================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2003 (COMMISSION FILE NUMBER: 0-27423) GOLDEN TELECOM, INC. (Exact name of registrant as specified in its charter) DELAWARE 51-0391303 (State of incorporation) (I.R.S. Employer Identification No.) REPRESENTATION OFFICE GOLDEN TELESERVICES, INC. 1 KOZHEVNICHESKY PROEZD MOSCOW, RUSSIA 115114 (Address of principal executive office) (011-7-501) 797-9300 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has 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 registrants were required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by checkmark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes [X] No [ ] At August 1, 2003 there were 27,788,913 outstanding shares of common stock of the registrant. ================================================================================ TABLE OF CONTENTS PAGE ---- PART I. FINANCIAL INFORMATION Item 1 Condensed Consolidated Financial Statements of Golden Telecom, Inc. (unaudited)......................................... 3 Condensed Consolidated Balance Sheets as of December 31, 2002 and June 30, 2003................................................................. 3-4 Condensed Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2002 and 2003...................................... 5 Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2002 and 2003............................................. 6 Notes to Condensed Consolidated Financial Statements..................... 7 Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations *.......................................................... 16 Item 4 Controls and Procedures.................................................. 31 PART II. OTHER INFORMATION Item 4 Submission of Matters to a Vote of Security Holders...................... 32 Item 6 Exhibits and Reports on Form 8-K......................................... 32 Signatures........................................................................... 33 * Please refer to the special note regarding forward-looking statements in this section. 2 PART I. FINANCIAL INFORMATION ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS OF GOLDEN TELECOM, INC. GOLDEN TELECOM, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS OF US$, EXCEPT SHARE DATA) DECEMBER 31, JUNE 30, 2002 2003 -------------- -------------- (AUDITED) (UNAUDITED) ASSETS CURRENT ASSETS Cash and cash equivalents ................................. $ 59,625 $ 55,305 Accounts receivable, net .................................. 42,226 50,639 VAT receivable ............................................ 3,998 9,901 Prepaid expenses .......................................... 7,811 8,386 Other current assets ...................................... 13,794 14,139 -------------- -------------- TOTAL CURRENT ASSETS ....................................... 127,454 138,370 Property and equipment, net of accumulated depreciation of $99,541 and $113,967 at December 31, 2002 and June 30, 2003, respectively ........................................ 166,121 174,607 Goodwill and intangible assets: Goodwill .................................................. 71,703 71,703 Intangible assets, net of accumulated amortization of $14,418 and $18,210 at December 31, 2002 and June 30, 2003, respectively .............................. 55,965 54,100 -------------- -------------- Net goodwill and intangible assets ........................ 127,668 125,803 Restricted cash ............................................ 1,515 1,136 Other non-current assets ................................... 13,052 9,688 -------------- -------------- TOTAL ASSETS ............................................... $ 435,810 $ 449,604 ============== ============== See notes to condensed consolidated financial statements. 3 GOLDEN TELECOM, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS OF US$, EXCEPT SHARE DATA) DECEMBER 31, JUNE 30, 2002 2003 -------------- -------------- (AUDITED) (UNAUDITED) LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES Accounts payable and accrued expenses ................................... $ 43,870 $ 52,114 VAT payable ............................................................. 4,398 8,262 Debt maturing within one year ........................................... 8,988 1,399 Current capital lease obligation ........................................ 1,775 1,859 Due to affiliates and related parties ................................... 1,999 1,813 Other current liabilities ............................................... 9,950 11,985 -------------- -------------- TOTAL CURRENT LIABILITIES ................................................ 70,980 77,432 Long-term debt, less current portion ..................................... 24,111 760 Long-term capital lease obligation, less current portion ................. 5,621 4,670 Long-term deferred tax liability ......................................... 12,406 9,070 Other non-current liabilities ............................................ 13,047 15,050 -------------- -------------- TOTAL LIABILITIES ........................................................ 126,165 106,982 Minority interest ........................................................ 2,187 2,359 SHAREHOLDERS' EQUITY Preferred stock, $0.01 par value (10,000,000 shares authorized; none issued and outstanding at December 31, 2002 and June 30, 2003) ........................................................ -- -- Common stock, $0.01 par value (100,000,000 shares authorized; 27,021,415 shares issued and outstanding at December 31, 2002 and 27,683,418 shares issued and outstanding at June 30, 2003) ..................................... 270 277 Additional paid-in capital .............................................. 446,215 454,358 Accumulated deficit ..................................................... (139,027) (114,372) -------------- -------------- TOTAL SHAREHOLDERS' EQUITY ............................................... 307,458 340,263 -------------- -------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY ............................... $ 435,810 $ 449,604 ============== ============== See notes to condensed consolidated financial statements. 4 GOLDEN TELECOM, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS OF US$, EXCEPT PER SHARE DATA) (UNAUDITED) THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, -------------------------- -------------------------- 2002 2003 2002 2003 ----------- ----------- ----------- ----------- REVENUE: Telecommunication services .................... $ 36,172 $ 80,463 $ 70,464 $ 158,439 Revenue from affiliates and related parties ... 3,045 299 5,103 699 ----------- ----------- ----------- ----------- TOTAL REVENUE .................................. 39,217 80,762 75,567 159,138 OPERATING COSTS AND EXPENSES: Access and network services (excluding depreciation and amortization) ............... 17,556 39,436 32,926 76,735 Selling, general and administrative (excluding depreciation and amortization)..... 10,237 13,385 19,924 26,823 Depreciation and amortization ................. 6,247 10,542 12,250 20,947 ----------- ----------- ----------- ----------- TOTAL OPERATING COSTS AND EXPENSES ............. 34,040 63,363 65,100 124,505 ----------- ----------- ----------- ----------- INCOME FROM OPERATIONS ......................... 5,177 17,399 10,467 34,633 OTHER INCOME (EXPENSE): Equity in earnings (losses) of ventures ....... (1,223) (148) 487 (29) Interest income ............................... 366 317 842 605 Interest expense .............................. (390) (892) (927) (1,578) Foreign currency gain (losses) ................ (182) 23 (507) 213 Minority interest ............................. (161) (123) (227) (215) ----------- ----------- ----------- ----------- TOTAL OTHER INCOME (EXPENSE) ................... (1,590) (823) (332) (1,004) ----------- ----------- ----------- ----------- Income before income taxes ..................... 3,587 16,576 10,135 33,629 Income taxes ................................... 833 4,741 2,149 8,974 ----------- ----------- ----------- ----------- Income before cumulative effect of a change in accounting principle .............. 2,754 11,835 7,986 24,655 Cumulative effect of a change in accounting principle, net of tax effect of $0 ............ -- -- 974 -- ----------- ----------- ----------- ----------- NET INCOME ..................................... $ 2,754 $ 11,835 $ 8,960 $ 24,655 =========== =========== =========== =========== Basic earnings per share of common stock: Income before cumulative effect of a change in accounting principle ............. $ 0.12 $ 0.43 $ 0.36 $ 0.90 Cumulative effect of a change in accounting principle ......................... -- -- 0.04 -- ----------- ----------- ----------- ----------- Net income per share - basic .................. $ 0.12 $ 0.43 $ 0.40 $ 0.90 =========== =========== =========== =========== Weighted average common shares - basic ......... 22,653 27,480 22,593 27,271 =========== =========== =========== =========== Diluted earnings per share of common stock: Income before cumulative effect of a change in accounting principle ............. $ 0.12 $ 0.42 $ 0.35 $ 0.89 Cumulative effect of a change in accounting principle ......................... -- -- 0.04 -- ----------- ----------- ----------- ----------- Net income per share - diluted ................ $ 0.12 $ 0.42 $ 0.39 $ 0.89 =========== =========== =========== =========== Weighted average common shares - diluted ....... 23,396 28,289 23,062 27,836 =========== =========== =========== =========== See notes to condensed consolidated financial statements. 5 GOLDEN TELECOM, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS OF US$) (UNAUDITED) SIX MONTHS ENDED JUNE 30, -------------------------- 2002 2003 ----------- ----------- OPERATING ACTIVITIES Net income .......................................................... $ 8,960 $ 24,655 Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities: Depreciation ........................................................ 10,017 16,304 Amortization ........................................................ 2,233 4,643 Equity in (earnings) losses of ventures, net of dividends received... (487) 29 Foreign currency (gain) losses ...................................... 507 (213) Cumulative effect of a change in accounting principle ............... (974) -- Other ............................................................... 432 80 Changes in assets and liabilities: Accounts receivable ................................................. (2,461) (8,266) Accounts payable and accrued expenses ............................... 4,143 8,187 VAT, net ............................................................ (352) (2,039) Other changes in assets and liabilities ............................. (2,628) 2,303 ----------- ----------- NET CASH PROVIDED BY OPERATING ACTIVITIES ............................ 19,390 45,683 INVESTING ACTIVITIES Purchases of property and equipment and intangible assets ........... (10,034) (27,816) Cash received from escrow account ................................... 3,000 -- Restricted cash ..................................................... 1,400 374 Proceeds from investments available for sale ........................ 8,978 -- Purchases of investments available for sale ......................... (2,000) -- Other investing ..................................................... 449 1,195 ----------- ----------- NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES .................. 1,793 (26,247) FINANCING ACTIVITIES: Repayments of debt .................................................. (8,847) (30,940) Net proceeds from exercise of employee stock options ................ 2,128 7,970 Other financing ..................................................... -- (867) ----------- ----------- NET CASH USED IN FINANCING ACTIVITIES ................................ (6,719) (23,837) Effect of exchange rate changes on cash and cash equivalents ......... (189) 81 ----------- ----------- Net increase (decrease) in cash and cash equivalents ................. 14,275 (4,320) Cash and cash equivalents at beginning of period ..................... 37,404 59,625 ----------- ----------- CASH AND CASH EQUIVALENTS AT END OF PERIOD ........................... $ 51,679 $ 55,305 =========== =========== See notes to condensed consolidated financial statements. 6 GOLDEN TELECOM, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. FINANCIAL PRESENTATION AND DISCLOSURES Golden Telecom, Inc. ("GTI", "Golden Telecom" or the "Company") is a provider of a broad range of telecommunications services to businesses, other telecommunications service providers and consumers. The Company provides these services through its operation of voice, Internet and data networks, international gateways, local access and various value-added services in the Commonwealth of Independent States ("CIS"), primarily in Russia, and through its fixed line and mobile operation in Ukraine. The financial statements included herein are unaudited and have been prepared in accordance with generally accepted accounting principles in the United States of America ("US GAAP") for interim financial reporting and United States Securities and Exchange Commission ("SEC") regulations. Certain information and footnote disclosures normally included in complete financial statements prepared in accordance with US GAAP and SEC rules and regulations have been condensed or omitted pursuant to such US GAAP and SEC rules and regulations. In the opinion of management, the financial statements reflect all adjustments of a normal and recurring nature necessary to present fairly the Company's financial position, results of operations and cash flows for the interim periods. These financial statements should be read in conjunction with the Company's 2002 audited consolidated financial statements and the notes related thereto. The results of operations for the three and six months ended June 30, 2003 may not be indicative of the operating results for the full year. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND PROCEDURES Goodwill and Intangible Assets Effective January 1, 2002, GTI adopted Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets." In accordance with SFAS No. 142, GTI discontinued the amortization of goodwill as of such date. The Company also reclassified to other intangible assets approximately $1.3 million previously classified as goodwill. 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 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, 2002 AS OF JUNE 30, 2003 --------------------------- --------------------------- (IN THOUSANDS) ACCUMULATED ACCUMULATED COST AMORTIZATION COST AMORTIZATION ------------ ------------ ------------ ------------ Amortized intangible assets: Telecommunications service contracts .... $ 48,022 $ (6,775) $ 50,703 $ (9,631) Contract-based customer relationships ... 8,322 (811) 8,322 (1,611) Licenses ................................ 3,167 (1,249) 3,327 (1,390) Other intangible assets ................. 10,872 (5,583) 9,958 (5,578) ------------ ------------ ------------ ------------ Total ................................... $ 70,383 $ (14,418) $ 72,310 $ (18,210) ============ ============ ============ ============ Other intangible assets include software, Internet software and related content, as well as other intangible assets. Comprehensive Income Comprehensive income is defined as the change in equity of a business enterprise during a period from non-owner sources. For the three and six months ended June 30, 2002 and 2003, comprehensive income for the Company is equal to net income. 7 GOLDEN TELECOM, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) 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 Accounting Principles Board ("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 Financial Accounting Standards Board ("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 earnings per share in annual and interim financial statements. While the Statement does not amend SFAS No. 123 to require companies to account for employee stock options using the fair value method, the disclosure provisions of SFAS No. 148 are applicable to all companies with stock-based employee compensation, regardless of whether they account for that compensation using the fair value method of SFAS No. 123 or the intrinsic value method of APB No. 25. SFAS No. 148 disclosure provisions are effective for years ending after December 15, 2002. 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 an impact on the Company's consolidated financial position or results of operations. The effect of applying SFAS No. 123 on the net income as reported is not representative of the effects on reported 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. THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ------------------------- ------------------------- 2002 2003 2002 2003 ----------- ----------- ----------- ----------- (IN THOUSANDS, EXCEPT PER SHARE DATA) Net income, as reported ......................... $ 2,754 $ 11,835 $ 8,960 $ 24,655 Deduct: total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects ..... 2,263 867 4,500 1,736 ----------- ----------- ----------- ----------- Pro forma net income ............................ $ 491 $ 10,968 $ 4,460 $ 22,919 =========== =========== =========== =========== Net income per share: Basic - as reported ............................ $ 0.12 $ 0.43 $ 0.40 $ 0.90 Basic - pro forma .............................. 0.02 0.40 0.20 0.84 Diluted - as reported .......................... 0.12 0.42 0.39 0.89 Diluted - pro forma ............................ 0.02 0.39 0.19 0.82 Asset Retirement Obligations In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations." This statement deals with the costs of closing facilities and removing assets. SFAS No. 143 requires entities to record the fair value of a legal liability for an asset retirement obligation in the period it is incurred. This cost is initially capitalized and amortized over the remaining life of the asset. Once the obligation is ultimately settled, any difference between the final cost and the recorded liability is recognized as a gain or loss on disposition. SFAS No. 143 is effective for years beginning after June 15, 2002. The adoption of SFAS No. 143 did not have an impact on the Company's consolidated financial position or results of operations. 8 GOLDEN TELECOM, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) Exit or Disposal Activities In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities," which requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. This statement nullifies Emerging Issues Task Force No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)," which required that a liability for an exit cost be recognized upon the entity's commitment to an exit plan. SFAS No. 146 is effective for exit or disposal activities that are initiated after December 31, 2002. The adoption of the provisions of SFAS No. 146 did not have an impact on the Company's results of operations or financial position. Financial Guarantees In November 2002, the FASB issued FASB Interpretation No. 45,"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" ("FIN No. 45"). FIN No. 45 requires that upon issuance of a guarantee, the guarantor must recognize a liability for the fair value of the obligation it assumes under that guarantee. The disclosure provisions of FIN No. 45 are effective for financial statements of annual periods that end after December 15, 2002. The provisions for initial recognition and measurement are effective on a prospective basis for guarantees that are issued or modified after December 31, 2002. The adoption of the FIN No. 45 did not have an impact on the Company's results of operations or financial position. Consolidation of Variable Interest Entities In January 2003, the FASB issued FIN No. 46, "Consolidation of Variable Interest Entities". FIN No. 46 defines the concept of "variable interest" and requires existing unconsolidated variable interest entities to be consolidated into the financial statement of their primary beneficiaries if the variable interest entities do not effectively disperse risks among the parties involved. FIN No. 46 applies immediately to variable interest entities created after January 31, 2003. It applies in the first fiscal year or interim period beginning after June 15, 2003, to variable interest entities in which an enterprise holds a variable interest that it acquires before February 1, 2003. If it is reasonably possible that an enterprise will consolidate or disclose information about a variable interest entity when FIN No. 46 becomes effective, the enterprise must disclose information about those entities in all financial statements issued after January 31, 2003. There were no such entities created after January 31, 2003. The interpretation may be applied prospectively with a cumulative-effect adjustment as of the date on which it is first applied or by restating previously issued financial statements for one or more years, with a cumulative-effect adjustment as of the beginning of the first year restated. The adoption of the remaining provisions of FIN No. 46 are not expected to have a material impact on the Company's results of operations or financial positions. 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. The new guidance amends SFAS No. 133 for decisions made: (a) as part of the Derivatives Implementation Group process that effectively required amendments to SFAS No. 133, (b) in connection with other Board projects dealing with financial instruments, and (c) regarding implementation issues raised in relation to the application of the definition of derivative. The amendments set forth in SFAS No. 149 improve financial reporting by requiring that contracts with comparable characteristics be accounted for similarly. 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 are not expected to have an impact on the Company's results of operations or financial position. 9 GOLDEN TELECOM, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) 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 is not expected to have an impact on the Company's results of operations or financial position. Use of Estimates in Preparation of Financial Statements The preparation of these condensed, consolidated financial statements, in conformity with US generally accepted accounting principles, 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 2002 amounts have been reclassified to conform to presentation adopted in the current period. 3. NET EARNINGS PER SHARE Basic earnings per share at June 30, 2002 and June 30, 2003 is computed on the basis of the weighted average number of common shares outstanding. Diluted earnings per share at June 30, 2002 and June 30, 2003 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 three months ended June 30, 2002 and 2003 was 29,166 and 19,166 stock options, respectively. The number of stock options excluded from the diluted earnings per share computation, because their effect was antidilutive for the six months ended June 30, 2002 and 2003 was 257,248 and 226,392 stock options, respectively. The components of basic and diluted earnings per share were as follows: THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ----------------------- ----------------------- 2002 2003 2002 2003 ---------- ---------- ---------- ---------- (IN THOUSANDS, EXCEPT PER SHARE DATA) Income before cumulative effect of a change in accounting principle ....................................... $ 2,754 $ 11,835 $ 7,986 $ 24,655 Weighted average outstanding of: Common stock ............................................... 22,653 27,480 22,593 27,271 Dilutive effect of: Employee stock options ..................................... 743 809 469 565 ---------- ---------- ---------- ---------- Common stock and common stock equivalents ................... 23,396 28,289 23,062 27,836 ========== ========== ========== ========== Earnings per share before cumulative effect of a change in accounting principle: Basic ...................................................... $ 0.12 $ 0.43 $ 0.36 $ 0.90 ========== ========== ========== ========== Diluted .................................................... $ 0.12 $ 0.42 $ 0.35 $ 0.89 ========== ========== ========== ========== 10 GOLDEN TELECOM, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) 4. INVESTMENT TRANSACTIONS In May 2003, GTI entered into a non-binding Memorandum of Understanding ("MOU") with Korporatsiya Sibchallenge to acquire 100% of the ownership interest in OOO Sibchallenge Telecom, an alternative wireline operator in Krasnoyarsk, Russia and 100% of the issued and outstanding shares of ZAO Tel, an internet service provider in Krasnoyarsk, Russia. The MOU states that the proposed price of the acquisition is approximately $15.0 million in cash. The closing of the transaction is subject to the completion of satisfactory due diligence, receipt and execution of definitive acquisition agreements, and receipt of normal regulatory approval. 5. CONTINGENCIES 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 June 30, 2003. It is the opinion of management that the ultimate resolution of the Company's liability for CIS Taxes, 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. 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. Financial Guarantees As of June 30, 2003, the Company has guaranteed $0.8 million of long-term debt for certain Russian registered ventures. Management estimates the fair value of these guarantees to be immaterial. Other Matters During 2002, Golden Telecom (Ukraine) ("GTU") was involved in a number of commercial disputes with Ukrtelecom and Ukrainian regulatory authorities. The most significant disputes include routing of traffic and GTU's lease rights of Ukrtelecom's technical premises. By the end of the first quarter of 2003, GTU had resolved these issues with Ukrtelecom, but it is possible that commercial disputes with Ukrtelecom and the Ukrainian authorities could resurface in the future. On March 1, 2002, the Company became aware the Kiev City Prosecutor's Office had initiated an investigation into the activities of the Company's management in GTU. GTU received a letter dated July 17, 2002 from the General Prosecutor of Ukraine stating that effective July 9, 2002 the Prosecutor's Office withdrew all charges against management due to the absence of grounds on which to prosecute. On October 7, 2002, the Kiev City Prosecutor's Office notified GTU that the previous decision to close the investigation had been revoked. In subsequent discussions with the Kiev City Prosecutor's Office, the investigators advised the management of GTU that the Prosecutor's Office is reviewing internal procedural requirements with the intent to close the investigation again. 11 GOLDEN TELECOM, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) 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. 6. SEGMENT INFORMATION 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 businesses for the three and six months ended June 30, 2002 and 2003. 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. 12 GOLDEN TELECOM, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) ADJUSTMENTS TO RECONCILE BUSINESS SEGMENT TO CONSOLIDATED RESULTS ---------------------- BUSINESS CARRIER BUSINESS EQUITY AND AND CONSUMER MOBILE CORPORATE & SEGMENT CONSOLIDATED METHOD AFFILIATE CORPORATE OPERATOR INTERNET SERVICES ELIMINATIONS TOTAL RESULTS VENTURES ADJUSTMENTS --------- --------- --------- --------- ------------ -------- ------------ --------- ----------- (IN THOUSANDS) THREE MONTHS ENDED JUNE 30, 2002 Revenue from external customers ................ $ 36,623 $ 25,219 $ 4,951 $ 3,292 $ -- $ 70,085 $ 39,217 $ (36,554) $ 5,686 Intersegment revenue ...... 140 121 -- -- (261) -- -- -- -- Operating income (loss) ... 9,239 6,987 (1,791) 954 (1,353) 14,036 5,177 (8,859) -- Identifiable assets ....... 150,595 128,020 44,244 9,176 93,397 425,432 302,944 (122,488) -- Capital expenditures ...... 8,441 4,315 510 53 37 13,356 5,400 (7,956) -- ADJUSTMENTS TO RECONCILE BUSINESS SEGMENT TO CONSOLIDATED RESULTS ----------------------- BUSINESS CARRIER BUSINESS EQUITY AND AND CONSUMER MOBILE CORPORATE & SEGMENT CONSOLIDATED METHOD AFFILIATE CORPORATE OPERATOR INTERNET SERVICES ELIMINATIONS TOTAL RESULTS VENTURES ADJUSTMENTS --------- --------- --------- --------- ------------ -------- ------------ --------- ----------- (IN THOUSANDS) THREE MONTHS ENDED JUNE 30, 2003 Revenue from external customers ............... $ 43,340 $ 26,707 $ 7,155 $ 3,606 $ -- $ 80,808 $ 80,762 $ (1,121) $ 1,075 Intersegment revenue ..... 274 159 -- -- (433) -- -- -- -- Operating income (loss)... 13,502 4,773 (565) 1,530 (1,949) 17,291 17,399 108 -- Identifiable assets ...... 140,150 155,945 45,921 7,472 103,809 453,297 449,604 (3,693) -- Capital expenditures ..... 9,840 5,241 933 127 11 16,152 16,027 (125) -- ADJUSTMENTS TO RECONCILE BUSINESS SEGMENT TO CONSOLIDATED RESULTS ----------------------- BUSINESS CARRIER BUSINESS EQUITY AND AND CONSUMER MOBILE CORPORATE & SEGMENT CONSOLIDATED METHOD AFFILIATE CORPORATE OPERATOR INTERNET SERVICES ELIMINATIONS TOTAL RESULTS VENTURES ADJUSTMENTS --------- --------- --------- --------- ------------ -------- --------- --------- ----------- (IN THOUSANDS) SIX MONTHS ENDED JUNE 30, 2002 Revenue from external customers ................ $ 71,443 $ 47,478 $ 10,177 $ 6,551 $ -- $ 135,649 $ 75,567 $ (69,996) $ 9,914 Intersegment revenue ...... 227 255 -- -- (482) -- -- -- -- Operating income (loss).... 18,725 13,099 (2,150) 1,533 (3,342) 27,865 10,467 (17,398) -- Identifiable assets ....... 150,595 128,020 44,244 9,176 93,397 425,432 302,944 (122,488) -- Capital expenditures ...... 14,532 7,399 1,177 102 44 23,254 10,034 (13,220) -- ADJUSTMENTS TO RECONCILE BUSINESS SEGMENT TO CONSOLIDATED RESULTS ----------------------- BUSINESS CARRIER BUSINESS EQUITY AND AND CONSUMER MOBILE CORPORATE & SEGMENT CONSOLIDATED METHOD AFFILIATE CORPORATE OPERATOR INTERNET SERVICES ELIMINATIONS TOTAL RESULTS VENTURES ADJUSTMENTS --------- --------- --------- --------- ------------ -------- --------- --------- ----------- (IN THOUSANDS) SIX MONTHS ENDED JUNE 30, 2003 Revenue from external customers ................ $ 82,008 $ 56,297 $ 14,222 $ 6,764 $ -- $ 159,291 $ 159,138 $ (2,285) $ 2,132 Intersegment revenue ...... 569 466 -- -- (1,035) -- -- -- -- Operating income (loss).... 24,069 12,275 (1,060) 2,575 (3,132) 34,727 34,633 (92) -- Identifiable assets ....... 140,150 155,945 45,921 7,472 103,809 453,297 449,604 (3,693) -- Capital expenditures ...... 17,380 8,968 1,428 209 30 28,015 27,816 (199) -- 13 GOLDEN TELECOM, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) (UNAUDITED) GEOGRAPHIC DATA Revenues are based on the location of the operating company providing the service. The following tables present financial information segmented by the Company's geographic regions for the three and six months ended June 30, 2002 and 2003. CORPORATE, OTHER COUNTRIES AND CONSOLIDATED RUSSIA UKRAINE ELIMINATIONS RESULTS ------ ------- ------------ ------------ THREE MONTHS ENDED JUNE 30, 2002 (IN THOUSANDS) Revenue.......................... $ 31,075 $ 8,692 $ (550) $ 39,217 Long-lived assets................ 174,629 24,077 1,117 199,823 CORPORATE, OTHER COUNTRIES AND CONSOLIDATED RUSSIA UKRAINE ELIMINATIONS RESULTS ------ ------- ------------ ------------ THREE MONTHS ENDED JUNE 30, 2003 (IN THOUSANDS) Revenue.......................... $ 71,210 $ 10,641 $ (1,089) $ 80,762 Long-lived assets................ 279,892 23,586 2,007 305,485 CORPORATE, OTHER COUNTRIES AND CONSOLIDATED RUSSIA UKRAINE ELIMINATIONS RESULTS ------ ------- ------------ ------------ SIX MONTHS ENDED JUNE 30, 2002 (IN THOUSANDS) Revenue.......................... $ 59,005 $ 16,922 $ (360) $ 75,567 Long-lived assets................ 174,629 24,077 1,117 199,823 CORPORATE, OTHER COUNTRIES AND CONSOLIDATED RUSSIA UKRAINE ELIMINATIONS RESULTS ------ ------- ------------ ------------ SIX MONTHS ENDED JUNE 30, 2003 (IN THOUSANDS) Revenue.......................... $ 140,289 $ 19,861 $ (1,012) $ 159,138 Long-lived assets................ 279,892 23,586 2,007 305,485 14 GOLDEN TELECOM, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) 7. SIGNIFICANT EQUITY METHOD SUBSIDIARY INFORMATION The following table presents summarized income statement information from the Company's significant equity investee, Sovintel, for the three and six months ended June 30, 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. THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, 2002 JUNE 30, 2002 ------------------ ---------------- (IN THOUSANDS) Revenues........................ $ 35,325 $ 67,680 Gross Margin.................... 15,581 30,102 Income from operations.......... 8,564 16,796 Net income...................... 5,963 11,964 8. SHAREHOLDERS' EQUITY The Company's outstanding shares of common stock increased by 198,578 and 264,077 shares issued in connection with the exercise of stock options in the three and six months ended June 30, 2002, respectively. The Company's outstanding shares of common stock increased by 526,698 and 662,003 shares issued in connection with the exercise of stock options in the three and six months ended June 30, 2003, respectively. 9. DEBT In June 2003, the Company settled early $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 as interest expense which was previously being recognized over the life of the facility. 10. SUBSEQUENT EVENTS In August 2003, subsidiaries of GTI signed share purchase agreements with JSC Korporatsiya SibChallenge, Perstel Enterprises Limited and Deleny Investments Limited to acquire 100% of the ownership interest in OOO SibChallenge Telecom, an alternative wireline operator in Krasnoyarsk, Russia which owns 100% of the issued and outstanding shares of ZAO Tel, an internet service provider in Krasnoyarsk, Russia. The share purchase agreements state that the aggregate price of the acquisition is approximately $15.0 million. The closing of the transaction is expected to occur in the third quarter of 2003 and is subject to the receipt of normal regulatory approvals and satisfaction of conditions precedent. 15 ITEM 2. 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 of the Company for the three and six months ended June 30, 2003 and June 30, 2002. This discussion should be read in conjunction with the Company's Condensed, Consolidated Financial Statements and the notes related thereto appearing elsewhere in this Report. OVERVIEW We are a leading facilities-based provider of integrated telecommunications and Internet services to businesses and other high-usage customers and telecommunications operators in 149 combined access points in Moscow, Kiev, St. Petersburg, Nizhny Novgorod and other major population centers throughout Russia and other countries of the Commonwealth of Independent States ("CIS"). We organize our operations into the four business groups, as follows: o BUSINESS AND CORPORATE SERVICES. Using our fiber optic and satellite-based networks in major metropolitan areas of Russia, Ukraine and other countries of the CIS, we provide business and corporate services including voice and data services with corporate clients across all geographical markets and all industry segments, except other telecommunications operators; o 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 with foreign and Russian telecommunications and mobile operators; o CONSUMER INTERNET SERVICES. Using our fiber optic and satellite-based network, we provide dial-up Internet access and web content offered through a family of Internet portals throughout Russia; and o 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 offer all of our integrated telecommunication services under the Golden Telecom brand and our consumer Internet services under the ROL brand in Russia. Additionally, we hold a minority interest in MCT Corp. ("MCT"), which in turn has ownership interests in 19 mobile operations located throughout Russia and in Uzbekistan and Tajikistan. 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. In August 2003, MCT concluded a binding agreement with OTJSC Mobile TeleSystems on the sale of five of its cellular operators. OTJSC Mobile TeleSystems will pay MCT $70.0 million and assume certain guarantees as part of the transaction. 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. We have traditionally 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 dollar/ruble exchange rate, so when the ruble devalues, their prices effectively become relatively cheaper than our prices. The ruble exchange rate with the dollar has become relatively stable since early 2000 and 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. Since early 2000, we have witnessed a recovery in the Russian market, but with downward pricing pressures persisting. The downward pricing pressures result from increased competition in Russia and the global trend toward lower telecommunications tariffs. In 2001 and 2002 our traffic volume increases exceeded the reduction in tariffs on certain types of voice traffic. This is a contributory factor to the increases in our revenue in 2001 and 2002. 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. 16 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 and have continued to add additional transmission capacity, which due to its fixed cost nature can initially depress margins, but will ultimately allow us to improve or maintain our margins. 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 their contracts with us. During 2002, Golden Telecom (Ukraine) ("GTU") was involved in a number of commercial disputes with Ukrtelecom and Ukrainian regulatory authorities. The most significant disputes include routing of traffic and GTU's lease rights of Ukrtelecom's technical premises. By the end of the first quarter of 2003, GTU had resolved these issues with Ukrtelecom, but it is possible that commercial disputes with Ukrtelecom and the Ukrainian authorities could resurface in the future. In February 2003, the Ukrainian Parliament overrode the President's veto and adopted changes to existing regulations relating to telecommunication services in Ukraine. The new regulations stipulate the cancellation of end-customer charges for incoming calls. These changes will come into force in six-months time, unless superseded by a new Law on Communications or over-ruled by a Constitutional Court decision. We expect that interconnect tariffs for calls from the PSTN to mobile networks to be lower than current tariffs that mobile operators charge customers for incoming calls. It is expected that mobile operators may be able to increase tariffs for outgoing calls and/or set higher monthly fees to compensate for the expected decrease in revenue. In addition to our traditional voice and data service provision, prior to 2002, we were actively pursuing a strategy of developing non-traditional telecom service offerings including those related to the Internet, such as web-hosting, web design, and vertical and horizontal Internet portal development. In line with experience outside of Russia, we did not see the rapid development of Internet based services that were expected. Internet based advertising and e-commerce revenues did not develop to significant levels and we reviewed our long term strategy for Internet based products. As a result of this review, we evaluated the future cash flows for this business, and we recorded an impairment charge of $20.9 million in the fourth quarter of 2001. We expect to see some growth in Internet based advertising and will continue to offer this service to support our dial-up Internet service and be in a position to capitalize on any upturn in demand for this service. 17 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. In June 2001 we completed the purchase of a leading Russian internet service provider, Cityline, together with Uralrelcom, another internet service provider and an infrastructure company, PTK, and together, these entities allowed us to increase our regional dial-up Internet presence and increase our numbering capacity and access lines in Moscow. The new Moscow capacity was initially placed into service in July 2002. The Moscow numbering capacity and some of the access lines provided by PTK are allocated to support Business and Corporate Services and Carrier and Operator Services division end-user customers, with the majority of the access lines being allocated to support planned increases in dial-up Internet subscribers in our Consumer Internet Services division. 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 in 2003. 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. 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. Certain revenues, such as connection fees, are deferred in accordance with Staff Accounting Bulletin ("SAB") No. 101. In connection with recording revenue, estimates and assumptions are required in determining the expected conversion of the revenue streams to cash collected. In line with guidance in SAB No. 101, 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. Allowance for doubtful accounts policies; the allowance estimation process requires management to make assumptions based on historical results, future expectations, the economic and competitive environment, changes in the creditworthiness of our customers, and other relevant factors. Changes in the underlying assumptions may have a significant impact on the results of our operations. In particular, we have certain amounts due to and from subsidiaries of a European telecommunications operator who is currently subject to bankruptcy proceedings. The ultimate resolution of this matter will be affected by a number of factors including the determination of legal obligations of each party, the course of the bankruptcy proceedings, and the enforceability of any determinations. We have recognized provisions based on our preliminary estimate of net exposure on the resolution of these receivables and payables. If our assessment proves to be incorrect we may have to recognize an additional provision of up to $1.6 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 SFAS No. 142, "Goodwill and Other Intangible Assets", on January 1, 2002, we will perform a goodwill impairment testing annually 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 18 discounted cash flow valuations performed in 2002, 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. RECENT ACCOUNTING PRONOUNCEMENTS Effective January 1, 2002, we adopted Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets." In accordance with SFAS No. 142, we discontinued the amortization of goodwill as of such date. We also reclassified to other intangible assets approximately $1.3 million previously classified as goodwill. Upon the adoption of SFAS No. 142, 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. In August 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No. 143, "Accounting for Asset Retirement Obligations." This statement deals with the costs of closing facilities and removing assets. SFAS No. 143 requires entities to record the fair value of a legal liability for an asset retirement obligation in the period it is incurred. This cost is initially capitalized and amortized over the remaining life of the asset. Once the obligation is ultimately settled, any difference between the final cost and the recorded liability is recognized as a gain or loss on disposition. SFAS No. 143 is effective for years beginning after June 15, 2002. The adoption of SFAS No. 143 did not have an impact on our consolidated financial position or results of operations. During the year ended December 31, 2002, the FASB issued several new accounting standards including, SFAS No. 145, "Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections", SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." In November 2002 the FASB also issued Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others". These standards did not have a material impact on the financial position or results of operations. In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities," which requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. This statement nullifies Emerging Issues Task Force No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)," which required that a liability for an exit cost be recognized upon the entity's commitment to an exit plan. SFAS No. 146 is effective for exit or disposal activities that are initiated after December 31, 2002. The adoption of the provisions of SFAS No. 146 did not have a material impact on our results of operations or financial position. In November 2002, the FASB issued FASB Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" ("FIN No. 45"). FIN No. 45 requires that upon issuance of a guarantee, the guarantor must recognize a liability for the fair value of the obligation it assumes under that guarantee. The disclosure provisions of FIN No. 45 are effective for financial statements of annual periods that end after December 15, 2002. The provisions for initial recognition and measurement are effective on a prospective basis for guarantees that are issued or modified after December 31, 2002. The adoption of the provisions of FIN No. 45 did not have a material impact on our results of operations or financial position. 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 earnings per share in annual and interim financial statements. While the Statement does not amend SFAS No. 123 to require companies to account for employee stock options using the fair value method, the disclosure provisions of SFAS No. 148 are applicable to all companies with stock-based employee compensation, regardless of whether they account for that compensation using the fair value method of SFAS No. 123 or the intrinsic value method of APB No. 25. SFAS No. 148 disclosure provisions are effective for years ending after December 15, 2002. We have adopted the amendments to SFAS No. 123 disclosure provisions required under SFAS No. 148 but we will continue to use the intrinsic value method under APB No. 25 to account for stock-based 19 compensation. As such, the adoption of SFAS No. 148 did not have a significant impact on our consolidated financial position or results of operations. The effect of applying SFAS No. 123 on the net income as reported is not representative of the effects on reported 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. THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ------------------- ------------------ 2002 2003 2002 2003 ------- -------- ------ -------- (IN THOUSANDS, EXCEPT PER SHARE DATA) Net income, as reported.............................. $ 2,754 $ 11,835 $8,960 $ 24,655 Deduct: total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects.......... 2,263 867 4,500 1,736 ------- -------- ------ -------- Pro forma net income................................. $ 491 $ 10,968 $4,460 $ 22,919 ======= ======== ====== ======== Net income per share: Basic - as reported................................. $ 0.12 $ 0.43 $ 0.40 $ 0.90 Basic - pro forma................................... 0.02 0.40 0.20 0.84 Diluted - as reported............................... 0.12 0.42 0.39 0.89 Diluted - pro forma................................. 0.02 0.39 0.19 0.82 In January 2003, the FASB issued FIN No. 46, "Consolidation of Variable Interest Entities". FIN No. 46 defines the concept of "variable interest" and requires existing unconsolidated variable interest entities to be consolidated into the financial statement of their primary beneficiaries if the variable interest entities do not effectively disperse risks among the parties involved. FIN No. 46 applies immediately to variable interest entities created after January 31, 2003. It applies in the first fiscal year or interim period beginning after June 15, 2003, to variable interest entities in which an enterprise holds a variable interest that it acquires before February 1, 2003. If it is reasonably possible that an enterprise will consolidate or disclose information about a variable interest entity when FIN No. 46 becomes effective, the enterprise must disclose information about those entities in all financial statements issued after January 31, 2003. As of the date of this report, there were no such entities created after January 31, 2003. The interpretation may be applied prospectively with a cumulative-effect adjustment as of the date on which it is first applied or by restating previously issued financial statements for one or more years, with a cumulative-effect adjustment as of the beginning of the first year restated. The adoption of the remaining provisions of FIN No. 46 are not expected to have a material impact on our results of operations or financial positions. 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. The new guidance amends SFAS No. 133 for decisions made: (a) as part of the Derivatives Implementation Group process that effectively required amendments to SFAS No. 133, (b) in connection with other Board projects dealing with financial instruments, and (c) regarding implementation issues raised in relation to the application of the definition of derivative. The amendments set forth in SFAS No. 149 improve financial reporting by requiring that contacts with comparable characteristics be accounted for similarly. 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 are not expected to have an impact on our results of operations or financial position. 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 is not expected to have an impact on our results of operations or financial position. 20 RESULTS OF OPERATIONS GTI is a leading facilities-based provider of integrated telecommunications and Internet services to businesses and other high-usage customers and telecommunications operators in Moscow, Kiev, St. Petersburg, Nizhny Novgorod and other major population centers throughout Russia and other countries of the Commonwealth of Independent States. The results of our four business groups 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 footnote 6 "Segment Information - Line of Business Data" to our condensed, consolidated financial statements. Our functional currency is the US dollar, as the majority of our cash flows are indexed to, or denominated in US dollars. 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. As we currently believe our functional currency is the US dollar, we do not expect this change to have a material impact on our results of operations or financial position. 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 in 2003. 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: o Consolidated Results of Operations. Consolidated Results of Operations for the Three Months Ended June 30, 2003 compared to the Consolidated Results of Operations for the Three Months Ended June 30, 2002. o Consolidated Results of Operations. Consolidated Results of Operations for the Six Months Ended June 30, 2003 compared to the Consolidated Results of Operations for the Six Months Ended June 30, 2002. o Consolidated Financial Positions. Significant changes in Consolidated Financial Position at June 30, 2003 compared to the Consolidated Financial Position at December 31, 2002. CONSOLIDATED RESULTS -- CONSOLIDATED RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED JUNE 30, 2003 COMPARED TO THE CONSOLIDATED RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED JUNE 30, 2002 REVENUE Our revenue increased by 106% to $80.7 million for the three months ended June 30, 2003 from $39.2 million for the three months ended June 30, 2002. The breakdown of revenue by business group was as follows: CONSOLIDATED REVENUE CONSOLIDATED REVENUE FOR THE THREE MONTHS FOR THE THREE MONTHS ENDED JUNE 30, 2002 ENDED JUNE 30, 2003 -------------------- -------------------- (IN MILLIONS) REVENUE Business and Corporate Services...... $ 16.5 $ 43.6 Carrier and Operator Services........ 14.8 26.8 Consumer Internet Services........... 5.0 7.2 Mobile Services...................... 3.3 3.6 Eliminations......................... (0.4) (0.5) ------ ------ TOTAL REVENUE......................... $ 39.2 $ 80.7 21 Business and Corporate Services. Revenue from Business and Corporate Services increased by 164% to $43.6 million for the three months ended June 30, 2003 from $16.5 million for the three months ended June 30, 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. Revenue for the Business and Corporate Services division of Golden Telecom BTS increased by 7% to $4.5 million for the three months ended June 30, 2003 from $4.2 million for the three months ended June 30, 2002. The increase in revenue was due to an increase in monthly recurring charges and increase in the total of minutes of use by business and corporate clients offset by lower equipment sales. Carrier and Operator services. Revenue from Carrier and Operator Services increased by 81% to $26.8 million for the three months ended June 30, 2003 from $14.8 million for the three months ended June 30, 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. Revenue for the Carrier and Operator Services division of Golden Telecom BTS increased by 108% to $2.5 million for the three months ended June 30, 2003 from $1.2 million for the three months ended June 30, 2002. The increase in revenue was due to an increase in monthly recurring charges and the termination of increasing volumes of incoming international traffic due to an increase in the number of cities in Ukraine licensed to perform these activities. Consumer Internet Services. Revenue from Consumer Internet Services increased by 44% to $7.2 million for the three months ended June 30, 2003 from $5.0 million for the three months ended June 30, 2002. The increase is largely the result of increases in the number of dial-up Interest subscribers from 182,555 at June 30, 2002 to 280,243 at June 30, 2003. The average revenue per dial-up Internet subscriber increased from approximately $8.13 per month to approximately $8.17 per month over the same period. Mobile Services. Revenue from Mobile Services increased by 9% to $3.6 million for the three months ended June 30, 2003 from $3.3 million for the three months ended June 30, 2002. Active subscribers increased from 36,246 at June 30, 2002 to 36,314 at June 30, 2003 and the average revenue per active subscriber has increased by 7% to approximately $31.46 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. EXPENSES The following table shows our principal expenses for the three months ended June 30, 2003 and June 30, 2002: CONSOLIDATED EXPENSES CONSOLIDATED EXPENSES FOR THE THREE MONTHS FOR THE THREE MONTHS ENDED JUNE 30, 2002 ENDED JUNE 30, 2003 --------------------- --------------------- (IN MILLIONS) COST OF REVENUE Business and Corporate Services .. $ 9.8 $ 18.9 Carrier and Operator Services .... 3.8 15.6 Consumer Internet Services ....... 3.7 4.8 Mobile Services .................. 0.7 0.6 Eliminations ..................... (0.4) (0.5) -------------- --------------- TOTAL COST OF REVENUE ............. 17.6 39.4 Selling, general and administrative .................. 10.2 13.3 Depreciation and amortization ..... 6.3 10.5 Equity in losses of ventures ...... 1.2 0.1 Interest income ................... (0.3) (0.3) Interest expense .................. 0.3 0.9 Foreign currency loss ............. 0.2 -- Provision for income taxes ........ $ 0.8 $ 4.8 Cost of Revenue Our cost of revenue increased by 124% to $39.4 million for the three months ended June 30, 2003 from $17.6 million for the three months ended June 30, 2002. 22 Business and Corporate Services. Cost of revenue from Business and Corporate Services increased by 93% to $18.9 million, or 43% of revenue, for the three months ended June 30, 2003 from $9.8 million, or 59% of revenue, for the three months ended June 30, 2002. The decrease in cost of revenue as a percentage of revenue 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. Cost of revenue for the Business and Corporate Services division of Golden Telecom BTS increased by 5% to $2.1 million, or 47% of revenue, for the three months ended June 30, 2003 from $2.0 million, or 48% of revenue, for the three months ended June 30, 2002. Carrier and Operator Services. Cost of revenue from Carrier and Operator Services increased by 311% to $15.6 million, or 58% of revenue, for the three months ended June 30, 2003 from $3.8 million, or 26% of revenue, for the three months ended June 30, 2002. The increase in cost of revenue as a percentage of revenue 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, increased competition in this market, and the substitution of high margin sales of dedicated channels to lower margin services, such as voice of Internet protocol. Cost of revenue for the Carrier and Operator Services division of Golden Telecom BTS increased by 125% to $1.8 million, or 72% of revenue, for the three months ended June 30, 2003 from $0.8 million, or 67% of revenue, for the three months ended June 30, 2002. Cost of revenue increased as a percentage of revenue due to the increased volumes of certain lower margin international incoming traffic revenue. Consumer Internet Services. Cost of revenue from Consumer Internet Services increased by 30% to $4.8 million, or 67% of revenue, for the three months ended June 30, 2003 from $3.7 million, or 74% of revenue, for the three months ended June 30, 2002. The decrease in cost of revenue as a percentage of revenue was mainly due to additional low cost local interconnect capacity becoming available in the third quarter of 2002. Mobile Services. Cost of revenue from Mobile Services decreased by 14% to $0.6 million, or 17% of revenue, for the three months ended June 30, 2003 from $0.7 million, or 21% of revenue, for the three months ended June 30, 2002. The decrease in cost of revenue as a percentage of revenue was mainly 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 30% to $13.3 million, or 16% of revenue, for the three months ended June 30, 2003 from $10.2 million, or 26% of revenue, for the three months ended June 30, 2002. This increase in selling, general and administrative expenses was mainly due to increases in employee related costs, advertising, and other selling, general and administrative expenses arising from the consolidation of Sovintel from September 17, 2002 into our results of operations. Depreciation and Amortization Our depreciation and amortization expenses increased by 67% to $10.5 million for the three months ended June 30, 2003 from $6.3 million for the three months ended June 30, 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. Equity in Losses of Ventures The losses after interest and tax charges from our investments in non-consolidated ventures were $0.1 million for the three months ended June 30, 2003 an improvement from losses of $1.2 million for the three months ended June 30, 2002. Our recognized looses from MCT more than offset recognized earnings at Sovintel of $3.0 million for the three months ended June 30, 2002. The primary decrease in equity in losses was due to writing down our investment in MCT to zero in the second quarter of 2002 thereby recognizing no more losses from this equity investee and 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. 23 Interest Income Our interest income was $0.3 million for the three months ended June 30, 2003 level which was with $0.3 million for the three months ended June 30, 2002. Interest Expense Our interest expense was $0.9 million for the three months ended June 30, 2003 up from $0.3 million for the three months ended June 30, 2002. The increase in the overall interest expense mainly reflects the effect of higher average balances of debt, including capital leases. Debt, excluding capital lease obligations, at June 30, 2003 was $2.2 million compared to $4.4 million at June 30, 2002. On June 30, 2003, we settled $30.0 million of outstanding debt plus accrued interest under a credit facility with ZAO Citibank. We drew upon this credit facility in the fourth quarter of 2002 to retire $30.0 million of the $46.0 million non-interest bearing promissory note issued to Rostelecom in connection with the acquisition of the remaining 50% ownership interest in Sovintel. 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 Gain / Loss Our foreign currency gain was negligible for the three months ended June 30, 2003, compared to a foreign currency loss of $0.2 million for the three months ended June 30, 2002. The improvement in foreign currency loss to a negligible foreign currency gain is due to a combination of movements in exchange rates and changes in the amount of net monetary assets that we have denominated in foreign currencies. Provision for Income Taxes Our charge for income taxes was $4.8 million for the three months ended June 30, 2003 compared to $0.8 million for the three months ended June 30, 2002. Our effective tax rate was 29% for the three months ended June 30, 2003 compared to 23% for the three months ended June 30, 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 three months ended June 30, 2003 as compared to the three months ended June 30, 2002. By the fourth quarter of 2002, we had recognized the full amount of carry-forward tax losses at our wholly-owned Russian subsidiary, Teleross, which previously had been recognized on a quarterly basis. Net Income and Net Income per Share Our net income for the three months ended June 30, 2003 was $11.8 million, compared to a net income of $2.8 million for the three months ended June 30, 2002. Our net income per share of common stock increased to $0.43 for the three months ended June 30, 2003, compared to a net income per share of $0.12 for the three months ended June 30, 2002. The increase in net income per share of common stock was due to the increase in net income and offset by an increase in the number of weighted average shares to 27,479,784 in the three months ended June 30, 2003, compared to 22,652,912 in the three months ended June 30, 2002. Our net income per share of common stock on a fully diluted basis increased to $0.42 for the three months ended June 30, 2003, compared to a net income per common share of $0.12 for the three months ended June 30, 2002. The increase in net income per share of common stock on a fully diluted basis was due to the increase in net income and offset by an increase in the number of weighted average shares assuming dilution to 28,289,228 for the three months ended June 30, 2003, compared to 23,395,879 for the three months ended June 30, 2002. 24 CONSOLIDATED RESULTS -- CONSOLIDATED RESULTS OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2003 COMPARED TO THE CONSOLIDATED RESULTS OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2002 REVENUE Our revenue increased by 110% to $159.1 million for the six months ended June 30, 2003 from $75.6 million for the six months ended June 30, 2002. The breakdown of revenue by business group was as follows: CONSOLIDATED REVENUE CONSOLIDATED REVENUE FOR THE SIX MONTHS FOR THE SIX MONTHS ENDED JUNE 30, 2002 ENDED JUNE 30, 2003 -------------------- -------------------- (IN MILLIONS) REVENUE Business and Corporate Services .. $ 32.1 $ 82.6 Carrier and Operator Services .... 27.3 56.6 Consumer Internet Services ....... 10.5 14.3 Mobile services .................. 6.6 6.8 Eliminations ..................... (0.9) (1.2) ----------- ----------- TOTAL REVENUE ..................... $ 75.6 $ 159.1 Business and Corporate Services. Revenue from Business and Corporate Services increased by 157% to $82.6 million for the six months ended June 30, 2003 from $32.1 million for the six months ended June 30, 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. Revenue for the Business and Corporate Services division of Golden Telecom BTS increased by 10% to $8.8 million for the six months ended June 30, 2003 from $8.0 million for the six months ended June 30, 2002. The increase in revenue was due to an increase in monthly recurring charges and increase in the total of minutes of use by business and corporate clients offset by lower equipment sales. Carrier and Operator services. Revenue from Carrier and Operator Services increased by 107% to $56.6 million for the six months ended June 30, 2003 from $27.3 million for the six months ended June 30, 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. Revenue for the Carrier and Operator Services division of Golden Telecom BTS increased by 87% to $4.3 million for the six months ended June 30, 2003 from $2.3 million for the six months ended June 30, 2002. The increase in revenue was due to an increase in monthly recurring charges and the termination of increased volumes of incoming international traffic due to an increase in the number of cities in Ukraine licensed to perform these activities. Consumer Internet Services. Revenue from Consumer Internet Services increased by 36% to $14.3 million for the six months ended June 30, 2003 from $10.5 million for the six months ended June 30, 2002. The increase is largely the result of increases in the number of dial-up Internet subscribers from 182,555 at June 30, 2002 to 280,243 at June 30, 2003. The average revenue per dial-up Internet subscriber decreased from approximately $8.98 per month to approximately $8.28 per month over the same period. Mobile Services. Revenue from Mobile Services increased by 3% to $6.8 million for the six months ended June 30, 2003 from $6.6 million for the six months ended June 30, 2002. Active subscribers increased from 36,246 at June 30, 2002 to 36,314 at June 30, 2003 and the average revenue per active subscriber has increased by 14% to approximately $33.57 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. EXPENSES The following table shows our principal expenses for the six months ended June 30, 2003 and June 30, 2002: 25 CONSOLIDATED EXPENSES CONSOLIDATED EXPENSES FOR THE SIX MONTHS FOR THE SIX MONTHS ENDED JUNE 30, 2002 ENDED JUNE 30, 2003 --------------------- --------------------- (IN MILLIONS) COST OF REVENUE Business and Corporate Services ..... $ 18.5 $ 35.6 Carrier and Operator Services ....... 6.8 31.7 Consumer Internet Services .......... 7.1 9.5 Mobile services ..................... 1.5 1.1 Eliminations ........................ (0.9) (1.2) ----------- ----------- TOTAL COST OF REVENUE ................ 33.0 76.7 Selling, general and administrative .. 19.9 26.8 Depreciation and amortization ........ 12.3 20.9 Equity in losses (earnings) of ventures ......................... (0.5) -- Interest income ...................... (0.8) (0.6) Interest expense ..................... 0.9 1.6 Foreign currency loss (gain) ........ 0.5 (0.2) Provision for income taxes ........... 2.1 9.0 Cost of Revenue Our cost of revenue increased by 132% to $76.7 million for the six months ended June 30, 2003 from $33.0 million for the six months ended June 30, 2002. Business and Corporate Services. Cost of revenue from Business and Corporate Services increased by 92% to $35.6 million, or 43% of revenue, for the six months ended June 30, 2003 from $18.5 million, or 58% of revenue, for the six months ended June 30, 2002. The decrease as a percentage of revenue 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. Cost of revenue for the Business and Corporate Services division of Golden Telecom BTS increased by 8% to $4.1 million, or 47% of revenue, for the six months ended June 30, 2003 and was $3.8 million, or 48% of revenue, for the six months ended June 30, 2002. Carrier and Operator Services. Cost of revenue from Carrier and Operator Services increased by 366% to $31.7 million, or 56% of revenue, for the six months ended June 30, 2003 from $6.8 million, or 25% of revenue, for the six months ended June 30, 2002. The increase as a percentage of revenue 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, increased competition in this market, and the substitution of high margin sales of dedicated channels to lower margin services, such as voice of Internet Protocol. Cost of revenue for the Carrier and Operator Services division of Golden Telecom BTS increased by 93% to $2.9 million, or 67% of revenue, for the six months ended June 30, 2003 and was $1.5 million, or 65% of revenue, for the six months ended June 30, 2002. Cost of revenue increased as a percentage of revenue due to the increased of lower margin international incoming traffic. Consumer Internet Services. Cost of revenue from Consumer Internet Services increased by 34% to $9.5 million, or 66% of revenue, for the six months ended June 30, 2003 from $7.1 million, or 68% of revenue, for the six months ended June 30, 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 27% to $1.1 million, or 16% of revenue, for the six months ended June 30, 2003 from $1.5 million, or 23% of revenue, for the six months ended June 30, 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 35% to $26.8 million, or 17% of revenue, for the six months ended June 30, 2003 from $19.9 million, or 26% of revenue, for the six months ended June 30, 2002. This increase in selling, general and administrative expenses was mainly due to increases in employee related costs, advertising, and other selling, general and administrative expenses arising from the consolidation of Sovintel from September 17, 2002 into our results of operations. 26 Depreciation and Amortization Our depreciation and amortization expenses increased by 70% to $20.9 million for the six months ended June 30, 2003 from $12.3 million for the six months ended June 30, 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. Equity in Earnings of Ventures The earnings after interest and tax charges from our investments in non-consolidated ventures was negligible for the six months ended June 30, 2003 down from earnings of $0.5 million for the six months ended June 30, 2002. We recognized earnings at Sovintel of $6.0 million for the six months ended June 30, 2002, which more than offset our recognized losses in MCT. The decrease in equity in earnings was due to the acquisition of the remaining 50% of Sovintel and its subsequent consolidation as of September 17, 2002 into our results of operations partly offset by writing down our investment in MCT to zero in the second quarter of 2002 thereby recognizing no more losses from this equity investee. Interest Income Our interest income was $0.6 million for the six months ended June 30, 2003 down from $0.8 million for the six months ended June 30, 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 $1.6 million for the six months ended June 30, 2003 up from $0.9 million for the six months ended June 30, 2002. The increase in overall interest expense mainly reflects the effect of higher average balances of debt, including capital leases. Debt, excluding capital lease obligations, at June 30, 2003 was $2.2 million compared to $4.4 million at June 30, 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 Gain / Loss Our foreign currency gain was $0.2 million for the six months ended June 30, 2003, compared to a foreign currency loss of $0.5 million for the six months ended June 30, 2002. The improvement in foreign currency loss to foreign currency gain 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. Provision for Income Taxes Our charge for income taxes was $9.0 million for the six months ended June 30, 2003 compared to $2.1 million for the six months ended June 30, 2002. Our effective tax rate was 27% for the six months ended June 30, 2003 compared to 23% for the six months ended June 30, 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 six months ended June 30, 2003 as compared to the six months ended June 30, 2002. By the fourth quarter of 2002, we had recognized the full amount of carry-forward tax losses at our wholly-owned Russian subsidiary, Teleross, which previously had been recognized on a quarterly basis. 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 six months ended June 30, 2003. 27 Net Income and Net Income per Share Our net income for the six months ended June 30, 2003 was $24.7 million, compared to a net income of $9.0 million for the six months ended June 30, 2002. Our net income per share of common stock increased to $0.90 for the six months ended June 30, 2003, compared to a net income per share of $0.40 for the six months ended June 30, 2002. The increase in net income per share of common stock was due to the increase in net income and offset by an increase in the number of weighted average shares to 27,271,078 in the six months ended June 30, 2003, compared to 22,593,244 in the six months ended June 30, 2002. Our net income per share of common stock on a fully diluted basis increased to $0.89 for the six months ended June 30, 2003, compared to a net income per common share of $0.39 for the six months ended June 30, 2002. The increase in net income per share of common stock on a fully diluted basis was due to the increase in net income and offset by an increase in the number of weighted average shares assuming dilution to 27,835,614 the six months ended June 30, 2003, compared to 23,061,724 for the six months ended June 30, 2002. CONSOLIDATED FINANCIAL POSITION -- SIGNIFICANT CHANGES IN CONSOLIDATED FINANCIAL POSITION AT JUNE 30, 2003 COMPARED TO CONSOLIDATED FINANCIAL POSITION AT DECEMBER 31, 2002 Accounts Receivable Accounts receivable increased from December 31, 2002 to June 30, 2003 as a result of increased revenue during the period ended June 30, 2003 and delays in timing of certain cash collections as we commenced integrating customer databases and billing information from TeleRoss into Sovintel. Debt Obligations Our debt position decreased at June 30, 2003 as compared to December 31, 2002 as a result of retiring our debt that consisted mainly of ROL Holdings Citibank Credit Facility of $30.0 million. Stockholders' Equity Shareholders' equity increased from December 31, 2002 to June 30, 2003 as a result of our net income of $24.7 million and proceeds of approximately $8.0 million received from the exercise of 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; and (2) amortization of certain acquired intangible assets is not deductible for income tax purposes. We have not recorded a tax benefit in relation to our US net operating loss carry-forward amount as our taxable US income is largely comprised of interest income and dividends which we do not expect to continue over the longer term. In 2002, as a result of our Russian and Ukrainian subsidiaries profitability for Russian and Ukrainian statutory purposes and reasonable certainty of future profits, we recorded deferred tax assets in the respective Russian and Ukrainian subsidiaries. LIQUIDITY AND CAPITAL RESOURCES Our cash and cash equivalents were $55.3 million and $59.6 million as of June 30, 2003 and December 31, 2002, respectively. Our total restricted cash was $1.1 million and $1.5 million as of June 30, 2003, and December 31, 2002, respectively. The restricted cash is maintained in connection with certain of our debt obligations as described below. 28 During the six months ended June 30, 2003 we had net cash inflows of $45.7 million from our operating activities. During the six months ended June 30, 2002, we had net cash inflows of $19.4 million from our operating activities. This increase in net cash inflows from operating activities at June 30, 2003 is mainly due to the increase in net income, increased revenues, and the consolidation of Sovintel into our results of operations and financial position from September 17, 2002. We used cash of $26.2 million for investing activities for the six months ended June 30, 2003 which were principally attributable to building our telecommunications networks. We had cash inflows of $1.8 million from investing activities for the six months ended June 30, 2002 which were principally attributable to proceeds received from investments available for sale, partially offset by cash outflows attributable to building our telecommunications networks. Network investing activities totaled $27.8 million for the six months ended June 30, 2003 and included capital expenditures principally attributable to building out our telecommunications network and the purchase of additional numbering capacity. Network investing activities totaled $10.0 million for the six months ended June 30, 2002 and included capital expenditures principally attributable to building our telecommunications network. For the six months ended June 30, 2002, we recovered funds from escrow of $3.0 million in association with our acquisition of PTK in June 2001. We had working capital of $60.9 million as of June 30, 2003 and $56.5 million as of December 31, 2002. At June 30, 2003, we had total debt, excluding capital lease obligations, of approximately $2.2 million, of which $1.4 million were current maturities. At December 31, 2002, we had total debt, excluding capital lease obligations, of approximately $33.1 million, of which $9.0 million were current maturities. Total debt includes amounts that were fully collateralized by restricted cash. At June 30, 2003 and December 31, 2002 none of our debt was at fixed interest rates. In June 2003, we settled early $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 as interest expense which was previously being recognized over the life of the facility. 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 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 June 30, 2003 for all these facilities totaled $1.1 million, of which $0.3 million was funded to our consolidated subsidiaries and $0.8 million was funded to our non-consolidated entities. In order for us to compete successfully, we may require substantial capital to continue to develop our networks and meet the funding requirements of our operations and ventures, including possible losses from operations. We may also require capital for our acquisition and business development initiatives. The net proceeds from our IPO, our private placement and our operating cash flows have been applied to these funding requirements. We also expect to fund these requirements through additional cash flow from operations, proceeds from additional equity and debt offerings that we may conduct, and debt financing facilities. In the future, we may execute especially large or numerous acquisitions, which may require us to raise additional funds through a dilutive equity issuance, through additional borrowings with collateralization and through the divestment of non-core assets, or combinations of the above. In the case especially large or numerous acquisitions do not materialize, we expect our current sources of funding to finance our capital requirements for the next 12 to 18 months. The actual amount and timing of our future capital requirements may differ materially from our current estimates because of changes or fluctuations in our anticipated acquisitions, investments, revenue, operating costs and network expansion plans and access to alternative sources of financing on favorable terms. Further, in order for us to compete successfully, we may require substantial capital to continue to develop our networks and meet the funding requirements of our operations and ventures, including any possible losses from operations. We will also require capital for other acquisition and business development initiatives. We expect to fund these requirements through our cash on hand, cash flow from operations, proceeds from additional equity and debt offerings that we may conduct, and debt financing facilities. 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. 29 As part of our drive to increase our network capacity, reduce costs and improve the quality of our service, we have leased additional fiber optic and satellite-based network capacity. The terms of these leases are generally five years or more and can involve significant advance payments. As demand for our telecommunication services increases we expect to enter into additional capacity agreements and may make significant financial commitments, in addition to our existing commitments. As of June 30, 2003, 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) LESS 1 - 3 4 - 5 TOTAL THAN 1 YEAR YEARS YEARS ----------- ----------- ----------- ----------- Short- and long-term debt .... $ 2,159 $ 1,399 $ 525 $ 235 Capital lease obligations .... 6,529 1,859 4,277 393 Non-cancelable lease obligations ................. 3,273 1,348 1,925 -- Purchase obligations ......... 10,967 5,292 5,675 -- ----------- ----------- ----------- ----------- Total contractual cash obligations ................. $ 22,928 $ 9,898 $ 12,402 $ 628 =========== =========== =========== =========== SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS Certain statements contained in "Management's Discussion and Analysis of Financial Condition and Results of Operations" and other parts of this document, including, without limitation, those concerning (i) future acquisitions and capital expenditures, including our plans to fund such acquisitions and capital expenditures (ii) projected traffic volumes, tariff levels, subscriber numbers and other growth indicators; (iii) anticipated revenues and expenses, including taxes; (iv) the Company's competitive environment; (v) the Company's potential liability for litigation; (vi) the Company's future tax liability; (vii) future performance of consolidated and equity method investments; (viii) the anticipated effect of recent accounting pronouncements; (ix) recognition of doubtful accounts and (x) the political, regulatory and financial situation in the markets in which we operate, 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 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, the political, economic and legal environment in the markets in which the Company operates, 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 the Company's filings with the U.S. Securities and Exchange Commission ("SEC") and especially in the Risk Factor sections therein, including, but not limited to the Company's report on Form 10-K for the year ended December 31, 2002. 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 30 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. ITEM 4. CONTROLS AND PROCEDURES Evaluation of Controls and Procedures The Company maintains disclosure controls and procedures, which have been designed to ensure that material information related to Golden Telecom, Inc. including its consolidated and non-consolidated subsidiaries, is made known to a disclosure committee on a regular basis. In response to recent legislation and proposed regulations, the Company has reviewed the internal control structure and disclosure controls and procedures pursuant to Rule 13a-14 and 15(d)-14(c) under the Securities and Exchange Act of 1934, as amended. Although the Company believes that the pre-existing disclosure controls and procedures were adequate to enable the Company to comply with the Company's disclosure obligations, as a result of such review, the Company implemented minor changes, primarily to formalize and document certain procedures already in place. The Company also established a disclosure committee comprised of certain members of the Company's senior management. As of June 30, 2003, the disclosure committee carried out an evaluation, under the supervision and with the participation of the Company's management, including the Company's Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures are effective in causing material information to be recorded, processed, summarized, and reported by management of the Company on a timely basis and to ensure that the quality and timeliness of the Company's public disclosures complies with the SEC disclosure requirements. Changes in Controls and Procedures There were no significant changes in the Company's internal controls or in other factors that could significantly affect these internal controls after the date of our most recent evaluation. 31 PART II. OTHER INFORMATION ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS On May 20, 2003, the Company held its annual meeting of shareholders. In connection with the meeting, the Company solicited proxies pursuant to Regulation 14 under the Securities Exchange Act of 1934 from holders of record of its common stock as of March 28, 2003. Each of the Company's nine nominees for election to its Board of Directors was elected to a term ending at the Company's annual meeting of shareholders to be held in 2004. One additional proposal was submitted to shareholders for approval and was approved. (1) The votes cast for each of the Company's nine nominees for election to the GTI's Board of Directors were as follows: NOMINEE FOR WITHHELD -------------------------- ----------------- ------------- Stan M. Abbeloos 25,106,646 409 Vladimir Androsik 25,106,046 1,009 Peter Aven 25,106,646 409 Michael Calvey 25,106,646 409 Ashley Dunster 25,106,646 409 David Herman 25,106,646 409 Andrey Kosogov 25,106,646 409 Michael North 25,106,046 1,009 Alexander Vinogradov 25,106,046 1,009 (2) Ratification of selection of Ernst & Young (CIS) Limited as the Company's independent auditors for 2003 - FOR 25,102,058 shares; AGAINST 4,997 shares; ABSTAIN 0 shares. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K a) Exhibits DESIGNATION DESCRIPTION ----------- ----------- 31.1 Certification of the Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 31.2 Certification of the Principal 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 b) Reports on Form 8-K DATE OF REPORT SUBJECT OF REPORT -------------- ----------------- April 28, 2003 Golden Telecom, Inc. announces its first quarter 2003 results. May 16, 2003 Golden Telecom, Inc. announces signing of a Memorandum of Understanding to acquire 100% ownership interest in OOO Sibchallenge Telecom and 100% of the issued and outstanding shares of ZAO Tel. June 25, 2003 Golden Telecom, Inc. announces holding preliminary discussions with Telenor over the possible acquisition of 100% of OOO Comincom in exchange for newly issued shares of GTI and the proposed underwritten offering of GTI Common Stock by certain of GTI's stockholder's. 32 SIGNATURES Pursuant to the requirements of the Securities Exchange Act 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. GOLDEN TELECOM, INC. (Registrant) By: /s/ DAVID STEWART ------------------------------------- Name: David Stewart Title: Chief Financial Officer and Treasurer (Principal Financial Officer) By: /s/ MICHAEL D WILSON ------------------------------------- Name: Michael D. Wilson Title: Corporate Controller (Principal Accounting Officer) Date: August 13, 2003 33 INDEX TO EXHIBITS EXHIBIT NUMBER DESCRIPTION -------- ----------- 31.1 Certification of the Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 31.2 Certification of the Principal 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