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VimpelCom Ltd. (NASDAQ:VIP)

Q2 2012 Earnings Results Conference

August 15, 2012 08:00 AM ET

Executives

Jo O. Lunder - CEO

Henk van Dalen - CFO

Gerbrand Nijman - Head of Investor Relations

Alexandra Tramont - FTI Consulting.

Analysts

Cesar Tiron – Morgan Stanley & Co.

JP Davids – Barclays Capital

Herve Drouet – HSBC Investment Bank Plc

Tibor Bokor - ING

Alexander Balakhnin – Goldman Sachs

Dalibor Vavruska – Citigroup London

Igor Semenov - Deutsche Bank

Operator

Good day ladies and gentlemen, and welcome to the VimpelCom Ltd Second Quarter 2012 Investor and Analyst Call. At this time, all participants are in a listen-only mode. Later we’ll conduct a question-and-answer session and instructions will be given at that time. (Operator Instructions) As a reminder, today’s conference call is being recorded.

I’d now like to turn the conference over to your host Ms. Alex Tramont of FTI. Please go ahead.

Alexandra Tramont

Thank you. Good afternoon ladies and gentlemen, and welcome to VimpelCom’s conference call to discuss the Company’s second quarter 2012 financial and operating results.

Before getting started, I would like to remind everyone that forward-looking statements made on this call involve certain risks and uncertainties. These statements relate, in part to one, the Company’s plans to maintain profitable growth in its business units, and expected future results in Italy and Ukraine and to the Company’s expected future debt position and refinancing plans.

Certain factors may cause actual results to differ materially from those contained in the forward-looking statements, including the risks detailed in one, the Company’s earnings release and presentation announcing second quarter 2012 results, two, the Company’s Annual Report on Form 20-F, and three, the most recent filings made by the Company with the Securities and Exchange Commission.

Certain amounts and percentages that are used here have been subject to rounding adjustments. As a result, certain numerical figures shown as total including in tables may not be exactly arithmetic aggregations of the figures that proceed or follow them. If you have not received a copy of the second quarter 2012 financial and operating results release, please contact investor relations at +31207977234 and it will be forwarded to you. In addition, the earnings release and the earnings presentation, each of which includes reconciliations of non-GAAP financial measures presented on this conference call can be downloaded from the VimpelCom website.

At this time, I’d like to turn the call over to Jo Lunder, Chief Executive Officer of VimpelCom. Please go ahead.

Jo O. Lunder

Thank you. Good morning to those in Europe and good morning to our guests from the United States and welcome to our second quarter earnings presentation. Let me start by introducing the members of the team here in Amsterdam. We have Henk van Dalen, our Chief Financial Officer, who will be covering the financials in detail and Gerbrand Nijman, our Head of Investor Relations.

The Group performance led to a 4% organic growth in revenue year-on-year, reaching $5.7 billion. Excluding FX impacts, EBITDA increased 8% compared to the same period last year, leading to a margin of 43.2%. We’re pleased with the continued positive developments in Russia, which experience double-digit EBITDA growth in local currency in the second quarter. Likewise Africa and Asia and CIS also saw the double-digit organic growth in EBITDA.

2012 remains a transition year in Ukraine as the negative effect from the movements to bundled tariff plans is expected to persist for the remainder of the year. In Italy we’re facing a challenging regulatory and economic environment, thus our operations there continue to outperform the market and win as further strengthens its market share in both mobile and fixed.

We also achieved strong subscriber growth in the second quarter with an increase of 8% reaching 208 million mobile subscribers. The largest contribution came from Africa and Asia, but the Company also achieved strong growth in fixed and mobile broadband subscribers in Russia, in Italy and Ukraine.

The company was able to deliver a solid performance in the second quarter despite a considerable negative impact from currency movements. Net income reached $488 million, almost a doubling of the last year and we delivered a solid cash flow with net cash from operating activities of $1.35 billion. In relation to the claim by FAS, the Russian Antimonopoly Service against Telenor and Weather II, we have no material updates today.

As you know as a result of the injection by the Russian court in relation to the FAS claim, VimpelCom decided to postpone the final 2011 dividend payments decision. We will of course update you if there are any material developments on this topic.

Moving on to the performance of the five business units, starting with Russia. In Russia the Company continued to maintain the positive operating trends seen in the first quarter. The business saw organic revenue growth of 8% while EBITDA increased 12% leading to an EBITDA margin of 43.1%. The highest margin we’ve recorded in the last five quarters. The 8% growth in total revenues were supported by a 35% increase in mobile data revenues as we continue to promote mobile data services.

On the operational excellence program, we’re also making significant progress. In order to improve the effectiveness and efficiency of our distribution, we’re implementing a full revenue sharing model with our dealers. This enables us to reduce subscriber acquisition costs and it also supports our efforts to reduce churn. Our churn rate decreased from 17% in the first quarter to 15% in the second quarter, but more work is required.

We also continue to improve the efficiency of our networks and this time we’ve already signed agreements with other telecom operators and service providers for joint use, maintenance, and development of network infrastructure. In addition, we’re reducing HR costs and rationalizing our regional reporting structure.

Lastly, the Company is directing certain non-core activities in Russia, including a call center and the network construction company. We are ahead of schedule in achieving our target of RUB5 billion in annualized savings. Last 12 months CapEx to revenues stood at 21% as we continue to invest in building out our 3G network and close the gap to our main competitors.

In July VimpelCom was awarded an LTE license, which we expect to enable us to drive the popularities of our mobile data services in the future. We expect to launch LTE services in 2013 and we’re currently finalizing our plans for the LTE investment roll out. In summary, we’re pleased with the progress in Russia and we will continue to execute from our strategy in that market.

Moving to Italy, in Italy Wind continued to outperform competitors and to take market share both in revenues and subscribers. Wind underlying total revenue growth of 2% excluding the impact of the MTR cuts. Winds mobile data offerings continue to achieve strong results year-on-year with mobile internet revenues of 50%, mobile messaging revenues up 10% and fixed broadband revenues up 4%.

Despite the decline in total revenues, an increase in energy related OpEx and an increase in bad debt in fixed line, the Company was able to deliver stable EBITDA in the second quarter over the previous year, with an increase in EBITDA margin. The mobile subscriber growth remains strong, driven by the success of Wind’s summer campaign maybe took over 75% of the net adds achieved of mobile network operators.

Mobile broadband subscribers increased by more than 10% and fixed broadband continue to perform strongly with subscribers increasing 7%. Looking at the second half of the year, the further cut in MTR effective from the 1st of July is expected to increase pressure on the top line. The MTR impact is expected to continue to reduce the total market value for the next 18 months. For these reasons we’re now adjusting our cost base with strong structural OpEx measures in order to protect our margin and our EBITDA levels.

We expect our position to be even stronger in 2013 with a continued improvement of our market share and we remain committed to the Italian market, where we see a long-term value potential.

Moving on to Africa and Asia, in our Africa and Asia business unit, reported revenues were flat over the previous year, impacted by local currency devaluation against the U.S. dollar in main operating units. On an organic basis, revenues recorded a growth of 8% driven by strong subscriber growth and an increase in data and by the added services in our key markets.

EBITDA amounted to $466 million with an organic growth of 13% as a result of good cost control in our major subsidiaries. In Algeria, our subscriber base grew 11%, driven by a substantial churn reduction coupled with strong subscriber growth. EBITDA increased 6%, supported by continued cost management. Our performance in Pakistan remain strong with Mobilink delivering organic revenue growth of 9%. EBITDA increased by 19% in local currency driven by improved cost control measures and tariff optimization.

In Bangladesh, our subscriber base showed impressive growth of 26% surpassing 25 million subscriber mark. Revenues grew 24% in local currency driven by our larger subscriber base in addition to higher level of value added services and data adoption.

Moving now to our Ukrainian business units. Revenues declined 1% year-on-year to UAH3.2 billion, driven by our ongoing transition to bundled tariff plans. The negative impact of the transition is expected to persist for the remainder of 2012 with an improving trend towards the very end of the year. Mobile revenues declined 2% mainly as a result again of the above mentioned transition to bundled tariff plans, while our fixed plan revenues increased by 10% in Ukraine.

EBITDA declined 10% to UAH1.6 billion, primarily due to lower mobile service revenues and higher interconnect costs caused by the growth of outgoing off-net mobile traffic. We also see increased operational cost mainly related to network, IT, energy, and frequency fees. We are now taking actions to improve the performance in the coming 12 months. These includes pricing initiatives to improve the mobile service revenue front and we also continue to focus on optimizing our cost base and on increased efficiency.

The Company has been so far this year successful in maintaining its subscriber market position and this coupled with the tariff and cost initiatives being implemented allows us to expect that operating performance on the Ukrainian business units will improve again in 2013.

Finally, the CIS business units. In the CIS business units we saw continued delivery of strong revenue and subscriber growth in the second quarter despite an increasingly competitive environment especially in Kazakhstan. Our revenues grew 10% year-on-year on an organic basis driven by increased penetration and strong mobile data growth, which more than offset the slowdown in voice revenues.

Fixed broadband also remains a key contributor in our organic revenue growth. EBITDA reached $182 million, up 11% on organic basis driven by a strong growth in Uzbekistan and Kyrgyzstan. EBITDA margin in the quarter declined marginally to 44.3%. However, control on operational costs provided evident improvements quarter-on-quarter. Subscriber growth in mobile was impressive in this region with an increase of 17% to 20.5 million.

Addressing two markets here, starting with Kazakhstan. In Kazakhstan, our largest CIS market we saw organic revenue growth of 4% affected by competitive environment and a limitation on tariff introduced by the regulator, which resulted in an average price per minute decline. EBITDA margin declined by 1.8 percentage points, however, EBITDA in local currency grew by 0.3%. VimpelCom protected its market position in Kazakhstan with improved ARPU trend and increased data revenues.

In Uzbekistan, our second biggest market in the CIS, revenue increased by 35%, supported by a 121% mobile data revenue growth. EBITDA margin was 50.6%, a sharp increase compared to previous years as a result of change in tariffs in the market and implementation of a cost efficiency program.

CapEx decreased by 20% in the CIS, in the second quarter of 2012 inline with our plan. The Company’s main investment projects focused on continued data development are on schedule and network expansion continues to support both traffic and revenue growth.

Now I will pass the floor to our CFO, Henk van Dalen, who will discuss the Group financials more in detail.

Henk van Dalen

Thank you, Jo. As a reminder we are presenting our results today on a pro forma basis unless otherwise noted. We believe pro forma financials provide the most meaningful comparison of financial performance for the quarter. The pro forma information presented reflects what the Company’s results of operations would have looked like had the Company’s transaction with Wind Telecom occurred on January 1, 2011.

For further details about the adjustments and assumptions of our pro forma results, please refer to VimpelCom’s press release issued on August 18, 2011 and May 14, 2012 available on our website.

The actual financial results of the second quarter of 2012 are been positive. First the pro forma financial performance in the second quarter. Total operating revenues in the quarter decreased by 4% year-on-year impacted by the unfavorable currency movements against the dollar. Overall, revenue growth on an organic basis was 4%, driven by strong performance across most business units. EBITDA increased 2% also impacted by unfavorable currency movements excluding the ForEx effects, EBITDA increased 8% compared to the same period last year, driven by double-digit organic EBITDA growth in the business units of Russia, Africa and Asia and CIS.

Overall growth was partially offset by the organic EBITDA decline of 10% in the Ukraine due to a transition to bundled tariff plans as we already mentioned. EBIT in the quarter increased 21%, positively affected as reported previously by the declining amortization pattern applied to intangible assets associated to customer relationships as part of the Wind Telecom acquisition. While the amortization of later periods is lower than the amortization in the year of acquisition.

The profit before tax increased 68% due to the higher EBIT, higher gain from our investment in Eurocent and the negative fair value adjustment on the investment in Vietnam recorded in the second quarter of 2011. In the second quarter ’12 there was a foreign exchange gain of $1 million while in the second quarter ’11 with foreign exchange loss of $6 million.

Net income increased 83% as a result of the increase in profit before tax and lower effective tax rate due to certain net operational losses included in the second quarter of ’11 which will not recognize before tax purposes.

Then to the actuals, of course all the actuals are significantly impacted by the Wind Telecom transaction that took place in April 2011, profit before tax increased 72% due to the increase in EBIT and the negative fair value adjustment on the investment in Vietnam reportedly the second quarter of ’11, which was partially offset by a 16% higher financing costs as a result of the Wind Telecom acquisition.

In the second quarter ’11 the foreign exchange loss rose to $3 million where in the second quarter ’12 was that already mentioned gain of $1 million. Net income increased as a result of the increase in profit before tax and the lower effective tax rate due to certain net operating losses incurred in the second quarter ’11 as previously mentioned.

Now to debt, cash, ratios as we normally do in every quarter as you can see on the slide, our financial position remained solid. On a consolidated basis, the actual net cash from operating activities in the second quarter was $1.35 billion. Net cash was positively impacted by the higher EBITDA, which was partially offset by higher interest and tax payments. The higher tax payments were mainly related to one-off tax payments by OTH of approximately €200 million arising from the sale of Tunisiana in 2011.

Gross debt decreased in the quarter from $28.6 billion to $26.6 billion, mainly due to ForEx movements and repayments of Ruble bank and Euro bank loans, partially refinanced by the issuance of Euro bonds. Net debt decreased to $23.1 billion, leading to a net debt to the last 12 months EBITDA of 2.4 on a pro forma basis at the end of the second quarter. So we ended the quarter with a balance of cash, cash equivalents, and deposits of $3.5 billion.

Turning to our debt maturity schedule, this remains well balanced over the coming years, it hasn’t in any material way changed in the second quarter. There is a peak in the maturity profile in 2017 caused by the Wind Italy debt, it’s meant to refinance this before that date as you know. However, this will not be completed before the end of 2013 and time will of course also depend on market circumstances. Total gross debt was $26.6 billion with an average rate of interest rate of 8.6%.

Our balance of foreign exchange exposures in gross debt remains diversified across the euro, ruble, the U.S. dollar and other currencies. And Russia we paid – prepaid a Sberbank loan of $0.3 billion and the Wind Italy we partly prepaid the Bridge loan for an amount of $0.3 billion as well. As mentioned previously, during the second quarter Wind issued a tap of the senior secured notes due 2018 for $0.07 billion to refinance existing debt and $2.5 billion uncommitted inter-company growth facility from VimpelCom to OTH was also approved by the OTH shareholders meeting which has been drawn upon only for a small amount in the quarter. Furthermore, and as you can see from the slides we have substantial undrawn committed revolving credit facilities in place for a total of $1.4 billion per June 30, 2012.

Then moving to the slides which we also always discuss to give an update on the financing structure per June 30, 2012. Taking you a little bit through the detail, the first is the block of debt related to Wind Italy that is the circle that you see on the right hand side, that’s about $13.9 billion of debt as at the end of the second quarter. That block of debt is ring fenced in the sense that it has no recourse on VimpelCom Ltd or any of the other companies in the group. So it is really on a standalone basis.

The second block of that amounted to $1.1 billion sits in the local subsidiaries of Orascom and has no recourse on the VimpelCom Group at all. And then the third block has to do with OJSC VimpelCom and VimpelCom Limited. This is the block you can see on the left hand side of the slide, totaling $11.6 billion with a portion of the debt attributed to VimpelCom Holding and a potion to OJSC VimpelCom. From a VimpelCom level also Orascom, OTH and the Weather Capital SP1 are funded with an intercompany loan.

Within this block of course the court injunction related to the first claim puts a temporary hold on up-streaming dividends or cash from OJSC VimpelCom to VimpelCom group level. Therefore at group level and of OTH we focus on available cash sources from within these operations and dividends up-streaming from the Ukraine. The cash availabilities in this block of entities are above $1 billion and this is a solid position for our operating requirements and obligations.

I will now turn the call back to Jo for his final remarks.

Jo O. Lunder

Thank you, Henk. Okay, overall I am pleased with the performance in most of our operations in the second quarter and this first half year of the value agenda 2012 to ’14. We continue to make progress on our strategic priorities while delivering solid profitable organic growth with a strong EBITDA margin of 43.2%.

On our journey to achieve the 2014 objectives, we are facing short-term challenges in some of our markets, but I believe we have a clear action plan to mitigate these. Let me address two of them. Ukraine; in Ukraine we are taking actions to improve our performance in the coming 12 months of a strong market position coupled with tariff and cost initiatives being implemented allow us to expect performance improvement in the Ukrainian business unit in 2013.

Two; in Italy. In Italy the further MTR cuts will continue to reduce the total market value over the next 18 months. For this reason we are adjusting our cost base through strong, structural OpEx measures in order to protect our margin and EBITDA level. We remain committed to the Italian market and we believe in its long-term value potential.

The summary; we are in the early stage of the implementation of our value agenda and we see many areas for improvements in our operations, that a significant upside that allowed a lot of programs on operational excellence, capital efficiency and profitable growth that will enable us to reach our main goal, increase cash flows from operations and via that create shareholder value.

With that I’ll open the floor for question and return back to operator. Operator?

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Cesar Tiron of Morgan Stanley. Please go ahead.

Cesar Tiron – Morgan Stanley & Co.

Hi, congratulations for your strong numbers. I have two questions. So the first one; in Russia you said that you are ahead of schedule to deliver the RUB5 billion synergy savings. I want to know if you’re not -- you don’t think you’re not able to exceed that, but because looking at what's disclosed in the Russian cluster it seems that most of the improvements in the Q2 comes from sales and marketing expenses, but it seems that you haven’t done much on the G&A. Is that possible to do anything in the G&A in the next quarters and possibly exceed this RUB5 billion and my second question is also on Russia. What do you think about the possible cancellation of the national roaming? Do you think this is going to happen and if it’s going to happen how do you think it will impact your business? Thank you.

Jo O. Lunder

Okay. Let’s talk about the operational excellence program first. As you rightfully pointed out we are ahead of schedule and we expect to reach at least RUB5 billion this year. We have seen clearly cost savings coming out of the recognition and commercial cost as the result of movement to revenue based commission schemes. But you should bear in mind that on G&A that the recent underlying inflation in any market also in the Russian markets, so when you look at the G&A base you should also factor that in and there is clear evidence of also improved performance on the G&A cost as part of the results that we are now presenting today.

So, I would say we are on track with our target and we might now also see a stage II of that program being launched this fall that could address other cost elements and hopefully we will be able to set new targets that to a larger extent can also go after the G&A cost base. Still we think that our cost initiatives that can be launched in Russia in through performance further, so that’s on the RUB5 billion program. On the national roaming question of your side, I think we -- it’s hard to speculate exactly what will be the outcome of that initiative.

The good news for VimpelCom is that, what we have seen so far will not influence our revenue base or earnings in any material way and we think this is more a rebalancing of the roaming regime rather than a harsher regulation that will lead to lower revenues and drop in earnings. So, we are quite comfortable with what we’ve seen so far of the initiative.

Cesar Tiron – Morgan Stanley & Co.

Thank you very much.

Operator

Our next question comes from JP Davids of Barclays. Please go ahead.

JP Davids – Barclays Capital

Thank you for the opportunity. Two questions, the first one, if the FAS and Telenor reached an agreement and evidence could resume out of Russia. Would you immediately payout the dividend that is currently suspended or might you consider some more aggressive deleveraging in the near term, i.e. showing that dividend just waiting for 2012. The second question is on Russia; you’ve sustained very strong growth levels in the top-line in the first half and indeed in the second half of ’11. Looking into the second half of ’12 are there plans in place to maintain those top-line growth levels or indeed accelerate them? Thank you.

Jo O. Lunder

Thank you very much. On your first question related to dividend, of course I understand this is of big interest and this is a Supervisory Board decision in VimpelCom and I would not like to speculate on this call today what that decision will be. I think we have to wait and see and that the Supervisory Board of VimpelCom Limited will make a decision whether to pay and the final 2011 dividend or not, and I think also they will set a record date as appropriate as part of that decision.

So, that’s the only update I can give on dividends today. And then on growth in the second half of ’12 in Russia, we remain quite optimistic and we believe we have good momentum in Russia right now. Of course we realize that that a strong second half of ’11 will make the second half of ’12 more challenging to reach. But we still believe in the growth potential in the Russian market and as I said earlier on the call, also on our opportunities going forward to further increase and improve our performance there.

JP Davids – Barclays Capital

Thank you. I appreciate that.

Jo O. Lunder

Thank you.

Operator

Our next question comes from Herve Drouet of HSBC. Please go ahead.

Herve Drouet – HSBC Investment Bank Plc

Hi, I have got two questions as well on my side. The first one is, in Ukraine could you give us a bit of, share with light with us about some specific action you think you can implement to address the margin pressure we’ve seen in Q2, and when do you think you can have an infliction point on the margin the way you can start to stabilize it and potentially may be potentially later improve it, the gain. And the second question is, in Uzbekistan I understand that one of your main competitor there got some quite big pressure from the regulator and some government agencies. Do you expect a risk to happen on VimpelCom side or do you think it’s pretty specific to that competitor? Thank you.

Jo O. Lunder

Very good, let’s address Ukraine first. Let me spend a little bit time on this question, because I think it’s important, but we share a little bit how we view that market and the situation, because the short-term pain that we have decided to take now is really an investment in our long-term market position in that market. MTS moved to bundles back in 2010 and the third plate in the market has also done adjustment to that structure. We continued with Pay As You Go tariffs probably a little bit too long and we’re planning to do a transition to bundles in a soft way and spending time on that.

Our judgment now is that in order to make sure that we have that strong market position in Ukraine in the years to come and in order to keep a brand premium in Ukraine we will not do the transition to bundle faster than what we planned in the beginning of the year and that’s why you see now the revenue is affected in this quarter and you will see them affected even more in the next quarter and probably melting into the fourth quarter and then in a period of three quarters we have done the full transition to bundle and we have done protected long-term market position and build a platform for keeping that position. So that the revenue dynamic and why we have to do this faster and more quickly, we believe it’s the best position for the company and shareholders.

And then of course as part of this we would also very much like to address the cost base because we see also in Ukraine some increased cost related to a few things on the network side. On IT we see it related to license fees and a few other things as well. So, now we are addressing these things by optimizing and headcount.

We are looking at a reduction in network site rental maintenance costs driven by an integration and reducement of sites. We are looking at the reduction in electricity costs by implementing power saving features in the networks and we’re also looking at optimization of media and advertising cost and all these needs to be balanced out, so that we’re not under investing in network and the markets and at the same time transitioning. So right now in Ukraine we are balancing all these different activities with the objective to go into ’13 with a rebalanced tariff base, a strong subscriber base and with the same strong market position we had in the beginning of this year.

So, that’s the whole dynamic and some of the cost initiatives that will take place and hopefully also will help us in the second part of the year and clearly building a platform for 2013 and beyond. When it comes to your question on Uzbekistan of course we operate in all our market in strict accordance with the local legislation and this includes Uzbekistan and we see very limited risk from the current case in Uzbekistan for our operations going forward. So, we have no information to share or disclose that indicates a high risk related to this specific example that you showed us. In fact we think that our opportunity is right now in Uzbekistan and we want to build capacity in the network and position ourselves for taking advantage of that.

Herve Drouet – HSBC Investment Bank Plc

Thank you very much.

Jo O. Lunder

Thank you.

Operator

Our next question comes from Tibor Bokor of ING. Please go ahead.

Tibor Bokor - ING

Hi, a quick follow-up on Uzbekistan. I understand that the leader of the market network has been shut down, so I would be expecting some exodus of the clients into your network. So, if you could tell us a little bit on this. Are you seeing a inflow of the clients, how much of additional clients can your network handle and if you decide to invest into more network, is this going to be a cash flow out of the group or is it going to be Uzbek based cash flow and lastly, can you pay dividends out of Uzbekistan? Thank you.

Jo O. Lunder

Yeah its clear right now that we are seeing an increase in our subscriber base in Uzbekistan, but that’s pretty obvious I think. So, the challenge right now is to make sure that we have good network load. We are implementing everything of our actions right now with respect to network and distribution channels, so that we can ensure quality and the increased demand we see in Uzbekistan also so we expect positive operational development as a result of this unfortunate situation for our friends and competitors in MTS.

When it comes to cash flows and dividend in Uzbekistan that is still an issue that needs to be resolved, so the positive cash flow generated there will remain inside Uzbekistan until we have more clarity on how we can upstream dividend from Uzbekistan, so that’s -- I don’t know whether Henk wants to add a few words on that.

Henk van Dalen

Yes, in addition to what Jo said, there are a couple of technical points but they might be manageable. But, I think one of the fundamental thing is that we have to establish that the Uzbeki business of the last two, three years has been developing in such a strong way that it is even more effective and also efficient for the group in value terms to invest the cash in Uzbekistan, because that is really also how significantly added to the strength of the operation that we have today.

Tibor Bokor - ING

Thank you, thanks for that. Quick question on Algeria. How long before -- how longer your network can sustain in a situation where you cannot put more CapEx into the network, we’re still seeing more subscriber growth and market growing, but this can't last forever. Can you comment a little bit on that?

Jo O. Lunder

First of all I think, compliments to our colleagues in both Cairo and in Algeria for being able to handle a growth like this in the circumstances that we operate under in Algeria and maybe there are some good learning’s there as well for the rest of our group how we can manage with less CapEx and maybe the networks have stronger strength to handle volumes than any of us realized before, this happened. We don’t see any immediate problems in Algeria. As we speak we are able to handle volumes. We are able to handle customers in a good way, and of course we understand that clarity on the strategic challenge we have Algeria is very important for operations.

That being said, we also think that having hurry in negotiations very often lead to a bad result. So, we believe it’s in the Company and our shareholders best interest to take the time necessary to negotiate and sit back and look whether we are satisfied with ending all those negotiations and then make a decision whether we accept it or not and at the same time try to manager operation and for that reason we have to be able to manage this without setting a firm deadline for management.

And so far they have done well and my understanding is that also in the next quarter we will handle growth and traffic without severe quality or other network problems. So, we are probably approaching a crossroad where things will start to get difficult, but as of now it looks like we are able to have quality both in operations and quality in negotiations without being in a hurry or rush. So, I am quite pleased with the way we handle those two processes in parallel.

Tibor Bokor - ING

Thank you very much.

Operator

Our next question comes from Alex Balakhnin of Goldman Sachs. Please go ahead.

Alexander Balakhnin – Goldman Sachs

Yes, good afternoon. I have two questions both are on the Russian activations. First is, are you satisfied with the quality of the network you have in Russia and the overall cost on the proposition and where do you think it stands vis-à-vis your main competitors. The reason I am asking is do you have a pricing premium which you had historically but in the same time you used to under-invest and my question really is, is it reasonable to draw a parallel between what you do now in Ukraine and what you might have to do in the next few quarters in Russia and raising your cost on proposition. My second question is on your excellence program execution. Again in Russia and basically we noticed that you still experience the pressure on your gross margin and a big chuck of the achievements are coming from SG&A. Can you specify probably the roadmap for improvement on your gross margin? And also if you were cutting the headcount, could you probably specify the management of the headcount reduction and how do you feel whether it impacts your competitiveness or not? Thanks.

Jo O. Lunder

Okay, I’ll start with the parallel you drew to Ukraine and then Henk can maybe throw some more color on the dynamic on the cost side in Russia including more pressure on the gross margin as used an example by you. Let’s, first of all I think these are two very different topics that you bundled in your question because Ukraine had already moved, competitors had already moved to bundles in Ukraine years back and we had a situation where we had to also move to bundles, so it was more a timing issue.

And we were late and right now I think we can all admit that we were too late in doing that adjustment. In Russia it’s very different. The Russian market is already on the move towards bundles, but this is happening much more in sync between the competitors and we are not late and we are not early. We are basically moving with the flow and adjusting our tariff structure to that movement to bundle. So it’s not an equal example.

The second part of your question that related to price premium and quality of the network I think if you analyze the average price per minute now, but the gap from VimpelCom to competitor is much lower than what it used to be. So in a way we have closed that premium gap and by the way average price per minute becomes less and less relevant as well when the transition to bundle to happens. So, I am not too concerned about the average price per minute and the perceived price premium either.

The third part of your question is the quality of the network. And here I think we are very focused right now. We are investing heavily in knowledge, in skills in making sure that we are spending now our capital the right way. And we see clearly now a window because we are as you know still having a gap on base stations on 3G in Russia. And that gap I hope you will be able now to close to MTS over the next 12 to 18 months and that is I would say very good timing with also the plan with a lot of LTE in Russia.

So we're now moving both performing better in the marketplace quarter-on-quarter and at the same time we are now using the time from now until mid ’13, second part of ’13 to close the 3G gap, and at the same time invest in the infrastructure which means that we will have a good momentum when we start transitioning from 3G to 4G. So, I understand we are having a challenge on network development and quality in Russia compared to both competitors, but we have good hopes that we’re well organized and do have a good plan for addressing that over the next 12 to 18 months and at the same time hopefully deliver results as we saw today. So, we will just have to wait and see whether that scenario plays out or not.

Henk van Dalen

Yeah, and on the gross margin I think actually Jo of course had mentioned already a couple of [points about our] of influence both on the development of the gross margin but in the fact sheets that we always publish, you see that the gross margin was in a level of 70% -- was 70% around in the second quarter 2011 and it is at 69.6% in the second quarter 2012 which is in comparison to the first quarter 2012 only a very small decrease of 0.3% partially and that is the result also for a little bit different mix. We have slightly higher percentage of fixed in the mix than we had in the previous quarters that we mentioned.

So we are basically quite happy with the stabilization and further improvements over the next couple of quarters also has to come from let’s say changing the model towards distribution, managing the churn, bringing that to a lower level and in fact actually we made a further step in the second quarter with further steps that that will follow and that will over time of course also impact the service margin and the gross margin as is [important].

Alexander Balakhnin – Goldman Sachs

Thank you.

Operator

Our next question comes from Dalibor Vavruska of Citigroup London. Please go ahead.

Dalibor Vavruska – Citigroup London

Hello, good afternoon, good evening. Just a few questions if I may. One is a general question about your balance and your thinking in terms of growth versus efficiency both CapEx and OpEx. I know that you have been very successful in terms of driving the efficiency and I think many people are probably pleased with the margin progress on the consolidated level.

But at the same time when you look at the revenue from all your key businesses I think the growth rate is slightly lower this quarter than the last year it’s still good and I am not talking about the FX rate I am talking about the local growth rate. I am just wondering if you can share with us the trends I mean, I think that the current levels maybe satisfactory but how -- what is this deceleration of growth continuing whether how are you thinking about growth as opposed to the efficiency measures in all your key businesses.

And my second question would be on Italy, I understand -- I hope that the understanding is correct that you had some price increase but it wasn’t followed by competition and therefore you reversed to the price hike. So, I am just wondering if you can comment on the competitive situation in Italy. And also on your earlier comment about staying in Italy, I am wondering if you are -- if you can say that you’re going to perform assessment about the equity value of the company and besides perhaps next year at some point when the decision comes about that in a rational basis or whether you are making some commitments now upfront about staying in Italy and potentially injecting capital from the holding level into Italy in the next year? Thank you.

Jo O. Lunder

Very good, Dalibor. Okay, so basically three questions, its growth, it’s the price increase exercise in Italy and the last one is equity value versus refinancing of the group. The first one let me try to be a little more contextual there. I think if you look at the growth in the years to come, now you will see the whole industry current transitioning through voice flattening and probably decreasing messaging services decreasing and then the whole question becomes how much data growth, will we have to compensate for those two first trends. And I think this is a industry challenge how do we price data, do we price them on speed, do we price them on volume or more competition will lead to different pricing models.

But to be a little bit more specific, I think the guidance we gave on mid -- around mid single-digit revenue growth for our operations in ’12, ’13 and ’14, there is no new assessment on our side to that guidance and then we also said that we will work very hard to control our cost base and make sure that we also delivered EBITDA growth in the same mid single-digit growth territory. And I think that’s what we have done in the first half of 2012 and we hope that will continue. And this includes the challenges we see now in Ukraine and it includes also the challenges we see in the Italian market in this period.

Frankly speaking, I think probably in general for the operators growth is as big issues as maybe delivering profitability. I think there are still a lot of structural changes you can do in your OpEx base and in general how you operate other companies that that can secure profitability and earnings going forward, but the revenue growth depends a lot on how the whole data story will play out in the global and telecom universe. So that’s question number one.

When it comes to the question number two, on price reductions, I am almost tempted to go all the way back to 2005 and remind everybody that back then our competitors in Italy had €11 higher ARPU than we had and today the deviation to one of them is approximately €1 compared to €11 and to the other one less than €4. So it’s pretty clear who has been driving prices in the Italian market, for sure it’s not Wind. But the good thing is that Wind has been able during those years to move from a low price operated to a value for money operator and I think that’s why you see also 75% of the net adds in Italian markets this summer ending up with Wind.

So, we are very pleased with the team in Italy and their ability to run their business and well play the marketing game in Italy and we increased some prices, that’s right and we did not reverse those prices at all. We implemented some more what I would say eye catching promotions that was very successful during the summer and led to this increase.

So this was not a result of lowering tariffs in Italy at all and the third question you ask about equity value and the ring fenced and the fact that its [ring] $14 billion of that in Italy and you might want to analyze what the equity value in Italy is, I think its clear for me and for the team in Italy and everyone that we will do in the next period now an assessment of the optimal funding structure of the Group and part of that is also clearly to look at what is the underlying equity value of the different funding box that Henk referenced in his presentation.

So, when I added that we believe in the long-term value play in Italy, I did not preempt the discussion related to the Ring fenced in the future funding structure and corporate structure of the Group, that discussion remains to be taken and if not yet concluded.

Dalibor Vavruska – Citigroup London

Thank you. Joe, can I just very briefly follow-up on your first question’s answer. I mean, you mentioned about – you did talk about the medium plan, I mean if you want single-digit plus any single-digit growth let’s say in local currencies, I mean, you basically are going to have negative growth in Italy for some time now. The Ukraine is now getting – which is basically becoming negative as well. The Algerian growth has slow down to below mid single-digit, I mean, its too basically single – low single-digit, so I mean are you expecting – do you think that these businesses will recover within lets say, 18 months or that you can get more growth from the other businesses or how do you get to the single-digit growth for the Group?

Jo O. Lunder

Well, I think what we see now is clearly that the dollar is strengthening considerably to our operating currencies, that the good part of that is of course the developments to net debt – that net debt was reduced to $1.3 billion in the quarter as a result again of the movement on the dollar. But I think it’s very hard to speculate exactly how the dollar will develop against these different currencies, Dalibor. Its ...

Dalibor Vavruska – Citigroup London

But even if you look at the average local currency, I think its now above 4%, but its going down, and if its 2% or 3% maybe it is with the trend continuing with 3% for the Group in – excluding the FX impact. I’m just wondering is that something you would be happy with or is that …?

Henk van Dalen

I think its clear Dalibor. Henk, speaking here, of course that – certainly for the next 12 months to 18 months the MTR growth in Italy will have of course an impact from on the total Group organic growth. On the other hand, if you look at how our Italian business performs excluding that MTR cut, then after that FX has been kind of out of the equation you see a very solid and sound development in that business that is also taking market share in the market.

We’re looking at organic growth rates in Russia, revenue growth rates in Pakistan, in Bangladesh, there are in Uzbekistan, there are considerable Algeria, even with the restrictions that the Algerian business as it is still showing good moment in growth. So that we’re able to also resolve some of those restrictions over the period. The comments we already mentioned that we will certainly be in addition and mentioned earlier the current situation on the Ukraine, we expect to return back to growth again within the next 12 months.

So in that context I think the statements that Joe made and that we made earlier as a Group around mid single-digit is still a valid statement and yeah, around mid single-digit is around 5%, so that can be round off plus or minus 1% on the 5%, on an organic basis.

Dalibor Vavruska – Citigroup London

Thank you very much.

Operator

Our next question comes from Igor Semenov with Deutsche Bank. Please go ahead.

Igor Semenov - Deutsche Bank

Yes, hi. Thank you very much. First, I wanted to follow-up on the – (indiscernible) question about headcount, he was asking about the Russian headcount plans, can you elaborate a little bit more on that area? And secondly, a question on the Russian fixed broadband dynamics, its clear that the net additions have slowed quite considerably, can you comment whether this is a general market slowing down, so significantly or whether there is something then on with your particular – with this particular segment of your company and this is nothing to do with the sector growth? Thank you.

Jo O. Lunder

Okay. Okay Igor, headcount first in Russia, there are basically two baskets here and the first one is when we outsource functions and I think you will see a trend towards increased outsourcing concepts in Russia, whether it is network operations or it is customer service or a function like that. So, you might see headcount reduction as a result of streamlining the business processes through outsourcing concepts, the other one is of course to general headcount reduction in the organization when we improve business processes and ask ourselves whether we are organized the right way. Part of the headcount reduction, we will also of course come out of exercises like that and I don’t want to quantify or time exactly how this will play out, but we’re working along both those dimensions. And then when it comes to fixed broadband, we believe that this market now has reached a point where investments in further subscriber base growth is not really paying back in a reasonable time and for us the reasonable time is 3-year plus. And for this reason we have decided not to concentrate on development of existing subscriber instead of on profitable acquisitions and on profitable growth and that’s why we’re growing below market in subscribers. But as I said, this is part of our main strategy. We focus on increasing the cash flows and create values instead of satisfying on certain selected KPIs that we don’t believe is supporting best.

Igor Semenov - Deutsche Bank

Okay. Thanks very much. And just on the headcount, I mean, do you – I guess, part of this is network maintenance or a significant part of this is network maintenance, employees, this is presumably without any adverse impact on the network quality?

Jo O. Lunder

That’s (indiscernible) …

Igor Semenov - Deutsche Bank

Still a question, but …

Jo O. Lunder

No, no of course this is very, very important. But the good thing is that we have a lot experience from network slopes and outsourcing of network operations from shareholders, from our own experience. I think we have a good knowledge base on what to look for and how to organize this outsourcing processes, and we feel very comfortable it’s not coming from the long-term quality, but the yield higher cash flows.

Igor Semenov - Deutsche Bank

Thanks very much.

Operator

I would now like to turn the conference back over to Mr. Joe Lunder for any closing remarks.

Jo O. Lunder

Okay. Thank you very much. Thank you everybody for taking the time this afternoon and morning in the U.S. We are as I said, pleased with the results and we hope that we will be able to execute on our plans and I appreciate your time and all the good questions. And as always, we have a strong IR team here in Amsterdam and sitting waiting for follow-up questions and of course also I hope to get around and see some of you in the next months to come. So with that I suggest that we close this call and move on. Thank you very much.

Operator

Ladies and Gentlemen this does conclude today’s conference. You may all disconnect and have a wonderful day.

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