, a $2.0 million additional charge recorded in
2006 related to introduction of fixed USD-RUR exchange rate for payroll related costs, and a 16%
increase in consolidated headcount, increased executive officer costs, and ongoing salary
increases. In the fourth quarter of 2006, we reversed a $2.6 million liability with a former
shareholder because of the expiration of the statute of limitations. Additionally, in 2005, we
reversed a $1.4 million accrued liability related to estimated payroll taxes recorded upon the
acquisition of one of our Russian subsidiaries. Furthermore, in 2005, we recorded a $1.1 million
charge for the revision of our estimate for unused vacation. Bad debt expense decreased by
approximately $3.8 million compared to the year ended December 31, 2005, mainly due to the revision
of our estimate for allowance for doubtful accounts. Taxes, other than income taxes, increased by
$3.1 million between years due to an increase in property taxes and non-recoverable VAT. Our
advertising costs
increased by $5.3 million due to intensified marketing campaign of our new products and
rebranding. The remaining $1.9 million net increase is the result of other selling, general and
administrative expenses increasing in line with the growth in our business.
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Depreciation and Amortization
Our depreciation and amortization expenses increased by 19% to $100.2 million for the year
ended December 31, 2006, from $84.0 million for the year ended December 31, 2005. Depreciation
expense increased by $13.9 million, or 21%, primarily due to depreciation on capital expenditures
to further develop our network. Depreciation expense increased by $3.2 million due to the change
in functional currency effective July 1, 2006. Amortization expense also increased by $2.3 million,
or 12%, primarily due to amortization on intangible assets arising from acquisitions consummated in
2005 and 2006. Amortization expense increased by $0.5 million due to the change in functional
currency effective July 1, 2006.
Equity in Earnings of Ventures
The earnings after interest and tax charges from our investments in non-consolidated ventures
increased to $1.9 million for the year ended December 31, 2006 from $0.4 million for the year ended
December 31, 2005. The increase is mainly due to the acquisition of 54% of Rascom in the fourth
quarter of 2005. We account for our investments in Rascom under the equity method because the
rights of the minority shareholder represent substantive participating rights, and as result, such
rights overcome the presumption that we control Rascom.
Interest Income
Our interest income for the year ended December 31, 2006, decreased to $1.2 million from $2.3
million for the year ended December 31, 2005. The decrease in interest income is due to decreased
cash balances held in interest bearing accounts.
Interest Expense
Our interest expense was $0.6 million for the year ended December 31, 2006, unchanged from the
year ended December 31, 2005.
Foreign Currency Gain (Loss)
Our foreign currency gain was $1.7 million for the year ended December 31, 2006, compared with
a loss of $1.2 million for the year ended December 31, 2005. The increase in foreign currency gain
is due to the combination of movements in exchange rates and change in functional currency
effective July 1, 2006. The impact of the change in functional currency resulted in a $1.3 million
decrease in foreign currency gain.
Minority Interest
Our minority interest was $4.8 million for the year ended December 31, 2006, compared to $3.0
million for the year ended December 31, 2005. Minority interest in our earnings increased due to an
increase in earnings and consolidation of recently acquired entities where our ownership interest
is less than 100%. In 2006, we acquired less than 100% of Tatintelcom and Kubtelecom.
Provision for Income Taxes
Our charge for income taxes was $40.4 million for the year ended December 31, 2006, compared
to $37.8 million for the year ended December 31, 2005. Our effective tax rate was 31% for the year
ended December 31, 2006, down from 32% for the year ended December 31, 2005. Tax expense decreased
by $1.8 million due to the change in functional currency effective July 1, 2006. We recognized
approximately $2.2 million in additional tax expense in 2005 since we changed our valuation allowance for
United States (“US”) deferred tax assets due to our reassessment of sources of future taxable
income in the US. Refer to Note 11 in the financial statements included in Item 8 of this form
10-K for a reconciliation of our statutory tax rate to the effective tax rate.
Net Income and Net Income per Share
Our net income for the year ended December 31, 2006 was $85.5 million, compared to a net
income of $76.1 million for the year ended December 31, 2005.
Our net income per share of common stock increased to $2.34 for the year ended December 31,
2006, compared to a net income per share of $2.09 for the year ended December 31, 2005. The
increase in net income per share of common stock was due to the increase in net income partly
offset by the cumulative effect of a change in accounting principle related to accounting for
share-based payments of $0.02 per share of common stock, and an increase in the number of weighted
average shares to 36,591,097 in the year ended December 31, 2006, compared to 36,378,175 in the
year ended December 31, 2005. The increase in outstanding shares was a direct result of the
employee stock option exercises and the issuance of restricted stock to certain members of
management.
Our net income per share of common stock on a fully diluted basis increased to $2.33 for the
year ended December 31, 2006, compared to a net income per common share of $2.08 for the year ended
December 31, 2005. The increase in net income per share of
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common stock on a fully diluted basis
was due to the increase in net income partly offset by the cumulative effect of a change in
accounting principle related to accounting for share-based payments of $0.02 per share of common
stock, and an increase in the number of weighted average shares assuming dilution to 36,716,600 the
year ended December 31, 2006, compared to 36,605,075 the year ended December 31, 2005.
Consolidated Financial Position — Significant Changes in Consolidated Financial Position at
December 31, 2006, compared to Consolidated Financial Position at December 31, 2005
Accounts Receivable
Accounts receivable increased by $56.0 million from $91.7 million at December 31, 2005, to
$147.7 December 31, 2006, as a result of increased revenue when comparing the month of December
2006 with the month of December 2005, and due to the changes in the settlements with local
operators following the introduction of the new Interconnection Rules.
Intangible Assets
Our intangible assets increased by $22.6 million from $93.9 million at December 31, 2005, to
$116.5 million at December 31, 2006, due to a $10.5 million impact of the change in functional
currency effective July 1, 2006, and as a result of additional intangible assets recorded upon the
acquisitions of Tatintelcom, TTK, Kubtelecom and S-Line, and the purchase of additional numbering
capacity, offset by amortization on continuing intangible assets of the consolidated subsidiaries.
Other Non-Current Liabilities
Our other non-current liabilities increased by $2.3 million from negligible amount at December
31, 2005, to $2.3 million at December 31, 2006, as a result of the adoption of SFAS No. 123R
related to accounting for share-based payments.
Minority Interest
Our minority interest increased by $11.6 million from $19.7 million at December 31, 2005, to
$31.3 million at December 31, 2005, due to a $1.8 million impact of the change in functional
currency effective July 1, 2006, $4.8 million minority interest in earnings for the year ended
December 31, 2006, and
consolidation of recently acquired Tatintelcom, Kubtelecom and S-Line where our ownership
interest is less than 100%.
Stockholders’ Equity
Shareholders’ equity increased by $142.1 million from $675.1 million at December 31, 2005, to
$817.2 million at December 31, 2006, as a result of our net income of $85.5 million offset by
declaring and paying $22.0 million in dividends in the year ended December 31, 2006, and a $75.1
million impact of the change in functional currency effective July 1, 2006, recorded as accumulated
other comprehensive income. Also, shareholders’ equity increased by $3.2 million due to stock
option exercises and by $0.3 million due to vesting of restricted shares.
Income Taxes
Our effective rate of income tax differs from the US statutory rate due to the impact of the
following factors: (1) different income tax rates and regulations apply in the countries where we
operate; (2) expenses that are non-deductible on the income tax return; (3) write-offs of certain
assets that are not deductible for tax purposes; and (4) changes in the valuation allowance for
deferred tax assets. We currently have deferred tax assets arising from deductible temporary
differences in our non-US subsidiaries. Due to the continued profitability of these subsidiaries,
we anticipate that these deferred tax assets will be realized through deduction against future
taxable income. We also have deferred tax assets related to net operating loss carry-forwards and
deductible temporary differences for US federal income tax purposes. We have recorded a full
valuation allowance against these deferred tax assets due to our assessment of sources of future
taxable income in the US. We have also recorded a deferred tax asset related to net operating loss
carry-forwards for Cyprus tax purposes. However, we have recorded a full valuation allowance since
we do not anticipate recognizing taxable income in our Cyprus entity in the foreseeable future.
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Liquidity and Capital Resources
The following table shows our cash flows for the years ended December 31, 2007, and December
31, 2006:
| Consolidated Cash Flows | Consolidated Cash Flows | |||||||
| For the Year | For the Year | |||||||
| Ended December 31, 2006 | Ended December 31,2007 | |||||||
| (in millions) | ||||||||
CASH FLOWS |
||||||||
Provided by operating activities |
$ | 160.7 | $ | 196.7 | ||||
Used in investing activities |
(201.1 | ) | (373.9 | ) | ||||
Provided by (used in) financing activities |
(9.8 | ) | 232.0 | |||||
Effect of exchange rate changes |
1.4 | 1.6 | ||||||
Net increase (decrease) in cash and cash equivalents |
$ | (48.8 | ) | $ | 56.4 | |||
Our cash and cash equivalents was $74.8 million and $18.4 million as of December 31, 2007 and
December 31, 2006, respectively.
Net cash provided by our operating activities increased by $36.0 million to $196.7 million for
the year ended December 31, 2007, from $160.7 million for the year ended December 31, 2006. This
increase in net cash inflows from operating activities for the year ended December 31, 2007 is
mainly due to a growth in revenue and operating income and the faster collections from our
customers.
During the year ended December 31, 2007, we received approximately $1,241.6 million in cash
from our customers for services and we paid approximately $988.5 million to suppliers and
employees. During the year ended December 31, 2006, we received approximately $802.1 million in
cash from our customers for services and we paid approximately $598.5 million to suppliers and
employees.
We used cash of $373.9 million for investing activities for the year ended December 31, 2007
and $201.1 million for the year ended December 31 2006 which were principally attributable to
building our telecommunications networks and acquisitions. Network investing activities for the
year ended December 31, 2007 are primarily related to purchases of telecommunication equipment and
included cash paid for capital expenditures principally attributable to the construction of our
telecommunications network in the regions. The majority of network investing activities related to
the construction of last mile access, the inter-city fiber optic network and network upgrades as a
result of increased customer connections.
We used cash of $132.1 million for the year ended December 31, 2007, for the acquisition of
Kolangon, ZAO Telecommunication Agency, ICA Center of Commercial Real Estate LLC, Corbina, ZAO
DirectNet, ZAO Satcomtel, Alcar LLC, Satel Tsentr LLC, TeleRoss joint ventures, ZAO Bryansk Tel,
BryanskIntel LLC, NTT LLC, and Skat-7 LLC. We used cash of $26.8 million for the year ended
December 31, 2006, for the acquisition of Tatintelcom, TTK, Kubtelecom, Telcom, S-Line and Corus.
In July 2007, we sold our minority share in MCT, a company operating mobile networks in
Uzbekistan, Tajikistan and Afghanistan. Our 22.8% stake in MCT was sold to TeliaSonera for cash
consideration of $41.3 million.
We paid no dividends during the year ended December 31, 2007. We paid dividends of $22.0
million to shareholders during the year ended December 31, 2006.
We received $20.4 million in cash from Rostelecom, which exercised its non dilution rights
under the existing shareholders agreement and acquired 392,988 newly issued shares in a transaction
exempt from registration.
We
had working capital of $77.7 million as of December 31, 2007 and $42.8 million as of
December 31, 2006. Our working capital ratio (current assets divided by current liabilities) was
1.24 as of December 31, 2007 and 1.23 as of December 31, 2006. We believe that our working capital
is sufficient to meet our requirements.
As part of our drive to increase our network capacity, reduce costs and improve the quality of
our service, we have leased fiber optic and satellite-based network capacity; the terms of these
leases are generally five years or more and can involve significant advance payments.
We expect to repay our debt as it becomes due from our operating cash flows or through
additional borrowings. We believe that our working capital together with our plans for external
financing will provide us with sufficient funds for our present and future obligations.
In February 2007, we entered into a five year lease agreement STM-1 fiber optic capacity from
Ufa to Krasnoyarsk. The lease has a term of five years and total payments of $9.8 million. We took
possession of this STM-1 fiber optic capacity beginning April 1,
2007. In conjunction with this transaction, we also entered into agreement whereby we agreed
to provide a loan of $9.8 million to the
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lessor. During the year ended December, 31 2007, we
disbursed $9.8 million to the
lessor under the loan agreement. The loan matures in 2012 and carries
interest at a rate of 9% per annum.
In July 2006, GTU entered into one-year revolving, credit facility for up to $3.5 million plus
a cash coverage facility of up to $2.0 million with Calyon Bank Ukraine (“Calyon”). The credit
facility extended through March 31, 2008. As of December 31, 2007, GTU had outstanding $2.2 million
under this credit facility. The credit facility carries interest at a rate equal to London
Interbank Offered Rate (“LIBOR”) plus 2% for the loans
denominated in USD and at prevailing bank’s offered rate plus a
margin of 2% for the loans denominated in Ukrainian Hryvna
(equivalent to approximately 14%, on average for loans outstanding,
at December 31, 2007). The credit facility requires GTU to maintain
accounts with Calyon in the currencies of the loan and ensure that the aggregate amount of incoming
payments credited to GTU’s accounts with Calyon in any calendar month is equal to, or greater than
30% of the aggregate amount of the loans outstanding as of the last day of such month.
In September 2006, Sovintel entered into a 90 day short term, revolving, credit facility for
up to $15.0 million with ZAO Citibank. As of December 31, 2007, Sovintel had borrowed $14.7 million
under this credit facility. The credit facility carries interest of 8% per annum. The credit
facility requires Sovintel to maintain accounts with ZAO Citibank in the currencies of the loan and
ensure that the aggregate amount of incoming payments credited to Sovintel’s accounts with ZAO
Citibank in any calendar month is equal to, or greater than 30% of the aggregate amount of the
loans outstanding as of the last day of such month.
In January 2007, we entered into a five-year term Facility Agreement (the “Facility
Agreement”) with banks, financial institutions and other institutional lenders, Citibank, N.A.
London Branch and ING Bank N.V. as mandated lead arrangers, and Citibank International plc as
agent. The Facility Agreement established an unsecured credit facility under which we, GTS Finance,
Inc., our wholly-owned subsidiary, and Sovintel may borrow up to an aggregate of $275.0 million.
The credit facility carries interest at a rate equal to LIBOR plus 1.5% per annum for the first
twenty-four months and LIBOR plus 2% per annum thereafter (equivalent
to approximately 6.5% at
December 31, 2007). Funds borrowed may be used for general corporate purposes, including
acquisitions, the payment of dividends and capital expenditures. The Facility Agreement places
various restrictions on us related to incurrence of debt, asset disposals, mergers and
acquisitions, and negative pledges. The Facility Agreement also requires us to meet various
financial and non-financial covenants, including several restrictions related to financial
condition. As of December, 31 2007, we had the ability to borrow up to $50.0 million under the
Facility Agreement. During the year ended December 31, 2007, we paid approximately $3.9 million of
origination fees to the lead arrangers.
We are exposed to market risk from changes in interest rates. We use derivative financial
instruments to manage our interest rate risks.
In October 2007, we entered into a three-year Interest Rate Swap agreement with Citibank, N.A.
London Branch, to reduce the volatility of cash flows in the interest payments for variable-rate
debt. Pursuant to the agreement, we will exchange interest payments on a regular basis, we will pay
a fixed rate equal to 4.355% in the event the fixed rate is equal to no greater than 5.4%, and
otherwise we shall pay LIBOR floating rate. We will receive interest payments, based on the
floating rate, from Citibank, N.A. London Branch.
Our credit ratings as of March 17, 2008 are as follows:
| Credit Rating Agency | Rating | Outlook | ||||||
Standard & Poor’s |
BB+ | Stable | ||||||
Moody’s |
Ba3 | Stable | ||||||
The cost of our borrowings is affected by our credit ratings. If our credit ratings were
downgraded, we could be required to pay higher interest rates on secured or unsecured borrowings
and could be subject to more restrictive financial covenants. We may not be able to obtain
additional financing on favorable terms. Our failure to generate sufficient funds in the future,
whether from operations or by raising additional debt or equity capital, may require us to delay or
abandon some or all of our anticipated expenditures, to sell assets, or both, which could have a
material adverse effect on our operations.
In addition, as the surviving corporation in the Merger as previously discussed, we assumed
Merger Sub’s obligations under an Unsecured Loan Agreement for up to $4.15 billion, dated February
15, 2008, by and between VimpelCom and Merger Sub (the “$4.15 Billion Loan Agreement”) and the
Amended and Restated Unsecured Loan Agreement for up to $41.4 million, dated December 21, 2007,
between Merger Sub and VimpelCom (the “$41.4 Million Loan Agreement” and, together with the $4.15
Billion Loan Agreement, the “Intercompany Loan Agreements”). In connection with our assumption of
Merger Sub’s obligations under the Intercompany Loan Agreements, on February 28, 2008, we entered
into a Subordination Deed (the “Subordination Agreement”) with VimpelCom and Citibank International
plc as agent, pursuant to which the Intercompany Loan Agreements have been subordinated to our
obligations under the Facility Agreement. The Subordination Agreement includes a provision that
gives VimpelCom the right, at any time or from time to time and on such terms as it may choose, to
convert all or part of our obligations to VimpelCom, including under the Intercompany Loan
Agreements, into equity capital.
Subject to the Subordination Agreement, the Intercompany Loan Agreements provide for VimpelCom
to make advances of funds to Merger Sub in an aggregate amount up to approximately $4.20 billion.
As of the time of the consummation of the Merger, Merger
Sub had borrowed approximately $3.84 billion under the Intercompany Loan Agreement. Amounts
advanced under the $4.15 Billion
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Loan Agreement and $41.1 Million Loan Agreement accrue interest at
a rate of three percent (3%) per annum and six percent (6%) per annum, respectively. Each advance
under the Intercompany Loan Agreements becomes due and payable, together with accrued interest on
the amount of such advance, no later than six months from the date of such advance. The
Intercompany Loan Agreements contain customary representations and warranties and events of default
customary for VimpelCom intercompany loan agreements. Subject to the Subordination Agreement,
payment of outstanding amounts due under the Intercompany Loan Agreements may be accelerated by
VimpelCom upon an event of default.
In connection with the Merger, we incurred an investment banking fee of approximately $15.2
million and made change of control payments of approximately $3.8 million.
Inflation
In 2006, Sovintel introduced semi-fixed USD–RUR exchange rate for settlements with the
majority of its customers. Following the introduction of the semi-fixed USD–RUR exchange rate for
settlements with its customers, Sovintel introduced the same exchange rate mechanism for
settlements with its employees related to salaries, bonuses and unused vacation accrual. Majority
of our costs are denominated in RUR and sensitive to rises in the general price level in Russia.
Moreover, in 2005, 2006 and 2007, the RUR appreciated in nominal terms against the USD, which
combined with the rate of inflation in Russia, resulted in a real appreciation of the RUR against
the USD. We would expect inflation-driven increases in these costs to put pressure on our margins.
While we could seek to raise our tariffs to compensate for such increase in costs, competitive
pressures may not permit increases that are sufficient to preserve operating margins.
According to Russian government estimates, inflation in Russia was 11% in 2005, 9% in 2006 and
12% in 2007. The Russian government expects inflation to be approximately 9% to 12% in 2008. The
inflation in Ukraine was 10% in 2005, 9% in 2006 and 17% in 2007.
Contractual Obligations
As of December 31, 2007, we had the following contractual obligations, including long-term
debt arrangements, capital leases, and commitments for future payments under non-cancelable lease
arrangements and purchase obligations:
| Payments Due by Period (3) | ||||||||||||||||||||
| (in thousands) | ||||||||||||||||||||
| Less | ||||||||||||||||||||
| than 1 | 1 – 3 | 4 - 5 | ||||||||||||||||||
| Total | year | years | years | Thereafter | ||||||||||||||||
Long-term debt |
$ | 262,071 | $ | 14,804 | $ | 231,827 | $ | 15,440 | $ | — | ||||||||||
Capital lease obligations |
13,296 | 4,050 | 8,518 | 728 | — | |||||||||||||||
Non-cancelable lease
obligations |
58,637 | 23,649 | 29,246 | 5,524 | 218 | |||||||||||||||
Purchase obligations (1) |
138,757 | 109,319 | 24,077 | 5,109 | 252 | |||||||||||||||
Other long-term liabilities (2) |
3,673 | — | 3,673 | — | — | |||||||||||||||
Total |
$ | 476,434 | $ | 151,822 | $ | 297,341 | $ | 26,801 | $ | 470 | ||||||||||
| (1) | Purchase obligations primarily include our contractual legal obligations for the future purchase of equipment, interconnect, and satellite transponder capacity. | |
| (2) | Other long-term liabilities primarily include obligations related to the SARs we have granted. | |
| (3) | Amounts include interest. | |
| (4) | FIN No. 48 liabilities of $18.9 million are excluded from the Contractual Obligations table because we are not able to make a reasonable reliable estimate of the period of cash settlement with the respective taxing authority. |
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Special Note Regarding Forward Looking
Certain statements contained in “Management’s Discussion and Analysis of Financial Condition
and Results of Operations” and other parts of this document, including, without limitation, those
concerning (i) future acquisitions and capital expenditures including our strategy of regional
expansion; (ii) projected traffic volumes and other growth indicators; (iii) anticipated revenues
and expenses; (iv) our competitive environment; (v) our plans to continue to develop our businesses
to create a uniform service platform (vi) our intention to offer our services under the Golden
Telecom brand; (vii) our business and growth strategy, including our strategy to develop into
residential markets; (viii) our intentions to expand our fiber optic capacity, broadband capacity,
including rollout of our FTTB network in the Top-65 cities of Russia and Ukraine, and add
transmission capacity; (ix) our intention to offer VoIP services; (x) our plans to migrate our
products and services to a new generation network; (xi) our plans to expand into the media market;
(xii) our intention to continue to use the assets of recently acquired companies in the manner such
assets were previously used; (xiii) our plans to continue to deploy the FMC network and launch FMC
services; (xiv) the deployment of our FTN and the effect of such deployment, (xv) the impact of
critical accounting policies, (xvi) expectations regarding delisting from NASDAQ and
deregistration from the SEC; (xvii) plans to cooperate with VimpelCom; and (xviii) the political,
regulatory and financial situation in the markets in which we operate, including macroeconomic
growth, the inflow of direct foreign investment and the effect of the Telecommunications Law and
its supporting regulations, are forward-looking and concern the Company’s projected operations,
economic performance and financial condition. These forward-looking statements are made pursuant to
the safe harbor provisions of the Securities Litigation Reform Act of 1995. It is important to note
that such statements involve risks and uncertainties and that actual results may differ materially
from those expressed or implied by such forward-looking statements. Among the key factors that have
a direct bearing on the Company’s results of operations, economic performance and financial
condition are the commercial and execution risks associated with implementing the Company’s
business plan, including our assessment of additional provisions, our ability to effectively deploy
our FTN, our ability to develop our fiber optic, broadband and DSL strategies, including developing
FTTB and VoIP services, our ability to deploy and integrate the technology necessary to migrate to
a new generation network, our ability to offer services under our DLD/ILD and compete with others
offering the same services, that we are not able to anticipate and realize on anticipated synergies
or in the manner expected, our ability to delist from NASDAQ and to deregister from the SEC, our
ability to move into the media market and offer new services in that area, our ability to develop a
FMC network in Ukraine and expand our mobile service offerings, our ability to integrate recently
acquired companies into our operations, and the political, economic and legal environment in the
markets in which the Company operates, including the impact of the new Telecommunications Law and
its supporting regulations, increasing competitiveness in the telecommunications and
Internet-related businesses that may limit growth opportunities, and increased and intense downward
price pressures on some of the services that we offer. These and other factors are discussed herein
under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and
elsewhere in this Report.
Additional information concerning factors that could cause results to differ materially from
those in the forward-looking statements are contained in this Form 10-K.
In addition, any statements that express, or involve discussions as to, expectations, beliefs,
plans, objectives, assumptions or future events or performance (often, but not always, through the
use of words or phrases such as “will likely result,” “are expected to,” “estimated,” “intends,”
“plans,” “projection” and “outlook”) are not historical facts and may be forward-looking and,
accordingly, such statements involve estimates, assumptions and uncertainties which could cause
actual results to differ materially from those expressed in the forward-looking statements.
Accordingly, any such statements are qualified in their entirety by reference to, and are
accompanied by, the factors discussed throughout this Report and investors, therefore, should not
place undue reliance on any such forward-looking statements.
Further, any forward-looking statement speaks only as of the date on which such statement is
made, and the Company undertakes no obligation to update any forward-looking statement or
statements to reflect events or circumstances after the date on which such statement is made or to
reflect the occurrence of unanticipated events. New factors may emerge from time to time, and it is
not possible for management to predict all of such factors. Further, management cannot assess the
impact of each such factor on the Company’s business or the extent to which any factor, or
combination of factors, may cause actual results to differ materially from those contained in any
forward-looking statements.
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ITEM 7A. Quantitative and Qualitative Disclosure About Market Risk
Our treasury function has managed our funding, liquidity and exposure to interest rate and
foreign currency exchange rate risks. Our investment treasury operations are conducted within
guidelines that have been established and authorized by our audit committee. In accordance with our
policy, we do not enter into any treasury management transactions of a speculative nature.
We are exposed to market risk from changes in foreign currency exchange rates. We do not
currently use derivative financial instruments, such as foreign exchange forward contracts or
foreign currency options, to manage our foreign exchange risk because the market for these types of
financial instruments in Russia is not well developed and the cost of these instruments is
relatively high. We do not hold or issue derivatives or other financial instruments for trading
purposes.
Prior to 2006, our principal sources of revenues were denominated primarily in USD. Because
our expenses were also primarily denominated in USD, the impact on our results of RUR depreciation
was insignificant.
We have shifted a substantial majority of our expenditures from USD to RUR. Nevertheless, we
can give no assurance that we are adequately protected from the impact of currency fluctuations.
Moreover, given that our reporting currency is the USD, RUR held in banks and other RUR denominated
assets and liabilities could fluctuate in line with any change in the value of the RUR. Prior to
July 2006, changes in the value of our RUR denominated monetary assets and liabilities resulted in
foreign currency gains or losses in our income statement. However, effective July 1, 2006 we
determined that the functional currency of our subsidiaries domiciled in Russia is the RUR.
Therefore, the financial statements of these subsidiaries are translated into USD using the current
rate method and translation gains and losses are no longer included in net income, but are instead
included as part of other comprehensive income.
We can, however, provide no assurance that these measures will adequately protect us from the
impact of currency fluctuations. A substantial decline in the value of the RUR against the USD
could materially adversely affect our results of operations.
Our cash and cash equivalents are held largely in interest bearing accounts in USD, RUR and
Ukrainian Hryvna. The book values of such accounts at December 31, 2007 and 2006 approximate their
fair value.
At December 31, 2007 we were exposed to market risk related to fluctuations in interest rates
on the $275.0 million Facility Agreement. We entered into an interest rate swap agreement with
Citibank, N.A. London Branch, effective from October 26, 2007 through October 26, 2010. Pursuant to
the agreement, we will exchange interest payments on a regular basis and pay a fixed rate equal to
4.355% in the event the London Interbank Offered Rate (“LIBOR”) is equal to no greater than 5.4%,
and otherwise we shall pay the LIBOR floating rate. We will receive interest payments based on the
floating rate from Citibank, N.A London Branch. We are required to mark to market the fair value of
the derivative instrument at the end of each reporting period which may result in significant
fluctuations in our earnings and financial condition. The loss of $3.0 million, recorded
for the period ended December 31, 2007, reflects the change in fair value of the derivative
instrument between inception and reporting dates. This change was primarily due to the fact that
the swap variable interest rate is tied to forward the LIBOR rates. The derivative instrument was
not designated as a hedge as of December 31, 2007.
The following table provides information (in thousands) about our cash equivalents, debt
obligations that are sensitive to changes in interest rates and related weighted average interest
rates by expected (contractual) maturity dates. Notional amounts are used to calculate the
contractual payments to be exchanged under the contract. Weighted average variable rates are based
on implied forward rates in the yield curve at the reporting date. The net fair value liability
represents the amount we would pay if we had exited the interest rate swap agreement as of December
31, 2007.
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| 2007 | 2006 | Fair | ||||||||||||||||||||||||||||||||||
| 2008 | 2009 | 2010 | 2011 | 2012 | Thereafter | Total | Total | Value | ||||||||||||||||||||||||||||
Cash equivalents |
$ | 74,799 | $ | — | $ | — | $ | — | $ | — | $ | — | $ | 74,799 | $ | 18,413 | $ | — | ||||||||||||||||||
Note receivable |
$ | 22,458 | $ | 21,140 | $ | 19,699 | $ | 3,504 | $ | — | $ | — | $ | 23,629 | $ | 2,879 | $ | — | ||||||||||||||||||
Average interest rate |
8.6 | % | 8.5 | % | 8.5 | % | 9.0 | % | — | — | 8.6 | % | 9.8 | % | — | |||||||||||||||||||||
Long-term debt, including current
portion |
||||||||||||||||||||||||||||||||||||
Variable rate |
$ | 225,000 | $ | 155,790 | $ | 86,580 | $ | 17,370 | $ | — | $ | — | $ | 242,839 | $ | 12,305 | $ | — | ||||||||||||||||||
Average interest rate |
5.69 | % | 5.03 | % | 6.04 | % | 6.02 | % | — | — | 6.85 | % | 10.5 | % | — | |||||||||||||||||||||
Interest Rate Swaps: |
||||||||||||||||||||||||||||||||||||
Variable to Fixed |
$ | 225,000 | $ | 155,790 | $ | — | $ | — | $ | — | $ | — | $ | 225,000 | — | $ | (3,060 | ) | ||||||||||||||||||
Average pay rate |
4.4 | % | 4.4 | % | 4.4 | % | — | — | — | 4.4 | % | — | — | |||||||||||||||||||||||
Average receive rate |
4.5 | % | 3.8 | % | 4.0 | % | — | — | — | 4.1 | % | — | — | |||||||||||||||||||||||
The following table provides information about our financial instruments by local currency and
where applicable, presents such information in USD equivalents (in thousands). The table summarizes
information on instruments that are sensitive to foreign currency exchange rates, including foreign
currency denominated debt obligations.
| 2007 | 2006 | |||||||||||||||||||||||||||||||
| 2008 | 2009 | 20010 | 2011 | 2012 | Thereafter | Total | Total | |||||||||||||||||||||||||
Assets |
||||||||||||||||||||||||||||||||
Current assets |
||||||||||||||||||||||||||||||||
Russian rubles |
$ | 278,917 | $ | — | $ | — | $ | — | $ | — | $ | — | $ | 278,917 | $ | 122,644 | ||||||||||||||||
Closing foreign
currency exchange rate |
24.55 | — | — | — | — | — | — | — | ||||||||||||||||||||||||
Ukrainian Hryvna |
$ | 21,544 | $ | — | $ | — | $ | — | $ | $ | — | $ | 21,544 | $ | 11,068 | |||||||||||||||||
Closing foreign
currency exchange rate |
5.05 | — | — | — | — | — | — | — | ||||||||||||||||||||||||
Kazakhstan Tenge |
$ | 2,597 | $ | — | $ | — | $ | — | $ | — | $ | — | $ | 2,597 | $ | 1,652 | ||||||||||||||||
Closing foreign
currency exchange rate |
120.3 | — | — | — | — | — | — | — | ||||||||||||||||||||||||
Uzbekistan Soom |
$ | 3,060 | $ | — | $ | — | $ | — | $ | — | $ | — | $ | 3,060 | $ | 1,948 | ||||||||||||||||
Closing foreign
currency exchange rate |
1,290 | — | — | — | — | — | — | — | ||||||||||||||||||||||||
Liabilities |
||||||||||||||||||||||||||||||||
Current liabilities |
||||||||||||||||||||||||||||||||
Russian rubles |
$ | 102,047 | $ | — | $ | — | $ | — | $ | — | $ | — | $ | 102,047 | $ | 27,961 | ||||||||||||||||
Closing foreign
currency exchange rate |
24.55 | — | — | — | — | — | — | — | ||||||||||||||||||||||||
Ukrainian Hryvna |
$ | 20,026 | $ | — | $ | — | $ | — | $ | — | $ | — | $ | 20,026 | $ | 15,192 | ||||||||||||||||
Closing foreign
currency exchange rate |
5.05 | — | — | — | — | — | — | — | ||||||||||||||||||||||||
Kazakhstan Tenge |
$ | 418 | $ | — | $ | — | $ | — | $ | — | $ | — | $ | 418 | $ | 35 | ||||||||||||||||
Closing foreign
currency exchange rate |
120.3 | — | — | — | — | — | — | — | ||||||||||||||||||||||||
Uzbekistan Soom |
$ | 484 | $ | — | $ | — | $ | — | $ | — | $ | — | $ | 484 | $ | 184 | ||||||||||||||||
Closing foreign
currency exchange rate |
1,290 | — | — | — | — | — | — | — | ||||||||||||||||||||||||
Our interest income and expense are most sensitive to changes in the general level of US
interest rates. In this regard, changes in US interest rates affect the interest earned on our
cash equivalents and short-term investments as well as interest paid on debt.
65
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ITEM 8. Financial Statements and Supplementary Data
INDEX TO FINANCIAL STATEMENTS
GOLDEN TELECOM, INC.
| Page | ||||
| 67 | ||||
| 68 | ||||
| 69 | ||||
| 71 | ||||
| 72 | ||||
| 73 | ||||
| 74 | ||||
66
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AUDITED CONSOLIDATED FINANCIAL STATEMENTS
GOLDEN TELECOM, INC.
Years Ended December 31, 2005, 2006 and 2007
With Report of Independent Registered Public Accounting Firm
Years Ended December 31, 2005, 2006 and 2007
With Report of Independent Registered Public Accounting Firm
67
Table of Contents
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Shareholders of Golden Telecom, Inc.
We have audited the accompanying consolidated balance sheets of Golden Telecom, Inc. (the
“Company”) as of December 31, 2007 and 2006, and the related consolidated statements of operations,
cash flows, and shareholders’ equity for each of the three years in the period ended December 31,
2007. Our audits also included the financial statement schedule listed in the Index at Item 15(a).
These financial statements and schedule are the responsibility of the Company’s management. Our responsibility
is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting
Oversight Board (United States). 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 examining, on a test basis, evidence 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, the financial statements referred to above present fairly, in all material
respects, the consolidated financial position of Golden Telecom, Inc. at December 31, 2007 and 2006
and the consolidated results of its operations and its cash flows for each of the three years in
the period ended December 31, 2007, in conformity with U.S. generally accepted accounting
principles. Also, in our opinion, the related financial statement schedule, when considered in
relation to the basic financial statements taken as a whole, presents fairly, in all material
respects, the information set forth therein.
As
discussed in Note 2 to the consolidated financial statements,
effective January 1, 2007, the Company
adopted the provisions of the FASB Interpretation No. 48, Accounting for Uncertainty in Income
Taxes — an Interpretation of FASB Statement No. 109; and
effective January 1, 2006, the Company adopted Statement of
Financial Accounting Standards No. 123 (revised 2004), Share
Based Payment.
We also have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the Company’s internal control over financial reporting as of
December 31, 2007, based on criteria established in Internal Control-Integrated Framework issued by
the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 17,
2008 expressed an adverse opinion thereon.
/s/ ERNST & YOUNG LLC
Moscow, Russia
March 17, 2008
March 17, 2008
68
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GOLDEN TELECOM, INC.
CONSOLIDATED BALANCE SHEETS
(In Thousands, Except Share Data)
(In Thousands, Except Share Data)
| December 31, | ||||||||
| 2006 | 2007 | |||||||
ASSETS |
||||||||
CURRENT ASSETS |
||||||||
Cash and cash equivalents |
$ | 18,413 | $ | 74,799 | ||||
Accounts receivable, net of allowance for doubtful accounts of
$25,224 and $26,952 at December 31, 2006 and 2007, respectively |
147,719 | 203,875 | ||||||
VAT receivable |
21,486 | 43,099 | ||||||
Prepaid expenses |
11,371 | 18,112 | ||||||
Taxes receivable, excluding VAT |
6,466 | 2,820 | ||||||
Notes receivable |
379 | 1,171 | ||||||
Deferred tax asset |
11,098 | 31,627 | ||||||
Inventory |
7,682 | 13,109 | ||||||
Due from affiliates and related parties |
1,227 | 1,591 | ||||||
Other current assets |
5,564 | 10,233 | ||||||
TOTAL CURRENT ASSETS |
231,405 | 400,436 | ||||||
Property and equipment: |
||||||||
Telecommunications equipment |
707,431 | 1,083,862 | ||||||
Telecommunications network held under capital leases |
23,867 | 53,795 | ||||||
Furniture, fixtures and equipment |
50,217 | 75,566 | ||||||
Construction in progress |
103,190 | 209,656 | ||||||
Other property |
20,401 | 45,175 | ||||||
| 905,106 | 1,468,054 | |||||||
Accumulated depreciation |
(352,765 | ) | (488,556 | ) | ||||
Net property and equipment |
552,341 | 979,498 | ||||||
Goodwill and intangible assets: |
||||||||
Goodwill |
180,539 | 311,482 | ||||||
Telecommunications service contracts |
69,983 | 69,802 | ||||||
Contract-based customer relationships |
13,526 | 27,543 | ||||||
Licenses |
22,653 | 108,509 | ||||||
Brand name |
— | 32,296 | ||||||
Other intangible assets |
10,383 | 11,435 | ||||||
Net goodwill and intangible assets |
297,084 | 561,067 | ||||||
Investments in and advances to ventures |
11,886 | 15,430 | ||||||
Notes receivable |
2,500 | 22,458 | ||||||
Restricted cash |
233 | — | ||||||
Other non-current assets |
11,741 | 20,002 | ||||||
TOTAL ASSETS |
$ | 1,107,190 | $ | 1,998,891 | ||||
The accompanying notes are an integral part of these consolidated financial statements.
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GOLDEN TELECOM, INC.
CONSOLIDATED BALANCE SHEETS
(In Thousands, Except Share Data)
(In Thousands, Except Share Data)
| December 31, | ||||||||
| 2006 | 2007 | |||||||
LIABILITIES AND SHAREHOLDERS’ EQUITY |
||||||||
CURRENT LIABILITIES |
||||||||
Accounts payable and accrued expenses |
$ | 146,058 | $ | 256,617 | ||||
VAT Payable |
2,725 | 7,872 | ||||||
Current capital lease obligations |
753 | 3,180 | ||||||
Debt maturing within one year |
12,305 | 17,680 | ||||||
Deferred revenue |
21,634 | 30,502 | ||||||
Due to related parties |
4,505 | 6,771 | ||||||
Liability for acquisition |
378 | — | ||||||
Other current liabilities |
233 | 95 | ||||||
TOTAL CURRENT LIABILITIES |
188,591 | 322,717 | ||||||
Long-term debt, less current portion |
29 | 225,159 | ||||||
Long-term deferred tax liability |
29,268 | 77,468 | ||||||
Long-term deferred revenue |
36,951 | 52,506 | ||||||
Long-term capital lease obligations |
1,591 | 8,129 | ||||||
Other non-current liabilities |
2,321 | 3,673 | ||||||
TOTAL LIABILITIES |
258,751 | 689,652 | ||||||
Minority interest |
31,263 | 94,177 | ||||||
SHAREHOLDERS’ EQUITY |
||||||||
Preferred stock, $0.01 par value (10,000,000 shares
authorized; none issued and outstanding at December 31, 2006 and 2007) |
— | — | ||||||
Common stock, $0.01 par value (100,000,000 shares authorized;
36,673,015 and 40,373,891 shares issued and outstanding at December 31,
2006 and 2007, respectively) |
367 | 404 | ||||||
Additional paid-in capital |
674,993 | 857,989 | ||||||
Retained earnings |
66,744 | 210,855 | ||||||
Accumulated other comprehensive income |
75,072 | 145,814 | ||||||
TOTAL SHAREHOLDERS’ EQUITY |
817,176 | 1,215,062 | ||||||
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY |
$ | 1,107,190 | $ | 1,998,891 | ||||
The accompanying notes are an integral part of these consolidated financial statements.
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GOLDEN TELECOM, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In Thousands, Except Per Share Data)
(In Thousands, Except Per Share Data)
| Year Ended December 31, | ||||||||||||
| 2005 | 2006 | 2007 | ||||||||||
REVENUE: |
||||||||||||
Telecommunication services |
$ | 662,742 | $ | 846,740 | $ | 1,281,572 | ||||||
Revenue from related parties |
4,637 | 7,877 | 11,327 | |||||||||
TOTAL REVENUE |
667,379 | 854,617 | 1,292,899 | |||||||||
OPERATING COSTS AND EXPENSES: |
||||||||||||
Access and network services (excluding depreciation
and amortization) |
347,532 | 474,389 | 741,361 | |||||||||
Selling, general and administrative (excluding
depreciation and amortization) |
119,890 | 152,808 | 241,916 | |||||||||
Depreciation and amortization |
84,015 | 100,209 | 140,258 | |||||||||
TOTAL OPERATING EXPENSES |
551,437 | 727,406 | 1,123,535 | |||||||||
INCOME FROM OPERATIONS |
115,942 | 127,211 | 169,364 | |||||||||
OTHER INCOME (EXPENSE): |
||||||||||||
Equity in earnings of ventures |
460 | 1,867 | 1,010 | |||||||||
Gain on sale of MCT Corp. |
— | — | 41,283 | |||||||||
Interest income |
2,295 | 1,211 | 4,349 | |||||||||
Interest expense |
(618 | ) | (580 | ) | (13,138 | ) | ||||||
Foreign currency gain (loss) |
(1,212 | ) | 1,697 | 15,652 | ||||||||
TOTAL OTHER INCOME |
925 | 4,195 | 49,156 | |||||||||
Income before minority interest and income taxes |
116,867 | 131,406 | 218,520 | |||||||||
Minority interest |
2,978 | 4,808 | 7,610 | |||||||||
Income taxes |
37,816 | 40,417 | 58,311 | |||||||||
Income before cumulative effect of a change in
accounting principle |
76,073 | 86,181 | 152,599 | |||||||||
Cumulative effect of a change in accounting
principle,
net of tax of $52 |
— | 681 | — | |||||||||
NET INCOME |
$ | 76,073 | $ | 85,500 | $ | 152,599 | ||||||
Basic earnings per share of common stock: |
||||||||||||
Income before cumulative effect of a change in
accounting principle |
$ | 2.09 | $ | 2.36 | $ | 3.93 | ||||||
Cumulative effect of a change in accounting principle |
— | 0.02 | — | |||||||||
Net income per share – basic |
$ | 2.09 | $ | 2.34 | $ | 3.93 | ||||||
Weighted average common shares
outstanding – basic |
36,378 | 36,591 | 38,798 | |||||||||
Diluted earnings per share of common stock: |
||||||||||||
Income before cumulative effect of a change in
accounting principle |
$ | 2.08 | $ | 2.35 | $ | 3.91 | ||||||
Cumulative effect of a change in accounting principle |
— | 0.02 | — | |||||||||
Net income per share – diluted |
$ | 2.08 | $ | 2.33 | $ | 3.91 | ||||||
Weighted average common shares
outstanding – diluted |
36,605 | 36,717 | 39,034 | |||||||||
Cash dividends per share |
$ | 0.80 | $ | 0.60 | $ | — | ||||||
The accompanying notes are an integral part of these consolidated financial statements.
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GOLDEN TELECOM, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
(In Thousands)
| Year Ended December 31, | ||||||||||||
| 2005 | 2006 | 2007 | ||||||||||
OPERATING ACTIVITIES |
||||||||||||
Net income |
$ | 76,073 | $ | 85,500 | $ | 152,599 | ||||||
Adjustments to reconcile net income to Net Cash Provided by
Operating Activities: |
||||||||||||
Depreciation |
65,329 | 79,219 | 113,528 | |||||||||
Amortization |
18,686 | 20,990 | 26,730 | |||||||||
Equity in earnings of ventures |
(460 | ) | (1,867 | ) | (1,010 | ) | ||||||
Minority interest |
2,978 | 4,808 | 7,610 | |||||||||
Gain on sale of MCT Corp. |
— | — | (41,283 | ) | ||||||||
Foreign currency (gain) loss |
1,212 | (1,697 | ) | (15,652 | ) | |||||||
Deferred tax benefit |
(3,815 | ) | (3,825 | ) | (18,038 | ) | ||||||
Bad debt expense |
7,967 | 4,128 | 5,277 | |||||||||
Stock based compensation expense |
— | 19,475 | 29,048 | |||||||||
Cumulative effect of a change in accounting principle, net of tax of $52 |
— | 681 | — | |||||||||
Other |
1,223 | 52 | 4,349 | |||||||||
Changes in assets and liabilities: |
||||||||||||
Accounts receivable |
(10,316 | ) | (55,960 | ) | (35,339 | ) | ||||||
Accounts payable and accrued expenses |
4,295 | 27,730 | (27,749 | ) | ||||||||
VAT, net |
(88 | ) | (13,800 | ) | (8,001 | ) | ||||||
Other assets and liabilities |
11,222 | (4,665 | ) | 4,616 | ||||||||
NET CASH PROVIDED BY OPERATING ACTIVITIES |
174,306 | 160,769 | 196,685 | |||||||||
INVESTING ACTIVITIES |
||||||||||||
Purchases of property and equipment and intangible assets |
(118,170 | ) | (175,598 | ) | (268,581 | ) | ||||||
Acquisitions, net of cash acquired |
(18,085 | ) | (26,778 | ) | (132,074 | ) | ||||||
Restricted cash |
446 | 333 | 233 | |||||||||
Proceeds from sale of MCT Corp. |
— | — | 41,283 | |||||||||
Loans made |
— | (5,906 | ) | (21,962 | ) | |||||||
Other investing |
2,743 | 6,830 | 7,183 | |||||||||
NET CASH USED IN INVESTING ACTIVITIES |
(133,066 | ) | (201,119 | ) | (373,918 | ) | ||||||
FINANCING ACTIVITIES |
||||||||||||
Repayments of debt |
(253 | ) | (643 | ) | (86,888 | ) | ||||||
Proceeds from debt |
— | 11,621 | 305,360 | |||||||||
Contribution from minority partner |
3,840 | — | — | |||||||||
Net proceeds from exercise of employee stock options |
1,435 | 3,154 | 3,282 | |||||||||
Issuance of common stock |
— | — | 20,416 | |||||||||
Cash dividends paid |
(29,119 | ) | (21,951 | ) | — | |||||||
Capital lease obligations |
(3,210 | ) | (1,954 | ) | (10,173 | ) | ||||||
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES |
(27,307 | ) | (9,773 | ) | 231,997 | |||||||
Effect of exchange rate changes on cash and cash equivalents |
(456 | ) | 1,360 | 1,622 | ||||||||
Net increase (decrease) in cash and cash equivalents |
13,477 | (48,763 | ) | 56,386 | ||||||||
Cash and cash equivalents at beginning of year |
53,699 | 67,176 | 18,413 | |||||||||
CASH AND CASH EQUIVALENTS AT END OF YEAR |
$ | 67,176 | $ | 18,413 | $ | 74,799 | ||||||
The accompanying notes are an integral part of these consolidated financial statements.
72
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GOLDEN TELECOM, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
For the Years Ended December 31, 2005, 2006, and 2007
(In Thousands)
For the Years Ended December 31, 2005, 2006, and 2007
(In Thousands)
| Retained | Accumulated | |||||||||||||||||||||||||||
| Additional | Deferred | Earnings | Other | |||||||||||||||||||||||||
| Common Stock | Paid-In | Equity | (Accumulated | Comprehensive | Total | |||||||||||||||||||||||
| Shares | Amount | Capital | Compensation | Deficit) | Income | Equity | ||||||||||||||||||||||
Balance at December 31, 2004 |
36,322 | $ | 363 | $ | 669,777 | $ | — | $ | (43,759 | ) | $ | — | $ | 626,381 | ||||||||||||||
Issuance of restricted shares |
27 | 1 | 771 | (772 | ) | — | — | — | ||||||||||||||||||||
Compensation expense |
— | — | — | 317 | — | — | 317 | |||||||||||||||||||||
Exercise of employee stock options |
109 | 1 | 1,450 | — | — | — | 1,451 | |||||||||||||||||||||
Cash dividends paid |
— | — | — | — | (29,119) | — | (29,119 | ) | ||||||||||||||||||||
Net income |
— | — | — | — | 76,073 | — | 76,073 | |||||||||||||||||||||
Balance at December 31, 2005 |
36,458 | $ | 365 | $ | 671,998 | $ | (455 | ) | $ | 3,195 | $ | — | $ | 675,103 | ||||||||||||||
Adoption of SFAS 123R – adjustment
to remove unearned compensation |
— | — | (455 | ) | 455 | — | — | — | ||||||||||||||||||||
Cancellation of restricted shares |
(8 | ) | — | — | — | — | — | — | ||||||||||||||||||||
Issuance of restricted shares |
8 | — | — | — | — | — | — | |||||||||||||||||||||
Compensation expense |
— | — | 298 | — | — | — | 298 | |||||||||||||||||||||
Exercise of employee stock options |
215 | 2 | 3,152 | — | — | — | 3,154 | |||||||||||||||||||||
Cash dividends paid |
— | — | — | — | (21,951 | ) | — | (21,951 | ) | |||||||||||||||||||
Comprehensive income: |
||||||||||||||||||||||||||||
Foreign currency translation
adjustment, net of tax of $2,181 |
— | — | — | — | — | 75,072 | 75,072 | |||||||||||||||||||||
Net income |
— | — | — | — | 85,500 | — | 85,500 | |||||||||||||||||||||
Comprehensive income |
— | — | — | — | — | — | 160,572 | |||||||||||||||||||||
Balance at December 31, 2006 |
36,673 | $ | 367 | $ | 674,993 | $ | — | $ | 66,744 | $ | 75,072 | $ | 817,176 | |||||||||||||||
Issuance of restricted shares |
8 | — | — | — | — | — | — | |||||||||||||||||||||
Compensation expense |
— | — | 17,205 | — | — | — | 17,205 | |||||||||||||||||||||
Exercise of employee stock options |
107 | 1 | 3,281 | — | — | — | 3,282 | |||||||||||||||||||||
Issuance of shares to Inure |
3,193 | 32 | 142,098 | — | — | — | 142,130 | |||||||||||||||||||||
Issuance of shares to Rostelecom |
393 | 4 | 20,412 | — | — | — | 20,416 | |||||||||||||||||||||
Adoption of
FIN No. 48 |
— | — | — | — | (8,488 | ) | — | (8,488 | ) | |||||||||||||||||||
Comprehensive income: |
||||||||||||||||||||||||||||
Foreign currency translation adjustment |
— | — | — | — | — | 70,742 | 70,742 | |||||||||||||||||||||
Net income |
— | — | — | — | 152,599 | — | 152,599 | |||||||||||||||||||||
Comprehensive income |
— | — | — | — | — | — | 223,341 | |||||||||||||||||||||
Balance at December 31, 2007 |
40,374 | $ | 404 | $ | 857,989 | $ | — | $ | 210,855 | $ | 145,814 | $ | 1,215,062 | |||||||||||||||
The accompanying notes are an integral part of these consolidated financial statements.
73
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GOLDEN TELECOM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1: Nature of Business Operations
Golden Telecom, Inc. (“GTI” or the “Company”) is a leading facilities-based provider of
integrated telecommunication and Internet services in major population centers throughout Russia
and other countries of the Commonwealth of Independent States (“CIS”). The Company offers voice,
data and Internet services to corporations, operators and consumers using its metropolitan overlay
network in major cities throughout Russia, Ukraine, Kazakhstan, and Uzbekistan, and via intercity
fiber optic and satellite-based networks, including approximately 295 combined access points in
Russia and other countries of the CIS. The Company offers mobile services in Moscow and Kiev and
Odessa in Ukraine. GTI was incorporated in Delaware on June 10, 1999 for the purpose of acting as
a holding company for Global TeleSystems, Inc.’s (“GTS”) operating entities within the CIS and
supporting non-CIS holding companies (the “CIS Entities”). On September 29, 1999, GTS transferred
its ownership rights in the CIS Entities to the Company in anticipation of the Company’s initial
public offering which closed on October 5, 1999.
Note 2: Summary of Significant Accounting Policies and Recent Accounting Pronouncements
Summary of Significant Accounting Policies
Principles of Consolidation
Wholly-owned and majority owned ventures where the Company has operating and financial control
are consolidated. All significant inter-company accounts and transactions are eliminated upon
consolidation. Results of subsidiaries acquired and accounted for by the purchase method have been
included in operations from the relevant date of acquisition.
Those ventures where the Company exercises significant influence, but does not exercise
operating and financial control are accounted for by the equity method. The Company will
discontinue applying the equity method of accounting for the Company’s equity method investments
when its share of the investees losses reduces the investments in and advances to ventures to zero.
Thereafter, the Company will not provide for additional losses unless the Company has guaranteed
obligations of the investee or is otherwise committed to provide further support for the investee.
If the investee subsequently reports net income, the Company will resume the equity method only
after the Company’s share of net income equals the share of net loss not recognized during the
period the equity method was suspended.
Income Taxes
The Company accounts for income taxes using the liability method required by Statement of
Financial Accounting Standards (“SFAS”) No. 109, “Accounting for Income Taxes.” Deferred income
taxes result from temporary differences between the tax basis of assets and liabilities and the
basis as reported in the consolidated financial statements, as well as the expected tax benefits of
net operating loss carryforwards which are expected to be realized. Additionally SFAS No. 109
requires that a valuation allowance must be established when it is more likely than not that all or
a portion of deferred tax assets will not be realized. The Company does not provide for deferred
taxes on the undistributed earnings of its foreign subsidiaries, as such earnings are intended to
be reinvested in those operations permanently. In the case of non-consolidated entities, where the
Company’s partner requests that a dividend be paid, the amounts are not expected to have a material
impact on the Company’s income tax liability. It is not practical to determine the amount of
unrecognized deferred tax liability for such reinvested earnings.
Accounting from Uncertainty in Income Taxes
On January 1, 2007, the Company adopted the provisions of Financial Accounting Standards Board
(‘‘FASB’’) Interpretation No. 48 (‘‘FIN No. 48’’), “Accounting for Uncertainty in Income Taxes — an
interpretation of SFAS No. 109”. FIN No. 48 creates a single model to address uncertainty in tax
positions and clarifies the accounting for income taxes by prescribing the minimum recognition
threshold a tax position is required to meet before being recognized in the financial statements.
FIN No. 48 also provides guidance on derecognition, measurement, classification, interest and
penalties, accounting in interim periods, disclosure and transition. The adoption of FIN No. 48
resulted in the cumulative effect adjustment to the opening balance of retained earnings as of
January 1, 2007, of approximately $8.5 million. As of December 31, 2007, the Company included
accruals for unrecognized income tax benefits totaling approximately $18.9 million as a component
of accrued liabilities.
A
reconciliation of the beginning and ending amount of unrecognized
income tax benefit is as follows:
74
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GOLDEN TELECOM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
| (in thousands) | ||||
Balance at January 1, 2007, excluding interest and penalties |
$ | 5,270 | ||
Additions based on tax positions related to the current
year (including additions related to the acquisition of ZAO
Cortec in May 2007 of $2,450) |
7,951 | |||
Additions of tax positions of prior years (including
additions related to the acquisition of ZAO Cortec in May
2007 of
$6,136) |
6,328 | |||
Reductions of tax positions of prior years |
(4,506 | ) | ||
Settlements |
(1,412 | ) | ||
Balance at December 31, 2007, excluding interest and penalties |
$ | 13,631 | ||
Approximately
$15.3 million of unrecognized income tax benefits, including interest and penalties of
approximately $5.3 million, if recognized, would affect the effective tax rate. The Company
considers it reasonably possible that approximately $2.0 million of the unrecognized income tax
benefit will be reversed within the next twelve months, due to expiration of the statute of
limitations. Amounts of unrecognized income tax benefits decreased by approximately $6.3 million,
including interest and penalties of approximately $2.0 million, due to the deconsolidation of a
variable interest entity since July 1, 2007.
The Company recognizes accrued interest related to unrecognized tax benefits and penalties in
income tax expenses. During the twelve months ended December 31, 2007, the Company recognized
approximately $2.5 million in interest and penalties. At December 31, 2007, the Company had
accrued for approximately $5.3 million for the payment of interest and penalties.
As
of December 31, 2007 the tax years ended December 31, 2004,
2005, 2006 and 2007 remained subject
to examination by United States (“US”), Russian and Ukrainian tax authorities.
Sale of Subsidiary Stock
The Company recognizes gains in the consolidated statement of operations for sales of
subsidiary stock where the value of the proceeds can be objectively determined and realization of
the gain is reasonably assured. The Company accounts for sales of subsidiary stock where the value
of the proceeds can not be objectively determined or realization of the gain is not reasonably
assured as an equity transaction in the Company’s consolidated financial statements. Once the
accounting treatment of the gain or loss on issuance of shares by a specific entity has been
determined, the Company consistently follows that treatment for all future issuances of shares by
that particular subsidiary.
Foreign Currency Translation
Prior to the third quarter of 2006, the functional currency for all of the Company’s foreign
subsidiaries was the United States dollar (“USD”). In the second and the third quarters of 2006,
EDN Sovintel LLC (“Sovintel”), the Company’s wholly-owned Russian subsidiary, introduced a
semi-fixed USD – Russian ruble (“RUR”) exchange rate for settlements with the majority of its
customers. This rate is applicable if the official USD exchange rate set by the Central Bank of
Russia (“CBR”) is below the semi-fixed level. If the RUR depreciates against the USD so that the
CBR exchange rate exceeds the semi-fixed level, Sovintel will resume applying the CBR exchange
rate, or floating rate, for settlements with its customers. As a result of these changes, the
Company reevaluated the functional currency criteria under SFAS No. 52, “Foreign Currency
Translation”, and determined that, beginning July 1, 2006, the functional currency of the Company’s
subsidiaries domiciled in Russia is the RUR. The change was adopted prospectively beginning July
1, 2006 in accordance with SFAS No. 52. The Company’s
subsidiaries in Ukraine changed their functional currency from the
USD to the Ukrainian Hryvna beginning from January 1, 2007. No restatement of comparative amounts was made for the
change in functional currency. Therefore, the financial statements of
the Company’s foreign subsidiaries are translated into USD using the current rate method.
Assets and liabilities were translated at the rate of exchange prevailing at the balance sheet
date. Stockholders’ equity was translated at the applicable historical rate. Revenue and expenses
were translated at the monthly average rates of exchange. Translation gains and losses were
included as part of accumulated other comprehensive income.
The functional currency of the Company’s remaining foreign subsidiaries is the USD because a
majority of their revenues, costs, property and equipment purchased, debt and trade liabilities is
either priced, incurred, payable or otherwise measured in USD.
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GOLDEN TELECOM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
Cash and Cash Equivalents and Restricted Cash
The Company classifies cash on hand and deposits in banks, including commercial paper, money
market accounts, and any other investments with an original maturity of three months or less from
the date of purchase, that the Company may hold from time to time, as cash and cash equivalents.
Restricted cash is primarily related to cash held in escrow at a financial institution for the
collateralization of debt obligations that certain of the Company’s consolidated subsidiaries and
equity ventures have borrowed from such financial institution.
Accounts Receivable
Accounts receivable are shown at their net realizable value which approximates their fair
value. The Company makes judgments as to the collectability of accounts receivable based on
historical trends and future expectations. To determine the allowance for doubtful accounts,
management reviews specific customer risks and the Company’s accounts receivable aging. The
allowance for doubtful accounts is estimated by applying estimated loss percentages against the
aging of accounts receivable. Bad debt expense for the years ended December 31, 2005, 2006 and
2007 was $8.0 million, $4.1 million and $5.3 million, respectively.
Inventories
Inventories,
which primarily represent purchased materials and parts held for
maintenance and sale to customers, are stated at the lower of cost or market. Cost is computed on either a specific
identification basis or a weighted average basis.
Property and Equipment
Property and equipment is stated at cost. Depreciation is calculated on a straight-line basis
over the lesser of the estimated lives, ranging from five to ten years for telecommunications
equipment, and three to five years for furniture, fixtures and equipment, and five to twenty years
for other property. Spare parts held for stand-by use are depreciated
over the estimated useful life of the related equipment. Construction in process reflects amounts
incurred for the configuration and build-out of telecommunications equipment not yet placed into
service. Maintenance and repairs are charged to expense as incurred. The Company has included in
property and equipment, capitalized leases in the amount of $23.9 million and $53.8 million at
December 31, 2006 and 2007, respectively, with associated accumulated depreciation of $12.5 million
and $22.9 million as of December 31, 2006 and 2007, respectively. Amortization of assets recorded
under capital leases is included in depreciation expense for the years ended December 31, 2005,
2006, and 2007.
At the time of retirement or other disposition of property and equipment, the cost and
accumulated depreciation are removed from the accounts and any resulting gain and loss is recorded
in the consolidated statement of operations.
Goodwill and Intangible Assets
Goodwill represents the excess of acquisition costs over the fair value of the net assets of
acquired businesses. Beginning January 1, 2002, goodwill has been identified as an indefinite
lived asset in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets”, and
accordingly amortization of goodwill ceased as of that date. Intangible assets, which are stated
at cost, consist principally of telecommunications service contracts, contract based customer
relationships, licenses, brand name, software and content and are amortized on a straight-line
basis over their estimated useful lives, generally five to ten years. In accordance with Accounting Principles Board (“APB”) Opinion No. 17,
“Intangible Assets” and SFAS No. 142 “Goodwill and Other Intangible Assets”, the Company continues
to evaluate the amortization period to determine whether events or circumstances warrant revised
amortization periods. Additionally, the Company considers whether the carrying value of such assets
should be reduced based on the future benefits.
Goodwill Impairment Assessment
Goodwill is reviewed annually, as of the beginning of the fourth quarter, for impairment or
whenever it is determined that impairment indicators exist. The Company determines whether an
impairment has occurred by assigning goodwill to the reporting units identified in accordance with
SFAS 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 goodwill impairment has occurred, the
Company recognizes a loss for the difference between the carrying amount and the implied fair value
of goodwill. No such losses were recognized in the three years ended December 31, 2005, 2006 and
2007.
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GOLDEN TELECOM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
Long-Lived Assets Impairment
Long-lived assets to be held and used by the Company are reviewed to determine whether an
event or change in circumstances indicates that the carrying amount of the asset may not be
recoverable. For long-lived assets to be held and used, the Company bases its evaluation on such
impairment indicators as the nature of the assets, the future economic benefit of the assets, any
historical or future profitability measurements, as well as other external market conditions or
factors that may be present. If such impairment indicators are present or other factors exist that
indicate that the carrying amount of the asset may not be recoverable, the Company determines
whether an impairment has occurred through the use of an undiscounted cash flows analysis of assets
at the lowest level for which identifiable cash flows exist. If impairment has occurred, the
Company recognizes a loss for the difference between the carrying amount and the fair value of the
asset. The fair value of the asset is measured using discounted cash flow analysis or other
valuation techniques. No such losses were recognized in the three years ended December 31, 2005,
2006 and 2007.
Revenue Recognition
The Company records as revenue the amount of telecommunications and Internet services
rendered, as measured primarily by the minutes of traffic processed and the time spent online using
our Internet services. Revenue from service contracts is accounted for when the services are
provided. Billings received in advance of service being performed are deferred and recognized as
revenue as the service is performed. The Company also defers up front connection fees which are
recognized over the estimated life of the customer. The Company recognizes revenue from equipment
sales when title to the equipment passes to the customer. The Company defers the revenue on
installed equipment until installation and testing are completed and accepted by the customer.
Domestic Long Distance/International Long Distance (“DLD/ILD”) and zonal revenues are recorded
gross or net depending on the contractual arrangements with the end-users. The Company recognizes
DLD/ILD and zonal revenues from local operators net of payments to these operators for
interconnection and agency fees when local operators establish end-user tariffs and assume credit
risk. Revenues are stated net of any value-added taxes charged to customers.
The Company has deferred connection fees and capitalized direct incremental costs related to
connection fees, not exceeding the revenue deferred. The deferral of revenue and capitalization of
cost of revenue related to connection fees will be recognized over the estimated life of the
customer, which is five years in the Business and Corporate Services division and Operator and
Carrier Services division and eighteen months for the customers in the Mobile Services division.
The total amount of deferred connection fees revenue was
$55.3 million and $76.1 million as of
December 31, 2006 and 2007, respectively. The total amount of capitalized direct incremental costs
related to connection fees was $13.0 million and $17.7 million as of December 31, 2006 and 2007,
respectively.
Advertising
The Company expenses the cost of advertising as incurred. Advertising expenses for the years
ended December 31, 2005, 2006 and 2007 were $4.4 million, $9.7 million and $13.0 million,
respectively.
Government Pension Funds
The Company contributes to the local state pension funds and social funds, on behalf of all
its CIS employees. In Russia, all social contributions, including contributions to the pension
fund, were substituted with a unified social tax (“UST”) calculated by the application of a
regressive rate from 26% to 2% to the annual gross remuneration of each employee. The
contributions are expensed as incurred.
Off Balance Sheet Risk and Concentration of Credit Risk
Financial instruments that potentially subject the Company to concentration of credit risk
consist primarily of cash, cash equivalents, and accounts and notes receivable. Of the $74.8
million of cash and cash equivalents held at December 31, 2007, $13.5 million was held in the US in
US financial institutions. The remaining balance is being principally maintained in US-owned banks
and local financial institutions within the CIS. The Company extends credit to various customers,
principally in Russia and Ukraine, and establishes an allowance for doubtful accounts. The Company
generally does not require collateral to extend credit to its customers.
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GOLDEN TELECOM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
Stock-Based Compensation
Until January 1, 2006, the Company followed the provisions of SFAS No. 123, “Accounting for
Stock-Based Compensation,” for its equity participation plan and Stock Appreciation Rights (“SARs”)
Plans. SFAS No. 123 generally allowed companies to either count for stock-based compensation under
the fair value method of SFAS No. 123 or under the intrinsic value method of APB No. 25,
“Accounting for Stock Issued to Employees.” The fair value method required compensation cost to be
measured at the grant date based on the value of the award and to be recognized over the service
period. The Company had elected to account for its stock-based compensation in accordance with the
provisions of APB No. 25 and present pro forma disclosures of results of operations as if the fair
value method had been adopted.
The effect of applying SFAS No. 123 on the reported net income and net income per share for
the year ended December 31, 2005 is as follows:
| (in thousands | ||||
| except per | ||||
| share date) | ||||
Net income, as reported |
$ | 76,073 | ||
Deduct: total stock-based employee compensation
expense determined under fair value based method
for all awards, net of related tax effects |
620 | |||
Pro forma net income |
$ | 75,453 | ||
Net income per share: |
||||
Basic – as reported |
$ | 2.09 | ||
Basic – pro forma |
2.07 | |||
Diluted – as reported |
2.08 | |||
Diluted – pro forma |
2.06 | |||
In December 2004, the FASB issued SFAS No. 123R (revised 2004), “Share Based Payment”, which
is a revision of SFAS No. 123. SFAS No. 123R supersedes APB No. 25, and amends SFAS No. 95,
“Statement of Cash Flows”. Under SFAS No. 123R, companies must calculate and record the cost of
equity instruments, such as stock options or restricted stock, awarded to employees for services
received in the income statement; pro forma disclosure is no longer permitted. The cost of the
equity instruments is to be measured based on the fair value of the instruments on the date they
are granted or, if the number of shares to be issued or the exercise price is unknown, remeasured
at each reporting date and is required to be recognized over the period during which the employees
are required to provide services in exchange for the equity instruments.
The Company adopted SFAS No. 123R as of January 1, 2006 using the modified prospective method
which requires the application of SFAS No. 123R in its accounting for SARs and stock options.
Prior to the adoption of SFAS No. 123R, the Company accounted for SARs by remeasuring the intrinsic
value of the SARs at each reporting period and adjusted compensation expense and the related
liability for the change in the intrinsic value. From January 1, 2006, the Company accounts for
SARs at fair value. In accordance with the modified prospective method, the consolidated financial
statements for prior periods have not been restated to reflect, and do not include, the impact of
SFAS No. 123R.
The impact of the adoption of SFAS No. 123R was an increase in cost of revenue of
approximately $0.2 million, an increase in selling, general and administrative expense of
approximately $1.9 million, including the associated payroll taxes, and a deferred tax benefit of
approximately $0.3 million for the year ended December 31, 2006. In addition, the Company recorded
a cumulative effect of a change in accounting principle of $0.7 million, net of tax, representing
the difference between the fair value and the intrinsic value of SARs at January 1, 2006. The
total impact of the adoption of SFAS No. 123R was a reduction in net income of approximately $2.5
million, net of tax, for the year ended December 31, 2006, equivalent to $0.07 per common share –
basic and $0.07 per common share – diluted, representing compensation expense in connection with
SARs (see Note 12). Compensation expense recorded in connection with outstanding SARs was $19.5
million and $11.8 million and a related tax benefit of $2.7 million and $0.7 million for the years
ended December 31, 2006 and 2007, respectively. Compensation expense recorded in connection with
outstanding stock options was negligible for the year ended December 31, 2006, because the stock
options were primarily vested at December 31, 2005 and was $16.8 million for the year ended
December 31, 2007.
The
Company recognizes the compensation cost, net of estimated
forfeitures, of all share-based awards other than those with market
conditions on a straight-line basis over the vesting period for each
separately vesting portion of the award. Compensation cost of all
share-based awards with market conditions are recognized on a
straight-line basis over the derived service period.
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GOLDEN TELECOM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
Consolidation of Variable Interest Entities
In January 2003, the FASB issued FASB Interpretation No. 46, “Consolidation of Variable
Interest Entities” (“FIN No. 46”). FIN No. 46 amended Accounting Research Bulletin No. 51,
“Consolidated Financial Statements”, and established standards for determining under what
circumstances a variable interest entity (“VIE”) should be consolidated with its primary
beneficiary. FIN No.46 also requires disclosure about VIEs that are not required to be consolidated
but in which the reporting entity has a significant variable interest. In December 2003, the FASB
revised certain implementation provisions of FIN No. 46. The revised interpretation (“FIN No. 46R”)
substantially retained the requirements of immediate application of FIN No. 46 to VIEs created
after January 31, 2003. With respect to older VIEs, the consolidation requirements under FIN No.
46R apply not later than for the first financial year or interim period ending after December 15,
2003, if such VIE is a special-purpose entity (“SPE”), and no later than for the first financial
year or interim period ending after March 15, 2004, if such a VIE is not a SPE. The Company did not
identify any previously formed VIEs. During 2007, the Company acquired several entities which were accounted for as asset purchases through VIE's.
Fair Value of Financial Instruments
The carrying amounts for cash and cash equivalents, accounts receivable, notes receivable,
accounts payable, accrued liabilities, and short- and long-term debt approximate their fair value.
At December 31, 2006, the Company held no debt at fixed rates. At December 31, 2007, the Company
had outstanding $14.7 million 8% fixed rate debt from ZAO Citibank under a 90-day revolving credit
facility which approximated fair value.
Derivative Financial Instruments
According to SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”, the
Company recognizes its derivative instruments as either assets or liabilities in the statement of
financial position at fair value. The accounting for changes in the fair value of a derivative
instrument depends on whether it has been designated and qualifies as part of a hedging
relationship and further, on the type of hedging relationship. For those derivative instruments
that are designated and qualify as hedging instruments, the Company must designate the hedging
instrument, based upon the exposure being hedged, as a fair value hedge, cash flow hedge or a hedge
of a net investment in a foreign operation. Depending on the nature of the hedge, changes in the
fair value of derivatives will either be offset against the change in fair value of the hedged
assets, liabilities, or firm commitments through earnings or recognized in other comprehensive
income until the hedged item is recognized in the statement of
operations. The ineffective portion of a derivative’s
change in fair value is immediately recognized in the statement of operations. For derivative instruments not
designated as hedging instruments, the change in fair value is recognized in the statement of operations during the period of change.
For derivative instruments that are designated and qualify as a cash flow hedge (i.e., hedging
the exposure to variability in expected future cash flows that is attributable to a particular
risk), the effective portion of the gain or loss on the derivative instrument is reported as a
component of other comprehensive income and reclassified into the statement of operations in the same line item
associated with the forecasted transaction in the same period or periods during which the hedged
transaction affects earnings (for example, in “interest expense” when the hedged transactions are
interest cash flows associated with floating-rate debt). The remaining gain or loss on the
derivative instrument in excess of the cumulative change in the present value of future cash flows
of the hedged item, if any, is recognized in the statement of operations during the
period of change.
For derivative instruments that are designated and qualify as a hedge of a net investment in a
foreign currency, the gain or loss is reported in other comprehensive income as part of the
cumulative translation adjustment to the extent it is effective. Any ineffective portions of net
investment hedges are recognized in the statement of operations during the period of
change.
For derivative instruments not designated as hedging instruments, the gain or loss is
recognized in the statement of operations during the period of change.
When hedge accounting is discontinued, the derivative is adjusted for changes in fair value
through the statement of operations. For fair value hedges, the underlying asset or liability will
no longer be adjusted for changes in fair value, and any asset of liability recorded in connection
with the hedging relationship will be removed from the balance sheet
and recorded in the statement of operations for the current period. For cash flow hedges, gains and losses that were accumulated in other comprehensive
income as a component of shareholders’ equity in connection with hedged assets or liabilities will
be recognized in the statement of operations, in the same period the hedged item affects earnings.
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GOLDEN TELECOM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
Changes in Accounting Estimates
Prior to the second quarter of 2005, the Company recorded estimates for unused vacation based
on the average salary levels for the Company’s employees and total days of unused vacation of
employees. During the second quarter of 2005, the Company revised estimates for unused vacation
based on the actual daily salary and unused vacation of each employee. Management determined that
this methodology results in a more accurate estimate of the amount of the Company’s obligations for
unused vacation. The change in accounting estimate decreased net income for the year ended
December 31, 2005 by approximately $1.3 million, net of tax, including the associated payroll taxes
(equivalent to $0.04 per common share – basic and diluted).
During the fourth quarter of 2006, the Company revised its estimate of allowance for doubtful
accounts to reflect changes in the business, recent historical collections experience and other
currently available evidence. The change in accounting estimate increased net income for the year
ended December 31, 2006 by approximately $2.4 million, net of tax (equivalent to $0.07 per common
share – basic and diluted).
Use of Estimates in Preparation of Financial Statements
The preparation of consolidated financial statements, in conformity with accounting principles
generally accepted in the US, requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and the disclosure of contingent liabilities as of the
date of the financial statements and reported amounts of revenues and expenses during the reported
period. Significant estimates, among others, include the allowance for doubtful accounts, the
allocation of purchase price to the fair value of net assets acquired in connection with business
combinations, fair values used in goodwill impairment evaluations of liabilities
established as of the date of business acquisitions, including certain long-term contractual
obligations. Actual results could differ from these estimates.
Comparative Figures
Certain prior year amounts have been reclassified to conform to the presentation adopted in
the current year. Such reclassifications did not affect the consolidated statements of operations.
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GOLDEN TELECOM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
Recent Accounting Pronouncements
Fair Value Measurements
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements”, which defines fair
value, establishes a framework for measuring fair value in generally accepted accounting
principles, and enhances fair value measurement disclosure. In February 2008, the FASB issued FASB
Staff Position (“FSP”) 157-1, “Application of FASB Statement No. 157 to FASB Statement No. 13 and
Other Accounting Pronouncements That Address Fair Value Measurements for Purposes of Lease
Classification or Measurement under Statement 13” and FSP 157-2, “Effective Date of FASB Statement
No.157”. FSP 157-1 amends SFAS No. 157 to remove certain leasing transactions from its scope. FSP
157-2 delays the effective date of SFAS No. 157 for all non-financial assets and non-financial
liabilities, except for items that are recognized or disclosed at fair value in the financial
statements on a recurring basis (at least annually), until the beginning of the first quarter of
fiscal 2009. The measurement and disclosure requirements related to financial assets and financial
liabilities are effective beginning in the first quarter of fiscal 2008. The adoption of SFAS No.
157 for financial assets and financial liabilities will not have a significant impact on the
Company’s financial position or results of operations. However, the resulting fair values
calculated under SFAS No. 157 after adoption may be different from the fair values that would have
been calculated under previous guidance. The Company is currently evaluating the impact that SFAS
No. 157 will have on the Company’s financial position or results of operations when it is applied
to non-financial assets and non-financial liabilities beginning in the first quarter of 2009.
Income Statement Presentation of Taxes Collected from Customers and Remitted to Government
Authorities
In June 2006, the Emerging Issues Task Force reached a consensus on EITF Issue No. 06-03
(“EITF No. 06-03”), “How Taxes Collected from Customers and Remitted to Governmental Authorities
Should Be Presented in the Income Statement (That Is, Gross versus Net Presentation)”. EITF No.
06-03 provides that the presentation of taxes assessed by a governmental authority that is directly
imposed on a revenue-producing transaction between a seller and a customer on either a gross basis
(included in revenues and costs) or on a net basis (excluded from revenues) is an accounting policy
decision that should be disclosed. The provisions of EITF No. 06-03 become effective for fiscal
years beginning after December 15, 2006. The adoption of EITF No. 06-03 did not have any effect on
the Company’s consolidated financial position or results of operations.
Fair Value Option
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets
and Financials Liabilities — Including an Amendment of FASB Statement No. 115”. This standard
permits measurement of certain financial assets and financial liabilities at fair value. If the
fair value option is elected, the unrealized gains and losses are reported in earnings at each
reporting date. Generally, the fair value option may be elected on an instrument-by-instrument
basis, as long as it is applied to the instrument in its entirety. The fair value option election
is irrevocable, unless a new election date occurs. SFAS No. 159 requires prospective application
and also establishes certain additional presentation and disclosure requirements. The standard is
effective as of the beginning of the fiscal year that begins after November 15, 2007. The Company
is currently evaluating the provisions of SFAS No. 159 to determine the potential impact, if any,
the adoption will have on the Company’s financial consolidated financial position or results of
operations.
Business Combinations
In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (“SFAS
No. 141R”). SFAS No. 141R significantly changes the accounting for business combinations Under SFAS
No. 141R, an acquired entity will be required to recognize all the assets acquired and liabilities
assumed in a transaction at the acquisition date fair value with limited exceptions. SFAS No. 141R
will change the accounting treatment for certain specific acquisition related items including
expensing acquisition related costs as incurred, valuing noncontrolling interests at fair value at
the acquisition date and expensing restructuring costs associated with an acquired business. SFAS
No. 141R also includes a substantial number of new disclosure requirements. SFAS No. 141R is to be
applied prospectively to business combinations for which the acquisition date is on or after
January 1, 2009. The Company expects SFAS No. 141R to have an impact on the accounting for future
business combinations once adopted but the effect is dependent upon the acquisitions that will be
made in the future.
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GOLDEN TELECOM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
Noncontrolling Interests in Consolidated Financial Statements
In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated
Financial Statements—an amendment of Accounting Research Bulletin No. 51 (“SFAS No. 160”). SFAS No.
160 establishes accounting and reporting standards for ownership interests in subsidiaries held by
parties other than the parent, the amount of consolidated net income attributable to the parent and
to the noncontrolling interest, changes in a parent’s ownership interest, and the valuation of
retained noncontrolling equity investments when a subsidiary is deconsolidated. SFAS No. 160 also
establishes disclosure requirements that clearly identify and distinguish between the interests of
the parent and the interests of the noncontrolling owners. SFAS No. 160 is effective on January 1,
2009. The Company is currently evaluating the potential impact, if any, the adoption of SFAS No.
160 will have on the consolidated financial position, results of operations and cash flows.
Note 3: Net Income Per Share
Basic earnings per share at December 31, 2005, 2006 and 2007 is computed on the basis of the
weighted average number of common shares outstanding. Diluted earnings per share at December 31,
2005, 2006 and 2007 is computed on the basis of the weighted average number of common shares
outstanding plus the effect of outstanding employee stock options using the “treasury stock”
method. The number of stock options excluded from the diluted earnings per share computation,
because their effect was antidilutive for the year ended December 31, 2005 was 10,000 stock
options, and for the years ended December 31, 2006 and 2007 was zero stock options.
The components of basic and diluted earnings per share were as follows:
| Year Ended December 31, | ||||||||||||
| 2005 | 2006 | 2007 | ||||||||||
| (in thousands, except per share data) | ||||||||||||
Net Income |
$ | 76,073 | $ | 85,500 | $ | 152,599 | ||||||
Weighted average shares outstanding of: |
||||||||||||
Common stock |
36,378 | 36,591 | 38,798 | |||||||||
Dilutive effect of: |
||||||||||||
Employee stock options |
227 | 126 | 236 | |||||||||
Common stock and common stock equivalents |
36,605 | 36,717 | 39,034 | |||||||||
Net Income per share: |
||||||||||||
Basic |
$ | 2.09 | $ | 2.34 | $ | 3.93 | ||||||
Diluted |
$ | 2.08 | $ | 2.33 | $ | 3.91 | ||||||
Note 4: Comprehensive Income
SFAS No. 130, “Reporting Comprehensive Income”, requires the reporting of comprehensive income
in addition to net income. Accumulated other comprehensive income includes foreign currency
translation adjustments. For the years ended December 31, 2006 and 2007, as a result of the change
in functional currency total comprehensive income included, in addition to net income, the effect
of translating RUR and UAH denominated financial statements of the Company’s subsidiaries domiciled
in Russia and Ukraine into the Company’s reporting currency, in accordance with SFAS No. 52.
Comprehensive income comprises the following:
| Year Ended December 31, | ||||||||||||
| 2005 | 2006 | 2007 | ||||||||||
| (in thousands) | ||||||||||||
Net income, as reported |
$ | 76,073 | $ | 85,500 | $ | 152,599 | ||||||
Foreign currency translation adjustment |
— | 75,072 | 70,742 | |||||||||
Comprehensive income |
$ | 76,073 | $ | 160,572 | $ | 223,341 | ||||||
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GOLDEN TELECOM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
Note 5: Goodwill and Intangible Assets
Amortization expense for intangible assets for the years ended December 31, 2005, 2006 and
2007 was $18.7 million, $21.0 million and $26.7 million, respectively. Amortization expense for the
succeeding five years is expected to be as follows: 2008 — $33.8 million, 2009 — $33.9 million,
2010 — $32.7 million, 2011 — $31.5 million and 2012 — $28.8 million. The total gross carrying value
and accumulated amortization of the Company’s intangible assets by major intangible asset class is
as follows:
| As of December 31, 2006 | As of December 31, 2007 | |||||||||||||||||||
| (in thousands) | ||||||||||||||||||||
| Weighted Average | Accumulated | Accumulated | ||||||||||||||||||
| Amortization Lives | Cost | Amortization | Cost | Amortization | ||||||||||||||||
Amortized intangible assets: |
||||||||||||||||||||
Telecommunications service contracts |
10 years | $ | 119,433 | $ | (49,450 | ) | $ | 136,716 | $ | (66,914 | ) | |||||||||
Contract-based customer relationships |
5 years | 42,104 | (28,578 | ) | 64,085 | (36,542 | ) | |||||||||||||
Licenses |
10 years | 26,948 | (4,295 | ) | 114,246 | (5,737 | ) | |||||||||||||
Brand name |
10 years | — | — | 36,859 | (4,563 | ) | ||||||||||||||
Other intangible assets |
6 years | 18,374 | (7,991 | ) | 21,261 | (9,826 | ) | |||||||||||||
Total |
$ | 206,859 | $ | (90,314 | ) | $ | 373,167 | $ | (123,582 | ) | ||||||||||
The changes on the carrying amount of goodwill for the years ended December 31, 2006 and 2007,
respectively, are as follows:
| Business & | Carrier & | Consumer | ||||||||||||||||||
| Corporate | Operator | Internet | Mobile | |||||||||||||||||
| Segment | Segment | Segment | Segment | Total | ||||||||||||||||
| (in thousands) | ||||||||||||||||||||
Balance as of December 31, 2005 |
$ | 88,387 | $ | 59,732 | $ | 1,130 | — | $ | 149,249 | |||||||||||
Goodwill related to acquisitions |
6,215 | 420 | 1,456 | — | 8,091 | |||||||||||||||
Other |
(133 | ) | (35 | ) | (717 | ) | — | (885 | ) | |||||||||||
Foreign currency translation adjustment |
12,983 | 11,011 | 90 | — | 24,084 | |||||||||||||||
Balance as of December 31, 2006 |
$ | 107,452 | $ | 71,128 | $ | 1,959 | — | $ | 180,539 | |||||||||||
Goodwill related to acquisitions |
22,355 | 3,209 | 83,009 | 6,153 | 114,726 | |||||||||||||||
Other |
(1,736 | ) | (231 | ) | (160 | ) | — | (2,127 | ) | |||||||||||
Foreign currency translation adjustment |
8,528 | 5,335 | 4,180 | 301 | 18,344 | |||||||||||||||
Balance as of December 31, 2007 |
$ | 136,599 | $ | 79,441 | $ | 88,988 | $ | 6,454 | $ | 311,482 | ||||||||||
Note 6: Business Combinations and Investment Transactions
Acquisitions in 2005
In March 2005, the Company completed the acquisition of 75% ownership interest in Dicom LLC
(“Dicom”), an early-stage wireless broadband enterprise, for approximately $0.5 million in cash.
In conjunction with the acquisition, the Company entered into a participants’ agreement which
provided the seller with a put option that, if exercised, would require the Company to purchase the
seller’s remaining 25% interest at fair market value. In addition, the participants’ agreement
provided the Company with a call option that, if exercised, would require the seller to sell after
February 1, 2008 the seller’s 25% interest at fair value in Dicom at any time beginning after
February 1, 2008, if Dicom’s valuation exceeds targeted levels by February 1, 2008. The results of
Dicom have been included in the Company’s consolidated operations since March 31, 2005.
In September 2005, the Company completed the acquisition of 60% of Sakhalin Telecom LLC
(“Sakhalin Telecom”), a fixed line alternative operator in the Far East region of Russia for $5.0
million in cash. As a result of this acquisition and combined with the Company’s previous
ownership in Sakhalin Telecom, the Company now owns 83% of Sakhalin Telecom. In October 2005, the
Company acquired 100% of ZAO Sochitelecom (“Sochitelecom”), a fixed line alternative operator in
the Krasnodar region of Russia, for approximately $2.1 million in cash. The results of Sakhalin
Telecom have been included in the Company’s consolidated operations since September 30, 2005. The
results of Sochitelecom have been included in the Company’s consolidated operations since October
31, 2005.
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GOLDEN TELECOM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
The Company’s consolidated financial statements reflect the allocation of the purchase price
based on a fair value assessment of the assets acquired and liabilities assumed, and as such, the
Company has assigned approximately $2.1 million to telecommunications services contracts intangible
assets which will be amortized over a weighted average period of approximately 10 years. The
excess of the purchase price over the fair value of the net assets acquired of approximately $2.1
million has been assigned to goodwill and is not deductible for tax purposes. Approximately $1.5
million of this goodwill has been assigned to Business and Corporate Services reportable segment,
approximately $0.3 million has been assigned to Carrier and Operator Services reportable segment
and approximately $0.3 million has been assigned to Consumer Internet Services reportable segment.
In October 2005, the Company acquired 100% of Antel Rascom, Ltd., a British Virgin Islands
company that owns 49% of ZAO Rascom (“Rascom”), an infrastructure and facilities company in
northwest region of Russia, for approximately $10.0 million in cash. In December 2005, the Company
acquired an additional 5% of Rascom for approximately $1.1 million in cash. The Company has
concluded that its 54% investment in Rascom does not qualify for accounting under the consolidation
method of accounting because the rights of the minority shareholder represent substantive
participating rights, and as result, such rights overcome the presumption that the Company controls
Rascom. Therefore, the Company accounts for this investment under the equity method.
In March 2005, the Company expensed approximately $1.0 million in external legal, financial
and consulting fees related to an acquisition opportunity the Company decided not to pursue,
including advisory fees of approximately $0.1 million paid to Alfa Group Consortium (“Alfa”), a
related party. In September 2005, the Company expensed approximately $0.8 million in external
legal, financial and consulting fees related to another acquisition, which the Company decided not
to pursue.
Acquisitions in 2006
In March 2006, the Company completed the acquisition of 70% ownership interest in ZAO Tatar
Intellectual Communications (“Tatintelcom”), an Internet service provider (“ISP”) in the Russian
Republic of Tatarstan, for approximately $4.0 million of cash consideration. The Company has
consolidated the financial position of Tatintelcom as of March 31, 2006 and the results of
operations of Tatintelcom from April 1, 2006.
The Company’s consolidated financial statements reflect the allocation of the purchase price
based on a fair value assessment of the assets acquired and liabilities assumed, and as such, the
Company has assigned approximately $4.8 million to right of way intangible assets which will be
amortized over a weighted average period of approximately 10 years.
In April 2006, the Company completed the acquisition of 100% ownership interest in TTK LLC
(“TTK”), a fixed line alternative operator in the Ivano-Frankovsk region of Ukraine, for
approximately $3.8 million consisting of cash consideration of $3.4 million and $0.4 recorded as a
liability. The Company has consolidated the financial position of TTK from April 30, 2006 and the
results of operations of TTK from May 1, 2006.
The Company’s consolidated financial statements reflect the allocation of the purchase price
based on a fair value assessment of the assets acquired and liabilities assumed, and as such, the
Company has assigned approximately $0.4 million to telecommunications services contracts intangible
assets which will be amortized over a weighted average period of approximately 10 years. The
excess of the purchase price over the fair value of the net assets acquired of approximately $2.0
million has been assigned to goodwill and is not deductible for tax purposes. This goodwill has
been assigned to Business and Corporate Services reportable segment.
In June 2006, the Company completed the acquisition of 74% ownership interest in Kubtelecom
LLC (“Kubtelecom”), a fixed line alternative operator in the Krasnodar region of Russia, for
approximately $10.1 million of cash consideration, plus the assumption of $3.9 million of debt and
other liabilities. The Company has consolidated the financial position of Kubtelecom from June 30,
2006. However, given the proximity of the acquisition to the Company’s quarter end, consolidation
of Kubtelecom’s results of operations commenced from July 1, 2006. See Note 14 concerning
litigation in association with the acquisition of Kubtelecom.
The Company’s consolidated financial statements reflect the allocation of the purchase price
based on a fair value assessment of the assets acquired and liabilities assumed, and as such, the
Company has assigned approximately $0.5 million to contract based customer relationship intangible
assets which will be amortized over a weighted average period of approximately 10 years and $0.6
million to other intangible assets which will be amortized over a weighted average period of
approximately 10 years. The excess of the purchase price over the fair value of the net assets
acquired of approximately $3.7 million has been assigned to goodwill and is not deductible for tax
purposes. Approximately $3.0 million of this goodwill has been assigned to Business and Corporate
Services reportable segment, approximately $0.4 million has been assigned to Carrier and Operator
Services reportable segment, and approximately $0.3 million has been assigned to Consumer Internet
Services reportable segment.
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GOLDEN TELECOM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
In August 2006, the Company completed the acquisition of 100% ownership interest in Telcom LLC
(“Telcom”), a fixed line alternative operator in Nizhny Novgorod, Russia, for approximately $1.7
million of cash consideration. The Company has consolidated the results of operations and
financial position of Telcom from August 1, 2006.
The Company’s consolidated financial statements reflect the allocation of the purchase price
based on a fair value assessment of the assets acquired and liabilities assumed, and as such, the
Company has assigned approximately $0.1 million to telecommunications services contracts intangible
assets which will be amortized over a weighted average period of approximately 10 years. The
excess of the purchase price over the fair value of the net assets acquired of approximately $0.8
million has been assigned to goodwill and is not deductible for tax purposes.
In July 2006, the Company paid $7.5 million in cash for the acquisition of 75% ownership
interest in S-Line LLC (“S-Line”), an early-stage wireless broadband enterprise in Kiev, Ukraine,
which closed in October 2006. The acquisition of S-Line was accounted for as an asset purchase of
telecommunication licenses through a VIE. In conjunction with this transaction, the Company also
entered into an agreement whereby the Company provided a secured loan of $2.5 million to the seller
with interest at 10% per annum. The loan is secured by the pledge of the remaining 25% interest in
S-Line and matures in November 2010 and is recorded in other non-current assets. See Note 14
concerning a regulatory dispute in association with the acquisition of S-Line.
In October 2006, the Company completed the acquisition of 100% ownership interest in ZAO Corus
ISP (“Corus”), an ISP in Ekaterinburg, Russia, for approximately $1.2 million of cash
consideration.
The Company’s financial statements reflect the allocation of the purchase price, and as such,
the Company has assigned approximately $1.2 million to goodwill which is not deductible for the tax
purpose.
Acquisitions in 2007
In February 2007, the Company completed the acquisition of 65% ownership interest in Fortland
Limited (“Fortland”) from an entity, the principal shareholder of which is also a shareholder in
three of the Company’s other subsidiaries. Fortland owns Kolangon-Optim LLC (“Kolangon”), an
early-stage digital video broadcast enterprise in Russia. The Company acquired Fortland for
approximately $51.7 million consisting of cash consideration of approximately $38.6 million paid in
April 2007, and a deferred payment of $11.1 million which
was subject to certain conditions and was paid in February 2008, approximately
$0.2 million of direct transaction costs and the assumption of approximately $1.8 million debt.
The acquisition of Fortland was accounted for as an asset purchase of television license through a
variable interest entity. The Company has consolidated the financial position and results of
operations of Fortland from February 1, 2007. On acquisition, the Company allocated approximately
$71.4 million to licenses, approximately $17.2 million to deferred tax liability, and approximately
$15.0 million to noncontrolling interest. In conjunction with this transaction, the Company also
entered into an agreement whereby the Company agreed to provide a secured loan of approximately
$12.1 million to the seller. The loan, issued in April 2007, is secured by a pledge of a 15%
interest in Fortland owned by the seller and matures in April 2011. In conjunction with this
transaction, the Company also entered into a put option agreement that, if exercised, would require
the Company to purchase the seller’s remaining 35% interest in Fortland at fair market value. In
conjunction with this transaction, the Company also entered into a call option agreement that, if
exercised, would require the seller to sell the seller’s remaining 35% interest in Fortland at fair
market value. The put and call options are exercisable on and after September 30, 2010.
In April 2007, the Company completed the acquisition of 100% ownership interest in ZAO
Telecommunications Agency (“Atel”), a fixed line alternative telecommunications operator in Perm,
for approximately $4.5 million in cash consideration. The Company has consolidated the financial
position and results of operations of Atel from April 1, 2007.
The Company’s consolidated financial statements reflect the preliminary allocation of the
purchase price based on a preliminary fair value assessment of the assets acquired and liabilities
assumed, and as such, the Company has assigned approximately $2.8 million to fixed assets which
will be depreciated over a weighted average period of approximately 7 years and approximately $0.3
million to deferred tax liability. The excess of the purchase price over the fair value of the net
assets acquired of approximately $2.0 million has been assigned to goodwill and is not deductible
for tax purposes. The purchase price allocation will be finalized upon completion of the valuation
of the acquired fixed and intangible assets. The goodwill has been assigned to Business and
Corporate Services reportable segment.
85
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GOLDEN TELECOM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
In May 2007, the Company completed the acquisition of 100% ownership interest in ICA Center of
Commercial Real Estate LLC (“CKN”), which owns 6,181 square meters of a building in Moscow. The
Company acquired CKN for approximately $9.8 million of cash consideration. The acquisition of CKN
was accounted for as an asset purchase of a building through a variable interest entity. On
acquisition, the Company allocated $12.0 million to fixed assets and approximately $2.2 million to
deferred tax liability. The Company has consolidated the financial position and the results of
operations of CKN from May 1, 2007.
In May 2007, the Company completed the acquisition of a 51% ownership interest in ZAO Cortec
and its subsidiaries (together “Corbina”) from Inure Enterprises Ltd. and Rambert Management
Limited, pursuant to a Stock Purchase Agreement. The total purchase price of approximately $196.9
million consisted of approximately $142.1 million of GTI’s common stock, representing 3,193,219
shares, cash consideration of approximately $8.2 million, and direct transaction costs of
approximately $1.6 million. In addition, as part of the purchase price, the Company refinanced
$45.0 million of debt that the seller owed to OAO Vneshtorgbank. The refinancing was effected
through a loan to Corbina from the Company. The purchase consideration of GTI’s common stock,
which was issued on May 25, 2007, was determined based on the closing price of the Company’s common
stock on December 20, 2006, when the Company announced that it had entered into a binding
Memorandum of Understanding with Dawn Key Limited to acquire a 51% ownership interest in Corbina.
Accordingly, the GTI shares issued in consideration are valued based on the average closing price
of the Company’s common stock for the five consecutive trading days between December 18, 2006 and
December 22, 2006, which was $44.51 per share. Management believes the acquisition of 51% of
Corbina further strengthens the Company’s position in the Company’s broadband strategy and
positions the Company to realize future operating and cost synergies. Corbina is an integrated
telecommunications provider of telecommunications and Internet services in Russia. The Company has
consolidated the financial position of Corbina from May 31, 2007 and the results of operations of
Corbina from June 1, 2007. Corbina held a variable interest and was the primary beneficiary of
Mircom Trading, Inc. (“Mircom”), a British Virgin Islands registered wholesale telecommunications
operator providing a range of carrier and operator services to foreign telecommunications
operators. Mircom is owned by a member of the Board of Directors of Corbina. The creditors of
Mircom have no recourse to the Company’s general credit. The Company changed its relationship with
Mircom and determined that Mircom no longer qualifies as a variable interest entity. Mircom was
deconsolidated as of July 1, 2007.
The acquisition of 51% ownership interest in Corbina was accounted for as a purchase business
combination in accordance with SFAS No. 141, “Business Combinations”. The following is the
condensed balance sheet of Corbina as of May 31, 2007 reflecting the preliminary purchase price
allocation to the net assets acquired:
| May 31, 2007 | ||||
| (in thousands) | ||||
ASSETS: |
||||
Current assets |
$ | 32,987 | ||
Property and equipment |
158,266 | |||
Intangible assets |
50,550 | |||
Goodwill |
104,343 | |||
Other assets |
14,355 | |||
Total assets |
$ | 360,501 | ||
LIABILITIES: |
||||
Current liabilities |
$ | 102,393 | ||
Non-current liabilities |
25,157 | |||
Net assets |
$ | 232,951 | ||
Less: Minority interest in net assets acquired |
(36,096 | ) | ||
Total purchase consideration and transaction costs |
$ | 196,855 | ||
Consideration and transaction costs: |
||||
GTI shares consideration |
142,130 | |||
Cash consideration |
8,204 | |||
Loan refinancing |
45,000 | |||
Direct transaction costs |
1,521 | |||
Total purchase consideration and transaction costs |
$ | 196,855 | ||
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GOLDEN TELECOM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
The Company’s financial statements reflect the preliminary allocation of the purchase price
based on a preliminary fair value assessment of the assets acquired and liabilities assumed, and as
such, the Company has assigned approximately $32.8 million to brand which will be amortized over a
period of 10 years, approximately $10.5 million to telecommunications service contracts intangible
assets which will be amortized over a weighted average period of
approximately 7 years,
approximately $6.7 million to contract-based customer relationship intangible assets which will be
amortized over a weighted average period of approximately 9 years, approximately $0.1 million to
licenses which will be amortized over a weighted average period of 5 years, and approximately $0.4
million to other intangible assets which will be amortized over a weighted average period of 5
years. The Company has recorded approximately $22.7 million of tax contingencies. The purchase
price allocation will be finalized upon the completion of the valuation of the acquired fixed and
intangible assets and resolving tax contingencies. The excess purchase price over the fair value
of the net tangible and intangible assets acquired of approximately $104.3 million has been
assigned to goodwill and is not deductible for tax purposes.
Approximately $13.0 million of this
goodwill has been assigned to the Business and Corporate Services reportable segment, approximately
$1.8 million of this goodwill has been assigned to the Carrier and Operator Services reportable
segment, approximately $83.3 million of this goodwill has been assigned to the Consumer Internet
Services reportable segment, and approximately $6.2 million of this goodwill has been assigned to
the Mobile Services reportable segment.
The following unaudited pro forma consolidated results of operations for the Company give
effect to the Corbina business combination as if it had occurred at the beginning of 2006 and to
give effect to the Corbina business combination as if it had occurred at the beginning of 2007.
These unaudited pro forma amounts are provided for informational purposes only and do not purport
to present the results of operations of the Company had the transactions assumed therein occurred
on or as of the date indicated, nor is it necessarily indicative of the results of operations which
may be achieved in the future.
| Twelve Months Ended December 31, | ||||||||
| 2006 | 2007 | |||||||
| (unaudited) | ||||||||
| (in thousands, except per share data) | ||||||||
Revenue |
$ | 938,422 | $ | 1,340,700 | ||||
Income before cumulative effect of
a change in accounting principle |
80,097 | 151,428 | ||||||
Cumulative effect of a change in
accounting principle |
(681 | ) | — | |||||
Net income |
$ | 79,416 | $ | 151,428 | ||||
Basic earnings per share of common stock: |
||||||||
Income before cumulative effect of
a change in accounting principle |
$ | 2.02 | $ | 3.90 | ||||
Cumulative effect of a change in
accounting principle |
(0.02 | ) | — | |||||
Net income per share – basic |
$ | 2.00 | $ | 3.90 | ||||
Diluted earnings per share of common stock: |
||||||||
Income before cumulative effect of
a change in accounting principle |
$ | 2.01 | $ | 3.88 | ||||
Cumulative effect of a change in
accounting principle |
(0.02 | ) | — | |||||
Net income per share — diluted |
$ | 1.99 | $ | 3.88 | ||||
In June 2007, the Company completed the acquisition of 100% ownership interest in ZAO Direct
Net Telecommunications (“DirectNet”) and ZAO Satcom Tel (“Satcomtel”), fixed line alternative
telecommunications operators in Moscow and the assets of NDNT, Inc. and NDNT (UK) Limited, for
approximately $1.5 million in cash consideration, including the
assignment of approximately $0.7
million of debt from the seller to the Company. The Company has consolidated the financial
position and the results of operations of DirectNet and Satcomtel from June 1, 2007.
87
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GOLDEN TELECOM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
The Company’s consolidated financial statements reflect the preliminary allocation of the
purchase price based on a preliminary fair value assessment of the assets acquired and liabilities
assumed, and as such, the Company has assigned approximately $0.1 million to telecommunications
services contracts intangible assets which will be amortized over a weighted average period of
approximately 10 years and approximately $0.4 million to fixed assets which will be depreciated
over a weighted average period of approximately 5 years. The excess of the purchase price over the
fair value of the net assets acquired of approximately $2.0 million has been assigned to goodwill
and is not deductible for tax purposes. The purchase price allocation will be finalized upon
completion of the valuation of the acquired fixed and intangible assets. The goodwill has been
assigned to Business and Corporate Services reportable segment.
In June 2007, the Company completed the acquisition of 75% ownership interest in Alcar LLC
(“Alcar”), an early-stage WiFi
enterprise in Russia from an entity, the principal share holder of which is also a shareholder in
four of the Company’s other subsidiaries. The Company acquired Alcar for approximately $1.9
million of cash consideration. The acquisition of Alcar was accounted for as an asset purchase of
WiFi frequencies through a variable interest entity. On acquisition, the Company allocated
approximately $2.5 million to licenses, approximately $0.6 million to deferred tax liability, and
approximately $0.5 million to noncontrolling interest. The Company has consolidated the financial
position and the results of operations of Alcar from June 1, 2007.
In August 2007, the Company completed the acquisition of 75% ownership interest in Satel
Tsentr LLC (“Satel”), an early stage WiFi enterprise in the Moscow region of Russia, from an
entity, the principal shareholder of which is also a shareholder in four of the Company’s other
subsidiaries. The Company acquired Satel for approximately $1.9 million in cash consideration. The
acquisition of Satel was accounted for as an asset purchase of WiFi frequencies through a variable
interest entity. On acquisition, the Company allocated approximately $2.5 million to licenses,
approximately $0.6 million to deferred tax liability, and approximately $0.5 million to
noncontrolling interest. In conjunction with this transaction, the Company also entered into a put
option agreement that, if exercised, would require the Company to purchase the seller’s remaining
25% interest in Satel at fair market value. In conjunction with this transaction, the Company also
entered into a call option agreement that, if exercised, would require the seller to sell the
seller’s remaining 25% interest in Satel at fair market value. The put and call options are
exercisable on or after September 30, 2010. The Company has consolidated the financial position and
results of operations of Satel from August 1, 2007.
In August and September 2007, the Company completed the acquisition of 50% ownership interest
in eight fixed line alternative telecommunications operators in various regions of Russia, for
approximately $2.5 million in cash consideration. As a result of these acquisitions and combined
with the Company’s previous ownership interest, the Company now has 100% ownership interest in
these eight entities. On acquisition, the Company allocated $1.0 million to property and equipment
and $1.7 million to goodwill.
In December 2007, the Company completed the acquisition of 100% ownership interest in New
Telecom Technologies LLC (“NTT”), a channel rent service provider in Krasnodar, Russia for
approximately $1.3 million in cash consideration. The Company has consolidated the financial
position and results of operations of NTT from December 1, 2007.
The Company’s consolidated financial statements reflect the preliminary allocation of the
purchase price based on a preliminary fair value assessment of the assets acquired and liabilities
assumed, and as such, the Company has assigned approximately $0.7 million to contract based
customer relationship intangible assets which will be amortized over a weighted average period of
approximately 5 years. Approximately $0.3 million has been allocated to fixed assets which will
be depreciated over a weighted average period or approximately 8 years and $0.3 million to deferred
tax liability. The purchase price allocation will be finalized upon completion of the valuation of
the acquired fixed and intangible assets.
In December 2007, the Company completed the acquisition of 100% ownership interest in ZAO
Bryansktel and BryanskIntel LLC which together form Group BryanskTel
(“BryanskTel”), a leading
alternative communication carrier in Bryansk, Russia. The Company acquired BryanskTel for
approximately $5.6 million in cash consideration. The Company has consolidated the financial
position and results of operations of BryanskTel from December 1, 2007.
88
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GOLDEN TELECOM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
The Company’s consolidated financial statements reflect the preliminary allocation of the
purchase price based on a preliminary fair value assessment of the assets acquired and liabilities
assumed, and as such, the Company has assigned approximately $4.5 million to contract based
customer relationship intangible assets which will be amortized over a weighted average period of
approximately 5 years and approximately $ 1.1 million to deferred tax liability. The excess of the
purchase price over the fair value of the net assets acquired of approximately $0.4 million has
been assigned to goodwill and is not deductible for tax purposes. The purchase price allocation
will be finalized upon completion of the valuation of the acquired fixed and intangible assets.
The goodwill has been assigned to Business and Corporate Services reportable segment.
In December 2007, the Company completed the acquisition of 100% ownership interest in Skat-7
LLC (“Skat-7”), a fixed line alternative operator, in Cherepovets, Russia for approximately $7.5
million in cash consideration. The Company has consolidated the financial position and results of
operations of Skat-7 from December 1, 2007.
The Company’s consolidated financial statements reflect the preliminary allocation of the
purchase price based on a preliminary fair value assessment of the assets acquired and liabilities
assumed, and as such, the Company has assigned approximately $2.2 million to contract based
customer relationship intangible assets which will be amortized over a weighted average period of
approximately 5 years and allocated approximately $0.5 million to deferred tax liability. The
excess of the purchase price over the fair value of the net assets acquired of approximately $4.5
million has been assigned to goodwill and is not deductible for tax purposes.
Pro-forma operating results assuming all of the above business combinations, except for
Corbina, had occurred as of the beginning of 2005 would not be materially different from the
results of operations as presented in the accompanying consolidated financial statements.
Note 7: Investments in and Advances to Ventures
The Company has various investments in ventures that are accounted for by the equity method.
The Company had ownership percentages in its equity method investments range from approximately 50%
to 54%. Refer to Note 6 for further discussion on the accounting for the Company’s 54% investment
in Rascom.
The components of the Company’s investments in and advances to ventures are as follows:
| December 31, | ||||||||
| 2006 | 2007 | |||||||
| (in thousands) | ||||||||
Equity in net assets acquired |
$ | 13,448 | $ | 16,955 | ||||
Goodwill as part of investment |
1,313 | 1,313 | ||||||
Difference between fair value and historical value of
assets acquired |
(1,355 | ) | (1,615 | ) | ||||
Cash advances and other |
(1,520 | ) | (1,223 | ) | ||||
Total investments in and advances to ventures |
$ | 11,886 | $ | 15,430 | ||||
The Company has financed the operating and investing cash flow requirements of several of the
Company’s ventures in the form of cash advances. The Company aggregates all of the receivable and
payable balances with the ventures in the Company’s investments in and cash advances to the
ventures.
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GOLDEN TELECOM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
Note 8: Supplemental Balance Sheet Information
| December 31, | ||||||||
| 2006 | 2007 | |||||||
| (in thousands) | ||||||||
Other current assets consist of: |
||||||||
Interest receivable |
$ | 120 | $ | 1,198 | ||||
Deferred cost |
4,355 | 6,862 | ||||||
Other current assets |
1,089 | 2,173 | ||||||
Total other current assets |
$ | 5,564 | $ | 10,233 | ||||
Other non-current assets consist of: |
||||||||
Deferred tax asset |
$ | 1,139 | $ | 2,094 | ||||
Deferred cost |
8,731 | 13,655 | ||||||
Deferred debt issuance cost |
— | 3,149 | ||||||
Other non-current assets |
1,871 | 1,104 | ||||||
Total other non- current assets |
$ | 11,741 | $ | 20,002 | ||||
Accounts payable and accrued expenses consists of: |
||||||||
Accounts payable |
$ | 78,799 | $ | 143,436 | ||||
Accrued compensation |
33,367 | 32,844 | ||||||
Accrued other taxes |
3,717 | 12,415 | ||||||
FIN No. 48 liability |
— | 18,925 | ||||||
Accrued access and network services |
27,734 | 38,548 | ||||||
Interest payable |
64 | 1,903 | ||||||
Other accrued expenses |
2,377 | 8,546 | ||||||
Total accounts payable and accrued expenses |
$ | 146,058 | $ | 256,617 | ||||
Note 9: Debt Obligations and Capital Leases
The
Company’s debt consists of:
| December 31, | ||||||||
| 2006 | 2007 | |||||||
| (in thousands) | ||||||||
Term Facility Agreement |
$ | — | $ | 225,000 | ||||
Citibank Credit Facility |
6,600 | 14,666 | ||||||
Calyon Bank Credit Facility |
3,921 | 2,178 | ||||||
Other Credit Facilities |
1,813 | 995 | ||||||
| 12,334 | 242,839 | |||||||
Less: debt maturing within one year |
12,305 | 17,680 | ||||||
Total long-term debt |
$ | 29 | $ | 225,159 | ||||
In January 2007, the Company entered into a five-year term facility agreement (the “Facility
Agreement”) with banks, financial institutions and other institutional lenders, Citibank, N.A.
London Branch and ING Bank N.V. as mandated lead arrangers, and Citibank International plc as
agent. The Facility Agreement established an unsecured credit facility under which, the Company,
GTS Finance, Inc., a wholly-owned subsidiary of the Company, and Sovintel may borrow up to an
aggregate of $275.0 million. The Facility Agreement carries interest at a rate equal to London
Interbank Offered Rate (“LIBOR”) plus 1.5% per annum for the first twenty-four months and LIBOR
plus 2% per annum thereafter (equivalent to approximately 6.5% at December 31, 2007). Funds
borrowed may be used for general corporate purposes, including acquisitions, the payment of
dividends and capital expenditures. The Facility Agreement places various restrictions on the
Company related to incurrence of debt, asset disposals, mergers and acquisitions, and negative
pledges. The Facility Agreement also requires the Company to meet various financial and
non-financial covenants, including several restrictions related to financial condition. As of
December 31, 2007, the Company has borrowed $225.0 million under the Facility Agreement. In
February 2007, the Company paid approximately $3.9 million of arrangement fees to the lead
arrangers which are recorded in other non-current assets.
In September 2006, Sovintel entered into a 90 day short-term revolving credit facility for up
to $15.0 million with ZAO Citibank. As of December 31, 2007, Sovintel has borrowed $14.7 million
under this credit facility. The credit facility carries interest at a rate of 8% per annum. The
credit facility requires Sovintel to maintain accounts with ZAO Citibank in the currencies of the
loan and ensure that the aggregate amount of incoming payments credited to Sovintel’s accounts with
ZAO Citibank in any calendar month is equal to, or greater than 30% of the aggregate amount of the
loans outstanding as of the last day of such month.
90
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GOLDEN TELECOM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
In July 2006, Golden Telecom (Ukraine) (“GTU”), the Company’s subsidiary in Ukraine entered
into one-year revolving, credit facility for up to $3.5 million plus a cash coverage facility of up
to $2.0 million with Calyon Bank Ukraine (“Calyon”). This credit facility has been prolonged until
March 2008. As of December 31, 2007, GTU had outstanding $2.2 million under this credit facility. The
credit facility carries interest at a rate equal to LIBOR plus 2% for the loans denominated in USD
and at prevailing bank’s offered rate plus a margin of 2% for the loans denominated in Ukrainian
Hryvna (equivalent to approximately 14%, on average for loans
outstanding, at December 31, 2007). The credit facility requires GTU to maintain accounts with Calyon in the currency of the
loan and ensure that the aggregate amount of incoming payments credited to GTU’s accounts with
Calyon in any calendar month is equal to, or greater than 50% of the aggregate amount of monthly
sales at least within the terms of credit facility agreement.
In August 2005, the Company entered into a lease for fiber optic capacity, including
facilities and maintenance, on major routes within Ukraine. The lease has a term of five years
with total payments of $4.1 million over the term of the lease. The lease is classified as a
capital lease in the balance sheet.
In January 2007, the Company entered into a five year lease agreement with ZAO Rascom, the
Company’s equity method investee, for the right to use eight STM-64 fiber optic cable systems
between Moscow and Stockholm. The Company had the right to take possession of two STM-64 fiber
optic cable systems as of January 1, 2007 and the option to increase to six STM-64 fiber optic
cable systems in the future. In connection with this lease, the Company has recorded a capitalized
leased asset, which was approximately $5.9 million as of December 31, 2007.
In February 2007, the Company entered into a five year lease agreement for the right to use
STM-1 fiber optic capacity on major routes within Russia. The Company had the right to take
possession of this STM-1 fiber optic capacity beginning April 1, 2007. In March 2007, the Company
issued a $2.0 million loan to the same company that has provided the lease, in May 2007 the Company
issued a loan of approximately $5.9 million to the same company that has provided the lease and in
October 2007 the Company issued an additional $1.9 million loan to the same company that has
provided the lease. The loan has payment terms of 59 months, which start in May 2007, and carries
interest at the rate of 9 percent per annum. In connection with this lease, the Company has
recorded a capitalized leased asset and a related capital lease obligation, which were
approximately $ 10.4 million and $9.2 million, respectively as of December 31, 2007.
In October 2007 the Company entered into a five year lease agreement with ZAO Rascom, the
Company’s equity method investee, for the right to use digital circuit between Moscow and
Stockholm. In connection with this lease, the Company has recorded a capitalized leased asset,
which was approximately $0.7 million as of December 31,
2007.
The following table presents minimum lease payments under capital leases:
| Lease payments | ||||
| (in thousands) | ||||
2008 |
$ | 4,050 | ||
2009 |
3,144 | |||
2010 |
2,878 | |||
2011 |
2,495 | |||
2012 |
728 | |||
| 13,295 | ||||
Less: amount representing
interest |
1,986 | |||
Total principal payments |
$ | 11,309 | ||
The
Company paid interest of $0.6 million, $0.5 million and
$11.0 million in 2005, 2006 and
2007, respectively.
Note 10: Derivative Financial Instruments
The Company accounts for its derivative and hedging activities under SFAS No. 133, “Accounting
for Derivative Instruments and Hedging Activities”. The Company is exposed to market risk from
changes in interest rates. The Company used a derivative financial instrument to manage or hedge its
interest rate risk. The Company did not hold or issue derivatives or other financial instruments
for trading purposes.
At December 31, 2007 the Company was exposed to market risk related to fluctuations in
interest rates on the Facility Agreement as discussed in Note 9. The objective of the derivative
instrument was to eliminate the variability of cash flows in the interest payments for this
variable-rate debt. The Company’s strategy to achieve that objective involved entering into an
interest rate swap that was specifically designated to certain variable rate instrument.
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GOLDEN TELECOM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
The Company entered into an interest rate swap agreement with a notional amount of $225.0
million with Citibank, N.A. London Branch, effective from October 26, 2007 through October 26,
2010. Pursuant to the agreement, the Company will exchange interest payments on a regular basis and
pay a fixed rate equal to 4.355% in the event the LIBOR rate is equal to no greater than 5.4%,
otherwise the Company will pay the LIBOR floating rate.
At the inception date of October 26, 2007, the interest rate swap agreement was not designated
as hedging instrument under SFAS 133. Accordingly, the Company was
required to mark to market the fair value of the derivative at the end of the reporting period. The
liability in the amount of $3.2 million associated with this interest rate swap agreement was
recorded in other non-current liabilities in the Consolidated Balance
Sheet for the period ended December 31, 2007, reflecting the
change in the fair value of the interest rate swap agreement between inception and reporting dates.
Note 11: Shareholders’ Equity
Common Stock
In May 2006, the Company granted 8,379 restricted shares of the Company’s common stock, par
value $0.01 per share, to certain members of the Board of Directors of the Company. These
restricted shares vested after one year.
In May 2007, the Company granted 6,120 restricted shares of the Company’s common stock, par
value $0.01 per share, to certain members of the Board of Directors. These restricted shares vest
after one year. In July 2007, the Company granted 1,500 restricted shares of the Company’s common
stock, par value $0.01 per share, to a member of management. These restricted shares vest after
one year.
At December 31, 2007, there were 7,620 unvested restricted shares of the Company’s common
stock with a value of approximately $0.4 million. The unvested restricted shares relate to
restricted shares issued to certain members of the Board of Directors and a member of senior
management of the Company.
In May 2007, the Company issued 3,193,219 unregistered shares of common stock to Inure in
partial settlement of the purchase price for the acquisition of 51% ownership interest in Corbina.
In July 2007, the Company issued 392,988 unregistered shares of the Company’s common stock,
par value $0.01, to OAO Rostelecom (“Rostelecom”) for cash consideration of approximately $20.4
million, or $51.95 per share of common stock, the closing price on the NASDAQ Global Select Market
(“NASDAQ”) on May 25, 2007. Rostelecom had the right to acquire these shares under the Shareholders
Agreement dated as of August 19, 2003. This right became exercisable due to Company shares being
issued as part of the acquisition of Corbina. No underwriter or underwriting discount was involved
in the offering. The shares of common stock were not registered under the Securities Act in
reliance on an exemption under Section 4(2) thereof.
The Company’s outstanding shares of common stock increased by 215,097 shares and 107,049
shares in the years ended December 31, 2006 and 2007, respectively, issued in connection with the
exercise of employee stock options. As of December 31, 2007, the Company had reserved 1,893,350
shares of common stock for issuance to certain employees and directors in connection with the
Equity Plan.
Preferred Stock
On May 17, 2000, the Company’s shareholders authorized 10 million shares of preferred stock,
none of which have been issued.
92
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GOLDEN TELECOM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
Dividends
During 2006, the Company paid three quarterly dividends of $0.20 per common share, for a total
of $0.60 per common share for the year. The total amount paid by the Company was $22.0 million.
The Company did not pay any dividends in 2007.
Note 12: Stock Appreciation Rights and Stock Option Plans
During the years ended December 31, 2005, 2006 and 2007, the Company recorded pretax
stock-based compensation expense of approximately zero,
$19.5 million and $29.0 million,
respectively, related to the expensing of the Company’s SARs, non-qualified stock options and
restricted shares.
In September 2005, the Company granted SARs to the Company’s Chief Executive Officer (“CEO”)
with respect to 200,000 shares of the Company’s common stock, at a share price which was the
closing price of the Company’s common stock on the NASDAQ on July 19, 2005 (“CEO Granting Share
Price”), which was $29.83, one-third of which vests and becomes nonforfeitable on each of the first
three anniversary dates from September 1, 2005, provided the CEO remains continuously employed by
the Company until each such relevant date. The SARs become fully vested if there is a change in
control, which occurred in February 2008. If, prior to February 28, 2009 and during the CEO’s
period of employment with the Company, the average closing stock price of one share of the
Company’s common stock on the NASDAQ exceeded $50.00 during any thirty day consecutive period, the
CEO would be granted SARs for an additional 200,000 shares of the Company’s common stock at the CEO
Granting Share Price, which SARs would be fully vested upon issuance. On February 3, 2007, the
Company’s common stock achieved the $50.00 threshold and the CEO was granted additional fully
vested SARs in respect of 200,000 shares of the Company’s common stock. The SARs granted do not
have a contractual term. However, all SARs shall be cancelled, and the Company shall make a payment
to the CEO upon the termination of employment for any reason with respect of the SARs vested. The
SARs provide for a cash only settlement and the related obligation is recorded as a liability in
the consolidated financial statements.
The Company has established the Golden Telecom, Inc. 2005 Stock Appreciation Rights Plan
(“2005 SAR Plan”) and the EDN Sovintel 2005 Stock Appreciation Rights Bonus Plan (“Sovintel SAR
Plan”), which are approved by the Company’s Board of Directors. The 2005 SAR Plan and the Sovintel
SAR Plan permit the grant of SARs to the Company’s senior management and employees. SAR awards are
granted at a share price which is the lower of: (i) the average between the high and low sales
price per share of the Company’s common stock on the grant date, or in case no such sale takes
place on the grant date, the last date on which a sale occurred or (ii) the average closing sales
price per share of the Company common stock for the fourteen trading days immediately preceding
such date (“Granting Share Price”). Seventy-five percent of the SAR grant shall be subject to time
vesting, one-third of which shall be and become vested and nonforfeitable on each of the first
three anniversary dates from the grant date, provided that the employee remains continuously
employed by the Company until each such relevant date. The Granting Share Price shall increase by
five percent on each anniversary date after the grant date in association with the SARs that shall
be and become vested and nonforfeitable on each such anniversary date. Twenty-five percent of the
SARs granted were subject to market condition vesting upon the Company’s common stock achieving a
closing trading price of at least $50.00 per share for thirty consecutive days as determined in the
sole discretion of the Company. On February 22, 2007, the Company’s common stock achieved the
$50.00 threshold and the market condition SARs became fully vested. The SARs have a contractual
term of five years. The aggregate number of shares of common stock which may be issued pursuant to
the 2005 SAR Plan at the discretion of the grantees, shall be 200,000 shares. The SARs issued
pursuant to the Sovintel SAR Plan provide for a cash only settlement. The related obligation is
recorded as a liability in the consolidated financial statements.
The fair value of each SAR award is estimated at the end of each reporting period using the
Monte Carlo simulation-based valuation model that uses the assumptions described in the table
below. Estimated volatilities are based on historical volatility of the Company’s stock for the
period matching the awards’ expected term. The Company uses historical data to estimate SAR
exercise and employee termination within the valuation model; separate groups of employees that
have similar historical exercise behavior are considered together for valuation purposes. The
expected term of SARs granted is derived from the output of the SAR valuation model and represents
the period of time that SARs granted are expected to be outstanding. The risk-free rate for periods
within the expected term of the SAR is based on the US Treasury yield curve in effect at the end of
the reporting period.
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GOLDEN TELECOM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
| Year Ended December 31, | ||||||
| 2006 | 2007 | |||||
Weighted-average volatility |
42.5% | 40.9 | % | |||
Expected dividend yield |
1.7% | — | ||||
Expected term |
0.12 – 4.75 years | 0.21 – 1.75 years | ||||
Risk-free rate |
4.7% | 3.5 | % | |||
A summary of activity under the SARs Plan, the Sovintel SARs Plan, and the SARs granted to the
CEO outside of these plans, as of December 31, 2005, 2006 and 2007, and changes during the twelve
months then ended are presented below:
| Year Ended December 31, | ||||||||||||||||||||||||||||||||||||
| 2005 | 2006 | 2007 | ||||||||||||||||||||||||||||||||||
| Weighted | Weighted | Aggregate | Weighted | Aggregate | ||||||||||||||||||||||||||||||||
| Average | Aggregate | Average | Intrinsic | Average | Intrinsic | |||||||||||||||||||||||||||||||
| Exercise | Intrinsic | Exercise | Value | Exercise | Value | |||||||||||||||||||||||||||||||
| SARs | Price | Value | SARs | Price | (in thousands) | SARs | Price | (in thousands) | ||||||||||||||||||||||||||||
Outstanding at beginning of year |
— | — | 1,251,800 | $ | 29.19 | 1,293,800 | $ | 29.05 | ||||||||||||||||||||||||||||
SARs granted |
1,251,800 | $ | 29.19 | 177,000 | 27.94 | — | — | |||||||||||||||||||||||||||||
SARs exercised |
— | — | (20,200 | ) | 28.15 | (926,334 | ) | 28.61 | ||||||||||||||||||||||||||||
SARs expired |
— | — | — | — | — | — | ||||||||||||||||||||||||||||||
SARs forfeited |
— | — | (114,800 | ) | 28.91 | (48,600 | ) | 28.82 | ||||||||||||||||||||||||||||
Outstanding at end of year |
1,251,800 | 29.19 | — | 1,293,800 | 29.05 | $ | 23,007 | 318,866 | 30.38 | $ | 7,467 | |||||||||||||||||||||||||
Exercisable at end of year |
— | — | — | 233,217 | $ | 28.63 | $ | 4,247 | 11,500 | $ | 28.29 | $ | 293 | |||||||||||||||||||||||
The weighted-average fair value of SARs outstanding as of December 31, 2007 was $21.99 per
SAR. As of December 31, 2007, there was approximately $1.9 million of total unrecognized
compensation cost related to non-vested SARs awards. That cost is expected to be recognized over a
weighted-average requisite service period of 0.9 years.
The
Company paid SARs of none, $0.3 million, and $26.8 million
in 2005, 2006 and 2007, respectively.
The Company has established the 1999 Equity Participation Plan of Golden Telecom, Inc. (the
“Equity Plan”) and granted stock options to key employees and members of the Board of Directors of
the Company. In April 2007, the Compensation Committee of the Board of Directors recommended and
the Board of Directors approved an amendment to the Equity Plan to increase the number of shares
available under the Equity Plan by 1,000,000. The decision of the Board of Directors was ratified
by the Company’s shareholders on May 17, 2007. Under the Equity Plan not more than 5,320,000
shares of common stock (subject to anti-dilution and other adjustment provisions) are authorized
for issuance upon exercise of options or upon vesting of restricted or deferred stock awards. As of
December 31, 2007, there were 1,893,350 securities remaining available for future issuance under
the Company’s Equity Plan.
The
fair value of options granted under the Equity Plan in 2005 are estimated to be $13.44 per
common share on the date of grant using the Black Scholes option pricing model with the following
assumptions:
| Year Ended December 31, 2005 | ||||
Risk free interest rate |
3.86 | % | ||
Dividend yield |
3.0 | % | ||
Expected life (years) |
3.0 | |||
Volatility |
88 | % | ||
There were no options granted
under the Equity Plan in 2006.
The
fair value of options granted under the Equity Plan in 2007 on the date of grant is
estimated using the Monte Carlo simulation-based valuation model that uses the assumptions
described in the table below.
| Year Ended December 31, 2007 | ||||
Risk free interest rate |
4.98 | % | ||
Dividend yield |
— | |||
Expected life (years) |
4.2 | |||
Volatility |
42 | % | ||
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GOLDEN TELECOM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
On June 27, 2007, the terms of the outstanding SARs issued under the 2005 SAR Plan and the
Sovintel SAR Plan were modified to cap the maximum payout to the employee at the closing sales
price per share of the Company’s common stock on the NASDAQ on June 27, 2007, or $53.80. On June
27, 2007, the participants of the 2005 SAR Plan, the Sovintel SAR Plan, and the SARs granted to the
CEO outside of these plans, were granted 829,950 stock options (one stock option for every capped
SAR) with essentially the same terms as the capped SARs with the exercise price of $53.80.
On June 28, 2007, the Company’s Board of Directors approved and the Company granted 621,870
options to senior management and key employees. Under the terms of the Company’s Equity Plan the
options were granted at a share price which was the closing sales price per share of the Company’s
common stock on the NASDAQ on the date immediately preceding the date of grant, which was $53.80
(“Option Granting Share Price”). Seventy-five percent of the options grant shall be subject to
time vesting, one-third of which shall be and become vested and nonforfeitable on each of the first
three anniversary dates from the grant date, provided that the employee remains continuously
employed by the Company until each such relevant date. The Option Granting Share Price shall
increase by five percent on each anniversary date after the grant date in association with the
options that shall be and become vested and nonforfeitable on each such anniversary date.
Twenty-five percent of the options granted are subject to market condition vesting upon the
Company’s common stock achieving an average closing trading price of at least $82.15 per share for
thirty consecutive days as determined in the sole discretion of the Company. On October 18, 2007,
the Company’s common stock achieved the $82.15 threshold and the market condition stock options
became fully vested. The options have a contractual term of five years and were to be settled in
stock only, but in connection with the merger in February 2008 the options were converted into the right to
receive $105 in cash less the exercise price. The rights to receive cash continue to vest in
accordance with their vesting schedule.
Additional information with respect to stock options activity is summarized as follows:
| Year Ended December 31, | ||||||||||||||||||||||||
| 2005 | 2006 | 2007 | ||||||||||||||||||||||
| Weighted | Weighted | Weighted | ||||||||||||||||||||||
| Average | Average | Average | ||||||||||||||||||||||
| Exercise | Exercise | Exercise | ||||||||||||||||||||||
| Shares | Price | Shares | Price | Shares | Price | |||||||||||||||||||
Outstanding at beginning of
year |
517,013 | $ | 14.18 | 373,012 | $ | 14.31 | 157,915 | $ | 13.82 | |||||||||||||||
Options granted |
2,500 | 26.32 | — | — | 1,549,820 | 55.85 | ||||||||||||||||||
Options exercised |
(109,000 | ) | 13.31 | (215,097 | ) | 14.66 | (107,049 | ) | 30.66 | |||||||||||||||
Options expired |
(12,500 | ) | 20.88 | — | — | (12,660 | ) | 14.52 | ||||||||||||||||
Options forfeited |
(25,001 | ) | 14.00 | — | — | (9,125 | ) | 55.46 | ||||||||||||||||
Outstanding at end of year |
373,012 | 14.31 | 157,915 | 13.82 | 1,578,901 | 53.69 | ||||||||||||||||||
Exercisable at end of year |
369,817 | $ | 14.22 | 157,915 | $ | 13.82 | 736,858 | $ | 49.33 | |||||||||||||||
The following table summarizes information about stock options outstanding and exercisable at
December 31, 2007:
| Options Exercisable | ||||||||||||
| Weighted | ||||||||||||
| Average | ||||||||||||
| Number | Remaining | |||||||||||
| Outstanding | Contractual | Intrinsic | ||||||||||
| Exercise Prices | and | Life | Value | |||||||||
| at December 31, 2007: | Exercisable | (In Years) | (In thousands) | |||||||||
$12.00 |
62,154 | 3.6 | $ | 5,529 | ||||||||
15.63 |
19,401 | 2.7 | 1,655 | |||||||||
53.80 |
644,803 | 4.5 | 30,402 | |||||||||
55.01 |
7,500 | 4.5 | 345 | |||||||||
61.04 |
1,500 | 4.8 | 60 | |||||||||
68.61 |
1,500 | 4.7 | 48 | |||||||||
| 736,858 | $ | 38,039 | ||||||||||
The weighted-average fair value of stock options outstanding as of December 31, 2007 was
$19.24 per stock option. As of December 31, 2007, there was approximately $9.9 million of total
unrecognized compensation cost related to non-vested stock option awards.
95
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GOLDEN TELECOM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Note 13: Income Taxes
The components of income before income taxes and minority interest were as follows:
| Year Ended December 31, | ||||||||||||
| 2005 | 2006 | 2007 | ||||||||||
| (in thousands) | ||||||||||||
Pretax income
(loss): |
||||||||||||
Domestic |
$ | (8,405 | ) | $ | (11,176 | ) | $ | 13,168 | ||||
Foreign |
125,272 | 142,582 | 205,352 | |||||||||
| $ | 116,867 | $ | 131,406 | $ | 218,520 | |||||||
The following is the Company’s significant components of the provision for income taxes
attributable to continuing operations:
| Year Ended December 31, | ||||||||||||
| 2005 | 2006 | 2007 | ||||||||||
| (in thousands) | ||||||||||||
Domestic — current |
$ | — | $ | — | $ | — | ||||||
Domestic — deferred |
2,234 | — | (19 | ) | ||||||||
Foreign — current |
41,630 | 44,242 | 76,348 | |||||||||
Foreign — deferred |
(6,048 | ) | (3,825 | ) | (18,018 | ) | ||||||
| $ | 37,816 | $ | 40,417 | $ | 58,311 | |||||||
The Company paid
income taxes of $41.4 million, $43.4 million and $65.1 million in 2005, 2006
and 2007, respectively.
US taxable income or losses recorded are reported on the Company’s consolidated US income tax
return. The Company was allocated its proportionate share, $23.6 million, of GTS’ US net operating
loss carry-forwards (“NOLs”) in 1999. As of December 31, 2007, the Company had NOLs for US federal
income tax purposes of approximately $18.6 million expiring in fiscal years between 2019 through
2027. In 2005, the Company recorded a full valuation allowance for NOLs for US federal income tax
purposes of $4.7 million. The Company also has NOLs for Cyprus tax purposes of approximately $20.6
million that do not expire. However, the Company has also recorded a valuation allowance for
Cyprus NOLs since it does not anticipate recognizing taxable income in Cyprus.
The reconciliation of the US statutory federal tax rate of 35.0% to the Company’s effective
tax rate is as follows:
| Year Ended December 31, | ||||||||||||
| 2005 | 2006 | 2007 | ||||||||||
Tax expense at US statutory rates |
(35.0 | )% | (35.0 | )% | (35.0 | )% | ||||||
Stock based compensation |
— | 0.1 | (1.9 | ) | ||||||||
Other non-deductible expenses |
(4.8 | ) | (4.8 | ) | (3.7 | ) | ||||||
Different foreign tax rates |
11.9 | 11.9 | 10.1 | |||||||||
Change in valuation allowance |
(4.2 | ) | (2.4 | ) | 4.1 | |||||||
Other permanent differences |
(0.3 | ) | (0.6 | ) | (0.3 | ) | ||||||
Tax expense |
(32.4 | )% | (30.8 | )% | (26.7 | )% | ||||||
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GOLDEN TELECOM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Deferred tax assets and liabilities are recorded based on temporary differences between book
bases of assets and liabilities and their bases for income tax purposes. The following table
summarizes major components of the Company’s deferred tax assets and liabilities:
| December 31, | ||||||||
| 2006 | 2007 | |||||||
| (in thousands) | ||||||||
Deferred Tax Assets: |
||||||||
Net operating loss carry-forwards |
$ | 6,242 | $ | 8,569 | ||||
Accrued expenses |
10,034 | 23,104 | ||||||
Deferred revenue |
13,940 | 19,463 | ||||||
Intangible assets |
2,359 | 2,232 | ||||||
Fixed assets |
294 | 701 | ||||||
Investment
in affiliates |
9,542 | — | ||||||
Other deferred tax assets |
3,046 | 14,561 | ||||||
Valuation allowance |
(21,092 | ) | (12,248 | ) | ||||
Total deferred tax asset |
$ | 24,365 | $ | 56,382 | ||||
Deferred Tax Liabilities: |
||||||||
Accrued revenue |
$ | 693 | $ | 1,271 | ||||
Deferred expenses |
3,129 | 6,007 | ||||||
Intangible assets |
26,606 | 56,478 | ||||||
Fixed assets |
9,172 | 32,880 | ||||||
Other deferred tax liabilities |
1,817 | 3,588 | ||||||
Total deferred tax liability |
$ | 41,417 | $ | (100,224 | ) | |||
Net deferred tax liability |
$ | (17,052 | ) | $ | (43,842 | ) | ||
The following table presents the Company’s deferred tax assets and liabilities as of December
31, 2006 and 2007 attributable to different tax paying components in different tax jurisdictions:
| December 31, | ||||||||
| 2006 | 2007 | |||||||
| (in thousands) | ||||||||
Deferred Tax Assets: |
||||||||
US tax component |
$ | — | $ | — | ||||
Foreign tax component |
24,365 | 56,382 | ||||||
Total deferred tax asset |
$ | 24,365 | $ | 56,382 | ||||
Deferred Tax Liability: |
||||||||
US tax component |
$ | — | $ | — | ||||
Foreign tax component |
41,417 | (100,224 | ) | |||||
Total deferred tax liability |
$ | 41,417 | $ | (100,224 | ) | |||
Net deferred tax liability |
$ | (17,052 | ) | $ | (43,842 | ) | ||
Note 14: Commitments and Contingencies
Leases
The Company has various cancelable and non-cancelable operating lease agreements for equipment
and office space with terms ranging from one to eight years. Rental expense for operating leases
aggregated $9.8 million, $12.3 million, and $26.1 million for the years ended December 31, 2005,
2006 and 2007, respectively.
Future minimum lease payments under non-cancelable operating leases with terms of one year or
more, as of December 31, 2007, are as follows: 2008 — $23.6 million, 2009 — $13.2 million, 2010 —
$10.3 million, 2011 — $5.8 million, 2012 — $4.1 million, and thereafter — $1.6 million.
Other Commitments and Contingencies
The Company has future purchase commitments of $138.8 million as of December 31, 2007, which
primarily includes equipment, interconnect and satellite transponder capacity.
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GOLDEN TELECOM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Tax Matters
The Company’s
policy is to accrue for non-income tax contingencies in the accounting period in which a
liability is deemed probable and the amount is reasonably determinable. In this regard, because of
the uncertainties associated with the Commonwealth of Independent States Taxes (“CIS Taxes”), the
Company’s final CIS Taxes may be in excess of the estimated amount expensed to date and accrued at
December 31, 2006 and 2007. It is the opinion of management that the ultimate resolution of the
Company’s CIS Tax liability, to the extent not previously provided for, will not have a material
effect on the financial condition of the Company. However, depending on the amount and timing of an
unfavorable resolution of any non-income tax contingencies associated with CIS Taxes, it is possible that the
Company’s future results of operations or cash flows could be materially affected in a particular
period.
The Company’s wholly-owned Russian subsidiary, Sovintel is engaged in litigation with the
Russian tax inspectorate in regard to claims issued by the tax inspectorate on September 25, 2006.
The Russian tax inspectorate claimed that Sovintel owes taxes, fines and penalties in the amount of
approximately $24.1 million for the years ended December 31, 2004 and 2005. On October 4, 2006,
Sovintel filed a lawsuit against the tax inspectorate disputing the claims. Court hearings were
held between November 8, 2006 and March 19, 2007. The first instance court ruled in favor of
Sovintel by dismissing the tax inspectorate’s claim. On April 3, 2007, the first instance court
ruled in favor of Sovintel by dismissing the tax inspectorate’s claim. On April 28, 2007, the tax
inspectorate appealed this decision. On July 16, 2007, the second instance court ruled in favor of
Sovintel by dismissing the tax inspectorate’s claim. The tax inspectorate appealed this decision in
the third instance court. The court hearing of the third instance court held on October 25, 2007
delayed consideration of the case by the third instance court until further notice from the court.
Currently, the Company does not consider an unfavorable outcome probable for this claim.
Starting in 2006, the Russian tax inspectorate, in the course of tax audits of Russian
long-distance telecom operators, started to challenge the offset of Value Added Taxes (“VAT”)
relating to the cost of international telecommunication services. Therefore, there is a risk that
the Company may be assessed additional VAT, fines and penalties on similar issues. The amount of
such risk relating to the years ended December 31, 2004 and 2005
is included in the $24.1 million
tax claim currently disputed, as disclosed above. The amount of similar risk relating to the year
ended December 31, 2007 is assessed as being up to $18.7 million. Should the Russian tax
inspectorate assert such claim, the Company will dispute such claim
and believes it will defend such action successfully. However, due to the fact that court cases on
such matters are appearing for the first time, the expected outcome of such cases is currently
unclear.
Russian Environment and Current Economic Situation
While there have been improvements in the Russian economic situation, such as an increase in
gross domestic product and a reduced rate of inflation, Russia continues economic reform and
development of its legal, tax and regulatory frameworks as required by a market economy. The
future stability of the Russian economy is largely dependent on these reforms and developments and
the effectiveness of economic, financial and monetary measures undertaken by the Russian
government.
In a letter dated December 20, 2006, several deputies of the State Duma wrote to the Russian
General Prosecutor alleging that Sovintel was illegally providing domestic and international
services prior to receipt of access codes. The letter states that because Sovintel had not yet
received access codes to offer such services in the first, second and third quarter of 2006, then
Sovintel was operating illegally in this respect. Further, the letter requests that the Prosecutor General’s
office conduct an investigation of Sovintel’s activities and, if appropriate, charge those Sovintel
officials responsible for the activities. Sovintel received the access codes in December 2006 and
prior to construction of its Federal Transit Network was operating under its previous licenses. The
Company believes that it was acting in accordance with Russian regulations and legislation and our
licenses. On March 14, 2007, the Investigation Department of the Moscow Division of the Ministry
of Interior Affairs issued a ruling against opening a criminal investigation. The issue is now
resolved.
Net Assets Position in Accordance with Statutory Requirements
In accordance with Russian legislation, joint stock companies must maintain a level of equity
(net assets) that is greater than the charter capital. In the event that a company’s net assets,
as determined under Russian accounting legislation, fall below certain minimum levels, specifically
below zero, the company can be forced to liquidate.
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GOLDEN TELECOM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Kolangon and some of the Company’s other regional entities have had, and continue to have,
negative equity as reported in each of their Russian statutory financial statements. Management
believes that the risk of the initiation of statutory liquidation procedures or other material
adverse actions is remote. However, if such actions were taken, it could have a material adverse
effect on the Company’s results of operations, financial position and operating plans. The Company
is currently in the process of remediating this situation.
Other Matters
In the ordinary course of business, the Company 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 Company operates. In the opinion of management, the
Company’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 Company.
Sovintel was engaged in litigation with a minority shareholder of Kubtelecom in regard to the
shareholder’s claim that the shareholder’s pre-emptive right to acquire 74% ownership in Kubtelecom
was breached. On December 4, 2006, the first instance court ruled in favor of the minority
shareholder. On March 14, 2007, the second instance court ruled in favor of Sovintel by dismissing
the minority shareholder’s claim. The minority shareholder appealed this ruling and on April 18,
2007, the third instance court ruled in favor of Sovintel. The shareholder appealed to the Supreme
Arbitration Court of the Russian Federation and on July 11, 2007, the court denied the claim. The
shareholder apparently failed to meet the deadline of October 18, 2007 to file a new claim with the
Supreme Arbitration Court of the Russian Federation. The case is now closed. On December 28, 2007
the minority shareholder filed an application of withdrawal from Kubtelecom as of which date the
16.54% ownership interest of the minority shareholder was transferred to Kubtelecom by operation of
law. Kubtelecom currently has an obligation to pay to the former minority shareholder the value of
the ownership interest of approximately $2.3 million not later than June 30, 2008.
On March 6, 2007, Rossvyaznadzor, a governmental body that reports to the Ministry of
Information Technologies and Communications of the Russian Federation, warned Sovintel that it
should remedy certain alleged violations in traffic routing. The allegation followed an inspection
by Rossvyaznadzor of an independent operator, OAO Arctel (“Arctel”). Rossvyaznadzor believes that
Sovintel inappropriately converted telephone traffic of Arctel into IP-telephone traffic and then
incorrectly routed this traffic abroad. Sovintel carried out a full analysis of the routing of
these calls. Following Sovintel’s review, the Company notified Rossvyaznadzor that the Company
believes that Sovintel has not violated its licenses. Sovintel filed a lawsuit against
Rossvyaznadzor and on May 17, 2007, the court turned down Sovintel’s lawsuit for procedural reasons
that the license in question had been annulled and that there were no grounds for dispute. On May
29, 2007, Sovintel appealed this court decision and on June 26, 2007, Sovintel withdrew its
lawsuit. On June 29, 2007, the court accepted Sovintel’s withdrawal of the lawsuit and revoked the
decision of the first instance court. The term for appeal expired on
November 29, 2007. The issue is now resolved.
The Company was engaged in a regulatory dispute with the National Commission of
Communication’s Regulation of Ukraine (“NCCR”) over a license, recorded at approximately $13.3
million, for wireless broadband radio frequencies issued to S-Line, a 75% owned Ukrainian
subsidiary of the Company. On April 18, 2007, the first instance court ruled in favor of S-Line
obliging the NCCR to re-register the license. NCCR appealed this decision and on August 3, 2007 the
second instance court ruled in favor of NCCR. On August 8, 2007, S-Line filed an appeal of this
decision to the Supreme Administrative Court of Ukraine. On September 11, 2007, the Supreme
Administrative Court of Ukraine upheld the decision of the first instance court obliging the NCCR
to re-register the license. Following the decision of the Supreme Administrative Court, NCCR took a
decision on October 18, 2007 to re-issue the license to S-Line and did so shortly thereafter.
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GOLDEN TELECOM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Note 15: Related Party Transactions
Revenue and cost of revenue with the Company’s equity investees, Alfa, Rostelecom, and Nye
Telenor East Invest AS (“Telenor”), significant shareholders of the Company, were as follows, for
the years ended December 31:
| 2005 | 2006 | 2007 | ||||||||||
| (in thousands) | ||||||||||||
Revenue from equity investees |
$ | 363 | $ | 779 | $ | 1,118 | ||||||
Revenue from Rostelecom |
646 | 1,953 | 4,051 | |||||||||
Revenue from Telenor |
470 | 593 | 623 | |||||||||
Revenue from Alfa |
3,158 | 4,552 | 5,535 | |||||||||
| $ | 4,637 | $ | 7,877 | $ | 11,327 | |||||||
Access and
network services from equity investees |
3,038 | 7,867 | 4,809 | |||||||||
Access and
network services from Rostelecom |
23,979 | 33,721 | 43,814 | |||||||||
Access and
network services from Telenor |
605 | 367 | 261 | |||||||||
Access and
network services from Alfa |
— | — | 103 | |||||||||
| $ | 27,622 | $ | 41,955 | $ | 48,987 | |||||||
Accounts receivable and accounts payable with the Company’s Alfa, Rostelecom, and Telenor,
significant shareholders of the Company, were as follows, at December 31:
| 2006 | 2007 | |||||||
| (in thousands) | ||||||||
Accounts receivable from Rostelecom |
$ | 439 | $ | 559 | ||||
Accounts receivable from Telenor |
107 | 97 | ||||||
Accounts receivable from Alfa |
681 | 935 | ||||||
| $ | 1,227 | $ | 1,591 | |||||
Accounts payable from Rostelecom |
4,441 | 6,326 | ||||||
Accounts payable from Telenor |
57 | 22 | ||||||
Accounts payable from Alfa |
7 | 423 | ||||||
| $ | 4,505 | $ | 6,771 | |||||
The Company maintains bank accounts with Alfa, which acts as one of the clearing agents for
the payroll of the Russian staff of the Company. The balances at these bank accounts were minimal
at December 31, 2006 and 2007. In addition, certain of the Company’s Russian subsidiaries maintain
current accounts with Alfa. The amounts on deposit were $0.3 million at December 31, 2006 and $0.2
million at December 31, 2007.
The Company purchased consulting services from Alfa in the amount of $0.5 million and $2.0
million in the years ended December 31, 2006 and 2007, respectively.
In 2006 and 2007, the Company has entered into various agreements with Alfa to provide the
Company with property and equipment liability insurance. The aggregate amount of remuneration paid
for services during 2007 under these agreements was $0.4 million.
Note 16: Segment Information
Line Of Business Data
The Company operates in four segments within the telecommunications industry. The four
segments are: (1) Business and Corporate Services; (2) Carrier and Operator Services; (3) Consumer
Internet Services; and (4) Mobile Services. The following table’s present financial information for
both consolidated subsidiaries and equity investee ventures, segmented by the Company’s lines of
business for the years ended December 31, 2005, 2006 and 2007, respectively. Transfers between
lines of businesses are included in the adjustments to reconcile segment to consolidated results.
The Company evaluates performance based on the operating income (loss) of each strategic business
unit, among other performance measures.
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GOLDEN TELECOM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
| Adjustments to Reconcile | ||||||||||||||||||||||||||||||||||||
| Business Segment to | ||||||||||||||||||||||||||||||||||||
| Consolidated Results | ||||||||||||||||||||||||||||||||||||
| Business | Carrier | Corporate, | Business | Equity | ||||||||||||||||||||||||||||||||
| and | and | Consumer | Mobile | Other & | Segment | Consolidated | Method | Affiliate | ||||||||||||||||||||||||||||
| Corporate | Operator | Internet | Services | Eliminations | Total | Results | Ventures | Adjustments | ||||||||||||||||||||||||||||
| (in thousands) | ||||||||||||||||||||||||||||||||||||
Year Ended |
||||||||||||||||||||||||||||||||||||
December 31, 2005 |
||||||||||||||||||||||||||||||||||||
Revenue from external
customers |
$ | 387,532 | $ | 222,904 | $ | 44,484 | $ | 14,103 | $ | — | $ | 669,023 | $ | 667,379 | $ | (4,449 | ) | $ | 2,805 | |||||||||||||||||
Intersegment revenue |
— | 52 | — | — | (52 | ) | — | — | — | — | ||||||||||||||||||||||||||
Operating income (loss) |
102,415 | 27,894 | (1,322 | ) | 3,523 | (16,268 | ) | 116,242 | 115,942 | (300 | ) | — | ||||||||||||||||||||||||
Identifiable assets |
494,266 | 323,278 | 67,511 | 2,855 | 21,759 | 909,669 | 882,211 | (27,458 | ) | — | ||||||||||||||||||||||||||
Capital expenditures |
89,386 | 32,879 | 8,360 | 367 | 132 | 131,124 | 130,775 | (349 | ) | — | ||||||||||||||||||||||||||
| Adjustments to Reconcile | ||||||||||||||||||||||||||||||||||||
| Business Segment to | ||||||||||||||||||||||||||||||||||||
| Consolidated Results | ||||||||||||||||||||||||||||||||||||
| Business | Carrier | Corporate, | Business | Equity | ||||||||||||||||||||||||||||||||
| and | and | Consumer | Mobile | Other & | Segment | Consolidated | Method | Affiliate | ||||||||||||||||||||||||||||
| Corporate | Operator | Internet | Services | Eliminations | Total | Results | Ventures | Adjustments | ||||||||||||||||||||||||||||
| (in thousands) | ||||||||||||||||||||||||||||||||||||
Year Ended |
||||||||||||||||||||||||||||||||||||
December 31, 2006 |
||||||||||||||||||||||||||||||||||||
Revenue from external
customers |
$ | 487,970 | $ | 318,698 | $ | 48,744 | $ | 9,599 | $ | — | $ | 865,011 | $ | 854,617 | $ | (18,074 | ) | $ | 7,680 | |||||||||||||||||
Intersegment revenue |
— | 42 | — | — | (42 | ) | — | — | — | — | ||||||||||||||||||||||||||
Operating income (loss) |
125,543 | 31,574 | (7,999 | ) | 722 | (18,514 | ) | 131,326 | 127,211 | (4,115 | ) | — | ||||||||||||||||||||||||
Identifiable assets |
611,275 | 428,684 | 107,966 | 14,543 | (20,677 | ) | 1,141,791 | 1,107,190 | (34,601 | ) | — | |||||||||||||||||||||||||
Capital expenditures |
105,291 | 45,542 | 21,626 | 13,069 | 95 | 185,623 | 179,772 | (5,851 | ) | — | ||||||||||||||||||||||||||
| Adjustments to Reconcile | ||||||||||||||||||||||||||||||||||||
| Business Segment to | ||||||||||||||||||||||||||||||||||||
| Consolidated Results | ||||||||||||||||||||||||||||||||||||
| Business | Carrier | Corporate, | Business | Equity | ||||||||||||||||||||||||||||||||
| and | and | Consumer | Mobile | Other & | Segment | Consolidated | Method | Affiliate | ||||||||||||||||||||||||||||
| Corporate | Operator | Internet | Services | Eliminations | Total | Results | Ventures | Adjustments | ||||||||||||||||||||||||||||
| (in thousands) | ||||||||||||||||||||||||||||||||||||
Year Ended |
||||||||||||||||||||||||||||||||||||
December 31, 2007 |
||||||||||||||||||||||||||||||||||||
Revenue from external
customers |
$ | 719,085 | $ | 493,843 | $ | 77,053 | $ | 18,087 | $ | — | $ | 1,308,068 | $ | 1,292,899 | $ | (20,426 | ) | $ | 5,257 | |||||||||||||||||
Intersegment revenue |
— | 7 | — | — | (7 | ) | — | — | — | — | ||||||||||||||||||||||||||
Operating income (loss) |
188,200 | 45,708 | (25,398 | ) | 2,028 | (38,450 | ) | 172,088 | 169,364 | (2,724 | ) | — | ||||||||||||||||||||||||
Identifiable assets |
958,733 | 602,973 | 403,024 | 36,554 | 37,952 | 2,039,236 | 1,998,891 | (40,345 | ) | — | ||||||||||||||||||||||||||
Capital expenditures |
183,761 | 68,046 | 70,769 | 7,669 | 5,021 | 335,266 | 326,184 | (9,082 | ) | — | ||||||||||||||||||||||||||
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GOLDEN TELECOM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Geographic Data
Revenues from external customers are based on the location of the operating company providing
the service.
The Company operated within two main geographic regions of the CIS: Russia and Ukraine.
Geographic information as of December 31, 2005, 2006 and 2007 is as follows:
| Corporate, | ||||||||||||||||
| Other | ||||||||||||||||
| Countries & | Consolidated | |||||||||||||||
| Russia | Ukraine | Eliminations | Results | |||||||||||||
| (in thousands) | ||||||||||||||||
Year ended December 31, 2005 |
||||||||||||||||
Revenue |
$ | 593,640 | $ | 73,816 | $ | (77 | ) | $ | 667,379 | |||||||
Long-lived assets |
374,676 | 39,121 | 13,755 | 427,552 | ||||||||||||
Year ended December 31, 2006 |
||||||||||||||||
Revenue |
$ | 766,169 | $ | 81,819 | $ | 6,629 | $ | 854,617 | ||||||||
Long-lived assets |
504,527 | 57,878 | 16,063 | 578,468 | ||||||||||||
Year ended December 31, 2007 |
||||||||||||||||
Revenue |
$ | 1,190,601 | $ | 105,319 | $ | (3,021 | ) | $ | 1,292,899 | |||||||
Long-lived assets |
926,000 | 73,879 | 37,509 | 1,037,388 | ||||||||||||
Note 17: Supplemental Cash Flow Information
The following table summarizes significant non-cash investing and financing activities for the
Company.
| Year Ended December 31, | ||||||||||||
| 2005 | 2006 | 2007 | ||||||||||
| (in thousands) | ||||||||||||
Issuance of common stock in
connection with an acquisition |
$ | — | $ | — | $ | 142,130 | ||||||
Capitalized leased assets |
3,580 | — | 18,407 | |||||||||
Amounts payable in connection with
business acquisitions |
885 | 378 | — | |||||||||
Capitalized
interest |
— | — | 5,901 | |||||||||
Note 18: Long Term Incentive Bonus Program
In July 2004, the Board of Directors of the Company adopted a Long Term Incentive Bonus
Program (“LTIBP”) for senior management of the Company, effective as of January 1, 2004. In
February 2006, the Board of Directors of the Company discontinued the LTIBP effective January 1,
2005. Accordingly, in the fourth quarter of 2005 the Company recorded a reduction in compensation
expense of $1.8 million. During the year ended December 31, 2005 the Company did not record any
expense associated with the LTIBP. The Company has not granted any shares under the LTIBP.
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GOLDEN TELECOM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Note 19: Quarterly Financial Data (Unaudited)
Summarized quarterly financial data is as follows:
| For the Three Months Ended | ||||||||||||||||
| March 31, | June 30, | September 30, | December 31, | |||||||||||||
| 2006 | 2006 | 2006 | 2006(2)(3) | |||||||||||||
| (in thousands, except per share data) | ||||||||||||||||
Revenues |
$ | 178,140 | $ | 196,968 | $ | 228,717 | $ | 250,792 | ||||||||
Access and network services (excluding
depreciation and amortization) |
93,393 | 105,608 | 128,153 | 147,235 | ||||||||||||
Gross Margin |
84,747 | 91,360 | 100,564 | 103,557 | ||||||||||||
Selling, general and administrative
(excluding
depreciation and amortization) |
33,881 | 33,569 | 37,505 | 47,853 | (4) | |||||||||||
Net income |
18,785 | 22,645 | 24,229 | 19,841 | ||||||||||||
Net income per share(1)- basic |
0.52 | 0.62 | 0.66 | 0.54 | ||||||||||||
Net income per share(1)- diluted |
0.51 | 0.62 | 0.66 | 0.54 | ||||||||||||
| For the Three Months Ended | ||||||||||||||||
| March 31, | June 30, | September 30, | December 31, | |||||||||||||
| 2007 | 2007 | 2007 | 2007 | |||||||||||||
| (in thousands, except per share data) | ||||||||||||||||
Revenues |
$ | 255,739 | $ | 297,669 | $ | 350,391 | $ | 389,100 | ||||||||
Access and network services (excluding
depreciation and amortization) |
150,095 | 171,633 | 202,004 | 217,629 | ||||||||||||
Gross Margin |
105,644 | 126,036 | 148,387 | 171,471 | ||||||||||||
Selling, general and administrative
(excluding
depreciation and amortization) |
48,986 | 44,797 | 63,316 | 84,817 | (5) | |||||||||||
Net income |
16,719 | 32,263 | 74,375 | 29,242 | ||||||||||||
Net income per share(1)-basic |
0.46 | 0.85 | 1.85 | 0.72 | ||||||||||||
Net income per share(1)- diluted |
0.45 | 0.85 | 1.84 | 0.71 | ||||||||||||
| (1) | The sum of the earnings per share for the four quarters will generally not equal earnings per share for the total year due to changes in the average number of common shares outstanding. | |
| (2) | The operating results for the fourth quarter of 2006 include the impact of a $2.8 million change in estimate with respect to the Company’s allowance for doubtful accounts. | |
| (3) | The operating results for the fourth quarter of 2006 include the impact of $2.6 million due to the reversal of liabilities to a former shareholder because of the expiration of the statute of limitations. | |
| (4) | Includes SARs expense of $13.8 million. | |
| (5) | Includes stock option expense of $7.5 million and SARs expense of $2.1 million and $3.7 million of expenses related to the merger as discussed in Note 20. |
Note 20: Subsequent Events
Merger Transaction
On December 21, 2007, the Company, VimpelCom Finance B.V. (“Parent”) and Lillian Acquisition,
Inc. (“Merger Sub”) entered into an Agreement and Plan of Merger (the “Merger Agreement”). Merger
Sub commenced a tender offer to purchase, at a price of $105.00 per share in cash without interest
(and less any amounts required to be deducted and withheld under any applicable law), any and all
outstanding shares of the Company’s common stock, par value $0.01 per share (the “Common Stock”) on
the terms and subject to the conditions specified in the offer to purchase dated January 18, 2008,
as amended (the “Offer to Purchase”) and related letter of transmittal (which, together with any
supplements or amendments thereto, collectively constitute the “Offer”). The Offer closed on
February 27, 2008 and the Company became a majority owned subsidiary of Merger Sub.
On February 28, 2008, Merger Sub and the Company filed a Certificate of Ownership and Merger
pursuant to which the Merger Sub was merged with and into the Company (the “Merger”). As a result
of the Merger, the Company will continue as the surviving corporation and will be a direct wholly
owned subsidiary of Parent and an indirect wholly owned subsidiary of VimpelCom.
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GOLDEN TELECOM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
As a result of the Merger, the Company no longer fulfills the numerical listing requirements
of the NASDAQ. Accordingly, on February 28, 2008, at the Company’s request, NASDAQ filed with the
SEC a Notification of Removal from Listing and/or Registration under Section 12(b) of the Exchange
Act on Form 25. Pursuant to Rule 12d2-2 under the Exchange Act, the delisting of the Shares from
NASDAQ was effective on March 10, 2008 and the Company’s reporting obligations under Section 12(b)
of the Exchange Act were suspended as of that date. Trading of the Company’s Common Stock on NASDAQ
ceased as of the close of trading on February 28, 2008. The Company’s Common Stock will be
deregistered under Section 12(b) of the Exchange Act no later than ninety (90) days after the date
of the Form 25. The Company also intends to file with the SEC a Certification on Form 15 under the
Exchange Act to suspend the Company’s remaining reporting obligations under the Exchange Act.
40,373,791
shares of the Company’s common stock were retired as a result of
the Merger.
In addition, the Company, as the surviving corporation in the Merger, assumed Merger Sub’s
obligations under an Unsecured Loan Agreement for up to $4.15 billion, dated February 15, 2008, by
and between VimpelCom and Merger Sub (the “$4.15 Billion Loan Agreement”) and the Amended and
Restated Unsecured Loan Agreement for up to $41.4 million, dated December 21, 2007, between Merger
Sub and VimpelCom (the “$41.4 Million Loan Agreement” and, together with the $4.15 Billion Loan
Agreement, the “Intercompany Loan Agreements”). In connection with the Company’s assumption of
Merger Sub’s obligations under the Intercompany Loan Agreements, on February 28, 2008, the Company
entered into a Subordination Deed (the “Subordination Agreement”) with VimpelCom and Citibank
International plc as agent, pursuant to which the Intercompany Loan Agreements have been
subordinated to the Company’s obligations under the Facility Agreement. The Subordination Agreement
includes a provision that gives VimpelCom the right, at any time or from time to time and on such
terms as it may choose, to convert all or part of the Company’s obligations to VimpelCom, including
under the Intercompany Loan Agreements, into equity capital in the Company.
Subject to the Subordination Agreement, the Intercompany Loan Agreements provide for VimpelCom
to make advances of funds to Merger Sub in an aggregate amount up to approximately $4.20 billion.
As of the time of the consummation of the Merger, Merger Sub had borrowed approximately $3.84
billion under the Intercompany Loan Agreement. Amounts advanced under the $4.15 Billion Loan
Agreement and $41.1 Million Loan Agreement accrue interest at a rate of three percent (3%) per
annum and six percent (6%) per annum, respectively. Each advance under the Intercompany Loan
Agreements becomes due and payable, together with accrued interest on the amount of such advance,
no later than six months from the date of such advance. The Intercompany Loan Agreements contain
customary representations and warranties and events of default customary for VimpelCom intercompany
loan agreements. Subject to the Subordination Agreement, payment of outstanding amounts due under
the Intercompany Loan Agreements may be accelerated by VimpelCom upon an event of default.
In connection with the Merger, the Company incurred an investment banking fee of approximately
$15.2 million, legal fees of approximately $8.0 and bonuses to members of the special committee and
certain eligible employees of approximately $1.8 million. Approximately $1.2 million of the
investment banking fee, approximately $2.4 million of the legal fees and approximately $1.3 million
of the bonuses to members of the special committee and certain eligible employees were recognized
during 2007. The remaining costs will be recognized in the first quarter of 2008. In addition,
the Company made change of control payments of approximately $3.8 million in the first quarter of
2008.
Share-Based Payments
In January 2008, stock options were granted to Corbina’s employees with respect to
approximately 3.99% of Corbina’s share capital under the 2007 Corbina Stock Option Plan approved by
Corbina’s Board of Directors at the general shareholder’s
meeting on December 11, 2007. The stock options will be settled
in cash by the Company.
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ITEM 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosure
None
ITEM 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
As required by Rules 13a-15 and 15d-15 under the Securities Exchange Act of 1934, management
has evaluated, with the participation of our Chief Executive Officer and Chief Financial Officer,
the effectiveness of our disclosure controls and procedures as of December 31, 2007. Disclosure
controls and procedures refer to controls and other procedures designed to ensure that information
required to be disclosed in the reports we file or submit under the Exchange Act is recorded,
processed, summarized and reported, within the time periods specified in the rules and forms of the
Security and Exchange Commission (“SEC”). Disclosure controls and procedures include, without
limitation, controls and procedures designed to ensure that information required to be disclosed by
us in our reports that we file or submit under the Exchange Act is accumulated and communicated to
management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to
allow timely decisions regarding our required disclosure. In designing and evaluating our
disclosure controls and procedures, management recognizes that any controls and procedures, no
matter how well designed and operated, can provide only reasonable assurance of achieving the
desired control objectives, and management was required to apply its judgment in evaluating and
implementing possible controls and procedures.
As described below, five material weaknesses were identified in our internal control over
financial reporting. The Public Company Accounting Oversight Board’s Auditing Standard No. 5
defines a material weakness as a deficiency, or a combination of deficiencies, in internal control
over financial reporting, such that there is a reasonable possibility that a material misstatement
of the company’s annual or interim financial statements will not be prevented or detected on a
timely basis. As a result of the material weaknesses identified, our Chief Executive Officer and
Chief Financial Officer have concluded that, as of December 31, 2007, the end of the period covered
by this report, our disclosure controls and procedures were not effective at a reasonable assurance
level.
Management’s Report on Internal Control over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over
financial reporting.
Internal control over financial reporting refers to a process designed by, or under the
supervision of, our Chief Executive Officer and Chief Financial Officer and effected by our board
of directors, management and other personnel, to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial statements for external
purposes in accordance with generally accepted accounting principles and includes those policies
and procedures that:
| • | pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of our assets; | ||
| • | provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and members of our board of directors; and | ||
| • | provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on our financial statements. |
Internal control over financial reporting cannot provide absolute assurance of achieving
financial reporting objectives because of its inherent limitations. Internal control over financial
reporting is a process that involves human diligence and compliance and is subject to lapses in
judgment and breakdowns resulting from human failures. Internal control over financial reporting
also can be circumvented by collusion or improper override. Because of such limitations, there is a
risk that material misstatements may not be prevented or detected on a timely basis by internal
control over financial reporting. However, these inherent limitations are known features of the
financial reporting process, and it is possible to design into the process safeguards to reduce,
though not eliminate, this risk.
Our management evaluated the effectiveness of our internal control over financial reporting as
of December 31, 2007 using the framework set forth in the report of the Treadway Commission’s
Committee of Sponsoring Organizations (COSO), “Internal Control—Integrated Framework”.
As a result of management’s evaluation of our internal control over financial reporting,
management identified five material weaknesses in our internal control. These material weaknesses
are described below.
On May 28, 2007, we completed the acquisition of Corbina. As permitted by the rules of the
SEC, we decided to exclude the Corbina businesses from our assessment of the effectiveness of its
internal control over financial reporting for the year ended
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December 31, 2007, the year of acquisition. The results of operations of Corbina have been
included in the consolidated financial statements of Golden Telecom for the period from June 1,
2007 through December 31, 2007. Total and net assets, total
revenues and net income subject to Corbina’s internal control
over financial reporting represented 14.4%, 6.5%, 6.9% and 0.3% of
our consolidated total and net assets, total revenue and net income
as of and for the year ended December 31, 2007. Management continues to evaluate the acquired companies’ internal
controls over financial reporting and has so far identified the following weaknesses in Corbina’s
internal control that it believes rise to the level of material weaknesses in our internal control:
1. Ineffective controls over accounting for revenues and billing process
We did not design and maintain effective controls over the accounting for revenues at Corbina.
Specifically, the controls over the INAC billing system were not designed and operating effectively
to ensure the completeness and accuracy of related revenues. This material weakness did not result
in material adjustments to our consolidated financial statements; however, there is a reasonable
possibility that due to this control deficiency a material misstatement of our consolidated
financial statements related to the revenue and respective advances received from customers line
items will not be prevented or detected on a timely basis.
2. Ineffective controls over financial statement closing process
We did not maintain effective controls over accounting for non-routine transactions or
accounting estimates at our Corbina subsidiary. Furthermore, we did not have effective controls
over the completeness, accuracy, validity and restricted access over complex spreadsheets used by
the Corbina subsidiary for the transformation of statutory accounts into U.S. GAAP. This material
weakness resulted in material audit adjustments to several of our significant accounts, including
accounts payable and accrued liabilities, allowance for doubtful accounts, income taxes, tax
contingencies and foreign currency translation. Furthermore, the material weakness resulted in
spending more time to complete the preparation and the annual audit of our consolidated financial
statements and late filing of this report.
3. Lack of controls over construction in process and fixed assets management
We did not maintain effective controls over recording of requisitions of equipment and spare
parts from warehouses to construction at Corbina. We also did not have systems and controls in
place to track existence of construction in process, and construction costs by project to ensure
timely commissioning and start of depreciation of fixed assets already placed in service. The lack
of timely reconciliation procedures and deficient recordkeeping controls result in material
weakness in this area such that there is a reasonable possibility that due to these control
deficiencies a material misstatement will not be prevented or detected on a timely basis.
4. Insufficient U.S. GAAP qualified accounting and finance personnel
Given the manual US GAAP closing process as it relates to non-routine transactions and
estimates, we did not have sufficient and skilled accounting and finance personnel necessary to
close our books under U.S. GAAP at our Corbina subsidiary. This material weakness resulted in
adjustments to several significant accounts and disclosures and contributed to other material
weaknesses described above.
5. Accounting for stock based compensation
During the quarter ended June 30, 2007, we determined that there was a mathematical mistake
made in the calculation of the compensation expense for stock appreciation rights (“SARs”) for the
three months ended March 31, 2007, which resulted in a $2.8 million overstatement of such expense
for that three-month period. We filed with the SEC Amendment No. 1 to Form 10-Q/A to restate our
unaudited financial statements as of and for the three months ended March 31, 2007. Management has
concluded that this error reflected a material weakness in the controls over the clerical accuracy
of Golden Telecom’s SARs stock-based compensation computations at March 31, 2007. During 2007,
there were other errors identified in the calculation of the compensation expense for SARs and
stock options, which prevent us from concluding that the material weakness has been remediated.
As a result of the material weaknesses described above, management has concluded that our
internal control over financial reporting was ineffective as of December 31, 2007 based on the
“Internal Control—Integrated Framework” set forth in COSO.
The effectiveness of our internal controls over financial reporting as of December 31, 2007
has been audited by Ernst & Young LLC, an independent registered public accounting firm. Their
attestation report on internal control over financial reporting is set forth below.
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Remediation activities and Changes in Internal Control over Financial Reporting
Remediation Activities
Management
believes the measures that were implemented to remediate the material
weaknesses that
had a material impact on our internal control over financial reporting since December 31, 2007, and
anticipates that these measures and other ongoing enhancements will continue to have a material
impact on our internal control over financial reporting in future periods. We expect our
remediation efforts for each material weakness identified above to continue in 2008. To remediate
these material weaknesses, we have adopted or will adopt the following changes:
| • | With respect to the material weakness from the first to the fourth, described above, we initiated a dedicated project on assessment of internal controls in Corbina. As a result of these efforts an action plan on remediation of all significant findings, including the material weaknesses described above, has been prepared and approved by the management. Execution of the action plan is in progress and it is to be completed in 2008. We also continue to recruit and hire additional qualified staff. We deployed Golden Telecom employees in the performance of more extensive procedures in connection with the December 31, 2007 consolidated Golden Telecom financial statement close process in response to the identified Corbina’s material weaknesses and to ensure the accuracy of Golden Telecom’s consolidated financial reporting. Further, we plan to increase Corbina’s training efforts for certain of its personnel. | ||
| • | With respect to the fifth material weakness, described above, we implemented additional manual controls and procedures over the computations made and recorded for our stock-based compensation expense. We plan to revise the calculation of stock-based compensation expense and implement additional manual and automated controls over the calculation process. |
Changes in Internal Control over Financial Reporting
Management has evaluated, with the participation of our Chief Executive Officer and Chief
Financial Officer, whether any changes in our internal control over financial reporting that
occurred during the period covered by this annual report have materially affected, or are
reasonably likely to materially affect, our internal control over financial reporting. Other than
the matters described in this Item 9A, there have not been any changes in internal control over
financial reporting that occurred during the three month period ended December 31, 2007 that have
materially affected, or are reasonably likely to materially affect, our internal control over
financial reporting.
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Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders of Golden Telecom, Inc.
We have audited Golden Telecom, Inc.’s (the “Company”) internal control over financial
reporting as of December 31, 2007, based on criteria established in Internal Control—Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO
criteria). Golden Telecom, Inc.’s management is responsible for maintaining effective internal
control over financial reporting, and for its assessment of the effectiveness of internal control
over financial reporting included in the accompanying Management’s Annual Report on Internal
Control over Financial Reporting. Our responsibility is to express an opinion on the company’s
internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether effective internal control over financial reporting was
maintained in all material respects. Our audit included obtaining an understanding of internal
control over financial reporting, assessing the risk that a material weakness exists, testing and
evaluating the design and operating effectiveness of internal control based on the assessed risk,
and performing such other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide
reasonable assurance regarding the reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with generally accepted accounting
principles. A company’s internal control over financial reporting includes those policies and
procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately
and fairly reflect the transactions and dispositions of the assets of the company; (2) provide
reasonable assurance that transactions are recorded as necessary to permit preparation of financial
statements in accordance with generally accepted accounting principles, and that receipts and
expenditures of the company are being made only in accordance with authorizations of management and
directors of the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company’s assets that could have
a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent
or detect misstatements. Also, projections of any evaluation of effectiveness to future periods
are subject to the risk that controls may become inadequate because of changes in conditions, or
that the degree of compliance with the policies or procedures may deteriorate.
As indicated in the accompanying Management’s Annual Report on Internal Control over Financial
Reporting, management’s assessment of the effectiveness of internal control over financial
reporting did not include the internal controls of Corbina which Golden Telecom, Inc. acquired on
May 28, 2007. Total and net
assets, total revenues and net income subject to Corbina’s internal control over financial
reporting represented 14.4%, 6.5%, 6.9% and 0.3% of Golden Telecom, Inc. consolidated total assets,
net assets, total revenue and net income as of and for the year ended December 31, 2007. Our audit
of internal control over financial reporting of the Company also did not include an evaluation of
the internal control over financial reporting of Corbina.
A material weakness is a deficiency, or combination of deficiencies, in internal control over
financial reporting, such that there is a reasonable possibility that a material misstatement of
the company’s annual or interim financial statements will not be prevented or detected on a timely
basis. The following material weaknesses has been identified and included in management’s
assessment.
Accounting and Finance Personnel
The Company did not have sufficient and skilled accounting and finance personnel necessary to
timely, consistently and appropriately close the Company’s books under U.S. GAAP at its Corbina
subsidiary. This material weakness resulted in adjustments to several of the Company’s
significant accounts and disclosures, was most notably observed with respect to the recording of
non-routine transactions and the determination of estimated amounts, and contributed to other
material weaknesses described below.
Financial Statement Close Process
The Company did not maintain effective controls over accounting for non-routine transactions
or accounting estimates at its Corbina subsidiary. Furthermore, the Company did not have effective
controls over the completeness, accuracy, validity and restricted access of complex spreadsheets
used by the Corbina subsidiary for the transformation of statutory accounts into U.S. GAAP. This
material weakness resulted in material audit adjustments to several of the Company’s significant
accounts, including accounts payable and accrued liabilities, allowance for doubtful accounts,
income taxes, tax contingencies and foreign currency translation.
Construction in process and fixed assets management
At its Corbina subsidiary, the Company did not maintain effective controls over the recording
of requisitions of equipment and spare parts from warehouses to construction in process. It also
did not have systems and controls in place to track the existence of construction in process and
construction costs by project to ensure timely commissioning and commencement of depreciation of
fixed
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assets already placed in service. The lack of timely reconciliation procedures and deficient
recordkeeping controls resulted in material audit adjustments to fixed asset, accumulated
depreciation and depreciation expense of the Company.
Revenue
The Company did not design and maintain effective controls over the accounting for revenues at
its Corbina subsidiary. Specifically, the controls over the INAC billing system were not designed and
operating effectively to ensure the completeness and accuracy of revenues. This material weakness
did not result in material adjustments to the Company’s consolidated financial statements; however,
there is a reasonable possibility that due to this control deficiency a material misstatement of
the Company’s consolidated financial statements related to the revenue and advances received from
customers accounts will not be prevented or detected on a timely basis.
Stock Based Compensation
The Company did not maintain effective management review controls over the accounting for
stock based compensation. Specifically, the Company incorrectly computed expense related to stock
appreciation rights in the first and second quarters of 2007 and inappropriately applied forfeiture
rate assumptions when computing the amount of compensation expense for stock options which became
fully vested as of December 31, 2007. The deficiencies in the Company’s controls over computation
and reporting of stock based compensation expense resulted in adjustments to equity, cost of sales
and general and administration expenses. This material weakness was observed and reported in the
Company’s interim quarterly filings and given the audit adjustments recorded in the Company’s year
end financial statements for the relevant significant accounts, the deficiencies giving rise to
this material weakness have not been remediated as of December 31, 2007.
These material weaknesses were considered in determining the nature, timing, and extent of
audit tests applied in our audit of the 2007 financial statements, and this report does not affect
our report dated March 17, 2008 on those financial statements.
In our opinion, because of the effect of the material weaknesses described above on the
achievement of the objectives of the control criteria, Golden Telecom, Inc. has not maintained
effective internal control over financial reporting as of December 31, 2007, based on the COSO
criteria.
/s/ Ernst & Young LLC
Moscow, Russia
March 17, 2008
ITEM 9B. Other Information
None
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PART III
ITEM 10. Directors and Executive Officers of the Registrant
The Board of Directors
The size of our Board is currently set at ten directors. The following table, prepared from
the information furnished to us, sets forth, with respect to each current director, the name, age
of the individual as of January 31, 2008, present principal occupation, employment history during
the last five years and business address. As of March 14, 2008, there were seven directors on the
Board.
Peter Covell Age 52 |
Mr. Covell has served as Chief Operations Officer of OAO Vimpel Communications (“VimpelCom”) since May 2006. From 2004 until 2006, Mr. Covell served as Chief Operations Officer at the Bulgarian Telecommunication Company, a telecommunications services provider. Mr. Covell served as Technical Consultant at Advent International, a private equity firm, from 2002 until 2004. Mr. Covell’s business address is 4 Krasnoproletarskaya, Moscow, Russia, 127006. | |
Patrick Gallagher Age 52 |
Mr. Gallagher, a citizen of the United Kingdom, has over 25 years experience in international telecommunications. In October 2007, Mr. Gallagher was appointed as a non-executive director of Harmonics Inc., a US publicly listed global provider of high performance video solutions to broadcast, cable, telecom, and other industries. In January 2008, he was appointed Chairman of Macro4 plc, a global software solutions company. From April 2004 to October 2007 he was a member of the Supervisory Board of Getronics NV, a Dutch listed global ICT solutions and services company. From April 2006 until March 2007, Mr. Gallagher was non-executive Vice Chairman of FLAG Telecom Group, a global company which owns and manages an extensive sub sea optical fiber network spanning four continents and serving the business markets of Asia, Europe, Middle East and the U.S. From March 2003 until March 2006, Mr. Gallagher was Executive Vice Chairman and Chief Executive Officer of FLAG Telecom Group. Prior to joining FLAG in March 2003, he had a 17 year career with British Telecommunications plc (“BT”). Initially, Mr. Gallagher held the position of Commercial Advisor and Commercial Director of BT and in 1994 he was appointed Director of Business Development to lead BT’s international expansion and investment strategy. He was President of BT Europe from January 1996 until July 2000 where he grew and managed BT’s European operations to include 12 equity joint venture companies and five subsidiaries, generating over £6 billion in annual revenue. Subsequently, he sat on BT’s Executive Committee as Group Strategy and Development Director where he was central to BT’s restructuring and strategic re-positioning. Before joining BT, Mr. Gallagher spent eight years with Racal Electronics, managing international communications projects in Europe, the Middle East and South America. Mr. Gallagher is a graduate of Warwick University with a degree in Economics and Industry. | |
Alexander Gersh Age 43 |
Mr. Gersh has served as Chief Financial Officer of NDS Group plc, a provider of technology solutions for digital pay-TV, since January 2005. From 2003 until December 2004, Mr. Gersh served as Chief Financial Officer of FLAG Telecom, a telecommunications services provider. Mr. Gersh has been a member of VimpelCom’s Audit Commission since June 2003 and the Chairman of VimpelCom’s Audit Commission since 2004. Mr. Gersh is a member of the Institute of Certified Public Accountants. Mr. Gersh’s business address is 1 Heathrow Boulevard, 28-6 Bath Road, West Drayton, Middelsex, UB7 0DQ, United Kingdom. | |
David Herman Age 62 |
Mr. Herman, a citizen of the United States, has served in senior executive positions throughout the world, including the Commonwealth of Independent States (“CIS”). He retired in 2002 from the position of Vice President of General Motors Corporation for Russia and the CIS after 29 years with General Motors and since 2002 has been a consultant to General Motors. Mr. Herman was instrumental in the establishment of a $340 million car plant by General Motors, Avtovaz and the European Bank for Reconstruction and Development. Prior to his appointment with General Motors in the Commonwealth of Independent States, Mr. Herman served as Chairman of Adam Opel A.G., and served as President of SAAB Automobile. | |
Dmitry
A. Pleskonos Age 43 |
Mr. Pleskonos has served as Executive Vice President, Business Development for the CIS at VimpelCom since May 2007. From January 2007 until May 2007, Mr. Pleskonos served as Vice President, General Manager for the Moscow Region of VimpelCom. From January 2006 until January 2007, Mr. Pleskonos served as General Manager for the Moscow Region of VimpelCom. From July 2004 until January 2006, Mr. Pleskonos served as Sales Director of VimpelCom. From May 2002 until June 2004, Mr. Pleskonos served as Sales Operations Director for Russia and CIS countries at Mars LLC, a consumer products manufacturer. Mr. Pleskonos’s business address is 4 Krasnoproletarskaya, Moscow, Russia, 127006. |
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Elena
A. Shmatova Age 48 |
Ms. Shmatova has served as Chief Financial Officer of VimpelCom since January 2003 and as Executive Vice President since October 2005. Ms. Shmatova served as Vice President of VimpelCom from June 2004 to October 2005. Ms. Shmatova’s business address is 4 Krasnoproletarskaya, Moscow, Russia, 127006. | |
Jean-Pierre Vandromme Age 53 |
Mr. Vandromme, a citizen of Belgium, has served as the Chief Executive Officer of the Company since September 1, 2005. Mr. Vandromme is also the founder and Chairman of VoIP.co.uk, a United Kingdom based company, and is a Board member of Completel, Ventelo Sweden and Norway, and was a Board member of Axxessit. From 2001 to 2003, Mr. Vandromme was Chairman, President and Chief Executive Officer of VENTELO Europe and from 1994 to 2001, Mr. Vandromme served in a variety of positions with Global TeleSystems, Inc. (“GTS”), including as President of GTS-Business Services. |
Other than Mr. Vandromme, none of the directors holds any other position with us.
Executive Officers who are not directors
Our executive officers and their ages and positions as of March 14, 2008 are as follows (other
than Mr. Vandromme’s information, which is set forth above):
Alexander Vinogradov President Age 53 |
Mr. Vinogradov, a citizen of Russia, became President and Chief Executive Officer of the Company in November 2001. Mr. Vinogradov has served on the Executive Committee of the Board since his initial election as a Director until May 2005. Prior to joining the Company as President and Chief Executive Officer, Mr. Vinogradov worked at EDN Sovintel LLC (“Sovintel”) as General Director from November 1995. Before his appointment as General Director, Mr. Vinogradov worked at Sovintel as Commercial Director, Head of Marketing and Sales and Head of Marketing and Development. Prior to his employment with Sovintel, Mr. Vinogradov worked for over 10 years at the Main Centre for Management of Long-Distance Communications of the USSR where he was in charge of numerous commercial and technical development programs. Mr. Vinogradov holds a degree from Moscow Telecommunications Institute and is a Member of the International Academy of Telecommunications. In 2003 he became a Master of Communications of the Russian Federation. | |
Boris Svetlichny Senior Vice President, Chief Financial Officer (CFO) and Treasurer Age 46 |
Mr. Svetlichny, a citizen of the United States, was appointed as Senior Vice President, Chief Financial Officer (CFO) and Treasurer in March 2006. From October 2004, Mr. Svetlichny served as the Financial Controller of Bulgarian Telecommunications Company Plc (“BTC”), the Bulgarian incumbent telecommunications operator. Prior to joining BTC, Mr. Svetlichny was a Partner from 2003 to 2004 with VSRK Associates Ltd., a United Kingdom based management consulting company. From 2000 to 2003, Mr. Svetlichny was the Director and Vice President of Finance of Ventelo (UK) Ltd. for its Western European operations, and from 1994 to 2000, Mr. Svetlichny served in a variety of positions with GTS, including Director of Finance of GTS’ Business Services and Finance Director of Sovintel. Mr. Svetlichny holds a BBA in Accounting from the University of Massachusetts and a MSIA (MBA) from Carnegie-Mellon University in the USA. | |
Ilya Smirnov
Vice President, General Counsel and
Corporate Secretary Age 40 |
Mr. Smirnov, a citizen of Russia, was appointed Vice-President, Acting General Counsel and Corporate Secretary of the Company in July, 2006. Mr. Smirnov became General Counsel in June 2007. Mr. Smirnov has been working for us as legal counsel and Director of Legal Department of Sovintel since 1995. He graduated from the Moscow State Institute of International Relations in 1989 and has an MBA degree from Dowling College of 2002. Mr. Smirnov has a strong background in business development and a deep knowledge of both Russian and Western law with extensive work experience and high professional skills. | |
Michael
Wilson Vice President, Corporate Controller and Principal Accounting Officer Age 38 |
Mr. Wilson, a citizen of the United States, was appointed Vice President, Corporate Controller and Principal Accounting Officer of the Company in July 2003, having joined the Company as the Director of Financial Reporting in September 1999. From November 1997 until September 1999, Mr. Wilson was Accounting and Finance Special Projects Director of GTS. Prior to that, Mr. Wilson worked as the General Ledger Accounting Manager for Computer Sciences Corporate in Washington, DC. Mr. Wilson is a Certified Public Accountant and a member of the American Institute of Certified Public Accountants. Mr. Wilson holds a Bachelors Degree in Accounting from Fairmont State College and a Masters Degree in Accounting from West Virginia University. |
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Kevin
Cuffe Vice President, Head of the BCS & Customer Care Business Units Age 47 |
Mr. Cuffe, a citizen of the United States, has been with the Company since 1998 where he previously served as Commercial Director for Sovintel. He came to the Company after 15 years with AT&T and worked in the Russian and European telecom markets from 1992 in a variety of senior management roles. In Russia, he led the commercial activities of AT&T’s first Russian joint venture. In Italy, he was AT&T’s Business Services Director charged with the development and extension of the Business Service offerings of AT&T in Southern Europe, the Middle East and Africa. He holds a Bachelor of Business Administration degree from the University of Miami and an MBA from San Diego State University. |
Section 16(a) Beneficial ownership reporting compliance
Based upon our records and other information, we believe all of our directors and executive
officers and other stockholders who may own 10% or more of our common stock have complied with the
requirements of the Securities and Exchange Commission (“SEC”) to report ownership and transactions
that change ownership.
Conduct guidelines
We have adopted our “Conduct Guidelines”, a code of ethics that applies to all employees,
including its executive officers. A copy of the Conduct Guidelines is posted on our Internet site
at http://www.goldentelecom.com. In the event that we make any amendment to, or grants any
waivers of, a provision of the Conduct Guidelines that applies to the principal executive officer,
principal financial officer, or principal accounting officer that requires disclosure under
applicable SEC rules, we intend to disclose such amendment or waiver and the reasons therefore on
its Internet site.
Audit Committee financial expert
The Board of Directors has determined that the Audit Committee members are financially
literate under the current listing standards of the Nasdaq National Market and able to devote
sufficient time to serving on the Audit Committee. The Board has also determined that Mr.
Alexander Gersh is currently the Audit Committee financial expert as defined in Item 407 of
Regulation S-K under the Securities Exchange Act of 1934. The Board has also determined that Mr.
Gersh is “independent” as defined by the Nasdaq National Market. The Board made a qualitative
assessment of Mr. Gersh’s level of knowledge and experience based on a number of factors, including
his formal education and experience.
ITEM 11. Executive Compensation
Compensation Committee Report
The Compensation Committee of the Board, which is composed of independent directors and has
the principal responsibilities described below, has furnished the following report:
The Compensation Committee has reviewed and discussed with management the Compensation
Discussion and Analysis for the year ended December 31, 2007. Based upon such review and
discussions, the members of the Compensation Committee recommended to the Board that the
Compensation Discussion and Analysis for the year ended December 31, 2007 be included in the our
Annual Report on Form 10K for filing with the SEC.
David Herman, Chair
Patrick Gallagher
Patrick Gallagher
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Compensation Discussion and Analysis
Overview of Compensation Program
The Compensation Committee has responsibility for seeking to ensure that our compensation
practices and policies are consistent with and serve the best interests of our stockholders. The
Compensation Committee seeks to ensure that the total compensation paid to the executive officers
is fair, reasonable and competitive and seeks to incentivize the maximization of sustainable
stockholder value.
Throughout this Annual Report on Form 10-K, the individuals who served as our Chief Executive
Officer and Chief Financial Officer during fiscal 2007, as well as the other individuals included
in the Summary Compensation Table below, are referred to as the “named executive officers.”
Compensation Philosophy and Objectives
The objective of our compensation program for the named executive officers is to attract,
motivate and retain suitable candidates for these positions. We currently compensate our senior
management with a mix of base salary, bonus, stock appreciation rights (“SARs”) and stock options.
This combination of compensation is designed to align management’s interests with the long term
interests of our stockholders through stock options and SARs while at the same time providing an
appropriate base salary tied to the named executive officer’s position and a bonus program designed
to reward strong performance in the short term. The Compensation Committee uses its judgment and
experience and considers the recommendations of management in determining the mix of compensation.
Management also relies on benchmarking surveys on executive compensation from time to time
completed by outside consultants when making recommendations to the Compensation Committee. The
Compensation Committee also informs itself of market practices for compensation related decisions.
The Compensation Committee reviews total short-term and long-term compensation annually and, as
part of this review process, meets personally with our senior management and a number of the named
executive officers to discuss their compensation, short and long term goals, and aspirations.
Historically, the Compensation Committee has not granted equity linked compensation annually;
however, such compensation has been awarded from time to time. With the appointment of our new
Chief Executive Officer in late 2005, the Compensation Committee decided to provide further
incentives to the new Chief Executive Officer and other named executive officers by providing
equity-linked compensation in the form of SARs. SARs were chosen instead of options, which were
awarded in the past, due to the fact that the SARs that were granted have very little dilutive
effect on stockholders, however, it was found that the SARs led to increased volatility of related
expenses. Consequently, in June 2007, the value of each outstanding SAR was capped at $53.80. Stock
options were then granted with an exercise price of $53.80 in amounts equal to the number of capped
SARs. The Compensation Committee also approved additional grants of stock options which were
granted in June 2007. It is not expected that SARs will be granted in the near future. While stock
options may continue to be awarded in the future as part of the total mix of compensation for
senior management, the Compensation Committee does not have a pre-determined schedule for
additional grants. The Compensation Committee expects to review the awarding of grants annually.
Elements of Compensation
Base Salary
We provide named executive officers with base salary to compensate them for services rendered
during the fiscal year and to provide an appropriate lifestyle given their professional status and
accomplishments. Our Chief Executive Officer’s salary was increased in 2007 to $600,000, an amount
that the Compensation Committee concluded is appropriate, given Mr. Vandromme’s contribution to our
growth and increase in service offerings. Base salaries reflect levels that the Compensation
Committee considers appropriate based on general experience.
Bonus
The named executive officers, with the exception of the Chief Executive Officer, are
participants in the our Bonus Plan for employees with an internal grade of 14 or higher (“Bonus
Plan”). The purpose of the Bonus Plan is to reward those managers who contribute to our success and
profitability. The Bonus Plan aims to coordinate the interest of the managers with the interests of
the Company so that goals of the managers are aligned with those of the Company and that high
quality work of the managers is rewarded. Under the Bonus Plan, bonuses are awarded on the basis of
our performance and individual performance. Determinations regarding bonus payments to employees
for 2007 have not yet been made us and the Compensation Committee.
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Company Performance
Our performance aspect of the Bonus Plan for 2007 is based on Earnings Before Interest, Tax,
Depreciation and Amortization (“EBITDA”) for 2007 compared to the our budget for 2007 (the “Company
Key Performance Indicator”). The results are determined following the final audit of our financial
results by our external auditors. The Company Key Performance Indicator coefficient can be between
0 and 1.5. There are three set EBITDA targets, which excludes, among other costs, equity-based
compensation costs. If the EBITDA for 2007 is more than EBITDA of $333 million, then the Company
Key Performance Indicator coefficient for that Company Key Performance Indicator will be 1.5. If
the EBITDA is less than $292.5 million, then the Company Key Performance Indicator coefficient will
be 0. EBITDA results between $292.5 million and $312 million will produce a Company Key Performance
Indicator coefficient of 0.5. EBITDA results above $312 million and up to and including $333
million will produce a Company Key Performance Indicator coefficient of 1. Adjustments to the Key
Performance Indicator for EBITDA results between $292.5 million and $333 million will be made on a
linear basis. The Company performance coefficient is derived by taking the Company Key Performance
Indicator coefficient, multiplying each by 100% to give a percentage. EBITDA for 2007 is $338.7
million.
Individual Performance
Each participant under the Bonus Plan has been assigned a seniority grade under the Watson
Wyatt grading system, based on his or her job responsibilities. The seniority grade determines the
percentage of the named executive officer’s salary which can form the basis for the officer’s bonus
(the “Bonus Target”). With the exception of one named executive officer’s Bonus Target which is 35%
of his annual base salary and Mr. Vandromme, who does not participate in the Bonus Plan, the other
named executive officers have Bonus Targets of 50% of their annual base salaries. The performance
of named executive officers who report directly to the Chief Executive Officer are evaluated by the
Chief Executive Officer. Named executive officers who do not report directly to the Chief Executive
Officer are evaluated by a colleague with a higher seniority grade chosen by the named executive
officer’s supervisor. The named executive officer’s supervisor then reviews the evaluations and
provides his or her additional feedback and evaluation, which results in the personal coefficient
determined by the named executive officer’s supervisor for the bonus. This coefficient ranges from
0 to 200%.
Bonus calculation
The named executive officer’s total bonus amount is arrived at by multiplying the our
performance coefficient by the Bonus Target and then multiplying that amount by the named executive
officer’s personal coefficient. There is also a bell curve for the Bonus Plan that is set such that
5% of Bonus Plan participants will receive a personal coefficient of 200%, 15% will receive a
personal coefficient of 150%, 60% will receive a personal coefficient of 100%, 15% will receive a
personal coefficient of 50% and 5% will receive a personal coefficient of 0%. The bell curve is
applied on both a departmental and Company wide basis to the personal coefficients. The bell curves
may have a variance of 5% on each of the percentages indicated above. The personal coefficients of
Bonus Plan participants may be adjusted so that personal coefficients fit into the required bell
curves for the Bonus Plan.
Bonus for the Chief Executive Officer
The Compensation Committee reviewed the performance of the Chief Executive Officer for 2006
and recommended to the Board a bonus of $375,000 for Mr. Vandromme, which represented 100% of his
target bonus under his employment agreement. In 2007, Mr. Vandromme’s bonus target was increased to
$500,000; however, we have not finalized our financial results for 2007 and the Compensation
Committee has not recommended a bonus amount for Mr. Vandromme for 2007. Mr. Vandromme’s target
bonus is in two parts. Forty percent of his target bonus is based on four key performance
indicators, equally weighted (the “Vandromme Key Performance Indicators”). Sixty percent of his
target bonus depends on us achieving certain EBITDA targets, as detailed below. The Vandromme Key
Performance Indicators are Mr. Vandromme (i) continuing to represent us with government, the media
and community in general and developing the Golden Telecom brand in its markets in a manner that
protects our ethical standards and image at large, (ii) assuring sustainable management, including
development of progression and succession planning for the management group, (iii) continuing our
regional expansion strategy, including demonstrating the integration and early synergies of
newly-acquired businesses, and (iv) instituting a “Go Fast” system within the Company and assuring
that all of Mr. Vandromme’s direct reports attend at least one “Go Fast” session per fiscal
quarter.
Sixty percent of Mr. Vandromme’s bonus is based on the EBITDA as described above. The results
are determined following the final audit of our financial results by our external auditors. If the
EBITDA for 2007 is more than $333 million, then Mr. Vandromme will receive $450,000. If the EBITDA
is less than $292.5, then Mr. Vandromme will not receive a bonus. If the EBITDA results are
between $292.5 million and $312 million then Mr. Vandromme will receive a $150,000 bonus. If the
EBITDA results are above $312 million and up to and including $333 million then Mr. Vandromme will
receive a $300,000 bonus. Adjustments to the Key Performance Indicators for EBITDA results between
$292.5 million and $333 million will be made on a linear basis. The EBITDA for 2007 is $338.7
million. For more information regarding Mr. Vandromme’s employment agreement, see “Chief Executive
Officer Employment Agreement” below.
Special Cash Bonuses
On December 21, 2007, we entered into an Agreement and Plan of Merger with VimpelCom Finance
B.V. (“Parent”) and Lillian Acquisition, Inc. (“Merger Sub”). Merger Sub commenced a tender offer
to purchase, at a price of $105.00 per share in cash without interest (and less any amounts
required to be deducted and withheld under any applicable law), any and all outstanding shares of
our common stock, par value $0.01 per share on the terms and subject to the conditions specified in
the offer to purchase dated January 18, 2008, as amended and related letter of transmittal (which,
together with any supplements or amendments thereto, collectively
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constitute the “Offer”). The Offer closed on February 27, 2008 and we became a majority owned
subsidiary of Merger Sub (the “Merger”). We also intend to pay special cash bonuses to certain
eligible employees. Such bonuses will be paid at the discretion of our Chief Executive Officer.
Pursuant to the terms of the Merger Agreement, the aggregate amount of the employee bonuses may not
exceed $2.0 million, less the amount of all fees paid as remuneration to members of the Special
Committee, without the prior written consent of VimpelCom. $1.25 million was paid in the aggregate
to the members of the Special Committee. Messrs. Smirnov, Svetlichny and Wilson will receive such
bonuses in the amounts of $17,500, $30,187, and $23,460, respectively.
Equity-based Compensation; Long Term Incentive Plans
Traditionally, the primary form of equity-based compensation that we awarded was non-qualified
stock options under our 1999 Equity Participation Plan (the “Equity Plan”). We selected this form
of compensation for several reasons including our desire to provide appropriate long term
incentives to directors, employees and senior management and to enable us to obtain and retain the
services of directors, key employees and consultants considered essential to our long range
success. We also selected this form of compensation because of the favorable effect of receiving
cash from the exercise of stock options. However, in order to reduce the potential dilution to
stockholders when shares are issued following stock option exercises, we considered other means by
which to provide an equally motivating form of incentive compensation while permitting us to issue
fewer shares. On November 22, 2005, the Board, with the recommendation of the Compensation
Committee, approved the Golden Telecom, Inc. 2005 SAR Plan and the Sovintel SAR Plan. The 2005 SAR
Plan provides for the award of SARs, which confer a benefit that is based on appreciation in value
of our common stock. The SARs under the 2005 SAR Plan were payable in either shares of our common
stock, or cash at the option of the holder if so stated in the award agreements. Since the 2005 SAR
Plan provides for the issuance of up to 200,000 shares of common stock to be issued to
participants, we requested and received approval for the 2005 SAR Plan at the 2006 annual meeting
of stockholders. The Sovintel SAR Plan provides for the award of SARs which are payable only in the
form of cash.
The purpose of the 2005 SAR Plan and the Sovintel SAR Plan is to promote our long-term success
and to create stockholder value by (a) encouraging named executive officers and other employees to
focus on critical long-range objectives, (b) attracting and retaining persons with exceptional
qualifications to serve as named executive officers, and (c) linking named executive officers and
other employees directly to stockholder interests by tying compensation to long-term appreciation
in our stock. Seventy-five percent of the SARs granted to date under the plans are subject to time
vesting with one-third of these grants becoming vested and nonforfeitable on each of the first
three anniversary dates from the grant date, provided that the named executive officer remains
continuously employed by us until each such relevant date. In addition, the base share price for
these grants increases by five percent on each anniversary date of the grant date for the SARs that
have not yet vested on such anniversary date resulting in an increasing base share price for the
unvested SARs. The remaining twenty-five percent of the SARs granted under the plans to date were
subject to performance vesting. The performance target was our common stock achieving a closing
trading price of at least $50.00 per share for thirty consecutive days. On February 22, 2007, our
common stock achieved the $50.00 threshold and the performance vesting SARs became fully vested.
The Compensation Committee was appointed by the Board to administer the 2005 SAR Plan and the
Sovintel SAR Plan and the Compensation Committee has delegated the day-to-day management of the
2005 SAR Plan and the Sovintel SAR Plan to members of our management. However, the Compensation
Committee determines the persons eligible to receive awards and the amounts of the awards. To date,
the Compensation Committee has awarded SARs consistent with the recommendations of management. SARs
awarded to our Chief Executive Officer are discussed above. The number of SARs awarded to the other
named executive officers and which have been recommended by our Chief Executive Officer and the
Director of Human Resources were approved by the Compensation Committee.
In 2007, we reviewed our SARs program and investigated other forms of equity based
compensation for our named executive officers and other employees to decrease volatility of related
expenses. On our recommendation, the Compensation Committee decided to issue stock options in 2007.
At the time the Equity Plan was adopted, the number of shares available for issuance under the
Equity Plan was calculated as 15% of our issued and outstanding shares on a fully diluted basis. In
order to further preserve the 15% ratio, an amendment to the Equity Plan was proposed by the
Compensation Committee in April 2007, subject to shareholder approval, to increase the number of
our shares authorized for issuance under the Equity Plan by 1,000,000. This amendment was approved
by our shareholders at the annual meeting of shareholders in May 2007.
We then decided to cap the value of each SAR at $53.80 and the Compensation Committee then
approved awards of stock options with an exercise price of $53.80 which were issued, with terms
generally mirroring those of the SARs. The Compensation Committee also issued additional options in
2007. Seventy-five percent of the options granted under these awards are subject to time vesting
with one-third of these grants becoming vested and nonforfeitable on each of the first three
anniversary dates from the grant date, provided that the named executive officer remains
continuously employed by us until each such relevant date. In addition, the base share price for
these grants increases by five percent on each anniversary date of the grant date for the options
that have not yet vested on such anniversary date resulting in an increasing base share price for
the unvested options. Twenty-five percent of the options granted under these awards were subject to
performance vesting. The performance target was our common stock achieving a closing trading price
of at least $82.15 per share for thirty consecutive days. On October 18, 2007, our common stock
achieved the $82.15 threshold and the performance vesting options became fully vested.
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The Compensation Committee was appointed by the Board to administer the Equity Plan and the
Compensation Committee has delegated the day-to-day management of the Equity Plan to members of our
management. However, the Compensation Committee determines the persons eligible to receive awards
and the amounts of the awards. To date, the Compensation Committee has awarded options consistent
with the recommendations of management.
Currency of Payments
Compensation paid to named executive officers may be paid in rubles at an exchange rate fixed
by us. Some named executive officers elect to receive their compensation in dollars, which may
result in a different, and usually higher, amount paid to the named executive officers due to
re-conversion of the compensation amounts to dollars from rubles at a rate close to the Russian
Central Bank rate.
Perquisites and Other Personal Benefits
We provide our named executive officers with other benefits detailed in the “All Other
Compensation ($)” column in the Summary Compensation Table that we believe are reasonable,
competitive and consistent with the our overall executive compensation program. We believe that
these benefits generally allow our executives to work more efficiently. The costs associated with
these benefits constitute only a small portion of the executive’s total compensation and include
premiums on life insurance policies. We also provide the following benefits: the use of a company
car, the use of a company driver for the named executive officers (with the exception of one named
executive officer), school fees for named executive officers’ children, matching 401(k)
contributions up to the Internal Revenue Service’s limit for American citizens, personal property
insurance, and tax preparation services. Two named executive officers are entitled to use the paid
VIP fast track service at Moscow airports. We believe that it is in our interest to provide this
service to these named executive officers to avoid the long lines for passport control and customs
at the Moscow airports.
Employment Agreements For Certain Executives
We have employment agreements with each of our five executive officers. Each agreement
provides, among other things, that in the event of the executive officer’s termination without
cause, the executive officer will be entitled to receive certain compensation and benefits. In
addition, Messrs. Jean-Pierre Vandromme, Alexander Vinogradov, Boris Svetlichny, and Kevin Cuffe
have change of control provisions in their respective employment agreements which provide for
additional payments upon a change of control. The employment agreements for Messrs. Vandromme,
Svetlichny and Cuffe also provide that, in the event of a change of control, we will make a tax
gross-up payment to cover any excise taxes that may be imposed under the U.S. Internal Revenue
Code’s “golden parachute” rules. As a result of the Merger, Messrs. Cuffe, Svetlichny, Vandromme
and Vinogradov were paid $652,000, $750,000, $1.27 million and $1.08 million, respectively, as
change of control payments.
“Change of Control” is defined in the respective employment agreements and does not apply to
changes of control involving our major shareholders, Altimo, Telenor, Rostelecom, or their
respective wholly-owned subsidiaries and legal successors. We believe that the change of control
provisions will help to retain executives and provide continuity of management in the event of any
actual or threatened change of control of the Company. It is natural, in the face of a pending
change of control, for executives to be concerned and distracted by uncertainty as to their ongoing
role in the organization after the transaction. We recognize the importance of reducing the risk
that these personal concerns could influence executive officers considering strategic opportunities
that may include a change of control of the Company. We believe that the change in control
agreements appropriately balance the cost to us relative to potential damage from distraction or
loss of key executives in connection with a potential change in control that could benefit our
shareholders.
Chief Executive Officer Employee Agreement
When considering the terms for Mr. Vandromme’s employment agreement in 2005, the Compensation
Committee engaged Mercer Human Resources Consulting SA to provide a review of market conditions for
executive compensation. Under the terms of Mr. Vandromme’s employment agreement, Mr. Vandromme
received a starting base salary of $500,000 per year, which amount will be reviewed by the
Compensation Committee annually. For 2007, the base salary was $600,000. Mr. Vandromme is eligible
for an annual performance-based, incentive bonus, which, for 2007, is in the amount of up to
$500,000. When Mr. Vandromme was hired, he was issued SARs with respect to 200,000 shares of our
common stock, at a share price of $29.83 (“Granting Share Price”), one-third of which SARs would
vest and become vested and nonforfeitable on each of the first three anniversary dates from
September 1, 2005, provided Mr. Vandromme remains continuously employed by us or one of our
subsidiaries or business units until each such relevant date. This grant was not made under the
SARs plans described above.
The agreement also provides that if, prior to August 31, 2008 and during Mr. Vandromme’s
period of employment with us or one of our subsidiaries or business units, the average closing
stock price per share of our common stock on the Nasdaq Global Select Market, or any such other
exchange on which our common stock may then be traded, exceeds an average of $50.00 during any
thirty day consecutive period, Mr. Vandromme would be granted SARs for an additional 200,000 shares
of our common stock at the Granting Share Price, which SARs shall be fully vested upon issuance. On
February 3, 2007, our common stock achieved the $50.00 threshold and Mr. Vandromme was granted
additional fully vested SARs in respect of 200,000 shares of our common stock. The SARs granted do
not have a contractual term, however, all SARs shall be cancelled, and we shall make a payment with
respect to the SARs vested to Mr. Vandromme upon the termination of employment for any reason. The
SARs provide for a cash only settlement. In
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June 2007, the value of the SARs was capped at $53.80. Stock options were then issued with an
exercise price of $53.80 and with terms generally similar to those of the SARs.
Taxation Policy for Expatriate Employees
Our Expatriate Taxation Policy (the “Taxation Policy”) provides that any expatriate employees
who are assigned to the our offices from third countries to work in Russia, Ukraine or other
countries of the CIS shall not be penalized in connection with any double or incremental taxation
of their income earned in connection with their employment with us. Income is generally defined as
base salary, cash bonuses and other benefits treated as compensation by us. The policy defines two
groups of employees for the purposes of the Taxation Policy: (i) those employees who are required
to file a tax declaration and pay taxes on their income in their country of assignment (“Host
Country Taxpayers”), and (ii) those employees who are required to file a tax declaration and pay
taxes on their income in both their home country and their host countries (“Home Country
Taxpayers”). With the exception of Mr. Vinogradov, a Russian citizen, and Mr. Vandromme, who is
Belgian and therefore considered a Host Country Taxpayer, all of the other named executive officers
are US citizens and are considered Home Country Taxpayers. We reimburse to the Home Country
Taxpayer the host country taxes and also grosses up for the Home Country Taxpayer for the income
tax effect (federal and state taxes for American citizens) in the host and home countries due to
the payment of the host country taxes by us.
Review of All Components of Executive Compensation
The Compensation Committee reviewed all components of the named executive officer’s
compensation for 2007. The Compensation Committee met with many of the named executive officers to
discuss the named executive officers’ respective goals, career objectives and compensation. The
Compensation Committee believes that the compensation for the named executive officers is
reasonable and not excessive.
Deductibility of Executive Compensation
As part of its role, the Compensation Committee reviews and considers the deductibility of
executive compensation under Section 162(m) of the Internal Revenue Code, which provides that we
may not deduct compensation of more than $1,000,000 that is paid to certain individuals. We believe
that compensation paid under the management incentive plans is generally fully deductible for
federal income tax purposes. However, in certain situations, the Compensation Committee may approve
compensation that will not meet these requirements in order to ensure competitive levels of total
compensation for its executive officers.
Accounting for Stock-Based Compensation
Beginning on January 1, 2006, we began accounting for stock-based payments including the
Equity Plan, the 2005 SAR Plan and the Sovintel SAR Plan in accordance with the requirements of
Financial Accounting Standards Board Statement No. 123 (revised).
SUMMARY COMPENSATION TABLE
The following table contains information concerning the compensation provided to the Chief
Executive Officer, Chief Financial Officer and the other three most highly compensated executive
officers (the named executive officers). We do not provide any pension benefits, nonqualified
defined contributions or other nonqualified deferred compensation plans to any executive officers.
| Non-Equity | ||||||||||||||||||||||||||||||||
| Stock | Option | Incentive Plan | All Other | |||||||||||||||||||||||||||||
| Name and | Bonus | Awards | Awards | Compensation | Compensation | |||||||||||||||||||||||||||
| Principal Position | Year | Salary ($) | ($) | ($)(2) | ($)(3) | ($) | ($) | Total ($) | ||||||||||||||||||||||||
Jean-Pierre Vandromme
Chief Executive Officer |
2007 | 615,889 | 650,000 | (1) | — | 6,424,164 | — | 54,797 | (4) | 7,744,850 | ||||||||||||||||||||||
| 2006 | 500,118 | 408,713 | — | 5,835,076 | — | 53,057 | 6,796,964 | |||||||||||||||||||||||||
Alexander Vinogradov
President |
2007 | 501,377 | — | 40,998 | — | 360,000 | (1) | 23,803 | (5) | 921,178 | ||||||||||||||||||||||
| 2006 | 481,534 | — | 60,890 | — | 127,518 | — | 669,942 | |||||||||||||||||||||||||
Boris Svetlichny
Senior Vice President,
Chief Financial
Officer and Treasurer |
2007 | 361,786 | — | — | 1,877,104 | 543,375 | (1) | 297,802 | (6) | 3,080,067 | ||||||||||||||||||||||
| 2006 | 246,109 | — | — | 597,549 | 250,254 | 108,732 | 1,202,644 | |||||||||||||||||||||||||
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| Non-Equity | ||||||||||||||||||||||||||||||||
| Stock | Option | Incentive Plan | All Other | |||||||||||||||||||||||||||||
| Name and | Bonus | Awards | Awards | Compensation | Compensation | |||||||||||||||||||||||||||
| Principal Position | Year | Salary ($) | ($)(1) | ($)(2) | ($)(3) | ($) | ($) | Total ($) | ||||||||||||||||||||||||
Kevin Cuffe
Vice Managing Director
Business & Consumer
Solutions BU |
2007 | 315,314 | — | — | 762,558 | 472,500 | (1) | 286,600 | (7) | 1,836,972 | ||||||||||||||||||||||
| 2006 | 302,475 | — | — | 728,704 | 164,832 | 131,554 | 1,327,565 | |||||||||||||||||||||||||
Michael Wilson
Vice President,
Corporate Controller
and Principal
Accounting Officer |
2007 | 270,371 | — | 12,770 | 545,614 | 295,596 | (1) | 177,455 | (8) | 1,301,806 | ||||||||||||||||||||||
| 2006 | 241,547 | — | 18,605 | 132,536 | 172,765 | 86,352 | 651,805 | |||||||||||||||||||||||||
| (1) | Determinations regarding bonus payments to employees for 2007 have not been made by the Compensation Committee. The number shown in this column assumes a maximum personal coefficient for each person. EBITDA for 2007 is $338.7 million. | |
| (2) | This column represents the dollar amount recognized for financial statements reporting purposes with respect to the 2006 and 2007 fiscal years for the grant date stock price of restricted shares. Fair value is calculated using the closing price of our stock on the date of grant recognized over the vesting period which is two years for Messrs. Vinogradov and Wilson, with one third of the restricted shares having vested when granted in 2005. | |
| (3) | The fair value of each SAR award is estimated at the end of each reporting period using the Monte Carlo simulation-based valuation model assuming a 0.12-1.57 year expected term, a 39.9% weighted average volatility, an expected dividend yield of 1.7% and a risk free rate of 3.45%. Estimated volatilities are based on historical volatility of our stock for the period matching the awards’ expected term. We use historical data to estimate SAR exercise and employee termination within the valuation model; separate groups of employees that have similar historical exercise behavior are considered together for valuation purposes. The expected term of the SARs granted is derived from the output of the SAR valuation model and represents the period of time that SARs granted are expected to be outstanding. The risk-free rate for periods within the expected term of the SAR is based on the US Treasury yield curve in effect at the end of the reporting period. | |
| The fair value of each Stock Option award is estimated at the grant date using the Monte Carlo simulation-based valuation model assuming a 0.17-2.49 year expected term, a 40.1% weighted average volatility, an expected dividend yield of 1.7% and a weighted average risk free rate of 5.00%. Estimated volatilities are based on historical volatility of our stock for the period matching the awards’ expected term. We use historical data to estimate Stock Option exercise and employee termination within the valuation model; separate groups of employees that have similar historical exercise behavior are considered together for valuation purposes. The expected term of the Stock Options granted is derived from the output of the Stock Option valuation model and represents the period of time that Stock Options granted are expected to be outstanding. The risk-free rate for periods within the expected term of the Stock Options granted is based on the US Treasury yield curve in effect at the grant date. | ||
| (4) | This amount includes costs associated with the personal use of two cars and drivers, personal cellular telephone use, medical premiums, tax filing preparation fees, and language lessons. | |
| (5) | This amount includes costs associated with the personal use of a car and driver, personal cellular telephone use, and medical premiums. | |
| (6) | This amount includes costs associated with personal use of a car and driver, personal cellular telephone use, legal fees related to his former employment, storage expenses, various travel expenses for Mr. Svetlichny’s family to obtain Russian visas, matching our contributions under our 401(k) plan, medical premiums, tax filing preparation fees, $41,920 in school fees for Mr. Svetlichny’s children, and $111,159 for Russian tax protection payments which were grossed up in the amount of $63,756 for his 2006 tax year and gross-ups on fringe benefits in the amount of $27,596. | |
| (7) | This amount includes costs associated with the personal use of a car and driver, personal cellular telephone use, storage expenses, $12,785 in school fees for Mr. Cuffe’s children, matching contributions under our 401(k) plan, medical premiums, tax filing preparation fees and $139,185 for Russian tax protection payments which were grossed up in the amount of $81,142 for his 2006 tax year, and gross-ups on fringe benefits. | |
| (8) | This amount includes storage fees, personal cellular telephone use, matching contributions under our 401(k) plan, medical premiums, tax filing preparation fees and $93,825 for Russian tax protection payments which were grossed up in the amount of $54,480 for his 2006 tax year. |
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GRANTS OF PLAN-BASED AWARDS IN 2007
The following table provides information about equity and non-equity awards granted to named
executive officers in 2007. Four of the named executive officers with grants detailed under the
“All Other Option Awards” column below were awarded stock options.
| Estimated Possible Payouts Under Non-Equity | All Other Option | |||||||||||||||||||||||||||||||
| Incentive Plan Awards (1) | Awards: Number of | |||||||||||||||||||||||||||||||
| Thres- | Securities | Exercise or Base | Market Price on | Grant Date Fair Value | ||||||||||||||||||||||||||||
| hold | Target | Maximum | Underlying Options | Price of Option | Grant Date | of Stock and Option | ||||||||||||||||||||||||||
| Name | Grant Date | ($) | ($) | ($) | (#) | Awards ($/Sh)(2) | ($/Sh)(3) | Awards ($) | ||||||||||||||||||||||||
Jean-Pierre Vandromme |
27-Jun-2007 | 200,000 | 53.80 | 53.80 | 2,884,000 | |||||||||||||||||||||||||||
Jean-Pierre Vandromme |
27-Jun-2007 | 667 | 53.80 | 53.80 | 11,166 | |||||||||||||||||||||||||||
Jean-Pierre Vandromme |
27-Jun-2007 | 66,667 | 53.80 | 53.80 | 1,153,339 | |||||||||||||||||||||||||||
Jean-Pierre Vandromme |
27-Jun-2007 | 66,666 | 53.80 | 53.80 | 1,201,988 | |||||||||||||||||||||||||||
Alexander Vinogradov |
120,000 | 480,000 | ||||||||||||||||||||||||||||||
Boris Svetlichny |
181,125 | 724,500 | ||||||||||||||||||||||||||||||
Boris Svetlichny |
27-Jun-2007 | 12,500 | 53.80 | 53.80 | 193,375 | |||||||||||||||||||||||||||
Boris Svetlichny |
27-Jun-2007 | 12,500 | 53.80 | 53.80 | 221,750 | |||||||||||||||||||||||||||
Boris Svetlichny |
27-Jun-2007 | 12,500 | 53.80 | 53.80 | 233,500 | |||||||||||||||||||||||||||
Boris Svetlichny |
27-Jun-2007 | 12,500 | 53.80 | 53.80 | 239,750 | |||||||||||||||||||||||||||
Boris Svetlichny |
28-Jun-2007 | 7,500 | 53.80 | 55.01 | 130,125 | |||||||||||||||||||||||||||
Boris Svetlichny |
28-Jun-2007 | 7,500 | 56.49 | 55.01 | 159,375 | |||||||||||||||||||||||||||
Boris Svetlichny |
28-Jun-2007 | 7,500 | 59.31 | 55.01 | 164,925 | |||||||||||||||||||||||||||
Boris Svetlichny |
28-Jun-2007 | 7,500 | 62.28 | 55.01 | 169,125 | |||||||||||||||||||||||||||
Kevin Cuffe |
157,500 | 630,000 | ||||||||||||||||||||||||||||||
Kevin Cuffe |
27-Jun-2007 | 12,500 | 53.80 | 53.80 | 229,000 | |||||||||||||||||||||||||||
Kevin Cuffe |
27-Jun-2007 | 12,500 | 53.80 | 53.80 | 230,375 | |||||||||||||||||||||||||||
Kevin Cuffe |
28-Jun-2007 | 1,875 | 53.80 | 55.01 | 32,531 | |||||||||||||||||||||||||||
Kevin Cuffe |
28-Jun-2007 | 1,875 | 56.49 | 55.01 | 39,844 | |||||||||||||||||||||||||||
Kevin Cuffe |
28-Jun-2007 | 1,875 | 59.31 | 55.01 | 41,231 | |||||||||||||||||||||||||||
Kevin Cuffe |
28-Jun-2007 | 1,875 | 62.28 | 55.01 | 42,281 | |||||||||||||||||||||||||||
Michael Wilson |
98,532 | 394,128 | ||||||||||||||||||||||||||||||
Michael Wilson |
27-Jun-2007 | 2,500 | 53.80 | 53.80 | 45,800 | |||||||||||||||||||||||||||
Michael Wilson |
27-Jun-2007 | 2,500 | 53.80 | 53.80 | 46,075 | |||||||||||||||||||||||||||
Michael Wilson |
27-Jun-2007 | 1,250 | 53.80 | 53.80 | 23,938 | |||||||||||||||||||||||||||
Michael Wilson |
27-Jun-2007 | 1,250 | 53.80 | 53.80 | 24,988 | |||||||||||||||||||||||||||
Michael Wilson |
27-Jun-2007 | 1,250 | 53.80 | 53.80 | 25,938 | |||||||||||||||||||||||||||
Michael Wilson |
28-Jun-2007 | 3,750 | 53.80 | 55.01 | 65,063 | |||||||||||||||||||||||||||
Michael Wilson |
28-Jun-2007 | 3,750 | 56.49 | 55.01 | 79,688 | |||||||||||||||||||||||||||
Michael Wilson |
28-Jun-2007 | 3,750 | 59.31 | 55.01 | 82,463 | |||||||||||||||||||||||||||
Michael Wilson |
28-Jun-2007 | 3,750 | 62.28 | 55.01 | 84,563 | |||||||||||||||||||||||||||
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| (1) | This column estimates the amounts that could have been earned under our Bonus Plan. For further details, please see the Summary Compensation. | |
| (2) | The exercise price increases by 5% on the anniversary of the grant date for the options that have not yet vested on such anniversary dated resulting in the increasing exercised price for the unvested option, as indicated. | |
| (3) | The market price is the closing price of our common stock on the Nasdaq market on the grant date. |
OUTSTANDING EQUITY AWARDS
AT THE END OF FISCAL 2007
AT THE END OF FISCAL 2007
The table below provides information on the holdings of stock option and SARs awards by the
named executive officers at December 31, 2007. This table includes unexercised, unvested and vested
stock option awards, and unexercised, unvested and vested SARs. The SARs expire five years from the
date of grant. Under the 2005 SAR Plan, awards may be settled in cash or in stock; up to 200,000
shares are reserved for SARs settled in stock. Under the Sovintel SAR Plan, SARs may only be
settled in cash. Under the 2005 SAR Plan and the Sovintel SAR Plan, 75% of the SARs are subject to
time vesting over three years and 25% are subject to performance vesting such that when our share
price reaches a certain target the SARs will vest. Upon termination of employment, SARs may not be
exercised after the thirtieth day following such termination of employment. SARs do not vest after
termination of employment.
With the exception of Mr. Cuffe’s stock options which vest in October 2009 and October 12,
2010 as described below (“Mr. Cuffe’s Original Options”), options vest annually over a three year
period, except for those options which were granted as vested. These options expire on the earlier
of five years from the date of grant or the expiration of six months from the employee’s
termination of employment. Options may be exercised through a cashless exercise. A portion of the
options are subject to performance vesting such that they vest when our share price reaches a
certain target.
Mr. Cuffe’s Original Options vested over three years and expire on the earlier of ten years
from the date of issuance of the options, eighteen months from termination of employment other than
by reason of his disability or death, the expiration of one year from the date termination of
employment by reason of disability, the expiration of one year from the date of death or the
expiration of three months from the date of termination of employment for cause. The options may be
exercised through a cashless exercise.
| Option Awards | ||||||||||||||||
| Equity | ||||||||||||||||
| Incentive Plan | ||||||||||||||||
| Awards: | ||||||||||||||||
| Number of | Number of | |||||||||||||||
| Securities | Securities | |||||||||||||||
| Underlying | Underlying | |||||||||||||||
| Unexercised | Unexercised | Option | ||||||||||||||
| Options (#) | Unearned | Option Exercise | Expiration | |||||||||||||
| Name | Exercisable1 | Options (#) | Price ($) | Date | ||||||||||||
Jean-Pierre Vandromme |
267,334 | 66,666 | (1) | 53.80 | 1-Sep-2010 | |||||||||||
| — | 66,666 | (2) | 29.83 | (3) | (4 | ) | ||||||||||
Alexander Vinogradov |
— | — | — | — | ||||||||||||
Boris Svetlichny |
7,500 | 22,500 | (5) | 53.80 | (6) | 28-Jun-2012 | ||||||||||
| 25,000 | 25,000 | (7) | 53.80 | 27-Jun-2012 | ||||||||||||
| — | 25,000 | (8) | 29.63 | (3)(9) | 17-Mar-2011 | |||||||||||
Kevin Cuffe |
1,875 | 5,625 | (10) | 53.80 | (6) | 28-Jun-2012 | ||||||||||
| 12,500 | 12,500 | (11) | 53.80 | 27-Jun-2012 | ||||||||||||
| — | 12,500 | (12) | 31.03 | (3)(13) | 12-Dec-2010 | |||||||||||
| 3,000 | — | 12.00 | 1-Oct-2009 | |||||||||||||
| 10,000 | — | 15.63 | 12-Oct-2010 | |||||||||||||
Michael Wilson |
3,750 | 11,250 | (14) | 53.80 | (6) | 28-Jun-2012 | ||||||||||
| 2,500 | 2,500 | (15) | 53.80 | 27 Jun-2012 | ||||||||||||
| 1,250 | 2,500 | (16) | 53.80 | 27 Jun-2012 | ||||||||||||
| — | 2,500 | (17) | 31.03 | (3)(13) | 12-Dec-2010 | |||||||||||
| — | 2,500 | (18) | 26.10 | (3)(19) | 26-Jul-2011 | |||||||||||
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| (1) | These options vest on September 1, 2008. | |
| (2) | These SARs vest on September 1, 2008. | |
| (3) | The exercise price of these SARs has been capped at $53.80 such that maximum amount that a person can receive per SAR exercised is the difference between the grant price and $53.80. | |
| (4) | Under the terms of Mr Vandromme’s employment agreement, there is no expiration date for his SARs. | |
| (5) | 7,500 options vest on June 28, 2008; 7,500 vest on June 28, 2009; and 7,500 vest on June 28, 2010. | |
| (6) | The base exercise price for this grant increases by 5 percent on each anniversary date of the grant date for the options that have not yet vested on such anniversary date resulting in an increased base exercise price for the unvested options as follows: |
| Vesting Date: | Exercise Price: | |||
June 28, 2008 |
$ | 56.49 | ||
June 28, 2009 |
$ | 59.31 | ||
June 28, 2010 |
$ | 62.28 | ||
| (7) | 12,500 options vest on March 17, 2008 and 12,500 options vest on March 17, 2009. | |
| (8) | 12,500 SARs vest on March 17, 2008 and 12,500 SARs vest on March 17, 2009. | |
| (9) | The base exercise price for this grant increases by 5 percent on each anniversary date of the grant date for the options that have not yet vested on such anniversary date resulting in an increased base exercise price for the unvested options as follows: |
| Vesting Date: | Exercise Price: | |||
March 17, 2008
|
$ | 32.67 | ||
March 17, 2009
|
$ | 34.30 | ||
| (10) | 1,875 options vest on June 28, 2008; 1,875 options vest on June 28, 2009; and 1,875 vest on June 28, 2010. | |
| (11) | These options vest on December 12, 2008. | |
| (12) | These SARs vest on December 12, 2008. | |
| (13) | The base exercise price for this grant increases by 5 percent on each anniversary date of the grant date for the options that have not yet vested on such anniversary date resulting in an increased base exercise price for the unvested options as follows: |
| Vesting Date: | Exercise Price: | |||
December 12, 2008
|
$ | 31.03 | ||
| (14) | 3,750 options vest on June 28, 2008; 3,750 options vest on June 28, 2009; and 3,750 options vest on June 28, 2010. | |
| (15) | 2,500 options vest on December 12, 2008. | |
| (16) | 1,250 options vest on July 26, 2008 and 1,250 vest on July 26, 2009. | |
| (17) | 2,500 vest on December 12, 2008. | |
| (18) | 1,250 vest on July 26, 2008 and 1,250 vest on July 26, 2009. | |
| (19) | The base exercise price for this grant increases by 5 percent on each anniversary date of the grant date for the options that have not yet vested on such anniversary date resulting in an increased base exercise price for the unvested options as follows: |
| Vesting Date: | Exercise Price: | |||
July 26, 2008
|
$ | 26.10 | ||
July 26, 2009
|
$ | 27.40 | ||
OPTION EXERCISES AND STOCK VESTED IN 2007
The following table provides information for the named executive officers on stock option
exercises during 2007, including the number of shares acquired upon exercise and the value
realized.
| Option Awards | ||||||||
| Number | Value | |||||||
| of Shares | Realized | |||||||
| Acquired on | on | |||||||
| Exercise | Exercise | |||||||
| Name | (#) | ($) | ||||||
Jean-Pierre Vandromme |
— | — | ||||||
Alexander Vinogradov |
30,000 | $ | 1,440,000 | |||||
Boris Svetlichny |
— | — | ||||||
Kevin Cuffe |
— | — | ||||||
Michael Wilson |
— | — | ||||||
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POTENTIAL PAYMENTS UPON TERMINATION OR CHANGE OF CONTROL
Employment Agreements
As described in the Compensation Discussion and Analysis, each of the named executive officers
have severance clauses in their employment contracts and four of these executives, Messrs.
Vandromme, Vinogradov, Svetlichny and Cuffe have change of control clauses. The Board determined
that, in each case, the Merger constituted a change of control thus entitling Messrs. Vandromme,
Vinogradov, Svetlichny and Cuffe to receive certain change of control payments. As a result of the
Merger, Messrs. Cuffe, Svetlichny, Vandromme and Vinogradov were paid $652,000, $750,000, $1.27
million and $1.08 million, respectively, as change of control payments.
Mr. Vandromme’s Employment Agreement. Under Mr. Vandromme’s employment agreement, upon a
change of control, he is entitled to receive a lump sum cash payment equal to two times his annual
salary, plus a pro rata bonus payment, calculated assuming achievement of target levels. In
addition, upon a change of control, Mr. Vandromme would become 100% vested in any outstanding SARs
granted pursuant to his employment agreement which were not previously vested. To the extent
applicable, we also would make a tax gross-up payment to Mr. Vandromme to cover any excise taxes
that may be imposed under the U.S. Internal Revenue Code’s “golden parachute” rules. We determined
that no gross up would be payable under this provision upon consummation of the Offer and the
Merger. If terminated without cause, Mr. Vandromme is entitled to cash severance equal to a pro
rata share of his bonus, calculated assuming achievement of target levels. Subject to the execution
of a release of employment related claims, Mr. Vandromme would be entitled to receive additional
compensation in a lump sum amount equal to nine months’ salary and continuation of benefits for six
months.
Mr. Vinogradov’s Employment Agreement. Under Mr. Vinogradov’s employment agreement, upon a
change of control, he is entitled to receive a lump sum cash payment equal to two times his annual
salary. If terminated without cause, Mr. Vinogradov is entitled to cash severance equal to a pro
rata share of his bonus. Subject to the execution of a release of employment related claims, Mr.
Vinogradov would be entitled to receive additional compensation equal to nine months’ salary and
continuation of benefits for nine months.
Mr. Svetlichny’s Employment Agreement. Under Mr. Svetlichny’s employment agreement, upon a
change of control, he is entitled to receive a lump sum cash payment equal to two times his annual
salary, plus a pro rata bonus payment, calculated assuming achievement of target levels. To the
extent applicable, we also would make a tax gross-up payment to Mr. Svetlichny to cover any excise
taxes that may be imposed under the U.S. Internal Revenue Code’s “golden parachute” rules. We
determined that no gross up will be payable under this provision upon consummation of the Offer and
the Merger. If terminated without cause, Mr. Svetlichny is entitled to cash severance equal to a
pro rata share of his annual target bonus, calculated assuming achievement of target levels.
Subject to the execution of a release of employment related claims, Mr. Svetlichny would be
entitled to receive additional compensation in the amount of nine months’ salary and continuation
of benefits (or cost of continuation) for six months.
Mr. Cuffe’s Employment Agreement. Under Mr. Cuffe’s employment agreement, upon a change of
control, he is entitled to receive a lump sum cash payment equal to two times his annual salary,
plus a pro rata bonus payment, calculated assuming achievement of target levels. To the extent
applicable, we also would make a tax gross-up payment to Mr. Cuffe to cover any excise taxes that
may be imposed under the U.S. Internal Revenue Code’s “golden parachute” rules. We determined that
no gross up would be payable under this provision upon consummation of the Offer and the Merger. If
terminated without cause, Mr. Cuffe is entitled to cash severance equal to a pro rata share of his
annual target bonus, calculated assuming achievement of target levels. Subject to the execution of
a release of employment related claims, Mr. Cuffe would be entitled to receive additional
compensation in the amount of nine months’ salary and continuation of benefits (or cost of
continuation) for six months.
Mr. Wilson’s Employment Agreement. Under Mr. Wilson’s employment agreement, if terminated
without cause, he is entitled to cash severance equal to a pro rata share of his annual target
bonus. Subject to the execution of a release of employment related claims, Mr. Wilson would be
entitled to receive additional compensation in the amount of six months’ salary and continuation of
benefits for six months. Mr. Wilson does not have a change of control provision in his employment
agreement.
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Potential Payments Upon Termination of Employment or Change of Control. The following table sets
forth the value of cash compensation and other benefits that would become payable to our executive
officers assuming a change of control and termination of employment on December 31, 2007, given the
executive officers’ compensation and service levels as of such date.
| Severance Upon | ||||||||
| Termination by | Severance Upon | Severance Upon | ||||||
| Reason of Total | Termination by | Change of Control | Termination Without | |||||
| Name | Disability | Reason of Death | Cash Payment | Cause (1) | ||||
| $ | $ | $ | $ | |||||
Jean-Pierre Vandromme |
(2) | (3) | 1,700,000 | 554,167 | ||||
Alexander Vinogradov(4) |
(2) | (3) | 1,008,000 | 403,000 | ||||
Boris Svetlichny |
(2) | (3) | 905,625 | 309,422 | ||||
Kevin Cuffe |
(2) | (3) | 787,500 | 269,063 | ||||
Michael Wilson |
(2) | (3) | — | 231,668 |
| (1) | Reflects the amount of severance payable assuming termination of their respective employment agreements without cause, including the following amounts which are conditioned upon the execution of the releases referenced above: Mr. Vandromme, $450,000; Mr. Vinogradov, $378,000; Mr. Svetlichny, $271,688; Mr. Cuffe, $236,250; and Mr. Wilson, $211,140. | |
| (2) | We provide no special compensation upon a termination by reason of total disability. However, we will pay all salary earned prior to the date of termination; a pro rata share of any bonus for the fiscal year in which the total disability occurred; any benefits in which the employee is a participant to the full extent of the employee’s rights under such plans; and reimbursement of business and/or entertainment expenses incurred by the employee prior to termination with the exception of disability benefits, which shall continue to be paid from our insured long-term disability plan for the period specified by such plan. In the event there is a period of time in which the employee is not paid salary and does not receive long-term disability payments for any reason, the Compensation Committee shall decide, in its sole discretion, whether we shall make interim payments to the employee until the commencement of payments under the long-term disability plan. Assuming a December 31, 2007 date of termination by reason of total disability and a 100% payout of target bonuses, the following named executive officers would receive the following pro rata share of any bonus: Mr Vandromme, $500,000; Mr. Vinogradov, $120,000; Mr. Svetlichny, $181,125; Mr. Cuffe, $157,500; and Mr. Wilson, $98,532. Due to Russian legislation, Mr. Vinogradov will also be paid an additional two weeks salary in the approximate amount of $19,385. | |
| (3) | We provide no special compensation for any period after the employee’s death. However, we will pay to the employee’s beneficiary, to the degree earned but not paid prior to the date of the employee’s death, all salary; a pro rata share of any bonus for the fiscal year in which the death occurred; any benefits in which the employee is a participant to the full extent of the employee’s rights under such plans; and reimbursement of business and/or entertainment expenses incurred by the employee prior to termination. Assuming a December 31, 2007 date of termination by reason of death and a 100% payout of target bonuses, the following named executive officers would receive the following pro rata share of any bonus: $500,000; Mr. Vinogradov, $120,000; Mr. Svetlichny, $181,125; Mr. Cuffe, $157,500; and Mr. Wilson, $98,532. | |
| (4) | Upon expiration of the term of Mr. Vinogradov’s employment agreement, he is entitled to an amount equal to $378,000, representing nine months salary. Mr. Vinogradov shall also be entitled to receive continuation of benefits under our medical insurance plan for the earlier of nine months or until such time as Mr. Vinogradov receives comparable benefits from a new employer. |
Company Equity Awards and Change of Control. The following table sets forth the value of vested
stock options and SARs (together, “Company Equity Awards”) that (a) will be converted into the
right to receive an amount in cash upon the Merger, and (b) will accelerate and become exercisable
upon a change in control, assuming a December 31, 2007 change of control date as determined by the
Board.
| Company Equity | ||||||
| Awards That | ||||||
| Accelerate | ||||||
| Vested Company | Upon a Change of | |||||
| Name | Equity Awards | Control | Total | |||
| $ | $ | $ | ||||
Jean-Pierre Vandromme |
13,687,501 | 5,011,283 | 18,698,798 | |||
Alexander Vinogradov |
— | — | — | |||
Boris Svetlichny |
— | — | — | |||
Kevin Cuffe |
— | — | — | |||
Michael Wilson |
— | — | — |
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We also intend to pay special cash bonuses to certain eligible employees. Such bonuses will be
paid at the discretion of our Chief Executive Officer. Pursuant to the terms of the Merger
Agreement, the aggregate amount of the employee bonuses may not exceed $2.0 million, less the
amount of all fees paid as remuneration to members of the Special Committee, without the prior
written consent of VimpelCom. $1.25 million was paid in the aggregate to the members of the Special
Committee. Messrs. Smirnov, Svetlichny and Wilson will receive such bonuses in the amounts of
$17,500, $30,187, and $23,460, respectively.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Mr. Herman (Chair), Mr. Gallagher, Mr. Johnsen, Mr. Malis, and Mr. Smyth served on the
Compensation Committee during 2007. There were no Compensation Committee interlocks or insider
participation during 2007.
DIRECTOR COMPENSATION
Board of Directors Fees
Commencing with the election of new directors at the 2006 annual meeting of stockholders and
until the 2007 annual meeting of stockholders, there were two levels of Board fees with one level
for non-executive directors who are not affiliated with a significant stockholder in the total
amount of $100,000, and a second level for non-executive directors who are affiliated with a
significant stockholder in us in the total amount of $75,000. In April 2007, the Board increased
the basic Board fees for a non-executive director to a total amount of $120,000, with such amounts
effective from the May 2007 annual meeting of shareholders. In conjunction with the increase, fees
for attending meetings or executing consents were discontinued. The Board fees are paid seventy
percent in cash and thirty percent in the form of shares of restricted stock pursuant to the Equity
Plan that vest after one complete year of service as a director. The cash portion of the Board fees
is paid 50% within two weeks after the annual meeting at which directors are elected, and 50% by
the following November 30.
Committee Fees
The Chairman of three of the Board’s five committees, excluding the Nominating and Corporate
Governance Committee and the Special Committee, receives an annual fee of $15,000 for accepting the
additional responsibilities of chairing a Board committee. The Board resolved on April 19, 2007 to
increase the fees to be paid to Messrs. Gallagher and Smyth to $50,000 for their service on the
Executive Committee.
Upon formation of the Special Committee, the Board did not approve any special compensation of
members for service on the Special Committee; rather, the Board determined that compensation of the
Special Committee members would be determined by the Board based upon the time and effort expended
by the Special Committee members. The Board intended that such compensation would not be based upon
the successful completion of a transaction, but upon the extent to which the Special Committee
members performed additional services on behalf of us. The amount of $1.25 million determined by
the Board and was paid to members of the Special Committee without regard to the success of the
Offer.
The amount of Board fees and committee chairmanship fees paid to a director is subject to pro
rata adjustment and refund to us, at the discretion of the Board, in the event of a director’s
resignation prior to completion of his scheduled term of service to us. Stock options are
automatically granted to independent directors under the Equity Plan. However, each eligible
director waived his right to receive stock options in 2005, 2006 and 2007, with the exception of
Mr. Herman who received 2,500 options in 2005. We pay for non-employee directors’ accommodations
and business class travel to and from the meetings of the Board and of committees.
The current compensation program for non-executive directors is designed to compensate the
directors fairly for work performed for a company of our size.
2007 DIRECTOR COMPENSATION TABLE
| All Other | ||||||||||||||||
| Fees Earned or Paid | Compensation | |||||||||||||||
| Name | in Cash ($) | Stock Awards ($) | ($) | Total ($) | ||||||||||||
Peter Aven |
84,000 | 36,000 | (1) | — | 120,000 | |||||||||||
Vladimir Bulgak |
84,000 | 36,000 | (1) | 41,963 | (3) | 162,183 | ||||||||||
Patrick Gallagher |
134,000 | 36,000 | (1) | — | 170,000 | |||||||||||
Thor Halvorsen |
84,000 | 36,000 | (1) | — | 120,000 | |||||||||||
David Herman |
99,000 | 36,000 | (1) | — | 135,000 | |||||||||||
Kjell Johnsen |
99,000 | 36,000 | (1) | — | 135,000 | |||||||||||
Alexey Khudyakov(2) |
— | — | — | — | ||||||||||||
Oleg Malis |
84,000 | 36,000 | (1) | — | 120,000 | |||||||||||
Ronny Naevdal(2) |
— | — | — | — | ||||||||||||
Alexey Reznikovich |
84,000 | 36,000 | (1) | — | 120,000 | |||||||||||
David Smyth |
149,000 | 36,000 | (1) | — | 185,000 | |||||||||||
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| (1) | During 2007, the non-executive directors received 680 shares of our common stock under the Equity Plan. In accordance with FAS 123R, the grant date fair value was $52.93 per share. Fair value is calculated using the closing price of our common stock on the date of grant recognized over the vesting period, which is one year. | |
| (2) | Messrs. Khudyakov and Naevdal did not stand for re-election at the May 2007 annual meeting of shareholders. | |
| (3) | Included in this figure is the cost of an office in the amount of $32,385 and the hiring of a personal assistant our office in the amount of $10,428. |
ITEM 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters
EQUITY COMPENSATION PLAN INFORMATION
The following table provides information on securities that were authorized for issuance under
our equity compensation plans as of December 31, 2007.
| (a) | (b) | (c) | ||||||||||
| Number of securities | ||||||||||||
| remaining available | ||||||||||||
| for future issuance | ||||||||||||
| Number of securities | under equity | |||||||||||
| to be issued upon | Weighted-average | compensation plans | ||||||||||
| exercise of | exercise price of | (excluding securities | ||||||||||
| outstanding options, | outstanding options, | reflected in column | ||||||||||
| Plan category | warrants and rights | warrants and rights | (a)) | |||||||||
Equity compensation plans approved by security holders (1) |
936,858 | $ | 45.42 | 956,492 | ||||||||
Total |
936,858 | $ | 45.42 | 956,492 | ||||||||
| (1) | Includes the Equity Plan and the 2005 SAR Plan |
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
As of March 14, 2008, Lillian Acquisition, Inc. is the sole beneficial owner of our common
stock.
ITEM 13. Certain Relationships and Related Transactions
We adopted a written policy on related party transactions (“Related Person Policy”). Related
person transactions are those transactions in which we are a participant where the amount involved
exceeds $120,000 and a director, nominee for director, executive officer, holder of more than 5% of
our common stock or an immediate family member of any of the above has a direct or indirect
material interest. Under the Related Person Policy, transactions that fall within the definition
will be referred to the Audit Committee for its review, approval or ratification. Based on its
consideration of all factors it deems relevant and appropriate, the Audit Committee will decide
whether or not to approve such transaction and will only approve those transactions that are in our
best interests. A related person transaction entered into without the pre-approval of the Audit
Committee shall not be deemed to violate the Related Person Policy as long as the related person
transaction is ratified by the Audit Committee as soon as reasonably practicable after it is
entered into.
Our Code of Conduct provides guidance on potential conflicts of interest and provides guidance
as to how an individual should act so as to avoid any such conflicts of interest. We believe that
these policies and procedures ensure that all related person transactions requiring disclosure
under the SEC rules are appropriately reviewed and approved or ratified.
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TRANSACTIONS WITH RELATED PERSONS
Certain Transactions with Altimo and Telenor
Mr. Reznikovich is Chief Executive Officer and Mr. Malis is Senior Vice President of Altimo,
which beneficially owned approximately 26.6% of the outstanding shares of our common stock until
February 28, 2008. Both Mr. Reznikovich and Mr. Malis were directors of the Company. In the past,
companies in the Alfa Group Consortium have provided investment banking, corporate finance and
consulting services to the Company. On September 7, 2007, our subsidiary, Sovintel, entered into an
agreement for provision of consulting services with Altimo with a value of up to $2.0 million,
excluding Russian value added taxes. The aggregate amount of remuneration paid for services during
2007 under this agreement was $2.0 million.
On September 1, 2006, Sovintel entered a two-year agreement with a company in the Alfa Group
Consortium to provide Sovintel with property and liability insurance. The aggregate amount of
remuneration paid for services during 2007 under this agreement was $0.3 million. In 2007, one of
our subsidiaries, Dicom LLC, entered a similar agreement for property and liability insurance with
a company in the Alfa Group Consortium. The aggregate amount of remuneration paid for services
during 2007 under this agreement was $0.1 million.
Mr. Halvorsen is an Executive Vice President of Telenor ASA, which beneficially owned
approximately 18.3% of the outstanding shares of our common stock until February 28, 2008 and Mr.
Johnsen is Head of Telenor Russia and a Senior Vice President of Telenor Central & Eastern Europe
which is an affiliate of Telenor. We entered into commercial arrangements in the ordinary course of
business with affiliates of Altimo, Telenor and Rostelecom. Rostelecom beneficially owned
approximately 10.9% of the outstanding shares of our common until February 28, 2008. In the regular
course of business, we enter into infrastructure, settlement and other operational contracts with
Rostelecom. During the period from January 1, 2007 through December 31, 2007, we incurred costs
from Rostelecom and Telenor under such contracts of approximately $43.8 million and $0.3 million,
respectively. We believe that the arrangements with these companies have been conducted on
commercially reasonable terms.
We maintain bank accounts with Alfa Bank, an affiliate of Altimo, which acts as one of the
clearing agents for the payroll of our Russian staff. The balances at these bank accounts were
minimal at December 31, 2007.
Certain Transactions with Family Members
We maintain bank accounts with International Moscow Bank. The spouse of our President was a
member of the Executive Board of Directors of International Moscow Bank until October 1, 2007. The
amount on deposit was approximately $7.4 million at December 31, 2007.
Mr. Malis’s brother is the General Director of ZAO Cortec and subsidiaries (together,
“Corbina”). We acquired a 51% ownership interest in Corbina on May 28, 2007. Prior to the
acquisition, we received revenues and incurred costs from Corbina.
Shareholders Agreement
On December 1, 2003, our subsidiaries completed the purchase of OAO Comincom from Telenor. As
a result of the transaction, Telenor, an affiliate of Telenor ASA, acquired approximately 19.5% of
our then issued and outstanding shares of our common stock. Also in connection with the
transaction, we and certain of our significant shareholders entered into a shareholders agreement
dated as of August 19, 2003 (the “Shareholders Agreement”) which became effective upon the closing
of the transaction. The original parties to the Shareholders Agreement were we, Altimo (then known
as Alfa Telecom Limited (“Alfa”)), Telenor, Rostelecom, Capital International Global Emerging
Markets Private Equity Fund L.P. (“Capital”), Cavendish Nominees Limited and First NIS Regional
Fund SICAV (together with Cavendish Nominees Limited, “Barings”). Upon the acquisition by Sunbird
Limited (“Sunbird”) from Altimo of our common stock currently held by Sunbird, Sunbird executed an
endorsement agreeing to be bound by the terms of the Shareholders Agreement.
The Shareholders Agreement terminated in February 2008 following the Offer. Under its terms,
the Shareholders Agreement terminated automatically at the earlier of the date on which all parties
thereto agree to terminate the agreement or the date on which any person, individually or
collectively with its affiliates, owned more than fifty percent of the issued and outstanding
common stock.
The Shareholders Agreement placed limitations on the ability of a shareholder who was a party
thereto, together with any of its affiliates, to acquire, individually or together with its
affiliates, beneficial ownership of fifty percent (50%) or more of the issued and outstanding
shares of our common stock, other than pursuant to a “Tender Offer” as defined in the Shareholders
Agreement. For purposes of the Shareholders Agreement, a “Tender Offer” was defined as an offer
made by a shareholder who was a party to the agreement or any of its affiliates to purchase any and
all of our issued and outstanding shares, which (subject to certain limitations in the event of
competing tender offers) was accepted by stockholders holding a simple majority of the issued and
outstanding shares of our common stock, excluding any shares of our common stock held by such
shareholder and its affiliates.
Except with respect to Tender Offers (as defined in the Shareholders Agreement), the
Shareholders Agreement restricted shareholders who were parties thereto and their affiliates from
engaging in business combinations with us without the prior approval of our Board, including the
affirmative vote of a majority of disinterested directors.
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The Shareholders Agreement further provided that, except with respect to Tender Offers (as
defined in the Shareholders Agreement), non-directed sales of shares effected through certain stock
exchanges or public offerings and transfers to controlled affiliates, until December 1, 2008, a
party to the Shareholders Agreement who held at least ten percent of the outstanding shares of
Common Stock wishing to transfer any shares of Common Stock is required first to give notice to
Altimo, Telenor, and Rostelecom, each of which had 30 days to offer to purchase for cash all (but
not less than all) of the offered shares of our common stock. If the offer was the same or higher
than the price set forth in the notice, then the transferor was obligated to transfer shares of our
common stock to the offeror.
Under the Shareholders Agreement, each party thereto agreed to certain rights, conditions and
limitations with respect to any direct or indirect sale, exchange, transfer, pledge, assignment,
distribution or other disposition, or issuance or creation of any option or any voting proxy,
voting trust or other agreement in respect of the Company, its management or any shares of our
common stock or other of our capital stock.
The Shareholders Agreement also afforded the parties thereto preemptive rights with respect to
issuances of securities, including our common stock, by us, so that their respective percentage
ownership may be maintained.
Registration Rights Agreements
We were a party to a Registration Rights Agreement dated as of August 19, 2003 among us,
Altimo (then known as Alfa), Telenor, Rostelecom, Capital and Barings. Under this Registration
Rights Agreement, each of Altimo, Telenor, Rostelecom and Barings had the right to request in
writing that we effect a registration under the Securities Act of 1933, as amended, to all or part
of our registrable securities held by such party. Each of Altimo, Telenor and Rostelecom is
entitled to two demand registrations. Each of Barings and Capital is entitled to one demand
registration.
We were a party to a registration rights agreement dated February 22, 2007 with Inure
Enterprises Ltd. (“Inure”). Under this registration rights agreement, Inure had the right to
request in writing that we effect a registration under the Securities Act of 1933, as amended, to
all or part (over 1,000,000) of our registrable securities held by Inure. Inure is entitled to two
demand registrations.
Confidentiality Agreements
On February 7, 2007, we and VimpelCom entered into a confidentiality agreement (the “First
Confidentiality Agreement”) in connection with discussions among the parties regarding the
potential coordination of business activities, including networks and sales operations, and
commercial opportunities of mutual interest (“Commercial Transactions”). The First Confidentiality
Agreement was superseded by a confidentiality agreement between us and VimpelCom dated October 15,
2007 (the “Second Confidentiality Agreement”) which was entered into in connection with the
exploration by the parties of a business combination transaction.
Under the First Confidentiality Agreement, as a condition to being furnished confidential
information of the other party, each of us and VimpelCom agreed, among other things, to hold in
strict confidence such confidential information and to use it only in connection with evaluating
Commercial Transactions.
Under the Second Confidentiality Agreement, as a condition to being furnished confidential
information of the other party, each of VimpelCom and we agreed, among other things, to keep such
information confidential and to use it only in connection with evaluating a potential transaction
between VimpelCom and us.
In addition, the parties agreed that for one year from the date of the Second Confidentiality
Agreement, subject to certain exceptions, the parties would not offer to hire or fire any person
currently or formerly employed by the other party directly or indirectly, solicit for employment or
hire any executive, officer or senior management employee of the other party or subsidiary thereof.
Both parties also agreed that, for a period of eighteen months after the date of the Second
Confidentiality Agreement, the parties and their controlled affiliates would not, directly or
indirectly, acquire or propose to acquire any securities of the other party, participate in any
solicitation of proxies to vote any securities of the other party, make any public announcement or
submit any proposal or offer for any extraordinary transactions involving control.
The Merger Agreement
The summary of the material terms of the Merger Agreement set forth in the Offer to Purchase
under the caption “SPECIAL FACTORS — The Merger Agreement” and the description of the conditions of
the Offer set forth in the Offer to Purchase under the caption “THE TENDER OFFER — 11. Certain
Conditions to the Offer” are incorporated herein by reference. The summary of the
127
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Merger Agreement and the description of the conditions of the Offer contained in the Offer to
Purchase are qualified in their entirety by reference to the Merger Agreement, a copy of which is
attached as Exhibit 2.1 to the our Current Report on Form 8-K filed with the SEC on December 21,
2007 and is incorporated herein by reference.
ITEM 14. Principal Accountant Fees and Services
Audit Fees. The fees for professional services rendered in connection with the audit of our 2007
and 2006 financial statements, the audit of our internal control over financial reporting as of
December 31, 2007 and 2006, and the review of the financial statements included in our 2007 and
2006 Forms 10-Q, from Ernst & Young were a total of $3,476,000 in 2007 and $1,590,000 in 2006.
These amounts also include statutory audits of certain subsidiaries, reviews of SEC filings and
accounting consultations.
Audit-Related Fees. Ernst & Young did not render professional audit-related services to us in 2007
and billed a total of $275,000 in 2006. Audit-related services generally include due diligence on
potential acquisitions.
Tax Fees. Ernst & Young’s fees for the years 2007 and 2006 for expatriate tax services were
$55,000 and $98,000, respectively.
All other fees. Ernst & Young’s fees for 2007 and 2006 for training courses were $70,000 and
$101,000, respectively.
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PART IV
ITEM 15. Exhibits and Financial Statement Schedules
a) The following documents are filed as part of this report:
| 1. | Financial Statements | ||
| The following consolidated financial statements of the Company are included as part of this document: | |||
| § | Report of Independent Registered Public Accounting Firm | ||
| § | Consolidated Balance Sheets as of December 31, 2006 and 2007 | ||
| § | Consolidated Statements of Operations for the years ended December 31, 2005, 2006 and 2007 | ||
| § | Consolidated Statements of Cash Flows for the years ended December 31, 2005, 2006 and 2007 | ||
| § | Consolidated Statements of Changes in Shareholders’ Equity for the years ended December 31, 2005, 2006 and 2007 | ||
| § | Notes to Consolidated Financial Statements |
| 2. | Consolidated Financial Statement Schedules |
We have furnished Schedule II — Valuation and Qualifying Accounts on Page 132.
All other schedules are omitted because they are not applicable or not required, or because
the required information is either incorporated herein by reference or included in the
financial statements or notes thereto included in this report.
b) Exhibits
| Exhibit Number | Description of Exhibit | |
3.1
|
Amended and Restated Certificate of Incorporation of Golden Telecom, Inc. (Incorporated by reference to Exhibit 3.1 to the Company’s current report on Form 8-K dated February 29, 2008). | |
3.2
|
Amended and Restated By-laws of Golden Telecom, Inc. (Incorporated by reference to Exhibit 3.2 to the Company’s current report on Form 8-K dated February 29, 2008). | |
4.1
|
Specimen certificate representing shares of Common Stock. (Incorporated by reference to Exhibit 4.1 to the Company’s registration statement on Form S-1 dated July 14, 1999 (Commission File No. 333-82791)). | |
10.1
|
Shareholders Agreement among Golden Telecom, Inc., Alfa Telecom Limited, Nye Telenor East Invest AS, OAO Rostelecom, Capital International Global Emerging Markets Private Equity Fund, L.P., Cavendish Nominees Limited and First NIS Regional Fund SICAV. (Incorporated by reference to Exhibit 99.7 to the Company’s current report on From 8-K dated August 19, 2003). | |
10.2
|
Registration Rights Agreement among Golden Telecom, Inc., Alfa Telecom Limited, Nye Telenor East Invest AS, OAO Rostelecom, Capital International Global Emerging Markets Private Equity Fund, L.P., Cavendish Nominees Limited and First NIS Regional Fund SICAV. (Incorporated by reference to Exhibit 99.5 to the Company’s current report on From 8-K dated August 19, 2003). | |
10.3
|
Golden Telecom, Inc. 1999 Equity Participation Plan. (Incorporated by reference to the Company’s definitive proxy statement on Form DEF-14A dated April 25, 2000). | |
10.4
|
Amendment to the Golden Telecom, Inc. 1999 Equity Participation Plan. (Incorporated by reference to the Company’s definitive proxy statement on Form DEF-14A dated May 23, 2001). | |
10.5
|
Amendment to the Golden Telecom, Inc. 1999 Equity Participation Plan. (Incorporated by reference to the Company’s definitive proxy statement on Form DEF-14A dated April 27, 2007). |
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Table of Contents
| Exhibit Number | Description of Exhibit | |
10.6
|
Form of Stock Option Award Agreement. (Incorporated by reference to Exhibit 10.8 to the Company’s annual report on Form 10-K for the year ended December 31, 2004). | |
10.7(a)
|
Golden Telecom, Inc. 2005 Stock Appreciation Rights Plan. (Incorporated by reference to Exhibit 10.1 to the Company’s current report on Form 8-K dated November 22, 2005). | |
10.7(b)
|
Amendment to the Golden Telecom, Inc. 2005 Stock Appreciation Rights Plan. (Incorporated by reference to Exhibit 10.1 to the Company’s current report on Form 8-K dated December 12, 2005). | |
10.8(a)
|
Form of Award Agreement under the Golden Telecom, Inc. 2005 Stock Appreciation Rights Plan. (Incorporated by reference to Exhibit 10.2 to the Company’s current report on Form 8-K dated November 22, 2005). | |
10.8(b)
|
Amended Form of Award Agreement under the Golden Telecom, Inc. 2005 Stock Appreciation Rights Plan. (Incorporated by reference to Exhibit 10.2 to the Company’s current report on Form 8-K dated December 12, 2005). | |
10.9
|
EDN Sovintel 2005 Stock Appreciation Rights Bonus Plan. (Incorporated by reference to Exhibit 10.3 to the Company’s current report on Form 8-K dated November 22, 2005). | |
10.10
|
Form of Award Agreement under the EDN Sovintel 2005 Stock Appreciation Bonus Rights Plan. (Incorporated by reference to Exhibit 10.4 to the Company’s current report on Form 8-K dated November 22, 2005). | |
10.11
|
Employment Agreement between Golden Telecom, Inc. and Jean-Pierre Vandromme, Chief Executive Officer. (Incorporated by reference to Exhibit 99.2 to the Company’s current report on Form 8-K dated July 18, 2005). | |
10.13(a)
|
Employment Agreement between Golden TeleServices, Inc. and Alexander Vinogradov, President. (Incorporated by reference to Exhibit 10.5 to the Company’s annual report on Form 10-K for the year ended December 31, 2004). | |
10.13(b)
|
Amendment No. 1 to Employment Agreement between Golden TeleServices, Inc. and Alexander Vinogradov, President. (Incorporated by reference to Exhibit 10.1 to the Company’s current report on Form 8-K dated October 24, 2005). | |
10.14
|
Employment Agreement between Golden Telecom, Inc. and Boris Svetlichny, Senior Vice-President, Chief Financial Officer and Treasurer. (Incorporated by reference to Exhibit 10.1 to the Company’s current report on Form 8-K dated January 26, 2006). | |
10.15
|
Employment agreement between Golden Telecom, Inc. and Ilya Smirnov, Vice President, General Counsel and Corporate Secretary. (Incorporated by reference to Exhibit 10.14 to the Company’s annual report on Form 10-K for the year ended December 31, 2006). | |
10.16*
|
Schedule of Compensation Arrangements with Directors. | |
10.17
|
Facility Agreement, dated January 25, 2007, entered into by Golden Telecom, Inc., GTS Finance, Inc., and EDN Sovintel LLC with Lenders, Citibank N.A. London Branch and ING Bank N.W. as mandated lead arrangers and Citibank International plc as agent. (Incorporated by reference to Exhibit 10.1 to the Company’s current report on Form 8-K dated January 25, 2007) as amended on March 22, 2007 and November 21, 2007 and incorporated by reference to Exhibits 10.1 to the Company’s current reports on Form 8-K dated March 22, 2007 and November 20, 2007, respectively. | |
10.18
|
Stock Purchase Agreement, dated as of February 22, 2007, by and among EDN Sovintel LLC, Golden Telecom, Inc., Inure Enterprises Ltd., and Rambert Management Limited. (Incorporated by reference to Exhibit 10.1 to the Company’s current report on Form 8-K dated February 22, 2007). | |
10.19
|
Registration Rights Agreement, dated as of February 22, 2007, by and between Golden Telecom, Inc. and Inure Enterprises Ltd. (Incorporated by reference to Exhibit 10.2 to the Company’s current report on Form 8-K dated February 22, 2007). | |
10.20*
|
Shareholders’ Agreement, dated as of February 22, 2007, by and among EDN Sovintel LLC, SFMT-CIS, Inc., Inure Enterprises Ltd., and ZAO Cortec and as amended on December 11, 2007. |
130
Table of Contents
| Exhibit Number | Description of Exhibit | |
10.21
|
Agreement and Plan of Merger, dated as of December 21, 2007, by and among the Company, VimpelCom Finance B.V. and Lillian Acquisition, Inc. (Incorporated by reference to Exhibit 2.1 to the Company’s current report on Form 8-K dated December 21, 2007). | |
10.22
|
Subordination Deed dated February 28, 2008 among the Company, Open Joint Stock Company “Vimpel-Communications” and Citibank International plc as agent (Incorporated by reference to Exhibit 10.1 to the Company’s current report on Form 8-K dated February 29, 2008) | |
21.1*
|
List of subsidiaries of Golden Telecom, Inc. | |
24.1*
|
Powers of Attorney (included on signature page). | |
31.1*
|
Certification of the Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
31.2*
|
Certification of the Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
32.1*
|
Certification of the Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
32.2*
|
Certification of the Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
| * | Filed herewith. |
131
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SIGNATURES
Pursuant to the requirements of the Section 13 or 15(d) of the Securities Exchange Act 1934,
as amended, the registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of Moscow, Russian Federation, on this 17th day
of March 2008.
| GOLDEN TELECOM, INC. (Registrant) |
||||||
| By: Name: |
/s/ BORIS SVETLICHNY
|
|||||
| Title: | Senior Vice President, Chief Financial Officer and Treasurer (Principal Financial Officer) |
|||||
| By: | /s/ MICHAEL D. WILSON
|
|||||
| Name: | Michael D. Wilson | |||||
| Title: | Vice President and Corporate Controller (Principal Accounting Officer) |
|||||
We, the undersigned officers and directors of Golden Telecom, Inc. hereby severally constitute
and appoint, Boris Svetlichny, Ilya Smirnov and Michael Wilson and each of them singly, as his true
and lawful attorney-in-fact and agents with full power of substitution and resubstitution, for him,
and in his name, place and stead, in any and all capacities to sign any and all amendments and
supplements to this annual report on Form 10-K and all amendments thereto, and to file the same,
with all exhibits thereto, and all other documents in connection therewith, in each case, with our
names and on our behalf in our capacities as officers and directors to enable Golden Telecom, Inc.
to comply with the provisions of the Securities Exchange Act of 1934, as amended, and all
requirements of the Securities and Exchange Commission, hereby ratifying and confirming our
signatures as they may be signed by our said attorney to said annual report on Form 10-K and any
and all amendments thereto.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons in the capacities indicated
| Signature | Title | Date | ||
/s/ JEAN-PIERRE VANDROMME
|
Chief Executive Officer and Director (Principal Executive Officer) | March 17, 2008 | ||
/s/ PETER COVELL
|
Director | March 17, 2008 | ||
/s/ PATRICK GALLAGHER
|
Director | March 17, 2008 | ||
/s/ ALEXANDER GERSH
|
Director | March 17, 2008 | ||
/s/ DAVID HERMAN
|
Director | March 17, 2008 | ||
/s/ DMITRY A. PLESKONOS
|
Director | March 17, 2008 | ||
| Director | ||||
/s/ BORIS SVETLICHNY
|
Senior Vice President, Chief
Financial Officer and Treasurer (Principal Financial Officer) |
March 17, 2008 | ||
/s/ MICHAEL D. WILSON
|
Vice President and Corporate Controller (Principal Accounting Officer) | March 17, 2008 |
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Table of Contents
SCHEDULE II — VALUATION AND QUALIFYING ACCOUNTS
Golden Telecom, Inc.
| COL. A | COL. B | COL. C | COL. D | COL. E | ||||||||||||||||
| Additions | ||||||||||||||||||||
| Balance at | Charged to | Reserves | Balance at | |||||||||||||||||
| Beginning | Costs and | From | End | |||||||||||||||||
| Description | of Period | Expenses | Acquisitions | Deductions | of Period | |||||||||||||||
Allowance for doubtful accounts at
12/31/07 |
25,224 | 5,277 | 4,122 | (7,671 | ) | 26,952 | ||||||||||||||
Allowance for doubtful accounts at
12/31/06 |
27,327 | 4,128 | — | (6,231 | ) | 25,224 | ||||||||||||||
Allowance for doubtful accounts at
12/31/05 |
23,205 | 7,967 | 53 | (3,898 | ) | 27,327 | ||||||||||||||
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Table of Contents
EXHIBIT INDEX
| Exhibit Number | Description of Exhibit | |
3.1
|
Amended and Restated Certificate of Incorporation of Golden Telecom, Inc. (Incorporated by reference to Exhibit 3.1 to the Company’s current report on Form 8-K dated February 29, 2008). | |
3.2
|
Amended and Restated By-laws of Golden Telecom, Inc. (Incorporated by reference to Exhibit 3.2 to the Company’s current report on Form 8-K dated February 29, 2008). | |
4.1
|
Specimen certificate representing shares of Common Stock. (Incorporated by reference to Exhibit 4.1 to the Company’s registration statement on Form S-1 dated July 14, 1999 (Commission File No. 333-82791)). | |
10.1
|
Shareholders Agreement among Golden Telecom, Inc., Alfa Telecom Limited, Nye Telenor East Invest AS, OAO Rostelecom, Capital International Global Emerging Markets Private Equity Fund, L.P., Cavendish Nominees Limited and First NIS Regional Fund SICAV. (Incorporated by reference to Exhibit 99.7 to the Company’s current report on From 8-K dated August 19, 2003). | |
10.2
|
Registration Rights Agreement among Golden Telecom, Inc., Alfa Telecom Limited, Nye Telenor East Invest AS, OAO Rostelecom, Capital International Global Emerging Markets Private Equity Fund, L.P., Cavendish Nominees Limited and First NIS Regional Fund SICAV. (Incorporated by reference to Exhibit 99.5 to the Company’s current report on From 8-K dated August 19, 2003). | |
10.3
|
Golden Telecom, Inc. 1999 Equity Participation Plan. (Incorporated by reference to the Company’s definitive proxy statement on Form DEF-14A dated April 25, 2000). | |
10.4
|
Amendment to the Golden Telecom, Inc. 1999 Equity Participation Plan. (Incorporated by reference to the Company’s definitive proxy statement on Form DEF-14A dated May 23, 2001). | |
10.5
|
Amendment to the Golden Telecom, Inc. 1999 Equity Participation Plan. (Incorporated by reference to the Company’s definitive proxy statement on Form DEF-14A dated April 27, 2007). | |
10.6
|
Form of Stock Option Award Agreement. (Incorporated by reference to Exhibit 10.8 to the Company’s annual report on Form 10-K for the year ended December 31, 2004). | |
10.7(a)
|
Golden Telecom, Inc. 2005 Stock Appreciation Rights Plan. (Incorporated by reference to Exhibit 10.1 to the Company’s current report on Form 8-K dated November 22, 2005). | |
10.7(b)
|
Amendment to the Golden Telecom, Inc. 2005 Stock Appreciation Rights Plan. (Incorporated by reference to Exhibit 10.1 to the Company’s current report on Form 8-K dated December 12, 2005). | |
10.8(a)
|
Form of Award Agreement under the Golden Telecom, Inc. 2005 Stock Appreciation Rights Plan. (Incorporated by reference to Exhibit 10.2 to the Company’s current report on Form 8-K dated November 22, 2005). | |
10.8(b)
|
Amended Form of Award Agreement under the Golden Telecom, Inc. 2005 Stock Appreciation Rights Plan. (Incorporated by reference to Exhibit 10.2 to the Company’s current report on Form 8-K dated December 12, 2005). | |
10.9
|
EDN Sovintel 2005 Stock Appreciation Rights Bonus Plan. (Incorporated by reference to Exhibit 10.3 to the Company’s current report on Form 8-K dated November 22, 2005). | |
10.10
|
Form of Award Agreement under the EDN Sovintel 2005 Stock Appreciation Bonus Rights Plan. (Incorporated by reference to Exhibit 10.4 to the Company’s current report on Form 8-K dated November 22, 2005). | |
10.11
|
Employment Agreement between Golden Telecom, Inc. and Jean-Pierre Vandromme, Chief Executive Officer. (Incorporated by reference to Exhibit 99.2 to the Company’s current report on Form 8-K dated July 18, 2005). | |
10.13(a)
|
Employment Agreement between Golden TeleServices, Inc. and Alexander Vinogradov, President. (Incorporated by reference to Exhibit 10.5 to the Company’s annual report on Form 10-K for the year ended December 31, 2004). | |
Table of Contents
| Exhibit Number | Description of Exhibit | |
10.13(b)
|
Amendment No. 1 to Employment Agreement between Golden TeleServices, Inc. and Alexander Vinogradov, President. (Incorporated by reference to Exhibit 10.1 to the Company’s current report on Form 8-K dated October 24, 2005). | |
10.14
|
Employment Agreement between Golden Telecom, Inc. and Boris Svetlichny, Senior Vice-President, Chief Financial Officer and Treasurer. (Incorporated by reference to Exhibit 10.1 to the Company’s current report on Form 8-K dated January 26, 2006). | |
10.15
|
Employment agreement between Golden Telecom, Inc. and Ilya Smirnov, Vice President, General Counsel and Corporate Secretary. (Incorporated by reference to Exhibit 10.14 to the Company’s annual report on Form 10-K for the year ended December 31, 2006). | |
10.16*
|
Schedule of Compensation Arrangements with Directors. | |
10.17
|
Facility Agreement, dated January 25, 2007, entered into by Golden Telecom, Inc., GTS Finance, Inc., and EDN Sovintel LLC with Lenders, Citibank N.A. London Branch and ING Bank N.W. as mandated lead arrangers and Citibank International plc as agent. (Incorporated by reference to Exhibit 10.1 to the Company’s current report on Form 8-K dated January 25, 2007) as amended on March 22, 2007 and November 21, 2007 and incorporated by reference to Exhibits 10.1 to the Company’s current reports on Form 8-K dated March 22, 2007 and November 20, 2007, respectively. | |
10.18
|
Stock Purchase Agreement, dated as of February 22, 2007, by and among EDN Sovintel LLC, Golden Telecom, Inc., Inure Enterprises Ltd., and Rambert Management Limited. (Incorporated by reference to Exhibit 10.1 to the Company’s current report on Form 8-K dated February 22, 2007). | |
10.19
|
Registration Rights Agreement, dated as of February 22, 2007, by and between Golden Telecom, Inc. and Inure Enterprises Ltd. (Incorporated by reference to Exhibit 10.2 to the Company’s current report on Form 8-K dated February 22, 2007). | |
10.20*
|
Shareholders’ Agreement, dated as of February 22, 2007, by and among EDN Sovintel LLC, SFMT-CIS, Inc., Inure Enterprises Ltd., and ZAO Cortec and as amended on December 11, 2007. | |
10.21
|
Agreement and Plan of Merger, dated as of December 21, 2007, by and among the Company, VimpelCom Finance B.V. and Lillian Acquisition, Inc. (Incorporated by reference to Exhibit 2.1 to the Company’s current report on Form 8-K dated December 21, 2007). | |
10.22
|
Subordination Deed dated February 28, 2008 among the Company, Open Joint Stock Company “Vimpel-Communications” and Citibank International Plc as agent (Incorporated by reference to Exhibit 10.1 to the Company’s current report on Form 8-K dated February 29, 2008) | |
21.1*
|
List of subsidiaries of Golden Telecom, Inc. | |
24.1*
|
Powers of Attorney (included on signature page). | |
31.1*
|
Certification of the Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
31.2*
|
Certification of the Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
32.1*
|
Certification of the Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
32.2*
|
Certification of the Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
| * | Filed herewith. |