<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON NOVEMBER 2, 1998.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------
(MARK ONE) FORM 20-F/A
[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: 001-14483
TELEMIG CELULAR PARTICIPACOES S.A.
(Exact name of Registrant as specified in its charter)
TELEMIG CELLULAR HOLDING COMPANY
(Translation of Registrant's name into English)
THE FEDERATIVE REPUBLIC OF BRAZIL
(Jurisdiction of incorporation or organization)
SCN-QUADRA CN2, LOTE F, 2(degrees) ANDAR, SALA 205
BRASILIA-DF, BRAZIL
(Address of principal executive offices)
SECURITIES REGISTERED OR TO BE REGISTERED PURSUANT TO SECTION 12(B) OF THE
ACT:
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TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
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<S> <C>
Preferred Shares, without par
value.......................... New York Stock Exchange*
</TABLE>
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* 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>
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PAGE
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<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......................................... 26
ITEM 3. Legal Proceedings............................................... 26
ITEM 4. Control of Registrant........................................... 27
ITEM 5. Nature of Trading Market........................................ 27
ITEM 6. Exchange Controls and Other Limitations Affecting Security
Holders........................................................ 30
ITEM 7. Taxation........................................................ 31
ITEM 8. Selected Financial Data......................................... 36
ITEM 9. Management's Discussion and Analysis of Financial Condition and
Revenues and
Expenses....................................................... 40
ITEM 9A. Quantitative and Qualitative Disclosures about Market Risk...... 55
ITEM 10. Directors and Officers of Registrant............................ 55
ITEM 11. Compensation of Directors and Officers.......................... 59
ITEM 12. Options to Purchase Securities from Registrant or Subsidiaries.. 59
ITEM 13. Interest of Management in Certain Transactions.................. 59
PART II
ITEM 14. Description of Securities to be Registered...................... 60
PART III
ITEM 15. Defaults upon Senior Securities................................. 73
ITEM 16. Changes in Securities and Changes in Security for Registered
Securities..................................................... 73
PART IV
ITEM 17. Consolidated Financial Statements............................... 73
ITEM 18. Consolidated Financial Statements............................... 73
ITEM 19. Consolidated Financial Statements and Exhibits.................. 73
</TABLE>
i
<PAGE>
PRESENTATION OF INFORMATION
OVERVIEW
Telemig Celular 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"), 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 subsidiaries 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 domestic and international long-distance operator. The restructuring
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. 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 of Telemig Celular S.A.
("Telemig Cellular") held by Telebras (representing 82.9% of the total share
capital of Telemig Cellular) was transferred to the Registrant. Telemig
Cellular is the primary provider of cellular telecommunications services in a
region that includes 93% of the municipalities in the state of Minas Gerais
and approximately 89.3% of the population of the state of Minas Gerais.
Telemig Cellular was formed on January 5, 1998 and on January 30, 1998
Telecomunicacoes de Minas Gerais S.A. ("Telemig"), the telecommunications
company for the state of Minas Gerais, spun off the assets and liabilities
associated with its cellular telecommunications operations to Telemig Cellular
effective January 1, 1998. See "Description of Business--The Company."
Substantially all of the Registrant's assets are shares of its operating
subsidiary. The Registrant relies almost exclusively on dividends from its
subsidiary to meet its needs for cash, including for the payment of dividends
to its shareholders. See "Management's Discussion and Analysis of Financial
Condition and Revenues and Expenses--Liquidity and Capital Resources."
As used herein, the "Company" refers to the Registrant and its consolidated
subsidiary Telemig Cellular.
PRESENTATION OF FINANCIAL INFORMATION
FINANCIAL STATEMENTS AND MINORITY INTERESTS
The audited consolidated statements of financial condition included herein
as of December 31, 1996 and 1997 and the related statements of revenues and
expenses, net interdivisional cash distribution (receipt) and changes in
divisional equity for each of the years ended December 31, 1995, 1996 and 1997
(including the notes thereto, the "Consolidated Financial Statements") present
the financial condition of the Registrant and the cellular telephone business
of Telemig, which was spun-off into the Registrant's subsidiary, Telemig
Cellular, effective January 1, 1998. The portion of the consolidated equity
and income before interest income, unallocated interest expense and taxes of
the Company attributable to shareholders of the Company 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 17.1% of the share capital of
Telemig. Substantially all such share capital is comprised of preferred shares
originally issued from time to time by Telemig in connection with its 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 that
ii
<PAGE>
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 "Management's Discussion and Analysis of
Financial Condition and Revenues and Expenses--Revenues and Expenses for the
years ended December 31, 1995, 1996 and 1997--Minority interests."
Cash and certain nonspecific debt relating to the cellular telephone
operations of Telemig could not be segregated from Telemig prior to December
31, 1997 and such amounts are not reflected in the Consolidated Financial
Statements. As a result, interest income, unallocated interest expense and
income tax expense relating to the cellular telecommunications business of
Telemig could not be identified and reflected in the Consolidated Financial
Statements. See "Management's Discussion and Analysis of Financial Condition
and Revenues and Expenses--Revenues and Expenses for the years ended December
31, 1995, 1996 and 1997--Allocated interest expense."
FORMATION OF REGISTRANT
The formations of the Registrant and Telemig Cellular 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 business of Telemig were transferred to Telemig Cellular at
their indexed historical cost. The revenues and expenses associated with such
assets and liabilities were also allocated to Telemig Cellular. Separate
records of revenues from the cellular telecommunications business of Telemig
were maintained historically. Accordingly, actual amounts were allocated for
the periods included herein. The Consolidated Statements of Revenues and
Expenses and Net Interdivisional Cash Distribution (Receipt) have been
prepared to include the historical activity related to the assets and
liabilities transferred. The Consolidated Financial Statements are not
necessarily indicative of what would have been the financial position and
revenues and expenses of the Company as of December 31, 1996 and 1997 and for
the three year period ended December 31, 1997 had the cellular
telecommunications business of Telemig been a separate legal entity during
such periods. See "Description of Business--Background," "--The Company" and
Notes 1, 2 and 23 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 Telemig Celular 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
Holding Companies. The assets which were spun-off from Telebras, in addition
to its investment in the operating subsidiary, resulted in an increase of
R$73,240 thousand in relation to the Company's historical divisional equity.
See Note 23 to the Consolidated Financial Statements. Allocated retained
earnings and future retained earnings will be the basis from which future
dividends will be payable.
EFFECTS OF INFLATION
The Consolidated Financial Statements contained herein are presented in
Brazilian reais and were prepared in accordance with generally accepted
accounting principles in Brazil ("Brazilian GAAP"). Pursuant to Brazilian
GAAP, the Consolidated Financial Statements and the other financial
information presented herein recognize certain effects of changes in the
purchasing power of Brazilian currency due to inflation and, unless otherwise
specified, have been indexed and expressed in constant reais of December 31,
1997 purchasing power by using the daily changes or the monthly average values
of the Unidade Fiscal de Referencia (the Tax Reference Unit or the "UFIR")
through December 31, 1995. See Note 2a to the Consolidated Financial
Statements.
iii
<PAGE>
Until December 31, 1995, the relevant inflation index selected by the
Comissao de Valores Mobiliarios (the Brazilian Securities Commission or
"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 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 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.
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.
CURRENCY TRANSLATIONS
All references herein to (i) the "real," "reais" or "R$" are to Brazilian
reais (plural) and to the Brazilian real (singular), the official currency of
Brazil and (ii) "U.S. dollars," "dollars" or "US$" are to United States
dollars. As of July 1, 1994, the denomination of the Brazilian currency unit
was changed to the real from the cruzeiro real (each real being equal to 2,750
cruzeiros reais at such time). All amounts in cruzeiros reais have been
restated in reais in this Registration Statement. Certain amounts herein may
not sum due to rounding.
This Registration Statement contains translations of certain real amounts
into U.S. dollars solely for the convenience of the reader. These translations
should not be construed as representations that the real amounts actually
represent such U.S. dollar amounts or could be or could have been converted
into U.S. dollars at the rate indicated. Unless otherwise indicated, such U.S.
dollar amounts have been translated from reais at the commercial buying rate
for the purchase of U.S. dollars (the "Commercial Market Rate") published by
Banco Central do Brasil (the "Central Bank of Brazil") for December 31, 1997,
which was R$1.1164 to US$1.00. The noon buying rate in New York City for cable
transfers in reais as certified by the Federal Reserve Bank of New York has
not been consistently reported for Brazilian currency during the periods for
which data are presented in this Registration Statement. See "Exchange Rates"
for information regarding rates of exchange.
MARKET INFORMATION
Upon the Breakup of Telebras, holders of common and preferred Telebras
shares ("Telebras Common Shares" and "Telebras Preferred Shares" and,
together, "Telebras Shares") were deemed under Brazilian law to own, in
addition to such Telebras Shares, one common or preferred share, as
applicable, of each New Holding Company for each such Telebras Share held by
them. Following the Breakup and until September 21, 1998, the Telebras Common
Shares and the common shares of the New Holding Companies traded only as a
unit on the Bolsa de Valores de Sao Paulo (the "Sao Paulo Stock Exchange"),
the Bolsa de Valores do Rio de Janeiro (the "Rio de Janeiro Stock Exchange")
and the seven other Brazilian stock exchanges (together with the Sao Paulo
Stock Exchange and the Rio de Janeiro Stock Exchange, the "Brazilian Stock
Exchanges"). Similarly, the Telebras Preferred Shares and the preferred shares
of the New Holding Companies traded only as a unit on the Brazilian Stock
Exchanges during this period. Telebras American Depositary Shares ("Telebras
ADSs"), each originally representing ownership of 1,000 Telebras Preferred
Shares, have continued to trade on the New York Stock Exchange, Inc. ("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
Holdings 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
iv
<PAGE>
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 20,000 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.
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Cell splitting: The process of dividing cells into smaller coverage areas by
reducing the power output and the antenna height of the base station
transmitter. Cell splitting increases capacity in a particular area by
allowing for the further reuse of frequencies by a mobile communications
system.
Cellular service: A mobile telephone service provided by means of a network
of interconnected low-powered base stations, each of which covers one small
geographic cell within the total cellular system service area.
Channel: One of a number of discrete frequency ranges utilized by a base
station.
Digital: A mode of representing a physical variable such as speech using
digits 0 and 1 only. The digits are transmitted in binary form as a series of
pulses. Digital networks allow for higher capacity and higher flexibility
through the use of computer-related technology for the transmission and
manipulation of telephone calls. Digital systems offer lower noise
interference and can incorporate encryption as a protection from external
interference.
Digital penetration: The substitution of equipment capable of transmitting
digital signals for equipment limited to analog transmission.
Exchange: See Switch.
Frame relay: A data transmission service using fast protocols based on
direct use of transmission lines.
Internet: A collection of interconnected networks spanning the entire world,
including university, corporate, government and research networks from around
the globe. These networks all use the IP (Internet Protocol) communications
protocol.
ISDN (Integrated Services Digital Network): A system in which several
services (e.g., speech and data) may be simultaneously transmitted end-to-end
in digital form.
Leased high-speed data communication: The digital exchange of information at
speeds exceeding 64Kbps transmitted through mediums that are leased to users
for their exclusive use.
Local loop: The system used to connect the subscriber to the nearest switch.
It generally consists of a pair of copper wires, but may also employ fiber-
optic circuits, microwave links or other technologies.
Manual international roaming: A service that permits a subscriber to use his
or her cellular phone on a foreign cellular operator's network. The subscriber
may only receive calls made to a temporary number issued to the subscriber by
the foreign operator for use while roaming.
Microcells: A small cell covered by a low-power base station. Microcells can
cover small areas such as a single building.
Network: An interconnected collection of elements. In a telephone network,
these consist of switches connected to each other and to customer equipment.
The transmission equipment may be based on fiber optic or metallic cable or
point-to-point radio connections.
Network usage charge: Amount paid per minute charged by network operators
for the use of their network by other network operators. Also known as an
"access charge" or "interconnection charge".
Optical fiber: A transmission medium which permits extremely high
capacities. It consists of a thin strand of glass that provides a pathway
along which waves of light can travel for telecommunications purposes.
vii
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Packet-switched data communication services: Data services based on
parceling or breaking the data stream into packets and switching the
individual packets. Information transmitted is segmented into cells of a
standardized length, which are then transmitted independently of one another,
allowing maximization of available capacity and usage of a single transmission
path for multiple communications. The cells are then reassembled upon reaching
their destination.
PBX (Private Branch Exchange): Telephone switchboard for private use, but
linked to the national telephone network.
Penetration: The measurement of the take-up of services. 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 hierarchical set of digital transport
structures, standardized for the transport of suitably adapted payloads over
physical transmission networks.
Sectorization: The process of dividing cells into sectors by using
directional antennae at the base station. Sectorization reduces co-channel
interference which permits smaller cells and increases network capacity.
Switch: These are used to set up and route telephone calls either to the
number called or to the next switch along the path. They may also record
information for billing and control purposes.
TDMA (Time Division Multiple Access): A standard of digital cellular
technology.
Universal service: The obligation to supply basic service to all users
throughout the national territory at reasonable prices.
Value Added Services: Value Added Services provide additional functionality
to the basic transmission services offered by a telecommunications network.
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 cruzeiro 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 and R$1.22 per US$1.00. As of October 23, 1998, the trading band has
not been reset by the Central Bank of Brazil.There can be no assurance that
the band will not be altered in the future or that the real will maintain its
current exchange rate in future periods.
The following table sets forth the Commercial Market Rate expressed in reais
per U.S. dollar for the periods and dates indicated. Prior to July 14, 1994,
the Federal Reserve Bank of New York did not publish a noon buying rate for
customs purposes in the City of New York for cable transfers in the Brazilian
real and its predecessor currencies (the "Noon Buying Rate").
<TABLE>
<CAPTION>
COMMERCIAL MARKET RATE:
NOMINAL REAIS PER US$1.00(1)
-----------------------------------
YEAR ENDED DECEMBER 31, LOW HIGH AVERAGE(2) PERIOD-END
- ----------------------- ------ ------ ---------- ----------
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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>
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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
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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 operating
subsidiaries, the Telebras System was the primary provider of local and
intrastate telecommunications service and the leading provider of cellular
mobile telephone service. The Telebras System also provided
telecommunications-related services, such as data communication, sound and
image transmission and other value-added services throughout Brazil. 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 as of January 1, 1998 into a separate company.
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 Brazilian regulation of the telecommunications industry. In August 1995,
the federal Constitution was amended to permit the Federal Government to grant
concessions to private companies to provide telecommunications services. In
July 1997, the federal Congress adopted Law No. 9,472 of July 16, 1997, the
Lei Geral de Telecomunicacoes (the "Telecommunications Law"), which provided
for the establishment of a new regulatory framework, the introduction of
competition and the privatization of the Telebras System. The
Telecommunications Law established an independent regulatory agency called
Agencia Nacional de Telecomunicacoes ("Anatel"), which has begun to adopt a
series of regulatory 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 of the Telebras
System, the Telebras System was restructured to form, in addition to Telebras,
the twelve New Holding Companies. Virtually all the assets and liabilities of
Telebras were allocated to the New Holding Companies which, together with
their respective subsidiaries, comprise (a) three regional fixed-line
operators, (b) eight regional cellular operators (including the Company) 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-
1
<PAGE>
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.
On July 29, 1998 the Federal Government sold to twelve buyers (the "New
Controlling Shareholders") its rights to receive shares of the twelve New
Holding Companies upon the distribution of such shares. The total
consideration to be paid to the Federal Government for the twelve New Holding
Companies is R$22.1 billion. In connection with this sale, the Federal
Government assigned to the New Controlling Shareholders all its economic and
voting rights with respect to the New Holding Companies and, as a consequence,
the New Controlling Shareholders now control the New Holding Companies.
Following the distribution of the shares of the New Holding Companies,
Telebras is expected to be delisted from the New York Stock Exchange and
liquidated.
The New Controlling Shareholder of the Registrant is Telpart Participacoes
S.A. ("Telpart"), a company owned by TIW do Brasil Ltda. (49%), Opportunity
MEM S.A. (27%) and a group of five Brazilian pension funds 24%. For a
description of the business activities of the shareholders of Telpart, see
"Control of Registrant." Telpart agreed to pay R$756 million for the Federal
Government's stake in the Registrant, R$302.4 million of which was paid on
August 4, 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 Telecommunications
Regulations has lead, 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 (i) the establishment of
an independent regulator and the development of comprehensive regulation of
the telecommunications sector, (ii) the Breakup of Telebras, (iii) the sale of
a controlling interest in the Registrant to one or more new investors and (iv)
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.
BAND A AND BAND B
Brazilian regulation allows cellular services to be offered within two
frequency ranges of the radio spectrum. These two frequency ranges are
referred to as "Band A" and "Band B" by Anatel. Band A is the frequency range
used by all of the former companies of the Telebras System, including the
Company, and by four independent companies that operate in discrete
geographical areas not covered by the Telebras System. Band B is the frequency
range used by all new competitors. No cellular operators may offer services
outside of Band A and Band B and no more than one operator may provide
cellular service within a given geographical area for each of Band A and Band
B. To the extent that the geographic areas represented by Band B concessions
differ from the Region in which the Company operates, more than one Band B
operator may compete with the Company (although each of such Band B operators
would be operating within a distinct geographical area and not competing with
each other). See "--Regulation of the Brazilian Telecommunications Industry--
Concessions and Licenses."
2
<PAGE>
THE COMPANY
The Company is the primary provider of cellular telecommunications services
in a region that includes 93% of the municipalities in the state of Minas
Gerais and approximately 89.3% of the population of the state of Minas Gerais
(the "Telemig Cellular Region" or the "Region"). Since the Company began to
offer cellular telecommunications services in April 1993, there has been
significant growth in subscriber levels and revenue. At December 31, 1996 and
December 31, 1997, the Company had 233,042 and 427,815 subscribers,
respectively. From December 31, 1994 to December 31, 1997, the Company's
penetration level, or proportion of the population of the Region that
subscribes to the Company's cellular service, increased from 0.3% to 2.8%. See
"--Network Coverage and Usage."
The Registrant is one of the New Holding Companies formed on May 22, 1998 as
part of the Breakup of Telebras. At June 30, 1998 the Registrant held 82.9% of
the share capital (including 89.2% of the voting capital) of Telemig Celular
S.A. ("Telemig Cellular") (which conducts the cellular operations formerly
conducted by Telecomunicacoes de Minas Gerais S.A.--Telemig ("Telemig")). See
"Presentation of Information--Overview."
The business of the Company is to furnish cellular telephone services in the
Telemig Cellular Region and engage in all activities related thereto in
accordance with the concession granted to Telemig by the Federal Government on
November 4, 1997 (the "Concession") and related approvals and authorizations.
The Concession expires on April 29, 2008 and, if the Company meets certain
obligations set forth in the Concession, may be renewed at the discretion of
Anatel for 15-year terms upon giving 30 months notice prior to the expiration
date and negotiating a renewal fee. See "--Regulation of the Brazilian
Telecommunications Industry." The Ministry of Communications has granted
cellular concessions to certain former Telebras operating subsidiaries ("Band
A Operators") and to certain new entrants ("Band B Operators"). The Band A
Operators and Band B Operators will compete against each other in different
regions of Brazil. The Company is a Band A Operator and will compete against
Vicunha Telecomunicacoes S.A., the Band B Operator who has been granted a
concession to offer cellular services in the Region and is expected to
commence operations in the Region by December 1998. See "--Background--Band A
and Band B" and "--Competition."
The Company's headquarters are located at SCN-Quadra CN2, Lote F, 2(degrees)
Andar, Sala 205, Brasilia-DF, 70710-500, Brazil, and its telephone number is
55-61-327-5519.
3
<PAGE>
THE REGION
The Telemig Cellular Region covers an area of approximately 509,437 square
kilometers, representing approximately 6% of Brazil's total area and 93% of
the municipalities in the state of Minas Gerais. The Region's population of
over 15 million represents 9.7% of the total population of Brazil. As of
December 31, 1996, the per capital income in the state of Minas Gerais was
approximately R$3,810. Minas Gerais generates approximately 8.7% of Brazil's
gross domestic product, mainly through industrial, commercial and agricultural
activities. As of December 31, 1997, the Telemig Cellular Region had 19
metropolitan areas with populations in excess of 100,000 people including the
cities of Belo Horizonte, Contagem, Juiz de Fora and Montes Claros. Companhia
de Telecomunicacoes do Brasil Central--CTBC Telecom ("CTB Central") offers
cellular telephone services in the western most part of the state of Minas
Gerais. The area covered by CTB Central includes 7% of the municipalities and
10.7% of the population of the state of Minas Gerais but is not part of the
Telemig Cellular Region, and CTB Central does not compete with the Company.
Set forth below is a map showing the location of the Telemig Cellular 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 and the
economy of the Telemig Cellular Region, in particular. See "--Brazilian
Economic Environment."
4
<PAGE>
SERVICES
The Company currently offers cellular services to its subscribers pursuant
to a variety of rate plans. See "--Rates" and "--Regulation of the Brazilian
Telecommunications Industry--Rate Regulation." At present, the Company offers
analog cellular telephone services and has commenced offering digital
technology with the introduction of caller identification service to its
customers. See "--Network." The Company does not sell products, such as
cellular phones, although at present such products are being offered in
connection with the provision of digital cellular service. The Company has
recently purchased 10,000 digital cellular handsets (TDMA/AMPS, IS-136A and
ACELP/EFRC vocoder). These handsets are being used by large-account customers
in order to facilitate the implementation of digital services. The
introduction of digital technology will allow the Company to increase
capacity, offer additional value-added services, and provide more secure
communication channels. See "--Network."
The following table sets forth the major ancillary services offered by the
Company:
<TABLE>
<CAPTION>
SERVICES DESCRIPTION
-------- -----------
<C> <S>
Voice Mail................. A voice mail service with message waiting
information.
Call Waiting............... A signal alerting user of another incoming call.
Call Forwarding............ A service permitting forwarding of calls.
Domestic Roaming........... Automatic roaming services with Brazil.
International Roaming...... Automatic roaming services with other countries.
International Call Block... A service permitting the user to block outgoing
international calls.
Three-Way Calling.......... A service permitting conference calls among three
parties.
Busy/No Answer Forwarding.. A service to automatically forward calls to a
wireline or cellular telephone
number if the telephone number is busy or there is
no answer.
1404 Service............... A 24-hour information line.
</TABLE>
The Company offers, in cooperation with the other Band A Operators,
automatic roaming services throughout Brazil that allow a subscriber to
receive calls made to the subscriber's number, regardless of the region in
which the subscriber is located. The Company also offers international roaming
service in Argentina, Uruguay and Paraguay through agreements with cellular
service providers in those countries. The Company will also offer roaming
services in cooperation with the Band B Operators. See "--Operating
Agreements--Roaming Agreements."
The Company also provides cellular service to subscribers of other Band A
Operators and certain Band B Operators roaming in the Region. The Company
charges such operators for the services provided to such subscribers pursuant
to roaming agreements entered into with such operators. See "--Operating
Agreements--Roaming Agreements."
The Company's customer service department provides 24-hour service in order
to resolve subscriber questions and service problems. Calls to the Company's
service line are toll-free, regardless of the location of the subscriber in
Brazil. In the first three months of 1998, the Company's customer service
department answered, on average, 298,000 calls per month, with an average call
time of 193 seconds. During the same period, the Company's customer service
department also answered, on average, 140 letters and e-mails per month. As of
March 31, 1998, the Company had 235 customer service attendants and had one
customer service attendant for every 1,940 subscribers.
The Company has installed customer service technology which registers the
reason for calls and provides information about the number of calls received
and answered, the abandonment rate resulting from calls not being answered
quickly and the number of calls answered in up to 10 seconds. All suggestions
and complaints about the quality of service are registered and forwarded to
the responsible area and all performance indicators are monitored daily.
Customers may order several value-added services, such as call forwarding and
call waiting, through the customer service department. Such services are made
available within an average of 30 minutes.
5
<PAGE>
The Company is implementing additional responsibilities for the customer
service department team, including calls to large-account customers, and other
calls to improve the Company's relationship with its customers. The Company is
also planning subscriber contacts in order to improve client retention,
specifically the retention of large-account and medium-account customers.
SALES AND MARKETING
TARGET MARKETS
The Company divides its market into the business user segment, which
accounted for 1.7% of the Company's revenues during 1997, and the personal
user segment, which accounted for 98.3% of the Company's revenues during 1997.
However, management believes that a significant number of personal users use
their cellular phones for personal and business purposes. Business customers
are defined as customers with four or more subscriptions and are divided into
large, medium and small businesses and by profitability levels. Personal users
are defined as customers with less than four subscriptions and are divided
according to profitability level.
From the commencement of cellular operations by the Company, subscribers
have consisted primarily of those segments of the Region's population with the
highest income levels. According to the Company's research, as of December 31,
1997, approximately 75% of the Company's subscribers were male, approximately
47% were college-educated and subscribers had an average age of 39.
The Company conducts credit checks to minimize the risk of default in
payment and service can be interrupted if a subscriber fails to make timely
payments.
SALES NETWORK
The Company markets its services through its direct, indirect and mixed
distribution channels. Set forth below is a description of each of the
Company's distribution channels.
Direct Distribution Channels (Company-owned, staffed and controlled). The
Company targets large businesses using its major accounts program whereby
potential large-account customers are identified, contacted directly by a
skilled sales force and, once they become subscribers, provided ongoing
support, in each case by the Company's sales force and authorized agents.
Small and medium-sized businesses are targeted through a combination of the
Company's corporate client focused sales force, company stores and the
marketing efforts of independent authorized agents.
The Company believes that company stores provide exclusivity, maximum
control and are effective in building image and brand awareness. From the
customer's perspective, company stores deliver standard service,
accountability and provide better customer service. The Company plans to
establish One-Stop-Solution Stores by the end of 1998, which will include
point-of-sale kiosks and a direct sales force. Large-account personal
customers will be targeted through such stores. In addition, the Company
intends to enter into agreements whereby authorized agents will sell and
repair handsets in Company stores.
Indirect Distribution Channels (independently-owned and operated). The
Company believes that authorized agents provide coverage across the Telemig
Cellular Region with minimal capital investment or operating expense. From the
customer's perspective, authorized agents provide accessibility in a broad
area of locations, convenience, diversity of products and pricing
alternatives.
The Company carefully selects its independent distributors based on criteria
that measure quality assistance, loyalty, productivity, available resources,
image, accountability, customer relations, operating history, and credit
policies. Based on these criteria, agents are classified as either Agent,
Special Agent or Master Agent (collectively, the "Agents"), and based on these
classifications the agents receive varying levels of commissions.
6
<PAGE>
The principal differences among the three agent classifications are the level
of experience of the agents, the quantity and quality of services offered to
subscribers and the level of exclusivity and support related to and received
from the Company. Agents' responsibilities are limited to direct sales.
Special Agents' responsibilities include direct sales, customer service,
technical assistance, and sale of a diversified array of services and
hardware. Master Agents are exclusive Telemig Cellular sales representatives
and their responsibilities include those of the Special Agent as well as
attending to corporate accounts, developing independent marketing strategies
and providing value-added services.
All of the Company's agents receive training and marketing support to assure
that they maintain high standards of service. Most of the independent
distributor contracts are established on an exclusive basis for three to four
years, but can be terminated at the Company's discretion in the event of poor
sales performance or actions by an independent distributor contrary to the
Company's operating policies or business ethics.
Agents have received an average commission of R$83 for each new customer
they sign up for service, provided that the customer retains and pays for
service for at least three months. In addition, agents are eligible for
quarterly bonuses for meeting or exceeding certain sales targets set by the
Company. Certain advertising and marketing costs incurred by them are
reimbursed by the Company through its shared advertising program.
As of December 31, 1997, the Company had 97 company stores and 111
authorized agents covering all major cities in the state of Minas Gerais.
Through its direct and indirect distribution channels, the Company is able to
sell its services and provide after-sale services to subscribers at convenient
locations.
Distribution Channels in Development. The Company plans to establish mixed
distribution channels that will be owned by third-parties and operated by the
Company. These channels will feature point-of-sale kiosks in third-party
establishments. The Company believes that these retailer kiosks provide broad
coverage in the marketplace and at the same time can be more effectively
controlled by the Company compared to independent distributors. Kiosks are
also effective in building image and brand awareness. From a customer's
perspective, retailer kiosks provide increased diversity and options in terms
of location, convenience, breadth of product and pricing, together with good
customer service. In addition, the Company is developing an E-Business program
which focuses on on-line business and customer service and seeks to provide
convenience to customers in the Telemig Cellular Region through assistance and
comprehensive information that will be available 24 hours a day, seven days a
week through the Company's web site.
7
<PAGE>
NETWORK COVERAGE AND USAGE
The following table shows the Company's subscriber base as well as coverage
and other statistics at the dates indicated.
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
--------------------------
1995 1996 1997
------- -------- -------
<S> <C> <C> <C>
Subscribers(1).................................. 89,634 233,042 427,815
Subscriber growth from prior period............. 112% 160% 84%
Estimated population of Region (millions)(2).... 14.7 14.9 15.1
Estimated covered population (millions)(3)...... 5.9 6.8 8.7
Percentage of population covered................ 40% 46% 58%
Regional penetration(4)......................... 0.6% 1.6% 2.8%
Percentage of Region covered.................... 16% 21% 31%
Average monthly incoming minutes of use per
subscriber..................................... 82 73 90(5)
Average monthly outgoing minutes of use per
subscriber..................................... 95 76 77
Average monthly revenue per subscriber (in
nominal reais)(6).............................. R$96.50 R$119.20 R$99.70
</TABLE>
- --------
(1) Reflects the total number of cellular lines in service at period end.
Separate lines owned by the same person are accounted for as separate
subscribers. The Company had 14,120 and 42,242 subscribers at December 31,
1993 and 1994 respectively.
(2) Population figures have been calculated by the Company based on Brazilian
population census data prepared by Instituto Brasileiro de Geografia e
Estatistica ("IBGE") using the average annual geometric population growth
rate as published by IBGE.
(3) Number of people within the Region that can access the Company's cellular
telephone signal.
(4) Number of subscribers divided by the population of the Region.
(5) The increase in 1997 principally reflected a reduction in the number of
registration areas in the Region from approximately 80 in 1995 and 1996 to
seven in 1997. This reduction allowed subscribers to receive calls from a
larger geographic area within the Telemig Cellular Region without
incurring the supplemental fee charged for calls received outside a
subscriber's Home Registration Area (DSL1) (defined below). This
development resulted in subscribers leaving their cellular phones turned
on for longer periods of time while traveling within the Region and,
therefore, receiving more calls. See "--Rates--Subscriber Rates."
(6) Net of value-added taxes.
Pursuant to the Concession, the Company has an obligation to provide
cellular service to a certain percentage of municipalities within the Telemig
Cellular Region, according to a time frame determined by reference to the
population of such municipalities, as set forth in the following table. To
date, the Company has met its yearly coverage obligations. See "--Regulation
of the Brazilian Telecommunications Industry."
<TABLE>
<CAPTION>
COERAGE REQUIRED BYV PERCENTAGE OF MUNICIPALITIES
NOVEMBER 4, REQUIRED TO BE COVERED POPULATION OF MUNICIPALITIES
- -------------------- ---------------------------- ----------------------------
<S> <C> <C>
1998.................... 100% over 200,000
1999.................... 100% between 100,000 and 200,000
2000.................... 90% between 75,000 and 100,000
2001.................... 80% between 50,000 and 75,000
2002.................... 70% between 30,000 and 50,000
</TABLE>
RATES
The Company generates cellular telecommunications revenue from (i)
activation fees, which are one-time sign-up charges paid to obtain cellular
service, (ii) usage charges, which include measured service charges based on
tenths of a minute of outgoing calls and roaming and other similar charges,
(iii) monthly subscription charges, (iv) network usage charges, which are the
amounts charged by the Company to other cellular and fixed line telephone
service providers for use of the Company's network by such service providers
(e.g., when one of such service provider's subscribers calls one of the
Company's subscribers) and (v) other services and charges, which primarily
include fees paid by clients for supplemental services such as call forwarding
and call waiting and fees
8
<PAGE>
arising from the transfer of cellular services from one subscriber to another.
Rates for the foregoing cellular telecommunications services provided by the
Company are subject to the final approval of Anatel. The Company submits
requests for rate adjustments to Anatel. See "--Regulation of the Brazilian
Telecommunications Industry."
SUBSCRIBER RATES
Since October 1994, cellular telephone service in Brazil, unlike that in
North America, has been offered on a "calling party pays" basis. Under the
policy of calling party pays, a cellular phone service subscriber generally
pays usage charges only for calls made by the subscriber. When a subscriber
makes a call from within a limited area (a "registration area") to a person
within the same registration area, the subscriber pays a certain base rate per
minute ("VC1"). If the recipient of the call is outside the registration area
from which the call was made but within the concession region of the cellular
provider for such registration area, the subscriber pays a higher rate
("VC2"). Calls made from within a registration area to a recipient located
outside the concession region in which such registration area is located are
billed at the highest per-minute rate ("VC3"). The Company earns VC1, VC2, or
VC3 revenues, as applicable, for all cellular calls originating from the
Region, whether made by a Company subscriber or a subscriber of another
cellular operator that is roaming in the Region. Similarly, when a Company
subscriber makes a cellular call outside the Region, the VC1, VC2, or VC3
revenues, as applicable, associated with that call are paid over to the
cellular operator from whose concession region the call is made. See "--
Operating Agreements--Roaming Agreements."
When a Company subscriber makes or receives a call while outside the
registration area in which such subscriber is registered for service (such
subscriber's "Home Registration Area"), the subscriber pays the Company a per-
call surcharge known as "AD." When a subscriber receives a call while outside
such subscriber's Home Registration Area, the subscriber pays a certain per-
minute rate if the subscriber is located within the Region ("DSL1"), or a
higher rate ("DSL2") if the subscriber is located outside the Region. The
Company's Region consists of 7 registration areas which vary in size depending
on population density.
Measured service charges are discounted 30% for calls made between 9:00 p.m.
and 7:00 a.m. Monday through Saturday and all day on Sundays and national
holidays. The Company may impose a 30% surcharge on all VC1 calls made from
one cellular phone to another. However, the Company has not done so since
February 1997.
The following table illustrates the average cellular telephone rates (net of
value-added taxes) for the Basic Service Plan in the Telemig Cellular Region
for each year of the four-year period ended December 31, 1997 in historical
reais. The Basic Service Plan has historically been used by over 60% of
subscribers and, as of December 31, 1997, was used by approximately 80% of
subscribers. The table does not reflect the effect of inflation, which
significantly reduced the real value of such rates over the course of the
periods presented.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------
1994 1995 1996 1997
------ ------ ------ ------
(IN REAIS)
<S> <C> <C> <C> <C>
Basic Service Plan:
Activation fee(1)................................ 157.07 169.39 308.75 299.84
Monthly subscription fee(1)...................... 26.07 26.34 29.18 28.00
VC1 (per minute)(1).............................. 0.29(2) 0.29 0.30 0.28
VC2 (per minute)(1).............................. 0.48(2) 0.48 0.57 0.58
VC3 (per minute)(1).............................. 0.60(2) 0.60 0.65 0.66
AD (per call)(1)................................. 0.50(2) 0.51 0.55 0.55
DSL 1 (per minute)(1)............................ 0.24(2) 0.25 0.29 0.29
DSL 2 (per minute)(1)............................ 0.29(2) 0.30 0.33 0.33
</TABLE>
- --------
(1) Weighted average peak rates, net of value-added taxes.
(2) Weighted average peak rates, net of value-added taxes for October through
December 1994. Prior to October 1994, a different, "mobile party pays"
rate structure applied.
9
<PAGE>
The following table sets forth certain terms of the Company's various plans
of service as of March 31, 1998.
<TABLE>
<CAPTION>
COST PER MINUTE
ACTIVATION MONTHLY ------------------- ADDITIONAL
PLANS(1) FEE SUBSCRIPTION FEE PEAK(2) OFF-PEAK(2) COST PEAK(3)
-------- ---------- ---------------- ------- ----------- ------------
<S> <C> <C> <C> <C> <C>
Basic Service Plan...... 299.84 28.00 0.28 0.20 0
Location Plan........... 0 50.63 0.28 0.20 0
Night Plan.............. 0 16.35 0.61 0.11 1.22
Flex Plan............... 145.06 19.38 0.61 0.11 1.22
</TABLE>
- --------
(1)All amounts are in nominal reais, net of value-added taxes.
(2)At VC1 rate.
(3)Additional per-call charge during peak hours.
The Basic Service Plan is for subscribers who use their phones frequently
during the day and night and service may be terminated at any time without
penalty. The Location Plan is also for subscribers who use their phones
frequently during the day and night, however, subscribers must pay a penalty
if their service is terminated within the first 12 months of initiating
service. The Night Plan is for subscribers who frequently use their phone at
night or on weekends and as with the Location Plan, subscribers must pay a
penalty if their service is terminated within the first 12 months of
initiating service. The Flex Plan is also for subscribers who frequently use
their phones at night or on weekends, however, service may be terminated at
any time without penalty.
NETWORK USAGE CHARGES
In addition to revenues arising from cellular calls originating within the
Region and calls made by the Company's subscribers while outside the Region,
the Company earns revenues from any call (cellular or fixed) originating
outside the Region, as well as any call originating on a fixed network within
the Region, and terminating on a cellular telephone within the Region. The
Company charges the operator from whose network such a call originates a
network usage charge for every minute the Company's network is used in
connection with the call. See "--Operating Agreements--Interconnection
Agreements." The Company's average network usage tariff was R$0.26, R$0.22 and
R$0.22 per minute in 1995, 1996 and 1997, respectively, net of value-added
taxes.
TAXES ON TELECOMMUNICATIONS SERVICES
The cost of all telecommunications services to the customer includes a
variety of taxes. 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 certain revenues from the provision of
telecommunications services. This rate in the state of Minas Gerais is 25% for
domestic telecommunications 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 to cover not only telecommunications
services, but also other services, including cellular activation, which had
not been previously subject to such tax, as of July 1, 1998. In addition,
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. In addition, the Company believes that Telemig, the legal
predecessor of Telemig Cellular, would be liable to Telemig Cellular for any
payments made by Telemig Cellular in connection with any claim arising out of
the retroactive application of the 25% ICMS tax on activation fees for periods
prior to 1998. See "Legal Proceedings." Accordingly, the Company has made no
provision for loss with respect to retroactive application of the ICMS.
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Telemig Cellular has filed a lawsuit with the Treasury Court of the state of
Minas Gerais seeking injunctive relief from retroactive and prospective
application of the ICMS tax to activation fees. On September 24, 1998, the
Treasury Court granted Telemig Cellular a temporary injunction relieving it
from payment of retroactive and prospective ICMS taxes with respect to
activation fees during the pendency of the lawsuit. The taxation authorities
of the state of Minas Gerais may appeal this decision, and there can be no
assurance that Telemig Cellular will ultimately prevail in any appeal made by
the taxing authorities relating to the temporary injunction or 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 for the
six-month period ended June 30, 1998, it would have a maximum negative impact
estimated at R$3.5 million on results of operations for 1998. However, because
the Company has eliminated activation fees for all of its calling plans except
the Basic Service Plan, the impact of the application of the 25% ICMS tax on
such fees for subsequent periods should not be material. See "Management's
Discussion and Analysis of Financial Condition and Revenues and Expenses--
Revenues and Expenses for the years ended December 31, 1995, 1996 and 1997--
Net operating revenues--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$36.9 million.
However, as discussed above, the Company believes that Telemig would be liable
to Telemig Cellular for any tax liability arising from the application of ICMS
to activation fees recognized prior to 1998. See "Legal Proceedings."
Management does not believe that the payment of retroactive ICMS taxes with
respect to activations fees 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.
Other taxes include two federal social contribution taxes, the Programa de
Assistencia aos Servidores de Empresas Publicas ("PASEP") and Contribuicao
para Financiamento da Seguridade Social ("COFINS"), imposed at a combined rate
of 2.65% on gross operating revenues for some telecommunications services. The
average rate of all such taxes, as a percentage of gross operating revenues,
was 18% in 1997. This rate is likely to increase in the future as a result of
activation fees becoming subject to ICMS.
BILLING AND ADMINISTRATION
At present, the Company uses a standard system for billing and
administration, rented from Telemig. The Company's current system has four
main functions: (i) subscriber registration; (ii) subscriber information
consultation; (iii) accounts payable management; and (iv) billing and
collection. At the time of subscriber activation, account information and
credit history are entered into the billing system by on-line operators.
The Company's new customized system, called Business Support and Control
System, developed by LHS Communication Systems Incorporated, will be
completely operational by October 1998.
The Company is responsible for billing its subscribers for all calls made by
such subscribers and collecting the payments related to such calls. The
Company also receives roaming fees (VC1, VC2 or VC3, as applicable) from other
cellular operators as a result of their subscribers roaming in the Region and,
conversely, the Company pays roaming fees to other cellular operators when its
subscribers roam outside of the Region. See "--Rates--Subscriber Rates."
In addition, the Company receives network usage fees from the regional
fixed-line and cellular operators when a call originates on the networks of
such operators and terminates on the Company's cellular network and,
conversely, the Company must pay network usage fees when calls from its
subscribers terminate on the network of another operator. After the collection
cycle is over, the Company, the fixed-line and cellular operators jointly
reconcile the amounts collected from subscribers against the amounts due to
each operator and pay the net amounts outstanding to the appropriate parties.
For international and domestic long-distance calls made by its subscribers,
the Company forwards the amount collected for such calls to Embratel and
charges Embratel a fee for the use of its cellular network.
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<PAGE>
The Company collects payments through direct debit to bank accounts from
approximately 20% of subscribers. The remaining subscribers generally make
cash or check payments through banks or bill collection facilities. The
Company does not collect payments through credit cards or have cashiers for
payment.
Pursuant to Brazilian law, customers must receive bills at least five days
before the due date and the Company must allow customers at least 15 days from
the due date before suspending service for non-payment. In addition, after 90
days of non-payment, Brazilian law allows telephone service providers to
eliminate service.
In the event a subscriber's payment is over 20 days past due (from the due
date), service is suspended until full payment for all outstanding charges is
received. The Company's provisions for accounts not probable of collection
were 2.6%, 1.0% and 7.6% of gross operating revenues in 1995, 1996 and 1997,
respectively. See "Management's Discussion and Analysis of Financial Condition
and Revenues and Expenses--Revenues and Expenses for the years ended December
31, 1995, 1996 and 1997--Operating expenses."
CELLULAR TELECOMMUNICATIONS TECHNOLOGY
GENERAL
Cellular telecommunications technology, including that utilized by the
Company, is based on the division of a given geographical territory into a
number of regions or "cells" which are generally contiguous. Each cell
contains a low-power transmitter-receiver, known as a "base station" or "cell
site," that communicates by radio signal with cellular telephones located in
the cell. Each cell is connected by fixed-lines or microwave links to a
central switching point or Mobile Telephone Switching Office ("MTSO"), which
controls the routing of calls and which, in turn, is connected to the Public
Switched Telephone Network ("PSTN"). The MTSO controls the assignment of
frequencies within the cell and allows cellular telephone users to move freely
from one cell to another across the service area while continuing their calls.
CAPACITY CONSIDERATIONS
Cellular telecommunications networks such as the Company's are planned and
constructed to meet a certain level of subscriber density and traffic demand.
Before this level is exceeded, certain steps must be taken to increase network
capacity in order to maintain service standards. Such capacity increases can
be accomplished by increasing digital penetration and by using such techniques
as sectorization and cell splitting. Other techniques to ensure service
quality at minimal cost include microcells. The Company believes that its
cellular network requires, and will continue to require, further expansion if
it is to meet existing and future demand for cellular service. The Company
plans to expand its network primarily through the use of digital technology.
See "--Quality of Service."
OPERATING CHARACTERISTICS
Cellular telecommunications networks are typically characterized by
relatively high fixed costs and relatively low variable costs. Until
technological limitations on network capacity are reached, additional capacity
can usually be added in increments that closely match demand and at less than
the proportionate cost of initial capacity.
NETWORK
The ability of the network to deliver high-quality service and extensive
geographic coverage is a key factor in the provision of cellular
telecommunications services. The Company develops its cellular network by
building new base stations and adding channels to existing base stations. Such
development is accomplished for the purpose of increasing network capacity and
improving coverage in direct response to projected subscriber demand.
The Company has focused on providing service to the principal cities and
surrounding areas in the state of Minas Gerais. Expansion of the cellular
network enhances the Company's ability to provide service in such key
12
<PAGE>
metropolitan areas where the demand for cellular services continues to
increase. The Company continues to expand its network to cover as broad a
geographical area as is economically feasible in order to meet consumer demand
for cellular service in areas outside the major urban centers. The Company's
Concession also contains certain obligations concerning network expansion. See
"--Regulation of the Brazilian Telecommunications Industry--Obligations of
Telecommunications Companies." The Company's network covered approximately 58%
of the population of the Telemig Cellular Region as of December 31, 1997.
As of March 31, 1998, the Company's cellular telecommunications network
consisted of eight cellular switches, 361 cells and 22 repeaters. The
Company's principal three switching centers, located in Belo Horizonte, employ
three Super Note NT DMS-MTX switches to provide switching services for Belo
Horizonte and the surrounding metropolitan area. Five other switching centers,
located in Juiz de Fora, Varginha, Divinopolis, Governador Valadares and Belo
Horizonte, employ SNSE NT DMS-MTX switches to provide switching services for
the remainder of the Region. The network is connected primarily by a
transmission system (mainly optical fiber), rented from Telemig. Since the
commencement of operations, the Company has been interconnected directly with
the local PSTNs and with every Band A Operator in the country, automatically
allowing subscribers to roam throughout Brazil, wherever cellular service
exists. Between 1992 and 1998, the Company spent approximately R$575 million
constructing its cellular telecommunications network.
The Company maintains a network administration system which is capable of
monitoring its base stations and principal network operations. In addition,
technicians operating this system have the ability to evaluate rapidly and
respond to technical difficulties in network operations. The Company analyzes
the performance data generated by this system in order to make the operating
adjustments or capital expenditures necessary to enhance network operations.
Prior to 1998, the Company's network used only AMPS analog technology. In
January 1998, the Company purchased equipment from Northern Telecom in order
to begin the process of converting part of its network to Time Division
Multiple Access ("TDMA") and using the TDMA IS 136-A technology. In the
metropolitan area of Belo Horizonte, the Company expects to fully implement
digital technology in the second half of 1998. By the end of 1998, the Company
expects that over 25% of its total traffic will be digital.
The Company believes that digitalization offers certain advantages over
analog services, including reduced operating costs, greater network capacity
and additional revenue through the sale of digital-specific value-added
cellular services. Digital cellular services also offer subscribers greater
security, although digital cellular phones are generally more expensive than
analog cellular phones. Digitalization represents one of the Company's key
strategic initiatives.
FRAUD DETECTION AND PREVENTION
Fraud resulting from cloned cellular phone calls has increased since the
Company began offering cellular services, and the Company believes that the
incidence of cloning is likely to continue to increase in the near term.
"Cloning" fraud occurs through the technological duplication of the cellular
signal of an authorized subscriber, enabling the defrauding party to make
calls using the authorized subscriber's signal. Such calls are then invoiced
to the authorized subscriber. Subscription fraud occurs when a person,
typically using a fictitious identification and address, obtains cellular
service with no intention of paying for the service and then incurs
substantial charges before the cellular operator is able to identify the fraud
and terminate service. When the Company discovers that a receivable has been
generated by a fraudulent call, the receivable is written off.
If any part of a fraudulent call is carried over another operator's network,
the Company is obligated to pay such operator the applicable network usage
charge, whether or not the Company ever collects the receivable associated
with that call. Similarly, the Company is entitled to receive its network
usage charge from other operators when it carries fraudulent calls from other
operators. See "--Rates--Network Usage Charges."
Fraud-detection measures currently employed by the Company involve the
manual review of call detail records which are produced within 24 hours after
calls are made. Among other things, the Company focuses
13
<PAGE>
attention on frequent international calls (more than four calls within any 24
hour period), calls longer than 59 minutes, billings in excess of R$3,000 or
in excess of R$1,000 but representing a 200% increase over the previous
month's billings. The Company's billing system generates daily reports on
customers' usage. Based on these reports, customers with delinquent payments
are contacted by the credit control staff of the Company and subsequently may
be deactivated, depending on the circumstances.
The Company, in conjunction with the other Band A Operators, is installing
DFMS (Digital Fraud Management System), a nation-wide fraud detection system
licensed from Digital Equipment Corporation. This system will analyze various
aspects of calls, including simultaneous usage by a single "subscriber," call
frequency and unusually high usage patterns. Although the Company continues to
make adjustments, the system has been operational within the Region since
September 1998.
Since the last quarter of 1997, the incidence of subscription fraud has
increased significantly. The increase in subscription fraud is primarily the
result of a significant increase in the number of individuals from the
neighboring state of Rio de Janeiro, where the waiting list includes over 1
million people, applying for service in the Telemig Region, where there is no
waiting list and an increase in the use of independent distributors to sign-up
new subscribers during special promotions in December 1997 and January 1998.
In response to the increase in subscription fraud, the Company has developed
subscription fraud prevention measures that include: (i) background checks of
its employees; (ii) fraud awareness and prevention training; and (iii) credit
checks of new customers through credit rating agencies. In 1997, the most
prevalent type of fraud was due to "cloning" and the subsequent international
calls made on the cloned service. In order to combat cloning fraud, the
Company blocked the international service of subscribers who did not use this
service. This restriction has prevented many cloned signals from accessing
international lines.
During 1998, the Company expects to invest an additional R$1.6 million in
its fraud-detection program.
QUALITY OF SERVICE
The Company has at times experienced quality of service problems, including
busy circuits, lack of system availability and dropped calls and signals.
However, in 1997, the "all circuits busy rate" (as a percentage of calls
attempted) was 1.95%, system availability on first call attempted was 95.34%
and the call and signal drop rate (as a percentage of calls attempted) was
1.73%. At present, the Company is not experiencing any significant quality of
service problems and exceeds all quality of service requirements established
by Anatel. See "--Regulation of the Brazilian Telecommunications Industry--
Obligations of Telecommunications Companies--Quality of Service."
COMPETITION
Until recently, Brazil's Constitution required that public
telecommunications concessions be granted to government-controlled enterprises
only, but permitted the granting of concessions to others for the provision of
nonpublic telecommunications services. A constitutional amendment passed in
August 1995 permits the Federal Government to grant concessions and licenses
to private companies to provide public telecommunications services. The first
law implementing the constitutional amendment, which was passed by the Federal
Congress in July 1996, provided for opening certain telecommunications
activities, including the mobile cellular, satellite communications and data
transmission areas, to competition from the private sector. See "--
Background--Regulatory Reform and Privatization" and "--Regulation of the
Brazilian Telecommunications Industry--Concessions and Licenses."
In January 1997, the Ministry of Communications called for bids from
companies and groups wishing to apply for licenses to provide mobile cellular
services on Band B in each of the ten areas specified in the request for
proposals. Bidders for the licenses, unlike participants in the privatization
of the Telebras System, were subject to limits on foreign participation and
required to be, or be affiliated with, a telecommunications operator.
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<PAGE>
A license to provide cellular services in the Region on Band B has been
granted to Vicunha Telecomunicacoes S.A. ("Vicunha"), a consortium comprised
of: (i) Telecom Italia (43%), (ii) the Brazilian textiles group Vicunha (37%)
and (iii) the media group Organizacoes Globo SA and Banco Bradesco SA,
Brazil's largest private sector bank (20%). The rights and obligations of
Vicunha under its concessions are substantially the same as the Company's
rights and obligations under its Concessions. However, the Company's
Concessions expire in April 2008 and Vicunha's license expires in April 2003.
Vicunha paid R$520 million for the license and has announced that it intends
to commence providing digital cellular services in the Region by December,
1998. Vicunha has also acquired a license to provide cellular services in the
neighboring states of Bahia and Sergipe for R$250 million where it began to
offer digital service in April, 1997. After December 31, 1999, additional
competitors may be authorized to offer cellular telephone service in the
Region. See "--Regulation of the Brazilian Telecommunications Industry."
The exact identities 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. Among such factors are the business strategies
and capabilities of current and 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 also competes with fixed-line telephone service operators.
Fixed-line density in the Telemig Cellular Region as of December 31, 1997 is
estimated by Telemig to have been approximately 12 telephone lines per 100
persons. If substantial capital were to be invested in the fixed-line
telephone industry, resulting in increased fixed-line density and improved
service, certain of the Company's existing and potential subscribers might
choose fixed-line service providers due to a number of factors, some of which
are price-related. However, the Company does not believe fixed-line service
providers present significant competition for the provision of
telecommunications services, as over 90% of the Company's current subscribers
have fixed-lines.
The Company also competes with certain other wireless communications
services, such as mobile radio, paging or beeper services, which are used by
some in the Telemig Cellular Region as a substitute for wireline services.
These competing wireless communication services are generally less expensive
than cellular services.
Technological advances in the communications field, such as the possible
introduction of Personal Communications Services ("PCS") and mobile satellite
services may introduce additional future competition for cellular systems.
Satellite services which can provide nation-wide coverage, may become
available in Brazil in the very near future. Although satellite services cover
a much greater area than cellular services, they are considerably more
expensive than cellular services and do not offer comparable coverage inside
buildings. PCS services, which are similar to digital cellular services,
cannot be supplied in Brazil without obtaining a concession to provide such
services from the Federal Government. The Federal Government has indicated
that it does not intend to issue concessions to provided PCS services until
2000. The Company does not currently plan to offer mobile satellite services
(other than pursuant to a roaming arrangement with a satellite service
provider) or PCS services, although it may consider doing so in the future.
OPERATING AGREEMENTS
INTERCONNECTION AGREEMENTS
The Company has entered into interconnection agreements with Telemig and
Embratel. The terms of these interconnection agreements include provisions for
the number of connection points, the method by which signals must be received
and transmitted, interconnection tariffs and the assumption of responsibility
for the costs of interconnection. See "--Regulation of the Brazilian
Telecommunications Industry--Obligations of Telecommunications Companies--
Interconnection."
15
<PAGE>
ROAMING AGREEMENTS
Agreements for automatic roaming have been entered into with the other seven
Band A Operators and with the following Band B Operators: BCP Telecomunicacoes
S.A., BCP Nordeste S.A. (formerly BSE S.A.), Americel S.A. and Algar
Telecomunicacoes S.A. In addition, agreements for automatic roaming have been
entered into with the four Band A independent operators. See "--Background--
Band A and Band B." The Company is currently negotiating roaming agreements
with the remaining Band B Operators. These roaming agreements permit the
Company's subscribers to use their cellular phones on the networks of other
cellular operators while travelling outside the Region ("roaming").
Conversely, the Company is required to provide cellular service to subscribers
of those cellular operators when those subscribers are within the Region. The
agreements require the Company and the other cellular operators to provide
service to roaming subscribers on the same basis as they provide service to
their own subscribers and to carry out a monthly reconciliation of roaming
subscriber usage charges. The Band B Operators and the Band A independent
operators are required to pay the Band A Operators certain fees for their use
of the automatic roaming network. The agreements have a three year term and
automatically renew for further one year terms.
The Company has also entered into international roaming agreements with
Miniphone S.A. (Band A--Buenos Aires), Compania de Radiocomunicaciones Moviles
S.A. (Band B--Buenos Aires), Telecom Personal S.A. (Band A--Interior/Northern
Argentina), Telefonica Comunicaciones Personales S.A. (Southern Argentina),
Administracion Nacional de Telecomunicaciones (Uruguay), Abiatar S.A.--Movicom
(Uruguay) and Telefonica Celular del Paraguai S.A. (Paraguay) that permit its
subscribers to use their cellular phones in Argentina, Uruguay and Paraguay
and subscribers of those companies to use their cellular phones in the Region.
In addition, the Company is currently negotiating an international roaming
agreement with Telecomunicacoes Moveis Nacionais S.A.--TMN (Portugal). The
terms of these international roaming agreements vary from agreement to
agreement.
EMPLOYEES
As of February 28, 1998, the Company had 383 full-time employees. 31.9% of
the Company's employees are employed in sales and marketing positions, 25.6%
in engineering positions, 19.8% in administrative positions, 8.6% in customer
service positions, 7.8% in finance positions and 6.3% in information
technology positions. Approximately 68% of all employees are members of state
labor unions associated with the Federacao Interestadual dos Trabalhadores em
Telecomunicacoes ("Fittel"). The Company negotiates new collective labor
agreements every year with the local unions. The collective agreements
currently in force expire in November 1998.
The Company's management considers the relations of the Company with its
work force to be satisfactory. The Company has never experienced a work
stoppage that had a material effect on its operations.
The Company participates in a pension fund, Fundacao Telebras de Seguridade
Social ("Sistel"), the purpose of which is to supplement government-provided
retirement benefits. The Company makes monthly contributions to Sistel
currently equal to 13.5% of the salary of each employee who is a Sistel
member. Each employee member also makes a monthly contribution to Sistel based
on age and salary. Members of Sistel qualify for full pension benefits after
reaching age 57 provided they have been members of Sistel for at least ten
uninterrupted years and have been affiliated with the social security system
during at least 35 years. Sistel operates independently from the Company, and
its assets and liabilities are fully segregated from those of the Company and
Telebras. 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 currently in place at that time. See Note 18 to the Consolidated
Financial Statements.
RESEARCH AND DEVELOPMENT
Until the Breakup of Telebras, Telemig and the other companies of the
Telebras System each contributed to the research and development center
operated by Telebras (Centro de Pesquisa e Desenvolvimento da Telebras or the
"Center"). Aggregate expenditures on research and development were R$1.0
million, R$1.8 million and R$2.0 million for 1995, 1996 and 1997,
respectively.
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Following the Breakup of Telebras, the Center will become a private,
independently administered non-profit foundation financed with resources from
the public and private sector and will continue to develop telecommunications
technology. Pursuant to a three year contract signed in May 1998 between
Telebras and Telemig Cellular, the Company is obligated to contribute a
maximum of R$1.2 million to the Center during the three years ending May 2001.
During the effectiveness of this agreement, the Company has access to
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 such as Band B operators on a fee-for-
service basis. At present the Company does not intend to carry out its own
independent research after the Breakup of Telebras, although this policy may
change as a result of the Company's privatization. The Company does not
independently develop new telecommunications hardware and depends upon the
manufacturers of telecommunications products for the development of new
hardware.
CAPITAL EXPENDITURES
The Company's priorities in the last five years have included and in the
future will continue to include increasing the number of available cellular
access lines, improving overall quality and, more recently, increasing the
level of digitalization of the Company's network.
The Company's capital expenditures historically have been planned and
allocated on a Telebras system-wide basis and have been subject to approval by
the Ministry of Communications. In addition, the budget for capital
expenditures of the Telebras System has been included in the annual budget of
the Federal Government and had to be approved by the Federal Congress. In
1995, the Federal Government instituted a broad investment program for public
and private businesses in the communications and postal sectors for the years
1995 through 1999 (Programa de Recuperacao e Expansao dos Sistemas de
Telecomunicacoes e Postal or "PASTE"). The foregoing constraints on capital
expenditures have prevented the Company from making certain investments that
it might otherwise have made to improve cellular telephone service in the
Region.
Since the privatization of Telebras, none of these requirements has applied.
The Company is now permitted to determine its own capital expenditure budget,
subject to compliance with certain obligations under the Concession. 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 Revenues and Expenses--Liquidity and
Capital Resources."
The 1998 annual capital expenditure budget for the Telebras System includes
capital expenditures of the Company. The Company has entered into contracts
for a total of R$178.1 million in 1998 capital expenditures. The Company
expects, however, that as a result of its privatization all capital
expenditures will be subject to revision by management and the new controlling
shareholders of the Company.
The following table sets forth the Company's capital expenditures for each
year in the three-year period ended December 31, 1997, in constant reais of
December 31, 1997.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------
1995 1996 1997
---------- ----------- -----------
(IN THOUSANDS OF CONSTANT REAIS)
<S> <C> <C> <C>
Automatic switching equipment............... 13,616 23,540 12,024
Other equipment............................. 62,734 162,208 98,324
Real estate................................. 702 603 879
Other assets................................ 1,593 1,772 2,561
---------- ----------- -----------
Total capital expenditures.................. 78,645 188,123 113,788
========== =========== ===========
</TABLE>
17
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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
Law No. 9,472 of July 16, 1997, the Lei Geral de Telecomunicacoes (the
"Telecommunications Law"), the regulations, decrees, orders and plans issued
thereunder and the Concession contract granting the Company the right to
provide certain telecommunications services, subject to certain obligations
contained in the Concession (the "List of Obligations").
BACKGROUND
From 1962 until 1967, the Brazilian telecommunications sector was regulated
by the Conselho Nacional de Telecomunicacoes (the "National Council of
Telecommunications"), and from 1967 until 1997 by the Ministry of
Communications, pursuant to Law No. 4,117 of August 27, 1962 and the Codigo
Brasileiro de Telecomunicacoes (the "Code of Telecommunications") promulgated
thereunder, 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 Band A Operators and the Band B Operators
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
Brazilian Government, including the Ministry of Communications, in the area of
telecommunications regulation. While independent, Anatel does maintain a close
working relationship with the Ministry of Communications and informs the
Ministry of its activities. Article 19, Section XXIX of the Telecommunications
Law requires Anatel to submit an annual report summarizing its activities to
the Ministry of Communications.
Anatel is managed by a five-member Conselho Diretor ("Board of Directors"),
headed by an executive president. The directors of Anatel are nominated by the
President of Brazil, subject to approval by the Senate. Each director serves
for a single fixed term of 5 years; directors may not be reappointed. In order
further to ensure Anatel's independence, the first directors have been
appointed for different terms, from 3 to 7 years, so that only one director's
mandate will expire per year, ensuring a staggered appointment of directors in
the future. The directors may not exercise any other professional, business
(other than university professor), union or political function, nor may they
hold a significant interest, whether direct or indirect, in any company
related to telecommunications.
Anatel is financed through the Fundo de Fiscalizacao das Telecomunicacoes
("Fistel"). Fistel is a fund administered by Anatel and its assets 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.
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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 (autorizacoes) are granted for services in the public regime ("Public
Regime") and services in the private regime ("Private Regime").
There are four companies that operate in the Public Regime: Embratel
Participacoes S.A., Telesp Participacoes S.A., Tele Centro Sul Participacoes
S.A., and Tele Norte Leste Participacoes S.A. As the primary providers of
fixed-line telephone services, which serve an important public function, these
four companies are subject to certain obligations. These obligations fall into
three basic categories: quality of service, continuity of service, and network
expansion and modernization.
Companies operating in the Private Regime, which includes every company
other than the four companies operating in the Public Regime, are generally
not subject to any general obligations that arise from general laws, but
rather may have obligations imposed on them by Anatel as part of the List of
Obligations appended to their concessions or licenses. Technically, the
General Plan on Quality applies to operators in both the Public Regime and the
Private Regime, but the terms of the General Plan on Quality allow Anatel to
waive its requirements and Anatel has stated that it does not plan to impose
any specific requirements on Private Regime companies outside of the context
of individual concessions and licenses other than such basic obligations as
those concerning network engineering.
Non-fixed Services--Private Regime--Concessions. Pursuant to the Minimum Law
and the Telecommunications Law, the Band A and Band B Operators 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,
and may be renewed at the discretion of Anatel for further periods of 15 years
if the List of Obligations contained in the 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 in any area of the country.
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 additional licenses will 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 any specific
obligations, although individual licenses may contain certain obligations. The
Company has not been granted any licenses as of the date of this Registration
Statement.
Operators in the Private Regime may be granted licenses to offer any type of
telecommunications service (including any services currently offered solely by
Public Regime companies). As noted above, there is currently a restriction on
Anatel's ability to license new cellular operators in the Private Regime until
December 31, 1999, although this restriction is not a permanent part of the
Private Regime and it is anticipated that new Private Regime licenses for
cellular services will be granted once the restriction period expires.
OBLIGATIONS OF TELECOMMUNICATIONS COMPANIES
Providers of telecommunications services are subject to certain obligations
contained in the List of Obligations of their concessions and licenses.
Providers of telecommunications services in the Private Regime,
19
<PAGE>
including the Band A and Band B Operators, are subject to a set of obligations
contained in their List of Obligations. Cellular companies, including the
Company, are not subject to the same level of formal obligations to which the
companies in the Public Regime are subject.
The Company must at all times meet certain obligations concerning quality of
service, network expansion and modernization pursuant to the List of
Obligations. Failure to meet the List of Obligations at any time may result in
fines and penalties of up to 0.05% of annual net operating revenues per day
until the Company complies with the obligations as well as potential
revocation of the Company's Concession. The Company meets the requirements set
forth in the List of Obligations.
The following two tables set forth the quality of service obligations and
the network expansion and modernization obligations of the Company as stated
in the List of Obligations for the period 1999-2002 and the Company's status
with regard to each obligation as of December 31, 1997.
NETWORK EXPANSION AND MODERNIZATION
<TABLE>
<CAPTION>
COMPANY
STATUS AS OF
DECEMBER 31, AT NOVEMBER 4,
1997 1998 1999 2000 2001 2002
------------ ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C>
Services Offered(1) in cities with
populations of:
30,000 to 50,000...................... 100% -- -- -- -- 70
50,000 to 75,000...................... 100% -- -- -- 80 --
75,000 to 100,000..................... 100% -- -- 90 -- --
100,000 to 200,000.................... 100% -- 100 -- -- --
Over 200,000 or state capital......... 100% 100 -- -- -- --
Maximum average installation waiting
time (days)(2)......................... 0 180 120 30 15 5
</TABLE>
- --------
(1) For services to be deemed to be offered in any city, service must be
available to at least 30% of the population.
(2) Between request for service and connection in areas with cellular
service.
QUALITY OF SERVICE
<TABLE>
<CAPTION>
COMPANY
STATUS MAXIMUM/
DURING MINIMUM
1997 REQUIRED
------- --------
<S> <C> <C>
Minimum average level of system availability(1) (% of time).. 99.8% 98%
Maximum call and signal drop rate(2)......................... 1.73% 3%
Maximum "all circuits busy" rate(3).......................... 1.95% 5%
Maximum interconnection drop rate(4)......................... 1.27% 3%
Minimum average system availability on first call attempt.... 95.34% 90%
Maximum number of customer complaints per month (per 100
subscribers)................................................ 0.1 5
</TABLE>
- --------
(1) Percentage of time system operational and available for call origination,
transport and completion.
(2) Rate of failed call completion due to signal loss between radio base
station and switching centers.
(3) Rate at which system rejects attempted calls during peak period because
no circuits are available.
(4) Rate at which interconnected calls fail to complete during peak periods.
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 at all times.
20
<PAGE>
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 non-discriminatory 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 for 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 and the requesting party
then has the right to select and purchase a subset of the network elements and
services available.
RATE REGULATION
Price-Caps. Concessions with the Band A and Band B cellular companies,
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 an upper limit, or price-cap, placed on a weighted average rate for a
basket of services, stipulated by Anatel. The services include the services in
the Basic Service Plan, including monthly subscription fees, VC1 calling, VC2
calling, VC3 calling, DSL1 calling, DSL2 calling, and AD charges, as well as
interconnection charges, including network usage fees.
The initial price-cap agreed by Anatel and the Company in the Concession is
based on the previously existing tariffs, which were developed based on the
fully allocated costs of the Company. 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.
The price-cap covers a basket of 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 20%, 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.
Similar to the regulatory systems in most countries going through
liberalization, Anatel has imposed a productivity factor (or X-factor) on the
four fixed-line companies operating in the Public Regime. Under this system,
the price-cap imposed on these operators is adjusted downward annually by a
specific productivity factor once certain other adjustments (such as for
inflation) have been made. There is no productivity factor or X-factor applied
to revise the price-cap for cellular companies downward.
Cellular Rates. Since October 1994, cellular telephone service in Brazil,
unlike that in North America, has been offered on a "calling party pays"
basis. Under the policy of calling party pays, a cellular telephone service
subscriber generally pays usage charges only for calls made by the subscriber.
When a subscriber makes a call from a limited geographic area (a "registration
area") to a person within the same registration area, the customer pays a
certain base rate per minute ("VC1"). If the recipient of the call is outside
the registration area from which the call was placed but within the concession
region of the cellular provider for such registration
21
<PAGE>
area, the subscriber pays a higher rate ("VC2"). Calls made from within a
registration area to a recipient located outside the concession region in
which such registration area is located are billed at the highest per-minute
rate ("VC3"). The Company earns VC1, VC2, or VC3 revenues, as applicable, for
all cellular calls originating from the Region, whether made by a Company
subscriber or a subscriber of another cellular operator that is roaming in the
Region. Similarly, when a Company subscriber originates a cellular call
outside the Region, the VC1, VC2, or VC3 revenues, as applicable, associated
with that call are paid over to the cellular operator from whose concession
region the call is made. See "--Operating Agreements--Roaming Agreements."
When a Company subscriber makes or receives a call while outside the Telemig
Cellular Region, the subscriber also pays the Company a per-call surcharge
known as "AD." When a Company subscriber receives a call while outside the
registration area in which such subscriber is registered for service (such
subscriber's "Home Registration Area"), the subscriber also pays a certain
per-minute rate if the subscriber is located within the Region ("DSL1"), or a
higher rate ("DSL2") if the subscriber is located outside the Region.
For a breakdown of the Company's current cellular service rates, see "--
Rates--Subscriber Rates."
Network Usage Charges. Other telecommunications companies wishing to
interconnect with and use the Company's network must pay certain fees,
primarily a network usage fee. The network usage fee is subject to a price-cap
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.
For a breakdown of the Company's current network usage charges, see "--
Rates--Subscriber Rates" and "--Network Usage Charges."
BRAZILIAN POLITICAL ENVIRONMENT
The Brazilian political environment was marked by high levels of uncertainty
after the country returned to civilian rule in 1985, ending 20 years of
military government. The death of a President-elect in 1985 and the
resignation of another President in the midst of impeachment proceedings in
1992, as well as rapid turnover at and immediately below the cabinet level,
adversely affected the implementation of consistent economic and monetary
policies, including consistent policies in the areas of government-owned
enterprises and telecommunications.
Mr. Fernando Henrique Cardoso, the Finance Minister at the time of
implementation of Brazil's latest economic stabilization plan (the "Real
Plan"), was elected President of Brazil in October 1994 and took office in
January 1995. He has generally sought to continue the economic stabilization
and liberalization policies he had developed as Finance Minister from May 1993
through April 1994. Although some important groups remain opposed to
significant elements of his program and the implementation of policies of
economic stabilization and liberalization is subject to significant
compromises and accommodations, President Cardoso is the leader of a coalition
of political parties that represents a majority of the federal Congress. His
party controls the state governments of the States of Sao Paulo, Rio de
Janeiro and Minas Gerais, and his policies have broad political support.
Elections for the President, Vice-President, state Governors and the members
of the Chamber of Deputies, as well as one third of the members of the Senate,
were held on October 4, 1998. President Cardoso was re-elected for a second
term as president. The outcome of these elections could have a strong impact
on the continuation of the economic reforms of the Cardoso administration.
There can be no assurance that the political consensus in favor of the
economic reform program pursued by the Cardoso administration can or will be
sustained following the elections.
22
<PAGE>
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 1997
Brazil experienced a financial crisis following the financial and economic
crisis in Asia. In response, the Federal Government adopted several economic
measures to protect the Real Plan and the stability of the Brazilian currency.
These measures included (i) an increase in interest rates, including a near
doubling of short-term interest rates, (ii) an increase in certain tax rates,
(iii) a reduction in Federal Government spending for 1998 and (iv)
restrictions on imports. Government policies to control inflation and to
reduce budget and trade deficits could also result in further actions that
could slow or halt Brazilian economic growth. It is not possible to foresee
how measures like these will affect the business, financial condition and
results of operations of the Company.
Brazil's trade deficit for 1997 increased to US$8.37 billion compared to
US$5.54 billion for 1996. There can be no assurance that the Brazilian
government will not introduce credit restrictions to subdue domestic demand in
order to reduce the trade deficit, nor that any such credit restrictions will
not have a material adverse
23
<PAGE>
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 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 Banco
Nacional de Desenvolvimento Economico e Social (the "National Development
Bank" or "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 declined significantly. The current market volatility in Latin
American and other emerging market countries' securities markets has also been
attributed, at least in part, to the effects of the Asian economic crisis.
There can be no assurance that the Brazilian securities markets will not
continue to be affected negatively by events elsewhere, especially in emerging
markets, or that such events will not adversely affect the value of the ADSs.
In reaction to the growing market volatility in Asia, the Federal Government
implemented several measures intended to curtail the outflow of foreign
investment, as Central Bank reserves were reduced from U.S.$61.2 billion in
September 1997 to U.S.$52.9 billion by the end of October 1997. On October 30,
1997, the Central Bank raised the benchmark interest rate from 20.7% to 43.4%
in order to retain investment funds in the country. On November 10, 1997 the
Federal Government presented a series of fiscal measures aimed at reducing the
24
<PAGE>
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, at 21.8% on May 20, 1998, at
21.0% on June 25, 1998 and at 19.75% on July 29, 1998. 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."
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 Financial Statements,
inflationary gains or losses on monetary assets and liabilities have been
allocated to their corresponding income or expense captions in the statement
of operations. Inflationary gains or losses without a corresponding income or
expense caption have been allocated to other net operating income (expense).
See Note 2a to the Financial Statements.
25
<PAGE>
ITEM 2: DESCRIPTION OF PROPERTY
The principal physical properties of the Company consist of transmission
equipment, switching equipment and base stations. The Company leases office
space (approximately 8,513.32 square meters) in Belo Horizonte from which the
majority of its management activities are conducted.
The Company also owns or leases the sites where its cellular network
equipment is installed. As of March 31, 1998, the Company had eight large
cellular switches in Belo Horizonte, Juiz de Fora, Varginha, Governador
Valadares and Divinopolis and 361 cell sites, of which 50 were located on land
owned by the Company and the remainder of which were located on land leased
from Telemig or third parties. Most of these leases do not expire prior to
December 1999 and are renewed every two years. In addition, the Company leases
109 retail stores throughout the Region. Pursuant to Brazilian legal
procedures, judicial liens have been placed on 14 of the Company's properties
pending the outcome of various legal proceedings to which the Company is a
party. In the event the Company prevails in such legal proceedings, such liens
will be lifted from the properties.
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 actions 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. 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, financial condition
or results of operations.
Telebras and Telemig, the legal predecessors of the Registrant and Telemig
Cellular, respectively, are defendants in a number of legal proceedings and
subject to certain other claims and contingencies. Liability for any claims
arising out of acts committed by Telemig prior to the effective date of the
spin-off of Telemig's cellular assets and liabilities to Telemig Cellular
remains with Telemig, except for labor and tax claims (for which Telemig and
Telemig Cellular are jointly and severally liable by operation of law) and
those liabilities for which specific accounting provisions have been assigned
to Telemig Cellular. However, under the shareholders' resolution pursuant to
which the spin-off was effected, Telemig Cellular has contribution rights
against Telemig with respect to the entire amount of any payments made by
Telemig Cellular in connection with any labor or tax claims brought against
Telemig Cellular and relating to acts committed by Telemig prior to the
effective date of the spin-off. Any claims against Telemig which are not met
by Telemig could result in claims
26
<PAGE>
against Telemig Cellular to the extent that Telemig Cellular has received
assets which might have been used to settle those claims had they not been
spun off from Telemig. Under the terms of the Breakup, liability for any
claims arising out of acts committed by Telebras prior to the effective date
of the Breakup remains with Telebras, except for labor and tax claims (for
which Telebras and the New Holding Companies are jointly and severally liable
by operation of law) and any liability for which specific accounting
provisions have been assigned to the Registrant or one of the other New
Holding Companies. Creditors of Telebras may challenge this allocation of
liability until September 14, 1998. Management of the Company believes that
the chances of any such claims materializing and having a material adverse
financial effect on the Company are remote.
ITEM 4: CONTROL OF REGISTRANT
Of the Registrant'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." Telpart owns 51.8% of the Common Shares.
Accordingly, Telpart has the ability to control the election of the
Registrant's Board of Directors and the direction and future operations of the
Company.
The following table sets forth information concerning the ownership of
Common Shares by Telpart and by the Registrant'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>
Telpart.......................................... 64,405,151,125 51.79%
All directors and executives officers as a group
(12 persons).................................... 11 0.00%
</TABLE>
The following is a brief description of the shareholders of Telpart.
TIW DO BRASIL LTDA. TIW do Brasil is an indirect wholly owned subsidiary of
Telesystem International Wireless, Inc. ("TIW"), a Canadian public company
whose shares are listed on NASDAQ, the Toronto Stock Exchange and the Montreal
Exchange. TIW develops, acquires, owns and operates wireless
telecommunications networks in developing and developed markets throughout the
world. Telesystem Ltd., a privately holding company, owns 18% of the equity
and 39% of the voting shares of TIW. TIW is also a shareholder in the
consortia that acquired control of another New Holding Company, Tele Norte
Celular Participacoes S.A.
OPPORTUNITY MEM S.A. Opportunity is indirectly held by investment and mutual
funds managed by Opportunity Bank, a private Brazilian investment bank.
Opportunity is also a shareholder in the consortia that acquired control of
another New Holding Company, Tele Norte Celular Participacoes S.A.
SISTEL--FUNDACAO SISTEL SEGURIDADE SOCIAL, TELOS--FUNDACAO EMBRATEL DE
SEGURIDADE SOCIAL, FUNCEF--FUNDACAO DOS ECONOMIARIOS FEDERAIS; PETROS--
FUNDACAO PETROBRAS DE SEGURIDADE SOCIAL AND PREVI--CAIXA DE PREVIDENCIA DOS
FUNCIONARIOS DO BANCO DO BRASIL. SISTEL, TELOS, FUNCEF, PETROS and PREVI are
pension funds.
The shareholders of Telpart are currently negotiating a shareholders'
agreement that will ensure pro rata representation of their respective
nominees on the Boards of Directors of Telpart and the Company.
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 Telemig Cellular 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
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<PAGE>
(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, Telemig Cellular shares traded on such exchanges as units with shares of
Telemig. Prior to the spin-off of Telemig's cellular operations to Telemig
Cellular, common shares and preferred shares of Telemig traded 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 Telemig Cellular as reported
on the Sao Paulo Stock Exchange since the spin-off of Telemig's cellular
operations. The market price of the Preferred Shares may differ materially
from the market price of the preferred shares of Telemig Cellular. Two factors
accounting for this difference are (i) that the Registrant has certain assets
and liabilities that Telemig Cellular does not (see Note 23 to the Financial
Statements) and (ii) that the capital structure of Telemig Cellular differs
significantly from that of the Registrant. As of May 18, 1998, Telemig
Cellular had 8,912,419 thousand common shares and 14,897,425 thousand
preferred shares outstanding. See "Description of Securities to be
Registered--Capital Stock--General."
<TABLE>
<CAPTION>
PRICES PER 1,000
PREFERRED SHARES OF
TELEMIG CELLULAR(1)
-------------------
HIGH LOW
-------------------
(in nominal reais)
<S> <C> <C>
May 18, 1998 through May 31, 1998........................ R$68.00 R$60.00
June 1, 1998 through June 30, 1998....................... R$60.00 R$ 30.00
July 1, 1998 through July 31, 1998....................... R$55.08 R$34.50
August 1, 1998 through August 31, 1998................... R$85.00 R$50.00
September 1, 1998 through September 30, 1998............. R$29.00 R$11.70
</TABLE>
- --------
(1) Share prices are for Telemig Cellular, a subsidiary of the Registrant, and
not for the Registrant itself.
Following the Breakup and until September 21, 1998, the preferred shares of
each of the New Holding Companies, including the Preferred Shares, traded on
the Brazilian Stock Exchanges only as a unit with the preferred shares of
Telebras. Telebras ADSs, each representing 1,000 Telebras preferred shares
and, since the Breakup, each also representing 1,000 preferred shares of each
of the New Holding Companies, have continued to trade on the NYSE.
On September 21, 1998, 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$1.34 R$0.95
October 1, 1998 through October 23, 1998................. R$1.03 R$0.71
</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 20,000 Preferred Shares of the Registrant, will be issued to the
holders of Telebras ADSs pursuant to a Deposit Agreement (the "Deposit
Agreement") among the Registrant, The Bank of New York as Depositary (the
"Depositary") and the holders of the ADSs from time to time. See "Description
of Securities to be Registered--Description of American Depositary Receipts in
respect of Preferred Shares."
Application has been made to list the ADSs on the NYSE upon issuance under
the symbol TMB. Prices at which the Preferred Shares and the ADSs may trade
cannot be predicted. There can be no assurance that an active
28
<PAGE>
trading market for the Preferred Shares in Brazil or for the ADSs in the
United States or elsewhere will develop or be sustained.
TRADING ON THE BRAZILIAN STOCK EXCHANGES
Of Brazil's nine stock exchanges, the Sao Paulo Stock Exchange and the Rio
de Janeiro Stock Exchange are the most significant. During 1997, the Sao Paulo
Stock Exchange accounted for approximately 93% of the trading value of equity
securities on all Brazilian stock exchanges, and the Sao Paulo Stock Exchange
and the Rio de Janeiro Stock Exchange together accounted for approximately 99%
of the trading value of equity securities on all Brazilian stock exchanges.
Each Brazilian stock exchange is a non-profit entity owned by its member
brokerage firms. Trading on each exchange is limited to member brokerage firms
and a limited number of authorized non-members. The Sao Paulo Stock Exchange
and the Rio de Janeiro Stock Exchange have two open outcry trading sessions
each day, from 10:00 a.m. to 1:00 p.m. and from 2:00 p.m. to 5:00 p.m. Trading
is also conducted during this time on an automated system on the Sao Paulo
Stock Exchange and on the National Electronic Trading System ("SENN"), a
computerized system that links the Rio de Janeiro Stock Exchange
electronically with the seven smaller regional exchanges. Market makers exist
on the Sao Paulo Stock Exchange, but are only authorized to make markets in
options for stock indices which are traded on that exchange and to engage in
transactions on META (Mercado de Empresas Teleassistidas), an electronic
trading system operating at the Sao Paulo Stock Exchange and permitting
trading in the securities of companies registered for that purpose. These
companies must appoint the market makers authorized to deal in their
securities. There are no specialists or market makers for the Company's shares
on the Sao Paulo Stock Exchange. The Comissao de Valores Mobiliarios (the
Brazilian Securities Commission or "CVM") and each of the Brazilian stock
exchanges have discretionary authority to suspend trading in shares of a
particular issuer under certain circumstances. Trading in securities listed on
the Brazilian stock exchanges may be effected off the exchanges in certain
circumstances, although such trading is very limited.
Settlement of transactions is effected three business days after the trade
date without adjustment of the purchase price for inflation. Payment for
shares is made through the facilities of separate clearinghouses for each
exchange,
which maintain accounts for member brokerage firms. The seller is ordinarily
required to deliver the shares to the exchange on the second business day
following the trade date. The clearinghouse for the Sao Paulo Stock Exchange
is Calispa S.A., which is owned by the member brokerage firms. The
clearinghouse for the Rio de Janeiro Stock Exchange is CLC-Camara de
Liquidacao e Custodia S.A., which is 99% owned by that exchange.
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 tends 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 non-residents of Brazil is subject
to certain limitations under Brazilian foreign investment legislation. See
"Description of Securities to be Registered."
29
<PAGE>
REGULATION OF BRAZILIAN SECURITIES MARKETS
The Brazilian securities markets are regulated by the CVM, which has
authority over stock exchanges and the securities markets generally, and by
the Central Bank of Brazil, which has, among other powers, licensing authority
over brokerage firms and regulates foreign investment and foreign exchange
transactions. The Brazilian securities market is governed by Law No. 6,385
dated December 7, 1976, as amended (the "Brazilian Securities Law"), and the
Brazilian Corporation Law.
Under the Brazilian Corporation Law, a company is either public, a
"companhia aberta," such as the Company, or private, a "companhia fechada."
All public companies are registered with the CVM and are subject to reporting
requirements. A company registered with the CVM may have its securities traded
either on the Brazilian stock exchanges or in the Brazilian over-the-counter
("Brazilian OTC") market. The shares of a public company, including the
Company, may also be traded privately, subject to certain limitations. To be
listed on the Brazilian stock exchanges, a company must apply for registration
with the CVM and the stock exchange where the head office of the company is
located. Once this stock exchange has admitted a company to listing and the
CVM has accepted its registration as a public company, its securities may be
traded on all other Brazilian stock exchanges.
Trading in securities on the Brazilian stock exchanges may be suspended at
the request of a company in anticipation of a material announcement. Trading
may also be suspended on the initiative of a Brazilian stock exchange or the
CVM, among other reasons, based on or due to a belief that a company has
provided inadequate information regarding a material event or has provided
inadequate responses to inquiries by the CVM or the relevant stock exchange.
The Brazilian Securities Law provided for, among other things, disclosure
requirements, restrictions on insider trading and price manipulation, and
protection of minority shareholders. However, the Brazilian securities markets
are not as highly regulated and supervised as the United States securities
markets or markets in certain other jurisdictions.
ITEM 6: EXCHANGE CONTROLS AND OTHER LIMITATIONS AFFECTING SECURITY HOLDERS
There are no restrictions on ownership of Preferred Shares or Common Shares
of the Registrant by individuals or legal entities domiciled outside Brazil.
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.
30
<PAGE>
Under Annex IV to Resolution No. 1,289 of the National Monetary Council, as
amended (the "Annex IV Regulations"), qualified foreign investors (which
principally include foreign financial institutions, insurance companies,
pension and investment funds, charitable foreign institutions and other
institutions that (i) seek to invest in financial markets and (ii) meet
certain minimum capital and other requirements) registered with the CVM and
acting through authorized custody accounts managed by local agents may buy and
sell shares on Brazilian stock exchanges without obtaining separate
Certificates of Registration for each transaction. Investors under the Annex
IV Regulations are also entitled to favorable tax treatment. See "Taxation--
Brazilian Tax Considerations." Resolution No. 1,927 of the National Monetary
Council, which is the restated and amended Annex V to Resolution No. 1,289 of
the National Monetary Council (the "Annex V Regulations"), provides for the
issuance of depositary receipts in foreign markets in respect of shares of
Brazilian issuers. The ADS program will be approved under the Annex V
Regulations by the Central Bank of Brazil and the CVM prior to the issuance of
the ADSs. Accordingly, the proceeds from the sale of ADSs by ADR holders
outside Brazil are free of Brazilian foreign investment controls and holders
of the ADSs will be entitled to favorable tax treatment. See "Taxation--
Brazilian Tax Considerations."
A Certificate of Registration will be issued in the name of the Depositary
with respect to the ADSs prior to the issuance of the ADSs and will be
maintained by the Custodian on behalf of the Depositary. Pursuant to the
Certificate of Registration, the Custodian and the Depositary are able to
convert dividends and other distributions with respect to the Preferred Shares
represented by ADSs into foreign currency and remit the proceeds outside
Brazil. In the event that a holder of ADSs exchanges such ADSs for Preferred
Shares, such holder will be entitled to continue to rely on the Depositary's
Certificate of Registration for five business days after such exchange,
following which such holder must seek to obtain its own Certificate of
Registration with the Central Bank of Brazil. Thereafter, any holder of
Preferred Shares may not be able to convert into foreign currency and remit
outside Brazil the proceeds from the disposition of, or distributions with
respect to, such Preferred Shares, unless such holder (i) qualifies under the
Annex IV Regulations or (ii) obtains its own Certificate of Registration, and
in the case of (ii), it will be subject to less favorable Brazilian tax
treatment than a holder of ADSs. See "Taxation--Brazilian Tax Considerations."
Under current Brazilian legislation, the Federal Government may impose
temporary restrictions on remittances of foreign capital abroad in the event
of a serious imbalance or an anticipated serious imbalance of Brazil's balance
of payments. For approximately six months in 1989 and early 1990, the Federal
Government froze all dividend and capital repatriations held by the Central
Bank of Brazil that were owed to foreign equity 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
31
<PAGE>
Shares or ADSs. Prospective holders of Preferred Shares or ADSs should consult
their own tax advisors as to the tax consequences of the acquisition,
ownership and disposition of Preferred Shares or ADSs in their particular
circumstances.
BRAZILIAN TAX CONSIDERATIONS
The following discussion summarizes the principal Brazilian tax consequences
of the acquisition, ownership and disposition of Preferred Shares or ADSs by a
holder that is not domiciled in Brazil for purposes of Brazilian taxation and,
in the case of a holder of Preferred Shares, that has registered its
investment in Preferred Shares with the Central Bank of Brazil as a U.S.
dollar investment (in each case, a "non-Brazilian holder"). It is based on
Brazilian law as currently in effect. Any change in such law may change the
consequences described below. The following discussion summarizes the
principal tax consequences applicable under current Brazilian law to non-
Brazilian holders of Preferred Shares or ADSs; it does not specifically
address all of the Brazilian tax considerations applicable to any particular
non-Brazilian holder, and each non-Brazilian holder should consult his or her
own tax advisor concerning the Brazilian tax consequences of an investment in
Preferred Shares or ADSs.
TAXATION OF DIVIDENDS
Dividends, including dividends paid in kind, paid by the Company (i) to the
Depositary in respect of the Preferred Shares underlying the ADSs or (ii) to a
non-Brazilian holder in respect of Preferred Shares will generally not be
subject to Brazilian withholding tax in the case of distributions of profits
earned as from January 1, 1996. Stock dividends relating to profits generated
prior to December 31, 1995 are not subject to withholding tax in Brazil unless
the stock is redeemed by the Company within five years from such distribution
or the non-Brazilian holder sells the stock in Brazil within such five-year
period.
Brazil has entered into tax treaties with several countries. However, there
is currently no tax treaty between the United States and Brazil. The only
Brazilian tax treaty now in effect that, if certain conditions are met, would
reduce the rate of the withholding tax on dividends in respect of profits
generated prior to December 31, 1995 below the generally applicable 15% rate
is the treaty with Japan, which would reduce such rate to 12.5% under the
circumstances stated in such treaty.
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,
32
<PAGE>
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 continue in the future or that it will not
be changed. Reductions in the tax rate provided for by Brazil's tax treaties
do not apply to tax on gains realized on sales or exchanges of Preferred
Shares.
Any exercise of preemptive rights relating to the Preferred Shares or ADSs
will not be subject to Brazilian taxation. Any gain on the sale or assignment
of preemptive rights relating to the Preferred Shares by the Depositary will
not be subject to Brazilian taxation.
DISTRIBUTIONS OF INTEREST ON NET WORTH
In accordance with Law No. 9,249, dated December 26, 1995, Brazilian
corporations may make payments to shareholders characterized as distributions
of interest on the Company's net worth. Such interest is limited to the
Federal Government's long-term interest rate (the "TJLP") as determined by the
Central Bank of Brazil from time to time (10.63% per annum for the three month
period starting June 1, 1998), and cannot exceed the greater of (i) 50% of net
income (before taking such distribution and any deductions for income taxes
into account) for the period in respect of which the payment is made or (ii)
50% of retained earnings.
Distributions of interest on net worth in respect of the Preferred Shares
paid to shareholders who are either Brazilian residents or non-Brazilian
residents, including holders of ADSs, are subject to Brazilian withholding tax
at the rate of 15% (except for interest due to the Federal Government, which
is exempt from tax withholding) and shall be deductible by the Registrant for
purposes of the Corporate Income Tax ("IRPJ") and Social Contribution on
Profit ("CSLL") (both of which are levied on the Company's profits), as long
as the payment of a distribution of interest is approved in the Registrant's
annual shareholders' meeting. The amount of distributions of interest on net
worth will be determined by the Board of Directors of the Registrant. No
assurance can be given that the Board of Directors of the Registrant will not
determine that future distributions of profits will be made by means of
interest on net worth instead of by means of dividends.
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
33
<PAGE>
in Brazil or in the relevant State to individuals or entities that are
resident or domiciled within such State in Brazil. There are no Brazilian
stamp, issue, registration, or similar taxes or duties payable by holders of
Preferred Shares or ADSs.
Pursuant to Decree 2,219, dated May 2, 1997, a financial transaction tax
(the "IOF") may be imposed on the conversion into Brazilian currency of the
proceeds of a foreign investment in Brazil (including investments in Preferred
Shares and ADSs and investments made under the Annex IV Regulations) and may
also be imposed upon the conversion of Brazilian currency into foreign
currency (e.g., for purposes of paying dividends and interest). The IOF tax
rate is currently 0%. Although the Minister of Finance has the legal power to
increase the rate to a maximum of 25%, any such increase will be applicable
only to transactions occurring after such increase becomes effective.
On January 24, 1997, a temporary tax was enacted. The Contribuicao
Provisoria sobre Movimentacao Financeira ("CPMF Tax"), which was created by
Constitutional Amendment No. 12 of August 16, 1996 and regulated by Law No.
9,311 of October 24, 1996, is levied on debits on bank accounts and certain
other payments made by a bank, at a rate of 0.2%, which may be raised at any
time to 0.25%. The CPMF Tax was initially scheduled to be collected until
February 22, 1998; the CPMF Tax was subsequently extended until January 27,
1999 by Law No. 9,539 of December 12, 1997.
REGISTERED CAPITAL
The amount of an investment in Preferred Shares held by a non-Brazilian
holder who qualifies under the Annex IV Regulations and obtains registration
with the CVM, or by the Depositary representing such holder, is eligible for
registration with the Central Bank of Brazil; such registration (the amount so
registered is referred to as "Registered Capital") allows the remittance
outside Brazil of foreign currency, converted at the Commercial Market Rate,
acquired with the proceeds of distributions on, and amounts realized with
respect to disposition of, 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
the 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-
34
<PAGE>
exempt organizations, financial institutions, holders liable for the
alternative minimum tax, securities traders who elect to account for their
investment in Preferred Shares or ADSs on a mark-to-market basis, and persons
holding Preferred Shares or ADSs in a hedging transaction or as part of a
straddle or conversion transaction.
Each holder should consult such holder's own tax advisor concerning the
overall tax consequences to it, including the consequences under foreign,
state and local laws, of an investment in Preferred Shares or ADSs.
In this discussion, references to "ADSs" also refer to Preferred Shares,
references to a "U.S. holder" are to a holder of an ADS (i) that is a citizen
or resident of the United States of America, (ii) that is a corporation
organized under the laws of the United States of America or any state thereof,
or (iii) that is otherwise subject to U.S. federal income taxation on a net
basis with respect to the ADS.
For purposes of the U.S. Internal Revenue Code of 1986, as amended (the
"Code"), holders of ADRs will be treated as owners of the ADSs represented by
such ADRs.
TAXATION OF DIVIDENDS
A U.S. holder will recognize ordinary dividend income for U.S. federal
income tax purposes in an amount equal to the amount of any cash and the value
of any property distributed by the Registrant as a dividend to the extent that
such distribution is paid out of the Registrant's current or accumulated
earnings and profits ("e&p"), as determined for U.S. federal income tax
purposes, when such distribution is received by the Custodian or by the U.S.
holder, in the case of a holder of Preferred Shares. To the extent that such a
distribution exceeds the Registrant's e&p, it will be treated as a non-taxable
return of capital, to the extent of the U.S. holder's tax basis in the ADS (or
Preferred Shares, as the case may be), and thereafter as capital gain. The
amount of any distribution will include the amount of Brazilian tax withheld
on the amount distributed and the amount of a distribution paid in reais will
be measured by reference to the exchange rate for converting reais into U.S.
dollars in effect on the date the distribution is received by the Custodian,
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.
35
<PAGE>
TAXATION OF CAPITAL GAINS
Upon the sale or other disposition of an ADS, a U.S. holder will recognize
gain or loss for U.S. federal income tax purposes in an amount equal to the
difference between the amount realized in consideration for the disposition of
the ADS (excluding the amount of any distribution paid to the Custodian but
not distributed by the Custodian prior to the disposition) and the U.S.
holder's tax basis in the ADS. Such gain or loss generally will be subject to
U.S. federal income tax and will be treated as capital gain or loss. Under
recently enacted legislation, long-term capital gains recognized by an
individual holder generally are subject to a maximum rate of 20 percent in
respect of property held for more than one year, effective for amounts
properly taken into account on or after January 1, 1998. The deductibility of
capital losses is subject to certain limitations. Gain realized by a U.S.
holder on a sale or disposition of ADSs generally will be treated as U.S.
source income. Consequently, in the case of a disposition of Preferred Shares
in Brazil (which, unlike a disposition of ADSs, would be taxable in Brazil),
the U.S. holder might not be able to use the foreign tax credit for Brazilian
tax imposed on gain.
A non-U.S. holder will not be subject to U.S. federal income tax or
withholding tax on gain realized on the sale or other disposition of an ADS
unless (i) such gain is effectively connected with the conduct by the holder
of a trade or business in the United States, or (ii) such holder is an
individual who is present in the United States of America for 183 days or more
in the taxable year of the sale and certain other conditions are met.
U.S. BACKUP WITHHOLDING AND INFORMATION REPORTING
The information reporting requirements of the Code generally will apply to
distributions to a U.S. holder. Distributions to non-U.S. holders generally
will be exempt from information reporting and backup withholding under current
law but a non-U.S. holder may be required to establish its non-U.S. status in
order to claim such exemption.
ITEM 8: SELECTED FINANCIAL DATA
GENERAL
The table set forth below presents selected financial information for the
Company at 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 Financial Statements and the notes thereto included
elsewhere in this Registration Statement. The 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 24 to the Consolidated Financial Statements for a
summary of the differences between Brazilian GAAP and U.S. GAAP and a
reconciliation to U.S. GAAP of the Company's divisional equity at December 31,
1996 and 1997 and income before interest income, unallocated interest expense
and taxes for the years ended December 31, 1996 and 1997. All other selected
financial information has been derived from the Company's accounting records.
The Consolidated Financial Statements present the consolidated financial
condition and revenues and expenses of the Registrant and the cellular
telecommunications business of Telemig, which was spun-off into the
Registrant's subsidiary Telemig Cellular, effective January 1, 1998. The
portion of the equity and income before interest income, unallocated interest
expense and taxes of the Company attributable to shareholders of the Company
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 17.1% of the share
capital of Telemig.
36
<PAGE>
Cash and certain nonspecific debt relating to the cellular
telecommunications operations of Telemig could not be segregated from Telemig
prior to December 31, 1997 and such amounts are not reflected in the
Consolidated Financial Statements. As a result, interest income, unallocated
interest expense and taxes relating to the cellular telecommunications Telemig
could not be identified and reflected in the Consolidated Financial
Statements. In view of the exclusion of such revenues and expenses from the
Consolidated Financial Statements, historical income per share and dividend
per share information has not been included in the table below.
See "Management's Discussion and Analysis of Financial Condition and Revenues
and Expenses--Revenues and Expenses for the years ended December 31, 1995,
1996 and 1997--Allocated interest expense."
The formations of the Registrant and Telemig Cellular 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 business of Telemig were transferred to Telemig Cellular at
their indexed historical cost. The revenues and expenses associated with such
assets and liabilities were also allocated to Telemig Cellular. Separate
records of revenues from the cellular telecommunications business of Telemig
were maintained historically. Accordingly, the actual amounts were allocated
for the periods included herein. The Consolidated Statements of Revenues and
Expenses and Net Interdivisional Cash Distribution (Receipt) have been
prepared to include the historical activity related to the assets and
liabilities transferred. The Consolidated Financial Statements are not
necessarily indicative of what would have been the financial condition and
revenues and expenses of the Company as of December 31, 1996 and 1997, and for
the three year period ended December 31, 1997 had the cellular
telecommunications business of Telemig been a separate legal entity during
such period. See "Description of Business--Background," "--The Company" and
Notes 1, 2 and 23 to the Consolidated Financial Statements.
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 Consolidated Statements
of Revenues and Expenses. Inflationary gains or losses without a corresponding
income or expense caption have been allocated to other net operating income
(expense). See Note 2a to the Consolidated Financial Statements.
Until December 31, 1995, the relevant inflation index selected by the CVM
and the one used for the constant currency method under Brazilian GAAP was the
UFIR. Effective January 1, 1996, the CVM no longer requires Brazilian
companies to restate their financial statements for reporting purposes in
constant currency by indexing historical amounts using the UFIR. Restatement
in constant currency is now optional and any general price index may be used.
The Brazilian Institute of Accountants has recommended that the IGP-M be used
for this purpose. The Company's management believes that the IGP-M is the most
appropriate measure of the general price inflation in Brazil and has elected
the IGP-M for purposes of preparing its consolidated financial statements in
accordance with the constant currency method as of January 1, 1996.
In July 1997, the three-year cumulative inflation rate for Brazil fell below
100%; however, for accounting purposes, the constant currency method has
continued to be applied. The Brazilian Institute of Accountants has not yet
published definitive rules regarding when the constant currency method of
accounting may no longer be used to prepare the 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
revenue and expense items will no longer be restated for inflation.
37
<PAGE>
SELECTED FINANCIAL INFORMATION
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------------------
1995 1996 1997 1997
---------- ---------- ---------- -------------------
(IN THOUSANDS OF CONSTANT REAIS, (IN THOUSANDS
EXCEPT PER SHARE DATA) OF U.S. DOLLARS)(1)
<S> <C> <C> <C> <C>
STATEMENT OF REVENUES
AND EXPENSES DATA:
Brazilian GAAP
Net operating revenue
from cellular
telecommunication
services(2)............ R$ 110,641 R$ 239,163 R$ 374,162 US$335,150
Cost of services........ (58,509) (86,352) (183,696) (164,543)
---------- ---------- ---------- ----------
Gross profit............ 52,132 152,811 190,466 170,607
Operating expenses:
Selling expense....... (4,946) (13,770) (57,723) (51,705)
General and adminis-
trative expense...... (9,817) (17,742) (28,020) (25,099)
Other net operating
income (expense)..... 11,470 11,546 (83) (74)
---------- ---------- ---------- ----------
Operating income before
interest............... 48,839 132,845 104,640 93,729
Allocated interest ex-
pense.................. -- (413) (10,193) (9,130)
---------- ---------- ---------- ----------
Operating income before
interest income and
unallocated interest
expense................ 48,839 132,432 94,447 84,599
Net non-operating ex-
pense.................. -- (957) -- --
Employees' profit
share.................. -- (269) -- --
---------- ---------- ---------- ----------
Income before interest
income, unallocated
interest expense, taxes
and minority
interests.............. 48,839 131,206 94,447 84,599
Minority interests
before interest income,
unallocated interest
expense and taxes...... (6,923) (21,704) (15,584) (13,959)
---------- ---------- ---------- ----------
Income before interest
income, unallocated
interest expense and
taxes(3)............... 41,916 109,502 78,863 70,640
========== ========== ========== ==========
U.S. GAAP
Income before interest income,
unallocated interest expense and
taxes(3).......................... 113,081 81,464 72,970
========== ========== ==========
FINANCIAL CONDITION DATA
(AT DECEMBER 31):
Brazilian GAAP
Property, plant and
equipment, net......... R$ 267,116 R$ 434,784 R$ 502,854 US$450,425
Total assets............ 288,838 471,794 577,685 517,453
Loans and financing--
current portion........ -- 38,513 41,033 36,755
Loans and financing--non
current portion........ -- 95,818 76,072 68,140
Divisional equity....... 175,597 257,857 346,433 310,311
U.S. GAAP
Property, plant and equipment,
net............................... 403,199 470,538 421,478
Total assets....................... 450,632 556,033 498,059
Loans and financing--current
portion........................... 37,514 39,271 35,176
Loans and financing--non current
portion........................... 95,818 76,072 68,140
Divisional equity.................. 240,088 328,474 294,226
</TABLE>
<TABLE>
<CAPTION>
MAY 22, 1998
----------------
(IN THOUSANDS OF
CONSTANT REAIS)
<S> <C>
NEW HOLDING COMPANY--BRAZILIAN GAAP SHAREHOLDERS' EQUITY(4):
Share capital................................................. 155,552
Income reserves............................................... 139,803
Retained earnings............................................. 124,318
-------
Total shareholders' equity.................................. 419,673
=======
</TABLE>
38
<PAGE>
SELECTED FINANCIAL INFORMATION FOR 1993 AND 1994:
Selected financial information as of and for the years ended December 31,
1993 and 1994 has not been presented as the accounting records for these years
were not maintained in a manner that would enable all costs, assets and
liabilities to be segregated between fixed and cellular operations. Given that
the Company's cellular business in 1993 and 1994 was in a developmental stage
having limited relevance to the Company's current operations, management
believes that the omitted selected financial information as of and for the
years ended December 31, 1993 and 1994 would not be material to an
understanding of the trends affecting the evolution of the Company's costs in
the periods presented or in future periods. However, information relating to
net operating revenues and number of subscribers at year end has been
presented in the following table.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------------------
1993 1994 1995 1996 1997 1997
------ ------ ------- ------- ------- ----------------
(IN THOUSANDS OF CONSTANT REAIS, (IN THOUSANDS OF
EXCEPT SUBSCRIBER DATA) U.S. DOLLARS)(1)
<S> <C> <C> <C> <C> <C> <C>
REVENUES AND SUBSCRIBERS
Net operating revenue... 3,015 20,225 110,641 239,163 374,162 335,150
Subscribers (year end).. 14,120 42,242 89,634 233,042 427,815
</TABLE>
- --------
(1) The translation of Brazilian real amounts into U.S. dollar amounts is
unaudited and included solely for the convenience of the reader. Such U.S.
dollar amounts have been translated from reais at the Commercial Market
Rate published by the Central Bank of Brazil for December 31, 1997 which
was R$1.1164 to US$1.00. This translation should not be construed as a
representation that the real amounts actually represent such U.S. dollar
amounts or could be converted into U.S. dollars at the rate indicated.
(2) Net operating revenue from telecommunication services includes revenues
from activation fees of R$0.1 million, R$45.1 million and R$30.3 million
in 1995, 1996 and 1997, respectively. As a result of the announcement by
the Band B operator in the Region that it will offer cellular services
with no activation fee, the Company eliminated the activation fee for the
Flex Plan and reduced the activation fee for the Basic Service Plan by
67.5% in October 1998. See "Description of Business--Rates--Subscriber
Rates." Although management believes that this elimination and reduction
of activation fees will have a negative impact on the Company's operating
revenues, management is not able to determine the extent to which, if any,
decreased revenues from activation fees will be positively offset by
growth in the Company's subscriber base and increased revenues from usage
charges resulting from increases in the volume of outgoing and incoming
calls. See "Management's Discussion and Analysis of Financial Condition
and Revenues and Expenses--Revenues and Expenses for the years ended
December 31, 1995, 1996 and 1997--Net operating revenues--Activation
fees."
(3) The consolidated net income of the Company has not been presented as cash
and nonspecific debt relating to the cellular telecommunications
operations of Telemig could not be segregated from Telemig prior to
December 31, 1997. Accordingly, the Consolidated Statement of Revenues and
Expenses Data does not include interest income and additional interest
expense, if any, associated with such cash and nonspecific debt. Had such
amounts been reported, the Company would have deducted income and social
contribution taxes utilizing the effective tax rates of Telemig Cellular
for the periods presented. For US GAAP purposes, the income and social
contribution taxes would have been adjusted from the Brazilian GAAP
amounts to reflect the impact of the indexation of permanent assets. In
addition, in order to report net income, minority interest would have been
adjusted giving effect to the adjustments noted above.
(4) 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 23 to the consolidated financial
statements.
39
<PAGE>
ITEM 9: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
REVENUES AND EXPENSES
The following discussion of the consolidated financial condition and
revenues and expenses of the Company for the years ended December 31, 1995,
1996 and 1997 should be read in conjunction with the Financial Statements of
the Company and the Notes thereto included elsewhere in this Registration
Statement. The Financial Statements have been prepared in accordance with
Brazilian GAAP, which differs in certain significant respects from U.S. GAAP.
Note 24 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 income before interest
income, unallocated interest expense and taxes for the two years ended
December 31, 1996 and 1997 and total divisional 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 82.9% of the total share
capital of Telemig Cellular, were transferred to the Registrant.
The Consolidated Financial Statements present the consolidated financial
condition and revenues and expenses of the cellular telecommunications
business of Telemig, which was spun-off into the Registrant's subsidiary
Telemig Cellular, effective January 1, 1998. The portion of the consolidated
equity and income before interest income, unallocated interest expense and
taxes of the Company attributable to shareholders of the Company 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 17.1% of the share capital of
Telemig.
The formations of the Registrant and Telemig Cellular 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 business of Telemig were transferred to Telemig Cellular at
their indexed historical cost. The revenues and expenses associated with such
assets and liabilities were also allocated to Telemig Cellular. Separate
records of revenues from the cellular telecommunications business of Telemig
were maintained historically. Accordingly, the actual amounts were allocated
for the periods included herein. The Consolidated Statements of Revenues and
Expenses and Net Interdivisional Cash Distribution (Receipt) have been
prepared to include the historical activity related to the assets and
liabilities transferred. The Consolidated Financial Statements are not
necessarily indicative of what would have been the financial condition and
revenues and expenses of the Company as of December 31, 1996 and 1997, and for
the three-year period ended December 31, 1997 had the cellular
telecommunications business of Telemig been a separate legal entity during
such period. See "Description of Business--Background," "--The Company" and
Notes 1, 2 and 23 to the Consolidated Financial Statements.
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 Telemig Celular Participacoes S.A. were established. After
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
40
<PAGE>
retained earnings does not represent the historical retained earnings of the
New Holding Companies. The assets which were spun-off from Telebras, in
addition to its investment in the operating subsidiary, resulted in an
increase of R$73,240 thousand in relation to the Company's historical
divisional equity. See Note 23 to the Consolidated Financial Statements.
Allocated retained earnings and future retained earnings will be the basis
from which future dividends will be payable.
Cash and certain nonspecific debt relating to the cellular
telecommunications operations of Telemig could not be segregated from Telemig
prior to December 31, 1997 and such amounts are not reflected in the
Consolidated Financial Statements. As a result, interest income, unallocated
interest expense and taxes relating to the cellular telecommunications Telemig
could not be identified and reflected in the Consolidated Financial
Statements.
POLITICAL, ECONOMIC, REGULATORY AND COMPETITIVE FACTORS
The following discussion should be read in conjunction with the "Description
of Business" section included elsewhere in this Registration Statement. As set
forth in greater detail below, the Company's financial condition and revenues
and expenses 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 revenues and expenses also have been, and are expected
to continue to be, affected by the political and economic environment in
Brazil. See "Description of Business--Brazilian Political Environment" and "--
Brazilian Economic Environment." In particular, the Company's financial
performance will be affected by (i) national economic growth and its impact on
demand for telecommunications services, (ii) the cost and availability of
financing and (iii) the exchange rates between Brazilian and foreign
currencies. In addition, the Presidential and Congressional elections to be
held in October 1998 could have a significant impact on whether the economic
stabilization and liberalization policies of the current administration can or
will be sustained following the elections.
In July 1996, Brazil's Congress enacted legislation, which opened mobile
cellular communications to competition from the private sector. As a result,
the Company expects to face competition in the Region beginning in the fourth
quarter of 1998 and anticipates that prices for cellular telecommunications
services will decline and its operating margins will diminish. 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 are beyond the Company's control. See "Description of
Business--Competition."
EFFECTS OF INFLATION AND DEVALUATION
The Company's results in the years for which financial information is
presented herein were affected by inflation and devaluation, and that
financial information should be evaluated in light of the methodology for
recognition of effects of inflation applied by the Company under Brazilian
GAAP.
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 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 statement of operations. Inflationary gains
or losses without a corresponding income or expense caption have been
allocated to other net operating income (expense). See Note 2a to the
Consolidated Financial Statements.
Until December 31, 1995, the relevant inflation index selected by the CVM
and the one used for the constant currency method under Brazilian GAAP was the
UFIR. Effective January 1, 1996, the CVM no longer requires Brazilian
companies to restate their financial statements for reporting purposes in
constant currency by indexing historical amounts using the UFIR. Restatement
in constant currency is now optional and any general price index
41
<PAGE>
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 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 the 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.
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. In the years under review, rate increases generally lagged behind
inflation, resulting in steady real rate decreases. See "Description of
Business--Rates--Subscriber Rates."
FOREIGN EXCHANGE AND INTEREST RATE EXPOSURE
The Company's financial condition and revenues and expenses may be affected
by changes in foreign currency exchange rates (primarily the U.S. dollar/reais
rate) and market rates of interest (primarily the London Interbank Offered
Rate ("LIBOR")).
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$59.6 million
of financial liabilities (primarily suppliers credits) denominated 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 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 revenues and expenses.
The Company also faces foreign exchange risk as a result of substantially all
its capital expenditures being incurred in dollars while its revenues are
earned almost entirely in reais. As a result of this mismatch, any increases
in the Company's capital costs arising from currency fluctuations may not be
compensated by increased revenues.
The Company's financial condition and revenues and expenses 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, all
of the Company's interest bearing liabilities bore interest at floating rates.
The Company has not entered into derivative contracts or made other
arrangements to hedge against this risk. Accordingly, should market interest
rates rise (principally LIBOR), the Company's financing expenses will
increase.
YEAR 2000 COMPLIANCE
Year 2000 compliance is the ability of computer hardware and software to
respond to the problems posed by the fact that computer programs traditionally
have used two digits rather than four to record the applicable year. As a
consequence, any of the Company's computer programs that has date-sensitive
software may recognize a date recorded as "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.
42
<PAGE>
The Company has purchased and is in the process of implementing new billing,
administrative and accounting equipment and software, all of which is year
2000 compliant and has received written assurance of such compliance. The cost
of these new applications and equipment was not material and management
believes that such new applications and equipment sufficiently address any
material year 2000 problems the Company might face. At present the Company's
network is being upgraded and should be fully year 2000 compliant by the
second quarter of 1999. However, the Company may be affected by year 2000
problems to the extent that other entities not affiliated with the Company,
including the other New Holding Companies, government entities and businesses,
are unsuccessful in achieving year 2000 compliance. As of August 30, 1998, the
Company had not determined its most probable worst case scenarios in relation
to the year 2000 problem or formulated contingency plans in respect of such
scenarios. Despite the preventative measures taken by the Company, no
assurances can be given that the year 2000 issue will not have an adverse
impact on the financial condition and results of operations of the Company.
CVM Instruction 276, which was issued on May 8, 1998, requires all Brazilian
public companies to have addressed the Year 2000 issue by December 31, 1998.
Unless a discretionary extension is granted by the CVM, failure to have
addressed the Year 2000 issue by the CVM's deadline could result in the
imposition of fines of R$500 per day. At present, the Company is reviewing
such requirements with the CVM. However, as of October 9, 1998, the Company
had not requested an extension from the CVM, although it intends to do so if
needed.
43
<PAGE>
REVENUES AND EXPENSES 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 income
before interest income, unallocated interest expense and taxes in constant
reais and as a percentage of gross operating revenues, as well as the
proportional change from year to year in each such component, expressed as a
percentage.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, % CHANGE
----------------------------------------------- -----------
1995- 1996-
1995 %(1) 1996 %(1) 1997 %(1) 1996 1997
------- ----- ------- ----- -------- ----- ----- -----
(IN THOUSANDS OF CONSTANT REAIS, EXCEPT PERCENTAGES)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Net operating revenue
from telecommunication
services:
Monthly subscription
charges.............. 42,864 33.0% 86,862 30.7% 145,576 31.9% 103% 68%
Activation fees....... 140 0.1 45,068 15.9 30,335 6.6 -- (33)
Usage charges......... 65,148 50.2 100,630 35.6 171,660 37.6 54 71
Network usage
charges.............. 21,044 16.2 45,076 15.9 101,904 22.3 114 126
Other................. 592 0.5 5,089 1.9 7,398 1.6 760 45
------- ----- ------- ----- -------- ----- --- -----
Total gross
operating
revenues........... 129,788 100 282,725 100 456,873 100 118 62
Value added and other
indirect taxes....... (19,147) (14.7) (43,562) (15.4) (82,711) (18.1) 128 90
------- ----- ------- ----- -------- ----- --- -----
Total............... 110,641 85.3 239,163 84.6 374,162 81.9 116 56
Cost of services:
Depreciation and
amortization......... (12,503) (9.6) (28,469) (10.0) (48,555) (10.6) 128 71
Personnel............. (1,163) (0.9) (1,842) (0.7) (2,959) (0.7) 58 61
Materials and
services............. (12,820) (9.9) (19,033) (6.7) (31,496) (6.9) 48 65
Other:
Fixed-line network
expenses........... (28,039) (21.6) (31,637) (11.2) (85,329) (18.7) 13 170
Leases and
insurance.......... (2,636) (2.0) (2,836) (1.0) (6,332) (1.4) 8 123
Fistel and municipal
taxes.............. (1,348) (1.0) (2,535) (0.9) (9,025) (2.0) 88 256
------- ----- ------- ----- -------- ----- --- -----
Total............. (58,509) (45.1) (86,352) (30.5) (183,696) (40.2) 48 113
Operating expenses:
Selling expense....... (4,946) (3.8) (13,770) (4.9) (57,723) (12.7) 178 319
General and
administrative
expense.............. (9,817) (7.6) (17,742) (6.3) (28,020) (6.1) 81 58
Other net operating
income (expense)..... 11,470 8.8 11,546 4.1 (83) -- 1 (101)
------- ----- ------- ----- -------- ----- --- -----
Total............... (3,293) (2.5) (19,966) (7.1) (85,826) (18.8) 506 330
------- ----- ------- ----- -------- ----- --- -----
Operating income before
interest............... 48,839 37.6 132,845 47.1 104,640 22.9 172 (21)
Allocated interest
expense................ -- -- (413) (0.1) (10,193) (2.2) -- 2,368
------- ----- ------- ----- -------- ----- --- -----
Operating income before
interest income and
unallocated interest
expense................ 48,839 37.6 132,432 46.9 94,447 20.7 171 (29)
Net non-operating
expense................ -- -- (957) (0.3) -- -- -- --
Employees' profit
share.................. -- -- (269) (0.1) -- -- -- --
------- ----- ------- ----- -------- ----- --- -----
Income before interest
income, unallocated
interest expense, taxes
and minority
interests.............. 48,839 37.6 131,206 46.5 94,447 20.7 169 (28)
Minority interests
before interest income,
unallocated interest
expense and taxes ..... (6,923) (5.3) (21,704) (7.7) (15,584) (3.4) 214 (28)
------- ----- ------- ----- -------- ----- --- -----
Income before interest
income and unallocated
interest expense and
taxes.................. 41,916 32.3 109,502 38.8 78,863 17.3 161 (28)
======= ===== ======= ===== ======== ===== === =====
</TABLE>
- --------
(1) Represents line item as a percentage of gross operating revenues.
(2) As a result of the announcement by the Band B operator in the Region that
it will offer cellular services with no activation fee, the Company
eliminated the activation fee for the Flex Plan and reduced the activation
fee for the Basic Service Plan by 67.5% in October 1998. See "Description
of Business--Rates--Subscriber Rates." Although management believes that
this elimination and reduction of activation fees will have a negative
impact on the Company's operating revenues, management is not able to
determine the extent to which, if any, decreased revenues from activation
fees will be positively offset by growth in the Company's subscriber base
and increased revenues from usage charges resulting from increases in the
volume of outgoing and incoming calls. See "--Net operating revenues--
Activation fees."
44
<PAGE>
NET OPERATING REVENUES
The Company generates operating revenue from (i) activation fees, which are
one-time sign-up charges paid to obtain cellular service and vary with the
service plan selected by the subscriber, (ii) usage charges, which include
measured service charges based on tenths of a minute of outgoing calls and
roaming and other similar charges, all of which depend upon which service plan
has been selected by the customer, (iii) monthly subscription payments, which
depend upon which service plan has been selected by the customer, (iv) network
usage charges, which are the amounts charged by the Company to other cellular
and fixed line telephone service providers for use of the Company's network by
such service providers' customers (e.g., when one of such customers calls one
of the Company's subscribers), and (v) other services and charges, which
primarily include fees for cellular telephone service charges paid by Telemig
and fees paid by clients for supplemental services such as call forwarding,
call waiting and call blocking. The Company does not presently sell handsets
or other equipment.
Net operating revenues increased by 56% to R$374.2 million in 1997 from
R$239.2 million in 1996, which in turn represented a 116% increase from
R$110.6 million in 1995. The growth in revenues over this three year period
was principally driven by increases in the number of the Company's
subscribers, which averaged 69,890, 154,725 and 304,591 in 1995, 1996 and
1997, respectively, representing increases of 121% in 1996 and 97% in 1997.
Until November 1996, the Company was not able to meet the entire demand for
cellular service in the Telemig Cellular Region and maintained a waiting list.
Since November 1996 the Company's capacity has exceeded demand in the Region.
Management believes that as the Region's cellular telephone market continues
to mature, demand for new service will continue to fall. In addition, Vicunha
Telecomunicacoes S.A. ("Vicunha") was granted a concession to offer cellular
telephone services in the Region on Band B in April 1998 and has announced it
will commence operations by the end of 1998, thereby increasing the available
capacity of cellular service in the Region. See "Description of Business--
Competition." As a consequence of these factors, management expects that the
growth rate of the Company's subscription base will flatten and that prices
will be subject to pressure. In particular, management anticipates that
activation fees will be a significantly declining source of income in 1998 and
in future periods as a result of increased competition. In each of the periods
under discussion, the effect of the growth in the Company's client base has
been offset in part by the decline in the real value of tariffs charged by the
Company as a consequence of nominal tariffs remaining largely unchanged during
periods of inflation. Revenue growth in 1997 was also offset by the effect of
activation fee discounts offered by the Company in order to increase its
client base.
Monthly subscription payments. Monthly subscription payments increased by
68% to R$145.6 million in 1997 from R$86.9 million in 1996, which in turn
represented an increase of 103% from R$42.9 million in 1995. Subscription
payments growth lagged the growth of average clients in 1997 as a consequence
of the effect of nominal subscription charges generally not increasing in line
with inflation, a 4% reduction in the average nominal monthly subscription
charge in the Company's Basic Service Plan, and an increased proportion of
customers choosing the Flex Plan, which has relatively low monthly payments.
Growth in subscription payments in 1996 reflected growth in the client base,
offset in part by the effect of inflation.
Activation fees. Activation fees decreased by 33% in 1997 to R$30.3 million
from R$45.1 million in 1996. The Company earned only R$0.1 million in
activation fees in 1995. The decline in activation fees in 1997 reflected a
greater proportion of new clients choosing the low-activation-fee Flex Plan
instead of the Basic Service Plan, the effect of promotions offered by the
Company in May and December 1997, pursuant to which discounts on activation
fees were offered, and a 3% reduction in the nominal activation fee in January
1997, offset in part by an increase in the number of persons signing up for
service. Promotions in 1997 generated approximately 112,000 new subscribers
but resulted in total 1997 discounts of R$22 million. The Company accounts for
discounts by recognizing in income only the amounts actually charged to
customers after giving effect to the discounts. The full amount of the
discount is recognized at the time the related revenues are earned. The
Company began offering discounts in December 1996 as a consequence of reduced
demand for new cellular subscriptions. As a result of the announcement by
Vicunha, the Band B cellular operator in the Region, that it will offer
cellular services with no activation fee, the Company eliminated the
activation fee for the Flex Plan
45
<PAGE>
and reduced the activation fee for the Basic Service Plan (the Company's only
calling plan that continues to charge an activation fee) by 67.5% in October
1998. See "Description of Business--Rates--Subscriber Rates." Although
management believes that this elimination and reduction of activation fees
will have a negative impact on the Company's operating revenues, management is
not able to determine the extent to which, if any, decreased revenues from
activation fees will be positively offset by growth in the Company's
subscriber base and increased revenues from usage charges resulting from
increases in the volume of outgoing and incoming calls.
The emergence of significant activation fees in 1996 was the result of the
Company's new customers generally choosing the Basic Service Plan, which
includes an activation fee, instead of the Location Plan or Night Plan, which
do not. The number of Basic Service Plan subscribers increased from 439 at
year end 1995 to 161,559 at year end 1996. Over the same period the number of
subscribers choosing no-activation fee plans was largely unchanged. These
trends reflected the Company's promotional efforts during December 1996, when
approximately 40,000 new Basic Service Plan subscribers signed up in response
to the Company's offer of a discounted activation fee, as well as the
preference of consumers for owning a cellular line (under the Basic Service
Plan) rather than renting it (under the other plans) during a year in which
demand for cellular service in the Region generally exceeded supply.
Usage charges. Usage charges increased by 71% to R$171.6 million in 1997
from R$100.6 million in 1996, which in turn represented an increase of 54%
from R$65.1 million in 1995. 1997 usage charges grew more slowly than the
number of clients as a consequence of the effect of nominal rates generally
not increasing in line with inflation and a 4% reduction in the average
nominal VC1 rate. Total minutes of use grew in line with subscriber growth,
reflecting a 53% increase in the average length of outgoing cellular-to-
cellular calls, offset by a decline in the number of calls. Management
believes that the increased average length of calls resulted from the
Company's waiver during most of 1997, of the 30% surcharge on VCI calls
between cellular telephones. The growth in usage charges in 1996 was
significantly less than the 121% growth in the average number of clients,
principally as a result of the total minutes of outgoing calls increasing by
only 77%, as well as the effect of nominal rates not increasing in line with
inflation.
Network usage charges. Network usage charges increased by 126% to R$101.9
million in 1997 from R$45.1 million in 1996, which in turn represented an
increase of 114% from R$21.0 million in 1995. These increases reflected growth
in the volume of calls to the Company's clients originating outside the
Company's network, principally calls from fixed line telephones in Minas
Gerais. The impact of this growth in volume was offset in part by the effect
of the nominal network usage tariff charged by the Company not increasing with
inflation during the period 1996 to 1997 and decreasing by 15.4% between 1995
and 1996. The increase in 1996 also reflected approximately R$10.0 million of
revenues earned in 1996 from Telemig's use of the Company's cellular platform
for public telephone and related services. The Company earned no comparable
revenues in 1995.
Other. Other revenues increased by 45% in 1997 to R$7.4 million from R$5.1
million in 1996, which was in turn an increase of 760% from R$0.6 million in
1995. Other operating revenues are comprised of sales of cellular telephone
services to Telemig (the fixed line telephone service provider in Minas
Gerais) and sales of ancillary services such as call forwarding and call
waiting.
Value added and other taxes. The principal taxes deducted from gross
operating revenue are a Minas Gerais state value-added tax, the Imposto sobre
Circulacao de Mercadorias e Servicos ("ICMS") on certain operating revenues
from the provision of telecommunications services and federal social
contribution taxes, including the Programa de Assistencia aos Servidores de
Empresas Publicas ("PASEP") and Contribuicao para Financiamento da Seguridade
Social ("COFINS"). The ICMS is 25.0%, except for the international service
rate, which was 13% from April 1994 to September 1996 and has been 0% since
September 1996. The PASEP and COFINS aggregate 2.65% of gross operating
revenues. Taxes on operating revenues were 15% of gross operating revenues in
1995 and 1996 and 18% in 1997. The increase in 1997 was due to a decrease that
year in the proportion of operating revenues comprised of activation fees,
which are not subject to the ICMS tax. Activation
46
<PAGE>
fees are expected to become subject to ICMS for the first time with effect
from July 1, 1998, which will significantly increase the effective rate of
taxation of operating revenues. See "Description of Business--Rates--Taxes on
Telecommunications 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 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. In addition, the Company believes that Telemig, the legal
predecessor of Telemig Cellular, would be liable to Telemig Cellular for any
payments made by Telemig Cellular in connection with any claim arising out of
the retroactive application of the 25% ICMS tax on activation fees for periods
prior to 1998. See "Legal Proceedings."
Telemig Cellular has filed a lawsuit with the Treasury Court of the state of
Minas Gerais seeking injunctive relief from retroactive and prospective
application of the ICMS tax to activation fees. On September 24, 1998, the
Treasury Court granted Telemig Cellular a temporary injunction relieving it
from payment of retroactive and prospective ICMS taxes with respect to
activation fees during the pendency of the lawsuit. The taxation authorities
of the state of Minas Gerais may appeal this decision, and there can be no
assurance that Telemig Cellular will ultimately prevail in any appeal made by
the taxing authorities relating to the temporary injunction or 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 for the
six-month period ended June 30, 1998, it would have a maximum negative impact
estimated at R$3.5 million on results of operations for 1998. However, because
the Company has eliminated activation fees for all of its calling plans except
the Basic Service Plan, the impact of the application of the 25% ICMS tax on
such fees for subsequent periods should not be material. 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$36.9
million. However, as discussed above, the Company believes that Telemig would
be liable to Telemig Cellular for any tax liability arising from the
application of ICMS to activation fees recognized prior to 1998. See "Legal
Proceedings."
Management does not believe that the payment of retroactive ICMS taxes with
respect to activations fees 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.
COST OF SERVICES
Cost of services increased by 113% to R$183.7 million in 1997 from R$86.4
million in 1996, which in turn represented a 48% increase from R$58.5 million
in 1995. The increase in 1997 principally related to payments to Telemig (the
Minas Gerais fixed line telephone services provider) for use of the fixed
lines in the Company's network, network usage charges paid to other telephone
service providers and depreciation. The increase in 1996 related principally
to depreciation expense. The following discussion addresses the separate line
items comprising cost of services.
Depreciation and amortization. Depreciation and amortization expenses grew
throughout the 1995 to 1997 period, increasing from R$12.5 million in 1995 to
R$48.6 million in 1997. These increases reflected the expansion of the
Company's network. The Company's permanent assets (excluding construction in
progress) had a gross book value of R$167.3 million, R$425.2 million and
R$574.9 million at December 31, 1995, 1996 and 1997. See Note 12 to the
Financial Statements. The Company's accounting policies and assumptions with
respect to depreciation and amortization did not change during this period.
47
<PAGE>
Personnel. Personnel expenses increased steadily during the 1995 to 1997
period, rising from R$1.2 million in 1995 to R$1.8 million in 1996 to R$3.0
million in 1997. These increases were principally due to increases in the
number of employees. Salaries did not increase materially during these years.
Materials and services. Materials and services expense increased by 65% to
R$31.5 million in 1997 from R$19.0 million in 1996, which in turn represented
a 48% increase from R$12.8 million in 1995. The increases in 1996 and 1997
both principally reflected increased volumes of calls subject to network usage
charges payable to other cellular and fixed line telephone service providers,
offset in part by the effect of nominal network usage tariffs not increasing
with inflation. Most of these charges were paid to Telemig in connection with
calls made by the Company's subscribers to Telemig fixed line telephones in
Minas Gerais.
Fixed-line network expenses. Fixed-line network expenses represent lease
payments to Telemig for use of interconnecting circuits among the Company's
radio base stations and switching centers and between the Company's network
and Telemig's network. Such expenses increased 170% to R$85.3 million in 1997
from R$31.6 million in 1996, which in turn represented a 13% increase from
R$28.0 million in 1995. The increase in 1997 reflected the expansion of the
Company's network from 64 cities at year end 1996 to 121 at the end of 1997.
Fixed line network expenses increased only slightly in 1996 because network
expansion in that year occurred primarily in Belo Horizonte, where expansion
costs are lower than in the rest of Minas Gerais. The Company's fixed line
network expenses are significant because of the size of the covered area in
the Minas Gerais region, as well as the number of separate cities covered.
Leases and insurance. Lease and insurance payments, which primarily include
fees paid to Telemig and third parties to rent land, infrastructure and
buildings for use in the cellular network, increased 123% to R$6.3 million in
1997 from R$2.8 million in 1996, which in turn represented a 8% increase from
R$2.6 million in 1995. These increases were due to higher rental fees and
infrastructure costs and reflected expansion of the Company's network.
Fistel and municipal taxes. Municipal taxes and payments to the Fundo de
Fiscalizacao das Telecomunicacoes ("Fistel") were R$1.3 million, R$2.5 million
and R$9.0 million in 1995, 1996 and 1997, respectively. The increase in 1997
reflected the payment of R$9.0 million in Fistel taxes resulting from a change
in government policy whereby such tax was assessed, beginning in 1997, against
telecommunications service providers. Prior to 1997, Fistel taxes were
assessed directly against consumers of telecommunications services and were
therefore not reflected in the Company's results of operations.
OPERATING EXPENSES
Operating expenses increased from R$3.3 million in 1995, to R$20.0 million
in 1996, to R$85.8 million in 1997. The discussion below addresses the
principal components of operating expenses during the 1995 to 1997 period.
Selling expense. Selling expense increased by 319% in 1997 to R$57.7 million
from R$13.8 million in 1996, which in turn represented a 178% increase from
R$4.9 million in 1995.
The increase in 1997 primarily reflected a substantial increase in
provisions to the allowance for accounts receivable that are not probable of
collection from R$2.8 million in 1996 to R$34.9 million in 1997 and a R$9.6
million (290%) increase in payments to third party service providers. The
increase in payments to third party service providers related principally to
marketing and advertising. R$20.8 million of the increase in provisions to the
allowance for accounts that are not probable of collection in 1997 reflected
growth in the Company's accounts receivable more than 90 days past due. The
increase in such overdue accounts reflected growth in the Company's accounts
receivable overall, an increase in the number of cellular customers with
relatively lower income (who are more prone to delay paying cellular telephone
bills) and increased consumer interest rates (which have adversely affected
the ability of consumers to meet payment obligations) resulting from the
48
<PAGE>
economic crisis experienced in Brazil in 1997. The remaining R$14.1 million of
the increase in provisions in 1997 reflected provisions made with respect to
accounts receivable less than 90 days past due at December 31, 1997, but as to
which management believed collection was improbable. A significant portion of
such accounts receivable arose from subscription fraud involving nonresidents
of Minas Gerais. Of the total amount of provisions of R$2.8 million in 1996,
R$1.0 million was attributable to fraud and R$1.8 million was attributable to
accounts receivable; of the total amount of provisions of R$34.9 million in
1997, R$14.1 million was attributable to fraud and R$20.8 million was
attributable to accounts receivable.
In March 1998 the Company initiated a number of practices (such as credit
checks on potential clients) in an effort to reduce the level of uncollected
accounts receivable. See "Description of Business--Fraud Detection and
Prevention." Management believes that these measures will help limit
nonpayment of accounts receivable and reduce levels of fraud in the future,
but expects that provisions for accounts receivable will nonetheless continue
to increase faster in 1998 than in 1997 due to the higher nonpayment rate
among the Company's customers and to the expected increase in the Company's
customer base after the privatization. In the first six months of 1998, the
Company recorded R$25.1 million of provisions to the allowance for accounts
that are not probable of collection.
The Company started to maintain records of the total number of subscriber
cancellations made in connection with overdue accounts receivable and the
total number (gross) of new subscribers in 1997. The total number of
subscriber cancellations made by the Company due to nonpayment in 1997 was
48,300 and the Company had a total of 243,100 new subscribers in 1997. The
total number of subscribers recorded by the Company at the end of 1995 and
1996 was 89,600 and 233,000, respectively.
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. Management has
implemented this policy in part by making provisions of 100% of the amount of
any account receivable more than 90 days past due and writing off any account
receivable more than 180 days past due. The Company also immediately charges
off any account receivable arising from fraud. Cellular service is cut off to
customers who have accounts receivable more than 20 days past due.
Prior to 1997, the Company did not experience significant losses from bad
debts and, accordingly, provisions to the allowance for accounts that are not
probable of collection were low in the Company's initial years of operations.
This experience was in part due to the fact that most of the Company's early
subscribers (who were also owners of a fixed telephone line) were required to
pledge their fixed lines as a guarantee of debts incurred in relation to their
cellular lines. Because nonpayment of a cellular account would also result in
a subscriber losing his fixed line, the Company's early subscribers had a
strong incentive to pay their cellular accounts.
The low provisions in the Company's initial years of operation also
reflected the unusual market situation that prevailed in the Region where an
activated cellular line was considered to have value because of the high cost
and long wait required to obtain such a line from the Company. In view of the
resale value of a cellular line in the secondary market, many of the Company's
subscribers had incentive to keep current in their payments. As the Company
began to satisfy a greater proportion of the Region's demand in 1997, however,
the value of a cellular line declined and the level of nonpayment among the
Company's customers increased. This increase in the rate of nonpayment among
the Company's subscribers also contributed to the 1997 increase in provisions.
The 1996 increase in selling expenses mainly reflected a R$3.8 million
increase in personnel expenses and a R$3.2 million increase in payments to
third party service providers. The increase in personnel expenses reflected an
increase in the average number of full time equivalent Company employees from
103 in 1995 to 256 in 1996. The increase in payments to third party service
providers related principally to marketing and advertising.
49
<PAGE>
General and administrative expense. General and administrative expense was
R$28.0 million in 1997, a 58% increase from R$17.7 million in 1996, which in
turn was a 81% increase from R$9.8 million in 1995. These increases were
principally due to increased payments to Telemig for the services of Telemig
employees in the fixed telephone service division, and shared overhead items,
reflecting growth in the Company's business. The amounts of such payments to
Telemig in 1995, 1996 and 1997 represent allocations to the Company of
personnel expense and overhead associated with such Telemig employees in the
fixed line telephone services division. Such allocations are based on
management's estimates of the proportion of such Telemig employees' time and
overhead items dedicated to the cellular business in those years. In
connection with the split up of Telemig in January 1998, the Company
contracted with Telemig for the continued provision of certain services by
Telemig employees, as well as the continued sharing of certain overhead
expenses. The Company expects that such services will continue to be required
in the short term, but the unit-costs of such services and sharing under such
contracts will not increase materially during that time.
In 1998, the Company and Embratel entered into a number of service,
infrastructure sharing and interconnection agreements. The Company does not
believe that these new agreements will have a significant impact on its future
operations.
Other net operating income (expense). The Company had other net operating
expense of R$0.10 million in 1997 and other net operating income of R$11.5
million for both 1996 and 1995. The principal driver of other net operating
income (expense) in these periods was net inflationary holding gains and
losses on accounts payable and other monetary assets and liabilities not
having a corresponding income statement line item. See Note 2a to the
Financial Statements. Such amounts totaled R$11.1 million of gains in 1995,
R$8.9 million of gains in 1996 and R$3.2 million of losses in 1997. The gains
in 1995 and 1996 principally reflected gains on accounts payable. Such gains
arise from the decline in the book value of accounts payable between the time
such accounts are recorded and the time they are paid (generally 30 days).
Losses in 1997 principally reflected losses arising from cash and cash
equivalents. Such losses arise from the decline in the real value of cash and
cash equivalents in an inflationary environment.
1997 net operating expense also was affected by a R$2.4 million decrease in
expenses caused by certain general overhead expenses of Telemig no longer
being allocated to the Company. This decrease in expenses was offset in part
by a R$1.9 million decrease in other operating income resulting from a decline
in fines received from delinquent customers. The decrease in fine payments
resulted from a reduction in the amount of such fines from 10% of the past due
amount in 1995 and 1996 to 2% in 1997, offset in part by an increase in the
number of such fines assessed. This reduction was mandated by federal law. The
Company imposes such fines when accounts receivable become one day past due.
The decrease in inflationary holding gains in 1996 was offset in part by a
R$3.0 million increase in fines paid by delinquent customers, which was a
consequence of increased accounts receivable.
ALLOCATED INTEREST EXPENSE
The Company had allocated interest expense of R$10.2 million in 1997 and
R$0.4 million in 1996. The Company had no allocated interest expense in 1995.
The Company's allocated interest expense reflects the debt that was assigned
to the Company upon its formation. See "Presentation of Information." Such
debt does not reflect the amounts of debt that the Company would have been
required to incur had it operated as a stand-alone entity from its inception.
The debt assigned to the Company was incurred by Telemig in the last quarter
of 1996. The significant increase in allocated interest expense in 1997
reflects higher interest payments due to an increase in the Company's average
debt from R$11.2 million in 1996 to R$125.7 million in 1997 and an increase in
average interest rates from 4.5% to 9.5%.
The historical financial statements of Telemig include cash and non-specific
debt that related to both the fixed and cellular operations of Telemig and
could not be segregated prior to December 31, 1997. As a result, the Financial
Statements do not include interest income or interest expense arising from
non-specific debt (i.e., unallocated interest expense). The total amount of
interest income and unallocated interest expense at Telemig
50
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during each of the reported periods is set forth in the table below.
Management believes that such amounts are not necessarily material to an
understanding of trends in the Company's interest income and expense because
the surplus cash balances and working capital of the combined fixed and
cellular operations of Telemig prior to December 31, 1997 were not necessarily
indicative of the cash position of the cellular operations.
<TABLE>
<CAPTION>
1995 1996 1997
------ ------ ------
(IN THOUSANDS OF
CONSTANT REAIS)
<S> <C> <C> <C>
Interest income....................................... 4,830 2,680 16,163
Unallocated interest expense.......................... 17,673 31,901 38,179
</TABLE>
NET NONOPERATING EXPENSE
The Company had R$1.0 million of net nonoperating expense in 1996. No such
expenses were recorded in 1995 or 1997.
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% of 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.
Employees' profit share was R$269 thousand in 1996. The Company did not record
employees' profit share in 1995 and 1997.
MINORITY INTERESTS
Minority interest was R$6.9 million, R$21.7 million and R$15.6 million in
1995, 1996 and 1997, respectively, reflecting 14.2%, 16.5% and 16.5% of income
before interest income, unallocated interest expense and taxes, respectively.
The 1996 and 1997 increases in minority interest as a percentage of income
before interest income, unallocated interest expense and taxes principally
reflected the issuance and sale by Telemig of preferred shares of such
entities to new subscribers pursuant to a system called "auto-financing."
Under such system, each new subscriber was required to invest in shares of
Telemig and the proceeds from such investment were used by such entities to
finance network expansion.
LIQUIDITY AND CAPITAL RESOURCES
The Registrant is a holding company and its principal assets are the shares
of its operating subsidiary. The Registrant relies almost exclusively on
dividends from its subsidiary to meet its needs for cash, including the
payment of dividends to its 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 for any given fiscal year. See
"Description of Securities to be Registered--Capital Stock--Dividends."
Management believes that the Registrant's shareholding in Telemig Cellular
is sufficient to allow the Registrant to control the payment of dividends by
such companies. The Registrant currently is able to nominate and elect all the
members of the boards of directors of Telemig Cellular. 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 Telemig
Cellular which, with respect to the Mandatory Dividend, could be limited only
under very strict
51
<PAGE>
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 Telemig
Cellular, 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 made capital expenditures of R$78.6 million, R$188.1 million and
R$113.8 million in 1995, 1996 and 1997, respectively. These expenditures
related primarily to expanding the number of access lines and to increasing
the number of cities included in the Company's network. See "Description of
Business--Capital Expenditures." Capital expenditures were funded 100%, 32%
and 100% by internally generated cash in 1995, 1996 and 1997, respectively.
The remainder was financed with indebtedness. The Company's ability to fund
investment with internally generated cash during these years does not reflect
what would have been the Company's cash flow were it a stand-alone business.
Among other factors, had the Company been operated on a stand-alone basis from
the inception of Telemig's cellular operations, the Company's cash flow would
have been significantly lower as a result of greater debt service requirements
and the obligation to pay income tax.
The Company has entered into contracts for a total of R$178.1 million in
1998 capital expenditures. Most of the planned 1998 capital expenditures will
be dedicated to expanding the capacity of the Company's analog network,
digitalizing the network in the Belo Horizonte metropolitan region and some
other urban areas improving the quality of the network.
Management expects that approximately R$156.1 million of planned 1998
capital expenditures will be funded by internally generated cash and R$22
million by external indebtedness.
The Company had R$117.1 million of indebtedness at December 31, 1997, all of
which was unsecured and 50.9% of which was dollar-denominated. R$91.6 million
of this indebtedness was to Telebras and R$23.7 million was to the Export
Development Corporation. See Note 16a to the Financial Statements.
Upon the Breakup of the Telebras System and the formation of the Registrant,
approximately R$56.8 million of Telemig Cellular's indebtedness, representing
loans from Telebras, became intercompany loans payable by Telemig Cellular 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.
R$33.0 million and R$47.1 million of interest and principal payments on the
Company's indebtedness as of December 31, 1997 will be due in 1998 and 1999,
respectively. The Company has no lines of credit or other credit commitments
available to it.
The Company's indebtedness reflects the allocation to the Company, upon the
split up of Telemig, of all Telemig indebtedness incurred specifically in
connection with the construction of its cellular network, plus the allocation
of a portion of loans from Telebras to Telemig. Such indebtedness is reflected
in the Company's Consolidated Financial Statements and, under the terms of the
split up, the Company is legally obligated to pay all amounts owed under such
indebtedness. Although the credit agreements evidencing the indebtedness have
not been legally assigned to the Company and Telemig remains the legal obligor
under such agreements, the Company has entered into back-to-back debt
agreements with Telemig matching the principal and interest payment terms of
such indebtedness. In addition, the Company and Telemig are seeking the
approval of the lenders to legally assign the underlying Telemig debt to the
Company. Any subsequent legal assignment of Telemig debt to the Company will
replace the back-to-back debt agreements currently in place between Telemig
and the Company. Accordingly, no net additional debt will be incurred by the
Company as a result of such assignment.
Substantially all the Company's start up costs and initial capital
investments were financed by cash flows from the fixed line telephone
operations of Telemig. Accordingly, the Company's indebtedness does not
reflect the amount of debt the Company would have been required to incur to
build its current network had the Company been operated on a stand-alone basis
from the inception of Telemig's cellular operations.
52
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Because the Registrant was formed on May 22, 1998, it was not subject to
dividend payment requirements during the reported periods and the Financial
Statements do not reflect dividend payments by the Registrant. In addition,
dividend payments made during the reported periods by Telemig are reflected in
the financial statements of that entity but not in the Financial Statements
included in this Registration Statement, which reflect certain assets and
liabilities of the cellular operations of Telemig but not the capital
structure of such entity. In 1998 and thereafter, the Registrant will be
subject to the mandatory dividend payment requirements described under
"Description of Securities to be Registered--Capital Stock."
U.S. GAAP RECONCILIATION
The Company prepares its consolidated financial statements in accordance
with Brazilian GAAP, which differs in significant respects from U.S. GAAP. The
principal differences between Brazilian GAAP and U.S. GAAP as they affected
the Company's revenues and expenses are: (i) 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
total amount of interest actually incurred on such loans while under U.S. GAAP
interest is capitalized based on the interest rate on the debt incurred up to
the lower of the amount of construction in progress and the total loans
incurred; (ii) 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;
and (iii) in accordance with Brazilian GAAP, the deferred tax liability
arising out of the indexation of permanent assets was charged to divisional
equity, whereas under U.S. GAAP the change would be to income for the year.
Income before interest income, unallocated interest expense and taxes under
U.S. GAAP was R$118.4 million and R$81.5 million for 1996 and 1997,
respectively. Until December 31, 1997, under both Brazilian and U.S. GAAP,
revenues from activation fees were recognized upon activation of a customer's
services. Under U.S. GAAP, effective January 1, 1998, net revenues from
activation fees will be deferred and amortized over the estimated effective
contract life. See Note 24 to the Consolidated Financial Statements.
RECENT RESULTS
The Company had consolidated net operating revenues and consolidated net
income of R$245.4 million and R$51.8 million, respectively, 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 to inflation occurring after December 31, 1995 or
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. 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$2 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 revenues for the first six months of 1998 reflect
an increase in the average number of cellular subscribers to approximately
444,000 in the first half of 1998 compared to 304,591 in the twelve months
ended December 31, 1997.
The Company's expenses in the first six months of 1998 evidenced a gradual
upward trend. Cost of services amounted to R$82.0 million, reflecting a
favorable renegotiation of certain technical service contracts with Telemig.
Selling expense amounted to R$47.1 million, reflecting increased provisions
(R$25.1 million) for accounts that management considered not probable of
collection. Management expects that such provisions will increase
significantly in the second half of 1998 as a consequence of increasing rates
of nonperforming accounts receivable.
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<PAGE>
Results for the first six months of 1998 are not necessarily indicative of
results for any other period or for the full year. The Company experienced
significant growth during the years from its inception through 1997, but the
number of the Company's cellular subscribers has remained almost flat during
1998, increasing less than 1% in both the six-month period ended June 30, 1998
and the nine-month period ended September 30, 1998. The expected commencement
of operations by the Band B cellular operator in Minas Gerais during the
fourth quarter of 1998 may have a negative impact on future growth in the
number of subscribers, require the Company to increase its marketing expenses
and decrease certain tariffs such as activation fees. The recent deterioration
of the Brazilian economic environment may also have a negative impact on the
future growth of the Company's revenues and may further increase the level of
bad debt expense. See "Description of Business--Brazilian Economic
Environment". In addition, management intends to develop and implement the
Company's own billing, customer care and financial reporting systems and
gradually cease using the resources of Telemig, its predecessor, in these
areas. Management expects that this change will increase the Company's
efficiency but anticipates that transition costs associated with the change
may adversely affect operating results.
Management believes that the material adjustments that would be required to
reconcile the first six months consolidated net income figure given above to
U.S. GAAP are comparable in nature to those discussed in Note 24 to the
Consolidated Financial Statements, except that indexation for inflation
subsequent to December 31, 1995 and through December 31, 1997 would be
required under U.S. GAAP and the cessation of indexation as from January 1,
1998 will eliminate the need for the recognition of an additional charge to
income under U.S. GAAP for the deferred income tax effects of indexation for
financial reporting purposes.
Comparative interim period net operating revenues and net income are not
presented herein. The Registrant was not formed prior to May 22, 1998 and did
not publish interim financial results for the first half of 1997. In addition,
the Registrant's operating subsidiaries' published interim 1997 results (if
any) were for the combined cellular and fixed line entities.
As part of the privatization of the Telebras System, the Federal Government
has offered Telebras System employees the right to purchase the Federal
Government's entire holding of Telebras preferred shares and preferred shares
of each of the New Holding Companies (representing 2.18% of the outstanding
capital stock of Telebras and of each New Holding Company) at a price of
R$69.24 per lot of 13,000 shares (each a "lot" and comprised of 1,000
preferred shares of each of Telebras and the twelve New Holding Companies).
This price represents a 50% discount from the market price of 1,000 Telebras
preferred shares at the time the Federal Government authorized the plan. The
initial period during which employees could subscribe for the shares began on
August 4, 1998 and expired on September 30, 1998. On August 28, 1998, the
Federal Government extended the period for the offer to October 30, 1998. The
offer period has not been extended again and the Federal Government has not
expressed any intention to do so. Each employee has the right to purchase up
to 144 lots of 13,000 preferred shares, subject to proration if the shares are
oversubscribed.
The Federal Government has offered 7.2 million lots, or 60% of the total
number of lots (12.1 million) that would be required if every employee in the
Telebras System offered to purchase the maximum 144 lots per employee allowed.
If offers to purchase are made for more than 7.2 million lots, employees will
be allocated the available 7.2 million lots on a pro-rata basis. Accordingly,
if every employee in the Telebras System offered to purchase the maximum 144
lots, each employee would be allocated 86.4 lots (or 60% of 144). This
allocation would increase up to 144 lots as the total number of Telebras
System-wide offers to purchase declined to 7.2 million lots or less. If total
employee demand is for less than 7.2 million lots, the unsold shares will
remain with the Federal Government. The market price of 1,000 Telebras
preferred shares when the offer to employees commenced on August 4, 1998 was
R$127.20. At this date, 1,000 Telebras preferred shares was equivalent to one
lot, because the distribution of New Holding Company preferred shares in
connection with the Breakup had not occurred. The market price of one lot on
October 30, 1998, when the offer to employees terminated, was R$91.00.
The employee stock offering will have no effect on the Company's financial
statements prepared under Brazilian GAAP. For U.S. GAAP purposes only, the
employee stock offering is deemed to give rise to compensation expense to the
extent of the excess of market price of the shares purchased over the Federal
Government's price to employees. Although the Federal Government, rather than
the Company or Telebras,
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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 subscription 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 US GAAP expense is not presently determinable, the
minimum amount (all of which will be recognized effective August 4, 1998) is
R$1.9 million. Effective October 30, 1998 the Company will record an
additional expense ranging from R$0 to R$0.5 million, depending on the total
number of shares above the minimum 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 US GAAP in connection with the employee share
offering will be R$421.6 million.
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 markets 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$60 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$6 million.
INTEREST RATE RISK
At December 31, 1997, the Company had approximately R$117 million in loans
and financing outstanding, all of which bore interest at floating interest
rate (LIBOR-based). The Company invests its excess liquidity (R$10 million at
December 31, 1997) mainly in short-term instruments. The potential loss to the
Company over one year that would have resulted from a hypothetical,
instantaneous and unfavorable change of 100 basis points in the interest rates
applicable to financial assets and liabilities on December 31, 1997 would be
approximately R$1 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 16 and 19 to the Consolidated Financial
Statements.
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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.
55--1
<PAGE>
The following are the current members of the Board of Directors and their
respective positions.
<TABLE>
<CAPTION>
NAME POSITION
- ---- ------------------
<S> <C>
Arthur Joaquim de Carvalho Chairman
Gerard Manuel Vazquez Director
Jose Leitao Viana Director
Diogo Luiz Botelho de Vasconcellos Director
Bruno Ducharme* Director
David Travesso Neto Director
Jose Fernando de Almeida Director
Margriet Zwarts** Director
Rene Patoine*** Director
Maria Amalia Delfim de Melo Coutrim Director
Pierre Fitzgibbon**** Director
Fernando dos Santos Dionisio Alternate Director
Ricardo Velloso Azevedo Alternate Director
Luiz Alonso Goncalves Neto Alternate Director
Denise Bastos Guedes Alternate Director
</TABLE>
Set forth below are brief biographical descriptions of the Directors.
Arthur Joaquim de Carvalho has served as the Chairman of the Board of
Directors since August 1998. On August 10, 1998, he was also elected to the
Board of Directors of Tele Norte Celular Participacoes S.A. In addition, Mr.
Carvalho is a Principal of CVC/Opportunity Equity Partners Ltd., a Cayman
Island privately owned investment company. He served as a Senior Investment
Officer for private equity at the Opportunity Group. Prior to working at
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.
Gerard Manuel Vazquez has served as member of the Board of Directors since
August 1998. He currently serves as a member of the Board of Tele Norte
Celular Participacoes S.A., and as President of Tele Norte Celular
Participacoes S. A., Telet S.A. and Americel S.A. Mr. Vazquez is Vice-
President and Executive Director for Latin America of Telesystem International
Wireless Inc. (TIW), a company of the Telesystem Ltd. group, and from 1994
until 1997 he held the same positions with Telesystem International Wireless
Services Inc. (TIWS). In addition, from 1995 to 1997 Mr. Vazquez was Executive
Director, International Business Development for the Americas, of Odyssey
Telecommunications International Inc. Mr. Vazquez was a Corporate Vice-
President of Future Electronics, a global electronics components distributor
from 1993 to 1994, and from 1990 to 1993 led the international marketing team
of the communications satellites division of Spar Aerospace Ltd. Prior to
this, he was a Director of marketing for Canadair Ltd. from 1987 to 1989, for
the CL215 Division, for Spain, Portugal and Latin America. He has served as
trade Commissioner for the Canadian Department of External Affairs at the
Canadian Embassies in Paris, Quito and Brasilia. Mr. Vazquez serves on various
Boards of Directors. He holds a bachelor's degree from McGill University,
Montreal, Canada and a certificate in business administration from the
University of Ottawa.
Jose Leitao Viana has served as a member of the Board of Directors since
August 1998. Since February 1996, Mr. Viana has been the Investment Director
of Fundacao SISTEL de Seguridade Social. Between 1985 and 1989 he served as
the Financial and Economic Director for Telebras. Mr. Viana holds a degree in
economics from the School of Economic Sciences of the University of the State
of Guanabara and a post-graduate degree in economic engineering and industrial
administration from the National School of Engineering -- UFRJ.
Diogo Luiz Botelho de Vasconcellos has served as a member of the Board of
Directors since August 1998. He is currently the Participation Manager of
PREVI -- Caixa de Previdencia dos Funcionarios do Banco do Brasil, where he
also served as the Operational Manager of PREVI. During 1997, Mr. Vasconcellos
served as the Staff Coordinator of Capital Markets for Banco do Brasil S.A. He
holds a degree in accounting.
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<PAGE>
Bruno Ducharme* was appointed to the Board of Directors of the Company in
September 1998. He serves as President and Chief Executive Officer of
Telesystem International Wireless Inc. ("TIW"), as Executive Vice-President of
Telesystem Ltd. ("Telesystem") and as a member of the Board of Directors of
Teleglobe Inc. and of MDSI Mobile data Solutions Inc. Mr. Ducharme joined the
Telesystem group of companies in 1990 as Vice-President of Telesystem
Financial Corporation and became a Vice-President of Telesystem in 1991. Mr.
Ducharme has held a number of executive positions with companies within the
Telesystem group including Executive Vice-President and Chief Financial
Officer of Teleglobe Inc. in 1993 and President and Chief Executive Officer of
Microcell Telecommunications Inc. in 1994. Mr. Ducharme holds a bachelor's
degree in civil law (BCL) from McGill University, a master's in business
administration from the Wharton School of the University of Pennsylvania, and
a master's degree in International Relations from the University of
Pennsylvania. (*Mr. Ducharme may not assume office until he obtains his
residence visa for Brazil. Until this event, his position will be filled by
his alternate Mr. Fernando Santos Dionisio, whose biography is set forth
below.)
David Travesso Neto has served as a member of the Board of Directors since
September 1998. He serves as Vice-President of Companhia Energetica de Minas
Gerais--CEMIG and Technical Executive officer of Companhia de Gas de Minas
Gerais--GASMIG. From 1974 to 1986 he served in many positions in Alcan
Aluminio do Brasil S.A. He also served as a professor of engineering at the
School of Engineering of the Federal University of Ouro Preto. He holds a
degree in production engineering from the Polytechnic School of the University
of Sao Paulo, a degree in business administration from the Getulio Vargas
Foundation and a masters degree in business administration from the University
of Geneva, Switzerland.
Jose Fernando de Almeida has served as a member of the Board of Directors
since September 1998. He joined Caixa Economica Federal in 1972 where he
served as Branch Manager, Regional Manager, Regional Superintendent, Executive
Officer of Administration and Human Resources, President and Executive Officer
of Housing and Mortgages. He serves as President and Chief Executive Officer
of Fundacao dos Economiarios Federais--FUNCEF (the pension fund of the
employees of Caixa Economica Federal). He holds a degree in mathematics from
the Fundacao Faculdade Estadual Norte do Parana.
Margriet Zwarts** was elected to the Board of Directors of the Company on
September 1, 1998. She currently serves as Vice-President of Legal Affairs of
Telesystem International Wireless Inc. Prior to that, she practiced law in
private practice, initially with the law firm of Martineu, Walker and since
1989 with the law firm of Ogilvy Renault, where she had been a partner since
1991. She holds a bachelor's degree in civil law and a bachelor's degree in
common law, both from McGill University, Montreal, Canada, and a master's
degree in english literature from the University of Toronto. She is a member
of the Quebec Bar and the Law Society of Upper Canada. (** Ms. Zwarts may not
assume office until she obtains her residence visa for Brazil. Until this
event, her position will be filled by her alternate Mr. Ricardo Velloso
Azevedo, whose biography is set forth below.)
Rene Patoine*** was elected to the Board of Directors of the Company on
September 1, 1998. He currently serves as Executive Vice-President of
Operations of Telesystem International Wireless Inc. He served as Vice-
President, Operations & Strategy Planning for Telecel International Inc. from
1995 to 1997, Executive Advisor and Engineering Director for Conecel S.A. in
Ecuador from 1993 to 1995, Project Director for Bell Canada International from
1992 to 1993, and General Manager of Telecel S.A. in Zaire from 1989 to 1991.
He holds a bachelor's degree in electrical engineering from the Sherbrooke
University, Quebec, Canada. (*** Mr. Patoine may not assume office until he
obtains his residence visa for Brazil. Until this event, his position will be
filled by his alternate Mr. Luiz Alonso Goncalves Neto, whose biography is set
forth below.)
Maria Amalia Delfim de Melo Coutrim was elected to the Board of Directors of
the Company on September 16, 1998. Mrs. Coutrim has over 17 years of
experience in equity research. She has worked for Banco Bradesco S.A. and
Triplic Corretora (stock brokerage). She also has served as a Director and
partner of Banco Icatu S.A. She is a partner of CVC/Opportunity Equity
Partners Ltd. and serves as a Director of this Company. She holds a degree in
economics from the Federal Rural University in the State of Rio de Janeiro.
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Pierre Fitzgibbon**** was appointed to the Board of Directors of the Company
in September 1998. He has been serving as Executive Vice President and Chief
Financial Officer of Telesysem International Wireless Inc. ("TIW") since June
1997. Prior to joining TIW, he served as Senior Vice President, Packaging
Division of Domtar Inc. from 1996 to 1997, Senior Vice President and Chief
Financial Officer for Domtar Inc. from 1993 to 1996, Vice President and Chief
Financial Officer for Peerless Carpet Corporation from 1988 to 1993 and Senior
Manager, Financial Services, and Director, Auditing Department for Price
Waterhouse from 1978 to 1988. Mr. Fitzgibbon holds a bachelor's degree in
business from Ecole des Hautes Etudes Commerciales, a Chartered Accountant
degree (C.A.) and a Corporate Financing Administration Program Certificate
from Harvard Business School. (**** Mr. Fitzgibbon may not assume office until
he obtains his residence visa for Brazil. Until this event, his position will
be filled by his alternate Mr. Denise Bastos Guedes, whose biography is set
forth below.)
Fernando dos Santos Dionisio was elected to the Board of Directors of the
Company on September 1, 1998 as an alternate to Mr. Bruno Ducharme and shall
remain in office only until the latter obtains his residence visa for Brazil.
He is a practicing attorney, a partner at the law firm of Brandi e Associados
and the Head of the Tax Office of Public Attorneys of the City of Rio de
Janeiro. He holds a law degree from the Law School of the University of the
State of Rio de Janeiro--UERJ and a masters degree in international relations
from the Catholic University of Rio de Janeiro.
Ricardo Velloso Azevedo was elected to the Board of Directors of the Company
on September 1, 1998 as an alternate to Ms. Margriet Zwarts and shall remain
in office only until the latter obtains her residence visa for Brazil. He is a
practicing attorney and a partner at the law firm of Brandi e Associados. He
holds a law degree from the Law School of the University of the State of Rio
de Janeiro--UERJ.
Luiz Alonso Goncalves Neto was elected to the Board of Directors of the
Company on September 1, 1998 as an alternate to Mr. Rene Patoine and shall
remain in office only until the latter obtains his residence visa for Brazil.
He is a practicing attorney and a partner at the law firm of Brandi e
Associados. He holds a law degree from the Law School of the University of the
State of Rio de Janeiro--UERJ.
Denise Bastos Guedes was elected to the Board of Directors of the Company on
September 16, 1998 as an alternate to Mr. Pierre Fitzgibbon and shall remain
in office only until the latter obtains his residence visa for Brazil. She is
a practicing attorney and a partner at the law firm of Brandi e Associados.
She holds a law degree from the Law School of the University of Sao Paulo and
a post-graduate degree form the Getulio Vargas Foundation.
BOARD OF EXECUTIVE OFFICERS
The Board of Executive Officers consists of one President and one Vice
President 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. All
current members were appointed in August 1998.
<TABLE>
<CAPTION>
NAME POSITION
- ---- --------------
<S> <C>
Jose Leitao Viana President
Luis Gonzaga Leal Vice-President
</TABLE>
Set forth below is a brief biographical description of the Executive Officer
not included above.
Luis Gonzaga Leal has been working for Telemig for 24 years. In addition to
many technical and managerial positions, he served as Manager of the
Engineering and Equipment Department and of the Business Planning Department.
He has served as the Superintendent of Telemig Celular from its inception. He
holds a degree in electronic telecommunications engineering from the Catholic
University of Minas Gerais, and a post-graduate degree from the Federal
University of Minas Gerais.
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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 was approximately R$169.9 thousand.
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$24.4 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 of the
Preferred Shares and Common Shares, the By-laws and the Brazilian Corporation
Law. This description is qualified by reference to the By-laws, which have
been filed (together with an English translation) as an exhibit to this
Registration Statement, and to the Brazilian Corporation Law. A copy of the
By-laws (together with an English translation) is available for inspection at
the principal office of the Depositary. Information on the trading market for
the Preferred Shares is set forth under "Nature of Trading Market" and
information on ownership of the Registrant's shares is set forth under
"Control of Registrant."
GENERAL
The capital stock of the Registrant is comprised of Preferred Shares and
Common Shares, all without par value. At May 22, 1998, there were 210,029,997
thousand outstanding Preferred Shares and 124,351,903 thousand outstanding
Common Shares. The Company's share capital may be increased only by
shareholder vote.
The Preferred Shares are 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 Registrant.
Under the Brazilian Corporation Law, the number of non-voting shares or
shares with limited voting rights, such as the Preferred Shares, may not
exceed two-thirds of the total number of shares. The Federal Government was
required by law prior to the privatization to own more than 50% of the voting
stock of the Registrant.
The majority of the members of the Board of Directors will be elected by the
controlling shareholders of Common Stock of the Company. Board members, even
if elected by one specific shareholder, have fiduciary duties towards the
Company 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 any amounts
allocated to founders' shares, income bonds, employees' and management's
participation in a company's profits.
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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$264.1 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 Stock 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
payments 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 non-voting 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.
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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 Shares. Such a meeting would be called
by publication of a notice in the Gazeta Mercantil and the Diario Oficial da
Uniao at least thirty days prior to the meeting but would not generally
require any other form of notice.
In any circumstances in which holders of Preferred Shares are entitled to
vote, each Preferred Share will entitle the holder thereof to one vote.
PREEMPTIVE RIGHTS
Each shareholder of the Registrant has a general preemptive right to
subscribe for shares in any capital increase, in proportion to its
shareholding. A period of 30 days following the publication of notice of the
capital increase is allowed for exercise of the right, and the right is
negotiable. However, a shareholders' meeting is authorized to eliminate
preemptive rights with respect to the issuance of new shares, debentures,
warrants and founders' shares convertible into new shares up to the limit of
the authorized share capital, provided that the distribution of these
securities is effected (i) on a stock exchange or in a public offering, (ii)
through an exchange of shares in a public offering the purpose of which is to
acquire control of another company or (iii) through the use of certain tax
incentives.
In the event of a capital increase which would maintain or increase the
proportion of capital represented by Preferred Shares, holders of ADSs, or of
Preferred Shares, would have preemptive rights to subscribe only to newly
issued Preferred Shares. In the event of a capital increase which would reduce
the proportion of capital represented by Preferred Shares, holders of ADSs, or
of Preferred Shares, would have preemptive rights to subscribe to Preferred
Shares, in proportion to their shareholdings and to Common Shares only to the
extent necessary to prevent dilution of their interest in the Registrant.
Preemptive rights to purchase shares may not be offered to U.S. holders of
ADSs unless a registration statement under the Securities Act is effective
with respect to the shares underlying such rights, or an exemption from the
registration requirements of the Securities Act is available. Consequently,
holders of ADSs who are U.S. persons or are located in the United States may
be restricted in their ability to participate in the exercise of preemptive
rights. See "--Description of American Depositary Receipts in respect of
Preferred Shares--Dividends, Other Distributions and Rights."
RIGHT OF REDEMPTION
Neither the Common Shares nor the Preferred Shares are redeemable, subject
to the right of a dissenting shareholder to seek redemption upon a decision
made at a shareholders' meeting by shareholders representing over 50% of the
voting shares (i) to change the preference of the Preferred Shares or to
create a class of shares having priority or preference over the Preferred
Shares, (ii) to modify the mandatory distribution of dividends, (iii) to
change the corporate purposes of the Registrant, (iv) to dissolve or liquidate
the Registrant, (v) to transfer all of the shares of the Registrant to another
company in order to make the Registrant a wholly-owned subsidiary of such
company (incorporacao de acoes), (vi) to approve the acquisition of another
company, the price of which exceeds certain limits set forth in the Brazilian
Corporation Law, and (vii) to merge or consolidate the Registrant with another
company, if certain liquidity standards provided in the Brazilian Corporation
Law are not met. The right to redemption lapses 30 days after publication of
the minutes of the relevant shareholders' meeting or, whenever the resolution
requires the approval of the holders of preferred shares by vote taken in a
special meeting of a majority of the holders of Preferred Shares affected by
the resolution, within 30 days from the publication of the minutes of such
special meeting. The Registrant would be entitled to reconsider any action
giving rise to redemption rights within 10 days following the expiration of
such rights if the redemption of shares of dissenting shareholders would
jeopardize the financial stability of the Registrant.
Unless otherwise provided in the By-laws (which is not the case with the
Registrant), shares are redeemable at their book value, determined on the
basis of the last annual balance sheet approved by the shareholders. If the
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shareholders' meeting giving rise to redemption rights occurs more than 60
days after the date of the last annual balance sheet, a shareholder may demand
that its shares be valued on the basis of a new balance sheet that is as of a
date within 60 days of such shareholders' meeting.
FORM AND TRANSFER
Shares of the Registrant are maintained in book-entry form with a transfer
agent (the "Transfer Agent") and the transfer of such shares is made in
accordance with the applicable provisions of the Brazilian Corporation Law,
which provides that a transfer of shares is effected by an entry made by the
Transfer Agent on its books, debiting the share account of the seller and
crediting the share account of the purchaser, against presentation of a
written order of the seller, or judicial authorization or order, in an
appropriate document which remains in the possession of the Transfer Agent.
The Preferred Shares underlying the ADS will be registered on the Transfer
Agent's records in the name of the Depositary.
Transfers of shares by a foreign investor are made in the same way and
executed by such investor's local agent on the investor's behalf except that,
if the original investment was registered with the Central Bank of Brazil
pursuant to the Annex IV Regulations, the foreign investor should also seek
amendment, if necessary, through its local agent, of the certificate of
registration to reflect the new ownership.
Each of the Sao Paulo Stock Exchange and the Rio de Janeiro Stock Exchange
operates a central clearing system. A holder of shares of the Registrant may
choose, at its discretion, to participate in these systems and all shares
elected to be put into the system will be deposited in custody with the
relevant stock exchange (through a Brazilian institution duly authorized to
operate by the Central Bank of Brazil having a clearing account with the
relevant stock exchange) and the fact that such shares are subject to custody
with the relevant stock exchange will be reflected in the Registrant's
register of shareholders. Each participating shareholder will, in turn, be
registered in the register of beneficial shareholders of the Registrant
maintained by the relevant stock exchange and will be treated in the same way
as registered shareholders.
DESCRIPTION OF AMERICAN DEPOSITARY RECEIPTS IN RESPECT OF PREFERRED SHARES
The following is a summary of the material provisions of the deposit
agreement (the "Deposit Agreement"), dated as of July 27, 1998 among the
Registrant, the Depositary, and the registered holders (the "Owners") and
beneficial owners from time to time of ADSs (the "Beneficial Owners"),
pursuant to which the ADSs representing Preferred Shares are to be issued.
This summary is subject to and qualified in its entirety by reference to the
Deposit Agreement, including the form of ADRs. Terms used in this description
and not otherwise defined shall have the meanings set forth in the Deposit
Agreement. A copy of the Deposit Agreement has been filed as an exhibit to
this Registration Statement. Copies of the Deposit Agreement are available for
inspection at the Corporate Trust Office of the Depositary, currently located
at 101 Barclay Street, New York, NY 10286, and at the office of the agent of
the Custodian, currently located at the principal Sao Paulo, Brazil office of
Banco Itau. The Depositary's principal executive office is located at 1 Wall
Street, New York, NY 10015.
AMERICAN DEPOSITARY RECEIPTS
ADRs evidencing ADSs are issuable by the Depositary pursuant to the Deposit
Agreement. Each ADR is in registered form and evidences a specified number of
ADSs, each ADS representing 20,000 Preferred Shares, or evidence of the right
to receive 20,000 Preferred Shares deposited with the Custodian and registered
in the name of the Depositary or its nominee (together with any additional
Preferred Shares at any time deposited or deemed deposited under the Deposit
Agreement and any and all other securities, cash and other property received
by the Depositary or the Custodian in respect of such Preferred Shares and at
such time held under the Deposit Agreement, the "Deposited Securities"). Only
persons in whose names ADRs are registered on the books of the Depositary are
treated by the Depositary and the Registrant as Owners.
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DEPOSIT, TRANSFER AND WITHDRAWAL
The By-laws provide that ownership of capital generally must be evidenced
only by a record of ownership maintained by the Registrant or an accredited
intermediary, such as a bank, acting as a registrar for the shares. Currently,
such function is performed by the Registrant as registrar (the "Registrar").
Accordingly, all references to the deposit, surrender and delivery of the
Preferred Shares refer only to book-entry transfers of the Preferred Shares in
Brazil. See "--Capital Stock" for a description of the characteristics and
rights of the Preferred Shares. All references to the deposit, surrender and
delivery of the ADS or the ADRs refer not only to the physical transfer of any
certificates representing such ADRs but also to any book-entry transfers.
The Preferred Shares represented by ADSs were deposited pursuant to the
Deposit Agreement by book-entry transfer to an account of the Custodian and
registered in the name of the Custodian. The Depositary is the holder of
record on the books of the Custodian of all such Preferred Shares.
The Depositary has agreed, subject to the terms and conditions of the
Deposit Agreement, that upon delivery (including by book-entry credit) to the
Custodian of the Preferred Shares (or evidence of rights to receive Preferred
Shares) and pursuant to appropriate instruments of transfer in a form
satisfactory to the Custodian, the Depositary will, upon payment of the fees,
charges and taxes provided in the Deposit Agreement, execute and deliver at
its Corporate Trust Office to, or upon the written order of, the person or
persons named in the notice of the Custodian delivered to the Depositary or
requested by the person depositing such Preferred Shares with the Depositary,
an ADR or ADRs, registered in the name or names of such person or persons, and
evidencing any authorized number of ADSs requested by such person or persons.
The Depositary will refuse to accept Preferred Shares for deposit whenever
it is notified in writing that such deposit would result in any violation of
applicable laws.
Upon surrender at the Corporate Trust Office of the Depositary of an ADR for
the purpose of withdrawal of the Deposited Securities represented by the ADSs
evidenced by such ADR, and upon payment of the fees of the Depositary,
governmental charges and taxes provided in the Deposit Agreement, and subject
to the terms and conditions of the Deposit Agreement, the By-laws, the
Deposited Securities and applicable law, the Owner of such ADR will be
entitled to book-entry credit with the Registrar together with physical
delivery (if physical delivery is permitted under the By-laws), to him or upon
his order, as permitted by applicable law, of the amount of Deposited
Securities at the time represented by the ADS or ADSs evidenced by such ADR.
Any forwarding of share certificates (if any), other securities, property,
cash and other documents of title for such delivery will be at the risk and
expense of the Owner.
Subject to the terms and conditions of the Deposit Agreement and any
limitations that may be established by the Depositary and unless requested by
the Registrant to cease doing so, the Depositary may execute and deliver ADRs
prior to the receipt of Preferred Shares (a "Pre-Release"), may deliver
Preferred Shares upon the receipt, and cancellation of ADRs which have been
Pre-Released, whether or not such cancellation is prior to the termination of
such Pre-Release or the Depositary knows that such ADR has been Pre-Released,
and may receive ADRs in lieu of Preferred Shares in satisfaction of a Pre-
Release.
Each Pre-Release must be (a) preceded or accompanied by a written
representation and agreement from the person to whom the ADRs are to be
delivered (the "Pre-Releasee") that the Pre-Release or its customer (i) owns
the Preferred Shares or ADRs to be remitted, as the case may be, (ii) assigns
all beneficial right, title and interest in such Preferred Shares or ADRs, as
the case may be, to the Depositary for the benefit of the Owners and (iii)
agrees in effect to hold such Preferred Shares or ADRs, as the case may be,
for the account of the Depositary until delivery of the same upon the
Depositary's request, (b) at all times fully collateralized with cash or U.S.
government securities, (c) terminable by the Depositary on not more than five
business days' notice and (d) subject to such further indemnities and credit
regulations as the Depositary deems appropriate. The Depositary will set
limits with respect to Pre-Release transactions to be entered into hereunder
with any particular Pre-Releasee on a case by case basis as the Depositary
deems appropriate. The collateral referred to in clause (b) above shall be
held by the Depositary for the benefit of the Owners as security for the
performance of the Pre-
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Releasee's obligations to the Depositary in connection with a Pre-Release
transaction, including the Pre-Releasee's obligation to deliver Preferred
Shares or ADRs upon termination of a Pre-Release transaction.
The Depositary will also limit the number of ADRs involved in such Pre-
Release transactions so that Preferred Shares not deposited but represented by
ADSs outstanding at any time as a result of Pre-Releases will not normally
exceed thirty percent (30%) of the ADSs outstanding (without giving effect to
ADSs evidenced by ADRs outstanding as a result of the Pre-Release), but the
Depositary reserves the right to disregard such limit from time to time as it
deems appropriate and may, with the prior written consent of the Registrant,
change such limit for purposes of general application. The Depositary may
retain for its own account any compensation received by it in connection with
the foregoing. Neither the Registrant nor the Custodian shall incur any
liability to Owners of ADRs as a result of such transactions.
DIVIDENDS, OTHER DISTRIBUTIONS AND RIGHTS
The Depositary is required to convert, as promptly as practicable and, in
any event, within one business day of its receipt thereof, into U.S. dollars,
all cash dividends or other distributions, net proceeds from the sale of
securities, property or rights, denominated in any currency other than U.S.
dollars that it receives in respect of the deposited Preferred Shares if
permitted under applicable laws and the Depositary determines that such
conversion into U.S. dollars and transfer to the United States can be effected
on a reasonable basis. If at the time of conversion, the resulting U.S.
dollars can, pursuant to applicable law, be transferred out of Brazil for
distribution, the Depositary will as promptly as practicable distribute the
amount received to the Owner entitled thereto in proportion to the number of
ADSs evidenced by such Owner's ADRs without regard to any distinctions among
Owners on account of exchange restrictions or otherwise. The amount
distributed will be reduced by any amounts to be withheld by the Registrant,
the Depositary or the Custodian, including amounts on account of any
applicable taxes and certain other expenses. For further details about
applicable taxes, see "Taxation."
If such conversion, transfer or distribution can be effected only with the
approval or license of any government or agency thereof, the Depositary will
file as promptly as practicable such application for approval or license;
however, the Depositary will be entitled to rely upon Brazilian local counsel
in such matters, which counsel will be instructed to act as promptly as
possible. If, pursuant to applicable law, any foreign currency received by the
Depositary or the Custodian cannot be converted to U.S. dollars, or if any
approval or license of any government or agency thereof that is required for
such conversion is denied or, in the opinion of the Depositary, cannot be
promptly obtained at a reasonable cost, the Depositary will, (a) as to the
portion of the foreign currency that is convertible into U.S. dollars, make
such conversion and (i) if permitted by applicable law, transfer such U.S.
dollars to the United States and distribute them to the Owners entitled
thereto or (ii) to the extent that such transfer is not permitted, hold such
U.S. dollars for the benefit of the Owners entitled thereto, uninvested and
without liability for interest thereon and (b) as to the nonconvertible
balance, if any, (i) if requested in writing by an Owner, distribute or cause
the Custodian to distribute the foreign currency (or an appropriate document
evidencing the right to receive such foreign currency) received by the
Depositary or the Custodian to such Owner and (ii) the Depositary shall hold
or will cause the Custodian to hold any amounts of nonconvertible foreign
currency not distributed pursuant to the immediately preceding subclause (i)
uninvested and without liability for the interest thereon for the respective
accounts of the Owners entitled to receive the same.
If the Registrant declares a dividend in, or free distribution of,
additional Preferred Shares with respect to the Preferred Shares represented
by the ADSs, the Depositary may, or will if the Registrant so requests,
distribute as promptly as practicable to the Owners of outstanding ADRs
entitled thereto, in proportion to the number of ADSs evidenced by their
respective ADRs, additional ADRs evidencing an aggregate number of ADSs that
represents the number of Preferred Shares received as such dividend or free
distribution, subject to the terms and conditions of the Deposit Agreement
with respect to the deposit of Preferred Shares and the issuance of ADSs
evidenced by ADRs, including the withholding of any tax or other governmental
charge and the payment of fees of the Depositary.
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The Depositary may withhold any such distribution of ADRs if it has not
received satisfactory assurances from the Registrant that such distribution
does not require registration under the Securities Act or is exempt from
registration under the provisions of such Act. In lieu of delivering ADRs for
fractional ADSs in the event of any such dividend or free distribution, the
Depositary will sell the amount of Preferred Shares represented by the
aggregate of such fractions and distribute the net proceeds in accordance with
the Deposit Agreement. If additional ADRs are not so distributed, each ADS
will thereafter also represent the additional Preferred Shares distributed
upon the Deposited Securities represented thereby.
If the Registrant offers, or causes to be offered, to the holders of
Preferred Shares any rights to subscribe for additional Preferred Shares or
any rights of any other nature, the Depositary, after consultation with the
Registrant, will have discretion as to the procedure to be followed in making
such rights available to Owners or in disposing of such rights for the benefit
of such Owners and making the net proceeds available to such Owners. If, by
the terms of such rights offering or for any other reason, it would be
unlawful for the Depositary to either make such rights available to any Owners
or dispose of such rights and make the net proceeds available to such Owners,
then the Depositary will allow the rights to lapse. If at the time of the
offering of any rights, the Depositary determines in its discretion that it is
lawful and feasible to make such rights available to all or certain Owners,
the Depositary may, and at the request of the Company will, distribute to any
Owners to whom it determines the distribution to be lawful and feasible, in
proportion to the number of ADSs held by such Owner, warrants or other
instruments therefor in such form as it deems appropriate.
If the Depositary determines that it is not lawful or feasible to make such
rights available to all or certain Owners, it may, and at the request of the
Registrant, will use its best efforts that are reasonable under the
circumstances to, sell the rights, warrants or other instruments in proportion
to the number of ADSs held by the Owners to whom it has determined it may not
lawfully or feasibly make such rights available, and allocate net proceeds of
such sales for the account of such Owners otherwise entitled to such rights,
warrants or other instruments, upon an averaged or other practical basis
without regard to any distinctions among such Owners because of exchange
restrictions or the date of delivery of any ADR or ADRs or otherwise. The
Depositary will not be responsible for any failure to determine that it may be
lawful or feasible to make such rights available to Owners in general or any
Owner or Owners in particular.
In circumstances in which rights would not otherwise be distributed, if an
Owner requests the distribution of warrants or other instruments in order to
exercise the rights allocable to the ADSs of such Owner, the Depositary will
promptly make such rights available to such Owner upon written notice from the
Registrant to the Depositary that (a) the Registrant has elected in its sole
discretion to permit such rights to be exercised and (b) such Owner has
executed such documents as the Registrant has determined in its sole
discretion are reasonably required under applicable law. Upon instruction
pursuant to such warrants or other instruments to the Depositary from such
Owner to exercise such rights, upon payment by such Owner to the Depositary
for the account of such Owner of an amount equal to the purchase price of the
Preferred Shares to be received in exercise of the rights, and upon payment of
the fees of the Depositary as set forth in such warrants or other instruments,
the Depositary will, on behalf of such Owner, exercise the rights and purchase
the Preferred Shares, and the Registrant will cause the Preferred Shares so
purchased to be delivered to the Depositary on behalf of such Owner. As agent
for such Owner, the Depositary will cause the Preferred Shares so purchased to
be deposited, and will execute and deliver ADRs to such Owner, pursuant to the
Deposit Agreement. Such a disposal of rights may reduce the Owners'
proportionate equity interest in the Registrant.
The Depositary will not offer rights to Owners having an address of record
in the United States unless a registration statement under the Securities Act
is in effect with respect to such rights and the Securities to which such
rights relate or unless the offering and sale thereof to such Owners are
exempt from registration under the Securities Act; however, the Registrant
will have no obligation to file a registration statement under the Securities
Act to make available to Owners any right to subscribe for or to purchase any
of the Securities.
Whenever the Depositary receives any distribution other than cash, Preferred
Shares or rights in respect of the Deposited Securities, the Depositary will,
as promptly as practicable, cause the securities or property received
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by it to be distributed to the Owners entitled thereto, after deduction or
upon payment of any fees and expenses of the Depositary or any taxes or other
governmental charges, in proportion to their holdings, respectively, in any
manner that the Depositary may deem equitable and practicable for
accomplishing such distribution; provided, however, that if in the opinion of
the Depositary such distribution cannot be made proportionately among the
Owners entitled thereto, or if for any other reason (including, but not
limited to, any requirement that the Registrant or the Depositary withhold an
amount on account of taxes or other governmental
charges or that such securities must be registered under the Securities Act,
in order to be distributed to Owners) the Depositary deems such distribution
not to be feasible, the Depositary may, after consultation with the
Registrant, adopt such method as it may deem equitable and practicable for the
purpose of effecting such distribution, including, but not limited to, the
public or private sale of the securities or property thus received, or any
part thereof, and the net proceeds of any such sale (net of the fees and
expenses of the Depositary) will be distributed by the Depositary to the
Owners entitled thereto as in the case of a distribution received in cash.
In connection with any distribution to Owners, the Registrant will remit to
the appropriate governmental authority or agency all amounts (if any) required
to be withheld by the Registrant and owing to such authority or agency by the
Registrant; and the Depositary and the Custodian will remit to the appropriate
governmental authority or agency all amounts (if any) required to be withheld
and owing to such authority or agency by the Depositary or Custodian. If the
Depositary determines that any distribution of property other than cash
(including Preferred Shares and rights to subscribe therefor) is subject to
any tax or governmental charge that the Depositary is obligated to withhold,
the Depositary may, by public or private sale, dispose of all or a portion of
such property in such amounts and in such manner as the Depositary deems
necessary and practicable to pay such taxes or governmental charges, and the
Depositary will distribute the net proceeds of any such sale or the balance of
any such property after deduction of such taxes or governmental charges to the
Owners entitled thereto in proportion to the number of ADSs held by them,
respectively.
Upon any change in nominal or par value, or split-up, consolidation or any
other reclassification of Deposited Securities, or upon any recapitalization,
reorganization, merger or consolidation or sale of assets affecting the
Registrant or to which it is a party, any Preferred Shares or other securities
that will be received by the Depositary or the Custodian in exchange for, in
conversion of, or in respect of Deposited Securities will be treated as new
Deposited Securities under the Deposit Agreement, and ADSs will thenceforth
represent, in addition to the existing Deposited Securities, the right to
receive the new Deposited Securities so received in exchange or conversion,
unless additional ADRs are delivered pursuant to the following sentence. In
any such case the Depositary may, and will if the Company so requests, execute
and deliver additional ADRS as in the case of a distribution in Preferred
Shares, or call for the surrender of outstanding ADRs to be exchanged for new
ADRs specifically describing such new Deposited Securities.
RECORD DATES
Whenever any cash dividend or other cash distribution shall become payable,
or whenever any distribution other than cash shall be made, or whenever rights
shall be issued with respect to the Deposited Securities, or whenever for any
reason the Depositary causes a change in the number of Preferred Shares that
are represented by each ADS or whenever the Depositary shall receive notice of
any meeting of holders of Preferred Shares or other Deposited Securities, or
whenever the Depositary shall find it necessary or convenient, the Depositary
will fix a record date, which date shall, to the extent practicable, be either
the same date as the record date fixed by the Registrant or if different from
the record date fixed by the Registrant, fixed after consultation with the
Registrant, (a) for the determination of the Owners who will be (i) entitled
to receive such dividend, distribution of rights, or, the net proceeds of the
sale thereof, or (ii) entitled to give instructions for the exercise of voting
rights at any such meeting, or (b) on or after which such ADS will represent
the changed number of Preferred Shares, all subject to the provisions of the
Deposit Agreement.
VOTING OF THE DEPOSITED SECURITIES
Preferred Shares do not entitle the holders thereof to vote on any matter
presented to a vote of shareholders of the Registrant except as set forth
under "--Capital Stock--Voting Rights." With respect to the circumstances
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set forth thereunder and if, in the future, the terms of the Preferred Shares
should be revised or amended so as to provide for voting rights, or should the
Preferred Shares obtain voting rights pursuant to the Brazilian Corporation
Law or through any change in the laws, rules, or regulations applicable to
such shares or through any change in interpretation of such laws, the
following shall apply.
As soon as practicable after receipt of notice of any meeting or
solicitation of consents or proxies of holders of Preferred Shares or other
Deposited Securities, if requested in writing by the Registrant, the
Depositary will, as soon as practicable thereafter, mail to all Owners a
notice, the form of which notice will be in the sole discretion of the
Depositary, containing (a) the information included in such notice of meeting
received by the Depositary from the Registrant (or a summary in English of the
notice of such meeting), (b) a statement that the Owners as of the close of
business on a specified record date will be entitled, subject to any
applicable provision of Brazilian law, the By-laws and the provisions of the
Deposited Securities, to instruct the Depositary as to the exercise of the
voting rights, if any, pertaining to the Preferred Shares or other Deposited
Securities represented by their respective ADSs and (c) a statement as to the
manner in which such instructions may be given, including an express
indication that instructions may be given or deemed given in accordance with
the last sentence of this paragraph if no instruction is received, to the
Depositary to give a discretionary proxy to a person designated by the
Registrant. Upon the written request of an Owner on such record date, received
on or before the date established by the Depositary for such purpose, the
Depositary will endeavor, insofar as practicable, to vote or cause to be voted
the amount of Preferred Shares or other Deposited Securities represented by
the ADSs evidenced by such ADRs in accordance with the instructions set forth
in such request. The Depositary may not itself exercise any voting discretion
over any Preferred Shares. If the Depositary does not receive instructions
from an Owner on or before the date established by the Depositary for such
purpose, the Depositary will deem such Owner to have instructed the Depositary
to give a discretionary proxy to a person designated by the Registrant to vote
the underlying Preferred Shares, provided that no such discretionary proxy
will be given with respect to any matter as to which the Registrant informs
the Depositary that (i) the Registrant does not wish such proxy given, (ii)
substantial opposition exists or (iii) the rights of holders of Preferred
Shares will be materially and adversely affected. Under Brazilian law the
Depositary may vote the Preferred Shares or other Deposited Securities
represented by ADSs and evidenced by ADRs in accordance with the instructions
of the Owners even if those instructions differ among such Owners.
Owners are not entitled to attend meetings of shareholders. An Owner 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
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be deemed, by continuing to hold such ADR, to consent and agree to such
amendment and to be bound by the Deposit Agreement as amended thereby. In no
event will any amendment impair the right of any Owner to surrender his ADR
and receive therefor the Preferred Shares and other property represented
thereby, except to comply with mandatory provisions of applicable law.
The Depositary will at any time at the direction of the Registrant terminate
the Deposit Agreement by mailing notice of such termination to the Owners then
outstanding at least 30 days prior to the date fixed in such notice for such
termination. The Depositary may likewise terminate the Deposit Agreement by
mailing notice of such termination to the Registrant and the Owners, if at any
time after 60 days have expired after the Depositary shall have delivered
written notice of its election to resign to the Registrant, a successor
depositary shall not have been appointed and accepted its appointment, in
accordance with the terms of the Deposit Agreement. If any ADRs remain
outstanding after the date of termination, the Depositary thereafter will
discontinue the registration of transfer of ADRs, will suspend the
distribution of dividends to the holders thereof and will not give any further
notices or perform any further acts under the Deposit Agreement, except for
(1) the collection of dividends and other distributions pertaining to the
Deposited Securities, (2) the sale of rights and other property and (3) the
delivery of Preferred Shares, together with any dividends or other
distributions received with respect thereto and the net proceeds of the sale
of any rights or other property, in exchange for surrendered ADRs (after
deducting, in each case, the fees of the Depositary for the surrender of an
ADR and other expenses set forth in the Deposit Agreement and any applicable
taxes or governmental charges).
At any time after the expiration of one year from the date of termination,
the Depositary may sell the Deposited Securities then held thereunder and hold
uninvested the net proceeds of such sale, together with any other cash,
unsegregated and without liability for interest, for the pro rata benefit of
the Owners that have not theretofore surrendered their ADRs, such Owners
thereupon becoming general creditors of the Depositary with respect to such
net proceeds. After making such sale, the Depositary will be discharged from
all obligations under the Deposit Agreement, except to account for net
proceeds and other cash (after deducting, in each case, the fee of the
Depositary and other expenses set forth in the Deposit Agreement for the
surrender of an ADR and any applicable taxes or other governmental charges)
and certain indemnification obligations. Upon termination of the Deposit
Agreement, the Registrant will also be discharged from all obligations
thereunder, except for certain obligations to the Depositary.
CHARGES OF DEPOSITARY
The Depositary will charge (to the extent permitted by applicable law) any
party depositing or withdrawing Preferred Shares or any party surrendering
ADRs or to whom ADRs are issued (including, without limitation, issuance
pursuant to a stock dividend or stock split declared by the Company or an
exchange of stock regarding the ADRs or Deposited Securities or a distribution
of ADRs pursuant to the Deposit Agreement), whichever is applicable: (1) taxes
and other governmental charges, (2) such registration fees as may from time to
time be in effect for the registration of transfers of Preferred Shares
generally on the register of the Registrant or the Registrar and applicable to
transfers of Preferred Shares to the name of the Depositary or its nominee or
the Custodian or its nominee on the making of deposits or withdrawals under
the Deposit Agreement, (3) such cable, telex and facsimile transmission
expenses as are expressly provided in the Deposit Agreement to be at the
expense of persons depositing Preferred Shares or Owners, (4) such expenses as
are incurred by the Depositary in the conversion of foreign currency pursuant
to the Deposit Agreement, (5) a fee not in excess of $5.00 per 100 ADSs (or
portion thereof) for the execution and delivery of ADRs pursuant to the
Deposit Agreement and the surrender of ADRs pursuant to the Deposit Agreement,
and (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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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
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any of their respective directors, employees, agents, or affiliates shall be
prevented, delayed or forbidden from, or be subject to any civil or criminal
penalty on account of, doing or performing any act or thing which by terms of
the Deposit Agreement it is provided will be done or performed; nor will the
Depositary or the Registrant incur any liability to any Owner or Beneficial
Owner of any ADR by reason of any nonperformance or delay, caused as
aforesaid, in the performance of any act or thing which by the terms of the
Deposit Agreement it is provided will or may be done or performed, or by
reason of any exercise of, or failure to exercise, any discretion provided for
under the Deposit Agreement. Where, by the terms of a distribution pursuant to
the Deposit Agreement, or an offering or distribution pursuant to the Deposit
Agreement, or for any other reason, the Depositary is prevented or prohibited
from making such distribution or offering available to Owners, and the
Depositary is prevented or prohibited from making such distribution or
offering on behalf of such Owners and making the net proceeds available to
such Owners, then the Depositary, after consultation with the Registrant, will
not make such distribution or offering, and will allow the rights, if
applicable, to lapse.
The Registrant and the Depositary assume no obligation nor will they be
subject to any liability under the Deposit Agreement to Owners or Beneficial
Owners of ADRs, except that they agree to perform their respective obligations
specifically set forth under the Deposit Agreement without negligence or bad
faith.
GOVERNING LAW
The Deposit Agreement is governed by the laws of the State of New York.
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PART III
ITEM 15: DEFAULTS UPON SENIOR SECURITIES
Not applicable.
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-30.
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 Statements of Financial Condition as of December 31, 1996
and 1997
Consolidated Statements of Revenues and Expenses for the Years Ended
December 31, 1995, 1996 and 1997
Consolidated Statements of Net Interdivisional Cash Distribution
(Receipt) for the Years Ended December 31, 1995, 1996 and 1997
Consolidated Statements of Changes in Divisional Equity for the Years
Ended December 31, 1997, 1996 and 1995
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 Mobile Cellular Service
10.2* Standard Concession Agreement for Mobile Cellular Service (English
translation)
23.1** Consent of KPMG Peat Marwick
--------
* Previously filed
** Filed herewith
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<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. 001-14483, to be signed on its
behalf by the undersigned, thereunto duly authorized.
Telemig Celular Participacoes S.A.
/s/ Jose Leitao Viana
By: _________________________________
Name: Jose Leitao Viana
Title: President
/s/ Luis Gonzaga Leal
By: _________________________________
Name: Luis Gonzaga Leal
Title: Vice-President
Dated: November 2, 1998
74
<PAGE>
TELEMIG CELULAR 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 Statements of Financial Condition............... F-3
Consolidated Statements of Revenues and Expenses............. F-4
Consolidated Statements of Net Interdivisional Cash
Distribution (Receipt)...................................... F-5
Consolidated Statements of Changes in Divisional Equity...... F-6
Notes to the Consolidated Financial Statements............... F-7 through F-30
</TABLE>
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders
Telemig Celular Participacoes S.A.
Brasilia--DF
We have audited the accompanying consolidated statements of financial
condition of Telemig Celular Participacoes S.A. as of December 31, 1996 and
1997, and the related consolidated statements of revenues and expenses, net
interdivisional cash distribution (receipt) and changes in divisional 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.
The accompanying consolidated financial statements have been prepared in
accordance with generally accepted accounting principles in Brazil and on the
basis set out in Note 2 to the consolidated financial statements. Accordingly,
interest income, unallocated interest expense, income tax expense and the
related assets and liabilities are not included in the consolidated financial
statements.
In our opinion, based on our audits, the consolidated financial statements
referred to above present fairly, in all material respects, the financial
condition of Telemig Celular Participacoes S.A. as of December 31, 1996 and
1997, and its revenues and expenses and net interdivisional cash distribution
(receipt) for each of the years in the three-year period ended December 31,
1997, in conformity with accounting principles generally accepted in Brazil
and on the basis set out in Note 2, 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 revenues and expenses for each of the years in
the two-year period ended December 31, 1997 and the divisional equity as of
December 31, 1996 and 1997 to the extent summarized in Note 24 of the
consolidated financial statements.
July 17, 1998
Brasilia, Brazil
KPMG Peat Marwick
F-2
<PAGE>
TELEMIG CELULAR PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 23)
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
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.............. 9 - 10,160 9,101
Accounts receivable:
Trade, net............................. 10 33,575 54,733 49,026
Receivable from related parties........ 19 547 1,016 910
Taxes receivable....................... - 3,664 3,282
Other assets........................... 11 885 2,815 2,521
------- ------- -------
Total current assets.................. 35,007 72,388 64,840
------- ------- -------
Noncurrent assets:
Other assets........................... 11 2,003 2,443 2,188
------- ------- -------
Permanent assets:
Property, plant and equipment, net..... 12 434,784 502,854 450,425
------- ------- -------
Total assets.......................... 471,794 577,685 517,453
======= ======= =======
Current liabilities:
Payroll and related accruals........... 13 1,487 1,585 1,420
Accounts payable and accrued expenses:
Suppliers.............................. 14 10,543 17,080 15,299
Payable to related parties............. 14, 19 2,439 4,441 3,978
Taxes other than income taxes.......... 15 5,550 - -
Deferred tax liabilities from
indexation adjustments................ 2(a) 794 1,635 1,464
Loans and financing:
Payable to Telebras.................... 16,19 38,513 28,674 25,685
Third parties.......................... 16 - 12,359 11,070
Other liabilities...................... 269 - -
------- ------- -------
Total current liabilities............. 59,595 65,774 58,916
------- ------- -------
Noncurrent liabilities:
Deferred tax liabilities from
indexation adjustments................ 2(a) 9,073 17,970 16,096
Loans and financing:
Payable to Telebras.................... 16,19 95,818 64,311 57,606
Third parties.......................... 16 - 11,761 10,535
Provisions for contingencies........... 17 208 193 173
------- ------- -------
Total noncurrent liabilities.......... 105,099 94,235 84,410
------- ------- -------
Minority interests...................... 2 49,243 71,243 63,816
Divisional equity....................... 257,857 346,433 310,311
------- ------- -------
Total liabilities and equity.......... 471,794 577,685 517,453
======= ======= =======
</TABLE>
See the accompanying notes to the consolidated financial statements.
F-3
<PAGE>
TELEMIG CELULAR PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 23)
CONSOLIDATED STATEMENTS OF REVENUES AND EXPENSES
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
cellular
telecommunications services:
Services provided to third
parties....................... 89,597 191,245 269,136 241,074
Services provided to the
Telebras operating companies.. 19 21,044 47,918 105,026 94,076
------- ------- -------- --------
Total net operating revenue.. 4 110,641 239,163 374,162 335,150
Cost of services:
Provided by third parties...... (16,855) (36,079) (64,891) (58,125)
Provided by the Telebras
operating companies........... 19 (41,654) (50,273) (118,805) (106,418)
------- ------- -------- --------
Total cost of services....... 5 (58,509) (86,352) (183,696) (164,543)
------- ------- -------- --------
Gross profit..................... 52,132 152,811 190,466 170,607
Operating expenses:
Selling expense................ (4,946) (13,770) (57,723) (51,705)
General and administrative
expense....................... (9,817) (17,742) (28,020) (25,099)
Other net operating income
(expense)..................... 6 11,470 11,546 (83) (74)
------- ------- -------- --------
Operating income before
interest........................ 48,839 132,845 104,640 93,729
Allocated interest expense....... - (413) (10,193) (9,130)
------- ------- -------- --------
Operating income before interest
income and unallocated interest
expense......................... 48,839 132,432 94,447 84,599
Net non-operating expense........ - (957) - -
Employees' profit share.......... - (269) - -
------- ------- -------- --------
Income before interest income,
unallocated interest expense,
taxes and minority interests.... 48,839 131,206 94,447 84,599
Minority interests before
interest income, unallocated
interest expense and taxes...... 2 (6,923) (21,704) (15,584) (13,959)
------- ------- -------- --------
Income before interest income,
unallocated interest expense and
taxes........................... 41,916 109,502 78,863 70,640
======= ======= ======== ========
</TABLE>
See the accompanying notes to the consolidated financial statements.
F-4
<PAGE>
TELEMIG CELULAR PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 23)
CONSOLIDATED STATEMENTS OF NET INTERDIVISIONAL CASH DISTRIBUTION (RECEIPT)
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:
Income before interest income,
unallocated interest expense and
taxes.............................. 41,916 109,502 78,863 70,640
Adjustments to reconcile income
before interest income, unallocated
interest expense and taxes to cash
provided by operating activities:
Depreciation and amortization...... 13,112 29,626 51,330 45,978
Minority interests in income before
interest income, unallocated
interest expense and taxes........ 6,923 21,704 15,584 13,959
Increase in allowance for doubtful
accounts.......................... 3,273 2,848 34,862 31,227
Increase in accounts receivable.... (17,274) (15,461) (56,489) (50,599)
Increase in taxes receivable....... -- -- (3,664) (3,282)
Increase in other current assets... (213) (672) (1,930) (1,729)
Increase in other noncurrent
assets............................ -- (2,003) (440) (394)
Increase in payroll and related
accruals.......................... 356 1,131 98 88
Increase (decrease) in accounts
payable and accrued expenses...... 39,599 (65,822) 8,539 7,649
Increase (decrease) in taxes other
than income taxes................. 1,980 3,570 (5,550) (4,971)
Increase in accrued interest....... -- 999 763 683
Decrease in provisions for
contingencies..................... (51) (19) (15) (13)
Increase (decrease) in other
current liabilities............... -- 269 (269) (241)
------- -------- -------- --------
89,621 85,672 121,682 108,995
------- -------- -------- --------
Investing activities:
Additions to property, plant and
equipment.......................... (78,645) (188,123) (113,788) (101,924)
Capitalized interest................ -- (71) (1,703) (1,525)
------- -------- -------- --------
(78,645) (188,194) (115,491) (103,449)
------- -------- -------- --------
Financing activities:
Loans repaid........................ -- -- (35,382) (31,693)
New loans obtained.................. -- 133,332 17,393 15,580
------- -------- -------- --------
-- 133,332 (17,989) (16,113)
------- -------- -------- --------
Increase (decrease) in cash and cash
equivalents......................... 10,976 30,810 (11,798) (10,567)
Cash and cash equivalents at the end
of the year......................... -- -- (10,160) (9,101)
------- -------- -------- --------
Net interdivisional cash distribution
(receipt)........................... 10,976 30,810 (21,958) (19,668)
======= ======== ======== ========
</TABLE>
See the accompanying notes to the consolidated financial statements.
F-5
<PAGE>
TELEMIG CELULAR PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 23)
CONSOLIDATED STATEMENTS OF CHANGES IN DIVISIONAL EQUITY
YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
(IN THOUSANDS OF CONSTANT BRAZILIAN REAIS--R$, OF DECEMBER 31, 1997
<TABLE>
<CAPTION>
DIVISIONAL
EQUITY
----------
<S> <C>
Balance at December 31, 1994....................................... 138,392
Income before interest income, unallocated interest expense and
taxes............................................................. 41,916
Capitalized interest............................................... 4,777
Net interdivisional cash distribution.............................. (10,976)
Minority interests effects other than on income.................... 1,488
-------
Balance at December 31, 1995....................................... 175,597
Income before interest income, unallocated interest expense and
taxes............................................................. 109,502
Capitalized interest............................................... 9,100
Deferred tax on full indexation.................................... (9,867)
Net interdivisional cash distribution.............................. (30,810)
Minority interests effects other than on income.................... 4,335
-------
Balance at December 31, 1996....................................... 257,857
Income before interest income, unallocated interest expense and
taxes............................................................. 78,863
Capitalized interest............................................... 3,909
Deferred tax on full indexation.................................... (9,738)
Net interdivisional cash receipt................................... 21,958
Minority interests effects other than on income.................... (6,416)
-------
Balance at December 31, 1997....................................... 346,433
=======
</TABLE>
See the accompanying notes to the consolidated financial statements.
F-6
<PAGE>
TELEMIG CELULAR PARTICIPACOES S.A.
(SEE NOTES 1, 2 AND 23)
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 Brazilian regulation 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 (the "New Holding
Companies"). 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 Telemig Celular Participacoes S.A. (the "Holding Company") was
formed.
Telemig Celular Participacoes S.A. was formed on May 22, 1998, through the
spin-off of certain assets and liabilities of Telebras, including 82.9% of the
share capital of Telemig Celular S.A.
Telemig Celular S.A. was formed on January 5, 1998 and subsequently received
on January 30, 1998 from Telecomunicacoes de Minas Gerais S.A. ("Telemig") the
assets and liabilities comprising its cellular telecommunications services.
Telemig Celular Participacoes S.A. and its subsidary, Telemig Celular S.A.
(the "Company") is the primary supplier of cellular telecommunications
services in the state of Minas Gerais under the terms of a concession granted
by the Federal Government on November 4, 1997 (the "Concession"). The
Concession will expire on April 29, 2008 and may be renewed at the discretion
of Anatel (as defined below) for a further term of 15 years. Through its
predecessor Telemig, the Company has provided cellular telecommunications
services in the state since April 1993. Until August 4, 1998, the Company was
controlled by the Federal Government (see Note 23c).
The Company's business, including the service it may provide and the rates
it charges, 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.
2. PRESENTATION OF THE FINANCIAL STATEMENTS
The consolidated financial statements present the financial condition and
revenues and expenses of Telemig Celular Participacoes S.A. and the cellular
telecommunications business of Telemig. The portion of consolidated equity and
income before interest income, unallocated interest expense and taxes
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" in the consolidated financial
statements. At December 31, 1997, such minority shareholders owned 17.1% of
the share capital of Telemig.
The formation of the Holding Company and Telemig Celular S.A. has 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 business of Telemig were transferred to Telemig Celular
S.A. at their indexed historical cost. The revenues and expenses associated
with such assets and liabilities were allocated to Telemig Celular S.A.
Separate records of revenues and costs of services of the cellular
telecommunications business were maintained historically. Accordingly, the
actual amounts were allocated for the periods included
F-7
<PAGE>
TELEMIG CELULAR PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of constant Brazilian Reais of December 31,
1997)
herein. The consolidated statements of revenues and expenses and net
interdivisional cash distribution (receipt) have been prepared to include the
historical activity related to the assets and liabilities transferred. The
consolidated financial statements are not necessarily indicative of what would
have been the financial condition and revenues and expenses of the Company as
of December 31, 1997 and 1996 and for the three year period ended December 31,
1997 had the cellular telecommunications business of Telemig been a separate
legal entity during such period.
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. Those 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 the human resource department), number of
requisitions issued (in relation to office material costs) and miles driven
(in relation to certain transport costs). Management believes that the amounts
included in the statements of revenues and expenses fairly reflect the income
before interest income, unallocated interest expense and taxes of the
business.
Prior to December 31, 1997 cash and certain non-specific debt could not be
segregated from Telemig. Accordingly, these amounts have not been included in
the accompanying consolidated financial statements. Additionally, interest
income and unallocated interest expense relating to the cellular
telecommunications business could not be identified. Consequently, income tax
expense and related liabilities do not appear in the consolidated financial
statements. See Note 2(d) for additional information regarding financial
statement presentation.
The presentation of the consolidated financial statements is consistent with
the presentation of the published financial statements of Telemig, from which
the financial information was extracted, except for certain reclassifications
within the statements of financial condition and the statements of revenues
and expenses which have been made to conform previously published financial
statements to the 1997 presentation within this registration statement and to
an additional provision for doubtful debts of R$14,097 in 1997 and the
recognition in 1995 of R$5,300 of network usage charges which had originally
been recognized in 1996 due to a delay in revenue recognition resulting from a
mathematical error. The additional provision resulted from an evaluation 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. This revealed that there was an extraordinarily high level of
delinquency of the new subscribers who were activated in December, 1997, which
the provision as originally established, based on historical experience, had
been insufficient to cover. The Company will not restate the previously
reported results of Telemig or the initial balance sheet of Telemig Celular
S.A. as the provision for doubtful debts recorded in those December 31, 1997
financial statements was considered adequate in light of the information
available at the date on which they were published.
The 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, which are restated from amounts carved out of the
statutory accounting records of Telemig, 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
F-8
<PAGE>
TELEMIG CELULAR PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of constant Brazilian Reais of December 31,
1997)
Reference Unit or ("UFIR") through to 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>
PERIOD INDEX ANNUAL 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 nonmonetary assets and
liabilities of the Company as of December 31, 1997 will become the new basis
for accounting, and statement of revenue and expense items will no longer be
restated for inflation.
ii. Consolidated Statements of revenues and expenses
Items in the consolidated statements of revenues and expenses are adjusted
by:
. allocating inflationary holding gains or losses on interest bearing
monetary assets and liabilities to their corresponding interest income
and expense captions;
. allocating inflationary holding gains and losses from other monetary
items to their corresponding income or expense captions. Amounts without
a corresponding income or expense caption were allocated to "Other net
operating income."
iii. Deferred income tax effects of indexation adjustments in 1996 and 1997
As a result of legislation mandating the discontinuation of the indexation
system for Brazilian corporate law and most fiscal purposes as from January 1,
1996, the indexation of assets and liabilities for financial 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$9,867 and R$9,738 in 1996 and 1997,
respectively, was recorded directly against divisional equity.
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.
F-9
<PAGE>
TELEMIG CELULAR PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of constant Brazilian Reais of December 31,
1997)
C. DIVISIONAL EQUITY
As discussed in Note 1, the Company was formed as a result of the specific
identification and spin-off of assets, liabilities and revenues and expenses
comprising the cellular telecommunications business of Telemig. Since Telemig
Celular S.A. did not exist prior to January 1, 1998 no individual capital
structure was maintained. Consequently, the net assets contributed have been
shown as "divisional equity" in the accompanying consolidated statements of
financial condition. Additionally, statements of changes in divisional equity
have been provided, which show the changes in the divisional equity for the
periods presented.
D. CONSOLIDATED STATEMENTS OF NET INTERDIVISIONAL CASH DISTRIBUTION (RECEIPT)
Because it was not possible to segregate the cash balances for the cellular
telecommunications business prior to December 31, 1997 a traditional statement
of cash flows could not be prepared for the periods presented. In lieu of
detailing the beginning and ending cash and cash equivalent balances, and the
net change in cash and cash equivalents between years, the net cash
transferred to/from the fixed line telecommunications business of Telemig has
been presented as "Net interdivisional cash distribution (receipt)" in the
statements of net interdivisional cash distribution (receipt).
At December 31, 1997 cash and cash equivalents of R$10,160 were allocated
from Telemig to the Company to meet future estimated working capital
requirements.
E. PRINCIPLES OF CONSOLIDATION
These consolidated financial statements include the financial records of the
Holding Company and its subsidiaries. All material intercompany accounts and
transactions have been eliminated.
3. SUMMARY OF THE PRINCIPAL ACCOUNTING PRACTICES
A. CASH AND CASH EQUIVALENTS
Cash equivalents are considered to be all highly liquid temporary cash
investments with original maturity dates of three months or less.
Any transfers of cash and cash equivalents have been recorded through
divisional equity.
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 statements of financial condition date by applying the interest
rate published by the National Association of Investment Bankers ("ANBID").
Trade accounts receivable also include services provided to customers up to
the statements of financial condition 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
consolidated statements of financial condition date. Exchange differences are
recognized in the statements of revenues and expenses as they occur.
F-10
<PAGE>
TELEMIG CELULAR PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of constant Brazilian Reais of December 31,
1997)
E. 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-progress. Depreciation is provided using the
straight-line method based on the estimated useful lives of the underlying
assets as determined by the public telecommunications service regulators. The
principal depreciation rates are shown in Note 12(b).
Interest, calculated monthly at a rate of 12% per annum on construction-in-
progress, is capitalized as part of property, plant and equipment until the
asset is placed in service.
F. ACCOUNTS PAYABLE
Accounts payable to suppliers are discounted to their present value using
the ANBID interest rate.
G. VACATION PAY ACCRUAL
Cumulative vacation pay due to employees is accrued as earned.
H. INCOME AND SOCIAL CONTRIBUTION TAXES
As described in note 2(a)(iii), the charges relating to deferred income tax
effects of indexation adjustments for 1996 and 1997 are recorded directly
against divisional equity.
I. LOANS AND FINANCING
Loans and financing include accrued interest to the consolidated statements
of financial condition date.
J. 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 statements of financial condition date.
K. REVENUE RECOGNITION
Revenues for all services are recognized when the service is provided.
Revenues from cellular telephone services consist of subscription charges,
usage charges, activation fees, network usage charges and charges for
maintenance and other customer 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. Revenues from
activation fees are recognized upon the activation of a customer's services.
L. 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 of R$0, R$20 and R$47 in
1995, 1996 and 1997, respectively.
The Company had no interest income during 1995, 1996 and 1997 as a result of
cash first being allocated to the Company on December 31, 1997.
M. RESEARCH AND DEVELOPMENT
Research and development costs are charged to expense as incurred. Total
research and development costs were R$1,075, R$1,819 and R$1,980 for 1995,
1996 and 1997, respectively.
F-11
<PAGE>
TELEMIG CELULAR PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of constant Brazilian Reais of December 31,
1997)
N. PENSION AND POST-RETIREMENT BENEFITS
The Company participates in a multi-employer plan that provides pension and
other post-retirement benefits for its employees. Current costs are determined
as the amount of required contribution for the period and are recorded on the
accrual basis.
O. EMPLOYEES' PROFIT SHARE
Accruals are made for granting employees the right to a share of profits.
The amount recorded is the employees' profit share attributable to those
employees in the cellular telecommunications business of Telemig.
P. EARNINGS PER SHARE
Earnings per share information has not been presented as the capital
structure of Telemig Celular Participacoes S.A. was not in place at December
31, 1997.
Q. SEGMENTAL INFORMATION
The Company operates solely in one segment for local and regional cellular
telecommunications. All revenues are generated in relation to services
provided in or routed through the state of Minas Gerais.
R. USE OF ESTIMATES
The preparation of consolidated financial statements in conformity with
Brazilian and US GAAP requires management to make estimates and assumptions
relating to the reporting of assets and liabilities and the disclosure of
contingent assets and liabilities at the date of the financial statements, and
the reported amounts of revenues and expenses during the period reported.
Actual results could differ from those estimates.
S. MINORITY INTERESTS
Minority interests reflected in the consolidated statements of financial
condition at December 31, 1996 and 1997 and in the consolidated statements of
revenues and expenses for the years ended December 31, 1995, 1996 and 1997
relate to the interests of shareholders other than Telebras in Telemig.
4. OPERATING REVENUE FROM CELLULAR TELECOMMUNICATIONS SERVICES
<TABLE>
<CAPTION>
1995 1996 1997
------- ------- -------
<S> <C> <C> <C>
Monthly subscription charges.................... 42,864 86,862 145,576
Activation fees................................. 140 45,068 30,335
Usage charges................................... 65,148 100,630 171,660
Network usage charges........................... 21,044 45,076 101,904
Other........................................... 592 5,089 7,398
------- ------- -------
Total gross operating revenue................... 129,788 282,725 456,873
Value added and other indirect taxes............ (19,147) (43,562) (82,711)
------- ------- -------
Net operating revenue from cellular
telecommunications services.................... 110,641 239,163 374,162
======= ======= =======
</TABLE>
There are, excluding Telemig, no customers who contribute more than 5% of
gross operating revenues.
F-12
<PAGE>
TELEMIG CELULAR PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of constant Brazilian Reais of December 31,
1997)
5. COST OF SERVICES
<TABLE>
<CAPTION>
1995 1996 1997
------ ------ -------
<S> <C> <C> <C>
Depreciation and amortization.......................... 12,503 28,469 48,555
Personnel.............................................. 1,163 1,842 2,959
Materials and services................................. 12,820 19,033 31,496
Fixed-line network expenses ........................... 28,039 31,637 85,329
Leases and insurance................................... 2,636 2,836 6,332
Fiscal and municipal taxes............................. 1,348 2,535 9,025
------ ------ -------
58,509 86,352 183,696
====== ====== =======
</TABLE>
6. OTHER NET OPERATING INCOME (EXPENSE)
<TABLE>
<CAPTION>
1995 1996 1997
------ ------ ------
<S> <C> <C> <C>
Contingencies........................................ - 19 15
Fines and expenses recovered......................... 2,710 5,715 3,803
Gain (losses) on non-monetary items.................. 11,093 8,851 (3,222)
Other................................................ (2,333) (3,039) (679)
------ ------ ------
11,470 11,546 (83)
====== ====== ======
</TABLE>
7. INCOME AND SOCIAL CONTRIBUTION TAXES
Brazilian income taxes comprise federal income tax and the social
contribution tax. In 1995, 1996 and 1997 the statutory 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. The changes produced a combined statutory rate of
48.18%, 30.56% and 33.00% in 1995, 1996 and 1997, respectively.
Income tax and social contribution tax expense have not been included in the
consolidated statements of revenues and expenses as a result of interest
income and unallocated interest expense of the cellular telecommunications
business not being identified and segregated from Telemig, resulting in an
incomplete presentation of income before taxes.
8. CASH FLOW INFORMATION
<TABLE>
<CAPTION>
1995 1996 1997
---- ---- -----
<S> <C> <C> <C>
Interest paid................................................ -- -- 9,402
</TABLE>
9. CASH AND CASH EQUIVALENTS
As of December 31, 1997 the Company was allocated R$10,160 in an interest
bearing deposit with Banco do Brasil S.A., a government-controlled entity.
10. TRADE ACCOUNTS RECEIVABLE, NET
<TABLE>
<CAPTION>
1996 1997
------ -------
<S> <C> <C>
Accrued amounts............................................. 7,964 9,912
Billed amounts.............................................. 31,732 69,828
Allowance for doubtful accounts............................. (6,121) (25,007)
------ -------
33,575 54,733
====== =======
</TABLE>
F-13
<PAGE>
TELEMIG CELULAR PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of constant Brazilian Reais of December 31,
1997)
The changes in the allowance for doubtful accounts were as follows:
<TABLE>
<CAPTION>
1995 1996 1997
----- ----- -------
<S> <C> <C> <C>
Beginning balance....................................... -- 3,273 6,121
Provision charged to selling expense.................... 3,273 2,848 34,862
Write-offs.............................................. -- -- (15,976)
----- ----- -------
Ending balance.......................................... 3,273 6,121 25,007
===== ===== =======
</TABLE>
11. OTHER ASSETS
<TABLE>
<CAPTION>
1996 1997
----- -----
<S> <C> <C>
Prepayments...................................................... 2,562 4,863
Other............................................................ 326 395
----- -----
2,888 5,258
===== =====
Current.......................................................... 885 2,815
Noncurrent....................................................... 2,003 2,443
</TABLE>
Prepayments consist primarily of fees paid on loans which are being amortized
over the term of the loans.
12. PROPERTY, PLANT AND EQUIPMENT, NET
A. COMPOSITION:
<TABLE>
<CAPTION>
1996 1997
------- --------
<S> <C> <C>
Construction-in-progress.................................. 62,439 32,620
Automatic switching equipment............................. 52,510 60,728
Transmission and other equipment.......................... 342,657 430,948
Buildings................................................. 10,211 14,101
Other assets.............................................. 19,866 69,148
------- --------
Total cost................................................ 487,683 607,545
Accumulated depreciation.................................. (52,899) (104,691)
------- --------
Property, plant and equipment, net........................ 434,784 502,854
======= ========
</TABLE>
Within "Other assets" the book value of land is R$99 and R$2,062 as of
December 31, 1996 and 1997, respectively.
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>
F-14
<PAGE>
TELEMIG CELULAR PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of constant Brazilian Reais of December 31,
1997)
C. RENTALS
The Company (directly or through Telemig) rents equipment and premises
through a number of operating agreements that expire at different dates. Total
annual rent expense under these agreements was as follows:
<TABLE>
<CAPTION>
1995 1996 1997
----- ----- -----
<S> <C> <C> <C>
Rent expense............................................... 1,545 2,826 7,216
===== ===== =====
</TABLE>
Rental commitments relate primarily to facilities where the future minimum
rental payments under leases with remaining noncancelable terms in excess of
one year are:
<TABLE>
<S> <C>
Year ending December 31,
1998................................................................ 7,102
1999................................................................ 7,244
2000................................................................ 7,394
2001................................................................ 7,551
2002 and after...................................................... 7,551
------
Total minimum payments.............................................. 36,842
======
</TABLE>
13. PAYROLL AND RELATED ACCRUALS
<TABLE>
<CAPTION>
1996 1997
----- -----
<S> <C> <C>
Wages and salaries............................................... 155 --
Accrued social security charges.................................. 1,166 1,585
Accrued benefits................................................. 166 --
----- -----
1,487 1,585
===== =====
</TABLE>
14. ACCOUNTS PAYABLE AND ACCRUED EXPENSES
<TABLE>
<CAPTION>
1996 1997
------ ------
<S> <C> <C>
Amounts payable to suppliers................................... 10,543 17,080
Payable to related parties..................................... 2,439 4,441
------ ------
12,982 21,521
====== ======
15. TAXES OTHER THAN INCOME TAXES
<CAPTION>
1996 1997
------ ------
<S> <C> <C>
Value-added taxes.............................................. 4,624 --
Other indirect taxes on operating revenues..................... 926 --
------ ------
5,550 --
====== ======
</TABLE>
All taxes payable at December 31, 1997, which are related to revenues (ICMS,
PASEP, COFINS) remained with Telemig when the assets and liabilities of the
cellular telecommunications business were transferred to Telemig Celular S.A.
because Telemig has legal responsibility for their payment.
F-15
<PAGE>
TELEMIG CELULAR PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of constant Brazilian Reais of December 31,
1997)
16. LOANS AND FINANCING
<TABLE>
<CAPTION>
1996 1997
------- -------
<S> <C> <C>
Loans payable to Telebras.................................. 133,332 91,619
Third parties.............................................. -- 23,724
Accrued interest........................................... 999 1,762
------- -------
134,331 117,105
======= =======
Current.................................................... 38,513 41,033
Noncurrent................................................. 95,818 76,072
A. LOANS PAYABLE TO TELEBRAS
<CAPTION>
1996 1997
------- -------
<S> <C> <C>
Export Development Corporation ("EDC") loans originally
issued by Telebras........................................ 42,915 35,477
Loans and financing by Telebras............................ 91,416 57,508
------- -------
134,331 92,985
======= =======
</TABLE>
The EDC loans are denominated in US dollars, bear interest at a rate of
LIBOR + 1%, payable semi-annually. The LIBOR rate was 5.85% at December 31,
1997. These bonds are due in installments through December 15, 2002. Effective
February 28, 1998, these loans were transferred from Telebras to Tele Norte
Leste Participacoes S.A.; accordingly, Telemig's obligation is to Tele Norte
Leste Participacoes S.A.
The loans and financing from Telebras are denominated in Brazilian Reais,
bear interest at the IGP-M rate plus 1% per month and are due in installments
through December 30, 1999. Effective February 28, 1998 these loans were
transferred from Telebras to Telemig Celular Participacoes S.A. See Note 23.
B. THIRD PARTIES
<TABLE>
<CAPTION>
1996 1997
---- ------
<S> <C> <C>
Other financing.................................................. -- 24,120
=== ======
</TABLE>
This loan is denominated in US dollars, bears interest at a rate of LIBOR +
1% annually and is due on October 15, 2002.
C. REPAYMENT SCHEDULE
Noncurrent loans are scheduled to be repaid as follows:
<TABLE>
<S> <C>
1999.................................. 39,047
2000.................................. 11,024
2001.................................. 11,024
2002.................................. 11,024
2003.................................. 3,953
------
Total................................. 76,072
======
</TABLE>
F-16
<PAGE>
TELEMIG CELULAR PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of constant Brazilian Reais of December 31,
1997)
D. CURRENCY ANALYSIS
Total debt is outstanding 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 91,366 57,508
US dollars 1.1164 42,965 59,597
------- -------
134,331 117,105
======= =======
</TABLE>
The Company does not hedge its foreign currency liabilities.
17. PROVISIONS FOR CONTINGENCIES
Provisions for contingent liabilities were as follows:
<TABLE>
<CAPTION>
1996 1997
---- ----
<S> <C> <C>
Labor claims....................................................... 208 193
=== ===
</TABLE>
Labor claims
The provision for labor claims is management's estimate of the most probable
loss in relation to various suits filed by current and former employees.
Potential litigation
Telebras and Telemig, the legal predecessors of the Holding Company and
Telemig Celular S.A., respectively, are defendants in a number of legal
proceedings and subject to certain other claims and contingencies. Liability
for any claims arising out of acts committed by Telemig prior to the effective
date of the spin-off of Telemig's cellular assets and liabilities to Telemig
Celular S.A. remains with Telemig, except for those liabilities for which
specific accounting provisions have been assigned to Telemig Celular S.A. Any
claims against Telemig which are not met by Telemig could result in claims
against Telemig Celular S.A. to the extent that Telemig Celular S.A. has
received assets which might have been used to settle those claims had they not
been spun off from Telemig. Under the terms of the breakup of Telebras,
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 (in which case Telebras and the Holding Company are jointly and
severally liable) and any liability for which specific accounting provisions
have been assigned to the Holding Company. Creditors of Telebras may challenge
this allocation of liability. Management believes that the chances of any
claims materializing and having a material adverse financial effect on the
Company and/or the Holding Company are remote and, therefore, no provision was
made.
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
F-17
<PAGE>
TELEMIG CELULAR PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of constant Brazilian Reais of December 31,
1997)
retroactively. In addition, the Company believes that the predecessor company,
Telemig, the legal predecessor of the Company, would be liable for any
payments made in connection with any claim arising out of the retroactive
application of the ICMS tax on activation fees for periods prior to 1998. 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 to activation fees earned during the past
five years, it would give rise to a maximum liability estimated at R$37,000.
If the ICMS tax were applied retroactively to activation fees earned by the
Company's subsidiaries since inception on January 5, 1998, it could have a
material negative impact on the financial condition and results of operations
of the Company subsequent to January 5, 1998.
18. PROVISION FOR PENSIONS
The Company participates in a multi-employer defined benefit pension plan
and other post-retirement benefit plans administered by the Fundacao Telebras
de Seguridade Social ("Sistel").
Approximately 96% of the Company's employees are covered by these plans. The
Company contributed and charged to expense R$170, R$570 and R$919 during 1995,
1996 and 1997, respectively, in respect of pension fund contributions.
Information from the plans' administrators is not available to permit the
Company to determine its 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 the multi-employer plans, the Company's
contributions are not segregated in separate accounts or restricted to provide
benefits only to employees of the Company. The Company is also contingently
liable for the total obligations of the plans.
The 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-18
<PAGE>
TELEMIG CELULAR PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of constant Brazilian Reais of December 31,
1997)
19. TRANSACTIONS WITH RELATED PARTIES
The principal related party transactions take place with Empresa Brasileira
de Telecomunicacoes S.A. ("Embratel"), a subsidiary of Telebras, in respect of
long-distance cellular telecommunications and with Telemig with respect to use
of its communications network.
The Company has an operating agreement with Embratel, which defines usage
charge fees 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 Company by the Federal
Government.
An interconnection agreement with Telemig defines the network charges when
cellular telecommunications takes place using Telemig equipment.
Agreements for automatic roaming have been entered into with the seven other
Band A operators in Brazil belonging to the Telebras group.
The Company is responsible for billing cellular subscribers for long-
distance calls and collecting payments owed to other cellular and fixed-line
carriers. The collection of outgoing calls is the responsibility of the
Company and the collection of incoming calls is the responsibility of the
originating telephone company. After the collection cycle is complete, the
Company and the regional fixed-line and cellular companies jointly reconcile
the amounts collected against the amounts, if any, transferred to each party,
and pay the net amounts outstanding to the appropriate parties, including the
long-distance portion of the charges to Embratel.
Until the breakup of Telebras, Telemig and the other companies of the
Telebras System each contributed to the research and development center
operated by Telebras (Centro de Pesquisa e Desenvolvimento da Telebras).
Following the breakup of Telebras, the research and development center will
become a private, independently administered foundation financed by
contributions from the New Holding Companies resulting from the breakup.
Pursuant to a three year contract signed in May 1998 between the foundation
and the Company, the Company is obligated to contribute a maximum of R$1,200
to the research and development center during the three years ending May 2001.
The actual amount spent in a given year may be adjusted downward at the option
of the foundation.
Additionally, Telebras charges a 1% per annum administration fee on the
allocation to the Company of debt originally contracted by Telebras. Telebras
has also charged interest on the loan of its own funds at a rate which is
currently 1% plus the indexation of the principal in accordance with the
variation of the IGP-M inflation index.
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................................... 547 1,016
Current liabilities:
Loans and financing......................................... 38,513 28,674
Accounts payable and accrued expenses....................... 2,439 4,441
Non current liabilities:
Loans and financing......................................... 95,818 64,311
</TABLE>
<TABLE>
<CAPTION>
1995 1996 1997
------ ------ -------
<S> <C> <C> <C>
Net operating revenue from cellular
telecommunications services ....................... 21,044 47,918 105,026
Cost of services.................................... 41,654 50,273 118,805
Operating expenses.................................. 8,959 14,766 22,220
Interest expense.................................... -- 413 10,193
</TABLE>
F-19
<PAGE>
TELEMIG CELULAR PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of constant Brazilian Reais of December 31,
1997)
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 users were
not maintained by the Company.
The Company believes that, except for interest income, unallocated interest
expense and taxes, all the costs of doing business are reflected in the
consolidated financial statements and that no additional amounts should be
added to the consolidated financial statements as a result of the cessation of
the activities previously performed by Telebras.
20. COMMITMENTS
At December 31, 1997 the Company approximately had the following capital
expenditure commitments:
<TABLE>
<CAPTION>
EXPECTED YEAR OF EXPENDITURE
----------------------------
<S> <C>
1998.............................................................. 178,080
</TABLE>
These commitments relate to the continuing expansion and modernization of
the cellular system, information technology, transmission equipment and the
messaging system.
21. INSURANCE
At December 31, 1997, in the opinion of management, all significant and high
risk assets and obligations were insured.
22. FAIR VALUES OF FINANCIAL ASSETS AND LIABILITIES
Estimated fair values of the Company's 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>
Deferred tax liabilities from indexation
adjustments.................................. 9,867 7,372 19,605 16,855
Loans and financing:
Financing................................... -- -- 23,724 24,260
Loans....................................... 91,416 90,513 57,508 55,397
Other debt.................................. 42,915 42,376 35,873 34,871
</TABLE>
Cash, cash equivalents, trade accounts receivable, other current assets,
accounts payable and accrued expenses
The carrying value of cash, cash equivalents, trade accounts receivable,
other current assets, accounts payable and accrued expenses are a reasonable
estimate of their fair value. Cash equivalents are represented
F-20
<PAGE>
TELEMIG CELULAR PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of constant Brazilian Reais of December 31,
1997)
principally by short-term investments, their fair values, and that of other
short-term investments and bank deposits not meeting the definition of cash
equivalents, were estimated using rates currently offered for deposits of
similar maturities.
Loans and financing
Interest rates that are currently available to the Company for issuance of
debt with similar terms and maturities were used to estimate fair value.
23. EVENTS SUBSEQUENT TO DECEMBER 31, 1997
A. INCORPORATION OF TELEMIG CELULAR S.A.
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 cellular telecommunications services.
On January 30, 1998, as part of a spin-off of cellular telecommunications
business by all of Telebras' subsidiaries, Telemig spun off the assets and
liabilities as of January 1, 1998 of its cellular telecommunications business
into a separate company. This new company, called "Telemig Celular S.A.", was
incorporated on January 5, 1998.
B. INCORPORATION OF TELEMIG CELULAR PARTICIPACOES S.A.
On May 22, 1998 the shareholders of Telebras approved Telebras' division
into the New Holding Companies using a procedure under Brazilian corporate law
called a cisao, whereby existing shareholders received shares in the New
Holding Companies in proportion to their holdings in Telebras. The New Holding
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 Telemig Celular 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.The assets which were spun-off from
Telebras, in addition to its investment in the operating subsidiary, resulted
in an increase of R$73,240 in relation to the Company's historical divisional
equity. 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 Company, and the "Holding Company
Consolidated Statement" column summarizes the consolidated balance sheet of
Telemig Celular Participacoes S.A. after the spin-off.
F-21
<PAGE>
TELEMIG CELULAR PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of constant Brazilian Reais of December 31,
1997)
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, Telemig Celular 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$419,673 includes retained earnings of R$124,318. The allocated
retained earnings and future retained earnings will be the basis from which
future dividends will be payable.
The "Adjustments and Eliminations" column includes (i) the elimination of
the Telebras investment in the Company and (ii) the elimination of inter
company loans, payables and receivables.
<TABLE>
<CAPTION>
DECEMBER 31, HOLDING
1997 SPIN-OFF ADJUSTMENTS COMPANY
HISTORICAL FROM AND CONSOLIDATED
BALANCES TELEBRAS ELIMINATIONS STATEMENT
------------ -------- ------------ ------------
<S> <C> <C> <C> <C>
Assets
Cash and cash equivalents.... 10,160 16,478 -- 26,638
Intercompany receivables..... -- 56,557 (56,557) --
Accounts receivable from
related parties.............. 1,016 -- -- 1,016
Other current assets......... 61,212 -- -- 61,212
------- ------- -------- -------
Total current assets......... 72,388 73,035 (56,557) 88,866
Intercompany receivables..... -- 272 (272) --
Other noncurrent assets...... 2,443 -- -- 2,443
Investment in subsidiary..... -- 346,433 (346,433) --
Property, plant and
equipment, net............... 502,854 -- -- 502,854
------- ------- -------- -------
Total permanent assets....... 502,854 346,433 (346,433) 502,854
------- ------- -------- -------
Total assets................. 577,685 419,740 (403,262) 594,163
======= ======= ======== =======
Liabilities:
Accounts payable to related
parties...................... 4,441 -- (4,352) 89
Loans and financing payable
to Telebras.................. 28,674 -- (28,674) --
Loans and financing payable
to third parties............. 12,359 -- -- 12,359
Other current liabilities.... 20,300 -- -- 20,300
------- ------- -------- -------
Total current liabilities.... 65,774 -- (33,026) 32,748
------- ------- -------- -------
Loans and financing payable
to Telebras.................. 64,311 -- (23,803) 40,508
Other........................ 29,924 -- -- 29,924
------- ------- -------- -------
Total noncurrent
liabilities.................. 94,235 -- (23,803) 70,432
Minority interests........... 71,243 -- -- 71,243
Divisional equity............ 346,433 -- (346,433) --
Share capital................ -- 155,552 -- 155,552
Income reserves.............. -- 139,803 -- 139,803
Retained earnings............ -- 124,318 -- 124,318
------- ------- -------- -------
Total shareholders' equity... 346,433 419,673 (346,433) 419,673
------- ------- -------- -------
Funds for capitalization..... -- 67 -- 67
------- ------- -------- -------
Total liabilities and
shareholders' equity......... 577,685 419,740 (403,262) 594,163
======= ======= ======== =======
</TABLE>
The formation of the Holding Company and of Telemig Celular S.A. has been
accounted for as a reorganization of entities under common control in a manner
similar to a pooling of interests. Brazilian corporate and tax law allows
state controlled companies that are participating in the government's
privatization program a three month delay between the accounting base date for
a spin-off and the date on which the shareholders' meeting approves the spin-
off, including the related accounting basis for the net assets spun off.
Furthermore, as allowed by Brazilian corporate law, the amounts shown in the
"Spin-off from Telebras" column as "Investment in subsidiary" was determined
based on the balance sheet of its subsidiary as of December 31, 1997. As a
result, the consolidated financial statements of the Holding Company will
include the results of operations and changes
F-22
<PAGE>
TELEMIG CELULAR PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of constant Brazilian Reais of December 31,
1997)
in financial condition of the subsidiaries from January 1, 1998 and the
effects of the cash and other assets (principally intercompany receivables)
allocated from Telebras as of March 1, 1998.
Capital
The capital stock of Telemig Celular Participacoes S.A. 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 Telemig Celular Participacoes
S.A.
Under the Brazilian Corporation Law, the number of non-voting shares or
shares with limited voting rights, such as the preferred shares, may not
exceed two-thirds of the total number of shares.
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, Telemig Celular Participacoes S.A. 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 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 the purposes of the Brazilian Corporation Law, and in accordance with
Telemig Celular Participacoes S.A.'s by-laws, the "Adjusted Net Income" is an
amount equal to Telemig Celular 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.
C. 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
F-23
<PAGE>
TELEMIG CELULAR PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of constant Brazilian Reais of December 31,
1997)
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.
24. SUMMARY OF THE DIFFERENCES BETWEEN BRAZILIAN AND US GAAP
The Company's 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 AMORTIZING 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.
Under US GAAP, in accordance with the provisions of Statement of Financial
Accounting Standards ("SFAS") No. 34 "Capitalization of Interest Costs,"
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 effects of these different criteria for capitalizing and amortizing
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
(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).................................. 2,881 1,355
------- ------
Less Brazilian GAAP capitalized interest:
Interest capitalized and credited to income
(Up to the limit of interest incurred on loans obtained
for financing capital investments)........................ (931) (1,183)
Interest capitalized and credited to reserves............. (9,100) (3,909)
------- ------
(10,031) (5,092)
------- ------
US GAAP Difference........................................ (7,150) (3,737)
======= ======
Amortization of capitalized interest difference
Amortization under Brazilian GAAP......................... 2,313 3,246
Less amortization under US GAAP........................... -- (240)
------- ------
US GAAP Difference........................................ 2,313 3,006
======= ======
</TABLE>
F-24
<PAGE>
TELEMIG CELULAR PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of constant Brazilian Reais of December 31,
1997)
B. PENSION AND OTHER POST-RETIREMENT BENEFITS
The Company participates in a multi-employer benefit plan that is operated
and administered by Sistel and provides for the costs of pension and other
post-retirement benefits based on a fixed percentage of remuneration, as
recommended annually by independent actuaries. Note 25 shows the funded status
of Sistel. The provisions of SFAS No. 87, "Employers' Accounting for
Pensions," for the purposes of calculating the funded status, were applied
with effect from January 1, 1992, because it was not feasible to apply them
from the effective date in the standard.
C. DISCLOSURE REQUIREMENTS
US GAAP disclosure requirements differ from those required by Brazilian
GAAP. However, in these consolidated financial statements, the level of
disclosure has been expanded to comply with US GAAP.
D. INTEREST EXPENSE
Brazilian GAAP requires interest to be shown as part of operating income.
Under US GAAP interest expense would be shown after operating income and
accrued interest would be included in accounts payable and accrued expenses.
E. 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 would be included as an expense in arriving at operating income.
F. 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.
G. 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 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.
H. ITEMS POSTED DIRECTLY TO DIVISIONAL EQUITY
Under Brazilian GAAP various items are posted directly to divisional equity,
which under US GAAP would be posted to the statements of revenues and
expenses. An example is capitalized interest. The posting of such items to
divisional equity gives rise to adjustments in the consolidated statements of
changes in divisional equity. Since the original postings to the equity
accounts would, under US GAAP, be made directly to the consolidated statements
of revenues and expenses, the adjustment is included in the reconciliation of
the income differences between US and Brazilian GAAP.
F-25
<PAGE>
TELEMIG CELULAR PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of constant Brazilian Reais of December 31,
1997)
I. INCOME TAXES
The Company has not presented income taxes since the consolidated financial
statements do not include interest income and unallocated interest expense as
a result of nonspecific cash and debt not being allocated from Telemig.
However, for Brazilian GAAP, the deferred tax charges relating to the deferred
income tax effects of indexation adjustments for 1996 and 1997, as described
in note 2(a)(iii), are recorded directly against divisional equity.
J. EARNINGS PER SHARE
Earnings per share has not been presented for Brazilian GAAP, as the capital
structure of the Holding Company was not in place at December 31, 1997.
Earnings per share has not been presented for US GAAP as the consolidated
statement of revenues and expenses excludes interest income, unallocated
interest expense and taxes, as a result of nonspecific cash and debt not being
allocated from Telemig.
K. DEFERRED TAXES
The deferred income tax liability arising out of the indexation of permanent
assets of R$9,867 in 1996 and R$9,738 in 1997 was charged directly to
divisional equity in accordance with Brazilian GAAP, whereas for US GAAP the
charge would be to income for the year. This adjustment has not been reflected
in US GAAP income as noted in note 24(i). Additionally the deferred taxes
effects of the US GAAP adjustments of R$683 and R$(550) in 1996 and 1997,
respectively, are not included in the reconciliation of income differences
between US and Brazilian GAAP.
L. VALUATION OF LONG-LIVED ASSETS
For US GAAP, effective January 1, 1996 the Company adopted SFAS No. 121
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets
to Be Disposed Of." In accordance with this standard, the Company periodically
evaluates the carrying value of long-lived assets to be held and used, when
events and circumstances warrant such a review. The carrying value of long-
lived assets is considered impaired when the anticipated undiscounted cash
flow from such assets is separately identifiable and is less than their
carrying value. In that event, a loss is recognized based on the amount by
which the carrying value exceeds the 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.
Brazilian GAAP does not require cash flow computations in order to determine
potential asset impairment.
M. RETAINED EARNINGS
For Brazilian GAAP, a company formed as a result of a cisao may have
retained earnings in its balance sheet if the parent company shareholders'
resolution adopting the cisao allocates retained earnings from the parent
company to the new company. Under U.S. GAAP, "retained earnings" allocated in
the cisao would not be considered historical retained earnings as such amount
would represent capital allocated from the parent company and would be
described as "distributable capital." As a result of the May 22, 1998 spin-
off, the Company will have U.S. GAAP distributable capital of R$124,318.
N. REVENUE RECOGNITION
Until December 31, 1997, under both Brazilian and U.S. GAAP, revenues from
activation fees were recognized upon activation of a customer's services.
Under US GAAP, effective January 1, 1998, net revenues from activation fees
will be deferred and amortized over 12 months, the estimated effective
contract life.
F-26
<PAGE>
TELEMIG CELULAR PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of constant Brazilian Reais of December 31,
1997)
RECONCILIATION OF THE INCOME DIFFERENCES BETWEEN US AND BRAZILIAN GAAP
<TABLE>
<CAPTION>
1996 1997
------- ------
<S> <C> <C>
Income before interest income, unallocated interest expense
and taxes as reported....................................... 109,502 78,863
Add (deduct):
Different criteria for:
Capitalized interest....................................... (7,150) (3,737)
Amortization of capitalized interest....................... 2,313 3,006
Capitalized interest on construction-in-progress posted
directly to equity........................................ 9,100 3,909
Minority interest in the above adjustments................. (684) (577)
------- ------
US GAAP income before interest income, unallocated interest
expense and taxes........................................... 113,081 81,464
======= ======
</TABLE>
RECONCILIATION OF THE DIVISIONAL EQUITY DIFFERENCES BETWEEN US AND BRAZILIAN
GAAP
<TABLE>
<CAPTION>
1996 1997
------- -------
<S> <C> <C>
Total divisional equity as reported........................... 257,857 346,433
Add (deduct):
Different criteria for:
Capitalized interest...................................... (35,781) (39,518)
Amortization of capitalized interest...................... 4,196 7,202
Minority interests in the above adjustments................. 3,393 3,693
Deferred tax effects of the above adjustments............... 10,423 10,664
------- -------
US GAAP divisional equity..................................... 240,088 328,474
======= =======
US GAAP supplementary information:
Total assets ............................................... 450,632 556,033
======= =======
Property, plant and equipment............................... 451,902 568,027
Accumulated depreciation.................................... (48,703) (97,489)
------- -------
Net property, plant and equipment........................... 403,199 470,538
======= =======
</TABLE>
STATEMENTS OF CHANGES IN DIVISIONAL EQUITY IN ACCORDANCE WITH US GAAP
<TABLE>
<S> <C> <C>
Balance at December 31, 1995..................................... 159,951
Income before interest income, unallocated interest expense and
taxes........................................................... 113,081
Net interdivisional cash distribution............................ (30,810)
Deferred tax on indexation of permanent assets................... (9,867)
Deferred tax on other US GAAP adjustments........................ 2,249
Minority interest effects other than on income before taxes...... 5,484
-------
Balance at December 31, 1996..................................... 240,088
Income before interest income, unallocated expense and taxes for
the year........................................................ 81,464
Net interdivisional cash receipt................................. 21,958
Deferred tax on indexation of permanent assets................... (9,738)
Deferred tax on other US GAAP adjustments........................ 241
Minority interest effects other than on income before taxes...... (5,539)
-------
Balance at December 31, 1997..................................... 328,474
=======
</TABLE>
F-27
<PAGE>
TELEMIG CELULAR PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of constant Brazilian Reais of December 31,
1997)
25. ADDITIONAL DISCLOSURES REQUIRED BY US GAAP
A. PENSION AND OTHER POST-RETIREMENT BENEFITS
The Company, together with substantially all of the other companies in the
Telebras group, participates in a 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:
Pension benefit plan
<TABLE>
<CAPTION>
1996 1997
---------- ----------
<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%
The above are real rates and exclude inflation.
Amortization of the unrecognized liability at transition: 18.94 years
commencing on January 1, 1991.
Other post-retirement benefits plan
<CAPTION>
1996 1997
---------- ----------
<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)
---------- ----------
Obligation in excess of plan assets.............. 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 fund liability calculations.
F-28
<PAGE>
TELEMIG CELULAR PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of constant Brazilian Reais of December 31,
1997)
The funded status of the pension and post retirement plans under Brazilian
and US GAAP differ. Benefit obligations differ because they have been prepared
using different actuarial assumptions permitted under Brazilian and US GAAP.
The net assets of the plans differ under Brazilian and US GAAP principally
due to the accrual of income tax contingencies of the pension fund for US GAAP
purposes in the amount of R$400,370 and R$487,269 in 1996 and 1997,
respectively. The contingency arises out of uncertainty as to the income tax
status of Brazilian pension funds in general because the tax law is unclear as
to whether these funds are exempt from tax on their investment gains. Under
Brazilian GAAP two methods of accounting for the income tax contingency are
currently permitted. The tax is either deducted from plan assets for the
purposes of determining the funded status of the plan or it is not deducted
but is disclosed in a note as being a contingency. Management of the pension
fund have determined that the Brazilian GAAP financial statements of the fund
be prepared on the basis that the legal arguments against assessment of the
tax on the investment gains are sufficiently strong as to avoid the need for
the potential liability to be recognized. However, for US GAAP purposes,
management of the Company believe that the assessment of this potential income
tax liability is probable. Accordingly, in determining the funded status for
US GAAP purposes, the potential income tax liability (calculated in accordance
with SFAS 109) has been deducted from the fair value of the plan assets.
B. CONCENTRATION OF RISKS
The Company is 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 trade accounts receivable is diversified. The
Company continually monitors the level of trade accounts receivable and limits
the exposure to bad debts by cutting access to the telephone network if any
invoice is twenty days past due. Exceptions comprise telephone services that
must be maintained for reasons of safety or national security.
In conducting its business, Telemig Celular S.A. is fully dependent upon the
cellular telecommunications concession as granted by the Federal Government.
Approximately 68% of all employees are members of state labor unions
associated with either the Federacao Nacional dos Trabalhadores em
Telecomunicacoes ("Fenattel"), or with the Federacao Interestadual dos
Trabalhadores em Telecomunicacoes ("Fittel"). The Company negotiates a new
collective labor agreement every year with the local union. The collective
agreement currently in force expires 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 Company's 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
F-29
<PAGE>
TELEMIG CELULAR PARTICIPACOES S.A.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Amounts expressed in thousands of constant Brazilian Reais of December 31,
1997)
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 holds assets, and major
customers.
SFAS NO. 132, "EMPLOYERS' DISCLOSURES ABOUT PENSIONS AND OTHER POSTRETIREMENT
BENEFITS"
SFAS No. 132 revises and standardizes employers' disclosures about pension
and other postretirement 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-30
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT AUDITORS
The Board of Directors
Telemig Celular Participacoes S.A.
We hereby consent to the use of our report included herein.
/s/ KPMG Peat Marwick
Brasilia, Brazil
October 29, 1998
