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Mobile Telesystems (NYSE:MBT)

Q1 2006 Earnings Conference Call

June 15th, 2006 10.00 am EST

Executives:

Andrei Terebenin, Vice President, Corporate Communication

Leonid Melamed, President and Chief Executive Officer

Vsevolod Rozanov, Chief Financial Officer

Eric Franke, Chief Operating Officer

Mark Burdon, Chief Financial Officer of UMC, (Ukrainian Operations)

Analysts:

Anna Kupriyanova, Renaissance Capital

Vladimir Postolovsky, UBS

Herve Drouet, HSBC

Alex Kuznetsov, Bear Stearns

Rizwan Ali, Bear Stearns

Sean Gardiner, Morgan Stanley

Sergei Arsenyev, Goldman Sachs

Jean Charles Lemardeley, JP Morgan

Alexei Yakovitsky, Deutsche Bank

Dalibor Vavruska, ING

Nadejda Golubeva, Aton

Alex Barenka(?), (Inaudible)

Alexander Balackman(?), (Inaudible)

Evgeny Golossnoy, Troika

Olga Vistrova

Yanis Petrovich(?), BBVA

Anna Bossong, CA IB

Presentation

Operator

Welcome to the Mobile Telesystems Q1 2006 financial results conference call, on Thursday, 15 June 2006. I will now hand the conference over to Mr. Andrei Terebenin. Please go ahead, sir. Operator instructions.

Andrei Terebenin, Vice President. Corporate Communication

Good day everybody and welcome to MTS’s conference call to discuss the company’s Q1 2006 financial operating results. Before beginning our discussion, I would like to remind everyone that except for historical information, comments made during this call may constitute forward-looking statements which may involve certain risks. These statements may relate to one of the following issues: first, the strategic development of [inaudible] [business exchanges?], both in Russia and abroad. Second, revenue and/or subscriber growth, indicated loan facilities and their usage. Third, financial indicators such as operating income before depreciation and amortization, average revenue per user, cash flow projections and/or return on invested capital. Fourth, the capital expenditures and operating expenses. Important factors could cause the actual results to differ materially from those contained in our projections or forward-looking statements. These statements may include company press releases, earnings presentations and certain reports and Form 20-F as well as other public filings made by the company with the United States Securities and Exchange commission, all of which are available on the company website, www1.mtsgsm.com and that of the US Securities and Exchange Commission at www.sec.gov.

MTS disavows any obligation to update any previously made forward-looking statements made on this conference call or make any adjustments to previously made statements to reflect changes and rates. Copies of the presentation and materials used as references in this conference call on our company website. I want to introduce the MTS team today at the conference call. Mr. Leonid Melamed, the President and CEO of MTS. Mr. Vsevolod Rozanov, Chief Financial Officer of MTS. Mr. Eric Franke, Chief Operating Officer of MTS. Mr. Mark Burdon, CFO of UMC, our Ukrainian Operation. Now I would like to introduce Mr. Leonid Melamed, the President and CEO of MTS.

Leonid Melamed, President and Chief Executive Officer

Thank you, Andrei. Good day, ladies and gentlemen. I would like to first off thank the shareholders of MTS for recently electing me President and CEO of MTS, not only a leading Russian blue-chip company, but the top mobile phone operator in region. MTS has gone through a period of rapid growth, demonstrating now that we are an effective operator in the markets of the former Soviet Union. As the Russian market matures, and as Ukrainian nears saturation point, we aim to further solidify our leadership position by improving upon the effectiveness of our operations, and seek additional opportunities for growth abroad using our economies of scale.

We witnessed difficult Q4 2005 and Q1 2006, but currently are pursuing a number of initiatives covering our entire value chain aimed at increasing our revenue in our home markets and optimizing business processes to improve upon our margins. We will be aggressive in examining costs and seek an acceptable rate of return on our investments and expenses. As a benchmark, we are seeking a return on invested capital of not less than 25% over a five-year period through organic and inorganic growth. At the same time, we will adhere to the highest principles of corporate governance and broaden our dialogue with investors and clients. Though our recent performance didn’t meet our expectations, we are confident that our optimization efforts will bear fruit towards the end of this year and lay a base for healthy growth in 2007 and 2008.

In Q1 2006 we maintained our leading revenue share in Russia and Ukraine, while showing a clear lead in market share in Belarus, Uzbekistan and Turkmenistan. In Ukraine, the mobile market has entered a more competitive environment after the acquisition of URS by Vimpelcom in November 2005. Nevertheless, UMC maintained its revenue leadership in the post-paid market. Our subsidiary in Uzbekistan increased its market share from 55% to 57% and remains a clear leader in the country’s telecommunications market. In Turkmenistan, our subsidiary continued to dominate the local market and now boasts a 75% market share compared to 74% at the end of the previous quarter. During Q1, MTS' joint venture in Belarus enjoyed a 51% market share as penetration in the country reached 46%. The company remains committed to acquiring a controlling stake in the joint venture.

Looking back more closely on Q1 2006, we witnessed a slight drop in revenue in Russia of 2.6% to $929 million QoverQ. We attribute this loss to seasonal issues, namely fewer working days and lower guest roaming revenues, as well as inappropriate price policies in a number of regions. We have adjusted prices in these regions and are now refocusing our marketing both on a national and local level. Our first step was to launch a new brand, a brand chosen as much for its innovative feel and its clarity. We are introducing segmented tariff plans for all services, targeted sales policies by region and loyalty programs, at the same time strengthening our proprietary distribution network by remodeling sales and service centers. On Tuesday, we also announced the gradual move towards fixed ruble-based tariffs as we simplify our payment process. The goal of these steps remains to increase sales, stimulate traffic and improve customer service.

In Ukraine, Q1 is also a weak quarter due to the winter holiday period and the effects of holiday-related promotions. Since the beginning of Q1 2006, interconnect payments received from state-controlled Ukrtelekom fell by 16.7%, and in turn rates between the mobile operators decreased accordingly. In Uzbekistan, revenues remained flat at $25.4 million, though net income fell by 8.7% due to a change in the company’s accounting policies. The group’s OIBDA margin of 46.5% was higher than Q4 2005, but fell slightly short of our expectations due to a one-time charge of $16 million in our provision for doubtful debt. If it wasn’t for this cost item, our OIBDA margin could have been more than another percentage point higher. For the group, we expect an OIBDA margin of above 50% moving forward as we more fully optimize our operating expenses.

Three factors contributed to our lower net income of $184 million. Firstly, on a QoverQ basis, we witnessed a decrease in revenues from our Russian and Ukrainian operating units. Secondly, we incurred an increase in other non-operating expenses mostly related to roaming fees. And lastly we recorded an increase in depreciation and amortization expenses. ARPU in Russia fell 15% QoverQ to $6.2. We expect that the introduction of CPP, coupled with targeted measures to stimulate voice traffic and the development of value-added services, should allow us to stabilize ARPU in 2006 and lay a foundation for growth for the future. As for value added services, we plan to improve upon its contribution to ARPU from the current level of 14%. For Ukraine, intensified competition will result in a future dilution of ARPU, though we are pleased with the rise in value-added services as a percentage of subscriber revenue and naturally view this as a driving factor for future growth.

Our advertising spending in Russia remains high, but we will reevaluate our expenses as we migrate from share of voice measure to principle of cost per net. In Q1 2006, we introduced a new system of dealer commission and we expect it will stimulate the acquisition of more profitable subscribers and exercise greater oversight of our dealers. In addition, we are reevaluating our approach on a group-wide basis to capital expenditures by placing more emphasis on payback periods and internal rates of return. Each macro-region is being given a set of key performance indicators, quality benchmarks and operational standards. We are already witnessing benefits from this system, as our capex blend is moving from one focused on coverage to capacity.

Within the entire group, we aim to improve our cost controls by delegating more decision-making authority to the regional level. We will be creating profit centers accordingly to our previously established macro regional management system. We are synthesizing business processes and management structures, both at a macro regional level and through our foreign operations, which will allow us to evaluate regional performance with a closer scrutiny. At the same time, we are prepared to apply key performance indicators to measure the detailed managerial effectiveness of our regional operations and subsidiaries. On April 24, 2006, the company appointed Vsevolod Rozanov as the Chief Financial Officer of MTS. Vsevolod brings a great deal of finance and telecom experience to MTS, having played an active role in the integration of Sistema’s fixed line operators, and let the successful initial public offering of Comstar UPS in February 2006. His appointment naturally will strengthen our management team at a crucial time for MTS. And now, I would like to pass this over to Vsevolod, who will elaborate more fully on opex and capex reductions measures.

Vsevolod Rozanov, Chief Financial Officer

Thank you, Leonid. Good day, ladies and gentlemen. First of all, I would like to thank you in turn, I would like to thank you for entrusting me with the role of CFO and in such an exciting company, one of the leading companies in Russia. Hopefully we will all fulfill the expectations of our investors. Leonid has already taken you through the major financial highlights of Q1, one-offs and our main goals and strategic initiatives for year 2006 and beyond. In my speech today, I would like to give you more details in two areas, opex and capex optimization initiatives. I would like to start with some specifics of our opex optimization program.

At the beginning of the year, we launched an opex optimization program with (AT Carn?) providing council and support. The main goal of the project was to help us identify various areas in our operating expenses budgeted for 2006. Which would lead us to OIBDA margin for the year at the level of 50% or higher. We also targeted long-term cost optimization growth on to year 2007 and beyond. Overall, the project was structured in a way to help us identify quick wins that can be done in 2006 and long-term cost optimization plans to help maintain healthy margins going forward. Over the course of these initiatives, we successfully identified a number of areas where optimization is required. We currently have a detailed execution plan in place which will lead us to significant opex reduction in 2006. Just to give you an example, for example dual commission.

Effective this year, we have changed our arrangements so that our partners are on fixed revenue sharing commission schemes. This helps us to achieve two major objectives. One, to attract quality subscribers and two, to avoid paying for subscribers who are not generating adequate revenue. The effect of this initiative can already be seen in Q1 in the reduction of the executive dual commission rates in Russia to $9.1, or by 15% when compared to the prior quarter. Another thing we have identified for improvement is the network maintenance. We have started contract renegotiations with a few of our larger vendors and we have revisited our network maintenance plans for this year. We’ll also see some cost optimization as a byproduct of our capex review program, for example the reduction of rental costs due to the cancellation of some of our network coverage projects.

In addition, we have finalized our call center and accounting center centralization projects, which we consolidated in our macro-regional level. And these services are no longer provided at the regional level. While these projects do not necessarily generate immediate cost savings, they do improve the efficiency of our internal processes, as well as drastically improving our customer service quality. Now I would like to turn to our capex review program. As you are aware, we previously announced guidance for the year 2006 for capex for the Group at the level of $1.95 billion. This number was in our budget for the year 2006 and it was approved by our board of directors. Over the last quarter, our management has performed a detailed review of our capex plans for 2006, to challenge some of the previous assumptions with the goal of lowering our capex levels. Our capex program is broken down into three main areas. Radio network, core network and other, including maintenance.

When we use all three components we specifically focused on our radio network spending, that in turn can be broken down between capacity and coverage capex. Primarily as a result of capacity versus coverage capex review, we have been able to optimize and reduce our 2006 spending program to approximately 12% for Russia. Which actually means decreasing from $1.308 billion to $1.165 billion in Russia. A total for the group of $1.8 billion. In Russia, we currently have over 50% of radio network capex going into the capacity compared to slightly over 40% in the year 2005. The main driver for this shift is expected growth in traffic holding and development of value added services. We have also reviewed our capex plans for all the markets where we operate and in some cases we have made minimal changes. For Ukraine, our budgeted $553 million capex remains unchanged.

Overall, after the extensive review processes just described, our management is confident that our new capex guidance for 2006 will help us meet our revenue and subscriber targets for the year. Having said that, I would like to stress that excluding acquisitions, in 2006 and going forward we expect to have a positive free cash flow. Now I would like to add a few words on our leverage structure and dividend quota. The company’s net debt to OIBDA ratio at the end of Q1 was 1.05. Our average cost of borrowing remains stable at 7%. In April, we signed a $1.53 billion syndicated loan facility with a number of leading international financial institutions to refinance our existing syndicated loan at the lower interest rate as well as for other corporate purposes. Our net debt to OIBDA ratio including the new syndicated loan facility is estimated to be at the 1.2 level by year end, still providing us with a sufficient flexibility to attract new financing if necessary.

In respect to the dividends, our board of directors recommended approximately 50% of net income pay out for the year ended December 31st 2005. This is a 10% increase compared to 2004. The decision to increase a dividend payout is based on the fact that the company had a strong cash flow from operations, expected to be cash flow positive in 2006 and has no immediate acquisition targets to use available cash. While the company doesn’t have a formal dividend policy, we expected that future dividend payouts will be in the range of 40-50% of our year’s GAAP net income.

In conclusion, I would like to emphasize that our management team is focused on delivering strong and sound performance through the rest of the year 2006 and making progress in improving the company’s profitability, cash flow and revenue growth. Now I would like to thank you and hand the call back to Andrei.

Andrei Terebenin

Thank you, Vsevolod. Now I would like to open the call to questions.

Questions and Answers

Operator

Thank you, sir. Operator instructions. Your first question comes from Ms. Anna Kupriyanova, please state your company name followed by your question.

Q - Anna Kupriyanova, Renaissance Capital

Thank you, my name is Anna Kupriyanova, I’m calling from Renaissance Capital. I have two questions, if I may. The first one is related to your guidance on EBITDA margins. You’ve mentioned in your press release expectations for EBITDA margins of about $0.55 going forward. Could you please explain how do you plan to eliminate the problems associated with bad debt and equipment subsidies which became as we understood the main reason for low EBITDA margins in this quarter. Could you please also comment, if the bad debts and equipment subsidies are associated with the Russian or Ukrainian businesses? The second question is related to your non-operating expenses, which as we understood affected your net income. Could you please provide us a breakdown for these items? That’s all. Thank you.

A - Andrei Terebenin

Can you please repeat for us the second question?

Q - Anna Kupriyanova, Renaissance Capital

My second question was related to your non-operating expenses which affected your net income, as we understood. Is there some other income or other expenses before the price, before taxes?

A - Vsevolod Rozanov

OK, this is Vsevolod. Thank you, Anna, for your questions. Speaking about OIBDA margin target of 50%, as I said, we launched an opex optimization program which we believe will be… Which has actually started to be implemented this quarter. We believe that the first results will be brought in the second half of the year. We expect to optimize certain business processes and there are also certain budget optimization initiatives and purchasing optimization initiatives which can basically be split roughly in equal parts, like one third for budget initiatives, one third for purchasing and one third for business process efficiency improvement. We expect that implementations of this initiative will lead us OIBDA margin of 50% plus for the whole year 2006.

Q - Anna Kupriyanova, Renaissance Capital

OK, Vsevolod, what about your bad debt and equipment subsidies plan?

A - Vsevolod Rozanov

Speaking about bad debt, the amount of bad debt was $60 million. This is the one-time situation in Q2, or in Q1 2005. We conducted an investigation of the situation and there was certain initiatives undertaken by the management, i.e. a USO agreement with the viewing provider, the new business processes between the IT and the finance functions which will allow us to highlight this problem as it can appear in the future. But we actually do not expect any repetition of such a problem in this year. The second item was the…

Q - Anna Kupriyanova, Renaissance Capital

The group subsidies, we understood that (inaudible) (gross loss first?), so a net loss of about $24 million. Could you just comment on that?

A - Vsevolod Rozanov

I think that first to stress that the bad debt situation has happened in Russia. And to answer the question about the handset subsidies, I would pass over to Mr. Burdon.

A - Mark Burdon, Chief Financial Officer of UMC

Good evening, or good morning, wherever you are. Basically in terms of handset subsidies, Anna, we have reviewed our policy overall, because we use them only for contact clients. And basically, in line with discussions with MTS and looking at our margins and our strategy, we are going to be moving away from handset subsidies in the Ukraine in the second half of the year. We will probably leave them in place only for the top end of our market. The more profitable segment of the business side.

Q - Anna Kupriyanova, Renaissance Capital

Thank you, and could you please answer one more question about these non-operating expenses? What kind of expenses do you have (acceptance of payment?)?

A - Vsevolod Rozanov

We were unfortunately there was a situation with roaming expenses which happened in Q4 2005. But unfortunately they were delayed in arrival to us and they arrived in Q1 in the amount of $22 million approximately. Which were written as non-operating expenses, because they accrued in Q4 in fact. However, the amount was not material enough to review the results of 2005.

Q - Anna Kupriyanova, Renaissance Capital

OK. Thank you very much.

Operator

Thank you. Your next question comes from Mr. Vladimir Postolovsky, please state your company name followed by your question.

Q - Vladimir Postolovsky, UBS

Good evening, gentlemen, it’s Vladimir Postolovsky from UBS. A couple of questions from me. Actually, on the last one, I didn’t quite catch, what was the issue with operating expenses, could you just give me the reason for this expense? Second question was, margins in Turkmenistan are still quite sharp. Is there anything going on the in country, or is it just a boost of subscriber additions and pressure on margins as a result? And finally, taxes. In this quarter obviously incentive tax related is very high. And can you explain why? Again, is it recurring or is it just a one-off? Thank you.

A - Vsevolod Rozanov

I would take the first question. The non-operating item, i.e. the roaming expenses, have basically accrued due to the certain logistics issues we had. Now we’re already at (six-day business process?) and basically the deal was no accruals made during Q4 2005 for such roaming.

Q - Vladimir Postolovsky, UBS

So these basically should have been sitting in service costs in Q4, right?

A - Vsevolod Rozanov

Sorry, I didn’t, I just can’t hear you.

Q - Vladimir Postolovsky, UBS

This number, in reality, it should have been included in service costs…?

A - Vsevolod Rozanov

In fact it should be opex for Q4 2005.

Q - Vladimir Postolovsky, UBS

OK, I understand. Thank you.

Operator

Thanks. The next question comes from Mr. Herve Drouet, please state your company name followed by your question.

Q - Herve Drouet, HSBC

Yes, good afternoon, this is Herve Drouet here from HSBC. Two questions. The first one is regarding your tariff policy. Can you say more about what is your strategy about your new tariff policy? Are you going to be the cost leader or price leader, or do you go more for the value customers? Is it an ad-hoc situation, depending on the country? Or do you want to have a global strategy for your pricing in Russia and CIS. The second question is regarding in fact churn, and it looks like, looking at the different countries, the Q1 churn was relatively high, especially in the Ukraine and Uzbekistan. If you can shed a little bit more light on that, I would be grateful. Thank you. ...hello?

A - Vsevolod Rozanov

Sorry, Herve, it seems we missed the second and third questions from Mr. Postolovsky, due to some communication issue. The Turkmenistan question was the change in the accountancy policy of the profit sharing agreement with the Turkmenistan Government which was previously considered as a capex. But up to starting this year, it’s the part of it, approximately half of it, was classified as capex and part of it was classified as opex. So basically this was the reason for a non-operating expense increase. And the effective tax rate increase is mainly attributable to the ForEx situation and depreciation of Ruble against dollars and you know the maturity of our organization concerning the (inaudible), thank you.

Operator

Thank you, sir, does that answer your question?

A - Leonid Melamed

Let me switch to the last two questions that have been asked about the tariff policy and the churn rate. About the tariff policy, we have through Q2 this year, we have revised the marketing strategy of the company and we now apply much more attention to the segmental approach, adopting our tariff rates from region to region and on a segmental basis. Having identified four main segments from our customers, our nationwide tariff policy with the special pricing procedures and in each region. We have also identified the measures to stimulate the compunction of the services of the company in order to stabilize the ARPU and to create the basis for the increase of the ARPU in the end of 2006 and/or 2007. So the segmented approach and stimulation of the usage are two measures we’d like to implement in our newly-adopted marketing policies. On top of the new brand that we have introduced in Q2 this year, and a new advertising strategy that could lead us to the financial results that we plan to achieve, that is the profitable goal. Then in churn rate, it has been relatively high in Q1 2006, same as the ARPU went down on a higher level than we anticipated, because of some special tariff programs that had been introduced in Q3 and Q4 of last year in some regions of the Russian Federation. That led us to negative consequences in Q1 2006. After we have revised our marketing strategy, we think we can eliminate this type of situation in the future, since we plan only to stimulate by our tariffs and products, the attraction of the active users to the portfolio of our company.

Q - Herve Drouet, HSBC

Just to be fair, on the first question I understood you well. On the tariff, are you saying that your new tariffs on, let’s say for example, you know, some of the tariffs where you have you know, for incoming calls, or the Ruble denominated tariff would be rolled out in all the regions? Or would you only roll it out in some of the regions?

A - Leonid Melamed

We’ll definitely introduce, and we have already introduced these tariffs Russia-wide. But in each region, there are specific pricing procedures and there have been established specific prices on those tariffs. Though the construction of these tariffs and the promotion companies for those tariffs are unified for the whole country.

Q - Herve Drouet, HSBC

OK. Thank you.

Operator

Thank you. The next question comes from Mr. Alex Kuznetsov. Please state your company name followed by your question.

Q – Alex Kuznetsov, Bear Stearns

Good afternoon. It is Alex Kuznetsov from Bear Stearns. Could you highlight why interconnect revenue in Ukraine has declined so much. Has your share in CPP revenue declined to 50% from 60%? Because I know that the government wanted to increase share receipt by UkrTelecom. Second, what was the reason for the change in accounting policies in Uzbekistan?

A – Mark Burdon

I’ll take the Ukraine question first. Yes, there was a change in the interconnect rate from January 1 2006, as part of the process of making UkrTelecom more attractive. So there was a 16.7% reduction in interconnect on traffic coming in from the PSTN and in line with that, mobile operators also reduce down their interconnect rates.

A - Vsevolod Rozanov

This is Vsevolod, and I will answer the second question. First of all, I think there was some misunderstanding here. The situation happened in Turkmenistan, rather than in Uzbekistan. And that was basically the situation where we reached the capitalization level of the license agreements we had with the Turkmen government, and from Q1 of this year, this ceased to be the capex system related expenses, but the opex related expenses. Thank you.

Q – Alex Kuznetsov, Bear Stearns

Do you mean that previously, the expense item has been capitalized and starting from this year you started expensing it?

A - Vsevolod Rozanov

Exactly.

Q – Alex Kuznetsov, Bear Stearns

And actually, in your press release, there’s a reference to Uzbekistan as well. The net income in Uzbekistan declined slightly due to a change in accounting policies?

A - Vsevolod Rozanov

Well this is the situation we described relates to Turkmenistan, we can get back to you specifically on Uzbekistan on that income later. I think Andrei will get back to you.

Q – Alex Kuznetsov, Bear Stearns

Thank you.

Operator

Thanks. The next question comes from Mr. Rizwan Ali, please state your company name followed by your question.

Q – Rizwan Ali, Bear Stearns

Yes, from Bear Stearns. My question was regards to the cost of launching your new brand. I’m assuming it was all in Q2. Was any part of the cost taken in Q1 – the cost of rebranding and launching the new brand – taken in Q1? Then my second question is, you know, you had a pretty significant drop in QoverQ ARPU in Russia. Whereas Vimpelcom also had a drop, it was much, much less. Is there any way you can explain why the drop in ARPUs in Russia for MTS is a lot more than Vimpelcom?

A - Leonid Melamed

This is Leonid. The costs for rebranding that we launched in Q2 were not registered in the financial results of our company in Q1. But we’d like to state that those costs are quite in line with our current advertisement budget and would not lead to huge increases in our advertisement expenses in Q3 of 2006. But they are to drop. What we can say is that first of all, we are in the competitive market and we, by pricing our products, have to a certain extent follow the general market situation. Now we would like to change the approach more to the way that we drive the market situation to a higher ARPU from 2006 and onwards. As I’ve already mentioned, there’s been some products and tariffs launched in Q3 and Q4 2005 that brought us a significant drop in revenues, especially in Q1 2006. Those customers brought us some increase in churn rate and decrease in ARPU. That’s why those products are – the distribution of these products have been stopped, and now we, due to our new marketing strategy, launch the set up of new products and new tariffs that would be more bottom line oriented and would protect our bottom line results.

Q – Rizwan Ali, Bear Stearns

And one last question. In the past, you’ve had problems consolidating the operations of the new company you’ve bought in the Far East. Do you think that still remains a problem?

A - Leonid Melamed

We don’t face this problem nowadays. Though we have established new initiatives on changing the model of corporate management in the company to increase the influence and the responsibilities of the macro-regional directors or the P&L results of the company. But this is the new initiatives, that will be what we hope will bring renew achievements and growth of revenues and decreasing of expenses, based on the effective accomplishment of the consolidation processes of the acquired companies that have been done by the team in 2005.

Q – Rizwan Ali, Bear Stearns

Thank you very much.

Operator

Thank you. The next question comes from Mr. Sean Gardiner, please state your company name, followed by your question.

Q – Sean Gardiner, Morgan Stanley

Thank you. It’s Morgan Stanley. Firstly, on your income statement, cost of services – you might already have answered this, but it rose to 18.5% of sales for the first three months of 2006. That sort of compared to an average of 12.5% in 2005. Can you just run through the dynamics there? I’m assuming part of it is new interconnect with Vimpelcom, but maybe just run through any other major changes there? And then the second question, just for Mr. Melamed, is since you’ve joined, what do you see is the biggest challenge in turning MTS around to be more effective in competing with Vimpelcom going forward? Thanks.

A - Vsevolod Rozanov

First question – this is Vsevolod – speaking about cost of services, the main reason for such a drastic increase of cost of services is the fact that as we mentioned, during Q4 2005 we didn’t account for about $22 million of roaming expenses. That’s why the increase in the cost of services QoverQ is that high.

Q – Sean Gardiner, Morgan Stanley

I thought you answered that question earlier by saying that the revenue expenses you included in other expenses below your operating income line?

A - Vsevolod Rozanov

Yes, but I mean that during Q4, the figure was lower because it wasn’t during Q4. Opex was lower for $22 million, which actually happened during Q4.

Q – Sean Gardiner, Morgan Stanley

And then for the first three quarters of last year? It averaged around 14.5% as well? So are there any other roaming expenses which haven’t been included?

A - Vsevolod Rozanov

Well obviously there are other prices in this area. This $22 million is the biggest QoverQ change. In fact, there is also the appearance of an interconnect agreement with Vimpelcom which increased our revenues but also increased our costs. That’s another reason for increase of costs of services.

Q – Sean Gardiner, Morgan Stanley

So what you’re saying with this roaming issue is that you’re going to be running your cost of services with $20 million-odd higher expense every quarter because roaming wasn’t correctly accounted for in Q4?

A - Vsevolod Rozanov

No. I mean that the cost of roaming in Q1 is relatively – definitely will change quarter by quarter. But this is the correct benchmark. Because it’s now assessed correctly. What I say is that the QoverQ increase happened due to the fact that the base in Q4 was lower by $22 million due to the unaccrual – the fact of the non-accrual of these roaming expenses.

Q – Sean Gardiner, Morgan Stanley

Well I’ll maybe ask it a different way then, because I still don’t really understand. If I look at it on a year on year basis, your cost of services was 13.5% of sales. In Q1 of this year it’s 18.5% of sales.

A - Vsevolod Rozanov

Well, this is correct. The second part of my previous answer, maybe I’m not answering clearly. We definitely expect cost of services to take a bigger bite of our expenses due to the increase of our interconnect rates, which is already happening in the first half of the year. It’s very likely to happen in the second half of this year, obviously. So these are two major factors.

Q – Sean Gardiner, Morgan Stanley

But if – sorry to harp on about this – but if I go back to what Vimpelcom said about their revenues of about $28 million net new revenues, so I assume an expense of $28 million net new expense. But if I take that off your cost of services, you’re still running at 16.5% of sales compared to 13.5% a year ago. So it doesn’t fully account for the whole increase in my…

A - Vsevolod Rozanov

I’m sorry, now I can hardly hear you.

Q – Sean Gardiner, Morgan Stanley

Can you just quantify how big the incremental interconnect costs that came to you from the new agreement with Vimpelcom were? In the quarter?

A - Vsevolod Rozanov

$23 million.

Q – Sean Gardiner, Morgan Stanley

$23 million. If I take $23 million off your $239 million, I still get a cost of services around 16.5% of sales, which is considerably higher than it was a year ago. So there’s still something else that’s growing in there that I don’t quite understand.

A - Vsevolod Rozanov

Yes but, there’s a significant increase, again, in interconnect, in line rental and the increase of traffic obviously, which happened in Q1 2006.

Q – Sean Gardiner, Morgan Stanley

OK then. OK.

Operator

Does that answer your question sir?

A - Leonid Melamed

There was a question to me. What I’ve understood we have to do in the company and that has been widely discussed in the management team and with the shareholders is to apply a much more monetaristic approach, I would say, to the business decisions we apply in the company. And that is a big, simple statement, but it leads to significant changes in organizational structure and business process we’ll have in MTF. Right now we understand that our basic task is to – and we have identified that – is our basic task is to create a long-term, stable revenue for the investor that I mentioned. Our ICE should be in the long-term growth of not less than 25% and as long as we have it high now, we of course are conservative in planning but plan to keep it as high as possible. So all of the measures we like to establish are oriented to increase the revenues for the shareholders. That has resulted in our technical policy and technical strategy in our operational model, in our marketing and advertisement strategy and in all the other decisions, our key strategy and other decisions that we apply in the company. So profitable growth is the main challenge I think the company is facing for the next coming years. This is reflected in the so-called ‘three plus one’ strategy model that is available to you in our presentation that is on our internet site. If would be interested about that we would be prepared to comment on it in the future. In general terms, I have also to say that our big disadvantage is the size and our geographical spreadings. That’s why we have to use the effect of synergy, we have to use the effect of scale sizes, we have to use the expertise of our colleagues that are located in five countries in the CIS region to generate a winning concept in each and every field of our operations. And that’s what we are oriented to achieve in the next coming months. Thank you.

Operator

Thanks. The next question comes from Mr. Sergei Arsenyev, please state your company name, followed by your question.

Q - Sergei Arsenyev, Goldman Sachs

Good afternoon, it’s Sergei Arsenyev from Goldman Sachs. I was just wondering if you could remind me, what is the number of personnel at MTS in Russia and do you have any plans for the headcount deductions in Russia? And my second question is on the Ukrainian interconnects. Just to follow up on that, what is the process for this? Do you expect further termination rate charges this year, or drops in termination rates this year? Or is the government done for this year? What is the process for this?

A - Leonid Melamed

This is Leonid. The headcount in MTS currently is 24,000 employees. And this number is quite big and we want to stimulate optimizing of the number of employment positions in the company. But not by one-time effort, like it was introduced to us by some advisors, I would say, but by constant deliberation of business solutions that would money-wise show our market regions and thus accompanies the proper amount of personnel we have to keep on board. So we are introducing top-down financial indicators and top-down benchmarks on employee efficiency to our macro-regions and other companies. We anticipate they would meet our indicators and on fulfillment of those indicators by improving their top line and improving their bottom line, they would identify the proper measures to use the personnel factor. So we cannot and we would not like to say now there is some one-time effort to anticipate in the near future, but we’re pretty sure that in the next coming nine months, there will be a significant improvement on the quality of usage of the employment positions in the company, all over Russia and in the daughter companies. And I pass you over to Mark.

A - Mark Burdon

This is Mark. Basically, really, there’s a political push to improve the result of UkrTelecom ahead of any privatization and therefore there is continued pressure on the interconnect or the mobile operators, actively working with the regulator in Ukraine on this issue. But we can’t rule out that later in the year there may be some further change to interconnect. Thank you.

Q - Sergei Arsenyev, Goldman Sachs

All right, and just a follow up on the headcount question. Do you have maybe some sort of, in the ideal world, do you have the optimal number of employees for MTS in Russia? What will that number be?

A - Leonid Melamed

Let me answer like we don’t have now this concrete number. We would deliberate it together with our macro-regions and daughter companies in the next coming six months and we would meet those benchmarks that we would identify by our management dialogues in 2007.

Q - Sergei Arsenyev, Goldman Sachs

OK. Thanks very much.

Operator

Thanks. Your next question comes from Mr. Jean Charles Lemardeley, please state your company name followed by your question.

Q - Jean Charles Lemardeley, JP Morgan

Yes, it’s JP Morgan. Just on the issue of CPP, you provide some positive comments regarding CPP in the press release, suggesting it could be a factor toward ARPU stabilization, that’s in contrast to what your predecessors had said and what the Vimpelcom management still says, describing CPP as a neutral to maybe margin negative. Could you provide us with you analysis of the impact of Calling Party Pays going forward for you? And the second question would be what do you expect in terms of average revenue per minute evolution in Q2 and beyond? You describe – you said you terminated some inappropriate pricing schemes. What were they, and what would be the impact we could expect on Q2 and beyond beginning with the Ruble pricing move now?

A - Leonid Melamed

We are quite unhappy with the current trends in the development of ARPU and we understand that the market – that we have to make some effort together with our competitors on stabilizing of the current ARPU level in the Russian Federation and by creating the basis for the growth of the ARPU in 2007 and onward. We understand that the CPP introduction, the financial situation of ourselves and our competitors from the market and the future stimulation of usage of additional value added services same as with the voice, would lead us to successful achievement of the target. That is to stabilize the drop of ARPU and to create the basis of a growth in 2007 and onwards. First, we enter some period of unpredictable development and the issue of the CPP. But we share the opinion of our rivals that as long as we see it right now, it would lead to an increase of ARPU in the Russian Federation. On top of this, we have a special program to be launched to stabilize the situation of constant dropping of ARPUs in the other countries where we have operations since there is a great trend of the dropping of ARPU accompanying the increase of penetration level. So we have to apply measures, marketing measures first of all, to stabilize the ARPU in the other CIS countries where we operate on the higher levels than we have now in Russian Federation and I think we’ve learned good lessons here and can be effective by achieving of this thing.

Q - Jean Charles Lemardeley, JP Morgan

So in your view, CPP will be a net positive for ARPU in Russia?

A - Leonid Melamed

I’m conservatively positive for this.

Q - Jean Charles Lemardeley, JP Morgan

OK. And in your guidance of 50% plus margin for the year, how much is built in, in additional interconnection revenues and costs, relative to 2005? Coming as a result of CPP, I guess, mostly in the second half?

A - Vsevolod Rozanov

This is Vsevolod – first of all, we’re now in the stage where we can only indulgently guess about the potential effect of CPP introduction, since the regulator has not yet formally announced all the tariffs, which will be in place. So basically, you know that June 20 is the deadline for such an announcement, which will also lead to a review of all the contractual relations, whether it’s between the operators, fixed and mobile operators in the telecoms business. Speaking about the effect and the incremental revenue and opex related to CPP, we believe that the current understanding of the situation means that we will not change our guidance, neither for revenue nor for OIBDA margin for 2006. This is I think the most I can tell you at this stage. Thank you.

Q - Jean Charles Lemardeley, JP Morgan

OK. So just on that, the guidance still assumes a large increase – a significant increase – in mobile to mobile interconnect revenues and costs, does it? Or does it not? As a result of CPP instruction?

A - Vsevolod Rozanov

No, we do not build in the significant increase of costs already in this.

Q - Jean Charles Lemardeley, JP Morgan

OK. And on average revenue per minute, you know, you had a steep decline sequentially. You were talking about terminating those pricing plans. What can you expect for Q2 on that front?

A - Leonid Melamed

We anticipate stabilization of the ARPU level in the next coming quarters. And with some increase of MOU that we face we understand that the APPM should slightly go down.

Q - Jean Charles Lemardeley, JP Morgan

OK. Thanks.

Operator

Your next question comes from Mr. Alexei Yakovitsky, please state your company, followed by your question.

Q - Alexei Yakovitsky, Deutsche Bank

Yes, good evening, it’s Alexei from Deutsche Bank. Can you quantify the impact of this new interconnect with Vimpelcom on your revenues in Russia in Q1? And also just a follow up on the previous discussion, Vimpelcom told us that you paid them $28 million under this new interconnect agreement, which is their revenues. And yes you told us that your cost to Vimpelcom, this new incremental cost, was $23 million. Where is the $5 million? And can you reconcile? Or I may not be getting this correctly. And to follow up on the EBITDA margin guidance for this year, should be expect to see EBITDA margin of over say 50% already in Q2? Because it’s not when you need to be delivering mid fifties in Q3 and Q4. Can you just confirm that you do realistically see EBITDA margin at 50% or over 50% for the full year 2006? Especially given that again the overall profitability could decline on a like for like basis because of the introduction of CPP if I understood you correctly from your earlier comments. Thank you.

A - Vsevolod Rozanov

Thanks, Alexei. On your first question, I think we’re comparing different numbers. Our understanding is that we have a formula of course related to the introduction of an incremental cost. But I think the numbers which were given during the Vimpelcom conference call were total numbers. Because we definitely have an interconnect agreement in 2005 and certain years beyond. Before, sorry. And this difference is the difference in tariffs. Your second question about OIBDA margin, we can’t give the exact guidance for Q2 at this stage, but the initiatives we are discussing, opex optimization initiatives, will obviously bring fruit in Q2. However, certain initiatives such as the deal with commission reduction, (as soon as?) the optimization in the course of certain functions within the corporate center will materialize this quarter. So in the past there were also seasonal effects which we expect to increase the OIBDA margin to at least the late forties. However, we are not in a position to provide the exact guidance relating to OIBDA margin for Q2. Thank you.

Q - Alexei Yakovitsky, Deutsche Bank

OK, and can you – just to go back to my very first question – the revenues, the incremental revenues from Vimpelcom, or from the new interconnect agreement…

A - Vsevolod Rozanov

They were $23 million.

Q - Alexei Yakovitsky, Deutsche Bank

$23 million OK. You paid them $24 million incrementally and they paid you $23 million?

A - Vsevolod Rozanov

Exactly.

Q - Alexei Yakovitsky, Deutsche Bank

It’s the same as… OK. Good. Thank you.

Operator

Thanks. The next question comes from Mr. Dalibor Vavruska. Please state your company name followed by your question.

Q - Dalibor Vavruska, ING

Hello, this is Dalibor Vavruska from ING. Two questions if I may. One a follow-up on Sean’s question about the challenges that the new management team is facing now in regards to this restructuring. I remember that the first thing up on the restructuring, somewhere, if I’m correct, toward the end of the year 2004 with the (inaudible) costs and EBITDA improvement. Can you perhaps say, assuming it’s a fair question, where the challenge is that the company faced last year, and which things you might want to approach differently in order to achieve steady results on the costs side? And the second question is, can you say broadly what are your capacity utilizations in Russia and whether some of the efforts to improve capex could not perhaps lead to excess capacity utilization or issues with capacity? Or whether this is not an issue at all. Thank you.

A - Leonid Melamed

As has been stated by Mr. Yuschenkov(?) actually, two months ago when he presented me as a candidate for the president’s position in this company, that there is a certain change in the periods of development of MTS that the company is facing. So last year was, how we understand it, was devoted to finalizing of the process of our consultation of the companies that have been acquired for the period of 2003 and 2004, and also in 2005. And it's been one phase and one challenge for the management in 2005. Now in 2006 our task is to increase efficiency of the existing structure to use the scale of sizes and to use the best expertise the company has evaluated in their headquarters and in the regions for the sake of the whole group. So what we're doing now is we're developing more responsibility to the macro regional level in order to use the entrepreneurial initiative of course under the guidance of our regulations and benchmarks we elaborate for the region and to explore their knowledge of the local market and knowledge of the specific efforts they can implement in their own regions to achieve better results in revenues and bottom line. So this is a new challenge for the company. We understand that all of the process management and change management systems are quite in order in themselves so the management can use the existing change management methodology and processes to make this process cheep, quick and affective and this is one of the biggest challenges the management sees in front of itself in the next coming quarter and the next coming half of the year.

Q - Dalibor Vavruska, ING

If I can recap it, the main difference is the level of delegation that you are going to apply. That previously that was not really part of the restructuring program, is that right?

A - Leonid Melamed

Exactly.

A - Eric Franke, Chief Operating Officer

Yes, my name is Eric Franke. Good evening, good day, ladies and gentlemen. Talking about our capacity utilization, I would like to explain a little bit what changes we have done in order to calculate and recalculate our capex and our investments and why we got this nice cut in capex which we announced today. Basically the main principal as we did before was to have an overall KPI on the whole Russian Federation which ended up that we were applying actually norms in areas where we didn't need to apply those norms. We have high growing regions but at the moment we also have a lot of low growing regions where the saturation is already up to a very high point. Basically (it goes that) while we have reserves and I can tell you that for instance in seeking capacity, if you look at 2004, 2005 we had reserves of about 40%, even more in some areas, which we had to do to take for the growth. Today we are looking at regions where we have basically only a 20% buffer which we need to cater for the normal organic growth of our high penetrated regions. If you look at the radio side we actually apply one rule and it is very simple. We delegate the responsibility for the quality and the capacity of the network further to our macro regions which was done earlier just centrally which also has a big effect on the possibilities of macro regions to tune and make variations according to their local situation. In that way we can actually achieve an actualization of the radio network which is close to 90% and so we have a high utilization building our estimations at this moment. I guess that is basically the main change which is also reflected in the reduction of our capex that we announced today.

Q - Dalibor Vavruska, ING

Thank you.

Operator

Thank you. Your next question comes from Nadejda Golubeva, please state your company name followed by your question.

Q – Nadejda Golubeva, Aton

This is Nadejda Golubeva, Aton. My first question is about Ukraine. First of all, could you specify what was exactly the incremental impact on costs and everything else from this change in interconnect in Ukraine? And also I see your minutes in Ukraine are up pretty significantly. Was there any free minutes granting and can I expect it (move on?)? And my second question is about your working capital. Back in fourth quarter 2005 we saw a significant increase in working capital and this time I was told it was one off. But it seems to be not one off because this quarter it went in high. So do you see some room for optimization of your working capital or should we expect it to remain at the same levels we see it now? Thank you.

A – Mark Burdon

I'll take the - this is Mark for the Ukraine questions. Basically in terms of the decline in revenue, about 50% of that decline is attributable to the change in interconnect. Costs declined basically less than 50% of that, so that's the…

Q – Nadejda Golubeva, Aton

Sorry, but could you provide absolute numbers please, just roughly?

A – Mark Burdon

Let's leave it at that I think, because we don't want to be so specific on some of these numbers. Basically the MOU increase is dealing with a couple of factors. One, we have seen in the market with both Kiaster(?) and Ashtoreth(?) increased offerings that encourage additional traffic into the network particularly on net traffic. And additionally, as part of our rollout we put much more capacity into the network at the end of Q4 and during Q1 and are using that as a tool for acquiring customers and keeping customers on our network. Thank you.

A - Vsevolod Rozanov

Speaking of the working capital, I would like to say that we definitely experienced more or less the same level or continue the trend in Q1. However, due to the new regulation in the (via Kia?) reclamation and certain other initiatives we are undertaking, which I mentioned the improvement of the procedures related to bad debt. We expect that there is room for improvement of our working capital over the next quarters.

Q – Nadejda Golubeva, Aton

What was the bad debt? So in other words you're saying that this is more or less a normalized level on the working capital? I mean the royalty sales, yes?

A - Vsevolod Rozanov

I wouldn't say that it's normalized because we definitely… One of the initiatives we have here is the focus on the reduction of the working capital. However, the effect of these initiatives is unlikely to happen, to be extremely material during Q2. That's probably the right answer.

Operator

Your next question comes from Alex Barenka(?), please state your company name followed by your question.

Q – Alex Barenka(?), (Inaudible)

Hello it’s Alex Barenka from (inaudible). Most of my question was already answered. But I want you to be a little bit more specific about the onetime charge of $60 million in the provision of doubtful debt. What is this provision related to?

A - Vsevolod Rozanov

This is Vsevolod. As I mentioned that during Q4 year 2005, certain onetime revenue was incorrectly billed. A portion of the revenue was incorrectly billed in one of our macro-regions. So basically the decision has been taken not to claim these revenues accounted due to the fact that basically it will definitely affect our customer loyalty.

Q – Alex Barenka(?), (Inaudible)

So it's an accounting mistake in the Q4 of last year?

A - Vsevolod Rozanov

It's not an accounting mistake in Q4, in Q1. It's a billing mistake in Q4.

Q – Alex Barenka(?), (Inaudible)

In Q4?

A - Vsevolod Rozanov

Clarified.

Q – Alex Barenka(?), (Inaudible)

OK. Thank you.

Operator

Thank you, sir, does that answer your question?

Q – Alex Barenka(?), (Inaudible)

Yes, thank you.

Operator

Your next question comes from Mr. Alexander Balackman(?). Please state your company name, followed by your question.

Q – Alexander Balackman(?), (Inaudible)

Hi, it’s Alexander Balackman(?) from (inaudible). I want to ask you how do you calculate ARPU because it is impossible to get $6.2 per month by dividing - I mean in Russia - by dividing your revenues in Russia for Q1 by average number, even adjusted by sales of handsets. I'm making this calculation, I get ARPU of 6.6, 6.7 but not 6.2. Can you please make clear how did you get $6.2 dollars?

A - Vsevolod Rozanov

This is Vsevolod. The fact that we calculate the ARPU (not by using the?) the service revenues and the connection fees and sales of handsets. But there are definitely certain items which are not accounted for while calculating ARPU. Special connections fees for example.

Q – Alexander Balackman(?), (Inaudible)

I see.

Operator

Your next question comes from Evgeny Golossnoy. Please state your company name, followed by your question.

Q – Evgeny Golossnoy, Troika

This is Evgeny Golossnoy from Troika. I've got a couple of questions. One is on handset subsidies. Then the general question is why do you do that at all and specifically why you do that to corporate customers that are probably most wealthy out of the whole range of your customers. The second is on interconnect rules and interconnect costs and service costs specifically. I was just wondering like with the Russian telecom market getting regulated and liberalized there should be a decrease in interconnect costs leaving apart the effects of introduction of CPP, right? But looking at your numbers year-on-year and percentage of service cost as a percent of service revenue we see an increase. So what's your view? How is that going to change? Do you see that declining or rising? And basically the third question was related to the four customer groups that you identified. Who are these customer groups and how do you plan to work with them to differentiate yourself from the competition or what's your marketing strategy as regards of each customer group?

A – Mark Burdon

This is Mark; I'll take the handset subsidy question. Basically the evolution of the market, particularly in the Ukraine, was one such that handset suppliers were not so reliable. And one of the ways sometime ago of settling down the contract market was to introduce handset subsidies and at the same time lock people in to long-term contracts. So those two things go hand-in-hand. As we see today handsets, there are just generally a normal supply of handsets into the market. And as I said earlier, this is a policy that we have reviewed and are changing particularly in the late second quarter and specifically from Q3. But we will retain them for key accounts, it's not so much in terms of looking at it from an acquisition point of view, it's looking at it from a corporate retention point of view and making sure that you keep those people with you. That's clearly very much the market that we have an edge in and that's our strategy to keep those clients with us. Thank you.

A - Vsevolod Rozanov

This is Vsevolod and I will answer the second question regarding the interconnect costs. We actually believe, first of all, we understand that there is a global trend related to interconnect costs, but there is a certain specific situation in Russia where first of all there is such a thing as the interconnect agreement between mobile operators and fee phone operators, specifically (as engineered for costs?) and in GTS which tariffs are usually eliminated in rubles and tend to increase significantly year-to-year because it's one of the major sources of revenue for them which is not regulated. Or which is, sometimes it's circulated and the ruble price is adjusted, which basically has a double effect on us as the price in rubles has increased and there is a ruble to dollar depreciation for us. There is also the thing which I mentioned before such as the traffic increase year-to-year and going forward and actually we already experienced this starting this year. There is a certain increase in interconnect tariffs between the mobile operators and between the fixed and mobile operators.

Q – Evgeny Golossnoy, Troika

So actually what you're saying is that as a percentage of service revenue your interconnect charges will only be increasing?

A - Vsevolod Rozanov

We can't exclude this. Obviously when we're discussing cost of services we will say that this is one of the items which are likely to increase actually as a result of CPP introduction.

Q – Evgeny Golossnoy, Troika

Okay, thank you.

A – Leonid Melamed

(When you know, now?) about the marketing strategy. So there are four target groups for us. This is wealthy individuals, corporate customers, family market and use market. On the wealthy individuals and corporate market we have the leadership position and our main task is to maintain this leadership position by introduction of special loyalty programs that would involved as much of the customers of these two groups as possible all over Russia. And of course we will try to increase the number of those customers in our portfolio, though the competition is very hard in this area and the stock is very - will be quite high once we would put very ambitious goals in front of ourselves there. So to keep the leadership by increasing the loyalty of these customers is our target, is our way. Mass market and the family market and the youth, our target is to increase the number of customers and to stimulate the usage by these customers of our services including WAP(?) to increase the ARPU that we generate out of the customers from this market. So the task is not just to increase the amount of customers there but to increase the amount of active customers. Of course, we think about our value position in each of the segments. And due to our differentiation in marketing and advertising strategy and in our branding strategy, a differentiation from our competitors, as long as our solutions will be correct ones we will be able to fulfill our goals. The solutions are there, we will se how they will be implemented in the numbers. Thank you.

Operator

Operator instructions. Your next question comes from Olga Vistrova(?), please state your company name, followed by your question.

Q – Olga Vistrova

Good evening. A few questions from me. First, regarding pricing strategy. I think some of your competitors currently are looking at keeping pricing stable in the Russian market and I was wondering what do you think of that? Do you think you will follow? Do you have any objections to that? And particularly given that the newly introduced plan has I think lower outgoing pressures, pressures for outgoing units. Second question, regarding the opex optimization program that you mentioned for 2007 onwards, can you elaborate a little bit on the exact cost items that you plan to target in your years and what will be the incremental impact on margins from those initiatives? And finally, on ARPU on Russia and Ukraine, I think you said to the press today that you see ARPU stabilizing in Russia at 6 to $6.5 and in the Ukraine 7 to $8. I was wondering which year you are talking about, first of all, and secondly, do you really think that there will be such a disparity in ARPU levels between Russian and the Ukraine? Thank you.

A – Leonid Melamed

This is Leonid. I will answer your question about the pricing strategy. So first of all I would have to say that in order to be competitive our pricing has to be adequate to the requirements of the competition. That doesn't mean we would like to follow the lowest proposals of our competitors, but we have to be competitive and that - we have to be competitive in all of the regions and in all of the segments where we operate following our strategy. So depending on our market share, depending on our desire to keep the position or increase our position in this segment our pricing should be different. Of course, as I've already mentioned, as long as our plan is to stabilize ARPU or increase it we have to apply the prices that would lead to achievement of this proper task. That's why our EPPM is the key indicator that we have to orient on while introducing our new prices in order to achieve the targets of keeping the ARPU and to create the basis of its development. So we have to be competitive, but by different identified methods we have to stimulate the high use of correctly priced product of the Company and to give the correct messages to the competition that we are on the way to face the competition but accumulate the increase in EPPM. If I answered your question there?

Q – Olga Vistrova

Yes, that's fine for the first one.

A - Vsevolod Rozanov

Second question, Olga, can you please clarify whether your question was mainly related to the year 2007 and other years going forward or 2006?

Q – Olga Vistrova

2007, because unless I missed it I think you didn't mention any details on that part of the opex optimization program.

A - Vsevolod Rozanov

Sorry, what did I mention?

Q – Olga Vistrova

I think in the beginning you did not mention details on your opex optimization program for 2007 onward. So that's why I asked

about it.

A - Vsevolod Rozanov

That's correct. The thing is that we're definitely working in the environment where it would be harder to forecast the CPP affect for year 2007. We're only making sure that the initiatives we are undertaking now will first last in the year 2007. So these are not onetime initiatives. And the initiatives throughout our discussion to - which will affect Q2 of this year is actually the introduction of the certain projects. Speaking for year 2007, we believe that when we are closer to this year we will be able to better guide you on the overall revenues and OIBDA margin and the contribution of the opex reduction measures to the OIBDA margin we will announce closer to the end of this year.

Q – Olga Vistrova

Okay, great, thank you. Again, can you also clarify two things. First, I think you also mentioned that you are undertaking a sort of restyling of the service centers, etc. Is it an additional cost to your branding program or is it separately? And if it is separate, how much approximately do you plan to spend if significant at all?

A - Vsevolod Rozanov

This is a call center, so it's basically the call center's centralization. What we had, we had call centers in all regions of Russia. Now we've centralized them into one each in each macro region, not always in the real macro region or center due to the lower cost, for example, there for the central region. We had our call center in Rezan(?). So that basically gives us better cost basically personnel cost, for example. (But you pay for what you get?). So we do not expect any additional increase of costs related to these call centers. And we are thinking of whether we can sort of optimize this function by maybe bringing together certain macro regional call centers.

Q – Olga Vistrova

Okay. And also on the advertising budget, what are your targets sort of relative terms or any terms that you can mention?

A – Leonid Melamed

We plan to keep the our advertising budget this year totally in accordance with the levels we had last year in 2005 despite the fact we have a rebranding campaign. This year - right now we are recalculating the budget for the second half of the year based on the new methodological approach since we have been planning the budget until now on the basis of share of voice principal. Now we're going to change to the cost per net adds principal and it can guide to some changes in the size of the budget, but we keep track the track on staying with conservative numbers and keeping the costs low.

Q – Olga Vistrova

Okay, thank you very much. And also, the last question that I asked about are poll levels in Ukraine and Russia?

A - Mark Burdon

Olga, this is Mark. For Ukraine the guidance still remains as previously given between $7 and $8 for this year. And I think that's the extent of the guidance at this point.

Q – Olga Vistrova

Okay. So basically this is not related to your view on the bottom of ARPU in the Ukraine, right? I just want to clarify that.

A - Mark Burdon

No.

Q – Olga Vistrova

OK, great. Thank you very much.

Operator

Your next question comes from Yanis Petrovich(?). Please state your company name, followed by your question.

Q – Yanis Petrovich(?), BBVA

Yanis Petrovich (?) from BBVA, Banco Bilbao Vizcaya Argentaria. A great part of your debt is in foreign currencies. I'd like to ask about your ForEx hedging policy.

A - Vsevolod Rozanov

That's a very good question. Actually during the previous years due to the fact that all of our revenues were eliminated, were paid in foreign currency and the vast majority of the core separating costs in capex was also in foreign currency. We believe that that was sort of perfect internal hedging as we call it. However, after the changes in the market and the current ForEx development, we are now starting to consider the opportunities for hedging our loans and basically in discussions with many banks. And I think that this BBVA is also one of the potential candidates to consider participation in this area. Now we are in the process of evaluation of the potential opportunities.

Q – Yanis Petrovich(?), BBVA

Okay, thank you very much. We are definitely a candidate for this.

Operator

Your next question comes from Anna Bossong. Please state your company name, followed by your question.

Q – Anna Bossong, CA IB

It's Anna Bossong from CA IB. My first question concerns in a way churn. We've seen a new FX rate announced for your customer which is effectively about a 6% tariff increase firstly. Secondly, you've been canceling a very low-priced tariff in the regions of Russia. And thirdly, we're hearing in the Ukraine you're phasing out handsets I believe. I'm wondering, does this mean - firstly, do I understand all these points correctly? And secondly, does it mean an increase in churn from Q2? And my other question was a very quick one. These roaming one-offs in Q4 of last year, were they all to do with Russia? And lastly, the interconnection rate proposals you've made concerning calling the party paid, you and Vimpelcom to the government - have they been accepted or are you still waiting word on whether that will be acceptable? Thank you.

A - Vsevolod Rozanov

Let me first start with the second and the third questions. Definitely the one-off of course items we discussed earlier, they only related to Russia, right? So it doesn't have anything to do with other countries we're operating in. As for the interconnect rate, we basically are in discussions with the regulators. We haven't had any formal position yet. And this also - the formal position of regulator will also affect the final interconnect rates in the industry.

Q – Anna Bossong, CA IB

Do you get the feeling that they're just favorably disposed towards your proposal?

A - Vsevolod Rozanov

Excuse me?

Q – Anna Bossong, CA IB

Do you think that they're favoring your proposal? Do you get the feeling they're happy with it?

A - Vsevolod Rozanov

Good question. I think it's better if the question should be asked to regulators. But it's a discussion. It's a discussion and we do not see that they are totally unhappy with this. So we have said that the final solution would be closer to what mobile operators are suggesting. I'll pass it over to Leonid for the first question.

A – Leonid Melamed

If you look at the numbers for Russia and the churn rate you would see that there is some certain volatility, especially driven by the special factors we had in Q3. And now there is some increase of churn rate. And of course if we will concentrate ourselves on profitable growth measures, that is to attract the more active users, it can lead us so to some increase in churn rate, but we of course - that would be just the result of increase of our - as we hope - will be the result of increase of our revenues and bottom-line. So in this way, if our strategy would be a correct one, we can say some concrete growth in churn rate in the next coming quarters.

Q – Anna Bossong, CA IB

And was I right to understand that there's effectively a 6% tariff increase in Russia from this new FX regime?

A - Vsevolod Rozanov

We don't put our strategy on increasing our revenues just on this sector. But in the current currency situation we understand it can bring us some modest increase in revenues that we actually would be happy to face.

Q – Anna Bossong, CA IB

Excellent, I think so too. Thank you.

Operator

Thanks. We have a follow up question from Vladimir Postolovsky. Please go ahead sir.

Q – Vladimir Postolovsky, UBS

Actually it's three full on questions if I may. The first one is on advertising expense. You said that you went to keep them at the same level as in 2005. Do I understand it correctly, that as a percentage of revenues as opposed in absolute terms? The second one - just going back to the Turkmenistan issue, it's a small one. But I never heard of a revenue sharing arrangement there. Could you just tell me what percentage of revenues have you agreed with them to share? And the decline in EBITDA was massive, so is mid 20's level something that you think is sustainable or is it just one of the (best of all?)? And finally, just going back to this issue of your applications, another question on that. We talked a lot about costs and capex control and obviously if you deliver I'm sure (Masclar will love you for that?). But in my opinion the big chief problem with MTS over the last few quarters has been massive market share losses of revenues. Why do you think MTS has been losing market share of revenues? And what you can do to stop that and hopefully reverse it? Thank you.

A - Vsevolod Rozanov

This is Vsevolod talking. I will handle the first two questions. Speaking of advertising costs, we believe that there - we meant when we answered the question regarding the advertising costs that there wouldn't be any deviations from the budget related to the new branding strategy. So basically there would be certain increases in advertising cost due to the media inflation, but it would be as planned and it would not affect any of the guidance we gave before or we are given now. Speaking about Turkmenistan, the situation there is as follows - and I think that it was actually there was a press release on this net income sharing agreement, not the revenue sharing agreement, which is actually 80-20, 80 for MTS and 20 for the Turkmenistan government. And if you wish to get more details on that again we can send some further details and refer you to press releases which were issued during the purchase of this operation.

Q – Vladimir Postolovsky, UBS

So in Q1 there was a reversal of everything that has happened so far, right? You've expensed 20% of the income from the costs, right?

A - Vsevolod Rozanov

Yes.

Q – Vladimir Postolovsky, UBS

OK.

A – Leonid Melamed

Let's answer the first question. It's a very important one and thank you very much for asking me one. First of all, I cannot say that we faced a dramatic drop of market share, especially in the revenues over the last year and a half. But of course we have some things to improve in our market position and the trends in our position on the Russian market. I understand that the Company has and we already launched the changes to very seriously change its marketing policy, the structure, including the advertising policy and including the structure of the products we offer to our users in order to stimulate the usage and in order to create concrete value propositions to our customers in a simple an explanatory way. We also have to - and as has been already started this year, to improve the effectiveness of our corporation with the independent dealers. And of course we have to use the advantage of having the biggest owned network of dealerships to sell more services to our customers. Also a very important issue is the quality of service. And we really face the problem of losing the level there and to change this we've issued the total quality measurement program in the Company and I'm pretty sure that quite soon the customers would feel the changes based on this. And the last but not the least here is the corporate culture issue. So the Company was more oriented on say business acquisitions developments and on I'd say expansion models of developments, neither then on customer orientation models and let's say financial targetings and benchmarkings in each business decision the Company is making. So if - it doesn't mean we need a dramatic change in the Company, but we need certain improvements and I understand that is why the new team is there. Thank you.

Q – Vladimir Postolovsky, UBS

Thank you.

Operator

The next question comes from Alex Kuznetsov. Please go ahead.

Q - Alex Kuznetsov, Bear Stearns

It is Alex Kuznetsov from Bear Stearns. I would like to inquire if you are going to increase your tariffs to offset CPP implementation. I understand that the transition to your fixed exchange rate is going to increase your effective tariff, but are you going to increase tariffs above this transition? And second, you highlighted that you're currently in the process of negotiating a new interconnect rate with the regulator. Firs of all, how close are you towards the end of this process, and since only two weeks are left before CPP is implemented? And secondly, I was under the impression that interconnect rates are regulated on the four dominant operators in Russia. And since Mobile Telesystems is not deemed a dominant operator I thought that interconnect rates are set by negotiating with your business partners?

A - Leonid Melamed

Answering the question about the increase of interconnect rates, we have to wait until the regulator will offer its standard for the fixed operator users - the price for the fixed operator users and then based on that it will create also the recommendations for the prices of interconnect from fixed to mobile. And based on these recommendations - solutions from one side and recommendations from another side, we plan to adjust our interconnect tariff policy of course in the area of increasing of the one that can be a source of additional revenues and should be a source of additional revenues for us since we have a very big network. But as it has been mentioned by Vsevolod, it has not yet been a built-in part of our OIBDA margin forecast.

A - Vsevolod Rozanov

And speaking about the negotiations related to interconnect rates, as I mentioned of course there are only two weeks remaining before the introduction of CPP, but unfortunately we haven't got the final position of the regulator. So we obviously will be stretched to finalize these negotiations within 10 days because I think for the regulator, the last day when they can announce the opposition is June 20th. So basically we'll have ten days to finalize our interconnect agreement. And I think we did a preliminary job, so basically now it seems that we will be able to do so. Speaking about the dominant operator situation, can you please clarify your question?

Q - Alex Kuznetsov, Bear Stearns

I meant that interconnect rate for dominant operators or regulators in Russia. But it's my understanding that interconnect rates for operators not deemed dominant can be set through the private negotiation of both parties - you and Vimpelcom or you and interregional operators.

A - Eric Franke

This is Eric Franke; let me answer that question because this is - as you know, we had exactly the same situation two years ago in our subsidiary in Ukraine where although mobile operators are considered of course not to be a regulated part of the market, and in this case called dominant operators, still you have to understand that when the tariffs are set for the end-user the affect automatically will become also a part of the whole structure of interconnect. So like it or not and since we are of course together with the other two big players in this market, a sizable part of the telecom structure, we do have to look at the interconnect rates as a part of the tariffs I think for the average person in Russia. We cannot avoid that. So it is always a part of the negotiations. However, we believe that, so our tariffs will not be set. We have a free market. But we believe that with dialog and explanation towards the government we can achieve a sort of compromise and as Vsevolod has already said, we are very close because it's only ten days. The experiences what we had in Ukraine at a

certain moment it rolls out and we think it's the 20th of this month.

Andrei Terebenin

Ladies and gentlemen, as we are close to two hours already on the phone I would suggest that we'll take just one more question.

Operator

We have a follow up from Sean Gardiner. Please go ahead, sir.

Sean Gardiner, Morgan Stanley

I'll make it a quick one. Firstly, can you just list your top three key performance indicators that have been set by Sistema and also weight them as a percent of relative importance just to sort of help us understand what you're targeting? And then secondly, you've spoken a lot about increasing usage of your subscribers, can you give us maybe a 30 second rundown on what you're going to do about the multiple ownership on your networks? Are you prepared to lower your churn periods or are you looking at other options as in active subscriber counting? Thanks.

A - Leonid Melamed

Frankly speaking, it's better to ask the shareholder for his requirements from the management, but - and I think they can be more specific with this. They've been of course much more targets in front of me, in front of the management team than three. But let's say - and this gives me some headaches, frankly speaking, for the last two months. But as it has been stated by Mr. Yuschenkov(?) on the conference call when the new president had been introduced two months ago that priority number one is to increase the market cap to a level of $20 billion as Sistema(?) anticipates is the correct valuation of the Company. And frankly speaking, looking into the observations of the analysis we can say that Mr. Yuscenkov’s task was not too far from what the analysts think our company is less for. Number two is to have stable revenues on the investments. And this is the basis - that's why this is the basis of our strategy that - of the renewed strategy of the company is to keep stable returns on investments on the level of higher than 25% near terms in the next coming five years and onward. And position number three is to (inaudible).

Operator

Does that answer your question?

Sean Gardiner, Morgan Stanley

It went dead just at the beginning of number three.

Operator

…hello, gentlemen? Ladies and gentlemen, we apologize for the pause in the presentation. The call will start again shortly. Thank you, our chair now joins us.

A - Leonid Melamed

Should I finish answering this question?

Sean Gardiner, Morgan Stanley

Yes, can you hear me? Just at number three - you were just saying number three and it went dead.

A - Leonid Melamed

And the third wish, the third benchmark or key priority for us is to create the company structure and the processes and also the brand in the way that it can be developed to the new regions and to the new let's say acquisition targets once the company and its shareholders would decide that it's reasonable to develop ourselves to the new markets and new territories.

Andrei Terebenin

Ladies and gentlemen, a final remark. First of all, thank you, everybody, for your active participation in our conference call. I would like to remind everyone that materials relating to this call as well as a transcript of our discussion will be available on our website at www1.MTSGSM.com. And again, thank you for participating today and have a nice day.

Operator

Ladies and gentlemen, that concludes the conference. Thank you for participating.

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Source: Mobile Telesystems, Q1 2006 Earnings Conference Call Transcript (MBT)
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