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. The recent economic downturn in both the European and global economies has resulted in reduced growth in the advertising market. A continuation of this economic downturn could adversely affect 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. In 2013, the Russian and Kazakh governments continued to take measures to support their economies in order to overcome the consequences of the economic downturn. 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.

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's and Domashny's 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, uncertainty exists about Peretz's 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.

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 depreciation of the ruble against the US dollar.

In 2012 and 2011, the Russian ruble appreciated by approximately 6% and depreciated by approximately 5%, respectively, against the US dollar. In 2013, the Russian ruble depreciated against the US dollar by 7%, and was on average 2% lower than the average value of the Russian ruble compared to the US dollar during 2012.

In 2013, the average exchange rate was RUR 31.85 to $1.00. The prevailing exchange rate as of December 31, 2013 was RUR 32.73 to $1.00. During the period from December 31, 2013 to March 1, 2014, the Russian ruble further depreciated against the US dollar to RUR 36.18 to $1.00. If the exchange rate between the ruble and the US dollar were further to depreciate, the revenues and operating results of the Company, as reported in US dollars, would be adversely affected. The current situation in Ukraine has the potential to further negatively impact the value of the Russian ruble.

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.

The Company has 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 derivative instruments with the notional amount of $82.5 million that were designated and qualify as fair value hedges, the Company recognized foreign currency gains on the derivative instruments of $916, as well as offsetting foreign currency losses on the hedged item in its consolidated statement of income for the period ended December 31, 2013. In 2012, the Company recognized foreign currency losses on the derivative instruments that qualify as fair value hedges of $1,233 as well as offsetting foreign currency gains on the hedged item in its consolidated statement of income for the foreign exchange forward contracts with notional the amount of $87.9 million.

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 2013, the Company entered into short-term non-designated hedges with the notional amount of $155.6 million to mitigate its exposure related to US dollar denominated payments and recognized foreign currency gains of $2,033 on derivative instruments in its consolidated statement of income for the period ended December 31, 2013. In 2012, the Company entered into short-term non-designated hedges with the notional amount of $81.5 million to mitigate its exposure related to US dollar denominated payments and recognized foreign currency losses of $272 on derivative instruments in its consolidated statement of income for the period ended December 31, 2012.

In January and February 2014, the Company entered into foreign exchange forward contracts with the notional amount of approximately $59.4 million 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 approximately 30%, 34% and 34% of the Company's total Russian advertising revenues 2011, 2012 and 2013, respectively.

Purchase commitments

The table below summarizes information with respect to the Company's commitments as of December 31, 2013:

	Total		2014		2015		2016		2017		2018

	(in thousands)
Acquisition of programming rights	$	227,816	$	189,020	$	29,690	$	9,106	$	—	$	—
Transmission and satellite fees		70,885		19,591		17,753		16,555		11,889		5,097
Leasehold obligations		37,547		7,231		7,595		7,802		8,090		6,829
Network affiliation agreements		9,593		3,026		2,998		1,823		1,746		—
Acquisition of format rights		852		852		—		—		—		—
Cable connections		2,158		1,707		451		—		—		—
Payments for intellectual rights		13,780		2,766		2,926		3,087		2,442		2,559
Other contractual obligations		22,148		4,359		4,784		4,678		4,390		3,937


Total	$	384,779	$	228,552	$	66,197	$	43,051	$	28,557	$	18,422

In addition, in connection with the planned digitalization in Russia and Kazakhstan, the Company may incur additional costs. In March, 2013, the Company entered into 10 year transmission agreements with the Russian Television and Radio Network ("RTRS"). Under the terms of these agreements, RTRS will provide to CTC and Domashny all services required for the channels to broadcast their signals in digital format throughout Russia to approximately 141.6 million viewers. The specific services, coverage and equipment to be provided by RTRS will be agreed by the parties on an annual basis pursuant to a rollout plan forming a part of the principal agreement between the parties. The agreements terminate on March 31, 2023. In 2013, the amount payable to RTRS by the CTC and Domashny channels combined was approximately $1.2 million. Fees payable to RTRS for 2014 will be determined in March 2014 according to RTRS rates and will be impacted by the timing of multiplex infrastructure rollout. The Company estimates that fees payable to RTRS for 2014 will be approximately $25 million for its CTC and Domashny channels in aggregate. Governmental authorities have indicated that each channel participating in the second multiplex will be expected to pay up to $26 million annually in transmission fees after the rollout. In addition, the Company expects to continue incurring analog transmission costs during the analog-to-digital transition period. In 2013, the Company incurred approximately $24 million of such expenses, excluding payments to RTRS, for all of its channels in aggregate.

Operating leases

The Company has several operating leases for 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 $7,241, $7,032 and $6,969 in 2011, 2012 and 2013, 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, 2012 and December 31, 2013. 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, 2012 and December 31, 2013, the Company included accruals for contingencies related to non-income taxes totaling $998 and $328, respectively, as a component of accrued liabilities, including amounts relating to pre-acquisition operations of the Channel 31 Group of $347 and nil, 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, 2013, management estimates such contingencies related to non-income taxes to be up to approximately $927.

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 currently have a standard term of ten years. In addition, the Company holds universal licenses, permitting each of its channels to broadcast through free-to-air, cable and satellite broadcasting, in either digital or analog format.

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, including tax audits, 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.