Mobile TeleSystems Public Joint Stock Company
Q2 2016 Earnings Call Transcript

Published: 18 Aug 2016

[Operator:]

Good day, ladies and gentlemen, and welcome to the Mobile TeleSystems’ Second Quarter 2016 Financial and Operating Results Conference Call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Joshua Tulgan. Please go ahead, sir.

[Joshua Tulgan:]

Good evening ladies and gentlemen. Welcome MTS’s conference call to discuss the Company's Second Quarter 2016 Financial and Operating Results. As always, before beginning our discussion, I am compelled to remind everyone that except for historical information, any statements made during this call may constitute forward-looking statements which may involve certain risks. These statements may relate to one of the following issues

[Andrei Dubovskov:]

Ladies and gentlemen, thank you for joining us on today's conference call to discuss the Company's financial and operating results for the second quarter 2016. Joining me today are Alexey Kornya, Vice President Finance, Investments and M&A Chief Financial Officer; Vasyl Latsanych, Vice President Strategy and Marketing; and new member of our team, Kirill Dmitriev, Vice President, he is responsible for Sales in our company. For Q2, we are pleased to report strong top-line growth of 5.3%. Total Group revenue increased to RUB 108.1 billion. Factors that have allowed us to build on our successful 3D strategy and set the pace for the market include strong retail sales as we effectively manage sustained aggressive behavior in distribution markets in Russia, stable service revenue despite ongoing weaker usage in certain mobile market segments, growth in B2C home internet and pay-tv markets despite continued declines in our fixed-voice segment, and growth in Ukraine through steady adoption of 3G data services. Macroeconomic factors and competitive issues continue to impact our performance in many ways, in particular voice and messaging usage in roaming, but in sum, our Group revenue performance currently out-paces the market. OIBDA performance was slightly weaker in Q2 than anticipated as we witnessed 4.3% decline in OIBDA for OIBDA margins of nearly 38%. Our guidance for the year was predicated on changes in the retail environment, but so far we have seen only sustained aggressive behavior in the retail space. Retail competition hurt both the gross margin and OIBDA directly, but it also has a sustained impact on effective pricing. These factors combined with the continuous macroeconomic volatility throughout our markets dampened our performance for the period. Now I turn the call over to Vasyl who will further elaborate on our revenue performance within our business units.

[Vasyl Latsanych:]

Thank you, Andrei. Good day ladies and gentlemen. For the period, total revenue in Russia increased by 3.3% to RUB 97.4 billion. Our mobile business revenue grew slightly during the period as we see a continuation of trends that has previously defined our growth amongst those, stronger data usage due to both the growth of the customer usage and migration to data plan as smartphone penetration reached over 51%. 3.2% growth in subscribers as we focus more in sales to our proprietary retail channel and higher handset sales as we continue to implement our retail strategy of upgrading existing feature phone users, as well as attracting new active voice and data users. In Russia, we continued to defend our market share by executing on our strategy of expanding of own retail footprint and promoting lower priced smartphones. We still believe that it will be clearly in the best interest of the markets to work to reduce overall SIM card sales and focus more on sales through mono brand channels, which would reduce pricing pressure and improve profitability for all operators. As we have long demonstrated, we continued to improve market share despite selling fewer SIM cards than our competitors. In our fixed-line business, revenue decreased by 2.8% to RUB 15.3 billion. We see continuous growth from our B2C broadband and Pay-TV market as market shares in Moscow in both home internet and Pay-TV rose. However, overall B2B and B2G spending has fallen down due to macroeconomical factors, which reduced overall voice calling. In Ukraine, revenue for the period increased by 13.5% to UAH 2.7 billion. Key drivers include an increase of subscribers and data consumption, which is rising as we have rolled out 3G to all major population centers throughout Ukraine. Among our foreign subsidiaries, revenue in Armenia declined 18.6% year-over-year, while in Turkmenistan, we saw a 7.5% decline. Both markets remain exposed to macroeconomic trends which continued to weaken voice and data usage. I will now hand over to Alexey Kornya, who will discuss the Group’s profitability and financial performance in more details.

[Alexey Kornya:]

Thank you, Vasyl. As Andrei noted, we witnessed the decline in year-over-year Group EBITDA of 4.3 to RUB 40.9 billion, while the decline we have seen in the contribution from our foreign subsidiaries have stabilized, Russia witnessed OIBDA decline due to factors we have long identified as having a negative impact on our OIBDA this year. In Russia, OIBDA declined by 3.7% to RUB 39.7 billion, two factors primarily shows our OIBDA, currency depreciation year-over-year, in particular the ruble with euro and the impact of roaming call cost and our retail expansion and that forced to manage the increased competition within the marketplace. Through the first half of 2016, we opened an additional 500 stores in our large retail footprint combined with our aggressive pricing in handsets the marginals which fell to 10% contributed due to the decline in OIBDA. Likewise, higher roaming cost due to relative weakness of the ruble for the period in relation to 2015 contributed most to our OIBDA margin declined achieving 40.8%. Overall, for the first half of 2016, we are only down 2.2% on OIBDA which is close to our previous guidance of minus 2%. This we anticipated, as we have seen so far no improvement in the competitive environment. Underlying trends remain structurally sound. OIBDA rate deterioration derived primarily from a rational retail activity unlike other markets without the substitution of new entrants or regulatory factors pressured profitability. We also see significant pressure from roaming both decreased usage and higher cost due to currency volatility that will continue to impact OIBDA in the third quarter. However, we see all that, we accomplished what we needed to do in implementing our retail strategy and we hope that the market takes steps towards repair in the second half of 2016. In Ukraine, OIBDA declined to UAH 827 million, we continue to reduce marginality of our revenue due to tariffs that promote international dialing and cost related to the rollout of our 3G network. Another significant factor is rebranding costs including licensing fees as we continue to rebrand the business of Vodafone Ukraine. We believe that profitability can eventually return in Ukraine – to Ukraine and in the second half 2016, we will see better profitability in Ukraine than in the first half of this year. OIBDA trends in Armenia reflects trailing new trends as we see customer usage impacted by the weakened economy through a reduction of international dialing and roaming. Macroeconomic factors also continued to put pressure on marginality in Turkmenistan with OIBDA declined 17.2% year-over-year. Group net profits for the period decreased year-over-year to RUB 9.1 billion, primarily this decline was attributable to a number of factors including OIBDA trends, the accelerated realization of up to RUB 3.1 billion of interest expense due to our repurchase of US$267 million of our 2020 bond – Eurobonds notes. A smaller non-cash Forex gain compared to the second half 2015 of roughly RUB 1 billion for the period due to the relative ruble weakness vis-à-vis our non-ruble denominated debt. Free cash flow to-date amounted to RUB 24 billion, an increase of 22% year-over-year for the period. CapEx include nearly RUB 40 billion, lower than in first half 2015 but in line with our guidance of RUB 85 billion for the year. Spending is lower in each of our markets as we focused on incremental investments in our more developed data markets and have completed our launch of our core 3G network in Ukraine. Recently, we paid our dividends of RUB 25 billion or RUB 14.01 per share. The Board of Directors also recommended that an Extraordinary General Meeting of Shareholders approve the semi-annual dividend payment of close to RUB 24 billion, or RUB 11.99 per share, which would satisfy our commitment to deliver RUB 25, RUB 26 per share in dividend over the course of calendar year 2016. By the end of the period, total debt stood at RUB 276 billion, net of leases and debt issuance cost which is trending lower due to our on-going debt repayment, as well as financial policies. Our net debt to last twelve months adjusted OIBDA remains stable at a manageable of 1.1 multiple, a comfortable level for the company and very low in relation to our peers. Virtually, our entire non-ruble debt position is currently covered by a combination of hedges, short-term deposits and stable long-term investments, all of which are denominated in US dollars or euro. Adding to this, we repurchased, as I mentioned US$267 million of our 2020 Eurobonds in the second quarter to take advantage of a favorable market and our strong liquidity position to provide hedges against currency volatility and balance sheet profitability. We remain focused on sustaining a strong balance sheet and identifying further ways to optimize our debt portfolio.

[Andrei Dubovskov:]

Thank you, Alexey. We have recently announced we have decided to dispose of our stake in UMS LLC, our 60.01% on subsidiary in Uzbekistan for a nominal sum of money. As we disclosed previously, we reached the decision based totally on a number of business decisions related to the medium and long-term development of our business. As Alexey indicated, these types of developments within the Group necessitates that we reduced our outlook for the year. In accordance with IFRS 5 disclosure requirements from Q3 2016, the Group share of present financial result is in a manner that enables users of the financial statements to evaluate the status of these continued operations. Results of this continued operation shall be excluded from the results of continuing operations and presented separately as a single amount of the statement of comprehensive income. In simple terms, we will present financial and operating figures in Q3 2016 without our previous operations in Uzbekistan from the beginning of 2015. Therefore, we are amending our group revenue outlook to 2% or 3% growth to reflect the exclusion of UMS LLC and in consideration of other factors, like the subscriber growth in Russia, recent data usage and sustaining data reduction in Russia and Ukraine, increased sales of handsets in Russia and rising share in Moscow with B2G and Pay-TV markets. As for OIBDA, the effect of excluding Uzbekistan will be reasonable. We forecast a minus 4% decline in total OIBDA, due primarily to sustained competitive pressures in the Russian distribution market and the company’s strategic efforts to sustain market share. The build out of 3G in Ukraine and non-market sectors impacting our profitability, developments in foreign subsidiaries and macroeconomic developments in currency volatility throughout our markets of operation. As for CapEx, we see no changes to our operating lines and we will achieve our guidance of RUB 85 billion. With that, I would like to open the call to questions. Thank you.

[Operator:]

[Operator Instructions] We will now take our first question from Roman Arbuzov from UBS. Please go ahead. Your line is open.

[Roman Arbuzov:]

Thank you very much for taking the questions. I have two please. So the first one is on distribution, distribution is clearly on everybody’s mind, it’s having a lot of attention. So, hypothetical scenario where your competitors actually takes some real steps forward on this front and we see an improvement in the competitive environment in distribution? Could you please help us understand the financial upside of such a move? So in your presentation on Slide 7, you talk about the 80 BPS impact on your margins from the retail development. So, is it correct for example to think that if you were to undo the retail expansion, which you’ve started from 2Q 2015 and also raise the handset prices back up to 20%, 30% gross margins, then you would be guessing something in the region of RUB 3 billion to RUB 4 billion of additional EBITDA in absolute terms. Is that the right way to think about it? And if you could just provide some numbers around here, that will be very, very helpful. And then secondly, also related to distribution, just on the top-line side, you’ve mentioned that the competitive intensity in distribution is actually weighing on the top-line. So do you think that if we see the improvements in distribution, do you think you will be able to raise prices as well? Thank you very much.

[Andrei Dubovskov:]

Ladies and gentlemen, could you mute the phone line. So, let me briefly answer the question for free. Actually, as you see from the second quarter of 2015, we observe the growing battle between the key players in the Russian markets which actually caused our steps towards the expansion of our retail chain and growth of the sales. Answering your question, yes, the potential change of the strategies of our competitors definitely positively impacts both of the OIBDA of our company and possibly of our competition. We expect to see the potential decision on the change of the market maybe in the next year, let me put it this way and we also assess that the decline of the sales market in Russia which we mentioned in our note will deliver a positive impact on OIBDA which can be estimated at a level, let me put it this way, roughly, dozens of billions of rubles annually. Actually, the pricing on the market is currently mostly impacted not by the prices on the services – on the mobile services, but by the prices of the handsets and yes, if the market change will happen, we will definitely see - probably we will see the positive impact of the OIBDA margin of our retail.

[Roman Arbuzov:]

All right. So, thank you very much. Can I just follow-up on that? So, you’ve mentioned dozens of billions of rubles, did I hear that right?

[Andrei Dubovskov:]

This is the estimation for the whole market.

[Roman Arbuzov:]

All right. So, for the whole market. Can you, from MTS’s perspective, could you maybe tell us what is retail as a percent of revenues? Did you just understand the cost – the retail cost base for MTS, is that possible?

[Andrei Dubovskov:]

Would you please repeat the question? Thanks.

[Roman Arbuzov:]

Sure. So, I am just trying to understand, either in absolute numbers or as a percent of revenues, what is retail? So for example, is retail cost, let’s say, 6% to 7% of your total Russian revenues, is that’s a good estimate?

[Andrei Dubovskov:]

On the top-line side, it is 10%.

[Roman Arbuzov:]

Is it 10%, so as a percent of your total Russian revenues, so 10% is retail cost, right?

[Alexey Kornya:]

It is the percent of – it’s Alexey Kornya, jumping in. It is the percent of our total Group revenue and it is actually presented in our disclosure materials that sales of goods represent and we have sales of goods only in Russia represent 10% of our total Group revenues.

[Roman Arbuzov:]

Well, sorry, I meant something else. I just meant the stores, right, the stores, the rent and then the personnel and the utility expenses in maintaining 5800 stores, which is 9% of your – or in absolute billions of rubles can you tell us what that is?

[Andrei Dubovskov:]

You ask, let me specify, you ask what is the share of our cost to breathe is represented by our distribution network.

[Roman Arbuzov:]

Basically, yes.

[Andrei Dubovskov:]

I think it is a very complicated analysis. You cannot easily separate that way through your overall cost base, because for example, how you calculate the cost of sales of SIM cards and so on so forth. So that is why we are not disclosing this figure and we don’t believe that any estimate would represent the reliable figure, because that would be based on a number of assumptions.

[Roman Arbuzov:]

Okay, thank you very much.

[Operator:]

Thank you. We will now take our next question from Herve Drouet from HSBC. Please go ahead. Your line is open.

[Herve Drouet:]

Yes, good afternoon. Two questions as well on my side and maybe more technical just on the financial. I’ve got a bit of difficulties to reconcile some numbers. Can you explain to me on the interest? I mean, in one of your slides, you explain basically, your weighted operating interest rate currently and with the decline of those interest rates, in Q2 it has been a significant increase on the interest cost. I was wondering, I mean, were there some element that explain that, were there some one-off? Is it linked to some of the purchase of your bonds that may explain that or some hedging cost? And also, as well, a bit of a technical question on the tax side, if you can explain as well, that the reasons why on the tax accrual for the Q2 has been a bit higher than what we’ve seen seasonally and quarter-on-quarter? Thank you.

[Alexey Kornya:]

Okay, thank you. It’s Alexey. In respect of interest expense, indeed we realized an accelerated interest accrual due to our buyback in the amount of those accelerated accrual is RUB 3.8 billion. So, that’s the major contribution to the growth of our interest expense in the second half. Yes.

[Herve Drouet:]

Sorry, just a follow-up on that, and will we expect a similar type of events coming in the second half or do you think it’s been just a one-off for you to buyback those bonds or do you think it can further over the course of the year?

[Alexey Kornya:]

It is a one-off, purely because of buyback exercise that which we have seen in the second quarter. So, we will have – we will not have anything like this. Effectively, we will even slightly reduce interest expense in the future, those RUB 3.8 billion which we recognized in the second quarter will go away from shorter period, but they will be equally distributed – this reduction will be equally distributed up until 2020. So, you will not see that meaningfully, but as far as the specific accelerated interest expense concerned that’s a one-off for this quarter. And as far as the tax expense concerned, the second quarter growth comparatively to first quarter is reflected or is shown because of some deferred taxes accrued for our dividends in Ukraine.

[Herve Drouet:]

Could you mention, how much of those deferred tax were?

[Alexey Kornya:]

We accrued deferred tax for non-distributed income in Ukraine. This is a financial kind of mathematics. So, if you are not distributing your net income as we do in Ukraine, you need to accrue deferred tax for these retained non-distributed income for the future period as you would pay that in the future in the form of dividend and then you will not charge the tax in this specific period. Did I explain it clearly?

[Herve Drouet:]

Yes, yes. I understand, Alexey. In terms of your – could you specify, just from Ukraine, how much the amount of this deferred accrual tax was in terms of, out of the – as a group tax?

[Alexey Kornya:]

RUB 600 million.

[Herve Drouet:]

Okay. Thank you. Thank you very much.

[Operator:]

Thank you. Our next question is from Alex Balakhnin from Goldman Sachs. Please go ahead. Your line is open.

[Alex Balakhnin:]

Yes, good afternoon. Few questions for me, if I may. First is, you mentioned roaming, which impacts the financial performance. I was wondering what was the net impact of lower roaming revenues on your total revenues, if you can quantify that. And then, my other question is on the service revenue growth in Russia. What are you doing like, what can you do in the next couple of quarters to come back to the growth on service revenues? And lastly, probably a little bit technical question, your EBITDA declined guidance. I assume that is because deconsolidated retrospectively so you basically 2015 ex-Uzbekistan and 2016 ex-Uzbekistan and that’s going to be minus four? Is that the correct understanding? Thank you.

[Vasyl Latsanych:]

Hi, this is Vasyl. First question, I will take it, it’s very simple. The roaming in total represents 7% of our total revenue, but as we have indicated in the papers, there was quite a bit impact on the overall revenue and OIBDA driven by the decrease of the usage and of the users of roaming in the last year and it continues to be stagnating this year. So, in total, we lost some 30 and more percent of traffic. Meanwhile, the customers have shifted from cheaper countries to more expensive countries for us meaning the impact on OIBDA was even more dramatic than on the revenue, unfortunately. That is totally market and macroeconomically driven factor and we are hardly influencing it in the general number. So we have undertaken a number of initiatives to keep on promoting the roaming service to the mass markets, the B2C customers, meanwhile, the B2B and B2G customers need to be cutting it back on the backdrop of the economical stagnation. Thank you.

[Andrei Dubovskov:]

Alexander, it’s Andrei Dubovskov, speaking to your next question about our growth in service revenue. I just want to remind you that the current time we had no negative service revenue growth and – do you hear me?

[Alex Balakhnin:]

Yes, I can hear you.

[Andrei Dubovskov:]

Oh, okay, sorry. We have some technical issues here. And unfortunately, you know that, we need to reguide our estimation about and our top-line business and we are waiting for the 2% or 3% revenue growth in Russia also. It means that the growth in the service revenue will be around zero, maybe little less, maybe a little more, but it will be not a question about the store growth, it will be a question about how we can keep our current level. And next question is our guidance for OIBDA decline. Let me pass through this question to Alexey.

[Alexey Kornya:]

Yes, Alexander. We confirm that our guidance now accounts for full deconsolidation of UMS operations from MTS financial statements, both in 2015 and in 2016. In accordance, as we mentioned with IFRS 5, we will deconsolidate UMS operations from MTS financial statements for all periods and we will present as a single line in our financials which is discontinued operations in our P&L. So that is why that will effect the comparative year-on-year and that is why that affects our guidance.

[Alex Balakhnin:]

Understood. Thanks. It’s clear.

[Operator:]

Thank you. Our next question is from Ivan Kim from VTB Capital. Please go ahead. Your line is open.

[Ivan Kim:]

Yes, good afternoon. First, I just wanted to ask – your potential share buyback program. What is a comfortable net leverage for you and I understand that you don’t have to borrow for the buyback because it has a lot of cash at hand, but that would still increase your net leverage given that all or most of the free cash flow is distributed for dividends. Secondly, I just wanted to ask on the fixed revenue and apparently if I heard that correctly, the decline is mostly driven by the voice in B2B. I was wondering what revenue trajectory is seen with B2C, I mean is it increasing overall without any kind of numbers, I understand and you don’t disclose that. And maybe if you can elaborate a little on the potential for convergence in the market in Moscow in particular and whether you could do it kind of more proactively in the future? And just one technical question, if I may, on the external MVN revenue in the second quarter, how much was that? Thank you.

[Alexey Kornya:]

Let me take the first one, on the potential buyback program. We are currently in discussion with the Board of Directors with – in a regular form we might have this program. So we will decide on that within next two months whether we do any buyback this year or not. As far as sources of funding concerned, we don’t think that if we decide that we do buyback this year, that it will be funded fully from that. We believe that our free cash flow will – at least partially to fund such exercise if we decide that we want to do that. And If I maybe on the third topic, it’s very quick, we are not disclosing the figures.

[Vasyl Latsanych:]

Thank you, Alexey. It’s Vasyl. I will start with a couple words on the fixed line. The revenue on the fixed line really consists of B2C and B2B market where B2B market is unfortunately under pressure from macroeconomic and general order – for general will to make some visible savings in the B2G segment and more and more scrutiny from the B2B segment to our business. In fact, if you look at the numbers, in the Q2 of 2015, we were enjoying revenue of RUB 8.3 billion which has stood down to RUB 7.8 billion in Q2 2016. Meanwhile, the B2C revenue increased from RUB 7.4 billion to RUB 7.5 billion, which is an increase on the backdrop of a decline in the B2C telephony as well as you pointed out the decline is quite expected in the B2B but we have to admit that in B2C the decline is also underway in the market. We generally manage to successfully replenish that full announced revenue with the revenue of broadband, home broadband and TV services and I would just note that during the recent year, we have totally reversed the trend starts falling of the TV subscribers base and TV revenues and increased and further increased the number of the subscribers and the revenue of B2C broadband customers.

[Kirill Dmitriev:]

And let me, this is Kirill, let me jump in. Actually, I would like to add a couple of words on the reasons for this growth. As you may observe in the second quarter 2016, we have enjoyed successful growth of our GPON subscribers in Moscow, because this is one realistic mentioned on your question. And actually, I think that’s it. Thank you.

[Andrei Dubovskov:]

If I may, I will elaborate on the first topic, why we are not disclosing the increase in external revenues. The key reason for that is, it’s not something which we want to disguise, but the fact that we don’t think that it is of any strategic importance external integrated service revenue on their own where we strategically focus is that – we are selling the services of telecom and integration altogether and we don’t have any, for example, sales force on its own or any sales force is sales force in a mission, the whole sales is going through MTS sales people and they go together with B2B team. So, it’s just to stress that you know, the external mission rating use is not something of a strategic important, what is of importance for us is that we integrated together with MTS core business and by that promoting our core business. That is why we don’t think that it makes any sense to focus on this specific type of revenues and we just add integration revenues as a separate line for transparency reasons. So that, we are not mixing it up with other revenue streams.

[Ivan Kim:]

Thank you very much.

[Operator:]

Thank you. Our next question is from Alexander Vengranovich from Otkritie Capital. Please go ahead. Your line is open.

[Alexander Vengranovich:]

Yes, hi. Also couple of questions from me. So first on your retail network. You had quite a significant build-up of the retail in the first half of the year. Do you plan to continue that build up in the second half of the year, because I didn’t get it from your previous comments? And if you can share with us what is the average cost of the openings of the average store which you are opening right now? And what sort of average fixed operating costs you have associated with opening of these stores? So that could be helpful to model that. And also the second, pretty technical question, I see your cash flow statements for the first half 2016, in that you have some notable increase in other receivables, is there any specific reason amplifying that? Thank you.

[Andrei Dubovskov:]

So, let me start answering the first part of your question, actually, regarding the retail network expansion, you ask, if you are still planning to continue the same pace, we have kept into half in terms of the opening of the stores, I would like to answer this, yes, to the end of this year, according to our previously approved strategy will quite aggressively are rolling out the additional outlets across Russia and as you probably see, we have delivered the most – the heaviest development amongst our competition when looking at the past 12 months results. But, our decision on the further steps to be taken in this direction will depend on the – on a few factors. On the strategic moves from our competition first of all, on the potential split or some other changes in the ownership of t he multi-brand networks in Russia and to some other factors. So far, we see that the positive outcome of this aggressive rollout is – it is positive in terms of the subscriber base growth and the top-line delivery and the quality of the new subscribers we can buy through this. Regarding the figures on the cost of the – average cost of the opening of a store, so let me put it this way, an average store, quite an average, costs us approximately RUB 1 million, roughly. Regarding the fixed operating cost of store, it – well, I wouldn’t like to go into so much details, because we can’t talk with it this way, in different cities across Russia, this level of cost may differ quite heavily.

[Alexander Vengranovich:]

Thanks.

[Alexey Kornya:]

Speaking about the third technical question on the other receivables, we saw the major growth in the receivables coming from roaming. So, out of, total about three plus growth in receivables during the half comes at the expense of roaming due to high roaming season and specific roaming promotions, which we have done.

[Alexander Vengranovich:]

Okay, thank you.

[Operator:]

Thank you. Our next question is from Alex [Indiscernible from Indiscernible] Capital. Please go ahead. Your line is open.

[Unidentified Analyst:]

Thank you. Good evening. My question relates to the implementation of anti-terror law. Have you had any new discussions with the authorities or internally? And could you please share any feedback with us and dispute trying to estimate a final impact on the industry and your thoughts from this perspective with some numbers will be very much appreciated. Thank you

[Andrei Dubovskov:]

Alex, thank you for the question. It’s Andrei Dubovskov. We have – no right now chose the discussion, because according to the latest from this area, there are no, some indications, there are not some conditions from the Russian government how we need to implement this requirement. And no estimations, no elaborations from our side right now.

[Unidentified Analyst:]

Okay, good. Thank you.

[Operator:]

Thank you. Our next question is from Olga Bystrova from Credit Suisse. Please go ahead. Your line is open.

[Olga Bystrova:]

Yes, good evening. So, just want to discuss little bit more on the distribution. Again, some of it may have been answered, but I want to clearly ask – try to ask the question slightly differently. I mean, you obviously have been suggesting to the market that you would like distribution to repair itself and to improve, however, the pace of your distribution has remained the same through – over the past couple of years and even maybe accelerated in the second quarter. I just want to – I mean, I understand why you are doing, but I want to understand, why do you think competitors will make the first step to try to repair distribution without fueling in a similar effort? And what do you expect to see from competitors first for you to change decision on your strategy in distribution? So that’s one question. Second question is, given, let’s say that your Russian EBITDA has declined almost 4%, could you roughly split the impact of the retail on that and the roaming costs increase? And then finally on the Ukraine margins, you are outlining couple of factors that are impacting margins in the Ukraine. Currently, in some areas it’s 3G, in some cases it’s let’s say interconnect and roaming, Vodafone bringing et cetera. Can you suggest to us what – which items do you expect to continue to impact Ukrainian margins in the second half of the year and which ones you expect to tamper off a little bit that we are seeing at? Thank you.

[Kirill Dmitriev:]

Kirill Dmitriev, so, thanks for your question. Let me start with the first part of it. Regarding distribution, changes in our outlook for this year. So, let me remind you that the recent focus, this aggressive expansion was the change of an ownership in one of the major Russian multi-brand retailer stores - second quarter last year and our aggressive increase of the stores across Russia was our answer to this challenge which would potentially put under huge risk of the leadership of our business in Russia. And, yes, in the quarter two, we have accelerated the growth of our – the expansion of our retail network, but this is according to the previously agreed plan or strategy if you like it. This is the natural way for us to kind of, force the competition to listen to our signal to the market meaning that, after they will realize completely that there is no way of winning the market – increasing the footprint of distribution across Russia. They will definitely reacted in the way we would like them to make. This is kind of in between step for us to make them listen to the previously announced plan for us, actually to decrease to make the subscription market in Russia lower than currently.

[Olga Bystrova:]

Yes and – what if they don’t do that? What is the response will be the opposite of what you are trying to achieve.

[Kirill Dmitriev:]

We are doing it in – we are doing it in quarter two to potentially have the outcome in quarter one next year for example, or quarter four this year. We have already – we already are receiving the signals from the market that and you may have read in the newspapers that there are some rumors about the split off of – which will be potentially one of the key flags to us to – which will indicate to us that we are on the right way.

[Olga Bystrova:]

Okay, so you are quite convinced that, I mean, you have a high conviction that the strategy will work for you?

[Kirill Dmitriev:]

The potential red flag for us – the potential indicator will be the decrease of the mono brand to multi-brand shops of our competitors. I mean, more or less significant ones which is not dependent on the seasonality and so forth and so on.

[Olga Bystrova:]

Okay, thank you.

[Operator:]

Thank you. Our next question is from Alex Kazbegi from Renaissance.

[Alexey Kornya:]

Not, excuse me, we did not yet take the answers on EBITDA, which Olga asked us. So if I may, address those questions.

[Operator:]

Sure.

[Alexey Kornya:]

Speaking overall about EBITDA, we clearly showed in our management presentation that we have behavior factor coming from roaming and overall macroeconomic impact on our margin rather than from distribution. Overall distribution expansion is responsible probably to about one percentage point decline, while roaming expense overall, activity in roaming as well as currency movements are responsible for two percentage points. And for example, if we talk about second quarter, we had a 30% growth in exchange rate or decline depending on the way you look. So the exchange rate to euro to ruble second quarter 2015 to second quarter 2016 was a 28% change, while in first quarter, that was just 17%. So that isn’t quite a sizable pressure on our margin and as the third quarter is the highest season for the roaming, we will see continued pressure in the third quarter coming from roaming and overall our margin. Speaking about which factors - speaking about Ukraine margins, we expect it to recover, as I mentioned in the second half of the year and we will see margins full year somewhere in the mid 30s towards the mid 30s which assumes certain good recovery in the second half of the year. And we do have certain rebranding cost and promotion cost which are one-off costs and we will go while overall macro situation in other fixed costs will retain.

[Vasyl Latsanych:]

Alexey, let me just add couple of words about the Ukrainian business. The costs that have impacted the OIBDA in the Q1 and Q2 are partially one-off. As Alexey noted those are related to rebranding and to the early phase of the 3G rollout and some of the cost that we had to incur with the 3G rollout throughout Ukraine. But those were also coupled with the roaming cost increase because of the Forex and because of the increase of the general traffic going out of Ukraine and some decrease of the traffic going into Ukraine which would be then impacting positively marginality, but unfortunately, that traffic declined. Our actions are as outlined in the area of tariff adjustments and changes. We do work on the increase of certain tariff plans, specifically for roaming and for international calling in Ukraine to react to the euro and dollar cost increase in certain markets, as well as after we have been redone all the shops in Ukraine which has mostly incurred the cost. We think this one-off will go away and we will see improvements throughout this year and next year in Ukrainian belt. Thank you.

[Olga Bystrova:]

Thank you.

[Operator:]

Thank you. So our next question is from Igor Goncharov from BCS Financial Group. Please go ahead. Your line is open.

[Igor Goncharov:]

Yes, thank you very much. I have two questions on the international businesses. One is on Uzbekistan and one is on Ukraine. Is there any kind of update on the potential results of the investigation that international authorities have been carrying out? And if there is no updates, when is one – what is the approximate timing on you should expecting indications in this respect? That’s number one, number two is on Ukraine. Can you maybe elaborate a bit on the progress of the rebranding. Your management has some of the shocks basically you are rebranded, can you maybe give some quantitative indicators of how this progresses and when do you expect a full rebranding to be completed? Thank you.

[Kirill Dmitriev:]

On Uzbekistan, let me take this one, we don’t have any update and we don’t have anything to say you to bring any clarity one as of basically.

[Andrei Dubovskov:]

Okay, so, let me answer the first question regarding the rebranding forces in Ukraine. We can reassure that the full rebranding will be finished, will be finalized by the end of this year. Currently, it is a process of rebranding taking place in almost every big cities. We have approximately 500 mono branded outlets in Ukraine and all of them will be fully refurbished and put under Vodafone closer to the end of November, maybe December. Even now, we don’t put any brand of MTS on air in any way of advertising and if you go into Ukrainian shop, you will see that approximately, I don’t know, 90% of the total service plans we are selling through them currently Vodafone, so.

[Igor Goncharov:]

Okay, thank you very much. Just to clarify, is it correct to understand that starting from the end of this year or beginning of the next year, basically MTS brand would not be used in Ukraine for your operations. It will be fully replaced by Vodafone brands not only in relation to 3G, but also in relation to normal voice service?

[Andrei Dubovskov:]

In reality, yes, you are absolutely correct.

[Igor Goncharov:]

Thank you very much.

[Operator:]

Thank you. The next question is from Alex Kazbegi from Renaissance. Please go ahead. Your line is open.

[Alex Kazbegi:]

Yes, hi. One question is, if you have something to say about this regulatory possible initiative on the fixed to mobile interconnect changes and how do you see that? And what’s the timeline if you see any changes on that? Secondly, just looking back, because again you’ve invested quite a lot of money in the GPON, you are clearly investing a lot of money in building the distribution network on the mobile side. If I look at GPON, I mean, I understand of course, that the number of subscribers in B2C is increasing, it probably would have been much worse if you have not done that investment, that’s almost probably a good estimation saying why the overall revenues remained flat. But more so to say, looking forward question, is there anything else you would expect from GPON to deliver? Let’s say, having great network anything on the B2B, big data, anything where you could see something substantial so to say, still coming through which we haven’t seen yet and maybe on the B2C as well, because – and all the subscribers decreased and as you are monetizing them better but, how do you see that? So to say, how do you see that investment, so to say, has worked out for you? And the same on the mobile side, and the distribution side, which I think backs everybody in a sense that I don’t think I understand that it looks like clearly it’s a prism of dilemma, but clearly, so to say, investing more money which with the diminishing return has to stop somewhere. That’s certainly is how I see it. So the question again is that, if you look back on your investments in the retail, giving the smartphones to the population instead of the feature phones, have you seen significant uptake in data usage, should we see some positive signs of that strategy overall and how do you see that subs to increase? That’s probably that’s all I have, thanks.

[Andrei Dubovskov:]

Good evening. It’s Andrei Dubovskov. It’s a very long question.

[Alex Kazbegi:]

Sorry.

[Andrei Dubovskov:]

And of course we need to share the discretion for the kind of said my topic. Speaking about the first question about the misinterpretations in the frequency mobile interconnection rate. There are a lot of hidden anticipations and the government – lot of – some changes behind the curtain, but unfortunately for us we have approximately the same information like you. No clear, no direct messages from government how it will be implementing in the market, but, of course, we are ready to do it in the same manner like our competitor, because there will be hesitation when we have much more negative feedback from this changes than our competitors. That’s all unfortunately. And talking about the GPON, let me pass this question to Vasyl.

[Vasyl Latsanych:]

Hi, Alex. This is Vasyl. Let me take the second question. It was really complex, so I will try to tap it quickly. The idea of the GPON was, as you might remember, in a couple of parts, one was to really replace the legacy technology which was no longer productive for Moscow, for such a big city and a dense city. We had a couple alliance and they were literally doomed, but when we have replaced that, we wanted to replace the service to the B2C market with a better quality and essentially higher ARPUs in the first place which I think we did and we are doing very successfully increasing the number of broadband and basically, going for a leadership in both broadband and TV services in Moscow, because of GPON has the great potential nobody else can match. But at the same time, you are right, there are some other – that the GPON performs better than any other technology and we are very much counting on that. Specifically the B2B and B2G tasks which are massive, not point-to-point like, could be represented only by a high quality network which have a distribution equal to GPON which there is no one else does. So, in fact, we are talking about let’s say street cameras, traffic cameras, and other video surveillance technologies which are very popular in large cities like, London, New York, Abu Dhabi or Moscow. So most of these cameras can be serviced by GPON with a higher quality better reliability and better performance than any other – with any other network, because there is no network, let me repeat – with the presence of GPON in Moscow. Now, the smart city infrastructure is extremely interesting for the development in Moscow. So this B2G and municipal services based on the GPON represent certain very good potential which we pilot and test in different environments, but specifically Moscow represent the biggest portion of all of the potential business in Russia in this area of course. Now the B2C market should still not be dropped with the simple broadband and TV services, so we are increasing the quality and going from the standard definition to HD and now piloting the 4K on GPON delivered to the customers at Moscow with MTS TV subscription. We have learnt the examples from Telecom China, China Telecom delivery of 4K services in certain Chinese cities and we see that as being a huge driver for both acquisition and development of the customers and 4K is in the top place of our colleagues at MGTS to be delivered over the MGTS GPON network through the whole Moscow City, through the whole Moscow customers. On top of that, there are certain synergy effects that GPON represents in Moscow and of that, the most significant one is the presence over the Moscow for quick connection of B2B customers, meaning that, if a B2B customer wants to be connected somewhere in the city, we would be quickly and easily connect to him better than any other competitor that will have to draw the line to that customer. Because we are normally already there with our GPON network and also there is the potential for a synergy for existing mobile network with the further development of femtocells, of small and picocells, street lights, light pole installation. The GPON represents great presence of fiber optics basically to next to every light pole in Moscow and we can deliver quick rollout of these services without extra cost and extra efforts for backhauling. Thank you.

[Alex Kazbegi:]

Just to quickly ask on this one, so, if all materializes which never does, but let’s say, if all those materialize incremental revenues, is it 5% or what you have now on the tax line or is it 15%, what’s the ballpark?

[Vasyl Latsanych:]

Well, I am not in a position now to say how many exactly, rubles, dollars or percentage points we would win back with these services. I can only say that, on the backdrop of hauling voice business which represents largest portion of all earnings of MGTS, all of these efforts are, first of all in a place to catch the haul and to sustain the business with improved margin as normally broadband represents better – presents better margin than TV – than phone services. But at the same time, those additional things are not necessarily revenue-driven, sometimes they improve the margin of the whole entity of the group, let’s say the same for backhauling of the base station is the cost advantage to MTS, not a revenue advantage to MGTS.

[Alex Kazbegi:]

Okay, thank you.

[Operator:]

[Operator Instructions] We have a new question from Roman Arbuzov from UBS. Please go ahead. Your line is open.

[Roman Arbuzov:]

Well, thank you very much for the follow-up opportunity. I just had two very quick technical questions. The first one is on EBITDA reconciliation. So, what I am talking about is a difference between the sum of the standalone countries at EBITDA level compared to the total that you report and the difference is typically around RUB 2 billion, but this quarter it was around RUB 3 billion. I just wanted to check what’s driving that and should we expect this to be the new norm that will go forward please. And then secondly, just on working capital, could you please just give us some sort of an understanding for the working capital dynamics for the rest of the year and for 2016 overall? Thank you.

[Alexey Kornya:]

Starting with the second one on the working capital dynamics, we expect that it will stay even slightly – might slightly improve this year. But generally, expect that it will be – it will be stable. We have some improvements on the back of lower CapEx, on the back of continued fourth – with improving efficiency on our working capital and we have expansion of our working capital with the expansion of our retail network. So those factors altogether keep the working capital stable. Speaking about OIBDA reconciliation – sorry.

[Roman Arbuzov:]

Just to clarify on working capital, is that what you expect to reverse of the big negative as that we saw in 2Q, do you expect to reverse in that in second half, right?

[Andrei Dubovskov:]

Yes, well, I am talking more year-on-year. So it’s not, I am not that much focused on the quarterly dynamics. I would say that, year-on-year, because there are a lot of seasonality with the accrual of roaming and so on so forth.

[Roman Arbuzov:]

Okay.

[Andrei Dubovskov:]

So, like, we see that – with the year, the full year dynamics being more pretty much stable, we expect it to be stable. And as far as EBITDA reconciliation concerned, there are two major factors, there are certain intra-group – I would say, reconciliations or intra-group business being deducted. And there are some headquarter costs which are being distributed among different businesses.

[Roman Arbuzov:]

So do you expect this relatively elevated level to carry on? So what we saw in the quarter is normalized?

[Andrei Dubovskov:]

Yes, I think, we should expect that being continue at the level where it is.

[Roman Arbuzov:]

Okay, thanks very much.

[Operator:]

Thank you. At this time, we don’t have any further questions.

[Joshua Tulgan:]

Okay, everyone, thank you again very much for your time and interest. Obviously, we welcome you at any time to contact the Investor Relations department if you have any further questions. The webcast of this discussion will be available on our website if you wish to replay the call and in the mean time, we appreciate everyone’s interest and wish everyone a pleasant day or evening.

[Operator:]

Thank you. That will conclude today’s conference call. Thank you for your participation ladies and gentlemen. You may now disconnect.