VEON Ltd (VEON) 2005 Q2 法說會逐字稿

Good afternoon everyone and welcome to the VimpelCom Second Quarter 2005 Conference Call. Today's call is being recorded. At this time I would like to turn the call over to Mr. Michael Polyviou from Financial Dynamics. Please go ahead sir.

Good morning and welcome to VimpelCom's conference call to discuss the Company's second quarter and 6 month 2005 financial and operating results. Before getting started I would like to remind everyone that except for historical information statements made on this conference call may constitute forward looking statements that may involve certain risks and uncertainties. These statements relate in part to the Company strategy and development plans such as national and CIS expansion, 2005 capital investment, future cash position, expected re-issuance of licenses and related frequencies and permission previously held by KB Impulse and expected growth in subscribers and penetration. Certain factors may cause actual results to differ materially from those contained in the forward looking statement including those risks detailed in the press release announcing second quarter and 6 month 2005 financial and operating results.

The Company's earnings presentation entitled Presentation of Q2 2005 Financial and Operating Results, the Company's annual report on Form 20-F for the year ended December 31 2004 and other public filings made by the Company with the United States Securities and Exchange Commission, each of which are posted on the Company's website at www.vimpelcom.com.

In addition the Company's second quarter and 6 month 2005 financial and operating results press release and Form 20-F are posted on the Securities Exchange Commission's website at www.sec.com. VimpelCom disclaims any obligation to update developments of these risk factors or to announce publicly any revision to any of the forward looking statements made on this conference call or to make corrections to reflect future events or developments.

If you have not received a copy of the second quarter and 6 month 2005 financial and operating results press release please contact [Vinesh Danan] at 212 850 5600 and they will be forwarded to you. In addition the press release and the earnings presentation, each of which includes reconciliations of non-gap financial measures, presented on this conference call can each be downloaded from the VimpelCom website.

At this time I would like to turn the call over to Alexander Izosimov, Chief Executive Officer of Vimpel Communications.

Thank you. Good morning everyone and thank you for joining our conference call today. [inaudible] participating on this call. Here with me are [indiscernible] Jere Calmes, our Executive Vice President who will try to brief you on our Russian perspectively. [indiscernible]. Today we will start our discussion with an overview of the main points of development. Then we’ll cover in detail our second quarter financial operating results and we will conclude with a brief status report on our corporate activities.

Let's start with the market. So further growth in Russia continues to surprise us. On our previous conference call we noted that the churn of absolute [indiscernible] subscriber growth in the first quarter 2005 was approximately 2 times higher than in 2004. In the second quarter the position didn't change much. Mobile operators added approximately 12m subscribers against 7m added during the same period a year ago. As a result, in part, penetration in Russia was estimated to have reached 70% at the end of July. If this growth continues through the rest of the year we will be close to 90% penetration at the end of 2005. [indiscernible] penetration growth versus net growth [indiscernible] is also increasing. However, as far as we are concerned, all [orders] of our KarTel are subscribers and the fact that [indiscernible] on several occasions presents an opportunity for us to win them over from the competition.

In Kazakhstan subscriber growth is also strong and is gradually [indiscernible]. [indiscernible].

The page is similar to that of Russia 2 years ago and I hope it will be able to increase acceleration patterns over the Russian regional.

In terms of the competition, I should say that we don’t see any significant changes in [indiscernible] on our last conference call in June. The competitive growth can vary from region to region. Price remains intense top and [ongoing] providers. Our market share remains stable. Practically on par with our own main competitor.

Our net adds in Kazakhstan [indiscernible] practically globally and we are rapidly gaining market share moving up 9 percentage points in the past 9 months.

In marketing and competitive developments I will address on our current strategy which is based on 3 key premises.

First extracting maximum value from existing operations. Second, optimizing the growth of our customer base mainly through the rapid subscriber growth in Russia. Third, extending into the CIS countries as a national area for continued growth.

[indiscernible] this strategy we continue to work to balance growth and profitability in the pursuit of our ongoing objective to increase value for our shareholders.

[indiscernible] focusing on how to shift it from subscriber growth value structure. We think this shift is justified since the subscription rate in Moscow was already exceeded high 20%. We believe that we are moving in the right direction in Moscow and our position in the high end of the segment has been improving. As a reflection of this our ARPU in Moscow in the second quarter increased by approximately 11% as compared to the first quarter. [indiscernible].

For the regions of [indiscernible] our business model continues to yield [vast] results. We lead the competition in terms of subscriber growth and we have already become the largest operator in our regions.

Our [credential] results have improved [indiscernible] in the North regions where we've been very late and where the competitive situation looked originally very unfair on both sides.

The success in the Russian region makes us confident that we can succeed in other countries as well. Our performance in Kazakhstan has strengthened this conviction.

Despite improving substantially our market share, we have also done a tremendous job in bringing business in line with all the standards. We should have a long-term public success on our mobility in Kazakhstan.

Recently we announced that we closed the deal to sell 50% minus 1 share of our Kazakh operations to a local partner. We believe the presence of a local partner is essential in order to decrease our risk profile. At the same time, we retain an option to increase our stake in KarTel into the stages maximum up to 100%.

Now turning to our financial results. Clearly indicate an absolute performance [revenue over] the second quarter of 2005. [indiscernible] subscriber net additions both in Russia and in Kazakhstan. As of today we serve approximately 33.3m subscribers, which is an increase of 37% compared to a year ago.

Looking at our key operating indicators, we’re very pleased with the over 7% growth in ARPU in the second quarter compared with the first quarter 2005. This is particularly encouraging given that last year we remained flat between the first and second quarters. The second quarter was marked by the launch of our key brand campaign. [Indiscernible] is 1 of the most famous and [indiscernible]. The new style has been developed to help us to leverage this exceptional equity even further by making it more visible its efforts. The [media] campaign was launched in April and although we are focused on the long-term impact, we believe you can see a positive response from the market.

Our financial figures lead us to know that we will continue to be a growth Company. Our net revenues grew by 59%, OIBDA by 62% and net income by 76%. [indiscernible] has more than doubled of that in 2004 with percentage increase virtually matching the annual growth we reported a year ago.

Market improvement is also very strong and ensures efficiency controlling the costs and the Company’s ability to capitalize [and acquire business gain].

A few more words about our strategies. As an addition of our [indiscernible] subscribe behavior we introduced the [indiscernible] subscribers in the first quarter of this year. We’re sure the same information as used by a number of leading operators like Vodafone. Mainly, active subscribers are those who in the last 3 months made a [indiscernible]. This figure totaled 88% at the end of the first quarter and 87% at the end of the second quarter. We believe that these numbers, to some extent, helped drive the multiples in Kazakhstan. And further, our subscriber base is not inflated.

Now a few words about churn. As you know we've produced churn reducing measures in the first half of 2004 and have produced good results in that time. In the second quarter reported churn was 8.8%. We showed that at top growth as compared to the previous quarter. However, this drop in churn was anticipated as a delay effect of an aggressive subscriber acquisition campaign in December 2004.

[indiscernible] churn is subject to a certain volatility depending on marketing moves made in previous period and other factors such as lack of number capacity was made in the spring and summer of 2004. Which makes it difficult to interpret the trend looking at just reported numbers, but directionally review our churn development as positive.

In any case it remains our main priority and we will continue working in order to reduce churn and [indiscernible] of our service [product].

Let's have Elena to present our second quarter financial results in detail.

Thank you Alexander. As we have already said the second quarter financials typically demonstrate positive effect and this year is no exception. However, 1 difference that should be noted this year is the increase in penetration level from 34.1% over the second quarter last year to 67.2% end of the second quarter this year.

So 1 could expect a slow down in organic growth. But looking on the financial results we still see an acceleration and we're pleased to report that our second quarter revenue increased by approximately 20% quarter to quarter, which is higher than 17% we experienced quarter to quarter in the last year.

And if you look in absolute terms, the growth is almost doubled. $129m of revenue added in 2005 versus $69m added quarter to quarter in 2004. With high state of growth on our top line, we delivered improving margins. Our [indiscernible] dropped improved substantially compared to the first quarter year 2005, adding approximately $90m since first quarter and $161m since second quarter last year. And in view of these terms we registered 51.4% OIBDA margins. The highest since foundation of our Company.

Net income also demonstrated improvement, adding approximately $49m since last quarter and approximately $69m compared to the second quarter last year.

Operational indicators such as ARPU, minutes of use and subscriber acquisition costs gave more flavor to our financial results as their trend explained the trend in revenue and in the sales associated costs. As usage increased, minutes of use showed a positive trend both quarter to quarter by 15% and 3% year to year. Partly it can be attributed to improvement of our customer base and our target on high end segment and partly to our campaigns. This promotion allows our customers free of charge call -- free of charge local or night call during the night but continuing high in the day time.

This proposal being attractive from a marketing point of view also facilitates more even traffic distribution between peak and off peak hours, which improves the net usage profile. As a result our decrease in average price per minute was worse than increase in traffic and so ARPU in the second quarter increased compared to the first quarter by 6.8% or 50 cents to each subscriber.

Our subscriber acquisition costs this quarter was slightly lower than a year ago and a quarter ago which reflects different combinations of core fixed expenses such as advertising and rival expenses such as [indiscernible] which depend on performance of subscribers signed up by viewers.

Subscriber acquisition costs stayed on quite a low level for a long period which has resulted in good return on marketing investment helping trim gross margins as we have already discussed.

The major changes in our balance sheet structure during the second quarter was our repayment of bonds in April in the amount of $250m and the first draw down of our syndicated loan facility which was signed in February for the total amount of $425m. We have drawn down $60m of this syndication in the second quarter. These 2 changes together with other operating activities and scheduled repayment of debt resulted in our total debt decrease compared with the first quarter, from $1.86b to $1.62b. While net debt balance increased by $58m at the end of the second quarter compared to the first quarter.

Our cash position as of today is strong due to our operating results. In addition to strong operational cash flow, as of today we have collected $175m for the sale of 50% minus 1 share of our subsidiary hold in KarTel, our Kazakhstan operation and we have closed the deal with a local partner.

$40m of this amount were paid to us in advance and already reflected in our cash flow and balance sheet as of June 30.

Second quarter financial activities also improved our debt structure as percentage of secured debt decreased from approximately 22% end of the first quarter to approximately 20% as of June 30. And weighted average interest rate decreased from 8.8% end of the first quarter to 8.4%.

Regarding balance sheet ratios, were in line with our Board imposed restrictions in terms of debt equity. It is rather stable and below 1. That will definitely should demonstrate improvement. It has decreased from 1.5 end of the year to 1.3 end of the second quarter and stays well below 2.

Our capital investments continued to be rather intensive. Approximately $206m in the second quarter compared to approximately $288m in the first quarter. As we have seen that as long as we still see rapid growth in subscribers and traffic we will continue to invest heavily in Russia and Kazakhstan, particularly when we see that our cash generation is coming closer to the level of our investment and we're getting a good return.

So far we are in line with our capital investment projections but following our strategy we will invest to grow. We still anticipate a slight increase in our capital investment above $1.4b if we see the same strong growth in subscribers and traffic in the second half of the year as we have seen in the first half of the year.

In the first quarter our cash generation covered 75% of our CapEx needs and in the second quarter 78%. So on last 12 months basis end of June, approximately 69% of capital investment not including acquisitions were covered by our own cash, which is in line with 2004 and we see improving trend which we assume will allow us to be free cash flow positive in 2006 in terms of current operations in Russia.

Well thank you Elena and moving on with our corporate objectives. On May 31 we completed the merger of KB Impuls, our fully owned subsidiary which held the [indiscernible] for Moscow. Immediately afterwards we submitted all necessary papers to reach KB Impuls [indiscernible]. We have received a letter from the regulator which informed us about the policy decision to [indiscernible]. We hope the process will be completed shortly and in the meantime we are [indiscernible].

Following our operating strategy and in line with the decision of our AGM in June this year we decided to merge 7 of our regional subsidiaries in [indiscernible] in order to make our Corporate structure support [more opposition].

Let me now take over to our Shareholders meeting. At our AGM this year we held the first election of our Board where the number of nominees exceeded the normal Board seats. In this case, as [indiscernible], the votes of KBR Holdings were crucial to the outcome. As a result, in the 9 member Board we have 3 executives from Alfa, 3 executives from Telenor and 8 non-affiliated Directors. David Haines, John [Bookner] and [indiscernible].

After the AGM we [indiscernible] will continue as our new Chairman and we hope that his previous experience in Russia and his knowledge of the industry as a former mobile marketing director of Vodafone will help the Company further develop its business.

As you know, VimpelCom moving into the Ukraine market is still unsolved. The Board of Directors didn’t approve the acquisition of the Ukrainian systems, nor of Wellcom. Although the majority of the Directors supported this move.

[indiscernible] convenes an EGM to vote on the decision on August 15. However, Alfa chose not to attend the meeting and as a result the meeting didn't take place because we required 50% quorum. [Indiscernible] in the case of a lack of quorum a Shareholders meeting may be convened again [indiscernible].

This concludes our presentation. I would like to take a moment. The [indiscernible] business is already successful delivering very strong financial results. We have a strategy that works and we have a strong dedicated management team. The team has proven many times its ability to deliver results which [indiscernible].

Thank you for your attention and let me now open the floor to questions.

Thank you. [OPERATOR INSTRUCTIONS] And our first question will come from Alex Kuznezov of Bear Stearns.

Good afternoon. Please accept my greeting on a strong result. I have 2 questions. First of all I would like to enquire if you had any major accounting changes, in particular, changes in revenue recognition in second quarter?

And second, do you have some estimate of incremental ARPUs in Russia and Kazakhstan?

Regarding accounting changes, there was no accounting changes or revenue recognition in this quarter.

And in terms of increments ARPU's, our position that right now we are bringing 7 -- $7 subscribers into the network. That's why you can see some tendencies that ARPU is not decreasing, but we have some increase this quarter. Also it was affected by some seasonal effects which is weaker first quarter results and then stronger second and third quarter for ARPU's.

The same goes for Kazakhstan. We don’t see any dilution effect yet on ARPUs. Kazakhstan is probably bring us profit in ARPU [indiscernible].

Thanks. And 1 follow up question. Do you have EBITDA margin for your Kazakhstan subsidiary?

Actually, we are not disclosing the segment information by our subsidiaries.

But you can calculate that if you look at our presentation and basically $16.9m divided over 43.9, which is 38.4%.

Thank you very much.

Our next question comes from Vladimir Postolovsky of UBS.

Good afternoon ladies and gentlemen. Congratulations on excellent results. 3 questions if I may? First 1 is ARPU. Obviously it's the focus of attention for all of us. Great results in second quarter, however, we're still wondering whether it's exaggerated seasonality, or whether the underlying trends are extremely strong? What in your opinion what was the prevalent factor to generate good performance quarter on quarter? Or if it seems too general then what are you seeing in third quarter ARPU rose to second quarter, are you still seeing an improvement or has it stabilized in third quarter?

The second question, universal services funds, have you paid anything or have you accrued anything in the second quarter?

And finally third question, are you still maintaining your 1.4 CapEx guidance for this year? Thank you.

I will start with the first 1. ARPU's. We believe that there is both 2 factors. First of all seasonality I think were not very well estimated by everybody, because in Russian market right now we see a very clear weaker month and very strong summer month helped by that people outside from their houses, people in new country houses in Russia and also helped by the strong [indiscernible]. And I think in their analyst forecast that was not reflected well enough.

But secondly I think it's really some positive trends which are on our market [indiscernible]. Our networks in most of the regions are becoming better and better. There is a good coverage, coverage of growth, coverage of territories, coverage of places where people have arrived during summer time. And this is, of course, if helping to grow minutes of use. Whereas in the [indiscernible] in terms of relative stories in Russia. We have biggest number of subscriber using [indiscernible] as an example. And that's also helping there growth of ARPU. We believe there are still more opportunities in the future for us to all gain in terms of growing revenues from existing subscribers.

But could you still give us an indication of what's happening in Q3 compared to Q2? The quarter on quarter in Q2 is great. But there are some suspicions that it could have been a fact of the weakness of ARPU in Q1 on the back of these extra holidays in January that we had in Russia. So in Q3 on Q2 are you seeing an increase or are you seeing a flattening of ARPU?

[indiscernible]. I think we had the results of the negative, the talked about first quarter, especially with the lack of working days. But additional working days were certainly helpful in reversing the flat trends that we had in 2004.

But in addition to that we had 2 main aspects that are helping ARPU. First we got more efficient in our promotional activity. The free minutes that we offered in the summer were at night when the network was unused versus the first quarter when we offered them at any time in the day. And 2, we have seen an improvement in customer mix, especially in Moscow where we saw a quite fast acceleration of ARPU first quarter 11% versus our average [indiscernible]. So we expect to see a third quarter -- perhaps we don’t give that.

Okay, so talking about the CapEx. Yes currently we're seeing that $1.4b is correct number for us. But as we are always saying that we investors grow and if subscribers and traffic are a growth people, then we will invest accordingly. And the Universal Service Front we stopped paying it this quarter and the charges of 1.4% of service revenue excluding intercollect.

And there was nothing booked in Q2?

It was already reflected, not for the full quarter of course, but as long as the statement regarding this payment was published. I [indiscernible] started paying since that day.

Thank you.

Our next question will come from Sergei Arpenyev of Goldman Sachs.

Good afternoon. Can I just ask you 2 questions please? Firstly on EBITDA margin guidance. I mean I know you don't really give formal guidance but just informally, you were talking previously about 45 to 50% EBITDA margin for 2005. Given very strong results in the second quarter and also quite decent results from the margin point of view in the first quarter, do you feel that EBITDA margins can come up closer to 50% towards the year end 2005 and beyond that do you believe that you can keep it in the sort of high 40s, low 50s bracket, given developments in your subscriber acquisition costs.

And my second question is on [indiscernible] extension in Ukraine. You were previously saying that from a management point of view, again if I remember correctly, if you would not get into Ukraine in the second quarter of 2005, then the whole venture would make little sense from your point of view, again if I remember your words correctly. Given that we're now in the third quarter and there's still no resolution, there's still shareholder issues, with that, do you think that there's still -- that it would make sense for you to get into Ukraine later in the year?

Thank you. I will take both questions. And obviously you are speaking about the quarter. We feel that move is highly accountable EBITDA margins to stay within [their quarter]. And also there is not that tradition as we said before that a given quarter [indiscernible], but in the long run, on average, we will be maintaining the guidance between 45 and 50.

Now about Ukraine. Yes, we're talking about quarter 2 as a self-imposed deadline on that 1. But also one has to take into account that it is a fundamentally strategic move and for 1 month or 1 month probably are not that crucial for that decision. But also which is more important, we've seen quite a few positive strategies coming from the Ukrainian market and we're waiting for the results. They're soon to be published the results [indiscernible]. They are quite encouraging in terms of recovery and general improved health of the Ukrainian market. That's 1 side. The other side [indiscernible] for the Ukrainian market and [indiscernible] and we had to incorporate this into our calculations. Still regarding [indiscernible] continues and the longer we wait, the more valuable the [indiscernible] transaction as it stands now makes sense for us.

Okay. Thank you very much.

Our next question comes from Stephen Pettifer of Merrill Lynch.

Good afternoon. I wonder if I could ask my first question about your sales and marketing expenses, specifically there seems to be a 20% decline in your dealer commission quarter-on-quarter, and at the same time there was a significant increase in the advertising and marketing line. Was that a reclassification or was there something specific behind that?

And secondly, could you give us your percentage of your revenue that comes from non-voice please?

First of all it was our expenses on the commissions. Yes, the statement is correct, we've had some increase of advertising expenses in the second quarter, mainly due to our branding campaign and we believe that was a very successful campaign, and right now we're getting more and more benefits from that.

In terms of dealer commissions, that's also correct in the second quarter, we decreased our dealer commissions in the regions. And that was a serious reduction. Right now we're paying on average only $8.5 for 1 sale in the regions, which is giving us a good savings, and I think is helping to improve for our economic sense and bring more profitability.

The good point is that we did decrease our commissions. We managed to still continue to be leaders in terms of growth, and I think that's even better than we have decreasing expansions. Actually we were doing that ahead of competition and right now we believe the competition will follow. But also we decreased commission, but still stay as leader in terms of sales.

As a follow up to that, can I just ask then if you feel that your advertising and marketing expenses were artificially high during the quarter?

No, they're not high. I think in addition to existing [indiscernible] an effect in June because of the strong promos during the Christmas month, we also clawed back some of the dealers -- deal commissions in the second quarter. That also helped a bit. But this is acquisition costs.

Thank you.

In answer to your [indiscernible] service question. In the second quarter 14% of revenues came from value added services, and that was broken down by 50% in messaging, 27% in GPRS access or our data access services, and 12% in infotainment for conference services. The other 10% was just the basic value added services like voicemail and [indiscernible].

Thanks very much.

Our next question comes from Herve Drouet with HSBC Bank.

Good afternoon. 2 questions as well. First 1 is did you change your definitions for recognizing active subscribers, and did it add any impact on ARPU for second quarter?

And second question again regarding subscriber acquisition costs and you were saying that dealer commission has been decreased. Do you think for the remaining quarters are we going to see a similar trend, that is, declining subscriber acquisition costs year-on-year as well as between sequential quarters? Thank you.

Have to say is the active subscriber indicators with an additional indicator that we're just providing, we cannot do any calculations of ARPU or MOU on the basis active subscribers. Our plan is simply to show the percentage of the customer base that we report, that is actually generating revenue for the Company. And it is our wish that all of our competitors start showing the same information in order to see the real trends in the market place.

In terms of subscriber acquisition costs we will try to be as efficient as possible, and you see that we're actually making some serious actions in this area. Our unified business model is helping us in this area, because we can control all our branches not too well to spend some not efficient money etc.

But we also need to say that competition in Russia is very tough. So we have strong competitors -- to national competitors, the local competitors which are also relatively aggressive. That’s why of course, it would be some pressure on expenses on marketing. That's why it's hard to predict that subscriber acquisition costs will always go down. I was hoping that approximately this level could be sustainable for some period of time.

And just 1 last comment that 1. It probably makes sense to look at the subscriber acquisition cost for the longer period rather than just 1 quarter. Because in different quarters, subject to some adjustment which is coming from the previous period, the claw back which generates already mentioned with additional bonuses which are paid here. The customers generate significant traffic. So they are subject to some fluctuation and this fluctuation would be [indiscernible] if you take it over a longer period of time.

Okay. Thank you.

Our next question comes from [Herve Brunet Ali] of Bear Stearns.

Good morning. I just want to be reminded of the changes in value added services accounting that you mentioned in the Press Release. Exactly what were those changes? It appears that at least going back to second quarter of '04 that a change in accounting reduced your revenues slightly?

We have made this change in the first quarter on the reported first quarter results, and the change was connected with the way we are reflecting our relations with the suppliers of the services, which were provided to the customers. So previously, we reflected the revenue from the customers 100%, and showed the cost which we are paying for the content also in the full amount. But then basing on our revaluation that our relations is more like [indiscernible] relations, we start reflecting only the difference between the amounts which the customer is paying for the full service, and what we are then paying for contents providers.

So that's the major difference which really decreased the revenue. And so we recalculated accordingly all our previous statements reflecting the revenue, so the comparison should be correct.

Given that your ARPU has been pretty strong in the second quarter, do you think there's more reasons for you to be more aggressive than what you'd earlier planned in subscriber growth for the rest of the year?

You know actually our strategy is to take the leadership in the remaining growth and that we will keep working hard in with bringing more subscribers to our networks in all regions where we operate. But what we would not prefer to do is to lead in terms of price wars. Actually with the pricing we call ourselves price followers and not price leaders. So we believe that today's level of price thinking, in terms of tariff, average price per minute is already low in Russia, and there is no need to keep decreasing prices there. The market will continue growing at this level. That's why we will try to bring more subscribers with our advantage, service quality, leadership in [the lease], leadership in terms of branding and distribution, but not to decrease pricing.

Okay. Thank you very much.

Our next question comes from Parah Sharmilder with American Century Investment.

Hi. Congratulations on some very strong numbers. I have 2 questions. You already touched upon the dealer commissions and that they will continue declining. Can you give us some sort of an estimate for the magnitude of how far you think they can go down? Obviously they can't go down to zero, so how far they can go down?

And the second question is, you already mentioned you would rather compete on things other than the price. My question is this, looking at your G&A expenses in the second quarter they were up 52%, which obviously did some very nice things for your EBITDA margin, while the revenue was up 59%. Given the fact that you do plan to focus on these additional services and additional things, what kind of ratio of G&A expenses to revenue do you think you can maintain, and be able to accomplish these things that you talked about? Thank you.

I'll start with the subscriber acquisition costs. So first of all, just to make clarification, we're saying that we made certain steps during the second quarter to decrease dealer commission. But looking forward we do believe that there will much less opportunities in the future to do that. Because when we're seeing 8.5 in the regions there's still – that’s a low region and we can't of course equate it zero, as you said.

So we'll try to be more efficient and we believe more operations and with that more business will have in Russia, more efficient we can be, as a result of we're using national advertising and all Russians are seeing that, increasing population coverage is more and more efficient. But still there is some limitation, and also there is a very tough competitive environment pressure from the competition as well. That's why we believe that stable tendencies in this area you can forecast going forward.

Sorry, can I jump in with a clarification question on this answer? You said expect stable tendencies. You mean flat dealer commission or you mean expect another 23% year over year drop in your commissions -- in dealer commissions when we get the second quarter '06?

No, I mean flat subscriber acquisition costs as an absolute number moving forwards. So right now we're paying $13/$14 per subscriber and we believe that's sustainable.

Thank you.

And now I'll address your second question on G&A. It's very difficult to guide that way, to do exact ratios where we have different elements of our P&L. But [indiscernible] to say that as the year becomes more sales and marketing driven, that our S&GA [indiscernible] margins. Margins that we have sustained between 45 to 50% as we said. And therefore whatever we will be generating in excess of it [indiscernible] will end up in our forecast , our marketing forecast. And therefore, when we look SG&A which is currently 31.5% in our P&L. The [indiscernible] push between marketing and SG&A costs will change, decreasing on SG&A and increasing on sales and marketing towards marketing expense. That's probably in the future what we're going to see.

And the next question comes from Reece Somerton with Citigroup.

Hi. Good afternoon. Can you give me some clarification of some guidance on some key numbers. Firstly, you mentioned that your market share in subscriber terms had been stable or slightly positive. Can you give us some idea of what trend you believe may have come through in the second quarter in terms of revenue share, if you had to define market share in terms of revenue, whether you expect it to have gained revenue share in the market?

And then the second question is, of your existing subscribers, so let's assume subscribers are to [indiscernible] 12 months ago, could you give us an idea of what increased spend the existing subscriber base may be showing?

In terms of market share with revenues, its really not that easy to predict before we know the real revenue numbers from all our competitors. And even more I would say, we can't estimate exact numbers because there are local operators in Russia, and they are not giving any their revenue numbers. That's why it's becoming too difficult to guide on this level. What we feel is that our dynamics in general terms of market share in terms of subscribers and the revenues [indiscernible] that's why [indiscernible] we not look to only to subscriber numbers, but also to look to active subscribers we believe we have regained quality subscriber base. And that's why we believe it is impossible to give exact numbers [indiscernible].

Your second question [inaudible]. We see from those subscribers [indiscernible]. But with that will be compensated to some extent with the price reductions and so on, but usage is going up by this much.

Our next question comes from Layla Dachan Horne with Edgerton Capital.

Hi, this is Layla Dachan Horne from Edgerton. I had a couple of questions. The first 1 was regarding revenue growth. If you could just help me understand a bit better the reason for the acceleration in the revenue growth year on year. You did speak about the quarter on quarter trend and the different issues regarding seasonality. But just to understand a bit better on a year on year basis, what you believe drove the revenue growth acceleration? That's the first question.

My second question is regarding the second half of this year especially as we come later in the year get into the Christmas period, do you think most of the operators have learnt their lesson, so to speak, compared to the Christmas quarter last year, which was very aggressive on the promotion side, where a lot of customers added, it was a bit debatable as to whether or not they were a good quality customers or not. And do you think it's realistic to expect a repeat of that, or people have probably have learned their lesson, some of your peers and maybe we don't see as an aggressive a Christmas period?

And then my last question is just on the margin side. You mentioned in your introduction, that you were better able to try and control some costs and see some economies of scale, and this helped improve the margins. 1 of the things you mentioned was the reduced dealer commission in the regions. Are there any other cost control measures you guys have been working on apart from the sales and marketing type costs? Thank you.

Let me start with the revenue growth. First of all just to remind everybody that during the last year we were actively developing on the new tariffs in Russian regions. And it was before coming to new regions of Russia and right now we're operating in 76 regions of Russia, and it was from less than a year ago. And also in each particular region it was strong development during this year. It was new [indiscernible], new [indiscernible] etc. That's why this was a very official investment and development as we've seen in terms of revenues.

Also we believe that working with existing subscriber bases is also giving us some results with the growing their revenue from -- growing the share of different subscribers on the market in particular in Moscow. That's also giving us this positive total consolidated effect on revenue growth.

As to lessons learned from Christmas, we can only hope that our competitors learnt their lesson from Christmas. [indiscernible] our active base number so that we can start to compare our more quality of base. Likewise we need to take a look at churn numbers that came after Christmas, and we'll see that in the second as well as in the third quarter. And as for marketing maybe [indiscernible].

In addition to dealer commissions, [indiscernible] control costs, but [indiscernible] from the very beginning has been product efficient strategy. We have a Greenfield approach. We started with 1 set of platforms and 1 set of IT systems, 7 contact centers not be expanded as we grow across Russia, and we're duplicating that model in Kazakhstan. We're now reaping some of the benefits of that decision that was taken 3 years ago.

Exactly, that's the way we're looking on this our unified model and the single approach help us to extract economy of scale on quite good volume, and so that leads to improvement of our margins.

[indiscernible] it is a [indiscernible] margin position at the moment for us is easier to constrain the costs rather than there is a need to reduce them. And that was something we focused on, where we look at the efficiencies of our personnel, and different cost elements and we're trying to match our expansion of the cost base in such a way that it will continuously improve our efficiency.

Thanks. I just have a very quick follow up. You mentioned earlier that the ARPU from existing users you're seeing because [indiscernible] 15% usage. In ARPU, is the ARPU from existing users also increasing or is the decline offsetting that usage increase? Thank you.

Obviously the trend decline historically has been offsetting the usage increase that we have seen. Not only have we seen an increase in ARPU we've actually seen reduction. Some of the more saturated markets, particularly in Moscow, that reduction is decelerating and, therefore, we hope that usage increase can be offset by a more stable price going forward, hopefully increase ARPU.

Are you referring to the existing users when you made some comment? So customers you've had in your network for 2/3/4 years, the ones not diluted from the new growth you've been experiencing?

It's hard to separate them out because you do have a natural migration from older [indiscernible]. I think the customers that do not change [indiscernible] and generally start to increase their usage because of getting used to the services ARPU increase. But we don't have separate data on that right now.

Okay. Thank you.

Our next question comes from Nick Barnes with Thames River Capital.

Hi, it's Nick Barnes here. I have a quick question on USO. You mentioned that you were accruing USOs since May, whereabouts is that reflected in your financials?

G&A costs.

In which line, sorry?

G&A, SG&A.

SG&A. Okay. That's great. Thanks.

Our next question comes from [Philip Townsend], [indiscernible].

Yes. Thank you. Good afternoon everybody, and very good results well done. Just a follow up if I could on the ARPU going forward. The Russian economy is continuing to do very well indeed. We're clearly getting, obviously you're growth into the regions with your $7 additions, but could we not argue that not only will the minutes of use grow in places like Moscow, but in the regions also. And therefore, using as we've thus guided, $7 as your additional ARPU going forward is perhaps the wrong thing to do?

In terms of what?

In terms of modeling?

Of course, it's impossible to give exact guidance. But in terms of indications we can say, first of all, minutes of use on the regional subscribers have an opportunity to grow. And we're doing that on existing customers we can foresee some growth of usage as well, like Moscow and in other markets we're seeing even more I would say.

Some of the other regions are still on the early stage of development, as a result of in North Western Urals we just started it's only 1 year operation and we still didn't fulfill our own coverage rollout, that's why this region in particular, we can foresee some growth of usage because of growing coverage.

Secondly, in the regions we still believe there is opportunity to grow revenues from [indiscernible]. As an example in the majority of rural areas there is no internet, and we are the only provider who can give them the really good internet access, and make revenues on that.

On the other hand, in the regions it is really difficult competitive situation there is still from local players which are very aggressive on pricing. We're getting the lead on them and we're taking market share from them but they still keep some part of the markets and they are very aggressive putting pressure on the overall ARPUs.

That's very helpful and thank you very much indeed, a second question, if I may. We see the Alpha Group is getting more and more involved in Turkey through Turkcell. Given the close relationship that you have with the Alpha Group, is it likely that perhaps some point in the future your expansion won't just be within the CIS, which is obviously stage 1? But that you will actually look to get outside what was the old Soviet Union and into other places as well, including maybe Turkey?

That would be possible but I don't expect it is going to [happen] it would be pure speculation. At the moment you have to look at the strategy which has been approved [in the quarter] and that includes the CIS. However, if you look at the propensity to do this of the Company as of what we do well, we actually have built the numbers very well and overall cost. And we also convert to the more recognized of low cost environment and [indiscernible] probably 1 of the highest margins on 1 of the lowest ARPU's in the world. So if you look at the Russias that way. So with this type of ambition, of course, we could attack a broader geography. But at the moment we are focusing on the CIS as a growth strategy for the Company.

That's super, thank you so much for your help.

Our next question comes from [Korina Sibiavkov with Blueberry Asset Management].

Hi, I have 2 questions, first is on your CapEx, would you be in the position right now to provide any CapEx guidance for 2006? And also could you provide some guidance on your minimum CapEx which you have to maintain in '06 for network maintenance?

My second question is on your funding. You've mentioned that you managed to decrease secured funding to 20%. Do you have any internal targets for the year-end, where do you want to see the secured debt as a percentage of total? And do you now have any funding plans for 2006, or it's too premature to talk about them? Thank you.

Thank you. Talking about the CapEx data so first we didn't say anything about year 2006. But again I am repeating myself we are always saying that we assume that the good level for investment for a new subscriber is around $100 per subscriber. Saying that, of course, you can see that recently we've delivered better results being below $100 per subscriber. But we still think that this is a good level because the quality which is the delivered on this level. And if previously we invested less that was connected with the question that subscriber growth was very, very strong. And then we have to make some catch up on this. So based on this you can see what will be a projection for the CapEx base. We will see there projections for the subscriber growth for year 2006.

Maintenance level for the capital investment we assume that this should be on the level of depreciation, somewhere between 15% or 20% revenue. And talking about our funding strategy, we assume that 20% of secured debt is quite a bit lower. Potentially it may get a bit lower because, of course, right now we have good access to capital markets. And can go with the increase of the proportion of our secured debt. But now also there is a trade between interest we are paying and security and covenants we are providing. So in this regard that's how we are looking at it this, and talking about funding we think that for this year we have already done a lot. You know that in the first quarter this year we issued the bond for $300m and secured syndicated loan for $425m. But we are still looking that potentially by the end of the year we will look for additional funding of approximately $300m.

Thank you.

Our next question comes from Anna Basong with CA IB.

Yes hello, congratulations on the good results as well. I just wanted to ask firstly about your gross margin which increased in the second quarter. And I wondered if it was just the change in your marketing policy and giving the free minutes only at night time? Or is there some other factors that need improvement in the gross margin that you can talk about?

And also secondly price competition, last quarter you were saying that you are seeing it easing, or it's actually looking a lot better than in previous quarters. Is that still the case or are you seeing some signs, perhaps Megafone having had a pretty bad quarter in terms of net adds, are they becoming more aggressive? Thanks.

In terms of the gross margin first of all we are benefiting from the qualities of scale and that is helping us in this area. And also we need to take into consideration that the number of minutes within the network is growing and this minutes is coming without any extras cost.

Can I ask what that figure is as a percentage on net traffic?

On net traffic its approximately 60% of the total traffic. And you have some damages for growing and defending region, on the region.

Its actually closer to 58% is on that traffic and growing.

At 58%?

Yes.

Thank you.

For our competition, yes we see some more mature behavior and mostly from our biggest competitor. So Begalcom and test and demonstrate more mature behavior. But still its aggressive, Megafone is seeing regions there are very aggressive for decreasing pricing. And also are very aggressive local players. So we believe that in general there are some more mature behavior but still the competition is tough.

When you say more aggressive do you mean then last quarter or just continuing to be very, very aggressive?

Actually in first of all in tariffs and secondly in all this newer commissions, special bonuses, marketing expenses of this marketing playing marketing game.

Great, thank you.

Our next question comes from [Thord Lender] with DNB Nor.

Good evening and congratulations on the good results. I was wondering whether you could disclose the expected figure for USO? Thank you.

Could you repeat the question you were breaking up?

Sir could you repeat the question please?

Yes sure [indiscernible] disclose the expected figure for USO?

USO, that's the [US] in [Kazakhstan]. [Inaudible].

Yes.

Alright it's approximately its $3.5m for the fourth but again as I said it's not the full quarter.

Thank you.

Our next question is a follow up with Vladimir Postolovsky with UBS.

Good evening again. 3 more questions if I may? The first 1 if I could just come back to margins. You are showing your near-term guidance is still flat to falling margins. I just want to understand what I am getting wrong. If you look at your subscriber consumer costs per percentage of revenues, it's about 11% to 12% at the moment. And all the growth additions about 2-thirds more than 2-thirds, is net additions. So that subscriber growth slows and there is all those net additions disappear. In theory there is 7% to 8% of margin to gain, I understand that there is some fixed element in marketing and so on. But still I would have thought that there should be an increase, a boost to margins as we are entering into a mature stage of the market. And you are still guiding to your flat to falling margins. Could you explain what do you see as an offsetting factor that would offset those gains?

That's the first question, the second question depreciation. There was significant increase this quarter both in the percentage of net book value of assets, and just generally if you look quarter-on-quarter of [Istanbul]. So I was just wondering if there was just a 1-off that let to that? And finally on pricing trends do you really believe that we are going to see some stabilization? To be honest when you talk to operators everybody is pointing fingers at somebody else. And what you just said at Megafone for example is 1 of the price aggressors, but at the same time if you look at the ARPU, actually the pace of ARPU erosion of Megafone, is probably the lowest in the market. So it looks like actually everybody's contributing a little bit and it still doesn't slowdown. Even this quarter with all the positive inputs and analysis you still had ARPU effectively per minute falling by about 6% quarter-on-quarter. And year-on-year it's probably about 30% down. So do you really see some stabilization of pricing or is it something you are just hoping for? Thank you.

Maybe I will talk about this market and how it's turned our position cost [fray] into a tax rate market. First [attribution] market is 120%, however, our gross sales actually increased year-over-year. We had our share of additional that does not go away in a tax rated market, it stays to be reclassified on that is the intention of course, but at the end of the day obviously it would be a mistake to assume that as soon as we hit saturation it would no longer happen. For your information, deeper our [inaudible] and so forth. That's the first thing. Of course, we have a hope that competitors start to put some more rationality into their average price per minute. [Interim] and Megafone have reported a higher ARPU but their average price per minute is significantly lower than ours. And if they do not come out in certain segments they we, of course, being specific [indiscernible] their targeted segments to [inaudible] even further.

I would just add that Megafone has average price per minute lower than both 2 leaders, and that's in all regions besides we are not resting [tomorrow], all the rest they have lower. They have some guaranteed ARPU's with limited number of days per owner of SIM cards. But average price of minutes is lower. And that's 1 of the reasons for them to grow in revenues. But in general I do [not] want a [indiscernible] more mature behavior, some more understanding. But feel a foreplay of market in general in Russia and that's not very easy and we wish to keep for price to become a certain level and the pressure is on the market.

And talking about depreciation. So actually you know that in the year 2004 we decreased the depreciating period for our telecom equipment. And then went further that has the additional affect as long as our investment, in the end of year 2004 were quite intensive. And as we have already discussed today, we are continuing to invest quite heavily and so depreciation is naturally growing.

Another point which we should mentioned and which influenced the line on depreciation and amortization, is the thing that we've merged with Rumble com region. And that we anticipated the revaluation of our licenses related to the regional operations will start depreciating, amortizing them practically since January this year, as the merger was completed by the end of the year 2004. So that's the items which increased to a certain extent our depreciation. And so from approximately 16% on average which we had seen in year 2004 we came to approximately 18%. But in middle term or longer term period this percentage we assume will be decreasing, again if we are talking about current operational.

Our next question comes from Sergei Arpenyev with Goldman Sachs.

Good afternoon again, just to follow up on a couple of your answers before. You mentioned that the improvement in the usage, 1 of the reasons for the improvement in usage was the improvement in the customer mix. I am just wondering whether you can tell with any degree of certainty, whether this improvement in the customer mix is coming from MTS? Or whether you are competing better against the smaller, local competitors?

And my second question is just to follow up on the decrease in dealer commissions, and to what extent the decrease in dealer commission was driven by change to the dealer commissions being charged as a percentage of revenues, rather than a fixed dollar amount? And if you can breakdown maybe or give an indication of what is the fixed and the variable element in the subscriber acquisition or in the dealer commission is? Thank you.

I am certainly not going to comment on [mix]. The beginning of this [show] we held up the change [force] and mark down and started to show some much more attractive value rather than going after the capacity of SIM cards. And what we are doing is we've been focusing on improving the customer mix of mix through new products. And, of course, investing in our new brand and new image. And here we are starting to see traction. We are gaining more and more customers and having accelerated revenue growth from business users, as well as the high-end consumer customers that bring in excess of $40 per month.

As for the regions, as of today we are still kind of weaker in terms of mass market. But we are only starting our campaigns and focus on that business segment of subscribers. Of course, we've got some percentage of corporate users, but feel we are not leading on the segment. And still there is an opportunity. There is opportunity to change your subscribers from the old first players of the market. In some markets it wasn't there and in some markets it was. Megafone in [North West] and in some markets there is local subscribers. And that's what we focus during their [indiscernible] here for [indiscernible] we tried to constantly increase our share on the business end. And that's also opportunity for growing revenues and ARPU's.

I am not sure if I get correctly your question, but you wanted some quantification about what are the fixed portion and the variable portion of subscriber acquisition costs.

In terms of dealer commissions, just to make some qualification the [theme] of some fixed payments, and payments that are from the usage is only used in Moscow. In the regions we just pay a 1-time fee and that's right now on average $8.5 per subscriber and we are not paying anything from the usage.

And in Moscow we pay roughly $3 at the beginning and depending on the quality of the customer the dealer commission can go up or can appreciate to $35.00.

And our final question comes from Parah Sharmilder with American Century Investments.

Yes I also wanted to follow up on the competition. 1 of the feedbacks that we received from, or I received from some of the regional operators, their incremental ARPU is now below 5. Can you comment on that in any way? And if you could give us some color on what incremental ARPU you are seeing in the region, in your scene in the region? Thank you.

First of all this local corporative really I think run into difficulties. Because they still don't have their raw [indiscernible] opportunities there which explains is having they don't have well recognized strong brands, with that brands, with that support of national advertising just like the whole competitors advantage bill which they can use as immediate pricing. That's why, of course, they are trying to have a low pricing and was left pay the [indiscernible] to price the subscribers that's why a lot of low call subscribers are going to this operation. Some operators are according to me is getting only $1.0 ARPU subscribers in the regions with the kind of very [dumping] the very dumping prices. As for us our average revenue per user is approximately [$50] for their existing regional subscribers and the same for incremental subscribers in the region.

There are no further questions. I would like to turn the call back over to [Michael Polyviou] closing remarks or additional comments.

Well thank you all for participating in our conference call. Hopefully we've answered most of your questions and helped you to understand the dynamics of our numbers. But if you have any further questions please do not be [displeased] to contact us. And Valery Frontow is always there to answer any more of your questions. And have a good day. Thank you very much, bye bye.

Ladies and gentlemen this does conclude today's teleconference you may now disconnect and have a great day.