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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 FORM 10-K x
    
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2004 o
    
    TRANSITION REPORT PURSUANT TO SECTIONS 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 COMMISSION FILE NUMBER: 0-27423 GOLDEN TELECOM, INC.  DELAWARE
    
    51-0391303(State of incorporation)
    
    (I.R.S. Employer Identification Nos.)
 REPRESENTATION OFFICE GOLDEN TELESERVICES, INC.
1 KOZHEVNICHESKY PROEZD
MOSCOW, RUSSIA 115114
(Address of principal executive offices) (011-7-501) 797-9300
(Registrants telephone number) Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $ 0.01 per share Indicate by check mark whether the registrants (1) have filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) have been subject to such
filing requirements for the past 90 days. Yes x No o Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained in this Form 10-K, and will not be
contained, to the best of the registrants knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. x Indicate by checkmark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes x No o The aggregate market value Golden Telecom, Inc. voting and non-voting
common equity held by non-affiliates as of June 30, 2004 (the last business day
of the registrants most recently completed second fiscal quarter) was
$183,227,679 based upon the closing price on the Nasdaq National Market as of
such date. On March 8, 2005, there were outstanding approximately 36,324,490 shares of
Common Stock of Golden Telecom, Inc. ITEM OF FORM 10-K
    
    DOCUMENTS INCORPORATED BY REFERENCEPart III, Items 10-14
    
    Portions of the Registrants proxy statement for
the 2005 annual meeting of shareholders to be
held in May 2005.




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GOLDEN TELECOM, INC.
FORM 10-K
YEAR ENDED DECEMBER 31, 2004 TABLE OF CONTENTS  
 PAGEPART IITEM 1.
    
    Business.
    
    
    3ITEM 2.
    
    Properties.
    
    
    38ITEM 3.
    
    Legal Proceedings.
    
    
    38ITEM 4.
    
    Submission of Matters to a Vote of Security Holders.
    
    
    38PART IIITEM 5.
    
    Market for the Companys Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities.
    
    
    39ITEM 6.
    
    Selected Financial Data.
    
    
    40ITEM 7.
    
    Managements Discussion and Analysis of Financial Condition
and Results of Operations.
    
    
    42ITEM 7A.
    
    Qualitative and Quantitative Disclosures About Market Risk.
    
    
    60ITEM 8.
    
    Financial Statements and Supplementary Data.
    
    
    62ITEM 9.
    
    Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.
    
    
    104ITEM 9A.
    
    Controls and Procedures.
    
    
    104ITEM 9B.
    
    Other Information.
    
    
    105PART IIIITEM 10.
    
    Directors and Executive Officers of the Registrant.
    
    
    106ITEM 11.
    
    Executive Compensation.
    
    
    106ITEM 12.
    
    Security Ownership of Certain Beneficial Owners and Management.
    
    
    106ITEM 13.
    
    Certain Relationships and Related Transactions.
    
    
    106ITEM 14.
    
    Principal Accountant Fees and Services.
    
    
    106PART IVITEM 15.
    
    Exhibits and Financial Statement Schedules.
    
    
    107SIGNATURES
    
    
    109Employment Agreement for President and CEOEmployment Agreement for COOEmployment Agmts. - CFO, General Counsel and Director of Mergers and AcquisitionsForm of Stock Option Award AgreementSchedule of Compensation Arrangements with DirectorsList of SubsidiariesConsent of Ernst & Young (CIS) LimitedConsent of Ernst & Young (CIS) LimitedCertification of CEO pursuant to Section 302Certification of CFO pursuant to Section 302Certification of CEO pursuant to Section 906Certification of CFO pursuant to Section 906




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PART I 
 ITEM 1. BUSINESS INTRODUCTION We are a leading facilities-based provider of integrated telecommunication
and Internet services in major population centers throughout Russia and other
countries of the Commonwealth of Independent States (CIS). We offer voice,
data and Internet services to corporations, operators and consumers using our
metropolitan overlay network in major cities including Moscow, Kiev, St.
Petersburg, Nizhny Novgorod, Krasnoyarsk, Samara, Kaliningrad, Almaty, and
Tashkent, and via intercity fiber optic and satellite-based networks, including
approximately 220 combined access points in Russia and other countries of the
CIS. In addition, we offer mobile services in Kiev and Odessa. We organize our operations into four business segments, as follows:  
    BUSINESS AND CORPORATE SERVICES. Using our fiber optic and
satellite-based networks in and between major metropolitan areas of
Russia, Ukraine and other countries of the CIS, we provide business
and corporate services including voice and data services to corporate
clients across all geographical markets and all industry segments,
other than telecommunications operators;
    CARRIER AND OPERATOR SERVICES. Using our fiber optic and
satellite-based networks in and between major metropolitan areas of
Russia, Ukraine and other countries of the CIS, we provide a range of
carrier and operator services including voice and data services to
foreign and Russian telecommunications and mobile operators;
    CONSUMER INTERNET SERVICES. Using our fiber optic and satellite-based
networks, we provide dial-up Internet access to the consumer market
and web content offered through a family of Internet portals
throughout Russia, Ukraine, Kazakhstan, and Uzbekistan; and
    MOBILE SERVICES. Using our mobile networks in Kiev and Odessa,
Ukraine, we provide mobile services with value-added features, such as
voicemail, roaming and messaging services on a subscription and
prepaid basis. We intend, wherever possible, to offer all of our integrated
telecommunication services under the Golden Telecom brand, although, some
services still carry local brands because of recent acquisitions. Our dial-up
Internet services are distributed under the ROL brand in Russia, Kazakhstan and
Uzbekistan and under the Svit-On-Line brand in Ukraine. Additionally, we hold a minority interest in MCT Corp. (MCT), which in
turn has ownership interests in 13 mobile operations located throughout Russia
and in Uzbekistan, Tajikistan and Afghanistan. We treat our ownership interest
in MCT as an equity method investment and are not actively involved in the
day-to-day management of the operations. BUSINESS SECTION OVERVIEW The following subsections within the Business section describe our business
strategy, our current position in the markets in which we operate, our corporate
history and development, our customer base, and a detailed review of our service
groups by operating segments. Additionally, we describe our licenses and our
network facilities. Finally, we provide a summary of the principal environments
in which we operate, the telecommunications markets, the political and economic
environments, and the legal, tax and regulatory regimes in Russia and Ukraine. BUSINESS STRATEGY Our objective is to be the leading facilities-based alternative voice, data
and Internet services company in Russia and key markets in the CIS. To achieve
this objective, we intend to:  
    Increase Market Share by Offering Bundled Data and Voice Services Over
an Integrated Network 3




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Corporate customers increasingly demand integrated telecommunications
solutions from one-stop providers that are able to deliver a full service
offering in the geographical areas in which these corporate customers
operate. As a result, we plan to continue to develop and combine our
businesses to create a unified service platform for local access, local
exchange, domestic and international long distance, data, Internet access
and services via turn-key solutions.  
    Extend Our Leading Position in High Growth Data and Internet Markets We plan to build on our position as a leading provider of data and
Internet communication services in Russia and other countries of the CIS by
increasing the number of network access points in our network to facilitate
the growing volume demand for data and Internet communications.  
    Reduce Operating Costs and Satisfy Capacity Needs through Network
Planning and Optimization Our network strategy includes building and owning our local exchange
and customer access networks. We have entered into long-term lease
agreements for long-distance and international fiber optic cable systems to
provide our regional and global connectivity, supplementing these leased
land-based channels with satellite circuits for redundancy and remote
connectivity. We intend to selectively invest in and to incrementally
expand the fiber optic capacity along our heavy traffic and high cost
intercity routes to reduce our unit transmission costs and ensure
sufficient capacity to meet the growing volume demand for data and Internet
services. Wherever possible, we target customers and sell products which
enable us to fully utilize existing fixed cost network infrastructure.  
    Focus Operating Activities and Capital Investments in Major
Metropolitan Areas We plan to make capital investments primarily in Moscow, Kiev, St.
Petersburg, Nizhny Novgorod, Krasnoyarsk, Samara, and Kaliningrad and other
major population centers in the CIS, where demand for our services is most
heavily concentrated. We also intend to expand our operations in regional
cities with sufficiently strong local economies that we believe the
potential exists to grow businesses that complement our current operations.  
    Pursue Consolidation Opportunities We intend to pursue consolidation opportunities through selective
acquisitions that will allow us to expand our geographical reach, add to
our service offerings and improve our market share while maintaining
operational control. We will target complementary opportunities that will
enable us to achieve synergies and economies of scale and seek regional
opportunities in major cities where we do not have our own local network
infrastructure. OUR POSITION IN THE RUSSIAN AND CIS MARKETS We believe that we are well positioned to maintain and consolidate our
strong presence in the Russian and CIS telecommunications markets for the
following reasons:  
    our early market entry and local market experience;
    our focus on service, quality and reliability;
    our strong infrastructure position in Moscow, Kiev, St. Petersburg,
Nizhny Novgorod, Krasnoyarsk, Samara, Kaliningrad, Almaty, and
Tashkent;
    our extensive customer base;
    our extensive range of integrated voice, data and Internet data
telecommunications services;
    our diverse and influential shareholder base; and
    our strong balance sheet position. CORPORATE HISTORY AND DEVELOPMENT Golden Telecom, Inc, initially a majority owned subsidiary of Global
TeleSystems, Inc. (GTS), was incorporated in Delaware in June 1999 in
preparation for our initial public offering (IPO) which took place in
September 1999. GTS was founded in 1983 as a not-for-profit company under the
name San Francisco/Moscow Teleport, Inc. and was among the first foreign
telecommunications operators in the former Soviet Union, where it began offering
data links to the United States (US) in 1986, international long distance
services in 1992, local access to its networks in 1994 and cellular services in
1995. At the time of our IPO, GTS contributed substantially all of the assets
that constituted Golden Telecom, Inc. In September 2002, we purchased 50% of EDN Sovintel (Sovintel) that we
did not own from OAO Rostelecom (Rostelecom), the Russian national long
distance carrier. As a result of this purchase, we now own 100% of Sovintel. In
April 2003, we merged the operations of TeleRoss, our wholly-owned subsidiary,
into Sovintel. 4




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In August 2003, we acquired 100% of OOO Sibchallenge Telecom
(Sibchallenge), the leading alternative wireline operator in Krasnoyarsk,
Russia. Sibchallenge owns 100% of ZAO Tel (Tel), an Internet service provider,
also based in Krasnoyarsk. In December 2003, we acquired 100% of OAO Comincom (Comincom), and its
wholly-owned subsidiary, OAO Combellga (Combellga), from Nye Telenor East
Invest AS (Telenor). As part of this transaction, we issued shares to Telenor
representing 19.5% of our shares outstanding after the acquisition. As of
December 1, 2004, all assets, liabilities, rights and obligations of Comincom,
and including Combellga, were transferred to Sovintel as pursuant to a merger of
these three wholly-owned subsidiaries. In February 2004, we completed the acquisition of 100% of ST-HOLDING
s.r.o., a Czech company that owns 50% plus one share in ZAO
Samara Telecom (Samara Telecom), a telecommunications service provider in
Samara, Russia, from ZAO SMARTS and individual owners. In April 2004, we completed the acquisition of 100% of the common shares in
OAO Balticom Mobile (Balticom) that owns 62% of ZAO WestBalt Telecom
(WestBalt), an alternative telecommunications operator in Kaliningrad, Russia. In April 2004, we completed the acquisition of the remaining 49% ownership
interest that we did not own in OOO Uralrelcom
(Uralrelcom). In May 2004, we completed the acquisition of 54% ownership interest in SP
Buzton (Buzton), an alternative telecommunications operator in Uzbekistan. The following table summarizes the four segments through which we currently
conduct our operations: SEGMENTS
    
    SUBSIDIARIESBUSINESS AND CORPORATE SERVICES:BCS division in Russia
    
    Sovintel, Agency for Business Communications(ADS), Sibchallenge, Samara Telecom,WestBaltBCS division in Ukraine
    
    Golden Telecom (Ukraine)CARRIER AND OPERATOR SERVICES:Carrier and Operator Services division in Russia
    
    Sovintel, ADS, Sibchallenge, SamaraTelecom, WestBaltCarrier and Operator Services division in Ukraine
    
    Golden Telecom (Ukraine)CONSUMER INTERNET SERVICES:Consumer Internet Services division
    
    Sovintel, ADS, TelMOBILE SERVICES:Golden Telecom GSM in Kiev and
Odessa, Ukraine
    
    Golden Telecom (Ukraine)
 CUSTOMER BASE We compete primarily for high-volume business customers and carriers who
require access to highly reliable and advanced telecommunications facilities to
operate their business. Together, our top five customers accounted for
approximately 11% of our consolidated revenues for the year ended December 31,
2004. Our largest customer, Vimpelcom, together with its affiliate KB Impulse,
accounted for approximately 5% of our consolidated revenues for the year ended
December 31, 2004. No other customer accounted for over 5% of our consolidated
revenues for the year ended December 31, 2004. Our principal customer segments are: Corporate Network Customers. Corporate network customers are typically
large multinational, Russian or Ukrainian companies which require the full range
of voice, data and Internet services in several cities across Russia, Ukraine
and other countries of the CIS. While pricing is always a factor, this segment
places more value on network coverage, reliability as defined by service level
agreements, and the ability to design, install and maintain local area networks
(LAN) and wide area networks (WAN). These customers are willing to make
longer-term commitments to integrated one-stop providers in exchange for higher
levels of service. 5




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Corporate End-Users. Corporate end-users are foreign and Russian
enterprises with centralized operations, either in Moscow, Kiev or in the
regions. These corporate end-users also require a full range of voice, data and
Internet services, but are more likely to purchase distinct services from
separate suppliers based on price. We attempt to acquire business from corporate
customers by providing superior technology and service levels at competitive
pricing. Small and Medium Enterprises (SME). We define small and medium
enterprises as those business customers that require a full range of voice, data
and Internet services and generally have monthly billings of less than $2,000. Fixed-Line Operators. Fixed-line operators are other telecommunications
providers, including other overlay operators operating in Moscow, alternative
regional fixed-line operators and local operators, which we refer to as the
local telcos. Price is the primary factor in their purchase decision, and
although long-term contracts are rare, traffic volumes can be large. Voice
telephony is a commodity for customers in this segment. Cellular Operators. Russian cellular operators purchase large quantities of
local numbering capacity in Moscow that they use in selling cellular services to
their customers. Ukrainian cellular operators distribute large volumes of
international and intercity traffic through our network in Ukraine. Price,
availability and quality of service are primary factors in the purchase decision
of these customers. Mass Market. We define the mass market as those customers who utilize
calling cards or dial-up Internet access. This market segment is
price-sensitive, but quality of service is also important, particularly in the
Internet access market. These customers predominately prepay for such services.
In Kiev and Odessa, Ukraine, we also offer mobile services to the mass market,
targeting individuals with above average disposable income, where price and
quality are also primary decision factors. PRICING Generally, our customers make payments to us in the appropriate local
currency, however the majority of our tariffs are denominated in United States
dollars (USD) and are indexed to the USD for settlement purposes. Also, the
majority of our operating costs are denominated in USD, but settled in the
appropriate local currency. OUR SERVICE GROUPS This section provides a detailed review of our business on a segment basis
and by operating division. We provide additional information on the services and
customers, marketing and pricing, and competition within each division. BUSINESS AND CORPORATE SERVICES (BCS): BCS DIVISION IN RUSSIA We operate a number of competitive local exchange carriers (CLECs) that
own and operate a fully-digital overlay network in a number of major Russian
cities. The majority of our services are provided through our wholly-owned
Moscow-based subsidiary: Sovintel. As of December 1, 2004, all assets,
liabilities, rights and obligations of Comincom and Combellga, were transferred
to Sovintel pursuant to a merger of these three wholly-owned subsidiaries. As a
result of this merger, Sovintel services over 256,000 telephone numbers for
business customers. Through Sovintel, we are an integrated provider of the
largest range of telecommunication services available on the Russian market,
including network access and hardware and software solutions including
installation, configuration and maintenance. Our geographical coverage includes
all major population centers in Russia including Moscow, St. Petersburg, Nizhny
Novgorod, Krasnoyarsk, Samara, and Kaliningrad. The BCS division of ADS has constructed network infrastructure to
support 27,600 city telephone numbers in Nizhny Novgorod. The BCS division of Sibchallenge has constructed network infrastructure to support
42,500 city telephone numbers in Krasnoyarsk. The BCS division of WestBalt has
constructed network infrastructure to support 29,100 city telephone numbers
in Kaliningrad. Services and Customers Local Access Services. Local access services are provided to business
customers through the connection of the customers premises to our fiber
network, which interconnects to the local public switched telephone network
(PSTN) in Moscow, St. Petersburg, Nizhny Novgorod, Khabarovsk, Ufa,
Vladivostok, Novosibirsk, Irkutsk, Kaliningrad, Ekaterinburg, Voronezh,
Krasnodar, and Krasnoyarsk. International and Domestic Long Distance Services. Outgoing international
voice services to business customers are provided through our international
gateways, which transmits international traffic through dedicated channels
leased from Rostelecom, the 6




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incumbent long distance operator. When an international call is placed to our
customer which has been assigned a number acquired from and serviced by an
independent local exchange provider, the calling party currently has the option
of dialing through either the public city code (095) in Moscow or via our
exclusive non-geographical area codes (501, 502 and 478). We have developed and
maintained a telecommunication network which utilizes non-geographical numbering
and allows transmission of long distance traffic. We expect due to regulatory
considerations, however, that non-geographical area codes will be discontinued
and customers will be migrated to public city codes in the coming years. In December 2003, we met with the Ministry of Communications to discuss the
use of non-geographical numbering on fixed telecommunication networks. As a
result of this meeting, we and the Ministry agreed to continue researching the
possibility of developing an experimental zone, with Sovintel as a participant,
in which we would route our customers long distance traffic through our own
network and route long distance traffic of interconnected operators to
Rostelecoms network. We have agreed to utilize Rostelecoms technical
facilities for our international traffic with the right to have our own direct
interconnection agreements and settlements with foreign operators for such
traffic. Domestic long distance services are primarily provided through our
intercity transmission network, leased capacity between major Russian cities,
and through interconnection with Rostelecoms network. We provide switched voice
services to regional customers through local city switches connected to earth
stations and intercity fiber optic lines. When a customer in one of these
regions makes a domestic long distance or an international call, it is typically
transmitted first to our Moscow hub by fiber or satellite transmission
facilities. The call is then connected to the customers destination through a
terrestrial line, through the Rostelecom network, or, for international calls,
through our international gateway. We offer very small aperture terminal
(VSAT) satellite services to customers located in remote areas that cannot be
physically connected through terrestrial cables to our regional long distance
switches, as well as to large infrastructure projects in need of sophisticated
and reliable communications systems. Our satellite transmission facilities
connect these customers directly to our Moscow-based hub through a VSAT antenna
installed at the customers location. Dedicated Internet and Data Services. We provide our business customers
with dedicated access to the Internet through our access and backbone networks.
We also offer traditional and high-speed data communications services, using
frame relay, X.25, asynchronous transfer mode and Internet Protocol (IP)
technologies, to business customers who require WAN to link computer networks in
geographically dispersed offices. We also provide private line channels to
customers who require high-capacity and high-quality domestic and international
point-to-point connections. Private lines can be used for both voice and data
applications. Integrated Voice and Data Services. The markets where we operate are
experiencing a continuing significant trend toward routing voice traffic over
the Internet using IP technology, known as Voice over IP or VoIP. We are a
leading provider of this service. In addition to using data networking services
for typical LAN to LAN interconnections, many customers will also route their
voice traffic over our frame relay data network to reduce overall
telecommunications expenses. Voice over frame relay involves packetizing voice
calls using frame relay, a data transmission protocol, and transporting the
voice call over our data network to be de-packetized at the terminating end.
The call is finally terminated through normal circuit switching. Packet
switching offers greater cost efficiencies over circuit switching, and offers
this division an opportunity to leverage its data network investment across a
greater number of services and geographic areas. This type of integrated
communication solution is also offered by Integrated Services Digital Network
(ISDN) products where basic services include telephony, fax, data
transmission, Internet access and video conferencing. Value-Added Services. We offer an increasing range of value-added services
such as dedicated hosting, co-location and IP, or IP-based Virtual Private
Networks (VPNs) and we intend to increase the number of value-added services
we offer to include other Internet-related products and services. Our Managed
Data Center, which consists of a total area of 600 square meters, continues to
be the leading hosting center in Russia and provides services to news agencies,
and financial and entertainment services providers. We enjoy strong sales
synergies between our Managed Data Center products and our IP transit sales
efforts. We offer a variety of information services addressing the needs of
financial markets including access to S.W.I.F.T., Reuters, Bloomberg and to the
Moscow Inter-bank Currency Exchange, or MICEX. We also have a Moscow-based Call
Center that has a leading position in providing telemarketing, actualization and
Hot Line services for business clients. We offer fixed mobile convergence
services in conjunction with Vimpelcom to corporate clients that wish to use
their mobile phone as an extension of their private branch exchange (PBX). Equipment Sales. As part of our integrated service offering, we sell
equipment manufactured by Nortel Networks, Cisco Systems, Alcatel, Siemens,
Avaya, Motorola and Ericsson. As part of our turnkey solutions, we also offer
the installation, configuration and maintenance of Nortel Meridian One products,
Norstar key systems, Mercator PBXs and the Passport lines of data equipment.
This close customer contact assists us in the marketing of additional services
and enhances customer retention. Major customers range from large multinational and Russian corporate groups
to small and medium-sized Russian enterprises. Our customers cover all industry
segments including business centers, hotels, financial institutions,
professional services firms, fast moving consumer goods companies, manufacturers
and companies involved in extractive industries. Our customers are located in
all major cities throughout Russia. Marketing and Pricing 7




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In Sovintel, sales to customers are made through a direct sales force
consisting of approximately 125 account managers in Moscow. Each of these
account managers targets specific customer groups and industry segments, and is
supported by specialists in technical sales support, marketing, customer service
and end-user training. Each account manager is allocated to one of four
geographical areas within Moscow for sales to all potential customers within
this area. In addition, a team of 89 regional sales managers is responsible for
supporting the regional sales force and maintaining relations with our regional
partners. We have a dedicated sales force in each of our regional branch offices
and for other regional cities we have sales incentive plans with our regional
partners. We train our employees to provide customer service at a level which is
comparable to that provided by Western telecommunications companies. As a
result, we believe we have earned a reputation for providing high-quality
telecommunications services through an experienced and professional customer
service staff. We price our services at a premium to those offered by the incumbent local
operator and competitively with other alternative service providers within the
market. We offer volume discounts to customers for exceeding certain defined
revenue thresholds. Although we publish standard tariffs, generally we are not
required to obtain regulatory approval to change tariffs. While pricing
competition remains a factor, especially for voice services, many corporate data
networking customers place more value on network coverage, reliability and our
ability to design, install and maintain LANs and WANs. These customers often
require integrated solutions, including connections to offices located in
different cities. Depending on the cities involved, there may be few operators
that can provide these services, and accordingly, there may be less pricing
pressure. Competition We compete principally on the basis of price, time to installation, network
quality, geographical network reach, customer service and range of services
offered. While we have a leading position in this market, we face significant
competition from other service providers, including:  
    the AFK Sistema Telecom group of companies, including alternative
operators such as Comstar, MTU-Inform, Telmos and Golden Line, for all
services provided to corporate customers within Moscow;
    Moscow City Telephone Network, the incumbent operator, currently
majority owned by Sistema Telecom, for services provided to the SME
market in Moscow;
    Equant, currently owned by Equant France, for corporate data
networking services across Russia;
    TransTelecom, currently owned by the Government of the Russian
Federation, for corporate data networking services across Russia;
    Peterstar, an affiliate of Telecominvest, a subsidiary of Metromedia
International Group, Inc., for services provided in St. Petersburg;
    Petersburg Telephone Network, the incumbent local operator in St.
Petersburg, for services provided in St. Petersburg; and
    Regional subsidiaries of Electrosvyaz, a holding group with majority
government ownership, for services within Russian regional cities. For
ADS the main competitor is the Electrosvyaz subsidiary, Volga Telecom,
while for Sibchallenge the main competitor is the Electrosvyaz
subsidiary, Ural Svyaz-Inform. BCS DIVISION IN UKRAINE The BCS division of Golden Telecom (Ukraine) (GTU), our largely
Kiev-based CLEC, has constructed and owns a 575 kilometer fiber optic network,
including 285 kilometers in Kiev, that is interconnected to the local public
telephone network in Kiev, to other major metropolitan areas in Ukraine, and to
our international gateway. Data and Internet access services are provided in 89
regional access points in 33 metropolitan cities in Ukraine using leased
terrestrial capacity from Ukrtelecom, an incumbent operator, and from some
alternative providers. Since the opening of our mobile service operation in Odessa in 2001, we
have expanded our local access service offerings into Odessa, targeting business
clients. In the third quarter of 2002, GTU started to offer local access and
pre-paid voice over IP services in Dnepropetrovsk. Further following our
regional development strategy, in the second quarter of 2003 we started to offer
local access, voice over IP and dial-up Internet services in Lviv, and in the
second quarter of 2004 we launched the same service offering in Zaporizhya.
During 2005 and 2006, we plan to launch our operations in additional major
metropolitan areas in Ukraine. 8




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In the second quarter of 2003, GTU constructed a Metropolitan Area Network
(MAN) in Kiev providing a new range of services, including broadband access to
Internet and VPN service. In the fourth quarter of 2004, GTU deployed a MAN in
Odessa. In the first quarter of 2004, GTU launched a Soft Switch class 4/5 in
Kiev providing interconnect with international operators via public Internet and
the possibility to offer new services such as VoIP VPN and IP Phone. During 2004, in order to expand market penetration in areas of presence in
Ukraine and to increase utilization of technical infrastructure, GTU began to
provide telecommunications services to residential customers. Due to the lack of
modern, high quality, and customer oriented telecommunications services
available in Ukraine, we are able to competitively price our services and at the
same time offer high quality telecommunications services through an experienced
and professional customer service staff. As of December 31, 2004, more than
1,000 residential customers have purchased GTUs BCS services. We plan to
increase the number of residential customers significantly during 2005. As of December 31, 2004, the BCS division of GTU serviced 26,700 telephone
lines for business and residential customers and connected more than 4,800
dedicated Internet ports. Services and Customers Local Access Services. Local access services are provided to business
customers through the connection of the customers premises to GTUs fiber
network, which interconnects to the local PSTN in Kiev, Odessa, Dnepropetrovsk,
Lviv and Zaporizhya. International and Domestic Long Distance Services. GTU provides outgoing
international voice services to business customers through its international
gateway, transmitting traffic to international operators using least-cost
routing. Domestic long distance services are primarily provided through our own
intercity transmission network, leased capacity between major Ukrainian cities,
and through interconnection with Utel and Ukrtelecoms network. Dedicated Internet and Data Services. GTU provides a private line service,
VPN services, an integrated voice and data ISDN connection, frame relay, X.25,
broadband digital subscriber line (xDSL), and dedicated Internet services.
GTUs main focus in 2004 was the development of broadband access to MAN and xDSL
services, required by customers with high-volume data traffic needs. Voice over Data Services. GTU is a leading provider of voice over data
services in Ukraine. Our pre-paid cards and our VoIP products introduced under
the brand Allo! kept a market leading position with more than a 50% market
share in Kiev, providing an alternative international calling solution for
corporate and mass market customers. Although this service has proved to be
popular in the Ukrainian market and continues to offer growth opportunities in
other metropolitan cities in Ukraine, the growth of VoIP-service market has been
hampered due to the introduction of State regulated prices in 2002. Information Services. GTU provides financial and banking services to
companies such as S.W.I.F.T. and Western Union, access to processing centers,
news services to companies such as Reuters, as well as conduits to airline
reservation systems in Ukraine. We have been chosen as one of two exclusive last
mile providers for Reuters services in Ukraine. Our data center provides server
co-location and hosting services for news agencies, and financial and
entertainment services providers. Call Center Services. With the launching of Call Center services at the end
of 2002, GTU captured the leading position in providing telemarketing,
actualization and Hot Line services for business clients in Kiev. Residential Telecommunications Services. In 2004, GTU developed unified
telephone and Internet broadband access services for residential customers. GTU
is planning for further development of residential telecommunications services
and is in process of implementing required structural changes that will allow us
to serve this market segment in the most effective way. The customers for this division primarily consist of corporate network
customers, corporate end-users, SMEs and high-end residential customers.
Pre-paid VoIP and dial-up Internet services are also provided as a mass market
offering. Marketing and Pricing While emphasizing the quality and reliability of its services, GTU
positions itself as a price competitive service provider to businesses. Sales to
our customers are made through our direct sales force and through various
alternative distribution channels. Our sales organization is divided into
Corporate, SME and Indirect sectors and consists of 25 account managers in Kiev
and 14 in the regions of Ukraine, 6 indirect sales managers in Kiev and 7 in the
regions. Alternative distribution channels are primarily built through agent
networks comprising information technology system integrators, telecom and
computer equipment distributors, IP and mobile services retail dealers, as well
as through cooperation contracts with business centers. Mass-market service
offerings are mainly conducted indirectly through alternative distribution
channels. 9




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GTU is a fast growing local access and Internet service provider for
businesses in Ukraine both in terms of market share and sales revenues due to
highly competitive offers for bundles of voice and Internet services. In order
to stimulate higher growth we follow an aggressive pricing policy for corporate
end-users, particularly in the regions outside Kiev. Additionally, an increase
in market share in data services is expected through the continued sale of
international private line connections, international frame relay connections,
and national corporate networks based on IP technologies. Competition In Kiev, in the market of voice services to business end-users we compete
with Ukrtelecom, the incumbent operator, Utel, and a number of other CLECs
including, Optima, Citius and Farlep. We believe that because of our early
market entry and our ability to provide integrated voice, data and Internet
services, we have a leading position in the high-end segments of the corporate
market. In other major metropolitan cities in Ukraine, we compete with several
other CLECs, the most significant being Optima, Velton, Farlep, and CSS
(Odessa). We are entering regional markets based on our advantage of integrated
voice, data and Internet offerings and providing high quality services to
business clients. Provision of Internet and data services is not licensed in Ukraine. As a
result there is a high level of competition on the market with more than 400
Internet Servie Providers (ISPs) in Ukraine, although some consolidation
through acquisitions has been observed on the market over the last year. The
main competitors in the corporate market for corporate data are Infocom, a
majority state-owned operator, Datacom, a data and integration services
provider, and Ukrtelecom. We seek to be competitive in the corporate networks
market by providing excellent geographical coverage, high quality circuits and
professional service. We defend our competitiveness in the Internet market by
focusing on a strategy to provide the best value and quality Internet services
for business. CARRIER AND OPERATOR SERVICES: CARRIER AND OPERATOR SERVICES IN RUSSIA The Carrier and Operator Services division of Golden Telecom provides voice
and data transmission services to other telecommunications operators, both
wireline and wireless. For international telecommunications voice operators, we are an alternative
to the incumbent for the completion of calls terminating in Russia and the CIS.
For domestic telecommunications voice operators, in addition to providing
termination for Russian and CIS destinations, we also offer international call
termination as well as providing telephone numbers (subscriber ports). In
addition, we offer VoIP and data services, including numbering capacity and
IP-centric solutions. Due to the geographic reach of our network and our high
volume of traffic, we have a lower cost basis than many of our competitors and
can therefore resell any excess termination capacity. During 2004, Russia
experienced a rapid expansion of the mobile networks into the lesser developed
parts of northern Russia and Siberia. To capitalize on this expansion brought on
by the mobile operators, we completed several projects with Vimpelcom, MTS and
Megafon in which we provide satellite based network extension into several
locations in Siberia, Sakhalin and the northern areas of Russia. We expect this
expansion to continue throughout 2005 during which time it is expected that
cellular operators will further implement their expansion plans throughout the
remaining areas of Russia. Additionally, for the wireless operators and smaller
voice providers, we provide telephone numbers that they use in selling their
services to their end-users. Our voice network infrastructure is integrated into the Moscow city
incumbent telephone network at 78 transit and local exchanges, allowing us to
deliver traffic within the local public network. In addition, our network
infrastructure is now integrated into the main public city networks operated by
the incumbent in St. Petersburg, Nizhny Novgorod, Samara and Krasnoyarsk. Our
network also interconnects directly with other fixed-line and cellular operators
in Moscow and with Rostelecom. We have constructed the infrastructure necessary
to support 150,000 ports, each corresponding to a unique telephone number. In
2004, we signed new agreements with MGTS which provide us with a further 2,000
Moscow numbers and approximately 4,000 access lines. This numbering capacity and
access lines will become fully operational in the first quarter of 2005 and will
carry additional voice and dial-up IP traffic generated by new corporate
customers and smaller carriers. In addition, in 2004 we entered into an
interconnect agreement with DalSvyaz, the incumbent operator in the Russian far
east and completed a network upgrade in Khabarovsk to provide 10,000 numbers,
which will become operational in the first quarter of 2005. In Krasnoyarsk, we
commissioned another 100,000 local numbers in 2004, of which 10,000 were already
sold to local cellular providers. For international data networking operators, we provide data connectivity
across Russia and the CIS. We have constructed a data network covering more than
200 cities across Russia and the CIS, primarily to serve our Russia-based
corporate customers, representing growth of 25% over 2003, when we operated in
only 160 cities. Through network interconnect agreements with global data
network operators, we also sell data networking services to customers outside
Russia and the CIS. We interconnect with these global providers at access
points in Stockholm, or London or Frankfurt. 10




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Our data network infrastructure consists of terrestrial and satellite
transmission capacity that we either lease or have purchased via indefeasible
rights of use (IRU). We currently have IRUs for a STM-16 between Moscow and
Stockholm, a STM-4 between Stockholm and London, and 45 Mb/s between Moscow and
9 cities in Russia. Our remaining terrestrial capacity is leased. For satellite
transmission, we entered into long-term agreements with Intelsat and
Intersputnik for capacity
covering Russia and the CIS. For IP capacity, we have nine STM-1 ports, four of
which are from UUNET and five of which are from Cable & Wireless. The Carrier and Operator Services division also provides domestic and
international IP transit services to ISPs in Russia and the CIS. Smaller ISPs
can connect to our IP backbone and then use our network to access the global
Internet or Russia-based Internet. Services and Customers Voice Services: The Carrier and Operator Services division offers two types
of voice services to its customers; call completion or termination services and
the provision of telephone numbers. For international operators, which include
traditional incumbents such as British Telecom as well as VoIP operators, we
provide call completion to the PSTNs located in Russia and the CIS. We typically
interconnect with these operators in London, Stockholm, or Frankfurt or
through the public Internet and they send us their traffic which is destined for
Russia and the CIS. International outbound switched voice traffic is routed by
destination based on either anticipated return traffic from the foreign operator
through non-geographical area codes, or through least-cost routing. We attempt
to direct international traffic through particular foreign operators so as to
balance our settlements paid to and received from foreign operators. Thereafter,
we direct all international outbound, switched voice traffic in excess of that
required to achieve the balance of the bilateral relationships to the lowest
cost route. Domestic operators in Russia and the CIS, including Russian wireless
companies such as Vimpelcom, also use us for call completion to the PSTNs
located in Russia and the CIS. They also send us international traffic that we
then pass onto the PSTN of international operators. Additionally, we provide
telephone-numbering capacity to Russian wireless operators who may purchase
large blocks of telephone numbers that they then provide to their end-users. During 2003, we started to provide equipment sales, installation and
maintenance services to cellular operators. This hardware is usually a PBX with
call center capabilities but it has also included LAN and WAN equipment. It is
our strategic intent to move beyond simply providing call completion into higher
value-added solutions such LAN and WAN solutions to cellular operators. During
2004, we started to provide satellite communication links to Russian cellular
operators. This solution is for hard-to-reach regions in Russia, such as Siberia
and the Russian far east, and allows cellular operators to grow in these markets
which still have a low cellular penetration rate. The customers for our voice services include international operators such
as MCI, AT&T, British Telecom, Cable & Wireless, TeleDenmark, TeliaSonera,
T-Systems, Telenor, Telecom Italia Sparkle, iBasis, and Teleglobe; domestic
cellular operators such as Vimpelcom, MTS, and Megafon; and domestic wireline
operators such as Comstar United Telesystems, Macomnet, and PeterStar. Data Services: The Carrier and Operator Services division also offers two
types of data services to its customers: data networking services such as frame
relay, synchronous digital hierarchy capacity and IP virtual private network
(IP VPN), and IP transit ports. In addition to providing the underlying
circuit capacity, the provisioning of both types of service also includes the
installation and maintenance of customer premises equipment (CPE) such as
routers, multiplexers and frame relay access devices. During 2004, we began offering the following new solutions to Carrier and
Operator customers and Corporate clients through our wholesale partnerships
which include:  
    Access to our Metropolitan Ethernet Network which offers high-capacity
data services, including access to our IP backbone at speeds ranging
from 2Mbit/s to STM-1 and Gigabit Ethernet circuits;
    Through our partnership with AT&T, we began offering our banking
customers access to a new IP VPN based SWIFT platform. This
application not only enriches our portfolio and strengthens our
partnership with AT&T, a leading global player, but also gives us
better access to the banking community in Russia and CIS;
    In addition, we started offering domestic and international IP VPN
services. These are based on our own MultiProtocol Label Switching
(MPLS) platform and take advantage of our international MPLS
interconnects with partners in the United States (US) and Western
Europe. Global data network operators sell worldwide data network services to their
multinational clients. Typically, these data network operators have constructed
extensive networks in the US, Western Europe and Asia Pacific but have
little, if any, infrastructure in Russia and the CIS. In order to sell a turnkey
solution to their customers, they need partners to reach the areas where they do
not have 11




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their own infrastructure. Through a network interconnect agreement with us,
these global operators are able to provide their clients connectivity to over
220 cities in Russia and the CIS where we have infrastructure. These global
operators market and re-sell our network as if it were their own network. Such
cooperation includes a joint project with British Telecom for the construction
of Visa Internationals access network in Russia and CIS. This now allows Visa
International member banks, over 45 banks in Russia and 25 banks in the CIS, to
access Visa International bank processing centers. Due to our large consumer and corporate customer base for Internet access
services, we require very high IP transit capacity from global providers such as
MCI, UUNET, and Cable & Wireless. This capacity requirement allows us to
obtain very favorable pricing from the global providers and, in turn, we can
offer Russian and CIS based ISPs an attractive pricing and quality combination
for the resale of IP services. Marketing and Pricing For each telephone number or subscriber port, customers generally pay a
one-time port fee, a flat monthly fee and per minute charges based on usage.
However, recent pricing trends for wireless operators have reflected an
increased emphasis on per minute charges based on usage, rather than on monthly
port fees. Smaller wireline operators continue to pay flat monthly fees plus
traffic charges. Voice call completion or termination services are priced per minute
according to destination. There is an increasing trend towards a single price
for all destinations in Russia although the typical pricing has separate rates
for Moscow and St. Petersburg and then a single rate for all other cities in
Russia. Prices for CIS countries will usually follow a similar pattern; the
major cities have separate rates and then the rest of the country is priced at
the same rate. The CIS countries have much smaller traffic volumes but the
prices and margins are much higher for these destinations than they are for
Russian destinations. We are actively expanding the geographic reach of our
network in order to capture these high revenue, high margin destinations. Pricing for data networking services is comprised of a number of elements:
a monthly fee for the international bandwidth capacity provided, a monthly fee
for the access port, a monthly fee for the last mile connection between our
network and the customer location and a monthly maintenance fee for any CPE that
we manage for the end-user. Additionally, there are one-time installation fees
for all of the elements listed above. Customers have the option to purchase the
CPE and provide their own maintenance, however, customers usually prefer a
turnkey solution where we manage all elements and are therefore responsible for
all service quality issues. Pricing for IP transit services sold to ISPs is either in the form of a
flat monthly fee for an IP port or based on the amount of traffic consumed by
the ISP. Typically, the larger ISPs will opt for a flat monthly fee for a large
port connection to Golden Telecom while the smaller ISPs prefer to pay per
megabyte of IP traffic that is sent to their network from our network. Competition For voice services, our main competitors are Rostelecom and Comstar United
Telesystems, part of the AFK Sistema group of companies. For data networking services, our main competitors are Equant and
TransTelecom. Equants data network in Russia is similar to our network but
their CIS coverage is not as extensive. Therefore, for networks that include
Russia and the CIS, we have a competitive advantage. Equants global presence
does, however, give it access to a wider corporate customer base than ours but
this advantage is offset, we believe, by the reluctance of Equants global
competitors such as MCI, British Telecom, Cable & Wireless, Infonet and AT&T
to use Equant locally to serve their customers. In effect, we have access to the
corporate clients of MCI, British Telecom, Cable & Wireless, Infonet and AT&T
that require connectivity to Russia and the CIS. For IP services, our main domestic competitor is TransTelecom. A number of
international IP transit providers such as Cable & Wireless and TeliaSonera
are also actively selling global IP transit services in Russia. In 2002, we
entered into a peering agreement with two other Tier 1 Russian ISPs. According
to the terms of this agreement, all Russian ISPs requiring access to these
networks will have to pay traffic charges whereas previously all peering was
free. As a result, we have been able to earn additional revenue from our
infrastructure investments in Russia while improving our competitive position
via other IP access providers. CARRIER AND OPERATOR SERVICES IN UKRAINE Services and Customers The Carrier and Operator Services division in
Ukraine operates leased international and domestic long distance networks and is
a provider of local access, international and intercity long distance services
in major Ukrainian cities where our switching equipment is located. The network
is comprised of our gateway international switching center (EWSD) in Kiev,
leased international and intercity fiber optic channels, and regional voice and
data switches. For local carriers we provide access to highly reliable and
advanced telecommunication services, WAN and broadband Internet in 27 access
points. We provide Internet 12




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access services to more than 20 ISPs in Ukraine. National frame relay service is
provided to major telecommunication operators and data carriers such as Velton,
Teleport SV and Relcom. The telecommunications company SITA is the major
consumer for our private line services. International connectivity outside the
country is provided through reciprocal cooperation agreements with international
operators such as Cable & Wireless, Telecom Austria and Elisa (former
Finnet International) as well as through Utel international networks. International and Domestic Long Distance Services. Through our gateway
switch in Kiev, we terminate incoming traffic for foreign operators destined for
our customers in Kiev, Odessa, Lviv, Dnepropetrovsk, Zaporizhya and most other
major metropolitan areas in Ukraine. Our incoming international traffic is also
terminated into other operator networks, with whom we have entered into
settlement agreements. These other operators are national cellular operator
networks like Ukrainian Mobile Communications (UMC) and Kyivstar, private
local exchange operators directly interconnected to our network and networks
belonging to Ukrtelecom, the incumbent operator in Ukraine. In 2003, we signed
amendments to the settlement agreement with Ukrtelecom allowing incoming
international traffic termination to Ukrainian PSTNs via Ukrtelecoms network.
In 2004, we also signed a new agreement with Utel for incoming international
traffic termination to Ukrainian PSTNs. Outgoing international traffic is routed
through our international gateway to international operators using least-cost
routing. We also offer domestic long distance services throughout Ukraine through
interconnection with Utel, Ukrtelecom, and through our own leased channels
between major Ukrainian cities. We hold an intercity operators license allowing
us to offer domestic long distance services directly and are interconnected in
major Ukrainian metropolitan areas to facilitate this offering. In September
2003, we signed amendments to settlement agreements with Ukrainian fixed-line
and mobile operators introducing the calling party pays (CPP) settlement
principle imposed by the changes in the Ukrainian telecommunication law. These
agreements remained in force in 2004 as well as the CPP settlement principle. The customers for this division primarily consist of international
operators, national fixed-line and cellular operators. Our main international
partners are Cable & Wireless, Elisa, and Telecom Austria. Cable & Wireless
route a major part of our outgoing and incoming international voice and data
traffic. The fixed-line operators include overlay and wireless local loop operators
in Kiev and other major cities of Ukraine, alternative regional fixed-line
operators and local operators. Among them Velton Teleport SV and Telesystems are
the major fixed-line operators in Ukraine purchasing our international
telecommunication, long distance, and voice services. A significant portion of our carrier revenue is generated from the
Ukrainian cellular operators large volumes of international and long distance
traffic. Price and quality of services are the primary factors in their purchase
decision. In 2004, several Ukrainian cellular operators, including UMC and
Kyivstar, received international communications license. Nevertheless, UMC, one
of our largest customers, continued sending a large volume of outgoing
international traffic through our network. Also, cellular operators have an
increasing demand for some value added services like our 800 service. Marketing and Pricing As a carrier for other telecommunication operators, we offer a more
attractive pricing structure for international calls than incumbent operators
like Ukrtelecom and Utel. Although price is still the primary factor in the
routing decision of the Ukrainian cellular and alternative carriers, more and
more of them demand high quality of international voice and data wholesale
services, making our offering even more attractive. As a result, our traffic
volume continues to increase, especially traffic to international destinations
and mobile networks in Ukraine. Our carrier operations are supported by a sales
force consisting of three sales managers responsible for sales to domestic
carriers and one for sales to international carriers. Despite high termination costs to the PSTN imposed by Ukrtelecom in 2003,
we successively worked with international carriers to increase volumes of
incoming international traffic terminated in Ukraine through our network. We
plan to expand our international network through new international
interconnection with major telecommunication carriers in Europe, the US and the
Middle East. Also, we utilize VoIP technology to route more international
traffic through our network. In February 2003, the Ukrainian Parliament overrode the Presidents veto
and adopted an amendment to the Ukrainian communication law prohibiting all
telecommunications operators from charging their customers for incoming calls,
thus introducing the CPP principle, which entered into effect on September 19,
2003. Simultaneously, state regulated tariffs for calls from the PSTN to mobile
networks were introduced allowing operators to receive and share revenue from
calls to mobile networks. To implement CPP settlements, we amended our
agreements with Ukrtelecom, Utel, other fixed-line carriers and Ukrainian
cellular operators establishing agreed access rates for the calls between
fixed-line and mobile networks. These changes became effective in October 2003
and enable us to receive a settlement when a fixed line party calls a mobile
telephone as well as to receive a portion of revenue when we route calls from
mobile to fixed-line networks. 13




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As a carrier for other ISPs, we offer an attractive pricing structure and,
therefore, we expect to retain our significant market share in this segment. We
expect to strengthen our positions in the regions of Ukraine due to close
cooperation with Ukrtelecom and Ucomline in these areas. In data services, an
increase in market share is expected through the continued sale of international
private line connections, international frame relay connections, and
provisioning of last mile services in major cities of Ukraine. Competition In Ukraine, the carrier market is dominated by Utel, with Kyivstar,
Ucomline, Velton and Optima becoming more competitive. Moreover, in 2004 several
Ukrainian cellular operators received international and intercity communications
licenses providing them the possibility to route their traffic themselves and to
compete with fixed line operators on this market. In response to these
conditions we are seeking to increase our share of this market by further
development of relationships with existing carrier clients by providing them
with Internet, data and value added services, and by interconnecting emerging
CLECs. Also, we plan to expand our network and interconnections within Ukraine
to reduce the termination cost of international incoming traffic coming to
Ukraine from international carriers. CONSUMER INTERNET SERVICES Services and Customers Dial-up Internet Services. We offer dial-up Internet services to consumer
markets in Russia, Ukraine, Kazakhstan, and Uzbekistan. As of December 31, 2004, we had a
subscriber base in excess of 413,000 active subscribers. We provide these
services under multiple brands, the most notable being ROL which is the flagship
of our dial-up services. As early as 1995, ROL, which at that time was known as
Russia Online, was the first Russian-English language, online service for
accessing the Internet through either dedicated private lines or dial-up
servers. Since that time, it has evolved as the only nationwide dial-up ISP in
Russia. With over 60 locations, including the major markets of Moscow, St.
Petersburg, Kiev, Almaty, and Tashkent we are also the largest ISP in the CIS. In
addition, we provide Russian language content based Internet
portals covering many topics including entertainment, education, computer-gaming
and communications specifically for the Russian mass-market. We market the
portals under the ROL brand and utilize the portal as a marketing channel for
both our existing and future customers. Furthermore, we offer advertising space
on our portals along with integrated web services to a variety of customers who
require online marketing. The consumer dial-up Internet access service has seen decreased utilization
rates over the last year as subscribers have decreased the average number of
hours spent online from approximately 25 hours to approximately 23 hours per
month. This is due to the further penetration of the market by competitors.
However, as entry level customers continue to become exposed to the Internet, we
expect their usage levels to increase. Growth in our consumer dial-up access
business during 2004 was driven by organic growth throughout the covered area.
We continued our expansion in the regional areas of Russia as well as in other
CIS countries and pursued our strategy of consolidating our brands into our
flagship brand, ROL. We plan on continuing these strategies throughout the
coming year. Asymmetric digital subscriber line (ADSL) Services. Customers receive
local access to our dial-up services throughout the covered areas through
capacity acquired through long term local interconnection agreements. Internet
backbone and long haul traffic is then provided over our domestic and
international long distance infrastructure. Currently, ROL has access to
multiple gigabit Ethernet fiber optic connections to the domestic networks as
well as the equivalent of an STM-4 international connection. ADSL services are
offered to customers in Moscow, St. Petersburg and Nizhny Novgorod. Customers of our ADSL services are provisioned through long-term agreements
with last mile providers. Although we saw dramatic growth and interest from new
customers for this service, the market is still in its infancy in Russia. In
general, we are following a strategy of providing ADSL services to our existing
customers who need on-demand-all-the-time connections. Marketing and Pricing Our dial-up services are offered mostly through prepaid tariff plans.
Almost all sales of ROL prepaid tariff plans are made possible through the sale
of scratch cards which are distributed through an extensive network of retail
outlets in our coverage area. As of December 31, 2004, the ROL distribution
network consisted of over 13,000 points of sale (POS) throughout our covered
area. The multi-tiered distribution channels and the number of POSs have grown
substantially during 2004. This growth is in part related to the establishment
of the ROL brand during 2002 and our marketing efforts to further establish
brand awareness in our primary markets. Furthermore, in regional areas a great
deal of emphasis was placed on expansion of our distribution channel to increase
availability of our services. 14




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Tariff plans are offered as Internet access packages with either hourly
based pricing policies or as bulk hour purchases. For prepaid services,
customers can purchase scratch cards from a POS or may pay directly through the
banking system. For postpaid schemes, which account for less than three percent
of sales, customers are invoiced on a monthly basis for hourly usage. Prepaid
tariff schemes provide the customer with lower hourly charges than with postpaid
tariffs. During 2004, the distribution network and POS were extensively used in our
marketing plans. We are continuing these efforts as they provide a closest
point of connection to our customers. Programs to improve our distribution
network will continue as our distribution network provides us with our closest
point of connection to our customers. These marketing efforts will be further
enhanced by our existing customer support network which provides continuous
support for end-users and business hour support for distribution customers.
Local access support numbers are provided to customers that connect them
directly to our coverage area support center located in Moscow. These calls are
carried over our voice network. Web advertising and integrated web services are marketed and sold either
directly or through an agency contract. Although the advertising market is still
in its infancy, online marketing schemes for our own services which are
connected to our content based portals will enable us to take advantage of sales
growth in the advertising market when it occurs. The ROL portals are the fourth
most visited web portals in Russia and the most visited content based portals. Competition Our dial-up services have localized competition mainly from small
businesses with limited regional coverage. In major markets, such as Moscow and
St. Petersburg, we compete with MTU-Intel and Web Plus, both of which are
affiliated with the incumbent city telephone companies. MOBILE SERVICES: GOLDEN TELECOM GSM We operate a cellular network using GSM-1800 cellular technology in Kiev
and Odessa, Ukraine, where our network covers an area with a population of
approximately 3.9 million people. Golden Telecom GSM began cellular operations
with a license allowing it to offer services in Kiev and the Kiev region and
later obtained a national operating license and commenced operations in Odessa.
However, during 2001 our mobile operations in Ukraine were under strong
competitive pressure leading to the overall decline in our mobile revenues. In
2002, we reassessed alternative strategies for our mobile operations, and
refocused our mobile operations as an additional service offered to high-end
mass market and business customers. In 2004, we became more active in the
prepaid market. Amendments to the Ukrainian Communications Law that entered into effect on
September 19, 2003, prohibited all telecommunications operators from charging
their end-user customers for incoming calls  the so called CPP principle. State
regulated tariffs for calls from the PSTN to mobile
networks were also introduced at this time, thus allowing mobile operators to
receive a share of revenue from calls to mobile networks. To effect CPP
settlements on our network, we entered into an interim agreement with Ukrtelecom
that assigns a national destination code numbering plan to our mobile customers
and reallocates our interconnect numbering capacity in Kiev and Odessa from our
mobile to our fixed network. This agreement became effective in November 2003
and enabled us to receive a settlement from revenue generated when a fixed line
party calls our mobile customer as well as releases direct city numbering
capacity for future sale to CLEC customers. Introduction of the national
destination code cancelled former numbering plan limitations and made possible
further development of our prepaid subscriber base. Services and Customers Mobile Services. We provide two types of mobile services to our clients: a
basic service for clients who utilize prepaid calling cards and an expanded
service for subscription clients, including international roaming with 100
operators in 56 countries, and value-added services such as voicemail, call
forwarding, conferencing, MMS and a broad range of short message service, or SMS
and voice information services. Our customers consist of a broad spectrum of private and corporate users.
Our customer base changed in 2004 due to the rapid growth of prepaid service
users. As of December 2004, prepaid subscribers constituted more than half of
our subscriber base. The remaining subscriber base is represented primarily by
the high-end mass market and business customer segments. Marketing and Pricing Our network has the widest frequency bandwidth allocated to any cellular
operator in Kiev, allowing us to deploy a high quality network throughout the
city and thus market ourself as a quality service provider. Due to the highly
competitive nature of the cellular market in Kiev, we focus on providing a
flexible and competitive tariff structure in two target markets. 15




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We position our subscription service as a high-quality service to private
and business users, providing clients with flexible tariff plans and a variety
of value-added services. During 2004, we continued two pricing schemes from the
previous year, one offering an unlimited number of local calls for a relatively
high monthly subscription fee, the other offering a price per minute for local
calls depending upon the total volume of calls. We have also introduced two new
pricing schemes: one with the common tariff for all outgoing calls, and one with
unlimited traffic free-of-charge within a closed corporate group. This strategy
allowed us to maintain our contract subscriber base and to utilize existing
network resources more efficiently. Our marketing strategy for pre-paid services is based on providing
competitive tariffs for mass-market users with low traffic volumes, which has
resulted in a significant increase of the number of prepaid subscribers during
2004. In March 2004, we introduced new international tariffs for prepaid
subscribers which has contributed in further increasing our subscriber base
growth. Our sales force in Kiev is represented only by direct sales
representatives, while in Odessa we utilize both direct sales and an alternative
retail dealers network. Our strategy is focused on maintaining our existing
high-end customer base with a gradual increase in the number of customers for
more efficient utilization of our network and frequency capacity. Competition The Ukrainian cellular market is highly competitive. UMC, wholly owned by
MTS, Kyivstar, owned by Telenor and an affiliated company of
Alfa Group, and Ukraine Radio Systems (URS) all operate GSM-900 networks. UMC
and Kyivstar offer nationwide coverage within Ukraine and have deployed GSM-1800
services in major metropolitan cities. UMC also operates a NMT-450 network
throughout Ukraine. URS has already launched its services in the 23 largest
Ukrainian cities. DCC, owned by Turkcell, also announced an aggressive plan to
become the third largest national GSM operator. By the end of 2004, the
Ukrainian mobile market reached 13.7 million subscribers with UMC and Kyivstar
together holding around 99% of the market. In 2004, we achieved an annual 43% growth in subscriber base to more than
57,000 customers with average revenue per user of more than $27 per month.
During the same period, our minutes of use per active subscriber decreased by
16% due to significant growth of prepaid subscriber base. This completes our discussion of our operating divisions. Please refer to
note 14  Segment Information of the Audited Financial Statements contained
within this document, for the quantitative disclosures for revenues by line of
business. ACCESS TO PUBLIC FILINGS Golden Telecom, Inc. provides public access to its annual report on Form
10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and
amendments to these reports filed with the Securities and Exchange Commission
(SEC) under the Securities Exchange Act of 1934. These documents may be
accessed free of charge on Golden Telecom, Inc.s website at the following
address: http://www.goldentelecom.com. These documents may also be found at the
SECs website at http://www.sec.gov. EMPLOYEES On December 31, 2004, we and our consolidated subsidiaries employed a total
of 3,395 full-time employees and our ventures, excluding MCT, employed 31
full-time employees. On December 31, 2003, we and our consolidated subsidiaries
employed a total of 3,004 full-time employees and our ventures, excluding MCT,
employed 134 full-time employees. Included in the number of full-time employees
were 12 and 11 expatriates as of December 31, 2004 and 2003, respectively. We do not have any collective bargaining agreements with our employees, and
we believe that our relations with our employees are good. We believe our future
success will depend on our continued ability to attract and retain highly
skilled and qualified employees. 16




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OUR LICENSES AND NETWORK FACILITIES SIGNIFICANT LICENSES Our subsidiaries and ventures hold the following licenses in Russia and
Ukraine, which are important to their operations. Renewal applications will be
applied for all licenses expiring in 2005. Switched Voice Services. In Russia, we hold several licenses for switched
services. Sovintel holds five such licenses. One license was issued to Sovintel
by the Ministry of Communications and authorizes Sovintel to provide local,
intra-zonal, intercity and international telephone services in a number of
cities, including Moscow and St. Petersburg. This license expires on March 17,
2008. Another license authorizes the provision of the same services in different
regions and expires on July 20, 2005. On October 4, 2002, a five-year license
was issued to Sovintel for provision of local and intercity services in 34
regions. This license allows our networks in these regions to interconnect with
the local public network. Two other licenses authorize the provision of the same
services in other Russian regions and expire on February 15, 2006 and October 4,
2006. On August 2, 1996, ADS was issued a ten-year license to provide local and
intra-zonal telephone services in Nizhny Novgorod and 16 other cities in the
Nizhegorod Region. WestBalt holds a license to provide local,
intercity and international telephone services in the Kaliningrad Region, which
expires on March 25, 2005. Also, Sibchallenge holds a five-year license
to provide local, intra-zonal and intercity telephone services in the
Krasnoyarsk Region, Moscow, St. Petersburg and some other cities. This license
expires on April 27, 2005. In addition to the foregoing licenses that are important to our operations
in Russia, on March 5, 2005, Sovintel submitted applications to the Ministry of
Communications for new licenses to provide domestic long distance
telecommunications service and international long distance telecommunications
services. These licenses were submitted in compliance with new Rules for
International and Domestic Long Distance issued by the Ministry of
Communications. The prerequisites for obtaining the required new licenses are
numerous and will require us to make significant capital investments in the
Russian regions during 2005 and 2006 that are, however, consistent with our
long-term objective to maintain our position as a leading provider of
telecommunications and Internet services across Russia and the CIS. In Kiev, Ukraine, we hold four licenses for provision of overlay network
services, including local, domestic long distance and international long
distance services, in the name of GTU. One license
authorizes the provision of intercity telephone services to all regions of
Ukraine and international telephone services in several regions of Ukraine,
including Kiev and Odessa. It expires on December 31, 2013. Another license
authorizes the provision of local telephone services in several cities,
including Kiev and Odessa. This license expires on December 31, 2007. Two more
licenses authorize the provision of intercity and local telephone services in
several Ukrainian cities. These licenses expire on January 28, 2014 and January
28, 2009, respectively. Another license for Wi-Fi technology within Kiev region
expires on December 3, 2009. Leased Circuits. Sovintel holds seven licenses to lease local, intercity and
international circuits in a number of regions of Russia, including Moscow and
St. Petersburg which expire on April 15, 2005, July 20, 2005, February 15, 2006,
three on July 5, 2006, and October 4, 2006, respectively. ADS holds a five-year
license to lease circuits in the Nizhegorod Region. This license expires on
September 8, 2005. Sibchallenge-Telecom was issued a license to lease circuits
in the Krasnoyarsk Region. This license expires on May 22, 2008. Tel holds a
license to lease circuits in a few regions including the Republic of Khakasia,
which expires October 24, 2007. On September 8, 2000, ADS was issued a five-year
license to lease circuits in the Nizhegorod Region. On May 29,
1999, Samara Telecom was granted a five-year license to lease
circuits on the territory of the Samara Region. It was extended until April 29,
2005. Data Services. Seven licenses to provide data transmission services were issued
to Sovintel for a large number of regions including Moscow and St. Petersburg.
The licenses are valid through April 15, 2005, July 20, 2005, February 15, 2006,
October 4, 2006, August 18, 2008, and two through October 4, 2007, respectively.
PTK was granted a five-year data transmission license for Moscow and the Moscow
region. This license expires on May 18, 2006. ADS holds a license to provide
data transmission services in the Nizhegorod Region. This license expires on
November 8, 2006. Sibchallenge a five-year license to provide data
transmission services in the Krasnoyarsk Region. This license expires on June
20, 2008. Samara Telecom was issued a license to provide data transmission
services in the Samara Region, which was extended until April 29, 2005. On
October 18, 2001, WestBalt was issued a five-year license to provide
data transmission services in the Kaliningrad Region. Local Access Services. PTK was issued a license to provide local telephone
services to 10,000 subscriber local access lines in Moscow. This license expires
on November 10, 2010. Sibchallenge was issued a ten-year license to
provide local telephone services using radio-access facilities in the
Krasnoyarsk Region. This license expires on December 19, 2007. On July 19, 1996,
Samara Telecom was granted a ten-year license to provide local telephone
services in the Samara Region. 17




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Telematics Services. Seven licenses to provide telematic services were issued to
Sovintel for a large number of regions including Moscow and St. Petersburg. The
licenses are valid through April 15, 2005, July 20, 2005, October 4, 2007,
February 15, 2006, October 4, 2006, October 4, 2007 and August 18, 2008,
respectively. Cityline holds a five-year license to provide telematics services
in Moscow and St. Petersburg. This license expires September 19, 2008. PTK was
granted a five-year license to provide telematics services for subscribers in
Moscow and the Moscow region. This license expires on March 15, 2006. On July
10, 2003 Sibchallenge was granted a five-year license to provide telematic
services in the Krasnoyarsk Region. ADS was issued a five-year license to
provide telematics services in the Nizhegorod Region. This license expires on
November 8, 2006. This license expires on
April, 26, 2006. WestBalt holds a five-year license to provide telematic
services in the Kaliningrad Region. This license expires on August 1, 2007.
Samara Telecom holds a license to provide telematic services in the Samara
Region, which was extended until April 29, 2005. Uralrelcom holds a license to
provide telematic services in the Sverdlovsk Region, which was extended until
June 27, 2005. Mobile Services. GTU holds an operating license for mobile services in Kiev and
the Kiev region, which expires on December 31, 2007. The associated frequency
licenses expire on July 31, 2013 and July 7, 2014. In addition, GTU received a
national operating license for provision of GSM-1800 mobile services within the
remaining territory of Ukraine valid until January 28, 2009, as well as a
frequency license for Odessa and the Odessa region valid until January 19, 2010.
GTU also holds a relay license for Kiev and the Kiev region, which expired on
January 25, 2005 and for the Odessa region, which expires on August 2, 2015. We
have submitted a renewal application for the relay license in Kiev and the Kiev
regions, however, license renewals appear to be delayed due to governmental
reorganization following the election of President Yuschenko. As a result of merger of Combellga and Comincom to Sovintel, all of
Combellgas and Comincoms telecommunication licenses must be re-issued to
Sovintel. Sovintel has filed the required applications to the appropriate state
authority and continues providing services under the said licenses.
Rossvyaznadzor has confirmed that Sovintel, pending receipt of the new licenses,
may continue to provide the services previously covered under the licenses
issued to Combellga and Comincom. NETWORK FACILITIES Our telecommunication networks reflect the licensing regime adopted by the
industry regulators in relevant countries and consist of technologically
advanced systems designed for businesses and consumers. We own the essential network elements of the network, including switching
technology and transmission technology, and either own or lease the network
transport elements as well as access to our customers. We also own the necessary
support systems to operate our network, serve our customers and charge for our
services. Metropolitan Area Networks In Moscow, Kiev, Odessa, St. Petersburg, Nizhny Novgorod, Krasnoyarsk,
Vladivostok, Khabarovsk, Voronezh and Samara we operate MANs. In each of these
locations, we own or lease local access lines and PBXs, local exchange switches,
local numbering capacity, fiber optic transmission rings and a fiber optic
backbone. Our facilities in Moscow are fully integrated with our domestic and
international networks, as well as with the networks of Rostelecom and the
Moscow City Public Telephone Network (MGTS). The Moscow MAN includes the following
facilities: Voice Services. We have access lines supporting more than 200,000 local access
numbers in the 095 area code which is a terrestrial code for the Moscow
region. Our network connects approximately 3,000 buildings to more than 1,100
PBXs. Our PBXs are typically located on customer premises to distribute advanced
telephony services in those premises to the end-users. Our PBXs function as
switches that permit users to receive incoming calls, to dial any other
telephones on the premises that are connected to the PBX, to access a line
leading to another PBX or to access an outside line to the public switched
telephone network. Sovintel has constructed approximately 4,200 kilometers of
fiber in Moscow. Sovintels network consists of 20 hub PBXs connected to the fiber optic
network, complemented by the EWSD local and tandem switches, Nokia DX-200, and
three Nortel DMS switches. These hub PBXs act as traffic aggregators for
Sovintels 900 PBXs located in customer premises. Sovintels network is
connected to major office buildings, hotels, business centers, and factories and
is co-located with 82 central offices of MGTS. In 45 MGTS central offices Sovintel has access to copper wire
facilities. The copper wire facilities are used when a customers requirements
do not justify the immediate investment in fiber optic facilities. To service the needs of SME and small office/home office customers,
Sovintel operates two solutions in Moscow: (1) a synchronous digital subscriber
line (SDSL) solution over the copper wire of the MGTS network and (2) a
Wireless Local Loop (WLL) solution based on AirLoop equipment of Lucent
Technologies and WalkAir equipment of Siemens. The SDSL technology provides a
customer with up to 4 telephone lines and a dedicated link to the Internet with
2Mbps downstream speed. We have 18




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approximately 3,500 SDSL contracts in Moscow and over 500 contracts in St.
Petersburg. We also have more than 4,000 ADSL customers in Moscow. Sovintels
WLL access network covers over 80% of corporate customers locations in Moscow.
Sovintel has begun installation of SDSL and ADSL solutions in other cities of
Russia, including Vladivostok, Voronezh and Volgograd. Data and IP services. Sovintel provides local access for its data service
offering in Moscow generally using the same intracity transport and customer
access network as described above. This network is complemented by access lines
leased from other Moscow-based operators that possess their own local access
networks where our data customers are not otherwise on our network. The steady
growth of our MAN has reduced the need for such outsourcing to less than 20%. We
operate 10 STM-1s in Stockholm to provide international IP connectivity. St. Petersburgs Networks. Sovintels St. Petersburg networks
consist of a EWSD switch, an Alcatel S12 switch
and hub PBXs interconnected to the St. Petersburg PSTN through the St.
Petersburg City Telephone Network, with capacity for 12,000 local numbers and
approximately 280 PBXs that are installed on customer premises and within
business centers. We have constructed approximately 1,000 kilometers of fiber
optic cable in and around St. Petersburg, which is used to connect office
buildings and business centers to our network. This is complemented by our data,
telephony and IP network with STM-16 capacity on our international cable system.
We also use 8 STM-1s as leased capacity. Kiev Local Network. In Ukraine, GTU provides local exchange carrier services
through our MAN in Kiev. GTU provides last mile connections, both copper and
fiber optic, from four large switches acting as hubs in Kiev and more than 30
PBXs that are installed at POPs and within business centers. In Kiev, we have
constructed a 300-kilometer fiber optic ring based on Synchronous Digital
Hierarchy, consisting of a main loop and five sub-rings. We plan to extend the
total fiber optic network to serve additional customers. We have also
constructed a data network consisting of seven data switches. Regional Local Networks. We offer combined voice and data services with access
to the local PSTN in 15 different major metropolitan areas in Russia. Depending
on the region, we have 400-3,000 local lines in service, for a total combined
capacity of more than 15,000 lines. Last mile access to the customers is usually
provided through leased copper or fiber optic lines. Additionally, our 2001
acquisition of ADS in Nizhny Novgorod provided us with approximately 30,000
access lines in service making us the second largest operator in this region.
Our acquisition of Sibchallenge in 2003 provided us with 200,000 telephone
numbers allocation in the city of Krasnoyarsk. With the acquisition of Samara
Telecom in February 2004, we have added another 100,000 telephone numbers in
service. WestBalt added 100,000 allocated telephone numbers in Kaliningrad. Dial-up Internet Local Access Network. Sovintel also employs dial-up Internet
access servers using more than 17,000 dial-up modem lines in 60 cities in Russia
and the CIS, allowing our customers Internet access through a local call. This
dial-up roaming service is also available in over 80 countries through the
international data-roaming entity, GRIC Dial. Through these dial-up access
servers, we offer local roaming for Internet access, whereby an Internet
customer normally residing in Moscow may travel to other regions in Russia and
outside Russia, call a local access number and access the Internet. This service
may further expand with the development of our network. We are continuing to review alternative access technologies with technology
providers, our partners, and other providers in the Russian Internet market. We
are establishing and building a premium Internet network for our subscribers,
and to this end we were the first to order Gigabit Switch Routers from Cisco for
the Russian market. Currently, we have three of these routers in major traffic
points in our network and we will be expanding, as necessary, with similar or
other large-scale technologies in the future. We are continuing to
expand our modem pools as necessary to meet market demands, subject to the
limitations of the infrastructures that are currently in place. In all cases,
our major backbone links are 100% redundant and provide immediate backup and
recovery facilities. The hub of our IP network is our Internet Data Center in Moscow. This
location has redundant power supplies as well as high-level security and fire
systems. The center was built taking world-class standards into consideration. International Networks Sovintel provides international switched voice, data and IP services in
Russia using leased transmission capacity that they obtain from Rostelecom and
Transtelecom within Russia, and international carriers beyond the Russian
borders. Similarly, in Ukraine, GTU leases capacity from Ukrtelecom for domestic
segments and from international operators for international segments. We operate
three international gateway switches. Two switches, Sovintels Nortel DMS 300
and Alcatel S12, are located in Moscow, and the other international gateway
switch, GTUs Siemens EWSD, is located in Kiev. Sovintel uses Nortel asynchronous transfer mode Passport technology for its
core data network to provide certain international private line circuits and
international data transmission services, such as X.25, asynchronous transfer
mode and frame relay and Cisco routers for Internet access. We lease domestic
fiber optic capacity necessary to implement these service offerings from
Rostelecom, Transtelecom, Ukrtelecom, Rascom and TeliaSonera. International
segments of these offerings are provided in cooperation with 19




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international operators such as TeliaSonera, UUNet, Cable & Wireless, AT&T and
Infonet. In Ukraine, international outgoing and incoming traffic is similarly
routed by GTU via fiber optic cable to Cable & Wireless, Sovintel in Moscow and
several other international operators. In addition to their terrestrial network,
Sovintel also uses satellite transmission to offer the same services between
Moscow and other major CIS cities such as Almaty, Tashkent, Tbilisi and Baku. Additionally, we lease STM-16 capacity (2.4 Gbps) from Moscow to Stockholm
from TeliaSonera and its subsidiary companies. The capacity on the TeliaSonera
fiber optic network was acquired on February 7, 2000, through a 10-year lease
agreement with an option to renew for 5 years. Initially the equivalent of an
STM-1 (155 Mbps) was activated in March 2000 and the capacity was incrementally
upgraded to STM-4 (622 Mbps) in August 2000 and to STM-16 (2.4 Gbps) in the
first quarter of 2001. We also leased 4 STM-1s in 2004 and 4 STM-1s to date in
2005 to cope with growing traffic requirements. Domestic Long Distance Networks Sovintel
has developed a land and satellite-based
regional network to provide domestic long distance and data services in Russia.
Our land-based domestic long distance network consists primarily of fiber optic
capacity leased from Rostelecom and Transtelecom. We use this land-based network
primarily to serve our regional voice, data and Internet businesses. This
network together with our satellite-based network currently accesses more than
160 different access points across Russia and in certain other large cities in
the CIS. We have also started construction of our own intercity fiber optic link in
cooperation with a mobile operator to decrease our reliance on leased capacity.
We expect that this intercity fiber optic link will be operational in the second
half of 2005. To date, this intercity fiber optic link has been completed from
Moscow to Noginsk, with other segments under construction. Sovintel
also has capacity on satellite transponders (90 MHz in C-band
and 72 MHz in Ku-band) from Intelsat. The coverage area of these satellites, or footprint, includes the full
territory of Russia and other countries of the CIS. Using these leased satellite
transponders, Sovintel serves 14 Regional Earth Stations (RESs) and more than
90 VSAT stations across Russia and the CIS. A VSAT is a relatively small
satellite antenna, typically 2.4 to 4 meters in diameter, used primarily for
satellite-based point-to-point applications. These RESs and VSATs interconnect
with our central hub in Moscow and with local facilities in the areas where the
RESs and VSATs are located. Starting in 2004, we began to use capacity of
Intersputnik, starting from 36MHz and gradually increasing up to 72MHz in
line with growing demand. Sovintels central hub in Moscow interconnects with
the Moscow-based international, domestic long distance and local facilities of
Sovintel. We also operate the network based on Eutelsat and Express space
segments both in Ku-band operating DAMA network. We also operate Express
capacity in C-band. Within these networks, we serve approximately 100 VSAT
stations in Russia. Sovintel developed land-based technology in parallel with a satellite
network for a number of reasons, including the following:  
    Fiber transmission is more suitable for data applications than
satellite transmission because of fewer transmission delays;
    VSAT technology is expensive for customers with limited capacity
requirements; and
    There is no public data network, so we need to establish land-based
points of presence in each location where customers require data
services. We are implementing a strategy to integrate our land-based and satellite
networks and to integrate the different technologies integral to each, thereby
developing a single, multi-purpose network. The technologies required to carry
voice over packet networks, such as voice over frame relay, voice over IP and
voice over asynchronous transfer mode, have become available and allow for such
network integration. This integration may benefit us in different ways. The
integration:  
    Creates the possibility to carry voice on net between multiple
locations. This application was not possible with a satellite-only
network because the time delays in consecutive satellite hops are
impractical for efficient communications at multiple locations;
    Creates the possibility to terminate traffic in significantly more
access points. Access points established originally for data services
may be extended to carry voice over an interface to a local voice
operator, allowing us to extend our service offering to other
operators;
    Improves network resilience both for voice and data networks through
the optimal combination of land-based fiber and satellite transport
capacity; and
    Enables us to operate an integrated network over which we could offer
voice, data and Internet services. We have already upgraded more than 30 points of presence to carry packet
switched voice, and we also intend to upgrade other points of presence to
provide this capability. 20




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THE ENVIRONMENT IN WHICH WE OPERATE To facilitate a more complete understanding of our business and our
operations, this section provides an overview of some of the key features of the
markets where we operate and derive substantially all of our revenue. These
overviews focus on our two largest markets, Russia and Ukraine and include:  
    An overview of the telecommunications markets;
    An overview of the political and economic environment; and
    An overview of the legal, tax and regulatory regimes. OVERVIEW OF TELECOMMUNICATIONS MARKETS IN RUSSIA AND UKRAINE The Telecommunications Market in Russia. Prior to the early 1990s, the
public telecommunications network in the former Soviet Union was inefficient,
unreliable and underdeveloped relative to the networks in more-developed
countries. In the early 1990s, the Ministry of Communications, which had
formerly controlled the Soviet telecommunications infrastructure, ceded
operational control to a single long distance and international carrier,
Rostelecom, and 80 incumbent regional operators, including four independent city
networks in Moscow, St. Petersburg and two other cities. The local telcos
provide local exchange services for customers within their regions, but since
February 2003 they are obligated to provide access to the international and
domestic long distance services. In the incumbent network domestic long distance
calls to and from areas outside the local telcos service area, as well as
international calls, are switched through Rostelecom, which interconnects with
the local telcos to complete domestic long distance calls and with foreign
carriers to complete international calls. The dissolution of the Soviet Union and the collapse of the centrally
planned economy reduced the funding available to the local telcos at a time when
demand for telecommunications was increasing. The growth in the Russian
telecommunications industry since the early 1990s has been principally driven by
businesses in Moscow requiring international and domestic long distance voice
and data services and by mobile telephony users. The growth in Moscow
accelerated as multinational corporations established a presence in the capital
and Russian businesses expanded. The formerly state-owned local telcos, however,
which generally employed an outdated, dilapidated analog infrastructure, could
not support the requirements of high-volume consumers of sophisticated
telecommunications services. As a result, the inadequacies of the existing
legacy networks constructed during the Soviet era became more apparent. Further,
the proceeds received by the Russian government from the privatization of state
telecommunications assets were not used for the infrastructure improvements
required to meet increased demand. As a result, the Ministry of Communications
issued licenses to domestic and foreign funded companies to encourage investment
in the telecommunications infrastructure. The licensing structure adopted by the
Ministry of Communications directly reflected the areas of the legacy networks
in most urgent need of investment. Generally, voice and telephony licenses were
issued to provide local access, local exchange, and international and domestic
long distance services. Although it remains subject to certain restrictions, significant progress
in privatization of the telecommunications industry in Russia has occurred. At
present, virtually all the former state telecommunications enterprises have been
privatized and, subject to restrictions, shares of the newly formed joint stock
companies have been sold to the public. Also, a significant number of private
operators provide a wide variety of telecommunications services pursuant to
licenses issued by the Ministry of Communications. In September 1995, the Russian government established Svyazinvest as a
holding company for the states telecommunications assets. Svyazinvest now holds
the Russian governments equity interests in all the incumbent local telcos, as
well as Rostelecom. In July 1997, a 25% plus one share interest in Svyazinvest
was sold to a private consortium, Mustcom Limited, for approximately $1.9
billion. In 2000, the government announced a plan to restructure and consolidate
Svyazinvests holdings and in 2002 the reorganization was completed by merging
all regional incumbent operators into 7 large interregional companies. On
February 2, 2005, the Russian Minister of Communications announced that the remaining 75% minus one share of Svyazinvest,
including Rostelecom, will be privatized in 2005 or 2006. Svyazinvest currently
owns controlling voting interests in all 7 interregional companies and
Rostelecom and owns substantial equity interests in four other local telcos,
including MGTS. On June 7, 2003, President Putin signed a new Law on Telecommunications
(the New Law) which came into effect on January 1, 2004. The New Law clarifies
areas in the telecommunications law which were poorly defined, such as
interconnect and licensing arrangements, however, most of the supporting
regulations for the New Law have not been passed and many key regulations exist
in draft form only. The New Law introduces the concept of the Universal Service Fund (the
USF). All telecommunications companies are expected to contribute to the USF
which is designed to support the development of telecommunications
infrastructure which is deemed to be economically unviable but socially
necessary. It is expected that the amount of the universal service
charge paid to the USF will not exceed 3% of
certain revenues of a 21




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telecommunications company. It is expected that the first payments to the USF
will be made in 2005, however, the Ministry of Communications has not indicated the exact date for such implementation, due to
the lack of supporting regulations to be issued by the Russian government. Under the New Law, interconnect regulation becomes, in theory, more
transparent. The New Law states that any telecommunications operator which has a
significant presence in a given market must provide interconnect arrangements to
all operators. This section of the New Law is designed to eliminate the
discrimination which is experienced by telecommunications operators when
attempting to interconnect with regional incumbents. In February 2005, we received notice from Vimpelcom,
our largest customer,
that it is diverting a volume of traffic away from us pursuant to the telephone
traffic routing provisions of the New Law and the General Scheme
for operation of the Russian GSM Network promulgated by the Ministry
of Communications. At this point, we are in discussions with Vimpelcom and
regulatory agencies and cannot accurately predict what will be the impact of
this new issue on our operations going forward. Since January 1, 2005, we have
lost approximately $0.2 million in revenue due to Vimpelcoms action. The New Law, as drafted, should make the licensing process more
transparent. Under the New Law, licenses will be issued with frequencies
attached to them and frequencies are to be sold through specially organized
tenders and auctions. If the frequencies are available, licenses must be issued
within thirty days of the application. The Telecommunications Market in Ukraine. The evolution of the
telecommunications sector in Ukraine is similar to that in Russia. Over the last
number of years, both incumbent and alternative CLEC operators in Ukraine
completed modernization of their networks in Kiev and in some other large
Ukrainian cities and became more active in service development. Outside Kiev and
other large cities, the infrastructure is still outdated and the industry is
generally inefficient and provides low-quality services. Many tariffs are still
set by the state as a result of political considerations although the levels of
such tariffs are now approximating those expected by the telecommunications
market. In contrast to Russia, there has been no privatization of the state-owned
telecommunications sector in Ukraine. Whereas privatization of Ukrtelecom, the
state monopoly, was considered crucial for raising funds for the state in 2004,
several changes in priorities and political positioning have resulted in further
delay. The Ukrainian government, appointed in 2005, has indicated that it does
not plan to sell any part of Ukrtelecom in 2005. To date, only about 7% of the
monopoly carrier has been privatized to employees and managers. Since August 2004, the Ministry of Transport and Communications was the
regulatory body that oversaw the Ukrainian telecommunications industry. The
Ministry was responsible for licensing, and setting tariff regulations. As of
January 2005, National Commission of Communications Regulation received the
above mentioned functions. Tariffs for local calls and calls between and within
regions are set at levels below those which would prevail in a deregulated
market. Inter-operator tariffs, however, are often set at levels which challenge
the ability of competing operators to effectively position themselves against
the monopoly operator. Ukrtelecom, the Ukrainian incumbent public operator, is the main provider
of telecommunications services in the country. Utel, a branch of Ukrtelecom
since 2004, is the dominant national and long distance operator. Ukrtelecom is a
joint stock company owned 93% by the State Property Fund with 31 branches, 27 of
which represent the company in each region of Ukraine. Ukrtelecom holds national
transmission networks, along with broadcasting, research and satellite assets.
Ukrtelecom also owns shares in five other Ukrainian telecommunication companies. Public switched voice telephony in Kiev is delivered through a layered
hierarchy similar to that used in Moscow. We connect our customers using our
local access network with fiber optic and copper-based facilities, which provide
direct interconnection with the Kiev city telephone network. The Ukrainian mobile telecoms market is currently served by five operating
companies. GTU commenced operations in accordance with its GSM-1800 license in
late 1996. OVERVIEW OF THE POLITICAL AND ECONOMIC ENVIRONMENTS IN RUSSIA AND UKRAINE Russias Political Environment. Since the dissolution of the Soviet Union
in December 1991, Russia has been in the process of a substantial political
transformation. The Russian Constitution, ratified in 1993, establishes a
three-branch governing system that replaced the Communist dominated Soviet
system. The three-branch system consists of a powerful executive branch led by
the President, a bicameral legislative branch with an upper assembly, the
Federation Council, and a lower assembly, the State Duma, and a judicial branch,
which is still underdeveloped. Boris Yeltsin was elected to a second term as
President in July 1996 but shortly thereafter lost popular support on account of
political and economic dislocations, disaffection with economic reform,
institutionalized corruption and his erratic stewardship of the country. On
December 31, 1999 Yeltsin resigned the presidency, thereby enabling the Prime
Minister, Vladimir Putin, to be elevated to the role of acting president and to
emerge as the winning candidate in the presidential election which was held on
an accelerated basis on March 26, 2000. On March 14, 2004, Vladimir Putin was
elected to a second presidential term. As a result of the frequent changes of government in Russia and the other
countries of the CIS, government policies are subject to rapid and potentially
radical change. High levels of corruption exist among government officials and
among commercial enterprises in which the state has an ownership interest. In an
attempt to increase the influence of federal authorities in the regions,
President 22




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Putin organized the Russian regions into seven administrative regions and
appointed special presidential representatives to coordinate and enforce federal
policies in each of these regions. Effective January 1, 2005, gubernatorial
elections were abolished in favor of a system under which regional governors
will be nominated by the President and then approved by local legislatures. The
regional governors authority has also been increased. These policies appear to
be leading to a reassertion of federal power in the regions but corruption on
the local and federal levels remains problematic. Russias Economic Environment. In the immediate aftermath of the 1998
financial crisis, the rubles value declined substantially below the 9.50 rubles
per USD floor set on that date, but in the last year has settled in the range of
27 to 28 rubles per USD, with the rate being 27.87 rubles per USD on January 1,
2005. The value of the ruble against the USD increased 6.1% in 2004. World oil
prices have contributed to the recent strength of the ruble as the Russian
Central Bank reported hard currency reserves of over $124.5 billion, as of
January 1, 2005. According to government figures, inflation has come under
relative control since the crises with annual inflation numbers of 84% for 1998,
36% for 1999, 20% for 2000, 19% for 2001, 16% for 2002, 14% for 2003 and 12% for
the year 2004. Inflation is expected to be approximately 11% in 2005. It is
estimated that there will be a $67.0 billion trade surplus in 2005 and a gross
domestic product increase of 5.8% in 2005 as compared to 2004. These positive
economic indicators must be considered in the context of Russias status as a
major exporter of oil and other natural resources. Any decline in world oil
prices could negatively impact the value of the ruble and the continued
development of Russias economy. Ukraines Political Environment. Ukraine declared independence from the
Soviet Union in 1991. Since that time, Ukraine has established a three-branch
system of government similar to that in Russia. Following a period of
significant political debate, the new Ukrainian Constitution was ratified in
June 1996. Independent Ukraines first President Leonid Kravchuk led the country
through a period of significant economic and social decline. Following the 1995
presidential elections, Leonid Kuchma succeeded him. Ukraine is one of the few
former Soviet republics to smoothly and peaceably transfer executive power.
President Kuchma was re-elected for another five-year term in November 1999. On
January 10, 2005 Victor Yuschenko was declared the President of
Ukraine after a divisive
presidential election against Victor Yanukovich. Until recently, political power was fairly evenly divided between the
president and parliament and consequently major policy decisions were frequently
blocked by parties exercising influence or control over the presidential
administration or the parliament. Political reform efforts progressed somewhat
during Mr. Kuchmas presidential period, but the judicial system lacked
independence and its decisions were often influenced by political
considerations. Preceding the third round of the presidential election on December 8, 2004,
the Ukrainian Parliament (Verkhovna Rada) adopted a draft law on amendments to
the Constitution that, to some extent, reduce presidential powers. These
amendments to the Constitution will take effect by January 1, 2006. Under the
amendments, the Parliament will form a new Cabinet of Ministers following the
Verkhovna Rada elections in March 2006. Additionally, the Verkhovna Rada
increased the term of the Parliament authority from four to five years. Considering the constitutional changes and the fact that significant
portions of the population in eastern Ukraine voted for President Yuschenkos
rival, Victor Yanukovich, in the presidential election, it is not clear whether
President Yuschenko will be able to maintain the same amount of control over
policy as his predecessor. Some Yanukovich supporters have vowed not to support
President Yuschenkos administration and have threatened to launch a secession
bid for eastern Ukraine. Ukraines Economic Environment. In September 1996, a new currency, the
hryvna, was introduced, replacing the temporary karbovanets (coupons) that were
in circulation following the countrys independence from the Soviet Union. The
National Bank of Ukraine, the nations central bank, has steadfastly refused to
permit wholesale printing of the currency despite much pressure from the
Parliament. The hryvna is now subject to a floating exchange rate whereas it was
previously kept within a fixed range. In 2004, the hryvna was stable, moving
from 5.33 per USD at December 31, 2003 to 5.31 at December 31, 2004. The
hryvnas stability was due in large part to increase in exports in both 2003 and
2004. While in 2003 increases of imports by 36% over 2002 led to a decrease in
Ukraines trade surplus from 980.3 million hryvna to 59.4 million hryvna, the
situation changed dramatically in the first half of 2004  export of goods and
services increased by 43% over the same period last year with 30% increase in
imports. Ukrainian current account surplus accumulated over 2004 allowed the
National Bank of Ukraine to increase the amount of its net gold and hard
currency reserves from $7.0 billion available at the end of 2003 to $9.5 billion
at end of December 2004. Social payments which were increased by the Government
during the presidential election campaign resulted in higher than a forecasted
rate of inflation of 12% in 2004. Nevertheless, Ukraine experienced 12% real GDP
growth in 2004 compared to 9% growth in 2003. OVERVIEW OF THE LEGAL, TAX AND REGULATORY REGIMES IN RUSSIA AND UKRAINE Russias Legal, Tax and Regulatory Regime. After the dissolution of the
Soviet Union in December 1991, former President Yeltsin and the Duma enacted
piecemeal legislation in an attempt to develop a legal framework to guide the
transition from a centralized command economy to a more market-oriented economy.
While the rudimentary legal framework continues to develop, legislation is 23




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often inconsistent, contradictory, poorly drafted and unclear. This general
characterization is particularly applicable to corporate governance regulations
and tax legislation. During 2000, at the urging of President Putins government,
the State Duma approved the first two parts of the revised and reportedly
simplified Russian Tax Code. The second part entered into effect as of January
1, 2001 and additional provisions came into effect as of January 1, 2002.
Similarly, under pressure from the executive branch, the Duma finally enacted a
new Labor Code, which entered into effect in February 2002 and replaced the
antiquated Labor Code left over from the Soviet era. Still, ambiguities in the
law are exploited by bureaucrats struggling to increase state budgetary
resources. Administrative regulations and decrees are frequently not published
and are not available for review. The judiciary in Russia is regarded as not
sufficiently independent from political influence and judges are frequently
underpaid, inexperienced and commercially unsophisticated. In addition, judges
are subject to intimidation, and corruption in the judiciary is not unusual.
Hence, in such an environment, contracts are frequently unenforceable in courts
of law. The State Duma has enacted legislation to protect foreign investment and
other property against expropriation and nationalization. In the event that such
property is expropriated or nationalized, legislation provides for reimbursement
of the value of the property and damages. However, due to the lack of state
budgetary resources, experience and political will to enforce these provisions,
and due to potential political changes, it is uncertain whether such protections
could be enforced. In addition to telecommunications legislation, the Russian
telecommunications industry has also been shaped by privatization legislation
and the privatization of state-owned telecommunications enterprises. Historically, taxes payable by Russian companies have been numerous and
substantial. These include taxes on profits, assets and payroll, and value-added
tax (VAT). The recently enacted Tax Code represents an attempt to rationalize
the federal tax system. We expect an overall reduction in our Russian tax burden
and have experienced such reductions over the past two years. For example, from
January 1, 2003, under the new Tax Code, taxes calculated on the basis of gross
revenue have been abolished. The maximum unified payroll tax rate has decreased
from 38.5% to 35.6% in 2001, remains at 35.6%. From January 1, 2002, the rate of
corporate profit tax decreased from 35% to 24%. The VAT rate decreased from 20%
to 18% as of January 1, 2004. Russian companies within the same ownership group cannot be consolidated,
and therefore, each company must pay its own Russian taxes. Because there is no
consolidation provision, dividends are subject to Russian taxes at each level
that they are paid. Currently, dividends are taxed at 15% and the payor is
required to withhold such tax when paying dividends, except with respect to
dividends paid to foreign entities that qualify for an exemption under treaties
on the avoidance of double taxation. In various jurisdictions, we are obligated to pay VAT on the purchase or
importation of assets, and for certain other transactions. In many instances,
VAT paid on purchases can be offset against VAT which we collect and otherwise
would remit to the tax authorities, or may be refundable. Because the law in
some jurisdictions is unclear, the local tax authorities could assert that we
are obligated to pay additional amounts of VAT. In our opinion, any additional
VAT which we may be obligated to pay would be immaterial. In addition, the new Tax Code authorizes Russias regional legislative
authorities to impose a local tax on the sale of goods and services on their
territories. A number of such subdivisions have exercised this authority,
including Moscow and St. Petersburg which have each established a local sales
tax rate of 5 percent. This local tax on the sale of goods was abolished as of
January 1, 2004. Pursuant
to the New Law and governmental decrees, the
Ministry of Communications is assigned the authority to regulate and control the
development of the communications industry in Russia. Additional legislation
defines the roles of other communications regulatory organs, with the Ministry
exercising responsibility over the issuance of each operators licenses and
supervising the other communications regulatory organs. The Federal Service for
the Supervision of Communications (Rossvyaznadzor), which is now a department
of the Ministry of Communications, is empowered to issue certain permits
required for network operation and for the importation and use of
telecommunications equipment. Rossvyaznadzor conducts periodic inspections to
determine an operators compliance with the terms and conditions of its licenses
and is authorized to issue orders and instructions requiring operators to bring
their network into compliance with their licenses or to face fines and/or to
suspend a license, or in the case of continued non-compliance, to initiate court
proceedings for the revocation of a license. In addition, entities such as
Svyazinvest at the federal level, as well as other entities in Moscow and St.
Petersburg and other administrative regions within Russia exercise significant
control over their respective local telephone networks and may therefore affect
the licensing process. The State Commission for Radio Frequencies (GKRCh) is responsible for
administering the utilization of the radio spectrum. This government agency
assigns and oversees the operation of radio frequencies. Legislation and normative acts specific to the telecommunications industry
provide the regulatory framework that guides our operations. On January 1, 2004,
the New Law came into effect. The New Law outlines the regulatory framework for
the telecommunications industry and clarifies certain poorly defined areas of
telecommunications such as interconnection and licensing. It sets forth general
principles for the right to carry on telecommunications activities, describes
government involvement in telecommunications regulation and operation,
establishes the institutional framework involved in regulation and
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telecommunications, and deals with various operational matters, such as
ownership of networks, protection of fair competition, interconnection, privacy
and liability. Separate legislation and administrative regulations implement
this institutional framework. The
New Law introduces a USF which will result in higher
costs for all operators, including CLECs such as our company. Under the New Law,
all telecom operators must contribute to the USF. The
USF is designed to fund socially important but economically
unviable projects. The New Law, however, does not provide clarity as to how the
USF will be collected and administered, and these matters
will be specified under regulations to be issued by the Ministry of
Communications supporting the New Law. It is expected that the amount of the
universal service charge will be not exceed 3% of certain of a
telecommunications companys revenues. It is expected that the
USF will
commence operating in 2005. The New Law also introduces the significant operator concept. Significant
operators are defined as those companies which generate either more than 25% of
traffic or possess more than 25% of the local numbering capacity. Significant
operators may not refuse to provide interconnect services, and interconnect
rates should be public and equal for all operators. This change will make it
more difficult for regional operators to discriminate against competitors in
order to protect their own operations. The New Law is also intended to make the telecommunications licensing
process more transparent. Licenses must be issued with frequencies attached to
them. Frequencies are to be sold through tenders or auctions and licenses must
be issued within thirty days if the frequencies are available. We cannot predict with any certainty how the New Law will affect us. Until
such time as appropriate implementing regulations are published by the Ministry
of Communications, there will be a period of confusion and ambiguity as
regulators interpret the legislation. We cannot predict with any certainty
whether we will face additional costs associated with the implementation of the
New Law. It can be difficult and expensive to comply with applicable Russian
telecommunications regulations. Telecommunications in Russia are confidential
and may only be intercepted pursuant to court order. Nevertheless, we are
subject to SORM, the Russian acronym for the surveillance system operated partly
by the Federal Security Service, a government agency that is responsible for
electronic surveillance. SORM requires telecommunications networks to facilitate
monitoring of electronic traffic. Many operators and commentators consider that
SORM, as applied, is inconsistent with the privacy provisions of the Russian
constitution. Full compliance with SORM may be expensive, burdensome and
unconstitutional, yet noncompliance with SORM may lead to the administration of
fines, penalties or the revocation of our operating licenses. Ukraines Legal, Tax, and Regulatory Regime. A primary contributor to the
relatively slow pace of reform in Ukraine has been the absence of a coherent and
enforceable legal framework to facilitate widespread privatization of government
assets. As an example, the privatization of Ukrtelecom, the State
telecommunications monopoly, has been repeatedly delayed because of the absence
of key laws required to enable such privatization. As with other former Soviet Republics, Ukraine is still plagued with
widespread corruption, however, organized criminal groups that were very active
throughout Ukraine during the 1990s have been almost completely disbanded.
Because of high levels of corruption among government officials and among
commercial enterprises in which the state has an ownership interest, the newly
elected President and the Government announced tackling corruption as one their
primary tasks. Although we do not believe we have been adversely affected by
these activities to date, organized or other crime could in the future have a
material adverse effect on our operations and the market price of our common
stock. After significant legislative changes over the last few years in Ukraine
and Russia, the Ukrainian tax regime differs significantly from the Russian tax
regime. The Ukrainian tax regime includes taxes on profits, on payroll, VAT, and
special fees and taxes levied against telecommunications operators. In order to
stimulate economic growth and broaden the tax base, in 1999 the Government
introduced a significant reduction in payroll taxes followed by a subsequent
abolition of revenue-based taxes in 2001. At the beginning of 2003, the
Ukrainian Parliament adopted amendments to the Profit Tax Law that, among other
changes, reduce the profits tax rate from 30% to 25%. The major components of
these amendments came into effect in 2004. The regulatory framework governing the telecommunications industry in
Ukraine has improved significantly after the new law On Telecommunications
came into force on December 23, 2003. The new law sets forth the general
principles for telecommunications activities, networks and services, including
the relationships between operators and customers. The new law provides for the
creation of two new executive bodies  the Central Executive Authority in the
Communication Sector (CEACS) and the National Commission for Communication
Regulation (NCCR) to replace the former State Committee for Communications. CEACS retains mostly administrative functions in the telecommunications
industry in Ukraine. CEACS develops draft telecommunications laws and other
legal documents, defines and monitors quality standards in telecommunications
services. NCCR retains regulatory functions in telecommunications and
radio-frequency utilization. It is also the central executive body with special
status subordinated to the President of Ukraine. NCCR supervises the observance
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telecommunication services. NCCR assigns numbering capacity, grant licenses,
registers services in the telecommunication sector, provide tariff regulation,
and applies sanctions to those that violate telecommunication laws. In February 2003, the Ukrainian Parliament adopted an amendment to the law
On Communications prohibiting all telecommunications operators from charging
their end-user customers for incoming calls, thus introducing the CPP principle,
which entered into effect on September 19, 2003. Additionally, on 14 May 2004 a
special Order regulating settlements between fixed, fixed wireless and mobile
operators was adopted by the State Committee for Communications of Ukraine. We
expect that both CPP principle and the Order will be in force at least until
July 2005. In addition to the CPP principle, state regulated tariffs for calls from
the public switched telephone network to mobile networks were introduced, thus
allowing mobile operators to receive a share of revenue from calls made to
mobile networks. To effect CPP settlements on our network we entered into an
agreement with Ukrtelecom that assigned a national destination code numbering
plan to our mobile customers and allowed to reallocate our interconnect
numbering capacity in Kiev and Odessa from our mobile to our fixed network. This
agreement became effective in November 2003 and enabled us to receive a
settlement from revenue generated when a fixed line party calls our mobile
customer as well as released direct city numbering capacity for future sale to
CLEC customers. On June 24, 2004 the Verkhovna Rada adopted amendments to the law On Radio
Frequency Resource determining the procedure of granting frequency licenses and
permits for the use of radio-electronic and emissive facilities, and for
frequency distribution. Pursuant to the law On Telecommunications, new Licensing Conditions for
conducting of activity in fixed line telecommunication area were adopted by the
State Committee for Communications on June 17, 2004 and came into force on
August 16, 2004. Licensing Conditions regulating provision of mobile services
and communication channels will be developed and adopted in 2005. The Cabinet of Ministers of Ukraine also adopted rules, effective January
1, 2005, establishing the necessary payments for obtaining numbering capacity.
It is also expected that in 2005 rules for the provision of telecommunication
services will be adopted by the Cabinet of Ministers and rules for
interconnection of operators networks will be adopted by NCCR. A new law On Individual Income Taxation came into force on January 1,
2004. The law sets the unified tax rate for personal income at 13% until
December 31, 2006 and 15% from January 1, 2007. FACTORS THAT MAY ADVERSELY AFFECT FUTURE RESULTS RISKS ASSOCIATED WITH DOING BUSINESS IN RUSSIA, UKRAINE AND
OTHER COUNTRIES OF THE CIS We generate substantially all our revenues from operations in Russia,
Ukraine and other countries of the CIS. All companies operating in the CIS,
including us, face significant political, economic, regulatory, legal and tax
risks, some of which are described below. POLITICAL INSTABILITY IN THE COUNTRIES IN WHICH WE OPERATE COULD DEPRESS FOREIGN
AND LOCAL INVESTMENT AND SPENDING, WHICH COULD ADVERSELY AFFECT OUR RESULTS OF
OPERATIONS Since the dissolution of the Soviet Union in December 1991, Russia, Ukraine
and other countries in which we operate have, to varying degrees, been
undergoing significant political and economic transformation. A generally stable
political climate has emerged but economic development remains hampered by the
absence of a consistent and comprehensive legislative framework necessary to
implement and enforce market oriented reforms and by incidents of corruption
among government officials. A re-occurrence of the political instability that
characterized the first several years of the transformation could disrupt the
direction and the pace of economic development. In addition, there has been
terrorist activity in Russia from time to time. Political instability or
terrorist activity could discourage foreign and local investment and spending,
in which case demand for our services could decrease and results of operations
could deteriorate. If this were to occur, then the market price of our stock
could decrease. THERE IS A VOLATILE POLITICAL SITUATION IN UKRAINE WHICH MAY NEGATIVELY IMPACT
OUR BUSINESS Historically, political and governmental instability has been a feature in
Ukraine. The relationship between various state authorities, Ukrainian
government policies and the political leaders who formulate and implement such
policies are subject to rapid change. In January 2005 Victor Yuschenko became
president of Ukraine in a very divisive election. It is unclear whether and in
what way current domestic and external policy will change under President
Yuschenkos administration. Major changes in the political climate in Ukraine,
in particular any changes affecting the stability of the Ukrainian government,
reforms, privatization, industrial restructuring or administrative reform, could
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ECONOMIC INSTABILITY IN RUSSIA AND UKRAINE COULD ADVERSELY AFFECT THE DEMAND FOR
OUR SERVICES AND OUR ABILITY TO COLLECT ON OUR INVOICES Although the Russian and Ukrainian economies have experienced periods of
economic downturn and heavy inflation, the political and economic situation in
Russia and Ukraine appears to have stabilized. Russia ceased to be highly
inflationary in 2003. However, any future instability or lack of economic growth
in the countries in which we operate could mean that demand for our services
could become depressed. During the first decade of its independence Ukraine had been dependant on
the receipt of financial assistance from several foreign governments and
international organizations, including the International Monetary Fund (IMF)
and the World Bank. In 2000, faced with a liquidity crisis on its external debt
payments, the Ukrainian government undertook a comprehensive debt restructuring
exercise that enabled Ukraine to meet its external debt obligations. Due to such
debt restructurings and other factors, Ukraine may be unable to continue to
receive funding from foreign governments and international organizations, as
well as to raise funds on the international capital markets, which may
materially adversely affect the financing of the budget deficit, the level of
inflation and/or the value of the hryvna. Ukraine continues to pursue a closer relationship with the North Atlantic
Treaty Organization, joining the World Trade Organization (WTO) and becoming
an associate member of the European Union. However, recently Russia, Ukraine and
a number of other CIS countries have signed an agreement on creation of the
Common Economic Area (CEA). Formation of the CEA was negatively regarded by
the IMF and international society and might be a drawback to Ukraines joining
the WTO. Any major changes in Ukraines relations with Western governments and
institutions may adversely affect the Ukrainian economy and our operations. THE CURRENCY CONTROL SYSTEM OF RUSSIA AND UKRAINE COULD ADVERSELY AFFECT OUR
ABILITY TO CONVERT RUBLES AND HRYVNAS TO HARD CURRENCY AND MANAGE CASH FLOWS The ruble and hryvna are generally non-convertible outside Russia and
Ukraine, respectively, so our ability to protect ourselves against devaluation
by converting to other currencies is significantly limited. Within Russia and
Ukraine, our ability to convert rubles and hryvna, respectively, into other
currencies is subject to rules that restrict the purposes for which conversion
and payment in foreign currencies are allowed. In Ukraine the companies are
allowed to keep balances in foreign currencies earned from export activities.
Therefore, the liquidity can be supported through synchronization of in- and
outflows nominated in the same currency. On the other hand, we manage
intercompany liquidity through intercompany loans to our subsidiaries. Under
Russian restated currency law, loans to residents may be subject to reserve
requirements. Likewise, such reserve requirements may be introduced for the
purchases of currency of Russian residents. Such reserve requirements, if they
become applicable to us, may adversely affect our operations. If there are
changes to the currency control systems in Russia and Ukraine, our ability to
manage our liquidity position and our currency risk may be adversely affected. RUSSIAN AND UKRAINIAN TELECOMMUNICATIONS POLICIES COULD AFFECT OUR COMPETITIVE
POSITION Russian and Ukrainian telecommunications regulations govern the procurement
and continuing validity of our licenses and the terms and conditions under which
we provide services. Adverse changes to these regulations may make it
prohibitively expensive for us to provide services or otherwise frustrate the
implementation of our business plans causing a material adverse effect on our
results of operations. As a result of changes in existing regulations, changes in interpretations
of existing regulations or arbitrary regulatory decisions affecting various
aspects of our business, we could experience:  
    Restrictions on how and where we can provide our services;
    Restrictions or delays in receiving approvals on our applications and
communications for necessary regulatory approvals for rolling out our
network in the regions for which we have licenses;
    Significant additional costs;
    Delays in implementing our operating or business plans; or
    Increased competition. The
New Law came into effect in
Russia on January 1, 2004, however, most of the supporting regulations have not
been enacted. Until such time as supporting regulations for the New Law are
enacted, we cannot predict with any certainty how the New Law will affect us.
The New Law may increase the regulation of our operations and, until 27




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such time as appropriate regulations consistent with the New Law are
promulgated, there will be a period of confusion and ambiguity as regulators
interpret the legislation. Such confusion and ambiguity may materially adversely
affect the functioning of our business. Any strengthening of incumbent operators
such as Rostelecom, which is one of our principal shareholders, MGTS or
Svyazinvest under the New Law or the large interregional companies could
adversely affect our business. Recently, the Russian government has issued several implementing acts under
the New Law, such as Resolution No. 87, dated February 18, 2005, approving the
list of the types of licensed telecommunication activities, and Resolution No.
68, dated February 11, 2005, regarding the rules applicable to the state
registration of telecommunication infrastructure such as real property. However,
it is presently not yet clear how these regulations would be implemented. Thus,
the uncertainty related to the New Law continues. ANY CHANGES IN REGULATIONS, COSTS OR CONFUSION FROM THE NEW LAW MAY AFFECT OUR
BUSINESS It has been reported recently that in connection with Russias possible
membership in the WTO, which would bring greater competition to the Russian
market, some Russian regulatory officials are seeking to limit foreign ownership
in Russian fixed line and wireless telecommunications companies and to provide
exclusivity to Rostelecom for Russian and international long distance voice
traffic for a period of time. We cannot predict whether this or other
legislation limiting foreign ownership or competition will be implemented and if
so, whether we would have to restructure or reduce our ownership interests in
our operating subsidiaries. We are uncertain how any required reduction or
restructuring could or would be implemented and what effect it would have on our
business. A restructuring or reduction of this nature could cause our business
to suffer. THERE IS UNCERTAINTY IN THE RUSSIAN TELECOMMUNICATIONS LICENSING REGIME The Russian agency responsible for issuing telecommunications licenses has
refused our applications for certain new telecommunications licenses on the
basis that the Russian government has not yet approved the list of licensed
telecommunications services. On February 18, 2005, the Russian government
approved such list of services, however, we cannot be certain when we will
receive the licenses for which we have applied. Draft regulations under the New Law have been published on the Ministry
of Communications website although the draft
regulations have not been passed into law. If passed, the draft regulations
would provide that only carriers that hold licenses for Russia long distance and
international long distance traffic will be able to provide such
services. We have been mentioned by the Ministry of
Communications as one of the companies that may receive international and
Russian long distance licenses under the draft regulations. On March 5, 2005,
we submitted applications to the Ministry of Communications for new
licenses to provide domestic long distance telecommunications service, and
international long distance telecommunications services. These licenses were
submitted in compliance with new Rules for International and Domestic Long
Distance issued by the Ministry of Communications. The prerequisites for
obtaining the required new licenses are numbers and will require us to make
significant capital investments in the Russian regions during 2005 and 2006 that
are, however, consistent with our long-term objective to maintain our position
as a leading provider of telecommunications and Internet services across Russia
and the CIS. If we do not receive such licenses, our revenues may suffer. THE NEW LAW AND DRAFT REGULATIONS PROVIDE SCOPE FOR THE INCUMBENT OPERATORS TO
RAISE INTERCONNECTION COSTS The New Law and draft regulations under the New Law provide an advantage to
Svyazinvest entities over alternative carriers in setting their own terms and
conditions for connection to their networks. The New Law and draft regulations
do not contain provisions for state regulation of access to communication
facilities and the lease of long distance channels. Some of our suppliers of
telecommunications services have raised their charges with us and we may
experience more such cost increases in the future. In the event that we decide
to challenge such draft regulations through the appropriate Russian government
ministries or courts, we cannot predict whether we will be successful in such
challenge. POLICIES OF THE UKRAINIAN GOVERNMENT CONCERNING TARIFF REGULATIONS MAY
NEGATIVELY INFLUENCE OUR TARIFF POLICY In 2001, the Ukrainian government attempted to regulate the provision of
VoIP through the introduction of VoIP licenses. Nevertheless, until now this
license process has not been formalized. Moreover, in 2003 the State Committee
of Communications of Ukraine consistent with the recommendation of the
Antimonopoly Committee of Ukraine (AICU) allowed the non-licensed provision of
VoIP services until licensing conditions are formalized. Such VoIP licensing
conditions were developed in 2004 but not yet implemented. In addition, in 2001
Ukrtelecom enforced obligatory VoIP traffic settlement payments for VoIP traffic
routed through its network, and in 2002 state regulated tariffs were extended on
VoIP traffic services. As a result, we cannot be sure that any resulting
licensing and related fees will not adversely affect our business should they be
implemented. OUR OPERATING LICENSES MAY NOT CLEARLY AUTHORIZE US TO PROVIDE ALL OF THE
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The licensing and regulatory regime in Russia, Ukraine, and the markets in
which we operate frequently do not keep pace with the technological advances in
the telecommunications industry. Further, a great deal of ambiguity exists in
regard to the interpretation of licenses and the application of rules and
regulations in regard to our new services, especially those new services enabled
by technological developments in telecommunications infrastructure and software.
Although our operating companies possess a wide range of licenses issued by the
Russian and Ukrainian regulatory agencies, it is possible that the technical
means by which we provide some of our services, or the service themselves, may
be subject to licensing requirements or restrictions and that our existing
licenses do not satisfy these requirements. In such events, we could be subject
to fines, penalties or suspension, limitation or revocation of licenses. The
suspension, limitation in scope or revocation of a significant license or the
levying of substantial fines could have a material adverse effect on our
operations and our financial results. RUSSIAN ANTI-TRUST POLICIES MAY LIMIT OUR ABILITY TO EXPAND OUR BUSINESSES AND
TO ESTABLISH MARKET RATES FOR OUR SERVICE OFFERINGS The Federal Anti-Monopoly Service (FAS), the state agency responsible for
establishing and enforcing the states anti-trust policies, adopted a policy
decision whereby each licensed telecommunications operator, including our
operating companies, may be classified as a monopolist. The policy was
declared to be without effect by the Russian courts. However, if the policy were
to be successfully enforced, our operating companies could be subject to
increased state regulation. Since our products are frequently priced at a
premium in comparison with the products of state-owned incumbent operators, it
is possible that we may be required to reduce our tariffs. Further, as we
continue to expand our operations, we may be subject to increasing anti-trust
restrictions imposed by the FAS. For example, ADS has been classified as a
monopolist in Nizhny Novgorod. Any such regulation of our pricing or restriction
in operations could be detrimental to our financial results. The proposed revisions to the Russian antitrust law which were approved by
the Russian government generally are intended to strengthen the position of the
FAS and widen its authority as well as expand the types of activities that may
be classified as subject to antitrust regulations. In particular, under the
proposed law, if several independent companies control more than 50% of a
particular market, each of them may be declared as having a dominant position in
the market. The adoption of this law may affect our operations. SPECIAL FEES AND TAXES LEVIED AGAINST TELECOMMUNICATIONS OPERATORS COULD
ADVERSELY AFFECT OUR RESULTS OF OPERATIONS From time to time, Ukrainian and Russian government officials seek to
offset budgetary shortfalls by increasing levies extracted from the
telecommunications industry. The provisions of the New Law require that all
Russian operators, including fixed-line operators, pay a portion of their
revenues to the USF, which will be established to fund socially
important but economically unviable projects. The USF is expected to be operating in
2005. The New Law, however, does not provide clarity as to how the
USF will be collected and administered. It is expected that the
amount of the Universal Service Charge will not exceed 3% of a certain
telecommunication companys revenues. These or other
similar industry-specific pieces of legislation may have a material adverse
effect on demand for our services and on our results of operations. Similarly,
the results of our operations could deteriorate if the government introduces any
new frequency or licensing fees substantially in excess of the amounts
previously budgeted for such fees. Under new regulations, the Ukrainian regulatory agency may require
licensees to pay similar annual amounts into local network development. If the
additional amounts required will be substantial, we cannot predict whether the
financial burden associated with compliance may be so burdensome as to cause a
deterioration of our financial results. Moreover, in 2004 the State Committee on
Communications of Ukraine established new license conditions, which came into
force on August 16, 2004. Under these conditions, any reissue of existing
fixed-voice licenses, even related to the change of a licensees legal address,
may require payment of the full license fee. At present we cannot estimate how
significantly these changes may impact our operations in Ukraine. RUSSIAN AND UKRAINIAN LEGISLATION MAY NOT ADEQUATELY PROTECT AGAINST
EXPROPRIATION AND NATIONALIZATION The governments of Russia and Ukraine have enacted legislation to protect
foreign investment and other property against expropriation and nationalization.
In the event that our property is expropriated or nationalized, legislation
provides for fair compensation. However, we cannot assure you that these
protections would be enforced. This uncertainty is due to several factors,
including:  
    The lack of state budgetary resources;
    The lack of an independent judiciary and sufficient
mechanisms to enforce judgments; and
    Corruption among government officials. In particular, in Ukraine, there has been no established history of
investor rights protection or responsibility to investors and in certain cases
the courts may not enforce these rights. In the event courts enforced rights of
investors granted under applicable 29




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Ukrainian legislation, the government and/or the legislature of Ukraine could
attempt to overrule any such court decisions legislatively through retroactive
legislative changes. Moreover, recently announced intentions of the newly
appointed Ukrainian government to re-privatize certain enterprises, that may be
considered as illegally privatized by the former government, may have an adverse
effect on the Ukrainian investment climate. In addition, social instability in Russia, Ukraine and other CIS countries,
coupled with difficult economic conditions, could lead to increased support for
centralized authority and a rise in nationalism. These sentiments could lead to
restrictions on foreign ownership of companies in the telecommunications
industry or large-scale nationalization or expropriation of foreign-owned assets
or businesses. Although we do not anticipate the nationalization or
expropriation of our assets because we were not created as a result of
privatization of any state enterprise, the concept of property rights is not
well developed in the laws of these countries and there is not a great deal of
experience in enforcing legislation enacted to protect private property against
nationalization and expropriation. As a result, we may not be able to obtain
proper redress in the courts, and we may not receive adequate compensation if in
the future any local government decides to nationalize or expropriate some or
all of our assets. If this occurs, our business would be harmed. WE MAY BE UNABLE TO ENFORCE OUR RIGHTS DUE TO AMBIGUITY IN THE LAWS AND LEGAL
STRUCTURES OF THE COUNTRIES WHERE WE OPERATE Current ambiguity in Russian, Ukrainian and other CIS laws makes it
difficult to determine if we would be able to enforce our rights in disputes
with our venture partners or other parties. Furthermore, the dispersion of
regulatory power among a number of government agencies in Russia, Ukraine and
the other countries of the CIS has resulted in inconsistent or contradictory
regulations and unpredictable enforcement. The Russian, Ukrainian and other CIS
governments have rapidly introduced laws and regulations and have changed their
legal structures in an effort to make their economies more market-oriented,
resulting in considerable legal confusion, especially in areas of the law that
directly affect our operations. We cannot assure you that local laws and
regulations will become stable in the future. Our ability to provide services in
Russia, Ukraine and other countries of the CIS could be adversely affected by
difficulties in protecting and enforcing our rights and by future changes to
local laws and regulations. Further, our ability to protect and enforce our
rights is dependent on the Russian, Ukrainian and CIS courts which are
underdeveloped, inefficient and, in places, corrupt. Enforcement of court orders
can in practice be very difficult in Russia and Ukraine. Additionally, court
orders are not always enforced or followed by law enforcement agencies. ANY UNFORESEEN CHANGES IN THE TAX LAWS IN RUSSIA OR UKRAINE COULD HAVE A
MATERIAL ADVERSE EFFECT ON OUR BUSINESS Russia Our Russian tax burden may become greater than the estimated amount that we
have expensed to date and paid or accrued on our balance sheets. Because of the
need for additional sources of budgetary finance, Russian tax authorities are
often arbitrary and aggressive in their interpretation of tax laws and their
many ambiguities, as well as in their enforcement and collection activities.
Many companies are often forced to negotiate their tax bills with tax inspectors
who demand higher taxes than applicable law appears to provide. Any additional
tax liability, as well as any unforeseen changes in the tax law, could have a
material adverse effect on our future results of operations or cash flows in a
particular period. Under Russian accounting and tax principles, financial
statements of Russian companies are not consolidated for tax purposes. As a
result, each Russian-registered entity in our group pays its own Russian taxes
and we cannot offset the profits or losses in any single entity against the
profits and losses in any other entity. As a result, our overall effective tax
rate may increase as we expand our operations, unless we are able to implement
an effective corporate structure that minimizes the effect of these Russian
accounting and tax norms. The
tax regime in Russia following the recent cases involving Yukos and
Vimpelcom has become less predictable. In addition, following ruling 169-0 of
the Constitutional Court regarding VAT, the tax authorities may be able to
re-qualify the tax treatment of certain transactions using subjective criteria
such as the intent or purpose of a transaction which creates further ambiguity
in application of the tax laws. Ukraine Similarly, Ukrainian tax law is unpredictable and tax authorities are often
arbitrary and aggressive in their interpretation of tax laws and their many
ambiguities, as well as in their enforcement and collection activities. The
constitution prohibits retroactive legislation, and the Taxation System Law
requires new tax laws to be adopted no later than six months prior to the
beginning of the next fiscal year in which the new tax laws are to become
effective. Nevertheless, sudden shifts in tax law and policy and retroactive
legislation are common. For example, in January 2003, the Ukrainian Parliament
adopted amendments to the Profits Tax Law which, in part, became effective as of
January 1, 2003. The law substantially changes the tax treatment of exchange
rate differences, dividends, transfer pricing, goodwill and other transactions.
Other amendments to the Profits Tax Law of Ukraine came into effect from January
1, 2004. Although the profit tax rate was decreased from 30% to 25%, some
adverse changes were introduced to the calculation of a taxable profit, such as
new bad debts deductibility treatment. The impact of the law on our operations
was positive so far, however, the future impact of the mentioned amendments is
still uncertain because of ambiguities and inconsistencies in the law 30




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that allow different interpretations by the tax authorities. If our
interpretation of the amendments differs from those of the local tax
authorities, we might be subject to higher tax liability and/or additional fees
and penalties. RUSSIAN AND UKRAINIAN LAWS MAY EXPOSE US TO LIABILITY FOR ACTIONS TAKEN BY OUR
SUBSIDIARIES OR VENTURE ENTITIES Under Russian laws, we may be jointly and severally liable for any
obligations of a subsidiary or venture entity under a transaction if:  
    We have the ability to issue mandatory instructions to the subsidiary
or venture entity and that ability is provided for by the charter of
the subsidiary or venture entity or in a contract between us and them;
and
    The subsidiary or venture entity concluded the transaction pursuant to
our mandatory instructions. In addition, we may have secondary liability for any obligations of a
subsidiary or venture entity if:  
    The subsidiary or venture entity becomes insolvent or bankrupt due to
our actions or our failure to act; and
    We have the ability to make decisions for the subsidiary or venture
entity as a result of our ownership interest, the terms of a contract
between us and them, or in any other way. In either of these circumstances, the shareholders of the subsidiary or
venture entity may seek compensation from us for the losses sustained by the
subsidiary or a venture entity if we knew that the action taken pursuant to our
instructions or the failure to act would result in loss. This type of liability
could result in significant obligations and adversely affect our business. Under Ukrainian laws, we may be held jointly and severally liable for any
obligations of our Ukrainian subsidiaries if we fail to initiate bankruptcy
proceedings with respect to such Ukrainian subsidiaries when required to do so
by law. THE IMPLEMENTATION OF UKRAINES NEW CIVIL AND COMMERCIAL CODES MAY CAUSE
INSTABILITY OF UKRAINIAN BUSINESS LEGAL ENVIRONMENT In January 2003, a new Civil Code was enacted by the Ukrainian Parliament
which sets forth new regulations in the areas of property law, copyright,
industrial ownership and trademarks and replaces the existing Civil Code adopted
in 1963. Also in January 2003, the Parliament enacted a new Commercial Code
which is intended to provide legal guidelines for economic activities and
relationships in the market, by regulating the use of natural resources, the
rights of industrial ownership and the use of securities and by defining the
insurance, banking and auditing procedures. However, the documents contain
controversial and often overlapping provisions. Until such time as a regulatory
practice for interpretation of the new legislation is established and
appropriate sub-legislation consistent with the new codes is
promulgated, there may be a period of confusion and ambiguity. Such confusion and ambiguity may
materially adversely affect the Ukrainian market and negatively impact
functioning of our business. RISKS ASSOCIATED WITH OUR BUSINESS WE MAY ENCOUNTER DIFFICULTIES EXPANDING AND OPERATING OUR BUSINESS, INCLUDING
THE INTEGRATION OF ACQUIRED COMPANIES We have experienced significant growth as a result of acquisitions and
expect such growth to continue. As we grow, it will become increasingly
difficult and more costly to manage our business. Acquisition transactions are accompanied by a number of risks, including
risks related to:  
    The consolidation of the operations and personnel of the acquired
companies;
    The potential disruption of our ongoing business and distraction of
management;
    The introduction of acquired technology content or rights into our
products and unanticipated expenses related to such integration;
    The potential negative impact on reported earnings;
    The possibility that revenues from acquired businesses and other
synergies may not materialize as anticipated;
    The deterioration of relationships with employees and customers as a
result of any integration of new management personnel; and 31




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
    Contingent liabilities associated with acquired businesses, especially
in the markets where we operate. We may not be successful in addressing these risks or any other problems
encountered in connection with our completed and future acquisitions and our
operating results may suffer as a result of any failure to integrate these
businesses with our existing operations. In addition, we may encounter difficulties in building our networks with
respect to:  
    Delivering services that are technically and economically feasible;
    Financing increases in the regional network construction and
development area;
    Obtaining in a timely manner and maintaining licenses, permissions to
operate telecommunication equipment, frequency allocations and other
governmental permissions sufficient to provide services to our
customers;
    Marketing our services in a large geographic area to new potential
customers;
    Obtaining sufficient interconnect arrangements;
    Meeting demands of local special interest groups;
    Obtaining compliance certificates for our telecommunications equipment
in a timely and cost-efficient manner; and
    Obtaining adequate supplies of network equipment. REORGANIZATION OF THE RUSSIAN TELECOMMUNICATIONS INDUSTRY MAY AFFECT OUR
COMPETITIVE POSITION Prior to 2002, Svyazinvest, a government-controlled holding entity,
controlled Rostelecom and most of other principal wire-line venture partners. In
2002, the telecommunications industry was restructured by merging all regional
incumbent operators into seven inter-regional operating companies. With this
consolidation, we may face stronger competition from these new entities.
Further, with the consummation of the Sovintel transaction in 2002, we are not
sure that we may rely on continued strong commercial relations with Rostelecom,
given that they are no longer our partner in Sovintel. Further, the consolidation of all regional incumbent operators into seven
inter-regional companies could affect our ability to expand into the various
regions of Russia. In order to effectively compete, we may need to expend
significant internal resources or acquire other technologies and companies to
provide or enhance our capabilities. Any of these efforts could have a material
adverse effect on our business, operating results and financial condition. REORGANIZATIONS IN THE UKRAINIAN TELECOMMUNICATIONS SECTOR MAY HAVE STRENGTHENED
THE POSITION OF THE MONOPOLY INCUMBENT AND ENCOURAGED UNFAIR COMPETITION In preparation for a large-scale privatization of the telecommunications
industry, the Ukrainian government reorganized the state telecommunications
sector so that Ukrtelecom, the state telecommunications operator, holds all the
governments interests in the telecommunications industry. Until recently the
Ukrainian government intended to sell up to 49% of Ukrtelecoms shares in the
near future. In anticipation of the privatization of Ukrtelecom, Ukrtelecom has
been transferred back from the Ukrainian Communications Committee to the State
Property Fund. The new Ukrainian government recently announced that they do not intend to
privatize Ukrtelecom in 2005. It is expected that the Ukrainian government will
continue to control at least 51% of Ukrtelecoms shares. This will allow the
Ukrainian government to control Ukrtelecom and will afford the Ukrainian
government the opportunity to further control the telecommunications industry
through Ukrtelecom.


The emergence of a single self-regulating Ukrainian telecommunications
monopoly may have adverse financial consequences for us because:  
    We have no effective recourse against the state monopoly carrier since
the state regulator controls and manages the monopoly carrier and the
judiciary system is severely underdeveloped and cannot be relied upon
to protect and enforce unfair competition;
    A single Ukrainian self-regulating monopoly is able to create
favorable market conditions for itself and cause unfavorable
conditions for us;
    Our ability to negotiate reasonable interconnection agreements and
rates may suffer; and 32




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
    Any subsequent privatization of Ukrtelecom may bring in strong
management and resources from a major telecommunications operator,
increasing its competitive strengths. OUR SALE OF PART OF GTU MAY NOT BRING THE EXPECTED BENEFITS TO US Recognizing that many of the markets in which we operate are complex, we
continue to seek strong local partners to assist us in those markets. In the
third quarter of 2004, we transferred 20% of our ownership interest in GTU to a
Ukrainian partner in exchange for services provided by the partner. Our partner
has been assisting us in resolving disputes with Ukrtelecom and the Ministry of
Communications. We continue to believe that Ukraine offers promising
investment opportunities but that there are still political and
commercial risks associated with operating in Ukraine. FAILURE TO OBTAIN SUFFICIENT AND RELIABLE TRANSMISSION CAPACITY AT REASONABLE
COSTS COULD CAUSE US TO INCUR LOSSES Historically, we have leased a substantial portion of our network
transmission capacity under agreements that generally have one to three-year
fixed terms. In addition, in 2001, we leased significant additional domestic and
international capacity that we utilize for data transmission under long-term
lease agreements that may be extended up to fifteen years. We rely on third
parties ability to provide data transmission capacity to us. These third
parties themselves, in turn, may be receiving capacity from others. If our lease
arrangements deteriorate or terminate and we are unable to enter into new
arrangements or if the entities from which we lease such capacity are unable to
perform their obligations under these arrangements, our cost structure, service
quality and network coverage could be adversely affected. We currently provide international switched voice, data and IP services in
Russia by relying on Rostelecom and Transtelecom to provide leased transmission
capacity within Russia. We rely on local operators for last-mile access to
end-users. These companies may be subject to political and economic pressures
not to lease capacity to foreign operators or competitors. Further, in light of
the acquisition of the remaining 50% ownership interest of Sovintel from
Rostelecom in 2002, Rostelecom may have less incentive to continue to provide
telecommunication services to us despite their significant shareholding in us.
Any changes in regulation or policies that restrict us from leasing adequate
capacity could have an adverse effect on our business. Local telecommunications
operators may, for business reasons or otherwise, resist giving us access to the
last mile. The failure of Rostelecom, Transtelecom, local operators or any other
provider to comply with lease arrangements or our inability to obtain other
long-term leases on a timely basis or maintain existing leases for fiber optic
cable or transmission capacity would prevent us from deploying and operating our
network as planned. This could have a material adverse effect on our ability to
operate. In Ukraine, we mainly lease transmission capacity from Ukrtelecom, the
Ukrainian incumbent fixed phone line network operator. In 2004, we started
leasing transmission capacity from alternative sources and we expect that the
risk of capacity lease from a single operator will be partly mitigated by the
end of 2005. Nevertheless, if Ukrtelecom does not make investments to
significantly increase the capacity of its transmission network or if we are not
able to lease capacity from another source in the future, we may not have
sufficient transmission capacity to expand our subscriber base. OUR ABILITY TO PROVIDE OUR SERVICES IS DEPENDENT ON SECURING AND MAINTAINING
INTERCONNECTION AGREEMENTS WITH ROSTELECOM, UKRTELECOM AND OTHER FACILITIES
PROVIDERS Our ability to provide telecommunications services depends on our ability
to secure and maintain interconnection agreements with Rostelecom, Ukrtelecom
and other incumbent owners of networks. Since we do not currently anticipate
owning all the facilities we need to operate our networks, we will always rely
on the telecommunications networks of other providers to some degree.
Interconnection is required to complete calls that originate on our networks but
terminate outside our networks, or that originate from outside our networks and
terminate on our networks. Our current interconnection agreements with incumbent
operators expires in various years between 2005 and 2014. We have experienced
substantial increases in interconnection costs with incumbent operators. It is
possible that in the future our interconnection agreements may not be renewed or
not renewed on a timely basis or on commercially reasonable terms. In Russia, we are dependent on Rostelecom for the provision of leased lines
and/or interconnect circuits used to connect our points of interconnection to
our network backbones. A failure by Rostelecom to provide such leased lines
and/or interconnect circuits in accordance with our plans, or to satisfy our
customers demands on certain routes, has in the past given rise to capacity
constraints in our network on certain routes. While we believe that these
capacity constraints have been eliminated, we may continue to experience
capacity constraints until we increase the number of points of interconnection
to our network, allowing us to route a greater proportion of traffic over our
network. In Ukraine, we are, to a great extent, dependent on Ukrtelecom for the
provision of leased lines and/or interconnect circuits used to connect our
indirect access customers throughout Ukraine as well as to provide access to our
network backbone in Russia. A failure 33




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by Ukrtelecom to provide such leased lines and/or interconnect circuits in
accordance with our plans, or to satisfy our customer demand on certain routes,
could give rise to capacity constraints in our network on certain routes in
Ukraine if are not able to find an alternative circuits provider. OUR NETWORK MAY NOT BE ABLE TO SUPPORT THE GROWING DEMANDS OF OUR CUSTOMERS The uninterrupted operation of our networks is vital to our success. The
stability of our systems depends on our ability to provide sufficient capacity
to meet the needs of our customers, and that, in turn, depends on the
integration of suitable technology into our networks. As we continue to increase
both the capacity and the reach of our networks, and as traffic volume continues
to increase, we will face increasing demands and challenges in managing our
circuit capacity and traffic management systems. Any prolonged failure of our
communications network or other systems or hardware that causes significant
interruptions to our operations could seriously damage our reputation and result
in customer attrition and financial losses. It is possible that the current economic difficulties and historical
circumstances in Russia and Ukraine may create difficulties in maintaining our
network. We rely to a significant degree on the Russian and Ukrainian networks
being able to deliver our services, and the underdevelopment of such networks
may hinder our ability to obtain sufficient capacity for our traffic volumes,
especially as we expand our Internet access business. Moreover, it is
increasingly difficult to expand within Moscow because the existing city network
does not have sufficient capacity, and we may be unable to procure enough
telephone numbers and connection lines for our customers utilizing our services.
These factors may have a material adverse effect on our expansion plans and our
ability to provide services to new customers. RUSSIAN COMPANIES MAY BE REQUIRED TO ADOPT A PLAN OF LIQUIDATION WHEN THEIR NET
ASSETS ARE NEGATIVE Under Russian law, in the event the value of a companys net assets is less
than the minimum charter capital allowed by law, such company may be required to
adopt a decision to liquidate. Even if the company declines to approve its
liquidation, governmental agencies responsible for the State registration of
companies, as well as other designated State bodies, for example, the Federal
Commission for the Securities Market, are authorized to bring a lawsuit seeking
liquidation of the company until the expiration of the relevant statute of
limitation. Some of our subsidiaries have in the past and continue to have
negative net asset values which could make them subject to the legal requirement
to adopt a plan of liquidation. Any voluntary or forced liquidation could have
material a adverse effect on our business. WE MAY HAVE DIFFICULTY SCALING AND ADAPTING OUR EXISTING ARCHITECTURE TO
ACCOMMODATE INCREASED TRAFFIC AND TECHNOLOGY ADVANCES Most of the telecommunication network architecture that we employ and the
architecture of local public networks were not originally designed to
accommodate levels or types of services we provide and it is unclear whether
current or future anticipated levels of traffic will result in delays or
interruptions in our services. In the future, we may be required to make
significant changes to our architecture, including moving to a completely new
architecture, or we may be required to invest to upgrade local public networks.
If we are required to switch architectures, we may incur substantial costs and
experience delays or interruptions in our operations. If we experience delays or
interruptions in our operations due to inadequacies in our current architecture
or as a result of a change in architectures, users may become dissatisfied with
our services and move to competing providers. Any loss of traffic, increased
costs, inefficiencies or failures to adapt to new technologies and the
associated adjustments to our architecture would have a material adverse effect
on our business. WE ARE IN A COMPETITIVE INDUSTRY AND OUR COMPETITORS MAY BE MORE SUCCESSFUL IN
ATTRACTING AND RETAINING CUSTOMERS The market for our products and services is competitive and we expect that
competition, especially in underdeveloped markets, will continue to intensify.
As we expand the scope of our offerings, we will compete directly with a greater
number of competitors providing business services in the same markets. Negative
competitive developments could have a material adverse effect on our business. Our competitors include incumbent Russian and Ukrainian operators and other
large international telecommunications providers doing business in the CIS. Our
competitors may have substantially greater resources, closer ties to
governmental authorities and longer operating histories. These advantages may
give them a competitive edge over alternative providers like us. This
competition may result in a loss of customers, falling prices and a decline in
revenues. We are operating in recently liberalized markets in an evolving and highly
competitive industry. We expect our competitors to continually improve their
products and services while also reducing their prices. Our success will depend
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The telecommunications market in Russia has historically been dominated by
Svyazinvest, including its subsidiary, Rostelecom, and in Ukraine by
Ukrtelecom, both being former state monopoly telecommunications services
providers. These companies and other established competitors have significant
competitive advantages over us which include:  
    Greater resources, market presence and network coverage;
    Greater brand name recognition, customer loyalty and goodwill;
    Control over domestic transmission lines and over access to these
lines by other participants; and
    Close ties to national and local regulatory authorities which may be
reluctant to adopt policies that would give rise to increased
competition for Rostelecom or Ukrtelecom. OUR PARTNERS ARE OFTEN ALSO OUR COMPETITORS Notwithstanding the provisions of the agreements with our venture partners,
such partners sometimes compete directly with our ventures. Competition with our
venture partners in the same markets may create conflicts of interest and may
result in deadlock in management and loss of customers. In 2002, we acquired the remaining 50% ownership interest of Sovintel from
Rostelecom, the dominant international and domestic long distance carrier in
Russia. As a result of this transaction, we are now directly competing with
Rostelecom, a formerly state-owned enterprise that previously was our partner in
Sovintel. Similarly, most of our regional partners across Russia offer local and
long distance services in competition with our local ventures and Sovintel. OUR EXISTING BILLING AND MANAGEMENT INFORMATION SYSTEMS MAY NOT BE ABLE TO MEET
OUR FUTURE NEEDS We may encounter difficulties in enhancing our billing and management
information systems and in integrating new technology into such systems. We have
historically operated through distinct companies, but we are in the process of
integrating our billing and management information systems so that we will be
able to bill our customers and to manage other administrative tasks through a
single system. If we are unable to integrate and upgrade our billing and
management information systems to support our integrated operations, our billing
may suffer which could have a material adverse effect on our revenues. Additionally, any damage to our network management center or our major
switching centers could harm our ability to monitor and manage network
operations and generate accurate call detail reports from which we derive our
billing information. In
our operations outside Moscow, Kiev, and St. Petersburg, we rely on our
ventures switches to provide information necessary to generate invoices. We
cannot ensure that their systems will meet our needs or the needs of our
customers. WE MAY ENCOUNTER DIFFICULTIES IN FULLY COMPLYING WITH APPLICABLE LAWS DUE TO
CONFUSION IN THE LAWS AND LEGAL STRUCTURES OF THE COUNTRIES WHERE WE OPERATE The application of the laws of any particular country is not always clear
or consistent. This is particularly so in Russia, Ukraine and other CIS
countries where the pace of legislative drafting has not always kept pace with
the demands of the marketplace. These countries often have commercial practices
and legal and regulatory frameworks that differ significantly from those in the
US and other Western countries. As a result, it is often difficult to ensure
that we are in compliance with changing legal requirements. If we, any of our
ventures or any of our acquired companies are found to be involved in practices
that do not comply with local laws or regulations, then we may be exposed, among
other things, to significant fines, the risk of prosecution or the suspension or
loss of our licenses, frequency allocations, authorizations or various
permissions, any of which could have a material adverse effect on us. The Ministry of Transport and Communications of Ukraine, and formerly the
Ukrainian Communications Committee, regularly check our compliance with the
requirements of the applicable legislation and our telecommunications licenses.
We use our best efforts to comply with all such requirements. However, we cannot
assure you that in the course of future inspections we will not be found to be
in violation of the applicable legislation. Any such finding could have a
material adverse effect on our operations. It may be difficult and prohibitively expensive for us to comply with
applicable Russian telecommunications regulations related to state surveillance
of communications traffic. Currently, Ukrainian authorities are also trying to
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communications traffic. Full compliance with these regulations that allow the
state to monitor voice and data traffic may be overly burdensome and expensive.
Noncompliance may lead to the imposition of fines or penalties on us, or the
revocation of our operating licenses. Further, some customers may decline to
utilize the services of a telecommunications provider whose networks facilitate
state surveillance of communications traffic. OUR TELECOMMUNICATIONS LICENSES MAY NOT BE EXTENDED OR MAY BE SUSPENDED OR
REVOKED Our telecommunications licenses expire in various years from 2005 to 2014.
If renewed, our licenses may contain additional obligations, including payment
obligations, or may cover reduced service areas. If our telecommunications
license for provision of local, intercity, interzonal and international
telephone services in the Moscow and St. Petersburg license area, which expires
on March 17, 2008, is not renewed, our business could be adversely affected.
Depending on the growth of our business in the other license areas, the failure
to have any other particular license renewed could also materially adversely
affect our business. As discussed above, we may not be able to comply with
licensing conditions for the intercity and international telephone services as
required by regulation No. 87 of the Russian government. If we fail to completely fulfill specific terms of any of our
telecommunications licenses related to line and operational capacity,
territorial or other technical requirements, payment or reporting obligations,
local registrations of our telecommunications licenses, frequency permissions or
other governmental permissions or if we provide our services in a manner that
violates applicable law, Rossvyaznadzor may suspend our licenses, frequency
permissions or other governmental permissions, or in the case of continued
non-compliance, initiate court proceedings for the revocation of our licenses.
If any of our telecommunications licenses are suspended or terminated or if
extensions requested are not granted and action is taken against our company or
our subsidiaries, our business could be adversely affected. In addition, many of our telecommunications licenses have not been
registered with local offices of the Ministry of Communications in the regions
where we do not operate our own equipment. Although, the Ministry of
Communications has informed us, in many cases only verbally, that we do not need
a local registration until we start to operate our equipment in the area,
failure to register contradicts the terms of our licenses. We cannot guarantee
that the Ministry of Communications will maintain this position and will not
take action against us for not registering our telecommunication licenses, which
could have a negative impact on our business. WE MAY FAIL TO OBTAIN RENEWALS OR EXTENSIONS OF OUR FREQUENCY ALLOCATIONS FOR
OUR EARTH STATIONS AND OTHER RADIO FREQUENCY EQUIPMENT THAT WE USE IN OUR
OPERATIONS Our frequency allocations for most of our license areas expire on the
expiration date of our corresponding licenses. We cannot predict whether we will
be able to obtain extensions of our frequency allocations and whether extensions
will be granted in a timely manner and without any significant additional costs.
It is possible that there could be a reallocation of frequencies upon the
expiration of existing allocations or the granting of frequency allocations for
the same channels as our frequency allocations, requiring that we coordinate the
use of our frequencies with the other license holder and/or experience a loss of
quality in our network. If we fail to obtain renewals or extensions of our frequency allocations
for parts of our network based on radio frequencies, which expire on various
dates between 2005 and 2008, or if other license holders are granted overlapping
frequencies, our business could be adversely affected. RISKS ASSOCIATED WITH OUR SHAREHOLDING STRUCTURE OUR SIGNIFICANT SHAREHOLDERS HAVE ENTERED INTO A SHAREHOLDERS AGREEMENT WHEREBY
THESE SHAREHOLDERS EXERCISE EFFECTIVE CONTROL OVER OUR BOARD OF DIRECTORS In August 2003, our major shareholders entered into a Shareholders
Agreement which became effective upon closure of the transaction in December
2003. In accordance with the terms of the Shareholders Agreement, Alfa Telecom
Limited (Alfa), Telenor, Rostelecom, Capital International Global Emerging
Markets Private Equity Fund, L.P., Cavendish Nominees Limited and First NIS
Regional Fund SICAV are able to exercise substantial control over our Board of
Directors. These relationships create the potential for conflicts of interest
between us and our shareholders. Although the Shareholders Agreement and other
agreements among the shareholders reduce the chance for conflicts of interest,
we cannot assure that any conflicts of interest will be resolved in our favor.
We cannot assure you that any group of directors will not take any actions that
may adversely affect the interests of minority shareholders. Further, if we
consummate any future acquisitions, such agreements may be amended or we and our
shareholders may enter into new agreements. OUR SIGNIFICANT SHAREHOLDERS HAVE OTHER INTERESTS WHICH MAY CONFLICT WITH OUR
INTERESTS 36




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One of our significant shareholders, Rostelecom, is one of our direct
competitors. Two of our shareholders, Alfa and Telenor, have ownership interests
in Vimpelcom, with whom we have significant commercial relationships. Although
we structure transactions so that they are at arms length, we cannot assure
you that these shareholders will not apply pressure on the Company to enter into
transactions which may not be the most commercially favorable to us. THE CURRENT GOVERNMENTS WELL-PUBLICIZED CAMPAIGN AGAINST RUSSIAS SO-CALLED
OLIGARCHS COULD HAVE ADVERSE EFFECTS ON US It has been widely reported in Russian and foreign media that the Russian
government is exerting pressure on the so-called oligarchs to cause them to
divest their commercial interests in certain economic areas of activity. The
media has reported also that the government has exerted significant influence on
companies owned or controlled by the oligarchs through tax inspections,
management changes, threats of and actual prosecution of management and key
officials, and other means. Real and perceived pressure on the oligarchs and
their businesses has seriously affected the economic activities of these
enterprises and their management. If the current or future governments in Russia were to apply significant
pressure on Alfa and its affiliated companies, it could have serious adverse
effects on our operations and financial results. Such effects could include, but
would not be limited to, the inability of the Board of Directors to act
independently from external pressure and the distraction of our management from
our day-to-day operations. ALFAS DISPUTE WITH THE MINISTRY OF COMMUNICATIONS MAY ADVERSELY AFFECT OUR
BUSINESS It has been widely reported that Alfa is involved in a dispute with the
Ministry of Communications regarding Alfas ownership interest in the mobile
operator Megafon. Should that dispute continue or escalate then the Ministry of
Communications may put pressure on Alfa and its holdings. One of Alfas other
holdings is Vimpelcom, our largest customer. Should the Ministry of
Communications apply pressure on us or Vimpelcom, it could have serious adverse
effects on our operations and financial results. RISKS ASSOCIATED WITH OUR SHARES OF COMMON STOCK OUR ABILITY TO PAY DIVIDENDS ON OUR COMMON STOCK MAY BE LIMITED During 2004, our Board of Directors declared four dividends of $0.20 per
common share each to shareholders. In February 2005, the Board of Directors
declared a dividend of $0.20 per common share each to shareholders of record on
March 17, 2005. The Board of Directors reviews our policy on dividends annually.
Even if we continue to generate significant cash flows in the future, our Board
of Directors may elect to retain earnings for our future development or for
other reasons and, consequently, not declare a dividend. Further, if we raise
any capital in the future, we may be restricted from paying dividends under the
terms of such financings. In addition, the governments in the countries where we
operate may further devalue their currencies and take other actions that may
restrict the ability of our subsidiaries to declare and pay dividends to us
which in turn may limit our ability to pay dividends to our shareholders. OUR SHARE PRICE HAS BEEN AND MAY CONTINUE TO BE HIGHLY VOLATILE The price of our shares has been subject to significant volatility since
our IPO in 1999. In addition, a number of particular factors may adversely
affect the market price of our shares or cause the market price to fluctuate and
decline materially. These factors include:  
    Issues concerning the perceived risks of investing in Russia and the
CIS, including significant ownership of our shares by a company that
is part of a large Russia-based financial and industrial concern;
    The limited number of our shares available for trading in public
markets;
    The potential sale of any large blocks of our shares by our management
or large shareholders;
    Mergers and strategic alliances in the telecommunications industry;
and
    Inconsistent or restrictive government regulation in the Russian and
Ukrainian telecommunications industries. In recent years, the market for stock in technology, telecommunications and
computer companies has been highly volatile. This is particularly true for
companies with relatively small capitalization, such as ours. 37




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ITEM 2. PROPERTIES Major Facilities We possess the right to occupy and utilize five floors, 6,694 square
meters, of a building in central Moscow, which houses our call center, customer
care center, Information technology and accounting offices for Sovintel. The
right to occupy and utilize this space is through leases, which expire between
April 2007 and November 2009. We possess the right to occupy and utilize four floors, 4,125 square
meters, of a building in central Moscow which serves as the principal sales and
marketing office for Sovintel and which houses our Representative Office. The
right to occupy and utilize this space is through a ten-year lease. This lease
expires in August 2012. We possess the right to occupy and utilize three floors, 4,025 square
meters, of a building in central Moscow, which serves as the principal technical
department for Sovintel. The right to occupy and utilize this space is through a
one-year lease, which expires in December 2005. In addition, we occupy and
utilize four floors, 2,377 square meters, of another building in central Moscow,
which also serves the technical department of Sovintel. The right to occupy and
utilize this space is through a one-year lease, which expires December 2005. We possess the right to occupy and utilize six floors of a building in
eastern Moscow, which serve principally as an office for the Consumer Internet
Services division of Sovintel and the technical department for Sovintel. The
right to occupy and utilize the space is through a fifty-five year lease, which
expires in 2050. We possess the right to occupy and utilize 1,041 square meters, of a
building in St. Petersburg. The right to occupy and utilize this space is
through a lease, which expires in January 2007. In addition, we possess the
right to occupy and utilize 1,110 square meters, of a building in Samara. The
right to occupy and utilize this space is through a lease which expires in 2008. We own a 5 floor, 2,600 square meters, building in Nizhny Novgorod which
serves as the principal office for ADS and we own a 5 floor, 4,432 square
meters, building in Krasnoyarsk which serves as the principal office for
Sibchallenge and Tel. Golden Telecom (Ukraine) occupies office and technical premises located in
Kiev under long-term leases which expire in 2006. Additionally they lease a
dealer-center and shop premises. Golden Telecom (Ukraine) also occupies an
office and technical premises in Odessa under a lease which expires in 2005. In Kazakhstan, we possess the right to occupy and utilize two floors, 747
square meters, of building in central Almaty which houses SA Telcom under a
long-term lease which expires in 2009. In Uzbekistan, we posses the right to
occupy and utilize two floors, 650 square meters, of a building in central
Tashkent which houses Buzton under a long-term lease which expires in 2013. We lease various buildings and space in buildings throughout the
Commonwealth of Independent States that we use for our offices. Beside these
office spaces, our principal facilities consist of telecommunications
installations, including switches of various sizes, cables and VSAT and other
transmission devices located throughout the Commonwealth of Independent States.
We believe that our facilities are adequate for our current needs. 
 ITEM 3. LEGAL PROCEEDINGS None 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None 38




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PART II 
 ITEM 5. MARKET FOR THE COMPANYS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES a) MARKET INFORMATION Our common stock has traded on the Nasdaq National Market since September
30, 1999 under the symbol GLDN. The following table sets forth, for the
periods indicated, the high and low closing prices per share for our common
stock, as reported on the Nasdaq National Market. HIGH
    
    
    
    LOW2003:First quarter
    
    
    15.19
    
    
    
    12.27Second quarter
    
    
    24.50
    
    
    
    14.58Third quarter
    
    
    32.76
    
    
    
    22.50Fourth quarter
    
    
    30.11
    
    
    
    25.182004:First quarter
    
    
    36.63
    
    
    
    28.24Second quarter
    
    
    35.93
    
    
    
    22.77Third quarter
    
    
    30.97
    
    
    
    23.61Fourth quarter
    
    
    31.45
    
    
    
    25.94
 b) HOLDERS As of March 8, 2005, there were approximately 17 holders of record of our
common stock. c) DIVIDENDS During 2004, we paid four quarterly dividends of $0.20 per common share,
for a total of $0.80 per common share for the year. The Board of Directors
reviews the Companys policy on dividends annually. In February 2005, the Board
of Directors of the Company declared a cash dividend of $0.20 per common share
payable on March 31, 2005 to shareholders of record as of March 17, 2005. We
believe that we have reached a level of operating profitability that allows for
expansion and maintenance capital expenditures to be financed entirely from
operational cash flows, and therefore we expect, subject to unexpected changes
in our business, that a dividend will continue to be paid in the future. d) RECENT SALES OF UNREGISTERED SECURITIES None For information regarding securities issued under our equity participation
plan, see Item 12. Security Ownership of Certain Beneficial Owners and
Management  Equity Compensation Plan Information 39




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ITEM 6. SELECTED FINANCIAL DATA The following selected historical consolidated financial data at December
31, 2000, 2001, 2002, 2003 and 2004, and for all of the years presented are
derived from consolidated financial statements of Golden Telecom, Inc. which
have been audited by Ernst & Young (CIS) Limited, independent auditors. The data should be read in conjunction with the consolidated financial
statements, related notes, and other financial information included in this
document. FOR THE YEARS ENDED DECEMBER 31,2000
    
    
    2001
    
    
    2002
    
    
    2003
    
    
    2004(IN THOUSANDS, EXCEPT PER SHARE DATA)STATEMENT OF OPERATIONS DATA:Revenues
    
    $
    113,089
    
    
    $
    140,038
    
    
    $
    198,727
    
    
    $
    360,534
    
    
    $
    583,978Cost of revenues (excluding
depreciation and amortization)
    
    
    50,954
    
    
    
    63,685
    
    
    
    91,189
    
    
    
    181,085
    
    
    
    300,588Gross margin
    
    
    62,135
    
    
    
    76,353
    
    
    
    107,538
    
    
    
    179,449
    
    
    
    283,390Selling, general and administrative
(excluding depreciation and
amortization)
    
    
    45,420
    
    
    
    48,935
    
    
    
    46,147
    
    
    
    64,384
    
    
    
    112,855Depreciation and amortization
    
    
    31,851
    
    
    
    41,398
    
    
    
    29,961
    
    
    
    45,334
    
    
    
    74,999Impairment charge
    
    
    
    
    
    
    31,291
    
    
    
    
    
    
    
    
    
    
    
    Income (loss) from continuing
operations
    
    
    (15,136
    )
    
    
    (45,271
    )
    
    
    31,430
    
    
    
    69,731
    
    
    
    95,536Equity in earnings (losses) of ventures
    
    
    (285
    )
    
    
    8,155
    
    
    
    4,375
    
    
    
    4,687
    
    
    
    278Interest income (expense), net
    
    
    7,126
    
    
    
    777
    
    
    
    (667
    )
    
    
    (872
    )
    
    
    559Foreign currency gain (loss)
    
    
    (390
    )
    
    
    (647
    )
    
    
    (1,174
    )
    
    
    (232
    )
    
    
    660Other non-operating expense
    
    
    (148
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Minority interest
    
    
    (431
    )
    
    
    (117
    )
    
    
    (527
    )
    
    
    (480
    )
    
    
    (1,506
    )Provision for income taxes
    
    
    990
    
    
    
    1,902
    
    
    
    4,627
    
    
    
    17,399
    
    
    
    30,744Net income (loss) before
cumulative effect of change
in accounting principle
    
    
    (10,254
    )
    
    
    (39,005
    )
    
    
    28,810
    
    
    
    55,435
    
    
    
    64,783Cumulative effect of change in
accounting principle
    
    
    
    
    
    
    
    
    
    
    974
    
    
    
    
    
    
    
    Net income (loss)
    
    
    (10,254
    )
    
    
    (39,005
    )
    
    
    29,784
    
    
    
    55,435
    
    
    
    64,783Income (loss) from continuing operations
per share  basic
    
    
    (0.63
    )
    
    
    (1.92
    )
    
    
    1.30
    
    
    
    2.45
    
    
    
    2.64Net income (loss) per share before
cumulative effect of change in
accounting principle  basic
    
    
    (0.43
    )
    
    
    (1.65
    )
    
    
    1.20
    
    
    
    1.20
    
    
    
    1.79Cumulative effect of change in
accounting principle
    
    
    
    
    
    
    
    
    
    
    0.04
    
    
    
    0.04
    
    
    
    Net income (loss) per share  basic
    
    
    (0.43
    )
    
    
    (1.65
    )
    
    
    1.24
    
    
    
    1.95
    
    
    
    1.79Weighted average shares  basic
    
    
    24,096
    
    
    
    23,605
    
    
    
    24,102
    
    
    
    28,468
    
    
    
    36,226Income (loss) from continuing operations
per share  diluted
    
    
    (0.63
    )
    
    
    (1.92
    )
    
    
    1.28
    
    
    
    2.40
    
    
    
    2.61Net income (loss) per share before
cumulative effect of change in
accounting principle  diluted
    
    
    (0.43
    )
    
    
    (1.65
    )
    
    
    1.17
    
    
    
    1.90
    
    
    
    1.77Cumulative effect of change in
accounting principle
    
    
    
    
    
    
    
    
    
    
    0.04
    
    
    
    
    
    
    
    Net income (loss) per share  diluted
    
    
    (0.43
    )
    
    
    (1.65
    )
    
    
    1.21
    
    
    
    1.90
    
    
    
    1.77Weighted average shares  diluted
    
    
    24,096
    
    
    
    23,605
    
    
    
    24,517
    
    
    
    29,107
    
    
    
    36,553Cash dividends per common share
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    0.80
 40




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AT DECEMBER 31,2000
    
    
    2001
    
    
    2002
    
    
    2003
    
    
    2004(IN THOUSANDS)BALANCE SHEET DATA:Cash and cash equivalents
    
    $
    57,889
    
    
    $
    37,404
    
    
    $
    59,625
    
    
    $
    65,180
    
    
    $
    53,699Investments available for sale
    
    
    54,344
    
    
    
    8,976
    
    
    
    
    
    
    
    
    
    
    
    Property and equipment, net
    
    
    82,377
    
    
    
    98,590
    
    
    
    166,121
    
    
    
    283,110
    
    
    
    347,891Investments in and advances to ventures
    
    
    49,629
    
    
    
    45,981
    
    
    
    721
    
    
    
    251
    
    
    
    742Goodwill and intangible assets, net
    
    
    70,045
    
    
    
    57,146
    
    
    
    127,669
    
    
    
    248,843
    
    
    
    247,570Total assets
    
    
    348,456
    
    
    
    300,384
    
    
    
    435,810
    
    
    
    729,226
    
    
    
    805,768Long-term debt, including long-term
capital lease obligations
    
    
    15,658
    
    
    
    10,733
    
    
    
    29,732
    
    
    
    3,963
    
    
    
    1,738Minority interest
    
    
    3,337
    
    
    
    5,967
    
    
    
    2,187
    
    
    
    2,722
    
    
    
    11,738Shareholders equity
    
    
    287,241
    
    
    
    224,892
    
    
    
    311,506
    
    
    
    584,279
    
    
    
    626,381
  Refer to note 5 to the Consolidated Financial Statements for descriptions
of recent acquisitions that impact the comparability of financial information.
Other business combinations not disclosed in the footnotes were as follows: In February 2000, Golden Telecom (Ukraine), acquired 99% of Sovam Teleport
Ukraine, including a 51% interest previously held by third parties. Sovam
Teleport Ukraine is a provider of data and Internet services to Ukraine-based
business. In March 2000, the Company acquired the assets of Referat.ru and
Absolute Games, two leading vertical Internet portals in the education and
computer gaming categories of the Russian Internet. In April 2000, the Company
acquired the assets of Fintek, a prominent Moscow-based Web design studio and
51% of Commercial Information Networks, the largest Internet service provider in
Nizhny Novgorod. In September 2000, SFMT-Rusnet, Inc., a wholly-owned
subsidiary, acquired 25% of SA Telcom LLP, a telecommunications and data
services provider in Kazakhstan, bringing its ownership interest in this company
up to 100%. The combined purchase price was less than $3.0 million in cash. In October 2000, the Company acquired the assets of IT INFOART STARS, a
leading horizontal Russian and English language Internet portal, for
approximately $8.3 million in cash. In December 2000, the Company acquired Agama
Limited (Agama) that owns the Agama family of web properties for approximately
$13.1 million in cash and the issuance of 399,872 shares of the Companys common
stock valued at $3.8 million. In December 2000, the Company acquired an approximately 24% ownership
interest in MCT Corp. in exchange for the Companys 100% ownership of Vostok
Mobile B.V., a Netherlands registered private limited holding company that owned
the Companys Russian mobile operations. Refer to note 4 to the Consolidated Financial Statements for a description
of the change in method of accounting for goodwill in 2002. In the third quarter of 2004, management determined that the Company has
been inadvertently carrying accruals for estimated taxes, other than income
taxes. Management concluded these accruals for estimated taxes should have been
considered unnecessary and reversed prior to January 1, 2000. The net effect of
the correction of this non-cash error was to reduce current liabilities and
non-current liabilities by $2.0 million each with an offsetting decrease to
accumulated deficit of $4.0 million in all periods presented. This adjustment
had no effect on the reported results of operations in any of the periods
presented. 41




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ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS The following discussion and analysis relates to our financial condition
and results of operations for each of the years ended December 31, 2004, 2003,
and 2002. This discussion should be read in conjunction with the Selected
Financial Data and the Companys Consolidated Financial Statements and the
notes related thereto appearing elsewhere in this Report. OVERVIEW We are a leading facilities-based provider of integrated telecommunication
and Internet services in major population centers throughout Russia and other
countries of the Commonwealth of Independent States (CIS). We offer voice,
data and Internet services to corporations, operators and consumers using our
metropolitan overlay network in major cities including Moscow, Kiev, St.
Petersburg, Nizhny Novgorod, Samara, Kaliningrad, Krasnoyarsk, Almaty, and
Tashkent, and via intercity fiber optic and satellite-based networks, including
approximately 220 combined access points in Russia and other countries of the
CIS. In addition, we offer mobile services in Kiev and Odessa. We organize our operations into four business segments, as follows:  
    BUSINESS AND CORPORATE SERVICES (BCS). Using our fiber optic and
satellite-based networks in and between major metropolitan areas of
Russia, Ukraine and other countries of the CIS, we provide business
and corporate services including voice and data services to corporate
clients across all geographical markets and all industry segments,
other than telecommunications operators;
    CARRIER AND OPERATOR SERVICES. Using our fiber optic and
satellite-based networks in and between major metropolitan areas of
Russia, Ukraine and other countries of the CIS, we provide a range of
carrier and operator services including voice and data services to
foreign and Russian telecommunications and mobile operators;
    CONSUMER INTERNET SERVICES. Using our fiber optic and satellite-based
networks, we provide dial-up Internet access to the consumer market
and web content offered through a family of Internet portals
throughout Russia, Ukraine, Kazakhstan, and Uzbekistan; and
    MOBILE SERVICES. Using our mobile networks in Kiev and Odessa,
Ukraine, we provide mobile services with value-added features, such as
voicemail, roaming and messaging services on a subscription and
prepaid basis. We intend, wherever possible, to offer all of our integrated
telecommunication services under the Golden Telecom brand, although, some
services still carry local brands because of recent acquisitions. Our dial-up
Internet services are distributed under the ROL brand in Russia, Kazakhstan and
Uzbekistan and under the Svit-On-Line brand in Ukraine. Additionally, we hold a minority interest in MCT Corp. (MCT), which in
turn has ownership interests in 13 mobile operations located throughout Russia
and in Uzbekistan, Tajikistan and Afghanistan. We treat our ownership interest
in MCT as an equity method investment and are not actively involved in the
day-to-day management of the operations. Most of our revenue is derived from high-volume business customers and
carriers. Our business customers include large multi-national companies, local
enterprises, financial institutions, hotels and government agencies. We believe
that the carriers, including mobile operators, which contribute a substantial
portion of our revenues, in turn derive a portion of their business from
high-volume business customers. Thus, we believe that the majority of our
ultimate end-users are businesses that require access to highly reliable and
advanced telecommunications facilities to sustain their operations. Traditionally, we have competed for customers on the basis of network
quality, customer service and range of services offered. In the past several
years, other telecommunications operators have also introduced high-quality
services to the segments of the business market in which we operate. Competition
with these operators is intense, and frequently results in declining prices for
some of our services, which adversely affect our revenues. In addition, some of
our competitors do not link their prices to the United States dollar (USD) -
ruble exchange rate, so when the ruble devalues, their prices effectively become
lower in relation to our prices. The ruble exchange rate with the USD has become
relatively stable since early 2000 and appreciated in 2003 and 2004 so price
pressures associated with devaluation have eased considerably. We cannot be
certain that the exchange rate will remain stable in the future and therefore we
may experience additional price pressures. RECENT ACQUISITIONS In August 2003, we completed the acquisition of 100% ownership interest in
OOO Sibchallenge (Sibchallenge), a telecommunications service provider in
Krasnoyarsk, Russia, for cash consideration of approximately $15.4 million. The
acquisition 42




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of Sibchallenge establishes our presence in the Krasnoyarsk region. In addition,
Sibchallenge has numbering capacity and interconnect agreements. In December 2003, we completed the acquisition of 100% of the shares in
OAO Comincom (Comincom), and its wholly-owned subsidiary, OAO Combellga (Combellga) from Nye
Telenor East Invest for a total purchase price of approximately $195.3 million,
consisting of approximately $193.5 million in our common stock and direct
transaction costs of approximately $1.8 million. The acquisition further
strengthens our position in the key Moscow and St. Petersburg communications
markets, and positions us to realize operating and capital expenditure
synergies. Comincom provided telecommunications services, principally to major
hotels, business offices, embassies and mobile communication companies through
its telecommunications network in Russia. As of December 1, 2004, all assets,
liabilities, rights and obligations of Comincom and Combellga were transferred
to Sovintel as part of the legal merger of these three wholly-owned
subsidiaries. In February 2004, we completed the acquisition of 100% ownership interest
in ST-HOLDING s.r.o. (ST-HOLDING), a Czech company that owns 50% plus one
share in ZAO Samara Telecom, a telecommunications service provider in Samara,
Russia from ZAO SMARTS and individual owners. In April 2004, we completed the
acquisition of 100% of the common stock in OAO Balticom Mobile (Balticom) that
owns 62% of ZAO WestBalt Telecom, an alternative telecommunications operator in
Kaliningrad, Russia. In April 2004, we completed the acquisition of the
remaining 49% ownership interest in OOO Uralrelcom that we did not already own.
In May 2004, we completed the acquisition of a 54% ownership interest in SP
Buzton (Buzton), an alternative telecommunications operator in Uzbekistan.
These companies were acquired for approximately $16.0 million in cash, with $1.1
million held in escrow for a period of one year related to Balticom and $0.5
million payable for Buzton upon satisfactory achievement of certain conditions. In August 2004, we entered into a share purchase agreement with Nodama
Holdings, Ltd. (Nodama), to acquire 100% of the common stock in Hudson
Telecom, Inc., a Delaware corporation, which owns 100% ownership interest in OOO
Digital Telephone Networks and OOO Digital Telephone Switches, which together
comprise one of the largest regional alternative operators in Russia. Their
operations are in Rostov-on-Don and the surrounding region. Upon closure, Nodama
will receive $45.0 million in cash of which $5.0 million will be placed in
escrow for a period of one year subject to the achievement of certain financial
conditions. Amounts in the escrow may be used to compensate us in the event of
the realization of certain contingent liabilities in the acquired entities.
While we expected to consummate this transaction in 2004, it has taken the
seller additional time to conclude this transaction. The consummation of the
transaction is conditioned upon, among other things, the completion of
satisfactory due diligence and the sellers fulfilment of certain conditions
precedent. The transaction is expected to close in the first half of 2005. OTHER DEVELOPMENTS On January 1, 2004, a new law On Telecommunications (the New Law) came
into effect in Russia. The New Law sets the legal basis for the
telecommunications business in Russia and defines the status that state bodies
have in the telecommunications sector. The New Law was designed to create a new
interconnect pricing regime in 2004 that should be more transparent and unified,
if fairly implemented. However, as of December 31, 2004, this pricing regime has
not been implemented. The New Law also creates a universal service charge
calculated as a percentage of revenue which is not expected to exceed 3% of
certain revenues of a telecommunications company. It is expected that the first
payments of the universal service charge will be made in 2005. The New Law may
increase the regulation of our operations, as it is intended to regulate
licenses for long distance, international long distance and Voice
over Internet Protocol (VoIP). Until such
time as appropriate regulations consistent with the New Law are promulgated,
there will be a period of confusion and ambiguity as regulators interpret the
legislation. In March of 2005, we submitted an application for an intercity and
international license in Russia. This license would allow us to handle
long-distance voice traffic for our customers and other licensed operators,
including mobile operators. This license is an integral component to our
strategy of becoming the number one nationwide operator in Russia. This
intercity and international license regime is an important component to Russias
liberalization plans for telecommunications. In anticipation of approval in
2005, we are planning the implementation of essential infrastructure including a
number of long-distance switches. Recognizing that many of the markets in which we operate are complex, in
particular as it relates to business, regulatory, political and cultural
matters, we occasionally seek experienced local partners to assist in markets
where we are likely to encounter operational difficulties. We have been
cooperating with local partners in Ukraine to resolve commercial and regulatory
disputes with monopoly 43




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operators and regulatory authorities in Ukraine but had not previously finalized
the compensation arrangement for the services. In addition to or in lieu of cash
compensation, the Board of Directors approved the sale of a non-controlling
interest in Golden Telecom (Ukraine) (GTU) to such parties. Upon approval of our Board of Directors, in August 2004 we entered into a
compensation arrangement for services provided to assist us in resolving
commercial and regulatory disputes with monopoly operators and regulatory
authorities in Ukraine. Our local partners have provided services on a success
fee basis. Our Board of Directors approved an arrangement that effectively
transferred 20% of the shares in GTU owned by us to the local partners as
compensation for the services already provided and certain additional services
to be provided. Under this arrangement, we paid the local partners $0.5 million
in cash and granted the local partner an option to purchase 20% of GTU for $0.5
million in cash, in a transaction where the cash and the value of the services
were approximately $3.6 million. This transaction closed in the third quarter of
2004, when the performance was completed and the option was exercised and
resulted in a charge to operating income of approximately $3.6 million. The
excess of the fair value of consideration exchanged for services over the book
value of 20% of net assets of GTU was recorded as a credit to the consolidated
equity, rather than income since we did not believe that the method
of determining fair value met the objectively determinable criteria
as required by Staff Accounting Bulletin Topic 5H. Fair value of the option approximated the fair value of shares
transferred to the local partner due to the short exercise period of the option
and was determined using the discounted cash flow valuation method. We continue
to believe that Ukraine offers promising investment opportunities but that there
are still political and commercial risks associated with operating in Ukraine. In July 2004, our Board of Directors adopted a Long-Term Incentive Bonus
Plan (LTIBP) for our senior management, effective as of January 1, 2004. The
LTIBP is designed to reward senior management with annual bonus awards
consisting of 100% restricted shares for our officers and 50% restricted shares
and 50% cash payments for other qualified employees participating in LTIBP if we
meet certain targets for net income growth established by the Board of
Directors. In addition, the program provides for a one-time grant of a limited
amount of shares to senior management in an aggregate amount not exceeding
50,000 shares. The LTIBP is intended to act as a retention mechanism for senior
management as the cash payments and the restricted stock vest over a three year
period. It is expected that the LTIBP will act as a substitute for our Equity
Participation Plan under which significant amounts of stock options were, in the
past, granted to senior management. During the twelve months ended December 31,
2004 we did not record any expenses associated with the LTIBP as we did not
achieve the operational and financial targets for 2004. We currently anticipate
repurchasing from time to time in the open market, a number of our shares equal
to the number of our shares that are subject to awards under the LTIBP. We have
not granted any shares under the LTIBP. In the third quarter of 2004, management determined that we had been
inadvertently carrying accruals for estimated taxes, other than income taxes.
Management concluded these accruals for estimated taxes should have been
considered unnecessary and reversed prior to January 1, 2000. The net effect of
the correction of this non-cash error was to reduce current liabilities and
non-current liabilities by $2.0 million each with an offsetting decrease to
accumulated deficit of $4.0 million in all periods presented. This adjustment
had no effect on the reported results of operations in any of the periods
presented. In February 2005, we received notice from Vimpelcom, our largest customer,
that it is diverting a volume of traffic away from us pursuant to the telephone
traffic routing provisions of the New Law and the General Scheme
for operation of the Russian GSM Network promulgated by the Russian Ministry of
Communications. At this point, we are in discussions with Vimpelcom and
regulatory agencies and cannot accurately predict what will be the impact of
this new issue on our operations going forward. Since January 1, 2005, we have
lost approximately $0.2 million in revenue due to Vimpelcoms action. HIGHLIGHTS AND OUTLOOK Since early 2000 we have witnessed a recovery in the Russian market, but
downward pricing pressures persist from increased competition and the global
trend toward lower telecommunications tariffs. In 2003 and 2004, our traffic
volume increases exceeded the reduction in tariffs on certain types of voice
traffic. This is a contributing factor to the increases in our revenue in 2003
and 2004, although the major factor of revenue increases in 2004 was the
acquisition of Comincom. We expect that this trend of year over
year increases in traffic volume will continue as long as the Russian economy
continues to develop at its current pace. Although our revenue growth is strong,
our overall margins continue to be impacted by price increases for services
received from monopolistic incumbent operations. In order to handle additional traffic volumes, we have expanded and will
continue to expand our fiber optic capacity along our heavy traffic and high
cost routes to mitigate declines in traffic margins, reduce our unit
transmission costs and ensure sufficient capacity to meet the growing demand for
data and Internet services. We expect to continue to add additional transmission
capacity, which due to its fixed cost nature can initially depress margins, but
will over time allow us to improve or maintain our margins. We continue to follow our strategy of regional expansion. The project for
the construction of the inter-city fiber optic link which we launched in the
middle of 2004 will be continued into the second half of 2005. At present, we
are constructing an inter-city fiber optic link from Moscow to Ufa through
Nizhny Novgorod and Kazan. Subject to weather conditions, we expect that this
inter-city fiber optic link will be operational in the second half of 2005. To
date, this inter-city fiber optic link has been completed from Moscow to
Noginsk. We intend to connect our operations in the European part of Russia to
this backbone network and plan to invest a total of approximately $40.0 million
to $50.0 million in this and related backbone projects through 2007. In Kiev, Ukraine we have entered into agreements to obtain sufficient
numbering capacity for our business services operations. Our ability to grow our
business services operations in Kiev may become limited if the parties who
provide our numbering capacity and other infrastructure requirements are unable
or unwilling to perform under their contracts with us. 44




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A significant portion of our carrier revenue is generated from the
Ukrainian cellular operators large volumes of international and long distance
traffic. Price and quality of services are the primary factors in their purchase
decision. In 2004, several Ukrainian cellular operators, including UMC and
Kyivstar, received international communications license.
Nevertheless, Ukrainian Mobile Communications (UMC), one
of our largest customers, continued sending a large volume of outgoing
international traffic through our network. Also, cellular operators have an
increasing demand for some value added services like our 800 service. We have seen a significant year-over-year increase in our dial-up Internet
subscriber numbers and we expect the increase to continue, as our base of
regional subscribers expands. As additional dial-up capacity becomes available
in Moscow, we expect to increase our market share in the capital as well. We have continued to integrate our acquisitions and improve operational
efficiency while at the same time controlling costs. We expect to incur further
costs in connection with overall streamlining of our operations during 2005.
During the twelve months ended December 31, 2004, we incurred consulting and
employee termination costs associated with the operational integration of
Comincom into our operations which has been recorded in selling, general and
administrative expense. In addition, we have incurred costs associated with,
among other things, Sarbanes-Oxley compliance and other consulting and
recruiting expenses. The rapid growth of the telecommunications market in Russia, Ukraine, and
the CIS is fueled by macroeconomic growth and the inflow of direct foreign
investment. We anticipate that the economic growth in these markets will create
additional demand for telecommunications services. Additionally, in line with
worldwide trends, we are starting to observe new customer demands for more
sophisticated telecommunications and Internet services as well as other new
technologies. We are responding to these customer demands by testing and
implementing new technologies such as VoIP, wireless local loop and high-speed
consumer Internet. Such new technologies will remove some of the barriers to
access that some of our customers currently face. For example, with wireless
local loop, we can connect remote customers to our network by by-passing the
incumbents wire network in order to provide higher quality access. Our
customers are willing to pay a premium for this type of technology and customer
service. With respect to 2005, we continue to see growth opportunities organically,
through select acquisitions, and through the development of new lines. While our
research indicates the telecommunications sector growth in business segments in
the Moscow and St. Petersburg markets of fixed telecommunications services will
continue to grow, we believe that the bulk of our growth will come from the key
regions of Rostov-On-Don, Nizhny Novgorod, Samara, Ufa, Krasnoyarsk,
Vladivostok, Khabarovsk, and Ekaterinburg. We will continue to align the strategy of each of our business segments
with market forces in the countries where we operate. In BCS, our strategy is to
focus on and grow our market-share through attractive service offerings
supported by excellent customer care. We are focused on expanding into the
regions as well as the fast growing small and medium-sized enterprise or (SME)
and the small office / home office or (SOHO) markets. In these cases where the
potential SME and SOHO customer is not on our network, our ability to fully benefit from growth in these market segments largely depends on
the regulatory situation and our ability to get access to the copper and other
infrastructure of the incumbent operators under reasonable terms and conditions.
In Carrier and Operator Services our strategy for future years will focus on
partnering with more mobile operators in the regions. We aim to provide mobile
operators with the right solutions for their needs and thereby benefit from the
mobile operator expansion and growth. Our 2004 growth in Consumer and Internet
Services indicates that our dial-up business continues to be very strong.
However, we also recognize that new technologies are making their way into
Russia, Ukraine, and CIS. Thus, we continue to beta test new technologies that
will benefit consumers and allow us to strengthen our market position as well as
to up-sell to our existing dial-up customer base. A recent example of this is
our implementation of WiMax and Wi-Fi in selected areas of Russia. Also, with
low penetration of dial-up services throughout the regions, we continue to see
potential in this market. CRITICAL ACCOUNTING POLICIES The fundamental objective of financial reporting is to provide useful
information that allows a reader to comprehend our business activities. To
assist that understanding, management has identified our critical accounting
policies. These policies have the potential to have a significant impact on our
financial statements, either because of the significance of the financial
statement item to which they relate, or because they require judgment and
estimation due to the uncertainty involved in measuring, at a specific point in
time, events which are continuous in nature. Revenue recognition policies; we recognize operating revenues as services
are rendered or as products are delivered to customers and installed. Under
multiple-delivery contracts, involving a combination of product delivery,
installation and maintenance, connection and service fees, revenues are
recognized based on the relative fair value of the respective amounts. Elements
are grouped if they are inseparable or objective evidence of fair value does not
exist. Certain revenues, such as connection and installation fees, are deferred.
We also defer direct incremental costs related to connection fees, not exceeding
the revenue deferred. Deferred revenues are subsequently recognized over the
estimated average customer lives, which are periodically reassessed by us, and
such reassessment may impact our future operating results. In determining the
recording of revenue, estimates and assumptions are required in assessing the
expected conversion of the revenue streams to cash collected. Allowance for doubtful accounts policies; the allowance estimation process
requires management to make assumptions based on historical results, future
expectations, the economic and competitive environment, changes in the
creditworthiness of our customers, 45




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and other relevant factors. Changes in the underlying assumptions may have a
significant impact on the results of our operations. In particular, we have
certain amounts due to and from subsidiaries of a European telecommunications
operator who is currently subject to bankruptcy proceedings. The ultimate
resolution of this matter will be affected by a number of factors including the
determination of legal obligations of each party, the course of the bankruptcy
proceedings, and the enforceability of any determinations. We have recognized
provisions based on our preliminary estimate of net exposure on the resolution
of these receivables and payables. If our assessment proves to be incorrect we
may have to recognize an additional provision of up to $2.2 million, net of tax,
although management believes that the possibility of such an adverse outcome is
remote. Long-lived asset recovery policies; this policy is in relation to
long-lived assets, consisting primarily of property and equipment and
intangibles, which comprise a significant portion of our total assets. Changes
in technology or changes in our intended use of these assets may cause the
estimated period of use or the value of these assets to change. We perform
periodic internal studies to confirm the appropriateness of estimated economic
useful lives for each category of current property and equipment. Additionally,
long-lived assets, including intangibles, are reviewed for impairment whenever
events or changes in circumstances have indicated that their carrying amounts
may not be recoverable. Estimates and assumptions used in both setting useful
lives and testing for recoverability of our long-lived assets require the
exercise of managements judgment and estimation based on certain assumptions
concerning the expected life of any asset and expected future cash flows from
the use of an asset. Goodwill and assessment of impairment; commencing from the adoption of
Statement on Financial Accounting Standard (SFAS) No. 142, Goodwill and Other
Intangible Assets, on January 1, 2002, we perform goodwill impairment testing
annually as of October 1 or whenever impairment indicators exist. This test
requires a significant degree of judgment about the future events and it
includes determination of the reporting units, allocation of goodwill to the
reporting units and comparison of the fair value with the carrying amount of
each reporting unit. Based on the discounted cash flow valuations performed in
2004, we concluded that for all reporting units the fair value is in excess of
the respective carrying amounts. Valuation allowance for deferred tax asset; we record valuation allowances
related to tax effects of deductible temporary differences and loss
carryforwards when, in the opinion of management, it is more likely than not
that the respective tax assets will not be realized. Changes in our assessment
of probability of realization of deferred tax assets may impact our effective
income tax rate. Business segment information; we changed our reporting for business
segments in the second quarter of 2003. Prior to the completion of the
acquisition of the remaining 50% ownership interest in Sovintel and the
subsequent merger of TeleRoss into Sovintel in April 2003, we managed our
business segments based on telecommunications products that we provided. In the
first quarter of 2003, we re-designed our business segments around customer
characteristics. Currently, we report four segments within the
telecommunications industry: Business and Corporate Services, Carrier and
Operator Services, Consumer Internet Services and Mobile Services. A significant
portion of our cost structure, including our investment in infrastructure,
benefits multiple segments. As a result, we perform allocations of certain costs
in order to report business segment information for management and financial
reporting purposes. Applying different allocation techniques and parameters
could impact the reported results of individual business segments. Functional currency; effective January 1, 2003, Russia is no longer
considered a hyperinflationary economy, therefore the determination of
functional currency for United States generally accepted accounting principles
(US GAAP) reporting purposes should be based on the analysis of the underlying
business transactions for each foreign subsidiary. We have determined in
accordance with the functional currency criteria of SFAS No. 52, Foreign
Currency Translation, that the USD should be considered the functional currency
of all foreign subsidiaries. There are subjective elements in this
determination, including a weight given to each specific criteria established by
SFAS No. 52. Changes in the underlying business transactions could lead to
different functional currency determination for a particular subsidiary, which
would have an impact on its reported financial position and results of
operations. CRITICAL ACCOUNTING ESTIMATES Accounting estimates are an integral part of the financial statements
prepared by management and are based upon managements current judgments.
Certain accounting estimates are particularly sensitive because of their
significance to the financial statements and because of the possibility that
future events affecting them may differ markedly from managements current
judgment. We believe the following items represent such particularly sensitive
accounting estimates: Allowance for doubtful accounts; any changes in the underlying assumptions
of recoverability of accounts receivable by respective aging group or certain
specific accounts that are excluded from the specific and general allowances
could have a material effect on our current and future results of operations. We
believe that the allowance for doubtful accounts is adequate to cover estimated
losses in our accounts receivable balances under current conditions. 46




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Tax provisions; in the course of preparing financial statements in
accordance with US GAAP, we record potential tax loss provisions under the
guidelines of SFAS No. 5, Accounting for Contingencies. In general SFAS No. 5
requires loss contingencies to be recorded when they are both probable and
reasonably estimable. In addition, we record other deferred tax provisions under
the guidelines of SFAS No. 109, Accounting for Income Taxes. Significant
judgment is required to determine when such provisions should be recorded, and
when facts and circumstances change, when such provisions should be released. Useful lives of property and equipment and certain intangible assets; our
network assets and amortizable intangible assets are depreciated and amortized
over periods generally ranging from five to ten years. Any reduction or increase
in the estimated useful lives for a particular category of fixed assets or
intangible assets could have a material effect on our future results of
operations. Business combinations; SFAS No. 141, Business Combinations, requires us
to recognize the share in the assets of businesses acquired and respective
liabilities assumed based on their fair values. Our estimates of the fair value
of the identified intangible assets of businesses acquired are based on our
expectations of future results of operations of such businesses. RECENT ACCOUNTING PRONOUNCEMENTS In January 2003, the Financial Accounting Standards Board (FASB) issued
FASB Interpretation No. 46, Consolidation of Variable Interest Entities (FIN
No. 46). FIN No. 46 amended Accounting Research Bulletin No. 51, Consolidated
Financial Statements, and established standards for determining under what
circumstances a variable interest (VIE) should be consolidated with its
primary beneficiary. FIN No.46 also requires disclosure about VIEs that are not
required to be consolidated but in which the reporting entity has a significant
variable interest. In December 2003, the FASB revised certain implementation
provisions of FIN No. 46. The revised interpretation (FIN No. 46R)
substantially retained the requirements of immediate application of FIN No. 46
to VIEs created after January 31, 2003. There were no such entities created
after January 31, 2003. With respect to older VIEs, the consolidation
requirements under FIN No. 46R apply not later than for the first financial year
or interim period ending after December 15, 2003, if such VIE is a
special-purpose entity (SPE), and no later than for the first financial year
or interim period ending after March 15, 2004, if such a VIE is not a SPE. We
did not identify any previously formed SPEs that are VIEs. Therefore the
adoption of FIN No. 46R did not have an impact on the financial position or
results of operations. In December 2004, the FASB issued Statement on Financial Accounting
Standard (SFAS) No. 123R (revised 2004), Share Based Payment, which is a
revision of SFAS No. 123, Accounting for Stock-Based Compensation SFAS No.
123R supersedes APB No. 25, Accounting for Stock Issued to Employees and amends
SFAS No. 95, Statement of Cash Flows. Under SFAS No. 123R, companies must
calculate and record the cost of equity instruments, such as stock options or
restricted stock, awarded to employees for services received in the income
statement; pro forma disclosure is no longer permitted. The cost of the equity
instruments is to be measured based on fair value of the instruments on the date
they are granted (with certain exceptions) and is required to be recognized over
the period during which the employees are required to provide services in
exchange for the equity instruments. SFAS No. 123R is effective in the first
interim or annual reporting period beginning after June 15, 2005. SFAS No. 123R provides two alternatives for adoption: (1) a modified
prospective method in which compensation cost is recognized for all awards
granted subsequent to the effective date of this statement as well as for the
unvested portion of awards outstanding as of the effective date and (2) an
modified retrospective method which follows the approach in the modified
prospective method, but also permits entities to restate prior periods to
reflect compensation cost calculated under SFAS No. 123 for pro forma amounts
disclosure. We plan to adopt SFAS No. 123R using the modified prospective
method. As we currently account for share based payments to employees in
accordance with the intrinsic value method permitted under ABP No. 25, no
compensation expense is recognized. The impact of adopting SFAS No. 123R cannot
be accurately estimated at this time, as it will depend on the amount of share
based awards granted in future periods. However, had we adopted SFAS No. 123R in
a prior period, the impact would approximate the impact of SFAS No. 123 as
described in the disclosure of pro forma net income and earnings per share. SFAS
No. 123R also requires that tax benefits received in excess of compensation cost
be reclassified from an operating cash flow to a financing cash flow in the
Consolidated Statement of Cash Flows. This change in classification will reduce
net operating cash flows and increase net financing cash flows in the periods
after adoption. In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary
Assets. SFAS No. 153 addresses the measurement of exchanges of nonmonetary
assets. The guidance in APB Opinion No. 29, Accounting for Nonmonetary
Transactions (APB No. 29), is based on the principle that exchanges of
nonmonetary assets should be measured based on the fair value of the assets
exchanged. The guidance in APB No. 29, however, included certain exceptions to
that principle. SFAS No. 153 amends APB No. 29 to eliminate the exception for
nonmonetary exchanges of similar productive assets and replaces it with a
general exception for exchanges of nonmonetary assets that do not have
commercial 47




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substance. A nonmonetary exchange has commercial substance if the future cash
flows of the entity are expected to change significantly as a result of the
exchange. This provisions of SFAS No. 153 are effective for financial statements
for fiscal years beginning after June 15, 2005. Earlier application is permitted
for nonmonetary asset exchanges incurred during fiscal years beginning after the
date SFAS No. 153 was issued. The adoption of the provisions of SFAS No. 153 is
not expected to have a material impact on our results of operations or financial
position. RESULTS OF OPERATIONS The results of our four business segments from the operations of our
consolidated entities combined with the non-consolidated entities where we are
actively involved in the day-to-day management, are shown in note 14 Segment
Information  Line of Business Data to our consolidated financial statements.
In addition, revenue and costs from related parties are shown in note 13
Related Party Transactions. In accordance with SFAS No. 52, we have determined that the functional
currency of each foreign subsidiary is the USD, as the majority of our cash
flows are indexed to, or denominated in USD. Through December 31, 2002, Russia
had been considered to be a highly inflationary environment. From January 1,
2003, Russia ceased to be considered as a highly inflationary economy. As we
believe that the functional currency of each foreign subsidiary is the USD, this
change did not have a material impact on our results of operations or financial
position. According to Russian government estimates, inflation in Russia was 16% in
2002, 14% in 2003 and 12% in 2004. The Russian government expects inflation to
be approximately 11% in 2005. Although the rate of inflation has been declining,
any return to heavy and sustained inflation could lead to market instability,
new financial crises, reduction in consumer buying power and erosion of consumer
confidence. As of April 15, 2003, all assets, liabilities, rights and obligations of
TeleRoss were transferred to Sovintel as part of the legal merger of these two
wholly-owned subsidiaries. This resulted in the reorganization of our operations
along the lines of customer characteristics as opposed to the types of
telecommunications products we provide. Therefore, in accordance with SFAS No.
131, Disclosures about Segments of an Enterprise and Related Information, we
have aligned our operating segments in the manner that the chief operating
decision maker manages the operations for purposes of making operating decisions
and allocating resources. THE DISCUSSION OF OUR RESULTS OF OPERATIONS IS ORGANIZED AS FOLLOWS:  
    Consolidated Results. Consolidated Results of Operations for the Year
Ended December 31, 2004 compared to the Consolidated Results of
Operations for the Year Ended December 31, 2003
    Consolidated Financial Position. Consolidated Financial Position at
December 31, 2004 compared to Consolidated Financial Position at
December 31, 2003
    Consolidated Results. Consolidated Results of Operations for the Year
Ended December 31, 2003 compared to the Consolidated Results of
Operations for the Year Ended December 31, 2002
    Consolidated Financial Position. Consolidated Financial Position at
December 31, 2003 compared to Consolidated Financial Position at
December 31, 2002 CONSOLIDATED RESULTS  CONSOLIDATED RESULTS OF OPERATIONS FOR THE YEAR ENDED
DECEMBER 31, 2004 COMPARED TO THE CONSOLIDATED RESULTS OF OPERATIONS FOR THE
YEAR ENDED DECEMBER 31, 2003 REVENUE Our revenue increased by 62% to $584.0 million for the year ended December
31, 2004 from $360.5 million for the year ended December 31, 2003. The overall
increase in revenue was due primarily to the consolidation of 100% of Comincoms
results of operations for a full year and, with respect to our existing
business, an increase in customer base and services provided to existing
customers, partially offset by lower prices for certain services. The breakdown
of revenue by business group was as follows: 48




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CONSOLIDATED REVENUE
    
    
    CONSOLIDATED REVENUEFOR THE YEAR
    
    
    FOR THE YEARENDED DECEMBER 31, 2003
    
    
    ENDED DECEMBER 31, 2004(IN MILLIONS)REVENUEBusiness and Corporate Services
    
    $
    188.9
    
    
    $
    324.8Carrier and Operator Services
    
    
    128.5
    
    
    
    198.9Consumer Internet Services
    
    
    30.8
    
    
    
    45.5Mobile Services
    
    
    13.9
    
    
    
    15.8Eliminations
    
    
    (1.6
    )
    
    
    (1.0
    )TOTAL REVENUE
    
    $
    360.5
    
    
    $
    584.0
 Business
and Corporate Services. Revenue from BCS increased by 72% to $324.8 million for the year ended
December 31, 2004 from $188.9 million for the year ended December 31, 2003. The
primary reason for the increase is due to the acquisition of 100% ownership
interest in Comincom in the fourth quarter of 2003. We began consolidating
Comincom into our results of operations from December 1, 2003. Comincoms
revenue from BCS was $90.7 million for the year ended December 31, 2004. BCS
revenue increased by approximately $8.3 million due to the 2004 acquisitions of
ST-HOLDING, Balticom, and Buzton. We began consolidating these three companies
into our results at various points during the first half of 2004. Additionally,
$3.5 million of the total increase is due to 2004 being the first full year that
we consolidated the results of Sibchallenge, an August 2003 acquisition. The
remainder of the increase was the result of expanding our pre-existing business.
In addition to the above factors, in our largest market, Moscow, we had
increases in our domestic traffic revenues due to adding approximately 9,100 new
corporate customers and signing up 99 new multi-tenant business centers and 10
new trade centers in the year ended December 31, 2004 along with actively
promoting new services among our client base. BCS Moscow recognized
approximately $23.7 million in revenue from new contracts in 2004 and grew the
number of its Direct Inward Dialing lines from 102,037 as of December 31, 2003
to approximately 116,668 as of December 31, 2004. Revenue
from the BCS division of GTU increased
by 52% to $28.8 million for the year ended December 31, 2004 from $19.0 million
for the year ended December 31, 2003. The increase in revenue was due to a 63%
increase in the number of serviced voice lines and a 28% increase in average
rate per minute of use. The latter was caused by the calling party
pays (CPP)
principle of settlement rates introduced by the Ukrainian Parliament in late
2003, which has increased revenue and settlement rates to Ukrainian mobile
networks. Carrier and Operator Services. Revenue from Carrier and Operator Services
increased by 55% to $198.9 million for the year ended December 31, 2004 from
$128.5 million for the year ended December 31, 2003. The primary reason for the
increase is due to the acquisition of 100% ownership interest in Comincom in the
fourth quarter of 2003. We began consolidating Comincom into our results of
operations from December 1, 2003. Comincoms revenue from Carrier and Operator
Services was $21.6 million for the year ended December 31, 2004. Also, revenue
increased by approximately $2.5 million due to the 2004 acquisitions of
ST-HOLDING, Balticom, and Buzton. We began consolidating these three companies
into our results at various points during the first half of 2004. Additionally,
$4.7 million of the total increase is due to 2004 being the first full year that
we consolidated the results of Sibchallenge, an August 2003 acquisition. We have
expanded our operations with existing partners and added a number of new
carriers specifically in the regions with increased volumes of traffic,
including VoIP. In addition, we continue to expand our business with major
cellular providers both in the capital and in the regions, which helped offset
general tariff declines, although pricing pressures still exist. Revenue for the Carrier and Operator Services division of GTU increased by
71% to $19.8 million for the year ended December 31, 2004 from $11.6 million for
the year ended December 31, 2003. The increase in revenue was due to a 91%
increase in incoming international traffic which we are able to terminate in a
number of cities in Ukraine, offset by a 34% decrease in outgoing international
traffic. Consumer Internet Services. Revenue from Consumer Internet Services
increased by 48% to $45.5 million for the year ended December 31, 2004 from
$30.8 million for the year ended December 31, 2003. The increase is largely the
result of increases in the number of dial-up Internet subscribers from 363,545
at December 31, 2003 to 413,351 at December 31, 2004 and the average revenue per
Internet subscriber increasing from approximately $8.39 per month to
approximately $9.03 per month over the same period. Mobile Services. Revenue from Mobile Services increased by 14% to $15.8
million for the year ended December 31, 2004 from $13.9 million for the year
ended December 31, 2003. Active subscribers increased from 40,026 at December
31, 2003 to 57,490 at December 31, 2004 due to an increase in the number of
prepaid subscribers driven by the overall Ukrainian mobile market growth. The
average revenue per active subscriber has decreased by 11% to approximately
$27.23 per month due to the decrease in the subscription fee for the tariff plan
which allows for unlimited local calls for a fixed payment as well as decrease
in the number of the subscribers using the said tariff plan and due to an
increase in the share of prepaid subscribers with lower activity and no fixed
charge. 49




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EXPENSES The following table shows our principal expenses for the years ended
December 31, 2003 and December 31, 2004: CONSOLIDATED EXPENSES
    
    
    CONSOLIDATED EXPENSESFOR THE YEAR ENDED
    
    
    FOR THE YEAR ENDEDDECEMBER 31, 2003
    
    
    DECEMBER 31, 2004(IN MILLIONS)COST OF REVENUEBusiness and Corporate Services
    
    $
    84.8
    
    
    $
    141.2Carrier and Operator Services
    
    
    74.9
    
    
    
    127.5Consumer Internet Services
    
    
    20.2
    
    
    
    26.9Mobile Services
    
    
    2.8
    
    
    
    6.0Eliminations
    
    
    (1.6
    )
    
    
    (1.0
    )TOTAL COST OF REVENUE
    
    
    181.1
    
    
    
    300.6Selling, general and administrative
    
    
    64.4
    
    
    
    112.9Depreciation and amortization
    
    
    45.3
    
    
    
    75.0Equity in earnings of ventures
    
    
    (4.7
    )
    
    
    (0.3
    )Interest income
    
    
    (1.1
    )
    
    
    (1.1
    )Interest expense
    
    
    2.0
    
    
    
    0.6Foreign currency (gain)/ loss
    
    
    0.2
    
    
    
    (0.7
    )Provision for income taxes
    
    $
    17.4
    
    
    $
    30.7
 Cost of Revenue Our cost of revenue increased by 66% to $300.6 million for the year ended
December 31, 2004 from $181.1 million for the year ended December 31, 2003. Business and Corporate Services. Cost of revenue from BCS increased by 67%
to $141.2 million, or 43% of revenue, for the year ended December 31, 2004 from
$84.8 million, or 45% of revenue, for the year ended December 31, 2003. The
primary reason for the increase in cost of revenue and the decrease in cost of
revenue as a percentage of revenue was due to the acquisition of 100% ownership
interest in Comincom in the fourth quarter of 2003. We began consolidating
Comincom into our results of operations from December 1, 2003. Comincoms cost
of revenue from BCS was $36.0 million for the year ended December 31, 2004, or
40% of its revenue. BCS cost of revenue increased by approximately $3.2 million
due to the 2004 acquisitions of ST-HOLDING, Balticom, and Buzton. We began
consolidating these three companies into our results at various points during
the first half of 2004. Additionally, $1.1 million of the total increase is due
to 2004 being the first full year that we consolidated the results of
Sibchallenge, an August 2003 acquisition. Cost of revenue as a percentage of
revenue decreased as we leveraged the fixed cost portion of our operations over
increased volumes. Cost of revenue for the BCS division of GTU increased by 60% to $14.6
million, or 51% of revenue, for the year ended December 31, 2004 from $9.1
million, or 48% of revenue, for the year ended December 31, 2003. Cost of
revenue increased as a percentage of revenue due to the increased volume of
lower margin traffic to mobile networks. Carrier and Operator Services. Cost of revenue from Carrier and Operator
Services increased by 70% to $127.5 million, or 64% of revenue, for the year
ended December 31, 2004 from $74.9 million, or 58% of revenue, for the year
ended December 31, 2003. The primary reason for the increase in cost of revenue
was due to the acquisition of 100% ownership interest in Comincom in the fourth
quarter of 2003. We began consolidating Comincom into our results of operations
from December 1, 2003. Comincoms cost of revenue from Carrier and Operator
Services was $12.4 million, or 57% of its revenue, for the year ended December
31, 2004. Also, cost of revenue increased by approximately $0.2 million due to
the 2004 acquisition of ST-HOLDING, Balticom, and Buzton. The increase in cost
of sales resulting from these acquisitions was minimal since the vast majority
of their cost of revenue is incurred with other majority-owned subsidiaries and
is, therefore, eliminated in consolidation. We began consolidating these three
companies into our results at various points during the first half of 2004.
Additionally, $1.2 million of the total increase is due to 2004 being the first
full year that we consolidated the results of Sibchallenge, an August 2003
acquisition. The increase in cost of revenue as a percentage of revenue resulted
from settlements to other operators not decreasing in line with the pricing
concessions to our customers partially offset by operational improvements in
terms of efficient use of available network resources. In addition, the cost of
revenue as a percentage of revenue increased due to higher volumes of lower
margin VoIP sales. Cost of revenue for the Carrier and Operator Services division of GTU
increased by 98% to $16.0 million, or 81% of revenue, for the year ended
December 31, 2004 from $8.1 million, or 70% of revenue, for the year ended
December 31, 2003. Cost of revenue increased as a percentage of revenue due to a
91% increase in lower margin international incoming traffic and a 34% decrease
in higher margin international outgoing traffic. 50




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Consumer Internet Services. Cost of revenue from Consumer Internet Services
increased by 33% to $26.9 million, or 59% of revenue, for the year ended
December 31, 2004 from $20.2 million, or 66% of revenue, for the year ended
December 31, 2003. The decrease as a percentage of revenue was mainly due to
leveraging the fixed cost portion of our operations over increased volumes. Mobile Services. Cost of revenue from Mobile Services increased by 114% to
$6.0 million, or 38% of revenue, for the year ended December 31, 2004 from $2.8
million, or 20% of revenue, for the year ended December 31, 2003. The cost of
revenue as a percentage of revenue increased due to the introduction of the CPP
principle by the Ukrainian Parliament in the third quarter of 2003 as settlement
costs for traffic to other mobile networks increased. Selling, General and Administrative Our selling, general and administrative expenses increased by 75% to $112.9
million, or 19% of revenue, for the year ended December 31, 2004 from $64.4
million, or 18% of revenue, for the year ended December 31, 2003. The primary
reason for the increase was acquisitions occurring in late 2003 and in 2004.
Other factors contributing to the increase were reserves and write-offs of
unrecoverable value-added taxes in certain subsidiaries, increased bad debt
expense, expenses associated with the December 1, 2004 legal merger and
integration of Comincom and Combellga including expense charges related to
payroll and assets taxes directly related to the legal merger, increase in cost
related to increases in temporary staffing, cost associated with new senior
management recruitment and employment, and additional expenses associated with
Sarbanes-Oxley compliance. In addition, in the third quarter of 2004, we
incurred $3.6 million in consulting fees in association with the transfer of 20%
of our ownership interest in GTU to a Ukrainian partner in exchange for services
provided by the partner. Depreciation and Amortization Our depreciation and amortization expenses increased by 66% to $75.0
million for the year ended December 31, 2004 from $45.3 million for the year
ended December 31, 2003. The increase was due in part to depreciation on
continuing capital expenditures of the consolidated entities, but primarily
relates to our acquisition of the 100% ownership interest in Comincom and
subsequent consolidation of Comincom as of December 1, 2003 into our results of
operations. As a result of consolidating Comincom, depreciation and amortization
increased by $18.9 million for the year ended December 31, 2004. Equity in Earnings of Ventures The earnings after interest and tax charges from our investments in
non-consolidated ventures decreased to $0.3 million for the year ended December
31, 2004 from $4.7 million for the year ended December 31, 2003. The decrease in
equity in earnings was mainly due to receiving a $4.7 million dividend from MCT
in the fourth quarter of 2003. Interest Income Our interest income for the year ended December 31, 2004 remained unchanged
from the $1.1 million for the year ended December 31, 2003. Interest Expense Our interest expense was $0.6 million for the year ended December 31, 2004
down from $2.0 million for the year ended December 31, 2003. Debt, excluding
capital lease obligations, at December 31, 2004 was $0.2 million compared to
$1.2 million at December 31, 2003. On June 30, 2003, we settled $30.0 million of
outstanding debt plus accrued interest under a credit facility with ZAO
Citibank. Foreign Currency Gain (Loss) Our foreign currency gain was $0.7 million for the year ended December 31,
2004, compared to a foreign currency loss of $0.2 million for the year ended
December 31, 2003. The improvement in foreign currency loss is due to the
combination of movements in exchange rates and changes in the amount of net
monetary assets that we have denominated in foreign currencies. Minority Interest Our minority interest was $1.5 million for the year ended December 31,
2004, compared to a $0.5 million for the year ended December 31, 2003. The
increase was the result of minority interests in the earnings of GTU, ZAO Samara
Telecom, ZAO WestBalt Telecom and Buzton. Except for GTU, each of these
consolidated subsidiaries was acquired during the first half of 2004. Minority
interests in the earnings of GTU arose in 2004 due to the sale of a
non-controlling interest to our local partners in Ukraine. 51




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Provision for Income Taxes Our charge for income taxes was $30.7 million for the year ended December
31, 2004 compared to $17.4 million for the year ended December 31, 2003. Our
effective tax rate was 32% for the year ended December 31, 2004 compared to 24%
for the year ended December 31, 2003 partly as a result of increases in
non-deductible expenses in 2004, versus recording a deferred tax benefit related
to the reduction of a deferred tax asset valuation allowance in 2003. The
overall increase in income tax expense is primarily due to the acquisition of
100% ownership interest in Comincom and subsequent consolidation of Comincom
from December 1, 2003 into our results of operations. In addition, there were
increased levels of taxable profits being incurred in our Russian and Ukrainian
subsidiaries in the year ended December 31, 2004 as compared to the year ended
December 31, 2003. Net Income and Net Income per Share Our net income for the year ended December 31, 2004 was $64.8 million,
compared to a net income of $55.4 million for the year ended December 31, 2003. Our net income per share of common stock decreased to $1.79 for the year
ended December 31, 2004, compared to a net income per share of $1.95 for the
year ended December 31, 2003. The decrease in net income per share of common
stock was due to the increase in net income partly offset by an increase in the
number of weighted average shares to 36,225,531 in the year ended December 31,
2004, compared to 28,467,677 in the year ended December 31, 2003. The increase
in outstanding shares was a direct result of the Comincom acquisition and
employee stock option exercises. Our net income per share of common stock on a fully diluted basis decreased
to $1.77 for the year ended December 31, 2004, compared to a net income per
common share of $1.90 for the year ended December 31, 2003. The decrease in net
income per share of common stock on a fully diluted basis was due to the
increase in net income partly offset by an increase in the number of weighted
average shares assuming dilution to 36,552,547 the year ended December 31, 2004,
compared to 29,106,540 for the year ended December 31, 2003. CONSOLIDATED FINANCIAL POSITION  SIGNIFICANT CHANGES IN CONSOLIDATED FINANCIAL
POSITION AT DECEMBER 31, 2004 COMPARED TO CONSOLIDATED FINANCIAL POSITION AT
DECEMBER 31, 2003 Accounts Receivable Accounts receivable increased from December 31, 2003 to December 31, 2004
as a result of increased revenue during the period ended December 31, 2004 and
slower collections from customers. Property and Equipment Our property and equipment increased at December 31, 2004 as compared to
December 31, 2003 mainly as a result of continuing capital expenditures. Intangible Assets Our intangible assets increased at December 31, 2004 as compared to
December 31, 2003 as a result of our acquisition of ST-HOLDING in February 2004,
our acquisition of Balticom Mobile in April 2004, Buzton in May 2004 and the
build out of new numbering capacity. Minority Interest Our minority interest increased at December 31, 2004 as compared to
December 31, 2003 as a result of minority interests in the equity of GTU, ZAO
Samara Telecom, ZAO WestBalt Telecom and Buzton. Except for GTU, each of these
consolidated subsidiaries was acquired during the first half of 2004. Minority
interests of GTU arose in 2004 due to the sale of a non-controlling interest to
our local partners in Ukraine. Stockholders Equity Shareholders equity increased from December 31, 2003 to December 31, 2004
as a result of our net income of $64.8 million, cash proceeds of approximately
$4.9 million received from the exercise of employee stock options, partially
offset by declaring and paying $29.0 million dividends for the year ended
December 31, 2004. In addition, we transferred 20% of the ownership interest in GTU to a
Ukrainian partner in exchange for services provided by the partner in August
2004. The excess of the fair value of consideration exchanged for services over
the book value of 20% of net assets of GTU was recorded as a credit to the
consolidated equity. In the third quarter of 2004, management determined that we have been
inadvertently carrying accruals for estimated taxes, other than income taxes.
Management concluded these accruals for estimated taxes should have been
considered unnecessary and reversed 52




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prior to January 1, 2000. The net effect of the correction of this non-cash
error was to reduce current liabilities and non-current liabilities by $2.0
million each with an offsetting decrease to accumulated deficit of $4.0 million
in all periods presented. CONSOLIDATED RESULTS  CONSOLIDATED RESULTS OF OPERATIONS FOR THE YEAR ENDED
DECEMBER 31, 2003 COMPARED TO THE CONSOLIDATED RESULTS OF OPERATIONS FOR THE
YEAR ENDED DECEMBER 31, 2002 REVENUE Our revenue increased by 81% to $360.5 million for the year ended December
31, 2003 from $198.7 million for the year ended December 31, 2002. The overall
increase in revenue was largely due to the consolidation of Sovintels results
of operations for a full year. The breakdown of revenue by business group was as
follows: CONSOLIDATED REVENUE
    
    
    CONSOLIDATED REVENUEFOR THE YEAR
    
    
    FOR THE YEARENDED DECEMBER 31, 2002
    
    
    ENDED DECEMBER 31, 2003(IN MILLIONS)REVENUEBusiness and Corporate Services
    
    $
    91.7
    
    
    $
    188.9Carrier and Operator Services
    
    
    73.9
    
    
    
    128.5Consumer Internet Services
    
    
    21.8
    
    
    
    30.8Mobile Services
    
    
    13.0
    
    
    
    13.9Eliminations
    
    
    (1.7
    )
    
    
    (1.6
    )TOTAL REVENUE
    
    $
    198.7
    
    
    $
    360.5
 Business and Corporate Services. Revenue from BCS increased by 106% to
$188.9 million for the year ended December 31, 2003 from $91.7 million for the
year ended December 31, 2002. The primary reason for the increase is due to the
acquisition of the remaining 50% ownership interest in Sovintel which was
completed in the third quarter of 2002. We began consolidating Sovintel into our
results of operations from September 17, 2002. In addition, we had increases in
our domestic traffic revenues due to adding approximately 1,600 new corporate
customers and signing up 74 new multi-tenant business centers in the year ended
December 31, 2003 along with actively promoting new services among our client
base. In addition, in the fourth quarter of 2003, we had approximately $5.0
million in customer premises equipment sales, higher than we have experienced in
previous quarters. The acquisition of 100% ownership interest in Comincom was completed in the
fourth quarter of 2003. We began consolidating Comincom into our results of
operations from December 1, 2003. As a result of consolidating Comincom, revenue
from BCS increased by $6.7 million for the year ended December 31, 2003. Revenue from the BCS division of GTU increased by 15% to $19.0 million for
the year ended December 31, 2003 from $16.5 million for the year ended December
31, 2002. The increase in revenue was due to an increase in the total intercity
minutes of use by business and corporate clients and an increase in monthly
recurring charges offset by lower equipment sales. Carrier and Operator Services. Revenue from Carrier and Operator Services
increased by 74% to $128.5 million for the year ended December 31, 2003 from
$73.9 million for the year ended December 31, 2002. The primary reason for the
increase is due to the acquisition of the remaining 50% ownership interest in
Sovintel, which was completed in the third quarter of 2002. We began
consolidating Sovintel into our results of operations from September 17, 2002.
In addition, we have added a number of new carriers with increased volumes of
traffic, especially VoIP, and increased the number of services that we offer to
cellular providers, which has more than offset general tariff declines, although
pricing pressures still exist. The acquisition of 100% ownership interest in Comincom was completed in the
fourth quarter of 2003. We began consolidating Comincom into our results of
operations from December 1, 2003. As a result of consolidating Comincom, revenue
from Carrier and Operator Services increased by $2.0 million for the year ended
December 31, 2003. Revenue for the Carrier and Operator Services division of GTU increased by
93% to $11.6 million for the year ended December 31, 2003 from $6.0 million for
the year ended December 31, 2002. The increase in revenue was due to increasing
volumes of incoming international traffic which we are able to terminate in a
number of cities in Ukraine as well as increasing volumes of outgoing
international traffic. Consumer Internet Services. Revenue from Consumer Internet Services
increased by 41% to $30.8 million for the year ended December 31, 2003 from
$21.8 million for the year ended December 31, 2002. The increase is largely the
result of increases in the number of dial-up Internet subscribers from 242,155
at December 31, 2002 to 363,545 at December 31, 2003 and the average revenue per
Internet subscriber increasing from approximately $7.84 per month to
approximately $8.39 per month over the same period. 53




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Mobile Services. Revenue from Mobile Services increased by 7% to $13.9
million for the year ended December 31, 2003 from $13.0 million for the year
ended December 31, 2002. Active subscribers increased from 35,386 at December
31, 2002 to 40,026 at December 31, 2003 and the average revenue per active
subscriber has increased by 8% to approximately $30.74 per month due to an
increasing number of subscribers on a tariff plan which allows for unlimited
local calls for a fixed payment of $99 per month. As a result of the adoption of
the CPP principle by the Ukrainian Parliament on September 17, 2003, we were
unable to charge our mobile customers for incoming calls and our revenues were
reduced accordingly. EXPENSES The following table shows our principal expenses for the years ended
December 31, 2002 and December 31, 2003: CONSOLIDATED EXPENSES
    
    
    CONSOLIDATED EXPENSESFOR THE YEAR ENDED
    
    
    FOR THE YEAR ENDEDDECEMBER 31, 2002
    
    
    DECEMBER 31, 2003(IN MILLIONS)COST OF REVENUEBusiness and Corporate Services
    
    $
    47.9
    
    
    $
    84.8Carrier and Operator Services
    
    
    27.4
    
    
    
    74.9Consumer Internet Services
    
    
    14.6
    
    
    
    20.2Mobile Services
    
    
    3.0
    
    
    
    2.8Eliminations
    
    
    (1.7
    )
    
    
    (1.6
    )TOTAL COST OF REVENUE
    
    
    91.2
    
    
    
    181.1Selling, general and administrative
    
    
    46.1
    
    
    
    64.4Depreciation and amortization
    
    
    30.0
    
    
    
    45.3Equity in earnings of ventures
    
    
    (4.4
    )
    
    
    (4.7
    )Interest income
    
    
    (1.6
    )
    
    
    (1.1
    )Interest expense
    
    
    2.2
    
    
    
    2.0Foreign currency loss
    
    
    1.2
    
    
    
    0.2Provision for income taxes
    
    $
    4.6
    
    
    $
    17.4
 Cost of Revenue Our cost of revenue increased by 99% to $181.1 million for the year ended
December 31, 2003 from $91.2 million for the year ended December 31, 2002. Business and Corporate Services. Cost of revenue from BCS increased by 77%
to $84.8 million, or 45% of revenue, for the year ended December 31, 2003 from
$47.9 million, or 52% of revenue, for the year ended December 31, 2002. The
increase in cost of revenue and the decrease in cost of revenue as a percentage
of revenue are mainly due to the acquisition of the remaining 50% ownership
interest in Sovintel which was completed in the third quarter of 2002. We began
consolidating Sovintel into our results of operations from September 17, 2002.
In addition, in the fourth quarter of 2003, we had approximately $5.0 million in
customer premises equipment sales with significantly lower margins as part of a
strategy to provide a wider range of communication and Internet technology
products to our existing customers. The acquisition of 100% ownership interest in Comincom was completed in the
fourth quarter of 2003. We began consolidating Comincom into our results of
operations from December 1, 2003. As a result of consolidating Comincom, cost of
revenue from Business and Corporate Services increased by $2.9 million for the
year ended December 31, 2003. Cost of revenue for the Business and Corporate Services division of GTU
increased by 20% to $9.1 million, or 48% of revenue, for the year ended December
31, 2003 from $7.6 million, or 46% of revenue, for the year ended December 31,
2002. Carrier and Operator Services. Cost of revenue from Carrier and Operator
Services increased by 173% to $74.9 million, or 58% of revenue, for the year
ended December 31, 2003 from $27.4 million, or 37% of revenue, for the year
ended December 31, 2002. The increase in cost of revenue and the increase in
cost of revenue as a percentage of revenue was due to the acquisition of the
remaining 50% ownership interest in Sovintel which was completed in the third
quarter of 2002. Sovintels cost of revenue as a percentage of revenue is
traditionally lower margin bilateral voice. We began consolidating Sovintel into
our results of operations from September 17, 2002. Cost of revenue for the Carrier and Operator Services division of GTU
increased by 113% to $8.1 million, or 70% of revenue, for the year ended
December 31, 2003 from $3.8 million, or 63% of revenue, for the year ended
December 31, 2002. Cost of revenue increased as a percentage of revenue due to
the increased volumes of lower margin international incoming and outgoing
traffic. 54




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The acquisition of 100% ownership interest in Comincom was completed in the
fourth quarter of 2003. We began consolidating Comincom into our results of
operations from December 1, 2003. As a result of consolidating Comincom, cost of
revenue from Carrier and Operator Services increased by $1.4 million for the
year ended December 31, 2003. Consumer Internet Services. Cost of revenue from Consumer Internet Services
increased by 38% to $20.2 million, or 66% of revenue, for the year ended
December 31, 2003 from $14.6 million, or 67% of revenue, for the year ended
December 31, 2002. The decrease as a percentage of revenue was mainly due to
additional low cost interconnect capacity becoming available in the third
quarter of 2002. Mobile Services. Cost of revenue from Mobile Services decreased by 7% to
$2.8 million, or 20% of revenue, for the year ended December 31, 2003 from $3.0
million, or 23% of revenue, for the year ended December 31, 2002. The cost of
revenue as a percentage of revenue decreased due to the increased number of
subscribers using the unlimited local call tariff plan which does not lead to
additional settlement costs with other operators. Selling, General and Administrative Our selling, general and administrative expenses increased by 40% to $64.4
million, or 18% of revenue, for the year ended December 31, 2003 from $46.1
million, or 23% of revenue, for the year ended December 31, 2002. This increase
in selling, general and administrative expenses was mainly due to increases in
employee related costs, advertising, inventory obsolescence, bad debt expense,
consulting costs associated with the operational integration of Comincom, and
other selling, general and administrative expenses arising from the
consolidation of Sovintel from September 17, 2002 and the consolidation of
Comincom from December 1, 2003 into our results of operations. Depreciation and Amortization Our depreciation and amortization expenses increased by 51% to $45.3
million for the year ended December 31, 2003 from $30.0 million for the year
ended December 31, 2002. The increase was due in part to depreciation on
continuing capital expenditures of the consolidated entities, but primarily
relates to our acquisition of the remaining 50% of Sovintel and subsequent
consolidation of Sovintel as of September 17, 2002 into our results of
operations. In addition, depreciation and amortization increased by $1.7 million
due to the consolidation of Comincom into our results of operations from
December 1, 2003. Equity in Earnings of Ventures The earnings after interest and tax charges from our investments in
non-consolidated ventures increased to $4.7 million for the year ended December
31, 2003 from $4.4 million for the year ended December 31, 2002. We recognized
earnings at Sovintel of $9.6 million for the period from January 1, 2002 to
September 16, 2002, which more than offset our recognized losses in MCT of $5.1
million. The increase in equity in earnings was mainly due to receiving a $4.7
million dividend from MCT in the fourth quarter of 2003, an equity investment in
which we have ceased recognition of losses as they exceeded our investment base,
partly offset by the effects of the acquisition of the remaining 50% of Sovintel
and its subsequent consolidation as of September 17, 2002 into our results of
operations. Interest Income Our interest income was $1.1 million for the year ended December 31, 2003
down from $1.6 million for the year ended December 31, 2002. The decrease in
interest income mainly reflects lower interest rates earned on deposits in
short-term US money market funds. Interest Expense Our interest expense was $2.0 million for the year ended December 31, 2003
down from $2.2 million for the year ended December 31, 2002. Debt, excluding
capital lease obligations, at December 31, 2003 was $1.2 million compared to
$33.1 million at December 31, 2002. On June 30, 2003, we settled $30.0 million
of outstanding debt plus accrued interest under a credit facility with ZAO
Citibank. There was no penalty for the early settlement of this debt however an
additional $0.2 million of previously capitalized financing costs was recognized
during the second quarter of 2003 which was previously being recognized over the
life of the facility. Foreign Currency Loss Our foreign currency loss was $0.2 million for the year ended December 31,
2003, compared to a foreign currency loss of $1.2 million for the year ended
December 31, 2002. The improvement in foreign currency loss is due to the
combination of movements in exchange rates and changes in the amount of net
monetary assets that we have denominated in foreign currencies. 55




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Provision for Income Taxes Our charge for income taxes was $17.4 million for the year ended December
31, 2003 compared to $4.6 million for the year ended December 31, 2002. Our
effective tax rate was 24% for the year ended December 31, 2003 compared to 14%
for the year ended December 31, 2002. The increase is primarily due to the
acquisition of the remaining 50% of Sovintel and subsequent consolidation of
Sovintel from September 17, 2002 into our results of operations. In addition,
there were increased levels of taxable profits being incurred in our Russian and
Ukrainian subsidiaries in the year ended December 31, 2003 as compared to the
year ended December 31, 2002. In the fourth quarter of 2002, we recognized the
full benefit of carry-forward tax losses of $2.8 million at our wholly-owned
Russian subsidiary, Teleross, which previously had been recognized on a
quarterly basis and we recognized $0.8 million of current deferred tax assets at
GTU. In the fourth quarter of 2003, we recognized the full benefit of US
carry-forward tax losses resulting in a deferred tax benefit of approximately
$1.9 million. Cumulative Effect of a Change in Accounting Principle We adopted SFAS No. 142 Accounting for Goodwill, effective from January
1, 2002. As a result, we recorded a cumulative effect of a change in accounting
principle for negative goodwill (deferred credit) arising on our equity method
investments in the amount of $1.0 million for the year ended December 31, 2002. Net Income and Net Income per Share Our net income for the year ended December 31, 2003 was $55.4 million,
compared to a net income of $29.8 million for the year ended December 31, 2002. Our net income per share of common stock increased to $1.95 for the year
ended December 31, 2003, compared to a net income per share of $1.24 for the
year ended December 31, 2002. The increase in net income per share of common
stock was due to the increase in net income partly offset by an increase in the
number of weighted average shares to 28,467,677 in the year ended December 31,
2003, compared to 24,101,943 in the year ended December 31, 2002. The increase
in outstanding shares was a direct result of the Comincom acquisition and
employee stock option exercises. Our net income per share of common stock on a fully diluted basis increased
to $1.90 for the year ended December 31, 2003, compared to a net income per
common share of $1.21 for the year ended December 31, 2002. The increase in net
income per share of common stock on a fully diluted basis was due to the
increase in net income partly offset by an increase in the number of weighted
average shares assuming dilution to 29,106,540 the year ended December 31, 2003,
compared to 24,516,803 for the year ended December 31, 2002. CONSOLIDATED FINANCIAL POSITION  SIGNIFICANT CHANGES IN CONSOLIDATED FINANCIAL
POSITION AT DECEMBER 31, 2003 COMPARED TO CONSOLIDATED FINANCIAL POSITION AT
DECEMBER 31, 2002 On December 1, 2003, we completed the acquisition of 100% of the shares of
Comincom previously held by Telenor and began consolidating the results of
operations and financial position of Comincom. Significant fluctuations in
certain balance sheet items as of December 31, 2003 as compared to December 31,
2002, were mainly due to the consolidation of Comincom into our financial
position. The most significant fluctuations of certain balance sheet items
include accounts receivable, property and equipment, goodwill and intangible
assets, accounts payable and accrued expenses, deferred tax liabilities and
shareholders equity. Other significant changes in balance sheet items,
excluding the effect of consolidating Comincom are discussed below. Accounts Receivable Accounts receivable increased from December 31, 2002 to December 31, 2003
as a result of increased revenue during the period ended December 31, 2003 and
slower collections from customers. Intangible Assets Our intangible assets increased at December 31, 2003 as compared to
December 31, 2002 as a result of our acquisition of Sibchallenge in August 2003. Debt Obligations Our debt position decreased at December 31, 2003 as compared to December
31, 2002 as a result of retiring our debt that consisted mainly of the Citibank
Credit Facility of $30.0 million. 56




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Stockholders Equity Shareholders equity increased from December 31, 2002 to December 31, 2003
as a result of our net income of $55.4 million and proceeds of approximately
$23.7 million received from the exercise of employee stock options. INCOME TAXES Our effective rate of income tax differs from the US statutory rate due to
the impact of the following factors: (1) different income tax rates and
regulations apply in the countries where we operate; (2) amortization of certain
acquired intangible assets is not deductible for income tax purposes; and (3)
write-offs of certain assets are not deductible for tax purposes. In 2002, as a
result of our Russian and Ukrainian subsidiaries profitability and reasonable
certainty of future profits, we reduced the valuation allowance for deferred tax
assets in the appropriate Russian and Ukrainian subsidiaries. As of December 31,
2004, we had a deferred tax asset of approximately $2.2 million related to net
operating loss carry-forward for US federal income tax purposes. We have
concluded that these US loss carry-forwards will be realizable as we anticipate
generating future taxable income in the US primarily by earning interest income
on intercompany loans to our foreign subsidiaries. We have also recorded a
deferred tax asset of $0.6 million related to net operating loss carry-forwards
for Cyprus tax purposes. However, we have recorded a full valuation allowance
since we do not anticipate recognizing taxable income in our Cyprus entity in
the foreseeable future since it has generate tax losses since 2003. We also had
approximately $10.8 million of other deferred tax assets arising from deductible
temporary differences in our non-US subsidiaries. Due to the continued
profitability of these subsidiaries, we fully anticipate that these other
deferred tax assets will be realized through the generation of future taxable
income. More information about income taxes and a reconciliation of the
statutory federal income tax rate to the effective income tax rate for each
period is included in note 11 to our consolidated financial statements. LIQUIDITY AND CAPITAL RESOURCES Our cash and cash equivalents was $53.7 million and $65.2 million as of
December 31, 2004 and December 31, 2003, respectively. Our total restricted cash
as of December 31, 2004 remained unchanged from the $1.0 million as of December
31, 2003. The restricted cash is maintained in connection with certain of our
debt obligations as described below. During the twelve months ended December 31, 2004, we had net cash inflows
of $145.1 million from our operating activities. During the twelve months ended
December 31, 2003, we had net cash inflows of $87.0 million from our operating
activities. This increase in net cash inflows from operating activities at
December 31, 2004 is mainly due to the increase of net income as a result of
increased revenues, and the consolidation of Comincom into our results of
operations and financial position from December 1, 2003. During the twelve months ended December 31, 2004, we received
approximately $566.8 million in cash from our customers for services and we paid
approximately $386.1 million to suppliers and employees. During the twelve
months ended December 31, 2003, we received approximately $342.8 million in cash
from our customers for services and we paid approximately $237.7 million to
suppliers and employees. We used cash of $128.4 million and $68.0 million for investing activities
for the twelve months ended December 31, 2004 and 2003, respectively, which were
principally attributable to building our telecommunications networks and
acquisitions. Network investing activities totaled $114.6 million for the twelve
months ended December 31, 2004 and included capital expenditures principally
attributable to building out our telecommunications network. The majority of
network investing activities related to construction of last mile access, the
intercity fiber project and network upgrades as a result of increased customer
connections. Network investing activities totaled $63.7 million for the twelve
months ended December 31, 2003. During 2005, we expect our capital expenditures
program will continue at a level sufficient to support our strategic and
operating needs and will remain consistent, as a percentage of revenue, with
2003 and 2004 capital expenditures as a percentage of revenue. We used cash of $15.5 million for the year ended December 31, 2004 for
acquisitions which include ST-HOLDING, Buzton, Uralrelcom, and Balticom Mobile.
We used cash of $12.3 million of the year ended December 31, 2003 for
acquisitions principally attributable to acquiring Sibchallenge. In October 2003, MCT declared a cash dividend of $1.90 per common share to
holders of record as of October 27, 2003. Our portion of this cash dividend was
approximately $4.7 million and was received in November 2003. For the year ended December 31, 2004, we received $4.9 million net
proceeds from the exercise of employee stock options and for the year ended
December 31, 2003, we received $23.7 million net proceeds from the exercise of
employee stock options. In 2004, we paid quarterly dividends of $0.20 per common share to
shareholders totaling $29.0 million. In February 2005 our Board of Directors
declared a cash dividend of $0.20 per common share to shareholders of record as
of March 17, 2005. The total amount of payable of approximately $7.3 million
will be paid to shareholders on March 31, 2005. We had working capital of $83.8 million as of December 31, 2004 and $90.3
million as of December 31, 2003. At December 31, 2004, we had total debt,
excluding capital lease obligations, of approximately $0.2 million, none of them
were current maturities. At 57




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December 31, 2003, we had total debt, excluding capital lease obligations, of
approximately $1.2 million, of which $1.0 million were current maturities. Total
debt included amounts that were fully collateralized by restricted cash. In the first quarter of 2000, we entered into a lease for the right to use
fiber optic capacity, including facilities and maintenance, from Moscow to
Stockholm. The lease has an initial term of ten years with an option to renew
for an additional five years. The lease required full prepayments as the
capacity increased from an STM-1 to an STM-4 to full capacity of STM-16. Full
prepayments were made to the lessor in April 2000, August 2000 and February
2001. These prepayments have been offset against the lease obligation in the
financial statements of the Company. We will continue to make payments for
maintenance for the term of the lease. In September 2001, we entered into a five year lease for the right to use
up to VC-3 fiber optic capacity on major routes within Russia to support the
increase in our interregional traffic and regional expansion strategy. In
December 2001, we issued a $9.1 million loan to the company that provided the
capital lease. The loan has payment terms of 56 months, which started in January
2002, and carries interest at the rate of 7 percent per annum. In the ordinary course of business, we have entered into long-term
agreements for satellite transponder capacity. In the twelve months ended
December 31, 2004, we entered into approximately $57.8 million of satellite
transponder capacity agreements generally with terms of 10 years. Some of our operating companies have received debt financing through direct
loans from affiliated companies. In addition, certain operating companies have
borrowed funds under a back-to-back, seven-year credit facility for up to $22.7
million from a Russian subsidiary of Citibank. Under this facility, we provide
full cash collateral, held in London, and recorded on our balance sheet as
restricted cash, for onshore loans made by the bank to our Russian registered
joint ventures. In a second, similar facility, we provide full cash collateral
for a short term back-to-back, revolving, credit facility for up to $10.0
million from the same bank for two of our larger Russian operating companies.
The funding level as of December 31, 2004 for all these facilities totaled $1.0
million, of which $0.2 million was funded to our consolidated subsidiaries and
$0.8 million was funded to our non-consolidated entities. In the future, we may execute especially large or numerous acquisitions,
which may require us to raise additional funds through a dilutive equity
issuance, additional borrowings with or without collateralization, through the
divestment of non-core assets, to suspend or cease dividend payments, or a
combination of the foregoing. In case especially large or numerous acquisitions
do not materialize, we expect our cash flow from operations to be sufficient to
fund our expected requirements, including our capital expenditure requirements.
However, the actual amount and timing of our future cash requirements may differ
materially from our current estimates because of changes or fluctuations in our
anticipated investments, revenue, operating costs and network expansion plans,
timing of acquisitions, and access to alternative sources of financing on
favorable terms. Further, in order for us to compete successfully, we may
require substantial additional cash to continue to develop our networks and meet
the funding requirements of our operations and ventures. To the extent our
current sources are not sufficient to meet these requirements, we may raise
additional funds through a dilutive equity issuance, additional borrowings with
or without collateralization, the divestment of non-core assets, the suspension
or cessation of dividend payments or a combination of the foregoing. We may not be able to obtain additional financing on favorable terms. As a
result, we may be subject to additional or more restrictive financial covenants,
our interest obligations may increase significantly and our shareholders may be
adversely diluted. Our failure to generate sufficient funds in the future,
whether from operations or by raising additional debt or equity capital, may
require us to delay or abandon some or all of our anticipated expenditures, to
sell assets, or both, which could have a material adverse effect on our
operations. We are negotiating with a financial institution to secure an
unsecured credit facility of $45.0 million to fund, in principle part, our
acquisition of Hudson Telecom, Inc. Such facility is expected to contain
restrictive covenants that will limit the flexibility of our operations. As part of our drive to increase our network capacity, reduce costs and
improve the quality of our service, we have leased additional fiber
optic capacity and
entered into agreements for satellite-based network capacity; the terms are generally five
years or more and can involve significant advance payments. As demand for our
telecommunication services increases we expect to enter into additional capacity
agreements and may make significant financial commitments, in addition to our
existing commitments. 58




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As of December 31, 2004, we had the following contractual obligations,
including short- and long-term debt arrangements commitments for future payments
under non-cancelable lease arrangements and purchase obligations: PAYMENTS DUE BY PERIOD(IN THOUSANDS)LESSTHAN 1
    
    
    1 - 3
    
    
    3 - 5TOTAL
    
    
    YEAR
    
    
    YEARS
    
    
    YEARS
    
    
    THEREAFTERLong-term debt
    
    $
    200
    
    
    $
    
    
    
    $
    200
    
    
    $
    
    
    
    $
    Capital lease obligations
    
    
    4,145
    
    
    
    2,553
    
    
    
    1,592
    
    
    
    
    
    
    
    Non-cancelable lease
obligations
    
    
    12,053
    
    
    
    4,485
    
    
    
    5,790
    
    
    
    1,527
    
    
    
    251Purchase obligations  (1)
    
    
    84,488
    
    
    
    21,431
    
    
    
    29,317
    
    
    
    15,873
    
    
    
    17,867Total contractual cash
obligations
    
    $
    100,886
    
    
    $
    28,469
    
    
    $
    36,899
    
    
    $
    17,400
    
    
    $
    18,118
  (1)
    
    Purchase obligations mainly include our contractual legal obligations for
the future purchase of equipment, interconnect, and satellite transponder
capacity. 59




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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK Our treasury function has managed our funding, liquidity and exposure to
interest rate and foreign currency exchange rate risks. Our investment treasury
operations are conducted within guidelines that have been established and
authorized by our audit committee. In accordance with our policy, we do not
enter into any treasury management transactions of a speculative nature. The ruble and the hryvna are generally non-convertible outside Russia and
Ukraine, respectively, so our ability to hedge against further devaluation by
converting to other currencies is significantly limited. Further, our ability to
convert rubles and hryvna into other currencies in Russia and Ukraine,
respectively, is subject to rules that restrict the purposes for which
conversion and the payment of foreign currencies are allowed. Given that much of our operating costs are indexed to or denominated in
USD, including employee compensation expense, capital expenditure and interest
expense, we have taken specific steps to minimize our exposure to fluctuations
in the appropriate foreign currency. Although local currency control regulations
require us to collect virtually all of our revenue in local currency, certain
ventures generally either price or invoice in USD or index their invoices and
collections to the applicable USD exchange rate. Customer contracts may include
clauses allowing additional invoicing if the applicable exchange rate changes
significantly between the invoice date and the date of payment, favorable terms
for early or pre-payments and heavy penalty clauses for overdue payments.
Maintaining the USD value of our revenue subjects us to additional tax on
exchange gains. Although we are attempting to match revenue, costs, borrowing and
repayments in terms of their respective currencies, we may experience economic
loss and a negative impact on earnings as a result of foreign currency exchange
rate fluctuations. Our cash and cash equivalents are held largely in interest bearing
accounts, in USD, however we do have bank accounts denominated in Russian rubles
and Ukrainian hryvna. The book values of such accounts at December 31, 2004 and
2003 approximate their fair value. Cash in excess of our immediate operating
needs is invested in US money market instruments. In accordance with our
investment policy, we maintain a diversified portfolio of low risk, fully liquid
securities. We are exposed to market risk from changes in interest rates on our
obligations and we also face exposure to adverse movements in foreign currency
exchange rates. We have developed risk management policies that establish
guidelines for managing foreign currency exchange rate risk and we also
periodically evaluate the materiality of foreign currency exchange exposures and
the financial instruments available to mitigate this exposure. The following table provides information (in thousands) about our cash
equivalents, investments available for sale, convertible loan, and debt
obligations that are sensitive to changes in interest rates. 2004
    
    
    20032005
    
    
    2006
    
    
    2007
    
    
    2008
    
    
    2008
    
    
    THEREAFTER
    
    
    TOTAL
    
    
    TOTALCash equivalents
    
    $
    53,699
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    53,699
    
    
    $
    65,180Note receivable
    
    $
    2,338
    
    
    $
    1,494
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    3,832
    
    
    $
    5,582Fixed rate
    
    
    7.00
    %
    
    
    7.00
    %
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7.00
    %
    
    
    7.00
    %Long-term debt, including
current portionVariable rate
    
    $
    
    
    
    $
    200
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    200
    
    
    $
    1,150Average interest rate
    
    
    
    
    
    
    2.70
    %
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
 60




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The following table provides information about our financial instruments by
local currency and where applicable, presents such information in USD
equivalents (in thousands). The table summarizes information on instruments that
are sensitive to foreign currency exchange rates, including foreign currency
denominated debt obligations. 2004
    
    
    20032005
    
    
    2006
    
    
    2007
    
    
    2008
    
    
    2009
    
    
    THEREAFTER
    
    
    TOTAL
    
    
    TOTALASSETSCurrent assetsRussian rubles
    
    $
    57,969
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    57,969
    
    
    $
    49,961Average foreign currency
exchange rate
    
    
    27.75
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Ukrainian hryvna
    
    $
    6,692
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    6,692
    
    
    $
    4,719Average foreign currency
exchange rate
    
    
    5.31
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Kazakhstan Tenge
    
    $
    875
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    875
    
    
    $
    824Average foreign currency
exchange rate
    
    
    130
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Uzbekistan Soom
    
    $
    546
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    546
    
    
    $
    Average foreign currency
exchange rate
    
    
    1,058
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    LIABILITIESCurrent liabilitiesRussian rubles
    
    $
    25,268
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    25,268
    
    
    $
    16,283Average foreign currency
exchange rate
    
    
    27.75
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Ukrainian hryvna
    
    $
    4,906
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    4,906
    
    
    
    3,053Average foreign currency
exchange rate
    
    
    5.31
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Kazakhstan Tenge
    
    $
    49
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    49
    
    
    $
    356Average foreign currency
exchange rate
    
    
    130
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Uzbekistan Soom
    
    $
    359
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    359
    
    
    $
    Average foreign currency
exchange rate
    
    
    1,058
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
 Our interest income and expense are most sensitive to changes in the
general level of U.S. interest rates. In this regard, changes in U.S. interest
rates affect the interest earned on our cash equivalents and short-term
investments as well as interest paid on debt. SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS Certain statements contained in Managements Discussion and Analysis of
Financial Condition and Results of Operations and other parts of this document,
including, without limitation, those concerning (i) future acquisitions and
capital expenditures; (ii) projected traffic volumes and other growth
indicators; (iii) anticipated revenues and expenses; (iv) the Companys
competitive environment; (v) the future performance of consolidated and equity
method investments; (vi) our intention to offer our services under the Golden
Telecom brand; (vii) our business and growth strategy, (viii) our intentions to
expand our fiber optic capacity and add transmission capacity; (ix) our
intention to continue to use the assets of recently acquired companies in the
manner such assets were previously used; (x) our plans to repurchase from time
to time in the open market a number of shares equal to the number of shares that
are subject to awards under the LTIBP, (xi) the impact of critical accounting
policies, and (xii) the political, regulatory and financial situation in the
markets in which we operate, including the effect of the new law On
Telecommunications and its supporting regulations, are forward-looking and
concern the Companys projected operations, economic performance and financial
condition. These forward-looking statements are made pursuant to the safe harbor
provisions of the Securities Litigation Reform Act of 1995. It is important to
note that such statements involve risks and uncertainties and that actual
results may differ materially from those expressed or implied by such
forward-looking statements. Among the key factors that have a direct bearing on
the Companys results of operations, economic performance and financial
condition are the commercial and execution risks associated with implementing
the Companys business plan, our ability to integrate recently acquired
companies into our operations, the political, economic and legal environment in
the markets in which the Company operates, including the impact of the new law
On Telecommunications and its supporting regulations, increasing
competitiveness in the telecommunications and Internet-related businesses that
may limit growth opportunities, and increased and intense downward price
pressures on some of the services that we offer. These and other factors are
discussed herein under Managements Discussion and Analysis of Financial
Condition and Results of Operations and elsewhere in this Report. Additional information concerning factors that could cause results to
differ materially from those in the forward-looking statements are contained in
this Form 10-K. In addition, any statements that express, or involve discussions as to,
expectations, beliefs, plans, objectives, assumptions or future events or
performance (often, but not always, through the use of words or phrases such as
will likely result, are expected to, estimated, intends, plans,
projection and outlook) are not historical facts and may be forward-looking
and, accordingly, such statements involve estimates, assumptions and
uncertainties which could cause actual results to differ materially from those
expressed in the forward-looking statements. Accordingly, any such statements
are qualified in their entirety by reference to, and are accompanied by, the
factors discussed throughout this Report and investors, therefore, should not
place undue reliance on any such forward-looking statements. Further, any forward-looking statement speaks only as of the date on which
such statement is made, and the Company undertakes no obligation to update any
forward-looking statement or statements to reflect events or circumstances after
the date on which such statement is made or to reflect the occurrence of
unanticipated events. New factors may emerge from time to time, and it is not
possible for management to predict all of such factors. Further, management
cannot assess the impact of each such factor on the Companys business or the
extent to which any factor, or combination of factors, may cause actual results
to differ materially from those contained in any forward-looking statements. 61




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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA INDEX TO FINANCIAL STATEMENTS GOLDEN TELECOM, INC. PAGEFINANCIAL STATEMENTSReport of Independent Auditors
    
    
    64Consolidated Balance Sheets as of December 31, 2003 and 2004
    
    
    66Consolidated Statements of Operations for the years ended December 31, 2002, 2003 and 2004
    
    
    68Consolidated Statements of Cash Flows for the years ended December 31, 2002, 2003 and 2004
    
    
    69Consolidated Statements of Shareholders Equity for the years ended December 31, 2002, 2003 and 2004
    
    
    70Notes to Consolidated Financial Statements
    
    
    71EDN SOVINTEL LLCFINANCIAL STATEMENTSReport of Independent Auditors
    
    
    97Statements of Income for the period from January 1 to September 16, 2002
    
    
    98Statements of Cash Flows for the period from January 1 to September 16, 2002
    
    
    99Notes to Financial Statements
    
    
    100
 62




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##### Table of Contents



AUDITED FINANCIAL STATEMENTS GOLDEN TELECOM, INC.
YEARS ENDED DECEMBER 31, 2002, 2003 AND 2004
WITH REPORT OF INDEPENDENT AUDITORS 63




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##### Table of Contents



REPORT OF INDEPENDENT REGISTERED PUBLIC
ACCOUNTING FIRM The Board of Directors and Shareholders
Golden Telecom, Inc. We have audited the accompanying consolidated balance sheets of Golden
Telecom, Inc. as of December 31, 2004 and 2003, and the related consolidated
statements of operations, shareholders equity, and cash flows for each of the
three years in the period ended December 31, 2004. Our audits also included the
financial statement schedule listed in the Index at Item 15(a). These financial
statements and schedule are the responsibility of the Companys management. Our
responsibility is to express an opinion on these financial statements and
schedule based on our audits. We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Golden Telecom,
Inc. at December 31, 2004 and 2003, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
December 31, 2004, in conformity with U.S. generally accepted accounting
principles. Also, in our opinion, the related financial statement schedule, when
considered in relation to the basic financial statements taken as a whole,
presents fairly, in all material respects, the information set forth therein. As discussed in Note 2 to the financial statements, in 2002 the Company
changed its method of accounting for goodwill. We also have audited, in accordance with the standards of the Public
Company Accounting Oversight Board (United States), the effectiveness of Golden
Telecom, Inc.s internal control over financial reporting as of December 31,
2004, based on criteria established in Internal Control  Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission
and our report dated March 11, 2005 expressed an unqualified opinion thereon. /s/ ERNST & YOUNG (CIS) LIMITED Moscow, Russia
March 11, 2005 64




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GOLDEN TELECOM, INC. 
 CONSOLIDATED BALANCE SHEETS  DECEMBER 31,2003
    
    
    2004(SEE NOTE16)ASSETSCURRENT ASSETSCash and cash equivalents
    
    $
    65,180
    
    
    $
    53,699Accounts receivable, net of allowance for doubtful accounts of
$13,896 and $23,205 at December 31, 2003 and 2004, respectively
    
    
    74,016
    
    
    
    89,177VAT receivable
    
    
    14,819
    
    
    
    19,022Prepaid expenses
    
    
    12,232
    
    
    
    13,793Deferred tax asset
    
    
    5,995
    
    
    
    7,863Other current assets
    
    
    15,909
    
    
    
    16,738TOTAL CURRENT ASSETS
    
    
    188,151
    
    
    
    200,292Property and equipment:Telecommunications equipment
    
    
    311,965
    
    
    
    396,060Telecommunications network held under capital leases
    
    
    28,712
    
    
    
    28,958Furniture, fixtures and equipment
    
    
    27,245
    
    
    
    34,721Other property
    
    
    13,080
    
    
    
    12,797Construction in progress
    
    
    34,234
    
    
    
    61,136415,236
    
    
    
    533,672Accumulated depreciation
    
    
    (132,126
    )
    
    
    (185,781
    )Net property and equipment
    
    
    283,110
    
    
    
    347,891Goodwill and intangible assets:Goodwill
    
    
    144,008
    
    
    
    146,254Telecommunications service contracts, net of accumulated amortization of
$13,619 as of December 31, 2003 and $21,917 as of December 31, 2004
    
    
    66,622
    
    
    
    70,333Contract-based customer relationships, net of accumulated amortization of
$2,859 as of December 31, 2003 and $10,883 as of December 31, 2004
    
    
    32,310
    
    
    
    25,966Licenses, net of accumulated amortization of $1,854 as of December 31, 2003
and $2,515 as of December 31, 2004
    
    
    2,103
    
    
    
    1,843Other intangible assets, net of accumulated amortization of $5,492 as of
December 31, 2003 and $6,684 as of December 31, 2004
    
    
    3,800
    
    
    
    3,174Net goodwill and intangible assets
    
    
    248,843
    
    
    
    247,570Restricted cash
    
    
    1,005
    
    
    
    1,012Other non-current assets
    
    
    8,117
    
    
    
    9,003TOTAL ASSETS
    
    $
    729,226
    
    
    $
    805,768
 The accompanying notes are an integral part of these financial statements. 66




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GOLDEN TELECOM, INC. CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS OF US$, EXCEPT SHARE DATA) DECEMBER 31,2003
    
    
    2004(SEE NOTE16)LIABILITIES AND SHAREHOLDERS EQUITYCURRENT LIABILITIESAccounts payable and accrued expenses
    
    $
    65,779
    
    
    $
    81,474VAT Payable
    
    
    10,167
    
    
    
    14,235Debt maturing within one year
    
    
    950
    
    
    
    Current capital lease obligations
    
    
    3,067
    
    
    
    2,301Deferred revenue
    
    
    9,192
    
    
    
    11,761Due to affiliates and related parties
    
    
    3,495
    
    
    
    3,199Other current liabilities
    
    
    5,249
    
    
    
    3,572TOTAL CURRENT LIABILITIES
    
    
    97,899
    
    
    
    116,542Long-term debt, less current portion
    
    
    200
    
    
    
    200Long-term deferred tax liability
    
    
    24,461
    
    
    
    24,244Long-term deferred revenue
    
    
    13,725
    
    
    
    23,124Long-term capital lease obligations
    
    
    3,763
    
    
    
    1,538Other non-current liabilities
    
    
    2,177
    
    
    
    2,001TOTAL LIABILITIES
    
    
    142,225
    
    
    
    167,649Minority interest
    
    
    2,722
    
    
    
    11,738SHAREHOLDERS EQUITYPreferred stock, $0.01 par value (10,000,000 shares
authorized; none issued and outstanding at December 31, 2003 and 2004)
    
    
    
    
    
    
    Common stock, $0.01 par value (100,000,000 shares authorized;
35,948,094 shares issued and outstanding at December 31,
2003 and 36,322,490 shares issued and outstanding at December 31, 2004)
    
    
    359
    
    
    
    363Additional paid-in capital
    
    
    663,464
    
    
    
    669,777Accumulated deficit
    
    
    (79,544
    )
    
    
    (43,759
    )TOTAL SHAREHOLDERS EQUITY
    
    
    584,279
    
    
    
    626,381TOTAL LIABILITIES AND SHAREHOLDERS EQUITY
    
    $
    729,226
    
    
    $
    805,768
 The accompanying notes are an integral part of these financial statements. 67




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GOLDEN TELECOM, INC. 
 CONSOLIDATED STATEMENTS OF OPERATIONS  YEAR ENDED DECEMBER 31,2002
    
    
    2003
    
    
    2004REVENUE:Telecommunication services
    
    $
    189,680
    
    
    $
    358,724
    
    
    $
    581,521Revenue from affiliates and related parties
    
    
    9,047
    
    
    
    1,810
    
    
    
    2,457TOTAL REVENUE
    
    
    198,727
    
    
    
    360,534
    
    
    
    583,978OPERATING COSTS AND EXPENSES:Access and network services (excluding depreciation
and amortization)
    
    
    91,189
    
    
    
    181,085
    
    
    
    300,588Selling, general and administrative (excluding
depreciation and amortization)
    
    
    46,147
    
    
    
    64,384
    
    
    
    112,855Depreciation and amortization
    
    
    29,961
    
    
    
    45,334
    
    
    
    74,999TOTAL OPERATING EXPENSES
    
    
    167,297
    
    
    
    290,803
    
    
    
    488,442INCOME FROM OPERATIONS
    
    
    31,430
    
    
    
    69,731
    
    
    
    95,536OTHER INCOME (EXPENSE):Equity in earnings of ventures
    
    
    4,375
    
    
    
    4,687
    
    
    
    278Interest income
    
    
    1,569
    
    
    
    1,084
    
    
    
    1,131Interest expense
    
    
    (2,236
    )
    
    
    (1,956
    )
    
    
    (572
    )Foreign currency gain (loss)
    
    
    (1,174
    )
    
    
    (232
    )
    
    
    660TOTAL OTHER INCOME (EXPENSE)
    
    
    2,534
    
    
    
    3,583
    
    
    
    1,497Income before minority interest and income taxes
    
    
    33,964
    
    
    
    73,314
    
    
    
    97,033Minority interest
    
    
    (527
    )
    
    
    (480
    )
    
    
    (1,506
    )Income taxes
    
    
    4,627
    
    
    
    17,399
    
    
    
    30,744Income before cumulative effect of change
in accounting principle
    
    
    28,810
    
    
    
    55,435
    
    
    
    64,783Cumulative effect of change in accounting principle
    
    
    974
    
    
    
    
    
    
    
    NET INCOME
    
    $
    29,784
    
    
    $
    55,435
    
    
    $
    64,783Basic earnings per share of common stock:Income before cumulative effect of
a change in accounting principle
    
    
    1.20
    
    
    
    1.95
    
    
    
    1.79Cumulative effect of a change in
accounting principle
    
    
    0.04
    
    
    
    
    
    
    
    Net income per share  basic
    
    $
    1.24
    
    
    $
    1.95
    
    
    $
    1.79Weighted average common shares
outstanding  basic
    
    
    24,102
    
    
    
    28,468
    
    
    
    36,226Diluted earnings per share of common stock:Income before cumulative effect of
a change in accounting principle
    
    
    1.17
    
    
    
    1.90
    
    
    
    1.77Cumulative effect of a change in
accounting principle
    
    
    0.04
    
    
    
    
    
    
    
    Net income per share  diluted
    
    $
    1.21
    
    
    $
    1.90
    
    
    $
    1.77Weighted average common shares
outstanding  diluted
    
    
    24,517
    
    
    
    29,107
    
    
    
    36,553Cash dividends per share
    
    $
    
    
    
    $
    
    
    
    $
    0.80
 The accompanying notes are an integral part of these financial statements. 68




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GOLDEN TELECOM, INC. 
 CONSOLIDATED STATEMENTS OF CASH FLOWS  YEAR ENDED DECEMBER 31,2002
    
    
    2003
    
    
    2004OPERATING ACTIVITIESNet income
    
    $
    29,784
    
    
    $
    55,435
    
    
    $
    64,783Adjustments to Reconcile net income to Net Cash Provided by
Operating Activities:Depreciation
    
    
    23,560
    
    
    
    34,837
    
    
    
    56,818Amortization
    
    
    6,401
    
    
    
    10,497
    
    
    
    18,181Equity in earnings of ventures
    
    
    (4,375
    )
    
    
    (4,687
    )
    
    
    (278
    )Minority interest
    
    
    527
    
    
    
    480
    
    
    
    1,506Foreign currency (gain) loss
    
    
    1,174
    
    
    
    232
    
    
    
    (660
    )Deferred tax benefit
    
    
    (4,213
    )
    
    
    (3,117
    )
    
    
    (4,606
    )Bad debt expense
    
    
    2,061
    
    
    
    3,592
    
    
    
    10,065Other
    
    
    (196
    )
    
    
    (96
    )
    
    
    (136
    )Changes in assets and liabilities:Accounts receivable
    
    
    (5,419
    )
    
    
    (15,302
    )
    
    
    (22,964
    )Accounts payable and accrued expenses
    
    
    (240
    )
    
    
    (3,928
    )
    
    
    26,288Other assets and liabilities
    
    
    1,582
    
    
    
    9,031
    
    
    
    (3,908
    )NET CASH PROVIDED BY OPERATING ACTIVITIES
    
    
    50,646
    
    
    
    86,974
    
    
    
    145,089INVESTING ACTIVITIESPurchases of property and equipment and intangible assets
    
    
    (29,431
    )
    
    
    (63,737
    )
    
    
    (114,649
    )Acquisitions, net of cash acquired
    
    
    (51,214
    )
    
    
    (12,282
    )
    
    
    (15,522
    )Loan received from equity investee
    
    
    9,973
    
    
    
    
    
    
    
    Cash received from escrow account
    
    
    3,000
    
    
    
    
    
    
    
    Restricted cash
    
    
    1,884
    
    
    
    510
    
    
    
    (7
    )Purchase of investments available for sale
    
    
    (2,000
    )
    
    
    
    
    
    
    Proceeds from investments available for sale
    
    
    10,976
    
    
    
    
    
    
    
    Dividend received from affiliated companies
    
    
    1,955
    
    
    
    4,775
    
    
    
    95Other investing
    
    
    2,688
    
    
    
    2,704
    
    
    
    1,705NET CASH USED IN INVESTING ACTIVITIES
    
    
    (52,169
    )
    
    
    (68,030
    )
    
    
    (128,378
    )FINANCING ACTIVITIESProceeds from debt
    
    
    30,000
    
    
    
    
    
    
    
    Repayments of debt
    
    
    (10,107
    )
    
    
    (35,132
    )
    
    
    (950
    )Net proceeds from exercise of employee stock options
    
    
    5,904
    
    
    
    23,737
    
    
    
    4,895Cash dividends paid
    
    
    
    
    
    
    
    
    
    
    (28,998
    )Other financing
    
    
    (1,618
    )
    
    
    (1,910
    )
    
    
    (3,385
    )NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES
    
    
    24,179
    
    
    
    (13,305
    )
    
    
    (28,438
    )Effect of exchange rate changes on cash and cash equivalents
    
    
    (435
    )
    
    
    (84
    )
    
    
    246Net increase (decrease) in cash and cash equivalents
    
    
    22,221
    
    
    
    5,555
    
    
    
    (11,481
    )Cash and cash equivalents at beginning of period
    
    
    37,404
    
    
    
    59,625
    
    
    
    65,180CASH AND CASH EQUIVALENTS AT END OF PERIOD
    
    $
    59,625
    
    
    $
    65,180
    
    
    $
    53,699
 The accompanying notes are an integral part of these financial statements. 69




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GOLDEN TELECOM, INC. 
 CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY 
 ADDITIONAL
    
    
    ACCUMULATED
    
    
    TOTALCOMMON STOCK
    
    
    TREASURY STOCK
    
    
    PAID-IN
    
    
    DEFICIT
    
    

DEFICITSHARES
    
    
    AMOUNT
    
    
    SHARES
    
    
    AMOUNT
    
    
    CAPITAL
    
    
    (SEE NOTE 16)
    
    
    EQUITYBalance at
December 31, 2001, as reported
    
    
    24,790
    
    
    $
    248
    
    
    
    (2,273
    )
    
    $
    (25,000
    )
    
    $
    414,407
    
    
    $
    (168,811
    )
    
    $
    220,844Prior period
adjustment,
see note 16
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,048
    
    
    
    4,048Balance at
December 31, 2001, as restated
    
    
    24,790
    
    
    $
    248
    
    
    
    (2,273
    )
    
    $
    (25,000
    )
    
    $
    414,407
    
    
    $
    (164,763
    )
    
    $
    224,892Compensatory common stock grants
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    340
    
    
    
    
    
    
    
    340Exercise of employee stock options
    
    
    480
    
    
    
    5
    
    
    
    
    
    
    
    
    
    
    
    5,822
    
    
    
    
    
    
    
    5,827Retirement of treasury shares
    
    
    (2,273
    )
    
    
    (23
    )
    
    
    2,273
    
    
    
    25,000
    
    
    
    (24,977
    )
    
    
    
    
    
    
    Acquisition of EDN Sovintel LLC
    
    
    4,024
    
    
    
    40
    
    
    
    
    
    
    
    
    
    
    
    50,623
    
    
    
    
    
    
    
    50,663Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    29,784
    
    
    
    29,784Balance at December 31, 2002
    
    
    27,021
    
    
    $
    270
    
    
    
    
    
    
    $
    
    
    
    $
    446,215
    
    
    $
    (134,979
    )
    
    $
    311,506Exercise of employee stock options
    
    
    1,919
    
    
    
    19
    
    
    
    
    
    
    
    
    
    
    
    23,834
    
    
    
    
    
    
    
    23,853Acquisition of OAO Comincom
    
    
    7,008
    
    
    
    70
    
    
    
    
    
    
    
    
    
    
    
    193,415
    
    
    
    
    
    
    
    193,485Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    55,435
    
    
    
    55,435Balance at December 31, 2003
    
    
    35,948
    
    
    $
    359
    
    
    
    
    
    
    $
    
    
    
    $
    663,464
    
    
    $
    (79,544
    )
    
    $
    584,279Exercise of employee stock options
    
    
    374
    
    
    
    4
    
    
    
    
    
    
    
    
    
    
    
    4,775
    
    
    
    
    
    
    
    4,779Sale of 20% of Golden Telecom
(Ukraine) (see note 18)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,538
    
    
    
    
    
    
    
    1,538Cash dividends paid
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (28,998
    )
    
    
    (28,998
    )Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    64,783
    
    
    
    64,783Balance at December 31, 2004
    
    
    36,322
    
    
    $
    363
    
    
    
    
    
    
    $
    
    
    
    $
    669,777
    
    
    $
    (43,759
    )
    
    $
    626,381
 The accompanying notes are an integral part of these financial statements. 70




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GOLDEN TELECOM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1: NATURE OF BUSINESS OPERATIONS Golden Telecom, Inc. (GTI or the Company) is a leading facilities-based
provider of integrated telecommunication and Internet services in major
population centers throughout Russia and other countries of the Commonwealth of
Independent States (CIS). The Company offers voice, data and Internet services
to corporations, operators and consumers using its metropolitan overlay network
in major cities including Moscow, Kiev, St. Petersburg, Nizhny Novgorod, Samara,
Kaliningrad, Krasnoyarsk, Almaty, and Tashkent, and via intercity fiber optic
and satellite-based networks, including approximately 220 combined access points
in Russia and other countries of the CIS. The Company offers mobile services in
Kiev and Odessa in Ukraine. Golden Telecom was incorporated in Delaware on June
10, 1999 for the purpose of acting as a holding company for Global TeleSystems,
Inc.s (GTS) operating entities within the CIS and supporting non-CIS holding
companies (the CIS Entities). On September 29, 1999, GTS transferred its
ownership rights in the CIS Entities to the Company in anticipation of the
Companys initial public offering (IPO) which closed on October 5, 1999. The CIS Entities were subsidiaries of GTS prior to the transfer of
ownership rights of the CIS Entities to the Company, and after the IPO, GTS
retained an approximately 67% interest in the Company. On May 11, 2001, GTS
completed the sale of approximately 12.2 million shares, or approximately 50%,
of GTIs common stock to a group of investors led by Alfa Group (Alfa), a
leading Russia-based financial and industrial concern, and two of the Companys
previously existing major shareholders, Capital International Global Emerging
Markets Private Equity Fund, L.P. and investment funds managed by Barings Vostok
Capital Partners, including Cavendish Nominees Limited and First NIS Regional
Fund SICAV. In July 2001, the Company completed a buy-back of $25.0 million, or
approximately 2.3 million shares, of the Companys common stock from a
subsidiary of GTS and in October 2001, GTS sold the remaining approximately 0.6
million shares of GTIs common stock and ceased being a shareholder of the
Company. NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND NEW ACCOUNTING
PRONOUNCEMENTS Principles of Consolidation Wholly owned subsidiaries and majority owned ventures where the Company has
operating and financial control are consolidated. Those ventures where the
Company exercises significant influence, but does not exercise operating and
financial control are accounted for by the equity method. All significant
inter-company accounts and transactions are eliminated upon consolidation. Results of subsidiaries acquired and accounted for by the purchase method
have been included in operations from the relevant date of acquisition. Foreign Currency Translation The functional currency of all the Companys foreign subsidiaries is the
United States dollar (USD) because the majority of their revenues, costs,
property and equipment purchased, and debt and trade liabilities is either
priced, incurred, payable or otherwise measured in USD. Each of the legal
entities domiciled in the CIS maintains its records and prepares its financial
statements in the local currency, principally either Russian rubles or Ukrainian
hryvna, in accordance with the requirements of domestic accounting and tax
legislation. The accompanying financial statements differ from the financial
statements used for statutory purposes in the CIS and other non-US jurisdictions
in that they reflect certain adjustments, recorded on the entities books, which
are appropriate to present the financial position, results of operations and
cash flows in accordance with accounting principles generally accepted in the
United States of America (US GAAP). The principal adjustments are related to
revenue recognition, foreign currency translation, deferred taxation,
consolidation, and depreciation and valuation of property and equipment and
intangible assets. The Company follows a translation policy in accordance with Statement of
Financial Accounting Standard (SFAS) No. 52, Foreign Currency Translation,
as amended by SFAS No. 130, Reporting Comprehensive Income. The temporal
method is used for translating assets and liabilities of the Companys legal
entities domiciled in the CIS and other non-United States jurisdictions.
Accordingly, monetary assets and liabilities are translated at current exchange
rates while non-monetary assets and liabilities are translated at their
historical rates. Income and expense accounts are translated at average monthly
rates of exchange. The resultant translation adjustments are included in the
operations of the subsidiaries and ventures. Generally, the ruble is not
convertible outside of Russia. The official exchange rate which is established
by the Central Bank of Russia is a reasonable approximation of market rate. The
official exchange rates which are used for translation in the accompanying
financial statements at the balance sheet date were 29.45 and 27.75 rubles per
USD as of December 31, 2003 and 2004, respectively. Through December 31, 2002,
Russia has been considered to be a highly inflationary environment. From January
1, 2003, Russia ceased to be considered as a highly inflationary economy. The
change had no impact on the consolidated financial statements. 71




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GOLDEN TELECOM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (CONTINUED) The translation of local currency denominated assets and liabilities into
USD for the purpose of these financial statements does not indicate that the
Company could realize or settle in USD the reported values of the assets and
liabilities. Likewise, it does not indicate that the Company could return or
distribute the reported USD value of capital to its shareholders. Cash and Cash Equivalents and Restricted Cash The Company classifies cash on hand and deposits in banks, including
commercial paper, money market accounts, and any other investments with an
original maturity of three months or less from the date of purchase, that the
Company may hold from time to time, as cash and cash equivalents. Restricted
cash is primarily related to cash held in escrow at a financial institution for
the collateralization of debt obligations that certain of the Companys
consolidated subsidiaries and equity ventures have borrowed from such financial
institution. Accounts Receivable Accounts receivable are shown at their net realizable value which
approximates their fair value. The allowance for doubtful accounts is estimated
by a combination of applying estimated loss percentages against the aging of
accounts receivable and specific identification. Bad debt expense for
the years
ended December 31, 2002, 2003 and 2004 was $2.1 million, $3.6 million and $10.1
million, respectively. Inventories Inventories, which are classified as other current assets, are stated at
the lower of cost or market. Cost is computed on either a specific
identification basis or a weighted average basis. Property and Equipment Property and equipment is stated at cost. Depreciation is calculated on a
straight-line basis over the lesser of the estimated lives, ranging from five to
ten years for telecommunications equipment and three to five years for
furniture, fixtures and equipment and other property, or their contractual term.
Construction in process reflects amounts incurred for the configuration and
build-out of telecommunications equipment not yet placed into service.
Maintenance and repairs are charged to expense as incurred. The Company has
included in property and equipment, capitalized leases in the amount of $28.7
million and $29.0 million at December 31, 2003 and 2004, respectively, with
associated accumulated depreciation of $9.2 million and $13.4 million as of
December 31, 2003 and 2004, respectively. Amortization of assets recorded under
capital leases is included with depreciation expense for the years ended
December 31, 2002, 2003, and 2004. Goodwill and Intangible Assets Goodwill represents the excess of acquisition costs over the fair value of
the net assets of acquired businesses, and was amortized on a straight-line
basis over its estimated useful life, five years, until December 31, 2001.
Beginning January 1, 2002, goodwill has been identified as an indefinite lived
asset in accordance with SFAS No. 142, Goodwill and Other Intangible Assts,
and accordingly amortization of goodwill ceased as of that date. Intangible
assets, which are stated at cost, consist principally of telecommunications
service contracts, contract based customer relationships, licenses, software and
content and are amortized on a straight-line basis over the lesser of their
estimated useful lives, generally five to ten years, or their contractual term.
In accordance with Accounting Principles Board (APB) Opinion No. 17,
Intangible Assets and SFAS No. 142 Goodwill and Other Intangible Assets, the
Company continues to evaluate the amortization period to determine whether
events or circumstances warrant revised amortization periods. Additionally, the
Company considers whether the carrying value of such assets should be reduced
based on the future benefits. Goodwill Impairment Assessment Goodwill is reviewed annually, as of the beginning of the fourth quarter,
for impairment or whenever it is determined that impairment indicators exit. The
Company determines whether an impairment has occurred by assigning goodwill to
the reporting units identified in accordance with SFAS No. 142, Goodwill and
Other Intangible Assets, and comparing the carrying amount of the reporting
unit to the fair value of the reporting unit. If a goodwill impairment has
occurred, the Company recognizes a loss for the difference between the carrying
amount and the implied fair value of goodwill. No such losses were recognized in
the three years ended December 31, 2002, 2003 and 2004. 72




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GOLDEN TELECOM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (CONTINUED) Long-Lived Assets Long-lived assets to be held and used by the Company are reviewed to
determine whether an event or change in circumstances indicates that the
carrying amount of the asset may not be recoverable. For long-lived assets to be
held and used, the Company bases its evaluation on such impairment indicators as
the nature of the assets, the future economic benefit of the assets, any
historical or future profitability measurements, as well as other external
market conditions or factors that may be present. If such impairment indicators
are present or other factors exist that indicate that the carrying amount of the
asset may not be recoverable, the Company determines whether an impairment has
occurred through the use of an undiscounted cash flows analysis of assets at the
lowest level for which identifiable cash flows exist. If impairment has
occurred, the Company recognizes a loss for the difference between the carrying
amount and the fair value of the asset. The fair value of the asset is measured
using discounted cash flow analysis or other valuation techniques. No such
losses were recognized in the three years ended December 31, 2002, 2003 and
2004. Income Taxes The Company accounts for income taxes using the liability method required
by SFAS No. 109, Accounting for Income Taxes. For interim reporting purposes,
the Company also follows the provisions of Accounting Principles Board No. 28,
Interim Financial Reporting, which requires the Company to account for income
taxes based on the Companys best estimate of the effective tax rate expected to
be applicable for the full fiscal year on a current year-to-date basis. The rate
so determined is based on the currently enacted tax rates of the Company in the
United States and the Companys subsidiaries in Russia and other CIS countries
and includes the Companys best estimate of the annual tax effect of
non-deductible expenses, primarily related to amortization of intangible assets,
foreign exchange and other permanent differences as well as the estimates as to
the realization of certain deferred tax assets. Deferred income taxes result
from temporary differences between the tax bases of assets and liabilities and
the bases as reported in the consolidated financial statements. The Company does
not provide for deferred taxes on the undistributed earnings of its foreign
subsidiaries, as such earnings are generally intended to be reinvested in those
operations permanently. In the case of non-consolidated entities, except MCT
Corp. (MCT), where our partner requests that a dividend be paid, the amounts
are not expected to have a material impact on the Companys income tax
liability. It is not practical to determine the amount of unrecognized deferred
tax liability for such reinvested earnings. Revenue Recognition The Company records as revenue the amount of telecommunications and
Internet services rendered, as measured primarily by the minutes of traffic
processed and the time spent online using Internet services. Revenue from
service contracts is accounted for when the services are provided. Billings
received in advance of service being performed are deferred and recognized as
revenue as the service is performed. The Company also defers up front connection
fees which is recognized over the estimated life of the customer. The Company
recognizes revenue from equipment sales when title to the equipment passes to
the customer. The Company defers the revenue on installed equipment until
installation and testing are completed and accepted by the customer. Revenues
are stated net of any value-added taxes charged to customers. Certain other
taxes that are based on revenues earned were incurred at a rate of 1% in 2002,
and have been included in operating expenses since these taxes are incidental to
the revenue cycle. The Company has deferred connection fees and capitalized direct incremental
costs related to connection fees, not exceeding the revenue deferred. The
deferral of revenue and capitalization of cost of revenue related to connection
fees will be recognized over the estimated life of the customer. The total
amount of deferred connection fees revenue was $20.0 million and $33.8 million
as of December 31, 2003 and 2004, respectively. The total amount of capitalized
direct incremental costs related to connection fees was $5.2 million and $8.0
million as of December 31, 2003 and 2004, respectively. In the fourth quarter of 2002, the Company re-assessed the average life of
the customer and concluded that the average life of the customer increased from
three to five years except for Golden Telecom (Ukraine) (GTU) which remained
at two years for customers in the Business and Corporate Services Division and
Operator and Carrier Services Division and eighteen months for customers in the
Mobile Services division. The impact of increasing the average life of the
customer from three to five years was approximately $0.7 million reduction in
revenue and $0.4 million decrease in cost of revenue in the fourth quarter of
2002. The impact of this change in customer life was $0.3 million reduction on
net income and $0.01 per common share  basic for the year ended December 31,
2002. 73




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GOLDEN TELECOM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (CONTINUED) In November 2002, the Financial Accounting Standards Board (FASB)
Emerging Issues Task Force issued its consensus concerning Revenue Arrangements
with Multiple Deliverables (EITF 00-21). EITF 00-21 addresses how to determine
whether a revenue arrangement involving multiple deliverables should be divided
into separate units of accounting, and, if separation is appropriate, how the
arrangement consideration should be measured and allocated to the identified
accounting units. The guidance in EITF 00-21 is effective for revenue
arrangements entered into in fiscal periods beginning after June 15, 2003. The
adoption of EITF 00-21 did not have a material impact on the Companys
consolidated financial position or results of operations. Advertising The Company expenses the cost of advertising as incurred. Advertising
expense for the years ended December 31, 2002, 2003 and 2004 was $3.7 million,
$5.2 million and $4.7 million, respectively. Government Pension Funds The Company contributes to the local state pension funds and social funds,
on behalf of all its CIS employees. In Russia, starting from January 1, 2001 all
social contributions, including contributions to the pension fund, were
substituted with a unified social tax (UST) calculated by the application of a
regressive rate from 35.6% to 5% to the annual gross remuneration of each
employee. The Company allocates UST to three social funds, including the pension
fund, where the rate of contributions to the pension fund vary from 28% to 5%,
respectively, depending on the annual gross salary of each employee. The
contributions are expensed as incurred. Comprehensive Income Comprehensive income is defined as the change in equity of a business
enterprise during a period from non-owner sources. For the years ended December
31, 2002, 2003 and 2004, comprehensive income for the Company is equal to net
income. Off Balance Sheet Risk and Concentration of Credit Risk Financial instruments that potentially subject the Company to concentration
of credit risk consist primarily of cash, cash equivalents, and accounts and
notes receivable. Of the $53.7 million of cash and cash equivalents held at
December 31, 2004, $31.0 million was held in United States (US) money market
instruments in US financial institutions. The remaining balance is being
maintained in US-owned banks and local financial institutions within the CIS.
The Company extends credit to various customers, principally in Russia and
Ukraine, and establishes an allowance for doubtful accounts for specific
customers that it determines to have significant credit risk. The Company
generally does not require collateral to extend credit to its customers. In
2001, the Company granted an unsecured loan to a party in a lease agreement, as
disclosed in note 8. Stock-Based Compensation The Company follows the provisions of SFAS No. 123, Accounting for
Stock-Based Compensation, for its Equity Participation Plan. SFAS No. 123
establishes a fair value method of accounting for employee stock options and
similar equity instruments. The fair value method requires compensation cost to
be measured at the grant date based on the value of the award and to be
recognized over the service period. SFAS No. 123 generally allows companies to
either account for stock-based compensation under the fair value method of SFAS
No. 123 or under the intrinsic value method of APB No. 25, Accounting for Stock
Issued to Employees. The Company has elected to account for its stock-based
compensation in accordance with the provisions of APB No. 25 and present pro
forma disclosures of results of operations as if the fair value method had been
adopted. In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation  Transition and Disclosure, which amends SFAS No. 123,
Accounting for Stock-Based Compensation, to provide alternative methods of
transition to SFAS No. 123s fair value method of accounting for stock-based
employee compensation. SFAS No. 148 also amends the disclosure provisions of
SFAS No. 123 and APB No. 28, Interim Financial Reporting, to require
disclosure in the summary of significant accounting policies of the effects of
an entitys accounting policy with respect to stock-based employee compensation
on reported net income and earrings per share in annual and interim financial
statements. The Company has adopted the amendments to SFAS No. 123 disclosure
provisions required under SFAS No. 148 but will continue to use the intrinsic
value method under APB No. 25 to account for stock-based compensation. As such,
the adoption of SFAS No. 148 did not have a significant impact of the Companys
consolidated financial position or results of operations. 74




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GOLDEN TELECOM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (CONTINUED) The effect of applying SFAS No. 123 on the reported net income, as
disclosed below is not representative of the effects on net income in future
years due to the vesting period of the stock options and the fair value of
additional stock options in future years. TWELVE MONTHS ENDEDDECEMBER 31,2002
    
    
    2003
    
    
    2004(IN THOUSANDS, EXCEPT PER SHARE DATA)Net income, as reported
    
    $
    29,784
    
    
    $
    55,435
    
    
    $
    64,783Deduct: total stock-based employee compensation
expense determined under fair value based method
for all awards, net of related tax effects
    
    
    7,937
    
    
    
    3,183
    
    
    
    1,922Pro forma net income
    
    $
    21,847
    
    
    $
    52,252
    
    
    $
    62,861Net income per share:Basic  as reported
    
    $
    1.24
    
    
    $
    1.95
    
    
    $
    1.79Basic  pro forma
    
    
    0.91
    
    
    
    1.84
    
    
    
    1.74Diluted  as reported
    
    
    1.21
    
    
    
    1.90
    
    
    
    1.77Diluted  pro forma
    
    
    0.89
    
    
    
    1.80
    
    
    
    1.72
 In December 2004, the FASB issued SFAS No. 123R (revised 2004), Share
Based Payment, which is a revision of SFAS No. 123, Accounting for Stock-Based
Compensation SFAS No. 123R supersedes APB No. 25, Accounting for Stock Issued
to Employees and amends SFAS No. 95, Statement of Cash Flows. Under SFAS No.
123R, companies must calculate and record the cost of equity instruments, such
as stock options or restricted stock, awarded to employees for services received
in the income statement; pro forma disclosure is no longer permitted. The cost
of the equity instruments is to be measured based on fair value of the
instruments on the date they are granted (with certain exceptions) and is
required to be recognized over the period during which the employees are
required to provide services in exchange for the equity instruments. SFAS No.
123R is effective in the first interim or annual reporting period beginning
after June 15, 2005. SFAS No. 123R provides two alternatives for adoption: (1) a modified
prospective method in which compensation cost is recognized for all awards
granted subsequent to the effective date of this statement as well as for the
unvested portion of awards outstanding as of the effective date and (2) an
modified retrospective method which follows the approach in the modified
prospective method, but also permits entities to restate prior periods to
reflect compensation cost calculated under SFAS No. 123 for pro forma amounts
disclosure. The Company plans to adopt SFAS No. 123R using the modified
prospective method. As the Company currently accounts for share based payments
to employees in accordance with the intrinsic value method permitted under ABP
No. 25, no compensation expense is recognized. The impact of adopting SFAS No.
123R cannot be accurately estimated at this time, as it will depend on the
amount of share based awards granted in future periods. However, had the Company
adopted SFAS No. 123R in a prior period, the impact would approximate the impact
of SFAS No. 123 as described in the disclosure of pro forma net income and
earnings per share. SFAS No. 123R also requires that tax benefits received in
excess of compensation cost be reclassified from an operating cash flow to a
financing cash flow in the Consolidated Statement of Cash Flows. This change in
classification will reduce net operating cash flows and increase net financing
cash flows in the periods after adoption. Consolidation of Variable Interest Entities In January 2003, the FASB issued FASB Interpretation No. 46, Consolidation
of Variable Interest Entities (FIN No. 46). FIN No. 46 amended Accounting
Research Bulletin No. 51, Consolidated Financial Statements, and established
standards for determining under what circumstances a variable interest (VIE)
should be consolidated with its primary beneficiary. FIN No.46 also requires
disclosure about VIEs that are not required to be consolidated but in which the
reporting entity has a significant variable interest. In December 2003, the FASB
revised certain implementation provisions of FIN No. 46. The revised
interpretation (FIN No. 46R) substantially retained the requirements of
immediate application of FIN No. 46 to VIEs created after January 31, 2003.
There were no such entities created after January 31, 2003. With respect to
older VIEs, the consolidation requirements under FIN No. 46R apply not later
than for the first financial year or interim period ending after December 15,
2003, if such VIE is a special-purpose entity (SPE), and no later than for the
first financial year or interim period ending after March 15, 2004, if such a
VIE is not a SPE. The Company did not identify any previously formed VIEs.
Therefore the adoption of FIN No. 46R did not have an impact on the financial
position or results of operations. 75




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GOLDEN TELECOM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (CONTINUED) Derivative Instruments and Hedging Activities In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities. SFAS No. 149 amends and
clarifies accounting for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities under SFAS
No. 133. SFAS No. 149 is generally effective for contracts entered into or
modified after June 30, 2003. The adoption of the provisions of SFAS No. 149 did
not have an impact on the Companys results of operations or financial position. Financial Instruments In May 2003, the FASB issued SFAS No. 150, Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and Equity. SFAS
No. 150 requires certain financial instruments that embody obligations of the
issuer and have characteristics of both liabilities and equity to be classified
as liabilities. The provisions of SFAS No. 150 are effective for financial
instruments entered into or modified after May 31, 2003 and to all other
instruments that exist as of the beginning of the first interim financial
reporting period beginning after June 15, 2003. The Company does not have any
financial instruments that meet the provisions of SFAS No. 150, therefore,
adopting the provisions of SFAS No. 150 did not have an impact on the Companys
results of operations or financial position. Fair Value of Financial Instruments The carrying amounts for cash and cash equivalents, accounts receivable,
accounts payable, accrued liabilities, and short- and long-term debt approximate
their fair value. The fair value of notes receivable, including the long-term
portion that are included in other current and non-current assets, respectively
was $5.6 million and $3.7 million at December 31, 2003 and 2004, respectively as
determined by discounting future payments by 5.5% at December 31, 2003 and by
5.0% at December 31, 2004. At December 31, 2003 and 2004, the Company held no
debt at fixed rates. Exchanges of Nonmonetary Assets In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary
Assets. SFAS No. 153 addresses the measurement of exchanges of nonmonetary
assets. The guidance in APB Opinion No. 29, Accounting for Nonmonetary
Transactions (APB No. 29), is based on the principle that exchanges of
nonmonetary assets should be measured based on the fair value of the assets
exchanged. The guidance in APB No. 29, however, included certain exceptions to
that principle. SFAS No. 153 amends APB No. 29 to eliminate the exception for
nonmonetary exchanges of similar productive assets and replaces it with a
general exception for exchanges of nonmonetary assets that do not have
commercial substance. A nonmonetary exchange has commercial substance if the
future cash flows of the entity are expected to change significantly as a result
of the exchange. This provisions of SFAS No. 153 are effective for financial
statements for fiscal years beginning after June 15, 2005. Earlier application
is permitted for nonmonetary asset exchanges incurred during fiscal years
beginning after the date SFAS No. 153 was issued. The adoption of the provisions
of SFAS No. 153 is not expected to have a material impact on the Companys
results of operations or financial position. Use of Estimates in Preparation of Financial Statements The preparation of these consolidated financial statements, in conformity
with US GAAP, requires management to make estimates and assumptions that affect
amounts in the financial statements and accompanying notes and the reported
amounts of revenues and expenses during the reporting period. Actual results
could differ from those estimates. Comparative Figures Certain prior year amounts have been reclassified to conform to the
presentation adopted in the current year. Such reclassifications did not affect
the consolidated statements of operations. 76




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GOLDEN TELECOM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (CONTINUED) NOTE 3: NET INCOME PER SHARE Basic earnings per share at December 31, 2003 and 2004 is computed on the
basis of the weighted average number of common shares outstanding. Diluted
earnings per share at December 31, 2003 and 2004 is computed on the basis of the
weighted average number of common shares outstanding plus the effect of
outstanding employee stock options using the treasury stock method. The number
of stock options excluded from the diluted earnings per share computation,
because their effect was antidilutive for the twelve months ended December 31,
2003 and 2004 was 10,000 stock options. The components of basic and diluted earnings per share were as follows: TWELVE MONTHS ENDEDDECEMBER 31,2002
    
    
    2003
    
    
    2004(IN THOUSANDS, EXCEPT PER SHARE DATA)Income before cumulative effect of a change in
accounting principle
    
    $
    28,810
    
    
    $
    55,435
    
    
    $
    64,783Weighted average shares outstanding of:Common stock
    
    
    24,102
    
    
    
    28,468
    
    
    
    36,226Dilutive effect of:Employee stock options
    
    
    415
    
    
    
    639
    
    
    
    327Common stock and common stock equivalents
    
    
    24,517
    
    
    
    29,107
    
    
    
    36,553Earnings per share before cumulative effect of a
change in accounting principle:Basic
    
    $
    1.20
    
    
    $
    1.95
    
    
    $
    1.79Diluted
    
    $
    1.17
    
    
    $
    1.90
    
    
    $
    1.77
 NOTE 4: GOODWILL AND INTANGIBLE ASSETS In June 2001, the FASB issued SFAS No. 141, Business Combinations, and
No. 142, Goodwill and Other Intangible Assets, effective for fiscal years
beginning after December 15, 2001. Upon the adoption of SFAS No. 142, the Company recorded a cumulative effect
of a change in accounting principle for negative goodwill (deferred credit)
arising on the Companys equity method investments in the amount of $1.0
million. The impact of non-amortization of goodwill on the Companys net income
for the twelve months ended December 31, 2002 was approximately $15.0 million
increase, or $0.62 per share of common stock  basic. Amortization expense for intangible assets for the twelve months ended
December 31, 2002, 2003 and 2004 was $6.4 million, $10.5 million and $18.2
million, respectively. Amortization expense for the succeeding five years is
expected to be as follows: 2005  $17.8 million, 2006  $16.5 million, 2007 -
$15.6 million, 2008  $13.8 million and 2009  $8.2 million. The total gross
carrying value and accumulated amortization of the Companys intangible assets
by major intangible asset class is as follows: AS OF DECEMBER 31, 2003
    
    
    AS OF DECEMBER 31, 2004(IN THOUSANDS)ACCUMULATED
    
    
    
    
    
    
    ACCUMULATEDCOST
    
    
    AMORTIZATION
    
    
    COST
    
    
    AMORTIZATIONAmortized intangible assets:Telecommunications service contracts
    
    $
    80,241
    
    
    $
    (13,619
    )
    
    $
    92,250
    
    
    $
    (21,917
    )Contract-based customer relationships
    
    
    35,169
    
    
    
    (2,859
    )
    
    
    36,849
    
    
    
    (10,883
    )Licenses
    
    
    3,957
    
    
    
    (1,854
    )
    
    
    4,358
    
    
    
    (2,515
    )Other intangible assets
    
    
    9,292
    
    
    
    (5,492
    )
    
    
    9,858
    
    
    
    (6,684
    )Total
    
    $
    128,659
    
    
    $
    (23,824
    )
    
    $
    143,315
    
    
    $
    (41,999
    )
 Other intangible assets include software, Internet software and related
content, as well as other intangible assets. 77




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GOLDEN TELECOM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (CONTINUED) The changes on the carrying amount of goodwill for the years ended December
31, 2003 and 2004, respectively, are as follows: BUSINESS&
    
    
    CARRIER &CORPORATE
    
    
    OPERATORSEGMENT
    
    
    SEGMENT
    
    
    TOTAL(IN THOUSANDS)Balance as of December 31, 2002
    
    $
    28,096
    
    
    $
    43,607
    
    
    $
    71,703Goodwill related to acquisitions
    
    
    56,796
    
    
    
    15,509
    
    
    
    72,305Balance as of December 31, 2003
    
    $
    84,892
    
    
    $
    59,116
    
    
    $
    144,008Goodwill related to acquisitions
    
    
    1,932
    
    
    
    314
    
    
    
    2,246Balance as of December 31, 2004
    
    $
    86,824
    
    
    $
    59,430
    
    
    $
    146,254
 NOTE 5: BUSINESS COMBINATIONS AND VENTURE TRANSACTIONS ACQUISITIONS IN 2002 In August 2002, the Company acquired approximately 31% of GTU, a majority
owned subsidiary, for cash consideration of approximately $5.2 million,
including $3.7 million recorded as a liability, net of $0.3 million discount,
determined at the rate of 6.11%. The acquisition was accounted for as a purchase
business combination under US GAAP. The Company has recorded approximately $1.8
million of contract-based customer relationship intangible assets that are
amortized over a period of approximately 5 years. There was no goodwill recorded
as a result of this transaction. In September 2002, subsidiaries of the Company completed the acquisition of
50% of EDN Sovintel LLC (Sovintel) that the Company did not own from Open
Joint Stock Company Rostelecom (Rostelecom), pursuant to an Ownership Interest
Purchase Agreement, dated March 13, 2002, by and among subsidiaries of the
Company and Rostelecom, bringing the Companys ownership in Sovintel to 100%.
The total purchase price of approximately $113.1 million consisted of
approximately $50.7 million in GTIs common stock, representing 4,024,067
shares, $10.0 million in cash consideration, $46.0 million in promissory note
consideration (see discussion below), and direct transaction costs of
approximately $7.1 million, including an investment banking fee of approximately
$3.3 million paid to an affiliate of Alfa, a shareholder of the Company.
Sovintel provides worldwide communications services, principally to major
hotels, business offices and mobile communication companies through its
telecommunications network in Russia. The Company began consolidating the
results of operations of Sovintel on September 17, 2002. In September 2002, TeleRoss LLC (TeleRoss), a wholly-owned Russian
subsidiary of the Company, issued a three month $46.0 million non-interest
bearing note payable to Rostelecom in partial settlement of the acquisition of
the remaining 50% ownership interest in Sovintel previously held by Rostelecom.
TeleRoss was required to and settled the note, in full, in December 2002. This
non-interest bearing note payable was recorded net of $0.7 million discount
representing imputed interest. The acquisition of the remaining 50% of Sovintel was accounted for as a
purchase business combination in accordance with SFAS No. 141, Business
Combinations. As the transaction reflected acquisition of the remaining 50%
interest in Sovintel which was not previously owned by the Company, the Company
has recorded the net assets acquired at 50% of estimated fair value and 50% of
historical US GAAP carrying values. The following is a condensed balance sheet
of Sovintel as of September 17, 2002, reflecting purchase price allocation to
the net assets acquired: 78




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GOLDEN TELECOM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (CONTINUED) SEPTEMBER 17, 2002(IN THOUSANDS)ASSETS:Current assets
    
    $
    43,223Property and equipment, net
    
    
    64,124Telecommunications service contracts
intangible assets, net
    
    
    14,742Contract based customer relationship
intangible assets, net
    
    
    6,350Licenses, net
    
    
    562Other intangible assets, net
    
    
    300Goodwill
    
    
    54,262Other assets
    
    
    11,114Total assets
    
    $
    194,677LIABILITIES:Current liabilities
    
    $
    23,774Non-current liabilities
    
    
    8,514Net assets
    
    $
    162,389Less: previous carrying value of the Companys
equity method investment in Sovintel
    
    
    (49,283
    )Total purchase consideration and acquisition costs
    
    $
    113,106Consideration and acquisition costs:Cash consideration
    
    $
    10,000Promissory note consideration, net of discount
    
    
    45,307GTI shares consideration
    
    
    50,663Direct transaction costs
    
    
    7,136Total purchase consideration and acquisition costs
    
    $
    113,106
 The Companys financial statements reflect the allocation of the purchase
price based on a fair value assessment of the assets acquired and liabilities
assumed, and as such, the Company has assigned approximately $14.7 million to
telecommunications service contracts intangible assets which are amortized over
a weighted average period of approximately 9 years, approximately $6.4 million
to contract based customer relationship intangible assets which are amortized
over a weighted average period of approximately 5 years, approximately $0.6
million to licenses which are amortized over a weighted average period of 5
years, and approximately $0.3 million to other identified intangible assets
which are amortized over 5 years. Property and equipment was adjusted to fair
value using a net current replacement cost valuation method. The excess purchase
price over the fair value of the net tangible and intangible assets acquired of
approximately $54.3 million has been assigned to goodwill and is not deductible
for tax purposes. Approximately $26.1 million of this goodwill has been assigned
to the Business and Corporate Services reportable segment and approximately
$28.2 million of this goodwill has been assigned to the Carrier and Operator
Services reportable segment. In accordance with SFAS No. 141, Business
Combinations and SFAS No. 142, Goodwill and Other Intangible Assets, the
Company will not amortize the goodwill recorded in connection with the
acquisition of the remaining 50% of Sovintel. The goodwill will be tested for
impairment at least annually. The following unaudited pro forma combined results of operations for the
Company give effect to the Sovintel business combination as if it had occurred
at the beginning of 2002. These pro forma amounts are provided for informational
purposes only and do not purport to present the results of operations of the
Company had the transactions assumed therein occurred on or as of the date
indicated, nor is it necessarily indicative of the results of operations which
may be achieved in the future. 79




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GOLDEN TELECOM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (CONTINUED) TWELVE MONTHS ENDEDDECEMBER 31, 2002(IN THOUSANDS, EXCEPT PERSHARE DATA)Revenue
    
    $
    286,998Income (loss) before cumulative effect of
a change in accounting principle
    
    
    36,587Cumulative effect of a change in
accounting principle
    
    
    974Net income (loss)
    
    $
    37,561Basic earnings (loss) per share of common stock:Income (loss) before cumulative effect of
a change in accounting principle
    
    $
    1.36Cumulative effect of a change in
accounting principle
    
    
    0.04Net income (loss) per share  basic
    
    $
    1.40Weighted average common shares  basic
    
    
    26,748Diluted earnings (loss) per share of common stock:Income (loss) before cumulative effect of
a change in accounting principle
    
    $
    1.34Cumulative effect of a change in
accounting principle
    
    
    0.04Net income (loss) per share  diluted
    
    $
    1.38Weighted average common shares  diluted
    
    
    27,163
 ACQUISITIONS IN 2003 In August 2003, the Company completed the acquisition of 100% of OOO
Sibchallenge (Sibchallenge), a telecommunications service provider in
Krasnoyarsk, Russia. The total purchase price of approximately $15.4 million
consisted of cash consideration of approximately $15.0 million and approximately
$0.4 million in direct transaction costs, including an investment banking fee of
$0.3 million paid to Belongers Limited, an affiliate of Alfa, a shareholder of
the Company. The acquisition of Sibchallenge establishes GTIs presence in the
Krasnoyarsk region. In addition, Sibchallenge has numbering capacity and
interconnect agreements. The acquisition of 100% of Sibchallenge was accounted for as a purchase
business combination in accordance with SFAS No. 141, Business Combinations.
The following is the condensed balance sheet of Sibchallenge as of August 31,
2003 reflecting purchase price allocation to the net assets acquired: AUGUST 31, 2003(IN THOUSANDS)ASSETS:Current assets
    
    $
    1,792Property and equipment
    
    
    7,057Telecommunications service contracts
intangible assets, net
    
    
    11,175Total assets
    
    $
    20,024LIABILITIES:Current liabilities
    
    $
    1,519Non-current liabilities
    
    
    3,121Net assets
    
    $
    15,384Consideration and acquisition costs:Cash consideration
    
    
    15,000Direct transaction costs
    
    
    384Total purchase consideration and transaction costs
    
    $
    15,384
 The Companys financial statements reflect the allocation of the purchase
price based on a fair value assessment of the assets acquired and liabilities
assumed and, as such, the Company has assigned approximately $11.2 million to
telecommunications service contracts intangible assets. These identified
intangible assets are amortized over a period of 10 years. There was no goodwill recorded as a result of this transaction. The results of operations of
Sibchallenge have been included in the Companys consolidated operations since
August 31, 2003. 80




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GOLDEN TELECOM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (CONTINUED) In December 2003, the Company completed the acquisition of 100% of the
shares in OAO Comincom (Comincom) from Nye Telenor East
Invest as (Telenor), pursuant to a
Share Exchange Agreement. The total purchase price of approximately $195.3
million consisted of approximately $193.5 million in GTIs common stock,
representing 7,007,794 shares and direct transaction costs of approximately $1.8
million. The purchase consideration has been determined using the closing date
of the transaction as December 1, 2003. Accordingly, the GTI shares issued in
consideration are valued based on the average closing price of the Companys
common stock for the five consecutive trading days between November 26, 2003 and
December 2, 2003, which was $27.61 per share. Comincom provides
telecommunications services, principally to major hotels, business offices and
mobile communication companies through its telecommunications network in Russia,
including Moscow, St. Petersburg, Voronezh, Samara and several other major
population centers. The Company began consolidating the results of operations of
Comincom on December 1, 2003. The acquisition of 100% of the shares in Comincom was accounted for as a
purchase business combination in accordance with SFAS No. 141, Business
Combinations. The following is the condensed balance sheet of Comincom as of
December 1, 2003 reflecting the purchase price allocation to the net assets
acquired: DECEMBER 1, 2003(IN THOUSANDS)ASSETS:Current assets
    
    $
    38,191Property and equipment
    
    
    84,749Telecommunications service contracts
intangible assets, net
    
    
    17,344Contract-based customer relationship
intangible assets, net
    
    
    26,847Licenses, net
    
    
    546Goodwill
    
    
    72,305Other assets
    
    
    1,575Total assets
    
    $
    241,557LIABILITIES:Current liabilities
    
    $
    28,678Non-current liabilities
    
    
    17,535Net assets
    
    $
    195,344Consideration and acquisition costs:GTI shares consideration
    
    
    193,485Direct transaction costs
    
    
    1,859Total purchase consideration and acquisition costs
    
    $
    195,344
 The Companys financial statements reflect the allocation of the purchase
price based on a fair value assessment of the assets acquired and liabilities
assumed, and as such, the Company has assigned approximately $17.3 million to
telecommunications service contracts intangible assets which will be amortized
over a weighted average period of approximately 10 years, approximately $26.8
million to contract-based customer relationship intangible assets which will be
amortized over a weighted average period of approximately 5 years, and
approximately $0.5 million to licenses which will be amortized over a weighted
average period of 4 years. Property and equipment was adjusted to fair value
using a net current replacement cost valuation method. The excess purchase price
over the fair value of the net tangible and intangible assets acquired of
approximately $72.3 million has been assigned to goodwill and is not deductible
for tax purposes. Approximately $15.5 million of this goodwill has been assigned
to the Carrier and Operator Services reportable segment and approximately $56.8
million of this goodwill has been assigned to the Business and Corporate
Services reportable segment. In accordance with SFAS No. 141, Business
Combinations, and SFAS No. 142 Goodwill and Other Intangible Assets, the
Company will not amortize the goodwill recorded in connection with the
acquisition of 100% of the shares in Comincom. The goodwill will be tested for
impairment at least annually. The following unaudited pro forma combined results of operations for the
Company give effect to the Sovintel, Sibchallenge and Comincom business
combinations as if they had occurred at the beginning of 2002 and to give effect
to the Sibchallenge and Comincom business combinations as if they had occurred
at the beginning of 2003. These pro forma amounts are provided for informational
purposes only and do not purport to present the results of operations of the
Company had the transactions assumed therein occurred on or as of the date
indicated, nor is it necessarily indicative of the results of operations which
may be achieved in the future. 81




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GOLDEN TELECOM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (CONTINUED) TWELVE MONTHS ENDEDDECEMBER 31,2002
    
    
    2003(IN THOUSANDS, EXCEPTPER SHARE DATA)Revenue
    
    $
    371,226
    
    
    $
    458,276Income before cumulative effect of
a change in accounting principle
    
    
    43,368
    
    
    
    61,802Cumulative effect of a change in
accounting principle
    
    
    974
    
    
    
    Net income
    
    $
    44,342
    
    
    $
    61,802Basic earnings per share of common stock:Income before cumulative effect of
a change in accounting principle
    
    $
    1.30
    
    
    $
    1.77Cumulative effect of a change in
accounting principle
    
    
    0.03
    
    
    
    Net income (loss) per share  basic
    
    $
    1.33
    
    
    $
    1.77Weighted average common shares  basic
    
    
    33,454
    
    
    
    34,990Diluted earnings (loss) per share of common stock:Income (loss) before cumulative effect of
a change in accounting principle
    
    $
    1.28
    
    
    $
    1.74Cumulative effect of a change in
accounting principle
    
    
    0.03
    
    
    
    Net income (loss) per share  diluted
    
    $
    1.31
    
    
    $
    1.74Weighted average common shares  diluted
    
    
    33,869
    
    
    
    35,539
 ACQUISITIONS IN 2004 In February 2004, the Company completed the acquisition of 100% ownership
interest in ST-HOLDING s.r.o. (ST-HOLDINGS), a Czech company that owns 50%
plus one share in ZAO Samara Telecom, a telecommunications service provider in
Samara, Russia from ZAO SMARTS and individual owners. In April 2004, the Company
completed the acquisition of 100% of the common stock in OAO Balticom Mobile
(Balticom) that owns 62% of ZAO WestBalt Telecom, an alternative
telecommunications operator in Kaliningrad, Russia. In April 2004, the Company
completed the acquisition of the remaining 49% ownership interest in OOO
Uralrelcom that the Company did not already own. In May 2004, the Company
completed the acquisition of a 54% ownership interest in SP Buzton (Buzton),
an alternative telecommunications operator in Uzbekistan. These companies were
acquired for approximately $16.0 million in cash, with $1.1 million held in
escrow for a period of one year related to Balticom and $0.5 million payable for
Buzton upon satisfactory achievement of certain conditions. The results of
ST-HOLDINGS have been included in the Companys consolidated operations since
February 1, 2004. The results of Balticom have been included in the Companys
consolidated operations since April 30, 2004. The results of Buzton have been
included in the Companys consolidated operations since May 31, 2004. In August 2004, the Company entered into a share purchase agreement with
Nodama Holdings, Ltd. (Nodama), to acquire 100% of Hudson Telecom, Inc., a
Delaware corporation, which owns 100% of OOO Digital Telephone Networks and OOO
Digital Telephone Switches, together comprising one of the largest regional
alternative operators in Russia operating in Rostov-on-Don and the surrounding
region. Upon closure, Nodama will receive $45.0 million in cash of which $5.0
million will be placed in escrow for a period of one year subject to the
achievement of certain financial conditions. Amounts in the escrow may be used
to compensate the Company in the event of the realization of certain contingent
liabilities in the acquired entities. While the Company had expected to
consummate this transaction in 2004, it has taken Nodama additional time to
conclude this transaction. The consummation of the transaction is conditioned
upon, among other things, the completion of satisfactory due diligence and the
sellers fulfillment of certain conditions precedent. The transaction is
expected to close in the first half of 2005. 82




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GOLDEN TELECOM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (CONTINUED) NOTE 6: INVESTMENTS IN AND ADVANCES TO VENTURES The Company has various investments in ventures that are accounted for by
the equity method. The Companys ownership percentages in its equity method
investments, in the periods shown, range from approximately 22% to 50%. The Company has financed the operating and investing cash flow requirements
of several of the Companys ventures in the form of cash advances. The Company
aggregates all of the receivable and payable balances with the ventures in the
Companys investments in and cash advances to the ventures. For all periods presented through December 31, 2004, the significant
investments accounted for under the equity method and the percentage interest
owned consist of the following: EQUITY METHOD ENTITIESPERIOD
    
    OWNERSHIPSovintel
    
    Through September 16, 2002
    
    
    50
    %Other Regional Ventures
    
    All
    
    
    50
    %TeleRoss Samara
    
    Through June 2002
    
    
    50
    %MCT
    
    From December 2000
    
    
    22%-24
    %
 TeleRoss Samara and Sovintel are accounted for using the consolidation
method subsequent to the dates indicated above. The following table presents summarized income statement information from
the Companys significant equity investee, Sovintel, for the period January 1,
2002 to September 16, 2002. Effective September 17, 2002, the Company began
consolidating the results of operations of Sovintel as a result of the
acquisition of the 50% interest not controlled previously. PERIOD FROM JANUARY 1 TOSEPTEMBER 16, 2002(IN THOUSANDS)Revenue
    
    $
    101,261Gross margin
    
    
    45,248Operating income
    
    
    25,875Net income
    
    
    19,115
 The Company recognized equity in losses related to its investment in MCT of
$5.1 million for the year ended December 31, 2002, reducing the carrying value
of the Companys investment in MCT to zero. In August 2003, MCT concluded a
binding agreement with OJSC Mobile TeleSystems (MTS) on the sale of five of
its cellular operators. MTS paid MCT approximately $70.0 million and assumed
certain guarantees as part of the transaction. In October 2003, MCT declared a
cash dividend of $1.90 per common share to shareholders of record as of October
27, 2003. The Companys portion of this cash dividend was approximately $4.7
million. This cash dividend was received in November 2003 and is classified as
part of equity in earnings in the consolidated statement of operations. In
November 2004, MCT concluded the sale of its 88% interest in Sibintertelecom to
MTS for approximately $41.0 million. Consideration has been given to the
resumption of equity accounting; however management does not believe that the
Companys share of income resulting from the sale of assets that MCT has made
would exceed losses that had previously not been recognized once the investment
in MCT had been reduced to zero. 83




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GOLDEN TELECOM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (CONTINUED) NOTE 7: SUPPLEMENTAL BALANCE SHEET INFORMATION DECEMBER 31,2003
    
    
    2004(IN THOUSANDS)Other current assets consist of:Inventory
    
    $
    7,932
    
    
    $
    8,911Notes receivable
    
    
    1,972
    
    
    
    2,338Other current assets
    
    
    6,005
    
    
    
    5,489Total other current assets
    
    $
    15,909
    
    
    $
    16,738Other non-current assets consist of:Notes receivable
    
    $
    3,610
    
    
    $
    1,494Investments in and advances to ventures
    
    
    251
    
    
    
    742Other non-current assets
    
    
    4,256
    
    
    
    6,767Total other non- current assets
    
    $
    8,117
    
    
    $
    9,003Accounts payable and accrued expenses consists
of:Accounts payable
    
    $
    45,389
    
    
    $
    57,566Interest payable
    
    
    11
    
    
    
    2Accrued compensation
    
    
    2,241
    
    
    
    3,046Accrued other taxes
    
    
    1,092
    
    
    
    480Accrued access and network services
    
    
    9,471
    
    
    
    11,262Other accrued expenses
    
    
    7,575
    
    
    
    9,118Total accounts payable and accrued expenses
    
    $
    65,779
    
    
    $
    81,474Other current liabilities consists of:Non-trade liabilities to GTS
    
    $
    2,904
    
    
    $
    2,904Other current liabilities
    
    
    2,345
    
    
    
    668Total other current liabilities
    
    $
    5,249
    
    
    $
    3,572
 NOTE 8: DEBT OBLIGATIONS AND CAPITAL LEASES The Company paid interest of $4.8 million, $2.0 million and $0.6 million in
2002, 2003 and 2004, respectively. Some of the Companys operating companies have received debt financing
through direct loans from affiliated companies. In addition, certain operating
companies have borrowed funds under a $22.7 million back-to-back, seven-year
credit facility from a Russian subsidiary of Citibank. Under this facility, the
Company provides full cash collateral, held in London and recorded on our
balance sheet as restricted cash, for onshore loans made by the bank to the
Companys Russian registered ventures. In a second, similar facility, the
Company provides full cash collateral for a $10.0 million short term
back-to-back, revolving, credit facility from the same bank for the Companys
larger Russian operating companies. The funding level as of December 31, 2004
for all these facilities totaled $1.0 million, of which $0.2 million was funded
to the Companys consolidated subsidiaries and $0.8 million was funded to the
Companys affiliates. The loan facilities carry interest at a rate equal to the
three-month London Inter-Bank Offering Rate (LIBOR) plus 1.0 percent per annum
(equivalent to approximately 2.7%, on average for loans outstanding, at December
31, 2004) and mature between December 2006 and January 2007. In the first quarter of 2000, the Company entered into a lease for fiber
capacity, including facilities and maintenance, from Moscow to Stockholm. The
lease has a term of ten years with an option to renew for an additional five
years. Prepayments were made to the lessor in April 2000, August 2000 and
February 2001. These prepayments have been offset in the balance sheet against
the capital lease obligation. In September 2001, the Company entered into a five year lease for the right
to use up to VC-3 fiber optic capacity on major routes within Russia to support
the increase in the Companys interregional traffic and regional expansion
strategy. The lease is classified as a capital lease in the balance sheet. In
December 2001, GTI issued a $9.1 million loan to the same company that has
provided the lease. The loan has payment terms of 56 months, which started in
January 2002, and carries interest at the rate of 7 percent per annum. 84




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GOLDEN TELECOM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (CONTINUED) The following table presents minimum lease payments under capital leases: LEASE PAYMENTS(IN THOUSANDS)2005
    
    $
    2,5532006
    
    
    1,5924,145Less: interest
    
    
    306Total principal payments
    
    $
    3,839
 In September 2002, ROL Holdings Limited (ROLH), a wholly-owned Cypriot
subsidiary of the Company, entered into a secured $30.0 million credit facility
with ZAO Citibank (Citibank Credit Facility). ROLH drew upon the Citibank
Credit Facility in the fourth quarter of 2002 to fund the repayment of $30.0
million of the $46.0 million non-interest bearing promissory note issued to
Rostelecom by TeleRoss in connection with the acquisition of the remaining 50%
ownership interest in Sovintel previously held by Rostelecom. In June 2003, the
Company settled early the $30.0 million of outstanding debt plus accrued
interest. There was no penalty for the early settlement of this debt however an
additional $0.2 million of previously capitalized financing costs was recognized
as interest expense which was previously being recognized over the life of the
facility. NOTE 9: SHAREHOLDERS EQUITY Common Stock In July 2001, the Company completed a buy-back of $25.0 million, or
approximately 2.3 million shares, of the Companys common stock at $11.00 per
share, from a subsidiary of GTS. In the fourth quarter of 2002, the Company
retired approximately 2.3 million of the Companys common stock held in
treasury. In August 2002, the Company issued 4,024,067 shares of common stock to
Rostelecom in partial settlement of the purchase price for the acquisition of
the remaining 50% ownership interest in Sovintel, previously held by Rostelecom. In December 2003, the Company issued 7,007,794 shares of common stock to
Telenor in settlement of the purchase price for the acquisition of 100%
ownership interest in Comincom, previously held by Telenor. The Companys outstanding shares of common stock increased by 1,918,882
shares and 374,396 shares in the twelve months ended December 31, 2003 and 2004,
respectively issued in connection with the exercise of employee stock options.
The Company has reserved 1,361,681 shares of common stock for issuance to
certain employees and directors in connection with the 1999 Equity Participation
Plan. Preferred Stock On May 17, 2000, the Companys shareholders authorized 10 million shares of
preferred stock, none of which have been issued. Additional Paid-In Capital As further described in note 18, in August 2004, the Company transferred
20% of the ownership interest in GTU to a Ukrainian partner in exchange for
services provided by the partner. The excess of the fair value of consideration
exchanged for services over the book value of 20% of net assets of GTU in the
amount of $1.5 million was recorded as a credit to the consolidated equity. Dividends During 2004, the Company paid four quarterly dividends of $0.20 per common
share, for a total of $0.80 per common share for the year. The total amount paid
by the Company was $29.0 million. 85




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GOLDEN TELECOM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (CONTINUED) NOTE 10: STOCK OPTION PLANS The Company has established the 1999 Equity Participation Plan of Golden
Telecom, Inc., (the Option Plan). The Company has granted and intends to offer
stock options to key employees and members of the Board of Directors of the
Company. The Company recognized $0.5 million in compensation expense in the year
ended December 31, 2002, in connection with options granted to employees of the
Companys equity investees. Under the Option Plan not more than 4,320,000 shares
of common stock (subject to anti-dilution and other adjustment provisions) are
authorized for issuance upon exercise of options or upon vesting of restricted
or deferred stock awards. Options granted under the Option Plan vest over a
three-year term from the date of grant with one-third vesting after one year and
one thirty-sixth vesting each month thereafter and expire ten years from the
date of grant. The fair value of options granted under the GTI Option Plan in 2002 are
estimated to be $8.77 per common share, in 2003 are estimated to be between
$9.39 and $15.05 per common share and in 2004 are estimated to be $14.59 per
common share, on the date of grant using the Black Scholes option pricing model
with the following assumptions: TWELVE MONTHS ENDED DECEMBER 31,2002
    
    
    2003
    
    
    2004Risk free interest rate
    
    
    4.71
    %
    
    
    2.89 - 3.55
    %
    
    
    4.39
    %Dividend yield
    
    
    0.0
    %
    
    
    0.0
    %
    
    
    3.0
    %Expected life (years)
    
    
    3.0
    
    
    
    3.0
    
    
    
    3.0Volatility
    
    
    123
    %
    
    
    104 - 108
    %
    
    
    95
    %
 Additional information with respect to stock options activity is summarized
as follows: YEAR ENDED DECEMBER 31,2003
    
    
    2004WEIGHTED
    
    
    
    
    
    
    WEIGHTEDAVERAGE
    
    
    
    
    
    
    AVERAGEEXERCISE
    
    
    
    
    
    
    EXERCISESHARES
    
    
    PRICE
    
    
    SHARES
    
    
    PRICEOutstanding at beginning of year
    
    
    2,657,073
    
    
    $
    12.75
    
    
    
    904,272
    
    
    $
    13.48Options granted
    
    
    195,000
    
    
    
    14.56
    
    
    
    5,000
    
    
    
    26.61Options exercised
    
    
    (1,918,882
    )
    
    
    12.43
    
    
    
    (374,396
    )
    
    
    12.76Options expired
    
    
    (20,054
    )
    
    
    27.06
    
    
    
    
    
    
    
    Options forfeited
    
    
    (8,865
    )
    
    
    15.63
    
    
    
    (17,863
    )
    
    
    12.00Outstanding at end of
year
    
    
    904,272
    
    
    
    13.48
    
    
    
    517,013
    
    
    
    14.18Options exercisable at end
of year
    
    
    566,324
    
    
    $
    13.49
    
    
    
    448,818
    
    
    $
    14.07
 The following table summarizes information about stock options outstanding: OPTIONS OUTSTANDING
    
    
    OPTIONS EXERCISABLEWEIGHTEDAVERAGEREMAINING
    
    
    WEIGHTED
    
    
    
    
    
    
    WEIGHTEDCONTRACTUAL
    
    
    AVERAGE
    
    
    
    
    
    
    AVERAGEEXERCISE PRICES
    
    NUMBER
    
    
    LIFE
    
    
    EXERCISE
    
    
    NUMBER
    
    
    EXERCISEAT DECEMBER 31, 2004:
    
    OUTSTANDING
    
    
    (IN YEARS)
    
    
    PRICE
    
    
    EXERCISABLE
    
    
    PRICE$
    12.00
    
    
    212,156
    
    
    
    5.7
    
    
    $
    12.00
    
    
    
    212,156
    
    
    $
    12.0014.00
    
    
    174,900
    
    
    
    8.1
    
    
    
    14.00
    
    
    
    111,705
    
    
    
    14.0015.63
    
    
    94,957
    
    
    
    5.3
    
    
    
    15.63
    
    
    
    94,957
    
    
    
    15.6319.45
    
    
    20,000
    
    
    
    3.4
    
    
    
    19.45
    
    
    
    20,000
    
    
    
    19.4526.61
    
    
    5,000
    
    
    
    4.4
    
    
    
    26.61
    
    
    
    
    
    
    
    33.25
    
    
    10,000
    
    
    
    5.4
    
    
    
    33.25
    
    
    
    10,000
    
    
    
    33.25
 86




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GOLDEN TELECOM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (CONTINUED) NOTE 11: INCOME TAXES The Company accounts for income taxes using the liability method required
by FASB Statement No. 109 Accounting for Income Taxes. The components of income before income taxes and minority interest were as
follows: YEAR ENDED DECEMBER 31,2002
    
    
    2003
    
    
    2004(IN THOUSANDS)Pretax income:Domestic
    
    $
    5,823
    
    
    $
    5,754
    
    
    $
    (4,853
    )Foreign
    
    
    28,141
    
    
    
    67,560
    
    
    
    101,886$
    33,964
    
    
    $
    73,314
    
    
    $
    97,033
 The following is the Companys significant components of the provision for
income taxes attributable to continuing operations: YEAR ENDED DECEMBER 31,2002
    
    
    2003
    
    
    2004(IN THOUSANDS)Domestic  current
    
    $
    16
    
    
    $
    
    
    
    $
    Domestic  deferred
    
    
    
    
    
    
    (1,861
    )
    
    
    (373
    )Foreign  current
    
    
    8,824
    
    
    
    20,516
    
    
    
    35,350Foreign  deferred
    
    
    (4,213
    )
    
    
    (1,256
    )
    
    
    (4,233
    )$
    4,627
    
    
    $
    17,399
    
    
    $
    30,744
 The Company paid income taxes of $8.5 million, $17.5 million and $36.1
million in 2002, 2003 and 2004, respectively. US taxable income or losses recorded are reported on the Companys
consolidated US income tax return. The Company was allocated its proportionate
share, $23.6 million, of GTS US net operating loss carry-forwards in 1999. As
of December 31, 2004, the Company had net operating loss carry-forwards for US
federal income tax purposes of approximately $6.5 million expiring in fiscal
years 2010 through 2019. The Company also has net operating loss carry-forwards
for Cyprus tax purposes of approximately $13.2 million which do not expire. The reconciliation of the US statutory federal tax rate of 35.0% to the
Companys effective tax rate is as follows: YEAR ENDED DECEMBER 31,2002
    
    
    2003
    
    
    2004Tax expense at US statutory rates
    
    
    (35.0
    )%
    
    
    (35.0
    )%
    
    
    (35.0
    )%Non-deductible expenses/non-taxable income:Amortization
    
    
    (0.7
    )
    
    
    (0.4
    )
    
    
    (0.6
    )Equity in earnings
    
    
    5.8
    
    
    
    
    
    
    
    0.1Other non-deductible expenses
    
    
    (5.3
    )
    
    
    (4.9
    )
    
    
    (7.3
    )Foreign exchange differences
    
    
    (1.2
    )
    
    
    (0.1
    )
    
    
    0.2Different foreign tax rates
    
    
    7.7
    
    
    
    9.3
    
    
    
    11.4Change in valuation allowance
    
    
    15.1
    
    
    
    3.1
    
    
    
    Other permanent differences
    
    
    
    
    
    
    4.3
    
    
    
    (0.5
    )Tax expense
    
    
    (13.6
    )%
    
    
    (23.7
    )%
    
    
    (31.7
    )%
 87




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GOLDEN TELECOM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (CONTINUED) Deferred tax assets and liabilities are recorded based on temporary
differences between book bases of assets and liabilities and their bases for
income tax purposes. The following table summarizes major components of the
Companys deferred tax assets and liabilities: DECEMBER 31,2003
    
    
    2004(IN THOUSANDS)Deferred Tax Assets:Net operating loss carry-forwards
    
    $
    2,514
    
    
    $
    2,793Accrued expenses
    
    
    2,525
    
    
    
    2,027Deferred revenue
    
    
    4,800
    
    
    
    7,639Other deferred tax assets
    
    
    1,117
    
    
    
    1,180Valuation allowance
    
    
    (559
    )
    
    
    (559
    )Total deferred tax asset
    
    $
    10,397
    
    
    $
    13,080Deferred Tax Liabilities:Accrued revenue
    
    $
    
    
    
    $
    16Deferred expenses
    
    
    1,306
    
    
    
    1,958Intangible assets
    
    
    21,489
    
    
    
    23,472Fixed assets
    
    
    5,468
    
    
    
    3,720Other deferred tax liabilities
    
    
    600
    
    
    
    295Total deferred tax liability
    
    $
    28,863
    
    
    $
    29,461Net deferred tax liability
    
    $
    (18,466
    )
    
    $
    (16,381
    )
 The following table presents the Companys deferred tax assets and
liabilities as of December 31, 2003 and 2004 attributable to different tax
paying components in different tax jurisdictions: DECEMBER 31,2003
    
    
    2004(IN THOUSANDS)Deferred Tax Assets:US tax component
    
    $
    1,861
    
    
    $
    2,234Foreign tax component
    
    
    8,536
    
    
    
    10,846Total deferred tax asset
    
    $
    10,397
    
    
    $
    13,080Deferred Tax Liability:US tax component
    
    $
    
    
    
    $
    Foreign tax component
    
    
    28,863
    
    
    
    29,461Total deferred tax liability
    
    $
    28,863
    
    
    $
    29,461Net deferred tax liability
    
    $
    (18,466
    )
    
    $
    (16,381
    )
 In
December 2004, the FASB issued FASB Staff Position
No. FAS 109-1, Application of FASB Statement No. 109,
Accounting for Income Taxes, to the Tax Deduction on Qualified
Production Activities Provided by the American Jobs Creation Act of
2004. Also in December 2004, the FASB issued FASB Staff Position
No. FAS 109-2, Accounting and Disclosure Guidance for the
Foreign Earnings Repatriation Provision within the American Jobs
Creations Act of 2004. The Company does not expect the adoption of
these new tax provisions to have a material impact on the
Companys consolidated financial position, results of
operations, or cash flows, since the Company does not have any
substantive operations in the United States. NOTE 12: COMMITMENTS AND CONTINGENCIES Leases The Company has various cancelable and non-cancelable operating lease
agreements for equipment and office space with terms ranging from one to five
years. Rental expense for operating leases aggregated $4.9 million, $4.9
million, and $6.5 million for the years ended December 31, 2002, 2003 and 2004,
respectively. Future minimum lease payments under non-cancelable operating leases with
terms of one year or more, as of December 31, 2004, are as follows: 2005  $4.5
million, 2006  $2.4 million, 2007  $1.7 million, 2008  $1.7 million, 2009
 $1.4 million, and thereafter  $0.4 million. Other Commitments and Contingencies The Company has future purchase commitments of $24.6 million and $84.5
million as of December 31, 2003 and 2004, respectively. In the ordinary course of business, the Company has issued financial
guarantees on debt for the benefit of certain of its non-consolidated ventures,
which is all collateralized by cash as described in note 8. The Company expects that all the collateralized debt will be repaid by the ventures. 88




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GOLDEN TELECOM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (CONTINUED) Major Customers The Company had one major customer in the Carrier and Operator reporting
segment, representing $23.1 million, or 12%, of total revenues in 2002, $27.6
million, or 8%, of total revenues in 2003 and $31.0 million, or 5%, of total
revenue in 2004. Tax Matters The Companys policy is to accrue for contingencies in the accounting
period in which a liability is deemed probable and the amount is reasonably
determinable. In this regard, because of the uncertainties associated with the
Commonwealth of Independent States Taxes (CIS Taxes), the Companys final CIS
Taxes may be in excess of the estimated amount expensed to date and accrued at
December 31, 2003 and 2004. It is the opinion of management that the ultimate
resolution of the Companys CIS Tax liability, to the extent not previously
provided for, will not have a material effect on the financial condition of the
Company. However, depending on the amount and timing of an unfavorable
resolution of any contingencies associated with CIS Taxes, it is possible that
the Companys future results of operations or cash flows could be materially
affected in a particular period. The Companys wholly-owned subsidiary, Sovintel, is engaged in litigation
with the Russian tax inspectorate in regard to claims against Comincom and OAO
Combellga (Combellga), both of which merged into Sovintel on December 1, 2004,
issued by the tax inspectorate on respectively. In accordance with the tax inspectorate decision, Comincom and
Combellga are required to pay additional taxes, fines and penalties in the
amount equal to approximately $5.5 million for years ended December 31, 2001 and
2002. Comincom and Combellga filed lawsuits against the tax inspectorate
disputing the claims, and the court ruled in favor of the Company in both cases
by dismissing the tax inspectorates claims on January 21, 2005 and December 20,
2004, respectively. The Company expects that the tax inspectorate will appeal
this decision. The term for last appeal expires in May 2005. The
Company does not consider an unfavorable outcome of this
matter probable at this time. While the Company
intends to defend its position vigorously, it is difficult to predict with any
degree of certainty the ultimate outcome of this litigation due to the state of
the Russian judicial system. Since the tax claims relate to periods before the
Company acquired 100% of the shares of Comincom, they are covered by the
indemnification provisions of the Share Exchange Agreement between the Company
and Telenor. Therefore, in case of unfavorable outcome of this litigation the
Company intends to seek indemnification from Telenor. Russian Environment and Current Economic Situation The Russian economy, while deemed to be of market status beginning in 2002,
continues to display certain traits consistent with that of a market in
transition. These characteristics have in the past included higher than normal
historic inflation, lack of liquidity in the capital markets, and the existence
of currency controls which cause the national currency to be illiquid outside of
Russia. The continued success and stability of the Russian economy will be
significantly impacted by the governments continued actions with regard to
supervisory, legal, and economic reforms. On January 1, 2004, a new law On Telecommunications (the New Law) came
into effect in Russia. The New Law sets the legal basis for the
telecommunications business in Russia and defines the status that state bodies
have in the telecommunications sector. The New Law was designed to create a new
interconnect pricing regime in 2004 that should be more transparent and unified,
if fairly implemented, and it creates a universal service charge calculated as a
percentage of revenue, which is not expected to exceed 3% of certain revenue. It
is expected that the first payments of the universal service charge will be made
in 2005. The New Law may increase the regulation of the
Companys operations, as it is intended to regulate licenses for
long distance, international long distance and Voice over Internet
Protocol. Until such time as appropriate regulations consistent with the New Law are
promulgated, there will be a period of confusion and ambiguity as regulators
interpret the legislation. In the ordinary course of business, the Company may be party to various
legal and tax proceedings, and subject to claims, certain of which relate to the
developing markets and evolving fiscal and regulatory environments in which the
Company operates. In the opinion of management, the Companys liability, if any,
in all pending litigation, other legal proceeding or other matters, will not
have a material effect upon the financial condition, results of operations or
liquidity of the Company. NOTE 13: RELATED PARTY TRANSACTIONS Transactions with the Companys equity investees, Alfa affiliates,
Rostelecom, and Telenor were as follows, for the years ended December 31: 2002
    
    
    2003
    
    
    2004(IN THOUSANDS)Revenue from equity investees
    
    $
    7,499
    
    
    $
    98
    
    
    $
    116Revenue from Rostelecom
    
    
    446
    
    
    
    575
    
    
    
    404Revenue from Telenor
    
    
    
    
    
    
    3
    
    
    
    139Revenue from Alfa affiliates
    
    
    1,102
    
    
    
    1,134
    
    
    
    1,798$
    9,047
    
    
    $
    1,810
    
    
    $
    2,457
 2002
    
    
    2003
    
    
    2004(IN THOUSANDS)Cost of revenue from equity investees
    
    
    8,527
    
    
    
    4,790
    
    
    
    4,798Cost of revenue from Rostelecom
    
    
    5,154
    
    
    
    16,860
    
    
    
    25,809Cost of revenue from Telenor
    
    
    
    
    
    
    27
    
    
    
    332Cost of revenue from Alfa affiliates
    
    
    
    
    
    
    
    
    
    
    56$
    13,681
    
    
    $
    21,677
    
    
    $
    30,995
 The related party revenue and cost of revenue from Rostelecom included in
the income statement represents revenue and cost of revenue from September 2002,
the date Rostelecom became a shareholder. 89




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GOLDEN TELECOM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (CONTINUED) The revenue and cost of revenue from Telenor included in the income
statement represents revenue and cost of revenue from December 2003, the date
Telenor became a shareholder. Included in other current assets at December 31, 2003 is approximately $0.3
million of accounts receivable from Alfa affiliates, approximately $0.2 million
of accounts receivable from Rostelecom, and approximately $0.1 million of
accounts receivable from Telenor. Included in other current assets at December
31, 2004 is approximately $0.3 million of accounts receivable from Alfa
affiliates, approximately $0.1 million of accounts receivable from Rostelecom,
and approximately $0.1 million of accounts receivable from Telenor. The Company maintains bank accounts with Alfa Bank, which act as one of the
clearing agents for the payroll of the Russian staff of the Company. The
balances at these bank accounts were minimal at December 31, 2003 and 2004. In
addition, certain of the Companys Russian subsidiaries maintain current
accounts with Alfa Bank. The amounts on deposit were minimal at December 31, 2003 and
$0.1 million at December 31, 2004. The Company maintains bank accounts with International Moscow Bank. The
Companys Chief Executive Officers spouse is a member of the
Executive Board of International Moscow Bank. The amounts on deposit were
approximately $5.1 million at December 31, 2003 and $1.7 million at December 31,
2004. The Company incurred approximately $3.3 million in consulting costs from an
affiliate of Alfa in relation to the acquisition of the remaining 50% of
Sovintel previously held by Rostelecom in 2002 and approximately $0.3 million in
consulting costs from an affiliate of Alfa in relation to the acquisition of
Sibchallenge in 2003. In addition, in 2003 the Company incurred approximately
$0.1 million in consulting costs from an affiliate of Alfa related to a
potential acquisition that was subsequently withdrawn from the market. In 2004,
the Company incurred approximately $0.1 million in consulting costs from an
affiliate of Alfa in relation to a potential acquisition. The Company has entered into a consulting services agreement with Alfa
Telecom under which the price was subject to adjustments. This consulting services
agreement became effective on April 1, 2003 and terminated on December 31, 2004.
The Company has reached an agreement with Alfa Telecom, in which compensation for
the services provided under the consulting services agreement were in the
aggregate $0.5 million for the period of April 1, 2003 through December 31,
2004. In September 2002, several Russian subsidiaries of the Company entered into
a one year agreement with OOO Alfa Insurance, an affiliate of Alfa, to provide
the Companys Russian employees with medical and dental insurance services. The
amount payable under this agreement was approximately $0.3 million. In December 2002, the Company entered into a one year agreement with OOO
Alfa Insurance, an affiliate of Alfa, to provide the Company with property and
equipment liability insurance. The amount payable under this agreement was
approximately $0.2 million. In December 2003, the Company entered into a one
year agreement with OOO Alfa Insurance, an affiliate of Alfa, to provide the
Company with property and equipment liability insurance. The amount payable
under this agreement was approximately $0.2 million. The Company extended this
agreement until February 2005 and in February 2005, the Company entered into a
one year agreement with OOO Alfa Insurance, an affiliate of Alfa, to provide the
Company with property and equipment liability insurance. The amount payable
under this agreement is approximately $0.2 million. A member of the Companys executive management is a relative of the general
director of two Russian based telecommunications services providers. The Company
received revenue from these two telecommunications services providers in the
amount of approximately $2.9 million and $5.3 million for the years ended
December 31, 2003 and December 31, 2004, respectively and incurred costs to
these two telecommunications services providers in the amount of approximately
$1.8 million and $1.9 million in the years ended December 31, 2003 and December
31, 2004, respectively. At December 31, 2003, the Company had accounts
receivable of approximately $0.5 million and accounts payable of approximately
$0.4 million with these two telecommunications services providers. At December
31, 2004, the Company had accounts receivable of approximately $0.7 million and
accounts payable of approximately $0.3 million with these two telecommunications
services providers. The Company provides telecommunications services to a marketing firm where
the former Chief Financial Officers spouse is the Chief Executive Officer. The
Company received revenue of approximately $0.1 million for the year ended
December 31, 2003 from the marketing firm. 90




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GOLDEN TELECOM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (CONTINUED) The Company issued loans to Russian employees principally to finance the
purchase of apartments in Russia. The amount of loans outstanding was
approximately $0.6 million at December 31, 2003 and approximately $0.3 million
at December 31, 2004. These loans typically have a 4% to 10% interest
rate per annum and are typically payable over 3 years. In November 2002, the Company
issued an approximately $0.1 million loan to the Finance Director of Sovintel, a
wholly-owned subsidiary of the Company which was partially forgiven by the
Company in 2004. NOTE 14: SEGMENT INFORMATION LINE OF BUSINESS DATA The Company operates in four segments within the telecommunications
industry. The four segments are: (1) Business and Corporate Services; (2)
Carrier and Operator Services; (3) Consumer Internet Services; and (4) Mobile
Services. The following tables present financial information for both
consolidated subsidiaries and equity investee ventures, segmented by the
Companys lines of business for the twelve months ended December 31, 2002, 2003
and 2004, respectively. Transfers between lines of businesses are included in
the adjustments to reconcile segment to consolidated results. The Company
evaluates performance based on the operating income (loss) of each strategic
business unit, among other performance measures. Prior to the completion of the
acquisition of the remaining 50% ownership interest in Sovintel and the
subsequent merger of TeleRoss into Sovintel in April 2003, the Company managed
business segments based on telecommunications products the Company provided. In
April 2003, the Company re-designed the business segments around customer
characteristics, and in accordance with SFAS No. 131, Disclosures about
Segments of an Enterprise and Related Information, the Company has presented
the following four segments consistent with the information used by the chief
operating decision maker to manage the operations for purposes of making
operating decisions and allocating resources. The Company has restated segment
information for prior periods to conform to the presentation adopted in the
current period. 91




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GOLDEN TELECOM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (CONTINUED) ADJUSTMENTS TO RECONCILEBUSINESS SEGMENT TOCONSOLIDATED RESULTSBUSINESS
    
    
    CARRIER
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    BUSINESS
    
    
    
    
    
    
    EQUITYAND
    
    
    AND
    
    
    CONSUMER
    
    
    MOBILE
    
    
    CORPORATE &
    
    
    SEGMENT
    
    
    CONSOLIDATED
    
    
    METHOD
    
    
    AFFILIATECORPORATE
    
    
    OPERATOR
    
    
    INTERNET
    
    
    SERVICES
    
    
    ELIMINATIONS
    
    
    TOTAL
    
    
    RESULTS
    
    
    VENTURES
    
    
    ADJUSTMENTS(IN THOUSANDS)TWELVE MONTHS ENDED
DECEMBER 31, 2002Revenue from external
customers
    
    $
    149,170
    
    
    $
    104,609
    
    
    $
    21,800
    
    
    $
    13,001
    
    
    $
    
    
    
    $
    288,580
    
    
    $
    198,727
    
    
    $
    (105,861
    )
    
    $
    16,008Intersegment revenue
    
    
    502
    
    
    
    717
    
    
    
    
    
    
    
    
    
    
    
    (1,219
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Operating income (loss)
    
    
    36,975
    
    
    
    28,620
    
    
    
    (4,356
    )
    
    
    3,553
    
    
    
    (6,511
    )
    
    
    58,281
    
    
    
    31,430
    
    
    
    (26,851
    )
    
    
    Identifiable assets
    
    
    161,635
    
    
    
    202,134
    
    
    
    41,896
    
    
    
    9,383
    
    
    
    24,315
    
    
    
    439,363
    
    
    
    435,810
    
    
    
    (3,553
    )
    
    
    Capital expenditures
    
    
    29,375
    
    
    
    15,417
    
    
    
    2,908
    
    
    
    449
    
    
    
    222
    
    
    
    48,371
    
    
    
    29,430
    
    
    
    (18,941
    )
    
    
    
 ADJUSTMENTS TO RECONCILEBUSINESS SEGMENT TOCONSOLIDATED RESULTSBUSINESS
    
    
    CARRIER
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    BUSINESS
    
    
    
    
    
    
    EQUITYAND
    
    
    AND
    
    
    CONSUMER
    
    
    MOBILE
    
    
    CORPORATE &
    
    
    SEGMENT
    
    
    CONSOLIDATED
    
    
    METHOD
    
    
    AFFILIATECORPORATE
    
    
    OPERATOR
    
    
    INTERNET
    
    
    SERVICES
    
    
    ELIMINATIONS
    
    
    TOTAL
    
    
    RESULTS
    
    
    VENTURES
    
    
    ADJUSTMENTS(IN THOUSANDS)TWELVE MONTHS ENDED
DECEMBER 31, 2003Revenue from external
customers
    
    $
    188,087
    
    
    $
    128,048
    
    
    $
    30,775
    
    
    $
    13,895
    
    
    $
    
    
    
    $
    360,805
    
    
    $
    360,534
    
    
    $
    (4,861
    )
    
    $
    4,590Intersegment revenue
    
    
    649
    
    
    
    793
    
    
    
    
    
    
    
    
    
    
    
    (1,442
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Operating income (loss)
    
    
    47,603
    
    
    
    26,503
    
    
    
    (2,457
    )
    
    
    5,278
    
    
    
    (6,976
    )
    
    
    69,951
    
    
    
    69,731
    
    
    
    (220
    )
    
    
    Identifiable assets
    
    
    385,087
    
    
    
    236,635
    
    
    
    52,584
    
    
    
    6,566
    
    
    
    52,042
    
    
    
    732,914
    
    
    
    729,226
    
    
    
    (3,688
    )
    
    
    Capital expenditures
    
    
    40,231
    
    
    
    20,317
    
    
    
    2,851
    
    
    
    569
    
    
    
    90
    
    
    
    64,058
    
    
    
    63,737
    
    
    
    (321
    )
    
    
    
 ADJUSTMENTS TO RECONCILEBUSINESS SEGMENT TOCONSOLIDATED RESULTSBUSINESS
    
    
    CARRIER
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    BUSINESS
    
    
    
    
    
    
    EQUITYAND
    
    
    AND
    
    
    CONSUMER
    
    
    MOBILE
    
    
    CORPORATE &
    
    
    SEGMENT
    
    
    CONSOLIDATED
    
    
    METHOD
    
    
    AFFILIATECORPORATE
    
    
    OPERATOR
    
    
    INTERNET
    
    
    SERVICES
    
    
    ELIMINATIONS
    
    
    TOTAL
    
    
    RESULTS
    
    
    VENTURES
    
    
    ADJUSTMENTS(IN THOUSANDS)TWELVE MONTHS ENDED
DECEMBER 31, 2004Revenue from external
customers
    
    $
    324,814
    
    
    $
    198,027
    
    
    $
    45,515
    
    
    $
    15,808
    
    
    $
    
    
    
    $
    584,164
    
    
    $
    583,978
    
    
    $
    (4,710
    )
    
    $
    4,524Intersegment revenue
    
    
    
    
    
    
    1,016
    
    
    
    
    
    
    
    
    
    
    
    (1,016
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Operating income (loss)
    
    
    72,345
    
    
    
    28,637
    
    
    
    2,159
    
    
    
    4,729
    
    
    
    (11,756
    )
    
    
    96,114
    
    
    
    95,536
    
    
    
    (578
    )
    
    
    Identifiable assets
    
    
    435,276
    
    
    
    261,424
    
    
    
    57,732
    
    
    
    5,693
    
    
    
    49,562
    
    
    
    809,687
    
    
    
    805,768
    
    
    
    (3,919
    )
    
    
    Capital expenditures
    
    
    80,107
    
    
    
    33,223
    
    
    
    4,920
    
    
    
    1,025
    
    
    
    178
    
    
    
    119,453
    
    
    
    118,101
    
    
    
    (1,352
    )
    
    
    
 92




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##### Table of Contents



GOLDEN TELECOM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (CONTINUED) GEOGRAPHIC DATA Revenues from external customers are based on the location of the operating
company providing the service. The Company operated within two main geographic regions of the CIS: Russia
and Ukraine. Geographic information as of December 31, 2002, 2003, and 2004 is
as follows: CORPORATE,OTHERCOUNTRIES
    
    
    CONSOLIDATEDRUSSIA
    
    
    UKRAINE
    
    
    & ELIMINATIONS
    
    
    RESULTS(IN THOUSANDS)YEAR ENDED DECEMBER 31, 2002Revenue
    
    $
    166,319
    
    
    $
    35,488
    
    
    $
    (3,080
    )
    
    $
    198,727Long-lived assets
    
    
    275,209
    
    
    
    24,541
    
    
    
    1,512
    
    
    
    301,262YEAR ENDED DECEMBER 31, 2003Revenue
    
    $
    318,426
    
    
    $
    44,524
    
    
    $
    (2,416
    )
    
    $
    360,534Long-lived assets
    
    
    509,339
    
    
    
    24,236
    
    
    
    2,886
    
    
    
    536,461YEAR ENDED DECEMBER 31, 2004Revenue
    
    $
    522,018
    
    
    $
    64,455
    
    
    $
    (2,495
    )
    
    $
    583,978Long-lived assets
    
    
    563,856
    
    
    
    27,995
    
    
    
    11,116
    
    
    
    602,967
 NOTE 15: SUPPLEMENTAL CASH FLOW INFORMATION The following table summarizes significant non-cash investing and financing
activities for the Company. TWELVE MONTHS ENDEDDECEMBER 31,2002
    
    
    2003
    
    
    2004(IN THOUSANDS)Issuance of common stock in connection
with acquisitions
    
    $
    50,663
    
    
    $
    193,485
    
    
    $
    Amounts payable in connection with
business acquisitions
    
    
    3,500
    
    
    
    
    
    
    
    400Capitalized leased assets
    
    
    
    
    
    
    420
    
    
    
    
 NOTE 16: PRIOR PERIOD ADJUSTMENT In the third quarter of 2004, management determined that the Company has
been inadvertently carrying accruals for estimated taxes, other than income
taxes. Management concluded these accruals for estimated taxes should have been
considered unnecessary and reversed prior to January 1, 2000. The net effect of
the correction of this non-cash error was to reduce current liabilities and
non-current liabilities by $2.0 million each with an offsetting decrease to
accumulated deficit of $4.0 million in all periods presented. This adjustment
had no effect on the reported results of operations in any of the periods
presented. 93




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GOLDEN TELECOM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (CONTINUED) NOTE 17: LONG TERM INCENTIVE BONUS PROGRAM In July 2004, the Board of Directors of the Company adopted a Long Term
Incentive Bonus Program (LTIBP) for senior management of the Company,
effective as of January 1, 2004. The LTIBP is designed to reward senior
management with annual bonus awards consisting of 100% shares for officers of
the Company and 50% shares and 50% cash payments for other qualified employees
participating in LTIBP if the Company meets certain targets for net income
growth established by the Board of Directors. In addition, the program provides
for a one-time grant of a limited amount of shares to senior management in an
aggregate amount not exceeding 50,000 shares. The LTIBP is intended to act as a
retention mechanism for senior management as the cash payments and the
restricted stock vest over a three year period. It is expected that the LTIBP
will act as a substitute for the Companys Equity Participation Plan under which
significant amounts of stock options were, in the past, granted to senior
management. During the twelve months ended December 31, 2004 the Company did not
record any expense associated with the LTIBP as the Company did not achieve the
operational and financial targets for 2004. The Company currently anticipates
repurchasing from time to time in the open market a number of the Companys
shares equal to the number of the Companys shares that are subject to awards
granted under the LTIBP. The Company has not granted any shares under the LTIBP. NOTE 18: SALE OF MINORITY INTEREST IN SUBSIDIARY Recognizing that many of the markets in which the Company operates are
complex, in particular as it relates to business, regulatory, political and
cultural matters, the Company occasionally seeks experienced local partners to
assist in markets where the Company is likely to encounter operational
difficulties. GTI has been cooperating with local partners in Ukraine to resolve
commercial and regulatory disputes with monopoly operators and regulatory
authorities in Ukraine but had not previously finalized the compensation
arrangement for the services. In addition to or in lieu of cash compensation,
the Board of Directors approved the sale of a non-controlling interest in GTU to
such parties. Upon approval of GTIs Board of Directors, in August 2004 the Company
entered into a compensation arrangement for services provided to assist the
Company in addressing commercial and regulatory disputes with monopoly operators
and regulatory authorities in Ukraine. The Companys local partners have
provided services on a success fee basis. The Companys Board of Directors
approved an arrangement that effectively transferred 20% of the shares in GTU
owned by the Company to the local partners as compensation for the services
already provided and certain additional services to be provided. Under this
arrangement, the Company paid the local partners $0.5 million in cash and
granted the local partners an option to purchase 20% of GTU for $0.5 million in
cash, in a transaction where the cash and the value of the services were
approximately $3.6 million. This transaction closed in the third quarter of
2004, when the performance was completed and the option was exercised and
resulted in a charge to operating income of approximately $3.6 million. The
excess of the fair value of consideration exchanged for services over the book
value of 20% of net assets of GTU was recorded as a credit to the consolidated
equity, rather than income since the Company did not believe that the
method of determining fair value met the objectively determinable
criteria as required by Staff Accounting Bulletin Topic 5H. Fair value of the option approximated the fair value of shares
transferred to the local partner due to the short exercise period of the option
and was determined using the discounted cash flow valuation method. 94




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GOLDEN TELECOM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  (CONTINUED) NOTE 19: QUARTERLY FINANCIAL DATA (UNAUDITED) Summarized quarterly financial data is as follows: ACTUALFOR THE THREE MONTHS ENDEDMARCH 31,
    
    
    JUNE 30,
    
    
    SEPTEMBER 30,
    
    
    DECEMBER 31,2003
    
    
    2003
    
    
    2003
    
    
    2003(IN THOUSANDS, EXCEPT PER SHARE DATA)Revenues
    
    $
    78,376
    
    
    $
    80,762
    
    
    $
    90,095
    
    
    $
    111,301Cost of Revenues
    
    
    37,299
    
    
    
    39,436
    
    
    
    44,883
    
    
    
    59,467Gross Margin
    
    
    41,077
    
    
    
    41,326
    
    
    
    45,212
    
    
    
    51,834Selling, general and administrative
    
    
    13,438
    
    
    
    13,385
    
    
    
    15,764
    
    
    
    21,797Net income
    
    
    12,820
    
    
    
    11,835
    
    
    
    12,506
    
    
    
    18,274Net income per share(1)- basic
    
    
    0.47
    
    
    
    0.43
    
    
    
    0.44
    
    
    
    0.59Net income per share(1)- diluted
    
    $
    0.47
    
    
    $
    0.42
    
    
    $
    0.43
    
    
    $
    0.58
 ACTUALFOR THE THREE MONTHS ENDEDMARCH 31,
    
    
    JUNE 30,
    
    
    SEPTEMBER 30,
    
    
    DECEMBER 31,2004
    
    
    2004
    
    
    2004
    
    
    2004(IN THOUSANDS, EXCEPT PER SHARE DATA)Revenues
    
    $
    133,174
    
    
    $
    138,873
    
    
    $
    152,713
    
    
    $
    159,218Cost of Revenues
    
    
    68,279
    
    
    
    70,215
    
    
    
    77,953
    
    
    
    84,141Gross Margin
    
    
    64,895
    
    
    
    68,658
    
    
    
    74,760
    
    
    
    75,077Selling, general and administrative
    
    
    26,393
    
    
    
    25,118
    
    
    
    29,518
    
    
    
    31,826Net income
    
    
    14,651
    
    
    
    16,909
    
    
    
    16,111
    
    
    
    17,112Net income per share(1)- basic
    
    
    0.41
    
    
    
    0.47
    
    
    
    0.44
    
    
    
    0.47Net income per share(1)- diluted
    
    $
    0.40
    
    
    $
    0.46
    
    
    $
    0.44
    
    
    $
    0.47
   (1)
    
    The sum of the earnings per share for the four quarters will generally not
equal earnings per share for the total year due to changes in the average
number of common shares outstanding. NOTE 20: SUBSEQUENT EVENTS In February 2005, the Board of Directors of the Company declared a cash
dividend of $0.20 per common share to shareholders of record as of March 17,
2005. The Company will pay the total amount of approximately $7.3 million to
shareholders on March 31, 2005. 95




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AUDITED FINANCIAL STATEMENTS EDN SOVINTEL LLC
THE PERIOD FROM JANUARY 1 TO SEPTEMBER 16, 2002
WITH REPORT OF INDEPENDENT AUDITORS 96




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REPORT OF INDEPENDENT AUDITORS The Board of Directors
EDN Sovintel LLC We have audited the accompanying statements of income and cash flows of EDN
Sovintel LLC for the period from January 1 to September 16, 2002. These
financial statements are the responsibility of the Companys management. Our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly,
in all material respects, the results of operations of EDN Sovintel LLC and its
cash flows for the period from January 1 to September 16, 2002, in conformity
with accounting principles generally accepted in the United States of America. /s/ ERNST & YOUNG (CIS) LIMITED Moscow, Russia
March 6, 2003 97




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EDN SOVINTEL LLC STATEMENTS OF INCOME PERIOD FROMJANUARY 1 TOSEPTEMBER 16,2002(IN THOUSANDSOF US$)REVENUES:Telecommunication services
    
    $
    96,610Revenue from affiliates
    
    
    4,651101,261OPERATING COSTS AND EXPENSES:Service costs (excluding depreciation)
    
    
    56,013Selling, general and administrative (excluding
depreciation)
    
    
    11,856Depreciation
    
    
    7,517TOTAL OPERATING COSTS AND EXPENSES
    
    
    75,386INCOME FROM OPERATIONS
    
    
    25,875OTHER INCOME (EXPENSE):Interest income
    
    
    508Interest expense
    
    
    (3
    )Foreign currency losses
    
    
    (618
    )TOTAL OTHER INCOME (EXPENSE)
    
    
    (113
    )Net income before taxes
    
    
    25,762Income taxes
    
    
    6,647NET INCOME
    
    $
    19,115
 The accompanying notes are an integral part of these financial statements. 98




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EDN SOVINTEL LLC STATEMENTS OF CASH FLOWS PERIOD FROMJANUARY 1 TOSEPTEMBER 16,2002(IN THOUSANDSOF US$)OPERATING ACTIVITIESNet income
    
    $
    19,115Adjustments to reconcile net income to net cash provided by
operating activities:Depreciation
    
    
    7,517Deferred income taxes
    
    
    (2,193
    )Provision for doubtful accounts
    
    
    Provision for obsolete inventory
    
    
    650Foreign exchange loss
    
    
    618Changes in operating assets and liabilities:Accounts receivable
    
    
    (6,407
    )Inventories
    
    
    2,459Inventory consigned to others
    
    
    1,063Prepaid expenses and other assets
    
    
    119VAT receivable, net
    
    
    (26
    )Trade payables
    
    
    5,377Accrued liabilities and other payables
    
    
    1,093Decrease amounts due to affiliated companies, net
    
    
    (1,239
    )NET CASH PROVIDED BY OPERATING ACTIVITIES
    
    
    28,146INVESTING ACTIVITIESPurchases of property and equipment
    
    
    (18,126
    )Loan to affiliated company
    
    
    (9,983
    )NET CASH USED IN INVESTING ACTIVITIES
    
    
    (28,109
    )FINANCING ACTIVITIESPayment of debt
    
    
    Payment of dividends
    
    
    (4,000
    )NET CASH USED IN FINANCING ACTIVITIES
    
    
    (4,000
    )Effect of exchange rate changes on cash
    
    
    (204
    )Net (decrease) increase in cash
    
    
    (4,167
    )Cash at beginning of period
    
    
    16,793CASH AT END OF PERIOD
    
    $
    12,626
 The accompanying notes are an integral part of these financial statements. 99




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EDN SOVINTEL LLC NOTES TO FINANCIAL STATEMENTS
(US$ AMOUNTS EXPRESSED IN THOUSANDS) NOTE 1. DESCRIPTION OF BUSINESS EDN Sovintel LLC (the Company, Sovintel), which became a wholly owned
subsidiary of Golden Telecom, Inc. (GTI) on September 17, 2002, was created in
1990 to design, construct, and operate a telecommunications network in Moscow
and later expanded its operations to other regions of Russia, including St.
Petersburg, Pskov and Kaliningrad. This network provides worldwide
communications services, principally to major hotels, business offices and
mobile communication companies. Effective September 17, 2002, subsidiaries of GTI completed the acquisition
of the remaining 50% of the Company previously held by Open Joint Stock Company
Rostelecom (Rostelecom), pursuant to an Ownership Interest Purchase Agreement,
dated March 13, 2002, by and among subsidiaries of GTI and Rostelecom, bringing
GTIs ownership interest in the Company to 100%. The accompanying financial statements are presented for purposes of
complying with the requirements of the U.S. Securities and Exchange Commission
for separate financial statements under Rule 3-09 of Regulation S-X. In that
regard, the statements of operations and cash flows for 2002 have been presented
for the period from January 1 to September 16, 2002. NOTE 2. BASIS OF PRESENTATION The Company maintains its records and prepares its financial statements in
Russian rubles in accordance with the requirements of Russian accounting and tax
legislation. The accompanying financial statements differ from the financial
statements used for statutory purposes in Russia in that they reflect certain
adjustments, not recorded on the Companys books, which are appropriate to
present the financial position, results of operations and cash flows in
accordance with generally accepted accounting principles in the United States of
America (US GAAP). The principal adjustments are related to revenue
recognition, certain accrued expenses, foreign currency translation, deferred
taxation, and depreciation and valuation of property and equipment. NOTE 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Use of Estimates The preparation of financial statements, in conformity with US GAAP,
requires management to make estimates and assumptions that affect the amounts
reported in the financial statements and accompanying notes. Actual results
could differ from those estimates. Foreign Currency Translation The Companys functional currency is the US dollar because the majority of
its revenues, costs, property and equipment purchased, and debt and trade
liabilities are either priced, incurred, payable or otherwise measured in US
dollars. Accordingly, transactions and balances not already measured in US
dollars (primarily Russian rubles) have been re-measured into US dollars in
accordance with the relevant provisions of Statement of Financial Accounting
Standards (SFAS) No. 52, Foreign Currency Translation. Under SFAS No. 52, revenues, costs, capital and non-monetary assets and
liabilities are translated at historical exchange rates prevailing on the
transaction dates. Monetary assets and liabilities are translated at exchange
rates prevailing on the balance sheet date. Exchange gains and losses arising
from re-measurement of monetary assets and liabilities that are not denominated
in US dollars are credited or charged to operations. The ruble is not a convertible currency outside the territory of Russia.
Official exchange rates are determined daily by the Central Bank of Russia
(CBR) and were considered to be a reasonable approximation of market rates
until mid-August 1998. Since that date, liquidity in the CBR currency trading
and inter-bank trading has varied as have bid and offer exchange rates. As a
result, the market rates have fluctuated significantly and have diverged from
the CBR rate. Nonetheless, the various market-related rates are based on the CBR
rate. Accordingly, CBR rates have been used for translation purposes in these
financial statements. The translation of ruble denominated assets and
liabilities into US dollars for the purpose of these financial statements does
not indicate that the Company could realize or settle in US dollars the reported
values of the assets and liabilities. Likewise, it does not indicate that the
Company could return or distribute the reported US dollar values of capital and
retained earnings to its shareholders. The official exchange rate as September 16, 2002 was 31.64 rubles per US
dollar, respectively. 100




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EDN SOVINTEL LLC NOTES TO FINANCIAL STATEMENTS  (CONTINUED) Property and Equipment Property and equipment are recorded at their historical cost. Depreciation
is provided on the straight-line method over the following estimated useful
lives: Network equipment
    
    10 yearsOther property and equipment
    
    3-5 years
 There is no depreciation charge for construction-in-progress. Depreciation
commences upon completion of the related project. Revenue Recognition The Company records as revenue the amount of telecommunications services
rendered, as measured primarily by the minutes of traffic processed, after
deducting an estimate of the traffic that are partial minutes and test traffic
which will be neither billed nor collected. Revenue from service contracts is
accounted for when the services are provided. Billings received in advance of
service being performed are deferred and recognized as revenue as the service is
performed. Revenues are stated net of any value-added-taxes (VAT) charged to
customers. Certain other taxes that are based on revenues for the period from
January 1 to September 16, 2002, amounted $1,016, respectively, and are charged
to selling, general and administrative expenses since these are incidental to
the revenue cycle. The Company has deferred telecommunication connection fees and capitalized
direct incremental costs related to connection fees, not exceeding the revenue
deferred. The deferral of revenue and capitalization of cost of revenue is
recognized over the estimated life of the customer, three years. The Company recognizes revenue from equipment sales when title to the
equipment passes to the customer. The Company defers the revenue on installed
equipment until installation and testing are completed and accepted by the
customer. Advertising The Company expenses the cost of advertising as incurred. Advertising
expenses for the period from January 1 to September 16, 2002 were $1,286 and are
included in selling, general and administrative expenses. Income Taxes The Company computes and records income taxes in accordance with SFAS No.
109, Accounting for Income Taxes. Government Pension Funds The Company contributes to the Russian Federation state pension fund,
social fund, medical insurance fund, unemployment fund and transport fund on
behalf of all its Russian employees. The contributions are expensed as incurred. Comprehensive Income Comprehensive income is defined as the change in equity of a business
enterprise during a period from non-owner sources. For the period from January 1
to September 16, 2002, comprehensive income for the Company is equal to net
income. NOTE 4. INCOME TAXES The Russian Federation was the only tax jurisdiction in which the Companys
income was taxed. The income tax expense reported in the accompanying statements
of income, for the period January 1 to September 16, 2002, represents the
provision for current and deferred taxes. 101




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EDN SOVINTEL LLC NOTES TO FINANCIAL STATEMENTS  (CONTINUED) Significant components of the provision for income taxes for the period
ended January 1 to September 16, 2002 is as follows: 2002Current tax expense
    
    $
    8,840Deferred tax expense (benefit)
    
    
    (2,193
    )Provision for income taxes
    
    $
    6,647
 A reconciliation between the statutory rate and the effective income tax
rate is as follows for the period January 1 to September 16, 2002: 2002Income tax expense at statutory tax rate of 24% from
January 1 through September 16, 2002
    
    $
    6,183Tax effect of permanent differences:Depreciation differences due to revaluation of fixed assets
    
    
    708Taxes on local currency exchange gains
    
    
    358Other permanent differences
    
    
    576Increase (decrease) in the valuation allowance for
deferred tax assets
    
    
    (1,178
    )Income tax expense reported in the financial statements
    
    $
    6,647
 The Company paid Russian profits tax of $9,657 in for the period from
January 1 to September 16, 2002, respectively. NOTE 5. RELATED PARTY TRANSACTIONS Transactions and balances with Rostelecom (one of the Companys members
prior to September 17, 2002) and its affiliates for the period from January 1 to
September 16, 2002 were as follows: 2002Sales
    
    $
    155Telecommunication lease and traffic costs
    
    
    7,056
 Transactions and balances with GTI and its affiliates, for the period from
January 1 to September 16, 2002 were as follows: 2002Sales
    
    $
    4,496Telecommunication services
    
    
    7,387Management service fees and reimbursements of expenses of
expatriate staff
    
    
    452
 In July 2002, the Company entered into a short-term loan agreement with
TeleRoss LLC (TeleRoss), a wholly owned subsidiary of GTI. Under this
agreement the Company provided TeleRoss with a working capital loan in the
amount of 315.5 million rubles (equal to approximately $9,970, at applicable
exchange rate at September 16, 2002) to be repaid by March 31, 2003. The Company
and TeleRoss have the right to prolong the term of the loan for one month and
the number of such prolongations is not limited. The loan bears an interest rate
of 21% per annum calculated based on the ruble denominated loan principle. The
interest is payable monthly starting October 2002. The Company included the
respective accrued interest income of $70 in the accompanying statement of
income for the period from January 1 to September 16, 2002. NOTE 6. CONCENTRATIONS OF CREDIT RISK AND MAJOR CUSTOMERS Financial instruments that potentially subject the Company to concentration
of credit risk consist primarily of temporary cash deposits and trade accounts
receivable. The Company deposits the majority of its available cash with two
foreign-owned financial institutions in Russia and maintains certain balances
with several Russian financial institutions. The Companys sales and accounts
receivable are made to and due from a variety of international and Russian
business customers within Russia. As of September 16, 2002, one customer
accounted for 8% of revenue and 9% of accounts receivable. The Company has no
other significant concentrations of credit risk except for transactions with
related parties as discussed in Note 5. 102




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EDN SOVINTEL LLC NOTES TO FINANCIAL STATEMENTS  (CONTINUED) NOTE 7. COMMITMENTS The Company has several cancelable operating leases for office and
warehouse space and telecommunications lines with terms ranging from one to five
years. Total rent expense for the period from January 1 to September 16, 2002 was
$2,549. NOTE 8. CONTINGENCIES The tax, legal and banking regulatory system continues to evolve in the
Russian Federation as the Russian government manages the transformation from a
command to a market-oriented economy. There were many new tax and foreign
currency laws and related regulations introduced during 2002 and previous years
which were not always clearly written and were, at times, conflicting. In
addition, their interpretation is subject to the opinions of a variety of local,
regional and federal tax inspectors, the Central Bank of Russia officials and
the Ministry of Finance. Instances of inconsistent opinions among and between
these authorities are not unusual. The Companys policy is to accrue contingencies in the accounting period in
which a loss is deemed probable and the amount is reasonably determinable. In
this regard, because of the uncertainties associated with the Russian tax and
legal systems, the ultimate taxes as well as penalties and interest, if any,
assessed may be in excess of the amounts paid to date and accrued as of
September 16, 2002. Management believes, based upon its best estimates, that the
Company has paid or accrued all taxes that are applicable for the current and
prior years, and complied with all essential provisions of laws and regulations
of the Russian Federation. In managements opinion, the ultimate determination
of the Companys overall tax liability and potential loss contingencies, to the
extent not previously provided for, will not have a material effect on the
financial position of the Company. The Companys operations and financial position will continue to be
affected by Russian political developments including the application of existing
and future legislation and tax regulations, which significantly impact the
Russian economy. The likelihood of such occurrences and their effect on the
Company could have a significant impact on the Companys current activity and
its overall ability to continue operations. The Company does not believe that
these contingencies, as related to its operations, are any more significant than
those of similar enterprises in Russia. In the ordinary course of business, the Company may be party to various
legal and tax proceedings, and subject to claims, certain of which relate to the
developing markets and evolving fiscal and regulatory environments in which the
Company operates. In the opinion of the management, the Companys liability, if
any, in all pending litigation, other legal proceeding or other matter other
than what is discussed above, will not have a material effect upon the financial
condition, results of operations or liquidity of the Company. 103




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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE None 
 ITEM 9A. CONTROLS AND PROCEDURES EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES As of the end of the period covered by this report, we carried out an
evaluation, under the supervision and with the participation of our management,
including our Chief Executive Officer and Chief Financial Officer, of the
effectiveness of the design and operation of our disclosure controls and
procedures, as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934.
Based on this evaluation, our Chief Executive Officer and Chief Financial
Officer concluded that, as of December 31, 2004, the Companys disclosure
controls and procedures are effective to ensure that the information required to
be disclosed by the Company in the reports that it files or submits under the
Exchange Act is recorded, processed, summarized and reported within the time
periods specified in SEC rules and forms. MANAGEMENTS REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING Our management is responsible for establishing and maintaining adequate
internal control over financial reporting, as such term is defined in Exchange
Act Rules 13a-15(f) and 15d-15(f). Under the supervision and with the
participation of our management, including our Chief Executive Officer and Chief
Financial Officer, we conducted an evaluation of the effectiveness of our
internal control over financial reporting as of December 31, 2004 based on the
framework in Internal ControlIntegrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO). Based on that
evaluation, our management concluded that our internal control over financial
reporting was effective as of December 31, 2004. Managements assessment of the effectiveness of our internal control over
financial reporting as of December 31, 2004 has been audited by Ernst & Young
(CIS) Limited, an independent registered public accounting firm, as stated in their
report which is included elsewhere herein. CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING There were no changes in our internal control over financial reporting
during the fourth quarter of 2004 that have materially affected, or are
reasonably likely to materially affect our internal control over financial
reporting. REPORT OF INDEPENDENT REGISTERED PUBLIC
ACCOUNTING FIRM The Board of Directors and Shareholders
Golden Telecom, Inc. We have audited managements assessment, included in the accompanying
Management Report on Internal Control Over Financial Reporting, that Golden
Telecom, Inc. maintained effective internal control over financial reporting as
of December 31, 2004, based on criteria established in Internal Control -
Integrated Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (the COSO criteria). Golden Telecom, Inc.s management is
responsible for maintaining effective internal control over financial reporting
and for its assessment of the effectiveness of internal control over financial
reporting. Our responsibility is to express an opinion on managements
assessment and an opinion on the effectiveness of the Companys internal control
over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether
effective internal control over financial reporting was maintained in all
material respects. Our audit included obtaining an understanding of the internal
control over financial reporting, evaluating managements assessment, testing
and evaluating the design and operating effectiveness of internal control, and
performing such other procedures as we considered necessary in the
circumstances. We believe that our audit provides a reasonable basis for our
opinion. A companys internal control over financial reporting is a process designed
to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A companys internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the companys
assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the
degree of compliance with policies or procedures may deteriorate. In
our opinion, managements assessment that Golden Telecom, Inc.
maintained
effective internal control over financial reporting as of December 31, 2004, is
fairly stated, in all material respects, based on the COSO criteria. Also, in
our opinion, Golden Telecom, Inc. maintained, in all material respects,
effective internal control over financial reporting as of December 31, 2004,
based on the COSO criteria. We have also audited, in accordance with the standards of the Public
Company Accounting Oversight Board (United States), the 2004 consolidated
financial statements of Golden Telecom, Inc.s and our report dated March 11,
2005 expressed an unqualified opinion thereon. /s/ ERNST & YOUNG (CIS) LIMITED Moscow, Russia
March 11, 2005 104




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ITEM 9B. OTHER INFORMATION None 105




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PART III 
 ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by Item 10 (other than the information required by
Item 406 of Regulation S-K) is incorporated herein by reference to the section
entitled Election of Directors, Executive Officers and Section 16(a)
Beneficial Ownership Reporting Compliance of our proxy statement for our 2005
Annual Meeting of Shareholders that we will file by April 30, 2005. The Company has adopted its Conduct Guidelines, a code of ethics that
applies to all employees, including its executive officers. A copy of the
Conduct Guidelines is posted on the Companys Internet site at
http://www.goldentelecom.com. In the event that the Company makes any amendment
to, or grants any waivers of, a provision of the Conduct Guidelines that applies
to the principal executive officer, principal financial officer, or principal
accounting officer that requires disclosure under applicable SEC rules, the
Company intends to disclose such amendment or waiver and the reasons therefore
on its Internet site. 
 ITEM 11. EXECUTIVE COMPENSATION The information required by Item 11 is incorporated herein by reference to
the section entitled Executive Compensation of our proxy statement for our
2005 Annual Meeting of Shareholders that we will file by April 30, 2005. 
 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by Item 12 (other than the information required by
Item 201(d) of Regulation S-K) is incorporated herein by reference to the
section entitled Common Stock Ownership of Certain Beneficial Owners and
Management of our proxy statement for our 2005 Annual Meeting of Shareholders
that we will file by April 30, 2005. The information with respect to Item 201(d) of Regulation S-K as of
December 31, 2004 is as follows: EQUITY COMPENSATION PLAN INFORMATION The following table provides information on securities that were authorized
for issuance under The 1999 GTI Equity Participation Plan as of December 31,
2004: (a)
    
    (b)
    
    (c)NUMBER OF SECURITIESREMAINING AVAILABLE FORNUMBER OF SECURITIES TO
    
    WEIGHTED-AVERAGE
    
    FUTURE ISSUANCE UNDERBE ISSUED UPON EXERCISE
    
    EXERCISE PRICE OF
    
    EQUITY COMPENSATIONOF OUTSTANDING OPTIONS,
    
    OUTSTANDING OPTIONS,
    
    PLANS (EXCLUDING SECURITIESPLAN CATEGORY
    
    WARRANTS AND RIGHTS
    
    WARRANTS AND RIGHTS
    
    REFLECTED IN COLUMN (a)).Equity compensation plan
approved by security
holders
    
    
    517,013
    
    
    $
    14.18
    
    
    
    844,668
 
 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by Item 13 is incorporated herein by reference to
the section entitled Certain Relationships and Related Transactions of our
proxy statement for our 2005 Annual Meeting of Shareholders that we will file by
April 30, 2005. 
 ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES The information required by Item 14 is incorporated herein by reference to
the section entitled Ratification of Appointment of Auditors of our proxy
statement for our 2005 Annual Meeting of Shareholders that we will file by April
30, 2005. 106




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##### Table of Contents



PART IV 
 ITEM 15. EXHIBIT AND FINANCIAL STATEMENT SCHEDULES  a)
    The following documents are filed as part of this report:  1.
    Financial Statements  The following consolidated financial statements of the Company are included
as part of this document:  
    Report of Independent Auditors
    Consolidated Balance Sheets as of December 31, 2003 and 2004
    Consolidated Statements of Operations for the years ended December 31,
2002, 2003 and 2004
    Consolidated Statements of Cash Flows for the years ended December 31,
2002, 2003 and 2004
    Consolidated Statements of Changes in Shareholders Equity for the
years ended December 31, 2002, 2003 and 2004
    Notes to Consolidated Financial Statements  The following financial statements of our significant equity method
investee until September 16, 2002, EDN Sovintel LLC, are included as part
of this document:  
    Report of Independent Auditors
    Statements of Income for the period from January 1 to September 16,
2002
    Statements of Cash Flows for the period from January 1 to September
16, 2002
    Notes to Financial Statements2.
    Consolidated Financial Statement Schedules  We have furnished Schedule II  Valuation and Qualifying Accounts on Page
111.All other schedules are omitted because they are not applicable or not
required, or because the required information is either incorporated herein
by reference or included in the financial statements or notes thereto
included in this report.  b)
    Exhibits ExhibitNumber
    
    Description of Exhibit3.1**
    
    Amended and Restated Certificate of Incorporation of Golden
Telecom, Inc.3.2**
    
    Amended and Restated By-laws of Golden Telecom, Inc.4.1**
    
    Specimen certificate representing shares of Common Stock10.1***
    
    Shareholders Agreement among Golden Telecom, Inc., Alfa
Telecom Limited, Nye Telenor East Invest AS, OAO Rostelecom,
Capital International Global Emerging Markets Private Equity
Fund, L.P., Cavendish Nominees Limited and First NIS
Regional Fund SICAV.10.2***
    
    Registration Rights Agreement among Golden Telecom, Inc.,
Alfa Telecom Limited, Nye Telenor East Invest AS, OAO
Rostelecom, Capital International Global Emerging Markets
Private Equity Fund, L.P., Cavendish Nominees Limited and
First NIS Regional Fund SICAV.10.3***
    
    Standstill Agreement among Golden Telecom, Inc., Alfa
Telecom Limited, Nye Telenor East Invest AS, OAO Rostelecom,
Capital International Global Emerging Markets Private Equity
Fund, L.P., Cavendish Nominees Limited and First NIS
Regional Fund SICAV.10.4(a)****
    
    Golden Telecom, Inc. 1999 Equity Participation Plan.10.4(b)*****
    
    Amendment to the Golden Telecom, Inc. 1999 Equity
Participation Plan.10.5*
    
    Employment agreement for the
President and Chief Executive Officer.10.6*
    
    Employment agreement for Chief
Operating Officer.10.7*
    
    Summary of employment agreements
for Chief Financial Officer, General Counsel, and Director of Mergers
and Acquisitions.10.8*
    
    Form of Stock Option Award Agreement.10.9*
    
    Schedule of Compensation Arrangements with Directors.21.1*
    
    List of subsidiaries of Golden Telecom, Inc.23.1*
    
    Consent of Ernst & Young (CIS) Limited, Independent Auditors
(Golden Telecom, Inc.).23.2*
    
    Consent of Ernst & Young (CIS) Limited, Independent Auditors
(EDN Sovintel LLC).24*
    
    Powers of Attorney (included on signature page).31.1*
    
    Certification of the Chief Executive Officer Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.31.2*
    
    Certification of the Chief Financial Officer Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.32.1*
    
    Certification of the Chief Executive Officer Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.32.2*
    
    Certification of the Chief Financial Officer Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
   *
    Filed herewith.  **
    Incorporated by reference to the correspondingly numbered Exhibit to the
Companys registration statement on Form S-1 dated July 14, 1999 and
amendments (Commission File No. 333-82791).  ***
    Incorporated by reference to the Companys current report on Form 8-K dated
August 19, 2003 (Commission File 0-27423).    ****
    Incorporated by reference to the Companys definitive proxy statement
on Form DEF-14A dated April 25, 2000 (Commission File No. 0-27423).  *****
    Incorporated by reference to the Companys definitive proxy statement
on Form DEF-14A dated May 23, 2001 (Commission File No. 0-27423). 107




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##### Table of Contents



SIGNATURES Pursuant to the requirements of the Section 13 or 15(d) of the
Securities Exchange Act 1934, as amended, the registrant has duly caused this
report to be signed on its behalf by the undersigned, thereunto duly authorized,
in the City of Moscow, Russian Federation, on this 11th day of March, 2005. GOLDEN TELECOM, INC.
(Registrant)By:
    /s/ BRIAN RICHName:
    Brian RichTitle:
    Senior Vice-President, Chief Financial
Officer and Treasurer
(Principal Financial Officer)By:
    /s/ MICHAEL D. WILSONName:
    Michael D. WilsonTitle:
    Vice President and Corporate Controller
(Principal Accounting Officer) We, the undersigned officers and directors of Golden Telecom, Inc.
hereby severally constitute and appoint, Derek Bloom, and Brian Rich and each of
them singly, as his true and lawful attorney-in-fact and agents with full power
of substitution and resubstitution, for him, and in his name, place and stead,
in any and all capacities to sign any and all amendments and supplements to this
annual report on Form 10-K and all amendments thereto, and to file the same,
with all exhibits thereto, and all other documents in connection therewith, in
each case, with our names and on our behalf in our capacities as officers and
directors to enable Golden Telecom, Inc. to comply with the provisions of the
Securities Exchange Act of 1934, as amended, and all requirements of the
Securities and Exchange Commission, hereby ratifying and confirming our
signatures as they may be signed by our said attorney to said annual report on
Form 10-K and any and all amendments thereto. Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons in the capacities
indicated SIGNATURE
    
    TITLE
    
    DATE/s/ ALEXANDER VINOGRADOV

Alexander Vinogradov
    
    President, Chief Executive
Officer and Director
(Principal Executive Officer)
    
    March 11, 2005/s/ PETER AVEN

Peter Aven
    
    Chairman of the Board
of Directors
    
    March 11, 2005/s/ VLADIMIR ANDROSIK

Vladimir Androsik
    
    Director
    
    March 11, 2005/s/ MICHAEL CALVEY

Michael Calvey
    
    Director
    
    March 11, 2005/s/ ASHLEY DUNSTER

Ashley Dunster
    
    Director
    
    March 11, 2005/s/ DAVID HERMAN

David Herman
    
    Director
    
    March 11, 2005/s/ KJELL MORTEN JOHNSEN

Kjell Morten Johnsen
    
    Director
    
    March 11, 2005/s/ ANDREI KOSOGOV

Andrei Kosogov
    
    Director
    
    March 11, 2005/s/ MICHAEL NORTH

Michael North
    
    Director
    
    March 11, 2005/s/ JAN EDVARD THYGESEN

Jan Edvard Thygesen
    
    Director
    
    March 11, 2005/s/ BRIAN RICH

Brian Rich
    
    Senior Vice President, Chief
Financial Officer and Treasurer
(Principal Financial Officer)
    
    March 11, 2005/s/ MICHAEL D. WILSONMichael D. Wilson
    
    Vice President and Corporate Controller
(Principal Accounting Officer)
    
    March 11, 2005
 109




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##### Table of Contents



SCHEDULE II  VALUATION AND QUALIFYING ACCOUNTS GOLDEN TELECOM, INC. COL. A
    
    COL. B
    
    
    COL. C
    
    
    COL. D
    
    
    COL. EADDITIONSBALANCE AT
    
    
    CHARGED TO
    
    
    RESERVES
    
    
    
    
    
    
    BALANCE ATBEGINNING
    
    
    COSTS AND
    
    
    FROM
    
    
    
    
    
    
    ENDDESCRIPTION
    
    OF PERIOD
    
    
    EXPENSES
    
    
    ACQUISITIONS
    
    
    DEDUCTIONS
    
    
    OF PERIODAllowance for doubtful accounts at
12/31/04
    
    
    13,896
    
    
    
    10,065
    
    
    
    117
    
    
    
    (873
    )
    
    
    23,205Allowance for doubtful accounts at
12/31/03
    
    
    8,686
    
    
    
    3,592
    
    
    
    2,966
    
    
    
    (1,348
    )
    
    
    13,896Allowance for doubtful accounts at
12/31/02
    
    
    3,800
    
    
    
    2,061
    
    
    
    4,539
    
    
    
    (1,714
    )
    
    
    8,686
 111




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##### Table of Contents



EXHIBIT INDEX ExhibitNumber
    
    Description of Exhibit3.1**
    
    Amended and Restated Certificate of Incorporation of Golden
Telecom, Inc.3.2**
    
    Amended and Restated By-laws of Golden Telecom, Inc.4.1**
    
    Specimen certificate representing shares of Common Stock10.1***
    
    Shareholders Agreement among Golden Telecom, Inc., Alfa
Telecom Limited, Nye Telenor East Invest AS, OAO Rostelecom,
Capital International Global Emerging Markets Private Equity
Fund, L.P., Cavendish Nominees Limited and First NIS
Regional Fund SICAV.10.2***
    
    Registration Rights Agreement among Golden Telecom, Inc.,
Alfa Telecom Limited, Nye Telenor East Invest AS, OAO
Rostelecom, Capital International Global Emerging Markets
Private Equity Fund, L.P., Cavendish Nominees Limited and
First NIS Regional Fund SICAV.10.3***
    
    Standstill Agreement among Golden Telecom, Inc., Alfa
Telecom Limited, Nye Telenor East Invest AS, OAO Rostelecom,
Capital International Global Emerging Markets Private Equity
Fund, L.P., Cavendish Nominees Limited and First NIS
Regional Fund SICAV.10.4(a)****
    
    Golden Telecom, Inc. 1999 Equity Participation Plan.10.4(b)*****
    
    Amendment to the Golden Telecom, Inc. 1999 Equity
Participation Plan.10.5*
    
    Employment agreement for President and Chief Executive Officer.10.6*
    
    Employment agreement for Chief Operating Officer.10.7*
    
    Summary of employment agreements for Chief Financial Officer,
General Counsel and Director of Mergers and Acquisitions.10.8*
    
    Form of Stock Option Award Agreement.10.9*
    
    Schedule of Compensation Arrangements with Directors.21.1*
    
    List of subsidiaries of Golden Telecom, Inc.23.1*
    
    Consent of Ernst & Young (CIS) Limited, Independent Auditors
(Golden Telecom, Inc.).23.2*
    
    Consent of Ernst & Young (CIS) Limited, Independent Auditors
(EDN Sovintel LLC).24*
    
    Powers of Attorney (included on signature page).31.1*
    
    Certification of the Chief Executive Officer Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.31.2*
    
    Certification of the Chief Financial Officer Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.32.1*
    
    Certification of the Chief Executive Officer Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.32.2*
    
    Certification of the Chief Financial Officer Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
   *
    Filed herewith.  **
    Incorporated by reference to the correspondingly numbered Exhibit to the
Companys registration statement on Form S-1 dated July 14, 1999 and
amendments (Commission File No. 333-82791).  ***
    Incorporated by reference to the Companys current report on Form 8-K dated
August 19, 2003 (Commission File 0-27423).  ****
    Incorporated by reference to the Companys definitive proxy statement
on Form DEF-14A dated April 25, 2000 (Commission File No. 0-27423).  *****
    Incorporated by reference to the Companys definitive proxy statement
on Form DEF-14A dated May 23, 2001 (Commission File No. 0-27423).