<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON NOVEMBER 2, 1998.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------
FORM 20-F/A
(MARK ONE)
[X] REGISTRATION STATEMENT PURSUANT TO SECTION 12(B)
OR (G) OF THE SECURITIES EXCHANGE ACT OF 1934
OR
[_] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended:
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
for the transition period from to
COMMISSION FILE NUMBER: 001-14477
TELE CENTRO SUL PARTICIPACOES S.A.
(Exact name of Registrant as specified in its charter)
TELE CENTRO SUL HOLDING COMPANY
(Translation of Registrant's name into English)
THE FEDERATIVE REPUBLIC OF BRAZIL
(Jurisdiction of incorporation or organization)
SCN-QUADRA 3, BLOCO A, 2(degrees) ANDAR, SALA 202
BRASILIA, DF, BRAZIL
(Address of principal executive offices)
SECURITIES REGISTERED OR TO BE REGISTERED PURSUANT TO SECTION 12(B) OF THE
ACT:
<TABLE>
<CAPTION>
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
------------------- -----------------------------------------
<S> <C>
Preferred Shares, without par
value.......................... New York Stock Exchange*
</TABLE>
- --------
* Not for trading, but only in connection with the listing of American
Depositary Shares, on the New York Stock Exchange.
SECURITIES REGISTERED OR TO BE REGISTERED PURSUANT TO SECTION 12(G) OF THE
ACT: None
SECURITIES FOR WHICH THERE IS A REPORTING OBLIGATION PURSUANT TO SECTION 15(D)
OF THE ACT: None
Indicate the number of outstanding shares of each of the issuer's classes of
capital or common stock as of the close of the last fiscal year covered by
this Registration Statement: None
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days.
Yes No X
Indicate by check mark which financial statement item the registrant has
elected to follow.
Item 17 Item 18 X
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- -------------------------------------------------------------------------------
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<C> <S> <C>
PRESENTATION OF INFORMATION................................... ii
GLOSSARY OF TERMS............................................. vi
EXCHANGE RATES................................................ ix
PART I
ITEM 1. Description of Business....................................... 1
ITEM 2. Description of Property....................................... 32
ITEM 3. Legal Proceedings............................................. 32
ITEM 4. Control of Registrant......................................... 33
ITEM 5. Nature of Trading Market...................................... 34
ITEM 6. Exchange Controls and Other Limitations Affecting Security
Holders....................................................... 37
ITEM 7. Taxation...................................................... 38
ITEM 8. Selected Financial Data....................................... 43
ITEM 9. Management's Discussion and Analysis of Financial Condition
and Results of Operations..................................... 46
ITEM 9A. Quantitative and Qualitative Disclosures about Market Risk.... 61
ITEM 10. Directors and Officers of Registrant.......................... 62
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.................... 66
PART III
ITEM 15. Defaults upon Senior Securities............................... 79
ITEM 16. Changes in Securities and Changes in Security for Registered
Securities.................................................... 79
PART IV
ITEM 17. Consolidated Financial Statements............................. 79
ITEM 18. Consolidated Financial Statements............................. 79
ITEM 19. Consolidated Financial Statements and Exhibits................ 79
</TABLE>
i
<PAGE>
PRESENTATION OF INFORMATION
OVERVIEW
Tele Centro Sul Participacoes S.A. (the "Registrant"), a corporation
organized under the laws of the Federative Republic of Brazil ("Brazil"), was
formed upon the reorganization of Telecomunicacoes Brasileiras S.A.--Telebras
("Telebras"), a corporation organized under the laws of Brazil that, together
with its operating subsidiaries (the "Telebras System"), was the primary
supplier of public telecommunications services in Brazil. On May 22, 1998, the
shareholders of Telebras approved the restructuring of the Telebras System to
form, in addition to Telebras, twelve new telecommunications companies (the
"New Holding Companies") by means of a procedure under Brazilian corporate law
called cisao or "split-up". The New Holding Companies were allocated
substantially all the assets and liabilities of Telebras, including the shares
held by Telebras of the operating companies of the Telebras System. The New
Holding Companies, together with their respective subsidiaries, comprise (a)
three regional fixed-line operators, (b) eight regional cellular operators and
(c) one national long-distance carrier. The separation of the Telebras System
into the New Holding Companies and their respective subsidiaries is referred
to in this Registration Statement on Form 20-F (the "Registration Statement")
as the "Breakup" of Telebras. Prior to the Breakup, Telebras, through its
operating subsidiaries, was the primary supplier of public telecommunications
services in Brazil. See "Description of Business--Background" and "--The
Company."
The Registrant is one of the New Holding Companies formed upon the Breakup
of Telebras. In the Breakup, all of the share capital held by Telebras in
Companhia Telefonica Melhoramento e Resistencia ("CTMR"), Telecomunicacoes de
Santa Catarina S.A. ("Telesc"), Telecomunicacoes do Parana S.A. ("Telepar"),
Telecomunicacoes do Mato Grosso do Sul S.A. ("Telems"), Telecomunicacoes do
Mato Grosso S.A. ("Telemat"), Telecomunicacoes de Brasilia S.A.
("Telebrasilia"), Telecomunicacoes de Goias S.A. ("Telegoias"),
Telecomunicacoes de Rondonia S.A. ("Teleron") and Telecomunicacoes do Acre
S.A. ("Teleacre") (together, the "Subsidiaries") was transferred to the
Registrant. The Subsidiaries are the principal providers of fixed-line public
telecommunications services in the western, central and southern regions of
Brazil. Prior to January 1, 1998, each Subsidiary also had a cellular
telephone business. In preparation for the Breakup of Telebras, on January 30,
1998, the cellular telephone businesses of the Subsidiaries were "spun off"
effective January 1, 1998 to newly formed cellular companies. See "Description
of Business--Background" and "--The Company."
A substantial part of the Registrant's assets is comprised of share capital
of its subsidiaries. The Registrant relies largely on dividends from its
subsidiaries to meet its need for cash, including for the payment of dividends
to its shareholders. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Liquidity and Capital Resources."
As used herein, the "Company" refers to the Registrant and its consolidated
Subsidiaries.
PRESENTATION OF FINANCIAL INFORMATION
FINANCIAL STATEMENTS AND MINORITY INTERESTS
The audited consolidated balance sheets included herein as of December 31,
1996 and 1997 and the related consolidated statements of income, cash flow and
changes in shareholders' equity for each of the years ended December 31, 1995,
1996 and 1997, (including the notes thereto, the "Consolidated Financial
Statements") are the consolidated financial statements of the Registrant and
the Subsidiaries. The portion of the consolidated equity and net income of the
Subsidiaries attributable to shareholders of the Subsidiaries other than
Telebras at December 31, 1996 and 1997, and for each of the years in the
three-year period ended December 31, 1997 is reflected as "minority interests"
in the Consolidated Financial Statements. At December 31, 1997, such minority
shareholders directly and indirectly owned the percentages shown in the table
below of the share capital of the Subsidiaries, respectively. Substantially
all such share capital is comprised of preferred shares originally issued
ii
<PAGE>
from time to time by the Subsidiaries in connection with such Subsidiaries'
auto-financing activities. The consideration paid for such preferred shares
was the higher of market or book value at the time of issuance, for shares
issued after August 1996, and book value for shares issued prior to August
1996. A secondary trading market has developed in such preferred shares in
which institutional and other investors participate. For a discussion of such
auto-financing activities, see "Description of Business--Rates--Local
Services."
<TABLE>
<CAPTION>
% OF SHARE % OF VOTING
CAPITAL OWNED STOCK OWNED BY
BY MINORITY MINORITY
STATE SUBSIDIARY SHAREHOLDERS(1) SHAREHOLDERS(1)
- ----- ---------- --------------- ---------------
<S> <C> <C> <C>
Acre.................... Telecomunicacoes do Acre S.A.--Teleacre 6.02% 1.32%
Rondonia................ Telecomunicacoes de Rondonia S.A.--Teleron 8.70 2.69
Goias/Tocantins......... Telecomunicacoes de Goias S.A.--Telegoias 16.23 19.64
Distrito Federal........ Telecomunicacoes de Brasilia
S.A.--Telebrasilia 18.60 19.13
Mato Grosso............. Telecomunicacoes do Mato Grosso
S.A.--Telemat 8.13 1.60
Mato Grosso do Sul...... Telecomunicacoes do Mato Grosso
do Sul S.A.--Telems 3.99 1.10
Parana.................. Telecomunicacoes do Parana S.A.--Telepar 32.69 18.02
Santa Catarina.......... Telecomunicacoes de Santa Catarina S.A.--Telesc 17.01 8.60
Rio Grande do Sul....... Companhia Telefonica Melhoramento e 21.44 18.68
Resistencia S.A.--CTMR(2)
</TABLE>
- --------
(1) Includes both direct and indirect ownership.
(2) CTMR serves a small area in the state of Rio Grande do Sul which includes
the cities of Pelotas, Capao do Leao, Morro Redondo and Turucu.
The Consolidated Financial Statements present the fixed-line
telecommunications business of the Subsidiaries as continuing operations and
the cellular telephone business as discontinued operations for all periods.
The assets and liabilities of the cellular telephone business are presented as
net assets of discontinued operations.
FORMATION OF REGISTRANT
The separation of the fixed and cellular telecommunications businesses and
the formation of the Registrant has been accounted as a reorganization of
entities under common control in a manner similar to a pooling of interests.
The assets and liabilities of the cellular telephone business were transferred
from the Subsidiaries at their indexed historical cost. The Consolidated
Financial Statements are not necessarily indicative of the financial position
and results of operations that would have occurred for the three-year period
ended December 31, 1997 had the fixed-line telecommunications businesses of
the Subsidiaries been separate legal entities during such periods. See
"Description of Business--Background," "--The Company" and Notes 1, 2 and 28
to the Consolidated Financial Statements.
At the May 22, 1998 Telebras shareholders' meeting, the shareholders
approved a specific structure for the shareholders' equity of each New Holding
Company, which included an allocation of a portion of the retained earnings of
Telebras. In this manner, the balances of capital, reserves and retained
earnings, together with the corresponding assets and liabilities, for the
formation of Tele Centro Sul Participacoes S.A. were established. Telebras
retained within its own shareholders' equity sufficient retained earnings from
which to pay certain dividends and other amounts. Telebras allocated to each
New Holding Company the balance of its retained earnings in proportion to the
total net assets allocated to each such Company. This value of allocated
retained earnings does not represent the historical retained earnings of the
New Holding Companies and resulted in an increase of R$204,689,000 in relation
to the Company's historical retained earnings. See Note 28 to the Consolidated
Financial Statements. Allocated retained earnings and future retained earnings
will be the basis from which future dividends will be payable.
iii
<PAGE>
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 financial
statements for periods ended before January 1, 1998. As a result, certain
interest income and expense relating to the cellular telecommunications
business could not be identified and, consequently, income from discontinued
operations is presented before unallocated interest income (expense) and
income tax expense. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Results of Operations for the years ended
December 31, 1995, 1996 and 1997--Allocated and unallocated interest expense
and unallocated interest income."
In connection with the formation of the Registrant, certain assets of
Telebras in addition to its interests in the Subsidiaries were spun off to the
Registrant. Such assets comprised cash and other current assets, noncurrent
assets and certain investments. See Note 28 to the Consolidated Financial
Statements, which includes a consolidated balance sheet of the Registrant
reflecting all the assets and liabilities spun off to the Registrant as of
February 28, 1998. The Registrant received R$5,292.9 million of Telebras
assets, including R$71.0 million in cash and cash equivalents. A substantial
amount of such assets (principally investment in subsidiaries) is eliminated
upon consolidation.
EFFECTS OF INFLATION
The Consolidated Financial Statements contained herein were prepared in
accordance with generally accepted accounting principles in Brazil ("Brazilian
GAAP") and are presented in Brazilian reais. Pursuant to Brazilian GAAP, the
Financial Statements and the other financial information presented herein
recognize certain effects of changes in the purchasing power of Brazilian
currency due to inflation and, unless otherwise specified, have been indexed
and expressed in constant reais of December 31, 1997 purchasing power by using
the daily changes or the monthly average values of the Unidade Fiscal de
Referencia (the Tax Reference Unit or the "UFIR") through December 31, 1995.
Until December 31, 1995, the relevant inflation index selected by the CVM
and the one used for the constant currency method under Brazilian GAAP was the
UFIR. Effective January 1, 1996, the Comissao de Valores Mobiliarios (the
Brazilian Securities Commission or "CVM"), no longer requires Brazilian
companies to restate their financial statements for reporting purposes in
constant currency by indexing historical amounts using the UFIR. Restatement
in constant currency is now optional and any general price index may be used.
The Brazilian Institute of Accountants has recommended that the Indice Geral
de Precos--Mercado (the General Prices Index-Market or the "IGP-M") be used
for this purpose. The Company's management believes that the IGP-M is the most
appropriate measure of the general price inflation in Brazil and has elected
the IGP-M for purposes of preparing its financial statements in accordance
with the constant currency method as of January 1, 1996. See Note 2 to the
Consolidated Financial Statements.
In July 1997, the three-year cumulative inflation rate for Brazil fell below
100%; however, for accounting purposes, the constant currency method has
continued to be applied. The Brazilian Institute of Accountants has not yet
published definitive rules regarding when the constant currency method of
accounting may no longer be used to prepare the Consolidated Financial
Statements. If the Brazilian Institute of Accountants determines that the
constant currency method may no longer be used to prepare the Consolidated
Financial Statements beginning January 1, 1998, the restated balances of
nonmonetary assets and liabilities of the Company as of December 31, 1997 will
become the new basis for accounting, and income statement items will no longer
be restated for inflation.
CURRENCY TRANSLATIONS
All references herein to (i) the "real," "reais" or "R$" are to Brazilian
reais (plural) and to the Brazilian real (singular), the official currency of
Brazil and (ii) "U.S. dollars," "dollars" or "US$" are to United States
dollars. As of July 1, 1994, the denomination of the Brazilian currency unit
was changed to the real from the cruzeiro real (each real being equal to 2,750
cruzeiros reais at such time). All amounts in cruzeiros reais have been
restated in reais in this Registration Statement. Certain amounts herein may
not sum due to rounding.
iv
<PAGE>
This Registration Statement contains translations of certain real amounts
into U.S. dollars solely for the convenience of the reader. These translations
should not be construed as representations that the real amounts actually
represent such U.S. dollar amounts or could be or could have been converted
into U.S. dollars at the rate indicated. Unless otherwise indicated, such U.S.
dollar amounts have been translated from reais at the commercial buying rate
for the purchase of U.S. dollars (the "Commercial Market Rate") published by
Banco Central do Brasil (the "Central Bank of Brazil") for December 31, 1997,
which was 1.1164 to US$1.00. The noon buying rate in New York City for cable
transfers in reais as certified by the Federal Reserve Bank of New York has
not been consistently reported for Brazilian currency during the periods for
which data are presented in this Registration Statement. See "Exchange Rates"
for information regarding rates of exchange.
MARKET INFORMATION
Upon the Breakup of Telebras, holders of common and preferred Telebras
shares ("Telebras Common Shares" and "Telebras Preferred Shares" and,
together, "Telebras Shares") were deemed under Brazilian law to own, in
addition to such Telebras Shares, one common or preferred share, as
applicable, of each New Holding Company for each such Telebras Share held by
them. Following the Breakup and until September 21, 1998, the Telebras Common
Shares and the common shares of the New Holding Companies traded only as a
unit on the Bolsa de Valores de Sao Paulo (the "Sao Paulo Stock Exchange"),
the Bolsa de Valores do Rio de Janeiro (the "Rio de Janeiro Stock Exchange")
and the seven other Brazilian stock exchanges (together with the Sao Paulo
Stock Exchange and the Rio de Janeiro Stock Exchange, the "Brazilian Stock
Exchanges"). Similarly, the Telebras Preferred Shares and the preferred shares
of the New Holding Companies traded only as a unit on the Brazilian Stock
Exchanges during this period. Telebras American Depositary Shares ("Telebras
ADSs"), each originally representing redeemed ownership of 1,000 Telebras
Preferred Shares, have continued to trade on the New York Stock Exchange, Inc.
(the "NYSE"), except that since the Breakup, each Telebras ADS has represented
1,000 Telebras Preferred Shares and 1,000 preferred shares of each of the New
Holding Companies. On September 21, 1998, the common shares and preferred
shares of each New Holding Company were distributed in Brazil and commenced
trading separately on the Brazilian Stock Exchanges. It is expected that
during the fourth quarter of 1998, American Depositary Shares representing
preferred shares of each New Holding Company will be issued and will commence
trading separately on the NYSE. See "Nature of Trading Market" and
"Description of Securities to be Registered--Description of American
Depositary Receipts in respect of Preferred Shares."
References herein to the "Preferred Shares" and "Common Shares" are to the
preferred shares and common shares, respectively, of the Registrant.
References to the American Depositary Shares or "ADSs" are to American
Depositary Shares, each representing 5,000 Preferred Shares. The ADSs will be
evidenced by American Depositary Receipts ("ADRs").
v
<PAGE>
GLOSSARY OF TERMS
The following explanations are not intended as technical definitions, but to
assist the general reader to understand certain terms as used in this
Registration Statement.
Access charge: Amount paid per minute charged by network operators for the
use of their network by other network operators. Also known as an
"interconnection charge" or "network usage charge".
Access gates: The points of interface between the network equipment (either
dedicated or switched) and the transmission media that connect network
equipment to the end user. The quantity of service is directly related to the
quantity of network access gates.
AMPS (Advanced Mobile Phone Service): An analog cellular telephone service
standard utilizing the 850 MHz band, in use in North America, parts of South
America, Australia and various other areas.
Analog: A mode of transmission or switching which is not digital, e.g., the
representation of voice, video or other modulated electrical audio signals
which are not in digital form.
Analog network: A network using analog technology with circuit switching,
capable of connecting one user with all the users, but with limited
transmission capacity.
ATM (Asynchronous Transfer Mode): A broadband switching technology that
permits the use of one network for different kinds of information (e.g.,
voice, data and video).
Automatic international roaming: A service which permits a subscriber to use
his or her cellular phone on a foreign cellular operator's network. The
subscriber may receive calls made to the subscriber's regular cellular number
(such calls are "automatically" passed to the foreign operator's network).
Band A Operator: A former Telebras cellular operating subsidiary that has
been granted a concession to provide cellular telecommunications services in a
particular area within a radio spectrum frequency range referred to by Anatel
as "Band A".
Band B Operator: A cellular operator that has been granted a concession to
provide cellular telecommunications services in a particular area within a
radio spectrum frequency range referred to by Anatel as "Band B".
Base station: In cellular mobile telecommunications, a radio
transmitter/receiver that maintains communications with the cellular
telephones within a given cell. Each base station in turn is interconnected
with other base stations and with the public switched telephone network.
Broadband services: Services characterized by a transmission speed of 2
Mbit/s or more. According to international standards, these services are
divided into two categories: (i) Interactive services, including
videotelephone/videoconferencing (both point-to-point and multipoint);
videomonitoring; interconnection of local networks; file transfer; CAD;
highspeed fax; e-mail for moving images or mixed documents; broadband
videotext; video on demand; retrieval of sound programs or fixed and moving
images; and (ii) Broadcast services, such as sound programs, television
programs (including high-definition TV and pay TV) and selective document
acquisition.
CATV (Cable television): Cable or fiber-based distribution of TV programs.
CDMA (Code Division Multiple Access): A standard of digital cellular
technology.
Cell: The geographic area covered by a single base station in a cellular
mobile phone system.
Cell splitting: The process of dividing cells into smaller coverage areas by
reducing their power output and the antenna height of the station transmitter.
Cell splitting increases capacity in a particular area by allowing for the
further reuse of frequencies by a mobile communications system.
vi
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Cellular service: A mobile telephone service provided by means of a network
of interconnected low-powered base stations, each of which covers one small
geographic cell within the total cellular system service area.
Channel: One of a number of discrete frequency ranges utilized by a base
station.
Digital: A mode of representing a physical variable such as speech using
digits 0 and 1 only. The digits are transmitted in binary form as a series of
pulses. Digital networks allow for higher capacity and higher flexibility
through the use of computer-related technology for the transmission and
manipulation of telephone calls. Digital systems offer lower noise
interference and can incorporate encryption as a protection from external
interference.
Digital penetration: The substitution of equipment capable of transmitting
digital signals for equipment limited to analog transmission.
Exchange: See Switch.
Frame relay: A data transmission service using fast protocols based on
direct use of transmission lines.
Internet: A collection of interconnected networks spanning the entire world,
including university, corporate, government and research networks from around
the globe. These networks all use the IP (Internet Protocol) communications
protocol.
ISDN (Integrated Services Digital Network): A system in which several
services (e.g., speech and data) may be simultaneously transmitted end-to-end
in digital form.
Leased high-speed data communication: The digital exchange of information at
speeds exceeding 64Kbps transmitted through mediums that are leased to users
for their exclusive use.
Local loop: The system used to connect the subscriber to the nearest switch.
It generally consists of a pair of copper wires, but may also employ fiber-
optic circuits, microwave links or other technologies.
Manual international roaming: A service that permits a subscriber to use his
or her cellular phone on a foreign cellular operator's network. The subscriber
may only receive calls made to a temporary number issued to the subscriber by
the foreign operator for use while roaming.
Microcells: A small cell covered by a low-power base station. Microcells can
cover small areas such as a single building.
Network: An interconnected collection of elements. In a telephone network,
these consist of switches connected to each other and to customer equipment.
The transmission equipment may be based on fiber optic or metallic cable or
point-to-point radio connections.
Network usage charge: Amount paid per minute charged by network operators
for the use of their network by other network operators. Also known as an
"access charge" or "interconnection charge."
Optical fiber: A transmission medium which permits extremely high
capacities. It consists of a thin strand of glass that provides a pathway
along which waves of light can travel for telecommunications purposes.
Packet-switched data communication services: Data services based on
parceling or breaking the data stream into packets and switching the
individual packets. Information transmitted is segmented into cells of a
standardized length, which are then transmitted independently of one another,
allowing maximization of available capacity and usage of a single transmission
path for multiple communications. The cells are then reassembled upon reaching
their destination.
vii
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PBX (Private Branch Exchange): Telephone switchboard for private use, but
linked to the national telephone network.
Penetration: The measurement of the take-up of services. As of any date, the
penetration is calculated by dividing the number of subscribers by the
population to which the service is available and multiplying the quotient by
100.
Private leased circuits: Voice, data or image transmission mediums leased to
users for their exclusive use.
PSTN (Public Switched Telephone Network): The public telephone network that
delivers basic telephone service and, in certain circumstances, more advanced
services.
Repeaters: A device that amplifies an input signal for retransmission.
Roaming: A function that enables cellular subscribers to use their cellular
phone on networks of operators other than the one with which they signed their
initial contract.
Satellite services: Satellites are used, among other things, for links with
countries that cannot be reached by cable or to provide an alternative to
cable and to form closed user networks.
SDH (Synchronous Digital Hierarchy): A hierarchy set of digital transport
structures, standardized for the transport of suitably adapted payloads over
physical transmission networks.
Sectorization: The process of dividing cells into sectors by using
directional antennae at the base station. Sectorization reduces co-channel
interference which permits smaller cells and increases network capacity.
Switch: These are used to set up and route telephone calls either to the
number called or to the next switch along the path. They may also record
information for billing and control purposes.
TDMA (Time Division Multiple Access): A standard of digital cellular
technology.
Universal service: The obligation to supply basic service to all users
throughout the national territory at reasonable prices.
Value Added Services: Value Added Services provide a higher level of
functionality than the basic transmission services offered by a
telecommunications network.
viii
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EXCHANGE RATES
There are two legal foreign exchange markets in Brazil--the commercial rate
exchange market (the "Commercial Market") and the floating rate exchange
market (the "Floating Market"). The Commercial Market is reserved primarily
for foreign trade transactions and transactions that generally require prior
approval from Brazilian monetary authorities, such as the purchase and sale of
registered investments by foreign persons and related remittances of funds
abroad. Purchases and sales of foreign exchange in the Commercial Market may
be carried out only through a financial institution in Brazil authorized to
buy and sell currency in that market. As used herein, the "Commercial Market
Rate" for any day is the commercial selling rate for Brazilian currency into
U.S. dollars, as reported by the Central Bank of Brazil. As used herein, the
"Floating Market Rate" is the prevailing selling rate for Brazilian currency
into U.S. dollars which applies to transactions to which the Commercial Market
Rate does not apply, as reported by the Central Bank of Brazil. Prior to the
implementation of the Real Plan, the Commercial Market Rate and the Floating
Market Rate differed significantly at times. Since the introduction of the
real, the two rates have not differed significantly, although there can be no
assurance that there will not be significant differences between the two rates
in the future. Both the Commercial Market Rate and the Floating Market Rate
are freely negotiated but are strongly influenced by the Central Bank of
Brazil.
On July 1, 1994 the real replaced the cruzeiro real as the unit of Brazilian
currency, with each real being equal to 2,750 cruzeiros reais. The issuance of
reais was initially subject to quantitative limits backed by a corresponding
amount of U.S. dollars in resources, but the Federal Government subsequently
expanded those quantitative limits and allowed the real to float, with parity
between the real and the U.S. dollar (R$1.00 to US$1.00) as a ceiling. On
March 6, 1995, the Central Bank of Brazil announced that it would intervene in
the market and buy or sell U.S. dollars, and established a trading band (faixa
de flutuacao) for the Commercial Market Rate (which is defined through
auction) within which the exchange rate between the real and the U.S. dollar
could fluctuate. The Central Bank of Brazil initially set the band with a
floor of R$0.86 per US$1.00 and a ceiling of R$0.90 per US$1.00 and provided
that, from and after May 2, 1995, the band would fluctuate between R$0.86 and
R$0.98 per US$1.00. Shortly thereafter, the Central Bank of Brazil issued a
new directive providing that the band would be between R$0.88 and R$0.93 per
US$1.00. On June 22, 1995, the Central Bank of Brazil issued another directive
providing that the band would be between R$0.91 and R$0.99 per US$1.00 and
subsequently reset the band on January 30, 1996 to between R$0.97 and R$1.06
per US$1.00. Upon resetting the band on January 30, 1996, the Central Bank of
Brazil adjusted the exchange rate within such band on a number of occasions,
generally in increments of R$0.001, by means of buying and selling U.S.
dollars in electronic auctions. On February 18, 1997, the band was reset by
the Central Bank of Brazil to float between R$1.05 and R$1.14 per US$1.00. On
May 5, 1998, the band was reset by the Central Bank of Brazil to float between
R$1.12 to R$1.22 per US$1.00. As of October 23, 1998, the trading band has not
been reset by the Central Bank of Brazil. There can be no assurance that the
band will not be altered in the future or that the real will maintain its
current exchange rate in future periods.
The following table sets forth the Commercial Market Rate expressed in reais
per U.S. dollar for the periods and dates indicated. Prior to July 14, 1994
the Federal Reserve Bank of New York did not publish a noon buying rate for
customs purposes in the City of New York for cable transfers in the Brazilian
real and the predecessor currencies (the "Noon Buying Rate").
<TABLE>
<CAPTION>
COMMERCIAL MARKET RATE:
NOMINAL REAIS PER US$1.00(1)
-----------------------------------
YEAR ENDED DECEMBER 31,(1) LOW HIGH AVERAGE(2) PERIOD-END
- -------------------------- ------ ------ ---------- ----------
<S> <C> <C> <C> <C>
1993....................................... 0.0044 0.1186 0.0369 0.1186
1994....................................... 0.1204 0.9815 0.6754 0.8490
1995....................................... 0.8340 0.9726 0.9227 0.9726
1996....................................... 0.9726 1.0394 1.0080 1.0394
1997....................................... 1.0395 1.1164 1.0555 1.1164(3)
1998 (through October 23).................. 1.1165 1.1911 1.1560 1.1911
</TABLE>
- --------
Source: Central Bank of Brazil
(1) Amounts expressed in nominal reais have been translated from the
predecessor Brazilian currencies in effect during the relevant period at
the rates of exchange at the times the successor currencies became the
lawful currency of Brazil.
(2) Represents the average of the month-end exchange rates during the relevant
period.
(3) The Noon Buying Rate on December 31, 1997 was R$1.1165 per U.S. dollar.
ix
<PAGE>
PART I
ITEM 1: DESCRIPTION OF BUSINESS
BACKGROUND
TELEBRAS AND THE TELEBRAS SYSTEM
Until 1972, telephone services in Brazil were provided by more than 900
independent companies, which supplied non-integrated basic telephone services.
Telebras was incorporated on November 9, 1972, pursuant to special
legislation, for the principal purposes of (i) acting as a holding company for
operating companies providing public telecommunications services in Brazil and
(ii) implementing the policies of the federal government of Brazil (the
"Federal Government") in the modernization and expansion of the Brazilian
telecommunications system. Between 1972 and 1975, Telebras, through its
subsidiaries, acquired almost all the other telephone companies in Brazil.
Telebras and its operating subsidiaries are referred to collectively herein as
the "Telebras System." Only four operating companies remained outside the
Telebras System at December 31, 1997, representing approximately 9% of all
lines in service in Brazil at that date. Telebras is controlled by the Federal
Government and the operations of the Telebras System are subject to regulation
by the Federal Government. The operating subsidiaries of Telebras were
controlled by the Federal Government until August 4, 1998. See "--Regulatory
Reform and Privatization."
At December 31, 1997, Telebras, through 28 operating subsidiaries, was the
primary supplier of public telecommunications services in Brazil. Empresa
Brasileira de Telecomunicacoes S.A.--Embratel ("Embratel"), a subsidiary of
Telebras, owned and operated all of the interstate and international telephone
transmission facilities in Brazil. Through the other 27 subsidiaries, the
Telebras System was the primary provider of local and intrastate
telecommunications services and the leading provider of cellular mobile
telephone services. The Telebras System also provided telecommunications-
related services such as data communication, sound and image transmission and
other value-added services. On January 30, 1998, each of the operating
subsidiaries other than Embratel and Companhia Telefonica da Borda do Campo--
CTBC spun off its cellular telephone operations into separate companies.
In 1997, Telebras was the second largest company in Brazil as measured by
gross revenues of R$20.7 billion.
REGULATORY REFORM AND PRIVATIZATION
Beginning in 1995, the Federal Government undertook a comprehensive reform
of regulation of the telecommunications industry. In August 1995, the federal
Constitution was amended to permit the Government to grant concessions to
private companies to provide telecommunications services. In July 1997, the
federal Congress adopted Law No. 9,472 of July 16, 1997, the Lei Geral de
Telecomunicacoes (the "Telecommunications Law"), which provided for the
establishment of a new regulatory framework, the introduction of competition
and the privatization of the Telebras System. The Telecommunications Law
established an independent regulatory agency called Agencia Nacional de
Telecomunicacoes ("Anatel"), which has begun to adopt a series of regulatory
enactments that implement the provisions of the Telecommunications Law
(together with the regulations, decrees, orders and plans issued by the
President of Brazil on telecommunications, the "Telecommunications
Regulations"). See "--Regulation of the Brazilian Telecommunications
Industry."
On May 22, 1998, in preparation for the privatization, the Telebras System
was restructured to form, in addition to Telebras, the twelve New Holding
Companies. Virtually all the assets and liabilities of Telebras were allocated
to the New Holding Companies, which, together with their respective
subsidiaries, now comprise (a) three regional fixed-line operators (including
the Company), (b) eight regional cellular operators and (c) one domestic and
international long-distance operator. Prior to the Breakup of the Telebras
System, Embratel provided all interstate telephone service and the other
subsidiaries of Telebras provided fixed-line and cellular service in their
respective territories, which, subject to limited exceptions, corresponded to
the separate Brazilian states. Following the Breakup, each of the eight
cellular operators provides cellular telephone service on Band A in one of
eight regions into which Brazil has been divided for purposes of cellular
telephone service and each of the three fixed-line operators provides local
fixed-line telephone service and intra-regional long-distance fixed-line
telephone service in one of three regions into which Brazil has been divided
for the purposes of fixed-line telephone service.
1
<PAGE>
On July 29, 1998, the Federal Government sold to twelve buyers (the "New
Controlling Shareholders") its rights to receive shares of the twelve New
Holding Companies upon the distribution of such shares. The total
consideration to be paid to the Federal Government for the twelve New Holding
Companies is R$22.1 billion. In connection with this sale, the Federal
Government assigned to the New Controlling Shareholders substantially all its
economic and voting rights with respect to the New Holding Companies and, as a
consequence, the New Controlling Shareholders now control the New Holding
Companies. Following the distribution of the shares of the New Holding
Companies, Telebras will be delisted from the New York Exchange and
liquidated.
The New Controlling Shareholder of the Registrant is Solpart Participacoes
S.A. ("Solpart"), a company owned by Techold Participacoes S.A. (19%), STET
International Netherlands N.V. (19%) and Timepart Participacoes Ltda. (62%).
For a description of the business activities of the shareholders of Solpart,
see "Control of Registrant." Solpart agreed to pay R$2.07 billion for the
Federal Government's stake in the Registrant, R$828 million of which was paid
on August 3, 1998 and the remainder of which will be paid in two equal
installments over the next two years. The entire proceeds of the sale of the
Federal Government's stake in the Registrant will be retained by the Federal
Government.
On August 20, 1998, Brazil's Minister of Communications determined that
Telebras would be dissolved and liquidated. The Minister announced that
Telebras will prepare, within the next twelve months, a liquidation plan to be
submitted to a shareholders' meeting convened to approve the dissolution of
Telebras and its subsequent liquidation.
The adoption of the Telecommunications Law and the Telecommunications
Regulations has led, and the privatization of the Telebras System will lead,
to sweeping changes in the operating, regulatory and competitive environment
for Brazilian telecommunications. The changes include (a) the establishment of
an independent regulator and the development of comprehensive regulation of
the telecommunications sector, (b) the Breakup of Telebras, (c) the sale of a
controlling interest in the Registrant to one or more new investors and (d)
the introduction of competition in the provision of all telecommunications
services. All of these developments will materially affect the Company and the
other New Holding Companies, and the Company cannot predict the effects of
these changes on its business, financial condition, results of operations or
prospects. The extensive changes in the structure and regulation of the
Brazilian telecommunications industry must also be carefully considered in
reviewing historical information and in evaluating the future financial and
operating performance of the Company.
THE COMPANY
The Registrant is one of the New Holding Companies formed upon the Breakup
of Telebras. It owns a controlling interest in nine providers of fixed-line
public telecommunications services in the western, central and southern
regions of Brazil. The nine consolidated subsidiaries of the Registrant are
listed in the chart below (the "Subsidiaries" or, individually, a
"Subsidiary"), along with the state in which they are located and the
percentage of share capital and voting stock of each subsidiary owned by the
Registrant at December 31, 1997. At December 31, 1997, the Company owned 80.0%
of the share capital and 85.7% of the voting stock of its Subsidiaries. The
Company also owns 8% of the voting capital of Companhia Riograndense de
Telecomunicacoes--CRT, the recently privatized fixed-line telecommunications
company serving the majority of the state of Rio Grande do Sul. The minority
interests in the Company are held by pension funds sponsored by public
companies, regional development funds, mutual funds and individuals who
obtained shares in the Company pursuant to the prior system of "auto-
financing" in which each new customer was required to invest in shares of
Telebras or its subsidiaries. For a discussion of auto-financing, see "--
Rates--Local Services." The shares of Telepar and Telebrasilia are listed on
the Brazilian Stock Exchanges. The shares of all the other Subsidiaries are
traded in Brazil on the over-the-counter market.
2
<PAGE>
<TABLE>
<CAPTION>
% OF SHARE % OF
CAPITAL VOTING
OWNED STOCK
BY OWNED BY
STATE SUBSIDIARY REGISTRANT REGISTRANT
- ----- ---------- ---------- ----------
<S> <C> <C> <C>
Acre.................... Telecomunicacoes do Acre S.A.--Teleacre 93.98% 98.68%
Rondonia................ Telecomunicacoes de Rondonia S.A.--Teleron 91.30 97.31
Goias/Tocantins......... Telecomunicacoes de Goias S.A.--Telegoias 83.77 80.36
Distrito Federal........ Telecomunicacoes de Brasilia 81.40 80.87
S.A.--Telebrasilia
Mato Grosso............. Telecomunicacoes do Mato Grosso 91.87 98.40
S.A.--Telemat
Mato Grosso do Sul...... Telecomunicacoes do Mato Grosso 96.01 98.90
do Sul S.A.--Telems
Parana.................. Telecomunicacoes do Parana S.A.--Telepar 67.31 81.98
Santa Catarina.......... Telecomunicacoes de Santa Catarina S.A.--Telesc 82.99 91.40
Rio Grande do Sul(1).... Companhia Telefonica Melhoramento e 78.56 81.32
Resistencia--CTMR
</TABLE>
- --------
(1) CTMR serves a small area in the state of Rio Grande do Sul which includes
the cities of Pelotas, Capao do Leao, Morro Redondo and Turucu.
The Company provides public fixed-line telecommunications services pursuant
to concessions granted to the Subsidiaries by the Federal Government (the
"Concessions"). Each Concession will expire on December 31, 2005 and may be
renewed for a further term of 20 years if the Company meets certain
obligations set forth in the Concessions. The Concessions may also be revoked
by Anatel prior to 2005 under certain circumstances. See "--Regulation of the
Brazilian Telecommunications Industry--Obligations of Telecommunications
Companies." If the Company elects to renew a Subsidiary's Concession, the
Subsidiary will be required to pay a biannual fee equal to 2% of its annual
net revenue from the provision of fixed-line public telecommunications
services in the Concession area for the prior year (excluding taxes and social
contributions) during the 20-year renewal period. See "--Regulation of the
Brazilian Telecommunications Industry--Concessions and Licenses."
The Concessions authorize the Company to operate in concession areas
covering a region (the "Region") consisting of eight states of Brazil, the
Federal District and a small part of Rio Grande do Sul, all located in the
western, central and southern regions of the country, as noted in the map
below, excluding: (a) small areas in the states of Goias and Mato Grosso do
Sul operated by Companhia Telefonica Brasil Central--CTBC, and (b) a small
area in the state of Parana, operated by Sercomtel S.A. CTBC and Sercomtel are
concessionaires who were not part of the Telebras System and continue to
operate independently. In the state of Rio Grande do Sul, the Company operates
only in the cities of Pelotas, Capao do Leao, Morro Redondo and Turucu through
Companhia Telefonica Melhoramento e Resistencia--CTMR. The Company also
supplies fixed-line telecommunications services in the locality of Rosario
located in the state of Bahia and in an area of 39,105 square kilometers in
the state of Minas Gerais as provided in an agreement between Telebrasilia and
Telecomunicacoes de Minas Gerais S.A.--Telemig, an operating subsidiary of
Tele Norte Leste Participacoes S.A. The Company expects to terminate the
agreement between Telebrasilia and Telemig by the end of 1998 and negotiations
are underway to transfer ownership of the fixed-line network and plant in the
state of Minas Gerais to Tele Norte Leste Participacoes S.A. The Company
currently holds the only Concessions to provide local fixed-line
telecommunications services in the Region, but the Telecommunications Law and
Telecommunications Regulations contemplate the introduction of limited
competition in the Region following the privatization and full competition
beginning at the earliest December 31, 2001. See "--Competition."
The Company's Concessions have been granted under the Public Regime. For a
description of the Public Regime, see "--Regulation of the Brazilian
Telecommunications Industry--Concessions and Licenses." The Company, together
with Embratel and the two other regional fixed-line companies, is one of four
companies in Brazil operating under Public Regime Concessions. As an operator
under the Public Regime, the Company is subject to certain obligations,
principally concerning the continuous provisions of service throughout the
Region ("universal service"), quality of service, and network expansion and
modernization. Anatel has the power, if
3
<PAGE>
certain of these obligations are not met, to impose penalties including
revocation of the Company's Concessions. See "--Regulation of the Brazilian
Telecommunications Industry--Obligations of Telecommunications Companies."
The Registrant's headquarters are located at SCN-Quadra 3, Bloco A,
2(degrees) Andar, Sala 202, Brasilia-DF, 70710-500, Brazil, its telephone
number is (5561)327-5552 and its fax number is (5561)327-5782.
THE REGION
The Region covers an area of 2,580,516 square kilometers, representing
30.19% of the country's total area. Its population of approximately 28 million
represents 17.3% of the total population of Brazil, and it has three
metropolitan areas with populations in excess of one million people. Per
capita income in the Region is approximately US$5,044 per year and the Region
generates approximately 18% of Brazil's gross domestic product. Approximately
24.5% of all domestic long-distance telecommunications traffic in Brazil
originates or terminates within the Region. The table below sets forth certain
key economic data for the state in which each Subsidiary operates and the
contribution made by each of the Subsidiaries to the Company's net operating
revenue and net income.
<TABLE>
<CAPTION>
% OF
% OF NET OPERATING % OF
GROSS PER REVENUE NET INCOME
POPULATION DOMESTIC CAPITA CONTRIBUTED TO CONTRIBUTED TO
PER SQUARE PRODUCT INCOME THE REGISTRANT THE REGISTRANT
STATE POPULATION KILOMETER FOR 1996 (US$) SUBSIDIARY IN 1997 IN 1997
- ----- ---------- ---------- -------- ------ ------------ -------------- --------------
<S> <C> <C> <C> <C> <C> <C> <C>
Acre 500,185 3.27 0.23 3,500 Teleacre 0.77 0.41
Rondonia 1,255,522 5.26 0.57 3,500 Teleron 2.43 0.50
Goias/Tocantins 4,783,300 7.72 2.43 4,000 Telegoias 14.73 11.83
Distrito Federal 2,900,100 498.12 2.37 6,400 Telebrasilia 16.18 20.50
Mato Grosso 2,287,846 2.52 1.09 3,700 Telemat 6.97 9.74
Mato Grosso do Sul 1,909,605 5.33 1.32 5,400 Telems 6.47 6.71
Parana 8,722,035 43.67 6.67 6,000 Telepar 32.35 23.57
Santa Catarina 4,958,339 51.91 3.29 5,200 Telesc 18.54 24.52
Rio Grande do Sul 335,036(2) -- -- -- CTMR(1) 1.56 2.22
</TABLE>
- --------
(1) CTMR serves only a small area in the state of Rio Grande do Sul which
includes the cities of Pelotas, Capao do Leao, Morro Redondo and Turucu
which represents approximately 2% of the state's GDP.
(2) Represents only those living in the CTMR Concession area.
4
<PAGE>
Set forth below is a map showing the Company's Region and the location of
the Region within Brazil.
[MAP OF BRAZIL]
The Company's business, financial condition, results of operations and
prospects depend in part on the performance of the Brazilian economy, in
general, and the Region, in particular. See "--Brazilian Economic
Environment."
CUSTOMER SERVICES
OVERVIEW
The services the Company provides and the composition of its revenues have
changed significantly as a result of the Telecommunications Law, the
Telecommunications Regulations and the Breakup and Privatization of the
Telebras System. The Company's current services include principally: (i) local
services, including installation charges, monthly subscription charges,
measured service and public telephones, (ii) intra-regional long-distance
service, (iii) data transmission, (iv) network services, including
interconnection and leasing of facilities, and (v) other services. The Company
does not sell, rent or otherwise provide telephone equipment such as handsets,
switchboards or other items. Currently, the interconnection revenues the
Company receives include fees paid by Embratel, cellular companies and other
telecommunications companies for the use of the Company's network. Prior to
April 1, 1998, the Company's interconnection revenues did not include any
revenues from Embratel. Rather than charging Embratel for interconnection, the
Company retained a fixed percentage of
5
<PAGE>
revenue from each interstate and international long-distance call that
originated on the Company's network. See "--Interregional and International
Service." The Company's revenues will be affected by increased competition,
the new regulatory environment and opportunities to offer a broader range of
services. See "--Competition" and "--Regulation of the Brazilian
Telecommunications Industry."
The following table breaks down the Company's revenue by type of service for
each of the years in the three-year period ended December 31, 1997. The
Company's tariffs for each category of service are described below under "--
Rates." Trends and events affecting the Company's operating revenue are
discussed under "Management's Discussion and Analysis of Financial Condition
and Results of Operations."
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------
1995 1996 1997
------- ------- -------
(IN MILLIONS OF REAIS)
<S> <C> <C> <C>
Local service..................................... 539.1 872.9 1,274.3
Intra-state long-distance service................. 545.4 600.1 517.8
Interstate long-distance service.................. 689.2 709.4 573.8
International long-distance service............... 78.1 74.4 65.3
Data transmission................................. 75.1 99.7 89.8
Network services.................................. 149.2 344.9 524.7
Other............................................. 24.9 35.9 40.5
------- ------- -------
Total............................................. 2,101.0 2,737.3 3,086.2
Taxes and discounts............................... (507.3) (657.3) (730.6)
------- ------- -------
Net operating revenue............................. 1,593.7 2,080.0 2,355.6
======= ======= =======
</TABLE>
LOCAL SERVICES
Local services include principally installation, monthly subscription,
measured service and public telephones. Measured service includes all calls
that originate and terminate within a single local area of the Region ("local
calls"). After the privatization of the Company, a new entrant will be granted
a license to provide local services in competition with the Company. See "--
Competition."
The Company owns and operates public telephones and telephone booths
throughout the Region. At December 31, 1997, the Company had 86,847 public
telephones, of which 69.65% could be operated with a prepaid telephone card.
The Company plans to continue to replace its coin operated telephones with
card operated telephones (at December 31, 1995 and 1996, only 20% and 42%,
respectively, of public telephones could be operated with a prepaid telephone
card). The Concessions require the Company to meet specified targets for
public telephone services. The targets proposed by Anatel require the Company
to increase the number of public telephones to 114,400 by year-end 1999. See
"--Network and Facilities--Network Expansion" and "--Regulation of the
Brazilian Telecommunications Industry--Obligations of Telecommunications
Companies--Network Expansion--General Plan on Universal Service."
INTRA-REGIONAL LONG-DISTANCE SERVICE
Intra-regional long-distance service consists of all calls that originate
within one local area and terminate within another local area of the Region
(together with interregional long-distance service, "interurban" service).
Interstate long-distance service consists of calls between states and intra-
state long-distance service consists of calls within a state. Intra-regional
long-distance service includes intra-state long-distance service and
interstate long-distance service within and between states in the Region.
Prior to the Breakup, each Subsidiary was the exclusive provider of long-
distance service that originated and terminated within the Subsidiary's
concession area. Since each Subsidiary's concession area generally coincided
with the boundaries of a state, each Subsidiary was, generally speaking, the
exclusive provider of intra-state long-distance service in the state in which
it operated. Embratel was the exclusive provider of long-distance service
between the states. By 1999, the Company and Embratel will be authorized to
provide intra-regional long-distance service. Therefore, the Company will
expand to provide long-distance service between the states of the Region and
Embratel will
6
<PAGE>
expand to provide intra-state long-distance service. Until the Company
completes its intra-regional long-distance network, the Company may lease
transmission facilities from Embratel to complete some interstate calls within
the Region.
Additionally, Anatel will grant two new licenses for the provision of intra-
regional long-distance service to new entrants. See "--Competition." The
Company expects a significant increase in long-distance services provided by
the Company since the Company estimates that during 1997 more than 70% of the
long-distance calls in the Region originated and terminated within the Region.
Of these calls, 83% were intra-state calls and 17% were calls between states
within the Region.
INTERREGIONAL AND INTERNATIONAL SERVICE
Interregional long-distance service consists of calls between a point
located within the Region and a point in Brazil outside the Region.
International long-distance service consists of calls between a point within
the Region and a point outside of Brazil. The Company is not itself authorized
to provide interregional long-distance or international service. Beginning in
2002, the Company may seek a license to provide interregional and
international long-distance service provided that it has met certain
obligations contained in the Concessions. See "--Competition" and "--
Regulation of the Brazilian Telecommunications Industry--Obligations of
Telecommunications Companies."
Prior to April 1, 1998, revenues from outgoing interstate and international
long-distance calls were divided between Embratel and the operating
subsidiaries of the Telebras System. The revenue-sharing arrangement with
Embratel was designed to equalize the return on investment of the operating
subsidiaries. Under this system, each of the Subsidiaries retained a fixed
percentage of the customer charges for outgoing interstate and international
long-distance calls and paid the balance to Embratel. The Subsidiaries
generally received no revenue from incoming interstate or international long-
distance calls. In the case of interstate collect calls, each Subsidiary and
the other state operator divided equally the portion of the customer charge
not paid to Embratel. Each Subsidiary's percentage of revenues from outgoing
calls was reset annually every March and made effective as of April 1. The
Company retained, on average, 74% of the customer charges for outgoing
interstate and international long-distance in 1997.
The following table lists, for each Subsidiary, the fixed percentage of
revenues retained by the Company from customer charges for interstate and
international long-distance calls for each of the years in the three-year
period ended December 31, 1997.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------
1995 1996 1997
------- ------- -------
<S> <C> <C> <C>
Telecomunicacoes do Acre S.A.--Teleacre...... 90% 85% 89%
Telecomunicacoes de Rondonia S.A.--Teleron... 76 70 72
Telecomunicacoes de Goias S.A.--Telegoias.... 80 76 55
Telecomunicacoes de Brasilia S.A.--
Telebrasilia................................ 69 64 56
Telecomunicacoes de Mato Grosso S.A.--
Telemat..................................... 87 78 84
Telecomunicacoes de Mato Grosso do Sul S.A.--
Telems...................................... 64 61 68
Telecomunicacoes do Parana S.A.--Telepar..... 77 76 83
Telecomunicacoes de Santa Catarina S.A.--
Telesc...................................... 90 83 42
Companhia Telefonica Melhoramento e
Resistencia--CTMR........................... 90 86 89
------- ------- -------
Company's average............................ 81% 78% 74%
</TABLE>
Effective on April 1, 1998, the system of revenue-sharing was discontinued.
The Company's relationship with Embratel, or any other provider of
interregional and international services, is now governed by interconnection
agreements regulated by Anatel under which the providers of interregional and
international services will pay the Company a network usage fee for the use of
its network. See "--Regulation of the Brazilian Telecommunications Industry"
and "--Network Services." In order to soften the impact of the discontinuation
of the revenue-sharing arrangement, the Company receives from Embratel a
supplemental per-minute rebate (Parcela Adicional de Transicao or "PAT") that
supplements the network usage charge. This supplemental per-
7
<PAGE>
minute rebate from Embratel will be gradually phased out over the next three
years. Except for the revenue from Embratel that the Company receives during
the three-year transitional period and interconnection revenues, the Company
no longer recognizes revenues from interregional and international long-
distance services. Embratel is now the only carrier of interregional and
international calls. However, the Telecommunications Regulations provide that
another long-distance carrier will be licensed following the privatization of
the Telebras System and, beginning in 2002, at the earliest, the Company may
be permitted to provide such long-distance services. See "--Competition."
NETWORK SERVICES
The Company provides access to its network to other telecommunications
companies and leases certain network facilities to other telecommunications
companies as part of its network services business. The Company increasingly
provides interconnection services to other telecommunications services
providers as a result of the spin-off of the cellular business of the
Subsidiaries, the Breakup of the Telebras System and the advent of
competition. Cellular companies, Embratel and certain licensees that operate
telecommunications services interconnect with the Company's network in order
to receive calls that originate on the Company's network, to deliver calls
that terminate on the Company's network and to transport over the Company's
network calls that originate and terminate outside of the Company's network.
Interconnection revenues consist of fees collected by the Company for such use
of its network by other telecommunications network operators (network usage
fees) and for providing a physical connection to the network. See "--Rates--
Network Services." Since July 1996, following the introduction of competition
in cellular services, the terms of interconnection between fixed-line and
cellular operators have been subject to regulation. See "--Regulation of the
Brazilian Telecommunications Industry--Rate Regulation--Network Usage
Charges."
Currently, the Company provides interconnection services to ten cellular
providers, including the cellular companies it spun off on January 30, 1998
and some operators of trunking services. In 1997, the Company signed
interconnection agreements with the Area 7 Band B cellular provider and, in
1998, the Company signed interconnection agreements with the Area 5, 6 and 7
Band A cellular providers. The Company is negotiating interconnection
agreements with the Area 5 and 6 Band B cellular providers. Shortly, the
Company will also enter into an interconnection agreement with Embratel, that
will be retroactively applied as of April 1, 1998, under which Embratel will
pay fees to the Company for the use of its local network and, in certain
cases, its intra-regional long-distance network. In addition, until the
Company completes its intra-regional long-distance network, it may lease
transmission facilities from Embratel to carry some interstate calls within
the Region. The Subsidiaries Telegoias, Teleron and CTMR expect to be net
recipients of fees under the interconnection agreement with Embratel. The
other Subsidiaries expect to make net payments of fees under the
interconnection agreement with Embratel until the Company completes
integration of its intra-regional network. The Company cannot predict whether
the interconnection agreement with Embratel will result in higher or lower
revenue for carrying interregional and international long-distance calls than
under the prior regime because it will depend on future increases or decreases
in the Company's and Embratel's market share and future increases or decreases
in traffic. See "--Interregional and International Service."
The terms of interconnection, particularly pricing and technical
requirements, may affect the Company's results of operations, its competitive
environment and its capital expenditure policies. Under the current regulatory
framework, all telecommunications service providers must provide
interconnection services on a nondiscriminatory basis. Subject to certain
requirements, providers are free to negotiate the terms of interconnection
but, in the event the parties fail to reach an agreement, Anatel will
establish the terms of interconnection. See "--Regulation of the Brazilian
Telecommunications Industry--Obligations of Telecommunications Companies--
Interconnection."
The Company also leases facilities. Other telecommunications companies,
particularly cellular companies, lease trunk lines from the Company for use
within their stand-alone networks and large corporate customers lease lines
from the Company for use within private networks connecting different internal
corporate sites.
8
<PAGE>
DATA TRANSMISSION SERVICE
The Company provides low- and high-speed data transmission services through
private leased circuits, X.25, FRAME RELAY and SMDS, using E1 networks, SDH,
ATM and IP backbones. The Company also offers data transmission services over
the public network infrastructure and provides access to Embratel's data
transmission network. Beginning in 1989, the Company invested in data
transmission capacity in response to the growing demand in Brazil for services
that require high velocity dedicated and switched digital circuits, such as
data, image and text transmission, corporate networking, Internet backbone and
video conferencing. At May 1, 1998, the Company had approximately 52,600
accesses for these services. The Company is installing an additional 8,000
access gates to increase the Company's capacity to provide data transmission
services.
OTHER SERVICES
The Company provides a variety of telecommunications services that extend
beyond basic telephone service including, value added services (0900, follow-
me, voice mail, call waiting), Internet related services (Internet Protocol
access, E-mail access), Yellow Page advertising and advertising on public
telephone cards. Telebrasilia and Telegoias also have hybrid fiber coaxial
networks that permit transmission of cable television and interactive
services. Since 1995, telecommuncations companies have been prohibited from
providing cable television services. The Company, however, plans to adapt its
hybrid fiber coaxial network to permit new providers of cable television
service and interactive services (including access to the internet) to use its
network to deliver their services. In the cable television area, competition
will take place among current providers of cable television service and new
providers that are in the process of being granted operating licenses by
Anatel. The Company expects that increased competition between the suppliers
of such services will result in greater demand for its network.
QUALITY OF SERVICE
The following table gives certain basic measures of the quality of
telecommunications services for each year in the five-year period ended
December 31, 1997.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------
1993 1994 1995 1996 1997
----- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C>
Repair requests per 100 installed access
lines.................................... 3.32 3.25 3.54 3.34 3.28
Response rate to repair requests
(percentage)(1).......................... 93.01 93.15 91.49 89.05 89.26
Rate of obtaining dialing tone with 3
seconds (percentage)..................... 98.86 98.77 99.00 N/A(2) N/A(2)
Call completion rate (direct-dialed
domestic long-distance calls)
(percentage)............................. 53.48 53.64 54.11 56.17 57.44
</TABLE>
- --------
(1) Response within 24 hours after request was made.
(2) As of 1996, Telebras stopped measuring this quality of service indicator.
The Company is required under the Telecommunications Regulations to meet
certain quality of service targets, including maximum periods to obtain a dial
tone, completed calls as a percentage of attempted calls, repair requests and
response rate to such requests, operator response periods and other measures
of service quality. See "--Regulation of the Brazilian Telecommunications
Industry--Obligations of Telecommunications Companies--Quality of Service--
General Plan on Quality." The Company has identified the quality of service
targets that the Company expects will be most difficult to meet, those the
Company expects to meet with medium difficulty and those the Company expects
to meet with relative ease. The targets the Company expects will be most
difficult to meet are call completion rates, maximum monthly repair requests
and the targeted response times to public telephone repair requests. As of
February 1998, the Company's rate of call completion was 57.89% for direct-
dialed domestic long-distance calls and 56.67% for local calls. The Company is
obligated by year end 1999 to increase the rate of call completion for local
and domestic long-distance calls to 60%. The Company expects that congestion
on the Company's network will decrease as the Company expands its own network.
However, the Company also anticipates future traffic problems at switching
stations as a result of the
9
<PAGE>
change in the numbering system. Anatel expects to implement the Numbering Plan
(Plano de Numeracao) in mid-year 1999. The Numbering Plan, as contemplated in
the current draft, will permit a customer to specify a long-distance carrier
by dialing three additional digits. The Numbering Plan will also increase from
7 to 8 the number of digits of individual telephone numbers. The Company also
expects that the Numbering Plan will cause the Company to accelerate the rate
at which the Company substitutes its analog switching centers for digital
switching centers, thereby accelerating the time by which the Company will
meet many other quality of service targets. Currently, the Company receives a
monthly average of 0.0328 repair requests per line and 0.32 public telephone
repair requests per line. The Company is obligated by year end 1999 to reduce
average monthly repair requests to 0.03 per line and 0.15 per line for public
telephones. In order to meet these targets, the Company expects to
significantly increase spending on systems to detect defects and supervise
repair. The Company also expects to invest in technology that will improve the
functioning of public telephones. By year-end 1999, the Company is obligated
to respond to 95% of public telephone repair requests within eight hours.
Currently, the Company responds to 88% of public telephone repair requests
within 24 hours. To meet this target, the Company expects to significantly
increase maintenance personnel. The Company expects to meet the target for
billing inaccuracy with average difficulty. Customer complaints of inaccurate
bills largely involve amounts due for 900 calls. All other targets the Company
has already met or expects to meet without difficulty.
RATES
Rates for telecommunications services provided by the Company are subject to
comprehensive regulation. See "--Regulation of the Brazilian
Telecommunications Industry--Rate Regulation." Since the relative
stabilization of the Brazilian economy in mid-1994, there have been two major
changes in rates for local and long-distance services. Effective in January
1996, rates for all services were increased, primarily to compensate for
accumulated effects of inflation. Effective in May 1997, the rate structure
was modified through a tariff rebalancing that resulted in higher charges for
measured service and monthly subscription, and lower charges for intra-
regional, interregional and international long-distance services. Monthly
subscription charges, for example, were increased by 270% for residential
customers and 59% for commercial customers. The Company believes that monthly
subscription charges are now generally in line with such charges in other
countries.
LOCAL SERVICES
The Company's revenue from local services consists principally of activation
and installation charges, monthly subscription charges, measured service
charges and public telephone charges.
Users of measured service, both residential and nonresidential, pay for
local calls on usage. Usage is measured in pulses. Pulses occur system-wide
every four minutes for local calls. These system-wide pulses are recorded
independently of when individual calls are actually made. In addition to
system-wide pulses, the system records one pulse for every call when the call
is connected. After the first pulse, only system-wide pulses are used in
determining the charge for a call. As a result, the time between the first
pulse and the second (system-wide) pulse may vary. For example, for a call
being charged using four-minute pulse increments, the time between the first
pulse and the second (system-wide) pulse may vary between one second and four
minutes. Approximately 72% of the Company's customers use over 90 pulses per
month.
For normal weekday calls, local call charges are determined by multiplying
the number of pulses by the charge per pulse. For calls being made any day
between midnight and 6:00 a.m., in addition to Saturdays from 2:00 p.m. to
midnight and all day Sunday and holidays, a caller is charged for only one
pulse regardless of the duration of a call. Each customer receives a total of
90 free pulses per month. Measured service charges are the same for all
customers.
10
<PAGE>
Since May 1997, the monthly subscription charge in nominal terms (including
taxes) has been R$13.82 for residential customers, R$20.73 for commercial
customers and R$27.64 for users of PBX systems and the price of one pulse
(including taxes) has been R$0.08. In 1997, monthly subscription charges
accounted for 35% of local service revenues. The following table illustrates
changes in subscription charges and measured service charges for local
telephone service for each year in the three-year period ended December 31,
1997 in constant reais of December 31, 1997 purchasing power.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------
1995 1996 1997
------- ------- -------
(IN REAIS)
<S> <C> <C> <C>
Average rates for local telephone service(1)
Monthly subscription:
Residential...................................... 0.82 3.00 7.78
Commercial....................................... 7.28 10.46 13.50
PBX.............................................. 9.41 13.94 18.00
Measured service (per local pulse)................. 0.025 0.038 0.054
</TABLE>
- --------
(1) Average of monthly average rates, net of value-added taxes.
Prior to May 1997, under a system called "auto-financing", each new customer
was required to invest in shares of Telebras or its subsidiaries. The amount
to be invested varied from time to time but was very substantial. In 1996, for
example, the required investment for a new line was R$1,117.63. Auto-financing
was phased out in 1997, and since July 1997 the installation charge, which was
initially R$300, has been reduced to R$80 in October 1997 and to R$50 in March
1998. The Company also charges an activation fee of R$48 when a customer
changes addresses.
INTRA-REGIONAL LONG-DISTANCE SERVICE
Currently, rates for intra-regional long-distance calls are computed on the
basis of the time and day, duration and distance of a call and use of special
services, such as operator assistance. Some intra-regional calls made within
the same area code may also be measured by pulses. Rates for domestic long-
distance (whether intra-regional or inter-regional) are uniform throughout
Brazil. See "--Regulation of the Brazilian Telecommunications Industry--Rate
Regulation."
The following table illustrates the historical changes in the Company's
average domestic long-distance rates for the periods indicated in constant
reais of December 31, 1997 purchasing power.
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
------------------------
1993 1994 1995 1996 1997
---- ---- ---- ---- ----
(IN REAIS)
<S> <C> <C> <C> <C> <C>
Domestic long-distance rates(1):
0 to 50 km........................................ 0.79 0.46 0.46 0.42 0.32
50 to 100 km...................................... 1.32 0.78 0.76 0.70 0.54
100 to 300 km..................................... 1.98 1.18 1.16 1.07 0.81
over 300 km....................................... 2.65 1.57 1.53 1.40 1.08
</TABLE>
- --------
(1) Rates for a domestic long-distance call, three minutes in duration
between the hours of 9:00 a.m. and 12:00 p.m. and 2:00 p.m. and 6:00 p.m.
(peak hours) on weekdays, net of value-added taxes.
11
<PAGE>
NETWORK SERVICES
The Company's revenue from network services consists primarily of two basic
categories: payments from other providers on a per-minute basis to terminate
calls using the Company's network and payments from other providers on a
contractual basis to use part of the Company's network. On a per-minute basis,
other providers pay the Company a network usage charge to terminate a call on
the Company's network. The network usage charge varies depending on whether
the provider uses the Company's local or long-distance network. Similarly, the
Company pays other fixed-line providers a network usage charge to terminate a
call on another fixed-line network and the Company pays cellular providers a
network usage charge to terminate a call on a cellular network. Cellular
telephone service in Brazil, unlike in North America, is offered on a "calling
party pays" basis. Under the policy of a calling party pays, a cellular
service subscriber generally pays cellular usage charges only for calls made
by the cellular subscriber and not for calls received. Calls received by a
cellular subscriber are paid for by the party that places the call in
accordance with a rate based on cellular per minute charges. For example, a
fixed-line customer pays a rate based on cellular per minute charges for calls
made to a cellular subscriber. The cellular base rate per minute charges are
generally VC1 for calls within the locality, VC2 for calls outside the
cellular subscriber's registration area, and VC3 for calls outside the
concession region in which the registration area is located. The Company
charges its fixed-line customers per minute charges based on either VC1, VC2,
or VC3 rates when a fixed-line customer calls a cellular subscriber. In turn,
the Company pays the cellular service provider the mobile network usage
charge.
The Company's revenue from network services also includes payments from
other telecommunications providers arranged on a contractual basis to use part
of the Company's network. Other providers, such as providers of trunking and
paging services, use the Company's transmission lines to connect a central
switching station to the Company's network. Some cellular providers use the
Company's network to connect cellular central switching stations to the
cellular radio base stations.
The table below sets forth the average rates charged by the Company for
network services charged on a per-minute basis in the three year period ended
December 31, 1997.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------
1995 1996 1997
-------- -------- --------
(IN REAIS)
<S> <C> <C> <C>
Network usage rate (local)........................... 0.027 0.033 0.038
Network usage rate (long-distance)................... 0.054 0.060 0.064
Cellular base rates per minute:
VC1................................................ 0.220 0.262 0.270
VC2................................................ 0.480 0.576 0.580
VC3................................................ 0.600 0.660 0.660
</TABLE>
DATA TRANSMISSION
The majority of revenue from data transmission services is generated by
monthly line rental charges for private leased circuits. The balance consists
mainly of nominal charges for access to the data transmission network and
measured charges based on the amount of data transmitted. The Company has a
discount policy that takes into account the length of the agreement and the
number of leased circuits. Effective in May 1997, line rental charges for
private leased circuits were reduced by 42%. In March 1998, the Company
adopted a discount policy for private lease circuits and the industrial use of
2Mbps circuits, focusing primarily on major corporate customers and
telecommunications service providers. The discounts are a function of duration
of the contract (from a 10% discount for a two-year contract up to 30% for a 5
year contract) and the contracted bandwidth (from a 5% discount for a minimum
of 51 circuits up to 25% for more than 500 circuits). In June 1998, the
Company revised the policy by focusing specifically on the telecommunications
services providers market. The Company offers a discount for the industrial
use of 2Mbps circuits based on the duration of the
12
<PAGE>
contract (from a 10% discount for a one-year contract up to 20% for a three-
year contract) and contracted bandwidth (from a 5% discount up to 48%,
depending on distances). Package switching data transmission services are also
a significant source of revenue for the Company. The following table
illustrates the Company's monthly line rental charges (including customer
discounts) for private leased circuits service for each year in the three-year
period ended December 31, 1997 in constant reais of December 31, 1997
purchasing power.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------
1995 1996 1997
--------- --------- ---------
(IN REAIS)
<S> <C> <C> <C>
Average rates for monthly line rental per
leased circuit:
Local circuit
4.8 kbits--digital modem................ 165.47 293.27 200.06
4.8 kbits--analog modem................. 514.69 293.27 200.06
9.6 kbits--digital modem................ 184.43 448.93 223.81
9.6 kbits--analog modem................. 833.74 448.93 223.81
64 kbits................................ 1,605.04 1,152.43 474.43
2 Mbits................................. 10,292.63 8,312.51 5,284.49
Long-distance circuit(1)
4.8 kbits/second capacity............... 2,157.93 1,790.20 962.53
9.6 kbits/second capacity............... 3,236.94 2,608.02 1,112.04
64 kbits/second capacity................ 9,178.15 5,940.72 2,335.00
2 Mbits/second capacity................. 58,829.47 45,844.62 29,088.43
</TABLE>
- --------
(1) Average of monthly average rates, net of value-added taxes, assuming a
transmission distance between 300 and 500 kilometers and a 3-year
contract.
TAXES ON TELECOMMUNICATIONS SERVICES
The cost of all telecommunications services to the customer includes a
variety of taxes. The Company deducts the amount of such taxes to present net
operating revenue. The principal tax is a state value-added tax, the Imposto
sobre Circulacao de Mercadorias e Servicos ("ICMS"), which the Brazilian
states impose at varying rates on revenues from the provision of
telecommunications services. The rate in the states that comprise the Region
is 25% for domestic telecommunications services, except the rate for Acre
which is 17%.
On June 19, 1998 the secretaries of the treasury of the individual Brazilian
states approved an agreement to interpret existing Brazilian tax law to
broaden the application of the ICMS to cover not only telecommunications
services, but also other services, including cellular activation, which had
not been previously subject to such tax. Pursuant to this new interpretation
of existing tax law, the ICMS tax may be applied retroactively for such
telecommunications services rendered during the last five years.
The Company believes that the attempt by the state treasury secretaries to
extend the scope of ICMS tax to services which are supplementary to basic
telecommunications services is unlawful because: (i) the state secretaries
acted beyond the scope of their authority; (ii) their interpretation would
subject certain services to taxation which are not considered
telecommunications services; and (iii) new taxes may not be applied
retroactively.
Each of the Registrant's Subsidiaries has filed lawsuits with the Treasury
Court of the Brazilian states in which such Subsidiaries are incorporated
seeking injunctive relief from prospective application of the ICMS tax to
activation fees. All of the Subsidiaries, except for Telemat, have obtained
from the applicable Treasury Court a temporary injunction relieving such
Subsidiary from payment of prospective ICMS taxes with respect to activation
fees during the pendency of the lawsuit. The taxation authorities of the
states where the lawsuits are pending may appeal the decisions of the Treasury
Court to grant temporary injunctions. There can be no assurance that the
Subsidiaries would ultimately prevail in any appeals relating to the temporary
injunctions or
13
<PAGE>
in the underlying litigation with respect to application of the ICMS tax to
activation fees. If the 25% ICMS tax were applied retroactively to activation
fees earned by the Company during the last five years, it would give rise to a
maximum liability estimated at R$128.1 million. Management does not believe
that the payment of retroactive ICMS taxes is probable and, therefore, no
provision for loss with respect to retroactive application of the ICMS has
been made or is expected to be made in the Company's consolidated financial
statements. Management does not believe that the application of the ICMS tax
on a prospective basis will have a material impact on the Company's results of
operations.
Other taxes on operating revenues include two federal social contribution
taxes, the Programa de Assistencia aos Servidores de Empresas Publicas
("PASEP") (0.65%) and the Contribuicao para Financiamento da Seguridade Social
("COFINS") (2.0%). The average rate of all such taxes, as a percentage of the
Company's gross operating revenues, was 25.67% in 1997.
NETWORK AND FACILITIES
GENERAL
The Company's network consists of installed lines and exchanges, a network
of access lines connecting customers to exchanges, and long-distance related
systems. At December 31, 1997, the Company's regional telephone network
included approximately 3.6 million installed lines, of which 3.1 million were
lines in service. Of the access lines in service at that time, 68.1% were
residential lines, 26.3% were commercial lines (including PBX lines) and 2.7%
were public telephone lines. Intra-regional long-distance transmission is
provided by a microwave network and by fiber optic cable. In 1997, the Company
provided services to 1,359 municipalities, representing 99.78% of all
municipalities in the Region.
The following table gives certain basic measures of the development of the
Company's network for each year in the five-year period ended December 31,
1997.
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
------------------------
1993 1994 1995 1996 1997
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Installed access lines (millions) (at period end).... 2.3 2.4 2.8 3.1 3.6
Access lines in service (millions) (at period end)... 2.0 2.2 2.5 2.8 3.2
Average access lines in service (millions)........... 1.9 2.1 2.3 2.6 2.9
Lines in service per 100 inhabitants (at period
end)................................................ 7.9 8.3 9.3 10.2 11.3
Percentage of installed access lines connected to
digital exchanges................................... 35.1 41.6 55.2 63.6 74.2
Employees per 1,000 access lines installed (at period
end)................................................ 6.63 6.57 5.18 4.57 3.25
Number of public telephones (thousands).............. 48.4 54.7 58.9 72.9 86.8
Local call pulses (billions)......................... 8.9 9.3 9.3 9.5 9.9
Domestic long-distance call minutes (billions)....... 3.2 3.7 4.4 5.2 5.6
International call minutes (millions)................ 18 23 37 45 55
</TABLE>
The Company believes that the unmet demand for fixed-line telecommunications
services in the Region is substantial. At December 31, 1997, 29% of the
households and 74% of the businesses in the Region had local telephone
service. Prior to the privatization, growth of lines in service was restricted
by government limits on capital expenditures and the high cost to customers of
obtaining service. See "--Capital Expenditures." In 1997, the Company
experienced a significant increase in applications for new lines, because the
cost to the customer of installing new lines significantly decreased following
the elimination of auto-financing. See "--Rate--Local Services." The customer
waiting period for the installation of a new line varies significantly
depending on the access network and the capacity of the switching center that
serves the locality. Approximately 1.6 million people are currently wait-
listed. The potentially long wait has resulted in a large secondary market for
the sale of telephone lines.
The Company began to install digital exchanges in 1989 and optical fiber
cable in 1986. Compared to the older analog technology, digital systems
improve the quality and efficiency of the network, accommodate higher
14
<PAGE>
traffic levels, require less maintenance and permit the Company to offer a
broad range of value added services simultaneously on the same network, such
as voice, text and data applications. Optical fiber provides greater
transmission capacity and significantly reduces the fading of signals, and
requires less frequent amplification, thereby reducing the cost of providing
service and increasing traffic and network reliability. Beginning in 1993, all
new lines installed by the Company were connected to digital exchanges and
during 1997, 10.43% of existing analog lines were converted to digital lines.
At December 31, 1997, 73.7% of all installed lines were connected to digital
exchanges. By year-end 1997, the Company had installed 209,600 kilometers of
optical fiber, 98,701 kilometers were installed during 1997. By the end of
2002, the Company plans to have replaced almost all of its analog exchanges
with digital exchanges.
In January 1998, the Company commenced various projects to turn the intra-
state transmission systems of the Subsidiaries into a network capable of
providing intra-regional service. The Company is in the process of integrating
its network and optimizing its gateway architecture to improve intra-regional
transmission. The Company hopes to complete the integration of its intra-
regional network by December 1998 but the Company can give no assurance that
the Company will meet this goal. The Company also plans to utilize new
technologies such as an orbital satellite position and establish strategic
partnerships to expand and diversify the range of services the Company can
offer. Subject to final approval by Anatel, the Company will be granted the
option to use Wireless Local Loop ("WLL") technology in localities with less
than 50,000 inhabitants. New entrants will be allowed to use the WLL
technology in localities with population above or below 50,000 inhabitants.
The Company will also be allowed to use the WLL technology in localities with
population above 50,000 inhabitants if the new entrant decides not to provide
services to that locality. The Company's planned network expansion will permit
the Company to expand nationally and internationally when authorized by Anatel
and help the Company meet quality and universal service obligations as
established by Anatel. See "--Regulation of the Brazilian Telecommunications
Industry--Obligations of Telecommunications Companies."
NETWORK EXPANSION
The Company is required under the Telecommunications Regulations to meet
certain targets regarding network expansion and modernization. The Company
estimates that these targets will require the Company to expand its network by
approximately 13% per year for 6 years. See "--Regulation of the Brazilian
Telecommunications Industry--Obligations of Telecommunications Companies--
Network Expansion--General Plan on Universal Service." The Company has
identified the targets that the Company expects will be most difficult to
meet, those the Company expects to meet with medium difficulty and those the
Company expects to meet with relative ease. The targets the Company expects
will be most difficult to meet are average waiting period for the installation
of a line and installation of public telephones. The Company is obligated to
reduce the average waiting time for installation of a line by year end 2001 to
four weeks. Currently, the average waiting time is 65 weeks. This target is
especially difficult to meet in low population areas. The Company believes
that prior to privatization, the Company would not have been able to comply
with these targets. However, following privatization, demand will be met more
readily as competitors enter the market and the Company expands its own
network without government-imposed restrictions on investments. See "--
Competition" and "--Capital Expenditures." The Company is obligated to install
114,400 public telephones by year end 1999, 50% with local and domestic long-
distance direct-dial capability and 25% with international long-distance
direct-dial capability. Currently, the Company has 86,800 public telephones
installed, approximately 91% with local and domestic long-distance direct-dial
capability and 1% with international long-distance direct-dial capability. All
other targets the Company has already met or expects to meet without any
difficulty.
BILLING AND ADMINISTRATION
The Company bills its customers for all calls made by its customers. The
Company receives network usage fees when calls from cellular carriers or other
fixed-line carriers terminate calls on its network and conversely, the Company
must pay network usage fees when calls from its customers terminate on the
network of a cellular carrier or one of the other fixed-line carriers. See "--
Rates--Network Services." After the collection cycle is over, the Company, the
cellular carriers and the other fixed-line carriers jointly reconcile the
amounts collected
15
<PAGE>
from customers against the amounts due to each carrier and pay the net amounts
outstanding to the appropriate parties. For international and domestic long-
distance calls, the Company charges Embratel a fee for the use of its local
network and forwards the amount collected from its customers for such calls to
Embratel.
The Company sends each customer a monthly telephone bill covering all the
services provided during the prior period. Customers are grouped in billing
cycles based on the date the bill is issued. The telephone bill separately
itemizes long-distance calls, calls made on a cellular network, 0800 and 0900
services and other value added services. 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 method of payment is at the option
of each customer.
During 1997, the Company blocked the service of approximately 2,742 thousand
lines (counting each occasion on which a line was blocked during the year),
and approximately 97.61% of such lines were unblocked following payment of the
overdue amounts. The Company charges interest at a rate of approximately 1%
per month plus a one-time late charge of 2% of the total amount outstanding.
At December 31, 1997, 13% of all receivables were outstanding for more than
30 days and 6% of all receivables were outstanding for more than 90 days.
Under previous regulations, the Company was not permitted to disconnect a
customer until a receivable has been outstanding for over 90 days. The
Concessions now authorize the Company to disconnect a customer after 30 days
with prior notice of 15 days. The Company's future disconnection policy will
depend on factors such as the level of unmet demand, the level of competition
and regulation governing disconnection. For a discussion of provisions for
past due accounts, see "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Results of Operations for the years ended
December 31, 1995, 1996 and 1997--Operating expenses--Selling expense."
COMPETITION
Since 1995, Brazil has adopted sweeping regulatory changes intended to
foster competition in the provision of telecommunications services. See "--
Background--Regulatory Reform and Privatization." Under the Telecommunications
Law and Telecommunications Regulations, Anatel is required, promptly after the
privatization is effected, to open the markets for local, intra-regional long-
distance, interregional long-distance and international long-distance services
to competition by granting licenses to new entrants. Anatel is required to
authorize three new entrants to provide local telephone service and intra-
regional long-distance telephone service, with each of the three new entrants
receiving two licenses to provide such services in a single fixed-line region.
Anatel is also required to authorize one new entrant to provide intra-
regional, interregional and international long-distance service by granting
licenses to provide such services throughout Brazil.
The Company and Embratel, the former long-distance carrier of the Telebras
System, will also be authorized to provide intra-regional long-distance
service. Therefore, the Company will expand to provide long-distance service
between the states of the Region, whereas prior to the privatization the
Company's long-distance service was limited to intra-state long-distance, and
Embratel will expand to provide intra-state long-distance service, whereas
prior to the privatization Embratel's long-distance service was limited to
interstate long-distance. The Company expects to significantly increase the
long-distance services provided by the Company since during 1998, more than
70% of the long-distance calls in the Region originated and terminated in the
Region. Of these calls, 83% were intra-state calls and 17% were calls between
states within the Region. See "--Customer Service--Intra-Regional Long-
Distance Service." The Company expects that Embratel will begin to compete
directly with the Company by starting to provide intra-state long-distance
service in the Region, and by continuing to provide interstate long-distance
service in the Region. Although the Company cannot predict the scope of
Embratel's activities or the effect of competition from Embratel, Embratel may
be a powerful competitor.
The licenses Anatel will provide to new entrants for the provision of intra-
regional long-distance service will be issued in the Private Regime and, as a
result, the licensees will not be subject to the same obligations to which
concessionaires operating in the Public Regime are subject. See "--Regulation
of the Brazilian
16
<PAGE>
Telecommunications Industry--Concessions and Licenses." Beginning in 2002,
Anatel may grant an unlimited number of additional licenses for the provision
of local, intra-regional long-distance, interregional long-distance and
international long-distance services. See "--Regulation of the Brazilian
Telecommunications Industry--Concessions and Licenses."
The Company is currently the exclusive provider of local service in the
Region, but the new operator to be authorized by Anatel will compete with the
Company in the provision of local service. Beginning in 2002, the Company may
face an unlimited number of competitors in local and intra-regional long-
distance, and it may itself seek a license to provide interregional and
international long-distance service provided that it has met certain
obligations contained in the Concession. See "--Regulation of the Brazilian
Telecommunications Industry--Obligations of Telecommunications Companies."
The Company's fixed-line services are also subject to competition from
providers of cellular telephone service. There are currently nine Band A
cellular operators in the Region that were spun-off from the Subsidiaries in
January 30, 1998: Teleacre Celular S.A., Teleron Celular S.A., Telegoias
Celular S.A., Telebrasilia Celular S.A., Telemat Celular S.A., Telems Celular
S.A., Telepar Celular S.A., Telesc Celular S.A. and CTMR Celular S.A. Three
additional Band A cellular telephone service operators also operate in the
Region: CRT Celular S.A., Sercomtel S.A., and CTBC Telecom S.A. There are
currently three Band B operators authorized to operate or currently operating
in the Region: Global Telecom Ltda., authorized to operate in the states of
Parana and Santa Catarina, Telet S.A., authorized to operate in the state of
Rio Grande do Sul and Americel S.A., currently operating in the states of
Acre, Rondonia, Mato Grosso do Sul, Mato Grosso, Tocantins, Goias and the
Distrito Federal.
The exact identity of other new entrants, the scope of increased competition
and any adverse effects on the Company's results and market share will depend
on a variety of factors that cannot now be assessed with precision and that
are beyond the Company's control. Among such factors are the business
strategies and capabilities of potential competitors, prevailing market
conditions at the time increased competition is permitted, the regulations
applicable to new entrants and the Company, and the effectiveness of the
Company's efforts to prepare for increased competition. One or more new
competitors may have technical or financial resources greater than those of
the Company. There can be no assurance that the entry of new competitors will
not have a material adverse effect on the Company's business, financial
condition, results of operations or prospects.
The Company is subject to comprehensive regulations that limit its ability
to set tariffs for its various services and that may limit is ability to
engage in activities that are considered to be anti-competitive. Such
regulations may limit the Company's ability to confront competition. See "--
Regulation of the Brazilian Telecommunications Industry."
EMPLOYEES
As of December 31, 1997, the Company had 13,945 employees. All of the
Company's employees are employed on a full-time basis, grouped according to
the following functions: corporate management (1.7%), marketing (1.8%), plant
expansion and modernization (14.1%), plant operation and maintenance (31.8%),
client services (20.8%), human resources (2.4%), budget and finance (4.8%),
supplies (2.8%), informations services (4.4%), administrative support (3.9%)
and general administration (11.5%).
Approximately 80.32% 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, 1998. The Company's management considers the relations
17
<PAGE>
of the Company with its work force to be satisfactory. The Company has never
experienced a work stoppage that had a material effect on its operations.
The Company participates in a pension fund established by Telebras, Fundacao
Sistel de Seguridade Social ("Sistel"), the primary purpose of which is to
supplement government-provided retirement benefits. The Company participates
in Sistel and makes monthly contributions to Sistel currently equal, on
average, to 13.5% of the total salaries of all employees who are Sistel
members. Each employee member also makes a monthly contribution to Sistel
based on age and salary (currently around 7.5% of their salaries). Members of
Sistel qualify for full pension benefits after reaching age 57 provided they
have been members of Sistel for at least ten uninterrupted years and have been
affiliated with the social security system during at least 35 years. Sistel
operates independently from the Company and Telebras, and its assets and
liabilities are fully segregated from those of the Company and Telebras. See
Note 21 to the Consolidated Financial Statements. Employees of the Company at
the time of the privatization have the right to maintain their rights and
benefits in Sistel in accordance with the terms in place at that time.
Telepar is the only Subsidiary that has offered to its employees a
complementary pension plan in addition to that offered by Sistel. In June of
1998, Telepar and 1,978 employees out of a total of 2,218 employees covered
under the complementary pension plan signed an agreement ending the employees'
rights to complementary benefits. The remaining 240 employees who did not
accept the agreement continue to be covered by the plan.
RESEARCH AND DEVELOPMENT
Until the Breakup of Telebras, the Company and the other companies of the
Telebras System were required to contribute to the research and development
center operated by Telebras (Centro de Pesquisa e Desenvolvimento da
Telebras--CPqD or the "Center") and also conducted some of their own
independent research and development. The Company's aggregate expenditures on
research and development were R$16.1 million, R$16.9 million and R$16.1
million for 1995, 1996 and 1997, respectively.
Following the Breakup of Telebras, the Center will become a private
independently administered nonprofit foundation financed with resources from
the public and private sector and will continue to develop telecommunications
technology. Pursuant to three year contracts signed in May 1998 between the
Telebras and each Subsidiary, the Company is obligated to contribute with a
total of R$ 63.3 million to the Center during a three- year period ending May
2001. During the effectiveness of this agreement, the Company has access to
telecommunications software developed and maintained by the Center and other
technological services provided by the Center such as equipment testing and
consulting and training services. It is possible that the Center will also
provide such services to third parties on a fee-for-service basis. The Company
may request additional technological support from the Center, more than
contemplated in the agreement, by contributing additional funds to the Center.
The Company conducts independent research and development in areas of
telecommunications services but does not independently plan to develop new
telecommunications hardware. The Company primarily depends on manufacturers of
telecommunications hardware for the development of new hardware.
CAPITAL EXPENDITURES
The primary focus of the Company's capital expenditure program has been the
expansion, modernization and digitalization of the network.
Prior to the privatization of Telebras, capital expenditures were planned
and allocated on a system-wide basis and were subject to approval by the
Ministry of Communications. In addition, the budget for capital expenditures
of the Telebras System was included in the annual budget of the Federal
Government and had to be
18
<PAGE>
approved by the federal Congress. In 1995, the Federal Government instituted a
broad investment program for public and private businesses in the
communications and postal sectors for the years 1995 through 1999 (Programa de
Recuperacao e Expansao dos Sistemas de Telecomunicacoes e Postal--PASTE or
"PASTE"). The Telebras System was required to conform its annual capital
expenditure budget to the guidelines set by PASTE. The companies that
comprised the Telebras System were further required to comply with public
bidding processes prior to hiring third-party contractors.
Since the privatization of Telebras, the Company's capital expenditures have
not been subject to prior government approval nor government-imposed spending
limits nor public bidding processes. The Company is now permitted to determine
its own capital expenditure budget, subject to compliance with certain
obligations to expand services under the Concessions. See "--Regulation of the
Brazilian Telecommunications Industry--Obligations of Telecommunications
Companies." In addition, the financing of capital expenditures is no longer
carried out on a system-wide basis, and the Company is required to obtain its
own financing. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Liquidity and Capital Resources."
The 1998 annual capital expenditure budget for the Telebras System includes
capital expenditures of the Company. The Company anticipates capital
expenditures for the first eight months of 1998 will be R$719.1 million which
is expected to be funded with debt and other sources (44%) and internally
generated funds from operations (56%). The Company expects, however, that as a
result of the privatization of Telebras, all capital expenditures will be
subject to revision by management and the new controlling shareholders of the
Company.
The following table sets forth, in constant reais of December 31, 1997
purchasing power, the Company's capital expenditures for each year in the
four-year period ended December 31, 1997.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------
(IN MILLIONS OF REAIS)
------------------------
1995 1996 1997
--------------- --------
<S> <C> <C> <C>
Operational investments(1)............................. 65.5 81.8 72.7
Telephone equipment:
General:
Exchanges.......................................... 109.2 193.2 263.5
Transmission....................................... 112.8 155.4 124.2
Outside plant...................................... 111.2 196.3 233.0
Real estate and power.............................. 53.9 44.1 22.5
Specialized networks............................... 14.7 -- 2.3
------ -------- --------
Total............................................ 401.8 589.0 645.5
Data transmission equipment............................ 39.9 39.4 46.2
Other Investments...................................... 398.7 388.5 360.6
------ -------- --------
Total capital expenditures....................... 905.9 1,098.7 1,125.0
====== ======== ========
</TABLE>
- --------
(1) Operational investments include investments to replace plant equipment and
other fixed assets generally without altering the capacity of the asset
replaced and certain investments in operational and technical support,
such as telecommunications management network systems.
REGULATION OF THE BRAZILIAN TELECOMMUNICATIONS INDUSTRY
GENERAL
The Company's business, including the services it may provide and the rates
it charges for telecommunications services, is regulated by Anatel pursuant to
the Telecommunications Law, the regulations, decrees, orders and plans issued
thereunder and the Concessions granting the Company the right to provide
certain telecommunications services, subject to certain obligations contained
in the Concessions (the "List of Obligations").
19
<PAGE>
BACKGROUND
From 1962 until 1967, the Brazilian telecommunications sector was regulated
by the Conselho Nacional de Telecomunicacoes (the "National Council of
Telecommunications"), and from 1967 until 1997 by the Ministry of
Communications, pursuant to Law No. 4,117 of August 27, 1962, as well as
certain regulations issued pursuant thereto from 1962 to 1996.
In August 1995, the Brazilian Congress amended the Brazilian Constitution to
allow the restructuring of the telecommunications sector. On July 19, 1996,
the Congress passed Law 9,295, the Lei Minima (the "Minimum Law"). The Minimum
Law began the process of opening up the cellular market to competition. The
Minimum Law was largely replaced by the Telecommunications Law, although
current cellular concessions for the former Telebras companies ("Band A") and
the private companies that were authorized to compete with the Band A
companies ("Band B") contain certain provisions derived from the Minimum Law.
In July 1997, the Congress passed the Telecommunications Law, which replaced
Law 4,117 and became the main basis for regulation of the telecommunications
sector, except for regulation of broadcasting, which was not addressed by the
Telecommunications Law.
REGULATORY AGENCY--ANATEL
The Telecommunications Law provides a framework for telecommunications
regulation. Article 8 of the Telecommunications Law established Anatel to
develop regulations and to enforce such regulations. The specific functions of
Anatel were set forth by the President of Brazil in Decree No. 2338 of October
7, 1997, the Regulamento da Agencia Nacional de Telecomunicacoes (the "Anatel
Decree"). Pursuant to the Telecommunications Law and the Anatel Decree, Anatel
replaces the Ministry of Communications as the regulatory agency for the
telecommunications sector. Anatel, unlike the Ministry of Communications, is
an independent regulatory agency. Anatel is administratively independent,
financially autonomous and not hierarchically subordinated to any organ of the
Federal Government, including the Ministry of Communications, in the area of
telecommunications regulation. While independent, Anatel does maintain a close
working relationship with the Ministry of Communications and informs the
Ministry of its activities. Article 19, Section XXIX of the Telecommunications
Law requires Anatel to submit an annual report summarizing its activities to
the Ministry of Communications.
Anatel is managed by a five-member Conselho Diretor ("Board of Directors"),
headed by an executive president. The directors of Anatel are nominated by the
President of Brazil, subject to approval by the Senate. Each director serves
for a single fixed term of 5 years; directors may not be reappointed. In order
further to ensure Anatel's independence, the first directors have been
appointed for different terms, from 3 to 7 years, so that only one director's
mandate will expire per year, ensuring a staggered appointment of directors in
the future. The directors may not exercise any other professional, business
(other than university professor), union or political function, nor may they
hold a significant interest, whether direct or indirect, in any company
related to telecommunications.
Anatel is financed through the Fundo de Fiscalizacao das Telecomunicacoes
("Fistel"). Fistel is a fund administered by Anatel and its funds are
currently the sole source of financing for Anatel's activities. Fistel
receives the proceeds of, among other things, a tax imposed on concessionaires
and fees charged for licenses and concessions.
Any proposed regulation of Anatel is subject to a period of public comment,
including public hearings. Anatel's actions may ultimately be challenged in
Brazilian courts.
CONCESSIONS AND LICENSES
Companies wishing to offer telecommunications services to consumers are
required to apply to Anatel for a concession or license. Concessions and
licenses are granted for services in the public regime ("Public Regime") and
services in the private regime ("Private Regime"). The Public Regime is
differentiated from the Private Regime primarily by the obligations imposed on
the companies in the Public Regime rather than the type of
20
<PAGE>
services offered by those companies. There are only four companies in the
Public Regime: Embratel and the three regional fixed-line companies. All other
telecommunications companies, including other companies providing the same
telecommunications services as the four companies in the Public Regime,
operate in the Private Regime.
Fixed-line Services--Public Regime. There are four providers of services in
the Public Regime: Embratel and the three regional fixed-line companies. These
four companies are the primary providers of the following fixed-line services
to the general public: local, intra-regional long-distance, interregional
long-distance and international long-distance. Each of these four companies
holds concessions, as required by the Telecommunications Law. Each Public
Regime concession is a specific grant of authority that allows the
concessionaire to offer a wide variety of telecommunications services but
specifically prohibits the concessionaire from offering certain
telecommunications services and imposes certain obligations on the
concessionaire concerning network expansion and modernization, quality and
continuity of service. The main restriction is that, until December 31, 2003,
the regional fixed-line companies will be prohibited from offering
interregional and international long-distance service, while Embratel will be
prohibited from offering local service unless certain obligations are met as
described below. Anatel is required, some time after the privatization process
is complete, to grant Embratel the right to offer full intra-regional long-
distance service, which is currently restricted to the regional fixed-line
companies. See "--Obligations of Telecommunications Companies--Public Regime--
Service Restrictions."
Concessions for Embratel and the three regional fixed-line companies are
granted for a fixed number of years, subject to certain obligations, with the
possibility of full renewal or revocation. See "--Obligations of
Telecommunications Companies--Public Regime--Service Restrictions." The
initial concessions for Embratel and the regional fixed-line companies have
been granted until 2005. After 2005, the concessions may be renewed. The
renewal period is currently 20 years. The current concessions granted to the
four companies in the Public Regime have not required the payment of a fee.
While terms for the grant of concessions to new entrants have not yet been
determined by Anatel, Embratel and the regional fixed-line companies are
required to pay biannual renewal fees after 2005 equal to 2% of annual net
revenues from the provision of fixed-line public telecommunications services
in the prior year (excluding taxes and social contributions) during the 20-
year renewal period.
Fixed-line Services--Private Regime. Licenses will be granted to new
competitors wishing to offer fixed-line-based services, including local,
intra-regional long-distance, interregional long-distance and international
long-distance, in the Private Regime. Licensees are not subject to the same
obligations as Public Regime concessionaires, although individual licenses may
contain certain obligations. After the privatization process for Embratel and
the three regional fixed-line companies is complete, Anatel is required to
authorize three new entrants to provide local telephone service and intra-
regional long-distance telephone service, with each of the three new entrants
receiving two licenses to provide such services in a single fixed-line Region,
in addition to authorizing one new entrant to provide intra-regional,
interregional and long-distance telephone and international telephone long-
distance by granting three licenses to provide such services throughout
Brazil. The bidding requirements are expected to contain certain minimum
technical and financial standards. The effective result of the license auction
will be that two companies compete in each of the markets for local service
(one regional fixed-line concessionaire and one licensee), four companies
compete in the markets for intra-regional long-distance service (one incumbent
regional fixed-line company, Embratel, and two licensees), and two companies
compete in the markets for interregional long-distance and international long-
distance (Embratel and one licensee). See "--Competition."
Until December 31, 2001, the four existing Public Regime concessionaires and
the new Private Regime licensees will be the only companies authorized to
offer local, intra-regional long-distance, interregional long-distance and
international long-distance services. Beginning January 1, 2002, the
Telecommunications Regulations require Anatel to end this period of
exclusivity and authorize new licensees wishing to offer such services. See
"--Competition."
21
<PAGE>
Non-fixed Services--Private Regime--Concessions. The Band A and Band B
cellular companies are in the Private Regime. Pursuant to the Minimum Law and
the Telecommunications Law, the cellular companies in Band A and Band B have
been granted concessions. Each cellular concession is a specific grant of
authority to operate cellular services, subject to certain obligations
contained in the List of Obligations. If a cellular company wishes to offer
any telecommunications service other than the cellular service authorized by
its concession, it may apply to Anatel for a license to offer such other
services. See "--Non-fixed Services--Private Regime--Licenses."
Each cellular concession has been granted for an initial period of 15 years,
subject to renewal for further periods of 15 years if the List of Obligations
contained in a concession has been met. The Band A cellular concessions did
not require the payment of a fee. Terms of payment for renewal of the Band A
and Band B cellular concessions have not yet been established.
Currently, there is a limit on the number of cellular companies. One company
may operate in Band A and one company in Band B for each cellular region.
Under the cellular concessions, Anatel may not authorize additional providers
of cellular service until December 31, 1999.
Non-fixed Services--Private Regime--Licenses. Except for cellular service,
for which no new licenses may be granted until December 31, 1999, licenses may
be granted to any company wishing to offer telecommunications services in the
Private Regime. Licensees are not subject to the same obligations as Public
Regime concessionaires, although individual licenses may contain certain
obligations.
OBLIGATIONS OF TELECOMMUNICATIONS COMPANIES
Providers of telecommunications services are subject to certain obligations
contained in the List of Obligations of their concessions and licenses. The
four providers of telecommunications services in the Public Regime are subject
to a set of special restrictions regarding the services they may offer,
contained in the Plano Geral de Outorgas ("General Plan of Concessions and
Licenses"), and special obligations regarding service quality, network
expansion and modernization contained primarily in the Plano Geral de Metas de
Qualidade ("General Plan on Quality") and the Plano Geral de Metas de
Universalizacao ("General Plan on Universal Service"). These restrictions and
obligations are also contained in the concessions of the four companies,
particularly in the List of Obligations.
Public Regime--Service Restrictions. Under the General Plan on Concessions
and Licenses, Embratel and the regional fixed-line companies are prohibited
from offering certain basic fixed-line telecommunications services until they
fulfill the List of Obligations as described below. Embratel is prohibited
from offering local or cellular services and the regional fixed-line companies
are prohibited from offering cellular, interregional long-distance and
international long-distance services. Anatel is required, some time after the
privatization is effected, to grant Embratel the right to enter the market for
full intra-regional long-distance service, including service within the
states, as a competitor to the regional fixed-line companies and to grant the
fixed-line companies the right to offer interstate intra-regional long-
distance service, which they were not authorized to offer in the past.
The General Plan of Concessions and Licenses provides certain incentives to
encourage Embratel and the three regional fixed-line companies to fulfill the
service quality, network expansion and modernization obligations contained in
the List of Obligations quickly. Under the General Plan of Concessions and
Licenses, the progress of Embratel and the regional fixed-line companies
towards attaining their List of Obligations will be measured annually by
Anatel. Two measuring dates, December 31, 2001 and December 31, 2003, are of
particular importance (the "2001 Targets" and the "2003 Targets"). See tables
in "--Network Expansion--General Plan on Universal Service" and "Quality of
Service--General Plan on Quality." In the period before the 2001 Targets are
measured, Anatel will regularly monitor the progress of Embratel and the
regional fixed-line companies and communicate with them. If they fail to meet
the 2001 Targets, Anatel may, at its discretion, revoke their concessions. If
they meet the 2001 Targets, they may continue to operate. In the period before
the 2003 Targets are measured, Anatel will regularly monitor the progress of
the four companies and communicate with them. If Embratel and the regional
fixed-line companies meet the 2003 Targets, the restrictions on the
22
<PAGE>
services the four companies may offer will be eliminated and the companies
will be allowed to apply for licenses to offer any other service. In addition,
if, in its review for the 2001 Targets, Anatel finds that any of the four
companies has met the 2003 Targets, Anatel will immediately eliminate the
restrictions on the telecommunications services that company may offer. Anatel
may also eliminate the restrictions on a date other than the official
measuring dates of December 31, 2001 and December 31, 2003 if it finds that a
company has met the 2003 Targets. Failure to meet the 2003 Targets could
result in revocation of the Concession.
In order to attract new entrants and ensure competition, there are also
certain restrictions on alliances, joint ventures, mergers and acquisitions
involving Public Regime concessionaires, including:
. A concessionaire is prohibited from holding more than 20 percent of the
equity in any other concessionaire
. Concessionaires offering different services in the Public Regime in
either the same or different regions are prohibited from offering
services jointly
. Concessionaires offering the same service in the Public Regime in
different regions are prohibited from offering services jointly
. Mergers between fixed-line regional companies and cellular companies are
prohibited
. Companies offering telephony services are prohibited from offering cable
television
Anatel has not yet determined whether the restrictions under its control
will expire in the future or under what conditions they would expire.
Network Expansion--General Plan on Universal Service. Under the General Plan
on Universal Service, the regional fixed-line companies are required to expand
switched, fixed-line service to cover the entire national territory of Brazil
in accordance with the List of Obligations. Embratel is also subject to the
universal service requirement of providing access to direct-dial interregional
and international long-distance service by installing public telephones in
remote regions and isolated communities. Since universal service requirements
are restricted to the provision of switched, fixed-line basic telephony
services, formal universal service requirements do not apply to cellular
companies, although the cellular companies are subject to certain similar
requirements under the cellular List of Obligations and certain cellular
regulations, including obligations to expand their networks and to provide
cellular services without pricing discrimination within customer categories.
Universal service will be financed through two primary mechanisms: (a) the
normal capital expenditure budgets of Embratel and the regional fixed-line
companies, and (b) a universal service fund.
Embratel and the regional fixed-line companies are themselves responsible
for financing their universal service obligations of network expansion from
their own revenues. No subsidies or other supplemental financing is
anticipated to finance the network expansion obligations contained in the List
of Obligations. However, the General Plan on Universal Service allows Anatel
to waive the network expansion requirements once a company succeeds in meeting
the 2001 Target for maximum waiting time for installation of a line of four
weeks. If a regional fixed-line company fails to meet its obligations in a
particular region, Anatel may grant licenses to competing companies to provide
the service and may compel the regional fixed-line company to make its network
available for the competitor's use.
The Telecommunications Law also provides for a universal service fund to
contribute to the costs of providing universal service. While the exact nature
of the universal service fund is not yet known, a bill has been submitted to
the Congress that states that if a company, after meeting its universal
service obligations, finds that it cannot operate a certain service in a
certain region at a profit, the company may apply to receive a subsidy from
the universal service fund--for costs incurred beyond costs necessary to meet
its obligations-- to ensure that it covers its costs in providing the service.
23
<PAGE>
The following table sets forth the network expansion and modernization
obligations of the Company as stated in the List of Obligations for the period
1999-2005 and the Company's status with respect to each obligation as of
December 31, 1997.
NETWORK EXPANSION AND MODERNIZATION
<TABLE>
<CAPTION>
COMPANY STATUS BY DECEMBER 31,
AS OF DECEMBER 31, -------------------------------------
1997 1999 2000 2001 2002 2003 2004 2005
------------------ ----- ----- ----- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Minimum total number of
installed lines in
million................ 3.6 4.7 5.3 5.9 -- -- -- --
Fixed switched service
fully available if
population greater
than:.................. n.a.(1) -- -- 1,000 -- 600 -- 300
Maximum waiting time for
installation of a line
(in weeks)............. 65(4) -- -- 4 3 2 1 1
Minimum number of public
telephones in service
(in thousands)......... 86.8 114.4 142.0 169.0 -- -- -- --
Public telephones per
1,000 inhabitants...... 3.12 -- -- -- -- 7.5 -- 8.0
Minimum ratio of public
telephones to fixed
terminals (%).......... 2.4 2.5 2.5 2.5 2.5 2.5 2.7 3.0
Minimum digitalization
level (% of network)... 74 75 -- 85 -- 95 -- 100
Maximum distance to a
public telephone
(meters)(2)............ n.a.(1) 800 -- 500 -- 300 -- --
Full-service public
telephone availability
as a % of total number
of public telephones:
international long-
distance(3).......... n.a.(1) 25 -- -- -- -- -- --
local and domestic
long-distance(3)..... n.a.(1) 50 -- -- -- -- -- --
in areas with no fixed
switched service (# of
inhabitants).......... n.a.(1) 1000 -- 600 -- 300 -- 100
</TABLE>
- --------
(1) Not available; the Company did not historically measure its performance
against this criterion.
(2) Applies only to areas where fixed switched service is fully available.
(3) Public telephones available 24 hours a day with direct-dial capability.
(4) Represents average waiting time for installation of a line. The Company
does not have information measuring maximum waiting time for installation
of a line.
Quality of Service--General Plan on Quality. The General Plan on Quality
contains a series of service quality obligations that are incorporated into
the List of Obligations of Embratel and each regional fixed-line company.
These include attainment of certain targets such as reducing average dial tone
delay, achievement of certain call completion rates for local, intra-regional
long-distance, and interregional and international long-distance calls,
reducing average operator assistance delay, reducing trouble reports per 100
lines, reducing average time of repair, reducing average time of installation,
increasing billing accuracy, and achieving certain customer satisfaction
levels for public payphones, residential telephony and nonresidential
telephony.
24
<PAGE>
The following table sets forth the quality of service obligations of the
Company as stated in the List of Obligations for the period 1999-2005 and the
Company's status with respect to each obligation as of December 31, 1997.
QUALITY OF SERVICE
<TABLE>
<CAPTION>
COMPANY STATUS
AS OF (BY DECEMBER 31,)
DECEMBER 31, -------------------
1997 1999 2001 2003 2005
-------------- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Dial tone within 3 seconds (% of cases).... 99(1) 98 99 99.5 --
Call completion rate during peak periods (%
of calls attempted)(2).................... 57 60 65 70 --
Maximum busy circuit rate during peak
periods(2) (% of calls attempted)......... 5 6 5 4 --
Maximum monthly repair requests per line... .03 .03 .025 .02 .015
Maximum monthly public telephone repair
requests per line......................... .32 .15 .12 .10 .08
Residential repair response speed (% within
24 hours)(3).............................. 89(6) 95 96 97 98
Nonresidential repair response speed (%
within 8 hours)(4)........................ 89(6) 95 96 97 98
Public telephone repair response speed (%
within 8 hours)........................... 88(7) 95 96 97 98
Operator availability during peak periods
(% answer/within 10 seconds).............. 86 92 93 94 95
Billing inaccuracy (inaccurate bills per
100 bills)(5)............................. .7 .4 .3 .2 --
Credit issued within one billing cycle for
claimed inaccuracies (% of cases)......... -- 95 96 97 98
</TABLE>
- --------
(1) As of December 31, 1995, the most recent date at which this was measured.
(2) For local and domestic long-distance calls.
(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.
(6) Includes residential and nonresidential. In 1997, the Company had a single
measurement for both residential and nonresidential repair response.
(7) Response within 24 hours; the Company did not historically measure its
performance against the 8-hour standard.
Failure to meet both network expansion and modernization obligations and the
quality of service obligations in the List of Obligations may result in fines
and penalties of up to R$50,000,000 as well as potential revocation of the
Company's Concession. The Company's ability to meet the obligations in the
List of Obligations will depend upon certain factors outside its control.
While there can be no assurances, the Company believes that it will be able to
meet these requirements.
Interconnection. Interconnection is mandatory between all telecommunications
networks upon request by any party. Interconnection tariffs are subject to a
price-cap established by Anatel. Rates below the applicable price-cap may be
negotiated between the parties. If a company offers an interconnection tariff
below the price-cap, it must offer that price to any other requesting party on
a nondiscriminatory basis.
Anatel has stated that it does not expect to grant parties requesting
interconnection the right to co-locate their equipment at this time. Co-
location means that a party requesting interconnection may place its switching
equipment in or near the local exchange of the network operator whose network
the requesting party wishes to use and connect to the network at this point of
presence. Co-location is currently a matter of negotiation between the
parties.
Anatel does not currently mandate unbundling of network elements and
services by the providers of such elements and services, although Anatel has
stated that it plans to review the issue on a regular basis and may introduce
unbundling in the future. In an unbundled regime, every network operator is
required to provide a detailed list of network services and elements which may
be purchased by a party requesting interconnection
25
<PAGE>
and the requesting party then has the right to select and purchase a subset of
the network elements and services available.
Number Portability. Number portability is the ability of a customer to move
to a new home or office or switch service providers while retaining the same
telephone number. Full number portability is mandatory within a local area.
RATE REGULATION
General. In May 1997, a tariff rebalancing was implemented pursuant to which
monthly subscription charges and measured service charges for all customers
increased, while domestic and international long-distance rates were lowered.
In addition, the previous mechanism for financing the installation of new
lines (auto-financing), which required customers to purchase shares of
Telebras, was eliminated and replaced with a flat installation charge. With
retroactive effect as of April 1, 1998, the regime used to divide domestic and
international long-distance revenues between Embratel and the regional fixed-
line companies was replaced with a network usage fee for interconnection such
as already existed for use of cellular networks by the fixed-line companies
and for use of the fixed networks by cellular operators. In addition to the
network usage charge, Embratel is also required to pay a supplemental per-
minute charge called Parcela Adicional de Transicao ("PAT") that supplements
the network usage charge. Embratel is the only company that is required to pay
PAT charges. Embratel will be required to pay PAT charges for three years,
after which time the PAT charges will be phased out.
Price-Caps. Concessions with the regional fixed-line companies and Embratel,
including the Concession with the Company, provide for a price-cap mechanism
to set and adjust rates on an annual basis. The price-cap mechanism consists
of a maximum amount, or price-cap, stipulated by Anatel, that may be charged
for a particular service and on a weighted average rate for a basket of basic
services. The services include all of the services in the basic service plan,
such as installation charges, monthly subscription fees, switched local
service, intra-regional long-distance, interregional long-distance and
international long-distance service, as well as public telephone service and
interconnection charges, including network usage fees. The main baskets for
the regional fixed-line companies are for local services, including
installation charges, the monthly subscription fee, and measured usage
charges, and for interconnection services, including network usage fees and
equipment rental charges. The main baskets for Embratel are interregional
long-distance, international long-distance and interconnection.
The initial price-cap established by Anatel in the Concession is based on
the previously existing tariffs. The initial price-cap will be adjusted on an
annual basis under a formula contained in the Concession. 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 an K-factor representing annual
productivity adjustments to the tariffs of Embratel and the regional fixed-
line companies. In the period 1998 to December 31, 2005, the tariffs of
Embratel and the regional fixed-line companies will be adjusted downward as
follows:
<TABLE>
<CAPTION>
K-FACTOR ANNUAL PRODUCTIVITY
ADJUSTMENTS
---------------------------------------
1998 1999 2000 2001 2002 2003 2004 2005
---- ---- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Fixed-line companies--local............ 0% 0% 0% 1% 1% 1% 1% 1%
Fixed-line companies--local
interconnection....................... 0% 0% 0% 5% 10% 15% 20% 20%
Embratel- interregional long-distance.. 2% 2% 2% 4% 4% 4% 5% 5%
Embratel- international long-distance.. 5% 5% 15% 15% 15% 15% 15% 15%
Fixed-line companies--intra-regional
long-distance and long-distance
interconnection....................... 2% 2% 2% 4% 4% 4% 5% 5%
</TABLE>
26
<PAGE>
The price-cap covers a basket of basic services. While the weighted average
tariff for the entire basket may not exceed the price-cap, the tariffs for
individual services within the basket may be increased. The Company may
increase the tariff for any individual service by up to 9% for local services
and 5% for long-distance services, subject to a downward adjustment for
inflation effects already captured in the annual upward adjustments of the
overall price-cap for the basket, so long as it adjusts other prices downward
to ensure that the weighted average tariff does not exceed the price-cap.
The Company may also offer alternative plans in addition to the basic
service plan. For instance, a customer might wish to choose an alternative
plan that allows unlimited calling for a set fee rather than pay the per-
minute fee under the basic service plan. Alternative plans must be submitted
to Anatel for approval, but are not currently subject to a price-cap.
For information on the Company's current tariffs and service plans, see "--
Rates."
Installation Charges. Installation charges for connection to the fixed-line
telephone network have been reduced to a maximum flat rate of R$80 for all
customers, both residential and nonresidential as of October 1997. All
regional fixed-line companies are subject to this maximum for installation
uniformly in every local calling area throughout Brazil. Local areas include
those areas currently connected to the fixed-line network and correspond
largely to urban areas. Customers outside of the local areas must negotiate
the price of installation with the Company. Currently, the Company is charging
an installation charge of R$50, rather than R$80. This fee replaces the
autofinancing mechanism which had been in place, which required customers to
purchase shares in Telebras. See "--Rates--Local Services."
Monthly Subscription Charges. Residential and nonresidential customers must
pay a monthly access fee for connection to the fixed-line telephone network.
There are currently three levels of monthly access fees in Brazil, R$10, R$15
and R$20, excluding taxes, depending on customer characteristics, with all
residential customers paying R$10 and most business customers paying R$15. See
"--Rates--Local Services."
Measured Service Charges. Users of local service, both residential and
nonresidential, pay for local calls depending on usage. Usage is measured in
pulses. Pulses occur system-wide every four minutes for local calls. These
system-wide pulses are recorded independently of when individual calls are
actually made. In addition to system-wide pulses, the system records one
individualized pulse for every call when the call is connected. After the
first individualized pulse, only system-wide pulses are used in determining
the charge for a call. The result of this system is that, while the time
between the second and every subsequent pulse is always in increments of four
minutes, the time between the first (individualized) pulse and the second
(system-wide) pulse may vary. For example, the time between the first
(individualized) pulse and the second (system-wide) pulse may vary between one
second and four minutes.
For normal weekday calls, local call charges are determined by multiplying
the number of pulses by the charge per pulse. For calls being made any day
between midnight and 6:00 a.m., in addition to Saturdays from 2:00 p.m. to
midnight and all day Sunday and holidays, a caller is charged for only one
pulse regardless of the duration of a call.
All users of local service currently receive 90 free pulses per month as
part of their monthly subscription, equivalent to about 140 minutes per month
in the case of an average user. Through the tariff rebalancing of May 1997,
measured usage charges increased by approximately 61%. See "--Rates--Local
Services."
Anatel has stated that, as a consequence of its tariff restructuring in May
1997, cross-subsidies among various telecommunication services have been
largely eliminated.
Intra-Regional Long-Distance. Users of service pay differing rates for local
measured service and intra-regional long-distance service. Intra-regional
long-distance consists of interurban calls originating and terminating within
the calling area of a regional fixed-line company. The Company is allowed to
carry such calls entirely over its own network. When it does so, the Company
receives all of the revenues from such calls. As
27
<PAGE>
part of the May 1997 tariff rebalancing, intra-regional long-distance rates
were lowered, with an effective reduction of approximately 20%. Intra-regional
calls are billed based on the duration of a call and distance. There are
currently 20 intra-regional long-distance tariffs based on combinations of
four day/time categories and five distance categories. Certain intra-regional
long-distance calls are made within an area code and are measured in pulses.
For a breakdown of the Company's current intra-regional long-distance
tariffs, see "--Rates--Intra-Regional Long-Distance Service."
Network Usage Charges. Other telecommunications companies wishing to
interconnect with and use the Company's network--primarily to gain access to
the Company's customers for call origination and completion--must pay certain
fees, primarily a network usage fee. In addition, other telecommunications
operators rent equipment, such as trunk lines, from the Company for use within
their own internal networks. Fees for network usage and equipment rental are
subject to price-caps stipulated by Anatel.
The price-cap for the network usage fee specified by Anatel varies from
company to company based on the underlying cost characteristics of each
company's network. The fee is a flat fee charged per minute of use which
represents an average charge for a basket of network elements and services.
Embratel, the cellular companies and any future new entrants into the market
must pay the network usage fee if they access end customers via the network of
a regional fixed-line company. In practical terms, even though the network
usage fee includes the costs of a variety of network elements and services,
the network usage fee primarily reflects the use of certain facilities of the
Company for which Embratel and the cellular companies do not have adequate
substitutes, particularly the local loop between local exchanges and end
customers. Anatel has stated that Embratel is likely to be the primary
provider of network usage fees since it will need to use at least the local
loop to access end customers for the provision of long-distance service and
since Embratel is under an obligation to provide universal long-distance
service.
In the past, the Company shared revenues for interstate and international
long-distance calls with Embratel rather than charging Embratel a network
usage fee for the use of the Company's network. Under this system, the Company
retained a fixed percentage of the revenues associated with such calls and
paid the balance of the revenues associated with such calls to Embratel. This
system was replaced with retroactive effect as of April 1, 1998 with the
interconnection charge regime that had already been in place for
interconnection of the Company's network with cellular networks, under which
the Company charges for connection to its network and usage of its network.
The total level of interconnection charges in the future is likely to depend
greatly on the interconnection regime adopted by Anatel and how it is
enforced. See "--Obligations of Telecommunications Companies--
Interconnection."
BRAZILIAN POLITICAL ENVIRONMENT
The Brazilian political environment was marked by high levels of uncertainty
after the country returned to civilian rule in 1985, ending 20 years of
military government. The death of a President-elect in 1985 and the
resignation of another President in the midst of impeachment proceedings in
1992, as well as rapid turnover at and immediately below the cabinet level,
adversely affected the implementation of consistent economic and monetary
policies, including consistent policies in the areas of government-owned
enterprises and telecommunications.
Mr. Fernando Henrique Cardoso, the Finance Minister at the time of
implementation of Brazil's latest economic stabilization plan (the "Real
Plan"), was elected President of Brazil in October 1994 and took office in
January 1995. He has generally sought to continue the economic stabilization
and liberalization policies he had developed as Finance Minister from May 1993
through April 1994. Although some important groups remain
28
<PAGE>
opposed to significant elements of his program and the implementation of
policies of economic stabilization and liberalization is subject to
significant compromises and accommodations, President Cardoso is the leader of
a coalition of political parties that represents a majority of the federal
Congress. His party controls the state governments of the States of Sao Paulo,
Rio de Janeiro and Minas Gerais, and his policies have broad political
support.
Elections for the President, Vice-President, state Governors and the members
of the Chamber of Deputies, as well as one third of the members of the Senate,
were held on October 4, 1998. President Cardoso was re-elected for a second
term as president. The outcome of these elections could have a strong impact
on the continuation of the economic reforms of the Cardoso administration.
There can be no assurance that the political consensus in favor of the
economic reform program pursued by the Cardoso administration can or will be
sustained following the elections.
BRAZILIAN ECONOMIC ENVIRONMENT
The financial condition and results of operations of the Company are
dependent on general economic conditions in Brazil, and in particular on (i)
economic growth and its impact on demand for telecommunications services, (ii)
the cost and availability of financing and (iii) exchange rates between
Brazilian and foreign currencies.
For many years, the Brazilian economy was extremely volatile, and the
Federal Government implemented a succession of programs intended to stabilize
the economy and provide a basis for sustainable, non-inflationary growth. The
Company was affected by economic instability and by such programs in a variety
of ways, particularly when they have resulted in contractions in demand or
very high real interest rates or prevented the Company from raising rates to
keep pace with the rate of inflation.
Until the introduction of the Real Plan, measures by the Federal Government
intended to influence the course of Brazil's economy, such as changes in
monetary, credit, tariff and other policies, were frequent and occasionally
drastic. See "Exchange Controls and Other Limitations Affecting Security
Holders." In particular, actions to control inflation, interest rates or
consumption included freezing bank accounts, imposing capital controls,
introducing high tariffs and other strong measures. Changes in policy, social
instability and other political and economic developments, and the Brazilian
government's responses to such developments, not infrequently have had a
material adverse effect on the Company's business, financial condition and
results of operations.
Beginning in December 1993, the Federal Government introduced the Real Plan,
an economic stabilization program intended to reduce the rate of inflation by
reducing certain public expenditures, collecting liabilities owed to the
Federal Government, increasing tax revenues, continuing to privatize
government-owned entities and introducing a new currency. The real was
introduced as Brazil's currency on July 1, 1994, based on a new unit of
account, the URV, introduced earlier in the year. Since taking office in
January 1995, President Cardoso has continued to implement the Real Plan. The
real generally appreciated through January 1995 and thereafter gradually
declined in value against the dollar, reaching R$1.1164 to US$1.00 at December
31, 1997. Under the Real Plan, the rate of inflation has decreased
significantly and there has been sustained growth in real gross domestic
product. See "--Inflation and Devaluation." Notwithstanding the success of the
Real Plan in lowering inflation and stabilizing the Brazilian economy, the
Real Plan also led to an economic slowdown, a rise in unemployment in some
regions and specific sectors of the economy, and adversely impacted certain
sectors of the economy.
Beginning in August 1998, following the devaluation of the Russian Ruble,
Brazil has experienced substantial capital outflows, significant declines in
its stock markets and speculative attacks on the Brazilian currency. In
response, the Federal Government has raised interest rates and stated that it
will continue to support the value of the real and to abide by the principles
inherent in the Real Plan. In early October 1998, reported capital outflows of
approximately US$1 billion per day led to speculation that the International
Monetary Fund would provide Brazil with a financial aid package. However, as
of October 9, 1998, no such package had been announced by the IMF or formally
requested by the Federal Government. Previously, in the fourth quarter of
29
<PAGE>
1997, Brazil experienced a financial crisis following the financial and
economic crisis in Asia. In response, the Federal Government adopted several
economic measures to protect the Real Plan and the stability of the Brazilian
currency. These measures included (i) an increase in interest rates, including
a near doubling of short-term interest rates, (ii) an increase in certain tax
rates, (iii) a reduction in Federal Government spending for 1998 and (iv)
restrictions on imports. Government policies to control inflation and to
reduce budget and trade deficits could also result in further actions that
could slow or halt Brazilian economic growth. It is not possible to foresee
how measures like these will affect the business, financial condition and
results of operations of the Company.
Brazil's trade deficit for 1997 increased to US$8.37 billion compared to
US$5.54 billion for 1996. There can be no assurance that the Federal
Government will not introduce credit restrictions to subdue domestic demand in
order to reduce the trade deficit, nor that any such credit restrictions will
not have a material adverse effect on the business, operations, financial
condition or results of operations of the Company. A continuing increase in
the trade deficit would substantially reduce Brazil's approximately US$50.8
billion of reserves at December 31, 1997 and could negatively affect Brazil's
economic development as a whole.
PRIVATIZATION
The Federal Government, directly or through various state-owned enterprises,
owns many companies and controls a major portion of activities in the mining
and oil and gas sectors. Most of the energy production and postal services
companies are directly or indirectly controlled by the Federal Government.
To reduce its participation in the economy, the Federal Government has
engaged in the privatization of certain state enterprises. The objectives of
the privatization program are (i) to reduce the role of the state in the
economy and allocate more resources to social investment, (ii) to reduce
public sector debt, (iii) to encourage increased competition and thereby raise
the standards and efficiency of Brazilian industry and (iv) to strengthen the
capital markets and promote wider share ownership. As originally presented the
Real Plan contemplated constitutional amendments which would permit private
participation in the state-controlled petroleum and telecommunications sectors
and in other areas that had constitutionally mandated monopolies, such as
pipeline distribution of gas and the shipping industry. These amendments were
approved by Congress in 1995. A council directly subordinate to the President,
the Conselho Nacional de Privatizacao (the "Privatization Council") and BNDES
are responsible for administering the privatization program.
As of December 31, 1996, a total of 52 state enterprises or divisions
thereof had been privatized, and several minority interests held by Federal
Government companies had been sold for nominal consideration totaling US$13.7
billion (including payment made in Brazilian currency and payment made by
means of qualified debt instruments issued to the federal government, its
agencies and state-controlled companies). To date, the privatizations have,
for the most part, been effected through share auctions conducted on Brazil's
stock exchanges. Although the majority of such share auctions have been
successful, there have been instances in which a share auction has failed due
to a lack of bidders. Privatization revenues for 1997 exceeded $26.0 billion.
Some of the Brazilian states, such as Sao Paulo, Minas Gerais, Pernambuco,
Paraiba and Maranhao are also conducting privatization programs in relation to
state services.
Brazilian labor unions have opposed certain of the privatization measures
proposed by the Federal Government, but the Federal Government has, to date,
been able to move forward with its program despite such opposition.
DEVELOPMENTS IN OTHER EMERGING MARKET COUNTRIES; BRAZILIAN AUSTERITY PROGRAM
The Brazilian securities markets are, to varying degrees, influenced by
economic and market conditions in other emerging market countries. Although
economic conditions are different in each country, investors' reactions to
developments in one country can have an effect on the securities of issuers in
other countries, including Brazil. For example, since the fourth quarter of
1997, the international financial markets have experienced significant
volatility, and a large number of financial market indices, including those in
Brazil, have
30
<PAGE>
declined significantly. The current market volatility in Latin America and
other emerging market countries' securities markets has also been attributed,
at least in part, to the effects of the Asian economic crisis. There can be no
assurance that the Brazilian securities markets will not continue to be
affected negatively by events elsewhere, especially in emerging markets, or
that such events will not adversely affect the value of the ADSs.
In reaction to the growing market volatility in Asia, the Federal Government
implemented several measures intended to curtail the outflow of foreign
investment, as Central Bank reserves were reduced from U.S.$61.2 billion in
September 1997 to U.S.$52.9 billion by the end of October 1997. On October 30,
1997, the Central Bank raised the benchmark interest rate from 20.7% to 43.4%,
in order to retain investment funds in the country. On November 10, 1997 the
Federal Government presented a series of fiscal measures aimed at reducing the
budget deficit and bolstering economic conditions. The measures included
certain tax increases, eliminations of budget expenses and reductions in
available fiscal incentives. The package of measures was intended to produce a
savings of R$20 billion, due to the decrease in expenses and the increase in
revenue. These fiscal measures have been substantially implemented.
Constitutional reforms affecting civil servants and social security have also
been accelerated and may result in lower Government deficits. However, there
can be no assurance that such measures will be successful in protecting the
Federal Government's present currency exchange rate policy and price stability
program.
Additionally, the decrease in economic activity caused by the increase in
interest rates and the fiscal measures may have substantial negative effects
on companies doing business in Brazil. Projected GDP growth for Brazil for
1998 has been reduced from approximately 4% to approximately 1%. It is
expected that these events may have the effect of reducing the purchasing
power of Brazilian consumers in general. Since the increase in interest rates,
the Central Bank has gradually reduced its benchmark interest rate, setting
its rates at 40.9% on December 1, 1997, at 38.0% on January 2, 1998, at 34.5%
on January 29, 1998, at 28.0% on March 5, 1998 and at 21.8% on May 20, 1998,
at 21.0% on June 25, 1998 and at 19.75% on July 29, 1998. However, there can
be no assurance that a decrease in interest rates will not cause further
investment outflows.
Events in Asia also may affect the competitiveness of Brazilian exports. In
addition, the proceeds from scheduled privatizations may not reach expected
levels, in which case the current account deficit would cause a deterioration
in foreign reserves, adversely affecting the currency exchange rate policy.
INFLATION AND DEVALUATION
Brazil experienced extremely high and generally unpredictable rates of
inflation and of devaluation of Brazilian currency for many years until the
implementation of the Real Plan. Inflation itself, as well as certain
governmental measures to combat inflation, and public speculation about
possible future actions have also historically contributed to economic
uncertainty in Brazil and to heightened volatility in the Brazilian securities
markets. The following table sets forth Brazilian inflation, as measured by
the UFIR for 1995 and the IGP-M for 1996-1998, and the devaluation of the
Brazilian currency against the U.S. dollar for the periods shown.
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31, FIRST QUARTER SIX MONTHS
-------------- ENDED MARCH 31, ENDED JUNE 30,
1995 1996 1997 1998 1998
---- ---- ---- --------------- --------------
(IN PERCENTAGES)
<S> <C> <C> <C> <C> <C>
Inflation (UFIR for 1995; IGP-M
for 1996-1998)................. 22.5 9.2 7.7 1.3 2.0
Devaluation (Brazilian currency
vs. US$)....................... 15.0 6.9 7.4 1.9 3.6
</TABLE>
Since the introduction of the Real Plan in July 1994, the rate of inflation
has decreased considerably. As measured by the IGP-M, the rate of inflation
was 7.7% for 1997, 1.3% for the first quarter of 1998 and 2.0% for the six
months ended June 30, 1998. Despite this reduction, the rate of inflation
remains high compared to other countries, and the potential for distortions or
dislocations attributable to changing prices continues to exist. The exchange
rate between the real and the U.S. dollar has also been relatively stable
since early July 1994, compared to prior periods, although the potential for
devaluation or volatility persists. See "Exchange Rates."
31
<PAGE>
ITEM 2: DESCRIPTION OF PROPERTY
The principal properties of the Company consist of transmission plants
(including outside plant and trunk lines), exchange equipment and switching
equipment. The Company's land and buildings principally consist of its
telephone exchanges and other technical, administrative and commercial
properties. Exchanges include local exchanges, "toll" exchanges that connect
local exchanges to long-distance transmission facilities and "tandem"
exchanges that connect local exchanges with each other and with toll
exchanges.
The Company's properties are located throughout the states of Acre,
Rondonia, Goias, Tocantins, Mato Grosso, Mato Grosso do Sul, Parana, and Santa
Catarina, as well as in the Distrito Federal and in a small area of the State
of Rio Grande do Sul. The buildings used by the Company's management are
primarily located in the capital cities of these states. At March 31, 1998,
the Company utilized 3,169 properties, of which 3,032 sites were owned by the
Company.
At December 31, 1997, equipment related to switching stations represented
approximately 25.12%, other equipment represented 35.95%, construction in
progress represented approximately 14.45%, buildings represented approximately
12.31% and other fixed assets represented approximately 12.17% of the net book
value of the Company's total fixed assets. At December 31, 1997, the net book
value of the Company's property, plant and equipment was R$6,444.5 million.
ITEM 3: LEGAL PROCEEDINGS
The Breakup of Telebras is subject to several lawsuits in which the
plaintiffs have requested, and in certain cases obtained, preliminary
injunctions against the Breakup. All of these preliminary injunctions have
been quashed by decisions of the relevant Federal Court, although several of
such decisions are currently on appeal. If any such appeal is successful, the
shareholders of Telebras will be required to reapprove the Breakup or other
legislative action may be required.
The lawsuits to which the Breakup has been subjected are based on a number
of legal theories, the principal among which are that (i) Brazil's
Constitution requires that the creation of the twelve New Holding Companies be
specifically authorized by the Telecommunications Law--the Breakup is not so
authorized; (ii) the shareholders' meeting of Telebras held on May 22, 1998
which approved the Breakup was not properly convened; (iii) national
sovereignty will be threatened if the country's telecommunications companies
are controlled by foreign entities; and (iv) the Telecommunications Law
requires that certain matters, such as the entry of new competitors and the
administration of development and technology funds, be regulated prior to the
Breakup and privatization either by an executive order of the President or by
an act of Congress. If any of the plaintiffs in the above-described lawsuits
ultimately prevails, the Breakup will have to be reinitiated. This could
require, depending upon the prevailing plaintiff's theory, any combination of
(i) amendment of the Telecommunications Law, (ii) reconvening the May 22, 1998
Telebras shareholders' meeting and (iii) the passage of additional laws by
Congress or issuance of executive orders by the President. It is theoretically
possible under Brazilian law for a court to require that the Breakup be
unwound, although the Company believes that this would not be likely to occur.
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 aggregate amount involved in such lawsuits is
approximately R$600.9 million. The Company has provided for or deposited in
court amounts to cover its estimated losses due to adverse legal judgments. In
the opinion of management, such actions, if decided adversely to the Company,
would not have a material adverse effect on the Company's business and
financial condition.
Telebras is the legal predecessor of the Registrant and is a defendant in a
number of legal proceedings and subject to certain other claims and
contingencies.
Under the terms of the Breakup, liability for any claims arising out of acts
committed by Telebras prior to the effective date of the Breakup remains with
Telebras, except for labor and tax claims (for which Telebras and
32
<PAGE>
the New Holding Companies are jointly and severally liable) and any liability
for which specific accounting provisions have been assigned to the Registrant
or one of the other New Holding Companies. Creditors of Telebras may challenge
this allocation of liability until September 14, 1998. Management of the
Company believes that the chances of any such claims materializing and having
a material adverse financial effect on the Company are remote.
Liability for any claims arising out of acts committed by the Subsidiaries
prior to the effective date of the spin-off of the Subsidiaries' cellular
assets and liabilities to the newly formed cellular companies remains with the
Subsidiaries, except for labor and tax claims (for which the Subsidiaries and
the newly formed cellular companies are jointly and severally liable by
operation of law) and those liabilities for which specific accounting
provisions have been assigned to the newly formed cellular companies. However,
under the shareholders' resolution pursuant to which the spin-off was
effected, the newly formed cellular companies have contribution rights against
the Subsidiaries with respect to the entire amount of any payments made by the
newly formed cellular companies in connection with any labor tax claims
brought against the newly formed cellular companies and relating to acts
committed by the Subsidiaries prior to the effective date of the spin-off.
ITEM 4: CONTROL OF REGISTRANT
Of the Company's two classes of capital stock outstanding, only the Common
Shares have full voting rights. The Preferred Shares have voting rights under
limited circumstances. See "Description of Securities to be Registered--
Capital Stock--Voting Rights." Solpart owns 51.8% of the Common Shares.
Accordingly, Solpart has the ability to control the election of the Company's
Board of Directors and the direction and future operations of the Company.
The following table sets forth information concerning the ownership of
Common Stock by Solpart and by the Company's officers and directors as a
group. The Company is not aware of any other shareholder owning more than
10.0% of the Common Shares.
<TABLE>
<CAPTION>
NUMBER OF PERCENTAGE OF
COMMON OUTSTANDING
NAME OF OWNER SHARES OWNED COMMON SHARES
------------- -------------- -------------
<S> <C> <C>
Solpart.......................................... 64,405,151,125 51.79%
All directors and executives officers as a group
(15 persons).................................... 31,402 0.00%
</TABLE>
The following is a brief description of the shareholders of Solpart.
TECHOLD PARTICIPACOES S.A. Techold is a subsidiary of Invitel S.A., a
company owned by (i) the following Brazilian pension funds: SISTEL--Fundacao
Sistel Seguridade Social, TELOS--Fundacao Embratel de Seguridade Social,
FUNCEL--Fundacao dos Economiarios Federais; PETROS--Fundacao Petrobras de
Seguridade Social and PREVI--Caixa de Previdencia dos Funcionarios do Banco do
Brasil and (ii) Opportunity Zain S.A., whose shareholders are the investment
funds and the companies controlled by the Opportunity Group. The Opportunity
Group is an investment and management group, whose activities include money
management and private equity in Brazil.
STET INTERNATIONAL NETHERLANDS N.V. Stet is part of a group headed by
Telecom Italia (BC) S.p.A. ("Telecom Italia"). Telecom Italia is the world's
seventh largest fixed-line telecommunications operator, with approximately
25.7 million installed fixed lines. It also provides, through its subsidiary
TIM (Telecom Italia Mobile), mobile telecommunications services worldwide to
more than 10.9 million subscribers. It also provides leased lines, data
communication services, satellite communications services and IT software
services, develops and manufactures telecommunications equipment and installs
telecommunications networks. Telecom Italia intends to selectively expand its
presence in key telecommunications markets outside Italy, focusing on Latin
America and Europe, through the acquisition of interests in existing fixed and
mobile service providers as well as of newly available license rights. It has
made investments in fixed and mobile service providers in Argentina, Chile,
Bolivia, Brazil, Cuba, Spain, France, Greece, Austria, the Czech Republic,
Serbia, China and India. Telecom Italia is also a participant in the consortia
that acquired control of two other New Holding Companies: Tele Celular Sul
Participacoes S.A. and Tele Nordeste Participacoes S.A.
33
<PAGE>
TIMEPART PARTICIPACOES LTDA. Timepart is a holding company owned by Telecom
Holding S.A., Privtel Investimentos S.A. and Teleunion S.A. Approximately 100%
of the share capital of Telecom Holding S.A. is owned by CSH LLC and CSH
Units. Approximately 100% of the share capital of Privtel Investimentos S.A.
is owned by Eduardo Cintra Santos. Approximately 100% of the share capital of
Teleunion S.A. is owned by Luiz Raymundo Tourinho Dantas. The sole purpose of
the entities that own Timepart is to invest in shares of other companies.
SHAREHOLDERS' AGREEMENT
On July 19, 1998, Techold Participacoes S.A. ("Techold"), STET International
Netherlands N.V. ("STET") and Timepart Participacoes Ltda. ("Timepart")
entered into a Shareholders' Agreement (the "Agreement"), which governs their
respective rights and obligations with respect to their shareholdings in the
Registrant. The Agreement provides for the formation of a new company, Solpart
Participacoes S.A. ("Solpart"), for the purposes of holding the investment in
and supervising the activities of the Registrant. Techold, STET and Timepart
each own 19%, 19% and 62%, respectively, of the common stock of Solpart and
62%, 38% and 0%, respectively, of the preferred stock of Solpart. The
Agreement provides for (i) rules for the management of Solpart; (ii) a right
of first offer, rights of first refusal and tag along rights for STET; (iii)
rights of first refusal for Techold with respect to the sale of STET's shares;
and (iv) the implementation of an Initial Business Plan of the Registrant.
The Agreement specifically provides that if Techold and/or Timepart (the
"Selling Parties") seek to sell a majority of Solpart's common shares and
preferred shares, STET may exercise a right of first offer with respect to all
the shares held by the Selling Parties. In addition, STET has rights of first
refusal with respect to a third party offer from (i) a telecommunications
competitor at a price equal to or below STET's offer price plus 15% thereof
("premium price") or (ii) a nontelecommunications competitor. STET's tag along
rights may be exercised if (i) the third party purchase price is greater than
the premium price and the third party purchaser is a telecommunications
competitor or (ii) in the event that the proposed sale of shares to a
telecommunications competitor when added to all other previous transfers of
shares by the Selling Parties would equal 10% or more of either the common
shares or preferred shares, or both, being transferred.
ITEM 5: NATURE OF TRADING MARKET
There has never been a trading market for the ADSs. Prior to September 21,
1998, there was no trading market for the Common Shares or the Preferred
Shares. The common shares and preferred shares of Tele Centro Sul's operating
subsidiaries Telepar and Telebrasilia have traded on the Bolsa de Valores de
Sao Paulo (the "Sao Paulo Stock Exchange"), the Bolsa de Valores do Rio de
Janeiro (the "Rio de Janeiro Stock Exchange") and the seven other Brazilian
stock exchanges (together with the Sao Paulo Stock Exchange and the Rio de
Janeiro Stock Exchange, the "Brazilian Stock Exchanges") since May 18, 1998.
Prior to that date, Telepar and Telebrasilia shares traded on such exchanges
as units with shares of the newly formed cellular companies formed upon the
spin-off of such Subsidiaries' cellular telephone businesses. Prior to the
spin-off of the Subsidiaries' cellular operations, common shares and preferred
shares of Telepar and Telebrasilia traded on the Brazilian Stock Exchanges.
The table below sets forth the high and low closing prices, in nominal
reais, for a thousand shares of Telepar and Telebrasilia on the Sao Paulo
Stock Exchange since the spin-off of the Subsidiaries' cellular operations.
<TABLE>
<CAPTION>
PRICES PER 1,000
PREFERRED SHARES OF
TELEPAR(1)
-------------------
HIGH LOW
-------------------
(IN NOMINAL REAIS)
<S> <C> <C>
May 18, 1998 through May 31, 1998.......................... R$480.00 R$228.00
June 1, 1998 through June 30, 1998......................... R$ 248.00 R$ 175.00
July 1, 1998 through July 31, 1998......................... R$ 272.60 R$ 190.00
August 1, 1998 through August 31, 1998..................... R$409.00 R$185.00
September 1, 1998 through September 30, 1998............... R$200.00 R$120.00
</TABLE>
- --------
(1) Share prices are for Telepar, a subsidiary of the Registrant, and not for
the Registrant itself.
34
<PAGE>
<TABLE>
<CAPTION>
PRICES PER 1,000
PREFERRED SHARES OF
TELEBRASILIA(1)
-------------------
HIGH LOW
-------------------
(IN NOMINAL REAIS)
<S> <C> <C>
May 18, 1998 through May 31, 1998.......................... R$ 440.00 R$191.00
June 1, 1998 through June 30, 1998......................... R$ 234.89 R$ 199.00
July 1, 1998 through July 31, 1998......................... R$ 225.00 R$ 190.00
August 1, 1998 through August 31, 1998..................... R$223.00 R$128.00
September 1, 1998 through September 30, 1998............... R$120.00 R$ 78.00
</TABLE>
- --------
(1) Share prices are for Telebrasilia, a subsidiary of the Registrant, and not
for the Registrant itself.
Following the Breakup and until September 21, 1998, the preferred shares of
each of the New Holding Companies, including the Preferred Shares, have been
traded on the Brazilian Stock Exchanges only as a unit with the preferred
shares of Telebras. Telebras ADSs, each representing 1,000 Telebras preferred
shares and, since the Breakup, each also representing 1,000 preferred shares
of each of the New Holding Companies, have continued to trade on the NYSE.
On September 21, 1998, common shares and preferred shares of each New
Holding Company, including the Preferred Shares, commenced trading separately
on the Brazilian Stock Exchanges. The table below sets forth, for the periods
indicated, the high and low closing sales prices for the Preferred Shares of
the Registrant as reported on the Sao Paulo Stock Exchange.
<TABLE>
<CAPTION>
PRICES PER
1,000
PREFERRED
SHARES OF
THE REGISTRANT
---------------
HIGH LOW
------- -------
(IN NOMINAL
REAIS)
<S> <C> <C>
September 21, 1998 through September 30, 1998................... R$13.20 R$10.00
October 1, 1998 through October 23, 1998........................ R$13.00 R$11.10
</TABLE>
It is expected that during the fourth quarter of 1998 American Depositary
Shares representing preferred shares of each New Holding Company will be
issued and commence trading separately on the NYSE. The ADSs, each
representing 5,000 Preferred Shares of the Registrant, will be issued to the
holders of Telebras ADSs pursuant to a Deposit Agreement (the "Deposit
Agreement") among the Registrant, The Bank of New York as Depositary (the
"Depositary") and the holders of the ADSs from time to time. See "Description
of Securities to be Registered--Description of American Depositary Receipts in
respect of Preferred Shares."
Application to list the Preferred Shares on the Brazilian Stock Exchanges
has been granted subject to distribution of the Preferred Shares and trading
on the Brazilian Stock Exchanges is expected to commence on September 21,
1998. Application has been made to list the ADSs on the NYSE upon issuance
under the symbol TCS. Prices at which the Preferred Shares and the ADSs may
trade cannot be predicted. There can be no assurance that an active trading
market for the Preferred Shares in Brazil or for the ADSs in the United States
or elsewhere will develop or be sustained.
TRADING ON THE BRAZILIAN STOCK EXCHANGES
Of Brazil's nine stock exchanges, the Sao Paulo Stock Exchange and the Rio
de Janeiro Stock Exchange are the most significant. During 1997, the Sao Paulo
Stock Exchange accounted for approximately 93% of the trading value of equity
securities on all Brazilian stock exchanges, and the Sao Paulo Stock Exchange
and the Rio de Janeiro Stock Exchange together accounted for approximately 99%
of the trading value of equity securities on all Brazilian stock exchanges.
Each Brazilian stock exchange is a non-profit entity owned by its member
brokerage firms. Trading on each exchange is limited to member brokerage firms
and a limited number of authorized non-members. The Sao Paulo Stock Exchange
and the Rio de Janeiro Stock Exchange have two open outcry trading sessions
each day, from
35
<PAGE>
10:00 a.m. to 1:00 p.m. and from 2:00 p.m. to 5:00 p.m. Trading is also
conducted during this time on an automated system on the Sao Paulo Stock
Exchange and on the National Electronic Trading System ("SENN"), a
computerized system that links the Rio de Janeiro Stock Exchange
electronically with the seven smaller regional exchanges. Market makers exist
on the Sao Paulo Stock Exchange, but are only authorized to make markets in
options for stock indices which are traded on that exchange and to engage in
transactions on META (Mercado de Empresas Teleassistidas), an electronic
trading system operating at the Sao Paulo Stock Exchange and permitting
trading in the securities of companies registered for that purpose. These
companies must appoint the market makers authorized to deal in their
securities. There are no specialists or market makers for the Company's shares
on the Sao Paulo Stock Exchange. The Comissao de Valores Mobiliarios (the
Brazilian Securities Commission or "CVM") and each of the Brazilian stock
exchanges have discretionary authority to suspend trading in shares of a
particular issuer under certain circumstances. Trading in securities listed on
the Brazilian stock exchanges may be effected off the exchanges in certain
circumstances, although such trading is very limited.
Settlement of transactions is effected three business days after the trade
date without adjustment of the purchase price for inflation. Payment for
shares is made through the facilities of separate clearinghouses for each
exchange, which maintain accounts for member brokerage firms. The seller is
ordinarily required to deliver the shares to the exchange on the second
business day following the trade date. The clearinghouse for the Sao Paulo
Stock Exchange is Calispa S.A., which is owned by the member brokerage firms.
The clearinghouse for the Rio de Janeiro Stock Exchange is CLC-Camara de
Liquidacao e Custodia S.A., which is 99% owned by that exchange.
At December 31, 1997, the aggregate market capitalization of the 536
companies listed on the Sao Paulo Stock Exchange was approximately R$285.0
billion. Substantially the same securities are listed on the Sao Paulo Stock
Exchange and on the Rio de Janeiro Stock Exchange. Although all the
outstanding shares of an exchange-listed company may trade on a Brazilian
stock exchange, in most cases less than half of the listed shares are actually
available for trading by the public, the remainder being held by small groups
of controlling persons that rarely trade their shares. This is particularly
true in the case of mixed-capital companies, such as the Company before the
privatization, of which more than half of the voting shares must by law be
owned by Brazilian governmental entities. For this reason, data showing the
total market capitalization of Brazilian stock exchanges tend to overstate the
liquidity of the Brazilian equity securities market.
Although the Brazilian equity market was Latin America's largest in terms of
market capitalization, it is relatively small and illiquid compared to major
world markets. In 1997, the combined daily trading volumes on these two
exchanges averaged approximately R$945.4 million. In 1997, the five most
actively traded issues represented approximately 72.9% of the total trading in
the cash market on the Sao Paulo Stock Exchange and approximately 50.5% of the
total trading in the cash market on the Rio de Janeiro Stock Exchange.
Trading on Brazilian stock exchanges by nonresidents of Brazil is subject to
certain limitations under Brazilian foreign investment legislation. See
"Description of Securities to be Registered."
REGULATION OF BRAZILIAN SECURITIES MARKETS
The Brazilian securities markets are regulated by the CVM, which has
authority over stock exchanges and the securities markets generally, and by
the Central Bank of Brazil, which has, among other powers, licensing authority
over brokerage firms and regulates foreign investment and foreign exchange
transactions. The Brazilian securities market is governed by Law No. 6,385
dated December 7, 1976, as amended (the "Brazilian Securities Law"), and the
Brazilian Corporation Law.
Under the Brazilian Corporation Law, a company is either public, a
"companhia aberta," such as the Company, or private, a "companhia fechada."
All public companies are registered with the CVM and are subject to reporting
requirements. A company registered with the CVM may have its securities traded
either on the Brazilian stock exchanges or in the Brazilian over-the-counter
("Brazilian OTC") market. The shares of a
36
<PAGE>
public company, including the Company, may also be traded privately, subject
to certain limitations. To be listed on the Brazilian stock exchanges, a
company must apply for registration with the CVM and the stock exchange where
the head office of the company is located. Once this stock exchange has
admitted a company to listing and the CVM has accepted its registration as a
public company, its securities may be traded on all other Brazilian stock
exchanges.
Trading in securities on the Brazilian stock exchanges may be suspended at
the request of a company in anticipation of a material announcement. Trading
may also be suspended on the initiative of a Brazilian stock exchange or the
CVM, among other reasons, based on or due to a belief that a company has
provided inadequate information regarding a material event or has provided
inadequate responses to inquiries by the CVM or the relevant stock exchange.
The Brazilian Securities Law provided for, among other things, disclosure
requirements, restrictions on insider trading and price manipulation, and
protection of minority shareholders. However, the Brazilian securities markets
are not as highly regulated and supervised as the United States securities
markets or markets in certain other jurisdictions.
ITEM 6: EXCHANGE CONTROLS AND OTHER LIMITATIONS AFFECTING SECURITY HOLDERS
There are no restrictions on ownership of Preferred Shares or Common Shares
of the Registrant by individuals or legal entities domiciled outside Brazil.
Until the Registrant was privatized, it was subject to provisions of
Brazilian corporate law applicable to mixed-capital companies under Brazilian
law. These provisions ceased to apply after the Registrant was privatized. As
a mixed-capital company, the Registrant was not subject to bankruptcy and the
Federal Government was contingently liable for the obligations of the
Registrant for so long as its assets were encumbered and attached. However,
substantial limitations applied to the attachment or sale of assets of the
operating subsidiaries of the Registrant that were used to provide
telecommunications services pursuant to the Company's concession. Similarly,
the sale of shares representing voting control of operating subsidiaries
providing public telecommunications services was subject to government
authorization. The sale of preferred shares of operating subsidiaries, or of
assets not used to provide telecommunications services, was not subject to
these restrictions.
The right to convert dividend payments and proceeds from the sale of shares
into foreign currency and to remit such amounts outside Brazil is subject to
restrictions under foreign investment legislation which generally requires,
among other things, that the relevant investments have been registered with
the Central Bank of Brazil. Such restrictions on the remittance of foreign
capital abroad may hinder or prevent Banco Itau S.A. (the "Custodian"), as
custodian for the Preferred Shares represented by ADSs, or holders who have
exchanged ADRs for Preferred Shares from converting dividends, distributions
or the proceeds from any sale of such Preferred Shares, as the case may be,
into U.S. dollars and remitting such U.S. dollars abroad. Holders of ADSs
could be adversely affected by delays in, or refusal to grant any, required
government approval for conversions of Brazilian currency payments and
remittances abroad of the Preferred Shares underlying the ADSs.
Under Annex IV to Resolution No. 1,289 of the National Monetary Council, as
amended (the "Annex IV Regulations"), qualified foreign investors (which
principally include foreign financial institutions, insurance companies,
pension and investment funds, charitable foreign institutions and other
institutions that (i) seek to invest in financial markets and (ii) meet
certain minimum capital and other requirements) registered with the CVM and
acting through authorized custody accounts managed by local agents may buy and
sell shares on Brazilian stock exchanges without obtaining separate
Certificates of Registration for each transaction. Investors under the Annex
IV Regulations are also entitled to favorable tax treatment. See "Taxation--
Brazilian Tax Considerations." Resolution No. 1,927 of the National Monetary
Council, which is the restated and amended Annex V to Resolution No. 1,289 of
the National Monetary Council (the "Annex V Regulations"), provides for the
issuance of depositary receipts in foreign markets in respect of shares of
Brazilian issuers. The ADS program
37
<PAGE>
will be approved under the Annex V Regulations by the Central Bank of Brazil
and the CVM prior to the issuance of the ADSs. Accordingly, the proceeds from
the sale of ADSs by ADR holders outside Brazil are free of Brazilian foreign
investment controls and holders of the ADSs will be entitled to favorable tax
treatment. See "Taxation--Brazilian Tax Considerations."
A Certificate of Registration will be issued in the name of the Depositary
with respect to the ADSs prior to the issuance of the ADSs and will be
maintained by the Custodian on behalf of the Depositary. Pursuant to the
Certificate of Registration, the Custodian and the Depositary are able to
convert dividends and other distributions with respect to the Preferred Shares
represented by ADSs into foreign currency and remit the proceeds outside
Brazil. In the event that a holder of ADSs exchanges such ADSs for Preferred
Shares, such holder will be entitled to continue to rely on the Depositary's
Certificate of Registration for five business days after such exchange,
following which such holder must seek to obtain its own Certificate of
Registration with the Central Bank of Brazil. Thereafter, any holder of
Preferred Shares may not be able to convert into foreign currency and remit
outside Brazil the proceeds from the disposition of, or distributions with
respect to, such Preferred Shares, unless such holder (i) qualifies under the
Annex IV Regulations or (ii) obtains its own Certificate of Registration, and
in the case of (ii), it will be subject to less favorable Brazilian tax
treatment than a holder of ADSs. See "Taxation--Brazilian Tax Considerations."
Under current Brazilian legislation, the Federal Government may impose
temporary restrictions on remittances of foreign capital abroad in the event
of a serious imbalance or an anticipated serious imbalance of Brazil's balance
of payments. For approximately six months in 1989 and early 1990, the Federal
Government froze all dividend and capital repatriations held by the Central
Bank of Brazil that were owed to foreign equity investors, in order to
conserve Brazil's foreign currency reserves. These amounts were subsequently
released in accordance with Federal Government directives. The imbalance in
Brazil's balance of payments increased during 1997, and there can be no
assurance that the Federal Government will not impose similar restrictions on
foreign repatriations in the future.
ITEM 7: TAXATION
The following summary contains a description of the principal Brazilian and
U.S. federal income tax consequences of the 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. This summary is also based upon the
representations of the Depositary and on the assumption that each obligation
in the Deposit Agreement relating to the ADRs and any related documents will
be performed in accordance with its terms. PROSPECTIVE PURCHASERS OF PREFERRED
SHARES OR ADSs SHOULD CONSULT THEIR OWN TAX ADVISORS AS TO THE TAX
CONSEQUENCES OF THE ACQUISITION, OWNERSHIP AND DISPOSITION OF PREFERRED SHARES
OR ADSs.
Although there is at present no income tax treaty between Brazil and the
United States, the tax authorities of the two countries have had discussions
that may culminate in such a treaty. No assurance can be given, however, as to
whether or when a treaty will enter into force or how it will affect the U.S.
holders of Preferred Shares or ADSs. Prospective holders of Preferred Shares
or ADSs should consult their own tax advisors as to the tax consequences of
the acquisition, ownership and disposition of Preferred Shares or ADSs in
their particular circumstances.
BRAZILIAN TAX CONSIDERATIONS
The following discussion summarizes the principal Brazilian tax consequences
of the acquisition, ownership and disposition of Preferred Shares or ADSs by a
holder that is not domiciled in Brazil for purposes of Brazilian taxation and,
in the case of a holder of Preferred Shares, that has registered its
investment in Preferred Shares with the Central Bank of Brazil as a U.S.
dollar investment (in each case, a "non-Brazilian holder"). It is based
38
<PAGE>
on Brazilian law as currently in effect. Any change in such law may change the
consequences described below. The following discussion summarizes the
principal tax consequences applicable under current Brazilian law to non-
Brazilian holders of Preferred Shares or ADSs; it does not specifically
address all of the Brazilian tax considerations applicable to any particular
non-Brazilian holder, and each non-Brazilian holder should consult his or her
own tax advisor concerning the Brazilian tax consequences of an investment in
Preferred Shares or ADSs.
TAXATION OF DIVIDENDS
Dividends, including dividends paid in kind, paid by the Company (i) to the
Depositary in respect of the Preferred Shares underlying the ADSs or (ii) to a
non-Brazilian holder in respect of Preferred Shares will generally not be
subject to Brazilian withholding tax in the case of distributions of profits
earned as from January 1, 1996. Stock dividends relating to profits generated
prior to December 31, 1995 are not subject to withholding tax in Brazil unless
the stock is redeemed by the Company within five years from such distribution
or the non-Brazilian holder sells the stock in Brazil within such five-year
period.
Brazil has entered into tax treaties with several countries. However, there
is currently no tax treaty between the United States and Brazil. The only
Brazilian tax treaty now in effect that, if certain conditions are met, would
reduce the rate of the withholding tax on dividends in respect of profits
generated prior to December 31, 1995 below the generally applicable 15% rate
is the treaty with Japan, which would reduce such rate to 12.5% under the
circumstances stated in such treaty.
TAXATION OF GAINS
Gains realized outside Brazil by a non-Brazilian holder on the disposition
of ADSs to another non-Brazilian holder are not subject to Brazilian tax.
The withdrawal of Preferred Shares in exchange for ADSs is not subject to
Brazilian tax. The deposit of Preferred Shares in exchange for ADSs is not
subject to Brazilian tax provided that the Preferred Shares are registered
under the Annex IV Regulations. In the event the Preferred Shares are not so
registered, the deposit of Preferred Shares in exchange for ADSs may be
subject to Brazilian capital gains tax at the rate of 10% or 15% as described
below. On receipt of the underlying Preferred Shares, a non-Brazilian holder
who qualifies under the Annex IV Regulations will be entitled to register the
U.S. dollar value of such shares with the Central Bank of Brazil as described
below under "--Registered Capital."
Non-Brazilian holders are not subject to tax in Brazil on gains realized on
sales of Preferred Shares that occur abroad or on the proceeds of a redemption
of, or a liquidating distribution with respect to, Preferred Shares. As a
general rule, non-Brazilian holders are subject to a withholding tax imposed
at a rate of 15% on gains realized on sales or exchanges of Preferred Shares
that occur in Brazil to or with a resident of Brazil outside of a Brazilian
stock exchange. Non-Brazilian holders are generally subject to a withholding
tax at a rate of 10% on gains realized on sales or exchanges in Brazil of
Preferred Shares that occur on a Brazilian stock exchange but will not be
subject to tax if either such a sale is made within five business days of the
withdrawal of such Preferred Shares in exchange for ADSs and the proceeds
thereof are remitted abroad within such five-day period, or such a sale is
made under the Annex IV Regulations by certain qualified institutional non-
Brazilian holders that register with the CVM. Gains realized by an investor
under the Annex IV Regulations are not subject to tax, provided certain
conditions are met. The "gain realized" is the difference between the amount
in Brazilian currency realized on the sale or exchange and the acquisition
cost, measured in Brazilian currency without any correction for inflation, of
the shares sold. The "gain realized" as a result of a transaction with respect
to shares registered as an investment with the Central Bank of Brazil (and not
subject to the Annex IV Regulations) will be calculated based on the foreign
currency amount registered with the Central Bank of Brazil. There can be no
assurance that the current preferential treatment for holders of ADSs and non-
Brazilian holders of Preferred Shares under the Annex IV Regulations will not
be changed. Reductions in the tax rate provided for by Brazil's tax treaties
do not apply to tax on gains realized on sales or exchanges of Preferred
Shares.
39
<PAGE>
Any exercise of preemptive rights relating to the Preferred Shares or ADSs
will not be subject to Brazilian taxation. Any gain on the sale or assignment
of preemptive rights relating to the Preferred Shares by the Depositary will
not be subject to Brazilian taxation.
DISTRIBUTIONS OF INTEREST ON NET WORTH
In accordance with Law No. 9,249, dated December 26, 1995, Brazilian
corporations may make payments to shareholders characterized as distributions
of interest on the Company's net worth. Such interest is limited to the
Federal Government's long-term interest rate (the "TJLP") as determined by the
Central Bank of Brazil from time to time (10.63% per annum for the three-month
period starting June 1, 1998), and cannot exceed the greater of (i) 50% of net
income (before taking such distribution and any deductions for income taxes
into account) for the period in respect of which the payment is made or (ii)
50% of retained earnings.
Distributions of interest on net worth in respect of the Preferred Shares
paid to shareholders who are either Brazilian residents or non-Brazilian
residents, including holders of ADSs, are subject to Brazilian withholding tax
at the rate of 15% (except for interest due to the Federal Government, which
is exempt from tax withholding) and shall be deductible by the Registrant for
purposes of the Corporate Income Tax ("IRPJ") and Social Contribution on
Profit ("CSLL") (both of which are levied on the Company's profits) as long as
the payment of a distribution of interest is approved in the Registrant's
annual shareholders' meeting. The amount of distributions of interest on net
worth will be determined by the Board of Directors of the Registrant. No
assurance can be given that the Board of Directors of the Registrant will not
determine that future distributions of profits will be made by means of
interest on net worth instead of by means of dividends.
Under Brazilian law and regulations, the amount paid to shareholders as
interest on net worth (net of any withholding tax) may be treated as payment
in lieu of the Mandatory Dividend and Preferred Dividend (as defined under
"Description of Securities to be Registered--Capital Stock--Dividends"). In
addition, any Brazilian corporation distributing interest on net worth is
obligated to distribute to shareholders an amount sufficient to ensure that
the net amount received (after payment of withholding taxes) is at least equal
to the Mandatory Dividend.
Distributions of interest on net worth in respect of the Preferred Shares,
including to holders of ADSs, may be converted into U.S. dollars and remitted
outside of Brazil to U.S. holders, subject to relevant exchange restrictions.
See "Description of Securities to be Registered--Capital Stock--Payment of
Dividends" and "--Description of American Depositary Receipts in respect of
Preferred Shares--Dividends, Other Distributions and Rights."
OTHER BRAZILIAN TAXES
There are no Brazilian inheritance, gift or succession taxes applicable to
the ownership, transfer or disposition of Preferred Shares or ADSs by a non-
Brazilian holder except for gift and inheritance taxes levied by some States
in Brazil on gifts made or inheritances bestowed by individuals or entities
not resident or domiciled in Brazil or in the revelant 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.
Pursuant to Decree 2,219 dated May 2, 1997,a financial transaction tax (the
"IOF") may be imposed on the conversion into Brazilian currency of the
proceeds of a foreign investment in Brazil (including investments in Preferred
Shares and ADSs and investments made under the Annex IV Regulations) and may
also be imposed upon the conversion of Brazilian currency into foreign
currency (e.g., for purposes of paying dividends and interest). The IOF tax
rate is currently 0%. Although the Minister of Finance has the legal power to
increase the rate to a maximum of 25%, any such increase will be applicable
only to transactions occurring after such increase becomes effective.
40
<PAGE>
On January 24, 1997, a temporary tax was enacted. The Contribuicao
Provisoria sobre Movimentacao Financeira ("CPMF Tax"), which was created by
Constitutional Amendment No. 12 of August 16, 1996 and regulated by Law No.
9,311 of October 24, 1996, is levied on debits on bank accounts and certain
other payments made by a bank at a rate of 0.2%, which may be raised at any
time to 0.25%. The CPMF Tax was initially scheduled to be collected until
February 22, 1998; the CPMF Tax was subsequently extended until January 27,
1999 by Law No. 9,539 of December 12, 1997.
REGISTERED CAPITAL
The amount of an investment in Preferred Shares held by a non-Brazilian
holder who qualifies under the Annex IV Regulations and obtains registration
with the CVM, or by the Depositary representing such holder, is eligible for
registration with the Central Bank of Brazil; such registration (the amount so
registered is referred to as "Registered Capital") allows the remittance
outside Brazil of foreign currency, converted at the Commercial Market Rate,
acquired with the proceeds of distributions on, and amounts realized with
respect to disposition of, such Preferred Shares. The Registered Capital for
each Preferred Share purchased in the form of an ADS, or purchased in Brazil,
and deposited with the Depositary in exchange for an ADS, will be equal to its
purchase price (in U.S. dollars) to the purchaser. The Registered Capital for
a Preferred Share that is withdrawn upon surrender of an ADS will be the U.S.
dollar equivalent of (i) the average price of the Preferred Share on the
Brazilian stock exchange on which the greatest number of Preferred Shares was
sold on the day of withdrawal, or (ii) if no Preferred Shares were sold on
that day, the average price on the Brazilian stock exchange on which the
greatest number of Preferred Shares were sold in the fifteen trading sessions
immediately preceding such withdrawal. The U.S. dollar value of the Preferred
Shares is determined on the basis of the average Commercial Market Rates
quoted by the Central Bank of Brazil on such date (or, if the average price of
Preferred Shares is determined under clause (ii) of the preceding sentence,
the average of such average quoted rates on the same fifteen dates used to
determine the average price of the Preferred Shares).
A non-Brazilian holder of Preferred Shares may experience delays in
effecting such registration, which may delay remittances abroad. Such a delay
may adversely affect the amount, in U.S. dollars, received by the non-
Brazilian holder.
U.S. FEDERAL INCOME TAX CONSIDERATIONS
The statements regarding U.S. tax law set forth below are based on U.S. law
as in force on the date of this Registration Statement, and changes to such
law subsequent to the date of this Registration Statement may affect the tax
consequences described herein. This summary describes the principal tax
consequences of the ownership and disposition of Preferred Shares or ADSs, but
it does not purport to be a comprehensive description of all of the tax
consequences that may be relevant to a decision to hold or dispose of
Preferred Shares or ADSs. This summary applies only to purchasers of Preferred
Shares or ADSs who will hold the Preferred Shares or ADSs as capital assets
and does not apply to special classes of holders such as dealers in securities
or currencies, holders whose functional currency is not the U.S. dollar,
holders of 10% or more of the shares of the Registrant, tax-exempt
organizations, financial institutions, holders liable for the alternative
minimum tax, securities traders who elect to account for their investment in
Preferred Shares or ADSs on a mark-to-market basis, and persons holding
Preferred Shares or ADSs in a hedging transaction or as part of a straddle or
conversion transaction.
Each holder should consult such holder's own tax advisor concerning the
overall tax consequences to it, including the consequences under foreign,
state and local laws, of an investment in Preferred Shares or ADSs.
In this discussion, references to "ADSs" also refer to Preferred Shares,
references to a "U.S. holder" are to a holder of an ADS (i) that is a citizen
or resident of the United States of America, (ii) that is a corporation
organized under the laws of the United States of America or any state thereof,
or (iii) that is otherwise subject to U.S. federal income taxation on a net
basis with respect to the ADS.
For purposes of the U.S. Internal Revenue Code of 1986, as amended (the
"Code"), holders of ADRs will be treated as owners of the ADSs represented by
such ADRs.
41
<PAGE>
TAXATION OF DIVIDENDS
A U.S. holder will recognize ordinary dividend income for U.S. federal
income tax purposes in an amount equal to the amount of any cash and the value
of any property distributed by the Registrant as a dividend to the extent that
such distribution is paid out of the Registrant's current or accumulated
earnings and profits ("e&p"), as determined for U.S. federal income tax
purposes, when such distribution is received by the Custodian or by the U.S.
holder, in the case of a holder of Preferred Shares. To the extent that such a
distribution exceeds the Registrant's e&p, it will be treated as a non-taxable
return of capital, to the extent of the U.S. holder's tax basis in the ADS (or
Preferred Shares, as the case may be), and thereafter as capital gain. The
amount of any distribution will include the amount of Brazilian tax withheld
on the amount distributed and the amount of a distribution paid in reais will
be measured by reference to the exchange rate for converting reais into U.S.
dollars in effect on the date the distribution is received by the Custodian 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 Registrant will not be eligible for the
dividends received deduction allowed to corporations under the Code.
Distributions out of e&p with respect to the ADSs generally will be treated
as dividend income from sources outside of the United States and generally
will be treated separately along with other items of "passive" (or, in the
case of certain U.S. holders, "financial services") income for purposes of
determining the credit for foreign income taxes allowed under the Code.
Subject to certain limitations, the Brazilian withholding tax paid in
connection with any distribution with respect to the ADSs may be claimed as a
credit against the U.S. federal income tax liability of a U.S. holder if such
U.S. holder elects for that year to credit all foreign income taxes, or such
Brazilian withholding tax may be taken as a deduction. Under new rules enacted
by Congress in 1997 and other guidance recently released by the U.S. Treasury,
foreign tax credits will not be allowed for withholding taxes imposed in
respect of certain short-term or hedged positions in securities or in respect
of arrangements in which a U.S. holder's expected economic profit, after non-
U.S. taxes, is insubstantial. U.S. holders should consult their own tax
advisors concerning the implications of these rules in light of their
particular circumstances.
Distributions of additional shares to holders with respect to their ADSs
that are made as part of a pro rata distribution to all shareholders of the
Registrant generally will not be subject to U.S. federal income tax.
A holder of an ADS that is a foreign corporation or non-resident alien
individual (a "non-U.S. holder") generally will not be subject to U.S. federal
income tax or withholding tax on distributions with respect to ADSs that are
treated as dividend income for U.S. federal income tax purposes, and generally
will not be subject to U.S. federal income tax or withholding tax on
distributions with respect to ADSs that are treated as capital gain for U.S.
federal income tax purposes unless such holder would be subject to U.S.
federal income tax on gain realized on the sale or other disposition of ADSs,
as discussed below.
TAXATION OF CAPITAL GAINS
Upon the sale or other disposition of an ADS, a U.S. holder will recognize
gain or loss for U.S. federal income tax purposes in an amount equal to the
difference between the amount realized in consideration for the disposition of
the ADS (excluding the amount of any distribution paid to the Custodian but
not distributed by the Custodian prior to the disposition) and the U.S.
holder's tax basis in the ADS. Such gain or loss generally will be subject to
U.S. federal income tax and will be treated as capital gain or loss. Under
recently enacted legislation, long-term capital gains recognized by an
individual holder generally are subject to a maximum rate of 20 percent in
respect of property held for more than one year, effective for amounts
properly taken into account on or after January 1, 1998. The deductibility of
capital losses is subject to certain limitations. Gain realized by a U.S.
holder on a sale or disposition of ADSs generally will be treated as U.S.
source income. Consequently, in the case of a disposition of Preferred Shares
in Brazil (which, unlike a disposition of ADSs,
42
<PAGE>
would be taxable in Brazil), the U.S. holder might not be able to use the
foreign tax credit for Brazilian tax imposed on gain.
A non-U.S. holder will not be subject to U.S. federal income tax or
withholding tax on gain realized on the sale or other disposition of an ADS
unless (i) such gain is effectively connected with the conduct by the holder
of a trade or business in the United States, or (ii) such holder is an
individual who is present in the United States of America for 183 days or more
in the taxable year of the sale and certain other conditions are met.
U.S. BACKUP WITHHOLDING AND INFORMATION REPORTING
The information reporting requirements of the Code generally will apply to
distributions to a U.S. holder. Distributions to non-U.S. holders generally
will be exempt from information reporting and backup withholding under current
law but a non-U.S. holder may be required to establish its non-U.S. status in
order to claim such exemption.
ITEM 8: SELECTED FINANCIAL DATA
GENERAL
The following table presents selected consolidated financial information for
the Company as of and for the periods indicated. The information as of
December 31, 1996 and 1997 and for the three-year period ended December 31,
1997 is derived from and should be read in conjunction with, and is qualified
in its entirety by reference to, the Consolidated Financial Statements and the
Notes thereto included elsewhere in this Registration Statement. These
Consolidated Financial Statements have been audited by KPMG Peat Marwick,
independent auditors, and their report on such Consolidated Financial
Statements appears elsewhere in this Registration Statement. The Consolidated
Financial Statements are prepared in accordance with Brazilian GAAP, which
differ in certain material respects from generally accepted accounting
principles in the United States ("U.S. GAAP"). See Note 29 to the Consolidated
Financial Statements for a summary of the differences between Brazilian GAAP
and U.S. GAAP as of and for the years ended December 31, 1996 and 1997. All
other selected consolidated financial information has been derived from the
Company's accounting records.
The Consolidated Financial Statements present the financial condition and
results of operations of the Registrant and its Subsidiaries. The portion of
the consolidated equity and net income of the Subsidiaries attributable to
shareholders of the Subsidiaries other than Telebras at December 31, 1996 and
1997, and for each of the years in the three-year period ended December 31,
1997 is reflected as "minority interests" in the Consolidated Financial
Statements. At December 31, 1997, such minority shareholders directly and
indirectly owned the percentages of share capital in the Subsidiaries shown in
"Presentation of Financial Information."
The Consolidated Financial Statements present the fixed-line
telecommunications business of the Registrant and its Subsidiaries, as
continuing operations and the cellular telephone business as discontinued
operations for all periods. The assets and liabilities of the cellular
telephone business are presented as net assets of discontinued operations.
The separation of the fixed and cellular telecommunications businesses has
been accounted as a reorganization of entities under common control in a
manner similar to a pooling of interests. The assets and liabilities of the
cellular telephone business were transferred from the Subsidiaries at their
indexed historical cost. The Consolidated Financial Statements are not
necessarily indicative of the financial position and results of operations
that would have occurred for the three-year period ended December 31, 1997 had
the fixed-line telecommunications businesses of the Subsidiaries been separate
legal entities during such period. See "Description of Business--Background,"
"--The Company" and Notes 1, 2 and 28 to the Consolidated Financial
Statements.
Prior to December 31, 1997 cash and certain non-specific debt of the
cellular telecommunications business could not be segregated from the
Subsidiaries. Accordingly, these amounts are included in the financial
43
<PAGE>
statements for periods ended before January 1, 1998. As a result, certain
interest income and expense relating to the cellular telecommunications
business could not be identified and, consequently, income from discontinued
operations is presented before unallocated interest income (expense) and
income tax expense. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Results of Operations for the years ended
December 31, 1995, 1996 and 1997--Allocated and unallocated interest expense
and unallocated interest income."
Certain of the constant real-denominated information herein has been
translated into U.S. dollars using the December 31, 1997 Commercial Market
Rate published by the Central Bank of Brazil of R$1.1164 to US$1.00. These
translations are presented solely for the convenience of the reader and should
not be construed as implying that local currency amounts represent, or could
have been, or could be, converted into U.S. dollars at such rates or any rate.
The Consolidated Financial Statements and, unless otherwise specified, all
financial information included in this Registration Statement, have been
restated to recognize certain effects of inflation and expressed in constant
reais of December 31, 1997 purchasing power. Such restatement has been
effected in accordance with Brazilian GAAP using the integral restatement
method (correcao integral) required by the CVM to be used for financial
statements of public corporations through December 31, 1995. Inflationary
gains or losses on monetary assets and liabilities have been allocated to
their corresponding income or expense caption in the income statement.
Inflationary gains or losses without a corresponding income or expense caption
have been allocated to other net operating income. See Note 2a to the
Consolidated Financial Statements.
Until December 31, 1995, the relevant inflation index selected by the CVM
and the one used for the constant currency method under Brazilian GAAP was the
UFIR. Effective January 1, 1996, the CVM no longer requires Brazilian
companies to restate their financial statements for reporting purposes is
constant currency by indexing historical amounts using the UFIR. Restatement
in constant currency is now optional and any general price index may be used.
The Brazilian Institute of Accountants has recommended that the IGP-M be used
for this purpose. The Company's management believes that the IGP-M is the most
appropriate measure of the general price inflation in Brazil and has elected
the IGP-M for purposes of preparing its consolidated financial statements in
accordance with the constant currency method as of January 1, 1996.
In July 1997, the three-year cumulative inflation rate for Brazil fell below
100%; however, for accounting purposes, the constant currency method has
continued to be applied. The Brazilian Institute of Accountants has not yet
published definitive rules regarding when the constant currency method of
accounting may no longer be used to prepare financial statements. If the
Brazilian Institute of Accountants determines that the constant currency
method may no longer be used to prepare financial statements beginning January
1, 1998, the restated balances of nonmonetary assets and liabilities of the
Company as of December 31, 1997 will become the new basis for accounting, and
income statement items will no longer be restated for inflation.
44
<PAGE>
SELECTED FINANCIAL INFORMATION
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------------------------------------
1993 1994 1995 1996 1997 1997
--------- --------- --------- ---------- ---------- ----------------
(IN THOUSANDS
(IN THOUSANDS OF CONSTANT OF U.S. DOLLARS,
REAIS OF DECEMBER 31, 1997, EXCEPT PER
EXCEPT PER SHARE DATA) SHARE DATA)(1)
<S> <C> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Brazilian GAAP
Net operating revenue
from telecommunication
services............... 1,506,681 1,638,540 1,593,701 2,079,975 2,355,612 2,110,007
Cost of services........ (838,514) (954,183) (997,632) (1,111,096) (1,238,991) (1,109,809)
--------- --------- --------- ---------- ---------- ----------
Gross profit............ 668,167 684,357 596,069 968,879 1,116,621 1,000,198
Operating expenses...... 352,551 419,037 377,865 394,711 462,005 413,835
--------- --------- --------- ---------- ---------- ----------
Operating income from
continuing operations
before interest
income/expense......... 315,616 265,320 218,204 574,168 654,616 586,363
Allocated interest
expense(2)............. -- -- (17,697) (10,125) (34,864) (31,229)
--------- --------- --------- ---------- ---------- ----------
Operating income from
continuing operations
before unallocated
interest income
(expense)(2)(3)(4)..... 315,616 265,320 200,507 564,043 619,752 555,134
--------- --------- --------- ---------- ---------- ----------
Net non-operating income
(expense).............. (6,775) (4,134) (1,348) (16,433) (25,094) (22,478)
Employees' profit
share.................. (10,728) (6,037) (8,475) (17,068) (26,524) (23,759)
Income from continuing
operations before
unallocated interest
income (expense), taxes
and minority
interests.............. 298,113 255,149 190,684 530,542 568,134 508,897
Income from discontinued
cellular operations
before unallocated
interest income
(expense), tax and
minority
interests(2)(3)(4)..... -- -- 149,135 297,274 341,636 306,016
Unallocated interest
income(2)(3)(4)........ 34,435 31,076 40,418 60,612 61,913 55,458
Unallocated interest
expense(2)(3)(4)....... (78,618) (25,930) (3,678) (1,488) (2,870) (2,571)
--------- --------- --------- ---------- ---------- ----------
Income before taxes and
minority interests..... 253,930 260,295 376,559 886,940 968,813 867,800
Income and social
contribution taxes..... 263,587 (73,976) (164,519) (231,713) (266,949) (239,116)
--------- --------- --------- ---------- ---------- ----------
Income before minority
interests.............. 517,517 186,319 212,040 655,227 701,864 628,684
Minority interests(5)... (77,598) (28,335) (26,910) (92,925) (138,599) (124,148)
--------- --------- --------- ---------- ---------- ----------
Net income.............. 439,919 157,984 185,130 562,302 563,265 504,536
========= ========= ========= ========== ========== ==========
U.S. GAAP:
Income from continuing operations before unallocated
interest income (expense),
income taxes and minority interests ................. 603,654 657,449 588,901
Income from discontinued cellular operations before
unallocated interest income (expense),
income taxes and minority interests.................. 311,076 362,585 324,781
Net income............................................ 619,298 673,743 603,496
NET INCOME PER THOUSAND SHARES:
Common shares-Basic(6)................................ 1.93 2.10 1.88
Common shares-Diluted(6).............................. 1.75 1.98 1.77
Preferred shares-Basic(6)............................. 1.93 2.10 1.88
Preferred shares-Diluted(6)........................... 1.75 1.98 1.77
BALANCE SHEET DATA:
Brazilian GAAP
Property, plant and
equipment, net......... 4,674,742 5,027,354 5,401,864 5,963,131 6,444,519 5,772,590
Total assets............ 5,526,729 5,924,108 6,399,994 7,530,147 8,480,956 7,596,700
Loans and financing--
current portion........ 152,470 109,218 63,383 104,191 110,414 98,902
Loans and financing--
noncurrent portion..... 214,496 149,868 125,996 142,354 183,994 164,810
Shareholders' equity.... 4,211,484 3,916,200 4,348,528 4,968,654 5,410,826 4,846,673
U.S. GAAP
Property, plant and equipment, net.................... 5,620,157 6,050,932 5,420,039
Total assets.......................................... 7,378,435 8,300,284 7,434,866
Loans and financing--current portion.................. 91,002 168,659 151,074
Loans and financing--noncurrent portion............... 142,354 110,051 98,577
Shareholders' equity.................................. 5,027,058 5,320,650 4,765,915
<CAPTION>
MAY 22, 1998
----------------
(IN THOUSANDS OF
CONSTANT REAIS)
<S> <C> <C> <C> <C> <C> <C>
NEW HOLDING COMPANY--BRAZILIAN GAAP SHAREHOLDERS' EQUITY (7)
Share capital............................................................... 1,936,659
Income reserves............................................................. 1,791,424
Retained earnings........................................................... 1,394,352
----------
Total shareholders' equity................................................. 5,122,435
==========
</TABLE>
- --------
(1) The translation of Brazilian real amounts into U.S. dollar amounts is
unaudited and included solely for the convenience of readers outside of
Brazil and has been performed using the closing selling exchange rate
published by the Central Bank of Brazil of R$1.1164 to US$1.00 as of
December 31, 1997. This translation should not be construed as a
representation that Brazilian real amounts could be converted to U.S.
dollars at this or any other rate.
(2) Allocated interest expense represents interest income attributable to
continuing operations. As discussed in Note 3, as the Company is unable to
present cellular operations as discontinued operations for 1993 and 1994,
total interest income and expense has been presented as unallocated.
45
<PAGE>
(3) The Company is unable to present cellular operations as discontinued
operations for 1993 and 1994. Accordingly, cellular operations results for
1993 and 1994 are included in "Operating income from continuing
operations."
(4) Unallocated interest income and expense represents interest income and
expense that could not be allocated between continuing and discontinued
operations.
(5) Minority interests represent the portion of net income attributable to
shareholders other than Telebras.
(6) Reflects net income per thousand shares of the Registrant. The Registrant
was not formed until subsequent to December 31, 1997. Accordingly, the
equity structure utilized for the earnings per share computations is that
of the Registrant as of May 22, 1998 (the date of its formation). At the
date of formation, the Registrant had 124,351,903 thousand Common Shares
(net of 17,128 thousand common shares in treasury) and 196,311,647
thousand Preferred Shares outstanding (exclusive of 13,718,350 thousand
preferred shares resulting from the settlement in April 1998, with
Telebras). See Note 29(e) to the Consolidated Financial Statements.
In February 1997, the Financial Accounting Standards Board issued SFAS No.
128 "Earnings Per Share." This new statement became effective for
financial statements for periods ending after December 15, 1997, and
provides computation, presentation and disclosure requirements for
earnings per share.
Since the preferred and common stockholders have different dividend,
voting and liquidation rights, Basic and Diluted earnings per share have
been calculated using the "two-class" method. The "two-class" method is an
earnings allocation formula that determines earnings per share for
preferred and common stock according to the dividends to be paid as
required by the Company's by-laws and participation rights in
undistributed earnings. Basic earnings per share is computed by dividing
income available to common and preferred shareholders by the weighted-
average number of common and preferred shares outstanding, respectively,
during the period. The weighted-average number of Common and Preferred
Shares used in computing basic earnings per share for 1997 was 124,351,903
thousand and 196,311,647 thousand, respectively.
As explained in Note 23 to the Consolidated Financial Statements, the
Company has received expansion plan contributions from companies and
individuals wishing to be connected to the national telephone network and
has also sponsored Community Expansion Plan agreements. These activities
are dilutive in nature to the Shareholders of the Registrant, whether the
shares to be issued are those of the Subsidiaries (which will impact the
minority interest recognized) or of the Registrant itself. If subsidiary
shares had been issued historically, the reduction to net income and the
increase in net earnings allocated to minority shareholders for 1996 and
1997 would have been approximately R$58,463 thousand and R$39,286
thousand, respectively. Earnings per share has been presented for net
income only since interest income, certain interest expense and social
contribution taxes have not been allocated between income from continuing
operations and income from discontinued operations.
(7) On May 22, 1998 the shareholders of Telebras approved Telebras' division
into the New Holding Companies, whereby existing shareholders received
shares in the New Holding Companies in proportion to their holdings in
Telebras. In addition to approving the allocation of assets and
liabilities to the New Holding Companies at the May 22, 1998 meeting, the
shareholders also approved a specific structure for the shareholders'
equity of each New Holding Company which included an allocation of a
portion of the retained earnings of Telebras. Consequently, the amounts of
the balances of capital, reserves and retained earnings were established.
For US GAAP purposes, the "retained earnings" allocated from Telebras
would be referred to as Distributable Capital as this amount represents
capital allocated from Telebras. See Note 28 to the Consolidated Financial
Statements.
ITEM 9: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion of the financial condition and results of
operations of the Company for the years ended December 31, 1995, 1996 and 1997
should be read in conjunction with the Consolidated Financial Statements of
the Company and the Notes thereto included elsewhere in this Registration
Statement. The Consolidated Financial Statements have been prepared in
accordance with Brazilian GAAP, which differs in certain significant respects
from U.S. GAAP. Note 29 to the Consolidated Financial Statements provides a
description of the principal differences between U.S. GAAP and Brazilian GAAP
as they relate to the Company, and a reconciliation to U.S. GAAP of net income
for the two years ended December 31, 1996 and 1997 and total shareholders'
equity as of December 31, 1996 and 1997.
FORMATION OF THE REGISTRANT AND PRESENTATION OF FINANCIAL INFORMATION
On May 22, 1998, in preparation for the privatization of the Telebras
System, the Telebras System was restructured to form, in addition to Telebras,
the twelve New Holding Companies. The restructuring of the Telebras System was
accomplished by means of a procedure under Brazilian law called cisao or
"split-up". Virtually all the assets and liabilities of Telebras were
allocated to the New Holding Companies which, together with their respective
subsidiaries, comprise (a) three regional fixed-line operators, (b) eight
regional cellular operators and (c) one domestic and international long-
distance operator. The Registrant is one of the New Holding Companies that was
formed on May 22, 1998 as part of the Breakup of Telebras. In the Breakup,
certain assets and liabilities of Telebras, including all of the share capital
in the Subsidiaries held in Telebras were transferred to the Registrant.
At the May 22, 1998 Telebras shareholders' meeting, the shareholders also
approved a specific structure for the shareholders' equity of each New Holding
Company, which included an allocation of a portion of the retained earnings of
Telebras. In this manner, the balances of capital, reserves and retained
earnings, together with the corresponding assets and liabilities, for the
formation of Tele Centro Sul Participacoes S.A. were established.
46
<PAGE>
Telebras retained within its own shareholders' equity sufficient retained
earnings from which to pay certain dividends and other amounts. Telebras
allocated to each New Holding Company the balance of its retained earnings in
proportion to the total net assets allocated to each such Company. This value
of allocated retained earnings does not represent the historical retained
earnings of the New Holding Companies and resulted in an increase of
R$204,689,000 in relation to the Company's historical retained earnings. See
Note 28 to the Consolidated Financial Statements. Allocated retained earnings
and future retained earnings will be the basis from which future dividends
will be payable.
The Consolidated Financial Statements present the financial condition and
results of operations of the Registrant and its Subsidiaries. The portion of
the equity and net income of the Subsidiaries attributable to shareholders of
the Subsidiaries other than Telebras at December 31, 1996 and 1997, and for
each of the years in the three-year period ended December 31, 1997 is
reflected as "minority interests" in the Consolidated Financial Statements. At
December 31, 1997, such minority shareholders directly and indirectly owned
percentages of the share capital of the Registrant and its Subsidiaries shown
in "Presentation of Information."
The Consolidated Financial Statements present the fixed-line
telecommunications business of the Subsidiaries, as continuing operations and
the cellular telephone business as discontinued operations for all periods.
The assets and liabilities of the cellular telephone business are presented as
net assets of discontinued operations.
The separation of the fixed and cellular telecommunications businesses has
been accounted as a reorganization of entities under common control in a
manner similar to a pooling of interests. The assets and liabilities of the
cellular telephone business were transferred from the Subsidiaries at their
indexed historical cost. The Consolidated Financial Statements are not
necessarily indicative of the financial position and results of operations
that would have occurred for the three-year period ended December 31, 1997 had
the fixed-line telecommunications businesses of the Subsidiaries been separate
legal entities during such periods. See "Description of Business--Background,"
"--The Company" and Notes 1, 2 and 28 to the Consolidated Financial
Statements.
Prior to December 31, 1997 cash and certain nonspecific debt of the cellular
telecommunications business could not be segregated from the Subsidiaries.
Accordingly, these amounts are included in the financial statements for
periods ended before January 1, 1998. As a result, certain interest income and
expense relating to the cellular telecommunications business could not be
identified and, consequently, income from discontinued operations is presented
before unallocated interest income (expense) and income tax expense.
In connection with the formation of the Registrant, certain assets of
Telebras in addition to its interests in the subsidiaries were spun off to the
Registrant. The principal such assets were loans receivable and advances for
capital increase received from the operating subsidiaries, cash and other
current assets. See Note 28 to the Consolidated Financial Statements, which
includes a balance sheet of the Registrant reflecting all the assets and
liabilities of the Registrant as of February 28, 1998. A substantial amount of
such assets (principally investment in subsidiaries) is eliminated upon
consolidation.
EFFECTS OF INFLATION
In accordance with Brazilian GAAP, the Financial Statements recognize
certain effects of inflation and restate data from prior periods in constant
reais of December 31, 1997 purchasing power. Such restatement has been
effected using the integral restatement method (correcao integral), which was
required by the CVM to be used for Financial Statements of public corporations
through December 31, 1995. In periods of inflation, monetary assets generate
inflationary loss and monetary liabilities generate inflationary gain, due to
the decline in purchasing power of the currency. In the Consolidated Financial
Statements, inflationary gains or losses on monetary assets and liabilities
have been allocated to their corresponding income or expense captions in the
income statement. Inflationary gains or losses without a corresponding income
or expense caption have been allocated to other net operating income. See Note
2a to the Consolidated Financial Statements.
47
<PAGE>
Until December 31, 1995, the relevant inflation index selected by the CVM
and the one used for the constant currency method under Brazilian GAAP was the
UFIR. Effective January 1, 1996, the CVM no longer requires Brazilian
companies to restate their financial statements for reporting purposes in
constant currency by indexing historical amounts using the UFIR. Restatement
in constant currency is now optional and any general price index may be used.
The Brazilian Institute of Accountants has recommended that the IGP-M be used
for this purpose. The Company's management believes that the IGP-M is the most
appropriate measure of the general price inflation in Brazil and has elected
the IGP-M for purposes of preparing its consolidated financial statements in
accordance with the constant currency method as of January 1, 1996.
In July 1997, the three-year cumulative inflation rate for Brazil fell below
100%; however, for accounting purposes, the constant currency method has
continued to be applied. The Brazilian Institute of Accountants has not yet
published definitive rules regarding when the constant currency method of
accounting may no longer be used to prepare Consolidated Financial Statements.
If the Brazilian Institute of Accountants determines that the constant
currency method may no longer be used to prepare Consolidated Financial
Statements beginning January 1, 1998, the restated balances of nonmonetary
assets and liabilities of the Company as of December 31, 1997 will become the
new basis for accounting, and income statement items will no longer be
restated for inflation. See "Selected Financial Data."
Because financial information for the Company is presented in constant
currency, reported revenues reflect average real rates (i.e., nominal rates as
restated in constant currency in accordance with variations in the applicable
index) rather than nominal rates. Inflation results in decreases in real rates
to the extent that nominal rate increases fail to keep pace with the rate of
inflation. See "Description of Business--Rates."
FOREIGN EXCHANGE AND INTEREST RATE EXPOSURE
The Company's financial condition and results of operations may be affected
by changes in foreign currency exchange rates (primarily the U.S. dollar/real
rate) and market rates of interest (primarily the London Interbank Offered
Rate (LIBOR) and medium-and long-term U.S. interest rates).
The principal foreign exchange risk faced by the Company arises from the
excess of interest-bearing foreign currency liabilities over foreign currency
income generating assets. At December 31, 1997, the Company had R$45.9 million
of financial liabilities (primarily long-term bank debt) denominated in
foreign currencies (all in U.S. dollars). The Company's revenues are earned
almost entirely in reais and the Company has no material dollar-denominated
assets. During the three years ended December 31, 1997, any losses arising
from the devaluation of the real against the U.S. dollar were more than offset
by net inflationary gains on monetary assets and liabilities. Should the
Company cease using the constant currency method of accounting in the future,
such inflationary gains would no longer be recognized. The Company does not
hedge its foreign currency exposure and, accordingly, any decrease in the
value of the real relative to the dollar could have a material adverse effect
on the Company's results of operations.
The Company's financial condition and results of operations may also be
affected by changes in market rates of interest (primarily LIBOR). The Company
is exposed to interest rate risk as a consequence of its floating rate debt
and limited floating rate interest earning assets. At December 31, 1997, 15.6%
of the Company's interest bearing liabilities bore interest at floating rates.
The Company has not entered into derivative contracts or made other
arrangements to hedge against this risk. Accordingly, should market interest
rates rise (principally LIBOR), the Company's financing expenses will
increase.
POLITICAL, ECONOMIC, REGULATORY AND COMPETITIVE CONSIDERATIONS
The following discussion should be read in conjunction with the "Description
of Business" section included elsewhere in this Registration Statement. As set
forth in greater detail below, the Company's financial condition and results
of operations are significantly affected by Brazilian telecommunications
regulation, including regulation of tariffs. See "Description of Business--
Regulation of the Brazilian Telecommunications Industry." The Company's
financial condition and results of operations also have been, and are expected
to
48
<PAGE>
continue to be, affected by the political and economic environment in Brazil.
See "'Description of Business-- Brazilian Political Environment" and "--
Brazilian Economic Environment." In particular, the Company's financial
performance will be affected by (i) national economic growth and its impact on
demand for telecommunications services, (ii) the cost and availability of
financing and (iii) the exchange rates between Brazilian and foreign
currencies. In addition, the Presidential and Congressional elections to be
held in October 1998 could have a significant impact on whether the economic
stabilization and liberalization policies of the current administration can or
will be sustained following the elections.
In April and May 1997, a tariff rebalancing was implemented pursuant to
which certain rates were adjusted and the percentage of revenues retained by
the fixed-line companies for domestic and international long-distance calls
pursuant to the division of revenues system in place prior to April 1998 was
lowered. The principal rate increases occurred with respect to monthly
subscription charges and local measured service charges. These increases were
partially offset by a decrease in domestic long-distance and international
long-distance rates. The monthly subscription charge increased from R$3.73 to
R$13.82 and the local measured service charge increased from R$0.05 per pulse
to R$0.08 per pulse. Average domestic long-distance and international long-
distance rates were reduced by approximately 16.7% and 17%, respectively. If
the tariff rebalancing had been effective as of January 1, 1997, the
composition of the Company's net operating revenues would have been
significantly affected and its total net operating revenues may have been
higher. Pro forma information reflecting the April and May 1997 rate changes
as if they had been in effect from January 1, 1997 has not been presented
because management believes that it is not possible to quantify with any
reasonable degree of certainty the influence on the volume of telephone use
that would have been caused by such changes in the first quarter of 1997.
Until April 1, 1998, revenues for fixed-line domestic and international
long-distance calls were divided between Embratel and the regional fixed-line
companies. Under this system, the Company and each regional fixed-line company
billed its customers for all domestic and international long-distance
telephone calls and retained a fixed percentage of the revenue, transferring
the remainder of the revenue to Embratel. The fixed percentage varied by
regional fixed-line company. As of March 31, 1998, the regional fixed-line
companies transferred an average of 33% of the total revenue for such calls to
Embratel.
As part of the liberalization of the Brazilian telecommunications sector,
this revenue-sharing system was eliminated as of April 1, 1998. Under the new
system, Embratel receives 100% of the revenues from domestic and international
long-distance calls that it carries but must pay certain per-minute
interconnection charges to the Company and the other regional fixed-line
companies for connection to and use of their networks. In addition, until June
30, 2001, Embratel must pay a supplemental per-minute charge for such
interconnection, the Parcela Adicional Temporaria (the "PAT"). The Company
does not expect that implementation of this new system will have a material
impact on its net income. However, it is expected that the allocation to
Embratel of 100% of the revenues generated by fixed-line domestic and
international long-distance calls that it carries will cause certain operating
revenues to decrease. This decrease is expected to be offset by increased
revenues resulting from the network usage charges and PAT paid to the Company
by Embratel.
Following the privatization of the telecommunications sector and, provided
that the obligations of the General Plans on Universal Service and Quality of
Service are met, the Company, currently the exclusive provider of local and
intra-state intra-regional long-distance service in the region, will be
authorized to offer interstate intra-regional long-distance service, which
represents a significant expansion of the services the company may offer, and
the company will face competition. Embratel and a new operator will be
authorized to provide local service beginning December 31, 2003 and December
31, 2002, respectively. Embratel will also be authorized to provide intra-
state, inter-regional long-distance service and two new licenses will be
granted to up to two new entrants to provide intra-regional long-distance
service. Beginning in 2002, the Company may face an unlimited number of
competitors in local and intra-regional long-distance, and it may itself seek
a license to provide interregional and international long-distance service.
The Company anticipates that, as a consequence of the competition, rates may
decline. The exact identity of new entrants, the scope of increased
competition and any adverse effects on the Company's results and market share
will depend on a variety of factors that cannot now be assessed with precision
and that are beyond the Company's control. See "Description of Business--
Competition."
49
<PAGE>
YEAR 2000 COMPLIANCE
Year 2000 compliance is the ability of computer hardware and software to
respond to the problems posed by the fact that some computer programs have
traditionally used two digits rather than four to define the applicable year.
As a consequence, any of the Company's computer programs that have date-
sensitive software may recognize a date using "00" as the year 1900 rather
than 2000. This could result in a system failure or miscalculations causing
disruption of operations, including a temporary inability to process
transactions, send invoices or engage in normal business activities.
At the beginning of 1997, at the requirement of Telebras, the Company began
to address the year 2000 issue. The Company has identified the hardware and
software that could be affected by the year 2000 issue and is in the process
of identifying and addressing potential problems. Specifically, the Company
has completed an inventory of the Company's 37 million lines of code, 170,059
computer programs and 172 systems and is in the process of diagnosis.
The Company's year 2000 program covers its telecommunications network
infrastructure as well as its computer hardware and software. In this regard,
the Company is compiling an inventory of equipment that could be affected by
the year 2000 problem and contacting the suppliers of such equipment regarding
the implementation of any necessary solution. In relation to its central
switching centers, the Company expects the year 2000 problem will be addressed
through new software releases that will be provided by the manufacturers of
the switching equipment.
To address other year 2000 issues, the Company will contract third-party
service providers who will work together with Company employees. The Company's
information services department will organize the company's efforts, including
the hiring of third parties. The Company's systems department will adopt and
implement the technical solutions.
The Company estimates that to achieve year 2000 compliance, the Company will
spend approximately R$20 million on its telecommunications hardware and
software and information systems, including the hiring of third parties. The
estimated year 2000 compliance dates vary between the Subsidiaries, ranging
from an expected compliance date of December 1998 for Telepar, Telesc,
Telebrasilia and Telems to August 1999 for Teleron. Although the Company
expects to be fully year 2000 compliant by August 1999, the Company is still
in the process of identifying and evaluating the year 2000 issue and can give
no assurance that the business and financial condition of the Company will not
be materially affected. As of August 30, 1998, the Company had not determined
its most probable worst case scenarios in relation to the year 2000 problem
and had not formulated contingency plans in respect of such scenarios.
The Company may also be affected by year 2000 issues to the extent that
other entities not affiliated with the Company, including government entities
and businesses, are unsuccessful in addressing this issue. The Company depends
primarily on large multinational suppliers for its telecommunications products
and computer services. The majority of the Company's suppliers, however, have
advised the Company that they expect to be year 2000 compliant by September
1999.
CVM Instruction 276, which was issued on May 8, 1998 requires all Brazilian
publicly-held companies to have addressed the Year 2000 problem by December
1998. Unless a discretionary extension is granted by the CVM, failure to have
addressed the Year 2000 problem by the CVM's deadline could result in the
imposition of fines of R$500 per day. On October 2, 1998, the Company
requested an extension of the deadline imposed by CVM Instruction 276 to March
1999. The Company requested the extension on account of the operating
subsidiaries Telemat and Teleron that do not believe they will be in
compliance until March 1999. As of October 9, 1998, the CVM had not responded
to the Company's request.
50
<PAGE>
RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1995, 1996, AND 1997
The following table sets forth, for each of the years in the three-year
period ended December 31, 1997, certain components of the Company's net
income, the percentage of gross operating revenues represented by each
component and the percentage increase (decrease) thereof during the three-year
period.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, % CHANGE
------------------------------------------------------- -------------------------
1995 % 1996 % 1997 % 1995 V. 1996 1996 V. 1997
--------- ----- ---------- ----- ---------- ----- ------------ ------------
(IN THOUSANDS OF REAIS EXCEPT PERCENTAGES)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
GROSS OPERATING
REVENUES:
Local services:
Monthly subscription
revenues.............. 111,579 5.3 235,847 8.6 449,683 14.6 111.4 90.7
Measured service
charges............... 267,539 12.7 400,128 14.6 532,562 17.3 49.6 33.1
Public telephones...... 39,076 1.9 67,267 2.5 121,948 4.0 72.1 81.3
Other.................. 120,953 5.8 169,654 6.2 170,090 5.5 40.3 0.3
--------- ----- ---------- ----- ---------- ----- ------- -----
Total................ 539,147 25.7 872,896 31.9 1,274,283 41.3 61.9 46.0
--------- ----- ---------- ----- ---------- ----- ------- -----
Non-local services:
Intra-state and
interstate............ 1,234,635 58.8 1,309,452 47.8 1,091,638 35.4 6.1 (16.6)
International.......... 78,069 3.7 74,354 2.7 65,359 2.1 (4.8) (12.1)
--------- ----- ---------- ----- ---------- ----- ------- -----
Total................ 1,312,704 62.5 1,383,806 50.6 1,156,997 37.5 5.4 (16.4)
--------- ----- ---------- ----- ---------- ----- ------- -----
Data transmission...... 75,099 3.6 99,739 3.6 89,775 2.9 32.8 (10.0)
Network services....... 149,173 7.1 344,890 12.6 524,740 17.0 131.2 52.2
Other.................. 24,850 1.2 35,938 1.3 40,459 1.3 44.6 12.6
--------- ----- ---------- ----- ---------- ----- ------- -----
Total................ 249,122 11.9 480,567 17.6 654,974 21.2 92.9 36.3
--------- ----- ---------- ----- ---------- ----- ------- -----
Total gross operating
revenue................ 2,100,973 100.0 2,737,269 100.0 3,086,254 100.0 30.3 12.8
--------- ----- ---------- ----- ---------- ----- ------- -----
Value added and other
taxes................. (503,908) (24.0) (650,518) (23.8) (722,448) (23.4) 29.1 11.0
Discounts.............. (3,364) (0.2) (6,776) (0.2) (8,194) (0.3) 101.4 20.9
--------- ----- ---------- ----- ---------- ----- ------- -----
Net operating revenue... 1,593,701 75.9 2,079,975 76.0 2,355,612 76.3 30.5 13.3
Cost of services:
Depreciation and
amortization.......... (564,565) (26.9) (603,264) (22.0) (669,979) (21.7) 6.9 11.1
Personnel.............. (241,948) (11.5) (244,771) (8.9) (221,968) (7.2) 1.2 (9.3)
Materials.............. (28,833) (1.4) (33,027) (1.2) (29,933) (1.0) 14.6 (9.4)
Services............... (150,904) (7.2) (212,150) (7.8) (297,777) (9.6) 40.6 40.4
Other:
Rental fees........... (9,912) (1.8) (16,255) (1.8) (16,560) (1.3) 63.9 1.9
Network maintenance... (1,470) (0.3) (1,629) (0.2) (2,774) (0.2) 10.8 70.3
--------- ----- ---------- ----- ---------- ----- ------- -----
Total cost of
services........... (997,632) (47.5) (1,111,096) (40.6) (1,238,991) (40.1) 11.4 11.5
--------- ----- ---------- ----- ---------- ----- ------- -----
Gross profit............ 596,069 28.4 968,879 35.4 1,116,621 36.2 62.5 15.3
Operating expense:
Selling expense........ (153,870) (7.3) (174,079) (6.4) (229,555) (7.4) 13.1 31.9
General and
administrative
expense............... (318,507) (15.2) (351,471) (12.8) (380,776) (12.3) 10.4 8.3
Other net operating
income................ 94,512 4.5 130,839 4.8 148,326 4.8 38.4 13.4
--------- ----- ---------- ----- ---------- ----- ------- -----
Total operating
expenses............ (377,865) (18.0) (394,711) (14.4) (462,005) (15.0) 4.5 17.1
--------- ----- ---------- ----- ---------- ----- ------- -----
Operating income before
interest............... 218,204 10.4 574,166 21.0 654,616 21.2 163.1 14.1
Net non-operating income
(expense).............. (1,348) (0.1) (16,433) (0.6) (25,094) (0.8) 1,119.1 52.7
Employees' profit
share................... (8,475) (0.4) (17,068) (0.6) (26,524) (0.9) 101.4 55.4
Income from discontinued
cellular operations
before interest income
(expense), taxes and
minority interests..... 149,135 7.1 297,274 10.9 341,636 11.1 99.3 14.9
Unallocated interest
income................. 40,418 1.9 60,612 2.2 61,913 2.0 50.0 2.2
Allocated and
unallocated interest
expense(1)............. (21,375) (1.0) (11,613) (0.4) (37,734) (1.2) (45.7) 224.9
--------- ----- ---------- ----- ---------- ----- ------- -----
Income before taxes and
minority interests..... 376,559 11.9 886,940 32.4 968,813 31.4 135.5 9.2
Income and social
contribution taxes..... (164,519) (7.8) (231,713) (8.5) (266,949) (8.7) 40.8 15.2
--------- ----- ---------- ----- ---------- ----- ------- -----
Income before minority
interests.............. 212,040 10.1 655,227 23.9 701,864 22.7 209.0 7.1
Minority interests...... (26,910) (1.3) (92,925) (3.4) (138,599) (4.5) 245.3 49.2
--------- ----- ---------- ----- ---------- ----- ------- -----
Net income.............. 185,130 8.8 562,302 20.5 563,265 18.3 203.7 0.2
========= ===== ========== ===== ========== ===== ======= =====
</TABLE>
- --------
(1) In the Consolidated Financial Statements, allocated and unallocated
interest expense are presented separately.
51
<PAGE>
GROSS OPERATING REVENUES
Gross operating revenues increased by 12.8% to R$3,086.3 million in 1997
from R$2,737.3 million in 1996, which in turn represented a 30.3% increase
from R$2,101.0 million in 1995. The growth in revenues in the three-year
period was principally due to an increase in the average number of lines,
increases in service charges for local services and increased interconnection
with the Company's network by cellular companies. Average lines in service
increased by 12.6% to 2,718 thousand in 1997 from 2,414 thousand in 1996,
which in turn represented a 12.7% increase from 2,143 thousand in 1995.
The structure of tariffs has changed substantially as part of a tariff
rebalancing process designed to eliminate cross-subsidies from long-distance
services to local services. Effective in May 1997, the rate structure was
modified through a tariff rebalancing that resulted in higher charges for
measured service and monthly subscription and lower charges for long-distance
services. Effective in January 1996, rates for all services were increased in
nominal terms, primarily to compensate for accumulated effects of inflation,
with the largest increases for local rates.
Local service. Gross operating revenues from local services increased by
46.0% to R$1,274.3 million in 1997 from R$872.9 million in 1996, which in turn
represented a 61.9% increase from R$539.1 million in 1995. The increase over
the three-year period primarily reflects increased monthly subscription
revenues associated with an increase in the number of lines in service and
tariff increases as well as increased measured service revenues due to tariff
increases. The increase in gross operating revenues was partly offset by a
decrease in average call volume per line in service. Average call volume per
line in service decreased by 7% and 12% in 1997 and 1996, respectively.
Monthly subscription revenues increased 90.7% to R$449.7 million in 1997
from R$235.8 million in 1996, which in turn represented an increase of 111.4%
from R$111.6 million in 1995. The increase over the three-year period
reflected an increase in the average number of lines in service as well as an
increase in the monthly subscription charge for all customers. The monthly
subscription charge effective January 1, 1996 increased by 259% for
residential customers and 59% for nonresidential customers. Effective May 1,
1997 there was an additional increase in the monthly subscription charge,
representing a 270% increase for residential customers and 59.3% for
nonresidential customers.
Measured service revenues increased by 33.1% to R$532.6 million in 1997 from
R$400.1 million in 1996, which in turn represented a 49.6% from R$267.5
million from 1995. The increase over the three-year period was principally due
to tariff increases. The price per pulse increased by 61.1% effective on April
4, 1997 in 1997 and by 89.5% effective on January 29, 1996 in 1996. Although
the average number of lines also increased over the three-year period for
residential and nonresidential customers, there was a decrease in the average
call volume per line in service due to the tariff increases such that overall
local call volume did not increase at the same rate as growth in the average
number of lines in service. Total pulses increased slightly to 7,643,773 in
1997 from 7,280,587 in 1996, which in turn represented a decrease from
7,341,666 total pulses in 1995.
Gross operating revenues from public telephones increased 81.3% to R$121.9
million from R$67.3 million, which in turn represented a 72.1% increase from
R$39.1 million in 1995. The increase over the three-year period was
principally due to: (i) a 25.3% and 16.4% increase in the number of public
telephones in 1997 and 1996 respectively; (ii) an increase in the usage of
pre-paid telephone cards and a commensurate increase in related average
nominal tariffs; and (iii) an increase in the usage of token operated public
telephones.
Gross revenue from other services increased by 0.3% to R$170.1 million in
1997 from R$169.7 million in 1996, which in turn represented a 40.3% increase
from R$121.0 million in 1995. The increase in 1997 was principally due to an
increase in line installation charges which replaced auto-financing in mid-
1997 and certain equipment rental payments received by the Company. The
increase in 1996 was principally due to increased lease payments to the
Company.
52
<PAGE>
Non-local services. Non-local services consisted until the privatization of
intra-state and interstate long-distance as well as international long-
distance service. For intra-state long-distance calls, the Company carried the
calls entirely over its own network and received 100% of the call revenue. For
interstate and international calls, the Company delivered the calls to
Embratel, generally at a local switching center, and Embratel transported the
calls for the bulk of the call distance over its network. For such calls, the
Company billed the customer for the full retail price of the call and paid a
fixed percentage of the call revenue to Embratel. For accounting purposes, the
Company booked only its percentage of the revenue for such calls. The fixed
percentage retained by the Company differed for each Subsidiary. Consequently,
the fixed percentage retained by the Company for interstate and international
calls is presented as an annual revenue weighted-average.
Gross revenue from non-local services decreased by 16.4% to R$1,157.0
million in 1997 from R$1,383.8 million in 1996, which in turn represented a
5.4% increase from R$1,312.7 million in 1995. The decrease in 1997 was largely
due to reductions in tariffs for intra-state, interstate and international
long-distance calls, a reduction in the fixed percentage of interstate and
international long-distance call revenue retained by the Company and a change
in the billing structure for such calls where by such calls were billed in 6-
second increments rather than whole minute increments. The decrease was offset
in part by an increase in the volume of intra-state, interstate and
international long-distance calls to 4,118 million minutes, 4,710 million
minutes and 5,129 million minutes in 1995, 1996 and 1997, respectively. The
increase in gross revenues in 1996 compared to 1995 was largely due to an
increase in the average number of intra-state, interstate and international
long-distance minutes per line in service, partially offset by a decrease in
tariffs for intra-state, interstate and international long-distance calls.
Revenues from intra-state and interstate long-distance service decreased by
16.6% to R$ $1,091.6 million in 1997 from $1,309.5 million in 1996, which in
turn represented at 6.1% increase from $1,234.6 million in 1995. The decrease
in revenues in 1997 was principally due to a decrease in the average basic
tariff for intra-state and interstate long-distance calls and a reduction in
the fixed percentage of interstate and international long-distance revenue
retained by the Subsidiaries, partially offset by an increase in the total
number of long-distance minutes. The average basic tariff for intra-state and
interstate service was reduced in May 1997 by 17.1% to R$0.25 from R$0.30. The
weighted average fixed percentage of interstate and international long-
distance revenue per call retained by the Company was reduced from 80.6% in
1995 to 77.7% in 1996, which in turn was reduced to 74.1% in 1997. See
"Description of Business--Rates--Intra-Regional Long-Distance Service." Anatel
replaced the system for sharing revenues between Embratel and the Company for
interstate long-distance services on April 28, 1998. Instead of retaining a
fixed percentage of revenue for all interstate and international long-distance
calls, the Company now charges Embratel per minute of use of the Company's
network. See "Description of Business--Regulation of the Brazilian
Telecommunications Industry--Rate Regulation." There can be no assurance that
the interconnection agreement with Embratel will not result in lower revenues
from carrying interstate and international long-distance calls than under the
prior regime.
The increase in revenues for 1996 was principally due to an increase in the
total number of long-distance minutes, partially offset by a decrease in the
basic tariff for intra-state and interstate long-distance calls and a decrease
in the fixed percentage of interstate long-distance revenue retained by the
Company on a weighted average basis.
Revenues from international long-distance service decreased by 12.1% to
R$65.4 million in 1997 from R$74.4 million in 1996, which in turn represented
a 4.8% decrease from R$78.1 million in 1995. The decrease over the three-year
period was principally due to a reduction in the international tariff in April
1997 and a decrease in the fixed percentage of international long-distance
revenues retained by the Company.
Data transmission. Gross operating revenues from data transmission decreased
by 10.0% to R$89.8 million in 1997 from R$99.7 million in 1996, which in turn
represented a 32.8% increase from R$75.1 million in 1995. The decrease from
1996 to 1997 was principally due to decreases in the average tariff for high-
capacity and low-capacity leased lines of 34.4% in April 1997 and 12.0% in
August 1996. The decrease in rates was partially offset by a 248% increase in
the total number of high-capacity leased lines.
53
<PAGE>
The increase in gross revenues from data transmission from 1995 to 1996 was
principally due a 219% increase in the number of high-capacity lines and to a
restructuring of data transmission services and tariffs on a system-wide basis
by the Ministry of Communications in 1996 which yielded an average tariff
decrease of 32.2% for high and low-capacity lease lines.
Network services. The Company provides access to its network to other
telecommunications companies and leases certain network facilities to other
telecommunications companies as part of its network services business. This
includes primarily interconnection fees from cellular companies paid for the
use of the Company's network and fees from cellular companies for the leasing
of transmission facilities, certain infrastructure and other equipment for use
in transporting cellular calls within their own internal networks. Gross
revenues from network services increased by 52.2% to R$524.7 million in 1997
from R$344.9 million in 1996, which in turn represented a 131.2% increase from
R$149.2 million in 1995. Network services have grown primarily due to growth
of cellular companies and consequently increased demands by cellular companies
for interconnection with the Company's network and demands by cellular company
to rent equipment. Interconnection revenues increased by 59.2% to R$423.6
million in 1997 from R$266.1 million in 1996, which in turn represented a
142.3% increase from R$109.8 million in 1995. Equipment rental revenues
increased by 28.4% to R$101.2 million in 1997 from R$78.8 million in 1996,
which in turn represented a 100% increase from R$39.4 million in 1995.
Management expects continued growth in revenues from network services as
cellular operators grow.
Value-added taxes and other taxes. The principal taxes deducted from gross
operating revenue are a state value-added tax, the ICMS, on operating revenues
from the provision of telecommunications services and federal social
contribution taxes, including the PASEP and COFINS. The Company collects these
taxes from its customers and transfers them to the appropriate governmental
activity. The rate of ICMS is 25.0%, except for international service for
which the rate was 13.0% from April 1994 to September 1996 and has been zero
since September 1996. The PASEP and COFINS aggregate 2.65% of gross operating
revenues.
On June 19, 1998 the secretaries of the treasury of the individual Brazilian
states approved an agreement to interpret existing Brazilian tax law to
broaden the application of the ICMS to cover not only telecommunications
services, but also other services, including cellular activation, which had
not been previously subject to such tax. Pursuant to this new interpretation
of existing tax law, the ICMS tax may be applied retroactively for such
telecommunications services rendered during the last five years.
The Company believes that the attempt by the state treasury secretaries to
extend the scope of ICMS tax to services which are supplementary to basic
telecommunications services is unlawful because: (i) the state secretaries
acted beyond the scope of their authority; (ii) their interpretation would
subject certain services to taxation which are not considered
telecommunications services; and (iii) no new taxes may be applied
retroactively.
Each of the Registrant's Subsidiaries has filed lawsuits with the Treasury
Court of the Brazilian states in which such Subsidiaries are incorporated
seeking injunctive relief from prospective application of the ICMS tax to
activation fees. All of the Subsidiaries, except for Telemat, have obtained
from the applicable Treasury Court a temporary injunction relieving such
Subsidiary from payment of prospective ICMS taxes with respect to activation
fees during the pendency of the lawsuit. The taxation authorities of the
states where the lawsuits are pending may appeal the decisions of the Treasury
Court to grant temporary injunctions. There can be no assurance that the
Subsidiaries would ultimately prevail in any appeals relating to the temporary
injunctions or in the underlying litigation with respect to application of the
ICMS tax to activation fees. If the 25% of ICMS tax were applied retroactively
to activation fees earned by the Company during the last five years, it would
give rise to a maximum liability estimated at R$128.1 million. Management does
not believe that the payment of retroactive ICMS taxes is probable and,
therefore, no provision for loss with respect to retroactive application of
the ICMS has been made or is expected to be made in the Company's consolidated
financial statements. Management does not believe that the application of the
ICMS tax on a prospective basis will have a material impact on the Company's
results of operations.
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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$8.88 million under "other net
operating income" in that year. In 1997, the Brazilian Supreme Court narrowed
its prior decision, leading the tax authorities to challenge similar 1995
credits recognized by other telecommunication companies. The authorities have
not challenged the Company's 1995 credit. If they were to do so successfully,
the Company's liability (including interest and penalties) would have amounted
to R$25 million at December 31, 1997. See Note 20 to the Consolidated
Financial Statements.
COST OF SERVICES
Cost of services includes those costs which are incurred as part of the
offering of the Company's telecommunication services to the public, including
costs associated with depreciation and amortization, materials, services and
personnel. Cost of services as a percentage of gross revenues decreased
steadily over the three-year period, but increased in absolute terms by 11.5%
to R$1,239.0 million in 1997 from R$1,111.1 million 1996, which in turn
represented a 11.4% increase from R$997.6 million in 1995.
Depreciation and amortization. Depreciation and amortization expenses
increased by 11.1% in 1997 to R$670.0 million in 1997 from R$603.3 million in
1996, which in turn represented a 6.9% increase from R$564.6 million in 1995.
The increase over the three-year period principally reflected growth of the
network. The Company's operating assets had a net book value of R$6,444.5
million, R$5,963.1 million, and R$5,401.9 million for 1997, 1996 and 1995,
respectively. The Company's accounting and assumptions with respect to
depreciation and amortization did not change during this period.
Personnel. Personnel expenses decreased by 9.3% to R$222.0 million in 1997
from R$244.8 million in 1996, which in turn represented at 1.2% increase from
R$241.9 million in 1995. The decrease in personnel expenses in 1997 was
principally due to a decrease in salaries in real terms and an average
reduction in the number of full-time employees by 488. The slight increase in
1996 was principally due to an increase in wages and other fringe benefits
during the period offset by a slight reduction in the total number of
employees.
Materials. Expenses related to materials decreased by 9.4% to R$29.9 million
from R$33.0 million in 1996, which in turn represented a 14.6% increase from
R$28.8 million in 1995. The decrease in costs related to materials was
principally due to increased digitalization of the Company's network in 1997,
which resulted in a decrease in maintenance costs. The increase in expenses
associated with materials in 1996 was principally due to an increase in
maintenance costs due to expansion of the network.
Services. Expenses related to services provided by third parties increased
40.4% in 1997 to R$297.8 million from R$212.2 million, which in turn
represented a 40.6% increase from R$150.9 million in 1995. The increase over
the three-year period was primarily due to increased interconnection payments
to cellular companies for calls originating on the Company's network and
terminating on cellular networks and increased maintenance costs due to
network growth.
Other. Other costs of service, which primarily include fees paid to third
parties to rent equipment and infrastructure for use in the network, increased
8.1% to R$19.3 million in 1997 from R$17.9 million in 1996, which in turn
represented a 57.1% increase from R$11.4 million in 1995. The increase in 1996
was due to higher rental payments, which increased to R$16.3 million from
R$9.9 million in 1995. Such higher rental payments reflected an increase in
the cost of renting certain infrastructure as a result of the renegotiation of
a contract. The increase in other costs of service in 1997 was principally due
to a R$1.1 million increase in miscellaneous network expenses. Rental fees did
not materially increase in 1997.
OPERATING EXPENSES
Operating expense increased by 17.1% to R$462.0 million in 1997 from R$394.7
million in 1996, which in turn represented a 4.5% increase from R$377.9
million in 1995. The increase over the three-year period was principally due
to increased selling expense and general and administrative expense.
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<PAGE>
Selling expense. Selling expense increased by 31.9% to R$229.6 million in
1997 from R$174.1 million in 1996, which in turn represented a 13.1% increase
from R$153.9 million in 1995. The increase in selling expense over the three-
year period primarily reflected increased commissions to vendors selling
prepaid telephone cards and increased materials expenses in connection with
the production of prepaid telephone cards. In addition, other selling expenses
increased by 209.6% to R$34.0 million in 1997 from R$10.9 million in 1996,
which in turn represented a 118.7% increase from R$5.0 million in 1995. The
increase over the three-year period was primarily due to increased provisions
to the allowance for accounts receivable that are not probable of collection.
Provisions to the allowance for accounts not probable of collection
increased 355% to R$31.2 million in 1997 from R$6.9 million in 1996, which in
turn represented an increase of 162% from R$2.6 million in 1995. These
increases reflected growth in the nonpayment of accounts by the Company's
customers. Management believes that this growth in the level of nonpayment was
principally due to the economic crisis that Brazil experienced in 1997. This
crisis, which was evidenced by increased interest rates and a reduction in the
availability of consumer financing, adversely affected the ability of the
Company's customers to meet payment obligations. The increase in nonpayment
was also due in part to a decline in the market value of fixed lines (which
were considered to have value due to the high cost of acquiring a fixed line
directly and the short supply of fixed lines) in the Region. As the market
value of the fixed lines decreased, the penalty to the subscriber of losing
his fixed line because of nonpayment also declined and subscribers with
significant debts to the Company had less incentive to pay their accounts.
In the first six months of 1998, the Company made provisions to the
allowance for accounts not probable of collection totaling R$27.9 million. In
an effort to reduce the level of overdue accounts, the Company has initiated a
number of practices, including disconnecting customers with accounts 30 days
past due, improving collection efforts and placing nonpaying customers on a
list of persons to be denied service should they seek to resume service in the
future. Management believes that these measures will help limit nonpayment of
accounts receivable but expects that provisions will nonetheless increase in
1998 due to the combined effect of a decrease in the average annual income of
the Company's subscribers and increased consumer interest rates in Brazil
(which have adversely affected the ability of some customers to meet payment
obligations). In addition, as cellular lines become increasingly available at
competitive prices in the Region, the Company believes that the market value
of a fixed line will continue to decline, thereby providing customers with
less incentive to pay their accounts.
It has been the Company's policy to maintain an allowance for past due
accounts receivable equal to management's estimate of probable future losses
on such accounts, based on historical losses on accounts receivable and the
Company's current level of overdue accounts receivable.
General and administrative expense. General and administrative expense
increased 8.3% to R$380.8 million in 1997 from R$351.5 million in 1996, which
in turn represented at 10.4% increase from R$318.5 million in 1995. The
increase over the three-year period was principally due to an increase in
fringe benefits, expenses related to third-party services including corporate
training, outside consulting fees and postage costs.
Other net operating income. Other net operating income increased by 13.4%
from R$148.3 million in 1997 from R$130.8 million in 1996, which in turn
represented a 38.4% increase from R$94.5 million in 1995. The increase in 1997
was principally due to technical and administrative services provided by the
Company, partially offset by a decrease in fines and expenses recovered by the
Company. The decrease in fines collected resulted from a reduction in the
amount of such fines from 10% of a bill to 2% mandated by Brazilian law. The
increase in other net operating income in 1996 was principally due to an
increase in the revenue generated from certain fines received from delinquent
customers and other expenses recovered by the Company.
ALLOCATED AND UNALLOCATED INTEREST EXPENSE AND UNALLOCATED INTEREST INCOME
As described in Note 2 to the Consolidated Financial Statements, prior to
December 31, 1997, cash and certain nonspecific debt relating to the cellular
telephone business could not be segregated. As a consequence, interest income
and certain interest expense relating to the cellular telephone business could
not be segregated
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<PAGE>
and such interest income and expense are presented in the Consolidated
Financial Statements as "unallocated interest income" and "unallocated
interest expense," respectively. The following discussion analyzes the
Company's combined allocated and unallocated interest expense, as well, as its
unallocated interest income.
Unallocated interest income increased 2.2% to R$61.9 million in 1997 from
R$60.6 million, which in turn represented a 50.0% increase from R$40.4 million
in 1995. The increase over the three-year period was due principally to
interest income earned on excess cash, which was partially offset in 1997 by a
decrease in interest rates.
Allocated and unallocated interest expense increased by 224.9% to R$37.7
million in 1997 from R$11.6 million in 1996, which in turn represented a 45.7%
decrease from R$21.4 million in 1995. The increase in 1997 was principally due
to: (i) a 19% increase in total debt; (ii) increased interest expense related
to Company debt indexed to the relatively high interest rate known as Taxa
Extra de Mercado do Banco do Brasil ("TEX"); (iii) a decrease in monetary
gains due to a constant exchange rate between the U.S. dollar and the
Brazilian real in 1997; and (iv) the institution of the Contribuicao
Provisoria sobre Movimentacao Financeira ("CPMF Tax"), which accounted for
R$11.5 million (30.5%) of total interest expense. The decrease in allocated
and unallocated interest expense in 1996 reflected monetary gains due to the
fact that a portion of the Company's debt was denominated in U.S. dollars. In
1996, the U.S. dollar/real exchange rate was below the rate of inflation
yielding a monetary gain for the Company.
EMPLOYEES' PROFIT SHARE
All Brazilian companies are required under Brazilian law to compensate
employees, in addition to their salary and benefits, with profit sharing. The
amount of such profit sharing is determined by negotiation between the Company
and the labor unions representing the employees. For state owned companies,
such profit sharing payments are limited to 25% of total proposed dividends.
Telebras has established two additional limits. In addition to the 25% limit
imposed on all state owned companies, companies in the Telebras System must
limit employees' share of profits to the lower of (i) the aggregate of the
employees' annual compensation and (ii) 50% the Company's net income adjusted
for dividends. Following the privatization of the Company, employee profit
share will be limited only by the 25% of dividends limit and will be
renegotiated by the Company and the unions representing its employees. The
Company's employees' profit share was R$8.5 million, R$17.1 million and R$26.5
million in 1995, 1996 and 1997, respectively.
MINORITY INTERESTS
Minority interest in the net income of the Subsidiaries was R$26.9 million,
R$92.9 million and R$138.6 million in 1995, 1996 and 1997, respectively,
reflecting 12.7%, 14.2% and 19.7% of income before minority interest,
respectively. The 1997 increase in minority interest as a percentage of income
before such interest principally reflected the issuance and sale by the
Company of preferred shares to new subscribers pursuant to a system called
"auto-financing". Under such system, each new subscriber was required to
invest in shares of the Company and the proceeds from such investment were
used by the Company to finance network expansion. The Company discontinued
auto-financing as of April 1997. See "--Liquidity and Capital Resources."
LIQUIDITY AND CAPITAL RESOURCES
The Registrant is a holding company and its principal assets are the shares
of its operating subsidiaries. The Registrant relies largely on dividends from
its subsidiaries to meet its need for cash, including for the payment of
dividends to shareholders. Under Law No. 6,404 of December 15, 1976, as
amended (the "Brazilian Corporation Law"), dividends may be paid only out of
retained earnings or accumulated profits in any given fiscal year. See
"Description of Securities to be Registered--Capital Stock--Dividends."
Management believes that the Registrant's shareholding in the Subsidiaries
is sufficient to allow the Registrant to control the payment of dividends by
such companies. The Registrant currently is able to nominate
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<PAGE>
and elect all the members of the boards of directors of the Subsidiaries.
However, under Brazilian law and the regulations of the Brazilian Securities
Commission, persons holding more than 10% of the voting stock of a company (a
percentage that may decrease up to 5% in the case of listed companies) may
require the company to adopt cumulative voting. Management believes that,
based on current holdings in its operating subsidiaries, if cumulative voting
were required, the Registrant would still be able to control the payment of
dividends by the Subsidiaries which, with respect to the Mandatory Dividend,
could be limited only under very strict circumstances. Board members, even if
elected by one specific shareholder, have fiduciary duties toward the company
and all its shareholders. The preferred shareholders and the minority voting
shareholders of the Subsidiaries, in each case voting as a single class of
such preferred shareholders and a single class of such minority voting
shareholders, elect one member each of the Audit Committee. The remaining
members of the Audit Committee are selected by the controlling shareholder.
The Company's principal liquidity and capital resource requirements are to
finance capital expenditures and investments related to the expansion,
improvement and maintenance of its property, plant and equipment.
Historically, the Company has financed its capital expenditures and
investments primarily with internally generated funds and with proceeds from
the required sale of the Company's shares to new customers ("auto-financing").
As of June 1997 the Company discontinued auto-financing. See "Description of
Business--Rates--Local Services."
The Company made capital expenditures of R$905.9 million, R$1,098.7 million
and R$1,125.0 million in 1995, 1996 and 1997, respectively. The principal
expenditures related primarily to the expansion and modernization of the
Company's network. See "Description of Business--Capital Expenditures." In
addition, the Company paid dividends of R$101.2 million, R$89.5 million and
R$157.2 million in 1995, 1996 and 1997, respectively. The Company anticipates
capital expenditures for the first eight months of 1998 will be R$719.1
million which in expected to be funded with debt and other sources (44%) and
internally generated funds from operations (56%). See "Description of
Business--Capital Expenditures."
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$701.0
million, R$982.0 million and R$986.5 million in 1995, 1996 and 1997,
respectively.
At December 31, 1997, the Company had a working capital deficiency. The
Company's current assets were R$737.2 million and its current liabilities were
R$916.4 million, summing to a working capital deficiency of R$179.2 million.
Included in the current liabilities were loans payable to Telebras of R$95.7
million and dividends payable to Telebras of R$139.0 million. As a result of
the Breakup, such loans and dividends became inter-company obligations payable
by the Registrant's operating subsidiaries to the Registrant. See Note 28(b)
to the Consolidated Financial Statements. Accordingly, these inter-company
items no longer affect the Company's liquidity on a consolidated basis. The
Company had a positive consolidated working capital balance at June 30, 1998.
The Company's total indebtedness for loans and financing was R$246.5 million
and R$294.4 million as of December 31, 1996 and 1997. The principal categories
of indebtedness at December 31, 1997 were the following:
Loans payable to Telebras (R$248.5 million). The Registrant's operating
subsidiaries had certain loans payable to Telebras, of which R$199.5
million was denominated in reais and payable at a contractual interest rate
of TEX (currently approximately 24%) plus an annual fee of 1%, and R$49.0
million was denominated in dollars and payable at an interest rate of 2.3%
per annum.
Upon the Breakup of the Telebras System and the formation of the
Registrant, approximately R$248.5 million of indebtedness of the
Registrant's operating subsidiaries, representing loans from Telebras,
became intercompany loans payable by the Registrant's operating
subsidiaries to the Registrant. Accordingly, these intercompany loans and
the market risk and interest expense relating to such loans will be
eliminated in the preparation of the Registrant's consolidated financial
statements in the future.
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<PAGE>
Other financing (R$45.9 million). Other financing relates to equipment
financing from Siemens, CPM, Ericsson, Furukawa, and others (denominated in
U.S. dollars). The financing bears interest at fixed interest rates between
1% and 16.3% per year and floating interest rates between LIBOR +0.44% and
LIBOR +5.5% per year and the last maturity date is 2001. This financing is
guaranteed by Telebras.
The Company has no committed lines of credit and current debt is
scheduled to be repaid as follows:
<TABLE>
<CAPTION>
YEAR R$ MILLION
---- ----------
1998.............................................................. 16.2
<S> <C>
1999.............................................................. 2.5
2000.............................................................. --
2001.............................................................. 27.2
2002.............................................................. --
2003 and thereafter............................................... --
----
Total........................................................... 45.9
====
</TABLE>
The Company is party to certain credit agreements related to its other
financing of R$45.9 million. The Company is in technical default under many of
these credit agreements because of the Breakup and privatization of the
Telebras System. Although the total amount of other financing is not material
and none of the creditors concerned has notified the Company that it intends
to pursue its rights and remedies with respect to the default, the Company has
begun negotiating waivers with such creditors. There can be no assurance that
waivers will be obtained or that the creditors will not pursue the rights and
remedies available to them.
The Company is also in technical default of its loans payable to Telebras,
but such loans became intercompany loans payable by the Registrant's operating
subsidiaries to the Registrant upon the completion of the Breakup.
RECONCILIATION TO U.S. GAAP
The Company prepares its financial statements in accordance with Brazilian
GAAP, which differs in significant respects from U.S. GAAP. The principal
differences between Brazilian GAAP and U.S. GAAP as they affected the
Company's results of operations are: (i) under Brazilian GAAP, loans and
financing balances in default are not always classified as current liabilities
while under U.S. GAAP, loans and financings in default or expected to be in
default within a year of the balance sheet date are classified as current
obligations unless creditors have provided the Company waivers for such
defaults; a portion of the Company's outstanding debt at December 31, 1997 is
in default or expected to be in default as a result of its privatization and
the Breakup of the Telebras System (see "--Liquidity and Capital Resources");
(ii) under Brazilian GAAP, interest on loans to finance construction in
progress is capitalized at the rate of 12% per annum of the total value of
construction in progress, regardless of the amount of interest actually
incurred on such loans while under U.S. GAAP interest is capitalized at the
interest rate on the debt incurred up to the lower of the amount of
construction in progress and the total loans incurred; (iii) until December
31, 1993 capitalized interest under Brazilian GAAP was not added to individual
assets but was capitalized separately and amortized over a time period
different from the estimated useful lives of the related assets while under
U.S. GAAP capitalized interest is added to the cost of individual assets and
is amortized over their estimated useful lives; (iv) under Brazilian GAAP the
issuance of shares of the Company to finance capital investments was recorded
at the book value of the shares while under U.S. GAAP the sale of shares must
be recorded at their market value resulting in a gain carried as deferred
income and amortized into current income on the same schedule as the plant
financed with the proceeds from the sale of the shares; (v) under Brazilian
GAAP proposed dividends are accrued for in the financial statements in
anticipation of their approval at the shareholders' meeting, while under U.S.
GAAP, dividends are not accrued until they are formally declared; and (vi)
under Brazilian GAAP, the deferred tax liability arising from the indexation
of assets and liabilities for financial reporting purposes was recorded
against retained earnings while under U.S. GAAP such effects would be charged
to income and social contribution taxes in the statements of income. Net
income
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under U.S. GAAP was R$622.6 million and R$673.7 million in 1996 and 1997,
respectively. See Note 29 to the Consolidated Financial Statements.
RECENT RESULTS
The Company has reported consolidated net operating revenues of R$1,218.2
million and consolidated net income of R$160.1 million for the six months
ended June 30, 1998. Such amounts are unaudited, have been determined in
accordance with the Brazilian Corporation Law and standards issued by the CVM
and have not been indexed for inflation occurring after December 31, 1995 or
been expressed in constant reais. Accordingly, such amounts, as well as the
six months amounts discussed in the paragraphs below, are not comparable to
the amounts included in the Consolidated Financial Statements, which have been
so indexed and expressed. See "Presentation of Information." Had consolidated
net operating revenues and consolidated net income for the six months ended
June 30, 1998 been indexed for inflation and expressed in constant reais on
the same basis as the amounts presented in the Consolidated Financial
Statements, such adjustments would have had no material effect on net
operating revenues and would have resulted in a downward adjustment of
approximately R$43 million to net income (principally reflecting additional
depreciation, net of related tax effects). As measured by the IGP-M, the
cumulative rate of inflation from the period December 31, 1995 to June 30,
1998 was 20.0%.
Consolidated net operating revenue for the first six months of 1998
evidenced a slight upward trend, reflecting an increase in monthly
subscription revenue to R$332.6 million associated with an increase in the
number of lines in service to 3.4 million lines at June 30, 1998, partially
offset by a decrease in the average number of pulses per line.
In the first six months of 1998, the Company's expenses trended upward more
rapidly than net operating revenues. Cost of sales in the first six months of
1998 rose to R$649.9 million. Other net operating income decreased to R$51.7
million, reflecting the renegotiation of service contracts with cellular
operators at lower prices and net non operating expense rose to R$33.9
million.
Results for the six months of 1998 are not necessarily indicative of results
for any other period or for the full year. Management believes that the
material adjustments that would be required to reconcile the first six month
figures given above to U.S. GAAP are comparable in nature to those discussed
in Note 29 to the Consolidated Financial Statements except that indexation for
inflation subsequent to December 31, 1995 and through December 31, 1997 would
be required under U.S. GAAP and the cessation of indexation as from January 1,
1998 will eliminate the need for the recognition of an additional charge to
income under U.S. GAAP for the deferred income tax effects of indexation for
financial reporting purposes.
Comparative interim period net operating revenues and net income are not
presented herein. The Registrant was not formed prior to May 22, 1998 and did
not publish interim financial results for the first half of 1997. In addition,
the Registrant's operating subsidiaries' published interim 1997 results (if
any) were for the combined cellular and fixed line entities.
As part of the privatization of the Telebras System, the Federal Government
has offered Telebras System employees the right to purchase the Federal
Government's entire holding of Telebras preferred shares and preferred shares
of each of the New Holding Companies (representing 2.18% of the outstanding
capital stock of Telebras and of each New Holding Company) at a price of
R$69.24 per lot of 13,000 shares (each a "lot" and comprised of 1,000
preferred shares of each of Telebras and the twelve New Holding Companies).
This price represents a 50% discount from the market price of 1,000 Telebras
preferred shares at the time the Federal Government authorized the plan. The
initial period during which employees could subscribe for the shares began on
August 4, 1998 and expired on September 30, 1998. On August 28, 1998, the
Federal Government extended the period for the offer to October 30, 1998. The
offer period has not been extended again and the Federal Government has not
expressed any intention to do so. Each employee has the right to purchase up
to 144 lots of 13,000 preferred shares, subject to proration if the shares are
oversubscribed.
The Federal Government has offered 7.2 million lots, or 60% of the total
number of lots (12.1 million) that would be required if every employee in the
Telebras System offered to purchase the maximum 144 lots per employee allowed.
If offers to purchase are made for more than 7.2 million lots, employees will
be allocated the
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available 7.2 million lots on a pro-rata basis. Accordingly, if every employee
in the Telebras System offered to purchase the maximum 144 lots, each employee
would be allocated 86.4 lots (or 60% of 144). This allocation would increase
up to 144 lots as the total number of Telebras System-wide offers to purchase
declined to 7.2 million lots or less. If total employee demand is for less
than 7.2 million lots, the unsold shares will remain with the Federal
Government. The market price of 1,000 Telebras preferred shares when the offer
to employees commenced on August 4, 1998 was R$127.20. At this date, 1,000
Telebras preferred shares was equivalent to one lot, because the distribution
of New Holding Company preferred shares in connection with the Breakup had not
occurred. The market price of one lot on October 30, 1998, when the offer to
employees terminated, was R$91.00.
The employee stock offering will have no effect on the Company's financial
statements prepared under Brazilian GAAP. For U.S. GAAP purposes only, the
employee stock offering is deemed to give rise to compensation expense to the
extent of the excess of market price of the shares purchased over the Federal
Government's price to employees. Although the Federal Government, rather than
the Company or Telebras, offered the shares to employees, under U.S. GAAP the
deemed compensation amount is "pushed down" to each of the New Holding
Companies in accordance with the number of shares purchased by each New
Holding Company and its subsidiaries' employees. The Company is not yet able
to determine the total amount of the expense that must be recognized under
U.S. GAAP because a complete count of employee subscription is not yet
available. A complete count is not available because a significant portion of
employee subscriptions for shares is made in paper rather than electronic
form. The tabulation of such paper subscriptions is required to be completed
by November 13, 1998. Although the total amount of the U.S. GAAP expense is
not presently determinable, the minimum amount (all of which will be
recognized effective August 4, 1998) is R$69.8 million. Effective October 30,
1998 the Company will record an additional expense ranging from R$0 to R$17.5
million, depending on the total number of shares above the maximum 60%
allocation that the Company's employees are able to purchase. These expenses
are calculated on the assumption that each of the Company's employees
purchases the maximum 144 lots per employee. For this actually to occur, each
of the Company's employees would have to subscribe for the maximum amount and
the employee offering as a whole would have to be sufficiently under-
subscribed to allow the Company's employees to be allocated the maximum 144
lots each. The maximum expense is calculated on two measurement dates: (i)
August 4, 1998, when it is assumed that the Company's employees take up 86.4
lots each (or 60% of the 144 lots maximum), which is the maximum amount that
the Company's employees could purchase in the event that the remaining
Telebras System employees also seek to take up the maximum allowable number of
shares; and (ii) October 30, 1998, when it is assumed that, based on system-
wide under-subscription, the Company's employees are allocated the remaining
57.6 lots each. The expense arising from the August 4 measurement date will be
recorded in the third quarter. The expense arising from the October 30
measurement date will be recorded in the fourth quarter.
The Company has been informed by Telebras that, for the Telebras System as a
whole, the maximum expense under U.S. GAAP in connection with the employee
share offering will be R$421.6.
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
The Company has exchange rate exposure with respect to the U.S. dollar.
Approximately R$45.9 million of the indebtedness of the Company is denominated
in U.S. dollars. The potential immediate loss to the Company that would result
from a hypothetical 10% change in foreign currency exchange rates would be
approximately R$4.6 million. In addition, if such a change were to be
sustained, the Company's cost of financing would increase in proportion to the
change.
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INTEREST RATE RISK
At December 31, 1997, the Company had approximately R$294 million in loans
and financing outstanding, of which R$248 million bore interest of fixed rates
and R$46 million bore interest at floating rates of interest (primarily LIBOR-
based). The Company invests its excess liquidity (R$25 million at December 31,
1997) mainly in short-term instruments. The potential loss to the Company over
one year that would have resulted from hypothetical, instantaneous and
unfavorable change of 100 basis points in the interest rates applicable to
financial
61--1
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assets and liabilities on December 31, 1997 would be approximately R$3
million. The above sensitivity analyses are based on the assumption of an
unfavorable 100 basis point movement of the interest rates applicable to each
homogenous category of financial assets and liabilities and sustained over a
period of one year. A homogenous category is defined according to the currency
in which financial assets and liabilities are denominated and assumes the same
interest rate movement within each homogenous category (e.g., U.S. dollars).
As a result, the Company's interest rate risk sensitivity model may overstate
the impact of interest rate fluctuations for such financial instruments as
consistently unfavorable movements of all interest rates are unlikely. See
Notes 19 and 24 to the Consolidated Financial Statements.
ITEM 10: DIRECTORS AND OFFICERS OF REGISTRANT
BOARD OF DIRECTORS
The Registrant is administered by a Board of Directors (Conselho de
Administracao) and a Board of Executive Officers (Diretoria). The Board of
Directors is comprised of eleven members serving for a term of three years.
The Board of Directors holds a regular meeting once every two months 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.
<TABLE>
<CAPTION>
NAME POSITION
---- --------
<S> <C>
Modesto Souza Barros Carvalhosa.................................. Chairman
Jair Antonio Bilachi............................................. Director
Arthur Joaquim de Carvalho....................................... Director
Carlos Augusto Salles............................................ Director
Luiz Raymundo Tourinho Dantas.................................... Director
Helio Falchi..................................................... Director
Carmelo Furci.................................................... Director
Benedito Jose Soares de Melo Pati................................ Director
Isabel Ribeiro de Almeida........................................ Director
Jorge de Moraes Jardim Filho..................................... Director
Claudio Salgueiro Garcia Munhoz.................................. Director
</TABLE>
Set forth below are brief biographical descriptions of the Directors.
Modesto Souza Barros Carvalhosa, 66 years old, has served as Chairman of the
Board of Directors since August 1998. He served as a consultant for legal
matters to the Sao Paulo Stock Exchange, Chairman of the Court of Ethics of
the Brazilian Bar Association--Sao Paulo Chapter and Professor of Commercial
Law at the School of Law of the University of Sao Paulo. He served as a member
of the International Faculty for Corporate and Capital Market Law and
Securities Regulation in Philadelphia, from 1975 to 1995. Mr. Carvalhosa holds
a law degree and a doctorate degree in law from the University of Sao Paulo,
as well as a post-graduate degree in the economics of law from the University
of Camerino (Italy).
Jair Antonio Bilachi, 42 years old, has served as member of the Board of
Directors since August 1998. He served as general manager of Bank of Brazil
(Banco do Brasil) branches in Brasilia, Nova Granada--SP and Cidade Morena--MS
from December 1990 to February 1995 and as Superintendent of Bank of Brazil in
the Federal District from February 1995 to November 1995. He currently serves
as President of PREVI--Caixa da Previdencia dos Funcionarios do Banco do
Brasil. He holds an accounting and a mathematics degree, as well as a post-
graduate degree in foreign trade from the UNEB-COPEX (Uniao Educacional de
Brasilia--Coordenacao de Estudos, Pesquisas, Pos-Graduacao e Extensao--
Brasilia Educational Union--Studies, Researches, Post-Graduate and Extension).
Arthur Joaquim de Carvalho, 41 years old, has served as member of the Board
of Directors since September 1998. On August 10, 1998, he was also elected to
the Board of Directors of Tele Norte Celular Participacoes
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S.A. and of Telemig Celular Participacoes S.A.. Mr. Carvalho serves as a
Principal of CVC/Opportunity Equity Partners Ltd., a Cayman Island privately
owned investment company. He has served as a Senior Investment Officer for
private equity at the Opportunity Group. Prior to Opportunity, he served as a
Managing Director of Manuel Joaquim de Carvalho Ltda., an export-oriented
agribusiness company. He holds a degree in Business Administration from the
Federal University of Bahia.
Carlos Augusto Coelho Salles, 59 years old, has served as member of the
Board of Directors since September 1998. From 1989 to 1998 he served as
Superintendent Executive Officer of Xerox do Brasil. He serves as the
President of Xerox do Brasil, Astor Administracao de Bens e Participacoes
Ltda., Centro de Desenvolvimento de Sistemas de Vitoria, and on the
Administrative Board of Sao Rafael Sociedade de Previdencia Privada. He holds
a law degree from the Law School of the University of the State of Rio de
Janeiro and a degree in Business Administration from the Getulio Vargas
Foundation of Rio de Janeiro.
Luiz Raymundo Tourinho Dantas, 71 years old, has served as member of the
Board of Directors since September 1998. He served as Executive Officer and
founder of Brasquip (a drilling devices manufacturer), of CASAFORTE--Credito
Imobiliario e Credito Financiamento and of Companhia de bebidas da Bahia--
CIBEB (Carlsberg) and as President of Companhia Valenca Industrial--Fabrica de
Tecidos. He also served as Vice President of the Commercial Association of
Bahia, of the Industry Federation of the State of Bahia and as Royal Consul of
Denmark. He holds a law degree from the Federal University of Bahia.
Helio Falchi, 75 years old, has served as a member of the Board of Directors
since August 1998. He is a partner at the law firm of Benedito J. Soares de
Melo Pati Advogados Associados. He serves as an officer of TMI Telemidia
Internacional do Brasil Ltda. and of Value Partners Brasil Ltda. He holds a
law degree from the Law School of the University of Sao Paulo.
Carmelo Furci, 45 years old, has served as a member of the Board of
Directors since September, 1998. He served as a Consultant of the Institute
for the New Chile and VECTOR of the Centro de Estudios Economicos y Sociales
(1978-82). He also served as the Coordinator of International Relations,
Enimont, Policy Advisor of the European Chemical Association and served in the
department of Foreign Relations of Europe at the World Bank (1994-97), where
he also served as Strategy Manager. He currently serves as Vice-Director at
the Chamber of Commerce of Milan. He holds a degree in sociology from the
Universita degli Studi di Roma and a doctorate degree in economics from the
London School of Economics and Political Science.
Benedito Jose Soares de Mello Patti, 74 years old, has served as a member of
the Board of Directors since September 1998. He is a practicing attorney and a
partner at the law firm of Benedito J. Soares de Melo Pati Advogados
Associados. He has served as President of Fiat Automoveis do Brasil S.A., of
Magneti Marelli do Brasil Ind. e Com. Ltda. and of GD do Brasil. He holds a
law degree from the Law School of the University of Sao Paulo.
Isabel Ribeiro de Almeida, 24 years old, has served as a member of the Board
of Directors since September 1998. She is a practicing attorney and an
associate at the law firm of Benedito J. Soares de Melo Pati Advogados
Associados. She holds a law degree from the Law School of the Catholic
University of Sao Paulo.
Jorge de Moraes Jardim Filho, 49 has served as a member of the Board of
Directors since August 1998. He served as a member of the Board of Directors
of ACESITA S.A. and Companhia Paulista de Forca e Luz S.A., Telegoias S.A.,
Telepisa S.A. and Telesp Celular Participacoes S.A.; as President of
Telecomunicacoes Brasileiras S.A.--Telebras (1995) and of Telebrasilia
(1991/1993), as interim Minister of State for Communications (1992-1995) and
as Chairman of the Board of Directors of Telebras (1992-1995) and of
Telebrasilia (1993). He has also served as the Secretary to the Ministry of
Communications from 1992 to 1995. He currently serves as the Superintendent
Director of Fundacao SISTEL de Seguridade Social, Chairman of the Board of
Directors of GTD S.A., Vice-President of the Board of Directors of Americel
S.A., Telet S.A., Paranapanema S.A. and World Trade Center of Sao Paulo. He
holds a degree in Engineering and a post-graduate degree in statistics and
economic engineering both from the University of Brasilia.
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Claudio Salgueiro Garcia Munhoz, 39 years old, was elected to the Board of
Directors of the Company in September, 1998. He joined Banco do Brasil in 1979
where he served in many positions in the General Management, including Manager
of Operations. He has also served as Administrative Director of BB Previdencia
(the Pension Fund of Banco do Brasil S.A.) and as a Member of the Fiscal
Council of the PREVI. He currently serves as Administrative Director of PREVI
and as an alternate member of the Superior Council of BB Previdencia. He holds
a degree in economics from the National University of Brasilia (UNB), and a
diploma from the Wharton School of the University of Pennsylvania.
BOARD OF EXECUTIVE OFFICERS
The Board of Executive Officers consists of one President, one Vice
President and three Executive Officers, with the following titles: Executive
Officer for Business, Network Executive Officer and Support Executive Officer,
elected by the Board of Directors for a term of three years. An Executive
Officer may be removed from office at any time.
The following are the Executive Officers and their respective positions.
<TABLE>
<CAPTION>
NAME POSITION
---- --------
<S> <C>
Ari Joaquim da Silva................. President and Executive Officer for
Business
Jonas de Oliveira Junior............. Vice-President
Francisco Aurelio Sampaio Santiago... Network Executive Officer
Giorgio Bampi........................ Support Executive Officer
</TABLE>
Set forth below are brief biographical descriptions of the Executive
Officers not included above.
Ari Joaquim da Silva, 46 years old, has served as an Executive Officer since
May 1998. He joined Telebras in 1980 as head of the Department of Planning and
Finance of Telebrasilia, where he also served as Manager of Strategic Planning
Coordination. He also served as manager of the Department of Planning and
Administrative Control of Telebras, a member of the Board of Directors of
Telegoias, a member of the Audit Committee of Sistel and a Superintendent of
Communication Services at Anatel. He holds a degree in accounting from the
University of the Federal District and graduate degrees in business
administration and executive training.
Jonas de Oliveira Junior, 49 years old, has served as an Executive Officer
since May 1998. Between 1974 and 1996, he served as a manager for Telebras in
areas of technical planning and engineering. Since 1996, he has served as a
manager assisting the President of Telebras in regulatory matters. He holds
degrees in electrical engineering and law from the Technical Institute of
Aeronautics and the Unified Teaching Center of Brasilia respectively, and a
graduate degree in systems analysis from the Institute of Aerospace Research.
Francisco Aurelio Sampaio Santiago, 43 years old, has served as an Executive
Officer since May 1998. He joined Telebras as an engineer at Telebrasilia
S.A.. Since joining Telebrasilia S.A., he has held various positions including
Executive Coordinator of Operations, Executive Coordinator of Engineering,
manager of the Department of Cellular Communications and Director of Human
Resources and Engineering. He holds an electrical engineering degree from the
University of Brasilia and has completed graduate studies in various
specialties of telecommunications and business planning.
Giorgio Bampi, 50 years old, has served as an Executive Officer since May
1998. Among other positions, he served as Fiscal Advisor to Companhia
Telefonica de Paranagua and Superintendent of Financial Administration of
Itaipu Binacional. Most recently, he served as Economics and Finance Director
and Director of Investor Relations of Telepar. He holds an accounting degree
from the Foundation of Social Studies of Parana.
ITEM 11: COMPENSATION OF DIRECTORS AND OFFICERS
For the year ended December 31, 1997, the aggregate amount of compensation
paid by the Registrant's subsidiaries to all directors and executive officers
of the Registrant's subsidiaries as a group was approximately R$4.5 million.
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For the year ended December 31, 1997, the aggregate amount set aside or
accrued by the Registrant's subsidiaries to provide pension, retirement or
similar benefits for officers and directors of the Registrant's subsidiaries
was approximately R$652.1 thousand. The Registrant did not have any officers
or directors for the year ended December 31, 1997 because it was not formed
until May 22, 1998 as part of the Breakup of Telebras.
ITEM 12: OPTIONS TO PURCHASE SECURITIES FROM REGISTRANT OR SUBSIDIARIES
None.
ITEM 13: INTEREST OF MANAGEMENT IN CERTAIN TRANSACTIONS
None.
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PART II
ITEM 14: DESCRIPTION OF SECURITIES TO BE REGISTERED
CAPITAL STOCK
Set forth below is a brief summary of the material provisions concerning the
Preferred Shares and Common Shares, the By-laws and the Brazilian Corporation
Law. This description is qualified by reference to the By-laws, which have
been filed (together with an English translation) as an exhibit to this
Registration Statement and to the Brazilian Corporation Law. A copy of the By-
laws (together with an English translation) is available for inspection at the
principal office of the Depositary. Information on the trading market for the
Preferred Shares is set forth under "Nature of Trading Market" and information
on ownership of the Registrant's shares is set forth under "Control of
Registrant."
GENERAL
The capital stock of the Registrant is comprised of Preferred Shares and
Common Shares, all without par value. At May 22, 1998, 1998, there were
210,029,997 thousand outstanding Preferred Shares and 124,351,903 thousand
outstanding Common Shares. The Company's share capital may be increased only
by shareholder vote.
The Preferred Shares are nonvoting except under limited circumstances and
are entitled to a preferential, noncumulative dividend and to priority over
the Common Shares in the case of liquidation of the Registrant.
Under the Brazilian Corporation Law, the number of nonvoting shares or
shares with limited voting rights, such as the Preferred Shares, may not
exceed two-thirds of the total number of shares. The Federal Government was
required by law prior to the privatization to own more than 50% of the voting
stock of the Registrant.
The majority of the members of the Board of Directors will be elected by the
controlling shareholders of Common Stock of the Registrant. Board members,
even if elected by one specific shareholder, have fiduciary duties towards the
Registrant and all its shareholders.
DIVIDENDS
Pursuant to its By-laws, the Registrant is required to distribute as
dividends in respect of each fiscal year ending on December 31, to the extent
amounts are available for distribution, an aggregate amount equal to at least
25% of Adjusted Net Income (as defined below) on such date (the "Mandatory
Dividend"). The annual dividend distributed to holders of Preferred Shares
(the "Preferred Dividend") has priority in the allocation of Adjusted Net
Income. Remaining amounts to be distributed are allocated first to the payment
of a dividend to holders of Common Shares in an amount equal to the Preferred
Dividend and the remainder is distributed equally among holders of Preferred
Shares and Common Shares. Under the Brazilian Corporation Law, a company is
permitted to suspend the Mandatory Dividend in respect of common shares and
preferred shares not entitled to a fixed or minimum dividend if its Board of
Directors and Audit Committee report to the shareholders' meeting that the
distribution would be incompatible with the financial circumstances of such
company and the shareholders ratify this conclusion at the shareholders'
meeting. In this case, (i) the Board of Directors must forward to the CVM
within five days of the shareholders' meeting an explanation justifying the
information transmitted at the meeting and (ii) the profits which were not
distributed for such reason are to be recorded as a special reserve and, if
not absorbed by losses in subsequent fiscal years, are to be paid as dividends
as soon as the financial situation of such company permits. The Preferred
Shares of the Registrant are entitled to a minimum dividend and thus the
Mandatory Dividend may be suspended only with respect to the Common Shares.
See "--Priority and Amount of Preferred Dividends." Dividends may be paid by
the Registrant out of retained earnings or accumulated profits in any given
fiscal year.
For the purposes of the Brazilian Corporation Law, accumulated profits are
defined as net income after income tax and social contribution for such fiscal
year, net of any accumulated losses from prior fiscal years and
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any amounts allocated to founders' shares, income bonds, employees' and
management's participation in a company's profits.
At each annual shareholders' meeting, the Board of Directors is required to
recommend how net profits for the preceding fiscal year are to be allocated.
Under the Brazilian Corporation Law, the Registrant is required to maintain a
statutory reserve, to which it must allocate 5% of net profits for each fiscal
year until the amount of such reserve equals 20% of the Registrant's paid-in
capital (the "Statutory Reserve"). Net losses, if any, may be charged against
the statutory reserve.
The Brazilian Corporation Law also provides for two additional discretionary
allocations of net profits that are subject to approval by shareholders at the
annual shareholders' meeting. First, a percentage of net profits may be
allocated to the contingency reserve for anticipated losses that are deemed
probable in future years (the "Contingency Reserve"). Any amount so allocated
in a prior year must be either (i) reversed in the fiscal year in which the
loss was anticipated if such loss does not in fact occur or (ii) written off
in the event that the anticipated loss occurs. Second, if the amount of
Unrealized Revenue exceeds the sum of (i) the statutory reserve, (ii) the
Contingency Reserve and (iii) retained earnings, such excess may be allocated
to the reserve (the "Unrealized Revenue Reserve"). Such allocations may not
hinder the payment of dividends on the Preferred Shares. "Unrealized Revenue"
is defined under the Brazilian Corporation Law as the sum of (i) the share of
equity earnings of affiliated companies which is not paid as cash dividends
and (ii) profits from installment sales to be received after the end of the
next succeeding fiscal year.
For the purposes of the Brazilian Corporation Law, and in accordance with
the Registrant's By-laws, the "Adjusted Net Income" is an amount equal to the
Registrant's net profit adjusted to reflect allocations to and from (i) the
Statutory Reserve; (ii) the Contingency Reserve and (iii) the Unrealized
Revenue Reserve.
The amounts available for distribution are determined on the basis of
financial statements prepared in accordance with the Brazilian Corporation
Law, which differ from financial statements, such as the Consolidated
Financial Statements included herein, that are prepared using the constant
currency method according to Brazilian GAAP.
In order to allow the payment of dividends after the Breakup, the
shareholders of Telebras approved, as a part of the Breakup, the allocation of
a proportional part of the retained earnings and reserves of Telebras
transferred to the Registrant as retained earnings of Registrant. These
earnings and reserves (which amount to R$3,185.8 million) are available for
payment of future dividends by the Registrant, if so decided by the
shareholders, although the Registrant is not legally obligated to do so.
PRIORITY AND AMOUNT OF PREFERRED DIVIDENDS
The Registrant's By-laws provide for a minimum yearly per share dividend for
the Preferred Shares equal to 6% of the amount obtained by dividing the total
share capital by the total number of shares of the Company. As a result of
such provision, holders of Preferred Shares are entitled to receive in any
year distributions of cash dividends prior to the holders of Common Shares
receiving any distribution of cash dividends in such year. In addition,
distributions of cash dividends in any year are made (i) first, to the holders
of Preferred Shares, up to the amount of the Preferred Dividend of the
Preferred Shares for such year, (ii) then, to the holders of Common Shares,
until the amount distributed in respect of each Common Share is equal to the
amount distributed in respect of each Preferred Share, and (iii) thereafter,
to the Common Shares and Preferred Shares on a pro rata basis. If the
Mandatory Dividend in any year is less than or equal to the Preferred Dividend
payable to the holders of Preferred Shares in such year, the holders of Common
Shares will not be entitled to receive any cash dividends from the Registrant
in such year, unless the holders of Common Shares approve dividends in excess
of the Preferred Dividend. In such circumstances, however, holders of
Preferred Shares will be entitled to the amount available for payment of
dividends up to an aggregate amount equal to the Preferred Dividend plus, in
the event the Preferred Dividend is higher than the amount available for
payment of dividends for such year, any retained earnings from previous years
may be used to make up for such shortfall. If the minimum dividend is not paid
for a period of three years, holders of Preferred Shares shall be entitled to
full voting rights until such time as the minimum dividend is paid in full for
any year.
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PAYMENT OF DIVIDENDS
The Registrant is required by law and its By-laws to hold an annual
shareholders' meeting by April 30 of each year at which, among other things,
an annual dividend may be declared by decision of the shareholders on the
recommendation of the Executive Officers, as approved by the Board of
Directors. The payment of annual dividends is based on the Financial
Statements prepared for the fiscal year ending December 31. Under the
Brazilian Corporation Law, dividends are required to be paid within 60 days
following the date the dividend is declared to shareholders of record on such
declaration date, unless a shareholders' resolution sets forth another date of
payment, which must occur prior to the end of the fiscal year in which such
dividend was declared. A shareholder has a three-year period from the dividend
payment date to claim dividends in respect of its shares, after which the
Registrant has no liability for such payment. Because the Registrant's shares
are issued in book-entry form, dividends with respect to any share are
automatically credited to the account holding such share and no action is
required on the part of the shareholder. The Registrant is not required to
adjust the amount of paid-in capital for inflation. Annual dividends may be
paid to shareholders on a pro rata basis according to the date when the
subscription price is paid to the Registrant.
Shareholders who are not residents of Brazil must register with the Central
Bank of Brazil in order for dividends, sales proceeds or other amounts with
respect to their shares to be eligible to be remitted outside of Brazil. The
Preferred Shares underlying the ADSs are held in Brazil by the Custodian, as
agent for the Depositary, which is the registered owner of the Registrant's
shares. See "--Description of American Depositary Receipts in respect of
Preferred Shares."
Payments of cash dividends and distributions, if any, will be made in
Brazilian currency to the Custodian on behalf of the Depositary, which will
then convert such proceeds into U.S. dollars and will cause such U.S. dollars
to be delivered to the Depositary for distribution to holders of ADRs. In the
event that the Custodian is unable to convert immediately the Brazilian
currency received as dividends into U.S. dollars, the amount of U.S. dollars
payable to holders of ADRs may be adversely affected by devaluations of the
Brazilian currency that occur before such dividends are converted and
remitted. Dividends in respect of the Preferred Shares paid to resident and
non-resident shareholders, including holders of ADSs, are not currently
subject to Brazilian withholding tax. See "Taxation--Brazilian Tax
Considerations."
VOTING RIGHTS
Each Common Share entitles the holder thereof to one vote at meetings of
shareholders of the Registrant. Preferred Shares do not entitle the holder to
vote except as set forth below. Holders of Preferred Shares are entitled to
attend or to address meetings of shareholders.
One of the three members of the permanent Audit Committee of the Registrant
and his or her alternate are elected by majority vote of the holders of
Preferred Shares present at the annual meeting of shareholders at which
members of the Audit Committee are elected.
Brazilian Corporation Law provides that certain nonvoting shares, such as
the Preferred Shares, acquire voting rights in the event the Registrant fails
for three consecutive fiscal years to pay the Preferred Dividend to which such
shares are entitled until such payment is made.
The Preferred Shares are entitled to full voting rights with respect to (i)
the approval of any long-term contract between the Company and its affiliates,
on the one hand, and any controlling shareholder of the Company, such
shareholder's affiliates and related parties, on the other hand and (ii)
resolutions modifying certain provisions of the By-laws. The Preferred Shares
are entitled to full voting rights with respect to any resolution submitted to
the shareholders' meeting for the delisting of the Registrant ("going
private") or during liquidation of the Registrant.
Any change in the preference, benefits, conditions of redemption and
amortization of the Preferred Shares, or the creation of a class of shares
having priority or preference over the Preferred Shares, would require the
approval of holders of a majority of the outstanding Preferred Shares at a
special meeting of holders of Preferred
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Shares. Such a meeting would be called by publication of a notice in the
Gazeta Mercantil and the Diario Oficial da Uniao at least thirty days prior to
the meeting but would not generally require any other form of notice.
In any circumstances in which holders of Preferred Shares are entitled to
vote, each Preferred Share will entitle the holder thereof to one vote.
PREEMPTIVE RIGHTS
Each shareholder of the Registrant has a general preemptive right to
subscribe for shares in any capital increase, in proportion to its
shareholding. A period of 30 days following the publication of notice of the
capital increase is allowed for exercise of the right, and the right is
negotiable. However, a shareholders' meeting is authorized to eliminate
preemptive rights with respect to the issuance of new shares, debentures,
warrants and founders' shares convertible into new shares up to the limit of
the authorized share capital, provided that the distribution of these
securities is effected (i) on a stock exchange or in a public offering, (ii)
through an exchange of shares in a public offering the purpose of which is to
acquire control of another company or (iii) through the use of certain tax
incentives.
In the event of a capital increase which would maintain or increase the
proportion of capital represented by Preferred Shares, holders of ADSs, or of
Preferred Shares, would have preemptive rights to subscribe only to newly
issued Preferred Shares. In the event of a capital increase which would reduce
the proportion of capital represented by Preferred Shares, holders of ADSs, or
of Preferred Shares, would have preemptive rights to subscribe to Preferred
Shares, in proportion to their shareholdings and to Common Shares only to the
extent necessary to prevent dilution of their interest in the Registrant.
Preemptive rights to purchase shares may not be offered to U.S. holders of
ADSs unless a registration statement under the Securities Act is effective
with respect to the shares underlying such rights, or an exemption from the
registration requirements of the Securities Act is available. Consequently,
holders of ADSs who are U.S. persons or are located in the United States may
be restricted in their ability to participate in the exercise of preemptive
rights. See "--Description of American Depositary Receipts--Dividends, Other
Distributions and Rights in respect of Preferred Shares."
RIGHT OF REDEMPTION
Neither the Common Shares nor the Preferred Shares are redeemable, subject
to the right of a dissenting shareholder to seek redemption upon a decision
made at a shareholders' meeting by shareholders representing over 50% of the
voting shares (i) to change the preference of the Preferred Shares or to
create a class of shares having priority or preference over the Preferred
Shares, (ii) to modify the mandatory distribution of dividends, (iii) to
change the corporate purposes of the Registrant, (iv) to dissolve or liquidate
the Registrant, (v) to transfer all of the shares of the Registrant to another
company in order to make the Registrant a wholly-owned subsidiary of such
company (incorporacao de acoes), (vi) to approve the acquisition of another
company, the price of which exceeds certain limits set forth in the Brazilian
Corporation Law, and (vii) to merge or consolidate the Registrant with another
company, if certain liquidity standards provided in the Brazilian Corporation
Law are not met. The right to redemption lapses 30 days after publication of
the minutes of the relevant shareholders' meeting or, whenever the resolution
requires the approval of the holders of Preferred Shares by vote taken in a
special meeting of a majority of the holders of Preferred Shares affected by
the resolution, within 30 days from the publication of the minutes of such
special meeting.. The Registrant would be entitled to reconsider any action
giving rise to redemption rights within 10 days following the expiration of
such rights if the redemption of shares of dissenting shareholders would
jeopardize the financial stability of the Registrant.
Unless otherwise provided in the By-laws (which is not the case with the
Registrant), shares are redeemable at their book value, determined on the
basis of the last annual balance sheet approved by the shareholders. If the
shareholders' meeting giving rise to redemption rights occurs more than 60
days after the date of the last annual balance sheet, a shareholder may demand
that its shares be valued on the basis of a new balance sheet that is as of a
date within 60 days of such shareholders' meeting.
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FORM AND TRANSFER
Shares of the Registrant are maintained in book-entry form with a transfer
agent (the "Transfer Agent") and the transfer of such shares is made in
accordance with the applicable provisions of the Brazilian Corporation Law,
which provides that a transfer of shares is effected by an entry made by the
Transfer Agent on its books, debiting the share account of the seller and
crediting the share account of the purchaser, against presentation of a
written order of the seller, or judicial authorization or order, in an
appropriate document which remains in the possession of the Transfer Agent.
The Preferred Shares underlying the ADS will be registered on the Transfer
Agent's records in the name of the Depositary.
Transfers of shares by a foreign investor are made in the same way and
executed by such investor's local agent on the investor's behalf except that,
if the original investment was registered with the Central Bank of Brazil
pursuant to the Annex IV Regulations, the foreign investor should also seek
amendment, if necessary, through its local agent, of the certificate of
registration to reflect the new ownership.
Each of the Sao Paulo Stock Exchange and the Rio de Janeiro Stock Exchange
operates a central clearing system. A holder of shares of the Registrant may
choose, at its discretion, to participate in these systems and all shares
elected to be put into the system will be deposited in custody with the
relevant stock exchange (through a Brazilian institution duly authorized to
operate by the Central Bank of Brazil having a clearing account with the
relevant stock exchange) and the fact that such shares are subject to custody
with the relevant stock exchange will be reflected in the Registrant's
register of shareholders. Each participating shareholder will, in turn, be
registered in the register of beneficial shareholders of the Registrant
maintained by the relevant stock exchange and will be treated in the same way
as registered shareholders.
DESCRIPTION OF AMERICAN DEPOSITARY RECEIPTS IN RESPECT OF PREFERRED SHARES
The following is a summary of the material provisions of the deposit
agreement (the "Deposit Agreement"), dated as of July 27, 1998 among the
Registrant, the Depositary, and the registered holders (the "Owners") and
beneficial owners from time to time of ADSs (the "Beneficial Owners"),
pursuant to which the ADSs representing Preferred Shares are to be issued.
This summary is subject to and qualified in its entirety by reference to the
Deposit Agreement, including the form of ADRs. Terms used in this description
and not otherwise defined shall have the meanings set forth in the Deposit
Agreement. A copy of the Deposit Agreement has been filed as an exhibit to
this Registration Statement. Copies of the Deposit Agreement are available for
inspection at the Corporate Trust Office of the Depositary, currently located
at 101 Barclay Street, New York, NY 10286, and at the office of the agent of
the Custodian, currently located at the principal Sao Paulo, Brazil office of
Banco Itau. The Depositary's principal executive office is located at 1 Wall
Street, New York, NY 10015.
AMERICAN DEPOSITARY RECEIPTS
ADRs evidencing ADSs are issuable by the Depositary pursuant to the Deposit
Agreement. Each ADR is in registered form and evidences a specified number of
ADSs, each ADS representing 5,000 Preferred Shares, or evidence of the right
to receive 5,000 Preferred Shares deposited with the Custodian and registered
in the name of the Depositary or its nominee (together with any additional
Preferred Shares at any time deposited or deemed deposited under the Deposit
Agreement and any and all other securities, cash and other property received
by the Depositary or the Custodian in respect of such Preferred Shares and at
such time held under the Deposit Agreement, the "Deposited Securities"). Only
persons in whose names ADRs are registered on the books of the Depositary are
treated by the Depositary and the Registrant as Owners.
DEPOSIT, TRANSFER AND WITHDRAWAL
The By-laws provide that ownership of capital generally must be evidenced
only by a record of ownership maintained by the Registrant or an accredited
intermediary, such as a bank, acting as a registrar for the shares. Currently,
such function is performed by the Registrant as registrar (the "Registrar").
Accordingly, all references
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to the deposit, surrender and delivery of the Preferred Shares refer only to
book-entry transfers of the Preferred Shares in Brazil. See "--Capital Stock"
for a description of the characteristics and rights of the Preferred Shares.
All references to the deposit, surrender and delivery of the ADS or the ADRs
refer not only to the physical transfer of any certificates representing such
ADRs but also to any book-entry transfers.
The Preferred Shares represented by ADSs were deposited pursuant to the
Deposit Agreement by book-entry transfer to an account of the Custodian and
registered in the name of the Custodian. The Depositary is the holder of
record on the books of the Custodian of all such Preferred Shares.
The Depositary has agreed, subject to the terms and conditions of the
Deposit Agreement, that upon delivery (including by book-entry credit) to the
Custodian of the Preferred Shares (or evidence of rights to receive Preferred
Shares) and pursuant to appropriate instruments of transfer in a form
satisfactory to the Custodian, the Depositary will, upon payment of the fees,
charges and taxes provided in the Deposit Agreement, execute and deliver at
its Corporate Trust Office to, or upon the written order of, the person or
persons named in the notice of the Custodian delivered to the Depositary or
requested by the person depositing such Preferred Shares with the Depositary,
an ADR or ADRs, registered in the name or names of such person or persons, and
evidencing any authorized number of ADSs requested by such person or persons.
The Depositary will refuse to accept Preferred Shares for deposit whenever
it is notified in writing that such deposit would result in any violation of
applicable laws. Neither the Depositary nor the Custodian, nor any nominee or
person on their behalf, will accept any Restricted ADR evidencing Restricted
ADSs issued pursuant to the Restricted Deposit Agreement, or Preferred Shares
withdrawn pursuant to the Restricted Deposit Agreement for the purpose of
deposit under the Deposit Agreement, or issue ADSs or ADRs against delivery
thereof, as long as such Restricted ADSs, Restricted ADRs or Preferred Shares
are or may be deemed restricted securities within the meaning of Rule
144(a)(3) under the Securities Act.
Upon surrender at the Corporate Trust Office of the Depositary of an ADR for
the purpose of withdrawal of the Deposited Securities represented by the ADSs
evidenced by such ADR and upon payment of the fees of the Depositary,
governmental charges and taxes provided in the Deposit Agreement, and subject
to the terms and conditions of the Deposit Agreement, the By-laws, the
Deposited Securities and applicable law, the Owner of such ADR will be
entitled to book-entry credit with the Registrar together with physical
delivery (if physical delivery is permitted under the By-laws), to him or upon
his order, as permitted by applicable law, of the amount of Deposited
Securities at the time represented by the ADS or ADSs evidenced by such ADR.
Any forwarding of share certificates (if any), other securities, property,
cash and other documents of title for such delivery will be at the risk and
expense of the Owner.
Subject to the terms and conditions of the Deposit Agreement and any
limitations that may be established by the Depositary and unless requested by
the Registrant to cease doing so, the Depositary may execute and deliver ADRs
prior to the receipt of Preferred Shares (a "Pre-Release"), may deliver
Preferred Shares upon the receipt, and cancellation of ADRs which have been
Pre-Released, whether or not such cancellation is prior to the termination of
such Pre-Release or the Depositary knows that such ADR has been Pre-Released,
and may receive ADRs in lieu of Preferred Shares in satisfaction of a Pre-
Release.
Each Pre-Release must be (a) preceded or accompanied by a written
representation and agreement from the person to whom the ADRs are to be
delivered (the "Pre-Releasee") that the Pre-Release or its customer (i) owns
the Preferred Shares or ADRs to be remitted, as the case may be, (ii) assigns
all beneficial right, title and interest in such Preferred Shares or ADRs, as
the case may be, to the Depositary for the benefit of the Owners and (iii)
agrees in effect to hold such Preferred Shares or ADRs, as the case may be,
for the account of the Depositary until delivery of the same upon the
Depositary's request, (b) at all times fully collateralized with cash or U.S.
government securities, (c) terminable by the Depositary on not more than five
business days' notice and (d) subject to such further indemnities and credit
regulations as the Depositary deems appropriate. The Depositary will set
limits with respect to Pre-Release transactions to be entered into hereunder
with any particular Pre-Releasee on a case by case basis as the Depositary
deems appropriate. The collateral referred to in clause (b)
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above shall be held by the Depositary for the benefit of the Owners as
security for the performance of the Pre-Releasee's obligations to the
Depositary in connection with a Pre-Release transaction, including the Pre-
Release's obligation to deliver Preferred Shares or ADRs upon termination of a
Pre-Release transaction.
The Depositary will also limit the number of ADRs involved in such Pre-
Release transactions so that Preferred Shares not deposited but represented by
ADSs outstanding at any time as a result of Pre-Releases will not normally
exceed thirty percent (30%) of the ADSs outstanding (without giving effect to
ADSs evidenced by ADRs outstanding as a result of the Pre-Release), but the
Depositary reserves the right to disregard such limit from time to time as it
deems appropriate and may, with the prior written consent of the Registrant,
change such limit for purposes of general application. The Depositary may
retain for its own account any compensation received by it in connection with
the foregoing. Neither the Registrant nor the Custodian shall incur any
liability to Owners of ADRs as a result of such transactions.
DIVIDENDS, OTHER DISTRIBUTIONS AND RIGHTS
The Depositary is required to convert, as promptly as practicable and, in
any event, within one business day of its receipt thereof, into U.S. dollars,
all cash dividends or other distributions, net proceeds from the sale of
securities, property or rights, denominated in any currency other than U.S.
dollars that it receives in respect of the deposited Preferred Shares if
permitted under applicable laws and the Depositary determines that such
conversion into U.S. dollars and transfer to the United States can be effected
on a reasonable basis. If at the time of conversion, the resulting U.S.
dollars can, pursuant to applicable law, be transferred out of Brazil for
distribution, the Depositary will as promptly as practicable distribute the
amount received to the Owner entitled thereto in proportion to the number of
ADSs evidenced by such Owner's ADRs without regard to any distinctions among
Owners on account of exchange restrictions or otherwise. The amount
distributed will be reduced by any amounts to be withheld by the Registrant,
the Depositary or the Custodian, including amounts on account of any
applicable taxes and certain other expenses. For further details about
applicable taxes, see "Taxation."
If such conversion, transfer or distribution can be effected only with the
approval or license of any government or agency thereof, the Depositary will
file as promptly as practicable such application for approval or license;
however, the Depositary will be entitled to rely upon Brazilian local counsel
in such matters, which counsel will be instructed to act as promptly as
possible. If, pursuant to applicable law, any foreign currency received by the
Depositary or the Custodian cannot be converted to U.S. dollars, or if any
approval or license of any government or agency thereof that is required for
such conversion is denied or, in the opinion of the Depositary, cannot be
promptly obtained at a reasonable cost, the Depositary will, (a) as to the
portion of the foreign currency that is convertible into U.S. dollars, make
such conversion and (i) if permitted by applicable law, transfer such U.S.
dollars to the United States and distribute them to the Owners entitled
thereto or (ii) to the extent that such transfer is not permitted, hold such
U.S. dollars for the benefit of the Owners entitled thereto, uninvested and
without liability for interest thereon and (b) as to the nonconvertible
balance, if any, (i) if requested in writing by an Owner, distribute or cause
the Custodian to distribute the foreign currency (or an appropriate document
evidencing the right to receive such foreign currency) received by the
Depositary or the Custodian to such Owner and (ii) the Depositary shall hold
or will cause the Custodian to hold any amounts of nonconvertible foreign
currency not distributed pursuant to the immediately preceding subclause (i)
uninvested and without liability for the interest thereon for the respective
accounts of the Owners entitled to receive the same.
If the Registrant declares a dividend in, or free distribution of,
additional Preferred Shares with respect to the Preferred Shares represented
by the ADSs, the Depositary may, or will if the Registrant so requests,
distribute as promptly as practicable to the Owners of outstanding ADRs
entitled thereto, in proportion to the number of ADSs evidenced by their
respective ADRs, additional ADRs evidencing an aggregate number of ADSs that
represents the number of Preferred Shares received as such dividend or free
distribution, subject to the terms and conditions of the Deposit Agreement
with respect to the deposit of Preferred Shares and the issuance of ADSs
evidenced by ADRs, including the withholding of any tax or other governmental
charge and the payment of fees of the Depositary.
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The Depositary may withhold any such distribution of ADRs if it has not
received satisfactory assurances from the Registrant that such distribution
does not require registration under the Securities Act or is exempt from
registration under the provisions of such Act. In lieu of delivering ADRs for
fractional ADSs in the event of any such dividend or free distribution, the
Depositary will sell the amount of Preferred Shares represented by the
aggregate of such fractions and distribute the net proceeds in accordance with
the Deposit Agreement. If additional ADRs are not so distributed, each ADS
will thereafter also represent the additional Preferred Shares distributed
upon the Deposited Securities represented thereby.
If the Registrant offers, or causes to be offered, to the holders of
Preferred Shares any rights to subscribe for additional Preferred Shares or
any rights of any other nature, the Depositary, after consultation with the
Registrant, will have discretion as to the procedure to be followed in making
such rights available to Owners or in disposing of such rights for the benefit
of such Owners and making the net proceeds available to such Owners. If, by
the terms of such rights offering for any other reason, it would be unlawful
for the Depositary may not either make such rights available to any Owners or
dispose of such rights and make the net proceeds available to such Owners,
then the Depositary will allow the rights to lapse. If at the time of the
offering of any rights, the Depositary determines in its discretion that it is
lawful and feasible to make such rights available to all or certain Owners,
the Depositary may, and at the request of the Company will, distribute to any
Owners to whom it determines the distribution to be lawful and feasible, in
proportion to the number of ADSs held by such Owner, warrants or other
instruments therefor in such form as it deems appropriate.
If the Depositary determines that it is not lawful or feasible to make such
rights available to all or certain Owners, it may, and at the request of the
Registrant, will use its best efforts that are reasonable under the
circumstances to, sell the rights, warrants or other instruments in proportion
to the number of ADSs held by the Owners to whom it has determined it may not
lawfully or feasibly make such rights available, and allocate net proceeds of
such sales for the account of such Owners otherwise entitled to such rights,
warrants or other instruments, upon an averaged or other practical basis
without regard to any distinctions among such Owners because of exchange
restrictions or the date of delivery of any ADR or ADRs or otherwise. The
Depositary will not be responsible for any failure to determine that it may be
lawful or feasible to make such rights available to Owners in general or any
Owner or Owners in particular.
In circumstances in which rights would not otherwise be distributed, if an
Owner requests the distribution of warrants or other instruments in order to
exercise the rights allocable to the ADSs of such Owner, the Depositary will
promptly make such rights available to such Owner upon written notice from the
Registrant to the Depositary that (a) the Registrant has elected in its sole
discretion to permit such rights to be exercised and (b) such Owner has
executed such documents as the Registrant has determined in its sole
discretion are reasonably required under applicable law. Upon instruction
pursuant to such warrants or other instruments to the Depositary from such
Owner to exercise such rights, upon payment by such Owner to the Depositary
for the account of such Owner of an amount equal to the purchase price of the
Preferred Shares to be received in exercise of the rights, and upon payment of
the fees of the Depositary as set forth in such warrants or other instruments,
the Depositary will, on behalf of such Owner, exercise the rights and purchase
the Preferred Shares, and the Registrant will cause the Preferred Shares so
purchased to be delivered to the Depositary on behalf of such Owner. As agent
for such Owner, the Depositary will cause the Preferred Shares so purchased to
be deposited, and will execute and deliver ADRs to such Owner, pursuant to the
Deposit Agreement. Such a disposal of rights may reduce the Owners'
proportionate equity interest in the Registrant.
The Depositary will not offer rights to Owners having an address of record
in the United States unless a registration statement under the Securities Act
is in effect with respect to such rights and the Securities to which such
rights relate or unless the offering and sale thereof to such Owners are
exempt from registration under the Securities Act; however, the Registrant
will have no obligation to file a registration statement under the Securities
Act to make available to Owners any right to subscribe for or to purchase any
of the Securities.
Whenever the Depositary receives any distribution other than cash, Preferred
Shares or rights in respect of the Deposited Securities, the Depositary will,
as promptly as practicable, cause the securities or property received
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by it to be distributed to the Owners entitled thereto, after deduction or
upon payment of any fees and expenses of the Depositary or any taxes or other
governmental charges, in proportion to their holdings, respectively, in any
manner that the Depositary may deem equitable and practicable for
accomplishing such distribution; provided, however, that if in the opinion of
the Depositary such distribution cannot be made proportionately among the
Owners entitled thereto, or if for any other reason (including, but not
limited to, any requirement that the Registrant or the Depositary withhold an
amount on account of taxes or other governmental charges or that such
securities must be registered under the Securities Act, in order to be
distributed to Owners) the Depositary deems such distribution not to be
feasible, the Depositary may, after consultation with the Registrant, adopt
such method as it may deem equitable and practicable for the purpose of
effecting such distribution, including, but not limited to, the public or
private sale of the securities or property thus received, or any part thereof,
and the net proceeds of any such sale (net of the fees and expenses of the
Depositary) will be distributed by the Depositary to the Owners entitled
thereto as in the case of a distribution received in cash.
In connection with any distribution to Owners, the Registrant will remit to
the appropriate governmental authority or agency all amounts (if any) required
to be withheld by the Registrant and owing to such authority or agency by the
Registrant; and the Depositary and the Custodian will remit to the appropriate
governmental authority or agency all amounts (if any) required to be withheld
and owing to such authority or agency by the Depositary or Custodian. If the
Depositary determines that any distribution of property other than cash
(including Preferred Shares and rights to subscribe therefor) is subject to
any tax or governmental charge that the Depositary is obligated to withhold,
the Depositary may, by public or private sale, dispose of all or a portion of
such property in such amounts and in such manner as the Depositary deems
necessary and practicable to pay such taxes or governmental charges, and the
Depositary will distribute the net proceeds of any such sale or the balance of
any such property after deduction of such taxes or governmental charges to the
Owners entitled thereto in proportion to the number of ADSs held by them,
respectively.
Upon any change in nominal or par value, or split-up, consolidation or any
other reclassification of Deposited Securities, or upon any recapitalization,
reorganization, merger or consolidation or sale of assets affecting the
Registrant or to which it is a party, any Preferred Shares or other securities
that will be received by the Depositary or the Custodian in exchange for, in
conversion of, or in respect of Deposited Securities will be treated as new
Deposited Securities under the Deposit Agreement, and ADSs will thenceforth
represent, in addition to the existing Deposited Securities, the right to
receive the new Deposited Securities so received in exchange or conversion,
unless additional ADRs are delivered pursuant to the following sentence. In
any such case the Depositary may, and will if the Company so requests, execute
and deliver additional ADRs as in the case of a distribution in Preferred
Shares, or call for the surrender of outstanding ADRs to be exchanged for new
ADRs specifically describing such new Deposited Securities.
RECORD DATES
Whenever any cash dividend or other cash distribution shall become payable,
or whenever any distribution other than cash shall be made, or whenever rights
shall be issued with respect to the Deposited Securities, or whenever for any
reason the Depositary causes a change in the number of Preferred Shares that
are represented by each ADS or whenever the Depositary shall receive notice of
any meeting of holders of Preferred Shares or other Deposited Securities, or
whenever the Depositary shall find it necessary or convenient, the Depositary
will fix a record date, which date shall, to the extent practicable, be either
the same date as the record date fixed by the Registrant or, if different from
the record date fixed by the Registrant, fixed after consultation with the
Registrant, (a) for the determination of the Owners who will be (i) entitled
to receive such dividend, distribution of rights, or the net proceeds of the
sale thereof, or (ii) entitled to give instructions for the exercise of voting
rights at any such meeting, or (b) on or after which such ADS will represent
the changed number of Preferred Shares, all subject to the provisions of the
Deposit Agreement.
VOTING OF THE DEPOSITED SECURITIES
Preferred Shares do not entitle the holders thereof to vote on any matter
presented to a vote of shareholders of the Registrant except as set forth
under "--Capital Stock--Voting Rights." With respect to the circumstances
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set forth thereunder and if, in the future, the terms of the Preferred Shares
should be revised or amended so as to provide for voting rights, or should the
Preferred Shares obtain voting rights pursuant to the Brazilian Corporation
Law or through any change in the laws, rules, or regulations applicable to
such shares or through any change in interpretation of such laws, the
following shall apply.
As soon as practicable after receipt of notice of any meeting or
solicitation of consents or proxies of holders of Preferred Shares or other
Deposited Securities, if requested in writing by the Registrant, the
Depositary will, as soon as practicable thereafter, mail to all Owners a
notice, the form of which notice will be in the sole discretion of the
Depositary, containing (a) the information included in such notice of meeting
received by the Depositary from the Registrant (or a summary in English of the
notice of such meeting), (b) a statement that the Owners as of the close of
business on a specified record date will be entitled, subject to any
applicable provision of Brazilian law, the By-laws and the provisions of the
Deposited Securities, to instruct the Depositary as to the exercise of the
voting rights, if any, pertaining to the Preferred Shares or other Deposited
Securities represented by their respective ADSs and (c) a statement as to the
manner in which such instructions may be given, including an express
indication that instructions may be given or deemed given in accordance with
the last sentence of this paragraph if no instruction is received, to the
Depositary to give a discretionary proxy to a person designated by the
Registrant. Upon the written request of an Owner on such record date, received
on or before the date established by the Depositary for such purpose, the
Depositary will endeavor, insofar as practicable, to vote or cause to be voted
the amount of Preferred Shares or other Deposited Securities represented by
the ADSs evidenced by such ADRs in accordance with the instructions set forth
in such request. The Depositary may not itself exercise any voting discretion
over any Preferred Shares. If the Depositary does not receive instructions
from an Owner on or before the date established by the Depositary for such
purpose, the Depositary will deem such Owner to have instructed the Depositary
to give a discretionary proxy to a person designated by the Registrant to vote
the underlying Preferred Shares, provided that no such discretionary proxy
will be given with respect to any matter as to which the Registrant informs
the Depositary that (i) the Registrant does not wish such proxy given, (ii)
substantial opposition exists or (iii) the rights of holders of Preferred
Shares will be materially and adversely affected. Under Brazilian law the
Depositary may vote the Preferred Shares or other Deposited Securities
represented by ADSs and evidenced by ADRs in accordance with the instructions
of the Owners even if those instructions differ among such Owners.
Owners are not entitled to attend meetings of shareholders. An Owner of ADRs
wishing to do so must cancel its ADRs and obtain delivery of the underlying
shares, registered in the name of such Owner, prior to the record date for
attendance at such meeting.
REPORTS AND OTHER COMMUNICATIONS
The Depositary will make available for inspection by Owners at its Corporate
Trust Office any reports and communications, including any proxy soliciting
material, received from the Registrant, which are both (a) received by the
Depositary as the holder of the Deposited Securities and (b) made generally
available to holders of such Deposited Securities by the Registrant. The
Depositary will also send to Owners copies of such reports when furnished by
the Registrant pursuant to the Deposit Agreement. Any such reports and
communications furnished to the Depositary by the Registrant will be furnished
in English, to the extent that such materials are required to be translated
into English pursuant to any regulations of the Commission.
AMENDMENT AND TERMINATION OF THE DEPOSIT AGREEMENT
The form of the ADRs and any provision of the Deposit Agreement may at any
time and from time to time be amended by agreement between the Registrant and
the Depositary in any respect which they may deem necessary or desirable. Any
amendment that imposes or increases any fees or charges (other than taxes and
other governmental charges, registration fees, cable, telex or facsimile
transmission costs, delivery costs or other such expenses), or which otherwise
prejudices any substantial existing rights of Owners, will not take effect as
to the outstanding ADRs until the expiration of 30 days after notice of such
amendment has been given to the Owners of outstanding ADRs. Every Owner and
Beneficial Owner at the time such amendment becomes effective will be deemed,
by continuing to hold such ADR, to consent and agree to such amendment and to
be bound by the
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Deposit Agreement as amended thereby. In no event will any amendment impair
the right of any Owner to surrender his ADR and receive therefor the Preferred
Shares and other property represented thereby, except to comply with mandatory
provisions of applicable law.
The Depositary will at any time at the direction of the Registrant terminate
the Deposit Agreement by mailing notice of such termination to the Owners then
outstanding at least 30 days prior to the date fixed in such notice for such
termination. The Depositary may likewise terminate the Deposit Agreement by
mailing notice of such termination to the Registrant and the Owners, if at any
time after 60 days have expired after the Depositary shall have delivered
written notice of its election to resign to the Registrant, a successor
depositary shall not have been appointed and accepted its appointment, in
accordance with the terms of the Deposit Agreement. If any ADRs remain
outstanding after the date of termination, the Depositary thereafter will
discontinue the registration of transfer of ADRs, will suspend the
distribution of dividends to the holders thereof and will not give any further
notices or perform any further acts under the Deposit Agreement, except for
(1) the collection of dividends and other distributions pertaining to the
Deposited Securities, (2) the sale of rights and other property and (3) the
delivery of Preferred Shares, together with any dividends or other
distributions received with respect thereto and the net proceeds of the sale
of any rights or other property, in exchange for surrendered ADRs (after
deducting, in each case, the fees of the Depositary for the surrender of an
ADR and other expenses set forth in the Deposit Agreement and any applicable
taxes or governmental charges).
At any time after the expiration of one year from the date of termination,
the Depositary may sell the Deposited Securities then held thereunder and hold
uninvested the net proceeds of such sale, together with any other cash,
unsegregated and without liability for interest, for the pro rata benefit of
the Owners that have not theretofore surrendered their ADRs, such Owners
thereupon becoming general creditors of the Depositary with respect to such
net proceeds. After making such sale, the Depositary will be discharged from
all obligations under the Deposit Agreement, except to account for net
proceeds and other cash (after deducting, in each case, the fee of the
Depositary and other expenses set forth in the Deposit Agreement for the
surrender of an ADR and any applicable taxes or other governmental charges)
and certain indemnification obligations. Upon termination of the Deposit
Agreement, the Registrant will also be discharged from all obligations
thereunder, except for certain obligations to the Depositary.
CHARGES OF DEPOSITARY
The Depositary will charge (to the extent permitted by applicable law) any
party depositing or withdrawing Preferred Shares or any party surrendering
ADRs or to whom ADRs are issued (including, without limitation, issuance
pursuant to a stock dividend or stock split declared by the Company or an
exchange of stock regarding the ADRs or Deposited Securities or a distribution
of ADRs pursuant to the Deposit Agreement), whichever is applicable: (1) taxes
and other governmental charges, (2) such registration fees as may from time to
time be in effect for the registration of transfers of Preferred Shares
generally on the register of the Registrant or the Registrar and applicable to
transfers of Preferred Shares to the name of the Depositary or its nominee or
the Custodian or its nominee on the making of deposits or withdrawals under
the Deposit Agreement, (3) such cable, telex and facsimile transmission
expenses as are expressly provided in the Deposit Agreement to be at the
expense of persons depositing Preferred Shares or Owners, (4) such expenses as
are incurred by the Depositary in the conversion of foreign currency pursuant
to the Deposit Agreement, (5) a fee not in excess of $5.00 per 100 ADSs (or
portion thereof) for the execution and delivery of ADRs pursuant to the
Deposit Agreement and the surrender of ADRs pursuant to the Deposit Agreement,
(6) a fee for the distribution of proceeds of sales of securities or rights
pursuant to the Deposit Agreement, such fee (which may be deducted from such
proceeds) being in an amount equal to the lesser of (i) the fee for issuance
of ADSs referred to above which would have been charged as a result of the
deposit of such securities (for purposes of this clause treating all such
securities as if they were Preferred Shares) or Preferred Shares received in
exercise of rights distributed to them pursuant to the Deposit Agreement, but
which securities or rights are instead sold by the Depositary and the net
proceeds distributed and (ii) the amount of such proceeds.
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<PAGE>
The Depositary, pursuant to the Deposit Agreement, may own and deal in any
class of securities of the Company and its affiliates and in ADRs.
LIABILITY OF OWNERS OR BENEFICIAL OWNERS FOR TAXES OR OTHER CHARGES
If any tax or other governmental charge shall become payable by the
Custodian, the Depositary or its nominee with respect to any ADR or any
Deposited Securities represented by the ADSs evidenced by such ADR, such tax
or other governmental charge will be payable by the Owner or Beneficial Owner
of such ADR. The Depositary may refuse to effect registration of transfer of
such ADR or any split-up or combination thereof or any withdrawal of Deposited
Securities underlying such ADR until such payment is made, and may withhold
any dividends or other distributions or may sell for the account of such Owner
or Beneficial Owner any part or all of the Deposited Securities underlying
such ADR and may apply such dividends or distributions or the proceeds of any
such sale in payment of any such tax or other governmental charge (and any
taxes or expenses arising out of such sale) and the Owner or Beneficial Owner
of such ADR will remain liable for any deficiency.
LIMITATION ON EXECUTION, DELIVERY, TRANSFER AND SURRENDER OF ADRS
The ADRs are transferable on the books of the Depositary, provided that the
Depositary may close the transfer books after consultation with the Registrant
to the extent practicable at any time or from time to time when deemed
expedient by it in connection with the performance of its duties or at the
request of the Registrant.
As a condition precedent to the execution and delivery, registration of
transfer, split-up, combination or surrender of any ADR, the delivery of any
distribution thereon or the withdrawal of Deposited Securities, the
Depositary, the Registrant, the Custodian or the Registrar may require payment
from the depositor of Preferred Shares or the presenter of the ADR of a sum
sufficient to reimburse it for any tax or other governmental charge and any
stock transfer or registration fee with respect thereto (including any such
tax, charge or fee with respect to Preferred Shares being deposited or
withdrawn) and payment of any other applicable fees provided for in the
Deposit Agreement. The Depositary may refuse to deliver ADRs, register the
transfer of any ADR or make any distribution of, or related to, the Preferred
Shares until it has received such proof of citizenship, residence, exchange
control approval, compliance with all applicable laws or regulations, or other
information as it may reasonably deem necessary or proper. The delivery,
transfer, registration of transfer, split-up, combination and surrender of
ADRs generally may be suspended or refused during any period when the transfer
books of the Depositary, the Registrant or the Registrar are closed or if any
such action is deemed necessary or advisable by the Depositary or the
Registrant, at any time or from time to time.
The Depositary will keep books, at its Corporate Trust Office, for the
registration and transfer of ADRs, which at all reasonable times will be open
for inspection by the Owners, provided that such inspection will not be for
the purpose of communicating with Owners in the interest of a business or
object other than the business of the Registrant or a matter related to the
Deposit Agreement or the ADRs.
The Depositary may upon notice to the Registrant appoint one or more co-
transfer agents reasonably acceptable to the Registrant for the purpose of
effecting transfers, combinations and split-ups of ADRs at designated transfer
offices on behalf of the Depositary. In carrying out its functions, a co-
transfer agent may require evidence of authority and compliance with
applicable laws and other requirements by Owners or persons entitled to ADRs
and will be entitled to protection and indemnity to the same extent as the
Depositary.
LIMITATION OF LIABILITY
Neither the Depositary nor the Registrant nor any of their respective
directors, employees, agents or affiliates will be liable to any Owners or
Beneficial Owners of ADRs if by reason of any provision of any present or
future law or regulation of the United States, Brazil or any other country, or
of any other governmental or regulatory authority or stock exchange, or by
reason of any provision, present or future, of the By-laws, or by reason of
any act of God or war or other circumstance beyond its control, the Depositary
or the Registrant or any of their respective directors, employees, agents, or
affiliates shall be prevented, delayed or forbidden from,
77
<PAGE>
or be subject to any civil or criminal penalty on account of, doing or
performing any act or thing which by terms of the Deposit Agreement it is
provided will be done or performed; nor will the Depositary or the Registrant
incur any liability to any Owner or Beneficial Owner of any ADR by reason of
any nonperformance or delay, caused as aforesaid, in the performance of any
act or thing which by the terms of the Deposit Agreement it is provided will
or may be done or performed, or by reason of any exercise of, or failure to
exercise, any discretion provided for under the Deposit Agreement. Where, by
the terms of a distribution pursuant to the Deposit Agreement, or an offering
or distribution pursuant to the Deposit Agreement, or for any other reason,
the Depositary is prevented or prohibited from making such distribution or
offering available to Owners, and the Depositary is prevented or prohibited
from making such distribution or offering on behalf of such Owners and making
the net proceeds available to such Owners, then the Depositary, after
consultation with the Registrant, will not make such distribution or offering,
and will allow the rights, if applicable, to lapse.
The Registrant and the Depositary assume no obligation nor will they be
subject to any liability under the Deposit Agreement to Owners or Beneficial
Owners of ADRs, except that they agree to perform their respective obligations
specifically set forth under the Deposit Agreement without negligence or bad
faith.
GOVERNING LAW
The Deposit Agreement is governed by the laws of the State of New York.
78
<PAGE>
PART III
ITEM 15: DEFAULTS UPON SENIOR SECURITIES
The Company is party to certain credit agreements that contain covenants
restricting, among other things, (i) the ability of Telebras to dispose of all
or a substantial part of its assets or to cease to control a company that was
an operating subsidiary of the Telebras System and (ii) the ability of the
Federal Government to dispose of its controlling interest in the Telebras
System. The Breakup of Telebras on May 22, 1998, the privatization of the New
Holding Companies on July 29, 1998 and the announced liquidation of Telebras
constitute events of default under such credit agreements. In addition, most
of the Company's other credit agreements include cross-default provisions and
cross-acceleration provisions that would permit the holders of such
indebtedness to declare the indebtedness to be in default and to accelerate
the maturity thereof if a significant portion of the principal amount of the
Company's debt is in default or accelerated. The total amount of the Company's
outstanding debt as of December 31, 1997 which is currently or expected to be
in default is approximately R$45.9 million. The Company is currently in
negotiations with its third-party creditors with respect to this indebtedness.
Although none of the Company's creditors has notified the Company that it
intends to pursue its rights and remedies with respect to these defaults,
there can be no assurance that the Company will be able to obtain waivers or
that the creditors will not exercise their rights and remedies under the
credit agreements.
ITEM 16: CHANGES IN SECURITIES AND CHANGES IN SECURITY FOR REGISTERED
SECURITIES
Not applicable.
PART IV
ITEM 17: CONSOLIDATED FINANCIAL STATEMENTS
The Registrant has responded to Item 18 in lieu of responding to this Item.
ITEM 18: CONSOLIDATED FINANCIAL STATEMENTS
Reference is made to pages F-1 through F-44.
ITEM 19: CONSOLIDATED FINANCIAL STATEMENTS AND EXHIBITS
(a) The following Financial Statements are filed as part of this Form 20-F:
Independent Auditors' Report
Consolidated Balance Sheets as of December 31, 1996 and 1997
Consolidated Statements of Income for the Years Ended December 31, 1995,
1996 and 1997
Consolidated Statements of Cash Flows for the Years Ended December 31,
1995, 1996 and 1997
Consolidated Statements of Changes in Shareholders' Equity for the Years
Ended December 31, 1995, 1996 and 1997
Notes to the Consolidated Financial Statements
(b) Exhibits
1.1* Charter of the Registrant
1.2* Charter of the Registrant (English translation)
2.1* Deposit Agreement dated as of July 27, 1998 among the Registrant,
The Bank of New York, as Depositary, and Owners and Beneficial
Owners of American Depositary Receipts issued thereunder
10.1* Standard Concession Agreement for Local, Switched, Fixed-Line
Telephone Service and Schedule of Omitted Concession Agreements
79
<PAGE>
10.2* Standard Concession Agreement for Local, Switched, Fixed-Line
Telephone Service and Schedule of Omitted Concession Agreements
(English translation)
10.3* Standard Concession Agreement for Domestic Long-Distance,
Switched, Fixed-Line Telephone Service and Schedule of Omitted
Concession Agreements
10.4* Standard Concession Agreement for Domestic Long-Distance,
Switched, Fixed-Line Telephone Service and Schedule of Omitted
Concession Agreements (English translation)
23.1** Consent of KPMG Peat Marwick
--------
* Previously filed
** Filed herewith
80
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 12 of the Securities Exchange Act of
1934, the Registrant certifies that it meets all of the requirements for
filing on Form 20-F and has duly caused this amendment to its registration
statement on Form 20-F, Commission File No. 001-14477, to be signed on its
behalf by the undersigned, thereunto duly authorized.
Tele Centro Sul Participacoes S.A.
/s/ Ari Joaquim da Silva
By:__________________________________
Name: Ari Joaquim da Silva
Title: President
/s/ Giorgio Bampi
By: _________________________________
Name: Giorgio Bampi
Title: Support Executive Officer
Dated: November 2, 1998
81
<PAGE>
TELE CENTRO SUL PARTICIPACOES S.A.
CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
CONTENTS
<TABLE>
<S> <C>
Independent Auditors' Report.................................. F-2
Consolidated Balance Sheets................................... F-3
Consolidated Statements of Income............................. F-5
Consolidated Statements of Cash Flows......................... F-6
Consolidated Statements of Changes in Shareholders' Equity.... F-7
Notes to the Consolidated Financial Statements................ F-8 through F-44
</TABLE>
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders
Tele Centro Sul Participacoes S.A.
Brasilia--DF
We have audited the accompanying consolidated balance sheets of Tele Centro
Sul Participacoes S.A. as of December 31, 1996 and 1997, and the related
consolidated statements of income, cash flows and changes in shareholders'
equity for each of the years in the three-year period ended December 31, 1997.
These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards in Brazil, which do not differ in any material respects from
generally accepted auditing standards in the United States of America. Those
standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence
supporting amounts and disclosures in the consolidated financial statements.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Tele
Centro Sul Participacoes S.A. as of December 31, 1996 and 1997, and the
results of its operations and cash flows for each of the years in the three-
year period ended December 31, 1997, in conformity with accounting principles
generally accepted in Brazil, including continued recognition of the effects
of changes in the purchasing power of the Brazilian currency as discussed in
Note 2.
Generally accepted accounting principles in Brazil vary in certain respects
from generally accepted accounting principles in the United States of America.
Application of generally accepted accounting principles in the United States
of America would have affected results of operations for each of the years in
the two-year period ended December 31, 1997 and shareholders' equity as of
December 31, 1996 and 1997 to the extent summarized in Note 29 of the
consolidated financial statements.
July 17, 1998
Brasilia, Brazil
KPMG Peat Marwick
F-2
<PAGE>
TELE CENTRO SUL PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
CONSOLIDATED BALANCE SHEETS
AS AT DECEMBER 31, 1996 AND 1997
(IN THOUSANDS OF CONSTANT BRAZILIAN REAIS--R$ OF DECEMBER 31, 1997 AND
THOUSANDS OF US DOLLARS--US$)
<TABLE>
<CAPTION>
DECEMBER 31
---------------------------------
1996 1997 1997
NOTE R$ R$ US$
---- --------- --------- -------------
UNAUDITED
(SEE NOTE 2B)
<S> <C> <C> <C> <C>
Current assets:
Cash and cash equivalents:
Deposits with Banco do Brasil S.A. .... 24 234,956 138,239 123,826
Other cash and cash equivalents........ 10 29,235 25,041 22,430
Accounts receivable:
Trade, net............................. 11 328,816 379,297 339,750
Receivable from related parties........ 24 9,033 6,941 6,217
Deferred and recoverable taxes.......... 12 67,327 114,232 102,322
Other assets:
Other accounts receivable from related
parties............................... 24 1,854 1,998 1,790
Other.................................. 13 81,897 71,495 64,040
--------- --------- ---------
Total current assets................... 753,118 737,243 660,375
--------- --------- ---------
Noncurrent assets:
Deferred and recoverable taxes......... 12 56,084 64,097 57,414
Other.................................. 13 50,404 83,998 75,240
--------- --------- ---------
Total noncurrent assets................ 106,488 148,095 132,654
--------- --------- ---------
Permanent assets:
Investments............................ 14 23,149 28,690 25,699
Property, plant and equipment, net..... 15 5,963,131 6,444,519 5,772,590
--------- --------- ---------
Total permanent assets................. 5,986,280 6,473,209 5,798,289
--------- --------- ---------
Net assets of discontinued operations... 2d 684,261 1,122,409 1,005,382
--------- --------- ---------
Total assets........................... 7,530,147 8,480,956 7,596,700
--------- --------- ---------
</TABLE>
See the accompanying notes to the consolidated financial statements.
F-3
<PAGE>
TELE CENTRO SUL PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
CONSOLIDATED BALANCE SHEETS--(CONTINUED)
AS AT DECEMBER 31, 1996 AND 1997
(IN THOUSANDS OF CONSTANT BRAZILIAN REAIS--R$ OF DECEMBER 31, 1997 AND
THOUSANDS OF US DOLLARS--US$)
<TABLE>
<CAPTION>
DECEMBER 31
---------------------------------
1996 1997 1997
NOTE R$ R$ US$
------ --------- --------- -------------
UNAUDITED
(SEE NOTE 2B)
<S> <C> <C> <C> <C>
Current liabilities:
Payroll and related accruals......... 16 106,973 102,117 91,470
Accounts payable and accrued
expenses:
Payable to related parties.......... 24 31,062 30,522 27,339
Other............................... 173,575 149,288 133,723
Taxes other than income taxes........ 17 105,982 138,449 124,014
Income taxes......................... 8 87,726 48,733 43,652
Dividends:
Payable to Telebras................. 18, 24 137,317 139,748 125,177
Other............................... 18 33,120 65,127 58,337
Loans and financing:
Payable to Telebras................. 24 64,649 95,748 85,765
Other financing..................... 19 39,542 14,666 13,137
Provisions for contingencies......... 20 82,012 102,190 91,535
Other liabilities:
Due to related parties.............. 24 8,748 4,189 3,752
Other liabilities................... 17,826 25,606 22,936
--------- --------- ---------
Total current liabilities........... 888,532 916,383 820,837
--------- --------- ---------
Noncurrent liabilities:
Income taxes......................... 8 169,022 255,879 229,200
Loans and financing:
Payable to Telebras................. 19, 24 47,466 152,748 136,821
Other financing..................... 19 94,888 31,246 27,989
Provision for pensions............... 21 123,044 127,887 114,553
Provisions for contingencies......... 20 23,286 25,247 22,615
Other liabilities.................... 809 891 798
--------- --------- ---------
Total noncurrent liabilities........ 458,515 593,898 531,976
--------- --------- ---------
Minority interests................... 2 863,798 1,375,041 1,231,675
--------- --------- ---------
Shareholders' equity:
Capital and reserves................ 3,996,807 4,221,163 3,781,048
Retained earnings................... 971,847 1,189,663 1,065,625
--------- --------- ---------
Total shareholders' equity........... 22 4,968,654 5,410,826 4,846,673
--------- --------- ---------
Funds for capitalization:
Expansion plan contributions........ 347,358 173,876 155,747
Other funds......................... 3,290 10,932 9,792
--------- --------- ---------
Total funds for capitalization...... 350,648 184,808 165,539
--------- --------- ---------
Total liabilities and shareholders'
equity............................. 7,530,147 8,480,956 7,596,700
========= ========= =========
</TABLE>
See the accompanying notes to the consolidated financial statements.
F-4
<PAGE>
TELE CENTRO SUL PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
(IN THOUSANDS OF CONSTANT BRAZILIAN REAIS--R$ OF DECEMBER 31, 1997 AND
THOUSANDS OF US DOLLARS--US$)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31
------------------------------------------------
1995 1996 1997 1997
NOTE R$ R$ R$ US$
---- --------- ---------- ---------- -------------
UNAUDITED
(SEE NOTE 2B)
<S> <C> <C> <C> <C> <C>
Net operating revenue
from telecommunication
services:
Services provided to
third parties......... 4 1,502,152 1,911,907 2,120,516 1,899,423
Services provided to
the Telebras operating
companies............. 24 91,549 168,068 235,096 210,584
--------- ---------- ---------- ----------
1,593,701 2,079,975 2,355,612 2,110,007
Cost of services:
Provided by third
parties............... 5 (930,219) (1,001,786) (1,049,429) (940,011)
Provided by the
Telebras operating
companies............. 24 (67,413) (109,310) (189,562) (169,798)
--------- ---------- ---------- ----------
(997,632) (1,111,096) (1,238,991) (1,109,809)
--------- ---------- ---------- ----------
Gross profit............. 596,069 968,879 1,116,621 1,000,198
Operating expenses:
Selling expense........ (153,870) (174,079) (229,555) (205,621)
General and
administrative
expense............... (318,507) (351,471) (380,776) (341,075)
Other net operating
income................ 6 94,512 130,839 148,326 132,861
--------- ---------- ---------- ----------
Operating income from
continuing operations
before interest
income/expense ......... 218,204 574,168 654,616 586,363
Allocated interest
expense................. (17,697) (10,125) (34,864) (31,229)
--------- ---------- ---------- ----------
Operating income from
continuing operations
before unallocated
interest income/expense
........................ 200,507 564,043 619,752 555,134
Net nonoperating
expense................. 7 (1,348) (16,433) (25,094) (22,478)
Employees' profit share.. (8,475) (17,068) (26,524) (23,759)
--------- ---------- ---------- ----------
Income from continuing
operations, before
unallocated interest
income/expense, taxes
and minority interests
........................ 190,684 530,542 568,134 508,897
Income from discontinued
cellular operations,
before unallocated
interest income/expense,
taxes and
minority interests...... 2d 149,135 297,274 341,636 306,016
Unallocated interest
income.................. 40,418 60,612 61,913 55,458
Unallocated interest
expense................. (3,678) (1,488) (2,870) (2,571)
--------- ---------- ---------- ----------
Income before taxes and
minority interests...... 376,559 886,940 968,813 867,800
Income and social
contribution taxes...... 8 (164,519) (231,713) (266,949) (239,116)
--------- ---------- ---------- ----------
Income before minority
interests............... 212,040 655,227 701,864 628,684
Minority interests....... 2c (26,910) (92,925) (138,599) (124,148)
--------- ---------- ---------- ----------
Net income............... 185,130 562,302 563,265 504,536
========= ========== ========== ==========
</TABLE>
See the accompanying notes to the consolidated financial statements.
F-5
<PAGE>
TELE CENTRO SUL PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
(IN THOUSANDS OF CONSTANT BRAZILIAN REAIS--R$ OF
DECEMBER 31, 1997 AND THOUSANDS OF US DOLLARS--US$)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31
------------------------------------------------
1995 1996 1997 1997
R$ R$ R$ US$
-------- ---------- ---------- --------------
UNAUDITED
(SEE NOTE 2B)
<S> <C> <C> <C> <C>
OPERATING ACTIVITIES:
Net income.................... 185,130 562,302 563,265 504,536
Less: Income from discontinued
cellular operations before
unallocated interest
income/expense, taxes and
minority interests........... (149,135) (297,274) (341,636) (306,016)
-------- ---------- ---------- ----------
Income from continuing
operations, net of
unallocated interest
income/expense and taxes
applicable to both continuing
and discontinued operations.. 35,995 265,028 221,629 198,520
Adjustments to reconcile net
income to cash provided by
operating activities:
Depreciation and
amortization................ 604,419 635,559 706,073 632,455
Minority interests........... 26,910 92,925 138,599 124,148
Loss (gain) on permanent
asset disposals............. (19,117) 4,871 20,751 18,587
Other provisions............. 4,909 1,451 4,457 3,992
Allowance for doubtful
accounts.................... 2,613 6,860 31,216 27,961
(Increase) decrease in income
tax rate.................... 24,438 2,286 13,241 11,860
(Increase) decrease in trade
accounts receivable, gross.. (6,810) (67,739) (79,605) (71,305)
(Increase) decrease in other
current assets.............. (21,687) (26,036) 10,258 9,188
(Increase) decrease in other
noncurrent assets........... (230) (20,607) 5,027 4,503
Increase (decrease) in
payroll and related
accruals.................... 20,406 (1,092) (4,856) (4,350)
Increase (decrease) in
accounts payable and accrued
expenses.................... (4,715) 97,180 (24,827) (22,238)
Increase (decrease) in taxes
other than income taxes..... 13,808 16,923 32,467 29,082
Increase (decrease) in other
current liabilities......... 2,376 6,829 3,221 2,885
Increase (decrease) in
accrued interest............ (13,148) 4,056 9,492 8,502
Increase (decrease) in income
taxes....................... 25,425 (71,356) (127,662) (114,351)
Increase (decrease) in
provisions for
contingencies............... (838) 33,425 22,139 19,831
Increase (decrease) in
provision for pensions...... 13,007 1,173 4,843 4,338
Increase (decrease) in other
noncurrent liabilities...... (6,728) 293 82 73
-------- ---------- ---------- ----------
701,033 982,029 986,545 883,681
-------- ---------- ---------- ----------
INVESTING ACTIVITIES:
Additions to investments...... 3,515 6,863 (3,825) (3,426)
Additions to property, plant
and equipment................ (905,879) (1,098,656) (1,125,019) (1,007,720)
Capitalized interest.......... (4,239) (251) -- --
Proceeds from asset
disposals.................... 42,509 23,554 44,696 40,036
-------- ---------- ---------- ----------
(864,094) (1,068,490) (1,084,148) (971,110)
-------- ---------- ---------- ----------
FINANCING ACTIVITIES:
Loans repaid.................. (152,943) (125,279) (157,559) (141,131)
New loans obtained............ 96,384 178,389 195,930 175,502
Expansion plan contributions
received..................... 323,250 240,952 222,585 199,377
Dividends paid................ (101,203) (89,456) (157,226) (140,833)
-------- ---------- ---------- ----------
165,488 204,606 103,730 92,915
-------- ---------- ---------- ----------
Increase in cash and cash
equivalents from continuing
operations................... 2,427 118,145 6,127 5,486
Net cash used in discontinued
operations, before
unallocated interest
income/expense and taxes..... (5,344) (22,945) (107,038) (95,878)
Cash and cash equivalents at
beginning of year............ 171,908 168,991 264,191 236,648
-------- ---------- ---------- ----------
Cash and cash equivalents at
end of year.................. 168,991 264,191 163,280 146,256
======== ========== ========== ==========
</TABLE>
See the accompanying notes to the consolidated financial statements.
F-6
<PAGE>
TELE CENTRO SUL PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
(IN THOUSANDS OF CONSTANT BRAZILIAN REAIS--R$ OF DECEMBER 31, 1997)
<TABLE>
<CAPTION>
CAPITAL
AND RETAINED
RESERVES EARNINGS TOTAL
--------- --------- ---------
<S> <C> <C> <C>
Balances at December 31, 1994.................. 3,270,969 645,229 3,916,198
Capital increase:
Expansion plan contributions................. 166,218 -- 166,218
Cash from Telebras........................... 21,648 -- 21,648
Other cash................................... 15,765 -- 15,765
Donations and subsidies for investments........ 16,103 -- 16,103
Interest on construction in progress........... 87,959 -- 87,959
Change in tax rates............................ 24,438 -- 24,438
Fiscal incentives.............................. 15,433 -- 15,433
Forfeited dividends............................ -- (292) (292)
Net income..................................... -- 185,130 185,130
Realization of unrealized income............... (42,380) 42,380 --
Transfers...................................... 117,362 (117,362) --
Dividends...................................... -- (93,391) (93,391)
Minority interest movements.................... (32,801) 26,120 (6,681)
--------- --------- ---------
Balances at December 31, 1995.................. 3,660,714 687,814 4,348,528
Capital increase:
Expansion plan contributions................. 232,446 -- 232,446
Cash from Telebras........................... 8,105 -- 8,105
Other cash................................... 16,806 -- 16,806
Donations and subsidies for investments........ 9,696 -- 9,696
Interest on construction in progress........... 137,617 -- 137,617
Change in tax rates............................ (3,085) 5,371 2,286
Fiscal incentives.............................. 21,936 -- 21,936
Forfeited dividends............................ -- (69) (69)
Net income..................................... -- 562,302 562,302
Deferred tax on full indexation................ -- (159,593) (159,593)
Realization of unrealized income............... (32,797) 32,043 (754)
Transfers...................................... 32,432 (32,432) --
Dividends...................................... -- (161,770) (161,770)
Minority interest movements.................... (87,063) 38,181 (48,882)
--------- --------- ---------
Balances at December 31, 1996.................. 3,996,807 971,847 4,968,654
Capital increase:
Expansion plan contributions................. 348,098 -- 348,098
Cash from Telebras........................... 1,564 -- 1,564
Other cash................................... 38,763 -- 38,763
Donations and subsidies for investments........ 20,301 -- 20,301
Interest on construction in progress........... 126,601 -- 126,601
Change in tax rates............................ 13,241 -- 13,241
Fiscal incentives.............................. 44,794 -- 44,794
Forfeited dividends............................ -- 1,187 1,187
Net income..................................... -- 563,265 563,265
Deferred tax on full indexation................ -- (150,147) (150,147)
Realization of unrealized income............... (26,864) 26,864 --
Transfers...................................... 35,789 (35,789) --
Dividends...................................... -- (192,851) (192,851)
Minority interest movements.................... (377,931) 5,287 (372,644)
--------- --------- ---------
Balances at December 31, 1997.................. 4,221,163 1,189,663 5,410,826
========= ========= =========
</TABLE>
See the accompanying notes to the consolidated financial statements.
F-7
<PAGE>
TELE CENTRO SUL PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Amounts expressed in thousands of constant Brazilian reais of December 31,
1997)
1. OPERATIONS AND BACKGROUND
Beginning in 1995, the federal government of Brazil (the "Federal
Government") undertook a comprehensive reform of the telecommunications
industry. In July, 1995 the Federal Congress adopted a General
Telecommunications Law providing for the privatization of Telecomunicacoes
Brasileiras S.A. ("Telebras") which, through its 28 operating subsidiaries,
was the primary supplier of public telecommunications services in Brazil.
In preparation for the privatization of the Telebras system, the operating
subsidiaries have been divided into twelve separate groups, (a) three regional
fixed line operators, (b) eight regional cellular operators and (c) one
national long-distance operator. The cellular telecommunications businesses
have firstly been separated from the operating subsidiaries and subsequently
the fixed-line businesses, the new cellular businesses and the long-distance
operator have been combined into the twelve separate groups. Both the
separation of the cellular businesses and the subsequent grouping of the
former Telebras subsidiaries have been performed using a procedure under
Brazilian corporate law called cisao or "spin-off". As part of this process
Tele Centro-Sul Participacoes S.A. (the "Holding Company") was formed.
The Holding Company was formed on May 22, 1998, through the spin-off of
certain assets and liabilities of Telebras, including the percentages of
participation in the share capital of the following companies (collectively
referred to as "the Subsidiaries"):
<TABLE>
<CAPTION>
MINORITY
INTEREST
PARTICIPATION PERCENTAGE
------------- ----------
<S> <C> <C>
Telecomunicacoes de Santa Catarina S.A. ............. 82.99% 17.01%
Telecomunicacoes de Parana S.A. ..................... 67.31% 32.69%
Companhia Telefonica Melhoramento e Resistencia
S.A. ............................................... 78.56% 21.44%
Telecomunicacoes de Goias S.A. ...................... 83.77% 16.23%
Telecomunicacoes do Mato Grosso do Sul S.A. ......... 96.01% 3.99%
Telecomunicacoes do Mato Grosso S.A. ................ 91.87% 8.13%
Telecomunicacoes de Rondonia S.A. ................... 91.31% 8.69%
Telecomunicacoes do Acre S.A. ....................... 93.98% 6.02%
Telecomunicacoes de Brasilia S.A. ................... 81.40% 18.60%
</TABLE>
Until August 4, 1998, the Companies were controlled by the Federal
Government (see Note 28).
Tele Centro Sul Participacoes S.A. and its subsidiaries (the "Companies")
are the principal providers of fixed-line telecommunications services in the
states of Santa Catarina, Parana, Goias, Tocantins, Mato Grosso do Sul, Mato
Grosso, Rondonia, Acre, the Federal District and in the region of Pelotas in
the state of Rio Grande do Sul under the terms of a concession to be granted
by the Federal Government which will expire on December 31, 2005 and may be
renewed for a further term of 20 years.
On January 30, 1998 the cellular telecommunications businesses of the
Companies were spun off into nine new companies (the "Cellular Companies"),
effective January 1, 1998.
The Companies' business, including the services they may provide and the
rates they charge, is regulated by Agencia Nacional de Telecomunicacoes
(Anatel), the regulatory authority for the Brazilian telecommunications
industry pursuant to Law No. 9,472 of July 16, 1997 and the related
regulations, decrees, orders and plans.
F-8
<PAGE>
TELE CENTRO SUL PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of constant Brazilian reais of December 31,
1997)
2. PRESENTATION OF THE FINANCIAL STATEMENTS
The consolidated financial statements reflect the financial condition and
results of operations of Tele Centro Sul Participacoes S.A. and its
subsidiaries. The portion of equity and net income attributable to
shareholders other than Telebras at December 31, 1996 and 1997, and for each
of the years in the three year period ended December 31, 1997 is reflected as
"minority interests". At December 31, 1997, such minority shareholders
participated in the share capital of the Companies at various percentages
between 3.99% and 32.69% (see Note 1).
The fixed line telecommunications business of the Companies is presented as
continuing operations and the cellular telecommunications business is
presented as discontinued operations for all periods. The assets and
liabilities of the cellular telecommunications business are presented as net
assets of discontinued operations. The formation of the Holding Company and
the transfer of assets and liabilities from the Companies to the Cellular
Companies have been accounted for as a reorganization of entities under common
control in a manner similar to a pooling of interests.
The assets and liabilities of the cellular telecommunications businesses
were transferred to the nine newly formed Cellular Companies at their indexed
historical cost. The associated revenues and expenses were also allocated to
the respective regional cellular companies. The consolidated financial
statements are not necessarily indicative of the financial position and
results of operations that would have occurred for the three-year period ended
December 31, 1997 had the fixed-line telecommunications businesses of the
Companies been separate legal entities during such period.
As separate records of revenues and costs of services were maintained for
the cellular business, 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
for certain transport costs. Management believes that the amounts included in
the consolidated financial statements fairly reflect the operating results of
the business.
Prior to December 31, 1997 cash and certain non-specific debt of the
cellular telecommunications business could not be segregated from the
Companies. Accordingly, these amounts are included in the combined financial
statements for periods ended before January 1, 1998. As a result, certain
interest income and expense relating to the cellular telecommunications
business could not be identified and consequently, income from discontinued
operations is presented before unallocated interest income/expense and taxes.
The presentation of the consolidated financial statements is consistent with
the presentation of the published financial statements of the Companies, from
which the accompanying financial information was extracted, except for certain
reclassifications within the Consolidated Balance Sheets and the Consolidated
Statements of Income which have been made to conform to previously published
financial information to the 1997 presentation within this registration
statement, for the presentation of the cellular businesses of the Companies as
discontinued operations and to reflect the portion of equity and net income
attributable to shareholders other than Telebras as minority interests.
Furthermore, the accompanying financial statements include an additional
provision for
F-9
<PAGE>
TELE CENTRO SUL PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of constant Brazilian reais of December 31,
1997)
doubtful debts of R$11,400, additional provisions for the Telepar
supplementary pension plan (See Note 21) of R$11,077 and the resulting effect
on deferred income taxes. This additional provision resulted from a
reevalution of the Company's probable losses in relation to trade accounts
receivable at December 31, 1997 in the light of the collection experience for
the first quarter of 1998. The Companies will not restate their previously
reported results as the provision for doubtful debts recorded in their
December 31, 1997 financial statements was considered adequate in the light of
information available at the date on which they were published.
The accompanying consolidated financial statements were prepared on a fully
indexed basis to recognize the effects of changes in the purchasing power of
the Brazilian currency during the periods presented.
A. FULL INDEXATION TO DECEMBER 31, 1997
The principal criteria adopted to prepare the fully indexed consolidated
financial statements maintained in accordance with the practices described in
Note 3, are as follows:
i. Inflation restatement index
The consolidated financial statements were indexed and expressed in currency
of constant purchasing power of December 31, 1997 by using the monthly average
values of the Unidade Fiscal de Referencia (the Tax Reference Unit or "UFIR")
through December 31, 1995 and the Indice Geral de Precos-Mercado (the General
Prices Index-Market or the "IGP-M") of the Fundacao Getulio Vargas in 1996 and
1997 following the cessation of the widespread use of the UFIR that resulted
from the change in Brazil's corporate law. Inflation for the three year period
ended December 31, 1997, as measured by the UFIR and the IGP-M, was as
follows:
<TABLE>
<CAPTION>
ANNUAL
PERIOD INDEX INFLATION
------ ----- ---------
%
<S> <C> <C>
Year ended December 31, 1995................................. UFIR 22.5
Year ended December 31, 1996................................. IGP-M 9.2
Year ended December 31, 1997................................. IGP-M 7.7
</TABLE>
Management believes that these indices are appropriate indications of
general price level inflation to be used under Brazilian and US GAAP, for the
years indicated.
In July 1997, the three-year cumulative inflation rate for Brazil fell below
100%. However, for accounting purposes, the constant currency method continued
to be applied through December 31, 1997. The Brazilian Institute of
Accountants has not yet published definitive rules regarding when the constant
currency method of accounting may no longer be used to prepare financial
statements. If the Brazilian Institute of Accountants determines that the
constant currency method may no longer be used to prepare financial statements
beginning January 1, 1998, the restated balances of non-monetary assets and
liabilities of the Companies as of December 31, 1997 will become the new basis
for accounting, and income statement items will no longer be restated for
inflation.
ii. Consolidated statements of income
Items in the consolidated statements of income are adjusted to the balance
sheet date by:
. allocating inflationary holding gains or losses on interest bearing
monetary assets and liabilities to their corresponding interest income
and expense captions;
F-10
<PAGE>
TELE CENTRO SUL PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of constant Brazilian reais of December 31,
1997)
. allocating inflationary holding gains and losses from other monetary
items to their corresponding income or expense captions. Amounts without
a corresponding income or expense caption were allocated to "other net
operating income".
iii. Deferred income tax effects of indexation adjustments in 1996 and 1997
As a result of legislation mandating the discontinuation of the indexation
system for Brazilian corporate law and most fiscal purposes as from January 1,
1996, the indexation of assets and liabilities for financial reporting
purposes herein is not permitted for tax purposes. Accordingly, a deferred tax
liability arises for the excess of net assets shown for financial reporting
purposes over the tax basis of these net assets. The charge relating to the
additional deferred tax liability of R$159,593 in 1996 and R$150,147 in 1997
was recorded directly against retained earnings.
B. TRANSLATION OF CONSTANT BRAZILIAN REAL AMOUNTS INTO US DOLLAR AMOUNTS
The translation of Brazilian Real amounts into US dollar amounts is
unaudited and included solely for the convenience of readers outside of Brazil
and has been performed using the closing selling exchange rate published by
the Central Bank of Brazil of R$1.1164 to US$1.00 as of December 31, 1997.
This translation should not be construed as a representation that Brazilian
Real amounts could be converted to US dollars at this or any other rate.
C. MINORITY INTERESTS
Minority interests relate to the interest of shareholders other than
Telebras in the Companies.
D. DISCONTINUED OPERATIONS
The accompanying consolidated financial statements reflect the cellular
telecommunications businesses of the Companies as discontinued operations.
Accordingly, the revenues, costs and expenses, assets and liabilities and cash
flows of these discontinued operations have been excluded from the respective
captions in the consolidated statements of income, consolidated balance sheets
and consolidated statements of cash flows and have been reported as "Income
from discontinued cellular operations before unallocated interest
income/expense, taxes and minority interest"; as "Net assets of discontinued
operations" and as "Net cash used in discontinued operations" for all periods
presented. Summarized financial information for the discontinued operations is
as follows:
<TABLE>
<CAPTION>
1995 1996 1997
------- --------- ---------
<S> <C> <C> <C>
Net operating revenues......................... 287,087 581,460 875,053
Income before unallocated interest
income/expense, taxes and minority interest... 149,135 297,274 341,636
Current assets......................................... 96,160 218,803
Property, plant and equipment, net..................... 903,374 1,151,242
Total assets........................................... 1,002,809 1,371,938
Current liabilities.................................... 142,737 70,455
Total liabilities...................................... 318,548 249,529
Net assets of discontinued operations.................. 684,261 1,122,409
</TABLE>
E. PRINCIPLES OF CONSOLIDATION
These consolidated financial statements include the financial records of the
Holding Company and its subsidiaries. All material intercompany balances and
transactions have been eliminated.
F-11
<PAGE>
TELE CENTRO SUL PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of constant Brazilian reais of December 31,
1997)
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.
B. TRADE ACCOUNTS RECEIVABLE
Accounts receivable from telephone subscribers are calculated at the tariff
rate on the date the services were rendered and discounted to their present
value at the balance sheet date by applying the interest rate published by the
National Association of Investment Bankers ("ANBID"). Customer 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 indexed cost or replacement value.
Cost of inventories is determined principally on the average cost basis.
Inventories are separated into network expansion and maintenance inventories.
Inventories for use in network expansion are classified as "Construction-in-
progress" under "Property, plant and equipment". Maintenance inventories are
classified as other current assets.
F. INVESTMENTS
Other investments, which comprise items held to maturity or for investment
purposes, are recorded at indexed cost, less a provision for losses when
considered necessary.
G. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment is stated at indexed cost. Improvements to
existing property are capitalized while maintenance and repair costs are
charged to expense as incurred. Materials allocated to specific projects are
added to construction-in-process. Depreciation is provided using the straight-
line method based on the estimated useful lives of the underlying assets as
determined by the public telecommunications service regulators. The principal
depreciation rates are shown in Note 15(b).
Interest, calculated monthly at a rate of 12% per annum on construction-in-
process, is capitalized as part of property, plant and equipment until the
asset is placed in service.
H. ACCOUNTS PAYABLE
Accounts payable to suppliers are discounted to their present value using
the ANBID interest rate.
I. VACATION PAY ACCRUAL
Cumulative vacation pay due to employees is accrued as earned.
J. INCOME AND SOCIAL CONTRIBUTION TAXES
Income and social contribution taxes comprise federal income tax and social
contribution tax. Deferred taxes are provided on temporary differences.
F-12
<PAGE>
TELE CENTRO SUL PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of constant Brazilian reais of December 31,
1997)
K. LOANS AND FINANCING
Loans and financing include accrued interest to the consolidated balance
sheet date.
L. PROVISIONS FOR CONTINGENCIES
Provisions for contingencies are based on legal advice and management's
opinion as to the likely outcome of the outstanding matters at the
consolidated balance sheet date.
M. REVENUE RECOGNITION
Revenues for all services are recognized when the service is provided.
Revenues from local services consist of line rental charges, service charges
based on the number of calls, network services, including interconnection and
leasing high-capacity lines, maintenance charges and charges for other
customer services. In 1997 revenue from local services also includes
installation fees which are recognized when the installation is complete.
Charges to customers for domestic, long-distance and international calls are
based on time, distance and use of services. Billings are monthly; unbilled
revenues from the billing date to the month end are estimated and recognized
as revenue during the month in which the service was provided. The revenues
from outgoing interregional and international long-distance calls are divided
between the Companies and Empresa Brasileira de Telecomunicacoes S.A.
("Embratel"), a subsidiary of Telebras. The Companies retain a fixed
percentage of the customer charges for outgoing interregional and
international long-distance calls and pay the balance to Embratel.
N. INTEREST INCOME
Interest income represents interest earned and gains and losses on
investments after adjusting for the effects of inflation as measured by the
variation in the inflation index. Unallocated interest income represents
interest income that could not be allocated between continuing and
discontinued operations.
O. INTEREST EXPENSE
Interest expense represents interest incurred and gains and losses on loans
and financing after adjusting for the effects of inflation as measured by the
variation in the inflation index and exchange gains and (losses) of R$6,002,
R$3,502 and R$(7,614) in 1995, 1996 and 1997, respectively. Unallocated
interest expense represents interest expense that could not be allocated
between continuing and discontinued operations.
P. RESEARCH AND DEVELOPMENT
Research and development costs are charged to expense as incurred. Total
research and development costs were R$16,102, R$16,934 and R$16,094 for 1995,
1996 and 1997, respectively.
Q. PENSION AND POST-RETIREMENT BENEFITS
The Companies sponsor a separate entity that provides pensions and other
post-retirement benefits for its employees through a multi-employer plan.
Current contributions and costs are determined actuarially and are recorded on
the accrual basis.
R. EMPLOYEE'S PROFIT SHARE
The Companies have made a provision for granting employees the right to a
share of their profits. The amount recorded is the employee's profit share
attributable to the continuing fixed-line telecommunications business.
F-13
<PAGE>
TELE CENTRO SUL PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of constant Brazilian reais of December 31,
1997)
S. EARNINGS PER THOUSAND SHARES
Earnings per thousand shares has not been calculated as the capital
structure of Tele Centro Sul Participacoes S.A. was not in place at December
31, 1997.
T. 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 Santa Catarina, Parana, Goias, Tocantins, Mato
Grosso do Sul, Mato Grosso, Rondonia, Acre, the Federal District and in the
region of Pelotas in the State of Rio Grande do Sul.
U. USE OF ESTIMATES
The preparation of the consolidated financial statements in conformity with
Brazilian and US GAAP requires management to make estimates and assumptions
relating to the reporting of assets and liabilities and the disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the period reported.
Actual results could differ from those estimates.
4. OPERATING REVENUE FROM FIXED TELECOMMUNICATIONS SERVICES
<TABLE>
<CAPTION>
1995 1996 1997
--------- --------- ---------
<S> <C> <C> <C>
Local services:
Monthly charges........................... 111,579 235,847 449,683
Measured service charges.................. 267,539 400,128 532,562
Public telephones......................... 39,076 67,267 121,948
Other..................................... 120,953 169,654 170,090
--------- --------- ---------
Total................................... 539,147 872,896 1,274,283
Non-local services
Intra-state and interstate................ 1,234,635 1,309,452 1,091,638
International............................. 78,069 74,354 65,359
--------- --------- ---------
Total................................... 1,312,704 1,383,806 1,156,997
--------- --------- ---------
Data transmission........................... 75,099 99,739 89,775
Network services............................ 149,173 344,890 524,740
Other....................................... 24,850 35,938 40,459
--------- --------- ---------
Gross operating revenues.................... 2,100,973 2,737,269 3,086,254
Value added and other indirect taxes........ (503,908) (650,518) (722,448)
Discounts................................... (3,364) (6,776) (8,194)
--------- --------- ---------
Net operating revenue....................... 1,593,701 2,079,975 2,355,612
========= ========= =========
There are no customers who contribute more than 5% of gross operating
revenues.
5. COST OF SERVICES
<CAPTION>
1995 1996 1997
--------- --------- ---------
<S> <C> <C> <C>
Depreciation and amortization............... 564,565 603,264 669,979
Personnel................................... 241,948 244,771 221,968
Materials................................... 28,833 33,027 29,933
Services.................................... 150,904 212,150 297,777
Other....................................... 11,382 17,884 19,334
--------- --------- ---------
997,632 1,111,096 1,238,991
========= ========= =========
</TABLE>
F-14
<PAGE>
TELE CENTRO SUL PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of constant Brazilian reais of December 31,
1997)
6. OTHER NET OPERATING INCOME (EXPENSE)
<TABLE>
<CAPTION>
1995 1996 1997
------- ------- -------
<S> <C> <C> <C>
Taxes other than income taxes..................... (2,205) (3,289) (1,392)
Technical and administrative services............. 9,821 12,724 25,129
Provisions for contingencies (Note 20)............ (36,694) (43,307) (37,831)
Fines and expenses recovered...................... 68,972 101,848 38,048
Other............................................. 54,618 62,863 124,372
------- ------- -------
94,512 130,839 148,326
======= ======= =======
</TABLE>
Fines and expenses recovered primarily represent penalties collected on past
due accounts receivable and recovery of sales taxes of prior periods. The
amount of penalties collected on past due accounts receivable amounted to
approximately R$55,657, R$78,026 and R$28,373 in 1995, 1996 and 1997,
respectively.
7. NET NONOPERATING EXPENSE
<TABLE>
<CAPTION>
1995 1996 1997
------- ------- -------
<S> <C> <C> <C>
Gain (loss) on disposal of permanent assets....... 19,117 (4,871) (20,751)
Other............................................. (20,465) (11,562) (4,343)
------- ------- -------
(1,348) (16,433) (25,094)
======= ======= =======
</TABLE>
8. INCOME AND SOCIAL CONTRIBUTION TAXES
As explained in Note 2, because cash and certain non specific debt was not
allocated to the cellular telecommunications business, the associated interest
income and expense was also not allocated. Consequently the Companies'
continuing operations include interest income and expense relating to
discontinued cellular operations. As a result, income tax expense and current
tax liabilities have not been allocated to the discontinued cellular
operations.
Brazilian income taxes comprise federal income tax and social contribution
tax. In 1995, 1996 and 1997 the rates for income tax were 43%, 25% and 25%
respectively, and for social contribution tax were 9.09%, 7.41% and 8.00%,
respectively. As a result of legislation enacted in 1996, the social
contribution tax in 1997 was no longer deductible from its own computation
base, nor was it deductible for income tax purposes. The changes produced a
combined statutory rate of 48.18%, 30.56% and 33.00% in 1995, 1996 and 1997,
respectively.
Deferred taxes are provided on temporary differences which include the
effects of indexation adjustments that will not give rise to deductions when
subsequently depreciated, amortized or disposed of.
In prior years the indexation adjustments to permanent assets and
shareholders' equity in accordance with the tax law gave rise to a tax
deductible expense, if the indexation of equity exceeded the indexation of
permanent assets, and to taxable income, called "inflationary profit", if the
indexation of permanent assets exceeded that of equity. In the latter case,
payment of the related tax liability could be deferred until it had been
deemed to have been realized either through depreciation or disposal of the
permanent assets in existence at the time the liability was recorded, subject
to a minimum realization rate of 10% per annum (5% per annum prior to 1995).
In 1996 and 1997, management elected to prepay income taxes on inflationary
profit that it had previously deferred. Brazilian companies making such a
prepayment in relation to 1997 were entitled to utilize an income tax rate of
10% instead of the then current rate of 25%. Similar reductions applied to the
prepayments
F-15
<PAGE>
TELE CENTRO SUL PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of constant Brazilian reais of December 31,
1997)
in 1995 and 1996. The result was a gain of R$0, R$28,342 and R$11,205 for 1995,
1996 and 1997, respectively, from the reduction in deferred tax liabilities.
The following is an analysis of the income tax expense (benefit):
<TABLE>
<CAPTION>
1995 1996 1997
------- -------- --------
<S> <C> <C> <C>
Social contribution charge...................... 36,287 66,204 79,295
Income tax...................................... 118,908 212,410 244,154
Fiscal losses................................... (1,304) (190) (2,497)
Deferred taxes.................................. 18,020 (16,418) (42,798)
Effect of rate changes on deferred tax.......... (7,392) (1,951) --
Early payment incentives........................ -- (28,342) (11,205)
------- -------- --------
Total tax expense............................. 164,519 231,713 266,949
======= ======== ========
Supplementary information regarding taxes posted directly to shareholders'
equity:
<CAPTION>
1995 1996 1997
------- -------- --------
<S> <C> <C> <C>
Deferred taxes.................................. -- (159,593) (150,147)
Effect of rate changes on deferred tax.......... 24,438 2,286 13,241
------- -------- --------
24,438 (157,307) (136,906)
======= ======== ========
</TABLE>
The following is a reconciliation of the amount calculated by applying the
combined statutory tax rates to the reported income before taxes and the
reported income tax expense:
<TABLE>
<CAPTION>
1995 1996 1997
------- ------- -------
<S> <C> <C> <C>
Income before taxes as reported in the
accompanying financial statements.............. 376,559 886,940 968,813
======= ======= =======
Tax charge at the combined statutory rate....... 181,426 271,049 319,708
Permanent additions:
Non-deductible expenses....................... 1,901 5,463 6,189
Employee's profit share....................... 4,083 5,215 8,753
Permanent exclusions:
Payments of dividends to shareholders
characterized as distribution of interest.... -- -- (38,657)
Tax exempt income............................. (126) (538) (2,715)
Capitalized interest.......................... (2,305) (3,283) (2,507)
Other items:
Utilizations of tax net operating losses...... -- (6,606) --
Effect of rate changes on deferred tax........ (7,392) (1,951) --
Early payment incentives...................... -- (28,342) (11,205)
Other incentives.............................. (3,039) (6,710) (1,241)
Other, net.................................... (10,029) (2,584) (11,376)
------- ------- -------
Income and social contribution taxes as reported
in the accompanying financial statements....... 164,519 231,713 266,949
======= ======= =======
Effective rate.................................. 43.7% 26.1% 27.6%
======= ======= =======
</TABLE>
F-16
<PAGE>
TELE CENTRO SUL PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of constant Brazilian reais of December 31,
1997)
In 1997, the Company characterized part of its dividends proposed for
payment at the end of 1997 as interest on shareholders' funds. As a result,
under Brazilian tax law, it was entitled to treat this part of the dividend as
a deduction for income tax purposes.
The composition of deferred tax assets and liabilities, based on temporary
differences, is as follows:
<TABLE>
<CAPTION>
1996 1997
------- -------
<S> <C> <C>
DEFERRED TAX ASSETS:
Provisions for contingencies............................... 33,734 40,864
Provision for pensions..................................... 42,413 41,286
Others..................................................... 4,937 32,339
------- -------
Total (see Note 12)........................................ 81,084 114,489
======= =======
DEFERRED TAX LIABILITIES:
Additional indexation expense from pre-1990................ 29,837 23,693
Others..................................................... 146,275 255,613
------- -------
Total...................................................... 176,112 279,306
======= =======
</TABLE>
All of the other deferred tax liabilities relate to the difference between
the tax basis of permanent assets, which was not indexed for inflation
subsequent to December 31, 1995, and the reporting basis, which includes
indexation through December 31, 1997.
The composition of tax liabilities is as follows:
<TABLE>
<CAPTION>
1996 1997
------- -------
<S> <C> <C>
Social contribution tax payable.............................. 29,068 16,339
Federal income tax payable................................... 51,568 8,967
Deferred tax liabilities..................................... 176,112 279,306
------- -------
Total...................................................... 256,748 304,612
======= =======
Current...................................................... 87,726 48,733
Non-current.................................................. 169,022 255,879
</TABLE>
9. CASH FLOW INFORMATION
<TABLE>
<CAPTION>
1995 1996 1997
------- ------- -------
<S> <C> <C> <C>
Income and social contribution tax paid............. 102,448 236,580 364,597
Interest paid....................................... 19,850 7,515 20,631
Cash paid against provisions for contingencies...... 18,759 4,291 7,846
Non cash transactions:
Fiscal incentive investment credits received...... 19,564 47,611 37,936
Donations received of property, plant and
equipment........................................ 16,103 9,696 20,301
Conversion of capitalizable funds into share
capital and share premium........................ 166,218 232,446 348,098
</TABLE>
10. CASH AND CASH EQUIVALENTS
<TABLE>
<CAPTION>
1996 1997
------ ------
<S> <C> <C>
Cash........................................................... 853 324
Bank accounts.................................................. 28,382 24,717
------ ------
29,235 25,041
====== ======
</TABLE>
F-17
<PAGE>
TELE CENTRO-SUL PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of constant Brazilian reais of December 31,
1997)
11. TRADE ACCOUNTS RECEIVABLE, NET
<TABLE>
<CAPTION>
1996 1997
------- -------
<S> <C> <C>
Accrued amounts............................................ 149,347 170,831
Billed amounts............................................. 183,474 230,872
Allowance for doubtful accounts............................ (4,005) (22,406)
------- -------
328,816 379,297
======= =======
</TABLE>
The changes in the allowance for doubtful accounts were as follows:
<TABLE>
<CAPTION>
1995 1996 1997
----- ------ -------
<S> <C> <C> <C>
Beginning balance.................................... 1,314 3,494 4,005
Provision charged to selling expense................. 2,613 6,860 31,216
Write-offs........................................... (433) (6,349) (12,815)
----- ------ -------
Ending balance....................................... 3,494 4,005 22,406
===== ====== =======
</TABLE>
12. DEFERRED AND RECOVERABLE TAXES
<TABLE>
<CAPTION>
1996 1997
------- -------
<S> <C> <C>
Tax deducted at source....................................... 293 1,622
Social contribution tax...................................... 1,140 1,701
Recoverable income tax....................................... 7,590 16,526
Deferred tax assets.......................................... 81,084 114,489
Sales and other taxes........................................ 33,304 43,991
------- -------
123,411 178,329
======= =======
Current...................................................... 67,327 114,232
Non current.................................................. 56,084 64,097
</TABLE>
13. OTHER ASSETS
<TABLE>
<CAPTION>
1996 1997
------- -------
<S> <C> <C>
Other debtors................................................ 4,486 4,317
Maintenance inventories...................................... 53,541 36,033
Prepayments.................................................. 3,516 2,914
Recoverable advances......................................... 15,653 13,630
Fiscal incentive investments................................. 17,008 36,037
Other........................................................ 38,097 62,562
------- -------
132,301 155,493
======= =======
Current...................................................... 81,897 71,495
Non-current.................................................. 50,404 83,998
</TABLE>
F-18
<PAGE>
TELE CENTRO-SUL PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of constant Brazilian reais of December 31,
1997)
14. INVESTMENTS
<TABLE>
<CAPTION>
1996 1997
------ ------
<S> <C> <C>
Fiscal incentive investments................................... 12,042 13,556
Other investments.............................................. 11,107 15,134
------ ------
23,149 28,690
====== ======
</TABLE>
15. PROPERTY, PLANT AND EQUIPMENT, NET
A. COMPOSITION:
<TABLE>
<CAPTION>
1996 1997
---------- ----------
<S> <C> <C>
Construction-in-progress............................. 1,167,791 931,259
Automatic switching equipment........................ 3,320,119 3,579,223
Other equipment...................................... 4,506,235 5,102,927
Buildings............................................ 1,216,997 1,379,530
Other assets......................................... 1,581,084 1,711,456
---------- ----------
Total cost........................................... 11,792,226 12,704,395
Accumulated depreciation............................. (5,829,095) (6,259,876)
---------- ----------
Property, plant and equipment, net................... 5,963,131 6,444,519
========== ==========
</TABLE>
Other equipment includes: Aerial, underground and building cables,
teleprinters, private automatic exchanges, generating equipment and furniture.
Other assets include. Underground cables, computer equipment, vehicles, land
and other assets. Within "Other assets" the book value of land is R$71,021 at
December 31, 1996 and R$71,998 at December 31, 1997.
B. DEPRECIATION RATES
The annual depreciation rates applied to property, plant and equipment are
as follows:
<TABLE>
<CAPTION>
%
----------
<S> <C>
Automatic switching equipment..................................... 7.69
Transmission and other equipment.................................. 10.00
Buildings......................................................... 4.00
Other assets (excluding land)..................................... 5.00-20.00
</TABLE>
C. RENTALS
The Companies rent equipment and premises through a number of operating
agreements that expire at different dates. Total annual rent expense under
these agreements was as follows:
<TABLE>
<CAPTION>
1995 1996 1997
------ ------ ------
<S> <C> <C> <C>
Rent expenditure in the year.......................... 12,388 29,887 30,146
</TABLE>
F-19
<PAGE>
TELE CENTRO-SUL PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of constant Brazilian reais of December 31,
1997)
Rental commitments relate primarily to facilities where the future minimum
rental payments under leases with remaining noncancelable terms in excess of
one year are:
<TABLE>
<S> <C>
Year ending December 31,
1998................................................................ 12,026
1999................................................................ 8,369
2000................................................................ 1,675
2001................................................................ 1,180
2002 ............................................................... 804
------
Total minimum rental payments..................................... 24,054
======
</TABLE>
16. PAYROLL AND RELATED ACCRUALS
<TABLE>
<CAPTION>
1996 1997
------- -------
<S> <C> <C>
Wages and salaries........................................... 28,336 27,180
Accrued social security charges.............................. 46,912 45,940
Accrued benefits............................................. 28,731 25,427
Payroll withholdings......................................... 2,994 3,570
------- -------
106,973 102,117
======= =======
</TABLE>
17. TAXES OTHER THAN INCOME TAXES
<TABLE>
<CAPTION>
1996 1997
------- -------
<S> <C> <C>
Value-added taxes............................................ 90,336 123,970
Other indirect taxes on operating revenues................... 15,646 14,479
------- -------
105,982 138,449
======= =======
</TABLE>
18. DIVIDENDS
<TABLE>
<CAPTION>
1996 1997
------- -------
<S> <C> <C>
Payable to Telebras.......................................... 137,317 139,748
Other........................................................ 33,120 65,127
------- -------
170,437 204,875
======= =======
</TABLE>
19. LOANS AND FINANCING
<TABLE>
<CAPTION>
1996 1997
------- -------
<S> <C> <C>
Loans payable to Telebras.................................... 112,115 248,496
Other financing.............................................. 134,430 45,912
------- -------
246,545 294,408
======= =======
Current...................................................... 104,191 110,414
Noncurrent................................................... 142,354 183,994
</TABLE>
F-20
<PAGE>
TELE CENTRO-SUL PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of constant Brazilian reais of December 31,
1997)
A. LOANS PAYABLE TO TELEBRAS
<TABLE>
<CAPTION>
1996 1997
------- -------
<S> <C> <C>
Eurobonds, originally issued by Telebras..................... 20,832 --
Loans and financing from Telebras............................ 91,283 248,496
------- -------
112,115 248,496
======= =======
</TABLE>
A.1. EUROBONDS ORIGINALLY ISSUED BY TELEBRAS
These are represented by three issues, all denominated in U.S. dollars, as
follows:
<TABLE>
<CAPTION>
PRINCIPAL ANNUAL INTEREST
REPAYMENT ORIGINAL INTEREST PAYMENT
ISSUE TERM SCHEDULE VALUE RATE SCHEDULE 1996
- ----- ---- --------- -------- -------- -------- ----
(US$
THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
4 1997 upon maturity 10,853 10% semi annual 13,777
5 1997 upon maturity 2,500 10.375% semi annual 2,799
6 1997 upon maturity 3,938 10% semi annual 4,006
Principal........................................................... 20,582
Accrued interest.................................................... 250
------
Total............................................................... 20,832
======
</TABLE>
In addition to the contractual interest, in connection with the Eurobonds,
the Companies paid Telebras a 0.5% per year administrative fee on the
outstanding balances.
A.2. LOANS AND FINANCING FROM TELEBRAS
<TABLE>
<CAPTION>
1996 1997
------ -------
<S> <C> <C>
Loans with Telebras........................................... 82,534 245,826
Accrued interest.............................................. 8,749 2,670
------ -------
91,283 248,496
====== =======
</TABLE>
The Company had outstanding loans denominated in Brazilian Reais in the
amount of R$199,527 payable to Telebras. Such loans bear interest at rates
based on TEX ("Taxa Extra de Mercado") plus 1% per annum. In addition, the
Company had outstanding loans denominated in U.S. dollars payable to Telebras
in the amount of R$48,969. Such loans bear interest at rates of 2.3% per
annum.
B. OTHER FINANCING
<TABLE>
<CAPTION>
1996 1997
------- ------
<S> <C> <C>
Equipment financing........................................... 130,240 32,884
Accrued interest.............................................. 4,190 13,028
------- ------
134,430 45,912
======= ======
</TABLE>
F-21
<PAGE>
TELE CENTRO-SUL PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of constant Brazilian reais of December 31,
1997)
The loans with the suppliers of telecommunications equipment, are repayable
in full in 2001. The loans are denominated in US dollars and bear interest at
fixed and variable rates. The fixed rates range from 1% to 16.3% per annum and
the variable rates range from 0.44% to 5.5% per annum plus LIBOR, which at
December 31, 1997 was 5.85%. The loans are guaranteed by Telebras.
C. REPAYMENT SCHEDULE
Noncurrent debt is scheduled to be repaid as follows:
<TABLE>
<S> <C>
1999................................................................. 40,384
2000................................................................. 72,287
2001................................................................. 30,514
2002................................................................. 3,254
2003 and thereafter.................................................. 37,555
-------
183,994
=======
</TABLE>
D. CURRENCY ANALYSIS
Total debt is denominated in the following currencies:
<TABLE>
<CAPTION>
EXCHANGE RATE
AT DECEMBER 31, 1997
(UNITS OF ONE
BRAZILIAN REAL) 1996 1997
-------------------- ------- -------
<S> <C> <C> <C>
Brazilian Reais......................... 1.0000 77,851 201,773
US dollars.............................. 1.1164 168,694 92,635
------- -------
246,545 294,408
======= =======
</TABLE>
The Companies do not hedge their foreign currency liabilities.
E. CREDIT AGREEMENT DEFAULTS
The Companies are party to certain credit agreements that contain covenants
restricting, among other things, (i) the ability of Telebras to dispose of all
or a substantial part of its assets or to cease to control a company that was
an operating subsidiary of the Telebras System and (ii) the ability of the
Federal Government to dispose of
its controlling interest in the Telebras System. The Breakup of Telebras on
May 22, 1998 and the privatization of the Companies constituted, an event of
default under such credit agreements. In addition, most of the Companies'
other credit agreements include cross-default provisions and cross-
acceleration provisions that would permit the holders of such indebtedness to
declare the indebtedness to be in default and to accelerate the maturity
thereof if a significant portion of the principal amount of the Companies'
debt is in default or accelerated. A portion of the Companies' outstanding
debt as of December 31, 1997 is in default as a result of the privatization.
The Companies are currently in negotiations with the appropriate creditors
with respect to this indebtedness.
The consolidated financial statements do not include any adjustments
relating to the recoverability of assets and classification of liabilities
that might be necessary should the Companies be unable to renegotiate their
credit agreements. The Companies believe that once the privatization is
finalized, the Companies' creditors will renegotiate the terms of these credit
agreements and/or provide appropriate waivers regarding such defaults.
F-22
<PAGE>
TELE CENTRO SUL PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of constant Brazilian reais of December 31,
1997)
20. PROVISIONS FOR CONTINGENCIES
The Companies are party to certain legal proceedings arising in the normal
course of business, including civil, administrative, tax, social security and
labor proceedings. The Companies have provided for the amounts to cover the
estimated losses due to adverse legal judgments. In the opinion of management,
such actions, if decided adversely to the Companies, would not have a material
adverse effect on the Companies' financial condition.
The components of the charge included in the combined statements of income
for contingent liabilities are as follows:
<TABLE>
<CAPTION>
1995 1996 1997
------ ------ ------
<S> <C> <C> <C>
Additional provisions................................... 17,935 38,231 29,985
Payments in excess of provisions........................ 18,759 4,806 7,846
------ ------ ------
36,694 43,037 37,831
====== ====== ======
</TABLE>
Provisions for contingent liabilities were as follows:
<TABLE>
<CAPTION>
1996 1997
------- -------
<S> <C> <C>
Labor claims................................................. 86,918 102,859
Disputed taxes............................................... 12,242 13,809
Civil claims................................................. 6,138 10,769
------- -------
105,298 127,437
======= =======
Current...................................................... 82,012 102,190
Non-current.................................................. 23,286 25,247
</TABLE>
Labor claims
The provisions for labor claims comprise management's estimate of the most
probable loss in relation to various suits filed by current and former
employees.
Disputed taxes
The determination of the manner in which the various federal, state and
municipal Brazilian taxes apply to the operations of the Company is subject to
varying interpretations arising from the unique nature of the Company's
operations. Management believes that its interpretation of the Company's tax
obligations is substantially in compliance with legislation. Accordingly, any
changes in the tax treatment afforded to the Company's operations will be the
result of new legislation or interpretive rulings of the tax authorities that
will, in the opinion of management, not have any retroactive impact.
Civil claims
The civil claims relate mainly to disputes with suppliers of
telecommunications equipment over price escalation clauses in their contracts.
Other
Telebras, the legal predecessor of the Company, is a defendant in a number
of legal proceedings and subject to 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
F-23
<PAGE>
TELE CENTRO SUL PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of constant Brazilian reais of December 31,
1997)
claims (for which Telebras and the New Holding Companies are jointly and
severally liable) 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 may 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 and, accordingly, no provision has been recorded.
Litigation
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.
Taxes--ICMS on activation fees and other services
On June 19, 1998 the secretaries of the treasury of the individual Brazilian
states approved an agreement to interpret existing Brazilian tax law to
broaden the application of the ICMS (Imposto sobre Circulacao de Mercadorias e
Servicos), a state value-added tax, to cover not only telecommunication
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.
The Company believes that the attempt by the state treasury secretaries to
extend the scope of ICMS tax to services which are supplementary to basic
telecommunications services is unlawful because: (i) the state secretaries
acted beyond the scope of their authority; (ii) their interpretation would
subject certain services to taxation which are not considered
telecommunications services; and (iii) new taxes may not be applied
retroactively. No provision for such taxes has been made in the accompanying
consolidated financial statements as the Company does not believe it is
probable that such taxes will be payable for services rendered during the last
five years.
There can be no assurance that the Company will prevail in its position that
the new interpretation by the state treasury secretaries is unlawful. If the
ICMS tax were applied retroactively for five years to activation fees earned
by the discontinued cellular operations, it would give rise to a maximum
liability estimated at R$128,000.
Compensation of overpaid FINSOCIAL against COFINS
A predecessor to the COFINS tax on gross operating revenues, called
FINSOCIAL, was originally introduced at a rate of 0.5% which was subsequently
increased in stages to a rate of 2.0%. The timing of these increases was
successfully challenged in court by a number of Brazilian companies, giving
rise to tax credits on account of past overpayments which could be compensated
against current payments of the similar tax, COFINS. The Company recorded a
credit for the overpaid FINSOCIAL tax in 1995 following both a High Court
ruling decreeing the unconstitutionality of the rate increases and subsequent
legislation allowing the taxpayer to offset the overpaid tax against other
taxes due to the same taxing authority. The Company realized the benefit by
offsetting its overpaid FINSOCIAL against current liabilities to COFINS and
recognized a gain of R$8,884 in 1995 and R$6,194 in 1996.
The Company has not been questioned by the tax authorities in relation to
this offset. However in 1997 the High Court effectively reversed its earlier
decision and decided that the FINSOCIAL tax rate increases were
F-24
<PAGE>
TELE CENTRO SUL PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of constant Brazilian reais of December 31,
1997)
applicable to service companies. Nevertheless the Company has maintained the
credit taken in 1995 on the grounds that telecommunications services in Brazil
are exempt from COFINS in accordance with the third amendment to the Brazilian
Constitution of March 17, 1993 (Art. 155, (S) 3(degrees)) and also because
they are considered to be a basic industry for all legal purposes in
accordance with Decree 640 of March 2, 1962, which continues to be valid. If
the Company were to be successfully challenged by the tax authorities and the
FINSOCIAL tax offset were found to be without legal support, it would be
liable to the unpaid COFINS tax which, together with interest and penalties
for late payment, would comprise a liability amounting to approximately
R$25,000 as of December 31, 1997, for which no provision has been established
in the attached statements.
21. PROVISION FOR PENSIONS
The Companies participate in a multi-employer defined benefit pension and
other post-retirement benefit plans administered by the Fundacao Telebras de
Seguridade Social ("Sistel").
Approximately 93% of the Companies' employees are covered by these plans.
The Companies contributed and charged to expense R$36,910, R$36,857 and
R$40,519 in 1995, 1996 and 1997, respectively, in respect of pension fund
contributions. Information from the plan's administrators is not available to
permit the Companies to determine their share of unfunded vested benefits, if
any. Management has no intention of withdrawing from these plans, nor is there
any intention to terminate the plans. As a member of a multi-employer plan,
the Companies' contributions are not segregated in separate accounts or
restricted to provide benefits only to employees of the Companies. The
Companies are also contingently liable for the total obligations of the plans.
The funded status of the Sistel Plan is presented below.
The pension benefit is generally defined as the difference between (i) 90%
of the retiree's average salary during the last 36 months indexed to the date
of retirement and (ii) the value of the retirement pension paid by the
Brazilian social security system. For retired employees the initial pension
payment is subsequently adjusted upwards to recognize cost of living increases
and productivity awards granted to active employees. In addition to the
pension supplements, post-retirement health care and life insurance benefits
are provided to eligible pensioners and their dependents.
Contributions to the plans are based on actuarial studies prepared by
independent actuaries under Brazilian regulations. The actuarial studies are
revised periodically to identify whether adjustments to the contributions are
necessary. A summary relating to the overall Sistel plan, in compliance with
accounting principles generally accepted in Brazil, is as follows:
<TABLE>
<CAPTION>
1996 1997
--------- ---------
<S> <C> <C>
Accumulated pension and other post-retirement benefit
obligations.......................................... 3,235,223 3,775,898
Other obligations..................................... 244,724 255,751
--------- ---------
Total obligations................................. 3,479,947 4,031,649
========= =========
Combined plan assets:
Interest bearing deposits........................... 1,849,298 1,714,153
Stocks and shares................................... 1,548,629 2,360,786
Investment properties............................... 376,805 363,305
Loans to beneficiaries.............................. 115,921 123,428
Other investments................................... 56,229 52,195
--------- ---------
Total plan assets................................. 3,946,882 4,613,867
========= =========
Excess of total plan assets over total obligations.... 466,935 582,218
========= =========
</TABLE>
F-25
<PAGE>
TELE CENTRO SUL PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of constant Brazilian reais of December 31,
1997)
In addition to the formal Sistel plan, a subsidiary, Telepar, has entered
into an agreement with 3,215 employees who joined the company before December
31, 1982 that grants them a supplementary pension. This right is granted only
if the employees retire on the grounds of time served (30 years for men and 25
years for women). The accumulated pension obligation related to the benefits
payable, assuming all 3,215 employees elect for the collective agreement, has
been accrued for as follows:
<TABLE>
<CAPTION>
1996 1997
------- -------
<S> <C> <C>
Provision for pension....................................... 123,044 127,887
</TABLE>
In June 1998, in connection with the breakup of Telebras, the Company
determined that the supplementary pension plan would be terminated. As a
result of the termination of the supplementary pension plan, the Company
allowed the members of the plan to elect to receive a cash payout of their
accumulated benefits or to transfer their accumulated benefit obligations to
the Sistel plan. The majority of the employees in the plan elected the cash
payout or for a transfer into the SISTEL plan, which resulted in a payment in
1998 of approximately R$55.0 million. The remaining accrual is to be used to
cover those employees that elected to transfer their benefits to the Sistel
plan, as well as to those for which no election had yet been made.
22. SHAREHOLDERS' EQUITY
The accompanying consolidated financial statements reflect the combined
shareholders' equity of the Companies, after segregating as minority interests
the participation of minority shareholders in each of the Companies at the
historical percentages applicable to shareholders other than Telebras. The
combined shareholders equity has been segregated between capital, reserves and
retained earnings.
23. EXPANSION PLAN CONTRIBUTIONS
Expansion plan contributions are the means by which the Companies have
financed the growth of their telecommunications network. The contributions
were made by companies or individuals to be connected to the national
telephone network. Such contributions were paid directly to the Companies and
interest received, when payments were made in installments, was transferred to
Telebras. The capital value received from the prospective telephone
subscribers was treated as follows:
. 80% was capitalized by the Companies in the name of Telebras, with the
value per share issued to Telebras being equal to the equity value per
share of each of the Companies at the end of the year preceding the
capitalization.
. 20% was remitted by the Companies to Telebras in the month following
receipt.
. Until December 31, 1995 the total capital value received was indexed
from the month of receipt to the date of the next audited balance sheet
and then capitalized in the name of the prospective subscriber by
Telebras or by the Companies, at a value per share equal to the equity
value per share shown in the audited balance sheet. From January 1, 1996
indexation was no longer applied and, for contracts signed as from that
date, the Telebras or the Companies were allowed the option of using a
market value per share, when that was higher than the equity value.
Also, as from June 1995, the capitalization of expansion plan
contributions was effected by the Companies issuing their own shares to
expansion plan subscribers.
F-26
<PAGE>
TELE CENTRO-SUL PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of constant Brazilian reais of December 31,
1997)
Expansion plan contributions of R$285,837, R$216,795, and R$182,258 in 1995,
1996 and 1997, respectively, were received. Expansion plan contributions
approved by the general meeting of shareholders for capitalization and
transfer to shareholders' equity amounted to R$166,218, R$232,446 and
R$348,098 in 1995, 1996 and 1997, respectively. The Companies' expansion plan
contribution program has been terminated, with no new contracts being signed
after June 30, 1997.
In addition to the expansion plans which it promoted directly, the Companies
also sponsored agreements between companies or individuals in a particular
community and independent contractors who undertook to develop the
telecommunications infrastructure required to connect them to the national
telephone network (Community Expansion Plan). The companies or individuals
paid the contractor. On completion of the project the Companies incorporated
the completed equipment into their fixed assets at the appraised value and
credited expansion plan contributions which are then treated in the same
manner as the capital values received from prospective telephone subscribers,
as described above.
24. TRANSACTIONS WITH RELATED PARTIES
The principal related party transactions take place with Embratel in respect
of long-distance telecommunications. The Companies have operating agreements
with Embratel, which define the charge per minute for inter-or intrastate
long-distance or international telephone calls with origin or destination in
the area specified by the telecommunications concession granted to the
Companies by the Federal Government. All charges to customers, including long-
distance, are billed by the Companies who transfer the long-distance portion
of the charges to Embratel. As a result, the Companies normally have a payable
to Embratel.
Embratel and the cellular companies of Telebras must pay a network usage fee
if they access end customers via the network of the Companies. In practical
terms, even though the network usage fee includes the costs of a variety of
network elements and services, the network usage fee primarily reflects the
use of certain facilities of the Companies for which Embratel and the cellular
companies do not have adequate substitutes, particularly the local loop
between local exchanges and customers.
In the past, the Companies shared revenues for interregional and
international long-distance calls with Embratel rather than charging Embratel
a network usage fee for the use of the Companies' network. Under this system,
the Companies retained a fixed percentage of the revenues associated with such
calls and paid the balance of the revenues associated with such calls to
Embratel. This system was replaced on April 28, 1998 with the interconnection
charge that had already been in place for interconnection of the Companies'
network with cellular networks, under which the Companies charge for
connection to their network and usage of their network.
Additionally, as a result of telephone calls to and from the service areas
of other telephone operators, the Companies have receivable and payable
positions with other telecommunications service providers in Brazil within the
Telebras group of companies relating to charges for the use of the networks
belonging to those telecommunications service providers.
F-27
<PAGE>
TELE CENTRO SUL PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of constant Brazilian reais of December 31,
1997)
A summary of the balances and transactions with these related parties is as
follows:
<TABLE>
<CAPTION>
1996 1997
------- -------
<S> <C> <C>
Current assets:
Trade accounts receivable.................................. 9,033 6,941
Other assets............................................... 1,854 1,998
Current liabilities:
Loans and financing........................................ 64,649 95,748
Accounts payable to related parties........................ 31,062 30,522
Other liabilities.......................................... 8,748 4,189
Dividends.................................................. 137,317 139,748
Non current liabilities:
Loans and financing........................................ 47,466 152,748
</TABLE>
<TABLE>
<CAPTION>
1995 1996 1997
------- -------- --------
<S> <C> <C> <C>
Net operating revenues........................ 91,549 168,068 235,096
Cost of services.............................. (67,413) (109,310) (189,562)
Operating expenses............................ 26,115 63,230 96,648
Interest expense.............................. (13,699) (13,667) (22,733)
Interest income............................... 3,346 8,663 3,551
</TABLE>
Until the breakup of Telebras, the Companies and other companies of the
Telebras system were required to contribute to the research and development
center operated by Telebras and also conducted their own independent research
and development. Following the breakup of Telebras, a private independently
administered research and development center was established. Pursuant to a
three year contract signed in May 1998, the telecommunications regulations
require the Companies to contribute R$63,317 to the research center during the
three year period ending May 2001.
Additionally, Telebras charges a 1% per annum administration fee on the
allocation to the Holding Company of debt originally contracted by Telebras.
Telebras has also charged interest on inter company loans at a rate which is
currently the interest rate on federal treasury bills plus 0.25%. These
interest charges are included in the above table as net interest expense.
Other related parties are Federal, State and Municipal Governments. Revenues
from telephone calls made by government bodies and related organizations have
not been included above because details of the type of telephone user were not
maintained.
The balances of amounts invested in government securities or through
government controlled entities are:
<TABLE>
<CAPTION>
1996 1997
------- -------
<S> <C> <C>
Cash and cash equivalents:
Deposits with Banco do Brasil S.A.......................... 234,956 138,239
</TABLE>
The Companies believe that all the costs of doing business are reflected in
the combined financial statements and that no additional expenditures will be
incurred as a result of the cessation of the activities previously performed
by Telebras.
25. COMMITMENTS
At December 31, 1997 the Companies had the approximately following capital
expenditure commitments:
<TABLE>
<CAPTION>
EXPECTED YEAR OF EXPENDITURE
----------------------------
<S> <C>
1998............................................................... 772,659
1999............................................................... 331,451
</TABLE>
F-28
<PAGE>
TELE CENTRO SUL PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of constant Brazilian reais of December 31,
1997)
These commitments are to be spent on continuing expansion and modernization
of the system, transmission equipment and data transmission equipment.
26. INSURANCE
At December 31, 1997, in the opinion of management, all significant and high
risk assets and obligations were insured.
27. FAIR VALUES OF FINANCIAL ASSETS AND LIABILITIES
Estimated fair values of the Companies' financial assets and liabilities
have been determined using available market information and appropriate
valuation methodologies. However, considerable judgment was required in
interpreting market data to produce the estimated fair values. Accordingly,
the estimates presented below are not necessarily indicative of the amounts
that could be realized in a current market exchange. The use of different
market assumptions and/or estimation methodologies may have a material effect
on the estimated fair values.
The fair value information as of December 31, 1996 and 1997 presented below
is based on pertinent information available to management as of those dates.
Although management is not aware of any factors that would significantly
affect the estimated fair value amounts at December 31, 1996, such amounts
have been fully indexed to December 31, 1997 and current estimates of fair
values may differ significantly from the amounts shown.
Where no comparison of book versus fair value is presented for a financial
asset or liability line item in the schedule below, no significant difference
in values is believed to exist.
<TABLE>
<CAPTION>
1996 1996 1997 1997
BOOK FAIR BOOK FAIR
VALUE VALUE VALUE VALUE
------- ------- ------- -------
<S> <C> <C> <C> <C>
Assets:
Other assets:
Deferred and recoverable income tax....... 123,411 116,617 178,329 163,854
Liabilities:
Income taxes............................... 256,748 148,085 304,612 234,127
Loans and financing:
Loans payable to Telebras................. 112,115 119,430 248,496 251,296
Other financing........................... 134,430 134,430 45,912 45,912
</TABLE>
Cash, cash equivalents, customer accounts receivable and other assets,
accounts payable and accrued liabilities.
The carrying value of cash and cash equivalents, trade accounts receivable
and other assets, accounts payable and accrued liabilities are a reasonable
estimate of their fair values. Cash equivalents are represented principally by
overnight-deposits for which the fair values were also considered to be the
same as the carrying value, as also trade accounts receivable, other assets,
accounts payable and accrued liabilities.
Loans and financing
Interest rates that are currently available to the Companies for issuance of
debt with similar terms and maturities were used to estimate fair value.
F-29
<PAGE>
TELE CENTRO SUL PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of constant Brazilian reais of December 31,
1997)
28. EVENTS SUBSEQUENT TO DECEMBER 31, 1997
A. INCORPORATION OF THE CELLULAR COMPANIES
At December 31, 1997, Telebras, through its operating subsidiaries, was the
principal supplier of public telecommunications services in Brazil, which
included being the leading provider of fixed-line telephone services. On
January 30, 1998 as part of a separation of the telephone business between
fixed and cellular operations by all of Telebras' subsidiaries, the Companies
spun off the assets and liabilities at December 31, 1997 of their cellular
telecommunications operations into separate companies. These new companies,
the Cellular Companies, were incorporated on January 5, 1998.
B. INCORPORATION OF TELE CENTRO SUL PARTICIPACOES S.A.
On May 22, 1998 the shareholders of Telebras approved Telebras' division
into twelve new holding companies using a procedure under Brazilian corporate
law called a cisao ("spin-off"), whereby existing shareholders received shares
in the new companies in proportion to their holdings in Telebras. The new
companies contain the assets and liabilities previously recorded in the
accounts of Telebras, except for the following which will remain on the books
of Telebras and not be allocated to the new holding companies:
. approximately R$98,000 of net assets which have been attributed to a
newly constituted research foundation that will take over the activities
previously performed by the Telebras Campinas Research and Development
Center, and,
. approximately R$370,000 of net assets that will provide the funds
required to liquidate Telebras, including approximately R$132,000 of
retroactive dividends to be paid to the holders of new shares issued in
April 1998, as a result of the resolution of the disputed capital
increase of 1990, approximately R$50,000 of indemnity payments to
employees and approximately R$87,000 of expenses arising out of the
privatization process.
In addition to approving the allocation of assets and liabilities to the new
holding companies at the May 22, 1998 meeting, the shareholders also approved
a specific structure for the shareholders' equity of each new holding company,
which included an allocation of a portion of the retained earnings of
Telebras. Consequently, the amounts of the balances of capital, reserves and
retained earnings, together with the corresponding assets and liabilities for
the formation of Tele Centro Sul Participacoes S.A. were established. After
Telebras retained within its own shareholders' equity sufficient retained
earnings from which to pay dividends on its 1997 earnings and in settlement of
dividends as a result of settlement of the 1990 disputed share increase,
Telebras allocated to each New Holding Company the balance of its retained
earnings in proportion to the allocated total net assets. This value of
allocated retained earnings does not represent the historical retained
earnings of the holding companies and resulted in an increase of R$204,689 in
relation to the Company's historical retained earnings. These values are shown
in the "Spin-off from Telebras" column in the following table. The first
column summarizes the December 31, 1997 consolidated historical balances of
the Companies' consolidated balance sheets, and the "Holding Company
Consolidated Statement" column summarizes the consolidated balance sheet of
Tele Centro Sul Participacoes S.A. after the spin-off.
As a result of the legal structure of the spin-off and as allowed under
Brazilian GAAP, a company formed as a result of a cisao will have such
retained earnings in its balance sheet as the parent company shareholders'
resolution adopting the cisao allocates from the parent company to the new
company. Accordingly, upon formation, Tele Centro Sul Participacoes S.A.'s
legal capital structure was defined by the resolutions approved by the
Telebras shareholders' meeting of May 22, 1998 so that its shareholders'
equity of R$5,122,435 includes retained earnings of R$1,394,352. The allocated
retained earnings and future retained earnings will be the basis from which
future dividends will be payable.
F-30
<PAGE>
TELE CENTRO SUL PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 31)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of constant Brazilian reais of December 31,
1997)
The "Adjustments and Eliminations" column includes (i) the elimination of
the Holding Company's investment in the Companies (ii) the elimination of
inter-company loans, payables and receivables (iii) the elimination of the net
assets of the discontinued cellular operations and (iv) the elimination of the
minority shareholdings in the discontinued cellular operations.
<TABLE>
<CAPTION>
DECEMBER
31, 1997 ADJUSTMENTS HOLDING COMPANY
HISTORICAL SPIN-OFF AND CONSOLIDATED
BALANCES FROM TELEBRAS ELIMINATIONS STATEMENT
---------- ------------- ------------ ---------------
<S> <C> <C> <C> <C>
Assets
Cash and cash equiva-
lents.................. 163,280 71,012 -- 234,292
Intercompany receiv-
ables.................. 8,939 337,046 (234,776) 111,209
Other current assets.... 565,024 1,197 -- 566,221
--------- --------- ---------- ---------
Total current assets.. 737,243 409,255 (234,776) 911,722
Intercompany receiv-
ables.................. -- 188,575 (152,748) 35,827
Other noncurrent as-
sets................... 148,095 4,590 -- 152,685
--------- --------- ---------- ---------
Total noncurrent as-
sets................. 148,095 193,165 (152,748) 188,512
Investment in subsidiar-
ies.................... 28,690 4,495,387 (4,495,387) 28,690
Advances for future cap-
ital increase.......... -- 152,496 (152,496) --
Property, plant and
equipment, net......... 6,444,519 42,634 -- 6,487,153
--------- --------- ---------- ---------
Total permanent as-
sets................. 6,473,209 4,690,517 (4,647,883) 6,515,843
Net assets of discontin-
ued operations......... 1,122,409 -- (1,122,409) --
--------- --------- ---------- ---------
Total assets............ 8,480,956 5,292,937 (6,157,816) 7,616,077
========= ========= ========== =========
Liabilities
Loans and financing..... 110,414 -- (95,748) 14,666
Other................... 805,969 -- (139,028) 666,941
--------- --------- ---------- ---------
Total current liabili-
ties................. 916,383 -- (234,776) 681,607
Loans and financing..... 183,994 -- (152,748) 31,246
Other................... 409,904 -- -- 409,904
--------- --------- ---------- ---------
Total noncurrent lia-
bilities............. 593,898 -- (152,748) 441,150
Minority interests...... 1,375,041 -- (206,970) 1,168,071
--------- --------- ---------- ---------
Share capital........... 4,221,163 1,936,659 (4,221,163) 1,936,659
Income reserves......... -- 1,791,424 -- 1,791,424
Retained earnings....... 1,189,663 1,394,352 (1,189,663) 1,394,352
--------- --------- ---------- ---------
Total shareholders'
equity............... 5,410,826 5,122,435 (5,410,826) 5,122,435
Funds for capitaliza-
tion................... 184,808 170,502 (152,496) 202,814
--------- --------- ---------- ---------
Total liabilities and
shareholders' equity... 8,480,956 5,292,937 (6,157,816) 7,616,077
========= ========= ========== =========
</TABLE>
The separation of the fixed and cellular telecommunications business and the
formation of the Holding Company have been accounted for as reorganizations of
entities under common control in a manner similar to a pooling of interests.
Brazilian corporate and tax law allows state controlled companies which are
participating in the government's privatization program a three month delay
between the accounting base date for a spin-off and the date on which the
shareholders' meeting approves the spin-off, including the related accounting
basis for the
F-31
<PAGE>
TELE CENTRO SUL PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of constant Brazilian reais of December 31,
1997)
net assets spun-off. Furthermore, as allowed by Brazilian corporate law, the
amount shown in the "Spin-off from Telebras" column as "Investment in
Subsidiaries" was determined based on the balance sheets of those subsidiaries
as of December 31, 1997. As a result, the consolidated financial statements of
the Holding Company for 1998 will include the results of operations and
changes in financial conditions 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.
Capital
The capital stock of the Holding Company is comprised of preferred shares
and common shares, all without par value. At May 22, 1998, there were
210,029,997 thousand outstanding preferred shares (inclusive of 13,718,350
thousand preferred shares resulting from the settlement in April 1998 with
Telebras as discussed below) and 124,351,903 thousand outstanding common
shares (net of 17,128 thousand common shares in treasury). The capital may be
increased only by a decision taken at a shareholders' meeting or by the Board
of Directors in connection with the capitalization of profits or reserves
previously allocated to capital increases at a shareholders' meeting.
The preferred shares are non-voting except under limited circumstances and
are entitled to a preferential, noncumulative dividend and to priority over
the common shares in the case of liquidation of the Holding Company.
Under the Brazilian Corporation Law, the number of non-voting shares, such
as the Preferred Shares, may not exceed two-thirds of the total number of
shares.
On June 7, 1990, the Board of Directors of Telebras authorized an increase
in Telebras share capital by public offer. During the offer period the CVM
initiated an investigation as to whether Brazilian securities law and
regulations regarding the correct pricing of the new shares issued had been
violated, because the shares were issued at a discount to equity value per
share. After its investigation the CVM notified the Federal Prosecutor's
Office that it believed no violation occurred since the price was established
in line with market prices for Telebras' shares traded on the Brazilian stock
exchanges. Nevertheless, the Federal Prosecutor decided to pursue the issue
through judicial channels. In April 1998, resolution was reached on the
disputed Telebras capital increase of 1990. In connection with the resolution
Telebras issued 13,718,350 thousand shares of preferred stock.
Dividends
Pursuant to its By-laws, the Holding Company is required to distribute as
dividends in respect of each fiscal year ending on December 31, to the extent
amounts are available for distribution, an aggregate amount equal to at least
25% of Adjusted Net Income (as defined) on such date (the "Mandatory
Dividend"). The annual dividend distributed to holders of Preferred Shares
(the "Preferred Dividend") has priority in the allocation of Adjusted Net
Income. Remaining amounts to be distributed are allocated first to the payment
of a dividend to holders of common shares in an amount equal to the Preferred
Dividend and the remainder is distributed equally among holders of preferred
shares and common shares.
For purposes of Brazilian Corporation Law, and in accordance with Tele
Centro Sul Participacoes S.A.'s By-laws, the "Adjusted Net Income" is an
amount equal to Tele Centro Sul Participacoes S.A.'s net profits adjusted to
reflect allocations to or from (i) the statutory reserve, (ii) a contingency
reserve for anticipated losses, if any, and (iii) an unrealized revenue
reserve, if any.
In addition, subsequent to December 31, 1997 an investigation relating to an
increase in the share capital of Telebras by a 1990 public offering has
concluded in favor of Telebras. Accordingly, Telebras has issued the 13,718
million preferred shares previously under investigation.
F-32
<PAGE>
TELE CENTRO SUL PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of constant Brazilian reais of December 31,
1997)
C. NEW REGULATORY ENVIRONMENT
On April 28, 1998, the revenue sharing regime used to divide interregional
and international long-distance revenues between Embratel and the Companies
was replaced with a network usage fee for interconnection, based on the terms
of an interconnection agreement with Embratel which became effective in April
1998.
The terms of this interconnection agreement, particularly pricing and
technical requirements, will significantly affect the Companies' results of
operations, competitive environment and capital expenditure policies. Under
the current regulatory framework, all telecommunications service providers
must provide interconnection services on a non-discriminatory basis. Subject
to certain requirements, providers are free to negotiate the terms of
interconnection but, in the event the parties fail to reach an agreement,
Anatel will establish the terms of interconnection.
The Companies do not expect the terms of the interconnection agreement to
have a material impact on net income initially as reduced net operating
revenues under the new structure are expected to be offset by a supplemental
per-minute rebate from Embratel called Parcela Adicional de Transicao ("PAT")
that supplements the network usage charge. Under the General Plan on
Concessions and Licenses, the fixed-line companies and Embratel, an affiliate
providing long distance services, are prohibited from offering certain basic
fixed-line telecommunications services until they fulfill certain specified
obligations. Embratel is prohibited from offering local or cellular services
and the regional fixed-line companies are prohibited from offering cellular,
interregional long-distance and international long-distance services. After
the privatization is effected, Embratel will be allowed to enter the market
for intraregional long-distance service as a competitor to the regional fixed-
line companies once the privatization of Telebras is completed.
D. CHANGE IN CONTROL (UNAUDITED)
On July 29, 1998, the Federal Government sold to twelve buyers (the "New
Controlling Shareholders") its rights to receive shares of the twelve New
Holding Companies upon the distribution of such shares. In connection with
this sale, the Federal Government assigned to the New Controlling Shareholders
substantially all its economic and voting rights with respect to the New
Holding Companies and, as a consequence, effective August 4, 1998, the New
Controlling Shareholders control the New Holding Companies.
29. SUMMARY OF THE DIFFERENCES BETWEEN BRAZILIAN AND US GAAP
The Companies' accounting policies comply with generally accepted accounting
principles in Brazil ("Brazilian GAAP"). Accounting policies which differ
significantly from generally accepted accounting principles in the United
States of America ("US GAAP") are described below:
A. DIFFERENT CRITERIA FOR CAPITALIZING AND DEPRECIATING CAPITALIZED INTEREST
Until December 31, 1993 capitalized interest was not added to the individual
assets in property, plant and equipment, instead it was capitalized separately
and amortized over a time period different from the useful lives of the
related assets. Under US GAAP, capitalized interest is added to the individual
assets and is amortized over their useful lives. Also, under Brazilian GAAP as
applied to companies in the telecommunications industry, interest attributable
to construction-in-progress is computed at the rate of 12% per annum of the
balance of construction-in-progress and that part which relates to interest on
third party loans is credited to interest expense based on actual interest
costs with the balance relating to own capital being credited to capital
reserves.
F-33
<PAGE>
TELE CENTRO SUL PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of constant Brazilian reais of December 31,
1997)
Under US GAAP, in accordance with the provisions of SFAS 34, interest
incurred on borrowings is capitalized to the extent that borrowings do not
exceed construction-in-progress. The credit is a reduction of interest
expense. Under US GAAP, the amount of interest capitalized excludes the
monetary gain associated with the borrowings and the foreign exchange gains
and losses on foreign currency borrowings. The US GAAP differences between the
accumulated capitalized interest on disposals and in accumulated amortization
on disposals relate to the differences between capitalized interest and
related accumulated amortization under Brazilian and US GAAP which is included
in the net book value of disposed property, plant and equipment. Although
these amounts have been determined to be the same, they are presented
individually in both the determination of the capitalized interest difference
and in the determination of the 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 US and
Brazilian GAAP.
The effects of these different criteria for capitalizing and depreciating
capitalized interest are presented below:
<TABLE>
<CAPTION>
1996 1997
-------- --------
<S> <C> <C>
CAPITALIZED INTEREST DIFFERENCE
US GAAP Capitalized Interest:
Interest which would have been capitalized and credited
to income under US GAAP (Being interest incurred on
loans from the Company's parent and from third
parties, except in years where total loans exceeded
total construction in progress, when capitalized
interest is reduced proportionately).................. 23,535 23,118
Difference in accumulated capitalized interest on
disposals............................................. 10,344 17,118
-------- --------
33,879 40,236
-------- --------
Less Brazilian GAAP Capitalized Interest:
Interest capitalized and credited to income under
Brazilian GAAP (Up to the limit of interest incurred
on loans obtained for financing capital investments).. (16,436) (24,568)
Interest capitalized and credited to reserves under
Brazilian GAAP (Difference between total capitalized
interest and interest capitalized and credited to
income)............................................... (115,546) (107,584)
-------- --------
Total capitalized interest under Brazilian GAAP (12%
per annum, applied monthly to the balance of
construction-in-progress)........................... (131,982) (132,152)
-------- --------
US GAAP Difference..................................... (98,103) (91,916)
======== ========
AMORTIZATION OF CAPITALIZED INTEREST DIFFERENCE
Amortization under Brazilian GAAP...................... 72,966 84,893
Less: Amortization under US GAAP....................... (25,294) (26,471)
US GAAP difference in accumulated amortization on
disposals........................................... (10,344) (17,118)
-------- --------
US GAAP Difference..................................... 37,328 41,304
======== ========
</TABLE>
F-34
<PAGE>
TELE CENTRO SUL PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of constant Brazilian reais of December 31,
1997)
B. REVERSAL OF PROPOSED DIVIDENDS
Under Brazilian GAAP proposed dividends are accrued for in the consolidated
financial statements in anticipation of their approval at the shareholders'
meeting. Under US GAAP, dividends are not accrued until they are formally
declared.
C. PENSION AND OTHER POST-RETIREMENT BENEFITS
The Companies participate in a multi-employer plan ("Sistel") and provide
for the costs of pensions and other post retirement benefits based on a fixed
percentage of remuneration, as recommended annually by independent actuaries.
For the purposes of US GAAP, the Companies are considered to contribute to a
multi-employer plan and consequently are required to disclose their annual
contributions and the funded status of the plan in accordance with US GAAP.
Note 30 shows the funded status of Sistel. The provisions of SFAS 87 for the
purposes of calculating the funded status were applied with effect from
January 1, 1992, because it was not feasible to apply them from the effective
date specified in the standard.
D. ITEMS POSTED DIRECTLY TO SHAREHOLDERS' EQUITY ACCOUNTS
Under Brazilian GAAP various items are posted directly to shareholders'
equity accounts that under US GAAP would be posted to the income statement.
Examples include capitalized interest, the effects of adjustments to tax rates
and tax incentive investment credits received. The posting of such items to
shareholders' equity gives rise to adjustments in the consolidated statements
of changes in shareholders' equity. Since the original postings by the
subsidiaries to their equity to equity accounts would, under US GAAP, be made
directly to the income statement, these consolidation adjustments must be
included in the reconciliation of net income in accordance with US GAAP. The
effects of changes in income tax rates posted directly to shareholders' equity
accounts arise from applying increases or decreases in tax rates to the
deferred tax liability relating to the special reserve arising from pre-1990
indexation adjustments to property, plant and equipment.
E. EARNINGS PER SHARE
Under Brazilian GAAP, net income per share is calculated on the number of
shares outstanding at the balance sheet date. Since the capital structure of
the Holding Company was not in place at December 31, 1997, earnings per share
is not presented for Brazilian GAAP.
In these combined financial statements, information is disclosed per lot of
one thousand shares, because this is the minimum number of shares that can be
traded on the Brazilian stock exchanges. Each American Depositary Share
("ADS") is equivalent to one thousand shares.
As discussed in Note 1, the Holding Company was not formed until subsequent
to December 31, 1997. For US GAAP purposes, the equity structure utilized for
the earnings per share computations is that of the new entity formed in May
1998. The Holding Company's equity structure has been used for all years
presented. At the date of formation, the Holding Company had 124,351,903
thousand common shares (net of 17,128 thousand common shares in treasury) and
196,311,647 thousand preferred shares outstanding (exclusive of the 13,718,350
thousand preferred shares resulting from the settlement in April 1998 with
Telebras).
In February 1997, the Financial Accounting Standards Board issued SFAS No.
128 "Earnings Per Share". This new statement became effective for financial
statements for periods ending after December 15, 1997, and provides
computation, presentation and disclosure requirements for earnings per share.
F-35
<PAGE>
TELE CENTRO SUL PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of constant Brazilian reais of December 31,
1997)
Since the preferred and common stockholders have different dividend, voting
and liquidation rights, Basic and Diluted earnings per share have been
calculated using the "two-class" method. The "two-class" method is an earnings
allocation formula that determines earnings per share for preferred and common
stock according to the dividends to be paid as required by the Company's by-
laws and participation rights in undistributed earnings.
Basic earnings per common share is computed by reducing net income by
distributable and undistributable net income available to preferred
shareholders and dividing net income available to common shareholders by the
weighted-average number of common shares outstanding during the period. Net
income available to preferred shareholders is the sum of the preferred stock
dividends up to a minimum of 6% of adjusted net income (as defined in the
Company's by-laws) (distributable net income) and the preferred shareholders'
portion of undistributed net income. Undistributed net income is computed by
deducting preferred stock dividends and common stock dividends from net
income. Undistributed net income is shared equally by the preferred and common
shareholders on a pro rata basis. Common stock dividends are calculated up to
25% of adjusted net income or an amount equal to the preferred stock dividend,
whichever is less. Diluted earnings per share is computed by reducing net
income for an increase to net earnings allocated to minority shareholders and
dividing such net income available to common and preferred shareholders by the
monthly weighted-average number of common and preferred shares outstanding
during the period. The weighted-average (thousand) shares outstanding for
diluted earnings per share is not greater than such shares used in the basic
earnings per share calculation since the dilutive share issue is that of the
Holding Company's subsidiaries, as indicated below.
The weighted-average number of common and preferred shares used in computing
basic earnings per share for 1997 was 124,351,903 thousand and 196,311,647
thousand (exclusive of the 13,718,350 thousand preferred shares resulting from
the settlement in April 1998 with Telebras), respectively. The Companies have
received certain contributions from customers or customers have independently
paid suppliers of telecommunication equipment and services for the
installation of fixed line services. These amounts are reflected as "funds for
capitalization" in the accompanying combined balance sheets. Once the
installation is essentially complete and the contributions have been received,
the funds will be converted into equity (see Note 23 to the combined financial
statements). These activities are dilutive in nature to the shareholders of
the Holding Company or the Companies, whether the shares to be issued are
those of the Holding Company's subsidiaries (which will impact the minority
interest recognized) or of the company itself. The expectation is that the
shares would be issued in the subsidiary companies rather than in the Holding
Company based on the manner in which such shares were issued in 1997 and 1998.
Management of the Holding Company determined this manner of issuing the shares
in these two years was appropriate as a result of the dilution of the
Brazilian Governments share of the ordinary voting shares of the Holding
Company below the 50% level which would have occurred if the shares had been
issued by the Holding Company. The shares are treated as outstanding and
included in the basic EPS calculation only when such funds are converted to
equity and the shares issued. The shares are treated as outstanding for
diluted EPS purposes when expansion plan contributions are received or when
Community Expansion Plan agreements have been approved (see note 23). If
subsidiary shares had been issued historically, the reduction to net income to
increase net earnings attributable to minority shareholders for 1996 and 1997
would have been R$58,463 and R$39,286, respectively.
The Company's preferred shares are non-voting except under certain limited
circumstances and are entitled to a preferential, noncumulative dividend and
to priority over the common shares in the event of liquidation of the Company.
The preferred shareholders were entitled to a non-cumulative dividend of
R$0.50 and R$0.60 per preferred share in 1996 and 1997, respectively. The
preferred shareholders would share equally in the undistributed earnings of
the Company in the amount of R$1.44 and R$1.50 per preferred share in 1996 and
1997, respectively.
F-36
<PAGE>
TELE CENTRO SUL PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of constant Brazilian reais of December 31,
1997)
In April 1998, resolution was reached on the disputed capital increase of
1990 (see Note 28). In connection with the resolution, the Company issued
13,718,350 shares of preferred stock. For Brazilian GAAP and US GAAP, such
shares are considered outstanding when issued.
Earnings per share has been presented for net income only since interest
income, certain interest expense and social contribution taxes have not been
allocated between income from continuing operations and income from
discontinued operations.
F. DISCLOSURE REQUIREMENTS
US-GAAP disclosure requirements differ from those required by Brazilian
GAAP. However, in these combined financial statements, the level of disclosure
has been expanded to comply with US GAAP.
G. INCOME TAXES
The Companies fully accrue for deferred income taxes on temporary
differences between tax and reporting records. The existing policies for
providing for deferred taxes are substantially in accordance with SFAS 109.
"Accounting for Income Taxes", except in connection with the deferred income
tax effects of indexation adjustments in 1996 and 1997 (see Note 2(a)(iii)).
Under US GAAP the deferred tax effects of the 1996 and 1997 indexation for
financial reporting purposes would be charged to income and social
contribution taxes in the combined statement of income. Consequently, this is
the only material difference in the implementation of SFAS 109 other than in
relation to the US GAAP adjustments described in this note to the combined
financial statements, and for the fact that deferred income taxes are shown
gross rather than being netted as required by US GAAP. Additionally, for US
GAAP purposes, deferred tax assets and liabilities are classified as current
or non current based on the classification of the asset or liability
attributing to the temporary difference.
H. INTEREST INCOME (EXPENSE)
Brazilian GAAP requires interest to be shown as part of operating income.
Under US GAAP interest income (expense) would be shown after operating income.
I. EMPLOYEES' PROFIT SHARE
Brazilian GAAP requires employees' profit share to be shown as an
appropriation of net income for the year. Under US GAAP employee profit
sharing is included as an expense in arriving at operating income.
J. PERMANENT ASSETS
Brazilian GAAP has a class of assets called permanent assets. This is the
collective name for all assets on which indexation adjustments were calculated
in the corporate and fiscal law accounts of Brazilian companies. Under US GAAP
the assets in this classification would be noncurrent assets.
Gain (losses) on the disposal of permanent assets were R$19,117 and
R$(4,871) and R$(20,751) in 1995, 1996 and 1997, respectively. Such gains
(losses) are classified as non-operating income for Brazilian GAAP. Under US
GAAP, such gains (losses) would increase/reduce operating income.
K. PRICE-LEVEL ADJUSTMENTS AND US GAAP PRESENTATION
The effects of price-level adjustments have not been eliminated in the
reconciliation to US GAAP, nor are the monetary gains or losses associated
with the various US GAAP adjustments separately identified, because the
F-37
<PAGE>
TELE CENTRO SUL PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of constant Brazilian reais of December 31,
1997)
application of inflation restatement as measured by the UFIR and the IGP-M
represents a comprehensive measure of the effects of price level changes in
the Brazilian economy and, as such, is considered a more meaningful
presentation than historical cost-based financial reporting for both Brazilian
and US accounting purposes.
L. FUNDS FOR CAPITALIZATION
i. Expansion plan contributions
Under Brazilian GAAP, expansion plan contributions received are included in
the consolidated balance sheet below equity until proposed subscribers have
paid for their telephone connection in full and a general meeting of
shareholders approves the capital increases. Until December 31, 1995 expansion
plan contributions were indexed from the month received to the date of the
next audited balance sheet and transferred to equity when capital stock was
issued to the subscriber, at a value per share equal to the equity value per
share shown on the latest audited balance sheet.
From January 1, 1996 indexation was no longer applied and, for contracts
signed as from that date, Telesp was allowed the option of using a value per
share equal to the market value, when this is higher than the equity value.
For US GAAP purposes, a portion of the expansion plan contributions would be
allocated to shareholders' equity based on the market value of the shares to
be issued to subscribers. The remainder of the expansion plan contributions
would be classified as a deferred credit and amortized to reduce depreciation
expense from the time the related construction-in-progress is completed.
ii. Donations and subsidies for investments
Under Brazilian GAAP those amounts, which comprise principally the excess of
the value of property, plant and equipment incorporated into the Company's
assets over the corresponding credits to expansion plan contributions
received, are recorded as a credit to other capital reserves. For US GAAP
purposes, the credit to capital reserves would be classified as a deferred
credit and amortized to reduce depreciation expense.
M. LOANS AND FINANCING
For US GAAP, loans and financing balances in default or expected to be in
default within a year of the balance sheet date would be classified as current
obligations unless creditors had provided the Company waivers for such
defaults. For Brazilian GAAP, loan and financing balances in technical default
are not always classified as current liabilities. A portion (R$45,912) of the
Company's outstanding debt at December 31, 1997 is currently in default or is
expected to be in default as a result of the privatization and accordingly,
for US GAAP, would be classified as current liabilities.
N. VALUATION OF LONG-LIVED ASSETS
For US GAAP, effective January 1, 1996 the Company adopted SFAS 121
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets
to Be Disposed Of." In accordance with this standard, the Company periodically
evaluates the carrying value of long-lived assets to be held and used, when
events and circumstances warrant such a review. The carrying value of long-
lived assets are 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. The
adoption of this standard did not have a material effect on the Company's
results or financial condition.
F-38
<PAGE>
TELE CENTRO SUL PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of constant Brazilian reais of December 31,
1997)
Brazilian GAAP does not require cash flow computations in order to determine
potential asset impairment.
O. RETAINED EARNINGS
For Brazilian GAAP, a company formed as a result of a cisao may have
retained earnings in its balance sheet if the parent company shareholders'
resolution adopting the cisao allocates retained earnings from the parent
company to the new company. Under 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." As a result of the May 22, 1998 spin-
off, the Company will have US GAAP distributable capital of R$1,394,352.
P. RECOGNITION OF GAINS FROM DISPUTED TAXES
Brazilian GAAP is less rigorous than US GAAP is establishing the criteria
which must be met for the recognition of a gain such as the R$8,884 and
R$6,194, recognized by the Company in 1995 and 1996, respectively in relation
to overpaid FINSOCIAL taxes (see Note 20). Under US GAAP these amounts which
total R$15,078 would be considered gain contingencies which would not be
recognized until receipt of the benefits were considered full and final.
F-39
<PAGE>
TELE CENTRO SUL PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of constant Brazilian reais of December 31,
1997)
NET INCOME RECONCILIATION OF THE DIFFERENCES BETWEEN US AND BRAZILIAN GAAP
<TABLE>
<CAPTION>
1996 1997
----------- -----------
<S> <C> <C>
Income from continuing operations before unallocated
interest income/expense, taxes and minority interest
as reported......................................... 530,542 568,134
Add (deduct):
Different criteria for:
Capitalized interest............................... (98,103) (91,916)
Amortization of capitalized interest............... 37,328 41,304
Contributions to plant expansion:
Amortization of deferred credit.................... 24,535 32,343
Reversal of COFINS tax credit....................... (6,194) --
Items posted directly to shareholders' equity:
Interest on construction in progress............... 115,546 107,584
----------- -----------
US GAAP income from continuing operations before
unallocated interest income/expense, income taxes
and minority interests.............................. 603,654 657,449
----------- -----------
Income as reported from discontinued cellular
operations before unallocated interest
income/expense, income taxes and minority
interests........................................... 297,274 341,636
Effect of US GAAP differences on income from
discontinued operations............................. 13,802 20,949
----------- -----------
US GAAP income from discontinued operations before
unallocated interest income/expense, income taxes
and minority interests.............................. 311,076 362,585
----------- -----------
Items relating to continuing and discontinued
operations:
Unallocated interest income......................... 60,612 61,913
Unallocated interest expense........................ (1,488) (2,870)
Income and social contribution taxes................ (231,713) (266,949)
Minority interests, Brazilian GAAP basis............ (92,925) (138,599)
Items posted directly to shareholder's equity:
Effects of changes in income tax rates............ 2,286 13,241
Fiscal tax incentive investments credits.......... 21,936 44,794
Deferred tax on full indexation................... (159,593) (150,147)
Deferred tax effects of the above adjustments:
In respect of continuing operations................ 56,977 20,680
In respect of discontinued operations.............. 2,807 (480)
Minority interest in above adjustments............... 45,669 72,126
----------- -----------
US GAAP net income................................... 619,298 673,743
=========== ===========
NET INCOME PER THOUSAND SHARES IN ACCORDANCE WITH US GAAP
Common shares--Basic................................. 1.93 2.10
Weighted average (thousand) common shares
outstanding....................................... 124,351,903 124,351,903
=========== ===========
Common shares--Diluted............................... 1.75 1.98
Weighted average (thousand) common shares
outstanding....................................... 124,351,903 124,351,903
=========== ===========
Preferred shares--Basic.............................. 1.93 2.10
Weighted average (thousand) preferred shares
outstanding....................................... 196,311,647 196,311,647
=========== ===========
Preferred shares--Diluted............................ 1.75 1.98
Weighted average (thousand) preferred shares
outstanding....................................... 196,311,647 196,311,647
=========== ===========
</TABLE>
F-40
<PAGE>
TELE CENTRO SUL PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 31)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of constant Brazilian reais of December 31,
1997)
SHAREHOLDERS EQUITY RECONCILIATION OF THE DIFFERENCES BETWEEN US AND BRAZILIAN
GAAP
<TABLE>
<CAPTION>
1996 1997
---------- ----------
<S> <C> <C>
Total shareholders' equity as reported.................. 4,968,654 5,410,826
Add (deduct):
Different criteria for:
Capitalized interest.................................. (609,231) (701,148)
Amortization of capitalized interest.................. 266,257 307,561
Reversal of proposed dividends......................... 161,770 192,851
Reversal of COFINS tax credit.......................... (15,078) (15,078)
Contributions to plant expansion:
Amortization of deferred credit....................... 52,566 84,909
Subscribed capital stock.............................. 59,205 (130,731)
Donations and subsidies for investment................ (40,435) (60,736)
Deferred tax effects of the above adjustments.......... 208,178 228,858
Adjustments in respect of discontinued operations:
Adjustments before income taxes....................... (25,247) (23,794)
Deferred tax effects of these adjustments............. 8,332 7,852
Minority interest in above adjustments................. (7,913) 19,280
---------- ----------
US GAAP shareholders' equity........................... 5,027,058 5,320,650
========== ==========
US GAAP supplementary information:
Total assets........................................... 7,378,435 8,300,284
========== ==========
Property, plant and equipment.......................... 11,182,995 12,003,247
Accumulated depreciation............................... (5,562,838) (5,952,315)
---------- ----------
Net property, plant and equipment...................... 5,620,157 6,050,932
========== ==========
</TABLE>
The deferred tax effect of the US GAAP adjustments noted above would
principally be classified as noncurrent on the balance sheet.
F-41
<PAGE>
TELE CENTRO SUL PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of constant Brazilian reais of December 31,
1997)
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY IN ACCORDANCE WITH
US-GAAP
<TABLE>
<CAPTION>
CAPITAL AND RETAINED
RESERVES EARNINGS TOTAL
----------- --------- ---------
<S> <C> <C> <C>
Balances at December 31, 1995............... 3,284,976 1,148,382 4,433,358
Capital increase:
Cash....................................... 24,157 -- 24,157
Expansion plan contributions:
Received................................... 216,795 -- 216,795
Deferred credits........................... (84,655) -- (84,655)
Realization of unrealized income............ (32,043) 32,043 --
Transfers to reserves....................... 32,432 (32,432) --
Forfeited dividends......................... -- (69) (69)
Net income.................................. -- 619,298 619,298
Dividends paid.............................. -- (89,456) (89,456)
Dividends declared but unclaimed............ -- (3,935) (3,935)
Minority interest on all movements in
shareholders' equity except for net
income..................................... (45,453) (42,982) (88,435)
--------- --------- ---------
Balances at December 31, 1996............... 3,396,209 1,630,849 5,027,058
Capital increase:
Cash....................................... 40,327 -- 40,327
Expansion plan contributions:
Received................................... 182,258 -- 182,258
Deferred credits........................... (24,096) -- (24,096)
Realization of unrealized income............ (26,864) 26,864 --
Transfers to reserves....................... 35,789 (35,789) --
Forfeited dividends......................... -- 1,187 1,187
Net income.................................. -- 673,743 673,743
Dividends paid.............................. -- (157,226) (157,226)
Dividends declared but unclaimed............ -- (4,544) (4,544)
Minority interest on all movements in
shareholders' equity except for net
income..................................... (262,473) (155,584) (418,057)
--------- --------- ---------
Balances at December 31, 1997............... 3,341,150 1,979,500 5,320,650
========= ========= =========
</TABLE>
30. ADDITIONAL DISCLOSURES REQUIRED BY US GAAP
A. POST-RETIREMENT BENEFITS
The Companies, together with other companies in the Telebras group, sponsor
multi-employer defined benefit pension and other post-retirement benefit
plans, which are operated and administered by Sistel. The funded status of the
Sistel pension and other post-retirement benefit plans and the related
actuarial assumptions in accordance with US GAAP are as follows:
<TABLE>
<CAPTION>
1996 1997
Pension benefit plan ---------- ----------
<S> <C> <C>
Funded status
Accumulated benefit obligation:
Vested........................................... 1,793,943 1,919,975
Non vested....................................... 3,250,909 3,479,300
---------- ----------
Total.......................................... 5,044,852 5,399,275
========== ==========
Projected benefit obligation...................... 6,636,907 7,258,074
Fair value of plan assets......................... (3,430,572) (3,897,051)
---------- ----------
Projected obligation in excess of assets.......... 3,206,335 3,361,023
========== ==========
The actuarial assumptions used were as follows:
Discount rate for determining projected benefit
obligations...................................... 6.00% 6.00%
Rate of increase in compensation levels........... 3.25% 3.25%
Expected long-term rate of return on plan assets.. 6.00% 6.00%
</TABLE>
The above are real rates and exclude inflation.
F-42
<PAGE>
TELE CENTRO SUL PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of constant Brazilian reais of December 31,
1997)
Amortization of the unrecognized liability at transaction: 18.94 years
commencing on January 1, 1991.
<TABLE>
<CAPTION>
1996 1997
Other post-retirement benefits plan --------- ---------
<S> <C> <C>
Funded status:
Accumulated post-retirement benefit obligations:
Retirees and dependents.............................. 371,125 380,561
Fully eligible active plan participants.............. 32,631 34,589
Other active plan participants....................... 885,917 997,791
--------- ---------
1,289,673 1,412,941
Fair value of plan assets............................ (76,600) (96,141)
--------- ---------
Funded status........................................ 1,213,073 1,316,800
========= =========
</TABLE>
Amortization of the unrecognized liability at transition: 18.84 years
commencing on January 1, 1992.
Health care cost trend rates of increase were projected at annual rates
excluding inflation ranging from 6.48% in 1998 decreasing to 2.00% in 2047.
The effect of a one percent annual increase in the assumed health care cost
trend rates would increase the accumulated post-retirement benefits obligation
at December 31, 1997 by R$237,063. Measurement of the accumulated post-
retirement benefit obligation was based on the same assumptions as were used
in the pension calculations.
The funded status of the pension and post retirement plans under Brazilian
and US GAAP differ. Benefit obligations differ because they have been prepared
using different actuarial assumptions permitted under Brazilian and US GAAP.
The net assets of the plans differ under Brazilian and US GAAP principally
due to the accrual of income tax contingencies of the pension fund for US GAAP
purposes in the amount of R$400,370 and R$487,269 in 1996 and 1997,
respectively. The contingency arises out of uncertainty as to the income tax
status of Brazilian pension funds in general because the tax law is unclear as
to whether these funds are exempt from tax on their investment gains. Under
Brazilian GAAP two methods of accounting for the income tax contingency are
currently permitted. The tax is either deducted from plan assets for the
purposes of determining the funded status of the plan or it is not deducted,
but is disclosed in a note as being a contingency. Management of the pension
fund have determined that the Brazilian GAAP financial statements of the fund
be prepared on the basis that the legal arguments against assessment of the
tax on the investment gains are sufficiently strong as to avoid the need for
the potential liability to be recognized. However, for US GAAP purposes,
management of the Company believe that the assessment of this potential income
tax liability is probable. Accordingly, in determining the funded status for
US GAAP purposes, the potential income tax liability (calculated in accordance
with SFAS 109) has been deducted from the fair value of the plan assets.
B. CONCENTRATION OF RISK
The Companies are prohibited from investing any surplus cash balances in
financial instruments other than government securities controlled by the
Central Bank of Brazil or the Federal Government owned bank, Banco do Brasil
S.A. There have been no losses in cash equivalents.
Credit risk with respect to customer accounts receivable is diversified. The
Companies continually monitor the level of customer accounts receivable and
limit the exposure to bad debts by cutting access to the telephone network if
any invoice is one month past-due. Exceptions comprise telephone services that
must be maintained for reasons of safety or national security.
For conducting their business, the Companies are fully dependent upon the
fixed-line telecommunications concession as granted by the Federal Government.
F-43
<PAGE>
TELE CENTRO SUL PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 28)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of constant Brazilian reais of December 31,
1997)
Approximately 80.32% of all employees are members of state labor unions
associated either with the Federaco Nacional dos Trabalhadores em
Telecomunicacoes ("Fenattel"), or with the Federacao Interestadual dos
Trabalhadores em Telecomunicacoes ("Fittel"). Management negotiates new
collective labor agreements every year with the local unions. The collective
agreements currently in force expire in November 1998.
There is no concentration of available sources of labor, services,
concessions or rights, other than those mentioned above, that could, if
suddenly eliminated, severely impact the Companies' operations.
C. NEW ACCOUNTING PRONOUNCEMENTS
SFAS NO. 130, "REPORTING COMPREHENSIVE INCOME"
SFAS No. 130 establishes the standards for reporting and displaying
comprehensive income and its components (revenues, expenses, gains and losses)
as part of a full set of financial statements. This statement requires that
all elements of comprehensive income be reported in a financial statement that
is displayed with the same prominence as other financial statements.
SFAS NO. 131, "DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED
INFORMATION"
SFAS No. 131 establishes the standards for the manner in which public
enterprises are required to report financial and descriptive information about
their operating segments. The standard defines operating segments as
components of an enterprise for which separate financial information is
available and evaluated regularly as a means for assessing segment performance
and allocating resources to segments. A measure of profit or loss, total
assets and other related information are required to be disclosed for each
operating segment. In addition, this standard requires the annual disclosure
of information concerning revenues derived from the enterprise's products or
services; countries in which it earns revenues or hold assets, and major
customers.
SFAS NO. 132, "EMPLOYERS' DISCLOSURES ABOUT PENSIONS AND OTHER POST-RETIREMENT
BENEFITS"
SFAS No. 132 revises and standardizes employers' disclosures about pension
and other post-retirement benefit plans. It does not change the measurement or
recognition of those plans.
The Company will comply with the requirements of SFAS No. 130, 131 and 132 in
1998.
F-44
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT AUDITORS
The Board of Directors
Tele Centro Sul Participacoes S.A.
We hereby consent to the use of our report included herein.
/s/ KPMG Peat Marwick
Brasilia, Brazil
October 29, 1998
