| GOLDEN TELECOM INC ITEM 1A Risk Factors Factors That May Adversely Affect Future Results Risks Associated With Doing Business in Russia, Ukraine and Other Countries of the CIS We generate substantially all our revenues from operations in Russia, Ukraine and other countries of the CIS All companies operating in the CIS, including us, face significant political, economic, regulatory, legal and tax risks, some of which are described below |
| Political instability in the countries in which we operate could depress foreign and local investment and spending, which could adversely affect our results of operations Since the dissolution of the Soviet Union in December 1991, Russia, Ukraine and other countries in which we operate have, to varying degrees, been undergoing significant political and economic transformation |
| A generally stable political climate has emerged but economic development remains hampered by the absence of a consistent and comprehensive legislative framework necessary to implement and enforce market oriented reforms and by incidents of corruption among government officials |
| A re-occurrence of the political instability that characterized the first several years of the transformation could disrupt the direction and the pace of economic development |
| In addition, there has been terrorist activity in Russia from time to time |
| Political instability or terrorist activity could discourage foreign and local investment and spending, in which case demand for our services could decrease and results of operations could deteriorate |
| If this were to occur, then the market price of our stock could decrease |
| There is a volatile political situation in Ukraine which may negatively impact our business Historically, political and governmental instability has been a feature in Ukraine |
| The relationship between various state authorities, Ukrainian government policies and the political leaders who formulate and implement such policies is subject to rapid change |
| In January 2005 Victor Yuschenko became president of Ukraine in a very divisive election |
| It is unclear whether and in what way current domestic and external policy will continue to change under President Yuschenko’s administration |
| Constitutional reform that became a point of consensus at the height of the Orange Revolution came into force on January 1, 2006 |
| The reform passes more power to the legislative body by allowing it to form a Government except for the Defense Minister and the Minister for Foreign Affairs whose appointment remains at the President’s discretion |
| Results of the reform will become clear when a new Parliament is formed as a result of the elections scheduled for March 26, 2006 |
| Major changes in the political climate in Ukraine, in particular any changes affecting the stability of the Ukrainian government, reforms, privatization, industrial restructuring or administrative reform, could materially effect our operations |
| Economic instability in Russia and Ukraine could adversely affect the demand for our services and our ability to collect on our invoices Although the Russian and Ukrainian economies have experienced periods of economic downturn and heavy inflation, the political and economic situation in Russia and Ukraine appears to have stabilized |
| Russia ceased to be highly inflationary in 2003 |
| However, any future instability or lack of economic growth in the countries in which we operate could mean that demand for our services could become depressed |
| Recently, the Russian economy has experienced positive trends, such as the increase in the gross domestic product, a relatively stable ruble, strong domestic demand, rising real wages and a reduced rate of inflation, however, these trends may not continue or may be abruptly reversed |
| During the first decade of its independence Ukraine had been dependent on the receipt of financial assistance from several foreign governments and international organizations, including the International Monetary Fund (“IMF”) and the World Bank |
| In 2000, faced with a liquidity crisis on its external debt payments, the Ukrainian government undertook a comprehensive debt restructuring exercise that enabled Ukraine to meet its external debt obligations |
| Ukraine continues to pursue a closer relationship with the North Atlantic Treaty Organization, joining the World Trade Organization (“WTO”) and becoming an associate member of the European Union |
| However, recently Russia, Ukraine and a number of other CIS countries have signed an agreement on creation of the Common Economic Area (“CEA”) |
| Formation of the CEA was negatively regarded by the IMF and international society and might be a drawback to Ukraine’s joining the WTO Any major changes in Ukraine’s relations with Western governments and institutions may adversely affect the Ukrainian economy and our operations |
| 29 _________________________________________________________________ [82]Table of Contents The currency control system of Russia and Ukraine could adversely affect our ability to convert rubles and hryvna’s to hard currency and manage cash flows The ruble and hryvna are generally non-convertible outside Russia and Ukraine, respectively, so our ability to protect ourselves against devaluation by converting to other currencies is significantly limited |
| Within Russia and Ukraine, our ability to convert rubles and hryvna, respectively, into other currencies is subject to rules that restrict the purposes for which conversion and payment in foreign currencies are allowed |
| In Ukraine, companies are allowed to keep balances in foreign currencies earned from export activities |
| Therefore, the liquidity can be supported through synchronization of in- and outflows denominated in the same currency |
| We manage intercompany liquidity through intercompany loans to our subsidiaries |
| Under Russian restated currency law, loans to residents may be subject to reserve requirements |
| Likewise, such reserve requirements may be introduced for the purchases of currency by Russian residents |
| Such reserve requirements, if they become applicable to us, may adversely affect our operations |
| If there are changes to the currency control systems in Russia and Ukraine, our ability to manage our liquidity position and our currency risk may be adversely affected |
| The Russian banking and financial system remains underdeveloped, and another banking crisis could place liquidity constraints on our business and adversely affect our financial condition Russia’s banking and other financial systems are not well developed or regulated, and Russian legislation relating to banks and bank accounts is subject to varying interpretations and inconsistent applications |
| Most Russian banks do not meet international banking standards, and the transparency of the Russian banking sector still lags far behind internationally accepted norms |
| As a result, the banking sector remains subject to periodic instability |
| Most recently, in May 2004, the Central Bank of Russia withdrew the banking license of Sodbusinessbank for violating anti-money laundering laws |
| This event, together with rumors of possible withdrawals of licenses of other banks, led to the destabilization of the Russian interbank loan market in June 2004, which in turn resulted in a temporary broader loss of confidence in the Russian banking system |
| The loss of confidence resulted in a large number of depositors withdrawing their bank deposits, causing temporary liquidity problems throughout the whole banking system, as a result of which several Russian banks limited or suspended their operations |
| The Central Bank of Russia undertook a number of steps towards stabilizing the banking sector, such as reducing the reserve requirements and expanding governmental deposit guarantees, and the Russian banking sector has since stabilized |
| However, another banking crisis, or the bankruptcy or insolvency of banks through which we receive or with which we hold funds, could result in the loss of our deposits or adversely affect our ability to complete banking transactions in Russia, which could have an adverse effect on our business and operations |
| Russian and Ukrainian telecommunications policies could affect our competitive position Russian and Ukrainian telecommunications regulations govern the procurement and continuing validity of our licenses and the terms and conditions under which we provide services |
| Adverse changes to these regulations may make it prohibitively expensive for us to provide services or otherwise frustrate the implementation of our business plans causing a material adverse effect on our results of operations |
| As a result of changes in existing regulations, changes in interpretations of existing regulations or arbitrary regulatory decisions affecting various aspects of our business, we could experience: • Restrictions on how and where we can provide our services; • Restrictions or delays in receiving approvals on our applications and communications for necessary regulatory approvals for rolling out our network in the regions for which we have licenses; • Significant additional costs; • Delays in implementing our operating or business plans; or • Increased competition |
| A new Telecommunications Law came into effect in Russia on January 1, 2004 |
| However, some of the supporting regulations have not been enacted |
| Until such time as supporting regulations for the Telecommunications Law are enacted, we cannot predict with any certainty how the Telecommunications Law will affect us |
| See “Our Licenses and Network Facilities” for a discussion of the effect of the Telecommunications Law on our business and our new DLD/ILD license and the creation of our own FTN designed to satisfy the requirements of our new license |
| 30 _________________________________________________________________ [83]Table of Contents Given the absence of the regulations there is uncertainty with regard to tariffs for connection and transit of traffic for dominant operators |
| The level of these tariffs will directly affect the cost of our business as well as the fees for our services for connection and traffic transit |
| We, therefore, may not be in compliance with the conditions of our new license until we obtain and promulgate our network codes |
| We are currently able to provide DLD/ILD services under our prior existing licenses |
| The Russian Ministry of Telecommunications may increase the regulation of our operations and, until such time as appropriate regulations consistent with the Telecommunications Law are promulgated, there will be a period of confusion and ambiguity as regulators interpret the legislation |
| It is expected that representatives from the Russian Ministry of Telecommunications will conduct consultations with the significant operators in March 2006 |
| However, such confusion adversely affects the functioning of our business and potentially creates claims that we are not in compliance with the new regulations, effective from January 1, 2006 |
| Recently, the Russian government has issued implementing acts under the Telecommunications Law, excluding telematics services altogether from the list of permitted services |
| However, it is not yet clear how these regulations would be implemented |
| Thus, uncertainty related to the Telecommunications Law continues |
| See “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 and new numbering capacity and interconnect rules |
| Any changes in regulations, costs or confusion from the Telecommunications Law may affect our business Recently adopted regulations show that the telecommunications business is phasing in substantial changes |
| For example, new regulations provide that operators providing zonal services within the same geographical area code should have their own zonal networks within such zone |
| We may not be in full compliance with these new regulations |
| Recently adopted regulations will prevent mobile operators from using local area codes, which may result in us losing part of the traffic from mobile operators |
| We cannot predict how much time it will take to fully implement these changes and such changes will largely depend on regulatory agencies |
| Any changes in regulations could cause our business to suffer |
| The Telecommunications Law and regulations provide scope for the incumbent operators to raise access costs The Telecommunications Law and regulations do not contain provisions for state regulation of access to communication facilities and the lease of long distance channels |
| Some of our suppliers of telecommunications services have raised their charges with us and we may experience more such cost increases in the future |
| In the event that we decide to challenge such actions of our suppliers through the appropriate Russian government ministries or courts, we cannot predict whether we will be successful in such challenge |
| In addition to that, the Interconnection Rules do not contain provisions for state regulations of interconnect costs charged by non-dominant operators |
| Effective January 1, 2006, one of our suppliers introduced charges for incoming calls from our customers on dial-up Internet access numbers |
| Introduction of similar charges by all non-dominant operators could materially affect our dial-up Internet operations |
| We are examining this situation and evaluating potential legal recourse |
| Our operating licenses may not clearly authorize us to provide all of the services that we offer The licensing and regulatory regime in Russia, Ukraine, and the markets in which we operate frequently do not keep pace with the technological advances in the telecommunications industry |
| Further, a great deal of ambiguity exists in regard to the interpretation of licenses and the application of rules and regulations in regard to our new services, especially those new services enabled by technological developments in telecommunications infrastructure and software |
| Although our operating companies possess a wide range of licenses issued by the Russian and Ukrainian regulatory agencies, it is possible that the technical means by which we provide some of our services, or the service themselves, may be subject to licensing requirements or restrictions and that our existing licenses do not satisfy these requirements |
| In such events, we could be subject to fines, penalties or suspension, limitation or revocation of licenses |
| The suspension, limitation in scope or revocation of a significant license or the levying of substantial fines could have a material adverse effect on our operations and our financial results |
| Russian anti-trust policies may limit our ability to expand our businesses and to establish market rates for our service offerings The Federal Anti-Monopoly Service (“FAS”), the state agency responsible for establishing and enforcing the state’s anti-trust policies, adopted a policy decision whereby each licensed telecommunications operator, including our operating companies, may be classified as a “monopolist” |
| However, if the policy were to be successfully enforced, our operating companies could be subject to increased state regulation |
| Since our products are frequently priced at a premium in comparison with the products of state-owned incumbent operators, it is possible that we may be required to reduce our tariffs |
| Further, as we continue to expand our operations, we may be subject to increasing anti-trust restrictions imposed by the FAS For example, ADS has been classified as a monopolist in Nizhny Novgorod |
| Any such regulation of our pricing or restriction in operations could be detrimental to our financial results |
| The proposed revisions to the Russian antitrust law which were approved by the Russian government generally are intended to strengthen the position of the FAS and widen its authority as well as expand the types of activities that may be classified as subject to antitrust regulations |
| In particular, under the proposed law, if several independent companies control more than 50prca of a particular 31 _________________________________________________________________ [84]Table of Contents market, each of them may be declared as having a dominant position in the market |
| The adoption of this law may affect our operations |
| Special fees and taxes levied against telecommunications operators could adversely affect our results of operations From time to time, Ukrainian and Russian government officials seek to offset budgetary shortfalls by increasing levies extracted from the telecommunications industry |
| The provisions of the Telecommunications Law require that all Russian operators, including fixed-line operators, pay a portion of their revenues to the Universal Service Fund, which was established to support the provision of universal, multipurpose telecommunications services throughout the Russian Federation |
| The Telecommunications Law states that it will be funded by telecommunications service providers in an amount determined by the Russian government |
| These or other similar industry-specific pieces of legislation may have a material adverse effect on demand for our services and on our results of operations |
| Similarly, the results of our operations could deteriorate if the government introduces any new frequency or licensing fees substantially in excess of the amounts previously budgeted for such fees |
| Under new regulations, the Ukrainian regulatory agency may require licensees to pay similar annual amounts into local network development |
| If the additional amounts required will be substantial, we cannot predict whether the financial burden associated with compliance may be so burdensome as to cause a deterioration of our financial results |
| Moreover, in 2004 the State Committee on Telecommunications of Ukraine established new license conditions, which came into force on August 16, 2004 |
| Under these conditions, any reissue of existing fixed-voice licenses, even related to the change of a licensee’s legal address, may require payment of the full license fee |
| At present we cannot estimate how significantly these changes may impact our operations in Ukraine |
| Russian and Ukrainian legislation may not adequately protect against expropriation and nationalization The governments of Russia and Ukraine have enacted legislation to protect foreign investment and other property against expropriation and nationalization |
| In the event that our property is expropriated or nationalized, legislation provides for fair compensation |
| However, we cannot assure you that these protections would be enforced |
| This uncertainty is due to several factors, including: • The lack of state budgetary resources; • The lack of an independent judiciary and sufficient mechanisms to enforce judgments; and • Corruption among government officials |
| In particular, in Ukraine, there has been no established history of investor rights protection or responsibility to investors and in certain cases the courts may not enforce these rights |
| In the event courts enforced rights of investors granted under applicable Ukrainian legislation, the government and/or the legislature of Ukraine could attempt to overrule any such court decisions legislatively through retroactive legislative changes |
| Moreover, recently announced intentions of the newly appointed Ukrainian government to re-privatize certain enterprises, that may be considered as illegally privatized by the former government, may have an adverse effect on the Ukrainian investment climate |
| In addition, social instability in Russia, Ukraine and other CIS countries, coupled with difficult economic conditions, could lead to increased support for centralized authority and a rise in nationalism |
| These sentiments could lead to restrictions on foreign ownership of companies in the telecommunications industry or large-scale nationalization or expropriation of foreign-owned assets or businesses |
| Although we do not anticipate the nationalization or expropriation of our assets because we were not created as a result of privatization of any state enterprise, the concept of property rights is not well developed in the laws of these countries and there is not a great deal of experience in enforcing legislation enacted to protect private property against nationalization and expropriation |
| As a result, we may not be able to obtain proper redress in the courts, and we may not receive adequate compensation if in the future any local government decides to nationalize or expropriate some or all of our assets |
| We may be unable to enforce our rights due to ambiguity in the laws and legal structures of the countries where we operate Current ambiguity in Russian, Ukrainian and other CIS laws makes it difficult to determine if we would be able to enforce our rights in disputes with our venture partners or other parties |
| Furthermore, the dispersion of regulatory power among a number of government agencies in Russia, Ukraine and the other countries of the CIS has resulted in inconsistent or contradictory regulations and unpredictable enforcement |
| The Russian, Ukrainian and other CIS governments have rapidly introduced laws and regulations and have changed their legal structures in an effort to make their economies more market-oriented, resulting in considerable legal confusion, especially in areas of the law that directly affect our operations |
| We cannot assure you that local laws and regulations will become stable in the future |
| Our ability to provide services in Russia, Ukraine and other countries of the CIS could be adversely affected by difficulties in protecting and enforcing our rights and by future changes to local laws and regulations |
| Further, our ability to protect 32 _________________________________________________________________ [85]Table of Contents and enforce our rights is dependent on the Russian, Ukrainian and CIS courts which are underdeveloped, inefficient and, in places, corrupt |
| Enforcement of court orders can in practice be very difficult in Russia and Ukraine |
| Additionally, court orders are not always enforced or followed by law enforcement agencies |
| 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 |
| The tax regime in Russia has become less predictable following the recent cases involving Yukos and Vimpelcom |
| In addition, following recent ruling of the Constitutional Court regarding VAT, the tax authorities may be able to re-qualify the tax treatment of certain transactions using subjective criteria such as the intent or purpose of a transaction which creates further ambiguity in application of the tax laws |
| Similarly, Ukrainian tax law is unpredictable and 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 |
| The constitution prohibits retroactive legislation, and the Taxation System Law requires new tax laws to be adopted no later than six months prior to the beginning of the next fiscal year in which the new tax laws are to become effective |
| Nevertheless, sudden shifts in tax law and policy and retroactive legislation are common |
| For example, in January 2003, the Ukrainian Parliament adopted amendments to the Profits Tax Law which, in part, became effective as of January 1, 2003 |
| The law substantially changes the tax treatment of exchange rate differences, dividends, transfer pricing, goodwill and other transactions |
| Other amendments to the Profits Tax Law of Ukraine came into effect from January 1, 2004 |
| Although the profit tax rate was decreased from 30prca to 25prca, some adverse changes were introduced to the calculation of a taxable profit, such as new bad debts deductibility treatment |
| The impact of the law on our operations was positive so far, however, the future impact of the mentioned amendments is still uncertain because of ambiguities and inconsistencies in the law that allow different interpretations by the tax authorities |
| If our interpretation of the amendments differs from those of the local tax authorities, we might be subject to higher tax liability and/or additional fees and penalties |
| Russian and Ukrainian laws may expose us to liability for actions taken by our subsidiaries or venture entities Under Russian law, we may be jointly and severally liable for any obligations of a subsidiary or venture entity under a transaction if: • We have the ability to issue mandatory instructions to the subsidiary or venture entity and that ability is provided for by the charter of the subsidiary or venture entity or in a contract between us and them; and • The subsidiary or venture entity concluded the transaction pursuant to our mandatory instructions |
| In addition, we may have secondary liability for any obligations of a subsidiary or venture entity if: • The subsidiary or venture entity becomes insolvent or bankrupt due to our actions or our failure to act; and • We have the ability to make decisions for the subsidiary or venture entity as a result of our ownership interest, the terms of a contract between us and them, or in any other way |
| In either of these circumstances, the shareholders of the subsidiary or venture entity may seek compensation from us for the losses sustained by the subsidiary or a venture entity if we knew that the action taken pursuant to our instructions or the failure to act would result in loss |
| This type of liability could result in significant obligations and adversely affect our business |
| Under Ukrainian laws, we may be held jointly and severally liable for any obligations of our Ukrainian subsidiaries if we fail to initiate bankruptcy proceedings with respect to such Ukrainian subsidiaries when required to do so by law |
| 33 _________________________________________________________________ [86]Table of Contents The implementation of Ukraine’s new Civil and Commercial Codes may cause instability of Ukrainian business legal enviroment In January 2003, a new Civil Code was enacted by the Ukrainian Parliament which sets forth new regulations in the areas of property law, copyright, industrial ownership and trademarks and replaces the existing Civil Code adopted in 1963 |
| Also in January 2003, the Parliament enacted a new Commercial Code which is intended to provide legal guidelines for economic activities and relationships in the market, by regulating the use of natural resources, the rights of industrial ownership and the use of securities and by defining the insurance, banking and auditing procedures |
| However, the documents contain controversial and often overlapping provisions |
| Until such time as a regulatory practice for interpretation of the new legislation is established and appropriate sub-legislation consistent with the new Codes is promulgated, their may be a period of confusion and ambiguity |
| Such confusion and ambiguity may materially adversely affect the Ukrainian market and negatively impact functioning of our business |
| Risks Associated with Our Business 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 |
| Reorganization of the Russian telecommunications industry may affect our competitive position Prior to 2002, Svyazinvest, a government-controlled holding entity, controlled Rostelecom and most of the other principal wire-line venture partners |
| In 2002, the telecommunications industry was restructured by merging almost all regional incumbent operators into seven inter-regional operating companies |
| With this consolidation, we may face stronger competition from these new entities |
| 34 _________________________________________________________________ [87]Table of Contents Further, with the consummation of the Sovintel transaction in 2002, in the future we may not have continued strong commercial relations with Rostelecom, given that they are no longer our partner in Sovintel |
| Further, if Svyazinvest is privatized, which may occur in 2006, it will have a substantial effect on the telecommunications market |
| The timing for transferring the profit side of the telephone network from long-distance to local service will also depend on the position of any new owner of Svyazinvest |
| Since Svyazinvest controls the biggest share of the market, any changes in this policy will directly affect the Company’s business |
| Further, the consolidation of all regional incumbent operators into seven inter-regional companies could affect our ability to expand into the various regions of Russia |
| In order to effectively compete, we may need to expend significant internal resources or acquire other technologies and companies to provide or enhance our capabilities |
| Reorganizations in the Ukrainian telecommunications sector may have strengthened the position of the monopoly incumbent and encouraged 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 intends to sell up to 49prca of Ukrtelecom’s shares in the near future |
| In anticipation of the privatization of Ukrtelecom, Ukrtelecom has been transferred back from the Ukrainian Telecommunications Committee to the State Property Fund |
| The new Ukrainian government is preparing Ukrtelecom for privatization in 2006 |
| It is expected that the Ukrainian government will continue to control at least 51prca of Ukrtelecom’s shares |
| This will allow the Ukrainian government to control Ukrtelecom and will afford the Ukrainian government the opportunity to further control the telecommunications industry through Ukrtelecom |
| The emergence of a single self-regulating Ukrainian telecommunications monopoly may have adverse financial consequences for us because: • We 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; • A single Ukrainian self-regulating monopoly is able to create favorable market conditions for itself and cause unfavorable conditions for us; • Our ability to negotiate reasonable interconnection agreements and rates may suffer; 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 |
| In addition, in 2001, we leased significant additional domestic and international capacity that we utilize for data transmission under long-term lease agreements that may be extended up to fifteen years |
| 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 TransTelecom 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 |
| Further, in light of the acquisition of the remaining 50prca ownership interest of Sovintel from Rostelecom in 2002, Rostelecom may have less incentive to continue to provide telecommunication services to us despite their significant shareholding in us |
| 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, TransTelecom, 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 |
| 35 _________________________________________________________________ [88]Table of Contents Our ability to provide our services is dependent on securing and maintaining interconnection agreements with Rostelecom, Ukrtelecom and other facilities providers Our ability to provide telecommunications services depends on our ability to secure and maintain interconnection agreements with Rostelecom, 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 2006 and 2014 |
| We have 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 |
| In Russia, we are dependent on Rostelecom for the provision of leased lines and/or interconnect circuits used to connect our points of interconnection to our network backbones |
| A failure by Rostelecom to provide such leased lines and/or interconnect circuits in accordance with our plans, or to satisfy our customers’ demands on certain routes, has in the past given rise to capacity constraints in our network on certain routes |
| While we believe that these capacity constraints have been eliminated, we may continue to experience capacity constraints until we increase the number of points of interconnection to our network, allowing us to route a greater proportion of traffic over our network |
| In Ukraine, we are, to a great extent, dependent on Ukrtelecom for the provision of leased lines and/or interconnect circuits used to connect our indirect access customers throughout Ukraine as well as to provide access to our network backbone in Russia |
| 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, could give rise to capacity constraints in our network on certain routes in Ukraine 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 increase, we will face increasing 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 |
| It is possible that the current economic difficulties and historical circumstances in Russia and Ukraine may create difficulties in maintaining our network |
| We rely to a significant degree on the Russian and Ukrainian networks being able 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 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 |
| Even if the 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 Commission for the Securities Market, are authorized to bring a lawsuit seeking liquidation of the company until the expiration of the relevant statute of limitation |
| Some of our subsidiaries had in the past negative net asset values which could make them subject to the legal requirement to adopt a plan of liquidation |
| Any voluntary or forced liquidation could have material adverse effect on our business |
| 36 _________________________________________________________________ [89]Table of Contents We may have difficulty scaling and adapting our existing architecture to accommodate increased traffic and technology advances Most of the telecommunication network architecture that we employ and the architecture 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 architecture, including moving to a completely new architecture, or we may be required to invest in order to upgrade local public networks |
| If we are required to switch architectures, 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 architecture or as a result of a change in architectures, users may become dissatisfied with our services and move to competing providers |
| Any loss of traffic, increased costs, inefficiencies or failures to adapt to new technologies and the associated adjustments to our architecture would 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 intensify |
| As we expand the scope of our offerings, we will compete directly with a greater number of competitors providing business services in the same markets |
| Negative competitive developments could have a material adverse effect on our business |
| Our competitors include incumbent Russian and Ukrainian operators and other large international telecommunications providers doing business in the CIS Our competitors may have substantially greater resources, closer ties to governmental authorities and longer operating histories |
| These advantages may give them a competitive edge over alternative providers like us |
| This competition may result in a loss of customers, falling prices and a decline in revenues |
| We are operating in recently liberalized markets in an evolving and highly competitive industry |
| We expect our competitors to continually improve their products and services while also reducing their 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, including its subsidiary, Rostelecom, and in Ukraine by Ukrtelecom, both being 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 that would give rise to increased competition for Rostelecom or Ukrtelecom |
| Recently, Comstar strengthened its position in the market by receiving approximately dlra1 billion as a result of its IPO MGTS is controlled by Comstar |
| As a result Comstar has an advantage in broadband access and has substantial funds that will probably be directed toward acquisitions of telecommunications businesses in Russia and the CIS Our partners are often also our competitors Notwithstanding the provisions of the agreements with our venture partners, such partners sometimes compete directly with our ventures |
| Competition with our venture partners in the same markets may create conflicts of interest and may result in deadlock in management and loss of customers |
| In 2002, we acquired the remaining 50prca ownership interest of Sovintel from Rostelecom, the dominant DLD/ILD carrier in Russia |
| As a result of this transaction, we directly compete with Rostelecom, a formerly Russian state-owned enterprise that previously was our partner in Sovintel |
| Similarly, most of our regional partners across Russia offer local and long distance services in competition with our local ventures and Sovintel |
| Our existing 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 |
| We have historically operated through distinct companies, but we are in the process of integrating our billing and 37 _________________________________________________________________ [90]Table of Contents management information systems so that we will be able to bill our customers and to manage other administrative tasks through a single system |
| If we are unable to integrate and upgrade our billing and management information systems to support our integrated operations, our billing may suffer which could have a material adverse effect on our revenues |
| In addition, in order to comply with the new regulations effective January 1, 2006, we will enter into service contracts with the local and intra-zonal operators, including Svyazinvest regional companies, to act as our regional agents for the provision of DLD/ILD services |
| In our operations outside Moscow and St |
| Petersburg, we will rely on our agents’ billing and information systems to provide information necessary to generate invoices |
| Thus, from January 1, 2006, we could be subject to risks associated with verification and calculation of volumes of long-distance services provided to end users, invoicing and revenue recognition |
| The absence in the regulations of a mandatory provision for local and intra-zonal network subscriber information to be shared with long-distance operators represents a substantial potential 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 |
| Amendments to relevant legislation giving operators the right to share the subscriber information without subscribers’ written consent have passed the first reading in the State Duma |
| However, until these amendments are enacted, our ability to obtain necessary subscriber information to bill and collect revenue could be impeded |
| Additionally, any damage to our network management center or our 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 |
| In our 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 |
| We may encounter difficulties in fully complying with applicable laws due to confusion 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 regularly 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 |
| 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 and expensive |
| 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 |
| Our telecommunications licenses may not be extended or may be suspended or revoked Our telecommunications licenses expire in various years from 2006 to 2013 |
| 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, interzonal and international telephone services are not renewed, our business could be adversely affected |
| In addition, new regulations adopted in furtherance of the Telecommunications Law, effective from January 1, 2006, provide that the Russian Ministry of Telecommunications may amend the conditions of the license, which can negatively affect our business by increasing our costs for providing telephone services |
| Depending on the growth of our business in the other license areas, the failure to have any other particular license renewed could also materially adversely affect our business |
| If we fail to completely fulfill specific terms of any of our telecommunications licenses related to line and operational capacity, 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, or in the case of continued non-compliance, initiate court proceedings for the revocation of our licenses |
| If any of our telecommunications licenses are suspended or 38 _________________________________________________________________ [91]Table of Contents terminated or if extensions requested are not granted and action is taken against our company or our subsidiaries, our business could be adversely affected |
| In addition, many of our telecommunications licenses have not been registered with local offices of the Russian Ministry of Telecommunications in the regions where we do not operate our own equipment |
| Although, the Russian Ministry of Telecommunications has informed us, in many cases only verbally, that we do not need a local registration until we start to operate our equipment in the area, failure to register contradicts the terms of our licenses |
| We cannot guarantee that the Russian Ministry of Telecommunications will maintain this position and will not take action against us for not registering our telecommunication licenses, which could have a negative impact on our business |
| 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 license 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 that there could be a reallocation of frequencies upon the expiration of existing allocations or the granting of frequency allocations for the same channels as our frequency allocations, requiring that we coordinate the use of our frequencies with the other license holder 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 between 2006 and 2008, or if other license holders are granted overlapping frequencies, our business could be adversely affected |
| Risks Associated With Our Shareholder Structure Our significant shareholders have other interests which may conflict with our interests One of our significant shareholders, Rostelecom, is one of our direct competitors |
| Two of our shareholders, Alfa and Telenor, have ownership interests in Vimpelcom and Kyivstar, with whom we have commercial relationships |
| Although we structure transactions so that they are at “arm’s length”, we cannot assure you that these shareholders will not apply pressure on us to enter into transactions which may not be the most commercially favorable to us |
| The current government’s well-publicized campaign against Russia’s so-called “oligarchs” could have adverse effects on us It has been widely reported in Russian and foreign media that the Russian government is exerting pressure on the so-called “oligarchs” to cause them to divest their commercial interests in certain economic areas of activity |
| The media has reported also that the government has exerted significant influence on companies owned or controlled by the oligarchs through tax inspections, management changes, threats of and actual prosecution of management and key officials, and other means |
| Real and perceived pressure on the “oligarchs” and their businesses has seriously affected the economic activities of these enterprises and their management |
| If the current or future governments in Russia were to apply significant pressure on Alfa and its affiliated companies, it could have serious adverse effects on our operations and financial results |
| Such effects could include, but would not be limited to, the inability of the Board of Directors to act independently from external pressure and the distraction of our management from our day-to-day operations |
| Alfa’s dispute with the Russian Ministry of Telecommunications may adversely affect our business It has been widely reported that Alfa is involved in a dispute with the Russian Ministry of Telecommunications regarding Alfa’s ownership interest in the mobile operator Megafon |
| Should that dispute continue or escalate then the Russian Ministry of Telecommunications may put pressure on Alfa and its holdings |
| One of Alfa’s other holdings is Vimpelcom, our largest customer |
| Should the Russian Ministry of Telecommunications apply pressure on us or Vimpelcom, it could have serious adverse effects on our operations and financial results |
| Certain disagreements between our shareholders may adversely affect our business On November 14, 2005 in response to alleged breaches by Alfa of the provisions of the Vimpelcom Shareholders Agreement, Telenor, commenced an arbitration proceeding against Alfa’s affiliates |
| On January 26, 2006 Telenor commenced three lawsuits in Moscow against Vimpelcom |
| On February 8, 2006 Telenor commenced an arbitration proceeding against Alfa in connection with 39 _________________________________________________________________ [92]Table of Contents alleged violations of the Shareholders Agreement relating to Kyivstar |
| At the present time we do not know what impact this dispute between our two largest shareholders may have on our business |
| Our significant shareholders have entered into a Shareholders Agreement whereby these shareholders exercise substantial control over our Board of Directors In August 2003, our major shareholders entered into a Shareholders Agreement which became effective in December 2003 |
| Although the Shareholders Agreement and other agreements among the shareholders reduce the chance for conflicts of interest, we cannot assure that any conflicts of interest will be resolved in our favor |
| We cannot assure you that any group of directors will not take any actions that may adversely affect the interests of minority shareholders |
| Further, if we consummate any future acquisitions, such agreements may be amended or we and our shareholders may enter into new agreements |
| Risks Associated With Our Shares of Common Stock Our ability to pay dividends on our common stock may be limited During 2005, our Board of Directors declared four dividends of dlra0dtta20 per common share each to shareholders |
| In February 2006, the Board of Directors declared a dividend of dlra0dtta20 per common share each to shareholders of record on March 17, 2006 |
| The Board of Directors reviews our policy on dividends annually |
| Even if we continue to generate significant cash flows in the future, our Board of Directors may elect to retain earnings for our future development or for other reasons and, consequently, not declare a dividend |
| Further, if we raise any capital in the future, we may be restricted from paying dividends under the terms of such financings |
| In addition, the governments in the countries where we operate may further devalue their currencies and take other actions that may restrict the ability of our subsidiaries to declare and pay dividends to us which in turn will limit our ability to pay dividends to our shareholders |
| Our share price has been and may continue to be highly volatile The price of our shares has been subject to significant volatility since our IPO in 1999 |
| In addition, a number of particular factors may adversely affect the market price of our shares or cause the market price to fluctuate and decline materially |
| These factors include: • Issues concerning the perceived risks of investing in Russia and the CIS, including significant ownership of our shares by a company that is part of a large Russia-based financial and industrial concern; • The limited number of our shares available for trading in public markets; • The potential sale of any large blocks of our shares by our management or large shareholders; • Mergers and strategic alliances in the telecommunications industry; and • Inconsistent or restrictive government regulation in the Russian and Ukrainian telecommunications industries |
| In recent years, the market for stock in technology, telecommunications and computer companies has been highly volatile |
| This is particularly true for companies with relatively small capitalization, such as ours |