<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON NOVEMBER 2, 1998.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------
FORM 20-F/A
(MARK ONE)
[X] REGISTRATION STATEMENT PURSUANT TO SECTION 12(B)
OR (G) OF THE SECURITIES EXCHANGE ACT OF 1934
OR
[_] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended:
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
for the transition period from to
COMMISSION FILE NUMBER: 001-14487
TELE NORTE LESTE PARTICIPACOES S.A.
(Exact name of Registrant as specified in its charter)
TELE NORTE LESTE HOLDING COMPANY
(Translation of Registrant's name into English)
THE FEDERATIVE REPUBLIC OF BRAZIL
(Jurisdiction of incorporation or organization)
SCN-QUADRA CN2, LOTE F, 2(degrees) ANDAR, SALA 200
BRASILIA, DF, BRAZIL
(Address of principal executive offices)
SECURITIES REGISTERED OR TO BE REGISTERED PURSUANT TO SECTION 12(B) OF THE
ACT:
<TABLE>
<CAPTION>
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
------------------- -----------------------------------------
<S> <C>
Preferred Shares, without par
value.......................... New York Stock Exchange*
</TABLE>
- --------
* Not for trading, but only in connection with the listing of American
Depositary Shares on the New York Stock Exchange
SECURITIES REGISTERED OR TO BE REGISTERED PURSUANT TO SECTION 12(G) OF THE
ACT: None
SECURITIES FOR WHICH THERE IS A REPORTING OBLIGATION PURSUANT TO SECTION 15(D)
OF THE ACT: None
Indicate the number of outstanding shares of each of the issuer's classes of
capital or common stock as of the close of the last fiscal year covered by
this Registration Statement: None
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days.
Yes No X
Indicate by check mark which financial statement item the registrant has
elected to follow.
Item 17 Item 18 X
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<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<C> <S> <C>
PRESENTATION OF INFORMATION................................... ii
GLOSSARY OF TERMS............................................. vi
EXCHANGE RATES................................................ ix
PART I
ITEM 1. Description of Business....................................... 1
ITEM 2. Description of Property....................................... 32
ITEM 3. Legal Proceedings............................................. 32
ITEM 4. Control of Registrant......................................... 33
ITEM 5. Nature of Trading Market...................................... 34
ITEM 6. Exchange Controls and Other Limitations Affecting Security
Holders....................................................... 37
ITEM 7. Taxation...................................................... 39
ITEM 8. Selected Financial Data....................................... 43
ITEM 9. Management's Discussion and Analysis of Financial Condition
and Results of Operations..................................... 48
ITEM 9A. Quantitative and Qualitative Disclosures about Market Risk.... 64
ITEM 10. Directors and Officers of Registrant.......................... 64
ITEM 11. Compensation of Directors and Officers........................ 67
ITEM 12. Options to Purchase Securities from Registrant or
Subsidiaries.................................................. 67
ITEM 13. Interest of Management in Certain Transactions................ 67
PART II
ITEM 14. Description of Securities to be Registered.................... 68
PART III
ITEM 15. Defaults upon Senior Securities............................... 81
ITEM 16. Changes in Securities and Changes in Security for Registered
Securities.................................................... 81
PART IV
ITEM 17. Consolidated Financial Statements............................. 81
ITEM 18. Consolidated Financial Statements............................. 81
ITEM 19. Consolidated Financial Statements and Exhibits................ 81
</TABLE>
i
<PAGE>
PRESENTATION OF INFORMATION
OVERVIEW
Tele Norte Leste Participacoes S.A. (the "Registrant"), a corporation
organized under the laws of the Federative Republic of Brazil ("Brazil"), was
formed upon the reorganization of Telecomunicacoes Brasileiras S.A.--Telebras
("Telebras"), a corporation organized under the laws of Brazil that, together
with its operating subsidiaries (the "Telebras System"), was the primary
supplier of public telecommunications services in Brazil. On May 22, 1998, the
shareholders of Telebras approved the restructuring of the Telebras System to
form, in addition to Telebras, twelve new telecommunications companies (the
"New Holding Companies") by means of a procedure under Brazilian corporate law
called cisao or "split-up". The New Holding Companies were allocated
substantially all the assets and liabilities of Telebras, including the shares
held by Telebras of the operating companies of the Telebras System. The New
Holding Companies, together with their respective subsidiaries, comprise (a)
three regional fixed-line operators, (b) eight regional cellular operators and
(c) one national long-distance carrier. The separation of the Telebras System
into the New Holding Companies and their respective subsidiaries is referred
to in this Registration Statement on Form 20-F (the "Registration Statement")
as the "Breakup" of Telebras. Prior to the Breakup, Telebras, through its
operating subsidiaries, was the primary supplier of public telecommunications
services in Brazil. See "Description of Business--Background" and "--The
Company."
The Registrant is one of the New Holding Companies formed upon the Breakup
of Telebras. In the Breakup, all of the share capital held by Telebras in
Telecomunicacoes do Rio de Janeiro S.A. ("Telerj"), Telecomunicacoes de Minas
Gerais S.A. ("Telemig"), Telecomunicacoes do Espirito Santo S.A. ("Telest"),
Telecomunicacoes da Bahia S.A. ("Telebahia"), Telecomunicacoes de Sergipe S.A.
("Telergipe"), Telecomunicacoes de Alagoas S.A. ("Telasa"), Telecomunicacoes
de Pernambuco S.A. ("Telpe"), Telecomunicacoes da Paraiba S.A. ("Telpa"),
Telecomunicacoes do Rio Grande do Norte S.A. ("Telern"), Telecomunicacoes do
Ceara S.A. ("Teleceara"), Telecomunicacoes do Piaui S.A. ("Telepisa"),
Telecomunicacoes do Maranhao S.A. ("Telma"), Telecomunicacoes do Amapa S.A.
("Teleamapa"), Telecomunicacoes do Para S.A. ("Telepara"), Telecomunicacoes do
Amazonas S.A. ("Telamazon") and Telecomunicacoes de Roraima S.A. ("Telaima")
(together, the "Subsidiaries") was transferred to the Registrant. The
Subsidiaries are the principal providers of fixed-line public
telecommunications services in the northern, northeastern and eastern regions
of Brazil. Prior to January 1, 1998, each Subsidiary also had a cellular
telephone business. In preparation for the Breakup of Telebras, on January 30,
1998, the cellular telephone businesses of the Subsidiaries were "spun off"
effective January 1, 1998 to newly formed cellular companies. See "Description
of Business--Background" and "--The Company."
A substantial part of the Registrant's assets is comprised of share capital
of its subsidiaries. The Registrant relies largely on dividends from its
subsidiaries to meet its need for cash, including for the payment of dividends
to its shareholders. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Liquidity and Capital Resources."
As used herein, the "Company" refers to the Registrant and its consolidated
Subsidiaries.
PRESENTATION OF FINANCIAL INFORMATION
FINANCIAL STATEMENTS AND MINORITY INTERESTS
The audited consolidated balance sheets included herein as of December 31,
1996 and 1997 and the related consolidated statements of income, cash flows
and changes in shareholders' equity for each of the years ended December 31,
1995, 1996 and 1997, (including the notes thereto, the "Consolidated Financial
Statements") are the consolidated financial statements of the Registrant and
the subsidiaries. The portion of the consolidated equity and net income of the
Subsidiaries attributable to shareholders of the Subsidiaries other than
Telebras at December 31, 1996 and 1997, and for each of the years in the
three-year period ended December 31, 1997 is reflected as "minority interests"
in the Consolidated Financial Statements. At December 31, 1997, such minority
shareholders directly and indirectly owned the percentages shown in the table
below of the share capital of the
ii
<PAGE>
Subsidiaries, respectively. Substantially all such share capital is comprised
of preferred shares originally issued from time to time by the Subsidiaries in
connection with such Subsidiaries' auto-financing activities. The
consideration paid for such preferred shares was the higher of market or book
value at the time of issuance, for shares issued after August 1996, and book
value for shares issued prior to August 1996. A secondary trading market has
developed in such preferred shares in which institutional and other investors
participate. For a discussion of such auto-financing activities, see
"Description of Business-- Rates-- Local Services."
<TABLE>
<CAPTION>
% OF SHARE % OF VOTING
CAPITAL OWNED STOCK OWNED
BY MINORITY BY MINORITY
STATE SUBSIDIARY SHAREHOLDERS/1/ SHAREHOLDERS/1/
----- ---------- --------------- ---------------
<C> <S> <C> <C>
Maranhao............. Telecomunicacoes do
Maranhao S.A.-Telma..... 33 17
Piaui................ Telecomunicacoes do
Piaui S.A.-Telepisa..... 22 2
Ceara................ Telecomunicacoes do
Ceara S.A.-Teleceara.... 21 15
Rio Grande do Norte.. Telecomunicacoes do Rio
Grande do Norte S.A.-
Telern.................. 25 7
Paraiba.............. Telecomunicacoes da
Paraiba S.A.-Telpa...... 28 5
Pernambuco........... Telecomunicacoes de
Pernambuco S.A.-Telpe... 23 5
Alagoas.............. Telecomunicacoes de
Alagoas S.A.-Telasa..... 22 3
Sergipe.............. Telecomunicacoes de
Sergipe S.A.-Telergipe.. 26 14
Bahia................ Telecomunicacoes da
Bahia S.A.-Telebahia.... 11 4
Roraima.............. Telecomunicacoes de
Roraima S.A.-Telaima.... 13 5
Amapa................ Telecomunicacoes do
Amapa S.A.-Teleamapa.... 9 6
Amazonas............. Telecomunicacoes do
Amazonas S.A.-
Telamazon............... 20 16
Para................. Telecomunicacoes do Para
S.A.-Telepara........... 31 3
Rio de Janeiro....... Telecomunicacoes do Rio
de Janeiro S.A.-Telerj.. 29 15
Minas Gerais......... Telecomunicacoes de
Minas Gerais S.A.-
Telemig................. 17 11
Espirito Santo....... Telecomunicacoes do
Espirito Santo S.A.-
Telest.................. 15 7
</TABLE>
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/1/Includes both direct and indirect ownership
The Consolidated Financial Statements present the fixed-line
telecommunications business of the Subsidiaries as continuing operations and
the cellular telephone business as discontinued operations for all periods.
The assets and liabilities of the cellular telephone business are presented as
net assets of discontinued operations.
FORMATION OF REGISTRANT
The separation of the fixed and cellular telecommunications businesses and
the formation of the Registrant has been accounted as a reorganization of
entities under common control in a manner similar to a pooling of interests.
The assets and liabilities of the cellular telephone business were transferred
from the Subsidiaries at their indexed historical cost. The Consolidated
Financial Statements are not necessarily indicative of the financial position
and results of operations that would have occurred for the three-year period
ended December 31, 1997 had the fixed-line telecommunications businesses of
the Subsidiaries been separate legal entities during such periods. See
"Description of Business--Background," "--The Company" and Notes 1, 2 and 28
to the Consolidated Financial Statements.
At the May 22, 1998 Telebras shareholders' meeting, the shareholders
approved a specific structure for the shareholders' equity of each New Holding
Company, which included an allocation of a portion of the retained earnings of
Telebras. In this manner, the balances of capital, reserves and retained
earnings, together with the corresponding assets and liabilities, for the
formation of Tele Norte Leste Participacoes S.A. were established. Telebras
retained within its own shareholders equity sufficient retained earnings from
which to pay certain dividends and other amounts. Telebras allocated to each
New Holding Company, the balance of its retained
iii
<PAGE>
earnings in proportion to the total net assets allocated to each such Company.
This value of allocated retained earnings does not represent the historical
retained earnings of the New Holding Companies and resulted in an increase of
R$1,906,669,000 in relation to the Company's historical retained earnings. See
Note 28 to the Consolidated Financial Statements. Allocated retained earnings
and future retained earnings will be the basis from which future dividends
will be payable.
Prior to December 31, 1997 cash and certain non-specific debt of the
cellular telecommunications business could not be segregated from the
Subsidiaries. Accordingly, these amounts are included in the consolidated
financial statements for periods ended before January 1, 1998. As a result,
certain interest income and expense relating to the cellular
telecommunications business could not be identified and, consequently, income
from discontinued operations is presented before unallocated interest income
(expense) and income tax expense. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Results of Operations for the
years ended December 31, 1995, 1996 and 1997--Allocated and unallocated
interest expense and unallocated interest income."
In connection with the formation of the Registrant, certain assets of
Telebras in addition to its interests in the Subsidiaries were spun off to the
Registrant. Such assets comprised cash and other current assets, noncurrent
assets and certain investments. See Note 28 to the Consolidated Financial
Statements, which includes a consolidated balance sheet of the Registrant
reflecting all the assets spun off to the Registrant as of February 28, 1998.
The Registrant received no indebtedness from Telebras, but received R$10,364
million of Telebras assets, including R$166 million in cash and cash
equivalents. A substantial amount of such assets (principally investment in
subsidiaries) is eliminated upon consolidation.
EFFECTS OF INFLATION
The Consolidated Financial Statements contained herein were prepared in
accordance with generally accepted accounting principles in Brazil ("Brazilian
GAAP") and are presented in Brazilian reais. Pursuant to Brazilian GAAP, the
Consolidated Financial Statements and the other financial information
presented herein recognize certain effects of changes in the purchasing power
of Brazilian currency due to inflation and, unless otherwise specified, have
been indexed and expressed in constant reais of December 31, 1997 purchasing
power by using the daily changes or the monthly average values of the Unidade
Fiscal de Referencia (the Tax Reference Unit or the "UFIR") through December
31, 1995.
Until December 31, 1995, the relevant inflation index selected by the CVM
and the one used for the constant currency method under Brazilian GAAP was the
UFIR. Effective January 1, 1996, the Comissao de Valores Mobiliarios (the
Brazilian Securities Commission or "CVM"), no longer requires Brazilian
companies to restate their financial statements for reporting purposes in
constant currency by indexing historical amounts using the UFIR. Restatement
in constant currency is now optional and any general price index may be used.
The Brazilian Institute of Accountants has recommended that the Indice Geral
de Precos--Mercado (the General Prices Index-Market or the "IGP-M") be used
for this purpose. The Company's management believes that the IGP-M is the most
appropriate measure of the general price inflation in Brazil and has elected
the IGP-M for purposes of preparing its financial statements in accordance
with the constant currency method as of January 1, 1996. See Note 2 to the
Consolidated Financial Statements.
In July 1997, the three-year cumulative inflation rate for Brazil fell below
100%; however, for accounting purposes, the constant currency method has
continued to be applied. The Brazilian Institute of Accountants has not yet
published definitive rules regarding when the constant currency method of
accounting may no longer be used to prepare the financial statements. If the
Brazilian Institute of Accountants determines that the constant currency
method may no longer be used to prepare the financial statements beginning
January 1, 1998, the restated balances of nonmonetary assets and liabilities
of the Company as of December 31, 1997 will become the new basis for
accounting, and income statement items will no longer be restated for
inflation.
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CURRENCY TRANSLATIONS
All references herein to (i) the "real," "reais" or "R$" are to Brazilian
reais (plural) and to the Brazilian real (singular), the official currency of
Brazil and (ii) "U.S. dollars," "dollars" or "US$" are to United States
dollars. As of July 1, 1994, the denomination of the Brazilian currency unit
was changed to the real from the cruzeiro real (each real being equal to 2,750
cruzeiros reais at such time). All amounts in cruzeiros reais have been
restated in reais in this Registration Statement. Certain amounts herein may
not sum due to rounding.
This Registration Statement contains translations of certain real amounts
into U.S. dollars solely for the convenience of the reader. These translations
should not be construed as representations that the real amounts actually
represent such U.S. dollar amounts or could be or could have been converted
into U.S. dollars at the rate indicated. Unless otherwise indicated, such U.S.
dollar amounts have been translated from reais at the commercial buying rate
for the purchase of U.S. dollars (the "Commercial Market Rate") published by
Banco Central do Brasil (the "Central Bank of Brazil") for December 31, 1997,
which was 1.1164 to US$1.00. The noon buying rate in New York City for cable
transfers in reais as certified by the Federal Reserve Bank of New York has
not been consistently reported for Brazilian currency during the periods for
which data are presented in this Registration Statement. See "Exchange Rates"
for information regarding rates of exchange.
MARKET INFORMATION
Upon the Breakup of Telebras, holders of common and preferred Telebras
shares ("Telebras Common Shares" and "Telebras Preferred Shares" and,
together, "Telebras Shares") were deemed under Brazilian law to own, in
addition to such Telebras Shares, one common or preferred share, as
applicable, of each New Holding Company for each such Telebras Share held by
them. Following the Breakup and until September 21, 1998, the Telebras Common
Shares and the common shares of the New Holding Companies traded only as a
unit on the Bolsa de Valores de Sao Paulo (the "Sao Paulo Stock Exchange"),
the Bolsa de Valores do Rio de Janeiro (the "Rio de Janeiro Stock Exchange")
and the seven other Brazilian stock exchanges (together with the Sao Paulo
Stock Exchange and the Rio de Janeiro Stock Exchange, the "Brazilian Stock
Exchanges"). Similarly, the Telebras Preferred Shares and the preferred shares
of the New Holding Companies traded only as a unit on the Brazilian Stock
Exchanges during this period. Telebras American Depositary Shares ("Telebras
ADSs"), each originally representing ownership of 1,000 Telebras Preferred
Shares, have continued to trade on the New York Stock Exchange, Inc. (the
"NYSE"), except that since the Breakup, each Telebras ADS has represented
1,000 Telebras Preferred Shares and 1,000 preferred shares of each of the New
Holding Companies. On September 21, 1998, the common shares and preferred
shares of each New Holding Company were distributed in Brazil and commenced
trading separately on the Brazilian Stock Exchanges. It is expected that
during the fourth quarter of 1998 American Depositary Shares representing
preferred shares of each New Holding Company will be issued and will commence
trading separately on the NYSE. See "Nature of Trading Market" and
"Description of Securities to be Registered--Description of American
Depositary Receipts in respect of Preferred Shares."
References herein to the "Preferred Shares" and "Common Shares" are to the
preferred shares and common shares, respectively, of the Registrant.
References to the American Depositary Shares or "ADSs" are to American
Depositary Shares, each representing 1,000 Preferred Shares. The ADSs will be
evidenced by American Depositary Receipts ("ADRs").
v
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GLOSSARY OF TERMS
The following explanations are not intended as technical definitions, but to
assist the general reader to understand certain terms as used in this
Registration Statement.
Access charge: Amount paid per minute charged by network operators for the
use of their network by other network operators. Also known as an
"interconnection charge" or "network usage charge".
Access gates: The points of interface between the network equipment (either
dedicated or switched) and the transmission media that connect network
equipment to the end user. The quantity of service is directly related to the
quantity of network access gates.
AMPS (Advanced Mobile Phone Service): An analog cellular telephone service
standard utilizing the 850 MHz band, in use in North America, parts of South
America, Australia and various other areas.
Analog: A mode of transmission or switching which is not digital, e.g., the
representation of voice, video or other modulated electrical audio signals
which are not in digital form.
Analog network: A network using analog technology with circuit switching,
capable of connecting one user with all the users, but with limited
transmission capacity.
ATM (Asynchronous Transfer Mode): A broadband switching technology that
permits the use of one network for different kinds of information (e.g.,
voice, data and video).
Automatic international roaming: A service which permits a subscriber to use
his or her cellular phone on a foreign cellular operator's network. The
subscriber may receive calls made to the subscriber's regular cellular number
(such calls are "automatically" passed to the foreign operator's network).
Band A Operator: A former Telebras cellular operating subsidiary that has
been granted a concession to provide cellular telecommunications services in a
particular area within a radio spectrum frequency range referred to by Anatel
as "Band A".
Band B Operator: A cellular operator that has been granted a concession to
provide cellular telecommunications services in a particular area within a
radio spectrum frequency range referred to by Anatel as "Band B".
Base station: In cellular mobile telecommunications, a radio
transmitter/receiver that maintains communications with the cellular
telephones within a given cell. Each base station in turn is interconnected
with other base stations and with the public switched telephone network.
Broadband services: Services characterized by a transmission speed of 2
Mbit/s or more. According to international standards, these services are
divided into two categories: (i) Interactive services, including
videotelephone/videoconferencing (both point-to-point and multipoint);
videomonitoring; interconnection of local networks; file transfer; CAD;
highspeed fax; e-mail for moving images or mixed documents; broadband
videotext; video on demand; retrieval of sound programs or fixed and moving
images; and (ii) Broadcast services, such as sound programs, television
programs (including high-definition TV and pay TV) and selective document
acquisition.
CATV (Cable television): Cable or fiber-based distribution of TV programs.
CDMA (Code Division Multiple Access): A standard of digital cellular
technology.
Cell: The geographic area covered by a single base station in a cellular
mobile phone system.
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Cell splitting: The process of dividing cells into smaller coverage areas by
reducing their power output and the antenna height of the station transmitter.
Cell splitting increases capacity in a particular area by allowing for the
further reuse of frequencies by a mobile communications system.
Cellular service: A mobile telephone service provided by means of a network
of interconnected low-powered base stations, each of which covers one small
geographic cell within the total cellular system service area.
Channel: One of a number of discrete frequency ranges utilized by a base
station.
Digital: A mode of representing a physical variable such as speech using
digits 0 and 1 only. The digits are transmitted in binary form as a series of
pulses. Digital networks allow for higher capacity and higher flexibility
through the use of computer-related technology for the transmission and
manipulation of telephone calls. Digital systems offer lower noise
interference and can incorporate encryption as a protection from external
interference.
Digital penetration: The substitution of equipment capable of transmitting
digital signals for equipment limited to analog transmission.
Exchange: See Switch.
Frame relay: A data transmission service using fast protocols based on
direct use of transmission lines.
Internet: A collection of interconnected networks spanning the entire world,
including university, corporate, government and research networks from around
the globe. These networks all use the IP (Internet Protocol) communications
protocol.
ISDN (Integrated Services Digital Network): A system in which several
services (e.g., speech and data) may be simultaneously transmitted end-to-end
in digital form.
Leased high-speed data communication: The digital exchange of information at
speeds exceeding 64Kbps transmitted through mediums that are leased to users
for their exclusive use.
Local loop: The system used to connect the subscriber to the nearest switch.
It generally consists of a pair of copper wires, but may also employ fiber-
optic circuits, microwave links or other technologies.
Manual international roaming: A service that permits a subscriber to use his
or her cellular phone on a foreign cellular operator's network. The subscriber
may only receive calls made to a temporary number issued to the subscriber by
the foreign operator for use while roaming.
Microcells: A small cell covered by a low-power base station. Microcells can
cover small areas such as a single building.
Network: An interconnected collection of elements. In a telephone network,
these consist of switches connected to each other and to customer equipment.
The transmission equipment may be based on fiber optic or metallic cable or
point-to-point radio connections.
Network usage charge: Amount paid per minute charged by network operators
for the use of their network by other network operators. Also known as an
"access charge" or "interconnection charge".
Optical fiber: A transmission medium which permits extremely high
capacities. It consists of a thin strand of glass that provides a pathway
along which waves of light can travel for telecommunications purposes.
Packet-switched data communication services: Data services based on
parceling or breaking the data stream into packets and switching the
individual packets. Information transmitted is segmented into cells of a
standardized length, which are then transmitted independently of one another,
allowing maximization of available capacity and usage of a single transmission
path for multiple communications. The cells are then reassembled upon reaching
their destination.
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PBX (Private Branch Exchange): Telephone switchboard for private use, but
linked to the national telephone network.
Penetration: The measurement of the take-up of services. As of any date, the
penetration is calculated by dividing the number of subscribers by the
population to which the service is available and multiplying the quotient by
100.
Private leased circuits: Voice, data or image transmission mediums leased to
users for their exclusive use.
PSTN (Public Switched Telephone Network): The public telephone network that
delivers basic telephone service and, in certain circumstances, more advanced
services.
Repeaters: A device that amplifies an input signal for retransmission.
Roaming: A function that enables cellular subscribers to use their cellular
phone on networks of operators other than the one with which they signed their
initial contract.
Satellite services: Satellites are used, among other things, for links with
countries that cannot be reached by cable or to provide an alternative to
cable and to form closed user networks.
SDH (Synchronous Digital Hierarchy): A hierarchy set of digital transport
structures, standardized for the transport of suitably adapted payloads over
physical transmission networks.
Sectorization: The process of dividing cells into sectors by using
directional antennae at the base station. Sectorization reduces co-channel
interference which permits smaller cells and increases network capacity.
Switch: These are used to set up and route telephone calls either to the
number called or to the next switch along the path. They may also record
information for billing and control purposes.
TDMA (Time Division Multiple Access): A standard of digital cellular
technology.
Universal service: The obligation to supply basic service to all users
throughout the national territory at reasonable prices.
Value Added Services: Value Added Services provide a higher level of
functionality than the basic transmission services offered by a
telecommunications network.
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EXCHANGE RATES
There are two legal foreign exchange markets in Brazil--the commercial rate
exchange market (the "Commercial Market") and the floating rate exchange
market (the "Floating Market"). The Commercial Market is reserved primarily
for foreign trade transactions and transactions that generally require prior
approval from Brazilian monetary authorities, such as the purchase and sale of
registered investments by foreign persons and related remittances of funds
abroad. Purchases and sales of foreign exchange in the Commercial Market may
be carried out only through a financial institution in Brazil authorized to
buy and sell currency in that market. As used herein, the "Commercial Market
Rate" for any day is the commercial selling rate for Brazilian currency into
U.S. dollars, as reported by the Central Bank of Brazil. As used herein, the
"Floating Market Rate" is the prevailing selling rate for Brazilian currency
into U.S. dollars which applies to transactions to which the Commercial Market
Rate does not apply, as reported by the Central Bank of Brazil. Prior to the
implementation of the Real Plan, the Commercial Market Rate and the Floating
Market Rate differed significantly at times. Since the introduction of the
real, the two rates have not differed significantly, although there can be no
assurance that there will not be significant differences between the two rates
in the future. Both the Commercial Market Rate and the Floating Market Rate
are freely negotiated but are strongly influenced by the Central Bank of
Brazil.
On July 1, 1994 the real replaced the cruzeiro real as the unit of Brazilian
currency, with each real being equal to 2,750 cruzeiros reais. The issuance of
reais was initially subject to quantitative limits backed by a corresponding
amount of U.S. dollars in resources, but the Federal Government subsequently
expanded those quantitative limits and allowed the real to float, with parity
between the real and the U.S. dollar (R$1.00 to US$1.00) as a ceiling. On
March 6, 1995, the Central Bank of Brazil announced that it would intervene in
the market and buy or sell U.S. dollars, and established a trading band (faixa
de flutuacao) for the Commercial Market Rate (which is defined through
auction) within which the exchange rate between the real and the U.S. dollar
could fluctuate. The Central Bank of Brazil initially set the band with a
floor of R$0.86 per US$1.00 and a ceiling of R$0.90 per US$1.00 and provided
that, from and after May 2, 1995, the band would fluctuate between R$0.86 and
R$0.98 per US$1.00. Shortly thereafter, the Central Bank of Brazil issued a
new directive providing that the band would be between R$0.88 and R$0.93 per
US$1.00. On June 22, 1995, the Central Bank of Brazil issued another directive
providing that the band would be between R$0.91 and R$0.99 per US$1.00 and
subsequently reset the band on January 30, 1996 to between R$0.97 and R$1.06
per US$1.00. Upon resetting the band on January 30, 1996, the Central Bank of
Brazil adjusted the exchange rate within such band on a number of occasions,
generally in increments of R$0.001, by means of buying and selling U.S.
dollars in electronic auctions. On February 18, 1997, the band was reset by
the Central Bank of Brazil to float between R$1.05 and R$1.14 per US$1.00. On
May 5, 1998, the band was reset by the Central Bank of Brazil to float between
R$1.12 to R$1.22 per US$1.00. As of October 23, 1998, the trading band has not
been reset by the Central Bank of Brazil. There can be no assurance that the
band will not be altered in the future or that the real will maintain its
current exchange rate in future periods.
The following table sets forth the Commercial Market Rate expressed in reais
per U.S. dollar for the periods and dates indicated. Prior to July 14, 1994,
The Federal Reserve Bank of New York did not publish a noon buying rate for
customs purposes in the City of New York for cable transfers in the Brazilian
real and its predecessor currencies (the "Noon Buying Rate").
<TABLE>
<CAPTION>
COMMERCIAL MARKET RATE:
NOMINAL REAIS PER US$1.00(1)
-----------------------------------
YEAR ENDED DECEMBER 31,(1) LOW HIGH AVERAGE(2) PERIOD-END
- -------------------------- ------ ------ ---------- ----------
<S> <C> <C> <C> <C>
1993....................................... 0.0044 0.1186 0.0369 0.1186
1994....................................... 0.1204 0.9815 0.6754 0.8490
1995....................................... 0.8340 0.9726 0.9227 0.9726
1996....................................... 0.9726 1.0394 1.0080 1.0394
1997....................................... 1.0395 1.1164 1.0555 1.1164(3)
1998 (through October 23).................. 1.1165 1.1911 1.1560 1.1911
</TABLE>
- --------
Source: Central Bank of Brazil
(1) Amounts expressed in nominal reais have been translated from the
predecessor Brazilian currencies in effect during the relevant period at
the rates of exchange at the times the successor currencies became the
lawful currency of Brazil.
(2) Represents the average of the month-end exchange rates during the relevant
period.
(3) The Noon Buying Rate on December 31, 1997 was R$1.1165 per U.S. dollar.
ix
<PAGE>
PART I
ITEM 1. DESCRIPTION OF BUSINESS
BACKGROUND
TELEBRAS AND THE TELEBRAS SYSTEM
Until 1972, telephone services in Brazil were provided by more than 900
independent companies, which supplied non-integrated basic telephone services.
Telebras was incorporated on November 9, 1972, pursuant to special
legislation, for the principal purposes of (i) acting as a holding company for
operating companies providing public telecommunications services in Brazil and
(ii) implementing the policies of the federal government of Brazil (the
"Federal Government") in the modernization and expansion of the Brazilian
telecommunications system. Between 1972 and 1975, Telebras, through its
subsidiaries, acquired almost all the other telephone companies in Brazil.
Telebras and its operating subsidiaries are referred to collectively herein as
the "Telebras System." Only four operating companies remained outside the
Telebras System, with a total at December 31, 1997 of approximately 9% of all
lines in service in Brazil at that date. Telebras is controlled by the Federal
Government and the operations of the Telebras System are subject to regulation
by the Federal Government. The operating subsidiaries of Telebras were
controlled by the Federal Government until August 4, 1998. See "--Regulatory
Reform and Privatization."
At December 31, 1997, Telebras, through 28 operating subsidiaries, was the
primary supplier of public telecommunications services in Brazil. Empresa
Brasileira de Telecomunicacoes S.A.--Embratel ("Embratel"), a subsidiary of
Telebras, owned and operated all of the interstate and international telephone
transmission facilities in Brazil. Through the other 27 subsidiaries, the
Telebras System was the primary provider of local and intrastate
telecommunications services and the leading provider of cellular mobile
telephone services, and it also provided telecommunications-related services
such as communication, sound and image transmission and other value-added
services. As of January 30, 1998, each of the operating subsidiaries other
than Embratel and Companhia Telefonica da Borda do Campo--CTBC spun off its
cellular telephone operations into separate companies.
In 1997, Telebras was the second largest company in Brazil as measured by
gross revenues of R$ 20.7 billion.
REGULATORY REFORM AND PRIVATIZATION
Beginning in 1995, the Federal Government undertook a comprehensive reform
of regulation of the telecommunications industry. In August 1995, the federal
Constitution was amended to permit the Federal Government to grant concessions
to private companies to provide telecommunications services. In July 1997, the
Federal Congress adopted Law No. 9,472 of July 16, 1997, the Lei Geral de
Telecomunicacoes (the "Telecommunications Law"), which provided for the
establishment of a new regulatory framework, the introduction of competition
and the privatization of the Telebras System. The Telecommunications Law
established an independent regulatory agency called Agencia Nacional de
Telecomunicacoes ("Anatel"), which has begun to adopt a series of regulatory
enactment's that implement the provisions of the Telecommunications Law
(together with the regulations, decrees, orders and plans issued by the
President of Brazil on telecommunications, the "Telecommunications
Regulations"). See "--Regulation of the Brazilian Telecommunications
Industry."
On May 22, 1998, in preparation for the privatization of the Telebras
system, the Telebras System was restructured to form, in addition to Telebras,
the twelve New Holding companies. Virtually all the assets and liabilities of
Telebras were allocated to the New Holding Companies, which, together with
their respective subsidiaries, now comprise (a) three regional fixed-line
operators (including the Company), (b) eight regional cellular operators and
(c) one domestic and international long-distance operator. Prior to the
Breakup of the Telebras System, Embratel provided all interstate telephone
service and the other subsidiaries of Telebras provided fixed-line and
cellular service in their respective territories, which, subject to limited
exceptions,
1
<PAGE>
corresponded to the separate Brazilian states. Following the Breakup, each of
the eight cellular operators provides cellular telephone service on Band A in
one of eight regions into which Brazil has been divided for purposes of
cellular telephone service and each of the three fixed-line operators provides
for local fixed-line telephone service and intra-regional long-distance fixed-
line telephone service in one of three regions into which Brazil has been
divided for the purposes of fixed-line telephone service.
On July 29, 1998, the Federal Government sold to twelve buyers (the "New
Controlling Shareholders") its rights to receive shares of the twelve New
Holding Companies upon the distribution of such shares. The total
consideration to be paid to the Federal Government for the twelve New Holding
Companies is R$22.1 billion. In connection with this sale, the Federal
Government assigned to the New Controlling Shareholders all its economic and
voting rights with respect to the New Holding Companies and, as a consequence,
the New Controlling Shareholders now control the New Holding Companies.
Following the distribution of the shares of the New Holding Companies,
Telebras will be delisted from the New York Stock Exchange and liquidated.
The New Controlling Shareholder of the Registrant is a consortium comprised
of Construtora Andrade Gutierrez S.A. (10.98%), Inepar S.A. Industria e
Construcoes (10.35%), Macal Investimentos e Participacoes Ltda. (10.35%),
Fiago Participacoes S.A. (9.68%), Brasil Veiculos Companhia de Seguros (5.20%)
and Companhia de Seguros Alianca do Brasil (5.20%), (collectively, "Telemar").
For a description of the business activities of the members of Telemar, see
"Control of Registrant." Telemar agreed to pay R$3.43 billion for the Federal
Government's stake in the Registrant, R$1.37 billion of which was paid on
August 3, 1998 and the remainder of which will be paid in two equal
installments over the next two years. The entire proceeds of the sale of the
Federal Government's stake in the Registrant will be retained by the Federal
Government.
On August 20, 1998, Brazil's Minister of Communications determined that
Telebras would be dissolved and liquidated. The Minister announced that
Telebras will prepare, within the next twelve months, a liquidation plan to be
submitted to a shareholders' meeting convened to approve the dissolution of
Telebras and its subsequent liquidation.
The adoption of the Telecommunications Law and the Telecommunications
Regulations has led, and the privatization of the Telebras System will lead,
to sweeping changes in the operating, regulatory and competitive environment
for Brazilian telecommunications. The changes include (a) the establishment of
an independent regulator and the development of comprehensive regulation of
the telecommunications sector, (b) the Breakup of Telebras, (c) the sale of a
controlling interest in the Registrant to one or more new investors and (d)
the introduction of competition in the provision of all telecommunications
services. All of these developments will materially affect the Company and the
other New Holding Companies, and the Company cannot predict the effects of
these changes on its business, financial condition, results of operations or
prospects. The extensive changes in the structure and regulation of the
Brazilian telecommunications industry must also be carefully considered in
reviewing historical information and in evaluating the future financial and
operating performance of the Company.
THE COMPANY
The Registrant is one of the New Holding Companies formed upon the Breakup
of Telebras. It owns a controlling interest in sixteen providers of fixed-line
public telecommunications services in the northern, north-eastern and eastern
regions of Brazil. The sixteen subsidiaries of the Registrant are listed in
the chart below (the "Subsidiaries" or, individually, a "Subsidiary"), along
with the percentage of share capital and voting stock of each owned by the
Registrant at December 31, 1997. At December 31, 1997 the Company owned 76% of
the share capital and 90% of the voting stock of its Subsidiaries.The minority
interests in the Company are held by pension funds sponsored by public
companies, regional development funds, mutual funds and individuals who
obtained shares in the Company pursuant to the prior system of "auto-
financing" in which each new customer was required to invest in shares of
Telebras or its subsidiaries. For a discussion of auto-financing see "--
Rates--Local Services." The shares of Telerj, Telemig and Telebahia are listed
on the Brazilian stock exchanges. The shares of all the other Subsidiaries are
traded in Brazil on the over-the-counter market.
2
<PAGE>
As a result of the Breakup of Telebras on May 22, 1998 and the privatization
of the New Holding Companies on July 29, 1998, the Company is in default under
a portion of the credit agreements to which it is a party. The Company is
currently under negotiations with the appropriate creditors with respect to
the indebtedness in default. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Liquidity and Capital
Resources" and "Defaults upon Senior Securities."
<TABLE>
<CAPTION>
% OF SHARE % OF VOTING
CAPITAL OWNED STOCK OWNED
STATE SUBSIDIARY BY REGISTRANT BY REGISTRANT
----- ---------- ------------- -------------
<C> <S> <C> <C>
Maranhao............. Telecomunicacoes do
Maranhao S.A.-Telma....... 67% 83%
Piaui................ Telecomunicacoes do Piaui
S.A.-Telepisa............. 78 98
Ceara................ Telecomunicacoes do Ceara
S.A.-Teleceara............ 79 85
Rio Grande do Norte.. Telecomunicacoes do Rio
Grande do Norte S.A.-
Telern.................... 75 93
Paraiba.............. Telecomunicacoes da
Paraiba S.A.-Telpa........ 72 95
Pernambuco........... Telecomunicacoes de
Pernambuco S.A.-Telpe..... 77 95
Alagoas.............. Telecomunicacoes de
Alagoas S.A.-Telasa....... 78 97
Sergipe.............. Telecomunicacoes de
Sergipe S.A.-Telergipe.... 74 86
Bahia................ Telecomunicacoes da Bahia
S.A.-Telebahia............ 89 96
Roraima.............. Telecomunicacoes de
Roraima S.A.-Telaima...... 87 95
Amapa................ Telecomunicacoes do Amapa
S.A.-Teleamapa............ 91 94
Amazonas............. Telecomunicacoes do
Amazonas S.A.-Telamazon... 80 84
Para................. Telecomunicacoes do Para
S.A.-Telepara............. 69 97
Rio de Janeiro....... Telecomunicacoes do Rio de
Janeiro S.A.-Telerj....... 71 85
Minas Gerais......... Telecomunicacoes de Minas
Gerais S.A.-Telemig....... 83 89
Espirito Santo....... Telecomunicacoes do
Espirito Santo S.A.-
Telest.................... 85 93
</TABLE>
The Company provides public fixed-line telecommunications services pursuant
to concessions granted to the Subsidiaries by the Federal Government (the
"Concessions"). Each Concession will expire on December 31, 2005 and may be
renewed for a further term of 20 years if the Company meets certain
obligations set forth in the Concession. The Concessions may also be revoked
by Anatel prior to 2005 under certain circumstances. See "--Regulation of the
Brazilian Telecommunications Industry--Obligations of Telecommunications
Companies." If the Company elects to renew a Subsidiary's Concession, the
Subsidiary will be required to pay a biannual fee equal to 2% of its annual
net revenue from the provision of fixed-line public telecommunications
services in the Concession area for the prior year (excluding taxes and social
contributions) during the 20-year renewal period. See "--Regulation of the
Brazilian Telecommunications Industry--Concessions and Licenses."
The Concessions authorize the Company to operate in concession areas
covering a region (the "Region") consisting of sixteen states of Brazil
located in the northern, north-eastern and eastern regions of the country as
listed in the chart above, excluding an area in the state of Minas Gerais
where Companhia de Telecomunicacoes do Brasil Central (CTBC Telecom), an
operator that was not part of the Telebras System, continues to operate
independently and an area of 39,105 square kilometers in the state of Minas
Gerais operated by Tele Centro Sul Participacoes S.A. as provided in an
agreement between Telemig and Telecomunicacoes de Brasilia S.A.--Telebrasilia,
an operating subsidiary of Tele Centro Sul Participacoes S.A. The Company
expects to terminate the agreement between Telemig and Telebrasilia by the end
of 1998 and negotiations are underway to acquire the fixed-line network and
plant in the state of Minas Gerais from Tele Centro Sul Participacoes S.A. The
portion of the sixteen above-listed states excluded from the Region represents
approximately 3.4% of total lines in service and 2.0% of the population of
such states. The Company currently holds the only Concessions to provide local
and intra-state public fixed-line telecommunications services in the Region,
but the Telecommunications Law and Telecommunications Regulations contemplate
the introduction of limited competition following the privatization and full
competition beginning at the earliest December 31, 2001. See "--Competition."
The Company's Concessions have been granted under the Public Regime. For a
description of the Public Regime, see "--Regulation of the Brazilian
Telecommunications Industry--Concessions and Licenses." The
3
<PAGE>
Company, together with Embratel and the two other regional fixed-line
companies, is one of four companies in Brazil operating under Public Regime
Concessions. As an operator under the Public Regime, the Company is subject to
certain obligations, principally concerning the continuous provisions of
service throughout the Region ("universal service"), quality of service, and
network expansion and modernization. Anatel has the power, if certain of these
obligations are not met, to impose penalties including revocation of the
Company's Concessions. See "--Regulation of the Brazilian Telecommunications
Industry--Obligations of Telecommunications Companies."
The Registrant's headquarters are located at SCN-Quadra CN2, Lote F,
2(degrees) Andar, Sala 200, Brasilia-DF, 70710-500 Brazil, and its telephone
number is (5561) 327-5544.
THE REGION
The states that primarily comprise the Region cover an area of 5.4 million
square kilometers, representing 64% of the country's total area. The
population of the states of the Region is approximately 86 million,
representing 54% of the total population of Brazil. The states of the Region
have 102 municipalities with populations in excess of 100,000 people.
Per capita income in the Region is approximately US$ 3,419 per year, varying
from US$ 1,318 for the state of Piaui to US$ 5,973 for the state of Rio de
Janeiro and the Region generates approximately 38% of Brazil's gross domestic
product. Unemployment rates at April 30, 1998 for the major cities in the
Region are: Rio de Janeiro (6.95%), Belo Horizonte (8.35%), Salvador (10.42%)
and Recife (11.01%). Approximately 35% of all domestic long-distance
telecommunications traffic in Brazil originates or terminates within the
Region. The table below sets forth certain key economic data for the state in
which each Subsidiary operates and the contribution made by each of the
Subsidiaries to the Company's net operating revenue and net income.
<TABLE>
<CAPTION>
% OF NET % OF NET
% OF GROSS PER OPERATING REVENUE INCOME
POPULATION NATIONAL CAPITA CONTRIBUTED TO CONTRIBUTED TO
POPULATION PER SQUARE PRODUCT FOR INCOME THE REGISTRANT THE REGISTRANT
STATE (MILLION) KILOMETER 1996 US$ SUBSIDIARY IN 1997 IN 1997
----- ---------- ---------- ----------- ------ ---------- ----------------- --------------
<S> <C> <C> <C> <C> <C> <C> <C>
Maranhao................ 5.2 15.7 1.1% 1,553 Telma 2.3% 1.2%
Piaui................... 2.7 10.6 0.5 1,318 Telepisa 1.6 1.1
Ceara................... 7.0 46.6 1.8 2,064 Teleceara 6.9 8.9
Rio Grande do Norte..... 2.6 48.3 0.9 2,723 Telern 2.4 2.1
Paraiba................. 3.3 58.0 0.7 1,720 Telpa 2.2 1.3
Pernambuco.............. 7.5 74.7 2.5 2,657 Telpe 6.5 10.9
Alagoas................. 2.7 94.0 0.8 2,236 Telasa 1.7 0.7
Sergipe................. 1.7 73.8 0.7 3,252 Telergipe 1.3 1.3
Bahia................... 12.7 22.1 4.5 2,778 Telebahia 11.3 12.6
Roraima................. 0.3 1.1 0.1 3,605 Telaima 0.3 0.3
Amapa................... 0.4 2.6 0.2 3,467 Teleamapa 0.4 0.5
Amazonas................ 2.5 1.5 1.2 3,947 Telamazon 2.3 1.8
Para.................... 5.7 4.4 2.1 3,006 Telepara 3.6 3.0
Rio de Janeiro.......... 13.5 304.7 10.3 5,973 Telerj 26.8 19.4
Minas Gerais............ 14.9 28.4 9.1 4,212 Telemig 25.8 28.2
Espirito Santo.......... 2.8 60.9 1.6 4,333 Telest 4.6 6.7
</TABLE>
4
<PAGE>
Set forth below is a map showing the location of the Region within Brazil.
[MAP OF BRAZIL]
The Company's business, financial condition, results of operations and
prospects depend in part on the performance of the Brazilian economy, in
general, and the Region, in particular. See "--Brazilian Economic
Environment."
CUSTOMER SERVICES
OVERVIEW
The services the Company provides and the composition of its revenues have
changed significantly as a result of the Telecommunications Law, the
Telecommunications Regulations and the Breakup and Privatization of the
Telebras System. The Company's current services include principally: (i) local
services, including installation charges, monthly subscription charges,
measured service and public telephones, (ii) intra-regional long-distance
service, (iii) data transmission, (iv) network services, including
interconnection and leasing of facilities, and (v) other services. The Company
does not sell, rent or otherwise provide telephone equipment such as handsets,
switchboards or other items. Currently, the interconnection revenues the
Company receives include fees paid by cellular companies and other
telecommunications companies for the use of the Company's network. Prior to
April 1, 1998, the Company's interconnection revenues did not include any
revenues from Embratel. Rather than charging Embratel for interconnection, the
Company retained a fixed percentage of revenue from
5
<PAGE>
each interstate and international long-distance call that originated on the
Company's network. See "--Interregional and International Service." The
Company's revenues will be affected by increased competition, the new
regulatory environment and opportunities to offer a broader range of services.
See "--Competition" and "--Regulation of the Brazilian Telecommunications
Industry."
The following table breaks down the Company's revenue by type of service for
each of the years in the three-year period ended December 31, 1997. The
Company's tariffs for each category of service are described below under "--
Rates." Trends and events affecting the Company's operating revenue are
discussed under "Management's Discussion and Analysis of Financial Condition
and Results of Operations."
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------
1995 1996 1997
------- ------- -------
(IN MILLIONS OF REAIS)
<S> <C> <C> <C>
Local services....................................... 1,360 2,285 3,135
Intra-state long-distance service.................... 875 1,010 828
Interstate long-distance service..................... 1,264 1,275 1,044
International long-distance service.................. 224 211 155
Data transmission.................................... 158 199 164
Network services..................................... 298 558 999
Other................................................ 33 39 35
------- ------- -------
Total................................................ 4,212 5,577 6,360
Taxes and discounts.................................. 969 1,303 1,401
------- ------- -------
Net operating revenue................................ 3,243 4,274 4,959
======= ======= =======
</TABLE>
LOCAL SERVICES
Local services include principally installation, monthly subscription,
measured service and public telephones. Measured service includes all calls
that originate and terminate within a single local area of the Region ("local
calls"). After the privatization of the Company, a new entrant will be granted
a license to provide local services in competition with the Company. See "--
Competition."
The Company owns and operates public telephones and telephone booths
throughout the Region. At December 31, 1997, the Company had 228,625 public
telephones, of which 82% could be operated with a prepaid telephone card. At
June 1998, the Company increased its number of public telephones to 246,051
and predicts that at December 1998 the Company will have 278,561 public
telephones in service and all of its coin operated telephones replaced with
card operated telephones. The Concessions require the Company to meet
specified targets for public telephone services and density. The targets
proposed by Anatel require the Company to increase the number of public
telephones to 293,000 by 1999. See "--Network and Facilities--Network
Expansion" and "--Regulation of the Brazilian Telecommunications Industry--
Obligations of Telecommunications Companies--Network Expansion--General Plan
on Universal Service."
INTRA-REGIONAL LONG-DISTANCE SERVICE
Intra-regional long-distance service consists of all calls that originate
within one local area and terminate within another local area of the Region
(together with interregional long-distance service, "interurban" service).
Interstate long-distance service consists of calls between states and intra-
state long-distance service consists of calls within a state. Intra-regional
long-distance service includes intra-state long-distance service and
interstate long-distance service within and between states in the Region.
Prior to the Breakup, each Subsidiary was the exclusive provider of long-
distance service that originated and terminated within the Subsidiary's
concession area. Since each Subsidiary's concession area generally coincided
with the boundaries of a state, each Subsidiary was, generally speaking, the
exclusive provider of intra-state long-distance service in the state in which
it operated. Embratel was the exclusive provider of long-distance service
between the states. After the privatization,
6
<PAGE>
the Company and Embratel will be authorized to provide intra-regional long-
distance service. Therefore, the Company will expand to provide long-distance
service between the states of the Region and Embratel will expand to provide
intra-state long-distance service. Until the Company completes its intra-
regional long-distance network, the Company may lease transmission facilities
from Embratel to complete some interstate calls within the Region.
Additionally, Anatel will grant two new licenses for the provision of intra-
regional long-distance service to new entrants. See "--Competition." During
1997, 76% of the long-distance calls in the Region originated and terminated
in the Region. Specifically, 50% were intra-state calls and 26% were
interstate calls between states in the Region.
INTERREGIONAL AND INTERNATIONAL SERVICE
Interregional long-distance service consists of calls between a point
located within the Region and a point in Brazil outside the Region.
International long-distance service consists of calls between a point within
the Region and a point outside of Brazil. The Company is not itself authorized
to provide interregional long-distance or international service. Beginning in
2002, the Company may seek a license to provide interregional and
international long-distance service provided that it has met certain
obligations contained in the Concessions. See "--Competition" and "--
Regulation of the Brazilian Telecommunications Industry--Obligations of
Telecommunications Companies."
Prior to April 1, 1998, revenues from outgoing interstate and international
long-distance calls were divided between Embratel and the operating
subsidiaries of the Telebras System. The revenue-sharing arrangement with
Embratel was designed to equalize the return on investment of the operating
subsidiaries. Under this system each of the Subsidiaries retained a fixed
percentage of the customer charges for outgoing interstate and international
long-distance calls and paid the balance to Embratel. The Subsidiaries
generally received no revenue from incoming interstate or international long-
distance calls. In the case of interstate collect calls, each Subsidiary and
the other state operator divided equally the portion of the customer charge
not paid to Embratel. Each Subsidiary's percentage of revenues from outgoing
calls was reset annually, effective as of April 1. The Company retained, on
average, 71% of the customer charges during 1997, varying from 63% for the
state of Rio de Janeiro to 89% for the state of Amapa.
The following table lists, for each Subsidiary, the fixed percentage of
revenues retained by the Company from customer charges for interstate and
international long-distance calls for each of the periods described.
<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31,
1995 1996 1997
------------ ------------ ------------
<S> <C> <C> <C>
Telecomunicacoes do Maranhao S.A.--
Telma................................. 87% 81% 87%
Telecomunicacoes do Piaui S.A.--
Telepisa.............................. 88 89 88
Telecomunicacoes do Ceara S.A.--
Teleceara............................. 86 80 63
Telecomunicacoes do Rio Grande do Norte
S.A.--Telern.......................... 79 73 68
Telecomunicacoes da Paraiba S.A.--
Telpa................................. 87 79 71
Telecomunicacoes de Pernambuco S.A.--
Telpe................................. 77 72 72
Telecomunicacoes de Alagoas S.A.--
Telasa................................ 90 87 78
Telecomunicacoes de Sergipe S.A.--
Telergipe............................. 90 86 76
Telecomunicacoes da Bahia S.A.--
Telebahia............................. 85 79 81
Telecomunicacoes de Roraima S.A.--
Telaima............................... 90 87 78
Telecomunicacoes do Amapa S.A.--
Teleamapa............................. 90 87 89
Telecomunicacoes do Amazonas S.A.--
Telamazon............................. 90 87 78
Telecomunicacoes do Para S.A.--
Telepara.............................. 83 80 82
Telecomunicacoes do Rio de Janeiro
S.A.--Telerj.......................... 88 80 63
Telecomunicacoes de Minas Gerais S.A.--
Telemig............................... 81 75 70
Telecomunicacoes do Espirito Santo
S.A.--Telest.......................... 83 77 78
--- --- ---
Company's average...................... 85% 78% 71%
=== === ===
</TABLE>
7
<PAGE>
Effective on April 1, 1998, the system of revenue-sharing was discontinued.
The Company's relationship with Embratel, or any other provider of
interregional and international services, is now governed by interconnection
agreements regulated by Anatel under which the providers of interregional and
international services each will pay the Company a network usage fee for the
use of its network. See "--Regulation of the Brazilian Telecommunications
Industry" and "--Network Services." In order to soften the impact of the
discontinuation of the revenue-sharing arrangement, the Company receives from
Embratel a supplemental per-minute rebate (Parcela Adicional de Transicao or
"PAT") that supplements the network usage charge. This supplemental per-minute
rebate from Embratel will be gradually phased out over the next three years.
Except for the revenue from Embratel that the Company receives during the
three-year transitional period and interconnection revenues, the Company no
longer recognizes revenues from interregional and international long-distance
services. Embratel is now the only carrier of interregional and international
calls. However, the Telecommunications Regulations provide that another long-
distance carrier will be licensed following the privatization of the Telebras
System and, beginning in 2002, at the earliest, the Company may be permitted
to provide such long-distance services. See "--Competition."
NETWORK SERVICES
The Company provides access to its network to other telecommunications
companies and leases certain network facilities to other telecommunications
companies as part of its network services business. The Company increasingly
provides interconnection services to other telecommunications services
providers as a result of the spin-off of the cellular business of the
Subsidiaries, the Breakup of the Telebras System and the advent of
competition. Cellular companies, Embratel and certain licensees that operate
telecommunications networks interconnect with the Company's network in order
to receive calls that originate on the Company's network, to deliver calls
that terminate on the Company's network and to transport over the Company's
network calls that originate and terminate outside of the Company's network.
Interconnection revenues consist of fees collected by the Company for such use
of its network by other telecommunications network operators (network usage
fees) and for providing a physical connection to the network. See "--Rates--
Network Services." Since July 1996, following the introduction of competition
in cellular services, the terms of interconnection between fixed-line and
cellular operators have been subject to regulation. See "--Regulation of the
Brazilian Telecommunications Industry--Rate Regulation--Network Usage
Charges."
Currently, the Company provides interconnection services to twenty cellular
providers, including the sixteen cellular providers that were spun off from
the Subsidiaries on January 30, 1998 and four Band B cellular providers, and
some operators of trunking services. Shortly, the Company will also enter into
an interconnection agreement with Embratel, that will be retroactively applied
as of April 1, 1998, under which Embratel will pay fees to the Company for the
use of its local network and, in certain cases, its intra-regional long-
distance network. In addition, until the Company completes its intra-regional
long-distance network, it may lease transmission facilities from Embratel to
carry some interstate calls within the Region. The Company expects to be a net
recipient of fees under the interconnection agreement with Embratel because
Embratel will have to use the Company's local network for every call that
Embratel carries that originates or terminates in the Company's Region and in
certain instances Embratel will also use the Company's intra-regional long-
distance network. On the other hand, the Company will use Embratel's network
only to carry certain intra-regional long-distance calls over areas where the
Company has yet to develop its intra-regional network. The Company cannot
predict whether the interconnection agreement with Embratel will result in
higher or lower revenue for carrying interregional and international long-
distance calls than under the prior regime because it will depend on future
increases or decreases in the Company's and Embratel's market share and future
increases or decreases in traffic. See "--Interregional and International
Service."
The terms of interconnection, particularly pricing and technical
requirements, may affect the Company's results of operations, its competitive
environment and its capital expenditure policies. Under the current regulatory
framework, all telecommunications service providers must provide
interconnection services on a nondiscriminatory basis. Subject to certain
requirements, providers are free to negotiate the terms of interconnection
but, in the event the parties fail to reach an agreement, Anatel will
establish the terms of interconnection. See "--Regulation of the Brazilian
Telecommunications Industry--Obligations of Telecommunications Companies--
Interconnection."
8
<PAGE>
The Company also leases facilities. Other telecommunications companies,
particularly cellular companies, lease dedicated lines from the Company for
use within their stand-alone networks and large corporate customers lease
lines from the Company for use within private networks connecting different
internal corporate sites.
DATA TRANSMISSION SERVICE
The Company provides low- and high-speed data transmission services through
private leased circuits, public network infrastructure exchanges, switched
circuits and access to Embratel's data transmission network. The Company has
provided data transmission services since mid 80's, including both low and
high speed services ranging from 9.6 Kbps to 2 Mbps, supported by public
telephone infrastructure. Tailored solutions for large customers may provide
data transmission at 34 Mbps and 155 Mbps for LAN interconnection,
videoconferencing, video/image transmission and multimedia applications. As of
December 31, 1997, the Company had a switched packet X.25/Frame Relay network
and a high speed E1 network which also supports a sub-network for dedicated IP
connections. At December 31, 1997, the Company had a total of 94,293 access
gates in service (91% dedicated and 9% switched).
OTHER SERVICES
The Company provides a variety of other telecommunications services that
extend beyond basic telephone service, such as toll-free or 800 service, a 900
service, Telecard, ISDN, Virtual Private Network (Centrex), voice and fax
mailboxes, value added services including call waiting, follow-me,
conferencing, speed dialing and caller ID, among others. The 800 service is
supported by an intelligent network platform with capacity for one million 800
national numbers, accessible at any point in Brazil.
QUALITY OF SERVICE
The following table gives certain basic measures of the quality of
telecommunications services for each year in the five-year period ended
December 31, 1997.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------
1993 1994 1995 1996 1997
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Repair requests per 100 installed access
lines.......................................... 4.4 4.5 3.5 4.5 4.9
Response rate to repair requests
(percentage)(1)................................ 87.4 84.7 83.4 80.5 81.2
Rate of obtaining dialing tone within 3 seconds
(percentage)................................... 96.0 96.3 97.5 N/A(2) N/A(2)
Call completion rate (direct-dialed domestic
long-distance calls)
(percentage)................................... 47.4 48.1 47.8 48.8 52.1
</TABLE>
- --------
(1) Response within 24 hours after request was made.
(2) As of 1996, Telebras stopped measuring this quality of service indicator.
The Company is required under the Telecommunications Regulations to meet
certain quality of service targets, including maximum periods to obtain a dial
tone, completed calls as a percentage of attempted calls, repair requests and
response rate to such requests, operator response periods and other measures
of service quality. See "--Regulation of the Brazilian Telecommunications
Industry--Obligations of Telecommunications Companies--Quality of Service--
General Plan on Quality." The Company has identified the quality of service
targets that the Company expects will be most difficult to meet, those the
Company expects to meet with medium difficulty and those the Company expects
to meet with relative ease. The targets the Company expects will be most
difficult to meet are primarily related to response speed to repair requests
and call completion rates. At December 1997, the Company responded within 24
hours to approximately 85% of repair requests. The Company is obligated by
year end 1999 to respond within 8 hours to 95% of repair requests. In order to
meet these targets, the Company expects to significantly increase spending on
systems to detect defects and supervise repair. The Company also expects to
invest in technology that will improve the functioning of public telephones.
At December 1997, the Company's call completion rate during peak periods was
52% for domestic long-distance calls and 49.9% for local calls. The Company is
obligated by year end 1999 to complete 60% of local and domestic long-distance
calls during peak periods. The Company expects to achieve a call completion
rate of 56.4% by December 1998 as a result of recent improvements in the
Company's network. However, the Company
9
<PAGE>
also anticipates future traffic problems at switching stations as a result of
the change in the numbering system. Anatel expects to implement the Numbering
Plan (Plano de Numeracao) in mid-year 1999. The Numbering Plan will permit a
customer to specify a long-distance carrier by dialing three additional
digits. The Numbering Plan will also increase from 7 to 8 the number of digits
of individual telephone numbers.
RATES
Rates for telecommunications services provided by the Company are subject to
comprehensive regulation. See "--Regulation of the Brazilian
Telecommunications Industry--Rate Regulation." Since the relative
stabilization of the Brazilian economy in mid-1994, there have been two major
changes in rates for local and long-distance services. Effective in January
1996, rates for all services were increased, primarily to compensate for
accumulated effects of inflation. Effective in May 1997, the rate structure
was modified through a tariff rebalancing that resulted in higher charges for
measured service and monthly subscription, and lower charges for intra-
regional, interregional and international long-distance services. Monthly
subscription charges, for example, were increased by 270% for residential
customers and 59% for commercial customers. The Company believes that monthly
subscription charges are now generally in line with such charges in other
countries.
LOCAL SERVICES
The Company's revenue from local services consists principally of activation
and installation charges, monthly subscription charges, measured service
charges and public telephone charges.
Users of measured service, both residential and nonresidential, pay for
local calls on usage. Usage is measured in pulses. Pulses occur system-wide
every four minutes for local calls. These system-wide pulses are recorded
independently of when individual calls are actually made. In addition to
system-wide pulses, the system records one pulse for every call when the call
is connected. After the first pulse, only system-wide pulses are used in
determining the charge for a call. As a result, the time between the first
pulse and the second (system-wide) pulse may vary. For example, for a call
being charged using four-minute pulse increments, the time between the first
pulse and the second (system-wide) pulse may vary between one second and four
minutes.
For normal weekday calls, local call charges are determined by multiplying
the number of pulses by the charge per pulse. For calls being made any day
between midnight and 6:00 a.m., in addition to Saturdays from 2:00 p.m. to
midnight and all day Sunday and holidays, a caller is charged for only one
pulse regardless of the duration of a call. Each customer receives a total of
90 free pulses per month. Measured service charges are the same for all
customers.
Since May 1997, the monthly subscription charge in nominal terms (including
taxes) has been R$13.82 for residential customers, R$20.73 for commercial
customers and R$27.64 for users of PBX systems and the price of one pulse
(including taxes) has been R$0.08. The following table illustrates changes in
subscription charges and measured service charges for local telephone service
for each year in the three-year period ended December 31, 1997 in constant
reais of December 31, 1997 purchasing power.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------
1995 1996 1997
------- ------- -------
(IN REAIS)
<S> <C> <C> <C>
Average rates for local telephone service(1)
Monthly subscription:
Residential..................................... 0.82 3.00 7.78
Commercial...................................... 7.28 10.46 13.50
Measured service (per local pulse)................ 0.025 0.038 0.054
</TABLE>
- --------
(1) Average of monthly average rates, net of value-added taxes.
Prior to May 1997, under a system called "auto-financing", each new customer
was required to invest in shares of Telebras or its subsidiaries. The amount
to be invested varied from time to time but was very substantial. In 1996, for
example, the required investment for a new line was R$1,117.63. Auto-financing
was
10
<PAGE>
phased out in 1997, and since July 1997 the installation charge, which was
initially R$300 has been reduced to R$80 in October 1997 and to R$50 in March
1998. The Company also charges an activation fee of R$48 when a customer
changes addresses.
INTRA-REGIONAL LONG-DISTANCE SERVICE
Currently rates for intra-regional long-distance calls are computed on the
basis of the time and day, duration and distance of a call and use of special
services, such as operator assistance. Some intra-regional calls made within
the same area code may also be measured by pulses. Rates for domestic long-
distance (whether intra-regional or interregional) are uniform throughout
Brazil. See "--Regulation of the Brazilian Telecommunications Industry--Rate
Regulation."
The following table illustrates the historical changes in the Company's
domestic long-distance rates for the periods indicated in constant reais of
December 31, 1997 purchasing power.
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
------------------------
1993 1994 1995 1996 1997
---- ---- ---- ---- ----
(IN REAIS)
<S> <C> <C> <C> <C> <C>
Domestic long-distance rates(1):
0 to 50 km........................................ 0.79 0.46 0.46 0.42 0.32
50 to 100 km...................................... 1.32 0.78 0.76 0.70 0.54
100 to 300 km..................................... 1.98 1.18 1.16 1.07 0.81
over 300 km....................................... 2.65 1.57 1.53 1.40 1.08
</TABLE>
- --------
(1) Rates for a domestic long-distance call, three minutes in duration between
the hours of 9:00 a.m. and 12:00 p.m. and 2:00 p.m. and 6:00 p.m. (peak
hours) on weekdays, net of value-added taxes.
NETWORK SERVICES
The Company's revenue from network services consists primarily of two basic
categories: payments from other providers on a per-minute basis to terminate
calls using the Company's network and payments from other providers on a
contractual basis to use part of the Company's network. On a per-minute basis,
other providers pay the Company a network usage charge to terminate a call on
the Company's network. The network usage charge varies depending on whether
the provider uses the Company's local or long-distance network. Similarly, the
Company pays other fixed-line providers a network usage charge to terminate a
call on another fixed-line network and the Company pays cellular providers a
network usage charge to terminate a call on a cellular network. Cellular
telephone service in Brazil, unlike in North America, is offered on a "calling
party pays" basis. Under the policy of a calling party pays, a cellular
service subscriber generally pays cellular usage charges only for calls made
by the cellular subscriber and not for calls received. Calls received by a
cellular subscriber are paid for by the party that places the call in
accordance with a rate based on cellular per minute charges. For example, a
fixed-line customer pays a rate based on cellular per minute charges for calls
made to a cellular subscriber. The cellular base rate per minute charges are
generally VC1 for calls within the locality, VC2 for calls outside the
cellular subscriber's registration area, and VC3 for calls outside the
concession region in which the registration area is located. The Company
charges its fixed-line customers per minute charges based on either VC1, VC2,
or VC3 rates when a fixed-line customer calls a cellular subscriber. In turn,
the Company pays the cellular service provider the mobile network usage
charge.
The Company's revenue from network services also includes payments from
other telecommunications providers arranged on a contractual basis to use part
of the Company's network. Other providers, such as providers of trunking and
paging services, use the Company's transmission lines to connect a central
switching station to the Company's network. Some cellular providers use the
Company's network to connect cellular central switching stations to the
cellular radio base stations. The Company also leases transmission lines,
certain infrastructure and other equipment to other providers of
telecommunications services.
11
<PAGE>
The table below sets forth the average rates charged by the Company for
network services charged on a per-minute basis in the three year period ended
December 31, 1997.
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
--------------
1995 1996 1997
---- ---- ----
(IN REAIS)
<S> <C> <C> <C>
Network usage rate (local)................................... 0.04 0.04 0.04
Network usage rate (domestic long-distance).................. 0.07 0.06 0.07
Cellular base rates per minute:
VC1........................................................ 0.33 0.31 0.29
VC2........................................................ 0.63 0.65 0.60
VC3........................................................ 0.79 0.74 0.69
</TABLE>
DATA TRANSMISSION
The majority of revenue from data transmission services is generated by
monthly line rental charges for private leased circuits. The balance consists
mainly of nominal charges for access to the data transmission network and
measured charges based on the amount of data transmitted. Effective in May
1997, line rental charges for private leased circuits were reduced by 42%. The
following table illustrates the Company's monthly line rental charges for
private leased circuits service for each year in the three-year period ended
December 31, 1997 in constant reais of December 31, 1997 purchasing power.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------
1995 1996 1997
--------- ---------- ---------
(IN REAIS)
<S> <C> <C> <C>
Average rates for monthly line rental per
leased circuit:
Local circuit
4.8 kbits - digital modem................... 165.47 293.27 200.06
4.8 kbits - analog modem.................... 514.69 293.27 200.06
9.6 kbits - digital modem................... 184.43 448.93 223.81
9.6 kbits - analog modem.................... 833.74 448.93 223.81
64 kbits.................................... 1,605.04 1,152.43 474.43
2 Mbits..................................... 10,292.63 8,312.51 5,284.49
Long-distance circuit (1)
4.8 kbits/second capacity................... 2,157.93 1,790.20 962.53
9.6 kbits/second capacity................... 3,236.94 2,608.02 1,112.04
64 kbits/second capacity.................... 9,178.15 5,940.72 2,,335.00
2 Mbits/second capacity..................... 58,829.47 45,844.62 29,088.43
</TABLE>
- --------
(1) Average of monthly average rates, net of value-added taxes, assuming a
transmission distance between 300 and 500 kilometres and a 3-year
contract.
TAXES ON TELECOMMUNICATIONS SERVICES
The cost of all telecommunications services to the customer includes a
variety of taxes. The Company deducts the amount of such taxes to present net
operating revenue. The principal tax is a state value-added tax, the Imposto
sobre Circulacao de Mercadorias e Servicos ("ICMS"), which the Brazilian
states impose at varying rates on revenues from the provision of
telecommunications services. The rates for domestic telecommunications
services vary among the states of the Region, 17% for Telepara, Telepisa and
Teleamapa, 37% for Telerj and 25% for all the others.
On June 19, 1998 the secretaries of the treasury of the individual Brazilian
states approved an agreement to interpret existing Brazilian tax law to
broaden the application of the ICMS to cover not only telecommunications
services, but also other services, including cellular activation, which had
not been previously subject to such tax. Pursuant to this new interpretation
of existing tax law, the ICMS tax may be applied retroactively for such
telecommunications services rendered during the last five years.
The Company believes that the attempt by the state treasury secretaries to
extend the scope of ICMS tax to services which are supplementary to basic
telecommunications services is unlawful because: (i) the state
12
<PAGE>
secretaries acted beyond the scope of their authority; (ii) their
interpretation would subject certain services to taxation which are not
considered telecommunications services; and (iii) new taxes may not be applied
retroactively.
Each of the Registrant's Subsidiaries has filed lawsuits with the Treasury
Court of the Brazilian states in which such Subsidiaries are incorporated
seeking injunctive relief from retroactive and prospective application of the
ICMS tax to activation fees. At present, Telemig is the only Subsidiary that
has obtained from the applicable Treasury Court a temporary injunction
relieving it from payment of retroactive ICMS taxes with respect to activation
fees during the pendency of the lawsuit. The taxation authorities of certain
of the states where the lawsuits are pending may appeal the decision of the
Treasury Courts to grant temporary injunctions. There can be no assurance that
the Subsidiaries will ultimately prevail in any appeals relating to the
temporary injunctions or in the underlying litigation with respect to
application of the ICMS tax to activation fees. As of September 14, 1998, the
Company started to charge its customers the ICMS tax.
If the 25% ICMS tax were applied retroactively to activation fees earned by
the Company during the last five years, it would give rise to a maximum
liability estimated at R$238.2 million. Management does not believe that the
payment of retroactive ICMS taxes is probable and, therefore, no provision for
loss with respect to retroactive application of the ICMS has been made or is
expected to be made in the Company's consolidated financial statements. The
Company expects to make provisions for loss estimated at R$8.5 million with
respect to application of the ICMS tax for the three months ended September
30, 1998. Management does not believe that application of the ICMS tax on a
prospective basis will have a material impact on the Company's results of
operations.
Other taxes on operating revenues include two federal social contribution
taxes, the Programa de Assistencia aos Servidores de Empresas Publicas
("PASEP") (0.65%) and the Contribuicao para Financiamento da Seguridade Social
("COFINS") (2.0%). The average rate of all such taxes, as a percentage of the
Company's gross operating revenues, was 21.8% in 1997.
NETWORK AND FACILITIES
GENERAL
The Company's network consists of installed lines and exchanges, a network
of access lines connecting customers to exchanges, and long-distance related
systems. At December 31, 1997, the Company's regional telephone network
included approximately 7.5 million installed lines, of which 6.6 million were
lines in service. Of the access lines in service at that time, 69.2% were
residential lines, 27.4% were commercial lines (including PBX) and 3.4% were
public telephone lines. Intra-regional long-distance transmission is provided
by a microwave network and by fiber optic cable.
The following table gives certain basic measures of the development of the
Company's network for each year in the five-year period ended December 31,
1997.
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
-----------------------------
1993 1994 1995 1996 1997
----- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C>
Installed access lines (millions) (at period
end)........................................... 5.0 5.2 5.6 6.4 7.5
Access lines in service (millions) (at period
end)........................................... 4.5 4.7 5.1 5.7 6.6
Average access lines in service (millions)...... 4.4 4.6 4.8 5.2 5.9
Lines in service per 100 inhabitants (at period
end)........................................... 5.4 5.5 5.9 6.6 7.6
Percentage of installed access lines connected
to digital exchanges........................... 24.6 29.8 45.0 56.0 63
Employees per 1,000 access lines installed (at
period end).................................... 8.5 8.4 6.5 5.6 4.6
Number of public telephones (thousands)......... 128.8 149.8 161.9 186.4 228.6
Domestic long-distance call minutes (billions).. 5.2 6.0 7.3 7.8 8.4
Local call pulses (billions).................... 22.8 24.0 26.1 25.8 25.8
International long-distance call minutes
(millions)..................................... 53.3 63.9 103.5 121.9 146.2
</TABLE>
13
<PAGE>
The Company's long-distance network combines the transmission facilities of
the Subsidiaries that were used to support intra-state transmission, except
for Telepara, Teleamapa and Telaima which relied, and will continue to rely,
primarily on satellite transmission provided by a long-distance carrier. In
January 1998, the Company commenced various projects to turn the intra-state
transmission systems of the Subsidiaries into a network capable of providing
intra-regional service. The Company expects to conclude in December 1998 the
interconnection of two blocks of the Region: i) Telemig, Telerj, Telebahia and
Telest in the south of the Company's concession area representing 37% of the
traffic in the Region and ii) Telpe and Telern, in the northeast of the
Company's concession area representing 1.6% of the traffic in the Region. The
Company is also working on agreements with Embratel to share optical cables.
The Company believes that the unmet demand for fixed-line telecommunications
services in the Region is substantial. At December 31, 1997, 30% of the
households and 64% of the businesses in the Region had local telephone
service. Prior to the privatization, growth of lines in service was restricted
by government limits on capital expenditures and the high cost to customers of
obtaining service. See "--Capital Expenditures." In 1997, the Company
experienced a significant increase in applications for new lines, because the
cost to the customer of installing new lines significantly decreased following
the elimination of auto-financing. See "--Rates--Local Services." The customer
waiting period for the installation of a new line varies significantly
depending on the access network and the capacity of the switching center that
serves the locality. Approximately 4.9 million people are currently wait-
listed.
The Company began to install digital exchanges in 1987 and fiber optic cable
in 1985. Compared to the older analog technology, digital systems improve the
quality and efficiency of the network, accommodate higher traffic levels,
require less maintenance and permit the Company to offer a broad range of
value added services simultaneously on the same network, such as voice, text
and data applications. Fiber optic provides greater transmission capacity and
significantly reduces the fading of signals, and requires less frequent
amplification, thereby reducing the cost of providing service and increasing
traffic and network reliability. Beginning in 1997, all new lines installed by
the Company were connected to digital exchanges and during 1997, 11.9% of
existing analog lines were converted to digital lines. At December 31, 1997,
63% of all installed lines were connected to digital exchanges. By year-end
1997, the Company had installed 295,000 kilometers of optical fiber. Under the
Telecommunications Regulations, the Company's local network must be 75%
digital by 2000 and 100% by 2006.
Subject to final approval by Anatel, the Company will be granted the option
to use Wireless Local Loop ("WLL") technology in localities with less than
50,000 inhabitants. New entrants will be allowed to use the WLL technology in
localities with population above or below 50,000 inhabitants. The Company will
also be allowed to use the WLL technology in localities with population above
50,000 inhabitants if the new entrant decides not to provide services to that
locality. Subject to final approval by Anatel, the Company will also be
granted a geostationary orbital position primarily to cover the concession
area. The Company believes that use of these technologies will generally
enhance the Company's competitiveness and reduce the time and costs necessary
to meet the Company's obligations under the Concessions. See "--Regulation of
the Brazilian Telecommunications Industry--Obligations of Telecommunications
Companies--Network Expansion--General Plan on Universal Service."
NETWORK EXPANSION
The Company is required under the Telecommunications Regulations to meet
certain targets regarding network expansion and modernization. The Company
estimates that these targets will require the Company to expand its network by
approximately 16% per year for 4 years. See "--Regulation of the Brazilian
Telecommunications Industry--Obligations of Telecommunications Companies--
Network Expansion--General Plan on Universal Service." The Company has
identified the targets that the Company expects will be most difficult to
meet, those the Company expects to meet with medium difficulty and those the
Company expects to meet with relative ease. The targets the Company expects
will be the most difficult to meet are the maximum targeted waiting times for
installation of a line, availability of switched service to low population
centers and maximum distances between public telephones. The Company is
obligated to reduce the maximum waiting time
14
<PAGE>
for installation of a line by year end 2001 to 4 weeks. At December 1997, the
Company's average waiting time was 72 weeks, ranging from 36 weeks for
Telebahia to 96 weeks for Telerj. In order to meet the targets, the Company
plans to expand its network to increase service to smaller localities. The
Company is obligated by year end 2001 to provide switched service to all
locations with populations above 1,000 persons. Currently, there are 2,455
localities in the Region with populations over 1,000 that do not have switched
service. The Company is obligated by year end 2001 to decrease the maximum
distance between public telephones to 800 metres. The Company does not have
accurate measurements of the distances between public telephones in the Region
but anticipates that to meet the target the Company will have to expend
considerable resources increasing public telephone density in the Region. All
other targets the Company has already met or expects to meet without
difficulty.
BILLING AND ADMINISTRATION
The Company bills its customers for all calls made by its customers. The
Company receives network usage fees when calls from cellular carriers or other
fixed-line carriers terminate calls on its network and conversely, the Company
must pay network usage fees when calls from its customers terminate on the
network of a cellular carrier or one of the other fixed-line carriers. See "--
Rates--Network Services." After the collection cycle is over, the Company, the
cellular carriers and the other fixed-line carriers jointly reconcile the
amounts collected from customers against the amounts due to each carrier and
pay the net amounts outstanding to the appropriate parties. For international
and domestic long distance calls, the Company charges Embratel a network usage
fee for the use of its local network and forwards the amount collected from
its customers for such calls to Embratel.
The Company sends each customer a monthly telephone bill covering all the
services provided during the prior period. Customers are grouped in billing
cycles based on the date the bill is issued. The telephone bill separately
itemizes long-distance calls, calls made on a cellular network, 0800, 0900
services and other value-added
services such as call waiting, voice mail and call forwarding. Customer
payments are effected mainly under agreements with various banks, either by
debiting the customer's checking account or by direct payment to a bank. The
method of payment is at the option of each customer.
At December 31, 1997, 16% of all receivables were outstanding for more than
30 days and 9% were outstanding for more than 90 days. Under the previous
Regulations, the Company was not permitted to disconnect a customer until a
receivable had been outstanding for over 90 days. The Concessions now
authorize the Company to disconnect a customer after 30 days. The Company also
charges interest at a rate of approximately 1% per month plus a one-time late
charge of 2% of the total amount outstanding. The Company's future
disconnection policy will depend on factors such as the level of unmet demand,
the level of competition and regulations governing disconnection. For a
discussion of provisions for past due accounts see "Management's Discussion
and Analysis of Financial Condition and Results of Operations--Results of
Operations for the years ended December 31, 1995, 1996 and 1997--Operating
expenses--Selling expense."
COMPETITION
Since 1995, Brazil has adopted sweeping regulatory changes intended to
foster competition in the provision of telecommunications services. See "--
Background--Regulatory Reform and Privatization." Under the Telecommunications
Law and Telecommunications Regulations, Anatel is required, promptly after the
privatization is effected, to open the markets for local, intra-regional long-
distance, interregional long-distance and international long-distance services
to competition by granting licenses to new entrants. Anatel is required to
authorize three new entrants to provide local telephone service and intra-
regional long-distance telephone service, with each of the three new entrants
receiving two licenses to provide such services in a single fixed-line region.
Anatel is also required to authorize one new entrant to provide intra-
regional, interregional and international long-distance service by granting
licenses to provide such services throughout Brazil.
The Company and Embratel, the former long-distance carrier of the Telebras
System, will also be authorized to provide intra-regional long-distance
service. Therefore, the Company will expand to provide long-distance
15
<PAGE>
service between the states of the Region, whereas prior to the privatization
the Company's long-distance service was limited to intra-state long-distance,
and Embratel will expand to provide intra-state long-distance service, whereas
prior to the privatization Embratel's long-distance service was limited to
interstate long-distance. The Company expects to significantly increase the
long-distance services provided by the Company since, during 1997, 76% of the
long-distance calls in the Region originated and terminated in the Region.
Approximately 50% were intra-state long-distance calls and 26% were interstate
long-distance calls between states in the Region. See "--Customer Services--
Intra-Regional Long-Distance Service." The Company expects that Embratel will
begin to compete directly with the Company by starting to provide intra-state
long-distance service in the Region and by continuing to provide interstate
long-distance service in the Region. Although the Company cannot predict the
scope of Embratel's activities or the effect of competition from Embratel,
Embratel may be a powerful competitor.
The licenses Anatel will provide to new entrants for the provision of intra-
regional long-distance service will be issued in the Private Regime and, as a
result, the licensees will not be subject to the same obligations to which
concessionaires operating in the Public Regime are subject. See "--Regulation
of the Brazilian Telecommunications Industry--Concessions and Licenses."
Beginning in 2002, Anatel may grant an unlimited number of additional licenses
for the provision of local, intra-regional long-distance, interregional long-
distance and international long-distance services. See "--Regulation of the
Brazilian Telecommunications Industry--Concessions and Licenses."
The Company is currently the exclusive provider of local service in the
Region, but the new operator to be authorized by Anatel will compete with the
Company in the provision of local service. Beginning in 2002, the Company may
face an unlimited number of competitors in local and intra-regional long-
distance, and it may itself seek a license to provide interregional and
international long-distance service provided that it has met certain
obligations contained in the Concession. See "--Regulation of the Brazilian
Telecommunications Industry--Obligations of Telecommunications Companies."
The Company's fixed-line services are also subject to competition from
providers of cellular telephone service. There are currently 16 Band A
cellular telephone service operators in the Region, which were spun-off from
the 16 Subsidiaries in January 30, 1998: a) Tele Sudeste Celular Participacoes
S.A. (states of Rio de Janeiro and Espirito Santo); b) Telemig Celular
Participacoes S.A. (state of Minas Gerais); c) Tele Leste Celular
Participacoes S.A. (states of Bahia and Sergipe); d) Tele Nordeste Celular
Participacoes S.A. (states of Alagoas, Pernambuco, Paraiba, Rio Grande do
Norte, Ceara and Piaui); and e) Tele Norte Celular Participacoes S.A. (states
of Amazonas, Para, Roraima, Amapa and Maranhao). Four Band B cellular
operators also compete in the Region; a) AlgarLightel, a consortium formed by
Algar (which also owns a private telephone company in the interior state of
Minas Gerais), Korea Mobile Telecom, and Construtora Queiroz Galvao (a
Brazilian construction firm); b) Vicunha, a consortium formed by Globo (a
major Brazilian media and communications group), Bradesco (a major Brazilian
private bank), the Vicunha Group (which runs actually the major steel industry
in Brazil, CSN and Cia. Vale do Rio Doce) and Telecom Italia-Stet; c) Vicunha
(the same consortium described in b above); and d) BSE, a consortium formed by
Bell South Corporation, the media group OESP, Safra Bank and Splice. In
addition, on October 19, 1998 Tele Centro Oeste/Inepar, a consortium comprised
of (i) Inepar S.A. Industria e Construcoes (50%) and (ii) Tele Centro Oeste
Celular Patricipacoes S.A. (50%), was awarded a license to provide cellular
services on Band B in competition with the Band A operator Tele Norte Celular
S.A. Tele Centro Oeste/Inepar plans to commence providing digital cellular
service in this area in April 1999.
The exact identity of the new entrants, the scope of increased competition
and any adverse effects on the Company's results and market share will depend
on a variety of factors that cannot now be assessed with precision and that
are beyond the Company's control. Among such factors are the business
strategies and capabilities of potential competitors, prevailing market
conditions at the time increased competition is permitted, the regulations
applicable to new entrants and the Company, and the effectiveness of the
Company's efforts to prepare for increased competition. One or more new
competitors may have technical or financial resources greater than those of
the Company. There can be no assurance that the entry of new competitors will
not have a material adverse effect on the Company's business, financial
condition, results of operations or prospects.
16
<PAGE>
The Company is subject to comprehensive regulations that limit its ability
to set tariffs for its various services and that may limit its ability to
engage in activities that are considered to be anti-competitive. Such
regulations may limit the Company's ability to confront competition. See "--
Regulation of the Brazilian Telecommunications Industry."
EMPLOYEES
As of March 1998, the Company had 33,295 employees. All of the Company's
employees are employed on a full-time basis, divided into the following
functions: plant operation and maintenance (39%), plant expansion and
modernization (11%), sales and marketing (20%), administrative support (13%),
corporate management (13%) and budget and finance (4%).
Approximately 74.4% of all employees are members of state labor unions
associated either with the Federacao Nacional dos Trabalhadores em
Telecomunicacoes--Fenattel ("Fenattel") or with the Federacao Interestadual
dos Trabalhadores em Telecomunicacoes--Fittel ("Fittel"). Some employees in
particular job categories are affiliated with other unions specific to such
categories. Each operating subsidiary of the Company negotiates a new
collective labor agreement every year with the local union. These negotiations
are carried out with the supervision and guidance of the Company, on one side,
and Fenattel or Fittel, on the other. The collective agreements currently in
force expire on November 30, 1998. The Company's management considers the
relations of the Company with its work force to be satisfactory. The Company
has never experienced a work stoppage that had a material effect on its
operations.
The Company participates in a pension fund established by Telebras, Fundacao
Sistel de Seguridade Social--Sistel ("Sistel"), the primary purpose of which
is to supplement government-provided retirement benefits. The Company
participates in Sistel and makes monthly contributions to Sistel currently
equal, on average, to 13.5% of the total salaries of all employees who are
Sistel members. Each employee member also makes a monthly contribution to
Sistel based on age and salary (currently around 7.5% of their salaries).
Members of Sistel qualify for full pension benefits after reaching age 57
provided they have been members of Sistel for at least ten uninterrupted years
and have been affiliated with the social security system during at least 35
years. Sistel operates independently from the Company and Telebras, and its
assets and liabilities are fully segregated from those of the Company and
Telebras. See Note 21 to the Consolidated Financial Statements. Employees of
the Company at the time of the privatization have the right to maintain their
rights and benefits in Sistel in accordance with the terms in place at that
time.
RESEARCH AND DEVELOPMENT
Until the Breakup of Telebras, the Company and the other companies of the
Telebras System were required to contribute to the research and development
center operated by Telebras (Centro de Pesquisa e Desenvolvimento da
Telebras--CPqD or the "Center") and also conducted some of their own
independent research and development. The Company's aggregate expenditures on
research and development were R$36.3 million, R$35.6 million and R$31.1
million for 1995, 1996 and 1997, respectively.
Following the Breakup of Telebras, the Center will become a private
independently administered non-profit foundation financed with resources from
the public and private sector and will continue to develop telecommunications
technology. Pursuant to three year contracts signed in May 1998 between
Telebras and each Subsidiary, the Company is obligated to contribute R$128.6
million to the Center during a three year period ending May 2001. During the
effectiveness of this agreement, the Company has access to telecommunications
software developed by the Center and other technological services provided by
the Center such as equipment testing and consulting and training services. It
is possible that the Center will also provide such services to third parties
on a fee-for-service basis. The Company may request additional technological
support from the Center than contemplated in the agreement by contributing
additional funds to the Center.
17
<PAGE>
The Company conducts independent research and development in areas of
telecommunications services but does not independently plan to develop new
telecommunications hardware. The Company primarily depends on manufacturers of
telecommunications hardware for the development of new hardware.
CAPITAL EXPENDITURES
The primary focus of the Company's capital expenditure program has been the
modernization and digitalization of the network.
Prior to the privatization of Telebras, capital expenditures were planned
and allocated on a system-wide basis and were subject to approval by the
Ministry of Communications. In addition, the budget for capital expenditures
of the Telebras System was included in the annual budget of the Federal
Government and had to be approved by the federal Congress. In 1995, the
Federal Government instituted a broad investment program for public and
private businesses in the communications and postal sectors for the years 1995
through 1999 (Programa de Recuperacao e Expansao dos Sistemas de
Telecomunicacoes e Postal--PASTE or "PASTE"). The Telebras System was required
to conform its annual capital expenditure budget to the guidelines set by
PASTE. The companies that comprised the Telebras System were further required
to comply with public bidding processes prior to hiring third party
contractors.
Since the privatization of Telebras, the Company's capital expenditures have
not been subject to prior government approval nor government-imposed spending
limits nor public bidding processes. The Company is now permitted to determine
its own capital expenditure budget, subject to compliance with certain
obligations to expand services under the Concessions. See "--Regulation of the
Brazilian Telecommunications Industry--Obligations of Telecommunications
Companies." In addition, the financing of capital expenditures is no longer
carried out on a system-wide basis, and the Company is required to obtain its
own financing. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Liquidity and Capital Resources."
The 1998 annual capital expenditure budget for the Telebras System includes
capital expenditures of the Company totaling approximately R$2,456 million.
The Company anticipates capital expenditures for the first eight months of
1998 will be R$1,477.6 million, which is expected to be funded with debt (37%)
and internally generated funds from operations (63%). The Company expects,
however, that as a result of the privatization, the Company's capital
expenditures will be subject to revision by management and the new controlling
shareholders of the Company.
18
<PAGE>
The following table sets forth, in constant reais of December 31, 1997
purchasing power, the Company's capital expenditures for each year in the
three-year period ended December 31, 1997.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------
1995 1996 1997
------- ------- -------
(IN MILLIONS OF REAIS)
<S> <C> <C> <C>
Operational Investments(1)........................... 210.6 272.2 294.1
Telephone equipment:
Exchanges.......................................... 421.9 620.8 634.8
Transmission....................................... 232.2 311.0 411.4
Infrastructure..................................... 81.4 152.0 125.8
External network................................... 343.0 480.1 558.4
Other.............................................. 296.8 291.9 463.5
Data transmission equipment.......................... 67.9 89.1 64.3
------- ------- -------
Total capital expenditures........................... 1,653.8 2,217.1 2,552.3
======= ======= =======
</TABLE>
- --------
(1) Operational investments include investments to replace plant equipment and
other fixed assets generally without altering the capacity of the asset
replaced and certain investments in operational and technical support,
such as telecommunications management network systems.
REGULATION OF THE BRAZILIAN TELECOMMUNICATIONS INDUSTRY
GENERAL
The Company's business, including the services it may provide and the rates
it charges for telecommunications services, is regulated by Anatel pursuant to
the Telecommunications Law, the regulations, decrees, orders and plans issued
thereunder and the Concessions granting the Company the right to provide
certain telecommunications services, subject to certain obligations contained
in the Concessions (the "List of Obligations").
BACKGROUND
From 1962 until 1967, the Brazilian telecommunications sector was regulated
by the Conselho Nacional de Telecomunicacoes (the "National Council of
Telecommunications"), and from 1967 until 1997 by the Ministry of
Communications, pursuant to Law No. 4,117 of August 27, 1962, as well as
certain regulations issued pursuant thereto from 1962 to 1996.
In August 1995, the Brazilian Congress amended the Brazilian Constitution to
allow the restructuring of the telecommunications sector. On July 19, 1996,
the Congress passed Law 9,295, the Lei Minima (the "Minimum Law"). The Minimum
Law began the process of opening up the cellular market to competition. The
Minimum Law was largely replaced by the Telecommunications Law, although
current cellular concessions for the former Telebras companies ("Band A") and
the private companies that were authorized to compete with the Band A
companies ("Band B") contain certain provisions derived from the Minimum Law.
In July 1997, the Congress passed the Telecommunications Law, which replaced
Law 4,117 and became the main basis for regulation of the telecommunications
sector, except for regulation of broadcasting, which was not addressed by the
Telecommunications Law.
REGULATORY AGENCY--ANATEL
The Telecommunications Law provides a framework for telecommunications
regulation. Article 8 of the Telecommunications Law established Anatel to
develop regulations and to enforce such regulations. The specific functions of
Anatel were set forth by the President of Brazil in Decree No. 2338 of October
7, 1997, the Regulamento da Agencia Nacional de Telecomunicacoes (the "Anatel
Decree"). Pursuant to the Telecommunications Law and the Anatel Decree, Anatel
replaces the Ministry of Communications as the regulatory agency for the
telecommunications sector. Anatel, unlike the Ministry of Communications, is
an independent regulatory agency. Anatel is administratively independent,
financially autonomous and not
19
<PAGE>
hierarchically subordinated to any organ of the Brazilian Government,
including the Ministry of Communications, in the area of telecommunications
regulation. While independent, Anatel does maintain a close working
relationship with the Ministry of Communications and informs the Ministry of
its activities. Article 19, Section XXIX of the Telecommunications Law
requires Anatel to submit an annual report summarizing its activities to the
Ministry of Communications.
Anatel is managed by a five-member Conselho Diretor ("Board of Directors"),
headed by an executive president. The directors of Anatel are nominated by the
President of Brazil, subject to approval by the Senate. Each director serves
for a single fixed term of 5 years; directors may not be reappointed. In order
further to ensure Anatel's independence, the first directors have been
appointed for different terms, from 3 to 7 years, so that only one director's
mandate will expire per year, ensuring a staggered appointment of directors in
the future. The directors may not exercise any other professional, business
(other than university professor), union or political function, nor may they
hold a significant interest, whether direct or indirect, in any company
related to telecommunications.
Anatel is financed through the Fundo de Fiscalizacao das Telecomunicacoes
("Fistel"). Fistel is a fund administered by Anatel and its funds are
currently the sole source of financing for Anatel's activities. Fistel
receives the proceeds of, among other things, a tax imposed on concessionaires
and fees charged for licenses and concessions.
Any proposed regulation of Anatel is subject to a period of public comment,
including public hearings. Anatel's actions may ultimately be challenged in
Brazilian courts.
CONCESSIONS AND LICENSES
Companies wishing to offer telecommunications services to consumers are
required to apply to Anatel for a concession or license. Concessions and
licenses are granted for services in the public regime ("Public Regime") and
services in the private regime ("Private Regime"). The Public Regime is
differentiated from the Private Regime primarily by the obligations imposed on
the companies in the Public Regime rather than the type of services offered by
those companies. There are only four companies in the Public Regime: Embratel
and the three regional fixed-line companies. All other telecommunications
companies, including other companies providing the same telecommunications
services as the four companies in the Public Regime, operate in the Private
Regime.
Fixed-line Services--Public Regime. There are four providers of services in
the Public Regime: Embratel and the three regional fixed-line companies. These
four companies are the primary providers of the following fixed-line services
to the general public: local, intra-regional long-distance, interregional
long-distance and international long-distance. Each of these four companies
holds concessions, as required by the Telecommunications Law. Each Public
Regime concession is a specific grant of authority that allows the
concessionaire to offer a wide variety of telecommunications services but
specifically prohibits the concessionaire from offering certain
telecommunications services and imposes certain obligations on the
concessionaire concerning network expansion and modernization, quality and
continuity of service. The main restriction is that, until December 31, 2003,
the regional fixed-line companies will be prohibited from offering
interregional and international long-distance service, while Embratel will be
prohibited from offering local service unless certain obligations are met as
described below. Anatel is required, some time after the privatization process
is complete, to grant Embratel the right to offer full intra-regional long-
distance service, which is currently restricted to the regional fixed-line
companies. See "--Obligations of Telecommunications Companies--Public Regime--
Service Restrictions."
Concessions for Embratel and the three regional fixed-line companies are
granted for a fixed number of years, subject to certain obligations, with the
possibility of full renewal or revocation. See "--Obligations of
Telecommunications Companies--Public Regime--Service Restrictions." The
initial concessions for Embratel and the regional fixed-line companies have
been granted until 2005. After 2005, the concessions may be renewed.
20
<PAGE>
The renewal period is currently 20 years. The current concessions granted to
the four companies in the Public Regime have not required the payment of a
fee. While terms for the grant of concessions to new entrants have not yet
been determined by Anatel, Embratel and the regional fixed-line companies are
required to pay biannual renewal fees after 2005 equal to 2% of annual net
revenues from the provision of fixed-line public telecommunications services
in the prior year (excluding taxes and social contributions) during the 20-
year renewal period.
Fixed-line Services--Private Regime. Licenses will be granted to new
competitors wishing to offer fixed-line-based services, including local,
intra-regional long-distance, interregional long-distance and international
long-distance, in the Private Regime. Licensees are not subject to the same
obligations as Public Regime concessionaires, although individual licenses may
contain certain obligations. After the privatization process for Embratel and
the three regional fixed-line companies is complete, Anatel is required to
authorize three new entrants to provide local telephone service and intra-
regional long-distance telephone service, with each of the three new entrants
receiving two licenses to provide such services in a single fixed-line Region,
in addition to authorizing one new entrant to provide intra-regional,
interregional and international telephone long-distance by granting three
licenses to provide such services throughout Brazil. The bidding requirements
are expected to contain certain minimum technical and financial standards. The
effective result of the license auction will be that two companies compete in
each of the markets for local service (one regional fixed-line concessionaire
and one licensee), four companies compete in the markets for intra-regional
long-distance service (one incumbent regional fixed-line company, Embratel,
and two licensees), and two companies compete in the markets for interregional
long-distance and international long-distance (Embratel and one licensee). See
"--Competition."
Until December 31, 2001, the four existing Public Regime concessionaires and
the new Private Regime licensees will be the only companies authorized to
offer local, intra-regional long-distance, interregional long-distance and
international long-distance services. Beginning January 1, 2002, the
Telecommunications Regulations require Anatel to end this period of
exclusivity and authorize new licensees wishing to offer such services. See
"--Competition."
Non-fixed Services--Private Regime--Concessions. The Band A and Band B
cellular companies are in the Private Regime. Pursuant to the Minimum Law and
the Telecommunications Law, the cellular companies in Band A and Band B have
been granted concessions. Each cellular concession is a specific grant of
authority to operate cellular services, subject to certain obligations
contained in the List of Obligations. If a cellular company wishes to offer
any telecommunications service other than the cellular service authorized by
its concession, it may apply to Anatel for a license to offer such other
services. See "--Non-fixed Services--Private Regime--Licenses."
Each cellular concession has been granted for an initial period of 15 years,
subject to renewal for further periods of 15 years if the List of Obligations
contained in a concession has been met. The Band A cellular concessions did
not require the payment of a fee. Terms of payment for renewal of the Band A
and Band B cellular concessions have not yet been established.
Currently, there is a limit on the number of cellular companies. One company
may operate in Band A and one company in Band B for each cellular region.
Under the cellular concessions, Anatel may not authorize additional providers
of cellular service until December 31, 1999.
Non-fixed Services--Private Regime--Licenses. Except for cellular service,
for which no new licenses may be granted until December 31, 1999, licenses may
be granted to any company wishing to offer non-fixed telecommunications
services in the Private Regime. Licensees are not subject to the same
obligations as Public Regime concessionaires, although individual licenses may
contain certain obligations.
OBLIGATIONS OF TELECOMMUNICATIONS COMPANIES
Providers of telecommunications services are subject to certain obligations
contained in the List of Obligations of their concessions and licenses. The
four providers of telecommunications services in the Public
21
<PAGE>
Regime are subject to a set of special restrictions regarding the services
they may offer, contained in the Plano Geral de Outorgas ("General Plan of
Concessions and Licenses"), and special obligations regarding service quality,
network expansion and modernization contained primarily in the Plano Geral de
Metas de Qualidade ("General Plan on Quality") and the Plano Geral de Metas de
Universalizacao ("General Plan on Universal Service"). These restrictions and
obligations are also contained in the concessions of the four companies,
particularly in the List of Obligations.
Public Regime--Service Restrictions. Under the General Plan on Concessions
and Licenses, Embratel and the regional fixed-line companies are prohibited
from offering certain basic fixed-line telecommunications services until they
fulfill the List of Obligations as described below. Embratel is prohibited
from offering local or cellular services and the regional fixed-line companies
are prohibited from offering cellular, interregional long-distance and
international long-distance services. Anatel is required, some time after the
privatization is effected, to grant Embratel the right to enter the market for
full intra-regional long-distance service, including service within the
states, as a competitor to the regional fixed-line companies and to grant the
fixed-line companies the right to offer interstate intra-regional long-
distance service, which they were not authorized to offer in the past.
The General Plan of Concessions and Licenses provides certain incentives to
encourage Embratel and the three regional fixed-line companies to fulfill the
service quality, network expansion and modernization obligations contained in
the List of Obligations quickly. Under the General Plan of Concessions and
Licenses, the progress of Embratel and the regional fixed-line companies
towards attaining their List of Obligations will be measured annually by
Anatel. Two measuring dates, December 31, 2001 and December 31, 2003 are of
particular importance (the "2001 Targets" and the "2003 Targets"). See tables
in "--Network Expansion--General Plan on Universal Service" and "--Quality of
Service--General Plan on Quality." In the period before the 2001 Targets are
measured, Anatel will regularly monitor the progress of Embratel and the
regional fixed-line companies and communicate with them. If they fail to meet
the 2001 Targets, Anatel may, at its discretion, revoke their concessions. If
they meet the 2001 Targets, they may continue to operate. In the period before
the 2003 Targets are measured, Anatel will regularly monitor the progress of
the four companies and communicate with them. If Embratel and the regional
fixed-line companies meet the 2003 Targets, the restrictions on the services
the four companies may offer will be eliminated and the companies will be
allowed to apply for licenses to offer any other service. In addition, if, in
its review for the 2001 Targets, Anatel finds that any of the four companies
has met the 2003 Targets, Anatel will immediately eliminate the restrictions
on the telecommunications services that company may offer. Anatel may also
eliminate the restrictions on a date other than the official measuring dates
of December 31, 2001 and December 31, 2003 if it finds that a company has met
the 2003 Targets. Failure to meet the 2003 Targets could result in revocation
of the Concessions.
In order to attract new entrants and ensure competition, there are also
certain restrictions on alliances, joint ventures, mergers and acquisitions
involving Public Regime concessionaires, including:
. A concessionaire is prohibited from holding more than 20 percent of the
equity in any other concessionaire
. Concessionaires offering different services in the Public Regime in
either the same or different regions are prohibited from offering
services jointly
. Concessionaires offering the same service in the Public Regime in
different regions are prohibited from offering services jointly
. Mergers between fixed-line regional companies and cellular companies are
prohibited
. Companies offering telephony services are prohibited from offering cable
television
Anatel has not yet determined whether the restrictions under its control
will expire in the future or under what conditions they would expire.
Network Expansion--General Plan on Universal Service. Under the General Plan
on Universal Service, the regional fixed-line companies are required to expand
switched, fixed-line service to cover the entire national
22
<PAGE>
territory of Brazil in accordance with the List of Obligations. Embratel is
also subject to the universal service requirement of providing access to
direct-dial interregional and international long-distance service by
installing public telephones in remote regions and isolated communities. Since
universal service requirements are restricted to the provision of switched,
fixed-line basic telephony services, formal universal service requirements do
not apply to cellular companies, although the cellular companies are subject
to certain similar requirements under the cellular List of Obligations and
certain cellular regulations, including obligations to expand their networks
and to provide cellular services without pricing discrimination within
customer categories.
Universal service will be financed through two primary mechanisms: (a) the
normal capital expenditure budgets of Embratel and the regional fixed-line
companies, and (b) a universal service fund.
Embratel and the regional fixed-line companies are themselves responsible
for financing their universal service obligations of network expansion from
their own revenues. No subsidies or other supplemental financing is
anticipated to finance the network expansion obligations contained in the List
of Obligations. However, the General Plan on Universal Service allows Anatel
to waive the network expansion requirements once a company succeeds in meeting
the 2001 Target for maximum waiting time for installation of a line of four
weeks. If a regional fixed-line company fails to meet its obligations in a
particular region, Anatel may grant licenses to competing companies to provide
the service and may compel the regional fixed-line company to make its network
available for the competitor's use.
The Telecommunications Law also provides for a universal service fund to
contribute to the costs of providing universal service. While the exact nature
of the universal service fund is not yet known, a bill has been submitted to
the Congress that states that if a company, after meeting its universal
service obligations, finds that it cannot operate a certain service in a
certain region at a profit, the company may apply to receive a subsidy from
the universal service fund--for costs incurred beyond costs necessary to meet
its obligations--to ensure that it covers its costs in providing the service.
23
<PAGE>
The following table sets forth the network expansion and modernization
obligations of the Company as stated in the List of Obligations for the period
1999-2005 and the Company's status with respect to each obligation as of
December 31, 1997.
NETWORK EXPANSION AND MODERNIZATION
<TABLE>
<CAPTION>
COMPANY STATUS
AS OF DECEMBER 31, BY DECEMBER 31,
------------------ -----------------------------------
1997 1999 2000 2001 2002 2003 2004 2005
---- ---- ---- ----- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Minimum total number of
installed lines (in
millions).............. 7.5 10.3 11.8 13.5 -- -- -- --
Fixed switched service
fully available if
population greater
than:.................. N/A(3) -- -- 1,000 -- 600 -- 300
Maximum average waiting
time for installation
of a line (in weeks)... 72(1) -- -- 4 3 2 1 --
Minimum number of public
telephones in service
(in thousands)......... 229 293 399 478 -- -- -- --
Public telephones per
1,000 inhabitants...... 2.7 -- -- -- 7.5 -- 8.0
Minimum ratio of public
telephones to fixed
terminals (%).......... 3.5 -- -- -- -- 2.5 -- 3.0
Minimum digitalization
level (% of network)... 63 75 -- 85 -- 95 -- 100
Maximum distance to a
public telephone
(meters)(1)............ N/A(5) 800 -- 500 -- 300 -- --
Full-service public
telephone
availability(4):
as a % of total number
of public telephones:
international long-
distance........... 0(6) 25 -- -- -- -- -- --
local and domestic
long-distance...... 63 50 -- -- -- -- -- --
in areas with no fixed
switched service
(# of inhabitants).... N/A(3) 1000 -- 600 -- 300 -- 100
</TABLE>
- --------
(1) Represents average waiting time for installation of a line in areas only
where fixed switched service is fully available. The Company does not have
information measuring maximum waiting time for installation of a line.
(2) The Company's subsidiary Telerj had an average waiting time of 2 years.
(3) Not available; the Company covered 53% of municipalities with populations
of 1000 or more with fixed service and in 91.4% of such municipalities, at
least one public telephone was available.
(4) Public telephones available 24 hours a day with direct-dial capability.
(5) Not available; the Company does not currently measure this information.
(6) The Company is currently testing products that would allow it to upgrade
its public telephone network to have international direct-dial capability.
Quality of Service--General Plan on Quality. The General Plan on Quality
contains a series of service quality obligations that are incorporated into
the List of Obligations of Embratel and each regional fixed-line company.
These include attainment of certain targets such as reducing average dial tone
delay, achievement of certain call completion rates for local, intra-regional
long-distance, and interregional and international long-distance calls,
reducing average operator assistance delay, reducing trouble reports per 100
lines, reducing average time of repair, reducing average time of installation,
increasing billing accuracy, and achieving certain customer satisfaction
levels for public payphones, residential telephony and nonresidential
telephony.
24
<PAGE>
The following table sets forth the quality of service obligations of the
Company as stated in the List of Obligations for the period 1999-2005 and the
Company's status with respect to each obligation as of December 31, 1997.
QUALITY OF SERVICE
<TABLE>
<CAPTION>
COMPANY STATUS
AS OF
DECEMBER 31, BY DECEMBER 31,
-------------- -------------------
1997 1999 2001 2003 2005
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Dial tone within 3 seconds (% of cases).... N/A(5) 98 99 99.5 99.5
Call completion rate during peak periods (%
of calls attempted)(1).................... 52.1 60 65 70 70
Maximum busy circuit rate during peak
periods(1) (% of calls attempted)......... 8.3(6) 6 5 4 4
Maximum monthly repair requests per 100
lines..................................... 4.9 3.0 2.5 2.0 1.5
Maximum monthly public telephone repair
requests per 100 lines.................... 23.5 15 12 10 8
Residential repair response speed (% within
24 hours)(2).............................. 81 95 96 97 98
Nonresidential repair response speed (%
within 8 hours)........................... 81(3) 95 96 97 98
Public telephone repair response speed (%
within 8 hours)........................... 89.2(3) 95 96 97 98
Operator availability during peak periods
(% answer/within 10 seconds).............. 85.3 92 93 94 95
Billing inaccuracy (inaccurate bills per
1000 bills)(4)............................ 10.7 4 3 2 2
Credit issued within one billing cycle for
claimed inaccuracies (% of cases)......... N/A(7) 95 96 97 98
</TABLE>
- --------
(1) For local and domestic long-distance calls.
(2) Must be within 48 hours in all cases.
(3) Not available; the Company does not currently measure this; the data is
presented for % within 24 hours; must be within 24 hours in all cases.
(4) A bill is considered inaccurate for this purpose if a customer claims it
is inaccurate.
(5) Not available; as of 1996, Telebras stopped measuring this quality of
service indicator.
(6) The Company measures only for domestic long-distance calls.
(7) Not available; while the Company does not measure against this criterion
for most of its Subsidiaries, the Company does not anticipate having
difficulties meeting this standard.
Failure to meet both network expansion and modernization obligations and the
quality of service obligations in the List of Obligations may result in fines
and penalties of up to R$50,000,000 as well as potential revocation of the
Company's Concessions. The Company's ability to meet the quality of service
obligations in the List of Obligations will depend upon certain factors
outside its control. While there can be no assurances, the Company believes
that it will be able to meet these requirements.
Interconnection. Interconnection is mandatory between all telecommunications
networks upon request by any party. Interconnection tariffs are subject to a
price-cap established by Anatel. Rates below the applicable price-cap may be
negotiated between the parties. If a company offers an interconnection tariff
below the price-cap, it must offer that price to any other requesting party on
a nondiscriminatory basis.
Anatel has stated that it does not expect to grant parties requesting
interconnection the right to co-locate their equipment at this time. Co-
location means that a party requesting interconnection may place its switching
equipment in or near the local exchange of the network operator whose network
the requesting party wishes to use and connect to the network at this point of
presence. Co-location is currently a matter of negotiation between the
parties.
25
<PAGE>
Anatel does not currently mandate unbundling of network elements and
services by the providers of such elements and services, although Anatel has
stated that it plans to review the issue on a regular basis and may introduce
unbundling in the future. In an unbundled regime, every network operator is
required to provide a detailed list of network services and elements which may
be purchased by a party requesting interconnection and the requesting party
then has the right to select and purchase a subset of the network elements and
services available.
Number Portability. Number portability is the ability of a customer to move
to a new home or office or switch service providers while retaining the same
telephone number. Full number portability is mandatory within a local area.
RATE REGULATION
General. In May 1997, a tariff rebalancing was implemented pursuant to which
monthly subscription charges and measured service charges for all customers
increased, while domestic and international long-distance rates were lowered.
In addition, the previous mechanism for financing the installation of new
lines (auto-financing), which required customers to purchase shares of
Telebras, was eliminated and replaced with a flat installation charge. With
retroactive effect as of April 1, 1998, the regime used to divide domestic and
international long-distance revenues between Embratel and the regional fixed-
line companies was replaced with a network usage fee for interconnection such
as already existed for use of cellular networks by the fixed-line companies
and for use of the fixed networks by cellular operators. In addition to the
network usage charge, Embratel is also required to pay a supplemental per-
minute charge called Parcela Adicional de Transicao ("PAT") that supplements
the network usage charge. Embratel is the only company that is required to pay
PAT charges. Embratel will be required to pay PAT charges for three years,
after which time the PAT charges will be phased out.
Price-Caps. Concessions with the regional fixed-line companies and Embratel,
including the Concessions with the Company, provide for a price-cap mechanism
to set and adjust rates on an annual basis. The price-cap mechanism consists
of a maximum amount, or price-cap, stipulated by Anatel, that may be charged
for a particular service and on a weighted average rate for a basket of basic
services. The services include all of the services in the basic service plan,
such as installation charges, monthly subscription fees, switched local
service, intra-regional long-distance, interregional long-distance and
international long-distance service, as well as public telephone service and
interconnection charges, including network usage fees. The main baskets for
the regional fixed-line companies are for local services, including
installation charges, the monthly subscription fee, and measured usage
charges, and for interconnection services, including network usage fees and
equipment rental charges. The main baskets for Embratel are interregional
long-distance, international long-distance and interconnection.
The initial price-cap established by Anatel in the Concessions is based on
the previously existing tariffs. The initial price-cap will be adjusted on an
annual basis under a formula contained in the Concessions. The formula allows
two adjustments to the price-cap. First, the price-cap is revised upward to
reflect increases in inflation by multiplying the price-cap by (1+1(y)), where
y represents the rate of inflation as measured by the Indice Geral de Precos--
Disponibilidade Interna ("IGP-DI"), an inflation index developed by the
Fundacao Getulio Vargas, a private Brazilian economic research organization.
Second, the inflation-adjusted price-cap is adjusted downward to ensure
productivity gains by multiplying the inflation-adjusted price-cap by (1-K),
where K represents a set productivity factor (the "K-factor").
26
<PAGE>
In order to provide an incentive to Embratel and the regional fixed-line
companies to increase their efficiency and to reward consumers of
telecommunications services, Anatel applies a K-factor representing annual
productivity adjustments to the tariffs of Embratel and the regional fixed-
line companies. In the period 1998 to December 31, 2005, the tariffs of
Embratel and the regional fixed-line companies will be adjusted downward as
follows:
<TABLE>
<CAPTION>
K-FACTOR ANNUAL PRODUCTIVITY
ADJUSTMENTS
---------------------------------------
1998 1999 2000 2001 2002 2003 2004 2005
---- ---- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Fixed-line companies--local............ 0% 0% 0% 1% 1% 1% 1% 1%
Fixed-line companies--local
interconnection....................... 0% 0% 0% 5% 10% 15% 20% 20%
Embratel- interregional long-distance.. 2% 2% 2% 4% 4% 4% 5% 5%
Embratel- international long-distance.. 5% 5% 15% 15% 15% 15% 15% 15%
Fixed-line companies--intra-regional
long-distance and long-distance
interconnection....................... 2% 2% 2% 4% 4% 4% 5% 5%
</TABLE>
The price-cap covers a basket of basic services. While the weighted average
tariff for the entire basket may not exceed the price-cap, the tariffs for
individual services within the basket may be increased. The Company may
increase the tariff for any individual service by up to 9% for local services
and 5% for long distance services, subject to a downward adjustment for
inflation effects already captured in the annual upward adjustments of the
overall price-cap for the basket, so long as it adjusts other prices downward
to ensure that the weighted average tariff does not exceed the price-cap.
The Company may also offer alternative plans in addition to the basic
service plan. For instance, a customer might wish to choose an alternative
plan that allows unlimited calling for a set fee rather than pay the per-
minute fee under the basic service plan. Alternative plans must be submitted
to Anatel for approval, but are not currently subject to a price-cap.
For information on the Company's current tariffs and service plans, see "--
Rates."
Installation Charges. Installation charges for connection to the fixed-line
telephone network have been reduced to a maximum flat rate of R$80 for all
customers, both residential and nonresidential as of October 1997. All
regional fixed-line companies are subject to this maximum for installation
uniformly in every local calling area throughout Brazil. Local areas include
those areas currently connected to the fixed-line network and correspond
largely to urban areas. Customers outside of the local areas must negotiate
the price of installation with the Company. Currently, the Company is charging
an installation charge of R$50, rather than R$80. This fee replaces the
autofinancing mechanism which had been in place, which required customers to
purchase shares in Telebras. See "--Rates--Local Services."
Monthly Subscription Charges. Residential and nonresidential customers must
pay a monthly access fee for connection to the fixed-line telephone network.
There are currently three levels of monthly access fees in Brazil, R$10, R$15
and R$20, excluding taxes, depending on customer characteristics, with all
residential customers paying R$10 and most business customers paying R$15. See
"--Rates--Local Services."
Measured Service Charges. Users of local service, both residential and
nonresidential, pay for local calls depending on usage. Usage is measured in
pulses. Pulses occur system-wide every four minutes for local calls. These
system-wide pulses are recorded independently of when individual calls are
actually made. In addition to system-wide pulses, the system records one
individualized pulse for every call when the call is connected. After the
first individualized pulse, only system-wide pulses are used in determining
the charge for a call. The result of this system is that, while the time
between the second and every subsequent pulse is always in increments of four
minutes, the time between the first (individualized) pulse and the second
(system-wide) pulse may vary. For example, the time between the first
(individualized) pulse and the second (system-wide) pulse may vary between one
second and four minutes.
For normal weekday calls, local call charges are determined by multiplying
the number of pulses by the charge per pulse. For calls being made any day
between midnight and 6:00 a.m., in addition to Saturdays from 2:00 p.m. to
midnight and all day Sunday and holidays, a caller is charged for only one
pulse regardless of the duration of a call.
27
<PAGE>
All users of local service currently receive 90 free pulses per month as
part of their monthly subscription, equivalent to about 140 minutes per month
in the case of an average user. Through the tariff rebalancing of May 1997,
measured usage charges increased by approximately 61%. See "--Rates--Local
Services."
Anatel has stated that, as a consequence of its tariff restructuring in May
1997, cross-subsidies among various telecommunications services have been
largely eliminated.
Intra-Regional Long-Distance. Users of service pay differing rates for local
measured service and intra-regional long-distance service. Intra-regional
long-distance consists of interurban calls originating and terminating within
the calling area of a regional fixed-line company. The Company is allowed to
carry such calls entirely over its own network. When it does so, the Company
receives all of the revenues from such calls. As part of the May 1997 tariff
rebalancing, intra-regional long-distance rates were lowered, with an
effective reduction of approximately 32%. Intra-regional calls are billed
based on the duration of a call and distance. There are currently 20 intra-
regional long-distance tariffs based on combinations of four day/time
categories and five distance categories. Certain intra-regional long-distance
calls occur within an area code and are measured in pulses.
For a breakdown of the Company's current intra-regional long-distance
tariffs, see "Rates--Intra-Regional Long-Distance Service."
Network Usage Charges. Other telecommunications companies wishing to
interconnect with and use the Company's network--primarily to gain access to
the Company's customers for call origination and completion--must pay certain
fees, primarily a network usage fee. In addition, other telecommunications
operators rent equipment, such as trunk lines, from the Company for use within
their own internal networks. Fees for network usage and equipment rental are
subject to price-caps stipulated by Anatel.
The price-cap for the network usage fee specified by Anatel varies from
company to company based on the underlying cost characteristics of each
company's network. The fee is a flat fee charged per minute of use which
represents an average charge for a basket of network elements and services.
Embratel, the cellular companies and any future new entrants into the market
must pay the network usage fee if they access end customers via the network of
a regional fixed-line company. In practical terms, even though the network
usage fee includes the costs of a variety of network elements and services,
the network usage fee primarily reflects the use of certain facilities of the
Company for which Embratel and the cellular companies do not have adequate
substitutes, particularly the local loop between local exchanges and end
customers. Anatel has stated that Embratel is likely to be the primary
provider of network usage fees since it will need to use at least the local
loop to access end customers for the provision of long-distance service and
since Embratel is under an obligation to provide universal long-distance
service.
In the past, the Company shared revenues for interstate and international
long-distance calls with Embratel rather than charging Embratel a network
usage fee for the use of the Company's network. Under this system, the Company
retained a fixed percentage of the revenues associated with such calls and
paid the balance of the revenues associated with such calls to Embratel. This
system was replaced with retroactive effect as of April 1, 1998 with the
interconnection charge regime that had already been in place for
interconnection of the Company's network with cellular networks, under which
the Company charges for connection to its network and usage of its network.
The total level of interconnection charges in the future is likely to depend
greatly on the interconnection regime adopted by Anatel and how it is
enforced. See "--Obligations of Telecommunications Companies--
Interconnection."
28
<PAGE>
BRAZILIAN POLITICAL ENVIRONMENT
The Brazilian political environment was marked by high levels of uncertainty
after the country returned to civilian rule in 1985, ending 20 years of
military government. The death of a President-elect in 1985 and the
resignation of another President in the midst of impeachment proceedings in
1992, as well as rapid turnover at and immediately below the cabinet level,
adversely affected the implementation of consistent economic and monetary
policies, including consistent policies in the areas of government-owned
enterprises and telecommunications.
Mr. Fernando Henrique Cardoso, the Finance Minister at the time of
implementation of Brazil's latest economic stabilization plan (the "Real
Plan"), was elected President of Brazil in October 1994 and took office in
January 1995. He has generally sought to continue the economic stabilization
and liberalization policies he had developed as Finance Minister from May 1993
through April 1994. Although some important groups remain opposed to
significant elements of his program and the implementation of policies of
economic stabilization and liberalization is subject to significant
compromises and accommodations, President Cardoso is the leader of a coalition
of political parties that represents a majority of the federal Congress. His
party controls the state governments of the States of Sao Paulo, Rio de
Janeiro and Minas Gerais, and his policies have broad political support.
Elections for the President, Vice-President, state Governors and the members
of the Chamber of Deputies, as well as one third of the members of the Senate
were held on October 4, 1998. President Cardoso was re-elected for a second
term as president. The outcome of these elections could have a strong impact
on the continuation of the economic reforms of the Cardoso administration.
There can be no assurance that the political consensus in favor of the
economic reform program pursued by the Cardoso administration can or will be
sustained following the elections.
BRAZILIAN ECONOMIC ENVIRONMENT
The financial condition and results of operations of the Company are
dependent on general economic conditions in Brazil, and in particular on (i)
economic growth and its impact on demand for telecommunications services, (ii)
the cost and availability of financing and (iii) exchange rates between
Brazilian and foreign currencies.
For many years, the Brazilian economy was extremely volatile, and the
Federal Government implemented a succession of programs intended to stabilize
the economy and provide a basis for sustainable, non-inflationary growth. The
Company was affected by economic instability and by such programs in a variety
of ways, particularly when they have resulted in contractions in demand or
very high real interest rates or prevented the Company from raising rates to
keep pace with the rate of inflation.
Until the introduction of the Real Plan, measures by the Federal Government
intended to influence the course of Brazil's economy, such as changes in
monetary, credit, tariff and other policies, were frequent and occasionally
drastic. See "Exchange Controls and Other Limitations Affecting Security
Holders." In particular, actions to control inflation, interest rates or
consumption included freezing bank accounts, imposing capital controls,
introducing high tariffs and other strong measures. Changes in policy, social
instability and other political and economic developments, and the Brazilian
government's responses to such developments, not infrequently have had a
material adverse effect on the Company's business, financial condition and
results of operations.
Beginning in December 1993, the Federal Government introduced the Real Plan,
an economic stabilization program intended to reduce the rate of inflation by
reducing certain public expenditures, collecting liabilities owed to the
Federal Government, increasing tax revenues, continuing to privatize
government-owned entities and introducing a new currency. The real was
introduced as Brazil's currency on July 1, 1994, based on a new unit of
account, the URV, introduced earlier in the year. Since taking office in
January 1995, President Cardoso has
29
<PAGE>
continued to implement the Real Plan. The real generally appreciated through
January 1995 and thereafter gradually declined in value against the dollar,
reaching R$1.1164 to US$1.00 at December 31, 1997. Under the Real Plan, the
rate of inflation has decreased significantly and there has been sustained
growth in real gross domestic product. See "--Inflation and Devaluation."
Notwithstanding the success of the Real Plan in lowering inflation and
stabilizing the Brazilian economy, the Real Plan also led to an economic
slowdown, a rise in unemployment in some regions and specific sectors of the
economy, and adversely impacted certain sectors of the economy.
Beginning in August 1998, following the devaluation of the Russian Ruble,
Brazil has experienced substantial capital outflows, significant declines in
its stock markets and speculative attacks on the Brazilian currency. In
response, the Federal Government has raised interest rates and stated that it
will continue to support the value of the real and to abide by the principles
inherent in the Real Plan. In early October 1998, reported capital outflows of
approximately US$1 billion per day led to speculation that the International
Monetary Fund would provide Brazil with a financial aid package. However, as
of October 9, 1998, no such package had been announced by the IMF or formally
requested by the Federal Government. Previously, in the fourth quarter of
1997, Brazil experienced a financial crisis following the financial and
economic crisis in Asia. In response, the Federal Government adopted several
economic measures to protect the Real Plan and the stability of the Brazilian
currency. These measures included (i) an increase in interest rates, including
a near doubling of short-term interest rates, (ii) an increase in certain tax
rates, (iii) a reduction in Federal Government spending for 1998 and (iv)
restrictions on imports. Government policies to control inflation and to
reduce budget and trade deficits could also result in further actions that
could slow or halt Brazilian economic growth. It is not possible to foresee
how measures like these will affect the business, financial condition and
results of operations of the Company.
Brazil's trade deficit for 1997 increased to US$8.37 billion compared to
US$5.54 billion for 1996. There can be no assurance that the Brazilian
government will not introduce credit restrictions to subdue domestic demand in
order to reduce the trade deficit, nor that any such credit restrictions will
not have a material adverse effect on the business, operations, financial
condition or results of operations of the Company. A continuing increase in
the trade deficit would substantially reduce Brazil's approximately US$50.8
billion of reserves at December 31, 1997 and could negatively affect Brazil's
economic development as a whole.
PRIVATIZATION
The Federal Government, directly or through various state-owned enterprises,
owns many companies and controls a major portion of activities in the mining
and oil and gas sectors. Most of the energy production, rail transport and
postal services companies are directly or indirectly controlled by the Federal
Government.
To reduce its participation in the economy, the Federal Government has
engaged in the privatization of certain state enterprises. The objectives of
the privatization program are (i) to reduce the role of the state in the
economy and allocate more resources to social investment, (ii) to reduce
public sector debt and (iii) to encourage increased competition and thereby
raise the standards and efficiency of Brazilian industry and (iv) to
strengthen the capital markets and promote wider share ownership. As
originally presented the Real Plan contemplated constitutional amendments
which would permit private participation in the state-controlled petroleum and
telecommunications sectors and in other areas that had constitutionally
mandated monopolies, such as pipeline distribution of gas and the shipping
industry. These amendments were approved by Congress in 1995. A council
directly subordinate to the President, the Conselho Nacional de Desestatizacao
(the "Privatization Council") and BNDES are responsible for administering the
privatization program.
As of December 31, 1996, a total of 52 state enterprises or divisions
thereof had been privatized, and several minority interests held by Federal
Government companies had been sold for nominal consideration totaling US$13.7
billion (including payment made in Brazilian currency and payment made by
means of qualified debt instruments issued to the federal government, its
agencies and state-controlled companies). To date, the privatizations have,
for the most part, been effected through share auctions conducted on Brazil's
stock exchanges. Although the majority of such auctions have been successful,
there have been instances in which a
30
<PAGE>
share auction has failed due to a lack of bidders. Privatization revenues for
1997 exceeded $26.0 billion. Some of the Brazilian states, such as Sao Paulo,
Minas Gerais, Pernambuco, Paraiba and Maranhao are also conducting
privatization programs in relation to state services.
Brazilian labor unions have opposed certain of the privatization measures
proposed by the Federal Government, but the Federal Government has, to date,
been able to move forward with its program despite such opposition.
DEVELOPMENTS IN OTHER EMERGING MARKET COUNTRIES; BRAZILIAN AUSTERITY PROGRAM
The Brazilian securities markets are, to varying degrees, influenced by
economic and market conditions in other emerging market countries. Although
economic conditions are different in each country, investors' reactions to
developments in one country can have an effect on the securities of issuers in
other countries, including Brazil. For example, since the fourth quarter of
1997, the international financial markets have experienced significant
volatility, and a large number of financial market indices, including those in
Brazil, have declined significantly. The current market volatility in Latin
American and other emerging market countries' securities markets has also been
attributed, at least in part, to the effects of the Asian economic crisis.
There can be no assurance that the Brazilian securities markets will not
continue to be affected negatively by events elsewhere, especially in emerging
markets, or that such events will not adversely affect the value of the ADSs.
In reaction to the growing market volatility in Asia, the Federal Government
implemented several measures intended to curtail the outflow of foreign
investment, as Central Bank reserves were reduced from U.S.$61.2 billion in
September 1997 to U.S.$52.9 billion by the end of October 1997. On October 30,
1997, the Central Bank raised the benchmark interest rate from 20.7% to 43.4%,
in order to retain investment funds in the country. On November 10, 1997 the
Federal Government presented a series of fiscal measures aimed at reducing the
budget deficit and bolstering economic conditions. The measures included
certain tax increases, eliminations of budget expenses and reductions in
available fiscal incentives. The package of measures was intended to produce a
savings of R$20 billion, due to the decrease in expenses and the increase in
revenue. These fiscal measures have been substantially implemented.
Constitutional reforms affecting civil servants and social security have also
been accelerated and may result in lower Government deficits. However, there
can be no assurance that such measures will be successful in protecting the
Federal Government's present currency exchange rate policy and price stability
program.
Additionally, the decrease in economic activity caused by the increase in
interest rates and the fiscal measures may have substantial negative effects
on companies doing business in Brazil. Projected GDP growth for Brazil for
1998 has been reduced from approximately 4% to approximately 1%. It is
expected that these events may have the effect of reducing the purchasing
power of Brazilian consumers in general. Since the increase in interest rates,
the Central Bank has gradually reduced its benchmark interest rate, setting
its rates at 40.9% on December 1, 1997, 38.0% on January 2, 1997, at 34.5% on
January 29, 1997, at 28.0% on March 5, 1998 and at 21.8% on May 20, 1998, at
21.0% on June 25, 1998 and at 19.75% on July 29, 1998. However, there can be
no assurance that a decrease in interest rates will not cause further
investment outflows.
Events in Asia also may affect the competitiveness of Brazilian exports. In
addition, the proceeds from scheduled privatizations may not reach expected
levels, in which case the current account deficit would cause a deterioration
in foreign reserves, adversely affecting the currency exchange rate policy.
INFLATION AND DEVALUATION
Brazil experienced extremely high and generally unpredictable rates of
inflation and of devaluation of Brazilian currency for many years until the
implementation of the Real Plan. Inflation itself, as well as certain
governmental measures to combat inflation, and public speculation about
possible future actions have also historically contributed to economic
uncertainty in Brazil and to heightened volatility in the Brazilian securities
markets. The following table sets forth Brazilian inflation, as measured by
the UFIR for 1995 and the IGP-M for 1996-1998, and the devaluation of the
Brazilian currency against the U.S. dollar for the periods shown.
31
<PAGE>
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31, FIRST QUARTER SIX MONTHS
-------------- ENDED MARCH 31, ENDED JUNE 30,
1995 1996 1997 1998 1998
---- ---- ---- --------------- --------------
(IN PERCENTAGES)
<S> <C> <C> <C> <C> <C>
Inflation (UFIR for 1995; IGP-M
for 1996-1998)................. 22.5 9.2 7.7 1.3 2.0
Devaluation (Brazilian currency
vs. US$)....................... 15.0 6.9 7.4 1.9 3.6
</TABLE>
Since the introduction of the Real Plan in July 1994, the rate of inflation
has decreased considerably. As measured by the IGP-M, the rate of inflation
was 7.7% for 1997, 1.3% for the first quarter of 1998 and 2.0% for the six
months ended June 30, 1998. Despite this reduction, the rate of inflation
remains high compared to other countries, and the potential for distortions or
dislocations attributable to changing prices continues to exist. The exchange
rate between the real and the U.S. dollar has also been relatively stable
since early July 1994, compared to prior periods, although the potential for
devaluation or volatility persists. See "Exchange Rates."
ITEM 2: DESCRIPTION OF PROPERTY
The principal properties of the Company consist of transmission plants
(including outside plant and trunk lines), exchange equipment and switching
equipment. The Company's land and buildings principally consist of its
telephone exchanges and other technical, administrative and commercial
properties. Exchanges include local exchanges, "toll" exchanges that connect
local exchanges to long-distance transmission facilities and "tandem"
exchanges that connect local exchanges with each other and with toll
exchanges.
The Company's properties are located throughout the states of Maranhao,
Piaui, Ceara, Rio Grande do Norte, Paraiba, Pernambuco, Alagoas, Sergipe,
Bahia, Roraima, Amapa, Amazonas, Para, Rio de Janeiro, Minas Gerais and
Espirito Santo. At March 31, 1998, the Company owned 5,325 properties, being
5,235 operating and 90 non-operating sites.
At December 31, 1997, plant, equipment related to automatic switching
stations represented approximately 24.6%, transmission equipment represented
31.2%, construction in progress represented approximately 19.8%, buildings,
underground equipment and lines represented approximately 14.3% and other
fixed assets represented approximately 10.1% of the net book value of the
Company's total fixed assets. At December 31, 1997, the net book value of the
Company's property, plant and equipment was R$13,282.3 million.
ITEM 3: LEGAL PROCEEDINGS
The Breakup of Telebras is subject to several lawsuits in which the
plaintiffs have requested, and in certain cases obtained, preliminary
injunctions against the Breakup. All of these preliminary injunctions have
been quashed by decisions of the relevant Federal Court, although several of
such decisions are currently on appeal. If any such appeal is successful, the
shareholders of Telebras will be required to reapprove the Breakup or other
legislative action may be required.
The lawsuits to which the Breakup has been subjected are based on a number
of legal theories, the principal among which are that (i) Brazil's
Constitution requires that the creation of the twelve New Holding Companies be
specifically authorized by the Telecommunications Law--the Breakup is not so
authorized; (ii) the Shareholders' meeting of Telebras held on May 22, 1998
which approved the Breakup was not properly convened; (iii) national
sovereignty will be threatened if the country's telecommunications companies
are controlled by foreign entities; and (iv) the Telecommunications Law
requires that certain matters, such as the entry of new competitors and the
administration of development and technology funds, be regulated prior to the
Breakup and privatization either by an executive order of the President or by
an act of Congress. If any of the plaintiffs in the above-described lawsuits
ultimately prevails, the Breakup will have to be reinitiated. This could
require, depending upon the prevailing plaintiff's theory, any combination of
(i) amendment of the Telecommunications Law, (ii) reconvening the May 22, 1998
Telebras shareholders' meeting and (iii) the passage of additional fees by
Congress or issuance of executive orders by the President. It is theoretically
possible under Brazilian law for a court to require that the Breakup be
unwound, although the Company believes that this would not be likely to occur.
32
<PAGE>
The Company is a party to certain legal proceedings arising in the normal
course of business, including civil, administrative, tax, social security and
labor proceedings. The Company has provided for or deposited in court amounts
to cover its estimated losses due to adverse legal judgments. In the opinion
of management, such actions, if decided adversely to the Company, would not
have a material adverse effect on the Company's business and financial
condition.
Telebras is the legal predecessor of the Registrant and is a defendant in a
number of legal proceedings and subject to certain other claims and
contingencies. Under the terms of the Breakup, liability for any claims
arising out of acts committed by Telebras prior to the effective date of the
Breakup remains with Telebras, except for labor and tax claims (for which
Telebras and the New Holding Companies are jointly and severally liable by
operation of law) and any liability for which specific accounting provisions
have been assigned to the Registrant or one of the other New Holding
Companies. Creditors of Telebras may challenge this allocation of liability
until September 14, 1998. Management of the Company believes that the chances
of any such claims materializing and having a material adverse financial
effect on the Company are remote.
Liability for any claims arising out of acts committed by the Subsidiaries
prior to the effective date of the spin-off of the Subsidiaries' cellular
assets and liabilities to the newly formed cellular companies remains with the
Subsidiaries, except for labor and tax claims (for which the Subsidiaries and
the newly formed cellular companies are jointly and severally liable by
operation of law) and those liabilities for which specific accounting
provisions have been assigned to the newly formed cellular companies. However,
under the shareholders' resolution pursuant to which the spin-off was
effected, the newly formed cellular companies have contribution rights against
the Subsidiaries with respect to the entire amount of any payments made by the
newly formed cellular companies in connection with any labor or tax claims
brought against the newly formed cellular companies and relating to acts
committed by the Subsidiaries prior to the effective date of the spin-off.
ITEM 4: CONTROL OF REGISTRANT
Of the Company's two classes of capital stock outstanding, only the Common
Shares have full voting rights. The Preferred Shares have voting rights under
limited circumstances. See "Description of Securities to be Registered--
Capital Stock--Voting Rights." Telemar owns 51.79% of the Common Shares.
Accordingly, Telemar has the ability to control the election of the Company's
Board of Directors and the direction and future operations of the Company.
The following table sets forth information concerning the ownership of
Common Shares by each member of Telemar and by the Company's officers and
directors as a group. The Company is not aware of any other shareholder owning
more than 10.0% of the Common Shares.
<TABLE>
<CAPTION>
NUMBER OF PERCENTAGE OF
COMMON OUTSTANDING
NAME OF OWNER SHARES OWNED COMMON SHARES
------------- -------------- -------------
<S> <C> <C>
Construtora Andrade Gutierrez S.A................ 13,653,892,000 10.98%
Macal Investimentos e Participacoes Ltda......... 12,881,031,000 10.35%
Inepar S.A. Industria e Construcoes.............. 12,881,031,000 10.35%
Fiago Participacoes S.A.......................... 12,043,763,125 9.68%
Companhia de Seguros Alianca do Brasil........... 6,472,717,000 5.20%
Brasil Veiculos Companhia de Seguros............. 6,472,717,000 5.20%
All directors and executives officers as a group
(15 persons).................................... 4 0.00%
</TABLE>
The following is a brief description of the members of the Telemar
consortium.
CONSTRUTORA ANDRADE GUTIERREZ S.A. Andrade Gutierrez is part of a Brazilian
group with revenues of US$1.5 billion in 1997. It has activities in the fields
of construction, public utilities and telecommunications and conducts business
in many countries like the United States, Mexico, Argentina, Paraguay,
Equator, Bolivia, Chile, Peru, Panama, Guinea, Angola and Portugal. Andrade
Gutierrez was responsible for the construction of
33
<PAGE>
Itaipu, the world's largest hydroelectric plant. Since 1993, Andrade Gutierrez
telecommunications' activities has conducted its activities through AG Telecom
(Andrade Gutierrez Telecomunicacoes), whose activities include information
technology services, credit card processing and optic fiber communications
networks.
INEPAR S.A. INDUSTRIA E CONSTRUCOES. Inepar is the main company of the
Inepar Group, a group of companies with revenues around US$412 million in 1997
and with activities in Brazil and throughout other Latin American countries.
Inepar Group is dedicated to the fields of telecommunications, energy and
construction. Its telecommunications activities include interests in projects
such as global satellite phone ("Iridium"), cable television, cellular phone
services, internet connection services and pager services.
MACAL INVESTIMENTOS E PARTICIPACOES LTDA. Macal is a holding company with
equity interests in several companies with different activities, particularly
in the telecommunications sector, among which are Mcom Wireless S.A. (trunking
and paging services), Shoptime S.A. (sales through a TV sales channel),
Multicanal Participacoes (cable television) and Almax Aluminio S.A.
FIAGO PARTICIPACOES S.A. Fiago was incorporated by FCF--Fundo Mutuo de
Investimentos em Acoes-- Carteira Livre (the "FCF", a Brazilian investment
fund) for the purposes of holding equity interests in telecommunications
companies in Brazil. The FCF fund is managed by Banco Fonte Cindam S.A., a
Brazilian investment bank.
BRASIL VEICULOS COMPANHIA DE SEGUROS. Brasil Veiculos is a Brazilian
insurance company with revenues of approximately US$150.0 million in the first
semester of 1998. It provides vehicle insurance products countrywide and has a
market share of 4.78% in the vehicles insurance market.
COMPANHIA DE SEGUROS ALIANCA DO BRASIL. Alianca do Brasil is a Brazilian
insurance company with revenues of approximately US$380.0 million in 1997. It
provides life insurance products nationwide and has a market share of 9.66% in
the domestic life insurance market and 10.81% in the domestic general risks
insurance market.
SHAREHOLDERS' AGREEMENT
On August 3, 1998, Construtora Andrade Gutierrez S.A., Macal Investimentos e
Participacoes Ltda., Inepar S.A. Industria e Construcoes, Companhia de Seguros
Alianca do Brasil, Brasil Veiculos Companhia de Seguros as well as BNDES
Participacoes S.A.--BNDESPAR (which owns 46,307,155 Common Shares), entered
into a Shareholders' Agreement (the "Shareholders' Agreement"). The
Shareholders' Agreement provides for (i) rules for the management of the
company and its subsidiaries, (ii) rights of first refusal or preemptive
rights in case of transfer of shares (BNDESPAR not included) and (iii) special
quorum for the adoption of certain corporate resolutions by the Board of
Directors and by the Shareholders' Meetings. Under the Shareholders'
Agreement, the parties agree to incorporate a holding company, which will have
also as a shareholder Fiago Participacoes S.A. (which is not a party to the
Shareholders' Agreement). Such holding company will hold all Common Shares
owned by the parties of the Shareholders' Agreement and also all the Common
Shares owned by Fiago Participacoes S.A. The incorporation of such holding
company is still subject to approval by the Brazilian Treasury and by Anatel.
The Shareholders' Agreement also states the intention of the parties to
distribute the equity interest in the holding company to be incorporated
(which will control the Registrant) in the following manner: (i) Construtora
Andrade Gutierrez S.A., Macal Investimentos e Participacoes Ltda., Inepar S.A.
Industria e Construcoes will own together 45% of the holding company's voting
stock, (ii) Companhia de Seguros Alianca do Brasil and/or Brasil Veiculos
Companhia de Seguros will own 10% of the holding company's voting stock, (iii)
BNDES Participacoes S.A.--BNDESPAR will own 25% of the holding company's
voting stock and (iv) Fiago Participacoes S.A. will own 19.9% of the holding
company's voting stock.
ITEM 5: NATURE OF TRADING MARKET
There has never been a trading market for the ADSs. Prior to September 21,
1998, there was no trading market for the Common Shares or the Preferred
Shares. Prior to the spin-off of the Subsidiaries' cellular
34
<PAGE>
operations, common shares and preferred shares of Telerj, Telemig and
Telebahia traded on the Bolsa de Valores de Sao Paulo (the "Sao Paulo Stock
Exchange"), the Bolsa de Valores do Rio de Janeiro (the "Rio de Janeiro Stock
Exchange") and the seven other Brazilian stock exchanges (together with the
Sao Paulo Stock Exchange and the Rio de Janeiro Stock Exchange, the "Brazilian
Stock Exchanges").
Effective May 18, 1998, shares of Telerj, Telemig and Telebahia began to
trade separately in Brazil from shares of the newly formed cellular companies
formed upon the spin-off of the cellular businesses of Telerj, Telemig and
Telebahia. The tables below set forth, for the periods indicated, the high and
low closing prices, in nominal reais, for the shares of Telerj, Telemig and
Telebahia on the Sao Paulo Stock Exchange since the spin-off of the
Subsidiaries' cellular operations.
<TABLE>
<CAPTION>
PRICES PER 1,000
PREFERRED SHARES
OF
TELERJ(1)
----------------
HIGH LOW
-------- -------
(IN NOMINAL
REAIS)
<S> <C> <C>
May 18, 1998 through May 31, 1998....................... R$108.07 R$96.00
June 1, 1998 through June 30, 1998...................... R$101.99 R$81.00
July 1, 1998 through July 31, 1998...................... R$107.01 R$80.00
August 1, 1998 through August 31, 1998.................. R$ 48.50 R$29.50
September 1, 1998 through September 30, 1998............ R$ 32.30 R$21.50
</TABLE>
- --------
(1) Share prices are for Telerj, a subsidiary of the Registrant, and not for
the Registrant itself.
<TABLE>
<CAPTION>
PRICES PER 1,000
PREFERRED SHARES
OF
TELEMIG(1)
-----------------
HIGH LOW
-------- --------
(IN NOMINAL
REAIS)
<S> <C> <C>
May 18, 1998 through May 31, 1998...................... R$106.00 R$100.00
June 1, 1998 through June 30, 1998..................... R$117.00 R$ 80.50
July 1, 1998 through July 31, 1998..................... R$ 96.50 R$ 77.49
August 1, 1998 through August 31, 1998................. R$ 47.00 R$ 32.00
September 1, 1998 through September 30, 1998........... R$ 31.00 R$ 28.00
</TABLE>
- --------
(1) Share prices are for Telemig, a subsidiary of the Registrant, and not for
the Registrant itself.
<TABLE>
<CAPTION>
PRICES PER
1,000
PREFERRED
SHARES OF
TELEBAHIA(1)
---------------
HIGH LOW
------- -------
(IN NOMINAL
REAIS)
<S> <C> <C>
May 18, 1998 through May 31, 1998........................ R$63.00 R$59.00
June 1, 1998 through June 30, 1998....................... R$63.00 R$50.00
July 1, 1998 through July 31, 1998....................... R$59.99 R$50.00
August 1, 1998 through August 31, 1998................... R$28.00 R$22.00
September 1, 1998 through September 30, 1998............. R$26.50 R$19.90
</TABLE>
- --------
(1) Share prices are for Telebahia, a subsidiary of the Registrant, and not
for the Registrant itself.
Following the Breakup and until September 21, 1998, the preferred shares of
each of the New Holding Companies, including the Preferred Shares, traded on
the Brazilian Stock Exchanges only as a unit with the preferred shares of
Telebras. Telebras ADSs, each representing 1,000 Telebras preferred shares
and, since the Breakup, each also representing 1,000 preferred shares of each
of the New Holding Companies, have continued to trade on the NYSE. See
"Presentation of Information."
On September 21, 1998, common shares and preferred shares of each New
Holding Company, including the Preferred Shares, commenced trading separately
on the Brazilian Stock Exchanges. The table below sets
35
<PAGE>
forth, for the periods indicated, the high and low closing sales prices for
the Preferred Shares of the Registrant as reported on the Sao Paulo Stock
Exchange.
<TABLE>
<CAPTION>
PRICES PER 1,000
PREFERRED SHARES OF
THE REGISTRANT
-------------------
HIGH LOW
-------------------
(IN NOMINAL REAIS)
<S> <C> <C>
September 21, 1998 through September 30, 1998........... R$ 15.20 R$ 13.00
October 1, 1998 through October 23, 1998................ R$ 17.00 R$ 10.70
</TABLE>
It is expected that during the fourth quarter of 1998 American Depositary
Shares representing preferred shares of each New Holding Company will be
issued and commence trading separately on the NYSE. The ADSs, each
representing 1,000 Preferred Shares of the Registrant, will be issued to the
holders of Telebras ADSs pursuant to a Deposit Agreement (the "Deposit
Agreement") among the Registrant, The Bank of New York as Depositary (the
"Depositary") and the holders of the ADSs from time to time. See "Description
of Securities to be Registered--Description of American Depositary Receipts in
respect of Preferred Shares."
Application has been made to list the ADSs on the NYSE upon issuance under
the symbol TNE. Prices at which the Preferred Shares and the ADSs may trade
cannot be predicted. There can be no assurance that an active trading market
for the Preferred Shares in Brazil or for the ADSs in the United States or
elsewhere will develop or be sustained.
TRADING ON THE BRAZILIAN STOCK EXCHANGES
Of Brazil's nine stock exchanges, the Sao Paulo Stock Exchange and the Rio
de Janeiro Stock Exchange are the most significant. During 1997, the Sao Paulo
Stock Exchange accounted for approximately 93% of the trading value of equity
securities on all Brazilian stock exchanges, and the Sao Paulo Stock Exchange
and the Rio de Janeiro Stock Exchange together accounted for approximately 99%
of the trading value of equity securities on all Brazilian stock exchanges.
Each Brazilian stock exchange is a non-profit entity owned by its member
brokerage firms. Trading on each exchange is limited to member brokerage firms
and a limited number of authorized non-members. The Sao Paulo Stock Exchange
and the Rio de Janeiro Stock Exchange have two open outcry trading sessions
each day, from 10:00 a.m. to 1:00 p.m. and from 2:00 p.m. to 5:00 p.m. Trading
is also conducted during this time on an automated system on the Sao Paulo
Stock Exchange and on the National Electronic Trading System ("SENN"), a
computerized system that links the Rio de Janeiro Stock Exchange
electronically with the seven smaller regional exchanges. Market makers exist
on the Sao Paulo Stock Exchange, but are only authorized to make markets in
options for stock indices which are traded on that exchange and to engage in
transactions on META (Mercado de Empresas Teleassistidas), an electronic
trading system operating at the Sao Paulo Stock Exchange and permitting
trading in the securities of companies registered for that purpose. These
companies must appoint the market makers authorized to deal in their
securities. There are no specialists or market makers for the Company's shares
on the Sao Paulo Stock Exchange. The Comissao de Valores Mobiliarios (the
Brazilian Securities Commission or "CVM") and each of the Brazilian stock
exchanges have discretionary authority to suspend trading in shares of a
particular issuer under certain circumstances. Trading in securities listed on
the Brazilian stock exchanges may be effected off the exchanges in certain
circumstances, although such trading is very limited.
Settlement of transactions is effected three business days after the trade
date without adjustment of the purchase price for inflation. Payment for
shares is made through the facilities of separate clearinghouses for each
exchange, which maintain accounts for member brokerage firms. The seller is
ordinarily required to deliver the shares to the exchange on the second
business day following the trade date. The clearinghouse for the Sao Paulo
Stock Exchange is Calispa S.A., which is owned by the member brokerage firms.
The clearinghouse for the Rio de Janeiro Stock Exchange is CLC-Camara de
Liquidacao e Custodia S.A., which is 99% owned by that exchange.
36
<PAGE>
At December 31, 1997, the aggregate market capitalization of the 536
companies listed on the Sao Paulo Stock Exchange was approximately R$285.0
billion. Substantially the same securities are listed on the Sao Paulo Stock
Exchange and on the Rio de Janeiro Stock Exchange. Although all the
outstanding shares of an exchange-listed company may trade on a Brazilian
stock exchange, in most cases less than half of the listed shares are actually
available for trading by the public, the remainder being held by small groups
of controlling persons that rarely trade their shares. This is particularly
true in the case of mixed-capital companies, such as the Company before the
privatization, of which more than half of the voting shares must by law be
owned by Brazilian governmental entities. For this reason, data showing the
total market capitalization of Brazilian stock exchanges tend to overstate the
liquidity of the Brazilian equity securities market.
Although the Brazilian equity market was Latin America's largest in terms of
market capitalization, it is relatively small and illiquid compared to major
world markets. In 1997, the combined daily trading volumes on these two
exchanges averaged approximately R$945.4 million. In 1997, the five most
actively traded issues represented approximately 72.9% of the total trading in
the cash market on the Sao Paulo Stock Exchange and approximately 50.5% of the
total trading in the cash market on the Rio de Janeiro Stock Exchange.
Trading on Brazilian stock exchanges by nonresidents of Brazil is subject to
certain limitations under Brazilian foreign investment legislation. See
"Description of Securities to be Registered."
REGULATION OF BRAZILIAN SECURITIES MARKETS
The Brazilian securities markets are regulated by the CVM, which has
authority over stock exchanges and the securities markets generally, and by
the Central Bank of Brazil, which has, among other powers, licensing authority
over brokerage firms and regulates foreign investment and foreign exchange
transactions. The Brazilian securities market is governed by Law No. 6,385
dated December 7, 1976, as amended (the "Brazilian Securities Law"), and the
Brazilian Corporation Law.
Under the Brazilian Corporation Law, a company is either public, a
"companhia aberta," such as the Company, or private, a "companhia fechada."
All public companies are registered with the CVM and are subject to reporting
requirements. A company registered with the CVM may have its securities traded
either on the Brazilian stock exchanges or in the Brazilian over-the-counter
("Brazilian OTC") market. The shares of a public company, including the
Company, may also be traded privately, subject to certain limitations. To be
listed on the Brazilian stock exchanges, a company must apply for registration
with the CVM and the stock exchange where the head office of the company is
located. Once this stock exchange has admitted a company to listing and the
CVM has accepted its registration as a public company, its securities may be
traded on all other Brazilian stock exchanges.
Trading in securities on the Brazilian stock exchanges may be suspended at
the request of a company in anticipation of a material announcement. Trading
may also be suspended on the initiative of a Brazilian stock exchange or the
CVM, among other reasons, based on or due to a belief that a company has
provided inadequate information regarding a material event or has provided
inadequate responses to inquiries by the CVM or the relevant stock exchange.
The Brazilian Securities Law provided for, among other things, disclosure
requirements, restrictions on insider trading and price manipulation, and
protection of minority shareholders. However, the Brazilian securities markets
are not as highly regulated and supervised as the United States securities
markets or markets in certain other jurisdictions.
ITEM 6: EXCHANGE CONTROLS AND OTHER LIMITATIONS AFFECTING SECURITY HOLDERS
There are no restrictions on ownership of Preferred Shares or Common Shares
of the Registrant by individuals or legal entities domiciled outside Brazil.
37
<PAGE>
Until the Registrant was privatized, it was subject to provisions of
Brazilian corporate law applicable to mixed-capital companies under Brazilian
law. These provisions ceased to apply after the Registrant was privatized. As
a mixed-capital company, the Registrant was not subject to bankruptcy and the
Federal Government was contingently liable for the obligations of the
Registrant for so long as its assets were encumbered and attached. However,
substantial limitations applied to the attachment or sale of assets of the
operating subsidiaries of the Registrant that were used to provide
telecommunications services pursuant to the Company's concession. Similarly,
the sale of shares representing voting control of operating subsidiaries
providing public telecommunications services was subject to government
authorization. The sale of preferred shares of operating subsidiaries, or of
assets not used to provide telecommunications services, was not subject to
these restrictions.
The right to convert dividend payments and proceeds from the sale of shares
into foreign currency and to remit such amounts outside Brazil is subject to
restrictions under foreign investment legislation which generally requires,
among other things, that the relevant investments have been registered with
the Central Bank of Brazil. Such restrictions on the remittance of foreign
capital abroad may hinder or prevent Banco Itau S.A. (the "Custodian"), as
custodian for the Preferred Shares represented by ADSs, or holders who have
exchanged ADRs for Preferred Shares from converting dividends, distributions
or the proceeds from any sale of such Preferred Shares, as the case may be,
into U.S. dollars and remitting such U.S. dollars abroad. Holders of ADSs
could be adversely affected by delays in, or refusal to grant any, required
government approval for conversions of Brazilian currency payments and
remittances abroad of the Preferred Shares underlying the ADSs.
Under Annex IV to Resolution No. 1,289 of the National Monetary Council, as
amended (the "Annex IV Regulations"), qualified foreign investors (which
principally include foreign financial institutions, insurance companies,
pension and investment funds, charitable foreign institutions and other
institutions that (i) seek to invest in financial markets and (ii) meet
certain minimum capital and other requirements) registered with the CVM and
acting through authorized custody accounts managed by local agents may buy and
sell shares on Brazilian stock exchanges without obtaining separate
Certificates of Registration for each transaction. Investors under the Annex
IV Regulations are also entitled to favorable tax treatment. See "Taxation--
Brazilian Tax Considerations." Resolution No. 1,927 of the National Monetary
Council, which is the restated and amended Annex V to Resolution No. 1,289 of
the National Monetary Council (the "Annex V Regulations"), provides for the
issuance of depositary receipts in foreign markets in respect of shares of
Brazilian issuers. The ADS program will be approved under the Annex V
Regulations by the Central Bank of Brazil and the CVM prior to the issuance of
the ADSs. Accordingly, the proceeds from the sale of ADSs by ADR holders
outside Brazil are free of Brazilian foreign investment controls and holders
of the ADSs will be entitled to favorable tax treatment. See "Taxation--
Brazilian Tax Considerations."
A Certificate of Registration will be issued in the name of the Depositary
with respect to the ADSs prior to the issuance of the ADSs and will be
maintained by the Custodian on behalf of the Depositary. Pursuant to the
Certificate of Registration, the Custodian and the Depositary are able to
convert dividends and other distributions with respect to the Preferred Shares
represented by ADSs into foreign currency and remit the proceeds outside
Brazil. In the event that a holder of ADSs exchanges such ADSs for Preferred
Shares, such holder will be entitled to continue to rely on the Depositary's
Certificate of Registration for five business days after such exchange,
following which such holder must seek to obtain its own Certificate of
Registration with the Central Bank of Brazil. Thereafter, any holder of
Preferred Shares may not be able to convert into foreign currency and remit
outside Brazil the proceeds from the disposition of, or distributions with
respect to, such Preferred Shares, unless such holder (i) qualifies under the
Annex IV Regulations or (ii) obtains its own Certificate of Registration, and
in the case of (ii), it will be subject to less favorable Brazilian tax
treatment than a holder of ADSs. See "Taxation--Brazilian Tax Considerations."
Under current Brazilian legislation, the Federal Government may impose
temporary restrictions on remittances of foreign capital abroad in the event
of a serious imbalance or an anticipated serious imbalance of Brazil's balance
of payments. For approximately six months in 1989 and early 1990, the Federal
Government froze all dividend and capital repatriations held by the Central
Bank of Brazil that were owed to foreign equity
38
<PAGE>
investors, in order to conserve Brazil's foreign currency reserves. These
amounts were subsequently released in accordance with Federal Government
directives. The imbalance in Brazil's balance of payments increased during
1997, and there can be no assurance that the Federal Government will not
impose similar restrictions on foreign repatriations in the future.
ITEM 7: TAXATION
The following summary contains a description of the principal Brazilian and
U.S. federal income tax consequences of the ownership and disposition of
Preferred Shares or ADSs, but it does not purport to be a comprehensive
description of all the tax considerations that may be relevant to a decision
to purchase Preferred Shares or ADSs. The summary is based upon the tax laws
of Brazil and regulations thereunder and on the tax laws of the United States
and regulations thereunder as in effect on the date hereof, which are subject
to change. This summary is also based upon the representations of the
Depositary and on the assumption that each obligation in the Deposit Agreement
relating to the ADRs and any related documents will be performed in accordance
with its terms. PROSPECTIVE PURCHASERS OF PREFERRED SHARES OR ADSs SHOULD
CONSULT THEIR OWN TAX ADVISORS AS TO THE TAX CONSEQUENCES OF THE ACQUISITION,
OWNERSHIP AND DISPOSITION OF PREFERRED SHARES OR ADSs.
Although there is at present no income tax treaty between Brazil and the
United States, the tax authorities of the two countries have had discussions
that may culminate in such a treaty. No assurance can be given, however, as to
whether or when a treaty will enter into force or how it will affect the U.S.
holders of Preferred Shares or ADSs. Prospective holders of Preferred Shares
or ADSs should consult their own tax advisors as to the tax consequences of
the acquisition, ownership and disposition of Preferred Shares or ADSs in
their particular circumstances.
BRAZILIAN TAX CONSIDERATIONS
The following discussion summarizes the principal Brazilian tax consequences
of the acquisition, ownership and disposition of Preferred Shares or ADSs by a
holder that is not domiciled in Brazil for purposes of Brazilian taxation and,
in the case of a holder of Preferred Shares, that has registered its
investment in Preferred Shares with the Central Bank of Brazil as a U.S.
dollar investment (in each case, a "non-Brazilian holder"). It is based on
Brazilian law as currently in effect. Any change in such law may change the
consequences described below. The following discussion summarizes the
principal tax consequences applicable under current Brazilian law to non-
Brazilian holders of Preferred Shares or ADSs; it does not specifically
address all of the Brazilian tax considerations applicable to any particular
non-Brazilian holder, and each non-Brazilian holder should consult his or her
own tax advisor concerning the Brazilian tax consequences of an investment in
Preferred Shares or ADSs.
TAXATION OF DIVIDENDS
Dividends, including dividends paid in kind, paid by the Company (i) to the
Depositary in respect of the Preferred Shares underlying the ADSs or (ii) to a
non-Brazilian holder in respect of Preferred Shares will generally not be
subject to Brazilian withholding tax in the case of distributions of profits
earned as from January 1, 1996. Stock dividends relating to profits generated
prior to December 31, 1995 are not subject to withholding tax in Brazil unless
the stock is redeemed by the Company within five years from such distribution
or the non-Brazilian holder sells the stock in Brazil within such five-year
period.
Brazil has entered into tax treaties with several countries. However, there
is currently no tax treaty between the United States and Brazil. The only
Brazilian tax treaty now in effect that, if certain conditions are met, would
reduce the rate of the withholding tax on dividends in respect of profits
generated prior to December 31, 1995 below the generally applicable 15% rate
is the treaty with Japan, which would reduce such rate to 12.5% under the
circumstances stated in such treaty.
39
<PAGE>
TAXATION OF GAINS
Gains realized outside Brazil by a non-Brazilian holder on the disposition
of ADSs to another non-Brazilian holder are not subject to Brazilian tax.
The withdrawal of Preferred Shares in exchange for ADSs is not subject to
Brazilian tax. The deposit of Preferred Shares in exchange for ADSs is not
subject to Brazilian tax provided that the Preferred Shares are registered
under the Annex IV Regulations. In the event the Preferred Shares are not so
registered, the deposit of Preferred Shares in exchange for ADSs may be
subject to Brazilian capital gains tax at the rate of 10% or 15% as described
below. On receipt of the underlying Preferred Shares, a non-Brazilian holder
who qualifies under the Annex IV Regulations will be entitled to register the
U.S. dollar value of such shares with the Central Bank of Brazil as described
below under "--Registered Capital."
Non-Brazilian holders are not subject to tax in Brazil on gains realized on
sales of Preferred Shares that occur abroad or on the proceeds of a redemption
of, or a liquidating distribution with respect to, Preferred Shares. As a
general rule, non-Brazilian holders are subject to a withholding tax imposed
at a rate of 15% on gains realized on sales or exchanges of Preferred Shares
that occur in Brazil to or with a resident of Brazil outside of a Brazilian
stock exchange. Non-Brazilian holders are generally subject to a withholding
tax at a rate of 10% on gains realized on sales or exchanges in Brazil of
Preferred Shares that occur on a Brazilian stock exchange but will not be
subject to tax if either such a sale is made within five business days of the
withdrawal of such Preferred Shares in exchange for ADSs and the proceeds
thereof are remitted abroad within such five-day period, or such a sale is
made under the Annex IV Regulations by certain qualified institutional non-
Brazilian holders that register with the CVM. Gains realized by an investor
under the Annex IV Regulations are not subject to tax, provided certain
conditions are met. The "gain realized" is the difference between the amount
in Brazilian currency realized on the sale or exchange and the acquisition
cost, measured in Brazilian currency without any correction for inflation, of
the shares sold. The "gain realized" as a result of a transaction with respect
to shares registered as an investment with the Central Bank of Brazil (and not
subject to the Annex IV Regulations) will be calculated based on the foreign
currency amount registered with the Central Bank of Brazil. There can be no
assurance that the current preferential treatment for holders of ADSs and non-
Brazilian holders of Preferred Shares under the Annex IV Regulations will not
be changed. Reductions in the tax rate provided for by Brazil's tax treaties
do not apply to tax on gains realized on sales or exchanges of Preferred
Shares.
Any exercise of preemptive rights relating to the Preferred Shares or ADSs
will not be subject to Brazilian taxation. Any gain on the sale or assignment
of preemptive rights relating to the Preferred Shares by the Depositary will
not be subject to Brazilian taxation.
DISTRIBUTIONS OF INTEREST ON NET WORTH
In accordance with Law No. 9,249, dated December 26, 1995, Brazilian
corporations may make payments to shareholders characterized as distributions
of interest on the Company's net worth. Such interest is limited to the
Federal Government's long-term interest rate (the "TJLP") as determined by the
Central Bank of Brazil from time to time (10.63% per annum for the three-month
period starting June 1, 1998), and cannot exceed the greater of (i) 50% of net
income (before taking such distribution and any deductions for income taxes
into account) for the period in respect of which the payment is made or (ii)
50% of retained earnings.
Distributions of interest on net worth in respect of the Preferred Shares
paid to shareholders who are either Brazilian residents or non-Brazilian
residents, including holders of ADSs, are subject to Brazilian withholding tax
at the rate of 15% (except for interest due to the Federal Government, which
is exempt from tax withholding) and shall be deductible by the Registrant for
purposes of the Corporate Income Tax ("IRPJ") and Social Contribution on
Profit ("CSLL") (both of which are levied on the Company's profits) as long as
the payment of a distribution of interest is approved in the Registrant's
annual shareholders' meeting. The amount of distributions of interest on net
worth will be determined by the Board of Directors of the Registrant. No
assurance can be given that the Board of Directors of the Registrant will not
determine that future distributions of profits will be made by means of
interest on net worth instead of by means of dividends.
40
<PAGE>
Under Brazilian law and regulations, the amount paid to shareholders as
interest on net worth (net of any withholding tax) may be treated as payment
in lieu of the Mandatory Dividend and Preferred Dividend (as defined under
"Description of Securities to be Registered--Capital Stock--Dividends"). In
addition, any Brazilian corporation distributing interest on net worth is
obligated to distribute to shareholders an amount sufficient to ensure that
the net amount received (after payment of withholding taxes) is at least equal
to the Mandatory Dividend.
Distributions of interest on net worth in respect of the Preferred Shares,
including to holders of ADSs, may be converted into U.S. dollars and remitted
outside of Brazil to U.S. holders, subject to relevant exchange restrictions.
See "Description of Securities to be Registered--Capital Stock--Payment of
Dividends" and "--Description of American Depositary Receipts in respect of
Preferred Shares--Dividends, Other Distributions and Rights."
OTHER BRAZILIAN TAXES
There are no Brazilian inheritance, gift or succession taxes applicable to
the ownership, transfer or disposition of Preferred Shares or ADSs by a non-
Brazilian holder except for gift and inheritance taxes levied by some States
in Brazil on gifts made or inheritances bestowed by individuals or entities
not resident or domiciled in Brazil in the relevant State to individuals or
entities that are resident or domiciled in the relevant State in Brazil. There
are no Brazilian stamp, issue, registration, or similar taxes or duties
payable by holders of Preferred Shares or ADSs.
Pursuant to Decree 2,219, dated May 2, 1997, a financial transaction tax
(the "IOF") may be imposed on the conversion into Brazilian currency of the
proceeds of a foreign investment in Brazil (including investments in Preferred
Shares and ADSs and investments made under the Annex IV Regulations) and may
also be imposed upon the conversion of Brazilian currency into foreign
currency (e.g., for purposes of paying dividends and interest). The IOF tax
rate is currently 0%. Although the Minister of Finance has the legal power to
increase the rate to a maximum of 25%, any such increase will be applicable
only to transactions occurring after such increase becomes effective.
On January 24, 1997, a temporary tax was enacted. The Contribuicao
Provisoria sobre Movimentacao Financeira ("CPMF Tax"), which was created by
Constitutional Amendment No. 12 of August 16, 1996 and regulated by Law No.
9,311 of October 24, 1996, is levied on debits on bank accounts and certain
other payments made by a bank at a rate of 0.2%, which may be raised at any
time to 0.25%. The CPMF Tax was initially scheduled to be collected until
February 22, 1998; the CPMF Tax was subsequently extended until January 27,
1999 by Law No. 9,539 of December 12, 1997.
REGISTERED CAPITAL
The amount of an investment in Preferred Shares held by a non-Brazilian
holder who qualifies under the Annex IV Regulations and obtains registration
with the CVM, or by the Depositary representing such holder, is eligible for
registration with the Central Bank of Brazil; such registration (the amount so
registered is referred to as "Registered Capital") allows the remittance
outside Brazil of foreign currency, converted at the Commercial Market Rate,
acquired with the proceeds of distributions on, and amounts realized with
respect to disposition of, Preferred Shares. The Registered Capital for each
Preferred Share purchased in the form of an ADS, or purchased in Brazil, and
deposited with the Depositary in exchange for an ADS, will be equal to its
purchase price (in U.S. dollars). The Registered Capital for a Preferred Share
that is withdrawn upon surrender of an ADS will be the U.S. dollar equivalent
of (i) the average price of the Preferred Share on the Brazilian stock
exchange on which the greatest number of Preferred Shares was sold on the day
of withdrawal, or (ii) if no Preferred Shares were sold on that day, the
average price on the Brazilian stock exchange on which the greatest number of
Preferred Shares were sold in the fifteen trading sessions immediately
preceding such withdrawal. The U.S. dollar value of the Preferred Shares is
determined on the basis of the average Commercial Market Rates quoted by the
Central Bank of Brazil on such date (or, if the average price of Preferred
Shares is determined under clause (ii) of the
41
<PAGE>
preceding sentence, the average of such average quoted rates on the same
fifteen dates used to determine the average price of the Preferred Shares).
A non-Brazilian holder of Preferred Shares may experience delays in
effecting such registration, which may delay remittances abroad. Such a delay
may adversely affect the amount, in U.S. dollars, received by the non-
Brazilian holder.
U.S. FEDERAL INCOME TAX CONSIDERATIONS
The statements regarding U.S. tax law set forth below are based on U.S. law
as in force on the date of this Registration Statement, and changes to such
law subsequent to the date of this Registration Statement may affect the tax
consequences described herein. This summary describes the principal tax
consequences of the ownership and disposition of Preferred Shares or ADSs, but
it does not purport to be a comprehensive description of all of the tax
consequences that may be relevant to a decision to hold or dispose of
Preferred Shares or ADSs. This summary applies only to purchasers of Preferred
Shares or ADSs who will hold the Preferred Shares or ADSs as capital assets
and does not apply to special classes of holders such as dealers in securities
or currencies, holders whose functional currency is not the U.S. dollar,
holders of 10% or more of the shares of the Registrant, tax-exempt
organizations, financial institutions, holders liable for the alternative
minimum tax, securities traders who elect to account for their investment in
Preferred Shares or ADSs on a mark-to-market basis, and persons holding
Preferred Shares or ADSs in a hedging transaction or as part of a straddle or
conversion transaction.
Each holder should consult such holder's own tax advisor concerning the
overall tax consequences to it, including the consequences under foreign,
state and local laws, of an investment in Preferred Shares or ADSs.
In this discussion, references to "ADSs" also refer to Preferred Shares,
references to a "U.S. holder" are to a holder of an ADS (i) that is a citizen
or resident of the United States of America, (ii) that is a corporation
organized under the laws of the United States of America or any state thereof,
or (iii) that is otherwise subject to U.S. federal income taxation on a net
basis with respect to the ADS.
For purposes of the U.S. Internal Revenue Code of 1986, as amended (the
"Code"), holders of ADRs will be treated as owners of the ADSs represented by
such ADRs.
TAXATION OF DIVIDENDS
A U.S. holder will recognize ordinary dividend income for U.S. federal
income tax purposes in an amount equal to the amount of any cash and the value
of any property distributed by the Registrant as a dividend to the extent that
such distribution is paid out of the Registrant's current or accumulated
earnings and profits ("e&p"), as determined for U.S. federal income tax
purposes, when such distribution is received by the Custodian or by the U.S.
holder, in the case of a holder of Preferred Shares. To the extent that such a
distribution exceeds the Registrant's e&p, it will be treated as a non-taxable
return of capital, to the extent of the U.S. holder's tax basis in the ADS or
Preferred Shares, as the case may be, and thereafter as capital gain. The
amount of any distribution will include the amount of Brazilian tax withheld
on the amount distributed and the amount of a distribution paid in reais will
be measured by reference to the exchange rate for converting reais into U.S.
dollars in effect on the date the distribution is received by the Custodian.
If the Custodian or U.S. holder, in the case of a holder of Preferred Shares,
does not convert such reais into U.S. dollars on the date it receives them, it
is possible that the U.S. holder will recognize foreign currency loss or gain,
which would be ordinary loss or gain, when the reais are converted into U.S.
dollars. Dividends paid by the Registrant will not be eligible for the
dividends received deduction allowed to corporations under the Code.
Distributions out of e&p with respect to the ADSs generally will be treated
as dividend income from sources outside of the United States and generally
will be treated separately along with other items of "passive" (or, in the
case of certain U.S. holders, "financial services") income for purposes of
determining the credit for foreign income taxes allowed under the Code.
Subject to certain limitations, the Brazilian withholding tax paid in
42
<PAGE>
connection with any distribution with respect to the ADSs may be claimed as a
credit against the U.S. federal income tax liability of a U.S. holder if such
U.S. holder elects for that year to credit all foreign income taxes, or such
Brazilian withholding tax may be taken as a deduction. Under new rules enacted
by Congress in 1997 and other guidance recently released by the U.S. Treasury,
foreign tax credits will not be allowed for withholding taxes imposed in
respect of certain short-term or hedged positions in securities or in respect
of arrangements in which a U.S. holder's expected economic profit, after non-
U.S. taxes, is insubstantial. U.S. holders should consult their own tax
advisors concerning the implications of these rules in light of their
particular circumstances.
Distributions of additional shares to holders with respect to their ADSs
that are made as part of a pro rata distribution to all shareholders of the
Registrant generally will not be subject to U.S. federal income tax.
A holder of an ADS that is a foreign corporation or non-resident alien
individual (a "non-U.S. holder") generally will not be subject to U.S. federal
income tax or withholding tax on distributions with respect to ADSs that are
treated as dividend income for U.S. federal income tax purposes, and generally
will not be subject to U.S. federal income tax or withholding tax on
distributions with respect to ADSs that are treated as capital gain for U.S.
federal income tax purposes unless such holder would be subject to U.S.
federal income tax on gain realized on the sale or other disposition of ADSs,
as discussed below.
TAXATION OF CAPITAL GAINS
Upon the sale or other disposition of an ADS, a U.S. holder will recognize
gain or loss for U.S. federal income tax purposes in an amount equal to the
difference between the amount realized in consideration for the disposition of
the ADS (excluding the amount of any distribution paid to the Custodian but
not distributed by the Custodian prior to the disposition) and the U.S.
holder's tax basis in the ADS. Such gain or loss generally will be subject to
U.S. federal income tax and will be treated as capital gain or loss. Under
recently enacted legislation, long-term capital gains recognized by an
individual holder generally are subject to a maximum rate of 20 percent in
respect of property held for more than one year, effective for amounts
properly taken into account on or after January 1, 1998. The deductibility of
capital losses is subject to certain limitations. Gain realized by a U.S.
holder on a sale or disposition of ADSs generally will be treated as U.S.
source income. Consequently, in the case of a disposition of Preferred Shares
in Brazil (which, unlike a disposition of ADSs, would be taxable in Brazil),
the U.S. holder might not be able to use the foreign tax credit for Brazilian
tax imposed on gain.
A non-U.S. holder will not be subject to U.S. federal income tax or
withholding tax on gain realized on the sale or other disposition of an ADS
unless (i) such gain is effectively connected with the conduct by the holder
of a trade or business in the United States, or (ii) such holder is an
individual who is present in the United States of America for 183 days or more
in the taxable year of the sale and certain other conditions are met.
U.S. BACKUP WITHHOLDING AND INFORMATION REPORTING
The information reporting requirements of the Code generally will apply to
distributions to a U.S. holder. Distributions to non-U.S. holders generally
will be exempt from information reporting and backup withholding under current
law but a non-U.S. holder may be required to establish its non-U.S. status in
order to claim such exemption.
ITEM 8: SELECTED FINANCIAL DATA
GENERAL
The following table presents selected combined financial information for the
Company as of and for the periods indicated. The information as of December
31, 1996 and 1997 and for the three-year period ended December 31, 1997 is
derived from and should be read in conjunction with, and is qualified in its
entirety by reference to, the Consolidated Financial Statements and the Notes
thereto included elsewhere in this Registration Statement. These Consolidated
Financial Statements have been audited by KPMG Peat Marwick, independent
43
<PAGE>
auditors, and their report on such Consolidated Financial Statements appears
elsewhere in this Registration Statement. The Consolidated Financial
Statements are prepared in accordance with Brazilian GAAP, which differ in
certain material respects from generally accepted accounting principles in the
United States ("U.S. GAAP"). See Note 29 to the Consolidated Financial
Statements for a summary of the differences between Brazilian GAAP and U.S.
GAAP as of and for the years ended December 31, 1996 and 1997. All other
selected consolidated financial information has been derived from the
Company's accounting records.
The Financial Statements present the financial condition and results of
operations of the Registrant and the Subsidiaries. The portion of the
consolidated equity and net income of the Subsidiaries attributable to
shareholders of the Subsidiaries other than Telebras at December 31, 1996 and
1997, and for each of the years in the three-year period ended December 31,
1997 is reflected as "minority interests" in the Consolidated Financial
Statements. At December 31, 1997, such minority shareholders directly and
indirectly owned the percentages of share capital in the Subsidiaries shown in
"Presentation of Financial Information."
The Consolidated Financial Statements present the fixed-line
telecommunications business of the Subsidiaries as continuing operations and
the cellular telephone business as discontinued operations for all periods.
The assets and liabilities of the cellular telephone business are presented as
net assets of discontinued operations.
The separation of the fixed and cellular telecommunications businesses has
been accounted as a reorganization of entities under common control in a
manner similar to a pooling of interests. The assets and liabilities of the
cellular telephone business were transferred from the Subsidiaries at their
indexed historical cost. The Consolidated Financial Statements are not
necessarily indicative of the financial position and results of operations
that would have occurred for the three-year period ended December 31, 1997 had
the fixed-line telecommunications businesses of the Subsidiaries been separate
legal entities during such period. See "Description of Business--Background,"
"--The Company" and Notes 1, 2 and 28 to the Consolidated Financial
Statements.
Prior to December 31, 1997 cash and certain nonspecific debt of the cellular
telecommunications business could not be segregated from the Subsidiaries.
Accordingly, these amounts are included in the financial statements for
periods ended before January 1, 1998. As a result, certain interest income and
expense relating to the cellular telecommunications business could not be
identified and, consequently, income from discontinued operations is presented
before unallocated interest income (expense) and income tax expense. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Results of Operations for the years ended December 31, 1995, 1996
and 1997--Allocated and unallocated interest expense and unallocated interest
income."
Certain of the constant real-denominated information herein has been
translated into U.S. dollars using the December 31, 1997 Commercial Market
Rate published by the Central Bank of Brazil of R$1.1164 to US$1.00. These
translations are presented solely for the convenience of the reader and should
not be construed as implying that local currency amounts represent, or could
have been, or could be, converted into U.S. dollars at such rates or any rate.
The Consolidated Financial Statements and, unless otherwise specified, all
financial information included in this Registration Statement, have been
restated to recognize certain effects of inflation and expressed in constant
reais of December 31, 1997 purchasing power. Such restatement has been
effected in accordance with Brazilian GAAP using the integral restatement
method (correcao integral) required by the CVM to be used for Consolidated
Financial Statements of public corporations through December 31, 1995.
Inflationary gains or losses on monetary assets and liabilities have been
allocated to their corresponding income or expense caption in the income
statement. Inflationary gains or losses without a corresponding income or
expense caption have been allocated to other net operating income. See Note 2a
to the Consolidated Financial Statements.
Until December 31, 1995, the relevant inflation index selected by the CVM
and the one used for the constant currency method under Brazilian GAAP was the
UFIR. Effective January 1, 1996, the CVM no longer requires
44
<PAGE>
Brazilian companies to restate their financial statements for reporting
purposes is constant currency by indexing historical amounts using the UFIR.
Restatement in constant currency is now optional and any general price index
may be used. The Brazilian Institute of Accountants has recommended that the
IGP-M be used for this purpose. The Company's management believes that the
IGP-M is the most appropriate measure of the general price inflation in Brazil
and has elected the IGP-M for purposes of preparing its combined financial
statements in accordance with the constant currency method as of January 1,
1996.
In July 1997, the three-year cumulative inflation rate for Brazil fell below
100%; however, for accounting purposes, the constant currency method has
continued to be applied. The Brazilian Institute of Accountants has not yet
published definitive rules regarding when the constant currency method of
accounting may no longer be used to prepare Consolidated Financial Statements.
If the Brazilian Institute of Accountants determines that the constant
currency method may no longer be used to prepare Consolidated Financial
Statements beginning January 1, 1998, the restated balances of nonmonetary
assets and liabilities of the Company as of December 31, 1997 will become the
new basis for accounting, and income statement items will no longer be
restated for inflation.
45
<PAGE>
SELECTED COMBINED FINANCIAL INFORMATION
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------------------------------------------
1993 1994 1995 1996 1997 1997
---------- ---------- ---------- ---------- ---------- ----------------
(IN THOUSANDS
(IN THOUSANDS OF CONSTANT OF U.S. DOLLARS,
REAIS OF DECEMBER 31, 1997, EXCEPT PER
EXCEPT PER SHARE DATA) SHARE DATA(1))
<S> <C> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Brazilian GAAP
Net operating revenue
from telecommunications
services............... 2,902,409 3,162,602 3,242,678 4,273,806 4,959,293 4,442,219
Cost of services........ (1,676,270) (1,992,682) (2,109,617) (2,343,600) (2,571,352) (2,303,253)
---------- ---------- ---------- ---------- ---------- ----------
Gross profit............ 1,226,139 1,169,920 1,133,061 1,930,206 2,387,941 2,138,966
Operating expenses...... (769,886) (1,033,951) (827,000) (1,018,653) (1,111,880) (995,951)
---------- ---------- ---------- ---------- ---------- ----------
Operating income from
continuing operations
before interest income
(expense).............. 456,253 135,969 306,061 911,553 1,276,061 1,143,015
Allocated interest
expense(2)............. -- -- (58,525) (61,780) (46,263) (41,439)
---------- ---------- ---------- ---------- ---------- ----------
Operating income from
continuing operations
before unallocated
interest income
(expense)(2)(3)(4)..... 456,253 135,969 247,536 849,773 1,229,798 1,101,576
Net non-operating income
(expense).............. (2,791) 6,844 (22,594) (10,239) (60,089) (53,824)
Employees' profit
share.................. (3,383) (1,372) (9,221) (30,197) (60,429) (54,128)
---------- ---------- ---------- ---------- ---------- ----------
Income from continuing
operations before
unallocated interest
income (expense), taxes
and minority
interests.............. 450,079 141,441 215,721 809,337 1,109,280 993,624
---------- ---------- ---------- ---------- ---------- ----------
Income from discontinued
cellular operations
before unallocated
interest income
(expense), taxes and
minority
interests(2)(3)(4)..... -- -- 316,876 679,409 788,790 706,548
Unallocated interest
income(2)(3)(4)........ 72,484 60,870 51,836 45,373 126,554 113,359
Unallocated interest
expense(2)(3)(4)....... (469,097) (102,615) (119,368) (121,374) (128,544) (115,141)
---------- ---------- ---------- ---------- ---------- ----------
Income before taxes and
minority interests..... 53,466 99,696 465,065 1,412,745 1,896,080 1,698,390
Income and social
contribution taxes..... 251,301 (23,865) (274,414) (386,464) (484,844) (434,292)
---------- ---------- ---------- ---------- ---------- ----------
Income before minority
interests.............. 304,767 75,831 190,651 1,026,281 1,411,236 1,264,098
Minority interests(5)... (35,328) (9,461) (18,249) (152,316) (312,351) (279,784)
---------- ---------- ---------- ---------- ---------- ----------
Net income.............. 269,439 66,370 172,402 873,965 1,098,885 984,314
========== ========== ========== ========== ========== ==========
U.S. GAAP:
Income from continuing operations before unallocated
interest income (expense), taxes and minority interests
........................................................ 1,032,275 1,231,777 1,103,347
Income from discontinued operations before unallocated
interest income (expense), taxes and minority interests
........................................................ 703,701 817,998 732,710
Net income............................................... 954,403 1,232,264 1,103,783
Net income per thousand shares:
Common shares--Basic(6).................................. 2.98 3.84 3.44
Common shares--Diluted(6)................................ 2.63 3.65 3.26
Preferred shares--Basic(6)............................... 2.98 3.84 3.44
Preferred shares--Diluted(6)............................. 2.63 3.65 3.26
BALANCE SHEET DATA:
Brazilian GAAP
Property, plant and
equipment, net......... 10,372,948 10,380,566 10,924,227 11,944,570 13,282,386 11,897,515
Total assets............ 11,425,700 11,859,291 12,651,244 14,745,909 16,635,800 14,901,291
Loans and financing--
Current portion........ 939,525 768,604 1,021,590 674,924 743,591 666,061
Loans and financing--Non
current portion........ 958,512 1,033,493 745,062 900,483 879,962 788,214
Shareholders' equity.... 7,697,509 6,889,480 7,765,262 8,625,148 9,486,508 8,497,410
U.S. GAAP
Property, plant and equipment, net....................... 11,925,910 13,159,191 11,787,165
Total assets............................................. 14,833,691 16,672,462 14,934,129
Loans and financing--Current portion..................... 610,316 680,264 609,337
Loans and financing--Non current portion................. 900,483 837,422 750,109
Shareholders' equity..................................... 9,444,782 9,793,419 8,772,321
</TABLE>
<TABLE>
<CAPTION>
MAY 22,
1998
----------------
(IN THOUSANDS OF
NEW HOLDING COMPANY--BRAZILIAN GAAP SHAREHOLDERS' EQUITY(7): CONSTANT REAIS)
<S> <C>
Share capital................................................. 3,741,151
Income reserves............................................... 3,113,932
Retained earnings............................................. 3,188,998
----------
Total Shareholders equity................................... 10,044,081
==========
</TABLE>
46
<PAGE>
- --------
(1) The translation of Brazilian real amounts into U.S. dollar amounts is
unaudited and included solely for the convenience of readers outside of
Brazil and has been performed using the closing selling exchange rate
published by the Central Bank of Brazil of R$1.1164 to US$1.00 as of
December 31, 1997. This translation should not be construed as a
representation that Brazilian real amounts could be converted to US
dollars at this or any other rate.
(2) Allocated interest expense represents interest expense attributable to
continuing operations. As discussed in note 3 below, as the Company is
unable to present cellular operations as discontinued operations for 1993
and 1994, total interest income and expense has been presented as
unallocated.
(3) The Company is unable to present cellular operations as discontinued
operations for 1993 and 1994. Accordingly, cellular operations results for
1993 and 1994 are included in "Operating income from continuing
operations."
(4) Unallocated interest income and expense represents interest income and
expense that could not be allocated between continuing and discontinued
operations.
(5) Minority interests represent the portion of net income attributable to
shareholders other than Telebras.
(6) Reflects net income per thousand shares of the Registrant. The Registrant
was not formed until subsequent to December 31, 1997. Accordingly, the
equity structure utilized for the earnings per share computations is that
of the Registrant as of May 22, 1998 (the date of its formation). At the
date of formation, the Registrant had 124,351,903 thousand Common Shares
(net of 17,128 thousand common shares in treasury) and 196,311,647
thousand preferred shares outstanding (exclusive of 13,718,350 thousand
preferred shares resulting from the settlement in April 1998 with
Telebras). See Note 29(e) to the Consolidated Financial Statements.
In February 1997, the Financial Accounting Standards Board issued SFAS No.
128 "Earnings Per Share." This new statement became effective for
financial statements for periods ending after December 15, 1997, and
provides computation, presentation and disclosure requirements for
earnings per share.
Since the preferred and common stockholders have different dividend,
voting and liquidation rights, Basic and Diluted earnings per share have
been calculated using the "two-class" method. The "two-class" method is an
earnings allocations formula that determines earnings per share for
preferred and common stock according to the dividends to be paid as
required by the Company's by-laws and participation rights in
undistributed earnings. Basic earnings per share is computed by dividing
income available to common and preferred shareholders, respectively, by
the weighted-average number of common and preferred shares outstanding
during the period. The weighted-average number of common and preferred
shares used in computing basic earnings per share for 1997 was 124,351,903
thousand and 196,311,647 thousand, respectively.
As explained in Note 23 to the Consolidated Financial Statements the
Company has received expansion plan contributions from companies and
individuals wishing to be connected to the national telephone network. It
has also sponsored Community Expansion Plan agreements. These activities
are dilutive in nature to the Shareholders of the Registrant, whether the
shares to be issued are those of the Subsidiaries (which will impact the
minority interest recognized) or of the Registrant itself. If
Subsidiaries' shares had been issued historically, the reduction to net
income to increase net earnings allocated to minority shareholders for
1996 and 1997 would have been approximately $89,666 thousand and $54,286
thousand, respectively. Earnings per share has been presented for net
income only since interest income, certain interest expense and social
contribution taxes have not been allocated between income from continuing
operations and income from discontinued operations.
(7) On May 22, 1998 the shareholders of Telebras approved Telebras' division
into the New Holding Companies, whereby existing shareholders received
shares in the New Holding Companies in proportion to their holdings in
Telebras. In addition to approving the allocation of assets and
liabilities to the New Holding Companies at the May 22, 1998 meeting, the
shareholders also approved a specific structure for the shareholders'
equity of each New Holding Company which included an allocation of a
portion of the retained earnings of Telebras. Consequently, the amounts of
the balances of capital, reserves and retained earnings were established.
For US GAAP purposes, the "retained earnings" allocated from Telebras
would be referred to as Distributable Capital as this amount represents
capital allocated from Telebras. See Note 28 to the Consolidated Financial
Statements.
47
<PAGE>
ITEM 9: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion of the financial condition and results of
operations of the Company for the years ended December 31, 1995, 1996 and 1997
should be read in conjunction with the Consolidated Financial Statements of
the Company and the Notes thereto included elsewhere in this Registration
Statement. The Consolidated Financial Statements have been prepared in
accordance with Brazilian GAAP, which differs in certain significant respects
from U.S. GAAP. Note 29 to the Consolidated Financial Statements provides a
description of the principal differences between U.S. GAAP and Brazilian GAAP
as they relate to the Company, and a reconciliation to U.S. GAAP of net income
for the two years ended December 31, 1996 and 1997 and total shareholders'
equity as of December 31, 1996 and 1997.
FORMATION OF THE REGISTRANT AND PRESENTATION OF FINANCIAL INFORMATION
On May 22, 1998, in preparation for the privatization of the Telebras
System, the Telebras System was restructured to form, in addition to Telebras,
the twelve New Holding Companies. The restructuring of the Telebras System was
accomplished by means of a procedure under Brazilian law called cisao or
"split-up". Virtually all the assets and liabilities of Telebras were
allocated to the New Holding Companies which, together with their respective
subsidiaries, comprise (a) three regional fixed-line operators, (b) eight
regional cellular operators and (c) one domestic and international long-
distance operator. The Registrant is one of the New Holding Companies that was
formed on May 22, 1998 as part of the Breakup of Telebras. In the Breakup,
certain assets and liabilities of Telebras, including all of the share capital
in the Subsidiaries held by Telebras were transferred to the Registrant.
At the May 22, 1998 Telebras shareholders' meeting, the shareholders also
approved a specific structure for the shareholders' equity of each New Holding
Company, which included an allocation of a portion of the retained earnings of
Telebras. In this manner, the balances of capital, reserves and retained
earnings, together with the corresponding assets and liabilities, for the
formation of Tele Norte Leste Participacoes S.A. were established. Telebras
retained within its own shareholders equity sufficient retained earnings from
which to pay certain dividends and other amounts. Telebras allocated to each
New Holding Company, the balance of its retained earnings in proportion to the
total net assets allocated to each such Company. This value of allocated
retained earnings does not represent the historical retained earnings of the
New Holding Companies and resulted in an increase of R$1,906,669,000 in
relation to the Company's historical retained earnings. See Note 28 of the
Consolidated Financial Statements. Allocated retained earnings and future
retained earnings will be the basis from which future dividends will be
payable.
The Consolidated Financial Statements present the financial condition and
results of operations of the Registrant and its Subsidiaries. The portion of
the equity and net income of the Subsidiaries attributable to shareholders of
the Subsidiaries other than Telebras at December 31, 1996 and 1997, and for
each of the years in the three-year period ended December 31, 1997 is
reflected as "minority interests" in the Consolidated Financial Statements. At
December 31, 1997, such minority shareholders directly and indirectly owned
the percentages of the share capital of the Subsidiaries shown in
"Presentation of Information."
The Consolidated Financial Statements present the fixed-line
telecommunications business of the Subsidiaries as continuing operations and
the cellular telephone business as discontinued operations for all periods.
The assets and liabilities of the cellular telephone business are presented as
net assets of discontinued operations.
The separation of the fixed and cellular telecommunications businesses has
been accounted as a reorganization of entities under common control in a
manner similar to a pooling of interests. The assets and liabilities of the
cellular telephone business were transferred from the Subsidiaries at their
indexed historical cost. The Consolidated Financial Statements are not
necessarily indicative of the financial position and results of operations
that would have occurred for the three-year period ended December 31, 1997 had
the fixed-line telecommunications businesses of the Subsidiaries been separate
legal entities during such periods. See
48
<PAGE>
"Description of Business--Background," "--The Company" and Notes 1, 2 and 28
to the Consolidated Financial Statements.
Prior to December 31, 1997 cash and certain non-specific debt of the
cellular telecommunications business could not be segregated from the
Subsidiaries. Accordingly, these amounts are included in the consolidated
financial statements for periods ended before January 1, 1998. As a result,
certain interest income and expense relating to the cellular
telecommunications business could not be identified and, consequently, income
from discontinued operations is presented before unallocated interest income
(expense) and income tax expense.
In connection with the formation of the Registrant, certain assets of
Telebras in addition to its interests in the Subsidiaries were spun off to the
Registrant. The principal such assets were loans receivable and advances for
capital increase received from the operating subsidiaries, cash and other
current assets. See Note 28 to the Consolidated Financial Statements, which
includes a balance sheet of the Registrant reflecting all the assets and
liabilities of the Registrant as of February 28, 1998. A substantial amount of
such assets (principally investment in subsidiaries) is eliminated upon
consolidation.
EFFECTS OF INFLATION
In accordance with Brazilian GAAP, the Consolidated Financial Statements
recognize certain effects of inflation and restate data from prior periods in
constant reais of December 31, 1997 purchasing power. Such restatement has
been effected using the integral restatement method (correcao integral), which
was required by the CVM to be used for financial statements of public
corporations through December 31, 1995. In periods of inflation, monetary
assets generate inflationary loss and monetary liabilities generate
inflationary gain, due to the decline in purchasing power of the currency. In
the Consolidated Financial Statements, inflationary gains or losses on
monetary assets and liabilities have been allocated to their corresponding
income or expense captions in the income statement. Inflationary gains or
losses without a corresponding income or expense caption have been allocated
to other net operating income. See Note 2a to the Consolidated Financial
Statements.
Until December 31, 1995, the relevant inflation index selected by the CVM
and the one used for the constant currency method under Brazilian GAAP was the
UFIR. Effective January 1, 1996, the CVM no longer requires Brazilian
companies to restate their financial statements for reporting purposes in
constant currency by indexing historical amounts using the UFIR. Restatement
in constant currency is now optional and any general price index may be used.
The Brazilian Institute of Accountants has recommended that the IGP-M be used
for this purpose. The Company's management believes that the IGP-M is the most
appropriate measure of the general price inflation in Brazil and has elected
the IGP-M for purposes of preparing its consolidated financial statements in
accordance with the constant currency method as of January 1, 1996.
In July 1997, the three-year cumulative inflation rate for Brazil fell below
100%; however, for accounting purposes, the constant currency method has
continued to be applied. The Brazilian Institute of Accountants has not yet
published definitive rules regarding when the constant currency method of
accounting may no longer be used to prepare financial statements. If the
Brazilian Institute of Accountants determines that the constant currency
method may no longer be used to prepare financial statements beginning January
1, 1998, the restated balances of nonmonetary assets and liabilities of the
Company as of December 31, 1997 will become the new basis for accounting, and
income statement items will no longer be restated for inflation. See "Selected
Financial Data."
Because financial information for the Company is presented in constant
currency, reported revenues reflect average real rates (i.e., nominal rates as
restated in constant currency in accordance with variations in the applicable
index) rather than nominal rates. Inflation results in decreases in real rates
to the extent that nominal rate increases fail to keep pace with the rate of
inflation. See "Description of Business--Rates."
POLITICAL, ECONOMIC, REGULATORY AND COMPETITIVE CONSIDERATIONS
The following discussion should be read in conjunction with the "Description
of Business" section included elsewhere in this Registration Statement. As set
forth in greater detail below, the Company's financial condition and results
of operations are significantly affected by Brazilian telecommunications
regulation, including regulation of tariffs. See "Description of Business--
Regulation of the Brazilian Telecommunications
49
<PAGE>
Industry." The Company's financial condition and results of operations also
have been, and are expected to continue to be, affected by the political and
economic environment in Brazil. See "'Description of Business-- condition and
results of operations are significantly affected by Brazilian
telecommunications regulation, including regulation of tariffs. See
"Description of Business--Regulation of the Brazilian Telecommunications
Industry." The Company's financial condition and results of operations also
have been, and are expected to continue to be, affected by the political and
economic environment in Brazil. See "'Description of Business-- Brazilian
Political Environment" and "--Brazilian Economic Environment." In particular,
the Company's financial performance will be affected by (i) national economic
growth and its impact on demand for telecommunications services, (ii) the cost
and availability of financing and (iii) the exchange rates between Brazilian
and foreign currencies. In addition, the Presidential and Congressional
elections to be held in October 1998 could have a significant impact on
whether the economic stabilization and liberalization policies of the current
administration can or will be sustained following the elections.
In April and May 1997, a tariff rebalancing was implemented pursuant to
which certain rates were adjusted and the percentage of revenues retained by
the fixed-line companies for domestic and international long-distance calls
pursuant to the division of revenues system in place prior to April 1998 was
lowered. The principal rate increases occurred with respect to monthly
subscription charges and local measured service charges. These increases were
partially offset by a decrease in domestic long-distance and international
long-distance rates. The monthly subscription charge increased from R$3.73 to
R$13.82 and the local measured service charge increased from R$0.05 per pulse
to R$0.08 per pulse. Average domestic long-distance and international long-
distance rates were reduced by approximately 16.7% and 17%, respectively. If
the tariff rebalancing had been effective as of January 1, 1997, the
composition of the Company's net operating revenues would have been
significantly affected and its total net operating revenues may have been
higher. Pro forma information reflecting the April and May 1997 rate changes
as if they had been in effect from January 1, 1997 has not been presented
because management believes that it is not possible to quantify with any
reasonable degree of certainty the influence on the volume of telephone use
that would have been caused by such changes in the first quarter of 1997.
Until April 1, 1998, revenues for fixed-line domestic and international
long-distance calls were divided between Embratel and the regional fixed-line
companies. Under this system, the Company and each regional fixed-line company
billed its customers for all domestic and international long-distance
telephone calls and retained a fixed percentage of the revenue, transferring
the remainder of the revenue to Embratel. The fixed percentage varied by
regional fixed-line company. As of March 31, 1998, the regional fixed-line
companies transferred an average of 33% of the total revenue for such calls to
Embratel.
As part of the liberalization of the Brazilian telecommunications sector,
this revenue-sharing system was eliminated as of April 1, 1998. Under the new
system, Embratel receives 100% of the revenues from domestic and international
long-distance calls that it carries but must pay certain per-minute
interconnection charges to the Company and the other regional fixed-line
companies for connection to and use of their networks. In addition, until June
30, 2001, Embratel must pay a supplemental per-minute charge for such
interconnection, the Parcela Adicional Temporaria (the "PAT"). The Company
does not expect that implementation of this new system will have a material
impact on its net income. However, it is expected that the allocation to
Embratel of 100% of the revenues generated by fixed-line domestic and
international long-distance calls that it carries will cause certain operating
revenues to decrease. This decrease is expected to be offset by increased
revenues resulting from the network usage charges and PAT paid to the Company
by Embratel.
Following the privatization of the telecommunications sector and, provided
that the obligations of the General Plans on Universal Service and Quality of
Service are met, the Company, currently the exclusive provider of local and
intra-state intra-regional long-distance service in the region, will be
authorized to offer interstate intra-regional long-distance service, which
represents a significant expansion of the services the company may offer, and
the company will face competition. Embratel and a new operator will be
authorized to provide local service beginning December 31, 2003 and December
31, 2002, respectively. Embratel will also be authorized to provide intra-
state, inter-regional long-distance service and two new licenses will be
granted to up
50
<PAGE>
to two new entrants to provide intra-regional long-distance service. Beginning
in 2002, the Company may face an unlimited number of competitors in local and
intra-regional long-distance, and it may itself seek a license to provide
interregional and international long-distance service. The Company anticipates
that, as a consequence of the competition, rates may decline. The exact
identity of new entrants, the scope of increased competition and any adverse
effects on the Company's results and market share will depend on a variety of
factors that cannot now be assessed with precision and that are beyond the
Company's control. See "Description of Business--Competition."
FOREIGN EXCHANGE AND INTEREST RATE EXPOSURE
The Company's financial condition and results of operations may be affected
by changes in foreign currency exchange rates (primarily the U.S. dollar/real
rate) and market rates of interest (primarily the London Interbank Offered
Rate (LIBOR) and medium-and long-term U.S. interest rates).
The principal foreign exchange risk faced by the Company arises from the
excess of interest-bearing foreign currency liabilities over foreign currency
income generating assets. At December 31, 1997, the Company had R$437.8
million of financial liabilities (primarily long-term bank debt) denominated
in foreign currencies (primarily U.S. dollars (65.7%). The Company's revenues
are earned almost entirely in reais and the Company has no material dollar-
denominated assets. During the three years ended December 31, 1997, any losses
arising from the devaluation of the real against the U.S. dollar were more
than offset by net inflationary gains on monetary assets and liabilities.
Should the Company cease using the constant currency method of accounting in
the future, such inflationary gains would no longer be recognized. The Company
does not hedge its foreign currency exposure and, accordingly, any decrease in
the value of the real relative to the dollar could have a material adverse
effect on the Company's results of operations.
The Company's consolidated financial condition and results of operations may
also be affected by changes in market rates of interest (primarily LIBOR). The
Company is exposed to interest rate risk as a consequence of its floating rate
debt and limited floating rate interest earning assets. At December 31, 1997,
88.2% of the Company's interest-bearing liabilities bore interest at floating
rates. The Company has not entered into derivative contracts or made other
arrangements to hedge against this risk. Accordingly, should market interest
rates rise (principally LIBOR), the Company's financing expenses will
increase.
YEAR 2000 COMPLIANCE
Year 2000 compliance is the ability of computer hardware and software to
respond to the problems posed by the fact that some computer programs have
traditionally used two digits rather than four to define the applicable year.
As a consequence, any of the Company's computer programs that have date-
sensitive software may recognize a date using "00" as the year 1900 rather
than 2000. This could result in a system failure or miscalculations causing
disruption of operations, including a temporary inability to process
transactions, send invoices or engage in normal business activities.
At the beginning of 1997, at the requirement of Telebras, the Company began
to address the year 2000 problem. The Company has identified the hardware and
software that could be affected by the year 2000 problem and is in the process
of identifying and addressing potential problems. Specifically, the Company
identified and diagnosed the year 2000 problem in all of the Company's 2,035
digital central switching centers (6.1 million of digital lines), has almost
completed an inventory of the Company's 26,600 terminals (including 13,700
microprocessors), and is in the process of diagnosis, after completing
identification, of the Company's 104,900 computer programs and 37 million
lines of code. Lines connected to analog switching centers are not affected by
the year 2000 problem.
The Company has organized its efforts in addressing the year 2000 problem
into the following areas of action: corporate systems, departmental systems,
information technology infrastructure, telecommunications and service
platforms and other automations. In respect of the telecommunications and
service platforms, the Company is in the process of correcting any identified
year 2000 problems in the telecommunications equipment
51
<PAGE>
and software primarily through products designed by suppliers. The Company is
testing and identifying any year 2000 problems in the engineering systems as
well as in areas of transmission, switching, data communication,
infrastructure and supervision systems. The Company expects to complete
necessary modifications to these systems by mid-1999.
The Company expects to contract third-party service providers who will work
together with Company employees to address the year 2000 problem. The Company
expects to use Company employees to contribute approximately 25% of the effort
necessary to achieve year 2000 compliance. The Company's information services
department will organize the Company's efforts, including the hiring of third
parties. The Company's systems department will adopt and implement the
technical solutions. Suppliers of switching equipment are providing new
software addressing the year 2000 problem. The Company estimates that to
achieve year 2000 compliance, the Company will spend approximately R$19.2
million on its information systems, including the hiring of third parties, and
approximately R$3.1 million on its telecommunications hardware and software.
This assumes an estimated cost of US$0.50 to update a terminal and US$0.70 to
update a line of code. Since the Company plans to have Company employees
contribute to the effort, the average cost per line decreases to US$0.52.
Although the Company expects its Subsidiaries to be year 2000 compliant by
June 1999, the Company is still in the process of identifying and evaluating
the year 2000 problem and can give no assurance that the business and
financial condition of the Company will not be materially affected.
The Company may also be affected by year 2000 problems to the extent that
other entities not affiliated with the Company, including government entities
and businesses, are unsuccessful in addressing this issue. The Company depends
primarily on large multinational suppliers for its telecommunications products
and computer services. The Company is in the process of obtaining guarantees
from its suppliers that their products and services are year 2000 compliant.
The majority of the Company's suppliers, however, have advised the Company
that they expect to be year 2000 compliant by September 1999. As of August 30,
1998, the Company had not determined its most probable worst case scenarios in
relation to the year 2000 problem and had not formulated contingency plans in
respect of such scenarios. However, the Company intends to determine such
scenarios and to formulate such contingency plans by December 1998.
CVM Instruction 276, which was issued on May 8, 1998, requires all Brazilian
publicly-held companies to have addressed the Year 2000 problem by December
31, 1998. Unless a discretionary extension is granted by the CVM, failure to
have addressed the Year 2000 problem by the CVM's deadline could result in the
imposition of fines of R$500 per day. On June 23, 1998, the Company requested
an extension of the deadline imposed by CVM Instruction 276 to September 1999.
The Company requested the extension on account of the operating subsidiary
Telerj. As of October 9, 1998, the CVM had not responded to the Company's
request.
52
<PAGE>
RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1995, 1996, AND 1997
The following table sets forth, for each of the years in the three-year
period ended December 31, 1997, certain components of the Company's net
income, the percentage of gross operating revenues represented by each
component and the percentage increase (decrease) thereof during the three-year
period.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, % CHANGE
------------------------------------------------------- -------------------------
1995 % 1996 % 1997 % 1995 V. 1996 1996 V. 1997
---------- ----- ---------- ----- ---------- ----- ------------ ------------
(IN THOUSANDS OF REAIS EXCEPT PERCENTAGES)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Gross operating
revenues:
Local services:
Monthly subscription
charges............... 232,705 5.5 451,829 8.1 893,525 14.1 94.2 97.8
Measured service
charges............... 724,489 17.2 1,184,479 21.3 1,404,289 22.1 63.5 18.6
Public telephones...... 101,656 2.4 185,004 3.3 263,105 4.1 82.0 42.2
Other.................. 300,818 7.1 463,230 8.3 574,394 9.0 54.0 24.0
---------- ----- ---------- ----- ---------- ----- ----- -----
Total................. 1,359,668 32.2 2,284,542 41.0 3,135,313 49.3 68.0 37.2
---------- ----- ---------- ----- ---------- ----- ----- -----
Non-local services:
Intra- and interstate.. 2,138,870 50.8 2,285,168 41.0 1,871,437 29.4 6.8 (18.1)
International.......... 224,646 5.3 211,520 3.8 155,086 2.5 (5.8) (26.7)
---------- ----- ---------- ----- ---------- ----- ----- -----
Total................. 2,363,516 56.1 2,496,688 44.8 2,026,523 31.9 5.6 (18.8)
---------- ----- ---------- ----- ---------- ----- ----- -----
Data transmission...... 157,896 3.8 198,865 3.5 164,346 2.6 25.9 (17.4)
Network services....... 298,387 7.1 558,319 10.0 999,380 15.7 87.1 79.0
Other.................. 32,201 0.8 38,765 0.7 34,628 0.5 20.4 (10.7)
---------- ----- ---------- ----- ---------- ----- ----- -----
Total gross operating
revenue................ 4,211,668 100.0 5,577,179 100.0 6,360,190 100.0 32.4 14.0
Value added and other
taxes................. (961,906) (22.8) (1,293,109) (23.2) (1,384,077) (21.8) 34.4 7.0
Discounts.............. (7,084) (0.2) (10,264) (0.2) (16,820) (0.3) 44.9 63.9
---------- ----- ---------- ----- ---------- ----- ----- -----
Net operating revenue... 3,242,678 77.0 4,273,806 76.6 4,959,293 78.0 31.8 16.0
---------- ----- ---------- ----- ---------- ----- ----- -----
Cost of services:
Depreciation and
amortization.......... (1,150,904) (27.3) (1,226,604) (22.0) (1,293,505) (20.3) 6.6 5.5
Personnel.............. (555,695) (13.2) (559,975) (10.0) (508,337) (8.0) 0.8 (9.2)
Materials.............. (72,604) (1.7) (80,688) (1.4) (71,307) (1.1) 11.1 (11.6)
Services............... (283,066) (6.7) (414,916) (7.4) (659,050) (10.4) 46.6 58.8
Other:
Rental fees............ (27,105) (2.0) (44,168) (1.9) (27,033) (0.9) 63.0 (38.8)
Network maintenance.... (20,243) (1.5) (17.249) (0.8) (12,120) (0.4) (14.8) (29.7)
---------- ----- ---------- ----- ---------- ----- ----- -----
Total cost of
services............. (2,109,617) (50.1) (2,343,600) (42.0) (2,571,352) (40.4) 11.1 9.7
Gross profit............ 1,133,061 26.9 1,930,206 34.6 2,387,941 37.5 70.4 23.7
Operating expenses:
Selling expense........ (297,306) (7.1) (382,718) (6.9) (544,060) (8.6) 28.7 42.2
General and
administrative
expense............... (715,407) (17.0) (827,894) (14.8) (816,487) (12.8) 15.7 (1.4)
Other net operating
income................ 185,713 4.4 191,959 3.4 248,667 3.9 3.4 29.5
Total operating
expenses............. (827,000) (19.6) (1,018,653) (18.8) (1,111,880) 17.5 23.2 9.2
---------- ----- ---------- ----- ---------- ----- ----- -----
Operating income before
interest .............. 306,061 7.3 911,553 16.3 1,276,061 20.1 197.8 40.0
Net nonoperating
expense................ (22,594) (10,239) (60,089)
Employees' profit
share.................. (9,221) (30,197) (60,429)
Income from discontinued
cellular operations
before interest, taxes
and minority
interests.............. 316,876 679,409 788,790
Unallocated interest
income................. 51,836 1.2 45,373 0.8 126,554 2.0 (12.5) 178.9
Allocated and
unallocated interest
expense(1)............. (177,893) (4.2) (183,154) (3.3) (174,807) (2.7) 3.0 (4.6)
---------- ----- ---------- ----- ---------- ----- ----- -----
Income before taxes and
minority interests..... 465,065 1,412,745 1,896,080
Income and social
contribution taxes..... (274,414) (386,464) (484,844)
---------- ---------- ----------
Income before minority
interests.............. 190,651 1,026,281 1,411,236
Minority interests...... (18,249) (152,316) (312,351)
---------- ---------- ----------
Net income.............. 172,402 873,965 1,098,885
========== ========== ==========
</TABLE>
- --------
(1) In the Consolidated Financial Statements, allocated and unallocated
interest expense are presented separately.
53
<PAGE>
GROSS OPERATING REVENUES
The Company generates operating revenue from (i) local services, including
monthly charges, measured service and public telephones, (ii) non-local
services which currently include intra-regional long-distance and
interregional long-distance and in the past included only intra-state long-
distance, interstate long-distance and international long-distance service,
(iii) network services, including interconnection and leasing high-capacity
lines, and (iv) other services. Operating revenues are offset by discounts to
customers and by value added and other taxes.
Gross operating revenues increased by 14.0% to R$6,360 million in 1997 from
R$5,577 million in 1996, which in turn represented a 32.4% increase from
R$4,212 million in 1995. The growth in revenues in the three-year period was
principally due to increases in the average number of lines in service,
increases in charges for local services and increased interconnection revenues
due to increased use of the Company's network by cellular companies. The
average number of lines in service increased by 13.7% to 5,912 thousand lines
in 1997 from 5,201 thousand lines in 1996, which in turn represented an 8.4%
increase from 4,799 thousand lines in 1995.
The structure of tariffs has changed substantially as part of a tariff
rebalancing process designed to eliminate cross-subsidies from long-distance
services to local services. Effective in May 1997, the rate structure was
modified through a tariff rebalancing that resulted in higher charges for
measured service and monthly subscription, and lower charges for long-distance
services. Effective in January 1996, rates for all services were increased in
nominal terms, primarily to compensate for accumulated effects of inflation,
with the largest increases for local rates.
Local services. Gross operating revenues from local services increased by
37.2% to R$3,135.3 million in 1997 from R$2,284.5 million in 1996, which in
turn represented a 68.0% increase from R$1,359.7 million in 1995. The increase
over the three-year period primarily reflects increased monthly subscription
revenues associated with increases in the number of lines in service and
tariff increases as well as increased measured service revenues associated
with tariff increases. These increases were partly offset in 1997 by a decline
in the overall volume of local calls.
Monthly subscription revenues increased by 97.8% to R$893.5 million in 1997
from R$451.8 million in 1996, which in turn represented an increase of 94.2%
from R$232.7 million in 1995. The monthly subscription charge increased
effective January 1, 1996 by 521.5% for residential customers, 80.6% for
nonresidential customers and 87.2% for customers using PBX systems. Effective
May 1, 1997 monthly subscription charges increased by a further 270.5% for
residential customers, 59.2% for nonresidential customers and 59.3% for
customers using PBX systems.
Measured service revenues increased by 18.6% to R$1,404.3 million in 1997
from R$1,184.5 million in 1996, which in turn represented a 63.5% increase
from R$724.5 million in 1995. The price per pulse also increased by 89.5%
effective January 29, 1996, and by 61.1% effective April 4, 1997. The increase
in measured service revenue from 1996 to 1997 due to the tariff increase was
partially offset by a slight decrease in overall local volume. Local volume
decreased by 0.6% to 23,905 million pulses in 1997 from 24,046 million pulses
in 1996, which in turn represented a 2.8% increase from 23,396 million pulses
in 1995. The growth reflects primarily increases in the number of lines in
service and tariff increases. Overall local volume decreased 0.6% in 1997
compared to 1996 largely due to higher tariffs, offsetting the increase in the
number of lines in service. Usage per line declined over the three-year period
due to tariff increases, with average annual pulses per line in service of
4,874, 4,623 and 4,044 in 1995, 1996 and 1997 respectively. Management does
not anticipate further large increases in local rates in the future.
Revenues from public telephones increased by 42.2% to R$263.1 million in
1997 from R$185.0 million in 1996, which in turn represented a 82.0% increase
from R$101.7 million in 1995. The increase over the three-year period was due
principally to growth of the public telephone network, growth in the number of
public telephones accepting pre-paid cards, which telephones experience usage,
and increases in tariffs for public telephone usage.
54
<PAGE>
Other revenues, primarily installation and line activation fees, increased
by 24.0% to R$574.4 million in 1997 from R$463.2 million in 1996, which in
turn represented an increase of 54.0% from R$300.8 million in 1995. The
increase over the three-year period reflected primarily an increase in the
number of lines in service. Fees paid by customers for installation and line
activation varied considerably during the period. Prior to April 1997, there
was no line installation charge; instead, customers requesting a line were
required to purchase shares in Telebras under a system called "auto-
financing". See "Business Description--Rates--Local Services.") The auto-
financing system was replaced in April 1997 with a flat installation charge.
Currently, all customers are charged R$50 for line installation.
Non-local services. Non-local services currently consist of intra-regional
long-distance calls and in the past consisted of intra-state long-distance,
interstate long-distance and international long-distance calls. For intra-
state long-distance calls, the Company carried the calls entirely over its own
network and received 100% of the call revenue. For interstate and
international long-distance calls, the Company delivered the calls to
Embratel, generally at a transit switching center, and Embratel transported
the call for the bulk of the call distance over its network. For such calls,
the Company billed the customer for the full retail price of the call and paid
a fixed percentage of the call revenue to Embratel. For accounting purposes,
the Company booked only its percentage of the revenue attributable to such
calls. The fixed percentage retained by the Company differed for each
Subsidiary. Consequently, the fixed percentage retained by the Company for
interstate and international calls is presented on a revenue- weighted average
basis. See "Business Description--Customer Services--Interregional and
International Service." Currently, the Company's sole revenue from
interregional and international long-distance calls is in the form of network
usage fees. The Company is now also authorized to offer interstate intra-
regional service, a significant expansion of the types and number of calls the
Company carries.
Gross revenues from non-local services decreased by 18.8% to R$2,026.5
million in 1997 from R$2,496.7 million in 1996, which in turn represented a
5.6% increase from R$2,363.5 million in 1995. The decline from 1996 to 1997
was largely due to reductions in tariffs for intra-state, interstate and
international long-distance calls, a reduction in the fixed percentage of
interstate and international long-distance call revenue retained by the
Company and a change in the billing structure for such calls where by calls
were billed in 6-second increments rather than whole-minute increments. The
decrease was offset in part by an 8.4% increase in the volume of intra-state
and interstate long-distance calls to 8,435 million minutes in 1997 from 7,783
million minutes in 1996 and by an 18.7% increase in the volume of
international long-distance calls to 141 million minutes in 1997 from 119
million minutes in 1996. The increase from 1995 to 1996 was due principally to
an increase in the number of intra-state and interstate long-distance minutes,
offset in part by reductions in tariffs for such calls and a decline in
international revenue due to tariff reductions.
Revenues from intra-state and interstate long-distance service decreased by
18.1% to R$1,871.4 million in 1997 from $2,285.2 million in 1996. The average
basic tariff for intra-state and interstate calls was reduced in May 1997 by
17.1% from R$0.30 to R$0.24 and the fixed percentage of interstate long-
distance revenue per call retained by the Company was reduced from 78.4% to
70.9%. These reductions were part of the tariff rebalancing process described
above. See "--Local services," and "Description of Business--Customer
Services--Interregional and International Service." Revenues from
international long distance service decreased by 26.7% to R$155.1 million in
1997 from R$211.5 million in 1996. The international tariffs charged by
Embratel were reduced by the Ministry in May 1997 by an average of 17% and the
fixed percentage of international long-distance revenues retained by the
Company was reduced from 79.1% to 68.3%, offsetting an increase in the number
of international minutes.
Revenues from intra-state and interstate long-distance service increased by
6.8% to R$2,285.2 million in 1996 from $2,138.9 million in 1995. Intra-state
and interstate minutes increased by 6.8% to 7,783 million minutes in 1996 from
7,290 million minutes in 1995. The average basic tariff for intra-state and
interstate calls remained stable in 1996 and the fixed percentage of
interstate long-distance revenue per call retained by the Company was reduced
from 84.8% to 78.4%. Revenues from international long distance service
decreased by 5.8% to R$211.5 million in 1996 from R$224.6 million in 1995. The
international tariffs charged by Embratel
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were reduced by the Ministry in September 1996 by an average of 13% and the
fixed percentage of international long-distance revenues retained by the
Company was reduced from 85.9% to 79.1%. These reductions were offset in part
by a 16% increase in the volume of international calls to 119 million minutes
in 1996 from 103 million minutes in 1995.
Anatel replaced the system for sharing revenues between Embratel and the
Company for interregional and international long-distance services with
retroactive effect as of April 1, 1998. Instead of retaining a fixed
percentage of revenue for all interregional and international long-distance
calls, the Company now charges Embratel per minute of use of the Company's
network. See "Description of Business--Regulation of the Brazilian
Telecommunications Industry--Rate Regulation." There can be no assurance that
the interconnection agreement with Embratel will not result in lower revenues
from carrying interregional and international long-distance calls than under
the prior regime.
Data Transmission. Gross operating revenues from data transmission decreased
by 17.4% to R$164.3 million in 1997 from R$198.9 million in 1996. This
reduction was largely due to a 42% reduction in rates charged for high-
capacity leased lines. The reduction was offset in part by a 34% increase in
the number of such lines in service to 94,293 lines in service in 1997 from
70,317 in 1996. Revenues increased by 25.9% to R$198.9 million in 1996 from
R$157.9 million in 1995, when the revenue-weighted average tariffs charged by
the Company were stable, due largely to increases in the number of high-
capacity lines in service, which increased by 27% to 70,317 lines in service
in 1996 from 56,296 in 1995.
Network services. The Company provides access to its network to other
telecommunications companies and leases certain network facilities to other
telecommunications and non-telecommunications companies as part of its network
services business. This includes primarily interconnection fees from cellular
companies paid for the use of the Company's network and equipment rental fees
from cellular companies, which rent equipment from the Company, such as
transmission facilities, for use in transporting cellular calls within their
own internal networks. Gross revenues from network services increased by 79.0%
to R$999.4 million in 1997 from R$558.3 million in 1996, which in turn
represented an 87.1% increase from R$298.4 million in 1995. Network services
have grown primarily due to growth of cellular companies and consequently
increased demands by cellular companies for interconnection with the Company's
network and demands by cellular company to rent equipment. Interconnection
revenues increased by 91% to R$803.9 million in 1997 from R$421.4 million in
1996, which in turn represented a 110% increase from R$200.8 million in 1995.
Equipment rental revenues increased by 93% to R$195.5 million in 1997 from
R$101.1 million in 1996, which in turn represented a 38% increase from R$73.5
million in 1995. Management expects continued growth in revenues from network
services as cellular operators grow.
Value-added taxes and other taxes. The principal taxes deducted from gross
operating revenue are a state value-added tax, the ICMS, on operating revenues
from the provision of telecommunications services and federal social
contribution taxes, including the PASEP and COFINS. The Company collects these
taxes from its customers and transfers them to the appropriate governmental
activity. The rate of ICMS is 25.0%, except for international service, for
which the rate was 13.0% from April 1994 to September 1996 and has been zero
percent since September 1996. The PASEP and COFINS aggregate 2.65% of gross
operating revenues.
On June 19, 1998 the secretaries of the treasury of the individual Brazilian
states approved an agreement to interpret existing Brazilian tax law to
broaden the application of the ICMS to cover not only telecommunications
services, but also other services, including cellular activation, which had
not been previously subject to such tax. Pursuant to this new interpretation
of existing tax law, the ICMS tax may be applied retroactively for such
telecommunications services rendered during the last five years.
The Company believes that the attempt by the state treasury secretaries to
extend the scope of ICMS tax to services which are supplementary to basic
telecommunications services is unlawful because: (i) the state secretaries
acted beyond the scope of their authority; (ii) their interpretation would
subject certain services to taxation which are not considered
telecommunications services; and (iii) no new taxes may be applied
retroactively.
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Each of the Registrant's Subsidiaries has filed lawsuits with the Treasury
Court of the Brazilian states in which such Subsidiaries are incorporated
seeking injunctive relief from retroactive and prospective application of the
ICMS tax to activation fees. At present, Telemig is the only Subsidiary that
has obtained from the applicable Treasury Court a temporary injunction
relieving it from payment of retroactive ICMS taxes with respect to activation
fees during the pendency of the lawsuit. The taxation authorities of the
states where the lawsuits are pending may appeal the decisions of the Treasury
Courts to grant temporary injunctions. There can be no assurance that the
Subsidiaries will ultimately prevail in any appeals relating to the temporary
injunctions or in the underlying litigation with respect to application of the
ICMS tax to activation fees. As of September 14, 1998, the Company started to
charge its customers the ICMS tax.
If the 25% ICMS tax were applied retroactively to activation fees earned by
the Company during the last five years, it would give rise to a maximum
liability estimated at R$238.2 million. Management does not believe that the
payment of retroactive ICMS taxes is probable and, therefore, no provision for
loss with respect to retroactive application of the ICMS has been made or is
expected to be made in the Company's consolidated financial statements. The
Company expects to make provisions for loss estimated at R$8.5 million with
respect to application of the ICMS tax for the three months ended September
30, 1998. Management does not believe that application of the ICMS tax on a
prospective basis will have a material impact on the Company's results of
operations.
In 1995, the Brazilian Supreme Court ruled that certain increases in the
rate of the FINSOCIAL tax (a predecessor tax to COFINS) were unconstitutional.
As a result, the Company recorded a credit of R$27.5 million under "other net
operating income" in that year. In 1997, the Brazilian Supreme Court narrowed
its prior decision, leading the tax authorities to challenge similar 1995
credits recognized by other telecommunication companies. The authorities have
not challenged the Company's 1995 credit. If they were to do so successfully,
the Company's liability (including interest and penalties) would have amounted
to R$49 million at December 31, 1997. See Note 20 to the Consolidated
Financial Statements.
Other. Other revenues remained relatively stable over the three-year period.
Other revenues totaled R$32.2 million, R$38.8 million and R$34.6 million in
1995, 1996 and 1997, respectively.
COST OF SERVICES
Cost of services includes those costs which are incurred as part of offering
the company's telecommunications services to the public, including primarily
depreciation and amortization costs, materials, services and personnel costs.
Cost of services as a percentage of gross revenues decreased steadily over the
three-year period but increased in absolute terms by 9.7% to R$2,571.4 million
in 1997 from R$2,343.6 million in 1996, which in turn represented an 11.1%
increase from R$2,109.6 million in 1995.
Depreciation and amortization. Depreciation expenses increased by 5.5% to
R$1,293.5 million in 1997 from R$1,226.6 million in 1996, which in turn
represented a 6.6% increase from R$1,150.9 million in 1995. The increase over
the three-year period principally reflected growth of the network. The
Company's operating assets had a net book value of R$11,945 million and
R$13,282 million at December 31, 1996 and 1997, respectively. The Company's
accounting policies and assumptions with respect to depreciation did not
change during this period.
Personnel. Personnel expenses decreased by 9.2% to R$508.3 million in 1997
from R$560.0 million in 1996, while such expenses slightly increased 0.8% from
R$555.7 million in 1995. The decrease in 1997 was principally due to a
decrease in costs associated with benefits to employees of the Company
including health and other fringe benefits and an absolute decrease in wages
of 5.7%, due in part to a reduction in personnel of 17.1% to 15,349 employees
in 1997 from 18,520 employees in 1996. The increase from 1995 to 1996 resulted
primarily from an absolute increase in wages of approximately 5.1% due to a
20% increase in wages pursuant to a collective bargaining agreement concluded
in December 1995 and a 3.6% increase in the number of employees to 18,520
employees in 1996 from 17,885 in 1995.
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<PAGE>
Materials. Expenses relating to materials decreased 11.6% to R$71.3 million
in 1997 from R$80.7 million in 1996, which in turn represented an increase of
11.1% from R$72.6 million in 1995. The decrease from 1996 to 1997 resulted
principally from a decrease in the real prices paid for materials as the
nominal prices paid for materials increased more slowly than the rate of
inflation. The increase in material costs in 1996 compared to 1995 was due
principally to growth of the network.
Services. Expenses related to services by third parties increased 58.8% to
R$659.1 million in 1997 from R$414.9 million in 1996, which in turn
represented a 46.6% increase from R$283.1 million in 1995. The increase over
the three-year period was primarily due to increased interconnection payments
to cellular companies for calls originating on the Company's network and
terminating on cellular networks and increased maintenance costs due to
network growth.
Other. Other costs of service, which primarily include fees paid to third
parties to rent equipment and infrastructure for use in the network, decreased
36.3% to R$39.1 million in 1997 from R$61.4 million in 1996, which in turn
represented a 29.7% increase from R$47.3 million in 1995. The increase in 1996
reflected a $17.1 million increase in rental fees resulting from (i) payments
to Embratel for the use of interconnecting circuits, (ii) an increase in the
cost of renting certain infrastructure and (iii) fees for leasing software.
The decrease in 1997 principally reflected a 38.8% decrease in rental costs
and a 29.7% decrease in network maintenance expenses.
OPERATING EXPENSES
Operating expenses increased by 9.2% to R$1,111.9 million in 1997 from
R$1,018.7 million in 1996, which in turn represented an increase of 23.2% from
R$827.0 million in 1995. The increase over the three-year period principally
reflected greater selling and general and administrative expense.
Selling expense. Selling expense increased by 42.2% to R$544.1 million in
1997 from R$382.7 million in 1996, which in turn represented a 28.7% increase
from R$297.3 million in 1995. The increase in selling expense over the three-
year period primarily reflected increased commissions to vendors selling
prepaid telephone cards and services to third parties, which include
consultants, in 1997 and publicity and postal expense in 1996, and increased
materials expenses in connection with the production of prepaid telephone
cards. In addition, other expenses increased by 127.7% to R$77.0 million in
1997 from R$33.8 million in 1996, which in turn represented a 61.6% increase
from R$20.9 million in 1995, principally due to increased provisions to the
allowance for accounts that are not probable of collection.
Provisions to the allowance for accounts not probable of collection
increased 258% to R$101.4 million in 1997 from R$28.3 million in 1996, which
in turn represented an increase of 282% from R$7.4 million in 1995. See notes
2 and 11 to the Consolidated Financial Statements. These increases reflected
growth in the nonpayment of accounts by the Company's customers. Management
believes that the growth in the level of nonpayment was principally due to the
economic crisis that Brazil experienced in 1997. This crisis, which was
evidenced by increased consumer and other interest rates and a reduction in
the availability of consumer financing, adversely affected the ability of the
Company's customers (particularly those living in the more economically
depressed northern states of the Region) to meet payment obligations. The
increase in nonpayment was also due in part to a reduction in the fine
collected by the Company for late payments from 10% of the outstanding bill to
2%, which resulted in subscribers having less incentive to pay their overdue
accounts.
In the first six months of 1998, the Company had provisions to the allowance
for accounts not probable of collection totaling R$68.1 million. In an effort
to reduce the level of overdue accounts, the Company has initiated a number of
practices, including disconnecting customers with accounts 30 days past due,
improving collection efforts and referring nonpaying customers to the local
credit bureau. Management believes that these measures will help limit
nonpayment of accounts receivable but expects that provisions will nonetheless
continue to increase in 1998 due to the combined effect of a decrease in the
average annual income of the Company's subscribers and increased consumer
interest rates in Brazil.
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<PAGE>
It has been the Company's policy to maintain an allowance for past due
accounts receivable equal to management's estimate of probable future losses
on such accounts, based on historical losses on accounts receivable and the
Company's current level of overdue accounts receivable.
General and administrative expense. General and administrative expense
decreased by 1.4% to R$816.5 million in 1997 from R$827.9 million in 1996,
which in turn represented a 15.7% increase from R$715.4 million in 1995. The
decrease from 1996 to 1997 reflected principally decreased personnel costs and
decreased general overhead costs. The increase from 1995 to 1996 reflected
principally increased third-party services costs, costs associated with
increased outsourcing to consultants and outside vendors and increased fees
paid to banks, as well as increased costs for rent and security of Company
installations.
Other net operating income. Other net operating income increased by 29.5% to
R$248.7 million in 1997 from R$192.0 million in 1996, which in turn
represented an increase of 3.4% from R$185.7 million in 1995. The increase
from 1996 to 1997 was principally due to an increase in services provided by
the Company to third parties, principally cellular companies, offset in part
by a reduction in fines collected by the Company for late payments by
customers. The decrease in fines collected resulted from a reduction in the
amount of such fines mandated by Brazilian law from 10% of the outstanding
bill to 2%. The increase from 1995 to 1996 resulted principally from an
increase in services provided by the Company to third parties, principally
cellular companies, offset by a substantial increase in payments related to an
early retirement program initiated by the Company.
ALLOCATED AND UNALLOCATED INTEREST EXPENSE AND UNALLOCATED INTEREST INCOME
As described in Note 2 to the Consolidated Financial Statements, prior to
December 31, 1997, cash and certain nonspecific debt relating to the cellular
telephone business could not be segregated. As a consequence, interest income
and certain interest expense relating to the cellular telephone business could
not be segregated and such interest income and expense are presented in the
Combined Financial Statements as "unallocated interest income" and
"unallocated interest expense", respectively.
Unallocated interest income increased by 178.9% to R$126.6 million in 1997
from R$45.4 million in 1996, which in turn represented a decrease of 14.1%
from R$51.8 million in 1995. The increase from 1996 to 1997 resulted
principally from an increase in interest rates earned during the period, which
resulted in greater interest income from cash on hand, an increase in such
cash on hand, and an increase in interest charged on late payments. The
decrease from 1995 to 1996 resulted principally from a reduction in interest
rates earned during the period, which resulted in lower interest income from
cash on hand, offset in part by an increase in such cash on hand.
Allocated and unallocated interest expense decreased by 4.8% to R$174.8
million in 1997 from R$183.2 million in 1996, which in turn represented an
increase of 2.3% from R$177.9 million in 1995. The decrease from 1996 to 1997
resulted principally from a reduction in total indebtedness together with a
decrease in the effective interest rates paid on such indebtedness. The
increase from 1995 to 1996 resulted principally from an increase in the
effective interest rates paid on indebtedness.
Prior to the separation of the fixed and cellular telecommunications
business, the Company received a material portion of its total cash flows from
1995, 1996 and 1997 from the cellular Companies. The Company will now need to
obtain financing from third parties to replace the amount it no longer
receives from the cellular Companies due to the split-up. As a result, net
interest expense is expected to increase in the future.
EMPLOYEES' PROFIT SHARE
All Brazilian companies are required under Brazilian law to compensate
employees, in addition to their salary and benefits, with profit sharing. The
amount of such profit sharing is determined by negotiation between the Company
and the labor unions representing the employees. For state owned companies,
such profit sharing payments are limited to 25% of total proposed dividends.
Telebras has established two additional limits. In
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<PAGE>
addition to the 25% limit imposed on all state owned companies, companies in
the Telebras System must limit employees' share of profits to the lower of (i)
the aggregate of the employees' annual compensation and (ii) 50% the Company's
net income adjusted for dividends. Following the privatization of the Company,
employee profit share will be limited only by the 25% of dividends limit and
will be renegotiated by the Company and the unions representing its employees.
The Company's employees' profit share was R$9.2 million, R$30.2 million and
R$60.4 million in 1995, 1996 and 1997, respectively.
MINORITY INTERESTS
Minority interest in the net income of the Subsidiaries was R$18.2 million,
R$152.3 million and R$312.4 million in 1995, 1996 and 1997, respectively,
reflecting 9.6%, 14.8% and 22.1% of income before minority interest,
respectively. The 1997 increase in minority interest as a percentage of income
before such interest principally reflected the issuance and sale by the
Company of preferred shares to new subscribers pursuant to a system called
"auto-financing". Under such system, each new subscriber was required to
invest in shares of the Company and the proceeds from such investment were
used by the Company to finance network expansion. The Company discontinued
auto-financing as of April 1997. See "--Liquidity and Capital Resources."
LIQUIDITY AND CAPITAL RESOURCES
The Registrant is a holding company and its principal assets are the shares
of its operating subsidiaries. The Registrant relies largely on dividends from
its subsidiaries to meet its need for cash, including for the payment of
dividends to shareholders. Under Law No. 6,404 of December 15, 1976, as
amended (the "Brazilian Corporation Law"), dividends may be paid only out of
retained earnings or accumulated profits in any given fiscal year. See
"Description of Securities to be Registered--Capital Stock--Dividends."
Management believes that the Registrant's shareholding in the Subsidiaries
is sufficient to allow the Registrant to control the payment of dividends by
such companies. The Registrant currently is able to nominate and elect all the
members of the boards of directors of the Subsidiaries. However, under
Brazilian law and the regulations of the Brazilian Securities Commission,
persons holding more than 10% of the voting stock, of a company (a percentage
that may decrease up to 5% in the case of listed companies) may require the
company to adopt cumulative voting. Management believes that, based on current
holdings in its operating subsidiaries, if cumulative voting were required,
the Registrant would still be able to control the payment of dividends by the
Subsidiaries which, with respect to the Mandatory Dividend, could be limited
only under very strict circumstances. Board members, even if elected by one
specific shareholder, have fiduciary duties toward the company and all its
shareholders. The preferred shareholders and the minority voting shareholders
of the Subsidiaries, in each case voting as a single class of such preferred
shareholders and a single class of such minority voting shareholders, elect
one member each of the Audit Committee. The remaining members of the Audit
Committee are selected by the controlling shareholder.
The Company's principal liquidity and capital resource requirements are to
finance capital expenditures and investments related to the expansion,
improvement and maintenance of its property, plant and equipment.
Historically, the Company has financed its capital expenditures and
investments primarily with internally generated funds and with proceeds from
the required sale of the Company's shares to new customers ("auto-financing").
As of April 1997 the Company discontinued auto-financing. See "--Description
of Business-- Rates--Local Services."
The Company made capital expenditures of R$1,653,758, R$2,217,123 and
R$2,552,261 in 1995, 1996 and 1997, respectively. The principal expenditures
related primarily to the expansion and modernization of the Company's network.
See "Description of Business--Capital Expenditures." In addition, the Company
paid dividends of R$57.3 million, R$138.0 million and R$265.2 million in 1995,
1996, and 1997, respectively. The Company anticipates capital expenditures for
the first eight months of 1998 will be R$1,477.6 million, which is expected to
be funded with debt (37%) and internally generated funds from operations
(63%). See "Description of Business--Capital Expenditures."
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<PAGE>
The Company's primary source of funds is cash flow generated from continuing
operations, net of taxes applicable to both continuing and discontinued
operations. Net cash flow generated from operating activities was R$1,454.1
million, R$1,674.2 million and R$1,828.1 million in 1995, 1996, and 1997,
respectively.
At December 31, 1997, the Company had a working capital deficiency. The
Company's current assets were R$1,391.6 million and its current liabilities
were R$2,496.3 million, summing to a working capital deficiency of R$1,104.7
million. Included in the current liabilities were loans payable to Telebras of
R$620.2 million and dividends payable to Telebras of R$397.8 million. As a
result of the Breakup, such loans and dividends became inter-company
obligations payable by the Registrant's operating subsidiaries to the
Registrant. See Note 28(b) to the Consolidated Financial Statements.
Accordingly, these inter-company items no longer affect the Company's
liquidity on a consolidated basis. The Company had a positive consolidated
working capital balance at June 30, 1998.
The Company's total indebtedness for loans and financing was R$1,575.4
million and R$1,623.6 million as of December 31, 1996 and 1997. The principal
categories of indebtedness at December 31, 1997 were the following:
Loans payable to Telebras (R$1,221.8 million). The Registrant's operating
subsidiaries had certain loans payable to Telebras, of which approximately
R$150.6 million were in foreign currency; the remainder were denominated in
reais at floating rates tied to TEX and IGP-M.
Upon the Breakup of the Telebras System and the formation of the
Registrant, approximately R$1,318.2 million of indebtedness of the
Registrant's operating subsidiaries, representing loans from Telebras,
became intercompany loans payable by the Registrant's operating
subsidiaries to the Registrant. Accordingly, these intercompany loans and
the market risk and interest expense relating to such loans will be
eliminated in the preparation of the Registrant's consolidated financial
statements in the future.
Other financing (R$295.8 million). Other financing relates to equipment
financing from Sophora, Alcatel, Equitel, EDC, Promon, Splice, NEC, Alcoa
Aluminum and other suppliers of telecommunications equipment (denominated
in U.S. dollars). The financing bears interest at fixed rates varying
between 10.9% and 18% per annum and floating rates varying between LIBOR +
1% and LIBOR + 5.5% per annum. This financing is guaranteed by Telebras.
The Company has no committed lines of credit. Noncurrent debt is scheduled
to be repaid as follows:
<TABLE>
<CAPTION>
YEAR R$ MILLION
---- ----------
<S> <C>
1999................................... 561,473
2000................................... 145,222
2001................................... 71,950
2002................................... 55,877
2003 and thereafter.................... 45,440
-------
Total................................ 879,962
=======
</TABLE>
The Company is party to certain credit agreements that contain covenants
restricting, among other things, (i) the ability of Telebras to dispose of all
or a substantial part of its assets or to cease to control a company that was
an operating subsidiary of the Telebras System and (ii) the ability of the
Federal Government to dispose of its controlling interest in the Telebras
System. The Breakup of Telebras on May 22, 1998, the privatization of the New
Holding Company on July 29, 1998 and the announced liquidation of Telebras
constituted events of default under such credit agreements. In addition, most
of the Company's other credit agreements include cross-default provisions and
cross-acceleration provisions that would permit the holders of such
indebtedness to declare the indebtedness to be in default and to accelerate
the maturity thereof if a significant portion of the principal amount of the
Company's debt is in default or accelerated. The total amount of the Company's
outstanding debt as of December 31, 1997 which is currently or is expected to
be in default is approximately R$133.1 million. The Company is in negotiations
with the appropriate creditors with respect to this indebtedness. Although
none
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of the Company's creditors have notified the Company that they intend to
pursue their rights and remedies with respect to these defaults, there can be
no assurance that the Company will be able to obtain waivers or that the
creditors will not exercise their rights and remedies under the credit
agreements.
RECONCILIATION TO U.S. GAAP
The Company prepares its consolidated financial statements in accordance
with Brazilian GAAP, which differs in significant respects from U.S. GAAP. The
principal differences between Brazilian GAAP and U.S. GAAP as they affected
the Company's results of operations are: (i) under Brazilian GAAP, loans and
financing balances in default are not always classified as current liabilities
while under U.S. GAAP, loans and financings in default or expected to be in
default within a year of the balance sheet date are classified as current
obligations unless creditors have provided the Company waivers for such
defaults; a portion of the Company's outstanding debt at December 31, 1997 is
in default or expected to be in default as a result of its privatization and
the Breakup of the Telebras System (see "--Liquidity and Capital Resources");
(ii) under Brazilian GAAP, interest on loans to finance construction in
progress is capitalized at the rate of 12% per annum of the total value of
construction in progress, regardless of the amount of interest actually
incurred on such loans while under U.S. GAAP interest is capitalized at the
interest rate on the debt incurred up to the lower of the amount of
construction in progress and the total loans incurred; (iii) until December
31, 1993 capitalized interest under Brazilian GAAP was not added to individual
assets but was capitalized separately and amortized over a time period
different from the estimated useful lives of the related assets while under
U.S. GAAP capitalized interest is added to the cost of individual assets and
is amortized over their estimated useful lives; (iv) under Brazilian GAAP the
issuance of shares of the Company to finance capital investments was recorded
at the book value of the shares while under U.S. GAAP the sale of shares must
be recorded at their market value resulting in a gain carried as deferred
income and amortized into current income on the same schedule as the plant
financed with the proceeds from the sale of the shares; (v) under Brazilian
GAAP proposed dividends are accrued for in the consolidated financial
statements in anticipation of their approval at the shareholders' meeting,
while under U.S. GAAP, dividends are not accrued until they are formally
declared; and (vi) under Brazilian GAAP, the deferred tax liability arising
from the indexation of assets and liabilities for financial reporting purposes
was recorded against retained earnings while under U.S. GAAP such effects
would be charged to income and social contribution taxes in the statements of
income. Net income under U.S. GAAP was R$954.4 million and R$1,232.3 million
in 1996 and 1997, respectively. See Note 29 to the Consolidated Financial
Statements.
RECENT RESULTS
The Company has reported consolidated net operating revenues of R$2,501.4
million and consolidated net income of R$313.3 million for the six months
ended June 30, 1998. Such amounts are unaudited, have been determined in
accordance with the Brazilian Corporation Law and standards issued by the CVM
and have not been indexed for inflation occurring after December 31, 1995 or
been expressed in constant reais. Accordingly, such amounts, as well as the
six months amounts discussed in the paragraph below, are not comparable to the
amounts included in the Consolidated Financial Statements, which have been so
indexed and expressed. See "Presentation of Information." Had consolidated net
operating revenues and consolidated net income for the six months ended June
30, 1998 been indexed for inflation and expressed in constant reais on the
same basis as the amounts presented in the Consolidated Financial Statements,
such adjustments would have had no material effect on net operating revenues
and would have resulted in a downward adjustment of approximately R$92 million
to net income (principally reflecting additional depreciation, net of related
tax effects). As measured by the IGP-M, the cumulative rate of inflation from
the period December 31, 1995 to June 30, 1998 was 20.0%.
Consolidated net operating revenue for the first six months of 1998 was
flat, reflecting a decrease in the average number of pulses per line in
service and pressure on tariffs, offset by an increase in the number of access
lines in service to 7,110,000 at June 30, 1998.
During the first six months of 1998, costs of service and operating expenses
were R$1,391.0 million and R$602.7 million, respectively, evidencing a slight
upward trend. The trend was offset in part by declining net interest expense
of R$65.5 million.
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Results for the six months of 1998 are not necessarily indicative of results
for any other period or for the full year. Management believes that the
material adjustments that would be required to reconcile the first six months,
net income figure given above to U.S. GAAP are comparable in nature to those
discussed in Note 29 to the Consolidated Financial Statements except that
indexation for inflation subsequent to December 31, 1995 and through December
31, 1997 would be required under U.S. GAAP and the cessation of indexation as
from January 1, 1998 will eliminate the need for the recognition of an
additional charge to income under U.S. GAAP for the deferred income tax
effects of indexation for financial reporting purposes.
Comparative interim period net operating revenues and net income are not
presented herein. The Registrant was not formed prior to May 22, 1998 and did
not publish interim financial results for the first half of 1997. In addition,
the Registrant's operating subsidiaries' published interim 1997 results (if
any) were for the combined cellular and fixed line entities.
As part of the privatization of the Telebras System, the Federal Government
has offered Telebras System employees the right to purchase the Federal
Government's entire holding of Telebras preferred shares and preferred shares
of each of the New Holding Companies (representing 2.18% of the outstanding
capital stock of Telebras and of each New Holding Company) at a price of
R$69.24 per lot of 13,000 shares (each a "lot" and comprised of 1,000
preferred shares of each of Telebras and the twelve New Holding Companies).
This price represents a 50% discount from the market price of 1,000 Telebras
preferred shares at the time the Federal Government authorized the plan. The
initial period during which employees could subscribe for the shares began on
August 4, 1998 and expired on September 30, 1998. On August 28, 1998, the
Federal Government extended the period for the offer to October 30, 1998. The
offer period has not been extended again and the Federal Government has not
expressed any intention to do so. Each employee has the right to purchase up
to 144 lots of 13,000 preferred shares, subject to proration if the shares are
oversubscribed.
The Federal Government has offered 7.2 million lots, or 60% of the total
number of lots (12.1 million) that would be required if every employee in the
Telebras System offered to purchase the maximum 144 lots per employee allowed.
If offers to purchase are made for more than 7.2 million lots, employees will
be allocated the available 7.2 million lots on a pro-rata basis. Accordingly,
if every employee in the Telebras System offered to purchase the maximum 144
lots, each employee would be allocated 86.4 lots (or 60% of 144). This
allocation would increase up to 144 lots as the total number of Telebras
System-wide offers to purchase declined to 7.2 million lots or less. If total
employee demand is for less than 7.2 million lots, the unsold shares will
remain with the Federal Government. The market price of 1,000 Telebras
preferred shares when the offer to employees commenced on August 4, 1998 was
R$127.20. At this date, 1,000 Telebras preferred shares was equivalent to one
lot, because the distribution of New Holding Company preferred shares in
connection with the Breakup had not occurred. The market price of one lot on
October 30, 1998, when the offer to employees terminated, was R$91.00.
The employee stock offering will have no effect on the Company's financial
statements prepared under Brazilian GAAP. For U.S. GAAP purposes only, the
employee stock offering is deemed to give rise to compensation expense to the
extent of the excess of market price of the shares purchased over the Federal
Government's price to employees. Although the Federal Government, rather than
the Company or Telebras, offered the shares to employees, under U.S. GAAP the
deemed compensation amount is "pushed down" to each of the New Holding
Companies in accordance with the number of shares purchased by each New
Holding Company and its subsidiaries' employees. The Company is not yet able
to determine the total amount of the expense that must be recognized under
U.S. GAAP because a complete count of employee subscription is not yet
available. A complete count is not available because a significant portion of
employee subscriptions for shares is made in paper rather than electronic
form. The tabulation of such paper subscriptions is required to be completed
by November 13, 1998. Although the total amount of the U.S. GAAP expense is
not presently determinable, the minimum amount (all of which will be
recognized effective August 4, 1998) is R$166.7 million. Effective October 30,
1998 the Company will record an additional expense ranging from R$0 to R$41.7
million, depending on the total number of shares above the maximum 60%
allocation that the Company's employees are able to purchase. These expenses
are calculated on the assumption that each of the Company's employees
purchases the maximum 144 lots per employee. For this actually to occur, each
of the Company's
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employees would have to subscribe for the maximum amount and the employee
offering as a whole would have to be sufficiently under-subscribed to allow
the Company's employees to be allocated the maximum 144 lots each. The maximum
expense is calculated on two measurement dates: (i) August 4, 1998, when it is
assumed that the Company's employees take up 86.4 lots each (or 60% of the 144
lots maximum), which is the maximum amount that the Company's employees could
purchase in the event that the remaining Telebras System employees also seek
to take up the maximum allowable number of shares; and (ii) October 30, 1998,
when it is assumed that, based on system-wide under-subscription, the
Company's employees are allocated the remaining 57.6 lots each. The expense
arising from the August 4 measurement date will be recorded in the third
quarter. The expense arising from the October 30 measurement date will be
recorded in the fourth quarter.
The Company has been informed by Telebras that, for the Telebras System as a
whole, the maximum expense under US GAAP in connection with the employee share
offering will be R$421.6million.
ITEM 9A: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to market risk from changes in both foreign currency
exchange rates and interest rates. The Company is exposed to foreign exchange
rate risk because certain of its costs are denominated in currencies
(primarily the U.S. dollar) other than those in which it earns revenues
(primarily the real). Similarly, the Company is subject to market risk
deriving from changes in interest rates which may affect the cost of its
financing. The Company does not use derivative instruments, such as foreign
exchange forward contracts, foreign currency options, interest rate swaps and
forward rate agreements, to manage these market risks, nor does it hold or
issue derivative or other foreign instruments for trading purposes.
EXCHANGE RATE RISK
The Company has exchange rate exposure with respect to the U.S. dollar and,
to a lesser extent, other currencies. Approximately R$288 million of the
indebtedness of the Company is denominated in U.S. dollars, and approximately
R$150 million of the Company's indebtedness is indexed to the Italian lira.
The potential immediate loss to the Company that would result from a
hypothetical 10% change in foreign currency exchange rates would be
approximately R$44 million. In addition, if such a change were to be
sustained, the Company's cost of financing would increase in proportion to the
change. This sensitivity analysis assumes an unfavorable 10% fluctuation in
all of the exchange rates affecting all the foreign currencies in which the
indebtedness described above are denominated. Since consistently and
simultaneously unfavorable movements in all relevant exchange rates are
unlikely, this assumption may overstate the impact of exchange rate
fluctuations on the Company's results of operations.
INTEREST RATE RISK
At December 31, 1997, the Company had approximately R$1,623 million in loans
and financing outstanding, of which approximately R$150 million bore interest
at fixed interest rates and approximately R$1,433 million bore interest at
floating rates of interest (primarily LIBOR-based). The Company invests its
excess liquidity (R$55 million at December 31, 1997) mainly in short-term
instruments. The potential loss to the Company over one year that would have
resulted from a hypothetical, instantaneous and unfavorable change of 100
basis points in the interest rates applicable to financial assets and
liabilities on December 31, 1997 would be approximately R$15 million. The
above sensitivity analyses are based on the assumption of unfavorable
100 basis point movement of the interest rates applicable to each homogenous
category of financial assets and liabilities and sustained over a period of
one year. A homogenous category is defined according to the currency in which
financial assets and liabilities are denominated and assumes the same interest
rate movement within each homogenous category (e.g. U.S. dollars). As a
result, the Company's interest rate risk sensitivity model may overstate the
impact of interest rate fluctuations for such financial instruments as
consistently unfavorable movements of all interest rates are unlikely. See
Note 19 to the Consolidated Financial Statements.
ITEM 10: DIRECTORS AND OFFICERS OF REGISTRANT
BOARD OF DIRECTORS
The Registrant is administered by a Board of Directors (Conselho de
Administracao) and a Board of Executive Officers (Diretoria). The Board of
Directors is comprised of eleven members serving for a term of three years.
The Board of Directors holds a regular meeting once a month and holds special
meetings when called by the Chairman or by two members of the Board of
Directors.
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The following are the current members of the Board of Directors and their
respective positions.
<TABLE>
<CAPTION>
NAME POSITION
---- --------
<S> <C>
Carlos Francisco Ribeiro Jereissati.............................. Chairman
Jose Pio Borges de Castro Filho.................................. Director
Sergio Lins de Andrade........................................... Director
Joao Bosco Madeiro da Costa...................................... Director
Atilano de Oms Sobrinho.......................................... Director
Antonio Dias Leite Neto.......................................... Director
Luiz Felipe Denucci Martins...................................... Director
Geraldo Pereira de Araujo........................................ Director
Durval Jose Soledade Santos...................................... Director
Jorge de Moraes Jardim Filho..................................... Director
Jorge Lucio Andrade de Castro.................................... Director
</TABLE>
Set forth below are brief biographical descriptions of the Directors.
Carlos Francisco Ribeiro Jereissati, 52 years old, has served as Chairman of
the Board of Directors since August 1998. He is the Chairman of the Board and
the Chief Executive Officer of La Fonte Participacoes S.A. He is also a
Director of Companhia Vidracaria Santa Marina. He holds a degree in economics
from Mackenzie University of Sao Paulo.
Jose Pio Borges de Castro Filho, 50 years old, has served as a Director
since August 1998. Since 1998 he has served as Vice-President of the Banco
Nacional de Desenvolvimento Economico e Social -- BNDES. He is currently a
Director of Aracruz Celulose S.A., and a member of the Permanent Committee on
Business of the Brazilian Ministry of Foreign Relations. He holds an
engineering degree from the Catholic University of Rio de Janeiro.
Sergio Lins Andrade, 53 years old, has served as a Director since August
1998. He has served as an Executive Officer of Construtora Andrade Gutierrez
since 1978, where he is also a Director. He also served as a Director of
Tibras from 1996 to 1998. He is Vice-President of Instituto Cultural Minerva.
He holds an engineering degree from the Federal University of Rio de Janeiro.
Joao Bosco Madeiro da Costa, 44 years old, has served as a Director since
August 1998. He is the Executive Officer in charge of investments of Caixa de
Previdencia dos Funcionarios do Banco do Brasil--PREVI. He also served as a
substitute Executive Officer of Banco do Brasil S.A. He holds a degree in
economics, a post-graduate degree in economic engineering and a MBA from the
University of Sao Paulo.
Atilano de Oms Sobrinho, 56 years old, has served as a Director since August
1998. He joined the INEPAR group of companies in 1960, where he served in many
different positions, including Industrial Director of ENCO Engenharia e
Comercio S.A., General Manager and President of INEPAR S.A. Industria de
Construcoes, President of IBR Industria Brasileira de Reles (electrical
parts), Superintendant of INEBRASA Industrias Eletromecanicas Brasileiras
S.A., Chairman of the Board of SECCIONAL do Brasil S.A. (metallic structures),
Director of TEKNERGIA (energy consulting), President of SID Informatica S.A.
(computers and electronics), President of INEPAR S.A. Eletroeletronica
(formerly Westinghouse Corporation and Inepar Semiconductors), member of the
Board of Directors of CARBOMAFRA (coal), and President of MEGAENERGIA
Participacoes Ltda. (construction management and consulting on energy
projects). He holds a law degree from the Curitiba Law School.
Antonio Dias Leite Neto, 51 years old, has served as a Director since August
1998. He served as the President of CMA gold mining company and Executive
Vice-President of Bradesco Seguros, an insurance company affiliated with Banco
Bradesco. From June 1993 to December 1997, he served as President and Chairman
of the Board of Multicanal Participacoes S.A., the largest paid TV company in
Latin America, co-founded by him in 1991. He holds a degree in economics from
the Catholic University of Rio de Janeiro.
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Luiz Felipe Denucci Martins, 53 years old, has served as a Director since
August 1998. The companies and governmental agencies where he has served
include Banco Central do Brasil, Telebras, Interamerican Development Bank and
Banco do Brasil. He has also served as President of Companhia de Seguros
Alianca do Brasil, Brasilcap--Capitalizacao S/A, Brasilsaude Companhia de
Seguros Gerais and as Superintendent of SUSEP--Superintendencia de Seguros
Privados, the Brazilian insurance regulatory agency. He holds an economics
degree from the Federal University of Rio de Janeiro and a degree in business
administration from Pantheon-Sorbone, University of Paris I.
Geraldo Pereira de Araujo, 48 years old, has served as a Director and
President of the Company since May 1998. He joined Telemig in 1973 where he
served as Assistant to the Vice-President, head of the Department of Planning,
head of the Department of Coordination of the Vice-President, substitute
member of the Board of Directors and Director of Engineering. He also served
at Embratel as head Advisor of Planning and Coordination and head of the
Department of Business Coordination. He holds a degree in telecommunications
engineering from the Military Institute of Engineering and a degree in
business administration from the Federal University of Rio de Janeiro. In
addition, he has completed graduate work in nuclear engineering.
Durval Jose Soledade Santos, 49 years old, has served as a Director since
August 1998. He served as a Director of BNDES Participacoes S.A.--BNDESPAR
(1995-1998), as Vice-President of BANERJ (Banco do Estado do Rio de Janeiro)
and its subsidiaries (1988-1991), and as General Superintendent of the
Brazilian Securities and Exchange Commission (1986). He has also served as a
member of the Board of Directors of Light S.A. (1997-1998) and of Aracruz
Celulose S.A. (1986-1988). He currently serves as a member of the Board of
Directors of the Sao Paulo Stock Exchange (BOVESPA), and of SOMA, the primary
over-the-counter market in Brazil. He holds a law degree from the Federal
University of Rio de Janeiro, with specialization in business law, a MBA from
the Federal University of Rio de Janeiro UFRJ and post-graduate degree in
economics from the Catholic University of Rio de Janeiro.
Jorge de Moraes Jardim Filho, 49 years old, has served as a Director since
August 1998. He has served as Superintendent of Fundacao SISTEL de Seguridade
Social, as Chairman of the Board of GDT S.A., as Vice-Chairman of the Board of
Americel S.A. (cellular phone company), Telet S.A. (cellular phone company),
Sao Paulo World Trade Center, member of the Board of Paranapanema (mining),
Tele Centro Sul Participacoes S.A., Telesp Celular S.A., ACESITA S.A. (steel),
Cia. Paulista de Forca (power distribution), Telepisa S.A., Chairman of the
Board of Telegoias S.A and Telebras, President of Telebras, Telebrasilia,
substitute Minister of Telecommunications between 1992 and 1995 and engineer
at Telebras, Telebrasilia and Standard Eletrica S.A. ITT. He holds a degree in
engineering from the University of Brasilia and a degree in statistics for
planning and economics from the Federal District University.
Jorge Lucio Andrade de Castro, 39 years old, has served as a Director since
August 1998. He has served in management positions at Caixa Economica Federal
and as Member of the Board at SEBRAE (a government agency serving small and
medium sized companies), DATAMEC (data processing), FUNCEF and SASSE
(insurance company). He holds business administration and accounting degrees
from the Catholic University in Minas Gerais.
BOARD OF EXECUTIVE OFFICERS
The Board of Executive Officers consists of one President and one Vice
President 1 (one) President,1 (one) Regulatory Vice President and 3 (three)
Executive Officers, with the following titles: Executive Officer for Business,
Support and Investor Relations Executive Officer and Network Executive
Officer, elected by the Board of Directors for a term of three years. An
Executive Officer may be removed from office at any time.
The following are the Executive Officers and their respective positions.
<TABLE>
<CAPTION>
NAME POSITION
---- --------
<S> <C>
Geraldo Pereira de Araujo..................... President
Otavio Marques de Azevedo..................... Vice President
Ercio Alberto Zilli........................... Regulatory Vice-President
Joao de Deus Pinheiro Macedo.................. Executive Officer for Business
Isaac Berensztejn............................. Support and Investor Relations
Executive Officer
Dalton Jose Ribeiro de Magalhaes.............. Network Executive Officer
</TABLE>
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Set forth below are brief biographical descriptions of the Executive
Officers not included above. The Board of Directors of the Company has granted
Mr. Pereira de Araujo, upon his request, a leave of absence for a period of 90
days beginning October 5, 1998.
Otavio Marques de Azevedo, 47 years old, has served as an Executive Officer
(Vice-President) since August 1998. He served as an Executive Officer and
President of Telemig from 1985 to 1990 and as the Executive Vice-President of
Telebras from 1991 to 1992. He has served as the President of AG Telecom since
1993. He holds a degree in electrical engineering.
Ercio Alberto Zilli, 44 years old, has served as an Executive Officer since
May 1998. He joined Telebras in 1977 and held various positions including head
of the Engineering Department and Corporate Planning, Advisor to the Director
of Planning and Engineering, head of the Division of Coordination of the South
and Southeast Regions and assistant to the Vice-President. Most recently he
has served as Advisor of Industrial Politics and Technology Policy to the
Executive Secretary of the Ministry of Communications and Special Advisor to
the Minister of Communications. He holds a degree in electrical engineering
from the University of Brasilia.
Joao de Deus Pinheiro de Macedo, 50 years old, has served as an Executive
Officer since May 1998. Since 1971, he served at Telebahia in various
positions, including managing the Department of Capital Operations and the
Department of Operational Control and Marketing, Advisor of Planning and
Control of the Presidency and as Director of Operations. He also served as a
member of the Board of Directors between 1985 and 1989. He holds an electrical
engineering degree from the Federal University of Bahia.
Isaac Berensztejn, 44 years old, has served as an Executive Officer since
May 1998. He joined Embratel in 1977 and has served in various positions
including head of the Division of Planning and Economic Studies, head of the
Division of Financial Operations and head of the Finance Department. He also
held various positions at the Embratel Foundation of Social Security
including, Investment Manager, Director of Finance and Administration and
member of the Board of Trustees. He holds degrees in Telecommunications
Engineering from the Catholic University of Rio de Janeiro and graduate
degrees in production engineering and business administration from the Federal
University of Rio de Janeiro.
Dalton Jose Ribeiro de Magalhaes, 52 years old, has served as an Executive
Officer since September 1998. He joined Embratel in 1969, holding various
positions including head of the Department of International Communications and
Executive Assistant to the Director of International Operations. He has also
served as Assistant to the Director of Operations of Telecomunicacoes de Rio
de Janeiro S.A., General Manager of Portugal Telecom North America Inc. and
President and Member of the Board of Tele Centro Sul Participacoes. Since
1996, he served as Administrative Director of Telebras. He holds a degree in
communications engineering from the Military Institute.
ITEM 11: COMPENSATION OF DIRECTORS AND OFFICERS
For the year ended December 31, 1997, the aggregate amount of compensation
paid by the Registrant's subsidiaries to all directors and executive officers
of the Registrant's subsidiaries as a group was approximately R$6.9 million.
For the year ended December 31, 1997, the aggregate amount set aside or
accrued by the Registrant's subsidiaries to provide pension, retirement or
similar benefits for officers and directors of the Registrant's subsidiaries
was approximately R$991.0 thousand. The Registrant did not have any officers
or directors for the year ended December 31, 1997 because it was not formed
until May 22, 1998 as part of the Breakup of Telebras.
ITEM 12: OPTIONS TO PURCHASE SECURITIES FROM REGISTRANT OR SUBSIDIARIES
None.
ITEM 13: INTEREST OF MANAGEMENT IN CERTAIN TRANSACTIONS
None.
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PART II
ITEM 14: DESCRIPTION OF SECURITIES TO BE REGISTERED
CAPITAL STOCK
Set forth below is a brief summary of the material provisions concerning the
Preferred Shares and Common Shares, the By-laws and the Brazilian Corporation
Law. This description is qualified by reference to the By-laws, which have
been filed (together with an English translation) as an exhibit to this
Registration Statement and to the Brazilian Corporation Law. A copy of the By-
laws (together with an English translation) is available for inspection at the
principal office of the Depositary. Information on the trading market for the
Preferred Shares is set forth under "Nature of Trading Market" and information
on ownership of the Registrant's shares is set forth under "Control of
Registrant."
GENERAL
The capital stock of the Registrant is comprised of Preferred Shares and
Common Shares, all without par value. At May 22, 1998, there were 210,029,997
thousand outstanding Preferred Shares and 124,351,903 thousand outstanding
Common Shares. The Company's share capital may be increased only by
shareholder vote.
The Preferred Shares are nonvoting except under limited circumstances and
are entitled to a preferential, noncumulative dividend and to priority over
the Common Shares in the case of liquidation of the Registrant.
Under the Brazilian Corporation Law, the number of non-voting shares or
shares with limited voting rights, such as the Preferred Shares, may not
exceed two-thirds of the total number of shares. The Federal Government was
required by law prior to the privatization to own more than 50% of the voting
stock of the Registrant.
The majority of the members of the Board of Directors will be elected by the
controlling shareholders of Common Stock of the Registrant. Board members,
even if elected by one specific shareholder, have fiduciary duties towards the
Registrant and all its shareholders.
DIVIDENDS
Pursuant to its By-laws, the Registrant is required to distribute as
dividends in respect of each fiscal year ending on December 31, to the extent
amounts are available for distribution, an aggregate amount equal to at least
25% of Adjusted Net Income (as defined below) on such date (the "Mandatory
Dividend"). The annual dividend distributed to holders of Preferred Shares
(the "Preferred Dividend") has priority in the allocation of Adjusted Net
Income. Remaining amounts to be distributed are allocated first to the payment
of a dividend to holders of Common Shares in an amount equal to the Preferred
Dividend and the remainder is distributed equally among holders of Preferred
Shares and Common Shares. Under the Brazilian Corporation Law, a company is
permitted to suspend the Mandatory Dividend in respect of common shares and
preferred shares not entitled to a fixed or minimum dividend if its Board of
Directors and Audit Committee report to the shareholders' meeting that the
distribution would be incompatible with the financial circumstances of such
company and the shareholders ratify this conclusion at the shareholders'
meeting. In this case, (i) the Board of Directors must forward to the CVM
within five days of the shareholders' meeting an explanation justifying the
information transmitted at the meeting and (ii) the profits which were not
distributed for such reason are to be recorded as a special reserve and, if
not absorbed by losses in subsequent fiscal years, are to be paid as dividends
as soon as the financial situation of such company permits. The Preferred
Shares of the Registrant are entitled to a minimum dividend and thus the
Mandatory Dividend may be suspended only with respect to the Common Shares.
See "--Priority and Amount of Preferred Dividends." Dividends may be paid by
the Registrant out of retained earnings or accumulated profits in any given
fiscal year.
For the purposes of the Brazilian Corporation Law, accumulated profits are
defined as net income after income tax and social contribution for such fiscal
year, net of any accumulated losses from prior fiscal years and
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any amounts allocated to founders' shares, income bonds, employees' and
management's participation in a company's profits.
At each annual shareholders' meeting, the Board of Directors is required to
recommend how net profits for the preceding fiscal year are to be allocated.
Under the Brazilian Corporation Law, the Registrant is required to maintain a
statutory reserve, to which it must allocate 5% of net profits for each fiscal
year until the amount of such reserve equals 20% of the Registrant's paid-in
capital (the Statutory Reserve). Net losses, if any, may be charged against
the statutory reserve.
The Brazilian Corporation Law also provides for two additional discretionary
allocations of net profits that are subject to approval by shareholders at the
annual shareholders' meeting. First, a percentage of net profits may be
allocated to the contingency reserve for anticipated losses that are deemed
probable in future years (the "Contingency Reserve"). Any amount so allocated
in a prior year must be either (i) reversed in the fiscal year in which the
loss was anticipated if such loss does not in fact occur or (ii) written off
in the event that the anticipated loss occurs. Second, if the amount of
Unrealized Revenue exceeds the sum of (i) the statutory reserve, (ii) the
Contingency Reserve and (iii) retained earnings, such excess may be allocated
to the revenue (the "Unrealized Revenue Reserve"). Such allocations may not
hinder the payment of dividends on the Preferred Shares. "Unrealized Revenue"
is defined under the Brazilian Corporation Law as the sum of (i) the share of
equity earnings of affiliated companies which is not paid as cash dividends
and (ii) profits from installment sales to be received after the end of the
next succeeding fiscal year.
For the purposes of the Brazilian Corporation Law, and in accordance with
the Registrant's By-law(s), the "Adjusted Net Income" is an amount equal to
the Registrant's net profit to reflect allocations to and from (i) the
Statutory Reserve; (ii) the Contingency Reserve and (iii) the Unrealized
Revenue Reserve.
The amounts available for distribution are determined on the basis of
financial statements prepared in accordance with the Brazilian Corporation
Law, which differ from financial statements, such as the Consolidated
Financial Statements included herein, that are prepared using the constant
currency method according to Brazilian GAAP.
In order to allow the payment of dividends after the Breakup, the
shareholders of Telebras approved, as a part of the Breakup, the allocation of
a proportional part of the retained earnings and reserves of Telebras
transferred to the Registrant as retained earnings of Registrant. These
earnings and reserves (which amount to R$6,302.9 million) are available for
payment of future dividends by the Registrant, if so decided by the
shareholders, although the Registrant is not legally obligated to do so.
PRIORITY AND AMOUNT OF PREFERRED DIVIDENDS
The Registrant's By-laws provide for a minimum dividend for the Preferred
Shares equal to 6% of the amount obtained by dividing the total share capital
by the total number of shares of the Company. As a result of such provision,
holders of Preferred Shares are entitled to receive in any year distributions
of cash dividends prior to the holders of Common Shares receiving any
distribution of cash dividends in such year. In addition, distributions of
cash dividends in any year are made (i) first, to the holders of Preferred
Shares, up to the amount of the Preferred Dividend of the Preferred Shares for
such year, (ii) then, to the holders of Common Shares, until the amount
distributed in respect of each Common Share is equal to the amount distributed
in respect of each Preferred Share, and (iii) thereafter, to the Common Shares
and Preferred Shares on a pro rata basis. If the Mandatory Dividend in any
year is less than or equal to the Preferred Dividend payable to the holders of
Preferred Shares in such year, the holders of Common Shares will not be
entitled to receive any cash dividends from the Registrant in such year,
unless the holders of Common Shares approve dividends in excess of the
Preferred Dividend. In such circumstances, however, holders of Preferred
Shares will be entitled to the amount available for payment of dividends up to
an aggregate amount equal to the Preferred Dividend plus, in the event the
Preferred Dividend is higher than the amount available for payment of
dividends for such year, any retained earnings from previous years may be used
to make up for such shortfall. If the minimum dividend is not paid for a
period of three years, holders of Preferred Shares shall be entitled to full
voting rights until such time as the minimum dividend is paid in full for any
year.
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PAYMENT OF DIVIDENDS
The Registrant is required by law and its By-laws to hold an annual
shareholders' meeting by April 30 of each year at which, among other things,
an annual dividend may be declared by decision of the shareholders on the
recommendation of the Executive Officers, as approved by the Board of
Directors. The payment of annual dividends is based on the Financial
Statements prepared for the fiscal year ending December 31. Under the
Brazilian Corporation Law, dividends are required to be paid within 60 days
following the date the dividend is declared to shareholders of record on such
declaration date, unless a shareholders' resolution sets forth another date of
payment, which must occur prior to the end of the fiscal year in which such
dividend was declared. A shareholder has a three-year period from the dividend
payment date to claim dividends in respect of its shares, after which the
Registrant has no liability for such payment. Because the Registrant's shares
are issued in book-entry form, dividends with respect to any share are
automatically credited to the account holding such share and no action is
required on the part of the shareholder. The Registrant is not required to
adjust the amount of paid-in capital for inflation. Annual dividends may be
paid to shareholders on a pro rata basis according to the date when the
subscription price is paid to the Registrant.
Shareholders who are not residents of Brazil must register with the Central
Bank of Brazil in order for dividends, sales proceeds or other amounts with
respect to their shares to be eligible to be remitted outside of Brazil. The
Preferred Shares underlying the ADSs are held in Brazil by the Custodian, as
agent for the Depositary, which is the registered owner of the Registrant's
shares. See "--Description of American Depositary Receipts in respect of
Preferred Shares."
Payments of cash dividends and distributions, if any, will be made in
Brazilian currency to the Custodian on behalf of the Depositary, which will
then convert such proceeds into U.S. dollars and will cause such U.S. dollars
to be delivered to the Depositary for distribution to holders of ADRs. In the
event that the Custodian is unable to convert immediately the Brazilian
currency received as dividends into U.S. dollars, the amount of U.S. dollars
payable to holders of ADRs may be adversely affected by devaluations of the
Brazilian currency that occur before such dividends are converted and
remitted. Dividends in respect of the Preferred Shares paid to resident and
non-resident shareholders, including holders of ADSs, are not currently
subject to Brazilian withholding tax. See "Taxation--Brazilian Tax
Considerations."
VOTING RIGHTS
Each Common Share entitles the holder thereof to one vote at meetings of
shareholders of the Registrant. Preferred Shares do not entitle the holder to
vote except as set forth below. Holders of Preferred Shares are entitled to
attend or to address meetings of shareholders.
One of the three members of the permanent Audit Committee of the Registrant
and his or her alternate are elected by majority vote of the holders of
Preferred Shares present at the annual meeting of shareholders at which
members of the Audit Committee are elected.
Brazilian Corporation Law provides that certain nonvoting shares, such as
the Preferred Shares, acquire voting rights in the event the Registrant fails
for three consecutive fiscal years to pay the Preferred Dividend to which such
shares are entitled until such payment is made.
The Preferred Shares are entitled to full voting rights with respect to (i)
the approval of any long-term contract between the Company and its affiliates,
on the one hand, and any controlling shareholder of the Company, such
shareholder's affiliates and related parties, on the other hand and (ii)
resolutions modifying certain provisions of the By-laws. The Preferred Shares
are entitled to full voting rights with respect to any resolution submitted to
the shareholders' meeting for the delisting of the Registrant ("going
private") or during liquidation of the Registrant.
Any change in the preference, benefits, conditions of redemption and
amortization of the Preferred Shares, or the creation of a class of shares
having priority or preference over the Preferred Shares, would require the
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approval of holders of a majority of the outstanding Preferred Shares at a
special meeting of holders of Preferred Shares. Such a meeting would be called
by publication of a notice in the Gazeta Mercantil and the Diario Oficial da
Uniao at least thirty days prior to the meeting but would not generally
require any other form of notice.
In any circumstances in which holders of Preferred Shares are entitled to
vote, each Preferred Share will entitle the holder thereof to one vote.
PREEMPTIVE RIGHTS
Each shareholder of the Registrant has a general preemptive right to
subscribe for shares in any capital increase, in proportion to its
shareholding. A period of 30 days following the publication of notice of the
capital increase is allowed for exercise of the right, and the right is
negotiable. However, a shareholders' meeting is authorized to eliminate
preemptive rights with respect to the issuance of new shares, debentures,
warrants and founders' shares convertible into new shares up to the limit of
the authorized share capital, provided that the distribution of these
securities is effected (i) on a stock exchange or in a public offering, (ii)
through an exchange of shares in a public offering the purpose of which is to
acquire control of another company or (iii) through the use of certain tax
incentives.
In the event of a capital increase which would maintain or increase the
proportion of capital represented by Preferred Shares, holders of ADSs, or of
Preferred Shares, would have preemptive rights to subscribe only to newly
issued Preferred Shares. In the event of a capital increase which would reduce
the proportion of capital represented by Preferred Shares, holders of ADSs, or
of Preferred Shares, would have preemptive rights to subscribe to Preferred
Shares, in proportion to their shareholdings and to Common Shares only to the
extent necessary to prevent dilution of their interest in the Registrant.
Preemptive rights to purchase shares may not be offered to U.S. holders of
ADSs unless a registration statement under the Securities Act is effective
with respect to the shares underlying such rights, or an exemption from the
registration requirements of the Securities Act is available. Consequently,
holders of ADSs who are U.S. persons or are located in the United States may
be restricted in their ability to participate in the exercise of preemptive
rights. See "--Description of American Depositary Receipts in respect of
Preferred Shares--Dividends, Other Distributions and Rights."
RIGHT OF REDEMPTION
Neither the Common Shares nor the Preferred Shares are redeemable, subject
to the right of a dissenting shareholder to seek redemption upon a decision
made at a shareholders' meeting by shareholders representing over 50% of the
voting shares to seek redemption upon a decision made at a shareholders'
meeting (i) to change the preference of the Preferred Shares or to create a
class of shares having priority or preference over the Preferred Shares, (ii)
to modify the mandatory distribution of dividends, (iii) to change the
corporate purposes of the Registrant, (iv) to dissolve or liquidate the
Registrant, (v) to transfer all of the shares of the Registrant to another
company in order to make the Registrant a wholly-owned subsidiary of such
company (incorporacao de acoes), (vi) to approve the acquisition of another
company, the price of which exceeds certain limits set forth in the Brazilian
Corporation Law and (vii) to merge or consolidate the Registrant with another
company, if certain liquidity standards provided in the Brazilian Corporation
Law are not met. The right to redemption lapses 30 days after publication of
the minutes of the relevant shareholders' meeting or, whenever the resolution
requires the approval of the holders of Preferred Shares by vote taken in a
special meeting of a majority of the holders of Preferred Shares affected by
the resolution, within 30 days from the publication of the minutes of such
special meeting. The Registrant would be entitled to reconsider any action
giving rise to redemption rights within 10 days following the expiration of
such rights if the redemption of shares of dissenting shareholders would
jeopardize the financial stability of the Registrant.
Unless otherwise provided in the By-laws (which is not the case with the
Registrant), shares are redeemable at their book value, determined on the
basis of the last annual balance sheet approved by the shareholders. If the
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shareholders' meeting giving rise to redemption rights occurs more than 60
days after the date of the last annual balance sheet, a shareholder may demand
that its shares be valued on the basis of a new balance sheet that is as of a
date within 60 days of such shareholders' meeting.
FORM AND TRANSFER
Shares of the Registrant are maintained in book-entry form with a transfer
agent (the "Transfer Agent") and the transfer of such shares is made in
accordance with the applicable provisions of the Brazilian Corporation Law,
which provides that a transfer of shares is effected by an entry made by the
Transfer Agent on its books, debiting the share account of the seller and
crediting the share account of the purchaser, against presentation of a
written order of the seller, or judicial authorization or order, in an
appropriate document which remains in the possession of the Transfer Agent.
The Preferred Shares underlying the ADS will be registered on the Transfer
Agent's records in the name of the Depositary.
Transfers of shares by a foreign investor are made in the same way and
executed by such investor's local agent on the investor's behalf except that,
if the original investment was registered with the Central Bank of Brazil
pursuant to the Annex IV Regulations, the foreign investor should also seek
amendment, if necessary, through its local agent, of the certificate of
registration to reflect the new ownership.
Each of the Sao Paulo Stock Exchange and the Rio de Janeiro Stock Exchange
operates a central clearing system. A holder of shares of the Registrant may
choose, at its discretion, to participate in these systems and all shares
elected to be put into the system will be deposited in custody with the
relevant stock exchange (through a Brazilian institution duly authorized to
operate by the Central Bank of Brazil having a clearing account with the
relevant stock exchange) and the fact that such shares are subject to custody
with the relevant stock exchange will be reflected in the Registrant's
register of shareholders. Each participating shareholder will, in turn, be
registered in the register of beneficial shareholders of the Registrant
maintained by the relevant stock exchange and will be treated in the same way
as registered shareholders.
DESCRIPTION OF AMERICAN DEPOSITARY RECEIPTS IN RESPECT OF PREFERRED SHARES
The following is a summary of the material provisions of the deposit
agreement (the "Deposit Agreement"), dated as of July 27, 1998 among the
Registrant, the Depositary, and the registered holders (the "Owners") and
beneficial owners from time to time of ADSs (the "Beneficial Owners"),
pursuant to which the ADSs representing Preferred Shares are to be issued.
This summary is subject to and qualified in its entirety by reference to the
Deposit Agreement, including the form of ADRs. Terms used in this description
and not otherwise defined shall have the meanings set forth in the Deposit
Agreement. A copy of the Deposit Agreement has been filed as an exhibit to
this Registration Statement. Copies of the Deposit Agreement are available for
inspection at the Corporate Trust Office of the Depositary, currently located
at 101 Barclay Street, New York, NY 10286, and at the office of the agent of
the Custodian, currently located at the principal Sao Paulo, Brazil office of
Banco Itau. The Depositary's principal executive office is located at 1 Wall
Street, New York, NY 10015.
AMERICAN DEPOSITARY RECEIPTS
ADRs evidencing ADSs are issuable by the Depositary pursuant to the Deposit
Agreement. Each ADR is in registered form and evidences a specified number of
ADSs, each ADS representing 1,000 Preferred Shares, or evidence of the right
to receive 1,000 Preferred Shares deposited with the Custodian and registered
in the name of the Depositary or its nominee (together with any additional
Preferred Shares at any time deposited or deemed deposited under the Deposit
Agreement and any and all other securities, cash and other property received
by the Depositary or the Custodian in respect of such Preferred Shares and at
such time held under the Deposit Agreement, the "Deposited Securities"). Only
persons in whose names ADRs are registered on the books of the Depositary are
treated by the Depositary and the Registrant as Owners.
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DEPOSIT, TRANSFER AND WITHDRAWAL
The By-laws provide that ownership of capital generally must be evidenced
only by a record of ownership maintained by the Registrant or an accredited
intermediary, such as a bank, acting as a registrar for the shares. Currently,
such function is performed by the Registrant as registrar (the "Registrar").
Accordingly, all references to the deposit, surrender and delivery of the
Preferred Shares refer only to book-entry transfers of the Preferred Shares in
Brazil. See "--Capital Stock" for a description of the characteristics and
rights of the Preferred Shares. All references to the deposit, surrender and
delivery of the ADS or the ADRs refer not only to the physical transfer of any
certificates representing such ADRs but also to any book-entry transfers.
The Preferred Shares represented by ADSs were deposited pursuant to the
Deposit Agreement by book-entry transfer to an account of the Custodian and
registered in the name of the Custodian. The Depositary is the holder of
record on the books of the Custodian of all such Preferred Shares.
The Depositary has agreed, subject to the terms and conditions of the
Deposit Agreement, that upon delivery (including by book-entry credit) to the
Custodian of the Preferred Shares (or evidence of rights to receive Preferred
Shares) and pursuant to appropriate instruments of transfer in a form
satisfactory to the Custodian, the Depositary will, upon payment of the fees,
charges and taxes provided in the Deposit Agreement, execute and deliver at
its Corporate Trust Office to, or upon the written order of, the person or
persons named in the notice of the Custodian delivered to the Depositary or
requested by the person depositing such Preferred Shares with the Depositary,
an ADR or ADRs, registered in the name or names of such person or persons, and
evidencing any authorized number of ADSs requested by such person or persons.
The Depositary will refuse to accept Preferred Shares for deposit whenever
it is notified in writing that such deposit would result in any violation of
applicable laws.
Upon surrender at the Corporate Trust Office of the Depositary of an ADR for
the purpose of withdrawal of the Deposited Securities represented by the ADSs
evidenced by such ADR, and upon payment of the fees of the Depositary,
governmental charges and taxes provided in the Deposit Agreement, and subject
to the terms and conditions of the Deposit Agreement, the By-laws, the
Deposited Securities and applicable law, the Owner of such ADR will be
entitled to book-entry credit with the Registrar together with physical
delivery (if physical delivery is permitted under the By-laws), to him or upon
his order, as permitted by applicable law, of the amount of Deposited
Securities at the time represented by the ADS or ADSs evidenced by such ADR.
Any forwarding of share certificates (if any), other securities, property,
cash and other documents of title for such delivery will be at the risk and
expense of the Owner.
Subject to the terms and conditions of the Deposit Agreement and any
limitations that may be established by the Depositary and unless requested by
the Registrant to cease doing so, the Depositary may execute and deliver ADRs
prior to the receipt of Preferred Shares (a "Pre-Release"), may deliver
Preferred Shares upon the receipt, and cancellation of ADRs which have been
Pre-Released, whether or not such cancellation is prior to the termination of
such Pre-Release or the Depositary knows that such ADR has been Pre-Released,
and may receive ADRs in lieu of Preferred Shares in satisfaction of a Pre-
Release.
Each Pre-Release must be (a) preceded or accompanied by a written
representation and agreement from the person to whom the ADRs are to be
delivered (the "Pre-Releasee") that the Pre-Release or its customer (i) owns
the Preferred Shares or ADRs to be remitted, as the case may be, (ii) assigns
all beneficial right, title and interest in such Preferred Shares or ADRs, as
the case may be, to the Depositary for the benefit of the Owners and (iii)
agrees in effect to hold such Preferred Shares or ADRs, as the case may be,
for the account of the Depositary until delivery of the same upon the
Depositary's request, (b) at all times fully collateralized with cash or U.S.
government securities, (c) terminable by the Depositary on not more than five
business days' notice and (d) subject to such further indemnities and credit
regulations as the Depositary deems appropriate. The Depositary will set
limits with respect to Pre-Release transactions to be entered into hereunder
with any particular Pre-Releasee on a case by case basis as the Depositary
deems appropriate. The collateral referred to in clause (b)
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above shall be held by the Depositary for the benefit of the Owners as
security for the performance of the Pre-Releasee's obligations to the
Depositary in connection with a Pre-Release transaction, including the Pre-
Release's obligation to deliver Preferred Shares or ADRs upon termination of a
Pre-Release transaction.
The Depositary will also limit the number of ADRs involved in such Pre-
Release transactions so that Preferred Shares not deposited but represented by
ADSs outstanding at any time as a result of Pre-Releases will not normally
exceed thirty percent (30%) of the ADSs outstanding (without giving effect to
ADSs evidenced by ADRs outstanding as a result of the Pre-Release), but the
Depositary reserves the right to disregard such limit from time to time as it
deems appropriate and may, with the prior written consent of the Registrant,
change such limit for purposes of general application. The Depositary may
retain for its own account any compensation received by it in connection with
the foregoing. Neither the Registrant nor the Custodian shall incur any
liability to Owners of ADRs as a result of such transactions.
DIVIDENDS, OTHER DISTRIBUTIONS AND RIGHTS
The Depositary is required to convert, as promptly as practicable and, in
any event, within one business day of its receipt thereof, into U.S. dollars,
all cash dividends or other distributions, net proceeds from the sale of
securities, property or rights, denominated in any currency other than U.S.
dollars that it receives in respect of the deposited Preferred Shares if
permitted under applicable laws and the Depositary determines that such
conversion into U.S. dollars and transfer to the United States can be effected
on a reasonable basis. If at the time of conversion, the resulting U.S.
dollars can, pursuant to applicable law, be transferred out of Brazil for
distribution, the Depositary will as promptly as practicable distribute the
amount received to the Owner entitled thereto in proportion to the number of
ADSs evidenced by such Owner's ADRs without regard to any distinctions among
Owners on account of exchange restrictions or otherwise. The amount
distributed will be reduced by any amounts to be withheld by the Registrant,
the Depositary or the Custodian, including amounts on account of any
applicable taxes and certain other expenses. For further details about
applicable taxes, see "Taxation."
If such conversion, transfer or distribution can be effected only with the
approval or license of any government or agency thereof, the Depositary will
file as promptly as practicable such application for approval or license;
however, the Depositary will be entitled to rely upon Brazilian local counsel
in such matters, which counsel will be instructed to act as promptly as
possible. If, pursuant to applicable law, any foreign currency received by the
Depositary or the Custodian cannot be converted to U.S. dollars, or if any
approval or license of any government or agency thereof that is required for
such conversion is denied or, in the opinion of the Depositary, cannot be
promptly obtained at a reasonable cost, the Depositary will, (a) as to the
portion of the foreign currency that is convertible into U.S. dollars, make
such conversion and (i) if permitted by applicable law, transfer such U.S.
dollars to the United States and distribute them to the Owners entitled
thereto or (ii) to the extent that such transfer is not permitted, hold such
U.S. dollars for the benefit of the Owners entitled thereto, uninvested and
without liability for interest thereon and (b) as to the nonconvertible
balance, if any, (i) if requested in writing by an Owner, distribute or cause
the Custodian to distribute the foreign currency (or an appropriate document
evidencing the right to receive such foreign currency) received by the
Depositary or the Custodian to such Owner and (ii) the Depositary shall hold
or will cause the Custodian to hold any amounts of nonconvertible foreign
currency not distributed pursuant to the immediately preceding subclause (i)
uninvested and without liability for the interest thereon for the respective
accounts of the Owners entitled to receive the same.
If the Registrant declares a dividend in, or free distribution of,
additional Preferred Shares with respect to the Preferred Shares represented
by the ADSs, the Depositary may, or will if the Registrant so requests,
distribute as promptly as practicable to the Owners of outstanding ADRs
entitled thereto, in proportion to the number of ADSs evidenced by their
respective ADRs, additional ADRs evidencing an aggregate number of ADSs that
represents the number of Preferred Shares received as such dividend or free
distribution, subject to the terms and conditions of the Deposit Agreement
with respect to the deposit of Preferred Shares and the issuance of ADSs
evidenced by ADRs, including the withholding of any tax or other governmental
charge and the payment of fees of the Depositary.
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The Depositary may withhold any such distribution of ADRs if it has not
received satisfactory assurances from the Registrant that such distribution
does not require registration under the Securities Act or is exempt from
registration under the provisions of such Act. In lieu of delivering ADRs for
fractional ADSs in the event of any such dividend or free distribution, the
Depositary will sell the amount of Preferred Shares represented by the
aggregate of such fractions and distribute the net proceeds in accordance with
the Deposit Agreement. If additional ADRs are not so distributed, each ADS
will thereafter also represent the additional Preferred Shares distributed
upon the Deposited Securities represented thereby.
If the Registrant offers, or causes to be offered, to the holders of
Preferred Shares any rights to subscribe for additional Preferred Shares or
any rights of any other nature, the Depositary, after consultation with the
Registrant, will have discretion as to the procedure to be followed in making
such rights available to Owners or in disposing of such rights for the benefit
of such Owners and making the net proceeds available to such Owners. If, by
the terms of such rights offering or for any other reason, it would be
unlawful for the Depositary to either make such rights available to any Owners
or dispose of such rights and make the net proceeds available to such Owners,
then the Depositary will allow the rights to lapse. If at the time of the
offering of any rights, the Depositary determines in its discretion that it is
lawful and feasible to make such rights available to all or certain Owners,
the Depositary may, and at the request of the Company will, distribute to any
Owners to whom it determines the distribution to be lawful and feasible, in
proportion to the number of ADSs held by such Owner, warrants or other
instruments therefor in such form as it deems appropriate.
If the Depositary determines that it is not lawful or feasible to make such
rights available to all or certain Owners, it may, and at the request of the
Registrant, will use its best efforts that are reasonable under the
circumstances to, sell the rights, warrants or other instruments in proportion
to the number of ADSs held by the Owners to whom it has determined it may not
lawfully or feasibly make such rights available, and allocate net proceeds of
such sales for the account of such Owners otherwise entitled to such rights,
warrants or other instruments, upon an averaged or other practical basis
without regard to any distinctions among such Owners because of exchange
restrictions or the date of delivery of any ADR or ADRs or otherwise. The
Depositary will not be responsible for any failure to determine that it may be
lawful or feasible to make such rights available to Owners in general or any
Owner or Owners in particular.
In circumstances in which rights would not otherwise be distributed, if an
Owner requests the distribution of warrants or other instruments in order to
exercise the rights allocable to the ADSs of such Owner, the Depositary will
promptly make such rights available to such Owner upon written notice from the
Registrant to the Depositary that (a) the Registrant has elected in its sole
discretion to permit such rights to be exercised and (b) such Owner has
executed such documents as the Registrant has determined in its sole
discretion are reasonably required under applicable law. Upon instruction
pursuant to such warrants or other instruments to the Depositary from such
Owner to exercise such rights, upon payment by such Owner to the Depositary
for the account of such Owner of an amount equal to the purchase price of the
Preferred Shares to be received in exercise of the rights, and upon payment of
the fees of the Depositary as set forth in such warrants or other instruments,
the Depositary will, on behalf of such Owner, exercise the rights and purchase
the Preferred Shares, and the Registrant will cause the Preferred Shares so
purchased to be delivered to the Depositary on behalf of such Owner. As agent
for such Owner, the Depositary will cause the Preferred Shares so purchased to
be deposited, and will execute and deliver ADRs to such Owner, pursuant to the
Deposit Agreement. Such a disposal of rights may reduce the Owners'
proportionate equity interest in the Registrant.
The Depositary will not offer rights to Owners having an address of record
in the United States unless a registration statement under the Securities Act
is in effect with respect to such rights and the Securities to which such
rights relate or unless the offering and sale thereof to such Owners are
exempt from registration under the Securities Act; however, the Registrant
will have no obligation to file a registration statement under the Securities
Act to make available to Owners any right to subscribe for or to purchase any
of the Securities.
Whenever the Depositary receives any distribution other than cash, Preferred
Shares or rights in respect of the Deposited Securities, the Depositary will,
as promptly as practicable, cause the securities or property received
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by it to be distributed to the Owners entitled thereto, after deduction or
upon payment of any fees and expenses of the Depositary or any taxes or other
governmental charges, in proportion to their holdings, respectively, in any
manner that the Depositary may deem equitable and practicable for
accomplishing such distribution; provided, however, that if in the opinion of
the Depositary such distribution cannot be made proportionately among the
Owners entitled thereto, or if for any other reason (including, but not
limited to, any requirement that the Registrant or the Depositary withhold an
amount on account of taxes or other governmental charges or that such
securities must be registered under the Securities Act, in order to be
distributed to Owners) the Depositary deems such distribution not to be
feasible, the Depositary may, after consultation with the Registrant, adopt
such method as it may deem equitable and practicable for the purpose of
effecting such distribution, including, but not limited to, the public or
private sale of the securities or property thus received, or any part thereof,
and the net proceeds of any such sale (net of the fees and expenses of the
Depositary) will be distributed by the Depositary to the Owners entitled
thereto as in the case of a distribution received in cash.
In connection with any distribution to Owners, the Registrant will remit to
the appropriate governmental authority or agency all amounts (if any) required
to be withheld by the Registrant and owing to such authority or agency by the
Registrant; and the Depositary and the Custodian will remit to the appropriate
governmental authority or agency all amounts (if any) required to be withheld
and owing to such authority or agency by the Depositary or Custodian. If the
Depositary determines that any distribution of property other than cash
(including Preferred Shares and rights to subscribe therefor) is subject to
any tax or governmental charge that the Depositary is obligated to withhold,
the Depositary may, by public or private sale, dispose of all or a portion of
such property in such amounts and in such manner as the Depositary deems
necessary and practicable to pay such taxes or governmental charges, and the
Depositary will distribute the net proceeds of any such sale or the balance of
any such property after deduction of such taxes or governmental charges to the
Owners entitled thereto in proportion to the number of ADSs held by them,
respectively.
Upon any change in nominal or par value, or split-up, consolidation or any
other reclassification of Deposited Securities, or upon any recapitalization,
reorganization, merger or consolidation or sale of assets affecting the
Registrant or to which it is a party, any Preferred Shares or other securities
that will be received by the Depositary or the Custodian in exchange for, in
conversion of, or in respect of Deposited Securities will be treated as new
Deposited Securities under the Deposit Agreement, and ADSs will thenceforth
represent, in addition to the existing Deposited Securities, the right to
receive the new Deposited Securities so received in exchange or conversion,
unless additional ADRs are delivered pursuant to the following sentence. In
any such case the Depositary may, and will if the Company so requests, execute
and deliver additional ADRs as in the case of a distribution in Preferred
Shares, or call for the surrender of outstanding ADRs to be exchanged for new
ADRs specifically describing such new Deposited Securities.
RECORD DATES
Whenever any cash dividend or other cash distribution shall become payable,
or whenever any distribution other than cash shall be made, or whenever rights
shall be issued with respect to the Deposited Securities, or whenever for any
reason the Depositary causes a change in the number of Preferred Shares that
are represented by each ADS or whenever the Depositary shall receive notice of
any meeting of holders of Preferred Shares or other Deposited Securities, or
whenever the Depositary shall find it necessary or convenient, the Depositary
will fix a record date, which date shall, to the extent practicable, be either
the same date as the record date fixed by the Registrant or, if different from
the record date fixed by the Registrant, fixed after consultation with the
Registrant, (a) for the determination of the Owners who will be (i) entitled
to receive such dividend, distribution of rights, or the net proceeds of the
sale thereof, or (ii) entitled to give instructions for the exercise of voting
rights at any such meeting, or (b) on or after which such ADS will represent
the changed number of Preferred Shares, all subject to the provisions of the
Deposit Agreement.
VOTING OF THE DEPOSITED SECURITIES
Preferred Shares do not entitle the holders thereof to vote on any matter
presented to a vote of shareholders of the Registrant except as set forth
under "--Capital Stock--Voting Rights." With respect to the circumstances
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set forth thereunder and if, in the future, the terms of the Preferred Shares
should be revised or amended so as to provide for voting rights, or should the
Preferred Shares obtain voting rights pursuant to the Brazilian Corporation
Law or through any change in the laws, rules, or regulations applicable to
such shares or through any change in interpretation of such laws, the
following shall apply.
As soon as practicable after receipt of notice of any meeting or
solicitation of consents or proxies of holders of Preferred Shares or other
Deposited Securities, if requested in writing by the Registrant, the
Depositary will, as soon as practicable thereafter, mail to all Owners a
notice, the form of which notice will be in the sole discretion of the
Depositary, containing (a) the information included in such notice of meeting
received by the Depositary from the Registrant (or a summary in English of the
notice of such meeting), (b) a statement that the Owners as of the close of
business on a specified record date will be entitled, subject to any
applicable provision of Brazilian law, the By-laws and the provisions of the
Deposited Securities, to instruct the Depositary as to the exercise of the
voting rights, if any, pertaining to the Preferred Shares or other Deposited
Securities represented by their respective ADSs and (c) a statement as to the
manner in which such instructions may be given, including an express
indication that instructions may be given or deemed given in accordance with
the last sentence of this paragraph if no instruction is received, to the
Depositary to give a discretionary proxy to a person designated by the
Registrant. Upon the written request of an Owner on such record date, received
on or before the date established by the Depositary for such purpose, the
Depositary will endeavor, insofar as practicable, to vote or cause to be voted
the amount of Preferred Shares or other Deposited Securities represented by
the ADSs evidenced by such ADRs in accordance with the instructions set forth
in such request. The Depositary may not itself exercise any voting discretion
over any Preferred Shares. If the Depositary does not receive instructions
from an Owner on or before the date established by the Depositary for such
purpose, the Depositary will deem such Owner to have instructed the Depositary
to give a discretionary proxy to a person designated by the Registrant to vote
the underlying Preferred Shares, provided that no such discretionary proxy
will be given with respect to any matter as to which the Registrant informs
the Depositary that (i) the Registrant does not wish such proxy given, (ii)
substantial opposition exists or (iii) the rights of holders of Preferred
Shares will be materially and adversely affected. Under Brazilian law the
Depositary may vote the Preferred Shares or other Deposited Securities
represented by ADSs and evidenced by ADRs in accordance with the instructions
of the Owners even if those instructions differ among such Owners.
Owners are not entitled to attend meetings of shareholders. An Owner of ADRs
wishing to do so must cancel its ADRs and obtain delivery of the underlying
shares, registered in the name of such Owner, prior to the record date for
attendance at such meeting.
REPORTS AND OTHER COMMUNICATIONS
The Depositary will make available for inspection by Owners at its Corporate
Trust Office any reports and communications, including any proxy soliciting
material, received from the Registrant, which are both (a) received by the
Depositary as the holder of the Deposited Securities and (b) made generally
available to holders of such Deposited Securities by the Registrant. The
Depositary will also send to Owners copies of such reports when furnished by
the Registrant pursuant to the Deposit Agreement. Any such reports and
communications furnished to the Depositary by the Registrant will be furnished
in English, to the extent that such materials are required to be translated
into English pursuant to any regulations of the Commission.
AMENDMENT AND TERMINATION OF THE DEPOSIT AGREEMENT
The form of the ADRs and any provision of the Deposit Agreement may at any
time and from time to time be amended by agreement between the Registrant and
the Depositary in any respect which they may deem necessary or desirable. Any
amendment that imposes or increases any fees or charges (other than taxes and
other governmental charges, registration fees, cable, telex or facsimile
transmission costs, delivery costs or other such expenses), or which otherwise
prejudices any substantial existing rights of Owners, will not take effect as
to the outstanding ADRs until the expiration of 30 days after notice of such
amendment has been given to the Owners of outstanding ADRs. Every Owner and
Beneficial Owner at the time such amendment becomes effective will
77
<PAGE>
be deemed, by continuing to hold such ADR, to consent and agree to such
amendment and to be bound by the Deposit Agreement as amended thereby. In no
event will any amendment impair the right of any Owner to surrender his ADR
and receive therefor the Preferred Shares and other property represented
thereby, except to comply with mandatory provisions of applicable law.
The Depositary will at any time at the direction of the Registrant terminate
the Deposit Agreement by mailing notice of such termination to the Owners then
outstanding at least 30 days prior to the date fixed in such notice for such
termination. The Depositary may likewise terminate the Deposit Agreement by
mailing notice of such termination to the Registrant and the Owners, if at any
time after 60 days have expired after the Depositary shall have delivered
written notice of its election to resign to the Registrant, a successor
depositary shall not have been appointed and accepted its appointment, in
accordance with the terms of the Deposit Agreement. If any ADRs remain
outstanding after the date of termination, the Depositary thereafter will
discontinue the registration of transfer of ADRs, will suspend the
distribution of dividends to the holders thereof and will not give any further
notices or perform any further acts under the Deposit Agreement, except for
(1) the collection of dividends and other distributions pertaining to the
Deposited Securities, (2) the sale of rights and other property and (3) the
delivery of Preferred Shares, together with any dividends or other
distributions received with respect thereto and the net proceeds of the sale
of any rights or other property, in exchange for surrendered ADRs (after
deducting, in each case, the fees of the Depositary for the surrender of an
ADR and other expenses set forth in the Deposit Agreement and any applicable
taxes or governmental charges).
At any time after the expiration of one year from the date of termination,
the Depositary may sell the Deposited Securities then held thereunder and hold
uninvested the net proceeds of such sale, together with any other cash,
unsegregated and without liability for interest, for the pro rata benefit of
the Owners that have not theretofore surrendered their ADRs, such Owners
thereupon becoming general creditors of the Depositary with respect to such
net proceeds. After making such sale, the Depositary will be discharged from
all obligations under the Deposit Agreement, except to account for net
proceeds and other cash (after deducting, in each case, the fee of the
Depositary and other expenses set forth in the Deposit Agreement for the
surrender of an ADR and any applicable taxes or other governmental charges)
and certain indemnification obligations. Upon termination of the Deposit
Agreement, the Registrant will also be discharged from all obligations
thereunder, except for certain obligations to the Depositary.
CHARGES OF DEPOSITARY
The Depositary will charge (to the extent permitted by applicable law) any
party depositing or withdrawing Preferred Shares or any party surrendering
ADRs or to whom ADRs are issued (including, without limitation, issuance
pursuant to a stock dividend or stock split declared by the Company or an
exchange of stock regarding the ADRs or Deposited Securities or a distribution
of ADRs pursuant to the Deposit Agreement), whichever is applicable: (1) taxes
and other governmental charges, (2) such registration fees as may from time to
time be in effect for the registration of transfers of Preferred Shares
generally on the register of the Registrant or the Registrar and applicable to
transfers of Preferred Shares to the name of the Depositary or its nominee or
the Custodian or its nominee on the making of deposits or withdrawals under
the Deposit Agreement, (3) such cable, telex and facsimile transmission
expenses as are expressly provided in the Deposit Agreement to be at the
expense of persons depositing Preferred Shares or Owners, (4) such expenses as
are incurred by the Depositary in the conversion of foreign currency pursuant
to the Deposit Agreement, (5) a fee not in excess of $5.00 per 100 ADSs (or
portion thereof) for the execution and delivery of ADRs pursuant to the
Deposit Agreement and the surrender of ADRs pursuant to the Deposit Agreement,
(6) a fee for the distribution of proceeds of sales of securities or rights
pursuant to the Deposit Agreement, such fee (which may be deducted from such
proceeds) being in an amount equal to the lesser of (i) the fee for issuance
of ADSs referred to above which would have been charged as a result of the
deposit of such securities (for purposes of this clause treating all such
securities as if they were Preferred Shares) or Preferred Shares received in
exercise of rights distributed to them pursuant to the Deposit Agreement, but
which securities or rights are instead sold by the Depositary and the net
proceeds distributed and (ii) the amount of such proceeds.
78
<PAGE>
The Depositary, pursuant to the Deposit Agreement, may own and deal in any
class of securities of the Company and its affiliates and in ADRs.
LIABILITY OF OWNERS OR BENEFICIAL OWNERS FOR TAXES OR OTHER CHARGES
If any tax or other governmental charge shall become payable by the
Custodian, the Depositary or its nominee as the registered holder of any
deposited Preferred Shares represented by ADSs evidenced by any ADR with
respect to any ADR or any Deposited Securities represented by the ADSs
evidenced by such ADR, such tax or other governmental charge will be payable
by the Owner or Beneficial Owner of such ADR. The Depositary may refuse to
effect registration of transfer of such ADR or any split-up or combination
thereof or any withdrawal of Deposited Securities underlying such ADR until
such payment is made, and may withhold any dividends or other distributions or
may sell for the account of such Owner or Beneficial Owner any part or all of
the Deposited Securities underlying such ADR and may apply such dividends or
distributions or the proceeds of any such sale in payment of any such tax or
other governmental charge (and any taxes or expenses arising out of such sale)
and the Owner or Beneficial Owner of such ADR will remain liable for any
deficiency.
LIMITATION ON EXECUTION, DELIVERY, TRANSFER AND SURRENDER OF ADRS
The ADRs are transferable on the books of the Depositary, provided that the
Depositary may close the transfer books after consultation with the Registrant
to the extent practicable at any time or from time to time when deemed
expedient by it in connection with the performance of its duties or at the
request of the Registrant.
As a condition precedent to the execution and delivery, registration of
transfer, split-up, combination or surrender of any ADR, the delivery of any
distribution thereon or the withdrawal of Deposited Securities, the
Depositary, the Registrant, the Custodian or the Registrar may require payment
from the depositor of Preferred Shares or the presenter of the ADR of a sum
sufficient to reimburse it for any tax or other governmental charge and any
stock transfer or registration fee with respect thereto (including any such
tax, charge or fee with respect to Preferred Shares being deposited or
withdrawn) and payment of any other applicable fees provided for in the
Deposit Agreement. The Depositary may refuse to deliver ADRs, register the
transfer of any ADR or make any distribution of, or related to, the Preferred
Shares until it has received such proof of citizenship, residence, exchange
control approval, compliance with all applicable laws or regulations, or other
information as it may reasonably deem necessary or proper. The delivery,
transfer, registration of transfer, split-up, combination and surrender of
ADRs generally may be suspended or refused during any period when the transfer
books of the Depositary, the Registrant or the Registrar are closed or if any
such action is deemed necessary or advisable by the Depositary or the
Registrant, at any time or from time to time.
The Depositary will keep books, at its Corporate Trust Office, for the
registration and transfer of ADRs, which at all reasonable times will be open
for inspection by the Owners, provided that such inspection will not be for
the purpose of communicating with Owners in the interest of a business or
object other than the business of the Registrant or a matter related to the
Deposit Agreement or the ADRs.
The Depositary may upon notice to the Registrant appoint one or more co-
transfer agents reasonably acceptable to the Registrant for the purpose of
effecting transfers, combinations and split-ups of ADRs at designated transfer
offices on behalf of the Depositary. In carrying out its functions, a co-
transfer agent may require evidence of authority and compliance with
applicable laws and other requirements by Owners or persons entitled to ADRs
and will be entitled to protection and indemnity to the same extent as the
Depositary.
LIMITATION OF LIABILITY
Neither the Depositary nor the Registrant nor any of their respective
directors, employees, agents or affiliates will be liable to any Owners or
Beneficial Owners of ADRs if by reason of any provision of any present or
future law or regulation of the United States, Brazil or any other country, or
of any other governmental or regulatory authority or stock exchange, or by
reason of any provision, present or future, of the By-laws, or by reason of
any act of God or war or other circumstance beyond its control, the Depositary
or the Registrant or
79
<PAGE>
any of their respective directors, employees, agents, or affiliates shall be
prevented, delayed or forbidden from, or be subject to any civil or criminal
penalty on account of, doing or performing any act or thing which by terms of
the Deposit Agreement it is provided will be done or performed; nor will the
Depositary or the Registrant incur any liability to any Owner or Beneficial
Owner of any ADR by reason of any nonperformance or delay, caused as
aforesaid, in the performance of any act or thing which by the terms of the
Deposit Agreement it is provided will or may be done or performed, or by
reason of any exercise of, or failure to exercise, any discretion provided for
under the Deposit Agreement. Where, by the terms of a distribution pursuant to
the Deposit Agreement, or an offering or distribution pursuant to the Deposit
Agreement, or for any other reason, the Depositary is prevented or prohibited
from making such distribution or offering available to Owners, and the
Depositary is prevented or prohibited from making such distribution or
offering on behalf of such Owners and making the net proceeds available to
such Owners, then the Depositary, after consultation with the Registrant, will
not make such distribution or offering, and will allow the rights, if
applicable, to lapse.
The Registrant and the Depositary assume no obligation nor will they be
subject to any liability under the Deposit Agreement to Owners or Beneficial
Owners of ADRs, except that they agree to perform their respective obligations
specifically set forth under the Deposit Agreement without negligence or bad
faith.
GOVERNING LAW
The Deposit Agreement is governed by the laws of the State of New York.
80
<PAGE>
PART III
ITEM 15: DEFAULTS UPON SENIOR SECURITIES
The Company is party to certain credit agreements that contain covenants
restricting, among other things, (i) the ability of Telebras to dispose of all
or a substantial part of its assets or to cease to control a company that was
an operating subsidiary of the Telebras System and (ii) the ability of the
Federal Government to dispose of its controlling interest in the Telebras
System. The Breakup of Telebras on May 22, 1998, the privatization of the New
Holding Companies on July 29, 1998 and the announced liquidation of Telebras
constitute events of default under such credit agreements. In addition, most
of the Company's other credit agreements include cross-default provisions and
cross-acceleration provisions that would permit the holders of such
indebtedness to declare the indebtedness to be in default and to accelerate
the maturity thereof if a significant portion of the principal amount of the
Company's debt is in default or accelerated. The total amount of the Company's
outstanding debt as of December 31, 1997 which is currently or expected to be
in default is approximately R$133.1 million. The Company is currently in
negotiations with the appropriate creditors with respect to this indebtedness.
Although none of the Company's creditors have notified the Company that they
intend to pursue their rights and remedies with respect to these defaults,
there can be no assurance that the Company will be able to obtain waivers or
that the creditors will not exercise their rights and remedies under the
credit agreements.
ITEM 16: CHANGES IN SECURITIES AND CHANGES IN SECURITY FOR REGISTERED
SECURITIES
Not applicable.
PART IV
ITEM 17: CONSOLIDATED FINANCIAL STATEMENTS
The Registrant has responded to Item 18 in lieu of responding to this Item.
ITEM 18: CONSOLIDATED FINANCIAL STATEMENTS
Reference is made to pages F-1 through F-44.
ITEM 19: CONSOLIDATED FINANCIAL STATEMENTS AND EXHIBITS
(a) The following Consolidated Financial Statements are filed as part of
this Form 20-F:
Independent Auditors' Report
Consolidated Balance Sheets as of December 31, 1996 and 1997
Consolidated Statements of Income for the Years Ended December 31, 1995,
1996 and 1997
Consolidated Statements of Cash Flows for the Years Ended December 31,
1995, 1996 and 1997
Consolidated Statements of Changes in Shareholders' Equity for the Years
Ended December 31, 1995, 1996 and 1997
Notes to the Consolidated Financial Statements
(b) Exhibits
<TABLE>
<C> <S>
1.1* Charter of the Registrant
1.2* Charter of the Registrant (English translation)
2.1* Deposit Agreement dated as of July 27, 1998 among the Registrant,
The Bank of New York, as Depositary, and Owners and Beneficial
Owners of American Depositary Receipts issued thereunder
</TABLE>
81
<PAGE>
<TABLE>
<C> <S>
10.1* Standard Concession Agreement for Local, Switched, Fixed-Line
Telephone Service and Schedule of Omitted Concession Agreements
10.2* Standard Concession Agreement for Local, Switched, Fixed-Line
Telephone Service and Schedule of Omitted Concession Agreements
(English translation)
10.3* Standard Concession Agreement for Domestic Long-Distance,
Switched, Fixed-Line Telephone Service and Schedule of Omitted
Concession Agreements
10.4* Standard Concession Agreement for Domestic Long-Distance,
Switched, Fixed-Line Telephone Service and Schedule of Omitted
Concession Agreements (English translation)
23.1** Consent of KPMG Peat Marwick
</TABLE>
- --------
* Previously filed
** Filed herewith
82
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 12 of the Securities Exchange Act of
1934, the Registrant certifies that it meets all of the requirements by filing
on Form 20-F and has duly caused this amendment to its registration statement
on Form 20-F, Commission File No. 001-14487, to be signed on its behalf by the
undersigned, thereunto duly authorized.
Tele Norte Leste Participacoes S.A.
/s/ Geraldo Pereira de Araujo
By: _________________________________
Name: Geraldo Pereira de Araujo
Title: President
/s/ Otavio Marques de Azevedo
By: _________________________________
Name: Otavio Marques de Azevedo
Title: Vice President
Dated: November 2, 1998
83
<PAGE>
TELE NORTE LESTE PARTICIPACOES S.A.
CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
CONTENTS
<TABLE>
<S> <C>
Independent Auditors' Report.................................. F-2
Consolidated Balance Sheets................................... F-3
Consolidated Statements of Income............................. F-4
Consolidated Statements of Cash Flows......................... F-5
Consolidated Statements of Changes in Shareholders' Equity.... F-6
Notes to the Consolidated Financial Statements................ F-7 through F-45
</TABLE>
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders
Tele Norte Leste Participacoes S.A.
Brasilia--DF
We have audited the accompanying consolidated balance sheets of Tele Norte
Leste Participacoes S.A. as of December 31, 1996 and 1997, and the related
consolidated statements of income, cash flows and changes in shareholders'
equity for each of the years in the three-year period ended December 31, 1997.
These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards in Brazil, which do not differ in any material respects from
generally accepted auditing standards in the United States of America. Those
standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence
supporting amounts and disclosures in the consolidated financial statements.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Tele Norte
Leste Participacoes S.A. as of December 31, 1996 and 1997, and the results of
its operations and cash flows for each of the years in the three-year period
ended December 31, 1997, in conformity with accounting principles generally
accepted in Brazil, including continued recognition of the effects of changes
in the purchasing power of the Brazilian currency as discussed in Note 2.
Generally accepted accounting principles in Brazil vary in certain respects
from generally accepted accounting principles in the United States of America.
Application of generally accepted accounting principles in the United States
of America would have affected results of operations for each of the years in
the two-year period ended December 31, 1997 and shareholders' equity as of
December 31, 1996 and 1997 to the extent summarized in Note 29 of the
consolidated financial statements.
July 17, 1998
Brasilia, Brazil
KPMG Peat Marwick
F-2
<PAGE>
TELE NORTE LESTE PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1996 AND 1997
(IN THOUSANDS OF CONSTANT BRAZILIAN REAIS--R$ OF
DECEMBER 31, 1997 AND THOUSANDS OF US DOLLARS--US$)
<TABLE>
<CAPTION>
DECEMBER 31
----------------------------------
1996 1997 1997
NOTE R$ R$ US$
----- ---------- ---------- ------------
(UNAUDITED
SEE NOTE 2B)
<S> <C> <C> <C> <C>
Current assets:
Cash and cash equivalents:
Deposits with Banco do Brasil........ 24 358,309 159,202 142,603
Other cash and cash equivalents...... 10 59,907 55,037 49,299
Accounts receivable:
Trade, net........................... 11 654,766 709,862 635,850
Receivables from related parties..... 24 19,087 11,352 10,168
Deferred and recoverable taxes....... 12 71,330 181,663 162,722
Other assets:
Other accounts receivable from
related parties..................... 24 5,960 26,643 23,864
Other................................ 13 258,268 247,822 221,984
---------- ---------- ----------
Total current assets................. 1,427,627 1,391,581 1,246,490
---------- ---------- ----------
Noncurrent assets:
Deferred and recoverable taxes....... 12 41,932 36,153 32,384
Other assets:
Other accounts receivable from
related parties..................... 24 800 2,080 1,863
Other................................ 13 28,950 60,329 54,039
---------- ---------- ----------
Total noncurrent assets.............. 71,682 98,562 88,286
---------- ---------- ----------
Permanent assets:
Investments.......................... 14 8,480 14,717 13,183
Property, plant and equipment, net... 15 11,944,570 13,282,386 11,897,515
---------- ---------- ----------
Total permanent assets............... 11,953,050 13,297,103 11,910,698
---------- ---------- ----------
Net assets of discontinued
operations........................... 1,293,550 1,848,554 1,655,817
---------- ---------- ----------
Total assets......................... 14,745,909 16,635,800 14,901,291
========== ========== ==========
Current liabilities:
Payroll and related accruals......... 16 237,531 201,191 180,214
Accounts payable and accrued
expenses:
Suppliers............................ 497,383 425,962 381,550
Payable to related parties........... 24 86,242 66,766 59,804
Taxes other than income taxes........ 17 168,631 269,434 241,342
Dividends............................ 18 341,870 556,142 498,157
Income taxes......................... 8 141,333 111,392 99,778
Loans and financing:
Payable to Telebras.................. 19,24 628,623 614,768 550,670
Other financing...................... 19 46,301 128,823 115,391
Provisions for contingencies......... 20 67,944 84,967 76,108
Other liabilities.................... 42,614 36,883 33,037
---------- ---------- ----------
Total current liabilities............ 2,258,472 2,496,328 2,236,051
---------- ---------- ----------
Noncurrent liabilities:
Income taxes......................... 8 430,352 585,394 524,359
Loans and financing:
Payable to Telebras.................. 19,24 678,337 703,463 630,118
Other financing...................... 21 222,146 176,499 158,096
Pension fund liabilities.............. 1,540 -- --
Provisions for contingencies.......... 20 47,443 53,954 48,329
Other liabilities..................... 14,607 24,202 21,679
---------- ---------- ----------
Total noncurrent liabilities......... 1,394,425 1,543,512 1,382,581
---------- ---------- ----------
Minority interests.................... 2 1,508,920 2,730,761 2,446,042
Shareholders equity:
Capital and reserves................. 7,715,186 8,204,179 7,348,781
Retained earnings.................... 909,962 1,282,329 1,148,629
---------- ---------- ----------
Total shareholders' equity............ 22 8,625,148 9,486,508 8,497,410
Funds for capitalization:
Expansion plan contributions......... 942,007 309,898 277,587
Other funds.......................... 16,937 68,793 61,620
---------- ---------- ----------
Total funds for capitalization....... 958,944 378,691 339,207
---------- ---------- ----------
Total liabilities and shareholders'
equity.............................. 14,745,909 16,635,800 14,901,291
========== ========== ==========
</TABLE>
See the accompanying notes to the consolidated financial statements.
F-3
<PAGE>
TELE NORTE LESTE PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
(IN THOUSANDS OF CONSTANT BRAZILIAN REAIS--R$ OF
DECEMBER 31, 1997 AND THOUSANDS OF US DOLLARS--US$)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31
------------------------------------------------
1995 1996 1997 1997
NOTE R$ R$ R$ US$
---- ---------- ---------- ---------- ------------
(UNAUDITED,
SEE NOTE 2B)
<S> <C> <C> <C> <C> <C>
Net operating revenue
from telecommunications
services:
Services provided to
third parties.......... 3,119,628 4,081,092 4,612,012 4,131,146
Services provided to the
Telebras operating com-
panies................. 24 123,050 192,714 347,281 311,073
---------- ---------- ---------- ----------
4 3,242,678 4,273,806 4,959,293 4,442,219
Cost of services:
Provided by third par-
ties................... (1,995,033) (2,106,050) (2,121,865) (1,900,631)
Provided by the Telebras
operating companies.... 24 (114,584) (237,550) (449,487) (402,622)
---------- ---------- ---------- ----------
5 (2,109,617) (2,343,600) (2,571,352) (2,303,253)
---------- ---------- ---------- ----------
Gross profit............. 1,133,061 1,930,206 2,387,941 2,138,966
Operating expenses:
Selling expense......... (297,306) (382,718) (544,060) (487,334)
General and administra-
tive expense........... (715,407) (827,894) (816,487) (731,357)
Other net operating in-
come................... 6 185,713 191,959 248,667 222,740
---------- ---------- ---------- ----------
Operating income from
continuing operations
before interest
income/expense......... 306,061 911,553 1,276,061 1,143,015
Allocated interest ex-
pense.................. (58,525) (61,780) (46,263) (41.439)
---------- ---------- ---------- ----------
Operating income from
continuing operations
before unallocated
interest
income/expense.......... 247,536 849,773 1,229,798 1,101,576
Net nonoperating
expense................. 7 (22,594) (10,239) (60,089) (53,824)
Employees' profit share.. (9,221) (30,197) (60,429) (54,128)
---------- ---------- ---------- ----------
Income from continuing
operations before unal-
located interest
income/expense, taxes
and minority interests.. 215,721 809,337 1,109,280 993,624
Income from discontinued
cellular operations
before unallocated
interest income/expense,
taxes and minority
interests............... 2d 316,876 679,409 788,790 706,548
Unallocated interest
income.................. 51,836 45,373 126,554 113,359
Unallocated interest
expense................. (119,368) (121,374) (128,544) (115,141)
---------- ---------- ---------- ----------
Income before taxes and
minority interests...... 465,065 1,412,745 1,896,080 1,698,390
Income and social
contribution taxes...... 8 (274,414) (386,464) (484,844) (434,292)
---------- ---------- ---------- ----------
Income before minority
interests............... 190,651 1,026,281 1,411,236 1,264,098
Minority interests....... 2 (18,249) (152,316) (312,351) (279,784)
---------- ---------- ---------- ----------
Net income............... 172,402 873,965 1,098,885 984,314
========== ========== ========== ==========
</TABLE>
See the accompanying notes to the consolidated financial statements.
F-4
<PAGE>
TELE NORTE LESTE PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
(IN THOUSANDS OF CONSTANT BRAZILIAN REAIS--R$ OF
DECEMBER 31, 1997 AND THOUSANDS OF US DOLLARS--US$)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31
------------------------------------------------
1995 1996 1997 1997
R$ R$ R$ US$
---------- ---------- ---------- ------------
(UNAUDITED
SEE NOTE 2B)
<S> <C> <C> <C> <C>
OPERATING ACTIVITIES:
Net income................... 172,402 873,965 1,098,885 984,314
Less: Income from
discontinued cellular
operations before
unallocated interest
income/expense,taxes and
minority interests.......... (316,876) (679,409) (788,790) (706,548)
---------- ---------- ---------- ----------
Income from continuing
operations, net of
unallocated interest
income/expense and taxes
applicable to both
continuing and discontinued
operations.................. (144,474) 194,556 310,095 277,766
Adjustments to reconcile net
income to cash provided by
operating activities:
Depreciation and
amortization................ 1,220,427 1,299,947 1,367,505 1,224,924
Minority interests........... 18,249 152,316 312,351 279,784
Loss on permanent asset
disposals................... 28,371 47,703 78,732 70,523
Other provisions............. 4,970 4,054 6,427 5,757
Allowance for doubtful
accounts.................... 7,441 28,316 101,375 90,805
(Increase) decrease in income
tax rate.................... 147,467 (7,742) (7,673) (6,873)
(Increase) in trade accounts
receivable.................. (101,520) (175,571) (148,736) (133,228)
(Increase) in other current
assets...................... (8,941) (100,814) (10,237) (9,170)
(Increase) decrease in other
noncurrent assets........... 3,688 (5,319) (7,873) (7,052)
Increase (decrease) in
payroll and related
accruals.................... 6,156 13,083 (36,340) (32,551)
Increase (decrease) in
accounts payable and accrued
expenses.................... 150,425 223,585 (90,897) (81,420)
Increase in taxes other than
income taxes................ 13,331 36,011 100,803 90,293
Increase (decrease) in other
current liabilities......... (8,595) 23,540 (5,731) (5,133)
Increase (decrease) in
accrued interest............ 10,028 (35,032) 44,420 39,789
Increase (decrease) in income
taxes....................... 35,073 (22,544) (217,680) (194,984)
Increase in provisions for
contingencies............... 49,399 10,086 23,534 21,080
Increase (decrease) in
provision for pension fund.. -- 1,540 (1,540) (1,379)
Increase (decrease) in other
noncurrent liabilities...... 22,594 (13,490) 9,595 8,595
---------- ---------- ---------- ----------
1,454,089 1,674,225 1,828,130 1,637,526
---------- ---------- ---------- ----------
INVESTING ACTIVITIES:
Additions to investments..... (6,234) 11,307 (2,394) (2,144)
Proceeds from investment
disposals................... 6,561 1,980 1,124 1,007
Additions to property plant
and equipment............... (1,653,758) (2,217,123) (2,552,261) (2,286,153)
Capitalized interest......... (150,577) (10,977) (65,765) (58,908)
Proceeds from asset
disposals................... 47,187 64,843 36,033 32,276
---------- ---------- ---------- ----------
(1,756,821) (2,149,970) (2,583,263) (2,313,922)
---------- ---------- ---------- ----------
FINANCING ACTIVITIES:
Loans repaid................. (716,145) (1,553,927) (1,250,222) (1,119,869)
New loans obtained........... 670,672 1,397,714 1,253,948 1,123,207
Cash received for future
capital increases........... 344,099 924,365 600,540 537,925
Purchase of treasury shares.. -- -- (153) (137)
Dividends paid............... (57,325) (138,029) (265,245) (237,590)
---------- ---------- ---------- ----------
241,301 630,123 338,868 303,536
---------- ---------- ---------- ----------
Increase (decrease) in cash
and cash equivalents from
continuing operations........ (61,431) 154,378 (416,265) (372,860)
Net cash provided by
discontinued operations,
before unallocated interest
income/expense and taxes .... 126,085 54,648 212,288 190,154
Cash and cash equivalents at
beginning of year............ 144,536 209,190 418,216 374,608
---------- ---------- ---------- ----------
Cash and cash equivalents at
end of year.................. 209,190 418,216 214,239 191,902
========== ========== ========== ==========
</TABLE>
See the accompanying notes to the consolidated financial statements.
F-5
<PAGE>
TELE NORTE LESTE PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
(IN THOUSANDS OF CONSTANT BRAZILIAN REAIS--R$ OF DECEMBER 31, 1997)
<TABLE>
<CAPTION>
CAPITAL AND RETAINED
RESERVES EARNINGS TOTAL
----------- --------- ---------
<S> <C> <C> <C>
Balances at December 31, 1994.............. 6,414,080 475,400 6,889,480
Capital increase:
Expansion plan contributions.............. 355,258 -- 355,258
Resources from Telebras................... 321,386 -- 321,386
Other cash................................ 36,926 -- 36,926
Donations and subsidies for investments.... 241 -- 241
Interest on construction in progress....... 41,874 -- 41,874
Change in tax rates........................ 58,091 89,376 147,467
Fiscal incentives.......................... 5,423 -- 5,423
Forfeited dividends........................ -- 59 59
Net income................................. -- 172,402 172,402
Realization of unrealized income........... (51,903) 51,903 --
Appropriations:
Transfers to reserves...................... 133,974 (133,974) --
Dividends.................................. -- (171,914) (171,914)
Minority interest movements................ (53,695) 20,354 (33,341)
---------- --------- ---------
Balances at December 31, 1995.............. 7,261,655 503,606 7,765,261
Capital increase:
Expansion plan contributions............... 273,391 -- 273,391
Resources from Telebras.................... 1,256 -- 1,256
Other resources............................ 42,483 -- 42,483
Donations and subsidies for investments.... 4,009 -- 4,009
Interest on construction in progress....... 235,117 -- 235,117
Change in tax rates........................ (13,114) 5,372 (7,742)
Fiscal incentives.......................... 22,107 -- 22,107
Forfeited dividends........................ -- 29 29
Net income................................. -- 873,965 873,965
Realization of unrealized income........... (81,751) 81,751 --
Deferred tax on full indexation............ -- (287,953) (287,953)
Appropriations:
Transfers to reserves...................... 46,871 (46,871) --
Dividends.................................. -- (301,300) (301,300)
Minority interest movements................ (76,838) 81,363 4,525
---------- --------- ---------
Balances at December 31, 1996.............. 7,715,186 909,962 8,625,148
Capital increase:
Expansion plan contributions............... 152,843 -- 152,843
Resources from Telebras.................... 2,708 -- 2,708
Other resources............................ 1,025,242 -- 1,025,242
Donations and subsidies for investments.... 9,349 -- 9,349
Interest on construction in progress....... 224,583 -- 224,583
Change in tax rates........................ 3,017 (10,690) (7,673)
Fiscal incentives.......................... 36,180 -- 36,180
Forfeited dividends........................ -- 909 909
Acquisition of treasury shares............. -- (153) (153)
Net income................................. -- 1,098,885 1,098,885
Realization of unrealized income........... (27,121) 27,121 --
Deferred tax on full indexation............ -- (291,597) (291,597)
Appropriations:
Transfers to reserves...................... 69,757 (69,757) --
Dividends.................................. -- (480,426) (480,426)
Minority interest movements................ (1,007,565) 98,075 (909,490)
---------- --------- ---------
Balances at December 31, 1997.............. 8,204,179 1,282,329 9,486,508
========== ========= =========
</TABLE>
See the accompanying notes to the consolidated financial statements.
F-6
<PAGE>
TELE NORTE LESTE PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(AMOUNTS EXPRESSED IN THOUSANDS OF CONSTANT BRAZILIAN REAIS OF DECEMBER 31,
1997)
1. OPERATIONS AND BACKGROUND
Beginning in 1995, the federal government of Brazil (the "Federal
Government") undertook a comprehensive reform of the telecommunications
industry. In July, 1995 the Federal Congress adopted a General
Telecommunications Law providing for the privatization of Telecomunicacoes
Brasileiras S.A. ("Telebras") which, through its 28 operating subsidiaries,
was the primary supplier of public telecommunications services in Brazil.
In preparation for the privatization of the Telebras system, the operating
subsidiaries have been divided into twelve separate groups, (a) three regional
fixed line operators, (b) eight regional cellular operators and (c) one
national long-distance operator. The cellular telecommunications businesses
have firstly been separated from the operating subsidiaries and subsequently
the fixed-line businesses, the new cellular businesses and the long-distance
operator have been combined into the twelve separate groups. Both the
separation of the cellular businesses and the subsequent grouping of the
former Telebras subsidiaries have been performed using a procedure under
Brazilian corporate law called cisao or "spin-off". As part of this process
Tele Norte Leste Participacoes S.A. (the "Holding Company") was formed.
The Holding Company was formed on May 22, 1998, through the spin-off of
certain assets and liabilities of Telebras, including the percentages of
participation in the share capital of the following companies (collectively
referred to as the "Subsidiaries"):
<TABLE>
<CAPTION>
MINORITY
INTEREST
PARTICIPATION PERCENTAGE
------------- ----------
<S> <C> <C>
Telecomunicacoes do Rio de Janeiro S.A............. 70.70% 29.30%
Telecomunicacoes do Espirito Santo S.A. ........... 85.23% 14.77%
Telecomunicacoes do Amazonas S.A. ................. 80.25% 19.75%
Telecomunicacoes de Roraima S.A. .................. 86.91% 13.09%
Telecomunicacoes do Amapa S.A. .................... 90.64% 9.36%
Telecomunicacoes do Para S.A. ..................... 69.04% 30.96%
Telecomunicacoes do Maranhao S.A. ................. 66.79% 33.21%
Telecomunicacoes do Piaui S.A. .................... 78.47% 21.53%
Telecomunicacoes do Ceara S.A. .................... 79.30% 20.70%
Telecomunicacoes do Rio Grande do Norte S.A. ...... 75.41% 24.59%
Telecomunicacoes de Pernambuco S.A. ............... 77.21% 22.79%
Telecomunicacoes de Alagoas S.A. .................. 77.60% 22.40%
Telecomunicacoes da Paraiba S.A. .................. 71.49% 28.51%
Telecomunicacoes de Minas Gerais S.A. ............. 82.94% 17.06%
Telecomunicacoes de Sergipe S.A. .................. 73.61% 26.39%
Telecomunicacoes da Bahia S.A. .................... 89.28% 10.72%
</TABLE>
Until August 4, 1998, the Company was controlled by the Federal Government
(see Note 28).
Tele Norte Leste Participacoes S.A. and its subsidiaries (the "Companies")
are the principal providers of fixed-line telecommunications services in the
states of Rio de Janeiro, Espirito Santo, Amazonas, Roraima, Amapa, Para,
Maranhao, Piaui, Ceara, Rio Grande do Norte, Pernambuco, Alagoas, Paraiba,
Minas Gerais, Sergipe and Bahia under the terms of a concession to be granted
by the Federal Government which will expire on December 31, 2005 and may be
renewed for a further term of 20 years.
On January 30, 1998 the cellular telecommunications businesses of the
Companies were spun off into thirteen new companies (the "Cellular
Companies"), effective January 1, 1998.
The Companies' business, including the services they may provide and the
rates they charge, is regulated by Agencia Nacional de Telecomunicacoes
(Anatel), the regulatory authority for the Brazilian telecommunications
industry pursuant to Law No. 9,472 of July 16, 1997 and the related
regulations, decrees, orders and plans.
F-7
<PAGE>
TELE NORTE LESTE PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(AMOUNTS EXPRESSED IN THOUSANDS OF CONSTANT BRAZILIAN REAIS OF DECEMBER 31,
1997)
2. PRESENTATION OF THE FINANCIAL STATEMENTS
The consolidated financial statements reflect the consolidated accounts of
Tele Norte Leste Participacoes S.A. and its subsidiaries. The portion of
equity and net income attributable to shareholders other than Telebras at
December 31, 1996 and 1997, and for each of the years in the three year period
ended December 31, 1997 is reflected as "minority interests". At December 31,
1997, such minority shareholders participated in the share capital of the
Companies at various percentages between 9.36% and 33.21% (see Note 1).
The fixed line telecommunications business of the Companies is presented as
continuing operations and the cellular telecommunications business is
presented as discontinued operations for all periods. The assets and
liabilities of the cellular telecommunications business are presented as net
assets of discontinued operations. The formation of the Holding Company and
the transfer of assets and liabilities from the Companies to the Cellular
Companies have been accounted for as a reorganization of entities under common
control in a manner similar to a pooling of interests.
The assets and liabilities of the cellular telecommunications businesses
were transferred to the sixteen newly formed Cellular Companies at their
indexed historical cost. The associated revenues and expenses were also
allocated to the Cellular Companies. The Consolidated Financial Statements are
not necessarily indicative of the financial position and results of operations
that would have occurred for the three-year period ended December 31, 1997 had
the fixed-line telecommunications businesses of the Holding Company and its
subsidiaries been separate legal entities during such period.
As separate records of revenues and costs of services were maintained for
the cellular businesses, the actual amounts could be identified and
transferred. With respect to costs other than costs of services, the
methodologies employed in transferring the assets and liabilities included the
specific identification of costs associated with those assets and liabilities,
and the allocation of costs where specific identification was not possible.
Allocations were made using criteria established by management that were
designed to ensure that all relevant costs were appropriately included in the
results of operations for the periods presented. The allocation criteria
included: square footage (in relation to land and building related expenses),
number of terminals (in relation to general management, accounting, data
processing, legal department and other general staff functions), number of
employees (in relation to human resource related expenses), number of
requisitions issued (in relation to office material costs) and miles driven
(in relation to certain transport costs). Management believes that the amounts
included in the consolidated financial statements fairly reflect the operating
results of the business.
Prior to December 31, 1997 cash and certain non-specific debt of the
cellular telecommunications business could not be segregated from the
Companies. Accordingly, these amounts are included in the combined financial
statements for periods ending before January 1, 1998. As a result, certain
interest income and expense relating to the cellular telecommunications
business could not be identified and consequently, income from discontinued
operations is presented before unallocated interest income/expense and income
tax expense.
The presentation of the consolidated financial statements is consistent with
the presentation of the published financial statements of the Companies, from
which the accompanying financial information was extracted, except for certain
reclassifications within the Consolidated Statements of Financial Condition
and the Consolidated Statements of Income which have been made to conform
previously published financial information to the 1997 presentation within
this registration statement, for the presentation of the cellular businesses
of the Companies as discontinued operations and to reflect the portion of
equity and net income attributable to shareholders other than Telebras as
minority interest. Furthermore, the accompanying financial statements include
an additional provision
F-8
<PAGE>
TELE NORTE LESTE PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(AMOUNTS EXPRESSED IN THOUSANDS OF CONSTANT BRAZILIAN REAIS OF DECEMBER 31,
1997)
for doubtful debts of R$73,695 and the resulting effect on deferred income
taxes. This additional provision resulted from a reevaluation of the Company's
probable losses in relation to trade accounts receivable at December 31, 1997
in the light of the collection experience for the first quarter of 1998. The
Companies will not restate their previously reported results as the provision
for doubtful debts recorded in their December 31, 1997 financial statements
was considered adequate in the light of information available at the date on
which they were published.
The accompanying consolidated financial statements were prepared on a fully
indexed basis to recognize the effects of changes in the purchasing power of
the Brazilian currency during the periods presented.
A. FULL INDEXATION TO DECEMBER 31, 1997
The principal criteria adopted to prepare the fully indexed consolidated
financial statements maintained in accordance with the practices described in
Note 3, are as follows:
i. Inflation restatement index
The consolidated financial statements were indexed and expressed in currency
of constant purchasing power of December 31, 1997 by using the monthly average
values of the Unidade Fiscal de Referencia (the Tax Reference Unit or "UFIR")
through December 31, 1995 and the Indice Geral de Precos-Mercado (the General
Prices Index-Market or the "IGP-M") of the Fundacao Getulio Vargas in 1996 and
1997 following the cessation of the widespread use of the UFIR that resulted
from the change in Brazil's corporate law. Inflation for the three year period
ended December 31, 1997, as measured by the UFIR and the IGP-M, was as
follows:
<TABLE>
<CAPTION>
ANNUAL
PERIOD INDEX INFLATION
------ ----- ---------
%
<S> <C> <C>
Year ended December 31, 1995................................. UFIR 22.5
Year ended December 31, 1996................................. IGP-M 9.2
Year ended December 3 l, 1997................................ IGP-M 7.7
</TABLE>
Management believes that these indices are appropriate indications of
general price level inflation to be used under Brazilian and US GAAP, for the
years indicated.
In July 1997, the three-year cumulative inflation rate for Brazil fell below
100%. However, for accounting purposes, the constant currency method continued
to be applied through December 31, 1997. The Brazilian Institute of
Accountants has not yet published definitive rules regarding when the constant
currency method of accounting may no longer be used to prepare financial
statements. If the Brazilian Institute of Accountants determines that the
constant currency method may no longer be used to prepare financial statements
beginning January 1, 1998, the restated balances of nonmonetary assets and
liabilities of the Companies as of December 31, 1997 will become the new basis
for accounting, and income statement items will no longer be restated for
inflation.
ii. Consolidated statements of income
Items in the consolidated statements of income are adjusted to the balance
sheet date by:
. allocating inflationary holding gains or losses on interest bearing
monetary assets and liabilities to their corresponding interest
income and expense captions;
. allocating inflationary holding gains and losses from other monetary
items to their corresponding income or expense captions. Amounts
without a corresponding income or expense caption were allocated to
"other net operating income".
iii. Deferred income tax effects of indexation adjustments in 1996 and 1997
As a result of legislation mandating the discontinuation of the indexation
system for Brazilian corporate law and most fiscal purposes as from January 1,
1996, the indexation of assets and liabilities for financial
F-9
<PAGE>
TELE NORTE LESTE PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(AMOUNTS EXPRESSED IN THOUSANDS OF CONSTANT BRAZILIAN REAIS OF DECEMBER 31,
1997)
reporting purposes herein is not permitted for tax purposes. Accordingly, a
deferred tax liability arises for the excess of net assets shown for financial
reporting purposes over the tax basis of these net assets. The charge relating
to the additional deferred tax liability of R$287,953 in 1996 and R$291,597 in
1997 was recorded directly against retained earnings.
B. TRANSLATION OF CONSTANT BRAZILIAN REAL AMOUNTS INTO US DOLLAR AMOUNTS
The translation of Brazilian Real amounts into US dollar amounts is
unaudited and included solely for the convenience of readers outside of Brazil
and has been performed using the closing selling exchange rate published by
the Central Bank of Brazil of R$1.1164 to US$1.00 as of December 31, 1997.
This translation should not be construed as a representation that Brazilian
Real amounts could be converted to US dollars at this or any other rate.
C. MINORITY INTERESTS
Minority interests relate to the interest of shareholders other than
Telebras in the Companies.
D. DISCONTINUED OPERATIONS
The accompanying consolidated financial statements reflect the cellular
telecommunications business as discontinued operations. Accordingly, the
revenues, costs and expenses, assets and liabilities and cash flows of these
discontinued operations have been excluded from the respective captions in the
combined statements of income, consolidated balance sheets and consolidated
statements of cash flow and have been reported as "Income from discontinued
cellular operations before unallocated interest income/expense, taxes and
minority interests"; as "Net assets of discontinued operations" and as "Net
cash provided by discontinued operations" for all periods presented.
Summarized financial information for the discontinued operations is as
follows:
<TABLE>
<CAPTION>
1995 1996 1997
------- --------- ---------
<S> <C> <C> <C>
Net operating revenues....................... 613,707 1,258,443 1,892,461
Income before unallocated interest
income/expense, taxes and minority interests
taxes....................................... 316,876 679,409 788,790
Current assets....................................... 175,731 381,142
Property, plant and equipment, net................... 2,109,542 2,575,624
Total assets......................................... 2,287,298 2,959,438
Current liabilities.................................. 636,050 610,392
Total liabilities.................................... 993,748 1,110,884
Net assets of discontinued operations................ 1,293,550 1,848,554
</TABLE>
E. PRINCIPLES OF CONSOLIDATION
These consolidated financial statements include the financial records of the
Holding Company and its subsidiaries. All material intercompany accounts and
transactions have been eliminated.
3. SUMMARY OF THE PRINCIPAL ACCOUNTING PRACTICES
A. CASH AND CASH EQUIVALENTS
Cash equivalents are considered to be all highly liquid temporary cash
investments with original maturity dates of three months or less.
F-10
<PAGE>
TELE NORTE LESTE PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(AMOUNTS EXPRESSED IN THOUSANDS OF CONSTANT BRAZILIAN REAIS OF DECEMBER 31,
1997)
B. TRADE ACCOUNTS RECEIVABLE
Accounts receivable from telephone subscribers are calculated at the tariff
rate on the date the services were recorded and discounted to their present
value at the balance sheet date by applying the interest rate published by the
National Association of Investment Bankers ("ANBID"). Trade accounts
receivable also include services provided to customers up to the balance sheet
date but not yet invoiced.
C. ALLOWANCE FOR DOUBTFUL ACCOUNTS
Provision is made for trade accounts receivable for which recoverability is
considered improbable.
D. FOREIGN CURRENCY TRANSACTIONS
Transactions in foreign currency are recorded at the prevailing exchange
rate at the time of the related transactions. Foreign currency denominated
assets and liabilities are translated using the exchange rate at the balance
sheet date. Exchange differences are recognized in the combined statement of
income as they occur.
E. INVENTORIES
Inventories are stated at the lower of indexed cost or replacement value.
Cost of inventories is determined principally on the average cost basis.
Inventories are separated into network expansion and maintenance inventories.
Inventories for use in network expansion are classified as "Construction-in-
progress" under "Property, plant and equipment". Maintenance inventories are
classified as other current assets.
F. INVESTMENTS
Other investments, which comprise items held to maturity or for investment
purposes, are recorded at indexed cost, less a provision for losses when
considered necessary.
G. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment is stated at indexed cost. Improvements to
existing property are capitalized while maintenance and repair costs are
charged to expense as incurred. Materials allocated to specific projects are
added to construction-in-process. Depreciation is provided using the straight-
line method based on the estimated useful lives of the underlying assets as
determined by the public telecommunications service regulators. The principal
depreciation rates are shown in Note 15(b).
Interest, calculated monthly at a rate of 12% per annum on construction-in-
process, is capitalized as part of property, plant and equipment until the
asset is placed in service.
H. ACCOUNTS PAYABLE
Accounts payable to suppliers are discounted to their present value using
the ANBID interest rate.
I. VACATION PAY ACCRUAL
Cumulative vacation pay due to employees is accrued as earned.
J. INCOME AND SOCIAL CONTRIBUTION TAXES
Income and social contribution taxes comprise federal income tax and social
contribution tax. Deferred taxes are provided on temporary differences.
K. LOANS AND FINANCING
Loans and financing include accrued interest to the consolidated balance
sheet date.
F-11
<PAGE>
TELE NORTE LESTE PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(AMOUNTS EXPRESSED IN THOUSANDS OF CONSTANT BRAZILIAN REAIS OF DECEMBER 31,
1997)
1. PROVISIONS FOR CONTINGENCIES
Provisions for contingencies are based on legal advice and management's
opinion as to the likely outcome of the outstanding matters at the
consolidated balance sheet date.
M. REVENUE RECOGNITION
Revenues for all services are recognized when the service is provided.
Revenues from local services consist of line rental charges, service charges
based on the number of calls, network services, including interconnection and
leasing high-capacity lines, maintenance charges and charges for other
customer services. In 1997 revenue from local services also includes
installation fees which are recognized when the installation is complete.
Charges to customers for domestic, long-distance and international calls are
based on time, distance and use of services. Billings are monthly; unbilled
revenues from the billing date to the month end are estimated and recognized
as revenue during the month in which the service was provided. The revenues
from outgoing interregional and international long-distance calls are divided
between the Companies and Empresa Brasileira de Telecomunicacoes S.A.
("Embratel"), a subsidiary of Telebras. The Companies retain a fixed
percentage of the customer charges for outgoing interregional and
international long-distance calls and pay the balance to Embratel.
N. INTEREST INCOME
Interest income represents interest earned and gains and losses on
investments after adjusting for the effects of inflation as measured by the
variation in the inflation index. Unallocated interest income represents
interest income that could not be allocated between continuing and
discontinued operations.
O. INTEREST EXPENSE
Interest expense represents interest incurred and gains on loans and
financing after adjusting for the effects of inflation as measured by the
variation in the inflation index and net exchange gains of R$240,140,
R$101,312 and R$131,845 in 1995, 1996 and 1997, respectively. Unallocated
interest expense represents interest expense that could not be allocated
between continuing and discontinued operations.
P. RESEARCH AND DEVELOPMENT
Research and development costs are charged to expense as incurred. Total
research and development costs were R$36,329, R$35,561 and R$31,072 for 1995,
1996 and 1997, respectively.
Q. PENSION AND POST-RETIREMENT BENEFITS
The Companies sponsor a separate entity that provides pensions and other
post-retirement benefits for its employees through a multi-employer plan.
Current contributions and costs are determined actuarially and are recorded on
the accrual basis.
R. EMPLOYEE'S PROFIT SHARE
The Companies have made a provision for granting employees the right to a
share of their profits. The amount recorded is the employee's profit share
attributable to the continuing fixed-line telecommunications business.
S. EARNINGS PER THOUSAND SHARES
Earnings per thousand shares has not been calculated as the capital
structure of Tele Norte Leste Participacoes S.A. was not in place at December
31, 1997.
F-12
<PAGE>
TELE NORTE LESTE PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(AMOUNTS EXPRESSED IN THOUSANDS OF CONSTANT BRAZILIAN REAIS OF DECEMBER 31,
1997)
T. SEGMENT INFORMATION
The business operates solely in the segment of local and regional fixed-line
telecommunications. All revenues are generated in relation to services
provided in the states of Rio de Janeiro, Espirito Santo, Amazonas, Roraima,
Amapa, Para, Maranhao, Piaui, Ceara, Rio Grande do Norte, Pernambuco, Alagoas,
Paraiba, Minas Gerais, Sergipe and Bahia.
U. USE OF ESTIMATES
The preparation of consolidated financial statements in conformity with
Brazilian and US GAAP requires management to make estimates and assumptions
relating to the reporting of assets and liabilities and the disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the period reported.
Actual results could differ from those estimates.
4. OPERATING REVENUE FROM FIXED TELECOMMUNICATIONS SERVICES
<TABLE>
<CAPTION>
1995 1996 1997
--------- ---------- ----------
<S> <C> <C> <C>
Local services:
Monthly charges......................... 232,705 451,829 893,525
Measured service charges................ 724,489 1,184,479 1,404,289
Public telephones....................... 101,656 185,004 263,105
Other................................... 300,818 463,230 574,394
--------- ---------- ----------
Total................................. 1,359,668 2,284,542 3,135,313
--------- ---------- ----------
Non-local services
Intra- and interstate................... 2,138,870 2,285,168 1,871,437
International........................... 224,646 211,520 155,086
--------- ---------- ----------
Total................................. 2,363,516 2,496,688 2,026,523
--------- ---------- ----------
Data transmission......................... 157,896 198,865 164,346
Network services.......................... 298,387 558,319 999,380
Other..................................... 32,201 38,765 34,628
--------- ---------- ----------
Gross operating revenues.................. 4,211,668 5,577,179 6,360,190
Value added and other indirect taxes...... (961,906) (1,293,109) (1,384,077)
Discounts................................. (7,084) (10,264) (16,820)
--------- ---------- ----------
Net operating revenue..................... 3,242,678 4,273,806 4,959,293
========= ========== ==========
</TABLE>
There are no customers who contribute more than 5% of gross operating
revenues.
5. COST OF SERVICES
<TABLE>
<CAPTION>
1995 1996 1997
--------- --------- ---------
<S> <C> <C> <C>
Depreciation and amortization.................. 1,150,904 1,226,604 1,293,505
Personnel...................................... 555,695 559,975 508,337
Materials...................................... 72,604 80,688 71,307
Services....................................... 283,066 414,916 659,050
Other.......................................... 47,348 61,417 39,153
--------- --------- ---------
2,109,617 2,343,600 2,571,352
========= ========= =========
</TABLE>
F-13
<PAGE>
TELE NORTE LESTE PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(AMOUNTS EXPRESSED IN THOUSANDS OF CONSTANT BRAZILIAN REAIS OF DECEMBER 31,
1997)
6. OTHER NET OPERATING INCOME (EXPENSE)
<TABLE>
<CAPTION>
1995 1996 1997
------- ------- -------
<S> <C> <C> <C>
Taxes other than income taxes..................... (7,071) (9,222) (7,214)
Technical and administrative services............. 87,576 132,695 202,408
Provision for contingencies (Note 20)............. (58,410) (37,222) (41,966)
Fines and expenses recovered...................... 179,919 190,938 92,831
Research and development.......................... (36,329) (35,561) (31,072)
Early retirement plan............................. -- (80,911) --
Donations......................................... (8) (9,304) (18,960)
Other............................................. 20,036 40,546 52,640
------- ------- -------
185,713 191,959 248,667
======= ======= =======
</TABLE>
Fines and expenses recovered primarily represent penalties collected on past
due accounts receivable and recovery of sales taxes of prior periods. The
amount of penalties collected on past due accounts receivable amounted to
R$126,662, R$174,359 and R$73,272 in 1995, 1996 and 1997, respectively.
7. NET NONOPERATING INCOME (EXPENSE)
<TABLE>
<CAPTION>
1995 1996 1997
------- ------- -------
<S> <C> <C> <C>
Loss on disposal of permanent assets.............. (28,371) (47,703) (78,732)
Other income...................................... 5,777 37,464 18,643
------- ------- -------
(22,594) (10,239) (60,089)
======= ======= =======
</TABLE>
8. INCOME AND SOCIAL CONTRIBUTION TAXES
As explained in Note 2, because cash and certain non specific debt was not
allocated to the cellular telecommunications business, the associated interest
income and expense was not allocated. Consequently the Companies' continuing
operations include interest income and expense relating to discontinued
cellular operations. As a result, income tax expense and current tax
liabilities have not been allocated to the discontinued cellular operations in
the accompanying financial statements.
Brazilian income taxes comprise federal income tax and social contribution
tax. In 1995, 1996 and 1997 the rates for income tax were 43%, 25% and 25%,
respectively, and for social contribution tax were 9.09%, 7.41% and 8.00%,
respectively. As a result of legislation enacted in 1996, the social
contribution tax in 1997 was no longer deductible from its own computation
base, nor was it deductible for income tax purposes. The changes produced a
combined statutory rate of 48.18%, 30.56% and 33.00% in 1995, 1996 and 1997,
respectively.
Deferred taxes are provided on temporary differences which include the
effects of indexation adjustments that will not give rise to deductions when
subsequently depreciated, amortized or disposed of.
In prior years the indexation adjustments to permanent assets and
shareholders' equity in accordance with the tax law gave rise to a tax
deductible expense, if the indexation of equity exceeded the indexation of
permanent assets, and to taxable income, called "inflationary profit", if the
indexation of permanent assets exceeded that of equity. In the latter case,
payment of the related tax liability could be deferred until it had been
deemed to have been realized either through depreciation or disposal of the
permanent assets in existence at the time the liability was recorded, subject
to a minimum realization rate of 10% per annum (5% per annum prior to 1995).
In 1995, 1996 and 1997, management elected to prepay income taxes on
inflationary profit that it had previously deferred. Brazilian companies
making such a prepayment in relation to 1997 were entitled to utilize
F-14
<PAGE>
TELE NORTE LESTE PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(AMOUNTS EXPRESSED IN THOUSANDS OF CONSTANT BRAZILIAN REAIS OF DECEMBER 31,
1997)
an income tax rate of 10% instead of the then current rate of 25%. Similar
reductions applied to the prepayments in 1995 and 1996. The result was a gain
of R$7,898 and R$37,605 for 1996 and 1997, respectively, from the reduction in
deferred tax liabilities.
The following is an analysis of the income tax expense (benefit):
<TABLE>
<CAPTION>
1995 1996 1997
------- ------- --------
<S> <C> <C> <C>
Social contribution charge....................... 92,453 98,984 150,241
Income tax....................................... 127,926 307,446 431,342
Losses from prior years.......................... (7,674) (31,319) (25,106)
Deferred taxes................................... 82,368 23,639 (35,003)
Effect of rate changes on deferred tax........... (19,130) (4,388) 975
Early payment incentives......................... (1,529) (7,898) (37,605)
------- ------- --------
Total tax expense................................ 274,414 386,464 (484,844)
======= ======= ========
</TABLE>
Supplementary information regarding taxes posted directly to shareholders'
equity:
<TABLE>
<CAPTION>
1995 1996 1997
-------- ------- -------
<S> <C> <C> <C>
Deferred taxes..................................... -- 287,953 291,597
Effect of rate changes on deferred tax............. (147,467) 7,742 7,673
-------- ------- -------
(147,467) 295,695 299,270
======== ======= =======
</TABLE>
The following is a reconciliation of the amount calculated by applying the
combined statutory tax rates to the reported income before taxes and the
reported income tax expense:
<TABLE>
<CAPTION>
1995 1996 1997
------- --------- ---------
<S> <C> <C> <C>
Income before taxes and minority interests
as reported in the accompanying financial
statements................................. 465,065 1,412,745 1,896,080
======= ========= =========
Tax charge at the combined statutory rate... 224,069 431,735 625,706
Permanent additions:
Current year tax losses not yet available
for credit............................... 84,420 -- --
Non-deductible expenses................... 11,615 1,813 6,067
Employee's profit share................... 3,877 6,646 10,456
Permanent exclusions:
Capitalized interest...................... (30,095) (14,700) (25,999)
Payments of dividends to shareholders
characterized as distributions of
interest................................. -- -- (57,227)
Other items:
Utilization of tax net operating losses... (2,371) (16,257) (25,926)
Effect of rate changes on deferred tax.... (19,130) (4,388) 975
Early payment incentives.................. (1,529) (7,899) (37,605)
Other incentives.......................... 3,727 (7,856) (11,590)
Other, net................................ (169) (2,630) (13)
------- --------- ---------
Income and social contribution taxes as
reported in the accompanying financial
statements................................. 274,414 386,464 484,844
======= ========= =========
Effective rate.............................. 59.0% 27.3% 25.5%
======= ========= =========
</TABLE>
F-15
<PAGE>
TELE NORTE LESTE PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(AMOUNTS EXPRESSED IN THOUSANDS OF CONSTANT BRAZILIAN REAIS OF DECEMBER 31,
1997)
In 1997, the Company characterized part of its dividends proposed for
payment at the end of 1997 as interest on shareholders' funds. As a result,
under Brazilian tax law it was entitled to treat this part of the dividend as
a deduction for income tax purposes.
The composition of deferred tax assets and liabilities, based on temporary
differences, is as follows:
<TABLE>
<CAPTION>
1996 1997
------- -------
<S> <C> <C>
DEFERRED TAX ASSETS:
Provisions for contingencies............................... 36,302 44,836
Fiscal losses.............................................. 20,445 6,542
Other...................................................... 21,926 56,085
------- -------
Total (see Note 12)...................................... 78,673 107,463
======= =======
DEFERRED TAX LIABILITIES:
Additional indexation expense from 1990.................... 154,918 98,969
Others..................................................... 284,059 545,877
------- -------
Total.................................................... 438,977 644,846
======= =======
</TABLE>
All of the other deferred tax liabilities relate to the difference between
the tax basis of permanent assets, which was not indexed for inflation
subsequent to December 31, 1995, and the reporting basis, which includes
indexation through December 31, 1997.
The composition of tax liabilities is as follows:
<TABLE>
<CAPTION>
1996 1997
------- -------
<S> <C> <C>
Social contribution tax payable.............................. 51,242 37,189
Federal income tax payable................................... 81,466 14,751
Deferred tax liabilities..................................... 438,977 644,846
------- -------
Total.................................................... 571,685 696,786
======= =======
Current...................................................... 141,333 111,392
Non current.................................................. 430,352 585,394
</TABLE>
9. CASH FLOW INFORMATION
<TABLE>
<CAPTION>
1995 1996 1997
------- ------- -------
<S> <C> <C> <C>
Income and social contribution tax paid............ 155,776 419,656 618,302
Interest paid...................................... 246,840 238,514 228,739
Cash paid against provisions for contingencies..... 8,260 16,578 8,094
Non cash transactions:
Conversion of loans into shares.................. 11,569 -- --
Fiscal incentive investment credits received..... 7,226 18,674 28,932
Donations received of property, plant and
equipment....................................... 241 4,009 9,349
Conversion of capitalizable funds into share
capital and share premium....................... 355,258 273,391 152,843
</TABLE>
F-16
<PAGE>
TELE NORTE LESTE PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(AMOUNTS EXPRESSED IN THOUSANDS OF CONSTANT BRAZILIAN REAIS OF DECEMBER 31,
1997)
10. CASH AND CASH EQUIVALENTS
<TABLE>
<CAPTION>
1996 1997
------ ------
<S> <C> <C>
Cash........................................................... 1,081 1,272
Bank accounts.................................................. 58,826 53,765
------ ------
59,907 55,037
====== ======
</TABLE>
11. TRADE ACCOUNTS RECEIVABLE, NET
<TABLE>
<CAPTION>
1996 1997
------- -------
<S> <C> <C>
Accrued amounts.......................................... 232,661 310,976
Billed amounts........................................... 436,422 489,209
Allowance for doubtful accounts.......................... (14,317) (90,323)
------- -------
654,766 709,862
======= =======
</TABLE>
The changes in the allowance for doubtful accounts were as follows:
<TABLE>
<CAPTION>
1995 1996 1997
------ ------- -------
<S> <C> <C> <C>
Beginning balance................................ 4,244 10,300 14,317
Provision charged to selling expense............. 7,441 28,316 101,375
Write-offs....................................... (1,385) (24,299) (25,369)
------ ------- -------
Ending balance................................... 10,300 14,317 90,323
====== ======= =======
</TABLE>
12. DEFERRED AND RECOVERABLE TAXES
<TABLE>
<CAPTION>
1996 1997
------- -------
<S> <C> <C>
Tax deducted at source..................................... 1,244 786
Social contribution tax.................................... 6,077 12,865
Recoverable income tax..................................... 10,597 52,319
Deferred tax assets........................................ 78,673 107,463
Sales and other taxes...................................... 16,671 44,383
------- -------
Total.................................................... 113,262 217,816
======= =======
Current.................................................... 71,330 181,663
Non-current................................................ 41,932 36,153
</TABLE>
F-17
<PAGE>
TELE NORTE LESTE PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(AMOUNTS EXPRESSED IN THOUSANDS OF CONSTANT BRAZILIAN REAIS OF DECEMBER 31,
1997)
13. OTHER ASSETS
<TABLE>
<CAPTION>
1996 1997
------- -------
<S> <C> <C>
Other debtors.............................................. 59,605 26,800
Maintenance inventories.................................... 121,651 133,010
Prepayments................................................ 21,318 11,233
Assets to be sold.......................................... 3,387 1,987
Recoverable advances....................................... 35,943 38,193
Fiscal incentive investments............................... 21,094 53,485
Other...................................................... 24,220 43,443
------- -------
Total.................................................... 287,218 308,151
======= =======
Current.................................................... 258,268 247,822
Non-current................................................ 28,950 60,329
</TABLE>
14. INVESTMENTS
<TABLE>
<CAPTION>
1996 1997
----- ------
<S> <C> <C>
Fiscal incentive investments.................................. 3,469 5,856
Other investments............................................. 5,011 8,861
----- ------
8,480 14,717
===== ======
</TABLE>
15. PROPERTY, PLANT AND EQUIPMENT, NET
A. COMPOSITION:
<TABLE>
<CAPTION>
1996 1997
----------- -----------
<S> <C> <C>
Construction-in-progress......................... 2,371,667 2,713,793
Automatic switching equipment.................... 7,787,039 8,063,185
Other equipment.................................. 9,451,270 10,407,846
Buildings........................................ 3,584,309 3,773,301
Other assets..................................... 2,872,421 3,052,453
----------- -----------
Total cost....................................... 26,066,706 28,010,578
Accumulated depreciation......................... (14,122,136) (14,728,192)
----------- -----------
Property, plant and equipment, net............... 11,944,570 13,282,386
=========== ===========
</TABLE>
Other equipment includes: Aerial, underground and building cables,
teleprinters, private automatic exchanges, generating equipment and furniture.
Other assets include: Underground cables, computer equipment, vehicles, land
and other assets. Within "Other assets" the book value of land is R$125,793 at
December 31, 1996 and R$125,319 at December 31, 1997.
F-18
<PAGE>
TELE NORTE LESTE PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(AMOUNTS EXPRESSED IN THOUSANDS OF CONSTANT BRAZILIAN REAIS OF DECEMBER 31,
1997)
B. DEPRECIATION RATES
The annual depreciation rates applied to property, plant and equipment are as
follows:
<TABLE>
<CAPTION>
%
-----------
<S> <C>
Automatic switching equipment.................................. 7.69
Other equipment................................................ 10.00
Buildings...................................................... 4.00
Other assets (excluding land).................................. 5.00--20.00
</TABLE>
C. RENTALS
The Companies rent equipment and premises through a number of operating
agreements that expire at different dates. Total annual rent expense under
these agreements was as follows:
<TABLE>
<CAPTION>
1995 1996 1997
------ ------ ------
<S> <C> <C> <C>
Rent expense.......................................... 46,656 92,577 83,301
====== ====== ======
</TABLE>
Rental commitments relate primarily to facilities where the future minimum
rental payments under leases with remaining noncancelable terms in excess of
one year are:
<TABLE>
<S> <C>
Year ending December 31,
1998.............................................................. 31,640
1999.............................................................. 31,571
2000.............................................................. 30,726
2001 ............................................................. 31,076
2002.............................................................. 31,480
2003 and thereafter............................................... 35,028
-------
Total minimum payments............................................ 191,521
=======
</TABLE>
16. PAYROLL AND RELATED ACCRUALS
<TABLE>
<CAPTION>
1996 1997
------- -------
<S> <C> <C>
Wages and salaries........................................... 38,907 49,454
Accrued social security charges.............................. 140,781 103,573
Accrued benefits............................................. 53,382 45,603
Payroll withholdings......................................... 4,461 2,561
------- -------
237,531 201,191
======= =======
</TABLE>
17. TAXES OTHER THAN INCOME TAXES
<TABLE>
<CAPTION>
1996 1997
------- -------
<S> <C> <C>
Value-added taxes............................................ 146,186 236,682
Other indirect taxes on operation revenues................... 22,445 32,752
------- -------
168,631 269,434
======= =======
</TABLE>
F-19
<PAGE>
TELE NORTE LESTE PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(AMOUNTS EXPRESSED IN THOUSANDS OF CONSTANT BRAZILIAN REAIS OF DECEMBER 31,
1997)
18. DIVIDENDS
<TABLE>
<CAPTION>
1996 1997
------- -------
<S> <C> <C>
Majority shareholders (see Note 24).......................... 258,042 365,054
Minority shareholders........................................ 43,258 115,372
Prior year dividends not claimed............................. 10,360 13,929
Employees' profit share...................................... 30,210 61,787
------- -------
341,870 556,142
======= =======
</TABLE>
19. LOANS AND FINANCING
<TABLE>
<CAPTION>
1996 1997
--------- ---------
<S> <C> <C>
Loans payable to Telebras............................... 1,250,105 1,221,844
Other financing......................................... 260,694 295,842
Accrued interest........................................ 64,608 105,867
--------- ---------
Total............................................... 1,575,407 1,623,553
========= =========
Current
Payable to Telebras................................... 628,623 614,768
Other financing....................................... 46,301 128,823
--------- ---------
674,924 743,591
Non-current
Payable to Telebras................................... 678,337 703,463
Other financing....................................... 222,146 176,499
--------- ---------
900,483 879,962
</TABLE>
A. LOANS PAYABLE TO TELEBRAS
<TABLE>
<CAPTION>
1996 1997
--------- ---------
<S> <C> <C>
Eurobonds, originally issued by Telebras................. 371,014 150,006
Debentures, originally issued by Telebras................ 362 --
Loans and financing from Telebras........................ 850,679 1,040,977
Other debt............................................... 28,050 30,861
--------- ---------
1,250,105 1,221,844
Accrued interest......................................... 56,855 96,387
--------- ---------
1,306,960 1,318,231
========= =========
</TABLE>
F-20
<PAGE>
TELE NORTE LESTE PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(AMOUNTS EXPRESSED IN THOUSANDS OF CONSTANT BRAZILIAN REAIS OF DECEMBER 31,
1997)
A.1 EUROBONDS ORIGINALLY ISSUED BY TELEBRAS
These are represented by five issues, four denominated in US Dollars and one
in Italian Lira, as follows:
<TABLE>
<CAPTION>
PRINCIPAL ANNUAL INTEREST
REPAYMENT ORIGINAL INTEREST PAYMENT
ISSUE TERM SCHEDULE VALUE RATE SCHEDULE 1996 1997
- ----- ---- ------------- ----------- -------- ----------- ------- -------
(US$ THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
3 1997 upon maturity 39,552 10.000% semi annual 86,679 --
4 1997 upon maturity 45,312 10.375% semi annual 50,998 --
5 1997 upon maturity 95,355 10.000% semi annual 28,991 --
6 1997 upon maturity 27,724 10.000% semi annual 30,842 --
(LIRA THOUSANDS)
1 1999 upon maturity 185,523,912 13.000% semi annual 173,504 150,006
------- -------
Principal................................................ 371,014 150,006
Accrued interest......................................... 27,044 20,303
------- -------
398,058 170,309
======= =======
</TABLE>
In addition to the contractual interest, in connection with the Eurobonds,
the Companies pay Telebras a 1% per year administrative fee on the outstanding
balances.
A.2 LOANS AND FINANCING FROM TELEBRAS
<TABLE>
<CAPTION>
1996 1997
------- ---------
<S> <C> <C>
Loans with Telebras........................................ 850,679 1,040,977
Accrued interest........................................... 26,593 70,243
------- ---------
877,272 1,111,220
======= =========
</TABLE>
The short-term loans were subject to the interest rate on federal treasury
bills (the "Remuneracao Diaria dos Titulos Publicos") plus 0.25%
B. OTHER FINANCING
<TABLE>
<CAPTION>
1996 1997
------- -------
<S> <C> <C>
Equipment financing.......................................... 182,300 189,508
Other........................................................ 78,394 106,334
------- -------
260,694 295,842
Accrued interest............................................. 7,753 9,480
------- -------
268,447 305,322
======= =======
</TABLE>
The loans with suppliers of telecommunications equipment, are repayable in
full on 2003. The loans are denominated in US dollars and bear interest at a
rate of LIBOR plus 3% to 6% per annum and interest of 10.88% to 18.00% per
annum. The loans are guaranteed by Telebras.
F-21
<PAGE>
TELE NORTE LESTE PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(AMOUNTS EXPRESSED IN THOUSANDS OF CONSTANT BRAZILIAN REAIS OF DECEMBER 31,
1997)
C. REPAYMENT SCHEDULE
Noncurrent debt is scheduled to be repaid as follows:
<TABLE>
<S> <C>
1999................................................................. 561,473
2000................................................................. 145,222
2001................................................................. 71,950
2002................................................................. 55,877
2003 and thereafter.................................................. 45,440
-------
879,962
=======
</TABLE>
D. CURRENCY ANALYSIS
Total debt is denominated in the following currencies:
<TABLE>
<CAPTION>
EXCHANGE RATE
AT DECEMBER 31, 1997 1996 1997
-------------------- --------- ---------
(UNITS OF ONE
BRAZILIAN REAL)
<S> <C> <C> <C>
Brazilian Reais..................... 1.0000 869,862 1,079,895
US dollars.......................... 1.1164 467,433 287,785
Italian lira........................ 0.0006342 173,504 150,006
--------- ---------
1,510,799 1,517,686
Accrued interest.................... 64,608 105,867
--------- ---------
1,575,407 1,623,553
========= =========
</TABLE>
The Companies do not hedge their foreign currency liabilities.
E. CREDIT AGREEMENT DEFAULTS
The Companies are party to certain credit agreements that contain covenants
restricting, among other things, (i) the ability of Telebras to dispose of all
or a substantial part of its assets or to cease to control a company that was
an operating subsidiary of the Telebras System and (ii) the ability of the
Federal Government to dispose of its controlling interest in the Telebras
System. The Breakup of Telebras on May 22, 1998, and the privatization of the
Companies constituted, an event of default under such credit agreements. In
addition, most of the Companies' other credit agreements include cross-default
provisions and cross-acceleration provisions that would permit the holders of
such indebtedness to declare the indebtedness to be in default and to
accelerate the maturity thereof if a significant portion of the principal
amount of the Companies' debt is in default or accelerated. Approximately
R$133,055 of the Companies' outstanding debt as of December 31, 1997 is in
default as a result of the privatization. The Companies are currently in
negotiations with the appropriate creditors with respect to this indebtedness.
The consolidated financial statements do not include any adjustments
relating to the recoverability of assets and classification of liabilities
that might be necessary should the Companies be unable to renegotiate its
credit agreements. The Companies believe that once the privatization is
finalized, the Companies' creditors will renegotiate the terms of these credit
agreements and/or provide appropriate waivers regarding such defaults.
F-22
<PAGE>
TELE NORTE LESTE PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(AMOUNTS EXPRESSED IN THOUSANDS OF CONSTANT BRAZILIAN REAIS OF DECEMBER 31,
1997)
20. PROVISIONS FOR CONTINGENCIES
The Companies are party to certain legal proceedings arising in the normal
course of business, including civil, administrative, tax, social security and
labor proceedings. The Companies have provided for the amounts to cover the
estimated losses due to adverse legal judgments. In the opinion of management,
such actions, if decided adversely to the Companies, would not have a material
adverse effect on the Companies' financial condition.
The components of the charge included in the combined statements of income
for contingent liabilities are as follows:
<TABLE>
<CAPTION>
1995 1996 1997
------ ------ ------
<S> <C> <C> <C>
Additional provisions................................... 33,306 32,711 23,534
Payments in excess of provisions........................ 25,104 4,511 18,432
------ ------ ------
58,410 37,222 41,966
====== ====== ======
</TABLE>
Provisions for contingent liabilities were as follows:
<TABLE>
<CAPTION>
1996 1997
------- -------
<S> <C> <C>
Labor claims................................................. 92,340 111,707
Disputed taxes............................................... 12,712 12,661
Civil claims................................................. 10,335 14,553
------- -------
115,387 138,921
======= =======
Current...................................................... 67,944 84,967
Non-current.................................................. 47,443 53,954
</TABLE>
Labor claims
The provision for labor claims comprises management's estimate of the most
probable loss in relation to various suits filed by current and former
employees.
Disputed taxes
The determination of the manner in which the various federal, state and
municipal Brazilian taxes apply to the operations of the Companies is subject
to varying interpretations arising from the unique nature of the Companies'
operations. Management believes that its interpretation of the Companies' tax
obligations is substantially in compliance with legislation. Accordingly, any
changes in the tax treatment afforded to the Companies' operations will be the
result of new legislation or interpretive rulings of the tax authorities that
will, in the opinion of management, not have any retroactive impact.
Civil claims
The civil claims relate mainly to disputes with suppliers of
telecommunications equipment over price escalation clauses in their contracts.
Taxes-ICMS on activation fees and other services
On June 19, 1998 the secretaries of the treasury of the individual Brazilian
states approved an agreement to interpret existing Brazilian tax law to
broaden the application of the ICMS (Imposto sobre Circulacao de Mercadorias e
Servicos), a state value-added tax, to cover not only telecommunications
services but also other services, including cellular activation, which had not
been previously subject to such tax. Pursuant to this new interpretation of
tax law, the ICMS tax may be applied retroactively for such services rendered
during the last five years.
F-23
<PAGE>
TELE NORTE LESTE PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(AMOUNTS EXPRESSED IN THOUSANDS OF CONSTANT BRAZILIAN REAIS OF DECEMBER 31,
1997)
The Company believes that the attempt by the state treasury secretaries to
extend the scope of ICMS tax to services which are supplementary to basic
telecommunications services is unlawful because: (i) the state secretaries
acted beyond the scope of their authority; (ii) their interpretation would
subject certain services to taxation which are not considered
telecommunications services; and (iii) new taxes may not be applied
retroactively. No provision for such taxes has been made in the accompanying
consolidated financial statements as the Company does not believe it is
probable that such taxes will be payable for services rendered during the last
five years.
There can be no assurance that the Company will prevail in its position that
the new interpretation by the state treasury secretaries is unlawful. If the
ICMS tax were applied retroactively for five years to activation fees earned
by the discontinued cellular operations, it would give rise to a maximum
liability estimated at R$238,000.
Compensation of overpaid FINSOCIAL against COFINS
A predecessor to the COFINS tax on gross operating revenues, called
FINSOCIAL, was originally introduced at a rate of 0.5% which was subsequently
increased in stages to a rate of 2.0%. The timing of these increases was
successfully challenged in court by a number of Brazilian companies, giving
rise to tax credits on account of past overpayments which could be compensated
against current payments of the similar tax, COFINS. The Company recorded a
credit for the overpaid FINSOCIAL tax following both a High Court ruling
decreeing the unconstitutionality of the rate increases and subsequent
legislation allowing the taxpayer to offset the overpaid tax against other
taxes due to the same taxing authority. The Company realized the benefit by
offsetting its overpaid FINSOCIAL against current liabilities to COFINS and
recognized a gain of R$27,459 in 1994.
The Company has not been questioned by the tax authorities in relation to
this offset. However in 1997 the High Court effectively reversed its earlier
decision and decided that the FINSOCIAL tax rate increases were applicable to
service companies. Nevertheless the Company has maintained the credit taken in
1994 on the grounds that telecommunications services in Brazil are exempt from
COFINS in accordance with the third amendment to the Brazilian Constitution of
March 17, 1993 (Art. 155, (S) 3(degrees)) and also because they are considered
to be a basic industry for all legal purposes in accordance with Decree 640 of
March 2, 1962, which continues to be valid. If the Company were to be
successfully challenged by the tax authorities and the FINSOCIAL tax offset
were found to be without legal support, it would be liable to the unpaid
COFINS tax which, together with interest and penalties for late payment, would
comprise a liability amounting to approximately R$49,000 as of December 31,
1997, for which no provision has been established in the attached financial
statements.
Other
Telebras, the legal predecessor of the Companies, is a defendant in a number
of legal proceedings and subject to other claims and contingencies. Any claims
against Telebras which are not satisfied by Telebras could result in claims
against the Companies or the Holding Company. Management believes that the
chances of any such claims materializing and having a material adverse
financial effect on the Companies or the Holding Company are remote, and,
therefore, no provision is made.
Management believes it has meritorious defenses to all lawsuits and legal
proceedings in which the Companies are defendants. Based on its evaluation of
such matters, and after consideration of reserves established, management
believes that the resolution of such matters will not have a material adverse
effect on the Companies' financial position or results of operations.
F-24
<PAGE>
TELE NORTE LESTE PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(AMOUNTS EXPRESSED IN THOUSANDS OF CONSTANT BRAZILIAN REAIS OF DECEMBER 31,
1997)
21. PROVISION FOR PENSIONS
The Companies participate in a multi-employer defined benefit pension and
other post-retirement benefit plans administered by the Fundacao Telebras de
Seguridade Social ("Sistel").
Approximately 97% of the Companies' employees are covered by these plans.
The Companies contributed and charged to expense R$115,341, R$113,105 and
R$108,393 in 1995, 1996 and 1997, respectively, in respect of pension fund
contributions. Information from the plans' administrators is not available to
permit the Companies to determine their share of unfunded vested benefits, if
any. Management has no intention of withdrawing from these plans, nor is there
any intention to terminate the plans. As a member of a multi-employer plan,
the Companies' contributions are not segregated in separate accounts or
restricted to provide benefits only to employees of the Companies. The
Companies are also contingently liable for the total obligations of the plans.
The funded status of the Sistel Plan is presented below.
As a member of the multi-employer plans, the Company's contributions are not
segregated in separate accounts or restricted to provide benefits only to
employees of the Company. The Company is also contingently liable for the
total obligations of the plans. The funded status of the Sistel plan is
presented below.
The pension benefit is generally defined as the difference between (i) 90%
of the retiree's average salary during the last 36 months indexed to the date
of retirement and (ii) the value of the retirement pension paid by the
Brazilian social security system. For retired employees the initial pension
payment is subsequently adjusted upwards to recognize cost of living increases
and productivity awards granted to active employees. In addition to the
pension supplements, post-retirement health care and life insurance benefits
are provided to eligible pensioners and their dependents.
Contributions to the plans are based on actuarial studies prepared by
independent actuaries under Brazilian regulations. The actuarial studies are
revised periodically to identify whether adjustments to the contributions are
necessary. A summary relating to the overall Sistel plan, in compliance with
accounting principles generally accepted in Brazil, is as follows:
<TABLE>
<CAPTION>
1996 1997
--------- ---------
<S> <C> <C>
Accumulated pension and other post-retirement benefits
obligations.......................................... 3,235,223 3,775,898
Other obligations..................................... 244,724 255,751
--------- ---------
Total obligations................................... 3,479,947 4,031,649
========= =========
Combined plan assets:
Interest bearing deposits............................ 1,849,298 1,714,153
Stocks and shares.................................... 1,548,629 2,360,786
Investment properties................................ 376,805 363,305
Loans to beneficiaries............................... 115,921 123,428
Other investments.................................... 56,229 52,195
--------- ---------
Total plan assets................................... 3,946,882 4,613,867
========= =========
Excess of total plan assets over total obligations.... 466,935 582,218
========= =========
</TABLE>
In addition to the formal Sistel plan, the Company pays pension benefits to
761 former employees of CTB, a predecessor company, in accordance with
agreements approved in 1971 and 1972. The Company accounts for the expense of
this agreement on the cash basis because it believes that the actuarially
computed liability and the annual expense are not material to its financial
position or results of operations.
F-25
<PAGE>
TELE NORTE LESTE PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(AMOUNTS EXPRESSED IN THOUSANDS OF CONSTANT BRAZILIAN REAIS OF DECEMBER 31,
1997)
22. SHAREHOLDERS' EQUITY
The accompanying consolidated financial statements reflect the consolidated
shareholders' equity of the Companies, after segregating as minority interests
the participation of minority shareholders in each of the Companies at the
historical percentages applicable to shareholders other than Telebras. The
combined shareholders' equity has been segregated between capital, reserves
and retained earnings.
23. EXPANSION PLAN CONTRIBUTIONS
Expansion plan contributions are the means by which the Companies have
financed the growth of their telecommunications network. The contributions
were made by companies or individuals to be connected to the national
telephone network. Such contributions were paid directly to the Companies and
interest received, when payments were made in installments, was transferred to
Telebras. The capital value received from the prospective telephone
subscribers was treated as follows:
. 80% was capitalized by the Companies in the name of Telebras, with
the value per share issued to Telebras being equal to the equity
value per share of each of the Companies at the end of the year
preceding the capitalization.
.20% was remitted by the Companies to Telebras in the month following
receipt.
. Until December 31, 1995 the total capital value received was indexed
from the month of receipt to the date of the next audited balance
sheet and then capitalized in the name of the prospective subscriber
by Telebras or by the Companies, at a value per share equal to the
equity value per share shown in the audited balance sheet. From
January 1, 1996 indexation was no longer applied and, for contracts
signed as from that date, Telebras or the Companies were allowed the
option of using a market value per share, when that was higher than
the equity value. Also, as from June 1995, the capitalization of
expansion plan contributions was effected by the Companies issuing
their own shares to expansion plan subscribers.
Expansion plan contributions of R$344,099, R$924,365, and R$600,540 in 1995,
1996 and 1997, respectively, were received. Expansion plan contributions
approved by the general meeting of shareholders for capitalization and
transfer to shareholders' equity amounted to R$713,570, R$317,130 and
R$1,180,793 in 1995, 1996 and 1997, respectively. The Companies' expansion
plan contribution program has been terminated, with no new contracts being
signed after June 30, 1997.
In addition to the expansion plans which it promoted directly, the Companies
also sponsored agreements between companies or individuals in a particular
community and independent contractors who undertook to develop the
telecommunications infrastructure required to connect them to the national
telephone network (Community Expansion Plan). The companies or individuals
paid the contractor. On completion of the project the Companies incorporated
the completed equipment into their fixed assets at the appraised value and
credited expansion plan contributions which are then treated in the same
manner as the capital values received from prospective telephone subscribers,
as described above.
24. TRANSACTIONS WITH RELATED PARTIES
The principal related party transactions take place with Embratel in respect
of long-distance telecommunications. The Companies have operating agreements
with Embratel, which define the charge per minute for inter-or intrastate
long-distance or international telephone calls with origin or destination in
the area specified by the telecommunications concession granted to the
Companies by the Federal Government. All
F-26
<PAGE>
TELE NORTE LESTE PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(AMOUNTS EXPRESSED IN THOUSANDS OF CONSTANT BRAZILIAN REAIS OF DECEMBER 31,
1997)
charges to customers, including long-distance, are billed by the Companies,
who transfer the long-distance portion of the charges to Embratel. As a
result, the Companies normally have a payable to Embratel.
Embratel and the cellular companies of Telebras must pay a network usage fee
if they access end customers via the network of the Companies. In practical
terms, even though the network usage fee includes the costs of a variety of
network elements and services, the network usage fee primarily reflects the
use of certain facilities of the Companies for which Embratel and the cellular
companies do not have adequate substitutes, particularly the local loop
between local exchanges and customers.
In the past, the Companies shared revenues for interregional and
international long-distance calls with Embratel rather than charging Embratel
a network usage fee for the use of the Companies' network. Under this system,
the Companies retained a fixed percentage of the revenues associated with such
calls and paid the balance of the revenues associated with such calls to
Embratel. This system was replaced on April 28, 1998 with the interconnection
charge that had already been in place for interconnection of the Companies'
network with cellular networks, under which the Companies charge for
connection to their network and usage of their network.
Additionally, as a result of telephone calls to and from the service areas
of other telephone operators, the Companies have receivable and payable
positions with other telecommunications service providers in Brazil within the
Telebras group of companies relating to charges for the use of the networks
belonging to those telecommunications service providers.
A summary of the balances and transactions with these related parties is as
follows:
<TABLE>
<CAPTION>
1996 1997
------- -------
<S> <C> <C>
Current assets:
Trade accounts receivable.................................. 19,087 11,352
Other assets............................................... 5,960 26,643
Non current assets...........................................
Other assets............................................... 800 2,080
Current liabilities:
Loans and financing........................................ 628,623 614,768
Accounts payable and accrued expenses...................... 86,242 66,766
Dividends.................................................. 258,042 365,054
Non current liabilities:
Loans and financing........................................ 678,337 703,463
</TABLE>
<TABLE>
<CAPTION>
1995 1996 1997
-------- -------- --------
<S> <C> <C> <C>
Net operating revenues....................... 123,050 192,714 347,281
Cost of services............................. 114,584 237,550 449,487
Operating expenses........................... (12,633) (30,449) (156,712)
Net interest expense......................... (119,023) (126,064) (93,107)
</TABLE>
Until the breakup of Telebras, the Companies and other companies of the
Telebras system were required to contribute to the research and development
center operated by Telebras and also conducted their own independent research
and development. Following the breakup of Telebras, a private independently
administered research and development center was established. Pursuant to an
agreement signed in May 1998 between the research and development center and
the Companies, the Companies are obligated to contribute R$128,600 to the
center during the three year period ending May 2001.
F-27
<PAGE>
TELE NORTE LESTE PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(AMOUNTS EXPRESSED IN THOUSANDS OF CONSTANT BRAZILIAN REAIS OF DECEMBER 31,
1997)
Additionally, Telebras charges a 1% per annum administration fee on the
allocation to the Holding Company of debt originally contracted by Telebras.
Telebras has also charged interest on inter company loans at a rate which is
currently the interest rate on federal treasury bills plus 0.25%. These
interest charges are included in the above table as net interest expense.
Other related parties are Federal, State and Municipal Governments. Revenues
from telephone calls made by government bodies and related organizations have
not been included above because details of the type of telephone user were not
maintained.
The balances of amounts invested in government securities or through
government controlled entities are:
<TABLE>
<CAPTION>
1996 1997
------- -------
<S> <C> <C>
Cash and cash equivalents:
Deposits with Banco do Brasil S.A.......................... 358,309 159,202
</TABLE>
The Companies believe that all the costs of doing business are reflected in
the combined financial statements and that no additional expenditures will be
incurred as a result of the cessation of the activities previously performed
by Telebras.
25. COMMITMENTS
At December 31, 1997 the Companies had approximately the following capital
expenditure commitments:
<TABLE>
<S> <C>
EXPECTED YEAR OF EXPENDITURE
1998............................................................... 1,038,000
1999............................................................... 30,000
</TABLE>
These commitments are to be spent on continuing expansion and modernization
of the system, transmission equipment and data transmission equipment.
26. INSURANCE
At December 31, 1997, in the opinion of management, all significant and high
risk assets and obligations were insured.
27. FAIR VALUES OF FINANCIAL ASSETS AND LIABILITIES
Estimated fair values of the Companies' financial assets and liabilities
have been determined using available market information and appropriate
valuation methodologies. However, considerable judgment was required in
interpreting market data to produce the estimated fair values. Accordingly,
the estimates presented below are not necessarily indicative of the amounts
that could be realized in a current market exchange. The use of different
market assumptions and/or estimation methodologies may have a material effect
on the estimated fair values.
The fair value information as of December 31, 1996 and 1997 presented below
is based on pertinent information available to management as of those dates.
Although management is not aware of any factors that would significantly
affect the estimated fair value amounts at December 31, 1996, such amounts
have been fully indexed to December 31, 1997 and current estimates of fair
values may differ significantly from the amounts shown.
F-28
<PAGE>
TELE NORTE LESTE PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE COMBINED FINANCIAL STATEMENTS--(CONTINUED)
(AMOUNTS EXPRESSED IN THOUSANDS OF CONSTANT BRAZILIAN REAIS OF DECEMBER 31,
1997)
Where no comparison of book versus fair value is presented for a financial
asset or liability line item in the schedule below, no significant difference
in values is believed to exist.
<TABLE>
<CAPTION>
1996 1996 1997 1997
BOOK FAIR BOOK FAIR
VALUE VALUE VALUE VALUE
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Assets:
Other assets:
Deferred and recoverable income
tax............................ 113,262 96,349 217,816 211,264
Liabilities:
Income taxes..................... 571,685 529,855 696,786 676,015
Loans and financing:
Loans payable to Telebras....... 1,306,960 1,287,804 1,318,231 1,316,094
Other financing................. 268,447 262,531 305,322 309,991
</TABLE>
Cash, cash equivalents, customer accounts receivable and other assets,
accounts payable and accrued liabilities.
The carrying value of cash and cash equivalents, trade accounts receivable
and other assets, accounts payable and accrued liabilities are a reasonable
estimate of their fair values. Cash equivalents are represented principally by
overnight-deposits for which the fair values were also considered to be the
same as the carrying value, as also trade accounts receivable, other assets,
accounts payable and accrued liabilities.
Loans and financing
Interest rates that are currently available to the Companies for issuance of
debt with similar terms and maturities were used to estimate fair value.
28. EVENTS SUBSEQUENT TO DECEMBER 31, 1997
A. INCORPORATION OF THE CELLULAR COMPANIES
At December 31, 1997, Telebras, through its operating subsidiaries, was the
principal supplier of public telecommunications services in Brazil, which
included being the leading provider of fixed-line telephone services. On
January 30, 1998 as part of a separation of the telephone business between
fixed and cellular operations by all of Telebras' subsidiaries, the Companies
spun off the assets and liabilities at December 31, 1997 of their cellular
telecommunications operations into separate companies. These new companies,
the Cellular Companies, were incorporated on January 5, 1998.
B. INCORPORATION OF TELE NORTE LESTE PARTICIPACOES S.A.
On May 22, 1998 the shareholders of Telebras approved Telebras' division
into twelve new holding companies using a procedure under Brazilian corporate
law called a cisao ("spin-off"), whereby existing shareholders received shares
in the new companies in proportion to their holdings in Telebras. The new
companies contain the assets and liabilities previously recorded in the
accounts of Telebras, except for the following, which will remain on the books
of Telebras and not be allocated to the new holding companies:
. approximately R$98,000 of net assets which have been attributed to a
newly constituted research foundation that will take over the activities
previously performed by the Telebras Campinas Research and Development
Center, and,
F-29
<PAGE>
TELE NORTE LESTE PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(AMOUNTS EXPRESSED IN THOUSANDS OF CONSTANT BRAZILIAN REAIS OF DECEMBER 31,
1997)
. approximately R$370,000 of net assets that will provide the funds
required to liquidate Telebras, including approximately R$132,000 of
retroactive dividends to be paid to the holders of new shares issued in
April 1998, as a result of the resolution of the disputed capital
increase of 1990, approximately R$50,000 of indemnity payments to
employees and approximately R$87,000 of expenses arising out of the
privatization process.
In addition to approving the allocation of assets and liabilities to the new
Holding Companies at the May 22, 1998 meeting, the shareholders also approved
a specific structure for the shareholders' equity of each new holding company,
which included an allocation of a portion of the retained earnings of
Telebras. Consequently, the amounts of the balances of capital, reserves and
retained earnings, together with the corresponding assets and liabilities for
the formation of Tele Norte Leste Participacoes S.A. were established. After
Telebras retained within its own shareholders equity sufficient retained
earnings from which to pay dividends on its 1997 earnings and in settlement of
dividends as a result of settlement of the 1990 disputed share increase,
Telebras allocated to each New Holding Company, the balance of its retained
earnings in proportion to the allocated total net assets. This value of
allocated retained earnings does not represent the historical retained
earnings of the Holding Companies and resulted in an increase of R$1,906,669
in relation to the Company's historical retained earnings. These values are
shown in the "Spin-off from Telebras" column in the following table. The first
column summarizes the December 31, 1997 consolidated historical balances of
the Companies' consolidated balance sheets, and the "Holding Company
Consolidated Statement" column summarizes the consolidated balance sheet of
Tele Norte Leste Participacoes S.A. after the spin-off.
As a result of the legal structure of the spin-off and as allowed under
Brazilian GAAP, a company formed as a result of a cisao will have such
retained earnings in its balance sheet as the parent company shareholders'
resolution adopting the cisao allocates from the parent company to the new
company. Accordingly, upon formation, Tele Norte Leste Participacoes S.A.'s
legal capital structure was defined by the resolutions approved by the
Telebras shareholders' meeting of May 22, 1998 so that its shareholders'
equity of R$10,044,081 includes retained earnings of R$3,188,998. The
allocated retained earnings and future retained earnings will be the basis
from which future dividends will be payable.
F-30
<PAGE>
TELE NORTE LESTE PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(AMOUNTS EXPRESSED IN THOUSANDS OF CONSTANT BRAZILIAN REAIS OF DECEMBER 31,
1997)
The "Adjustments and Eliminations" column includes (i) the elimination of
the Holding Company investment in the Companies, (ii) the elimination of inter
company loans, payables and receivables, (iii) the elimination of the net
assets of the discontinued cellular operations and (iv) the elimination of the
minority shareholdings in the discontinued cellular operations.
<TABLE>
<CAPTION>
DECEMBER 31, 1997 SPIN-OFF ADJUSTMENTS HOLDING COMPANY
HISTORICAL FROM AND CONSOLIDATED
BALANCES TELEBRAS ELIMINATIONS STATEMENT
----------------- ---------- ------------ ---------------
<S> <C> <C> <C> <C>
Assets
Cash and cash equiva-
lents.................. 214,239 165,707 -- 379,946
Intercompany receiv-
ables.................. 37,995 1,110,139 (1,017,969) 130,165
Other current assets.... 1,139,347 -- -- 1,139,347
---------- ---------- ----------- ----------
Total current as-
sets............... 1,391,581 1,275,846 (1,017,969) 1,649,458
Intercompany receiv-
ables.................. 2,080 737,985 (698,022) 42,043
Other noncurrent as-
sets................... 96,482 -- -- 96,482
---------- ---------- ----------- ----------
Total noncurrent as-
sets............... 98,562 737,985 (698,022) 138,525
Investment in subsidiar-
ies.................... -- 8,021,211 (8,021,211) --
Other investments....... 14,717 -- -- 14,717
Advances for future cap-
ital increase.......... -- 308,425 (308,425) --
Property, plant and
equipment.............. 13,282,386 20,534 -- 13,302,920
---------- ---------- ----------- ----------
Total permanent as-
sets............... 13,297,103 8,350,170 (8,329,636) 13,317,637
Discontinued opera-
tions.................. 1,848,554 -- (1,848,554) --
---------- ---------- ----------- ----------
Total assets............ 16,635,800 10,364,001 (11,894,181) 15,105,620
========== ========== =========== ==========
Liabilities
Loans and financing..... 743,591 -- (620,209) 123,382
Other................... 1,752,737 (397,760) 1,354,977
---------- ---------- ----------- ----------
Total current lia-
bilities........... 2,496,328 -- (1,017,969) 1,478,359
Loans and financing..... 879,962 -- (698,022) 181,940
Other................... 663,550 -- -- 663,550
---------- ---------- ----------- ----------
Total noncurrent li-
abilities.......... 1,543,512 -- (698,022) 845,490
Minority interest....... 2,730,761 -- (383,257) 2,347,504
Share capital........... -- 3,741,151 -- 3,741,151
Capital and reserves.... 8,204,179 -- (8,204,179) --
Income reserves......... -- 3,113,932 -- 3,113,932
Retained earnings....... 1,282,329 3,188,998 (1,282,329) 3,188,998
---------- ---------- ----------- ----------
Total shareholders'
equity............. 9,486,508 10,044,081 (9,486,508) 10,044,081
Expansion plan contribu-
tions.................. 378,691 319,920 (308,425) 390,186
---------- ---------- ----------- ----------
Total liabilities and
shareholders' equity... 16,635,800 10,364,001 (11,894,181) 15,105,620
========== ========== =========== ==========
</TABLE>
The separation of the fixed and cellular telecommunications business and the
formation of the Holding Company have been accounted for as reorganizations of
entities under common control in a manner similar to a pooling of interests.
Brazilian corporate and tax law allows state controlled companies which are
participating in the government's privatization program a three month delay
between the accounting base date for a spin-off and the date on which the
shareholders' meeting approves the spin-off, including the related accounting
basis for the net assets spun-off. Furthermore, as allowed by Brazilian
corporate law, the amount shown in the "Spin-off from Telebras" column as
"Investment in subsidiaries" was determined based on the balance sheets of
those
F-31
<PAGE>
TELE NORTE LESTE PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(AMOUNTS EXPRESSED IN THOUSANDS OF CONSTANT BRAZILIAN REAIS OF DECEMBER 31,
1997)
subsidiaries as of December 31, 1997. As a result, the consolidated financial
statements of the Holding Company for 1998 will include the results of
operations and changes in financial condition of the subsidiaries from January
1, 1998 and the effects of the cash and other assets (principally intercompany
receivables) allocated from Telebras as of March 1, 1998.
The capital stock of the Holding Company is comprised of preferred shares
and common shares, all without par value. At May 22, 1998, there were
210,029,997 thousand outstanding preferred shares (inclusive of 13,718,350
thousand preferred shares resulting from the settlement in April 1998 with
Telebras as discussed below) and 124,351,903 thousand outstanding common
shares (net of 17,128 thousand common shares in treasury). The capital may be
increased only by a decision taken at a shareholders' meeting or by the Board
of Directors in connection with the capitalization of profits or reserves
previously allocated to capital increases at a shareholders' meeting.
The preferred shares are non-voting except under limited circumstances and
are entitled to a preferential, noncumulative dividend and to priority over
the common shares in the case of liquidation of the Holding Company.
Under the Brazilian Corporation Law, the number of non-voting shares, such
as the preferred shares, may not exceed two-thirds of the total number of
shares.
On June 7, 1990, the Board of Directors of Telebras authorized an increase
in Telebras share capital by public offer. During the offer period the CVM
initiated an investigation as to whether Brazilian securities law and
regulations regarding the correct pricing of the new shares issued had been
violated, because the shares were issued at a discount to equity value per
share. After its investigation the CVM notified the Federal Prosecutor's
Office that it believed no violation occurred since the price was established
in line with market prices for Telebras' shares traded on the Brazilian stock
exchanges. Nevertheless, the Federal Prosecutor decided to pursue the issue
through judicial channels. In April 1998, resolution was reached on the
disputed Telebras capital increase of 1990. In connection with the resolution
Telebras issued 13,718,350 thousand shares of preferred stock.
Dividends
Pursuant to its By-laws, the Holding Company is required to distribute as
dividends in respect of each fiscal year ending on December 31, to the extent
amounts are available for distribution, an aggregate amount equal to at least
25% of Adjusted Net Income (as defined below) on such date (the "Mandatory
Dividend"). The annual dividend distributed to holders of preferred shares
(the "Preferred Dividend") has priority in the allocation of Adjusted Net
Income. Remaining amounts to be distributed are allocated first to the payment
of a dividend to holders of common shares in an amount equal to the Preferred
Dividend and the remainder is distributed equally among holders of preferred
shares and common shares.
For purposes of Brazilian Corporation Law, and in accordance with Tele Norte
Leste Participacoes S.A.'s By-laws, the "Adjusted Net Income" is an amount
equal to Tele Norte Leste Participacoes S.A.'s net profits adjusted to reflect
allocations to or from (i) the statutory reserve, (ii) a contingency reserve
for anticipated losses, if any, and (iii) an unrealized revenue reserve, if
any.
In addition, subsequent to December 31, 1997 an investigation relating to an
increase in the share capital of Telebras by a 1990 public offering has
concluded in favor of Telebras. Accordingly, Telebras has issued the 13,718
million preferred shares previously under investigation.
F-32
<PAGE>
TELE NORTE LESTE PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(AMOUNTS EXPRESSED IN THOUSANDS OF CONSTANT BRAZILIAN REAIS OF DECEMBER 31,
1997)
C. NEW REGULATORY ENVIRONMENT
On April 28, 1998, the revenue sharing regime used to divide interregional
and international long-distance revenues between Embratel and the Companies
was replaced with a network usage fee for interconnection, based on the terms
of an interconnection agreement with Embratel which became effective in April
1998.
The terms of this interconnection agreement, particularly pricing and
technical requirements, will significantly affect the Companies' results of
operations, competitive environment and capital expenditure policies. Under
the current regulatory framework, all telecommunications service providers
must provide interconnection services on a non-discriminatory basis. Subject
to certain requirements, providers are free to negotiate the terms of
interconnection but, in the event the parties fail to reach an agreement,
Anatel will establish the terms of interconnection.
The Companies do not expect the terms of the interconnection agreement to
have a material impact on net income initially as reduced net operating
revenues under the new structure are expected to be offset by a supplement
per-minute rebate from Embratel called Parcela Adicional de Transicao ("PAT")
that supplements the network usage charge. Under the General Plan on
Concessions and Licenses, the fixed-line companies and Embratel, an affiliate
providing long distance services, are prohibited from offering certain basic
fixed-line telecommunications services until they fulfill certain specified
obligations. Embratel is prohibited from offering local or cellular services
and the regional fixed-line companies are prohibited from offering cellular,
interregional long-distance and international long-distance services. After
the privatization is effected, Embratel will be allowed to enter the market
for intraregional long-distance service as a competitor to the regional fixed-
line companies once the privatization of Telebras is completed.
D. CHANGE IN CONTROL (UNAUDITED)
On July 29, 1998, the Federal Government sold to eleven separate buyers (the
"New Controlling Shareholders") its rights to receive shares of the twelve New
Holding Companies upon the distribution of such shares. In connection with
this sale, the Federal Government assigned to the New Controlling Shareholders
substantially all its economic and voting rights with respect to the New
Holding Companies and, as a consequence, effective August 4, 1998 the New
Controlling Shareholders control the New Holding Companies.
29. SUMMARY OF THE DIFFERENCES BETWEEN BRAZILIAN AND US GAAP
The Companies' accounting policies comply with generally accepted accounting
principles in Brazil ("Brazilian GAAP"). Accounting policies which differ
significantly from generally accepted accounting principles in the United
States of America ("US GAAP") are described below:
A. DIFFERENT CRITERIA FOR CAPITALIZING AND DEPRECIATING CAPITALIZED INTEREST
Until December 31, 1993 capitalized interest was not added to the individual
assets in property, plant and equipment, instead it was capitalized separately
and amortized over a time period different from the useful lives of the
related assets. Under US GAAP, capitalized interest is added to the individual
assets and is amortized over their useful lives. Also, under Brazilian GAAP as
applied to companies in the telecommunications industry, interest attributable
to construction-in-progress is computed at the rate of 12% per annum of the
balance of construction-in-progress and that part which relates to interest on
third party loans is credited to interest expense based on actual interest
costs with the balance relating to own capital being credited to capital
reserves.
F-33
<PAGE>
TELE NORTE LESTE PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(AMOUNTS EXPRESSED IN THOUSANDS OF CONSTANT BRAZILIAN REAIS OF DECEMBER 31,
1997)
Under US GAAP, in accordance with the provisions of SFAS 34, interest
incurred on borrowings is capitalized to the extent that borrowings do not
exceed construction-in-progress. The credit is a reduction of interest
expense. Under US GAAP, the amount of interest capitalized excludes the
monetary gain associated with the borrowings and the foreign exchange gains
and losses on foreign currency borrowings. The US GAAP differences between the
accumulated capitalized interest on disposals and in accumulated amortization
on disposals relate to the differences between capitalized interest and
related accumulated amortization under Brazilian and US GAAP which is included
in the net book value of disposed property, plant and equipment. Although
these amounts have been determined to be the same, there are presented
individually in both the determination of the capitalized interest difference
and in the determination of amortization of the capitalized interest
difference in order to demonstrate the origin of the reconciling items for
capitalized interest and amortization of capitalized interest which are
disclosed in the net income reconciliation of the differences between U.S. and
Brazilian GAAP.
The effects of these different criteria for capitalizing and depreciating
capitalized interest are presented below:
<TABLE>
<CAPTION>
1996 1997
-------- --------
<S> <C> <C>
CAPITALIZED INTEREST DIFFERENCE
US GAAP capitalized interest:
Interest which would have been capitalized and credited
to income under US GAAP (Being interest incurred on
loans from the Company's parent and from third
parties, except in years where total loans exceeded
total construction in progress, when capitalized
interest is reduced proportionately).................. 202,857 180,028
Difference in accumulated capitalized interest on
disposals............................................. 2,600 12,673
-------- --------
205,457 192,701
-------- --------
Less Brazilian GAAP capitalized interest:
Interest capitalized and credited to income under
Brazilian GAAP (Up to the limit of interest incurred
on loans obtained for financing capital investments).. (33,766) (126,824)
Interest capitalized and credited to reserves under
Brazilian GAAP (Difference between total capitalized
interest and interest capitalized and credited to
income)............................................... (200,728) (192,711)
-------- --------
Total capitalized interest under Brazilian GAAP (12%
per annum, applied monthly to the balance of
construction-in-progress)........................... (234,494) (319,535)
-------- --------
US GAAP Difference....................................... (29,037) (126,834)
======== ========
AMORTIZATION OF CAPITALIZED INTEREST DIFFERENCE
Amortization under Brazilian GAAP...................... 181,590 209,386
Less: Amortization under US GAAP....................... (156,484) (174,414)
US GAAP difference in accumulated amortization on
disposals........................................... (2,600) (12,673)
-------- --------
US GAAP Difference..................................... 22,506 22,299
======== ========
</TABLE>
B. REVERSAL OF PROPOSED DIVIDENDS
Under Brazilian GAAP proposed dividends are accrued for in the consolidated
financial statements in anticipation of their approval at the shareholders'
meeting. Under US GAAP, dividends are not accrued until they are formally
declared.
F-34
<PAGE>
TELE NORTE LESTE PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(AMOUNTS EXPRESSED IN THOUSANDS OF CONSTANT BRAZILIAN REAIS OF DECEMBER 31,
1997)
C. PENSION AND OTHER POST-RETIREMENT BENEFITS
The Companies participate in a multi-employer plan ("Sistel") and provide
for the costs of pensions and other post retirement benefits based on a fixed
percentage of remuneration, as recommended annually by independent actuaries.
For the purposes of US GAAP, the Companies are considered to contribute to a
multi-employer plan and consequently are required to disclose its annual
contributions and the funded status of the plan in accordance with US GAAP.
Note 32 shows the funded status of Sistel. The provisions of SFAS 87 for the
purposes of calculating the funded status were applied with effect from
January 1, 1992, because it was not feasible to apply them from the effective
date specified in the standard.
D. ITEMS POSTED DIRECTLY TO SHAREHOLDERS' EQUITY ACCOUNTS
Under Brazilian GAAP various items are posted directly to shareholders'
equity accounts that under US GAAP would be posted to the income statement.
Examples include capitalized interest, the effects of adjustments to tax rates
and tax incentive investment credits received. The posting of such items to
shareholders' equity gives rise to adjustments in the consolidated statements
of changes in shareholders' equity. Since the original postings to equity
accounts would, under US GAAP, be made directly to the income statement, these
adjustments must be included in the reconciliation of net income in accordance
with US GAAP. The effects of changes in income tax rates posted directly to
shareholders' equity accounts arise from applying increases or decreases in
tax rates to the deferred tax liability relating to the special reserve
arising from pre-1990 indexation adjustments to property, plant and equipment.
E. EARNINGS PER SHARE
Under Brazilian GAAP, net income per share is calculated on the number of
shares outstanding at the balance sheet date. Since the capital structure of
the Holding Company was not in place at December 31, 1997, earning per share
is not presented for Brazilian GAAP.
In these combined financial statements, information is disclosed per lot of
one thousand shares, because this is the minimum number of shares that can be
traded on the Brazilian stock exchanges. Each American Depositary Share
("ADS") is equivalent to one thousand shares.
As discussed in Note 1, the Holding Company was not formed until subsequent
to December 31, 1997. For US GAAP purposes, the equity structure utilized for
the earnings per share computations is that of the new entity formed in May
1998. The Holding Company's equity structure has been used for all years
presented. At the date of formation, the Holding Company had 124,351,903
thousand common shares (net of 17,128 thousand common shares in treasury) and
196,311,647 thousand preferred shares outstanding (exclusive of the 13,718,350
thousand preferred shares resulting from the settlement in April 1998 with
Telebras).
Since the preferred and common stockholders have different dividend, voting
and liquidation rights, Basic and Diluted earnings per share have been
calculated using the "two-class" method. The "two-class" method is an earnings
allocation formula that determines earnings per share for preferred and common
stock according to the dividends to be paid as required by the Company's by-
laws and participation rights in undistributed earnings.
Basic earnings per common share is computed by reducing net income by
distributable and undistributable net income available to preferred
shareholders and dividing net income available to common and preferred
shareholders by the weighted-average number of common and preferred shares
outstanding during the period. Net income available to preferred shareholders
is the sum of the preferred stock dividends up to a minimum of
F-35
<PAGE>
TELE NORTE LESTE PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(AMOUNTS EXPRESSED IN THOUSANDS OF CONSTANT BRAZILIAN REAIS OF DECEMBER 31,
1997)
6% of adjusted net income, as defined in the Company's by-laws (distributable
net income) and the preferred shareholders portion of undistributed net
income. Undistributed net income is computed by deducting preferred and common
stock dividends from net income. Undistributed net income is shared equally by
the preferred and common shareholders on a pro rata basis. Common stock
dividends are calculated up to 25% of adjusted net income or an amount equal
to the preferred stock dividend, whichever is less. Diluted earnings per share
is computed by reducing net income for an increase to net earnings allocated
to minority shareholders and dividing such net income available to common and
preferred shareholders by the monthly weighted-average number of common and
preferred shares outstanding during the period. The weighted average
(thousand) shares outstanding for diluted earnings per share is not greater
than such shares used in the basic earnings per share calculation since the
dilutive share issue is that of the Holding Company's subsidiaries.
In February 1997, the Financial Accounting Standards Board issued SFAS No.
128 "Earnings Per Share". This new statement became effective December 15,
1997, and provides computation, presentation and disclosure requirements for
earnings per share.
The weighted-average number of common and preferred shares used in computing
basic earnings per share for 1997 was 124,351,903 thousand and 196,311,647
thousand (exclusive of the 13,718,350 thousand preferred shares resulting from
the settlement in April 1998 with Telebras), respectively. The Companies have
received certain contributions from customers or customers have independently
paid suppliers of telecommunications equipment and services for the
installation of fixed-line services. These amounts are reflected as "funds for
capitalization" in the accompanying combined balance sheets. Once the
installation is essentially complete and the contributions have been received,
the funds will be converted into equity. (See Note 23 to the combined
financial statements). These activities are dilutive in nature to the
shareholders of the Holding Company or the Companies, whether the shares to be
issued are those of the Holding Company's subsidiaries, (which will impact the
minority interest recognized) or of the company itself. The expectation is
that the shares would be issued in the subsidiary companies rather than in the
Holding Company based on the manner in which such shares were issued in 1997
and 1998. Management of the Holding Company determined this manner of issuing
the shares in these two years was appropriate as a result of the dilution of
the Brazilian Government's share of the ordinary voting shares of the Holding
Company below the 50% level which would have occurred if the shares had been
issued by the Holding Company. The shares are treated as outstanding and
included in the basic EPS calculation only when such funds are converted to
equity and the shares issued. The shares are treated as outstanding for
diluted EPS purposes when expansion plan contributions are received or when
Community Expansion Plan agreements have been approved (see note 23). If
subsidiary shares had been issued historically, the reduction to net income to
increase net earnings attributable to minority shareholders for 1996 and 1997
would have been R$89,666 and R$54,286, respectively.
The Company's preferred shares are non-voting except under certain limited
circumstances and are entitled to a preferential, noncumulative dividend and
to priority over the common shares in the event of liquidation of the Company.
The preferred shareholders were entitled to a non-cumulative dividend of
R$1.03 and R$1.69 per preferred share in 1996 and 1997, respectively. The
preferred shareholders would share equally in the undistributed earnings of
the Company in the amount of R$1.94 and R$2.15 per preferred share in 1996 and
1997, respectively.
In April 1998, resolution was reached on the disputed capital increase of
1990 (see Note 28). In connection with the resolution, the Company issued
13,718,350 shares of preferred stock. For Brazilian GAAP, such shares are
considered outstanding when issued. For US GAAP purposes, the weighted average
share outstanding
F-36
<PAGE>
TELE NORTE LESTE PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(AMOUNTS EXPRESSED IN THOUSANDS OF CONSTANT BRAZILIAN REAIS OF DECEMBER 31,
1997)
computation includes these shares as having been outstanding from 1990 as they
were issued for services provided in 1990 for no additional consideration,
and, when issued, provided holders retroactively with the same rights to
dividends as other shareholders who had held their shares since 1990.
Earnings per share has been presented for net income only since interest
income, certain interest expense and social contribution taxes have not been
allocated between income from continuing operations and income from
discontinued operations.
F. DISCLOSURE REQUIREMENTS
US-GAAP disclosure requirement differ from those required by Brazilian GAAP.
However, in these combined financial statements, the level of disclosure has
been expanded to comply with US GAAP.
G. INCOME TAXES
The Companies fully accrue for deferred income taxes on temporary
differences between tax and reporting records. The existing policies for
providing for deferred taxes are substantially in accordance with SFAS 109,
"Accounting for Income Taxes", except in connection with the deferred income
tax effects of indexation adjustments in 1996 and 1997 (see Note 2(a)(iii)).
Under US GAAP the deferred tax effects of the 1996 and 1997 indexation for
financial reporting purposes would be charged to income and social
contribution taxes in the combined statement of income. Consequently, this is
the only material difference in the implementation of SFAS 109 other than in
relation to the US GAAP adjustments described in this note to the combined
financial statements, and for the fact that deferred income taxes are shown
gross rather than being netted as required by US GAAP. Additionally, for US
GAAP purposes, deferred tax assets and liabilities are classified as current
or non current based on the classification of the asset or liability
attributing to the temporary difference.
H. INTEREST INCOME (EXPENSE)
Brazilian GAAP requires interest to be shown as part of operating income.
Under US GAAP interest income (expense) would be shown after operating income.
I. EMPLOYEES' PROFIT SHARE
Brazilian GAAP requires employees' profit share to be shown as an
appropriation of net income for the year. Under US GAAP employee profit
sharing is included as an expense in arriving at operating income.
J. PERMANENT ASSETS
Brazilian GAAP has a class of assets called permanent assets. This is the
collective name for all assets on which indexation adjustments were calculated
in the corporate and fiscal law accounts of Brazilian companies. Under US GAAP
the assets in this classification would be noncurrent assets.
Losses on the disposal of permanent assets were R$28,371, R$47,703 and
R$78,732 in 1995, 1996 and 1997, respectively. Such gains and losses were
classified as non-operating income (expenses) for Brazilian GAAP. Under US
GAAP such losses would reduce operating income.
K. PRICE-LEVEL ADJUSTMENTS AND US GAAP PRESENTATION
The effects of price-level adjustments have not been eliminated in the
reconciliation to US GAAP, nor are the monetary gains or losses associated
with the various US GAAP adjustments separately identified, because
F-37
<PAGE>
TELE NORTE LESTE PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(AMOUNTS EXPRESSED IN THOUSANDS OF CONSTANT BRAZILIAN REAIS OF DECEMBER 31,
1997)
the application of inflation restatement as measured by the UFIR and the IGP-M
represents a comprehensive measure of the effects of price level changes in
the Brazilian economy and, as such, is considered a more meaningful
presentation than historical cost-based financial reporting for both Brazilian
and US accounting purposes.
L. FUNDS FOR CAPITALIZATION
i. Expansion plan contributions
Under Brazilian GAAP expansion plan contributions received are included in
the combined balance sheet below equity until proposed subscribers have paid
for their telephone connection in full and a general meeting of shareholders
approves the capital increases. Until December 31, 1995 expansion plan
contributions were indexed from the month received to the date of the next
audited balance sheet and transferred to equity when capital stock was issued
to the subscriber, at a value per share equal to the equity value per share
shown on the latest audited balance sheet.
From January 1, 1996 indexation was no longer applied and, for contracts
signed as from that date, the Companies were allowed the option of using a
value per share equal to the market value, when this is higher than the equity
value. For US GAAP purposes, a portion of the expansion plan contributions
would be allocated to shareholders' equity based on the market value of the
shares to be issued to subscribers. The remainder of the expansion plan
contributions would be classified as a deferred credit and amortized to reduce
depreciation expense from the time the related construction-in-progress is
completed.
ii. Donations and subsidies for investments
Under Brazilian GAAP, those amounts, which comprise principally the excess
of the value of property, plant and equipment incorporated into the Companies'
assets over the corresponding credits to expansion plan contributions
received, are recorded as a credit to other capital reserves. For US GAAP
purposes, the credit to capital reserves would be classified as a deferred
credit and amortized to reduce depreciation expense.
M. LOANS AND FINANCING
For US GAAP, loans and financing balances in default or expected to be in
default within a year of the balance sheet date would be classified as current
obligations unless creditors had provided the Company wavers for such
defaults. For Brazilian GAAP, loan and financing balances in technical default
are not always classified as current liabilities. A portion (R$133,055) of the
Company's outstanding debt at December 31, 1997 is currently in default or is
expected to be in default as a result of the privatization and accordingly,
for US GAAP, would be classified as current liabilities.
N. VALUATION OF LONG-LIVED ASSETS
For US GAAP, effective January 1, 1996 the Companies adopted SFAS 121
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets
to Be Disposed Of." In accordance with this standard, the company periodically
evaluates the carrying value of long-lived assets to be held and used, when
events and circumstances warrant such a review. The carrying value of long-
lived assets is considered impaired when the anticipated undiscounted cash
flow from such assets is separately identifiable and is less than their
carrying value. In that event, a loss is recognized based on the amount by
which the carrying value exceeds the
F-38
<PAGE>
TELE NORTE LESTE PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(AMOUNTS EXPRESSED IN THOUSANDS OF CONSTANT BRAZILIAN REAIS OF DECEMBER 31,
1997)
fair market value of the assets. The adoption of this standard did not have a
material effect on the Companies' results or financial condition.
Brazilian GAAP does not require discounting cash flow computation in order
to determine potential asset impairment.
O. RETAINED EARNINGS
For Brazilian GAAP, a company formed as a result of a cisao may have
retained earnings in its balance sheet if the parent company shareholders'
resolution adopting the cisao allocates retained earnings from the parent
company to the new company. Under U.S. GAAP, "retained earnings" allocated in
the cisao would not be considered historical retained earnings as such amount
would represent capital allocated from the parent company and would be
described as "distributable capital." As a result of the May 22, 1998 spin-
off, the Company will have U.S. GAAP distributable capital of R$3,188,998.
P. RECOGNITION OF GAINS FROM DISPUTED TAXES
Brazilian GAAP is less rigorous that US GAAP in establishing the criteria
which must be met for the recognition of a gain such as the R$27,459
recognized by the Company in 1994 in relation to overpaid FINSOCIAL taxes (see
Note 20). Under US GAAP this amount would be considered a gain contingency
which would not be recognized until receipt of the benefit were to be
considered full and final.
F-39
<PAGE>
TELE NORTE LESTE PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(AMOUNTS EXPRESSED IN THOUSANDS OF CONSTANT BRAZILIAN REAIS OF DECEMBER 31,
1997)
NET INCOME RECONCILIATION OF THE DIFFERENCES BETWEEN US AND BRAZILIAN GAAP
<TABLE>
<CAPTION>
1996 1997
----------- -----------
<S> <C> <C>
Income from continuing operations before
unallocated interest income/expense, taxes and
minority interest as reported.................... 809,337 1,109,280
Add (deduct):
Different criteria for:
Capitalized interest........................... (29,037) (126,834)
Amortization of capitalized interest........... 22,506 22,299
Contributions to plant expansion:
Amortization of deferred credit................ 28,741 34,321
Items posted directly to shareholders' equity:
Interest on construction in progress........... 200,728 192,711
----------- -----------
US GAAP income from continuing operations before
unallocated interest income/expense, income
taxes and minority interests................... 1,032,275 1,231,777
----------- -----------
Income as reported from discontinued operations
before unallocated interest income/expense,
income taxes and minority interests............ 679,409 788,790
Effect of US GAAP differences on income from
discontinued operations........................ 24,292 29,208
----------- -----------
US GAAP income from discontinued operations
before unallocated interest income/expense,
income taxes and minority interests............ 703,701 817,998
=========== ===========
Items relating to continuing and discontinued
operations:
Unallocated interest income..................... 45,373 126,554
Unallocated interest expense.................... (121,374) (128,544)
Income and social contribution taxes............ (386,464) (484,844)
Minority interests, Brazilian GAAP basis........ (152,316) (312,351)
Add (deduct):
Items posted directly to shareholder's equity:
Effects of changes in income tax rates........ (7,742) (7,673)
Tax incentive investments credits............. 22,107 36,180
Deferred tax on full indexation............... (287,953) (291,597)
Deferred tax effects of the above adjustments:
In respect of continuing operations........... 22,785 55,200
In respect of discontinued operations......... 4,130 879
Minority interests in the above adjustments.... 79,881 188,685
----------- -----------
US GAAP net income................................ 954,403 1,232,264
=========== ===========
Common shares--Basic............................ 2.98 3.84
Weighted average (thousand) common shares
outstanding.................................. 124,351,903 124,351,903
=========== ===========
Common shares--Diluted.......................... 2.63 3.65
Weighted average (thousand) common shares
outstanding.................................. 124,351,903 124,351,903
=========== ===========
Preferred shares--Basic......................... 2.98 3.84
Weighted average (thousand) preferred shares
outstanding.................................. 196,311,647 196,311,647
=========== ===========
Preferred shares--Diluted....................... 2.63 3.65
Weighted average (thousand) preferred shares
outstanding.................................. 196,311,647 196,311,647
=========== ===========
</TABLE>
F-40
<PAGE>
TELE NORTE LESTE PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(AMOUNTS EXPRESSED IN THOUSANDS OF CONSTANT BRAZILIAN REAIS OF DECEMBER 31,
1997)
SHAREHOLDERS' EQUITY RECONCILIATION OF THE DIFFERENCES BETWEEN US AND BRAZILIAN
GAAP
<TABLE>
<CAPTION>
1996 1997
----------- -----------
<S> <C> <C>
Total shareholders' equity as reported........... 8,625,148 9,486,508
Add (deduct):
Different criteria for:
Capitalized interest.......................... (257,670) (384,504)
Amortization of capitalized interest.......... 239,010 261,309
Reversal of proposed dividends................. 301,300 480,426
Reversal of COFINS tax credit.................. (27,459) (27,459)
Contributions to plant expansion:
Amortization of deferred credit............... 60,000 94,321
Subscribed capital stock...................... 527,761 (192,057)
Donations and subsidies for investment........ (9,060) (18,409)
Deferred tax effects of the above adjustments.. 135,110 190,310
Adjustments in respect of discontinued
operations:
Adjustments before income taxes............... (42,788) (45,452)
Deferred tax effects of these adjustments..... 14,120 14,999
Minority interests in the above adjustments.... (120,690) (66,573)
----------- -----------
US GAAP shareholders' equity................... 9,444,782 9,793,419
=========== ===========
US GAAP Supplementary information:
Total assets................................... 14,833,691 16,672,462
=========== ===========
Property, plant and equipment.................. 25,809,036 27,626,074
Accumulated depreciation....................... (13,883,126) (14,466,883)
----------- -----------
Net property, plant and equipment.............. 11,925,910 13,159,191
=========== ===========
</TABLE>
The deferred tax effect of the US GAAP adjustments noted above would be
classified mainly as a noncurrent asset in the balance sheet.
F-41
<PAGE>
TELE NORTE LESTE PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(AMOUNTS EXPRESSED IN THOUSANDS OF CONSTANT BRAZILIAN REAIS OF DECEMBER 31,
1997)
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY IN ACCORDANCE WITH
US-GAAP
<TABLE>
<CAPTION>
CAPITAL RETAINED
AND RESERVES EARNINGS TOTAL
------------ --------- ----------
<S> <C> <C> <C>
Balances at December 31, 1995............. 6,872,028 1,091,447 7,963,475
Expansion plan contributions:
Received................................. 924,790 -- 924,790
Deferred credits......................... (62,260) -- (62,260)
Forfeited dividends....................... -- 29 29
Net income for the year................... -- 954,403 954,403
Realization of unrealized income.......... (81,751) 81,751 --
Transfers to reserves..................... 46,871 (46,871) --
Dividends paid............................ -- (138,029) (138,029)
Dividends declared but unclaimed.......... -- (3,675) (3,675)
Minority interests on all movements in
shareholders equity, except for net
income................................... (105,855) (88,096) (193,951)
--------- --------- ----------
Balances at December 31, 1996............. 7,593,823 1,850,959 9,444,782
Expansion plan contributions:
Received................................. 548,684 -- 548,684
Deferred credits......................... (87,709) -- (87,709)
Acquisition of treasury shares............ -- (153) (153)
Forfeited dividends....................... -- 909 909
Net income for the year................... -- 1,232,264 1,232,264
Realization of unrealized income.......... (27,121) 27,121 --
Transfers to reserves..................... 69,757 (69,757) --
Dividends paid............................ -- (265,245) (265,245)
Dividends declared but unclaimed.......... -- (4,478) (4,478)
Minority interests on all movements in
shareholders equity, except for net
income................................... (782,433) (293,202) (1,075,635)
--------- --------- ----------
Balances at December 31, 1997............. 7,315,001 2,478,418 9,793,419
========= ========= ==========
</TABLE>
F-42
<PAGE>
TELE NORTE LESTE PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(AMOUNTS EXPRESSED IN THOUSANDS OF CONSTANT BRAZILIAN REAIS OF DECEMBER 31,
1997)
30. ADDITIONAL DISCLOSURES REQUIRED BY US GAAP
A. PENSION AND POST-RETIREMENT BENEFITS
The Companies, together with other companies in the Telebras group, sponsor
multi-employer defined benefit pension and other post-retirement benefit
plans, which are operated and administered by Sistel. The funded status of the
Sistel pension and other post-retirement benefit plans and the related
actuarial assumptions in accordance with US GAAP are as follows:
<TABLE>
<CAPTION>
1996 1997
---------- ----------
<S> <C> <C>
PENSION BENEFIT PLAN
Funded status
Accumulated benefit obligation:
Vested........................................... 1,793,943 1,919,975
Non vested....................................... 3,250,909 3,479,300
---------- ----------
Total........................................... 5,044,852 5,399,275
========== ==========
Projected benefit obligation...................... 6,636,907 7,258,074
Fair value of plan assets......................... (3,430,572) (3,897,051)
---------- ----------
Projected obligation in excess of assets.......... 3,206,335 3,361,023
========== ==========
The actuarial assumptions used were as follows:
Discount rate for determining projected benefit
obligations...................................... 6.00% 6.00%
Rate of increase in compensation levels........... 3.25% 3.25%
Expected long-term rate of return on plan assets.. 6.00% 6.00%
The above are real rates and exclude inflation.
Amortization of the unrecognized liability at transaction: 18.94 years
commencing on January 1, 1991.
<CAPTION>
1996 1997
---------- ----------
<S> <C> <C>
OTHER POST-RETIREMENT BENEFITS PLAN
Funded status:
Accumulated post-retirement benefit obligations:
Retirees and dependents.......................... 371,125 380,561
Fully eligible active plan participants.......... 32,631 34,589
Other active plan participants................... 885,917 997,791
---------- ----------
1,289,673 1,412,941
Fair value of plan assets......................... (76,600) (96,141)
---------- ----------
Funded status..................................... 1,213,073 1,316,800
========== ==========
</TABLE>
Amortization of the unrecognized liability at transition: 18.84 years
commencing on January 1, 1992.
Health care cost trend rates of increase were projected at annual rates
excluding inflation ranging from 6.48% in 1998 decreasing to 2.00% in 2047.
The effect of a one percent annual increase in the assumed health care cost
trend rates would increase the accumulated post-retirement benefits obligation
at December 31, 1997 by R$237,063. Measurement of the accumulated post-
retirement benefit obligation was based on the same assumptions as were used
in the pension calculations.
F-43
<PAGE>
TELE NORTE LESTE PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(AMOUNTS EXPRESSED IN THOUSANDS OF CONSTANT BRAZILIAN REAIS OF DECEMBER 31,
1997)
The funded status of the pension and post retirement plans under Brazilian
and US GAAP differ. Benefit obligations differ because they have been prepared
using different actuarial assumptions permitted under Brazilian and US GAAP.
The net assets of the plans differ under Brazilian and US GAAP principally
due to the accrual of income tax contingencies of the pension fund for US GAAP
purposes in the amount of R$400,370 and R$487,269 in 1996 and 1997,
respectively. The contingency arises out of uncertainty as to the income tax
status of Brazilian pension funds in general because the tax law is unclear as
to whether these funds are exempt from tax on their investment gains. Under
Brazilian GAAP two methods of accounting for the income tax contingency are
currently permitted. The tax is either deducted from plan assets for the
purposes of determining the funded status of the plan or it is not deducted
but is disclosed in a note as being a contingency. Management of the pension
fund have determined that the Brazilian GAAP financial statements of the fund
be prepared on the basis that the legal arguments against assessment of the
tax on the investment gains are sufficiently strong as to avoid the need for
the potential liability to be recognized. However, for US GAAP purposes,
management of the Company believe that the assessment of this potential income
tax liability is probable. Accordingly, in determining the funded status for
US GAAP purposes, the potential income tax liability (calculated in accordance
with SFAS 109) has been deducted from the fair value of the plan assets.
B. DEFERRED TAXES
The deferred tax assets in Note 12 to these combined financial statements
are shown net of valuation allowances of R$63,560 in 1996 and R$102,352 in
1997. Deferred tax assets are established in relation to temporarily
disallowed items in the calculation of taxable profits and on tax losses when
management believe that the results of future operations will generate
sufficient taxable income to realize these deferred tax assets.
C. CONCENTRATION OF RISK
The Companies are prohibited from investing any surplus cash balances in
financial instruments other than government securities controlled by the
Central Bank of Brazil or the Federal Government owned bank, Banco do Brasil
S.A. There have been no losses in cash equivalents.
Credit risk with respect to customer accounts receivable is diversified. The
Companies continually monitor the level of customer accounts receivable and
limit the exposure to bad debts by cutting access to the telephone network if
any invoice is one month past due. Exceptions comprise telephone services that
must be maintained for reasons of safety or national security.
For conducting their business, the Companies are fully dependent upon the
fixed-line telecommunications concession as granted by the Federal Government.
Approximately 75% of all employees are members of state labor unions
associated either with the Federacao Nacional dos Trabalhadores em
Telecomunicacoes ("Fenattel"), or with the Federacao Interestadual dos
Trabalhadores em Telecomunicacoes ("Fittel"). Management negotiates new
collective labor agreements every year with the local unions. The collective
agreements currently in force expire in November 1998.
There is no concentration of available sources of labor, services,
concessions or rights, other than those mentioned above, that could, if
suddenly eliminated, severely impact the Companies' operations.
F-44
<PAGE>
TELE NORTE LESTE PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(AMOUNTS EXPRESSED IN THOUSANDS OF CONSTANT BRAZILIAN REAIS OF DECEMBER 31,
1997)
D. NEW ACCOUNTING PRONOUNCEMENTS
SFAS NO. 130, "REPORTING COMPREHENSIVE INCOME"
SFAS No. 130 establishes the standards for reporting and displaying
comprehensive income and its components (revenues, expenses, gains and losses)
as part of a full set of financial statements. This statement requires that
all elements of comprehensive income be reported in a financial statement that
is displayed with the same prominence as other financial statements.
SFAS NO. 131, "DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED
INFORMATION"
SFAS No. 131 establishes the standards for the manner in which public
enterprises are required to report financial and descriptive information about
their operating segments. The standard defines operating segments as
components of an enterprise for which separate financial information is
available and evaluated regularly as a means for assessing segment performance
and allocating resources to segments. A measure of profit or loss, total
assets and other related information are required to be disclosed for each
operating segment. In addition, this standard requires the annual disclosure
of information concerning revenues derived from the enterprise's products or
services; countries in which it earns revenues or hold assets, and major
customers.
SFAS NO. 132, "EMPLOYERS' DISCLOSURES ABOUT PENSIONS AND OTHER POST-RETIREMENT
BENEFITS"
SFAS No. 132 revises and standardizes employers' disclosures about pension
and other post-retirement benefit plans. It does not change the measurement or
recognition of those plans.
The Company will comply with the requirements of SFAS No. 130, 131 and 132 in
1998.
F-45
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT AUDITORS
The Board of Directors
Tele Norte Leste Participacoes S.A.
We hereby consent to the use of our report included herein.
/s/ KPMG Peat Marwick
Brasilia, Brazil
October 29, 1998
