Mobile TeleSystems PJSC (MBT) 2005 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the MTS second-quarter 2005 financial results conference call on the 30th of August, 2005. Throughout today's recorded presentation, all participants will be in a listen-only mode. After the presentation, there will be an opportunity to ask questions. (Operator Instructions). I will now hand the conference over to Mr. Andrey Braginski. Please go ahead, sir.

Good evening. Before getting started, I would like to remind everyone that statements made during this conference call reflect the opinion of management as of the date of this call. Future developments may render these statements outdated. However, we do not intend to update the guidance provided today before our next quarterly conference call. Please note that reconciliation of operating income before depreciation and amortization or operating income can be found on the Company's website.

By now, you should have received a copy of our press release by e-mail. If not, the press release, as well as the management presentation, can be found on our website at www.mtsgsm.com in the Investor Relations Financial Reports section. Now I would like to pass the call over to Vassily Sidorov, President and Chief Executive Officer of MTS. Vassily?

Thank you, Andrey. Good evening, ladies and gentlemen. Welcome to MTS' second-quarter results conference call. First of all, I want to take you through the Company's highlights for the quarter and our recent developments. Then, Nikolai Tsekhomsky, our CFO, will run you through the financials. After that, we will answer any questions.

Let me start by saying that I believe we are presenting a strong set of numbers today. We have demonstrated continued growth in our customer base and a robust increase in our revenues and net earnings. During our conference call in June, I suggested that we would return to sequential growth during the second quarter. We have done that, with revenues up 17%. Year on year, our revenues increased by 35%.

Since the beginning of the year, our new customer additions amounted to 14.1 million. That brings MTS' total consolidated subscriber base to 48.23 million as of yesterday. Looking ahead, I expect we will pass the 50 million mark in the next couple of months. All link up (ph) to one of the top 10 largest mobile phone operators in the world in terms of subscribers.

Looking at the market situation in Russia, reported penetration increased from 51% at the beginning of the year to 71% at the end of July. This growth is the result of two factors. First, new users generate new biometrics as disposable income in Russia continues to rise, and second, the global multi-SIM card ownership. By the beginning of the year, we expect penetration will exceed 80% and reach 100% towards the end of 2006.

Also remember we have a clear growth strategy in Russia. Essentially, we try to balance our investments into new subscriber acquisitions while at the same time strengthen our focus on customer loyalty and attention. That strategy has renewed, in fact, and is working well.

Let me give you an example. We have a number of series of CRM campaigns targeted at different subscriber segments. These resulted in a favorable churn rate in the second quarter of 6.8%. In July and August, churn was also stable. Although some of the customers added by various promotions in December last year stopped using MTS afterwards, the churn was gradual and did not result in a sudden overall rise in churn.

While we maintained clear comparisons in some Russian regions, we have not pioneered any third costs (ph) this year. We're actually seeing evidence of a certain degree of stabilization in the market. Our recent marketing activity was in the form of various below-the-line initiatives not leading to quality clients.

You will be pleased to hear that our ARPU in Russia has actually increased from $9.1 in the first quarter to $9.3 in the second quarter. This was on the back of positive seasonal factors such as a rise in roaming revenues and the discontinuation of premier promotions.

We're continuing to review our technology service and marketing options to deliver a more rewarding experience to our customers. Regionally, we have carried out extensive qualitative and quantitative research with our customers, and we expect to introduce important changes to our products and services in the next couple of months.

As part of this effort to hold a launch in online services in Moscow and St. Petersburg in mid-September, we continue to see i-mode as pivotal in providing a platform for future subscriber revenue and ARPU growth. In addition, we're planning to launch BlackBerry later on this year, targeted at our corporate customers. These value-added services will also act as a platform for sustained differentiation as our business competes in various markets. At the same time, we still do not have an immediate intention to change MTS' visual identity in the way that a lot of our competitors did recently.

Turning to the Ukraine, I'm happy to report that the business climate there has improved following the stabilization in the political process. New buyer penetration has increased from 29% at the beginning of the year to 31% at the end of July.

Driven by strong economic growth and lower prices, we expect penetration to exceed 50% at the year end. According to the latest estimates, the Ukraine's GDP growth in the first half of 2005 was 5.6%. Our business in Ukraine is doing extremely well. This is despite an increase in competition. We added 1.4 million subscribers in the second quarter and 3.1 million year-to-date. We also report strong growth in revenue of 21.7% on a sequential basis. Compared to last year, revenues were up 52.4%.

Ukraine today is a very dynamic market with two recent GSM entrants – Turkcell/DCC and WorldCom. They are actively building their subscriber base through aggressive promotions. However, we are very much the leading operator in Ukraine, with excellent coverage and network quality, superior service and better reception, as well as an outstanding management team. I have no doubt that despite increased competition, we can continue to expand our customer base and increase our revenues.

Our ARPU in Ukraine increased from $10 in the first quarter to $10.8 in the second. This was due in part to the strength of the local currency and partly due to discontinued promotions and positive seasonal factors.

To bring ourselves more in line with Kyivstar and to ensure that we maintain a competitive edge, we lowered our prepaid tariffs at the beginning of May, although we expect increased per-subscriber traffic volumes on the back of price cuts to provide us with higher revenues per customer.

In Uzbekistan, the market is growing steadily. This underlines our belief that the new CIS markets represent attractive growth opportunities for us. GDP growth in Uzbekistan was 7.2%. Our leading market share in Uzbekistan remains at 57%, and we have approximately 400,000 subscribers. ARPU increased by almost $1.00 to $17.6.

In Belarus, we continue to see strong subscriber additions, with 400,000 new customers added in the second quarter and 534,000 year-to-date. That brings us a total of 1.75 million subscribers currently. In this duopoly market, our market share rose further to 51%. Similar to Russia and Ukraine, our ARPU in Belarus increased $11.3 from $11 in the first quarter.

Unfortunately, we cannot report any progress in our discussions with the Belarussian government on our acquisition of a controlling stake in the business from the state. However, we are still focusing on our strategy to consolidate control of this successful business.

At the end of the second quarter, we completed an important acquisition of the leading mobile operator in Turkmenistan. This acquisition brings us another 59,000 subscribers, and we managed to complete the deal at a reasonable valuation. This move extended our license portfolio by 6.6 million people and provided us with the leading position in the Turkmenistan market. This market is very small today, with just over 1% of mobile penetration, but is set to grow on the back of untapped demand for telecom services.

As we reported, this acquisition didn't go without a hitch. The day after we bought the company, its service was disconnected by the government. After a series of personal meetings, the officials granted a return to operations. Over the past month, we have been building a working relationship with the Turkmen government, which we hope will lead to the removal of further obstacles in our development of a successful mobile business in this country.

Moving on to corporate issues -- a significant development for our Company was the addition of a new independent director to the MTS Board. We are fortunate to welcome Sir Peter Middleton, a former advisor and permanent secretary at the UK Treasury, as our Director. I'm certain that he will add a great deal of knowledge and value to our Board. Our seven-seat Board now has two independent directors.

With regard to Deutsche Telecom's ownership, there really isn't anything new to tell you today. The exclusivity of our principal shareholder, Sistema, require Deutsche Telecom's 10% stake in MTS expired on August 15. According to statements made by Sistema's President, the holding remains interested in buying the stake. The option of us buying the shares is not really feasible, as we are unlikely to secure the go-ahead from the Board needed to substantially increase our debt in order to buy back the shares.

On the regulatory front, during the five-month -- during the quiet summer months, there have been a number of developments on key regulatory initiatives that are currently being discussed – current-party fees, non-affordability or MOUs (ph). As I said previously, these initiatives may be either a threat or an opportunity for our business, depending on how they are enforced. So this remains an area we are watching closely and we will obviously keep you updated on any developments.

The one regulatory initiative that has been enforced so far is the Universal Service Fund. We paid a contribution equal to 1.2% of our service revenues in Russia for two months of the second quarter, amounting to a total payment for approximately $8 million.

To sum up, our business continues to perform very well. We reported robust revenue growth, delivered by strong subscriber uptick, and we are on track for over 25% topline growth for the year. There are no changes to our guidance of low 50s for our OIBDA margin.

On CapEx, we are spending not more than $100 per new subscriber, and our total CapEx for the year should not exceed 2 billion. We remain focused on delivering positive cash flow. With this in mind, we are planning our CapEx in absolute terms to be lower in 2006 than in 2005.

On this note, I would like to pass the call to Nikolai to take you through this Company's financials in more detail. Nikolai?

Thank you, Vassily. Ladies and gentlemen, Vassily has already giving you many of the key figures. What I would like to do is to dig a little deeper into the financials. As you heard, our second-quarter results are strong in all markets where we operate, compared with both the previous quarter and the same period last year. Overall financial performance is very much in line with our expectations, representing purely organic growth of the business.

As you well know, mobile market is subject to seasonal fluctuations. Historically, the second and third quarters are the strongest quarters for our business, with more revenues from roaming and airtime. Another contributing factor is that we obviously see a much lower impact on the business from year-end promotional campaigns.

Today, I would like to highlight in more detail the most significant areas of interest. This includes overall group performance, some details of financial performance in the CIS markets, and our balance sheet and cash flow fundamentals.

Our consolidated revenues in the quarter increased by 17% or 180 million when compared with previous quarter and 34.7% when compared to the same period of last year.

In absolute terms, OIBDA for the group increased by 21% in the second quarter to reach 652 million. The OIBDA margins reached 52.7%, almost 2 percentage points up comparing to the first-quarter figure of 50.8%. The minimal impact from OIBDA came from a 17% increase in gross margin. That was followed by only 10% increase in operating expenses and 11% increase in sales and marketing expenses.

Our consolidated pre-SACs (ph) OIBDA margin for the quarter amounted to $793 million or 64.1%. This has improved by 1.2 percentage points when compared with the previous quarter's 664.3 million or 62.8%. And in second quarter, we saw an approximately 11% increase in sales and marketing expense. This occurred mainly due to our summer JEANS sales plan advertising campaigns in Russia. The effect from increased advertising was somewhat upset by the reduction in dealer commission expenses.

For the rest of the year, we will continue to focus on the dealer commission expenses as an important business driver. We expect this number to decrease as a percentage of our revenues going forward.

The structure of our general and administrative expenses remained relatively stable through the quarter. It was also consistent with the previous periods. There were no one-off items during the quarter that had a cumulative significant effect on our general and administrative expenses or OIBDA.

Vassily talked about the regulatory situation. As he said, the only change so far is the introduction of the Universal Service Plan levied in Russia. This was introduced in May and has negatively impacted our OIBDA by around 8 million or 0.6%.

While on this subject, I would also like to update you on the current status of the one-offs reported in the previous quarter. In Ukraine during the quarter, we continued to reserve for a potential VAT liability on mobile operators' contributions to the Ukrainian State Pension Fund. The amount reserved in the second quarter was 2.5 million. Our reserve now amounts to a total of $4.7 million. This is for the six-month period.

The Company, along with the other participants in the market, has received decisions from tax authorities claiming back taxes. However, the industry continues to argue the VAT should not apply to the pension fund levy, and the matter is yet to be finally clarified.

The banking system normalized in Ukraine during the quarter, following the political uncertainty at the end of last year. As a result, we didn't see any additional bad debt exposures.

There is one final tax point I would like to mention. At the last conference call, I told you that as a result of a routine tax audit, we received a tax assessment from the authorities in Moscow for a total amount of $13.4 million. Since then, we filed an appeal with arbitration court for a total amount of approximately 10 million. And in the second quarter, our appeal was supported by the arbitration court. We do, however, expect that this decision will be appealed by the tax authorities, but there have been no further developments on this case to date.

Now I would like to move on and draw your attention to some numbers used for analyzing our performance in the CIS market. I will note operating revenues in Russia, Ukraine and Uzbekistan increased by 16, 22 and 17%, respectively. We attribute this increase to both organic growth in our subscriber base and seasonal factors. As I already mentioned, we expect this trend to continue for the third quarter with a slowdown towards the end of the year.

We have seen the effect during the quarter of some 4% appreciation of the hryvnia against U.S. dollar. On a positive note, this resulted in a 10 million foreign exchange gain. On a negative note, it's almost entirely offset by 1% depreciation of the Russian ruble against the U.S. dollar.

Moving on to the balance sheet -- overall, the position remains quite strong, with an available cash balance at the end of the quarter of $637 million. We have paid out almost 100 million in dividends and plan to distribute the remaining 300 million during the third quarter. As you know, we acquired Turkmenistan-based operator at the end of the second quarter. This acquisition had a minimal impact on our operational results and added approximately $60 million in assets to our balance sheet position, including 47 million of goodwill.

We also spent 336 million on acquisitions of property, plant and equipment and intangibles during the quarter. This is 95 million less than we spent in the first quarter. However, we remain on track to meet our 2 million practical guidance for the year. This decrease is attributable only to the timing of our actual cash payments to equipment suppliers.

Our leverage position remains strong, with net debt to last 12 months OIBDA ratio at 0.7. Our average cost of borrowing also shows an overall positive annual dynamic, decreasing from 7.4% in the fourth quarter of 2004 to 7.1% in the first quarter of this year and further to 7.05% in the second quarter. This positive trend is in line with our continued effort to improve our credit rating and corporate governance standards.

That concludes the rather more formal part of the conference call. Thank you for your attention, and let me now open the call to questions.

(Operator Instructions). Alex Kazbegi.

It's Alex Kazbegi from Renaissance Capital. I don't know how many questions I am allowed, but I will try to shoot for, let's say, three. The first one -- I was wondering if you can clarify the situation with the ARPU and the usage dynamics, because if you compare, again, your results second quarter versus first in last year, as well as what's been reported clearly, the increase in your ARPU was also driven by the increase in the reported minutes of use, which is obviously not the case with MTS. So if you could clarify the reasons behind that.

Second question is that if you look also to your effective taxation, or rather net margin, Ukraine had quite the high net margin there reported, so I was wondering if that's again some kind of one-off? Is it sustainable? Again, any reason behind that?

And then if I may also just to -- clarifying sort of question on sort of more accounting type. One was very -- read your -- reflect, actually, the universal fund contribution, and what's the reason for the 400 million increase in your accrued expenses on the balance sheet? Thank you.

Alex, we will start from the last question. The Universal Service Fund contribution is reported under other operating expenses line in the P&L, and the short-term liability in the balance sheet is our accrued dividends. So the increase is due to the dividends we're going to pay in the third quarter.

So that was about 100 million, right? Or is it more than that?

It's a 300 million impact.

Okay, okay. And the taxation?

Could you repeat your question on UFC (ph), please.

Well, on UFC, it was just the question that the performance that you had, the net margin in the second quarter -- I mean, it looks like your effective tax rate which you paid in Ukraine was quite low. I feel that would -- would the number sort of imply the 31% net margin there, and (multiple speakers)

Alex, it's actually quite consistent with the previous quarter. It's 26%. And we believe that going forward, it will be at the level of approximately 26, 27%.

Okay. So nothing unusual there?

Nothing unusual.

Okay, Alex, on ARPU, we did see a price shrinking in ARPU, both for Russia and Ukraine. We did see also a slight decoupling of this positive dynamic with the minutes of use dynamic. We have seen at the same time, if you take Russia as an example, a positive dynamic on minutes of use by MTS users. There's been a slight decrease in the minutes of use for JEANS, primarily on the back of discontinuation of our many promotions, as well as the subscriber mix that has been changing more towards the lower end and lower using end of the market.

So, generally, we've seen probably two things. On the one hand, we've seen the core customer base, both for Russia and for Ukraine, either stable or positive on their usage, as well as their ARPU contributions generally, and therefore, the average also ARPU numbers going up, while the blended numbers, including the lower and of subscribers, being dilutive on the MOU side.

Okay. Could it be also because you include in your minutes of usage the billable and free minutes as well, and the sort of basically free minutes just disappeared in the second quarter because of the first?

That is true, but there are methodological differences with some of the other players.

Vladimir Postolovsky.

Vladimir Postolovsky from Brunswick UBS. Three questions as well, if I may. The first one, on the ARPU dynamic. Well, first of all, congratulations with solid numbers. I guess one of the things that we are never able to do is compare your results with VimpelCom, and for the second quarter in a row, in terms of sequential ARPU dynamics, you have underperformed VimpelCom by about 2 percentage points in Russia, so 2, 2.5.

Could you kind of give your view of what is happening -- either that the net additions that you had a relatively low quarter compared to VimpelCom, or do you think that there is a redistribution of somewhere high up the chain toward the high end of the market that is going on? Now, I would've thought that given that we didn't see an increase in the churn rate as we expressed on the back of this aggressive campaigning in Christmas last year, and on the back of falling minutes, the net additions being of low quality -- but, you know, anyway, I would appreciate your comment.

The second question, gross service margin -- once again, the dynamics were somewhat different. The VimpelCom showed an improvement in second quarter in gross service margin. You showed a deterioration. I was just wondering what the reason was for the deterioration in your gross service margin.

And finally, on the interest rate, you know, effective interest rate is about 5.8%. That seems quite low compared to where the bond rates are. So does it mean that you capitalized a significant part of your interest expense? Just want to confirm that. Thanks very much.

Vladimir, the difference in the ARPU dynamics should be largely attributed to the fact that we have historically been stronger in the higher end of the market and the more valuable part of the subscriber buy. On the back of this, even though we've developed in what we see positive dynamics on our revenue side and on our ARPU side. Obviously, in relative terms, this positive change has a more dramatic effect on competition that has lower -- or historically had a lower share in this higher end of the market. And therefore, we are seeing -- we're probably seeing similar incremental ARPU generally, but in terms of arithmetic, we're seeing when, you know, when the price is permanent, we (technical difficulty) -- I don't want to say worse, but a different customer mix, with a lower share in the higher-end customers. That should explain the bulk of the difference that you are referring to.

On your second question about the gross margin, I would like to mention that if you compare quarter on quarter, we have a slight increase in gross margin from 80.8% to 81%.

It's gross service margin in particular. There was not -- almost no change, right? But still there was a bit of a decline. I'm not including the equipment in that. I'm just looking about -- just service costs and service revenues. And you know, still, I guess what I was -- there was some one-off costs in Q4 and Q1 that you were mentioning because of the launches in the regions, right? And then VimpelCom reported an improvement in Q2, and looked like we're on the right track, and then you posted a slight deterioration. So I was just wondering -- is there any part there, any factors that are keeping gross service margin under pressure?

Not really. We believe that’s been a consistently quite strong margin.

Fair enough. I was just wondering where the dynamics are different.

And to your third question about interest -- interest capitalized -- it's at the same level as in the first quarter. First quarter, we capitalized 11.7 million -- sorry. In the first quarter, yes, 11.7 million, and in the second -- and in Q2, it's 12.3 million. So it's quite consistent as well.

Herve Drouet.

This is Herve Drouet from HSBC. I've got two questions. Both are related to subscriber acquisition costs. If we start with Russia, and again, if we compare with what has happened at VimpelCom, we saw a decline in subscriber acquisition costs mainly coming from a decline in terms of the commissions paid to dealers. On your -- what you report, you have relatively little subscriber acquisition costs. Are you planning to follow the move of VimpelCom in terms of reducing dealer commissions, is my first question?

And on the other side in Ukraine, you showed a quite sharp decline on that side on subscriber acquisition costs and on mainly again due to dealer commission, in this case, cuts. With an entry of new -- the two other operators in the market, I mean, are they aligning with that cut, or do you think it may affect market share in the short term in Ukraine? Thank you.

Let me start with SAC. First of all, one has to realize that there are differences in the way we calculate SAC between MTS and VimpelCom. Our competitor does not include commission to dealers for payment transfers and scratch card sales, which we do. And VimpelCom, as far as we know, does not include expenditures on VTL inter SAC (ph), which we do as well.

Now, relating to -- referring to the dealer commission dynamic, we believe there is room for further changes -- downward changes in dealer commission for Russia. At the same time, what we think is going to be happening more is actually a redistribution from the up-front commissions to performance-based in terms of payments. But generally, we believe there is certainly not a lot of room, but certain income premiums on the commission part of SAC for Russia.

Relating to Ukraine, we have seen a fairly dramatic decline in SAC. A large part of that, although -- $5.00, actually -- $5.50 was attributed to the decline in handset subsidies. And this came on the back of the SAC that we did not have to pay customers due to VAT on the handset that we used for subsidies. The actual amount of subsidies didn't change much, but the per-subscriber part of handset subsidies decreased on the back of these changes in terms of not having to pay VAT or customers ready for terminals that we sold below cost (multiple speakers)

So I (multiple speakers)

-- contributor.

So you are saying -- I mean, the sharp decline in Ukraine for subscriber acquisition costs is mainly due to subsidies, not that much on dealer commissions?

Out of $8.00, we have $5.50 derived from the handset subsidy difference. $1.00 from, as I said, in promotion, and $1.50 from dealer commission decrease. Also, so I should just -- so that you know, there has been a pickup in advertising on the back of a more active advertising campaign in the second quarter, COM-TS (ph) in Russia, as we were promoting two telephones (ph) on a federal level.

And the fact that in Russia, maybe, you know, you are not willing too much to really reduce your subscriber acquisition costs at the moment, is it due to a willingness maybe to regain some market share in Russia?

Well, obviously, in centralizing the distribution network as part of the obvious -- one of the obvious instruments to be used in acquiring further customers, and especially when we refer to the quality of these customers, it's worthwhile properly incentivating dealers to get the right customers to join in the effort. So, yes, I would say that we're not expecting a dramatic decline. We are expecting more of a redistribution in the structural SAC for Russia, albeit from acquisition-related expenses to a redemption and away from straight upfront commissions towards, as I've said, performance-based incentive payments.

Philip Townsend.

It's Philip Townsend from Arnhold and S. Bleichroeder. Just if I could pursue this same ARPU question, do I understand essentially what you are seeing is that existing high-quality customers are using more minutes essentially and counteracting the declines that you are getting from moving into lower-quality customers as the penetration in Russia grows?

The second thing, if I may just to pursue also, the subscriber acquisition costs. Could I ask roughly how much the ARPU is in the regions of Russia, and did I understand that in Ukraine, they are about $8.00? Thank you.

Yes, you are right. In terms of the MOU dynamic, we've seen our MOUs for contract subscribers going up in Russia from 247 minutes up to 282 minutes. So, JEANS, we've seen a decline actually from 109 to 102. So you are right in assuming that this is explained primarily by the mix and the changing mix towards the lower-using, lower-paying customers on this part of the subscriber mix.

Yes, that's helpful. On that basis, therefore, are we really saying that the overall revenues for the Company for the year could be higher? So what we're really saying is that the existing customers are using more and more, and that's counteracting newcomers? Should we really be revising up our estimates for revenues for the full year?

I would say that we are certainly seeing a more dramatic increase in -- or more dramatic pickup in the MTS contract ARPUs. To give you a specific number, they went up by $3.00 quarter on quarter, whereas the JEANS ARPU only went up by $0.10. So yes, there is a much more dramatic dynamic. But at the same time, we are sticking to our indication that we will see roughly around a 25% credit in the top line for the year.

That's great. Could we just move onto the subscriber acquisition costs question, please?

As far as subscriber acquisition costs, they are around, if you compare the Moscow to the other regions, for Moscow, they are around $30. For the other regions, it ranges in the vicinity of 12 to $17.

Okay, that's super. And for the Ukraine?

For the Ukraine, our current SAC -- our Q2 SAC will look $14.2.

Okay, that's super. Okay, that's about it. And congratulations on the very good numbers.

Dalibor Vavruska.

This is Dalibor Vavruska from ING. I've got two questions, if I may. One is returning to the ARPU question and the comparison with VimpelCom, which was made, you basically said that incremental ARPUs are around the same. My question is VimpelCom, which has started this campaign, they have relatively low market share on the business customer segment, but they are trying to break into that. The question is in the last couple of weeks, whether you have seen any more pressure in the high ARPU segment coming from VimpelCom or perhaps other companies as well?

The second question is on the CapEx side and also on the technology launches that you mentioned. You were talking about BlackBerry, i-mode. There is certainly a massive opportunity in the data market in Russia. On the other hand, obviously, it's going to cost some money if it should bring some returns. My question is how much of this is reflected in the CapEx forecast?

Also, if I can ask whether at the moment whether you see better returns on these data investments versus the voice investment? In other words, given the capacity constraints that you might perhaps have, what is going to be prioritized in terms of data versus voice in terms of investment choice? Thank you.

I would not be able to draw a particular example of there being more pressure or less pressure from VimpelCom over the past couple of weeks. We are aware of the fact that our competitors, not only VimpelCom but the others, are strong. They have a strong presence and have built a significant presence in the regions. We are competing with them on terms that are -- they may be different from one region to another, but fundamentally, what matters a lot is the personal advantage, A., and B., what matters is the quality of service, both from the point of view of the range of services, the natural quality and the customer care quality that we -- and those are the things that we compete on.

And obviously, this is an ongoing process. It's never -- even if there's never a little pressure coming from any of the competitors, but I wouldn't say that anything has dramatically changed over the past couple of weeks. Now, as far as fighting for this high ARPU or high-value customer base, obviously, if that breaks for us, we believe that the BlackBerry will be a good differentiating factor. We should be the first ones to enter the market with a localized BlackBerry. i-mode is targeting a different segment, depending on the price of the handset, but it certainly should become a value-added service-enhancing, topline-enhancing platform.

And also, I would like to also draw your attention that this is not the only thing -- these are not the only things that we're doing. Just to give you another example, we have only recently in April and May launched GPRS access for prepaid customers in Russia, and this will become a much more meaningful contributor to the value-added service part of our revenue as we go forward.

Now, of course, all the traffic forecasts have been taken into account in planning CapEx for this year. So this does not imply in any way a change in our CapEx guidance. When we refer to the return on investment on data compared to voice, obviously voice by far has a much higher return on investment -- much better return on investment than data. That is fairly clear. At the same time, the way we plan our networks always incorporates the capacity required to service the data or to provide the data services that we've been talking about.

Okay, I mean, if I can just ask -- thanks for that explanation. It's very useful. But just the question was if you are not in position of having extra capacity and the return in voice is higher than data, that might suggest that perhaps the move into data is going to be more gradual or slower. Is that -- and you perhaps use it as a differentiating factor, but you might not prioritize it just because the returns is no higher and there's still growth in the voice market.

Well, certainly. We would certainly believe that the bulk of our earnings will continue to be derived from voice on the back of additional scope or intake on the back of more usage potentially. We don't claim that data is going to dramatically -- the data contribution to the overall topline is going to dramatically increase. It will always be -- it should be meaningful and should become more meaningful than what it is right now, but it will not be going up dramatically.

So we know what the limitations are in terms of demand for these services. But, at the same time, we believe that the market's going to evolve very fast, and if you look in absolute terms rather than in relative terms, in absolute terms, these numbers are growing. The market is growing year on year very fast. So I think we are sober in terms of our estimates as to how much this can contribute to our topline, but at the same time, we believe that differentiating technologies and differentiating services are going to play a certain role in positioning of us vis-a-vis the competition.

Alex Kuznetsov.

It is Alex Kuznetsov from Bear Stearns. I have a couple of questions. First of all, a question regarding effective tax rate. Effective tax rate has been declining since the last quarter of 2004 and amounted to 25.4% this quarter, which is lower than in the previous quarter and lower than effective tax rate reported by VimpelCom. Are there any reasons for this decline apart from a special agreement with the Russian government?

And the second question, could you tell us if a decline in subscriber acquisition costs reported in Ukraine is sustainable? Because as I can see, there was a dramatic decline to $14? And then I would like to inquire if we should expect some rebound in subscriber acquisition costs going forward?

Answering your effective tax rate question, I would say that first of all, you have to consider that if you look at the consolidated figure, you have to keep in mind that last year, it was a different rate in Ukraine, and this way, we see a certain reduction as a result of changing the rate. Effective tax rate is at a consolidated level of 25.4, which is in line with our expectation, but as I said, the effective tax for the year will be in the range of 26, 27%, and I wouldn't say that there are any special situations in this rate. We believe it is quite a reasonable number and the number in line with the rates stated by the government in the countries where we have the rate.

Thank you.

As far as SAC in Ukraine is concerned, we do believe that actually it may be flat -- likely to remain flat quarter on quarter for Q3 compared to Q2, and may go up slightly towards Q4, but not significantly.

Do you expect an increase in subscriber acquisition in the last quarter? In other words, as the pattern observed last year?

I'm sorry, say it again?

Do you expect increase in the number of net additions in the fourth quarter? Because the pattern we observed in the previous year.

We are expecting more additions in Q4, seasonally, of course, compared to the other quarters.

But I had a perception, then, that usually there was a relationship between subscriber acquisition costs and the number of net additions. Do you expect it to be different this year?

No, obviously, there is a clear relationship between the two indicators, but we still believe that our SAC is likely to go up towards the end of the year, as primarily on the back of higher SACs for the contract part of the customers.

Rizwan Ali.

Yes, from Bear Stearns. Good morning. My question is in regards to the i-mode. Why did you choose the i-mode technology? And does that in any way change your longer-term strategy of deploying 3G services?

We chose i-mode because it was a business model that we liked. It went beyond just a platform, which we thought was very functional. It went beyond just the user-friendly interface that we liked a lot and thought it was very applicable to Russia and could be popular in Russia. It applied to the philosophy behind this business and to how NTT DoCoMo introduced its relationship and has built its relationships and partnerships relationships basically with the content providers. It expanded the circle of content providers -- you know, made it more user-friendly in terms of sales force of rankings to those content providers, etc.

So, we believe it's really a very friendly interface and something that will be demanded in Russia. Plus, NTT DoCoMo offered an arrangement which was loose enough to offer us, you know, a fairly loose arrangement with them, but at the same time was stringent enough to force us into committing to certain KPIs that we believe we're going to fulfill. That does not in any way prevent us from any alliances going forward, be it on value-added services or other fronts.

Also, my second question (multiple speakers)

As far as 3G is concerned, i-mode works on GPRS. It will work on -- it does work on 3G. So the same service is going to be offered by 3G-compatible i-mode phones. That would not in any way prevent or alter materially our business model on the 3G rollout.

My other question as regards to your ARPUs in Ukraine. If I heard you correctly, you were suggesting that by giving discounts, you were able to increase the ARPU, which means that the price elasticity of the tariff is more than one. Is that what you are suggesting?

Good evening, ladies and gentlemen. Adam Wojacki. I am actually the marketing and sales director in Ukraine, so I will take the liberty to answer this question. The ARPU increase Q2 to Q1 was mainly due to a couple of factors. As we said, seasonality is one of them, (indiscernible), and then the other one is discontinuation of our promotions -- free minutes promotions which we were giving to our customers. And mainly that's, you know, that's the reason when we see from Q2 to Q1, you know, increase in the ARPU. As far as the elasticity, at this stage of the market development, we do not believe that it is above 100%. So it is below.

Eric Mueller.

Arista Capital (ph). Just to follow up on the ARPU and tariffs. You had said that tariffs were stabilizing, and it does look like your tariffs were up 5% quarter over quarter. Can you tell me what's the difference between your business and VimpelCom's in that their tariffs are diluting quarter over quarter? And also, can you give us a sense of what MegaFon has been doing in the past month or two in Moscow?

Well, in terms of tariffs, we continue to be quite at somewhat of a premium in many regions. In some cases, we have to do away with this premium pricing and bring ourselves more in line with the rest of the market. In some cases, we, on the back of our network quality or other depreciating factors, we can continue being premially priced. To give you an example, in Moscow, we are about 15% more expensive on average than VimpelCom. And MegaFon, since you asked about them as well, is about 25% less expensive than we are on a blended basis.

We are consistently seeing some initiatives occasionally popping up -- price-related initiatives in the regions. At the same time, as I've said, we are, save for some regional exceptions, we are growing from scratch in the regions that we are launching from, you know. A new -- as greenfields, where competition is already very intense, we're not pursuing discounted -- discounts or initiatives that will -- would hurt us on the price permanent side. So, I guess our business is not that much different from any other operators. It's just a question of how many regions each one of us has to get aggressive on. And this obviously differs between one operator the other.

Okay, so it's fair to say that you all are less aggressive than -- in the regions on pricing than some of your competitors?

No, I think generally, there is a very similar understanding of us needing to basically retain as much value in this market as possible, certainly at the level of the two largest players. There's some unreasonable behavior and some unreasonable arbitrators. It's fairly reasonable as long as their economics substantiate it from some of the smaller players. But we believe that to sustain the quality and to bring the value proposition that we can to our customers, we need to -- we move a little bit on price, and we offer our premium quality and a full range of services, and that's how we position ourselves.

Sergei Arsenyev.

It's Sergei Arsenyev from Goldman Sachs. Can I just follow up on the Ukrainian ARPU or rather yield question? If you look at the yield in local currency terms and take away the currency appreciation, the yield was up 15% quarter over quarter. I'm just wondering whether -- what the math behind it -- is it just the elimination of the free minutes, or were there also some form of pricing increases in the quarter? So, that's number one.

And second question for Ukraine as well. What kind of competitive activity are you seeing in DCC -- I'm sorry, from DCC, from the new entrant? Are they competing on price? Are they competing on subsidies? And do you believe that they are becoming a threat or will become a threat later on in the year or in 2006? Thank you.

Answering the first question, ARPU in the Ukraine -- yes, as I've explained before, we discontinued the price-driven promotion, which were, you know, in the last quarter or in Q4 and Q1. In Q2, we've seen the increase in average price per minute, and with the lower MOUs, it resulted in the increase in the ARPU.

But there were no tariff increases (multiple speakers)

-- in dollar terms and in local currency. As far as the activities of our third competitor, DCC, or, you know, Life, as it is the brand name for the operator, at this stage, they are rapidly developing the network coverage, the range of services, and obviously being the third one, they're also very aggressive on the pricing side. So, that's -- we will see to continue until they will be on the competitive basis as far as the coverage and the network quality is concerned.

But just to make sure, you did not increase prices in Ukraine in the second quarter?

Well, if you look at the -- we did not increase the prices in Ukraine in the second quarter, but we discontinued the price-driven promotions.

No, that's clear. Thank you.

Vadim Koshov.

Discovery Capital. Good afternoon, gentlemen. Three questions. Number one is regarding minutes of use. If you think about the business on aggregate, can you give us an idea where you expect the minutes of use to grow going forward, let's say, looking out year and two years, and maybe you can express it as a multiple of the GDP growth. I mean, so it's sort of a general question, but I think it becomes more relevant as we move forward. That's question number one.

Question number two -- can you give us sort of a heads-up on the promotions -- promotional activity that you're planning for the fourth and the first quarter of 2005 and 2006?

And the last question is have you gotten any closer to determining on what will be the CapEx that you will allocate in 2006 to the 3G rollout?

Okay, let me start with MOUs. We do not expect MOUs, at least for the foreseeable future, which is, let's say, two and a half years, to dramatically go up. We actually think that we will see a decline in minutes of use, a slight decline towards -- quarter on quarter in Q4 compares to Q3. We should see a slight strengthening on minutes of use in Q3 compared to the current quarter. But thereafter, for the next couple of years, we are projecting a fairly flat dynamic on minutes of use.

(indiscernible -- in Russian)

Now as far as CapEx, we are -- we have included the 3G rollout, but on a very limited scale into our preliminary CapEx program because it has yet to be approved by the Board. But certainly, it is part of the projections that we're making. But this assumes that we will get the license either towards the end of first half of 2006 or in Q3 of 2006. So that is why we are not projecting an overly significant investment into 3G in 2006.

I'm not sure if I caught it, but the question on promotional activity?

Right. What was the question exactly on promotional activity?

Basically, should we expect the repeat of what was happening in the last year during the fourth quarter and the first quarter?

As I've said, our focus right now is on not so much on being price-aggressive, and actually we think that what we should be offering is more a little bit differentiating factor, should be more -- less about price and more about quality of service, quality network and the best (ph) acquisition in general -- we have lured some tough customers together with the rest of the players. From the experience of Q4 and Q1, as like from this year's (ph), and I did not see any reason why we should be, why you should -- any one of us should be expecting a planning the same level of price aggression coming from any of the players towards the end of the year.

And can you say that this is sort of the understanding that the other two major players have?

I'm sorry, I didn't hear that.

Do you get the sense that this is the same sort of understanding and the same view that the other competitors have for this situation?

We believe that for most of the key players -- these are the three national players -- the focus is much more shifting away from pure subscriber figures as such towards value and towards revenue and towards profitability and towards the things that count, and value in general. So yes, we believe that we are more or less on the same ground with the rest of the market.

Alex Kuznetsov.

It is Alex Kuznetsov from Bear Stearns. Could you provide us with some highlights on the additional pension payments in Ukrainian pension plan, please? And also, you pointed out that you consider reduced promotions in Ukraine this quarter. Did Kyivstar follow this move or they decided to increase its market share by continuing promotions?

I will start by answering the second question regarding the promotion. As it was, you know, during the last conference call, when we said that we will not be the first one and we will try to stay away from the price-driven promotions, surely we steal from the other market players running the aggressive price promotions. UMC was trying to answer those promotions. And you know, to some degree, we see that the other players in the market also as here in Russia are conscious about the strength, the value of the market and moving away from the pricing promotions.

Thank you.

I believe the first question was not about the pension contribution but actually about VAT payments, which are due on top of the pension charges, which are in Ukraine. And as they already said that we accrued 2.5 million in the first quarter and accrued 4.7 million in Q2. That's what we believe our total liability is at the moment.

And could you highlights why this decision -- governmental decision is currently questioned? And I know that it's questioned, not only by you but also by other operators such as Golden Telecom, Kyivstar.

The reason is very simple, because the nature of VAT is to be charged on the -- certainly, you know, it's a value-added tax. In reality, what the government of Ukraine is trying to charge us on top of the other levy, which is a pension payment. They are still -- we believe that it's not reasonable to charge additional tax on top of other tax. That's the story behind it. That's why we try to -- we basically sent a number of letters and we will go to court if needed to clear this issue.

Anna Bossong.

Anna Bossong from CA IB. I wonder if you could give me the incremental ARPUs at the moment in Moscow, the regions and Ukraine, if that hasn't already been given out, which I didn't think it had been. And also in Moscow, we're hearing that some -- there's been some success by competitors in taking market share amongst higher-value customers, and you did talk about having a pricing premium. Does this mean that we should expect tariffs to be brought down amongst just the postpaid customers in Moscow in the third quarter?

As far as incremental ARPUs are concerned, we are at 6.50 to $7.00 for Russia and about $8.50 in Ukraine.

$8.50 in Ukraine. Could you give Russian regions at all?

We usually don't give the breakdown. So I would rather stick to the blended figure.

As far as further decreases, as I've said, we are going to protect our price permanence inasmuch as that is possible. That being said, we will take into account the competitive dynamic and therefore be mindful of the competition. So I don't think I'm in a position to give you precise percentages as to where we will go, but certainly, the promotions that we may be launching towards the end of the year will be much more reasonable, which will be much less APPM dilutive, if at all.

That's very good. Can I have a follow-up question on rebranding? Did I understand correctly when you said you are not going to change the look of your MTS logo or whatever -- that it means you're not going to spend money on your branding in the third quarter?

As I've said, or as I may have alluded to, we are in a permanent state of work on how to enhance the communication between the Company and the clients, and the visual part of how we come across is obviously part of that. We are not going to go through a dramatic visual change in how we visualize the brand in the next couple of quarters. That does not imply that we are not thinking or implementing enhancements on the fundamental quality of the service or the way we communicate the service to the market.

Alex Yakovitsky.

This is Alexei Yakovitsky from UFG. Congratulations on the good numbers. I have two questions. I wonder if you can comment on the ARPU trend so far in the third quarter -- so we expect a stable ARPU again? Have you seen any usage growth finally in the third quarter relative to the second? And the second question, can you be a little bit more specific, if you can, on CapEx for next year? Are we talking about 1 billion, 1.5 billion, closer to 2 billion, as this year? Thank you.

In terms of ARPU trend, I think we are generally seeing a rather flat dynamic so far. But it's probably too early to guide more specifically than that. In terms of CapEx, we believe that we will be over 1.5, but as I've said, below what we will have invested towards the end of this year.

Paulina Cordiasco (ph).

It's Paulina Cordiasco from BlueBay. I have two questions. First is a follow-up on the service costs. Given the dynamics that service costs shown in the second quarter, should we expect service costs to continue to increase as a percentage of the revenue, or should we expect them to remain flat compared to 2004 results?

And the second question is on your funding mix. Given that you turned free cash flow positive and assuming these dynamics would continue, should we expect the total debt to decline in absolute terms next year? Thank you.

Yes, I think on the service costs, we may see some increases as the fixed line operators position themselves more strongly against the mobile in terms of redistributing part of their revenue through interconnect regimes or changing interconnect regimes. So definitely have a slight negative effect on the gross margin. Now, as far as funding mix is concerned, save for situations in which we would be making sizable acquisitions, there is no reason why our debt should not be going down significantly in absolute terms.

Vladimir Postolovsky.

Two more questions. The first one is on your comment regarding Deutsche Telecom's stake. Frankly, it's the first time I heard you categorically saying that it is extremely -- well, pretty much it's a no go for you to buy back the stake on British Telecom, at least part of it. The way you phrase it, it sounds like -- well, you said that the Board will not have time to approve it. But should we read it as Sistema would not allow you to do that? Or, well, I mean, basically is a definite no from you -- from the Company, or there is still some possibility of that happening?

And the second question is on churn, just coming back to my previous question. I guess we all expected to see a little bit of an increase in churn rate on the back of those aggressive campaigns in December and January, and yet we're only seeing an improvement here. So I was just wondering do you expect some increase in churn in the second half of the year, maybe as, you know, gradually those lower ARPU stops churn out, or you think that the current dynamics of improvements will continue? Thanks, and again, congratulations on the numbers.

On BT's stake, I was basing my comment on the previous consultations that I've had with the Board members and seeing the potential acquisitions that could be potentially in the pipeline, I think that general perception at the Board level is that we are better-positioned to use the cash that we have and that we may potentially raise through additional debt instruments to make acquisitions in new markets. We are going to use them to buy back share currently -- (multiple speakers)

Even if we're talking about (multiple speakers)

-- especially given the returns at which these shares are likely to be offered. Now, there is always -- there is still a possibility -- it's not a categorical note from the Board, but this is based on my broadcast based on these consultations. So that's where we stand now.

Now as far as churn, we see, as we believe that some of these customers will gradually churn out of our system, we will see some pickup in churn towards the end of the year.

Okay, thanks very much. And sorry, if I may, just one more on pricing. We're continually hearing, both from yourself and from VimpelCom that the pricing discipline is improving and that, you know, the pricing pressure should recede. But yet if you look at use of minutes, we continue to see 20 to 30% annual rate of erosion. I guess if you remain confident that the pricing pressures will subside, then could you provide us with some timing as to when you expect we should see some stabilization -- actual stabilization of use of minutes?

Well, I think it's difficult to give you a precise timeline or precise amounts, or date even less so. I think the general logic that I have alluded to previously is the one that is followed by most of the players. As I've said as well, there are some regional exceptions that get played by certain operators. And these sometimes are material in terms of the overall numbers. So it's difficult to predict an exact date, but at the same time, the overall trend is towards a sort of stabilization, and what we've seen quarter on quarter is representative of that. So I think it has to a certain extent started happening.

(Operator Instructions). Anna Bossong.

It just refers to the comments you made about interconnection rates with the fixed line operators and that they may become less favorable. Could you perhaps elaborate on that a little bit, please?

Well, as you know, interconnection regimes have been largely unregulated previously on the back of there being a general trend towards more regulation of the industry, and potentially redistributing part of the profits derived from mobile services towards fixed line and the Universal Service Fund is just one of those examples. There is a likelihood that the way regulators will look at the interconnect regime, which is going to be much more regulated, is that it's one of the ways that we are redistributing assets between fixed and mobile in favor of fixed, obviously.

So, that's point number one. Point number two, with the upcoming privatization of segments (ph), there will be probably also a clear agenda of the private shareholders to eat away part of the economics away from their competition. And we are to a certain significant extent now competing for traffic with the fixed line operators as well, as there is significant substitution in Russia, especially, of the mobile -- of fixed to mobile.

So that's -- but there's other demands that I was basing my function on that we may see some redistribution and some increase in interconnect and therefore potential depletion of the margin.

Thank you. Would that mean actually then potentially increasing termination as well as initiation charges for calls? Or are you looking more at termination charges? How do you think it might work out?

Mostly termination, but it could be both.

Thank you, sir. We seem to have no further questions. Please continue.

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