COMMITMENTS AND CONTINGENCIES

6 Months Ended

Jun. 30, 2011

COMMITMENTS AND CONTINGENCIES

COMMITMENTS AND CONTINGENCIES

10.   COMMITMENTS AND CONTINGENCIES

Operating environment

        Russia and Kazakhstan continue to implement economic reforms and to develop the legal, tax and regulatory frameworks to support a market economy. The future stability of the Russian and Kazakh economies is largely dependent upon these reforms and developments and the effectiveness of economic, financial and monetary measures undertaken by their governments.

        The Russian and Kazakh economies are vulnerable to market downturns and economic slowdowns elsewhere in the world. In the first half of 2011, the Russian and Kazakh governments continued to take measures to support their economies in order to overcome the consequences of the global financial crisis. Despite some indications of recovery there continues to be uncertainty regarding further economic growth, access to capital and cost of capital, which could negatively affect the Company's future financial position, results of operations and business prospects.

        While management believes it is taking appropriate measures to support the sustainability of the Company's business in the current circumstances, unexpected further deterioration in the areas described above could negatively affect the Company's results and financial position in a manner not currently determinable.

Exchange rate

        Although the Company's reporting currency is the US dollar, it generates almost all of its revenues through the sale of advertising, which in Russia is sold primarily in rubles. The ruble is also the functional currency of the Company's principal operating subsidiaries. As a result, the Company's reported revenues and results of operations are impacted by fluctuations in the exchange rate between the US dollar and the Russian ruble. Additionally, given that substantially all of its revenues are generated in rubles, the Company faces the exchange rate risk relating to payments that it must make in currencies other than the ruble. The Company generally pays for non-Russian produced programming in US dollars.

        In the first half of 2011, the Russian ruble appreciated against the US dollar by 9%, and was on average 5% higher than the average value of the Russian ruble compared to the US dollar during the same period of 2010. In 2009 and 2010, the Russian ruble depreciated approximately 3% and 1%, respectively, against the US dollar.

        If the exchange rate between the ruble and the US dollar were to depreciate, the revenues and operating results of the Company, as reported in US dollars, will be adversely affected.

Television advertising sales

        In the Russian television market, national television advertising historically was not placed directly with broadcasters. Instead, sales houses, including Video International, historically controlled the placement of a large portion of national television advertising. In Russia, the Company had several agreements with Video International for the placement of advertising on each of the Networks and Television Station Groups. In Kazakhstan the Company places all of its national advertising through Video International.

        As a result of an amendment to the Russian advertising law that became effective from January 1, 2011, television broadcasters are prohibited from signing agreements with media sales houses that control more than 35% of the Russian television advertising market. Video International controlled more than 35% of the Russian television advertising market before 2011. In order to bring the Company's cooperation with Video International into compliance with the new legislation, it terminated its agency agreements with Video International in respect of the Networks and Television Station Groups for Moscow-based clients effective December 31, 2010, and implemented a new structure for the sale of its advertising.

        Starting January 1, 2011, the Company's own sales house serves as the exclusive advertising sales agent responsible for all of the Company's national and regional advertising sales, with the exception of advertising sales to local clients of the regional stations, which continue to be made through Video International.

        The Company has also implemented a new model of cooperation with Video International. Under the terms of this agreement, the Company pays Video International both fixed license fees for the use of the software package and variable service fees, which depend on the amount of services rendered. The aggregate amount of compensation payable is calculated on the basis of the Company's Russian channels' television advertising revenues (including network revenues and the revenues from regional advertising placed by Moscow-based clients, but excluding revenues from social advertising and some sponsorship revenues, as well as placement by Video International of national advertising). The parties have also agreed that the compensation payable to Video International under the new agreement may be decreased by the mutual consent of the parties on an annual basis. In the three months ended June 30, 2011, the amount of compensation expense related to services provided by Video International was $22,237, compared with agency commission fees of $17,548 paid to Video International in respect of national and regional advertising from Moscow-based clients in the three months ending June 30, 2010. In the six months ended June 30, 2011, the amount of compensation expense related to services provided by Video International was $40,327, compared with agency commission fees of $33,850 paid to Video International in respect of national and regional advertising from Moscow-based clients in the six months ending June 30, 2010.

        The new agreement has a five-year term, running through the end of 2015, and may be unilaterally terminated by either party effective January 1st of any year during the term without penalty, provided that such party provides written notice of termination not later than 180 days before such date.

        In addition to the agreement between the Company's sales house and Video International described above, a number of Company's owned-and-operated regional stations have signed agency agreements with local subsidiaries of Video International with respect to advertising sales to local clients. Under the terms of such agreements, the Company pays Video International a commission fee set as a percentage of the actual gross revenues received from advertising sales by the relevant local station. The aggregate headline commission payable to Video International under such agreements annually is 12% of the regional station's total gross advertising revenues, including VAT. The parties have also agreed that the commission payable to Video International under those agreements may be subject to reduction upon mutual consent of the parties on an annual basis.

        The agreements are terminable either by mutual written agreement, or unilaterally by giving 180 calendar days' notice. As compensation for early termination, the terminating party must pay the other party a forfeit fee based on a certain percentage of the regional station's actual gross revenues for the six full calendar months preceding the termination date. Such forfeit fee will be subject to further negotiations between the parties and may be subject to adjustment.

        In Kazakhstan, the Company has an agreement with Video International for the placement of advertising on Channel 31 that expires in 2015. The Channel 31 agreement may be terminated upon 180 days' notice by either party.

        The Company may be unsuccessful, especially in the short-term, in transitioning to a new system of advertising sales that produces the same advertising volumes and revenues, at the same margins, as it has enjoyed historically.

Assets with indefinite useful lives

        The Company has assets recorded on its consolidated balance sheet, such as broadcasting licenses, trademarks and goodwill, which have indefinite lives and represent a significant portion of the Company's total assets. Assets with indefinite useful lives are not subject to amortization but are tested for impairment annually, in the fourth quarter, or between annual tests if events or changes in circumstances indicate that an asset might be impaired. Outside the annual review, there are a number of factors which could trigger an impairment review including under-performance of operating segments or changes in projected results; changes in the manner of utilization of an asset; severe and sustained declines in the traded price of the Company's common stock that are not attributable to factors other than the underlying value of its assets; negative market conditions or economic trends; and specific events, such as new legislation, new market entrants, changes in technology or adverse legal judgments that the Company believes could have a negative impact on its business. See also Note 2.

        The Company considers all current information in respect of determining the need for or calculating any impairment charge, however, future changes in events or circumstances, such as changes in the economy, further decreases in the Company's audience shares or ratings, increased competition from cable or other providers, or changes in the audience measurement system could result in decreases in the fair value of the Company's intangible assets and may require the Company to record additional impairment losses that could have an adverse impact on its net income. In addition, the Russian government has announced plans to introduce digital broadcasting in various stages throughout Russia. The specific terms of the transition are not yet fully determined. The transition to digital broadcasting also could adversely impact the Company's operations or the value of its broadcasting licenses and goodwill.

Purchase commitments

        The Company has commitments to purchase programming rights, for which the license period has not started or the underlying program is not yet available. As of June 30, 2011, such commitments amounted to $235,112 (at the US dollar/ruble exchange rate as of June 30, 2011). The Company is obligated to pay $108,979, $74,302 and $51,831 in 2011, 2012 and 2013, respectively, under these commitments.

        In addition, the Company has commitments to purchase format rights. As of June 30, 2011, these commitments amounted to $700 (at the US dollar/ruble exchange rate as of June 30, 2011), all of which is payable in 2011.

        The Company also has commitments to purchase transmission and satellite services. As of June 30, 2011, these commitments amounted to $86,404 (at the US dollar/ruble exchange rate as of June 30, 2011), of which $7,946, $17,330, $18,890, $20,403 and $21,834 are payable in the years from 2011 to 2015, respectively. The amounts for these commitments depend on future inflation rates in Russia, which could change the prices for such services.

        Also, the Company has commitments for cable connections to secure the right of its stations to be connected by cable to additional households. As of June 30, 2011, these commitments amounted to $11,282 (at the US dollar/ruble exchange rate as of June 30, 2011), of which $2,909, $1,733, $1,733, $1,733 and $3,173 are payable in the years from 2011 to 2015, respectively.

        In addition, in October 2010 the Company signed an agreement to upgrade its broadcasting equipment at cost of $16,320, of which the outstanding amount to be paid in 2011 amounts to $378.

Operating leases

        The Company has several operating leases for satellite transponders and office space with terms ranging from one to eleven years.

        On December 30, 2010, a Company entered into definitive lease agreements in respect of new headquarters facilities in Moscow. These definitive leases have retroactive effect from November 17, 2010. Pursuant to the lease agreements, the Company is leasing an aggregate of 7,000 square meters of office space in an office building in central Moscow. The lease agreements have 10-year initial terms and the Company has the right to extend the term for an additional 10-year period, at the current market rate. The base rent is approximately $0.481 per square meter per annum (at the exchange rate as of June 30, 2011), for a total of approximately $3,367 per year inclusive of all taxes and levies and exclusive of VAT. The base rent for the first year of the lease agreements starting November 17, 2010 ending November 16, 2011 will be approximately $0.456 per square meter per annum (at the exchange rate as of June 30, 2011), thus the total amount of the rent for the first year will be approximately $3,192.

        On April 4, 2011, the Company entered into definitive lease agreements in respect of additional space of 2,365 square meters in these headquarters. The lease agreements have 10-year initial terms and the Company has the right to extend the term for an additional 10-year period, at the current market rate. The base rent is approximately $0.534 per square meter per annum (at the exchange rate as of June 30, 2011), for a total of approximately $1,263 per year inclusive of all taxes and levies and exclusive of VAT. The base rent for the first year of the lease agreements starting April 4, 2011 ending April 3, 2012 will be approximately $0.356 per square meter per annum (at the exchange rate as of June 30, 2011), thus the total amount of the rent for the first year will be approximately $842.

        In addition to the lease payments described above, the Company is also required to pay technical costs arising from maintenance of the premises, taxes and some supplementary municipal services, in total amount of $640.

Income Taxes

        As of December 31, 2010 and June 30, 2011, the Company included accruals for unrecognized income tax benefits and related interest and penalties totaling $5,280 and $5,301, respectively, as a component of accrued liabilities, including amounts relating to pre-acquisition operations of the Channel 31 Group of $3,464 and $3,491, respectively. All of the unrecognized income tax benefits, if recognized, would affect the Company's effective tax rate.

        Although the Company believes it is more likely than not that all recognized income tax benefits would be sustained upon examination, the Company has recognized some income tax benefits that have a reasonable possibility of successfully being challenged by the tax authorities. These income tax positions could result in total unrecognized tax benefits increasing by up to $2,187 if the Company were to lose such a challenge by the tax authorities. However, the Company believes that it is reasonably possible that only $193 of the total $2,187 potential increase could occur within twelve months from June 30, 2011. This amount mainly represents certain recognized income tax benefits which may be challenged by the tax authorities during their current inspections of Soho Media, DTV Network, Domashny Network and certain income tax penalties which may be imposed by US tax authorities as the result of late payment by CTC Media, Inc. of estimated tax for 2007.

        The total amount of unrecognized tax benefit that could significantly change within 12 months due to a lapse of statutory limitation term was $2,400 as of June 30, 2011.

        The tax years ended December 31, 2008, 2009 and 2010 and the six months ended June 30, 2011 remain subject to examination by the Russian and US tax authorities. The tax years ended December 31, 2006 through 2010 and the six months ended June 30, 2011 remain subject to examination by the Kazakh tax authorities.

Non-Income Taxes

        The Company's policy is to accrue for contingencies related to non-income taxes in the accounting period in which the liability is deemed probable and the amount is reasonably determinable. In this regard, because of the uncertainties associated with the Russian tax system, the Company's final Russian taxes may be in excess of the estimated amount expensed to date and accrued at December 31, 2010 and June 30, 2011. This is due to a combination of the evolving nature of applicable tax legislation, varying approaches by regional and local tax inspectors, and inconsistent rulings on technical matters at the judicial level. The tax authorities have also aggressively imposed material tax assessments on Russian businesses, at times without a clear legislative basis.

        As of December 31, 2010 and June 30, 2011, the Company included accruals for contingencies related to non-income taxes totaling $5,023 and $4,941, respectively, as a component of accrued liabilities, including amounts relating to pre-acquisition operations of the Channel 31 Group of $3,589 and $3,617, respectively.

        Additionally, the Company has identified possible contingences related to non-income taxes, which are not accrued. Such possible non-income tax contingencies could materialize and require the Company to pay additional amounts of tax. As of June 30, 2011, management estimates such contingencies related to non-income taxes to be up to approximately $650.

        It is the opinion of management that the ultimate resolution of the Company's tax liabilities, 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 taxes, it is possible that the Company's future operations or cash flows could be materially affected in a particular period.

Broadcast Licenses

        All broadcast television stations in Russia are required to have broadcasting and other operating licenses. Only a limited number of such licenses are available in each locality. These licenses generally require renewal every five years. Pursuant to a new legislation that will come into force in November 2011, the term of broadcast licenses will be extended to ten years, and new licenses will cover both digital and analog broadcasting.

        A broadcaster must conform its programming to the programming concept outlined in the broadcasting license. In particular, the broadcaster is obliged to ensure the compliance of their programming with the declared genres of the channel and to maintain a required balance in a volume-genre ratio of broadcasted materials, both prescribed in the license. Until recently, the broadcasting licenses of the Company's independent affiliate stations also contained various restrictions, including requirements with respect to the minimum amount of locally produced programming that must be broadcast.

        The broadcasting license of Channel 31 in Kazakhstan contains various restrictions and obligations. Under Kazakh laws, broadcasters are required to broadcast at least 50% of their programming in the Kazakh language during every six-hour slot.

The Company may not always be in full compliance with these requirements. Also, the Company's independent affiliates have not always been in full compliance with all requirements of their licenses or obtained all the licenses necessary for broadcasting. If the terms of a license are not complied with, or if a television station otherwise violates applicable Russian legislation or regulations, the license, after a warning notice from the regulator, may be suspended or terminated (which decision may be appealed in court). If an independent affiliate were to broadcast without all the necessary licenses, broadcasting may be terminated and fines could be imposed. Management believes that the probability of initiation of action against any material owned-and operated station or independent affiliate is remote.

Net Assets Position in Accordance with Statutory Requirements

        In accordance with Russian legislation, joint stock companies must maintain a level of equity (net assets) that is greater than their charter capital. In the event that a company's net assets, as determined under Russian accounting legislation, fall below certain minimum levels, specifically below zero, the company can be forced to liquidate.

        Certain of the Company's regional subsidiaries have had, and some continue to have, negative equity as reported in their Russian statutory financial statements. Management believes that the risk of the initiation of statutory liquidation procedures or other material adverse actions is remote. However, if such actions were taken, it could have a material adverse effect on the Company's results of operations, financial position and operating plans.

Legal and Tax Proceedings

        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 proceedings or other matters, will not have a material effect upon the financial condition, results of operations or liquidity of the Company.