As filed with the Securities and Exchange Commission on June 30, 1999
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SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
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FORM 20-F
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
Commission file number: 001-14479
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TELE NORTE CELULAR PARTICIPACOES S.A.
(Exact Name of Registrant as Specified in Its Charter)
<TABLE>
<S> <C>
Tele Norte Cellular Holding Company The Federative Republic of Brazil
(Translation of Registrant's Name into English) (Jurisdiction of Incorporation or Organization)
</TABLE>
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SCN, Quadra 3, Bloco A, Sobreloja
70713-000 Brasilia, DF, Brazil
(Address of Principal Executive Offices)
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Securities registered or to be registered pursuant to Section
12(b) of the Act:
<TABLE>
Title of Each Class Name of Each Exchange On Which Registered
------------------- -----------------------------------------
<S> <C>
Preferred Shares, without par value* New York Stock Exchange
American Depositary Shares, each New York Stock Exchange
representing 50,000 Preferred Shares
</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 period covered by this Annual
Report:
124,369,030,532 Common Shares, without par value
210,029,997,060 Preferred Shares, without par value
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days.
Yes _X_ No ___
Indicate by check mark which financial statement item the Registrant
has elected to follow.
Item 17 ___ Item 18 _X_
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<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
PART I
<S> <C>
Item 1. Description of Business................................................................................1
Item 2. Description of Property...............................................................................18
Item 3. Legal Proceedings.....................................................................................18
Item 4. Control of Registrant.................................................................................20
Item 5. Nature of Trading Market..............................................................................21
Item 6. Exchange Controls and Other Limitations Affecting Security Holders....................................23
Item 7. Taxation..............................................................................................24
Item 8. Selected Financial Data...............................................................................29
Item 9. Management's Discussion and Analysis of Financial Condition and Results of Operations.................31
Item 9A. Quantitative and Qualitative Disclosures About Market Risk............................................38
Item 10. Directors and Officers of Registrant..................................................................39
Item 11. Compensation of Directors and Officers................................................................42
Item 12. Options to Purchase Securities from Registrant or Subsidiaries........................................42
Item 13. Interest of Management in Certain Transactions........................................................42
PART II
Item 14. Description of Securities to be Registered............................................................42
PART III
Item 15. Defaults upon Senior Securities.......................................................................42
Item 16. Changes in Securities, Changes in Security for Registered Securities and Use of Proceeds..............43
PART IV
Item 17. Financial Statements..................................................................................43
Item 18. Financial Statements..................................................................................43
Item 19. Financial Statements and Exhibits.....................................................................43
Index of Defined Terms.........................................................................................44
Technical Glossary.............................................................................................45
</TABLE>
<PAGE>
Tele Norte Celular Participacoes S.A. ("Tele Norte Celular"), a corporation
organized under the laws of the Federative Republic of Brazil ("Brazil"), is
referred to in this Annual Report as the "Registrant." Its subsidiaries are
referred to as the "Subsidiaries." The Registrant and the Subsidiaries are
referred to collectively as the "Company." The Registrant is one of the
companies formed as a result of the breakup of Telecomunicacoes Brasileiras S.A.
- - Telebras ("Telebras") by Brazil's federal government (the "Federal
Government") in May 1998. Each of the Subsidiaries was formed in January 1998 by
spinning off the cellular telecommunications operations of an operating company
controlled by Telebras (collectively, the "Predecessor Companies"). References
to the operations of the Company, prior to January 1998, are to the cellular
operations of the Predecessor Companies. See "Description of
Business - Historical Background."
References in this Annual Report to "Preferred Shares" and "Common Shares"
are to the preferred shares and common shares, respectively, of the Registrant.
References to "American Depositary Shares" or "ADSs" are to American Depositary
Shares, each representing 50,000 Preferred Shares. The ADSs are evidenced by
American Depositary Receipts ("ADRs").
References in this Annual Report to (i) the "real," "reais" or "R$" are to
Brazilian reais (plural) and to the Brazilian real (singular), the currency of
Brazil and (ii) "U.S. dollars," "dollars" or "US$" are to United States dollars.
The consolidated financial statements of the Company as of December 31,
1997 and 1998 and for the years ended December 31, 1996, 1997 and 1998 (the
"Consolidated Financial Statements") have been prepared in accordance with
generally accepted accounting principles in the United States ("U.S. GAAP"). The
Consolidated Financial Statements and other financial information as of and for
the year ended December 31, 1998 are presented in nominal reais and do not
recognize the effects of inflation. The Consolidated Financial Statements and
other financial information for prior dates and periods have been indexed and
expressed in constant reais of December 31, 1997 purchasing power using the
integral restatement method (correcao monetaria integral). Consolidated
financial statements prepared in accordance with generally accepted accounting
principles in Brazil ("Brazilian GAAP") have been published in Brazil.
This Annual Report contains forward-looking statements. The Company and its
representatives may also make forward-looking statements in press releases and
oral statements. Statements that are not statements of historical fact,
including statements about the beliefs and expectations of the Company's
management, are forward-looking statements. The words "anticipates," "believes,"
"estimates," "expects," "forecasts," "intends," "plans," "predicts," "projects"
and "targets" and similar words are intended to identify these statements, which
necessarily involve known and unknown risks and uncertainties. Known risks and
uncertainties, some of which are discussed at pages 15-18 herein, include those
resulting from the short history of the Company as an independent,
private-sector entity and the introduction of competition to the Brazilian
telecommunications sector, as well as those relating to the cost and
availability of financing, the performance of the Brazilian economy generally,
the levels of exchange rates between Brazilian and foreign currencies and the
Federal Government's telecommunications policy. Accordingly, the actual results
of operations of the Company may be different from the Company's current
expectations, and the reader should not place undue reliance on these
forward-looking statements. Forward-looking statements speak only as of the date
they are made, and the Company does not undertake any obligation to update them
in light of new information or future developments.
Certain terms are defined the first time they are used in this Annual
Report. The "Index of Defined Terms" that begins on page 44 lists those terms
and where they are defined. The "Technical Glossary" that begins on page 45
provides definitions of certain technical terms used herein.
<PAGE>
PART I
Item 1. Description of Business
The Company provides cellular telecommunications services in the Brazilian
States of Para, Amazonas, Maranhao, Amapa, and Roraima (the "Region") under
concessions from the Federal Government (the "Concessions"). Cellular
telecommunications services were first offered by one of the Predecessor
Companies in the State of Maranhao in April 1994, and the Company is the only
provider of cellular telecommunications services in the Region. At December 31,
1998, the Company had approximately 218,600 subscribers.
The Registrant and its Operating Subsidiaries
The following table sets forth the contribution made by each Subsidiary to
the Company's net operating revenues and net income for the year ending December
31, 1998 and the Registrant's ownership in each Subsidiary at December 31, 1998.
<TABLE>
<CAPTION>
Contribution to consolidated results Registrant's ownership
------------------------------------ ------------------------------
% of net operat- % of net % of share % of voting
Subsidiary ing revenues income capital stock
- ---------- ----------------- -------- ---------- -----------
<S> <C> <C> <C> <C>
Telepara Celular S.A............... 36.5 25.0 69.04 96.58
Telamazon Celular S.A.............. 36.3 36.0 80.26 84.13
Telma Celular S.A.................. 18.2 24.7 66.79 82.79
Teleamapa Celular S.A.............. 5.3 8.3 90.64 94.45
Telaima Celular S.A................ 3.7 6.0 86.91 95.08
</TABLE>
Substantially all of the Registrant's assets other than cash consist of
shares in the Subsidiaries. The Registrant relies almost exclusively on
dividends from the Subsidiaries to meet its needs for cash, including cash to
pay dividends to its shareholders. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Liquidity and Capital Resources."
The Registrant's headquarters are located at SCN, Quadra 3, Bloco A,
Sobreloja, 70713-000 Brasilia-DF, Brazil, and its telephone number is
5561-429-5600.
Historical Background
Prior to the incorporation of Telebras in 1972, there were more than 900
telecommunications companies operating throughout Brazil. Between 1972 and 1975,
Telebras and its operating subsidiaries (collectively, the "Telebras System")
acquired almost all the other telephone companies in Brazil and thus came to
have a monopoly over the provision of public telecommunications services in
almost all areas of the country. Beginning in 1995, the Federal Government
undertook a comprehensive reform of Brazil's telecommunications regulatory
system. In July 1997, Brazil's National Congress adopted the Lei Geral de
Telecomunicacoes (the "General Telecommunications Law," and together with the
regulations, decrees, orders and plans on telecommunications issued by Brazil's
Executive Branch, the "Telecommunications Regulations"), which provided for the
establishment of a new regulatory framework, the introduction of competition and
the privatization of Telebras. The General Telecommunications Law established an
independent regulatory agency called Agencia Nacional de Telecomunicacoes-
ANATEL ("Anatel").
In January 1998, in preparation for the restructuring and privatization of
the Telebras System, the cellular telecommunications operations of Telebras'
operating subsidiaries were spun off into separate companies. In May 1998,
Telebras was restructured to form, in addition to Telebras, 12 new holding
companies (the "New Holding Companies") by means of a procedure under Brazilian
corporate law called cisao, or split-up. Virtually all the assets and
liabilities of Telebras, including the shares held by Telebras in the operating
companies of the Telebras System, were allocated to the New Holding Companies.
The split-up of the Telebras System into the New Holding Companies is referred
to herein as the "Breakup" or the "Breakup of Telebras."
The New Holding Companies, together with their respective subsidiaries,
consist of (a) eight cellular service providers, each operating in one of eight
regions (each a "Cellular Region"), (b) three fixed-line service providers, each
providing local and intraregional long-distance service in one of three regions
(each a "Fixed-Line Region") and (c) Embratel Participacoes S.A. - Embratel
("Embratel"), which provides domestic (including intraregional and
interregional) long-distance telephone service and international telephone
service throughout Brazil.
The Registrant is one of the New Holding Companies. In the Breakup, the
Registrant was allocated all the share capital held by Telebras in the operating
subsidiaries of the Telebras System that provided cellular telecommunications
services in the States of Para, Maranhao, Roraima, Amapa, and Amazonas. In July
1998, the Federal Government sold substantially all its shares of the New
Holding Companies, including the Registrant, to private-sector buyers. The
Federal Government's common shares of the Registrant were purchased by Telpart
Participacoes S.A. ("Telpart"), a consortium comprising TIW do Brasil Ltda. and
Newtel Participacoes S.A. See "Control of Registrant."
The Region
The Region covers an area of approximately 3,532,000 square kilometers,
representing approximately 41% of Brazil's area. The Region's population of
approximately 14.7 million represents 9% of the population of Brazil. The Region
has 18 metropolitan areas with populations in excess of 100,000 people,
including the cities of Belem, Manaus, Sao Luiz, Boa Vista and Macapa. During
1997, the Region generated approximately 4.3% of Brazil's gross domestic
product.
Set forth below is a map showing the location of the Region within Brazil.
[GRAPHIC OMITTED]
<PAGE>
The following table sets forth population, Gross Domestic Product ("GDP")
and per capita income statistics for each state in the Region at the dates and
for the years indicated.
<TABLE>
<CAPTION>
At July 1, 1998 Year ended December 31, 1997
---------------------------------- ----------------------------------
Population % of Brazil's % of Brazil's Per capita
State (millions)(1) population (1) GDP (2) income (2)
- ----- ------------- -------------- ------------- ----------
<S> <C> <C> <C> <C>
Para (Telepara
Celular S.A.)............. 5.8 3.6 2.0 R$2,390.22
Amazonas (Telamazon Celular S.A.)
2.5 1.6 1.2 R$2,174.42
Maranhao (Telma
Celular S.A.)............. 5.4 3.3 0.9 R$1,159.54
Amapa (Teleamapa
Celular S.A.)............. 0.4 0.3 0.1 R$1,773.41
Roraima (Telaima
Celular S.A.)............. 0.3 0.2 0.1 R$3,252.82
------ ------ ------
Region........................ 14.4 9.0 4.3
====== ====== ======
</TABLE>
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(1) Estimates of the Instituto Brasileiro de Geografia e Estatistica - IBGE
("IBGE").
(2) Data for 1997 as published by the Central Bank of Brazil
(the "Central Bank").
The Company's business, financial condition, results of operations and
prospects depend in part on the performance of the Brazilian economy and the
economy of the Region, in particular. See "--Brazilian Economic Environment."
Services
The Company offers cellular telecommunications services to its subscribers
pursuant to a variety of rate plans. At present, the Company offers only analog
service, but is implementing digital service. See "--Network." The Company also
offers ancillary services, including voicemail, call forwarding, call waiting
and three-way calling. The sale of cellular telephones, which began in 1999, is
not a significant part of the Company's business, although such equipment is
being offered in connection with the provision of cellular telecommunications
services.
Through agreements with other cellular service providers, the Company
offers automatic roaming services throughout Brazil that allow subscribers to
make and receive calls while out of the Region. The Company offers international
roaming in Argentina, Uruguay and Paraguay through agreements with local
cellular service providers. The Company also provides cellular
telecommunications services to subscribers of other cellular service providers
while they are in the Region. The Company charges the other service providers
pursuant to roaming agreements for the service provided to their subscribers.
See "--Operating Agreements--Roaming Agreements."
The Company has four customer service departments, Centros de Atendimento
do Servico Celular (CASC), one located in each state in the Region except for
the State of Amapa. At present, 24-hour customer service is only available in
the State of Para. The Company is establishing a Customer call center in the
city of Belem that will provide 24-hour customer service throughout the Region.
At December 31, 1998, the Company had approximately 200 customer service
attendants. During 1998, the customer service team answered, on average, in
excess of 2,000 calls per working day.
Sales and Marketing
In early 1999, the Company introduced the brand "Amazonia Celular."
Amazonia Celular is now the brand name under which cellular telecommunications
services of all of the Subsidiaries are marketed.
The Company divides its market into categories corresponding to the amount
of cellular telephone usage. The Company's customers consist primarily of high
and middle-income individuals. According to the Company's research at December
31, 1998, approximately 60% of the Company's subscribers were male, and the
average age of the Company's subscribers was between 40 and 45.
Pursuant to Anatel's regulations, cellular telecommunications services must
be provided to all individual applicants, regardless of income level, in the
order in which applications are received. In order to assist in managing the
risk of payment defaults, the Company currently conducts credit checks on its
customers. Service can be interrupted if a customer fails to make timely
payments. See "--Billing and Collection."
Sales Network
The Company markets its services through a network of Company-owned stores
and independent distributors in the Region. At December 31, 1998, the Company
operated seven Company stores in addition to sharing stores with the Predecessor
Companies in many of the cities not served by Company stores. At December 31,
1998, the Company managed 25 independent distribution locations, primarily in
metropolitan centers. Through its direct sales force and independent
distributors, the Company sells cellular telecommunications services and through
the Company stores and CASCs the Company provides after-sales services to
subscribers.
Independent distributors. The Company selects its independent distributors
based on their creditworthiness and an assessment of their premises. All of the
Company's independent distributors receive basic training relating to the
activation of cellular telecommunications services. Prior to December 31, 1998,
independent distributors did not receive a commission for the promotion of the
Company's cellular telecommunications services and the Company did not provide
independent distributors with advertising or marketing support. Beginning in
1999, independent distributors receive a fixed commission of R$70 for each new
customer they sign up for service, provided that the customer retains and pays
for service for at least three months, and all exclusive independent
distributors receive marketing support and financing from the Company to assure
that they maintain certain standards of service.
Network and Subscriber Data
The following table sets forth information on the Company's subscriber
base, coverage and related matters at the dates and for the years indicated.
<TABLE>
<CAPTION>
1996 1997 1998
-------- -------- --------
<S> <C> <C> <C>
Cellular lines in service at year-end ....................... 158,858 207,769 218,600
Subscriber growth during year................................ 100.6% 30.8% 5.2%
Estimated population of the Region at year-end
(millions)(1)............................................ 13.7 14.0 14.7
Estimated covered population at year-end
(millions)(2)............................................ 6.2 6.9 7.4
Percentage of population covered at year-end (3)............. 45.4% 49.1% 50.3%
Penetration at year-end (4).................................. 1.16% 1.51% 1.49%
Average monthly incoming minutes of use
per subscriber........................................... 59.12 85.58 90.45
Average monthly outgoing minutes of use
per subscriber........................................... 76.81 95.5 90.63
Average monthly revenues per subscriber (5).................. R$107.68 R$109.57 R$93.10
</TABLE>
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(1) Estimates of the IBGE at July 1, 1998
(2) Estimates by the Company's management of the number of people within the
Region who can access the Company's cellular telephone signal.
(3) Estimates by the Company's management of the percentage of population of
the Region who can access the Company's cellular telephone signal.
(4) Number of cellular lines in service divided by the population of the Region.
(5) In nominal reais, net of value-added taxes.
The Concessions contain certain network expansion and modernization
obligations. See "--Regulation of the Brazilian Telecommunications
Industry--Obligations of Telecommunications Companies." The Company's management
believes that the Company will be able to meet all such obligations.
Sources of Revenue
The Company generates revenue from (i) usage charges, which include
measured service charges for outgoing calls and roaming and other similar
charges, (ii) monthly subscription charges, (iii) network usage charges, which
are amounts charged by the Company to other cellular and fixed-line service
providers, and to Embratel as the long-distance service provider, for use of the
Company's network, (iv) activation fees, which are one-time sign-up charges paid
to obtain cellular telecommunications services and (v) other charges, including
charges for call forwarding, call waiting and call blocking. The Company's rates
are subject to the approval of Anatel. See "--Regulation of the Brazilian
Telecommunications Industry."
Subscriber Rates
Since October 1994, cellular telecommunications service in Brazil, unlike
North America, has been offered on a "calling party pays" basis, under which the
subscriber pays only for calls that he or she originates (in addition, a
subscriber pays roaming charges on calls made or received outside his or her
home registration area).
Subscriber charges are computed based on the subscriber's calling plan, the
location of the party called, the place from which the call originates and
certain other factors, as described below. The Region is divided into 65
registration areas. The lowest base rate per minute ("VC1") applies to calls
made by a subscriber in a registration area to persons in the same registration
area. Charges for calls from one registration area to another within the Region
are assessed at a higher rate ("VC2"). Calls from the Region to persons outside
the Region are billed at the highest rate ("VC3"). When a subscriber makes or
receives a call while outside the Region, a per-call surcharge known as "AD" is
applicable. When a subscriber receives a call outside his or her home
registration area, the subscriber also pays a certain rate per minute if the
subscriber is located within the Region ("DSL1"), or a higher rate if the
subscriber is located outside the Region ("DSL2"). Measured service charges are
discounted 30% for calls made on Saturdays, Sundays and national holidays and
for calls made during Monday through Friday. A 30% surcharge is imposed on VC1
calls made to cellular telephones operating on the competitors' network.
At December 31, 1998, the Company offered only one plan of service, the
Basic Service plan. This plan requires an activation fee of R$330.00 and has a
monthly subscription charge of R$25.00. No additional minutes or usage discounts
are available. However, the Company plans to provide different service options
to its subscribers during the second half of 1999. The following table sets
forth the average rates for the Basic Service plan for each year in the
three-year period ended December 31, 1998 in actual reais.
<TABLE>
<CAPTION>
1996 1997 1998
------ ---------- ------
(in reais)
<S> <C> <C> <C>
Activation fee (1)........................................... 364.13 330.00 330.00
Monthly subscription fee (1)................................. 30.27 25.00 25.00
Time Charges Per Minute:
VC1 (per minute)(1)(2).................................... 0.29 0.27 0.27
VC2 (per minute)(2)(3).................................... 0.58 0.58 0.58
VC3 (per minute)(2)....................................... 0.66 0.66 0.66
DSL1 (per minute)(2)...................................... 0.29 0.29 0.29
DSL2 (per minute)(2)...................................... 0.33 0.33 0.33
AD (per call)(2)............................................. 0.55 0.55 0.55
</TABLE>
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(1) The rates presented are averages of the rates net of any applicable
value-added taxes charged by the Subsidiaries, weighted by number of
subscribers.
(2) All amounts are weighted average peak rates in nominal reais net of any
applicable value-added taxes.
(3) As of May 10, 1999 there is no longer a difference between VC1 rates and
VC2 rates.
Roaming Fees
The Company also receives revenue pursuant to roaming agreements with other
cellular service providers. See "--Operating Agreements--Roaming Agreements."
When a call is made from within the Region by a subscriber of another cellular
service provider, that service provider pays the Company for the call at the
applicable rate. Conversely, when a Company's subscriber makes a cellular call
outside the Region, the Company must pay the charges associated with that call
to the cellular service provider in whose region the call originates.
Network Usage Charges
The Company earns revenues from any call (cellular or fixed-line)
originating with another cellular or fixed-line service provider and terminating
on a cellular telephone within the Region. The Company charges the service
provider from whose network the 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 average network usage
tariff charged by the Company to other service providers in 1996, 1997 and 1998
was R$0.19 per minute, respectively, net of value-added taxes.
Taxes on Telecommunications Services
The cost of telecommunications services to the subscribers includes a
variety of taxes. The average rate of all such taxes, as a percentage of gross
operating revenues for the Company, was approximately 20.5% in 1998. The
principal taxes are a state value-added tax, the Imposto sobre Circulacao de
Mercadorias e Servicos (the "ICMS") and the Imposto sobre Servicos (the "ISS").
The ICMS is a tax that the Brazilian states impose at varying rates on certain
revenues from the sale of goods and services, including certain
telecommunications services. The ICMS rate in each state in the Region is 25%
(except Amapa where it is 17%) for domestic telecommunications services. The ISS
is a municipal tax imposed on services not subject to the ICMS and its average
rate is 5%.
Other taxes on gross operating revenues include two federal social
contribution taxes, the Programa de Integracao Social ("PIS") and the
Contribuicao para Financiamento da Seguridade Social ("COFINS"), imposed on
certain telecommunications services at a combined rate of 3.65% of gross
operating revenues. Prior to February 1999, the combined rate of both taxes was
2.65%.
In June 1998, the governments of the individual Brazilian states approved
an agreement to interpret existing Brazilian tax law to apply the ICMS to
certain services to which the ICMS had not previously been applied, including
cellular activation and monthly subscription. The agreement also provides that
the ICMS may be applied retroactively to activation services rendered during the
five years preceding June 1998. See "Legal Proceedings."
Billing and Collection
The Company's billing system has four main functions; (i) subscriber
registration, (ii) subscriber information management, (iii) accounts payable
management and (iv) billing and collection. To smooth the billing and collection
cycles, the Company uses six staggered cycles each month. At present, the
Company is implementing a new billing system which was developed by LHS
Communication Systems Incorporated and is scheduled to be fully operational by
the third quarter of 1999.
Pursuant to Brazilian law, subscribers must receive a bill at least five
days before the due date. If a subscriber's payment is more than 20 days
past-due, service is suspended until full payment for all outstanding charges is
received. If a subscriber's payment is more than 90 days past-due, service is
discontinued.
After each collection cycle, the Company and other telecommunications
services providers reconcile the roaming and network usage fees owed between
them and settle on a net basis. See "--Rates--Roaming Fees" and "--Network Usage
Charges." 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
telecommunications network.
The Company's bad debts expenses were 0%, 5.6% and 16.5% of operating
revenues in 1996, 1997 and 1998, respectively. The increase in the level of
doubtful accounts is due to a variety of factors. In the fourth quarter of 1998
the Company put in place new credit and collection policies and an anti-fraud
system in order to reduce the level of bad debt. As a result of these measures,
the Company's management expects that bad debt levels will decline in the
future. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Results of Operations."
Network
At December 31, 1998, the Company's cellular telecommunications network
covered approximately 50.3% of the Region's population. The Company continues to
expand its cellular telecommunications network to cover as broad a geographical
area as is economically feasible in order to meet consumer demand. Under the
Concessions, the Company has certain obligations concerning network expansion.
See "--Regulation of the Brazilian Telecommunications Industry--Obligations of
Telecommunications Companies."
At December 31, 1998, the Company's cellular telecommunications network
consisted of seven switches and 228 cell sites. The Company's principal
switching centers are located in the five capital cities and employ AMPS analog
technology.
The Company increases the capacity and improves the quality of its cellular
telecommunications network by building new base stations and adding channels to
existing base stations. This development is carried out in response to projected
subscriber demand. Management believes that its cellular telecommunications
network will require further development to meet increasing demand for cellular
telecommunications services in and around the Region's major metropolitan areas.
See "--Quality of Service."
The Company plans to centralize its network administration system in the
City of Belem. This system is capable of monitoring the base stations, switching
centers and all critical network operational parameters. The Company analyzes
the performance data generated by this system in order to make the operating
adjustments and capital expenditures necessary to maintain and enhance network
operations. In addition, technicians operating this system will have the ability
to rapidly evaluate and respond to technical difficulties in network operations.
The Company plans to introduce digital technology in July 1999. The
Company's management believes that digitization offers clear advantages over
analog technology, including greater network capacity, reduced operating costs
and additional revenue through the sale of value-added services. Digital
cellular telecommunications services also offers subscribers greater security.
Ericsson Telecomunicacoes S.A. is the Company's principal supplier of
cellular telecommunications equipment.
Fraud Detection and Prevention
Fraud resulting from cloned cellular telephone calls has increased
continuously since the Company began offering cellular telecommunications
services, and the Company's management believes that the incidence of cloning is
likely to continue to increase in the near term. Cloning fraud consists of
duplicating the cellular signal of a bona fide subscriber, enabling the
perpetrator of the fraud to make telephone calls using the subscriber's signal.
Such calls are billed to the subscriber, but the receivable is written off when
the Company discovers that it arose from a fraudulent call. If part of a
fraudulent call is carried by the network of another service provider, the
Company is obligated to pay that service provider the applicable network usage
fee, regardless of whether the Company ever collects the receivable associated
with the call.
Subscription fraud occurs when a person, typically using a fictitious
identification and address, obtains cellular telecommunications services 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.
Historically and at present, the majority of losses relating to fraud are a
result of cloning fraud. When the Company discovers that a receivable has been
generated by a fraudulent call, the receivable is written off.
The Company has implemented fraud-detection and fraud-prevention measures
in an effort to reduce fraud-related losses. Fraud-detection measures involve
the collection and review of call records to detect abnormal calling patterns.
When abnormal patterns are found, the subscriber is contacted by the fraud
control staff of the Company and, if cloning has occurred, the subscriber's
number is changed. Fraud-prevention measures include restrictions on
international calls from a given number and restrictions on three-way calling by
customers with international direct-dial access.
The Company installed a nation-wide fraud detection system licensed from
Digital Equipment Corporation. This system aids in fraud detection in various
ways, including identifying instances of simultaneous usage by a single
subscriber, call frequency and unusually high usage patterns. The system has
been operational within the Region since the fourth quarter of 1998. The
Company's management expects to invest R$4.2 million in fraud-control systems
during 1999.
Quality of Service
The Company has at times experienced quality of service problems, including
busy circuits, lack of system availability and dropped calls. At present, the
Company is not experiencing any significant quality of service problems and
exceeds most of the quality of service requirements established by Anatel.
See "--Regulation of the Brazilian Telecommunications Industry--Obligations of
Telecommunications Companies--Quality of service and network expansion."
Competition
Band B Competition
The General Telecommunications Law provides for the introduction of
competition in telecommunications services in Brazil. The Federal Government has
granted ten licenses to private companies (each a "Band B Service Provider") to
provide cellular telecommunications services within particular regions of Brazil
on a frequency range referred to as "Band B." The frequency range used by the
cellular service providers that were spun off from the Telebras System,
including the Company (each a "Band A Service Provider") is referred to as "Band
A." Each Band B license covers a geographic region which generally corresponds
to a Cellular Region. See "--Regulation of the Brazilian Telecommunications
Industry--Concessions and Licenses."
In 1998, a license to provide cellular telecommunications services in the
Region on Band B has been granted to Tele Centro Oeste/Inepar, a consortium
comprised of (i) Inepar S.A. Industria e Construcoes (50%) and (ii) Tele Centro
Oeste Celular Participacoes S.A. (50%). Tele Centro Oeste/Inepar paid R$60.5
million for the license and intends to commence providing digital cellular
telecommunications services based on the TDMA standard in the Region in the
second half of 1999. The rights and obligations of Tele Centro Oeste/Inepar
under its concessions are substantially the same as the Company's rights and
obligations under its Concessions. However, the Concessions expire in 2009,
while Tele Centro Oeste/Inepar's licenses expire in 2013. Both may be renewed at
the discretion of Anatel for additional 15 year periods. Tele Centro Oeste
Celular Participacoes S.A. currently provides cellular telecommunications
services in the States of Goias, Mato Grosso do Sul, Mato Grosso, Rondonia,
Acre, Tocantins and the Federal District.
Other Competition
The Company also competes with fixed-line telephone service providers.
Certain of the Company's existing and potential subscribers might increase the
use of fixed-line service to take advantage of the lower prices for
telecommunications services offered by fixed-line providers if the quality of
the services provided was improved. Quality of service concerns associated with
the fixed-line service provider include installation delays, service
interruptions and service availability. However, the quality of service of
fixed-line providers could improve, if competitors make significant investments
in the fixed-line telephone network in the Region.
The primary fixed-line service provider in the Region is Tele Norte Leste
Participacoes S.A., which operates under the brand name of Telemar. The second
company to obtain a concession to provide fixed-line telecommunications services
in the Region is Canbra Telefonica S.A. (a consortium comprised of Bell Canada
International, Wireless Local Looping L.P., Qualcomm Incorporated, SLI Wireless
and Taquari Participacoes S.A.). Canbra Telefonica S.A. expects to provide
fixed-line telecommunications services to the Region by the end of 1999.
The Company also competes with certain other wireless telecommunications
services, such as mobile radio, paging and beeper services, which are used by
some people in the Region as a substitute for cellular telecommunications
services. These competing wireless telecommunications services are generally
less expensive than cellular telecommunications services.
Technological advances in the telecommunications field, such as Personal
Communications Services ("PCS"), may in the future introduce additional
competition for cellular service providers. PCS services, which are similar to
digital cellular telecommunications services, require a concession from the
Federal Government. The Federal Government has indicated that it does not intend
to issue concessions to provide PCS services until 2000. Satellite services,
which provide nationwide coverage, are available in Brazil. Although satellite
services have the benefit of covering a much greater area than cellular
telecommunications services, they are considerably more expensive than cellular
telecommunications services and do not offer comparable coverage inside
buildings.
There can be no assurance that the entry of new competitors will not have a
material adverse effect on the Company's business, financial condition, results
of operations or prospects. Any adverse effects on the Company's results and
market share from competitive pressures will depend on a variety of factors that
cannot now be assessed with precision and that are beyond the Company's control.
Among such factors are the identity of the competitors, their business
strategies and capabilities, prevailing market conditions at the time, 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.
Operating Agreements
Interconnection Agreements
The Company has entered into interconnection agreements with Embratel and
each of the Predecessor Companies. The terms of these interconnection agreements
include provisions for the number of connection points, the method by which
signals must be received and transmitted and the costs and fees of
interconnection. In addition, network usage charges are assessed based on the
terms of these agreements. See "--Regulation of the Brazilian Telecommunications
Industry--Obligations of Telecommunications Companies--Interconnection."
Roaming Agreements
Agreements for automatic roaming have been entered into with all the other
Band A Service Providers and with the following Band B Service Providers: BCP
Telecomunicacoes S.A., BCP Nordeste S.A. (formerly BSE S.A.), Telet S.A., Tess
S.A., Maxitel S.A., Americel S.A. and Algar Telecomunicacoes Leste S.A. - ATL
Global Telecom. These roaming agreements permit the Company's subscribers to use
their cellular telephones on the networks of other cellular service providers
while traveling or "roaming" outside the Region. Conversely, the Company is
required to provide cellular telecommunications services to subscribers of those
cellular service providers from outside the Region when those subscribers are
within the Region. The agreements require the Company and the other cellular
service providers 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 agreements have a
three-year term and automatically renew for further one-year terms.
The Company has also entered into international roaming agreements with
foreign carriers that permit its subscribers to use their cellular telephones in
Argentina, Uruguay and Paraguay and subscribers of those carriers to use their
cellular telephones in the Region. The Company is negotiating an international
roaming agreement that, if concluded, would permit its subscribers to use their
cellular telephones in Portugal. The terms of these international roaming
agreements vary from agreement to agreement.
Employees
At December 31, 1998, the Company had 450 employees. Approximately 17% of
the Company's employees were employed in technical or operational positions, 39%
in sales and marketing, 30% in finance and administrative support and 14% in
customer service. Approximately 36% of all employees are members of state labor
unions associated with the Federacao Interestadual dos Trabalhadores em
Telecomunicacoes - Fittel ("Fittel"). Each Subsidiary negotiates a new
collective labor agreement every year with the local union.
The Company's management considers the relations of the Company with its
work force to be satisfactory. Neither the Company nor any Predecessor Company
has experienced a work stoppage that had a material effect on its operations.
The Company participates in a pension fund administered by Fundacao
Telebras de Seguridade Social - Sistel ("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 for at least 35 years. Sistel operates independently from the Company,
and its assets and liabilities are fully segregated from those of the Company.
Employees of the Company at the time of the privatization had the right to
maintain their rights and benefits in Sistel.
Sistel is a multi-employer defined benefit plan that covers the former
employees of the Telebras System, and the Company is contingently liable for all
of the unfunded obligations of the plan. (See Note 11 to the Consolidated
Financial Statements.) The Company believes that Sistel may be replaced by one
or more separate plans, but there can be no assurances as to when this will
occur or what the consequences will be for the Company or its employees.
Research and Development
In connection with the Breakup, the Company was required to enter into a
three-year contract in May 1998 the Centro de Pesquisa e Desenvolvimento da
Telebras under which the Company is obligated to contribute a maximum of R$1.2
million during the three years ending May 2001. The Company does not conduct any
independent research and primarily depends upon the manufacturers of
telecommunications products for the development of new hardware.
Capital Expenditures
Prior to privatization, the Company's capital expenditures were planned and
allocated on a system-wide basis and subject to approval by the Federal
Government. These constraints on capital expenditures prevented the Company from
making certain investments that otherwise would have been made to improve
cellular telecommunications services in the Region. Since the privatization of
Telebras, these restrictions have not applied. The Company is now permitted to
determine its own capital expenditure budget, subject to compliance with certain
obligations to expand service under the Concessions. See "--Regulation of the
Brazilian Telecommunications Industry--Obligations of Telecommunications
Companies."
The Company's capital expenditure priorities include introducing digital
technology, improving overall quality, and increasing network capacity and
coverage. The Company expects that its capital expenditures will be
approximately R$100 million in 1999.
The Company's capital expenditures for 1996 and 1997, in constant reais of
1997, were approximately R$105.5 million and R$51.8 million, respectively, and
in 1998, in nominal reais, were approximately R$31.7 million.
Regulation of the Brazilian Telecommunications Industry
General
The Company's business, including the services it provides and the rates it
charges, is subject to comprehensive regulation under the General
Telecommunications Law, a new comprehensive regulatory framework for the
provision of telecommunications services enacted by Anatel in July 1997 and
various administrative enactments thereunder. The Subsidiaries operate under
Concessions that authorize them to provide specified services and sets forth
certain obligations (the "List of Obligations").
Anatel is the regulatory agency for telecommunications under the October
1997 Regulamento da Agencia Nacional de Telecomunicacoes (the "Anatel Decree").
Anatel is administratively independent and financially autonomous. Anatel
maintains a close relationship with the Ministry of Communications and is
required to report on its activities to the Ministry of Communications. It has
authority to propose and issue regulations that are legally binding on
telecommunications services providers. Any such proposed regulation is subject
to a period of public comment, which may include public hearings, and may be
challenged in Brazilian courts, as may any other action taken by Anatel.
Concessions and Licenses
Concessions and licenses to provide telecommunications services are granted
under the public regime or the private regime. The Concessions are granted under
the private regime and the Subsidiaries are subject to requirements imposed by
Anatel in the List of Obligations.
Pursuant to the Lei Minima (the "Minimum Law") and the General
Telecommunications Law, the Band A and Band B Service Providers have been
granted concessions. Each concession is a specific grant of authority to supply
cellular telecommunications services, subject to certain requirements contained
in the applicable list of obligations appended to each concession. If a cellular
service provider wishes to offer any telecommunications services other than the
cellular telecommunications services authorized by its concession, it may apply
to Anatel for a license to offer such other services.
Each 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 has been met. The Concessions to provide cellular
telecommunications services in the states of Para, Amazonas, Maranhao, Amapa and
Roraima expire in March 2009, August 2009, April 2009, May 2009 and July 2009
respectively.
Currently, the number of cellular service providers that may provide
cellular telecommunications services in the Region is limited to one Band
A Service Provider and one Band B Service Provider. Under the Concessions,
Anatel may not authorize additional providers of cellular telecommunications
services until December 31, 2001.
Obligations of Telecommunications Companies
General. As described below, the Company is subject to certain requirements
relating to quality of service, network expansion and interconnection. Anatel
does not currently require network operators to unbundle network elements and
services, although Anatel has stated that it plans to review the issue on a
regular basis and may require unbundling in the future. In an unbundled regime,
each network operator is required to provide a detailed list of network services
and elements which may be purchased separately by a party requesting
interconnection.
Quality of service and network expansion. The Company, like other cellular
service providers, is subject to obligations set forth in the List of
Obligations concerning quality of service and network expansion and
modernization. Failure to meet these obligations 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
Concessions.
The following two tables set forth the Company's certain obligations as
provided in the List of Obligations at the times indicated and the Company's
performance with regard to each category of obligation at December 31, 1998.
While there can be no assurances, the Company expects to be in compliance with
the List of Obligations at all times.
<TABLE>
<CAPTION>
Telamazon Telaima Teleamapa Telepara Telma
Celular Celular Celular Celular Celular
S.A. S.A. S.A. S.A. S.A.
Status at Status at Status at Status at Status at Minimum Coverage
December December December December December Required by November 4,
31, 31, 31, 31, 31, ---------------------------------
1998 1998 1998 1998 1998 1998 1999 2000 2001 2002
--------- --------- --------- --------- --------- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Services offered (1)
in cities with
populations of:
30,000 to 50,000..... 0% n/a 100% 32% 50% -- -- -- -- 70%
50,000 to 75,000..... 75% n/a n/a 100% 63% -- -- -- 80% --
75,000 to 100,000.... n/a n/a n/a 100% 100% -- -- 90% -- --
100,000 to 200,000... n/a n/a n/a 100% 67% -- 100% -- -- --
Over 200,000 or
state capitals..... 100% 100% 100% 100% 100% 100% -- -- -- --
Maximum average
installation waiting
time (in days)(2)..... 180 180 180 180 180 180 120 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) Time between request for service and connection in areas with cellular
telecommunications service.
<TABLE>
<CAPTION>
Telamazon Telaima Teleamapa Telepara Telma
Celular S.A. Celular S.A. Celular S.A. Celular S.A. Celular S.A.
Status at Status at Status at Status at Status at Maximum/
December 31, December 31, December 31, December 31, December 31, Minimum
1998 1998 1998 1998 1998 Required
------------ ------------ ------------ ------------ ------------ --------
<S> <C> <C> <C> <C> <C> <C>
Minimum average level of
system availability (1)..... 99% 99% 98% 99% 99% 98%
Maximum network drop rate (2)... 3% 2% 2% 3% 3% 3%
Maximum "all circuits busy"
rate (3).................... 3% 2% 3% 4% 1% 5%
Maximum interconnection drop
rate (4).................... 0% 1% 2% 0% 0% 3%
Minimum average system
availability on first call
attempt..................... 90% 96% 91% 93% 90% 90%
Maximum number of customer
complaints per month
(per 100 subscribers)....... 0.1% 0.5% 0.5% 0.2% 0.2% 4
</TABLE>
- ------------------
(1) Percentage of time system is 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.
Interconnection. All telecommunications services providers are required to
provide interconnection upon request to any party that provides public
telecommunications services. The terms and conditions of interconnection are to
be freely negotiated between parties, subject to a price cap established by
Anatel. If a company offers any party an interconnection tariff below the price
cap, it must offer that tariff to any other requesting party on a
nondiscriminatory basis.
Anatel has stated that for the time being it does not expect to require
network operators to permit co-location of equipment. Co-location means that a
network operator permits another party to place its switching equipment in or
near the local exchange of the network operator and to connect to the network at
this location. Co-location is currently a matter for negotiation between
interested parties.
Rate Regulation
The Concessions provide for a price-cap mechanism to set and adjust rates
on an annual basis. The cap is a maximum weighted average price for a basket of
services. The basket includes the services in the Basic Service Plan, including
monthly subscription fees, VC1 charges, VC2 charges, VC3 charges, DSL1 charges,
DSL2 charges, and AD charges, as well as interconnection charges, including
network usage fees and charges to provide a physical connection to the network
(interligacao).
The initial price cap agreed upon by Anatel and the Company in the
Concessions is based on previously existing tariffs, which were developed based
on the fully allocated costs of the Company. The initial price cap is adjusted
on an annual basis under a formula set forth in the Concessions. The price cap
is adjusted to reflect 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 weighted average tariff for the entire basket of services may not
exceed the price cap, but 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.
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 a flat fee charged per minute of use which represents an
average charge for a basket of network elements and services. The network usage
fee charged by Band A Service Providers is subject to a price cap set by Anatel.
The price cap for the network usage fee varies from company to company based on
the underlying cost characteristics of each company's network.
Brazilian Political Environment
The Brazilian political environment was marked by high levels of
uncertainty after the country returned to civilian rule in 1985, ending 20 years
of military government. The death of a President-elect in 1985 and the
resignation of another President in the midst of impeachment proceedings in
1992, as well as rapid turnover in the Federal Government at and immediately
below the cabinet level, adversely affected the implementation of consistent
economic and monetary policies.
Fernando Henrique Cardoso, who was Finance Minister at the time of
implementation of Brazil's latest economic stabilization plan (the "Real Plan"),
was elected President of Brazil in October 1994 and, in October 1998, was
reelected for an additional four-year term, which began in January 1999.
President Cardoso is the leader of a coalition of six political parties that
represents a majority in the federal Congress. His party, the Brazilian Social
Democratic Party, holds the second largest number of seats in the coalition.
1999 to date has been marked by difficult relations between the Federal
Government and certain state governments. In the 1998 elections for state
governors, candidates from parties allied with the President's coalition
prevailed in 21 of 27 states, including the State of Sao Paulo. Opposition
candidates won in six states, including the States of Rio de Janeiro, Minas
Gerais and Rio Grande do Sul. In January 1999, the new Governor of the State of
Minas Gerais announced that his state would suspend payments on its debt to the
Federal Government for 90 days. The Governor of the State of Rio Grande do Sul
subsequently obtained a court order permitting his state to make its debt
payments into an escrow account, pending resolution of a request of seven states
to renegotiate refinancing agreements they had reached with the Federal
Government in 1997. The Federal Government has responded by seeking to withhold
constitutionally-mandated transfers to the State of Minas Gerais. The Federal
Government has notified certain international financial institutions that it
will no longer guarantee those states' obligations to those institutions,
leading the World Bank to suspend loans to the States of Minas Gerais and Rio
Grande do Sul.
In February 1999, certain state governors pressed for a renegotiation of
their states' refinancing agreements with the Federal Government. The President
offered instead to make loans to the states to cover the costs of layoffs and
pension reform and promised to review a law exempting exports from state taxes.
The Federal Government has initiated negotiations with the World Bank to secure
funding for such loans. The Federal Government is also proposing to refinance
certain debt of Brazil's municipalities for a period of 30 years at a rate
equivalent to 9% above the rate of inflation, in return for which the
municipalities are to be required to cut costs sharply and adopt strict fiscal
guidelines.
Conflicts between the Federal Government and state governments could
complicate the passage of the government's fiscal reform package and longer-term
fiscal measures, including a reform of the tax system, and Brazil's ability to
meet the agreed targets under the country's agreements with the International
Monetary Fund (the "IMF"). See "--Brazilian Economic Environment."
Brazilian Economic Environment
The Company's business, prospects, financial condition and results of
operations are dependent on general economic conditions in Brazil, and in
particular on (i) economic growth and its impact on demand for telecommunication
services, (ii) the cost and availability of financing and (iii) exchange rates
between Brazilian and foreign currencies.
For many years before the introduction of the Real Plan in late 1993, the
Brazilian economy was extremely volatile. The Federal Government implemented a
succession of programs intended to stabilize the economy and provide a basis for
sustainable, noninflationary growth. Changes in monetary, credit, tariff and
other policies were frequent and occasionally drastic. In particular, actions to
control inflation, interest rates or consumption included freezing bank
accounts, imposing capital controls, introducing high tariffs and other strong
measures. Changes in policy, social instability and other political and economic
developments, and the Brazilian government's responses to such developments, not
infrequently had a material adverse effect on the Company's business,
operations, financial condition and results of operations.
The Federal Government introduced the Real Plan in December 1993. The Real
Plan is an economic stabilization program intended to reduce the rate of
inflation by reducing certain public expenditures, collecting liabilities owed
to the Federal Government, increasing tax revenues, continuing to privatize
government-owned entities and introducing a new currency. The real was
introduced as Brazil's currency on July 1, 1994, initially with an exchange rate
of R$1.00 to US$1.00. The real appreciated through January 1995 and thereafter
gradually declined in value against the dollar, reaching R$1.2087 to US$1.00 at
December 31, 1998. Notwithstanding the success of the Real Plan in lowering
inflation and stabilizing the Brazilian economy, the Real Plan has also led to
economic slowdown, and a rise in unemployment in most regions and sectors of the
economy.
The Asian financial crisis in 1998 and the ripple effects of that crisis
presented a serious challenge for Brazil. After reaching a historical high of
US$74.7 billion at April 30, 1998, Brazil's international reserves declined to
US$42.4 billion at October 31.
In November 1998, in response to continuing pressure on the real and the
rapid decline in the country's dollar reserves, Brazil negotiated a US$41.5
billion loan package arranged by the IMF. Acceptance of the IMF package
committed Brazil to implement a combination of spending cuts and tax increases.
Brazil received the first installment of approximately US$9.4 billion in two
disbursements. Brazil's level of international reserves stabilized following the
announcement of the support package, reaching US$44.6 billion at December 31,
1998.
After some initial progress in implementing a Fiscal Stabilization Program
announced in late 1998, the Federal Government encountered difficulties in
implementing the program in Congress. See "--Brazilian Political Environment."
The Central Bank attempted a controlled devaluation of the real by widening the
band within which the real was permitted to trade, but subsequent Central Bank
intervention failed to keep the rate within the new band. On January 15, the
Central Bank announced that the real would be permitted to float, with Central
Bank intervention to take place only in times of extreme volatility. Both the
level of international reserves and the value of the real continued to decline.
At January 31, Brazil's international reserves stood at US$36.1 billion and the
Commercial Market Rate stood at R$1.9832 to US$1.00.
In the following weeks, the Federal Government had a series of legislative
successes with its efforts to implement the expense reduction and revenue
enhancement measures under its Fiscal Stabilization Program. Brazil also began
negotiations with the IMF on adjustments to the previously-agreed 1999-2001
economic program, and agreement was reached in March on new economic targets.
Brazil received a second payment, of approximately US$4.9 billion, from the IMF,
followed by an additional US$4.9 billion in bilateral loans under the IMF-led
support package. Subsequent disbursements will depend on Brazil's ability to
meet the agreed primary surplus targets and on Brazil's progress in implementing
fiscal reforms. There can be no assurance that Brazil will be able to meet the
primary surplus targets under its agreement with the IMF and, accordingly, that
the full amount under the IMF-led support package will be available to Brazil.
After giving effect to the inflows from the IMF-led support package,
Brazil's international reserves stood at US$38.9 billion on April 8, 1999. The
Commercial Market Rate stood at R$1.72 to US$1.00. on March 31, 1999.
As a result of the foregoing events, GDP dropped 1.64% during the fourth
quarter of 1998, reflecting declines of 6.45%, 2.45% and 0.65% in the
agricultural, industrial and services sectors, respectively. GDP declined by
0.15% in the full year 1998, compared with 3.47% growth during the preceding
year. Brazil's current account deficit continued to grow in 1998, reaching
US$35.2 billion for 1998, compared with a US$33.4 billion deficit for the
preceding year. At the end of the first quarter of 1999, the current account
deficit stood at US$3.5 billion, the result of a US$535 million trade deficit
and US$3.4 billion in debt service during that quarter. Foreign direct
investment inflows increased 52.6% in 1998, totaling US$26.1 billion. Of that
amount, 23.4%, or US$6.1 billion, resulted from foreign participation in the
national privatization program. In the first two months of 1999, foreign direct
investment inflows totaled US$5.7 billion, bringing such investment to US$29.7
billion in the twelve months ended February 28, 1999.
Developments in Other Emerging Market Countries
The Brazilian securities markets are influenced by economic and market
conditions in other emerging market countries. Although economic conditions are
different in each country, developments in one country can have an effect on
investors' perceptions of the risks of investing in the securities of issuers in
other countries, including Brazil. During 1998 and 1999, the international
financial markets have experienced significant volatility, with significant
adverse effects on demand for and prices of securities of issuers in virtually
all emerging markets, including Brazil.
The current volatility in the securities markets in Latin American and
other emerging market countries has been attributed, at least in part, to the
effects of the Asian and the Russian economic crises of 1997-98. For example,
the crisis in Asia in the fourth quarter of 1997 provoked a significant
financial and economic crisis in Brazil. In August 1998, following the
devaluation of the Russian ruble, Brazil again experienced substantial capital
outflows and significant declines in its stock markets. See "--Brazilian
Economic Environment."
There can be no assurance that the Brazilian securities markets will
not continue to be affected negatively by events elsewhere, especially in
emerging markets, or that such events will not adversely affect the prices of
the Company's securities.
Inflation and Devaluation
Brazil experienced extremely high and generally unpredictable rates of
inflation and of devaluation of Brazilian currency for many years until the
implementation of the Real Plan. Inflation itself, as well as certain
governmental measures to combat inflation, and public speculation about possible
future actions have also historically contributed to economic uncertainty in
Brazil and to heightened volatility in the Brazilian securities markets. See
"--Brazilian Economic Environment."
The following table sets forth the rate of Brazilian inflation, as measured
by the Indice Geral de Precos - Mercado (the General Price Index - Market or
"IGP-M"), and the devaluation of the Brazilian currency against the U.S. dollar
during the periods indicated.
<TABLE>
<CAPTION>
Year ended December 31,
1996 1997 1998
---- ---- ----
(percentages)
<S> <C> <C> <C>
Inflation (IGP-M)...................................................... 9.2 7.7 1.8
Devaluation (Brazilian currency vs. US$).............................. 6.9 7.4 8.3
</TABLE>
Under the Real Plan, the rate of Brazilian inflation has decreased
considerably since July 1994. The exchange rate between the real and the U.S.
dollar remained relatively stable from mid-1994 to year-end 1998, but extreme
volatility has returned in 1999. See "--Brazilian Economic Environment." During
the first quarter of 1999, inflation, as measured by the IGP-M, amounted to 7.4%
and the devaluation of the real against the U.S. dollar was 42%.
Inflation and devaluation have potentially adverse consequences for the
Company's business, prospects, financial condition and results of operations.
These factors introduce distortions into the Company's financial statements and
make period-to-period comparisons difficult and unreliable. Differences between
the relative rate of Brazilian inflation as compared to the rates of Brazil's
trading partners, on the one hand, and the rate of currency devaluation, on the
other, can cause balance sheet losses for the Company on its foreign
currency-denominated liabilities. Inflation places pressure on the Company's
rates and may invite Federal Government efforts to control inflation by holding
down the rates that Brazilian public utilities are permitted to charge.
There can be no assurance that Brazilian inflation will remain at modest
rates or, if there is an increase in inflation, that the Company's business,
prospects, financial condition and results of operations will not be adversely
affected.
Item 2. Description of Property
The principal physical properties of the Company consist of transmission
equipment, switching equipment and base stations. The Company's headquarters are
located in Brasilia and the Company leases approximately 3,200 square meters of
office space in the cities of Belem, Macapa, Sao Luiz and Boa Vista and owns
approximately 2,480 square meters of office space in Manaus.
The Company also leases the sites where its cellular telecommunications
network equipment is installed. At December 31, 1998, the Company had seven
cellular switches in Belem, Maraba, Sao Luiz, Manaus, Macapa and Boa Vista and
186 cell sites, all of which were located on land leased by the Company. Most of
these leases are renewable on a yearly basis.
Item 3. Legal Proceedings
Litigation Related to the Breakup of Telebras
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.
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 12 New Holding Companies be specifically
authorized by the Telecommunications Law; (ii) the Telebras shareholders'
meeting 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 and (ii)
reconvening the May 22, 1998 Telebras shareholders' meeting. It is theoretically
possible under Brazilian law for a court to require that the Breakup be unwound,
although the Company's management believes that this would not be likely to
occur.
Litigation Arising Out of Events Prior to the Breakup
Telebras and the Predecessor Companies, the legal predecessors of the
Registrant, and the Subsidiaries, respectively, are defendants in a number of
legal proceedings including tax and labor-related matters and subject to certain
other claims and contingencies. Liability for any claims arising out of acts
committed by the Predecessor Companies, prior to the effective date of the
spin-off of the cellular assets and liabilities of the Predecessor Companies to
the Subsidiaries, remains with the Predecessor Companies, except for labor and
tax claims (for which the Predecessor Companies and the Subsidiaries are jointly
and severally liable, as the case may be, by operation of law) and those
liabilities with respect to which the Predecessor Companies had made specific
accounting provisions prior to the Breakup, assigning them to the Subsidiaries.
However, under the shareholders' resolution pursuant to which the spin-off was
effected, the Subsidiaries have contribution rights against the Predecessor
Companies, as the case may be, with respect to the entire amount of any payments
made by the Subsidiaries in connection with any labor or tax claims brought
against the Subsidiaries and relating to acts committed by the Predecessor
Companies prior to the effective date of the spin-off. Any claims against the
Predecessor Companies which are not satisfied by the Predecessor Companies could
result in claims against the Subsidiaries to the extent that the Subsidiaries
have received assets which might have been used to settle those claims had they
not been spun off from the Predecessor Companies.
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 with respect to which Telebras made a specific accounting provision
prior to the Breakup to the extent that such provision has been assigned to the
Registrant or one of the other New Holding Companies. The Company's management
believes that the chances of claims of this nature materializing and having a
material adverse financial effect on the Company are remote.
Litigation Related to the Application of the ICMS
In June 1998, the governments of the individual Brazilian states approved
an agreement to interpret existing Brazilian tax law to apply the ICMS to
certain services, including cellular activation and monthly subscriptions. The
agreement also provides that the ICMS may be applied retroactively to activation
services rendered during the five years preceding June 1998.
The Company's management believes that the attempt by the state governments
to extend the scope of the ICMS to services that are supplementary to basic
telecommunications services such as cellular activation and monthly
subscriptions, is unlawful because (i) the state governments acted beyond the
scope of their authority, (ii) their interpretation would subject certain
services which are not telecommunications services to taxation and (iii) new
taxes may not be applied retroactively.
Taxation of Cellular Activation
Each of the Subsidiaries has filed a lawsuit with the Treasury Court of the
state in which it is located seeking injunctive relief from retroactive and
prospective application of the ICMS to cellular activation. Each of the
Subsidiaries has obtained a temporary injunction relieving it from the payment
of the ICMS on cellular activation during the pendency of the lawsuits.
Nonetheless, the tax authorities of the states where the lawsuits are pending
may appeal the decisions of the Treasury Court to grant temporary injunctions.
There can be no assurance that the Subsidiaries will ultimately prevail in any
appeal relating to the temporary injunctions or in the underlying litigation
with respect to application of the ICMS to cellular activation.
The Company's management does not believe that the retroactive application
of the ICMS to cellular activation is probable. Therefore, no provision with
respect to such application has been made or is expected to be made in the
Consolidated Financial Statements. The Company has made provisions totaling
approximately R$2.8 million for the application of the ICMS on cellular
activation from the effective date of the agreement to December 31, 1998. The
Company's management does not believe that application of the ICMS to cellular
activation, applied on a prospective basis, will have a material impact on the
Company's results of operations.
There can be no assurance that the Company will prevail in its position
that the new interpretation by the state governments is unlawful. Five-year
retroactive application of the ICMS to cellular activation would have a material
adverse impact on the financial condition and results of operations of the
Company. Application of the ICMS to cellular activation for the full year ended
December 31, 1998, it would have a maximum negative impact estimated at R$3.9
million on results of operations for 1998. However, the Company's management
believes that the Predecessor Companies would be liable to the Subsidiaries for
any tax liability arising from the retroactive application of the ICMS to
cellular activation recognized prior to 1998.
Taxation of Monthly Subscriptions and Other Services
In December 1998, each of the Subsidiaries filed an injunction with the
Treasury Court of the State in which it is located and therefore suspended the
remittance of the ICMS on monthly subscriptions and additional services and has
deposited such amounts in a trust account administered by the courts. There can
be no assurance that the Company will prevail in its proceedings or in the
underlying litigation. Accordingly, the Company has recorded a provision of
R$3.3 million in the Consolidated Financial Statements.
Other Litigation
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
the Company's 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.
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. 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. 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 S.A................................................................ 64,405,151,125 51.79%
</TABLE>
The Registrant's officers and directors as a group own less than .01% of
the Common Shares.
Telpart is a consortium comprising TIW do Brasil Ltda. (49%) and Newtel
Participacoes S.A. (51%). Telpart also owns a controlling interest in Telemig
Celular Participacoes S.A., the Band A Service Provider in the Cellular Region
that covers the State of Minas Gerais.
TIW do Brasil Ltda. 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.
Newtel Participacoes S.A. ("Newtel") is a holding company. Fifty-one
percent of Newtel is owned by Opportunity MEM S.A., which is indirectly held by
investment and mutual funds managed by Opportunity Bank ("Opportunity"), a
private Brazilian investment bank. Forty-nine percent of Newtel is owned by the
following Brazilian pension funds: 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.
At present, the shareholders of Telpart are negotiating a shareholders'
agreement relating to representation of their respective nominees on the Boards
of Directors of Telpart and the Registrant.
Item 5. Nature of Trading Market
The principal trading market for the Preferred Shares is the Bolsa de
Valores de Sao Paulo (the "Sao Paulo Stock Exchange"). The Preferred Shares are
also traded on the Bolsa de Valores do Rio de Janeiro (the "Rio de Janeiro Stock
Exchange") and the seven other Brazilian stock exchanges. At December 31, 1998,
the Registrant had approximately 2.6 million common and preferred shareholders.
The Preferred Shares commenced trading separately on the Brazilian stock
exchanges on September 21, 1998. The following table sets forth the reported
high and low closing sale prices for Preferred Shares of the Registrant as
reported on the Sao Paulo Stock Exchange for the periods indicated.
<TABLE>
<CAPTION>
Nominal reais per
1,000 Preferred Shares
------------------------
High Low
---- ---
<S> <C> <C>
Third quarter 1998 (beginning September 21, 1998)......................... R$0.55 R$0.12
Fourth quarter 1998....................................................... R$1.10 R$0.21
First quarter 1999........................................................ R$1.08 R$0.45
</TABLE>
In the United States, the Preferred Shares trade in the form of ADSs each
representing 50,000 Preferred Shares, issued by The Bank of New York, as
depositary (the "Depositary") pursuant to a Deposit Agreement (the "Deposit
Agreement") among the Registrant, the Depositary and the registered holders and
beneficial owners from time to time of ADRs. The ADSs commenced trading
separately on the NYSE on November 16, 1998 under the symbol TCN. At December
31, 1998, there were approximately 160 holders of record of ADSs. The following
table sets forth the reported high and low closing sales prices for ADSs on the
NYSE for the period indicated.
<TABLE>
<CAPTION>
U.S. dollars per ADS
---------------------------
High Low
--------- ---------
<S> <C> <C>
Fourth quarter 1998 (beginning November 16, 1998).................... US$45 US$11 3/4
First quarter 1999................................................... US$14 3/4 US$26 1/4
</TABLE>
Trading on the Brazilian Stock Exchanges
Of Brazil's nine stock exchanges, the Sao Paulo Stock Exchange and the Rio
de Janeiro Stock Exchange are the most significant. During 1998, the Sao Paulo
Stock Exchange accounted for approximately 93% of the trading value of equity
securities on all Brazilian stock exchanges, and the Sao Paulo Stock Exchange
and the Rio de Janeiro Stock Exchange together accounted for approximately 99%
of the trading value of equity securities on all Brazilian stock exchanges.
Each Brazilian stock exchange is a nonprofit entity owned by its member
brokerage firms. Trading on each exchange is limited to member brokerage firms
and a limited number of authorized nonmembers. The Sao Paulo Stock Exchange and
the Rio de Janeiro Stock Exchange have two open outcry trading sessions each
day, from 10:30 a.m. to 1:30 p.m. and from 2:30 p.m. to 5:30 p.m., though the
Rio de Janeiro Stock Exchange has recently announced plans to convert its
operations to electronic trading. Trading is also conducted from 10:00 a.m. to
6:00 p.m. on an automated system on the Sao Paulo Stock Exchange and on the
National Electronic Trading System ("SENN"), a computerized system that links
the Rio de Janeiro Stock Exchange electronically with the seven smaller regional
exchanges. There are no specialists or market makers for the Registrant's shares
on the Sao Paulo Stock Exchange. Trading in securities listed on the Brazilian
stock exchanges may be effected off the exchanges in certain circumstances,
although such trading is very limited.
Settlement of transactions is effected three business days after the trade
date without adjustment of the purchase price for inflation. Payment for shares
is made through the facilities of separate clearinghouses for each exchange,
which maintain accounts for member brokerage firms. The seller is ordinarily
required to deliver the shares to the exchange on the second business day
following the trade date. The clearinghouse for the Sao Paulo Stock Exchange is
Companhia Brasileira de Liquidacao e Custodia S.A. - CBLC, which is controlled
mainly by the member brokerage firms and banks that are not members of that
exchange. The clearinghouse for the Rio de Janeiro Stock Exchange is CLC -
Camara de Liquidacao e Custodia S.A., which is 99% owned by that exchange.
At December 31, 1998, the aggregate market capitalization of the 527
companies listed on the Sao Paulo Stock Exchange was approximately R$194.4
billion. Substantially the same securities are listed on the Sao Paulo Stock
Exchange and on the Rio de Janeiro Stock Exchange. Although all the outstanding
shares of an exchange-listed company may trade on a Brazilian stock exchange, in
most cases less than half of the listed shares are actually available for
trading by the public, the remainder being held by small groups of controlling
persons that rarely trade their shares. For this reason, data showing the total
market capitalization of Brazilian stock exchanges tend to overstate the
liquidity of the Brazilian equity securities market.
The Brazilian equity market is relatively small and illiquid compared to
major world markets. In 1998, the combined daily trading volumes on the Sao
Paulo Stock Exchange and the Rio de Janeiro Stock Exchange averaged
approximately R$805.5 million. In 1998, the five most actively traded issues
represented approximately 61.5% of the total trading in the cash market on the
Sao Paulo Stock Exchange and approximately 67.2% of the total trading in the
cash market on the Rio de Janeiro Stock Exchange.
Trading on Brazilian stock exchanges by nonresidents of Brazil is subject
to certain limitations under Brazilian foreign investment legislation.
Regulation of Brazilian Securities Markets
The Brazilian securities markets are regulated by the Comissao de Valores
Mobiliarios (the Brazilian Securities Commission or "CVM"), which has authority
over stock exchanges and the securities markets generally, and by the Central
Bank, which has, among other powers, licensing authority over brokerage firms
and regulates foreign investment and foreign exchange transactions. The
Brazilian securities market is governed by Law No. 6,385, as amended (the
"Brazilian Securities Law") and Law No. 6,404, as amended (the "Brazilian
Corporation Law").
Under the Brazilian Corporation Law, a company is either public, a
companhia aberta, such as the Registrant, or private, a companhia fechada. All
public companies are registered with the CVM and are subject to reporting
requirements. A company registered with the CVM may have its securities traded
either on the Brazilian stock exchanges or in the Brazilian over-the-counter
market. The shares of a public company may also be traded privately, subject to
certain limitations. To be listed on the Brazilian stock exchanges, a company
must apply for registration with the CVM and the stock exchange where the head
office of the company is located. Once this stock exchange has admitted a
company to listing and the CVM has accepted its registration as a public
company, its securities may be traded on all other Brazilian stock exchanges.
Trading in securities on the Brazilian stock exchanges may be suspended at
the request of a company in anticipation of a material announcement. Trading may
also be suspended on the initiative of a Brazilian stock exchange or the CVM,
among other reasons, based on or due to a belief that a company has provided
inadequate information regarding a material event or has provided inadequate
responses to inquiries by the CVM or the relevant stock exchange.
The Brazilian Securities Law provides for, among other things, disclosure
requirements, restrictions on insider trading and price manipulation, and
protection of minority shareholders. However, the Brazilian securities markets
are not as highly regulated and supervised as the United States securities
markets or markets in certain other jurisdictions.
Item 6. Exchange Controls and Other Limitations Affecting Security Holders
There are no restrictions on ownership of Preferred Shares or Common Shares
of the Registrant by individuals or legal entities domiciled outside Brazil.
The right to convert dividend payments and proceeds from the sale of shares
into foreign currency and to remit such amounts outside Brazil is subject to
restrictions under foreign investment legislation which generally requires,
among other things, that the relevant investments have been registered with the
Central Bank. Such restrictions on the remittance of foreign capital abroad may
hinder or prevent Banco Itau S.A. (the "Custodian"), as custodian for the
Preferred Shares represented by ADSs, or holders who have exchanged ADRs for
Preferred Shares from converting dividends, distributions or the proceeds from
any sale of such Preferred Shares, as the case may be, into U.S. dollars and
remitting such U.S. dollars abroad. Holders of ADSs could be adversely affected
by delays in, or refusal to grant any, required government approval for
conversions of Brazilian currency payments and remittances abroad of the
Preferred Shares underlying the ADSs.
Under Annex IV to Resolution No. 1,289 of the National Monetary Council, as
amended (the "Annex IV Regulations"), qualified foreign investors (which
principally include foreign financial institutions, insurance companies, pension
and investment funds, charitable foreign institutions and other institutions
that meet certain minimum capital and other requirements) registered with the
CVM and acting through authorized custody accounts managed by local agents may
buy and sell shares on Brazilian stock exchanges without obtaining separate
Certificates of Registration for each transaction. Investors under the Annex IV
Regulations are also entitled to favorable tax treatment. See
"Taxation--Brazilian Tax Considerations." Resolution No. 1,927 of the National
Monetary Council, which is the restated and amended Annex V to Resolution No.
1,289 of the National Monetary Council (the "Annex V Regulations"), provides for
the issuance of depositary receipts in foreign markets in respect of shares of
Brazilian issuers. The ADS program had been approved under the Annex V
Regulations by the Central Bank and the CVM prior to the issuance of the ADSs.
Accordingly, the proceeds from the sale of ADSs by ADR holders outside Brazil
are free of Brazilian foreign investment controls and holders of the ADSs will
be entitled to favorable tax treatment. See "Taxation--Brazilian Tax
Considerations."
A Certificate of Registration has been issued in the name of the Depositary
with respect to the ADSs and is maintained by the Custodian on behalf of the
Depositary. Pursuant to the Certificate of Registration, the Custodian and the
Depositary are able to convert dividends and other distributions with respect to
the Preferred Shares represented by ADSs into foreign currency and remit the
proceeds outside Brazil. In the event that a holder of ADSs exchanges such ADSs
for Preferred Shares, such holder will be entitled to continue to rely on the
Depositary's Certificate of Registration for five business days after such
exchange, following which such holder must seek to obtain its own Certificate of
Registration with the Central Bank. Thereafter, any holder of Preferred Shares
may not be able to convert into foreign currency and remit outside Brazil the
proceeds from the disposition of, or distributions with respect to, such
Preferred Shares, unless such holder qualifies under the Annex IV Regulations or
obtains its own Certificate of Registration. A holder that obtains a Certificate
of Registration will be subject to less favorable Brazilian tax treatment than a
holder of ADSs. See "Taxation--Brazilian Tax Considerations."
Under current Brazilian legislation, the Federal Government may impose
temporary restrictions on remittances of foreign capital abroad in the event of
a serious imbalance or an anticipated serious imbalance of Brazil's balance of
payments. For approximately six months in 1989 and early 1990, the Federal
Government froze all dividend and capital repatriations held by the Central Bank
that were owed to foreign equity investors, in order to conserve Brazil's
foreign currency reserves. These amounts were subsequently released in
accordance with Federal Government directives. The imbalance in Brazil's balance
of payments increased during 1998, and there can be no assurance that the
Federal Government will not impose similar restrictions on foreign repatriations
in the future.
Item 7. Taxation
The following summary contains a description of the principal Brazilian and
U.S. federal income tax consequences of the acquisition, ownership and
disposition of Preferred Shares or ADSs, but it does not purport to be a
comprehensive description of all the tax considerations that may be relevant to
a decision to purchase Preferred Shares or ADSs. The summary is based upon the
tax laws of Brazil and regulations thereunder and on the tax laws of the United
States and regulations thereunder as in effect on the date hereof, which are
subject to change. Prospective purchasers of Preferred Shares or ADSs should
consult their own tax advisors as to the tax consequences of the acquisition,
ownership and disposition of Preferred Shares or ADSs.
Although there is at present no income tax treaty between Brazil and the
United States, the tax authorities of the two countries have had discussions
that may culminate in such a treaty. No assurance can be given, however, as to
whether or when a treaty will enter into force or how it will affect the U.S.
holders of Preferred Shares or ADSs.
Brazilian Tax Considerations
The following discussion summarizes the principal Brazilian tax
consequences of the acquisition, ownership and disposition of Preferred Shares
or ADSs by a holder not deemed to be domiciled in Brazil for Brazilian tax
purposes (a "non-Brazilian holder"). This discussion does not address all the
Brazilian tax considerations that may be applicable to any particular
non-Brazilian holder, and each non-Brazilian holder should consult his or her
own tax advisor about the Brazilian tax consequences of investing in Preferred
Shares or ADSs.
Taxation of Dividends
Dividends paid by the Registrant in cash or in kind from profits of periods
beginning on or after January 1, 1996 (i) to the Depositary in respect of
Preferred Shares underlying ADSs or (ii) to a non-Brazilian holder in respect of
Preferred Shares will generally not be subject to Brazilian withholding tax.
Dividends paid from profits generated before January 1, 1996 may be subject to
Brazilian withholding tax at varying rates, except that stock dividends are not
subject to Brazilian tax unless the stock is subsequently redeemed by the
Registrant, or the non-Brazilian holder sells the stock in Brazil, within five
years after the distribution.
The only Brazilian tax treaty now in effect that would (if certain
conditions are met) reduce the rate of the withholding tax on dividends paid
from profits generated before January 1, 1996 is the treaty with Japan, which
would reduce the rate to 12.5% under the circumstances set forth in the treaty.
Taxation of Gains
Gains realized outside Brazil by a non-Brazilian holder on the disposition
of ADSs to another non-Brazilian holder are not subject to Brazilian tax.
Neither the deposit of Preferred Shares in exchange for ADSs nor the withdrawal
of Preferred Shares upon cancellation of ADSs is subject to Brazilian tax.
Non-Brazilian holders are not subject to tax in Brazil on gains realized on
dispositions of Preferred Shares outside Brazil to other non-Brazilian holders.
Gains realized by non-Brazilian holders on dispositions of Preferred Shares
in Brazil or in transactions with Brazilian residents may be free of Brazilian
tax, taxed at a rate of 10% or taxed at a rate of 15%, depending on the
circumstances. Gains on the disposition of Preferred Shares obtained upon
cancellation of ADSs are not taxed in Brazil if such disposition is made, and
the proceeds are remitted abroad, within five business days after cancellation.
Gains on the sale or exchange of duly-registered investments under the Annex IV
Regulations are not subject to Brazilian tax if such sale or exchange occurs on
a Brazilian stock exchange. Gains realized through transactions on Brazilian
stock exchanges are generally subject to tax at a rate of 10%. Gains realized
through off-exchange transactions in Brazil or with Brazilian residents are
generally subject to tax at a rate of 15%. Brazil's tax treaties do not grant
relief from taxes on gains realized on sales or exchanges of Preferred Shares.
Any gains realized by a non-Brazilian holder upon the redemption of
Preferred Shares will be treated as gains from the disposition of such Preferred
Shares to a Brazilian resident occurring off of a stock exchange and will
accordingly be subject to tax at a rate of 15%.
Gain is measured by the difference between the amount in Brazilian currency
realized on the sale or exchange and the acquisition cost of the shares sold,
measured in Brazilian currency without any correction for inflation; the
acquisition cost of shares registered as an investment with the Central Bank is
calculated on the basis of the foreign currency amount registered with the
Central Bank.
There can be no assurance that the current preferential treatment for
holders of ADSs and non-Brazilian holders of Preferred Shares under the Annex IV
Regulations will be maintained.
Any exercise of preemptive rights relating to the Preferred Shares or ADSs
will not be subject to Brazilian taxation. Gains on the sale or assignment of
preemptive rights relating to the Preferred Shares will be treated differently
for Brazilian tax purposes depending on (i) whether the sale or assignment is
made by the Depositary or the investor and (ii) whether the transaction takes
place on a Brazilian stock exchange. Gains on sales or assignments made by the
Depositary on a Brazilian stock exchange are not taxed in Brazil, but gains on
other sales or assignments may be subject to tax at rates up to 15%.
Distributions of Interest on Capital
Brazilian corporations may make payments to shareholders characterized as
interest on the capital of the Registrant as an alternative form of making
dividend distributions. The rate of interest may not be higher than the Federal
Government's long-term interest rate (the "TJLP") as determined by the Central
Bank from time to time (13.48% per annum for the three month period starting
April 1999). The total amount distributed as interest on capital may not exceed
the greater of (i) 50% of net income (before taking such distribution and any
deductions for income taxes into account) for the year in respect of which the
payment is made or (ii) 50% of retained earnings for the year prior to the year
in respect of which the payment is made. Payments of interest on capital are
decided by the shareholders on the basis of recommendations of the company's
board of directors.
Distributions of interest on capital paid to Brazilian and non-Brazilian
holders of Preferred Shares, including payments to the Depositary in respect of
Preferred Shares underlying ADSs, are deductible by the Registrant for Brazilian
corporate income tax purposes Such payments are subject to Brazilian withholding
tax at the rate of 15%, except for payments to persons who are exempt from tax
in Brazil, which are free of Brazilian tax, and except for payments to persons
situated in jurisdictions deemed to be tax havens (i.e., countries that either
have no income tax or in which the income tax rate is less than 20%), which are
subject to tax at a 25% rate.
No assurance can be given that the Board of Directors of the Registrant
will not recommend that future distributions of profits should be made by means
of interest on capital instead of by means of dividends.
Amounts paid as interest on capital (net of applicable withholding tax) may
be treated as payments in respect of the dividends the Registrant is obligated
to distribute to its shareholders in accordance with its Charter and the
Brazilian Corporation Law.
Distributions of interest on capital in respect of the Preferred Shares,
including distributions to the Depositary in respect of Preferred Shares
underlying ADSs, may be converted into U.S. dollars and remitted outside of
Brazil, subject to applicable exchange controls.
Other Brazilian Taxes
There are no Brazilian inheritance, gift or succession taxes applicable to
the ownership, transfer or disposition of Preferred Shares or ADSs by a
non-Brazilian holder except for gift and inheritance taxes levied by some states
in Brazil on gifts made or inheritances bestowed by individuals or entities not
resident or domiciled in Brazil or in the relevant State to individuals or
entities that are resident or domiciled within such State in Brazil. There are
no Brazilian stamp, issue, registration, or similar taxes or duties payable by
holders of Preferred Shares or ADSs.
A financial transaction tax (the "IOF tax") may be imposed on the
conversion of Brazilian currency into foreign currency (e.g., for purposes of
paying dividends and interest). The rate of IOF tax rate on such conversions is
currently 0%, but the Minister of Finance has the legal power to increase the
rate to a maximum of 25%. Any such increase will be applicable only
prospectively.
In addition to the IOF tax, a second, temporary tax that applies to the
removal of funds from accounts at banks and other financial institutions (the
"CPMF tax") will be imposed on distributions by the Registrant in respect of
ADSs at the time such distributions are converted into U.S. dollars and remitted
abroad by the Custodian. The CPMF tax will be in effect until June 2002, unless
its term is extended, and such tax will be imposed at a rate of 0.38% from June
1999 until June 2000 and at a rate of 0.30% from June 2000 until June 2002.
Registered Capital
Amounts invested in Preferred Shares by a non-Brazilian holder who
qualifies under the Annex IV Regulations and obtains registration with the CVM,
or by the Depositary representing an ADS holder, are eligible for registration
with the Central Bank. Such registration (the amount so registered is referred
to as "Registered Capital") allows the remittance outside Brazil of foreign
currency, converted at the Commercial Market Rate, acquired with the proceeds of
distributions on, and amounts realized through dispositions of such Preferred
Shares. The Registered Capital per Preferred Share purchased in the form of an
ADS, or purchased in Brazil and deposited with the Depositary in exchange for an
ADS, will be equal to its purchase price (stated in U.S. dollars). The
Registered Capital per Preferred Share withdrawn upon cancellation of an ADS
will be the U.S. dollar equivalent of (i) the average price of a Preferred Share
on the Brazilian stock exchange on which the most Preferred Shares were traded
on the day of withdrawal or, (ii) if no Preferred Shares were traded on that
day, the average price on the Brazilian stock exchange on which the most
Preferred Shares were traded in the fifteen trading sessions immediately
preceding such withdrawal. The U.S. dollar equivalent will be determined on the
basis of the average Commercial Market Rates quoted by the Central Bank on such
date or dates.
A non-Brazilian holder of Preferred Shares may experience delays in
effecting Central Bank registration, which may delay remittances abroad. Such a
delay may adversely affect the amount in U.S. dollars, received by the
non-Brazilian holder.
U.S. Federal Income Tax Considerations
The statements regarding U.S. tax law set forth below are based on U.S. law
as in force on the date of this Annual Report, and changes to such law
subsequent to the date of this Annual Report may affect the tax consequences
described herein. This summary describes the principal tax consequences of the
ownership and disposition of Preferred Shares or ADSs, but it does not purport
to be a comprehensive description of all of the tax consequences that may be
relevant to a decision to hold or dispose of Preferred Shares or ADSs. This
summary applies only to purchasers of Preferred Shares or ADSs who will hold the
Preferred Shares or ADSs as capital assets and does not apply to special classes
of holders such as dealers in securities or currencies, holders whose functional
currency is not the U.S. dollar, holders of 10% or more of the shares of the
Registrant (taking into account shares held directly through depositary
arrangements), tax-exempt organizations, financial institutions, holders liable
for the alternative minimum tax, securities traders who elect to account for
their investment in Preferred Shares or ADSs on a mark-to-market basis, and
persons holding Preferred Shares or ADSs in a hedging transaction or as part of
a straddle or conversion transaction.
Each holder should consult such holder's own tax advisor concerning the
overall tax consequences to it, including the consequences under laws other than
U.S. federal income tax laws, of an investment in Preferred Shares or ADSs.
In this discussion, references to "ADSs" also refer to Preferred Shares,
references to a "U.S. holder" are to a holder of an ADS (i) that is a citizen or
resident of the United States of America, (ii) that is a corporation organized
under the laws of the United States of America or any state thereof, or (iii)
that is otherwise subject to U.S. federal income taxation on a net basis with
respect to the ADS.
For purposes of the U.S. Internal Revenue Code of 1986, as amended (the
"Code"), holders of ADRs will be treated as owners of the ADSs represented by
such ADRs.
Taxation of Dividends
A U.S. holder will recognize ordinary dividend income for U.S. federal
income tax purposes in an amount equal to the amount of any cash and the value
of any property distributed by the 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 nontaxable
return of capital, to the extent of the U.S. holder's tax basis in the ADS (or
Preferred Shares, as the case may be), and thereafter as capital gain. The
amount of any distribution will include the amount of Brazilian tax withheld on
the amount distributed and the amount of a distribution paid in reais will be
measured by reference to the exchange rate for converting reais into U.S.
dollars in effect on the date the distribution is received by the Custodian, or
by a U.S. holder, in the case of a holder of Preferred Shares. If the Custodian
or U.S. holder, in the case of a holder of Preferred Shares, does not convert
such reais into U.S. dollars on the date it receives them, it is possible that
the U.S. holder will recognize foreign currency loss or gain, which would be
ordinary loss or gain, when the reais are converted into U.S. dollars. Dividends
paid by the 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, Brazilian income tax withheld in connection with any distribution
with respect to the ADSs may be claimed as a credit against the U.S. federal
income tax liability of a U.S. holder if such U.S. holder elects for that year
to credit all foreign income taxes, or such Brazilian withholding tax may be
taken as a deduction. Foreign tax credits will not be allowed for withholding
taxes imposed in respect of certain short-term or hedged positions in securities
or in respect of arrangements in which a U.S. holder's expected economic profit,
after non-U.S. taxes, is insubstantial. U.S. holders should consult their own
tax advisors concerning the implications of these rules in light of their
particular circumstances.
Distributions of additional shares to holders with respect to their ADSs
that are made as part of a pro rata distribution to all shareholders of the
Registrant generally will not be subject to U.S. federal income tax.
A holder of an ADS that is a foreign corporation or nonresident alien
individual (a "non-U.S. holder") generally will not be subject to U.S. federal
income tax or withholding tax on distributions with respect to ADSs that are
treated as dividend income for U.S. federal income tax purposes, and generally
will not be subject to U.S. federal income tax or withholding tax on
distributions with respect to ADSs that are treated as capital gain for U.S.
federal income tax purposes unless such holder would be subject to U.S. federal
income tax on gain realized on the sale or other disposition of ADSs, as
discussed below.
Taxation of Capital Gains
Upon the sale or other disposition of an ADS, a U.S. holder will recognize
gain or loss for U.S. federal income tax purposes in an amount equal to the
difference between the amount realized in consideration for the disposition of
the ADS (excluding the amount of any distribution paid to the Custodian but not
distributed by the Custodian prior to the disposition) and the U.S. holder's tax
basis in the ADS. Such gain or loss generally will be subject to U.S. federal
income tax and will be treated as capital gain or loss. Long-term capital gains
recognized by an individual holder generally are subject to a maximum rate of 20
percent in respect of property held for more than one year. The deductibility of
capital losses is subject to certain limitations. Gain realized by a U.S. holder
on a sale or disposition of ADSs generally will be treated as U.S. source
income. Consequently, if Brazilian tax is imposed on such gain, the U.S. holder
will not be able to use the corresponding foreign tax credit, unless the holder
has other foreign source income of the appropriate type in respect of which the
credit may be used.
A non-U.S. holder will not be subject to U.S. federal income tax or
withholding tax on gain realized on the sale or other disposition of an ADS
unless (i) such gain is effectively connected with the conduct by the holder of
a trade or business in the United States, or (ii) such holder is an individual
who is present in the United States of America for 183 days or more in the
taxable year of the sale and certain other conditions are met.
U.S. Backup Withholding and Information Reporting
The information reporting requirements of the Code generally will apply to
distributions to a U.S. holder. Distributions to non-U.S. holders generally will
be exempt from information reporting and backup withholding under current law
but a non-U.S. holder may be required to establish its non-U.S. status in order
to claim such exemption.
Item 8. Selected Financial Data
Background
The selected financial information presented below should be read in
conjunction with, the Consolidated Financial Statements and the notes thereto
and Management's Discussion and Analysis of Financial Condition and Results of
Operations. The Consolidated Financial Statements have been audited by Ernst &
Young Auditores Independentes S.C. for 1998 and by KPMG Auditores Independentes
for 1996 and 1997, and their reports on the Consolidated Financial Statements
appear elsewhere in this Annual Report. The Consolidated Financial Statements
are prepared in accordance with U.S. GAAP.
U.S. GAAP Selected Financial Information
<TABLE>
<CAPTION>
Years ended December 31,
-------------------------------------------------
1996 1997 1998
------------ -------------- --------------
(thousands of constant reais at (thousands of
December 31, 1997) nominal reais,
except per
share data)
<S> <C> <C> <C>
Statement of operations data:
Revenues................................................ 166,453 219,316 232,555
Operating income........................................ 106,204 118,727 57,910
Income before unallocated interest and taxes............ 86,869 84,532 --
Net income (1).......................................... -- -- 31,532
Basic and diluted earnings in reais per common
thousand shares (1)................................ -- -- 0.09
Other financial data:
EBITDA (2).............................................. 113,676 131,023 96,624
Capital expenditures.................................... 105,467 51,768 31,672
<CAPTION>
As of December 31,
-------------------------------------------------
1996 1997 1998
------------ -------------- --------------
(thousands of constant reais at (thousands of
December 31, 1997) nominal reais,
except per
share data)
<S> <C> <C> <C>
Balance sheet data:
Cash and cash equivalents............................... -- 8,845 79,733
Working capital......................................... 6,580 17,161 78,654
Total assets............................................ 207,558 266,137 358,724
Long-term debt (including current portion).............. 16,842 24,057 39,203
Divisional equity....................................... 137,315 157,192 --
Shareholders' equity.................................... -- -- 189,852
</TABLE>
- ------------------
(1) Net income and earnings per share have not been presented for the prior
years, since interest and income taxes could not be segregated from the
Predecessor Companies. See Note 2 to the Consolidated Financial Statements.
(2) EBITDA consists of operating income plus depreciation and amortization and,
in 1998, impairment of assets. The Company's management believes that
EBITDA is a standard measure that is commonly reported and widely used by
analysts, investors and others in the wireless communications industry. The
information has been disclosed herein to permit a more complete comparative
analysis of the Company's operating performance and capitalization relative
to other companies in the industry. These indicators should not be
considered as a substitute or alternative for net income or cash flows.
Selected financial information as of and for the years ended December 31,
1994 and 1995 in accordance with U.S. GAAP is not provided because the
accounting records for those years were not maintained in a manner that would
readily permit all costs, assets and liabilities to be segregated between fixed
and cellular telecommunications operations in accordance with U.S. GAAP.
However, selected financial information as of and for the year ended December
31, 1995 in accordance with Brazilian GAAP is available, and is presented below
together with selected financial information as of and for the years ended
December 31, 1996, 1997 and 1998. For the year ended December 31, 1994, net
operating revenues were R$17.2 million and the Company had 17,699 subscribers.
Brazilian GAAP Selected Financial Information
<TABLE>
<CAPTION>
Years ended December 31,
----------------------------------------------------------
1995 1996 1997 1998 (1)
------ ------- ------ -------------
(thousands of constant reais at (thousands of
December 31, 1997) nominal reais,
except per
share data)
<S> <C> <C> <C> <C>
Statement of operations data:
Revenues................................................ 73,111 166,453 219,316 238,163
Operating income before interest and taxes.............. 48,555 105,885 118,881 64,206
Income before unallocated interest
and taxes.......................................... 37,973 83,978 82,291 --
Net income (2).......................................... -- -- -- 32,630
Basic and diluted earnings in reais per
common thousand shares (2)......................... -- -- -- 0.10
As of December 31,
---------------------------------------------------------
1995 1996 1997 1998 (1)
------ ------- ------ -------------
(thousands of constant reais at (thousands of
December 31, 1997) nominal reais,
except per
share data)
<S> <C> <C> <C> <C>
Balance sheet data:
Cash and cash equivalents............................... -- -- 8,845 79,733
Working capital......................................... 15,748 6,580 17,161 75,535
Total assets............................................ 94,716 208,541 271,349 361,736
Long-term debt (including current portion).............. 16,572 16,842 25,294 39,203
Divisional equity....................................... 46,496 138,113 165,308 --
Shareholders' equity.................................... -- -- -- 192,092
</TABLE>
- ------------------
(1) Certain information provided for 1998 differs from the Brazilian GAAP
financial information published in Brazil because the information published
in Brazil has been indexed through 1995, while the financial information
presented here has been indexed through 1997.
(2) Net income and earnings per share have not been presented for the prior
years, since interest and income taxes could not be segregated from the
Predecessor Companies.
The following table sets forth the period-end, average, high and low
Commercial Market Rate (through February 21, 1995) and Noon Buying Rate (from
February 22, 1995) expressed in reais per U.S. dollar for the periods indicated.
<TABLE>
<CAPTION>
Average for
Year Year-end year (1) High Low
- ------------ -------- ----------- ------ ------
<S> <C> <C> <C> <C>
1994................................................ 0.8460 0.6450 1.0000 0.1186
1995................................................ 0.9722 0.9228 0.9722 0.8450
1996................................................ 1.0393 1.0080 1.0413 0.9733
1997................................................ 1.1165 1.0805 1.1166 1.0394
1998................................................ 1.2085 1.1640 1.2090 1.1160
1999 (through May 31, 1999)......................... 1.7340 1.8553 2.2000 1.2074
</TABLE>
- ------------------
(1) Represents the average of the exchange rates on the last day of each month.
Source: Data as published by the Central Bank through February 21, 1995 and
the Federal Reserve Bank of New York since February 22, 1995.
Item 9. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Management's discussion and analysis is intended to assist in the
understanding and assessment of significant changes and trends in the results of
operations and financial condition of the Company. It should be read in
conjunction with the Consolidated Financial Statements and accompanying notes.
All financial data and discussion herein are based upon financial statements
prepared in accordance with U.S. GAAP.
Presentation of Financial Information
On May 22, 1998, in preparation for the privatization, the Telebras System
was restructured to form the 12 New Holding Companies, including the Registrant.
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. In the
Breakup, certain assets and liabilities of Telebras, including 80.3% of the
total share capital of Telamazon Celular, 86.9% of Telaima Celular, 90.6% of
Teleamapa Celular, 69.09% of Telepara Celular and 66.8% of Telma Celular were
transferred to the Registrant.
The Registrant was created effective February 28, 1998. For 1998, the
Consolidated Financial Statements reflect the consolidated financial condition
and results of operations of the Registrant and its Subsidiaries. For earlier
dates and periods, the Consolidated Financial Statements reflect only the
financial condition and results of operations of the cellular operations of the
Predecessor Companies. The formations of the Registrant and its Subsidiaries
have been accounted for as a reorganization of entities under common control in
a manner similar to a pooling of interests.
Upon its creation, the Registrant received, in addition to its shares of
the Subsidiaries, certain assets of Telebras consisting primarily of cash. As a
result, the consolidated shareholders' equity of the Company giving effect to
the Breakup of Telebras was R$2.0 million higher than divisional equity at
December 31, 1997.
The Subsidiaries were created effective January 1, 1998, by splitting up
the Predecessor Companies to separate their cellular operations from their
fixed-line operations. The assets and liabilities of the cellular
telecommunications businesses of the Predecessor Companies were transferred to
the Subsidiaries at their indexed historical costs. The revenues and expenses
associated with such assets and liabilities were also allocated to the
Subsidiaries. For 1998, the Consolidated Financial Statements reflect the
operations of the Subsidiaries as fully independent companies. For prior years,
the Consolidated Financial Statements reflect the cellular operations of the
Predecessor Companies, but are not necessarily indicative of what the financial
condition and results of operations of the Company would have been if the
cellular operations of the Predecessor Companies had been a separate legal
entity prior to 1998.
In preparing financial statements for years prior to 1998, it was not
possible to determine the amount of the Predecessor Companies' cash and
nonspecific debt that should be allocated to the cellular operations, and there
was no shareholders' equity specifically attributable to the cellular
operations. As a result, the presentation of the Consolidated Financial
Statements for 1996 and 1997 is different from 1998. In particular, for 1996 and
1997 the statement of operations does not include interest income or taxes and
includes only the allocable portion of interest expense, and it accordingly does
not present net income and historical earnings per share information.
The Company's accounting methodology changed in 1998 to reflect the lower
level of inflation in Brazil. Through December 31, 1997, the Consolidated
Financial Statements recognize certain effects of inflation and have been
restated in constant reais of December 31, 1997 purchasing power. The
restatement was made using the integral restatement method prescribed by the
CVM, which is an acceptable method of recognizing effects of inflation under
U.S. GAAP. Inflationary gains or losses on monetary assets and liabilities were
allocated to their corresponding income or expense caption in the Consolidated
Statements of Operations. Inflationary gains or losses without a corresponding
income or expense caption were allocated to other net operating income
(expense).
During 1997, the three-year cumulative inflation rate fell below 100%, and
as a result the Company no longer uses the integral restatement method effective
January 1, 1998. Accordingly, the Consolidated Financial Statements for 1998 are
presented in nominal reais and do not recognize effects of inflation. Financial
statements for prior dates and periods, which are restated in constant reais of
December 31, 1997, have not been further restated.
Composition of Operating Revenues and Expenses
The Company generates cellular service revenues from (a) 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; (b) monthly subscription
payments, which depend upon which service plan has been selected by the
customer; (c) 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; (d) activation fees,
which are one-time sign-up charges paid to obtain cellular service and vary with
the service plan selected by the subscriber; and (e) other services and charges.
The Company did not sell handsets in 1998 but began selling them in the second
quarter of 1999, although this will not contribute significantly to operating
income because the Company plans to offer handsets at cost, as an incentive for
its customers to subscribe to its services.
The principal taxes deducted from gross operating revenue are (i) a state
value-added tax, the ICMS, imposed on certain operating revenues from
telecommunications services (except for international, which has been exempt
from the ICMS since September 1996) and (ii) federal social contribution taxes,
including PIS and COFINS. The rate of the ICMS is 25.0%. The combined rate of
PIS and COFINS is 3.65% of gross operating revenues. Prior to February 1999, it
was 2.65%.
Operating expenses consist of cost of services, selling, general and
administrative expenses, bad debt expense, depreciation and, in 1998, a charge
for impairment of certain analog transmission equipment. Cost of services
consists primarily of fixed costs such as leased line charges, site rental and
network maintenance, including overhead, as well as variable costs such as
certain interconnection charges. Selling, general and administrative expenses
consist primarily of salaries, wages and related benefits for administrative
personnel, advertising and promotional expenses and other overhead expenses.
Results of Operations
The following discussion presents comparisons of results of operations for
1998 and 1997 and for 1997 and 1996. Because of the extensive changes in the
Company's circumstances in 1998 and related changes in financial statement
presentation, results of operations for 1998 and 1997 are not comparable in many
respects, and results of operations for 1998 are not necessarily indicative of
results to be expected for future periods.
1998 Compared to 1997
Net operating revenues were R$232.6 million in 1998, up 6% from R$219.3
million in 1997. The growth in revenues was attributable mainly to an increase
of 13% in the average number of subscribers, which was partly offset by lower
activation fee revenues as a result of fewer subscribers initiating services in
1998. Management expects that the reduction of activation fees together with
reductions in tariffs, will help stimulate growth in the Company's subscriber
base resulting in an increase in revenues from monthly subscription payments and
an increase in revenues from usage charges as a result of an increase in call
volume, but management is not able to determine the extent to which these
effects will offset the reduction in fees and tariffs. In 1999, a competing
cellular service provider will begin operating for the first time in the Region,
increasing the availability of cellular services in the Region. The Company's
management expects the advent of competition will contribute to declining prices
and will affect the Company's ability to maintain growth in its subscriber base.
Cost of services was R$48.9 million in 1998, up 24% from R$39.4 million in
1997. The increase is directly attributable to increased interconnection costs,
as a higher volume of calls was subject to network usage charges payable to
other cellular and fixed-line service providers.
Selling, general and administrative expenses were R$50.3 million in 1998,
up 43.3% from R$35.1 million of allocated costs recognized by the Predecessor
Companies in 1997. The increase reflects provisions for contingencies in the
amount of R$9.0 million, including R$6.2 million relating to the Company's legal
action contesting the application of ICMS to monthly subscription. In addition,
selling, general and administrative costs in 1998 reflect the costs associated
with the independent operation of the Company plus the costs of one-year service
contracts with the Predecessor Companies to assist the Company in its early
stages of autonomy. At present, the Company has largely ceased to rely on
services provided by the Predecessor Companies, because during 1998 and early
1999 the Company developed almost fully independent administrative capabilities.
Bad debt expense was R$38.4 million in 1998, compared to R$12.3 million in
1997. During the year, the Company continued to experience significant bad debt
levels due to a variety of factors, including (a) overall growth in the
Company's accounts receivable; (b) an increase in the number of customers with
relatively lower income (who are more prone to delay paying cellular telephone
bills); (c) subscription fraud; (d) poor credit and collection procedures; and
(e) increased consumer interest rates (which have adversely affected the ability
of consumers to meet payment obligations) resulting from adverse economic
conditions in Brazil. The Company maintains an allowance for past-due accounts
receivable in an amount equal to management's estimate of probable future losses
on such accounts, based on historical losses and the current level of overdue
accounts receivable. The Company also immediately charges off any account
receivable arising from fraud. Cellular service is cut off to customers who have
accounts receivable that are more than 20 days past-due. In the fourth quarter
of 1998, the Company put in place new credit and collection policies and is
implementing an anti-fraud system, which will be in operation in the second half
of 1999 in order to reduce the level of bad debt. As a result of these measures,
management expects that bad debt levels will decline in the future.
The Company's competitor in the Region will begin operating in the second
half of 1999, and will offer only digital service. As a result, the Company will
be offering primarily digital service to new customers. This will speed the
obsolescence of the Company's analog equipment, which in the fourth quarter of
1998 triggered a charge of R$18.4 million for impairment of its analog
transmission equipment. Depreciation expense was R$20.3 million in 1998,
compared to R$12.3 million in 1997, reflecting the increased investment in
property, plant and equipment. In addition, at the end of 1998, the Company
revised its estimate of useful lives of property, plant and equipment in light
of the advent of competition and a review of industry practices. This change
will result in a further increase depreciation expense for 1999 by approximately
R$15 million.
Interest income was R$8.6 million in 1998, due to investment of cash on
hand. The Company did not recognize interest income in 1997. Interest expense
increased to R$4.0 million in 1998, from R$0.8 million (on an allocated expense
basis) in 1997, reflecting the R$15.1 million net increase in consolidated
indebtedness. Foreign exchange loss was R$2.5 million in 1998, due to the effect
of devaluation of the real on the Company's debt. Debt denominated in U.S.
dollars amounted to R$29.0 million at December 31, 1998. The Company will also
recognize substantially higher foreign exchange loss due to the devaluation of
the real in 1999. In the first quarter of 1999, the devaluation of the real
against the U.S. dollar was 42%, resulting in exchange loss of approximately
R$12 million.
Income and social contribution taxes were R$16.9 million in 1998. The
effective rate of tax on pretax income was 28%, compared to the combined
statutory rate of 33%. The Company did not incur income and social contribution
taxes in 1997.
Minority interest of R$11.6 million consists of the share of profit of the
Subsidiaries that is attributable to shareholders other than the Registrant. Net
income for 1998 was R$31.5 million or R$0.09 per thousand common shares.
1997 Compared to 1996
Net operating revenues were R$219.3 million in 1997, up 32% from R$166.5
million in 1996. The growth in revenues was attributable mainly to an increase
of more than 60% in the average number of subscribers. The rate of revenue
growth lagged behind the rate of subscriber growth in 1997 because (a) most
subscription charges did not increase with inflation; (b) a lower number of
subscribers initiated service resulting in a reduction of activation fee
revenues; and (c) there was an increase in the volume of calls to the Company's
clients originating outside the Company's network.
Cost of services was R$39.4 million in 1997, up 30% from R$30.2 million in
1996. This increase was related mainly to increased network usage charges paid
to the Predecessor Companies and other fixed-line providers throughout Brazil.
The increase in the amount of network usage charges was related to an increase
in the total volume of calls, and was offset partially because network usage
charges did not increase with inflation. The increase in cost of services was
also attributable to increased leased line costs. The increase in leased line
usage was a result of the continued expansion of the Company's network,
particularly in the States of Amazonas and Para.
Selling, general and administrative expenses were R$35.1 million in 1997,
compared to R$27.3 million in 1996. This increase was attributable principally
to increased costs of services provided by the Predecessor Companies, reflecting
growth in the Company's business. The amounts of such costs in 1996 and 1997
represent allocations to the Company of personnel and overhead expenses for
services provided by the employees of the Predecessor Companies. The allocations
are based on management's estimates of such expenses dedicated to the cellular
business in those years. The increase also reflected increased marketing and
advertising expenses.
Bad debt expense was R$12.3 million in 1997, compared to R$0.2 million in
1996. Prior to 1997, the Company did not experience significant losses from bad
debts and, accordingly, provisions for past due accounts receivable were low in
the initial years of operation. This was due in part to the fact that most of
the Company's early subscribers were required to pledge their fixed lines as a
guarantee security for payment for cellular service. Because nonpayment of
cellular accounts would result in subscribers losing fixed-line services, the
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. In view of the value of a cellular line,
many of the Company's subscribers had greater incentive to keep current in their
payments. As the Company began to satisfy a greater proportion of the Region's
demand in 1997, 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.
Depreciation expenses were R$12.3 million in 1997, compared to R$7.5
million in 1996. This increase reflected the expansion of the Company's network
through investment in property, plant and equipment.
Liquidity and Capital Resources
In 1998, cash provided by operating activities was R$84.8 million and the
amount of EBITDA (operating income plus depreciation and the charge for
impairment of long-lived assets) was R$96.6 million. Additionally, the Company
received R$2.0 million in cash upon the Breakup of Telebras, and at year-end it
had cash and cash equivalents of R$79.7 million.
The Company invested R$31.7 million in 1998 in acquisitions of property,
plant and equipment, as it continued to develop its network to increase coverage
and quality of service and to prepare for the advent of competition. These
investments were made during a period of transition, as the Subsidiaries were
spun off from the Predecessor Companies at the beginning of the year, Telebras
was broken up and the controlling interest in the Company was sold in August.
The Company had R$39.2 million of unsecured indebtedness at December 31,
1998, of which R$29 million was denominated in U.S. dollars and bore interest at
LIBOR plus 0.4% and R$10.2 million in reais bearing interest at a rate indexed
to the variation of "Fundo Extra-Mercado" disclosed by the Bank of Brazil. All
of the Company's indebtedness arises from equipment financing. Part represents
financing originally incurred by the Predecessor Companies and assigned to the
Subsidiaries. The balance represents financing originally incurred by Telebras
and made available by Telebras to the Predecessor Companies. In 1998 the
indebtedness was assigned to the Subsidiaries, and in the Breakup of Telebras
the credit was assigned to an unaffiliated New Holding Company.
Substantially all the Company's start-up costs and initial capital
investments were financed by cash flows from the fixed-line telephone operations
of the Predecessor Companies. 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 if the Company had operated on a stand-alone basis
from the inception of the Predecessor Companies' cellular telecommunications
operations.
The Registrant is required to distribute to its shareholders, either as
dividends or as tax-deductible interest on net worth, 25% of its adjusted net
income determined in accordance with Brazilian accounting principles as adjusted
in accordance with Brazilian corporate law. The Registrant is also required to
pay a noncumulative preferred dividend on its preferred shares in an amount
equal to 6% of the share capital attributable to the preferred shares under
Brazilian corporate law. For purposes of the mandatory distribution requirement,
the Registrant included in adjusted net income part of the unrealized income
reserve transferred upon the Breakup of Telebras, which amounted to R$59.3
million and is included in distributable capital and other reserves in the
shareholders' equity of the Consolidated Financial Statements. The Company
decided to include the unrealized reserve in the calculation of the mandatory
distribution requirements over a ten year period. As a result, the total
dividend for the year ended December 31, 1998 amounted to R$11.0 million, of
which R$7.6 million was transferred into a special reserve for future
investments. The actual cash dividend payment pertaining to the year 1998 was
R$3.5 million. There can be no assurance that the mandatory distribution of the
unrealized income reserve will not result in substantial additional dividend
requirements.
The Registrant was formed in 1998, and the cash flows reflected in the
Consolidated Financial Statements for 1996 and 1997 do not reflect any payments
of income and social contribution taxes or dividends or the amount of financing
or debt service the Company would have borne if it had been an independent
company.
The Registrant's only significant asset other than cash is its shares in
the Subsidiaries. The Registrant relies almost exclusively on dividends from the
Subsidiaries to meet its needs for cash, including for the payment of dividends
to its shareholders. The Registrant controls the payment of dividends by the
Subsidiaries, subject to limitations under Brazilian corporate law.
The Company participates in a multi-employer defined benefit plan that
covers the former employees of the Telebras System, and the Company is
contingently liable for the unfunded obligations of the plan. See Note 11 to the
Consolidated Financial Statements.
Capital Expenditures
The Company currently expects that its capital expenditures for the years
1999 through 2001 will aggregate approximately R$300 million, with approximately
R$100 million of that amount falling in 1999. This estimate is based on March
31, 1999 exchange rates, and because a substantial portion of capital
expenditures is denominated in U.S. dollars, further devaluation of the real
could require that the estimate be increased. The estimated amount and timing of
capital expenditures are also subject to a number of other risks and
uncertainties.
The Company believes that its capital expenditure requirements can be met
through a combination of cash flow from operations and equipment financing from
a variety of sources.
Economic, Regulatory and Competitive Factors
The Company's financial condition and operations are significantly affected
by Brazilian telecommunications regulation, including regulation of tariffs. The
Company's financial condition and results of operations also have been, and are
expected to continue to be, affected by the political and economic environment
in Brazil. In particular, the Company's financial performance will be affected
by (a) economic growth in the Region and its impact on demand for
telecommunications services, (b) the cost and availability of financing and (c)
the exchange rates between Brazilian and foreign currencies.
The Company will face competition in the Region in 1999 and anticipates
that competition will contribute to declining prices for cellular
telecommunications services and increasing pressure on operating margins. The
future growth and results of operations of the Company will depend significantly
on a variety of factors including its ability to attract new subscribers, the
rate of growth of the subscriber base, the usage and revenue generated from its
subscribers, the level of airtime and equipment prices, the rate of churn and
its ability to control costs. 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 many of which are beyond
the Company's control.
The Brazilian economy has in the past been subject to high levels of
inflation. In 1998, inflation was 1.8% as measured by the IGP-M index, but
inflation has increased in 1999. Inflation for the first quarter of 1999 was
7.4% and there can be no assurance that it will not remain at a high rate for
the rest of the year. The Company does not expect that increases in its rates
will keep pace with inflation, so high inflation would be likely to have an
adverse effect on the Company's operating margins. High inflation could also
have a variety of other effects on the Company's financial condition and results
of operations that are not at present foreseeable. Because financial information
for the Company for 1996 and 1997 is presented in constant reais as of December
31, 1997, reported revenues for those years reflect average real rates (i.e.,
actual rates as restated in constant currency in accordance with variations in
the applicable index) rather than actual rates.
The Brazilian currency has from time to time been subject to significant
devaluation against the U.S. dollar and other foreign currencies. In 1998,
devaluation of the real was 8.3%, but in the first quarter of 1999 there was a
42% devaluation. Devaluation results in exchange loss on the Company's U.S.
dollar-denominated indebtedness. Indebtedness denominated in U.S. dollars
amounted to R$29 million (approximately 74% of the Company's indebtedness) at
December 31, 1998 and is expected to increase in 1999 and future years.
Devaluation also increases the costs in real terms of equipment that is priced
in U.S. dollars, which constitutes a substantial portion of the Company's
capital expenditure requirements.
Impact of the Year 2000 Issue
The Year 2000 Issue arises because many information technology systems and
embedded systems existing in certain automated equipment and associated software
use two digits, rather than four, to identify a year. Date-sensitive systems may
potentially be unable to process accurately certain data before, on, or after
January 1, 2000 and, if not addressed, the impact on operations and financial
reporting may range from minor errors and miscalculations to significant systems
failure, causing disruptions to various operations and activities including a
temporary inability to render and send invoices, to process customer orders, to
provide customer service, and facilitate various engineering and administrative
functions.
Based on recent assessments, the Company determined that it will be
required to modify or replace significant portions of its software and certain
hardware. The Company began independent operations during 1998, and the major
portion of the equipment and software it uses was purchased in 1998 and 1999 and
is Year 2000 compliant. With respect to other equipment and software, however,
if modifications and replacements are not made, or are not completed timely, the
Year 2000 Issue could have a material impact on the operations of the Company.
To address the Year 2000 Issue, the Company has formulated a plan to ensure that
the critical, date-sensitive systems and applications it relies on are Year 2000
compliant prior to December 31, 1999.
The Company's plan to address the Year 2000 Issue involves assessment,
remediation, testing and implementation. These phases run concurrently for
different systems. To date, the Company completed the assessment of all systems
critical to its operation and activities, which require modification or
replacement prior to Year 2000. The remediation and the testing phases for all
significant systems are expected to be completed by June 30, 1999, with 100%
completion targeted for October 31, 1999.
The Company relies to varying degrees on external business partners, such
as third party vendors and service providers (including banks for payment
processing) and interconnected telecommunication network operators. For example,
calls originating on the Company's networks that terminate on other networks may
experience problems unless the other networks' systems are Year 2000 compliant.
The Company has begun to ask its external business partners about their progress
in identifying and addressing the Year 2000 Issue. Once such information is
collected, the Company will formulate contingency plans, such as the
identification of alternative Year 2000 compliant service providers. For basic
telephony, however, in most cases there is only one provider and the Company
will not be able to select alternative providers. The inability of external
business partners to complete their Year 2000 compliance process in a timely
fashion could materially impact the Company. The effect of non-compliance by
external agents is not determinable. The Company is in the process of developing
contingency plans for its business critical system in the event of a Year 2000
failure. These contingency plans involve, among other actions, manual
workarounds and adjusting staffing strategies.
The Company will utilize both internal and external resources to reprogram
or replace, test, and implement the software and operating equipment for Year
2000 compliance. The total cost of the Year 2000 project to be incurred in 1999
is estimated at R$0.5 million and is not expected to have a material impact on
the Company's financial position or results of operations.
Management of the Company believes it has an effective program in place to
resolve the Year 2000 issue in a timely manner. As noted above, the Company has
not yet completed all necessary phases of the Year 2000 program. There can be no
assurance that there will not be delays, or increased costs associated with the
implementation of required changes, which could have an adverse effect on future
operations. If the Company does not complete any additional phases, its ability
to take customer orders, provide services, invoice customers and collect
payments could be adversely affected.
The foregoing disclosure is based on management's current expectation,
estimates and projections, which could ultimately prove to be inaccurate.
Notwithstanding the efforts described above, the Company could potentially
experience disruptions to some operations or supplies as a result of Year 2000
issues. Such disruptions could include problems from non-compliant systems
utilized by suppliers, customers, governmental entities and others; or the
inability or failure to identify all critical Year 2000 issues or to develop
appropriate contingency plans for all Year 2000 issues that ultimately may
arise. In addition, disruptions in the economy generally resulting from Year
2000 issues could also materially adversely affect the Company. The amount of
potential liability and lost revenues cannot be reasonably estimated at this
time.
The most likely worst case scenario of failure by the Company, the
interconnected telecommunication network operators or its other external
business partners to resolve their Year 2000 Issue would be a temporary slowdown
or cessation of its operations and certain activities in one or more of the
areas in which it is operating at the time of the failure. The impact of such
failure cannot be reasonably estimated at this time.
Item 9A. Quantitative and Qualitative Disclosures About Market Risk
The Company is primarily 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 and debt are denominated
in currencies (primarily the U.S. dollar) other than those in which it earns
revenues (primarily the real). Similarly, the Company is subject to market risk
deriving from changes in interest rates which may affect the cost of its
financing. The Company does not use derivative instruments, such as foreign
exchange forward contracts, foreign currency options, interest rate swaps and
forward rate agreements, to manage these market risks, nor does it hold or issue
derivative or other financial instruments for trading purposes.
Exchange Rate Risk
The Company has exchange rate exposure with respect to the U.S. dollar.
Approximately R$29.0 million of the Company's indebtedness is denominated in
U.S. dollars. The potential additional costs to the Company that would result
from a hypothetical 25% change in foreign currency exchange rates would be
approximately R$7.3 million.
Interest Rate Risk
At December 31, 1998, the Company had approximately R$39.2 million in loans
and financing outstanding, all of which bore interest at floating rates. The
Company invests its excess liquidity (R$79.7 million at December 31, 1998)
mainly in short-term instruments. The potential loss in earnings 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, 1998 would be approximately
R$0.5 million. The above sensitivity analysis is based on the assumption of an
unfavorable 100 basis point movement of the interest rates applicable to each
homogeneous category of financial assets and liabilities and sustained over a
period of one year. A homogeneous category is defined according to the currency
in which financial assets and liabilities are denominated and assumes the same
interest rate movement within each homogeneous category (e.g. U.S. dollars). As
a result, the Company's interest rate risk sensitivity model may overstate the
impact of interest rate fluctuations for such financial instruments as
consistently unfavorable movements of all interest rates are unlikely. See Note
5 to the Consolidated Financial Statements.
Item 10. Directors and Officers of Registrant
Board of Directors
The Registrant is administered by a Board of Directors (Conselho de
Administracao) and a Board of Executive Officers (Diretoria). The Board of
Directors comprises eleven members serving for a term of three years. The Board
of Directors holds a regular meeting once every two months and holds special
meetings when called by the Chairman or by two members of the Board of
Directors.
The following are the current members of the Board of Directors and their
respective positions.
<TABLE>
<CAPTION>
Name Position Date elected
- ----------- -------- --------------------
<S> <C> <C>
Arthur Joaquim de Carvalho...................................... Chairman August 10, 1998
Gerard Manuel Vazquez........................................... Director August 10, 1998
Wellington Dantas de Amorim..................................... Director August 10,1998
Bruno Ducharme.................................................. Director September 1, 1998
David Travesso Neto............................................. Director September 1,1998
Zeno Antonio Brandt............................................. Director September 1,1998
Margriet Zwarts................................................. Director September 1, 1998
Rene Patoine.................................................... Director September 1, 1998
Maria Amalia Delfim de Melo Coutrim............................. Director September 16, 1998
Sergio Jose Teixeira............................................ Director April 23, 1999
Peter Gerald White.............................................. Director April 23, 1999
</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 Telemig Celular Participacoes S.A. In addition, Mr.
Carvalho is a Principal of CVC/Opportunity Equity Partners Ltd., a Cayman
Islands 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 a member of the Board of Directors
since August 1998. He serves as President of the Company and as a member of the
Board of Telemig 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 of 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.
Wellington Dantas de Amorim has served as a member of the Board of
Directors since August 1998. Since April 1998, Mr. Amorim has served as the
Investment Manager for PREVI - Caixa de Previdencia dos Funcionarios do Banco do
Brasil. From 1982 to 1998, Mr. Amorim served as an employee of Banco do Brasil
S.A. ("BB"). He served as Assistant to the Executive Committee of BB and Member
of the Technical Consulting of the Executive Committee of BB. He has served also
as the Coordinator of the Center of Planning and Control for the Rio de Janeiro
State Cabinet. He holds a degree and a masters degree in international relations
from the University of Brasilia.
Bruno Ducharme was appointed to the Board of Directors of the Company in
September 1998. He serves as President and Chief Executive Officer of 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 from McGill University, a master's degree 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.
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.
Zeno Antonio Brandt has served as a member of the Board of Directors since
September 1998. He joined Banco do Brasil S.A. in 1986 where he has served as
Chief of Service, Supervisor, Manager of Resources, and Branch Manager until
1997. He has diplomas in management, business administration, finance and sales.
Margriet Zwarts was elected to the Board of Directors of the Company on
September 1, 1998. She serves as Vice-President of Legal Affairs of Telesystem
International Wireless Inc. Prior to that, she practiced law in private
practice, initially with the Montreal law firm of Martineau, Walker and since
1989 with the Montreal 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.
Rene Patoine was elected to the Board of Directors of the Company on
September 1, 1998. Mr. Patoine has been Executive Vice-President of Operations
of the Company since September 1998. Prior to that he served as Executive
Vice-President of Operations of Telesystem International Wireless Inc. He served
as Vice-President of 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
Sherbrooke University, Quebec, Canada.
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.
Sergio Jose Teixeira was elected to the Board of Directors of the Company
on April 23, 1999. He has served as a board memeber of Fundacao Petrobras de
Seguridade Social. At Petroleo Brasileiro S.A. - Petrobras and Petrobras
Mineracao S.A. - Petromisa, he acquired broad experience in the areas of
business administration, coordination, management and planning of human resource
activities. He also serves a Professor at the Rio de Janeiro Education and
Culture State office. He holds a degree in business administration from the
Faculdade de Ciencia Contabeise Administrativas Moraes Juniior and a degree in
politics and strategy studies from the Escola Superior de Guerra.
Peter Gerald White was elected to the Board of Directors of the Company on
April 23, 1999. He previously served as special assistant to the Federal
Minister of Forestry and Rural Development in Canada, and special assistant to
the Premier of Quebec. He founded the Laval Congress on Canadian Affairs in
1961, and in 1969 formed the Sterling Newspaper Group. He has received the
recognition of Chevalier de l'Ordre National de la Legion d'Honneur in 1997 by
the President of France for his role in developing strong economic ties between
Canada and France. He served as the President of the Canada-France Business Club
and later as Chairman of the Canadian Institute of International Affairs. He
served as Chairman, President and CEO of Domgroup Ltd., Publisher of Saturday
Night Magazine, founding Chairman of Public Policy Forum, President of the
Council for Canadian Unity, Executive Vice-President of The Ravelston
Corporation and Argus Corporation, and Director of Hollinger Inc., UniMedia
Inc., Southam Inc., Telesystem Ltd., Proprietary Energy Industries Inc., Cinram
International, and Normerica Building Systems Inc. He holds a law degree from
the University of Laval.
Executive Officers
The following are the Executive Officers and their respective positions.
<TABLE>
<CAPTION>
Name Position
- ------------- ---------------------------------------------------
<S> <C>
Marcio Kaiser.............................................. President and Chief Executive Officer
Joao Cox Neto.............................................. Chief Financial Officer and Market Relations
Executive Officer
Rene Patoine............................................... Executive and Vice-President of Operations
Jose Alberto D'Ambrosio.................................... Vice-President of Human Resources and Administration
Antonio Jose Ribeiro dos Santos............................ Vice-President of Business Development
Benoit Bellerose........................................... Corporate Controller
Marcos Aurelio Lopes de Oliveira........................... Superintendent of Telepara Celular S.A., Teleamapa
Celular S.A., Telma Celular S.A., Telamazon Celular
S.A., Telaima Celular S.A.
</TABLE>
Set forth below are brief biographical descriptions of the Executive
Officers not included above.
Marcio Kaiser was appointed President and Chief Executive Officer of
Telemig Celular Participacoes S.A. and Tele Norte Celular Participacoes S.A. on
January 4, 1999. Mr. Kaiser has extensive management and marketing experience in
high technology, particularly the computer technology sector. He was, until
recently, President and Managing Director of Oracle Brazil. Before that, Mr.
Kaiser spent 20 years with IBM Brazil and IBM Latin America. He served
successively as Chief Financial Officer, Regional Director, Country Director of
Sales and Marketing, Vice-President and Director of Technology and Executive
Committee Member for IBM Brazil. He also served as General Services Manager for
IBM Latin America.
Joao Cox Neto has been Chief Financial Officer since April 1, 1999. Prior
to joining Telemig Celular Participacoes S.A. and Tele Norte Celular
Participacoes S.A., Mr. Cox held the position of Chief Financial Officer at
Odebrecht Servicos de Infraestrutura S.A. (OSI), the infrastructure and public
service arm of the Odebrecht Group. Previously, he held various financial
management positions at the Odebrecht Group, including Finance Director for the
holding company and CFO for OPP Petroquimica S.A. Mr. Cox holds a degree in
Economics from Universidade Federal da Bahia and has attended to graduate
studies in Economics at the Universite du Quebec a Montreal and at the Oxford
University's CPS program. Since 1991 Mr. Cox has been a member of the Board of
Directors of several companies in Brazil and Argentina and he is currently a
member of the Board of ABRASCA (Brazilian Association of Public Companies) and
IBRI (Brazilian Institute for Investor Relations).
Jose Alberto D'Ambrosio was appointed Vice President of Human Resources and
Administration on April 1, 1999. Mr. D'Ambrosio previously served as Director of
Human Resources Products and Services at PricewaterhouseCoopers, where he worked
extensively with multinational corporations in directing human resources
consulting projects. Prior to that, he served as a Senior Consultant at Towers
Perrin where he was responsible for designing, implementing and monitoring
Compensation and Benefits Programs as well as for leading the Health Care
consulting practice area in Latin America. Including his first assignment as
Human Resources Manager for Alcoa Aluminio S.A., Mr. D'Ambrosio has 23 years of
experience in the Human Resources field. He holds a degree in economics from
Faculdade de Administracao e Economia de S.J. da Boa Vista/Sao Paulo as well a
Post-Graduate degree in Administration from Instituto Maua de Tecnologia/Sao
Paulo.
Antonio Jose Ribeiro dos Santos has been appointed Vice-President of
Business Development. Mr. Santos, with 28 years experience in the Brazilian
telecommunications industry, joined the company's management team from
Telebrasilia S.A., a recently privatized telephone company in Brasilia where he
headed the engineering department. At Telebrasilia, he was responsible for
projects such as the implementation and expansion of cellular lines. Mr. dos
Santos worked for the first private cellular company in Brazil, Americel, as the
head of the Strategic Planning Directory and for the B-Band cellular company in
the State of Rio Grande do Sul, Telet S.A., where he was an Executive
Vice-President. He also is a part-time professor at Brasilia University in the
Department of Electric Engineering. Mr. dos Santos graduated from the University
of Brasilia and holds a degree in Electric Engineering.
Benoit Bellerose serves as Corporate Controller of the Company. Prior to
joining the Company, Mr. Bellerose was the assistant controller at Telesystem
International Wireless Inc. Before 1997 Mr. Bellerose was a principal at Ernst &
Young in Canada. Mr. Bellerose holds a bachelor's degree in Business
Administration from the Universite du Quebec a Trois-Rivieres, Canada and is a
member of the Canadian Institute of Chartered Accountants.
Marcos Aurelio Lopes de Oliveira has served as an Executive Officer since
May 1998. From 1991 to 1996 he served as President of Telecomunicacoes do Para
S.A. - TELEPARA, and from 1996 to 1998, he served as Director of Engineering.
Currently he serves as Superintendent of Telepara Celular S.A., Teleamapa
Celular S.A., Telma Celular S.A., Telamazon Celular S.A. and Telaima Celular
S.A. He holds a degree in electrical engineering from the Federal University of
Para.
Item 11. Compensation of Directors and Officers
For the year ended December 31, 1998, the aggregate amount of compensation
paid by the Company to all directors and executive officers as a group was
approximately R$108.4 thousand.
For the year ended December 31, 1998, the Company did not set aside or
accrue monies to provide pension, retirement or similar benefits for officers
and directors.
Item 12. Options to Purchase Securities from Registrant or Subsidiaries
None.
Item 13. Interest of Management in Certain Transactions
None.
PART II
Item 14. Description of Securities to be Registered
None.
PART III
Item 15. Defaults upon Senior Securities
Not applicable.
Item 16. Changes in Securities, Changes in Security for Registered Securities
and Use of Proceeds.
None.
PART IV
Item 17. Financial Statements
The Registrant has responded to Item 18 in lieu of responding to this Item.
Item 18. Financial Statements
Reference is made to pages F-1 through F-27.
Item 19. Financial Statements and Exhibits
(a) The following Consolidated Financial Statements are filed as
part of this Form 20-F:
Independent Auditors' Report
Consolidated Balance Sheets
Consolidated Statements of Operations and Comprehensive Income
Consolidated Statement of Cash Flows
Consolidated Statement of Net Interdivisional Cash
Distribution (Receipt)
Consolidated Statement of Changes in Shareholders' Equity
Notes to the Consolidated Financial Statements
(b) Exhibits:
Amendments to the Charter of the Registrant* previously filed
with the Registrant's Registration Statement on September 18,
1998.
Amendment to the Deposit Agreement** previously filed with the
Registrant's Registration Statement on September 18, 1998.
There are omitted from the exhibits filed with or incorporated
by reference into this Annual Report certain promissory notes
and other instruments and agreements with respect to long-term
debt of the Company, none of which authorizes securities in a
total amount that exceeds 10% of the total assets of the
Company. The Company hereby agrees to furnish to the
Securities and Exchange Commission copies of any such omitted
promissory notes or other instruments or agreements as the
Commission requests.
- --------
* Incorporated by reference to the Holding Company's Form 6-K filed on April
23, 1999 and May 8, 1999.
** Incorporated by reference to the exhibits filed with the Holding Company's
Current Report on Form F-6 on October 28, 1998 (No. 333-9554).
<PAGE>
INDEX OF DEFINED TERMS
Page
AD.................................................7
ADRs..............................................ii
ADSs..............................................ii
American Depositary Shares........................ii
Anatel.............................................1
Anatel Decree.....................................12
Annex IV Regulations..............................23
Annex V Regulations...............................23
Band A............................................10
Band A Service Provider...........................10
Band B............................................10
Band B Service Provider...........................10
BB................................................39
Brazil............................................ii
Brazilian Corporation Law.........................22
Brazilian GAAP....................................ii
Brazilian Securities Law..........................22
Breakup............................................1
Breakup of Telebras................................1
Cellular Region....................................2
Central Bank.......................................4
Code..............................................27
COFINS.............................................8
Common Shares.....................................ii
Company...........................................ii
Concessions........................................1
Consolidated Financial Statements.................ii
CPMF tax..........................................26
Custodian.........................................23
CVM...............................................22
Deposit Agreement.................................21
Depositary........................................21
dollars...........................................ii
DSL1...............................................7
DSL2...............................................7
e&p...............................................27
Embratel...........................................2
Federal Government................................ii
Fittel............................................11
Fixed-Line Region..................................2
GDP................................................4
General Telecommunications Law.....................1
IBGE...............................................4
ICMS...............................................7
IGP-DI............................................15
IGP-M.............................................18
IMF...............................................16
IOF tax...........................................26
ISS................................................7
List of Obligations...............................12
Minimum Law.......................................13
New Holding Companies..............................1
Newtel............................................21
non-Brazilian holder..............................24
non-U.S. holder...................................28
Opportunity.......................................21
PCS...............................................10
PIS................................................8
Predecessor Companies.............................ii
Preferred Shares..................................ii
R$................................................ii
reais.............................................ii
real..............................................ii
Real Plan.........................................15
Region.............................................1
Registered Capital................................26
Registrant........................................ii
Rio de Janeiro Stock Exchange.....................21
Sao Paulo Stock Exchange..........................21
SENN..............................................22
Sistel............................................12
Subsidiaries......................................ii
Page
Tele Norte Celular................................ii
Telebras..........................................ii
Telebras System....................................1
Telecommunications Regulations.....................1
Telesystem........................................40
Telpart............................................2
TIW...............................................21
TJLP..............................................25
U.S. dollars......................................ii
U.S. GAAP.........................................ii
U.S. holder.......................................27
US$...............................................ii
VC1................................................6
VC2................................................6
VC3................................................6
<PAGE>
TECHNICAL GLOSSARY
The following explanations are not intended as technical definitions, but
to assist the general reader to understand certain terms as used in this Annual
Report.
Access charge: Amount paid per minute charged by network operators for the
use of their network by other network operators. Also known as an
"interconnection charge" or "network usage charge."
Access gates: The points of interface between the network equipment (either
dedicated or switched) and the transmission media that connect network equipment
to the end user. The quantity of service is directly related to the quantity of
network access gates.
AMPS (Advanced Mobile Phone Service): An analog cellular telecommunications
services 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 telephone on a foreign cellular service provider's
network. The subscriber may receive calls made to the subscriber's regular
cellular telephone number (such calls are "automatically" passed to the foreign
service provider's network).
Band A Service Provider: A former Telebras operating subsidiary that has
been granted a concession to provide cellular telecommunications services in a
particular area within a radio spectrum frequency range referred to by Anatel as
"Band A."
Band B Service Provider: A cellular service provider that has been granted
a concession to provide cellular telecommunications services in a particular
area within a radio spectrum frequency range referred to by Anatel as "Band B."
Base station: A radio transmitter/receiver that maintains communications
with the cellular telephones within a given cell. Each base station in turn is
interconnected with other base stations and with the public switched telephone
network.
Broadband services: Services characterized by a transmission speed of 2
Mbit/s or more. According to international standards, these services are divided
into two categories: (i) Interactive services, including
videotelephone/videoconferencing (both point-to-point and multipoint);
videomonitoring; interconnection of local networks; file transfer; CAD;
high-speed fax; e-mail for moving images or mixed documents; broadband
videotext; video on demand; retrieval of sound programs or fixed and moving
images; and (ii) Broadcast services, such as sound programs, television programs
(including high-definition TV and pay TV) and selective document acquisition.
CATV (Cable television): Cable or fiber-based distribution of TV programs.
CDMA (Code Division Multiple Access): A standard of digital cellular
telecommunications technology.
Cell: The geographic area covered by a single base station in a cellular
telecommunications system.
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 cellular telecommunications system.
Cellular service: A mobile telecommunications service provided by means of
a network of interconnected, low-powered base stations, each of which covers one
small geographic cell within the total cellular telecommunications system
service area.
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 64 kbps transmitted through mediums that are leased to users
for their exclusive use.
Local loop: The system used to connect the subscriber to the nearest
switch. It generally consists of a pair of copper wires, but may also employ
fiber-optic circuits, microwave links or other technologies.
Manual international roaming: A service that permits a subscriber to use
his or her cellular telephone on a foreign cellular service provider's network.
The subscriber may only receive calls made to a temporary number issued to the
subscriber by the foreign service provider for use while roaming.
Microcells: A small cell covered by a low-power base station. Microcells
can cover small areas such as a single building.
Network: An interconnected collection of elements. In a telephone network,
these consist of switches connected to each other and to customer equipment. The
transmission equipment may be based on fiber optic or metallic cable or
point-to-point radio connections.
Network usage charge: Amount paid per minute charged by network operators
for the use of their network by other network operators. Also known as an
"access charge" or "interconnection charge."
Optical fiber: A transmission medium which permits extremely high
capacities. It consists of a thin strand of glass that provides a pathway along
which waves of light can travel for telecommunications purposes.
Packet-switched data communication services: Data services based on
parceling or breaking the data stream into packets and switching the individual
packets. Information transmitted is segmented into cells of a standardized
length, which are then transmitted independently of one another, allowing
maximization of available capacity and usage of a single transmission path for
multiple communications. The cells are then reassembled upon reaching their
destination.
PBX (Private Branch Exchange): Telephone switchboard for private use, but
linked to the national telephone network.
Penetration: The measurement of the take-up of services. At any date, the
penetration is calculated by dividing the number of subscribers by the
population to which the service is available and multiplying the quotient by
100.
Private leased circuits: Voice, data or image transmission mediums leased
to users for their exclusive use.
PSTN (Public Switched Telephone Network): The public telephone network that
delivers basic telephone service and, in certain circumstances, more advanced
services.
Repeaters: A device that amplifies an input signal for retransmission.
Roaming: A function that enables subscribers to use their cellular
telephone on networks of service providers 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
telecommunications technology.
Universal service: The obligation to supply basic service to all users
throughout the national territory at reasonable prices.
Value Added Services: Value Added Services provide additional functionality
to the basic transmission services offered by a telecommunications network.
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 12 of the Securities Exchange Act
of 1934, the Registrant certifies that it meets all of the requirements for
filing on Form 20-F and has duly caused this Annual Report to be signed on its
behalf by the undersigned, thereunto duly authorized.
TELE NORTE CELULAR PARTICIPACOES S.A.
By: /s/ Marcio Kaiser
------------------------------------
Name: Marcio Kaiser
Title: President and Chief Executive
Officer
By: /s/ Joao Cox Neto
------------------------------------
Name: Joao Cox Neto
Title: Chief Financial Officer and Market
Relations Executive Officer
Dated: June 30, 1999
<PAGE>
TELE NORTE CELULAR PARTICIPACOES S.A.
CONSOLIDATED FINANCIAL STATEMENTS
CONTENTS
<TABLE>
<S> <C>
Independent Auditors' Report....................................................................................F-2
Consolidated Balance Sheets.....................................................................................F-4
Consolidated Statements of Operations and Comprehensive Income..................................................F-5
Consolidated Statement of Cash Flows............................................................................F-6
Consolidated Statement of Net Interdivisional Cash Distribution (Receipt).......................................F-7
Consolidated Statement of Changes in Shareholders' Equity.......................................................F-8
Notes to the Consolidated Financial Statements.....................................................F-9 through F-27
</TABLE>
<PAGE>
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and Shareholders
Tele Norte Celular Participacoes S.A.
We have audited the accompanying consolidated balance sheet of Tele Norte
Celular Participacoes S.A. as of December 31, 1998, and the related consolidated
statements of operations and comprehensive income, changes in shareholders'
equity, and cash flows for the year then ended. These financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Tele Norte Celular
Participacoes S.A. at December 31, 1998, and the consolidated results of its
operations and its cash flows for the year then ended, in conformity with
accounting principles generally accepted in the United States.
Brasilia, Brazil
February 10, 1999
Ernst & Young Auditores Independentes S.C.
<PAGE>
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and Shareholders
Tele Norte Celular Participacoes S.A.
Brasilia - DF
We have audited the accompanying consolidated balance sheet of Tele Norte
Celular Participacoes S.A. as of December 31, 1997, and the related consolidated
statements of operations and comprehensive income, net interdivisional cash
distribution (receipt), and changes in shareholders' equity for each of the
years in the two year period then ended. These consolidated financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these consolidated financial statements based on our
audits.
We conducted our audits in accordance with generally accepted auditing standards
in Brazil, which do not differ in any material respects from generally accepted
auditing standards in the United States of America. Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
The accompanying consolidated financial statements, referred to above, have been
prepared in accordance with generally accepted accounting principles in the
United States of America 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, the consolidated financial statements present fairly, in all
material respects, the financial position of Tele Norte Celular Participacoes
S.A. as of December 31, 1997, and its results of its operations and its cash
flows for each of the years in the two-year period then ended, in conformity
with accounting principles generally accepted in the United States.
July 17, 1998
Brasilia, Brazil
KPMG Auditores Independentes
<PAGE>
Tele Norte Celular Participacoes S.A.
[see notes 1, 2, 12 and 13]
CONSOLIDATED BALANCE SHEETS
Figures are in Brazilian Reais - R$
<TABLE>
<CAPTION>
December 31, December 31,
1997 1998
- --------------------------------------------------------------------------------------------------
[thousands of R$ [thousands of R$
constant - note 2] actual - note 2]
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents 8,845 79,733
Trade receivables, net of allowance for doubtful
accounts of R$9,696 and R$18,220 39,703 30,092
Other receivables -- 13,940
Deferred income taxes -- 16,472
Other current assets 643 4,988
- --------------------------------------------------------------------------------------------------
49,191 145,225
- --------------------------------------------------------------------------------------------------
Property, plant and equipment, net 216,730 207,340
Deferred income taxes -- 3,929
Other non current assets 216 2,230
- --------------------------------------------------------------------------------------------------
266,137 358,724
==================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable 18,733 4,542
Accrued liabilities 1,926 10,813
Value added and other taxes payable 1,971 8,838
Income taxes payable -- 12,188
Deferred income taxes 571 --
Current portion of long-term debt
Third parties 1,815 13,226
Payable to a related party 6,430 --
Deferred activation fees -- 5,266
Other current liabilities 584 11,698
- --------------------------------------------------------------------------------------------------
32,030 66,571
- --------------------------------------------------------------------------------------------------
Deferred income taxes 3,456 --
Long-term debt
Third parties 7,217 25,977
Payable to a related party 8,595 --
Provision for contingencies 13 9,043
Minority interest 57,634 67,281
- --------------------------------------------------------------------------------------------------
76,915 102,301
- --------------------------------------------------------------------------------------------------
Shareholders' equity
Divisional equity 157,192 --
Preferred shares, no par value, issued and outstanding
210,029,997 thousand shares -- 36,266
Common shares, no par value, issued and outstanding
124,369,031 thousand shares -- 21,483
Other capital and reserves -- 102,618
Retained earnings -- 29,485
- --------------------------------------------------------------------------------------------------
157,192 189,852
- --------------------------------------------------------------------------------------------------
266,137 358,724
==================================================================================================
</TABLE>
See the accompanying notes to the consolidated financial statements
Tele Norte Celular Participacoes S.A.
[see notes 1,2, 12 and 13]
CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME
Figures are in Brazilian Reais - R$
<TABLE>
<CAPTION>
Year ended December 31,
1996 1997 1998
- --------------------------------------------------------------------------------------------------
[thousands of R$ [thousands of R$
constant - note 2] actual - note 2]
<S> <C> <C> <C>
Revenues:
Services provided to third parties 143,073 175,833 206,629
Services provided to related parties 23,380 43,483 25,926
- --------------------------------------------------------------------------------------------------
166,453 219,316 232,555
- --------------------------------------------------------------------------------------------------
Cost of services:
Provided by related parties 27,437 35,503 20,987
Others 2,716 3,896 27,912
Selling, general and administrative expenses 27,334 35,088 50,292
Bad debt expense 154 12,333 38,428
Other net operating (income) expense (4,864) 1,473 (1,688)
Depreciation 7,472 12,296 20,266
Impairment of long-lived assets -- -- 18,448
- --------------------------------------------------------------------------------------------------
Operating income 106,204 118,727 57,910
Interest income -- -- (8,591)
Interest expense -- -- 4,047
Foreign exchange loss (gain) (1,155) (1,058) 2,472
Allocated interest expense -- 791 --
Net non-operating income 1,159 979 --
- --------------------------------------------------------------------------------------------------
Income before minority interest, unallocated
interest expense and taxes 106,200 118,015 59,982
Minority interest before unallocated interest
expense and taxes 19,331 33,483
- ---------------------------------------------------------------------------
Income before unallocated interest expense
and taxes 86,869 84,532
---------------------------
Income taxes 16,897
Minority interest 11,553
----------
Net income and comprehensive income 31,532
==========
Basic and diluted earnings, in Reais per
thousand common shares 0.09
==================================================================================================
</TABLE>
See the accompanying notes to the consolidated financial statements
<PAGE>
Tele Norte Celular Participacoes S.A.
[see notes 1,2, 12 and 13]
CONSOLIDATED STATEMENT OF CASH FLOWS
Figures are in Brazilian Reais - R$
<TABLE>
<CAPTION>
Year ended
December 31,
1998
- -------------------------------------------------------------------------------------------------
[thousands of R$
actual - note 2]
<S> <C>
Operating activities:
Net income 31,532
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation 20,266
Deferred income taxes (24,428)
Minority interest 11,553
Unrealized foreign exchange loss on long-term debt 1,700
Provision for contingencies 9,030
Impairment of long-lived assets 18,448
Compensation expense 1,200
Changes in operating assets and liabilities:
Trade receivables 9,611
Accounts payable and accrued liabilities 4,864
Accounts payable related to property, plant and equipment (14,121)
Value added and other taxes payable 6,867
Income taxes payable 12,188
Deferred activation fees 5,266
Others (9,185)
- --------------------------------------------------------------------------------------------------
Net cash provided by operating activities 84,791
- --------------------------------------------------------------------------------------------------
Investing activities:
Proceeds from sales of property, plant and equipment 2,348
Additions to property, plant and equipment (31,672)
- --------------------------------------------------------------------------------------------------
Net cash used in investing activities (29,324)
- --------------------------------------------------------------------------------------------------
Financing activities:
Increase in long-term debt 21,971
Repayment of long-term debt (8,525)
Contribution upon Spin-Off 1,975
- --------------------------------------------------------------------------------------------------
Net cash provided by financing activities 15,421
- --------------------------------------------------------------------------------------------------
Increase in cash and cash equivalents for the year 70,888
Cash and cash equivalents, beginning of the year 8,845
- --------------------------------------------------------------------------------------------------
Cash and cash equivalents, end of the year 79,733
==================================================================================================
Supplemental cash flow information:
Income taxes paid 29,229
Interest paid 2,343
==================================================================================================
</TABLE>
See the accompanying notes to the consolidated financial statements
<PAGE>
Tele Norte Celular Participacoes S.A.
[see notes 1 and 2 ]
CONSOLIDATED STATEMENTS OF NET
INTERDIVISIONAL CASH DISTRIBUTION (RECEIPT)
Figures are in Brazilian Reais - R$
<TABLE>
<CAPTION>
Year ended
December 31,
1996 1997
- --------------------------------------------------------------------------------------------------
[thousands of R$
constant - note 2]
<S> <C> <C>
Operating activities:
Income before unallocated interest expense and taxes 86,869 84,532
Adjustments to reconcile to cash provided by operating activities:
Depreciation 7,472 12,296
Minority interest in income before unallocated interest
expense and taxes 19,331 33,483
Trade receivables (15,161) (10,672)
Other current assets (610) (206)
Trade payables and accrued liabilities (1,821) 3,373
Value added and other taxes payable 1,233 (2,412)
Other current liabilities 81 443
- --------------------------------------------------------------------------------------------------
97,394 120,837
- --------------------------------------------------------------------------------------------------
Investing activities:
Additions to property, plant and equipment (105,467) (51,768)
Proceeds fromdisposal of property, plant and equipment 408 26
- --------------------------------------------------------------------------------------------------
(105,059) (51,742)
- --------------------------------------------------------------------------------------------------
Financing activities:
Repayment of long-term debt (2,233) (14,496)
Increase in long-term debt -- 25,925
- --------------------------------------------------------------------------------------------------
(2,233) 11,429
- --------------------------------------------------------------------------------------------------
Increase (decrease) in cash and cash equivalents (9,898) 80,524
Cash and cash equivalents, beginning of the year -- --
Cash and cash equivalents, end of the year -- (8,845)
- --------------------------------------------------------------------------------------------------
Net interdivisional cash distribution (receipt) (9,898) 71,679
==================================================================================================
Supplemental cash distribution information:
Interest paid 60 7,108
==================================================================================================
</TABLE>
See the accompanying notes to the consolidated financial statements
<PAGE>
Tele Norte Celular Participacoes S.A.
[see notes 1, 2, 12 and 13]
CONSOLIDATED STATEMENTS
OF CHANGES IN SHAREHOLDERS' EQUITY
Figures are in thousands of constant Brazilian Reais - R$ of December 31, 1997
for the years ended December 31, 1996 and 1997 and in thousands of actual
Brazilian Reais - R$ for the year ended December 31, 1998
<TABLE>
<CAPTION>
Other capital and
reserves
---------------------
Divisional Preferred Common Distributable Retained
equity shares shares capital Others earnings Total
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1995 45,935 -- -- -- -- -- 45,935
- -----------------------------------------------------------------------------------------------------------
Income before unallocated
interest expense and taxes 86,869 -- -- -- -- -- 86,869
Deferred taxes (3,843) -- -- -- -- -- (3,843)
Net interdivisional cash 9,898 -- -- -- -- -- 9,898
receipt
Minority interest effects
other than on income (1,544) -- -- -- -- -- (1,544)
- -----------------------------------------------------------------------------------------------------------
Balance at December 31, 1996 137,315 -- -- -- -- -- 137,315
- -----------------------------------------------------------------------------------------------------------
Income before unallocated
interest expense and taxes 84,532 -- -- -- -- -- 84,532
Deferred taxes (596) -- -- -- -- -- (596)
Net interdivisional cash (71,679) -- -- -- -- -- (71,679)
distribution
Minority interest effects
other than on income 7,620 -- -- -- -- -- 7,620
- -----------------------------------------------------------------------------------------------------------
Balance at December 31, 1997 157,192 -- -- -- -- -- 157,192
- -----------------------------------------------------------------------------------------------------------
Contributed capital from the
Spin-Off 1,975 -- -- -- -- -- 1,975
Allocation of divisional
equity as a result of (159,167) 36,266 21,483 46,789 54,629 -- --
Spin-Off
Contributed capital -- -- -- -- 1,200 -- 1,200
Interest on capital -- -- -- -- -- (2,047) (2,047)
Net income -- -- -- -- -- 31,532 31,532
- -----------------------------------------------------------------------------------------------------------
Balance at December 31, 1998 -- 36,266 21,483 46,789 55,829 29,485 189,852
===========================================================================================================
</TABLE>
See the accompanying notes to the consolidated financial statements
<PAGE>
Tele Norte Celular Participacoes S.A.
NOTES TO THE CONSOLIDATED
FINANCIAL STATEMENTS
Amounts are in thousands of constant Brazilian Reais - R$ of December 31, 1997
as of and for the years ended December 31, 1996 and December 31, 1997 and in
thousands of actual Brazilian Reais - R$ as of and for the year ended December
31, 1998
1. Background and description of business
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 1997, 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 [the "Telebras System"].
In preparation for the privatization of the Telebras system, the operating
subsidiaries were divided into twelve separate groups, (a) three regional fixed
line operators, (b) eight regional cellular operators and (c) one national
long-distance operator. The cellular telecommunications businesses were first
separated from the operating subsidiaries, and subsequently the fixed line
businesses, the new cellular businesses and the long-distance operator were
combined into twelve separate groups [the "New Holding Companies", individually,
"New Holding Company"]. Both the separation of the cellular businesses and the
subsequent grouping of the former Telebras subsidiaries were performed using a
procedure under Brazilian corporate law called cisao ["Spin-Off"]. As part of
this process Tele Norte Celular Participacoes S.A. was formed on May 22, 1998,
through the Spin-Off of certain assets and liabilities of Telebras, including
80.3%, 86.9%, 90.6%, 69% and 66.8% of the share capital of Telamazon Celular
S.A., Telaima Celular S.A., Teleamapa Celular S.A., Telepara Celular S.A. and
Telma Celular S.A. [together the "subsidiaries"], respectively.
Telamazon Celular S.A., Telaima Celular S.A., Teleamapa Celular S.A., Telepara
Celular S.A. and Telma Celular S.A. were formed on January 5, 1998 and
subsequently received on January 30, 1998 from Telecomunicacoes do Amazonas S.A.
["Telamazon"], Telecomunicacoes de Roraima S.A. ["Telaima"], Telecomunicacoes do
Amapa S.A. ["Teleamapa"], Telecomunicacoes do Para S.A. ["Telepara"] and
Telecomunicacoes do Maranhao S.A. ["Telma"] the assets and liabilities
comprising their respective cellular telecommunications services [together the
"predecessor companies"]. Tele Norte Celular Participacoes S.A. and its
subsidiaries [together the "Company"] are the primary suppliers of cellular
telecommunications services in the states of Amazonas, Roraima, Amapa, Para and
Maranhao under the terms of concessions granted by the Federal Government on
October 23, 1997 [the "Concessions"]. The Concessions will expire in 2009 and
may be renewed at the discretion of Agencia Nacional de Telecomunicacoes
["Anatel"], the regulatory authority for the Brazilian telecommunications
industry, for a further term of 15 years. Through their predecessors Telamazon,
Telaima, Teleamapa, Telepara and Telma, the Company has provided cellular
telecommunications services in the states of Amazonas, Roraima, Amapa, Para and
Maranhao since April 1994.
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,
effective August 4, 1998, substantially all its economic and voting rights with
respect to the New Holding Companies.
The Company's business, including the services it may provide and the rates it
charges, is regulated by Anatel and is fully dependent upon the cellular
telecommunications concession granted by the Federal Government.
The Company will be required to make significant capital and operating
expenditures on an ongoing basis in order to deploy its cellular
telecommunications network which will require the Company to seek additional
financing. Some of these investments may be financed through debt denominated in
foreign currencies. The country's currency is subject to significant devaluation
which could result in difficulties or additional costs in raising financing. A
significant devaluation and a return to high levels of inflation could have an
adverse effect on the Brazilian economy, and, as a result, it could affect the
Company's financial position, cash flows or results of operations.
2. Presentation of the financial statements
These consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States and rules and
regulations adopted by the United States Securities and Exchange Commission.
Certain of the comparative figures have been reclassified to conform with the
presentation adopted in the current year.
The Company has also published consolidated financial statements prepared in
accordance with accounting principles generally accepted in Brazil and rules and
regulations adopted by the Brazilian Securities Commission ["CVM"].
a. Basis of presentation prior to December 31, 1997
The Spin-Off of the cellular telecommunications businesses of Telamazon,
Telaima, Teleamapa, Telepara and Telma to the Company was accounted for as a
reorganization of entities under common control in a manner similar to a pooling
of interests. The assets and liabilities of the cellular telecommunications
businesses of Telamazon, Telaima, Teleamapa, Telepara and Telma were transferred
to the Company at their indexed historical costs. The revenues and expenses
associated with such assets and liabilities were allocated to the Company.
Separate records of revenues and costs of services of the cellular
telecommunications businesses were maintained historically. Accordingly, the
actual amounts were allocated for the 1996 and 1997 fiscal years included
herein.
The consolidated statements of operations and of 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
for each year in the two-year period ended December 31, 1997 had the cellular
telecommunications businesses of Telamazon, Telaima, Teleamapa, Telepara and
Telma been separate legal entities 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 consolidated statements 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 resources department], number of requisitions issued [in relation
to office material costs] and miles driven [in relation to certain
transportation costs]. Management believes that the amounts included in the
consolidated statements of operations for the years ended December 31, 1996 and
1997 fairly reflect the income before interest income, unallocated interest
expense and taxes of the cellular telecommunications businesses of Telamazon,
Telaima, Teleamapa, Telepara and Telma.
Prior to December 31, 1997, cash and certain non-specific debt could not be
segregated from Telamazon, Telaima, Teleamapa, Telepara and Telma. 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 businesses could not be identified.
Consequently, income tax expense and related liabilities do not appear in the
consolidated statements of operations and balance sheets for 1996 and 1997. 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 two-year period
ended December 31, 1997 is reflected as "minority interest" in the consolidated
financial statements. At December 31, 1997, such minority shareholders owned
19.74%, 13.09%, 9.36%, 30.96% and 33.21% of the share capital of Telamazon,
Telaima, Teleamapa, Telepara and Telma, respectively. All taxes payable at
December 31, 1997, related to revenues [ICMS, PASEP, COFINS] remained with the
predecessor companies when the assets and liabilities of the cellular
telecommunications businesses were transferred to the subsidiaries. The legal
responsibility for their payment remained with the predecessor companies.
Because it was not possible to segregate the cash balances for the cellular
telecommunications businesses prior to December 31, 1997, a traditional
statement of cash flows could not be prepared for each of the years in the
two-year period ended December 31,1997. In lieu of detailing the beginning and
ending cash and cash equivalents balances, and the net change in cash and cash
equivalents between years, the net cash transferred to/from the fixed line
telecommunications businesses of Telamazon, Telaima, Teleamapa, Telepara and
Telma has been presented as "Net interdivisional cash distribution [receipt]" in
the statements of net interdivisional cash distribution [receipt].
At December 31, 1997, cash equivalents of R$8,845 comprising an interest bearing
deposit with Banco do Brazil S.A., a goverment-controlled entity, were allocated
from Telamazon, Telaima, Teleamapa, Telepara and Telma to the Company to meet
future estimated working capital requirements.
Since the Company's subsidiaries did not exist prior to January 1, 1998, no
individual capital structure was maintained. Consequently, the net assets
contributed were shown as "divisional equity" in the accompanying consolidated
balance sheet as of December 31, 1997, and changes in net assets contributed
were presented in the consolidated statements of changes in shareholders' equity
for each of the years in the two-year period ended December 31, 1997.
Earnings per share has not been presented for the years ended December 31, 1996
and 1997, as the consolidated statements of operations exclude interest income,
unallocated interest expense and taxes, as a result of nonspecific cash and debt
not being allocated from Telamazon, Telaima, Teleamapa, Telepara and Telma.
Full indexation to December 31, 1997
The consolidated financial statements as of and for the years prior to December
31, 1997 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.
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 Indice Geral de
Precos-Mercado [the General Prices Index-Market or the "IGP-M"] of the Fundacao
Getulio Vargas in 1996 and 1997. Inflation for the two-year period ended
December 31, 1997, as measured by the IGP-M, was as follows:
<TABLE>
<CAPTION>
Period Index Annual inflation
- ------------------------------------------------------------------------------------------
%
<S> <C> <C>
Year ended December 31, 1996 IGP-M 9.2
Year ended December 31, 1997 IGP-M 7.7
</TABLE>
Management believes that this index is an appropriate indication of general
price-level inflation to be used for the years indicated.
The effects of price-level adjustments and the monetary gains and losses
associated with the indexation have not been eliminated in these financial
statements, because the application of inflation restatement as measured by 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.
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 restated balances of non-monetary
assets and liabilities of the Company as of December 31, 1997 were used as the
opening balances on January 1, 1998 and are no longer restated for inflation
beginning January 1, 1998.
ii. Consolidated statements of operations
Items in the consolidated statements of operations for the years ended December
31, 1996 and 1997 are adjusted by:
o allocating inflationary holding gains or losses on interest bearing
monetary assets and liabilities to their corresponding interest income
and expense captions;
o 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) expense."
iii. Deferred income tax effects of indexation adjustments in 1996 and 1997
As a result of legislation mandating the discontinuation of the indexation
system from January 1, 1996, the indexation of assets and liabilities 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 this deferred tax liability of
R$4,021 and R$4,091 in 1996 and 1997, respectively, was recorded directly
against divisional equity.
b. Basis of presentation subsequent to December 31, 1997
On May 22, 1998, the shareholders of Telebras approved the Spin-Off, 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, with limited
exceptions.
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. This value of allocated retained earnings does
not represent the historical retained earnings of the New Holding Companies and
therefore is presented as "Distributable Capital" on the consolidated statements
of changes in shareholders' equity. The net assets which were spun-off from
Telebras, in addition to its investment in the operating subsidiaries, resulted
in a net equity increase of R$1,975 in relation to the Company's historical
divisional equity.
The first column in the table below summarizes the December 31, 1997
consolidated historical balances of the Company, and the "Company Consolidated
Statement" column summarizes the opening consolidated balance sheet at January
1, 1998 of Tele Norte Celular Participacoes S.A. after giving effect to the
Spin-Off adjustments and eliminations. The "Adjustments and Eliminations" column
includes (i) the transfer of cash from Telebras to the Company and (ii) the set
up of the legal capital structure of the Company.
<PAGE>
<TABLE>
<CAPTION>
December 31,
1997 Adjustments Company
Historical and Consolidated
Balances Eliminations Statement
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Assets
Cash and cash equivalents 8,845 2,000 10,845
Accounts receivable from
related party 430 -- 430
Other assets 40,132 -- 40,132
- ----------------------------------------------------------------------------------------------------------------------
49,407 2,000 51,407
Property, plant and equipment, net 216,730 -- 216,730
- ----------------------------------------------------------------------------------------------------------------------
266,137 2,000 268,137
======================================================================================================================
Liabilities
Accounts payable to related party 1,722 -- 1,722
Loans from Telebras 6,430 -- 6,430
Loans from third parties 1,815 -- 1,815
Other current liabilities 22,063 -- 22,063
- ----------------------------------------------------------------------------------------------------------------------
32,030 -- 32,030
- ----------------------------------------------------------------------------------------------------------------------
Loans from Telebras 8,595 -- 8,595
Other non current liabilities 10,686 25 10,711
Minority interest 57,634 -- 57,634
- ----------------------------------------------------------------------------------------------------------------------
76,915 25 76,940
- ----------------------------------------------------------------------------------------------------------------------
Divisional equity 157,192 (157,192) --
Share capital -- 57,749 57,749
Other capital and reserves -- 54,629 54,629
Distributable capital -- 46,789 46,789
- ----------------------------------------------------------------------------------------------------------------------
157,192 1,975 159,167
- ----------------------------------------------------------------------------------------------------------------------
266,137 2,000 268,137
======================================================================================================================
</TABLE>
The December 31, 1997 historical balances have been adjusted to record deferred
income tax assets amounting to R$2,294 and to record a corresponding increase to
divisional equity of R$1,841 and minority interest of R$453. This adjustment,
which is related to temporary differences between carrying and tax values of
certain assets, had no impact on the Company's 1997 results of operations
because the 1997 statement of operations did not give effect to income taxes.
An amount of R$7,338 has been reclassified from divisional equity to Minority
interest on the balance sheet as at December 31, 1997 to correct a computational
error whereby divisional equity was overstated and minority interest was
understated by R$7,338 respectively. This error had no impact on the Company's
results as at December 31, 1997, as it was a misallocation between two balance
sheet items.
Upon formation, the Company's legal capital structure was defined by the
resolutions approved by the Telebras shareholders' meeting of May 22, 1998. The
value of shareholders' equity of R$167,283 includes distributable capital of
R$46,789.
The allocated distributable capital and future retained earnings computed using
Brazilian GAAP will be the basis from which future dividends will be payable.
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. As a result, the consolidated financial
statements of the Company include the results of operations and changes in
financial condition of the subsidiaries from January 1, 1998 and the effects of
the cash allocated from Telebras as of March 1, 1998.
3. Summary of accounting policies
The summary of significant accounting policies is as follows:
a. Consolidation
The consolidated financial statements of the Company for the year ended December
31, 1998 include the accounts of the Company and its subsidiaries. All
significant intercompany transactions and balances have been eliminated.
b. Cash equivalents
Cash equivalents consist of highly liquid investments with original maturities
of three months or less.
c. Foreign currency transactions
Transactions in foreign currency are recorded at the prevailing exchange rate at
the time of the related transactions. Foreign currency denominated monetary
assets and liabilities are translated using the exchange rate at the balance
sheet date. Exchange differences are recognized in the statements of operations
as they occur.
<PAGE>
d. Property, plant and equipment
Property, plant and equipment are stated at indexed cost through December 31,
1997, and at cost thereafter. Depreciation is provided using the straight-line
method based on the estimated useful lives of the underlying assets as follows:
Years
- ---------------------------------------------------------------------------
Buildings 20
Network equipment 6 to 8
Other equipment 4 to 5
- ---------------------------------------------------------------------------
Interest incurred on borrowings is capitalized as part of property, plant and
equipment until the asset is placed in service, to the extent that borrowings do
not exceed construction-in-progress. The amount of interest capitalized excludes
the inflationary element in local currency borrowings and the foreign exchange
gains and losses on foreign currency borrowings.
The Company reviews property, plant and equipment for impairment whenever events
or changes in circumstances indicate that the carrying amount may not be
recoverable [see note 10].
In December 1998, to comply with industry practice, the Company reduced the
estimated useful lives of certain of its assets as follows: network equipment
from 10 to 13 years to 6 to 8 years, buildings from 25 years to 20 years and
other equipment from 5 to 20 years to 4 to 5 years. The Company believes that
the estimated useful lives used by the industry better reflect the period of the
economic benefits to be received from the assets. The effect of this change will
be to increase depreciation expense in future years.
e. Revenue recognition
Revenues for 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. 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. Effective January 1, 1998, the Company defers net activation fees.
These fees are amortized over twelve months, the estimated effective contract
life.
f. Pension and other post-retirement benefits
The Company participates in a multi-employer plan that provides pension and
other post-retirement benefits for its employees. The costs of pension and other
post-retirement benefits are based on a fixed percentage of remuneration, as
recommended annually by independent actuaries. Current costs are determined as
the amount of required contribution for the period and are recorded on an
accrual basis.
g. Use of estimates
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles 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.
h. Advertising costs
Advertising costs are expensed as incurred and included in selling, general and
administrative expenses. They amounted to R$930 for the year ended December 31,
1998. The Company did not maintain specific records for prior years.
i. New accounting pronouncements
SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities"
SFAS No. 133 requires recognition of all derivative instruments as either assets
or liabilities in the balance sheet and measurement of such instruments at fair
value. The standard, which must be adopted in fiscal year 2000 at the latest,
also requires certain disclosures about derivative transactions and hedging
strategies. The financial impact of the eventual adoption of SFAS No. 133 has
not yet been determined.
4. Property, plant and equipment
<TABLE>
<CAPTION>
Accumulated Carrying
Cost depreciation value
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
December 31, 1997
Land and buildings 5,334 196 5,138
Network equipment 177,106 18,938 158,168
Other equipment 11,416 2,371 9,045
Construction-in-progress 44,379 -- 44,379
- -----------------------------------------------------------------------------------------------------------------------
238,235 21,505 216,730
=======================================================================================================================
December 31, 1998
Land and buildings 6,096 417 5,679
Network equipment 216,561 38,974 177,587
Other equipment 5,947 2,243 3,704
Construction-in-progress 20,370 -- 20,370
- -----------------------------------------------------------------------------------------------------------------------
248,974 41,634 207,340
=======================================================================================================================
</TABLE>
The amount of interest capitalized as part of property, plant and equipment is
R$3,847, R$3,251 and R$2,268 for the years ended December 31, 1996, 1997 and
1998, respectively.
5. Long-term debt
<TABLE>
<CAPTION>
December 31, December 31,
1997 1998
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Term loan 15,025 10,231
Loans payable 9,032 28,972
- ----------------------------------------------------------------------------------------------------------------------
24,057 39,203
Less current maturities 8,245 13,226
- ----------------------------------------------------------------------------------------------------------------------
15,812 25,977
======================================================================================================================
</TABLE>
Term loan
This loan is denominated in Brazilian Reais, bears interest at a rate indexed to
the variation of "Fundo Extra-Mercado" disclosed by the Bank of Brazil. The
variation was 27.63% at December 31, 1998. It is due in monthly installments
through September 2000.
Loans payable
The loans are denominated in US dollars and bear interest at LIBOR + 0.4%. The
LIBOR rate was 5.06% at December 31, 1998 [5.85% at December 31, 1997]. They are
payable in semi-annual installments through March 2003.
Minimum annual principal repayments of all long-term debt during the next five
years are as follows:
- ---------------------------------------------------------------------------
1999 13,226
2000 10,332
2001 6,648
2002 6,648
2003 2,349
- ---------------------------------------------------------------------------
Total 39,203
===========================================================================
6. Capital stock
The capital stock of the Company is comprised of preferred shares and common
shares, all without par value. The Company has 700,000,000 thousand shares
authorized [including both preferred and common shares]. At May 22, 1998 [the
date the Company was legally formed], there were 210,029,997 thousand
outstanding preferred shares and 124,369,031 thousand outstanding common shares.
The capital may be increased by a decision taken at a shareholders' meeting or
by the Board of Directors in connection with the capitalization of profits or
reserves, provided that the amounts were allocated for capital increases at a
previous shareholders' meeting.
The preferred shares are non-voting except under limited circumstances and are
entitled to a preferential, 6% non-cumulative dividend. The preferred shares are
also entitled to priority over the common shares in the case of liquidation of
the Company.
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 outstanding shares.
As part of the privatization of Telebras, the Brazilian Federal Government
offered Telebras' employees the right to purchase, at a discounted price, the
Federal Government's entire holding of Telebras preferred shares and the
preferred shares of each of the New Holding Companies created as a result of the
Spin-Off. The period during which employees could subscribe for the shares began
on August 4, 1998, and expired on October 30, 1998. In 1998, the Company
recorded compensation expense and contributed capital in the amount of R$1,200
related to this offer.
Dividends
Under Brazilian Corporation Law, dividends can only be paid out of the
distributable capital arising from the Spin-Off and from future retained
earnings. Pursuant to its by-laws, the Company is required to distribute as
dividends in respect of each fiscal year ending on December 31, to the extent
amounts are available for distribution, an aggregate amount equal to at least
25% of Adjusted Net Income [as defined below] on such date. The 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 per share equal to the Preferred Dividend, and the
remainder is distributed equally, on a per share basis, among holders of
preferred shares and common shares.
For the purposes of the Brazilian Corporation Law, and in accordance with the
Company's by-laws, the "Adjusted Net Income" is an amount equal to the Company's
net profits under Brazilian GAAP adjusted to reflect allocations to or from (i)
the legal reserve, (ii) a contingency reserve for anticipated losses, if any,
and (iii) an unrealized revenue reserve, if any. Under Brazilian Corporation
Law, the Company is required to appropriate 5% of its annual earnings,
calculated using Brazilian GAAP, after absorbing accumulated losses, to a legal
reserve, which is restricted as to distribution. This reserve may be used to
increase capital or to absorb losses, but may not be distributed as dividends.
At December 31, 1998, the Company's financial statements, prepared using
Brazilian GAAP, presented an unconsolidated total equity of R$183,931 including
a legal reserve of R$5,491.
Additionally, Brazilian corporations are permitted to attribute tax-deductible
interest expense on shareholders' equity, which may either be paid in cash, in
the form of a dividend, or used to increase capital stock value for statutory
purposes. For financial reporting purposes, such interest on capital is recorded
as a reduction from retained earnings.
7. Earnings per common share
In these consolidated financial statements, information is disclosed per lot of
one thousand shares, because this is the minimum number of shares that can be
traded on the Brazilian stock exchanges.
As discussed in Note 1, the Company was formed subsequent to December 31, 1997.
The equity structure utilized for earnings per share computations is that of the
new entity formed in May 1998.
Since the preferred and common shareholders have different dividend, voting and
liquidation rights, basic earnings per share has been calculated using the
"two-class" method. The "two-class" method is an earnings allocation formula
that determines earnings per share for preferred and common shares according to
the dividends to be paid as required by the Company's by-laws and participation
rights in undistributed earnings.
Basic earnings per common share is computed by reducing net income by
distributable and undistributable net income available to preferred shareholders
and dividing net income available to common shareholders by the weighted-average
number of common shares outstanding during the period. Net income available to
preferred shareholders is the sum of the preferred dividends [distributable net
income] and the preferred shareholders' portion of undistributed net income.
Undistributed net income is computed by deducting preferred dividends and common
dividends from net income. Undistributed net income is shared equally, on a per
share basis, by the preferred and common shareholders.
<PAGE>
The following table sets forth the computation of basic and diluted earnings per
thousand of common shares:
<TABLE>
<CAPTION>
1998
- ----------------------------------------------------------------------------------------------------------------------
<S> <C>
Numerator:
Net income 31,532
Less: Distributable net income available to preferred stockholders (2,176)
Undistributed net income allocated to preferred stockholders (17,629)
- ----------------------------------------------------------------------------------------------------------------------
Numerator for basic and diluted earnings per thousand shares-income
available to common stockholders 11,727
======================================================================================================================
Denominator:
Basic and diluted weighted-average number of common shares
(in thousands) 124,369,031
======================================================================================================================
Basic and diluted earnings, in Reais per thousand common shares 0.09
======================================================================================================================
</TABLE>
8. Income taxes
Brazilian income taxes comprise federal income tax and the social contribution
tax. The statutory rates for income tax and for the social contribution tax are
25% and 8%, respectively.
Following is the detail of income tax expense for the year ended December 31,
1998:
<TABLE>
- ----------------------------------------------------------------------------------------------------------------------
<S> <C>
Federal income tax charge 31,150
Social contribution tax charge 10,175
Deferred taxes (24,428)
- ----------------------------------------------------------------------------------------------------------------------
Income tax expense as reported in the accompanying financial statements 16,897
======================================================================================================================
<CAPTION>
Following is a reconciliation of the reported income tax expense and the amount
calculated by applying the combined statutory tax rate of 33% for the year ended
December 31, 1998:
- ----------------------------------------------------------------------------------------------------------------------
<S> <C>
Tax charge at the combined statutory rate 19,794
Non-deductible expenses 2,330
Non-taxable income (5,227)
- ----------------------------------------------------------------------------------------------------------------------
Income tax expense as reported in the accompanying financial statements 16,897
======================================================================================================================
</TABLE>
<PAGE>
Following is an analysis of deferred income tax assets and liabilities:
<TABLE>
- ----------------------------------------------------------------------------------------------------------------------
<S> <C>
Deferred tax assets:
Allowance for doubtful accounts 6,013
Impairment of equipment 6,087
Accrued expenses and provision for contingencies 13,154
Capitalized interest 2,339
- ----------------------------------------------------------------------------------------------------------------------
27,593
Deferred tax liabilities:
Cumulative indexation differences (7,192)
- ----------------------------------------------------------------------------------------------------------------------
Net deferred tax assets 20,401
======================================================================================================================
Current portion 16,472
Long-term deferred income taxes 3,929
- ----------------------------------------------------------------------------------------------------------------------
Net deferred tax assets 20,401
======================================================================================================================
</TABLE>
9. Transactions with related parties
Up until the change of control of the Company on August 4, 1998, Empresa
Brasileira de Telecomunicacoes S.A., a long-distance cellular telecommunications
company, the predecessor companies and the other parties to the Telebras group
were related to the Company. The Company has operating agreements with these
companies for inter or intrastate long-distance, international telephone calls,
automatic roaming and interconnection. The Company executed several service
contracts with the predecessor companies to perform certain administrative tasks
on the Company's behalf.
One of the Company's shareholders provides technical assistance and services to
the Company. The consideration accrued by the Company for these services
amounted to R$ 3,656 for 1998.
10. Impairment of long-lived assets
During the fourth quarter of 1998, the Company recorded a write-down of certain
of its analog transmission network equipment amounting to R$18,448.
In 1998, the Ministry of Communications granted to a newly formed consortium an
additional license to provide enhanced services in the Company's concession area
in the form of digital cellular services. The commercial operation of the
consortium is expected to begin in 1999. The introduction of competition with
digital capacity in the Company's market will result in an acceleration of its
plan to replace its existing analog equipment with more modern digital
equipment. As a result, the analog transmission network equipment will be
removed before the end of its useful life due to the declining demand for analog
services.
The amount of the write-down was established by comparing the fair value of the
analog transmission equipment, established based on the expected future cash
flow from the use of this equipment, discounted at a risk-adjusted rate, to the
carrying amount of the impaired equipment.
11. Pension plan and other post-retirement benefit plans
The Company, together with substantially all of the other companies in the
former Telebras group, participates in a multi-employer defined benefit pension
plan and other post-retirement benefit plans administered by the Fundacao
Telebras de Seguridade Social ["Sistel"], a minority shareholder.
Approximately 96% of the Company's employees are covered by these plans. The
Company contributed and charged to expense R$1,677, R$2,152 and R$786 during
1996, 1997 and 1998, respectively, in respect of pension fund contributions. 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 contingently liable for the total unfunded projected benefit
obligations [the "Obligations"] of the plans. As at December 31, 1998, these
plans had Obligations amounting to R$3,091,802. There is insufficient
information available to determine the Company's portion of these Obligations,
as the allocation of the plan assets among the sponsors is not determinable at
the moment. If the plans' assets were allocated to the sponsors on a pro rata
basis based on their respective shares of the projected benefit obligations, the
Company's portion of the Obligations would be approximately R$11,026.
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. The actuarial studies are revised periodically to
identify whether adjustments to the contributions are necessary.
The provisions of SFAS No. 87, "Employers' Accounting for Pensions", for the
purpose of calculating the funded status, were applied with effects from January
1, 1992, because it was not feasible to apply them from the effective date in
the standard.
Beginning in 1998, the Company adopted the disclosure requirements of SFAS No.
132 "Employers' Disclosures About Pensions and Other Post-retirement Benefits"
which revised and standardized employers' disclosures about pension and other
post-retirement benefit plans. It does not change the measurement or recognition
of those plans.
The change in plans assets and benefit obligation of the Sistel pension and
other post-retirement benefit plans (health and life insurance) and the related
actuarial assumptions are as follows:
<PAGE>
<TABLE>
<CAPTION>
Change in plan assets
Pension Other
--------------------------------- ---------------------------------
1997 1998 1997 1998
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Fair value of plan assets at beginning of year 3,430,600 3,897,000 76,600 96,141
Actual return on plan assets 307,400 (199,000) 3,355 (6,285)
Sponsors' contributions 209,000 211,000 28,108 25,528
Plan participant's contributions 114,000 120,000 -- --
Benefits paid (142,000) (192,000) (10,240) (14,198)
Administrative expenses (22,000) (25,000) (1,682) (1,948)
- -----------------------------------------------------------------------------------------------------------------------
Fair value of plan assets at end of year 3,897,000 3,812,000 96,141 99,238
========================================================================================================================
<CAPTION>
Change in benefit obligations
Pension Other
---------------------------------- ----------------------------------
1997 1998 1997 1998
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Benefit obligation at beginning of year 6,637,000 7,258,000 1,170,230 1,471,187
Service cost 323,000 385,000 50,263 49,752
Interest cost 358,000 456,000 72,876 75,615
Actuarial (gains) losses 104,000 (2,196,000) 189,740 (263,368)
Administrative expenses (22,000) (25,000) (1,682) (1,948)
Benefits paid (142,000) (192,000) (10,240) (14,198)
- ----------------------------------------------------------------------------------------------------------------------
Benefit obligation at end of year 7,258,000 5,686,000 1,471,187 1,317,040
======================================================================================================================
<CAPTION>
1997 1998
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
The weighted - average actuarial assumptions, as determined by actuaries,
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% 10.00%
</TABLE>
The above rates exclude inflation.
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 (decrease) in the assumed health care
cost trend rates would increase (decrease) the accumulated post-retirement
benefits obligation at December 31, 1997 and 1998 by R$237,063 and R$183,160,
respectively. Measurement of the accumulated post-retirement benefit obligation
was based on the same assumptions as were used in the pension fund liability
calculations.
12. Commitments
At December 31, 1998, the Company had capital expenditure commitments of R$9,906
expected to be incurred during 1999. These commitments relate to the continuing
expansion and modernization of the network.
The Company rents equipment and premises through a number of operating lease
agreements that expire at different dates. Total rent expense under these
agreements was R$1,133, R$1,809 and R$4,254 for the years ended December 31,
1996, 1997 and 1998, respectively.
Future minimum lease payments under noncancelable operating leases with an
initial term of one year or more are as follows at December 31, 1998.
Year ending December 31,
- -------------------------------------------------------------------------------
1999 2,985
2000 2,440
2001 1,457
2002 1,226
2003 1,008
- -------------------------------------------------------------------------------
Total minimum payments 9,116
- -------------------------------------------------------------------------------
The Company's concession requires that certain network coverage requirements and
service quality milestones be met to continue to be valid and permit the Company
to operate.
13. Contingencies
ICMS tax on monthly fees and additional services
The Company believes that the ICMS [Imposto sobre Circulacao de Mercadorias e
Servicos], a state value-added tax, relates to telecommunications services, and
therefore that the application of ICMS on monthly fees and additional services
lacks legal support, as these do not constitute telecommunications services.
During the fourth quarter of 1998, the Company filed an injunction with the
State Treasury Department of each of the five states in which it operates and
therefore stopped remitting to the state governments the ICMS on monthly fees
and additional services. There can be no assurance that the Company will prevail
in its proceedings and, as a result, a provision of R$ 3,389 was recorded in the
accompanying consolidated financial statements.
ICMS tax 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 to cover not only telecommunications services but
also other services, including cellular activation, which had not been
previously subject to such tax. Pursuant to this new interpretation of tax law,
the ICMS tax may be applied retroactively for such services rendered during the
last five years.
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, lacks legal support. In addition, the Company
believes that Telamazon, Telaima, Teleamapa, Telepara and Telma, the legal
predecessors of the Company's subsidiaries, 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.
There can be no assurance that the Company will prevail in its position that the
new interpretation by the state treasury secretaries lacks legal support. If the
ICMS tax was applied retroactively to activation fees earned by the Subsidiaries
since inception on January 5, 1998, it could have a negative impact of R$3,930
on the financial condition and results of operations of the Company for the year
ended December 31, 1998. The Company does not believe it is probable that such
taxes will be applied retroactively and therefore a provision of R$2,760 was
recorded in the accompanying consolidated financial statements for the
application of ICMS on activation fees from June 19, 1998 only.
Other litigation
The Company is subject to legal proceedings, administrative proceedings and
claims of various types in the ordinary course of its business for which a
provision of R$2,894 has been recorded in these accompanying consolidated
financial statements. In management's opinion, the ultimate settlements, if any,
will not have any additional significantly adverse effect on the Company's
financial condition or results of operations.
Potential litigation
The Company, Telamazon, Telaima, Teleamapa, Telepara, Telma and Telebras 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
Telamazon, Telaima, Teleamapa, Telepara, Telma prior to May 22, 1998, the date
of the Spin-Off, except for those liabilities for which specific accounting
provisions have been assigned to the subsidiaries, remains with Telamazon,
Telaima, Teleamapa, Telepara, Telma. Any claims against Telamazon, Telaima,
Teleamapa, Telepara, Telma and Telebras could result in claims against the
Company to the extent that the subsidiaries received assets which might have
been used to settle those claims had they not been spun-off. 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, for which Telebras and the Company are jointly
and severally liable, and any liability for which specific accounting provisions
have been assigned to the Company. Creditors of Telebras may challenge this
allocation of liability. Management believes that the chances of any claims
materializing and having a material adverse effect on the Company are remote,
and therefore no provision was made.
14. Financial instruments
a. Fair value 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 is required in interpreting market
data to develop the estimated fair values. Accordingly, the amounts 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, 1997 and 1998 presented below is
based on pertinent information available to management as of those dates.
Financial assets or liabilities are not shown when no significant difference in
values is believed to exist.
<TABLE>
<CAPTION>
December 31, December 31,
------------------------- -------------------------
1997 1997 1998 1998
Book Fair Book Fair
value value value value
<S> <C> <C> <C> <C>
Long-term debt
Term loan 15,025 15,025 10,231 11,903
Loans payables 9,032 9,032 28,972 27,260
===============================================================================================================
</TABLE>
The carrying value of cash, cash equivalents, trade receivables, other current
assets, accounts payable and accrued liabilities are a reasonable estimate of
their fair value because of the short maturities of such instruments. Interest
rates that are currently available to the Company for issuance of debt with
similar terms and maturities were used to estimate the fair value of long term
debt.
b. Concentration of risks
Credit risk with respect to trade receivables is diversified. The Company
continually monitors the level of trade receivables 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.
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.
15. Subsequent event
Brazilian Real devaluation
In January and February 1999, the Brazilian Real devalued against the US dollar.
At December 31, 1998 the exchange rate to the US dollar was 1.2087 and as at
February 10, 1999 was 1.9020, which represents a significant devaluation
compared to December 31, 1998.
This devaluation will have an overall adverse effect on the Brazilian economy,
increase the Company's liabilities denominated in foreign currency and their
related interest expenses and increase the cost of imported equipment. The
Company has certain unsettled liabilities that are denominated in US dollars.
Any foreign exchange losses will be recorded in the Company's results in the
period in which the devaluation occurs.
