17. 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. Considerable uncertainty remains concerning economic stability globally in the medium-term. The economic downturn experienced in the second half of 2011, in both the European and global economies, resulted in reduced growth in the advertising market. During 2012, the Russian and Kazakh governments continued to take measures to support their economies in order to overcome the consequences of the economic downturn. A continuation of this economic downturn could adversely affect further economic growth, access to capital and cost of capital, advertisers and business confidence, which could negatively affect the Company's future financial position, results of operations and business prospects. Despite some indications of recovery there continues to be uncertainty regarding further economic growth in Russia, the depth and duration of the European area recession, and consequently the extent of the global economic slowdown, which could negatively affect the Company's future financial position, results of operations and business prospects.

Although 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.

Transition to digital broadcasting

The Company believes that the introduction of digitalization will not adversely affect its ability to broadcast in the medium term, as its channels will continue to broadcast in the analog format under existing analog licenses until the transition to the digital format is completed. However, there is currently great uncertainty regarding the effect of the implementation of digital broadcasting on the Company's business models, as it is difficult to predict accurately how the digitalization of broadcasting may affect the market. While digital broadcasting would increase CTC' and Domashny' overall technical penetration, the necessary investments for digital migration may not be fully monetized. In addition, under Roskomnadzor's terms of participation in the second multiplex, the Company expects to encounter certain risks and uncertainties in the execution of CTC and Domashny business models, which could significantly impact the operations and fair value of its reporting units and related goodwill. Also, an uncertainty exists about Peretz' technical penetration and its impact on advertising revenues after the end of analog broadcasting. Subject to the availability of further information from the government and market participants, and the Company's ability to make further assessments of the government's plans, additional impairments may be required in the foreseeable future. See also Note 10.

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 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. Although the Company had entered in the past and continues to enter into hedging transactions in an effort to reduce some of its foreign exchange risk (see below), it could be negatively impacted by any future depreciation of the ruble against the US dollar.

In 2012, the Russian ruble appreciated against the US dollar by 6.0%, but was on average 5.5% lower than the average value of the Russian ruble compared to the US dollar during 2011. In 2011 and 2010, the Russian ruble depreciated approximately 5.3% 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, would be adversely affected.

Derivative Financial instruments

As part of its risk management strategy, the Company uses derivative financial instruments, primarily foreign exchange forward contracts, to mitigate its exposure to currency exchange risk related to US-dollar denominated payments. The Company's objective is to offset gains and losses resulting from these exposures with losses and gains on the derivative contracts used to hedge them, thereby reducing volatility of earnings or protecting fair values of assets and liabilities. It is the Company's policy to enter into foreign currency derivative transactions only to the extent considered necessary to meet its objectives as stated above.

In 2012, the Company entered into certain foreign exchange forward contracts designated as fair value hedges to protect the value of its existing foreign currency liabilities and firm commitments. For these derivative instruments that were designated and qualify as fair value hedges, the Company recognized losses on the derivative instruments of $1,233, as well as offsetting gains on the hedged item, as foreign currency gain (loss) on its consolidated statement of income. The notional amount of these foreign exchange forward contracts was $87,917 in 2012.

While certain of the Company's derivative instruments are designated as hedging instruments, the derivative instruments that are designed to hedge a risk, but are not designated as hedging instruments, are referred to as an "economic hedge" or "non-designated hedges". Changes in the fair value of these non-designated hedging instruments are recognized in the expense line item in the consolidated statement of income that is consistent with the nature of the hedged risk. In 2012, the Company entered into short-term non-designated hedges to mitigate its exposure related to US-dollar denominated payments of dividends and recognized losses of $272 on derivative instruments as foreign currency losses on its consolidated statement of income. The notional amount of these foreign exchange forward contracts was $81,500 in 2012.

The fair values of the Company's derivative assets and liabilities designated as hedging instruments, of $186 and $495, respectively, have been classified as Level 2. The fair value of the Company's foreign exchange forward contracts is determined based on the present value of future cash flows using market-based observable inputs such as forward rates, discount rates and foreign currency exchange rates. Counterparty credit risk did not have a material impact on derivative fair value estimates. The Company's derivative instruments are short-term in nature, primarily one month to one year in duration.

In January 2013, the Company entered into foreign exchange forward contracts for approximately $72,000 to reduce a portion of the Company's foreign exchange risk related to US-dollar denominated payments.

Concentrations

The Company's revenues received from the top ten advertisers accounted for 34% of the of the Company's total advertising revenues of $775,806 in 2012.

Purchase commitments

The table below summarizes information with respect to the Company's commitments as of December 31, 2012:

	Total		2013		2014		2015		2016		2017

	(in thousands)
Acquisition of programming rights	$	250,486	$	202,154	$	48,332	$	—	$	—	$	—
Transmission and satellite fees		115,474		22,766		22,494		22,515		23,718		23,981
Leasehold obligations		36,457		7,762		8,093		8,551		8,971		3,080
Network affiliation agreements		9,409		2,984		2,931		2,184		1,009		301
Acquisition of format rights		1,113		1,113		—		—		—		—
Cable connections		4,883		2,170		2,170		543		—		—
Payments for intellectual rights		15,571		2,947		3,118		3,290		3,461		2,755
Other contractual obligations		9,783		2,741		2,505		2,808		844		885

Total	$	443,176	$	244,637	$	89,643	$	39,891	$	38,003	$	31,002

In addition, in connection with the planned digitalization in Russia and Kazakhstan, the Company may incur additional costs. We expect to continue incurring analog transmission costs during the analog-to-digital transition period. In 2012, the Company incurred approximately $26 million of such expenses; it may also incur further costs, in addition to those it currently has, during the transition period and thereafter. Governmental authorities have indicated that each channel participating in the second digital multiplex will be expected to pay up to $26 million annually in transmission fees. In the transition period, these transmission fees are expected to be lower and are to be paid by way of stage payments as the rollout progresses. Also, current legislation does not provide 'must carry' obligations for cable operators, and accordingly the Company may be unable to secure or maintain carriage of its channels' signals over cable in certain regions, or at transmission rates that are consistent with historical experience. As a result, there can be no assurance that the Company will be able to negotiate mutually acceptable transmission agreements in the future relating to the carriage of its signals with cable providers.

Operating leases

The Company has several operating leases for satellite transponders and office space with terms ranging from one to eleven years, including lease of office space in an office building in central Moscow. Total operating lease expenses were $5,130, $6,905 and $7,032 in 2010, 2011 and 2012, respectively.

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, 2011 and December 31, 2012. 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 may take a more assertive position in their assessment of the legislation and it is possible that transactions and activities that have not been challenged in the past may be challenged retroactively.

As of December 31, 2011 and December 31, 2012, the Company included accruals for contingencies related to non-income taxes totaling $2,722 and $998, respectively, as a component of accrued liabilities, including amounts relating to pre-acquisition operations of the Channel 31 Group of $1,700 and $347, 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 December 31, 2012, management estimates such contingencies related to non-income taxes to be up to approximately $1,055.

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.

Compliance with Licenses terms

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 historically generally required renewal every five years. In November 2011, the federal law "Improving Regulation of Mass Media, Television and Radio Broadcasting" came into force and introduced a standard license term of ten years, as well as the new concept of a so-called "universal license". A universal license permits the channel to broadcast through free-to-air, cable and satellite broadcasting, in either digital or analog format. The Company has obtained universal licenses for all its channels.

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 its programming with the declared genres of the channel and to sustain the volume-genre ratio of broadcasted materials prescribed in the license.

The broadcasting license of Channel 31 in Kazakhstan contains various restrictions and obligations. Kazakh law currently requires that broadcasters 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 the 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.

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 late 2011, a lawsuit was filed in Russia against the Company (Peretz Channel) and other unrelated parties concerning alleged patent infringement in connection with a process used in a TV program aired in 2009 and 2010. In the first half of 2012, the plaintiffs amended their claim to decrease the amount of damages and remove their claim for joint liability. On November 26, 2012, the court of Yaroslavl upheld the Company's position. However, on January 14, 2013, the plaintiffs appealed this decision in the appeals court of Yaroslavl. The first hearings are scheduled for March 14, 2013.

In its preparations for the court hearings, the Company filed a petition with the Russian federal service for intellectual property ("Rospatent") challenging the validity of the patent at issue. In August 2012, the patent was invalidated by Rospatent and the decision came into force on October 10, 2012. The plaintiffs appealed this decision in the Moscow court. On January 22, 2013, the Moscow court upheld Rospatent's decision. However, the plaintiffs may appeal this decision further to the higher court.

The Company has currently assessed the probability of unfavorable outcomes as remote.