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Mobile TeleSystems (NYSE:MBT)

Q2 2006 Earnings Call

September 5, 2006 10:00 am ET

Executives

Andrei Terebenin - Vice President, Corporate Communications

Leonid Melamed - President and Chief Executive Officer

Vsevolod Rozanov - Chief Financial Officer

Mikhail Shamolin - Vice President

Mark Burden - Director of Finance, UMC

Analysts

Vladimir Postolovsky - Brunswick UBS

Sergei Arsenyev - Goldman Sachs

Alex Kuznetsov - Bear, Stearns & Co.

Sean Gardiner - Morgan Stanley

Will [Milner]

Nadejda Golubeva - Aton

Olga Bystrova - Credit Suisse

Stephen Pettyfer - Merrill Lynch

Yuri Polyakov - Credit Suisse

Layla [Govi]

Dalibor Vavruska - ING

Anna Bossong - CA-IB

Vladimir Postolovsky - Brunswick UBS

Alex Kuznetsov - Bear, Stearns & Co.

Presentation

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the second quarter 2006 financial results conference call on Tuesday, the fifth of September, 2006. Throughout today’s recorded presentation all participants will be in a listen-only mode. After the presentation, there will be an opportunity to ask questions.

(Operator Instructions)

I will now hand the conference over to Mr. Andrei Terebenin. Please go ahead, sir.

Andrei Terebenin

Good day, ladies and gentlemen, and welcome to MTS conference call to discuss the company’s second quarter 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: the strategic development of MTS business activities, both in Russia and abroad; revenue and or subscriber growth; syndicated loan facilities and day usage; legal actions still proceeding directed at the company or its representatives; regulatory changes the impact of company’s operation in the markets in which we operate; financial indicators such as operating income before depreciation and amortization, average revenue per user, cash flow projections and/or return on invested capital; 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 included company press releases, earnings presentations, MTS annual reports, and Form 20-F, as well as other public filings made by the company with the United States Securities and Exchange Commission and all of which are available on the company website at www1.mtsgsm.com or that of the United States Securities and Exchange Commission at www.sec.gov.

MTS dissolves any obligation to update any previously made forward-looking statements either during this conference call or make any adjustments to previously made statements to reflect changes in brief. Copies of the presentation materials used in this conference call are available on our company website.

Participating in the call today are Leonid Melamed, President and Chief Executive Officer, Vsevolod Rozanov, Vice President, Finance and Investing, Chief Financial Officer, and Mark Burden, Finance Director of UMC, our Ukrainian subsidiary.

Now, Leonid Melamed, President and Chief Executive Officer, will take you through the quarter.

Leonid Melamed

Good day, ladies and gentlemen. As I mentioned during our last call, we have undertaken a number of initiatives aimed at enhancing shareholder value, increasing the benefits for our customers, and motivate our team of managers and employees at MTS. The first step was the June approval of our three-platform strategy. In essence, we first affirm our goal of markets and revenue leadership in Russia. Second, increase our network coverage and achieve revenue leadership in markets throughout the CIS, and the third, to build up our international relations in headquarters to create value in new markets.

In addition, we call it Plus One, our aim is to take advantage of opportunities to integrate vertically or horizontally to bring great value to our customers and shareholders.

To achieve these goals, however, we needed a management structure to develop competitive advantages in our markets of operations, better manage our costs and make people more accountable for their performance. At the same time, we realize the need to promote efficiencies and ensure that our record for transparency and good governance remains undamaged.

As a result, the Board of Directors voted to approve a change in the organization of our operations. On the 14th of August, we officially reorganized the company and the MTS Group. Each of our markets of operations now constitutes of its own business unit, responsible for the P&L performance to the group headquarters.

Indeed, at the heart of MTS Group is the corporate center, which will be responsible for in general developing group strategy and investment policy, managing the brand, determining operational and functional procedures, as well as benchmarks in [PPI] for each business unit and allocating shared functional resources throughout the group.

The headquarters will also be responsible for M&A activity of the group.

The benefits of this sort of structure will enable us to take further advantage of economies of scale, realize competitive advantages for operational synergies, and allow knowledge and skill transfers within the group.

Centralizing certain functions improves operational efficiencies while planning for the group, as opposed to individual markets, allows us to realize scale benefits ranging from equipment procurement to media services.

Similarly, linkages throughout the organization open up many possibilities to develop competitive advantages for all of our markets, which may range from bringing products to markets faster to optimizing networks.

In the short-term, the move allows us to trim our corporate center staff as we optimize certain functions. As we announced recently, we reduced our personnel at the group level by nearly 800 people. By the end of the year, our goal is to reduce personnel to 19,700 people in Russia by outsourcing and out-stocking certain functions, and automating to a degree personnel in terms of processes.

Over the long-term, the structure will allow us to be more competitive in both our existing and prospective markets, attract business partners, and develop a world-class caliber of personnel. The purpose is simple: MTS Group should be more valuable than the sum of its parts.

Let me pass to the group in our markets.

For the second quarter, top-line revenue growth for the group increased 20.7% year on year, or 16% quarter on quarter. OIBDA increased 22% quarter on quarter, giving us an OIBDA margin of 48.9%. Net income increased 60% quarter on quarter.

The management of MTS understands the issue of bottom-line growth, which year on year was down 11%. We are sensitive to our bottom-line performance and are working to restore our margins through further cost reductions, the result of which will be seen towards the end of the year.

As for our markets, subscriber growth was robust over the course of Q2. We added 3.05 million subscribers for the period, out of which 2.21 million subscribers in Russia, 660,000 subscribers in Ukraine, and over 180,000 in total for Uzbekistan and Turkmenistan.

According to third-party sources, we have also led in subscriber additions in Russia for the past two months as well.

Let me pass to Russia. For the second quarter, top-line revenue growth for Russia increased 17% both quarter on quarter and year on year. This improvement was funded marginally by increased seasonal traffic, new tariff policies, including the introduction of new products and services.

OIBDA increased 18% quarter on quarter, giving us an OIBDA margin for Russia of 47.2%. This is an improvement of 0.5% from Q1.

Net income in Russia increased 60% quarter on quarter, to $193.6 million. A return to business as usual, we show a return to business as usual as we no longer saw the one-time event [just] in the first quarter.

In Russia, nominal penetration reached over 97% in the second quarter. Estimates of real penetration range from 60% to 80%. Our market share was 34%.

With the market becoming saturated, new subscribers will be harder to come by. Stimulating our existing base and attracting new subscribers from other networks will be key to our future growth. To do so, we introduced a new brand in the middle of Q2 and we also introduced the first of many products and services to support the brand.

First of all, let me mention the tariff plan Pervyi, or [inaudible] in English, a national tariff plan launched in early June that attracted 1.4 million new subscribers within the first month of availability. Most importantly though, the tariff plan is proving successful at extracting more value from our customers. Average MOU for Pervyi subscribers was $193, while the average revenue per user was $8.70.

This was one factor that drove ARPU higher for our Russian subscribers to $7.50, included for inter-connect revenues.

The Pervyi plan features free incoming calls, a feature friendly to the introduction of the calling party pays principle, or CPP, which was introduced on the first of July. Given our past experience in Ukraine where CPP was introduced in 2003, we anticipated increased usage, but the challenge remained as to whether or not we could extract additional value from our users to compensate for the loss of revenue from incoming calls. Though we feel it is too early to draw any conclusions about our customers’ behavior as a result of the CPP introduction, the dynamics of our Pervyi tariff plan subscribers spread through Russia is an encouraging sign.

Now I pass to Ukraine.

For the second quarter, top-line revenue growth for Ukraine increased 13% quarter on quarter and 23% year on year, for increased traffic due to efforts to stimulate on-traffic traffic, rising usage, particularly in the post-paid segment, increasing distribution.

OIBDA increased 29% quarter on quarter, giving us an OIBDA margin for Ukraine of 51.7%. This is due to an increase in traffic revenue, cost-cutting activities, including renegotiation of support contracts, decrease in advertising and marketing expenses, such as sponsorship of the Winter Olympics, left in Q1.

Net income in Ukraine increased 41% quarter on quarter.

In the Ukraine, we see the markets with nominal penetration exceeding 76%. In real terms, we estimate that this may be in the range of 50% to 60%. Our market share was 42%.

In Q2, we also refreshed our JEANS brand, our successful youth-focused product and a driver of our pre-paid subscriber and revenue growth.

We also increased our distribution network, which now exceeds 35,000 points of sale.

Other markets -- in Uzbekistan and Turkmenistan, revenues grew and we continue to build upon our leadership in these early-stages markets. Penetration was Uzbekistan, 6%, Turkmenistan, 2%. Our market shares were Uzbekistan, 55%, Turkmenistan, 80%.

In both markets, we continue to roll out our networks and increase our coverage.

Our Uzbekistan operation, Uzdunrobita, introduced our new brand in June, 2006, while in Turkmenistan, we will launch the new brand in late September.

In Belarus, where our operations are not consolidated, our market share remains stable at 52%.

Let me take this opportunity as well to reiterate our intention on gaining control of what we legally acquired in Kyrgyzstan. We will contest any attempt to obtain assets owned by Bitel and will continue our efforts in gaining operational control of the company to the fullest extent of the law.

Let me announce some additional significant events.

Lastly, this past Friday, our Board of Directors approved a share repurchase program whereby MTS and/or MTS Bermuda, our recently established, wholly-owned subsidiary, can buy up to 10% outstanding ADRs that provide voting rights to up to 10% of outstanding entire shares over a period of 12 months. The repurchases will be made through the open market or private transactions in full compliance with SEC norms and regulations.

Our management came to MTS with the task of enhancing shareholder value. In our view, MTS is both undervalued and under-leveraged, and the Board of Directors shares this idea with the management, and undertaking the initiative will provide our shareholders a reasonable return and allow the company to better take advantages on future business opportunities.

Our strong capital structure and ability to generate cash flows allows us to take this step now. We are fully capable of funding our own cap-ex, and am certain that the leadership Vsevolod Rozanov has shown in regard of the finance and control of MTS will ensure that this remains the key.

In addition, acting upon my proposal, the board has also proposed amending our charter to create a management board, which will provide strategic counsel to the company’s management. It is my hope that shareholders will approve this measure at our next shareholder meeting.

In some ways, we have created a new value proposition for our customers, adopted new structures and policies to build well and motivate our team, and enhanced shareholder value. On this note, Sergey Schebetov and Vladimir Lagutin were already appointed to the positions of Chairman and Deputy Chairman of the Board of Directors. We are particularly grateful to the responsiveness and guidance shown by our Board of Directors during this period and the input of our main shareholder, AFK Sistema.

Our next challenge is executing -- applying ourselves to the tasks at hand and achieving the operational goals we have targeted. I am pleased with how far we have come, but I also must acknowledge that there is still much to be done ahead.

Now, let me pass the word to Vsevolod Rozanov, our Chief Financial Officer. He will talk more about our financial performance. Thank you.

Vsevolod Rozanov

Thank you, Leonid. Good day, ladies and gentlemen. First of all, I would like to say a few words about capital expenditures of the group. For the group, we spent nearly $411 million on the acquisition of property, plants and equipment, as well as other intangibles related to our group cap-ex program.

As a percentage of sales, this is a slight increase, roughly 1.5% from Q1, driven largely by the network build-out in our non-Russian business units.

In Russia, cap-ex as a percentage of sales declined for the quarter by 2.5% and remains in line with the budgeted $1.155 billion for the year.

As we have stated previously, we continue to invest considerably more in our networks and our network capacity compared to the coverage. This is the logical progression of our network expansion plan and reflection of our strategy to grow value-added component to our revenue.

Although for year 2006 in Russia, almost 60% of our total cap-ex spending will be capacity related, with the remainder split between the coverage, which will account for approximately 35% and other.

In Ukraine, we achieved a further significant development in our network coverage, building in excess of 1,100 base stations and continued to work on improvements in our network corridor. Our network coverage now reaches in excess of 95% of the country.

On the marketing front, quality is becoming more of a differentiator among all operators in the market. All these initiatives are part of our strategy to capture the largest share of the market during the final period of significant market growth in Ukraine.

At the end of Q2, cash and cash equivalents totaled $556 million, providing us with adequate levels of free cash for corporate and operating purposes.

Our free cash flow in Q2 amounted to $159 million. We expect to remain free cash flow positive for the year.

MTS Group net debt to OIBDA ratio at the end of Q2 fell slightly to 1.0. In addition, as we discussed in Q1, we closed our $1.33 billion syndicated loan facility with a number of leading international and financial institutions. As a sign of confidence in not only MTS but the market, at the general syndication stage, the [rollout] was oversubscribed by almost 50%. We are using the loan to refinance existing debt at a low interest rate, as well as for other corporate purposes.

I also would like to point out that our effective interest rate remains stable compared to Q1.

As we have previously stated, we launched our op-ex renew program at the beginning of this year, with a target to achieve 1% to 2% OIBDA improvement over one year, starting from the time we implement our initiatives.

Though second quarter OIBDA improved on the back of seasonal revenue increase, we should begin to see material results linked to our cost-cutting initiatives.

In addition to the things Leonid mentioned, such as labor cost reduction and some economy of scale effects coming through the centralization of call centers, we anticipate further optimization through the following initiatives:

  • Technical maintenance costs as a result of better pricing and upgrade of network with more advanced software and hardware that effectively requires less frequent maintenance;
  • Revising and optimizing our marketing costs -- we are consolidating some of the programs with larger vendors and thus negotiating on better discounts as well as better planning process;
  • Dealing down on handset subsidies in Ukraine;
  • Decrease cost of precious SIM cards and cost of pre-paid cards manufacturing -- we are negotiating on favorable terms with vendors.

As for additional corporate news, this past June, our shareholders voted to pay annual dividends of 7.6 Rubles per ordinary share, or roughly $1.40 per ADR for the year 2005, which represents roughly $562 million, or 50% of our year 2005 net income. Dividends will be paid in four installments until the end of year 2006.

Now I would like to pass the word to Andrei Terebenin.

Andrei Terebenin

Thank you, Vsevolod. Now we will open the call to questions.

Question-and-Answer Session

Operator

(Operator Instructions)

Our first question comes from Mr. Vladimir Postolovsky. Please go ahead with your question.

Vladimir Postolovsky - Brunswick UBS

Good afternoon, gentlemen. Congratulations on the fantastic results. A couple of questions. The first one is on your ADR buy-back program. Why you decided to repurchase ADRs? Local shares are trading at a discount to them. I am just curious.

The other question on that, in your press release you are saying that you will repurchase them for corporate needs. It does not sound like you will definitely cancel them. From this point of view, how long can you keep them for under Russian legislation? What else can you do with the shares after you repurchase the ADRs?

That is on ADRs. Looking at your ARPU dynamics, which is obviously very impressive quarter on quarter, I am just wondering what impact there might have been from discontinuance of discount packages? The question would be when did you discontinue discount packages and when your last free minutes lapsed, if you wish -- was it in Q1 or in Q2?

Finally, it would be great if you could provide us the overall amount of inter-connect revenues in Russia in Q2 and compared to the number for Q1 as well. Thank you.

Leonid Melamed

Thank you, Vladimir, for your question. To answer your first question about our ADR buy-back, I would like to state that the main goal of our shareholders to approve this plan on the latest Board of Directors was the idea that the ADRs of the company, the shares of the company are undervalued and the company in general is under-leveraged. That is why it is from the viewpoint of our shareholders, it is worth it to buy the shares of the company, the ADRs -- for example, the ADRs whenever they are traded now because it is still financially profitable and reasonable for the company.

Secondly, the ADR is an instrument, a very useful facility and we really can use it for much more tasks than we can use the shares from the local market. There are different possibilities how we can use in the future those ADRs that we plan to buy back from the market. There are no concrete plans right now about that, but it is easy to mention that we can use them, for example, to attract additional financing for the group by issuing the convertible obligations or by using them in some M&A activities for the group of companies. It is not something that is on the agenda right now, but these are the opportunities that will be from the viewpoint of the shareholders of the company, the management, easy to implement once we repurchased our ADRs from the market.

By answering this, I have also perhaps answered the question what do we mean by business opportunities. These are actually -- for example, these are two business opportunities that could be used by the repurchased ADRs from the stock market.

Regarding inter-connect rates, I will pass the word to Vsevolod Rozanov.

Vsevolod Rozanov

Thank you, Leonid. We usually do not disclose numbers related to inter-connect. I can mention one thing is that in the Q2, we did not see significant growth of the revenues there. It was approximately 10% growth lower than the overall revenue growth in Russia.

Vladimir Postolovsky - Brunswick UBS

You did disclose them in Q1. You said it was about $24 million, and the [inaudible] mentioned that they increased substantially, because in Q1 they only inter-connected with you, and in Q2, they started inter-connecting with other operators. So you are saying for you it was different, right? That inter-connect grew only by 10%? If it was 24, then it would have been what, 27 in Q2 only?

Vsevolod Rozanov

I think that is correct.

Vladimir Postolovsky - Brunswick UBS

Thank you, and on discount packages?

Andrei Terebenin

If you do not mind, I will pass the word to Mr. Mikhail Shamolin, who just joined us. He is the Vice President of the company in the newly adopted, the head of the business unit Russia, and if I understand your question, it is linked with Russia. That is why he is the right person to answer.

Mikhail Shamolin

Yes, as far as discount packages go, you recall the fourth quarter of 2005 and the first quarter of 2006. In the fourth quarter of 2005, we launched a new year promotion with the heavy discounted on-net calls. This allowed us to generate a significant amount of new subscribers in November-December. We have been coming out of this promotion during January and February. We have finished coming out of this by the beginning of March. This large amount of customers that we have been able to pick up during this promotion, we have been able to retain most of them, and we have grown the ARPU and MOU on those customers, which also positively impacted the results of the second quarter, as you can see.

Vladimir Postolovsky - Brunswick UBS

Then there was nothing since? I remember there was some tariff plans that when you offered some additional minutes for up-front payment of $10 or $20, and I thought that those minutes might have lasted through May. Is that true or not?

Mikhail Shamolin

That was a promotion, but it was negligible on the back of our overall sales and financial results. It was not a massive action and it did not draw a lot of subscribers.

Vladimir Postolovsky - Brunswick UBS

Thank you.

Operator

Thank you. Our next question comes from Sergei Arsenyev. Please go ahead with your question.

Sergei Arsenyev - Goldman Sachs

Good afternoon. A couple of questions, please. Firstly, I was wondering whether you are still keeping with your full-year EBITDA margin target of 50%, given that the first-half EBITDA margin was around 48%, right? So do you still believe that you can compensate for this in the second-half of the year?

Related question to that, for UMB, you are putting something in for the employee reduction, so related to that, when do you expect the timing of the employee reduction to start coming through? Also, if you can give a little bit more detail on that -- what is the level of severance that you expect, what is the accounting treatment is going to be, et cetera?

Finally, if you could also say what was the impact of the branding, if you can quantify that, the impact of your branding or the overall cost of your branding in the second quarter. Thank you very much.

Leonid Melamed

Thank you very much for the questions. Regarding OIBDA margin, yes, as we understand that we only achieved 48.9% of the margin in Q2, we have a very serious task to achieve 50% of the margin on an annual basis through significant improvement of our bottom-line numbers in the second-half of the year, but we still keep this indication to the end of the year. We have revised the budget for the business plans of our business unit for the second-half of this year, based on the trends and achievements in Q2, and we have indication from our business units that this task is still fulfill able. That is why we keep on this indication of 50% OIBDA margin until the end of the year.

Regarding the reduction of employees and the severance to be paid out of that, same as the other ways we use to reduce our office expenses, I will pass the word to Vsevolod Rozanov.

Vsevolod Rozanov

Thank you, Leonid. Speaking about severance packages, we plan to be in line with the overall practice in Russia, which usually is, in majority of cases, it is two months salary for the employee who is being laid off. As for the accounting for the employee reduction, as soon as we have formalized this plan, we will start including the costs, but they will be allocated. This plan is not realized at once. I do not think that we will see any negative long-term effect on this related to the employee reduction program.

The last question was?

Sergei Arsenyev - Goldman Sachs

On the cost of re-branding.

Vsevolod Rozanov

On the cost of re-branding. Okay, the cost of re-branding, as it was announced, the branding itself was approximately $4 million. As we said in Q1, we delayed or performed a significant number of the marketing initiatives, specifically those related to our image building. They moved to the Q2. We did not see too much of the image advertising anyway in the Q2, and the majority of the advertising expenses were related to tariff plan Pervyi, which was described by Leonid.

Sergei Arsenyev - Goldman Sachs

Can I just follow up on the accounting for the employee reduction? If I understood correctly, this is going to be, the severance payment is going to be a part of the personnel costs rather than a one-off, and you would not take a provision against it, in the fourth quarter, for example?

Vsevolod Rozanov

That is correct.

Sergei Arsenyev - Goldman Sachs

Thank you.

Operator

Thank you. Our next question comes from Mr. Alex Kuznetsov. Please go ahead with your question.

Alex Kuznetsov - Bear, Stearns & Co.

Good afternoon. It appears that revenue increased much more significantly than according to your guidance both in the first quarter and in the second quarter. It appears that the revenue growth in the first-half of this year was about 21.5% compared with the previous year. Do you expect that you might exceed your revenue targets for the entire year?

Second question is about CPP. Since CPP was introduced a couple of months ago, I would like to inquire if you can share with us your outlook on the impact on your financials.

Leonid Melamed

Thank you, Alex. We are facing the first quarter of promising growth in our revenues, this is the Q2, and we would like to be conservative with our forecast for the year end regarding the growth in revenues. That is why we would give the former indicator, the one we have offered at the end of Q1, that is to the growth of from 10% to 15% until the year end. We would like to be sure that the transfer phase now would become the fundamental direction of the development, both of the market and of the operations of our company in particular.

Regarding CPP, I would say that the introduction of CPP -- let me be also quite conservative here. I would just say the introduction of CPP does not change our indications for the year-end. We still need some more time to check the results of the CPP introduction.

Also, because in accordance to the international experience of introduction of CPP that we have studied, there are certain changes in the behavior of the customers of the mobile operators through three months after the introduction of CPP, and we need to get a look at a more long period to give you some serious fundamental answers to this question.

To come back to our forecasts and our indications, I would like to say that we now see the development in accordance with what has been anticipated by MTS management and that allows us to keep our indications for the year and for the group in general, and Russia in particular, stable. Thank you.

Operator

Thank you. Our next question comes from Mr. Sean Gardiner. Please go ahead with your question.

Sean Gardiner - Morgan Stanley

Yes, it is Sean Gardiner. Just two questions. First, a quick one on the buy-back. Are there any limitations on when you can start the buy-back, or could it start theoretically tomorrow? Secondly, on the cost-savings, you talk about one to two percentage points OIBDA margin improvement over year. That seems to be roughly $60 million to $120 million in cost savings. Can you help us understand how much of that comes from your employee reductions and then how much is coming from the items you mentioned, which are things like your technical maintenance cost savings and optimizing your marketing costs? Also, whether there is room to go further than $120 million, which will be the top-end of the range? Thank you.

Leonid Melamed

Regarding the buy-back, we have to state that this operation of ours is something -- is the action subject to approval of Federal Anti-monopoly Service Russian Federation. We, in accordance to the law, after the decision of the Board of Directors, will in the next coming couple of days apply for the permission. Hopefully we will receive it in the next comings months, hopefully in a more short period of time, but for official timing for this type of permissions.

Once we have it, the permission, we will be able to start executing this program.

Sean Gardiner - Morgan Stanley

Sorry, just on that -- you are referring to the law which has recently changed, which allows the majority of shareholders to increase their stakes to certain percentage threshold lots, getting permission? Is the problem that Sistema needs to get permission to increase its stake? Is that what is holding you back?

Leonid Melamed

No, this -- if I understand your question correctly, the necessity to receive the permission is not linked with the special growth of one of the shareholder’s share in the capital of the company. It is just linked to the current legislation and we have to follow up with it.

Sean Gardiner - Morgan Stanley

Okay. Thank you.

Vsevolod Rozanov

To the second question, I would like to mention that material savings from the personnel reduction are unlikely to be seen during this calendar year, as the majority of the cases will materialize closer to the end of the year.

We estimate the other measures, which were discussed earlier in the speech, at approximately the same level that you mentioned.

Leonid Melamed

Excuse me, let me add to what Vsevolod has said, and let me make it clear -- it has never been the idea of the management that the reduction of the personnel would lead us to serious cost reductions. We are not talking in general terms of a reduction of a personnel. We are talking about optimizing the headcount and the structure of the operations of the company in order to make them more efficient. We understand that -- we look at the benchmarks of the best companies in Europe. We look at the benchmarks of the amount of subscribers per employee in Eastern Europe and CIS and we understand what is the best practice that the companies have in the market, but it is not a direct link between optimizing our headcount and decreasing of our op-ex.

There is a certain link there, but the main thrust for us is to improve the quality of our operations and to make the company more manageable. Thank you.

Sean Gardiner - Morgan Stanley

Just to sum up, your total cost savings you think you can get going forward is roughly 2% at the top-end. Is that roughly 2% of your sales, or do you think you can go further than that in 2007?

Vsevolod Rozanov

In 2007, yes. We are now developing a program of further improving the efficiency. As was said, we expect to get approximately 1% to 2% of the margin cost savings the implementation of the existing plans, and now while we are starting purchasing for year 2007, we are also -- we can add new ways to further improve the efficiency.

Sean Gardiner - Morgan Stanley

Last question, I promise. In the second quarter, I think you suggested you did not have any cost-savings under your current plan. Is that right? So everything starts from the third quarter and fourth quarter of this year?

Vsevolod Rozanov

No, that is not right. Of course, there are already certain initiatives started in the Ukraine, and Mark can elaborate further on that. Our people already on certain programs started in the Russian business, and in the Uzbekistan business as well.

Mark, if you would like to add a few words.

Mark Burden

Basically, what we are working on is a number of initiatives. One to encourage on-net traffic, so that the balance of our Internet costs reduces as a percentage of our revenue. As you are aware, we continue to build out fiber-optic network, which is generally also having a positive effect in improving our gross margin, and we have certain other initiatives dealing with maintenance costs where we have already started that work a few months ago, and we are also looking at handset subsidies, as I mentioned on the call for Q1, and that is now being implemented, though that change is now being implemented.

So a number of initiatives have started during Q2.

Operator

Thank you. Our next question comes from Mr. Will [Milner]. Please go ahead with your question.

Will [Milner]

Thank you. I am just looking at your Russian pricing and usage trends, trying to understand those a bit better. It looks like in Q2 you are able to turn quarterly price declines into a sequential price increase, and increase usage significantly. My question is really, what drove this? Is it an exceptional quarter, possibly linked with the introduction of CPP? Or do you see prices increasing over the next few quarters? That is my first question.

Secondly, can you give us an update on your full-year 2006 cap-ex guidance?

Thirdly, can you update on your long-term leverage targets? You say you are under-leveraged in relation to the share buy-back program you have announced today. Thank you.

Leonid Melamed

Thank you, Will. Regarding the pricing in Russia in Q2, we have to say that we try to keep our ATPM stable, and we do not show no decrease, no significant increase of ATPM in Russia into Q2, but we have been quite successful in stimulating of usage. Having stable ATPM and increased FMOU, we have gained high ARPU and that is totally in accordance with the strategy 3+1 that we have adopted a quarter ago and we have presented to the investors already, where we said that of the markets with high penetration, such as Russia, we would like to concentrate our marketing efforts in stimulating of the usage.

Vsevolod Rozanov

Answering your second question regarding the cap-ex guidance for year 2006, we do not change our guidance. It remains at the level of $1.8 billion, with Russia, as we said, approximately $1.155 billion, another approximately $600 million in the Ukraine, and the remaining in Uzbekistan and Turkmenistan.

Would you be so kind to repeat your third question?

Will [Milner]

Yes, the third question was can you give an update on how you see long-term leverage target business in terms of net debt to EBITDA, since you claim that the business is under-leveraged in relation to the share buy-back program you have announced?

Vsevolod Rozanov

We will be watching very carefully how the situation develops and we are definitely keen to remain at the very conservative side, in terms of management of our debt and in terms of [inaudible] related to our leverage. We do not expect to overcome the ratio of net debt to OIBDA more than 2 in the near future.

Will [Milner]

Sorry, I did not catch the last bit? Did you say…

Vsevolod Rozanov

Net debt to OIBDA ratio will unlikely be higher than 2.

Will [Milner]

Thank you.

Operator

Our next question comes from Ms. Nadejda Golubeva. Please go ahead with your question.

Nadejda Golubeva - Aton

Congratulations on great results. My first question is about Ukraine. Your revenue growth quarter on quarter there is another impressive effect, both in absolute terms and compared to Kyivstar. Could you give us a bit of color on what is going there and how you see the competitive landscape? Do you feel a significant pressure? [So far in the quarter], did something change since second quarter? Also, if possible you are planning some additional advertising expenses in Q3 for third quarter, or probably [anchored them] already, in order to maintain your revenue share and subscriber share? This will be very helpful.

Also, I see your margin on equipment sales deteriorated in the second quarter compared to the first quarter. Could you explain whether this is because of Ukraine? Could you comment on this, please, as well?

Finally, a follow-up on the previously asked question. Your margin guidance about 50%, so I guess this is a result of the impact of CPP, because after CPP introduction, we can assume in addition to revenue and costs, which just technically reduce the margin, so am I correct that your 50% EBITDA margin guidance, this is without CPP impact? Thank you very much.

Mark Burden

Thank you for your questions, Nadejda. In terms of competitive pressure, certainly there is competitive pressure. [B-Line] entered the market in Q2, and came in with interesting offers. Concerning Astelit, they continue to find a place for themselves in the market, although they are struggling to find a full place in the market, and Kyivstar continues well in Prussia. That is why we have a number of actions that we are taking, the encouragement and stimulation of our own on-net traffic, attention to quality, continued significant rollout to ensure coverage in all key areas of Ukraine, and focusing on distribution points, as we want to be much closer to the customer than we have been in the past.

We are starting to see improvements that lead through and have set through to an increase in our revenue, increase in usage, yet holding up in terms of ATPM.

Clearly there will be cost pressure, although the actions that we have taken, started taking in Q2, we expect to see continuing to give us benefits in Q3, and whilst we will obviously defend our position, we feel that there is a -- the moves we have started will bring us additional benefits in Q3 and through to the end of the year.

In terms of margins on handsets, you will find that Q2 was a quarter in which we adjusted our strategies, so therefore you have a sort of blended impact going forward. Going forward, we will move away from handset subsidies, except for contract clients. This is mainly as a tool for customer retention and defending what we have as a very strong position in that segment of the market. Thank you.

Nadejda Golubeva - Aton

Excuse me, Mark, can you clarify -- should we expect some additional advertising expenses in Ukraine in third quarter compared to revenue, or do you think that you will be able to defend your market share with the same level of advertising as percentage of revenue?

Mark Burden

Basically, we would expect that there may be a slight uplift in Q3 and Q4, given our programs. As you are aware, we had a very strong program in Q1, which we had a follow-on effect in Q2, so Q2 is a lower percentage of revenue. We would expect that to pick up a little bit towards the -- in Q3 and Q4, but still bringing additional benefits in terms of our EBITDA margin overall.

Nadejda Golubeva - Aton

Thank you very much. Could you comment on the margin and CPP?

Vsevolod Rozanov

I am sorry. Can you please repeat your question regarding the margin?

Nadejda Golubeva - Aton

My question was your 50% EBITDA margin, is it without the impact from CPP, because after CPP is introduced, we will see an addition to revenue in the quarter, which will put pressure on the EBITDA margin, even in case EBITDA remains same in absolute terms, so -- your guidance, does it include CPP impact or this is net of CPP impact?

Vsevolod Rozanov

This is including CPP effect.

Nadejda Golubeva - Aton

I’m sorry?

Vsevolod Rozanov

The guidance is for actual results of the MTS for the year 2006, including all possible effects at this stage.

Operator

Thank you. Our next question comes from Ms. Olga Bystrova. Please go ahead with your questions.

Olga Bystrova - Credit Suisse

Good evening. Congratulations on the great results. My first question is related to advertising expenses in Russia. Obviously in the second quarter there was a jump in let’s say advertising and marketing components of subscriber acquisition costs, and you mentioned that you are planning some cost-savings on this item as well. Would you give us some guidance where we should look at this item for the full year?

My second question is regarding Uzbekistan margins. You mentioned that there were some initiatives, cost initiatives introduced in Uzbekistan in the second quarter. However, if I understand correctly, there was some reduction in margins in this country in the second quarter versus previous quarters. Can you explain what is going on there, basically?

Third question is value-added services, ARPU declined in absolute and relative terms as a percent of ARPU, overall ARPU. Could you also comment on what were the regions and how should we think about this item going forward in your view?

Finally, July subscriber statistics -- could you maybe provide us some guidance on what were the gross additions at MTS in July? Thank you very much.

Leonid Melamed

Thank you very much. Regarding SAC, the acquisition costs, we as a part of our cost efficiency solution, there is a solution of optimizing of our marketing expenses. We are planning to pay reduced commissions in accordance to the market, and that is not a subject of a big influence from our side. This is more a subject of the market trends, whereas from the advertising costs and the amount of advertising that took place, we have implemented a new way of estimation of our necessities, and that allowed us to make significant decrease compared with our initial plan of our advertising expenses for the second half of this year. That is why we anticipate some reduction in sub acquisition cost indicator, but I would avoid giving concrete indication on this parameter right now.

Regarding the Uzbekistan margins, I will pass the word to Vsevolod.

Vsevolod Rozanov

First of all, I would like to mention that the margins in Uzbekistan are extremely healthy and we expect them to continue to be so.

In the second quarter, we introduced certain measures which will increase on-net traffic to reduce inter-connect costs, which actually led to a significant increase in the cost of rollout a few quarters. We also saw some initiatives related to maintenance reduction there, which did not materialize to that extent in the second quarter, hence the results are not -- hence you cannot see the results on the second quarter numbers. Thank you.

Olga Bystrova - Credit Suisse

Thank you. Can I just quantify? Still, I understand and I realize that the margins are higher, but I was just wondering, was there anything in the second quarter in this country that basically caused the reduction on margins quarter on quarter?

Vsevolod Rozanov

The key reason for the margin reduction quarter on quarter is the significant cap-ex program, which was launched at the end of 2004 and beginning of 2005. Thus, there was a significant increase in depreciation and amortization. Thank you.

Leonid Melamed

Regarding the share of voice in ARPU, in Russia, we registered that 11% of our ARPU was driven by voice in the second quarter, so the growth was mainly driven by the voice services that were provided to our customers.

Our future trend there is still -- we think the share of voice will increase and keep more or less stable in the level of 13% of our total ARPU. That is what we anticipate.

Regarding the July subscribers, I would like to pass the word to Mikhail Shamolin.

Mikhail Shamolin

In July, our total amount of gross additions was at the level of 1.9 million in Russia, of which 800,000 customers have been churned from the previous period. Therefore, our total net additions in July were slightly above 1.1 million customers. This churn number of 800,000 is nothing unusual, and not the lowest in the given period.

Operator

Thank you. Our next question comes from Stephen Pettyfer. Please go ahead with your question.

Stephen Pettyfer - Merrill Lynch

Four questions, if I may. Firstly, on the subject of the ADR buy-back, could I just clarify on that, will you be actually canceling underlying shares, or will you be holding them in treasury for future purposes?

Second question relates again to your advertising expenditure in the second quarter. It looks to me as if you -- it has been like a 70% sequential rise in your advertising, in the absolute advertising and marketing bill, and I just wondered, in addition to the marketing, the sort of re-branding costs, what went on there?

Thirdly, on the depreciation line, is this flat sequential rise something normal?

Finally, just to go back again to the 50% full-year EBITDA margin target, given your comments that you are not really expecting much of the cost benefits to come through in the second-half, I was wondering again if you could help me understand how you are going to achieve that target? Thank you.

Leonid Melamed

Thank you, Stephen. To answer the question about the ADR buy-back, we would like to stress that we are not going to cancel those shares. We are going to keep them as treasury shares. The company recently [shift] in Bermuda, wholly-owned by MTS.

The marketing expenses in Q2, I will ask Mikhail Shamolin to comment.

Mikhail Shamolin

Yes, actually, the sales and marketing expenses grew in absolute terms from about $128 million to about $152 million in Q2, and mainly due to the growth of advertising expenses in Russia related to the launch of new brands and heavy promotion of the first tariff plan.

However, as the share of revenue, those sales and marketing expenses have remained stable at 10%. Given that we are not planning heavy and aggressive promotions in Q3, and given that we have adopted a program to increase the efficiency of our marketing and communications, we expect this level to go down.

Vsevolod Rozanov

As for the third question, we expect depreciation to go steadily up in the next quarters, as we are implementing our cap-ex program.

Speaking about full-year EBITDA margin guidance, we believe that we will be able to realize those initiatives within -- the effect of the realization of the initiatives I mentioned will come later in this year, so we believe that there is no necessity or any evidence that we have to change our guidance at this stage.

Operator

Our next question comes from Mr. Yuri Polyakov. Please go ahead with your question.

Yuri Polyakov - Credit Suisse

Yuri Polyakov, Credit Suisse. I am on the fixed income side, so my question is related to that, and I have three questions. My first question is, could you please indicate what the proportion of secured debt is or was as established total debt as at the end of the second quarter, and how it compares to the level of debt at the end of the first quarter? If you do not have the answer to this question during the call, we would be grateful if you could follow-up subsequent to the call.

My second question is, could you give any guidance on the company’s total and net debt levels expected by the end of the year?

My third and final question is, could you elaborate a little bit more on your target leverage levels? You have mentioned a couple of times that the company is considered to be under-leveraged by management and shareholders, and yet you have said that the maximum net debt to EBITDA level would be in the region of 2.0. Could you indicate any timeframe, if any, within which you would get to this level? Thanks in advance.

Vsevolod Rozanov

Thank you. For the first question, the answer is zero, nil -- there was no unsecured debt in the company.

On the second question, we do not foresee any significant change in the balance sheet until the end of the year. Obviously it depends on how our M&A program goes and other potential, or other events, corporate events, but for business to go on as usual, we do not see any potential change in the position there.

Speaking about target leverage level, I thought I previously mentioned the ratio of net debt to OIBDA as 2. We believe that this is the level of indebtedness which will not lead to any review of our credit rating. Thank you.

Operator

Thank you. Our next question comes from Ms. Layla [Govi]. Please go ahead with your question.

Layla [Govi]

I have a couple of questions. The first one, just on real penetration -- at the beginning of the call, you mentioned estimates ranged between 60% and 80%. I am just wondering if you think the addressable market is fully penetrated at this stage, or if you do feel there is more growth to come. That is my first question.

The second question is just the general operating environment that you speak about, also focusing more on driving usage of your existing customers, kind of a similar view to VimpelCom. I am wondering if you think Megafon shares this similar view in terms of seeing more stabilization in pricing, no aggressive promotions, that kind of thing, but just the outlook really that you think they may be sharing for the rest of the year in order to keep the overall environment stable.

The last question, can you please jut remind us how much of your revenues come from incoming calls before the introduction of CPP? Thank you.

Leonid Melamed

Thank you. Regarding the market penetration, we anticipate that the growth will take place in Russia as well, but we do not anticipate a quick growth there. That is why we think that the assimilation of usage is a fundamental task for the company for the end of this year and the year 2007, and perhaps will stay as our main task regarding the revenue side of our [ownership] for the future years to come.

Still, the market is growing, if you believe the third parties’ analysis published in press, by something like 1.5% to 2% a month, and in the next coming quarter, perhaps, I think this type of growth will stay stable.

Regarding the activities of our shareholders, our internal communication policy does not allow us to comment on the activities of the competitors. That is why I would rather not answer that, but I would definitely say that we anticipate that the activities of our main colleagues and competitors in the market would help all of us to keep the market, revenue-wise, grow and it would help all of us to show better bottom-line results in the next coming future. So we suppose that pricing discipline would be the unified principal of marketing activity for the major players for the Russian market in the next coming period.

Layla [Govi]

Then, just the last question about the incoming calls?

Vsevolod Rozanov

That, depending on the quarter, constitutes approximately 8% to 10%.

Layla [Govi]

8% to 10%, so that is basically from incoming calls from fixed line?

Vsevolod Rozanov

That is not from a fixed line only, but all incoming calls.

Layla [Govi]

Is the vast majority fixed line?

Vsevolod Rozanov

Yes.

Layla [Govi]

Okay, so therefore, since you have small proportions coming from incoming mobile calls, I was just a little confused earlier when you mentioned international comparisons at the effect of introducing calling party pays to see what effect that has on usage. When we look at fixed line, incoming calls from fixed line with client party pays introduction, has there been much of an impact on usage in that respect, or wasn’t it more because of the incoming calls from mobile where we saw more interesting data about the impact? Do you see what I mean?

Basically, I am asking you where is the upside? You mentioned international comparisons with the introduction of CPP, and what I do not understand is if most of your incoming calls before CPP was introduced was coming from fixed line and not really from mobile, why is it important to still monitor the behavior of your customers? Where could we see additional upside that we do not see at the moment in terms of your customer behavior? Why is it relevant to monitor customer behavior?

Mikhail Shamolin

First of all, the revenues still, as Vsevolod rightly pointed out, was about 8% to 10%. Most of the -- the vast majority of the on-net incoming calls and incoming calls from competitors were free, even before the introduction of CPP, so we are talking mostly fixed line incoming calls.

Layla [Govi]

That is right.

Mikhail Shamolin

The fact we saw in Ukraine, and Mark Burden can comment on that in more detail, have been the increase in incoming calls for which we now get inter-connect revenues from fixed line operators, as well as the overall increase in traffic stimulated by the CPP introduction. So this is why we are monitoring our traffic development constantly. It is too early to tell exactly how the traffic will be developing because we only have two months of the CPP introduced in the market, and typically it takes three to six months for changes to penetrate, because people have to get their bills first and then their speaking behavior changes.

Layla [Govi]

I guess that is really my question, your very last comment. Why would the speaking behavior change if up until now, they were not really being charged for incoming mobile-to-mobile calls?

Mikhail Shamolin

I will pass that to Mark, because he has the practical Ukraine experience.

Mark Burden

Let me just talk you through the experience that we found. Basically, one, people keep their phones on. The habit in Ukraine, and I can only speak basically of Ukraine’s experience, although we also looked at international studies, but basically people keeping their handsets on, so they are more available for calls and take calls. They can control their bill.

The second thing is, obviously it depends on the level of inter-connect that is set in the market. Secondly, the level of the price from the PSTN to mobile, and then the competitive dynamics between the operators in terms of will somebody move off of PSTN and move to make a mobile call?

Initially, we saw a very high level of PSTN to mobile, which has subsequently been competed away and moved on to mobile as the price of mobile-to-mobile calls, irrespective of network, has been more competitive than a PSTN to mobile call.

The other factor that you see here in Russia is the level of inter-connect was set much lower than it was in Ukraine, so there will be a different dynamic as a result of that as well.

Layla [Govi]

Okay, that is very helpful. Thank you. Sorry, I just have one last follow-up. Sorry about this, it is just actually on an earlier question regarding the margin guidance about the 50%, and you mentioned the cost-cutting, we will see towards the end of year an impact from that to help you with that 50% target. Just to clarify, are you then saying that there is incremental cost-cutting on top to see additional margin upside from 2007?

Vsevolod Rozanov

I am confirming that where we are implementing the existing program, which will help us to reach an additional 1% to 2% OIBDA margin improvement, we are currently planning to put together the program for efficiency improvement for year 2007.

Operator

Thank you. Our next question comes from Mr. Dalibor Vavruska. Please go ahead with your question, sir.

Dalibor Vavruska - ING

Good evening. Just a quick question about the subscriber trends. We saw the numbers in July, which were quite encouraging for MTS, in terms of net additions. We do not know the numbers for August yet, but I am just wondering whether you can maybe give some light on the, shed some light on the pricing policies in the market right now in the third quarter. How is the market developing? You said you expect a rather stable pricing as opposed to the increase that we saw in the previous quarter. I do not know how much you can tell us about the most recent subscriber and pricing trends right now.

Mikhail Shamolin

The pricing in the market remained relatively stable. As I was speaking earlier, we have come out of all the promotions and discounted tariffs that we had, which helped the revenue side.

In the third quarter, we also do not see any aggressive pricing in the market. Moreover, after the introduction of CPP, we saw the introduction by almost all of the operators, the increase of the price of the first minute, which is the measure aimed at compensating the negative CPP effect, because of the reduction in revenue from incoming calls.

Shortly, we do not see any aggression in pricing in third quarter and expect a reasonable pricing behavior from all the players.

Dalibor Vavruska - ING

Thank you. Could you maybe say on the market share side, obviously the July number was quite remarkable for MTS. Do you see this as a new trend or do you think that there is some maybe one-off effects in July, that the trend might be a bit different?

Leonid Melamed

We would like to be conservative. We have implemented a number of measures that show their certain effectiveness, but we have to leave a longer period of time and observe the numbers to be absolutely sure that we are on the right track on increasing mobile market share.

We are doing very concrete things in a very concrete direction and we would like to be conservative with forecasts.

Dalibor Vavruska - ING

Lastly, if I can ask one on the pricing and ARPU, obviously as a result of the CPP, the customers will stop paying for the incoming calls. Is there a specific marketing initiative aimed to make these customers to pay the same money to raise the increased usage in other ways not to decrease the ARPU? Is there anything, any specific campaigns or anything targeted on that?

Leonid Melamed

Approximately half of the revenues that were a result of a decrease of the revenues from incoming calls will be now compensated by the inter-connect revenues that will grow, in accordance with our forecasts, that we hope to grow in the second-half of the year.

The other part of the decrease in the revenues due to the introduction of CPP should be subject to the tariff policy of the company and the policy to stimulate usage, also of the additional services that we plan to do in the second-half of this year. So stimulating voice services, the usage of the voice services and additional services is the key element to combat the negative efforts of the reduction of the revenues due to the introduction of CPP.

Operator

Thank you. Our next question comes from Ms. Anna Bossong. Please go ahead with your question.

Anna Bossong - CA-IB

Thank you very much. I just have three questions. My first is just to absolutely clarify the cost-savings story. I am sorry to go over this again, but I think what you are saying is that you had a 49% EBITDA margin the second quarter, and if everything stays the same with your cost-savings, that should theoretically rise to 50% or 51%, let’s say. Then, in 2007, you are saying on top of that, more cost-savings, so potentially from 50% to 51%, 52%. Is that the correct way to understand the guidance you are giving?

Secondly, just on the churn, you said that in July, there was 800,000 churn and 1.9 million gross adds, which sounds to me like something like 30% -- sorry, forget that question.

My next question is on signing of fixed-line contracts. We have heard that VimpelCom is not getting the full progress in signing fixed-line operators to its new inter-connection regime, and I am just wondering if you are having similar problems and if you think maybe that will affect your third quarter results. That is all. Thank you.

Vsevolod Rozanov

Speaking about the first question, we are not providing the guidance for year 2007 yet. I will only confirm that again, the guidance for year 2006 is 50%, and we expect it to reach via the measures which were discussed earlier. The measures, which we are now developing for further efficiency improvement in the year 2007, will I feel [relate] and we will be able to quantify them I suppose in the beginning of the year, or announce them in the beginning of the year 2007, probably during the full-year results call.

Anna Bossong - CA-IB

Right, but your cost-savings you are saying you are looking to ad 1% to 2% percent to margins by the end of this year, which I assume means in something like the fourth quarter. Secondly, you are saying there are more cost savings to come in 2007. That is more or less the correct interpretation?

Vsevolod Rozanov

Again, the measures which we are undertaking are intended to optimize our OIBDA margin and also to mitigate the effects, as to one of the participants was mentioning, mitigate the effect of the CPP introduction, and the measures, which are to be in effect in the year 2007, new measures, are not quantified yet.

Leonid Melamed

To answer your question regarding the inter-connect relationship through the other operators, we have not yet changed the policy that we have introduced several weeks ago. The pricing policy, I mean. Yes, we can confirm that we have some pressure from the Anti-monopoly officers of the Russian Federation in this area. We are currently looking at the situation and will deliberate our solution, whether it will be a change of our policy or keep them stable, in the next coming ten days.

Operator

Thank you. Our next question comes from Mr. Vladimir Postolovsky. Please go ahead with your question

Vladimir Postolovsky - Brunswick UBS

I have two follow-up questions, if I may. One is on the effective tax rate, which was again very high in Q2. Could you explain why? It seems to be like a trend now, 36% in Q1 and now 31% in Q2. Could you comment on that please? That would be great.

The second one, are you in a position to give us any indication of relative direction that -- well, hopefully a bit more than direction that is going to happen with cap-ex in ’07. How significant do you expect the decline to be from 2006?

Finally, could you remind me, when did you launch your tariff plan first? I thought it was the beginning of June. If that is the case, it should not have affect Q2 that much, but anyway, if you could remind me, that would be great.

Vsevolod Rozanov

Speaking about the effective tax rate, the first question, we believe that first of all, it increased in Q2, although it still remains at, in the 30s. The reason for increase of effective tax rate is the Rubel appreciation dynamics, which affected I suppose all the companies whose revenues were nominated. There are also certain tax effects on the debt and interest expenses, so we obviously are focusing on the improvement in this area as it is one of the areas which might lead to increase of the net income and the net income margin, but again here, we remain quite conservative and do not expect this number to dramatically decrease over the quarters.

The second question regarding the guidance for year 2007, currently all the investment projects have been under review. The review is being finalized and we are finishing our strategic sessions, which we provided as for the guidance for the cap-ex 2007. Obviously it will not be higher than this year, and we expect a certain decrease, but the extent of this decrease, it is a little bit premature to announce yet as the projects themselves, the investment projects are not fully reviewed yet.

For the third question, the tariff on Pervyi was introduced in the beginning of June, as you are totally correct. The success rate was such that we believe that the effect was material.

Vladimir Postolovsky - Brunswick UBS

How many subscribers did you have on it at the end of the quarter, please, roughly?

Vsevolod Rozanov

Almost 1 million subscribers on tariff Pervyi until the end of the quarter.

Operator

Our next question comes from Mr. Sergei Arsenyev. Please go ahead with your question.

Sergei Arsenyev - Goldman Sachs

Good afternoon again, just a couple of very quick follow-ups. On the employee reduction, the 19,300 employees in Russia, will you view this as the optimal level of employment, or can there be further incremental cuts beyond that number?

Just on the share buy-back, will the share buy-back impact your dividend policy in 2006?

Leonid Melamed

Regarding the optimization of the amount of employees, we understand that the best practices in Europe was at the level from 2,500 to 3,000 subscribers per employee in the company. This is the industrial best practice. We are trying to end up next year definitely in this area. But as I have already said, the main task for us is to identify what positions should be just reduced, what type of services we should outsource, and if we should do that, how to increase the efficiency of our operations by outsourcing.

We understand that it will optimize the headcount of our company in 2007 in Russia through all of 2007 in Russia and we will give you the indications of what will be the trend there in the end of 2006. As a guidance, this industrial best practice benchmarks that we used.

Regarding our share buy-back program, we cannot comment on the dividend policy of the company because it is a shareholders affair. We understand that the decisions of the shareholders would be driven by the interest of the shareholders themselves and the financials of the company would allow them to keep the dividend policy that they would actually prefer to have when they are going to make decisions on this topic. So the introduction of the share buy-back program will not create additional restrictions or limitations on the dividend policy of the company.

Operator

Thank you. Our next question comes from Mr. Alex Kuznetsov. Please go ahead with your question, sir.

Alex Kuznetsov - Bear, Stearns & Co.

Good afternoon. I have two more follow-up questions. First, do you have a long-term guidance of cap-ex as a percentage of your service revenue? Secondly, we have noticed that NTS ARPU, according to the old definition, is lower than that of VimpelCom, while your minutes of use are higher. Are there any reasons for the lower effective tariff, apart from a higher percentage of corporate customers?

Vsevolod Rozanov

We currently do not provide long-term guidance on cap-ex. As a part of our effort to increase the financial discipline in the company, we are reviewing all the programs now. Again, I suppose that when we are able to provide the guidance for you in 2007, we will be able to provide certain guidance for a couple more years after that, when we clearly have the inventory longer -- per our portfolio or investment projects and our satisfaction in terms of the requirements we apply to all the projects in MTS.

Leonid Melamed

On the ARPU side, you can see our ARPU has been at the level of $7.50 in Q2, according to the same methodology that our competitors have been using. I understand that the ARPU of VimpelCom is very similar to that number, so I do not think that we are lower in ARPU.

Alex Kuznetsov - Bear, Stearns & Co.

Oh, I see. So your old methodology was different from VimpelCom. I was under the impression that VimpelCom does include roaming revenues into ARPU calculation. Maybe I was mistaken.

Leonid Melamed

No, the roaming revenues are not included in the ARPU calculation, but the inter-connect revenues are.

Alex Kuznetsov - Bear, Stearns & Co.

Also, could you provide us the current split between maintenance cap-ex and expansion cap-ex?

Vsevolod Rozanov

I am sorry, could you please repeat the question?

Alex Kuznetsov - Bear, Stearns & Co.

Could you provide us with the current split between maintenance and expansion cap-ex? What percentage of your cap-ex is spent to maintain current facilities?

Vsevolod Rozanov

Unfortunately, our information policy does not allow us to disclose more numbers on cap-ex than we have already discussed.

Andrei Terebenin

Last question, please.

Operator

Our next question comes from Mr. Sean Gardiner. Please go ahead with your question, sir.

Sean Gardiner - Morgan Stanley

Just a follow-up question for myself as well. When do you expect to start to report active versus inactive subscribers on a regular basis? Or don’t you think those metrics are worthwhile for your business for the coming year also?

Secondly, just going back to this cost-cutting story, could you just help us understand the size of some of the costs that you are targeting? The technical maintenance costs, which you highlighted, can you give us an absolute number for 2005, what that cost line item was so we can understand the potential magnitude? Maybe also for the sim-card and scratch-card costs, another item. If you could just help us there, thanks.

Leonid Melamed

Our churn policy is quite stable and we keep on following this policy through the last several years. It has not been actually the matter of change for the upcoming period of time. If you will understand the pressure of the markets to somehow change the data that we develop and deliver, then we will have the discussion on this topic and we will come out with a solution here. Until now, we keep on stable charted policy and it is available on our Internet site.

Vsevolod Rozanov

As for the second question, I would mention that both items you mentioned are between 1% and 2% of our revenue, so it is quite a big number.

Sean Gardiner - Morgan Stanley

Each item, to expand a little bit, is 1% to 2%?

Vsevolod Rozanov

Yes.

Andrei Terebenin

Thank you very much, ladies and gentlemen, for your interest. We welcome you at any time to contact our Investor Relations department for further questions. A webcast of this discussion will be available on our website, if you wish to replay the call. In the meantime, we appreciate your interest again and wish you a pleasant day. Thank you very much.

Operator

Ladies and gentlemen, this concludes the second quarter 2006 financial results conference call. Thank you for participating. You may now disconnect your telephones.

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Source: Mobile TeleSystems Q2 2006 Earnings Call Transcript (MBT)
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