As filed with the Securities and Exchange Commission on July 6, 1999
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SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
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FORM 20-F/A
Amendment No.1
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
Commission file number: 001-14487
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TELE NORTE LESTE PARTICIPACOES S.A.
(Exact Name of Registrant as Specified in Its Charter)
Tele Norte Leste Holding Company The Federative Republic of Brazil
(Translation of Registrant's (Jurisdiction of Incorporation or
Name into English) Organization)
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Rua General Polidoro 99, 4(degree) andar
22280-001 Rio de Janeiro, RJ, Brazil
(Address of Principal Executive Offices)
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Securities registered or to be registered pursuant to Section 12(b) of the Act:
Title of Each Class Name of Each Exchange On
Preferred Shares, without par value* Which Registered
American Depositary Shares, each New York Stock Exchange
representing 1,000 Preferred Shares New York Stock Exchange
- ------------
* 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 period covered by this Annual
Report:
124,369,030,532 Common Shares, without par value
210,029,997,060 Preferred Shares, without par value
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 X No __
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>
<CAPTION>
TABLE OF CONTENTS
Page
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PART I
<S> <C> <C>
Item 1. Description of Business.............................................................................1
Item 2. Description of Property............................................................................28
Item 3. Legal Proceedings..................................................................................29
Item 4. Control of Registrant..............................................................................31
Item 5. Nature of Trading Market...........................................................................33
Item 6. Exchange Controls and Other Limitations Affecting Security Holders.................................35
Item 7. Taxation...........................................................................................36
Item 8. Selected Financial Data............................................................................40
Item 9. Management's Discussion and Analysis of Financial Condition and Results of Operations..............45
Item 9A. Quantitative and Qualitative Disclosures about Market Risk.........................................59
Item 10. Directors and Officers of Registrant...............................................................60
Item 11. Compensation of Directors and Officers.............................................................65
Item 12. Options to Purchase Securities from Registrant or Subsidiaries.....................................65
Item 13. Interest of Management in Certain Transactions.....................................................65
PART II
Item 14. Description of Securities to be Registered.........................................................65
PART III
Item 15. Defaults upon Senior Securities....................................................................65
Item 16. Changes in Securities, Changes in Security for Registered Securities and Use of Proceeds...........66
PART IV
Item 17. Financial Statements...............................................................................66
Item 18. Financial Statements...............................................................................66
Item 19. Financial Statements and Exhibits..................................................................66
Index of Defined Terms........................................................................................67
Technical Glossary............................................................................................68
</TABLE>
<PAGE>
EXPLANATORY NOTE
Tele Norte Leste S.A. (the "Company") has prepared this amended Annual
Report dated July 6, 1999 for the purpose of filing in electronic format the
Annual Report on Form 20-F that was filed in paper format on June 30, 1999.
The filing of this amended Annual Report should not be understood to mean
that any statements contained herein are true or complete as of any date
subsequent to June 30, 1998.
<PAGE>
PRESENTATION OF FINANCIAL INFORMATION
In this Annual Report, Tele Norte Leste Participacoes S.A., a corporation
organized under the laws of the Federative Republic of Brazil ("Brazil"), is
referred to as the "Holding Company" and the Holding Company and its
subsidiaries (the "Subsidiaries") are referred to collectively as the "Company."
References to the Company's businesses and operations are references to the
businesses and operations of the Subsidiaries and/or the Holding Company as the
case may be.
References to (i) the "real," "reais" or "R$" are to Brazilian reais
(plural) and the Brazilian real (singular) and (ii) "U.S. dollars," "dollars" or
"US$" are to United States dollars. All amounts in Brazilian currencies that
existed prior to the adoption of the real as the Brazilian currency on July 1,
1994 have been restated in reais. The Company's audited financial statements as
of December 31, 1997 and 1998 and for the years ended December 31, 1996, 1997
and 1998 (the "Consolidated Financial Statements") contained in this Annual
Report are presented in reais. For periods and dates before January 1, 1998, the
Consolidated Financial Statements and, unless otherwise specified, the other
financial data included herein recognize certain effects of inflation and are
restated in constant reais of December 31, 1997 purchasing power. For subsequent
periods and dates, the Consolidated Financial Statements and such other data are
presented in nominal reais and do not recognize effects of inflation. See
"Selected Financial Data."
Certain terms are defined the first time they are used in this Annual
Report. The "Index of Defined Terms" that begins on page 67 lists those terms
and where they are defined. Technical terms are defined in the Technical
Glossary on page 68.
FORWARD-LOOKING INFORMATION
This Annual Report contains forward-looking statements. The Company and its
representatives may also make forward-looking statements in press releases and
oral statements. Statements that are not statements of historical fact,
including statements about the beliefs and expectations of the Company's
management, are forward-looking statements. The words "anticipates," "believes,"
"estimates," "expects," "forecasts," "intends," "plans," "predicts," "projects"
and "targets" and similar words are intended to identify these statements, which
necessarily involve known and unknown risks and uncertainties. Known risks and
uncertainties, some of which are discussed at pages 25 - 28 herein, include
those resulting from the short history of the Company's operations as an
independent, private-sector, entity and the introduction of competition to the
Brazilian telecommunications sector, as well as those relating to the cost and
availability of financing, the performance of the Brazilian economy generally,
the levels of exchange rates between Brazilian and foreign currencies and the
Federal Government's telecommunications policy. Accordingly, the actual results
of operations of the Company may be different from the Company's current
expectations, and the reader should not place undue reliance on these
forward-looking statements. Forward-looking statements speak only as of the date
they are made, and the Company does not undertake any obligation to update them
in light of new information or future developments.
<PAGE>
PART I
Item 1. Description of Business
The Holding Company is one of the companies formed as a result of the
breakup of Telecomunicacoes Brasileiras S.A. - Telebras ("Telebras") by Brazil's
federal government (the "Federal Government") in May 1998. Each of the
Subsidiaries is an operating company formerly controlled by Telebras. In January
1998, the Subsidiaries, which had provided both fixed-line and cellular
telecommunications services, spun off their cellular telecommunications
operations into new companies that are now under separate control (the "Spun-off
Companies"). See "--Historical Background."
The Company provides fixed-line telecommunications services in Brazil under
concessions from the Federal Government (the "Concessions"). The Concessions
authorize the Subsidiaries to provide fixed-line telecommunications service in
an area (the "Region") including almost all of sixteen states located in the
northern, northeastern and southeastern regions of Brazil. See "--The Region."
Until April 1999, the Company was the only supplier of local fixed-line and
intrastate long-distance services in the Region. In February 1999, two licenses
were auctioned to permit a competitor to provide both local and intraregional
long-distance services in the Region in competition with the Company. Canbra
Telefonica S.A. ("Canbra") presented the winning bid for the licenses and
received authorization to begin operations in April 1999. In July 1999, Empresa
Brasileira de Telecomunicacoes S.A. - Embratel ("Embratel") and Bonari Holdings
Ltda. ("Bonari") will be authorized to provide intrastate long-distance services
in competition with the Company. See "--Competition."
The Company does not provide interstate long-distance fixed-line
telecommunications services between the states in the Region. However, in July
1999, the Company will be authorized to provide interstate long-distance
services between the states in the Region in competition with Canbra, Embratel
and Bonari. At December 31, 1998, the Company had approximately 7.8 million
lines in service.
The Holding Company and its Operating Subsidiaries
The following table sets forth the contribution made by each Subsidiary to
the Company's net operating revenues for the year ended December 31, 1998 and
the Holding Company's shareholding, direct or indirect, in each Subsidiary at
December 31, 1998.
<TABLE>
<CAPTION>
Contribution to
consolidated results Holding Company ownership
-------------------- -------------------------
% of net operating % of share % of voting
Subsidiary revenues capital stock
- ------------ -------------------- ------------ -----------
<S> <C> <C> <C>
Telecomunicacoes do Rio de Janeiro S.A. - Telerj............... 26 70 85
Telecomunicacoes de Minas Gerais S.A. - Telemig................ 25 81 89
Telecomunicacoes da Bahia S.A. - Telebahia..................... 12 82 96
Telecomunicacoes do Ceara S.A. - Teleceara..................... 6 79 85
Telecomunicacoes de Pernambuco S.A. - Telpe.................... 7 76 95
Telecomunicacoes do Espirito Santo S.A. - Telest............... 4 83 93
Telecomunicacoes do Para S.A. - Telepara....................... 4 56 97
Telecomunicacoes do Rio Grande do Norte S.A. - Telern.......... 2 72 93
Telecomunicacoes do Amazonas S.A. - Telamazon.................. 2 75 84
Telecomunicacoes do Maranhao S.A. - Telma...................... 2 64 83
Telecomunicacoes de Alagoas S.A. - Telasa...................... 2 72 97
Telecomunicacoes do Piaui S.A. - Telepisa...................... 2 74 98
Telecomunicacoes da Paraiba S.A. - Telpa....................... 3 64 93
Telecomunicacoes de Sergipe S.A. - Telergipe................... 1 67 81
Telecomunicacoes do Amapa S.A. - Teleamapa..................... 1 82 93
Telecomunicacoes de Roraima S.A. - Telaima..................... 1 63 77
</TABLE>
Elsewhere in this Annual Report, the individual Subsidiaries are referred
to by the short names that form part of their corporate names as set forth in
the foregoing table.
Substantially all the Holding Company's assets consist of shares in the
Subsidiaries. The Holding Company relies almost exclusively on dividends from
the Subsidiaries and interest on loans to the Subsidiaries to meet its needs for
cash, including cash to pay dividends to its shareholders. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources."
The Company's management is considering a corporate restructuring to
simplify its present corporate structure. Because any such restructuring would
involve complex issues (including possible redemption rights for minority
shareholders in each of the Subsidiaries and approval from Anatel) and
necessarily require a significant amount of time for implementation, the
Company's management cannot predict when such a restructuring might be completed
or what form the restructuring might take.
The Holding Company's headquarters are located at Rua General Polidoro 99,
4(degree) andar, 22280-001, Rio de Janeiro, RJ, Brazil, and its telephone number
is 5521-543-8003.
Historical Background
Prior to the incorporation of Telebras in 1972, there were more than 900
telecommunications companies operating throughout Brazil. Between 1972 and 1975,
Telebras and its operating Subsidiaries (collectively, the "Telebras System")
acquired almost all the other telephone companies in Brazil and thus came to
have a monopoly over the provision of public telecommunications services in
almost all areas of the country. Beginning in 1995, the Federal Government
undertook a comprehensive reform of Brazil's telecommunications regulatory
system. In July 1997, Brazil's National Congress adopted the Lei Geral de
Telecomunicacoes (the "General Telecommunications Law," and together with the
regulations, decrees, orders and plans on telecommunications issued by Brazil's
Executive Branch, the "Telecommunications Regulations"), which provided for the
establishment of a new regulatory framework, the introduction of competition and
the privatization of Telebras. The General Telecommunications Law established an
independent regulatory agency called Agencia Nacional de Telecomunicacoes -
ANATEL ("Anatel").
In January 1998, in preparation for the restructuring and privatization of
the Telebras System, the cellular telecommunications operations of the Telebras'
operating subsidiaries were spun off into separate companies. In May 1998,
Telebras was restructured to form, in addition to Telebras, 12 new holding
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 virtually all the assets and liabilities of Telebras, including the
shares held by Telebras in the operating companies of the Telebras System. The
split-up of the Telebras System into the New Holding Companies is referred to
herein as the "Breakup" or the "Breakup of Telebras."
The New Holding Companies, together with their respective subsidiaries,
consist of (a) eight cellular service providers, each operating in one of the
Regions into which Brazil has been divided for purposes of cellular
telecommunications services in the frequency range formerly used by the
companies of the Telebras System (each a "Cellular Region"), (b) three regional
fixed-line service providers, each providing local and intraregional
long-distance service in one of the three regions into which Brazil has been
divided for purposes of fixed-line telecommunications (each a "Fixed-Line
Region"), and (c) Embratel, which provides domestic (including intraregional and
interregional) long-distance service and international long-distance service
throughout Brazil.
The Holding Company is one of the New Holding Companies. In the Breakup,
the Holding Company was allocated all the share capital held by Telebras in the
operating subsidiaries of the Telebras System that provided fixed-line
telecommunications service in most of the northern, northeastern and
southeastern regions of Brazil, except for the State of Sao Paulo. In July 1998,
the Federal Government sold all its voting shares of the New Holding Companies,
including the Holding Company, to private-sector buyers. The sale of all of the
Federal Government's voting shares to private-sector buyers is referred to
herein as the "Privatization" or the "Privatization of Telebras." The Federal
Government's shares of the Holding Company (51.79% of the voting shares) were
purchased by Telemar, a consortium comprising of Construtora Andrade Gutierrez
S.A., Inepar S.A Industria e Construcoes, Macal Investimentos e Participacoes
Ltda., Fiago Participacoes S.A., Brasil Veiculos Companhia de Seguros and
Companhia de Seguros Alianca do Brasil. Telemar agreed to pay R$3.43 billion for
the Federal Government's shares of which R$1.37 billion has already been paid.
The remaining balance is to paid in two equal installments in August 1999 and
August 2000. Each installment payment will be adjusted for inflation and bear a
fixed interest rate of 12% per annum.
The Region
The Concessions authorize the Company to provide fixed-line
telecommunications service in sixteen states of Brazil located in the northern,
northeastern and southeastern regions of Brazil as listed in the chart below,
excluding an area in the state of Minas Gerais where Companhia de
Telecomunicacoes do Brasil Central, a company that was not part of the Telebras
System, continues to operate independently and an area of 39,105 square
kilometers, also in the State of Minas Gerais, operated by Tele Centro Sul
Participacoes S.A. The portion of the sixteen states excluded from the Region
represents approximately 3.2% of total lines in service and 2.6% of the
population of the states.
The states in the Region cover an area of 5.4 million square kilometers,
representing 64% of the country's total area and generating approximately 39% of
Brazil's gross domestic product. The population of the states in the Region is
approximately 87 million, representing 55% of the total population of Brazil.
The Region has 102 municipalities with populations in excess of 100,000
inhabitants. Per capita income in the Region is approximately US$3,588 per year,
varying from US$1,560 in the State of Piaui to US$6,740 in the State of Rio de
Janeiro.
<PAGE>
The following table sets forth certain key economic data for 1997 for the
state in which each Subsidiary operates.
<TABLE>
<CAPTION>
Population % of gross
Population per square National Per capita
State Subsidiary (million)(1) kilometer product income US$
- -------------- ---------- ------------ ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Rio de Janeiro..................... Telerj 13.6 308.7 11.4 6,740
Minas Gerais....................... Telemig 17.0 29.0 8.3 3,970
Bahia.............................. Telebahia 12.7 22.4 4.5 2,900
Ceara.............................. Teleceara 7.0 47.0 1.8 2,110
Pernambuco......................... Telpe 7.5 75.5 2.3 2,540
Espirito Santo..................... Telest 2.9 61.8 1.7 4,930
Para............................... Telepara 5.7 4.6 2.3 3,370
Rio Grande do Norte................ Telern 2.6 49.0 1.0 3,220
Amazonas........................... Telamazon 2.5 1.6 1.3 4,510
Maranhao........................... Telma 5.3 15.7 1.1 1,700
Alagoas............................ Telasa 2.7 95.3 0.6 1,970
Piaui.............................. Telepisa 2.7 10.7 0.5 1,560
Paraiba............................ Telpa 3.4 59.1 0.8 1,920
Sergipe............................ Telergipe 1.7 75.2 0.8 4,040
Amapa.............................. Teleamapa 0.4 2.8 0.2 4,240
Roraima............................ Telaima 0.3 1.2 0.1 4,920
</TABLE>
- ------------------
(1) Estimates made by the Instituto Brasileiro de Geografia e Estatistica -
IBGE (the "IBGE") at year-end 1997.
Set forth below is a map showing the location of the Region within Brazil.
[GRAPHIC OMITTED]
The Company's business, financial condition, results of operations and
prospects depend in part on the performance of the Brazilian economy and the
economy of the Region, in particular. See "--Brazilian Economic Environment."
Services
Overview
The fixed-line telecommunications services offered by the Company to its
customers consist of (i) local service, including installation, monthly
subscription, measured service, public telephones and supplemental local
services, (ii) intrastate long-distance services within the states in the
Region, (iii) data transmission services, (iv) network services, including
interconnection and leasing of facilities, and (v) other services. Until April
1998, the Company received revenue from outgoing interstate and international
long-distance calls under a revenue-sharing arrangement with Embratel. See
"--Interregional and International Service." The interconnection revenues the
Company receives include fees paid by Embratel, cellular service providers and
other telecommunications companies for use of the Company's network. The fees
the Company receives from Embratel are accounted for as remuneration for the use
of the network and the fees paid by other telecommunications service providers
are accounted for as internetwork services. See "--Remuneration for the Use of
the Network", "--Internetwork Services" and "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Nonlocal Services."
The Company does not sell, rent or otherwise provide telephone equipment such as
handsets or switchboards. In July 1999, the Company will be authorized to
provide interstate long-distance services between the states in the Region.
Beginning in 2002, the Company may obtain authorization to provide interregional
and international long-distance service, provided that it has met certain
obligations set forth in the Concessions. See "--Competition" and "--Regulation
of the Brazilian Telecommunications Industry--Obligations of Telecommunications
Companies--Public Regime--Service Restrictions."
The following table sets forth the Company's revenue by type of service for
the indicated years. The Company's tariffs for each category of service are
discussed 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,
--------------------------------
1996 1997 1998
---- ---- ----
(millions of reais) (1)
<S> <C> <C> <C>
Local service.......................................................... 2,285 3,135 3,861
Intrastate long-distance service....................................... 1,010 828 894
Interstate long-distance service....................................... 1,275 1,044 226
International long-distance service.................................... 211 155 38
Data transmission...................................................... 199 164 212
Remuneration for the use of the network................................ 0 0 493
Internetwork services.................................................. 558 999 1,114
Other.................................................................. 39 35 108
------- ------- -------
Total.................................................................. 5,577 6,360 6,946
Taxes and discounts.................................................... (1,303) (1,401) (1,788)
------- ------- -------
Net operating revenue.................................................. 4,274 4,959 5,158
======= ======= =======
</TABLE>
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(1) In constant reais of December 31, 1997 purchasing power for periods prior
to January 1, 1998.
Local Service
Local service includes installation, monthly subscription, measured
service, public telephones and supplemental local services. Measured service
includes all calls that originate and terminate within a single local area in
the Region ("local calls"). Until February 1999, the Company was the only
authorized supplier of local fixed-line and intrastate telecommunications
services in the Region. In February 1999, Anatel, pursuant to the
Telecommunications Regulations, awarded an operating license to the winning
bidder, Canbra, to provide local fixed-line and intraregional long-distance
telecommunication services in the Region in competition with the Company. See
"--Competition."
The Company owns and operates public telephones throughout the Region. At
December 31, 1998, the Company had 265.8 thousand public telephones, of which
81% could be operated with a prepaid card. Anatel's targets require the Company
to increase the number of public telephones to 336 thousand by year-end 1999.
See "--Regulation of the Brazilian Telecommunications Industry--Obligations of
Telecommunications Companies--Network Expansion--General Plan on Universal
Service."
The Company provides a variety of other supplemental local services that
include voice and fax mailboxes, call waiting, call forwarding, conferencing,
speed dialing and caller ID.
Intraregional (Intrastate and Interstate) Long-Distance Service
Each state in the Region is divided into a number of local areas. Calls
from one local area in the Region to another are referred to as "intraregional
long-distance" calls. Intraregional long-distance service includes intrastate
long-distance calls (nonlocal calls within a given state) and interstate
long-distance calls (calls between states in the Region). Prior to the formation
of the New Holding Companies, each Subsidiary was the exclusive provider of
long-distance service that originated and terminated within its concession area.
Each concession area roughly coincided with the states, so, generally speaking,
each Subsidiary was the exclusive provider of intrastate long-distance service
in its state. Embratel was the exclusive provider of long-distance service
between states. Embratel did not provide intrastate long-distance service. In
February 1999, Canbra was awarded licenses to provide local fixed-line and
intraregional long-distance telecommunications services in the Region in
competition with the Company. In January 1999, Bonari was awarded licenses to
provide long-distance services throughout Brazil in competition with Embratel.
In July 1999, Embratel, Bonari and Canbra will be authorized to provide
intrastate long-distance service throughout Brazil, including within the States
in the Region, and the Company will be authorized to provide interstate
long-distance service between the states in the Region. See "--Competition." The
Company is expanding its network by installing a new backbone and connecting the
Subsidiaries' networks in order to provide interstate long-distance service in
the Region and Embratel and Bonari are expanding their networks to provide
intrastate long-distance service throughout Brazil. Until the Company completes
this expansion, the Company will lease facilities from Embratel to complete
interstate long-distance calls between states in the Region. The Company may
also lease facilities from Bonari or Canbra, or both, to complete interstate
long-distance calls between states in the Region. See "-- Network and
Facilities."
Interregional and International Service
Interregional long-distance service consists of calls between a point
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 Brazil. The Company is not authorized to provide interregional or
international long-distance service. The Company may, however, provide
interregional and international long-distance service by December 31, 2001 if it
meets its 2003 targets by December 31, 2001. See "--Competition" and
"--Regulation of the Brazilian Telecommunications Industry--Obligations of
Telecommunications Companies--Public Regime--Service Restrictions."
Until April 1998, Embratel and the other operating subsidiaries of the
Telebras System divided the revenue from outgoing interstate and international
long-distance calls. The revenue-sharing arrangement with Embratel was designed
to balance the return on investment of the other operating subsidiaries. Under
this system, each Subsidiary 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. The average percentage
retained by the Subsidiaries was 78% and 71% for 1996 and 1997 respectively.
In April 1998, the system of revenue sharing between Embratel and the other
operating subsidiaries was discontinued and the Company no longer recognizes
revenues from interstate and international long-distance services. The Company's
relationship with Embratel is now governed by interconnection agreements under
which Embratel pays the Company fees for the use of its network. See
"--Remuneration for the Use of the Network."
Data Transmission Services
The Company provides low- and high-speed data transmission services through
private leased circuits and switched circuits. The Company has provided data
transmission services since the mid 1980's, including both low and high speed
services ranging from 9.6 Kbps to 2 Mbps, supported by public telephone
infrastructure. The Company provides tailored solutions for large customers that
include data transmission at 34 Mbps and 155 Mbps for LAN interconnection,
videoconferencing, video/image transmission and multimedia applications.
The Company offers dedicated digital lines that facilitate transmission of
high volumes of data, voice and images, at specified speeds, independent of
codes and protocols, and is available 24 hours a day on a contractual basis. The
Company also offers switched packets for small to medium data volumes, at X-25
and X-28 protocols, with fees based on time and volume. Frame Relay service
permits interconnection of LANs, multimedia applications and data transmission
at speeds up to 2 Mbps, over digital networks and combines the high performance
of dedicated circuits with the flexibility of the switched products.
The Company contracted a capacity of 25,000 access ports and four network
management systems for its leased line network to provide data services in the
Region. The network uses TDM technology and will begin full operation in the
fourth quarter of 1999. Circuits will be available to customers at dedicated
data rates.
Another priority of the Company is the development of the multi-services
network, scheduled to start operations by September 1999. The network is based
on ATM and IP technology to support internet and multimedia services. It will
have an initial capacity of 12,000 access gates for dial-up IP and 1,000 for
dedicated IP.
The Company is also expanding its packet switched network to cover all 16
states of the Region. It shall be ready to provide interstate services in the
fourth quarter of 1999 with a capacity of 24,000 access ports supporting
standardized protocols such as X-25, frame relay and SNA.
Remuneration for the Use of the Network
Effective April 1998, the Company entered into an interconnection agreement
with Embratel, regulated by Anatel, under which Embratel pays the Company fees
on a per minute basis for long-distance calls carried by Embratel that are
originated or completed using the Company's local network. The Company also
receives from Embratel a supplemental per-minute fee called the Parcela
Adicional de Transicao ("PAT"). The PAT was implemented in April 1998 in order
to reduce the impact of the discontinuation of the revenue-sharing arrangement
between the Company and Embratel. See "--Interregional and International
Service." The PAT will be gradually phased out by June 30, 2001. In January
2000, the Company will review its interconnection agreements with Embratel and
begin to charge Embratel for billing services.
In the near term, the Company will most likely sign similar interconnection
agreements with Canbra, its competitor in local and intraregional service, and
Bonari, the new domestic and international long-distance provider.
Internetwork Services
The Company provides access to its network to other telecommunications
service providers and leases network facilities to telecommunications service
providers and corporate customers.
Use of the Company's interconnection services has grown as a result of the
spin-off of the cellular telecommunications business of the Subsidiaries, the
privatization of the companies of the Telebras System and the advent of
competition in the telecommunications sector in Brazil. Cellular service
providers and certain operators of trunking services have agreements with the
Company that allow them to interconnect with the Company's network in order to
receive calls that originate on the Company's network and to complete calls that
terminate on the Company's network, to connect central switching stations to the
Company's network and to lease certain facilities from the Company. The Company
provides interconnection services to the sixteen cellular service providers that
were spun off from the Subsidiaries and five Band B cellular service providers
and operators of trunking services.
Telecommunications service providers that provide interconnection services
are required to provide such services on a nondiscriminatory basis. Subject to
certain requirements, they are free to negotiate the terms of their
interconnection agreements but, if 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." The terms of interconnection, particularly the
pricing and technical requirements, may affect the Company's results of
operations, its competitive environment and its capital expenditure
requirements.
The Company also leases facilities to others. Other telecommunications
service providers, particularly cellular service providers, lease trunk lines
from the Company for use within their stand-alone networks, and large corporate
customers lease lines from the Company for use in private networks connecting
different corporate sites.
Other Services
The Company provides other services that include telephone directories,
equipment rentals, technical assistance and additional services such as billing
and accounting services that the Company provides to the cellular companies that
were spun off from the Subsidiaries and are now under separate control. The
services provided to the cellular companies are in the process of being phased
out as the cellular companies develop their own billing and accounting
departments.
Other services include certain additional and value added services such as
ISDN, that allows voice, data, image and sound transmission supported by a
single digital line permitting the user to use simultaneously, for example,
voice transmission and the internet. In-dialing service (direct transmission of
external calls to extensions) is also offered by the Company to those corporate
clients that work with PBX systems. For corporate clients in need of a large
quantity of phone accesses, the Company offers digital trunk services that allow
up to 30 simultaneous connections within a single physical loop of 2 Mbps,
increasing the speed and otherwise optimization of the client's telephone
system.
The Company also provides a variety of other telecommunications services
that extend beyond basic telephone service, such as toll-free or 800 service,
based on an intelligent network platform with large capacity that is accessible
from any point in Brazil and that supports applications such as telemarketing,
customer service operations and home banking.
Through the use of the Company's Internet Protocol ("IP") network, the
Company provides high-speed access to corporations, internet providers and
commercial centers. The Company's IP Internet services also support the
formation of virtual private networks and additional value added services, such
as electronic commerce, public terminal access to the Internet and web hosting.
Quality of Service
The following table sets forth information on service quality for the
periods indicated.
<TABLE>
<CAPTION>
Year ended December 31,
-----------------------------------------
1994 1995 1996 1997 1998
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Monthly repair requests (% of lines in service)................... 4.5 3.5 4.5 4.9 4.8
Residential repair response speed (% within 24 hours)............. 84.7 83.4 80.5 81.2 79.5
Call completion rate for local calls during peak periods (% of
calls attempted)............................................. 48.1 47.8 48.8 49.9 53.7
Billing complaints (per thousand bills) .......................... n.a. n.a. n.a. 10.7 18.7
Operator availability during peak periods (% response within 10
seconds)..................................................... n.a. n.a. n.a. n.a. 85.5
</TABLE>
The Company is required under the Telecommunications Regulations to meet
certain service quality targets relating to maximum periods to obtain a dial
tone, completed calls as a percentage of attempted calls, repair requests and
response rates 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 targets the Company expects will be most
difficult to meet are those relating to response speed to repair requests, call
completion rates and billing inaccuracy. Currently, the Company responds within
24 hours to approximately 79.5% of residential repair requests. The Company is
obligated by year-end 1999 to respond within 24 hours to 95% of residential
repair requests. During 1998, the Company's call completion rate during peak
periods was 44.3% for domestic long-distance calls and 53.7% for local calls.
The Company is obligated by year-end 1999 to increase its call completion rate
to 60% of local and domestic long-distance calls during peak periods. In order
to meet these targets, the Company expects to significantly increase spending on
systems to detect defects and supervise repair. Currently, approximately 1.9% of
the Company's customers complain of billing inaccuracies. The Company is
required by year-end 1999 to reduce the percentage of customer complaints about
billing inaccuracies to 0.4%.
In July 1999, Anatel expects to implement the Plano de Numeracao (the
"Numbering Plan"). The Numbering Plan will require a customer to specify a
long-distance carrier for each call by dialing two additional digits. Although
the Company is making the necessary adjustments to its switching stations,
including adapting its analog switching stations, it anticipates future traffic
problems at switching stations as a result of the change in the numbering system
- - especially in the weeks following the implementation of the Numbering Plan.
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 intraregional, interregional and
international long-distance service. Monthly subscription charges, for example,
were increased by 270% for residential customers and 59% for commercial
customers. The Company's management believes that monthly subscription charges
are now generally in line with charges in other countries.
The Concessions establish a price-cap mechanism for annual rate
adjustments, which places an upper limit on a weighted average of the rates for
a basket of local and long-distance services and for interconnection charges.
The basket includes activation and subscription fees and measured usage fees for
local, long-distance and public telephone services. Subject to certain limits,
the rates for individual services within the basket may be increased by up to 9%
above the limit, so long as the weighted average rate for the entire basket does
not exceed the limit. The Concessions provide for the price cap to be adjusted
periodically to take account of inflation and productivity gains. See
"--Regulation of the Brazilian Telecommunications Industry--Rate Regulation."
In accordance with the Concessions, the Company has been authorized by
Anatel to put into effect certain rate increases on June 22, 1999. The increases
raise the average tariff for the basic service plan by 7.99%. Specifically, the
installation charge has decreased from R$80 to R$50, while monthly subscription
charges increased 17.7%, the maximum permitted. Measured service charges
increased by 6.9%, slightly below the rate of inflation during the relevant
period. Long-distance rates increased 5.46%, representing the difference between
the inflation rate during the period and the applicable reduction for deemed
productivity gains.
Local Rates
The Company's revenue from local service 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 depending on usage. Usage is measured in
pulses. Pulses occur system-wide every four minutes for most local calls and
every sixty seconds for local calls made between certain municipalities. 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.
Local call charges for normal weekday calls, 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., on Saturdays between 2:00 p.m. and midnight and
all day Sunday and holidays, a caller is charged for only one pulse regardless
of the duration of a call. Prior to April 1997, calls during off-peak hours were
billed on the basis of duration. Each customer receives a total of 90 free
pulses per month. Measured service charges are the same for all customers.
Since May 1997, the average monthly subscription charge (including taxes at
rates that vary from state to state) 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 sets
forth selected information on the Company's subscription charges and measured
service charges for local telephone service for the periods indicated.
<TABLE>
<CAPTION>
Year ended December 31,
-------------------------------------
1996 1997 1998
---- ---- ----
(nominal reais) (1)
<S> <C> <C> <C>
Average rates for local telephone service(2):
Monthly subscription:
Residential......................................... 3.00 7.78 10.00
Commercial.......................................... 10.46 13.50 15.00
Measured service (per local pulse)...................... 0.038 0.054 0.058
</TABLE>
- ------------------
(1) In constant reais of December 31, 1997 purchasing power for any period prior
to January 1, 1998. (2) Average of monthly average rates, net of taxes.
The Company charges an installation fee of R$50 for the installation of a
line and a fee of R$46 when a customer changes addresses. Prior to May 1997,
under a system called "auto-financing," each customer requesting the activation
of a line was required to invest in shares of Telebras or its subsidiaries. The
amount to be invested varied from time to time but was substantial. In 1996, for
example, the required investment for a new line was R$1,117.63. Auto-financing
was phased out in 1997, and the installation charge, which was initially R$300,
was reduced to R$80 in October 1997 and R$50 in March 1998.
Intraregional Long-Distance Rates
Rates for intraregional long-distance calls are computed on the basis of
the time of day, day of the week, duration and distance of the call and vary
depending on whether special services, such as operator assistance, are used.
Some intraregional calls made within the same area code may also be measured by
pulses. The following table sets forth selected information on the Company's
domestic long-distance rates during the periods indicated.
<TABLE>
<CAPTION>
Year ended December 31,
---------------------------------
1996 1997 1998
---- ---- ----
(nominal reais) (1)
Domestic long-distance rates(2)(3):
<S> <C> <C> <C>
0 to 50 km................................................... 0.42 0.36 0.32
50 to 100 km................................................. 0.72 0.65 0.54
100 to 300 km................................................ 1.07 0.96 0.81
Over 300 km.................................................... 1.40 1.26 1.08
</TABLE>
- ------------------
(1) In constant reais of December 31, 1997 purchasing power for periods prior
to January 1, 1998.
(2) Average of monthly average rates, net of taxes.
(3) Rates for a domestic long-distance call, three minutes in duration
between the hours of 9 a.m. and noon and 2 p.m. and
6 p.m. (peak hours) on weekdays, net of value-added taxes.
Network Usage Charges
The Company's revenues from network usage charges consist primarily of two
basic categories: payments from other telecommunications service providers on a
per-minute basis to complete calls using the Company's network and payments from
other telecommunications service providers on a contractual basis to use part of
the Company's network. Other telecommunications service providers pay the
Company a network usage charge computed on a per-minute basis to complete a call
on the Company's network. The network usage charge varies depending on whether
the telecommunications service provider uses the Company's local or
long-distance network. Similarly, the Company pays other fixed-line service
providers a network usage charge to complete calls on their networks, and the
Company pays cellular service providers a network usage charge to complete calls
on their networks. The terms and conditions of interconnection are freely
negotiated between parties, subject to a price cap established by Anatel. If the
Company offers to any party an interconnection tariff below the price cap, it
must offer that tariff to any other requesting party on a nondiscriminatory
basis.
Cellular telecommunications service in Brazil, unlike in North America, is
offered on a "calling party pays" basis under which the subscriber pays only for
calls that he or she originates (in addition, a subscriber pays roaming charges
on calls made or received outside his or her home registration area). Under the
policy of a calling party pays, a cellular service subscriber generally pays
cellular usage charges only for calls made by the cellular service subscriber
and not for calls received. Calls received by a cellular service 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 service customer pays a
rate based on cellular per minute charges for calls made to a cellular service
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 area in which the
registration area is located. The Company charges its fixed-line service
customers per minute charges based on either VC1, VC2, or VC3 rates when a
fixed-line service customer calls a cellular subscriber. In turn, the Company
pays the cellular service provider the mobile network usage charge.
The following table sets forth the average per-minute rates charged by the
Company for network services during the indicated years.
<TABLE>
<CAPTION>
Year ended December 31,
-------------------------------
1996 1997 1998
---- ---- ----
(nominal reais) (1)
<S> <C> <C> <C>
Network usage rate (local)............................................. 0.04 0.04 0.04
Network usage rate (long-distance ).................................... 0.06 0.07 0.06
Per minute charges for calls made to cellular telephones:
VC1............................................................... 0.31 0.29 0.27
VC2............................................................... 0.65 0.60 0.58
VC3............................................................... 0.74 0.69 0.66
</TABLE>
- ------------------
(1) In constant reais of December 31, 1997 purchasing power for periods prior
to January 1, 1998. The amounts are also net of taxes and averaged across
the Subsidiaries.
The Company's revenue from network services also includes payments from
other telecommunications service providers arranged on a contractual basis to
use part of the Company's network. Other telecommunications service providers,
such as providers of trunking and paging services, may use the Company's network
to connect a central switching station to the Company's network. Some cellular
service 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.
Data Transmission Rates
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 service charges based on the amount of data transmitted. Effective in
May 1997, line rental charges for private leased circuits were reduced by 42%.
Rates charged for data transmission services are determined solely by the
Company and are not subject to a price cap. However, data transmission services
must be offered on a on a nondiscriminatory basis. The following table sets
forth selected information about the Company's average monthly line rental
charges for private leased circuits service during the indicated years.
<TABLE>
<CAPTION>
Year ended December 31,
------------------------------------------
1996 1997 1998
---- ---- ----
(nominal reais)
(1)
Average rates for monthly line rental per leased circuit (2):
<S> <C> <C> <C>
Local circuit:
4.8 Kbps................................................... 293.27 200.06 167.00
9.6 Kbps................................................... 448.93 223.81 167.00
64 Kbps.................................................... 1,152.43 474.43 343.00
2 Mbps..................................................... 8,312.51 5,284.49 4,350.00
Long-distance circuit (3):
4.8 Kbps................................................... 1,790.20 962.53 718.00
9.6 Kbps................................................... 2,608.02 1,112.04 718.00
64 Kbps.................................................... 5,940.72 2,335.00 1,942.00
2 Mbps..................................................... 45,844.00 29,088.00 20,936.00
</TABLE>
- ------------------
(1) In constant reais of December 31, 1997 purchasing power for periods prior to
January 1, 1998.
(2) Average of monthly average rates, net of taxes.
(3) Assuming a transmission distance between 300 and 500 kilometers and a
three-year contract.
Value-added Taxes on Telecommunications Services
The cost of telecommunications services to the customer includes a variety
of taxes. The average rate of all such taxes, as a percentage of the Company's
gross operating revenues, was 24% in 1998. 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 in the Region, ranging from
17% for Telepara, Telepisa and Teleamapa, 35% for Telerj and 25% for the
remaining states of the Region.
Other taxes on gross operating revenues include two federal taxes, the
Programa de Integracao Social ("PIS") and the Contribuicao para Financiamento da
Seguridade Social ("COFINS") imposed on gross operating revenues at a combined
rate of 2.65%. These taxes were increased to a combined rate of 3.65% of gross
operating revenues in February 1999. The increase of 1% may be offset against
the social contribution tax imposed on profits during the same fiscal year.
In June 1998, the governments of the individual Brazilian states approved
an agreement to interpret existing Brazilian tax law to apply the ICMS to
certain services, including activation and monthly subscription fees, to which
it had not previously been applied. There is a risk that the state governments
could seek to apply the ICMS retroactively to activation and subscription fees
charged during the five years preceding June 30, 1998. See "Legal Proceedings."
Billing and Collection
The Company sends each customer a monthly bill covering all the services
provided during the prior period. Customers are grouped in billing cycles based
on the date bills are issued. The telephone bill separately itemizes
long-distance calls, calls made on a cellular network, 800 and 900 services and
other services such as call waiting, voice mail and call forwarding. Customer
payments are effected under agreements with various banks, either by debiting
the customer's checking account or by direct payment to a bank.
The Company charges interest at a rate of 1% per month plus a one-time late
charge of 2% of the amount outstanding. At December 31, 1998, 12% of all account
receivables were outstanding for more than 30 days and 4.5% were outstanding for
more than 90 days. Under prior regulations, the Company was not permitted to
disconnect a customer's service until a receivable was outstanding for over 90
days. The Concessions now authorize the Company to restrict a customer from
making outgoing calls after 30 days, restrict a customer from making outgoing or
receiving incoming calls after 60 days and disconnect a customer completely
after 90 days. The Company's future disconnection policy will depend on factors
such as the level of unmet demand, the level of competition and regulations
governing the Company's disconnection policy. 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, 1996, 1997 and 1998--Operating expenses--Selling expense."
The Company is remunerated for the use of its network by Embratel for each
call carried by Embratel to or from another fixed-line carrier that originates
or terminates on the Company's network. In the future, the Company will also
receive remuneration from Bonari, the newly authorized long-distance provider,
for each such call carried by Bonari that originates or terminates on the
Company's network. Such remuneration is regulated by Anatel. See "Rates--Network
Usage Charges." The Company also receives from Embratel a supplemental
per-minute fee that will be gradually phased out by June 30, 2001. See
"--Services--Remuneration for the Use of its Network."
When a call is originated on the Company's network, the Company bills its
customer, retains any access fee for use of the Company's network (including, in
the case of Embratel, the supplemental per-minute fee) and transfers the balance
to the long-distance carrier. The long-distance carrier is then responsible to
transfer the appropriate amount to the other fixed-line carrier where such call
is terminated. The Company is negotiating with Embratel to create a procedure
that would reduce the impact on the Company of uncollected receivables by
deducting in a subsequent billing cycle any uncollected amounts from the prior
month.
The Company also receives revenues from internetwork services, primarily
from cellular service providers that interconnect with the Company's network.
The Company bills its customers for calls made from the Company's fixed-line
network to cellular customers. Conversely, calls made from cellular service
customers to fixed-line customers are billed by the cellular service provider.
After the billing cycle is over, the Company and the cellular service provider
reconcile the amounts owed to each other (the fixed and mobile network usage
rates and any fees owed on a contractual basis) and pay the net amount
outstanding to the appropriate party. The Company also provided billing services
during 1998 to cellular service providers that were spun-off from the
Subsidiaries and are now under separate control.
The Company also bills its customers for certain special services on behalf
of other telecommunications service providers. The most representative of such
special services is the 900 service provided by specific 900 service providers
that have agreements with Embratel. The Company bills its customers for use of
the 900 service and, after the Company collects the payments from its customer,
retains a network usage fee and a fee for the billing service and transfers the
balance to Embratel. Embratel then transfers the portion owed to the 900 service
provider. The Company also bills cellular service providers and other network
service providers that lease network facilities from the Company for use within
their stand-alone networks.
Network and Facilities
General
The Company's network includes installed lines and exchanges, a network of
access lines connecting customers to exchanges, trunk lines connecting exchanges
and long-distance transmission equipment. At December 31, 1998, the Company's
regional telephone network included approximately 8.8 million installed lines,
of which 7.8 million were lines in service. Of the access lines in service at
that time, approximately 71% were residential lines, 26% were commercial lines
and 3% were public telephone lines. Intraregional long-distance transmission is
provided by a microwave network and by fiber optic cable. The Company's
management believes that the unmet demand for fixed-line telecommunications
services in the Region is substantial. At December 31, 1998, 37% of the
households and 68% of the businesses in the Region had local telephone service.
The following table sets forth selected information about the Company's
network at the dates and for the years indicated.
<TABLE>
<CAPTION>
At and for year ended December 31,
-----------------------------------------
1994 1995 1996 1997 1998
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Installed access lines (millions)................................... 5.2 5.6 6.4 7.5 8.8
Access lines in service (millions).................................. 4.7 5.1 5.7 6.6 7.8
Average access lines in service for year ended (millions)........... 4.6 4.8 5.2 5.9 7.2
Lines in service per 100 inhabitants................................ 5.5 5.9 6.6 7.6 9.0
Percentage of installed access lines connected to digital exchanges. 29.8 45.0 56.0 63.0 72.7
Employees per 1,000 access lines installed.......................... 8.4 6.5 5.6 4.6 2.8
Public telephones in service (thousands)............................ 149.8 161.9 186.4 228.6 265.8
Local call pulses for year ended (billions)......................... 24.0 26.1 25.8 25.8 26.9
Domestic long-distance call minutes for year ended (billions)....... 6.0 7.3 7.8 8.4 9.9
International call minutes for year ended (millions)................ 63.9 103.5 121.9 146.2 167.2
</TABLE>
In most of the states in the Region, the Company's long-distance network
includes the fixed-line transmission facilities that the Subsidiaries used to
support intrastate transmission. Telepara, Teleamapa, Telamazon and Telaima,
however, relied, and will continue to rely, primarily on satellite transmission
provided by a long-distance carrier.
The Company is focusing on expanding its network in order to provide
interstate long-distance service between the states in the Region. The Company
is investing in a backbone that will connect the major capitals and large cities
located in the Company's Region. The Company estimates that it will invest a
total of approximately R$200 million (including investments in transmission and
switching stations) to expand its network to provide interstate service. The
Company estimates that in the fourth quarter of 1999, it will have expanded it's
network to service interstate calls between all states in the Company's region
except for the Amazon region. The Company and Embratel are also negotiating the
terms for usage of each other's network in order for the Company to provide
interstate service and for Embratel to provide intrastate service.
The Company began to install digital exchanges in 1987. 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, such as
voice, text and data applications. Beginning in 1997, all new lines installed by
the Company have been connected to digital exchanges. At December 31, 1998, 73%
of all installed lines were connected to digital exchanges.
The Company began to install fiber-optic cable in 1985. Fiber optic
provides greater transmission capacity. By significantly reducing the fading of
signals and requiring less frequent amplification, fiber-optic cable reduces the
cost of providing service and increases traffic and network reliability. By
year-end 1998, a total of 412,000 kilometers had been installed for use in the
Company's network.
Network Expansion
The Company is required under the Telecommunications Regulations to meet
certain targets relating to network expansion and modernization. See
"--Regulation of the Brazilian Telecommunications Industry--Obligations of
Telecommunications Companies--Network Expansion--General Plan on Universal
Service." The targets the Company expects to be most difficult to meet are those
relating to availability of switched service to low population centers and
maximum distances between public telephones. Company is obligated by year-end
2001 to provide switched service to all locations with populations above 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 meters. 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. The Company is also obligated to reduce the maximum waiting time
for activation of a line to four weeks by year-end 2001. The customer waiting
period for the activation of a new line varies significantly depending on the
capacity of the switching center that serves the locality. In order to meet the
targets, the Company plans to expand its network to increase service to smaller
localities.
Upon privatization, the Company also agreed with Anatel that it would meet
certain deadlines for installing lines for those customers that had requested
the installation of a line under the prior auto-financing system but had not yet
received a line. Under the prior auto-financing system, each customer requesting
the installation of a line was required to invest in shares of Telebras or its
subsidiaries. Since the Company did not meet these deadlines by the end of 1998,
Anatel required the Company to provide, free of charge, certain services to
these customers that included free installation, waiver of the monthly
subscription fee and pre-paid telephone cards. The total value of the free
services provided by the Company as required by Anatel totaled approximately
R$13 million and benefited approximately 120,000 customers. In April 1999, the
Company completed the installation of all lines ordered under the auto-financing
system. The Company does not expect to be subject to further penalties related
to this matter.
Competition
Until April 1999, the Company was the only supplier of local fixed-line and
intrastate telecommunications services in the Region. However, the
Telecommunications Regulations provided for the introduction of competition in
telecommunications services in Brazil and required Anatel to permit one
competitor to provide local and intraregional long-distance fixed-line services
in the Region and one additional competitor (in addition to Embratel) to provide
intraregional long-distance services in the Region. The new licensees that
compete with the Company are not subject to the same service quality and network
expansion and modernization obligations that the Company is subject to under its
Concessions. Beginning in 2002, the Company may face an unlimited number of
competitors in local and intraregional 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 Concessions. See
"--Regulation of the Brazilian Telecommunications Industry--Concessions and
Licenses."
In February 1999, Canbra won the bid for the operating license to provide
local and intraregional long-distance fixed-line services in the Region. Canbra
paid R$60 million for the operating license, the minimum price set by the
Brazilian government. Canbra also agreed with Anatel to carry out a network
expansion plan that requires Canbra to have an installed capacity of 1.6 million
lines by December 1999. Canbra, through the WLL consortium and SLI Wireless,
will initially serve cities and municipalities in the Region that include all 16
state capitals and an additional 13 other municipalities by 1999 and 35 other
municipalities by 2000, with a total of 2.2 million lines.
Canbra is a consortium led by Bell Canada International ("Bell Canada") and
WLL International Inc ("WLL"), both with 34.4% interest in the consortium,
Qualcomm Inc., with 16.2% and Grupo Vicunha/Liberman with 15%. The consortium
that comprises Canbra also received authorization under the name Megatel do
Brasil S.A. ("Megatel") to provide local fixed-line services in competition with
Telesp Participacoes S.A. ("Telesp"). Telesp is the regional fixed-line service
provider operating in the State of Sao Paulo. Bell Canada is a subsidiary of BCE
Inc., the largest telecommunications company in Canada and a leading provider of
telecommunications services in markets outside of Canada. WLL was formed in June
1998 to provide fixed-line telecommunications and data transmission services in
Latin America. The primary sponsors of WLL include Telecom Partners, Centennial
Funds and Crescendo Ventures. Qualcomm is a supplier of CDMA wireless local loop
networks worldwide and develops digital wireless communications products and
services based on its CDMA digital technology. Grupo Vicunha is an important
Brazilian investment group that has played a major role in many recent
high-profile privatizations in Brazil. Grupo Vicunha is also the controlling
shareholder of Companhia Siderurgica Nacional, the former state owned steel
company, which in turn holds a significant interest in CVRD, the major Brazilian
mining Company. The Liberman Group invests in fixed wireless telecommunications
in Latin America through SLI Wireless, a part of the Liberman Group.
In July 1999, Embratel, the former long-distance service provider of the
Telebras System, will be authorized to provide intrastate long-distance services
in competition with the Company. Embratel is controlled by MCI Worldcom, a
global telecommunications company with revenue of more than $30 billion and
established operations in over 65 countries. The Company's management does not
expect its intrastate long-distance service to decrease significantly as a
result of the entrance of Embratel into the intrastate long-distance market.
Embratel has a limited intrastate network and will pay network usage rates to
the Company for all intrastate long-distance calls carried by Embratel that use
the Company's local network either to complete or initiate the call.
In January 1999, Bonari was awarded licenses to provide long-distance
services throughout Brazil in competition with Embratel. In July 1999, Bonari,
along with Embratel, will be authorized to provide intrastate long-distance
service in the Region in competition with the Company. The partners that
comprise Bonari include: (i) National Grid, the owner and operator of the
electricity transmission network in the United Kingdom with a quoted market
value of over US$10 billion, (ii) France Telecom, one of the world's leading
telecommunications carriers with 1998 consolidated operating revenues of 24.6
billion euros, and (iii) Sprint, a global U.S. based communications company with
US$17 billion in annual revenues.
The Company is also subject to competition from cellular service providers.
There are ten cellular service providers in the Region, including Tele Sudeste
Celular S.A., Telemig Celular S.A. and Tele Leste Celular S.A. and various Band
B operators that include Algar Telecom Leste - ATL and Maxitel (operated by
Vicunha Telecomunicacoes Ltda.). The competition from cellular service providers
is limited by the fact that tariffs for cellular calls are much higher than
tariffs for calls on the Company's fixed-line network. The Company also earns
more on calls made by the Company's customers to cellular service users than on
calls made by the Company's customers to other fixed-line customers, even taking
into account the network usage charges the Company must pay the cellular service
provider.
The Company does not provide interstate long-distance fixed-line
telecommunications services between the states in the Region. In July 1999,
however, the Company will be authorized to provide interstate long-distance
services between the states in the Region in competition with Embratel, Bonari
and Canbra.
In December 1998, Anatel approved a resolution outlining a numbering plan
for fixed-line service providers in Brazil. The Numbering Plan will promote
competition between providers of fixed-line long-distance services by requiring
the caller to choose a service provider for each long-distance call by prefacing
the call with numbers that identify the carrier. Following the implementation of
the Numbering Plan, the Company's management anticipates that the Company will
immediately begin to compete with Embratel in intrastate and interstate
long-distance service and, by the fourth quarter of 1999, the Company also
expects to compete with Canbra in local and intrastate and interstate
long-distance service and with Bonari in intrastate and interstate long-distance
service.
The Company does not anticipate a major, across-the-board tariff reduction
(in nominal terms) in the first year of competition. The Company does expect
that with the entrance of competition, competitors will develop significant
marketing campaigns combined with aggressive policies of targeting loyal, high
volume customers with price promotions, volume discounts and other price
incentives. Although the Company is still in the process of formulating its
marketing plan, it estimates that in response to competition, the Company will
substantially increase its marketing expenses during 1999, estimating a
preliminary budget of approximately R$100 million, primarily to market the
Company's brand name, Telemar, and its two digit access code (31).
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. The Company's management expects that the combined
effect of the entrance of competitors in the market for intrastate long-distance
service in the Region and the entrance of the Company into the interstate market
will initially adversely affect the Company's market share and income from
operations. The Company's management, however, expects that eventually the
anticipated combined growth in both the interstate and intrastate markets, and
the increased use by cellular providers of the Company's network, will generate
higher interconnection revenues - especially from increased use of the Company's
local network by other providers to connect calls that are originated or
terminated by the Company's local service customers. The Company's management
expects that telephony revenue per line will continue to decline, in real terms,
as it expands its network to lower income customers. Canbra is a potentially
powerful competitor with significant expertise in the areas of building and
successfully managing telecommunications operations, advanced technology and
international finance. Embratel, the former long-distance carrier of the
Telebras System, has an extensive transmission network, extensive experience and
financial resources. Bonari is owned by National Grid, Sprint and France
Telecom, companies with extensive experience in network development,
installation of optical fiber cable, and at the forefront of integrating
long-distance, local and wireless communications. Any adverse effects on the
Company's results and market share from competitive pressures 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 technical and financial
resources available to the Company's competitors, the business strategies and
capabilities of the competitors, prevailing market conditions, the regulations
applicable to new entrants and the Company and the effectiveness of the
Company's efforts to prepare for increased competition.
Employees
At December 31, 1998, the Company had 24,157 employees. All the Company's
employees are employed on a full-time basis, divided into the following
functions: plant operation and maintenance 44%, plant expansion and
modernization 10%, sales and marketing 23%, administrative support 12%,
corporate management 8% and budget and finance 3%.
Approximately 72.3% 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"). 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,
1999, except for the Subsidiaries covering the States of Rio de Janeiro,
Espirito Santo, Rio Grande do Norte, Maranhao e Amazonas, that represent
approximately 10,360 employees. In respect of these Subsidiaries, the collective
agreements of 1998 have not yet been renewed for 1999 and are still being
negotiated with the local unions. In Espirito Santo, representing 981 employees,
the process has already entered the labor court. Based upon previous judicial
decisions, the Company's management does not expect a significant increase in
employee benefits already provided by the Company, even in the event of an
adverse judgment. More recently, however, the recent reduction of approximately
25% of the Company's employees at the end of 1998, has generated an increasing
number of labor disputes. See "--Legal Proceedings." The Company is creating a
new policy whereby employees will be compensated in accordance with their
ability to meet certain targets set by the Company's management. In addition,
the Company will offer additional employee training to prepare the employees to
reach the targets. Neither the Company nor the Predecessor Company has ever
experienced a work stoppage that had a material effect on its operations.
Employees of the Company at the time of the privatization had the right to
maintain their rights and benefits in Fundacao Telebras de Seguridade Social -
Sistel ("Sistel"), a multi-employer defined benefit plan that supplements
government-provided retirement benefits. The Company makes monthly contributions
to Sistel currently equal to 13.5% of the salary of each employee who is a
Sistel member. Each employee member also makes a monthly contribution to Sistel
based on age and salary. 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 for
at least 35 years. Sistel operates independently from the Company, and its
assets and liabilities are fully segregated from those of the Company. See Note
22 to the Consolidated Financial Statements. Sistel covers the employees of the
companies of the former Telebras System, and the Company is contingently liable
for all of the unfunded obligations of the plan. Employees hired since the
privatization have been permitted to join Sistel.
The Company and the other sponsors of Sistel (primarily the former Telebras
companies) are considering a break-up of Sistel that would generate a separate
plan for each of the sponsors for their own employees. The sponsors would
expect, however, to jointly maintain a plan offering the current benefits under
Sistel for those employees who have already retired and the funding for such
plan would be provided by all the sponsors in accordance with the method of
allocation used in the break-up of Sistel. The plans for the new funds would be
modified to the needs of the new sponsors. Because the sponsors are only in the
preliminary stages of discussing the proposed break-up of Sistel, the amounts of
the independent reserve liabilities with respect to each sponsors' participation
are not yet measurable and, therefore, the final configuration of each sponsor's
plan and the consequences for the Company or its employees cannot be assessed.
Research and Development
The Company conducts independent research and development in areas of
telecommunications services but does not independently develop new
telecommunications hardware. The Company primarily depends on manufacturers of
telecommunications products for the development of new hardware.
In connection with the Breakup, the Subsidiaries were required to enter
into three-year contracts which obligate them to contribute in aggregate a
maximum of R$128.6 million during the three years ending May 2001 to the
Fundacao Centro de Pesquisa e Desenvolvimento das Telecomunicacoes (the
"Center"), a research and development center formerly operated by Telebras.
During the effectiveness of its agreement with the Center, 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. The Center may also provide 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. The Center is developing, on the
Company's behalf, projects involving an integrated billing and customer care
system and network management systems. Systems developed by the Center for the
Company's use are not subject to royalties or licensing fees. Other projects
developed by the foundation, such as equipment management systems, public
telephone control and the external network management system have been already
implemented in many of the Subsidiaries. The Company's research and development
expenses during 1996, 1997 and 1998, including its contribution to the Center,
were R$35.6 million, R$31.1 million and R$42.1 respectively.
Capital Expenditures
Before the Privatization, the Company's capital expenditures were planned
and allocated on a system-wide basis and subject to approval by the Federal
Government. These constraints on capital expenditures prevented the Company from
making certain investments that otherwise might have been made to improve
telecommunications services in the Region. Since the Privatization, these
restrictions have not applied. The Company is now permitted to determine its own
capital expenditure budget, subject to compliance with certain obligations to
expand service under the Concessions. See "--Regulation of the Brazilian
Telecommunications Industry--Obligations of Telecommunications Companies."
The Company's 1999 annual capital expenditure budget totals approximately
R$2,400 million, which is expected to be funded with debt (up to 50%, a major
portion raised in the domestic market and the balance pending international
market conditions more favorable for Brazilian borrowers) and internally
generated funds from operations (at least 50%). The Company's management expects
to allocate approximately 65% of the Company's planned 1999 capital expenditures
to meet the Company's obligations in respect of the General Plan on Universal
Service and the General Plan on Quality. The Company also estimates that it will
spend approximately R$200 million to develop its long distance backbone
(including approximately R$130 million for transmission facilities and R$60 to
R$70 million for switching centers) and approximately R$140 million to adjust
its switching centers to comply with the Numbering Plan. The Company's
management expects to allocate the remaining 20% to expand data services,
generate new businesses and increase investments in information technology,
including addressing any remaining year 2000 issues.
The following table sets forth the Company's capital expenditures for each
year in the three-year period ended December 31, 1998.
<TABLE>
<CAPTION>
Year ended December 31,
----------------------------------
1996 1997 1998
---- ---- ----
(millions of reais) (1)
<S> <C> <C> <C>
Operational investments(2)........................................... 272.2 294.1 266.4
Telephone equipment:
Exchanges 620.8 634.8 513.9
Transmission...................................................... 311.0 411.4 404.3
Infrastructure.................................................... 152.0 125.8 134.1
External network.................................................. 480.1 558.4 649.9
Other............................................................. 302.9 529.2 374.8
Data transmission equipment.......................................... 89.1 64.3 64.3
-------- -------- --------
Total capital expenditures........................................... 2,228.1 2,618.0 2,407.7
======= ======= =======
</TABLE>
- ------------------
(1) In constant reais of December 31, 1997 purchasing power for periods prior to
January 1, 1998.
(2) 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 provides and the rates it
charges, is subject to comprehensive regulation under the General
Telecommunications Law and various administrative enactments thereunder. Each of
the Subsidiaries operates under a Concession that authorizes it to provide
specified services and sets forth certain obligations (the "List of
Obligations").
Anatel is the regulatory agency for telecommunications under the General
Telecommunications Law and the October 1997 Regulamento da Agencia Nacional de
Telecomunicacoes (the "Anatel Decree"). Anatel is administratively independent
and financially autonomous. Anatel is required to report on its activities to
the Ministry of Communications and to the Brazilian Congress. Any proposed
regulation of Anatel is subject to a period of public comment, including public
hearings, and Anatel's decisions may be challenged in the Brazilian courts.
Concessions and Licenses
Concessions and licenses to provide telecommunications services are granted
under the public regime or the private regime. Companies that provide services
under the public regime ("public regime companies") are subject to certain
obligations as to quality of service, continuity of service, universality of
service, network expansion and modernization. Companies that provide services
under the private regime ("private regime companies") are generally not subject
to the requirements as to continuity of service, universality of service or
modernization, but they are subject to certain network expansion and quality of
service obligations set forth in their licenses. The companies that operate in
the public regime include the four primary public regime companies (Embratel,
the Company and the two other regional fixed-line service providers) and certain
other local operators. The four primary public regime companies are the primary
providers of fixed-line telecommunications services in Brazil that include local
service and intraregional, interregional and international long-distance
service. All other telecommunications service providers, including the other
companies authorized to provide fixed-line services in the Company's Region,
operate in the private regime.
Public regime companies, such as the Company, also often offer certain
services in the private regime of which the most significant are data
transmission services.
Fixed-line Services--Public Regime. Each public regime company operates
under concessions that expire in 2005 but, subject to meeting certain
obligations, may be renewed for an additional 20-year period. The Concessions
may also be revoked prior to expiration. See "--Obligations of
Telecommunications Companies--Public Regime--Service Restrictions." Every second
year during the 20-year renewal period, public regime companies will be required
to pay biannual renewal fees equal to 2% of annual net revenues from the
provision of telecommunications services (excluding taxes and social
contributions) during the immediately preceding year.
The Company, like the other regional fixed-line companies, is generally not
permitted to offer interregional, international long-distance service or other
specified telecommunications services until December 31, 2003. However, if all
the Subsidiaries meet their network expansion and universal service targets of
December 31, 2003 by December 31, 2001, the Company would receive authorization
to offer any sort of telecommunications services beginning in 2002, whether or
not in the Region, including interregional and international long-distance
service. See "--Obligations of Telecommunications Companies--Public
Regime--Service Restrictions."
Fixed-line Services--Private Regime. The Telecommunications Regulations
provide for the introduction of competition in telecommunications services in
Brazil by requiring the Federal Government to authorize four private regime
companies--one to provide local service and intraregional long-distance service
in each of the three Fixed-line Regions and one to provide intraregional,
interregional and international long-distance service throughout Brazil. Anatel
has already granted to a private regime operator the licenses to operate in the
Company's Region. Anatel has also granted to two other private regime companies
the licenses to operate in one of the other Fixed-line Regions and the licenses
to provide intraregional, interregional and international long-distance service
in competition with Embratel. The auction for the licenses to operate in the
remaining Fixed-line Region did not attract any bidders and will be rescheduled.
Following the completion of the auctions, authorizations will have been granted
in each Fixed-line Region for two regional fixed-line companies to provide local
service (a public regime company and a private regime company), four fixed-line
companies to provide intraregional long-distance service (a public regime
company, two private regime companies and Embratel) and two companies to provide
interregional long-distance and international long-distance (Embratel and
Bonari). Beginning in 2002, Anatel may authorize additional private regime
companies to provide intraregional, interregional and international telephone
long-distance. See "--Competition."
Obligations of Telecommunications Companies.
The Company, like other telecommunications service providers, is subject to
obligations concerning quality of service and network expansion and
modernization. The four public regime companies are also 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 in the Plano Geral de Metas de Universalizacao ("General
Plan on Universal Service") and the Plano Geral de Metas de Qualidade ("General
Plan on Quality").
Public Regime--Service Restrictions. The General Plan of Concessions and
Licenses prohibits the regional fixed-line service providers from offering
cellular, interregional long-distance or international long-distance services
and prohibits Embratel from offering local or cellular services until December
31, 2003. Such service restrictions may be suspended by December 31, 2001 for
any company that meets the 2003 targets by December 31, 2001.
Anatel will monitor the progress of Embratel and the regional fixed-line
service providers towards meeting their Lists of Obligations. See tables in
"--Network Expansion--General Plan on Universal Service" and "--Quality of
Service--General Plan on Quality." Anatel may revoke the concessions of
companies that fail to meet their 2003 targets. Each regional fixed-line
provider will be authorized to provide all other telecommunication services
(except for fixed-line services in the private regime within the Region and
cable TV services) either (i) beginning in 2004; or (ii) beginning in 2002,
provided that all of its operating subsidiaries have met their respective 2003
targets.
Public regime companies are also subject to certain restrictions on
alliances, joint ventures, mergers and acquisitions, including:
- a public regime company is prohibited from holding more than 20
percent of the voting stock in any other public regime company for a
five year period beginning July 1998 (following that period the
prohibition is suspended provided that the acquisition is not deemed
detrimental to the implementation of the General Plan of Concessions
and Licenses);
- mergers between regional fixed-line service providers and cellular
service providers are prohibited (this prohibition also applies to
private regime companies); and
- companies offering telephony services are prohibited from offering
cable television (unless a public auction to provide such services in
the relevant region is held and no one appears).
Network Expansion--General Plan on Universal Service. Under the General
Plan on Universal Service, each regional fixed-line service provider is required
to expand fixed-line service within its Fixed-line Region in accordance with the
List of Obligations and Embratel is required to expand access to long-distance
service by installing public telephones in remote regions. No subsidies or other
supplemental financings are anticipated to finance the network expansion
obligations of the public regime companies. Any Subsidiary that meets its
December 31, 2001 target of four weeks maximum waiting time for installation of
a line in advance of the deadline will no longer be subject to the network
expansion requirements. If a public regime company fails to meet its obligations
in a particular Fixed-line Region, Anatel may apply the penalties established in
the Concessions. In the event of extreme failure on account of a public regime
company that endangers the provision of basic telecommunications services to the
region and upon proof that the public region company is incapable of providing
the service, Anatel would be obligated to issue a license to another company to
service the region.
The following table sets forth the Company's network expansion and
modernization obligations as provided in the List of Obligations at the times
indicated and the Company's average performance with respect to each category of
obligation at December 31, 1998.
<TABLE>
<CAPTION>
Company status
at December 31, By December 31,
-------------------------------------------------------
1998 1999 2000 2001 2002 2003 2004 2005
---- ---- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Minimum number of installed lines
(millions)........................... 8.8 10.3 11.8 13.5 -- -- -- --
Fixed-line service available to all
communities larger than:............. n.a. -- -- 1,000 -- 600 -- 300
Maximum waiting time for installation
of a line (weeks)(1)................. n.a. -- -- 4 3 2 1 --
Minimum number of public telephones
in service (thousands)............... 266 336 402 483 -- -- -- --
Minimum number of public telephones
per 1,000 inhabitants................ 3.1 -- -- -- -- 7.5 -- 8.0
Minimum public telephones as a
percentage of fixed lines............ 3.4 -- -- -- -- 2.5 -- 3.0
Minimum digitalization level of
network (%).......................... 73 75 -- 85 -- 95 -- 100
</TABLE>
- ------------------
(1) Applies only to areas where fixed-line service is fully available.
Quality of Service--General Plan on Quality. Under the General Plan on
Quality, each regional fixed-line company and Embratel is required to meet
certain service quality obligations established in its List of Obligations. The
following table sets forth information regarding the Company's obligations at
year-end 1999-2005 and the Company's performance with respect to each category
of obligation at 1998.
<TABLE>
<CAPTION>
Company status
at December 31, By December 31,
----------------------------------------------------
1998 1999 2000 2001 2002 2003 2004 2005
-------------- ---- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Dial tone within 3 seconds (% of cases)......... 99 98 -- 99 -- 99.5 -- 99.5
Call completion rate during peak periods (% of
calls attempted) (1).......................... 53.7(2) 60 -- 65 -- 70 -- 70
Maximum number of uncompleted calls due to
network congestion (% of calls attempted) (1)... 6.5 6 -- 5 -- 4 -- 4
Maximum monthly repair requests (% of lines
in service)..................................... 4.8 3.0 -- 2.5 -- 2.0 -- 1.5
Maximum monthly public telephone repair
requests (% of public telephones in service).... 21.5 15 -- 12 -- 10 -- 8
Residential repair response speed (% within
24 hours)(3).................................... 79.5 95 -- 96 -- 97 -- 98
Nonresidential repair response speed (% within
8 hours)(4)..................................... n.a. 95 -- 96 -- 97 -- 98
Public telephone repair response speed (%
within 8 hours)............................... 88 95 -- 96 -- 97 -- 98
Operator availability during peak periods
(% response within 10 seconds).................. 85.5 92 -- 93 -- 94 -- 95
Billing complaints (per thousand bills issued)(5). 18.7 4 -- 3 -- 2 -- 2
Credit issued within one billing cycle for
claimed inaccuracies (% of cases)............... n.a. 95 -- 96 -- 97 -- 98
</TABLE>
- ------------------
(1) For local and domestic long-distance calls.
(2) The Company's status for local calls only. The Company's status as of
December 31, 1998 for long-distance calls was 44.3%.
(3) Must always be within 48 hours.
(4) Must always be within 24 hours.
(5) A bill is considered inaccurate for this purpose if a customer claims it is
inaccurate.
Fines and Penalties. Failure to meet the network expansion and
modernization obligations in the List of Obligations may result in fines and
penalties of up to R$50 million as well as potential revocation of the
Concessions. Failure to meet the quality of services obligations in the List of
Obligations may result in fines and penalties of up to R$40 million. While there
can be no assurances, the Company's management believes that it will be able to
meet these requirements, however, the Company's ability to meet the quality of
service obligations in the List of Obligations will depend upon certain factors
outside its control. See "--Network and Facilities--Network Expansion" and
"Quality of Service."
Interconnection. All public regime companies are required to provide
interconnection upon request to any provider of public telecommunications
services. The terms and conditions of interconnection are freely negotiated
between parties, subject to a price cap established by Anatel. If a company
offers any party an interconnection tariff below the price cap, it must offer
that tariff to any other requesting party on a nondiscriminatory basis.
Anatel does not currently require network operators to unbundle network
elements and services, although Anatel has stated that it plans to review the
issue on a regular basis and may require unbundling in the future. In an
unbundled regime, each network operator is required to provide a detailed list
of network services and elements which may be purchased separately by a party
requesting interconnection.
Rate Regulation
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,
interregional 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 charges for
long-distance services that are determined based on five rates that vary with
the time of day and the distance called.
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").
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, in real terms, 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--intraregional 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 increase does not exceed the inflation and
productivity-adjusted 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."
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 in the Federal Government at and immediately
below the cabinet level, adversely affected the implementation of consistent
economic and monetary policies.
Fernando Henrique Cardoso, who was 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, in October 1998, was
reelected for an additional four-year term, which began in January 1999.
President Cardoso is the leader of a coalition of six political parties that
represents a majority in the federal Congress. His party, the Brazilian Social
Democratic Party, holds the second largest number of seats in the coalition.
1999 to date has been marked by difficult relations between the Federal
Government and certain state governments. In the 1998 elections for state
governors, candidates from parties allied with the President's coalition
prevailed in 21 of 27 states, including the State of Sao Paulo. Opposition
candidates won in six states, including the States of Rio de Janeiro and Rio
Grande do Sul. In January 1999, the new Governor of the State of Minas Gerais
announced that his state would suspend payments on its debt to the Federal
Government for 90 days. The Governor of the State of Rio Grande do Sul
subsequently obtained a court order permitting his state to make its debt
payments into an escrow account, pending resolution of a request of seven states
to renegotiate refinancing agreements they had reached with the Federal
Government in 1997. The Federal Government has responded by seeking to withhold
constitutionally mandated transfers to the State of Minas Gerais. The Federal
Government has notified certain international financial institutions that it
will no longer guarantee obligations of the States of Minas Gerais and Rio
Grande do Sul to those institutions, leading the World Bank to suspend loans to
certain Brazilian states.
In February 1999, certain state governors pressed for a renegotiation of
their states' refinancing agreements with the Federal Government. The President
offered instead to make loans to the states to cover the costs of layoffs and
pension reform and promised to review a law exempting exports from state taxes.
The Federal Government has initiated negotiations with the World Bank to secure
funding for such loans. The Federal Government is also proposing to refinance
certain debt of Brazil's municipalities for a period of 30 years at a rate
equivalent to 9% above the rate of inflation, in return for which the
municipalities are to be required to cut costs sharply and adopt strict fiscal
guidelines.
Conflicts between the Federal Government and state governments could
complicate the passage of the government's fiscal reform package and longer-term
fiscal measures, including a reform of the tax system, and Brazil's ability to
meet the agreed targets under the country's agreements with the International
Monetary Fund (the "IMF"). See "--Brazilian Economic Environment."
Brazilian Economic Environment
The Company's business, prospects, financial condition and results of
operations 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 before the introduction of the Real Plan in late 1993, the
Brazilian economy was extremely volatile. The Federal Government implemented a
succession of programs intended to stabilize the economy and provide a basis for
sustainable, noninflationary growth. Changes in monetary, credit, tariff and
other policies were frequent and occasionally drastic. 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 had a material adverse effect on the Company's business,
operations, financial condition and results of operations.
The Federal Government introduced the Real Plan in December 1993. The Real
Plan is 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, initially with an exchange rate
of R$1.00 to US$1.00. The real appreciated through January 1995 and thereafter
gradually declined in value against the dollar, reaching R$1.2085 to US$1.00 at
December 31, 1998. Notwithstanding the success of the Real Plan in lowering
inflation and stabilizing the Brazilian economy, the Real Plan has also led to
economic slowdown, and a rise in unemployment in most regions and sectors of the
economy.
The Asian financial crisis in 1998 and the ripple effects of that crisis
presented a serious challenge for Brazil. After reaching a historical high of
US$74.7 billion at April 30, 1998, Brazil's international reserves declined to
US$42.4 billion at October 31.
In November 1998, in response to continuing pressure on the real and the
rapid decline in the country's dollar reserves, Brazil negotiated a US$41.5
billion loan package arranged by the IMF. Acceptance of the IMF package
committed Brazil to implement a combination of spending cuts and tax increases.
Brazil received the first installment of approximately US$9.4 billion in two
disbursements. Brazil's level of international reserves stabilized following the
announcement of the support package, reaching US$44.6 billion at December 31,
1998. At year-end 1998, the Commercial Market Rate stood at R$1.2085 to US$1.00.
After some initial progress in implementing a Fiscal Stabilization Program
announced in late 1998, the Federal Government encountered difficulties in
implementing the program in Congress. See "--Brazilian Political Environment."
The Central Bank attempted a controlled devaluation of the real by widening the
band within which the real was permitted to trade, but subsequent Central Bank
intervention failed to keep the rate within the new band. On January 15, the
Central Bank announced that the real would be permitted to float, with Central
Bank intervention to take place only in times of extreme volatility. Both the
level of international reserves and the value of the real continued to decline.
At January 31, Brazil's international reserves stood at US$36.1 billion and the
Commercial Market Rate stood at R$1.9832 to US$1.00.
In the following weeks, the Federal Government had a series of legislative
successes with its efforts to implement the expense reduction and revenue
enhancement measures under its Fiscal Stabilization Program. Brazil also began
negotiations with the IMF on adjustments to the previously agreed 1999-2001
economic program, and agreement was reached in March on new economic targets.
Brazil received a second disbursement, of approximately US$4.9 billion, from the
IMF, followed by an additional US$4.9 billion in bilateral loans under the
IMF-led support package. Subsequent disbursements will depend on Brazil's
ability to meet the agreed primary surplus targets and on Brazil's progress in
implementing fiscal reforms. There can be no assurance that Brazil will be able
to meet the primary surplus targets under its agreement with the IMF and,
accordingly, that the full amount under the IMF-led support package will be
available to Brazil.
After giving effect to the inflows from the IMF-led support package,
Brazil's international reserves stood at US$38.9 billion on April 8, 1999. The
Commercial Market Rate stood at R$1.72 to US$1.00 on March 31, 1999.
As a result of the foregoing events, GDP dropped 1.64% during the fourth
quarter of 1998, reflecting declines of 6.45%, 2.45% and 0.65% in the
agricultural, industrial and services sectors, respectively. GDP declined by
0.15% in the full year 1998, compared with 3.47% growth during the preceding
year. Brazil's current account deficit continued to grow in 1998, reaching
US$35.2 billion for 1998, compared with a US$33.4 billion deficit for the
preceding year. At the end of the first quarter of 1999, the current account
deficit stood at US$3.5 billion, the result of a US$535 million trade deficit
and US$3.4 billion in debt service during that quarter. Foreign direct
investment inflows increased 52.6% in 1998, totaling US$26.1 billion. Of that
amount, 23.4%, or US$6.1 billion, resulted from foreign participation in the
national privatization program. In the first two months of 1999, foreign direct
investment inflows totaled US$5.7 billion, bringing such investment to US$29.7
billion in the twelve months ended February 28, 1999.
Developments in Other Emerging Market Countries
The Brazilian securities markets are influenced by economic and market
conditions in other emerging market countries. Although economic conditions are
different in each country, developments in one country can have an effect on
investors' perceptions of the risks of investing in the securities of issuers in
other countries, including Brazil. During 1998 and 1999, the international
financial markets have experienced significant volatility, with significant
adverse effects on demand for and prices of securities of issues virtually all
emerging markets, including Brazil.
The current volatility in the securities markets in Latin American and
other emerging market countries' has been attributed, at least in part, to the
effects of the Asian and the Russian economic crises of 1997-98. For example,
the crisis in Asia in the fourth quarter of 1997 provoked a significant
financial and crisis in Brazil. In August 1998, following the devaluation of the
Russian ruble, Brazil again experienced substantial capital outflows and
significant declines in its stock markets. See "--Brazilian Economic
Environment."
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 prices of the
Company's securities.
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. See
"--Brazilian Economic Environment."
The following table sets forth the rate of Brazilian inflation, as measured
by the Indice Geral de Precos - Mercado (the General Price Index - Market or
"IGP-M"), and the devaluation of the Brazilian currency against the U.S. dollar
during the periods indicated.
<TABLE>
<CAPTION>
Year ended December 31,
---------------------------------
1996 1997 1998
---- ---- ----
(percentages)
<S> <C> <C> <C>
Inflation (IGP-M)...................................................... 9.2 7.7 1.8
Devaluation (Brazilian currency vs. US$)............................... 6.9 7.4 8.3
</TABLE>
Under the Real Plan, the rate of Brazilian inflation has decreased
considerably since July 1994. The exchange rate between the real and the U.S.
dollar remained relatively stable from mid-1994 to year-end 1998, but extreme
volatility has returned in 1999. See "--Brazilian Economic Environment." During
the first quarter of 1999, inflation, as measured by the IGP-M, amounted to 7.4%
and the devaluation of the real against the U.S. dollar was 42%.
Inflation and devaluation have potentially adverse consequences for the
Company's business, prospects, financial condition and results of operations.
These factors introduce distortions into the Company's financial statements and
make period-to-period comparisons difficult and unreliable. Differences between
the relative rate of Brazilian inflation as compared to the rates of Brazil's
trading partners, on the one hand, and the rate of currency devaluation, on the
other, can cause balance sheet losses for the Company on its foreign
currency-denominated liabilities. Inflation places pressure on the Company's
rates and invites Federal Government efforts to control inflation by holding
down the rates that Brazilian public utilities are permitted to charge.
There can be no assurance that Brazilian inflation will remain at modest
rates or, if there is an increase in inflation, that the Company's business,
prospects, financial condition and results of operations will not be adversely
affected.
Item 2. Description of Property
The principal properties of the Company consist of transmission equipment
(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, "transfer" exchanges that connect local
exchanges to long-distance transmission facilities and "tandem" exchanges that
connect local exchanges with each other and with "transfer" exchanges.
The Company's properties are located in 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 December 31, 1998, the Company owned 4,133 properties, consisting of 3,927
operating and 206 non-operating sites.
At December 31, 1998, plant equipment related to switching stations
represented approximately 27.0% of the net book value of the Company's total
fixed assets, transmission equipment represented 34.3%, construction in progress
represented approximately 12.0%, buildings, underground equipment and lines
represented approximately 15.5% and other fixed assets represented approximately
11.2%. At December 31, 1998, the net book value of the Company's property, plant
and equipment was R$14,080.9 million.
Item 3. Legal Proceedings
The legality of the Breakup and Privatization of Telebras was challenged in
numerous legal proceedings, some of which have now been dismissed. A few,
however, are still pending. The Company's management believes that the ultimate
resolution of those proceedings will not have a material adverse effect on the
Company's business or financial condition.
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 Holding Company 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 Holding Company or one of the other New Holding Companies. Creditors of
Telebras had until September 14, 1998 to challenge this allocation of liability.
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 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, not related to the assets of the former.
The principal material tax proceedings to which the Company is a party are
listed below:
ICMS on activation fees and other services. On June 19, 1998, the
secretaries of the treasuries 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 activation, which had not previously been 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.
The Company believes that the attempt by the Brazilian States 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 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.
The legality of the extension of the scope of ICMS tax and its
retroactivity is being challenged in various legal proceedings to obtain an
interim relief from the obligation to retain ICMS. 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 pending lawsuit. Beginning in September 1998, the
Company decided to retain the ICMS tax from its customer and deposit the
retained tax in court. The provision of R$30.145 million (see Notes 8 and 21 of
the Consolidated Financial Statements) reflects the maximum liability, for the
period from June 1998 to September 1998 (the period following the
reinterpretation of the application of ICMS and prior to the time when the
Company began to retain the additional ICMS tax from its customers) that the
Company would incur if the courts rule that the more broadly applicable ICMS tax
applies as of the date the tax was reinterpreted, June 19, 1998.
If ICMS tax were applied retroactively to activation fees earned by the
Company during the last five years, it would give rise to an approximate
liability of R$238.2 million.
FINSOCIAL. 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 1995. In 1997, the Brazilian Supreme Court
narrowed its prior decision, leading the tax authorities to challenge similar
1995 credits recognized by other telecommunication companies.
During 1998, various FINSOCIAL assessments were issued against the Company
on account of the credit taken by the Company in 1995. Based on these
assessments and previous Supreme Court decisions, the Company decided to make a
provision on account of these assessments (see Note 8 of the Consolidated
Financial Statements).
National Social Security Institute - INSS. Brazilian social security
regulations establish that a company contracting third-party services is jointly
liable before the "INSS" for the payment of the INSS social contribution due by
the contracted party. The tax assessment issued against the company in 1998,
totaling R$7.8 million, is deemed by the management as a probable loss.
Brazilian social security regulations also establish that any indirect
remuneration, usually called fringe benefits, shall be included in the company
payroll for purposes of payment of the INSS social contribution. Fringe
benefits, for legal purposes is the remuneration, of any nature, paid to the
employee such as foreign language courses and technical qualification courses.
The tax assessment issued against the company for indirect remuneration in 1998,
totaling R$13.1 million, is deemed by the management as a probable loss.
Imposto Sobre Servicos - ISS. Under the Federal Constitution of 1988,
telecommunications services are subject to a sales tax, the ICMS. However, a
number of services are also offered to clients in addition to or in connection
with telecommunications services that do not fall within the scope of
telecommunications services as such and, accordingly, should not be subject to
ICMS. Consequently, the company did not collect ICMS from clients for related or
additional services.
Recently, a number of municipalities in which the Subsidiaries are located
took the position that such related and accessory services are subject to
services tax (Imposto sobre Servicos - ISS), which is generally levied at the
maximum rate of 5%.
In 1998, a number of tax assessments, representing a total amount of
R$49.230 million, were issued against the Company. Because there is no case law
on this question, the Company took the position that the tax assessments
represented a probable loss. Provision for the probable loss was therefore made,
based on the probability of loss on each of the several tax assessments issued
against the Company.
The principal material labor proceedings to which the Company is a party
are listed below:
Dangerous work conditions premium. Under Brazilian law, employees working
in dangerous conditions, as defined in applicable legislation, are entitled to
payment of an extra amount equal to 30% of their basic salary (dangerous work
conditions premium).
The claim relating to this dangerous work premium arises out of an
adjustment to the amount payable under trade union agreements for employees
working within an environment considered to be dangerous, principally operations
close to high tension electric installations. In 1998 a definitive ruling by the
Superior Labor Tribunal ("TST") provided guidance on determining dangerous work
premiums. Because the premium paid by the company in accordance with the trade
union agreement is inconsistent with the ruling of the TST, it is very likely
that these claims will ultimately be decided against the Company.
Inflation indexation adjustments (Bresser Plan and URP Plan). The claims
related to inflation indexation adjustments refer to adjustment of salaries by
inflation indices under certain economic stabilization programs announced by the
government in prior years (the Bresser Plan, introduced in 1987, and the URP
(Price Reference Unit) Plan, introduced in 1989). The employees claim that these
economic stabilization programs understated their salaries, and that they are
entitled to receive the amount that their salaries were understated.
Although the TST had already taken the position that employees do not have
the right to salary increases related to the economic stabilization plans, the
Company reevaluated the risk of loss in 1998 based on an unfavorable ruling by
the TST one of these claims. The TST has also issued a decision in another claim
in favor of the employee and ordered proceedings against the company.
Productivity premiums. Claims for productivity premiums relate to
collective bargaining agreements through which the Company agreed to implement a
model to establish employees' productivity and the resulting payment of a share
of profits. As the model and consequent payment were never implemented, the
employees filed claims for such payment.
Equalization of salary scales. The Company also has claims against it to
equalize salary scales among certain employees that do the same work, within a
given period of time, with the same productivity and technical performance.
This type of judicial proceeding usually involves significant amounts of
money because it relates to the difference in monthly salaries over an entire
period. In addition, the proceedings usually depend on questions of evidence and
the tribunals' interpretation of the evidence.
Accordingly, after analyzing the evidence produced in a number of
proceedings and the decisions in those proceedings, the Company came to the
conclusion that the tendency was to judge in favor of the employee. For this
reason, the Company decided to make a provision in its financial statements for
these claims based on an estimate of the amounts owed to the employees.
Item 4. Control of Registrant
References in this Annual Report to "Preferred Shares" and "Common Shares"
are to the preferred shares and common shares, respectively, of the Holding
Company. References to "American Depositary Shares" or "ADSs" are to American
Depositary Shares, each representing 1,000 Preferred Shares. The ADSs are
evidenced by American Depositary Receipts ("ADRs").
Of the Holding 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. A consortium (the "Telemar Consortium"), which
consists of the companies named in the following table, owns 51.79% of the
Common Shares. Accordingly, the Telemar Consortium has the ability to control
the election of the Company's Board of Directors and the direction and future
operations of the Company. A new holding company, Telemar Participacoes S.A.
("Telemar") has been formed to hold all the Common Shares now owned by the
Telemar Consortium. The formation of Telemar has been approved by Anatel and is
awaiting approval by the Brazilian treasury. See "--Shareholders' Agreement".
All the remaining 48.21% of the common shares and all the preferred shares
are in the possession of shareholders other than the Telemar Consortium.
The following table sets forth information concerning the ownership of
Common Stock in the Holding Company by the members of the Telemar Consortium and
by the Holding Company's officers and directors. The Holding Company is not
aware of any other shareholder owning more than 10% of the Common Shares.
<TABLE>
<CAPTION>
Percentage of
Number of Common Outstanding
Name of Owner Shares Owned Common Shares
- ---------------- ---------------- -------------
<S> <C> <C>
Construtora Andrade Gutierrez S.A................................. 13,653,892,000 12.58
Macal Investimentos e Participacoes Ltda.......................... 12,881,031,000 11.86
Inepar S.A. Industria e Construcoes............................... 12,881,031,000 11.86
Fiago Participacoes S.A........................................... 12,043,763,125 10.31
Companhia de Seguros Alianca do Brasil............................ 6,472,717,000 2.59
Brasil Veiculos Companhia de Seguros.............................. 6,472,717,000 2.59
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. is part of a Brazilian group that had
revenues of R$1,415 million in 1998. It has activities in the fields of
construction, public utilities and telecommunications and conducts business in
Brazil and many other countries, including the United States, Mexico, Argentina,
Paraguay, Equator, Bolivia, Chile, Peru, Panama, Guinea, Angola and Portugal.
Andrade Gutierrez was responsible for the construction of Itaipu, the world's
largest operating hydroelectric plant. Since 1993, Andrade Gutierrez has
conducted its telecommunications activities through AG Telecom, whose activities
include information technology services, credit card processing and optical
fiber communications networks.
Inepar S.A. Industria e Construcoes is the main company of the Inepar
Group, a group of companies with activities in Brazil and in other Latin
American countries. The Inepar Group is dedicated to the fields of
telecommunications, energy and construction. Its telecommunications activities
include interests in projects such as a global satellite phone system
("Iridium"), cable television, cellular telephone services, internet connection
services and pager services.
Macal Investimentos e Participacoes Ltda. 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 shopping network),
Multicanal Participacoes S.A.(cable television) and Almax Aluminio S.A.
Fiago Participacoes S.A. was formed 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.
FCF is managed by Banco Fonte Cindam S.A., a Brazilian investment bank.
Brasil Veiculos Companhia de Seguros is a Brazilian insurance company that
had revenues of R$308 million in 1998. It provides vehicle insurance products in
Brazil and has a market share of 4.78% in the vehicles insurance market.
Companhia de Seguros Alianca do Brasil is a Brazilian insurance company
that had revenues of R$495 million in 1998. It provides life insurance products
in Brazil and has market shares of 9.66% in the domestic life insurance market
and 10.81% in the domestic general risk insurance market.
Shareholders' Agreement
On August 3, 1998, the members of the Telemar Consortium and BNDES
Participacoes S.A - BNDESPAR ("BNDESPAR") entered into a Shareholders' Agreement
(the "Shareholders' Agreement") that establishes (i) rules for the management of
the Holding Company and its Subsidiaries, (ii) restrictions on transfers of
Holding Company shares (in which BNDESPAR is not included), (iii) special
procedures and quorum requirements for the adoption of certain corporate
decisions by the Board of Directors and by Shareholders' Meetings and (iv) rules
for the appointment of the members of the Board of Directors. In the
Shareholders' Agreement, the parties agreed to form Telemar, which will also
have Fiago Participacoes S.A. (which is not a party to the Shareholders'
Agreement) as one of its shareholders. The parties to the Shareholders'
Agreement and Fiago Participacoes S.A. will contribute all their Common Shares
to Telemar. The Shareholders' Agreement provides that the voting stock of
Telemar (which will control the Holding Company) will be held as follows: (i)
Construtora Andrade Gutierrez S.A., Macal Investimentos e Participacoes Ltda.
and Inepar S.A. Industria e Construcoes--45.1%, (ii) Companhia de Seguros
Alianca do Brasil and/or Brasil Veiculos Companhia de Seguros--10%, (iii)
BNDESPAR--25% and (iv) Fiago Participacoes S.A.--19.9%.
Item 5. Nature of Trading Market
The principal trading market for the Preferred Shares is the Bolsa de
Valores de Sao Paulo (the "Sao Paulo Stock Exchange"). The Preferred Shares are
also traded on the Bolsa de Valores do Rio de Janeiro (the "Rio de Janeiro Stock
Exchange") and the seven other Brazilian stock exchanges. At December 31, 1998,
the Holding Company had approximately 2.4 million shareholders.
The Preferred Shares commenced trading separately on the Brazilian stock
exchanges on September 21, 1998. The following table sets forth the reported
high and low closing sale prices for Preferred Shares of the Holding Company on
the Sao Paulo Stock Exchange for the periods indicated.
<TABLE>
<CAPTION>
Nominal reais per
1,000 Preferred Shares
----------------------
High Low
---- -----
<S> <C> <C>
Third quarter 1998 (beginning September 21, 1998).............................. 15.20 13.00
Fourth quarter 1998............................................................ 22.30 10.70
</TABLE>
In the United States, the Preferred Shares trade in the form of ADSs, each
representing 1,000 Preferred Shares, issued by The Bank of New York, as
depositary (the "Depositary") pursuant to a Deposit Agreement (the "Deposit
Agreement") among the Holding Company, the Depositary and the registered holders
and beneficial owners from time to time of ADRs. The ADSs commenced trading
separately on the NYSE on November 16, 1998 under the symbol TNE. At December
31, 1998, there were approximately 93,000 beneficial owners of ADSs. The
following table sets forth the reported high and low closing sales prices for
ADSs on the NYSE for the period indicated.
<TABLE>
<CAPTION>
U.S. dollars per ADS
---------------------
High Low
---- ---
<S> <C> <C>
Fourth quarter 1998 (beginning November 16, 1998)............................. 20.00 11.75
</TABLE>
The common shares and preferred shares of Telerj, Telemig and Telebahia are
also traded on the Sao Paulo Stock Exchange, the Rio de Janeiro Stock Exchange,
and seven other Brazilian stock exchanges. The common shares and preferred
shares of Telaima, Telamazon, Telasa, Teleamapa, Teleceara, Telepara, Telepisa,
Telergipe, Telern, Telest, Telma, Telpa and Telpe are traded on Sociedade
Operadora de Mercado de Acesso - SOMA, an over-the-counter trading system based
in Rio de Janeiro. In 1998, the daily trading volumes on the SOMA averaged
approximately R$4.6 million and the average number of daily transactions was
47,400.
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 1998, 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., though the
Rio de Janeiro Stock Exchange has recently announced plans to convert its
operations to electronic trading. 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.
There are no specialists or market makers for the Holding Company's shares on
the Sao Paulo Stock Exchange. 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
Companhia Brasileira de Liquidacao e Custodia S.A. - CBLC, which is controlled
mainly by the member brokerage firms and banks that are not members of that
exchange. 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.
At December 31, 1998, the aggregate market capitalization of the 527
companies listed on the Sao Paulo Stock Exchange was approximately US$160.9
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. For this reason, data showing the total
market capitalization of Brazilian stock exchanges tend to overstate the
liquidity of the Brazilian equity securities market.
The Brazilian equity market is relatively small and illiquid compared to
major world markets. In 1998, the combined daily trading volumes on the Sao
Paulo Stock Exchange and the Rio de Janeiro Stock Exchange averaged
approximately US$757.7 million. In 1998, the five most actively traded issues
represented approximately 61.5% of the total trading in the cash market on the
Sao Paulo Stock Exchange and approximately 67.21% 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.
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, 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, as amended (the
"Brazilian Securities Law") and Law No. 6,404, as amended (the "Brazilian
Corporation Law").
Under the Brazilian Corporation Law, a company is either public, a
companhia aberta, such as the Holding 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
market. The shares of a public 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 provides 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 Holding Company by individuals or legal entities domiciled outside
Brazil.
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. 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 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 had been approved under the Annex V
Regulations by the Central Bank 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 has been issued in the name of the Depositary
with respect to the ADSs and is 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. 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 qualifies under the Annex IV Regulations or
obtains its own Certificate of Registration. A holder that obtains a Certificate
of Registration 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
that were owed to foreign equity 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 1998, 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 acquisition, 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. 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 in force 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 not deemed to be domiciled in Brazil for Brazilian tax
purposes (a "non-Brazilian holder"). This discussion does not address all the
Brazilian tax considerations that may be applicable to any particular
non-Brazilian holder, and each non-Brazilian holder should consult his or her
own tax advisor about the Brazilian tax consequences of investing in Preferred
Shares or ADSs.
Taxation of Dividends
Dividends paid by the Holding Company in cash or in kind from profits of
periods beginning on or after January 1, 1996 (i) to the Depositary in respect
of Preferred Shares underlying ADSs or (ii) to a non-Brazilian holder in respect
of Preferred Shares will generally not be subject to Brazilian withholding tax.
Dividends paid from profits generated before January 1, 1996 may be subject to
Brazilian withholding tax at varying rates, except that stock dividends are not
subject to Brazilian tax unless the stock is subsequently redeemed by the
Holding Company, or the non-Brazilian holder sells the stock in Brazil, within
five years after the distribution.
The only Brazilian tax treaty now in effect that would (if certain
conditions are met) reduce the rate of the withholding tax on dividends paid
from profits generated before January 1, 1996 is the treaty with Japan, which
would reduce the rate to 12.5% under the circumstances set forth in the treaty.
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.
Neither the deposit of Preferred Shares in exchange for ADSs nor the withdrawal
of Preferred Shares upon cancellation of ADSs is subject to Brazilian tax.
Non-Brazilian holders are not subject to tax in Brazil on gains realized on
dispositions of Preferred Shares outside Brazil to other non-Brazilian holders.
Gains realized by non-Brazilian holders on dispositions of Preferred Shares
in Brazil or in transactions with Brazilian residents may be free of Brazilian
tax, taxed at a rate of 10% or taxed at a rate of 15%, depending on the
circumstances. Gains on the disposition of Preferred Shares obtained upon
cancellation of ADSs are not taxed in Brazil if such disposition is made, and
the proceeds are remitted abroad, within five business days after cancellation.
Gains on the sale or exchange of duly-registered investments under the Annex IV
Regulations are not subject to Brazilian tax, but such sale or exchange must
occur on a Brazilian stock exchange. Gains realized through transactions on
Brazilian stock exchanges are generally subject to tax at a rate of 10%. Gains
realized through off-exchange transactions in Brazil or with Brazilian residents
are generally subject to tax at a rate of 15%. Brazil's tax treaties do not
grant relief from taxes on gains realized on sales or exchanges of Preferred
Shares.
Any gains realized by a non-Brazilian holder upon the redemption of
Preferred Shares will be treated as gains from the disposition of such Preferred
Shares to a Brazilian resident occurring off of a stock exchange and will
accordingly be subject to tax at a rate of 15%.
Gain is measured by the difference between the amount in Brazilian currency
realized on the sale or exchange and the acquisition cost of the shares sold,
measured in Brazilian currency without any correction for inflation; the
acquisition cost of shares registered as an investment with the Central Bank is
calculated on the basis of the foreign currency amount registered with the
Central Bank.
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 be maintained.
Any exercise of preemptive rights relating to the Preferred Shares or ADSs
will not be subject to Brazilian taxation. Gains on the sale or assignment of
preemptive rights relating to the Preferred Shares will be treated differently
for Brazilian tax purposes depending on whether the sale or assignment is made
by the Depositary or the investor and depending on the investor's status under
Brazilian law. Gains on sales or assignments made by the Depositary on a
Brazilian stock exchange are not taxed in Brazil, but gains on other sales or
assignments may be subject to tax at rates up to 15%.
Distributions of Interest on Capital
Brazilian corporations may make payments to shareholders characterized as
interest on the capital of the Holding Company as an alternative form of making
dividend distributions. The rate of interest may not be higher than the Federal
Government's long-term interest rate (the "TJLP") as determined by the Central
Bank from time to time (13.48% per annum for the three month period starting
April 1999). The total amount distributed as interest on capital may not exceed
the greater of (i) 50% of net income (before taking such distribution and any
deductions for income taxes into account) for the year in respect of which the
payment is made or (ii) 50% of retained earnings. Payments of interest on
capital are decided by the shareholders on the basis of recommendations of the
company's board of directors.
Distributions of interest on capital paid to Brazilian and non-Brazilian
holders of Preferred Shares, including payments to the Depositary in respect of
Preferred Shares underlying ADSs, are deductible by the Holding Company for
Brazilian corporate income tax purposes. Such payments are subject to Brazilian
withholding tax at the rate of 15%, except for payments to persons who are
exempt from tax in Brazil, which are free of Brazilian tax, and except for
payments to persons situated in jurisdictions deemed to be tax havens (i.e.,
countries that either have no income tax or in which the income tax rate is less
than 20%), which may be subject to tax at a 25% rate, although the matter is not
free from doubt.
No assurance can be given that the Board of Directors of the Holding
Company will not recommend that future distributions of profits should be made
by means of interest on capital instead of by means of dividends.
Amounts paid as interest on capital (net of applicable withholding tax) may
be treated as payments in respect of the dividends the Holding Company is
obligated to distribute to its shareholders in accordance with its Charter and
the Brazilian Corporation Law. Distributions of interest on capital in respect
of the Preferred Shares, including distributions to the Depositary in respect of
Preferred Shares underlying ADSs, may be converted into U.S. dollars and
remitted outside of Brazil, subject to applicable exchange controls.
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 or in the relevant State to individuals or
entities that are resident or domiciled within such State in Brazil. There are
no Brazilian stamp, issue, registration, or similar taxes or duties payable by
holders of Preferred Shares or ADSs.
A financial transaction tax (the "IOF tax") may be imposed on the
conversion of Brazilian currency into foreign currency (e.g., for purposes of
paying dividends and interest). The rate of IOF tax rate on such conversions is
currently 0%, but the Minister of Finance has the legal power to increase the
rate to a maximum of 25%. Any such increase will be applicable only
prospectively.
In addition to the IOF tax, a second, temporary tax that applies to the
removal of funds from accounts at banks and other financial institutions (the
"CPMF tax") will be imposed on distributions by the Holding Company in respect
of ADSs at the time such distributions are converted into U.S. dollars and
remitted abroad by the Custodian. The CPMF tax will be in effect until June
2002, unless its term is extended, and such tax will be imposed at a rate of
0.38% from June 1999 until June 2000 and at a rate of 0.30% from June 2000 until
June 2002.
Registered Capital
Amounts invested in Preferred Shares by a non-Brazilian holder who
qualifies under the Annex IV Regulations and obtains registration with the CVM,
or by the Depositary representing an ADS holder, are eligible for registration
with the Central Bank. 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 through dispositions of such Preferred
Shares. The Registered Capital per 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 (stated in U.S. dollars). The
Registered Capital per Preferred Share withdrawn upon cancellation of an ADS
will be the U.S. dollar equivalent of (i) the average price of a Preferred Share
on the Brazilian stock exchange on which the most Preferred Shares were traded
on the day of withdrawal or, (ii) if no Preferred Shares were traded on that
day, the average price on the Brazilian stock exchange on which the most
Preferred Shares were traded in the fifteen trading sessions immediately
preceding such withdrawal. The U.S. dollar equivalent will be determined on the
basis of the average Commercial Market Rates quoted by the Central Bank on such
date or dates.
A non-Brazilian holder of Preferred Shares may experience delays in
effecting Central Bank 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 Annual Report, and changes to such law
subsequent to the date of this Annual Report 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
Holding Company (taking into account shares held directly through depositary
arrangements), 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 laws other than
U.S. federal income tax 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 Holding Company as a dividend to the extent
that such distribution is paid out of the Holding Company'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 Holding Company's e&p, it will be treated as a
nontaxable 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, or by a U.S. holder, in the case of a holder of Preferred Shares. 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 Holding Company 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, Brazilian income tax withheld in 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. 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
Holding Company generally will not be subject to U.S. federal income tax.
A holder of an ADS that is a foreign corporation or nonresident 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. 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. 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, if Brazilian tax is imposed on such gain, the U.S. holder
will not be able to use the corresponding foreign tax credit, unless the holder
has other foreign source income of the appropriate type in respect of which the
credit may be used.
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
Background
The selected financial information presented below should be read in
conjunction with, the Consolidated Financial Statements and the notes thereto.
The Consolidated Financial Statements have been audited by
PricewaterhouseCoopers Auditores Independentes for 1998 and by KPMG Peat Marwick
for 1997 and 1996, and their reports on the Consolidated Financial Statements
appear elsewhere in this Annual Report.
The following paragraphs discuss some important features of the
presentation of the selected financial information and the Consolidated
Financial Statements. These features should be kept in mind in evaluating the
selected financial information and in reading "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
Brazilian GAAP and U.S. GAAP
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 31
to the Consolidated Financial Statements for a summary of the differences
between Brazilian GAAP and notes 32 and 33 for a reconciliation to U.S. GAAP of
net income for the years ended December 31, 1996, 1997 and 1998, and
shareholders' equity as of December 31, 1997 and 1998.
Presentation of 1998 Income Statement
The consolidated income statement of the Company for the year ended
December 31, 1998 reflects the operations of each of the Subsidiaries for the
full year 1998 and the operations of the Holding Company for the period from
February 28, 1998, the effective date of its establishment in the Breakup of
Telebras, to December 31, 1998. For any period prior to January 1, 1998, the
Consolidated Financial Statements and, unless otherwise specified, all financial
information included in this Annual Report recognize certain effects of
inflation and are restated in constant reais of December 31, 1997 purchasing
power, all in accordance with Brazilian GAAP using the integral restatement
method (correcao integral). The Company used the IGP-M inflation index for
purposes of preparing its financial statements for 1996 and 1997. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Effects of Changes in Presentation of Financial Statements in 1998."
Inflationary gains or losses on monetary assets and liabilities were allocated
to their corresponding income or expense caption in the Consolidated Statements
of Income.
For 1998, the Company has not restated the financial statements for
recognizing the impact of inflation, because the low rate of Brazilian inflation
in 1998 (1.8% as measured by the IGP-M) would have made any restatement for
inflation insignificant. The restated balances of nonmonetary assets and
liabilities as of December 31, 1997, which reflect inflation through December
31, 1997, were used as the opening balances for 1998. The Consolidated Financial
Statements as of and for the year ended December 31, 1998 are presented in
nominal reais and do not recognize effects of inflation subsequent to December
31, 1997. Financial statements for prior dates and periods, which were restated
in constant reais of December 31, 1997, have not been further restated.
Accounting Consequences of the Breakup of Telebras
The formation of the Holding Company and the transfer of assets and
liabilities from the Subsidiaries to the Spun-off Companies have been accounted
for as a reorganization of entities under common control in a manner similar to
a pooling of interests. As of December 31, 1997 and for the years ended December
31, 1996 and 1997, the fixed line telecommunications businesses of the
Subsidiaries are presented as continuing operations and the cellular
telecommunications businesses are presented as discontinued operations.
The assets and liabilities of the cellular telecommunications business are
presented as net assets of discontinued operations and were transferred to the
Spun-off Companies at their indexed historical cost. The revenues and expenses
associated with such assets and liabilities were also allocated to the Spun-off
Companies. For revenues and cost of services, separate records were maintained
historically for the cellular telecommunications businesses of the Subsidiaries,
so actual amounts were allocated to the Spun-off Companies. Costs other than
cost of services were allocated between the Subsidiaries and the Spun-off
Companies using methodologies described in Note 2 to the Consolidated Financial
Statements. Through December 31, 1997, cash and certain non-specific debt
relating to the cellular telecommunications businesses of the Subsidiaries could
not be segregated. Consequently, the corresponding amounts of income and expense
are recorded as unallocated interest income/expense, and income tax expense is
presented after income from discontinued operations.
The Consolidated Financial Statements are not necessarily indicative of
what the financial condition or results of operations of the Company would have
been if the Spun-off Companies had been separate legal entities before 1998.
At the May 22, 1998 Telebras shareholders' meeting, the shareholders
established the shareholders' equity of each New Holding Company, and allocated
to each a portion of the retained earnings of Telebras. Telebras retained
sufficient retained earnings from which to pay certain dividends and other
amounts. The balance of Telebras's retained earnings was allocated to each New
Holding Company in proportion to the total net assets allocated to each such
company. The retained earnings so allocated do not represent the historical
retained earnings of the New Holding Companies. The retained earnings allocated
to the Company resulted in an increase of R$1,906.7 million in relation to the
historical retained earnings of the Subsidiaries. See Note 1(c) to the
Consolidated Financial Statements. The amount of distributable retained earnings
of the Holding Company includes retained earnings allocated to the Holding
Company in the Breakup of Telebras.
For 1996 and 1997, "minority interests" in the Consolidated Financial
Statements reflects the interest of shareholders other than Telebras in the
Subsidiaries. For 1998, "minority interests" reflects the interest of
shareholders other than the Holding Company in the Subsidiaries.
Difference from Financial Statements Published in Brazil
The Company's statutory financial statements prepared in accordance with
the Brazilian Corporation Law (the "Statutory Financial Statements") are the
basis for dividend and tax determinations. The Consolidated Financial Statements
include the effects of inflation through December 31, 1997, while the Statutory
Financial Statements include the effects of inflation only through December 31,
1995. The Statutory Financial Statements also differ from the Consolidated
Financial Statements in respect of certain reclassifications and presentation of
comparative information. See Notes 2 and 29 to the Consolidated Financial
Statements.
<PAGE>
<TABLE>
<CAPTION>
Selected Financial Information
Year ended December 31,
-------------------------------------------------------------------------
1994 1995 1996 1997 1998
--------- -------------- -------------- ---------------- ------------
(thousands of reais,
except per share data) (1)
<S> <C> <C> <C> <C> <C>
Income Statement Data:
Brazilian GAAP
Net operating revenue................... 3,162,602 3,242,678 4,273,806 4,959,293 5,158,417
Cost of services........................ (1,992,682) (2,109,617) (2,343,600) (2,571,352) (3,080,895)
----------- ----------- ----------- ----------- -----------
Gross profit............................ 1,169,920 1,133,061 1,930,206 2,387,941 2,077,522
Operating expenses...................... (1,033,951) (827,000) (1,018,653) (1,111,880) (1,028,229)
----------- ----------- ----------- ----------- -----------
Operating income from continuing
operations before interest........... 135,969 306,061 911,553 1,276,061 1,049,293
Interest income......................... -- -- -- -- 162,323
Interest expense (2).................... -- (58,525) (61,780) (46,263) (123,650)
------------ ------------ ------------ ------------- -------------
135,969 247,536 849,773 1,229,798 1,087,966
Net non-operating income (expense)...... 6,844 (22,594) (10,239) (60,089) (127,262)
Employees' profit share................. (1,372) (9,221) (30,197) (60,429) (10,842)
Income from continuing operations
before unallocated interest,
extraordinary items and taxes and
minority interests................... 141,441 215,721 809,337 1,109,280 949,862
Income from discontinued cellular
operations before unallocated
interest, taxes and minority -- 316,876 679,409 788,790 --
interests............................
Unallocated interest income (3)......... 60,870 51,836 45,373 126,554 --
Unallocated interest expense (3)........ (102,615) (119,368) (121,374) (128,544) --
----------- ----------- ----------- ----------- ------------
Income before extraordinary items,
taxes and minority interests......... 99,696 465,065 1,412,745 1,896,080 949,862
Extraordinary items(4).................. -- -- -- -- (1,034,834)
Tax effects on extraordinary items...... -- -- -- -- 306,491
------------ ------------ ------------ ----------- -----------
Income before taxes and minority
interest............................. 99,696 465,065 1,412,745 1,896,080 221,519
Income tax and social contribution...... (23,865) (274,414) (386,464) (484,844) (230,135)
Minority interests...................... (9,461) (18,249) (152,316) (312,351) 99,306
----------- ----------- ----------- ----------- -----------
Net income.............................. 66,370 172,402 873,965 1,098,885 90,690
=========== =========== =========== =========== ===========
Earning per thousand shares (in reais).. 0.27
U.S. GAAP
Income (loss) from continuing operations before unallocated interest
income (expenses), taxes and minority interests........................ 1,032,275 1,231,777 (7,014)
Income from discontinued operations before unallocated interest, taxes
and minority interests.................................................. 703,701 817,998 --
Net income (loss).......................................................... 954,403 1,232,264 (39,409)
Net income (loss) per thousand shares:
Common shares--Basic....................................................... 2.98 3.84 (0.12)
Common shares--Diluted..................................................... 2.63 3.65 (0.12)
Preferred shares--Basic.................................................... 2.98 3.84 (0.12)
Preferred shares--Diluted.................................................. 2.63 3.65 (0.12)
</TABLE>
- ------------------
(1) Presented in constant reais of December 31, 1997 purchasing power for years
prior to 1998.
(2) For 1995, 1996 and 1997, interest expense allocable to continuing
operations. For 1994, the Company is unable to present cellular operations
as discontinued operations, and total interest income and expense have been
presented as unallocated interest income and expense.
(3) For years prior to 1998, unallocated interest income and expense represents
interest income and expense that could not be allocated between continuing
and discontinued operations.
(4) See Note 8 to the Financial Statements.
<PAGE>
<TABLE>
<CAPTION>
December 31,
---------------------------------------------------------------------------
1994 1995 1996 1997 1998
--------- -------- ------ -------- --------
(thousands of reais,
except per share data) (1)
<S> <C> <C> <C> <C> <C>
Balance Sheet Data:
Brazilian GAAP
Property, plant and equipment, net...... 10,380,566 10,924,227 11,944,570 13,282,386 14,080,903
Total assets............................ 11,859,291 12,651,244 14,745,909 16,635,800 16,183,778
Loans and financing--current
portion.............................. 768,604 1,021,590 674,924 743,591 104,039
Loans and financing--non
current portion...................... 1,033,493 745,061 900,483 879,962 223,168
Shareholders' equity.................... 6,889,480 7,765,262 8,625,148 9,486,508 9,931,827
U.S. GAAP
Property, plant and equipment, net...................................... 11,925,910 13,159,191 13,802,441
Total assets............................................................ 14,833,691 16,672,462 16,196,274
Loans and financing--current portion..................................... 610,316 680,264 181,671
Loans and financing--non current portion................................. 900,483 837,422 145,536
Shareholders' equity.................................................... 9,444,782 9,793,419 9,963,178
</TABLE>
- ------------------
(1) Presented in constant reais of December 31, 1997 purchasing power for
periods prior to January 1, 1998.
Exchange Rates
The Holding Company will pay any cash dividends and make any other cash
distributions with respect to Preferred Shares (and Common) in Brazilian
currency. Accordingly, exchange rate fluctuations will affect the U.S. dollar
amounts received by the holders of ADSs on conversion by the Depositary of
dividends and distributions in Brazilian currency on the Preferred Shares
represented by the ADSs. Fluctuations in the exchange rate between the Brazilian
currency and the U.S. dollar will also affect the U.S. dollar equivalent of the
price of the Preferred Shares on the Brazilian stock exchanges. Exchange rate
fluctuations may also affect the Holding Company's results of operations. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Effects of Inflation." The Holding Company does not hedge its
obligations under its foreign currency-denominated indebtedness.
There are two legal 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 "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. 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.
Between March 1995 and January 1999, the Central Bank maintained a band
within which the exchange rate between the real and the U.S. dollar fluctuated,
and the Central Bank intervened in the foreign exchange market from time to
time. From January 20, 1998 through December 31, 1998, the band was between
R$1.1164 and R$1.2085 per US$1.00. In early January 1999, the Central Bank
attempted a controlled devaluation of the real by widening the band within which
the real was permitted to trade, but subsequent Central Bank intervention failed
to keep the rate within the new band. On January 15, the Central Bank announced
that the real would be permitted to float, with Central Bank intervention to
take place only in times of extreme volatility. Both the level of international
reserves and the value of the real continued to decline. At January 31, Brazil's
international reserves stood at US$36.1 billion and the Commercial Market Rate
stood at R$1.98 to US$1.00. See "Description of Business--Brazilian Economic
Environment."
The following table sets forth the period-end, average, high and low
Commercial Market Rate (through February 21, 1995) and Noon Buying Rate (from
February 22, 1995), expressed in reais per U.S. dollar for the periods
indicated.
<TABLE>
<CAPTION>
Average for
Period Period-end Period(1) High Low
- --------- ---------- ----------- ------ ------
<S> <C> <C> <C> <C>
1994................................................ 0.8460 0.6450 1.0000 0.1186
1995................................................ 0.9722 0.9228 0.9722 0.8450
1996................................................ 1.0393 1.0080 1.0413 0.9733
1997................................................ 1.1165 1.0805 1.1166 1.0394
1998................................................ 1.2085 1.1640 1.2090 1.1160
1999 (through May 31,1999)......................... 1.7340 1.8553 2.2000 1.2074
</TABLE>
- ------------------
(1) Average of the rates on the last day of each month in the period.
Source: Central Bank through February 21, 1995; Federal Reserve Bank of New
York thereafter.
At June 18, 1999, the Commercial Market Rate was R$1.7610 to US$1.00.
Item 9. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Formation of the Holding Company 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 Holding Company and 11 other 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 service
providers, (b) eight regional Spun-off Companies and (c) one domestic and
international long-distance service provider. In the Breakup, certain assets and
liabilities of Telebras were transferred to the Holding Company, including the
shares of the Subsidiaries owned by Telebras. See Note 1 to the Consolidated
Financial Statements.
The following discussion should be read in conjunction with the
Consolidated Financial Statements of the Company, which are included elsewhere
in this Annual Report. Certain important features of the presentation of the
Consolidated Financial Statements are described in the introduction to "Selected
Financial Data."
Spinoff of Cellular Telecommunications Business
Effective January 1, 1998, the cellular telecommunications businesses of
the Subsidiaries were spun off into separate companies. For 1996 and 1997, the
Consolidated Financial Statements present the fixed-line telecommunications
businesses of the Subsidiaries as continuing operations and the cellular
telecommunications businesses as discontinued operations. See "Selected
Financial Data--Background--Accounting Consequences of the Breakup of Telebras."
Income from the cellular operations (before unallocated interest expense, taxes
and minority interest) accounted for 41.6% and 48.1% of the Company's income
before taxes and minority interest in 1997 and 1996, respectively.
Effects of Changes in Rates and Changes in Revenue Sharing
In addition to the spin-off of the cellular businesses of the Subsidiaries,
there were three major changes in the structure of telecommunications rates that
affected the Company's results in 1997 and 1998.
- Rate rebalancing. Charges for local and nonlocal services changed
substantially as part of a rate rebalancing process designed to
eliminate cross-subsidies from long-distance services to local
services. Effective in April and May 1997, rates for measured service
and monthly subscription charges increased, and rates for
long-distance services decreased. Monthly subscription charges, for
example, increased by 270% for residential customers and 59% for
commercial customers. These changes had a positive effect on revenues
from local service and an adverse effect on revenues from nonlocal
services, which affected 1997 as compared to 1996 (because the
changed rates applied from May 1997 onward) and 1998 as compared to
1997 (because the changed rates applied for the full year 1998).
- Elimination of Embratel revenue-sharing. Until April 1998,
the Company received a fixed percentage of revenue from interregional
and international long-distance calls carried by Embratel that
originated in the Company's Region. This revenue-sharing arrangement
ended effective April 1, 1998. Since then, the Company receives
interconnection fees from Embratel on a per-minute basis for
interregional and international calls carried by Embratel that are
initiated or completed on the Company's fixed-line network. The
Company also receives from Embratel a supplemental per-minute charge
called the Parcela Adicional de Transicao ("PAT") in order to reduce
the impact of the discontinuation of the revenue-sharing arrangement.
During 1998, the monthly average PAT was R$0.018 per minute. The PAT
will be gradually phased out by June 30, 2001. See "Description of
Business--Services--Interregional and International Service" and
"--Remuneration for the Use of the Network." These changes had a
substantial adverse input on revenues beginning in the second half of
1998.
- Interconnection fees. The Company receives interconnection fees
from cellular operators and, since April 1998, from Embratel. The
growth in cellular telecommunications and the discontinuation of
Embratel revenue-sharing have resulted in substantial growth in
interconnection revenues in 1997 and 1998.
Effects of Changes in Presentation of Financial Statements in 1998
There are two significant differences in presentation between the
Consolidated Financial Statements of the Company for 1998 and for earlier years.
Each of these differences should be taken into account in comparing financial
condition and results of operations for 1998 and for prior years.
- Creation of the Holding Company. The Holding Company was created
effective February 28, 1998 in the Breakup of Telebras. For 1998,
the Consolidated Financial Statements reflect the consolidated
financial condition and results of operations of the Holding
Company and the Subsidiaries. For earlier dates and periods, the
Consolidated Financial Statements reflect only the combined
financial condition and results of operations of the
Subsidiaries, except that the portion of equity and net income
attributable to shareholders other than Telebras is presented as
"minority interests."
- Indexation for inflation. The Consolidated Financial
Statements for 1996 and 1997 were prepared using the integral
restatement method to recognize the effects of inflation, and
presented in constant reais of December 31, 1997. For 1998, the
Company has not restated the financial statements for recognizing the
impact of inflation, because the low rate of Brazilian inflation in
1998 (1.8% as measured by the IGP-M) would have made any restatement
for inflation insignificant. Management believes that the lack of
indexation of the Consolidated Financial Statements at and for the
year ended December 31, 1998 has no material impact on the
comparability of the figures for 1998 with figures for prior periods.
See "Selected Financial Data" and Note 2 to the Consolidated
Financial Statements.
Political, Economic, Regulatory and Competitive Factors
The following discussion should be read in conjunction with the
"Description of Business" section included elsewhere in this Annual Report. As
set forth in greater detail below, the Company's financial condition and
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 net income 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) economic growth in the Region and its impact on demand for
telecommunications services, (ii) the cost and availability of financing and
(iii) exchange rates between Brazilian and foreign currencies.
Until February 1999, the Company was the only authorized supplier of local
fixed-line and intrastate telecommunications services in the Region. In February
1999, two licenses were auctioned to permit a competitor to provide local
fixed-line and intraregional long-distance telecommunications services in the
Region in competition with 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. Any adverse
effects on the Company's results and market share from competitive pressures
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 technical
and financial resources available to the Company's competitors, the business
strategies and capabilities of the competitors, prevailing market conditions,
the regulations applicable to new entrants and the Company and the effectiveness
of the Company's efforts to prepare for increased competition. See "Description
of Business--Competition."
Foreign Exchange and Interest Rate Exposure
The principal foreign exchange risk faced by the Company arises from
incurring a substantial part of its indebtedness in foreign currency while its
revenues are earned almost entirely in reais. As a result of this mismatch, any
increases in the Company's financing liabilities arising from currency
fluctuations may not be compensated by increased revenues. At December 31, 1998,
74.4% of the Company's indebtedness, or R$243.5 million, was denominated in U.S.
dollars. The Company's foreign-currency indebtedness consists primarily of
supplier credits. The Company's management expects that the amount of supplier
credits will increase in order to finance the expansion of its network.
Devaluation of the real results in exchange loss on foreign-currency
indebtedness, which was about R$43.0 million in 1998 and R$122.2 million for the
first quarter of 1999. In the past, the Company has not hedged its risks of
foreign-exchange losses arising from its foreign currency indebtedness because
management considered such risks to be small relative to the Company's income.
However, management may consider entering into hedging arrangements in the
future if the Company's foreign currency-denominated financing increases.
The Company is exposed to interest rate risk as a consequence of its
floating rate debt. At December 31, 1998, 78% of the Company's foreign currency
indebtedness bore interest at floating rates. The Company has not entered into
derivative contracts or made other arrangements to hedge against this risk.
Accordingly, if market interest rates (principally LIBOR) rise, the Company's
financing expenses will increase.
Results of Operations for 1996, 1997 and 1998
The following table sets forth certain components of the Company's net
income, as well as the percentage change of each from the prior year, for each
of the years in the three-year period ended December 31, 1998.
<TABLE>
<CAPTION>
Year ended December 31, % Change
--------------------------------------- -------------------------------
1996 1997 1998 1996 v. 1997 1997 v. 1998
------- ------ ------ ------------ ------------
(million of reais)(1)
<S> <C> <C> <C> <C> <C>
Net operating revenue................... 4,273.8 4,959.3 5,158.4 16.0 4.0
Cost of services........................ (2,343.6) (2,571.4) (3,080.9) 9.7 19.8
--------- ---------- ----------
Gross profit .......................... 1,930.2 2,387.9 2,077.5 23.7 (13.0)
Operating (expenses) income:
Selling............................. (382.7) (544.1) (576.5) 42.2 6.0
General and administrative.......... (827.9) (816.5) (784.4) (1.4) (3.9)
Other net operating income.......... 192.0 248.7 332.6 29.5 33.8
Operating income from continuing
operations before interest ....... 911.6 1,276.1 1,049.3 40.0 (17.8)
Interest income........................ -- -- 162.3 -- --
Interest expense (2)................... (61.8) (46.3) (123.7) (25.1) --
--------- ---------- -----------
849.8 1,230.0 1,088.0 44.7 (11.5)
Net non-operating expense.............. (10.2) (60.1) (127.3) 489.2 111.8
Employees' profit share................ (30.2) (60.4) (10.8) 100.0 (82.1)
--------- ---------- ----------
Income from continuing operations
before unallocated interest,
extraordinary items, taxes and
minority interests................ 809.3 1,109.3 949.9 37.1 (14.4)
Income from discontinued cellular
operations before unallocated
interest, taxes and minority
Interests......................... 679.4 788.8 -- 16.1 --
Unallocated interest income (3)........ 45.4 126.6 -- 178.9 --
Unallocated interest expense (3)....... (121.4) (128.5) -- 5.9 --
--------- ---------- --------
Income before extraordinary items, taxes
and minority interests............ 1,412.7 1,896.l 949.9 34.2 (49.9)
Extraordinary items ................... -- -- (1,034.8) -- --
Tax effects on extraordinary items..... -- -- 306.5 -- --
Income tax and social contribution..... (386.5) (484.8) (230.1) 25.4 (52.5)
Minority interests..................... (152.3) (312.4) 99.3 105.1 131.8
-------- --------- ---------
Net income............................. 874.0 1,098.9 90.7 25.7 (91.8)
======== ========= =========
</TABLE>
- ------------------
(1) Information for 1996 and 1997 is presented in constant reais of December
31, 1997. Information for the year ended December 31, 1998 is presented in
nominal reais. Columns may not add due to rounding.
(2) For 1996 and 1997, interest expense allocable to continuing operations.
(3) For 1996 and 1997, unallocated interest income and expense represents
interest income and expense that could not be allocated between continuing
and discontinued operations.
<PAGE>
Net Operating Revenues
The Company's revenues consist primarily of the following:
- local service charges, which include monthly charges, measured
service charges, installation charges, supplemental local services
(such as call waiting, call forwarding, voice and fax mailboxes, speed
dialing and caller ID), and charges for use of public telephones
(including stored value cards);
- nonlocal service charges, which include intrastate service charges
for long-distance calls within states in the Region and, for periods
prior to April 1998, revenue from Embratel for outgoing interstate and
international long-distance calls;
- remuneration for the use of the Company's network, which includes
payments from Embratel (for the period since April 1998) to use the
Company's network;
- internetwork revenues which include payments derived from
interconnection with other telecommunications service providers on
a per-minute basis and on a contractual basis to use part of the
Company's network;
- charges for data transmission (measured service and monthly rentals);
and
- charges for other services.
Gross operating revenues are offset by value-added and other indirect taxes
and discounts to customers. The composition of operating revenues by category of
service is presented in the Consolidated Financial Statements and discussed
below before deduction of value-added and other indirect taxes. The Company does
not determine net operating revenues for each category of revenue. The following
table sets forth certain components of the Company's operating revenues, as well
as the percentage change of each from the prior year, for 1996, 1997 and 1998.
<PAGE>
<TABLE>
<CAPTION>
Year ended December 31, % Change
1996- 1997-
1996 1997 1998 1997 1998
(in millions of reais) (1)
<S> <C> <C> <C> <C> <C>
Gross operating revenues:
Local services:
Monthly charges...................... 451.8 893.5 1,413.0 97.8 58.1
Measured service charges............. 1,184.5 1,404.3 1,624.8 18.6 15.7
Public telephones.................... 185.0 263.1 353.8 42.2 34.5
Other................................ 463.2 574.4 469.6 24.0 (18.2)
----------- ----------- -----------
Total.............................. 2,284.5 3,135.3 3,861.3 37.2 23.2
----------- ----------- -----------
Nonlocal services:
Intrastate........................... 1,010.6 827.6 893.8 (18.1) 8.0
Interstate........................... 1,274.6 1,043.8 226.1 (18.1) (78.3)
International........................ 211.5 155.1 37.7 (26.7) (75.7)
----------- ----------- -----------
Total.............................. 2,496.7 2,026.5 1,157.6 (18.8) (42.9)
----------- ----------- -----------
Remuneration for the use of the network
and PAT.............................. -- -- 492.9 -- --
Data transmission...................... 198.9 164.3 212.3 (17.4) 29.2
Internetwork services.................. 558.3 999.4 1,114.0 79.0 11.5
Other.................................. 38.8 34.6 108.2 (10.8) 212.7
----------- ----------- -----------
Total gross operating revenue............. 5,577.2 6,360.2 6,946.3 14.0 9.2
Value added and other indirect
taxes................................ (1,293.1) (1,384.1 (1,766.6) (7.0) (27.6)
Discounts.............................. (10.3) (16.8) (21.3) (63.1) (26.8)
----------- ----------- -----------
Net operating revenue..................... 4,273.8 4,959.3 5,158.4 16.0 4.0
=========== =========== ===========
</TABLE>
- ------------------
(1) Information for the years ended December 31, 1996 and 1997 is presented in
constant reais of December 31, 1997. Information for the year ended
December 31, 1998 is presented in nominal reais. Columns may not add due to
rounding.
Charges for local and nonlocal services changed substantially as part of a
rate rebalancing process designed to eliminate cross-subsidies from
long-distance services to local services. Effective May 1997, rates for measured
service and monthly subscription charges were increased, and rates for
long-distance services were decreased. Monthly subscription charges, for
example, were increased by 270% for residential customers and 59% for commercial
customers.
Local Services
Revenues from local services increased 23.2% to R$3,861.3 million in 1998
from R$3,135.3 million 1997, which in turn reflected an increase of 37.2% from
R$2,284.5 million in 1996. The growth in revenues from local services over the
three-year period resulted principally from general rate increases (for monthly
subscriptions and measured service charges, including charges for use of public
telephones) and increases in the average number of lines in service. The average
number of lines in service increased 22.0% to 7.2 million average lines in
service during 1998 and increased 13.5% to 5.9 million average lines in service
during 1997.
Monthly subscription charges. Revenues from monthly subscription charges
increased 58.1%, to R$1,413.0 million in 1998 from R$893.5 million in 1997,
which in turn represented an increase of 97.8% from R$451.8 million in 1996. The
growth over the three-year period was due principally to an increase in monthly
subscription rates and an increase in the average number of lines in service.
Effective May 1997, monthly subscription charges increased 270.5% for
residential customers, 59.3% for customers using PBX systems and 59.2% for other
nonresidential customers.
Measured service charges. Revenue from measured service charges increased
15.7%, to R$1,624.8 million in 1998 from R$1,404.3 million in 1997, which in
turn represented an increase of 18.6% from R$1,184.5 million in 1996. The growth
over the three-year period was due principally to increases in rates charged per
pulse and secondarily to an increase in usage as measured by the number of
pulses registered, which is directly correlated to the number of lines in
service. See "Description of Business--Rates--Local Rates." The price per pulse
increased 61.1% in April 1997. The number of local call pulses increased 4.3% in
1998 compared to 1997. There was no significant change in the total local call
pulses from 1996 to 1997 but there was a significant drop in the total number of
pulses above the 90 free pulses that each customer receives, reflecting
decreased telephone usage attributable to the price increase.
Public telephones. Revenues from charges for use of public telephones
increased 34.5% in 1998 to R$353.8 million from R$263.1 million in 1997, which
in turn represented an increase of 42.2% from R$185.0 million in 1996. The
growth in revenues from public telephones over the three-year period was due
principally to an increase in per-pulse rates, which resulted in greater
revenues from the sale of prepaid public telephone cards and telephone tokens,
as well as to growth of the Company's public telephone network. Since prepaid
public telephone cards and tokens are valid for a specified number of pulses,
their prices were increased when per-pulse rates were increased.
Other Local Services. Revenues from other local services primarily include
revenues from service charges for line installation and activation and charges
for supplemental local services such as call waiting, call forwarding, voice and
fax mailboxes, speed dialing and caller ID. Revenues from other local services
decreased 18.2%, to R$469.6 million in 1998 from R$574.4 million in 1997, which
in turn represented a 24.0% increase from R$463.2 million in 1996. The decrease
in 1998 reflected the full year effect of a reduction of line installation fees
from R$300 to R$80 in October 1997, the partial year effect of a further
reduction in March 1998 charged for installation of a line and the suspension in
November 1998 of line activation charges. These decreases were partially offset
by a 17.3% increase in the number of lines installed in 1998. The increase in
1997 reflected the elimination of the auto-financing system in April 1997 that
was replaced with a line installation charge and a 17.2% increase the number of
lines installed. See "Description of Business--Rates--Local Rates" and
"--Liquidity and Capital Resources." The increase in 1997 was partially offset
by the partial-year effects of the October 1997 decrease in line installation
charges from R$300 to R$80. As calculated by the Company's management, margins
on installation fees are very small, and it is accordingly not appropriate to
defer recognition of this revenue over future periods. Although installation
fees are capped by Anatel at R$80, the Company now charges R$50 and expects to
further reduce installation fees as competition increases.
Nonlocal Services
Revenues from nonlocal services decreased 42.9% to R$1,157.6 million in
1998 from R$2,026.5 million in 1997, which in turn represented a decrease of
18.8% from R$2,496.7 million in 1996. The decrease in 1998 resulted from the
discontinuation in April 1998 of the revenue-sharing arrangement between the
Company and Embratel. The decrease in 1998 was partially offset by a 17.9%
increase in domestic long-distance traffic for the year as a whole, which had
the effect, during January to April of 1998, of increasing the long-distance
call revenue retained by the Company from Embratel under their revenue-sharing
arrangement. The decrease in 1997 resulted from reductions in rates for
intrastate, interstate and international long-distance calls and a reduction in
the fixed percentage of interstate and international long-distance call revenue
retained by the Company from Embratel during 1997. The effects of rate
reductions were partially offset by a 7.7% increase in the volume of intrastate
and interstate long-distance calls and a 19.9% increase in the volume of
international long-distance calls, which effectively increased the amount of
long-distance call revenue retained by the Company from Embratel under their
revenue-sharing arrangement.
Intrastate long-distance. Revenues from intrastate long-distance service
increased 8.0% to R$893.8 million in 1998 from R$827.6 million in 1997. The
increase in 1998 was due principally to an increase in domestic long-distance
call-minutes (approximately 50% of which are intrastate and 50% are interstate
long-distance call minutes), which was partially offset by the full year effect
of rate decreases averaging over 30% in May 1997. The decrease in 1997
principally reflected the partial year effect of a reduction in the average
basic tariff for interstate long-distance calls in May 1997 and was partially
offset by an increase in domestic long-distance call minutes.
Interstate long-distance. Revenues from interstate long-distance service
decreased 78.3%, to R$226.1 million in 1998 from R$1,043.8 million in 1997 after
having decreased 18.1% in 1997 from R$1,274.6 million in 1996. The decrease in
1998 resulted from the discontinuation of the Company's revenue sharing
arrangement with Embratel. The decrease in 1997 reflected a reduction in the
average basic tariff for interstate calls in May 1997 and a reduction in the
fixed percentage of interstate and international long-distance call revenues
retained by the Company from Embratel and was partially offset by an increase in
domestic long-distance call minutes.
International long-distance. Revenues from international long-distance
service decreased 75.7% to R$37.7 million in 1998 from R$155.1 million in 1997,
which in turn reflected a decrease of 26.7% from R$211.5 million in 1996. The
decrease in 1998 resulted from the discontinuation of the Company's
revenue-sharing arrangement with Embratel, which was offset in part by a 14.4%
increase in international long-distance call minutes. The decrease in 1997
reflected a significant reduction in May 1997 in rates for international
long-distance calls and a reduction from 79.1% to 68.3% in the fixed percentage
of international long-distance revenues retained by the Company from Embratel,
offset in part by a 19.9% increase in the number of international long-distance
call minutes.
Remuneration for the Use of the Network
Remuneration for the use of the network, totaling R$492.9 million in 1998,
consists of payments from Embratel on a per-minute basis for interstate and
international calls carried by Embratel that are initiated or completed on the
Company's fixed-line network, which replaces the revenue sharing arrangement
between the Company and Embratel that was terminated in April 1998. Remuneration
for the use of the network also includes the PAT, a supplemental per-minute
charge that the Company receives from Embratel in order to reduce the impact of
the discontinuation of the revenue-sharing arrangement. During 1998, the monthly
average PAT was R$0.018 per minute. This supplemental per-minute rebate from
Embratel will be gradually phased out by June 30, 2001. See "Description of
Business--Services--Interregional and International Service" and "--Remuneration
for the Use of the Network."
Data Transmission
Revenues from data transmission increased 29.2% to R$212.3 million in 1998
from R$164.3 million in 1997, which in turn reflected a decrease of 17.4%, from
R$198.9 million, in 1996. The increase in 1998 principally reflected an increase
in contracts for dedicated-line service, as well as an increase in the volume of
data transmitted for customers transmitting data using non-dedicated, "switched"
lines, with a shift toward higher-velocity services in both categories. These
increases were partially offset by a continued decrease in rates charged for
data transmission. The decrease in 1997 principally reflected a 42% reduction in
rates charged for data transmission offset in part by a 34% increase in the
number of contracts for dedicated-line services and a shift toward
higher-velocity services.
Internetwork Services
Revenues from internetwork services consist primarily of interconnection
payments from telecommunications service providers, primarily cellular service
providers, on a per-minute basis to complete calls using the Company's network
and interconnection payments on a contractual basis to use part of the Company's
network. Revenues from network services also include fees paid by cellular
service providers for the rental from the Company of transmission facilities, to
transport cellular calls within their own internal networks. Revenues from
internetwork services increased 11.5% to R$1,114.0 million in 1998 from R$999.4
million in 1997, which in turn reflected a 79.0% increase from R$558.3 million
in 1996. The increase over the three-year period principally reflected the
growth of cellular service providers and the resulting increased demand for the
Company's facilities. Interconnection revenues increased 45.1% in 1998 and 94.2%
1997. Revenues from facilities rentals increased 18.4% in 1998 and 91.9% in
1997. Management expects continued growth in revenues from network services as
cellular operators grow.
Other Services
Revenues from other services consist of telephone directory revenues,
equipment rentals and miscellaneous. Such revenues increased 212.7% to R$108.2
million in 1998 from R$34.6 million in 1997. Revenues from other services
decreased 10.8% in 1997 from R$38.8 million in 1996. The increase in 1998 was
principally due to services rendered to the cellular companies that were spun
off from the Company in January 1998.
Cost of Services
Cost of services includes primarily depreciation and amortization costs,
third-party services, personnel costs and costs of materials. Cost of services
increased 19.8% to R$3,080.9 in 1998 from R$2,571.4 million in 1997, which in
turn reflected an increase of 9.7% from R$2,343.6 million in 1996. The following
table sets forth certain components of the Company's costs of services, as well
as the percentage change of each from the prior year, for each of the years in
the three-year period ended December 31, 1998.
<TABLE>
<CAPTION>
Year ended December 31, % Change
----------------------------------------------------------------
1996- 1997-
1996 1997 1998 1997 1998
---- ---- ---- ----- -----
(millions of reais)(1)
<S> <C> <C> <C> <C> <C>
Cost of services:
Depreciation and amortization....... 1,226.6 1,293.5 1,503.4 5.5 16.2
Services............................ 414.9 659.1 952.3 58.8 44.5
Personnel........................... 560.0 508.3 446.8 (9.2) (12.1)
Materials........................... 80.7 71.3 116.9 (11.6) 63.9
Other:
Rent and insurance................ 45.7 26.9 36.3 (41.0) 34.5
Taxes............................. 0.9 1.4 15.0 55.6 971.4
Miscellaneous..................... 14.8 10.8 10.3 (27.2) (4.6)
--------- --------- ---------
Total cost of services......... 2,343.6 2,571.4 3,080.9 9.7 19.8
======= ======= =======
</TABLE>
- ------------------
(1) Information for December 31, 1996 and 1997 is presented in constant reais
of December 31, 1997. Information for the year ended December 31, 1998 is
presented in nominal reais. Columns may not add due to rounding.
Depreciation and amortization. Depreciation expense increased 16.2% to
R$1,503.4 million in 1998 from R$1,293.5 million in 1997, which in turn
reflected an increase of 5.5% from R$1,226.6 million in 1996. The increase over
the three-year period principally reflected an increase in the amount of the
Company's depreciable assets due to the growth of its network.
Services. Expenses for third-party services consist primarily of
interconnection payments to cellular service providers for calls originating on
the Company's network and terminating on cellular networks and costs relating to
maintenance and repair of terminal equipment and infrastructure. Expenses for
services in 1998 primarily reflect approximately R$569 million for
interconnection payments actually paid to cellular service providers and
approximately R$215 million for third-party "technical plant" services, with the
remainder (of approximately R$168 million) representing the cost of
miscellaneous services rendered by third parties. In 1997, such expenses
consisted primarily of approximately R$449 million in costs of interconnection
with the cellular operations that were spun off from the Company in January 1998
and approximately R$117 million for third-party technical plant services, with
the remainder (of approximately R$93 million) representing miscellaneous
third-party services. The increase in interconnection costs is due to growth in
call volume. The increases in expenditures for third-party technical plant
services reflect increases in the number of terminals in service as well as
compliance with the network expansion targets set by Anatel and the accelerated
pace of lines installed for customers who invested under the prior
auto-financing system.
Personnel. Personnel expenses decreased 12.1%, to R$446.8 million in 1998
from R$508.3 million in 1997, which in turn reflected a decrease of 9.2% from
R$560.0 million in 1996. The decrease in 1998 primarily reflected an absolute
decrease of approximately 25% in the number of employees of the Company in the
second half of 1998. The reduction in personnel was largely a result of a
voluntary termination program (the "Program") initiated by the Company in
October 1998. See "Description of Business--Employees." Although the program
began only in the fourth quarter, it had significant effects on personnel
expense for the year because the average remuneration of employees opting for
the Program was significantly above the average remuneration for Company
employees. The Company recorded certain nonrecurring extraordinary charges in
connection with the Program. See "--Extraordinary Items (Nonrecurring Charges)."
In addition, the Company significantly reduced the number of management
personnel in August 1998 by replacing the separate management structures for
each of the Company's 16 operating companies with four regional structures. In
addition, the Company eliminated certain hierarchical levels in the management
structure and terminated certain management benefits. The number of employees
decreased to 24,157 at year-end 1998 from 33,295 at year-end 1997. The decrease
in personnel in 1997 was due primarily to a headcount reduction in 1997 of
approximately 7% compared to 1996. The number of employees per 1,000 installed
access lines decreased from 5.6 at year-end 1996 to 4.6 in 1997 and to 2.8 in
1998.
Materials. Expenses for materials increased 63.9% to R$116.9 million in
1998 from R$71.3 million in 1997 after decreasing 11.6% in 1997 from R$80.7
million in 1996. The increase in materials costs in 1998 compared to 1997 was
due principally to growth of the network and improvements in quality of service
to meet Anatel requirements. The decrease in 1997 resulted principally from the
fact that nominal prices paid for materials increased more slowly than the rate
of inflation.
Other. Costs of other services consist primarily of certain taxes,
insurance and fees paid to third parties as rent for equipment used in the
Company's network. Such costs increased 56.9% to R$61.5 million in 1998 from
R$39.1 million in 1997, which in turn reflected a decrease of 36.2% from R$61.4
million in 1996. The increase in 1998 reflected the full effectiveness of a tax
imposed on providers of telecommunications services, the Taxa de Fiscalizacao de
Telecomunicacoes - FISTEL (an ANATEL fee for the inspection of switching
stations first imposed in nominal amounts in 1997), an increase in an urban real
estate tax (Imposto Predial Territorial Urbano) and an increase in rental and
insurance costs. The increase in insurance costs resulted from compliance with a
new requirement by Anatel that the Company obtain "all risks" insurance. The
decrease in 1997 principally reflected a 41.1% decrease in rental costs and a
27% decrease in miscellaneous expenses.
Operating Expenses
Operating expenses include selling, general and administrative and other
operating expenses and are offset by other operating income. Operating expenses
decreased 7.5% to R$1,028.2 million in 1998 from R$1,111.9 million in 1997,
which in turn reflected an increase of 9.2% from R$1,018.7 million in 1996.
Selling Expense. Selling expense increased 6.0% in 1998 and 42.2% in 1997.
The increase in 1998 reflected an increase in marketing expenses (primarily for
institutional and image advertising). The increase in 1997 reflected a
significant increase in provisions for doubtful accounts due to a change in the
Company's policy for provisioning, increases in costs of materials (particularly
prepaid telephone cards) and commissions to vendors selling prepaid telephone
cards and an increase in services supplied by third parties, especially market
research consultants.
General and Administrative Expense. General and administrative expense
decreased 3.9% to R$784.4 million in 1998 from R$816.5 million in 1997, which in
turn represented a decline of 1.4% from R$827.9 million in 1996. The decrease in
1998 reflected a 45.2% reduction in administrative overhead costs (primarily
personnel), which were largely offset by costs of third-party services in
connection with the privatization (such as costs for due diligence, accounting
and post-privatization analysis of the Company). The decrease in 1997 reflected
decreases in costs of administrative personnel (principally a decrease in wages
and benefits provided to employees) and in general overhead costs, which were
partially offset by an increase in costs for third party services.
Other Net Operating Income. Other net operating income includes revenues
from fines collected by the Company for late payments by customers, technical
and administrative services (such as billing, computer services and the like)
rendered by the Company to third parties (principally cellular companies),
research and development expenses, provisions for contingencies and
miscellaneous other categories of operating income and expense. Other net
operating income increased 33.8% to R$332.6 million in 1998 from R$248.7 million
in 1997, which in turn reflected an increase of 29.5% from R$192.0 million in
1996. The increase in 1997 was principally due to an increase in income for
technical and administrative services rendered to third parties and by the
absence in 1997 of provisions for early retirement of employees, which totaled
R$80.9 million in 1996, which were 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 rate at which such fines are to be
calculated under Brazilian law from 10% of the outstanding bill to 2%. See Note
7 to the Consolidated Financial Statements.
Extraordinary Items
In 1998, the Company recorded extraordinary charges totaling R$1,034.8
million. These extraordinary items consist principally of contingencies for
certain labor claims, provisions relating to certain tax contingencies,
implementation of a voluntary employment termination program, and acceleration
of depreciation of analog equipment. See Note 8 to the Consolidated Financial
Statements.
Interest Income (Expense)
The Company had interest income of R$162.3 million in 1998, compared with
unallocated interest income of R$126.6 million and R$45.4 million in 1997 and
1996, respectively. Interest income in 1998 consisted primarily of interest
income on cash and cash equivalents (which increased significantly in 1998
following the receipt by the Company of R$165.7 in connection with the Breakup
of Telebras) and accounts receivable from subscribers and cellular telephone
companies. See "--Liquidity and Capital Resources." The increase in unallocated
interest income in 1997 resulted principally from an increase in interest rates
and cash on hand, as well as an increase in interest on accounts receivable.
Interest expense amounted to R$123.7 million in 1998, compared with
allocated and unallocated interest expense of R$174.8 million and R$183.4
million in 1997 and 1996, respectively. The decrease in interest expense in 1998
resulted primarily from a reduction in consolidated indebtedness attributable to
the Breakup of Telebras. Upon its creation, the Holding Company received, in
addition to the shares of the Subsidiaries, certain assets of Telebras
consisting primarily of claims against the Subsidiaries. These assets and the
related liabilities of the Subsidiaries are eliminated in consolidation. As a
result, the consolidated indebtedness of the Company as of December 31, 1998 is
substantially lower than the combined indebtedness shown in the Consolidated
Financial Statements as of December 31, 1997. The decrease in allocated and
unallocated interest expense in 1997 resulted principally from a reduction in
total indebtedness together with a decrease in the effective rates paid on such
indebtedness.
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 were limited to 25% of total proposed 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$10.8 million in 1998 and R$60.4 million in 1997.
Minority Interests
Minority interests reflect the participation of the Subsidiaries' minority
shareholders in the net income or loss, as the case may be, of such
Subsidiaries. Minority interests in 1998 reflect such minority shareholders'
R$99.3 million share in the overall losses experienced at the Subsidiaries. The
large minority participation in losses relative to the Company's consolidated
net loss before minority interests of R$8.6 million was due primarily to large
losses sustained by Telerj, Telamazon and Telasa, where minority shareholdings
are comparatively large, which were partially offset by minority participation
in net income of other operating subsidiaries, particularly Telemig, where
minority shareholdings are comparatively small. Minority interest in the net
income of the Subsidiaries in 1996 and 1997 was R$152.3 million and R$312.4
million, respectively, reflecting 14.8% and 22.1% of income before minority
interest, respectively. The increase in 1997 in minority interest as a
percentage of income before such interest principally reflected the
capitalization by the Company (through the issuance of preferred shares) of
resources collected from new subscribers pursuant to a system called
"auto-financing." See "--Liquidity and Capital Resources."
Liquidity and Capital Resources
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$1,828.1 million and R$2,793.5 million in 1997 and 1998, respectively.
The Company's principal uses of funds are for capital expenditures and
payments of dividends to shareholders. Capital expenditures totaled R$2,407.7
million, R$2,618.0 million and R$2,228.1 million for the years ended December
31, 1998, 1997 and 1996, respectively. The expenditures related primarily to the
expansion and modernization at the Company's network. See "Description of
Business--Capital Expenditures." In addition, the Company paid dividends of
R$481.0 million, R$265.2 million and R$138.0 million in 1998, 1997 and 1996,
respectively.
In the past, the Company's investing activities were financed using a
combination of inter-company loans from Telebras and the system of
"auto-financing." Under the system of auto-financing, prospective telephone
customers were required to make expansion plan contributions directly to the
telephone company from which service was solicited. Such contributions to the
Subsidiaries were capitalized by the issuance of preferred shares to its new
customer at the first ordinary shareholders meeting following the year which the
customer completed payment of the expansion plan contribution. The system of
auto-financing has been terminated, with no new contracts having been signed
after June 1997. See Note 24 to the Consolidated Financial Statements. The
Company received resources totaling R$600.5 million and R$924.4 million through
the auto-financing system in the years ended December 31, 1997 and 1996,
respectively.
The Company had R$327.2 million of total indebtedness at December 31, 1998.
The principal source of the Company's indebtedness was financing from suppliers
for the purchase of equipment. Approximately 74.4% of financing from suppliers
is denominated in U.S. dollars. See Note 20 to the Consolidated Financial
Statements. Such financing relates to equipment financing from Siemens do Brasil
Ltda., Alcatel Telecomunicacoes, NEC do Brasil Ltda., Bosch, Alcoa Aluminum,
Splice Telecomunicacoes and other suppliers of telecommunications equipment. The
financing bears interest at fixed rates varying between 10.9% and 12.8% per
annum and floating rates varying between LIBOR + 3% and LIBOR + 6.6% per annum.
The Company's total indebtedness for loans and financing was R$1,623.6
million and R$1,575.4 million as of December 31, 1997 and 1996, respectively, a
substantial majority of which consisted of intercompany financing from Telebras.
Except for equipment financings (which are with entities not affiliated with
Telebras), the Company's obligation with respect to these obligations as of
December 31, 1998 terminated upon the Breakup of Telebras.
The Company has planned capital expenditures of approximately R$2,400
million in 1999. Management expects that a significant portion of its 1999
capital expenditures will be funded by internally generated cash, but it expects
that the Company will have access to financing of approximately R$1,500 million.
The Company expects financing to be available from suppliers and financial
institutions, primarily from the Banco Nacional de Desenvolvimento Economico e
Social - BNDES, with which the Company is currently engaged in negotiations
regarding a possible financing. Although the Company's capital expenditures for
the year 2000 will depend upon economic conditions in the Region, management
believes that such expenditures will be approximately R$2,100 million.
The Holding Company is required to distribute to its shareholders, either
as dividends or as tax-deductible interest on capital (in the later case when
the conditions provided in the law are met), 25% of its adjusted net income
determined in accordance with Brazilian accounting principles, as adjusted in
accordance with Brazilian corporate law including any realization of the net
income reserve. The Holding Company is also required to pay a non-cumulative
preferred dividend on its preferred shares in an amount equal to 6% of the share
capital attributable to the preferred shares under Brazilian corporate law.
The Company participates in a multi-employer defined benefit plan that
covers the former employees of the Telebras System, and the Company is
contingently liable for the unfunded obligations of the plan. See Note 22 to the
Consolidated Financial Statements.
The Holding Company's principal assets are the shares of the Subsidiaries.
The Holding Company relies almost exclusively on dividends from the Subsidiaries
to meet its needs for cash, including for the payment of dividends to its
shareholders. The Holding Company controls the payment of dividends by the
Subsidiaries, subject to limitations under Brazilian law.
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 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, 1998 which is currently or is expected to be in default is
approximately R$111.4 million. The Company is 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.
U.S. GAAP Reconciliation
The Company prepares its consolidated financial statements in accordance
with Brazilian GAAP, which differs in significant respects from U.S. GAAP. The
differences are described in Note 31 to the Consolidated Financial Statements.
For 1998, U.S. GAAP net loss is R$39.4 million (net income of R$1,232.3 million
in 1997), compared to R$90.7 million net income under Brazilian GAAP (net income
of R$1,098.9 million in 1997). Shareholders' equity at December 31, 1998 is
R$9,963.2 million under U.S. GAAP compared to R$9,931.8 million under Brazilian
GAAP.
The differences between Brazilian GAAP and U.S. GAAP that have the most
significant effects on net income and shareholders' equity are the treatment of
capitalized interest and the accounting for auto-financing contributions,
proposed dividends and discounted stock purchases by employees. See Note 31 to
the Consolidated Financial Statements. In addition, 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.
Year 2000 Compliance
Some computer programs use two digits rather than four to identify years,
which can cause them to treat references to the year 2000 as references to the
year 1900. Mistakes of this kind in Company computer programs running
date-sensitive applications could cause miscalculations or lead to a system
failure that would disrupt the Company's operations, resulting in a temporary
inability to process transactions, send invoices or engage in normal business
activities. "Year 2000 compliance" refers to preparing a system to respond to
problems of this nature upon the advent of the year 2000.
In October 1998, the Company's Information Technology ("IT") Department
created a year 2000 project office to coordinate the Company's efforts to
achieve year 2000 compliance. The objectives of the Project office were to
define a common strategy to address the year 2000 issue, to create a method
capable of implementing the defined strategy and to put in place a management
system that would track the Company's efforts to achieve year 2000 compliance.
Under management's strategy for addressing the year 2000 problem, the
Company was divided into five areas: (i) information systems, (ii)
telecommunications plant, (iii) hardware and software, (iv) infrastructure and
(v) partners. Information systems includes all the applications developed or
bought by the Company that are running in mainframes and in personal computers
(high and low platforms). The telecommunications plant involves all the
equipment, including software, related to switching, data transmission, data
communications, network management and network infrastructure. The third area
refers to all computing hardware and software used by the Company regardless of
its function. Infrastructure includes all the equipment related to the site
environment, including items such as fax machines, elevators and energy systems.
The last area refers to the external entities that have commercial relations
with the Company, such as customers and suppliers.
To organize the Company's efforts to achieve year 2000 compliance, the
Company has appointed a general project manager and a segment manager for each
one of the five segments. Additionally, approximately 80 employees throughout
the Subsidiaries have been assigned year 2000 coordinating responsibilities,
approximately 100 additional employees are employed full time or part time in
the project, and more that 200 vendors are also involved in the project. The
Company also formed a year 2000 steering committee comprised of the IT Director
and the major executives from the area of information technology representing
the four major regions of the Company. The steering committee meets every 15
days to evaluate the Company's year 2000 compliance based on information
generated by the project office.
In respect of information systems, the Company inventoried 110 million
lines of code and determined that 60 million lines of code needed to be
converted to address the year 2000 problem. Approximately 80% of the 60 million
lines of code have already been converted and are already implemented and
running. The remaining lines of code are currently being converted and
undergoing testing and certification and are scheduled to be converted by June
30. The efforts to achieve year 2000 compliance in the telecommunications plant
segment include (i) negotiating with the major Company's telecommunications
suppliers to create year 2000 ready versions of the Company's plant equipment
and, (ii) with the assistance of a U.S. based telecommunications consulting
firm, assessing the plant systems as a whole, identifying the most critical
areas of the business that may be impacted by year 2000 issues, performing
exhaustive tests and creating a detailed business contingency plan. For the
hardware and software segment, the Company defined a base line of high platform
mainframe hardware and software and has already concluded work necessary to make
such hardware and software year 2000 compliant. In the low platform hardware and
software, which includes desktops, local networks and servers, the Company is
working with third parties, particularly suppliers, to implement a certification
process that includes adjustments or replacements to software and hardware when
necessary. In respect of infrastructure, over 90% of the Company's components
are already year 2000 compliant and the Company has negotiated with the
Company's major telecommunications suppliers to create year 2000 compliant
infrastructure. With respect to partners, the Company began promoting in June
large events, organized by the year 2000 project office and various business
departments, for customers to communicate to customers the status of the
Company's year 2000 compliance efforts, including directing customers how to
fix, test and create contingencies for their own businesses. The Company expects
to complete the necessary adjustments and testing in respect of each segment by
June 30, complete implementation of its contingency plans by October 30 and is
already prepared to be audited by specialized firms to evaluate the Company's
year 2000 compliance.
In order to implement the project phases described above by the projected
dates, the Company has planned a budget totaling R$95 million. The total budget
is divided between the five project segments in the following manner: R$28
million for information systems, R$55 million for telecommunications plant
segment, R$10 million for hardware and software, R$1.5 million for
infrastructure and R$0.5 million for partners. The Company estimated that it
will spend 80% of the total planned budget in order to complete the project and
achieve year 2000 compliance.
The most likely year 2000 worst case scenario that the Company may face
relates to the occurrence of data transmission and billing problems. Such
problems would severely impact the Company's operations and damage the Company's
reputation, especially if the year 2000 problem were to cause the Company's
systems to generate incorrect billing information. The Company cannot estimate
the potential total lost revenue if such problems were to occur. The Company has
focused its efforts during the phases of assessment, correction and contingency
planning to bring the risk related to the occurrence of such problems close to
zero.
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 financial
instruments for trading purposes.
Exchange Rate Risk
On January 13, 1999, the Brazilian monetary authorities raised the ceiling
of the foreign exchange trading band ceiling between the real and the U.S.
dollar under the crawling-peg exchange control system in place, establishing a
new maximum rate of R$1.32 to US$1.00. As a consequence of continued strong
downward pressures on the real, the Central Bank abandoned the new band on
January 18, 1999 and announced that the currency would be allowed to float, and
the value of the real continued to decline. The Commercial Market Rate value of
the real declined from R$1.2085 per US$1.00 at December 31, 1998 to R$1.6607 per
dollar at April 30, 1999.
The Company has exchange rate exposure with respect to the U.S. dollar. In
April 1999, approximately R$413.6 million of the indebtedness of the Company was
denominated in foreign currency. The potential immediate loss to the Company
that would result from a hypothetical additional 10% change in foreign currency
exchange rates from that date would be approximately R$41.4 million.
Interest Rate Risk
At December 31, 1998, the Company had approximately R$327.2 million in
loans and financing outstanding, approximately 83% of which bore interest at
floating rates. The Company invests its excess liquidity (R$266 million at
December 31, 1998) mainly in short-term instruments. The Company would not have
suffered a measurable loss over one year if a hypothetical, instantaneous and
unfavorable change of 100 basis points in the interest rates applicable to
financial assets and liabilities on December 31, 1998 had occurred. The Company
had sufficient cash surpluses earning interest at floating rates to
counterbalance its floating rate liabilities. The above sensitivity analyses are
based on the assumption of an unfavorable 100 basis point movement of the
interest rates applicable to each homogeneous category of financial assets and
liabilities and sustained over a period of one year. A homogeneous category is
defined according to the currency in which financial assets and liabilities are
denominated and assumes the same interest rate movement within each homogeneous
category (e.g. U.S. dollars). As a result, the Company's interest rate risk
sensitivity model may overstate the impact of interest rate fluctuation for such
financial instruments as consistently unfavorable movements of all interest
rates are unlikely.
Item 10. Directors and Officers of Registrant
Board of Directors
The Holding Company 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 regular members and eleven alternates 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.
The following are the current members of the Board of Directors and their
respective positions.
Name Position
-------------- --------------
Carlos Francisco Ribeiro Jereissati................ Chairman
Sergio Lins de Andrade............................. Director
Atilano de Oms Sobrinho............................ Director
Antonio Dias Leite Neto............................ Director
Paulo Eduardo Cabral Furtado....................... Director
Jose Mauro Mettrau Carneiro da Cunha............... Director
Derci Alcantara.................................... Director
Manoel Horacio Francisco da Silva.................. Director
Jose Leitao Viana.................................. Director
Jose Maria Guimaraes Monteiro...................... Director
Rossano Maranhao Pinto............................. Director
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 served as a Director of the Sao
Paulo Stock Exchange and Vice Chairman of the Board of Directors of Companhia
Vidracaria Santa Marina (Saint Gobain Group). He currently serves as the main
Executive of the Jereissati Group (La Fonte/Iguatemi), as a Member of the
Council of Directors of Americel S.A., President of the Executive Council of
ABRASCE (Brazilian Association of Shopping Malls) and member of the Consultant
Council of SECOVI (Union of the Companies engaged in the Purchase, Sale, Rental
and Management of Residential and Commercial Real Estate of Sao Paulo). He holds
a degree in economics from Mackenzie University of Sao Paulo.
Sergio Lins Andrade, 54 years old, has served as a Director since August
1998. He served as a Director of Tibras from 1996 to 1998. He currently serves
as the Chairman of the Board of Directors of Construtora Andrade Gutierrez,
where he has served as a Director since 1978, and of Zagope - Empresa de Obras
Publicas S.A. and as Vice-President of Instituto Cultural Minerva. He holds an
engineering degree from the Federal University of Rio de Janeiro.
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),
Superintendent 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, 52 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. He served as President and Chairman of the Board of Multicanal
Participacoes S.A. and of Multicanal Telecomunicacoes S.A. the largest paid TV
company in Latin America, co-founded by him in 1991. He currently serves as
Managing Partner of Macal Investimentos e Participacoes S.A.., as Chairman of
the Board of Directors of Shoptime S.A. and of CMA Mineracao S.A. and of TV Sky
Shop. He holds a degree in economics from the Catholic University of Rio de
Janeiro.
Paulo Eduardo Cabral Furtado, 44 years old, was elected to the Board of
Directors on April 30, 1999. He served as Deputy Executive Officer of the Caixa
Economica Federal (1997-1999). He currently serves as the President of FUNCEF
(the Pension Fund of Caixa Economica Federal) and as a Director of Companhia
Vale do Rio Doce - CVRD. He holds an law degree from the Federal University of
Para and a graduate degree in Economic and Corporate Law from the Graduate
School of Economics of the Getulio Vargas Foundation.
Jose Mauro Mettrau Carneiro da Cunha, 49 years old, was elected to the
Board of Directors on April 30, 1999. He has served as an Executive Officer of
BNDES since 1991, and as Vice-President since 1999. He has also served as a
Director of Aracruz Celulose S.A. since 1999 and as a Director of Light S.A.
since 1997. He holds a degree in mechanical engineering from Catholic University
of Petropolis and a masters degree in Industrial and Transportation Projects
Engineering from COPPE of The Federal University of Rio de Janeiro.
Derci Alcantara, 43 years old, was elected to the Board of Directors on
April 30, 1999. He served as General Manager of several branches of Banco do
Brasil S.A., where he also served as Deputy Superintendent, Regional
Superintendent for the Sate of Rio Grande do Sul and Regional Superintendent for
the Sate of Parana. He currently serves as an Investment Director of PREVI. He
holds a Business Administration degree by the Federal University of Santa
Maria/RS, Master in Business Administration in finance and capital markets from
IBMEC-The Brazilian Institute of Capital Markets, a masters degree in Business
Administration from the Federal University of Rio Grande do Sul.
Manoel Horacio Francisco da Silva, 53 years old, was elected to the Board
of Directors on April 30, 1999 and has been serving as President of the Company
since February, 1999. He served as President of Paper and Pulp branch of
Companhia Vale do Rio Doce, of Sharp Equipamentos Eletronicos S.A. and of
Ficap/Marvin Corporation do Brazil and as Superintendent Director for the
Restructuring of Companhia Vale do Rio Doce at Companhia Siderurgica Nacional.
He holds a degree in Business Administration from the Catholic University of Sao
Paulo and diplomas in advanced management programs held by Harvard and Oxford
Universities.
Jose Leitao Viana, 60 years old, has served as a member of the Board of
Directors since February 1999. Since February 1996, Mr. Viana has been the
Investment Director of Fundacao SISTEL de Seguridade Social. He served as a
member of the Board of Directors of Telebrasilia, Telerj, Telpe, Telemig and
Telemig Celular Participacoes S.A. He also served as Financial and Economic
Director and Vice President of Telecomunicacoes de Minas Gerais S.A. and as the
Financial and Economic Director for Telebras. Mr. Viana holds a degree in
economics from the School of Economic Sciences of the University of the State of
Guanabara and a post-graduate degree in economic engineering and industrial
administration from the National School of Engineering - UFRJ.
Jose Maria Guimaraes Monteiro, 59 years old, was elected to the Board of
Directors on April 30, 1999. He served as President of Companhia de Seguros do
Estado de Sao Paulo - COSESP (1998). He currently serves as President of
Companhia de Seguros Alianca do Brasil, of Brasil Veiculos Companhia de Seguros
and of Brasilsaude Companhia de Seguros. He holds a degree in Business
Administration from the Getulio Vargas Foundation.
Rossano Maranhao Pinto, 42 years old, was elected to the Board of Directors
on April 30, 1999. He joined Banco do Brasil S.A. in 1976 where, among other
positions, he served as Team Coordinator, as Deputy-Manager of the Financial
Administration of the International Department and as Executive Superintendent
of the Business Strategic Unit of the International Department. Still with Banco
do Brasil, he currently serves as Executive Officer for Business of the
International and Commercial Departments. He also serves as a Director of the
Brazilian American Merchant Bank and Executive Officer of Banco Latino Americano
de Exportaciones (Panama). He holds a degree from the Associacao de Ensino
Unificado do Brasil and a Master of Science in Economics from the University of
Illinois.
The following are the current alternate members of the Board of Directors
and their respective positions.
Name Position
------------- ------------------
Jose Maria de Cesarino Henriques Soares......... Alternate Director
Celso Fernandez Quintella....................... Alternate Director
Mario Celso Petraglia........................... Alternate Director
Carlos Alberto da Veiga Sicupira................ Alternate Director
Thales Salomao Belem de Souza................... Alternate Director
Nelson Rozental................................. Alternate Director
Armenio Augusto de Almeida Sabugueiro........... Alternate Director
Durval Jose Soledade Santos..................... Alternate Director
Hassan Gerbim................................... Alternate Director
Fernando Antonio Pimentel de Melo............... Alternate Director
Wilson Pumar de Paula........................... Alternate Director
Set forth below are brief biographical descriptions of Alternate Members of
the Board of Directors.
Jose Maria de Cesarino Henriques Soares, 58 years old, was elected as
alternate to Director Carlos Francisco Ribeiro Jereissati on April 30, 1999. He
serves as an Executive Officer of Consulting Group do Brasil since 1987. Prior
to that he served as the Superintendent of the Sao Paulo Stock Exchange. He
holds a degree in Business Administration from the Getulio Vargas Foundation and
diplomas in advanced management from INSEAD, France.
Celso Fernandez Quintella, 55 years old, was elected as alternate to
Director Sergio Lins de Andrade on April 30, 1999. He has been serving as an
Executive Officer of Construtora Andrade Gutierrez S.A. since 1991. He served as
a Director of Flexibras Tubos Flexiveis Ltda. from 1986 to 1989 and as President
and a Board member from 1989 to 1991. He also served as a Director of Companhia
Eletromecanica CELMA from 1991 to 1996 and is currently as Chairman of the Board
of UNNISA - Solucoes em Meios de Pagamento Ltda. He holds a degree in mechanical
engineering from the Federal University of Rio de Janeiro and an OPM degree from
the Harvard Business School.
Mario Celso Petraglia, 55 years old, was elected as alternate to Director
Atilano de Oms Sobrinho on April 30, 1999. Among several positions held by Mr.
Petraglia in the Inepar Group of companies, he served as Administrative and
Financial Executive Officer, as Financial Executive Officer, as a member of the
Board of Directors and as Vice-President of Inepar S.A. Industria e Construcoes,
as an Executive Officer of Inepar Administracao e Participacoes S.A., as a
Member of the Board of Directors of Iridium do Brasil and of Inepar-Fem
Equipamentos e Montagens, where he also chaired the Board, and as an Executive
Officer of Inepar Energia S.A., of Divisa Veiculos Ltda., of Euro Import
Veiculos Ltda., of Inepar Telecom Ltda., of TV PR Televisao a Cabo Ltda. and of
TV Cabo Resistencia SS Ltda. He holds a law degree from the Law School of the
University of Curitiba.
Carlos Alberto da Veiga Sicupira, 51 years old, was elected as alternate to
Director Antonio Dias Leite Neto on April 30, 1999. He holds a degree in
Business Administration from the Federal University of Rio de Janeiro - UFRJ. He
served as an Executive Officer of Banco de Investimentos Garantia S.A. where he
also served as Chairman of the Board of Directors. He served as Superintendent
Director of Lojas Americanas S.A. He currently serves as the Chairman of the
Board of Directors of Lojas Americanas S.A. and of Artex S.A. Fabrica de
Artefatos Texteis, and as a Director of Companhia Cervejaria Brahma and of
Polonia Participacoes S.A., where he also serves as an Executive Officer.
Thales Salomao Belem de Souza, 44 years old, was elected as alternate to
Director Paulo Eduardo Cabral Furtado on April 30, 1999. He served as General
Manager of Agencia Valenca, Rio de Janeiro (1998-1999), Agencia Cirio, Para
(1996-1997 and 1990-1991) and Agencia Abaetuba, Para (1986-1987). He also served
as Regional Superintendent of SUREG/PA) and as a member of the Commission of the
Central Bank of Brazil formed to investigate BANPARA in 1987. He currently
serves as Real Estate Director of FUNCEF and as a Director of Ferronorte,
Ferropasa and Ferroban. He holds a degree in data processing from the Para High
Teaching Center.
Nelson Rozental, 46 years old, was elected as alternate to Director Jose
Mauro Mettrau Carneiro da Cunha on April 30, 1999. He serves as an Executive
Officer of BNDESPAR, as a member of the Board of Directors of Bahia Sul Celulose
S.A., of the Rio de Janeiro Stock Exchange, of Iochpe-Maxion, as an alternate
member of the board of Light Servicos de Eletricidade S.A., as a member of the
Consulting Board of Brasil Private Equity Fundo Mutuo de Investimento em Acoes -
Carteira Livre and of the Investment Committee of Fundo Brazilian Equity
Partners and of Fundo Bradesco Templeton de Valor e Liquidez. He holds a degree
production engineering from the Federal University of Rio de Janeiro - UFRJ, a
masters degree in Business Administration with a major in finance from the
COPPEAD/UFRJ.
Armenio Augusto de Almeida Sabugueiro, 53 years old, was elected as
alternate to Director Derci Alcantara on April 30, 1999. He serves as Manager of
Financial Transactions of the Pension Fund of the Employees of Banco do Brasil -
PREVI. He held several positions as a professor in many institutions in Rio de
Janeiro. He holds a degree in Physics from the Federal University of Rio de
Janeiro.
Durval Jose Soledade Santos, 50 years old, was elected as alternate to
Manoel Horacio Francisco da Silva on April 30, 1999. 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), of Aracruz Celulose S.A. (1986-1988) and a Regular Director of the
Company from August 1998 to April 1999. He currently serves as a member of the
Board of Directors of the Sao Paulo Stock Exchange (BOVESPA), of ABRASCA - The
Brazilian Association of Publicly-Held Companies and of La Fonte Participacoes.
He is also a senior partner of Motta, Fernandes Rocha Advogados. 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.
Hassan Gerbim, 53 years old, was elected as alternate to Director Jose
Maria Guimaraes Monteiro on April 30, 1999. He served as a member of the Board
of Directors, as President and as an Executive Director of Telecomunicacoes de
Brasilia S.A. - Telebrasilia from 1993 to 1999. He serves as a Vice-President of
Companhia Alianca de Seguros do Brasil and as an Executive Officer of Brasilcap
Capitalizacao S.A. He holds a degree in electrical engineering from the
University of Brasilia.
Fernando Antonio Pimentel de Melo, was elected as alternate to Director
Jose Leitao Viana on April 30, 1999. He served as designated counsel and
representative of SISTEL before Telpe, as Assistant to the Superintendent
Director and as Head of the Legal Department of SISTEL, as Member of the
Technical Commission for Legal Matters of the Brazilian Association of Private
Pension Funds - ABRAPP, where he also served as a Pension Director and as Member
of the Legal Commission of the Counsel of Administration of Complementary
Pension, of which he later became a Regular Member and a Member of the Chamber
of Appeals. He serves as a member of the Board of Directors of TELEMAR
Nordeste/Norte/Leste, of Telesp Participacoes S.A., as Pension Director of
SISTEL, as Vice-President of SINDAPP and as a Superintendent Director of SISTEL.
He holds a law degree from the Federal University of Pernambuco.
Wilson Pumar de Paula, 47 years old, was elected as alternate to Director
Rossano Maranhao Pinto on April 30, 1999. He serves as Information Systems
Manager of PREVI - The Pension Fund of the Employees of Banco do Brasil S.A.
since 1996. He holds a degree of Systems Analyst and a MBA from the Getulio
Vargas Foundation.
Board of Executive Officers
The Board of Executive Officers consists of a President, Vice-President,
Regulatory Vice-President three Executive Officers, 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.
Name Position
---------- --------------------------------
Manoel Horacio Francisco da Silva...... President
Jose Fernandes Pauletti............... Vice-President of Operations
Renato Cesar Moreira Braga............. Vice-President of Finance
Geraldo Pereira de Araujo.............. Vice-President of Technology
Vacant................................. Vice-President of Administration
Jose Fernandes Pauletti, 50 years old, was elected Vice-President of
Operations on May 5, 1999. He served as Vice-Director of Finance of Embratel, as
Control Executive Officer, Vice-President and President of Elebra Computers, as
Vice-President of Digital, as Support Executive Officer of STC Telecomunicacoes
and as an Executive Officer of Promom. He holds a degree in Business
Administration and an MBA, both from Fundacao Getulio Vargas.
Renato Cesar Moreira Braga, 42 years old, was elected Vice-President of
Finance on May 5, 1999. He served as Chief Financial Officer of TAM Airlines
Group and Ericsson Telecom, as Marketing Director (Ericsson), as Treasury
Director (Pepsi-Cola Bottling), and as Financial Manager (Ericsson and Noragro).
He holds a degree in Chemical Engineering from Universidade Federal Fluminense,
a MBA degree in finance from the Instituto Brasileiro de Mercado de Capitais and
a diploma for completion of the MSc program in production engineering.
Geraldo Pereira de Araujo, 49 years old, years old, was elected
Vice-President of Technology on May 5, 1999. He joined Telemig in 1973 where he
served as Assistant to the Vice-President, as head of the Department of
Planning, as head of the Department of Coordination of the Vice-President, as
Alternate Member of the Board of Directors and as Director of Engineering. He
also served as head Advisor of Planning and Coordination and as head of the
Department of Business Coordination of Embratel, as President of the
Telecomunicacoes do Rio de Janeiro - TELERJ and as President of the Company from
May 1998 to January 1999. 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.
Item 11. Compensation of Directors and Officers
For the year ended December 31, 1998, the aggregate amount of compensation
paid by the Holding Company to all directors and executive officers of the
Holding Company was approximately R$1.2 million.
For the year ended December 31, 1998, the aggregate amount set aside or
accrued by the Holding Company to provide pension, retirement or similar
benefits for officers and directors of the Holding Company was approximately
R$35,134.
Item 12. Options to Purchase Securities from Registrant or Subsidiaries
None.
Item 13. Interest of Management in Certain Transactions
None.
PART II
Item 14. Description of Securities to be Registered
None.
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
at December 31, 1998 which is currently or is expected to be in default is
approximately R$111.4 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, Changes in Security for Registered Securities
and Use of Proceeds
None.
PART IV
Item 17. Financial Statements
The Holding Company has responded to Item 18 in lieu of responding to this
Item.
Item 18. Financial Statements
Reference is made to pages F-1 through F-61.
Item 19. Financial Statements and Exhibits
(a) The following Financial Statements are filed as part of this Form 20-F:
Independent Auditors' Report
Reports of Independent Accountants................ F-2
Consolidated Balance Sheet ....................... F-4
Consolidated Statement of Income ................. F-5
Consolidated Statement of Changes
in Financial Position .......................... F-6 and F-7
Consolidated Statement of Changes
in Shareholders' Equity ....................... F-8 and F-9
Notes to the Consolidated Financial Statements.... F-10 through F-61
(b) Exhibits
Amendment to the Charter of the Holding Company* previously
filed with the Holding Company's Registration Statement on
September 18, 1998.
There are omitted from the exhibits filed with or incorporated
by reference into this Annual Report certain promissory notes
and other instruments and agreements with respect to long-term
debt of the Company, none of which authorizes securities in a
total amount that exceeds 10% of the total assets of the
Company. The Company hereby agrees to furnish to the
Securities and Exchange Commission copies of any such omitted
promissory notes or other instruments or agreements as the
Commission requests.
<PAGE>
Index of Defined Terms
Page
----
<PAGE>
ADRs...............................................31
ADSs...............................................31
American Depositary Shares.........................31
Anatel..............................................2
Anatel Decree......................................20
Annex IV Regulations...............................35
Annex V Regulations................................35
Band A.............................................68
Band B.............................................68
Bell Canada........................................16
BNDESPAR...........................................32
Bonari..............................................1
Brazil.............................................ii
Brazilian Corporation Law..........................34
Brazilian Securities Law...........................34
Breakup.............................................2
Breakup of Telebras.................................2
Canbra..............................................1
Cellular Region.....................................2
Center.............................................19
Code...............................................39
COFINS.............................................13
Commercial Market..................................44
Common Shares......................................31
Company............................................ii
Concessions.........................................1
Consolidated Financial Statements..................ii
CPMF tax...........................................38
Custodian..........................................35
Deposit Agreement..................................33
Depositary.........................................33
dollars............................................ii
e&p................................................39
Embratel............................................1
FCF................................................32
Federal Government..................................1
Fenattel...........................................18
Fittel.............................................18
Fixed-Line Region...................................2
Floating Market....................................44
Floating Market Rate...............................44
General Plan of Concessions and Licenses...........21
General Plan on Quality............................22
General Plan on Universal Service..................22
General Telecommunications Law......................2
Holding Company....................................ii
IBGE................................................4
ICMS...............................................13
IGP-DI.............................................24
IGP-M..............................................28
IMF................................................26
IOF tax............................................38
IP..................................................8
Iridium............................................32
IT.................................................58
K-factor...........................................24
List of Obligations................................20
local calls.........................................5
Megatel............................................16
New Holding Companies...............................2
non-Brazilian holder...............................36
non-U.S. holder....................................40
Numbering Plan......................................9
PAT.................................................7
PIS................................................13
Preferred Shares...................................31
Privatization.......................................3
Privatization of Telebras...........................3
Program............................................54
R$.................................................ii
reais..............................................ii
real...............................................ii
RealPlan...........................................25
Region..............................................1
Registered Capital.................................38
Rio de Janeiro Stock Exchange......................33
Sao Paulo Stock Exchange...........................33
SENN...............................................34
Shareholders'Agreement.............................32
Sistel.............................................18
Spun-off Companies..................................1
Statutory Financial Statements.....................42
Subsidiaries.......................................ii
Telebras............................................1
Telebras System.....................................2
Telecommunications Regulations......................2
Telemar............................................31
Telemar Consortium.................................31
Telesp.............................................16
TJLP...............................................37
TST................................................31
U.S. dollars.......................................ii
U.S. GAAP..........................................41
U.S. holder........................................39
US$................................................ii
WLL................................................16
<PAGE>
Technical Glossary
The following explanations are not intended as technical definitions, but
to assist the general reader to understand certain terms as used in this Annual
Report.
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.
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).
Band A Service Provider: A former Telebras 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 Service Provider: A cellular service provider 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: 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;
high-speed 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.
Cell: The geographic area covered by a single base station in a cellular
telecommunications system.
Cellular service: A mobile telecommunications 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 telecommunications system
service area.
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.
IP (Internet protocol): An interconnection protocol for sub-networks, in
particular for those with different physical characteristics. It is used by the
Internet.
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 64 Kbps 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.
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.
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. At 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.
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 hierarchical 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
telecommunications 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 additional functionality
to the basic transmission services offered by a telecommunications network.
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 12 of the Securities Exchange Act
of 1934, the Holding Company certifies that it meets all of the requirements for
filing on Form 20-F and has duly caused this amended Annual Report to be signed
on its behalf by the undersigned, thereunto duly authorized.
TELE NORTE LESTE PARTICIPACOES S.A.
By: /S/ RENATO CESAR MOREIRA BRAGA
------------------------------------
Name: Renato Cesar Moreira Braga
Title: Vice-President of Finance
By: /S/ MANOEL HORACIO FRANCISCO DA SILVA
-------------------------------------------
Name: Manoel Horacio Francisco da Silva
Title: President
Dated: July 6, 1999
<PAGE>
TELE NORTE LESTE PARTICIPACOES S.A.
CONSOLIDATED FINANCIAL STATEMENTS
For the years ended December 31, 1996, 1997 and 1998
CONTENTS
Reports of Independent Accountants.......... F-2
Consolidated Balance Sheet ................. F-4
Consolidated Statement of Income ........... F-5
Consolidated Statement of
Changes in Financial Position .............. F-6 and F-7
Consolidated Statement of
Changes in Shareholders' Equity ............ F-8 and F-9
Notes to the Consolidated Financial
Statements...................................F-10 through F-61
<PAGE>
Report of Independent Accountants
To the Board of Directors and Shareholders
Tele Norte Leste Participacoes S.A.
We have audited the accompanying consolidated balance sheet of Tele Norte
Leste Participacoes S.A. and its subsidiaries as of December 31, 1998, and the
related consolidated statements of income, of changes in financial position and
of changes in shareholders' equity for the year then ended. 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 audit. The consolidated financial statements of the
Company as at December 31, 1997 and for each of the years in the two-year period
then ended were audited by other accountants whose report dated July 17, 1998
expressed an unqualified opinion on those statements.
We conducted our audit in accordance with auditing standards generally
accepted in Brazil and 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 the amounts and disclosures in
the 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
audit provides 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. and its subsidiaries as of December 31, 1998 and the
results of their operations and the changes in their financial position for the
year then ended in conformity with accounting principles generally accepted in
Brazil.
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 the year ended December
31, 1998 and shareholders' equity as of December 31, 1998 to the extent
summarized in Notes 32 and 33 of the consolidated financial statements.
PricewaterhouseCoopers Brasilia, Brazil
Auditores Independentes February 12, 1999,
except as to 30(a)
which is dated as of
April 30,1999
<PAGE>
Report of Independent Auditors
To 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, 1997, and the related consolidated
statements of income, of changes in financial position and of changes in
shareholders' equity for each of the years in the two year period then ended.
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 the amounts and disclosures in
the 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, 1997, and the results of its operations
and the changes in its financial position for each of the years in the two-year
period then ended, in conformity with accounting principles generally accepted
in Brazil, including continued recognition of the effects of changes in the
puchasing 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 shareholder's equity as of December
31m 1997 to the extent summarized in Note 32 e 33 of the consolidated financial
statements.
July 17, 1998
Brasilia, Brazil
KPMG Auditores Independentes
<PAGE>
TELE NORTE LESTE PARTICIPACOES S.A.
CONSOLIDATED BALANCE SHEET
As at December 31
<TABLE>
<CAPTION>
(Expressed in thousands of Brazilian Reais)
1997 1998
Note R$ R$
---- --------- ---------
<S> <C> <C> <C>
Current assets:
Cash and cash equivalents:
Restricted deposits ............................................ 25 159,202 -
Other cash and cash equivalents ................................ 11 55,037 375,502
Accounts receivable:
Trade, net ..................................................... 12 709,862 881,653
Receivables from related parties ............................... 25 11,352 -
Deferred and recoverable taxes ................................. 10 181,663 270,628
Other assets:
Other accounts receivable from related parties ................. 25 26,643 -
Other .......................................................... 14 247,822 223,564
--------- ---------
Total current assets 1,391,581 1,751,347
------------- -------------
Noncurrent assets:
Deferred and recoverable taxes ................................. 10 36,153 217,420
Other accounts receivable from related parties ................. 25 2,080 -
Other .......................................................... 14 60,329 119,209
-------- --------
Total noncurrent assets 98,562 336,629
------------- -------------
Permanent assets:
Investments .................................................... 15 14,717 14,899
Property, plant and equipment, net ............................. 16 13,282,386 14,080,903
------------- -------------
Total permanent assets 13,297,103 14,095,802
------------- -------------
Net assets of discontinued operations 1 1,848,554
------------- -------------
Total assets 16,635,800 16,183,778
============= =============
Current liabilities:
Payroll and related accruals ................................... 17 201,191 151,212
Accounts payable and accrued expenses:
Suppliers..................................................... 425,962 789,898
Payable to related parties ................................... 25 66,766 -
Taxes other than income taxes .................................. 18 269,434 283,536
Dividends ...................................................... 19 494,355 288,565
Income taxes ................................................... 10 111,392 108,299
Loans and financing:
Payable to Telebras .......................................... 20,25 614,768 -
Other financing .............................................. 20 128,823 104,039
Provisions for contingencies ................................... 21 84,967 422,773
Amounts withheld from customers, payable to Embratel............ 3.o. 98,670 195,849
Other........................................................... - 138,703
------------- -------------
Total current liabilities 2,496,328 2,482,874
------------- -------------
Noncurrent liabilities:
Income taxes ................................................... 10 585,394 566,569
Loans and financing:
Payable to Telebras............................................. 20,25 703,463 -
Other financing ................................................ 20 176,499 223,168
Provisions for contingencies ..................................... 21 53,954 230,390
Other............................................................. 24,202 15,203
------------- -------------
Total noncurrent liabilities 1,543,512 1,035,330
------------- -------------
Minority interests ............................................. 2 2,730,761 2,679,946
Shareholders' equity:
Capital and reserves............................................ 8,204,179 6,806,779
Retained earnings............................................... 1,282,329 3,125,048
------------- -------------
Total shareholders' equity 23 9,486,508 9,931,827
Funds for capitalization:
Expansion plan contributions ................................... 24 309,898 21,269
Other funds .................................................... 24 68,793 32,532
------------- -------------
Total funds for capitalization 378,691 53,801
------------- -------------
Total shareholders' equity and funds for capitalization ........ 9,865,199 9,985,628
------------- -------------
Total liabilities and shareholders' equity 16,635,800 16,183,778
============= =============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
<PAGE>
TELE NORTE LESTE PARTICIPACOES S.A.
CONSOLIDATED STATEMENT OF INCOME
Years ended December 31
<TABLE>
<CAPTION>
(Expressed in thousands of Brazilian Reais)
1996 1997 1998
Note R$ R$ R$
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Net operating revenue from telecommunications services: 4
Services provided to third parties....................... 4,081,092 4,612,012 4,311,320
Services provided to the Telebras operating companies.... 25 192,714 347,281 847,097
----------- ----------- ------------
4,273,806 4,959,293 5,158,417
Cost of services: 5
Provided by third parties................................ (2,106,050) (2,121,865) (2,808,417)
Provided by the Telebras operating companies............. 25 (237,550) (449,487) (272,478)
----------- ----------- ------------
(2,343,600) (2,571,352) (3,080,895)
----------- ----------- ------------
Gross profit 1,930,206 2,387,941 2,077,522
Operating (expenses) income:
Selling.................................................. (382,718) (544,060) (576,484)
General and administrative............................... (827,894) (816,487) (784,373)
Other net operating income .............................. 7 191,959 248,667 332,628
----------- ----------- ------------
Operating income from continuing operations before interest 911,553 1,276,061 1,049,293
Interest income............................................ 6 - - 162,323
Interest expense (Allocated for 1996 and 1997)............. 6 (61,780) (46,263) (123,650)
----------- ----------- ------------
849,773 1,229,798 1,087,966
Net non-operating expense ................................. 9 (10,239) (60,089) (127,262)
Employees' profit share.................................... (30,197) (60,429) (10,842)
----------- ----------- ------------
Income from continuing operations before unallocated interest
extraordinary items, taxes and minority interests........ 809,337 1,109,280 949,862
Income from discontinued cellular operations before
unallocated interest, taxes and minority interests....... 2.d. 679,409 788,790 -
Unallocated interest income................................ 6 45,373 126,554 -
Unallocated interest expense............................... 6 (121,374) (128,544) -
----------- ----------- ------------
Income before extraordinary items, taxes and minority interests 1,412,745 1,896,080 949,862
Extraordinary items........................................ 8 - - (1,034,834)
Tax effects on extraordinary items ........................ - - 306,491
----------- ----------- ------------
Income before taxes and minority interests 1,412,745 1,896,080 221,519
Income tax and social contribution ........................ 10 (386,464) (484,844) (230,135)
----------- ----------- ------------
Income (loss) before minority interests 1,026,281 1,411,236 (8,616)
Minority interests......................................... 2 (152,316) (312,351) 99,306
----------- ----------- ------------
Net income 873,965 1,098,885 90,690
=========== =========== ============
Earnings per thousand shares (in Reais) 0.27
============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
<PAGE>
TELE NORTE LESTE PARTICIPACOES S.A.
CONSOLIDATED STATEMENT OF CHANGES IN FINANCIAL POSITION
Years ended December 31
<TABLE>
<CAPTION>
(Expressed in thousands of Brazilian Reais)
1996 1997 1998
R$ R$ R$
-------- -------- ------
Financial resources were provided by:
<S> <C> <C> <C>
Net income for the year................................................... 873,965 1,098,885 90,690
Less: Income from discontinued cellular operations before unallocated
interest, taxes and minority interest....................... (679,409) (788,790) -
-------- --------- -------
Income from continuing operations, net of unallocated interest
and taxes applicable to both continuing and discontinued
operations............................................................ 194,556 310,095 90,690
Minority interest......................................................... 152,316 312,351 (99,306)
Expenses (income) not affecting working capital:
Depreciation and amortization......................................... 1,299,948 1,367,505 1,688,349
Provision for probable losses in tax incentives....................... 4,054 6,427 35,258
Capitalized interest.................................................. (10,977) (65,765) (105,093)
Monetary variation/exchange difference on
long-term liabilities/assets....................................... - - 60,374
Deferred income tax and social contribution........................... - - (181,507)
Disposals of investments.............................................. 1,980 1,124 -
Property, plant and equipment disposals............................... 112,546 114,765 178,652
Provision for contingencies........................................... 639 6,511 176,435
Other................................................................. - - (7,037)
-------- --------- -------
1,755,062 2,053,013 1,836,815
-------- --------- -------
Increase in long-term liabilities............................................. 143,471 - 100,237
Decrease in long-term receivables............................................. 8,595 - -
Increase in funds for capitalization.......................................... 607,235 - 69,367
Capital increase ............................................................. 317,130 1,180,793 -
Other sources ............................................................... - - 16,973
-------- --------- -------
1,076,431 1,180,793 186,577
-------- --------- -------
Reduction of net current liabilities
upon Break-up of Telebras................................................. - - 1,275,847
Net cash provided by discontinued operations, before unallocated
interest and taxes........................................................ 54,648 212,288 -
-------- --------- -------
Total funds provided 2,886,141 3,446,094 3,299,239
======== ========= =======
Financial resources were used for:
Increase in long-term receivables......................................... - 2,094 44,849
Decrease in long-term liabilities......................................... - 12,466 -
Decrease in funds for capitalization...................................... - 580,253 -
Decrease in deferred tax.................................................. 21,235 83,185 -
Other ............................................................... 7,714 6,917 -
Increase in permanent assets
Investments........................................................... (11,307) 2,394 10,897
Property, plant and equipment......................................... 2,217,123 2,552,261 2,475,481
-------- --------- -------
2,234,765 3,239,570 2,531,227
-------- --------- -------
Accrued dividends............................................................. 301,300 480,426 241,148
Transfer from long-term to current liabilities ............................... - - 153,644
-------- --------- -------
Total funds used 2,536,065 3,719,996 2,926,019
======== ========= =======
Increase (decrease) in working capital 350,076 (273,902) 373,220
======== ========= =======
</TABLE>
<PAGE>
TELE NORTE LESTE PARTICIPACOES S.A.
CONSOLIDATED STATEMENT OF CHANGES IN FINANCIAL POSITION (continued)
<TABLE>
<CAPTION>
Changes in working capital
Current assets
<S> <C> <C> <C>
At the end of the year..................................................... 1,427,627 1,391,581 1,751,347
At the beginning of the year............................................... 958,122 1,427,627 1,391,581
-------- --------- -------
469,505 (36,046) 359,766
-------- --------- -------
Current liabilities
At the end of the year..................................................... 2,258,472 2,496,328 2,482,874
At the beginning of the year............................................... 2,139,043 2,258,472 2,496,328
-------- --------- -------
119,429 237,856 (13,454)
-------- --------- -------
Increase (decrease) in working capital 350,076 (273,902) 373,220
======== ========= =======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
<PAGE>
TELE NORTE LESTE PARTICIPACOES S.A.
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
Years ended December 31, 1996, 1997 and 1998
(Expressed in thousands of Brazilian Reais)
<TABLE>
<CAPTION>
Capital
and Retained
reserves earnings Total
--------------- --------------- --------------
<S> <C> <C> <C>
Balances at December 31, 1995
Capital increase: 7,261,655 503,606 7,765,261
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
incentive............................... 22,107 - 22,107
Forfeited
dividends............................... - 29 29
Net
income.................................. - 873,965 873,965
Realization of unrealized
revenue................................. (81,751) 81,751 -
Deferred tax on full
indexation.............................. - (287,953) (287,953)
Appropriations:
Transfer to
reserves............................. 46,871 (46,871) -
Dividends............................
Minority interest - (301,300) (301,300)
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
incentive............................... 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
revenue................................. (27,121) 27,121 -
Deferred tax on full
indexation.............................. - (291,597) (291,597)
Appropriations:
Transfer to
reserves............................. 69,757 (69,757) -
Dividends............................
Minority interest - (480,426) (480,426)
movements............................... (1,007,565) 98,075 (909,490)
Balances at December 31, 1997 ============ =============== ==============
8,204,179 1,282,329 9,486,508
============ =============== ==============
</TABLE>
<PAGE>
TELE NORTE LESTE PARTICIPACOES S.A.
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
Unrealized
Statutory revenue Retained
Share capital reserve reserve earnings Total
-------------------- ------------------ --------------- ------------- --------------
<S> <C> <C> <C> <C> <C>
Balances at January 1, 1998 - 8,204,179 - 1,282,329 9,486,508
Allocation among accounts approved by
shareholders and net assets
received upon Break-up of Telebras............... 3,741,151 (8,204,179) 3,113,932 1,906,669 557,573
Additional net assets received on the
Break-up of Telebras............................. - - - 21,525 21,525
Net income....................................... - - - 90,690 90,690
Realization of unrealized revenue................ - - (57,112) 57,112 -
Appropriations: -
Transfer to - 8,808 - (8,808) -
reserves.....................................
Dividends.................................... - - - (224,469) (224,469)
------------------- ------------------ --------------- ------------- --------------
Balances at December 31, 1998 3,741,151 8,808 3,056,820 3,125,048 9,931,827
=================== ================== =============== ============= ==============
</TABLE>
<PAGE>
TELE NORTE LESTE PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in thousands of Brazilian Reais, unless otherwise stated)
1. Operations and background
a. Operations
The Companies Tele Norte Leste Participacoes S.A. ("Holding Company") and
its subsidiaries (collectively referred to as the "Subsidiaries"), (together,
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 in Brazil under the terms of a
concession granted by the federal government of Brazil (the "Federal
Government") which will expire on December 31, 2005 and may be renewed for a
further term of 20 years.
Until August 4, 1998, the Companies were controlled by the Brazilian
Federal Government. 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 9,472 of July 16, 1997 and the
related regulations and decrees.
b. Background
Beginning in 1995, 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 were 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 were
separated from the operating subsidiaries and subsequently the fixed-line
businesses, the new cellular businesses and the long distance operator were
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 Corporation Law called cisao or
"spin-off". On January 30, 1998, the cellular telecommunications business of the
Subsidiaries were spun off into sixteen new companies (the "Cellular
Companies"), effective January 1, 1998. As part of this process the Holding
Company was formed on May 22, 1998 (the "Break-up" of Telebras).
c. Formation of the Holding Company
The Holding Company was created effective February 28, 1998, through the
spin-off of certain assets and liabilities of Telebras, including the
percentages of participation in the share capital of the following subsidiaries.
<TABLE>
<CAPTION>
1997 1998
--------------------------- ---------------------------
Total (%) Voting (%) Total (%) Voting (%)
Participation Participation Participation Participation
------------ ------------ ------------ -------------
<S> <C> <C> <C> <C>
Telecomunicacoes do Espirito Santo S.A. ............ 85.23 93.26 83.02 93.26
Telecomunicacoes da Bahia S.A. .................... 89.28 95.79 81.98 95.79
Telecomunicacoes do Amapa S.A. .................... 90.64 94.45 81.65 92.87
Telecomunicacoes de Minas Gerais S.A................ 82.94 89.18 80.99 89.18
Telecomunicacoes do Ceara S.A. ..................... 79.30 85.28 78.71 85.28
Telecomunicacoes de Pernambuco S.A. ................ 77.21 95.06 76.29 95.06
Telecomunicacoes do Amazonas S.A. .................. 80.25 84.13 75.18 84.13
Telecomunicacoes do Piaui S.A. ..................... 78.47 97.88 73.61 97.88
Telecomunicacoes de Alagoas S.A. ................... 77.60 97.39 72.16 97.39
Telecomunicacoes do Rio
Grande do Norte S.A. ............................... 75.41 92.57 71.62 92.57
Telecomunicacoes do Rio de Janeiro S.A. ............ 70.70 85.02 70.16 85.02
Telecomunicacoes de Sergipe S.A. ................... 73.61 85.52 66.96 80.75
Telecomunicacoes da Paraiba S.A. ................... 71.49 95.08 64.38 92.54
Telecomunicacoes do Maranhao S.A. .................. 66.79 82.80 63.73 82.80
Telecomunicacoes de Roraima S.A. ................... 86.91 95.08 62.74 76.51
Telecomunicacoes do Para S.A. ...................... 69.04 96.58 56.01 96.58
</TABLE>
At the time of the spin-off, the existing shareholders received shares in
the new holding companies in proportion to their holdings in Telebras. The new
companies received the assets and liabilities previously recorded in the
accounts of Telebras, except certain assets designated to meet Telebras'
commitments. 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 new holding companies and resulted in an increase of R$ 1,906,669 in
relation to the Holding Company's historical retained earnings. The allocated
retained earnings and future retained earnings, determined in accordance with
Brazilian Corporation Law, will be the basis from which future dividends will be
payable.
The assets and liabilities transferred to the Holding Company are shown in
the "Spin-off from Telebras" column in the following table. The first column
summarizes the December 31, 1997 historical balances of the Subsidiaries'
combined balance sheets and the last column summarizes the consolidated balance
sheet of the Companies after the spin-off, which is the basis for the opening
balances at January 1, 1998.
<PAGE>
The "Adjustments and Eliminations" column includes (i) the elimination of
the Holding Company investment in the Subsidiaries, (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>
January 1,
December 31, Spin-off Adjustments 1998
1997 from and Consolidated
Balance Sheet Telebras Eliminations Balance Sheet
------------- -------- ------------ -------------
Assets
<S> <C> <C> <C>
Cash and cash equivalents............... 214,239 165,707 - 379,946
Intercompany receivables................ 37,995 1,110,139 (1,017,969) 130,165
Other current assets.................... 1,139,347 - - 1,139,347
--------------- --------------- ----------------- ---------------
Total current assets 1,391,581 1,275,846 (1,017,969) 1,649,458
Intercompany receivables................ 2,080 737,985 (698,022) 42,043
Other noncurrent assets................. 96,482 - - 96,482
--------------- --------------- ----------------- ---------------
Total noncurrent assets 98,562 737,985 (698,022) 138,525
Investment in subsidiaries.............. - 8,02l,211 (8,021,211) -
Other investments....................... 14,717 - - 14,717
Advances for future capital increase.... - 308,425 (308,425) -
Property, plant and equipment........... 13,282,386 20,534 - 13,302,920
--------------- --------------- ----------------- ---------------
Total permanent assets 13,297,103 8,350,170 (8,329,636) 13,317,637
Discontinued operations................. 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 liabilities 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 liabilities 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 contributions............ 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>
<PAGE>
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 Corporation Law and tax regulations allow 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
Corporation Law, the amount shown in the "Spin-off from Telebras" column as
"Investment in subsidiaries" was determined based on the balance sheets of those
Subsidiaries as of December 31, 1997. As a result, the consolidated financial
statements of the Holding Company for 1998 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.
d. Privatization
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.
2. Presentation of the financial statements
The consolidated financial statements have been prepared under Brazilian
generally accepted accounting principles ("Brazilian GAAP") to reflect the
consolidated accounts of Tele Norte Leste Participacoes S.A. and its
subsidiaries. Such accounting principles differ from the accounting principles
prescribed by Brazilian Corporation Law, as discussed below (Note 29). The
portion of equity and net income attributable to shareholders other than
Telebras at December 31, 1997 and the Holding Company at December 31, 1998, and
for each of the years in the three-year period ended December 31, 1998 is
reflected as "Minority interests". At December 31, 1998, such minority
shareholders participated in the share capital of the Subsidiaries at various
percentages between 16.98% and 43.99% (Note 1).
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
Cellular Companies, were incorporated on January 5, 1998.
The fixed line telecommunications business of the Subsidiaries is presented
as continuing operations and the cellular telecommunications business is
presented as discontinued operations for the periods ended December 31, 1997.
The assets and liabilities of the cellular telecommunications business are
presented as net assets of discontinued operations on that date. The formation
of the Holding Company and the transfer of assets and liabilities from the
Subsidiaries 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 two-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
Subsidiaries. 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 Holding
Company and the Subsidiaries, from which the accompanying financial information
was derived, except for certain reclassifications within the Consolidated
Statement of Changes in Financial Condition and the Consolidated Statement of
Income which have been made to conform previously published financial
information to the 1996 and 1997 presentation, for the presentation of the
cellular businesses of the Subsidiaries as discontinued operations and to
reflect the portion of equity and net income attributable to shareholders other
than Telebras as minority interest. Furthermore, additional provisions for
doubtful debts of R$ 64,412 and for impairment of property and equipment of R$
9,283 were recorded in the consolidated financial statements at December 31,
1997, net of deferred income taxes, which were charged to income in the
statutory records in 1998.
The preparation of financial statements 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.
a. Full indexation to December 31, 1997
The consolidated financial statements as at December 31, 1997 and for the
years in the two-year period then ended were prepared on a fully indexed basis
to recognize the effects of changes in the purchasing power of the Brazilian
currency. All amounts in Reais as at December 31, 1997 and for the years in the
two-year period then ended are presented in constant Reais of December 31, 1997
price-levels (the "constant currency method" as determined by the Comissao de
Valores Mobiliarios ("CVM"), the Brazilian Securities Commission).
Amounts in Reais as at and for the year ended December 31, 1998 are
presented in nominal Reais. Although Brazilian GAAP require financial statements
to be indexed for inflation through to the current balance sheet date and
discount accounts receivable and payable to their present values, in view of the
low levels of inflation during 1998, the Companies consider the effects on the
results of operations and the financial position of not having prepared the
financial statements on a fully-indexed basis and not having presented
prior-period balances at constant price-levels at the latest balance sheet date,
not to be significant.
Furthermore, as measured by the criteria established by U.S. generally
accepted accounting principles ("US GAAP"), as the three-year cumulative general
price-inflation had fallen below 100%, no inflation accounting adjustments would
be appropriate for primary financial statements prepared under US GAAP after
December 31, 1997. The effects of price-level adjustments have not been
eliminated in the reconciliation between Brazilian GAAP and US GAAP (Note 31) as
the application of inflation restatement represents a comprehensive measure of
the effects of price level changes in the Brazilian economy and, as such, for
periods prior to 1998, is considered a more meaningful presentation than
historical cost-based financial reporting for both Brazilian and US accounting
purposes.
The principal criteria adopted to prepare the fully indexed consolidated
financial statements as at and through December 31, 1997, maintained in
accordance with the practices described in Note 3, are as follows:
i. Inflation restatement index
The consolidated financial statements at and for the periods ended December
31, 1997 were indexed and expressed in currency of constant purchasing power on
that date by using the monthly average values of the Unidade Fiscal de
Referencia-UFIR through December 31, 1995 and the Indice Geral de Precos -
Mercado (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 Corporation Law. Inflation for
the three-year period ended December 31, 1998, as measured by the IGP-M, was as
follows:
Annual
Period Index inflation-%
------ ----- -----------
Year ended December 31, 1996............... IGP-M 9.2
Year ended December 31, 1997............... IGP-M 7.7
Year ended December 31, 1998 (*)........... IGP-M 1.8
(*) not used for restatement purposes
Management believes that these indices are appropriate indications of
general price-level inflation.
ii. Consolidated statements of income and of changes in financial position for
the years ended December 31, 1996 and 1997
Items in the consolidated statements were adjusted by:
. allocating inflationary holding gains or losses on interest
bearing monetary assets and liabilities to
their corresponding interest income and expense captions; and
. 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 Corporation Law and most fiscal purposes as from January 1,
1996, the indexation of assets and liabilities for financial reporting purposes
included 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. Minority interests
Minority interests relate to the interest of shareholders other than
Telebras as at and for the periods ended December 31 1997 and the Holding
Company as at and for the year ended December 31, 1998 in the Subsidiaries.
c. Discontinued operations
The consolidated financial statements reflect the cellular
telecommunications business as discontinued operations at and for the periods
ended December 31, 1997. Accordingly, the revenues, costs and expenses, assets
and liabilities of these discontinued operations have been excluded from the
respective captions in the consolidated balance sheets and consolidated
statements of income, and have been reported as "Income from discontinued
cellular operations before unallocated interest, taxes and minority interests",
as "Net assets of discontinued operations" and as "Net cash provided by
discontinued operations" for these periods. Condensed financial information as
at and for the years ended December 31 for the discontinued operations is as
follows:
1996 1997
--------------- ----------------
Net operating revenues..................... 1,258,443 1,892,461
=============== ================
Income before unallocated interest,
taxes and minority interests taxes..... 679,409 788,790
=============== ================
Current and noncurrent assets.............. 177,756 383,814
Property, plant and equipment, net......... 2,109,542 2,575,624
--------------- ----------------
Total assets............................... 2,287,298 2,959,438
Current liabilities........................ 636,050 6l0,392
Noncurrent liabilities..................... 357,298 500,492
--------------- ----------------
Net assets of discontinued operations...... 1,293,950 1,848,554
=============== ================
d. 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.
For 1998, the consolidated financial statements reflect the consolidated
financial condition and results of operations of the Holding Company and the
Subsidiaries. For earlier dates and periods, the consolidated financial
statements reflect only the combined financial condition and results of
operations of the Subsidiaries, except that the portion of equity and net income
attributable to shareholders other than Telebras is presented as "minority
interests."
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. Trading
securities include accrued interest and are marked-to-market. Through to August
4, 1998, the Companies were prohibited from investing any surplus cash balances
in financial instruments other than government securities issued by the Central
Bank of Brazil or the Federal Government owned bank, Banco do Brasil S.A.
b. Trade accounts receivable
Accounts receivable from telephone subscribers are calculated at the
tariff rate on the date the services were recorded and at December 31, 1996 and
1997 were 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 consolidated statement of
income as they occur.
e. Inventories
Inventories are stated at the lower of cost (indexed through December 31,
1997) 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 cost, inflation-indexed through
December 31, 1997. 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-progress.
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
detailed in Note 16(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. Interest capitalized which exceeds
interest expense on loans obtained to finance construction-in-progress is
recorded in a restricted capital reserve directly in shareholders' equity.
Interest capitalized has not been recorded by the Holding Company. Excess
interest recorded in the Subsidiaries' reserves is reflected in the Holding
Company's Unrealized revenue reserve (Note 23(d)). Interest capitalized is
depreciated once the assets to which it relates become operational. Through to
December 31, 1998, but not thereafter, such interest, calculated at 12%, was
deductible for purposes of determining taxes on income.
Management reviews long-lived assets, primarily buildings and equipment to
be held and used in the business, for the purpose of determining and measuring
impairment on a recurring basis or when events or changes in circumstances
indicate that the carrying value of an asset or group of assets may not be
recoverable. Write-down of the carrying value of assets or groups of assets is
made if and when appropriate.
Assets are grouped and evaluated for possible impairment; impairment is
assessed on the basis of the projected recovery of depreciation charges through
results of operations. Certain impairment losses were recorded in the periods
presented.
h. Accounts payable
Accounts payable to suppliers at December 31, 1996 and 1997 were discounted
to their present value using the ANBID interest rate.
j. Vacation pay accrual
Cumulative vacation pay due to employees is accrued as earned.
k. 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. Net
operating tax loss carryforwards are recognized as deferred tax assets as losses
are incurred and a net valuation allowance is recorded against such tax loss
carryforwards. Valuation allowances have been established, based on management's
expectation that realization of the loss carryforwards is not probable.
l. Loans and financing
Loans and financing include accrued interest to the balance sheet date.
m. Provisions for contingencies
Provisions for contingencies reflect reasonably estimable and probable
losses based on legal advice and management's opinion as to the likely outcome
of the outstanding matters at the balance sheet date.
o. 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 1998 and 1997, revenue from local services also includes
installation fees which are recognized when the installation is complete.
Management considers that the margins obtained on installation fees are
reasonable and it would not be appropriate to defer this revenue over future
periods. 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 is provided.
On April 28, 1998, the revenue sharing regime used to divide interregional
and international long-distance revenues between Empresa Brasileira de
Telecomunicacoes S.A. ("Embratel"), the former government controlled
long-distance and international operator, and the Subsidiaries 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.
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 reduction of the net operating revenues under the new interconnection
agreement structure have been partially offset by a supplement per-minute rebate
from Embratel (Parcela Adicional de Transicao -PAT), in the amount of R$ 163,423
for the year ended December 31, 1998, that supplements the network usage charge
and will be gradually phased out over the next two years. The reduction in
revenues under the new interconnection structure for the year ended December 31,
1998 amounted to R$ 442,196. Under the General Plan on Concessions and Licenses,
the fixed-line companies and Embratel 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. In July
1999, Embratel will be allowed to enter the market for intrastate long-distance
service as a competitor to the regional fixed-line companies.
Amounts are withheld from customers for payment to Embratel under the new
revenue sharing arrangements.
p. Marketing costs
Marketing costs are reported in selling expenses and include costs of
advertising and other marketing activities. Advertising expenses were R$ 62,755,
R$ 63,359 and R$ 82,925 for the years ended December 31, 1996, 1997 and 1998,
respectively. No deferred advertising assets are recognized at the balance sheet
dates presented.
q. Interest income
Interest income represents interest earned and gains and losses on
investments after adjusting for the effects of inflation for the years ended
December 31, 1996 and 1997, 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 (Note 2(c)). Note 6
presents less detail for periods prior to 1998.
r. Interest expense
Interest expense represents interest incurred and gains on loans and
financing after adjusting for the effects of inflation for the years ended
December 31, 1996 and 1997, as measured by the variation in the inflation index,
and net exchange losses of R$ 101,312, R$ 131,845 and R$ 42,814 in 1996 and 1997
and 1998, respectively. Unallocated interest expense represents interest expense
that could not be allocated between continuing and discontinued operations (Note
2(c)). Note 6 presents less detail for periods prior to 1998.
s. Research and development
Research and development costs are charged to expense as incurred. Total
research and development costs were R$ 35,561, R$ 31,072 and R$ 42,116 for 1996,
1997 and 1998, respectively.
t. 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. Certain Subsidiaries also sponsor a defined-benefits plan,
which was available to employees in prior periods.
u. Extraordinary items
The extraordinary charges recognized in the year ended December 31, 1998
are of an unusual and infrequent nature and were primarily incurred following
the change in ownership of the Holding Company after the privatization of the
Brazilian telecommunications system. The charges reflect the new strategic
position assumed by the Holding Company and its Subsidiaries in promoting the
restructuring and adaptation of operating and management structures to meet new
competition and the Anatel regulations.
v. Employee's profit share
The Subsidiaries have made provisions 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.
x. Earnings per shares
Earnings per thousand shares have been calculated only for the year ended
December 31, 1998 as the capital structure of the Holding Company was not in
place at December 31, 1997. The net income of the Holding Company is the same as
that presented in the consolidated statement of income. Earnings and dividends
per share are disclosed in amounts per thousand shares, as a one thousand share
lot is the minimum number of shares that can be traded on the Brazilian stock
exchanges.
y. Segment information
The Companies operate 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.
z. Concentration of credit risk
Financial instruments which potentially subject the Companies to
concentrations of credit risk include cash and cash equivalents, trade accounts
receivable and advances to suppliers. The Companies limit their credit risk
associated with cash and cash equivalents by placing investments with highly
rated financial institutions in short-term securities. With respect to trade
accounts receivable, the Companies limit their credit risk by selling to a
geographically dispersed customer base and by performing ongoing credit
evaluations. 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 taking all permitted measures
to partially suspend services after the invoice is 30 days past due and blocking
access to the telephone network after 90 days. Exceptions comprise telephone
services that must be maintained for reasons of safety or national security. For
the periods presented, no single external customer amounts to 10% or more of the
Companies' annual operating revenues, except that one customer, Embratel,
represented 11% of operating revenues in the year ended December 31, 1998.
Advances to suppliers are made only to select long-standing suppliers. The
financial condition of such suppliers is analyzed on an ongoing basis to limit
credit risk. The Companies are fully dependent upon the fixed-line
telecommunications concession as granted by the Federal Government.
4. Operating revenue from fixed telecommunications services
<TABLE>
<CAPTION>
1996 1997 1998
<S> <C> <C> <C>
Local services:
Monthly charges............................ 451,829 893,525 1,413,021
Measured service charges................... 1,184,479 1,404,289 1,624,817
Public telephones.......................... 185,004 263,105 353,846
Other...................................... 463,230 574,394 469,618
------- ---------- ----------
Total 2,284,542 3,135,313 3,861,302
--------------- ------------- ---------------
Non-local services
Intrastate................................. 1,010,569 827,606 893,806
Interstate (i)............................. 1,274,599 1,043,831 226,105
International (i).......................... 211,520 155,086 37,706
--------------- ------------- ---------------
Total 2,496,688 2,026,523 1,157,617
---------------- ------------- ---------------
Remuneration for the use of network and PAT (i) 492,910
Data transmission.............................. 198,865 164,346 212,296
Internetwork revenues.......................... 558,319 999,380 1,114,002
Other.......................................... 38,765 34,628 108,199
---------------- ------------- --------------
Gross operating revenues....................... 5,577,179 6,360,190 6,946,326
Value added and other indirect taxes........... (1,293,109) (1,384,077) (1,766,623)
Discounts (primarily on public telephone cards) (10,264) (16,820) (21,286)
--------------- ------------- ---------------
Net operating revenue.......................... 4,273,806 4,959,293 5,158,417
=============== ============= ===============
</TABLE>
(i) In April 1997, the existing revenue sharing program among the fixed-line
operators and Embratel was adjusted and the percentage of revenues retained
by the fixed-line companies for domestic and international long-distance
calls was lowered. Until April 1, 1998, revenues for fixed-line domestic
and international long-distance calls were divided among the Embratel and
the regional fixed-line companies. Under this system, each fixed-line
company billed its customers for all domestic and international
long-distance telephone calls and retained a percentage of the revenues
(such percentage was set by the Ministry of Communications) from all such
calls, transferring the remainder of the revenue to Embratel. This
revenue-sharing system was eliminated as of April 1, 1998 and replaced by a
new system in which Embratel receives 100% of the revenues from fixed-line
(i) interregional long-distance calls, (ii) certain intra-regional
long-distance calls and (iii) international long-distance calls that it
carries, but must pay certain per-minute interconnection charges to the
regional fixed-line companies for connection to and use of their networks
in originating and/or completing such calls. In addition, until June 30,
2001, the Embratel must pay a supplemental per-minute charge for such
interconnection, the PAT (Note 3(o)). The supplemental per-minute charge
for interconnection (PAT) received by the Subsidiaries in the year ended
December 31, 1998 amounted to R$ 163,423
5. Cost of services
1996 1997 1998
--------------- ------------- ---------------
Depreciation
and amortization....... 1,226,604 1,293,505 1,503,356
Services............... 414,916 659,050 952,310
Personnel.............. 559,975 508,337 446,816
Materials.............. 80,688 71,307 116,862
Other.................. 61,417 39,153 61,551
--------------- ------------- ---------------
2,343,600 2,571,352 3,080,895
=============== ============= ===============
6. Interest income (expense)
1996 1997 1998
--------------- ----------- --------
Interest income
Interest income on cash
equivalents and trading
securities........................... 44,693 122,720 48,134
Interest on overdue
receivables from subscribers.......... - - 37,180
Interest on receivables from
Cellular Companies.................... - - 30,749
Discounts obtained..................... - - 8,274
Other.................................. 680 3,834 37,986
--------------- ----------- --------
45,373 126,554 162,323
=============== =========== ========
Allocated interest income - -
--------------- -----------
Unallocated interest income 45,373 126,554
--------------- -----------
Interest expense
Interest charges
on debts.............................. (173,006) (156,273) (6,842)
Exchange rate variations
on loans.............................. ..(10,148) (18,534) (41,421)
CPMF (tax on bank account
debits and withdrawals) - - (23,526)
Banking charges, taxes
and other.................. - - (51,861)
------------ ------------ ---------
(183,154) (174,807) (123,650)
============ ============= ==========
Allocated interest expense (61,780) (46,263)
------------ -------------
Unallocated interest expense (121,374) (128,544)
------------ -------------
7. Other net operating income (expense)
1996 1997 1998
------- ------ -------
Interest in Subsidiaries'
credits made directly to equity - - 107,228
Fines and expenses recovered................ 190,938 92,831 115,461
Technical and administrative services....... 132,695 202,408 64,632
Research and development.................... (35,561) (31,072) (42,116)
Taxes other than income taxes............... (9,222 ) (7,214) (11,691)
Provision for contingencies (i)............. (37,222) (41,966) -
Voluntary termination program (i)........... (80,911) - -
Donations .................................. (9,304) (18,960) (2,123)
Other....................................... 40,546 52,640 101,237
------ ------ -------
191,959 248,667 332,628
=============== ========= ===========
(i) For the year ended December 31, 1998, expenses are included as
"Extraordinary items" (Note 8).
Interest in Subsidiaries' credits made directly to equity represents
amounts recorded by the Subsidiaries in their respective shareholders'
equity accounts without affecting net income (primarily the interest on
construction-in-progress reserves of R$ 113,225 Note 3(g)) but which are
recorded by the Holding Company in a separate line item in the consolidated
statement of income.
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$ 174,359, R$ 73,272 and R$ 59,270 in 1996, 1997, and 1998
respectively.
8. Extraordinary items
Extraordinary charges recorded in 1998 were as follows:
1998
----
(i) Supplementation of provisions for labor contingencies.... 256,625
(ii) Tax related contingency provisions....................... 207,516
(iii) Implementation of the voluntary termination program...... 207,219
(iv) Acceleration of depreciation (for substitution)
of analog equipment...................................... 106,000
(v) Civil claims and related provisions...................... 62,184
(vi) Fair value adjustment of shares due
former Telebras debentureholders......................... 48,714
(vii) Adjustment of physical inventory of fixed assets......... 48,394
(viii) Provision for pension supplementation.................... 46,375
(ix) Others (individually less than R$ 28,000)................ 51,807
---------
1,034,834
=========
The events justifying the charge in the year ended December 31, 1998 are
summarized as follows:
(i) Supplementation of provisions for labor contingencies
These amounts represent labor claims related to:
. Health and safety - includes a charge of R$ 102,557 following a
definitive ruling provided by the Superior Labor Tribunal in 1998
providing guidance on determining dangerous work premiums. The charge
reflects an adjustment to the amount payable under trade union
agreements for employees working within an environment considered as
dangerous principally operations close to high tension electric
installations;
. Inflation indexation adjustments - includes a charge of R$ 42,250
relating to a labor case claiming that the inflation index adjusting
salaries following certain economic stabilization programs announced by
the government in past years understated employee salaries. A
reevaluation of the risk of loss in 1998 was made subsequent to an
unfavorable ruling by the Superior Labor Tribunal following certain
procedural errors in the appeals process. Additionally, a further R$
20,129 was provided following a risk review to meet employee class
actions sponsored by the regional trade unions;
. Productivity premiums - includes a charge of R$19,805 relating to
collective bargaining agreements; and
. Salary scale adjustments - includes a charge of R$ 29,183 to reflect
the probable loss arising from labor cases filed by employees claiming
equalization of salary scales among certain employee classifications.
(ii) Tax related contingency provisions
Recent changes in the tax code for telecommunications and the new
relationship between tax authorities and privatized companies have generated
disputes over the jurisdiction of certain taxes and contributions, requiring
adjustments to provisions.
. Value-added tax on sales and services (ICMS) - includes a charge of R$
30,145 relating principally to assessments raised in 1998 claiming tax
on installation and activation charges for the period prior to the tax
being invoiced to telephone subscribers (June to September 1998) (Note
21). Management believes that in view of the recent nature of this
assessment and the lack of jurisprudence, the possibility of loss is
considered to be probable;
. Social contribution levy on revenues (FINSOCIAL) and the Public
Service Savings Employee Program contributions (PASEP) - includes a
charge of R$ 55,508. 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 Companies recorded
a credit of R$27,575 under "Other net operating income" in that year.
In 1997, the Brazilian Supreme Court narrowed its prior decision,
leading the tax authorities to challenge similar 1995 credits
recognized by other telecommunication companies. The PASEP contingency
is of a similar nature. Management reevaluated this issue in 1998
after having received various FINSOCIAL assessments and believes that,
in view of the Supreme Court decision, such amount will be payable;
. Service taxes (ISS) - includes a charge of R$ 49,230 relating to tax
assessments issued in 1998 relating to services not falling under the
ICMS tax basis, such as equipment rentals, added value services and
other technical and administrative services. Management believes that
in view of the recent nature of this assessment and the lack of
jurisprudence, the possibility of loss is considered to be probable;
and
. Social security contributions on payroll (INSS) - includes a charge of
R$ 20,916 relating principally to assessments raised in 1998 alleging
social security co-obligations (R$ 7,802) and contributions due on
employee professional development benefits (R$ 13,114).
(iii) Implementation of the voluntary termination program
In light of the new concessions being awarded to competitors as from
1999, pursuant to the privatization rules (Note 1(d)), the Subsidiaries
implemented a plan for the voluntary termination of employees, for which
7,395 employees opted in the year ended December 31, 1998. This program was
announced prior to the date of the financial statements and approved by the
Board of Directors. The program specifically identified the number of
employees to be terminated, their job classifications or functions, and
their location. The benefit arrangements were communicated to the employees.
The program was completed by December 31, 1998 and the amount of R$ 207,219
represents the total benefits actually paid to the former employees of the
Companies through that date.
(iv) Acceleration of depreciation (for substitution) of analog equipment
The Concession technology standards target presupposes substitution of
analog equipment by digital equipment in periods that are shorter than the
original estimated useful lives of these assets, thereby requiring
acceleration of depreciation. The Subsidiaries intend to accelerate the rate
of replacement of the remaining analog transmission equipment. In 1998,
management determined the substitution of approximately R$ 858,560 of such
equipment (at December 31, 1998 net book values) by, at least, 2005, the
date by which all equipment must be digital under the Anatel regulations.
Such equipment is comprised of analog assets, including automatic switching
equipment (R$487,707) and transmission equipment (R$367,351), against which
provisions for acceleration of depreciation were made.
(v) Civil claims and related provision
The Companies provided as probable loss contingencies, following legal
or judicial rulings in the year ended December 31, 1998, the following
amounts related to civil claims:
. Civil damages case - includes a charge of R$ 11,500 relating to a suit
filed in 1998 for an alleged breach of service contract; and
. Rent agreement - includes a charge of R$ 10,253 relating to an alleged
breach of a rental contract.
(vi) Fair value adjustment of shares due former Telebras debentureholders
As described in Note 23 (a), the Holding Company inherited an
obligation upon the Break-up of Telebras to issue preferred shares in
resolution of a dispute on the conversion in 1990 of certain debentures for
shares in Telebras. Following a legal ruling on April, 22 1998 and upon
receiving instructions from Telebras, the Holding Company updated the
obligation based on the fair value of the shares at December 31, 1998.
(vii) Adjustment of physical inventory of fixed assets
Adjustment of physical inventory of fixed assets relates to write-off
of assets, principally automatic switching equipment (R$ 12,920),
underground and building cables (R$ 11,485) and transmission equipment (R$
5,326), not located.
(viii)Provision for pension supplementation
The additional provision for pension in the amount of R$ 46,375 relates
to the actuarial calculation, prepared by independent actuaries, for the
supplementation of benefits paid by the Brazilian government to the
employees of Companhia Brasileira de Telefones, a predecessor company,
which, up to December 31, 1998, was accounted on a cash basis (Note 22).
9. Net nonoperating income (expense)
1996 1997 1998
--------- --------- --------
Loss on disposal of permanent assets..... (47,703) (78,732) (95,327)
Other income (expense)................... 37,464 18,643 (31,935)
------ --------- ---------
(10,239) (60,089) (127,262)
========= ========= =========
10. Income and social contribution taxes
Brazilian income taxes comprise federal income tax and social
contribution tax. The composite statutory rates were 30.56%, 33.00% and
33.00%, in 1996, 1997 and 1998 respectively. Based on legislation enacted
in February 1999 (Note 30(c)), the social contribution rate is increased
to 12% from May 1 through December 31, 1999. Deferred tax temporary
differences (net liability) reversing during this period have not been
adjusted at December 31, 1998 to reflect the increased social contribution
rate.
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.
Because cash and certain non-specific debt were not allocated to the
cellular telecommunications business (Note 2), the associated interest
income and expense was not allocated. Consequently, although the
Companies' continuing operations include interest income and expense
relating to discontinued cellular operations through December 31, 1997,
income tax expense and current tax liabilities have not been allocated to
the discontinued cellular operations.
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, or 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 was
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. In 1996 and 1997,
management elected to prepay income taxes on the remaining inflationary
profit that it had previously deferred. Brazilian companies making such a
prepayment in relation to 1997 were entitled to utilize an income tax rate
of 10% instead of the then current rate of 25%. Similar reductions applied
to the prepayments in 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 and social contribution
expense (benefit) :
1996 1997 1998
------ ------ -----
Social contribution charge.............. 98,984 150,241 106,185
Income tax charge....................... 307,446 431,342 57,330
Losses recorded from prior years........ (31,319) (25,106) (58,364)
Deferred taxes.......................... 23,639 (35,003) (181,507)
Effect of rate changes on deferred tax.. (4,388) 975 -
Early payment gain...................... (7,898) (37,605) -
------ -------- -------
386,464 484,844 (76,356)
======= ======== ========
Tax benefit on extraordinary items......... - - (306,491)
Income tax and social
contribution expense.......................386,464 484,844 230,135
-------- --------- -------
Total tax charge (benefit).................386,464 484,844 (76,356)
======= ======== =======
<PAGE>
The following is a reconciliation of the amount calculated by
applying the composite statutory tax rates of income
tax and social contribution to the reported income
before taxes to the reported income tax expense
(benefit):
<TABLE>
<CAPTION>
1996 1997 1998
---- ---- ----
<S> <C> <C> <C>
Income before taxes (except tax benefit on
extraordinary items) and minority interests
as reported in the financial statements 1,412,745 1,896,080 221,519
Add : Tax benefit on extraordinary items - - (306,491)
----------- ---------- ---------
Income (loss) before taxes
and minority interests 1,412,745 1,896,080 (84,972)
============ =========== =========
Tax charge (benefit) at the
composite statutory rate............... 431,735 625,706 (28,041)
Permanent differences additions:
Non-deductible expenses (i)......... 1,813 6,067 70,171
Employees' profit share............. 6,646 10,456 3,734
Capitalized interest................ (14,700) (25,999) (65,932)
Tax benefit from deductibility
of notional interest
attributed to shareholders' equity.. - (57,227) -
Other items:
Tax net operating losses............ (16,257) (25,926) (58,364)
Effect of rate changes on
deferred tax........................ (4,388) 975 -
Early payment incentives............ (7,899) (37,605) -
Other incentives.................... (7,856) (11,590) 65
Other, net.......................... (2,630) (13) 2,011
Income and social contribution
taxes as reported 386,464 484,844 (76,356)
======== ========= ========
Effective rate 27.3% 25.5% (89.9%)
============ ============= ========
</TABLE>
(i) Includes write-offs of (a) fixed assets not located during
physical inventory (Note 8(vii)) for which no technical
appraisal report is available and, therefore, were not
considered deductible for tax purposes, in the amount of R$
41,719 and (b) non-collectible accounts receivable in the amount
of R$ 27,177.
Brazilian corporations are permitted to determine a tax-deductible
notional interest expense attributable to shareholders' equity, which
is treated as a dividend and distributed in a manner similar to a
dividend. For financial reporting purposes, interest attributed to
shareholders' equity is recorded as a deduction from unappropriated
retained earnings. In 1996, the withholding tax was payable by the
companies and was accrued and charged to income. As from 1997, the
withholding tax is payable by the companies on behalf of the
shareholder (Note 23(b)).
The composition of tax assets (Note 13), is as follows:
1997 1998
--------------- ---------------
Deferred tax assets:
Net operating losses ........... 108,894 253,444
Valuation allowance ....... (102,352) (119,850)
Provisions for contingencies.... 44,836 176,912
Other........................... 56,085 7,337
107,463 317,843
============== ===============
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 it is probable that the results of future
operations will generate sufficient taxable income to realize these
deferred tax assets. Net operating loss carryforwards have no expiry dates
and are recognized as deferred tax assets as losses are incurred. Federal
income tax regulations currently state that tax losses available for
offset are limited in any one year to 30% of annual income before tax
determined in accordance with Brazilian Corporation Law. Valuation
allowances have been established when, based on management's expectation,
realization of the loss carryforwards is not probable.
The composition of tax liabilities is as follows:
1997 1998
--------- --------
Federal income tax payable.......................... 14,751 49,199
Social contribution tax payable..................... 37,189 13,371
Deferred tax liabilities
Additional indexation expense from 1990........ 98,969 73,627
Others......................................... 545,877 538,671
696,786 674,868
========= ========
Current .......................................... 144,923 100,851
Noncurrent.......................................... 551,863 574,017
Deferred tax liabilities - Additional indexation expense from 1990
relate to the non-tax deductible increase arising from pre-1990 indexation
adjustments to property, plant and equipment.
Deferred tax liabilities - Others 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 (Note 2(a)(iii)). The counter-entry
was charged directly to shareholders' equity.
11. Other cash and cash equivalents
1997 1998
--------------- ---------------
Cash and bank accounts.................. 55,037 109,503
Trading securities......................... - 251,578
Held-to-maturity investments............ - 14,421
---------------- ---------------
55,037 375,502
================ ===============
<PAGE>
12. Trade accounts receivable, net
1997 1998
--------------- -----------
Billed amounts............................. 489,209 628,459
Accrued amounts............................ 310,976
308,541
Allowance for doubtful accounts............ (90,323) (55,347)
--------------- -----------
709,862 881,653
=============== ===========
The changes in the allowance for doubtful accounts were as follows:
1996 1997 1998
--------- ---------- ----------
Beginning balance....................... 10,300 14,317 90,323
Provision charged to selling expenses... 28,316 101,375 81,180
Write-offs..............................(24,299) (25,369) (116,156)
Ending balance 14,317 90,323 55,347
======== ========== ==========
13. Deferred and recoverable taxes
1997 1998
----------- ---------
Deferred tax assets (Note 10)........ 107,463 317,843
Recoverable income tax............... 52,319 101,470
Recoverable social contribution tax.. 12,865 35,865
Sales and other taxes................ 44,383 29,673
Tax deducted at source............... 786 3,197
---------- ---------
Total 217,816 488,048
========== ==========
Current............................... 181,663 270,628
Noncurrent............................ 36,153 217,420
14. Other assets
1997 1998
----------- --------
Recoverable advances and deposits.......... 38,193 92,162
Fiscal incentive investments............... 53,485 68,767
Other debtors.............................. 26,800 68,374
Maintenance inventories.................... 133,010 32,729
Prepayments................................ 11,233 10,518
Assets to be sold.......................... 1,987 -
Other...................................... 43,443 70,223
------ --------
Total 308,151 342,773
=========== =========
Current.................................... 247,822 223,564
Noncurrent................................. 60,329 119,209
Recoverable advances at December 31, 1998 relate to advances to employees,
in the amount of R$ 27,986 and judicial deposits related to civil and
labor claims (Note 8 (i) and (v)), totaling R$ 30,494.
15. Investments
1997 1998
--------- --------
Fiscal incentive investments................ 5,856 6,051
Other investments........................... 8,861 8,848
--------- --------
14,717 14,899
========= ========
16. Property, plant and equipment net
a. Composition
1997 1998
------- ------
Buildings.............................. 3,773,301 4,196,872
Automatic switching equipment.......... 8,063,185 8,801,169
Other equipment........................ 10,407,846 11,594,372
Construction-in-progress............... 2,713,793 1,683,248
Other assets........................... 3,052,453 3,467,044
--------- ---------
Total cost....................... 28,010,578 29,742,705
Accumulated depreciation............... (14,728,192) (15,661,802)
Property, plant and equipment, net 13,282,386 14,080,903
Capitalized interest is detailed in Note 31 (a).
Other equipment includes: Overhead, 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$
125,319 at December 31, 1997 and R$ 152,060 at December 31, 1998.
b. Depreciation rates
The annual depreciation rates applied to property, plant and equipment are
as follows:
%
-----
Buildings................................... 4.00
Automatic switching equipment............... 7.69
Other equipment............................. 10.00
Other assets (excluding land)............... 5.00 - 20.00
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:
1996 1997 1998
--------------- ------------- ---------------
Rent expense 92,577 83,301 78,513
=============== ============= ===============
Rental commitments relate primarily to facilities where the future
minimum rental payments under leases with remaining noncancelable terms in
excess of one year are:
Year ending December 31, 1997 1998
--------------- ---------------
1998................. 31,640
1999................. 31,571 23,614
2000................. 30,726 18,681
2001................. 31,076 18,110
2002 ................ 31,480 17,257
2003 and thereafter.. 35,028 17,767
--------------- ---------------
Total minimum payments 191,521 95,429
=============== ===============
17. Payroll and related accruals
1997 1998
--------------- ---------------
Accrued social security charges..... 103,573 78,783
Wages and salaries.................. 49,454 38,938
Accrued benefits.................... 45,603 31,755
Payroll withholdings................ 2,561 1,736
--------------- ---------------
201,191 151,212
=============== ===============
18. Taxes other than income taxes
1997 1998
--------------- ---------------
Value-added taxes.................. 236,682 264,813
Other indirect taxes
on operating revenues.............. 32,752 18,723
--------------- ---------------
269,434 283,536
=============== ===============
19. Dividends
1997 1998
--------------- ---------------
Minority shareholders............... 115,372 167,735
Majority shareholders (Note 22)..... 365,054 83,484
Prior years' dividends not claimed.. 13,929 37,346
---------------- ---------------
494,355 288,565
================ ================
20. Loans and financing
a. Composition
1997 1998
--------------- ---------------
Third party financing
Equipment financing (i)....... 189,508 310,286
Other......................... 106,334 9,455
--------------- ---------------
295,842 319,741
Loans payable to Telebras
Eurobonds, originally
issued by Telebras (ii)....... 150,006 -
Loans and financing
from Telebras (iii)........... 1,040,977 -
Other debt.................... 30,861 -
--------------- ---------------
1,221,844 -
Accrued interest
Third party................... 9,480 7,466
Telebras...................... 96,387 -
--------------- ---------------
105,867 7,466
--------------- ----------------
Total 1,623,553 327,207
================ ================
Current
Third party financing......... 128,823 104,039
Payable to Telebras........... 614,768 -
--------------- ----------------
743,591 104,039
================ =================
1997 1998
--------------- ---------------
Noncurrent
Third party financing ........ 176,499 223,168
Payable to Telebras........... 703,463 -
--------------- ---------------
879,962 223,168
=============== =================
(i) The loans with suppliers of telecommunications equipment, are, in
the majority, repayable by 2002 and relate to contracts for the supply and
installation of hardware and software under the network expansion program.
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. The LIBOR benchmark rate at December
31, 1998 was 5.05%.
(ii) Represented by an Italian Lira-denominated loan (L.185,523,912)
due 1999 bearing annual interest of 13.00%. In addition to the contractual
interest, in connection with the Eurobonds, the Subsidiaries paid Telebras
a 1% per year administrative fee on the outstanding balances. Such
balances were eliminated upon the Break-up of Telebras.
(iii) The short-term loans were subject to the daily interest rate on
Brazilian federal treasury bills (Remuneracao Diaria dos Titulos Publicos)
plus a spread of 0.25% per annum.
The Companies have no committed lines of credit.
b. Repayment schedule
Noncurrent debt is scheduled to be repaid as follows:
1997 1998
--------------- --------------
1999.......................... 561,473 -
2000.......................... 145,222 72,169
2001.......................... 71,950 48,265
2002.......................... 55,877 79,452
2003.......................... 45,440 14,735
2004 and thereafter........... 8,547
--------------- --------------
879,962 223,168
=============== ==============
c. Currency analysis
1997 1998
--------------- ---------------
Brazilian Reais......................... 1,079,895 76,214
US dollars.............................. 287,785 243,527
Italian lira ........................... 150,006 -
--------------- ---------------
1,517,686 319,741
Accrued interest....................... 105,867 7,466
--------------- ---------------
1.623,553 327,207
=============== ===============
The Companies do not hedge their foreign currency liabilities.
d. 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$ 111,400 of the Companies'
outstanding debt as of December 31, 1998 (1997 - R$ 133,055) 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 the
credit agreements.
21. 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 probable 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.
Provisions for contingent liabilities were as follows:
1997 1998
-------------- ---------------
Labor claims.......................... 111,707 327,910
Disputed taxes........................ 12,661 194,762
Civil claims.......................... 14,553 130,491
-------------- ---------------
138,921 653,163
============== ===============
Current............................... 84,967 422,773
Noncurrent............................ 53,954 230,390
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 and probable contingencies relating to
benefits and indexation adjustments (Note 8(i)).
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 a probable liability
arising from an obligation spun-off from Telebras in relation to its
convertible debentures (Note 8(vi)) and to disputes with suppliers of
telecommunications equipment over price-escalation clauses in their
contracts and contract terminations.
Other possible contingencies - On June 19, 1998, the individual
Brazilian State treasuries 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. In 1998, the Companies provided for ICMS not invoiced and withheld
from June to September (Note 8(ii)). The Companies believe that the
attempt by the States 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 consolidated financial statements for periods prior
to June 1998 as the Companies do not believe it is probable that such
taxes will be payable for services rendered during the last five years.
Had the ICMS tax (37% in the case of the State of Rio de Janeiro in 1998
and 17% to 25% for the other states) been applied retroactively to
activation fees earned by the Companies during the last five years through
June 1998, it would give rise to a maximum liability estimated at
R$238,000. Management does not believe that the payment of retroactive
ICMS taxes is probable and, therefore, no provision for loss with respect
to retroactive application of the ICMS has been made or is expected to be
made in the Company's consolidated financial statements. There can be no
assurance that the Companies will prevail in its position that the new
interpretation by the state treasury secretaries is unlawful.
Telebras, the legal predecessor of the Companies, is a defendant in a
number of legal proceedings and subject to other claims and contingencies.
Any claims against Telebras, which are not satisfied by Telebras, could
result in claims against the Companies. Management believes that the
chances of any such claims materializing and having a material adverse
financial effect on the Companies are remote, and, therefore, no provision
had been made.
Management believes it has meritorious defenses to all lawsuits and
legal proceedings in which the Companies are defendants. Based on its
evaluation of such matters, and after consideration of reserves
established, management believes that the resolution of such matters will
not have a material adverse effect on the Companies' financial position or
results of operations.
22. Provision for pensions
The Companies participate in a multi-employer defined benefit pension
and other post-retirement benefit plans administered by the Fundacao
Telebras de Seguridade Social ("Sistel").
Approximately 97% of the Companies' employees are covered by these
plans. The Companies contributed and charged to expense R$ 113,105, R$
108,393 and R$ 86,566 in 1996, 1997 and 1998, 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. 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.
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 of the assets and obligations of
the multi-employer plan, determined in compliance with actuarial and
accounting principles generally accepted in Brazil, is as follows:
1997 1998
--------------- ---------------
Combined plan assets:
Interest bearing deposits......... 1,714,153 2,539,338
Stocks and shares................. 2,360,786 1,676,103
Investment properties............. 363,305 394,553
Loans to beneficiaries............ 123,428 115,854
Other investments................. 53,871 50,386
--------------- ---------------
Total plan assets 4,615,543 4,776,234
=============== ===============
Combined plan obligations:
Accumulated pension and
other post-retirement
benefits obligations ............. 3,775,898 3,676,626
Other obligations................. 808,647 1,005,523
--------------- ---------------
Total obligations................. 4,584,545 4,682,149
=============== ===============
Excess of total plan
assets over total obligations 30,998 94,085
=============== ===============
The obligations of the plans include an accrual of income tax
contingencies of the pension fund of R$ 487,269 and R$ 637,411 in 1997 and
1998, 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 through to 1997.
The Companies and the other sponsors of Sistel (primarily the former
Telebras companies) are considering a break-up of Sistel that would
generate a separate plan for each of the sponsors for their own employees.
The sponsors would expect, however, to jointly maintain a plan offering
the current benefits under Sistel for those employees who have already
retired and the funding for such plan would be provided by all the
sponsors in accordance with the method of allocation used in the break-up
of Sistel. The plans for the new funds would be modified to the needs of
the new sponsors. Because the sponsors are only in the preliminary stages
of discussing the proposed break-up of Sistel, the amounts of the
independent reserve liabilities with respect to each sponsors' respective
participation are not yet measurable and, therefore, the final
configuration of each sponsor's plan and the consequences for the
Companies or its employees cannot be assessed.
In addition to the formal Sistel plan, certain Subsidiaries sponsor a
pension plan, which supplements the benefit paid by the Brazilian
government. This plan assures the beneficiary, in life, supplementation of
earnings, readjusted whenever the employees of the Companies receive a
salary readjustment. The pension supplementation plan was established in
1971, before the creation of Sistel and pays benefits to 963 former
employees of Companhia Brasileira de Telefones, a predecessor company, in
accordance with agreements approved in 1971. Based on an actuarial
calculation, prepared by independent actuaries, R$ 46,375 was charged to
income for the year ended December 31, 1998 (Note 8(viii)) to meet cover
unfunded liabilities. With the exception of this accrual to cover unfunded
liabilities in 1998, the Companies account for the expense of this
agreement on a cash basis. Contributions paid to this plan in 1996, 1997
and 1998 were R$ 8,220, R$ 7,879 and R$ 8,030, respectively.
23. Shareholders' equity
The consolidated financial statements reflect the consolidated
shareholders' equity of the Holding Company and the Subsidiaries, after
segregating as minority interests the participation of minority
shareholders in each of the Subsidiaries at the historical percentages
applicable to shareholders other than Telebras in 1997 and other than the
Holding Company in 1998. The December 31, 1997 combined shareholders'
equity was segregated between capital, reserves and retained earnings as
per the Telebras spin-off (Note 1(c)).
a. Share capital
The capital stock of the Holding Company is comprised of preferred
shares and common shares, all without par value. At December 31, 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 124,369,031 thousand
outstanding common shares. 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 for 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. Authorized capital of the Holding Company (the amount up
to which the Board of Directors is mandated by the shareholders to
increase capital) at December 31, 1998 is 700 billion 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 to determine whether Brazilian
securities law and regulations regarding the 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 to meet the obligation. Accordingly,
the Holding Company updated the obligation for the 2,516,572 thousand
preferred shares allocated to the Holding Company on the Break-up of
Telebras based on the fair value of the shares to December 31, 1998,
charging R$ 48,714 to income (Note 8(vi)) increasing the liability to R$
50,320 (included in Provision for contingencies).
b. Dividends and interest attributed to shareholders' equity
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 hereinafter defined) (the
"Mandatory Dividend"). The annual dividend distributed to holders of
preferred shares (the "Preferred Dividend") has priority in the allocation
of Adjusted Net Income in determining the Preferred Dividend in relation
to the Mandatory Dividend. 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.
The Preferred Dividend corresponds to a non-cumulative preferred
dividend equal to 6% of share capital determined in accordance with
accounting principles prescribed by Brazilian Corporation Law (which
differ from the accounting principles used herein), in proportion of
preferred shares to total capital.
For purposes of Brazilian Corporation Law, and in accordance with the
Holding Company's By-laws, the Adjusted Net Income is an amount equal to
the Holding Company's net profits determined in accordance with accounting
principles prescribed by Brazilian Corporation Law (which differ from the
accounting principles used herein) adjusted to reflect allocations to or
from (i) the statutory reserve, (ii) an equity contingency reserve for
anticipated losses, if any, and (iii) an unrealized revenue reserve, if
any.
The dividends for the year ended December 31, 1998 were calculated as
follows:
1998
----------------- ---------------
Preferred Common
Shares Shares
----------------- ---------------
Capital................................. 3,741,151 3,741,151
Proportion of capital.................. 62.81% 37.19%
----------------- ---------------
Preferred and common capital........... 2,349,750 1,391,401
Percentage of dividends................ 6% 6%
================= ===============
Dividends.............................. 140,985 83,484
================= ===============
Number of shares (thousands) 210,029,997 124,369,31
----------------- ---------------
Dividends per thousand shares (in Reais) 0.67 0.67
----------------- ---------------
The calculation of the Adjusted Net Income for purposes of dividend
distribution is presented below:
1998
----
Net income for the year
(determined in accordance with accounting
principles prescribed by Brazilian Corporation
Law (which differ from the accounting principles
used herein - Notes 2 and 29)................... 176,165
Realization of unrealized revenue reserve............ 57,112
Transfer to statutory (legal) reserve................ (8,808)
---------
Adjusted Net Income 224,469
==========
Dividends proposed 224,469
==========
<PAGE>
The Holding Company's By-laws, in accordance with Law No. 9249 of
December 26, 1995, also provide for distribution of interest attributed to
shareholders' equity as an alternative form of payment to shareholders.
Such interest rate is limited to the average Taxa de Juros de Longo Prazo
- TJLP (the Brazilian Government Long-Term Interest Rate) during the
applicable period and cannot exceed the greater of 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 50% of
retained earnings. Distribution of interest may also be accounted for as a
tax deductible expense of the company, for both income tax and social
contribution purposes. The amount paid to shareholders as interest
attributed to shareholders' equity, net of any withholding tax, may be
included as part of any Mandatory Dividend. In that case, under Brazilian
law, the company is obligated to distribute to shareholders an amount
sufficient to ensure that the net amount received by the shareholders,
after payment by the company of applicable Brazilian withholding taxes
(15% in 1998) in respect of distribution of interest, is at least equal to
the Mandatory Dividend.
At December 31, 1997, the Holding Company deducted from retained
earnings an interest charge attributed to shareholders' equity of R$
178,754 and the related withholding tax of R$ 26,279 which is treated as
though it were a declared dividend distribution. The gross amount was
treated as tax deductible once the interest was credited to the
shareholders generating a tax saving of R$ 57,227. No such interest charge
was determined for 1996 and 1998.
c. Statutory (legal) reserve
Under Brazilian Corporation Law, the Holding Company is required to
maintain a "legal reserve" to which it must allocate 5% of its "Net
Profits" (determined in accordance with accounting principles prescribed
by Brazilian Corporation Law for each fiscal year until the amount of the
reserve equals 20% of paid-in capital. Accumulated losses, if any, may be
charged against the legal reserve.
d. Unrealized revenue reserve
Under Brazilian Corporation Law, if the amount of "Unrealized Revenue"
(as hereinafter defined) for any particular year exceeds the sum allocated
to (i) the statutory (legal) reserve, (ii) the discretionary reserves,
(iii) the contingency reserve and (iv) the reserve for investment projects
in such year, such excess may be allocated to an Unrealized Revenue
Reserve. Unrealized Revenue in any particular year represents the sum of
(i) price-level restatement of certain balance sheet accounts (through
1995) in such year, (ii) the share of equity in the earnings of subsidiary
and associated companies in such year and (iii) profits from installment
sales to be received after the end of the next succeeding fiscal year.
In the case of the Holding Company, the revenue represents income
earned but not yet realized financially arising from restatement of
certain balance sheet accounts and adjustment of investments recorded on
the equity method. The equity adjustment arises primarily from the
interest capitalized which exceeds interest expense on loans obtained to
finance construction-in-progress and is recorded in an appropriated
capital reserve directly in shareholders' equity. The reserve is realized
when the permanent assets from which it originates are disposed of,
dividends are received or other events occur, in conformity with CVM
regulations. Realization of this reserve is credited to retained earnings.
e. Discretionary reserves
Under Brazilian Corporation Law, a company may also provide for
discretionary allocations of "net profits" to the extent set forth in its
by-laws. The Holding Company's By-laws provide for a discretionary reserve
account for capital increases, which cannot exceed 80% of paid-in capital
after distributions of dividends. Under Brazilian Corporation Law, a
portion of the Holding Company's Net Profits may be allocated for
discretionary appropriations for plant expansion and other capital
investment projects, the amount of which is based on a capital budget
previously presented by management and approved by shareholders. After
completion of the relevant capital projects, the Holding Company may
retain the appropriation until a shareholder vote to transfer all or a
portion of the reserve to capital or retained earnings.
f. Retained earnings
The balance of the retained earnings is to be used to support future
investments in accordance with the Companies' investment plans.
Distributable earnings are limited to the balance of this account in the
statutory records which at December 31, 1998 present a balance of R$
2,407,234.
24. Funds for Capitalization
a. Expansion plan contributions
Expansion plan contributions are the means by which the Subsidiaries
had in the past financed the growth of their telecommunications network.
As from July 1, 1997, this source was rescinded by Ordinance 261 of April
30, 1997. The contributions were made by companies or individuals to be
connected to the national telephone network. Such contributions were paid
directly to the Subsidiaries 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 Subsidiaries 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 Subsidiaries at the end of the year preceding
the capitalization;
. 20% was remitted by the Subsidiaries to Telebras in the month
following receipt; and
. 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 Subsidiaries, 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 Subsidiaries issuing
their own shares to expansion plan subscribers.
The Subsidiaries' expansion plan contribution program has been
terminated, with no new contracts signed after June 30, 1997. Expansion
plan contributions of R$ 924,365 and R$ 600,540 in 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$ 317,130 and R$ 1,180,793 in 1996 and
1997, respectively.
<PAGE>
In addition to the expansion plans, which they promoted directly, the
Subsidiaries 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
Subsidiaries incorporated the completed equipment into their fixed assets
at the appraised value and credited expansion plan contributions which
were then treated in the same manner as the expansion plan contributions
received from prospective telephone subscribers, as described above.
During 1998, the Subsidiaries issued preferred shares in settlement of
the financial installments received as expansion plan contributions. The
movement on the account is presented below:
At December 31, 1997............................................. 378,691
Receipt of funds by Subsidiaries
under installment programs................................. 69,367
Capital increase of minority
shareholders in Subsidiaries............................ (394,257)
-------------
At December 31, 1998 53,801
=============
The account balance at December 31, 1998 refers to the monetary
correction lag of balances of expansion plan contributions.
b. Other funds
Other funds are comprised of resources received which are expected to
be capitalized.
25. Transactions with related parties
Until August 4, 1998, the principal related party transactions took
place with Embratel in respect of long-distance telecommunications. The
Subsidiaries 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 Subsidiaries by the Federal
Government. All charges to customers, including long-distance, are billed
by the Subsidiaries, who transfer the long-distance portion of the charges
to Embratel. As a result, the Subsidiaries 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
Subsidiaries. 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
Subsidiaries 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 Subsidiaries shared revenues for interregional and
international long-distance calls with Embratel rather than charging
Embratel a network usage fee for the use of the Subsidiaries' 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 Subsidiaries' network with cellular networks,
under which the Subsidiaries 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 Subsidiaries have receivable and
payable positions with other telecommunications service providers in
Brazil within the former 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:
1997
---------
Current assets:
Trade accounts receivable......................... 11,352
Other assets...................................... 26,643
Noncurrent assets
Other assets...................................... 2,080
Current liabilities:
Loans and financing............................... 614,768
Accounts payable and accrued expenses............. 66,766
Dividends......................................... 365,054
Noncurrent liabilities:
Loans and financing............................... 703,463
1996 1997 1998
-------- -------- ---------
Net operating revenues:
Telecommunication services..... 192,714 347,281 847,097
Other services...................... 66,011 187,784 56,167
258,725 535,065 903,264
-------- -------- ---------
Cost of services................. (237,550) (449,487) (272,478)
Operating expenses............... (35,562) (31,072) (22,209)
Net interest expense............. (126,064) (93,107)
Through December 31, 1997, the transactions with the Cellular Companies
are classified as Discontinued operations; such transactions, upon the
spin-off of the Cellular Companies (Note 1(b)) and through to the date of
privatization are treated as related parties. Net operating revenues for
the period in 1998 accruing from the Cellular Companies totaled R$
639,453.
Until the Break-up of Telebras, the Subsidiaries 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 Subsidiaries, the Subsidiaries are
obligated to contribute R$ 128,594 in total to the center over the three
year period ending May 2001. No provision is made for this future
obligation. The research and development contributions are charged to
income as paid.
Additionally, Telebras charged 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 intercompany loans at a
rate equal to 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 through to August 4, 1998 were 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 (Deposits with Banco do Brasil S.A.) were
R$ 159,202 at December 31, 1997.
The Companies believe that all the costs of doing business are
reflected in the financial statements and that no additional expenditures
will be incurred as a result of the cessation of the activities previously
performed by Telebras.
26. Commitments
At December 31, 1998 the Companies had approximately the following
capital expenditure commitments:
Expected year of expenditure:
1999...............................2,400,000
2000...............................2,150,000
These commitments are to be incurred on continuing expansion and
modernization of the system, transmission equipment and data transmission
equipment.
The Subsidiaries are obligated to contribute R$ 128,594 in total to a
research and development center over the three-year period ending May
2001.
Approximately 72% 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 1999.
27. Insurance
At December 31, 1998, in the opinion of management, all significant
assets civil liability and other obligations were adequately insured, and
the "all risks" coverage requirements established by Anatel have been met.
28. Fair values of financial assets and liabilities
Estimated fair values of the Companies' financial assets and
liabilities were determined using available market information and
appropriate valuation methodologies. Considerable judgment was required in
interpreting market data to produce the estimated fair values; such
estimates 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,
1997 and 1998 determined for the financial asset or liability line items
indicated that no significant difference in relation to the carrying
values is believed to exist. Interest rates that are currently available
to the Companies for issuance of debt with similar terms and maturities
were used to estimate fair value.
29. Reconciliation between balances determined in accordance with accounting
principles prescribed by Brazilian Corporation Law and Brazilian generally
accepted accounting principles (Note 2)
<TABLE>
<CAPTION>
As at and for the year ended
December 31, 1998
-----------------------------
Shareholders'
Net income equity
---------- ------
<S> <C> <C>
Consolidated balances determined in accordance with accounting
principles prescribed by Brazilian Corporation Law............................ 176,165 9,214,013
Additional net assets received on the Break-up of Telebras..................... - 21,525
Prior period price-level restatements
.property and equipment........................................................ - 1,633,502
.deferred tax effects (*)........................................... .......... - (545,861)
.minority interest............................................................. - (251,855)
Amounts recorded for Brazilian GAAP at December 31, 1997:
Allowance for doubtful accounts............................................... 64,412 -
Provision for impairment of property and equipment............................ 9,283 -
Realization of prior period price-level restatements
.cost of services.............................................................. (181,792) (162,119)
.net non-operating income/expense.............................................. (37,029) (37,029)
Interest in Subsidiaries' charges made directly to equity...................... (12,246) (12,246)
Other.......................................................................... 187 187
Deferred tax effects. ......................................................... 49,050 49,050
Minority interest.............................................................. 22,660 22,660
------ ------
Brazilian generally accepted accounting principles, as reported herein 90,690 9,931,827
====== =========
</TABLE>
(*) The deferred tax liability arises for the excess of net assets
shown for financial reporting purposes over the tax basis of these net
assets determined in accordance with accounting principles prescribed by
Brazilian Corporation Law. The charge relating to the additional deferred
tax liability was recorded directly against retained earnings.
30. Subsequent Events
a. Changes in the exchange rate policy
On January 13, 1999, the Brazilian monetary authorities raised the
foreign exchange trading band ceiling between the Real and the U.S. dollar
over which they had previously supported the rate under the crawling-peg
exchange control system in place, establishing a new maximum rate of R$
1.32 to U.S.$ 1.00. As a consequence of continued strong downward
pressures on the Real, the Central Bank was forced to abandon the new band
during trading on January 18, 1999 and announce that the currency would be
allowed to float. Again, the market forced a further significant
depreciation of the Real. At December 31, 1998 the commercial market rate
for purchasing one U.S. Dollar was R$ 1.2085 and at April 30, 1999 was R$
1.6607.
<PAGE>
b. Concession awarded to competitor
As contemplated under the privatization rules, in January 1999, Anatel
auctioned licenses authorizing a competitor to provide local fixed-line
and intraregional long-distance services in the region in competition with
the Companies. The entrant - Canbra Telefonica S.A. merges the experiences
of three global telecommunications corporations; Bell Canada
International, WLL International Inc (both with a 34.4% interest in the
consortium) and Qualcomm Inc. (16.2% interest). Grupo Vicunha/Liberman
also participates with 15% interest in the consortium.
c. Significant changes to tax legislation
The following changes announced by the Brazilian authorities are likely
to impact the financial position and results of operations of the
Companies as from 1999:
. the income tax withholding rate applied to payments for services
rendered to non-resident companies and individuals is increased from
15% to 25% (many treaty rates, however, limit the rate to 15%);
. Federal Tax Instruction No. 162 issued in January 1999, determines
that the annual rates of depreciation for tax purposes for certain
telecommunication equipment such as automatic switching equipment
(Companies' average - 7.69%) and transmission equipment (10%) are
increased to 20%;
. the social contribution rate is increased from 8% to 12% of taxable
profits as from May 1, 1999 and through December 31, 1999;
. the rate for COFINS, a social contribution calculated on net sales,
increases from 2% to 3%, although one third of this tax can be used as
a credit against social contribution, but the credit cannot be carried
over to future years;
. the tax base of both COFINS and PIS, both of which are social
contributions on net sales revenues, is extended to encompass other
income, including financial income;
. loans between companies (excluding financial entities), including
related companies, and between companies and individuals are now
subject to IOF (a tax on financial transactions). The applicable daily
rate depends on the type of loan ; and
. the CPMF tax (a tax on bank account debits and withdrawals) is
suspended from January 22, 1999 but returns as from June 17, 1999 for
a further three years at a rate increased from 0.20% to 0.38% for the
first year falling to 0.30% for the remaining two years.
31. 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
that 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 under Brazilian GAAP,
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.
<PAGE>
Under US GAAP, in accordance with the provisions of U.S. Statement of
Financial Accounting Standards ("SFAS") No. 34 of the U.S. Financial
Accounting Standards Board, 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, they 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 annual effects of these different criteria for capitalizing and
amortizing capitalized interest are presented below:
<TABLE>
<CAPTION>
1996 1997 1998
----------- ----------- ------------
<S> <C> <C> <C>
Capitalized interest difference US GAAP capitalized interest in the year:
Interest which would have been capitalized and credited to income under
US GAAP (Being interest incurred on loans from third parties, except
in years where total loans exceeded total construction-in-progress,
when capitalized interest is
reduced proportionately)...................................... 202,857 180,028 42,190
Difference in accumulated capitalized interest on disposals....... 2,600 12,673 20,355
-------- -------- --------
205,457 192,701 62,545
-------- -------- --------
Less: Brazilian GAAP capitalized interest in the year:
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) (105,093)
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) (113,225)
-------- -------- --------
Total capitalized interest under Brazilian GAAP (12%
per annum, applied monthly to the balance of
construction-in-progress).............................. (234,494) (319,535) (218,318)
-------- -------- --------
US GAAP Difference ............................................. (29,037) (126,834) (155,773)
======= ======== ========
Amortization of capitalized interest difference in the year:
Amortization under Brazilian GAAP.................................. 181,590 209,386 146,298
Less: Amortization under US GAAP................................... (156,484) (174,4l4) (125,433)
US GAAP difference in accumulated amortization on disposals........ (2,600) (12,673) (20,355)
-------- --------- ---------
US GAAP Difference ................................................ 22,506 22,299 510
======== ======== ====
</TABLE>
b. Reversal of proposed dividends
Under Brazilian GAAP, proposed dividends are accrued for in the
financial statements in anticipation of their approval at the
shareholders' meeting.
<PAGE>
Under US GAAP, dividends are not accrued until they are formally declared.
c. Pension and other post-retirement benefits
Under Brazilian GAAP, amounts due to the multi-employer pension plan
are treated on an accrual basis as the obligations fall due. Note
disclosure includes a summary of the actuarial report prepared under
Brazilian actuarial principles.
Under 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(b) shows the funded status of Sistel. The provisions of SFAS
No. 87, "Employers' Accounting for Pensions", 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. SFAS No. 132, "Employers' disclosures about
pensions and other post-retirement benefits" 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 supplemental disclosures under US GAAP are also provided in Note
36(b).
d. Items posted directly to shareholders' equity accounts
Under Brazilian GAAP, various items are posted directly to
shareholders' equity accounts. Examples include capitalized interest, the
effects of adjustments to tax rates and tax incentive investment credits
received. As noted in (a) above, Brazilian telecommunications companies
capitalize interest attributable to construction-in-progress 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.
Under US GAAP, such items relating to third party debt would be posted
to the income statement. 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 are included in the reconciliation of net income determined in
accordance with US GAAP.
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
earnings per share is presented for Brazilian GAAP only for the year ended
December 31, 1998. Information is disclosed per lot of one thousand
shares, because this is the minimum number of shares that can be,
generally, traded on the Brazilian stock exchanges.
Under US GAAP, the equity structure utilized for the earnings per share
computations for the year ended December 31, 1997 is that of the new
entity formed in May 1998. At the date of formation, the Holding Company
had 124,351,903 thousand common shares 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 shareholders have different dividend,
voting and liquidation rights, Basic and Diluted earnings per share have
been calculated using the "two-class" method, pursuant to 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 "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 Holding 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 Dividend (up to a minimum of 6% of preferred share capital
determined under accounting principles prescribed by Brazilian Corporation
Law as defined in the Holding Company's by-laws) and the preferred
shareholders portion of undistributed net income (Note 23). 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. Undistributed net income is computed by deducting the
Preferred Dividend and common stock dividends from net income.
Undistributed net income is shared equally by the preferred and common
shareholders on a pro rata basis. The common stock Mandatory Dividend is
calculated up to 25% of Adjusted Net Income or an amount equal to the
Preferred 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.
The weighted-average number of common and preferred shares used in
computing basic earnings per share for (i) 1998 was 124,369,031 thousand
and 205,457,214 thousand (inclusive of the 13,718,350 thousand preferred
shares resulting from the settlement in April 1998 with Telebras (Note
24)), and (ii) 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 Subsidiaries
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 balance sheets. Once the installation
is essentially complete and the contributions have been received, the
funds will be converted into equity (Note 24). These activities are
dilutive in nature to the shareholders of the Holding Company or the
Subsidiaries, whether the shares to be issued are those of the
Subsidiaries, (which will impact the minority interest recognized) or of
the Holding Company itself. The expectation is that the shares would be
issued by the Subsidiaries rather than by 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 common 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 (Note 24). Pursuant to SFAS
No. 128, no potential issuance of these shares was included in the
computation of Diluted EPS for the year ended December 31, 1998 as such
effect would have had an antidilutive effect on earnings per share. If
Subsidiary shares had been issued historically, the reduction to net
income to increase net earnings attributable to minority shareholders for
1996 and 1997 and would have been R$ 89,666 and R$ 54,286, respectively.
The Holding 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 Holding Company. The preferred shareholders were
entitled to a non-cumulative dividend, in Reais, of R$ 1.03, R$ 1.69 and
R$ 0.67 per thousand preferred shares in 1996, 1997 and 1998,
respectively. The preferred shareholders would share equally in the
undistributed earnings, in Reais, of the Holding Company in the amount of
R$ 2.15 per thousand preferred share in 1997 (1998 - nil).
Earnings per share for 1996 and 1997 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. Segment reporting
Under Brazilian GAAP, no separate segment reporting is required.
Under US GAAP, SFAS No. 131 "Disclosures about Segments of an
Enterprise and Related Information" 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.
Management considers the Companies operate in a single segment in the
provision of telecommunications services. Therefore no US GAAP segment
disclosures are required.
g. Comprehensive income
Under US GAAP, the Companies have adopted SFAS No. 130, "Reporting
Comprehensive Income". Comprehensive income is not different from net
income presented in accordance with US GAAP.
h. Disclosure requirements
Under US GAAP disclosure requirement differ from those required by
Brazilian GAAP. However, in these Brazilian GAAP financial statements, the
level of disclosure has been expanded to comply with US GAAP.
i. Income taxes
Under Brazilian GAAP, the Companies fully accrue for deferred income
taxes on temporary differences between tax and reporting records. The
deferred tax asset is shown net of valuation allowances. Valuation
allowances are established when management does not consider recovery to
be probable. The existing policies under Brazilian GAAP for providing for
deferred taxes are substantially in accordance with SFAS No. 109,
"Accounting for Income Taxes" except as stated below. Additionally,
deferred income taxes are shown gross rather than being netted.
Under US GAAP, the deferred tax effects of the 1996 and 1997 indexation
for financial reporting purposes (Note 2(a)(iii)) would be charged first
to income and not directly to shareholders' equity. Additionally, deferred
income taxes are netted rather than being shown gross. Additionally, for
US GAAP purposes, deferred tax assets and liabilities are classified as
current or noncurrent based on the classification of the asset or
liability underlying the temporary difference.
j. Interest income (expense)
Under Brazilian GAAP, interest income (expense) is required to be shown as
part of operating income.
Under US GAAP, interest income (expense) would be shown after operating
income.
k. Extraordinary items
Under Brazilian GAAP, separate disclosure of extraordinary items, net
of tax, is required when such items are considered to be unusual and of an
infrequent (non-recurring) nature. The criteria is less well defined
compared to US GAAP.
Under US GAAP, extraordinary items, as defined by U.S. Accounting
Principles Board Opinion No. 30, "Reporting the Results of
Operations-Reporting the Effects of Disposal of a Segment of a Business,
and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions", are events and transactions that are distinguished by their
unusual nature and by the infrequency of their occurrence. Thus, both of
the following criteria should be met to classify an event or transaction
as an extraordinary item: (a) Unusual nature - the underlying event or
transaction should possess a high degree of abnormality and be of a type
clearly unrelated to, or only incidentally related to, the ordinary and
typical activities of the entity, taking into account the environment in
which the entity operates: unusual nature is not established by the fact
that an event or transaction is beyond the control of management; and (b)
Infrequency of occurrence - the underlying event or transaction should be
of a type that would not reasonably be expected to recur in the
foreseeable future, taking into account the environment in which the
entity operates; however, mere infrequency of occurrence of a particular
event or transaction does not by itself imply that its effects should be
classified as extraordinary. In rare situations, an event or transaction
may occur that clearly meets both criteria and thus gives rise to an
extraordinary gain or loss that includes one or more of the gains or
losses enumerated above.
In view of the significant differences in presentation, the statement
of income for the year ended December 31, 1998 has been recast and
separately presented on a condensed US GAAP basis.
l. Employees' profit share
Under Brazilian GAAP, employees' profit share is required 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.
m. Permanent assets
Under Brazilian GAAP, the financial statements present a class of
assets called permanent assets. This is the collective name for all assets
on which indexation adjustments were calculated in the Corporation Law and
fiscal law accounts of Brazilian companies through 1995. Under Brazilian
GAAP, gains and losses on the disposal of permanent assets are classified
as non-operating income (expense).
Under US GAAP, these assets would be classified as noncurrent assets.
Under US GAAP, gains and losses on the disposal of permanent assets are
classified as an adjustment to operating income.
n. Price-level adjustments and US GAAP presentation
Amounts in the financial statements as at and for the year ended
December 31, 1998 are presented in nominal Reais. Although Brazilian GAAP
require financial statements to be indexed for inflation through to the
current balance sheet date, in view of the low levels of inflation during
1998, the Companies consider the effects on the results of operations and
the financial position of not having prepared the financial statements on
a fully-indexed basis and not having presented prior-period balances at
constant price-levels at the latest balance sheet date, not to be
significant.
The effects of price-level adjustments recorded in the Brazilian GAAP
consolidated financial statements through December 31, 1997 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 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.
o. Funds for capitalization
i. Expansion plan contributions
Under Brazilian GAAP, expansion plan contributions received are
included in the balance sheet after total shareholders' equity until such
time as the 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 end of the subsequent fiscal
year-end and transferred to shareholders' 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 fiscal year-end balance sheet. From January
1, 1996, indexation was no longer applied and, for contracts signed as
from that date, the Subsidiaries were allowed the option of using a value
per share equal to the market value, when this is higher than the equity
value. The Subsidiaries' expansion plan contribution program has been
terminated, with no new contracts signed after June 30, 1997.
Under US GAAP, in the combined financial statements through December
31, 1997, 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. As from 1998, in the consolidated financial
statements, as such amounts, upon capitalization, will be converted to
shares held by third parties in the Subsidiaries, this expansion plan
contribution balance is considered as being part of minority interests
under US GAAP. 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
Subsidiaries' assets over the corresponding credits to expansion plan
contributions received, are recorded as a credit to other capital
reserves.
Under US GAAP, the credit to capital reserves is classified as a
deferred credit and amortized to reduce depreciation expense.
p. Loans and Financing
Under Brazilian GAAP, loan and financing balances in technical default
are not always classified as current liabilities. A portion of the
Companies' outstanding debt at December 31, 1998, R$ 111,400 is currently
in default (1997 - R$ 133,055) as a result of the privatization.
Under 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 Companies waivers
for such defaults and accordingly, the debt would be classified as current
liabilities.
q. Valuation of Long-lived Assets
Under Brazilian GAAP, companies are required to determine if operating
income is sufficient to absorb the depreciation or amortization of
long-lived assets in order to assess potential asset impairment. In the
event such operating income is insufficient to recover the depreciation
due to permanent impairment of assets, the assets, or groups of assets,
are written-down to recoverable values, preferably, based on the projected
discounted cash flows of future operations. In the event of a planned
substitution of assets prior to the end of the original estimated useful
life of the asset, depreciation of such asset is accelerated to assure the
asset becomes fully depreciated at the estimated date of substitution.
Under US GAAP, SFAS No. 121, "Accounting for the Impairment of
Long-lived Assets and for Long-lived Assets to Be Disposed Of", requires
companies to 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
fair market value of the assets or discounted cash flows generated by the
assets. No impairment provisions were recorded by the Companies other than
the acceleration of depreciation in 1998 (Note 8 (iv)).
r. Retained earnings
Under Brazilian GAAP, a company formed as a result of a cisao may
present retained earnings in its balance sheet if the parent company
shareholders' resolution adopting the cisao so deems by allocating
retained earnings from the parent company to the new company.
Under US 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."
s. Provision for dividends and notional interest attributable to own capital
Under Brazilian Corporation Law, at each balance sheet date the
Directors are required to propose a dividend distribution from earnings
and accrue for this in the financial statements. Under Brazilian GAAP,
companies are permitted to distribute or capitalize an amount of interest,
subject to certain limitations, calculated based on a government interest
rate, on shareholders' equity. Such amounts are deductible for tax
purposes and are presented as a deduction from shareholders' equity.
Although not affecting net income except for the tax benefit, in certain
cases companies include this notional charge in interest expense and
reverse out the same amount before the net income total.
Under US GAAP, since proposed dividends may be ratified or modified at
the annual Shareholders' Meeting such dividends would not be considered as
declared at the balance sheet date and would therefore not be accrued.
However, interim dividends paid or interest credited to shareholders as
capital remuneration under Brazilian legislation would be considered as
declared for US GAAP purposes. Under US GAAP, no similar interest
distribution concept exists.
t. Employee stock discount purchases
As part of the privatization of the Telebras system, the Federal
Government 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
Companies) at a price (in Reais) of R$ 69.24 per lot of shares (each
"lot'" is 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
had the right to purchase up to 144 lots of preferred shares, subject to
proration if the shares are oversubscribed. The market price (in Reais) 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
Companies preferred shares in connection with the Break-up had not
occurred. The market price (in Reais) of one lot on October 30, 1998, when
the offer to employees terminated, was R$ 91.00.
Under Brazilian GAAP, the employee stock offering has no effect on the
financial statements
Under US GAAP, the employee stock offering is deemed to give rise to
compensation expense, classified as an extraordinary item, to the extent
of the excess of market price of the shares purchased over the Federal
Government's price to employees. The discount below market value at which
the shares will be sold to employees identifies the share distribution as
a compensatory plan. Terms of the plan were determined on the grant date
thus identifying the plan as a fixed plan. The measurement date for
measurement of such compensation cost under APB No. 25 "Accounting for
Stock Issued to Employees" was August 4, 1998. Although the Federal
Government, rather than the Holding Company, Subsidiaries or Telebras,
offered the shares to employees, under US GAAP, the deemed compensation
amount is "pushed down" to each of the Holding Company in accordance with
the number of shares purchased by the Holding Company's and Subsidiaries'
employees. The minimum amount to be recognized is R$ 166,700. A precise
calculation of the value of the shares would involve the application of an
option-pricing model (Black-Scholes, for example) as recommended in SFAS
No. 123 ,"Accounting for Stock Based Compensation" in order to calculate
the market price of the shares. For the purpose of determining net income
in accordance with US GAAP, as the shares could be immediately acquired by
full payment in cash and immediately resold at almost market price with
the investment clubs created for the sale of such shares and as the period
of exercise was relatively short, the market price on or around August 4,
1998 was considered as the market value of the shares.
u. Related parties
Under Brazilian GAAP, related parties are generally defined in a more
limited manner and require fewer disclosures than US standards. As a
result, many of the disclosures required in the United States are not
required under Brazilian generally accepted accounting principles.
Disclosure has been expanded under Brazilian GAAP.
v. Statement of Cash Flows
Under Brazilian GAAP, a statement of changes in financial position is
required to be presented which reflects the source and application of
funds in terms of movement in working capital.
Under US GAAP, presentation of a statement of cash flows describing the
cash flows provided by or used in operating, investing and financing
activities is required. SFAS No. 95, " Statement of Cash Flows",
establishes specific presentation requirements and requires additional
disclosures, such as the amount of interest and income taxes paid and non
cash transactions such as acquisition of property, plant and equipment
through capital leases, utilization of escrow deposits in settlement of
liabilities and debt for equity conversions, among others. A statement of
cash flows has been presented herein to supplement the Brazilian GAAP
disclosure (Note 33(a)).
w. Classification of income statement line items
Under Brazilian GAAP, as noted above, the classification of certain
income and expense items is presented differently from US GAAP. A number
of significant presentation differences have arisen in the year ended
December 31, 1998. Accordingly, the consolidated income statement under
Brazilian GAAP has been recast to present a condensed consolidated income
statement in accordance with US GAAP (Note 35). The reclassifications are
summarized as follows:
(i) Interest in Subsidiaries' credits made directly to equity - which
represent amounts recorded by the Subsidiaries in their respective
shareholders' equity accounts without affecting net income but which
are recorded by the Holding Company in a separate line item in the
consolidated statement of income in accordance with Brazilian GAAP.
Such amounts have been reclassified to the respective line items to
which they relate in the condensed consolidated income statement in
accordance with US GAAP.
(ii) Interest income and interest expense - such items, together with other
financial charges are displayed within operating income in the
consolidated statement of income in accordance with Brazilian GAAP.
Such amounts have been reclassified to non-operating income and
expenses in the condensed consolidated income statement in accordance
with US GAAP.
(iii) Extraordinary item - as detailed in Note 8, certain charges arising
after the privatization of the Companies were treated as extraordinary
items in a separate line item in the consolidated statement of income
in accordance with Brazilian GAAP. Such amounts have been reclassified
to the respective line items to which they relate in the condensed
consolidated income statement in accordance with US GAAP.
(iv) Employees' profit share - these expenses have been classified in the
consolidated statement of income in accordance with Brazilian GAAP
after non-operating expenses. Such amounts have been reclassified to
operating expenses in the condensed consolidated income statement in
accordance with US GAAP.
(v) The net income differences between Brazilian GAAP and US GAAP- as
detailed in the reconciliation in Note 32, were incorporated in the
condensed consolidated income statement in accordance with US GAAP.
x. New US GAAP accounting pronouncement not yet adopted
In June 1998, SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities" was issued. This statement establishes accounting and
reporting standards for derivative instruments, including certain
derivative instruments embedded in other contracts (collectively referred
to as derivatives), and for hedging activities. It requires that an entity
recognizes all derivatives as either assets or liabilities in the
statement of financial position and measure those instruments at fair
value. This statement is currently effective for fiscal years beginning
after June 15, 1999 (January 1, 2000 in the case of the Companies).
Management is evaluating SFAS No. 133 to determine its impact, if any, on
the financial statements.
Statement of Positions 98-1 - "Accounting for the Cost of Computer
Software Developed or Obtained for Internal Use" and SOP 98-5 - "Reporting
on the Costs of Start-Up Activities" were issued in March and April 1998,
to be effective for fiscal years beginning after December 15, 1998. The
Companies believe that the adoption of these SOPs will not result in
significant differences from the reported financial statements.
32. Net income reconciliation of the differences between Brazilian GAAP and US
GAAP
<TABLE>
<CAPTION>
1996 1997 1998
------------ ------------ -------------
<S> <C> <C> <C>
Income from continuing operations before unallocated interest
(1996 and 1997), extraordinary items, taxes and minority
interest, as reported under Brazilian GAAP............................. 809,337 1,109,280 949,862
Line reclassification:
Extraordinary items - - (1,034,834)
Tax effects on extraordinary items - - 306,491
------------ ------------ -------------
809,337 1,109,280 221,519
Add (deduct):
Different criteria for:
Capitalized interest................................................. (29,037) (126,834) (155,773
)
Amortization of capitalized interest................................. 22,506 22,299 510
Reversal of COFINS tax credit........................................ 27,459
Contributions to plant expansion:
Amortization of deferred credit...................................... 28,741 34,321 36,484
Employee stock discount purchases...................................... (166,700)
Items posted directly to shareholders' equity:
Interest on construction-in-progress................................. 200,728 192,711 113,225
------------ ------------ -------------
US GAAP income (loss) from continuing operations before unallocated
interest, taxes and minority interests............................... 1,032,275 1,231,777 (7,014)
----------- ------------- -----------
Income from discontinued operations before unallocated interest,
taxes and minority interests as reported under Brazilian GAAP 679,409 788,790 -
US GAAP differences on income from discontinued operations............. 24,292 29,208 -
------------ ------------ -------------
US GAAP income from discontinued operations before unallocated
interest, taxes and minority interests............................... 703,701 817,998 -
----------- ----------- ------------
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
1996 1997 1998
------------ ------------ -------------
<S> <C> <C> <C>
Items relating to both continuing and discontinued operations:
Unallocated interest income........................................ 45,373 126,554 -
Unallocated interest expense....................................... (121,374) (128,544) -
Income and social contribution taxes - Brazilian GAAP basis........ (386,464) (484,844) (230,135)
Minority interests - Brazilian GAAP - basis........................ (152,316) (312,351) 99,306
Add (deduct):
Items posted directly to shareholders' 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 55,200 100,644
In respect of discontinued operations........................... 4,130 879 -
Minority interests in the above adjustments........................ 79,881 188,685 (2,210)
------------ ------------ -------------
(77,872) 487 (32,395)
------------ ------------ -------------
US GAAP net income (loss) 954,403 1,232,264 (39,409)
============ ============ =============
Earnings/(loss) per thousand common shares-Basic (in Reais)........ 2.98 3.84 (0.12)
Weighted average (thousand) common shares outstanding........... 124,351,903 124,351,903 124,369,031
============ ============ =============
Earnings/(loss) per thousand common shares -Diluted (in Reais)..... 2.63 3.65 (0.12)
Weighted average (thousand) common shares outstanding........... 124,351,903 124,351,903 124,369,031
============ ============ =============
Earnings/(loss) per thousand preferred shares -Basic (in Reais).... 2.98 3.84 (0.12)
Weighted average (thousand) preferred shares outstanding........ 196,311,647 196,311,647 205,457,214
============ ============ =============
Earnings/(loss) per thousand preferred shares -Diluted (in Reais).. 2.63 3.65 (0.12)
Weighted average (thousand) preferred shares outstanding........ 196,311,647 196,311,647 205,457,214
============ ============ =============
</TABLE>
<PAGE>
33. Shareholders' equity reconciliation of the differences between Brazilian
GAAP and US GAAP
<TABLE>
<CAPTION>
1997 1998
---------------- -----------------
<S> <C> <C>
Total shareholders' equity, as reported under Brazilian GAAP............. 9,486,508 9,931,827
Add (deduct):
Different criteria for:
Capitalized interest.............................................. (384,504) (540,277)
Amortization of capitalized interest.............................. 261,309 261,819
Reversal of proposed dividends ...................................... 480,426 224,469
Reversal of COFINS tax credit........................................ (27,459) -
Contributions to plant expansion:
Amortization of deferred credit................................... 94,321 130,805
Subscribed capital stock............................................. (192,057) (192,057)
Donations and subsidies for investment............................... (18,409) (18,409)
Difference in Additional net assets received upon break-up of
Telebras and adjustment in respect of discontinued
operations, net of tax ........................................... (30,453) (57,170)
Deferred tax effects of the above adjustments........................ 190,310 290,954
Minority interests on the above adjustments.......................... (66,573) (68,783)
---------------- -----------------
US GAAP shareholders' equity 9,793,419 9,963,178
================ =================
US GAAP supplementary information:
Property, plant and equipment........................................ 27,626,074 29,202,424
Accumulated depreciation............................................. (14,466,883) (15,399,983)
---------------- -----------------
Net property, plant and equipment.................................... 13,159,191 13,802,441
================ =================
Total assets......................................................... 16,672,462 16,196,274
================ =================
</TABLE>
The deferred tax effect of the US GAAP adjustments noted above would be
classified mainly as a noncurrent asset in the balance sheet
<PAGE>
34. Consolidated statements of changes in shareholders' equity in accordance
with USGAAP Years ended December 31, 1997 and 1998
<TABLE>
<CAPTION>
Capital and Retained
reserves earnings Total
----------------- ------------- --------------
<S> <C> <C> <C>
Balances at December 31, 1996 7,593,823 1,850,959 9,444,782
Expansion plan contributions
548,684
Received................................................ 548,684 -
Deferred (87,709
credits..................................... (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 -
Transfer to
reserves........................................ 69,757 (69,757) -
Dividends
paid................................................ - (265,245) (265,245)
Dividends declared but
unclaimed................. - (4,478) (4,478)
Minority interest 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>
<TABLE>
<CAPTION>
Share capital Unrealize
and additional Statutory revenue Retained Total
paid-in capital reserve reserved earnings
-------------------- ------------------ -------------- ------------- --------------
<S> <C> <C> <C> <C> <C>
Balances at January 1, 1998 - 7,315,001 2,478,418 9,793,419
-------------------- ------------------ -------------- ------------- --------------
--------------------
Allocation among accounts
approved
by shareholders' and net
assets received
upon Break-up of
Telebras............ 3,741,151 (7,315,001) 3,113,932 963,376 503,458
Additional net assets received on -
the
Break-up of
Telebras.............................. - - 19,436 19,436
Loss for the -
year......................................... - - (39,409) (39,409)
Realization of unrealized
income............... (57,112) 57,112 -
Employee stock discount
purchases........... 166,700 - - - 166,700
Transfer to - -
reserves..................................... 8,808 - (8,808)
Dividends - (480,426
paid............................................ - - (480,426) )
==================== ================== ============== ============= ==============
Balances at December 31, 1998 3,907,851 8,808 3,056,820 2,989,699 9,963,178
==================== ================== ============== ============= ==============
</TABLE>
35 Condensed consolidated statement of income prepared in accordance with US
GAAP (Note 31(w))
Year ended December 31, 1998
<TABLE>
<CAPTION>
R$
<S> <C>
Gross Operating revenue from telecommunications services ......... 6,946,326
Deductions (primarily indirect taxes) ........................ (1,787,909)
---------------
Net operating revenue 5,158,417
Cost of services ................................................. (3,188,891)
---------------
Gross profit 1,969,526
Operating (expenses):
Selling....................................................... (566,923)
General and administrative.................................... (1,447,638)
Other net operating expense................................... (70,122)
---------------
Operating loss (115,157)
Interest expense, net............................................. (31,652)
---------------
Loss before extraordinary items, taxes and minority interests (146,809)
Extraordinary items (employee stock purchase discount)............ (166,700)
---------------
Loss before taxes and minority interests (313,509)
Income tax and social contribution ............................... 177,000
---------------
Loss before minority interests (136,509)
Minority interests................................................ 97,100
---------------
Loss for the year (39,409)
Loss per thousand shares:
Common shares - Basic (in Reais).............................. (0.12)
Weighted average (thousand) common shares outstanding......... 124,369,031
===============
Common shares - Diluted (in Reais)............................ (0.12)
Weighted average (thousand) common shares outstanding......... 124,369,031
Preferred shares - Basic (in Reais)........................... (0.12)
Weighted average (thousand) preferred shares outstanding...... 205,457,214
Preferred shares - Diluted (in Reais)........................ (0.12)
Weighted average (thousand) preferred shares outstanding..... 205,457,214
</TABLE>
<PAGE>
36. Additional disclosures required by US GAAP
a. Consolidated statement of cash flows based on
Brazilian GAAP balances
<TABLE>
<CAPTION>
Years ended December 31,
(Expressed in thousands of Brazilian Reais)
1996 1997 1998
R$ R$ R$
<S> <C> <C> <C>
Operating activities:
Net income...................................... 873,965 1,098.885 90,690
Less: Income from discontinued cellular operations
before unallocated interest income/ expense taxes
and minority interests........................ (679,409) (788,790) -
------------- ------------- -------------
Income from continuing operations, net of unallocated interest
and taxes applicable to both continuing and discontinued
operations . 194,556 310,095 90,690
Adjustments to reconcile net income to cash provided by
operating activities:
Depreciation and amortization................ 1,299,947 1,367,505 1,688,349
Minority interests........................... 152,316 312,351 (99,306)
Loss on permanent asset disposals............ 47,703 78,732 95,327
Other provisions............................. 4,054 6,427 48,491
Increase in income tax rate................... (7,742) (7,673) -
(Increase) in trade accounts receivable....... (147,255) (47,361) (160,439)
(Increase) in other current assets............ (100,814) (10,237) 143,072
(Increase) decrease in other noncurrent assets (5,319) (7.873) (16,837)
Increase (decrease) in payroll and related accruals 13,083 (36,340) (49,979)
Increase (decrease) in accounts payable and accrued
expenses..................................... 223,585 (90,897) 297,170
Increase in taxes other than income taxes .... 36,011 100,803 14,102
Increase (decrease) in other current liabilities 23,540 (5,731) 507,898
Increase (decrease) in accrued interest....... (35,032) 44,420 21,885
Increase (decrease) in income taxes........... (22,544) (217,680) (292,150)
Increase in provisions for contingencies...... 10,086 23,534 514,242
Increase (decrease) in provision for pension fund 1,540 (1,540) -
Increase (decrease) in other noncurrent liabilities (13,490) 9,595 (8,999)
Cash provided by operating activities 1,674,225 1,828,130 2,793,516
------------- ------------- -------------
Investing activities:
Additions to (disposals of) investments......... 13,287 (1,270) 21,342
Additions to property, plant and equipment...... (2,228,100) (2,618,026) (2,407,670)
Proceeds from asset disposals................... 64,843 36,033 -
------------- ------------- -------------
Cash used in investing activities (2,149,970) (2,583,263) (2,386,328)
------------- ------------- -------------
Financing activities:
Loans
Issuances..................................... 1,397,714 1,253,948 -
Repayments.................................... (1,553,927) (1,250,222) -
Cash received upon break-up of Telebras......... - - 165,707
Cash received for future capital increases, net. 924,365 600,540 69,367
Purchase of treasury shares..................... - (153) -
Dividends and interest attributed to equity, paid (138,029) (265,245) (480,998)
------------- ------------- -------------
Cash provided by (used in) financing activities 630,123 338,868 (245,924)
------------- ------------- -------------
Increase (decrease) in cash and cash equivalents from
continuing operations........................... 154,378 (416,265) 161,264
Net cash provided by discontinued operations, before
unallocated interest income/expense and taxes... 54,648 212,288 -
Cash and cash equivalents at beginning of year...... 209,190 418,216 214,239
------------- ------------- -------------
Cash and cash equivalents at end of year 418,216 214,239 375,503
============= ============== =============
</TABLE>
<PAGE>
Supplemental cash flow information
<TABLE>
<CAPTION>
1996 1997 1998
------------- ------------- -------------
<S> <C> <C> <C>
Income and social contribution tax paid........................... 419,656 618,302 171,801
Interest paid..................................................... 238,514 228,739 46,434
Cash paid against provisions for contingencies.................... 16,578 8,094 23,571
Non cash transactions:
Fiscal incentive investment credits received.................. 18,674 28,932 15,447
Donations received of property, plant and equipment........... 4,009 9,349 9,887
Conversion of expansion plan contributions into share
capital and share premium................................... 273,391 152,843 394,257
</TABLE>
Further non-cash transactions arose on the Break-up of Telebras and the
additional net assets received upon the Break-up (Note 1(c)).
b. Pension and post-retirement benefits
The Companies, together with other companies in the former 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>
1997 1998
---------------- -----------------
<S> <C> <C>
Pension benefit plan
Funded status
Accumulated benefit obligation:
Vested............................................................ 1,919,975 2,421,646
Non vested........................................................ 3,479,300 4,018,319
---------------- -----------------
Total 5,399,275 6,439,965
================ =================
Projected benefit obligation......................................... 7,258,073 8,281,791
Fair value of plan assets............................................ (3,897,051) (3,811,718)
---------------- -----------------
Projected obligation in excess of assets 3,361,022 4,470,073
================ =================
The actuarial assumptions used (above an inflation index) 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..................... 10.00% 10.00%
</TABLE>
Amortization of the unrecognized liability at transaction: 18.94 years
commencing on January 1, 1991.
