Sistema
Annual Report 2014

Plain-text annual report

2014 ANNUAL REPORT TABLE OF CONTENTS Sistema today History timeline Company structure President’s speech Strategic Review Strategy Sistema’s financial results Shareholder capital and securities Our investments MTS Detsky Mir Medsi Group Lesinvest Group (Segezha) Bashkirian Power Grid Company RTI SG-trans MTS Bank RZ Agro Holding Targin Binnopharm Real estate Sistema Shyam TeleServices Sistema Mass Media 2 4 8 10 11 12 20 24 27 28 34 38 44 52 56 60 64 68 72 76 80 84 88 Corporate governance system Corporate governance principles General Meeting of shareholders Board of Directors Commitees of the Board of Directors 91 92 94 96 99 President and the Management Board 101 Internal control and audit Development of the corporate governance system in 2014 Remuneration Risks Sustainable development Responsible investor Social investment Education, science, innovation Culture Environment Society Appendices 103 104 105 106 113 114 115 115 117 119 121 124 1 SISTEMA TODAY Established in 1993, today Sistema is a large private investor operating in the real sector of the Russian economy. Sistema’s investment portfolio comprises stakes in predominantly Russian companies from various sectors of economy, including telecommunications, utilities, retail, high tech, pulp and paper, pharmaceuticals, healthcare, railway transportation, agriculture, finance, mass media, tourism, etc. Sistema is the controlling shareholder in most of its portfolio companies. Sistema’s competencies focus on improvement of the operational efficiency of acquired assets through restructuring and attracting industry partners to enhance expertise and reduce financial risks. >13 sectors >20 years >150 000 employees of operations of history jobs created Sectors of operations Telecom HighTech Consumer Pulp&Paper Oil services Banking Energy Other 60% 17% 9% 4% 3% 2% 2% 3% Real estate Transportation services Agriculture Healthcare and pharmaceuticals Tourism Note: Based on aggregate income from assets Contribution to national development RUB 100 billion Payments to the federal and regional budgets in 2014 Over RUB 700 million Social and charity investment in 2014 RUB 62.8 billion Investment in existing and new assets in 2014 2 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHShareholder value Efficient management Transparent corporate governance Strong government relations Financial stability Experienced risk management Clear strategy High level of expertise Shareholder capital structure V. Evtushenkov GDR Programme (LSE) Ordinary shares (Moscow Exchange) 64.2% 19% 16.8% Note: including the shares held by insiders, management and members of the Board of Director and ordinary shares on Sistema Group’s balance sheet. Financial stability Revenue for 2014 631.9 RUB billion Adjusted OIBDA for 2014 165.2 RUB billion The company’s shares are traded on the London Stock Exchange (LSE) as Global Depositary Receipts (GDRs), with one GDR representing 20 ordinary shares. Its Global Depositary Receipts are listed on the LSE under ticker symbol SSA. The company’s shares are also listed on the Moscow Exchange under ticker symbol AFKS. Dividends received in 2014 55.6 RUB billion 3 CORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENTHISTORY TIMELINE 1993-1995 1996-2002 2003-2004 1993 Sistema JSFC is founded. Sistema acquires a 40.4% stake in MTS and starts its development in partnership with Deutsche Telekom. Sistema acquires control of Comstar (50%) and Kosmos TV (50%) in a transaction totalling approximately US$ 35 million. Sistema actively consolidates assets in the core sectors of Russia’s economy, acquiring assets in telecommunications, electronics, tourism, retail, oil and gas, construction and real estate. Sistema invests in MGTS, establishes Vimpel Communications and Sistema- Hals, as well as project management companies. During VimpelCo’s IPO on the New York Stock Exchange, raising US$ 110.8 million Sistema, sells its stake in VimpelCom. MTS completes an IPO on the New York Stock Exchange, generating US$ 323 million. As a result of consolidation, Comstar-OTS received a 99% controlling stake in MTU-Inform, 100% stake in Telmos, 100% stake in MTU-Intelm and 55.62% stake in MGTS. This event became a milestone in the consolidation of alternative communication operators under our control to create a united digital operator. Sistema creates an insurance holding on the basis of ROSNO and attracts a strategic partner – Allianz AG, one of the largest insurance groups in the world. As a result of this transaction, Sistema received a 49% stake in ROSNO and Allianz AG received 47.2%. 4 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECH2005 2006 2007-2008 Sistema launches its IPO on the London Stock Exchange, raising US$ 1.56 billion. IPO of Comstar-OTS. Sistema launches an IPO for Comstar- OTS, raising US$ 1 billion on the London Stock Exchange. Sistema acquires a 100% stake in American Hospital Group and a 100% stake in the Medexpress chain of clinics, later merged into Medsi Group. Sistema buys minority stakes in Bashkir oil and energy companies (together, the «BashTEK compa- nies»), including Bashneft and Bashenergo, for a total amount of about US$ 600 million. Sistema actively develops bank- ing business and increases its stake in the Moscow Bank for Reconstruction and Development (MBRD) to 98.9%. Later, MBRD consolidated 66% of the shares in East-West United Bank. Sistema-Hals launches its IPO, raising US$ 409 billion on the London Stock Exchange. SITRONICS is established as a result of development and consolidation of high-tech assets by Sistema. Sistema successfully exits from insurance business by selling 47.4% of ROSNO to Allianz, with an option for Allianz to buy the remaining 3% over the next several years. Sistema increases its stake in SITRONICS to 60% and launches an IPO on the London Stock Exchange, raising US$ 2.35 billion. Sistema first acquires a 10% and then a 41% stake in Shyam Telelink Ltd and enters into a call option agreement allowing it to increase its stake from 51% to 74%. The transaction was worth US$ 46.74 million. 5 CORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENT2009-2010 2011 2012 Sistema establishes RTI, a company consolidating Sistema’s high-tech business, including Concern RTI Systems and SITRONICS. Sistema transitions from the operating holding model to the investment company model. Rosimushchestvo acquires 14% of SSTL for US$ 647 million as a result of an additional issue of shares. VAO Intourist and Thomas Cook Group Plc complete a transaction to form a joint venture based on the tour operator and retail business of Intourist. Thomas Cook purchased a 50.1% stake for a total of US$ 45 million. Later, Thomas Cook increased its stake in the JV to 75%. Sistema sells 24.4% of MGTS to MTS for RUB 10.56 billion, completing consolidation of its telecom assets. Sistema makes its first invest- ments in the agricultural sector by acquiring a 100% stake in Don- skoe for RUB 476.5 million and a 100% stake in First Cavalry Army Stud Farm for RUB 303 million. Both land clusters are located in the Rostov Region with a com- bined land of 39,000 hectares. Sistema acquires a 100% stake in SG-trans, the largest independent LPG transport operator in Russia, for RUB 22.77 billion. Medsi Group commences merger of assets with the Medical Centre for the Mayor and Government of Moscow. In exchange for a 25% stake, Medsi received 3 hospitals, 3 health resorts and 3 outpatient clinics. Thus, Medsi Group became a full-service medical company. RTI buys a 50% stake in NVi- sion Group and increases its stake in SITRONICS to 100%. SITRONICS was delisted from the London Stock Exchange on August 23, 2012 Sistema sells power generation assets of Bashkirenergo to Inter RAO UES for RUB 11.2 billion. Sistema and Louis-Dreyfus family members form a farming joint venture in Russia. The JV combines both parties’ agricultural assets, totalling approximately 90,000 hectares. Sistema consolidates its telecom assets and sells its 50.91% stake in Comstar-OTS to MTS in a transaction worth about US$ 1.32 billion. Sistema acquires controlling stakes in BashTEK companies for US$ 2 billion, increasing its shareholding in Bashneft to 76.5%. Sistema exits from real estate construction business. VTB Bank acquires a controlling stake in Sistema-Hals. Later, Sistema completed the sale of the remaining shares in Sistema-Hals. Sistema buys a 49% stake in NK RussNeft in a transaction worth less than $100 million. 6 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHKEY EVENTS 2013 2014 Sistema sells its 49% stake in NK RussNeft for US$ 1.2 billion. Sistema acquires 51% of Business-Nedvizhimost, which owns 76 properties with a total area of 178,000 sq m, from MGTS- Nedvizhimost for RUB 3.2 billion. Later, Sistema purchased the remaining 49% for RUB 3.1 billion. In April 2014, Sistema acquired a 10.8% stake in OZON for US$ 75 million. MTS also acquired a 10.8% stake at the same price. In July 2014, Sistema pays RUB 19.9 billion in dividends. This translates to a dividend yield of around 5% as of the payout date. Sistema invests in oil service assets by acquiring 100% of Bashneft-Service Assets (later renamed Targin) from Bashneft for RUB 4.1 billion. The Board of Directors of Sistema approves a new incentive programme, based on share price performance and cash flow at the Corporate Centre level. Sistema begins investment in forestry and pulp and paper industries. In September 2014, LLC LesInvest, part of the Group, acquired 100% shares of OJSC Segezha Pulp and Paper Mill from the Bank of Moscow and 100% of shares of LLC Derevoobrabotka-Proekt (Group of companies). The net external debt of the acquired assets is equal to zero (see p. 44). The Group of companies is the largest producer of sack paper and paper sacks in Russia and the second largest man- ufacturer of paper sacks in Europe. In 2014, Sistema increased its stake in NVision Group to 100%. Sistema expands its footprint in the retail sector. In October 2014, Sistema buys a 40% stake in the holding company which owns the assets of Concept Group, one of the leaders in the Russian retail clothing market in terms of revenue growth, in a transaction worth about RUB 1 billion. The documents signed provide for an option for Sistema to increase its shareholding in Concept Group to the controlling level within three years. MTS-Bank issues additional shares for RUB 13.1 billion. Sistema purchased 2,474,818 ordinary shares for RUB 9.46 billion. MTS purchased 952,000 ordinary shares for RUB 3.64 billion. In December 2014 by the court Siste- ma transfered all its shares in Bash- neft to the Government. In February 2015 the Moscow Arbitration Court upheld the claim of the Corporation to the LLC Ural-Invest and decided to recover losses from the defendant in favor of Sistema. In March 2015 Sistema and LLC Ural-Invest signed a settlement agreement under which the fund transfers RUB 46.5 billion to the Corporation, of which RUB 4.6 billion invested in the fund charita- ble projects. Later on Sistema has received additional compensation of RUB 12.9 billion. 7 CORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENT1. Основные логотипы Основной цвет pantone 647c 1.1. Допустимый цвет pantone 195c. Использовать только после согласования с представителями АФК «Система»! 2. Допустимые варианты логотипов COMPANY STRUCTURE Используются при невозможности размещения основного варианта. (на перетяжках, в ряду одинаковых по высоте логотипов компаний и т. д.) Использовать только после согласования с представителями АФК «Система»! 2.1. Допустимые варианты логотипов 53% 87% RZ Agro Group 50% Используются при физической невозможности воспроизведения мелкой текстовой части логотипа. Over (ручки, шильдики, значки и т. д.) 100,000 Использовать только после согласования с представителями АФК «Система»! 104 mln 195 hectares of land worth of assets subscribers RUB billion Over 99% 91% 100% Over 109 mln store visits per year 80,000 km of power grids 49 drilling rigs, 180 crews 3. Допустимые цветовые решения 75% 50% company of JSFC Sistema 74% Использовать только после согласования с представителями АФК «Система»! 6 mln doses Over Over 6 mln visits per year 34,000 «Выворотка» of railcars under management of Hepatitis B vaccine per year на белой плашке (при пестром фоне) Черный серый элемент марки – 50% черного цвета 8 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHWorld-wide reach of activities and diversified asset structure enable Sistema JSFC to achieve sustainable operating and financial performance. 86% 66% Real estate 100% 11.8 mln subscribers 2,617 rooms under management 388,000 m2 under design and construction and over 442,000 m2 under management SSTL 57% 85% 10.8% HSD services in over 800 Indian cities and towns Mikron has developed a proprietary 65 nm chip technology 21million unique users monthly 100% 40% 4.5 mln m3 of allowable cut 342 stores 9 CORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENTPRESIDENT’S SPEECH 32% in the previous year. One of the key assets in our portfolio is Detsky Mir, Russia’s best-known children’s goods brand, demonstrated the third largest revenue and highest growth rate of all the Group’s assets. Detsky Mir’s value increases each year, and the company continues to retain its leading industry position, with over 330 stores across Russia. Our company RTI develops high- tech assets in the microelectronics and defence industries, as well as smart IT systems. The initiatives we have implemented to optimise the business and increase its financial stability in 2014 have led to a considerable improvement in the Group’s returns. Last year Sistema continued to actively develop its healthcare business Medsi, which generated a 4% year-on-year revenue growth, in rouble terms, despite the closure for redevelopment of some medical facilities during the year. Medsi’s strategy is currently focused on increasing its market share in the medium term, both by constructing new treatment facilities and increasing patient loyalty. Our Indian business, SSTL, has largely delivered on its financial targets and we expect that it will near OIBDA breakeven in 2015 as we continue to reduce its reliance on Sistema. Whilst numerous regulatory challenges continue to persist, the latest licensing rounds have shown both demand and price increase in the 800 mhz spectrum that SSTL operates in. This is encouraging and may create strategic opportunities as the sector outlook improves and evolves. In 2014, we continued our search for attractive investment opportunities in Russia, investing in the pulp and industry. With vast felling area, low production costs, and proximity of export markets, LesInvest Group, Russia’s biggest producer of sack paper and paper sacks and Europe’s second largest paper sack maker, has significant growth potential. We intend to further enhance its value, create new jobs and modernize production facilities. Last year, Sistema also entered the e-commerce and fashion retail market by acquiring interests in OZON Holdings Limited and Concept Group. With more than 20 years of experience operating in Russia, we have proved that Sistema has the capacity and expertise to create value for all the stakeholders not only during periods of growth, but also in times of volatility and uncertainty. Meeting our social responsibilities is a core element of our business strategy, and we are committed to developing our people, investing in talent and diligence, as well as fostering regional innovation and social development. As we look into 2015, Sistema remains in a strong financial position. We have a stable and growing dividend flow from current investments, a much reduced corporate costs and a process of vigorous assessment of each opportunity on its financial merits. With these fundamentals in place, we believe Sistema is well placed to capitalise on new investment opportunities and we look forward to delivering value to the Group’s shareholders in the coming year. Mikhail Shamolin President of Sistema 2014 was a challenging year both in corporate and macroeconomic terms. In this period, Sistema faced numerous operational and strategic pressures and I am pleased to see the Group has successfully navigated these obstacles, demonstrating the resilience of our business model and acquiring invaluable experience, which will assist us in our future development. In addition to external macroeconomic factors, Sistema was, undoubtedly, affected by the situation surrounding Bashneft last year. Following litigation, Sistema transferred the asset to the state, subsequently obtaining cash compensation as a good-faith buyer. The events had a significant impact on our portfolio, but it did not change the essence of our business and our competencies. We are still a unique Russian company that employs efficient management, the right strategic decisions and a professional team to turn distressed and complicated assets into leaders in their respective industries. In 2014, we have achieved solid results, with consolidated revenues growing by 7.2%. Ten out of our thirteen biggest assets increased their revenues; eleven out of thirteen achieved positive OIBDA; nine showed positive net income and paid dividends. Developing assets’ share of Sistema’s total revenue grew to 41% in 2014 from 10 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHSTRATEGIC REVIEW Strategy Financial results Shareholder capital and securities 12 20 24 STRATEGY Mission Long-term growth of shareholder value through efficient management of the asset portfolio and achievement of high returns on investment. High returns on investment Lower investment risk Unique expertise on the Russian market and a strong management team Diversified and balanced portfolio in the fundamental segments of the Russian economy and balanced contribution of assets to the total value Value creation model The model of Sistema as an investment company envisages creation of shareholder value through constant reinvestment of capital - accumulation of cash from incoming dividends and monetisation of assets, distribution of the received profit in form of dividends among Sistema’s shareholders, reinvestment in existing assets and new investment projects in order to receive further income. • Shareholder dividends • New investments 1 n pital allo c a ti o a C Search fo opportu r i niti n v e e s s t m e n t Sistema JSFC 4 M o n 2 G rowing in a r e h older valu e e tiz ation 3 h s • Profit on sales • Dividend yield 12 Resources: • Expert evaluation and experience • Financial resources • Management resources • Reputational resources New investments: • Strategy development • Business optimization • Synergy with the Group companies • Management efficiency • Preparation for monetization ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHComponents of successful growth Our business Our principles of operation Our strategy Our efficiency Creation of value by leveraging competencies: Lean and competitive structure: Science applications to create art: No cash – no reward: • Internal rate of return on investments above weighted-average cost of capital (IRR>WACC) with a 5-7-year payback period • Focus on investment with a positive net cash flow • Acquiring assets with an acceptable debt level (Debt/OIBDA < 3.0x) for preserving the Group’s stable financial situation • Keeping consolidated Debt/EBITDA at 2x • Payout to shareholders of up to 30% of profit • Remuneration of investment managers fully depends on cash generated by their portfolio for Sistema • Cash may be received from dividends or monetisation • Current dividends from MTS are not included in calculation of remuneration • Remuneration is paid after deducting the portfolio’s expenses and the Central Bank’s rate • Assessment and • Managing assets development of business strategies for our assets without involvement in operations according to the principle of deal origination and industry expertise of portfolio managers • Monitoring of M&A • A team of strategic experts, macroeconomists and communication professionals opportunities in current and new sectors • Development and implementation of asset monetisation plans • Hiring efficient management for companies under our control • Providing comprehensive support to our assets in attracting financial and other resources • Increasing operational efficiency of acquired assets through restructuring and attracting industry partners to increase expertise and share financial risks 13 CORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENTInvestment strategy Medium-term goals of Sistema as an investment company • Generating a substantial cash flow at Hold Co through portfolio monetisation and dividends from subsidiaries, as well as by finding and benefiting from unique investment opportunities in Russia • Balancing investment portfolio with export-oriented industrial companies in Russia that may become a source of foreign currency liquidity • Restructuring and supporting portfolio companies operating in segments that are most sensitive to changes in the economic situation • Building industry leaders in private healthcare, high technology and microelectronics, pulp and paper industry, in order to maximise returns on shareholder capital Investment criteria Sectors and industries: sectors, that are complementary to current investments and enable the use of the competence of Corporation and implementation of synergy with the current portfolio; new, economically attractive industries subject to availability of expert evaluation or industry partner Business geography: primarily Russia and the CIS; monitoring of other geographical opportunities from the viewpoint of diversification of market outlets and currency risk Scope of assets: large and medium assets ensuring leadership in the market due to synergetic effects, opportunities for industry consolidation and successful implementation of investment and operating strategy 14 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHSistema JSFC Investment Vision Industry Telecommunications in Russia Strategy Develop to obtain stable dividend flow Key industry characteristics • Slowing down growth of the mobile communications market • Growing penetration of data transfer services • Growth in the OTT services segment Children’s goods retail • The sector is resistant to deterioration of macroeconomic situation • Low market concentration with opportunities for consolidation • Demographic situation will continue promotion of growth of consumer expenditures on children’s goods Grow business volume to obtain dividend income; and possible partial sale given the favourable conditions Sistema JSFC investment vision Sistema JSFC views MTS as a strategic asset that is generating high dividend income. In order to achieve the targets on dividend flow, MTS will continue to develop actively the data transfer services, focus its marketing efforts on holding its leading positions in Russia and explore potential for synergies with other businesses of Sistema JSFC Group, including, MTS Bank and Ozon Holding, to get competitive advantages on the market. More about the operating strategy see p. 28 Sistema JSFC views Detsky Mir as a promising asset that has already achieved significant results and is able to bring in substantial returns on capital in the form of dividends or by means of partial monetization. Since the children’s goods retail sector is resistant to economic recessions, Sistema JSFC is planning active development of the Detsky Mir chain and opening about 40 new stores in 2015. More about the operating strategy see p. 34 Private healthcare • High growth rate of the Russian private healthcare services market • Government support to the sector • Low market concentration with opportunities for consolidation Grow business volume and introduce the best practices in healthcare Sistema JSFC sees a high potential of the Russian private healthcare market development and is building up the federal network providing high-quality healthcare and rehabilitation services for the country citizens. During the next two years, Medsi will focus its efforts on expanding business scale by constructing new medical centers, introducing new healthcare technologies and further improving of the quality of services. More about the operating strategy see p. 38 15 CORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENTIndustry Wood processing industry Key industry characteristics • The ruble rate depreciation and large transport leverage reduce the competitiveness of importers • Rated wood cutting of Russia exceeds in three times the felling volume • Export-oriented industry with the largest great of currency returns Electric grid business • Steady and slight growth of power consumption – by 0.4% in 2014 • In autumn 2013, tariffs of natural monopolies for 2014 were frozen • In 2014 tariff growth was limited at the rate of 3.8% Strategy Sistema JSFC investment vision Develop the asset by restructuring and optimizing of business; getting on the dividend flow in the medium term Sistema JSFC acquired assets of GC LesInvest at the end of 2014. Sistema JSFC is planning to ensure return on capital by optimizing of current business, improving controllability and transparency, as well as subsequently expanding production (in particular, paper sacks and plywood). More about the operating strategy see p. 44 Further develop the business after successful transition to RAB regulation of tariffs, maintain a steady dividend flow The strategy of electric grid assets is focused on growth of business by modernizing of equipment, building of modern grids using Smart Grid components and developing the region infrastructure. Sistema JSFC intends to develop the business by consolidating and subsequently modernizing of regional assets. The company transition to the 10-year tariff regulation using the return-on- investment (RAB) method will enable effective long-term business development planning and is aimed to improve its investment attractiveness. The company expects to invest over 29 bln. rub. in the electric grid sector of the Republic for the 10-year term. More about the operating strategy see p. 52 Railway transportation • The segment of liquefied gases (LNG) transportation shows the highest stability in the sector • LNG transportation volume has grown by 8% in 2014, while bulk oil cargo transportation volumes by 2% in total Develop LNG transportation segment and maintain profitability In 2015, Sistema JSFC will focus on supporting SG-trans current business and achieving operational objectives. Maintaining of profitability will be achieved by efficient wagon fleet management and optimization of leasing agreements. More about the operating strategy see p. 60 16 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHIndustry Key industry characteristics Strategy Sistema JSFC investment vision Pharmaceuticals • The market volume has grown by 9.3% in monetary terms in 2014 • Share of foreign producers in the Russian market is over 70% • Russia has launched the programme for import substitution • Starting from 2014, the government may limit participation of foreign companies in government tenders Expand product portfolio and establish partnership with an industry expert Sistema JSFC is planning to develop the pharmaceutical business by implementing large-scale projects on launching new production lines and procurement of third- party products. Gain in product portfolio by partnership with international companies will contribute in increase of production capacity utilization, Binnopharm is also planning to upscale production by participating in the programme for import substitution. More about the operating strategy see p. 76 High Technologies • The government demand for high-tech products is growing • Growing demand for intelligent transport systems • Development of microelectronics will be supported by the import substitution programme Improve the economic performance of the business, develop own intellectual products and achieve a steady dividend flow in the medium term In 2014, Sistema JSDC has begun restructuring JSC RTI high-tech assets in order to improve the economic performance of the business and achieve a stable dividend flow in the medium term. The main development focus will be on the segments of defense industry, microelectronics and intelligent IT systems. RTI is planning to increase its profitability by growing intellectual property share in finished products, to increase production of microchips by extending cooperation with the government and to focus on new products in the aerospace industry. More about the operating strategy see p. 54 17 CORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENTIndustry Oilfield services Key industry characteristics Strategy Sistema JSFC investment vision • Industry consolidation with the biggest players • Increase of volumes of horizontal drilling • Demand for high-tech oilfield services Develop promising segments of high-tech drilling, improve the profitability of business and potential partnership with an industry expert Investments in Targin have a significant growth potential by modernization of the vehicle fleet to increase profitability, introduction of new technologies to diversify range of services and optimization of business and its structure. Sistema JSFC is planning to attract an industry partner to extend Targin expert evaluation. More about the operating strategy see p. 72 Banking sector • Increased cost of funding • Tougher regulation of retail lending • For the first time in several years, corporate lending grew faster than retail lending Develop and support the banking business, provide effective risk management Sistema JSFC investment strategy in the banking business provides for growth of shareholder capital returns while maintaining the high level of MTS Bank financial stability. Under current economic conditions, Sistema JSFC is focused on improvement of the risk management system and growing of Bank’s customer deposits. Sistema JSFC also sees a growth potential for the banking business in the synergy with MTS. More about the operating strategy see p. 54 Real estate • Due to an unprecedented volume of commissioned real estate in 2014, the office real estate market now has a surplus • Subsidizing of the mortgage rate will support the residential real estate market Construct and develop the most liquid real estate assets and monetize by leasing and sales Sistema JSFC is planning construction and monetization of residential real estate assets, as well as aggregation of office real estate assets and increase in revenue from management and leasing and property management, which will be used to finance new projects and will enable to pay portfolio dividends. More about the operating strategy see p. 80 18 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHIndustry Key industry characteristics Telecommunications in India • • Three largest Indian operators have taken up 58% of the market • Competition in the data transfer services segment is growing • In 2015, a new auction for several frequency bands was held, including for 800 MHz, where SSTL operates Media assets • Rate of growth of the Russian media market is slowing down • Ownership ratio of foreign companies in any Russian mass media company has been limited to 20% • The government is stimulating telecasting of the Russian content on the part of state Agriculture • Export-oriented industry with a high share of currency returns • Russia became the world’s third largest wheat producer in 2014 • Russia’s wheat output in comparison with the previous year grew up by 13% as compared with the global growth of 1% Strategy Reduce expenditures for the business funding and resolve regulatory issues Search for new promising markets and develop convergent media products in partnership with other Sistema Group companies Expand the land bank and develop export channels Sistema JSFC investment vision In 2015, we plan to continue with financial rehabilitation of the Indian business and significantly reduce its need in financing of its operating activity on the part of Sistema JSFC. In case of resolved regulatory issues regarding frequency spectrum use, Sistema JSFC may consider opportunities of partnership with an industry expert. More about the operating strategy see p. 84 Sistema JSFC investment strategy in regard to media assets of SMM is focused on creating conditions for entry into emerging markets in the new digital environment, developing new digital services and digital media. Successful implementation of the strategy will contribute in maximum use of current competitive advantages of Sistema Group as a whole. More about the operating strategy see p. 88 The strategy of agriculture business development proposes further expansion of the land bank by strategic acquisitions and partners attracting . The targeted regions are Rostov region, Stavropol territory and Krasnodar territory. Sistema JSFC is also planning to develop export channels and such segments as seeds production and sale and contracted harvest works. More about the operating strategy see p. 68 19 CORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENTSistema’s financial results (US$ millions) Revenues Adjusted OIBDA Operating income Adjusted operating income FY 2014 FY 2013 Change 16,585.0 18,502.0 (10.4%) 4,438.3 5,570.2 (20.3%) 1,738.4 3,566.6 (51.3%) 2,146.1 2,936.7 (26.9%) Net (loss)/ income attributable to Sistema (4,087.6) 2,257.5 - Adjusted net income attributable to Sistema 1,194.9 1,623.5 (26.4%) (RUB millions) Revenues Adjusted OIBDA Operating income Adjusted operating income FY 2014 FY 2013 Change 631,865 589,251 7.2% 165,171 177,400 (6.9%) 60,876 113,588 (46.4%) 78,353 93,527 (16.2%) Net (loss)/ income attributable to Sistema (232,556) 71,898 - Adjusted net income attributable to Sistema 44,194 51,706 (14.5%) Note: The reporting currency of the Group’s US GAAP consolidated financial statements is the US dollar. Here and hereafter, the financial information in Russian roubles has been presented for the users’ convenience and is not derived from audited financial statements. Financial figures in US dollars were converted to roubles using following approach: amounts from the statement of financial position – using closing rates as of the reporting dates, amounts from the income statement – using average rates of the reporting periods except for significant transactions / accruals, which were converted using exchange rate as of date of a transaction /accrual or actual rouble amounts for transactions/accruals nominated in roubles. Following its transfer to the Russian Federation in December 2014 of shares in Bashneft, Bashneft’s results are treated as a disposal, reported as discontinued operations and excluded from the Group’s financial results for all periods presented. The Group’s financial results for the fourth quarter and the full year of 2014 were impacted by the rouble depreciating significantly against the US dollar. In 2014, Sistema recognised loss from certain one-off items, which significantly impacted the company’s financial results. The largest one- off items include: US$ 5.0 billion loss from the deconsolidation of Bashneft, US$ 290.0 million loss from the impairment of long-lived assets in India (SSTL) and US$92.5 million of accrued provisions for cash and deposits in Delta Bank (MTS). 20 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHRevenues Sistema’s consolidated revenues in rouble terms increased by 7.2% year-on-year in 2014 despite the challenging economic environment, and reflect a strong contribution from all the Group’s companies, particularly from MTS, Detsky mir, as well as Targin (acquired in the third quarter of 2013) and the pulp and paper business (acquired in the third quarter of 2014). Ten of Sistema’s 13 major assets demonstrated revenue growth in 2014 in rouble terms. Revenues by sectors* Telecom HighTech Consumer Pulp&Paper Oil services Banking Energy Other 61% 17% 9% 4% 3% 2% 2% 2% * Based on aggregate revenues of 4Q 2014 As of the fourth quarter of 2014, the Company began consolidating LesInvest into the Group’s financial results. In the fourth quarter of 2014, LesInvest already contributed RUB 7.2 billion and RUB 1.1 billion to the Group’s consolidated revenue and OIBDA. The consolidation of Targin contributed approximately RUB 16 billion to the Group’s revenue growth for the full year of 2014. Revenue analysis, RUB bln +12.3 +13.7 +9.4 +7.2 631.9 589.3 Revenue 2013 MTS revenue growth Growth at other assets and consolidation of Targin, net Detsky mir revenue growth Consolidation of LesInvest in 4Q Revenue 2014 21 CORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENTOIBDA The Group’s adjusted OIBDA decreased by 6.9% year-on-year in rouble terms in 2014, mainly due to accrued provisions for the loan portfolio to individuals at MTS Bank. Eleven of Sistema’s 13 major companies reported positive adjusted OIBDA in the reporting year. OIBDA analysis, RUB bln 177.4 +2.1 +1.5 +1.1 –1.1 OIBDA 2013 Destky mir OIBDA growth Decreased loss of SSTL Consolidation of LesInvest in 4Q Decreased OIBDA of other assets, net 165.2 OIBDA 2014 –15.8 Decrease in MTS Bank OIBDA Net income In 2014, adjusted consolidated net income attributable to Sistema decreased by 14.5% year-on- year in rouble terms, mainly due to US$ 548.6 million (RUB 21.1 billion) worth of foreign exchange losses. Nine of Sistema’s 13 major companies reported net income in 2014. The Group’s net income includes Sistema’s share in Bashneft’s net profit for the period of ownership: US$ 1.2 billion in 2014 and US$ 1.1 billion in 2013. Capital expenditures Capital expenditures increased by 21.4% YoY mainly driven by MTS due to US dollar appreciation. Active construction and modernisation of medical facilities at MEDSI added RUB 3 bln to capital expenditures of the Group in 2014. Other largest contributors to the Group’s CAPEX are RTI, BPGC, Detsky mir and real estate projects. The Group’s SG&A expenses grew by 6.2% YoY, which is lower than the rate of inflation. Corp Centre’s SG&A increased by 4.9% YoY in 2014, mainly due to one-off optimisation costs in 4Q 2014 and non-cash accruals for incentive programme in 2014. In 2015, Sistema plans to reduce its SG&A by 25-30%. 22 Group’s capital expenditures, RUB bln MTS 81.6 RTI 3.0 BPGC 3.1 Other 7.7 21.4% 115.8 95.4 2013 2014 92.6 MTS 4.0 3.3 RTI BPGC 3.0 Medsi 12.9 Other ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHGroup’s debt A 35% increase in consolidated debt was mainly due to the dollar appreciating against the rouble and MTS increased obligations. MTS debt increased due to borrowing of additional funds at attractive terms to hedge risks of low liquidity in the future on the back of market situation. In October 2014, MTS signed an agreement with Sberbank of Russia to open a non-revolving line of credit for a total amount of RUB 50 billion and maturity in September 2021. The Group’s debt currency profile remained largely stable. A large part of US dollar denominated debt relates to MTS and the Corporate Centre, obligations of Sistema’s other Russian subsidiaries are largely denominated in roubles. Group’s debt, RUB bln Group’s debt by currency 464.9 56.7 68.8 47.3 MTS RTI Corporate Centre 292.1 Other assets 344.3 33.9 51.5 40.2 218.7 4% 4% 66% 59% 30% 37% 2013 2014 2013 2014 USD RUB Other currencies Debt at Corporate level The Corporate Centre’s debt increased due to dollar appreciation against the rouble. The Corporate Centre’s obligations in US dollars are mostly represented by Eurobonds with maturity in 2019. Corp Centre’s cash position amounted to RUB 28.8 bln , 70% of Sistema’s cash was denominated in US dollars. Net debt at Corporate level amounted to RUB 40 bln. In 2015, Sistema plans to repay RUB 2.8 bln of rouble bonds and RUB 12.2 bln of loans from banks (RUB 8.6 bln had already been repaid after the reporting period). Corporate Centre’s debt, RUB bln Corporate Centre’s debt by currency 68.8 Cash position Debt 51.5 41.8 28.8 66% 59% USD RUB 34% 41% 2013 2014 2013 2014 * Including highly liquid financial instruments 23 CORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENTSHAREHOLDER CAPITAL AND SECURITIES Sistema’s shareholders* Evtushenkov V.P. Deutsche Bank (GDR programme) National Settlement Depositary (Moscow Exchange) Sistema Finance Investments (Ordinary shares)** Sistema Holding Limited (ГДР)** Other*** 64.2% 17.6% 0.8% 9.5% 1.4% 6.5% Sistema has 9,650,000,000 ordinary shares outstanding, with a par value of RUB 0.09 each. The company’s shareholder capital amounts to RUB 868,500,000. Sistema had its IPO in February 2005 and was listed on the London Stock Exchange under ticker symbol SSA. The company’s shares are traded on the London Stock Exchange as Global Depositary Receipts (GDRs) with one GDR representing 20 ordinary shares. Its ordinary shares are traded on the Moscow Exchange under ticker symbol AFKS. Sistema’s free float on the London Stock Exchange is approximately 19% and 16.8% of the shares are traded on the Moscow Exchange (including positions of insiders, shares owned by management and members of the Board of Directors, and ordinary shares on Sistema’s Group balance sheet). Sistema’s shares are included in the benchmark indices of the Moscow Exchange (MICEX Index and RTS Index). These are capitalisation- weighted composite indices calculated based on prices of the 50 most liquid stocks of major Russian issues from Russia’s key sectors. Sistema’s shares are also included in MICEX Financial Services Index (a sector index). Sector Indices are capitalisation-weighted indices calculated based on prices of the most liquid shares of Russian issuers operating in the relevant sector, which are admitted to trading on the Moscow Exchange and are included in the Broad Market Index. The Moscow Exchange’s multi- asset indices are composite indices comprised of stocks and bonds admitted to trading on the Moscow Exchange, that can be used as investment vehicles by Russian Pension Funds. Sistema’s shares are included in equity sub-index and bond sub-index. Sistema’s GDRs are also included in MSCI Russia Index. This serves to confirm international recognition of the company and strengthen its reputation among the largest institutional investors with index strategies. Shares of MTS, Sistema’s subsidiary, are traded on the New York Stock Exchange as ADRs (ticker: MBT). Its ordinary shares are traded on the Moscow Exchange under ticker sym- bol MTSS. Chairman of the Board of Directors of Sistema Vladimir Evtushenkov, with 64.19% of shares, is Sistema’s principal shareholder. Number of outstanding shares amounts 9,650,000,000 Ordinary shares with nominal value of RUB 0.09 The share capital amounts RUB 868.5 million * As of December 23, 2015 *Shares and GDRs owned by Sistema Group *** Shares held by insiders (management, members of the Board of Directors and others) 24 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHSistema’s shareholders* Sistema’s GDRs and ordinary shares significantly decreased in the sec- ond half of 2014 due to the situation around Bashneft and changes in macroeconomic conditions. The rou- ble depreciated against the US dollar by 75.3% in 2014, Brent oil price fell by 44.5% in 2014. Sistema’s GDRs dropped by 83.8% between January 1, 2014 and Jan- uary 1, 2014. The closing price of Sistema’s GDR on the London Stock Exchange on the first trading day of 2014 was US$ 31.25 with a market capitalisation of US$ 15,078 million, while on the last trading day it was US$ 5.21 with a market capitali- sation of US$ 2,514 million. Siste- ma’s ordinary shares decreased by 74.5% in 2014, RTS index lost 45.2% for the year. Sistema’s GDRs reached a high of US$ 32.08 on January 10, 2014 and a low of US$ 1.88 on December 16, 2014. The average daily trading vol- ume on the London Stock Exchange in 2014 was 997,240 GDRs. Between January 1, 2015 and March 31, 2015, Sistema’s GDRs gained 42% and its ordinary shares rose by 57%, while RTS Index was up 11.3%. The company’s market capitali- sation as of March 31, 2015, was USD$ 3.6 billion. Ordinary shares s e r a h s f o . l l i m n i e m u l o V 250 200 150 100 50 e r a h s r e p B U R 50 45 40 35 30 25 20 15 10 5 12.2013 01.2014 02.2014 03.2014 04.2014 05.2014 06.2014 07.2014 08.2014 09.2014 10.2014 11.2014 12.2014 01.2015 02.2015 03.2015 Trading volume Ordinary shares RTS Index Global depositary receipts R D G f o . s u o h t n i e m u l o V 10 000 9 000 8 000 7 000 6 000 5 000 4 000 3 000 2 000 1 000 R D G r o f S U $ 35 30 25 20 15 10 5 12.2013 01.2014 02.2014 03.2014 04.2014 05.2014 06.2014 07.2014 08.2014 09.2014 10.2014 11.2014 12.2014 01.2015 02.2015 03.2015 Trading volume GDR of Sistema JSFC * Source: Bloomberg 25 CORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENT 556 5.0% 300 3.1% Dividends, US$ mln Yield Dividend yield of Sistema in 2010-2014 87 0.7% 17 0.0% 82 0.8% 2010 2011 2012 2013 2014 In June 2014, the Annual General Meeting of Shareholders approved the total amount of dividend payment on Sistema’s shares for 2013 at RUB 19.9 billion, representing a payment of RUB 2.06 per ordinary share (RUB 41.2 per GDR). The total proposed dividend payment has been determined on the basis of Sistema’s full year 2013 US GAAP net income and the corporate centre’s net gain from the sale of stake in RussNeft in July 2013. In July 2014, Sistema paid out record dividends, corresponding to dividend yield of 5%. Dividends Sistema’s dividend policy aims to provide a regular and sizeable divi- dend flow, while allowing the compa- ny to maintain the financial flexibility to take advantage of attractive invest- ment opportunities in the future. Dividends are declared on the basis of results from the previous financial period, and the company’s dividend policy is for annual dividends to be a minimum of 10% of the corporation’s consolidated net income under US GAAP (net of any special dividends paid). In addition, in the event of a large asset sale for cash, special div- idends will be declared in an amount of at least 10% of the net gain from such a transaction, as determined by the Board of Directors. Under Russian law, the total amount of div- idends with respect to any year may not exceed the company’s annual unconsolidated net income deter- mined in accordance with Russian Accounting Standards (RAS). BOND PORTFOLIO Debt profile at the holding company level includes rouble bonds and Eurobonds. As of December 31, 2014, Sistema had two rouble bond issues and one Eurobond issue: • Eurobonds issued in May 2012 with a par value of US$ 500 million and a coupon rate of 6.95% (semi- annual payments), maturing on May 17, 2019 The bonds mature in 15 years. In addition, bondholders have the right to redeem their bonds at the point of expiration, 18 months from the date the bonds were placed. • 3-series rouble bonds with a par value of RUB 19 billion maturing on November 24, 2016 and with a coupon rate of 8.75% (semi-annual payments) • 4-series amortised rouble bonds with a par value of RUB 19.5 billion maturing on March 15, 2016 and with a coupon rate of 7.65% (semi- annual payments) In 2014, Sistema repaid its 2-series rouble bond issue with a par value of RUB 20 billion. In February 2015, Sistema completed the placement of RUB 10 billion Series BO-01 unconvertible interest- bearing bonds with a par value of RUB 1,000 at the rate of 17% per annum. Coupon payments will be made on a semi-annual basis. Placement of exchange bonds was the first market transaction in the Russian market since the turn of 2014 among BB credit rating corporate borrowers, as well as the first market transaction in the corporate segment in 2015. The successful placement showed the attractiveness of Sistema JSFC securities and interest to the current investment strategy. 26 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHOUR INVESTMENTS MTS Detsky Mir Medsi group LesInvest group (Segezha) Bashkirian Power Grid Company RTI SG-trans MTS Bank RZ agro holding Targin Binnopharm Real estate Sistema Shyam Teleservices Sistema mass media 28 34 38 44 52 56 60 64 68 72 76 80 84 88 MTS Mobile TeleSystems (MTS) is a leading telecom operator in Russia and the CIS countries. Together with its subsidiaries, MTS provides services to about 104m mobile subscribers in Russia, Armenia, Ukraine, Turkmenistan and Uzbekistan. The company also provides fixed telephony and pay- TV services in Moscow (MGTS), in all federal districts of Russia and in Ukraine. Management President – A.A. Dubovskov Chairman of the Board of Directors – R. Sommer Sistema’s effective ownership 53% Revenue Number of subscribers Market share in data segment Position in Russian mobile market 410.8 104 RUB bln mln 37% №1 Industry* The growth rate of the Russian telecom market slowed down in 2014 to 2.7% compared to 5% in 2013, mainly due to the decline in the growth rate of the mobile market from 5% to 3%. The penetration of OTT services (Skype, WhatsApp, Viber, etc.) continues to increase and has reached 13% in Moscow. This trend is expected to result in a further downturn in the mobile voice market as part of mobile voice usage continues to be replaced by Voice over IP (VoIP) and SMS is replaced by iMessaging. Operators’ revenues from data services in Russia, mln RUB 176,806 139,713 99,994 75,636 53,026 2010 2011 2012 2013 2014 * According to company data and information from ACM-Consulting, TMT-Consulting, iKS-Consulting and Svyaznoy. 28 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHData communication services continue to drive growth in the mobile business through incentives to increase smart- phone and tablet penetration, promo- tion of packaged “voice&data” plans, development of data communication networks and distribution channels. In 2014, the penetration rate for data ser- vices in Russia reached 60%. Over the last three years, data traffic in Russia has grown sevenfold, with LTE traffic accounting for 12% of total traffic as of December 2014. According to expert estimates, the broadband access (BBA) subscrib- er base in Russia totalled 28.9 mln households in 2014. The fixed BBA market in 2014 increased by 5.1%. In 2015, the BBA and pay-TV markets will remain highly competitive, with 3-4 players in every large city of Rus- sia. The growth in the BBA subscriber base will be mainly driven by churn from competitors. According to fore- casts, the number of BBA subscribers in 2015 may increase by 3.7% to 29.96 mln households. The pay TV market in Russia grew by 6.1% in 2014 to RUB 57 bn, with the number of pay-TV subscribers rising by 8.3% to 37.8 mln. The TV market re- mains among the fastest growing mar- kets due to the development of hybrid and satellite TV. In 2015, growth rates of the pay TV market and subscriber base in Russia are predicted to slow down from 4.2% to 3.8%, respectively, with a penetration rate of above 70%. Subscriber base in Russia, m 243 240 231 228 219 Subscribers in Russia, mln MTS market share 32.6% 30.7% 30.9% 31.0% 31.0% 2010 2011 2012 2013 2014 Over 2014, the sales of mobile phones and smartphones in Russia increased by 6% to 44m units with the share of smartphones in total phone sales reaching 64%. The market is characterised by a fall in the average smartphone price with an increase in the share of low cost models in total sales to 60-65%. The growth of tablet unit sales also slowed down to 33% in 2014 year- on-year compared to 125% growth in 2013; however, in monetary terms, sales remained stable. In 4Q 2014, the financial results of telecom companies were affected by fluctuations in the rouble exchange rate against foreign currencies and lower growth in retail lending, push- ing up the costs of imported telecom equipment and international roam- ing and interconnect costs of tele- com operators. Therefore, rates for premium international roaming and voice calls are expected to increase. The majority of markets where MTS operates will continue to be exposed to currency risks In 2015. Besides, there is the risk of a decline in consumption in the telecom market, especially for international roaming services. Steady growth in 2014 MTS remains the leader in total revenues and OIBDA among the Russian «Big Three» operators, with the lowest churn rate in 2014 and a 7.5% year-on-year growth in the mobile subscriber base in Russia. MTS also leads in mobile data revenue with a 38.8% market share among the «Big Three» as of the end of 2014 and a 35.9% year-on-year increase in data revenue in 2014. * Calculated from company press releases. ** mobile subscriber base in Russia for the 2010-2013 includes MTS subscribers recorded on the basis of 6-month activity. From the 3rd quarter of 2014 MTS has moved to the account of subscribers based on 3-month activity, the data for 2014 include a 3-month MTS subscribers. MTS revenues by geographies, bln RUB 378.2 11% 398.4 11% 410.8 9% 89% 89% 91% 2012 2013 2014 Revenue in Russia Revenue in other countries 29 CORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENTMTS revenues in Russia by services, bln RUB Mobile revenue Fixed-line revenue Other revenue 291 62.5 21.4 In 2014, MTS continued active investments in the construction of 3G and 4G data networks along with modernization and expansion of 3G networks in strategic regions and quality improvement projects imple- mented in Moscow and Saint-Pe- tersburg. According to Speedtest data, MTS has the best data down- load speeds and the lowest network lag in Russia. In Moscow, according to Speedtest user measurements, MTS’s LTE networks have the high- est data download speeds, following the large-scale construction of net- works undertaken in 2013-2014. The 4G network was launched into commercial operation in 76 Russian regions compared to 15 regions at the end of 2013, with MTS leading in terms of the number of Russian regions covered by LTE networks as of the end of 2014. In Moscow, MTS focused on the quality of data services, which resulted in a 10-fold growth in LTE traffic with over half of the total Internet (smartphone) traffic being generated by LTE users. The launch of a small cell deployment project in large Russian cities will enable MTS to increase the LTE network speeds and capacity and improve radio coverage in locations where mobile Internet usage is particularly high. At the first stage, MTS will implement the project in Moscow (200 cells) and Saint Petersburg. MTS LTE coverage map in Russia Regions of LTE coverage in 2013 The launch of LTE networks in 2014 The launch of LTE networks in 2015 In 2014, fixed broadband access was the main driver of growth in the subscriber base and revenues in fixed-line business, coming from new connections and increase in average monthly revenue per user (ARPU). apartments or 90% of households in Moscow. The number of MTS GPON users reached 1.1 bln. The number of fixed BBA and GPON TV users in the corporate segment was up 50%. Total Internet traffic in the MGTS network grew by 45% for the year. MGTS GPON (GigabitPON) network with digital TV signal and home Internet with the speed of up to 1 GB/s became available in 3.5 mln In 2014 MGTS implemented several contracts for connecting transport hubs in the capital, student hostels, and traffic lights to high-speed data channels. MGTS also successfully implemented a video surveillance project for the elections to the Moscow Duma in September 2014. Large-scale projects implemented in 2014 include the launch of MVNO on MTS network, which provided subscribers with access to packaged services, including fixed- line Internet, telephony and pay TV; mobile Internet and voice calls; 30 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHand mobile TV. Implementation of IMS (IP Multimedia Subsystem) was completed in Moscow, which enables the operator to launch its own OTT services. Deterioration of macroeconomic conditions and the political situation in Ukraine in 2Q 2014 has led to a drop in the consumption of communication services by MTS- Ukraine subscribers, especially data and content delivery services. Starting from August 2014, MTS- Ukraine ceased services in the Crimea for technical reasons. Key events • In April 2014 MTS acquired a 10.8% stake in OZON Holdings Limited, one of Russia’s largest e-com- merce businesses, for US$ 75 mil- lion. Sistema also acquired a 10.8% stake in OZON at the same price. • In May 2014, MTS became the only Russian telecom brand to be included in the BRANDZ™ Top 100 Most Valuable Global Brands for the seventh time, ranked 9th among the world’s 10 most valuable telecom brands. Its brand value increased by 14.5% over the year to US$ 12.18 bln. • I In July 2014, MTS signed a settle- ment agreement with the Republic of Uzbekistan to resume opera- tions in the country, under which MTS received a 50.01% stake in UMS. The network was launched on December 1, 2014. • In November 2014, MTS in partner- ship with Sistema Mass Media an- nounced plans to launch satellite TV services under the MTS brand. The services will be available for 95% of the country’s population. • In December 2014, MTS signed a Operational strategy 15,000 base stations (LTE/3G/2G) built in 2014 76 regions with LTE coverage infrastructure facilities, non- transport monitoring (people, trouble notification). Development of new sales channel formats will take place at ОZON Holding, the largest multi-brand player engaged in online sales of operator products. In 2015, MTS will launch its service and product offerings, sale of SIM cards and subscriber equipment, payments from MTS account using Ozone applications, etc. in real time. MTS will continue to actively develop data services as the most promising business segment and deploy multiband LTE networks with frequency aggregation at a later stage. In 2015, MTS plans to provide 4G network coverage in all Russian regions. Construction of micro cells will be continued in locations with massive web traffic along with installation of indoor base stations in large cities. SON (self-organizing network) implemented in Moscow since 2014 will also be deployed in other Russian regions. As for construction and modernisation of fixed-line networks based on target technologies, MTS plans to connect over 90% households with FTTB (fiber-to-building) technology. In response to OTT market trends, from mid 2015, MTS plans to launch its own IP telephony and messaging service based on Rich Communication Suite technology (similar to Skype, Viber, WhatsApp). Work on the Big Data project - search for additional revenue opportunities and improvement of operational efficiency by using IT assets – MTS data storages - will be continued. 4,245 retail stores including 2,919 MTS brand stores According to the 2015-2018 development strategy for financial services offered by MTS and MTS Bank, the share of MTS subscribers in the bank’s client portfolio is expected to expand from 2% to 7%. The key focus in the development of financial services in 2015 will be on the launch of a single digital wallet for MTS customers, development of NFC services and launch of new products: digital signature on a SIM card, virtual card, money transfer service, expansion of fee-based financial services (insurance, railway and air tickets). The MTS strategy for foreign markets is aimed at maintaining and strengthening its leadership position in the broadband internet segment, building and upgrading networks, improving efficiency, expanding the frequency band, developing new growth points: mobile advertising, mobile commerce, М2М, Big Data. 31 partnership agreement with Vimpel- Com to jointly plan, develop and use LTE networks in certain Russian regions. Under the agreement, between 2014 and 2016, MTS will de- velop shared mobile data networks in 19 regions, while VimpelCom will construct networks in 17 regions. According to the M2M service strategies for 2015-2017, work will be carried out in the following 5 areas: motor vehicle monitoring and dispatching, insurance telematics, security and search systems, monitoring of residential and commercial properties and CORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENTFinancial results of MTS RUB million Revenue OIBDA 2014 2013 Change 410,758 398,443 3.1% 171,812 176,299 (2.5%) Operating income 98,698 114,866 (14.1%) Net income attributable to Sistema 27,725 42,270 (34.4%) Capital expenditures Net debt 92,599 81,575 230,651 188,086 13.5% 22.6% MTS retained its leading position among the Big Three operators in the Russian telecom market in 2014, both in terms of revenue and profitability. MTS’ revenue in rouble terms increased by 3.1% year-on-year in 2014, as a result of the continued development of its data services and subscriber base growth. The total subscriber base increased by 4.1% to 104.1 million customers as of December 31, 2014. In February 2015, MTS’ subsidiary MTS Ukraine won a tender for a nationwide licence for 3G telecommunication services in the 1950-1965 MHz/2140-2155 MHz spectrum ranges. Granted for a term of 15 years, the licence cost UAH 2.715 billion. In accordance with the conditions stipulated in the tender papers, MTS is required to launch 3G services in all of the regional centres across Ukraine within 18 months upon allocation of the licence. MTS mobile subscriber base, mln 104.1 99.8 74.6 Russia 20.2 Ukraine 1.7 2.2 0.2 Turkmenistan Armenia Uzbekistan 5.3 Belarus 2013 2014 Revenue per user and minutes of usage at MTS in Russia 372 359 339 339 ARPU, RUB MoU, min 2013 2014 32 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHIn 2014, MTS’ capital expenditures of RUB 92.6 billion slightly exceeded the target of RUB 90 billion due to prepayments to the vendors in anticipation of further depreciation of the rouble. Key projects include the enhancement of 3G networks in Russia, roll-out of LTE/4G networks throughout Russia, and the ongoing deployment of GPON in Moscow, as well as network modernization in other markets of operations. Sberbank of Russia to open a non- revolving credit facility for a total amount of RUB 50bn maturing in September 2021. MTS debt increased due to additional borrowings made on attractive terms to hedge the risks of low liquidity in the future. In October 2014, MTS signed an agreement with The high proportion of rouble- denominated debt mitigates the risks associated with currency volatility and enhances the company’s financial stability. MTS debt profile Debt by instruments Loans Bonds Debt by currency* RUB USD EUR 62% 38% 75% 24% 1% * The debt structure by currency includes risks of currency hedging in the amount of US$ 675.3 million at the end 4th quarter of 2014 As of December 31, 2014, MTS Ukraine, a subsidiary of MTS, held US$ 90.2 million in current accounts and deposits in Delta Bank, the fourth largest bank in Ukraine. In December 2014, Delta Bank delayed customer payments and put limits on cash withdrawals. In March 2015, the National Bank of Ukraine adopted a resolution declaring Delta Bank to be insolvent. The Group recognised a provision for cash and deposits in Delta Bank in the financial statements for 2014. MTS Free Cash Flow, RUB bln 159.9 159.5 73.7 2013 57.0 2014 Free cash flow Operating cash flow 33 CORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENTDETSKY MIR The Detsky Mir Group is the largest children’s goods retailer in Russia and the CIS. The Group includes the Detsky Mir retail chain in Russia and Kazakhstan, the early development chain ELC in Russia and the online stores detmir.ru and elc-russia.ru. Management President – V.S. Chirakhov Chairman of the Board of Directors – C. A. Baxter Sistema’s effective ownership 99% Revenue Number of stores Visits per year Like-for-like sales growth in roubles 45.4 RUB bln 322 >109 mln +13.6% Industry* In 2014, the market of children’s goods kept growing despite a slowdown in Russia’s economy. Similar to food retail, the market for children’s goods is resistant to macroeconomic challenges, as was clearly demonstrated by the financial crisis of 2008-2009 when the population’s spending on children’s goods rose by 9% (outpaced only by spending on food with 11%). Replacement of so-called uncivilised retail (open-air markets, kiosks, fairs) by modern formats and market consolidation by the largest players continued in 2014. Detsky Mir retained its leadership in 2014 with its market share rising from 8.1% to 10.0%. * RosInter, M-Video, Synovate Comcon, X5 Retail Group, Rosstat. 34 Market for children’s goods during the crisis period (2008-2009), RUB per capita Disposable income Children goods Spending per capita Food retail 3.9% 5.7% 9.9% 10.8% –30.0% –21.1% Restaurants –7.8% –6.0% GDP in nominal terms Electronics GDP in real terms In 2014, the market for children’s goods increased by 3.2% in rouble terms. In 2015, experts expect market growth to slow down to 2.7%, however, demographics will continue to drive up spending on children’s goods. The gov- ernment’s support of family and moth- erhood, including the Maternity Capital Programme, contributes significantly to a rise in birth rates. According to Rosstat, Russia had a record num- ber of births in 2014 (1.9 million). By resolution of the Russian Government the Maternity Capital Programme was extended to 2017, which will probably have a positive effect on the birth rates in 2015-2016 through additional finan- cial support provided to families. ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHBirth and death rates convergence, % per 1,000 habitants Birth rate Death rate 16.4 15.9 16.1 15.1 14.6 14.5 14.1 14.2 13.5 13.3 13.2 10.2 10.4 10.2 10.3 11.3 12.0 12.3 12.5 12.6 13.3 13.0 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Steady growth in 2014 In 2014, Detsky Mir continued to improve business efficiency. Key projects implemented during the reporting year include the construction of Detsky Mir’s warehouse in the Moscow region, the introduction of a unified SAP IT platform and the launch of a 7,000 sq.m. flagship store in the centre of Moscow, which became the biggest children’s goods store in Russia. In 2014, the company opened 56 new Detsky Mir stores and 16 ELC stores*. Detsky mir stores and retail space 322 390 252 216 291 320 2012 2013 2014 Amount of stores Retail space, ‘000 sq m The retail space of Detsky Mir expanded by 22% in 2014 to 390,000 m2 from 320,000 a year earlier. All newly launched Detsky Mir stores were designed in a new concept providing for a large number of play areas, which was first implemented in the Mega – Belaya Dacha mall in December 2013. Ten largest stores in the chain were remodelled to the new concept. Detsky Mir’s share in total children’s retail market 10% 8.1% 7.1% 2012 2013 2014 The key growth segments in 2014 were toys and baby products where the market share of Detsky Mir in 2014 rose from 13.2% to 16.3% and from 9.2% to 11.9%, respectively. These two categories are expected to remain the key growth areas in 2015. Thus, according to a forecast by Synovate Comcon, in 2015 the market share of Detsky Mir in the toys category will reach 19.7% and in the baby products category it will expand to 13.1%. Key events • In August 2014, the flagship Detsky Mir store was opened in the centre of Moscow in Vozdvizhenka St. With a total area of 7,000 m2, the store became the largest children’s goods store in Russia, and also a leader in the Detsky Mir chain in terms of customer traffic and sales in two months after opening. • In December 2014, Vladimir Chirakhov, CEO of Detsky Mir, became the company’s minority shareholder, with a 1.08% stake, as part of a long-term incentive programme. • In August and December 2014, Detsky Mir paid out RUB 2.5 bln in dividends based on performance in 2013 and 9 months of 2014. * ELC stores – stores selling learning toys 35 CORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENTOperational strategy In 2015, Detsky Mir expects to see positive effects from the measures taken to improve operational efficiency: the launch of a unified SAP platform, modernisation of cashier services, opening of a new warehouse in Bekasovo and introduction of a new concept. In July 2015, it is planned to launch the company’s own warehouse for 70,000 pallets, which will significantly increase the speed of deliveries. This, in turn, will considerably increase inventory turnover and inventory management efficiency. The company will continue opening new stores in cities with a population of at least 50,000 people and replacing chains of other retailers on the back of the deteriorating macroeconomic conditions. In 2015, Detsky Mmir expects to open 60 new stores. The affordable price policy will remain the chain’s priority in 2015 and subsequent years, which will help to attract new customer and increase loyalty among the existing clientele. Online sales will remain the key driver of Detsky Mir’ development as a multi- channel retailer. All initiatives which were launched in the pilot format, namely, electronic kiosks, online application for smartphones, in- store pick-up service will be actively used to maximise the customer interaction efficiency. №1 on the market for children’s goods in Russia 7,000 м2 the largest toy store in Russia 123% growth in the online store’s revenue 38% gross profit margin 1.6х Net debt/OIBDA 36 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHFinancial results of Detsky mir RUB million Revenue OIBDA Operating income Net income attributable to Sistema Net debt 2014 2013 Change 45,446 36,001 4,910 4,170 2,043 7,866 2,771 2,137 1,299 5,062 26.2% 77.2% 95.1% 57.2% 55.4% Detsky mir revenue and OIBDA margin 45,446 10.8% 36,001 7.7% 2013 2014 Revenue, mln RUB OIBDA margin A minor decrease in gross margins in 2014 was due to the rouble de- preciation against global currencies and the need to maintain affordable prices at our stores, which ensured additional incoming traffic. Double-digit growth of like-for-like sales resulted from a competitive price policy, marketing activities and improved merchandising. The key driver of like-for-like sales growth was increase in traffic, i.e. inflow of new customers and higher conversion. Opening of new stores in the new format, an attractive loyalty programme and competitive prices will encourage like-for-like sales growth in the future. Detsky mir’s OIBDA in rouble terms grew by 77.2% year-on-year in 2014. The OIBDA margin increased to 10.8% in 2014 compared to 7.7% in 2013, reflecting improved operating efficiency. Detsky mir’s SG&A expenses declined as a percentage of revenues to 29.4% in 2014, compared to 31.8% in the previous year. Retailer’s net debt is at a comfortable level – Net debt/OIBDA amounted to 1.6. The company’s debt is denominated in roubles. Like-for-like growth of Detsky mir Detsky mir saw its rouble revenues increase by 26.2% year-on-year in 2014 to RUB 45.4 billion as a result of double-digit growth in like-for-like sales and high revenue growth in the stores opened in 2012 and 2013. Like-for-like sales increased by 13.6% year-on-year in rouble terms. 12.40% 13.60% 8.20% 7.90% 2013 2014 Like-for-like traffic growth Like-for-like sales growth 37 CORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENTMEDSI GROUP 1 №1 provider of private healthcare services in Russia Medsi Group is a leading provider of private healthcare in Russia, offering a complete range of preventive, diagnostic and treatment services as well as rehabilitation services for children and adults. Management President – E.A. Brusilova Chairman of the Board of Directors – M.V. Shamolin Sistema’s effective ownership Revenue Number of doctors Patient visits per year Healthcare facilities 75% 9.8 RUB bln 1,842 >6 mln 230,000 m2 Industry* The market for private healthcare services in Russia demonstrated double-digit growth in 2014 and reached RUB 530 bln. The com- bined effect of structural market changes and the government’s initiatives will continue to support the development of the private healthcare sector. The trend to- wards consolidation, and reduction in the number of public healthcare facilities, which emerged in 2013, will continue in 2015. In 2014, the Moscow market held 28% of legal private healthcare market, which is primarily due to the fact that the VHI (voluntary health insurance) segment is much * Sources: Biznesstat, analysis of the Company. 38 more developed in the capital. Over the last 5 years, the private healthcare market grew more than twofold, reflecting a considerable in- crease in the number of private clin- ics and a higher quality of services compared to free public healthcare and shadow healthcare services. Private healthcare market in Russia, bln RUB 29% 28% 25% 91 98 17% 41 51 66 85 7% 7% 2011 2012 2013 2014 2015 2016 Fact Forecast Market value, RUB bln Growth rate, % ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHThe value of the VHI segment, which has historically been showing high growth rates, amounted to almost RUB 100 bln in 2014, up 50% from 2009. The Moscow market, which accounts for more than 60% of the total VHI market, is characterised by a high concentration of large corporations and dynamic growth of businesses that are the main customers of insurance companies. The VHI segment exhibits a strong correlation with the economic and Voluntary medical insurance market in Russia, RUB bln 13% 13% 58 60 61 11% 11% 41 47 53 3% 2% 2011 2012 2013 2014 2015 2016 Fact Forecast Market value, RUB bln Growth rate, % Steady growth in 2014 Medsi is the largest federal chain of clinics, serving more than 6 mln patients every year. Its market share by revenues amounted to 2% in Russia and over 6% in Moscow in 2014. business environment in Russia. The economic downturn results in a reduction in the scope and options of VHI programmes and, in some cases, VHI being denied to some employees. In the next year, the healthcare industry will mainly be shaped by ongoing reforms stimulating the public and private sectors to consolidate their efforts to further develop the healthcare market in the country. There is a tendency towards engaging private clinics to provide services under OHI (obligatory health insurance) programmes; initiatives are being proposed to enable patients to pay extra on top of the fees covered by OHI or set off their expenses against VHI and to grant certain benefits to healthcare facilities. Moreover, the government is taking measures aimed at curbing under-the-counter payments for medical services, which currently account for about 25% of the entire healthcare market. MEDSI medical facilities Moscow 1 clinical diagnostic centre 16 clinics 3 hospitals 2 sanatoriums 3 welness centres Regions 7 clinics 1 sanatorium (Yalta) Bryansk 1 25 Moscow 1 N.Novgorod 1 Nyagan Perm 1 Nizhnevartovsk 1 1 Yalta Barnaul 1 39 CORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENTIn 2014, the construction of the second flagship clinical and diagnostic centre with a total area of 22,000 m2 was started at Krasnaya Presnya. The centre will offer a complete range of outpatient and diagnostic medical services, as well as inpatient treatment and rehabilitation services. Last year, four inefficient loss- making clinics were closed in the regions; however, Medsi continued its development in Moscow by opening a new clinic for outpatient primary and diagnostic care. After the integration with SUE Medical Centre assets was completed in 2014, the company launched a large-scale investment programme to modernise its assets and install new high-tech equipment, introduce new medical services and modern treatment methods, and establish cross sales within the Group by providing a full range of medical services. Patient visits growth at MEDSI, mln Number of surgeries 6.0 6.0 5.0 +135% 7,838 4.1 3.4 +19% 3,336 2,797 2010 2011 2012 2013 2014 2012 2013 2014 Medsi started implementation of the first reconstruction phase at the hospital in Otradnoe in collaboration with Royal Philips and works to convert one of its outpatient clinics into a modern children’s healthcare centre in cooperation with Vamed. The key initiative for the Group’s business efficiency improvement in 2014 was restructuring of the management system, granting additional powers and responsibilities to key assets and at the same time optimising the motivation system. In addition, the company continued to improve business efficiency by introducing a cutting-edge unified IT system and expanding medical space in two existing clinics. 40 The introduction of new high- precision diagnostic equipment and modern surgical applicances resulted in substantial shifts in the quantity, quality and scope of provided medical care. The refurbishment of its asset base has enabled Medsi to obtain licenses and quotas for high-tech medical care (HTMC) under the state programmes from the beginning of 2015. Improved efficiency of clinical hospitals is largely due to the im- plementation of new technologies; in particular, the company gradu- ally transitioned to a laparoscopic approach which is now used in most surgeries, thereby increasing the patient flow and reducing the duration of their stay in the hospi- tal. As a result, the total number of surgeries performed increased by 135%, while the occupancy rate in clinical hospitals in Otradnoe and Botkinsky proezd reached 43% and 65%, respectively. In the near future, the company will implement invasive arrhythmology and open a full-ser- vice pain management clinic. ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHKey events • In November 2014, Elena • In January 2015, at the World Brusilova was appointed President of Medsi Group. Economic Forum in Davos, Medsi and Royal Phillips announced a new joint initiative to set up a new unique training centre on the basis of Medsi’s assets. The decline in the purchasing power caused by the deterioration of the macroeconomic environment is affecting the private healthcare segment. The most significant drop in demand is expected in the regions with a low average income per capita. Operational strategy The company’s strategy is focused on organic growth and selective investments in the most successful and efficient healthcare assets. The key long-term drivers for growth inlcude investment projects scheduled for 2015, such as launching the clinical and diagnostic centre on Krasnaya Presnya, completing modernisation of the surgery, intensive care and sterilisation units in the hospital in Otradnoe, creating a radiology unit in Otradnoe, renovating the outpatient clinic in Khoroshevsky proezd and creating a specialised children’s clinic on its basis. In addition to the large-scale investment programme, the company will increase its patient flow and improve operational and management efficiency. Strong emphasis will be placed on the retail segment: the marketing promotion programme for services and clinics started in 4Q 2014 will be continued in 2015. Medsi is currently cooperating with all major insurance companies. Maintaining and increasing the insurance flow through new products and flexible pricing, despite the challenging economic situation, is also one of the company’s KPIs. Qualifying for state quotas on high-tech medical care (HTMC) and providing services under obligatory health insurance programmes at affordable rates, will present additional opportunities for Medsi. The company’s optimisation programme provides for creating an efficient and manageable business process chain. A new unified information system to be implemented in 2015-2016 will help cut the managing company’s expenses through automation. In 2014, the incentive system for the operational staff and management was updated to include a variable component linked to individual performance and financial and operating KPIs. 41 CORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENTFinancial results of Medsi RUB millions Revenue OIBDA Operating income Net income attributable to Sistema 2014 9,767 866 382 533 2013 Change 9,362 1,408 4.3% (38.5%) 970 (60.6%) 1,011 (47.3%) Net debt (1,003) (4,415) 77.3% Medsi’s rouble revenues grew by 4.3% year-on-year in 2014, reflect- ing an 0.7% rise in the number of patient visits to 6.035 million, and a 4.0% increase in the aver- age bill in rouble terms, which totalled RUB 1,618. The share of individual contracts in the company’s revenues decreased by 2.0 p.p. to 22%, while the share represented by insurance compa- nies and legal entities increased to 42% and 11%, respectively. Healthcare facilities in Moscow and the Moscow region were the biggest contributors to the Group’s revenue. In 2014, they accounted for 88.1% of MEDSI’s revenue. This growth was largely driven by a strong increase in the revenue generated by CDC on Belorusskaya, which increased by 12.9% (with an OIBDA margin of 45.9%) and accounted for 20.4% of the Group’s total revenue in 2014. MEDSI’s revenue by assets CDC on Belorusskaya Hospitals Clinics Other 20.4% 12.4% 58.5% 8.7% MEDSI’s revenue by clients Insurance companies Corporate clients Individuals State contract Other 42% 22% 24% 11% 1% 42 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHIn 2014, the Group’s selling, general and administrative expenses (SG&A) rose by 22.5%, due to an increase in personnel expenses and growth of advertising and marketing expens- es. Increase of personnel expenses reflected MEDSI’s management system redesign and introduction of new functional areas and business units. Growth of advertising expenses resulted from the Group’s stepped- up marketing activities targeting indi- vidual customers to improve utilisa- tion rates across its medical assets and increase brand awareness. The SG&A/revenue ratio grew to 17.4% versus 14.8% in the previous year. In the reporting period, OIBDA declined by 38.5% versus 2013 to RUB 866 million, OIBDA margin was 8.9%. MEDSI’s CAPEX in 2014 totalled RUB 2,981.1 million, a more than eight-fold increase over the previous year. In 2014, Medsi launched three investment projects in Moscow, including the construction of a new clinical and diagnostic centre in Krasnaya Presnya, which will include an adult and children’s in- patient hospital. This new clinical and diagnostic centre is scheduled to open in the second half of 2015. The company also started the renovation of its clinics in Otradnoe and on Khoroshevskoye highway, the latter is to be converted into a specialised children’s clinic. MEDSI’s CAPEX, mln RUB +770.7% 2,981 342 2013 2014 SG&A expenses of MEDSI, mln RUB +22.5% 1,695 As of 31 December 2014, the Group’s total debt stood at RUB 2,352.3 million versus RUB 2,397.3 million at the end of 2013. All liabili- ties of the Group are denominated in roubles. Most of MEDSI’s debt (67%) is made up by long-term liabilities with maturing in 3-5 years. As aof the end of 2014, MEDSI had a net cash position of RUB 1,003 million. MEDSI’s debt, mln RUB -1,9% 6,813 17.4% 2,397 3,355 2,352 1,384 14.8% 2013 2014 2013 2014 SG&A/Revenue SG&A Total debt Cash position 43 CORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENTLESINVEST GROUP (SEGEZHA) LesInvest Group is a vertically integrated pulp and paper company with a full cycle of timber harvesting and advanced wood processing operations. LesInvest Group manufactures pulp and paper products, paper sacks, birch plywood, chipboard, and fibreboard. Management President – S.A. Pomelov Chairman of the Board of Directors – A.M. Uzdenov Sistema’s effective ownership 100% Revenue 24.7 RUB bln Number of plants in Russia and Europe 9+8 Share of export sales 61% Industry* Sack paper The share of sack paper in the global paper packaging consumption amounts to 3%. The global sack paper market is dominated by unbleached sack paper, accounting for 87%. Over the next 5 years, the global market for unbleached paper is expected to grow at 2% annually, with consumption growth to be led by Asia, Latin America and the Middle East. * Source: LesInvest, Vision Hunters, RISI, Enter Vision, BNP Paridas UNECE, Bloomberg, Morgan Stanley, Russian Ministry of Industry and Trade, Rosstat, Federal Customs Service, Pöyry, Federal Forestry Agency, NETLA, Food and Agriculture Organization. Consumption of unbleached paper, mln tonnes +2% –1% +2% +2% CAGR +2% 6.5 6.6 2010 2011 6.6 6.8 2013 2014 6.7 2012 Fact 7.5 2020 Forecast China producers occupy 41% of the unbleached paper global market, however, this paper is of low quality. Paper quality depends on the avail- ability of coniferous wood feedstock. Only 21% of paper produced globally (in Europe, Russia, North America) corresponds to these standards and delivers high profitability. 44 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHPaper sacks In 2014, the consumption of paper sacks in Russia was 841 mln pieces with 32% share of import (the main importers are Ukraine, Poland, Germany). The market is expected to grow by 1.5% annually through 2020 and is local in its nature (with geographic proximity between consumers and producers), which is due to lead time and short hauling distance benefits. About 86% of consumers are manufacturers of building materials (cement and dry mixtures). Production of paper sacks in Russia, mln 917 780 803 700 723 541 562 554 562 841 575 CAGR +1,5% 2020 Forecast 121 146 160 238 241 266 2010 2011 2012 2013 2014 Fact Import Production in Russia Plywood World production of plywood, mln m3 The global production of birch ply- wood is approximately 5.9 mln m3. The largest reserves of feedstock (birchlogs) for plywood production are concentrated in Russia, which accounts for 53% of global market. Birch plywood is a premium segment, growing 4% annually and generating a steady growth in demand and prices. The largest consumers of birch plywood are Europe (36%), Russia (27%) and Asia (25%). The key growth driver for the birch plywood market is development of shipbuilding, construction and machine building industries, where birch plywood is non-substitutable. High growth in birch plywood consumption is predicted for both the mature European and North American markets and emerging markets in Asia and the Middle East. 85 79 +9% 108 +8% 99 +8% 92 CAGR +3% 102 113 87 93 5.4 2010 5.4 2011 5.7 2013 5.9 2014 Fact CAGR +4% Birch plywood Plywood (coniferous, tropical etc) 7.7 2020 Forecast 45 CORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENTProduction of timber products in Russia (fiberboards, MDF, HDF), ‘000 m3 2,468 2,579 2,612 2,056 2,743 CAGR +1% 2,908 2010 2011 2013 2014 2012 Fact 2020 Forecast Production and export of sawn timber in Russia, mln m3 19.1 17.7 21.0 18.5 20.6 19.3 21.7 19.5 21.4 20.8 22.7 22.0 2010 2011 2012 2013 2014 Fact Production Export 2020 Forecast The largest sawn timber producers are located in the Irkutsk and Arkhangelsk regions as well as in the Krasnoyarsk territory. Fibreboard Consumption of FB (fibreboard), MDF (medium density fibreboard), HDF (high density fibreboard) in Russia totals 3,438,000 m3, with approximately 24% being imported. Production in Russia is 2,743,000 m3 with only 5% being exported. The Russian market is highly fragmented with unmet demand for high-quality boards of 500,000 m3. The share of low- quality board produced by outdated equipment in Russia is still high (21%). The main consumers of wood boards are manufacturers of furniture and doors (57%); the construction industry consumes approximately 39% of the output. Total consumption growth through 2020 is expected at 1% per. Sawn timber Out of the 21.4 mln m3 of soft sawn timber produced in Russia, approximately 1 mln m3 per year is consumed within the country and over 90% is exported, mainly to China (32%). The sawn timber market is not saturated with top-5 companies occupying only 10% of the market in Europe and 7% in Russia. The bulk of consumption growth is expected to take place in China, USA, Russia and is estimated at 1.2% per year. Stagnation in the European market may lead to a drop in sawn timber prices in the short run, while in Asia prices are expected to rise, reflecting growing construction rates and positive GDP growth. The main consumer of sawn timber is the construction industry. 46 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHForest resources Worldwide forest resources amount to 527 bln m3; 16% of them are locat- ed in Russia with its world’s largest coniferous forests of 46.3 bln m3. Russia has a high growth potential with the annual allowable cut of 669 mln m3, which is three times higher than the actual cut. Allowable and actual cut in Russia, mln m3 633 669 669 CAGR +4% India and China are among countries that have a deficit of forest resources, while Russia, Brazil and Finland have a potential for growth in wood harvesting. 176 2010 195 203 2013 Fact 2014 Allowable cut Actual cut 669 251 2020 Forecast Business of LesInvest Group On September 29, 2014, Les- Invest, a subsidiary of Sistema JSFC, completed a transaction to acquire 100% of Segezha Pulp and Paper Mill and 100% of Derevoobrabotka-Proekt. In 2014, the company conducted negotiations with the key customers and successfully secured contracts for 2015, managing to maintain sta- ble volumes and win new custom- ers. In 2014, LesInvest focused on the reorganisation of the procure- ment system, logistics services, which enabled the company to re- duce wood harvesting costs and to improve the terms of wood supply contracts. LesInvest Group imple- mented a new efficient business model, modified the organisational structure and formed a new top management team, which includes professionals with high expertise in the industry. In the second half of 2014, on the back of growth in foreign currency sales, which account for 61% of the Group’s total revenue, and a weakening rouble, the advantages of LesInvest Group over its key competitors both in Russia and abroad increased substantially. Segezha Pulp and Paper Mill – sack paper Sack paper accounts for 17% of the Group’s total revenue and approximately for 25% of its foreign currency revenue. Segezha PPM is ranked number four globally and number one in Russia in the production of high-end unbleached sack paper of European quality. Around 45% of produced paper is supplied to the converting plants of the Group producing paper sacks in Russia, Europe and Turkey. Its market share of unbleached paper production in Russia is 70%. The mill is a major exporter supplying products to Egypt, Indonesia, Pakistan, Mexico, Malaysia, Vietnam. In 2015, LesIinvest costs, which are mostly denominated in local currency, will receive an additional competitive advantage before the importers in the form of more attractive pricing and low transport costs. In 2015, LesInvest Group plans to implement an investment project for modernisation of Segezha PPM, which is expected to increase the sack paper output by 44% to 366,000 tonnes by 2017. Segezha Paper Plant. Sack paper export, ‘000 tonnes 199 195 180 2012 2013 2014 47 CORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENTSegezha Packaging – paper sacks Segezha Packaging is a manufacturer of high-quality sacks, which has one plant in Russia, six plants in Europe (Netherlands, Germany, Denmark, Czech Republic, Romania, Italy) and two plants in Turkey. Segezha Packaging is ranked number one in Russia and number two in Europe by the production of high-end paper sacks. Own resource base allows to control the cost of production. 11% of sacks produced in Russia are exported to Kazakhstan, Uzbekistan and Kyrgyzstan. Approximately 49.6% of sacks manufactured at the plants in Europe and Turkey are supplied to Spain, Belgium, France, Hungary, Georgia, USA and Iraq. In 2015, LesInvest Group started an investment project to increase the conversion capacity for production of paper sacks in Russia. In 2016, supported by import substitution policy, production and sales are expected to grow by 28%. The company also plans to increase maintenance capital expenditures for the plants in Europe and Turkey. Export of paper sacks, mln 372 380 32 45 2013 2014 Russia Europe, Turkey Vyatka Plywood Mill – birch plywood, fibreboard Vyatka Plywood Mill is the fourth largest producer of birch plywood production Russia. Thanks to its advantageous geographic location (North-West of Privolzhsky Federal District), the company is able to supply products worldwide. The company uses wood feedstock certified by the FSC (Forest Stewardship Council – international organisation which created a system for certification of environmentally and socially responsible forest management). Approximately 56% of the products are exported to Turkey, Germany, Netherlands, France, USA and other countries. Export of plywood, ‘000 m3 53 52 44 In 2015, LesInvest Group will launch an investment programme to build new production facilities in the Vologda and Kirov regions. By 2020, the company expects to see a threefold increase in production of birch plywood. Fibreboard For Vyatka Plywood Mill, fibreboard is a complementary product received in the process of plywood production, enabling the company to efficiently recycle waste. The share of Vyatka Plywood Mill in the Russian fibreboard market is 5%. All products are sold domestically. Fibreboard production, running m2 23,872 22,815 20,274 Sawn timber LesInvest Group is a vertically integrated company, which also owns timber sawing facilities making it possible to achieve synergies between the Group’s business segments. LesInvest Group holds a 1.4% share of total sawn timber production in Russia and a 3% share in the North- Western Federal District, where major producers are located. The bulk of the Group’s sawn timber is produced by Sokol Woodworking Plant, Segezha Woodworking Plant and Onega Woodworking Plant. The share of export is 95%, products are supplied to the UK, Egypt, France and Belgium. In 2015, LesInvest Group plans to construct a new boiler plant at Onega WWP. In-house heat production will enable the company to reduce gas consumption and benefit from cost reduction. 2012 2013 2014 2012 2013 2014 48 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHComplete house sets Wood feedstock Wood feedstock is a major cost item in the cost structure of LesInvest’s product portfolio (30% to 60%). Own resource base allows the Group to control the cost of production and guarantees feedstock secutiry. The Group includes 15 wood harvesting companies located in the Republic of Karelia, Kirov, Vologda and Arkhangelsk Regions. The annual allowable cut for LesInvest Group is 4.5 mln m3. In 2015, LesInvest will continue implementation of the investment project to renew its fleet of lumber trucks, logging and auxiliary equipment. Investments are also planned to build forest roads. These steps will allow it to substantially increase the utilisation of allowable cut. • In February 2014, «Sokolsky • As a result of the 2014 LesInvest won the All-Russian forest industry award Lesprom Awards in the category Business Strategy of the Year. (The award was established in 2002 by the online trading system Lesprom Network and it is the only professional award in the Russian forest industry). The award ceremony was not only an annual meeting place for representatives of the state, forest industry companies and the leading media but also one of the key events in the business community of Russia. DOK» won the award of Lesprom Awards-2014 for the project «Residence of Father Christmas» in the Olympic Sochi in the category «Design of wood». The construction of the residence took 110 cubic meters of timber. The palace was built in the coastal area of the park near the Iceberg Ice Palace, which held the Olympic figure skating competitions. • In 2014, «Sokolsky CBK» in the competition of the Golden Mercury National Prize was awarded a diploma as «The best company- exporter in the production of consumer goods». • In 2014, Vyatka FC made the first deliveries of birch plywood in Saudi Arabia, UAE and Australia. Sokol WWP is the only company in Russia producing high-quality laminated veneer lumber (LVL) and complete house sets. The plant holds a 15% share of the LVL market in Russia. Sokol WWP is ranked num- ber one in Russia by the production of complete house sets and LVL. The average annual growth rate of this market is expected at around 4.5% through 2020. LVL is an export prod- uct which is supplied to Italy, Ger- many, France, Slovenia and Japan. In 2015, LesInvest Group plans to build a new boiler house at Sokol WWP. Key events • On September 29, 2014, LesInvest LLC, a subsidiary of Sistema JSFC, completed a transaction to acquire 100% of Segezha PPM and 100% of Derevoobrabotka-Proekt. • In 2014, LesInvest Group implement- ed the Wood Supply Project to renew logging and auxiliary equipment at key production facilities of the Group. • The head office of LesInvest Group was relocated from Moscow to Petrozavodsk (Republic of Karelia). This relocation will create additional jobs in Karelia and increase contri- butions to the Republic’s budget. • In 2014, «Segezha Packaging» (Russia) signed a contract with IKEA to supply paper consumer packag- ing (bags with handles). In 2015 it is planned to increase the volume of supply by 30%. №1 in Russia №2 in Europe №4 №1 in the world in Russia by production of high-end paper sacks by production of high-quality unbleached sack paper №4 in Russia by production of birch plywood by LVL production №1 in Russia 49 CORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENTFinancial Results of LesInvest* Financial results, RUB bln 20.8 20.9 24.7 10.2% 2.1 11.4% 2.4 12.9% 3.2 2012 2013 2014 Revenue OIBDA OIBDA margin Revenue by geography Russia Export Sistema JSFC consolidates the results of LesInvest in Q4 2014. LesInvest’s revenue and OIBDA in Q4 2014 brought RUB 7.2 bln and RUB 1.1 bln to the Group, respectively. In 2014, due to measures aimed at optimizing the business, LesInvest improved the OIBDA margin from 11.4 pct in 2013 up to 12.9 pct in 2014. In general, the growth in revenue was affected by the depreciation of the ruble against the US dollar and euro, given that more than 61 pct of LesInvest’s revenue accounts for exports sales. Over 42 pct of all export sales are exports to European countries. 39% 61% UK Austria Germany UAE Estonia Indonesia Sweden France Finland Other 15% 12% 8% 7% 6% 6% 6% 5% 5% 30% The depreciation of the ruble had a positive impact and improved the LesInvest’s competitive advantage in the market. Thus, the production cost of pouch paper reduced from 510 euro/ton to 394 euro/ton – it is the lowest figure among LesInvest’s competitors. The production cost of birch plywood at the Vyatka Plywood Factory reduced from 280 euro/ cu.m to 232 euro/cu.m. Revenue by segments Logging Housebuilding and glued beam Sacks and sack paper Dendrochemistry Plywood and slabs Lumber Other 4% 62% 4% 17% 3% 10% 2% * Based on the management reporting data 50 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHIn 2014, the production segment of pouch paper and paper bags brought the most of the Group’s revenue – 65 pct. Operative marketing-control of market prices, elimination of the excessive number of agents in chain sales and increased demand for bleached and unbleached paper in Europe allowed for raising prices in Q3 2014, which in turn resulted in increase in revenue from pouch paper sales by 24 pct. During 2014, due to an increase demand in the market, production of high-tech paper – the highest cost-effective product among all types of paper – was actively developing. In 2014, the revenue from paper bags has also increased by 14 pct owing to growth of construction materials production and increased demand for this product in the market. The segment profitability rose through the development of manufacture of high-margin products for dry construction mixtures. The revenue of plywood production segment makes 10 pct in the Group’s total revenue, and it increased by 13 pct in 2014. More than 50 pct of this product were exported. The growth of the segment revenue and profitability was also supported by the depreciation of the ruble. Increase in revenue from fiberboard is due to increase both in sales volume of goods manufactured and accumulated inventories as well as to rise in market prices. Granting the deferral of payment for laminated chip boards made it possible to maintain the sales volumes, as well as to sell the accumulated stock. The revenue from the Timber segment accounts for 10 pct in the total revenue, and in 2014 it increased by 20.1 pct, which was due to rising market prices and the currency exchange rate. The logging segment showed in increase by 7 pct in 2014 thanks to review and optimization of current contracts, including through elimi- nation of intermediaries. In addition, high-value assortments were sold and export supplies were increased. Revenue from housing construction and LVL segment grew by 9 pct in 2014. Last year, this segment saw an increase in market prices and reduction in rates of commission fees. Revenue from wood chemistry segment increased in 2014 by 34 pct mainly due to the grown in demand for some products and, as a result, increase in sales volume. Production Cost Production cost for sack paper, EUR/tonnes 510 394 474 471 654 555 Segezha Plant Segezha plant (after RUB depreciation) China Mondi (Steti), Europe Mondi (Frantschach), Europe Horizon/Kehra Estonia Production cost for birch plywood, EUR/m3 491 500 361 280 260 232 215 Vyatka plywood plant Vyatka plywood plant (after RUB depreciation) Sveza (Russia) Sveza (Russia) (after RUB depreciation) Latvia Poland Finland Own lumbering helps control the cost of wood raw material, giving additional advantages over competitors. Production cost of pouch paper and birch veneer is one of the lowest in the global market. 51 CORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENTBASHKIRIAN POWER GRID COMPANY Bashkirian Power Grid Company (BPGC) is a large regional company providing electricity transmission services between central Russia and the Urals, and power transmission and distribution services to consumers in the Republic of Bashkortostan. Management CEO – A.Y. Makarov Chairman of the Board of Directors – F.V. Evtushenkov Sistema’s effective ownership 91% Revenue Metering devices Circuit length Transformer capacity 13.8 RUB bln 88,000 >80,000 km >21,000 MVA Industry* One of the main trends in the power utilities industry is a moderate growth rate of demand for electricity, balanced with an increased efficiency of consumption. Electricity consumption in Russia grew by 0.4% in 2014 to 1,035.2 bln kW*h, while power generation increased only by 0.1% to 1,046.3 bln kW*h. There is a considerable shift in de- mand - while in rural areas elec- tricity consumption is declining, its consumption in large cities is grow- ing considerably. At the same time, within the cities, a decline in electric- ity consumption in industrial zones is offset by its growth in areas where construction of office, commercial or residential properties is under- 52 Electricity production and consumption in Russia, bln kVt*h 1,021 1,040 1,025 1,009 1,054 1,045 1,046 1,049 1,038 1,031 1,035 1,041 2010 2011 2012 2013 2014 2015 Forecast Production Consumption way. Such changes in the geography of demand for electricity create the need to support underutilised elec- tric grids and invest in power grids on the new sites. * Source of information: official site of JSC "SO UPS". ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHElectricity production and consumption in Republic of Bashkortostan, bln kVt*h 24.2 25 25.4 25.7 26.4 26.2 25.2 25.5 24.3 22.4 22.2 18.1 2010 2011 2012 Fact 2013 2014 2015 Forecast Production Consumption As a state-regulated business, the power grid business is affected by frequent changes in legislation. In the autumn of 2013, the Russian Government froze the tariffs of natu- ral monopolies for 2014, which, first of all, was aimed to curb inflation and support companies operating in the construction materials sector, wood processing, metal and mining and chemical industries. In these sectors, the costs of monopoly ser- vices account for 11% to 21% of total costs. In 2014, the increase in tariffs for 2015 was capped at 3.8%. At the same time, according to the regional department of Rosstat, the inflation rate in Bashkortostan in 2014 was 11.2%, which is higher than in the previous five years. Steady growth in 2014 BPGC is among the ten largest pow- er grid companies in Russia in terms of transmitted power, and holds a leading position relative to other ter- ritorial grid companies (TGCs), that are part of Interregional Distribution Grid Company (IDGC), in terms of the total length of transmission lines in operation and the number of substa- tions, transformer substations and distribution points. Circuit length and transformer capacity 85,714 85,959 82,257 4,742 4,583 4,597 2012 2013 2014 Transformer capacity, MVA Circuit length, km In 2014, BPGC continued installing electricity meters (Automatic System for Commercial Measuring of Power Consumption) as part of the the programme aimed at improving the performance of existing power grid assets. During the project implementation, BPGC installed over 88,000 meters, resulting in a substantial reduction of actual power losses. The company also implemented new IT systems to automate project reporting and progress tracking, ensure the efficiency and transparency of business processes. In 2014, BPGC was also developing non-regulated activities and established BPGC Engineering LLC, which acts as EPC contractor for a number of power grid infrastructure facilities in the Republic of Bashkortostan. One of the priorities in BPGC’s activities is consolidation of power grid assets in the Republic of Bashkortostan to expand the power grid business. In 2014, the company continued to acquire and lease abandoned and municipal power grids. In particular, comprehensive preparatory work was carried out to privatise power grid assets in Ufa and Kumertau. Number of new connections per year 17,180 12,948 19,790 2012 2013 2014 53 CORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENTBPGC’s investment programme in 2014 amounted to RUB 3.3 bln. The company’s capital investments in 2014 were directed towards devel- oping the grid infrastructure in the Republic of Bashkortostan, improv- ing energy efficiency at production facilities and meeting the demand for electric power and capacity in the long- and medium term . The modernisation programme is designed to create conditions for ensuring reliable power supply to consumers and reducing harmful environmental impacts. Key events • In 2014, BPGC’s subsidiary, Bashkirenergo LLC, became the first power company in Rus- sia to switch to a 10-year tariff regulation and to determine its rates based on return on invested capital (RAB), while rates of other power companies are set for no more than 5 years. Regulation of tariffs by return on invested capital has a number of advan- tages for power grid companies, consumers and the country as a whole. These include incentives to reduce costs, solid invest- ments with favourable rates, an opportunity for distribution grid companies to plan development programmes over the long-term, as well as to improve their ser- vice quality and offer predictable tariffs. The 10-year regulation period will enable both energy consumers and energy providers to effectively implement long-term business development planning with the aim of enhancing their investment appeal. Investments into the Republic of Bashkorto- stan’s electricity sector will total more than RUB 29 billion for the 10-year period. • In 2014 the preliminary feasibility study for the comprehensive modernization of the electric grid infrastructure Ufa with elements of Smart Grid was completed. The pilot project (1.5% of the total project) will be implemented in April and May 2015 for the network in which it is in need to provide the maximum level of automation and observability. The main part of the project will be implemented until the end of 2020. Operational strategy The key objectives of BPGC are to ensure reliable power supply to con- sumers and improve the operational efficiency of the business. In 2015, BPGC will proceed with its efficiency improvement programme in order to reduce losses and create a Data Centre (DC) and a Grid Control Centre (GCC). Key strategic areas include implementation of the long-term equipment upgrade programme, efficient tariff investments, reduction of operational losses. The company also plans to complete the main part of the Smart Grid project in Ufa and TGC consolidation. As for the company’s development in the non-regulated segments, the engineering company plans to replicate the Smart Grid technology in all of BPGC’s assets and provide IT and communication services to customers. Structure of capital expenditures Reconstruction New construction Other investments 37% 31% 37% 54 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHFinancial results of BPGC RUB millions Revenue OIBDA Operating income Net income attributable to Sistema Capital expenditures 2014 2013 Change 13,778 13,271 5,267 3,444 2,701 3,262 5,651 3,981 2,786 3,054 3.8% (6.8%) (13.5%) (3.1%) 6.8% BPGC’s revenue grew by 3.8% year- on-year in 2014, reflecting organic growth in electricity consumption and an increase in technological connections to the power grids. Boiler tariffs for transmission services were frozen in 2014. Power consumption in 2014 was up 3.2% year-on-year, largely as a result of acceleration of power connections. BPGC acquired 19,790 new consumers in 2014, 15.2% more than in 2013. BPGC’s OIBDA in rouble terms declined by 6.8% year-on-year in 2014. This mainly resulted from a rise in operating expenses in 2014 compared to 2013, as well as from the recognition of income from one- off transactions in 2013, including the disposal of fixed assets and accrued penalties for late customer payments. Distribution grid losses increased from 8.27% in 2013 to 8.46% in 2014, as BPGC started to operate electric grid systems previously owned by territorial grid operators (OJSC Rosenergoatom Concern and LLC Teploelektroset) from the second half of 2014, in addition to the grids already in operation. BPGC is a debt-free company. Its capital expenditures grew by 6.8% to RUB 3.3 billion in 2014. Distribution grids Transmission grids 20,936 19,683 20,680 19,080 20,192 18,514 8.7% 8.2% 8.8% 1.7% 1.5% 1.6% 2012 2013 2014 2012 2013 2014 Productive supply, mln kWh Productive supply, mln kWh Losses Losses 55 CORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENTRTI RTI Group is a major Russian industrial holding, which develops and manufactures high-tech products and infrastructure solutions using proprietary microelectronic technologies. RTI subsidiaries have their own R&D infrastructure and implement projects of unique complexity and scale in the fields of radio communication and space technology, threat monitoring and control solutions, microelectronics and system integration. RTI was established by Sistema and the Bank of Moscow in February 2011. RTI Group includes RTI Systems Concern, NIIME and Mikron, and NVision Group. Management President – S.F. Boev Chairman of the Board of Directors – E.M. Primakov Sistema’s effective ownership Revenue 84.7% 70.9 RUB bln Industry* The defence segment is expected to see a considerable growth in demand for high-tech products. In accordance with the approved National Arms Programme through 2020, budgetary defence spending will total about RUB 20 trln. Up to 70% of this amount is expected to be invested in procurement of new defence systems and equipment. М | B | Т Transport tickets produced 300 mln Micro-chips exported 731 mln Employees 20,000 Russia’s government defence spending, trln RUB 3.3 2.1 2.5 3.1 3.2 2013 2014 2015 2016 2017 Fact Forecast The Russian microelectronics mar- ket in 2014 is estimated at over US$ 2 bln, which is only 1% of the global market. Mass civil market segments in Russia are dominated by foreign companies. Russian microelectron- ics companies mainly manufacture products for military and special applications, which account for about 40% of the domestic micro- electronics market. In the future, the microelectronics industry will be supported by the growing demand for RFID (Radio Frequency Identifi- cation) based solutions, including orders from the government. The main demand drivers are the semi- conductor segment and the telecom sector, which, given the import sub- stitution programme, the imposed sanctions and devaluation of the national currency, is likely to boost the demand for Russian microelec- tronic products. * Source: the main directions of budgetary policy for 2015 and the planning period of 2016 and 2017, RTI analysis 56 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHThe Russian market of information and communication technologies in general showed strong growth with the main consumers being the top 20 largest Russian companies. The average annual growth rate in this market is forecast to stand at 10% until 2017, with the segment of in- tegrated security systems being the most attractive one. Steady growth in 2014 RTI develops assets in the defence industry, microelectronics and system integration. In 2014, Sistema developed and started implementing a restructuring plan for RTI’s high- tech assets to improve its operating efficiency and profitability. In particular, Sistema completed the transaction to purchase the shares of NVision Group («NVision») and became the sole shareholder of this company. NVision is now headed by a new management team. The system integration segment was severely hit by the economic downturn in Russia in 2014, which also affected the finan- cial results of ths business. In 2014, Sistema launched an initiative aimed at streamlining its business and cut- ting costs. NVision managed to retain its position in its traditional markets and maintained relationships with such anchor customers as MTS, VimpelCom, FGC (UES). Besides, the company increased its customer base by adding such major custom- ers as the Moscow Department of Information Technologies, Transneft, Severstal, Special Economic Zones, regional governments, etc. RTI’s Defence Solutions BU demon- strated the highest growth rates with revenues rising by almost 30% in 2014. This growth was driven by active implementation of contracts Information and Communication technologies market services for government and companies, bln RUB 721 735 780 830 910 2013 2014 2015 2016 2017 Fact Forecast RTI Group’s structure Sistema 50% –0.5 share 84.7% RTI 63% 97% 50% +0.5 share RTI Concern Systems Micron NVision Group for construction of radar stations. RTI has a big portfolio of national defence orders and the Defence Solutions BU generates the highest profit margin in the Group. Moreover, RTI develops its own R&D competencies and pays a lot of attention to the development of R&D initiatives. In 2014, RTI started pre-project research and development of proprietary aero- space systems (ASSs), which will enable the company to enter new promising markets. A programme of cooperation between RTI and the Russian Academy of Sciences provides for a broad range of joint activities in a number of promising areas, including the development of complex robotised energy and transportation systems. The head company in RTI’s Micro- electronics Solutions BU is NIIME and Mikron («Mikron»). Mikron is the largest microelectronics manufac- turer in Russia, up to 50 mln of its microchips per month are exported to Europe, USA and South-East Asia. Currently, Mikron is implementing ca. 40 R&D projects aimed at de- veloping nearly 100 new products, some of which are to be launched in the near future. RTI Group’s revenue structure Defence solutions ICS Microelectronics Complex security systems Other 50% 28% 16% 3% 3% 57 CORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENTIn February 2014, Mikron completed the development of its proprietary 65 nm chip technology and is now actively carrying out R&D work on the 45 nm technology. Micron Group has set up a complete production chain from chip development to the final product, which allows it to produce the entire range of high- tech products for the mass market: intelligent chip cards – smart cards, transport and other RFID cards (us- ing Radio Frequency Identification technology), SIM cards, chip bank cards, social cards and other iden- tification documents, new products for industrial electronics. The com- pany supplies products to 400 cus- tomers in Russia and 100 customers in other countries. Moscow Metro, State Company Transportation Organizer from Saint Petersburg, state transportation companies in Kazan, Magnitogorsk, Tyumen, Nizhny Novgorod are among Mikron Group’s customers. In March 2014, Mikron obtained a licence from Cadence Design Sys- tems, the world’s leader in e-design innovations, for chip design software using 90 nm technology. In 2014 Mikron: • Supplied over 2 mln chips for pre- vious-generation travel passports and 800,000 chips for biometric travel passports; • Developed 32 types of integrated circuits for industrial and com- mercial applications; • Launched production of 51 inte- grated circuits for various appli- cations; • Supplied 300 mln transport tickets; • Exported 713 mln chips. In 2014, RUSNANO acquired a 25.1% stake in Mikron as a result of conversion of its share in Sitron- ics-Nano – a joint project between RUSNANO and Mikron to set up the manufacturing of 90 nm microchips. No. 5 in terms of microchip sales among full cycle manufacturers in Europe 500 types of microchips in production 3,500 customers 60 countries of exports Key events • In February 2014, Mikron became • In May 2014, Mikron became a • In December, Mikron produced a member of the OSPT (Open Standard for Public Transport) Al- liance, which was created in 2010 by the leaders of the payment in- dustry to develop new-generation fare payment systems. partner of the Silicon Trust interna- tional marketing programme, which comprises more than 20 compa- nies, including the world’s micro- electronics industry leaders such as Gemalto, Giesecke & Devrient and Infineon Technologies. first Elbrus-2СМ processors man- ufactured with 90nm technology. Based on these processors, MCST plans to start production of com- pact motherboards «Monokub-M». Financial results of RTI RUB millions Revenue Adjusted OIBDA Adjusted operating income Adjusted net loss attributable to Sistema Net debt 58 2014 2013 Change 70,892 69,923 4,564 1,267 (4,416) 3,908 839 (670) 1.4% 16.8% 51.1% - 37,907 29,748 27.4% ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHIn 2014, RTI’s rouble revenues increased by 1.4% year-on-year as a result of revenue growth at the Defence Solutions BU and the Microelectronics Solutions BU. RTI Group’s revenue, bln RUB 70.9 69.9 2013 2014 In 2014, the Defence Solutions BU delivered a 29.0% year-on-year increase in rouble revenue, following the accelerating execution of radar station construction contracts, which Key segments results Defense solutions 24.9 17% 32.2 15% 2013 2014 Revenue, bln rub Adj OIBDA margin were put on experimental combat duty during the reporting period. the Information and Communication Technologies BU. Rouble revenue at the Microelec- tronics Solutions BU grew by 4.1% year-on-year in 2014, reflecting higher sales of integrated circuits as a result of an increase in demand for home technology in the current economic environment. Thus, in 2014, Mikron produced more than 2.8 million chips for passports, delivered 300 million transport tickets, and exported 713 million chips. The reve- nue growth in both BUs was, howev- er, offset by decreased revenues at RTI’s adjusted OIBDA in rouble terms increased by 16.8% year-on-year in 2014 and by 23.6% year-on-year in the fourth quarter, following revenue growth. The OIBDA margin of De- fence Solutions BU exceeded 15% and the OIBDA margin of Micro- electronics Solutions BU increased to 11%. The OIBDA loss of the Information and Communication Technologies BU was reduced from RUB 2.5 billion in 2013 to RUB 0.8 billion in 2014. Microelectronics solutions Information and Communi- cation Technologies 9.8 10% 2013 10.2 11% 2014 33.3 –2,5 2013 24.1 –0,8 2014 Revenue, bln rub Adj OIBDA margin Revenue, bln rub Adj OIBDA,bln RUB Growth of debt in 2014 was mainly due to increased liabilities relating to the loans received under state defence contracts from large state-owned banks against the guarantees of the Defence Ministry and with full compensation of interest (effec- tively zero interest rate). The debt related to state defence contracts accounted for 50.1% of the total debt amount. Sales by geography Russia and CIS (excl. Ukraine) Ukraine Asia-Pacific Central and Eastern Europe 93% 3% 2%2% Sales by currency RUB USD UAH Other 83% 11% 3% 3% 59 CORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENTSG-TRANS SG-trans is a leading railcar opera- tor in Russia, accounting for about 40% of the county’s LPG tank car fleet. SG-trans owns a diversified fleet with more than 34,000 rail cars under management in 2014. Siste- ma has been developing the trans- portation business in collaboration with its industry partner Unirail since late 2012. Management President – A.R. Taicher Chairman of the Board of Directors – A.M. Uzdenov Sistema’s effective ownership 50% Revenue Share of Russia’s LPG tank car fleet Number of rail cars under management Share of Russia’s LPG transportation market 20.4 RUB bln 40% 34.0 thousand 30% Industry* The fall in railway transportation volumes in 2014 was 0.8% compared to a decrease of 2.8% in the previous year. However, the negative trend is expected to continue due to the unfavourable market environment in 2014. As in 2013, open-car shipments of goods such as building materials, ferrous and non-ferrous metal ore demonstrated the largest decrease. Transportation of fertilizers, grains and timber rose considerably, reflecting increased attractiveness of exports due to the rouble depreciating against the US dollar and favourable export prices. Freight volumes of liquefied gases (LPG) – one of the main segments of ST-trans – grew by 8% in 2014, while oil cargo volumes rose by 2% over the year. The share of SG-trans in the LPG transportation market in 2014 was 30%. LPG gross production in Russia**, mln tonnes 22.4 20.1 18.3 16.4 17.3 2010 2011 2012 2013 2014 * Source of information: Russian Railways, Cortes, Petromarket ** According to preliminary company data. 60 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHDespite the stagnation of transportation in certain segments, there is still a surplus of rail car fleet in the market, mainly attributable to state-owned rail car manufacturers, which is partially offset by a gradual replacement of old fleet by private carriers. The daily leasing rate for open rail cars in December 2014 dropped by approximately 25% year-on-year to RUB 425-450, for oil & petroleum tank cars it fell by 30% to RUB 600 per day, while the rate for LPG tank cars lowered only by 5% to RUB 1,400 per day. The LPG transportation segment is expected to grow in 2015, Steady growth in 2014 In 2014, company management focused its efforts on streamlining operational processes and optimis- ing the rolling stock to meet cus- tomer requirements and to respond to the current market conditions. In particular, the leasing portfolio was streamlined and part of the oil and petroleum fleet was returned driven by the increasing demand for petrochemical products and launch of new production facilities. However, the growth rate will slow down as export attractiveness will decrease amid falling prices and reduced investments in the oil and gas sector. LPG transportation volumes on the Russian Railways network, mln tonnes 18.5 19.4 15 15.8 16.8 2010 2011 2012 2013 2014 to the leasing companies earlier than planned, which made it possi- ble to reduce cash outflows caused by a drop in leasing rates and to reduce debt. The company increased its own fleet of LPG tank cars to meet its obligations under long-term con- tracts. About 60% of the contracts of SG-trans are long-term in nature, securing a strong market position. In 2014, SG-trans customer base exceeded 100 clients, including major oil and gas market players such as SIBUR, Bashneft, SANORS, NOVATEK, Rosneft. In 2014, Tatneft Group became SG-trans’ client. Operated fleet size and composition Oil tank cars LPG carriers LPG carriers Other 12,438 17,395 4,135 72 In addition, SG-trans successfully operates in the sector of the loose and bulk cargo, providing services to metal and mining companies. The company chose to take advantage of low spot rates to rent additional railcars to facilitate volume commit- ments, as this was more efficient than purchasing railcars in current market conditions. The share of rented rail cars in the total fleet under management increased from 12% at the end 2013 to 24% at the end of 2014. According to preliminary company data. 61 CORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENTGrowth of rail car fleet managed by SG-Trans Operational strategy In September 2014, Sistema ap- proved an updated development strategy for SG-trans, reflecting the new market environment. The main emphasis will be placed on reducing costs and debt. Oil and liquefied gas transportation will remain the company’s target seg- ment. Special attention will be paid to financial discipline and cash management efficiency. In 2015, management will focus on main- taining and expanding contracts with current customers. In 2015, SG-trans may purchase new rail cars, provided that favourable opportunities are presented and the demand for such cars is guaranteed. Key investments will be made in the company’s own railway infrastructure and IT to reduce operating expenses. >100 customers 60% of long-term contracts 31,655 34,040 26,463 2012 2013 2014 In 2014, the company established a repair management business segment and concluded repair contracts with five companies. In 2014, SG-trans repaired about 4,000 rail cars. As part of an effort to cut costs the company purchases the most expensive components directly from producers. SG-trans loading volumes, ktonnes 18,771 20,536 11,092 2012 2013 2014 Key events • In January 2014, the consolidation of SG-trans, Financial Alliance and Bashneft-trans was successfully completed. 62 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHFinancial results of SG-trans* RUB millions Revenue OIBDA Net income attributable to Sistema 2014 2013 Change 20,429 20,119 1.5% 3.9% 6,016 439 (40.5%) 6,253 261 Net debt 21,700 28,010 (22.5%) Despite the unfavourable trends in the railway freight industry, SG- trans increased its revenue by 1.5% YoY, which was driven by increased shipping volumes for LPG, crude oil and petroleum products. OIBDA rose by 3.5% YoY as a result of railcar fleet optimisation and improved repair and maintenance management. Net income fell year-on-year due to a rise in interest expenses. In 2014, management’s efforts were directed towards streamlining operational processes and optimising the rolling stock to meet customer requirements and to respond to the current market conditions. Thus, the leasing portfo- lio was reduced and some of the oil and petrol rail cars were returned to the leasing companies earlier than planned, which made it possible to re- duce cash outflows caused by a drop in leasing rates and to decrease debt. The railcar fleet under SG-trans’ management increased by 7.5% year-on-year to 34 thousand units (including 17.4 thousand of LPG cars). The share of leased cars in the total fleet rose from 12% as of the end of 2013 to 24% as of the end of 2014. Railcars in ownership accounted for 51% of the total fleet. SG-trans turnover, mln tonnes*km SG-trans debt profile 35,674 31,941 18,564 5.3 5.3 22.1 12.0 10.1 23.9 12.0 11.9 2012 2013 2014 2012 2013 2014 * Sistema owns 50% of SG-Trans shares and does not consolidate this company in financial results. Data for 2013 are presented in accordance with US GAAP. Leasing Bank loans 63 CORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENTMTS-BANK MTS Bank is engaged in banking ac- tivities in Russia providing a complete range of financial services to individu- als and corporate customers. Being a systemically important operator in the payment, lending and savings market, the bank has a strong position among Russia’s largest banks. Management President – I.V. Filatov (before March 2015 – M.M. Chaikin) Chairman of the Board of Directors – A.V. Abugov Sistema’s effective ownership 87% Industry* Assets Gross loan portfolio Total capital 196.3 111.9 RUB bln RUB bln 27.7 RUB bln Capital adequacy ratio (N1.0) 16.95% Assets of the banking sector, trln RUB 23% 15% 29.4 33.8 19% 41.6 49.5 16% 77.6 57.4 35% 2009 2010 2011 2012 2013 2014 Assets, trln RUB Growth rate Key Central Bank rate, % 17.00% 8.75% 7.75% 8.00% 8.25% 5.50% 2009 2010 2011 2012 2013 2014 * CBR 64 The past year was a challenging one for the financial sector. The increase in the CBR’s key interest rate from 5.5% p.a. to 17.0% p.a. and a sharp rise in interest rates on other funding sources substantially increased the cost of borrowing. The slowdown in economic growth rates prevented the Russian banks from compensating for this increase by active operations, putting serious pressure on their revenues and capital levels. According to the year-end results, the consumer lending sector demonstrated slower growth compared to the previous years. In addition to higher interest rates and slower economic growth, consumer lending was affected by tighter regulations introduced by the CBR, a decline in real household income and gloomier consumer sentiment. As a result, retail lending growth rates dropped by half against 2013 and transactional risks increased considerably in all segments by the end of the year. ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHThe situation in the corporate lending segment is slightly different. The restrictions on foreign fund- raising forced Russian companies to borrow more actively in the domestic market. According to the year-end results, corporate lending grew faster than retail for the first time in the last few years. Growth rate of retail lending  40% 38% 7.7 10 30% 3.6 11% 4 5.6 2009 2010 2011 2012 2013 Retail loans, trln RUB Growth rate Corporate lending growth rates 13% 14.1 12.5 26% 17.7 20 13% 13% 22.5 13% 11.3 13% 13% 2014 32% 29.6 2009 2010 2011 2012 2013 2014 Corporate loans, trln RUB Growth rate Steady growth in 2014 Over the last three years, MTS Bank strengthened its position as a reliable savings institution. Following the expansion of its regional office network, the retail deposit portfolio grew by 23% year-on-year despite the negative market trends. Number of cards issued by MTS Bank, mln 217 224 191 Plastic cards issued, mln Credit cards issued, mln 163 15 22 29 32 2011 2012 2013 2014 65 CORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENTThe retail business imposes very strict requirements on bank capital. Over 2014, MTS Bank increased its capital more than twofold: at the beginning of 2015, the Bank’s equity was RUB 27 bln against RUB 12 bln at the beginning of 2012. The largest increase in capital took place in 2014 and during an additional share issue, which was subsequently purchased by MTS and Sistema and generated RUB 13.1 bln for MTS Bank. Capital adequacy ratio (N1), MTS Bank 17.58% 13.59% 13.26% 11.95% 11.38% 12.18% 01.01.2010 01.01.2011 01.01.2012 01.01.2013 01.01.2014 01.01.2015 In response to the deterioration of the macroeconomic conditions, the Bank adjusted its retail and corporate credit policies to reduce credit risks. In 2014, the Bank pursued a conservative provisioning policy, which will be also continued in 2015. In 2014, the Bank took timely measures to reduce costs and optimise the retail office network. The CBR granted accreditation to MTS Bank to provide financial services to the companies operating in priority and strategic industries, which testifies to the bank’s reliability. MTS Bank is included in the list of banks that may receive state funds from the Deposit Insurance Agency for recapitalisation. Through participation in the programme, the Bank will be able to rise over RUB 7 bln for Tier 2 capital on attractive terms for a 3-year period. The main condition of the programme is that the recipient bank should provide loans to sectors that are strategically important for the Russian economy, and grant mortgage loans and loans to SMBs (small and medium-sized businesses) for an amount at least equal to 1% of the Bank’s portfolio on a monthly basis. In 2014, the Bank started issuing China UnionPay cards. By joining China UnionPay, the Bank substan- tially minimised the risks associated with the processing of its payments and was able to make attractive propositions to sole traders and pri- vate individuals in the Russian Far East, who actively cooperate with suppliers from China. Key events Operational strategy • In March 2015, Fitch Ratings confirmed the rating of MTS Bank at В+ with a stable outlook. • According to the 2014 year-end results, MTS Bank was ranked number eight among plastic card issuers. • In December 2014, MTS Bank successfully completed an additional share issue, raising RUB 13.1 bln. TOP-50 Russian banks which was started in 2012, resulted in explosive growth in the retail assets portfolio, including the credit card segment. Over the last three years the household loan portfolio increased more than threefold with an annual growth rate of 62%. In 2012, MTS Bank completed rebranding and started the implementation of its strategy based on synergies with MTS. The business model restructuring, MTS Bank’s strategy is aimed at development of retail lending and transactional services for individuals segment. However, the Bank does not seek to turn into 66 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHa retail monoliner and maintains moderate growth rates in the target corporate segments, having kept its portfolio of corporate borrowers. The Banks’ operational strategy provides for greater cooperation with the mobile operator MTS. MTS Bank already widely uses the operator’s retail chain and IT infrastructure. In the future, the Bank and MTS intend to share a common database under the Big Data Project in order to mitigate risks, boost sales and speed up product development. Capital adequacy ratio (N1) of Russian banks 17.6% 17.1% 16.2% 15.5% 15.1% 15.0% 14.2% 13.7% 13.5% 12.5% 12.4% 12.3% 11.7% 11.6% 11.5% MTS Bank ING Bank (Eurasia) BNP Paribas TKS Bank CitiBank Home Credit Finance MCB Unicredit Bank Rosbank Gazprombank Raiffeisen Bank Promsvyazbank VTB 24 Uralsib Sberbank 17.6% Result of MTS Bank Financial results of MTS Bank RUB millions Revenue Operating (loss)/income Net income/(loss) attributable to Sistema 2014 2013 Change 26,565 28,763 (7.6%) (15,252) (11,212) 604 598 - - In 2014, MTS Bank’s revenues decreased by 7.6% year-on-year in rouble terms. This was largely due to lower revenues reported in the fourth quarter amid unfavourable market conditions. Interest income grew by 4.9% in 2014, gross loan portfolio increased by 3.1%. Assets and loan portfolio, RUB bln 220.4 183.8 220.7 198.5 Interest and commission income, RUB bln 24 25.1 4.6 4.4 2013 2014 Interest income Commission income 2013 2014 Assets Credit portfolio * CBR The bank reported a net loss in the fourth quarter and in 2014 due to increased provisions for the loan portfolio to individuals, which amounted to RUB 73 billion or 39% of total loan portfolio (including interbank financing). MTS Bank has a conservative provisioning policy and demonstrates high stability ratios. Its provisions/retail loans ratio amounted to 28% compared to 16% in 2013. 67 CORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENTAGRICULTURE Sistema’s business in the agricultural sector is represented by RZ Agro (50%) and the Group of companies «Step». RZ Agro Group RZ Agro Holding («RZ Argo») – is one of the largest producers of grain and oil-bearing crops in the south of Russia with a land bank of 99 thousand ha, jointly controlled by Sistema JSFC and members of the Louis-Dreyfus family. Currently it comprises six farms grouped into three regional clusters in the Rostov Region and the Stavropol Territory. GC «Step» unites five farms located in the Krasnodar region, with a land bank to manage - 26.3 thousand hectares. Management RZ Agro: CEO – S. MacFarlane GC «Step»: CEO – K. Averin Chairman of the Board of Directors - T. Schultz Chairman of the Board of Directors – A. Uzdenov Sistema’s effective ownership in RZ Agro Sistema’s effective ownership in GC «Step» Gross harvest 50% 85% >470 ‘000 tonnes RZ Agro land bank 125 тыс. га Industry* As a result of a steady growth of grain exports over the last few years, Russia, which has 9% of the world’s arable land, regained its status as one of the largest global exporters. In 2014, grain exports from Russia totalled 27 mln tonnes, including 20 mln tonnes of wheat, or 12% of global wheat exports. In 2014, owing to favourable weather conditions in Russia, gross production of main crops – grain, oil-bearing plants, sugar beet, vegetables and fruit – grew considerably. The 100 mln tonne grain harvest became one of the largest in the last 20 years. Wheat production amounted to 59 mln tonnes, placing Russia among the three largest global producers (after China and India) with 9% shares. Wheat production in Russia grew by 13%, while the growth in the total worldwide production in 2014 was only 1%. Gross harvest volume of grain in Russia, mln tonnes 58 7% 17,7 89 31% 27 66 23% 16 88 29% 25 100 28% 27 2010 2011 2012 2013 2014 Gross harvest Export % of export * Source: USDA, International Grains Council. 68 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHAccording to a forecast by the International Grains Council, in 2015- 2020 global grain consumption and production will grow at approximately the same rate – around 1.5% per year, driven by the continuous expansion of the world’s population and rising demand from the food and livestock breeding industries. Production growth will be primarily driven by an improvement in crop yields. Wheat production and consumption forecast, mln tonnes CAGR stock ~1,5% 1,988 1,960 1,988 1,960 1,978 1,987 2,007 2,015 2,037 2,043 2,066 2,071 22% 21% 20% 20% 19% 19% 2014/15 2015/16 2016/17 2017/18 2018/19 2019/20 Production Consumption Forecast Stock / Consumption, % RZ Agro Group operates in the So- thern and North Caucasian Federal Districts – Russia’s key grain pro- ducing regions, which account for about 70% of winter wheat, over 95% of winter barley and approximately 35% of oil-bearing crops produced in Russia. In 2014, the grain produc- ers in Rostov Region, where the RZ Agro Group has five farms, harvested 9.5 mln tonnes of grain and grain legumes, almost 3 mln tonnes more than last year. It was a record harvest of the last 24 years. RZ Agro today The total land bank under RZ Agro’s management is 99 thousand ha, including 65 thousand ha (66%) of land in its ownership. Around 91% of RZ Agro land is under cultivation. The Group includes six farms grouped into three territorial production clusters: Rostov-East, Rostov-South and Stavropol-West. Land bank by clusters (99,000 ha) Lipetsk Tambov Kursk Voronezh Belgorod Saratov Volgograd 1 Rostov East cluster • 43 kha • 3 farms • 30% freehold • 70% long term lease (maturity 13 years) 2 Rostov South cluster • 47 kha • 2 farms • close to Azov sea port • 98% under freehold 1 2 Rostov- on- Don Krasnodar 3 Stavropol 3 Stavropol cluster • 10 kha • 1 farm • 39% freehold, • 61% mid-term leases (maturity 3 years Novorossiysk port RZ Agro is a highly specialised farm holding. In 2014, crop farming generated 98% of its total income. The main crop types grown are winter wheat, barley, sunflower, corn, pea, sugar beet. Livestock breeding is represented by First Cavalry Army Stud Farm – a famous horse breeding farm maintaining a nucleus herd and having the largest number of Budyonny horses. RZ Argo has developed and im- plemented a long-term crop rota- tion plan, with minor adjustments made annually depending on the expected profitability of crops and previous harvest. 69 CORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENTStructure of cultivated area in 2014 Winter grain Forage crops Summer grain Legumes Sunflower Sugar beet Other oil-making Par 48 13 8 8 4 4 1 14 In 2014, special attention was paid to soil condition diagnostics and climate monitoring; soil remediation and land productivity improvement; implementation of technologies that help to adopt production to climatic changes, especially to drought conditions. Starting from the 2013/2014 production year, certain drought-resistant crops such as camelina and sorghum were included in the crop rotation schemes in the Rostov-East cluster. RZ Agro sells approximately 90% of its products on the international and domestic markets. The remaining 10% is used as seeds and to pay land rent. Over the last four years, RZ Agro managed to increase its sales 5-fold with the share of direct exports rising from 14% in 2011 to 32% in 2014. In 2014, RZ Agro carried out direct grain deliveries to Egypt, Georgia, Armenia, Turkey, Iran, Saudi Arabia, South Africa. RZ Agro actively expands its pool of counterparties by establishing part- nership relations with end consum- ers in the importing countries and on the domestic market. To this end, co- operation is being strengthened with the Russian Export Insurance Agency (EXIAR). Domestic sales (68%) are mainly made to medium-sized ex- porters and large trading houses and directly to domestic consumers. were made to install monitoring and security systems, such as fuel consumption monitoring, video surveillance, fencing and automated accounting. In 2014, a new grain quality laboratory was set up and outfitted with modern equipment at SP Novotroitskoe (part of the Stavropol- West cluster) along with a new electronic weighing scale with a maximum capacity of 80 tonnes. The quality laboratory at Krasnaya Zvezda (Rostov-East cluster) received a new device for express analysis of grain. Re-equipment of production is one of RZ Agro’s priorities. In 2014, 13 new units of modern tillage machinery (cultivators, harrows), 4 sowing machines, 1 tractor, 2 loaders, and other agricultural machinery were purchased. Additionally, investments The company prepared a five- year production re-equipment programme for 2015-2020. The key objectives are to continue replacing old machinery with modern high- performance units and to upgrade the fleet and equipment. GC "Step" today In the second half of 2014, Sistema, via its wholly owned subsidiary Krasnodar-Argo, acquired another agricultural asset - Stepppe Group comprising five agricultural enterprises located in the Krasnodar Territory with a land bank of 26.3 thousand ha under management. In 2014, the average wheat yield at the enterprises was 6.7 tonnes/ha. The high (Class 3) export quality and proximity to export ports enable the enterprises to obtain maximum selling prices for their products. Operational strategy Management of agricultural assets is carried out through a cluster approach, whereby self-sufficient clusters of 30,000-50,000 ha of closely located land areas work together to optimise operating and investment costs. Operational strategy aims to in- crease crop yields and optimise pro- 70 duction and management expenses by using modern agricultural tech- nologies and implementing modern cost monitoring systems. Sistema’s management focuses on the development of related activi- ties to enhance business efficiency. Focus areas include: • grain procurement and trading (target procurement programme – up to 500,000 tonnes per year); • seed production and sale pro- gramme; • harvesting contracting (crop harvesting services in the north regions). ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHFinancial results of RZ Agro RUB million Revenue OIBDA Operating income/(loss) Net income/(loss) attributable to Sistema 2014 2 387 735 594 182 2013 Change 895 166.7% (150) (241) (187) - - - Revenue of RZ Agro increased by 167% YoY driven by a record harvest of 300, 000 tonnes in 2014. Gross harvest volumes, ‘000 tonnes In 2014, RZ Agro developed its own export channels – the share of direct export sales increased to 32% in 2014. RZ Agro exported wheat to Egypt, Georgia, Armenia, Turkey, Iran and other countries. 16.3 26.8 Key operating statistics 2012 (5 clusters) 2013 (5 clusters) 2014 (6 clusters) Total land bank , ha 89,000 89,000 100,000 Freehold land ratio,% Cultivated land ratio, % Production (all crops), kmt 188.7 Wheat yield, t/ha 15% 89% 134 2.8 68% 89% 141 3.0 66% 91% 300 4.5 Export sales of RZ Agro 14.4 18.6 96.9 2013 2014 Wheat Barley Sunflower Crop yield of wheat grew by 50% to 4.5 tonnes/ha, yield of barley in- creased by 80% to 3.4 tonnes/ha, yield of sunflower also grew by 28% to 2.3 tonnes/ha. The OIBDA margin expanded to 30.8%. 22% 78% 18% 82% 14% 86% 2011/2012 2012/2013 2013/2014 Direct export Indirect export 32% 68% 2014/2015 Forecast 71 CORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENT TARGIN Targin is a major Russian oilfield services holding operating in the Republic of Bashkortostan, Nenets Autonomous District, Western and Eastern Siberia. Targin Group consists of a managing company and subsidiaries providing drilling, well repair and workover, mechanical maintenance and transportation services. TARGIN Management President – K.F. Zakirov Chairman of the Board of Directors – F.V. Evtushenkov. Sistema’s effective ownership Revenue Transport vehicles Annual wells commissioning Employees 100% 23.5 RUB bln 5,010 193 18,000 Industry* The global oilfield services market reached US$ 150 bln in 2014, with Russia capturing about 17% of the market. According to expert forecasts, over the next five years, the market may grow by 33%. The share of foreign companies in the Russian oilfield services market is about 18%, more than half of it is held by Schlumberger, a global oilfield services company. Targin’s share of the Russian market is around 2.7%. Revenue of oil service companies in Russia, US$ bln Intensification 2.2 3.9 4.4 Geophysics Well servicing Drilling 15.4 * Sources: RU-Energy, Delloitte, Vedomosti, Kommersant. 72 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHDrilling services occupy over half of the Russian oilfield services market. In 2014, Europe, the US and Can- ada imposed sanctions restricting access to drilling and production technologies in Arctic environment and to offshore and shale projects for major Russian oil companies. Simultaneously, foreign players started withdrawing from the Rus- sian market, which may slow down the implementation of new projects. These events forced Russian oil companies to start developing their own oilfield service divisions. The acquisition of Orenburg Drilling Company and Weatherford’s drilling operations by Rosneft will consider- ably increase the market share held by domestic service divisions. Key players of Russia’s drilling market in 2014 Eurasia Drilling Surgutneftegaz Siberian Service Company Weatherford Ru-Energy Other 29% 24% 5% 5% 5% 32% 2014 was also marked by a trend towards active market consolidation. Closing of the transaction on purchase of Russian drilling industry leader Eurasia Drilling Company (EDC) by a global company Schlumberger will increase the concentration of players in the market in the near future. Oil well drilling in Russia dropped by 7% in H1 2014 for the first time since the financial crisis of 2008-2009. This drop is also associated with the transition to horizontal drilling with its volumes increasing by 63%. The share of horizontal drilling in Russia grew from 10% to 25% since 2011. Currently, only 20% of oil is extracted by tertiary recovery methods such as hydraulic fracturing and drilling multilateral wells. Steady growth in 2014 The demand for high-tech oilfield services is continuously growing. The competitiveness of independent service companies in the market is determined by the availability of cutting-edge technologies and highly productive multi-functional equipment. Sistema acquired Targin at the end of 2013 and carried out work to modernise and restructure the busi- ness in 2014. The completed consol- idation of the Group companies in accordance with the one segment – one company principle will enable it to reduce costs in future periods. Implementation of the approved investment programme will improve the company’s technological infra- structure to a level in line with best industry practice in just a few years. Capital expenditures totalled RUB 3.7 billion, through which Targin formed four new workover crews, purchased five mobile drilling rigs (160 tonnes each) and a 320 tonne drilling rig, and upgraded five rigs (250 tonnes each). In addition, it bought more than 290 units of special equipment, over 100 units of process equipment for various purposes and other. Approximately 40% of capital expenditure in 2014 was invested in production devel- opment, with about 63% of the total cost spent on the drilling segment. Investment projects are financed with the company’s own (32%) and borrowed funds (68%). Rouble loans were obtained from Russia’s largest banks at comfortable terms to finance the investment programme. In 2015, 60% of investment pro- gram will be directed at production development. The largest projects include acquisition of four drilling rigs, two backfill equipment fleets and two fleets of coiled tubing units with nitrogen pumping equipment, modernisation of one drilling rig and purchase of over 150 specialised equipment units. 73 CORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENTGeographical scope Drilling WRR* Mechanical service Transport 2,100 people 42 drilling crews 2,200 people 175 WRR crews 8 FPCP** crews 4,200 people 2 plants 9,100 people > 5,100 units of equipment Moscow One of the objectives of Targin was to diversify its client base following reorientation of the company from Bashneft’s oilfield services division. In 2014, in addition to Bashneft, the company also provided services to Rosneft and its subsidiaries, Gazpromneft, Slavneft- Megionneftegaz, and others. Bashneft accounted for about 77% of the company’s revenues in 2014. In 2014, Targin commenced project in Serbia under a well repair contract. After successful completion of the first stage, the number of crews for the project may be increased. Drilling services are also planned for the future. In 2014, Targin started a project to provide integrated services involving the preparation of wells for hydraulic fracturing. Operational strategy Targin’s strategy focuses on increas- ing its market share and diversifying its client base by providing a full cycle of high-tech drilling services. The Drilling segment plans to develop well construction services and new service areas in line with the development of Russia’s oil and gas industry. The well repair and workover seg- ment requires implementation of new technologies and services for emergency response and develop- ment of enhanced oil recovery and other techniques. The key objective of the Logistics segment is to maintain the fleet age structure in line with the require- ments of the main customers. The key target is the transition from conventional transportation service to transport logistics. 130 types of oilfield services 290 drilling and repair crews * WRR - Wells repairs and renewals ** FPCP - Flexible pump and compressor pipes 74 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHFinancial results of Targin RUB millions Revenue OIBDA Operating income Net income attributable to Sistema 2014 2013 Change 23,549 24,435 -3.6% 58.3% 52.3% 1,901 1,136 459 124.8% 3,008 1,731 1,032 Sistema acquired Targin in October 2013. During 2014, Targin contributed RUB 23.5 billion and RUB 3.0 billion to the Group’s consolidated revenue and OIBDA, respectively. OIBDA margin grew from 7.8% to 12.8%. Operational results in the Drilling segment Operational results in the Well Repair and Workover segment 193 407 2014 161 408 2013 Drilling volumes, th m Commissioned wells 1 138 1 158 167 175 2013 2014 Workover, khours Crews During 2014, Targin’s business was restructured and its operating facilities underwent reconstruction. Capital expenditures totalled RUB 3.7 billion, through which Targin formed four new workover crews, purchased five mobile drilling rigs (160 tonnes each) and a 320 tonne drilling rig, and upgraded five rigs (250 tonnes each). In addition, it bought more than 290 units of special equipment, over 100 units of process equipment for various purposes and other. Approximately 40% of capital expenditure in 2014 was invested in production development, with about 63% of the total cost spent on the drilling segment. 23.5 RUB bln Revenue 12.8% OIBDA margin 75 CORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENTBINNOPHARM Binnopharm is a pharmaceutical company that operates one of Rus- sia’s largest full-cycle manufacturing facility, producing biotech drugs in line with the international quality standard GMP (Good Manufacturing Practice). The priority areas of the company’s activities include devel- opment and commercialisation of drugs for treating socially significant diseases (oncologic, haematologic, contagious and respiratory diseases). Binnopharm Group includes Ali- um Plant - a modern complex for production of infusion solutions – and distribution company Binno- pharm Distribution, which sells both Binnopharm’s and third-party pharmaceuticals. Management CEO – A.N. Chupin Chairman of the Board of Directors – D.L. Zubov company of JSFC Sistema Sistema’s effective ownership 74% Revenue Area of Binnopharm plant Area of Alium plant Supplied doses of Hepatitis B vaccine 2.5 RUB bln 32,000 m2 19,000 m2 5.4 mln Industry* The Russian pharmaceutical market remains one of the fastest growing markets in the world. According to DSM Group, the total market size increased by 9.3% in value terms in 2014 to RUB 1.14 trn, with the commercial segment increasing by 10.8% and hospital segment by 10.0% in monetary terms, while the additional pharmacological support segment contracted by 0.9%. * DCM Group 76 Volume of Russian pharmaceutical market and share of foreign players, mln RUB 735.0 524.0 211.0 2010 824.0 598.0 226.0 2011 1,045.2 1,142.0 778.2 267.0 2013 857.0 285.0 2014 920.0 686.0 234.0 2012 Russian producers Foreign producers ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHMost of the year-on-year growth in the Russian market came from increases in product selling prices; in physical terms, the market contracted by 3.6%. According to estimates by the Russian Ministry of Health, the market share held by foreign manufacturers in 2014 was over 70% in monetary terms. The key focus of the import substitution programme is placed on increasing the share of Russian manufacturers in the pharmaceutical industry. The most important event in 2014 in the state control over the industry was a resolution prepared by the Ministry of Industry and Trade, banning the admission of foreign drugs to government tenders in case two or more bids are received from Russian manufacturers. Another important event in the sector in 2014 was the entry into force of Federal law “On contract system in the area of state procurement” and the government’s transition to the Federal Contracting System, which had a short-term effect of reduction in regional purchasing volumes. Experts are mostly positive on the outlook for the domestic pharmaceutical market. According to the latest forecasts by DSM Group, market volumes will grow by around 9% in 2015 versus 2014. The growth in the commercial segment is expected at about 10%, and in the state segment at about 6%. Most of that growth will be provided by the Russian pharmaceuticals, facilitated by the import substitution programme. Volume of state procurements in pharmacy and share of Russian players, bln RUB 211 77% 23% 2010 267 285 226 234 77% 76% 79% 85% 24% 2011 24% 2012 21% 2013 Fact 15% 2014 Forecast Russian producers Foreign producers Binnopharm’s business in 2014 Binnopharm Group Binnopharm State-of-the-art biotech production, meeting the GMP and ISO standards with area of 32 thousand square meters 20 thousand square meters of classified premises Strong R&D department with a number of biotech products in a pipeline Alium Binnopharm Distribution • I.V. generics production corresponded to GMP requirements • Located in 5 km from Moscow ring road • An overhaul project in 2013-2014 - replacing the filling line bottling from glass bottles to modern plastic containers • Current production capacity: 14.4 mln plastic bottles per year; launched in September 2014 • Presence in nearly 30 regions across Russia • Sales of third-party products, mainly in the hospital segment (government procurement) • Direct contract with big international companies • Sale of Binnopharm’s products 77 CORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENTIn 2014, Binnopharm’s results were affected by the government’s transition to the Federal Contracting System. After the relevant law took effect, regional purchases of drugs were virtually frozen, resulting in more than 45% reduction in Binnopharm’s distribution revenues in the first half of 2014. In 2014, Binnopharm continued deliveries of Regevac (a hepatitis B vaccine) under government contracts. The delivery volume in 2014 dropped by 1.8 mln doses from the previous year to 5.4 mln, which also contributed to the decline in the company’s revenue. The expected revenue fall due to structural changes was offset by adequate optimisation measures: selling, administrative and man- agement expenses were reduced by RUB 70 mln, and thus the ratio of these expenses to revenue remained at the level of the previous year. Binnopharm’s annual output capacity, mln pcs Tablets up to 1,400 Capsules up 45 to Ampoules 80 up to Aerosols 20 up to Syringes up 18 to Binnopharm actively cooperates with foreign manufacturers under the ex- isting contract production agreements and plans to enter into new ones (among the company’s partners are ViiV Healthcare and Fresenius Kabi). In early 2015, Binnopharm’s facility started repackaging operations for Ketosteril – one of the key products in Fresenius Kabi’s Russian portfolio. In 2014, a new drug, Beklometazon (aerosol for treatment of lung diseases), was registered, the market for this product in Russia is estimated at RUB 500 mln per year. Key events • In February 2014, Binnopharm launched a new syringe line for production of pre-filled syringes. The line has an annual capacity of 18 mln of syringes. Registration of Binnopharm’s biotech products in the new form is in progress. • In March 2014, the company signed an agreement with ViiV Healthcare Trading to 78 continue ViiV drug production at Binnopharm’s facilities up to the end of 2016. • In December 2014, Alexey Chupin was appointed CEO of Binnopharm. • In September 2014, Binnopharm launched its upgraded filling line for infusion solutions at the Alium plant. Binnopharm also signed new cooperation agreements with international pharmaceutical companies. • In December 2014, Binnopharm’s aerosol product line was expanded following the registration of Beklometazol; development and registration of new drugs are underway. ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHOperational strategy The key objective of the company’s operational strategy is to expand the company’s own drug portfolio and efficiently utilise its main production units: biotech production facility, aerosol line, lines for production of solid drug forms and infusion solutions. Binnopharm will continue producing Regevak B vaccine, erythropoietin β, interferon ingredient. Furthermore, the second and third phases of clinical research for its own biotech drugs – Interferon α2β, Erythropoietin α will be carried out in 2015. Binnopharm actively works on the list of drugs to develop in the medium term, both by the in-house R&D department and through technology transfer by obtaining production licenses for the new drugs. Utilisation of the lines producing aerosol and solid pharmaceutical forms will be ensured through im- plementation of contract production projects with foreign pharmaceuti- cal companies and commencement of Binnopharm’s generic drugs production. Alium Plant is currently producing simple infusion solu- tions – dextroglucose and sodium chloride. In 2015, the plant will start production of amylum and intrave- nous generics that do not require clinical trials and may be registered by the end of 2015. Financial results of Binnopharm RUB millions Revenue OIBDA Operating income Adjusted net income attributable to Sistema Binnopharm’s rouble revenue declined by 25.2% year-on-year in 2014 and by 33.1% year-on-year in the fourth quarter. The results were impacted by the entry into force of the Federal law “On the Contract System in the State and Municipal Procurement of Goods, Works and Services” and government’s transition to the federal contract system which practically put freeze on regional procurement of medicines and resulted in a temporary decrease of revenues from Binnopharm’s distribution business by more than 45% in the first half of 2014. However, government procurement of drugs is generally expected to increase in 2015. Furthermore, Binnopharm will participate in the government’s import substitution programmes for drugs as a local manufacturer. Binnopharm’s sales of Regevak 538 970 350 600 2013 2014 Sales of Regevak B, mln rub Supply of Regevak B, thousands doses 2014 2,485 322 136 4 2013 Change 3,321 (25.2%) 652 425 285 (50.7%) (68.1%) (98.5%) In 2014, Binnopharm’s OIBDA decreased following a decline in revenue and gross profit. A drop in revenue was expected due to structural changes, but this was supported by corresponding optimisation measures, which led to Binnopharm’s SG&A expenses falling by RUB 70 million in 2014. The SG&A/revenue ratio therefore remained at the same level as in 2013. 79 CORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENTREAL ESTATE This business area is represented by a number of companies, in- cluding the following key players: Leader-Invest, Business -Nedvizhi- most and Mosdachtrest. Sistema’s strategy in real estate business is focused on increasing the value of the portfolio under management with further monetisation through rent income, development and sale. Management Leader-Invest: CEO – E.G. Rubtsov Business-Nedvizhimost: CEO – I.V. Shabdurasulov Mosdachtrest: CEO – S.V. Gavrilenko Chairman of the Board of Directors – F. V. Evtushenkov Chairman of the Board of Directors – L.A. Monosov Chairman of the Board of Directors – S.A. Drozdov Sistema’s effective ownership 100% Under design and construction >388 ‘000 m2 Under management >442 ‘000 m2 Cottages >60.1 ‘000 m2 Industry* In 2014, new residential space commissioned in Moscow increased to 3.2 mln m2 from 3.1 mln m2 in 2013. Between January and October 2014, 135,370 real estate transactions were made on the market, which is only 7% lower than the record of 2013. Sources: Rosreestr, AHML, Knight Frank, ILM 80 Deals with real estate in Moscow, for 5 years 1,402 19,798 4,555 24,770 12,107 31,961 85,650 91,224 96,656 21,251 35,282 18,650 35,725 145,775 135,370 2010 2011 2012 2013 2014 Purchase and sale Mortgage Share participation agreement ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHEarly 2015 saw a decline in purchasing activity due to a rise in mortgage interest rates and toughening of requirements for borrowers. The most badly-hit segment will be the construction of comfort class housing where the share of mortgage-based transactions is about 60%. However, the anti-crisis measures taken by the Russian Government to subsidise mortgage interest rates are expected to support the market in the second half of 2015. Weighted-average mortgage rate for 5 years % 6 . 4 1 % 6 . 4 1 % 4 . 4 1 % 5 . 3 1 % 5 . 3 1 % 1 . 3 1 1 % 3 . 4 1 % 7 . 2 1 % 6 . 3 1 % 5 . 3 1 % 4 . 3 1 % 1 . 3 1 % 1 . 1 1 % 1 . 1 1 % 1 . 1 1 % 0 . 1 1 % 4 . 2 1 % 8 . 0 1 The interest rate on ruble loans The interest rate on foreign currency loans % 2 . 2 1 % 1 . 2 1 % 0 . 2 1 % 1 . 2 1 % 9 . 1 1 % 2 . 2 1 % 3 . 2 1 % 8 . 2 1 % 7 . 2 1 % 6 . 2 1 % 4 . 2 1 % 2 . 2 1 % 2 . 2 1 % 2 . 2 1 % 8 . 9 % 6 . 9 % 7 . 9 % 7 . 9 % 6 . 9 % 7 . 9 % 8 . 9 % 7 . 9 % 8 . 9 % 6 . 9 % 6 . 9 % 3 . 9 % 5 . 9 % 4 . 9 I ‘09 II ‘09 III ‘09 IV ‘09 I ‘10 II ‘10 III ‘10 IV ‘10 I ‘11 II ‘11 III ‘11 IV ‘11 I ‘12 II ‘12 III ‘12 IV ‘12 I ‘13 II ‘13 III ‘13 IV ‘13 I ‘14 II ‘14 III ‘14 It is most likely that in 2015 the competition among developers will increase and the market will become a buyer’s market: the quality of properties offered in the primary market is expected to increase along with active promotion campaign. The office property market hit a record high in new space delivery (1.4 mln m2), which is almost two times more than in 2013. The vacancy rate grew by 29% for A class space and 17% for B class space amid depressed demand caused by general economic crisis. Dollar- denominated rental rates fell by more than 10%. During 2014, 1.29 mln m2 of office space was rented or bought out, 15% lower than in 2013. The activity of tenants and investors slowed down by the end of 2014, and in 2015 the demand for office space may continue falling. Office real estate, commissioned in 2014, ‘000 m2 1,366 707 650 9 Class А Class B+ Class B- Average Rent rates 850 High volatility in currency markets in late 2014 resulted in a decline in average rental rates by 10% to 15% depending on the class of properties. Class А Class В 830 833 800 760 710 690 685 455 480 483 492 430 410 410 670 400 2008 2009 2010 2011 2012 2013 2014 2015 2016 81 CORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENTThe planned increase in new space delivery in 2014-2016 (almost 3 mln m2) amid slack demand may lead to a further increase in vacancy rate to 30% on average, decline in rental rates by 10% and toughening of competition among the landlords. According to the 2014 end year results, the demand for rent of premium real estate dropped by 9% year-on- year. The main reasons for the fall in demand for properties of this category are the general economic situation as well as the practice of setting rental rates in foreign currency prevailing in the market. The Moscow premium rental market in 2015 will depend on two key factors: geopolitical situation and currency exchange rates. Steady growth in 2014 Sistema’s real estate assets are grouped into several distinct areas – real estate management, development, and management of Serebryany Bor real estate – which are represented by Business- Nedvizhimost, Leader-Invest and Mosdachtrest, respectively. Leader-Invest is a development company investing in construction of residential property (comfort, business, premium and deluxe classes in the Central Moscow) and commercial property. As at the end of 2014, the development project portfolio held by Leader-Invest included 13 real estate objects with a combined area of 388,000 m2. Six of these properties with a combined area of 103,000 m2 are under construction. In 2014, Leader- Invest continued implementation of the project for the construction of an office building in Nagatino iLand with a total area of 31,000 m2. The company successfully completed work on renovation of three buildings (former automatic telephone exchanges) totalling 28,000 m2 in area and signed contracts to participate in shared- equity construction of 6,600 m2 of apartments worth RUB 1.4 bln in total. In April 2014, Sistema acquired an additional 49% stake in Busi- ness-Nedvizhimost for RUB 3.1 bln, bringing its stake to 100%. Business Nedvizhimost owns 76 real estate sites located across Moscow which cover a total area of approximately 178,000 m2 and were used by MGTS as automat- ic telephone stations (ATS) prior to the implementation of GPON (Gigabit-capable Passive Optical Network) technology. Business-Nedvizhimost provides professional and management ser- vices both for its own commercial real estate and that of its partners, including renting and selling of buildings. Business-Nedvizhimost owns a unique pool of real estate properties: mansions in the centre of Moscow, office and retail prop- erties, business centres located virtually in every district of Mos- cow, industrial and warehousing properties in Moscow and Moscow Region. The total portfolio of prop- erties under management as at the end of 2014 was over 442,000 m2. In 2014, a detailed operational programme was developed for further commercialisation of the buildings previously occupied by ATS. During 2014, the company partially renovated premises in six properties located in the centre of Moscow with a total area over 22,000 m2, which were cleared from the MGTS equipment. In 2014, Business-Nedvizhimost completed the sale of a property in Moscow’s downtown and entered into a new project together with a co-investor partner for the construction of a residential building with a total area of 13,000 m2 and aggregate apartment space of 6,300 m2. The project will be completed in the first quarter of 2016. Mosdachtrest is a management company focusing on the rental and maintenance of cottages (Serebryany Bor, Barvikha, Zhavoronki, Trudovaya) and office premises in Moscow. The total cottage area as at the end of 2014 was over 60,100 m2. In 2014, Mosdachtrest approved the architectural concept for reconstruction of buildings and performed repair work in Serebryany Bor cottages. 82 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHKey events • In April 2014, Sistema acquired an additional 49% stake in Business- Nedvizhimost for RUB 3.1 bln. • In early 2015, Business -Nedvizhimost acquired a 51% stake in Rent-Nedvizhimost for RUB 3.8 bln. Operational strategy In accordance with the set objectives, in 2015 Leader-Invest plans to put into operation three projects totalling 11,300 m2 in area and start construction of four real estate objects with a total area of 41,800 m2. Also, there is a plan for Business -Nedvizhimost to transfer 16 properties with a combined area of 179,000 m2 to Leader-Invest for development in 2015. The operational strategy of Mosdachtrest in 2015 will focus on maintaining a steady rental cash flow as well as reconstruction and monetisation of cottages in Serebryany Bor. 83 CORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENTSISTEMA SHYAM TELESERVICES Sistema Shyam TeleServices Ltd. (SSTL) is a CDMA mobile operator providing telecom services in India under the MTS brand. Management CEO – D.V. Shukov Chairman of the Board of Directors – R. Sommer Sistema’s effective ownership 56.7% Revenue Regions of operations in India Subscribers Data services subscribers 220.7 US$ mln 9 9.1 mln 1.6 mln Industry* The telecom market in India continued to grow steadily in 2014, with most of its growth coming from GSM subscribers and accelerated development of the data services. As of December 2014, the total subscriber base in the country reached a historical high of 971 mln with the total penetration of 77.6%. The active subscriber base grew by 9.2% over the year. CDMA subscriber base and market share contracted by 1.1%. Although several companies left the market in 2012-2013, there are still 12 mobile operators in the country, including 8 GSM operators, 3 GSM/ CDMA operators and one CDMA operator (SSTL). The top three operators in India (Bharti Airtel, Vodafone and Idea) strengthened their positions in 2014 with a combined market share based on subscriber base exceeding 58%. * Source: TRAI, Statista.com 84 Data services segment is the major driver in the industry’s development. During 2014, traffic generated by 2G and 3G broadband services grew by 74%, with 3G network traffic growing by 114%, and 2G network traffic growing by modest 41%. Over the year, the share of 3G services as a percentage of total telecom services rose from 42% to 52%. Data services penetration in India 5.6% 3.3% 0.96% 1.1% 1.2% 2010 2011 2012 2013 2014 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECH15% each quarter, the current penetration rate is only 22%. The aggressive growth is supported by active promotion of low-priced handsets. Operators in India are starting to develop and promote 4G (LTE) networks and services in the market. With about 5.5 mln 4G subscriber terminals purchased in the country, only 85 thousand of them are active. The competition in the data services segment should become tougher considering the scheduled launch of LTE by RJIO and growing market activity of 3G operators. Smartphones penetration in India 34% 30% 27% 22% 14% 9% 5% 2011 2012 2013 2014 2015 2016 2017 Fact Forecast The 900 and 1800 MHz licenses of Airtel, Vodafone, Idea Cellular and Reliance Telecom will expire in 2015-2016 in 18 districts. In this connection, the Indian Ministry of Communications held a new auction in March 2015 for a number of frequency bands, including 800 MHz used by SSTL. According to the auction terms, the starting prices for 800 MHz frequencies were almost twice as high as the price quoted at the last auction in March 2013. SSTL did not participate in the auction. To provide more efficient utilisation of the limited frequency resources in the country, the Government of India prepared draft regulations on the spectrum sale and spectrum sharing by operators; however, these regulations are not expected to be finalised and approved until the second quarter of 2015 at the earliest. Steady growth in 2014 In 2014, SSTL’s revenue in Indian rupees grew by 10% from 2013, with a 33.6% increase in the revenue from data transmission services - of company’s key area of development. The share of data revenue in total sales grew from 27% to 47%. SSTL subscriber base 8.5 1.3 2013 7.4 1.6 2014 Voice subscribers, mln Data subscribers, mln 85 CORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENTIn March 2014, SSTL introduced one of the cheapest rate plans in India for data services, presented its own Internet movie theatre called MTS Movies, where the subscribers can watch movies free of charge, and conducted an active marketing campaign, with the MTS Internet Baby video watched by 25 mln of viewers, marking a new record in viewing on Youtube in India. SSTL was able to rapidly develop its data services by introducing measures to streamline and improve sales efficiency. This included implementing a pilot project to launch SSTL’s distribution sales model in Gurgaon and New Delhi, a pilot project in Kerala providing distributors with loans to purchase voice devices and data transmission equipment, and a model for sharing revenue with distributors in Delhi. Key events Operational strategy The key strategic objective of SSTL in 2015 is to achieve OIBDA breakeven. SSTL will focus on growth in the data segment, active monetisation of voice services and optimisation of company costs. • In July 2014, SSTL started selling a new innovative device (Mblaze PowerWifi) – a mobile Wi-Fi router with high-capacity storage battery and smartphone recharging function. • In October 2014, SSTL launched a new advertising campaign GB Festival and started promotion of a new line of data rate plans, thus strengthening its position as a price leader. • In 2014, for the third year in a row, the MTS brand was included in the list of Brand Equity 50 Most Trusted Service Brands in India. The brand was also recognised as the most innovative brand in the telecom sector in India and ranked among the top three most recognizable brands of mobile Internet providers. 86 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECH2013 Change 209.4 5,4% (146.5) - - - Financial results of SSTL US$ millions Revenue Adjusted OIBDA 2014 220.7 (81.5) Adjusted operating loss (141.8) (210.2) Adjusted loss attributable to Sistema (129.7) (225.1) Net debt 544.0 568.6 (4.3%) SSTL’s revenues increased by 5.4% year-on-year in 2014, mainly as a result of development of its data segment. Non-voice revenues from both data and VAS accounted for 46.9% of the opera- tor’s total revenue in the fourth quarter of 2014, compared to 34.5% in the corresponding period of 2013. In 2014, SSTL significantly narrowed its year-on-year adjusted OIBDA loss by 44.3% through its cost optimisa- tion programme despite the active marketing campaign it conducted in the fourth quarter of 2014. SSTL results in local currency 3,520 2,909 2,844 2,996 3,188 3,348 3,427 3,508 35.7% 34.4% 34.5% 34.5% 34.5% 38.6% 43% 47% I '13 II '13 III '13 IV '13 I '14 II '14 III '14 IV '14 Revenue, mln rupees Share of non-voice revenues SSTL operating results 89 328 95 363 97 373 107 414 115 117 117 416 401 401 II '13 III '13 IV '13 I '14 II '14 III '14 IV '14 81 295 I '13 ARPU (rupees) MOU (min) As of December 31, 2014, SSTL’s wire- less (voice and data) subscriber base totalled 9.0 million. The data subscrib- er base grew by 23.0% year-on-year in 2014 to 1.6 million. In the fourth quarter, subscribers’ MOU increased by 6% year-on-year to 396 minutes. Blended mobile ARPU in rupees grew by 26% year-on-year to INR 122. 87 CORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENTSISTEMA MASS MEDIA Sistema Mass Media (SMM) is one of Russia’s leading media holdings that manages media assets in pay TV, advertising, digital content distribution and VAS services for telecom operators. SMM owns and manages STREAM TV Company JSC («Stream TV»), RA Maxima JSC («Maxima»), TsTC LLC («TsTV»), and Stream LLC («Stream»). Management President – G.Sh. Khasianova Chairman of the Board of Directors – A.V. Abugov Sistema’s effective ownership 86% Revenue Audience Own TV channels Pay TV subscribers 3,4 RUB bln 30,2 mln 9 11,8 mln Pay-TV market in Russia 35.1 37.1 64% 68% 40.9 75% 31.9 28.7 53% 58% 2011 2012 2013 2014 2015 Pay-Tv subscriber base, mln Pay-TV penetration Industry* Russia’s multimedia market in 2014 was affected by the overall slowdown in economic growth rates and changes in the geopoliti- cal situation. In the segment of TV content pro- duction, changes in the geopolitical situation caused a decline in sales of Russian content in Ukraine and, as a result, a fall in profitability of Russian producers. The neg- ative effect was partially offset by the growth of the Russian pay TV market. Due to the rapid growth of digital technologies, the market ex- perienced considerable changes in terms of subscriber base structure, with the share of cable TV subscrib- ers dropping from 52% to 49%. * Association of Russian Communication Agencies, ZenithOptimedia, company data. 88 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHIn 2014, the federal Law «On Mass Media» was amended to include provisions which capped the stake that can be held by foreign compa- nies in any Russian media at 20%. The law affects the following three groups of market players: represen- tative offices of foreign publishing holdings in Russia, Russian versions of foreign TV channels broadcast via cable networks and public media holdings with foreign participation. Advertising on non-terrestrial channels has been banned with effect from January 1, 2015; how- ever, in February 2015, commercial channels with a foreign content not exceeding 25% regained this right. The most promising segments in the industry under the current condi- tions are still represented by digital media and Internet advertising using new audience targeting and analysis tools and technologies. Steady growth in 2014 In 2014 work to optimise Sistema’s media assets and improve their efficiency continued, allowing SMM to generate a net profit despite the general deterioration of the situation in the industry. Stream TV channels maintain their leadership position in the market in terms of average annual reach in the majority of niche groups. The company has been actively expanding its subscriber base in the Russian and CIS markets: in 2014, its subscriber base grew by 10.3% to 11.8 mln. In 2014, Stream LLC, which provides a universal multimedia entertainment service, actively developed in cooperation with MTS the following services launched in 2013: GOOD’OK (RBT – replacing the usual ringback tone sound with music), MTS-Info (information services for MTS subscribers), MTS Puls (application with entertainment content for mobile phones). The GOOD’OK service was also launched for subscribers of MTS Ukraine and MTS Belarus in 2014. Primary sales of RBT service to MTS Russia subscribers grew by 31% over the year. Key events In 2014, Stream LLC launched a new area – mobile advertising and distribution of А2Р messages with information and service content based on its own proprietary solution. The successful implementation of the strategy ensured considerable growth of revenue and OIBDA. The revenue grew by approximately 60% to RUB 1.3 bln, while OIBDA reached RUB 330 mln, with the increase in OIBDA margin from 7% in 2013 to 26% in 2014. • In March 2014, Gyulnara Khasianova was appointed SMM President. • In April 2014, ORK signed a contract to launch a full-cycle film production project under the order of Rossiya Channel. • In October 2014, Okhota i Кybalka (Hunting and Fishing) TV channel owned by TVC Stream won in the «Best Lifestyle Channel» category at the Golden Ray Awards. • In December 2014, SMM took control over Stream LLC. TC Stream subscriber base, mln 10.7 11.8 7.7 2012 2013 2014 89 CORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENTOperational strategy SMM’s strategy aims to further improve efficiency and profitability in traditional areas and launch new business areas in digital media and online advertising. In the situation of changes in market conditions, Stream TV will focus on retaining current positions and increasing distribution in the CIS markets. The company plans to launch and promote an international version of the Hunting and Fishing Channel and special versions of channels for foreign markets. Stream’s development strategy envisages further development of value-added services (VAS) for MTS and development of mobile adver- tising services (A2P) in partnership with MTS. Financial results RUB millions Revenue OIBDA Operating profit Net income attributable to Sistema Net debt 2014 3,366 977 308 95 292 2013 Change 3,498 1,454 199 15 204 (3.8%) (32.8%) 54.7% 554.0% 43.1% Revenue of SMM in rubles fell by 3.8% for the full 2014 and by 28.1% year on year in the fourth quarter. OIBDA in rubles decreased in 2014 by 32.8% compared to the previous year and by 65.0% year on year in the fourth quarter of 2014. Decrease in revenues and OIBDA was due to a general deterioration of the situation in the industry (reducing advertising budgets led to a fall in demand for TV series) as well as the loss of the market of Ukraine for the re-sale and distribution of television series. 90 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHCORPORATE GOVERNANCE SYSTEM Corporate Governance Principles Corporate Governance Structure General Meeting of Shareholders Board of Directors Commitees of the Board of Directors President and the Management Board Internal Control and Audit Development of the Corporate Governance System in 2014 Remuneration Risks 92 93 94 96 99 101 103 104 105 106 Corporate Governance Principles Maintaining the system of corporate governance and transparency at the level of the world’s best practices is one of the crucial elements of the strategy of Sistema as an investment company. High quality of corporate governance and informational transparency enable the company to attract partners and investors and increase return on equity by taking more efficient managerial decisions. The Corporation’s corporate governance system is based on the following core principles: • transparency and clarity of all processes for investors and partners; • a transparent dividend policy; • an active and professional Board of Directors; • investment decisions made in compliance with the established procedures; • the attention of the Board of Directors to all transactions with related parties; • an active role of the Board of Directors in the strategic planning process; • development of corporate governance in portfolio companies. Sistema is guided by these principles in all of its activities, including strategic and financial management, HR and social policy, reporting, control and audit, risk management. Sistema’s principles and procedures of corporate governance are set forth in its Charter and a number of publicly available internal regulations. Together these documents define the structure and competence of the Corporation’s governance and control bodies. The Corporate Governance and Ethics Code sets forth additional commitments of Sistema in the area of transparency, social responsibility, and ethical business principles. Sistema makes every effort to bring its corporate governance practices in line with the recommendations specified by the Bank of Russia in the Corporate Governance Code (Letter of the Bank of Russia No. 06-52/2463* dated April 10, 2014) and the guidelines set out in the UK Corporate Governance Code.** The consistency of Sistema’s corporate governance practices with the standards set out in the Corporate Governance Code and the UK Corporate Governance Code is analyzed in Annexes 9.7 and 9.8 to this report. Where corporate governance practices at Sistema deviate from the recommendations set forth in the above documents, the Corporation clarifies how the balance of interests is otherwise maintained in accordance with the applicable standards of corporate governance. The Corporation’s main governance bodies are: the General Meeting of shareholders, the Board of Directors, the President and the Management Board. The Board of Directors and the President have committees that conduct a more in-depth analysis of the proposed solutions in specific areas and develop recommendations for the governance bodies of Sistema. The existing organizational structure of the Corporation that was adopted in December 2013, including the adjustments and amendments made later, reflects Sistema’s operation in accordance with investment company model. * The text of the Corporate Conduct Code is available at the following address: http://www.cbr.ru/sbrfr_new/files/legislation/ letters/2014/Inf_apr_1014.pdf ** The text of the UK Corporate Governance Code is available at the following address: http:// www.frc.org.uk/Our-Work/Publications/Corporate- -Governance/UK-Corporate-Governance-Code- -September-2012.aspx 92 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHCorporate Governance Structure of Sistema JSFC* Secretariat of the Chairman of the Board of Directors Secretariat of the Board of Directors Board of Directors Chairman of Board of Directors V.P. Evtushenkov Internal Control and Audit Department Executive Vice-President – Head of Department Secretariat of the President President, Chairman of Management Board Management Board First Vice-President, Senior Vice-President, Vice-President Investment portfolio * As of 31 December 2014. Finance and Investment Division Senior Vice-President, Head of Division Corporate Governance Division Senior Vice-President, Head of Division Legal Division Vice-President, Head of Division Corporate Communications Division Vice-President, Head of Division Strategy Division Vice-President, Head of Division Human Resources Division Vice-President, Head of Division Security and IT Department Executive Vice-President – Head of Department Administrative Department Head of Administration – Head of Department 93 CORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENTGENERAL MEETING OF SHAREHOLDERS Principles of operation The General Meeting of shareholders is the supreme governance body of Sistema. Its operation is governed by the laws of the Russian Federation on joint-stock companies, as well as the provisions of the Corporation’s Charter and bylaws. The General Meeting procedure aims to make sure that the rights of the sharehold- ers are respected and all applicable legal requirements, as well as best international practices in corporate governance, are observed. Information and materials for the meeting are made available to the shareholders in Russian and in Eng- lish and are published on Sistema’s official website (www.sistema.ru; www.sistema.com). Along with the notice of the forthcoming meeting, shareholders get voting ballots. The venues of Sistema’s General Meet- ings of shareholders are always located in the vicinity of the Corpora- tion’s headquarters. Observance of shareholders' rights Sistema aims to ensure maximum protection of the shareholders’ right to participate in running the Cor- poration and receiving profit. The fundamental rights of a shareholder in this respect are the rights to par- ticipate in the work of the General Meeting of shareholders and to vote on the items on the agenda, and also the right to receive dividends. To secure the right of the share- holders to take part in the work of the general meeting, a notice of Sistema’s General Meetings of shareholders, as well as voting bal- lots, are circulated to all the share- holders at least 30 days before the meeting, and all materials covering the agenda items are published on the Company’s website in Russian and in English (www.sistema.ru; www.sistema.com). The ballot may be filled out by the shareholder in advance and mailed to Sistema to the address specified in the ballot. In this case the vote of the share- holder will be taken into account when counting the voting results. Depositary receipt holders may vote on the agenda items of shareholder meetings by proxy through Deutsche Bank AG, which is used as the depositary bank for Sistema’s GDR programme: Global Equity Services, Trust and Securities Services, Email: adr@db.com thus providing a guarantee for the protection of the rights of all the shareholders of the Corporation. The votes of GDR holders, information about whom has been disclosed to the depositary, are collected by Deutsche Bank AG via clearing systems and are included in the general voting ballot of the depositary, with all votes cast for the proposed draft resolution, against it, and abstentions specified. Each shareholder can also attend General Meetings of shareholders in person or through a representative and vote on the agenda items directly at the Meeting. An important guarantee of the shareholder’s right to participate in running the Corporation is the right to access documents that the Company is obliged to retain in line with the provisions of the Federal Law On Joint-Stock Companies. To exercise this right, a shareholder should send a written request to the Corporate Secretary of Sistema asking for access to the documents that the shareholder wishes to see. When a shareholder is granted access to confidential documents, such a shareholder makes a written non-disclosure obligation Holders of material blocks of shares are entitled to make proposals on the agenda of the General Meeting of shareholders and nominate candidates to the Corporation’s governance and control bodies*. Proposals on the agenda of the Annual General Meeting of shareholders of Sistema are accepted in writing within 100 days after the end of the financial year**. Candidates nominated to the governance and control bodies of the Corporation are preliminarily interviewed by the Nomination, Remuneration and Corporate Governance Committee of the Board of Directors of Sistema. . * Holders of 10 and more % of the Company's voting shares also have the right to request an Extraordinary General Meeting of shareholders to be conducted. ** If an Extraordinary General Meeting of shareholders is conducted with its agenda containing an item on the election of the Board of Directors, holders of sufficient blocks of shares have the right to nominate candidates to the Board of Directors. Proposals to this effect must be received by the Company no later than 30 days before the date of such a meeting. 94 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHFor the purposes of observance of the shareholders’ rights to the Company’s profit the Corporation announces the amount of dividends recommended by the Board of Directors in advance along with the date on which the shareholder register is to be made for the purposes of the payment. Therefore, the shareholders always have the opportunity to dispose of their shares taking into account the expected dividend payments. Dividend policy To determine the recommended amount of dividends payable, the Corporation’s Board of Directors abides by the dividend policy approved in October 2011. In compliance with this policy, the amount of dividends payable shall be at least 10% of the group’s net income generated during the previous financial year as per reports prepared in compliance with international accounting standards and at least 10% of the net cash income generated by the Corporation’s investment transactions over the same period (special dividend). This approach allows the Corporation to pay predictable amounts of dividends. General Meetings held in 2014 and their results Quorum at General Meetings of Shareholders for three years 81.60% 83.66% 82.39% 79.18% 76.55% EGM dated 14/06/2012 AGM dated 30/06/2012 EGM dated 01/11/2012 AGM dated 29/06/2013 AGM dated 28/06/2014 The Annual General Meeting of the shareholders of Sistema was held on 28 June 2014. The AGM (1) approved the Company’s annual report and annual financial statements, including the profit and losses account for 2013, (2) determined the amount, procedure, forms and timelines of dividend payments on the company’s shares, (3) elected members of the Board of Directors, (4) elected members of the Auditing Commission, (5) and approved the auditors of the Corporation. As resolved by the Annual General Meeting of shareholders and recommended by the Corporation’s Board of Directors, RUB 19, 879m were allocated to pay dividends, which equalled RUB 2.06 per one ordinary share of Sistema. The amount of dividends was determined in compliance with the current dividend policy. Dividends increased by 115% compared with the amount paid in 2013.* The Annual General Meeting of shareholders approved CJSC Deloitte and Touche CIS as Sistema’s auditor for 2014 to perform the audit according to the Russian Accounting Standards and the US GAAP. The auditor was selected following an open tender organized by the Audit, Finance and Risk Committee of the Board of Directors of Sistema. In 2014, Sistema did not convene any Extraordinary General Meetings. * In 2013, RUB 9,264m were allocated for dividends, equalling RUB 0.96 per one share of Sistema JSFC. 95 CORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENTBOARD OF DIRECTORS The Board of Directors of Sistema is responsible for strategic management of the Corporation and plays the key role in organising an effective system of corporate governance: it determines the strategy, works out strategic and financial development plans, sets the principles for investing, appraises executive performance and assesses risks, approves principles for corporate governance procedures, approves transactions and controls the work of the Corporation in general. The terms of reference of the Board of Directors are set out in the Charter of Sistema. The Board of Directors of Sistema effective as of 31 December 2014 was elected at the Annual General Meet- ing of the Company’s Shareholders on 28 June 2014, and its membership remained unchanged compared to the previous year. The Board of Di- rectors of Sistema has 13 members. Independent members of the Board of Directors form a majority. Members of the Board of Directors of Sistema elected on June 28, 2014 Vladimir Evtushenkov Alexander Goncharuk David Yakobachvili Sergey Boev Brian Dickie Chairman of the Board of Directors Deputy Chairman of the Board of Directors Non-executive member Deputy Chairman of the Board of Directors Independent Director Non-executive member Independent Director Dmitry Zubov Robert Kocharyan Jeannot Krecké Peter Mandelson Munnings Roger Non-executive member Independent Director Independent Director Independent Director Independent Director Mark Holtzman Serge Tchuruk Independent Director Independent Director Mikhail Shamolin Executive member, President and CEO 96 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHComposition of Board of Directors Executive member (Mikhail Shamolin) Independent Director (B. Dickie, R. Kocharyan, J. Krecké, P. Mandelson, R. Munnings, M. Holtzman, S. Tchuruk, D. Yakobachvili) Non-executive member (S. Boev, A. Goncharuk, D. Zubov.) 61% 31% 8% Meetings of the Board of Directors approved work plan for the year. The work plan of the Board of Directors is developed proceeding from the logics of the strategic planning and reporting cycle of Sistema. Reports on and discussions of additional matters (such as transactions) are included in agendas of scheduled Board meetings on a routine basis. Additional sessions are organized whenever an urgent matter needs to be considered. Forming the work plan of the Board of Directors and including additional items into the plan falls within the remit of the Board Chairman. In 2014 the Board of Directors held 10 meetings: eight scheduled regular Board meetings, and two extraordinary meetings, one of which was held in the form of absentee voting. The Board of Directors reviewed a total of 100 agenda items in 2014: Number of in-person meetings Number of letter ballots Number of items in accordance with the BoD work plan Number of items reviewed at Board meetings Subjects reviewed by the Board of Directors in 2014 2014 2013 9 1 39 100 8 1 43 105 Business strategies, investments, new types of activities Corporate governance and securities Participation in affiliates, groups, unions; branch offices Approval of transactions Approval of internal documents Financial reports, planning and audit Functional strategies Personnel appointment, HR policy 27% 7% 12% 21% 1% 17% 6% 9% In 2014 the agenda of the Board of Directors was mainly related to business strategy, approval of trans- actions (including shareholdings in portfolio companies) and corporate governance. The Board of Direc- tors’ focus on these areas proceeds from the nature of the Corporation’s operation as an investment compa- ny, when particular attention should be given to strategy and corporate governance of portfolio compa- nies, portfolio strategy, analysis of new investment opportunities and transactions. 97 CORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENTPreparation for the meetings and quorum of the Board of Directors The procedure of preparation for the meetings of the Board of Directors is aimed at ensuring an efficient use of the time and experience of the Board members in order to enable them to take important decisions on the Corporation’s strategic development. Materials on the agenda are provided to the Board of Directors of Sistema 10 days before meetings, which gives them the possibility to comfortably form their own position for the voting. The majority of main agenda items must be previewed at the meetings of Committees of the Board of Directors of the Corporation. Members of the Sistema Board of Directors meet with the speakers and the management at a business dinner the evening before the meeting, so that they can discuss the items on the agenda of the Board and inquire about the voting positions of the parties in an informal environment. Sessions of the Board of Directors normally take place with high attendance of the Board members. The average quorum of meetings in 2014 was 91.5%. Participation of the Sistema Board members in meetings of the Board of Directors and its committees in 2014* Board of Directors Strategy Committee Audit, Finance and Risk Committee Nomination, Remuneration and Corporate Governance Committee Ethics and Control Committee Investor Relations and Dividend Policy Committee Participation in meetings V. Evtushenkov 9/10** S. Boev A. Goncharuk B. Dickie D. Zubov R. Kocharyan J. Krecké P. Mandelson R. Munnings M. Holtzman S. Tchuruk M. Shamolin D. Iakobachvili 9/10 7/10 10/10 10/10 10/10 10/10 8/10 10/10 7/10 9/10 10/10 10/10 8/11 6/11 4/11 0/3 5/8 1/3 10/11 10/13 11/13 13/13 12/13 2/5 6/8 13/13 4/7 3/7 7/7 6/7 5/8 3/3 8/8 8/8 8/8 8/8 7/7 6/7 5/5 7/7 5/7 7/7 5/7 1/7 7/7 * The membership of the Board of Directors is given as of 31 December 2014. ** The first number denotes the number of meetings attended by the Board member, the second number stands for the total number of meetings the member could potentially participate in. 98 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHCommitees of the Board of Directors Nomination, Remuneration and Corporate Governance Committee R. Kocharyan Committee Chairman, A. Goncharuk B. Dickie, D. Zubov, J. Krecké, R. Munnings. Independent Director Non-Executive Director 67% 33% The main tasks • preliminary consideration of the - to the boards of directors of • management’s performance evalua- candidates: - to the board of directors; - to the top management posi- tions in the Corporation and portfolio companies; portfolio companies; - to the position of corporate sec- retary of the Corporation; • the policy of motivation and compen- sation for the Corporation employees; tion and determination of parameters of awarding bonuses to employees; • systems of corporate governance of the Corporation and portfolio companies, protection of rights and interests of shareholders. Meetings and issues considered in 2014 8 meetings, considered 26 issues formation of a system of motivation, performance evaluation and awarding bonuses to employees corporate governance and protection of shareholders’ rights preliminary consideration of the candidates 12 6 6 Audit, Finance and Risk Committee R. Munnings Committee Chairman, S. Boev, P. Mandelson, M. Holtzman, S. Tchuruk, D. Iakobachvili Independent Director Non-Executive Director 83% 17% The main tasks • Preparation and audit of the finan- cial statements of the Corporation, control of these processes: • interaction with the external audi- tors of the Corporation; • assessment of the risk manage- ment system and compliance with applicable legal requirements in the area of financial reporting, auditing and planning; • budget process and financial modeling; • internal audit; • warning system on potential cases of fraud; • preliminary assessment of large transactions and transactions with interested parties. Meetings and issues considered in 2014 13 meetings, considered 74 issues Evaluation of individual transactions The process of financial planning and risk management Processes of internal control, audit and warning systems for potential cases of fraud Organizational and other matters Preparation and audit of financial statements External auditors 35 15 8 6 2 8 99 CORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENTStrategy Committee V. Evtushenkov Committee Chairman, S. Boev, A. Goncharuk, R. Kocharyan, M. Shamolin, D. Iakobachvili, M. Hecker Independent Director Non-Executive Director Management 29% 42% 29% The main tasks • strategy development for portfolio • reviewing mergers and acquisitions • all projects of the Group companies; • strategic planning methodology review; • preliminary approval of the strategy and the strategic objectives of the Corporation; and major investment projects; • all mergers and acquisitions in the Group with monetary value of more than US$ 100 million; • all projects of the Group associated with entering new markets; with substantial Government participation. Meetings and issues considered in 2014 11 meetings, considered 12 issues, all questions on the development strategy of the portfolio companies. Ethics and Control Committee A. Goncharuk Committee Chairman, S. Boev, B. Dickie, R. Kocharyan, Independent Director Non-Executive Director R. Munnings, S. Tchuruk 67% 33% The main tasks • internal control and audit (together with the Audit, Finance and Risk Committee); • function of corporate security; • monitoring of compliance with the • anti-corruption system in the Corporation and Group companies. Code of Ethics; Meetings and issues considered in 2014 7 meetings, considered 16 issues. internal audits of the internal control and audit and quality control environment functional strategy and internal control in the field of internal control and security anti-corruption system organizational matters 6 4 2 4 Investor Relations and Dividend Policy Committee D. Iakobachvili Committee Chairman, J. Krecké, P. Mandelson, R. Munnings, M. Holtzman, M. Shamolin Independent Director Management 83% 17% The main tasks • maintaining effective relationships with the financial community and public authorities as well as increasing the investment attractiveness of Sistema securities; 100 • the dividend policy of Sistema, • protect the rights and interests of including the formation of recommendations to the Board of Directors in respect of the amount of dividends payable; the shareholders. ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHPRESIDENT AND THE MANAGEMENT BOARD Mikhail Shamolin President of Sistema, Chairman of the Management Board • Mikhail was born in 1970 in Moscow. • In 1992, he graduated from the Moscow Automobile and Road Technical Institute. • In 1993, graduated from the Russian Presidential Academy of Public Administration. Sistema’s Management Board determines the methods of implementing the development strategy of the Corporation, works out development plans, sets investment procedures and controls their observance, appraises the performance of the personnel, and pre-considers items submitted to the Corporation’s Board of Directors. The President of Sistema is a permanent chief executive officer whose main function is executive management and settlement of relevant matters outside the remit of the General Meeting of shareholders, Board of Directors and Management Board for the purposes of ensuring profit of the Corporation, as well as observance of its shareholders’ rights and legitimate interests. The President reports to the Board of Directors and the General Meeting of the Corporation’s shareholders. From 10 March 2011, Sistema’s President is Mikhail Shamolin. On 15 March 2014, the Board of Directors took the decision to extend his appointment as the Corporation’s President for three years. • In 1996-1997, he completed an Execu- tive Programme in Finance and Man- agement at the University of Pennsyl- vania’s Wharton School of Business. • In 1998-2004, he worked at the international consulting company McKinsey&Co. • In 2004-2005, he held the position of the Managing Director for the Ferroalloys Division at Interpipe Corp (Ukraine). • In 2004-2005, he held the position of the Managing Director for the Ferroalloys Division at Interpipe Corp (Ukraine). • In 2005-2011, he was Vice President for Sales and Customer Service, then Vice President, Head of MTS Russia and President of MTS. • Appointed President of Sistema on 10 March 2011. On 15 March 2014, the Board of Directors reappointed Mr Shamolin President and Chair- man of the Management Board of Sistema for a three-year term. In 2014, the Management Board of the Company held 24 meetings and considered 33 agenda items in the following key areas: 2. Preparation of forecasts of and reports on the execution of quarterly, semi-annual, and annual budgets. 1. Preliminary review of matters to be submitted to the Board of Directors, including: • the Corporation’s investment policy and priority investment areas; 3. Strategic planning at the Corporation and S/As, including the establishment of top-down indicators of the strategic planning cycle. 4. Debt and borrowings management. • development strategy and value creation for key portfolio assets of Sistema; 5. Risk management and preparation of risk maps. • internal control and audit; 6. Monitoring and management of investment projects. • HR policy; • corporate social responsibility. 101 CORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENTMembers of Sistema's Management Board Mikhail Shamolin Anton Abugov Christopher Alan Baxter Elena Vitchak Chairman of the Management Board, President and CEO First Vice-President, Investment portfolio manager Senior Vice-President, Investment portfolio manager Vice-President, Head of HR Department Sergey Drozdov Felix Evtushenkov Leonid Monosov Oleg Mubarakshin Senior Vice-President, Head of the Corporate governance division First Vice-President, Investment portfolio manager Vice-President, Investment portfolio manager Vice-President, Head of the Legal functional division Vsevolod Rozanov Senior Vice-President, Chief Financial Officer Andrei Terebenin Senior Vice-President, Investment portfolio manager Ali Uzdenov Senior Vice-President, Investment portfolio manager Michael Hecker Vice-President, Head of Strategy After the end of the reporting period, in February 2015, Nikolay Vasilkov became member of the Management Board, after being appointed Vice President, Head of Strategy Function. Michael Hecker was at the same time relieved of the responsibilities of a Management Board member. Changes in the top management in 2014 A number of changes in the top management of the Company took place in 2014: A. Buyanov 25 June 2014 was relieved of his duties as First Vice President. A. Terebenin 22 May 2014 was appointed Senior Vice President and relieved of his duties as Vice President, Head of the Corporate Communications Function. А. Chupin 07 May 2014 was relieved of his duties as Vice President. D. Khidasheli 30 September 2014 was relieved of his duties as Vice President. M. Hecker 12 February 2014 was appointed Vice President, Head of Strategy Function. A. Shlyakhturov 10 September 2014 was transferred from the position of Executive Vice President, Head of the Security and IT Department to the position of the Advisor to the Chairman of the Board of Directors. V. Shukshin 10 September 2014 was appointed Executive Vice President, Head of the Security and IT Department. 102 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHINTERNAL CONTROL AND AUDIT The process of internal control is implemented at all levels of the Corporation’s management, including the Board of Directors, Board Committees, the Corporation’s management and the Internal Control and Audit Department. To perform its key tasks, the Internal Control and Audit Department carries out the following functions: • performing independent audits of individual operations, processes, and units; Internal audit at the Corporation and Sistema Group companies is the scope of responsibility of the Internal Control and Audit Department that functionally reports to the Board of Directors and administratively to the President. Head of the Department is appointed and dismissed by the President following a resolution passed by the Corporation’s Board of Directors after preliminary approval of the Board’s Ethics and Control Committee. Head of the De- partment is a certified internal auditor and has more than 15 years of experi- ence in the field. The main tasks of the Internal Control and Audit Department are: • helping shareholders and the management improve the internal control system by performing regular audits of efficiency of the Corporation’s internal control, risk management, and corporate governance systems; • contributing to the achievement of the Corporation’s strategic goals in the most efficient ways possible; • supplying the management and the shareholders of the Corporation with objective information on existing internal risks and their probability; • enhancing the awareness of the Corporation’s management about the performance of Sistema Group companies; • controlling the achievement of the goals of the shareholders of the Corporation and Sistema Group companies. • assessing the efficiency of the internal control system; • assessing the efficiency of the risk management system; • assessing the corporate governance system, preventing violation of law and the Corporation’s regulations, ensuring observance of professional and ethical standards, and preparing recommendations for improvement thereof; • developing recommendations to remedy deficiencies identified and monitoring remediation thereof; • examining and evaluating documents provided with regard to specific investment projects for compliance with current regulations; performing scheduled and unscheduled monitoring of performance against project targets; • ensuring uninterrupted functioning of the whistleblowing programme; • administering investigations, including internal ones; • monitoring compliance with the Corporation’s internal regulations; • monitoring execution of assignments issued by the Management Board and the President of the Corporation; • monitoring and investigating instances potentially qualifying as disciplinary violation and/or violation of execution discipline and/or conflict in the Corporation or Sistema Group companies. The Internal Control and Audit Department has all the resources and authority required to perform the above functions. The Internal Control and Audit Department closely interacts with the Corporation’s external auditors, coordinates work and offers consultations in the course of preparing the Department’s annual audit plan with regard to assessment of the efficiency of internal control over financial accounts, and also during discussion and assessment of identified risks. In 2014, the Internal Control and Audit Department conducted 65 scheduled and unscheduled audits to assess the efficiency of internal control and risk management systems. Audits performed by the Internal Control and Audit Department did not uncover any weaknesses or risks that could affect the sustainability of the Corporation’s business as a whole. Reports on results of activities performed by the Internal Control and Audit Department in H1 2014 and FY2014 were submitted to the Audit, Finance and Risk Committee and to the Ethics and Control Committee of Sistema’s Board of Directors*. The Department’s report for FY2014 was reviewed by Sistema’s Board of Directors. In December 2014, in accordance with requirements of the Listing Rules of the Moscow Exchange, the Corporation’s Board of Directors approved the Policy on internal audit at Sistema, which defines the goals, objectives and powers of the Internal Control and Audit Department. * Joint meetings of the Committees. 103 CORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENTAfter the end of the reporting period, in February 2015, the Board of Directors approved the Policy on the internal control system. This top level documents sets forth the key principles of organisation of internal control as an ongoing and integrated process, which involves all divisions and governance bodies of the Corporation. Notably, the Policy on the internal control system defines: • the goals and objectives of the internal control system; • principles of functioning of the internal control system; • the structure of the internal control system and the list of its entities; • division of responsibilities and powers between entities of the internal control system (management, the Internal Control and Audit Department, the Board of Directors and Board Committees). External Audit In compliance with the decision of the Board’s Audit and Finance Commit- tee, the following procedures have been developed at the Corporation for selecting external consultants for the purposes of audit of the financial and accounting reports of Sistema. The Audit and Finance Committee performs annual assessment of the quality of audit services. If the quality of services provided by the current auditor is deemed insufficient, the Au- dit Committee arranges a tender for selection of a new auditor. If the qual- ity of services provided by the current auditor is deemed sufficient, nego- tiations will be held with the auditor about the price of auditing services for the next period. However, to ensure impartiality and objectivity of the audi- tor, the Audit and Finance Committee of Sistema has decided that a tender for auditing services shall be held at least once in every five years. DEVELOPMENT OF THE CORPORATE GOVERNANCE SYSTEM IN 2014 All independent directors have extensive practical work experience and solid reputation in the international professional community, which means that their judgment in the capacity of Board members will not be influenced by the management or individual shareholders. One of the Board members has vast experience in the audit of financial statements. Independent directors make up the majority of the Board, which ensures the required level of objectivity and independence from the influence of the Corporation’s executive bodies in the course of decision-making by the Board. In June 2014, the Corporation’s ordinary shares were included in the first (top) quotation list of the Moscow Stock Exchange, thus confirming their status as the first class securities in the Russian market, attesting to the high assessment of Sistema’s corporate governance standards and granting access to a broader range of investors. In view of the above, the Corporation assumed additional commitments to maintain the corporate governance system at the high level and bring some of its components in compliance with the new requirements of the Listing Rules of the Moscow Exchange. In December 2014, the Board of Directors approved new versions of the terms of reference of some Board Committees and the Corporate Secretary and adopted a new Policy on internal audit. The In 2014, 13 members were elected to the Corporation’s Board of Directors, out of whom eight meet the independence criteria of the Moscow Exchange and the Russian Corporate Governance Code. The following independent directors were elected to the Board: • David Iakobachvili; • Brian Dickie; • Robert Kocharyan; • Jeannot Krecké; • Peter Mandelson; • Roger Munnings; • Marc Holtzman; • Serge Tchuruk. 104 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHintroduced amendments formalised the functions of Board Committees and the Corporate Secretary that are directly specified in the Listing Rules and introduced provisions on the procedure of appointment of head of the Internal Control and Audit Department. The Corporation also plans to amend the Terms of Reference of the General Meeting of Shareholders and the Terms of Reference of the Board of Directors in the near term. In June 2014, Sistema’s Annual General Meeting of shareholders approved payment of dividends in the amount of RUB 19,879m, i.e. RUB 2.06 per ordinary share, which corresponds to a dividend yield of ca. 5.22% per annum. The sum of dividends was determined in compliance with the current dividend policy, which was applied for the second successive year. Remuneration Remuneration and compensations payable to members of Sistema’s Board of Directors are calculated on the basis of the Policy on remuner- ation and compensations payable to members of the Board of Directors of the Corporation, approved by the resolution of the General Meeting of shareholders of Sistema on 30 June 2006 (Minutes No.1-06) as amended by the resolution of the General Meet- ing of the shareholders of Sistema on 16 February 2009 (Minutes No.1-09). The Policy provides for the payment of the following to the Board members: • fixed amounts for participation in meetings of the Board of Directors and its Committees, including re- imbursement of expenses related to participation in meetings of the Board of Directors; • fixed amounts for acting in the capacity of the Chairman or a Deputy Chairman of the Board of Directors, and for chairing Board Committees; • based on the performance during a year, members of the Board of Directors get additional perfor- mance-related remuneration in the form of a fixed amount, half of which is payable in shares (US$ 250,000 - 325,000); • also, if the capitalisation of the Corporation has grown over the year, members of the Board of Directors get additional remuner- ation amounting to 0.1% of the incremental capitalisation. The Policy on remuneration and compensations payable to members of the Board of Directors of the Cor- poration also envisages standard lia- bility insurance for Board members. The Corporation does not provide loans to Board members. The short-term (up to 1 year) incen- tive scheme for the top managers of Sistema in 2014 consisted of the following elements: • a fixed monthly salary determined in line with the internal system of job categories (grades); employment and corporate relations between the Corporation and its management; No extra compensation above the level stipulated by labour laws of the Russian Federation is paid to the President or other senior ex- ecutives in case of termination of employment. Sistema does not pay remuneration to members of executive bodies for serving on the Management Board. The Corporation does not grant loans to senior executives. • bonuses paid for project imple- mentation and generating cash in- come. Remuneration is paid based on workers’ individual performance and positive cash flow generated by projects of Investment Portfolios and Functions and Departments of Sistema. Payments may amount to up to 20% of cash income exceed- ing the target. Top executives of the Corpora- tion were paid a total of RUB 2,746,764,517 in fixed salary and bonuses for the calendar year 2014. Payments to top executives under the long-term incentive programme in the form of the Corporation’s shares totalled RUB 1,659,419,767 in 2014, including RUB 1,559,140,150 for years 2013 and 2012. Remuneration paid to the members of Sistema’s Board of Directors in 2014 totalled RUB 334,447,900. Board members also received reim- bursement of their expenses in- curred in connection with their duties amounting to RUB 3,608,900. In 2014, the three-year long-term in- centive programme for Sistema’s top management (2012-2014) was com- pleted. Its members were allocated the last shares due for distribution for the last period of the programme. The long-term incentive system for top management of Sistema was extended for another three-year peri- od (2015-2017). The programme is aimed at increasing Sistema’s share- holder value and creating additional incentives for maintaining long-term 105 CORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENTRISKS The key risk factors related to Sistema The Corporation may face a variety of risks in the course of its business operations. The main risks that the Corporation may encounter are the consequences of the processes and factors that Sistema has little or no influence on. Hence, efficient as- sessment and management of risks remain an important component of the strategy of Sistema. The risk management system of Sistema is based on a two-level approach to risk management, namely, detection of risks in subsidiaries and affiliates and in the Corporation and their integration for assessing their influence on the Group in general. The main objective is to provide a reasonable guarantee that the strategic goals will be achieved and to ensure that the level of risk will be kept within the limits that are acceptable for the shareholders and the management of the Corporation. The integrated risk management system (ERM) operating at Sistema was built in compliance with international standards, recommendations and best practices in risk management. Corporation Risk assessment Information on risks Risk identification Monitoring Risk reporting Risk mitigation At subsidiaries level Risk assessment Risk identification Мониторинг Risk assessment Риск Limits, regulations, etc. Risk identification Снижение Мониторинг Risk assessment Риск Risk identification Снижение Monitoring Risk reporting Risk mitigation The integrated risk management system (ERM) implemented in the Corporation envisages the presence of the following components and procedures: • identification of risks at all levels of the management (from the top to the line management), which includes finding the risk owner and making a risk passport; Company’s key financial indicators (Monte Carlo modelling); • development of plans to mitigate identified risks at all management levels; • regular risk monitoring and control; • preparation of reports on the company’s risks. • primary assessment of the materiality of identified risks and their analysis (VaR methodology); • ranging of risks by management levels; • assessment of the aggregate influence of material risks on the 106 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHRisk management process Link with the decision-making process Within ERM processes Key management processes Risk appetite Strategic planning • Dynamic financial planning • Overview of risk-adjusted strategic options • Portfolio optimisation based on risk-gain ratio Risk assessment Risk identification Monitoring Risk reporting Limits and thresholds Performance management • Investment management • Risk-adjusted performance measures Risk reduction Budget/CAPEX • Criteria based on the risk at the annual budgeting • Risk-based criteria for large projects Risk-adjusted ROI Interaction with stakeholders • Understanding and coordination of risk appetite of all stakeholders • Rating management As part of quarterly ERM procedures the risk managers of Sistema Group compile risk registers for subsidiaries and a consolidated risk register for the Group, prioritise risks and aggregate them into portfolios, develop a risk map and analyse its key trends, conduct an analysis of the impact that material risks have on the financial results of specific subsidiaries and Sistema Group as a whole, using simulation and financial modelling methods. In order to deal with the risks included in the risk register of Sistema Group the company developed risk management (mitigation) and response plans for specific subsidiaries, which may be extended, adjusted and then approved by the risk committees of the respective companies. Quarterly monitoring of the Corporation’s risks is performed at the level of the Management Board and the Risk Sub-Committee operating under the umbrella of the Finance and Investment Committee of Sistema by reviewing the effects of the mitigation and response measures taken and by reassessing the already identified and/or new risks, as well as by evaluating their potential impact on the financial results of the Corporation and Sistema Group as a whole. The top management of Sistema presents a regular risk management report to the Audit, Finance and Risk Committee of the Board of Directors of Sistema. Sistema’s Board of Directors review risk management reports on a biannual basis. The Group’s risk management system keeps developing and improving. Various risk mitigation mechanisms are being widely applied (including insurance), financial risk control and response procedures are being improved. At the Corporation level particular attention is given to the risks of investment projects starting from the stage of project origination up to the stage of completion. The risk management systems of subsidiaries are currently at different stages of development depending on the time of their introduction. These systems are being gradually improved in accordance with the plans approved earlier. As new assets are added to Sistema’s portfolio, individual plans are developed in order to implement risk management systems depending on the specific needs of such assets. The risk management processes of subsidiaries are monitored by the Corporation via Sistema’s representation in collective governance and executive bodies of S/As. 107 CORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENTExternal risks The risks related to changes in the political and economic situation in Russia are material to Sistema because most of the Corporation’s business is conducted in the Russian Federation. Moreover, many of the Corporation’s subsidiaries operate in the emerging markets, including Armenia, the Republic of Belarus, Ukraine, Uzbekistan, Turkmenistan and India, which are also character- ized by the risks listed below. Economic risks • The business of Sistema is inex- tricably linked with the state of the global economy and financial markets and heavily depends on the Russian economy in particu- lar, which in its turn relies on the export of oil, gas and other com- modities. Further weakening of the rouble against the US dollar and Euro amid a slump in the oil prices, imposed sanctions and increased capital flight from Russia may result in a rise in costs and a drop in revenues or impede the achieve- ment of financial targets and repayment of debt by the Group’s subsidiaries. • Capital flight from Russia and the downgrading of the sovereign credit rating by international rating agencies, as well as restrictions introduced for foreign companies in Russia as a result of sanctions, may have a negative impact on the joint ventures (partnerships) and new investment projects of the Group’s companies. Growing infla- tion may result in higher expenses and, therefore, put pressure on profit margins and also affect the domestic demand for products of Sistema Group’s companies. • If in the medium term sanctions are maintained and the access of Russian banks and businesses to foreign debt remains restricted, this may significantly increase the current liquidity deficit in the market and result in further interest rate rises. • An unfavourable macroeconomic environment in many countries of Sistema’s operations may make it necessary to reevaluate goodwill for some of the assets. • Foreign currency control and restrictions on capital repatriation may adversely affect the business of Sistema Group and reduce the value of Sistema’s investment in Russia. Political and social risks • The influence of geopolitical • The risks of inter-state conflicts risks has significantly intensified as protectionism and economic sanctions are increasingly being used as a tool for achieving geopolitical goals. have significantly risen compared with the beginning of 2014, both in terms of their probability and the effect that they may produce on various areas. Legal risks and uncertainty The risks related to weaknesses in the Russian regulatory framework include, to various degrees, the following. • Possible discrepancies, ambiguity and anomalies in: (1) federal laws; (2) orders, directives and regulations issued by the Russian President, Government and federal ministers; (3) and regional and local laws, rules and requirements. • Relative unpredictability of legislative and administrative decisions and court rulings and a lack of means that could make the understanding of such legislative decisions and court rulings easier. • There is no clarity about the influence of the Federal Law «On Strategic Foreign Investment» and the new Customs Treaty of Russia, Belarus and Kazakhstan on Sistema’s business and its foreign shareholders. Russia’s accession to the World Trade Organisation may result in certain legislative and other changes in the markets of Sistema’s operations. • The shareholder responsibilities provided for by the corporate laws of the Russian Federation may result in Sistema being held financially liable for its subsidiaries. 108 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECH• If minority shareholders of Sistema’s subsidiaries contest past or future related-party transactions or other transactions or vote against related-party transactions or other transactions in the future, this will limit Sistema’s operational capacity. • If the Russian Federal Anti-mo- nopoly Service (FAS) concludes that Sistema or one of its mate- rial subsidiaries has acquired or founded a new company in vio- lation of the anti-monopoly law or has otherwise violated com- petition laws, this may result in administrative sanctions. • Failure to formally comply with certain requirements of the Russian law may result in Sistema or one of its subsidiaries incorporated in Russia being forced to carry out liquidation, their ownership structure may be called into question and early debt repayment claims may be made. Taxation system of the Russian Federation • The Russian law on transfer • On 1 January 2015 new rules pricing may make it necessary to introduce adjustments to the price setting system of Sistema Group’s companies and result in additional tax obligations with regard to controlled transactions. were introduced relating to the taxation of undistributed profits of controlled foreign companies, the concept of a beneficiary owner, tax residence of legal entities and in- direct sale of properties in Russia. As a result of the need to apply new taxation rules the Group’s companies may face new tax lia- bilities arising due to the uncer- tainty around interpretation of the tax law and the lack of previous law enforcement practice. Risks related to the operations of Sistema There is no certainty that the business strategy will be successfully implemented. • The key components of the business strategy include development of a balanced and diversified asset portfolio in sectors and regions where Sistema has competitive advantages, and also proactive management of the investment portfolio and involvement of leading international and Russian partners. Despite having a well-formulated strategy, Sistema cannot guarantee achievement of the established goals, efficient management of the portfolio companies or taking up of new investment opportunities. • The success of Sistema’s strategy depends on numerous factors, including obtaining of the necessary permits from the authorities, sufficient demand from consumers, successful development of technologies, efficient management of spending, timely completion of development and introduction of new products and services by the Group’s companies, successful differentiation of the companies’ offers from their rivals and perception of the goods by the market. The company may face difficulties in generating profits from acquisitions, integration, disposal or restructuring of assets. • Sistema grows its business via new acquisitions, sale and restructuring of assets. The process of taking investment opportunities in the market entails certain risks, including the risks of not finding relevant targets or their not being available for acquisition, a risk of insufficient or inadequate due diligence of the target company’s operations and/or financial situation, risks of the assets being overvalued and overpaid for and, consequently, of occurrence of financial risks exceeding expectations and discovery of financial liabilities not found earlier. • Acquisition of additional businesses may also put additional pressure on the Corporation’s cash flows, especially if the acquisition is paid for in cash. Besides, if an acquisition deal is not closed or closed with delays, it may negatively affect Sistema’s achievement of its strategic growth goals and have a substantial negative impact on the current business, operational results, financial situation and prospects. 109 CORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENT• absence of external sources of financing; • changes in the terms of existing agreements on financing; • emergence of new business opportunities or investment in existing businesses, in case of sizable investments; • a slower than planned growth of revenue; • deterioration of the economic situation in the countries of Sistema’s operations. Covenants might limit the ability to raise debt financing, carry out investment programmes or participate in various businesses. Sistema’s bank loan agreements and agreements of some of its S/As on bank loans and debt securities contain certain restrictive covenants. These covenants put restrictions on attraction of additional debt financing, encumbrance of property with pledges, sale of assets and transactions with affiliates. Such covenants may result in restriction of Sistema’s operations, including financing of capital expenses, or limit the possibilities for timely repayment of debt or payments on liabilities. If operations of subsidiaries are restricted, their revenue may decline, which, in turn, may limit Sistema’s opportunities for using such revenue to service the debt or finance its subsidiaries. Moreover, mergers and restructuring of subsidiaries, in certain circumstances, disposal of assets may lead to breach of restricting covenants under such subsidiaries’ loan agreements, which may bring about acceleration of such loans or reclassification of long-term loans into short-term loans. • Moreover, Sistema may encounter problems of integrating assets into the existing structure, their optimal management or necessary restructuring. These risks include inability to efficiently assimilate and integrate operating assets and personnel of the acquired company into the business, inability to establish and integrate all the necessary control systems and mechanisms, including with regard to facilities and agreements related to logistics and distribution, conflicts between majority and minority shareholders, hostility and/or unwillingness to cooperate on the part of the acquired asset’s management, potential loss of customers of the acquired asset. • Potential disposals of assets carry certain risks related to potential inability to execute the transaction or undervaluation of the sold asset, liabilities arising from the sale of asset, failure to meet deadlines for transaction closure or loss of synergy between existing assets. Besides, execution of such transactions, including restructuring, merger of businesses or financial resources depends on a combination of necessary conditions, including corporate and government consents. There is no certainty that such deals will be completed on the announced terms or closed at all. Sistema’s ability to maintain its competitiveness and implement its business strategy in many respects depends on the management and key employees. • The top management team is the key to implementing Sistema’s strategy. Moreover, further success of the investment portfolios and their ability to efficiently implement a common strategy, including plans of growth and increase of scale, will to a large degree depend on the efforts of individual management teams working with the specific assets. 110 Sistema’s ability to service its debt largely depends on the cash flows from its subsidiaries. Sistema’s financial performance largely depends on the ability of its subsidiaries to generate cash flows needed to service its financial liabilities, including repayment of debt and interest and any other borrowing in the future. From time to time, the Group companies’ abilities to make such payouts may be limited as a result of regulatory, tax or other restrictions. Disposal of one of the Group’s core assets reduces the Group’s materiality and the amount of expected dividend flow from subsidiaries, which along with tightening of bank funding may have a negative impact on servicing current liabilities and hinder access to debt financing in the future. The success of Sistema in many respects depends on the success of its core asset, MTS. Sistema’s financial performance in many respects depends on the success of its core asset, MTS. If MTS fails to generate the necessary income, it may impinge on Sistema’s ability to service its debt liabilities and secure growth and business expansion through restructuring and acquisition of assets. Consequently, the risks and events that may have a material detrimental effect on MTS, its operating results, financial standing and prospects may, in turn, have a material detrimental effect on Sistema, its operating results, financial standing or prospects. In the event of problems with fund raising or financing, Sistema’s operations would be curtailed accordingly. Future financial receipts and cash flows from Sistema’s subsidiaries and affiliates may not be sufficient to cover the planned expenses in the event of contingencies, such as: ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHLicences and permits required for Sistema Group companies’ business may be deemed invalid, revoked, rescinded or not prolonged, or contain encumbrances that restrict Sistema’s operations. Operations of Sistema Group companies are regulated by various government bodies and agencies as pertains to obtaining and renewing licences, approvals and permits and also the need to constantly abide by existing legislation, regulations and standards. Regulating authorities to a large extent rely on their own judgment when interpreting and implementing requirements of applicable laws, regulations and standards, issuing and extending licences, approvals, sanctions and permits and monitoring compliance with licence requirements. There is no guarantee that existing licences and permits, including those issued to the Group’s companies, will be extended, new licences and permits will be issued or that the companies will be able to comply with the terms of corresponding licences. There is no guarantee either that any of the existing or future licences or permits will not be suspended or revoked on some or other grounds. Any of these circumstances can have material negative consequences for the business of Sistema. If ambiguity of privatisation laws is used to challenge Sistema’s property rights to its privatised subsidiaries, and the company is unable to defend its position, there is a risk of losing its share in such assets or subsidiaries. • Sistema’s portfolio contains several privatised assets. Since the Russian laws on privatisation are rather ambiguous, inconsistent and conflicting with other laws, for example, there are conflicts between federal and local laws, the privatisation of many companies could be challenged, including the possibility of discriminatory challenges. • If the legitimacy of privatisation of a company is contested, and Sistema is unable to defend its stand in the dispute, there is a risk of losing a stake in such company or its assets, which may have a material adverse effect on the business, financial situation, performance or development prospects of the Corporation.. The business of Sistema is regulated by the anti- corruption laws under the jurisdictions in which it operates, including the anti-corruption laws of the Russian Federation and the Foreign Corrupt Practices Act of the USA, and may be regulated by the UK Bribery Act 2010, and violations of applicable laws may lead to penalties and reputational risks. • Any investigation into potential violations of the FCPA, the UK Bribery Act or other anti- corruption laws of the US, the UK or other jurisdictions may affect the reputation, business, financial situation and performance of Sistema. All segments where Sistema operates are open to competition on the part of other companies. • Operations in the segments of telecommunications, high technology, banking, retail, media, tourism, private healthcare services and pharmaceuticals are exposed to the influence of economic and other factors. Each segment exhibits strong competition between companies in Russia and other countries, including but not limited to competition in terms of price, product and service quality. Inability of Sistema Group companies to compete efficiently may have a material negative impact on the business, performance, financial situation and prospects. Sistema depends on the ability to maintain its brand quality and reputation. • Developing and maintaining brand awareness for the Group companies is a crucial component of shaping the public opinion about their existing and future products and services. Sistema believes that the importance of company brand is growing steadily at the highly competitive markets. Successful development and improvement of brand awareness to a large extent depends on the efficiency of marketing operations and the companies’ ability to provide useful and quality products and services at competitive prices. The efforts to develop the brand may be incommensurate with actual revenues which may be insufficient to cover expenses on such activities. 111 CORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENTEVENTS RELATED TO THE DECONSOLIDATION OF BASHNEFT The civil proceedings brought against Sistema and Sistema-Invest In December 2014, Bashneft Shares were transferred to the Russian Federation. Criminal proceedings relating to the privatization of Bashneft On September 24, 2014, a civil claim was filed with the Arbitrazh (Com- mercial) Court of the City of Mos- cow (“Arbitrazh Court”) by the First Deputy General Prosecutor of Russia seeking to return shares of JSOC “Bashneft” (Bashneft”) held by Siste- ma and its wholly owned subsidiary Sistema-Invest (“Bashneft Shares”) to the Russian Federation (the “Civil Claim”). The Civil Claim asserted that the privatization of Bashneft was unlawful as Bashneft was originally the property of the Russian Federa- tion and, as a result, the authorities of the Republic of Bashkortostan were not legally entitled to privat- ize Bashneft without obtaining the requisite consents from the Russian Federal authorities. On November 7, 2014, the Arbitrazh Court issued a written decision, rul- ing in favour of the Civil Claim. On November 12, 2014, Sistema’s Board of Directors considered and decided not to appeal the deci- sion of the Arbitrazh Court, but rather focus on filing claims for the recovery of damages from the counterparties and/or their legal successors (LLC Ural-Invest) which sold the Bashneft Shares to Sistema and Sistema-Invest. In December 2014, Sistema as a good faith buyer filed a claim with the Arbitrazh Court for the recovery of damages from LLC Ural-Invest (“Ural-Invest”), suffered by Sistema as a result of loss of the Bashneft Shares. In February 2015, the Arbitrazh Court ruled in favour of Sistema’s claim for the recovery of RUB 70.7 billion damage from Ural-Invest. In March 2015, Sistema and Ural-Invest signed a settlement agreement. In accordance with the terms of the settlement agreement, all the property owned by Ural-Invest, i.e. cash assets of approximately RUB 46.5 billion, will be transferred to Sistema. Given the social importance of the projects of the URAL charitable fund (“Fund”), which is affiliated with Ural-Invest, and in accordance with the terms of the settlement agreement Sistema will invest RUB 4.6 billion of the funds receivable from Ural-Invest to the Fund’s socially important charitable projects. On March 30, the Arbitrazh Court approved the settlement agreement signed by Sistema and Ural-Invest. In April 2014, a criminal investigation was commenced in respect of Mr. Ural Rakhimov (the son of Mr. Murtaza Rakhimov, who was the President of the Republic of Bashkortostan during the period when the BashTEK companies were privatized) and Mr. Levon Airapetyan. These persons have been accused of misappropriating Bashneft via an illegal privatization process and have also been accused of legalization with respect to Bashneft. On September 16, 2014, the majority shareholder and Chairman of the Board of Directors of Sistema, Mr. Vladimir Evtushenkov was charged with legalization of assets that were wrongfully acquired by other persons, and placed under house arrest. In December 2014, Mr. Vladimir Evtushenkov was released from house arrest and is now participating as normal in business of Sistema Group, as the Chairman of Sistema’s Board of Directors. 112 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHSUSTAINABLE DEVELOPMENT Responsible investor Social investment Education, science, innovation Culture Environment Society Responsibility towards employees 114 115 115 117 119 121 122 Responsible investor Sistema has substantial influence on the development of many sectors of the Russian economy and society in general. The Corporation abides by the Principles for Responsible Investment developed by an international investor group under the UNO’s aegis in response to growing concerns involved in the interplay of environmental and social issues as well as issues of corporate governance and investment practices. The Company measures up its business goals against the background of social interests and gives consideration to environmental, social, and corporate governance (ESG) factors underpinning the development of market sectors and regions its portfolio companies operate in. Matrix of Interested Parties h g i H s s e n i s u b n o i t a r o p r o c e h t n o e c n e u l f n i f o e e r g e D w o L Shareholders and investors Government Local communities Employees Customers Mass media Partners Suppliers Competitors Non-profit and social organisations Low Degree of interest on behalf of Sistema High Sistema's core documents governing sustainable development Corporate Social Responsibility Policy of Sistema The key strategic management tool for sustainable development of the Company. Determines the basic principles, fields and priorities for stakeholder relationship management) Ethics Code Regulates the standards of corporation relations and ensures open, honest and ethical business conduct Corporate Code of Conduct Defines commitments voluntarily assumed by the Corporation in addition to the requirements of effective law in terms of transparency, openness and anti-corruption procedures Reports on corporate social responsibility are reviewed annually by the Board of Directors, who determines strategic goals and assesses the efficiency of social investment made. Sistema’s Corporate Communications Function and specialised units of the Corporation’s subsidiaries manage corporate social responsibility and prepare and publish related non- finance reports. 114 СМИКонкурентыМестные сообществаКлиентыГосударствоНКО и общественныеорганизацииПоставщикиСотрудникиАкционеры и инвесторыПартнерыABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECH Social investment An important component of Siste- ma’s corporate social responsibility is charity promoted in line with the social investment concept, i.e., a purposeful long-term social policy linking strategic interests of the corporation and its shareholders with society’s needs. The basic principles of charity efforts as well as areas to be addressed are out- lined in the Policy Sistema’s Charity Work. The key body in charge of the Corporation’s charity and social projects is Sistema Charitable Foun- dation (Sistema CF), who accumu- lates funds allocated from profits of subsidiaries for general corporate programmes. The Foundation works in the following key focus areas: • science; • education; • awareness; • culture and art; • preservation of religious and his- torical heritage; • healthcare and social security; • fitness and sports. On top of that, subsidiaries pursue their own CSR and charity projects. In the last three years (2012, 2013, and 2014), Sistema Group’s total spending on charity and social re- sponsibility exceeded RUB 5.3 bln. The Corporation seeks to consist- ently deepen integration of its CSR projects and improve their efficiency through combined effort of all com- panies of the Sistema Group. These companies increasingly use projects designed to develop business and address social needs at the same time. 2014 was the year when the Corporation reached a whole new level of synergies in corporate social responsibility: its subsidiaries and affiliates took active part in joint projects promoting high technol- ogies, human development, and education of the youth, as well as volunteer campaigns, the corner- stones of Sistema’s social policy. >4,5 RUB mln total amount of expenses on charity and social responsibility projects for three years Education, science, innovation Sistema’s broadest-scale project in education and science is Lift to the Future, a nationwide young talent development programme launched in 2011 with the support of the Russian Ministry of Educa- tion and Science, the Agency for Strategic Initiatives (ASI), and more than 500 partner organisations. The programme uses a special procedure for talent screening and development and intends to provide students with early career guidance and inspire scientific and techno- logical creativity. The ASI’s supervi- sory board (chaired by the Russian president V.Putin) recommended the project for replication in various re- gions of Russia (administrations of 19 regions of Russia signed related cooperation agreements). 115 CORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENT2014 became the year of establishment of four talent high schools for science and research in the Moscow, Smolensk, and Vladimir regions and Bashkortostan. School and university students submitted 370 innovation projects in Environment & Natural Resources, Power Engineering, Information Technologies, Telecommunications, Transport Technologies, Healthcare & Pharmaceuticals, Microelectronics, etc., to be reviewed by expert contest judges. Master classes, lectures, contests, and conferences for school and university students involved representatives of most companies of the Sistema Group. The Corporation also offered a career guidance programme for participants of Lift to the Future, children of employees of S/As, and students of sponsored child welfare centres and schools by organising tours to MTS, MTS Bank, MGTS, Detsky Mir, Mikron, Stream, and BPGC. Lift to the Future 19 regions of Russia >150 ths >30 ths participants of innovation project contests 64 winners admitted for traineeship in European hi-tech enterprises project participants 500 holders of the Programme scholarship 95 contests 270 academic mentors held among school and college students since the beginning of the Programme provided with grants to organise projects for school students in various regions of Russia In December 2014 Sistema and its subsidiaries MTS and SSTL held a first-ever Russian-Indian Youth Innovation Summit in New Delhi dedicated to latest technologies and prospects of international cooperation in telecom innovations. The summit was supported by the Russian Embassy in India. MTS hosts Telecom Idea, a contest of new ‘smart’ IT solutions helping city environments become more comfortable, eco-friendly, and accessible for all social groups. After four years in Russia, in 2014 the contest was extended to India for the first time. >400 colleges and startups participating in the contest since its start >600 projects submitted by young scientists for potential use in business; some of them successfully implemented The summit also involved an interactive culture and technology exhibition From Russia with Progress dedicated to outstanding Russian inventions. 116 1968 THe beST AVAilAble mAcHiNe foR coNTRolled NucleAR fuSioN Physicists in many countries tried to tackle the problem, aiming to create the world's first fusion reactor. Tachomac enabled scientists to reproduce nuclear fusions similar to those observed on the Sun. proteins, To get power today, we mostly burn oil, gas, and coal. However, the planet's oil and gas reserves are limited, and with ever-growing power consumption, they may be almost exhausted within 30-50 years. besides, oil and gas are not just fuels, they are valuable feedstocks used to produce a variety of chemicals, useful substances. what kind of progress should power engineering now aim for? within the universe, there is colossal energy released from the interior of the Sun and stars in nuclear fusions. using such power on planet earth might seem nothing more than fantasy at first: it would require temperatures of millions and millions of degrees. Physicists in many countries tried to tackle the problem, other and first aiming to create the world's first fusion reactor. one method showing promise was tochamac, special contraptions for magnetic plasma confinement. These enabled scientists to reproduce nuclear fusions similar to those observed on the Sun. The tochamac was developed and demonstrated in 1968 by a group of physicists lead by lev Artsimovich, fellow of the Soviet Academy of Sciences. The name of the device is an acronym of the Russian full name translated as "Toroidal cHamber with mAgnetic coils". The tochamac is still perceived as the best available machine for controlled nuclear fusion, and it is hoped it will provide mankind with inexhaustible energy. ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHMTS and MGTS are partners of the New Technology School project originated by the IT Department of Moscow and designed to broaden the use of information and communication technologies (ICT) in education. VivaCell-MTS supported Armenian schools in setting up Creativity Labs, modern classrooms equipped with interactive blackboards, latest computers and movable furniture specially designed for individual and group use. Sistema takes active part in the development of national innovation infrastructure. The Corporation is among the shareholders of Technopark Sarov (co-run with Rosatom and RUSNANO) designed for innovation projects to be carried out at the VNIIEF Russian Federal Nuclear Centre for the benefit of Russian economy. In October 2013 Sistema CF first provided support to Valdai International Discussion Club, a convention in Sochi bringing together more than 800 representatives of the global academic community, including professors from major universities of nearly 50 countries. Technopark Sarov 1.5 RUB bln in aggregate revenue of the Technopark’s companies as of the end of 2014 54 resident companies at Technopark Sarov (with over 600 employees) Culture Sistema pursues several sizeable initiatives in culture and arts aiming to preserve and promote national cultural and historical legacy. Sistema CF supports numerous theatre, music, and art projects, as well as leading performance teams and museums. Its charity recipients include over 20 institutions and foundations active in the field of culture, including the Nikolay Petrov Foundation, the Benois Centre, the Valery Gergiev Foundation, the Foundation for Support of Church Construction in Moscow, the Valaam Convent & Nature Reserve, and the Field of Prokhorovka Museum of Armoured Vehicles. 117 CORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENTThe largest recipient of the Corporation’s long-term social investments is the Russian Museum, Sistema’s partner since 2003. Support of the Sistema CF allows the museum to carry out large-scale exhibition, editorial, art restoration, and educational projects. In particular, the museum is currently building an extensive interregional and international network of ‘virtual branches’ to make the vast collection of Russian arts accessible to the mainstream audience. The number of new museum branches doubled in 2013-2014. In 2014 the museum opened 28 information and education centres based in libraries, museums, and learning institutions in St Petersburg, Angarsk, Arkhangelsk, Volsk, Izhevsk, Ishim, Kaluga, Kostomuksha, Kondopoga, Petrozavodsk, Pikalyovo, Saransk, Sortaval, Yuzhno-Sakhalinsk, and locations in Turkey and Finland. The West wing of St Michael’s Castle (the Engineers’ Castle) in St Petersburg now hosts an «e-museum», a state-of-the-art multi media centre providing access to the Russian Museum’s rich art collection via latest technologies. Sistema helps the museum to constantly upgrade the centre’s hard- and software to maintain its high-tech status. The various projects performed by the Russian Museum in 2014 with support from Sistema include new multi media programmes, books on Russian arts, and the VIIth international Imperial Garden of Russia festival. 118 Russian Museum A new cooperation agreement between Sistema and the Russian Museum on financing of various museum’s projects was signed. It is termed until 2023 and contemplates financing in amount of The Russian Museum currently operates 158 «virtual branches» 300 RUB mln (119 – in Russia, 37 – abroad 2 – in the Antarctica) 4,000 of the multi media centre in 2011-2014 visitors 4,700 participants of video conference calls 127 events organised in the multi media theatre 600 images exhibited in the multi media centre’s gallery ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHSince 2009 Sistema has been sponsoring the annual May Festival of Children’s Films organising free charity shows of Russia’s best motion pictures and cartoons for children. The programme is designed to develop modern learning methods and provide leisure experience to children from orphanages and social boarding schools, disabled children, and families with foster children. Another project that made great progress in 2014 is Mobile Library, an innovative social learning project originated by MTS and involving the installation of «virtual» bookshelves in libraries and other broad access institutions allowing users to down- load masterpieces of the Russian and foreign literature, including those from school curricula, on mobile devices using QR codes. MTS pursues the Mobile Library project in over 30 regions of Russia, as well as Ukraine and Belarus. >400 mobile libraries opened in just 8 regions of Central Russia in 2014 >10 ths books of a combined volume that would take almost 300 years to read have been downloaded by mobile library users Environment The Corporation’s environmental efforts are focused on: • implementation of energy-saving principles; • safe waste reclamation; • protection of the atmosphere; • protection of water and land resources; • environmental education of the younger generation. Sistema and its subsidiaries are actively involved in environmental efforts in regions where they operate, working to gradually reduce their environmental impact, improve the ecology and enhance environmental consciousness. The Corporation rigorously abides by environment protection principles and complies with all relevant laws and regulations. The amount of resources used* Resource type Thermal energy Electrical energy Water Used for 2014 2,738.12 Gcal 3,422,652.91 RUB 3,491 thous. kWh 13,266,014.45 RUB 16,470 m3 438,275.64 RUB Sistema participated in financing of the Republic of Bashkiria’s water programme. The programme embraced 20 districts and 8 cities of Bashkiria and envisaged reconstruction and major repairs of existing and construction of new water intakes, conduits and water supply systems, drilling of wells and installation of water towers, mainly in remote rural areas where they are often the only source of drinking water. Companies whose activities are directly related to natural resources management or have an impact on public health pay special attention to environmental safety. Notably, Targin has introduced an HSE (health, safety and environment) system that enables it to work safely at a customer’s facilities and helps to preserve the environment. In 2014 the system was first certified by ISO 9001, ISO 14001, and OHSAS - 18001. LesInvest Group, the biggest forest user in the European part of Russia, is certified to FSC**, which, among other things, envisages forest restoration and close cooperation with environmental organisations and local communities. * Data for 2014 according to the Corporate Center ** FSC (Forest Stewardship Council) is an independent international organisation who has created a certification system for environmentally and socially responsible forest management. 119 CORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENT94% of forest lands leased by Sistema are FSC-certified In 2014, the pilot project for safe disposal of batter- ies and electronic waste was launched at 300 sales outlets in Moscow and the Moscow region. The project was then carried out in 10 Russian cities. >3,000 Sistema Group employees took part in the corporate Saturday clean-up It has already become a good tradition for Sistema employees to volunteer to clean up public areas in cities and natural sites by organising spring Saturday clean- ups in Moscow and other regions. Since 2010, Sistema has been supporting projects of the Russian Geographic Society. In 2014 it supported the Society’s first nationwide festival involving all of its 85 regional divisions at the Central House of Artists in Moscow. The week-long festival attracted about 60,000 visitors, including many children and teenagers who also participated in the event’s rich educational programme. Reforestation, ha 12,427 12,380 11,929 2012 2013 2014 The amount of the Group’s reforestation work is growing year after year: In 2014, the area where planting and combined reforestation work took place grew by 4.2% vs 2012. Medsi Group strictly complies with Russian sanitary regulations on hospital waste handling. Medsi clinics take regular steps to prevent hospital-acquired infections and ensure epidemiological safety of their patients and employees. Bacteriological tests show a definite improvement in the epidemic safety of Medsi clinics in recent years. MTS’ retail outlets now serve as drop-off stations for used batteries to be disposed as per high environmental safety standards. The campaign runs under the title Discard It Right and fits into a broader Eco Office programme promoting environment conservation principles since 2012. In 2014 MTS organised its first national open eco lesson Mobile Technology for Ecology as part of the Green Schools programme sup- ported by the inter-regional public organisation EKA Green Movement of Russia. During the lesson, teach- ers and volunteers at more than 1,000 Russian schools talked about the role of modern technologies in environment protection. In Armenia, VivaCell-MTS together with the Foundation for the Preservation of Wildlife and Cultural Assets (FPWC) launched a number of innovative projects seeking to develop alternative energy sources and introduce environment-friendly solutions in rural areas. The Corporation is also involved in preservation of biological diversity, notably, by supporting the Eurasian Center for Leopard Studies and Preservation and particularly one of its key projects, the Leopard Land national park. Thus, in 2014 it spon- sored biochemical works in the park and the development of technology infrastructure, fire control, and an electronic database of the Amur leopard population. Sistema also contributed to a leopard-themed education campaign targeting local communities, including school students of the Khasansky municipality (Primorye). 120 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHSociety In 2014, the Sistema Charitable Foundation began shaping a corpo- rate volunteer movement as a tool of non-financial charity. Volunteers from Sistema supported tens of cultural, social, educational and sports projects in various regions where the Group operates. MTS has launched a corporate volun- teer theater, whose actors stage educating performances for the employees’ children and inmates of orphanages. Detsky Mir joined this project in 2014. BPGC arranged an educational show on electrical safe- ty staged by the Bashkirian State Puppet Theater in Belebei, Kumer- tau, Neftekamsk and Ufa. In just 2014, the number of volunteers at the Sistema Group grew by almost 2.5 times, from 3,300 to 8,000. Employees of all Sistema Group companies took part in New Year charity campaigns, with over 2,000 employees acting as volunteers. The Wishing Tree Charity Performances Theater Season In 2014, 200 volunteers bought New Year gifts for children at orphanages and helped to organise holiday parties for them. Every December, the Sistema Charitable Foundation organises charity performances for disadvantaged children. Sistema employees bought tickets for Town Musicians of Bremen, a musical. New Year celebrations were attended by children from the Moscow region, Vladimir, Torzhok, Emmaus, Tula, Ryazan, Noginsk and Udomlya. Children from 17 orphanages and from poor families from Moscow, the Moscow region and the Tver region attended the charity performances. The project reached out to over 300 children from orphanages, children from large families and disabled children from the Moscow and Tver regions. In summer 2014, the Sistema Charitable Foundation sponsored the purchase and delivery of a large relief consignment for refugees from Ukraine. Employees of all group companies joined the Foundation’s initiative, contributing over 200 cu m of humanitarian aid, including living essentials and vaccines. The Group’s companies work hard to implement social and educating programmes for the benefit of their customers. MTS pursues Children and the Internet, a programme de- signed to promote rules of useful and safe use of the world wide web among younger schoolchildren, their parents and teachers, as well as Internet for All, a programme teaching older people to use the Internet and adapt in the informa- tion-oriented society. 121 CORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENTThe project has been implemented in most cities of Russia and Belarus, its total audience exceeding 300,000 people MTS and MGTS support the Children Online help line, has by now received over 10,000 calls and processed over 2,500 e-mails regarding safe use of the Internet by minors. In September 2014, BPGC signed an agreement with the Bashkirian Education Ministry on joint implementation of initiatives to prevent children’s electrical injuries as part of the Safe Childhood project. Bashkirenergo’s employees gave electric safety lessons at 221 schools of the republic. In November 2014, Medsi launched a unique project under the slogan Be Healthy with Medsi promoting a healthy lifestyle among corporate customers and partners of the com- pany. Within this programme, Med- si’s best doctors and fitness instruc- tors offer lectures and consultations on such issues as handling chronic fatigue and stress, pregnancy and work, children’s health, etc. Healthcare, support of the disabled and promotion of sports are among priorities of Sistema’s social policy. Renovation of a rehabilitation center for children with cerebral palsy at the Martha and Mary Convent of Mercy began in 2014. Since 2008, the Sistema Charitable Foundation has provided a total of RUB 100m for the Convent’s restoration. This unique project supported by the Moscow City Government and the Russian Orthodox Church will help to improve the quality of life of families with disabled children that are in need of continuous care. For several years, SSTL has been involved in an initiative to end polio in India, working hard to increase general awareness about polio vaccination through promotional text messages and other channels of communication. In the past three years, subscribers of MTS India received 20m texts reminding them to get their shots. As a result of this large-scale programme, on 27 March 2014 the World Health Organisation certified India polio- free, and UNICEF is now considering this model for use in Africa. Sistema encourages the development of Russian sports by supporting the country’s Olympic and Paralympic teams, as well as sports schools and clubs for children and the young. In November 2014, Sistema and the Russian Paralympic Committee organised treatment and rehabilitation of athletes in the Republic of Altay, at the unique Altay Resort belonging to the Intourist Hotel Group. The Sistema Charitable Foundation also supported the Moscow Olympro team of the Vozrozhdenie club, which participated in the 12th International Football Tournament for Amputees that took place in Sochi. Sistema sponsored the establishment of a family camp for the Moscow equestrian club for the disabled in Yevpatoria (Crimea), where children underwent a unique course of rehabilitation through exercise. Sistema’s subsidiaries are also actively involved in promotion of sports at regional and national levels. 122 Responsibility towards employees Sistema is one of Russia’s biggest and most attractive employers, employing over 150,000 people in Russia (0.4% of the workforce) and other countries it operates in. The Corporation uses the best HR management practices and fully complies with labour legislation of countries it works in, offering its employees competitive remuneration and social benefits (health and life insurance, sports events, etc.). For social aid to employees, employees’ children and retirees in 2014 Company allocated 220 RUB mln Following the Corporation’s transition to the investment company model, the Board of Directors approved a new incentive system designed to ensure profitability of investment and monetisation of created value for each individual project and for the Corporation in general. The incentive programme is geared towards value creation and/or implementation of projects, as well as financial self-sufficiency of project teams. The new incentive mechanism provides the best way to align the interests of Sistema’s management and shareholders. The incentive system for the senior management first launched in 2010 is based on changes in the price of Sistema shares and total shareholder return (TSR). The programme’s participants may receive additional bonuses linked to increase of the Corporation’s capitalisation in the form of ordinary shares. ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHThe Corporation has a system of internal career lifts. In 2014, Sistema launched the Talent Bank project that is designed to search for, develop and rotate top managers of subsidiaries that have high potential and high motivation for growth. In 2014, over 100 senior managers from the Group’s companies underwent remote and in-person assessment. Based on its results, 53 managers were selected to start a development programme in 2015. Yet another HR initiative that was launched in 2014 is the School of In-House Coaches. The project seeks to create a pool of efficient corporate coaches to develop key business skills and competencies of medium and junior management using the best expertise in the sphere. Important tools of non-financial motivation and employee engagement promotion are corporate volunteering and sports movements. The central sports event of the year was the 12th Summer Games, which united over 3,000 employees from 60 companies of Sistema Group from different regions of Russia, the CIS and India. Sistema conducts annual engagement surveys to give its employees an opportunity to share their thoughts on the most important issues and give feedback, to find out the company’s strengths and areas that need improvement and development and to determine priorities when planning HR events for the next year. The Corporation sets itself ambitious goals and looks up to the most successful international companies. In 2014, about 28,000 employees took part in the survey. The measures taken by Sistema improved employee engagement by 14% compared to 2013, reaching the level of the world’s most successful companies. Almost all areas and parameters of the survey demonstrated a positive trend. Sistema and MTS traditionally win leading positions in Russian employer ratings. In 2014: by 14% employee engagement increased compared to 2013 and reached the level of the most successful companies in the world Sistema’s Board Chairman ranks among the top 10 business leaders of Russia according to Kommersant and the Russian Managers’ Association. Sistema’s president was ranked 1st among CEOs of diversified holding companies in Russia’s Top 1000 Best Managers 2014. Yet another six of the company’s top managers were named best in their respective professional categories (finance and investment, corporate governance, HR, GR, PR, IT). Sistema confirmed its previously won A.hr grade («High level of employer appeal») in Expert RA’s employer rating Sistema won the special nomination award Best Corporate Mass Media System in the Best Corporate Media 2014 competition MTS won the #1 position in HeadHunter’s annual Employers of Russia rating for a second consecutive year, and was also included in HeadHunter’s list of top Russian employers of the young 123 CORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENTSISTEMA JSFC AND SUBSIDIARIES Consolidated Financial Statements As of December 31, 2014 and 2013 and for the Years Then Ended INDEPENDENT AUDITORS’ REPORT CONSOLIDATED FINANCIAL STATEMENTS AS OF DECEMBER 31, 2014 AND 2013 AND FOR THE YEARS THEN ENDED: Consolidated statements of financial position as of December 31, 2014 and 2013 Consolidated statements of operations and comprehensive income for the years ended December 31, 2014 and 2013 Consolidated statements of cash flows for the years ended December 31, 2014 and 2013 Consolidated statements of changes in shareholders’ equity for the years ended December 31, 2014 and 2013 Notes to the consolidated financial statements 125 126 126 128 130 132 134 INDEPENDENT AUDITORS’ REPORT To the Board of Directors and Shareholders of Sistema Joint Stock Financial Corporation We have audited the accompanying consolidated financial statements of Sistema Joint Stock Financial Corporation and its subsidiaries, which comprise the consolidated statements of financial position as of December 31, 2014 and 2013, and the related consolidated statements of operations and comprehensive income, cash flows and changes in shareholders’ equity for the years then ended, and the related notes to the consolidated financial statements and appendix thereto. Management’s Responsibility for the Consolidated Financial Statements Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of the consolidated financial statements that are free from material misstatement, whether due to fraud or error. Auditors’ Responsibility Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with the Russian Federal Auditing Standards and auditing standards generally accepted in the United States of America. Those standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity’s preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. Accordingly, we express no such opinion. Opinion In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Sistema Joint Stock Financial Corporation and its subsidiaries as of December 31, 2014 and 2013, and the results of their operations and their cash flows for the years then ended in accordance with accounting principles gener- ally accepted in the United States of America. April 2, 2015 Moscow, Russian Federation Raikhman M.V., Partner (Certificate no. 01-001195 dated January 14, 2013) The Entity: Sistema Joint Stock Financial Corporation Certificate of state registration № 025.866, issued by the Moscow Registration Chamber on 16.07.1993. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion. Certificate of registration in the Unified State Register № 1027700003891 of 11.11.2002, issued by Moscow Inspectorate of the Russian Ministry of Taxation № 46. Address: Building 1, 13 Mokhovaya street, Moscow, 125009, Russia. Independent Auditors: ZAO Deloitte & Touche CIS Certificate of state registration № 018.482, issued by the Moscow Registration Chamber on 30.10.1992. Certificate of registration in the Unified State Register № 1027700425444 of 13.11.2002, issued by Moscow Interdistrict Inspectorate of the Russian Ministry of Taxation № 39. Certificate of membership in “NP “Audit Chamber of Russia” (auditors’ SRO) of 20.05.2009 № 3026, ORNZ 10201017407. 125 APPENDICESCORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENTCONSOLIDATED STATEMENTS OF FINANCIAL POSITION AS OF DECEMBER 31, 2014 AND 2013 (Amounts in thousands of U.S. dollars, except share and per share amounts) Notes 2014 2013 ASSETS CURRENT ASSETS: Cash and cash equivalents Short-term investments Assets from banking activities, current portion (including cash and cash equivalents of $843,715 and $1,132,368) Accounts receivable VAT receivable Inventories and spare parts Deferred tax assets Other current assets Current assets of Bashneft Total current assets NON-CURRENT ASSETS: Property, plant and equipment Advance payments for non-current assets Goodwill Other intangible assets Investments in affiliates Assets from banking activities, net of current portion Debt issuance costs Deferred tax assets Long-term investments Other non-current assets Non-current assets of Bashneft Total non-current assets TOTAL ASSETS 8 7 9 11 21 10 2 12 13 14 16 7 21 17 2 $ 1,288,722 $ 479,341 2,180,196 1,163,092 236,438 1,244,509 245,571 832,060 - 7,669,929 7,191,394 84,560 817,537 1,721,389 356,018 1,374,367 42,267 392,866 316,625 703,525 - 13,000,548 1,537,492 1,562,547 3,898,740 1,630,593 335,289 1,131,302 330,388 1,084,547 3,054,728 14,565,626 11,151,341 162,978 1,327,779 2,162,700 365,266 2,554,229 78,348 297,419 249,071 714,458 9,619,779 28,683,368 $ 20,670,477 $ 43,248,994 См. Примечания к консолидированной финансовой отчетности и приложение к ним. 126 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHLIABILITIES AND EQUITY CURRENT LIABILITIES: Accounts payable Liabilities from banking activities, current portion Taxes payable Deferred tax liabilities Subscriber prepayments, current portion Accrued expenses and other current liabilities Short-term loans payable Current portion of long-term debt Current liabilities of Bashneft Total current liabilities LONG-TERM LIABILITIES: Long-term debt, net of current portion Subscriber prepayments, net of current portion Liabilities from banking activities, net of current portion Deferred tax liabilities Asset retirement obligations Postretirement benefits obligations Property, plant and equipment contributions Other long-term liabilities Non-current liabilities of Bashneft Total long-term liabilities TOTAL LIABILITIES Commitments and contingencies Redeemable noncontrolling interests SHAREHOLDERS’ EQUITY: Share capital (9,650,000,000 shares issued; 9,435,902,596 and 9,274,755,045 shares outstanding with par value of 0.09 Russian Rubles, respectively) Treasury stock (214,097,404 and 375,244,955 shares with par value of 0.09 Russian Rubles, respectively) Additional paid-in capital Retained earnings Accumulated other comprehensive loss Total shareholders’ equity Non-redeemable noncontrolling interests TOTAL EQUITY TOTAL LIABILITIES AND EQUITY Notes 2014 2013 18 21 19 20 2 20 18 21 28 2 30 29 24 24 $ 1,584,251 $ 2,180,491 290,635 64,947 390,736 1,315,656 129,938 1,598,770 - 7,555,424 6,534,055 59,064 167,860 787,631 53,715 45,344 41,358 475,713 - 8,164,740 15,720,164 - 792,766 1,943,133 3,864,415 490,564 114,192 620,281 1,567,890 40,836 2,102,911 2,663,432 13,407,654 8,375,161 101,240 772,525 902,591 83,809 53,943 74,174 443,032 3,734,024 14,540,499 27,948,153 - 805,130 30,057 30,057 (246,351) 2,604,913 4,210,623 (3,743,402) 2,855,840 1,301,707 4,157,547 $ 20,670,477 $ (426,715) 2,616,608 8,993,469 (906,718) 10,306,701 4,189,010 14,495,711 43,248,994 See notes to the consolidated financial statements and appendix thereto. 127 APPENDICESCORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENTCONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME FOR THE YEARS ENDED DECEMBER 31, 2014 AND 2013 (Amounts in thousands of U.S. dollars, except share and per share amounts) Notes 2014 2013 $ 15,886,775 $ 698,182 16,584,957 17,623,153 878,832 18,501,985 (7,460,524) (7,907,148) (760,084) (3,431,075) (2,292,118) (193,122) 73,124 - (864,629) - 181,305 - (99,385) 1,738,449 212,774 (811,346) - (548,596) 591,281 (453,417) $ 137,864 $ 15 15 4 6 30 21 2 2 1,517,054 (4,969,011) (3,314,093) (773,539) (4,087,632) (278,161) (3,809,471) (3,886,388) $ (52,099) 72,899 172 (3,865,416) $ $ (523,960) (3,896,207) (2,633,548) (239,814) 29,866 (258,048) (804,545) 1,200,000 - 371,100 (273,109) 3,566,572 182,447 (960,136) 30,199 (298,264) 2,520,818 (842,107) 1,678,711 1,540,489 - 3,219,200 (961,672) 2,257,528 1,102,161 1,155,367 (885,770) 32,200 45,499 5,310 (802,761) (7,179,509) $ 2,416,439 Sales Revenue from banking activities TOTAL REVENUES Cost of sales, exclusive of depreciation and amortization shown separately below Cost related to banking activities, exclusive of depreciation and amortization shown separately below Selling, general and administrative expenses Depreciation and amortization Taxes other than income tax Equity in results of affiliates Impairment of goodwill Impairment of other assets Gain on disposal of investment in RussNeft Gain from reentry into Uzbekistan Gain on Bitel case resolution Other operating expenses OPERATING INCOME Interest income Interest expense Change in fair value of derivative instruments Foreign currency transaction loss Income before income tax Income tax expense Net income excluding Bashneft Income of Bashneft operations, net of tax effect of $427,716 and $455,637 Loss on deconsolidation of Bashneft, net of tax effect of nil NET (LOSS) / INCOME Noncontrolling interests NET (LOSS) / INCOME ATTRIBUTABLE TO SISTEMA JSFC Including: From continuing operations From Bashneft operations and its deconsolidation OTHER COMPREHENSIVE (LOSS)/INCOME, NET OF TAX Currency translation loss Unrealized (loss)/gain on available-for-sale securities Unrealized gain on derivatives Unrecognized actuarial gain Other comprehensive (loss)/income, net of tax TOTAL COMPREHENSIVE (LOSS)/INCOME См. Примечания к консолидированной финансовой отчетности и приложение к ним. 128 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHIncluding: Attributable to noncontrolling interests Attributable to Sistema JSFC Weighted average number of common shares outstanding – basic and diluted Earnings per share, basic and diluted, U.S. cent (Loss)/earnings per share from continuing operations (Loss)/earnings per share from Bashneft operations and its deconsolidation Total (loss)/earnings per share attributable to Sistema JSFC shareholders Notes 2014 2013 (255,193) (6,924,316) 738,912 1,677,527 9,350,539,484 9,239,817,019 (2.98) (40.74) (43.72) 11.93 12.50 24.43 CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 2014 AND 2013 (Amounts in thousands of U.S. dollars) 2014 2013 CASH FLOWS FROM OPERATING ACTIVITIES: Net (loss) / income Income of Bashneft operations Loss on deconsolidation of Bashneft Net income excluding Bashneft Adjustments to reconcile net income to net cash provided by operations: Depreciation and amortization Equity in results of affiliates Deferred income tax expense Foreign currency transaction loss Gain from disposal of investment in RussNeft Gain on Bitel case resolution, net of cash received of $125,000 Gain on reentry into Uzbekistan Gain on disposal of property, plant and equipment Gain on disposal of subsidiaries Amortization of connection fees Allowance for loan losses Dividends received from affiliates Non-cash compensation to employees Impairment of goodwill Impairment of other assets Other non-cash items $ $ (3,314,093) (1,517,054) 4,969,011 137,864 2,292,118 (73,124) 36,338 548,596 - - (181,305) (26,731) (139,082) (23,019) 260,417 70,369 79,430 - 864,629 19,937 3,219,200 (1,540,489) - 1,678,711 2,633,548 (29,866) 140,292 298,264 (1,200,000) (246,100) - (7,226) - (60,309) 212,081 65,247 54,158 258,048 804,545 (15,057) 129 APPENDICESCORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENTCONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 2014 AND 2013 (CONTINUED) (Amounts in thousands of U.S. dollars) Changes in operating assets and liabilities, net of effects from purchases of businesses: Trading securities Accounts receivable VAT receivable Inventories and spare parts Other current assets Accounts payable Subscriber prepayments Taxes payable Accrued expenses and other current liabilities Net cash from operating activities excluding Bashneft Net cash from operating activities of Bashneft Net cash provided by operating activities CASH FLOWS FROM INVESTING ACTIVITIES: Payments for purchases of property, plant and equipment Proceeds from sale of property, plant and equipment Payments for purchases of intangible assets Payments for businesses, net of cash acquired Proceeds from sale of subsidiaries, net of cash disposed Purchase of investments in affiliated companies Payments for purchases of long-term investments Proceeds from sale of long-term investments Payments for purchases of short-term investments Proceeds from sale of short-term investments Payments for purchases of other non-current assets Increase in restricted cash Net decrease/(increase) in loans to customers of the banking segment Net cash used in investing activities excluding Bashneft Net cash used in investing activities of Bashneft (net of cash disposed of $961,733) Net cash used in investing activities $ 2014 2013 267,153 (44,241) (17,192) (490,362) (114,574) 560,603 (11,593) (5,394) 281,592 4,292,429 2,755,291 7,047,720 (2,362,652) 80,332 (539,930) (392,409) 150,000 (201,582) (836,916) 511,227 (1,327,702) 1,622,718 - - 664,089 (2,632,825) (3,256,540) (5,889,365) $ (406,687) (240,586) (174,951) (171,320) (93,381) 533,948 110,112 109,503 (54,127) 4,198,847 2,629,988 6,828,835 (2,455,276) 39,592 (539,117) (34,664) 561,402 (63,753) (105,000) 1,286,292 (1,337,304) 1,047,317 (44,879) (15,819) (70,458) (1,731,667) (1,158,995) (2,890,662) См. Примечания к консолидированной финансовой отчетности и приложение к ним. 130 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHCASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from/(principal payments on) short-term borrowings, net Net decrease in deposits from customers of the banking segment Proceeds from long-term borrowings Principal payments on long-term borrowings Acquisition of noncontrolling interests in existing subsidiaries Dividends paid Proceeds from capital transactions with shares of existing subsidiaries Net cash used in financing activities excluding Bashneft Net cash provided by/(used in) financing activities of Bashenft Net cash used in financing activities Effect of foreign currency translation on cash and cash equivalents Net (decrease)/increase in cash and cash equivalents Cash and cash equivalents at the beginning of the year, including Bashneft (включая денежные средства и их эквиваленты АНК «Башнефть») Less: cash and cash equivalents of Bashneft at the end of the year Cash and cash equivalents at the end of the year Comprising: Non-banking activities Banking activities CASH PAID DURING THE YEAR FOR: Interest, net of amounts capitalized Income taxes NON-CASH INVESTING AND FINANCING ACTIVITIES: Acquisition of intangible assets Equipment and licenses acquired under capital leases Amounts owed for capital expenditures Payables related to business acquisitions 2014 2013 $ $ $ $ $ $ 185,838 (701,620) 2,850,171 (2,274,350) (67,432) (1,198,028) 41,141 (1,164,280) 885,338 (278,942) (1,938,436) (1,059,023) 3,191,460 2,132,437 - 2,132,437 1,288,722 843,715 (876,692) (377,298) - 203,904 401,206 1,760 (231,036) (177,105) 1,900,322 (2,539,405) (299,184) (1,225,440) 69,002 (2,502,846) (580,164) (3,083,010) (293,247) 561,916 2,629,544 3,191,460 (521,600) 2,669,860 1,537,492 1,132,368 (1,160,300) (735,797) 670,300 223,628 124,826 345 See notes to the consolidated financial statements and appendix thereto. 131 APPENDICESCORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENTCONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY FOR THE YEARS ENDED DECEMBER 31, 2014 AND 2013 (Amounts in thousands of U.S. dollars, except share amounts) Share capital Treasury stock Shares Amount Shares Amount Additional paid-in capital Retained earnings Accumulated other compre- hensive Loss Shareholders’ equity Non-redeemable non-controlling interests Total equity Redeemable non-controlling interests Balances at January 1, 2013 Net income/(loss) Other comprehensive (loss)/income Settlements under long-term motivation program Accrued compensation cost Business combinations, disposals and capital transactions of subsidiaries Change in fair and redemption value of noncontrolling interests Dividends declared by Sistema JSFC Dividends declared by subsidiaries 9,650,000,000 - 30,057 - (440,425,038) - (501,109) - - - - - - - - - - - - - - - - 65,180,083 - - 74,394 - - - - - - - - - 2,859,491 - - (13,262) 54,158 (283,779) - - - Balances at December 31, 2013 9,650,000,000 30,057 (375,244,955) (426,715) 2,616,608 8,993,469 (906,718) 10,306,701 Net (loss)/income Other comprehensive (loss)/ income Settlements under long-term motivation program Accrued compensation cost Business combinations, disposals and capital transactions of subsidiaries Change in fair and redemption value of noncontrolling interests Dividends declared by Sistema JSFC Dividends declared by subsidiaries Deconsolidation of Bashneft - - - - - - - - - - - - - - - - - - - - - - - - 122,129,298 - 132,811 - (141,239) 79,430 39,018,253 47,553 50,114 - - - - - - - - - - - - Balances at December 31, 2014 9,650,000,000 30,057 (214,097,404) (246,351) 2,604,913 4,210,623 7,110,467 2,257,528 (326,717) 9,172,189 2,257,528 4,109,505 1,021,588 13,281,694 3,279,116 (580,001) (580,001) (229,192) (809,193) - - - - - - - - - - - (99,406) (275,120) (120,957) (574,257) - - - - - - - - - - - - - - 61,132 54,158 (283,779) (99,406) (275,120) - (8,428) 79,430 97,667 (120,957) (574,257) - 2,291,873 2,855,840 2,291,873 (3,743,402) 237,429 - - - - - - (491,574) (889,068) (1,384,789) 1,301,707 61,132 54,158 (46,350) (99,406) (275,120) (8,428) 79,430 (393,907) (120,957) (574,257) (889,068) 907,084 4,157,547 731,661 (59,916) 6,432 27,547 99,406 805,130 (78,937) (54,384) 120,957 792,766 - - - - - - - - - (4,087,632) (4,087,632) 852,476 (3,235,156) (5,128,557) (5,128,557) (974,348) (6,102,905) (950,320) 4,189,010 (950,320) 14,495,711 See notes to the consolidated financial statements and appendix thereto. 132 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECH Share capital Treasury stock Shares Amount Shares Amount Additional paid-in capital Retained earnings Accumulated other compre- hensive Loss Shareholders’ equity Non-redeemable non-controlling interests Total equity Redeemable non-controlling interests Balances at January 1, 2013 9,650,000,000 30,057 (440,425,038) (501,109) 2,859,491 7,110,467 2,257,528 (326,717) - 9,172,189 2,257,528 4,109,505 1,021,588 13,281,694 3,279,116 Balances at December 31, 2013 9,650,000,000 30,057 (375,244,955) (426,715) 2,616,608 8,993,469 (906,718) 10,306,701 Net income/(loss) Other comprehensive (loss)/income Settlements under long-term motivation program Accrued compensation cost Business combinations, disposals and capital transactions of subsidiaries Change in fair and redemption value of noncontrolling interests Dividends declared by Sistema JSFC Dividends declared by subsidiaries Net (loss)/income Other comprehensive (loss)/ income Settlements under long-term motivation program Accrued compensation cost Business combinations, disposals and capital transactions of subsidiaries Change in fair and redemption value of noncontrolling interests Dividends declared by Sistema JSFC Dividends declared by subsidiaries Deconsolidation of Bashneft 65,180,083 74,394 (13,262) 54,158 (283,779) - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - 122,129,298 132,811 (141,239) 79,430 39,018,253 47,553 50,114 - - - - - - - - - - - (4,087,632) - (4,087,632) 852,476 (3,235,156) - - - - (99,406) (275,120) - - - - - (120,957) (574,257) - - (580,001) (580,001) (229,192) (809,193) - - - - - - 61,132 54,158 (283,779) (99,406) (275,120) - - - 237,429 - - 61,132 54,158 (46,350) (99,406) (275,120) (950,320) 4,189,010 (950,320) 14,495,711 (5,128,557) (5,128,557) (974,348) (6,102,905) - - - - - - 2,291,873 (8,428) 79,430 97,667 (120,957) (574,257) - 2,291,873 2,855,840 - - (491,574) (889,068) (1,384,789) 1,301,707 (8,428) 79,430 (393,907) (120,957) (574,257) (889,068) 907,084 4,157,547 Balances at December 31, 2014 9,650,000,000 30,057 (214,097,404) (246,351) 2,604,913 4,210,623 (3,743,402) See notes to the consolidated financial statements and appendix thereto. 731,661 (59,916) 6,432 - - 27,547 99,406 - - 805,130 (78,937) (54,384) - - - 120,957 - - 792,766 133 APPENDICESCORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENT NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2014 AND 2013 (Amounts in thousands of U.S. dollars, unless otherwise stated) 1. BASIS OF PREPARATION Sistema Joint Stock Financial Corporation (the “Company”, together with its subsidiaries, the “Group”) invests in, and manages a range of companies which operate in the telecommunications, oil and energy, high technology, banking, timber, real estate and other sectors. The Company and the majority of its consolidated subsidiaries are incorporated in the Russian Federation (“RF”). The controlling shareholder of the Company is Vladimir P. Evtushenkov. Minority holdings are held by certain top executives and directors of the Company. The rest of the shares are listed on the London Stock Exchange in the form of Global Depositary Receipts (“GDRs”) and on the Moscow Exchange. Below are the Group’s significant entities and their principal activities as of December 31, 2014: Significant entities Short name Principal activity Sistema Joint Stock Financial Corporation Sistema Investing and financing Mobile TeleSystems SistemaShyamTeleS ervicesLimited MTS Bank RTI Detsky mir-Center Medsi Targin Bashkirian Power Grid Company (Note 5) LesInvest (Note 3) Leader-Invest Voting interests as of December 31, 2014 and 2013 – 93%. MTS SSTL Telecommunications Telecommunications MTS Bank Banking RTI Technology Detsky mir Retail trading Medsi Targin BPGC Healthcare services Oilfield services Energy transmission LesInvest Timber Leader-Invest Real estate Beneficial ownership as of December 31, 2014 года 2013 года 53% 57% 87% 85% 99% 75% 100% 91%(1) 100% 100% 53% 57% 87% 85% 100% 75% 100% 79%(1) - 100% The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”). The Group’s entities maintain accounting records in the local currencies of the countries of their domicile in accordance with the requirements of respective accounting and tax legislation. The accompanying financial statements differ from the financial statements prepared for statutory purposes in that they reflect certain adjustments, appropriate to present the financial position, results of operations and cash flows in accordance with U.S. GAAP, which are not recorded in the accounting books of the Group’s entities. In determining and applying accounting policies, judgement is often required in respect of items where the choice of specific policy, accounting estimate or assumption could materially affect the reported results of operations or financial position of the Group. Management considers that certain accounting estimates and assumptions relating to business combinations and disposals, property, plant and equipment, intangible assets and goodwill, provisions and contingent liabilities and impairment are the Group’s critical accounting estimates A discussion of these estimates together with the summary of the Group’s significant accounting policies is provided in appendix A1 to the notes to these consolidated financial statements. 134 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECH 2. DECONSOLIDATION OF BASHNEFT n September 2014, a civil claim was filed with the Moscow Court of Arbitration by the Prosecutor General’s Office of the Russian Federation seeking the transfer to the Russian Federation of all shares in Bashneft held by the Group. The civil claim asserted that the transfer of Bashneft from the property of the Russian Federation into the property of Bashkortostan in 1992-1993 had been unlawful, as no requisite consent had been obtained from the federal authorities, and therefore all subsequent transactions with Bashneft shares should be considered null and void. In November 2014, the court ruled in favour of the plaintiff and ordered the transfer of the Bashneft shares held by the Group to the Russian Federation. The transfer of the shares took place in December 2014. The Group deconsolidated Bashneft in December 2014 and recognized a loss upon loss of control, measured as the difference between the carrying amount of noncontrolling interests in the former subsidiary (including accumulated other comprehensive income attributable to the noncontrolling interests) at the date Bashneft was deconsolidated and the carrying amount of its assets and liabilities. The Group also removed the amount previously accumulated in the translation adjustment component of equity and attributable to Bashneft and reported it as part of the loss on transfer of Bashneft shares to the Russian Federation. The loss on deconsolidation of Bashneft recognized in the consolidated statement of operations and comprehensive income for the year ended December 31, 2014 is measured as follows: Net assets as at deconsolidation date Noncontrolling interests Accumulated currency translation adjustment Loss on deconsolidation of Bashneft Noncontrolling interests Loss on deconsolidation of Bashneft Tax effect Loss on deconsolidation of Bashneft, net of tax $ $ $ 4,061,927 (1,384,789) 2,291,873 - 4,969,011 - 4,969,011 - 4,969,011 Bashneft results were separately presented in the consolidated statements of operations and comprehensive income for the years ended December 31, 2014 and 2013 as follows: Revenues Income from Bashneft, before income taxes Income tax expense Income from Bashneft, net of tax effect 2014 2013 $ 16,224,383 $ 1,944,770 (427,716) 1,517,054 17,783,111 1,996,126 (455,637) 1,540,489 135 APPENDICESCORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENTAdditionally, the assets and liabilities pertaining to Bashneft have been presented separately within the consolidated statement of financial position as of December 31, 2013 as follows: Cash and cash equivalents Accounts receivable Inventories and spare parts Other current assets Intragroup balances Current assets of Bashneft Property, plant and equipment Other non-current assets Intragroup balances Non-current assets of Bashneft Accounts payable Debt, current portion Other current liabilities Intragroup balances Current liabilities of Bashneft Debt, long-term portion Other long-term liabilities Intragroup balances Long-term liabilities of Bashneft $ $ $ $ $ 625,417 593,016 716,847 2,659,069 (1,539,621) 3,054,728 8,794,360 941,695 (116,276) 9,619,779 (1,351,326) (367,147) (1,096,320) 151,361 (2,6 63,432) (2,419,639) (1,344,437) 30,052 (3,734,024) he Group retains no continuing involvement with Bashneft after it has been deconsolidated, other than routine transactions in the normal course of business. In December 2014, the Group filed a claim with the Moscow Court of Arbitration for the recovery of RUB 70.7 billion losses from Ural- Invest, a legal successor of the seller of the Bashneft shares to the Group. In February 2015, the сourt upheld the Group’s claim. In March 2015, the Group and Ural-Invest signed a settlement agreement. In accordance with its terms, all assets owned by Ural-Invest of RUB 46.5 billion, will be transferred to the Group, which will invest RUB 4.6 billion of this amount into the projects of Ural charitable fund. In March 2015 the Moscow Court of Arbitration approved the settlement agreement between the Group and Ural-Invest. The transfer of assets did not occur as of the date of the issuance of the consolidated financial statements and therefore the Group did not recognize the gain in the consolidated statement of operations and comprehensive income. 136 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECH3. BUSINESS COMBINATIONS Business combinations in 2014 LesInvest – In September 2014, LesInvest, a wholly owned subsidiary of the Group, acquired 100% of the share capital of OJSC Segezha Pulp and Paper Mill and LLC Derevoobrabotka-Proekt (together with their subsidiaries – “LesInvest Group”), a leading manufacturer of sack paper and paper sacks and exporter of timber products and ply wood, for a total cash consideration of $287 million. The Group sees high growth potential for the LesInvest Group business, to be unlocked by improving operating efficiency and upgrading production facilities. The following table summarizes consideration paid and the amounts of the assets acquired and liabilities assumed that were recognized at the acquisition date: Property, plant and equipment Inventories Deferred tax assets Other assets Accounts payable and other liabilities Cash consideration paid $ $ 110,917 109,876 76,047 117,367 (127,000) 287,207 The purchase price allocation of LesInvest Group was not finalized as of the date of these consolidated financial statements, as the Group had not completed the valuation of individual assets and liabilities of LesInvest Group. The Group’s consolidated financial statements reflect the allocation of the purchase price based on a preliminary fair value assessment of the assets acquired and liabilities assumed. Other acquisitions The information on other business combinations which took place in 2014 is summarized below: Acquiree Principal activity Date of acquisition Interest acquired Acquiring segment Purchase price SMARTS-Ivanovo Mobile operator SMARTS-Ufa Penza-GSM Step Group Total Mobile operator Mobile operator Grain production December December December December 100% 100% 100% 85% MTS MTS MTS Corporate 7,480 7,040 34,121 63,965 $ 112,606 137 APPENDICESCORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENT The following table summarizes the amounts of the assets acquired and liabilities assumed relating to such acquisitions at the acquisition date: Current assets Property, plant and equipment Rights to use radio frequencies Goodwill Other non-current assets Current liabilities Non-current liabilities Noncontrolling interests Purchase price $ $ 25,935 78,467 25,759 29,247 5,061 (32,722) (9,546) (9,595) 112,606 The purchase price allocations of SMARTS-Ivanovo, SMARTS-Ufa and Penza-GSM were not finalized as of the date of these financial statements as the Group had not completed the valuation of the individual assets of each entity. The Group’s consolidated financial statements reflect the allocation of the purchase price based on a preliminary fair value assessment of the assets acquired and liabilities assumed. The excess of the consideration paid over the value of net assets in the amount of $29 million was preliminarily allocated to goodwill which was attributable to the MTS segment. Goodwill is mainly attributable to the expected synergies from combining the operations of MTS and acquired companies. In December 2014, Krasnodar Agro, a wholly owned subsidiary of the Group, acquired 85% of the voting shares of the five grain producers in Krasnodar region (Step Group). Pro forma results of operations (unaudited) The following pro forma financial data for the years ended December 31, 2014 and 2013 give effect to the acquisition of LesInvest Group as if it had occurred as of January 1, 2013: Revenues Net income The pro forma information is based on various assumptions and estimates. The pro forma information is neither necessarily indicative of the operating results that would have occurred if the Group acquisitions had been consummated as of January 1, 2013, nor is it necessarily indicative of future operating results. The pro forma information does not give effect to any potential revenue enhancements or cost synergies or other operating efficiencies that could result from the acquisitions. The actual results of operations of these companies are included into the consolidated financial statements of the Group only from the respective dates of acquisition. Net revenues Net income 2014 2013 $ 17,130,212 $ (3,346,547) 19,199,485 3,052,629 The following amounts of revenue and earnings of LesInvest Group since the acquisition date in September 2014 are included into the consolidated statement of operations and comprehensive income for the year ended December 31, 2014: 2014 $ 151,227 14,178 The results of operations of other acquired businesses have not been included because the effects of these business combinations, individually and in aggregate, were not material to the Group’s consolidated results of operations. 138 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHBusiness combinations in 2013 SITRONICS-Nano – In May 2013, the Group acquired an additional 12.3% ownership interest in SITRONICS- Nano, previously an affiliate, from RUSNANO for cash consideration of RUB 2 billion ($61.1 million at the acquisition date) increasing its voting interest to 62.1%. Simultaneously, the Group and RUSNANO amended existing call and put option agreements. Under the amended agreements, the Group had a call Current assets Net investment in the lease Current liabilities Non-current liabilities Noncontrolling interests Fair value of previously held interest Cash consideration option to acquire RUSNANO’s shares in Sitronics-Nano for RUB 6.1 billion plus 7.63% p.a. at any time till November 1, 2017. RUSNANO had a put option to sell its remaining shares in SITRONICS-Nano for RUB 8.1 billion not earlier than October 31, 2016 and not later than November 1, 2017. This acquisition allowed the Group to secure its rights for use of 180 and 90 nanometre equipment that has been leased from SITRONICS-Nano. As a result of the transactions, the Group obtained control over SITRONICS-Nano and accounted for this business combination by applying the acquisition method. The following table summarizes the consideration paid for SITRONICS- Nano and the assets acquired and liabilities assumed recognized at the acquisition date, as well as the fair value of the noncontrolling interests in the investee: $ $ 73,231 518,916 (76,700) (18,829) (187,164) 309,454 (248,309) 61,145 As part of this business combination, the Group recognised a revaluation gain resulting from the remeasurement of its previously held interest. The difference in the amount of $22.4 million between the fair value of previously held interest and the carrying value of the Group’s investment has been recorded within other operating expenses, net in the consolidated statement of operations and comprehensive income. The fair value of previously held interest and the noncontrolling interests in SITRONICS-Nano were estimated based on the amount of consideration in the transaction described above. In May 2014, following the issuance of additional shares in Mikron, a subsidiary of RTI, such put and call option agreements between the Group and ROSNANO were amended (Note 5). 139 APPENDICESCORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENT4. DISPOSALS Disposals in 2014 NIIDAR-Nedvizhimost – In 2014, the Group sold its 100% interest in NIIDAR-Nedvizhimost, a subsidiary of RTI which managed rental property, for a total cash consideration of $150.0 million. As a result of this transaction, the Group recognized gain on disposal of subsidiaries of $139.1 million, included in other operating expenses in the consolidated statement of operations and comprehensive income. Disposals in 2013 SG-trans – During 2013, the Group completed a reorganisation of its transportation assets. As a result of the reorganization, SG-trans, which was acquired in 2012 was split into two legal entities: SG-trading which comprised the non-core non- transportation assets and SG-trans which retained all the core transport assets. In April 2013 the Group sold a 70% stake in SG-trans to Financial Alliance, an affiliate of the Group, for cash consideration of RUB 12 billion ($380.2 million at the disposal date), thereby reducing its direct ownership in SG-trans from 100% to 30%. Upon disposal, the Group deconsolidated SG-trans and accounted for its remaining interest using the equity method. As a result of the transaction, the Group recognized a gain of $4.0 million in the consolidated statement of operations and comprehensive income. In July 2013, the Group further sold additional 15% of SG-trans to Unirail, a shareholder of Financial Alliance, for a cash consideration of RUB 2.5 billion ($76.4 million) with no gain or loss recognized as a result of this transaction. RussNeft – In July 2013, the Group sold its 49% stake in RussNeft, the Group’s affiliate, for cash consideration of $1,200 million. Prior to the disposal, the Group has been accounting for this investment using the equity method. As of the disposal date, the carrying value of the Group’s investment in RussNeft was nil. Accordingly, the Group recognized a $1,200 million gain on this disposal being the difference between the consideration received and the carrying value of investment disposed. 5. CAPITAL TRANSACTIONS OF SUBSIDIARIES Transactions in 2014 MTS Bank – In December 2014, the Group participated in additional share issue of MTS Bank for $309.0 million. The transaction resulted in no change in noncontrolling interests and additional paid-in capital. Mikron – In May 2014, Mikron issued additional shares representing 25.1% of its share capital in exchange for 37.7% interest in SITRONICS- Nano, owned by OJSC RUSNANO. Upon completion of the transaction, the Group’s effective ownership in Mikron decreased to 53.0%. The transaction was accounted for directly in equity and resulted in a decrease of noncontrolling interests and an increase of additional paid-in capital by $44.1 million. Simultaneously, the Group and RUSNANO substituted their existing put and call option agreements on RUSNANO’s share in SITRONICS- Nano for new put and call option agreements on its 25.1% share in Mikron. The terms of the option agreements remained unchanged. Business-Nedvizhimost – In April 2014, MTS sold a 49% stake in Business-Nedvizhimost, a company which owns and manages a real estate portfolio in Moscow, to the Company for $91.8 million. This transfer of ownership interest within the Group resulted in an increase of noncontrolling interests and a decrease of additional paid-in capital by $47.4 million. NVision – In January 2014, the Group acquired an additional 38.75% stake in NVision from minority shareholders for $82.5 million, $37.5 million of which was paid in cash and $45.0 million in the Company’s treasury shares. Upon completion of this transaction, the Group’s ownership in NVision was 88.75%. The transaction was accounted for directly in equity and resulted in an increase of noncontrolling interests by $42.0 million and a decrease of additional paid-in capital by $121.8 million. In December 2014, the Group acquired the remaining 11.25% stake in NVision for approximately $10.0 million. The transaction was accounted for directly in equity and resulted in a decrease of noncontrolling interests by $13.8 million and a decrease of additional paid-in capital by $24.0 million. Transactions in 2013 Business-Nedvizhimost – In December 2013, MTS sold a 51% stake in Business-Nedvizhimost to the Company for RUB 3.2 billion ($98.5 million as of the transaction date). This transfer of ownership interest within the Group resulted in an increase of noncontrolling interests and a decrease of additional paid-in capital by $42.7 million. RTI – In December 2013, RTI issued 4,687,500,000 common shares with par value of 1 Russan ruble which were acquired by existing shareholders, the Company and the Bank of Moscow, for cash consideration of RUB 6.0 billion ($183.9 million as of the purchase date) in proportion to their existing ownership interests. The Bank of Moscow received a put 140 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHoption to sell its 703,125,000 shares acquired upon their issuance to the Group at a price of $27.5 million plus 8.25% p.a. not earlier than December 26, 2016 and not later than December 26, 2018. As a result of this put option, the Group classified the underlying noncontrolling interests as redeemable. Targin – In September 2013, the Company acquired a 100% stake in Bashneft Services Assets, (renamed to Targin in July 2014) from Bashneft for RUB 4.1 billion ($126.8 million as at transaction date). This transfer of ownership interest within the Group resulted in a decrease of noncontrolling interests and an increase of additional paid-in capital by $24.4 million. MTS – In September-December 2013, the Group acquired 0.6% of MTS ordinary shares on the open market for $120.0 million. The transaction was accounted for directly in equity and resulted in a decrease of noncontrolling interests by $23.0 million and a decrease of additional paid-in capital by $97.0 million. Detsky mir – In September 2013, Detsky mir purchased 25%+1 of its own shares from Sberbank for cash consideration of $140.0 million. The transaction was accounted for directly in equity and resulted in a decrease of noncontrolling interests by $5.4 million and a decrease of additional paid-in capital by $134.6 million. The Group took a long-term loan from Sberbank to fund the purchase. Simultaneously the Group has pledged these shares to Sberbank as security against the loan. SITRONICS-N – In September 2013, the Group undertook restructuring of certain RTI assets. Upon completion of a series of transactions, SITRONICS, a subsidiary of RTI, spun off two companies, SITRONICS-N and RTI Microelectronics, with allocation of all its major assets and liabilities to these companies. To complete the restructuring process a 100% stake in SITRONICS was sold to SITRONICS-N for 1 RUB. In October 2013, the Company acquired a 100% stake in SITRONICS-N from RTI for RUB 1.0 billion ($31.0 million as at transaction date). This transaction resulted in an increase of noncontrolling interests and a decrease of additional paid-in capital by $11.0 million. Mikron – In August 2013, Mikron issued 691,962 ordinary shares which were purchased by the RF for cash consideration of RUB 465 million ($14.1 million). This transaction was accounted for directly in equity and resulted in an increase of noncontrolling interests by $5.2 million and an increase of additional paid-in capital by $8.9 million. MTS Bank – In April 2013, MTS acquired a 25.0945% stake in MTS Bank through the purchase of its additional share issuance for RUB 5 billion ($123 million). Upon completion of the transaction, the Group’s effective ownership in MTS Bank decreased from 99% to 87%. This transfer of ownership interest within the Group resulted in an increase of noncontrolling interests and a decrease of additional paid-in capital by $105 million. Capital transactions of Bashneft and its subsidiaries UPC – In September 2014, the Group terminated a contract for the acquisition of a 98% stake in UPC from Bashneft. As a consequence of this transaction, Bashneft obtained control over UPC. This resulted in the Group’s ownership in UPC decreasing from 99.0% to 78.0% and the Group’s ownership in Ufaorgsintez decreasing from 86.5% to 78.7%. These transactions resulted in an increase of noncontrolling interests in the amount of $4.8 million and a decrease of additional paid-in capital by $20.9 million. Bashneft-Polyus – On 23 May 2014, in accordance with an order from the Federal Agency for Subsoil Use (“Rosnedra”) the Trebs and Titov oilfield license was transferred from Bashneft to its subsidiary Bashneft- Polyus. This transaction resulted in an increase in noncontrolling interests in the amount of $113.0 million with a corresponding decrease in the Group’s constructive obligation to OJSC LUKOIL in the amount of $139.1 million and an increase in additional paid-in capital by $26.1 million. Sistema-Invest – In May 2014, the reorganization of CJSC Sistema- Invest (“Sistema-Invest”) was completed. 38,139,925 ordinary shares of Bashneft previously held by CJSC Bashneft-Invest, wholly- owned subsidiary of Bashneft created through a spinoff from Sistema- Invest, and 8,885,866 preferred shares bought back from the shareholders were cancelled. The transactions were accounted for directly in equity and resulted in a decrease of noncontrolling interests by $694.6 million and an increase of additional paid-in capital by $199.4 million. The Group’s ownership in Bashneft increased from 75.0% to 78.8% and in BPGC – from 79.3% to 91.0%. Ufaorgsintez – In March 2014, pursuant to the terms of a voluntary tender offer originally announced in December 2013, Ufaorgsintez completed the acquisition of its ordinary shares for a total consideration of $26.5 million. As a result, the Group’s ownership in Ufaorgsintez increased from 76.8% to 86.5%. The transaction was accounted for directly in equity and resulted in a decrease of noncontrolling interests by $49.5 million and an increase of additional paid-in capital by $22.5 million. UPC – In September 2013, the Company acquired a 98% stake in United Petrochemical Company (“UPC”) from Bashneft for RUB 6.2 billion ($192.0 million as at transaction date), which resulted in a decrease of noncontrolling interests and an increase of additional paid-in capital by $41.4 million. 141 APPENDICESCORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENT 6. ВREENTRY INTO UZBEKISTAN Following unsuccessful tenders on sale of Uzdunrobita equipment, the representatives of the Republic of Uzbekistan and MTS commenced negotiations in relation to the return of MTS to the market. In July 2014, MTS signed a settlement agreement with the Republic of Uzbekistan eliminating all mutual claims (“Settlement Agreement”). International arbitration proceedings between MTS and the Republic of Uzbekistan in the International Center for Settlement of Investment Disputes, Member of the World Bank Group (ICSID), were discontinued following the submission of a joint application by the both parties. The government authorities provided certain guarantees to MTS in relation to the protection of any future investment in the Republic of Uzbekistan to encourage the return of MTS to the market. Also, the Republic of Uzbekistan established a legal entity, Universal Mobile Systems LLC (“UMS”), with such entity having no legal connection to the previously liquidated entity, Uzdunrobita. UMS was granted 2G, 3G and LTE licenses and received frequencies, numbering capacity and other permits required for the launch of operations. In September 2014, a 50.01% ownership interest in UMS was transferred to the Group by a state- owned enterprise established and managed by the State committee for communications, development of information systems and telecommunications technologies of the Republic of Uzbekistan, which retained the remaining 49.99% in UMS.The Group concluded that, upon receiving the 50.01% ownership interest, the Group obtained control over UMS and consolidated the entity. The Group estimated the fair value of the entity’s assets and liabilities, as well as the noncontrolling interests in UMS as of the date of the transfer, and recognized a gain from reentry into Uzbekistan pursuant to the Settlement Agreement in the amount of $181 million. The Group has determined that the Settlement Agreement primarily addressed two separate elements – the elimination of all mutual claims and guarantees granted to MTS in connection with its reentry into the Republic of Uzbekistan. The Group concluded that the aforementioned consideration of $181 million related to, in its entirety, a financial incentive to encourage the reentry into the Republic of Uzbekistan and as such, recognition in continuing operations was appropriate. No element was allocated to the non-satisfaction and elimination of mutual claims as this was deemed to have minimal value. The following table summarizes the amounts of the assets and liabilities recognized at the date of obtaining control, as well as the fair value of the noncontrolling interests at that date: Property, plant and equipment Intangible assets Other non-current assets Noncontrolling interests Gain from reentry into Uzbekistan $ $ 119,211 132,333 31,610 (101,849) 181,305 142 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECH7. ASSETS FROM BANKING ACTIVITIES Assets from banking activities, net of an allowance for loan losses, as of December 31, 2014 and 2013 consisted of the following: 2014 2013 Cash and cash equivalents Loans to customers Investments in securities (trading) Loans to banks Investments in securities (available-for-sale) Other investments Less: allowance for loan losses Assets from banking activities, net Less: amounts maturing after one year $ 843,715 $ 2,597,696 368,567 131,919 87,652 85,956 (560,942) 3,554,563 (1,374,367) Assets from banking activities, current portion $ 2,180,196 $ Major categories of loans to customers as of December 31, 2014 and 2013 comprise the following: 1,132,368 4,842,982 551,513 161,229 154,356 127,096 (516,575) 6,452,969 (2,554,229) 3,898,740 Corporate customers Individuals Total 2014 2013 1,294,744 $ 1,302,952 2,739,345 2,103,637 2,597,696 $ 4,842,982 $ $ As of December 31, 2014, 79.7% and 0.6% of the balance of loans to corporate customers and individuals, respectively, were evaluated individually for impairment (2013: 80.0% and 0.5%). The following table presents the effective average interest rates by category of loans as of December 31, 2014 and 2013: 2014 2013 RUB USD Other RUB USD Other Loans to customers - corporate customers - individuals Loans to banks 10.5% 19.0% 7.9% 8.8% 4.4% 0.01% 9.2% 6.5% 0.01% 10.8% 23.4% 4.5% 7.0% 8.3% 0.1% 9.8% 4.2% 0.1% The movement in the allowance for loan losses in 2014 and 2013 was as follows: 2014 2013 Allowance for loan losses, beginning of the year Additions charged to operating results less recovery of allowance Amounts written off against the allowance Currency translation adjustment Allowance for loan losses, end of the year $ $ 516,575 $ 423,121 (162,705) (216,049) 560,942 $ 329,803 248,032 (37,185) (24,075) 516,575 143 APPENDICESCORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENT 8. SHORT-TERM INVESTMENTS Short-term investments as of December 31, 2014 and 2013 consisted of the following: Bank deposits with original maturities exceeding three months Trading securities Available-for-sale securities Promissory notes and loans Total 2014 2013 202,644 $ 97,550 74,149 104,998 647,077 499,437 354,838 61,195 479,341 $ 1,562,547 $ $ Promissory notes and loans to third parties are primarily denominated in USD and bear interest rates varying from 4.0% to 6.0% as of December 31, 2014. The effective interest rates on bank deposits with original maturities exceeding three months as of December 31, 2014 are between 1.0% and 5.3% (December 31, 2013: 4.2% and 14.0%). 9. ACCOUNTS RECEIVABLE Accounts receivable, net of provision for doubtful accounts, as of December 31, 2014 and 2013 consisted of the following: Trade receivables Less: provision for doubtful accounts Total 2014 2013 1,246,580 $ (83,488) 1,808,403 (177,810) 1,163,092 $ 1,630,593 $ $ Write-off of trade receivables against provision for doubtful accounts in 2014 and 2013 amounted to $134.7 million and $96.5 million respectively. 10. OTHER CURRENT ASSETS Other current assets as of December 31, 2014 and 2013 consisted of the following: Prepaid expenses and other receivables $ 564,594 $ Tax advances and overpayments Advances paid to third parties Less: provision for doubtful accounts 121,360 242,184 928,138 (96,078) 763,791 136,164 246,727 1,146,682 (62,135) 2014 2013 Total 144 $ 832,060 $ 1,084,547 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECH 11. INVENTORIES AND SPARE PARTS Inventories and spare parts as of December 31, 2014 and 2013 consisted of the following: Finished goods and goods for resale Raw materials and spare parts Work-in-progress Costs and estimated earnings in excess of billings on uncompleted contracts Less: long-term portion Total 2014 2013 $ 405,243 $ 232,248 89,506 531,052 1,258,049 (13,540) 593,500 377,292 151,434 116,984 1,239,210 (107,908) $ 1,244,509 $ 1,131,302 12. PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment, net of accumulated depreciation, as of December 31, 2014 and 2013 consisted of the following: Switches, transmission devices, network and base station equipment $ 9,066,682 $ 14,083,007 2014 2013 Buildings and leasehold improvements Power and utilities Other plant, machinery and equipment Construction in progress and equipment for installation Land Less: accumulated depreciation 1,392,585 496,303 1,495,420 897,260 148,238 2,166,179 760,686 2,620,291 1,576,285 160,973 13,496,488 21,367,421 (6,305,094) (10,216,080) Total $ 7,191,394 $ 11,151,341 Depreciation expense for the years ended December 31, 2014 and 2013 amounted to $1,778.6 million and $2,089 million respectively. Impairments of property, plant and equipment for the years ended December 31, 2014 and 2013 amounted to $290.4 million and $285.9 million respectively (Note 15). 145 APPENDICESCORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENT 13. GOODWILL The carrying amounts of goodwill attributable to each reportable segment are as follows: Balance as of January 1, 2013 Gross amount of goodwill Accumulated impairment loss Impairment (Note 15) Disposals Currency translation adjustment Balance as of December 31, 2013 Gross amount of goodwill Accumulated impairment loss MTS SSTL RTI MTS Bank Other Total 1,441,836 339,059 278,449 67,919 95,636 2,222,899 (48,261) (339,059) - (67,919) - (455,239) $ 1,393,575 $ - $ 278,449 $ - $ 95,636 $ 1,767,660 - (722) (93,958) - - - (258,048) - (17,210) - - - - (67,816) (258,048) (68,538) (2,127) (113,295) 1,343,717 300,047 254,291 63,068 25,693 1,986,816 (44,822) (300,047) (251,100) (63,068) - (659,037) $ 1,298,895 $ - $ 3,191 $ - $ 25,693 $ 1,327,779 Business combinations (Note 3) Currency translation adjustment Balance as of December 31, 2014 Gross amount of goodwill Accumulated impairment loss 29,247 (524,502) 829,716 ( 26,076) - - - (1,335) - - - 29,247 (13,652) (539,489) 293,424 147,937 36,691 12,041 1,319,809 (293,424) (146,081) (36,691) - (502,272) $ 803,640 $ - $ 1,856 $ - $ 12,041 $ 817,537 146 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECH 14. OTHER INTANGIBLE ASSETS Intangible assets other than goodwill as of December 31, 2014 and 2013 consisted of the following: Amortized intangible assets: Billing and telecommunication software $ Operating licenses Radio frequencies Acquired customer base and customer relationships Software and other Unamortized intangible assets: Trademarks Numbering capacity with indefinite contractual life 2014 Accumu lated amortization Gross carrying value Net carrying value Gross carrying value 2013 Accumu lated amortization Net carrying value 974,142 704,536 203,419 (603,303) (214,352) (101,034) 225,495 855,003 (136,714) (376,890) 370,839 490,184 102,385 88,781 478,113 1,053,559 768,488 301,042 (580,156) (157,778) (149,954) 468,497 973,084 (247,643) (481,941) 473,403 610,710 151,088 220,854 491,143 2,962,595 (1,432,293) 1,530,302 3,564,670 (1,617,472) 1,947,198 184,811 6,276 - - 184,811 206,135 6,276 9,367 - - 206,135 9,367 Total $ 3,153,682 (1,432,293) 1,721,389 3,780,172 (1,617,472) 2,162,700 Impairments of intangible assets other than goodwill for the years ended December 31, 2014 and 2013 amounted to $nil and $298.2 million respectively (Note 15). Amortization expense recorded on other intangible assets for the years ended December 31, 2014 and 2013 amounted to $513.5 million and $544.6 million, respectively. The estimated amortization expense for the five years ending December 31, 2019 and thereafter is as follows: Year ending December 31, 2015 2016 2017 2018 2019 Thereafter Actual amortization expense to be reported in future periods could differ from these estimates as a result of new intangible assets acquisitions, changes in useful lives and other relevant factors. $ 367,272 306,060 214,242 122,424 61,212 459,092 $ 1,530,302 147 APPENDICESCORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENT 15. IMPAIRMENT OF OTHER ASSETS Impairment of other assets recognized by the Group in the years ended December 31, 2014 and 2013 comprised the following: Impairment of long-lived assets in India $ 290,438 $ 2014 2013 Impairment of 180 and 90 nm equipment and intangible assets Impairment of system integration intangible assets Impairment of other long-lived assets Impairment of available-for-sale securities Provision for cash and deposits in Delta Bank (Ukraine) Provision for doubtful accounts Inventory obsolescence Other - - 175,386 135,000 92,517 103,625 30,442 37,221 - 357,906 125,747 106,753 - - 134,392 46,504 33,243 Total impairments of other assets $ 864,629 $ 804,545 Impairment of 180 and 90 nm equipment and intangibles assets – As of December 31, 2013 the Group carried out a review of the recoverable amount of long-lived assets used in the production of microchips. As a result of this impairment review, an impairment charge of $357.9 million was recognized in the consolidated statement of operations and comprehensive income for the year ended December 31, 2013, which was allocated to the RTI segment. As of December 31, 2014, the Group identified indicators that the carrying amounts of 180 and 90 nm equipment with a total carrying value of $108.4 million may not be recoverable. These indicators included lower than expected revenue and profitability levels. The Group carried out review that supported the carrying value of the equipment and indicated that no additional impairment is required. The estimated fair value of such long-lived assets was determined based on unobservable inputs (“Level 3” of the hierarchy established by U.S. GAAP guidance). When calculating the future cash flows used in the assessment of the fair value of long-lived assets, the Group considered historical and projected revenue and operating costs, market conditions, asset ages, asset utilization and other relevant information. The key assumptions used in the fair value calculations included pre-tax discount rate of 25.0%-56.3% depending on the business line (2013: 21.5%-43.8%), compound annual growth rate during the projected twelve-year period of 21.8% (2013: 11.7%), growth rate after that period of 2.3% (2013: 2.3%). Impairment of system integration intangible assets – During the year ended December 31, 2013, the Group identified indicators that the carrying amounts of long-lived assets attributable to NVision, a subsidiary of RTI, may not be recoverable. These indicators included lower than expected revenue and profitability levels and downward revisions to management’s forecasts for the NVision business. Subsequent to its acquisition by the Group in 2012, NVision experienced a significant decrease in purchases made by its key customers and, as a result, revenue forecasts were substantially reduced as compared to those existing at the acquisition date. Based on the revised forecasts, the Group determined that the carrying value of the NVision asset group exceeded its undiscounted cash flows. The Group then compared the fair value of the asset group to its carrying value and determined the impairment loss. The impairment loss was allocated to the carrying values of the long-lived assets, but not below their individual fair values. The Group estimated the fair value of the assets primarily using an income approach based on unobservable inputs (“Level 3” of the hierarchy established by U.S. GAAP guidance), with the key assumptions including a discount rate of 16.5% and 3-7% of revenue royalty payments for the trademark. The decline in the fair value of the NVision reporting unit and its intangible assets, as well as fair value changes for other assets and liabilities in the two-step goodwill impairment test, resulted in an implied fair value of goodwill being substantially below its carrying value. As a result of the impairment review, for certain intangible assets with a carrying value of $129.1 million the Group concluded that the fair value amounted to $3.3 million and recorded an impairment charge of $125.7 million in the consolidated statement of operations and comprehensive income for the year ended December 31, 2013. The Group also recorded an impairment charge on goodwill of $258.0 million based on its implied fair value. The relevant impairment charges were allocated to the RTI segment. 148 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECH Provision for cash and deposits in Delta Bank (Ukraine) – As of December 31, 2014, MTS Ukraine, a subsdiary of MTS, held $90.2 million in current accounts and deposits in Delta Bank, the fourth largest bank in Ukraine. In December 2014, Delta Bank delayed customer payments and put limits on cash withdrawals. In March 2015, the National Bank of Ukraine adopted a resolution declaring Delta Bank to be insolvent. The Group treated Delta Bank’s insolvency as a recognized subsequent event and provided against the full amount of deposited funds ($90.2 million) and related interest ($2.3 million). 16. INVESTMENTS IN AFFILIATES Investments in affiliates as of December 31, 2014 and 2013 consisted of the following: MTS Belarus OZON SG-trans (2013: SG-trans and Financial Alliance, Note 4) Concept Group Other Total 2014 2013 Voting power Carrying value Voting power Carrying value 49.0% 21.6% 50.0% 40.0% $ 107,237 49.0% $ 165,174 91,080 83,555 18,913 55,233 50.0% - 133,551 - 66 541 $ 356,018 $ 365,266 Investment in OZON – In April 2014, the Group acquired a 21.6% of ownership interest in OZON Holdings Limited (“OZON”), a leading Russian e-commerce company, through an additional share issuance for $150.0 million. The Group has the right to nominate two out of eight representatives to the board of directors. Management concluded that, upon completion of the acquisition, the Group gained significant influence over OZON and therefore adopted equity method of accounting for this investment. The Group also obtained a call option for an additional 4.6% stake in OZON exercisable through August 2015. The difference between the equity investment carrying amount of $91 million and underlying equity in net assets as of December 31, 2014 of $26.0 million represents equity- method goodwill, mainly attributable to the expected synergies from commercial arrangements and co- branding programs. Investment in Concept Group – In October 2014, the Group acquired a 40% of ownership interest in Rangecroft Ltd, a holding company of Concept Group, one of Russia’s leading fashion clothing retailers, for $26.0 million, and obtained a call option to acquire another 14.2% of its share capital exercisable till October 2017. In accordance with the shareholders agreement, the Group has the right to nominate three out of nine representatives to the board of directors and, if the call option is exercised, up to five of the nine representatives. A number of key operating decisions for Concept Group, including an approval of an operating budget, require seven out of nine votes; such operating decisions represent participating rights of the shareholders. As a consequence of this, the Group has concluded that it does not have control over the investee and has therefore adopted the equity method of accounting for this investment. Merger of SG-trans and Finance Alliance – In January 2014, SG-trans and Finance Alliance merged into a single legal entity named SG-trans. The Group retained 50% beneficial interest in the newly established entity. The financial position and results of operations of significant affiliates as of and for the year ended December 31, 2014 were as follows: 149 APPENDICESCORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENT The financial position and results of operations of significant affiliates as of and for the year ended December 31, 2014 were as follows: MTS Belarus OZON SG-trans Concept Group Total assets Total liabilities Net income/(loss) $ 303,315 (94,102) 194,317 192,860 (71,403) (77,690) 641,193 (453,119) 12,059 91,607 (65,646) 5,792 (unaudited) The financial position and results of operations of significant Group affiliates as of and for the year ended December 31, 2013 were as follows: (unaudited) MTS Belarus Financial Alliance(1) Total assets Total liabilities Net income/(loss) (1) Including SG-trans amounts. $ 379,050 (96,580) 145,975 1,480,703 (1,185,979) 13,435 17. LONG-TERM INVESTMENTS Long-term investments as of December 31, 2014 and 2013 consisted of the following: Bank deposits Loans and notes Other Total The effective interest rates on long-term investments as of December 31, 2014 were between 6.2% and 6.3% for EUR denominated investments (2013: 6.0% – 8.6%). 2014 2013 242,006 $ 51,400 23,219 90,727 129,638 28,706 316,625 $ 249,071 $ $ 150 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECH 18. LIABILITIES FROM BANKING ACTIVITIES Liabilities from banking activities as of December 31, 2014 and 2013 consisted of the following: Term deposits Deposits repayable on demand Promissory notes issued and other liabilities Less: amounts maturing within one year Total liabilities from banking activities, net of current portion 2014 2013 $ $ 1,567,548 $ 537,365 243,438 2,348,351 (2,180,491) 167,860 $ 2,561,569 1,859,832 215,539 4,636,940 (3,864,415) 772,525 As of December 31, 2014 the fair value of liabilities from banking activities amounted to $2,270 million; as of December 31, 2013 – approximated their carrying value. The following table presents the effective average interest rates by categories of bank deposits and notes issued as of December 31, 2014 and 2013: Term deposits: - corporate customers - individuals Promissory notes issued Deposits repayable on demand: - corporate customers - individuals RUB 2014 USD Other RUB 2013 USD Other 14.5% 10.0% 8.0% 0.5% 0.5% 3.0% 3.7% - - 2.9% 3.4% - - 0.1% 0.2% 7.4% 9.7% 7.3% 4.9% 0.6% 1.8% 3.7% - - 2.1% 2.3% - - 0.07% 0.1% 151 APPENDICESCORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENT19. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES Accrued expenses and other current liabilities as of December 31, 2014 and 2013 consisted of the following: Customers’ advances Accrued payroll Accruals for services Accrued interest on loans Financial instruments at fair value Dividends payable Other Total 2014 2013 $ 546,793 $ 267,971 210,924 51,805 47,086 1,369 189,708 350,896 430,946 328,050 74,621 13,199 6,729 363,449 $ 1,315,656 $ 1,567,890 20. LONG-TERM DEBT Long-term debt as of December 31, 2014 and 2013 consisted of the following: 2014 2013 Loans from banks and financial institutions $ 5,049,820 $ Notes and corporate bonds Capital leases Loans from related parties Vendor financing Other borrowings Less: amounts maturing within one year 2,781,512 239,401 37 16,662 45,393 8,132,825 (1,598,770) 5,447,071 4,888,603 80,506 64 31,871 29,957 10,478,072 (2,102,911) Total $ 6,534,055 $ 8,375,161 The schedule of repayments of long-term debt for the next five years and thereafter is as follows: Year ended December 31 2015 2016 2017 2018 2019 Thereafter Total 152 $ $ 1,598,770 1,185,257 1,469,871 1,022,949 1,148,236 1,707,742 8,132,825 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECH Loans from banks and financial institutions – Loans from banks and financial institutions as of December 31, 2014 and 2013 consisted of the following: Maturity Interest rate (as at December 31, 2014) 2014 2013 2015-2020 LIBOR+1.15% (1.51%) $ USD-DENOMINATED: Calyon, INGBank, NordeaBank, RaiffeisenZentralbankOsterreich China Development Bank Bank of China 2015-2018 2015-2021 LIBOR+1.5% (1.86%) LIBOR+1.5%-3.5% (1.86%-3.86%) LIBOR+0.23%-1.8% (0.59%-2.16%) SkandinavskaEnskildaBanken 2015-2017 Bank of Moscow 2015 LIBOR+7.5% (7.76%) HSBC Bank and ING BHF Bank Other EUR-DENOMINATED: Credit Agricole Corporate Bank, BNP Paribas Bank of Moscow LBBW BankofChina Other RUB-DENOMINATED: Sberbank Gazprombank Raiffeisenbank Bank of Moscow VTB Unicredit Alfa-Bank Credit bank of Moscow Other Other currencies Total 2015-2018 EURIBOR+1.65% (1.82%) 2015-2017 2015-2017 EURIBOR+5.0% (5.15%) EURIBOR+1.52% (1.69%) 2015-2021 2015-2018 2015-2016 2015-2018 8.45%-15.0% 9.0%-10.6% Mosprime+1.45%-5.25% (23.42%-29.02%), 9.45% CBR+3.0% (11.25%); Mosprime+4.5%-8.85% (28.27%-31.02%); 2015-2018 9.0%-22.75% 2016 2015 2016 Mosprime+5.2% (12.17%); 10.1-10.4% 9.75%-14.18% 19.0% 673,698 179,421 170,552 798,440 187,497 170,615 91,987 129,494 82,552 - 14,230 82,552 12,022 27,223 1,212,440 1,407,843 33,649 27,333 16,995 - 12,187 90,164 47,574 - 25,630 74,403 14,398 162,005 3,007,244 2,922,817 253,170 149,568 294,439 71,891 128,993 256,258 86,461 37,179 27,143 8,888 30,928 77,571 73,248 92,486 30,554 53,560 3,729,574 3,872,824 17,642 4,399 $ 5,049,820 5,447,071 The fair value of loans from banks and financial institutions, including the current portion, is estimated using discounted cash flows and market-based expectations for interest rates, credit risk and the contractual terms of the debt instruments (“Level 2” of the hierarchy established by the U.S. GAAP guidance). As of December 31, 2014 the fair value of loans from banks and financial institutions, including the current portion, amounted to $4,730 million; as of December 31, 2013 – approximates their carrying value. 153 APPENDICESCORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENT Notes and corporate bonds – Notes and corporate bonds as of December 31, 2014 and 2013 consisted of the following: Currency Interest rate Fair value 2014 Carrying value 2013 Carrying value MTS International 2020 MTS International 2023 Sistema International 2019 MTS OJSC Notes due 2020 SSTL 2019 MTS OJSC Notes due 2023 MTS OJSC Notes due 2017 Sistema JSFC Bonds due 2016 MTS OJSC Notes due 2015 Sistema JSFC Bonds due 2016 MTS OJSC Notes due 2016 DM-Center Bonds due 2015 MTS OJSC Notes due 2018 MTS OJSC Notes due 2014 Sistema JSFC Bonds due 2014 Other Total USD USD USD RUB INR RUB RUB RUB RUB RUB RUB RUB RUB RUB RUB 8.625% $ 601,019 $ 623,140 $ 5.00% 6.95% 8.15% 15.75% 8.25% 8.70% 8.75% 7.75% 7.65% 8.75% 8.50% 12.00% - - 369,641 338,193 253,296 202,111 133,313 151,181 113,840 131,364 60,376 29,851 16,238 2,298 - - 531 478,500 464,979 266,627 202,111 177,751 171,894 145,949 134,045 65,271 31,780 16,418 2,419 - - 628 747,634 500,000 487,854 458,306 206,795 305,538 294,191 329,790 230,567 406,985 54,627 35,137 117,442 416,098 296,544 1,095 $ 2,403,252 $ 2,781,512 $ 4,888,603 All Group RUB-denominated notes and corporate bonds are traded on Moscow Exchange. USD-denominated notes issued by MTS International due 2020 and 2023 and Sistema International due 2019 are traded on the Irish Stock Exchange. The fair values of notes and corporate bonds are based on the market quotes as of December 31, 2014 at the exchanges which they are traded on. In certain instances the Group has an unconditional obligation to repurchase notes at par value if claimed by the noteholders, where a subsequent sequential coupon is announced. The notes therefore can be defined as callable obligations under the FASB authoritative guidance on debt, as the holders have the unilateral right to demand repurchase of the notes at par value upon announcement of new coupons. The FASB authoritative guidance on debt requires callable obligations to be disclosed as maturing in the reporting period when the demand for repurchase could be submitted disregarding the expectations of the Group about the intentions of the noteholders. The Group discloses such notes in the aggregated maturities schedule in the reporting periods when the noteholders have the unilateral right to demand repurchase. The dates of the announcement for each particular note issue are as follows: MTS OJSC Notes due 2018 MTS OJSC Notes due 2020 MTS OJSC Notes due 2023 December 2015 November 2015 March 2018 154 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECH Available credit facilities – As of December 31, 2014, the Group’s total available unused credit facilities amounted to $1,344.2 million and related to the following credit lines: Sberbank Maturity 2015 – 2018 CitiBank Europe 2024 Gazprombank 2016 – 2021 Interest rate 9.3%-18% LIBOR 6M+0.9%; 9.75%-25% ING BankEurasia 2015 Mosprime/LIBOR/ EURIBOR + 1.50% 2015 Other Total Available till Available amount 2015 – 2018 2015 2016 – 2021 766,013 300,009 198,291 44,438 35,468 $ 1,344,219 Covenants – Loans and notes payable by the Group are subject to various restrictive covenants, including, but not limited to compliance with certain financial ratios, limitations on dispositions of assets and transactions within the Group and retention of principal telecom licenses. The adverse court’s ruling in respect of the Bashneft shares owned by the Group and their further disposition (Note.2) gave certain lenders the right to call the debt under several loan agreements. The lenders waived their rights to demand early repayment with regard to these covenant violations prior to the issuance date of these consolidated financial statements, and the Group retained noncurrent classification for this long-term debt in its consolidated statement of financial position as of December 31, 2014. As of December 31, 2014, the Group also had $138.5 million of its RUB-denominated long- term debt which was presented within current liabilities in the consolidated statement of financial position because of non-compliance with certain financial ratios by its subsidiaries. 21. INCOME TAX The Group’s income tax expense for the years ended December 31, 2014 and 2013 was as follows: Current provision Deferred income tax expense Total $ $ 2014 2013 417,079 $ 36,338 453,417 $ 619,643 222,464 842,107 Income tax expense calculated by applying the Russian statutory income tax rate of 20% to income from continuing operations before income tax differs from income tax expense recognized in the consolidated statements of operations and comprehensive income as a consequence of the following adjustments: Adjustments due to: Equity in earnings of subsidiaries Other non-deductible expenses Change in valuation allowance Settlements with tax authorities Effect of rates different from standard Currency exchange and translation differences Non-taxable income Other Income tax expense 2014 2013 $ 118,256 $ 504,164 147,678 98,094 165,819 11,553 (43,477) (5,685) (21,491) (17,330) $ 453,417 $ 144,647 129,330 148,909 (9,108) (44,044) (10,828) - (20,963) 842,107 155 APPENDICESCORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENT The tax effects of temporary differences that give rise to the deferred tax assets and liabilities are presented below: 2014 2013 Deferred tax assets: Tax losses carried forward Accrued expenses and accounts payable Property, plant and equipment Intangible assets Other Less: valuation allowance Total deferred tax assets Deferred tax liabilities: Property, plant and equipment Intangible assets Undistributed earnings of subsidiaries and affiliates Other Total deferred tax liabilities Net deferred tax assets, current portion Net deferred tax assets, long-term portion Net deferred tax liabilities, current portion Net deferred tax liabilities, long-term portion $ 1,088,645 $ 165,569 243,112 143,917 111,686 1,752,929 (1,194,858) 558,071 (348,206) (219,907) (124,444) (79,655) (772,212) $ 245,571 $ 392,866 (64,947) (787,631) $ $ 855,851 248,061 152,210 182,846 209,147 1,648,115 (996,221) 651,894 (534,109) (218,014) (208,995) (79,751) (1,040,869) 330,388 297,419 (114,192) (902,591) The Group has the following balances for income tax losses carried forward as of December 31, 2014 and 2013: Jurisdiction India Russia Luxembourg Total Period for carry-forward 2014 2013 2015-2020 $ 2015-2024 не ограничен 521,547 442,370 124,728 $ 483,680 246,870 125,301 $ 1,088,645 $ 855,851 Management has established valuation allowances against certain deferred tax assets, which are less likely than not to be realized in future periods. In evaluating the Group’s ability to realize its deferred tax assets, the Company considers all available positive and negative evidence, including operating results, ongoing tax planning, and forecasts of future taxable income on a jurisdiction by jurisdiction basis. The valuation allowance as of December 31, 2014 and 2013 relates to the following deferred tax assets: Tax losses carried forward Sale of investment in Svyazinvest Impairment of long-lived assets in SSTL Other Total 156 $ $ 2014 2013 850,118 $ 51,103 128,286 165,351 1,194,858 $ 689,731 65,996 70,194 170,300 996,221 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECH 22. HEDGING ACTIVITIES The Group regularly enters into variable-to-fixed interest rate swap agreements to manage exposure to changes in variable interest rates related to its debt obligations. The instruments qualify for cash flow hedge accounting under U.S. GAAP. Each interest rate swap matches the exact maturity dates of the underlying debt allowing for highly-effective hedges. Interest rate swap contracts outstanding as of December 31, 2014 mature in 2015, 2018 and 2020 In addition to the above, the Group has also entered into several cross-currency interest rate swap agreements. These contracts hedged the risk of both interest rate and currency fluctuations and assumed periodic exchanges of both principal and interest payments from RUB- denominated amounts to USD- and Euro- denominated amounts to be exchanged at a specified rate. The rate was determined by the market spot rate upon issuance. Cross- currency interest rate swap contracts mature in 2019-2020. The Group entered into cross-currency interest rate swap agreements designated to manage the exposure of changes in variable interest rate and currency exchange rate for 21.7% of its USD- and Euro- denominated bank loans and Eurobonds outstanding as of December 31, 2014. The following table presents the fair value of the Group’s derivative instruments designated as hedges in the consolidated statements of financial position December 31, 2014 and 2013. Location 2014 2013 ASSETS Cross-currency interest rate swaps Interest rate swaps Total LIABILITIES Other non-current assets Other non-current assets Interest rate swaps Accrued expenses and other current liabilities Total $ $ 389,915 $ 142 390,057 (47,086) (47,086) $ 55,760 367 56,127 (13,199) (13,199) The following table presents the effect of the Group’s derivative instruments designated as hedges (i.e. gain/(loss) recognized) in the consolidated statements of operations and comprehensive income for the years ended December 31, 2014 and 2013. The amounts presented include the ineffective portion of derivative instruments and the amounts reclassified into earnings from accumulated other comprehensive income. Location 2014 2013 Interest rate swaps, including i neffective portion of 4,503 and (879) Cross-currency interest rate swaps, including ineffective portion of (60,252) and nil Total Interest income / (expense) Foreign currency transaction loss / (gain) $ $ 6,012 $ (5,778) 397,901 (24,397) 403,913 $ (30,175) 157 APPENDICESCORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENT The following table presents the effect of the Group’s agreements designated as hedges in accumulated other comprehensive income for the years ended December 31, 2014 and 2013 (net of tax). Accumulated gain, beginning of the year Fair value adjustments Reclassified into earnings Accumulated gain 2014 2013 $ $ 46,210 $ 376,582 (303,683) $ 119,109 807 21,697 23,706 46,210 As of December 31, 2014, the outstanding hedging instruments were highly effective. $18.0 million of accumulated gain is expected to be reclassified into net income during the next twelve months. Cash inflows and outflows related to hedging instruments were included in cash flows from operating and financing activities in the consolidated statements of cash flows for the years ended December 31, 2014 and 2013. 158 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECH 23. FAIR VALUE MEASUREMENTS The following fair value hierarchy table presents information regarding the Group’s assets and liabilities measured at fair value on a recurring basis as of December 31, 2014 and 2013: Fair value measurements using Quoted prices in active markets for identical assets (Level 1) Significant other observable inputs (Level 2) Significant unobservable inputs (Level 3) Total fair value DECEMBER 31, 2014 Assets at fair value: Trading securities $ Available-for-sale securities Derivative instruments Total assets Liabilities at fair value: Derivative instruments Contingent consideration Redeemable noncontrolling interests Total liabilities DECEMBER 31, 2013 Assets at fair value: Trading securities Available-for-sale securities Derivative instruments Total assets Liabilities at fair value: Derivative instruments Contingent consideration Redeemable noncontrolling interests $ $ 466,117 $ 158,370 - 624,487 - $ - 390,057 390,057 (12,128) (59,933) - - - - - $ 3,431 - 3,431 - (1,760) (56,734) 466,117 161,801 390,057 1,017,975 (72,061) (1,760) (56,734) (12,128) $ (59,933) $ (58,494) $ (130,555) 1,050,950 $ 248,534 1,575 1,301,059 - - - - $ - $ 253,255 56,127 309,382 (12,863) - - 7,405 - 7,405 - (336) (89,583) 1,050,950 509,194 57,702 1,617,846 (12,863) (336) (89,583) Total liabilities $ $ (12,863) $ (89,919) $ (102,782) 159 APPENDICESCORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENT 24. SHARE CAPITAL As of December 31, 2014 and 2013, the Company had 9,650,000,000 voting common shares with a par value of RUB 0.09 issued, of which 9,435,902,596 and 9,274,755,045 shares were outstanding, respectively. Dividends declared by the Company in the years ended December 31, 2014 and 2013 are as follows: Dividends declared (including dividends on treasury shares of $16,842 and $8,080 respectively) 2014 2013 591,099 283,200 Accumulated other comprehensive loss – The following table represents components of accumulated other comprehensive loss balance, net of taxes, as of December 31, 2014 and 2013: Accumulated currency translation loss Unrealized (loss)/gain on available-for-sale securities Unrealized gain on derivatives Unrecognized actuarial gain Total accumulated other comprehensive loss Less: amounts of accumulated other comprehensive loss attributable to noncontrolling interests Total accumulated other comprehensive loss attributable to Sistema JSFC $ $ $ 2014 2013 (5,402,999) $ (1,516,611) (14,499) 119,109 9,553 37,600 46,210 9,381 (5,288,836) $ (1,423,420) 1,545,434 516,702 (3,743,402) $ (906,718) 25. SEGMENT INFORMATION As a diversified holding company, the Company invests in a range of companies which meet its investment and return criteria. The Chief Operating Decision Maker is the Company’s Management Board. Information reported to the Company’s Management Board for the purpose of resource allocation and the assessment of segment performance is focused on each individual investment holding. The Group’s reportable segments are MTS, SSTL, MTS Bank, RTI and Corporate. The Other category includes other operating segments including Targin, BPGC, LesInvest, Sistema Mass-media, Detsky mir, Intourist, Medsi, Binnopharm, Sitronics-N, Leader-Invest and SG-trans, none of which meets the quantitative thresholds for determining reportable segments. See Note 1 for a description of the activities of each operating segment of the Group. The accounting policies of the reportable segments are the same as the Group’s accounting policies described in appendix A1.to the notes to the financial statements. Segment profit represents the operating income/(loss). 160 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECH - - - - - - Financial information by reportable segment is presented below: MTS RTI MTS Bank SSTL Corporate Total reportable segments Other Total For the year ended December 31, 2014 Net sales to external customers(a) Equity in results of affiliates(b) Чистый процентный доход / (расход) (в) Depreciation and amortization Intersegment sales 28,521 316,820 17,263 10,837,126 1,528,287 698,182 220,717 (37,940) - - (377,575) 49,967 25,391 13,334,279 3,250,678 16,584,957 387,995 37,242 425,237 - - (37,940) (24,477) (62,417) (377,575) (377,575) 1,934,339 85,796 17,735 60,374 14,274 2,112,518 179,600 2,292,118 Operating income/(loss) 2,765,484 172,070 (396,963) (431,828) (546,842) 1,561,921 286,744 1,848,665 Interest income 120,926 42,160 Interest expense 435,117 143,175 - - 7,477 90,277 Income tax expense/ (benefit) 533,856 33,831 (61,779) Investments in affiliate 152,262 36 - - - Segment assets 11,014,182 2,125,279 3,882,609 485,465 Indebtedness(d) 5,191,423 841,307 - 568,170 106,825 135,031 (127,264) 100,448 1,949,713 1,223,056 277,388 803,600 378,644 252,746 50,609 73,809 74,773 95,815 327,997 877,409 453,417 348,561 19,457,248 3,201,538 22,658,786 7,823,956 438,807 8,262,763 Capital expenditures (e) 2,314,951 105,052 27,592 43,296 28,099 2,518,990 383,592 2,902,582 MTS RTI MTS Bank SSTL Corporate Total reportable segments Other Total For the year ended December 31, 2013 Net sales to external customers(a) 12,488,877 1,685,546 878,832 209,432 Intersegment sales 21,884 509,963 24,301 Equity in results of affiliates(b) Net interest revenue/ (expense) (c) Depreciation and amortization 77,615 (1,696) - - - 2,244,014 96,374 40,678 19,152 46,237 36,742 15,308,924 3,193,061 18,501,985 592,890 18,115 611,005 - - 75,919 (40,165) 35,754 40,678 - 40,678 63,666 14,378 2,437,584 195,964 2,633,548 Operating income/(loss) 3,662,740 (776,878) 18,954 (210,185) Interest income 87,704 45,045 Interest expense 486,636 138,020 - - 9,522 121,513 Income tax expense/ (benefit) 720,893 (80,025) (2,645) Investments in affiliates 153,168 - - - - Segment assets 15,218,084 2,530,299 6,919,610 847,342 Indebtedness(d) 6,682,047 1,228,635 - 596,641 834,945 116,328 159,215 140,376 45,210 3,572,805 1,574,531 3,529,576 84,721 3,614,297 258,599 45,791 304,390 905,384 129,802 1,035,186 778,599 63,508 198,378 166,886 842,107 365,264 29,088,140 3,250,757 32,338,897 10,081,854 437,054 10,518,908 Capital expenditures (e) 2,561,310 95,009 21,379 45,765 73,224 2,796,687 197,706 2,994,393 (a) Interest income and expense of MTS Bank are presented as revenues from financial services and cost of financial services, correspondingly, in the Group’s consolidated financial statements. (b) Equity in results of affiliates of MTS segment for the year,2014 includes $135 million of its share of the earnings of MTS Bank and Stream, which is further eliminated on consolidation (2013: $5 million). (c) Represents the net interest result of the Group’s banking activities. In reviewing the performance of MTS Bank, the chief operating decision maker reviews the net interest result, rather than the gross interest amounts. (d) Represents the sum of short-term and long-term debt. (e) Represents purchases of property, plant and equipment and intangible assets. 161 APPENDICESCORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENT The following table summarizes dividends to Corporate, declared in 2014 and 2013: Bashneft MTS Other $ 2014 2013 818,456 $ 744,460 89,903 1,162,041 635,369 49,084 The reconciliation of segment operating income to the consolidated income from continuing operations before income tax expense and a reconciliation of segment assets to the consolidated assets are as follows: Operating income – reportable segments Operating income – other Intersegment eliminations Operating income Interest income Change in fair value of derivative financial instruments Interest expense Foreign currency transaction loss Income from continuing operations before income tax Total assets – reportable segments Total assets – Bashneft Total assets – other Intersegment eliminations Total assets $ $ $ 2014 2013 1,561,921 $ 286,744 1,848,665 (110,216) 3,529,576 84,721 3,614,297 (47,725) 1,738,449 $ 3,566,572 212,774 - (811,346) (548,596) 591,281 182,447 30,199 (960,136) (298,264) 2,520,818 $ $ 2014 2013 19,457,248 $ - 3,201,538 22,658,786 29,088,140 12,674,507 3,250,757 45,013,404 (1,988,309) (1,764,410) 20,670,477 $ 43,248,994 For the years ended December 31, 2014 and 2013, the Group did not have revenues from transactions with a single external customer amounting to 10% or more of the Group’s consolidated revenues. For the years ended December 31, 2014 and 2013 the Group’s revenues outside of the RF were as follows: Ukraine India Armenia Central and Eastern Europe Other Total 162 $ $ 2014 2013 818,456 $ 1,162,041 272,863 186,120 107,372 154,753 253,196 156,883 40,997 210,661 1,534,816 $ 1,944,147 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECH As of December 31, 2014 and 2013, the Group’s long-lived assets located outside of the RF were as follows: Ukraine India Armenia Central and Eastern Europe Other Total $ $ 2014 2013 332,987 $ 320,604 288,308 68,369 87,870 755,373 710,225 354,840 34,953 111,887 1,098,138 $ 1,967,278 26. RELATED PARTY TRANSACTIONS The Group sells goods and provides services to and purchases goods and services from its related parties on normal commercial terms. During the years ended December 31, 2014 and 2013, the Group entered into transactions with related parties as follows: Sales Revenue from banking activities Cost related to banking activities Cost of sales Selling, general and administrative expenses 2014 2013 $ 17,220 $ 34 (48,385) (45,595) (515) As of December 31, 2014 and 2013, the related party balances were as follows: 2014 2013 Assets: Short-term investments Accounts receivable, net Other current assets Long-term investments Liabilities: Accounts payable Liabilities from banking activities Accrued expenses and other current liabilities Long-term debt $ $ 5,212 $ 5,469 27,083 36,174 (4,134) (541,556) (3,411) (37) 14,921 51 (30,370) (1,188) (12,110) 9,840 1,362 4,907 17,402 (890) (526,056) (646) (64) 163 APPENDICESCORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENT expense of $79.4 million and $54.2 million in the consolidated statement of operations and comprehensive income for the years ended December 31, 2014 and 2013, respectively. The fair value of awards granted was measured based on the fair value of the Company’s ordinary shares. 27. SHARE-BASED COMPENSATION The Company and several of its subsidiaries operate share-based compensation plans in order to compensate their employees. This is done through either “equity” plans, in which employees may exercise their options for shares, or “phantom” plans, which generally allow employees to receive cash compensation which varies depending on the share price that the options are linked to. All such plans, including those of MTS, are immaterial to the Group and consequently have not been disclosed here. A discussion has been included below of the plans operated at the Company level. Sistema JSFC share-based long- term motivation program – In 2014 and 2013 the Company’s Board of Directors established two-year motivational programs for senior and mid-level management. Participants of the programs upon fulfillment of certain performance conditions and subject to continuing employment with the Group will be granted ordinary shares in the Company. As a result, the Group recognized an 28. ASSET RETIREMENT OBLIGATIONS As of December 31, 2014 and 2013, the estimated present value of the Group’s asset retirement obligations and change in liabilities were as follows: Balance, beginning of the year Liabilities incurred in the current period Property dispositions Accretion expense Revisions in estimated cash flows Currency translation adjustment Balance, end of the year Current portion Long-term portion Balance, end of the year $ $ $ 2014 2013 83,809 $ 1,900 (1,067) 6,559 677 (38,163) 53,715 $ - 53,715 53,715 $ 90,986 9,257 - 2,963 (13,840) (5,557) 83,809 - 83,809 83,809 The Group’s asset retirement obligations relate primarily to the cost of removing telecommunication equipment from sites. Revisions in estimated cash flows are attributable to changes in economic assumptions, such as inflation rates. The Group recorded the long-term portion of asset retirement obligations as a separate line item in the consolidated statements of financial position, the current portion – as a component of accrued expenses and other current liabilities. 164 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECH29. REDEEMABLE NONCONTROLLING INTERESTS Redeemable noncontrolling interests as of December 31, 2014 and 2013 consisted of the following: SSTL K-Telecom, MTS subsidiary in Armenia RTI (Note 5) Total $ $ 2014 2013 720,000 $ 56,734 16,032 792,766 $ 688,000 89,583 27,547 805,130 The Group is a party to a put option agreement to acquire the RF’s 17.14% interest in SSTL during one year beginning March 2016 at the higher of $777 million or its market value at that date determined by an independent appraiser. The Group accounted for the redeemable noncontrolling interests in SSTL at the redemption value and presented this as temporary equity in its consolidated statements of financial position. 30. COMMITMENTS AND CONTINGENCIES Operating leases – The Group leases land, buildings and office space mainly from municipal organizations through contracts which expire in various years through 2068. Rental expense under operating leases amounting to $641.0 million and $678.5 million for the years ended December 31, 2014 and 2013, respectively, is included in selling, general and administrative expenses. Rental expense under operating leases amounting to $204.6 million and $238.1 million for the years ended December 31, 2014 and 2013 respectively, is included in cost of sales. Future minimum rental payments under operating leases in effect as of December 31, 2014, are as follows: Year ended December 31 2015 2016 2017 2018 2019 Thereafter Total $ $ 282,393 204,009 202,489 204,662 199,758 303,487 1,396,798 165 APPENDICESCORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENT Capital commitments – As of December 31, 2014, the Group had executed purchase agreements of approximately $840.0 million to acquire property, plant and equipment and intangible assets. Guarantees – As of December 31, 2014, MTS Bank and its subsidiaries guaranteed loans for several companies, including related parties, which totaled $217.2 million. These guarantees would require payment by the Group only in the event of default on payment by the respective debtor. As of December 31, 2014, no event of default has occurred under any of the guarantees issued by the Group. Commitments on loans and unused credit lines – As of December 31, 2014, MTS Bank and its subsidiaries had $126.9 million of commitments on loans and unused credit lines available to its customers. Taxation – Russia currently has a number of laws related to various taxes imposed by both federal and regional governmental authorities. Applicable taxes include VAT, corporate income tax, a number of turnover-based taxes, and payroll (social) taxes. Laws related to these taxes have not been in force for significant periods, in contrast to more developed market economies; therefore, the government’s implementation of these regulations is often inconsistent or nonexistent. Accordingly, few precedents with regard to tax rulings have been established. Tax declarations, together with other legal compliance areas (for example, customs and currency control matters), are subject to review and investigation by a number of authorities, which are enabled by law to impose extremely severe fines, penalties and interest charges. These facts create tax risks in Russia that are more significant than those typically found in countries with more developed tax systems. Generally, according to Russian tax legislation, tax declarations remain open and subject to inspection for a period of three years following the tax year. As of December 31, 166 2014, tax declarations of certain companies of the Group in Russia for the preceding three fiscal years were open for further review. The Group purchases supplemental software from foreign suppliers of telecommunications equipment in the ordinary course of business. The Group’s management believes that customs duties are calculated in compliance with applicable legislation. However there is a risk that the customs authorities may take a different view and impose additional customs duties. Pricing of revenue and expenses between each of the Group’s subsidiaries and various discounts and bonuses to the Group’s subscribers in the course of performing its marketing activities may be subject to transfer pricing rules. The Group’s management believes that taxes payable are calculated in compliance with the applicable tax regulations relating to transfer pricing. However there is a risk that the tax authorities may take a different view and impose additional tax liabilities. As of December 31, 2014 and 2013, no provision was recorded in the consolidated financial statements in respect of such additional claims. In November 2014, the Russian legislation was amended to introduce the concept of “controlled foreign companies” and the new tax regime for such entities. It is expected that the adoption of the new rules will generally lead to an increase in the administrative and, in certain cases, tax burden for the Russian entities that have subsidiary structures incorporated outside the Russian Federation. The management does not believe the law can materially impact the Group’s tax obligations as of December 31, 2014. Management believes that it has adequately provided for tax and customs liabilities in the accompanying consolidated financial statements. As of December 31, 2014 and 2013, the provision accrued amounted to $53.3 million and $69.6 million, respectively. In addition, the accrual for unrecognized income tax benefits, potential penalties and interest recorded in accordance with the authoritative guidance on income taxes totaled $6.1 million and $18.8 million as of December 31, 2014 and 2013, respectively. However, the risk remains that the relevant authorities could take differing positions with regard to interpretive issues and the effect could be significant. With regard to matters where practice concerning payment of taxes is unclear, management estimated possible tax exposure to be $21 million and $nil as of December 31, 2014 and 2013, respectively. Operating environment – Starting from March 2014, sanctions have been imposed in several tranches by the U.S. and the E.U. on certain Russian officials, businessmen and companies. Following the decline in oil prices in 2014 and early 2015, Russia, which is the main market of the Group’s operations, has experienced significant economic instability, characterized by the substantial depreciation of the Russian rouble, growth of interest rates caused by the decision of the Central Bank of the Russian Federation to significantly increase its key interest rate, a forecasted decline in gross domestic product and a significant decline in the value of shares traded on the Russian stock exchanges. International credit agencies downgraded Russia’s long- term foreign currency sovereign rating with a negative outlook. Neither the Company, nor any of its subsidiaries are subject to the current sanctions, and the Group does not appear on the U.S. or E.U. lists of sanctioned parties. However, there is significant uncertainty regarding the extent or timing of any potential further economic or trade sanctions. Any continuing economic and political instability could have a negative impact on the Group’s operating results. Although the Group’s reporting currency is the U.S. dollar, it generates most of its revenues in Russian roubles, which is also the functional currency of its principal ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHoperating subsidiaries. Therefore, the Group’s reported results of operations are significantly impacted by the fluctuations in the exchange rate between the U.S. dollar and the Russian rouble, which depreciated against the U.S. dollar by 42% in 2014, and was on average 17% lower than the average value of the Russian rouble compared to the U.S. dollar during 2013. Also, given that most of the Group’s revenues are generated in Russian roubles, the Group faces exchange rate risk relating to payments that the Group must make in currencies other than the Russian rouble. During 2014, a deterioration in the political environment in Ukraine, the second largest market of the Group’s operations, has led to general instability, economic deterioration and armed conflict in the eastern portion of Ukraine. The deterioration has further exacerbated the country’s already weak macroeconomic trends, which have led to reduced credit ratings, significant depreciation of its national currency and increased inflation. In 2014, the Ukrainian Parliament adopted a law allowing for the imposition of sanctions against countries, persons and companies deemed by the Ukrainian government to threaten Ukrainian national interests, national security, sovereignty or the territorial integrity of Ukraine. The National Bank of Ukraine passed a decree prohibiting Ukrainian companies from paying dividends to foreign investors. These circumstances, combined with continued political and economic instability in Ukraine, could result in a negative impact on our business, including the Group’s financial position and results of operations. For example, such risks apply to the Group’s funds deposited in Ukrainian banks, the liquidity of which is negatively affected by the economic downturn. As of December 31, 2014, the Group held $376.9 million in current accounts and deposits in Ukrainian banks, including $90.2 million in Delta Bank (Note15) (fully provided as of December 31, 2014) and $25.1 million in Kyivska Rus Bank (Note 31). LTE license – In July 2012, the Federal Service for Supervision in the Area of Communications, Information Technologies and Mass Media allocated MTS the necessary license and frequencies to provide LTE telecommunication services in Russia. Under the terms and conditions of the LTE license, the Group is obligated to fully deploy LTE networks within seven years, commencing from January 1, 2013 and deliver LTE services in each population center with over 50,000 inhabitants in Russia by 2019. Also, the Group is obligated to invest at least 15 billion rubles ($266.6 million using December 31, 2014 exchange rate) annually toward the LTE roll-out until the network is fully deployed. Management believes that as of December 31, 2014 the Group is in compliance with these conditions. Bitel – In June 2013, an agreement was reached between Altimo, Altimo Holdings, MTS and its subsidiary MTS Finance, Nomihold and other associated parties to settle all disputes that have arisen from the Group’s investment in Bitel made in 2005. The agreement covered matters involving a number of parties and legal proceedings, including those in the Isle of Man, London, Luxembourg and other jurisdictions. Pursuant to the agreement, all proceedings between the parties and their associated parties were discontinued and waived, and MTS received a total payment of $150 million. All parties made the necessary submissions to the respective courts and tribunals to document the settlement, which, among other actions, fully discharged any and all outstanding obligations under the award previously rendered by the London Court of International Arbitration (LCIA) against MTS Finance in 2011, as well as settled the tripartite LCIA arbitration between MTS, MTS Finance and Nomihold and a tort action filed by Nomihold against MTS in the English Courts. Upon concluding the settlement agreement, the Group released a provision of $221 million, comprising $170 million set by the LCIA plus $51 million in damages, interest and other costs, that had been previously provided for in relation to the dispute with Nomihold. The Group also recognized a gain of $150 million with respect to the settlement payment in the consolidated statement of operations and comprehensive income for the year ended December 31, 2013. Restriction on transactions with the shares of BPGC and Ufaorgsintez – In 2014, in the course of a litigation, which the Group is not a party to, the court imposed restrictions on transactions with the shares of BPGC and Ufaorgsintez, owned by the Group. The restrictions do not limit the Group’s voting rights, rights to receive dividends or any other shareholders rights. Investigations into former operations in Uzbekistan – In March 2014, the Group received requests for the provision of information from the United States Securities and Exchange Commission and the United States Department of Justice relating to an investigation of the Group’s former subsidiary in Uzbekistan. The Group cannot predict the outcome of the investigations, including any fines or penalties that may be imposed, and such fines or penalties could be significant. Other – In the ordinary course of business, the Group is a party to various legal proceedings, and subject to claims, certain of which relate to the developing markets and evolving fiscal and regulatory environments in which the Group operates. In the opinion of management, the Group’s liability, if any, in all pending litigation, other legal proceedings or other matters will not have a material effect upon the financial condition, results of operations or liquidity of the Group. Management estimates the range of reasonably possible losses, if any, in all pending litigations or other legal proceedings being up to $28.0 million. 167 APPENDICESCORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENT31. SUBSEQUENT EVENTS For the purpose of the accompanying consolidated financial statements, subsequent events have been evaluated through April 2, 2015. terms of the license MTS-Ukraine is required to launch provision of 3G services in all of the regional centers across Ukraine within 18 months upon allocation of the license. Acquisition of 3G license in Ukraine – In February 2015, MTS- Ukraine won a tender to acquire a nationwide license for the provision of 3G telecommunications services. The license with the cost of UAH 2,715 million ($156.9 million at the acquisition date) has been granted for 15 years. In accordance with the Bond placement – In February 2015, the Company completed the placement of Series BO-01 unconvertible interest-bearing RUB- denominated bonds for the total amount of RUB 10 billion ($160.3 million at the date of the placement) at the coupon rate of 17% per annum. Insolvency of Kyivska Rus Bank – In March 2015, the National Bank of Ukraine adopted a resolution declaring Kyivska Rus Bank (Ukraine) to be insolvent. As of December 31, 2014, the Group held $25.1 million in deposits in the bank. Management determined that insolvency of the bank did not provide evidence related to conditions existing as of December 31, 2014, and therefore considered to be a nonrecognized subsequent event. A1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Principles of consolidation – The consolidated financial statements include the accounts of the Company, as well as entities where the Company has operating and financial control, most often through the direct or indirect ownership of a majority voting interest. Those ventures where the Group exer- cises significant influence but does not have operating and financial control are accounted for using the equity meth- od. Investments in which the Group does not have the ability to exercise significant influence over operating and financial policies are accounted for under the cost method and included in long-term investments in the consoli- dated statements of financial position. The consolidated financial statements also include accounts of variable inter- est entities (“VIEs”) in which the Group is deemed to be the primary beneficiary. An entity is generally a VIE if it meets any of the following criteria: (i) the entity has insufficient equity to finance its activities without additional subordinat- ed financial support from other parties, (ii) the equity investors cannot make significant decisions about the entity’s operations or (iii) the voting rights of some investors are not proportion- al to their obligations to absorb the expected losses of the entity or receive the expected returns of the entity and substantially all of the entity’s activities involve or are conducted on behalf of the investor with disproportionately few voting rights. All significant intercompany transac- tions, balances and unrealized gains and losses on transactions have been eliminated. Use of estimates – The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses of the reporting period. Actual results could differ from those estimates. Significant estimates for the Group in- clude the allowances for doubtful ac- counts, customer loans and deferred tax assets, the valuation of goodwill and other long-lived assets, asset retirement obligations, unrecognized income tax benefits, redeemable noncontrolling interests, derivative instruments, share-based compen- sation, assets acquired and liabilities assumed in business combinations, the recoverability of investments, and the estimates of oil and gas reserves. Concentration of business risk – The Group’s principal business activ- ities are in the RF, Ukraine and India. Laws and regulations affecting busi- nesses operating in these countries are subject to rapid changes, which could impact the Group’s assets and operations. Foreign currency – Management has determined that the functional cur- rencies of most of the Group’s operat- ing subsidiaries are the currencies of the countries of their domicile. In preparing the financial statements of the entities within the Group, transactions in currencies other than the entities’ functional currency are recognized at the rates of exchange prevailing on the dates of the trans- actions. At each balance sheet date, monetary assets and liabilities that are denominated in foreign curren- cies are retranslated at the rates prevailing at that date. Non-monetary items carried at fair value that are denominated in foreign currencies are translated at the rates prevailing at the date when the fair value was determined. Non-monetary items that are measured in terms of historical cost in a foreign currency are not restated. The Group has selected USD as its reporting currency. The Group’s as- sets and liabilities are translated into USD at exchange rates prevailing on the reporting period end date. Rev- enues, expenses, gains and losses are translated into USD at average exchange rates prevailing during the reporting period. Equity is translated at the applicable historical rates. The 168 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHresulting translation gain or loss is recorded as a separate component of other comprehensive income. On the disposal of a subsidiary whose financial statements are prepared in a currency other than the reporting currency of the Group, all of the accumulated currency transla- tion adjustments in respect of that operation attributable to the Group are reclassified to profit or loss. As of December 31, 2014, the official exchange rate of the Russian Ruble, the functional currency of most of the Group’s subsidiaries, determined by the Central Bank of the RF was RUB 56.26 for 1 USD (RUB 32.73 for 1 USD as of December 31, 2013). Revenue recognition – Generally, revenues are recognized when all of the following conditions have been met: (i) there is persuasive evidence of an arrangement; (ii) delivery has occurred; (iii) the fee is fixed and determinable; and (iv) collectability of the fee is reasonably assured. Rev- enue amounts are presented net of value-added taxes. Revenues under arrangements specific to the respective reportable segments of the Group are recognized as follows: of new subscribers, installation and activation of wireless, wireline and data transmission services (“connec- tion fees”) are deferred and recog- nized over the estimated average subscriber life, as follows: Mobile subscribers Residential wireline voice phone subscribers Residential subscribers of broadband internet service Other fixed line subscribers 1 -12.5 yearsт 15 years 1 year 3-5 yearsт MTS calculates an average life of mobile subscribers for each region in which it operates and amortizes connection fees based on the aver- age life specific to that region. Incentives provided to customers are usually offered on signing a new contract or as part of a promotional offering. Incentives representing the reduction of the selling price of the service (free minutes and discounts) are recorded in the period to which they relate, when the respective reve- nue is recognized, as a reduction to both accounts receivable and reve- nue. However, if the sales incentive is a free product or service delivered at the time of sale, the cost of the free product or service is classified as an expense. In particular, the Group sells handsets at prices below cost to contract subscribers. Such subsidies are recognized in the cost of sales. MTS Revenues derived from wireless, local telephone, long distance, data and video services are recognized when services are provided. This is based upon either usage (minutes of traffic processed, volume of data trans- mitted) or period of time (monthly subscription fees). Content revenue is presented net of related costs when MTS acts as an agent of the content providers while the gross revenue and related costs are recorded when MTS is a primary obligor in the arrangement. Upfront fees received for connection RTI Revenues from the long-term con- tracts are recognised using the percentage-of-completion method of accounting, measured by the percent of contract costs incurred to-date to estimated total contract costs. The completed-contract method is used for a single contract or a group of contracts for which reasonably dependable estimates cannot be made or for which inherent hazards make estimates doubtful. Provisions for estimated losses on construction contracts in progress are made in their entirety in the period in which such losses are determined. A total expected loss on a contract is recognised immediately in profit or loss. Contract expenses are recognised as incurred unless they create an asset related to future contract activity. The sales of software products and system integration services are generally multiple-element arrange- ments, involving the provision of related services, including custom- ization, implementation and inte- gration services, as well as ongoing support and maintenance provided to customers. A multiple-element arrangement is separated into more than one unit of accounting if all of the following criteria are met: (a) the delivered items have value to the customer on a standalone basis; and (b) the ar- rangement includes a general right of return relative to the delivered items, delivery or performance of the undelivered items is considered probable and substantially in the control of the Group. If evidence of the fair value of the undelivered elements of the arrange- ment does not exist, all revenue from the arrangement is deferred until such time that evidence of fair value does exist, or until all elements of the arrange- ment are delivered. Fees allocated to post-contract support are recognized as revenue on a pro rata basis over the support period. Fees allocated to other services are recognized as revenue as services are performed. In cases where extended payment terms exist, license and related cus- tomization fees are recognized when payments are due, unless a history of collection, without providing conces- sions, has been established under comparable arrangements. When sale agreements provide price protection to the dealer, the revenue is deferred until the dealer sells the merchandise to a third party due 169 APPENDICESCORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENTto the frequent sales price reductions and rapid technology obsolescence. Where certain products of this seg- ment are sold with a product return right, a reserve is established. In addition other post-contract support obligations are accrued at the time of sale. MTS Bank Revenues from interest bearing as- sets are recognized on an accrual ba- sis using the effective interest meth- od. The effective interest method is a method of calculating the amortized cost of a financial asset or a financial liability (or group of financial assets or financial liabilities) and of allocat- ing the interest income or interest expense over the relevant period. The effective interest rate is the rate that exactly discounts estimated fu- ture cash receipts (including all fees on points paid or received that form an integral part of the effective inter- est rate, transaction costs and other premiums or discounts) through the expected life of the debt instrument, or (where appropriate) a shorter period, to the net carrying amount on initial recognition. Regulated services – Regulated tariff services provided by the Group primarily consist of local fixed-line telephone services and services rendered to other operators, such as traffic charges, connection fees and line rental services, provided by MTS in certain regions of RF, and energy transmission services provided by BPGC. Changes in the rate structure for such services are subject to the Federal Tariff Service approval. Rev- enues from regulated tariff services represented approximately 5.5% and 6.0% of the consolidated revenues for the years ended December 31, 2014 and 2013, respectively. Cash and cash equivalents – Cash equivalents include demand deposits and other highly liquid investments with an original maturity of three months or less. Within the cash and cash equivalents balance are cash 170 equivalents of $777.2 million and $1,211.8 million as of December 31, 2014 and 2013, respectively, which primarily comprise term deposits with banks and bank promissory notes with original maturities of three months or less. Restricted cash – Restricted cash includes cash and cash equivalents restricted by agreements with third parties for special purposes. Financial instruments – The Group’s financial instruments include cash and cash equivalents, short-term investments, accounts receivable, derivative financial instruments, financial assets and liabilities from banking activities, accounts payable and short-term and long-term debt. Hedging activities – The Group uses derivative instruments, including swap, forward and option contracts to manage foreign currency and interest rate risk exposures. The Group designates derivatives as either fair value hedges or cash flow hedges in case the required criteria are met. Changes in the fair value of derivatives that are designated and qualify as fair value hedges are record- ed in the consolidated statement of operations and comprehensive income together with any changes in the fair value of the hedged asset or liability that is attributed to the hedged risk. The effective portion of changes in the fair value of derivatives that are designated and qualify as cash flow hedges are recognized in accumu- lated other comprehensive loss. Gains and losses associated with the related hedged items are recognized in the consolidated statements of operations and comprehensive in- come, depending on their nature. The gain or loss relating to the ineffective portion is recognized immediately in the consolidated statement of oper- ations and comprehensive income. For derivatives that do not meet the conditions for hedge accounting, gains and losses from changes in the fair value are included in the consol- idated statement of operations and comprehensive income (Note 22). Assets and liabilities related to multiple derivative contracts with one counterparty are not offset by the Group. The Group does not use financial in- struments for trading or speculative purposes. Fair value of financial instruments – The fair value of certain financial instruments approximates their carrying value due to the short-term nature of these amounts, namely cash and cash equivalents, short- term investments, accounts receiva- ble and accounts payable, short-term debt and assets and liabilities from banking activities which are included in current assets and liabilities. Fair value measurements – The Group reviews its fair value hierarchy classifications quarterly. Changes in significant observable valuation inputs identified during these reviews may trigger reclassification of fair value hierarchy levels of financial as- sets and liabilities. During the years ended December 31, 2014 and 2013 no reclassifications occurred. A three-level valuation hierarchy has been established under U.S. GAAP for disclosure of fair value measure- ments. The valuation hierarchy is based on the transparency of inputs to the valuation of an asset or liability as of the measurement date. The three levels are defined as follows: • Level 1 – inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets; • Level 2 – inputs to the valuation methodology include quoted pric- es for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument; • Level 3 – one or more inputs to the valuation methodology are unob- servable and significant to the fair value measurement. ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHAccounts receivable – Accounts re- ceivable are stated at their net realiz- able value after deducting a provision for doubtful accounts. Such provision reflects either specific cases of de- linquencies or defaults or estimates based on evidence of collectability. Assets from banking activities – As- sets from banking activities comprise assets (cash and cash equivalents, loans, investments and other) involved in operations of MTS Bank. Impair- ment losses on loans to customers and banks are included in the allow- ance for loan losses. The allowance for loan losses represents management’s best estimate of probable credit losses inherent in the lending portfolios as of the reporting period end. Loans that are not individually reviewed are evaluated as a group using reserve factor percentages based on historic loss experience and qualitative factors. Loans deemed to be uncollectible are charged against the allowance for loan losses. Correspondingly, recoveries of amounts previously charged as uncol- lectible are credited to the allowance for loan losses. A provision for loan losses is charged to the consolidated statement of operations and compre- hensive income based on manage- ment’s evaluation of the estimated losses, after giving consideration to the net chargeoffs which have been incurred in the Group’s loan portfolio. The Group performs detailed reviews of its lending portfolios on a periodic and systematic basis to identify in- herent risks and to assess the overall collectability of those portfolios. The allowance on certain homogene- ous loan portfolios, which generally consist of consumer and mortgage loans, is based on an evaluation of aggregated portfolios of homogene- ous loans, generally by loan type. Loss forecast models are utilized for portfolios of homogeneous loans which consider a variety of factors including, but not limited to, historical loss experience, anticipated defaults or foreclosures based on portfolio trends, delinquencies and credit scores, and estimated loss factors by loan type. The remaining loan portfolios are re- viewed on an individual loan basis. Loans subject to individual reviews are analyzed and segregated by risk according to the Group’s internal risk rating scale. These risk classifications, in conjunction with an analysis of histor- ical loss experience, current economic conditions and performance trends within specific portfolio segments, and any other pertinent information result in the estimation allowances for loan losses. An allowance for loan losses is established for individually impaired loans. A loan is considered impaired when, based on current information and events, it is probable that the Group will be unable to collect all amounts due, including principal and interest, according to the contractual terms of the agreement. Individually impaired loans are measured based on the present value of payments expected to be received, or for loans that are solely dependent on the collateral for repay- ment, the estimated fair value of the collateral. If the recorded investment in impaired loans exceeds the measure of estimated fair value, an allowance is established as a component of the allowance for loan losses. Inventories and spare parts – Invento- ries comprise raw materials, work-in- progress, finished goods and goods for resale. Inventory and spare parts are stated at the lower of cost or market value. Inventory is accounted for using either first-in, first-out or the weight- ed-average cost method. Depreciation for property, plant and equipment is computed under the straight-line method utilizing estimated useful lives of the assets as follows: The cost of raw materials includes the cost of purchase, customs duties, transportation and handling costs. Work-in-progress and finished goods are stated at production cost which includes direct production expenses and manufacturing overheads. Costs and estimated earnings in excess of billings on uncompleted contracts include the accumulated costs of projects contracted with third parties, net of related progress billings. The Group periodically assesses its inven- tories and spare parts for obsolete or slow-moving stock. Value-added taxes – Value-added taxes (“VAT”) related to sales are payable to the tax authorities on an accrual basis based on invoices issued to the customer. VAT incurred for purchases may be reclaimed, subject to certain restrictions, against VAT related to sales. VAT related to purchase transactions that will be reclaimed against future sales are recorded as VAT receivable in the accompanying financial statements. Property, plant and equipment – Property, plant and equipment are stated at historical cost. Cost includes major expenditures for improvements and replacements, which extend use- ful lives of the assets or increase their revenue generating capacity. Repairs and maintenance, including preventa- tive maintenance, are charged to the consolidated statement of opera- tions and comprehensive income as incurred. The cost of major overhauls and replacements, which extend useful lives of the assets or increase their revenue generating capacity, are cap- italized to the cost of the assets. Buildings Leasehold improvements Switches and transmission devices Network and base station equipment Power and utilities Other plant, machinery and equipment Lesser of the estimated useful life or the term of the lease 20-50 years 7-31 years 4-12 years 3-47 years 3-25 years 171 APPENDICESCORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENTWhilst there are certain assets within the Group that have useful lives longer than those presented above, these assets are quantitatively insignificant in comparison to the overall Group balance for each category. As such, the Group has taken the approach of reporting the useful economic lives which most faithfully represent the majority of assets, in order to provide a more reasonable range that more closely relates to the Group norm. As- sets held under capital leases are ini- tially recognized as assets of the Group at their fair value at the inception of a lease or, if lower, at the present value of minimum lease payments. The discount rate used in determining the present value of the minimum lease payments is the Group’s incremental borrowing rate, unless (1) it is prac- ticable to determine the implicit rate computed by the lessor; and (2) the implicit rate is less than the Group’s incremental borrowing rate. If both of those conditions are met, the interest rate implicit in the lease is used. Items of property, plant and equip- ment that are retired or otherwise disposed of are eliminated from the consolidated statement of financial position along with the corresponding accumulated depreciation. Any gain or loss resulting from such retirement or disposal is included in the determi- nation of net income. Construction in progress and equip- ment for installation are not depre- ciated until an asset is placed into service. Asset retirement obligations – The Group calculates asset retirement obligations and an associated asset retirement cost when the Group has a legal or constructive obligation in con- nection with the retirement of tangible long-lived assets. Business combinations – Acquisitions of businesses from third parties are accounted for using the acquisition method, with assets and liabilities of an acquired entities being measured at their fair values as at the date of acquisition. Noncontrolling interests are measured at fair value. 172 Goodwill – Goodwill is determined as the excess of the consideration trans- ferred plus the fair value of any noncon- trolling interests in the acquiree at the acquisition date over the fair values of the identifiable net assets acquired. The excess of the fair values of the identifia- ble net assets acquired over the cost of the business combination plus the fair value of any noncontrolling interests in the acquiree at the acquisition date is credited to income (“negative goodwill”). Goodwill is not amortized to oper- ations, but instead is reviewed for impairment at least annually. At first step, the Group asseses qual- itative factors to determine whether it is more likely than not that goodwill is impaired as a basis for determining whether it is necessary to perform the quantitative impairment test. Goodwill is than reviewed for impairment by comparing the carrying value of each reporting unit’s net assets (including allocated goodwill) to the fair value of the reporting unit. If the reporting unit’s carrying amount is greater than its fair value, the next step is per- formed whereby the implied fair value that relates to the reporting unit’s goodwill is compared to the carrying value of the reporting unit’s goodwill. The Group recognizes a goodwill impairment charge for the amount by which the carrying value of goodwill exceeds the fair value. Other intangible assets – Other intangible assets include billing and telecommunication software and oth- er software, operating licenses, ac- quired customer bases and customer relationships, radio frequencies, trademarks and telephone numbering capacity. All finite-life intangible assets are amortized using the straight-line method utilizing estimated useful lives of the assets as follows: Billing and telecommunication softwareе Operating licenses Acquired customer base Acquired radio frequencies Software and other 1-20 years 3-20 years 1-8 years 2-15 years 1-10 years Trademarks and numbering capacity with indefinite contractual life are not amortized, but are reviewed, at least annually, for impairment. If the fair value of the intangible asset is less than its carrying value, an impairment loss is recognized in an amount equal to the difference. The Group also evaluates the remaining useful life of its intangible assets that are not subject to amortization on an annual basis to determine whether events and circumstances continue to support an indefinite useful life. If an intangible asset that is not being amortized is subsequently determined to have a finite useful life, that asset is tested for impairment. Investments – The Group’s share in the net assets and net income of cer- tain entities, where the Group has the ability to exercise significant influence over their operating and financial policies (“affiliates”) is included in the consolidated financial statements using the equity method of accounting. The Group’s share in the net income of affiliates is included within operat- ing income, given that the Group has day-to-day involvement in the business activities and they are considered to be integral to the Group’s business. Other-than-temporary decreases in the value of investments in affiliates are recognized in net income. All other equity investments, which consist of investments for which the Group does not have the ability to exercise significant influence, are accounted for under the cost method or at fair value. Investments in private companies are carried at cost, less provisions for other-than-temporary impairment in value. For public com- panies that have readily determinable fair values, the Group classifies its eq- uity investments as available-for-sale or trading. For available-for-sale securities, the Group records these investments at their fair values with unrealized holding gains and losses included in the consolidated state- ment of operations and comprehen- sive income/(loss), net of any related tax effect. For trading securities, the Group records the investment at fair value. Unrealized holding gains ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHand losses for trading securities are included in earnings. The Group purchases promissory notes for investing purposes. These notes are carried at cost and the discount against the nominal value is accrued over the period to maturity. A provision is made, based on management assessment, for notes that are considered uncol- lectible. The notes are classified as held-to-maturity. Investments which are expected to be realized within twelve months after the statement of financial position date are classified as short-term investments. Other investments are classified as long-term investments. Debt issuance costs – Debt issuance costs are recorded as an asset and amortized using the effective interest method over the terms of the related loans. Impairment of long-lived assets other than goodwill and indefinite lived intangible assets – The Group periodi- cally evaluates the recoverability of the carrying amount of its long-lived assets. Whenever events or changes in cir- cumstances indicate that the carrying amounts of those assets may not be recoverable, the Group compares the undiscounted net cash flows estimated to be generated by those assets to the carrying amount of those assets. When these undiscounted cash flows are less than the carrying amounts of the assets, the Group records impairment losses to write the asset down to fair value, measured by the estimated dis- counted net future cash flows expected to be generated from the use of the assets (Note 15). Liabilities from banking activities – Liabilities from banking activities include deposits from banks and customers, promissory notes issued and other liabilities that arise out of operations of MTS Bank. Property, plant and equipment contributions – Telecommunication equipment and transmission devices, installed at newly constructed prop- erties in Moscow, have been histor- ically transferred to OJSC Moscow City Telephone Network (hereinafter, “MGTS”), a fixed line operator and subsidiary of the Group, by the Mos- cow City Government free of charge. These assets are capitalized by the Group at their market value at the date of transfer. Simultaneously, deferred revenue is recorded in the same amount and is amortized as a reduc- tion of the depreciation charge in the consolidated statement of operations and comprehensive income over the contributed assets’ life. Income taxes – Income taxes of the Group’s Russian entities have been computed in accordance with RF laws. The corporate income tax rate in the RF is 20%. The income tax rate on dividends paid within Russia is 9% or 0% subject to meeting certain condi- tions. The foreign subsidiaries of the Group are paying income taxes in their respective jurisdictions. Deferred tax assets and liabilities are recognized for differences between the carrying amounts of assets and liabilities in the consolidated finan- cial statements and the tax bases of assets and liabilities that will result in future taxable or deductible amounts. The deferred tax assets and liabili- ties are measured using the enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. In making such determina- tion, the Group considers all available positive and negative evidence, includ- ing future reversals of existing taxable temporary differences, projected future taxable income, tax plan- ning strategies and recent financial operations. Uncertain tax positions are recognized in the consolidated financial statements for positions which are not considered more likely than not of being sustained based on the technical merits upon examination by the tax authorities. The measurement of the tax benefit recognized in the consolidated financial statements is based upon the largest amount of tax benefit that, in man- agement’s judgment, is greater than 50% likely of being realized based on a cumulative probability assessment of the possible outcomes. The Group recognizes interest and penalties relating to unrecognized tax benefits within income taxes. Treasury stock – If the Group re- acquires the Company’s own equity instruments, those instruments (“treasury shares”) are recognized as a deduction of equity at cost, being the consideration paid to reacquire the shares. No gain or loss is recognized in profit or loss on the purchase, sale, issue or cancellation of the Compa- ny’s own equity instruments. Such treasury shares may be acquired and held by the Company or by other subsidiaries of the Group. Share-based compensation – The Group calculates and records the fair value of equity instruments, such as stock options or restricted stock, awarded to employees for services re- ceived and recognizes such amounts in the consolidated statement of op- erations and comprehensive income. The fair value of the equity instru- ments is measured on the date they are granted and is recognized over the period during which the employees are required to provide services in exchange for the equity instruments (Note 27). Share-based compensa- tion expense includes the estimated effects of forfeitures. Such estimates are adjusted over the requisite service period to the extent actual forfeitures differ, or are expected to differ from such estimates. Changes in estimat- ed forfeitures are recognized in the period of change and also impact the amount of expense to be recognized in future periods. For share-based compensation that include a component that will be settled in cash, and a component that is settled in equity, the Group accounts for the awards separately, based on their substance. For the component that is settled in cash, the awards gen- erally are accounted for as liabilities with compensation cost recognized over the service (vesting) period of the award based on the fair value of the award remeasured at each reporting 173 APPENDICESCORPORATE GOVERNANCE SYSTEMSUSTAINABLE DEVELOPMENTperiod. For the component that is settled in equity, compensation cost is measured based on the fair value of the award on the date of grant and the compensation cost is recognized over the service (vesting) period of the award. Retirement and postretirement benefits – Subsidiaries of the Group contribute to local state pension funds and social funds, on behalf of their employees. In Russia all social contributions paid during the year ended December 31, 2014 are represented by payments to governmental social funds, includ- ing the Pension Fund of the Russian Federation, the Social Security Fund of the Russian Federation and the Medical Insurance Fund of the Rus- sian Federation. In the Ukraine, subsidiaries of the Group are required to contribute a specified percentage of each employ- ee’s payroll up to a fixed limit into a pension fund, an unemployment fund and a social security fund. The con- tributions are expensed as incurred. In addition to the above, MGTS have defined benefit plans to provide their employees certain benefits upon and after retirement. The net period cost of the Group’s defined benefit plans is measured on an actuarial basis using the projected unit credit method and several actuarial assumptions. The recognition of expense for defined benefit plans is significantly impacted by estimates made by management such as discount rates used to value certain liabilities, expected return on assets, mortality rates, future rates of compensation increase and other re- lated assumptions. Gains and losses occur when actual experience differs from actuarial assumptions. If such gains or losses exceed ten percent of the greater of plan assets or plan liabilities the Company amortizes those gains or losses over the aver- age remaining service period of the employees. Borrowing costs – Borrowing costs are recognized as an expense in the period in which they are incurred. Borrowing costs for assets that require a period of time to get them ready for their intended use are capi- talized and amortized over the related assets’ estimated useful lives. outstanding during the year, adjusted for the dilutive effect of all potential shares that were outstanding during the year. Such potentially dilutive shares are excluded when the effect would be to increase diluted earnings per share or reduce the diluted loss per share. Advertising costs – Advertising costs are expensed as incurred. Advertising costs for the year ended December 31, 2014 and 2013 were $266.0 million and $328.7 million, respectively, and were reflected as a component of selling, general and administrative expenses in the accompanying con- solidated statements of operations and comprehensive income. Redeemable noncontrolling interests – From time to time, in order to optimize the structure of business acquisitions and to defer payment of the purchase price the Group enters into put and call option agreements to acquire noncontrolling interests in the existing subsidiaries. As these put and call option agreements are not freestanding, the underlying shares of such put and call option agreements are classified as redeemable secu- rities and are accounted for at either redemption value or the fair value of redeemable noncontrolling interests as of the reporting date. The fair value of redeemable noncontrolling inter- ests is assessed based on discounted future cash flows of the acquired entity (“Level 3” significant unobservable inputs of the hierarchy established by U.S. GAAP guidance). Any changes in redemption value of redeemable noncontrolling interests are accounted for in the Group’s retained earnings. Redeemable noncontrolling interests are presented as temporary equity in the consolidated statement of finan- cial position. Earnings per share – Basic earn- ings per share (“EPS”) is based on net income attributable to the Group divided by the weighted average number of shares outstanding during the year. Distributions to shareholders – Distributable retained earnings of the Group are based on amounts ex- tracted from the standalone statutory accounts of the Company (based on the Russian accounting standards) and may significantly differ from consolidated amounts calculated on the basis of U.S. GAAP. Reclassifications and revisions – Certain comparative information presented in the consolidated financial statements for the year ended De- cember 31, 2013 has been revised in order to achieve comparability with the presentation used in the consolidated financial statements for the year ended December 31, 2014. Such reclassifica- tions and revisions were not significant to the Group financial statements, except for presentation of the loss on deconsolidation of Bashneft (Note 2). Recently adopted accounting pro- nouncements – Effective January 1, 2014, the Group adopted Accounting Standards Update (“ASU”) 2013-05, Parent’s Accounting for the Cumu- lative Translation Adjustment upon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a For- eign Entity, ASU 2013-07, Liquidation Basis of Accounting and ASU 2013- 11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists. The adoption of these amend- ments did not have a material impact on the Group’s consolidated balance sheet or results of operations. Transition to International Financial Reporting Standards –To conform with the Russian legislation, the Group will prepare its consolidated financial statements for the year ended Decem- ber 31, 2015 in accordance with Inter- national Financial Reporting Standards (“IFRS”). The Group records in the statement of financial position the funded sta- tus of its pension plans based on the projected benefit obligation. Diluted EPS is based on net income attributable to the Group adjusted in certain circumstances, divided by the weighted average number of shares 174 ABOUT COMPANYSTRATEGIC REVIEWOUR INVESTMENTSPRESIDENT’S SPEECHCONTACTS Investor Relations Department +7 495 730-66-00 +7 495 692-22-88 Press Center +7 495 730-71-88 Inquiry Desk +7 495 737-01-01 Address 13, Mokhovaya Str., Moscow 125009 DISCLAIMER Certain statements in this report may contain assumptions or fore- casts in respect to forthcoming events within Sistema. The words “expect”, “estimate”, “intend”, “will”, “could” and similar expressions identify forward-looking statements. We wish to caution you that these statements are only predictions and that actual events or results may differ materially. We do not intend to update these statements to reflect events and circumstances occur- ring after the above-mentioned date or to reflect the occurrence of unanticipated events. Many fac- tors could cause Sistema’s actual results to differ materially from those contained in our projections or forward-looking statements, including, among others, deteriorat- ing economic and credit conditions, our competitive environment, risks associated with operating in Rus- sia, rapid technological and market change in our industries, as well as many other risks specifically related to Sistema and its operations. JSFC Sistema 13, Mokhovaya Str., Moscow 125009 Tel. +7 (495) 692 2288 ir@sistema.ru www.sistema.com © JSFC Sistema 2015. All rights reserved 

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