(GOLDEN TELECOM INC. GLOBE WATERMARK)
ACCESS GRANTED
A WORLD WITHOUT BARRIERS Golden Telecom Inc. ANNUAL REPORT 2005
(GOLDEN TELECOM LOGO)
(GOLDEN TELECOM INC. GLOBE WATERMARK)
(GOLDEN TELECOM LOGO)
(GOLDEN TELECOM INC. GLOBE WATERMARK)
CONTENT:
Chairman's Letter to Shareholders 02 - 03
Report from the Chief Executive Officer 04 - 10
Financial Performance 11
Business and Corporate Services 12 - 13
Carrier and Operator Services 14 - 15
Consumer Internet Services 16 - 17
Mobile Services 18 - 19
Board of Directors 20 - 21
Financial review 22 - 83
(GOLDEN TELECOM INC. GLOBE WATERMARK)
02-03
WE CHOSE "ACCESS GRANTED" AND "WORLD WITHOUT BARRIERS" AS THE THEMES FOR THIS
YEAR'S ANNUAL REPORT TO SHAREHOLDERS. WE BELIEVE THAT THESE THEMES REFLECT THE
MAJOR NEW CAPABILITY WE OBTAINED DURING 2005 AS A RESULT OF RECEIVING OUR
LICENSE TO PROVIDE INTERNATIONAL AND LONG-DISTANCE SERVICES ON OUR OWN NETWORK.
OVER THE YEARS, GOLDEN TELECOM HAS BECOME A LEADER IN THE RUSSIAN
TELECOMMUNICATIONS INDUSTRY AND CONTINUES ITS FIRM DEVELOPMENT AS THE NUMBER
ONE NATIONAL FULL SERVICES TELECOM OPERATOR IN THE CIS. WE HAVE IMPORTANT
REGIONAL OPERATIONS IN RUSSIA, UKRAINE, UZBEKISTAN, AND KAZAKHSTAN, AND A STRONG
PORTFOLIO OF SERVICES THAT INCLUDES VOICE, DATA, DIAL-UP AND BROADBAND INTERNET,
AND MOBILE TELECOMMUNICATIONS.
(GOLDEN TELECOM INC. LOGO) ANNUAL REPORT 2005
Chairman's Letter to Shareholders
UNPRECEDENTED ACCESS
IN A LANDMARK YEAR
DEAR SHAREHOLDERS:
By the end of 2005, Golden Telecom had largely completed construction of its own
Federal Transit Network ("FTN") in accordance with the provisions of the new
license. With these developments, we have been granted access to the entire
Russian Federation as a market for long-distance and international services. Our
FTN allows us to expand our addressable market within Russia and it allows us to
connect in and out of Russia on our own network. In short, Golden Telecom is at
a landmark stage in its development. We will immediately leverage this
opportunity to broaden the geographic range of our business base and to
penetrate new market segments. The new license provides the foundation we need
to make Golden Telecom the leading telecommunications operator in Russia and the
Commonwealth of Independent States ("CIS"), and I am confident we will make
rapid progress in achieving our objective.
Over the years, Golden Telecom has become a leader in the Russian
telecommunications industry and continues its firm development as the number one
national full service telecom operator in the CIS. We have important regional
operations in Russia, Ukraine, Uzbekistan, and Kazakhstan, and a strong
portfolio of services that includes voice, data, dial-up and broadband Internet,
and mobile telecommunications. We carry traffic for other carriers and we
operate a thriving call center business offering a full array of services to
major business customers that need reliable communications across multiple sites
and users. Golden Telecom's fiber optic project opens up exciting opportunities
for the development of broadband service offerings for customers. The Company
expects to become Russia's leading provider of broadband Internet access to
consumers and businesses. Golden Telecom will further develop its broadband
strategy to take advantage of the growing demand for broadband in Russia. These
achievements clearly demonstrate our ability to identify and serve customer
needs, to successfully build strong and appealing brands across our portfolio,
and to create dynamic regional businesses.
The opportunities of liberalization
Russia continues to liberalize its telecommunications market and in 2005 there
were major regulatory changes. The new rules and regulations that were adopted
on March 28, 2005 and came into effect on January 1, 2006 transformed our
industry by stimulating more competition, which in turn will benefit customers.
The new interconnection requirements affect numbering capacity, network design,
use of radio frequency spectrum and traffic routing. Since January 1, 2006
Russian incumbent operators have been obliged to provide equal interconnection
and traffic routing for all operators, including incumbent affiliated companies.
There must now be non-discriminatory access to the market for all operators,
including both incumbent operators and independent operators such as Golden
Telecom. The rules also specify that prices charged by incumbent operators for
interconnection and traffic routing are subject to government regulation.
Golden Telecom views all these developments positively as we remain focused on
our customers and we already have wider network coverage than our alternative
operator competitors. We have always developed our business in a way that allows
us to take full advantage of deregulation. We anticipated that Golden Telecom
would be granted increasing access to customers, and we are now taking advantage
of these opportunities to continue to expand Golden Telecom as a world-class
telecommunications brand. We are ideally qualified to compete successfully in
the newly liberalized market places in Russia, Ukraine, and other countries in
the CIS.
Separate roles for our CEO and President
In addition to the major regulatory moves in 2005, Golden Telecom decided to
separate the roles of Chief Executive Officer and President during the year.
Jean-Pierre Vandromme was appointed Chief Executive Officer effective September
1, 2005 with responsibility for all operational issues. Alexander Vinogradov
remained as President and will coordinate Golden Telecom's government relations,
regulatory requirements, and regional expansion.
We warmly welcome Mr. Vandromme and his extensive expertise. The Board is
confident that Mr. Vandromme's extensive background in telecommunications and
his proven track record at the cutting edge of our industry will ensure that
Golden Telecom achieves its vision of being the leading telecommunications
provider for its business and Internet customers.
The changes in Russia's telecommunications industry, as well as our strengthened
management team, provide an excellent foundation for future consolidation and
growth and creating shareholder value.
PETR AVEN /s/ PETR AVEN
Chairman,
Board of Directors
Golden Telecom, Inc.
(GOLDEN TELECOM INC. GLOBE WATERMARK)
GOLDEN TELECOM ACHIEVED RECORD RESULTS FOR THE YEAR ENDING DECEMBER 31, 2005. WE
DEMONSTRATED STRONG GROWTH IN OUR MAIN LINES OF BUSINESS AS WELL AS CONTINUED
GROWTH IN OVERALL CONSOLIDATED REVENUES, OPERATING INCOME, AND NET INCOME. THIS
IMPRESSIVE PERFORMANCE MEANS WE HAVE NOW HAD SIX SUCCESSIVE YEARS OF GROWTH.
DURING 2005 WE ESTABLISHED A COMPREHENSIVE TWO-FOLD STRATEGY THAT WILL SEE US
LEVERAGE CURRENT AND FUTURE BUSINESS OPPORTUNITIES AND PAVE THE WAY FOR
CONTINUING SUCCESS: SHORT-TO-MID-TERM: UTILIZE OUR LONG DISTANCE LICENSE AND
DEPLOY FTN. MID-TO-LONG-TERM: DEVELOP BROADBAND ACCESS.
(GOLDEN TELECOM INC. LOGO) ANNUAL REPORT 2005
Report from the Chief Executive Officer
GOLDEN TELECOM ACHIEVES RECORD RESULTS AND
GAINS ACCESS TO A NEW ERA OF GROWTH
Golden Telecom achieved record results for the year ending December 31, 2005. We
demonstrated strong growth in our main lines of business as well as continued
growth in overall consolidated revenues, operating income, and net income. This
impressive performance means we have now had six successive years of growth.
The Company's consolidated revenues rose 14% to US$667.4 million compared to
US$584.0 million in the financial year ended December 31, 2004. Golden Telecom's
net income rose 17% in 2005 to US$76.1 million from US$64.8 million in 2004.
Golden Telecom continues to maintain a healthy cash balance. In 2005, our cash
flow from operations allowed us to pay US$29.1 million in cash dividends to our
common shareholders, spend US$18.1 million on acquisitions funded by cash, and
apply US$118.2 million toward the purchase of fixed and intangible assets. With
virtually no long-term or short-term debt and strong cash flows, Golden Telecom
is in an excellent financial position, and continues to be well positioned to
take advantage of future opportunities. In 2005, we were able to implement our
Federal Transit Network ("FTN") in compliance with the Russian
telecommunications rules and regulations that came into force on January 1,
2006, and in compliance with the Company's Russian long distance license
obtained in 2005.
Our FTN and our new license transform our business prospects through greater
access to infrastructure and potential customers. Our acquisitions are also
boosting our network's strengths and our geographic reach. We now have greater
access - in terms of geography and market segments - than at any time in our
history. Not only do we have greater access but we also have the requisite
knowledge and skills to fully exploit these new opportunities. We expect to
pursue such opportunities to benefit our shareholders and our customers. Given
our strong market-oriented culture and our track record of high quality service
offerings, we are confident that we will quickly leverage the business potential
of the new environment in which we are operating. The developments of 2005
assist our regional ambitions enormously and grant us true access to a world
without borders. For telecommunications users in all our markets, Golden Telecom
will increasingly become the provider of choice, setting new benchmarks in
service, technology and price.
Our Strategy
Golden Telecom's ultimate aim is to be the leading telecommunications operator
in Russia and the Commonwealth of Independent States ("CIS"). During the next
few years, Golden Telecom will be one of a very small number of operators in the
Russian market to be able to provide international and domestic long-distance,
as well as intercity services, to all types of customers.
During 2005 we established a comprehensive two-fold strategy that will see us
leverage current and future business opportunities and pave the way for
continuing success:
SHORT-TO-MID-TERM: Utilize our long distance license and deploy our FTN.
MID-TO-LONG-TERM: Develop broadband access.
SHORT-TO-MID-TERM
Our FTN is an exciting new opportunity that allows us to reduce the cost of
transit and avoid the need to send traffic via incumbent operators. The network
consists of 4 international long-distance switches, as well as 7 domestic
long-distance switches and 88 access nodes - located in each constituent
territory of Russia. It allows us to expand regionally and penetrate new
markets. At a single stroke, our addressable market has increased from only 25
regions in Russia with a population of 77.1 million people to all 88 Russian
regions with a population of 143.0 million.
We will also be able to broaden our segment range by serving the promising small
and medium-sized business ("SMB") sector and the small office home office
("SOHO") segment while also increasing our presence in the consumer market. With
our FTN, we now have access to 1.3 million businesses, compared to just 0.3
million before, and 32 million existing residential customers.
The new license and the FTN also allow us to operate long-distance voice traffic
for other licensed operators, including mobile operators. This is an important
business opportunity because all operators without a long-distance license will
have to be interconnected to an FTN provider.
In addition, the incumbent operators have previously only served other carriers,
as opposed to end-users. Golden Telecom is therefore the only new license holder
with its own network that has experience in serving end-users. We believe this
experience will serve us well in securing future traffic gains.
MID-TO-LONG-TERM
Our primary focus moving forward will be on providing broadband services for
both business and consumer users. Offering broadband to consumers is an
important expansion of our successful Internet capabilities.
06-07
MID-TO-LONG-TERM
OUR PRIMARY FOCUS MOVING FORWARD WILL BE ON PROVIDING BROADBAND SERVICES FOR
BOTH BUSINESS AND CONSUMER USERS. OFFERING BROADBAND TO CONSUMERS IS AN
IMPORTANT EXPANSION OF OUR SUCCESSFUL INTERNET CAPABILITIES.
We fully understand the importance of building coherent business streams from
broadband. Total Internet Protocol ("IP") bandwidth in Russia has doubled
annually since 2003. The broadband explosion will further accelerate the demand
for bandwidth. We expect the number of broadband users in Russia will double
annually and reach 7.9 million users by 2010.
We currently serve our large corporate users with broadband by running fiber of
the buildings they occupy. Looking ahead, we anticipate a mixed broadband
delivery platform that will include wireless service offerings to address a much
wider business and consumer market with multiple products and services. Golden
Telecom is looking at many ways of delivering broadband services in the future.
As part of this strategy, we recently signed a framework agreement with Nortel
to deploy up to 5,000 Wireless Fidelity ("WiFi") access nodes in Moscow. Golden
Telecom plans to conclude testing of sample WiFi access nodes during the second
quarter of 2006. After the testing is completed, we will phase in customer
access plans throughout Moscow. The network will provide universal broadband
coverage in Moscow and will support our aim of offering universal indoor and
outdoor access to the majority of the target market of approximately 3.9 million
households in Moscow that can afford both a computer and broadband services, as
well as to almost all businesses. Our services will include Voice over IP
("VoIP") capabilities that will be packaged with the Company's Aport Internet
search engine to offer location-based search services. These broadband services
will be competitively priced and offer higher speed than many other Internet
access services currently available in Moscow.
Fiber Optic Cable Line
To facilitate the implementation of our broadband strategy and the offering of
services under our long distance license Golden Telecom has completed the
construction of our Fiber Optic Cable Line ("FOCL") from Moscow to Nizhny
Novgorod in November 2005. The line became operational in March 2006 and will
eventually run through Nizhny Novgorod to Ufa and Kazan. We plan to expand our
FOCL further from Kazan to Ekaterinburg through Naberezhnye Chelni and Perm, and
also from Ufa up to Saratov, and finally from Moscow to Krasnodar through
Rostov-on-Don. Our partner in this project is Vimpelcom. This high capacity
backbone is expected to be completed and operational in the second half of 2007.
Our acquisition of a 54% interest in ZAO Rascom ("Rascom") in 2005 complements
our FOCL development. Rascom has its own infrastructure and facilities linking
Moscow and St. Petersburg and extending to the Russian border with Finland.
These facilities provide Golden Telecom with the opportunity to expand services
that require considerable trunking capacity, such as broadband access and the
deployment of the FTN. Our intended FOCL coverage will ensure that we target
high potential regions that have a combined population of 63.4 million people
which is approximately 45% of the entire population of Russia and where the
annual fixed line market volume in terms of revenues exceeds $4.4 billion.
Growing regionally
Regional development is one of our major objectives. We are creating the right
conditions for steady organic growth, but we also intend to acquire
small-to-medium alternative carriers with coverage, clients, broadband access,
and a local loop as a means of augmenting our regional development.
Our acquisitions during the year were an integral part of the enhanced access we
have secured in all our markets. Each acquisition has delivered a specific
resource that improves our ability to access customers both today and in the
future. The October 2005 acquisition of ZAO Sochitelecom in Sochi (Krasnodar
region), for example, provides us access to smaller corporate
(GOLDEN TELECOM INC. LOGO)
I WOULD LIKE TO THANK THE ENTIRE SENIOR MANAGEMENT TEAM OF GOLDEN TELECOM FOR
THEIR HARD WORK DURING THE YEAR. I ALSO EXPRESS MY GRATITUDE TO EACH OF OUR
EMPLOYEES FOR THEIR LOYALTY AND DETERMINATION. WE WERE GRANTED ACCESS TO
UNPRECEDENTED NEW OPPORTUNITIES IN 2005. I AM CONFIDENT WE WILL EXPLOIT THE NEW
OPPORTUNITIES TO THE FULL AND SEE EVEN MORE SUCCESS IN THE FUTURE.
and residential fixed-line and broadband customers in one of the fastest growing
markets in Russia. Our acquisition of a further 60% in 000 Joint Venture
Sakhalin Telecom Limited ("Sakhalin Telecom"), in September 2005, gives us
access to a growing number of leading oil and gas multinational companies
operating in Sakhalin. We are also starting to use Sakhalin Telecom's network to
provide broadband Internet to residential customers in the region to capture the
growing demand for this service. Our goal, ultimately, is to follow our
customers and to serve their needs wherever they are in Russia or the CIS. We
believe macro-economic growth in Russia, Ukraine and the CIS will continue to
help us build and expand our client base, especially as we continue to develop
our network and services to realize our vision of being the telecommunications
leader in Russia and the CIS.
OUTLOOK
For 2006, the Company expects to grow organically, through selected
acquisitions, and through development of new product lines. The Company plans to
expand its broadband access strategy in 2006. We already have the option to
increase, as needed, the number of WiFi nodes in Moscow from 5,000 to more than
15,000. Additionally, as part of this broadband access rollout strategy, we have
installed approximately 870 DSL nodes outside Moscow with a combined capacity of
25,260 ports, of which 17,030 are already deployed. Golden Telecom will
aggressively pursue its broadband strategy and will make use of any technology
it deems appropriate to achieve its goals. In closing, I should emphasize that
Golden Telecom has entered a new era and has moved closer to achieving our goal
to be the leading telecommunications provider in Russia and the CIS. There was
clear evidence of our leadership when we were named in the Annual National
Business Excellence Awards as "Company of the Year 2005". We at Golden Telecom
are proud of this prestigious award that was presented under the patronage of
the Russian Federation's Ministry of Economic Development and Trade.
I would like to thank the entire senior management team of Golden Telecom for
their hard work during the year.
I also express my gratitude to each of our employees for their loyalty and
determination. We were granted access to unprecedented new opportunities in
2005.I am confident we will exploit the new opportunities to the full and see
even more success in the future.
JEAN-PIERRE VANDROMME
Chief Executive Officer
Golden Telecom, Inc.
/s/ JEAN-PIERRE VANDROMME
08-09
Golden Telecom's Federal Transit Network
(TRANSIT NETWORK MAP)
Golden Telecom's Long Distance ("LD") Potential Market
BEFORE AFTER
LD LICENSE DEPLOYMENT LD LICENSE DEPLOYMENT (2006 - FORECAST)
--------------------- ---------------------------------------
Coverage 25 regions Coverage 88 regions
Population 77.1 mln Population 143 mln
Share in GDP 57% Share in GDP 100%
LD Market Volume $ 1.9 bill. LD Market Volume US$ 3.3 bill.
Businesses 0.3 mln Businesses 1.3 mln
Residential -- Residential 32 mln
Source: IKS-Consulting
(TRANSIT NETWORK MAP)
10-11
Golden Telecom's
Fiber Optic Cable Line
(FIBER OPTIC CABLE LINE MAP)
Golden Telecom's Fiber Optic Cable Line ("FOCL") Regions Data
POPULATION, TOTAL REGIONAL PRODUCT FIXED LINE MARKET VALUE TOTAL TELECOM MARKET
MLN PEOPLE (US$ BILLION)(2004) (US$ BILLION)(2004) (US$ BILLION)(2004)
---------------- ---------------------- ----------------------- --------------------
Total FOCL
Regions 63.458 258 5 13
Total Russian Federation 143.500 582 8 19
44% 44% 63% 68%
Source: IKS-Consulting, Goscomstat
(GOLDEN TELECOM INC. LOGO) ANNUAL REPORT 2005
FINANCIAL
PERFORMANCE
Financial results
FOR THE YEAR ENDED DECEMBER 31,
-------------------------------
US$ MILLIONS (EXCEPT PER SHARE DATA) 2005 2004 CHANGES %
------------------------------------ ------------ ------------ ------------
Revenue $ 667.4 $ 584.0 $ 14.28
Income from operations 116.0 95.5 21.47
Net Income 76.1 64.8 17.44
Net income per share - diluted 2.08 1.77 17.51
Weighted average common shares outstanding - diluted 36.6 36.6 0.00
Purchase of property, plan and equipment and intangible assets 118.2 114.6 3.14
Cash spent on acquisitions, net of cash acquired $ 18.1 $ 15.5 16.77
Financial position
AS OF DECEMBER 31,
-----------------------------
2005 2004
------------ ------------ ------------
Total assets $ 882.2 $ 805.8 9.48
Total debt and capital leases, including current portion 4.3 4.0 7.50
Shareholders' equity $ 675.1 $ 626.4 7.77
Closing prices per share
2005 2004
----------------------------- -----------------------------
US$ HIGH LOW HIGH LOW
--- ------------ ------------ ------------ ------------
First quarter $ 30.37 $ 24.69 $ 36.63 $ 28.24
Second quarter 30.32 24.82 35.93 22.77
Third quarter 31.34 27.13 30.97 23.61
Fourth quarter 31.39 25.40 31.45 25.94
Total Revenue US$m 2002-2005
(TOTAL REVENUE BAR CHART)
2001 2002 2003 2004 2005
---- ---- ---- ---- ----
100 $140.0 $198.7 $360.5 $584.0 $667.4
Revenue per division US$m 2005
(REVENUE PER DIVISION PIE CHART)
Business and Corporate Services $387.4
Carrier and Operator Services $221.4
Consumer Internet Services $ 44.5
Mobile Services $ 14.1
12-13
(BUSINESS AND CORPORATE SERVICES WATERMARK)
OUR BUSINESS AND CORPORATE SERVICES ("BCS") DIVISION IS OUR LARGEST LINE
BUSINESS. WE PROVIDE BUSINESS AND CORPORATE SERVICES INCLUDING VOICE AND DATA
SERVICES TO SOME OF THE MOST PRESTIGIOUS CORPORATE CLIENTS IN RUSSIA AND THE
CIS. ANNUAL REVENUE FOR THE YEAR WAS US$387.4 MILLION COMPARED TO US$324.8
MILLION IN 2004, AN INCREASE OF 19% OVER THE PREVIOUS YEAR. OPERATING INCOME WAS
US$102.3 MILLION, UP 41% FROM US$72.3 MILLION IN 2004.
THIS DIVISION HAD AN EXCELLENT YEAR IN 2005 AND CONTINUED TO EXHIBIT SUSTAINED
GROWTH IN THE FACE OF STRONG COMPETITION AND A RAPIDLY CHANGING REGULATORY
ENVIRONMENT. THE SUBSTANTIAL REVENUE AND OPERATING INCOME INCREASES REFLECT
CONTINUING STRONG DEMAND FOR OUR FIXED LINE TELECOMMUNICATIONS SOLUTIONS
THROUGHOUT RUSSIA AND THE COMMONWEALTH OF INDEPENDENT STATES ("CIS"). THE
PERFORMANCE ALSO UNDERLINES THE SUCCESS OF GOLDEN TELECOM'S ONGOING STRATEGY TO
GROW MARKET SHARE THROUGH ATTRACTIVE SERVICE OFFERINGS AND A FOCUS ON CUSTOMER
CARE.
A key theme during Golden Telecom's continued expansion of its operations far
beyond Moscow and across borders. Our BCS division is now truly borderless,
providing connectivity to business and corporate customers in Russia, and across
international borders to Ukraine, Kazakhstan and Uzbekistan.
(GOLDEN TELECOM INC. LOGO) ANNUAL REPORT 2005
BUSINESS AND CORPORATE
SERVICES
Maintaining leadership
In 2005, Golden Telecom maintained its leadership in the corporate segment in
both Moscow and in Russia as a whole. Revenues increased year-on-year largely
due to continued macro-economic growth in Russia and the CIS which has
contributed to an increase in our client base as well as the continuing demand
for our telecommunications from a large number of existing customers across our
various geographic markets. Operating margins in BCS remained robust and
increased to 26% in 2005 from 22% in 2004, which reflected the demand for
high-value and high-margin services from our customers as they develop their
businesses in regions outside of the major cities of Russia and the CIS.
In Moscow, which represents over 60% of our BCS business, we now serve
approximately 70% of the large-enterprise market. We saw a continuing boom in
commercial real estate during 2005, which we have been able to translate into a
growing stream of profitable revenues from business users. We achieved this by
maintaining good relationships with real-estate developers. Golden Telecom is
also recognized as having the strongest sales team in the market for the
business and corporate solutions sector. In this regard, our Key Accounts
program launched in 2005 is expected to increase loyalty among our major
business and corporate customers. Our strategy is to maintain focus on our
existing customer base while also serving new customers in this market segment.
We also attracted new customers in 2005 by expanding into the rapidly growing
small and medium-sized business ("SMB") segment and the Small Office-Home Office
("SOHO") markets. Business from SMBs is growing quickly and we will continue to
target this segment.
In the first quarter of 2005, we signed telecom services partner agreements with
more than 21 multi-tenant business centers in Moscow. This growth continued
during the remainder of the year. In the third quarter, for example, Golden
Telecom added 25 new multi-tenant business centers and 5 new trade centers. By
year end, we had signed 105 new multi-tenant business centers and 18 new trade
centers. We also strengthened our portfolio of four-star and five-star hotels in
Moscow by signing 3 additional major international brands. Our sound track
record in the hotels sector was further underlined when Golden Telecom was named
"Best Partner" in the 2005 Moscow Hotels Management Association Automation
Awards. Golden Telecom also provided a portfolio of communications services to
the Evaluation Commission of the International Olympic Committee in March. The
number of contracts signed by the BCS division in 2005 rose by 13%, as compared
to 2004.
Call centers
We continue to provide major corporate customers with call center services and
saw significant revenue growth of 25% over 2004 in this area. Golden Telecom
opened a second site for its call center operations in November 2005 to offer
Call Processing Center ("CPC") services to corporate clients. We see excellent
growth prospects in this business and we plan to expand our CPC activities still
further to meet the strong demand in this sector.
WE ALSO BENEFITED FROM INCREASED DEMAND FOR SERVICES FROM OUR EXISTING CUSTOMERS
IN ST. PETERSBURG, NIZHNY NOVGOROD, KHABAROVSK, ARKHANGELSK, UFA, VLADIVISTOK,
IRKUTSK, EKATERINBURG, VORONEZH, KRASNODAR, TYUMEN, VOLGOGRAD, SAMARA, TULA, AND
KRASNOYARSK, AND OTHER MAJOR POPULATION CENTERS
The total number of contracts in the BCS segment increased from 162,728
contracts at year-end 2004 to 184,206 at year-end 2005
14-15
(CARRIER AND OPERATOR SERVICES WATERMARK)
(GOLDEN TELECOM INC. LOGO) ANNUAL REPORT 2005
CARRIER AND OPERATOR
SERVICES
OUR CARRIER AND OPERATOR SERVICES ("COS") DIVISION IS A WHOLESALE PROVIDER OF
VOICE, DATA AND INTERNET SERVICES TO FOREIGN AND RUSSIAN TELECOMMUNICATIONS AND
MOBILE OPERATORS. ANNUAL REVENUE FOR THE YEAR WAS US$221.4 MILLION, AN INCREASE
OF 11% OVER THE US$198.9 OF THE PREVIOUS YEAR.
Our ability to deliver services across the Russian regions and across
international borders is important to customers of our COS division. We are
transmitting an increased volume of international and domestic
telecommunications, data and Internet traffic for other international and
domestic operators. When our customers partner with Golden Telecom, they choose
a company with a presence not just in Russia, but in other countries in the
Commonwealth of Independent States ("CIS"). They also understand that Golden
Telecom is committed to building its regional operations This provides a
platform for a long-term business relationships. Our wholesale customers realize
that Golden Telecom's borderless world is helping to shape a mutually prosperous
future.
Growth of wholesale traffic
The increase in COS revenues was due to the expansion of our operations with
existing partners and the addition of new carriers in the regions as we continue
to expand the number of available destinations where we land our traffic. The
growth in revenues also reflects the higher volume of traffic from existing and
new customers. Our revenues from transmission of international traffic in Russia
increased as we carried more traffic that terminated in CIS countries.
Expansion, new carriers, and higher volumes
The total customer contracts in COS increased by 13% at year-end 2005, compared
to year-end 2004. The 2005 liberalization of the long-distance market will
provide Golden Telecom more opportunities by allowing local operators to
conclude traffic exchange agreements with us as a licensed long distance
carrier. We see our Federal Transit Network ("FTN") as a major resource for
serving our COS customers.
(CONSUMER INTERNET SERVICES WATERMARK)
16-17
OUR CONSUMER INTERNET SERVICES DIVISION SERVES CUSTOMERS ACROSS RUSSIA,
KAZAKHSTAN AND UZBEKISTAN THROUGH OUR BRAND ROL, AND IN UKRAINE THROUGH
SVIT-ON-LINE. SERVICES ARE PROVIDED MAINLY THROUGH DIAL-UP INTERNET, WITH
PRE-PAID USAGE CARDS OFFERED IN ECONOMICALLY VIABLE AREAS. AS OF DECEMBER 2005,
ROL AND SVIT-ON-LINE WERE AVAILABLE AT MORE THAN 17,000 POINTS OF SALE. GOLDEN
TELECOM IS NOW LOOKING TO PROVIDE HIGH QUALITY BROADBAND INTERNET SERVICES TO
CONSUMERS IN ALL ITS MARKETS.
(GOLDEN TELECOM INC. LOGO) ANNUAL REPORT 2005
CONSUMER INTERNET SERVICES
WHEN GOLDEN TELECOM SHOWCASES ITS ABILITY TO DELIVER BORDERLESS COMMUNICATIONS,
OUR TRACK RECORD IN THE INTERNET COMES TO THE FORE. FOR OVER A DECADE, ROL HAS
BEEN ACKNOWLEDGED AS THE NATIONAL LEADER IN PROVIDING INTERNET ACCESS, OFFERING
SERVICES THROUGHOUT RUSSIA. OUR INTERNET SERVICES CROSS INTERNATIONAL BORDERS.
ROL'S DIAL-UP SERVICES ARE THE ONLY WAY MANY PEOPLE HAVE ACCESS TO THE
BORDERLESS ONLINE WORLD.
Golden Telecom is pushing Internet its vision of a borderless online world
aggressively forward in 2006 and beyond. In the next year, we plan to pursue
vigorous expansion of our broadband access strategy with a focus on the consumer
market. Golden Telecom's broadband access strategy will bring the borderless
world of the Internet to more people in Russia and other countries in the
Commonwealth of Independent States ("CIS") than ever before.
Serving the dial-up market
The Consumer Internet Services division operated in a very competitive
environment during 2005 but still succeeded in increasing the number of dial-up
Internet access points from 413,351 at December 31, 2004 to 422,480 to December
31, 2005.
The division's flagship brand - ROL - is Russia's largest dial-up Internet
provider and is the umbrella under which we are consolidating our other acquired
brands. Moscow and St. Petersburg remain our main dial-up markets and Golden
Telecom held a market share among Internet users at year end of more than 50%.
ROL has helped the Internet become a lifestyle, a basis of prosperity, and an
inexhaustible source of knowledge for many Internet users. It has helped the
Internet become a part of everyday life for many people in Russia and elsewhere
in the CIS.
Our broadband strategy
The broadband opportunity is enormous and Golden Telecom has a comprehensive
broadband strategy that we believe will enjoy significant success. Golden
Telecom has to date focused its broadband offering on the corporate sector where
it is the leading provider of leased-line Internet services to corporate
customers. We are now turning our attention to meeting the demand for broadband
among millions of consumers. We have already combined our consumer dial-up and
consumer broadband Internet businesses into one business unit.
Golden Telecom has adopted a strategy of providing wireless Internet in major
cities. We continue to test new technologies that will benefit customers and
allow Golden Telecom to strengthen its leading position in the consumer Internet
market as well as to up-sell the existing dial-up customer base. A recent
example of this is Golden Telecom's pilot program in Moscow of Wireless Fidelity
("WiFi") - major wireless solutions for delivering broadband to customers. This
project follows the cutting-edge examples set by Google, Earthlink and others
that have built WiFi municipal networks in San Francisco, Philadelphia, Miami,
Minneapolis, Taipei, London and many other cities.
Golden Telecom is exploring opportunities to use WiFi in other cities such as
St. Petersburg, Nizhny Novgorod, and elsewhere in Russia where the Company
expects the highest potential demand for these types of products and
technologies. For example, we have already deployed some 870 Digital Subscriber
Line ("DSL") nodes outside Moscow with a combined capacity of 25,260 ports, of
which 17,030 are already deployed.
Golden Telecom is pursuing its broadband strategy aggressively with the ultimate
aim of providing high quality broadband Internet services to consumers in all of
our markets.
18-19
(MOBILE SERVICES WATERMARK)
(GOLDEN TELECOM INC. LOGO) ANNUAL REPORT 2005
MOBILE SERVICES
OUR MOBILE SERVICES DIVISION COVERS A POPULATION OF OVER 3.6 MILLION
THROUGH ITS CELLULAR NETWORK IN UKRAINE. GOLDEN TELECOM WAS THE FIRST
GSM OPERATOR IN UKRAINE AND IN 2006 WILL CELEBRATE 10 YEARS OF
OPERATIONS IN THIS MARKET. ANNUAL REVENUE FOR THE YEAR FROM OUR MOBILE
SERVICES WAS US$14.1 MILLION, A DECREASE OF 11% OVER THE PREVIOUS YEAR.
OPERATING INCOME WAS US$3.5 MILLION, A 26% DECREASE OVER 2004.
For 10 years we have ensured our customers in Ukraine have full access in
conjunction with the freedom of mobile telephony. This is another aspect of the
borderless world of communications that we provide.
Our overall strategy is to develop the mobile business as a value-added
service in conjunction with our fixed line business in Kiev and Odessa.
We are targeting premium private customers and high-revenue business
customers who are already our wireline subscribers.
The division's performance is in line with management's expectations of
maintaining a profitable line of business, with minimal capital
expenditure. The business primarily offers services to our existing BCS
customers in Ukraine.
20-21
BOARD OF DIRECTORS
Petr Aven David Herman Kjell Johnsen
Alfa Bank, President GOLDEN TELECOM, INC. Telenor Networks, Vice President
Member of the Board
GOLDEN TELECOM, INC. Audit Committee, Chairman GOLDEN TELECOM, INC.
Chairman of the Board Compensation Committee, Chairman Member of the Board
Nominating and Corporate Nominating and Corporate Governance Executive Committee, Chairman
Governance Committee Member Committee, Chairman Compensation Committee Member
Nominating and Corporate
Governance Committee Member
Michael Calvey Oleg Malis Alexey Khudyakov
Baring Vostok Capital Partners, Altimo, Senior Vice-President Altimo, Vice President
Co-Managing Partner
Baring Private Equity Partners GOLDEN TELECOM, INC. GOLDEN TELECOM, INC.
Limited, Senior Partner Member of the Board Member of the Board
Executive Committee Member Compensation Committee Member
GOLDEN TELECOM, INC.
Member of the Board
Audit Committee Member
Nominating and Corporate
Governance Committee Member
Executive Committee Member
(GOLDEN TELECOM INC. LOGO) ANNUAL REPORT 2005
Jan Thygesen Dmitry Korol
Telenor Central and Eastern Europe, GOLDEN TELECOM, INC.
Executive Vice President Member of the Board
Telenor Nordic Mobile, CEO
GOLDEN TELECOM, INC.
Member of the Board
Vladimir Androsik Vladimir Bulgak
OAO Svyazinvest, GOLDEN TELECOM, INC.
Advisor to the General Director Member of the Board
GOLDEN TELECOM, INC.
Member of the Board
22-23
FINANCIAL REVIEW
Selected Financial Data 23
Management's Discussion and Analysis
of Financial Condition and Results of Operations 25 - 50
Report of Independent Registered
Public Accounting Firm 51
Consolidated Balance Sheets
as of December 31, 2004 and 2005 52 - 53
Consolidated Statements of Operations for the
years ended December 31, 2003, 2004 and 2005 54
Consolidated Statements of Cash Flows for the
years ended December 31, 2003, 2004 and 2005 55
Consolidated Statements of Shareholders' Equity
for the years ended December 31, 2003, 2004 and 2005 56
Notes to Consolidated
Financial Statements 57 - 81
Management's Report
on Internal Control over Financial Reporting 82
Report of Independent Registered
Public Accounting Firm 83
(GOLDEN TELECOM INC. LOGO) ANNUAL REPORT 2005
Selected Financial Data
The following selected historical consolidated financial data at December 31,
2001, 2002, 2003, 2004 and 2005, and for all of the years presented are derived
from consolidated financial statements of Golden Telecom, Inc. (the "Company")
which have been audited by Ernst & Young (CIS) Limited and Ernst & Young LLC,
independent registered public accounting firms.
The data should be read in conjunction with the consolidated financial
statements, related notes, and other financial information included in this
document.
FOR THE YEARS ENDED DECEMBER 31,
------------------------------------------------------------------
US$'000S (EXCEPT PER SHARE DATA) 2001 2002 2003 2004 2005
-------------------------------- ---------- ---------- ---------- ---------- ----------
STATEMENT OF OPERATIONS DATA:
Revenues $ 140,038 $ 198,727 $ 360,534 $ 583,978 $ 667,379
Cost of revenues (excluding depreciation and amortization) 63,685 91,189 181,085 300,588 347,532
Gross margin 76,353 107,538 179,449 283,390 319,847
Selling, general and administrative
(excluding depreciation and amortization) 48,935 46,147 64,384 112,855 119,890
Depreciation and amortization 41,398 29,961 45,334 74,999 84,015
Impairment charge 31,291 -- -- -- --
Income (loss) from operations (45,271) 31,430 69,731 95,536 115,942
Equity in earnings of ventures 8,155 4,375 4,687 278 460
Interest income (expense), net 777 (667) (872) 559 1,677
Foreign currency gain (loss) (647) (1,174) (232) 660 (1,212)
Minority interest 117 527 480 1,506 2,978
Provision for income taxes 1,902 4,627 17,399 30,744 37,816
Net income (loss) before cumulative effect
of change in accounting principle (39,005) 28,810 55,435 64,783 76,073
Cumulative effect of change in accounting principle -- 974 -- -- --
Net income (loss) (39,005) 29,784 55,435 64,783 76,073
Net income (loss) per share before cumulative effect
of change in accounting principle - basic (1.65) 1.20 1.95 1.79 2.09
Cumulative effect of change in accounting principle -- 0.04 -- -- --
Net income (loss) per share - basic (1.65) 1.24 1.95 1.79 2.09
Weighted average shares - basic 23,605 24,102 28,468 36,226 36,378
Net income (loss) per share before cumulative effect
of change in accounting principle - diluted (1.65) 1.17 1.90 1.77 2.08
Cumulative effect of change in accounting principle -- 0.04 -- -- --
Net income (loss) per share - diluted (1.65) 1.21 1.90 1.77 2.08
Weighted average shares - diluted 23,605 24,517 29,107 36,553 36,605
Cash dividends per common share -- -- -- 0.80 0.80
24-25
AT DECEMBER 31,
--------------------------------------------------------------
US$'000s 2001 2002 2003 2004 2005
-------- ---------- ---------- ---------- ---------- ----------
BALANCE SHEET DATA:
Cash and cash equivalents $ 37,404 $ 59,625 $ 65,180 $ 53,699 $ 67,176
Investments available for sale 8,976 -- -- -- --
Property and equipment, net 98,590 166,121 283,110 347,891 407,907
Investments in and advances to ventures 45,981 721 251 742 10,889
Goodwill and intangible assets, net 57,146 127,669 248,843 247,570 243,129
Total assets 300,384 435,810 729,226 805,768 882,211
Long-term debt, including long-term capital lease obligations 10,733 29,732 3,963 1,738 2,367
Minority interest 5,967 2,187 2,722 11,738 19,693
Shareholders' equity 224,892 311,506 584,279 626,381 675,103
Refer to Note 5 to the Consolidated Financial Statements for descriptions of
recent acquisitions that impact the comparability of financial information.
Other less recent business combinations and information not disclosed in the
footnotes were as follows:
In June 2001, the Company acquired Internet service provider ("ISP") ZAO
Cityline ("Cityline"), 51% of ISP OOO Uralrelcom ("Uralrelcom") and
infrastructure company ZAO First Telecommunications Company ("PTK") for cash
consideration of approximately $29.0 million, including $6.0 million that was
held in escrow.
In September 2001, the Company acquired 51% of Agency for Business
Communications ("ADS"), a competitive local exchange carrier operating primarily
in Nizhny Novgorod, for cash consideration of approximately $2.9 million. The
impact of this acquisition was not material.
The results of operations of Cityline, Uralrelcom and PTK have been included in
the Company's consolidated operations since June 1, 2001. The results of
operations of ADS have been included in the Company's consolidated operations
since September 1, 2001.
In August 2002, the Company acquired approximately 31% of Golden Telecom
(Ukraine) ("GTU") for cash consideration of approximately $5.2 million,
including $3.7 million recorded as a liability, net of $0.3 million discount,
determined at the rate of 6.11%. The acquisition was accounted for as a purchase
business combination under US GAAP. The Company recorded approximately $1.8
million of contract-based customer relationship intangible assets that is
amortized over a period of approximately 5 years. There was no goodwill recorded
as a result of this transaction.
In September 2002, subsidiaries of the Company completed the acquisition of 50%
of EDN Sovintel LLC ("Sovintel") that the Company did not own from OAO
Rostelecom ("Rostelecom"), pursuant to an Ownership Interest Purchase Agreement,
dated March 13, 2002, by and among subsidiaries of the Company and Rostelecom,
bringing the Company's ownership in Sovintel to 100%. The total purchase price
of approximately $113.1 million consisted of approximately $50.7 million in the
Company's common stock, representing 4,024,067 shares, $10.0 million in cash
consideration, $46.0 million in promissory note consideration, and direct
transaction costs of approximately $7.1 million, including an investment banking
fee of approximately $3.3 million paid to an affiliate of Alfa Group Consortium,
a shareholder of the Company. Sovintel provides worldwide communications
services, principally to major hotels, business offices and mobile communication
companies through its telecommunications network in Russia. The Company began
consolidating the results of operations of Sovintel on September 17, 2002.
In June 2001, the Financial Accounting Standards Board issued Statement on
Financial Accounting Standard ("SFAS") No. 141, "Business Combinations" and No.
142, "Goodwill and Other Intangible Assets", effective for fiscal years
beginning after December 15, 2001. In accordance with SFAS No. 141 and SFAS No.
142, the Company ceased amortizing goodwill as of January 1, 2002.
In the third quarter of 2004, management determined that the Company had been
inadvertently carrying accruals for estimated taxes, other than income taxes.
Management concluded these accruals for estimated taxes should have been
considered unnecessary and reversed prior to January 1, 2000. The net effect of
the correction of this non-cash error was to reduce current liabilities and
non-current liabilities by $2.0 million each with an offsetting decrease to
accumulated deficit of $4.0 million in 2001 through 2004. This adjustment had no
effect on the reported results of operations in any of the periods presented.
(GOLDEN TELECOM INC. LOGO) ANNUAL REPORT 2005
Management's Discussion and Analysis
of Financial Condition and Results of Operations
The following discussion and analysis relates to our financial condition and
results of operations for each of the years ended December 31, 2003, 2004, and
2005. This discussion should be read in conjunction with the "Selected Financial
Data" and our Consolidated Financial Statements and the notes related thereto
appearing elsewhere in this document.
OVERVIEW
We are a leading facilities-based provider of integrated telecommunication and
Internet services in major population centers throughout Russia and other
countries of the Commonwealth of Independent States ("CIS"). We offer voice,
data and Internet services to corporations, operators and consumers using our
metropolitan overlay network in major cities throughout Russia, Ukraine,
Kazakhstan, and Uzbekistan, and via leased channels and intercity fiber optic
and satellite-based networks, including approximately 259 access points in
Russia and other countries of the CIS. In addition, we offer mobile services in
the Ukrainian cities of Kiev and Odessa.
We organize our operations into four business segments, as follows:
Business and Corporate Services ("BCS")
Using our fiber optic and satellite-based networks in and between major
metropolitan areas of Russia, Ukraine and other countries of the CIS, we provide
business and corporate services including voice and data services to corporate
clients across all geographical markets and all industry segments, other than
telecommunications operators;
Carrier and Operator Services
Using our fiber optic and satellite-based networks in and between major
metropolitan areas of Russia, Ukraine and other countries of the CIS, we provide
a range of carrier and operator service including voice and data services to
foreign and Russian telecommunications and mobile operators;
Consumer Internet Services
Using our fiber optic and satellite-based networks, we provide Internet access
to the consumer market and web content offered through a family of Internet
portals throughout Russia, Ukraine, Kazakhstan, and Uzbekistan; and
Mobile Services
Using our mobile networks in Kiev and Odessa, Ukraine, we provide mobile
services with value-added features, such as voicemail, roaming and messaging
services on a subscription and prepaid basis.
We intend, wherever possible, to offer all of our integrated telecommunication
services under the Golden Telecom brand, although, some services still carry
local brands because of recent acquisitions. Our dial-up Internet services are
distributed under the ROL brand in Russia, Kazakhstan and Uzbekistan and under
the Svit-On-Line brand in Ukraine.
Most of our revenue is derived from high-volume business customers and carriers.
Our business customers include large multi-national companies, local
enterprises, financial institutions, hotels and government agencies. We also
believe that carriers derive a portion of their business from high-volume
business customers. Thus, we believe that the majority of our ultimate end-users
are businesses that require access to highly reliable and advanced
telecommunications facilities to sustain their operations.
Traditionally, we have competed for customers on the basis of network quality,
customer service and range of services offered. In the past several years, other
telecommunications operators have also introduced high-quality services to the
segments of the business market in which we operate. Competition with these
operators is intense, and frequently results in declining prices for some of our
services, which adversely affect our revenues. In addition, some of our
competitors do not link their prices to the United States dollar ("USD") - ruble
exchange rate, so when the ruble devalues, their prices effectively become lower
in relation to our prices, which are mostly set in USD. The ruble exchange rate
with the USD has become relatively stable since early 2000 and has slightly
appreciated during the three year period ending December 31, 2005, so price
pressures associated with devaluation have eased considerably. We cannot be
certain that the exchange rate will remain stable in the future and therefore we
may experience additional price pressures.
In 2005, we continued to experience growth in our main lines of business and to
benefit from strong macro-economic growth in the markets where we operate. We
successfully
26-27
implemented our Federal Transit Network ("FTN") in 2005 to comply with the new
laws and regulations on intercity long distance services that came into effect
on January 1, 2006. Despite being faced with challenges of continued changes in
the regulatory and telecommunications environment in Russia and Ukraine, we
remained focused on developing our business through organic growth,
acquisitions, and the expansion of our services.
RECENT ACQUISITIONS
We continue to pursue consolidation opportunities through selective acquisitions
that will allow us to expand our geographical reach, add to our service
offerings, and improve our market share while maintaining operational control.
Our recent acquisitions have enabled us to realize new opportunities in major
cities in the Russian regions by increasing our customer base, increasing our
access to critical infrastructure including such as last mile, and furthering
our consumer broadband strategy in Moscow, St. Petersburg, and other cities in
Russia. Described below are our acquisitions occurring in 2004 and 2005. Refer
to note 5 in the financial statements included in this report for more details
about acquisitions occurring in 2003, 2004, and 2005.
In February 2004, we completed the acquisition of 100% ownership interest in
ST-HOLDING s.r.o. ("ST-HOLDING"), a Czech company that owns 50% plus one share
in ZAO Samara Telecom, a telecommunications service provider in Samara, Russia,
from ZAO SMARTS and individual owners for cash consideration of approximately
$4.8 million in cash.
In April 2004, we completed the acquisition of 100% of the common shares in OAO
Balticom Mobile ("Balticom") that owns 62% of ZAO WestBalt Telecom, an
alternative telecommunications operator in Kaliningrad, Russia, for cash
consideration of approximately $7.2 million.
In April 2004, we completed the acquisition of the remaining 49% ownership
interest in OOO Uralrelcom that we did not own for cash consideration of
approximately $1.0 million.
In May 2004, we completed the acquisition of 54% ownership interest in SP Buzton
("Buzton"), an alternative telecommunications operator in Uzbekistan, for cash
consideration of approximately $3.0 million.
In March 2005, we completed the acquisition of 75% ownership interest in OOO
Dicom ("Dicom"), an early-stage wireless broadband enterprise, for approximately
$0.5 million in cash. In conjunction with this acquisition, we entered into a
participants' agreement which provided the seller with a put option that, if
exercised, would require us to purchase the seller's 25% interest at fair market
value. The participants' agreement provided us with a call option that, if
exercised, would require the seller to sell after February 1, 2008, its 25%
interest in Dicom at anytime beginning after February 1, 2008, if Dicom's
valuation exceeds targeted levels by February 1, 2008.
In September 2005, we completed the acquisition of 60% of OOO Joint Venture
Sakhalin Telecom Limited ("Sakhalin Telecom"), a fixed line alternative operator
in the Far East region of Russia for approximately $5.0 million in cash. As a
result of this acquisition and combined with our previous ownership interest, we
now own 83% of Sakhalin Telecom.
In October 2005, we completed the acquisition of 100% of Antel Rascom Ltd., a
British Virgin Islands company that owns a 49% interest in ZAO Rascom
("Rascom"), for $10 million in cash. In November 2005, Antel Rascom Ltd., our
wholly owned subsidiary, acquired an additional 5% of Rascom for $1.1 million in
cash, raising our total ownership interest to 54%. Although we now have a
majority voting interest, we account for Rascom using the equity method due to
certain participating rights of minority shareholders. Rascom has infrastructure
and facilities in the Moscow and St. Petersburg regions and elsewhere in
northwest Russia.
In October 2005, we completed the acquisition of 100% of ZAO Sochitelecom
("Sochitelecom"), a fixed line alternative operator in the Krasnodar region of
Russia for a total purchase price of $3.0 million consisting of cash
consideration of $2.1 million and $0.9 million, currently recorded as a
liability, to be settled in cash upon the satisfactory achievement of certain
conditions.
In March 2005, we expensed approximately $1.0 million in external legal,
financial and consulting fees related to an acquisition opportunity that we
decided not to pursue, including advisory fees of approximately $0.1 million
paid to an affiliate of Alfa Telecom Limited, one of our significant
shareholders. In September 2005, we expensed approximately $0.8 million in
external legal, financial and consulting fees related to the previously
announced acquisition of Hudson Telecom, Inc. and its subsidiaries, which we
decided not to pursue.
REGULATORY DEVELOPMENTS
On January 1, 2004, a new Law on Communications (the "Telecommunications Law")
came into effect in Russia. While some of the supporting regulations to
implement the Telecommunications Law have not been enacted,
(GOLDEN TELECOM INC. LOGO) ANNUAL REPORT 2005
the Russian government approved in March 2005 new rules for interconnection (the
"Interconnection Rules") that became effective on January 1, 2006. These
Interconnection Rules contemplate a new three-layer interconnection system
consisting of domestic long distance / international long distance ("DLD/ILD"),
zonal, and local operators. Under this new structure, end-users will have the
right to choose a long-distance operator, and DLD/ILD operators will be required
to have interconnection points in each of the 88 constituent territories of the
Russian Federation. In addition, the Telecommunications Law created a universal
service fund ("USF") charge, which became effective May 3, 2005, calculated as
1.2% of revenue from services provided to customers, excluding interconnection
and other operators' traffic routing revenue. We have incurred approximately
$2.6 million in Russian Federation USF charges for May through December 2005.
However, on February 28, 2006, the Constitutional Court of the Russian
Federation ruled that the provisions of the Telecommunications Law relating to
the USF charge do not comply with the Constitution of the Russian Federation and
shall become null and void as of January 1, 2007, unless the Telecommunications
Law is amended prior to that date. The Constitutional Court established that
essential criteria of the charge, including the maximum rate and basis of
calculation, must be established by law and not by the government. We continue
to have regular dialogue about these current regulatory issues with the Ministry
of Information Technologies and Communications of the Russian Federation (the
"Russian Ministry of Telecommunications").
On May 31, 2005, we received a DLD/ILD license in Russia valid until May 31,
2012. We are required under the license to begin providing services and fulfil
the network requirements specified in the Interconnection Rules not later than
May 31, 2007. On January 16, 2006, we announced that the construction of our FTN
was complete in compliance with the Telecommunications Law and our DLD/ILD
license. To date, we are one of two alternative operators who have complied with
these requirements. The FTN consists of four international communications
transit nodes, seven intercity communications transit nodes deployed in each
federal district of Russia, and 88 connection points of FTN access nodes located
in each constituent territory of Russia. We have obtained the required
governmental permissions for operation of all the international and intercity
communications transit nodes that are part of the FTN. Although construction of
the 88 connection points has been completed, we are awaiting formal
commissioning by Rossvyaznadzor, a governmental body that reports to the Russian
Ministry of Telecommunications and is responsible for the control and the
supervision of information technology and communications as well as for
commissioning the long-distance networks. Additionally, we learned informally on
March 3, 2006, that codes of access to our long distance services that are part
of the approval to operate our FTN were granted. The access codes for customers
to access our services are to be "56" for our ILD service and "51" for our DLD
service. According to remarks made by the Russian Minister of
Telecommunications, we are currently one of only two alternative operators which
have begun active work under new the DLD/ILD licenses. Procedurally, once the
Ministry of Justice of the Russian Federation has registered the order of the
Russian Minister of Telecommunications to grant FTN access codes to us, that
decision will officially be published. Registration by the Ministry of Justice
is expected shortly.
On October 19, 2005, the Russian government enacted the Rules on Price
Establishment for Interconnection and Traffic Routing. These rules list
interconnection services and traffic routing services provided by the incumbent
operators that are subject to pricing regulation by the government. The
effective utilization and implementation of the Russian long distance license is
subject to and dependent upon pending establishment of tariffs for
interconnection and traffic routing services to be provided by incumbent OAO
Svyazinvest ("Svyazinvest") state-owned companies. Such tariffs are to be
established by Rossvyaznadzor, and in the absence of such regulated tariffs the
incumbent Svyazinvest companies may attempt to impose their independently
established tariffs on alternative long-distance operators. The tariffs will be
paid by long-distance operators to the incumbent Svyazinvest local and zonal
operators for each minute of long distance traffic that is carried such that all
long-distance operators will be cross-subsidizing the local and zonal network of
the Svyazinvest companies. However, to minimize the impact of such payments to
the incumbent companies, we have received licenses to provide zonal services in
all the regions of the Russian Federation, and we are developing plans to
construct zonal networks in selected regions.
We believe that our DLD/ILD license will enable us to protect our relationship
with our corporate clients and, in the long term, expand our business into the
residential long distance market. We currently anticipate that our new license
will result in an increase of DLD/ILD revenues since we will begin to earn long
distance revenue directly from end-users. In the previous system, the incumbent
Svyazinvest companies collected full tariffs for DLD/ILD calls and passed only a
portion of the revenue to the DLD/ILD operator.
28-29
However, in the near term, we do not expect significant growth in our DLD/ILD
gross margins since we will incur additional costs payable to the incumbent
Svyazinvest companies in the form of compensatory fees and other surcharges.
DLD/ILD carriers will continue to pay this compensatory fee until local tariffs
are raised to an economically viable level. This increase in local tariffs is
expected to be completed by 2008. Under the new system, the incumbent
Svyazinvest companies may also act as agents for DLD/ILD carriers, billing
clients for long distance calls and collecting payments on behalf of the DLD/ILD
operators. We are still analyzing these future DLD/ILD revenues to determine the
impact on our business and how these will be classified for segment reporting
purposes.
On March 4, 2006, the Russian President approved amendments to the
Telecommunications Law that would introduce calling party pays rules ("CPP
Rules"). Effective July 1, 2006, under the CPP Rules, all incoming calls, on
fixed and mobile lines, in Russia will be free of charge, and only the
fixed-line or mobile operators originating the call may charge the customer for
the call. Currently, subscribers of fixed-line telephones do not pay for
incoming calls and, therefore, the CPP Rules will not have an impact on
fixed-to-fixed line calls, but the CPP Rules will impact the fixed-to-mobile
calls as mobile companies traditionally charged for incoming calls in Russia.
On September 20, 2005, the National Commission for Communication's Regulation in
Ukraine issued an international license ("Ukrainian International License") to
Golden Telecom Ukraine ("GTU"). The Ukrainian International License allows GTU
to provide international telecommunications services throughout all of Ukraine,
allows the leasing of channels to third parties, and increases GTU's potential
as an international telecommunications carrier.
In February 2005, we received notice from Vimpelcom, our largest customer, that
it was diverting a volume of traffic away from our network due to their
preliminary interpretation of traffic routing regulations issued by the Russian
Ministry of Telecommunications. However, in the third quarter of 2005, Vimpelcom
traffic volumes were restored to their previous 2004 levels as a result of our
discussions with Vimpelcom and clarification from the regulatory agencies.
In June 2005, another carrier expressed its intentions to divert a portion of
its traffic from our network. This diversion of traffic resulted in a decrease
of average monthly revenues of approximately $0.9 million. We do not expect this
carrier to reduce their traffic volumes further in the foreseeable future.
However, revenues from carriers and operators are by nature volatile and can
fluctuate significantly between periods.
Early in the second quarter of 2005, GTU suffered a significant decrease in
outgoing international traffic revenue from one of our largest customers,
Ukrainian Mobile Communications ("UMC"). The loss was expected since UMC had
obtained an international carrier license in the third quarter of 2004. This
change in routing resulted in our quarterly UMC international outgoing traffic
revenues decreasing from $1.5 million in the first quarter of 2005 to negligible
amounts in the second, third, and fourth quarters of 2005. We do not anticipate
the reinstatement of this UMC revenue from outgoing international traffic since
the international carrier license allows UMC to interconnect directly with
international carriers.
OTHER DEVELOPMENTS
Prior to the second quarter of 2005, we recorded estimates for unused vacation
based on the average salary levels of our employees and total days of unused
vacation of employees. During the second quarter of 2005, we revised estimates
for unused vacation based on the actual daily salary and unused vacation of each
employee. Management determined that this methodology results in a more accurate
estimate of the amount of our obligation for unused vacation. The change in
accounting estimate decreased net income for the year ended December 31, 2005 by
approximately $1.3 million, net of tax, including the associated payroll taxes,
(equivalent to $0.04 per common share - basic and $0.04 per common share
- diluted).
During the third and fourth quarter of 2005, we incurred approximately $2.2
million in employee termination costs primarily related to the departure of our
former Chief Operating Officer, Chief Financial Officer, and other senior
employees. We may continue to incur such costs in 2006 as we continue to
streamline our operations and integrate newly acquired subsidiaries.
In September 2005, we granted stock appreciation rights ("SARs") to our Chief
Executive Officer ("CEO") with respect to 200,000 shares of our common stock, at
a share price which was the closing price of our common stock on the NASDAQ
National Market on July 19, 2005 ("CEO Granting Share Price"), which was $29.83,
one-third of which shall be and become vested and nonforfeitable on each of the
first three anniversary dates from September 1, 2005, provided the CEO remains
continuously employed by us until each such relevant date. If, prior to August
31, 2008 and during the CEO's period of employment with us, the average closing
stock price of one
(GOLDEN TELECOM INC. LOGO) ANNUAL REPORT 2005
share of our common stock on the NASDAQ National Market, or any such other
exchange on which the our common stock may then be traded, exceeds $50.00 during
any thirty day consecutive period, the CEO will be granted SARs for an
additional 200,000 shares of our common stock at the CEO Granting Share Price,
which SARs shall be fully vested upon issuance. The SARs provide for a cash only
settlement and the related obligation is recorded as a liability in the
consolidated financial statements.
In December 2005, we granted SARs with respect to 851,800 shares of our common
stock to senior management and other employees. The SARs were granted pursuant
to the Golden Telecom, Inc. 2005 Stock Appreciation Rights Plan and the EDN
Sovintel Stock Appreciation Rights Bonus Plan at a share price which is the
lower of: (i) the average between the high and low sales price per share of the
of common stock on the grant date, or in case no such sale takes place on grant
date, the last date on which a sale occurred or (ii) the average closing sales
price per share of our common stock for the fourteen trading days immediately
preceding such date, which was $26.808 ("Granting Share Price"). Seventy-five
percent of the SAR grant shall be subject to time vesting, one-third of which
shall be and become vested and nonforfeitable on each of the first three
anniversary dates from December 12, 2005, provided that the employee remains
continuously employed by the Company until each such relevant date. The Granting
Share Price shall increase by five percent on each anniversary date after
December 12, 2005, in association with the SARs that shall be and become vested
and nonforfeitable on each such anniversary date. Twenty-five percent of the
SARs granted are subject to performance vesting upon the our common stock
achieving a closing trading price of at least $50.00 per share for thirty
consecutive days as determined in the sole discretion of the Company. If the
Company's Common Stock does not achieve a closing trading price of at least
$50.00 per share for thirty consecutive days within three years of the date of
grant, such portion of the SARs shall expire by its terms and shall not be
exercisable. The aggregate number of shares of common stock which maybe issued
pursuant to the Golden Telecom, Inc. 2005 Stock Appreciation Rights Plan at the
discretion of the grantees shall be 200,000 shares. The remainder of the SARs
provides for a cash settlement. The related obligation is recorded as a
liability in the consolidated financial statements.
In July 2004, our Board of Directors adopted a Long Term Incentive Bonus Program
("LTIBP") for senior management of the Company, effective as of January 1, 2004.
In February 2006, our Board of Directors discontinued the LTIBP effective
January 1, 2005. During the year ended December 31, 2005 we did not record any
expense associated with the LTIBP. We have not granted any shares under the
LTIBP.
HIGHLIGHTS AND OUTLOOK
Since early 2000 we have witnessed a recovery in the Russian market, but
downward pricing pressures persist from increased competition and the global
trend toward lower telecommunications tariffs. In 2004 and 2005, our traffic
volume increases exceeded the reduction in tariffs on certain types of voice
traffic. This is a contributing factor to the increases in our revenue in 2004
and 2005. We expect that this trend of year over year increases in traffic
volume will continue as long as the Russian economy continues to develop at its
current pace. Although our revenue growth is strong, our overall margins
continue to be impacted by price increases for services received from
monopolistic incumbent operators.
In order to handle additional traffic volumes, we have expanded and will
continue to expand our fiber optic capacity along our heavy traffic and high
cost routes to mitigate declines in traffic margins, reduce our unit
transmission costs and ensure sufficient capacity to meet the growing demand for
data and Internet services. We expect to continue to add additional transmission
capacity, which due to its fixed cost nature can initially depress margins, but
will over time allow us to improve or maintain our margins.
We continue to follow our strategy of regional expansion. The project for the
construction of the intercity fiber optic link that we launched in the middle of
2004 has continued throughout 2005 and into 2006. At present, we are
constructing in partnership with Vimpelcom an inter-city fiberoptic link from
Moscow to Ufa through Nizhny Novgorod and Kazan. Subject to weather conditions,
we expect that this inter-city fiber optic link will be operational in the
fourth quarter of 2006. To date, this inter-city fiber optic link has been
completed from Moscow to Nizhny Novgorod and from Ufa to Almetyevsk. At present
we have laid approximately 1,255 kilometers of cable for this project; we
anticipate that the entire Moscowto Ufa inter-city fiber optic link will require
us to lay approximately 1,575 kilometers of cable. We intend to connect our
operations in the European part of Russia to this backbone network and plan to
invest a total of approximately $55.0 million to $60.0 million in this and
related backbone projects through 2007. In addition, we started construction of
the Oktyabrsky to Samara inter-city fiber optic link. At present we have laid
approximately 65 kilometers of cable for this project; we anticipate that the
entire Oktyabrsky to Samara inter-city fiber optic link will require us to lay
approximately
30-31
450 kilometers of cable. This Oktyabrsky to Samara link is part of a larger
fiber optic cable line also being constructed in partnership with Vimpelcom that
will run from Ufa to Saratov. We plan on completing this project by the end of
2007. To date, we have invested approximately $18.3 million in these projects.
The rapid growth of the telecommunications market in Russia, Ukraine, and the
CIS is fueled by macroeconomic growth and the inflow of direct foreign
investment. We anticipate that the economic growth in these markets will create
additional demand for telecommunications services. Additionally, in line with
worldwide trends, we are starting to observe new customer demands for more
sophisticated telecommunications and Internet services as well as other new
technologies. We are responding to these customer demands by testing and
implementing new technologies such as voice over Internet protocol ("VoIP"),
wireless local loop and highspeed consumer Internet. Such new technologies will
remove some of the barriers to access that some of our customers currently face.
For example, with wireless local loop, we can connect remote customers to our
network by bypassing the incumbents' wire network in order to provide higher
quality access. Our customers are willing to pay a premium for this type of
technology and customer service.
We continue to see growth opportunities organically, through select
acquisitions, and through the development of new product lines. While our
research indicates the telecommunications services sector in business segments
in the Moscow and St. Petersburg markets of fixed telecommunications services
will continue to grow, we believe that the bulk of our growth will come from key
regional cities.
We will continue to align the strategy of each of our business segments with
market forces in the countries where we operate. In BCS, our strategy is to
defend and grow our market-share through attractive service offerings supported
by excellent customer care. We are focused on expanding into the regions as well
as the fast growing small and medium-sized businesses ("SMB") and the small
office / home office ("SOHO") markets. In those cases where the potential SMB
and SOHO customer is not on our network, our ability to fully benefit from
growth in these market segments largely depends on the regulatory situation and
our ability to get access to the copper and other infrastructure of the
incumbent operators under reasonable terms and conditions.
In Carrier and Operator Services, our strategy focuses on partnering with more
operators in the regions to enhance our termination capabilities. We have also
launched additional value-added products for our carrier partners that
strengthen our leading position in the Russian and CIS markets. These new
products are designed to offer "best quality" voice and data transport to ensure
greater customer loyalty while protecting margins.
In Consumer Internet Services, we recognize that new technologies are making
their way into Russia, Ukraine, and the CIS. We expect that broadband
competition and substitution will increase in the future, and that dial-up
margins will continue to decline over time as the average revenue per subscriber
continues to decline. In response to a decline in our dial-up subscriber base in
Moscow, we are currently exploring opportunities to enter the broadband market
in Moscow and elsewhere in Russia. We currently offer consumer broadband in
selected cities such as St. Petersburg, Nizhny Novgorod, Ekaterinburg,
Krasnoyarsk, and Sochi. However, our expansion in this area is currently limited
by restrictions on our access to unbundled local loop. Therefore, we are
currently looking at alternatives to deliver quality broadband Internet services
at competitive pricing in our major markets. As part of our broadband access
strategy, we recently entered into a framework agreement with Nortel to develop
up to 5,000 WiFi access nodes in Moscow, with the possibility to increase the
number of access nodes as needed. We plan to offer universal indoor and outdoor
access to the majority of approximately 3.9 million households in Moscow. The
services to be offered will include VoIP capabilities that will be packaged with
our Aport Internet search engine to offer location-based search services. The
broadband services will be competitively priced and will offer higher speed
services than many other Internet access services currently available in Moscow.
Currently, we expect to continue testing of our WiFi access nodes in selected
areas and anticipate concluding testing during the second quarter of 2006. After
the WiFi testing is completed, we will phase-in our customer access plans
throughout Moscow. Additionally, as part of this broadband access rollout
strategy, we have deployed approximately 870 DSL nodes outside of Moscow with a
combined capacity of 25,260 ports, of which 17,030 are already deployed. We plan
to continue such development of broadband and DSL in other selected regions.
Additionally, to enhance our overall consumer Internet strategy, we have
combined both the consumer broadband and dial-up Internet businesses into one
business unit.
Our Mobile Services line of business allows us to provide additional services to
our Ukrainian wireline customers. In the future, we expect to follow a marketing
strategy aimed on attracting high revenue customers and maintaining our
corporate market share in Kiev and Odessa. However, in
(GOLDEN TELECOM INC. LOGO) ANNUAL REPORT 2005
the mass-market, whether the current level of competition requires nationwide
coverage capabilities and aggressive advertising campaigns to be successful, our
market-share and revenues will decline.
Our recently constructed FTN will also present new opportunities for growth. Our
FTN provides us with a potential customer base across all geographic zones in
the Russian Federation of up to 1.3 million businesses, 143 million people, of
which there are 32 million residential customers, in the 88 Russian regions.
This is an increase from our previous breadth of coverage which only allowed us
to reach 25 regions in Russia with a population of 77.1 million people. With the
FTN, we will be able to offer our wide range of telecommunications services,
including DLD/ILD telecommunications services, to every person and all
businesses across Russia's eleven time zones.
CRITICAL ACCOUNTING POLICIES
The fundamental objective of financial reporting is to provide useful
information that allows a reader to comprehend our business activities. To
assist that understanding, management has identified our "critical accounting
policies". These policies have the potential to have a significant impact on our
financial statements, either because of the significance of the financial
statement item to which they relate, or because they require judgment and
estimation due to the uncertainty involved in measuring, at a specific point in
time, events which are continuous in nature.
Revenue recognition policies; we recognize operating revenues as services are
rendered or as products are delivered to customers and installed. Under
multiple-delivery contracts, involving a combination of product delivery,
installation and maintenance, connection and service fees, revenues are
recognized based on the relative fair value of the respective amounts. Elements
are grouped if they are inseparable or objective evidence of fair value does not
exist. Certain revenues, such as connection and installation fees, are deferred.
We also defer direct incremental costs related to connection fees, not exceeding
the revenue deferred. Deferred revenues are subsequently recognized over the
estimated average customer lives, which are periodically reassessed by us, and
such reassessment may impact our future operating results. In determining the
recording of revenue, estimates and assumptions are required in assessing the
expected conversion of the revenue streams to cash collected.
Allowance for doubtful accounts policies; the allowance estimation process
requires management to make assumptions based on historical results, future
expectations, the economic and competitive environment, changes in the
creditworthiness of our customers, and other relevant factors. Changes in the
underlying assumptions may have a significant impact on the results of our
operations. In particular, we have certain amounts due to and from subsidiaries
of a European telecommunications operator who is currently subject to bankruptcy
proceedings. The ultimate resolution of this matter will be affected by a number
of factors including the determination of legal obligations of each party, the
course of the bankruptcy proceedings, and the enforceability of any
determinations. We have recognized provisions based on our preliminary estimate
of net exposure on the resolution of these receivables and payables. If our
assessment proves to be incorrect we may have to recognize an additional
provision of up to $1.9 million, net of tax, although management believes that
the possibility of such an adverse outcome is remote.
Long-lived asset recovery policies; this policy is in relation to long-lived
assets, consisting primarily of property and equipment and intangibles, which
comprise a significant portion of our total assets. Changes in technology or
changes in our intended use of these assets may cause the estimated period of
use or the value of these assets to change. We perform periodic internal studies
to confirm the appropriateness of estimated economic useful lives for each
category of current property and equipment. Additionally, long-lived assets,
including intangibles, are reviewed for impairment whenever events or changes in
circumstances have indicated that their carrying amounts may not be recoverable.
Estimates and assumptions used in both setting useful lives and testing for
recoverability of our long-lived assets require the exercise of management's
judgment and estimation based on certain assumptions concerning the expected
life of any asset and expected future cash flows from the use of an asset.
Goodwill and assessment of impairment; Commencing from the adoption of Statement
on Financial Accounting Standard ("SFAS") No. 142, "Goodwill and Other
Intangible Assets", on January 1, 2002, we perform goodwill impairment testing
annually as of October 1 or whenever impairment indicators exist. This test
requires a significant degree of judgment about the future events and it
includes determination of the reporting units, allocation of goodwill to the
reporting units and comparison of the fair value with the carrying amount of
each reporting unit. Based on the discounted cash flow valuations
32-33
performed in 2005, we concluded that for all reporting units the fair value is
in excess of the respective carrying amounts.
Valuation allowance for deferred tax asset; we record valuation allowances
related to tax effects of deductible temporary differences and loss carry
forwards when, in the opinion of management, it is more likely than not that the
respective tax assets will not be realized. Changes in our assessment of
probability of realization of deferred tax assets may impact our effective
income tax rate.
Business segment information; we report four segments within the
telecommunications industry: Business and Corporate Services, Carrier and
Operator Services, Consumer Internet Services and Mobile Services. A significant
portion of our cost structure, including our investment in infrastructure,
benefits multiple segments. As a result, we perform allocations of certain costs
in order to report business segment information for management and financial
reporting purposes. Applying different allocation techniques and parameters
could impact the reported results of individual business segments.
Functional currency; effective January 1, 2003, Russia is no longer considered a
hyperinflationary economy, therefore the determination of functional currency
for United States generally accepted accounting principles ("US GAAP") reporting
purposes should be based on the analysis of the underlying business transactions
for each foreign subsidiary. We have determined in accordance with the
functional currency criteria of SFAS No. 52, "Foreign Currency Translation",
that the USD should be considered the functional currency of all foreign
subsidiaries. There are subjective elements in this determination, including a
weight given to each specific criteria established by SFAS No. 52. Changes in
the underlying business transactions could lead to different functional currency
determination for a particular subsidiary, which would have an impact on its
reported financial position and results of operations.
CRITICAL ACCOUNTING ESTIMATES
Accounting estimates are an integral part of the financial statements prepared
by management and are based upon management's current judgments. Certain
accounting estimates are particularly sensitive because of their significance to
the financial statements and because of the possibility that future events
affecting them may differ markedly from management's current judgment. We
believe the following items represent such particularly sensitive accounting
estimates:
Allowance for doubtful accounts; any changes in the underlying assumptions of
recoverability of accounts receivable by respective aging group or certain
specific accounts that are excluded from the specific and general allowances
could have a material effect on our current and future results of operations. We
believe that the allowance for doubtful accounts is adequate to cover estimated
losses in our accounts receivable balances under current conditions.
Tax provisions; in the course of preparing financial statements in accordance
with US GAAP, we record potential tax loss provisions under the guidelines of
SFAS No. 5, "Accounting for Contingencies". In general SFAS No. 5 requires loss
contingencies to be recorded when they are both probable and reasonably
estimable. In addition, we record other deferred tax provisions under the
guidelines of SFAS No. 109, "Accounting for Income Taxes". Significant judgment
is required to determine when such provisions should be recorded, and when facts
and circumstances change, when such provisions should be released.
Useful lives of property and equipment and certain intangible assets; our
network assets and amortizable intangible assets are depreciated and amortized
over periods generally ranging from five to ten years. Any reduction or increase
in the estimated useful lives for a particular category of fixed assets or
intangible assets could have a material effect on our future results of
operations.
Business combinations; SFAS No. 141, "Business Combinations", requires us to
recognize the share in the assets of businesses acquired and respective
liabilities assumed based on their fair values. Our estimates of the fair value
of the identified intangible assets of businesses acquired are based on our
expectations of future results of operations of such businesses.
RECENT ACCOUNTING PRONOUNCEMENTS
Until January 1, 2006, we followed the provisions of SFAS No. 123, "Accounting
for Stock-Based Compensation," for our Equity Participation Plan and SARs Plans.
SFAS No. 123 establishes a fair value method of accounting for employee stock
options and similar equity instruments. The fair value method requires
compensation cost to be measured at the grant date based on the value of the
award and to be recognized over the service period. SFAS No. 123 generally
allowed companies to either account for stock-based compensation under the fair
value method of SFAS No. 123 or under the intrinsic value method of APB
("Accounting Principles Board") No. 25, "Accounting for Stock Issued to
(GOLDEN TELECOM INC. LOGO) ANNUAL REPORT 2005
Employees." We had elected to account for our stock-based compensation in
accordance with the provisions of APB No. 25 and present pro forma disclosures
of results of operations as if the fair value method had been adopted. The
intrinsic value of the SARs, which are classified as liability awards, and the
related compensation expense are re-measured at the end of each reporting
period.
In December 2004, the FASB issued SFAS No. 123R (revised 2004), "Share Based
Payment", which is a revision of SFAS No. 123, "Accounting for Stock-Based
Compensation" SFAS No. 123R supersedes APB No. 25, "Accounting for Stock Issued
to Employees and amends SFAS No. 95, "Statement of Cash Flows". Under SFAS No.
123R, companies must calculate and record the cost of equity instruments, such
as stock options or restricted stock, awarded to employees for services received
in the income statement; pro forma disclosure is no longer permitted. The cost
of the equity instruments is to be measured based on fair value of the
instruments on the date they are granted (with certain exceptions) and is
required to be recognized over the period during which the employees are
required to provide services in exchange for the equity instruments. In April
2005, the Securities and Exchange Commission delayed the effective date of SFAS
No. 123R until January 1, 2006 for calendar year companies.
SFAS No. 123R provides two alternatives for adoption: (1) a "modified
prospective" method in which compensation cost is recognized for all awards
granted subsequent to the effective date of this SFAS No. 123R as well as for
the unvested portion of awards outstanding as of the effective date and (2) a
"modified retrospective" method which follows the approach in the "modified
prospective" method, but also permits entities to restate prior periods to
reflect compensation cost calculated under SFAS No. 123 for pro forma amounts
disclosure. We plan to adopt SFAS No. 123R using the modified prospective
method. As we currently accounts for stock options issued to employees in
accordance with the intrinsic value method permitted under APB No. 25, no
compensation expense is recognized. We currently account for SARs by remeasuring
the intrinsic value of the SARs at each reporting period and adjust compensation
expense and the related liability for the change in intrinsic value. As of
January 1, 2006, we will account for SARs at fair value, in compliance with SFAS
No. 123R. The impact of adopting SFAS No. 123R cannot be accurately estimated at
this time, as the incremental compensation expense will depend, among other
factors, on the amount of share based awards granted in future periods. SFAS No.
123R also requires that tax benefits received in excess of compensation cost be
reclassified from an operating cash flow to a financing cash flow in the
Consolidated Statement of Cash Flows. This change in classification will reduce
net operating cash flows and increase net financing cash flows in the periods
after adoption.
In March 2005, the FASB issued FASB Interpretation No. 47 ("FIN No. 47"),
"Accounting for Conditional Assets Retirement Obligations". FIN No. 47 clarifies
that an entity must record a liability for a "conditional" asset retirement
obligation if the fair value of the obligation can be reasonably estimated. FIN
No. 47 is effective no later than the end of the fiscal year ending after
December 15, 2005. The adoption of FIN No. 47 did not have a material effect on
our financial position, results of operations, or cash flow.
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error
Corrections", which is a replacement of Accounting Principles Board Opinion No.
20, "Accounting Changes" and SFAS No. 3, "Reporting Changes in Interim Financial
Statements". SFAS No. 154 applies to all voluntary changes in accounting
principle and changes the accounting for and reporting of a change in accounting
principle. SFAS No. 154 requires retrospective application to prior periods'
financial statements of a voluntary change in accounting principle unless it is
impracticable. In addition, SFAS No. 154 requires that a change in method of
depreciation, amortization, or depletion for long-lived, non-financial assets be
accounted for as a change in accounting estimate that is effected by a change in
accounting principle. SFAS No. 154 is effective for accounting changes and
corrections of errors made in fiscal years beginning after December 15, 2005.
The impact of adopting of SFAS No. 154 cannot be accurately estimated at this
time as no such accounting changes are currently contemplated.
RESULTS OF OPERATIONS
The results of our four business segments from the operations of our
consolidated entities combined with the non-consolidated entities where we are
actively involved in the day-to-day management, are shown in note 14 "Segment
Information - Line of Business Data" to our consolidated financial statements.
In addition, revenue and costs from related parties are shown in note 13
"Related Party Transactions".
In accordance with SFAS No. 52, we have determined that the functional currency
of each foreign subsidiary is the USD, as the majority of our cash flows are
indexed to,
34-35
or denominated in USD. Through December 31, 2002, Russia had been considered to
be a highly inflationary environment. From January 1, 2003, Russia ceased to be
considered as a highly inflationary economy. As the functional currency of each
foreign subsidiary is the USD, this change did not have a material impact on our
results of operations or financial position.
According to Russian government estimates, inflation in Russia was 12% in 2003,
12% in 2004 and 11% in 2005. The Russian government expects inflation to be
approximately 10% to 11% in 2006. Although the rate of inflation has been
declining, any return to heavy and sustained inflation could lead to market
instability, new financial crises, reduction in consumer buying power and
erosion of consumer confidence.
THE DISCUSSION OF OUR RESULTS OF OPERATIONS IS ORGANIZED AS FOLLOWS:
Consolidated Results
Consolidated Results of Operations for the Year Ended December 31, 2005,
compared to the Consolidated Results of Operations for the Year Ended December
31, 2004
Consolidated Financial Position
Consolidated Financial Position at December 31, 2005, compared to Consolidated
Financial Position at December 31, 2004
Consolidated Results
Consolidated Results of Operations for the Year Ended December 31, 2004,
compared to the Consolidated Results of Operations for the Year Ended December
31, 2003
Consolidated Financial Position
Consolidated Financial Position at December 31, 2004, compared to Consolidated
Financial Position at December 31, 2003
CONSOLIDATED RESULTS
Consolidated Results of Operations for the Year Ended December 31, 2005,
Compared to the Consolidated Results of Operations for the Year Ended December
31, 2004
REVENUE
Our revenue increased by 14% to $667.4 million for the year ended December 31,
2005 from $584.0 million for the year ended December 31, 2004. The breakdown of
revenue by business group was as follows:
CONSOLIDATED REVENUE CONSOLIDATED REVENUE
-------------------- --------------------
FOR THE YEAR ENDED FOR THE YEAR ENDED
US$ MILLIONS DECEMBER 31, 2004 DECEMBER 31, 2005
------------ -------------------- --------------------
REVENUE
Business and Corporate Services $ 324.8 $ 387.4
Carrier and Operator Services 198.9 221.4
Consumer Internet Services 45.5 44.5
Mobile Services 15.8 14.1
Eliminations (1.0) --
---------------- ----------------
TOTAL $ 584.0 $ 667.4
(GOLDEN TELECOM INC. LOGO) ANNUAL REPORT 2005
Business and Corporate Services: Revenue from Business and Corporate Services
increased by 19% to $387.4 million for the year ended December 31, 2005 from
$324.8 million for the year ended December 31, 2004. Macro-economic growth in
Russia, Ukraine, and the CIS and continuing demand for our telecommunications
solutions have continued to help us increase revenue in this line of business.
Our total number of contracts in this line of business increased from 162,728 on
December 31, 2004, to 184,206 on December 31, 2005, an increase of 13%.
Revenue from the BCS division of EDN Sovintel ("Sovintel"), our largest
subsidiary, increased by 16% to $318.0 million for the year ended December 31,
2005, from $273.1 million(1) for the year ended December 31, 2004. BCS revenue
in Moscow, our largest market, increased by $23.2 million, or 10%, to $246.1
million in 2005 from $222.9 million in 2004. However, as a percentage of total
Sovintel BCS revenue, Moscow decreased from approximately 82% in 2004 to
approximately 77% of Sovintel's total BCS revenue in 2005. This decrease is the
result of the expansion of Sovintel's BCS business in the Russian regions. Our
BCS Moscow voice revenue continues to grow as we expand our client base and
comprises over half of our total BCS revenue in that market. In 2005, Moscow BCS
revenue from data and Internet services grew significantly not only due to an
increase in our customer base, but also due to increased business from existing
customers. In 2005, we experienced significant growth in our data and Internet
service offerings. Data and Internet services comprised approximately 38% of our
total billings in 2005, up from 34% in 2004. We expect our revenue from BCS
Moscow to continue to grow as we continue to experience significant investment
in the Moscow commercial real-estate market.
Our ongoing relationships with Moscow real-estate developers should enable us to
continue to grow the number of trade and business centers where we provide
services to end users. Furthermore, we have implemented a key account program in
Moscow to protect our relationships with our largest clients and to foster cross
selling. Additionally, we expect demand for call center and data center services
to continue to demonstrate strong growth in Moscow. Our revenue from call
centers and data centers increased by approximately $1.2 million, or 34%, in
between 2004 and 2005. These services now account for approximately $4.7 million
in revenue in BCS Sovintel. Refer to the table below for key operating
statistics for BCS Moscow.
Between 2004 and 2005, Sovintel regional BCS revenue increased in both absolute
terms and as a percentage of Sovintel BCS revenue. Sovintel's regional BCS
business continues to grow as we assist our customers in developing their
businesses in Russian regions outside of Moscow.
Revenue from the BCS division of GTU increased by 39% to $40.1 million for the
year ended December 31, 2005, from $28.8 million for the year ended December 31,
2004. This increase in revenue was due to a 61% increase in the number of
serviced voice lines partially resulting from growth in residential customers
and a 10% increase in the average rate per minute of use resulting from a change
in traffic mix in favor of higher-rated traffic to mobile networks.
Additionally, data and Internet revenue increased by approximately $4.3 million
due to an increase in the number of ports in service.
(in whole numbers)
BCS MOSCOW CUSTOMER STATISTICS ON DEC 31: 2004 2005 % CHANGE
----------------------------------------- ------------ ------------ ------------
Total clients 22,657 23,013 2
Business centers 686 791 15
Trade centers 50 68 36
Hotels 45 48 7
Direct inward dialing lines 116,668 127,000 9
Ethernet / Metropolitan Ethernet Network connections 1,138 1,708 50
High speed Internet active contracts 251 485 93
(1) For comparability, the amounts shown for Sovintel in 2004 include
adjustments to combine Sovintel and Comincom for the full year of 2004
since Comincom was merged into Sovintel in December 2004.
36-37
Partly offsetting these increasing factors was a 21% decrease in average
minutes of use per line per month due to more residential, SMBs, and regional
customers in the client base. In 2005, GTU began providing voice and Internet
services to residential customers and had approximately 4,000 residential
customers as of December 31, 2005. GTU expects revenue from residential
customers to increase in the future as it expands its network to reach more
residential buildings in Ukraine.
Our acquisition strategy also contributed to the overall BCS growth in 2005. Our
revenue increased by approximately $3.8 million due to the acquisitions of
ST-HOLDING, Balticom, and Buzton in 2004 and by $1.7 million due to the
acquisitions of Sakhalin Telecom and Sochitelecom in 2005. Our regional
acquisition strategy has enabled us to increase our access to last mile
infrastructure, thus enabling us to expand our corporate client base.
Carrier and Operator Services. Revenue from Carrier and Operator Services
increased by 11% to $221.4 million for the year ended December 31, 2005, from
$198.9 million for the year ended December 31, 2004. Our total number of
contracts in this line of business grew by 13% to 1,827 as of December 31, 2005,
from 1,618 as of December 31, 2004.
Carrier and Operator Services revenue from Sovintel increased by 12% to $200.8
million for the year ended December 31, 2005, from $179.8 million(2) for the
year ended December 31, 2004. In Sovintel, we have expanded our operations with
existing partners and added a number of new carriers in the regions with
increased volumes of traffic. Additionally, our revenue from international
traffic increased as we carried larger volumes of lower-margin traffic destined
to CIS countries. We expect that our revenues in this line of business will
continue to increase in future periods as we expand our termination capabilities
as we continue to develop our network. However, we continue to observe
competitive pressure on revenues in the major cities and in the regions from
established and new local competitors.
Revenue for the Carrier and Operator Services division of GTU decreased by 1% to
$19.7 million for the year ended December 31, 2005, from $19.8 million for the
year ended December 31, 2004. $2.5 million of this decrease was the result of a
decrease in incoming international revenue. Incoming international minutes of
use decreased by 24% during the year due to a sharp decrease in incoming
international minutes from UMC along with a decrease in transit traffic from
various international operators. As mentioned previously, UMC received an
international carrier license in the third quarter of 2004, allowing it to
operate independently on the international markets without using the GTU network
for transit purposes. The decrease in incoming international revenue was offset
by a $1.3 million increase in carrier's carrier revenue due to a 15% increase in
carrier's carrier minutes of use resulting from a rise in low margin transit
traffic on mobile networks. Additionally, data revenues increased by $0.9
million due to an increase in ports in service as we added capacity between Kiev
and Frankfurt via two VC3 channels. In the future, we expect a further decline
in GTU voice wholesale revenues as major operators in the Ukrainian market
establish direct interconnection between their networks.
Our acquisition strategy in Russia also contributed to the overall Carrier and
Operator Services growth in 2005. Our revenue increased by approximately $1.1
million due to the acquisitions of ST-HOLDING, Balticom, and Buzton in 2004 and
by $0.3 million due to the acquisitions of Sakhalin Telecom and Sochitelecom in
2005.
Consumer Internet Services. Revenue from Consumer Internet Services decreased by
2% to $44.5 million for the year ended December 31, 2005, from $45.5 million for
the year ended December 31, 2004. This decrease was primarily the result of our
revenue from consumer dial-up Internet decreasing by approximately $7.8 million
between the years. Although the average revenue per dial-up Internet subscriber
decreased from $9.03 per month for the year ended December 31, 2004, to
approximately $6.85 per month for the year ended December 31, 2005, the number
of dial-up Internet subscribers increased from 413,351 at December 31, 2004, to
422,480 at December 31, 2005. The demographics of our dial-up subscriber base
continue to change as we add regional subscribers and lose subscribers in
Moscow. The consumer Internet market in Moscow has become more competitive due
to the increasing availability of other Internet access technologies. Offsetting
the decrease in dial-up revenue was a $6.8 million increase in other consumer
Internet products, such as consumer broadband, primarily from customers outside
of Moscow. We anticipate that our revenue from consumer broadband will increase
as we embark with our broadband access rollout. Our current and past base of
dial-up Internet subscribers in Moscow and throughout Russia
(2) For comparability, the amounts shown for Sovintel in 2004 include
adjustments to combine Sovintel and Comincom for the full year of 2004
since Comincom was merged into Sovintel in December 2004.
(GOLDEN TELECOM INC. LOGO) ANNUAL REPORT 2005
will allow us to specifically target subscribers that currently use or have
previously used our Internet services.
Mobile Services. Revenue from Mobile Services decreased by 11% to $14.1 million
for the year ended December 31, 2005, from $15.8 million for the year ended
December 31, 2004. Active subscribers decreased from 57,490 at December 31,
2004, to 47,502 at December 31, 2005, due to increased competition in the
Ukrainian mobile market. The average revenue per active subscriber has decreased
by 17% from approximately $27.23 per month to approximately $22.73 per month
primarily due to a 20% decrease in the number of contract subscribers with
average monthly revenue per subscriber of approximately $36.92. Furthermore,
promotions and pricing concessions are increasingly necessary due to increased
competition in the Ukrainian mobile market.
EXPENSES
The following table shows our principal expenses for the years ended December
31, 2005 and December 31, 2004:
CONSOLIDATED EXPENSES CONSOLIDATED EXPENSES
FOR THE YEAR ENDED FOR THE YEAR ENDED
US$ MILLIONS DECEMBER 31, 2004 DECEMBER 31, 2005
------------ --------------------- ---------------------
COST OF REVENUE
Business and Corporate Services $ 141.2 $ 165.7
Carrier and Operator Services 127.5 145.7
Consumer Internet Services 26.9 29.9
Mobile Services 6.0 6.2
Eliminations (1.0) --
---------------- ----------------
TOTAL COST OF REVENUE 300.6 347.5
Selling, general and administrative 112.9 119.9
Depreciation and amortization 75.0 84.0
Equity in earnings of ventures (0.3) (0.4)
Interest income (1.1) (2.3)
Interest expense 0.6 0.6
Foreign currency (gain) / loss (0.7) 1.2
Provision for income taxes $ 30.7 $ 37.8
COST OF REVENUE
Our cost of revenue increased by 16% to $347.5 million for the year ended
December 31, 2005 from $300.6 million for the year ended December 31, 2004.
Business and Corporate Services. Cost of revenue from BCS increased by 17% to
$165.7 million for the year ended December 31, 2005 from $141.2 million for the
year ended December 31, 2004. Cost of revenue as a percentage of revenue
remained unchanged at 43% between the periods.
We continue to maintain robust gross margins in this line of business due to the
continued demand for high-volume and high-margin services from our customers.
Cost of revenue for the BCS division of Sovintel increased by 13% to $133.6
million, or 42% of revenue, for the year ended December 31, 2005, from $118.0
million(3), or 43% of revenue, for the year ended December 31, 2004. Cost of
revenue as a percentage revenue remained relatively unchanged between the years.
(3) For comparability, the amounts shown for Sovintel in 2004 include
adjustments to combine Sovintel and Comincom for the full year of 2004
since Comincom was merged into Sovintel in December 2004.
38-39
Cost of revenue for the BCS division of GTU increased by 39% to $20.3 million,
or 51% of revenue, for the year ended December 31, 2005, from $14.6 million, or
51% of revenue, for the year ended December 31, 2004. Cost of revenue as a
percentage of revenue remained unchanged between the years.
BCS cost of revenue increased by approximately $1.1 million due to the
acquisitions of ST-HOLDING, Balticom, and Buzton in 2004 and by $1.1 million due
to the acquisitions of Sakhalin Telecom and Sochitelecom in 2005.
Carrier and Operator Services. Cost of revenue from Carrier and Operator
Services increased by 14% to $145.7 million, or 66% of revenue, for the year
ended December 31, 2005, from $127.5 million, or 64% of revenue, for the year
ended December 31, 2004. We continue to observe pressure on our operating
margins in this line of business, attributable to competition and to a change in
our traffic mix.
Cost of revenue for the Carrier and Operator Services division of Sovintel
increased by 13% to $138.7 million, or 69% of revenue, for the year ended
December 31, 2005, from $123.0 million(4), or 68% of revenue, for the year ended
December 31, 2004. The increase in cost of revenue as a percentage of revenue is
primarily due to a change in our traffic mix to favor traffic terminated in CIS
countries, which have higher settlement rates, and due to an increase in traffic
terminated to mobile networks, which typically have higher settlement rates than
fixed networks.
Cost of revenue for the Carrier and Operator Services division of GTU decreased
to $15.5 million, or 79% of revenue for the year ended December 31, 2005, from
$16.0 million, or 81% of revenue for the year ended December 31, 2004. Cost of
revenue decreased as a percentage of revenue primarily due to lower margin
incoming international traffic accounting for a smaller portion of our total
wholesale traffic in 2005.
Carrier and Operator Services cost of revenue increased by approximately $0.9
million due to the acquisitions of ST-HOLDING, Balticom, and Buzlon in 2004 and
by $0.2 million due to the acquisitions of Sakhalin Telecom and Sochitelecom in
2005.
Consumer Internet Services. Cost of revenue from Consumer Internet Services
increased by 11% to $29.9 million, or 67% of revenue, for the year ended
December 31, 2005, from $26.9 million, or 59% of revenue, for the year ended
December 31, 2004. The increase in cost of revenue as a percentage of revenue
was mainly the result of network costs not decreasing in line with revenue
declines from dial-up Internet. As regional subscribers account for a larger
portion of our total subscriber base, margins in this line of business have
decreased due to incremental network costs incurred to provide access to
regional customers. Furthermore, the impact of a decline in subscribers in
Moscow has not resulted in an immediate decline of network costs, which are more
fixed in nature.
Mobile Services. Cost of revenue from Mobile Services increased by 3% to $6.2
million, or 44% of revenue for the year ended December 31, 2005, from $6.0
million, or 38% of revenue for the year ended December 31, 2004. The increase in
cost of revenue as a percentage of revenue is mainly due to an increase in
hryvna based settlement rates due to a devaluation of the USD in April 2005 and
to an increase in traffic to other mobile networks with higher settlement rates.
SELLING, GENERAL AND ADMINISTRATIVE
Our selling, general and administrative expenses increased by 6% to $119.9
million, or 18% of revenue, for the year ended December 31, 2005, from $112.9
million, or 19% of revenue, for the year ended December 31, 2004. During the
year ended December 31, 2004, we incurred $3.6 million in consulting fees in
association with the transfer of 20% of our ownership interest in GTU to a
Ukrainian partner in exchange for services provided by the partner. Bad debt
expense decreased by approximately $2.0 million compared to the year ended
December 31, 2004, due to improved collections resulting from integrating
Comincom into Sovintel's operations late in 2004. Additionally, the reversal of
a $1.4 million tax contingency accrual decreased payroll and other taxes in the
first quarter of 2005. These decreasing factors were partly offset by expensing
$1.8 million of capitalized acquisition costs in the year ended December 31,
2005, related to acquisition opportunities that we decided not to pursue.
Furthermore, severance costs increased by approximately $0.8 million since we
recorded approximately $2.2 million of charges in the second half of 2005
related to separation payments paid to our former Chief Operating Office, Chief
Financial Officer, and other senior employees. Ongoing employee related costs
such as salaries, bonuses, insurance and other benefits increased by
approximately $8.2 million, or 14%, primarily due to an 7% increase in
consolidated headcount, increased executive officer costs, and ongoing salary
increases. Included in the increase in employee related costs is a $1.1 million
charge recorded in the second
(4) For comparability, the amounts shown for Sovintel in 2004 include
adjustments to combine Sovintel and Comincom for the full year of 2004
since Comincom was merged into Sovintel in December 2004.
(GOLDEN TELECOM INC. LOGO) ANNUAL REPORT 2005
quarter of 2005 for the revision of our estimate for unused vacation. The
remaining $3.2 million net increase is the result of other office expenses
increasing in line with the growth in our business.
DEPRECIATION AND AMORTIZATION
Our depreciation and amortization expenses increased by 12% to $84.0 million for
the year ended December 31, 2005, from $75.0 million for the year ended December
31, 2004. Depreciation expense increased by $8.5 million, or 15%, primarily due
to depreciation on capital expenditures to further develop our network.
Amortization expense also increased by $0.5 million due to amortization on
intangible assets arising from acquisitions consummated in 2004 and 2005 offset
by certain intangible assets related to interconnection contracts in Ukraine
becoming fully amortized.
EQUITY IN EARNINGS OF VENTURES
The earnings after interest and tax charges from our investments in
non-consolidated ventures increased to $0.4 million for the year ended December
31, 2005 from $0.3 million for the year ended December 31, 2004. We recognized
earnings at Sakhalin Telecom of $0.6 million, primarily due to Sakhalin
Telecom's gain on the sale of its ownership interest in ZAO Sakhalin Telecom
Mobile which occurred in September 2005, prior to our purchase of an additional
60% ownership interest in Sakhalin Telecom. In addition, we recognized losses of
$0.2 million from our other Russian ventures.
INTEREST INCOME
Our interest income increased to $2.3 million for the year ended December 31,
2005, from the $1.1 million for the year ended December 31, 2004. The increase
in interest income is due to increased cash balances held in interest bearing
accounts and an increase in interest rates applicable to these accounts.
INTEREST EXPENSE
Our interest expense was $0.6 million for the year ended December 31, 2005,
unchanged from the year ended December 31, 2004.
FOREIGN CURRENCY GAIN (LOSS)
Our foreign currency loss was $1.2 million for the year ended December 31, 2005,
compared with a gain of $0.7 million from the year ended December 31, 2004. The
increase in foreign currency loss is due to the combination of movements in
exchange rates and changes in the amount of net monetary assets that we have
denominated in foreign currencies.
MINORITY INTEREST
Our minority interest was $3.0 million for the year ended December 31, 2005,
compared to $1.5 million for the year ended December 31, 2004. Minority interest
increased primarily due to $3.8 million in cash contributed to GTU by our
minority partner in Ukraine. Additionally, minority interest in our earnings
increased due to the consolidation of recently acquired entities where our
ownership interest is less than 100%. In the first half of 2004 we acquired less
than 100% ownership in ZAO Samara Telecom, ZAO WestBalt Telecom, and Buzton.
Minority interests in the earnings of GTU also arose in 2004 due to the sale of
a non-controlling interest to our local partners in Ukraine. In 2005, we
acquired less than 100% ownership in Dicom and Sakhalin Telecom.
PROVISION FOR INCOME TAXES
Our charge for income taxes was $37.8 million for the year ended December 31,
2005, compared to $30.7 million for the year ended December 31, 2004. Our
effective tax rate was 32% for the year ended December 31, 2005, unchanged from
the year ended December 31, 2004. We recognized approximately $2.2 million in
additional tax expense in 2005 since we changed our valuation allowance for
United States ("US") deferred tax assets due to our reassessment of sources of
future taxable income in the US. Our effective tax rate for the year ended
December 31, 2004, was impacted by $3.6 million of non-deductible consulting
expenses incurred in association with the transfer of 20% of our ownership
interest in GTU to a Ukrainian partner in exchange for services provided by that
partner. Refer to note 11 in the financial statements included in this Annual
Report for a reconciliation of our statutory tax rate to the effective tax rate.
NET INCOME AND NET INCOME PER SHARE
Our net income for the year ended December 31, 2005 was $76.1 million, compared
to a net income of $64.8 million for the year ended December 31, 2004.
Our net income per share of common stock increased to $2.09 for the year ended
December 31, 2005, compared to a net income per share of $1.79 for the year
ended December 31, 2004. The increase in net income per share of common stock
was due to the increase in net income partly offset by an increase in the number
of weighted average shares to 36,378,175 in the year ended December 31, 2005,
compared to 36,255,531 in the year ended December 31, 2004. The increase in
outstanding shares was a direct result of the employee stock option exercises
and the issuance of restricted stock to certain members of management.
40-41
Our net income per share of common stock on a fully diluted basis increased to
$2.08 for the year ended December 31, 2005, compared to a net income per common
share of $1.77 for the year ended December 31, 2004. The increase in net income
per share of common stock on a fully diluted basis was due to the increase in
net income partly offset by an increase in the number of weighted average shares
assuming dilution to 36,605,075 the year ended December 31, 2005, compared to
36,552,547 for the year ended December 31, 2004.
CONSOLIDATED FINANCIAL POSITION
Significant Changes in Consolidated Financial Position at December 31, 2005,
compared to Consolidated Financial Position at December 31, 2004
ACCOUNTS RECEIVABLE
Accounts receivable increased from December 31, 2004, to December 31, 2005, as a
result of increased revenue when comparing the month of December 2005 with the
month of December 2004.
INTANGIBLE ASSETS
Our intangible assets decreased at December 31, 2005, as compared to December
31, 2004, as a result of amortization on continuing intangible assets of the
consolidated subsidiaries exceeding intangible asset additions. Also
contributing to the decrease was the reversal of an income tax contingent
liability related to an acquisition as described in more detail in the other
non-current liabilities discussion below. Offsetting these decreasing factors
were additional intangible assets recorded upon the acquisitions of Dicom,
Sakhalin Telecom, and Sochitelecom and the purchase of additional numbering
capacity.
OTHER NON-CURRENT LIABILITIES
Our other non-current liabilities decreased at December 31, 2005, as compared to
December 31, 2004, as a result of the reversal of a $2.0 million accrued
liability related to a tax contingency. This accrued liability was recorded upon
the acquisition of one of our Russian subsidiaries. Management has concluded
that the probability of this accrued liability arising in the future is remote
due to the expiry of Russian regulatory statutes of limitations, for any
potential tax claims from the Russian tax inspectorate.
MINORITY INTEREST
Our minority interest increased at December 31, 2005, as compared to December
31, 2004, due to the consolidation of recently acquired entities where our
ownership interest is less than 100%. In the first half of 2004 we acquired less
than 100% ownership in ZAO Samara Telecom, ZAO WestBalt Telecom, and Buzton.
Minority interests in the earnings of GTU also arose in 2004 due to the sale of
a non-controlling interest to our local partners in Ukraine. In 2005, we began
to consolidate Dicom and Sakhalin Telecom. Both of these entities have minority
ownership interests. Additionally, minority interest increased due to $3.8
million in cash contributed to GTU by our minority partner in Ukraine.
STOCKHOLDERS' EQUITY
Shareholders' equity increased from December 31, 2004, to December 31, 2005, as
a result of our net income of $76.1 million offset by declaring and paying $29.1
million in dividends in the year ended December 31, 2005. Also, shareholders'
equity increased by $1.8 million due to stock option exercises and the issuance
of restricted shares to certain members of management.
CONSOLIDATED RESULTS
Consolidated Results of Operations for the Year Ended December 31, 2004,
Compared to the Consolidated Results of Operations for the Year Ended December
31, 2003
REVENUE
Our revenue increased by 62% to $584.0 million for the year ended December 31,
2004 from $360.5 million for the year ended December 31, 2003. The overall
increase in revenue was due primarily to the consolidation of 100% of Comincom's
results of operations for a full year and, with respect to our existing
business, an increase in customer base and services provided to existing
customers, partially offset by lower prices for certain services. The breakdown
of revenue by business group was as follows:
(GOLDEN TELECOM INC. LOGO) ANNUAL REPORT 2005
CONSOLIDATED REVENUE CONSOLIDATED REVENUE
FOR THE YEAR ENDED FOR THE YEAR ENDED
US$ MILLIONS DECEMBER 31, 2003 DECEMBER 31, 2004
------------ -------------------- --------------------
REVENUE
Business and Corporate Services $ 188.9 $ 324.8
Carrier and Operator Services 128.5 198.9
Consumer Internet Services 30.8 45.5
Mobile Services 13.9 15.8
Eliminations (1.6) (1.0)
---------------- ----------------
TOTAL REVENUE $ 360.5 $ 584.0
Business and Corporate Service. Revenue from BCS increased by 72% to $324.8
million for the year ended December 31, 2004 from $188.9 million for the year
ended December 31, 2003. The primary reason for the increase is due to the
acquisition of 100% ownership interest in Comincom in the fourth quarter of
2003. We began consolidating Comincom into our results of operations from
December 1, 2003. Comincom's revenue from BCS was $90.7 million for the year
ended December 31, 2004. BCS revenue increased by approximately $8.3 million due
to the 2004 acquisitions of ST-HOLDING, Balticom, and Buzton. We began
consolidating these three companies into our results at various points during
the first half of 2004. Additionally, $3.5 million of the total increase is due
to 2004 being the first full year that we consolidated the results of
Sibchallenge, an August 2003 acquisition. The remainder of the increase was the
result of expanding our pre-existing business. In our largest market, Moscow, we
had increases in our domestic traffic revenues due to adding approximately 9,100
new corporate customers and signing up 99 new multi-tenant business centers and
10 new trade centers in the year ended December 31, 2004 along with actively
promoting new services among our client base. BCS Moscow recognized
approximately $23.7 million in revenue from new contracts in 2004 and grew the
number of its Direct Inward Dialing lines from 102,037 as of December 31, 2003
to approximately 116,668 as of December 31, 2004. Also, the macro-economic
growth in Russia, Ukraine, and the CIS helped us to expand our client base. We
assisted our customers develop their businesses as they expanded regionally.
Revenue from the BCS division of GTU increased by 52% to $28.8 million for the
year ended December 31, 2004 from $19.0 million for the year ended December 31,
2003. The increase in revenue was due to a 63% increase in the number of
serviced voice lines and a 28% increase in average rate per minute of use. The
latter was caused by the CPP principle of settlement rates introduced by the
Ukrainian Parliament in the late 2003, which has increased revenue and
settlement rates to Ukrainian mobile networks.
Carrier and Operator Services. Revenue from Carrier and Operator Services
increased by 55% to $198.9 million for the year ended December 31, 2004 from
$128.5 million for the year ended December 31, 2003. The primary reason for the
increase is due to the acquisition of 100% ownership interest in Comincom in the
fourth quarter of 2003. We began consolidating Comincom into our results of
operations from December 1, 2003. Comincom's revenue from Carrier and Operator
Services was $21.6 million for the year ended December 31, 2004. Also, revenue
increased by approximately $2.5 million due to the 2004 acquisitions of
ST-HOLDING, Balticom, and Buzton. We began consolidating these three companies
into our results at various points during the first half of 2004. Additionally,
$4.7 million of the total increase is due to 2004 being the first full year that
we consolidated the results of Sibchallenge, an August 2003 acquisition. We have
expanded our operations with existing partners and added a number of new
carriers specifically in the regions with increased volumes of traffic,
including VoIP. In addition, we continue to expand our business with major
cellular providers both in the capital and in the regions, which helped offset
general tariff declines, although pricing pressures still exist.
Revenue for the Carrier and Operator Services division of GTU increased by 71%
to $19.8 million for the year ended December 31, 2004 from $11.6 million for the
year ended December 31, 2003. The increase in revenue was due to a 91 % increase
in incoming international traffic which we are able to terminate in a number of
cities in Ukraine, offset by a 34% decrease in outgoing international traffic.
42-43
Consumer Internet Services: Revenue from Consumer Internet Services increased by
48% to $45.5 million for the year ended December 31, 2004 from $30.8 million for
the year ended December 31, 2003. The increase is largely the result of
increases in the number of dial-up Internet subscribers from 363,545 at December
31, 2003 to 413,351 at December 31, 2004 and the average revenue per Internet
subscriber increasing from approximately $8.39 per month to approximately $9.03
per month over the same period.
Mobile Services. Revenue from Mobile Services increased by 14% to $15.8 million
for the year ended December 31, 2004 from $13.9 million for the year ended
December 31, 2003. Active subscribers increased from 40,026 at December 31, 2003
to 57,490 at December 31, 2004 due to an increase in the number of prepaid
subscribers driven by the overall Ukrainian mobile market growth. The average
revenue per active subscriber has decreased by 11 % to approximately $27.23 per
month due to the decrease in the subscription fee for the tariff plan which
allows for unlimited local calls for a fixed payment as well as decrease in the
number of the subscribers using the said tariff plan and due to an increase in
the share of prepaid subscribers with lower activity and no fixed charge.
EXPENSES
The following table shows our principal expenses for the years ended December
31, 2003, and December 31, 2004:
CONSOLIDATED EXPENSES CONSOLIDATED EXPENSES
FOR THE YEAR ENDED FOR THE YEAR ENDED
US$ MILLIONS DECEMBER 31, 2003 DECEMBER 31, 2004
------------ --------------------- ---------------------
COST OF REVENUE
Business and Corporate Services $ 84.8 $ 141.2
Carrier and Operator Services 74.9 127.5
Consumer Internet Services 20.2 26.9
Mobile Services 2.8 6.0
Eliminations (1.6) (1.0)
---------------- ----------------
TOTAL COST OF REVENUE 181.1 300.6
Selling, general and administrative 64.4 112.9
Depreciation and amortization 45.3 75.0
Equity in earnings of ventures (4.7) (0.3)
Interest income (1.1) (1.1)
Interest expense 2.0 0.6
Foreign currency (gain)/ loss 0.2 (0.7)
Provision for income taxes $ 17.4 $ 30.7
COST OF REVENUE
Our cost of revenue increased by 66% to $300.6 million for the year ended
December 31, 2004 from $181.1 million for the year ended December 31, 2003.
Business and Corporate Services: Cost of revenue from BCS increased by 67% to
$141.2 million, or 43% of revenue, for the year ended December 31, 2004 from
$84.8 million, or 45% of revenue, for the year ended December 31, 2003. The
primary reason for the increase in cost of revenue and the decrease in cost of
revenue as a percentage of revenue was due to the acquisition of 100% ownership
interest in Comincom in the fourth quarter of 2003. We began consolidating
Comincom into our results of operations from December 1, 2003. Comincom's cost
of revenue from BCS was $36.0 million for the year ended December 31, 2004, or
40% of its revenue. BCS cost of revenue increased by approximately $3.2 million
due to the 2004 acquisitions of ST-HOLDING, Balticom, and Buzton. We began
consolidating these three companies into our results at various points during
the first half of 2004. Additionally, $1.1 million of the total increase is due
to 2004 being the first full year that we consolidated the results of
Sibchallenge, an August 2003 acquisition. Cost of revenue as a percentage of
revenue decreased as we leveraged the fixed cost portion of our operations over
increased volumes.
(GOLDEN TELECOM INC. LOGO)
Cost of revenue for the BCS division of GTU increased by 60% to $14.6 million,
or 51% of revenue, for the year ended December 31, 2004 from $9.1 million, or
48% of revenue, for the year ended December 31, 2003. Cost of revenue increased
as a percentage of revenue due to the increased volume of lower margin traffic
to mobile networks.
Carrier and Operator Services: Cost of revenue from Carrier and Operator
Services increased by 70% to $127.5 million, or 64% of revenue, for the year
ended December 31, 2004 from $74.9 million, or 58% of revenue, for the year
ended December 31, 2003. The primary reason for the increase in cost of revenue
was due to the acquisition of 100% ownership interest in Comincom in the fourth
quarter of 2003. We began consolidating Comincom into our results of operations
from December 1, 2003. Comincom's cost of revenue from Carrier and Operator
Services was $12.4 million, or 57% of its revenue, for the year ended December
31, 2004. Also, cost of revenue increased by approximately $0.2 million due to
the 2004 acquisition of ST-HOLDING, Balticom, and Buzton. The increase in cost
of sales resulting from these acquisitions was minimal since the vast majority
of their cost of revenue is incurred with other majority-owned subsidiaries and
is, therefore, eliminated in consolidation. We began consolidating these three
companies into our results at various points during the first half of 2004.
Additionally, $1.2 million of the total increase is due to 2004 being the first
full year that we consolidated the results of Sibchallenge, an August 2003
acquisition. The increase in cost of revenue as a percentage of revenue resulted
from settlements to other operators not decreasing in line with the pricing
concessions to our customers partially offset by operational improvements in
terms of efficient use of available network resources. In addition, the cost of
revenue as a percentage of revenue increased due to higher volumes of lower
margin VoIP sales.
Cost of revenue for the Carrier and Operator Services division of GTU increased
by 98% to $16.0 million, or 81% of revenue, for the year ended December 31, 2004
from $8.1 million, or 70% of revenue, for the year ended December 31, 2003. Cost
of revenue increased as a percentage of revenue due to a 91% increase in lower
margin international incoming traffic and a 34% decrease in higher margin
international outgoing traffic.
Consumer Internet Services: Cost of revenue from Consumer Internet Services
increased by 33% to $26.9 million, or 59% of revenue, for the year ended
December 31, 2004 from $20.2 million, or 66% of revenue, for the year ended
December 31, 2003. The decrease as a percentage of revenue was mainly due to
leveraging the fixed cost portion of our operations over increased volumes.
Mobile Services: Cost of revenue from Mobile Services increased by 114% to $6.0
million, or 38% of revenue, for the year ended December 31, 2004 from $2.8
million, or 20% of revenue, for the year ended December 31, 2003. The cost of
revenue as a percentage of revenue increased due to the introduction of the CPP
principle by the Ukrainian Parliament in the third quarter of 2003 as settlement
costs for traffic to other mobile networks increased.
SELLING, GENERAL AND ADMINISTRATIVE
Our selling, general and administrative expenses increased by 75% to $112.9
million, or 19% of revenue, for the year ended December 31, 2004 from $64.4
million, or 18% of revenue, for the year ended December 31, 2003. The primary
reason for the increase was acquisitions occurring in late 2003 and in 2004.
Other factors contributing to the increase were reserves and write-offs of
unrecoverable value-added taxes in certain subsidiaries, increased bad debt
expense due to uncollectible receivables in Comincom, expenses associated with
the December 1, 2004 legal merger and integration of Comincom including expense
charges related to payroll and assets taxes directly related to the legal
merger, increase in cost related to increases in temporary staffing, cost
associated with new senior management recruitment and employment, and additional
expenses associated with Sarbanes-Oxley compliance. In addition, in the third
quarter of 2004, we incurred $3.6 million in consulting fees in association with
the transfer of 20% of our ownership interest in GTU to a Ukrainian partner in
exchange for services provided by the partner.
DEPRECIATION AND AMORTIZATION
Our depreciation and amortization expenses increased by 66% to $75.0 million for
the year ended December 31, 2004 from $45.3 million for the year ended December
31, 2003. The increase was due in part to depreciation on continuing capital
expenditures of the consolidated entities, but primarily relates to our
acquisition of the 100% ownership interest in Comincom and subsequent
consolidation of Comincom as of December 1, 2003 into our results of operations.
As a result of consolidating Comincom, depreciation and amortization increased
by $18.9 million for the year ended December 31, 2004.
44-45
EQUITY IN EARNINGS OF VENTURES
The earnings after interest and tax charges from our investments in
non-consolidated ventures decreased to $0.3 million for the year ended December
31, 2004 from $4.7 million for the year ended December 31, 2003. The decrease in
equity in earnings was mainly due to receiving a $4.7 million distribution from
MCT in the fourth quarter of 2003.
INTEREST INCOME
Our interest income for the year ended December 31, 2004 remained unchanged from
the $1.1 million for the year ended December 31, 2003.
INTEREST EXPENSE
Our interest expense was $0.6 million for the year ended December 31, 2004 down
from $2.0 million for the year ended December 31, 2003. Debt, excluding capital
lease obligations, at December 31, 2004 was $0.2 million compared to $1.2
million at December 31, 2003. On June 30, 2003, we settled $30.0 million of
outstanding debt plus accrued interest under a credit facility with ZAO
Citibank.
FOREIGN CURRENCY GAIN (LOSS)
Our foreign currency gain was $0.7 million for the year ended December 31, 2004,
compared to a foreign currency loss of $0.2 million for the year ended December
31, 2003. The improvement in foreign currency loss is due to the combination of
movements in exchange rates and changes in the amount of net monetary assets
that we have denominated in foreign currencies.
MINORITY INTEREST
Our minority interest was $1.5 million for the year ended December 31, 2004,
compared to a $0.5 million for the year ended December 31, 2003. The increase
was the result of minority interests in the earnings of GTU, ZAO Samara Telecom,
ZAO WestBalt Telecom and Buzton. Except for GTU, each of these consolidated
subsidiaries was acquired during the first half of 2004. Minority interests in
the earnings of GTU arose in 2004 due to the sale of a non-controlling interest
to our local partners in Ukraine.
PROVISION FOR INCOME TAXES
Our charge for income taxes was $30.7 million for the year ended December 31,
2004 compared to $17.4 million for the year ended December 31, 2003. Our
effective tax rate was 32% for the year ended December 31, 2004 compared to 24%
for the year ended December 31, 2003 partly as a result of increases in
non-deductible expenses in 2004, versus recording a deferred tax benefit related
to the reversal of a deferred tax asset valuation allowance in 2003. The overall
increase in income tax expense is primarily due to the acquisition of 100%
ownership interest in Comincom and subsequent consolidation of Comincom from
December 1, 2003 into our results of operations. In addition, there were
increased levels of taxable profits being incurred in our Russian and Ukrainian
subsidiaries in the year ended December 31, 2004 as compared to the year ended
December 31, 2003.
NET INCOME AND NET INCOME PER SHARE
Our net income for the year ended December 31, 2004 was $64.8 million, compared
to a net income of $55.4 million for the year ended December 31, 2003.
Our net income per share of common stock decreased to $1.79 for the year ended
December 31, 2004, compared to a net income per share of $1.95 for the year
ended December 31, 2003. The decrease in net income per share of common stock
was due to the increase in net income partly offset by an increase in the number
of weighted average shares to 36,225,531 in the year ended December 31, 2004,
compared to 28,467,677 in the year ended December 31, 2003. The increase in
outstanding shares was a direct result of the Comincom acquisition and employee
stock option exercises.
Our net income per share of common stock on a fully diluted basis decreased to
$1.77 for the year ended December 31, 2004, compared to a net income per common
share of $1.90 for the year ended December 31, 2003. The decrease in net income
per share of common stock on a fully diluted basis was due to the increase in
net income partly offset by an increase in the number of weighted average shares
assuming dilution to 36,552,547 the year ended December 31, 2004, compared to
29,106,540 for the year ended December 31, 2003.
CONSOLIDATED FINANCIAL POSITION
Significant Changes in Consolidated Financial Position at December 31, 2004
compared to Consolidated Financial Position at December 31, 2003
ACCOUNTS RECEIVABLE
Accounts receivable increased from December 31, 2003 to December 31, 2004 as a
result of increased revenue during the period ended December 31, 2004 and slower
collections from customers.
(GOLDEN TELECOM INC. LOGO) ANNUAL REPORT 2005
INTANGIBLE ASSETS
Our intangible assets increased at December 31, 2004 as compared to December 31,
2003 as a result of our acquisition of ST-HOLDING in February 2004, our
acquisition of Balticom Mobile in April 2004, Buzton in May 2004 and the build
out of new numbering capacity.
MINORITY INTEREST
Our minority interest increased at December 31, 2004 as compared to December 31,
2003 as a result of minority interests in the equity of GTU, ZAO Samara Telecom,
ZAO WestBalt Telecom and Buzton. Except for GTU, each of these consolidated
subsidiaries was acquired during the first half of 2004. Minority interests in
the earnings of GTU arose in 2004 due to the sale of a non-controlling interest
to our local partners in Ukraine.
STOCKHOLDERS' EQUITY
Shareholders' equity increased from December 31, 2003 to December 31, 2004 as a
result of our net income of $64.8 million, cash proceeds of approximately $4.9
million received from the exercise of employee stock options, partially offset
by declaring and paying $29.0 million dividends for the year ended December 31,
2004.
In addition, we transferred 20% of the ownership interest in GTU to a Ukrainian
partner in exchange for services provided by the partner in August 2004. The
excess of the fair value of consideration exchanged for services over the book
value of 20% of net assets of GTU was recorded as a credit to the consolidated
equity.
In the third quarter of 2004, management determined that we have been
inadvertently carrying accruals for estimated taxes, other than income taxes.
Management concluded these accruals for estimated taxes should have been
considered unnecessary and reversed prior to January 1, 2000. The net effect of
the correction of this non-cash error was to reduce current liabilities and
non-current liabilities by $2.0 million each with an offsetting decrease to
accumulated deficit of $4.0 million in all periods presented.
INCOME TAXES
Our effective rate of income tax differs from the US statutory rate due to the
impact of the following factors: (1) different income tax rates and regulations
apply in the countries where we operate; (2) expenses non-deductible on the
income tax return; (3) write-offs of certain assets are not deductible for tax
purposes; and (4) changes in the valuation allowance for deferred tax assets. We
currently have deferred tax assets arising from deductible temporary differences
in our non-US subsidiaries. Due to the continued profitability of these
subsidiaries, we anticipate that these deferred tax assets will be realized
through the generation of future taxable income. We also have deferred tax
assets related to net operating loss carry-forwards and deductible temporary
differences for US federal income tax purposes. In 2005, we recorded a full
valuation allowance against these deferred tax assets due to our reassessment of
sources of future taxable income in the United States. We have also recorded a
deferred tax asset related to net operating loss carry-forwards for Cyprus tax
purposes. However, we have recorded a full valuation allowance since we do not
anticipate recognizing taxable income in our Cyprus entity in the foreseeable
future.
LIQUIDITY AND CAPITAL RESOURCES
Our cash and cash equivalents was $67.2 million and $53.7 million as of December
31, 2005, and December 31, 2004, respectively. Our total restricted cash was
$0.6 million and $1.0 million as of December 31, 2005, and December 31, 2004,
respectively. The restricted cash is maintained in connection with certain of
our debt obligations as described below.
During the year ended December 31, 2005, we had net cash inflows of $174.3
million from our operating activities. During the year ended December 31, 2004,
we had net cash inflows of $145.2 million from our operating activities. This
increase in net cash inflows from operating activities at December 31, 2005, is
mainly due to the increase of net income as a result of increased revenues.
During the year ended December 31, 2005, we received approximately $662.9
million in cash from our customers for services and we paid approximately $449.0
million to suppliers and employees. During the year ended December 31, 2004, we
received approximately $566.8 million in cash from our customers for services
and we paid approximately $386.1 million to suppliers and employees.
We used cash of $133.1 million and $128.5 million for investing activities for
the year ended December 31, 2005, and 2004, respectively, which were principally
attributable to building our telecommunications networks and acquisitions.
Network investing activities totaled $118.2 million for the year ended December
31, 2005, and included capital expenditures principally attributable to building
out our telecommunications network. The majority of network investing activities
related to construction of last mile access, the construction of our FTN, and
the intercity fiber project and network upgrades as
46-47
a result of increased customer connections. Network investing activities totaled
$114.6 million for the year ended December 31, 2004. With respect to capital
expenditures in 2006, we expect that these expenditures will increase by
approximately 2%, in terms of a percentage of revenues, up from 20% of revenues
in 2005, to approximately 22% of revenues in 2006. The capital expenditures
increase is largely attributable to the implementation of our broadband
strategy, the construction of the FTN, and the build out of the fiber optic
network.
MINORITY INTEREST
We used cash of $18.1 million for the year ended December 31, 2005, for
acquisitions which include Dicom, Sakhalin Telecom, Sochitelecom, and Rascom. We
used cash of $15.5 million for the year ended December 31, 2004, for
acquisitions which include ST-HOLDING, Buzton, Uralrelcom, and Balticom Mobile.
For the year ended December 31, 2005, we received $1.4 million net proceeds from
the exercise of employee stock options and for the year ended December 31, 2004,
we received $4.9 million net proceeds from the exercise of employee stock
options. In 2005, we also received a $3.8 million cash contribution from our
minority partner in Ukraine.
In 2005, we paid quarterly dividends of $0.20 per common share to shareholders
totaling $29.1 million. In February 2006 our Board of Directors declared a cash
dividend of $0.20 per common share to shareholders of record as of March 17,
2006. The total amount of payable of approximately $7.3 million will be paid to
shareholders on March 31, 2006.
We had working capital of $79.1 million as of December 31, 2005, and $83.8
million as of December 31, 2004. At December 31, 2005, we had a negligible
amount of long-term debt, excluding capital lease obligations. At December 31,
2004, we had total debt, excluding capital lease obligations, of approximately
$0.2 million, none of which were current maturities. Total debt included amounts
that were fully collateralized by restricted cash.
As part of our drive to increase our network capacity, reduce costs and improve
the quality of our service, we have leased additional fiber optic and
satellite-based network capacity; the terms of these leases are generally five
years or more and can involve significant advance payments. As demand for our
telecommunication services increases we expect to enter into additional capacity
agreements and may make significant financial commitments, in addition to our
existing commitments. In the year ended December 31, 2005, we entered into
approximately $68.3 million of satellite transponder capacity agreements
generally with terms of 10 years.
In August 2005, we entered into a lease for fiber optic capacity, including
facilities and maintenance, on major routes within Ukraine. The lease has a term
of five years and total payments of $4.1 million. The first year of the lease
has been prepaid while payments should be made on a monthly basis in subsequent
years.
In order to comply with the known long distance license requirements and to be
operational in 2006, we incurred approximately $12.6 million in capital
expenditures and approximately $1.0 million in operational expenditures in 2005.
In total, we estimate that we will need to make capital expenditures of
approximately $50.0 million in order to fulfill the network requirements,
specified in the Interconnection Rules and to successfully implement our long
distance license. However, there are still unknown and yet to be clarified
portions of the laws and regulations that will affect both the timing and cost
of the long distance license implementation.
Some of our operating companies have received debt financing through direct
loans from affiliated companies. In addition, certain operating companies have
borrowed funds under a back-to-back, seven-year credit facility for up to $22.7
million from a Russian subsidiary of Citibank. Under this facility, we provide
full cash collateral, held in London, and recorded on our balance sheet as
restricted cash, for onshore loans made by the bank to our Russian registered
joint ventures. In a second, similar facility, we provide full cash collateral
for a short term back-to-back, revolving, credit facility for up to $10.0
million from the same bank for two of our larger Russian operating companies.
The funding level as of December 31, 2005, for all these facilities totaled $0.2
million was funded to our non-consolidated entities.
In the future, we may execute large or numerous acquisitions, which may require
external financing most likely to be raised through secured or unsecured
borrowings. However, we may also raise the required funding through a dilutive
equity issuance, through the divestment of non-core assets, or combinations of
the above. In case large or numerous acquisitions do not materialize, we expect
our current sources of funding to finance our capital requirements. The actual
amount and timing of our future capital requirements may differ materially from
our current estimates because of changes or fluctuations in our anticipated
acquisitions, investments, revenue, operating costs, technology and network
expansion plans and access to alternative sources of financing on favorable
terms. Further, in order for us to
(GOLDEN TELECOM INC. LOGO) ANNUAL REPORT 2005
compete successfully, we may require substantial capital to continue to develop
our networks and meet the funding requirements of our operations. We will also
require capital for other acquisition and business development initiatives. We
expect to fund these requirements through cash on hand, cash flow from
operations, proceeds from additional equity and debt offerings, and debt
financing facilities.
We may not be able to obtain additional financing on favorable terms. As a
result, we may become subject to additional or more restrictive financial
covenants, our interest obligations may increase significantly and our
shareholders may be adversely diluted. Our failure to generate sufficient funds
in the future, whether from operations or by raising additional debt or equity
capital, may require us to delay or abandon some or all of our anticipated
expenditures, to sell assets, or both, which could have a material adverse
effect on our operations.
In late 2006 and subsequent years, we may incur significant cash outlays to
settle SARs issued in 2005 to our CEO, senior management, and other employees.
These cash outlays could be especially significant if our stock price exceeds
$50.00 per share prior to certain deadlines specified in the SAR plans occurring
in the second half of 2008. The terms of these SARs are described in detail in
the "Other developments" section in this Management's Discussion and Analysis of
Financial Condition and Results of Operations.
As of December 31, 2005, we had the following contractual obligations, including
short- and long-term debt arrangements commitments for future payments under
non-cancelable lease arrangements and purchase obligations:
LESS THAN 1-3 4-5
US$'000s TOTAL 1 YEAR YEARS YEARS THEREAFTER
---------------------------------- ------------- ------------- ------------- ------------- -------------
PAYMENTS DUE BY PERIOD
Long-term debt $ 27 $ -- $ 27 $ -- $ --
Capital lease obligations 4,758 2,179 2,245 334 --
Non-cancelable lease obligations 16,782 9,514 6,600 514 154
Purchase obligations (1) 86,841 28,375 29,000 14,473 14,993
------------- ------------- ------------- ------------- -------------
TOTAL CONTRACTUAL CASH OBLIGATIONS $ 108,408 $ 40,068 $ 37,872 $ 15,321 $ 15,147
------------- ------------- ------------- ------------- -------------
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Our treasury function has managed our funding, liquidity and exposure to
interest rate and foreign currency exchange rate risks. Our investment treasury
operations are conducted within guidelines that have been established and
authorized by our audit committee. In accordance with our policy, we do not
enter into any treasury management transactions of a speculative nature.
The ruble and the hryvna are generally non-convertible outside Russia and
Ukraine, respectively, so our ability to hedge against devaluation by converting
to other currencies is significantly limited. Further, our ability to convert
rubles and hryvna into other currencies in Russia and Ukraine, respectively, is
subject to rules that restrict the purposes for which conversion and the payment
of foreign currencies are allowed.
Given that much of our operating costs are indexed to or denominated in USD,
including employee compensation expense, capital expenditure and interest
expense, we have taken specific steps to minimize our exposure to fluctuations
in the appropriate foreign currency. Although local currency control regulations
require us to collect virtually all of our revenue in local currency, our
subsidiaries generally either price or invoice in USD or index their invoices
and collections to the applicable USD exchange rate. Customer contracts may
include clauses allowing additional invoicing if the applicable exchange rate
changes significantly between the invoice date and the date of payment,
favorable terms for early or prepayments and heavy penalty clauses for overdue
payments. Maintaining the USD value of our revenue subjects us to additional tax
on exchange gains.
----------
(1) Purchase obligations primarily include our contractual legal obligations
for the future purchase of equipment, interconnect, and satellite
transponder capacity.
48-49
Although we are attempting to match revenue, costs, borrowing and repayments in
terms of their respective currencies, we may experience economic loss and a
negative impact on earnings as a result of foreign currency exchange rate
fluctuations.
Our cash and cash equivalents are held largely in interest bearing accounts, in
USD, however we do have bank accounts denominated in Russian rubles and
Ukrainian hryvna. The book values of such accounts at December 31, 2005 and 2004
approximate their fair value. Cash in excess of our immediate operating needs is
invested in US money market instruments. In accordance with our investment
policy, we maintain a diversified portfolio of low risk, fully liquid
securities.
We are exposed to market risk from changes in interest rates on our obligations
and we also face exposure to adverse movements in foreign currency exchange
rates. We have developed risk management policies that establish guidelines for
managing foreign currency exchange rate risk and we also periodically evaluate
the materiality of foreign currency exchange exposures and the financial
instruments available to mitigate this exposure.
The following table provides information (in thousands) about our cash
equivalents and debt obligations that are sensitive to changes in interest
rates.
2005 2004
US$'000s 2006 2007 2008 2009 2010 THEREAFTER TOTAL TOTAL
-------------------------- ------- ------- ------- ------- ------- ---------- ------- -------
Cash equivalents $67,176 $ -- $ -- $ -- $ -- $ -- $67,176 $53,699
Note receivable $ 1,494 $ -- $ -- $ -- $ -- $ -- $ 1,494 $ 3,832
Fixed rate 7.00% -- -- -- -- -- 7.00% 7.00%
Long-term debt,
including current portion:
Variable rate $ 27 $ -- $ -- $ -- $ -- $ -- $ 27 $ 200
Average interest rate -- -- -- -- -- -- -- --
(GOLDEN TELECOM INC. LOGO)
The following table provides information about our financial instruments by
local currency and where applicable, presents such information in USD
equivalents (in thousands). The table summarizes information on instruments that
are sensitive to foreign currency exchange rates, including foreign currency
denominated debt obligations.
Our interest income and expense are most sensitive to changes in the general
level of U.S. interest rates. In this regard, changes in U.S. interest rates
affect the interest earned on our cash equivalents and short-term investments as
well as interest paid on debt.
2005 2004
US$'000s 2006 2007 2008 2009 2010 THEREAFTER TOTAL TOTAL
------------------------ ------- ------- ------- ------- ------- ---------- ------- -------
ASSETS
CURRENT ASSETS
Russian rubles $73,463 $ -- $ -- $ -- $ -- $ -- $73,463 $57,969
Closing foreign currency
exchange rate 28.78 -- -- -- -- -- -- --
Ukrainian Hryvna $ 7,135 $ -- $ -- $ -- $ -- $ -- $ 7,135 $ 6,692
Closing foreign currency
exchange rate 5.05 -- -- -- -- -- -- --
Kazakhstan Tenge $ 1,267 $ -- $ -- $ -- $ -- $ -- $ 1,267 $ 875
Closing foreign currency 133.77 -- -- -- -- -- -- --
exchange rate
Uzbekistan Soom $ 1,073 $ -- $ -- $ -- $ -- $ -- $ 1,073 $ 546
Closing foreign currency
exchange rate 1,180 -- -- -- -- -- -- --
LIABILITIES
CURRENT LIABILITIES
Russian rubles $21,528 $ -- $ -- $ -- $ -- $ -- $21,528 $25,268
Closing foreign currency
exchange rate 28.78 -- -- -- -- -- -- --
Ukrainian Hryvna $ 3,696 $ -- $ -- $ -- $ -- $ -- $ 3,696 $ 4,906
Closing foreign currency
exchange rate 5.05 -- -- -- -- -- -- --
Kazakhstan Tenge $ 57 $ -- $ -- $ -- $ -- $ -- $ 57 $ 49
Closing foreign currency
exchange rate 133.77 -- -- -- -- -- -- --
Uzbekistan Soom $ 156 $ -- $ -- $ -- $ -- $ -- $ 156 $ 359
Closing foreign currency
exchange rate 1,180 -- -- -- -- -- -- --
50-51
SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS
Certain statements contained in "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and other parts of this document,
including, without limitation, those concerning (i) future acquisitions and
capital expenditures including our strategy of regional expansion; (ii)
projected traffic volumes and other growth indicators; (iii) anticipated
revenues and expenses; (iv) our competitive environment; (v) the future
performance of consolidated and equity method investments; (vi) our intention to
offer our services under the Golden Telecom brand; (vii) our business and growth
strategy, (viii) our intentions to expand our fiber optic capacity, broadband
capacity, DSL, and add transmission capacity; (ix) our intention to continue to
use the assets of recently acquired companies in the manner such assets were
previously used; (x) the deployment of our FTN and the effect of such deployment
including expected increases in revenues from our DLD/ILD license, (xi) the
impact of critical accounting policies, and (xii) the political, regulatory and
financial situation in the markets in which we operate, including macroeconomic
growth, the inflow of direct foreign investment and the effect of the
Telecommunications Law and its supporting regulations, are forward-looking and
concern the Company's projected operations, economic performance and financial
condition. These forward-looking statements are made pursuant to the safe harbor
provisions of the Securities Litigation Reform Act of 1995. It is important to
note that such statements involve risks and uncertainties and that actual
results may differ materially from those expressed or implied by such
forward-looking statements. Among the key factors that have a direct bearing on
the Company's results of operations, economic performance and financial
condition are the commercial and execution risks associated with implementing
the Company's business plan, including our assessment of additional provisions,
our ability to effectively deploy our FTN, our ability to develop our fiber
optic, broadband and DSL strategies, our ability to integrate recently acquired
companies into our operations, the political, economic and legal environment in
the markets in which the Company operates, including the impact of the new
Telecommunications Law and its supporting regulations, increasing
competitiveness in the telecommunications and Internet-related businesses that
may limit growth opportunities, and increased and intense downward price
pressures on some of the services that we offer. These and other factors are
discussed herein under "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and elsewhere in this Report.
Additional information concerning factors that could cause results to differ
materially from those in the forward-looking statements are contained in this
Annual Report.
In addition, any statements that express, or involve discussions as to,
expectations, beliefs, plans, objectives, assumptions or future events or
performance (often, but not always, through the use of words or phrases such as
"will likely result," "are expected to," "estimated," "intends," "plans,"
"projection" and "outlook") are not historical facts and may be forward-looking
and, accordingly, such statements involve estimates, assumptions and
uncertainties which could cause actual results to differ materially from those
expressed in the forward-looking statements. Accordingly, any such statements
are qualified in their entirety by reference to, and are accompanied by, the
factors discussed throughout this Report and investors, therefore, should not
place undue reliance on any such forward-looking statements.
Further, any forward-looking statement speaks only as of the date on which such
statement is made, and the Company undertakes no obligation to update any
forward-looking statement or statements to reflect events or circumstances after
the date on which such statement is made or to reflect the occurrence of
unanticipated events. New factors may emerge from time to time, and it is not
possible for management to predict all of such factors. Further, management
cannot assess the impact of each such factor on the Company's business or the
extent to which any factor, or combination of factors, may cause actual results
to differ materially from those contained in any forward-looking statements.
(GOLDEN TELECOM INC. LOGO) ANNUAL REPORT 2005
Report of Independent Registered
Public Accounting Firm
THE BOARD OF DIRECTORS AND SHAREHOLDERS OF GOLDEN TELECOM, INC.
We have audited the accompanying consolidated balance sheets of Golden Telecom,
Inc. as of December 31, 2004 and 2005, and the related consolidated statements
of operations, cash flows, and shareholders' equity for each of the three years
in the period ended December 31, 2005. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Golden Telecom,
Inc. at December 31, 2004 and 2005, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
December 31, 2005, in conformity with U.S. generally accepted accounting
principles.
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of Golden Telecom,
Inc.'s internal control over financial reporting as of December 31, 2005, based
on criteria established in Internal Control - Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission and our report
dated March 15, 2006 expressed an unqualified opinion thereon.
/s/ ERNST & YOUNG LLC
ERNST & YOUNG LLC
Moscow, Russia
March 15, 2006
52-53
CONSOLIDATED BALANCE SHEETS
AT DECEMBER 31,
--------------------------
US$'000s (EXCEPT PER SHARE DATA) 2004 2005
---------- ----------
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 53,699 $ 67,176
Accounts receivable, net of allowance for doubtful accounts of $23,205
and $27,327 at December 31, 2004 and 2005, respectively 89,177 91,709
VAT receivable 19,022 21,986
Prepaid expenses 13,793 8,083
Deferred tax asset 7,863 8,994
Other current assets 16,738 13,009
---------- ----------
TOTAL CURRENT ASSETS 200,292 210,957
PROPERTY AND EQUIPMENT:
Telecommunications equipment 396,060 494,097
Telecommunications network held under capital leases 28,958 32,538
Furniture, fixtures and equipment 34,721 41,524
Other property 12,797 16,374
Construction in progress 61,136 70,470
---------- ----------
533,672 655,003
Accumulated depreciation (185,781) (247,096)
---------- ----------
Net property and equipment 347,891 407,907
GOODWILL AND INTANGIBLE ASSETS:
Goodwill 146,254 149,249
Telecommunications service contracts, net of accumulated amortization of
$21,917 as of December 31, 2004 and $32,009 as of December 31, 2005 70,333 67,357
Contract-based customer relationships, net of accumulated amortization of
$10,883 as of December 31, 2004 and $18,241 as of December 31, 2005 25,966 18,608
Licenses, net of accumulated amortization of $2,515 as of December 31, 2004
and $3,182 as of December 31, 2005 1,843 3,994
Other intangible assets, net of accumulated amortization of $6,684
as of December 31, 2004 and $7,216 as of December 31, 2005 3,174 3,921
---------- ----------
Net goodwill and intangible assets 247,570 243,129
Restricted cash 1,012 566
Other non-current assets 9,003 19,652
---------- ----------
TOTAL ASSETS $ 805,768 $ 882,211
========== ==========
The accompanying notes are an integral part of these financial statements.
(GOLDEN TELECOM INC. LOGO) ANNUAL REPORT 2005
Consolidated Balance Sheets (continued)
AT DECEMBER 31,
--------------------------
US$'000s (EXCEPT PER SHARE DATA) 2004 2005
---------- ----------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable and accrued expenses $ 81,474 $ 89,404
VAT Payable 14,235 17,190
Current capital lease obligations 2,301 1,941
Deferred revenue 11,761 16,799
Due to affiliates and related parties 3,199 2,470
Other current liabilities 3 572 4,079
---------- ----------
TOTAL CURRENT LIABILITIES 116,542 131,883
Long-term debt, less current portion 200 27
Long-term deferred tax liability 24,244 22,287
Long-term deferred revenue 23,124 30,878
Long-term capital lease obligations 1,538 2,340
Other non-current liabilities 2,001 --
---------- ----------
TOTAL LIABILITIES 167,649 187,415
Minority interest 11,738 19,693
SHAREHOLDERS' EQUITY
Preferred stock, $0.01 par value (10,000,000 shares authorized;
none issued and outstanding at December 31, 2004 and 2005) -- --
Common stock, $0.01 par value (100,000,000 shares authorized;
36,322,490 and 36,458,490 shares issued and outstanding at
December 31, 2004 and 2005, respectively) 363 365
Additional paid-in capital 669,777 671,998
Deferred equity compensation -- (455)
Retained earnings (accumulated deficit) (43,759) 3,195
---------- ----------
TOTAL SHAREHOLDERS' EQUITY 626,381 675,103
---------- ----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 805,768 $ 882,211
---------- ----------
The accompanying notes are an integral part of these financial statements.
54-55
Consolidated Statements of Operations
YEAR ENDED DECEMBER 31,
---------------------------------------
US$'000s (EXCEPT PER SHARE DATA) 2003 2004 2005
--------- --------- ---------
REVENUE:
Telecommunication services $ 358,724 $ 581,521 $ 662,742
Revenue from affiliates and related parties 1,810 2,457 4,637
--------- --------- ---------
TOTAL REVENUE 360,534 583,978 667,379
OPERATING COSTS AND EXPENSES:
Access and network services (excluding depreciation and amortization) 181,085 300,588 347,532
Selling, general and administrative (excluding depreciation
and amortization) 64,384 112,855 119,890
Depreciation and amortization 45,334 74,999 84,015
--------- --------- ---------
TOTAL OPERATING EXPENSES 290,803 488,442 551,437
--------- --------- ---------
INCOME FROM OPERATIONS 69,731 95,536 115,942
OTHER INCOME (EXPENSE):
Equity in earnings of ventures 4,687 278 460
Interest income 1,084 1,131 2,295
Interest expense (1,956) (572) (618)
Foreign currency gain (loss) (232) 660 (1,212)
--------- --------- ---------
TOTAL OTHER INCOME 3,583 1,497 925
--------- --------- ---------
Income before minority interest and income taxes 73,314 97,033 116,867
Minority interest 480 1,506 2,978
Income taxes 17,399 30,744 37,816
--------- --------- ---------
NET INCOME $ 55,435 $ 64,783 $ 76,073
--------- --------- ---------
BASIC EARNINGS PER SHARE OF COMMON STOCK:
Net income per share - basic $ 1.95 $ 1.79 $ 2.09
--------- --------- ---------
Weighted average common shares outstanding - basic 28,468 36,226 36,378
--------- --------- ---------
DILUTED EARNINGS PER SHARE OF COMMON STOCK:
Net income per share - diluted $ 1.90 $ 1.77 $ 2.08
--------- --------- ---------
Weighted average common shares outstanding - diluted 29,107 36,553 36,605
--------- --------- ---------
Cash dividends per share $ -- $ 0.80 $ 0.80
--------- --------- ---------
The accompanying notes are an integral part of these financial statements.
(GOLDEN TELECOM INC. LOGO) ANNUAL REPORT 2005
Consolidated Statements of Cash Flows
YEAR ENDED DECEMBER 31,
---------------------------------------
US$'000s 2003 2004 2005
--------- --------- ---------
OPERATING ACTIVITIES
Net income $ 55,435 $ 64,783 $ 76,073
ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH
PROVIDED BY OPERATING ACTIVITIES:
Depreciation 34,837 56,818 65,329
Amortization 10,497 18,181 18,686
Equity in earnings (4,687) (278) (460)
Minority interest 480 1,506 2,978
Foreign currency (gain) loss 232 (660) 1,212
Deferred tax benefit (3,117) (4,606) (3,815)
Bad debt expense 3,592 10,065 7,967
Other (54) (41) 1,223
CHANGES IN ASSETS AND LIABILITIES:
Accounts receivable (15,302) (22,964) (10,316)
Accounts payable and accrued expenses (3,928) 26,288 4,295
Other assets and liabilities 9,031 (3,908) 11,134
--------- --------- ---------
NET CASH PROVIDED BY OPERATING ACTIVITIES 87,016 145,184 174,306
INVESTING ACTIVITIES
Purchases of property and equipment and intangible assets (63,737) (114,649) (118,170)
Acquisitions, net of cash acquired (12,282) (15,522) (18,085)
Restricted cash 510 (7) 446
Distribution received from affiliated company 4,733 -- --
Other investing 2,704 1,705 2,743
--------- --------- ---------
NET CASH USED IN INVESTING ACTIVITIES (68,072) (128,473) (133,066)
FINANCING ACTIVITIES
Repayment of debt (35,132) (950) (253)
Contribution from minority partner -- -- 3,840
Net proceeds from exercise of employee stock options 23,737 4,895 1,435
Cash dividends paid -- (28,998) (29,119)
Other financing (1,910) (3,385) (3,210)
--------- --------- ---------
NET CASH USED IN FINANCING ACTIVITIES (13,305) (28,438) (27,307)
Effect of exchange rate changes on cash and cash equivalents (84) 246 (456)
--------- --------- ---------
Net increase (decrease) in cash and cash equivalents 5,555 (11,481) 13,477
Cash and cash equivalents at beginning of period 59,625 65,180 53,699
--------- --------- ---------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 65,180 $ 53,699 $ 67,176
========= ========= =========
The accompanying notes are an integral part of these financial statements.
Consolidated Statements of Shareholders' Equity
YEARS ENDED DECEMBER 31, 2003, 2004, AND 2005
---------------------------------------------------------------------------------
RETAINED
ADDITIONAL DEFERRED EARNINGS
COMMON STOCK PAID-IN EQUITY (ACCUMULATED TOTAL
US$'000s SHARES AMOUNT CAPITAL COMPENSATION DEFICIT) EQUITY
---------------------------------- --------- --------- ---------- ------------ ------------ ---------
BALANCE AT DECEMBER 31, 2002 27,021 $ 270 $ 446,215 $ -- $(134,979) $ 311,506
Exercise of employee stock options 1,919 19 23,834 -- -- 23,853
Acquisition of OAO Comincom 7,008 70 193,415 -- -- 193,485
Net income -- -- -- -- 55,435 55,435
--------- --------- --------- --------- --------- ---------
BALANCE AT DECEMBER 31, 2003 35,948 $ 359 $ 663,464 $ -- $ (79,544) $ 584,279
Exercise of employee stock options 374 4 4,775 -- -- 4,779
Sale of 20% of Golden Telecom
(Ukraine) (see note 17) -- -- 1,538 -- -- 1,538
Cash dividends paid -- -- -- -- (28,998) (28,998)
Net income -- -- -- -- 64,783 64,783
--------- --------- --------- --------- --------- ---------
BALANCE AT DECEMBER 31, 2004 36,322 $ 363 $ 669,777 $ -- $ (43,759) $ 626,381
Issuance of restricted shares
(see note 9) 27 1 771 (772) -- --
Compensation expense -- -- -- 317 -- 317
Exercise of employee stock options 109 1 1,450 -- -- 1,451
Cash dividends paid -- -- -- -- (29,119) (29,119)
Net income -- -- -- -- 76,073 76,073
--------- --------- --------- --------- --------- ---------
BALANCE AT DECEMBER 31, 2005 36,458 $ 365 $ 671,998 $ (455) $ 3,195 $ 675,103
========= ========= ========= ========= ========= =========
The accompanying notes are an integral part of these financial statements.
(GOLDEN TELECOM INC. LOGO) ANNUAL REPORT 2005
Notes to Consolidated Financial Statements
NOTE 1: NATURE OF BUSINESS OPERATIONS
Golden Telecom, Inc. ("GTI" or the "Company") is a leading facilities-based
provider of integrated telecommunication and Internet services in major
population centers throughout Russia and other countries of the Commonwealth of
Independent States ("CIS"). The Company offers voice, data and Internet services
to corporations, operators and consumers using its metropolitan overlay network
in major cities throughout Russia, Ukraine, Kazakhstan, and Uzbekistan, and via
intercity fiber optic and satellite-based networks, including approximately 259
combined access points in Russia and other countries of the CIS. The Company
offers mobile services in Kiev and Odessa in Ukraine. GTI was incorporated in
Delaware on June 10, 1999 for the purpose of acting as a holding company for
Global TeleSystems, Inc.'s ("GTS") operating entities within the CIS and
supporting non-CIS holding companies (the "CIS Entities"). On September 29,
1999, GTS transferred its ownership rights in the CIS Entities to the Company in
anticipation of the Company's initial public offering which closed on October 5,
1999.
NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND RECENT ACCOUNTING
PRONOUNCEMENTS
PRINCIPLES OF CONSOLIDATION
Wholly owned subsidiaries and majority owned ventures where the Company has
operating and financial control are consolidated. All significant inter-company
accounts and transactions are eliminated upon consolidation. Results of
subsidiaries acquired and accounted for by the purchase method have been
included in operations from the relevant date of acquisition.
Those ventures where the Company exercises significant influence, but does not
exercise operating and financial control are accounted for by the equity method.
The Company will discontinue applying the equity method of accounting for the
Company's equity method investments when its share of the investees losses
reduces the investments in and advances to ventures to zero. Thereafter, the
Company will not provide for additional losses unless the Company has guaranteed
obligations of the investee or is otherwise committed to provide further support
for the investee. If the investee subsequently reports net income, the Company
will resume the equity method only after the Company's share of net income
equals the share of net loss not recognized during the period the equity method
was suspended.
SALE OF SUBSIDIARY STOCK
The Company recognizes gains in the consolidated statement of operations for
sales of subsidiary stock where the value of the proceeds can be objectively
determined and realization of the gain is reasonably assured. The Company
accounts for sales of subsidiary stock where the value of the proceeds can not
be objectively determined or realization of the gain is not reasonable assured
as an equity transaction in the Company's consolidated financial statements.
Once the accounting treatment of the gain or loss on issuance of shares by a
specific entity has been determined, the Company consistently follows that
treatment for all future issuances of shares by that particular subsidiary.
FOREIGN CURRENCY TRANSLATION
The functional currency of all the Company's foreign subsidiaries is the United
States dollar ("USD") because the majority of their revenues, costs, property
and equipment purchased, and debt and trade liabilities is either priced,
incurred, payable or otherwise measured in USD. Each of the legal entities
domiciled in the CIS maintains its records and prepares its financial statements
in the local currency, principally either Russian rubles or Ukrainian hryvna, in
accordance with the requirements of domestic accounting and tax legislation. The
accompanying financial statements differ from the financial statements used for
statutory purposes in the CIS and other non-US jurisdictions in that they
reflect certain adjustments, recorded on the entities' books, which are
appropriate to present the financial position, results of operations and cash
flows in accordance with accounting principles generally accepted in the United
States of America ("US GAAP"). The principal adjustments are related to revenue
recognition, foreign currency translation, deferred taxation, consolidation, and
depreciation and valuation of property and equipment and intangible assets.
The Company follows a remeasurement policy in accordance with Statement of
Financial Accounting Standard ("SFAS") No. 52, "Foreign Currency Translation,"
as amended by SFAS No. 130, "Reporting Comprehensive Income". The temporal
method is used for translating assets and liabilities of the Company's legal
entities domiciled in the CIS and other non-United States jurisdictions.
Accordingly, monetary assets and liabilities are translated at current exchange
rates while non-monetary assets and liabilities are translated at their
historical rates. Income and expense accounts are translated at average monthly
rates of exchange. The resultant translation
58-59
adjustments are included in the operations of the subsidiaries and ventures.
Generally, the ruble is not convertible outside of Russia. The official exchange
rate which is established by the Central Bank of Russia is a reasonable
approximation of market rate. The official exchange rates which are used for
translation in the accompanying financial statements at the balance sheet date
were 27.75 and 28.78 rubles per USD as of December 31, 2004 and 2005,
respectively. Through December 31, 2002, Russia has been considered to be a
highly inflationary environment. From January 1, 2003, Russia ceased to be
considered as a highly inflationary economy. The change had no impact on the
consolidated financial statements.
The translation of local currency denominated assets and liabilities into USD
for the purpose of these financial statements does not indicate that the Company
could realize or settle in USD the reported values of the assets and
liabilities. Likewise, it does not indicate that the Company could return or
distribute the reported USD value of capital to its shareholders.
CASH AND CASH EQUIVALENTS AND RESTRICTED CASH
The Company classifies cash on hand and deposits in banks, including commercial
paper, money market accounts, and any other investments with an original
maturity of three months or less from the date of purchase, that the Company may
hold from time to time, as cash and cash equivalents. Restricted cash is
primarily related to cash held in escrow at a financial institution for the
collateralization of debt obligations that certain of the Company's consolidated
subsidiaries and equity ventures have borrowed from such financial institution.
ACCOUNTS RECEIVABLE
Accounts receivable are shown at their net realizable value which approximates
their fair value. The allowance for doubtful accounts is estimated by a
combination of applying estimated loss percentages against the aging of accounts
receivable and specific identification. Bad debt expense for the years ended
December 31, 2003, 2004 and 2005 was $3.6 million, $10.1 million and $8.0
million, respectively.
INVENTORIES
Inventories, which are classified as other current assets, are stated at the
lower of cost or market. Cost is computed on either a specific identification
basis or a weighted average basis.
PROPERTY AND EQUIPMENT
Property and equipment is stated at cost. Depreciation is calculated on a
straight-line basis over the lesser of the estimated lives, ranging from five to
ten years for telecommunications equipment, three to five years for furniture,
fixtures and equipment, and five to twenty years for other property, or their
contractual term. Construction in process reflects amounts incurred for the
configuration and build-out of telecommunications equipment not yet placed into
service. Maintenance and repairs are charged to expense as incurred. The Company
has included in property and equipment, capitalized leases in the amount of
$29.0 million and $32.5 million at December 31, 2004 and 2005, respectively,
with associated accumulated depreciation of $13.4 million and $17.7 million as
of December 31, 2004 and 2005, respectively. Depreciation of assets recorded
under capital leases is included with depreciation expense for the years ended
December 31, 2003, 2004, and 2005.
GOODWILL AND INTANGIBLE ASSETS
Goodwill represents the excess of acquisition costs over the fair value of the
net assets of acquired businesses. Beginning January 1, 2002, goodwill has been
identified as an indefinite lived asset in accordance with SFAS No. 142,
"Goodwill and Other Intangible Assets", and accordingly amortization of goodwill
ceased as of that date. Intangible assets, which are stated at cost, consist
principally of telecommunications service contracts, contract based customer
relationships, licenses, software and content and are amortized on a
straight-line basis over the lesser of their estimated useful lives, generally
five to ten years, or their contractual term. In accordance with Accounting
Principles Board ("APB") Opinion No. 17, "Intangible Assets" and SFAS No. 142
"Goodwill and Other Intangible Assets", the Company continues to evaluate the
amortization period to determine whether events or circumstances warrant revised
amortization periods. Additionally, the Company considers whether the carrying
value of such assets should be reduced based on the future benefits.
GOODWILL IMPAIRMENT ASSESSMENT
Goodwill is reviewed annually, as of the beginning of the fourth quarter, for
impairment or whenever it is determined that impairment indicators exist. The
Company determines whether an impairment has occurred by assigning goodwill to
the reporting units identified in accordance with SFAS No. 142, "Goodwill and
Other Intangible Assets", and comparing the carrying amount of the reporting
unit to the fair value of
(GOLDEN TELECOM INC. LOGO) ANNUAL REPORT 2005
the reporting unit. If a goodwill impairment has occurred, the Company
recognizes a loss for the difference between the carrying amount and the implied
fair value of goodwill. No such losses were recognized in the three years ended
December 31, 2003, 2004 and 2005.
LONG-LIVED ASSETS IMPAIRMENT
Long-lived assets to be held and used by the Company are reviewed to determine
whether an event or change in circumstances indicates that the carrying amount
of the asset may not be recoverable. For long-lived assets to be held and used,
the Company bases its evaluation on such impairment indicators as the nature of
the assets, the future economic benefit of the assets, any historical or future
profitability measurements, as well as other external market conditions or
factors that may be present. If such impairment indicators are present or other
factors exist that indicate that the carrying amount of the asset may not be
recoverable, the Company determines whether an impairment has occurred through
the use of an undiscounted cash flows analysis of assets at the lowest level for
which identifiable cash flows exist. If impairment has occurred, the Company
recognizes a loss for the difference between the carrying amount and the fair
value of the asset. The fair value of the asset is measured using discounted
cash flow analysis or other valuation techniques. No such losses were recognized
in the three years ended December 31, 2003, 2004 and 2005.
INCOME TAXES
The Company accounts for income taxes using the liability method required by
SFAS No. 109, "Accounting for Income Taxes." For interim reporting purposes, the
Company also follows the provisions of APB No. 28, "Interim Financial
Reporting," which requires the Company to account for income taxes based on the
Company's best estimate of the effective tax rate expected to be applicable for
the full fiscal year on a current year-to-date basis. The rate so determined is
based on the currently enacted tax rates of the Company in the United States and
the Company's subsidiaries in Russia and other CIS countries and includes the
Company's best estimate of the annual tax effect of non-deductible expenses,
primarily related to amortization of intangible assets, foreign exchange and
other permanent differences as well as the estimates as to the realization of
certain deferred tax assets. Deferred income taxes result from temporary
differences between the tax bases of assets and liabilities and the bases as
reported in the consolidated financial statements. The Company does not provide
for deferred taxes on the undistributed earnings of its foreign subsidiaries, as
such earnings are generally intended to be reinvested in those operations
permanently. In the case of non-consolidated entities, where our partner
requests that a dividend be paid, the amounts are not expected to have a
material impact on the Company's income tax liability. It is not practical to
determine the amount of unrecognized deferred tax liability for such reinvested
earnings.
REVENUE RECOGNITION
The Company records as revenue the amount of telecommunications and Internet
services rendered, as measured primarily by the minutes of traffic processed and
the time spent online using our Internet services. Revenue from service
contracts is accounted for when the services are provided. Billings received in
advance of service being performed are deferred and recognized as revenue as the
service is performed. The Company also defers up front connection fees which are
recognized over the estimated life of the customer. The Company recognizes
revenue from equipment sales when title to the equipment passes to the customer.
The Company defers the revenue on installed equipment until installation and
testing are completed and accepted by the customer. Revenues are stated net of
any value-added taxes charged to customers.
The Company has deferred connection fees and capitalized direct incremental
costs related to connection fees, not exceeding the revenue deferred. The
deferral of revenue and capitalization of cost of revenue related to connection
fees will be recognized over the estimated life of the customer, which is five
years in the Business and Corporate Services division and Operator and Carrier
Services division and eighteen months for the customers in the Mobile Services
division. The total amount of deferred connection fees revenue was $33.8 million
and $47.7 million as of December 31, 2004 and 2005, respectively. The total
amount of capitalized direct incremental costs related to connection fees was
$8.0 million and $11.5 million as of December 31, 2004 and 2005, respectively.
In November 2002, the Financial Accounting Standards Board ("FASB") Emerging
Issues Task Force issued its consensus concerning Revenue Arrangements with
Multiple Deliverables ("EITF 00-21"). EITF 00-21 addresses how to determine
whether a revenue arrangement involving multiple deliverables should be divided
into separate units of accounting, and, if separation is appropriate, how the
arrangement consideration should be measured and allocated to the identified
accounting units. The guidance in EITF 00-21 is effective for revenue
60-61
arrangements entered into in fiscal periods beginning after June 15, 2003. The
adoption of EITF 00-21 did not have a material impact on the Company's
consolidated financial position or results of operations.
ADVERTISING
The Company expenses the cost of advertising as incurred. Advertising expenses
for the years ended December 31, 2003, 2004 and 2005 were $5.2 million, $4.7
million and $4.4 million, respectively.
GOVERNMENT PENSION FUNDS
The Company contributes to the local state pension funds and social funds, on
behalf of all its CIS employees. In Russia, all social contributions, including
contributions to the pension fund, are made through a unified social tax ("UST")
calculated by the application of a regressive rate from 26% to 2% to the annual
gross remuneration of each employee which was 35.6% to 2% before January 1,
2005. In 2003 and 2004, the Company allocated UST to three social funds,
including the pension fund, where the rate of contributions to the pension fund
varied from 28% to 2%, respectively, depending on the annual gross salary of
each employee. Starting from January 1, 2005, the Company allocates UST to the
three social funds, including the pension fund, where the rate of contribution
to the pension fund varies from 20% to 2%. The contributions are expensed as
incurred.
COMPREHENSIVE INCOME
Comprehensive income is defined as the change in equity of a business enterprise
during a period from non-owner sources. For the years ended December 31, 2003,
2004 and 2005, comprehensive income for the Company is equal to net income.
OFF BALANCE SHEET RISK AND CONCENTRATION OF CREDIT RISK
Financial instruments that potentially subject the Company to concentration of
credit risk consist primarily of cash, cash equivalents, and accounts and notes
receivable. Of the $67.2 million of cash and cash equivalents held at December
31, 2005, $32.4 million was held in United States ("US") money market
instruments in US financial institutions. The remaining balance is being
maintained in US-owned banks and local financial institutions within the CIS.
The Company extends credit to various customers, principally in Russia and
Ukraine, and establishes an allowance for doubtful accounts for specific
customers that it determines to have significant credit risk. The Company
generally does not require collateral to extend credit to its customers.
STOCK-BASED COMPENSATION
Until January 1, 2006, the Company followed the provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation," for its Equity Participation Plan and
Stock Appreciation Rights ("SAR"s) Plans. SFAS No. 123 establishes a fair value
method of accounting for employee stock options and similar equity instruments.
The fair value method requires compensation cost to be measured at the grant
date based on the value of the award and to be recognized over the service
period. SFAS No. 123 generally allowed companies to either account for
stock-based compensation under the fair value method of SFAS No. 123 or under
the intrinsic value method of APB No. 25, "Accounting for Stock Issued to
Employees." The Company had elected to account for its stock-based compensation
in accordance with the provisions of APB No. 25 and present pro forma
disclosures of results of operations as if the fair value method had been
adopted. The intrinsic value of the SARs, which are classified as liability
awards, and the related compensation expense are re-measured at the end of each
reporting period.
In December 2004, the FASB issued SFAS No. 123R (revised 2004), "Share Based
Payment", which is a revision of SFAS No. 123, "Accounting for Stock-Based
Compensation" SFAS No. 123R supersedes APB No. 25, "Accounting for Stock Issued
to Employees and amends SFAS No. 95, "Statement of Cash Flows". Under SFAS No.
123R, companies must calculate and record the cost of equity instruments, such
as stock options or restricted stock, awarded to employees for services received
in the income statement; pro forma disclosure is no longer permitted. The cost
of the equity instruments is to be measured based on fair value of the
instruments on the date they are granted (with certain exceptions) and is
required to be recognized over the period during which the employees are
required to provide services in exchange for the equity instruments. In April
2005, the Securities and Exchange Commission delayed the effective date of SFAS
No. 123R until January 1, 2006 for calendar year companies.
SFAS No. 123R provides two alternatives for adoption: (1)a "modified
prospective" method in which compensation cost is recognized for all awards
granted subsequent to the effective date of this SFAS No. 123R as well as for
the unvested portion of awards outstanding as of the effective date and (2) a
"modified retrospective" method which follows the approach in the "modified
prospective" method, but also permits entities to restate prior periods to
reflect compensation cost calculated under SFAS No. 123 for pro forma amounts
disclosure. The Company plans to adopt SFAS No. 123R using the modified
(GOLDEN TELECOM INC. LOGO) ANNUAL REPORT 2005
prospective method. As the Company currently accounts for stock options issued
to employees in accordance with the intrinsic value method permitted under APB
No. 25, no compensation expense is recognized. The Company currently accounts
for SARs by remeasuring the intrinsic value of the SARs at each reporting period
and adjusts compensation expense and the related liability for the change in
intrinsic value. As of January 1, 2006, the Company will account for SARs at
fair value, in compliance with SFAS No. 123R. The impact of adopting SFAS No.
123R cannot be accurately estimated at this time, as the incremental
compensation expense will depend, among other factors, on the amount of share
based awards granted in future periods. SFAS No. 123R also requires that tax
benefits received in excess of compensation cost be reclassified from an
operating cash flow to a financing cash flow in the Consolidated Statement of
Cash Flows. This change in classification will reduce net operating cash flows
and increase net financing cash flows in the periods after adoption.
The effect of applying SFAS No. 123 on the reported net income, as disclosed
below is not representative of the effects on net income in future years due to
the vesting period of the stock options, the effect of the adoption of SFAS No.
123R, as described above, with respect to SARs, and the fair value of additional
stock options in future years.
TWELVE MONTHS ENDED DECEMBER 31,
----------------------------------------
US$'000s (EXCEPT PER SHARE DATA) 2003 2004 2005
---------- ---------- ----------
NET INCOME, AS REPORTED $ 55,435 $ 64,783 $ 76,073
Deduct: total stock-based employee compensation expense determined under
fair value based method for all awards, net of related tax effects 3,183 1,922 620
---------- ---------- ----------
PRO FORMA NET INCOME $ 52,252 $ 62,861 $ 75,453
---------- ---------- ----------
NET INCOME PER SHARE:
Basic - as reported $ 1.95 $ 1.79 $ 2.09
Basic - pro forma 1.84 1.74 2.07
Diluted - as reported 1.90 1.77 2.08
Diluted - pro forma 1.80 1.72 2.06
CONSOLIDATION OF VARIABLE INTEREST ENTITIES
In January 2003, the FASB issued FASB Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN No. 46"). FIN No. 46 amended Accounting
Research Bulletin No. 51, "Consolidated Financial Statements", and established
standards for determining under what circumstances a variable interest ("VIE")
should be consolidated with its primary beneficiary. FIN No. 46 also requires
disclosure about VIEs that are not required to be consolidated but in which the
reporting entity has a significant variable interest. In December 2003, the FASB
revised certain implementation provisions of FIN No. 46. The revised
interpretation ("FIN No. 46R") substantially retained the requirements of
immediate application of FIN No. 46 to VIEs created after January 31, 2003.
There were no such entities created after January 31, 2003. With respect to
older VIEs, the consolidation requirements under FIN No. 46R apply not later
than for the first financial year or interim period ending after December 15,
2003, if such VIE is a special-purpose entity ("SPE"), and no later than for the
first financial year or interim period ending after March 15, 2004, if such a
VIE is not a SPE. The Company did not identify any previously formed VIEs.
Therefore the adoption of FIN No. 46R did not have an impact on the financial
position or results of operations.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts for cash and cash equivalents, accounts receivable,
accounts payable, accrued liabilities, and short- and long-term debt approximate
their fair value. The fair value of notes receivable, including the long-term
portion that are included in other current and non-current assets, respectively
was $3.7 million at December 31, 2004 as determined by discounting future
payments by 5.0%. At December 31, 2005, notes receivable consisted of only the
current portion which approximates fair value. At December 31, 2004 and 2005,
the Company held no debt at fixed rates.
62-63
EXCHANGES OF NONMONETARY ASSETS
In December 2004, the FASB issued SFAS No. 153, "Exchanges of Nonmonetary
Assets". SFAS No. 153 addresses the measurement of exchanges of nonmonetary
assets. SFAS No. 153 amends APB No. 29 to eliminate the exception for
nonmonetary exchanges of similar productive assets and replaces it with a
general exception for exchanges of nonmonetary assets that do not have
commercial substance.
A nonmonetary exchange has commercial substance if the future cash flows of the
entity are expected to change significantly as a result of the exchange. This
provisions of SFAS No. 153 are effective for financial statements for fiscal
years beginning after June 15, 2005. Earlier application is permitted for
nonmonetary asset exchanges incurred during fiscal years beginning after the
date SFAS No. 153 was issued. The adoption of the provisions of SFAS No. 153 did
not have a material impact on the Company's results of operations, financial
position or cash flow.
ASSET RETIREMENT OBLIGATIONS
In March 2005, the FASB issued FASB Interpretation No. 47 ("FIN No. 47"),
"Accounting for Conditional Assets Retirement Obligations". FIN No. 47 clarifies
that an entity must record a liability for a "conditional" asset retirement
obligation if the fair value of the obligation can be reasonably estimated. FIN
No. 47 is effective no later than the end of the fiscal year ending after
December 15, 2005. The adoption of FIN No. 47 did not have a material effect on
the financial position, results of operations, or cash flow.
ACCOUNTING CHANGES AND ERROR CORRECTIONS
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error
Corrections", which is a replacement of APB Opinion No. 20, "Accounting Changes"
and SFAS No. 3, "Reporting Changes in Interim Financial Statements". SFAS No.
154 applies to all voluntary changes in accounting principle and changes the
accounting for and reporting of a change in accounting principle. SFAS No. 154
requires retrospective application to prior periods' financial statements of a
voluntary change in accounting principle unless it is impracticable. In
addition, SFAS No. 154 requires that a change in method of depreciation,
amortization, or depletion for long-lived, nonfinancial assets be accounted for
as a change in accounting estimate that is effected by a change in accounting
principle. SFAS No. 154 is effective for accounting changes and corrections of
errors made in fiscal years beginning after December 15, 2005. The impact
adopting SFAS No. 154 cannot be accurately estimated at this time as no such
accounting changes are currently contemplated.
CHANGE IN ACCOUNTING ESTIMATE
Prior to the second quarter of 2005, the Company recorded estimates for unused
vacation based on the average salary levels for the Company's employees and
total days of unused vacation of employees. During the second quarter of 2005,
the Company revised estimates for unused vacation based on the actual daily
salary and unused vacation of each employee. Management determined that this
methodology results in a more accurate estimate of the amount of the Company's
obligations for unused vacation. The change in accounting estimate decreased net
income for the twelve months ended December 31, 2005 by approximately $1.3
million, net of tax, including the associated payroll taxes, (equivalent to
$0.04 per common share -basic and $0.04 per common share - diluted).
USE OF ESTIMATES IN PREPARATION OF FINANCIAL STATEMENTS
The preparation of these consolidated financial statements, in conformity with
US GAAP, requires management to make estimates and assumptions that affect
amounts in the financial statements and accompanying notes and the reported
amounts of revenues and expenses during the reporting period. Actual results
could differ from those estimates.
COMPARATIVE FIGURES
Certain prior year amounts have been reclassified to conform to the presentation
adopted in the current year. Such reclassifications did not affect the
consolidated statements of operations.
(GOLDEN TELECOM INC. LOGO) ANNUAL REPORT 2005
NOTE 3: NET INCOME PER SHARE
Basic earnings per share at December 31, 2004 and 2005 is computed on the basis
of the weighted average number of common shares outstanding. Diluted earnings
per share at December 31, 2004 and 2005 is computed on the basis of the weighted
average number of common shares outstanding plus the effect of outstanding
employee stock options using the "treasury stock" method. The number of stock
options excluded from the diluted earnings per share computation, because their
effect was antidilutive for the twelve months ended December 31, 2004 and 2005
was 10,000 stock options. The components of basic and diluted earnings per share
were as follows:
TWELVE MONTHS ENDED DECEMBER 31,
----------------------------------------
US'000s (EXCEPT PER SHARE DATA) 2003 2004 2005
---------- ---------- ----------
NET INCOME $ 55,435 $ 64,783 $ 76,073
---------- ---------- ----------
WEIGHTED AVERAGE SHARES OUTSTANDING OF:
Common stock 28,468 36,226 36,378
DILUTIVE EFFECT OF:
Employee stock options 639 327 227
---------- ---------- ----------
COMMON STOCK AND COMMON STOCK EQUIVALENTS 29,107 36,553 36,605
---------- ---------- ----------
NET INCOME PER SHARE:
Basic $ 1.95 $ 1.79 $ 2.09
---------- ---------- ----------
Diluted $ 1.90 $ 1.77 $ 2.08
---------- ---------- ----------
NOTE 4: GOODWILL AND INTANGIBLE ASSETS
Amortization expense for intangible assets for the twelve months ended December
31, 2003, 2004 and 2005 was $10.5 million, $18.2 million and $18.7 million,
respectively. Amortization expense for the succeeding five years is expected to
be as follows: 2006 -$18.1 million, 2007 -$17.1 million, 2008 -$15.3 million,
2009 -$10.0 million and 2010 -$9.5 million. The total gross carrying value and
accumulated amortization of the Company's intangible assets by major intangible
asset class is as follows:
AS OF DECEMBER 31, 2004 AS OF DECEMBER 31, 2005
----------------------------- -----------------------------
WEIGHTED AVERAGE ACCUMULATED ACCUMULATED
AMORTIZATION LIVES COST AMORTIZATION COST AMORTIZATION
------------------ ------------ ------------ ------------ ------------
AMORTIZED INTANGIBLE ASSETS:
Telecommunications service contracts 10 years $ 92,250 $ (21,917) $ 99,366 $ (32,009)
Contract-based customer relationships 5 years 36,849 (10,883) 36,849 (18,241)
Licenses 8 years 4,358 (2,515) 7,176 (3,182)
Other intangible assets 4 years 9,858 (6,684) 11,137 (7,216)
------------ ------------ ------------ ------------
TOTAL $ 143,315 $ (41,999) $ 154,528 $ (60,648)
------------ ------------ ------------ ------------
64-65
Other intangible assets include software, Internet software and related content,
as well as other intangible assets.
The changes on the carrying amount of goodwill for the year ended December 31,
2004 and 2005, respectively, are as follows:
BUSINESS & CARRIER & CONSUMER
CORPORATE OPERATOR INTERNET
US$'000s SEGMENT SEGMENT SEGMENT TOTAL
------------ ------------ ------------ ------------
BALANCE AS OF DECEMBER 31, 2003 $ 84,892 $ 59,116 $ -- 144,008
Goodwill related to acquisitions 1,932 314 -- 2,246
------------ ------------ ------------ ------------
BALANCE AS OF DECEMBER 31, 2004 $ 86,824 $ 59,430 $ -- 146,254
Goodwill related to acquisitions 1,563 302 1,130 2,995
------------ ------------ ------------ ------------
BALANCE AS OF DECEMBER 31, 2005 $ 88,387 $ 59,732 $ 1,130 $ 149,249
============ ============ ============ ============
NOTE 5: BUSINESS COMBINATIONS ACQUISITIONS IN 2003
In August 2003, the Company completed the acquisition of 100% of OOO
Sibchallenge ("Sibchallenge"), a telecommunications service provider in
Krasnoyarsk, Russia. The total purchase price of approximately $15.4 million
consisted of cash consideration of approximately $15.0 million and approximately
$0.4 million in direct transaction costs, including an advisory fee of $0.3
million paid to Alfa Group Consortium ("Alfa"), a significant shareholder of the
Company. The acquisition of Sibchallenge establishes GTI's presence in the
Krasnoyarsk region. In addition, Sibchallenge has numbering capacity and
interconnect agreements. The acquisition of 100% of Sibchallenge was accounted
for as a purchase business combination in accordance with SFAS No. 141,
"Business Combinations". The following is the condensed balance sheet of
Sibchallenge as of August 31, 2003 reflecting purchase price allocation to the
net assets acquired:
US$'000S AUGUST 31, 2003
-------- ---------------
ASSETS
Current assets $ 1,792
Property and equipment 7,057
Telecommunications service contracts intangible assets, net 11,175
-----------
TOTAL ASSETS $ 20,024
===========
LIABILITIES:
Current liabilities $ 1,519
Non-current liabilities 3,121
-----------
NET ASSETS $ 15,384
===========
CONSOLIDATED AND ACQUISITION COSTS:
Cash consideration 15,000
Direct transaction costs 384
-----------
TOTAL PURCHASE CONSIDERATION AND TRANSACTION COSTS $ 15,384
===========
(GOLDEN TELECOM INC. LOGO) ANNUAL REPORT 2005
The Company's financial statements reflect the allocation of the purchase price
based on a fair value assessment of the assets acquired and liabilities assumed
and, as such, the Company has assigned approximately $11.2 million to
telecommunications service contracts intangible assets. These identified
intangible assets are amortized over a period of 10 years. There was no goodwill
recorded as a result of this transaction. The results of operations of
Sibchallenge have been included in the Company's consolidated operations since
August 31, 2003.
In December 2003, the Company completed the acquisition of 100% of the shares in
OAO Comincom ("Comincom") from Nye Telenor East Invest ("Telenor"), pursuant to
a Share Exchange Agreement. The total purchase price of approximately $195.3
million consisted of approximately $193.5 million in GTI's common stock,
representing 7,007,794 shares and direct transaction costs of approximately $1.8
million. The purchase consideration has been determined using the closing date
of the transaction as December 1, 2003. Accordingly, the GTI shares issued in
consideration are valued based on the average closing price of the Company's
common stock for the five consecutive trading days between November 26, 2003 and
December 2, 2003, which was $27.61 per share. Comincom provides
telecommunications services, principally to major hotels, business offices and
mobile communication companies through its telecommunications network in Russia,
including Moscow, St. Petersburg, Voronezh, Samara and several other major
population centers. The Company began consolidating the results of operations of
Comincom on December 1, 2003.
The acquisition of 100% of the shares in Comincom was accounted for as a
purchase business combination in accordance with SFAS No. 141, "Business
Combinations". The following is the condensed balance sheet of Comincom as of
December 1, 2003 reflecting the purchase price allocation to the net assets
acquired:
US$'000s DECEMBER 1, 2003
-----------------
ASSETS:
Current assets $ 38,191
Property and equipment 84,749
Telecommunications service contracts intangible assets, net 17,344
Contract-based customer relationship intangible assets, net 26,847
Licenses, net 546
Goodwill 72,305
Other assets 1,575
-----------------
TOTAL ASSETS $ 241,557
-----------------
LIABILITIES
Current liabilities $ 28,678
Non-current liabilities 17,535
-----------------
NET ASSETS $ 195,344
-----------------
CONSIDERATION AND ACQUISITION COSTS:
GTI shares consideration 193,485
Direct transaction costs 1,859
-----------------
TOTAL PURCHASE CONSIDERATION AND ACQUISITION COSTS $ 195,344
-----------------
66-67
The Company's financial statements reflect the allocation of the purchase price
based on a fair value assessment of the assets acquired and liabilities assumed,
and as such, the Company has assigned approximately $17.3 million to
telecommunications service contracts intangible assets which are amortized over
a weighted average period of approximately 10 years, approximately $26.8 million
to contract-based customer relationship intangible assets which are amortized
over a weighted average period of approximately 5 years, and approximately $0.5
million to licenses are be amortized over a weighted average period of 4 years.
Property and equipment was adjusted to fair value using a net current
replacement cost valuation method. The excess purchase price over the fair value
of the net tangible and intangible assets acquired of approximately $72.3
million has been assigned to goodwill and is not deductible for tax purposes.
Approximately $15.5 million of this goodwill has been assigned to the Carrier
and Operator Services reportable segment and approximately $56.8 million of this
goodwill has been assigned to the Business and Corporate Services reportable
segment. In accordance with SFAS No. 141, "Business Combinations", and SFAS No.
142 "Goodwill and Other Intangible Assets", the Company does not amortize the
goodwill recorded in connection with the acquisition of 100% of the shares in
Comincom. The goodwill is tested for impairment at least annually.
The following unaudited pro forma combined results of operations for the Company
give effect to the Sibchallenge and Comincom business combinations as if they
had occurred at the beginning of 2003. These pro forma amounts are provided for
informational purposes only and do not purport to present the results of
operations of the Company had the transactions assumed therein occurred on or as
of the date indicated, nor is it necessarily indicative of the results of
operations which may be achieved in the future.
TWELVE MONTHS ENDED
US$'000s (EXCEPT PER SHARE DATA) DECEMBER 31, 2003
-------------------
Revenue $ 458,276
Net income $ 61,802
---------------
BASIC EARNINGS PER SHARE OF COMMON STOCK:
Net income per share - basic $ 1.77
---------------
Weighted average common shares - basic 34,990
---------------
DILUTED EARNINGS PER SHARE OF COMMON STOCK:
Net income per share - diluted $ 1.74
---------------
Weighted average common shares - diluted 35,539
---------------
(GOLDEN TELECOM INC. LOGO) ANNUAL REPORT 2005
ACQUISITIONS IN 2004
In February 2004, the Company completed the acquisition of 100% ownership
interest in ST-HOLDING s.r.o. ("ST-HOLDINGS"), a Czech company that owns 50%
plus one share in ZAO Samara Telecom, a telecommunications service provider in
Samara, Russia from ZAO SMARTS and individual owners. In April 2004, the Company
completed the acquisition of 100% of the common stock in OAO Balticom Mobile
("Balticom") that owns 62% of ZAO WestBalt Telecom, an alternative
telecommunications operator in Kaliningrad, Russia. In April 2004, the Company
completed the acquisition of the remaining 49% ownership interest in OOO
Uralrelcom that the Company did not already own. In May 2004, the Company
completed the acquisition of a 54% ownership interest in SP Buzton ("Buzton"),
an alternative telecommunications operator in Uzbekistan. These acquisitions
were purchased for approximately $16.0 million in cash. The results of
ST-HOLDINGS have been included in the Company's consolidated operations since
February 1, 2004. The results of Balticom have been included in the Company's
consolidated operations since April 30, 2004. The results of Buzton have been
included in the Company's consolidated operations since May 31, 2004.
The Company's consolidated financial statements reflect the allocation of the
purchase price based on a fair value assessment of the assets acquired and
liabilities assumed, and as such, the Company has assigned approximately $7.4
million to telecommunications services contracts intangible assets which are
amortized over a weighted average period of approximately 10 years. The excess
of the purchase price over the fair value of the net assets acquired of
approximately $2.2 million has been assigned to goodwill and is not deductible
for tax purposes. Approximately $1.9 million of this goodwill has been assigned
to Business and Corporate Services reportable segment and approximately $0.3
million has been assigned to Carrier and Operator Services reportable segment.
In accordance with SFAS No. 141, "Business Combinations", and SFAS No. 142,
"Goodwill and Other Intangible Assets", the Company does not amortize the
goodwill recorded in connection with the above acquisitions. The goodwill is
tested for impairment at least annually.
ACQUISITIONS IN 2005
In March 2005, the Company completed the acquisition of 75% ownership interest
in OOO Dicom ("Dicom"), an early stage wireless broadband enterprise, for
approximately $0.5 million in cash. In conjunction with the acquisition, the
Company entered into a participants' agreement which provided the seller with a
put option that, if exercised, would require the Company to purchase the
seller's remaining 25% interest at fair market value. In addition, the
participants' agreement provided the Company with a call option that, if
exercised, would require the seller to sell after February 1, 2008 the seller's
25% interest in Dicom at any time beginning after February 1, 2008, if Dicom's
valuation exceeds targeted levels by February 1, 2008. The results of Dicom have
been included in the Company's consolidated operations since March 31, 2005.
In September 2005, the Company completed the acquisition of 60% of OOO Joint
Venture Sakhalin Telecom Limited ("Sakhalin Telecom"), a fixed line alternative
operator in the Far East region of Russia for $5.0 million in cash. As a result
of this acquisition and combined with the Company's previous ownership in
Sakhalin Telecom, the Company now owns 83% of Sakhalin Telecom. In October 2005,
the Company acquired 100% of ZAO Sochitelecom ("Sochitelecom"), a fixed line
alternative operator in the Krasnodar region of Russia, for approximately $3.0
million consisting of cash consideration of $2.1 million and $0.9 million to be
settled in cash upon the satisfactory achievement of certain conditions. The
results of Sakhalin Telecom have been included in the Company's consolidated
operations since September 30, 2005. The results of Sochitelecom have been
included in the Company's consolidated operations since October 31, 2005.
The Company's consolidated financial statements reflect the allocation of the
purchase price based on a fair value assessment of the assets acquired and
liabilities assumed, and as such, the Company has assigned approximately $2.1
million to telecommunications services contracts intangible assets which will be
amortized over a weighted average period of approximately 10 years. The excess
of the purchase price over the fair value of the net assets acquired of
approximately $3.0 million has been assigned to goodwill and is not deductible
for tax purposes. Approximately $1.6 million of this goodwill has been assigned
to Business and Corporate Services reportable segment, approximately $0.3
million has been assigned to Carrier and Operator Services reportable segment
and approximately $1.1 million has been assigned to Consumer Internet Services
reportable segment. In accordance with SFAS No. 141, "Business Combinations",
and SFAS No. 142, "Goodwill and Other Intangible Assets", the Company will not
amortize the goodwill recorded in connection with the above acquisitions. The
goodwill will be tested for impairment at least annually.
68-69
The pro-forma results of operations that give effect to acquisitions completed
in 2005 as if they had occurred at the beginning of the year would not differ
from the actual results by a material amount.
In October 2005, the Company acquired 100% of Antel Rascom, Ltd., a British
Virgin Islands company that owns 49% of ZAO Rascom ("Rascom"), an infrastructure
and facilities company in northwest region of Russia, for approximately $10.0
million in cash. In December 2005, the Company acquired an additional 5% of
Rascom for approximately $1.1 million in cash. The Company has concluded that
its 54% investment in Rascom does not qualify for accounting under the
consolidation method of accounting because the rights of the minority
shareholder represent substantive participating rights, and as result, such
rights overcome the presumption that the Company controls Rascom. Therefore, the
Company accounts for this investment under the equity method.
In March 2005, the Company expensed approximately $1.0 million in external
legal, financial and consulting fees related to an acquisition opportunity the
Company decided not to pursue, including advisory fees of approximately $0.1
million paid to Alfa. In September 2005, the Company expensed approximately $0.8
million in external legal, financial and consulting fees related to the
acquisition of Hudson Telecom, Inc., which the Company decided not to pursue.
The components of the Company's investments in and advances to ventures are as
follows:
NOTE 6: INVESTMENTS IN AND ADVANCES TO VENTURES
The Company has various investments in ventures that are accounted for by the
equity method. The Company's ownership percentages in its equity method
investments range from approximately 50% to 54%.
The Company has financed the operating and investing cash flow requirements of
several of the Company's ventures in the form of cash advances. The Company
aggregates all of the receivable and payable balances with the ventures in the
Company's investments in and cash advances to the ventures.
In October 2003, MCT Corp. ("MCT") declared a cash dividend of $1.90 per Common
share. The Company's portion of this cash distribution was approximately $4.7
million. This cash distribution was received in November 2003 and is classified
as part of equity in earnings in the consolidated statement of operations.
The Company's 22.8% investment in MCT no longer qualifies for accounting under
the equity method because the majority ownership of MCT is concentrated among a
small group of shareholders who operate MCT without regard to the views of the
Company and because the Company has attempted to obtain more financial
information than is currently available to MCT's other shareholders and is
unable to obtain such information.
DECEMBER 31,
--------------------------------
US$'000s 2004 2005
--------------------------------------------------------------------- ------------- -------------
Equity in net assets acquired $ 1,236 $ 11,565
Goodwill as part of investment -- 1,313
Difference between fair value and historical value of assets acquired -- (1,095)
Cash advances and other (494) (894)
------------- -------------
Total investments in and advances to ventures $ 742 $ 10,889
------------- -------------
(GOLDEN TELECOM INC. LOGO) ANNUAL REPORT 2005
NOTE 7: SUPPLEMENTAL BALANCE SHEET INFORMATION
DECEMBER 31,
-------------------------------
US$'000s 2004 2005
------------- -------------
OTHER CURRENT ASSETS CONSIST OF:
Inventory $ 8,911 $ 5,310
Notes receivable 2,338 1,494
Other current assets 5,489 6,205
------------- -------------
TOTAL OTHER CURRENT ASSETS $ 16,738 $ 13,009
------------- -------------
OTHER NON-CURRENT ASSETS CONSIST OF:
Notes receivable $ 1,494 $ --
Investments in and advances to ventures 742 10,889
Other non-current assets 6,767 8,763
------------- -------------
TOTAL OTHER NON-CURRENT ASSETS $ 9,003 $ 19,652
------------- -------------
ACCOUNTS PAYABLE AND ACCRUED EXPENSES CONSISTS OF:
Accounts payble $ 57,566 $ 60,043
Accrued compensation 5,605 11,322
Accrued other taxes 2,856 3,132
Accrued access and network services 11,791 12,196
Other accrued expenses 3,656 2,711
------------- -------------
TOTAL ACCOUNTS PAYABLE AND ACCRUED EXPENSES $ 81,474 $ 89,404
------------- -------------
OTHER CURRENT LIABILITIES CONSISTS OF:
Non-trade liabilities to GTS $ 2,904 $ 2,904
Other current liabilities 668 1,175
------------- -------------
TOTAL OTHER CURRENT LIABILITIES $ 3,572 $ 4,079
------------- -------------
NOTE 8: DEBT OBLIGATIONS AND CAPITAL LEASES
The Company paid interest of $2.0 million, $0.6 million and $0.6 million in
2003, 2004 and 2005, respectively.
Some of the Company's operating companies have received debt financing through
direct loans from affiliated companies. In addition, certain operating companies
have borrowed funds under a $22.7 million back-to-back, seven-year credit
facility from a Russian subsidiary of Citibank. Under this facility, the Company
provides full cash collateral, held in London and recorded on our balance sheet
as restricted cash, for onshore loans made by the bankto the Company's Russian
registered ventures. In a second, similar facility, the Company provides full
cash collateral for a $10.0 million short term back-to-back, revolving, credit
facility from the same bank for the Company's larger Russian operating
companies. The funding level as of December 31, 2005 for all these facilities
totaled $0.2 million, of which none was funded to the Company's consolidated
subsidiaries and $0.2 million was funded to the Company's affiliates. The loan
facilities carry interest at a rate equal to the three-month London Inter-Bank
Offering Rate ("LIBOR") plus 1.0 percent per annum (equivalent to approximately
5.3%, on average for loans outstanding, at December 31, 2005) and mature between
December 2006 and January 2007.
In August 2005, the Company entered into a lease for fiber optic capacity,
including facilities and maintenance, on major routes within Ukraine. The lease
has a term of five years and total payments of $4.1 million. The lease is
classified as a capital lease in the balance sheet.
70-71
The following table presents minimum lease payments under capital leases:
US$'000s LEASE PAYMENTS
--------------
2006 $ 2,179
2007 872
2008 742
2009 631
2010 334
--------------
4,758
Less: amount representing interest 477
--------------
TOTAL PRINCIPAL PAYMENTS $ 4,281
--------------
NOTE 9: SHAREHOLDERS' EQUITY
COMMON STOCK
In December 2003, the Company issued 7,007,794 shares of common stock to Telenor
in settlement of the purchase price for the acquisition of 100% ownership
interest in Comincom, previously held by Telenor.
In August 2005, the Company issued 27,000 restricted shares of the Company's
common stock, par value $0.01 per share, to senior management of the Company.
These restricted shares gradually vest over three years.
The Company's outstanding shares of common stock increased by 374,396 shares and
109,000 shares in the twelve months ended December 31, 2004 and 2005,
respectively issued in connection with the exercise of employee stock options.
The Company has reserved 1,225,681 shares of common stock for issuance to
certain employees and directors in connection with the 1999 Equity Participation
Plan.
PREFERRED STOCK
On May 17, 2000, the Company's shareholders authorized 10 million shares of
preferred stock, none of which have been issued.
ADDITIONAL PAID-IN CAPITAL
As further described in Note 17, in August 2004, the Company transferred 20% of
the ownership interest in GTU to a Ukrainian partner in exchange for services
provided by the partner. The excess of the fair value of consideration exchanged
for services over the book value of 20% of net assets of GTU in the amount of
$1.5 million was recorded as a credit to the consolidated equity.
DIVIDENDS
During 2005, the Company paid four quarterly dividends of $0.20 per common
share, for a total of $0.80 per common share for the year. The total amount paid
by the Company was $29.1 million.
NOTE 10: STOCK OPTION AND STOCK APPRECIATION RIGHTS PLANS
The Company has established the 1999 Equity Participation Plan of Golden
Telecom, Inc. (the "Option Plan"). The Company has granted and intends to offer
stock options to key employees and members of the Board of Directors of the
Company. Under the Option Plan not more than 4,320,000 shares of common stock
(subject to anti-dilution and other adjustment provisions) are authorized for
issuance upon exercise of options or upon vesting of restricted or deferred
stock awards. Options granted to key employees of the Company under the Option
Plan vest over a three-year term from the date of grant with one-third vesting
after one year and one thirty-sixth vesting each month thereafter and expire ten
years from the date of grant. Options granted to members of the Board of
Directors of the Company under the Option vest over a one-year term from the
date of grant and expire five years from the date of grant.
The fair value of options granted under the GTI Option Plan in 2003 are
estimated to be between $9.39 and $15.05 per common share, in 2004 are estimated
to be $14.59 per common share and, in 2005 are estimated to be $13.44 per common
share on the date of grant using the Black Scholes option pricing model with the
following assumptions:
(GOLDEN TELECOM INC. LOGO) ANNUAL REPORT 2005
TWELVE MONTHS ENDED DECEMBER 31,
---------------------------------------------------
2003 2004 2005
------------- ------------- -------------
Risk free interest rate 2.89-3.55% 4.39% 3.86%
Dividend yield 0.0% 3.0% 3.0%
Expected life (years) 3.0 3.0 3.0
Volatility 104-108% 95% 88%
Additional information with respect to stock options activity is summarized as
follows:
YEAR ENDED DECEMBER 31,
---------------------------------------------------------------------
2004 2005
-------------------------------- --------------------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
EXERCISE EXERCISE
US$'000S (EXCEPT PER SHARE DATA) SHARES PRICE SHARES PRICE
---------------------------------- ------------- ------------- ------------- -------------
Outstanding at beginning of year 904,272 $ 13.48 517,013 $ 14.18
Options granted 5,000 26.61 2,500 26.32
Options exercised (374,396) 12.76 (109,000) 13.31
Options expired -- -- (12,500) 20.88
Options forfeited (17,863) 12.00 (25,001) 14.00
------------- -------------
Outstanding at end of year 517,013 14.18 373,012 14.31
------------- -------------
Options exercisable at end of year 448,818 $ 14.07 369,817 $ 14.22
The following table summarizes information about stock options outstanding:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------------------- -----------------------------------
WEIGHTED
AVERAGE
REMAINING WEIGHTED WEIGHTED
CONTRACTUAL AVERAGE AVERAGE
EXERCISE PRICES NUMBER LIFE EXERCISE NUMBER EXERCISE
AT DECEMBER 31, 2005 OUTSTANDING (IN YEARS) PRICE EXERCISABLE PRICE
-------------------- --------------- --------------- --------------- --------------- ---------------
12.00 142,856 4.3 $ 12.00 142,856 $ 12.00
14.00 149,899 2.1 14.00 149,204 14.00
15.63 55,257 3.6 15.63 55,257 15.63
19.45 10,000 2.4 19.45 10,000 19.45
26.32 2,500 4.4 26.32 -- --
26.61 2,500 3.4 26.61 2,500 26.61
33.25 10,000 4.4 33.25 10,000 33.25
72-73
In September 2005, the Company granted stock appreciation rights ("SARs") to the
Company's Chief Executive Officer ("CEO") with respect to 200,000 shares of the
Company's common stock, at a share price which was the closing price of the
Company's common stock on the NASDAQ National Market on July 19, 2005 ("CEO
Granting Share Price"), which was $29.83, one-third of which shall be and become
vested and nonforfeitable on each of the first three anniversary dates from
September 1, 2005, provided the CEO remains continuously employed by the Company
until each such relevant date. If, prior to August 31, 2008 and during the CEO's
period of employment with the Company, the average closing stock price of one
share of the Company's common stock on the NASDAQ National Market, or any such
other exchange on which the Company's common stock may then be traded, exceeds
$50.00 during any thirty day consecutive period, the CEO will be granted SARs
for an additional 200,000 shares of the Company's common stock at the CEO
Granting Share Price, which SARs shall be fully vested upon issuance. The SARs
provide for a cash only settlement and the related obligation is recorded as a
liability in the consolidated financial statements.
In December 2005, the Company granted SARs with respect to 851,800 shares of the
Company's common stock to senior management and employees of the Company. The
SARs were granted pursuant to the Golden Telecom, Inc. 2005 Stock Appreciation
Rights Plan and the EDN Sovintel Stock Appreciation Rights Bonus Plan at a share
price which is the lower of: (i) the average between the high and low sales
price per share of the Company's common stock on the grant date, or in case no
such sale takes place on grant date, the last date on which a sale occurred or
(ii) the average closing sales price per share of the Company common stock for
the fourteen trading days immediately preceding such date, which was $26.808
("Granting Share Price"). Seventy-five percent of the SAR grant shall be subject
to time vesting, one-third of which shall be and become vested and
nonforfeitable on each of the first three anniversary dates from December 12,
2005, provided that the employee remains continuously employed by the Company
until each such relevant date. The Granting Share Price shall increase by five
percent on each anniversary date after December 12, 2005 in association with the
SARs that shall be and become vested and nonforfeitable on each such anniversary
date. Twenty-five percent of the SARs granted are subject to performance vesting
upon the Company's common stock achieving a closing trading price of at least
$50.00 per share for thirty consecutive days as determined in the sole
discretion of the Company. If the Company's Common Stock does not achieve a
closing trading price of at least $50.00 per share for thirty consecutive days
within three years of the date of grant, such portion of the SARs shall expire
by its terms and shall not be exercisable. The aggregate number of shares of
common stock which may be issued pursuant to the Golden Telecom, Inc. 2005 Stock
Appreciation Rights Plan at the discretion of the grantees, shall be 200,000
shares. The remainder of the SARs provides for a cash settlement. The related
obligation is recorded as liability in the consolidated financial statements.
NOTE 11: INCOME TAXES
The Company accounts for income taxes using the liability method required by
FASB Statement No. 109 "Accounting for Income Taxes".
The components of income before income taxes and minority interest were as
follows:
YEAR ENDED DECEMBER 31,
--------------------------------------------
US$'000s 2003 2004 2005
--------------------- ----------- ----------- -----------
PRETAX INCOME (LOSS):
Domestic $ 5,754 $ (4,853) $ (8,405)
Foreign 67,560 101,886 125,272
----------- ----------- -----------
$ 73,314 $ 97,033 $ 116,867
----------- ----------- -----------
(GOLDEN TELECOM INC. LOGO) ANNUAL REPORT 2005
The following is the Company's significant components of the provision for
income taxes attributable to continuing operations:
YEAR ENDED DECEMBER 31,
------------------------------------------------
US$'000s 2003 2004 2005
------------ ------------ ------------
Domestic - current $ -- $ -- $ --
Domestic - deferred (1,861) (373) 2,234
Foreign - current 20,516 35,350 41,630
Foreign - deferred (1,256) (4,233) (6,048)
------------ ------------ ------------
$ 17,399 $ 30,744 $ 37,816
============ ============ ============
The Company paid income taxes of $17.5 million, $36.1 million and $41.4 million
in 2003, 2004 and 2005, respectively.
US taxable income or losses recorded are reported on the Company's consolidated
US income tax return. The Company was allocated its proportionate share, $23.6
million, of GTS' US net operating loss carry-forwards ("NOLs") in 1999. As of
December 31, 2005, the Company had NOLs for US federal income tax purposes of
approximately $13.5 million expiring in fiscal years 2019 through 2025. In 2005,
the Company recorded a full valuation allowance for NOLs for US federal income
tax purposes of $4.7 million, including a $2.2 million or $0.06 per share (both
basic and diluted) adjustment to the opening balance of the valuation allowance
due to the reassessment of sources of future taxable income in the US. The
Company also had NOLs for Cyprus tax purposes of approximately $19.9 million
that do not expire. However, the Company has recorded a full valuation allowance
for Cyprus NOLs since it does not anticipate recognizing taxable income in
Cyprus.
The reconciliation of the US statutory federal tax rate of 35.0% to the
Company's effective tax rate is as follows:
YEAR ENDED DECEMBER 31,
--------------------------------------------------
US$'000s 2003 2004 2005
------------ ------------ ------------
Tax expense at US statutory rates (35.0)% (35.0)% (35.0)%
Non-deductible expenses (4.9) (7.3) (4.8)
Foreign exchange differences (0.1) 0.2 (0.3)
Different foreign tax rates 9.3 11.4 11.9
Change in valuation allowance 3.1 0.0 (4.2)
Other permanent differences 3.9 (1.0) 0.0
------------ ------------ ------------
Tax expense (23.7)% (31.7)% (32.4)%
============ ============ ============
74-75
Deferred tax assets and liabilities are recorded based on temporary differences
between book bases of assets and liabilities and their bases for income tax
purposes. The following table summarizes major components of the Company's
deferred tax assets and liabilities:
DECEMBER 31,
--------------------------------
US$'000s 2004 2005
------------- -------------
DEFERRED TAX ASSETS:
Net operating loss carry-forwards $ 2,793 $ 5,581
Accrued expenses 2,173 3 314
Deferred revenue 7,639 11,056
Intangible assets 2,832 2 595
Other deferred tax assets 1,180 2,550
Valuation allowance (3,537) (8,441)
------------- -------------
TOTAL DEFERRED TAX ASSET $ 13,080 $ 16,655
============= =============
DEFERRED TAX LIABILITIES:
Accrued revenue $ 16 $ --
Deferred expenses 1,958 2,812
Intangible assets 23,472 21,337
Fixed assets 3,720 5,500
Other deferred tax liabilities 295 299
------------- -------------
TOTAL DEFERRED TAX LIABILITY $ 29,461 $ 29,948
============= =============
NET DEFERRED TAX LIABILITY $ (16,381) $ (13,293)
============= =============
The following table presents the Company's deferred tax assets and liabilities
as of December 31, 2004 and 2005 attributable to different tax paying components
in different tax jurisdictions:
DECEMBER 31,
--------------------------------
US$'000s 2004 2005
------------- -------------
DEFERRED TAX ASSETS:
US tax component $ 2,234 $ --
Foreign tax component 10,846 16,655
TOTAL DEFERRED TAX ASSET $ 13,080 $ 16,655
DEFERRED TAX LIABILITY
US tax component $ -- $ --
Foreign tax component 29,461 29,948
------------- -------------
TOTAL DEFERRED TAX LIABILITY $ 29,461 $ 29,948
------------- -------------
NET DEFERRED TAX LIABILITY $ (16,381) $ (13,293)
------------- -------------
(GOLDEN TELECOM INC. LOGO) ANNUAL REPORT 2005
In December 2004, the FASB issued FASB Staff Position No. FAS 109-1,
"Application of FASB Statement No. 109, Accounting for Income Taxes, to the Tax
Deduction on Qualified Production Activities Provided by the American Jobs
Creation Act of 2004". Also in December 2004, the FASB issued FASB Staff
Position No. FAS 109-2, "Accounting and Disclosure Guidance for the Foreign
Earnings Repatriation Provision with the American Jobs Creation Act of 2004".
The adoption of these new rules did not have a material impact on the Company's
consolidated financial position, results of operations, or cash flows, since the
Company does not have any substantive operations in the US.
NOTE 12: COMMITMENTS AND CONTINGENCIES
LEASES
The Company has various cancelable and non-cancelable operating lease agreements
for equipment and office space with terms ranging from one to five years. Rental
expense for operating leases aggregated $4.9 million, $6.5 million, and $9.8
million for the years ended December 31, 2003, 2004 and 2005, respectively.
Future minimum lease payments under non-cancelable operating leases with terms
of one year or more, as of December 31, 2005, are as follows: 2006 - $9.5
million, 2007 - $2.6 million, 2008 - $2.2 million, 2009 - $1.8 million, 2010 -
$0.4 million, and thereafter - $0.2 million.
OTHER COMMITMENTS AND CONTINGENCIES
The Company has future purchase commitments of $86.8 million as of December 31,
2005.
In the ordinary course of business, the Company has issued financial guarantees
on debt for the benefit of certain of its non-consolidated ventures, which is
all collateralized by cash as described in Note 8. The Company expects that all
the collateralized debt will be repaid by the ventures.
MAJOR CUSTOMERS
The Company had one major customer in the Carrier and Operator reporting
segment, representing $27.6 million, or 8%, of total revenues in 2003, $31.0
million, or 5%, of total revenues in 2004 and $26.3 million, or 4%, of total
revenue in 2005.
TAX MATTERS
The Company's policy is to accrue for contingencies in the accounting period in
which a liability is deemed probable and the amount is reasonably determinable.
In this regard, because of the uncertainties associated with the Commonwealth of
Independent States Taxes ("CIS Taxes"), the Company's final CIS Taxes may be in
excess of the estimated amount expensed to date and accrued at December 31, 2004
and 2005. It is the opinion of management that the ultimate resolution of the
Company's CIS Tax liability, to the extent not previously provided for, will not
have a material effect on the financial condition of the Company. However,
depending on the amount and timing of an unfavorable resolution of any
contingencies associated with CIS Taxes, it is possible that the Company's
future results of operations or cash flows could be materially affected in a
particular period.
The Company's wholly-owned subsidiary, Sovintel, is engaged in litigation with
the Russian tax inspectorate in regard to a claim against Comincom, which merged
into Sovintel on December 1, 2004, issued by the tax inspectorate on July 8,
2004. The Russian tax inspectorate claimed that Sovintel owes taxes, fines and
penalties in connection with Comincom in the amount of $0.8 million for the
years ended December 31, 2001 and 2002. Comincom filed a lawsuit against the tax
inspectorate disputing the claims, and the court ruled in favor of the Company
by dismissing the tax inspectorate's claim on January 21, 2005. On July 11,
2005, the third instance court decided that the case against Comincom shall be
reverted to the first instance court for new consideration. The first instance
court ruled in favor of the Company by dismissing the tax inspectorate's claim
on October 24, 2005. The tax inspectorate did not appeal this decision in the
first instance court. In addition, the tax inspectorate did not appeal this
decision in the second instance court. The Company expects that the tax
inspectorate will appeal this decision in the third instance court. The term for
last appeal expires on March 22, 2006. The Company does not consider an
unfavorable outcome probable for this claim. Since the tax claim relates to the
period before the Company acquired 100% of shares of Comincom, the claims are
covered by the indemnification provisions of the Share Exchange Agreement
between the Company and Telenor. Therefore, in case of an unfavorable outcome of
this litigation, the Company intends to seek indemnification from Telenor.
In March 2005, the Company reversed a $2.0 million accrued liability related to
estimated taxes, including $0.6 million related to income taxes. This accrued
liability was recorded upon the acquisition of one of the Company's Russian
subsidiaries. Management has concluded that the probability of this accrued
liability arising in the future is remote due to the expiry of Russian
regulatory statutes of limitations for any
76-77
potential tax claims from the Russian tax inspectorate. The net effect of the
reversal of this accrued liability was $1.4 million reduction in selling,
general and administrative expenses in the twelve months ended December 31,
2005, and $0.6 million reduction in intangible assets for the portion associated
with income tax.
RUSSIAN ENVIRONMENT AND CURRENT ECONOMIC SITUATION
The Russian economy, while deemed to be of market status beginning in 2002,
continues to display certain traits consistent with that of a market in
transition. These characteristics have in the past included higher than normal
historic inflation, lack of liquidity in the capital markets, and the existence
of currency controls which cause the national currency to be illiquid outside of
Russia. The continued success and stability of the Russian economy will be
significantly impacted by the government's continued actions with regard to
supervisory, legal, and economic reforms.
On January 1, 2004, a new Law on Communications (the "Telecommunications Law")
came into effect in Russia. While some of the supporting regulations to
implement the Telecommunications Law have not been enacted, the Russian
government approved in March 2005 new rules for interconnection (the
"Interconnection Rules") that became effective on January 1, 2006. These
Interconnection Rules contemplate a new three-layer interconnection system
consisting of domestic long distance / international long distance ("DLD/ILD"),
zonal, and local operators. Under this new structure, end-users will have the
right to choose a long-distance operator and DLD/ILD operators will be required
to have interconnection points in each of the 88 constituent territories of the
Russian Federation. In addition, the Telecommunications Law created a universal
service fund ("USF") charge, which became effective May 3, 2005, calculated as
1.2% of revenue from services provided to customers, excluding interconnection
and other operators' traffic routing revenue. The Company has incurred
approximately $2.6 million in Russian Federation USF charges for May through
December 2005 which is recorded in selling, general and administrative expense.
On May 31, 2005, the Company received a DLD/ILD license in Russia valid until
May 31, 2012. The Company is required under the license to begin providing
services and fulfill the network requirements specified in the Interconnection
Rules not later than May 31, 2007. The Company has construction a Federal
Transit Network ("FTN") in compliance with the Telecommunications Law and the
DLD/ILD license. The FTN consists of four international communications transit
nodes, seven intercity communications transit nodes deployed in each federal
district of Russia, and 88 connection points or FTN access nodes located in each
constituent territory of Russia. The Company has obtained the required
governmental permissions for operation of all the international and intercity
communications transit nodes that are part of the FTN. Although construction of
the 88 connection points has been completed, the Company is awaiting formal
commissioning by Rossvyaznadzor, a governmental body that reports to the
Ministry of Information Technologies and Communications of the Russian
Federation and is responsible for the control and the supervision of information
technology and communications as well as for commissioning the long distance
networks.
On October 19, 2005, the Russian government enacted the Rules on Price
Establishment for Interconnection and Traffic Routing. These rules list
interconnection services and traffic routing services provided by the incumbent
operators that are subject to pricing regulation by the government. The
effective utilization and implementation of the Russian long distance license is
subject to and dependent upon pending establishment of tariffs for
interconnection and traffic routing services to be provided by incumbent OAO
Svyazinvest ("Svyazinvest") state-owned companies. Such tariffs are to be
established by Rossvyaznadzor, and in the absence of such regulated tariffs the
incumbent Svyazinvest companies may attempt to impose their independently
established tariffs on alternative long-distance operators. The tariffs will be
paid by long-distance operators to the incumbent Svyazinvest local and zonal
operators for each minute of long distance traffic that is carried such that all
long-distance operators will be cross-subsidizing the local and zonal network of
the Svyazinvest companies. However, to minimize the impacts of such payments to
the incumbent companies, the Company has received licenses to provide zonal
services in all the regions of the Russian Federation, and the Company is
developing plans to construct zonal networks in selected regions.
On September 20, 2005, the National Commission of Communication's Regulation in
Ukraine issued an international license ("Ukrainian International License") to
Golden Telecom Ukraine ("GTU"). The Ukrainian International License allows GTU
to provide international telecommunications services throughout all of Ukraine,
allows the leasing of channels to third parties, and increases GTU's potential
as an international telecommunications carrier.
(GOLDEN TELECOM INC. LOGO) ANNUAL REPORT 2005
OTHER MATTERS
In the ordinary course of business, the Company may be party to various legal
and tax proceedings, and subject to claims, certain of which relate to the
developing markets and evolving fiscal and regulatory environments in which the
Company operates. In the opinion of management, the Company's liability, if any,
in all pending litigation, other legal proceeding or other matters, will not
have a material effect upon the financial condition, results of operations or
liquidity of the Company.
NOTE 13: RELATED PARTY TRANSACTIONS
Transactions with the Company's equity investees, Alfa, OAO Rostelecom
("Rostelecom"), and Telenor, significant shareholders of the Company, were as
follows, for the years ended December 31:
US$'000s 2003 2004 2005
------------- ------------- -------------
Revenue from equity investees $ 98 $ 116 $ 363
Revenue from Rostelecom 575 404 646
Revenue from Telenor 3 139 470
Revenue from Alfa 1,134 1,798 3,158
------------- ------------- -------------
$ 1,810 $ 2,457 $ 4,637
------------- ------------- -------------
Cost of revenue from equity investees 4,790 4,798 3,038
Cost of revenue from Rostelecom 16,860 25,809 23,979
Cost of revenue from Telenor 27 332 605
Cost of revenue from Alfa -- 56 --
------------- ------------- -------------
$ 21,677 $ 30,995 $ 27,622
------------- ------------- -------------
The revenue and cost of revenue from Telenor included in the income statement
represents revenue and cost of revenue from December 2003, the date Telenor
became a shareholder.
Included in other current assets at December 31, 2004 is approximately $0.3
million of accounts receivable from Alfa, approximately $0.1 million of accounts
receivable from Rostelecom, and approximately $0.1 million of accounts
receivable from Telenor. Included in other current assets at December 31, 2005
is approximately $0.5 million of accounts receivable from Alfa, and
approximately $0.2 million of accounts receivable from Telenor.
The Company maintains bank accounts with Alfa, which acts as one of the clearing
agents for the payroll of the Russian staff of the Company. The balances at
these bank accounts were minimal at December 31, 2004 and 2005. In addition,
certain of the Company's Russian subsidiaries maintain current accounts with
Alfa. The amounts on deposit were $0.1 million at December 31, 2004 and $0.2
million at December 31, 2005.
The Company maintains bank accounts with International Moscow Bank. The spouse
of the Company's President is a member of the Executive Board of Directors of
International Moscow Bank. The amounts on deposit were approximately $1.7
million at December 31, 2004 and $2.6 million at December 31, 2005.
In 2003, the Company incurred approximately $0.3 million in advisory fees from
Alfa in relation to the acquisition of Sibchallenge. In addition, in 2003 the
Company incurred approximately $0.1 million in advisory from Alfa related to a
potential acquisition that was subsequently withdrawn from the market. In 2005,
the Company expensed approximately $0.1 million in advisory fees from Alfa in
relation to a potential acquisition opportunity the Company decided not to
pursue.
The Company purchased consulting services from Alfa in the amount of $0.5
million and $0.7 million in the years ended December 31, 2004 and 2005,
respectively.
In December 2003, the Company entered into a one year agreement with Alfa to
provide the Company with property and equipment liability insurance. The amount
payable under this agreement was approximately $0.2 million. The Company
extended this agreement until February 2005 and in February 2005, the Company
entered into a one year agreement with Alfa, to provide the Company with
property and equipment liability insurance. The amount payable under this
agreement is approximately $0.4 million.
78-79
A member of the Company's Board of Directors is a relative of the general
director of two Russian based telecommunications services providers. The Company
received revenue from these two telecommunications services providers in the
amount of approximately $5.3 million and $5.1 million for the years ended
December 31, 2004 and December 31, 2005, respectively and incurred costs to
these two telecommunications services providers in the amount of approximately
$1.9 million and $1.3 million in the years ended December 31, 2004 and December
31, 2005, respectively. At December 31, 2004, the Company had accounts
receivable of approximately $0.7 million and accounts payable of approximately
$0.3 million with these two telecommunications services providers. At December
31, 2005, the Company had accounts receivable of approximately $0.9 million and
zero accounts payable with these two telecommunications services providers.
NOTE 14: SEGMENT INFORMATION
LINE OF BUSINESS DATA
The Company operates in four segments within the telecommunications industry.
The four segments are: (1) Business and Corporate Services; (2) Carrier and
Operator Services; (3) Consumer Internet Services; and (4) Mobile Services. The
following tables present financial information for both consolidated
subsidiaries and equity investee ventures, segmented by the Company's lines of
business for the twelve months ended December 31, 2003, 2004 and 2005,
respectively. Transfers between lines of businesses are included in the
adjustments to reconcile segment to consolidated results. The Company evaluates
performance based on the operating income (loss) of each strategic business
unit, among other performance measures.
TWELVE MONTHS ENDED DECEMBER 31, 2003
------------------------------------------------------------------------------------------------------------
ADJUSTMENTS TO RECONCILE
BUSINESS SEGMENT TO
CONSOLIDATED RESULTS
-----------------------
BUSINESS CARRIER BUSINESS EQUITY
AND AND CONSUMER MOBILE CORPORATE & SEGMENT CONSOLIDATED METHOD AFFILIATE
US$'000s CORPORATE OPERATOR INTERNET SERVICES ELIMINATORS TOTAL RESULTS VENTURES ADJUSTMENTS
---------- ---------- ---------- ---------- ----------- ---------- ------------ ---------- -----------
Revenue from external $ 188,087 $ 128,048 $ 30,775 $ 13,895 $ -- $ 360,805 $ 360,534 $ (4,861) $ 4,590
customers
Intersegment revenue 649 793 -- -- (1,442) -- -- -- --
Operating income (loss) 47,603 26,503 (2,457) 5,278 (6,976) 69,951 69,731 (220) --
Identifiable assets 385,087 236,635 52,584 6,566 52,042 732,914 729,226 (3,688) --
Capital expenditures 40,231 20,317 2,851 569 90 64,058 63,737 (321) --
TWELVE MONTHS ENDED DECEMBER 31, 2004
------------------------------------------------------------------------------------------------------------
ADJUSTMENTS TO RECONCILE
BUSINESS SEGMENT TO
CONSOLIDATED RESULTS
-----------------------
BUSINESS CARRIER BUSINESS EQUITY
AND AND CONSUMER MOBILE CORPORATE & SEGMENT CONSOLIDATED METHOD AFFILIATE
US$'000s CORPORATE OPERATOR INTERNET SERVICES ELIMINATORS TOTAL RESULTS VENTURES ADJUSTMENTS
---------- ---------- ---------- ---------- ----------- ---------- ------------ ---------- -----------
Revenue from external
customers $ 324,814 $ 198,027 $ 45,515 $ 15,808 $ -- $ 584,164 $ 583,978 $ (4,710) $ 4,524
Intersegment revenue -- 1,016 -- -- (1,016) -- -- -- --
Operating income (loss) 72,345 28,637 2,159 4,729 (11,756) 96,114 95,536 (578) --
Identifiable assets 435,276 261,424 57,732 5,693 49,562 809,687 805,768 (3,919) --
Capital expenditures 80,107 33,223 4,920 1,025 178 119,453 118,101 (1,352) --
(GOLDEN TELECOM INC. LOGO) ANNUAL REPORT 2005
TWELVE MONTHS ENDED DECEMBER 31, 2005
--------------------------------------------------------------------------------------------------------
ADJUSTMENTS TO RECONCILE
BUSINESS SEGMENTS TO
CONSOLIDATED RESULTS
--------------------------------------------------------------------------------------------------------
BUSINESS CARRIER BUSINESS EQUITY
AND AND CONSUMER MOBILE CORPORATE & SEGMENT CONSOLIDATED METHOD AFFILIATE
US$'000S CORPORATE OPERATOR INTERNET SERVICES ELIMINATIONS TOTAL RESULTS VENTURES ADJUSTMENTS
--------- -------- -------- -------- ------------ -------- ------------ -------- -----------
Revenue from external $ 387,532 $222,904 $ 44,484 $ 14,103 $ -- $669,023 $ 667,379 $ (4,449) $ 2,805
customers
Intersegment revenue -- 52 -- -- (52) -- -- -- --
Operating income (loss) 102,415 27,894 (1,322) 3,523 (16,268) 116,242 115,942 (300) --
Identifiable assets 494,266 323,278 67,511 2,855 21,759 909,669 882,211 (27,458) --
Capital expenditures 89,386 32,879 8,360 367 132 131,124 130,775 (349) --
GEOGRAPHIC DATA
Revenues from external customers are based on the location of the operating
company providing the service.
The Company operated within two main geographic regions of the CIS: Russia and
Ukraine. Geographic information as of December 31, 2003, 2004 and 2005 is as
follows:
CORPORATE,
OTHER
COUNTRIES & CONSOLIDATED
US$'000S RUSSIA UKRAINE ELIMINATIONS RESULTS
-------- ------- ------------ ------------
YEAR ENDED DECEMBER 31, 2003
Revenue $318,426 $44,524 $ (2,416) $ 360,534
Long-lived assets 509,339 24,236 2,886 536,461
YEAR ENDED DECEMBER 31, 2004
Revenue $522,018 $64,455 $ (2,495) $ 583,978
Long-lived assets 563,856 27,995 11,116 602,967
YEAR ENDED DECEMBER 31, 2005
Revenue $593,640 $73,816 $ (77) $ 667,379
Long-lived assets 611,788 44,801 14,092 670,681
80-81
NOTE 15: SUPPLEMENTAL CASH FLOW INFORMATION
The following table summarizes significant non-cash investing and financing
activities for the Company.
TWELVE MONTHS ENDED DECEMBER 31,
--------------------------------
US$'000S 2003 2004 2005
-------------------------------------------------------- -------- ---- ------
Issuance of common stock in connection with acquisitions $193,485 $ -- $ --
Amounts payable in connection with business acquisitions -- 400 885
Capitalized leased assets 420 -- 3,580
NOTE 16: LONG TERM INCENTIVE BONUS PROGRAM
In July 2004, the Board of Directors of the Company adopted a Long Term
Incentive Bonus Program ("LTIBP") for senior management of the Company,
effective as of January 1, 2004. In February 2006, the Board of Directors of the
Company discontinued the LTIBP effective January 1, 2005. Accordingly, in the
fourth quarter of 2005 the Company recorded a reduction in compensation expense
of $1.8 million. During the twelve months ended December 31, 2005 the Company
did not record any expense associated with the LTIBP. The Company has not
granted any shares under the LTIBP.
NOTE 17: SALE OF MINORITY INTEREST IN SUBSIDIARY
Recognizing that many of the markets in which the Company operates are complex,
in particular as it relates to business, regulatory, political and cultural
matters, the Company occasionally seeks experienced local partners to assist in
markets where the Company is likely to encounter operational difficulties. GTI
has been cooperating with local partners in Ukraine to resolve commercial and
regulatory disputes with monopoly operators and regulatory authorities in
Ukraine but had not previously finalized the compensation arrangement for the
services. In addition to or in lieu of cash compensation, the Board of Directors
approved the sale of a non-controlling interest in GTU to such parties.
Upon approval of GTI's Board of Directors, in August 2004 the Company entered
into a compensation arrangement for services provided to assist the Company in
addressing commercial and regulatory disputes with monopoly operators and
regulatory authorities in Ukraine. The Company's local partners have provided
services on a success fee basis. The Company's Board of Directors approved an
arrangement that effectively transferred 20% of the shares in GTU owned by the
Company to the local partners as compensation for the services already provided
and certain additional services to be provided. Under this arrangement, the
Company paid the local partners $0.5 million in cash and granted the local
partners an option to purchase 20% of GTU for $0.5 million in cash, in a
transaction where the cash and the value of the services were approximately $3.6
million. This transaction closed in the third quarter of 2004, when the
performance was completed and the option was exercised and resulted in a charge
to operating income of approximately $3.6 million. The excess of the fair value
of consideration exchanged for services over the book value of 20% of net assets
of GTU was recorded as a credit to the consolidated equity. Fair value of the
option approximated the fair value of shares transferred to the local partner
due to the short exercise period of the option and was determined using the
discounted cash flow valuation method.
In December 2005, in connection with an increase of GTU registered capital, the
Company received a $3.8 million cash contribution from the minority partner of
GTU.
(GOLDEN TELECOM INC. LOGO) ANNUAL REPORT 2005
NOTE 18: QUARTERLY FINANCIAL DATA (UNAUDITED)
Summarized quarterly financial data is as follows:
FOR THE THREE MONTHS ENDED
--------------------------------------------------------
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
US$'000S (EXCEPT PER SHARE DATA) 2004 2004 2004 2004
-------------------------------- --------- -------- ------------- ------------
Revenues $ 133,174 $138,873 $ 152,713 $ 159,218
Cost of Revenues 68,279 70,215 77,953 84,141
Gross Margin 64,895 68,658 74,760 75,077
Selling, general and administrative 26,393 25,118 29,518 31,826
Net income 14,651 16,909 16,111 17,112
Net income per share (1) - basic 0.41 O.47 O 44 O 47
Net income per share (1) - diluted 0.40 0.46 0.44 0.47
FOR THE THREE MONTHS ENDED
--------------------------------------------------------
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
US$'000S (EXCEPT PER SHARE DATA) 2005 2005 2005 2005
-------------------------------- --------- -------- ------------- ------------
Revenues $ 156,465 $165,509 $ 169,930 $ 175,475
Cost of Revenues 79,997 86,191 88,345 92,999
Gross Margin 76,468 79,318 81,585 82,476
Selling, general and administrative 27,586 28,828 30,967 32,509
Net income 20,027 19,767 18,395 17,884
Net income per share (1) - basic 0.55 0.54 0.51 0.49
Net income per share (1) - diluted 0.55 0.54 0.50 0.49
NOTE 19: SUBSEQUENT EVENTS
In February 2006, the Board of Directors of the Company declared a cash dividend
of $0.20 per common share to shareholders of record as of March 17, 2006. The
Company will pay the total amount of approximately $7.3 million to shareholders
on March 31, 2006.
The Company's wholly-owned subsidiary, Sovintel, is engaged in litigation with
the Russian tax inspectorate in regard to claims issued by the tax inspectorate
on February 1, 2006. The Russian tax inspectorate claimed that Sovintel owes
taxes, fines and penalties in the amount of $1.9 million for the years ended
December 31, 2002 and 2003. On February 16, 2006, Sovintel filed a lawsuit
against the tax inspectorate disputing the claims. The Company does not consider
an unfavorable outcome probable for this claim.
1 The sum of the earnings per share for the four quarters will generally
not equal earnings per share for the total year due to changes in the
average number of common shares outstanding.
82-83
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTING AND FINANCIAL DISCLOSURE
None.
CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
As of the end of the period covered by this report, we carried out an
evaluation, under the supervision and with the participation of our management,
including our Chief Executive Officer and Chief Financial Officer, of the
effectiveness of the design and operation of our disclosure controls and
procedures, as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934.
Based on this evaluation, our Chief Executive Officer and Chief Financial
Officer concluded that, as of December 31, 2005, the Company's disclosure
controls and procedures are effective to ensure that the information required to
be disclosed by the Company in the reports that it files or submits under the
Exchange Act is recorded, processed, summarized and reported within the time
periods specified in SEC rules and forms.
MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Our management is responsible for establishing and maintaining adequate internal
control over financial reporting, as such term is defined in Exchange Act Rules
13a-15(f) and 15d-15(f). Under the supervision and with the participation of our
management, including our Chief Executive Officer and Chief Financial Officer,
we conducted an evaluation of the effectiveness of our internal control over
financial reporting as of December 31, 2005 based on the framework in Internal
Control-Integrated Framework issued by the Committee of Sponsoring Organizations
of the Treadway Commission (COSO). Based on that evaluation, our management
concluded that our internal control over financial reporting was effective as of
December 31, 2005.
Management's assessment of the effectiveness of our internal control over
financial reporting as of December 31, 2005 has been audited by Ernst & Young
LLC, an independent registered public accounting firm, as stated in their report
which is included elsewhere herein.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
There were no changes in our internal control over financial reporting during
the fourth quarter of 2005 that have materially affected, or are reasonably
likely to materially affect, our internal control over financial reporting.
(GOLDEN TELECOM INC. LOGO) ANNUAL REPORT 2005
Report of Independent Registered
Public Accounting Firm
THE BOARD OF DIRECTORS AND SHAREHOLDERS OF GOLDEN TELECOM, INC.
We have audited management's assessment, included in the accompanying Management
Report on Internal Control Over Financial Reporting, that Golden Telecom, Inc.
maintained effective internal control over financial reporting as of December
31, 2005, based on criteria established in Internal Control - Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission (the COSO criteria). Golden Telecom, Inc.'s management is responsible
for maintaining effective internal control over financial reporting and for its
assessment of the effectiveness of internal control over financial reporting.
Our responsibility is to express an opinion on management's assessment and an
opinion on the effectiveness of the Company's internal control over financial
reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of the internal control
over financial reporting, evaluating management's assessment, testing and
evaluating the design and operating effectiveness of internal control, and
performing such other procedures as we considered necessary in the
circumstances. We believe that our audit provides a reasonable basis for our
opinion.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with policies or procedures may deteriorate.
In our opinion, management's assessment that Golden Telecom, Inc. maintained
effective internal control over financial reporting as of December 31, 2005, is
fairly stated, in all material respects, based on the COSO criteria. Also, in
our opinion, Golden Telecom, Inc. maintained, in all material respects,
effective internal control over financial reporting as of December 31, 2005,
based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the 2005 consolidated financial
statements of Golden Telecom, Inc.'s and our report dated March 15, 2006
expressed an unqualified opinion thereon.
-s- ERNST & YOUNG LLC
ERNST &YOUNG LLC
Moscow, Russia
March 15, 2006
84
Independent Auditors
Ernst &Young LLC
Stockholder Information
ANNUAL MEETING MAY 18TH, 2006
The Annual Meeting of Golden Telecom, Inc. will be held at 1:00 p.m. local time
in the Salon Marzio,
Ground Floor, Kempinski Hotel
Corvinus Budapest, Erzs bet t re 7-8,
Budapest, Hungary
Telephone: +36 1 429 3777
Facsimile:+36 1 429 4777
REGISTER AND TRANSFER AGENT
Correspondence concerning Golden Telecom, Inc. stock holding or changes of
address should be directed to:
Mellon Investor Services
480 Washington Boulevard
29th Floor
Jersey City, NJ 07310
Telephone: +1 201 680 6578
Facsimile: +1 201 680 4604
Internet: www.melloninvestor.com
General Information
General information about the company may be obtained by contacting:
INVESTOR RELATIONS
Telephone: + 7 495 797 9300
Facsimile: +7 495 797 9330
Email: ir@gldn.net
Internet: www.goldentelecom.com
The consolidated financial statements for Golden Telecom, Inc. for the fiscal
year ended December 31, 2005 included in this Annual Report are also contained
in the Form 10-K that was filed with the United States Securities and Exchange
Commission on March 16, 2006, which document contains additional information
about the company.
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